BioCardia, Inc. - Quarter Report: 2010 September (Form 10-Q)

Cardo Medical, Inc. ("Cardo" or the "Company") is an orthopedic medical device company specializing in designing, developing and marketing high performance reconstructive joint devices and spinal surgical devices. Reconstructive joint devices are used to replace knee, hip and other joints that have deteriorated through disease or injury. Spinal surgical devices involve products to stabilize the spine for fusion and reconstructive procedures. Within these areas, Cardo intends to focus on the higher-growth sectors of the orthopedic industry, such as advanced minimally invasive instrumentation and bone-conserving high performance implants. Cardo is focused on developing surgical devices that will enable surgeons to bridge the gap between soft tissue-driven sports medicine techniques and classical reconstructive surgical procedures.

The accompanying condensed consolidated balance sheet as of December 31, 2009, which has been derived from Cardo's audited financial statements as of that date, and the unaudited condensed consolidated financial information of Cardo as of September 30, 2010 and for the three and nine months ended September 30, 2010 and 2009, has been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X. In the opinion of management, such financial information includes all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the Company's financial position at such date and the operating results and cash flows for such periods. Operating results for the interim periods ended September 30, 2010 are not necessarily indicative of the results that may be expected for the entire year.

Certain information and footnote disclosure normally included in financial statements in accordance with generally accepted accounting principles have been omitted pursuant to the rules of the United States Securities and Exchange Commission ("SEC"). These unaudited financial statements should be read in conjunction with our audited financial statements and accompanying notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC on March 31, 2010.

The condensed consolidated financial statements include the accounts of Cardo, Accelerated Innovation, Inc. ("Accelerated"), Uni-Knee LLC ("Uni") and Cervical Xpand LLC ("Cervical"). All significant intercompany transactions have been eliminated in consolidation. The non-controlling and minority interests in these companies is represented by a single balance in the condensed consolidated balance sheets.

As reflected in the accompanying financial statements, the Company had losses from operations of $11,050,000 and negative cash flows from operations of $3,707,000 during the nine months ended September 30, 2010, an accumulated deficit of $22,215,000 and limited cash to fund its future operations. Management anticipates that the Company will sustain further losses through the fourth quarter of 2010 and require additional capital to supplement operations. Thus far, the Company has been able to finance its operating losses through a series of equity issuances. Nevertheless, there is no assurance that the Company will be able to finance any future operating losses and as such, there is substantial doubt about the Company's ability to continue as a going concern. The Company's financial condition deteriorated rapidly during the quarter ended September 30, 2010. Management is actively seeking various sources of financing; however, there are no assurances that any such financing can be obtained on favorable terms, if at all. Cardo's management and board of directors have met frequently during the quarter ended September 30, 2010 and through the date of this filing to contemplate the steps by which management will follow to maintain operations without business interruptions.

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During October and November 2010, the Company's management took the following measures:

• terminated over half of the Company's employees;
• had the Company's Chief Executive Officer and President forego their salaries;
• reduced office space by not renewing the corporate headquarters facility lease;
• scaled back research and development activities;
• deferred manufacturing of inventories required to build additional base-level implant banks; and
• engaged an investnent adviser to assist it in seeking alternative sources of capital; including selling of some or all of the Company's assets and other strategic alternatives.

Management continues to closely monitor its operating costs to conserve cash until additional funds become available through financing or operating activities.

Due to the Company's financial condition and continued inability to raise sufficient funds in order to fully execute a profitable sales strategy, the Company evaluated the carrying amounts of the Company's goodwill and other intangible assets for recoverability. Based on the results of these tests, management determined that the fair values of these assets were less than their respective carrying values. As such, impairment charges totaling $5,283,000 were charged to operations during the quarter ended September 30, 2010. Additionally, Cardo's management evaluated the net realizable value of its inventories and, based on reduced future projected revenues, recorded an inventory reserve of $1,620,400 at September 30, 2010.

In view of the matters described above, recoverability of a major portion of the recorded asset amounts shown in the accompanying consolidated balance sheet is dependent upon continued operations of the Company, which, in turn, is dependent upon the Company's ability to continue to raise capital and ultimately generate positive cash flows from operations. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classifications of liabilities that might be necessary should the Company be unable to continue its existence.

Inventory is stated at the lower of cost or net realizable value. Cost is determined on a first-in, first-out basis; and the inventory is primarily comprised of work in process and finished goods. Work in process consists of fabrication costs paid relating to items currently in production. Finished goods are completed knee, spine and hip replacement products ready for sales to customers.

At each balance sheet date, the Company evaluates its ending inventories for excess quantities and obsolescence. This evaluation includes an analysis of sales levels by product type. Among other factors, the Company considers current product configurations, historical and forecasted demand, market conditions and product life cycles when determining the net realizable value of the inventory. Provisions are made to reduce excess or obsolete inventories to their estimated net realizable values. Once established, write-downs are considered permanent adjustments to the cost basis of the excess or obsolete inventory. Management recorded an excess inventory reserve of $1,620,400 during the quarter ended September 30, 2010. Cardo did not have any inventory considered by management to be excess or obsolete as of December 31, 2009.

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Goodwill and Other Intangible Assets

Goodwill represents the excess of purchase price over fair value of tangible net assets of acquired businesses after amounts allocated to other intangible assets. Other intangible assets include a royalty agreement, developed technology and customer relationships which are amortized on a straight-line basis over 2 to 10 years. Goodwill and other intangible assets were generated when the Company acquired the non-controlling interests of Accelerated, Cervical and Uni.

Goodwill and long-lived assets are assessed for impairment annually or more frequently if events or circumstances occur that indicate that the carrying amount of the assets may not be recoverable. Cardo conducts its annual evaluations for impairment at the end of the fourth quarter of each year. The Company concluded that there were no such events or changes in circumstances during 2009; however, during the quarter ended September 30, 2010, the changes in Cardo's financial condition and continued inability to raise sufficient funds in order to fully execute a profitable sales strategy indicated the carrying values of its goodwill and other intangible assets may not be recoverable. Goodwill impairment testing is based on a two step process, where the first step compares the fair value of the reporting unit to the carrying value of the unit. If the first step test indicates impairment, the second step test compares the fair value of a reporting unit with its carrying value using discounted cash flow projections. Long-lived asset impairment testing compares the projected undiscounted future cash flows associated with the related assets over their estimated useful lives against their respective carrying amount. Impairment, if any, is based on the excess of the carrying amount over the fair value, based on market value when available, or discounted expected cash flows, of those assets and is recorded in the period in which the determination is made. These evaluations require us to make certain assumptions and estimate future revenues and profitability.

Based on the assessments performed for the year ended December 31, 2009, the Company determined that the fair value of the knee and hip reporting units were in excess of the corresponding assets' carrying value as of December 31, 2009. Accordingly, no impairment charges were recorded for the year ended December 31, 2009.

During the quarter ended September 30, 2010, Cardo's management performed an assessment of its goodwill and other intangible assets for impairment. The Company's management determined that the fair value of the knee and hip reporting units were not in excess of the corresponding assets' carrying value as of September 30, 2010 and recorded a non-cash impairment charge of $4,050,000 during the quarter then ended. In addition, management recorded a non-cash impairment charge of $1,233,000 against the goodwill associated with the knee and hip reporting units.

As of September 30, 2010, the Company had two customers that accounted for 28.6% and 10.3%, respectively, of its accounts receivable. As of December 31, 2009, the Company had four customers that accounted for 28.2%, 15.6%, 15.4% and 10.0%, respectively, of its accounts receivable.

The Company had four customers that comprised 20.5%, 14.0%, 13.4% and 11.4%, respectively, of the Company's net sales for the three months ended September 30, 2010. The Company had two customers that comprised 45.3%, and 28.7%, respectively, of the Company's net sales for the three months ended September 30, 2009.

The Company had three customers that comprised 17.6%, 14.9% and 14.0%, respectively, of the Company's net sales for the nine months ended September 30, 2010. The Company had three customers that comprised 31.2%, 26.6%, and 14.9%, respectively, of the Company's net sales for the nine months ended September 30, 2009.

Certain amounts from prior periods have been reclassified to conform to the current period presentation.

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Recent Accounting Pronouncements

There are no recently issued accounting pronouncements that the Company has yet to adopt that are expected to have a material effect on its financial position, results of operations, or cash flows.

Inventories consisted of the following at:

During the quarter ended September 30, 2010, the Company's recorded an inventory reserve of $1,620,400 to reflect excess inventory on-hand or in-process implant components as of September 30, 2010. Of this amount, $567,000 was allocable to Cardo's Recon Division and $1,053,400 was allocable to Cardo's Spine Division. The inventory reserve is included with inventory usage in cost of goods sold in the accompanying condensed consolidated statements of operations for the three and nine months ended September 30, 2010.

In 2008, the Company completed the acquisition of the Uni, Cervical and Accelerated minority interests, which were accounted for using the purchase accounting method. The transactions resulted in the following goodwill and intangible assets as of December 31, 2008 and 2009.

Other intangible assets identified in the transactions related to a royalty agreement, developed technology and customer relationships. These assets belong in the knee and hip reporting units under the Reconstructive segment. The goodwill resulting from the acquisition of Accelerated belongs in the knee and hip reporting units and the goodwill resulting from the acquisition of Cervical belongs in the internally developed reporting unit under the Spine segment. The amounts allocated to in-process research and development for Accelerated were recorded as research and development expenses in the consolidated statement of operations during the year ended December 31, 2008. Goodwill associated with the purchase of Cervical was deemed to be impaired and written off during the year ended December 31, 2008.

During the quarter ended September 30, 2010, due to the Company's financial condition and continued inability to raise sufficient funds in order to fully execute a profitable sales strategy, the Company determined an interim impairment test was necessary. Based upon the assessments, it was determined that the fair value of the Company's knee and hip reporting units were below their respective assets' carrying values at September 30, 2010. Accordingly, the Company recognized a non-cash goodwill impairment charge of $1,233,000 and an impairment charge to its

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other intangible assets of $4,050,000 in the accompanying condensed consolidated statements of operations for the three and nine months ended September 30, 2010. As a result of these impairment charges, the goodwill and other intangible assets had no remaining book value as of September 30, 2010. There was no income tax effect as the corresponding income tax assets were offset by a full valuation account.

On August 29, 2008, the Company issued options to certain employees and Board members to purchase membership units in Cardo. The options give the grantees the right to purchase up to 2,398,400 shares of the Company's common stock at an exercise price of $0.23 per share. The options vest 20% each year over a five-year period and expire after ten years. The weighted average grant date fair value of options granted was $0.13 per option, for a total fair value of $300,000, which will be reflected as an operating expense over the vesting period of the options. Stock option compensation recognized for the nine months ended September 30, 2010 and 2009 in the accompanying condensed consolidated statements of operations amounted to $51,082 and $89,562, respectively. Stock option compensation recognized for the three months ended September 30, 2010 and 2009 in the accompanying condensed consolidated statements of operations amounted to $15,486 and $27,105, respectively.

The fair value of each option award was estimated on the date of grant using the Black-Scholes option valuation model that uses the assumptions noted in the following table. Because the Black-Scholes option valuation model incorporates ranges of assumptions for inputs, those ranges are disclosed. To estimate volatility of the options over their expected terms, the Company measured the historical volatility of the components of the small cap sector of the Dow Jones medical equipment index for a period equal to the expected life of the Cardo options. It also measured the volatility of other public companies with similar size and industry characteristics to Cardo for the same period. These measurements were averaged and the result was used as expected volatility. As there was no history of option lives at Cardo, the expected term of options granted was the midpoint between the vesting periods and the contractual life of the options. The risk-free rate for periods within the contractual life of the option was based on the U.S. Treasury yield curve in effect at the time of grant. The forfeiture rate was based on an analysis of the nature of the recipients' jobs and relationships to the Company.

A summary of stock option activity as of September 30, 2010, and changes during the period then ended is presented below.

The aggregate intrinsic value represents the closing stock price as of September 30, 2010 less the exercise price, multiplied by the number of options that have an exercise price that is less than the closing stock price.

On April 8, 2010, the Board of Directors approved the 2010 Equity Incentive Plan (the "2010 Incentive Plan"), which was voted on and approved by the Company's stockholders at the Annual Meeting held on June 16, 2010. The 2010 Incentive Plan authorizes the Company to grant up to 23,000,000 incentive stock options, stock appreciation rights, restricted stock grants, restricted stock units, performance shares, performance units or cash awards. As of the date of this filing, no awards have been granted under the 2010 Incentive Plan.

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NOTE 5 — STOCKHOLDERS' EQUITY

The Company's authorized capital consists of 750,000,000 shares of common stock and 50,000,000 shares of preferred stock. The Company's preferred stock may be designated into series pursuant to authority granted by its Certificate of Incorporation, and on approval from its Board of Directors. As of September 30, 2010, the Company did not have any preferred stock issued.

The Company's businesses are currently organized into the following two reportable segments; reconstructive products (the "Reconstructive Division") and spine products (the "Spine Division"). The Reconstructive Division segment is comprised of activity relating to the Company's unicompartmental knee, patellofemoral products, and the total knee and hip products. The Spine Division segment is comprised of the spinal lumbar fusion system, cervical plate and screw systems, and various interbody products.

The division into these reportable segments is based on the nature of the products offered. Management evaluates performance and allocates resources based on several factors, of which the primary financial measure is segment operating results. Due to the distinct nature of the products in the Company's Reconstructive Division, and the fact that it has a more developed market for its products, it is considered by management as a separate segment. The Company's Spine Division is still in the process of developing the market and obtaining instrumentation necessary to sell the products in greater quantities. As a result of the unique characteristics of this product line, the Spine Division is considered by management as a separate segment.

Prior to September 30, 2010, the Company's Reconstructive Division included $1,233,000 of goodwill and $4,050,000 in other intangible assets, net of amortization, relating to the Company's unicompartmental knee and hip products. These assets were determined by Cardo's management to be fully impaired during the current quarter.

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The following table sets forth financial information by reportable segment as of September 30, 2010 and for the three and nine months ended September 30, 2010 and 2009:

Included in cost of sales for the three and nine months ended September 30, 2010 in the Reconstructive Division is $567,000 of inventory reserves. Included in cost of sales for the three and nine months ended September 30, 2010 in the Spine Division is $1,053,400 of inventory reserves. All of the Company's net sales were attributable to activity in the United States. There were no long-lived assets held in foreign countries.

In November 2010, the Company entered into two secured promissory notes (collectively, the "Notes") with two individuals (collectively, the "Lenders"). The aggregate proceeds from the Notes were $500,000. One of the Lenders is the brother of the Company's Chief Executive Officer. The Notes mature on March 2, 2011 and March 4, 2011, respectively, which may be extended for up to 60 days by the Company, provided the Company gives the Lenders notice of such extension period at least two business days prior to the maturity date, and bear simple interest at 12% per annum.

In connection with the Notes, the Company entered into a security agreement with each lender, in which the Company granted a security interest, up to the amount of the principal and interest, in all of the Company's right, title and interest in all of the Company's assets, other than its accounts receivable.

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ITEM 2 — MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The discussion and analysis of our financial condition and results of operations are based on our financial statements, which we have prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to 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, as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, we evaluate estimates and judgments, including those described in greater detail below. We base our estimates on historical experience and on various other factors that we believe are 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.