1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

Hydromer, Inc. & Subsidiary (the “Company”) is a polymer research and development company based in Branchburg, New Jersey. The Company develops polymer complexes for commercial markets in both the United States and abroad for the medical, cosmetics, animal health and industrial fields. The Company also offers R&D, engineering and contract coating services (through its wholly owned subsidiary, Biosearch Medical Products, Inc. (“Biosearch”)) in its array of capabilities. The Company obtains patent rights on certain products from which royalty revenues can be received. Biosearch, a U.S. based corporation, was also previously a medical device manufacturer for various medical products companies. During the 2010 fiscal year, the Company sold off the remaining part of its OEM medical device business (see Footnote 14).

Principles of Consolidation

The consolidated financial statements include the accounts of Hydromer, Inc. and its wholly owned subsidiary. All significant intercompany balances and transactions have been eliminated.

Cash and Cash Equivalents

Cash and cash equivalents consist of investments with original maturities of three months or less.

Short-Term Investments

Short-term investments consist of investments other than cash and cash equivalents with original maturities of greater than three months and less than one year. Short-term investments as of June 30, 2011 was $50,000, comprising of a bank CD with an interest rate of 0.345%. Short term investments as of June 30, 2010 were $440,000.

Accounts Receivables

Accounts receivable are uncollateralized, non-interest-bearing customer obligations due under normal trade terms requiring payment typically within 30 days from the invoice date, or in the case of royalties or contract payments (see Revenue Recognition), usually 45 days from the end of a calendar quarter. Trade accounts receivable are stated at the amount billed to the customer; royalties and contract revenues are estimated until reported by the licensee / contractual party. Payments of accounts receivable are allocated to the specific invoices identified on the customer's remittance advice or, if unspecified, are applied to the oldest unpaid invoices. The carrying amount of accounts receivable is reduced by a valuation allowance that reflects the Company's best estimate of the amounts that may not be collected. This estimate is based on reviews of all balances in excess of 90 days past due from the invoice date. Based on this assessment of current credit worthiness, the Company estimates the portion, if any, of the balance that will not be collected. Management also considers the need for additional general reserves and reviews its valuation allowance on a quarterly basis.

Fair Value Measurements

Accounting Standards Codification (“ASC”) 820-10, Fair Value Measurements, defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under ASC 820-10 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or the most advantageous market for an asset or liability in an orderly transaction between participants on the measurement date. Valuation techniques used to measure fair value under ASC 820-10 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on the levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

• Level 1 - Quoted prices in active markets for identical assets or liabilities.

• Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or corroborated by observable market data or substantially the full term of the assets or liabilities.

• Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the value of the assets or liabilities

Inventories

Inventories are valued at the lower of cost, determined by the first-in, first-out method, or market and include appropriate amounts of labor and overhead.

Depreciation

The cost of property and equipment, which includes a reasonable portion of labor costs for equipment built in-house, is depreciated on a straight-line method over the estimated useful lives of the assets: 5-10 years for machinery and equipment, 3-5 years for furniture and office equipment and 40 years for the building. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is reflected in income for the period. Repairs and maintenance which do not extend the useful lives of the related assets are expensed as incurred.

Patents

Registration and maintenance costs associated with the filing and registration of patents are prepaid and amortized over its remaining life of the patent, not to exceed 20 years. Costs associated with patents which are not approved or abandoned are expensed in the period in which such patents are not approved or abandoned. The annual maintenance fees associated with existing patents are expensed over 12 months and are included in Prepaid Expenses. The Research and Development costs associated with the patented technology are expensed as incurred and are not capitalized.

Long-Lived Assets

The Company assesses long-lived assets for impairment as required under ASC 360-10, Accounting for the Impairment or Disposal of Long-Lived Assets. The Company reviews for impairment whenever events or circumstances indicate that the carrying amount of these assets may not be recoverable. The Company assesses these assets for impairment based on estimated future cash flows from these assets.

Revenue Recognition

Revenues from product and services sales are recognized at the time of shipment or services rendered provided that collection of the resulting receivable is probable. Revenues from royalties are recognized upon the sale of certain products by licensees with whom the Company has licensing agreements. Contract Revenues, which includes payments from Stand Still, Supply or Support agreements that are typically based on time frames, are recognized in the periods to which it pertains. Deferred revenues are recorded when agreements call for payment ahead of when the amounts are earned.

Shipping and Handling Charges

The Company includes costs of shipping and handling billed to customers in Revenues and the related expense of shipping and handling costs in Cost of Sales.

Advertising

Advertising costs are expensed as incurred except for tangible assets, such as printed advertising materials, which are expensed as consumed. Advertising expense was $110,745 and $47,340 for the years ended June 30, 2011 and 2010, respectively.

 

Research and Development

Research and development costs, primarily employee salaries and benefits, are charged to operations when incurred and are included in Operating Expenses. The amounts charged to expense for the years ended June 30, 2011 and 2010 were $654,952 and $837,351, respectively.

Stock Based Compensation

The Company accounts for stock and stock options issued for services and compensation to employees under ASC 718-10. For non-employees, the fair market value of the Company's stock on the date of stock issuance or option/grant is used. The Company determines the fair market value of the options issued under the Black-Scholes Pricing Model. Under the provisions of ASC 718-10, share-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the employee's requisite service period (generally the vesting period of the equity grant). There were no such stock option grants issued during the years ended June 30, 2011 and June 30, 2010.

Foreign Currency Translation

The Company’s functional currency is the United States Dollar. The Company accounts for foreign currency translation pursuant to Financial Accounting Standards Board (“FASB”) ASC 830-20, Foreign Currency Transactions.   All assets and liabilities are translated into United States dollars using the rates prevailing at the end of the period.  Revenues and expenses are translated using the average exchange rates prevailing throughout the period.  Unrealized foreign exchange amounts resulting from translations at different rates according to their nature are included in accumulated other comprehensive income or loss.  Recognized foreign currency transaction gains and losses are recognized in the operations.

Comprehensive Income (Loss)

The Company applies the provisions of FASB’s ASC 220-10, Reporting Comprehensive Income. in which unrealized gains and losses from foreign exchange translations are reported in the consolidated statements of shareholders’ deficit as comprehensive income (loss).

As of June 30, 2011, there was no comprehensive income (loss).

Income Taxes

Income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the bases of assets and liabilities for financial and income tax reporting. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred taxes are also recognized for operating losses that are available to offset future federal and state income taxes. Any interest charges on underpayment or other assessments are recorded as interest expense. Any penalties are recorded in Operating Expenses.

Effective January 1, 2007, the Company adopted the provisions of ASC 740-10, Accounting for Uncertainty in Income Taxes. The implementation of ASC 740-10 had no impact on the Company’s financial statements as the Company has not recognized any uncertain income tax positions.

Earnings Per Share

Earnings per share, in accordance with the provisions of ASC 260-10, Earnings Per Share, is computed by dividing net income by the weighted average number of common stock shares outstanding during the period.

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 and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Reclassification

Certain amounts previously reported may have been reclassified to conform to the 2011 presentation.

 

 

2. CONCENTRATION OF CREDIT AND BUSINESS RISK

The Company is exposed to additional credit and business risks due to its concentration of activity with certain parties. For example, at times throughout the year, the Company may maintain certain bank accounts in excess of FDIC insured limits.

In addition, the Company provides credit in the normal course of business to customers. Ongoing credit evaluations of its customers are performed, and allowances for doubtful accounts are based on factors surrounding the credit risk of specific customers, historical trends and other information.

There were no significant customers for the years ended June 30, 2010 and 2011.

 

 

3. FAIR VALUE

In accordance with ASC 820-10, the following table represents the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2011 and June 30, 2010, respectively:

as of June 30, 2011	Level 1	Level 2	Level 3	Total
Assets
Investments	$ 50,000	-	-	$ 50,000
Total Assets	$ 50,000	-	-	$ 50,000
Liabilities - n/a	-	-	-	-

 

as of June 30, 2010	Level 1	Level 2	Level 3	Total
Assets
Investments	$ 440,000	-	-	$ 440,000
Total Assets	$ 440,000	-	-	$ 440,000
Liabilities - n/a	-	-	-	-

Some of the Company’s financial instruments are not measured at fair value on a recurring basis but are recorded at amounts that approximate fair value due to their liquid or short-term nature, such as cash and cash equivalents, receivables and payables. The carrying amount of the mortgage is consistent with the terms available in the market for instruments with similar risk.

 

 

 

4. INVENTORY

Inventory consists of:

		June 30,
		2011		2010
Finished goods	$	197,389	$	98,690
Work in process		32,116		202
Raw materials		215,099		149,677
	$	444,604	$	248,569

 

 

 

5. PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

		June 30,
		2011		2010
Land	$	472,410	$	472,410
Building		2,323,016		2,307,449
Machinery and equipment		2,250,263		2,164,899
Equipment under capital leases		86,729		86,729
Furniture and fixtures		209,818		204,027
		5,342,236		5,235,514
Less: Accumulate depreciation and amortization		(2,441,596)		(2,220,742)
Accumulated depreciation on capital leases		(36,728)		(26,236)
Property and Equipment, net	$	2,863,912	$	2,988,536

Depreciation expense, including that on assets under capitalized leases, charged to operations, was $231,347 and $225,051 for the years ended June 30, 2011 and 2010, respectively. During the year ended June 30, 2010, $1,743,800 in fully depreciated equipment and fixtures were written-off and approximately $567,000 in equipment (approximately $413,000 in accumulated depreciation) was sold as part of the product lines sold to Forefront Medical Technology (PTE) Ltd. (see Footnote 14).

 

 

6. INTANGIBLE ASSETS

Intangible Assets, including prepaid Patent Costs included in Prepaid Expenses of $82,434 and $83,495 as of June 30, 2011 and 2010, respectively, are comprised of the following:

				June 30,
				2011		2010
Patents	$		1,440,365		$	1,403,865
Trademarks			103,383			66,218
Less:  Accumulated amortization			(641,083)			(546,866)
Intangible Assets, net	$		902,665		$	923,217

Future amortization of Intangible Assets, as of June 30, 2011, are as follows:

Year ending June 30,
2012	$	156,276
2013		103,209
2014		96,600
2015		94,051
2016		89,773
Thereafter		362,756
	$	902,665

Amortization expense for the years ended June 30, 2011 and 2010 were $200,446 and $205,937, respectively.

 

 

7. LEASES

The Company acquired equipment under long-term leases. For financial reporting purposes, the present value of the minimum lease payments has been capitalized.

Future payments under these capital lease arrangements, which includes $3,667 in finance charges, are as follows:

Year ending June 30,
2012	$	20,506
2013		17,246
	$	37,752

 

 

 

 

8. LONG-TERM DEBT

As of June 30, 2011, the Company’s facility is financed by a twenty-five year mortgage note bearing a five year fixed interest rate of 6.75%, and then reset every five years at 2.75% over the then New York Federal Home Loan Bank 5/20 Amortizing Advance Rate. The mortgage is secured by the real estate and improvements, and all rents from leases subsequently entered into, amortized with monthly payments. As of June 30, 2011, the book value of the real estate and improvements was $2,224,061.

As a result of the net losses for the years ended June 30, 2010 and June 30, 2011, the Company did not meet certain financial covenants required under the loan document. Loan modifications and covenant waivers were issued by the lender during each year. On October 13, 2011, the Company and the bank entered into a loan modification agreement pursuant to which the bank waived the June 30, 2011 covenants and defaults in exchange for the Company providing its accounts receivable and inventory as collateral. Although waivers/modifications were granted by the lender, there is no certainty that future waivers/modifications would be granted.

 

Long-term debt is comprised of the following:

		June 30,
		2011		2010
Mortgage note	$	2,766,537	$	2,817,836
Less:  Current Maturities		(51,720)		(48,800)
Long-term Debt,       Net of Current Maturities	$	2,714,817	$	2,769,036

Maturities of the long-term debt are as follows:

Year ending June 30,		As of June 30, 20111
2012	$	51,720
2013		55,899
2014		59,847
2015		64,074
2016		68,119
Thereafter		2,466,878
	$	2,766,537

 

9. INCOME TAXES

The income tax provision (benefit) is comprised of the following:

			Federal		State		Total
Year Ended June 30, 2011
Current	$		-	$	4,160	$	4,160
Deferred			(314,045)		(17,177)		(331,222)
	$		(314,045)	$	(13,017)	$	(327,062)
Year Ended June 30, 2010
Current	$		-	$	4,160	$	4,160
Deferred			(355,096)		(110,702)		(465,798)
	$		(355,096)	$	(106,542)	$	(461,638)

The Company’s deferred tax asset and liability as presented in the Company’s financial statements are comprised of the following:

		June 30,
		2011		2010
Deferred Tax Asset
Net Operating Losses	$	891,783	$	514,684
Adjustment of Goodwill		196,069		196,069
Research & Development Credits		618,302		597,261
Valuation Allowance		(387,350)		(296,069)
Total Deferred Tax Assets		1,318,804		1,011,945
Deferred Tax Liability
Depreciation		(294,012)		(318,375)
Total Deferred Tax Liability	$	(294,012)	$	(318,375)

 

 

Deferred taxes are recognized for temporary differences between the bases of assets and liabilities for financial statement and income tax purposes. The differences relate primarily to depreciable assets (using accelerated depreciation methods for income tax purposes). The Company’s adjustment to Goodwill in 2004 and 2006 created a deferred tax asset, which although has an indefinite life, has been fully reserved for as realization of its benefit is unlikely.

As of June 30, 2011, the Company has net operating loss carry forwards of approximately $1,982,512 and $3,249,692 for Federal and State tax purposes respectively. These net operating loss carry forwards may be used to reduce federal and state taxable income and tax liabilities in future years and expire in various years through June 30, 2031 and June 30, 2018 for Federal and State tax purposes, respectively. In addition, the Company has Research and Development Tax Credits of approximately $368,490 and $249,812 for Federal and State tax purposes, respectively, which expire in various years through June 30, 2031 and June 30, 2018, respectively.

The Company’s provision for income taxes differs from applying the statutory U.S. federal income tax rate to the income before income taxes. The primary differences result from providing for state income taxes, generation of allowable tax credits and from deducting certain expenses for financial statement purposes but not for federal income tax purposes.

A reconciliation between taxes computed at the federal statutory rate and the consolidated effective tax rate follows:

		June 30,
		2011				2010
Federal statutory tax rate		(34.0)	%			(34.0)			%
State income tax - net of federal tax benefit		(5.2)				(2.6)
R & D credits		(2.3)				(7.2)
Adjustment in valuation allowances		8.3					-
Permanent and other differences		(2.8)					(1.4)
		(36.0)	%			(45.2)			%

 

10. STOCK OPTIONS AND AWARDS

On February 22, 2000 the Board of Directors approved an option plan that granted each director 2,000 fully vested options for each meeting attended, awarded at the annual meeting at the 5-day market price average.

Open options under this plan awarded to the Board of Directors are as follows:

Issuance Date	Options Issued	Exercise Price		Expiration Date	Options Exercised
Nov 15, 2006	50,000	$1.18	Nov 15, 2011		-

During the 2008 fiscal year, 15,000 fully vested five year options, at a $3.00 exercise price, were granted as part of a Stock Subscription.

There were no stock option issuances during the 2010 or 2011 fiscal years.

A summary of activity under the plan for the years ending June 30, 2010 and 2011 are as follows:

						Common Stock Options Outstanding
						Weighted Average
							Shares	Exercise Price
Balance, June 30, 2009						183,000			$   1.53
Cancelled						(56,000)			2.10
Balance, June 30, 2010						127,000			$   1.28
Cancelled						(62,000)			0.95
Balance, June 30, 2011						65,000			$   1.60

Following is a summary of the status of options outstanding as of June 30, 2011:

Outstanding Options .									Exercisable Options .
Exercise Price Range			Number		Weighted Average Remaining Contractual Life		Weighted Average Exercise Price		Number		Weighted Average Exercise Price
$1.18		50,000			0.4 years		$1.18		50,000		$1.18
$3.00		15,000			1.1 years		$3.00		15,000		$3.00
		65,000			0.6 years		$1.60		65,000		$1.60

As the stock price of the Company’s stock on June 30, 2011 was lower than the exercise prices of the outstanding and exercisable options, there was no intrinsic value of the options.

 

 

11. RETIREMENT PLAN

The Company sponsors a qualified 401(k) plan covering substantially all full time employees under which eligible employees can defer a portion of their annual compensation. The Company determines annually, the amount of matching contributions. There were no Company matching contributions made to the plan during the fiscal years ended June 30, 2010 or June 30, 2011.

 

 

 

 

 

 

 

12. INDUSTRY SEGMENT INFORMATION

The Company operates two primary business segments: (1) Polymer Research and (2) Medical Products.

Products included in the polymer research segment are Aquamere^®, Aquatrix^®, Dermaseal^®, Dragonhyde^®, Hydromer^® Anti-Fog/Condensation Control Coatings, Hydromer^® Lubricious Coatings, Sea-Slide^® and T-HEXX^® Barrier Dips and Sprays. Research and Development services and all of the Company’s royalties and contract revenues are reported in this segment.

The medical products segment included an OEM product line of bipolar coagulation probes, placement catheters, bilary stents, jejunal and enteral feeding accessories, guidewires, biofeedback devices for fecal and urinary incontinence and other endoscopic accessories. With the exception of the biofeedback devices, all the medical device product lines were sold in fiscal 2009 and 2010. Also remaining in this segment are contract coating services and engineering equipment sales and services.

Due to the multitude of products offered and the product gross margins, the Company does not track sales contribution by products.

The Company operates globally in its segments with several large customers that are important to their operating results. No single customer accounted for more than 10% of the polymer research segment sales for the 2010 and 2011 fiscal years. For the medical products segment, the top three customers accounted for 51% and 87% of that segment’s 2011 and 2010 sales, respectively.

The Company evaluates the segments by revenues, total expenses and earnings before income taxes. The Company’s assets are not reviewed by business segment. The accounting policies of these segments are described in the summary of significant accounting policies.

 

 

Corporate Overhead, primarily the salaries and benefits of senior management, support services (Accounting, Legal, Human Resources and Purchasing) and other shared services (building maintenance and warehousing), is reflected separately from the results of the business segments in the following:

 

		Polymer Research						Medical   Products			Corporate Overhead						Total
Year Ended June 30, 2011
Revenue	$	4,225,184				$		1,289,831								$	5,515,015
Expenses		(3,627,262)						(1,171,504)		$	(1,624,609)						(6,423,375)
Earnings (Loss) before Income Taxes	$	597,922				$		118,327		$	(1,624,609)					$	(908,360)
Year Ended June 30, 2010
Revenue	$	4,136,010				$		2,064,494								$	6,200,504
Expenses		(3,738,588)						(1,813,998)		$	(1,668,908)						(7,221,494)
Earnings (Loss) before Income Taxes	$	397,422				$		250,496		$	(1,668,908)					$	(1,020,990)

Included under the Medical Products segment was the pre-tax gain from the sale of product lines of $335,629 in fiscal 2010.

 

Geographic revenues were as follows for the years ended June 30,

	2011	2010
Domestic:	60%	72%
Foreign:	40%	28%

 

 

13. EARNINGS PER SHARE

The following table sets forth the computation of earnings per share:

		2011			2010
Numerator:
Net loss	$	(581,298)		$	(559,352)
Denominator:
Denominator for basic earnings per share - weighted average shares outstanding		4,772,318			4,772,318
Effect of dilutive securities - Stock Options		-			-
Denominator for dilutive earnings per share under the treasury stock method - weighted average shares outstanding		4,772,318			4,772,318
Basic Loss per share	$		(0.12)	$		(0.12)
Dilutive Earnings per share			n/a	$		n/a

Common stock equivalents (consisting of 65,000 and 127,000 stock options for the years ended June 30, 2011 and 2010, respectively) were not included in computing diluted earnings per share as their effect would have been anti-dilutive.

 

14. SALE OF PRODUCT LINES

On November 25, 2009, the Company’s wholly owned subsidiary, Biosearch Medical Products, Inc. (“Biosearch”) sold its Private Label Jejunostomy Catheter and Nasogastric Feeding Catheter business to Forefront Medical Technology (PTE) Ltd (“Forefront”), a wholly owned subsidiary of Vicplas International Limited – a company registered in the Republic of Singapore, for $800,000 in cash, half received upon closing with the balance received in March 2010. 

This sale included inventory and equipment related to that business and also called for the assignment of certain customer supply agreements to Forefront and a three year non-compete provision.  A separate supply agreement for Hydromer® hydrophilic coating solution used on those products was also entered between the parties.  Biosearch continued manufacturing the products, at an agreed upon transfer price, until Forefront completed the transition in April 2010.

The product lines sold were part of the “Medical Products” segment (see Footnote 12) in which operations and cash flows could not be broken down further. Therefore, along with the continued manufacturing, this transactions did not meet the criteria of discontinued operations under ASC 205-20, Discontinued Operations.

The gain on sale of the product lines are reflected separately on the Consolidated Statement of Operations.

 

 

15. CONTINGENCIES

Royalty revenues and support fees recorded by the Company are based on the sales of products as reported by the Company’s customers, which has the risk of being under- or over-reported. To minimize such risks, the Company’s management utilizes its knowledge and understanding of the customer’s business, the market and other pertinent factors in assessing the validity of reported royalties or support fees. In addition, the Company may have a right to audit the amounts reported.

The Company has not received any claims by its customers for possible overpayment of royalties or support fees.