The increase in loss of approximately CAD26 million is substantially due to a non-cash CAD23 million impairment charge on technology and goodwill, a non-cash CAD2 million increase in amortization expense on technology and a CAD1 million increase in other losses.
Impairment of Goodwill and Technology
During the fourth quarter of 2008, the company’s market capitalization remained below the value of the shareholders equity for a significant period of time, indicating potential impairment of the company’s goodwill and other intangible assets. As a result of these market indicators and the company’s impairment testing, the company recorded an impairment charge of CAD3,557,082 to write down acquired goodwill to CADnil and an impairment charge of CAD19,503,930 to write down the net book value of acquired technologies to CADnil.
Termination of Distribution Agreement
On December 22, 2008, the distribution agreement between Neovasc and a third party distributor was terminated. On termination the company was required to repurchase inventory held by the distributor less a 25% restocking fee. Under EIC-156 Accounting by a vendor for consideration given to a customer, Neovasc is required to recognize the inventory repurchase as a reduction in revenue and the income statement impact of the termination was to reduce revenue by CAD516,601, decrease cost of goods sold by CAD308,203 and recognize interest income of CAD45,024 (for the interest due on accounts receivable from the distributor).
Inventory Write Down
During the last quarter of the year, Neovasc severed its direct sales force employees who sold the company’s Metricath products and terminated its distributor of Aegis products. As a result, the company has limited sales channels through which to sell the Metricath and Aegis product lines. While management continues to look for new distributors to carry these products, there is no certainty, when, or if, they will be able to find a suitable partner. With no certain sales in 2009 from these products the company incurred an inventory write down of CAD626,925.
Repayable Contribution Write Back
As noted above, the Metricath products do not currently have an established sales channel and Neovasc cannot predict whether or not it will be able to establish a suitable channel in the future or generate revenue from these products in 2009. As a result, the company released CAD320,445 liability for the repayable contribution agreement repayable from royalties generated from future Metricath sales.
Revenues
Sales of catheter products for the year ended December 31, 2008 were CAD262,118 a marginal increase over sales of CAD258,017 in the comparable period in 2007, despite a heavy investment in a direct sales force and a substantial marketing effort. As described above, the direct sales force has been terminated and the company is looking for a new distributor to carry its Metricath product. Sales of tissue and surgical products and services for the year ended December 31, 2008 were CAD1,284,121, as compared to sales of CAD1,259,856 for the year ended December 31, 2007, a marginal increase of approximately 2%. These revenues were derived from the sales of Peripatch products and contract manufacturing revenues. In the fourth quarter the company reduced revenues by CAD516,601 associated with the repurchase of inventory from a terminated distribution agreement. Revenue in the prior quarters was correctly recognized at that time and the reduction in revenue arises solely from the termination of the distribution agreement in accordance with EIC 156 – Accounting by a vendor for consideration given to a customer.
Cost of Sales
The cost of sales for the year ended December 31, 2008 were CAD708,300 as compared to CAD799,593 in 2007, and the overall gross margin for 2008 was 54% as compared to 47% in 2007. The gross margin for 2008 has been positively impacted by termination of the distribution agreement discussed above. Due to the 25% restocking fee, only 75% of the inventory returned resulted in a payment obligation of the company and a corresponding revenue reduction, while 100% of the reacquired inventory was recognized and resulted in a reversal of cost of goods sold. The 25% of revenue remaining effectively has a zero cost of goods and positively impacts the gross margin for 2008.
Expenses
Total expenses for the year ended December 31, 2008 and 2007 were CAD35,498,908 and CAD8,631,675 respectively. The increase in expenses from 2007 to 2008 can be explained by an increase in operating expenses associated with additional costs incurred by the newly acquired activities in Israel of CAD1,940,462, an increase in amortization on intangible assets of CAD2,129,570, an impairment of intangible assets of CAD23,061,012, inventory write down of 626,925, and an offsetting recovery on the repayable contribution agreement of CAD320,445.
Liquidity and Capital Resources
The company finances its operations and capital expenditures with cash generated from operations, lines of credit, long-term debt and equity financings. At December 31, 2008, the company had cash and cash equivalents of CAD2,498,439 as compared to cash of CAD3,242,404 as of December 31, 2007. At December 31, 2008 the Company had working capital of CAD2,123,519 as compared to working capital of CAD3,431,266 at December 31, 2007. In addition, at December 31, 2008 the Company had restricted cash related to a security on long-term debt of CAD50,000 (December 31, 2007 – CAD50,000) included in long-term assets. Cash used in operations was CAD8,477,808 for the year ended December 31, 2008, as compared to CAD6,439,828 for the year ended December 31, 2007, an increase of CAD2,037,980. The increase in cash usage was related to the increase in expenses borne by the Company at the newly acquired operations in Israel and in increased sales and marketing expenditures.
