1. Basis of Presentation, Organization and Business and Summary of Significant Accounting Policies

Basis of Presentation

These consolidated financial statements of Misonix, Inc. (“Misonix” or the “Company”) include the accounts of Misonix and its 100% owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

Organization and Business

Misonix designs, manufactures, develops and markets therapeutic ultrasonic devices. These products are used for precise bone sculpting, removal of soft tumors, and tissue debridement in the fields of orthopedic surgery, plastic surgery, neurosurgery, podiatry and vascular surgery. In the United States, our products are marketed primarily through a hybrid sales approach. This includes direct sales representatives, managed by regional sales managers, along with independent distributors. Outside the United States, we sell BoneScalpel and SonaStar to specialty distributors who purchase products from us to resell to their clinical customer bases. We sell to all major markets in the Americas, Europe, Middle East, Asia Pacific and Africa. The Company operates as one business segment.

High Intensity Focused Ultrasound Technology

The Company sold its rights to the high intensity focused ultrasound technology to SonaCare Medical, LLC (“SonaCare”) in May 2010. The Company may receive up to approximately $5.8 million in payment for the sale. SonaCare will pay the Company 7% of the gross revenues received from its sales of the (i) prostate product in Europe and (ii) kidney and liver products worldwide, until the Company has received payments of $3 million, and thereafter 5% of the gross revenues, up to an aggregate payment of $5.8 million, all subject to a minimum annual royalty of $250,000. Cumulative payments through June 30, 2018 were $2,542,579. 

Cash and Cash Equivalents

The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.  All of the Company’s cash is maintained in bank accounts and accordingly it does not have cash equivalents at June 30, 2018. The Company’s cash balance at June 30, 2018 was $10,979,455.

The Company maintains cash balances at various financial institutions. At June 30, 2018, these financial institutions held cash that was approximately $10,729,455 in excess of amounts insured by the Federal Deposit Insurance Corporation and other government agencies.

Major Customers and Concentration of Credit Risk

Included in sales from continuing operations are sales to the Company distributor of SonaStar in China of $6,969,258, $0 and $0, for the fiscal years ended June 30, 2018, 2017 and 2016, respectively, inclusive of product licensing fees of $4,010,000. Accounts receivable from this customer were $293,915 at June 30, 2018.

Total royalties from Medtronic Minimally Invasive Therapies (“MMIT”) related to their sales of the Company’s ultrasonic cutting and sculpting products, which use high frequency sound waves to coagulate and divide tissue for both open and laparoscopic surgery, were $525,000, $3,764,000 and $3,903,000 for the fiscal years ended June 30, 2018, 2017 and 2016, respectively. Accounts receivable from MMIT royalties were $0 and $925,000 at June 30, 2018 and 2017, respectively. The license agreement with MMIT expired in August 2017.

At June 30, 2018 and 2017, the Company’s accounts receivable with customers outside the United States were approximately $1,630,000 and $860,000, respectively, none of which is over 90 days.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and judgments that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions are used for but not limited to establishing the allowance for doubtful accounts, valuation of inventory, depreciation, asset impairment evaluations and establishing deferred tax assets and related valuation allowances, and stock-based compensation. Actual results could differ from those estimates.

Accounts Receivable

Accounts receivable, principally trade, are generally due within 30 to 90 days and are stated at amounts due from customers, net of an allowance for doubtful accounts. The Company performs ongoing credit evaluations and adjusts credit limits based upon payment history and the customer’s current credit worthiness, as determined by a review of their current credit information. The Company continuously monitors aging reports, collections and payments from customers and maintains a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified. While such credit losses have historically been within expectations and the provisions established, the Company cannot guarantee that the same credit loss rates will be experienced in the future. The Company writes off accounts receivable when they become uncollectible.

Inventories

Inventories are stated at the lower of cost (first-in, first-out) or net realizable value and consist of raw materials, work-in process and finished goods and include purchased materials, direct labor and manufacturing overhead. Management evaluates the need to record adjustments to write down inventory to the lower of cost or net realizable value on a quarterly basis. The Company’s policy is to assess the valuation of all inventories, including raw materials, work-in-process and finished goods and it writes down its inventory for estimated obsolescence based upon the age of inventory and assumptions about future demand and usage. Inventory items used for demonstration purposes, rentals or on consignment are classified as property, plant and equipment. 

Property, Plant and Equipment

Property, plant and equipment are recorded at cost. Minor replacements and maintenance and repair expenses are charged to expense as incurred. Depreciation of property and equipment is provided using the straight-line method over estimated useful lives ranging from 3 to 5 years. Leasehold improvements are amortized over the life of the lease or the useful life of the related asset, whichever is shorter. The Company’s policy is to periodically evaluate the appropriateness of the lives assigned to property, plant and equipment and make adjustments if necessary. Inventory items included in property, plant and equipment are depreciated using the straight line method over estimated useful lives of 3 to 5 years. Depreciation of BoneScapel and Sonic OneOR generators which are consigned to customers are depreciated over a 5 year period, and depreciation is charged to selling expenses. See Note 4.

Revenue Recognition

The Company records revenue upon shipment for products shipped F.O.B. shipping point. Products shipped F.O.B. destination points are recorded as revenue when received at the point of destination. Shipments under agreements with distributors are not subject to return, and payment for these shipments is not contingent on sales by the distributor. Accordingly, the Company recognizes revenue on shipments to distributors in the same manner as with other customers. Service contracts and royalty income are recognized when earned. The Company generally warrantees its product for a 12 month period, and accordingly records a related warranty reserve. Historical warranty costs have not been significant.

The Company presents taxes collected from customers and remitted to governmental authorities in the consolidated statements of operations on a net basis.

License revenue is recorded when 1) a contract has been executed, 2) the underlying intellectual property has been transferred, 3) the payment terms are identified and 4) the risk of a reversal of revenue from lack of receipt of consideration or other factors has passed. License revenue for the years ended June 30, 2018, 2017 and 2016 was $4,010,000, $0 and $0, respectively.

On October 19, 2017, the Company entered into a License and Exclusive Manufacturing Agreement (the “Agreement”) with Hunan Xing Hang Rui Kang Bio-technologies Co., Ltd., a Chinese corporation (the “Licensee”or “Hunan” ) under which Misonix has licensed certain manufacturing and distribution rights to its SonaStar product line in China, Hong Kong and Macau (the “Territory”) in exchange for payments totaling at least $11,000,000.

The Agreement with Hunan provides for the following three primary revenue streams:

In addition, the Agreement contains a provision allowing for Misonix to be reimbursed by Hunan for it’s out of pocket costs to assist Hunan with training to build the product, to the extent Hunan requests any training. We consider this option to be a substantive option which should be accounted for as a separate event as the event occurs rather than as a deliverable in the original arrangement. We also believe that this will be an immaterial portion of this contract.

During the year ended June 30, 2018, the Company delivered the licensed SonaStar technology to the Licensee, and recorded license revenue of $4,010,000.

Long-Lived Assets

The carrying values of intangible and other long-lived assets, excluding goodwill, are periodically reviewed to determine if any impairment indicators are present. If it is determined that such indicators are present and the review indicates that the assets will not be fully recoverable, based on undiscounted estimated cash flows over the remaining amortization and depreciation period, their carrying values are reduced to estimated fair value. Impairment indicators include, among other conditions, cash flow deficits, historic or anticipated decline in revenue or operating profit, adverse legal or regulatory developments, accumulation of costs significantly in excess of amounts originally expected to acquire the asset and a material decrease in the fair value of some or all of the assets. Assets are grouped at the lowest levels for which there are identifiable cash flows that are largely independent of the cash flows generated by other asset groups. No such impairment was deemed to exist in fiscal 2018 and 2017.

Goodwill

Goodwill is not amortized. We review goodwill for impairment annually and whenever events or changes indicate that the carrying value of an asset may not be recoverable. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of significant assets or products. Application of this impairment test requires significant judgments, including estimation of cash flows, which is dependent on internal forecasts, estimation of the long term rate of growth for the Company’s business, the useful lives over which cash flows will occur and determination of the Company’s weighted average cost of capital. The Company also compares its market capitalization to the value of its goodwill to view for evidence of impairment. The Company completed its annual goodwill impairment tests for fiscal 2018 and 2017 as of June 30th each year. No impairment of goodwill was deemed to exist in fiscal 2018 and 2017. 

Patents

The cost of acquiring or processing patents is capitalized at cost. This amount is being amortized using the straight-line method over the estimated useful lives of the underlying assets, which is approximately 17 years. Patents totaled $757,447 and $719,136 at June 30, 2018 and 2017, respectively. Amortization expense for the years ended June 30, 2018, 2017 and 2016 was approximately $127,000, $110,000 and $94,000, respectively.

The following is a schedule of estimated future patent amortization expense as of June 30, 2018 during the following fiscal years:

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income in those periods in which temporary differences become deductible.  Should management determine that it is more likely than not that some portion of the deferred tax asset will not be realized, a valuation allowance against the deferred tax asset would be established in the period such determination was made.

The Company recognizes a tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized in the financial statements from such position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. The Company classifies income tax related interest and penalties as a component of income tax expense.

Earnings Per Share

Earnings per share (“EPS”) is calculated using the two class method, which allocates earnings among common stock and participating securities to calculate EPS when an entity’s capital structure includes either two or more classes of common stock or common stock and participating securities. Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities. As such, unvested restricted stock of the Company are considered participating securities. The dilutive effect of options and their equivalents (including non-vested stock issued under stock based compensation plans), is computed using the “treasury” method.

Basic income per common share is based on the weighted average number of common shares outstanding during the period. Diluted income per common share includes the dilutive effect of potential common shares outstanding. The following table sets forth the reconciliation of weighted average shares outstanding and diluted weighted average shares outstanding:

Diluted EPS for the three years ended June 30, 2018 as presented is the same as basic EPS as the inclusion of the effect of common share equivalents then outstanding would be anti-dilutive. Accordingly, excluded from the calculation of diluted EPS are the dilutive effect of options to purchase 211,801, 473,848, and 467,733 shares of common stock for the years ended June 30, 2018, 2017 and 2016, respectively. Also excluded from the calculation of both basic and diluted earnings per share for the years ended June 30, 2018 and 2017 are the 400,000 shares of restricted common stock which were issued in December 2016.

Research and Development

All research and development expenses are expensed as incurred and are included in operating expenses.

Advertising Expense

The cost of advertising is expensed in the period the advertising first takes place. The Company incurred approximately $0, $76,000 and $386,000 in advertising costs during the fiscal years ended June 30, 2018, 2017 and 2016, respectively. Advertising costs are reported in selling expenses on the statement of operations.

Depreciation Expense for Consigned Inventory

The Company typically provides to its United States customers, on a consignment basis, the generators used to power its BoneScapel and SonicOne products. Title to these generators remains at all times with the Company. When these generators are deployed in the field at customer locations, the Company depreciates these units over a five year period and charges the depreciation to selling expenses. Depreciation expense relating to consigned generators for the three years ended June 30, 2018 was $487,000, $425,000 and $416,000, respectively. Prior to fiscal 2017, consigned units were depreciated over a three year period. The impact of this change in accounting estimate was a reduction in expense of approximately $283,000 for the year ended June 30, 2017, compared to what the expense would have been without this change.

Shipping and Handling

Shipping and handling fees for the fiscal years ended June 30, 2018, 2017 and 2016 were approximately $99,000, $119,000 and $109,000 respectively, and are reported as a component of net sales. Shipping and handling costs for the fiscal years ended June 30, 2018, 2017 and 2016 were approximately $289,000, $337,000 and $142,000, respectively, and are reported as a component of selling expenses.

Stock-Based Compensation

The Company measures compensation cost for all share based payments at fair value and recognizes the cost over the vesting period.  The Company uses the Black-Scholes method to value awards and utilizes the straight line amortization method to recognize the expense associated with the awards with graded vesting terms. 

Restricted Stock Awards

The Company measures compensation cost for all restricted stock awards at fair value and recognizes the cost over the vesting period.  For awards that have market conditions, the Company uses the Monte Carlo valuation method to value awards and utilizes the straight line amortization method to recognize the expense associated with the awards with graded vesting terms. Where awards have performance conditions, the Company will determine the probability of achieving those conditions and will record compensation expense when it is probable that the conditions will be met.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (the “FASB”) issued ASC Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), which was subsequently updated. This purpose of the updated standard is to provide enhancements to the quality and consistency of revenue recognition between companies using U.S. GAAP and International Financial Reporting Standards. The new five-step recognition model introduces the core principle of recognizing revenue in an amount that reflects the consideration to which the entity expects to be entitled in exchange for the promised goods or services.

When effective, as amended, ASU 2014-09 will require us to use either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients; or (ii) a modified retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures to describe the nature, amount, timing and uncertainty of revenue, certain costs and cash flows arising from our contracts with customers).  This standard became effective for the Company on July 1, 2018 and we will adopt the new pronouncement under the modified retrospective approach.

We have reviewed our various revenue streams within our reporting segment and have gathered data regarding the segregation of those revenue streams into the following types for analysis (i) sale of medical device products under standard ship and bill practices, (ii) consignment and leasing of medical device products, and (iii) licensing agreements related to medical technology. We have gathered data and quantified the amount of sales by type of revenue stream and categorized the types of sales for the purpose of comparing how we currently recognize revenue to the new standard in order to quantify the impact of this ASU.  We have finalized our review on our medical device product sales and the consignment and leasing of medical devices. We generally anticipate having substantially similar performance obligations under the new guidance as compared with deliverables and units of account currently being recognized.  We expect to recognize an immaterial adjustment to retained earnings reflecting the cumulative impact for the above described revenue streams.

Due to the nature of the licensing agreements that the Company enters into, the revenue recognition treatment required under the new standard will depend on contract-specific terms. The Company is in the process of concluding on the impact that the standard will have on this revenue stream and will need to consistently evaluate the nature of any implicit price concession granted on a major license and IP agreement with the Company’s Chinese partner which will impact the timing of royalty revenue to be recorded under the contract. This may result in revenue being recognized on this license earlier than current practice although such revenue has not yet been recorded and the Company has not yet concluded on any necessary adjustment to retained earnings upon adoption. 

In February 2016, the FASB issued guidance on lease accounting requiring lessees to recognize a right-of-use asset and a lease liability for long-term leases. The liability will be equal to the present value of lease payments. This guidance must be applied using a modified retrospective transition approach to all annual and interim periods presented and is effective for the Company beginning in fiscal 2019. The Company is currently in the early stages of evaluating this guidance to determine the impact it will have on its consolidated financial statements.

In August 2016, the FASB issued guidance on the Statement of Cash Flows Classification of certain cash receipts and cash payments (a consensus of the Emerging Issues Task Force). This guidance addresses the following eight specific cash flow issues: Debt prepayment or debt extinguishment costs; settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; contingent consideration payments made after a business combination; proceeds from the settlement of insurance claims; proceeds from the settlement of corporate-owned life insurance policies (including bank-owned life insurance policies); distributions received from equity method investees; beneficial interests in securitization transactions; and separately identifiable cash flows and application of the predominance principle. This guidance will be effective for the Company beginning in fiscal 2019. As this guidance only affects the classification within the statement of cash flows, ASU 2016-15 is not expected to have a material impact on the Company’s consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations: Clarifying the Definition of a Business (“ASU 2017-01”). ASU 2017-01 clarifies the definition of a business for determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2017, and early adoption is permitted. The Company is in the process of evaluating the impact of the adoption of ASU 2017-01 on its consolidated financial statements.

There are no other recently issued accounting pronouncements that are expected to have a material effect on the Company’s financial position, results of operations or cash flows.

Recently Adopted Accounting Pronouncements

In March 2016, the FASB issued Accounting Standards Update No. 2016-09 “Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” intended to simplify several aspects of accounting for share-based payment transactions. The Company adopted these amendments beginning in the first quarter of fiscal 2018. The guidance requires that all excess tax benefits and tax deficiencies previously recorded as additional paid-in capital be prospectively recorded in income tax expense. The guidance allows for an increase in the threshold for net share settlement up to the maximum statutory rate in employees’ applicable jurisdictions without triggering liability classification. The adoption of this guidance had an immaterial impact on income taxes on the Company’s Consolidated Statement of Operations for the year ended June 30, 2018. The Company elected to apply the presentation requirement for cash flows related to excess tax benefits prospectively, which had an immaterial impact on both net cash from operating activities and net cash used in financing activities for the year ended June 30, 2018. The presentation requirements for cash flows related to employee taxes paid for withheld shares had no impact on any of the periods presented on the Company’s Consolidated Statements of Cash Flows since such cash flows have historically been presented as a financing activity. Finally, the Company has elected to account for forfeitures as they occur, rather than estimate expected forfeitures. As a result, the Company recorded the cumulative impact of $908,875 as an increase to Deferred Income Taxes with a corresponding decrease to Accumulated Deficit.