Item 1 of Part I of our Annual Report on Form 10-K and our Consolidated Financial Statements, accompanying Notes and other information listed in the accompanying Financial Table of Contents.
Overview
We develop, manufacture and market a broad line of innovative, technologically enhanced PVC-free and latex-free urinary continence and urine drainage care products for the extended care and acute care markets. Our products are comprised of our base products, which include our male external catheters and standard silicone Foley catheters, and our advanced products, which include our intermittent catheters, our anti-infection Foley catheters and our FemSoft Insert. We market our products under our Rochester Medical®
brand, and also supply our products to several large medical product companies for sale under brands owned by these companies, which are referred to as private label sales. We sell our products both in the domestic market and internationally. International sales accounted for approximately 58% and 60% of total sales in the fiscal years ending September 30, 2009 and 2008, respectively.
We sell our products in the United States under the Rochester Medical brand name through a thirteen-person direct sales force. Through our subsidiary, Rochester Medical Limited, we sell our products in the United Kingdom under the Rochester Medical brand name through a sixteen-person direct sales force. We also rely on various independent distributors to sell our products. The primary markets for our products are distributors, extended care facilities and individual hospitals and healthcare institutions.
A significant portion of our net sales to date have depended on our ability to provide products that meet the requirements of medical product companies that resell or distribute our products, and on the sales and marketing efforts of such entities. Private label sales arrangements with these entities are likely to continue to be a significant, but declining, percentage of our revenues in the future, while we continue to establish our own market presence under the Rochester Medical brand name. Private label sales represented 33% of total sales in fiscal 2009, compared to 32% of total sales in fiscal 2008.
For fiscal 2009, we increased the investment in our sales and marketing programs, primarily through cash generated from current operations, to support Rochester Medical branded sales growth in the U.S. and Europe. Our advanced products will eventually contribute a higher profit margin than our base products, and our Rochester Medical branded products contribute a higher profit margin than private label sales, particularly branded sales in the United Kingdom and elsewhere in Europe. Increasing our percentage of sales of branded products versus private label sales over time will have a positive impact on our gross margin. Branded sales accounted for 67% of total sales for the year ended September 30, 2009, compared to 68% for the prior year. Advanced products accounted for 15% of total sales for the year ended September 30, 2009, compared to 13% for the prior year.
Net sales for our fiscal year ended September 30, 2009 were $34.8 million, a decrease of $0.4 million from $35.2 million in the prior fiscal year. The decrease in net sales resulted from a 2% decrease in branded sales for the fiscal year, partially offset by a 2% increase in private label sales. The decrease in branded sales resulted from a decrease in sales of base products in the United Kingdom primarily due to fluctuations in the foreign currency exchange rate between the US dollar and the British pound, partially offset by an increase in sales of advanced products in the U.S. and internationally. The aggregate effect of exchange rate fluctuations for the year resulted in a decrease of $2.8 million in net branded sales.
Our five largest customers in fiscal 2009 represented approximately 34% of our total net sales. Because our larger customers typically purchase products in relatively large quantities at a time, our financial performance can fluctuate from quarter to quarter depending upon the timing of their purchases. We expect to continue to depend upon a relatively small number of customers for a significant percentage of our net sales.
We also sell our Rochester Medical brand products and other companies’ products direct to the patient in the United Kingdom through the Script-Easy program. U.K. residents can call a toll free number and order products for direct home delivery upon verification of a prescription from a doctor.
Our manufacturing facilities, which we own, are located in Stewartville, Minnesota, and have been designed to accommodate the specialized requirements for the manufacture of medical devices, including FDA requirements for Quality System Regulation. A substantial portion of the expenses associated with our manufacturing facilities are fixed in nature (i.e. depreciation) and will reduce our operating margin until such time, if ever, as we are able to increase utilization of our capacity through increased sales of our products.
Events that have contributed to the recent growth of our business include:
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In February 2004, we brought suit against certain Group Purchasing Organizations (GPOs) and individual defendants alleging anti-competitive conduct against the defendants in the markets for standard and anti-infection Foley catheters as well as urethral catheters, and sought an unspecified amount of damages and injunctive and other relief. Beginning in November 2006 and concluding in January 2009, we reached a settlement with each of the defendants, resulting in aggregate settlement proceeds to us of $61,325,000 (net $39,605,000 after payment of attorneys’ fees and expenses) and an Innovative Technology Contract with Novation. No further action is expected with respect to this lawsuit.
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In November 2006, we announced we had been awarded a national Group Purchasing Contract for urological products from Premier Purchasing Partners, L.P. (“Premier”). Premier is one of the largest GPOs in the United States with over $27 billion in contract purchases per year. Premier is owned by more than 200 leading not-for-profit hospitals and affiliated with more than 1,500 hospitals and 42,000 other healthcare sites. The contract includes our Foley catheters (including our infection control catheters), male external catheters, intermittent catheters, and urethral inserts. The contract became effective March 1, 2007, and has been extended through February 2013.
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As mentioned above, Novation awarded us an Innovative Technology Contract for our urological catheter products and related accessories, including our advanced infection control catheters. Novation provides contracting services to nearly 25,000 members of VHA, Inc. and the University HealthSystem Consortium, or UHC, and more than 15,000 customers of Provista (formerly HPPI). The Innovative Technology Contract has a three year term from the effective date of September 1, 2007.
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In November 2009, we were also awarded a urological products contract with Broadlane Inc. This contract is effective January 1, 2010 and is a two year contract. Broadlane is a GPO whose clients include more than 915 acute care hospitals, more than 2,600 sub-acute care facilities and more than 18,000 physician practices.
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Effective April 1, 2008, the four regional Durable Medical Equipment Medicare Administrative Contractors covering the United States implemented a new reimbursement policy covering the use of intermittent catheters. The main policy change now allows an intermittent catheter user a maximum of 200 catheters per month instead of four catheters per month under the previous policy. We believe this is a very positive change in helping reduce urinary tract infections and improving the quality of life for intermittent catheter users. We expect the updated Medicare coverage policy will increase the usage of intermittent catheters in the U.S., although the scale and pace of the change are difficult to predict.
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On May 15, 2008, we announced that the United Kingdom’s Association for Continence Advice (ACA) awarded us its trophy for best product for our Hydrosil Discreet intermittent catheter. There were seventeen entries competing for the ACA “Look Good, Feel Good Award” at the ACA annual conference, including entries from our major competitors. The ACA is a membership organization for health and social care professionals concerned with the progression of care for continence.
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On June 12, 2008, we announced that Rochester Medical was a winner of a Premier Performance Award, presented by the Premier healthcare alliance’s Purchasing Partners unit. We were one of 54 of more than 800 Premier contracted suppliers to receive the Performance Award, which recognizes the efforts of contracted suppliers to meet or exceed Premier members’ service expectations. In selecting recipients, satisfaction and performance data are collected and scored over four successive calendar quarters. Organizations scoring 80 percent or higher earn the Performance Award.
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In January 2009, we introduced Magic3, our advanced line of silicone intermittent catheters, which are the first intermittent catheters created from a composition of three distinct functional layers. We initiated a
comprehensive marketing campaign by rolling out the Magic3 intermittent catheter line in the U.S. with introduction to our distribution partners and targeted clinical call points. The marketing campaign encompassed clinicians as well as catheter users. Concurrently, the new product line was introduced by Rochester Medical Limited in the United Kingdom and Europe where a similar comprehensive marketing campaign was launched.
Our net income for fiscal 2009 was $109,000, or $0.01 per diluted share, compared to $759,000, or $0.06 per diluted share in fiscal 2008. Net income was impacted by our increased strategic investment in sales and marketing programs and increased costs in research and development of new products. Additionally, we experienced a challenging economic environment in fiscal 2009 in which some customers in geographic regions in which we operate reduced or deferred purchases of our products.
As of September 30, 2009, we had $6.4 million in cash and cash equivalents, and $29.9 million invested in marketable securities. The marketable securities primarily consist of $27.1 million invested in U.S. treasury bills and $2.8 million invested in mutual funds. Our investments in marketable securities are subject to interest rate risk and the value thereof could be adversely affected due to movements in interest rates. Our investment choices, however, are conservative and are intended to reduce the risk of loss or any material impact on our financial condition. We are currently reporting an unrealized loss of $544,000 related to the mutual fund as a result of the recent fluctuations in the credit markets impacting the current market value. We consider these unrealized losses temporary as we have the intent and ability to hold these investments long enough to avoid realizing any significant losses.
In fiscal 2010, we plan to continue with our strategic focus on sales growth of Rochester Medical brand products, principally in the U.S. and Europe but in other markets as opportunites arise, through increased investment in our sales and marketing programs. We expect such increased investment to be funded primarily through cash generated from current operations. We will also continue to look for other strategic opportunities to increase our product line and distribution capabilities.
In addition to our marketing campaign for our Magic3 advanced line of silicone intermittent catheters, we will be marketing our new Strata brand of Foley catheters. In September 2009, we introduced our new StrataSI and StrataNF silicone Foley catheters. The improved silicone design consists of a soft, pliable inner core surrounded by ultra-sort, ultra-smooth outer layers allowing for softness and flexibility we believe is unique in an all-silicone catheter. The StrataNF version includes a nitrofurazone anti-infective matrix within the silicone.
In September 2009, the FemSoft Insert was approved for inclusion in Part IX of the UK Drug Tariff as a prescription product that is reimbursable under the National Healthcare System. In November 2009, Medicare issued a specific reimbursement code which covers our FemSoft Insert. We believe the availability of National Healthcare System reimbursement and Medicare reimbursement, both of which commence in 2010, will help this unique device become an economically accessible and often preferred solution for incontinent women in the United Kingdom and in the United States. We are making sales and marketing preparations accordingly to ensure that clinicians and women have access to this excellent choice.
Application of Critical Accounting Policies
Management’s Discussion and Analysis of Financial Condition and Results of Operations addresses our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the 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. On an on-going basis, we evaluate these estimates and judgments. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies, among others, affect the more significant judgments and estimates used in the preparation of our financial statements.
Inventories
Inventories, consisting of material, labor and manufacturing overhead, are stated at the lower of cost (first-in, first-out method) or market. Our policy is to establish an excess and obsolete reserve for our products in excess of the expected demand for such products. At September 30, 2009, this reserve was approximately $126,000, compared to $122,000 at September 30, 2008. If actual future demand or market conditions differ from those projected by us, additional inventory valuation adjustments may be required. These valuation adjustments would be included in cost of goods sold.
Accounts Receivable
We maintain an allowance for doubtful accounts, which is calculated by a combination of specific account identification as well as percentages of past due balances. At September 30, 2009, this allowance was approximately $63,000 compared to $65,000 at September 30, 2008. If actual future collections or customer liquidity conditions differ from those projected by us, additional receivables valuation adjustments may be required. We perform periodic credit evaluations of our customers’ financial condition. We require prepayments by certain foreign customers. Receivables generally are due within 30 to 60 days.
Revenue Recognition
We have standard contract terms with all non - Group Purchase Organization customers, which include our independent distributors, of FOB shipping point; as such, sales are recognized upon shipment. GPO customers have terms of FOB destination per the agreement and thus sales are recognized upon delivery of goods to the customer. Revenue is recognized when title and risk of ownership have passed, the price to the buyer is fixed and determinable and recoverability is reasonably assured. For all GPO customer orders shipped within the last five working days of a quarter, we monitor the shipping tracking number for such shipments to verify receipt by the customer. If we are able to verify receipt by the customer by the end of the month, the sale is recognized. Payment terms for all customers range from prepayment to 60 days. Customers cannot return unsold products unless we have authorized such return for warranty claims. We do not grant significant price concessions to our customers.
We warrant that the products we sell to our customers will conform to the description and specifications furnished by us, and that the products will be free from defects in material and workmanship. In the event of a warranty claim, the customer is responsible for shipping the product(s) back to us, freight prepaid. If the failure of the product is due to a breach of warranty, we may repair or replace the defective product(s) at our option and return the repaired or replaced product(s) to the customer, freight prepaid. This is the limit of our warranty liability, and this warranty is made in lieu of all other written or unwritten express or implied warranties. Historically, due to the nature of use of our products and low replacement cost, our warranty exposure has been immaterial.
Other than our limited warranty obligation, we do not have significant post-shipment obligations to, or significant acceptance provisions with, our customers, including our distributors.
During the year ended September 30, 2007, we recognized $525,000 of deferred revenue related to a 10 year distribution agreement with Coloplast. As part of the original agreement, Coloplast paid us $1,000,000 for the exclusive right to market and sell the Release-NF Foley catheter in the U.K. for a period of 10 years. Amounts received for upfront license fees under multiple-element supply and distribution arrangements are deferred and recognized over the period of supply, if such arrangements require our on-going services or performance. During fiscal 2007, both companies mutually agreed to terminate the contract thus accelerating the recognition of our remaining deferred revenue. During fiscal 2008 and 2009, we did not receive upfront license fees under any multiple-element supply and distribution arrangements.
Income Taxes
The carrying value of our net deferred tax assets assumes that we will be able to generate sufficient taxable income in the United States, based on estimates and assumptions. We record a valuation allowance to reduce the
carrying value of our net deferred tax asset to the amount that is more likely than not to be realized. For 2009, no valuation allowance has been recorded against the net deferred tax assets because there is sufficient future projected income to sustain that the deferred tax assets will more likely than not be able to be utilized. On a quarterly basis, we evaluate the realizability of our deferred tax assets and assess the requirements for a valuation allowance.
Valuation of Goodwill and Other Intangibles
We follow Accounting Standards Codification (ASC) 350, Goodwill and Other Intangible Assets. When we acquire a company, the purchase price is allocated, as applicable, between identifiable trademarks, other intangible assets, net tangible assets, and goodwill as required by U.S. generally accepted accounting principles . Determining the portion of the purchase price allocated to the trademarks and other intangible assets requires us to make significant estimates. The amount of the purchase price allocated to trademarks and other intangible assets is determined by estimating the future cash flows of each trademark or technology and discounting the net cash flows back to their present values. The discount rate used is determined at the time of acquisition in accordance with accepted valuation methods.
Goodwill represents the excess of the aggregate purchase price over the fair value of net assets of the acquired business. Goodwill is tested for impairment annually on the anniversary date of the acquisition, or more frequently if changes in circumstance or the occurrence of events suggest that the carrying amount may be impaired. We have determined the reporting unit continues to be at the enterprise level. In our judgment, the market capitalization of our company is the best indicator of the fair value of the reporting unit and we have used the market capitalization of our company in our annual impairment test. Goodwill was $4.6 million and $5.2 million as of September 30, 2009 and 2008, respectively. The change is entirely the result of fluctuations in the exchange rate between the British pound and the U.S. dollar.
Finite-life intangible assets consist primarily of purchased technology, patents and trademarks and are amortized using the straight-line method, as appropriate, over their estimated useful lives, ranging from 5 to 20 years. All of our intangible assets are finite-life and amortized on a straight-line basis. We review these intangible assets for impairment as changes in circumstance or the occurrence of events suggest the remaining value may not be recoverable. Other intangible assets, net of accumulated amortization, were $6.2 million and $7.1 million as of September 30, 2009 and 2008, respectively.
Long-Lived Assets
We follow ASC 360, Property, Plant and Equipment. As such, we review our long-lived assets for impairment whenever events or changes in circumstances indicate that our carrying value of long-lived assets may not be recoverable. Long-lived assets are considered not recoverable when the carrying amount of a long-lived asset (asset group) exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group). If it is determined that a long-lived asset (asset group) is not recoverable, an impairment loss is recorded equal to the excess of the carrying amount of the long-lived asset (asset group) over the long-lived asset’s (asset group’s) fair value. Fair value is the amount at which the long-lived asset (asset group) could be bought or sold in a current transaction between a willing buyer and seller, other than in a forced or liquidation sale.
Stock-Based Compensation
Effective October 1, 2005, we adopted the accounting provisions that are now part of ASC 718, Compensation-Stock Compensation. Under the fair value recognition provisions of ASC 718, we measure stock-based compensation cost at the grant date based on the fair value of the award and recognize the compensation expense over the requisite service period, which is generally the vesting period. We elected the modified-prospective method of adopting ASC 718, under which prior periods are not retroactively revised. Estimated stock-based compensation expense for the non-vested portion of awards granted prior to the effective date is being recognized over the remaining service period using the compensation cost estimated for pro forma disclosures under ASC 718. Total stock-based compensation expense recognized during the fiscal year ended September 30, 2009 was $0.9 million after-tax ($1.3 million pre-tax). See Note 7 to our consolidated financial statements for further information regarding our stock-based compensation programs.
We use the Black-Scholes option pricing model to determine the fair value of stock options as of the grant date. The fair value of stock options under the Black-Scholes model requires management to make assumptions regarding projected employee stock option exercise behaviors, risk-free interest rate, volatility of our stock price and expected dividends.
We analyze historical employee stock option exercise and termination data to estimate the expected life assumption. We believe that historical data currently represents the best estimate of the expected life of a new employee option. We also stratify our employee population based upon distinctive exercise behavior patterns. The risk-free interest rate we use is based on the yield, on the grant date, of a zero-coupon U.S. Treasury bond whose maturity period equals or approximates the option’s expected term. We calculate the expected volatility based solely on historical volatility which continues to be the most appropriate measure for us. The dividend yield rate used is zero as we have not nor expect to pay dividends. The amount of stock-based compensation expense we recognize during a period is based on the portion of the awards that are ultimately expected to vest. We estimate pre-vesting option forfeitures at the time of grant by analyzing historical data and revise those estimates in subsequent periods if actual forfeitures differ from those estimates.
If factors change and we employ different assumptions for estimating stock-based compensation expense in future periods or if we decide to use a different valuation model, the expense associated with new awards in future periods may differ significantly from what we have recorded in the current period related to historical awards and could materially affect our net earnings and diluted earnings per share of a future period. There were no modifications to any of our plans in 2009.
There is a risk that our estimates of the fair values of our stock-based awards on the grant dates as determined using the Black-Scholes model may bear little resemblance to the actual values realized upon the exercise or forfeiture of those stock-based awards in the future. Some employee stock options may expire without value, or only realize minimal intrinsic value, as compared to the fair values originally estimated on the grant date and recognized in our financial statements. Alternatively, some employee stock options may realize significantly more value than the fair values originally estimated on the grant date and recognized in our financial statements.
Results of Operations
The following table sets forth, for the periods indicated, certain items from our statements of operations expressed as a percentage of net sales:
Our products are comprised of our base products, which include our male external catheters and standard silicone Foley catheters, and our advanced products, which include our intermittent catheters, our anti-infection Foley catheters and our FemSoft Insert. The following table sets forth, for the periods indicated, net sales information by product category (base products and advanced products), marketing method (private label and
Rochester Medical branded sales) and distribution channel (domestic and international markets) (all dollar amounts below are in thousands):
Fiscal Year Ended September 30, 2009 Compared to Fiscal Year Ended September 30, 2008
Net Sales. Net sales decreased 1% to $34.8 million in fiscal 2009 from $35.2 million in the prior fiscal year. The decrease in net sales resulted from a 2% decrease in branded sales for the fiscal year, partially offset by a 2% increase in private label sales. The decrease in branded sales resulted from a decrease in sales of base products in the United Kingdom primarily due to fluctuations in the foreign currency exchange rate between the US dollar and the British pound, partially offset by an increase in sales of advanced products in the U.S. and internationally. The aggregate effect of exchange rate fluctuations for the year resulted in a decrease of $2.8 million in net branded sales. Domestic sales of branded products increased by 7% for fiscal 2009 compared to fiscal 2008. Our international branded sales decreased 6% compared to fiscal 2008 primarily as a result of the change in foreign currency exchange rates. Private label sales of base products were up slightly from the prior year offset by a slight decrease in sales of advanced products to Hollister. Sales of products under the Rochester Medical brand comprised 67% of total sales in fiscal 2009, with private label sales representing 33% of total sales. In fiscal 2008, private label sales comprised 32% of total sales. We expect private label sales as a percentage of total sales to decline over time as we focus more on our branded sales.
Gross Margin. Our gross margin as a percentage of net sales was 48% in fiscal 2009 compared to 47% in the prior fiscal year. Our increase in gross margin in fiscal 2009 was primarily affected by increased sales of higher margin products and lower raw material costs.
Marketing and Selling. For fiscal 2009, we increased the investment in our sales and marketing programs, primarily through cash generated from current operations, to support Rochester Medical branded sales growth in the U.S. and Europe. Marketing and selling expense primarily includes costs associated with base salary paid to sales and marketing personnel, sales commissions, and travel and advertising expense. Marketing and selling expense increased 9% in fiscal 2009 as compared to fiscal 2008, with marketing and selling expense of approximately $10.3 million in fiscal 2009 and $9.5 million in fiscal 2008. The increase in marketing and selling expense is primarily related to $660,000 of increased advertising and project costs, $63,000 of compensation expenses, $54,000 increase in consulting fees, $34,000 in utilities and $33,000 of increased travel expenses. Marketing and selling expense as a percentage of net sales for fiscal 2009 was 30% compared to 27% for fiscal 2008.
Research and Development. Research and development expense primarily includes internal labor costs, materials used to develop new products as well as expense associated with third-party vendors performing validation and investigative research regarding our products and development activities. Research and development expense increased 19% to $1,241,000 in fiscal 2009 from $1,044,000 in the prior fiscal year. The increase in research and development expense relates primarily to increased compensation expense of $177,000 and $50,000 of project costs, offset by a decrease in supplies expense of $30,000. Research and development expense as a percentage of net sales for fiscal 2009 and fiscal 2008 was 4% and 3%, respectively.
General and Administrative. General and administrative expense primarily includes payroll expense related to our management and accounting, information technology and human resources staff, as well as fees and expenses of outside legal counsel, accounting advisors and auditors. General and administrative expense declined to $6.0 million in 2009 from $6.7 million in fiscal 2008. The changes in general and administrative expense primarily relate to decreased administrative costs of $286,000 in professional fees, $211,000 of other expenses, $82,000 of travel expenses, $63,000 of utilities expenses, $44,000 of consulting fees and $38,000 in charitable contributions, offset by increases of $91,000 in compensation expense. General and administrative expense as a percentage of net sales for fiscal 2009 and fiscal 2008 was 17% and 19%, respectively.
Interest Income. Interest income decreased 77% to $283,000 in fiscal 2009 from $1.2 million in the prior fiscal year. The decrease reflects overall lower interest rates on investments.
Interest Expense. Interest expense decreased 46% to $259,000 in fiscal 2009 from $478,000 in fiscal 2008. The decrease in interest expense reflects decreases in outstanding debt used to partially finance our asset acquisitions in June 2006 from Mentor and Coloplast and refinancing of debt at a lower interest rate.
Income Taxes. As of September 30, 2009, we have federal net operating loss carryforwards available to offset future taxable income. No valuation allowance has been recorded against the net deferred tax assets because there is sufficient future projected income to sustain that the deferred tax assets will more likely than not be able to be utilized.
For fiscal 2009, we had an effective tax rate of approximately 77% that was affected by foreign operations, incentive stock options and research and development tax credits. The amount of these items in comparison to our net income for the current year results in a significant effect on the effective tax rate percentage. In future periods of taxable earnings, we expect to report an income tax provision using an effective tax rate in the range of 30-34%.
Net Income. Our net income decreased to $109,000 in fiscal 2009 from $759,000 in 2008. Net income was impacted by our increased strategic investment in sales and marketing programs and increased costs in research and development of new products. Additionally, we experienced a challenging economic environment in fiscal 2009 in which some customers in geographic regions in which we operate reduced or deferred purchases of our products.
Fiscal Year Ended September 30, 2008 Compared to Fiscal Year Ended September 30, 2007
Net Sales. Net sales increased 7.7% to $35.2 million in fiscal 2008 from $32.7 million in the prior fiscal year. The increase in net sales was a result of an increase in branded sales offset by a decrease in private label sales. The increase in branded sales primarily was attributable to increased sales of branded advanced products in the United States and increased sales of branded base products in the United Kingdom. Domestic sales of branded products increased by 26% for fiscal 2008 compared to fiscal 2007. Our international branded sales increased 23% compared to fiscal 2007. Private label sales of both base products and advanced products were down from last year, primarily as a result of decreased sales to Coloplast and Hollister. Sales of products under the Rochester Medical brand comprised 68% of total sales in fiscal 2008, with private label sales representing 32% of total sales. In fiscal 2007, private label sales comprised 41% of total sales.
Gross Margin. Our gross margin as a percentage of net sales was 47% in fiscal 2008 compared to 52% in the prior fiscal year. Our decrease in gross margin in fiscal 2008 was primarily impacted by increased costs for medical insurance, raw materials and freight during 2008. Additionally, a significant portion of our increased sales were of lower margin products.
Marketing and Selling. For fiscal 2008, we increased the investment in our sales and marketing programs, primarily through cash generated from current operations, to support Rochester Medical branded sales growth in the U.S. and Europe. Marketing and selling expense primarily includes costs associated with base salary paid to sales and marketing personnel, sales commissions, and travel and advertising expense. Marketing and selling expense increased 46% in fiscal 2008 as compared to fiscal 2007, with marketing and selling expense of approximately $9.5 million in fiscal 2008 and $6.5 million in fiscal 2007. The increase in marketing and selling expense is primarily related to increased sales personnel and related expenses of $660,000 incurred in the Company’s U.K. operations, $1.6 million in increased staff in U.S. acute care marketing, $550,000 of increased advertising and
project costs and $140,000 of increased stock-based compensation expense. Marketing and selling expense as a percentage of net sales for fiscal 2008 was 27% compared to 20% for fiscal 2007.
Research and Development. Research and development expense primarily includes internal labor costs, as well as expense associated with third-party vendors performing validation and investigative research regarding our products and development activities. Research and development expense increased 11% to $1,044,000 in fiscal 2008 from $943,000 in the prior fiscal year. The increase in research and development expense relates primarily to increased project costs of $168,000 and $15,000 of increased stock-based compensation expense, offset by a decrease in compensation expense of $103,000. Research and development expense as a percentage of net sales for each of fiscal 2008 and fiscal 2007 was 3%.
General and Administrative. General and administrative expense primarily includes payroll expense related to our management and accounting, information technology and human resources staff, as well as fees and expenses of outside legal counsel, accounting advisors and auditors. General and administrative expense remained flat at $6.7 million in fiscal 2008 and fiscal 2007. The changes in general and administrative expense primarily relate to decreased administrative costs of $900,000 of stock-based compensation expense, offset by increases of $610,000 in professional fees, $55,000 of insurance, $50,000 of compensation expense, $60,000 in charitable contributions and $40,000 related to travel. General and administrative expense as a percentage of net sales for fiscal 2008 and fiscal 2007 was 19% and 21%, respectively.
Interest Income. Interest income decreased 4% to $1.2 million in fiscal 2008 from $1.3 million in the prior fiscal year. The decrease reflects overall lower interest rates on investments.
Interest Expense. Interest expense decreased 7% to $478,000 in fiscal 2008 from $513,000 in fiscal 2007. The decrease in interest expense reflects decreases in outstanding debt used to partially finance our asset acquisitions in June 2006 from Mentor and Coloplast.
Income Taxes. For the year ended September 30, 2008, we had a federal net operating loss. No valuation allowance was recorded against the net deferred tax assets because there was sufficient future projected income as well as excess income from 2007 to sustain that the deferred tax assets will more likely than not be able to be utilized.
As of September 30, 2008, we had no federal net operating loss carryforwards available to offset future taxable income, since our earnings were sufficient to fully utilize the net operating loss carryforward of $21.0 million during fiscal 2007. For fiscal 2008, we had an effective income tax rate of approximately (320)% due to a few new or one time items. We had a one time adjustment for deferred taxes resulting from a change in tax rate as well as retroactive changes. There was also a first time deduction for Domestic Production Activities, arising from the change in taxable income position in the 2007 fiscal year. Lastly, we performed a detailed analysis of our research and development activities for the current and prior years which, coupled with the change in taxable income position in the 2007 fiscal year, resulted in additional tax credits. Other items having a material effect on the effective income tax rate were tax exempt interest and unrecognized tax benefits.
Net Income. Our net income decreased to $759,000 in fiscal 2008, which is more consistent with our expectations compared to $34,050,000 in fiscal 2007. Lawsuit settlements of approximately $39 million pre-tax were recognized in fiscal 2007. Net income was also impacted by our increased strategic investment in sales and marketing programs.
Liquidity and Capital Resources
We have historically financed our operations primarily through public offerings and private placements of our equity securities, and have raised approximately $40.7 million in net proceeds since our inception.
Our cash, cash equivalents and marketable securities were $36.3 million at September 30, 2009 compared with $37.0 million at September 30, 2008. The decrease in cash primarily resulted from cash used for capital expenditures and debt repayments offset by cash provided by litigation settlements, stock option exercises and operations. As of September 30, 2009, we had $29.9 million invested in marketable securities. The marketable securities primarily consist of $27.1 million invested in U.S. treasury bills and $2.8 million invested in mutual
funds. Our investments in marketable securities are subject to interest rate risk and the value thereof could be adversely affected due to movements in interest rates. Our investment choices, however, are conservative and are intended to reduce the risk of loss or any material impact on our financial condition. We are currently reporting an unrealized loss of $544,000 related to the mutual fund as a result of the recent fluctuations in the credit markets impacting the current market value. We consider these unrealized losses temporary as we have the intent and ability to hold these investments long enough to avoid realizing any significant losses.
We generated a net $1.7 million of cash in operating activities during the year compared with $2.4 million for the same period last year, with the primary difference being increased levels of inventory in 2009. Cash flow provided by operating activities in 2009 was comprised of net income of $109,000, decreased by an increase in net working capital components and increased by net non-cash charges of $3.2 million, including depreciation and amortization of $1.9 million and stock-based compensation of $1.3 million. Significant working capital changes are as follows:
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a $658,000 increase in accounts receivable reflecting increasing sales activity over prior year;
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a $1,102,000 increase in inventory as we increased our finished goods and work-in-process inventory to support the increase in sales volume;
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a $197,000 decrease in deferred income taxes;
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a $321,000 decrease in accounts payable reflecting timing of payments; and
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a $325,000 increase in other current liabilities including normal business expense accruals.
During fiscal 2009, our working capital position, excluding cash and marketable securities, increased by $519,000. Accounts receivable balances increased $658,000 during the fiscal year primarily due to increased sales at the end of the fourth quarter. Inventories as of September 30, 2009 increased $1.1 million over fiscal 2008 as we carried more inventory in anticipation of increased sales and new product launches. Other current assets were relatively flat with fiscal 2008. Changes in other asset and liability balances related to timing differences.
Investing activities, primarily capital expenditures and the purchase of marketable securities, used net cash of $2.7 million in fiscal 2009.
Financing activities, primarily long term debt payments and share repurchases offset by increases in short term debt and proceeds from stock option exercises, used net cash of $653,000 in fiscal 2009.
In June 2006, we entered into a $7,000,000 credit facility with U.S. Bank National Association. The credit facility consisted of a $5,000,000 term loan payable in five years and accruing interest at a rate equal to 4.77%, and a revolving line of credit of up to $2,000,000, maturing annually on March 31, with interest payable monthly at a floating rate based on the quoted one-month LIBOR rate plus 1.60%. In March 2009, we paid off the entire term loan and terminated the revolving line of credit.
In June 2006, in conjunction with the asset purchase agreement with Coloplast, we entered into an unsecured loan note deed with Coloplast with an outstanding principal amount of $5,340,000. The promissory note is non-interest bearing payable and due in five equal installments of $1,068,000 payable annually on June 2. We have imputed interest on the note at 6.90% and reflect a net liability of $1,927,910 on our balance sheet as of September 30, 2009.
In February 2009, we entered into a $14,000,000 credit facility with UBS Financial. The credit facility consists of a revolving line of credit of up to $14,000,000 with interest accruing monthly at a floating rate based on the quoted one-month LIBOR rate plus 1.25%. As of September 30, 2009, we had an outstanding balance of $1,878,447 under the revolving line of credit. Our obligations under the credit facility are payable on demand and are secured by our investments in marketable securities held at UBS.
We currently believe that our existing resources and anticipated cash flows from operations will be sufficient to satisfy our capital needs for the foreseeable future. However, our actual liquidity and capital requirements will depend upon numerous factors, including the costs, method and timing of expansion of sales and marketing activities; the amount of revenues from sales of our existing and new products; changes in, termination of, and the
success of, existing and new distribution arrangements; the cost of maintaining, enforcing and defending patents and other intellectual property rights; competing technological and market developments; developments related to regulatory and third party reimbursement matters; the cost and progress of our research and development efforts; opportunities for growth through acquisition, joint venture or other business combinations, if any; and other factors. Our ability to obtain financing for acquisitions or other general corporate and commercial purposes will depend on our operating and financial performance and is also subject to prevailing economic conditions and to financial, business and other factors beyond our control. Recently, global credit markets and the financial services industry have been experiencing a period of unprecedented turmoil characterized by the bankruptcy, failure or sale of various financial institutions, a general tightening of credit, and an unprecedented level of market intervention from the United States and other governments. These events have adversely affected the U.S. and world economy, and may adversely affect the availability and cost of financing. In the event that additional financing is needed, we may seek to raise additional funds through public or private financing, collaborative relationships or other arrangements. Any additional equity financing may be dilutive to shareholders, and debt financing, if available, may involve significant restrictive covenants. Collaborative arrangements, if necessary to raise additional funds, may require us to relinquish our rights to certain of our technologies, products or marketing territories. Failure to raise capital when needed could have a material adverse effect on our business, financial condition and results of operations. There can be no assurance that such financing, if required, will be available on terms satisfactory to us, if at all.
Disclosures about Contractual Obligations and Commercial Commitments
The following table summarizes our contractual commitments and commercial obligations that affect our financial condition and liquidity position as of September 30, 2009:
(1)
See Item 8 of Part II of this Form 10-K, “Financial Statements and Supplementary Data - Note 8 - Income Taxes.”
Off-Balance Sheet Arrangements
As of September 30, 2009, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.
New Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles - a replacement of FASB Statement No 162 (the Codification). The Codification reorganized the existing U.S. accounting and reporting standards into a single source of authoritative accounting principles arranged by topic. The Codification supersedes all existing U.S. accounting standards; all other accounting literature not included in the Codification, except for rules and interpretive releases of the SEC, which are also sources of authoritative U.S. GAAP for SEC registrants, is considered non-authoritative. The Codification was effective on a prospective basis for interim and annual reporting periods ending after September 15, 2009. We adopted the Codification in our year ended September 30, 2009. The adoption of the
Codification changed our references to U.S. GAAP, but it had no impact on our consolidated financial position or results of operations.
In September 2006, the FASB issued new guidance for using fair value to measure assets and liabilities. The new guidance, which is now a part of ASC 820, Fair Value Measurements and Disclosures, defines fair value, establishes a framework for measuring fair value under U.S. GAAP and expands disclosures about fair value measurements. The new guidance applies whenever other pronouncements require or permit assets or liabilities to be measured by fair value and while not requiring new fair value measurements, may change current practices. We adopted the new guidance in the second quarter of fiscal 2009. The adoption did not have a material impact on our consolidated financial position or results of operations, as it is a disclosure-only standard.
In December 2007, the FASB issued updated accounting standards on business combinations. The new standards, which are now part of ASC 805, Business Combinations, establish principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. ASC 805 also provides guidance for recognizing and measuring the goodwill acquired in the business combination or a gain from a bargain purchase and determines what information to disclose to enable users of financial statements to evaluate the nature and financial effects of the business combination. ASC 805 applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, which for us is the first quarter of fiscal 2010. ASC 805 will impact our consolidated financial statements for business combinations with an acquisition date on or after adoption in the first quarter of fiscal 2010.
In December 2007, the FASB issued new accounting and reporting standards for noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. Under the new standards, which are now part of ASC 810, Noncontrolling Interests in Consolidated Financial Statement, minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. ASC 810 also establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary and requires expanded disclosures. The new standards are effective for fiscal years beginning on or after December 15, 2008. We do not expect the adoption of ASC 810 will have a material impact on our financial position or results of operations.
In March 2008, the FASB issued new guidance on the disclosure of derivative instruments and hedging activities. The new guidance, which is now a part of ASC 815, Derivatives and Hedging Activities, requires enhanced disclosures about an entity’s derivative and hedging activities in order to improve the transparency of financial reporting. The provisions of the new guidance were effective for fiscal years and interim periods beginning after November 15, 2008. We adopted the new guidance in the first quarter of 2009. The adoption did not have a material impact on our consolidated financial position or results of operations, as it is a disclosure-only standard.
In April 2009, the FASB issued new guidance related to the disclosure of the fair value of financial instruments. The new guidance, which is now a part of ASC 825, Financial Instruments, requires fair value disclosures in both interim as well as annual financial statements in order to provide more timely information about the effects of current market conditions on financial instruments. The new guidance is effective for interim and annual periods ending after June 15, 2009. We adopted the new guidance for our interim period ending June 30, 2009. The adoption did not have a material impact on our consolidated financial position for results of operations, as it is a disclosure-only standard.
In April 2009, the FASB issued new guidance applicable to investments in debt securities for which other-than-temporary impairments may be recorded. Under the new guidance, which is now a part of ASC 320, Investments - Debt and Equity Securities, if an entity’s management asserts that it does not have the intent to sell a debt security and it is more likely than not that it will not have to sell the security before recovery of its cost basis, then an entity may separate other-than-temporary impairments into two components: 1) the amount related to credit losses (recorded in earnings), and 2) all other amounts (recorded in other comprehensive income). This guidance is to be applied prospectively and is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The adoption did not have a material impact on our consolidated financial position or results of operations.
In May 2009, the FASB issued new guidance for accounting for subsequent events. The new guidance, which is now a part of ASC 855, Subsequent Events, establishes the accounting for, and disclosure of, events that occur after
the balance sheet date but before financial statements are issued or are available to be issued. The new guidance requires the disclosure of the date through which and entity has evaluated subsequent events and the basis for that date. We adopted the new guidance for our interim period ending June, 30, 2009. The adoption of the new guidance and the related disclosures had no impact on our consolidated financial position or results of operations.
Cautionary Statement Regarding Forward Looking Information
Statements other than historical information contained herein constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements may be identified by the use of terminology such as “believe,” “may,” “will,” “expect,” “anticipate,” “predict,” “intend,” “designed,” “estimate,” “should” or “continue” or the negatives thereof or other variations thereon or comparable terminology. Such forward-looking statements involve known or unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements, or industry results, to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, the following:
•
the uncertainty of market acceptance of new product introductions;
•
the uncertainty of gaining new strategic relationships;
•
the uncertainty of timing of revenues from private label sales (particularly with respect to international customers);
•
the uncertainty of successfully establishing our separate Rochester Medical brand identity;
•
the uncertainty of successfully integrating and growing our U.K. operations;
•
the risks associated with operating an international business, including the impact of foreign currency exchange rate fluctuations;
•
FDA and other regulatory review and response times;
•
the securing of Group Purchasing Organization contract participation;
•
the uncertainty of gaining significant sales from secured GPO contracts;
•
the impact of continued healthcare cost containment;
•
new laws related to healthcare availability, healthcare reform, payment for healthcare products and services or the marketing and distribution of products, including legislative or administrative reforms to the U.S. Medicare and Medicaid systems or other U.S. or international reimbursement systems;
•
changes in the tax or environmental laws or standards affecting our business;
•
and other risk factors listed from time to time in our SEC reports, including, without limitation, the section entitled “Risk Factors” in Item 1A
Item 7 above. The report of Grant Thornton LLP on our internal control over financial reporting is contained in Item 8 above.
Changes in Internal Control Over Financial Reporting. During our fourth fiscal quarter, there was no significant change made in our internal control over financial reporting (as defined in Rule 13(a) - 15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
Other Information
None.
PART III
ITEM 10.
Directors, Executive Officers and Corporate Governance
The information with respect to the Board of Directors contained under the heading “Election of Directors”, the information contained under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” and the information contained under the heading “Corporate Governance - Board Meetings and Committees - Audit Committee” in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 2009, is incorporated herein by reference. Information with respect to our executive officers is provided in Part I, Item 1.
We have adopted a code of ethics in compliance with applicable rules of the Securities and Exchange Commission that applies to all of our employees, including our principal executive officer, our principal financial officer and our principal accounting officer or controller, or persons performing similar functions. We have posted a copy of the code of ethics on our website at www.rocm.com. We intend to disclose any amendments to, or waivers from, any provision of the code of ethics by posting such information on such website.
ITEM 11.
Executive Compensation
The information contained under the heading “Executive Compensation” in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 2009, (except for the information set forth under the subcaption “Compensation Committee Report on Executive Compensation”) is incorporated herein by reference.
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a) Equity Compensation Plans. The information contained under the heading “Proposal No. 2 - Proposal to Approve the Rochester Medical Corporation 2010 Stock Incentive Plan - Equity Compensation Plan Information” in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 2009, is incorporated herein by reference.
(b) Security Ownership. The information contained under the heading “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 2009, is incorporated herein by reference.
ITEM 13.
Certain Relationships and Related Transactions, and Director Independence
The information contained under the heading “Certain Relationships and Related Transactions” in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 2009, is incorporated herein by reference.
ITEM 14.
Principal Accounting Fees and Services
The information contained under the heading “Audit Committee Report and Payment of Fees to Auditor” in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 2009, is incorporated herein by reference.
PART IV
ITEM 15.
Exhibits and Financial Statement Schedules
(a)(1) The following financial statements are filed herewith in Item 8.
(i) Consolidated Balance Sheets as of September 30, 2009 and 2008.
(ii) Consolidated Statements of Operations for the years ended September 30, 2009, 2008 and 2007.
(iii) Consolidated Statement of Shareholders’ Equity and Comprehensive Income (Loss) for the years ended September 30, 2009, 2008 and 2007.
(iv) Consolidated Statements of Cash Flows for the years ended September 30, 2009, 2008 and 2007.
(v) Notes to Consolidated Financial Statements.
(a)(2) Financial Statement Schedules.
Schedule II - Valuation and Qualifying Accounts
Financial statement schedules other than those listed have been omitted since they are not required or are not applicable or the required information is shown in the financial statements or related notes.
(b) Exhibits
The following exhibits are submitted herewith:
*
Filed herewith.

Management contract or compensatory plan or arrangement required to be filed as an exhibit to Form 10-K pursuant to Item 15(c) of Form 10-K.
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.
Rochester Medical Corporation
By:
/s/ Anthony J. Conway
Anthony J. Conway
Chairman of the Board, President and,
Chief Executive Officer
Dated: December 11, 2009
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons in the capacities and on the dates indicated.
Dated: December 11, 2009
ROCHESTER MEDICAL CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(1)
Uncollectible accounts written off net of recoveries
(2)
Obsolete inventory written off against the allowance
INDEX TO EXHIBITS
ITEM 7A.
Quantitative and Qualitative Disclosures about Market Risk.
Our primary financial instrument market risk results from fluctuations in interest rates. Our cash is invested in bank deposits and money market funds denominated in U.S. dollars and British pounds. The carrying value of these cash equivalents approximates fair market value. Our investments in marketable securities are subject to interest rate risk and the value thereof could be adversely affected due to movements in interest rates. Our investment choices, however, are conservative in light of current economic conditions, and include primarily U.S. treasury bills to reduce the risk of loss or any material impact on our financial condition. Our revolving line of credit bears interest at a floating rate based on the quoted one-month LIBOR rate plus 1.25%. As of September 30, 2009 we had an outstanding balance of $1,878,447 under the revolving line of credit.
In future periods, we believe a greater portion of our revenues could be denominated in currencies other than the U.S. dollar, thereby increasing our exposure to exchange rate gains and losses on non-U.S. currency transactions. Sales through our subsidiary, Rochester Medical Limited, are denominated in British pounds, and fluctuations in the rate of exchange between the U.S. dollar and the British pound could adversely affect our financial results.
Otherwise, we do not believe our operations are currently subject to significant market risks for interest rates, foreign currency exchange rates, commodity prices or other relevant market price risks of a material nature. We do not currently use derivative financial instruments to manage interest rate risk or enter into forward exchange contracts to hedge exposure to foreign currencies, or any other derivative financial instruments for trading or speculative purposes. In the future, if we believe an increase in our currency exposure merits further review, we may consider entering into transactions to mitigate that risk.
ITEM 8.
ITEM 8.
Financial Statements and Supplementary Data
Rochester Medical Corporation
Consolidated Financial Statements
Years Ended September 30, 2009, 2008 and 2007
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Rochester Medical Corporation
We have audited the accompanying consolidated balance sheet of Rochester Medical Corporation (a Minnesota corporation) and subsidiary (collectively, the “Company”) as of September 30, 2009 and 2008 and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss), and cash flows for each of the two years in the period ended September 30, 2009. Our audit of the basic financial statements included the financial statement schedule listed in the index appearing under Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Rochester Medical Corporation and subsidiary as of September 30, 2009 and 2008, and the results of their operations and their cash flows for each of the two years in the period ended September 30, 2009 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Rochester Medical Corporation’s internal control over financial reporting as of September 30, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated December 11, 2009 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ Grant Thornton LLP
Minneapolis, Minnesota
December 11, 2009
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Rochester Medical Corporation
We have audited Rochester Medical Corporation’s (the “Company”) internal control over financial reporting as of September 30, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Rochester Medical Corporation maintained, in all material respects, effective internal control over financial reporting as of September 30, 2009, based on criteria established in Internal Control - Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Rochester Medical Corporation as of September 30, 2009 and 2008, and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss), and cash flows and financial statement schedule for each of the two years in the period ended September 30, 2009, and our report dated December 11, 2009 expressed an unqualified opinion on those financial statements and financial statement schedule.
/s/ Grant Thornton LLP
Minneapolis, Minnesota
December 11, 2009
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
of Rochester Medical Corporation
We have audited the consolidated statements of operations, shareholders’ equity and comprehensive income, and cash flows of Rochester Medical Corporation and subsidiary for the year ended September 30, 2007. Our audit also included the financial statement schedule of Rochester Medical Corporation listed in Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of Rochester Medical Corporation and subsidiary’s operations and their cash flows for the year ended September 30, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ McGladrey & Pullen LLP
Minneapolis, Minnesota
December 3, 2007
ROCHESTER MEDICAL CORPORATION
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these financial statements.
ROCHESTER MEDICAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
ROCHESTER MEDICAL CORPORATION
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE
INCOME (LOSS)
The accompanying notes are an integral part of these financial statements.
ROCHESTER MEDICAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these financial statements.
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2009
1.
Description of Business and Basis of Presentation
Rochester Medical Corporation develops, manufactures and markets a broad line of innovative, technologically enhanced urinary continence and urine drainage care products for the home care and acute/extended care markets. The Company currently manufactures and markets standard continence care products, including male external catheters, Foley catheters and intermittent catheters and innovative and technologically advanced products such as its FemSoft Insert, StrataNF catheter and antibacterial and hydrophilic intermittent catheters. The Company markets its products under its Rochester Medical brand, and also supplies its products to several large medical product companies for sale under brands owned by these companies, which are referred to as private label sales.
The Company’s fiscal year end is September 30. The accompanying financial statements include the accounts of Rochester Medical Corporation and Rochester Medical Limited, its wholly owned subsidiary in the United Kingdom, together which are herein referred to as “the Company”.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant items subject to estimates and assumptions include the valuation allowances for inventories and accounts receivable, fair value assumptions related to investments, deferred income tax assets and stock-based compensation. Actual results could differ from those estimates.
2.
Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Rochester Medical Corporation and its wholly owned subsidiary. All material intercompany accounts and transactions are eliminated in consolidation.
Cash Equivalents
The Company considers all highly liquid investments with a remaining maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents includes balances in foreign accounts totaling $4.2 million and $3.9 million at September 30, 2009 and 2008, respectively. The Company maintains its cash in bank deposit accounts which, at times, may exceed the insurance limits of the Federal Deposit Insurance Corporation. The Company has not experienced any losses in such accounts.
Marketable Securities
As of September 30, 2009, the Company has $29.9 million invested in high quality, investment grade debt securities, primarily consisting of $27.1 million invested in U.S. treasury bills and $2.8 million invested in a mutual fund. The Company is currently reporting an unrealized loss of $544,268 related to the mutual fund as a result of the recent fluctuations in the credit markets impacting the current market value. The Company considers these unrealized losses temporary as it has the intent and ability to hold these investments to maturity.
Marketable securities are classified as available for sale and are carried at fair value, with unrealized gains or losses included as a separate component of shareholders’ equity. The cost and fair value of available-for-sale securities were as follows:
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Losses recognized are recorded in Other expense, in the consolidated statements of operations. Gains and losses from the sale of investments are calculated based on the specific identification method.
Effective October 1, 2008, the Company adopted the accounting standards which are now part of Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures, for financial assets and liabilities that are re-measured and reported at fair value at each reporting period. Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 requires that fair value measurements be classified and disclosed using one of the following three categories:
Level 1. Quoted prices (unadjusted) 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 in active markets for similar assets or liabilities; quoted prices for identical or similar assets in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; or
Level 3. Inputs that are unobservable for the asset or liability and that are significant to the fair value of the assets or liabilities.
The adoption of these standards did not have a material impact on the Company’s consolidated financial statements. The Company has determined that the values given to its marketable securities are appropriate and are measured using Level 1 inputs.
Fair Value of Financial Instruments
The carrying amounts of all financial instruments, including cash, accounts receivable, accounts payable and accrued expenses approximate their fair values because of the short maturity of these instruments. The carrying amounts of the Company’s long-term debt approximates fair value based on rates offered to the Company for debt.
Concentration of Credit
The Company manufactures and sells its products to a full range of companies in the medical industry on a worldwide basis. There is a concentration of sales to larger medical wholesalers and distributors. The Company performs periodic credit evaluations of its customers’ financial condition. The Company requires irrevocable letters of credit on sales to certain foreign customers. Receivables generally are due within 30 to 60 days.
Accounts Receivable
The Company grants credit to customers in the normal course of business, but generally does not require collateral or any other security to support its receivables. The Company maintains an allowance for doubtful accounts for potential credit losses. Uncollectible accounts are written-off against the allowance when it is deemed that a customer account is uncollectible. Accounts outstanding longer than the contractual payment terms are considered past due. The Company determines its allowances by considering a number of factors, including the length of time accounts receivables are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. Accounts receivable balances written off have been within management’s expectations.
Inventories
Inventories, consisting of material, labor and manufacturing overhead, are stated at the lower of cost (first-in, first-out method) or market.
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is based on estimated useful lives of 4-10 years for equipment and fixtures and 25-35 years for buildings computed using the straight-line method. Additions and improvements that extend the lives of the assets are capitalized while expenditures for repairs and maintenance are expensed as incurred.
Finite Life Intangible Assets
Finite life intangible assets consist primarily of purchased trademarks, a supply agreement, and customer relationships and are amortized using the straight-line method, as appropriate, over their estimated useful lives, ranging from 5 to 20 years. The Company reviews these intangible assets as changes in circumstance or the occurrence of events suggest the remaining value may not be recoverable. No impairment loss was recognized in the fiscal years ended September 30, 2009, 2008 and 2007.
Goodwill and Other Intangible Assets
The Company records as goodwill the excess of purchase price over the fair value of the identifiable net assets acquired as prescribed by ASC 350, Goodwill and Other Intangible Assets. Under ASC 350, goodwill and intangibles with indefinite useful lives are not amortized. ASC 350 also requires, at a minimum, an annual assessment of the carrying value of goodwill and other intangibles with indefinite useful lives. If the carrying value of goodwill or an intangible asset exceeds its fair value, an impairment loss shall be recognized. The Company tests annually for impairment on the anniversary date of the acquisition of the asset, which is currently on June 2nd of each fiscal year, or more frequently if events and circumstances indicate that the asset might be impaired. The recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge would be recognized by the amount that the carrying amount of the asset exceeds the fair value of the asset. The Company performed annual goodwill impairment testing by comparing the market value of the Company’s assets at June 2, 2009 to the net book value of its equity, and concluded that the goodwill was not impaired. No impairment loss was recognized in the fiscal years ended September 30, 2009, 2008 and 2007. The decrease in value of goodwill as of September 30, 2009 is entirely related to the change in foreign currency exchange rates in the United Kingdom.
Long-Lived Assets
The Company reviews its long-lived assets for impairment as prescribed by ASC 360, Property, Plant, and Equipment, whenever events or changes in circumstances indicate that its carrying value of long-lived assets may not be recoverable. Long-lived assets are considered not recoverable when the carrying amount of a long-lived asset (asset group) exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group). If it is determined that a long-lived asset (asset group) is not recoverable, an impairment loss is recorded equal to the excess of the carrying amount of the long-lived asset (asset group) over the long-lived asset’s (asset group’s) fair value. Fair value is the amount at which the long-lived asset (asset group) could be bought or sold in a current transaction between a willing buyer and seller, other than in a forced or liquidation sale. No impairment loss was recognized in the fiscal years ended September 30, 2009, 2008 and 2007.
Foreign Currency Translation
The financial statements of the Company’s non-U.S. subsidiary are translated into U.S. dollars in accordance with ASC 830, Foreign Currency Matters. Under ASC 830, the assets and liabilities of certain non-U.S. subsidiaries whose functional currencies are other than the U.S. dollar are translated at current rates of exchange. Revenue and expense items are translated at the average exchange rates. The resulting translation adjustments are recorded directly into accumulated other comprehensive income (loss).
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Patents
Capitalized costs include costs incurred in connection with making patent applications for the Company’s products and are amortized on a straight-line basis over eight years. The Company periodically reviews its patents for impairment of value. Any adjustment from the analysis is charged to operations.
Revenue Recognition
The Company has standard contract terms with all non-Group Purchase Organization customers, which include our independent distributors, of FOB shipping point; as such, sales are recognized upon shipment. Group Purchase Organization customers have terms of FOB destination per the agreement and thus sales are recognized upon delivery of goods to the customer. Revenue is recognized when title and risk of ownership have passed, the price to the buyer is fixed and determinable and recoverability is reasonably assured. For all Group Purchase Organization customer orders shipped within the last five working days of a quarter, the Company monitors the shipping tracking number for such shipments to verify receipt by the customer. If the Company is able to verify receipt by the customer by the end of the month, the sale is recognized. Payment terms for all customers range from prepayment to 60 days. Customers cannot return unsold products unless the Company has authorized such return for warranty claims. The Company does not grant significant price concessions to its customers.
The Company warrants that the products it sells to its customers will conform to the description and specifications furnished by the Company, and that the products will be free from defects in material and workmanship. In the event of a warranty claim, the customer is responsible for shipping the product(s) back to the Company, freight prepaid. If the failure of the product is due to a breach of warranty, the Company may repair or replace the defective product(s) at its option and return the repaired or replaced product(s) to the customer, freight prepaid. This is the limit of the Company’s warranty liability, and this warranty is made in lieu of all other written or unwritten express or implied warranties. Historically, due to the nature of use of the Company’s products and low replacement cost, the Company’s warranty exposure has been immaterial.
Other than the Company’s limited warranty obligation, the Company does not have significant post-shipment obligations to, or significant acceptance provisions with, its customers, including its distributors.
During the year ended September 30, 2007, the Company recognized $525,000 of deferred revenue related to a 10 year distribution agreement with Coloplast. As part of the original agreement, Coloplast paid the Company $1,000,000 for the exclusive right to market and sell the Release-NF Foley catheter in the U.K. for a period of 10 years. Amounts received for upfront license fees under multiple-element supply and distribution arrangements are deferred and recognized over the period of supply, if such arrangements require on-going services or performance by the Company. During fiscal 2007, both companies mutually agreed to terminate the contract thus accelerating the recognition of the remaining deferred revenue of the Company. During fiscal 2008 and 2009, the Company did not receive upfront license fees under any multiple-element supply and distribution arrangements.
Shipping and Handling
Shipping and handling billed to customers is recorded as revenue. Shipping and handling costs are recorded within cost of goods sold.
Research and Development Costs
Research and development costs are charged to operations as incurred. Research and development costs include clinical testing costs, certain salary and related expenses, other labor costs, materials and an allocation of certain overhead expenses.
Income Taxes
Income taxes are accounted for under the liability method. Deferred income taxes are provided for temporary differences between financial reporting and tax bases of assets and liabilities. The Company records a valuation
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
allowance to reduce the carrying value of its net deferred tax assets to the amount that is more likely than not to be realized. The Company has determined it is more likely than not that all deferred tax assets will be realized and therefore no valuation allowance is necessary.
It is the Company’s practice to recognize penalties and/or interest to income tax matters in income tax expenses. As of September 30, 2009, the Company did not have a material amount of accrued interest or penalties related to unrecognized tax benefits.
The Company is subject to income tax examinations in the U.S. federal jurisdiction, as well as in the United Kingdom and various state jurisdictions. The Internal Revenue Service (“IRS”) completed an examination of the Company’s income tax return for the fiscal year ended September 30, 2007 and a settlement was reached in September 2009. Reserves in accordance with ASC 740, Income Taxes for unrecognized tax benefits was more than the additional taxes assessed by the IRS. The remaining reserves relating to the 2007 tax year were released during the year ended September 30, 2009, as a result of the settlement.
Advertising Costs
The Company incurred advertising expenses of approximately $929,000, $946,000 and $397,000 for the years ended September 30, 2009, 2008 and 2007, respectively. All advertising costs are charged to operations as incurred.
Stock-Based Compensation
Stock-based compensation expense includes: (a) compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of, October 1, 2005, based on grant-date fair value estimated in accordance with the accounting provisions that are now part of ASC 718, Compensation-Stock Compensation; and (b) compensation expense for all stock-based compensation awards granted subsequent to October 1, 2005, based on grant-date fair value estimated in accordance with the provisions of ASC 718, recognized utilizing the accelerated expense attribution method for awards with graded vesting. The Company recorded approximately $1,330,000, $1,365,000 and $2,100,000 ($878,000, $887,000 and $1,365,000 net of tax) of related stock-based compensation expense for the years ended September 30, 2009, 2008 and 2007, respectively.
Net Income Per Share
Net income per common share is calculated in accordance with ASC 260, Earnings Per Share. The Company’s basic net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period, increased to include dilutive potential common shares issuable upon the exercise of stock options that were outstanding during the period. For periods of net loss, diluted net loss per common share equals basic net loss per common share because common stock equivalents are not included in periods where there is a loss, as they are antidilutive. A reconciliation of the numerator and denominator in the basic and diluted net income per share calculation is as follows:
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Employee stock options of 230,000, 5,000 and 30,000 for fiscal years 2009, 2008 and 2007, respectively, have been excluded from the diluted net income per common share calculations because their exercise prices were greater than the average market price of the Company’s common stock.
Business Segment
The Company conducts its business within one business segment which is defined as developing, manufacturing and marketing urinary continence and urinary drainage care products.
New Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles - a replacement of FASB Statement No 162 (the Codification). The Codification reorganized the existing U.S. accounting and reporting standards into a single source of authoritative accounting principles arranged by topic. The Codification supersedes all existing U.S. accounting standards; all other accounting literature not included in the Codification, except for rules and interpretive releases of the SEC, which are also sources of authoritative U.S. GAAP for SEC registrants, is considered non-authoritative. The Codification was effective on a prospective basis for interim and annual reporting periods ending after September 15, 2009. The Company adopted the Codification in its fiscal year ended September 30, 2009. The adoption of the Codification changed the Company’s references to U.S. GAAP, but it had no impact on the Company’s consolidated financial position or results of operations.
In September 2006, the FASB issued new guidance for using fair value to measure assets and liabilities. The new guidance, which is now a part of ASC 820, Fair Value Measurements and Disclosures, defines fair value, establishes a framework for measuring fair value under U.S. GAAP and expands disclosures about fair value measurements. The new guidance applies whenever other pronouncements require or permit assets or liabilities to be measured by fair value and while not requiring new fair value measurements, may change current practices. The Company adopted the new guidance in the second quarter of fiscal 2009. The adoption did not have a material impact on the Company’s consolidated financial position or results of operations, as it is a disclosure-only standard.
In December 2007, the FASB issued updated accounting standards on business combinations. The new standards, which are now part of ASC 805, Business Combinations, establish principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. ASC 805 also provides guidance for recognizing and measuring the goodwill acquired in the business combination or a gain from a bargain purchase and determines what information to disclose to enable users of financial statements to evaluate the nature and financial effects of the business combination. ASC 805 applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, which for the Company is the first quarter of fiscal 2010. ASC 805 will impact the Company’s consolidated financial statements for business combinations with an acquisition date on or after adoption in the first quarter of fiscal 2010.
In December 2007, the FASB issued new accounting and reporting standards for noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. Under the new standards, which are now part of ASC 810, Noncontrolling Interests in Consolidated Financial Statement, minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. ASC 810 also establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary and requires expanded disclosures. The new standards are effective for fiscal years beginning on or after December 15, 2008. The Company does not expect the adoption of ASC 810 will have a material impact on its financial position or results of operations.
In March 2008, the FASB issued new guidance on the disclosure of derivative instruments and hedging activities. The new guidance, which is now a part of ASC 815, Derivatives and Hedging Activities, requires enhanced disclosures about an entity’s derivative and hedging activities in order to improve the transparency of
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
financial reporting. The provisions of the new guidance were effective for fiscal years and interim periods beginning after November 15, 2008. The Company adopted the new guidance in the first quarter of 2009. The adoption did not have a material impact on the Company’s consolidated financial position or results of operations, as it is a disclosure-only standard.
In April 2009, the FASB issued new guidance related to the disclosure of the fair value of financial instruments. The new guidance, which is now a part of ASC 825, Financial Instruments, requires fair value disclosures in both interim as well as annual financial statements in order to provide more timely information about the effects of current market conditions on financial instruments. The new guidance is effective for interim and annual periods ending after June 15, 2009. The Company adopted the new guidance for its interim period ending June 30, 2009. The adoption did not have a material impact on the Company’s consolidated financial position for results of operations, as it is a disclosure-only standard.
In April 2009, the FASB issued new guidance applicable to investments in debt securities for which other-than-temporary impairments may be recorded. Under the new guidance, which is now a part of ASC 320, Investments - Debt and Equity Securities, if an entity’s management asserts that it does not have the intent to sell a debt security and it is more likely than not that it will not have to sell the security before recovery of its cost basis, then an entity may separate other-than-temporary impairments into two components: 1) the amount related to credit losses (recorded in earnings), and 2) all other amounts (recorded in other comprehensive income). This guidance is to be applied prospectively and is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The adoption did not have a material impact on the Company’s consolidated financial position or results of operations.
In May 2009, the FASB issued new guidance for accounting for subsequent events. The new guidance, which is now a part of ASC 855, Subsequent Events, establishes the accounting for, and disclosure of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The new guidance requires the disclosure of the date through which and entity has evaluated subsequent events and the basis for that date. The Company adopted the new guidance for its interim period ending June, 30, 2009. The adoption of the new guidance and the related disclosures had no impact on the Company’s consolidated financial position or results of operations.
3.
Other Income (Loss)
During fiscal 2009, the Company recorded $1,200,000 of other income, consisting primarily of a cash settlement from Covidien Ltd. when the Company reached a settlement with Covidien Ltd., Tyco International (US) Inc. and Tyco Health Care Group, L.P., with respect to the lawsuit it initiated in February 2004 against certain GPOs and individual defendants alleging anti-competitive conduct against the defendants in the markets for standard and anti-infection Foley catheters as well as urethral catheters,. Under the settlement agreement, Covidien Ltd. paid the Company $3,500,000 (net $1,000,000 after payment of attorney’s fees and expenses) and was dismissed from the lawsuit.
During fiscal 2008, the Company recorded a foreign currency transaction loss of $89,000 related to the note payable to Coloplast A/S.
During the fiscal year ended September 30, 2007, the Company recorded $38,855,000 of other income, consisting primarily of two cash settlements. The first occurred on November 20, 2006, when the Company reached a settlement with Premier, Inc and Premier Purchasing Partners, L.P. with respect to the lawsuit. Under the settlement agreement, Premier paid the Company $8,825,000 (net $5,155,000 after payment of attorneys’ fees and expenses) and was dismissed from the lawsuit. The second occurred on December 14, 2006, when the Company reached a settlement with C.R. Bard, Inc., whereby C.R. Bard, Inc. paid the Company $49,000,000 (net $33,450,000 after payment of attorneys’ fees and expenses) and was dismissed from the lawsuit.
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4.
Inventories
Inventories are summarized as follows:
5.
Finite Life Intangible Assets
Finite life intangible assets were as follows:
Amortization expense related to these assets was as follows:
Estimated annual amortization expense for these assets over the next five years is as follows:
6.
Leases
The Company leases many of its automobiles for its sales staff in the United Kingdom for various terms under long-term, non-cancelable operating lease agreements. The leases expire at various dates through 2013. In the normal course of business, it is expected that these leases will be replaced by leases on other vehicles as the lease terms expire.
Lease expense totaled approximately $312,000, $245,000 and $19,000 during fiscal 2009, 2008 and 2007, respectively.
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following is a schedule by year of estimated future minimum rental payments required under the operating lease agreements:
7.
Shareholders’ Equity
Stock Options
The Rochester Medical Corporation 1991 Stock Option Plan authorized the issuance of up to 2,000,000 shares of Common Stock. Under the terms of the 1991 Stock Option Plan, the Board of Directors could grant employee incentive stock options equal to fair market value of the Company’s Common Stock or employee non-qualified options at a price which could not be less than 85% of the fair market value. Per the terms of the 1991 Stock Option Plan, as of April 20, 2001, no new stock options may be granted under the 1991 Stock Option Plan. As of September 30, 2009, 146,200 options remain outstanding under the 1991 Stock Option Plan.
The 1995 Non-Statutory Stock Option Plan authorizes the issuance of up to 100,000 shares of Common Stock. Per the terms of the 1995 Non-Statutory Stock Option Plan, no option may be granted with a term longer than ten years. The vesting schedule for options granted under the 1995 Non-Statutory Stock Option Plan is determined by the Compensation Committee of the Company’s Board of Directors. As of September 30, 2009, 88,000 shares remain available for issuance under the 1995 Non-Statutory Stock Option Plan, and there were no options outstanding under the plan.
The 2001 Stock Incentive Plan authorizes the issuance of up to 2,000,000 shares of Common Stock pursuant to grants of incentive stock options, non-qualified options or restricted stock. Per the terms of the 2001 Stock Incentive Plan, options may be granted with a term no longer than ten years. The vesting schedule and term for options and restricted stock granted under the 2001 Stock Incentive Plan is determined by the Compensation Committee of the Company’s Board of Directors. As of September 30, 2009, 146,500 shares remain available for issuance under the 2001 Stock Incentive Plan, and there were 1,348,500 options outstanding under the plan.
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Option activity is summarized as follows:
During the year ended September 30, 2007, two of the Company’s executives and one of its directors tendered an aggregate of 41,340 shares with a fair market value of $485,750 to the Company as consideration for the exercise of 56,000 stock options with an exercise price of $485,750. The shares acquired by the Company were subsequently retired.
The number of stock options exercisable at September 30, 2009, 2008 and 2007 was 1,062,075, 1,264,384 and 1,323,334 at a weighted average exercise price of $6.04, $5.36 and $4.96 per share, respectively.
At September 30, 2009, the aggregate intrinsic value of options outstanding was $7,313,983, and the aggregate intrinsic value of options exercisable was $6,428,970. Total intrinsic value of options exercised was $2,848,159 for the year ended September 30, 2009.
As of September 30, 2009, $1,302,539 of unrecognized compensation costs related to non-vested awards is expected to be recognized over a weighted average period of approximately fourteen months.
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The weighted average fair value of options granted in 2009, 2008 and 2007 was $6.70, $6.86 and $8.03 per share, respectively. The exercise price of options outstanding at September 30, 2009 ranged from $2.17 to $18.02 per share as summarized in the following table:
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
The Black-Scholes option pricing model was used to estimate the fair value of stock-based awards with the following weighted-average assumptions for the years ended September 30:
The risk-free rate is based on a treasury instrument whose term is consistent with the expected life of the Company’s stock options. The expected volatility, holding period, and forfeitures of options are based on historical experience.
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
8.
Income Taxes
Deferred income taxes are due to temporary differences between the carrying values of certain assets and liabilities for financial reporting and income tax purposes, in addition to certain tax carryforwards. Significant components of deferred income taxes are as follows:
The deferred tax amounts above have been classified in the accompanying balance sheets as follows:
The Company records a valuation allowance to reduce the carrying value of its net deferred tax assets to the amount that is more likely than not to be realized. The Company has determined it is more likely than not that all deferred tax assets will be realized and therefore no valuation allowance is necessary for the year ended September 30, 2009.
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The income (loss) before taxes and the provision for taxes for the years ended September 30, 2009, 2008, and 2007 consist of the following:
The reconciliation between the statutory federal income tax rate and the effective income tax rate for the years ended September 30 is as follows:
On October 1, 2007, the Company adopted accounting provisions that now form part of ASC 740, Income Taxes, and which clarify the accounting for uncertainty in tax positions recognized in the financial statements. These provisions create a single model to address uncertainty in tax positions and clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. ASC 740 also provides guidance on derecognition, measurement,
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
classification, interest and penalties, accounting in interim periods, disclosure and transition. At the adoption date, October 1, 2007, the Company did not have a material liability for unrecognized tax benefits. As of September 30, 2009, the Company has recognized approximately $56,000 for unrecognized tax benefits. If the Company were to prevail on all unrecognized tax benefits recorded at September 30, 2009, the total gross unrecognized tax benefit totaling approximately $56,000 would benefit the Company’s effective tax rate if recognized.
It is the Company’s practice to recognize penalties and/or interest to income tax matters in income tax expenses. As of September 30, 2009, the Company did not have a material amount of accrued interest or penalties related to unrecognized tax benefits.
The Company is subject to income tax examinations in the U.S. Federal jurisdiction, as well as in the United Kingdom and various state jurisdictions. The Internal Revenue Service completed an examination of our income tax return for the fiscal year ended September 30, 2007, and a settlement was reached in September 2009. ASC 740 reserves relating to the settlement items were more than the additional taxes assessed by the IRS. The remaining ASC 740 reserves relating to the 2007 tax year were released during the year ended September 30, 2009, as a result of the settlement.
A reconciliation of the beginning and ending amount of unrecognized tax benefit is as follows:
9.
Related Party Transactions
The brother-in-law of the CEO and President, has performed legal services for the Company. During the years ended September 30, 2008 and 2007, the Company incurred legal fees and expenses of approximately $3,000 and $34,000, respectively, to such counsel for services rendered in connection with litigation and for general legal services. Management believes the fees paid for the services rendered to the Company were on terms at least as favorable to the Company as could have been obtained from an unrelated party. There were no expenses incurred for legal fees from this related party during the year ended September 30, 2009.
10.
Significant Customers
Significant customers, measured as a percentage of sales, are summarized as follows:
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11.
Employee Benefit Plan
The Company has a 401(k) plan covering employees meeting certain eligibility requirements. The Company currently matches employee contributions at a rate of 50% with a maximum match of 2.5% of salary. The total matching expense for the years ended September 30, 2009, 2008 and 2007 was $136,497, $120,536 and $70,817, respectively.
12.
Geographic Area Data
Sales related to customers in the United States, Europe and the rest of the world are as follows:
Sales are attributed to countries based upon the address to which the Company ships products, as set forth on the customer’s purchase order.
Long-lived assets, excluding deferred income tax assets of the Company are located in the United States and Europe as follows:
13.
Line of Credit and Long-Term Debt
In June 2006, in conjunction with an asset purchase agreement with Coloplast A/S, the Company entered into an unsecured loan note deed with Coloplast with an outstanding principal amount of $5,340,000. The promissory note is non-interest bearing and payable in five equal annual installments of $1,068,000 payable annually on June 2. The Company has imputed interest on the note at 6.90% which reflected the Company’s cost of borrowing at the date of the purchase agreement and the discount is being amortized over the life of the note. The liability balance was $1,927,910 and $2,796,929 at September 30, 2009 and 2008, respectively.
In June 2006, we entered into a $7,000,000 credit facility with U.S. Bank National Association. The credit facility consisted of a $5,000,000 term loan payable in five years and accruing interest at a rate equal to 4.77%, and a revolving line of credit of up to $2,000,000, maturing annually on March 31, with interest payable monthly at a floating rate based on the quoted one-month LIBOR rate plus 1.60%. In March 2009, we paid off the entire term loan and terminated the revolving line of credit.
In February 2009, we entered into a $14,000,000 credit facility with UBS Financial. The credit facility consists of a revolving line of credit of up to $14,000,000 with interest accruing monthly at a floating rate based on the quoted one-month LIBOR rate plus 1.25%. As of September 30, 2009 we had an outstanding balance of $1,878,447 under the revolving line of credit. Our obligations under the credit facility are payable on demand and are secured by our investments in marketable securities held at UBS.
ROCHESTER MEDICAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Aggregate maturities of long-term debt are as follows for the years ending September 30:
14.
Share Repurchase Program
On March 3, 2009, the Company announced its intention to repurchase some of its outstanding common shares pursuant to its previously authorized share repurchase program. Up to 2,000,000 shares may be repurchased from time to time on the open market, or pursuant to negotiated or block transactions, in accordance with applicable Securities and Exchange Commission regulations. During the three months ended September 30, 2009, no shares were repurchased. During fiscal 2009, the Company repurchased 110,653 shares of common stock pursuant to this program at an average price of $9.56 per share. Total cash consideration for the repurchased shares was approximately $1,100,000. As of September 30, 2009, there remained 1,847,347 shares that may be purchased under the program.
15.
Quarterly Results (Unaudited)
Summary data relating to the results of operations for each quarter of the years ended September 30, 2009 and 2008 follows (in thousands, except per share amounts):
16.
Subsequent Events
The Company evaluated its September 30, 2009 financial statements for subsequent events through December 11, 2009, the date the financial statements were available to be issued. The Company is not aware of any subsequent events which would require recognition or disclosure in the financial statements.
ITEM 9.
ITEM 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
On March 11, 2008, the Audit Committee of the Board of Directors of Rochester Medical Corporation, after a review of proposals for audit services from several public accountants, decided to engage Grant Thornton LLP as our independent registered public accounting firm for the fiscal year commencing October 1, 2007 and ending September 30, 2008. McGladrey & Pullen LLP (“McGladrey & Pullen”), the then-current independent registered public accounting firm, was dismissed by the Audit Committee as of March 11, 2008.
In connection with the audit of the fiscal year ended September 30, 2007, and the subsequent interim period through March 11, 2008, there were no disagreements between us and McGladrey & Pullen on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of McGladrey & Pullen, would have caused McGladrey & Pullen to make reference in connection with their opinion to the subject matter of the disagreement.
There were no reportable events (as defined in Regulation S-K Item 304(a)(1)(v)) during our two most recent fiscal years ended September 30, 2007, or the subsequent interim period through March 11, 2008.
The audit reports of McGladrey & Pullen on our consolidated financial statements as of and for the years ended September 30, 2007 and September 30, 2006 did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope, or accounting principles.
A letter from McGladrey & Pullen LLP is included as Exhibit 16 to this Form 10-K.
On March 13, 2008, the Audit Committee engaged Grant Thornton as our independent registered public accounting firm. During our two most recent fiscal years and the subsequent interim period through February 29, 2008, we did not consult with Grant Thornton LLP regarding any of the matters set forth in Item 304(a)(2)(i) and (ii) of Regulation S-K.
ITEM 9A.
ITEM 9A.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures. As of the end of the period covered by this report (the Evaluation Date) we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 as amended (the Exchange Act)). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms, and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control Over Financial Reporting. Management’s report on our internal control over financial reporting is contained in Item 7 above. The report of Grant Thornton LLP on our internal control over financial reporting is contained in Item 8 above.
Changes in Internal Control Over Financial Reporting. During our fourth fiscal quarter, there was no significant change made in our internal control over financial reporting (as defined in Rule 13(a) - 15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B.
Other Information
None.
PART III
ITEM 10.
ITEM 10.
Directors, Executive Officers and Corporate Governance
The information with respect to the Board of Directors contained under the heading “Election of Directors”, the information contained under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” and the information contained under the heading “Corporate Governance - Board Meetings and Committees - Audit Committee” in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 2009, is incorporated herein by reference. Information with respect to our executive officers is provided in Part I, Item 1.
We have adopted a code of ethics in compliance with applicable rules of the Securities and Exchange Commission that applies to all of our employees, including our principal executive officer, our principal financial officer and our principal accounting officer or controller, or persons performing similar functions. We have posted a copy of the code of ethics on our website at www.rocm.com. We intend to disclose any amendments to, or waivers from, any provision of the code of ethics by posting such information on such website.
ITEM 11.
ITEM 11.
Executive Compensation
The information contained under the heading “Executive Compensation” in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 2009, (except for the information set forth under the subcaption “Compensation Committee Report on Executive Compensation”) is incorporated herein by reference.
ITEM 12.
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a) Equity Compensation Plans. The information contained under the heading “Proposal No. 2 - Proposal to Approve the Rochester Medical Corporation 2010 Stock Incentive Plan - Equity Compensation Plan Information” in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 2009, is incorporated herein by reference.
(b) Security Ownership. The information contained under the heading “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 2009, is incorporated herein by reference.
ITEM 13.
ITEM 13.
Certain Relationships and Related Transactions, and Director Independence
The information contained under the heading “Certain Relationships and Related Transactions” in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 2009, is incorporated herein by reference.
ITEM 14.
ITEM 14.
Principal Accounting Fees and Services
The information contained under the heading “Audit Committee Report and Payment of Fees to Auditor” in the Proxy Statement for Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission within 120 days of the close of the fiscal year ended September 30, 2009, is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15.
Exhibits and Financial Statement Schedules
(a)(1) The following financial statements are filed herewith in Item 8.
(i) Consolidated Balance Sheets as of September 30, 2009 and 2008.
(ii) Consolidated Statements of Operations for the years ended September 30, 2009, 2008 and 2007.
(iii) Consolidated Statement of Shareholders’ Equity and Comprehensive Income (Loss) for the years ended September 30, 2009, 2008 and 2007.
(iv) Consolidated Statements of Cash Flows for the years ended September 30, 2009, 2008 and 2007.
(v) Notes to Consolidated Financial Statements.
(a)(2) Financial Statement Schedules.
Schedule II - Valuation and Qualifying Accounts
Financial statement schedules other than those listed have been omitted since they are not required or are not applicable or the required information is shown in the financial statements or related notes.
(b) Exhibits
The following exhibits are submitted herewith:
*
Filed herewith.

Management contract or compensatory plan or arrangement required to be filed as an exhibit to Form 10-K pursuant to Item 15(c) of Form 10-K.
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.
Rochester Medical Corporation
By:
/s/ Anthony J. Conway
Anthony J. Conway
Chairman of the Board, President and,
Chief Executive Officer
Dated: December 11, 2009
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons in the capacities and on the dates indicated.
Dated: December 11, 2009
ROCHESTER MEDICAL CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(1)
Uncollectible accounts written off net of recoveries
(2)
Obsolete inventory written off against the allowance
INDEX TO EXHIBITS