UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15 (d)
of the Securities Exchange Act of 1934
For Quarterly Period Ended March 31, 2005
Commission File Number 0-10832
AFP Imaging Corporation
------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
New York 13-2956272
- --------------------------------- ------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
250 Clearbrook Road, Elmsford, New York 10523
---------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
914-592-6100
(Registrant's Telephone Number, Including Area Code)
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____ No__X__
The registrant had 9,399,717 shares of its common stock outstanding as of May 2,
2005.
1
This Quarterly Report on Form 10-Q contains certain forward-looking statements
within the meaning of the Private Securities Reform Act of 1995. Forward-looking
statements involve known and unknown risks and uncertainties and other factors
that could cause actual results of AFP Imaging Corporation (collectively with
its subsidiaries, the "Company") or achievements expressed or implied by such
forward-looking statements to not occur, not be realized or differ materially
from that stated in such forward-looking statements. Forward-looking statements
may be identified by terminology such as "may," "will," "could," "would,"
"project," "expect," "believe," "estimate," "anticipate," "intend," "continue,"
"potential," "opportunity" or similar terms, variations of such terms, or the
negative of such terms or variations. Potential risks, uncertainties and factors
include, but are not limited to:
o adverse changes in general economic conditions,
o the Company's ability to repay its debts when due,
o changes in the markets for the Company's products and services,
o the ability of the Company to successfully design, develop,
manufacture and sell new products,
o the Company's ability to successfully market its existing and new
products,
o adverse business conditions,
o changing industry and competitive conditions,
o the effect of technological advancements on the Company's products,
o maintaining operating efficiencies,
o pricing pressures,
o risks associated with foreign sales,
o the Company's ability to attract and retain key personnel,
o difficulties in maintaining adequate long-term financing to meet the
Company's obligations and fund the Company's operations,
o changes in the nature or enforcement of laws and regulations
concerning the Company's products, services, suppliers, or the
Company's customers,
o determinations in various outstanding legal matters,
o changes in currency exchange rates and regulations, and
o other factors set forth in this Quarterly Report on Form 10-Q, and the
Company's Annual Report on Form 10-K for the year ended June 30, 2004,
and from time to time in the Company's other filings with the
Securities and Exchange Commission.
Readers are urged to carefully review and consider the various disclosures made
by the Company in this Current Report on Form 10-Q, the Company's Annual Report
on Form 10-K for the year ended June 30, 2004, and the Company's other filings
with the SEC. These reports attempt to advise interested parties of the risks
and factors that may affect the Company's business, financial condition and
results of operations and prospects. The forward-looking statements made in
this Form 10-Q speak only as of the date hereof and we disclaim any obligation
to provide updates, revisions or amendments to any forward-looking statements
to reflect changes in the Company's expectations or future events.
PART I. Financial Information
The consolidated financial statements included herein have been prepared by the
Company without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission. While certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles in the United States have been condensed or
omitted pursuant to such rules and regulations, the Company believes that the
disclosures made herein are adequate to make the information presented not
misleading. It is recommended that these consolidated financial statements be
read in conjunction with the Company's consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 2004.
In the opinion of the Company, all adjustments necessary to present fairly the
Company's consolidated financial position as of March 31, 2005, and its results
of operations for the three and nine-month periods ended March 31, 2005 and
2004, and its cash flows for the nine-months period ended March 31, 2005 and
2004, consisting of normal recurring adjustments, have been included.
2
Item 1: FINANCIAL STATEMENTS
AFP Imaging Corporation and Subsidiaries
Consolidated Balance Sheets - March 31, 2005 and June 30, 2004
Assets March 31, June 30,
2005 2004
------------ -----------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 435,530 $ 331,993
Accounts receivable, less allowance for
doubtful accounts of $93,000 and
$95,000, respectively
2,627,713 2,503,760
Inventories 3,116,775 2,704,009
Prepaid expenses and other current assets 114,855 267,380
Deferred Income Taxes 340,000 --
------------ ------------
Total current assets 6,634,873 5,807,142
------------ ------------
PROPERTY, PLANT AND EQUIPMENT,
At cost 1,640,247 1,502,811
Less accumulated depreciation (1,247,184) (1,114,540)
------------ ------------
393,063 388,271
------------ ------------
Other Assets 41,251 49,482
------------ ------------
$ 7,069,187 $ 6,244,895
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 651,057 $ 1,451,094
Accounts payable 1,388,652 922,499
Accrued expenses 797,248 847,923
------------ ------------
Total current liabilities 2,836,957 3,221,516
Long Term Debt 22,222 222,223
------------ ------------
Deferred Rent 120,496 135,760
------------ ------------
Total liabilities 2,979,675 3,579,499
------------ ------------
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value; authorized
30,000,000 shares, issued and outstanding
9,399,717 and 9,270,617 shares at March
31, 2005, and June 30, 2004, respectively
93,997 92,710
Common stock warrants 19,800 19,800
Paid-in capital in excess of par 11,584,701 11,545,883
Accumulated deficit (7,608,986) (8,992,997)
------------ ------------
Total shareholders' equity 4,089,512 2,665,396
------------ ------------
$ 7,069,187 $ 6,244,895
============ ============
The accompanying notes to financial statements are an integral part of these
statements.
3
AFP Imaging Corporation and Subsidiaries
Consolidated Statements of Shareholders' Equity
For the Nine Months Ended March 31, 2005 and 2004
(Unaudited)
Common Paid-in
Common Stock Capital In Accumulated
Stock Warrants Excess of Par Deficit Total
------- -------- ----------- ------------ ---------
Balance June 30, 2003 $92,710 $19,800 $11,545,883 $(10,338,464) $1,319,929
Net income for nine months
ended March 31, 2004 -- -- -- 938,011 938,011
------------------------------------------------------------------------
Balance March 31, 2004 $92,710 $19,800 $11,545,883 $ (9,400,453) $2,257,940
======= ======== =========== ============ ==========
Balance June 30, 2004 $92,710 $19,800 $11,545,883 $ (8,992,997) $2,665,396
Issuance of 129,100 shares of common
stock in connection with the exercise of
stock options 1,287 -- 38,818 -- 40,105
Net income for nine months
ended March 31, 2005 -- -- -- 1,384,011 1,384,011
------------------------------------------------------------------------
Balance March 31, 2005 $93,997 $19,800 $11,584,701 $ (7,608,986) $4,089,512
======= ======== =========== ============ ==========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
4
AFP Imaging Corporation and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
Three Months Ended Nine Months Ended
March 31, March 31,
---------------------------- ------------------------------
2005 2004 2005 2004
---------------------------- ------------------------------
Net sales $ 6,240,931 $5,476,342 16,978,637 $14,191,778
Cost of sales 3,765,143 3,385,645 10,285,131 8,695,005
----------- ---------- ------------ ------------
Gross profit 2,475,788 2,090,697 6,693,506 5,496,773
Selling, general and administrative expenses (Note 7) 1,715,313 1,497,066 5,270,786 4,044,428
Research and development expenses 97,106 97,571 275,691 298,168
----------- ---------- ------------ ------------
1,812,419 1,594,637 5,546,477 4,342,596
----------- ---------- ------------ ------------
Operating income 663,369 496,060 1,147,029 1,154,177
Interest expense, net 22,235 36,491 104,543 119,632
----------- ---------- ------------ ------------
Income before provision/(benefit) for income taxes 641,134 459,569 1,042,486 1,034,545
Provision/(benefit) for income taxes (357,465) 35,062 (341,525) 96,534
----------- ---------- ------------ ------------
Net income $ 998,599 $ 424,507 $ 1,384,011 $ 938,011
=========== ========== ============ ============
Net income per common share:
Basic $ .11 $ .05 $ .15 $ .10
Diluted $ .10 $ .04 $ .14 $ .10
Weighted average outstanding common stock:
Basic 9,399,717 9,271,054 9,373,386 9,271,054
========== ========== ============ ===========
Diluted 9,933,654 9,822,026 9,939,761 9,542,032
========== ========== ============ ===========
The accompanying notes to consolidated financial statements are an integral part
of these statements.
5
AFP Imaging Corporation and Subsidiaries
Consolidated Statements of Cash Flows
For the Nine Months Ended March 31, 2005 and 2004
(Unaudited)
2005 2004
------------ ----------
Cash flows from operating activities:
Net Income $ 1,384,011 $ 938,011
Adjustments to reconcile net income to net cash provided by operating activities-
Depreciation and amortization 172,600 159,964
Deferred Income tax benefit (340,000) --
Change in assets and liabilities:
(Increase)/decrease in accounts receivable (123,953) 159,920
(Increase) in inventories (412,766) (26,972)
Decrease/(Increase) in prepaid expenses and other assets 105,536 (6,988)
Increase in accounts payable 466,153 148,505
(Decrease)/increase in accrued expenses (50,675) 49,855
------------ ----------
Total adjustments (183,105) 484,284
------------ ----------
Net cash provided by operating activities 1,200,906 1,422,295
------------ ----------
Cash flows from investing activities:
Capital expenditures (137,436) (86,222)
------------ ----------
Net cash used in investing activities (137,436) (86,222)
------------ ----------
Cash flow from financing activities:
Repayment of debt (1,000,038) (1,359,023)
Exercise of common stock options 40,105 --
------------ ----------
Net cash used by financing activities (959,933) (1,359,023)
------------ ----------
Net increase/(decrease) in cash and cash equivalents 103,537 (22,950)
Cash and cash equivalents, at beginning of period 331,993 658,138
------------ ----------
Cash and cash equivalents, at end of period
$ 435,530 $ 635,188
=========== ==========
Supplemental cash flow disclosures:
Cash paid during the year for-
Interest $ 109,294 $ 126,580
Income taxes net of refunds $ 35,940 $ 11,534
The accompanying notes to consolidated financial statements are an integral part
of these consolidated statements.
6
AFP Imaging Corporation and Subsidiaries
Notes to Consolidated Financial Statements
March 31, 2005
(Unaudited)
(1) General:
AFP Imaging Corporation (together with its subsidiaries, the "Company") was
organized on September 20, 1978, under the laws of the State of New York. Since
such date, the Company has been engaged in the business of designing,
developing, manufacturing and distributing equipment for generating, capturing
and producing medical and dental images through digital technology, as well as
the chemical processing of photosensitive materials. Medical, dental, veterinary
and industrial professionals use these products. The Company's products are
distributed to worldwide markets under various brand names through a network of
independent and unaffiliated dealers. The Company has only one business segment,
medical/dental.
The accounting policies followed during the interim periods reported on herein
are in conformity with accounting principles generally accepted in the United
States and are consistent with those applied for annual periods, as described in
the Company's consolidated financial statements included in the Company's Annual
Report on Form 10-K for the year ended June 30, 2004.
(2) Stock Option Plans:
The Company currently has in effect three employee incentive stock option plans,
under which approximately 2,071,000 shares of common stock are currently
authorized and available for issuance. The Company accounts for these plans
pursuant to Accounting Principles Board Opinion No. 25 "Accounting for Stock
Issued to Employees," under which no compensation cost has been recognized. Had
compensation cost for these plans been determined based on the fair value at the
grant dates consistent with Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation", and SFAS No. 148 "Accounting
for Stock-Based Compensation-Transition and Disclosure-an Amendment of FASB No.
123" the Company's net income and earnings per share would have been reduced by
approximately $5,000 and $17,000 for the three and nine-month periods ended
March 31, 2005, and approximately $5,000 and $8,000 for the three and nine-month
periods ended March 31, 2004.
Stock options to purchase 30,000 shares of the Company's common stock were
granted to the Company's outside Board of Director members in the nine-month
period ended March 31, 2005, in accordance with the Company's policy for
non-employee director compensation. Subsequent to March 31, 2005, the Company
accelerated the vesting of 300,000 stock options previously granted to executive
officers. There will be no significant effect on the Company's results of
operations as a result of this acceleration of vesting.
(3) Basic and Diluted Income (Loss) Per Common Share:
The computation of net income per common share is based upon the weighted
average number of common shares outstanding during the period, plus, in periods
in which they have a dilutive effect, the effect of shares contingently
issuable. The diluted weighted average number of shares outstanding includes
489,547 and 238,728 shares of common stock issuable upon exercise of outstanding
stock options in the nine months ended March 31, 2005 and 2004, respectively.
The diluted weighted average number of shares outstanding includes 457,295 and
484,356 shares of common stock issuable upon exercise of outstanding stock
options in the three months ended March 31, 2005 and 2004, respectively. The
diluted weighted average number of shares outstanding includes 76,827 and 32,250
shares of common stock issuable upon the exercise of outstanding warrants in the
nine months ended March 31, 2005 and 2004, respectively. The diluted weighted
average number of shares outstanding includes 76,642 and 66,316 shares of common
stock issuable upon the exercise of outstanding warrants in the three months
ended March 31, 2005 and 2004, respectively.
(4) Long and Short Term Debt:
On September 21, 2004, the Company renewed its senior secured credit facility
(the "Renewed Revolving Credit Loan") with its existing senior secured lender
for an additional three-year period. The Renewed Revolving Credit Loan consists
of a $2.5 million revolving line of credit, which is secured by all of the
Company's inventory, accounts receivable, equipment, officer life insurance
policies and proceeds thereof, trademarks, licenses, patents and general
intangibles. The Renewed Revolving Credit Loan has an interest rate of 1.375%
over the prime rate, currently at 5 3/4 %, has a specific formula to calculate
available funds based on eligible accounts receivable and inventory, and has
certain reporting requirements to the senior secured lender. The Renewed
Revolving Credit Loan also requires that certain financial ratios and net worth
amounts be maintained. The Renewed Revolving Credit Loan provides for increases
in the interest rate charged on monies outstanding under specific circumstances.
As of March 31, 2005, the amount outstanding under the Renewed Revolving Credit
Loan was $384,390 and the Company was in compliance with all the terms and
conditions of the Renewed Revolving Credit Loan. Included in debt is a
subordinated promissory note related to a prior acquisition. This note totals
$288,889 at March 31, 2005, of which approximately $266,667 has been classified
as a current liability; repayment is scheduled at $22,222.22 per month until
April 2006. A second subordinated promissory note related to a prior acquisition
was repaid in full as of December 31, 2004.
7
(5) Inventory:
Inventories, which include material and a small component of labor and
manufacturing overhead, are stated at the lower of cost (first-in, first-out) or
market (net realizable value). Production materials represent a small component
of inventory at month-end due to the manufacturing cycle. The Company uses a
standard cost accounting system in conjunction with an actual perpetual
inventory system to properly account for, control, and maintain the movement of
all inventory components. All standard costs are reviewed periodically and
updated accordingly to verify that the standard costs approximate the actual
costs. At March 31, 2005 and June 30, 2004, inventories consist of the
following:
March 31, 2005 June 30, 2004
-------------- -------------
(Unaudited)
----------
Raw materials and sub-component parts $1,857,515 $1,354,424
Work-in-process and finished goods 1,259,260 1,348,585
---------- -------------
$3,116,775 $2,704,009
========== ==============
(6) Income Taxes:
Income taxes are accounted for under the asset and liability method. Deferred
income taxes are recorded for temporary differences between financial statement
carrying amounts and the tax basis of assets and liabilities. Deferred tax
assets reflect the tax rates expected to be in effect in the period in which the
differences are expected to reverse. The Company records a valuation allowance
to reduce its deferred tax asset to an amount that is more likely than not to be
realized.
During the quarter ended March 31, 2005, the Company recorded an income tax
benefit of approximately $340,000, resulting from a decrease in the Company's
valuation allowance against its deferred tax asset. The deferred tax asset
primarily relates to losses reported in prior years. As of March 31, 2005, the
Company believes it is likely that they will utilize a portion of these prior
year net operating loss carryforwards. The remaining balance of the tax benefit
recorded for the three and nine months ended March 31, 2005, includes state
income and capital taxes, and related refunds and credits received. The
Company's income tax provision for the Fiscal 2004 three and nine-month periods
relate to state income and capital taxes, net of any refunds received. As of
March 31, 2005, the Company had approximately $8.7 million in federal net
operating loss carryforwards, and approximately $14.0 million in state net
operating loss carryforwards.
(7) Commitments and Contingencies:
On October 4, 2004, the Company joined the alternative dispute resolution
("ADR") process (for smaller claims) consisting of third party defendants who
made a settlement offer to a neutral party to resolve their liability related to
the offsite disposition of trash and waste in a landfill in New Jersey prior to
1985. Selling, General and Administrative expenses for the nine months ended
March 31, 2005 include a provision of $75,000, which represents the Company's
potential liability under this settlement offer, net of the Company's insurance
carrier's agreed upon contribution towards the total settlement. This offer has
not been accepted at the current time, and no counter proposals have been
received. The Company is currently awaiting a further settlement proposal from
the ADR neutral party.
On December 6, 2004, the Company reached an agreement as to the parameters of a
settlement, which was finalized on February 8, 2005 and paid on February 18,
2005, relating to a different environmental claim filed in 2001 in the Superior
Court of New Jersey, Morris County, which alleged that the Company's
discontinued graphic arts camera subsidiary had contaminated a portion of the
subsidiary's site during the manufacturing process prior to 1985. The settlement
included a Release and Indemnification as well as a Stipulation of Dismissal
with Prejudice. Selling, General and Administrative expenses for the nine months
ended March 31, 2005 includes a provision of $125,000, which brings the total
accrued liability on this claim to $325,000. This represents the Company's
entire liability under this settlement offer, net of the Company's insurance
carrier's agreed upon contribution towards the total and final settlement, and
was paid in full.
(8) New Accounting Standards:
In November and December 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 151, "Inventory Costs-an Amendment of ARB No. 43, Chapter 4,"
SFAS No. 152, "Accounting for Real Estate Time-Sharing Transactions-an Amendment
of FASB Statement No. 66 and 67," and SFAS No. 153, "Exchanges of Non-monetary
Assets-an Amendment of APB Opinion No. 29." The Company has determined that
these statements will not have any effect on the Company's results of operations
or financial position.
8
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment." This
statement requires companies to begin expensing equity-based awards in the first
annual reporting period beginning after June 15, 2005. This statement will be
effective for the Company beginning in Fiscal 2006. The Company is continuing to
review the terms and conditions of Statement 123R to determine the effect on the
Company's results of operations and financial position, however, the Company
does not currently believe that Statement 123R will have a significant impact.
9
Item 2: Management's Discussion and Analysis of Financial Condition and Results
of Operation
Capital Resources and Liquidity
The Company's working capital at March 31, 2005 increased by approximately
$1,212,300 from June 30, 2004. This increase principally is due to internally
generated funds, reductions in the revolver debt, an increase in the current
deferred tax asset, and increases in accounts payable, offset by scheduled
payments on the subordinated debt and increases in inventory levels and accounts
receivable.
The Company's increase in sales this fiscal year has increased cash collections
and profits. This cash has been used to reduce debt whenever possible. A small
percentage increase by customers using national credit cards continues to
expedites the collection process. The Company is currently working towards
increasing its finished goods inventory levels, so as to better satisfy
worldwide customer demand; however due to increasing sales, the increase in
inventory is currently in production components. The Company has not changed its
payment policies to its vendors.
On September 21, 2004, the Company renewed its senior secured credit facility
(the "Renewed Revolving Credit Loan") with its existing senior secured lender
for an additional three-year period. The maximum borrowing permitted under the
Renewed Revolving Credit Loan is lower than that under the original credit
facility with the lender, based on the Company's current requirements. However,
the Renewed Revolving Credit Loan has more favorable terms, including a lower
interest rate and less stringent reporting requirements, than that under the
prior credit facility and gives the Company the ability to borrow on a specific
amount of foreign accounts receivable. The Renewed Revolving Credit Loan
consists of a $2.5 million revolving line of credit, which is secured by all of
the Company's inventory, accounts receivable, equipment, officer life insurance
policies and proceeds thereof, trademarks, licenses, patents and general
intangibles. The Renewed Revolving Credit Loan has an interest rate of 1.375%
over the prime rate, currently at 5-3/4 %, has a specific formula to calculate
available funds based on eligible accounts receivable and inventory, and has
certain reporting requirements to the senior secured lender. The Renewed
Revolving Credit Loan also requires that certain financial ratios and net worth
amounts be maintained. The Renewed Revolving Credit Loan provides for increases
in the interest rate charged on monies outstanding under specific circumstances.
As of March 31, 2005, the amount outstanding under the Renewed Revolving Credit
Loan was $384,390 and the Company was in compliance with all the terms and
conditions of the Renewed Revolving Credit Loan.
Included in debt is a subordinated promissory note related to a prior dental
company acquisition. This note totals $288,889 in principal amount at March 31,
2005, of which approximately $266,667 has been classified as a current
liability. The Company is current on all principal and interest payments due the
note holder. A second subordinated promissory note related to a different prior
acquisition was repaid in full as of December 31, 2004.
The Company's historical operating cash flows generally have been positive;
however, the Company is dependent upon the Renewed Revolving Credit Loan to
finance its ongoing operations. It is believed that the Revolving Credit Loan is
sufficient to finance the Company's ongoing working capital requirements for the
foreseeable future. The Company expects its working capital requirements will
continue to be financed by operations and from borrowings, including borrowings
under the Renewed Revolving Credit Loan. The Company currently believes that
there are no significant trends, demands, commitments or contingencies, which
are reasonably likely to result in a material increase or decrease in its
liquidity or capital resources in the foreseeable near-term future. As of May 6,
2005, the Company had available approximately $2,159,000 of unused credit under
the terms of the Renewed Revolving Credit Loan.
The terms of the Renewed Revolving Credit Loan limit the amount of capital
expenditures. However, such terms can be waived by the senior secured lender
when needed. Capital expenditures for the first nine months of Fiscal 2005 were
$137,436, consisting of tooling, foundry and test equipment expenditures related
to the design, development and production of the new imaging products, upgrades
to the Company's network and email servers, new computer equipment for the sales
personnel, and the purchase of a new trade show booth for national dental
exhibitions. Where practical, the Company continues to conserve its cash. The
Company expects to continue to finance any future capital requirements
principally from internally generated funds.
Results of Operations - Nine Months Fiscal 2005 Versus Nine Months Fiscal 2004
Sales increased approximately $2,786,800 or 19.6%, between the Fiscal 2005 and
Fiscal 2004 nine-month periods. Approximately 60% of this increase is
attributable to the continued growth of the Company's digital products in both
the domestic and international marketplaces. The balance of the increase in
sales is mainly attributable to increased x-ray sales and x-ray processor sales.
The Company's international sales increased 65%, mainly due to sales of the new
products.
10
Gross profit as a percent of sales improved slightly (.7 percentage points)
between the Fiscal 2005 and Fiscal 2004 nine-month periods; however, the detail
between material costs and labor and overhead costs showed significant
differences. Material costs, as a percent of sales increased .8 percentage
points, mainly due to the strength of the Euro related to the dollar, offset by
production improvements in other new products and price increases implemented in
the third quarter for some of the imported products. Labor and overhead costs
increased $142,000 due to the significantly higher sales volumes in this
nine-month period. However, the relative percentage points for labor and
overhead costs decreased 1.5 percentage points due to the higher sales base.
Selling, general, and administrative costs increased approximately $1,226,400 or
30%, between the Fiscal 2005 and Fiscal 2004 nine-month periods. This increase
is due to several different factors: (1) as of December 31, 2004, the Company
had recorded a total of $300,000 of G&A costs which included associated legal
and settlement fees related to two separate environmental lawsuits (one of which
was settled in February 2005), and (2) marketing and sales costs increased
approximately $620,000 in the current period due to the Company aggressively
pursuing various sales opportunities in both the domestic and international
markets, including increased travel costs, attendance at several national and
regional clinical exhibitions, additional advertising, and increased operating
costs. There were also consulting costs related to exploring various acquisition
opportunities in the current period. The Company anticipates continuing to
evaluate acquisition opportunities and therefore may continue to incur related
consulting costs in the future. Such costs relating to acquisition opportunities
may vary significantly between quarters depending on the extent of acquisition
activities. Due to the continued growth in sales, variable general operating
expenses have also shown a slight increase.
Research and development costs declined slightly, approximately $22,500 or 7.5%,
between the Fiscal 2005 and Fiscal 2004 nine-month periods, all in the first six
months of the fiscal year. The Company continues to invest in the design,
development and refinement of its new digital imaging products, as well as to
invest in sustaining engineering and related costs for its existing products.
Research and development costs may fluctuate between reporting periods, due to
changing research and development consulting requirements, initiation or
completion of certain project tasks, and market demands.
Interest expense, net decreased slightly, approximately $15,100 or 12.6%,
between the Fiscal 2005 and Fiscal 2004 nine-month periods. A subordinated note
was repaid as of December 2004, and the other subordinated note had a lower
principal amount and slightly lower interest rate in the current nine-month
period. This was offset by approximately $66,000 more in the average monthly
revolving credit borrowings for the current nine-month period ended March 31,
2005 and the prime rate of borrowing, upon which interest rates for all senior
debt is based, was slightly higher,
A deferred income tax benefit of approximately $340,000 resulting from a
decrease in the Company's valuation allowance against its deferred tax asset was
recorded as of March 31, 2005. The deferred tax asset primarily relates to
losses reported in prior years. The Company believes it is likely that they will
utilize a portion of these prior year net operating loss carryforwards, based on
the Company's current strong earnings history. As a result, net income for the
nine months ended March 31, 2005 was $340,000 ($.03 per diluted share) higher
than would have been reported if such tax benefit had not been recorded. The
remaining balance of the tax benefit recorded for the nine months ended March
31, 2005, includes state income and capital taxes, and related refunds and
credits received. The Company's income tax provision for the Fiscal 2004
nine-month period relates to state income and capital taxes, net of any refunds
received.
Results of Operations - Third Quarter Fiscal 2005 Versus Third Quarter Fiscal
2004
Sales increased approximately $764,600 or 14% between the third quarter Fiscal
2005 and the third quarter Fiscal 2004. Most of this increase is attributable to
the continued sales growth of the Company's digital products in both the
domestic and international marketplaces. The Company's international sales
increased 30% in the third quarter Fiscal 2005 compared to the third quarter
Fiscal 2004, mainly due to new products.
Gross profit as a percent of sales improved 1.5 percentage points between the
third quarter Fiscal 2005 and the third quarter Fiscal 2004. Material costs, as
a percent of sales stayed relatively constant between the periods, attributable
to the strength of the Euro related to the dollar, offset by production
improvements in other new products, and price increases implemented in the third
quarter for some of the imported products. Labor and overhead costs increased
slightly in the current three-month period, as the higher sales required higher
operating costs. However, the relative percentage points for labor and overhead
costs decreased 1.3 percentage points due to the higher sales base.
Selling, general, and administrative costs increased approximately $218,200 or
14.6%, between the third quarter Fiscal 2005 and the third quarter Fiscal 2004.
This increase is due to marketing and sales costs increased approximately
$150,000 in the current period due to the Company aggressively pursuing various
sales opportunities in both the domestic and international markets, including
increased travel costs, attendance at several national and regional clinical
exhibitions, additional advertising, and increased operating costs. The balance
of this increase can be attributed to increased variable general operating
expenses commensurate with the increase in sales.
11
Research and development costs stayed relatively constant between the third
quarter Fiscal 2005 and the third quarter Fiscal 2004. The Company continues to
invest in the design, development and refinement of its new imaging products, as
well as to invest in sustaining engineering and related costs for its existing
products. Research and development costs may fluctuate between reporting
periods, due to changing research and development consulting requirements,
initiation or completion of certain project tasks, and market demands.
Interest expense, net decreased approximately $14,300 or 39.2%, between the
third quarter Fiscal 2005 and the third quarter Fiscal 2004. There was
approximately $288,000 less in the average monthly revolving credit borrowings
for the current three-month period ended March 31, 2005 offset by the prime rate
of borrowing, upon which interest rates for all senior debt is based, was
slightly higher. Additionally, there was both a lower principal amount and lower
interest rate on an outstanding subordinated note whose interest rate is based
on the 12-month Libor rate of borrowing. A separate subordinated note was repaid
as of December 2004, which reduced interest expense by $8,800.
A deferred income tax benefit of approximately $340,000 resulting from a
decrease in the Company's valuation allowance against its deferred tax asset was
recorded as of March 31, 2005. The deferred tax asset primarily relates to
losses reported in prior years. The Company believes it is likely that they will
utilize a portion of these prior year net operating loss carryforwards, based on
the Company's current strong earnings history. As a result, net income for the
three months ended March 31, 2005 was $340,000 ($.03 per diluted share) higher
than would have been reported if such tax benefit had not been recorded. The
remaining balance of the tax benefit recorded for the three months ended March
31, 2005, includes state income and capital taxes, and related refunds and
credits received. The Company's income tax provision for the Fiscal 2004
three-month period relates to state income and capital taxes, net of any refunds
received.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to makes estimates
and assumptions that affect the reported amounts of assets and liabilities and
the reported amounts of revenues and expenses. These estimates and assumptions
are evaluated on an ongoing basis based on historical internal operations,
industry trends and conditions, market conditions and other information that
management believes to be reasonable or applicable under the circumstances.
There can be no assurances that actual results of operations will be consistent
with management's estimates and assumptions, and that reported results of
operations will not be adversely affected by the requirement to make accounting
adjustments to reflect changes in these estimates from time to time. The
following policies are those that management believes to be the most sensitive
to estimates and judgments.
Accounts Receivable
The Company reports accounts receivable net of reserves for doubtful accounts.
Credit is extended to worldwide distributors on varying terms between 30 and 90
days. The reserve for doubtful accounts is management's best estimate of the
amount of probable credit losses in the Company's existing accounts receivable
and is based upon continual analysis of the accounts receivable aging including
credit risk of specific customers, historical trends and other related
information. The Company writes off accounts receivable when they become
uncollectible. There have been no significant changes in the computation
methodology of the reserve for doubtful accounts in the past three years and the
Company has not had significant bad debt write-offs in the past few years.
Management believes that any potential risk associated with the estimate of
reserve for doubtful accounts is therefore limited.
Inventories
Inventories, which include material and a small component of work-in-process
labor and overhead, are stated at the lower of cost (first in, first out) or
market (net realizable value). The Company uses a standard cost accounting
system in conjunction with an actual perpetual system to properly account for,
control and maintain the movement of all inventory components. The Company has
established inventory reserves based on inventory estimated to be obsolete, slow
moving, or unmarketable due to changing technological and market conditions. If
actual market and technical conditions are less favorable than those
anticipated, additional inventory reserves would be required. There have been no
significant changes in the computation methodology of the reserves for inventory
in the past three years.
Warranties
The Company records a liability for an estimate of costs that it expects to
incur under its limited warranty based on revenues. Various factors affect the
Company's warranty liability, including (1) number of units sold, (2) historical
rates of claims, (3) anticipated rates of claims, as well as (4) costs per
claim. The Company periodically assesses the adequacy of its warranty liability
based on changes in these factors.
12
In March 2005, the Company began to include an extended warranty with its
digital sensors. The Company will monitor the rate and costs of claims and
review the adequacy of its warranty liability and make any changes as necessary.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred
income taxes are recorded for temporary differences between financial statement
carrying amounts and the tax basis of assets and liabilities. Deferred tax
assets reflect the tax rates expected to be in effect in the period in which the
differences are expected to reverse. The Company records a valuation allowance
to reduce its tax asset when it is more likely than not that a portion of the
amount may not be realized. The Company estimates its valuation allowance based
on an estimated forecast of its future profitability. Any significant changes in
future profitability resulting from variations in future revenues or expenses
could affect the valuation allowance on its deferred tax asset and operating
results could be effected, accordingly.
Item 3: Quantitative and Qualitative Disclosures About Market Risk.
The Company's earnings and cash flows are subject to changes in interest
rates (short-term prime based interest rates and the 12-month LIBOR rate)
primarily from its borrowings under its senior and subordinate debt. The Company
does not believe that it is materially exposed to changes in interest rates; as
at March 31, 2005 there was approximately $673,000 in total debt outstanding.
The Company does not currently use interest rate derivative instruments to
manage exposure to interest rate changes.
The Company's earnings and cash flows are subject to foreign currency exchange
rate risk, specifically the Euro/Dollar and the Yen/Dollar. The Company does not
believe that it is materially exposed to foreign currency exchange rate risk due
to the volume of purchases in foreign currency relative to purchases in US
dollars; however the relative strength of the Dollar to the Euro or to the Yen
does affect the Company's Gross Profit. The Company continuously monitors all
changes in foreign currency and adjusts its pricing to customers to reflect
these changes.
Item 4: Controls and Procedures.
a) Evaluation of disclosure controls and procedures
Our co-chief executive officers and chief financial officer have reviewed and
evaluated the effectiveness of the Company's disclosure controls and procedures
(as defined in Rule 13a - 15 (e) of the Securities Exchange Act of 1934 (the
"Act")). Based on their review and evaluation, the co-chief executive officers
and chief financial officer have concluded that, as of March 31, 2005, the
Company's disclosure controls and procedures were adequate and effective to
ensure that information required to be disclosed by the Company in the reports
that it files or submits under the Act is recorded, processed, summarized and
reported, within the time periods specified in the rules and forms of the
Securities and Exchange Commission.
(b) Changes in internal controls
During the quarter ended March 31, 2005, there were no significant changes in
the Company's internal controls over financial reporting or in other factors
that could materially affect, or is reasonably likely to materially affect,
these internal controls, nor were there any significant deficiencies or material
weaknesses in these internal controls requiring corrective actions. As a result,
no corrective actions were taken.
13
Part II Other Information
Item 1: Legal Proceedings.
Reference is made to Item 3 in the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 2004, and to the references therein, for a discussion
of all material pending legal proceedings to which the Company and its
subsidiaries are parties.
On October 4, 2004, the Company joined the alternative dispute resolution
("ADR") process (for smaller claims) consisting of third party defendants who
made a settlement offer to a neutral party to resolve their liability related to
the offsite disposition of trash and waste in a landfill in New Jersey prior to
1985. The Company's financial statements for the three months ended September
30, 2004 include a provision of $75,000, which represents the Company's
potential liability under this settlement offer, net of the Company's insurance
carrier's agreed-upon contribution towards the total settlement. This offer has
not been accepted at the current time, and no counter proposals have been
received. The Company is currently awaiting a further settlement proposal from
the ADR neutral party.
On December 6, 2004, the Company reached an agreement as to the parameters of a
settlement, which was finalized on February 8, 2005, and paid on February 18,
2005, relating to a different environmental claim filed in 2001 in the Superior
Court of New Jersey, Morris County, which alleged that the Company's
discontinued graphic arts camera subsidiary had contaminated a portion of the
subsidiary's site during the manufacturing process prior to 1985. The settlement
included a Release and Indemnification as well as a Stipulation of Dismissal
with Prejudice. The Company's financial statements for the three months ended
December 31, 2004, include a provision of $125,000, which brings the total
accrued liability on this claim to $325,000. This represents the Company's
entire liability under this settlement offer, net of the Company's insurance
carrier's agreed-upon contribution towards the total and final settlement.
Item 2: Unregistered Sales in Equity Securities and Uses of Proceeds.
None
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.
(a) Exhibits:
(1) 31.1, 31.2, 31.3 - Certifications pursuant to
Exchange Act Rule 13a - 14 (a).
(2) 32.1, 32.2, 32.3 - Certifications pursuant to 18
U.S.C. Section 1350 of the Sarbanes - Oxley Act of 2002.
14
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.
AFP IMAGING CORPORATION
/s/ David Vozick
---------------------------------
David Vozick
Chairman of the Board
Secretary, Treasurer
Date: May 13, 2005
/s/ Donald Rabinovitch
---------------------------------
Donald Rabinovitch
President
(Principal Executive Officer)
Date: May 13, 2005
/s/ Elise Nissen
---------------------------------
Elise Nissen
Chief Financial Officer
(Principal Financial
and Accounting Officer)
Date: May 13, 2005
15