ANGIODYNAMICS INC - Quarter Report: 2010 February (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended February 28, 2010

OR

For the transition period from              to             

Commission file number 0-50761

AngioDynamics, Inc.

(Exact name of registrant as specified in its charter)

(518) 795-1400

Registrant’s telephone number, including area code

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the Issuer’s classes of common stock, as of the latest practicable date.

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AngioDynamics, Inc. and Subsidiaries

INDEX

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CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(in thousands, except per share data)

The accompanying notes are an integral part of these interim consolidated financial statements.

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CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

The accompanying notes are an integral part of these interim consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

The accompanying notes are an integral part of these interim consolidated financial statements.

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CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY AND

COMPREHENSIVE INCOME

Nine Months Ended February 28, 2010

(unaudited)

(in thousands, except share data)

The accompanying notes are an integral part of these interim consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

February 28, 2010 and February 28, 2009

(unaudited)

NOTE A – CONSOLIDATED FINANCIAL STATEMENTS

The consolidated balance sheet as of February 28, 2010, the consolidated statement of stockholders’ equity and comprehensive income for the nine months ended February 28, 2010, the consolidated statement of cash flows for the nine months ended February 28, 2010 and February 28, 2009 and the consolidated statements of income for the three and nine months ended February 28, 2010 and February 28, 2009 have been prepared by the Company without audit. The consolidated balance sheet as of May 31, 2009 was derived from audited consolidated financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments (which include only normally recurring adjustments) necessary to state fairly the financial position, changes in stockholders’ equity and comprehensive income, results of operations and cash flows as of and for the period ended February 28, 2010 (and for all periods presented) have been made. Certain prior period amounts have been reclassified for comparative purposes to conform to current quarter and year to date presentation. The reclassifications, made for the purpose of including strategic business unit management costs in marketing costs, resulted in an increase in marketing costs of $255,000 in the third quarter of the prior year and $781,000 in the prior year to date with comparative decreases in general and administrative costs for the same periods.

Certain information and footnote disclosures, normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted. It is suggested that these unaudited interim consolidated financial statements be read in conjunction with the financial statements and notes thereto included in the Annual Report on Form 10-K for the fiscal year ended May 31, 2009, filed by the Company on August 14, 2009. The results of operations in the fiscal periods ended February 28, 2010 and February 28, 2009 are not necessarily indicative of the operating results for the respective full fiscal years.

The unaudited interim consolidated financial statements for the three and nine months ended February 28, 2010 include the accounts of AngioDynamics, Inc. and its wholly owned subsidiaries, RITA Medical Systems, LLC, and AngioDynamics UK Limited (collectively, the “Company”). All intercompany balances and transactions have been eliminated.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE A – CONSOLIDATED FINANCIAL STATEMENTS – (cont’d)

The Company has organized its business into three reportable segments: Peripheral Vascular, Access and Oncology/Surgery. The Peripheral Vascular segment is comprised of the venous, angiographic, PTA, drainage and thrombolytic product lines. The Access segment is comprised of the dialysis, ports and PICC product lines. The Oncology/Surgery segment is comprised of the RFA, embolization, Habib and NanoKnife product lines. The Company’s chief operating decision maker evaluates performance based on the reportable segments and utilizes net sales, gross profit and operating income as primary profitability measures. The expenses related to certain shared and corporate activities are allocated to these segments on a percentage of total sales basis or operating expense basis, as deemed appropriate.

The Company has performed an evaluation of subsequent events through the date the financial statements were issued.

NOTE B – ACQUISITIONS

FlowMedica, Inc.

On January 12, 2009 the Company completed the acquisition of certain assets of FlowMedica, Inc. for approximately $1.75 million in cash and a contingent payment based on fiscal 2011 sales of FlowMedica products. With this acquisition, the Company purchased the Benephit product line, a therapeutic approach to deliver drugs directly to the kidneys in order to prevent and treat acute kidney injury, in the emerging field of Targeted Renal Therapy. Intangible assets acquired totaled approximately $1.3 million which have been identified as product technologies (10-year weighted average useful life). Inventory acquired totaled approximately $400,000. The acquisition has been accounted for as a purchase and accordingly, the Company has included the results of operations in the financial statements effective January 12, 2009. The pro-forma effects of the acquisition were not material to the Company’s income statement and balance sheet. Ten employees of FlowMedica, Inc. became employees of the Company upon completion of the acquisition.

Diomed, Inc. and Diomed UK Limited

On June 17, 2008, the Company completed the acquisition of certain U.S. assets of Diomed, Inc. and UK assets of Diomed UK Limited, in separate transactions, for an aggregate purchase price of approximately $11.1 million in cash including capitalized acquisition costs. With this acquisition, the Company substantially strengthened its position in the market for the treatment of varicose veins. The combination of Diomed endovenous laser products with the Company’s existing venous product line provides the Company with a comprehensive venous product offering. The total of the net tangible assets acquired was $5.5 million.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE B – ACQUISITIONS (cont’d)

Goodwill recorded as a result of these acquisitions was approximately $1.9 million. Intangible assets acquired, other than goodwill, totaled approximately $3.7 million of which $3.6 million has been identified as customer relationships (8-year estimated weighted average useful life) and $100,000 has been identified as product technologies (10-year estimated weighted average useful life).

The acquisition has been accounted for as a purchase and, accordingly, the Company has included the results of operations in the financial statements effective June 17, 2008. The pro-forma effects of the Diomed acquisition on the Company’s income statement and balance sheet were not material. Thirty five employees of Diomed became employees of the Company upon completion of the acquisitions.

Oncobionic, Inc.

On May 9, 2008, the Company completed the acquisition of all the issued and outstanding shares of capital stock of Oncobionic, Inc. pursuant to the terms of the Stock Purchase Agreement entered into on October 12, 2006. The closing of the acquisition came as a result of the successful use of irreversible electroporation (IRE) technology in the first human clinical trial for the treatment of soft tissue in April 2008.

Under the October 2006 Stock Purchase Agreement, the Company agreed to pay a total purchase price of $25.4 million, including $400,000 of assumed liabilities. The Company made payments of $5.0 million upon the execution of the stock purchase agreement in October 2006, $10.0 million on May 9, 2008 upon closing the acquisition, $5.0 million in November 2008 and $5.0 million in November 2009.

The Stock Purchase Agreement also provides for future royalty payments due on net sales of any catheter-based products sold by the Company that incorporate irreversible electroporation technology (“IRE”). The Company holds a license to such technology under a license agreement with the Regents of the University of California (the “UC License”).

The Company has accounted for the acquisition of Oncobionic as a purchase under accounting principles generally accepted in the United States of America. Under the purchase method of accounting, the assets and liabilities of Oncobionic were recorded as of the acquisition date, at their respective fair values, and consolidated with those of AngioDynamics. $25.2 million of the purchase price was recorded as product technology and is being amortized over a 15 year useful life. The Company has recorded goodwill and a deferred tax liability of $9.3 million. In future periods the deferred tax liability will be reduced to offset the tax impact of non-deductible amortization expense on the intangible assets acquired.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE C – ASSET PURCHASE AGREEMENTS

Medron, Inc.

On May 1, 2006, the Company entered into an Asset Purchase Agreement with Medron, Inc. to acquire the rights, titles, and interests in, and to, Patent Pending Technology for purposes of manufacturing, marketing, and selling proprietary Vascular Access Ports, following administrative approval. As of February 28, 2010, the Company has paid $5.5 million in accordance with this agreement. That amount, net of accumulated amortization, has been included on the balance sheet under the caption “Intangible assets” and is being amortized on a straight line basis over the expected useful life of the assets. A potential future payment of $2.5 million is due upon issuance (within 10 years of the effective date of the agreement) of a U.S. patent claiming priority to the Patent Application, or any issuance of a patent to the Company within 10 years of the effective date of the agreement in which the original owners are the inventors.

NOTE D – INVENTORIES

Inventories consist of the following:

NOTE E – GOODWILL AND INTANGIBLE ASSETS

Goodwill is not amortized but rather is tested for impairment during the third quarter of each fiscal year or more frequently if triggering events indicating potential impairment arise. Goodwill and intangible assets have been recorded at either incurred or allocated cost. Allocated costs were based on respective fair market values at the date of acquisition.

There were no changes in the carrying amount of goodwill for the nine months ended February 28, 2010.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE E – GOODWILL AND INTANGIBLE ASSETS – (cont’d)

Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in each business combination. Beginning in fiscal 2009 the Company began reporting three operating segments as opposed to a single segment in prior periods. The Company’s reporting units are consistent with the Company’s operating segments, and include Peripheral Vascular, Access and Oncology/Surgery. As a result, the carrying value of goodwill was allocated to each of the Company’s reporting units on a relative fair value basis. The Company completed its annual evaluation of goodwill by reporting unit as of December 31, 2009. The Company’s assessment of goodwill impairment indicated that the fair value of each of the Company’s reporting units exceeded its carrying value and therefore goodwill in each of the reporting units was not impaired. The fair value of Peripheral Vascular, Access and Oncology/Surgery exceeded its carrying value by 26%, 6% and 16%, respectively. The sum of the fair values of the reporting units was reconciled to the Company’s current market capitalization (based upon the Company’s stock price) plus an estimated control premium of approximately 8% as of December 31, 2009.

To determine fair value, the Company utilized two market-based approaches and an income approach. Under the market-based approaches, the Company utilized information regarding the Company as well as publicly available industry information to determine earnings multiples and sales multiples. Under the income approach, the Company determined fair value based on estimated future cash flows of each reporting unit, discounted by an estimated weighted-average cost of capital, which reflects the overall level of inherent risk of a reporting unit and the rate of return an outside investor would expect to earn. The Company determined the discounted cash flow as the best indicator to determine fair value.

Determining the fair value of a reporting unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates, operating margins, discount rates and future market conditions, among others. Solely for purposes of establishing inputs for the fair value calculations, the Company assumed that the current economic conditions would continue through fiscal year 2011, followed by a recovery thereafter. In addition, the Company applied gross margin assumptions consistent with the Company’s historical trends at various revenue levels and used an EBITDA exit multiple of 6.0, 6.0 and 7.0 to calculate the terminal value of the Peripheral Vascular, Access and Oncology/Surgery reporting units, respectively, compared to an EBITDA exit multiple of 6.5, 7.0 and 8.0, respectively, used in the prior year. In addition, the Company used a discount rate of 21%, 15% and 18% to calculate the fair value of its Peripheral Vascular, Access and Oncology/Surgery reporting units, respectively. These discount rates vary from the rates of 19%, 16% and 19%, respectively, used in the prior year primarily due to the fact that additional risk premiums were added to take into account the economic downturn and specific inherent risks associated with each reporting unit.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE E – GOODWILL AND INTANGIBLE ASSETS – (cont’d)

Even though the Company determined that there was no goodwill impairment as of December 31, 2009, the future occurrence of a potential indicator of impairment, such as a significant adverse change in legal factors or business climate, an adverse action or assessment by a regulator, unanticipated competition, a material negative change in relationships with significant customers, strategic decisions made in response to economic or competitive conditions, loss of key personnel or a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or disposed of, would require an interim assessment for some or all of the reporting units prior to the next required annual assessment as of December 31, 2010. It is not possible at this time to determine if any such future impairment charge would result or, if it does, whether such charge would be material.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE E – GOODWILL AND INTANGIBLE ASSETS – (cont’d)

Intangible assets are amortized over their estimated useful lives. The balances of intangible assets are as follows:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE F – ACCRUED LIABILITIES

Accrued liabilities consist of the following:

NOTE G – INCOME TAXES

The Company’s effective income tax rate for the three month periods ending February 28, 2010 and February 28, 2009 was 38% and 30%, respectively. The Company’s effective income tax rate for the nine month periods ending February 28, 2010 and February 28, 2009 was 38% and 34%, respectively. The prior year quarter and year to date benefited from utilization of R&D tax credits. The R&D tax credit expired from the tax law on December 31, 2007. On October 3, 2008, the “Tax Extenders and Alternative Minimum Tax Relief Act of 2008” became law. The law retroactively extended the R&D tax credits from January 1, 2008 to December 31, 2009. The retroactive one-time impact is reflected in the Company’s prior year third quarter and year to date effective tax rates.

In September 2009, the Company received $1.7 million in cash as a tax refund related to completion of an examination of the Company’s federal income tax returns for fiscal years 2006 and 2007 by the Internal Revenue Service. This refund was primarily related to the tax deduction of costs incurred related to the acquisition of RITA Medical Systems, Inc. and was recorded as a reduction in goodwill during the third quarter of fiscal 2009 when notification from the Internal Revenue Service was received.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE H – EARNINGS PER COMMON SHARE

Basic earnings per share are based on the weighted average number of common shares outstanding without consideration of potential common stock. Diluted earnings per share further includes the dilutive effect of potential common stock consisting of stock options, warrants, and restricted stock units, provided that the inclusion of such securities is not antidilutive.

The following table sets forth the reconciliation of the weighted-average number of common shares:

Excluded from the calculation of diluted earnings per common share are options and warrants issued to employees and non-employees to purchase 1,997,760 and 2,367,495 shares of common stock for the three and nine months ended February 28, 2010 and 1,501,025 and 1,384,362 for the three and nine months ended February 28, 2009, as their inclusion would be antidilutive. The exercise prices of these options were between $11.16 and $53.92 at February 28, 2010.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE I – SEGMENT AND GEOGRAPHIC INFORMATION

The Company has organized its business into three reportable segments: Peripheral Vascular, Access and Oncology/Surgery. The Peripheral Vascular segment is comprised of the venous, angiographic, PTA, drainage and thrombolytic product lines. The Access segment is comprised of the dialysis, ports and PICC product lines. The Oncology/Surgery segment is comprised of the RFA, embolization, Habib and NanoKnife product lines.

Selected information by reportable segment is presented in the following tables (in thousands):

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE I – SEGMENT AND GEOGRAPHIC INFORMATION – (cont’d)

In accordance with accounting policies on disclosure of segment reporting, the internal organization that is used by management for making operating decisions and assessing performance is used as the source of the Company’s reportable segments. The accounting policies of the segments are the same as those described in Accounting Policies, Note 1, of the Company’s Annual Report on Form 10-K for the fiscal year ended May 31, 2009, filed by the Company on August 14, 2009. The Company’s chief operating decision maker evaluates performance based on the reportable segments and utilizes net sales, gross profit and operating income as primary profitability measures. The expenses related to certain shared and corporate activities are allocated to these segments on a percentage of total sales basis or a percentage of operating expense basis, as deemed appropriate.

Total sales for geographic areas are summarized below (in thousands):

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE J – FAIR VALUE

Effective June 1, 2008, the Company adopted an accounting policy regarding fair value. Under this policy, fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This policy establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The policy describes three levels of inputs that may be used to measure fair value which are provided in the table below. The adoption of this policy had no impact on the Company’s financial statements other than the disclosures presented herein.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE J – FAIR VALUE – (cont’d)

There were no changes in the level 3 fair value instruments for the nine months ended February 28, 2010.

The following tables provide information by level for assets and liabilities that are measured at fair value on a recurring basis (in thousands):

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE J – FAIR VALUE – (cont’d)

In March 2008, FASB issued authoritative guidance which is intended to improve financial reporting about derivative instruments and hedging activities by requiring companies to enhance disclosure about how these instruments and activities affect their financial position, performance and cash flows. This guidance also improves the transparency about the location and amounts of derivative instruments in a company’s financial statements and how they are accounted for. The guidance is effective for both interim and annual reporting periods beginning after November 15, 2008. The Company has provided the required disclosures in the February 28, 2010 consolidated financial statements.

In January 2010, the FASB updated the disclosure requirements for fair value measurements. The updated guidance requires companies to disclose separately the investments that transfer in and out of Levels 1 and 2 and the reasons for those transfers. Additionally, in the reconciliation for fair value measurements using significant unobservable inputs (Level 3), companies should present separately information about purchases, sales, issuances and settlements. The updated guidance is effective for the reporting periods beginning after December 15, 2009 (the Company’s 2010 fiscal fourth quarter), except for the disclosures about purchases, sales, issuances and settlements in the Level 3 reconciliation, which are effective for fiscal years beginning after December 15, 2010 (the Company’s 2012 fiscal year). The Company will provide the additional disclosures necessary beginning in the Company’s fiscal year 2010 Annual Report on Form 10-K.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE J – FAIR VALUE – (cont’d)

The Company is exposed to market risk due to changes in interest rates. To reduce that risk, the Company periodically enters into certain derivative financial instruments to hedge its underlying economic exposure. The Company uses derivative instruments as part of its interest rate risk management strategy. The derivative instruments used are fixed-to-floating rate interest rate swaps, which are subject to fair-value hedge accounting treatment. The Company recognized interest income of $94,000 and interest expense of $9,000 for the three and nine months ended February 28, 2010, respectively, and interest expense of $18,000 and $502,000 for the three and nine months ended February 28, 2009 on the fair value hedge.

NOTE K – MARKETABLE SECURITIES

Marketable securities, which are principally government agency bonds, auction rate investments and corporate commercial paper, are classified as “available-for-sale securities” in accordance with authoritative guidance issued by FASB and reported at fair value, with unrealized gains and losses excluded from operations and reported as a component of accumulated other comprehensive income (loss), net of the related tax effects, in stockholders’ equity. Cost is determined using the specific identification method. The Company holds investments in auction rate securities in order to generate higher than typical money market rate investment returns. Auction rate securities typically are high credit quality, generally achieved with municipal bond insurance. Credit risks are eased by the historical track record of bond insurers, which back a majority of this market. Sell orders for any security traded through an auction process could exceed bids and, in such cases, the auction fails and the Company may be unable to liquidate its position in the securities in the near term. At February 28, 2010 and May 31, 2009, the Company had $1.85 million in investments in two auction rate securities issued by New York state and local government authorities that had failed auctions. The authorities are current in their interest payments on the securities.

Marketable securities as of February 28, 2010 consisted of the following:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE K – MARKETABLE SECURITIES – (cont’d)

Marketable securities as of May 31, 2009 consisted of the following:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE L – LITIGATION

AngioDynamics v. Vascular Solutions

On July 29, 2009, the Company commenced an action in the United States District Court for the District of Delaware against Vascular Solutions, Inc. In this action, the Company alleges that Vascular Solutions’ Vari-Lase Bright-Tip fiber product line infringes on claims of two of the Company’s patents, US 7,273,478 and US 7,559,329 (“the ‘478 and ‘329 patents”). These patents relate to methods of treating varicose veins using endovenous laser treatments. Vascular Solutions has filed with the U.S. Patent & Trademark Offices (“PTO”) requests for inter partes reexamination of the ‘478 and ‘329 patents. The PTO has initiated reexamination of the ‘478 and ‘329 patents, and the Company has filed responsive papers vigorously opposing the reexamination and supporting the patents. Vascular Solutions has filed a motion to transfer the case to the federal court in Minnesota, and the Company has opposed the motion, which is now fully briefed and awaiting decision by the Court. The Company also has initiated pretrial discovery in the Delaware federal court case. Vascular Solutions has filed a motion to stay the Delaware case pending the reexamination proceedings in the PTO; the Company has opposed the motion, which is now fully briefed and is awaiting decision by the Court.

AngioDynamics v. biolitec AG and Wolfgang Neuberger

On January 2, 2008, the Company commenced an action in the United States District Court for the Northern District of New York against biolitec, Inc. In this action, the Company is seeking judgment against biolitec for defense and indemnification in two lawsuits which have been settled by the Company. The Company’s claims arise out of a Supply and Distribution Agreement (“SDA”) entered into between the Company and biolitec on April 1, 2002. Biolitec has filed counter-claims against the Company in this action, seeking reimbursement of approximately $1.6 million in alleged past defense costs paid by biolitec in one of the settled cases. In October 2009, the Company commenced an action in the United States District Court for the District of Massachusetts against biolitec AG and Wolfgang Neuberger. The Complaint in this action was amended in March 2010. This action seeks to recover against biolitec, Inc.’s parent entities and CEO for tortiously interfering with biolitec, Inc.’s contractual obligation to defend and indemnify the Company, and also seeks to pierce the corporate veil of biolitec, Inc. and to invalidate certain alleged fraudulent transfers in order to hold biolitec, Inc.’s parent entities jointly and severally liable for the alleged breach of the SDA.

The Company is party to legal actions that arise in the ordinary course of business. The Company believes that any liability resulting from any currently pending litigation will not, individually or in the aggregate, have a material adverse effect on the Company’s business, financial condition, results of operations, or cash flows.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)

NOTE M – RECENTLY ADOPTED ACCOUNTING POLICIES

In November 2007, the FASB issued authoritative guidance which establishes disclosure requirements for arrangements entered into by companies to collaboratively develop, manufacture, or market products and which also establishes income statement classification of collaboration transactions between the parties. The Company has adopted this guidance effective June 1, 2009 and the adoption had no impact on the Company’s consolidated financial statements.

In December 2007, the FASB revised the authoritative guidance for business combinations, which establishes principles and requirements for how the acquirer in a business combination recognizes and measures the assets acquired, liabilities assumed and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired or gain from a bargain purchase; and determines what information to disclose to enable readers of the financial statements to evaluate the nature and financial effects of the business combination. This guidance is effective for business combinations for which the acquisition date is on or after fiscal years beginning after December 15, 2008 (the Company’s 2010 fiscal year) and will be applied prospectively, with the exception of the accounting for valuation allowances on deferred taxes and acquired tax contingencies. Adjustments made to valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions that closed prior to the effective date of this policy would also apply the provisions of this policy. The Company has adopted this guidance effective June 1, 2009 and the adoption had no impact on the Company’s consolidated financial statements.

In December 2007, the FASB issued authoritative guidance which establishes reporting standards that require companies to more clearly identify in the financial statements and disclose the impact of noncontrolling interest in a consolidated subsidiary on the consolidated financial statements. The Company has adopted this guidance effective June 1, 2009 and the adoption had no impact on the Company’s consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

February 28, 2010 and February 28, 2009

(unaudited)