-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Wwl6LeHkLzY3auxkMVhJDTk3/PrGHg2vIBLkageSpQN8ccOoxW4C52xgBR+j/lfg e45VStS866lUOcHIxyh16w== 0001177497-04-000207.txt : 20041110 0001177497-04-000207.hdr.sgml : 20041110 20041109170541 ACCESSION NUMBER: 0001177497-04-000207 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20040930 FILED AS OF DATE: 20041109 DATE AS OF CHANGE: 20041109 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KENSEY NASH CORP CENTRAL INDEX KEY: 0001002811 STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841] IRS NUMBER: 363316412 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-27120 FILM NUMBER: 041130432 BUSINESS ADDRESS: STREET 1: MARSH CREEK CORPORATE CENTER STREET 2: 55 EAST UWCHLAN AVE STE 204 CITY: EXTON STATE: PA ZIP: 19341 BUSINESS PHONE: 6105947156 MAIL ADDRESS: STREET 1: 55 EAST UWCHLAN AVE STREET 2: STE 201 CITY: EXTON STATE: PA ZIP: 19341 10-Q 1 form10q_kenseynash-09302004.txt FORM 10Q KENSEY NASH 0930-2004 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended: SEPTEMBER 30, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period From __________ to __________. Commission File Number: 0-27120 KENSEY NASH CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 36-3316412 (State or other jurisdiction (IRS Employer Identification No.) of incorporation or organization) MARSH CREEK CORPORATE CENTER, 55 EAST UWCHLAN AVENUE, EXTON, PENNSYLVANIA 19341 (Address of principal executive offices and zip code) Registrant's telephone number, including area code: (610) 524-0188 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No__ Indicate by check mark whether the registrant is an accelerated filer (as defined in rule 12b-2 of the Exchange Act ). Yes - X No__ As of October 31, 2004, there were 11,342,122 outstanding shares of Common Stock, par value $.001, of the registrant. KENSEY NASH CORPORATION QUARTER ENDED SEPTEMBER 30, 2004
INDEX PAGE ---- PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets as of September 30, 2004 (Unaudited) and June 30, 2004............... 3 Condensed Consolidated Statements of Operations for the three months ended September 30, 2004 and 2003 (Unaudited)................................................. 4 Condensed Consolidated Statements of Stockholders' Equity for the three months ended September 30, 2004 (Unaudited) and for the year ended June 30, 2004...................................... 5 Condensed Consolidated Statements of Cash Flows for the three months ended September 30, 2004 and 2003 (Unaudited)... 6 Notes to Condensed Consolidated Financial Statements (Unaudited)....... 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......................... 16 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..................... 35 ITEM 4. CONTROLS AND PROCEDURES........................................................ 35 PART II - OTHER INFORMATION ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS................... 36 ITEM 6. EXHIBITS...................................................................... 36 SIGNATURES................................................................................... 37 EXHIBITS..................................................................................... 38
2 PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS [OBJECT OMITTED] KENSEY NASH CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS - ------------------------------------------------------------------------------------------------------------------------------------ September 30, ASSETS 2004 June 30, CURRENT ASSETS: (Unaudited) 2004 ---------------- --------------- Cash and cash equivalents ................................................................ $ 6,541,161 $ 14,615,633 Investments .............................................................................. 50,630,683 46,480,854 Trade receivables, net of allowance for doubtful accounts of $127,152 and $13,590 at September 30, 2004 and June 30, 2004, respectively ..................... 5,358,199 6,005,702 Royalties receivable ..................................................................... 4,557,818 4,432,692 Other receivables (including approximately $20,000 and $14,000 at September 30, 2004 and June 30, 2004, respectively, due from employees ................ 648,670 511,186 Inventory ................................................................................ 3,821,815 3,481,599 Deferred tax asset, current portion ...................................................... 2,611,094 2,607,669 Prepaid expenses and other ............................................................... 1,463,880 1,418,528 ------------- ------------- Total current assets .............................................................. 75,633,320 79,553,863 ------------- ------------- PROPERTY, PLANT AND EQUIPMENT, AT COST: Land ..................................................................................... 3,245,972 -- Leasehold improvements ................................................................... 9,699,370 9,599,237 Machinery, furniture and equipment ....................................................... 19,703,964 18,598,090 Construction in progress - new facility .................................................. 1,581,458 918,442 Construction in progress ................................................................. 970,107 1,142,349 ------------- ------------- Total property, plant and equipment ............................................... 35,200,871 30,258,118 Accumulated depreciation ................................................................. (15,147,073) (14,273,218) ------------- ------------- Net property, plant and equipment ................................................. 20,053,798 15,984,900 ------------- ------------- OTHER ASSETS: Deferred tax asset, non-current portion .................................................. 2,825 2,825 Acquired patents and proprietary rights, net of accumulated amortization of $1,930,810 and $1,685,743 at September 30, 2004 and June 30, 2004, resectively .......... 4,765,556 2,410,623 Goodwill ................................................................................. 3,284,303 3,284,303 ------------- ------------- Total other assets ................................................................ 8,052,684 5,697,751 ------------- ------------- TOTAL ...................................................................................... $ 103,739,802 $ 101,236,514 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable ......................................................................... $ 2,280,862 $ 1,847,127 Accrued expenses ......................................................................... 3,441,437 4,636,239 Current portion of debt .................................................................. - 219,147 Deferred revenue ......................................................................... 18,534 109,773 ------------- ------------- Total current liabilities ......................................................... 5,740,833 6,812,286 ------------- ------------- Total liabilities ................................................................. 5,740,833 6,812,286 ------------- ------------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, $.001 par value, 100,000 shares authorized, no shares issued or outstanding at September 30, 2004 and June 30, 2004 ............... -- -- Common stock, $.001 par value, 25,000,000 shares authorized, 11,514,808 and 11,511,806 shares issued and outstanding at September 30, 2004 and June 30, 2004, respectively ................................... 11,515 11,512 Capital in excess of par value ........................................................... 78,571,692 78,497,472 Retained earnings ........................................................................ 19,306,920 16,151,233 Accumulated other comprehensive income (loss) ............................................ 108,842 (235,989) ------------- ------------- Total stockholders' equity ........................................................ 97,998,969 94,424,228 ------------- ------------- TOTAL ...................................................................................... $ 103,739,802 $ 101,236,514 ============= =============
See notes to condensed consolidated financial statements. 3
KENSEY NASH CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) - ------------------------------------------------------------------------------------------ Three Months Ended September 30, ------------------------------ 2004 2003 REVENUES: Net sales ............................................. $ 10,106,632 $ 7,311,950 Research and development .............................. 253,292 235,301 Royalty income ........................................ 4,717,470 4,839,595 ------------ ------------ Total revenues ............................... 15,077,394 12,386,846 ------------ ------------ OPERATING COSTS AND EXPENSES: Cost of products sold ................................. 4,046,504 3,342,131 Research and development .............................. 4,383,524 4,077,981 Selling, general and administrative ................... 2,474,189 1,960,090 ------------ ------------ Total operating costs and expenses ........... 10,904,217 9,380,202 ------------ ------------ INCOME FROM OPERATIONS .................................. 4,173,177 3,006,644 ------------ ------------ OTHER INCOME: Interest income ....................................... 309,818 290,200 Interest expense ...................................... (4,559) (20,170) Other income .......................................... 29,688 2,323 ------------ ------------ Total other income - net ..................... 334,947 272,353 ------------ ------------ INCOME BEFORE INCOME TAX ................................ 4,508,124 3,278,997 Income tax expense ...................................... (1,352,437) (771,755) ------------ ------------ NET INCOME .............................................. $ 3,155,687 $ 2,507,242 ============ ============ BASIC EARNINGS PER SHARE ................................ $ 0.27 $ 0.22 ============ ============ DILUTED EARNINGS PER SHARE .............................. $ 0.26 $ 0.20 ============ ============ WEIGHTED AVERAGE COMMON SHARES OUTSTANDING .................................... 11,514,246 11,430,624 ============ ============ DILUTED WEIGHTED AVERAGE COMMON SHARES OUTSTANDING .................................... 12,281,315 12,312,776 ============ ============ See notes to condensed consolidated financial statements
4 KENSEY NASH CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - --------------------------------------------------------------------------------
Capital Accumulated Common Stock in Excess Other -------------------- of Par Retained Comprehensive Comprehensive Shares Amount Value Earnings Income/(Loss) Income Total ------------- ------------ ------------- ------------- ------------- BALANCE, JUNE 30, 2003 11,366,975 $ 11,367 $ 76,356,345 $ 3,200,450 $ (18,374) $ 79,549,788 Exercise of stock options 285,331 286 3,386,148 3,386,434 Stock repurchase (See Note 6) (140,500) (141) (2,998,133) (2,998,274) Tax benefit from exercise of stock options 1,708,479 1,708,479 Stock options granted to non-employee 11,378 11,378 Employee stock-based compensation 33,255 33,255 Net income 12,950,783 $ 12,950,783 12,950,783 Foreign currency translation adjustment 68,569 68,569 68,569 Change in unrealized loss on investments (net of tax) (286,184) (286,184) (286,184) ------------ Comprehensive income $ 12,733,168 ---------- -------- ------------ ------------ --------- ============ ----------- BALANCE, JUNE 30, 2004 11,511,806 $ 11,512 $ 78,497,472 $ 16,151,233 $(235,989) $ 94,424,228 ---------- -------- ------------ ------------ --------- ------------ Exercise of stock options 28,002 28 323,837 323,865 Stock repurchase (See Note 6) (25,000) (25) (604,437) (604,462) Tax benefit from exercise of stock options 177,688 177,688 Employee stock-based compensation 177,132 177,132 Net income 3,155,687 $ 3,155,687 3,155,687 Foreign currency translation adjustment 6,556 6,556 6,556 Change in unrealized gain on investments (net of tax) 338,275 338,275 338,275 ------------ Comprehensive income $ 3,500,518 ---------- -------- ------------ ------------ --------- ============ ------------ BALANCE, SEPTEMBER 30, 2004 (Unaudited) 11,514,808 $ 11,515 $ 78,571,692 $ 19,306,920 $ 108,842 $ 97,998,969 ========== ======== ============ ============ ========= ============ See notes to condensed consolidated financial statements.
5
KENSEY NASH CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) - ------------------------------------------------------------------------------------------------- Three Months Ended September 30, ------------------------ OPERATING ACTIVITIES: Net income ..................................................... $ 3,155,687 $ 2,507,242 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ............................. 1,265,795 983,402 Employee stock-based compensation ......................... 177,132 - Tax benefit from exercise of stock options ................ 177,688 410,319 Changes in assets and liabilities which provided (used) cash: Accounts receivable ....................................... 384,893 1,399,056 Deferred tax asset ........................................ (3,425) (427,305) Prepaid expenses and other current assets ................. (65,552) 684,981 Inventory ................................................. (340,216) (313,647) Accounts payable and accrued expenses ..................... (761,067) 660,642 Deferred revenue .......................................... (91,239) 31,007 ------------ ------------ Net cash provided by operating activities ......... 3,899,696 5,935,697 ------------ ------------ INVESTING ACTIVITIES: Purchase of land for new facility .............................. (3,245,972) - Additions to property, plant and equipment ..................... (1,033,765) (1,433,265) Additions to new facility construction in progress ............. (663,016) - Purchase of proprietary rights ................................. (2,600,000) - Sale of investments ............................................ 250,000 - Purchase of investments ........................................ (4,188,227) (2,516,083) ------------ ------------ Net cash used in investing activities ............. (11,480,980) (3,949,348) ------------ ------------ FINANCING ACTIVITIES: Repayments of long term debt ................................... (219,147) (203,453) Stock repurchase ............................................... (604,462) - Proceeds from exercise of stock options ........................ 323,865 1,196,098 ------------ ------------ Net cash (used in) provided by financing activities (499,744) 992,645 ------------ ------------ EFFECT OF EXHANGE RATE ON CASH ................................... 6,556 11,513 (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ................. (8,074,472) 2,990,507 CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................... 14,615,633 15,040,857 ------------ ------------ CASH AND CASH EQUIVALENTS, END OF PERIOD ......................... $ 6,541,161 $ 18,031,364 ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest ......................................... $ 4,559 $ 20,171 ============ ============ Cash paid for income taxes ..................................... $ 1,935,000 $ - ============ ============ SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITY: Increase in prepaid expense related to non-employee stock options (See Note 5) ................. $ - $ 11,378 ============ ============ See notes to condensed consolidated financial statements.
6 KENSEY NASH CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 -- CONDENSED CONSOLIDATED FINANCIAL STATEMENTS PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION The condensed consolidated balance sheet as of September 30, 2004, condensed consolidated statements of operations for the three months ended September 30, 2004 and 2003, condensed consolidated statement of stockholders' equity for the three months ended September 30, 2004 and condensed consolidated statements of cash flows for the three months ended September 30, 2004 and 2003 of Kensey Nash Corporation (the Company) have not been audited by the Company's independent auditors. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position at September 30, 2004 and June 30, 2004, results of operations for the three months ended September 30, 2004 and 2003, stockholders' equity for the three months ended September 30, 2004 and for the year ended June 30, 2004 and cash flows for the three months ended September 30, 2004 and 2003 have been made. The consolidated financial statements include the accounts of Kensey Nash Corporation, Kensey Nash Holding Company and Kensey Nash Europe GmbH. All intercompany transactions and balances have been eliminated. The Company was incorporated in Delaware on August 6, 1984. Kensey Nash Holding Company, incorporated in Delaware in January 1992, was formed to hold title to certain Company patents and has no operations. Kensey Nash Europe GmbH, incorporated in Germany in January 2002, was formed for the purpose of European sales and marketing of the TriActiv(R) Balloon Protected Flush Extraction System (the TriActiv) which was commercially launched in Europe in May 2002. Certain information and footnote disclosures normally included in the Company's annual financial statements, prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's consolidated financial statements filed with the Securities and Exchange Commission (SEC) in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2004. The results of operations for the three month period ended September 30, 2004 are not necessarily indicative of operating results for the full year. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America necessarily requires management to make estimates and assumptions. These estimates and assumptions, which may differ from actual results, will affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenue and expense during the periods presented. CASH, CASH EQUIVALENTS AND INVESTMENTS Cash and cash equivalents represent cash in banks and short-term investments having an original maturity of less than three months. Investments at September 30, 2004 consisted primarily of high quality municipal and U.S. government and corporate obligations. In accordance with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS 115), the Company has classified its entire investment portfolio as available-for-sale marketable securities with secondary or resale markets. The Company's entire investment portfolio is reported at fair value with unrealized gains and losses included in stockholders' equity (see Comprehensive Income). 7 In March 2004, the FASB ratified the Emerging Issues Task Force (EITF) Issue 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF 03-1). EITF 03-1 requires certain quantitative and qualitative disclosures for securities accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The disclosure requirements under EITF 03-1 were effective for fiscal years ending after December 15, 2003 and the recognition and measurement requirements are effective for periods beginning after June 15, 2004. The Company has included the required disclosures in these financial statements. On September 30, 2004, the FASB issued FSP EITF Issue 03-1-1, which delayed the effective dates of paragraphs 10-20 of EITF Issue No. 03-1. The Company's adoption of the recognition and measurement requirements of EITF 03-1 is not expected to have a material impact on the Company's financial position or results of operations. The following is a summary of available-for-sale securities at September 30, 2004 and June 30, 2004:
Quarter Ended September 30, 2004 --------------------------------------------------------------------- Amortized Gross Unrealized Estimated ------------------------------ Description Cost Gain Loss Fair Value - ----------------------------------------- ----------------- -------------- --------------- ------------------ Municipal Obligations $ 46,108,645 $ 230,944 $ (117,792) $ 46,221,797 U.S. Government Agency Obligations 2,339,681 - (139,553) 2,200,128 U.S. Corporate Obligations 2,186,000 23,565 (807) 2,208,758 ----------------- -------------- --------------- ------------------ Total Investments $ 50,634,326 $ 254,509 $ (258,152) $ 50,630,683 ================= ============== =============== ================== Year Ended June 30, 2004 --------------------------------------------------------------------- Amortized Gross Unrealized Estimated ------------------------------ Description Cost Gain Loss Fair Value - ----------------------------------------- ----------------- -------------- --------------- ------------------ Municipal Obligations $ 42,249,426 $ 21,641 $ (391,248) $ 41,879,819 U.S. Government Agency Obligations 2,326,608 - (145,210) 2,181,398 U.S. Corporate Obligations 2,421,000 8,190 (9,553) 2,419,637 ----------------- -------------- --------------- ------------------ Total Investments $ 46,997,034 $ 29,831 $ (546,011) $ 46,480,854 ================= ============== =============== ==================
The majority of the above investments have maturities ranging from 2 to 13 years. Also, there are certain municipal variable-rate demand obligations that have maturities ranging from 6 to 31 years. These municipal variable-rate demand obligations are putable weekly and callable on a monthly basis. There were no realized gains or losses on investments in the quarter ended September 30, 2004 and year ended June 30, 2004. The investment securities shown below currently have fair values less than amortized cost and therefore contain unrealized losses. The Company has evaluated these securities and has determined that the decline in value is not related to any company or industry specific event. At September 30, 2004, there were approximately eleven out of fifty-four investment securities with unrealized losses. The Company anticipates full recovery of amortized costs with respect to these securities at maturity or sooner in the event of a more favorable market interest rate environment. The lengths of time the securities have been in a continuous unrealized loss position, aggregated by investment by category, at September 30, 2004 were as follows: 8
Description Loss < 12 months Loss > 12 months Total - ------------------------------------ ----------------------------- ------------------------------- ------------------------------ Gross Gross Gross Estimated unrealized Estimated unrealized Estimated unrealized Fair Value losses Fair Value losses Fair Value losses -------------- ------------ --------------- -------------- --------------- --------------- Municipal Obligations $ 4,577,521 $ (46,340) $ 1,684,300 $ (71,452) $ 6,261,821 $ (117,792) U.S. Government Agency Obligations - - 2,339,681 (139,553) 2,339,681 (139,553) U.S. Corporate Obligations 186,000 (807) - - 186,000 (807) -------------- ------------ --------------- -------------- --------------- --------------- Total Investments $ 4,763,521 $ (47,147) $ 4,023,981 $ (211,005) $ 8,787,502 $ (258,152) ============== ============ =============== ============== =============== ===============
EXPORT SALES There were $125,750 and $157,194 in export sales from the Company's U.S. operations to unaffiliated customers in Europe and Asia in the three months ended September 30, 2004 and 2003, respectively. REVENUE RECOGNITION SALES REVENUE The Company recognizes revenue under the provisions of Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements (SAB 101). Accordingly, sales revenue is recognized when the related product is shipped. All product is shipped free-on-board shipping point. Advance payments received for products or services are recorded as deferred revenue and are recognized when the product is shipped or services are performed. The Company reduces sales revenue for estimated customer returns and other allowances, including discounts. The Company manufactures custom medical products for its customers which are subject to return only for failure to meet customer specifications. The Company had sales returns allowances and discounts of $30,669 and $93,640 at September 30, 2004 and 2003, respectively. RESEARCH AND DEVELOPMENT REVENUE Revenue under research and development contracts is recognized as the related expenses are incurred. All revenues recorded on this line item are government programs under which the U.S. government funds the research of high risk, enabling technologies. The programs reflected in the statement of operations for the quarter ended September 30, 2004 and fiscal year 2004 are awards for the research of a synthetic vascular graft which concluded in September of 2004 and a NIH breast cancer drug delivery grant which concluded in October 2003. ROYALTY INCOME Royalty revenue is recognized as the related product is sold. The Company recognizes substantially all of its royalty revenue at the end of each month, in accordance with its St. Jude Medical and Orthovita agreements, when the Company is advised by the respective party of the total end-user product sales dollars for the month. Royalty payments are received within 45 days of the end of each calendar quarter. The Company receives a 6% royalty on every Angio-Seal unit sold by St. Jude Medical, its licensee. The final contracted decrease in the royalty rate, from 9% to 6%, occurred in April 2004 when four million cumulative units had been sold. As of September 30, 2004 approximately 4.7 million Angio-Seal units had been sold. The Company receives a royalty on all co-developed VITOSS FOAM product sales by Orthovita. The royalty is pursuant to an agreement entered into between the Company and Orthovita in March of 2003. The first royalty was earned in February of 2004 when the first co-developed product was commercially launched by Orthovita. In addition, in a separate transaction, the Company acquired proprietary rights of a third party to the VITOSS technology. This acquisition entitled the Company to certain rights, including the economic rights, of the third party. These economic rights included a royalty on all products 9 containing the VITOSS technology. The first royalty under this transaction was earned for the quarter ended September 30, 2004, when the transaction was completed. EARNINGS PER SHARE Earnings per share are calculated in accordance with SFAS No. 128, Earnings per Share, which requires the Company to report both basic and diluted earnings per share (EPS). Basic and diluted EPS are computed using the weighted average number of shares of common stock outstanding, with common equivalent shares from options included in the diluted computation when their effect is dilutive. As of September 30, 2004 options to purchase 204,293 shares of our Common Stock at prices ranging from $28.56 to $34.36 per share were outstanding, but were not included in the computation of diluted earnings per share because the exercise price of the options exceeds the average market price and would have been antidilutive. As of September 30, 2003, options to purchase 1,467 shares of our Common Stock at a price of $25.55 per share were outstanding, but were not included in the computation of diluted earnings per share because the exercise price of the options exceeds the average market price and would have been antidilutive. STOCK-BASED COMPENSATION Stock-based compensation cost is accounted for under SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123), which permits (i) recognition of the fair value of stock-based awards as an expense, or (ii) continued application of the intrinsic value method of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). The Company accounts for its stock-based employee and director compensation plans under the recognition and measurement principles of APB 25. Under this intrinsic value method, compensation cost represents the excess, if any, of the quoted market price of the Company's Common Stock at the grant date over the amount the grantee must pay for the stock. The Company's policy is to grant stock options with an exercise price equal to the fair market value of the Company's Common Stock at the date of grant. Options granted to non-employees, as defined under SFAS 123, are recorded as compensation expense. See Note 5 for options granted to non-employee outside consultants in July 2003 and October 2002. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment to FASB Statement No. 123, Accounting for Stock-Based Compensation (SFAS 148). The Company implemented the "disclosure only" provisions of SFAS No. 148 in the period ended December 31, 2002. Accordingly, no compensation cost has been recognized for the Company's two stock option plans. Had compensation cost for the plans been determined based on the fair market value of the options at the grant date, consistent with the provisions of SFAS No. 123, as amended by SFAS No. 148, the Company's fully-taxed net income and earnings per share for the three months ended September 30, 2004 and 2003 would have been reduced to the pro forma amounts below: 10
Three Months Ended September 30, --------------------------- 2004 2003 Net income, as reported ................................................. $ 3,155,687 $ 2,507,242 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (557,766) (350,666) ----------- ------------- Pro forma net income .................................................... $ 2,597,921 $ 2,156,576 =========== ============= Earnings per share: Basic - as reported .................................................. $ 0.27 $ 0.22 =========== ============= Basic - pro forma .................................................... $ 0.23 $ 0.19 =========== ============= Diluted - as reported ................................................ $ 0.26 $ 0.20 =========== ============= Diluted - pro forma .................................................. $ 0.21 $ 0.18 =========== =============
COMPREHENSIVE INCOME The Company accounts for comprehensive income under the provisions of SFAS No. 130, Reporting Comprehensive Income (SFAS 130). Accordingly, accumulated other comprehensive income (loss) is shown in the consolidated statements of stockholders' equity at September 30, 2004 and June 30, 2004, and is comprised of net unrealized gains and losses on the Company's available-for-sale securities and foreign currency translation adjustments. The tax (expense) benefit of other comprehensive income for the three months ended September 30, 2004 and for the fiscal year ended June 30, 2004 was $(174,263) and $147,428, respectively. GOODWILL Goodwill represents the excess of cost over the fair value of the identifiable net assets of THM Biomedical, Inc. (THM), a company acquired in September 2000. Effective July 1, 2001, the Company adopted SFAS No. 141, Business Combinations (SFAS 141) and SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142). SFAS 141 requires that the purchase method of accounting be used for all business combinations subsequent to June 30, 2001 and specifies criteria for recognizing intangible assets acquired in a business combination. Under SFAS 142, goodwill and intangible assets with indefinite useful lives are no longer amortized, but are subject to annual impairment tests. Intangible assets with definite useful lives continue to be amortized over their respective useful lives. There were no changes to the net carrying amount of goodwill for the three month period ended September 30, 2004 from June 30, 2004. The Company completed its initial required goodwill impairment test under SFAS 142 in the first quarter of fiscal 2002. The most recent tests in fiscal 2004, 2003 and 2002 indicated that goodwill was not impaired. PATENTS AND PROPRIETARY RIGHTS The costs of internally developed patents are expensed when incurred due to the long development cycle for patents and the Company's inability to measure the recoverability of these costs when incurred. The entire cost of acquired patents is being amortized over the remaining period of economic benefit, ranging from 5 to 10 years at September 30, 2004. The gross carrying amount of such patents at September 30, 2004 was $4,096,366 with accumulated amortization of $1,751,500. Amortization expense on these patents was $65,757 for the three month period ended September 30, 2004. Amortization expense on the Company's acquired patents is estimated at $263,026 for each of the years ending June 30, 2005, 2006, 2007, 2008 and 2009. 11 In August 2004, the Company acquired the intellectual property rights of a third party, an inventor of the VITOSS technology (the Inventor), for $2,600,000 under an assignment agreement with the Inventor (the Assignment Agreement). Under the Assignment Agreement, the Company receives all intellectual property rights of the Inventor that had not previously been assigned to Orthovita. Also under the Assignment Agreement, the Company receives a royalty from Orthovita on the sale of all Orthovita products containing the VITOSS technology, up to a total royalty to be received of $4,035,782. The entire cost of these proprietary rights is being amortized over the sixty month period the Company anticipates to receive the royalty in relation to the proprietary rights. Amortization expense on these proprietary rights was $179,310 for the three months ended September 30, 2004. Amortization expense on these proprietary rights is estimated at $476,667 for the year ending June 30, 2005 and $520,000 for each of the years ending June 30, 2006 through 2009. NEW ACCOUNTING PRONOUNCEMENTS In December 2003, the FASB issued SFAS No. 132 (revised 2003), Employers' Disclosures about Pensions and Other Postretirement Benefits - an amendment of FASB Statements No. 87, 88, and 106 (SFAS 132 revised), which improves financial statement disclosures for defined benefit plans. The change replaces existing FASB disclosure requirements for pensions and requires additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The project was initiated by the FASB in response to concerns raised by investors and other users of financial statements about the need for greater transparency of pension information. The guidance is effective for fiscal years ending after December 15, 2003, and for the first fiscal quarter of the year following initial application of the annual disclosure requirements. The Company's adoption of SFAS 132 revised provides enhanced disclosures of 401(k) matching contributions but has no impact on the Company's financial position or results of operations. NOTE 2 -- INVENTORY Inventory is stated at the lower of cost (determined by the average cost method, which approximates first-in, first-out) or market. Inventory primarily includes the cost of material utilized in the processing of the Company's products and is as follows: September 30, June 30, 2004 2004 ------------- ----------- Raw materials ...................... $ 3,128,419 $ 2,449,180 Work in process .................... 493,074 603,069 Finished goods ..................... 367,887 472,565 ----------- ----------- Gross inventory .................... 3,989,380 3,524,814 Provision for inventory obsolescence (167,565) (43,215) ----------- ----------- Net inventory ...................... $ 3,821,815 $ 3,481,599 =========== =========== Adjustments to inventory are made at the individual part level for estimated excess, obsolescence or impaired balances, to reflect inventory at the lower of cost or market. Factors influencing these adjustments include: changes in demand, rapid technological changes, product life cycle and development plans, component cost trends, product pricing, physical deterioration and quality concerns. Revisions to these adjustments would be required if any of these factors differ from our estimates. 12 NOTE 3 -- ACCRUED EXPENSES As of September 30, 2004 and June 30, 2004, accrued expenses consisted of the following: September 30, June 30, 2004 2004 ----------- ---------- Accrued payroll and related compensation $1,283,313 $1,852,078 Current tax liability .................. 1,290,632 1,873,195 Other .................................. 867,492 910,966 ---------- ---------- Total .................................. $3,441,437 $4,636,239 ========== ========== NOTE 4 -- DEBT On September 1, 2000, in conjunction with the acquisition of THM Biomedical, the Company incurred a note payable in the amount of $4.5 million (the Acquisition Obligation). The Acquisition Obligation was due in equal quarterly installments. As of September 30, 2004, the Company had repaid the entire Acquisition Obligation and had no remaining debt. NOTE 5 -- CONSULTING CONTRACTS In October 2002, the Company granted options to purchase 50,000 shares of common stock to a physician pursuant to a five-year consulting agreement related to the development of a carotid artery application for the TriActiv System. In July 2003, the Company granted options to purchase 1,500 shares of common stock to a physician pursuant to a two-year consulting agreement related to the development of orthopaedic applications for the Company's porous and non-porous tissue fixation and regeneration devices and drug delivery devices. The Company calculated the fair value of these non-employee options in accordance with SFAS No.123, as $375,550 and $11,378 for the October 2002 and July 2003 grants, respectively, using the Black-Scholes option-pricing model. These amounts were recorded as prepaid consulting expense and increases to additional paid in capital in the quarters ended December 31, 2002 and September 30, 2003, respectively. The prepaid expense is being amortized to research and development expense over the terms of the agreements. Accordingly, $20,200 was recorded as a component of research and development expense for each of the three month periods ended September 30, 2004 and 2003. NOTE 6 -- STOCK REPURCHASE PROGRAM On August 17, 2004, the Company announced that its board of directors had reinstated a program to repurchase issued and outstanding shares of Common Stock over a six month period from the date of the board reinstatement. The reinstated plan calls for the repurchase of up to 259,500 shares, the balance under the original plan approved in October 2003. As of September 30, 2004, the Company had repurchased and retired 25,000 shares of its Common Stock under the reinstated plan at a cost of approximately $600,000 (an average market price of $24.14 per share). In October 2004, the Company repurchased and retired an additional 174,867 shares at a cost of approximately $4.5 million (an average market price of $25.94 per share), leaving approximately 59,633 shares authorized for repurchase under the current authorized plan. The Company is financing the repurchases using its available cash. The Company plans to continue to repurchase its shares for cash, from time to time in the open market, through block trades or otherwise. The repurchase program does not require the Company to purchase any specific 13 dollar value or number of shares. Any purchases under the program will depend on market conditions and may be commenced or suspended at any time or from time to time without prior notice. The following table contains information about our purchases of our equity securities during July, August, and September 2004:
Total number of Maximum Number Average Price Shares Purchased of Shares that May Total Number of Paid per as Part of a Publicly Yet Be Purchased Period Shares Purchased Share Announced Program Under the Program - ------------------------------------------------------------------------------------------------------------------------ July 1-31, 2004 - - - - August 1-31, 2004 - - - - September 1-30, 2004 25,000 $ 24.14 25,000 234,500 ------------------------------------------------------------------------------------------- Total 25,000 $ 24.14 25,000 234,500 ===========================================================================================
NOTE 7 --INCOME TAXES As of June 30, 2004, the Company had net operating loss (NOL) carryforwards for state tax purposes totaling $20.0 million, which will expire through 2024. In addition, the Company had a foreign NOL of $300,000 at June 30, 2004, which will not expire. During the fourth quarter of fiscal year 2003, the Company performed a retrospective research and development tax credit study for fiscal years 1993 through 2003. The Company recorded the majority of the tax credit resulting from this study ($1.5 million) in the fourth quarter of fiscal 2003. During the first quarter of fiscal 2004, the Company recorded an additional portion of the research and development tax credit ($310,000) and professional service fees as a component of selling, general and administrative expenses ($50,500) related to this research and development tax credit study. NOTE 8 -- RETIREMENT PLAN The Company has a 401(k) Salary Reduction Plan and Trust (the 401(k) Plan) in which all employees that are at least 21 years of age are eligible to participate. Contributions to the 401(k) Plan are made by employees through an employee salary reduction election. Effective October 1, 1999, the Company implemented a 25% discretionary matching contribution, on up to 6% of an employee's total compensation, for all employee contributions. Effective July 1, 2004, the Company revised its discretionary matching contribution to 50%, on up to 6% of an employee's total compensation, for all employee contributions. Employer contributions to the 401(k) plan for the three months ended September 30, 2004 and 2003 were $91,914 and $31,354, respectively. NOTE 9 -- RESTRICTED STOCK The Company may provide restricted stock grants under the Employee Plan approved by the Company's stockholders. During fiscal 2004 and the first quarter of fiscal 2005, the Company granted shares to the independent, non-employee members of the Board of Directors and to executive officers of the Company. Shares awarded under the plan vest in installments of up to three years and unvested shares are forfeited upon termination of employment. The Board of Directors shares vest in three equal annual installments contingent upon the Company's achievement of certain earnings per share targets, Company Common Stock price targets and continued service of the board member on each anniversary of the date of grant. The executive 14 officer shares vest in three equal annual installments based solely on continued employment with the Company. The Company made the following grants to non-employee, independent directors and executive officers during the period ended September 30, 2004 and fiscal year ended June 30, 2004: September 30 June 30, 2004 2004 ---------- ---------- Shares granted: Independent, non-employee directors - 11,580 Executive officers ................ 55,500 - ---------- ---------- Total shares granted ................ 55,500 11,580 ========== ========== Fair value on the date of grant ..... $1,531,060 $ 253,950 ========== ========== The fair value disclosed above is based upon the closing price of the Company's common stock on the date of grant. Compensation expense related to all restricted stock grants is being recorded over the three-year vesting period of these grants. For the three months ended September 30, 2004 the Company recognized expense of $177,132 related to restricted share awards. 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes included in this report and our audited consolidated financial statements and the related notes contained in our Annual Report on Form 10-K for the fiscal year ended June 30, 2004, as filed with the Securities and Exchange Commission. OVERVIEW Kensey Nash Corporation is a leading medical technology company providing innovative solutions, via novel technologies, for a wide range of medical procedures. We have expanded our business model extensively over the last ten years from vascular puncture closure and today provide an extensive range of products into multiple medical markets, primarily cardiovascular, sports medicine and spine, amongst others. As the inventor of the Angio-Seal(TM) Vascular Closure Device (Angio-Seal), a device designed to seal and close femoral artery punctures made during diagnostic and therapeutic cardiovascular catheterizations, we were the first company to place an absorbable biomaterial component into the human vascular system. As pioneers in the field of absorbable biomaterials, we have developed significant experience, expertise and competitive advantage in the design, development, manufacture and processing of absorbable biomaterials for medical applications. Our most recent advance into the cardiovascular market is the TriActiv(R) Balloon Protected Flush Extraction System (the TriActiv), a device designed to provide embolic protection during the treatment of diseased vessels. Again, we are on the forefront of an emerging medical market as the adoption of embolic protection is projected to grow rapidly due to its proven clinical benefits. Our original success is rooted in the Angio-Seal, of which we were the original designer, developer and manufacturer. St. Jude Medical, Inc. (St. Jude Medical) acquired the worldwide license to the Angio-Seal device in March of 1999. The Angio-Seal was commercialized in the U.S. in 1996 and is currently the worldwide leader in the vascular closure device market. St. Jude Medical develops and manufactures the product as well as markets and distributes the product worldwide. We currently receive a 6% royalty on every Angio-Seal device sold to the end-user and also sell to St. Jude Medical the collagen plug component of the Angio-Seal. In addition, we are a secondary source for the anchor component, which is primarily manufactured by St. Jude Medical. As specified in our contract with St. Jude Medical, in April 2004 when the four millionth Angio-Seal unit had been sold, the royalty rate was reduced to 6% from 9%. No further rate reductions will occur. We have utilized the knowledge gained during the development process of the absorbable biomaterials components of the Angio-Seal, the anchor and the collagen plug, as a springboard into the application of absorbable biomaterials into multiple medical markets. Our history with these biomaterials has made us experts in the design, development, manufacture and processing of proprietary biomaterials products which we now apply to the fields of orthopaedics (including sports medicine and spine), cardiology, drug/biologics delivery, periodontal, general surgery and wound care. We have several strategic partnerships and alliances through which our biomaterials products are developed and marketed. We intend to continue to leverage our proprietary knowledge and expertise in each of these markets to develop new products and technologies and to explore additional applications for our existing products. The TriActiv System is a device designed to provide embolic protection during the treatment of diseased vessels, with an initial application in diseased saphenous vein grafts. The TriActiv system is a balloon embolic protection device in a market populated or pursued by both balloon and filter devices. While both approaches have advantages and disadvantages, we believe the unique design of the TriActiv device as a system offers three key features: an embolic protection balloon, a flush catheter and an active, controlled extraction system, may offer the most complete and effective solution to embolic protection. On July 28, 2004, we submitted a 510(k) application to the FDA for 16 commercial approval of the TriActiv System in the United States. In late October, we received a comment letter from the FDA related to our 510(k) application. We completed and filed our response with the FDA on November 8, 2004. We continue to anticipate approval from the FDA by the end of our second quarter of fiscal 2005 and are planning a U.S. commercial launch in the third quarter of fiscal 2005. In August 2004, we announced that we would be selling and marketing the TriActiv System via a direct sales force. Future generations of the TriActiv device, currently in development and in clinical trials, will address additional markets. These future applications will potentially include the treatment of diseased carotid, peripheral and native coronary arteries as well as acute myocardial infarction (AMI) (a heart attack) and the removal of thrombus during such treatment. Revenues. Our revenues consist of three components: net sales, research and development revenue and royalty income. Net Sales. Net sales is comprised of sales of absorbable biomaterials products and the TriActiv device. Biomaterials. The biomaterials component of net sales, which comprises 99% of total net sales, represents the sale of our biomaterials products to customers for use in the following markets: orthopaedics (sports medicine and spine), cardiology, drug/biologics delivery, periodontal, general surgery and wound care. The two most significant components of our biomaterials sales are the absorbable components of the Angio-Seal, supplied to St. Jude Medical, and our orthopaedic product sales. Our orthopaedic product sales to date have consisted primarily of sales to Arthrex, Inc. (Arthrex) and Orthovita, Inc. (Orthovita). Arthrex is a privately-held orthopaedics company for which we manufacture a wide array of sports medicine products. Orthovita is a publicly held orthopaedic biomaterials company for which we manufacture bone graft subsititute products used primarily in the spine. Below is a table showing the trends in our Angio-Seal and orthopaedic sales as a percentage of total biomaterial sales: ----------------------- ----------------------------------- THREE MONTHS ENDED ----------------------------------- SALES OF: SEPTEMBER 30, SEPTEMBER 30, 2004 2003 ----------------------- ---------------- ------------------ Angio-Seal Components 37% 42% ----------------------- ---------------- ------------------ Orthopaedic Products 57% 53% ----------------------- ---------------- ------------------ The decline in the Angio-Seal components as a percentage of our total biomaterials sales from the first quarter of fiscal 2004 to the first quarter of fiscal 2005 is related to the transition of the manufacture of the absorbable polymer anchor to St. Jude Medical. Based on discussions with St. Jude Medical, we believe their current plans are for us to remain a supplier of approximately 15 to 20% of the future anchor requirements for the Angio-Seal. We continue to supply a minimum of 50% of the collagen component for the device under a three-year contract with St. Jude Medical, which currently expires in December 2005. The future of this portion of our biomaterials sales is dependent upon the continued success of the Angio-Seal in the vascular closure market. Today, it is estimated that the Angio-Seal has approximately 60% of this market based on sales of 360,000 devices to the end-user during the quarter ended September 30, 2004. The Angio-Seal market share could be impacted by future competition in this market or new technologies to address diagnostic or therapeutic treatment of diseased coronary arteries. Our orthopaedic sales increased $1.9 million in the first quarter of fiscal 2005 to $5.7 million from $3.8 million in the first quarter of fiscal 2004. The increase in our orthopaedic products sales from the first quarter fiscal 2004 to the first quarter fiscal 2005 as a percentage of total biomaterials sales was primarily related to sales of bone graft subsititute products to Orthovita which began in the third quarter of fiscal 2004 and totaled $2.3 million dollars in the 17 first quarter of fiscal 2005. We expect the growth in our overall biomaterials sales, which was 38% in the three months ended September 30, 2004 over the comparable prior year period, will continue because of greater acceptance by the medical community of biomaterials and technological advances which have expanded the applications for our biomaterials products. Due to this greater acceptance, we have been able to expand our biomaterials customer and product base by initiating new partnerships within the medical device industry as well as expanding the product lines for our current customers. The growth of the orthopaedic protion of our business is dependent on several factors, including the success of our current partners in sports medicine and spine, the continued acceptance of biomaterials-based products in these two markets as well as expanded future acceptance, and our ability to offer new products or technologies and attract new partners in these markets. We are regularly evaluating our current technologies and potential new technologies on which to base new avenues of growth into the sports medicine and spine markets. TriActiv. The TriActiv device was commercially launched in Europe in the fourth quarter of fiscal 2002. We are selling directly to the market in Germany and through distributors throughout the rest of Europe. We currently have distribution agreements for sales in Ireland, Switzerland, Austria, Italy, Netherlands and the United Kingdom. We are in the process of identifying distributors for additional markets in Europe and Asia. The TriActiv sales were less than 1% of our total sales for the three months ended September 30, 2004 and 2003. We anticipate sales of the TriActiv device will become a more significant component of net sales during the second half of our fiscal year ended June 30, 2005 and beyond as we gain new customers in the European markets, introduce new versions and applications of the product and launch the product in the U.S. market. We currently anticipate U.S. commercial launch of the TriActiv device in the third quarter of fiscal 2005, through a small direct sales force, subject to regulatory approval from the FDA. The TriActiv System is a platform technology, offering not only our initial application for the protection from embolization during treatment of diseased saphenous vein grafts, but future applications for the treatment of carotid artery disease and the removal of thrombus, amongst others. Embolic protection is a relatively new technology and is still subject to acceptance by the medical community, particularly for future applications. In addition, because we intend to commercially launch the device ourselves, against other large, experienced medical device sales teams, we are challenged with the development of a successful launch strategy which will differentiate the TriActiv device from other competing products. We received European Community approval (CE Mark) to market the second-generation of the TriActiv device, the TriActiv(R) FX Embolic Protection System (the TriActiv FX), in fiscal 2004. This second generation device incorporates several important ease-of-use design enhancements including an integrated, fully disposable flush and extraction system, a new balloon inflator that simplifies catheter exchanges during the procedure, and a monorail flush catheter to enhance device usage and reduce procedure time. We have since made additional changes to the FX System which required a new dossier submission to the European Union. This submission is expected in November 2004 and a European product launch is expected in our third fiscal quarter of fiscal 2005. Research and Development Revenue. Research and development revenue was derived from a National Institute of Standards and Technology (NIST) grant in the three months ended September 30, 2004 and from both the NIST grant and a National Institute of Health (NIH) grant in the three months ended September 30, 2003. In October 2001 we received the NIST grant, a $1.9 million grant over a three-year period, under which we are researching a synthetic vascular graft, utilizing our porous tissue matrix (PTM) technology. We continue to develop this technology, however this grant funding concluded in September 2004 and we will receive no additional funding for this grant. In January 2003, we received from NIH $100,000 over a one-year period, under which we were researching sustained or controlled release of chemotherapeutic drugs for the treatment of breast cancer utilizing our PTM technology. This grant was completed in early fiscal 2004, but 18 we are continuing to independently develop this drug delivery technology for commercial use and expectations of future grant applications. Royalty Income. Our royalty income primarily consists of royalties received from St. Jude Medical and Orthovita. Royalties from St. Jude Medical are received on every Angio-Seal unit sold worldwide. We anticipate sales of the Angio-Seal will continue to grow with continued procedure growth and as St. Jude Medical continues to expand its sales and marketing efforts, including its continued introduction of the Angio-Seal product line in the Japanese market, and releases future generations of the Angio-Seal system. Our royalty rate as of September 30, 2003 was 9%. Under our License Agreeement with St. Jude Medical, there was a final contracted decrease in the royalty rate, to 6%, upon reaching four million cumulative units sold. This final rate reduction occurred in April 2004. We currently believe continued Angio-Seal unit growth will partially offset this 33% decline in royalty rate for a net reduction in royalty income in fiscal 2005 from fiscal 2004 of approximately 10-15%. We therefore expect that royalty income from the Angio-Seal will continue to be a significant source of revenue. As of September 30, 2004, approximately 4,700,000 Angio-Seal units had been sold. In March 2003, we entered into an agreement with Orthovita under which we will develop and commercialize products based on Orthovita's proprietary, ultra porous VITOSS(TM) bone void filler material in combination with our proprietary biomaterials. The products will have applications in the bone grafting and spinal surgery markets. Under the agreement, the products will be co-developed, we will manufacture the products and Orthovita will market and sell the products worldwide. In addition, we receive a royalty on Orthovita's end-user sales of all co-developed products. In August 2004, in order to enhance the overall business relationship with Orthovita, we acquired the proprietary rights of a third party, an inventor of the VITOSS technology (the Inventor), for $2.6 million under an assignment agreement with the Inventor (the Assignment Agreement). Under the Assignment Agreement, the Company receives an additional royalty from Orthovita on the end-user sales of all Orthovita products containing the VITOSS technology, up to a total royalty to be received of $4,035,782. Orthovita launched its initial bone grafting and spinal product line, VITOSS scaffold FOAM strips and cylinders, in the third quarter of fiscal 2004 and the second family of products, VITOSS scaffold FOAM flow in June 2004. We believe the unique technology associated with the VITOSS FOAM products and the size and strength of the spine market will result in the Orthovita component of our royalty income becoming more significant over the next several quarters and beyond. Cost of Products Sold. The gross margin on sales increased to 60% in the three months ended September 30, 2004 compared to 54% in the three months ended September 30, 2003. We have experienced higher volume of our sales of biomaterials products and greater manufacturing efficiencies, which has lowered our unit costs in many of our product lines. We anticipate the gross margin on our biomaterials products will remain at or close to this level with increases in sales volume and efficiencies gained in new product lines. These improvements could potentially be offset by initial margins on the TriActiv product line in the second half of fiscal 2005, our first year of commercial production for the U.S. We anticipate a 58% to 60% gross margin on sales for fiscal 2005, which is heavily reliant on the product mix of our sales, specifically the TriActiv device sales which will slightly offset the biomaterials margins until the manufacturing process matures and volumes increase. Research and Development Expenses. Research and development expense consists of expenses incurred for the development of our proprietary technologies, such as the TriActiv System, absorbable and nonabsorbable biomaterials products and technologies and other development programs, including expenses under the NIST program. In December 2001, we began our TriActiv U.S. pivotal clinical study, the PRIDE study, a randomized trial with a potential 80 sites in the U.S and Europe. We completed enrollment in the PRIDE study during March 2004. We enrolled a total of 894 patients in the study, including roll-in patients, at 68 sites in the U.S. and 10 sites in Europe. Submission of data from the trial to the FDA for 510(k) approval occurred in July 2004. In late October, we announced 19 that we had received a comment letter, a letter in which the FDA asks questions or requests additional information related to our submission, from the FDA. We have prepared and submitted our response to the FDA and continue to expect approval for the TriActiv system by the end of our second fiscal quarter ending December 31, 2005. We plan to initiate a U.S. registry on a next generation TriActiv device, the TriActiv FX, in our second half of fiscal 2005. The study is a planned 100 to 120 patient study at 20 sites in the U.S. We cannot make any assurances as to the successful completion of these trials or subsequent regulatory approval for the TriActiv System or for future applications in the U.S. or in Europe. Clinical efforts in pursuit of FDA approval and continuing development of the TriActiv System, as well as our continued development of proprietary biomaterials products and technologies, require significant research and development expenditures. We anticipate research and development expense will continue to increase as we pursue commercialization of the TriActiv System in the U.S., and explore opportunities for other indications related to the TriActiv System as well as our other technologies, including the continued development of proprietary biomaterials technologies. While we believe research and development expenditures will increase in dollars, we believe that they will decrease as a percentage of total revenue as our revenue continues to grow. Research and development expense was 29% of total revenues for the three months ended September 30, 2004 compared to 33% of total revenue for the three months ended September 30, 2003. Selling, General and Administrative. Selling, general and administrative expenses include general and administrative costs, including activities of our finance, human resource and business development departments, as well as costs related to the sales and marketing of our products. The general and administrative component of selling, general and administrative expenses has increased over the same period in 2004. This increase is a result of the overall growth of our business, specifically in personnel expenses, as well as expenses incurred related to compliance with new SEC and corporate governance regulations. The sales and marketing component of selling, general and administrative expenses consists of marketing expenses in the U.S., related primarily to the U.S. commercialization efforts of the TriActiv device, and sales and marketing efforts at our German subsidiary. We have a subsidiary in Germany, Kensey Nash Europe GmbH, where we have established a European sales and marketing team. This team consisted of three clinical specialists and four sales people as of September 30, 2004. We will continue to add personnel to this team as we believe is required to meet our clinical and sales goals. This team is selling the product direct in the German market and supports our distributor relationships in the rest of Europe. Our sales and marketing expenses have only increased slightly in the first quarter of fiscal 2005 over the same period in fiscal 2004. This increase related to increased marketing efforts as we move toward commercialization of the TriActiv in the U.S. offset in large part by a decrease in clinical study expenses in support of third party reimbursement of TriActiv in Europe. We anticipate sales and marketing expenses will increase as we await U.S. regulatory approval of the TriActiv, prepare for U.S. launch of the product and ultimately launch the product in the third quarter of fiscal 2005. If we are granted approval from the FDA, we plan to market and sell the device in the U.S. using a small direct sales team with an anticipated market launch in the third quarter of fiscal 2005. Our initial estimates of the cost of a direct sales plan would increase selling expense in fiscal 2005 by $2.5 million to $3.0 million, including personnel and marketing expenses, over fiscal 2004. We also continue to expand our marketing efforts for our biomaterials business. Income Tax Expense. We estimate that our effective tax rate for the fiscal 2005 will be approximately 30%, which includes estimates of our current year research and development tax credit as well as non-taxable interest income. 20 CRITICAL ACCOUNTING POLICIES Our "critical accounting policies" are those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about matters that are inherently uncertain and may change in future periods. It is not intended to be a comprehensive list of all of our significant accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management's judgment in their application. There are also areas in which the selection of an available alternative policy would not produce a materially different result. We have identified the following as our critical accounting policies: revenue recognition, accounting for stock-based compensation, allowance for doubtful accounts, inventory valuation and income taxes. Revenue Recognition. We recognize revenue under the provisions of Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements (SAB 101). Sales Revenue. Accordingly, sales revenue is recognized when the related product is shipped. Advance payments received for products or services are recorded as deferred revenue and are recognized when the product is shipped or services are performed. All of our shipments are Free on Board (F.O.B.) shipping point. We reduce sales for estimated customer returns, discounts and other allowances, if applicable. Our products are custom manufactured for our customers and are subject to return only for failure to meet customer specification. Research and Development Revenue. Revenue under research and development contracts is recognized as the related expenses are incurred. All revenues recorded on this line item are government programs under which the U.S. government funds the research of high risk, enabling technologies. Royalty Revenue. Royalty revenue is recognized as the related product is sold. We recognize substantially all of our royalty revenue at the end of each month, in accordance with our customer agreements. (See Note 1 to the Condensed Consolidated Financial Statements - Revenue Recognition). Accounting for Stock-Based Compensation. We account for stock-based compensation costs under SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, which permits (i) recognition of the fair value of stock-based awards as an expense, or (ii) continued application of the intrinsic value method of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). We account for our stock-based employee and director compensation plans under the recognition and measurement principles of APB 25. Under this intrinsic value method, compensation cost represents the excess, if any, of the quoted market price of our common stock at the grant date over the amount the grantee must pay for the stock. Our policy is to grant stock options at the fair market value at the date of grant. Therefore, we have not recognized any compensation expense for options granted to employees. We account for stock-based awards to non-employees using the fair value method in accordance with SFAS No. 123, which requires using the Black-Scholes option-pricing model to determine the fair value of the option at the original grant date. Options granted to non-employees, as defined under SFAS No. 123, (as amended by SFAS No. 148) and Emerging Issues Task Force (EITF) 96-18 Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring or in Conjunction with Selling, Goods or Services, are recorded as an expense over the contractual service period. We granted options to non-employee, outside consultants during fiscal 2003 and 2004. See Note 5 to the financial statements for information regarding options granted to non-employees in July 2003 and October 2002. Allowance for Doubtful Accounts. Our allowance for doubtful accounts is determined using a combination of factors to ensure that our trade receivables balances are not overstated due to uncollectibility. We maintain a bad debt reserve for all customers based on a variety of factors, including the length of 21 time receivables are past due, trends in overall weighted average risk rating of the total portfolio, significant one-time events and historical experience with each customer. Also, we record additional reserves for individual accounts when we become aware of a customer's inability to meet its financial obligations to us, such as in the case of bankruptcy filings or deterioration in the customer's operating results or financial position. If circumstances related to specific customers change, our estimates of the recoverability of receivables would be adjusted. We believe our allowance at September 30, 2004 was sufficient to cover all existing accounts receivable. Inventory Valuation. Our inventory is stated at the lower of cost or market. Adjustments to inventory are made at the individual part level for estimated excess, obsolescence or impaired balances, to reflect inventory at the lower of cost or market. Factors influencing these adjustments include changes in demand, rapid technological changes, product life cycle and development plans, component cost trends, product pricing, physical deterioration and quality concerns. Revisions to these adjustments would be required if any of these factors differ from our estimates. Income Taxes. Our estimated effective tax rate includes the impact of certain estimated research and development tax credits and non-taxable interest income. Material changes in, or differences from, our estimates could impact our estimate of our effective tax rate. RESULTS OF OPERATIONS COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 The following table summarizes our operating results for the three months ended September 30, 2004 compared to the three months ended September 30, 2003.
- ----------------------------- ---------------------------------------------------------------- --------------------- THREE MONTHS ENDED PERCENT CHANGE FROM ---------------------------------------------------------------- ($ MILLIONS) SEPTEMBER 30, % OF TOTAL SEPTEMBER 30, % OF TOTAL PRIOR PERIOD TO 2004 REVENUES 2003 REVENUES CURRENT PERIOD ============================= ================== ============ ================= ============== ===================== REVENUES: ============================= ================== ============ ================= ============== ===================== Total Revenues $15.1 100% $12.4 100% 22% ============================= ================== ============ ================= ============== ===================== Net Sales $10.1 67% $7.3 59% 38% - ----------------------------- ------------------ ------------ ----------------- -------------- --------------------- Research & Development $0.3 2% $0.2 2% 8% Revenue - ----------------------------- ------------------ ------------ ----------------- -------------- --------------------- Royalty Income $4.7 31% $4.8 39% (3%) ============================= ================== ============ ================= ============== ===================== EXPENSES: ============================= ================== ============ ================= ============== ===================== Cost of Products Sold $4.0 27% $3.3 27% 21% - ----------------------------- ------------------ ------------ ----------------- -------------- --------------------- Research & Development $4.4 29% $4.1 33% 7% Expense - ----------------------------- ------------------ ------------ ----------------- -------------- --------------------- Selling, General & Administrative Expense $2.5 16% $2.0 16% 26% - ----------------------------- ------------------ ------------ ----------------- -------------- --------------------- Interest Income $0.3 2% $0.3 2% 7% - ----------------------------- ------------------ ------------ ----------------- -------------- ---------------------
Total Revenues. Total revenues increased 22% to $15.1 million in the three months ended September 30, 2004 from $12.4 million in the three months ended September 30, 2003. Net Sales. Net sales of products increased 38% to $10.1 million for the three months ended September 30, 2004 from $7.3 million for the three months ended September 30, 2003, as we continued to increase sales to existing customers and expand sales to new customers. This increase was 22 primarily attributable to increased sales of our cardiology biomaterial products and our orthopaedic products, specifically our bone graft subsititute products. Orthopaedic sales increased 49% to $5.7 million in the three months ended September 30, 2004 from $3.8 million for the three months ended September 30, 2003. Cardiology biomaterial sales increased by 22% to $3.8 million from $3.1 million for the three months ended September 30, 2004 and 2003. This increase related to sales of the collagen plug component of the Angio-Seal product, which increased $1.2 million, or 51% over the prior year comparable period, offset the expected decrease in sales of the polymer anchor component of the Angio-Seal. Sales of the anchor component declined to $229,000 from $736,000 for the three months ended September 30, 2004 and 2003, respectively. As evidenced in our first quarter of fiscal 2005, we anticipate several factors will compensate for the decline in sales of this one component. We expect these factors will include the growth in our spine products, growth in sales of the collagen plug component of the Angio-Seal, growth in sales to our other existing biomaterials customers and the addition of new customers. Sales levels of our sports medicine products throughout the remainder of fiscal 2005 are estimated to remain relatively consistent with the levels experienced in the first quarter of fiscal 2005. Net sales for the three months ended September 30, 2004 and September 30, 2003 consisted almost entirely of biomaterials sales, as the TriActiv sales were less than 1% of total sales in both periods. Research and Development Revenues. Research and development revenues increased 8% to $253,000 from $235,000 for the three months ended September 30, 2004 and 2003, respectively. The revenues for the three months ended September 30, 2004 consisted of amounts generated under our NIST synthetic vascular graft grant. The slight increase from the prior year primarily reflected an increase in reimbursements under the synthetic vascular graft grant, which generated $253,000 in revenue for the three months ended September 30, 2004 compared to $183,000 for the three months ended September 30, 2003. This increase was attributable to expenses associated with pre-clinical studies, which are a significant component of the total reimbursement under the grant. Specifically, in our first quarter fiscal 2005, revenues generated from such study activities were $148,000 compared to $94,000 in the first quarter of fiscal 2004. The NIH breast cancer drug delivery grant, which was received in January 2003, contributed $52,000 in revenue in the three months ended September 30, 2003 and $0 in revenue for the three months ended September 30, 2004, as the project concluded in October 2003. The following table summarizes the research and development revenue as of September 30, 2004 compared to September 30, 2003:
- -------------------------------------- ------------------- ------------------ ------------------------- SEPTEMBER 30, SEPTEMBER 30, PERCENTAGE CHANGE FROM GRANT 2004 2003 FY 04 TO FY 05 - -------------------------------------- ------------------- ------------------ ------------------------- NIST Vascular Graft $253,000 $183,000 38% - -------------------------------------- ------------------- ------------------ ------------------------- NIH Breast Cancer Drug Delivery $ 0 $ 52,000 (100%) - -------------------------------------- ------------------- ------------------ ------------------------- TOTAL R&D REVENUE $253,000 $235,000 8% ====================================== =================== ================== =========================
Royalty Income. Royalty income decreased 3% to $4.7 million from $4.8 million in the three months ended September 30, 2004 and 2003, respectively. This decrease was due to the decrease in the Angio-Seal contracted royalty rate from 9% to 6% in April 2004. Angio Seal royalties decreased from $4.8 million to $4.1 million in the first quarters of fiscal 2004 and 2005, respectively. The decrease in the royalty rate was offset by a greater number of units sold as well as an increase in the average selling price for the Angio-Seal. This increase in the average selling price was partially due to favorable exchange rates. Royalty units increased 25% as approximately 360,000 Angio-Seal units were sold to end-users during the three months ended September 30, 2004 compared to approximately 288,000 units sold during the three months ended September 30, 2003. We believe that the increase in units were due to St. Jude Medical's continued sales and marketing efforts, which have resulted in greater market share and overall increased adoption of vascular closure devices in the market. 23 Partially offsetting the Angio-Seal royalty income decrease, royalty income also included royalties from Orthovita under the March 2003 manufacturing, development and supply agreement between our two companies. This royalty is received on all end-user sales of co-developed VITOSS products by Orthovita. The first royalty was earned in the third quarter of fiscal 2004 when Orthovita commercially launched the first co-developed products. Additionally, we acquired proprietary rights from a third party inventor of the VITOSS technology. Under this agreement the Company receives an additional royalty from Orthovita on the end-user sales of all Orthovita products containing the VITOSS technology. The first payment was earned in the quarter ended September 30, 2004. (See Note 1 to the Condensed Consolidated Financial Statements - Patents and Proprietary Rights). Total royalty income from Orthovita was approximately $571,000 for the first quarter of fiscal 2005. Cost of Products Sold. Cost of products sold increased 21% to $4.0 million in the three months ended September 30, 2004 from $3.3 million in the three months ended September 30, 2003. Gross margin on sales increased 600 basis points in the three months ended September 30, 2004 to 60% compared to 54% in the three months ended September 30, 2003. The increase in gross margin reflects the higher margins on our biomaterials products attributable in part to higher volumes, which resulted in manufacturing efficiencies, as well as continued allocation of overhead across greater sales volumes, resulting in a decrease in per unit costs. We expect that over the 2005 fiscal year these margins will be offset by the TriActiv device and new products, which should have slightly lower margins until the manufacturing processes mature and volumes grow. Research and Development Expenses. Research and development expenses increased 7% to $4.4 million in the three months ended September 30, 2004 compared to $4.1 million in the three months ended September 30, 2003. While research and development expenditures continued to increase in absolute dollars, they decreased as a percentage of total revenue to 33% from 29% for the first quarters of fiscal years 2004 and 2005, respectively. Expense increases were primarily due to our development efforts on our biomaterials products, including our work under the NIST grant. Biomaterials and other proprietary technologies spending increased $212,000, or 14%, to $1.8 million as of September 30, 2004 from $1.6 million as of September 30, 2003 related primarily to increases in personnel costs of $150,000, legal and consulting costs of $36,000 and facility costs, including rent, electric and depreciation, of $29,000 all of which supported our continued development of new products and processes for our current and prospective customers. Research and development expenses related to the TriActiv system increased $93,000, or 4%, to $2.6 million in the three months ended September 30, 2004 from $2.5 million in the three months ended September 30, 2003. Expense increases occurred in personnel costs ($428,000), product design costs related to the TriActiv system ($242,000), patent counsel fees and other consulting costs ($106,000), and facility costs, including rent, electric and depreciation ($143,000), all of which supported the growth in the development efforts on future generations of the TriActiv system. These cost increases were largely offset by an $865,000 decrease in clinical trial costs due to the conclusion of the PRIDE clinical trial in March 2004. We expect research and development expenses to increase as we investigate and develop new products, conduct clinical trials and seek regulatory approvals for our proprietary products. Selling, General and Administrative Expense. Selling, general and administrative expense increased 26% to $2.5 million in the three months ended September 30, 2004 from $2.0 million in the three months ended September 30, 2003. This was primarily the result of general and administrative expenses, which increased $514,000 to $1.5 million in the three months ended September 30, 2004 from $1.0 million in the three months ended September 30, 2003, primarily attributable to a $332,000 increase in personnel expense. In addition, we had a $140,000 increase in bad debt expense, primarily the result of a $110,000 reserve for a potential bad debt write off. Sales and marketing expenses remained consistent at $950,000 in the three months ended September 30, 2004 and 2003. The TriActiv European sales and marketing costs decreased slightly, by $21,600, due to a decrease in expenses related to a marketing clinical study in support of third party reimbursement of the TriActiv device in Europe. These clinical study expenses decreased $86,000 to $61,000 in 24 the three months ended September 30, 2004 from $148,000 in the three months ended September 30, 2003. The study is expected to conclude by December 2004. This decrease was partially offset by an increase in personnel expenses of $49,000. Offsetting the slight decline in European sales and marketing costs, U.S. marketing expenses increased slightly, by $22,100. This increase related to exhibition expenses as well as marketing efforts associated with the commercialization of the TriActiv system in the U.S. Net Interest Income. Interest expense decreased 77% to $5,000 in the three months ended September 30, 2004 from $20,000 in the three months ended September 30, 2003. This decrease was the result of a lower average debt principal balance. Interest income increased by 7% to $310,000 in the three months ended September 30, 2004 from $290,000 in the three months ended September 30, 2003. This increase was consistent with the increase in our cash and investment balances, which increased by 6% from the comparable period. LIQUIDITY AND CAPITAL RESOURCES Our cash, cash equivalents and investments were $57.2 million at September 30, 2004, a decrease of $3.9 million from our balance of $61.1 million at June 30, 2004, the end of our prior fiscal year. In addition, our working capital was $69.9 million at September 30, 2004, a decrease of $2.8 million from our working capital of $72.7 million at June 30, 2004. OPERATING ACTIVITIES Net cash provided by our operating activities was $3.9 million in the three months ended September 30, 2004. For the three months ended September 30, 2004, we had net income of $3.2 million, a tax benefit from the exercise of stock options of $178,000, non-cash employee stock-based compensation of $177,000, and non-cash depreciation and amortization of $1.3 million. Cash used as a result of changes in asset and liability balances was $877,000. The decrease in cash related to the change in assets and liabilities was primarily due to an increase in inventory ($340,000) and decrease in our accounts payable and accrued expenses ($761,000) as well as in deferred revenue ($91,000). This was partially offset by a decrease in accounts receivable, which provided cash of $385,000. The inventory increase was primarily due to stocking of one of our primary raw materials to take advantage of a quantity price reduction. The decrease in accounts payable and accrued expenses related to our bonus payment to employees in September and a federal tax payment made in September 2004. These payments were offset by increases to our accrued tax liability for future estimated federal tax payments and an increase in our trade accounts payable balance related to our continued growth. Decreases in accounts receivable related to the timing of customer payments in addition to the recording of a $110,000 reserve for a potential bad debt write off. INVESTING ACTIVITIES Cash used in investing activities was $11.5 million for the three month period ended September 30, 2004. This was the result of purchase and redemption activity within our investment portfolio in addition to the $2.6 million acquisition of proprietary rights (See Note 1 to the Condensed Consolidated Financial Statements - Patents and Proprietary Rights). In addition, during the period we had investments of $250,000 mature or be called. We subsequently purchased new investments with these proceeds as well as invested an additional $4.0 million of our cash and/or cash equivalents, for total investment purchases of $4.2 million. See Note 1 to the condensed consolidated financial statements included in this quarterly report for a description of our available-for sale securities. See the discussion below of cash used in purchasing property, plant and equipment. We have a $25.0 million capital spending plan for fiscal 2005, of which approximately $20 million will be expended on our new facility (see discussion below), and the remainder will be expended to continue to expand our research and development and manufacturing capabilities and upgrade our MIS technology infrastructure. In the first quarter of fiscal 2005, we purchased land and started construction of our new facility. The new facility will be located in the general vicinity of our existing facility. Long term, the proposed building site could accommodate a 25 220,000 square foot facility and thus provide for our future growth and continued expansion. Our construction plan has three phases. Phase one is the construction of a 160,000 square foot building shell and the fit-out of 90,000 square feet of space for our manufacturing and quality assurance operations. Phase one began in our first fiscal quarter of 2005, and will continue for a period of eighteen to twenty four months and have a total estimated cost of $25 million, including the land purchase. Phase two would increase the total building size to 175,000 square feet and is anticipated to be complete by the end of five years. The second phase would allow the complete transition of all our personnel and operations to the new facility. Phase three would complete the building to the maximum of 220,000 square feet, when necessary. We intend to finance the construction of this building from current available cash on hand or liquid investments. FINANCING ACTIVITIES The exercise of stock options provided cash of $324,000 for the three months ended September 30, 2004. We believe that option exercises will continue through fiscal 2005 due to the current market price of our common stock compared to the average exercise price of outstanding options. DEBT On September 1, 2000, we incurred an obligation in the amount of $4.5 million in conjunction with the acquisition of THM Biomedical, Inc. The obligation was due in equal quarterly installments. As of September 30, 2004 the entire obligation was paid in full. No debt remains on our balance sheet. STOCK REPURCHASE PROGRAM On August 17, 2004, we announced that our board of directors had reinstated a program to repurchase issued and outstanding shares of Common Stock over six months from the date of the board reinstatement. The reinstated plan calls for the repurchase of up to 259,500 shares, the balance under the original plan approved in October 2003. As of September 30, 2004, we had repurchased and retired 25,000 shares of common stock under the current program at a cost of approximately $600,000, or an average market price of $24.14 per share. In October 2004, we repurchased an additional 174,867 shares of common stock under the program at a cost of approximately $4.5 million or an average market price of $25.94 per share. We financed all of these repurchases using our available cash. We plan to continue to repurchase our shares for cash, from time to time in the open market, through block trades or otherwise. The repurchase program does not require us to purchase any specific dollar value or number of shares. Any purchases under the program will depend on market conditions and may be commenced or suspended at any time or from time to time without prior notice. RESEARCH AND DEVELOPMENT TAX CREDIT During the fourth quarter of fiscal year 2003, we performed a retrospective research and development tax credit study for fiscal years 1993 through 2003. We recorded the majority of this tax credit ($1.5 million) in the fourth quarter of fiscal 2003. During the first quarter of our fiscal 2004, we recorded an additional portion of the research and development tax credit ($310,000) and professional service fees as a component of selling, general and administrative expenses ($50,500) related to this research and development tax credit study. GENERAL We plan to continue to spend substantial amounts to fund clinical trials, to gain regulatory approvals and to continue to expand research and development activities, particularly for the TriActiv System and our biomaterials products. In addition to the potential cash requirements associated with our announced reinstatement of the stock repurchase plan (see above), we will continue the construction of our new facility to support the continued growth of our biomaterials business and expected commercial launch of the TriActiv System, as discussed above. If approved by the FDA, we plan to market and sell the TriActiv System in the U.S. through a small, dedicated direct sales force initially comprised of approximately ten salespeople. Our initial estimates of the cost of a direct sales plan would increase selling expense in fiscal 2005 over fiscal 2004 by $2.5 million to $3.0 million, including personnel and marketing 26 expenses. We believe our current cash and investment balances, in addition to cash generated from operations, will be sufficient to meet our operating, financing and capital requirements through at least the next 12 months. We also believe our cash and investment balances will be sufficient on a longer term basis, however, it will depend on numerous factors, including market acceptance of our existing and future products; the successful commercialization of products in development and costs associated with that commercialization; progress in our product development efforts; the magnitude and scope of such efforts; progress with pre-clinical studies, clinical trials and product clearance by the FDA and other agencies; the cost and timing of our efforts to expand our manufacturing, sales, and marketing capabilities; the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights; competing technological and market developments; and the development of strategic alliances for the marketing of certain of our products. The terms of any future equity financing we undertake may be dilutive to our stockholders and the terms of any debt financing may contain restrictive covenants that limit our ability to pursue certain courses of action. Our ability to obtain financing is dependent on the status of our future business prospects, as well as conditions prevailing in the relevant capital markets. No assurance can be given that any additional financing will be available to us, or will be available to us on acceptable terms' should such a need arise. Our estimate of the time periods for which our cash and cash equivalents will be adequate to fund operations is a forward looking statement within the meaning of Private Securities Litigation Reform Act of 1995 and is subject to risks and uncertainties. Actual results may differ materially from those contemplated in such forward-looking statements. In addition to those described above, factors which may cause such a difference are set forth below under the caption "Risks Factors" below. RISK FACTORS You should carefully consider the risks, uncertainties and other factors described below, in addition to the other information set forth in this report, because they could materially and adversely affect our business, operating results, financial condition, cash flows and prospects as well as adversely affect the value of an investment in our common stock. RISKS RELATED TO OUR BUSINESS WE MAY NOT BE ABLE TO OBTAIN THE NECESSARY REGULATORY APPROVALS FOR THE TRIACTIV SYSTEM IN THE UNITED STATES. The FDA has not approved the TriActiv System for marketing. Prior to granting approval, the FDA may require clarification of information provided in our regulatory submissions, more information or more clinical studies. If granted, FDA approval may impose limitations on the uses for which our product may be marketed or how our product may be marketed. Should we experience delays or be unable to receive approval from the FDA, our growth prospects will be diminished. ALTHOUGH WE HAVE RECEIVED CE MARK APPROVAL AND EVEN IF WE RECEIVE FDA APPROVAL, WE MAY NOT BE SUCCESSFUL COMMERCIALIZING THE TRIACTIV SYSTEM THROUGH A DIRECT SALES FORCE. If the TriActiv System obtains the necessary governmental approvals, we will need to commercialize the product. We may not be able to successfully develop and train our own sales force to sell and market the TriActiv System. We recently began to build a sales and marketing force, but had no prior experience hiring or training a sales and marketing force. We may not be able to expand and maintain an internal sales and marketing force with technical expertise and supporting distribution capabilities. If we are unable to successfully commercialize the TriActiv device, our growth prospects will be diminished. 27 WE DERIVE A SUBSTANTIAL MAJORITY OF OUR REVENUES FROM ONLY TWO CUSTOMERS. A substantial majority of our total revenues are derived from only two customers. Royalty income from, and sales of biomaterials to, St. Jude Medical associated with the Angio-Seal represented approximately 58% of our total revenue for fiscal 2004 while sales of biomaterials products to Arthrex, a distributor of orthopaedic products, represented approximately 30% of total revenues. It is not possible for us to predict the future level of demand for our products that will be generated by these customers or the future demand for the Angio-Seal from customers of St. Jude Medical. Our customer concentration exposes us to the risk of changes in the business condition of either our major customers and to the risk that the loss of a major customer would adversely affect our results of operations. Our relationship with these customers is subject to change at any time. WE ANTICIPATE THAT A SUBSTANTIAL PORTION OF OUR REVENUES WILL CONTINUE TO COME FROM THE ANGIO-SEAL, WHICH IS MANUFACTURED, MARKETED AND DISTRIBUTED BY ST. JUDE MEDICAL. Under our license agreements with St. Jude Medical, the Angio-Seal is manufactured, marketed and sold on a worldwide basis by St. Jude Medical. Two of our significant sources of revenue for the future are expected to be sales of collagen to St. Jude Medical for use in the Angio-Seal and royalty income from the sale of the Angio-Seal product line. Our success with the Angio-Seal depends in part on the time, effort and attention that St. Jude Medical devotes to the Angio-Seal product line and on their success in manufacturing, marketing and selling the Angio-Seal product line. Under the terms of our agreements with St. Jude Medical, we have no control over the pricing and marketing strategy for the Angio-Seal product line. In addition, we depend on St. Jude Medical to successfully maintain levels of manufacturing sufficient to meet anticipated demand, abide by applicable manufacturing regulations and seek reimbursement approvals. St. Jude Medical can terminate our arrangement at any time for any reason upon 12 months notice. At such time, all sales and marketing, manufacturing and distribution rights to the Angio-Seal would be returned to us. St. Jude Medical may not successfully pass future inspections of its manufacturing facility or adequately perform its manufacturing, marketing and selling duties. Any such failure by St. Jude Medical may negatively impact Angio-Seal unit sales and therefore reduce our royalties. IF OUR BIOMATERIALS PRODUCTS ARE NOT SUCCESSFUL, OUR OPERATING RESULTS AND BUSINESS MAY BE SUBSTANTIALLY IMPAIRED. The success of our existing biomaterials products, as well as any we develop in the future, depends on a variety of factors, including our ability to continue to manufacture, sell and competitively price these products and the acceptance of these products by the medical profession. In addition, we may be required to obtain regulatory approval for any future biomaterials products. We will require substantial additional funds to develop and market our biomaterials products. We expect to fund the growth of our biomaterials business out of our operating income, but this operating income may not be sufficient to develop new biomaterials products. To date, we have relied on strategic partners or customers to market and sell our biomaterials products. We cannot assure you that we will commercialize our products successfully through our planned development of a sales force. WE DEPEND ON OUR CUSTOMERS TO MARKET AND OBTAIN REGULATORY APPROVALS FOR THEIR BIOMATERIALS PRODUCTS. We depend on the efforts of our biomaterials customers in marketing their products that include our biomaterials components. There can be no assurance that our customers' end-use products that include our biomaterials components will be commercialized successfully by our customers or that our customers will otherwise be able to compete effectively in their markets. THE MARKETS FOR OUR PRODUCTS ARE HIGHLY COMPETITIVE AND ARE LIKELY TO BECOME MORE COMPETITIVE, AND OUR COMPETITORS MAY BE ABLE TO RESPOND MORE QUICKLY TO NEW OR EMERGING TECHNOLOGIES AND CHANGES IN CUSTOMER REQUIREMENTS. The markets for our current and proposed products are fragmented, intensely competitive, subject to rapid change and sensitive to new product introductions and enhancements. We expect that the competitive environment for our products will become more intense as additional companies enter our markets and as new techniques and technologies are adopted. Our biomaterials and medical devices compete directly and indirectly for customers with a range of products and technologies produced by a wide variety of companies, as well as other processes and procedures which do not require the use of our products or those of our 28 competitors. Many of our existing competitors, as well as a number of potential new competitors, have longer operating histories in these markets, greater name recognition, larger customer bases and greater financial, technical and marketing resources. Our biomaterials products compete with the products of many of the larger companies in the industry. In the vascular sealing device market, our products compete with products sold by Datascope Corporation, Perclose, Inc. (a subsidiary of Abbott Laboratories) and Vascular Solutions, Inc., amongst other smaller competitors. The majority of vascular sealing is performed through manual compression, which represents our primary competition. The TriActiv System is currently only commercially available in Europe where our competitors include Boston Scientific Corporation, Johnson and Johnson, Inc., Medtronic, Inc. (which owns Percu-Surge, Inc.) and Guidant Corporation, among others. If we are successful in commercializing the TriActiv System in the U.S., we anticipate the competitors will be the same companies against which we are competing in Europe, as well as others. Our competitors may have broader product lines, which allow them to negotiate exclusive, long-term supply contracts and offer comprehensive pricing for their products. Broader product lines may also provide our competitors with a significant advantage in marketing competing products to group purchasing organizations and other managed care organizations that are increasingly seeking to reduce costs through centralized purchasing. Greater financial resources and product development capabilities may allow our competitors to respond more quickly to new or emerging technologies and changes in customer requirements that may render our products obsolete. Because a significant portion of our revenue depends on sales of medical devices by our customers to the end-user market, we are also affected by competition within the markets for these devices. Competition within the medical device market could also have an adverse effect on our business for a variety of reasons, including that our customers may compete directly with larger, dominant manufacturers with extensive product lines and greater sales, marketing and distribution capabilities. We are also unable to control other factors that may impact the commercialization of our components for end use products, such as marketing and sales efforts and competitive pricing pressures within particular markets. IF OUR PRODUCTS ARE NOT ACCEPTED BY THE MEDICAL COMMUNITY OR IF OUR PRODUCTS ARE REPLACED BY NEW TECHNOLOGIES, OUR BUSINESS MAY SUFFER. The success of our existing products depends on continued acceptance of these products by the medical community. We cannot predict whether or not our products will continue to be accepted and if that acceptance will be sustained to over the long term. The success of any products we develop in the future will depend on the adoption of these products by our targeted markets. We cannot predict how quickly, if at all, the medical community will accept our future products or the extent to which our future products will be used. If we encounter difficulties introducing future products into our targeted markets, our operating results and business may be substantially impaired. In addition, new technologies and techniques may be developed which may render our current products, along with those under development, obsolete. THE LOSS OF, OR INTERRUPTION OF SUPPLY FROM, KEY VENDORS COULD LIMIT OUR ABILITY TO MANUFACTURE OUR PRODUCTS. We purchase certain materials and components for our products from various suppliers. Some of these components are custom made for us, including many of our absorbable polymer and suture raw materials which are used in our custom polymer products across all markets. Any loss of, or interruption of supply from, key vendors may require us to find new vendors. We could experience production or development delays while we seek new vendors. WE MAY HAVE PROBLEMS MANUFACTURING AND DELIVERING OUR BIOMATERIALS PRODUCTS IN THE FUTURE. The biomaterials industry is an emerging area, using many materials which are untested or whose properties are still not known. Consequently, from time to time we may experience unanticipated difficulties in manufacturing and delivering our biomaterials products to our customers. These difficulties may include an inability to meet customer demand, delays in delivering products or quality control problems with certain biomaterials products. 29 OUR USE OF HAZARDOUS MATERIALS EXPOSES US TO THE RISK OF MATERIAL ENVIRONMENTAL LIABILITIES. Because we use hazardous substances in our research and development and manufacturing operations, we are potentially subject to material liabilities related to personal injuries or property damages that may be caused by hazardous substance releases or exposures at or from our facility. Decontamination costs, other clean-up costs and related damages or liabilities could substantially impair our business and operating results. We are required to comply with increasingly stringent laws and regulations governing environmental protection and workplace safety, including requirements governing the handling, storage and disposal of hazardous substances. ST. JUDE MEDICAL'S AND OUR INTERNATIONAL SALES ARE SUBJECT TO A NUMBER OF RISKS THAT COULD HARM FUTURE INTERNATIONAL SALES OF ANGIO-SEAL AND OUR ABILITY TO SUCCESSFULLY COMMERCIALIZE NEW PRODUCTS IN INTERNATIONAL MARKETS. St. Jude Medical sells the Angio-Seal product line internationally and pays us a royalty on each unit sold. We also sell the TriActiv device, as well as some of our other products, in the international markets. Our royalties from international sales of the Angio-Seal product line by St. Jude Medical and our revenues from our other international sales are subject to several risks, including: o the impact of recessions in economies both within and outside the United States; o unexpected changes in regulatory requirements, tariffs or other trade barriers; o weaker intellectual property rights protection in some countries; o fluctuations in exchange rates; o potentially adverse tax consequences; and o political and economic instability. The occurrence of any of these events could seriously harm St. Jude Medical's or our future international sales. OUR SUCCESS DEPENDS ON KEY PERSONNEL, THE LOSS OF WHOM COULD IMPAIR OUR OPERATING RESULTS AND BUSINESS. Our success depends, to a significant extent, upon the efforts and abilities of Joseph W. Kaufmann, Douglas G. Evans, Wendy F. DiCicco and other members of senior management. The loss of the services of one or more of these key employees could harm our operating results and business. In addition, we will not be successful unless we can attract and retain skilled personnel, particularly in the areas of research and product development. OUR FAILURE TO EXPAND OUR MANAGEMENT SYSTEMS AND CONTROLS TO SUPPORT ANTICIPATED GROWTH OR INTEGRATE FUTURE ACQUISITIONS COULD SERIOUSLY HARM OUR OPERATING RESULTS AND BUSINESS. Our operations continue to grow and we expect this expansion to continue as we execute our business strategy. Sustaining our growth has placed significant demands on management and our administrative, operational, information technology, manufacturing, financial and personnel resources. Accordingly, our future operating results will depend on the ability of our officers and other key employees to continue to implement and improve our operational, client support and financial control systems, and effectively expand, train and manage our employee base. We may not be able to manage our growth successfully. ANY ACQUISITIONS THAT WE UNDERTAKE COULD BE DIFFICULT TO INTEGRATE, DISRUPT OUR BUSINESS, DILUTE STOCKHOLDER VALUE AND HARM OUR OPERATING RESULTS. We may acquire or make investments in complementary businesses, technologies, services or products if appropriate opportunities arise. The process of integrating any acquired business, technology, service or product into our business and operations may result in unforeseen operating difficulties and expenditures. Integration of any acquired company also may consume much of our management's time and attention that could otherwise be available for ongoing 30 development of our business. Moreover, the anticipated benefits of any acquisition may not be realized. Furthermore, we may be unable to identify, negotiate or finance future acquisitions successfully. Future acquisitions could result in potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or amortization expenses related to goodwill and other intangible assets. WE ARE BUILDING A NEW MANUFACTURING FACILITY AND WILL TRANSITION 100% OF OUR MANUFACTURING CAPABILITIES TO THIS NEW FACILITY. IF WE ENCOUNTER DIFFICULTIES IN THE TRANSITION PHASE, WE MAY LOSE REVENUE, AND WE MAY BE UNABLE TO MAINTAIN OUR CUSTOMER RELATIONSHIPS. We manufacture all of the products we sell at our existing location in Exton, Pennsylvania. We have purchased land and are currently constructing a new manufacturing facility near of our existing facility. We plan to transfer all of our manufacturing processes to this new facility in our second quarter of fiscal 2006. If the transition is delayed, we may have inadequate manufacturing capabilities to meet all of our customers' requirements. If we are unable to manufacture our customers' products, or are unable to meet their production requirements, in our existing or new facility for any reason, we may lose revenue and/or may not be able to maintain our relationships with our customers. Although we carry business interruption insurance to cover lost revenue and profits, this insurance would only cover losses experienced in the existing facility or new facitliy, once completed but does not cover transition delays or complications. In addition, our business interruption insurance would not compensate us for the loss of opportunity and potential adverse impact on relations with our existing customers resulting from our inability to produce products for them. OUR FUTURE OPERATING RESULTS ARE DIFFICULT TO PREDICT AND MAY VARY SIGNIFICANTLY FROM QUARTER TO QUARTER. Our operating results have varied significantly from quarter to quarter in the past and are likely to vary substantially in the future as a result of a number of factors, some of which are not in our control, including: o market perception and acceptance of our customer's products; o our efforts to increase sales of our biomaterials products; o our efforts to gain FDA approval and commercialize the TriActiv device; o our efforts to gain CE Mark and FDA approval for future generations of the TriActiv device; o the loss of significant orders; o changes in our relationship with St. Jude Medical; o our establishment of strategic alliances or acquisitions; o timely implementation of new and improved products; o delays in obtaining regulatory approvals; o increased competition; and o litigation concerning intellectual property rights in the medical device industry. You should not rely upon our results of operations for any particular quarter as an indication of our results for a full year or any other quarter. RISKS RELATED TO OUR INTELLECTUAL PROPERTY IF WE ARE UNABLE TO PROTECT OUR PATENTS AND PROPRIETARY RIGHTS, OUR REPUTATION AND COMPETITIVENESS IN THE MARKETPLACE MAY BE MATERIALLY DAMAGED. 31 We regard our patents, biomaterials trade secrets and other intellectual property as important to our success. We rely upon patent law, trade secret protection, confidentiality agreements and license agreements with St. Jude Medical to protect our proprietary rights. Although we have registered certain of our patents with applicable governmental authorities, effective patent protection may not be available in every country in which our products are made available, and we have not sought protection for our intellectual property in every country where our products may be sold. The steps we take to protect our proprietary rights may not be adequate to ensure that third parties will not infringe or otherwise violate our patents or similar proprietary rights. WE MAY BE ACCUSED OF INFRINGING UPON THE PROPRIETARY RIGHTS OF OTHERS AND ANY RELATED LITIGATION COULD MATERIALLY DAMAGE OUR OPERATING RESULTS AND BUSINESS. Third parties may claim that we have violated their intellectual property rights. An adverse determination in any intellectual property litigation or interference proceedings brought against us could prohibit us from selling our products, subject us to significant liabilities to third parties or require us to seek licenses from third parties. The costs associated with these license arrangements may be substantial and could include ongoing royalties. Furthermore, the necessary licenses may not be available to us on satisfactory terms, if at all. Adverse determinations in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing and selling our products. Any of these claims, with or without merit, could subject us to costly litigation and divert the attention of key personnel. WE DO NOT OWN OR CONTROL THE USE OF THE ANGIO-SEAL DEVICE TRADEMARK. The term Angio-Seal is a trademark of St. Jude Medical. All goodwill generated by the marketing and sales of devices bearing the Angio-Seal trademark belongs to St. Jude Medical and not to us. Should the St. Jude Medical license agreements terminate, we would not have the right to call any of our products "Angio-Seal" unless we purchase or license the trademark from St. Jude Medical. Without rights to the Angio-Seal trademark, we would have to market our products under a different trademark. Moreover, upon the termination of the St. Jude Medical license agreements, St. Jude Medical would have the right to compete against us by selling collagen and puncture closure devices under the Angio-Seal trademark. Thus, purchasers of puncture closure devices may be more likely to recognize and purchase products labeled Angio-Seal regardless of whether those devices originate from us. RISKS RELATED TO OUR INDUSTRY WE MAY FACE PRODUCT LIABILITY CLAIMS THAT COULD RESULT IN COSTLY LITIGATION AND SIGNIFICANT LIABILITIES. The clinical testing, manufacture and sale of medical products involve an inherent risk that human subjects in clinical testing or consumers of the products may suffer serious bodily injury or death due to side effects or other unintended negative reactions to our products. Accordingly, the clinical testing, manufacture and sale of our products entail significant risk of product liability claims. The medical device industry in general has been subject to significant product liability litigation. Any product liability claims, with or without merit, could result in costly litigation, reduced sales, significant liabilities and diversion of our management's time, attention and resources. We cannot be sure that our product liability insurance coverage is adequate or that it will continue to be available to us on acceptable terms, if at all. WE FACE UNCERTAINTY RELATING TO THIRD PARTY REIMBURSEMENT FOR OUR PRODUCTS. We could be seriously harmed by changes in reimbursement policies of governmental or private healthcare payers, particularly to the extent any changes affect reimbursement for catheterization procedures in which our Angio-Seal products are used. Physicians, hospitals and other users of our products may fail to obtain sufficient reimbursement from healthcare payers for procedures in which our products are used or adverse changes may occur in governmental and private third-party payers' policies toward reimbursement for these procedures. 32 OUR PRODUCTS AND MANUFACTURING ACTIVITIES ARE SUBJECT TO EXTENSIVE GOVERNMENTAL REGULATION THAT COULD MAKE IT MORE EXPENSIVE AND TIME CONSUMING FOR US TO INTRODUCE NEW AND IMPROVED PRODUCTS. Our products and manufacturing activities are subject to extensive regulation by a number of governmental agencies, including the FDA and comparable international agencies. We are required to: o obtain the approval of the FDA and international agencies before we can market and sell new products; o satisfy these agencies' requirements for all of our labeling, sales and promotional materials in connection with our existing products; o comply with all applicable manufacturing regulations; and o undergo rigorous inspections by these agencies. Compliance with the regulations of these agencies may delay or prevent us from introducing any new or improved products, including the TriActiv System. Furthermore, we may be subject to sanctions, including temporary or permanent suspension of operations, product recalls and marketing restrictions if we fail to comply with the laws and regulations pertaining to our business. We are also required to demonstrate compliance with the FDA's quality system regulations. The FDA enforces its quality system regulations through pre-approval and periodic post-approval inspections. These regulations relate to product testing, vendor qualification, design control and quality assurance, as well as the maintenance of records and documentation. If we are unable to conform to these regulations, we will be required to locate alternative manufacturers that do conform. Identifying and qualifying alternative manufacturers may be a long, costly and difficult process and could seriously harm our business. The FDA and international regulatory agencies may also limit the indications for which our products are approved. These regulatory agencies may restrict or withdraw approvals we have received if additional information becomes available to support this action. RISKS RELATED TO OUR SECURITIES THE TRADING PRICE OF OUR COMMON STOCK IS LIKELY TO FLUCTUATE SUBSTANTIALLY IN THE FUTURE. The trading price of our common stock may fluctuate widely as a result of a number of factors, some of which are not in our control, including: o our ability to meet or exceed our own forecasts or expectations of analysts or investors; o quarter to quarter variations in our operating results; o announcements regarding clinical activities or new products by us or our competitors; o general conditions in the medical device industry; o changes in our own forecasts or earnings estimates by analysts; o our partners ability to meet or exceed the forecasts or expectations of analysts or investors; o price and volume fluctuations in the overall stock market, which have particularly affected the market prices of many medical device companies; and o general economic conditions. 33 In addition, the market for our stock has experienced, and may continue to experience, price and volume fluctuations unrelated or disproportionate to our operating performance. As a result, you may not be able to sell shares of our common stock at or above the price at which you purchase them. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against that company. If any securities litigation is initiated against us, with or without merit, we could incur substantial costs, and our management's attention and resources could be diverted from our business. FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET BY MANAGEMENT AND OTHER STOCKHOLDERS WITH SIGNIFICANT HOLDINGS COULD CAUSE OUR STOCK PRICE TO FALL. Sales of a substantial number of shares of our common stock in the public market by management or other significant stockholders or the perception that such sales could occur, could cause the market price of our common stock to decline or adversely affect our future ability to raise capital through an offering of equity securities. OUR SECOND AMENDED AND RESTATED CERTIFICATE OF INCORPORATION AND DELAWARE LAW MAY DISCOURAGE AN ACQUISITION OF OUR COMPANY. Provisions of our second amended and restated certificate of incorporation and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. FORWARD-LOOKING STATEMENTS This report includes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. We have based these forward-looking statements largely on our current expectations and projections about future events and trends affecting our business. In this report, the words "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "expect," "plan" and similar expressions, as they relate to Kensey Nash, our business or our management, are intended to identify forward-looking statements, but they are not exclusive means of identifying them. A number of risks, uncertainties and other factors could cause our actual results, performance, financial condition, cash flows, prospects and opportunities to differ materially from those expressed in, or implied by, the forward-looking statements. These risks, uncertainties and other factors include, among other things: o general economic and business conditions, both nationally and in our markets; o the impact of competition; o anticipated trends in our business; o existing and future regulations affecting our business; o strategic alliances and acquisition opportunities; and o other risk factors set forth under "Risk Factors" above. Except as expressly required by the federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this report. Our results of operations in any past period should not be considered indicative of the results to be expected for future periods. Fluctuations in operating results may also result in fluctuations in the price of our common stock. 34 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our interest income and expense are sensitive to changes in the general level of interest rates. In this regard, changes in interest rates affect the interest earned on our cash, cash equivalents and investments. Our investment portfolio consists primarily of high quality U.S. government, municipal and corporate securities with maturities ranging from 2 to 13 years. Also, the portfolio includes certain municipal variable rate demand obligations that have maturities ranging from 6 to 31 years. These municipal variable-rate demand obligations are putable weekly and callable on a monthly basis. We mitigate default risk by investing in what we believe are safe and high credit quality securities and by monitoring the credit rating of investment issuers. Our portfolio includes only marketable securities with secondary or resale markets. We have an audit committee approved investment strategy which provides guidance on the duration and types of our investments. These available-for-sale securities are subject to interest rate risk and decrease in market value if interest rates increase. At September 30, 2004, our total portfolio consisted of approximately $50.6 million of investments. While our investments may be sold at anytime because the portfolio includes available-for-sale marketable securities with secondary or resale markets, we generally hold securities until the earlier of their call date or their maturity. Therefore, we do not expect our results of operations or cash flows to be materially impacted due to a sudden change in interest rates. ITEM 4. CONTROLS AND PROCEDURES We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2004, our disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed by us in the reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. There was not any change in the our internal control over financial reporting during the quarter ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Any control system, no matter how well designed and operated, can provide only reasonable (not absolute) assurance that its objectives will be met. Furthermore, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. 35 PART II - OTHER INFORMATION ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. The following table contains information about our purchases of our equity securities during July, August, and September 2004:
Total number of Maximum Number Average Price Shares Purchased of Shares that May Total Number of Paid per as Part of a Publicly Yet Be Purchased Period Shares Purchased Share Announced Program Under the Program - ------------------------------------------------------------------------------------------------------------- July 1-31, 2004 - - - - August 1-31, 2004 - - - - September 1-30, 2004 25,000 $ 24.14 25,000 234,500 --------------------------------------------------------------------------------------- Total 25,000 $ 24.14 25,000 234,500 =======================================================================================
On August 17, 2004, we announced publicly that our board of directors had reinstated a program to repurchase issued and outstanding shares of our Common Stock over a six month period from the date of the board reinstatement, which will expire in February 2005. The reinstated plan calls for the repurchase of up to 259,500 shares. ITEM 6. EXHIBITS. 31.1 Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a). 31.2 Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a). 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 36 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. KENSEY NASH CORPORATION Date: November 9, 2004 By: /s/ Wendy F. DiCicco, CPA -------------------------------------------- Wendy F. DiCicco, CPA Chief Financial Officer (Principal Financial and Accounting Officer) 37 EX-31 2 exh311_kenseynash-09302004.txt CERTIFICATION OF CEO EXHIBIT 31.1 CERTIFICATION I, Joseph W. Kaufmann, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Kensey Nash Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 9, 2004 /s/ Joseph W. Kaufmann ---------------------- Joseph W. Kaufmann Chief Executive Officer EX-31 3 exh312_kenseynash-09302004.txt CERTIFICATION OF CFO EXHIBIT 31.2 CERTIFICATION I, Wendy F. DiCicco, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Kensey Nash Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 9, 2004 /s/ Wendy F. DiCicco, CPA ------------------------- Wendy F. DiCicco, CPA Chief Financial Officer EX-32 4 exh321_kenseynash-09302004.txt CERTIFICATION OF CEO EXHIBIT 32.1 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Kensey Nash Corporation (the "Company") on Form 10-Q for the quarter ended September 30, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Joseph W. Kaufmann, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Date: November 9, 2004 /s/ Joseph W. Kaufmann ---------------------- Joseph W. Kaufmann Chief Executive Officer EX-32 5 exh322_kenseynash-09302004.txt CERTIFICATION OF CFO EXHIBIT 32.2 CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Kensey Nash Corporation (the "Company") on Form 10-Q for the quarter ended September 30, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Wendy F. DiCicco, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Date: November 9, 2004 /s/ Wendy F. DiCicco, CPA ------------------------- Wendy F. DiCicco, CPA Chief Financial Officer 41 -----END PRIVACY-ENHANCED MESSAGE-----