<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1996
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 0-27212
ENDOCARE, INC.
A DELAWARE CORPORATION I.R.S. EMPLOYER I.D. NO. 33-0618093
18 TECHNOLOGY DRIVE, SUITE 134
IRVINE, CALIFORNIA 92618
(714) 450-1410
----------------------------------------
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
-------- --------
The number of shares of the Registrant's Common Stock, par value $.001 per
share, outstanding on August 8, 1996 was 5,635,139.
<PAGE> 2
ENDOCARE, INC.
FORM 10-Q, QUARTER ENDED JUNE 30, 1996
INDEX
<TABLE>
<CAPTION>
<S> <C> <C>
PART I. FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Statements of Operations for the three and six months 3
ended June 30, 1996 and 1995
Consolidated Balance Sheets at June 30, 1996 and 4
December 31, 1995
Consolidated Statements of Cash Flows for the six months 5
ended June 30, 1996 and 1995
Notes to Financial Statements 6
Item 2 Management's Discussion and Analysis of Financial Condition 9
and Results of Operations
PART II. OTHER INFORMATION
Item 1 Legal Proceedings 13
Item 2 Changes in Securities 13
Item 3 Defaults Upon Senior Securities 13
Item 4 Submission of Matters to a Vote of Security Holders 13
Item 5 Other Information 13
Item 6 Exhibits and Reports on Form 8-K 13
Signature Page 14
</TABLE>
- 2 -
<PAGE> 3
ITEM 1. FINANCIAL STATEMENTS
ENDOCARE, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ----------------------------
1996 1995 1996 1995
--------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Revenues:
Net product sales $ 419,785 $ 271,425 $ 788,841 $ 587,747
Research revenues 0 48,473 1,600 108,241
--------- --------- ---------- ---------
Total revenues 419,785 319,898 790,441 695,988
Costs and expenses:
Cost of sales 234,859 82,748 476,164 186,222
Research and development 230,006 253,775 363,656 451,764
Selling, general and administrative 349,477 165,095 597,884 330,739
Impairment loss on long-lived assets 0 0 324,878 0
---------- --------- ---------- ---------
Total costs and expenses 814,342 501,618 $1,762,582 968,725
---------- --------- ---------- ---------
Loss before income taxes (394,557) (181,720) (972,141) (272,737)
Provision for income taxes 0 0 0 0
--------- --------- ---------- ---------
Net loss $(394,557) $(181,720) $ (972,141) $(272,737)
========= ========= ========== =========
Net loss per share of common stock $ (.07) $ (.17)
====== ======
Weighted average shares and common
stock equivalents outstanding 5,635,139 5,630,130
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
- 3 -
<PAGE> 4
ENDOCARE, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, 1996 December 31, 1995
(unaudited) (audited)
----------- -----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 282,104 $ 1,941
Accounts receivable, net 115,367 102,416
Inventories 146,093 219,298
Prepaid expenses and other current assets 21,479 7,335
---------- -----------
Total current assets 565,043 330,990
Property and equipment, at cost 393,494 760,011
Less accumulated depreciation and amortization (273,007) (362,046)
---------- -----------
Net property and equipment 120,487 397,965
Intangible assets 0 60,831
Other assets 15,907 15,907
---------- -----------
Total assets $ 701,437 $ 805,693
========== ===========
LIABILITIES AND SHAREHOLDERS'/DIVISION EQUITY
Current liabilities:
Accounts payable $ 277,059 $ 0
Accrued payroll expenses 40,004 0
Other accrued liabilities 22,501 1,628
Customer deposits 985 932
---------- -----------
Total current liabilities 340,549 2,560
Shareholders'/division equity:
Advances from Medstone International, Inc. 0 2,831,364
Common stock, $.001 par value 5,635 0
Additional paid-in capital 1,327,394 0
Accumulated deficit (972,141) (2,028,231)
---------- -----------
Total shareholders'/division equity 360,888 803,133
---------- -----------
Total liabilities and equity $ 701,437 $ 805,693
========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
- 4 -
<PAGE> 5
ENDOCARE, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended June 30,
-----------------------------------
1996 1995
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(972,141) $(272,737)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation 16,260 79,451
Impairment loss on long-lived assets 324,878 0
Changes in operating assets and liabilities:
Accounts receivable (12,951) 93,871
Inventories 73,205 22,923
Prepaid expenses and other current assets (14,144) 13,000
Accounts payable 277,059 10,496
Accrued payroll expenses 40,004 (28,428)
Other accrued liabilities 20,873 172
Customer deposits 53 0
---------- ----------
Net cash used in operating activities (246,904) (81,252)
Cash flows from investing activities:
Purchases of property and equipment (20,207) (5,264)
Proceeds from disposals of property and equipment 17,379 0
--------- ---------
Net cash used in investing activities (2,828) (5,264)
Cash flows from financing activities:
Advances from Medstone 0 86,516
Issuance of common stock, Medstone Distribution 500,000 0
Issuance of common stock, other 29,895 0
--------- ---------
Net cash provided by financing activities 529,895 86,516
--------- ---------
Net increase in cash and cash equivalents 280,163 0
Cash and cash equivalents, beginning of period 1,941 0
--------- ---------
Cash and cash equivalents, end of period $ 282,104 $ 0
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
- 5 -
<PAGE> 6
ENDOCARE, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND OPERATIONS OF THE COMPANY
Endocare, Inc. (the "Company") designs, manufactures, and markets medical
devices to treat prostate diseases worldwide.
Since its formation in 1990, Endocare operated first as a research and
development department, then later as a division of Medstone International,
Inc. ("Medstone"). Effective January 1, 1996, Endocare became a totally
independent, publicly-owned corporation. At the beginning of 1996,
Endocare, Inc. issued 5,616,528 shares of Endocare common stock to Medstone
in exchange for $500,000 cash and the accounts receivable, inventory, and
other net assets of the Endocare Division. On February 6, 1996, Medstone
distributed to existing Medstone shareholders a stock dividend of one share
of Endocare common stock for each share of Medstone common stock
outstanding on December 29, 1995.
All 1995 comparative amounts shown in the accompanying financial statements
reflect operations while Endocare was a division of Medstone. In
particular, the December 31, 1995 Balance Sheet is before Medstone's
conversion of its net advance to equity and before Medstone's contribution
of $500,000 cash.
2. BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared by
Endocare, Inc. in accordance with Securities and Exchange Commission rules
and regulations. In the opinion of Company management, the unaudited
financial statements include all entries and adjustments necessary for a
fair presentation.
These financial statements should be read in conjunction with the audited
financial statements and other information included in the Company's Form
10-K for the year ended December 31, 1995. Financial results for this
interim six-month period are not necessarily indicative of results to be
expected for the full year 1996.
3. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenue
and expenses during the reporting period. Actual results could differ from
those estimates.
- 6 -
<PAGE> 7
4. SUPPLEMENTAL FINANCIAL STATEMENT DATA
<TABLE>
<CAPTION>
June 30, December 31,
1996 1995
--------- ------------
<S> <C> <C>
Inventories:
Raw materials $ 54,561 $ 168,788
Work in process 26,512 2,849
Finished goods 65,020 47,661
--------- ---------
Total inventories $ 146,093 $ 219,298
========= =========
Property and Equipment:
Production equipment $ 112,031 $ 721,104
Furniture and fixtures 47,750 38,907
Leasehold improvements 7,076 0
Assets held for disposal (net of reserves) 226,637 0
--------- ---------
Total property and equipment, at cost 393,494 760,011
Accumulated depreciation (273,007) (362,046)
--------- ---------
Net property and equipment $ 120,487 $ 397,965
========= =========
</TABLE>
5. IMPLEMENTATION OF NEW ACCOUNTING PRONOUNCEMENT: ASSET IMPAIRMENT
In March 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Effective
January 1, 1996, Endocare adopted this pronouncement. In accordance with
this standard, the Company reviewed the cash flows being generated by
certain assets which were not expected to be utilized fully in the Company's
operations after its spin-out from Medstone International, Inc. Based upon
this review, effective January 1, 1996, Endocare reduced the value of
certain property and equipment by $264,047 and intangible organizational
costs by $60,831 to their estimated fair market values. These adjustments
were charged to operations in the quarter ended March 31, 1996.
The majority of the property and equipment adjustment pertained to laser
machines which were no longer generating sales of the Company's ProLase
laser catheters. At the December 31, 1995 spin-out date, these sixteen
lasers had a net book value of $311,665. Effective January 1, 1996,
Endocare reduced them to their estimated disposal value of $50,000, of which
$15,750 was realized in the first quarter of 1996 and $1,629 in the second
quarter.
The $60,831 adjustment to intangible organizational costs is described in
Note 6 below.
- 7 -
<PAGE> 8
6. INTANGIBLE ASSETS
At the end of 1995, Medstone International, Inc. incurred significant
legal, accounting, and other professional expenses in connection with its
Distribution of its subsidiaries, Endocare and Urogen, to its existing
Medstone shareholders. Medstone elected to capitalize these expenses as
deferred organizational costs on its Balance Sheet. At the time of the
actual Distribution, $60,831 was allocated by Medstone to Endocare,
appearing as Intangible Assets on Endocare's initial December 31, 1995
Balance Sheet. Effective January 1, 1996, in accordance with the new
accounting standard described in Note 5 above, Endocare wrote off these
amounts entirely.
7. IMPLEMENTATION OF NEW ACCOUNTING PRONOUNCEMENT:
STOCK-BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation." Effective January 1, 1996, Endocare adopted
this pronouncement. In accordance with this standard, the Company has
elected to follow the guidance of Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees." Per this election,
compensation related to employee stock options is calculated as the
difference between the grant price and the fair market value of the
underlying common shares at the grant date. Endocare's usual practice is
to issue stock options with a grant price equal to the fair market value
of the Company's common stock on the grant date. Hence, this difference
typically will be zero.
8. EARNINGS PER SHARE
Earnings per share data for the period is computed using the weighted
average number of common shares and dilutive common stock options
outstanding, at the average market price for the period. Fully diluted
earnings per share amounts are not presented because they approximate
primary earnings per share.
Earnings per share data is not presented for 1995, because at that time
Endocare was operating as a division of Medstone. Endocare, Inc. shares
were not outstanding at any time during 1995.
- 8 -
<PAGE> 9
ITEM 2.
ENDOCARE, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Endocare, Inc. (the "Company") designs, manufactures, and markets medical
devices to treat diseases of the prostate, i.e., benign prostate enlargement
and prostate cancer. Endocare's business strategy addresses three time frames,
representing immediate, intermediate, and long-term opportunities:
- Endocare's Surgical Disposable devices are being actively marketed at
present. Since 1993, Endocare has marketed its ProLase line of
disposable laser catheters. In the fourth quarter of 1995, Endocare
introduced two new product lines, UroLoops and VaporBars, which
contributed the largest portion of the Company's revenue in the first half
of 1996.
- Endocare's Surgical Systems are intended to provide intermediate growth.
In the second quarter of 1996, Endocare introduced its CryoCare system.
This equipment allows treatment of prostate tumors using minimally
invasive probes which produce rapid, controlled freezing and destruction
of the tumor.
- Endocare's proposed Office-Based Therapy products are envisioned as the
foundation for its long-term growth. If successfully developed, this
therapeutic approach would offer a pain-free way to provide immediate
relief of prostate obstruction in an office-based setting.
Since its formation in 1990, Endocare operated first as a research and
development department, then later as a division of Medstone International,
Inc. ("Medstone"). In this form, Endocare shared facilities and certain
personnel with its parent. Effective January 1, 1996, Endocare began operating
as a totally independent corporation. Comparisons of financial results for
1996 with those of 1995 may be impacted significantly by these two very
different organizational structures. In 1995 Endocare received direction,
services, actual funding, and accounting allocations from Medstone. In 1996
Endocare is independent. All 1996 charges are directly incurred by Endocare as
it replaces services previously provided by Medstone with its own resources.
- 9 -
<PAGE> 10
RESULTS OF OPERATIONS
The following table summarizes the six-month Statements of Operations for 1996
and 1995.
<TABLE>
<CAPTION>
Dollars (thousands) Percentages
Six Months Ended Six Months Ended
June 30, June 30, Percent
------------------ -------------------- Increase
1996 1995 1996 1995 (Decrease)
------ ------ -------- -------- ----------
<S> <C> <C> <C> <C> <C>
Revenues:
Net product sales $ 789 $ 588 100 % 84 % +34%
Research revenues 1 108 0 16 -99%
------ ----- ---- ---
Total revenues 790 696 100 % 100 % +14%
Costs and expenses:
Cost of sales 476 186 60 27 +156%
Research and development 363 452 46 65 -20%
Selling, general and administrative 598 331 76 47 +81%
Impairment loss on long-lived assets 325 0 41 0 ---
------ ----- ---- ---
Total costs and expenses 1,762 969 223 139 +82%
------ ----- ---- ---
Loss before income taxes (972) (273) (123) (39) +256%
Provision for income taxes 0 0 0 0
------ ----- ---- ---
Net loss $ (972) $(273) (123)% (39)% +256%
====== ===== ==== ===
</TABLE>
Product revenue in the second quarter of 1996 increased to $420,000, 55% higher
than the second quarter of 1995 and 14% higher than the immediately preceding
first quarter of 1996. Product revenue for the first six months of 1996 was
$789,000, a 34% increase from 1995. As Endocare's product lines evolved, the
mix of products sold changed significantly between 1995 and 1996. In 1995
product sales consisted almost entirely of ProLase laser catheters, the volumes
of which had dropped considerably by 1996. However, Endocare's newly
introduced UroLoops and VaporBars contributed significant revenue in the first
half of 1996. Furthermore, in May of 1996 Endocare introduced its new CryoCare
surgical systems, which accounted for over a third of second quarter revenue.
The increase in total revenue was somewhat lower because Endocare no longer is
performing research services for Medstone International, which had reported
roughly $50,000 per quarter of service revenue in 1995.
Second quarter gross margins increased to 44% from 35% in the first quarter,
largely due to the introduction of high margin CryoCare systems and a decrease
in sales of low margin DioLase units. Margins in 1996 remain lower than those
reported in comparable periods of 1995 for several reasons. First, 1996 has
virtually no research revenues from Medstone, which had been reported as 100%
margin in 1995. Second, by 1996 competitive market pressures had reduced
margins for ProLase products. Finally, 1996 saw significant sales of low
margin DioLase units, particularly in the first quarter.
- 10 -
<PAGE> 11
Compared to 1995, research and development expense in 1996 declined by $24,000
and $88,000 for the three and six months respectively. As noted previously,
Endocare performed virtually no engineering services for Medstone,
concentrating its efforts on its own Endocare products. Also, Endocare was at
a low point in two product development cycles. CryoCare had already completed
regulatory approvals, requiring only limited fine-tuning in preparation for its
second quarter market introduction. The major new research and development
effort, Office-Based Therapy, was in the relatively low-cost startup phase,
acquiring the desired licenses and patents.
For the first six months, selling, general and administrative expense increased
to $598,000, 81% higher than 1995. Most of that increase, $184,000, occurred
in the second quarter when sales and marketing expenses were particularly high
for the introduction of the new CryoCare systems at the annual American
Urological Association trade show. Increases also reflected the higher
administrative expense of operating as an independent, publicly-traded company,
as well as general investment in sales and marketing resources to establish a
foundation for future revenue growth.
The overall loss for the second quarter decreased to $395,000 from $578,000 in
the first quarter of 1996. For the first six months, the loss was $972,000
compared to $273,000 in 1995. Much of this increase came from the changes in
product margin mix and increase in selling, general and administrative costs
described above. In addition, a major factor in the loss was the effect of
adopting the new accounting pronouncement requiring review of long-lived assets
for possible impairment. As described in Note 5 to the financial statements,
review of the assets contributed to Endocare by Medstone resulted in a
write-down of $325,000 effective January 1, 1996.
LIQUIDITY AND CAPITAL RESOURCES
In connection with the spin-out, Medstone contributed $500,000 cash to
Endocare. In addition, Endocare took possession of $102,000 of its accounts
receivable and $219,000 of inventory. Medstone retained responsibility for all
financial liabilities incurred before January 1, 1996. With this initial base
of current assets, Endocare was able to manage its operations so that cash
balances remained at $282,000 at June 30, 1996.
Despite higher revenue levels, firm credit management kept June 30 net accounts
receivable at $115,000, only slightly higher than the $102,000 at the beginning
of the year. Improved inventory management brought that balance down to
$146,000 from $219,000 at December 31, 1995. Fixed asset additions during the
six months were roughly $20,000. As described in Note 5 to the financial
statements, implementation of a new accounting standard resulted in write-off
of $325,000 of non-current assets effective January 1, 1996. As expected,
starting from the initial balance of zero, accounts payable and other current
liabilities grew to a more normal operating level of approximately $340,000.
- 11 -
<PAGE> 12
At June 30, 1996, the ratio of current assets to current liabilities was 1.7 to
1. Per its current financial operating plans, the Company believes that its
existing cash resources, combined with anticipated cash flows from future
operations, possibly supplemented by a line of credit currently under
negotiation, can provide sufficient resources to meet present and reasonably
foreseeable working capital requirements and other cash needs through the end
of the fiscal year. Insofar as the Company elects to undertake or accelerate
significant research and development projects for new products, it may require
additional outside financing at that time.
The preceding forward-looking statements are subject to uncertainties in
economic conditions, regulatory issues, and other risk factors highlighted in
the Company's Form 10-K for the period ended December 31, 1995. Such factors
may cause actual future results to differ significantly from management's
current expectations.
- 12 -
<PAGE> 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
As described in Note 1 to the financial statements, in January 1996
Endocare was spun-out from its previous parent company, Medstone
International, Inc., becoming a totally independent,
publicly-traded corporation. In the first quarter of 1996,
Endocare, Inc. issued 5,616,528 shares of Endocare common stock to
Medstone in exchange for $500,000 cash and the accounts receivable,
inventory, and other net assets of the Endocare Division. On
February 6, 1996, Medstone distributed to existing Medstone
shareholders a stock dividend of one share of Endocare common stock
for each share of Medstone common stock outstanding on December 29,
1995.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 11 Calculation of Earnings Per Share page 15
Exhibit 27 Financial Data Schedule page 16
(b) Reports on Form 8-K
April 25, 1996: Licensing agreement with Brigham and
Women's Hospital.
April 29, 1996: Change in accountants to KPMG Peat
Marwick LLP.
- 13 -
<PAGE> 14
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) 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.
ENDOCARE, INC.
(Registrant)
Date: August 13, 1996 /s/ PAUL W. MIKUS
------------------------------
Paul W. Mikus
Chairman of the Board,
Chief Executive Officer, President,
Chief Financial Officer
- 14 -
<PAGE> 1
EXHIBIT 11.
ENDOCARE, INC.
CALCULATION OF EARNINGS PER SHARE
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, 1996 June 30, 1996
------------- -------------
<S> <C> <C>
Net loss $ (394,557) $ (972,141)
============= =============
Weighted average number of common shares
outstanding during the period 5,635,139 5,630,130
============= =============
Primary net loss per share $ (.07) $ (.17)
======= =======
Fully diluted net loss per share $ (.07) $ (.17)
======= =======
</TABLE>
Notes: Earnings per share data is not presented for 1995 because
Endocare was operating as a division of Medstone
International, Inc. at that time.
The effect of potential exercise of common stock options
is not included in these calculations because such effect
would be anti-dilutive.
- 15 -
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 282,104
<SECURITIES> 0
<RECEIVABLES> 172,739
<ALLOWANCES> 57,372
<INVENTORY> 146,093
<CURRENT-ASSETS> 565,043
<PP&E> 393,494
<DEPRECIATION> 273,007
<TOTAL-ASSETS> 701,437
<CURRENT-LIABILITIES> 340,549
<BONDS> 0
0
0
<COMMON> 1,333,029
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 701,437
<SALES> 788,841
<TOTAL-REVENUES> 790,441
<CGS> 476,164
<TOTAL-COSTS> 476,164
<OTHER-EXPENSES> 1,286,418
<LOSS-PROVISION> 8,420
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (972,141)
<INCOME-TAX> 0
<INCOME-CONTINUING> (972,141)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (972,141)
<EPS-PRIMARY> (.17)
<EPS-DILUTED> (.17)
</TABLE>
