MSON Misonix Inc

Notes to Condensed Consolidated Financial Statements

For the Three Months Ended September 30, 2019 and 2018 (unaudited)

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

Basis of Presentation

These condensed 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.

The accompanying unaudited condensed consolidated financial statements have 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 10 of Regulation S-X. Accordingly, these financial statements do not include all the information and footnotes required by U.S. GAAP for complete financial statements. As such, they should be read with reference to the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2019 (the “2019 Form 10-K”), which provides a more complete explanation of the Company’s accounting policies, financial position, operating results, business properties and other matters. In the opinion of management, these financial statements reflect all adjustments considered necessary for a fair statement of interim results.

Organization and Business

Misonix designs, manufactures, and markets minimally invasive surgical ultrasonic medical devices and markets, sells and distributes Theraskin, a biologically active human skin allograft used to support healing of wound which compliments Misonix’s ultrasonic medical devices. Misonix’s ultrasonic products are used for precise bone sculpting, removal of soft and hard tumors, and tissue debridement, primarily in the areas of neurosurgery, orthopedic surgery, plastic surgery, wound care and maxillo-facial surgery.

The Company strives to help proprietary procedural solutions become the standard of care and enhance patient outcomes throughout the world. Misonix intends to accomplish this, in part, by utilizing its best in class surgical ultrasonic technology to change patient outcomes in Spine, Neuro and Wound Care. Misonix is currently developing proprietary procedural solutions around its recently FDA cleared Nexus Ultrasonic Generator. In addition, through its acquisition of Solsys Medical LLC (“Solsys”), Misonix completed its first procedural expansion of its ultrasonic surgical technology, adding the TheraSkin product, a leading cellular skin substitute indicated for all wounds, to its product portfolio.

In the United States, Misonix sells its products through its direct sales force, in addition to a network of commissioned agents assisted by Misonix personnel. Outside of the United States, the Company generally sells to distributors who then resell the products to hospitals. The Misonix sales force operates as two groups, Surgical (Neuro and Spine Applications) and Wound. The Company operates with one business segment.

Acquisition of Solsys Medical, LLC

On September 27, 2019, the Company completed the acquisition (the “Solsys Acquisition”) of Solsys Medical, LLC (“Solsys”), a privately held regenerative medical company, in an all-stock transaction valued at approximately $109 million. Solsys is the exclusive marketer and distributor of TheraSkin® in the U.S., through an agreement with LifeNet. Solsys owns the TheraSkin® brand name, which was commercially launched in January 2010. TheraSkin is a biologically active human skin allograft which has all of the relevant characteristics of human skin, including living cells, growth factors, and a collagen matrix, needed to heal wounds. TheraSkin is derived from human skin tissue from consenting and highly screened donors and is manufactured by LifeNet. As a result of the Solsys Acquisition, Misonix, Inc. formerly known as New Misonix, Inc. (“New Misonix”) became the parent public-reporting company of the combined company; Misonix, Inc., now known as Misonix Opco, Inc., and Solsys became direct, wholly owned subsidiaries of New Misonix. The acquisition of Solsys is expected to broaden substantially Misonix’s addressable market through wound care solutions that are complementary to its existing products. After the completion of the Solsys Acquisition, Misonix shareholders immediately prior to the closing owned 64% of the combined entity, and Solsys unitholders owned 36%. The Company issued 5,703,082 shares in connection with this transaction. Transaction fees were approximately $4.4 million, of which $1.3 million were capitalized as additional paid in capital in connection with the registration of these shares. The Solsys assets, liabilities and results of operations are included in the Company’s financial statements from the acquisition date.

The common stock of New Misonix was created with a par value per share of $.0001, whereas the par value of Misonix Opco, Inc. is $.01. Accordingly, the Company has recorded a reclassification of $151,997 between common stock and additional paid in capital during the three months ended September 30, 2019 to account for this change.

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 is required to 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 September 30, 2019 were $2,542,579. Currently, SonaCare is in default of its royalty payment due March 31, 2019. Although the Company is in discussions with SonaCare regarding this default, there can be no assurance that the payments will be received on a timely basis or at all. Due to this default, the Company has not recorded any income relating to this payment.

Major Customers and Concentration of Credit Risk

Included in revenues are sales to the Company distributor of Bone Scalpel in China of approximately $1.5 million and $1.5 million, for the three months ended September 30, 2019 and 2018, respectively. Accounts receivable from this customer were $2.0 million and $0.5 million at September 30, 2019 and June 30, 2019, respectively.

At September 30, 2019 and June 30, 2019, the Company’s accounts receivable with customers outside the United States were approximately $4.2 million and $2.2 million, respectively, $0.6 million of which is over 90 days at September 30, 2019.

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 awards 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 the Company’s basic and diluted earning per share calculation:

Diluted EPS for the three months ended September 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 632,301 shares of common stock for the three months ended September 30, 2018. Also excluded from the calculation of earnings per share for the three months ended September 30, 2019 and 2018 are the unvested restricted stock awards that were issued in December 2016.

Recent Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instrument (“ASU 2016-13”). ASU 2016-13 replaces the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for SEC filers for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted only as of annual reporting periods beginning after December 15, 2018. Management is currently assessing the impact ASU 2016-13 will have on the Company.

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 February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), and has since issued amendments thereto, related to the accounting for leases (collectively referred to as “ASC 842”). ASC 842 establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The Company adopted ASC 842 on July 1, 2019. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. Entities have the option to continue to apply historical accounting under Topic 840, including its disclosure requirements, in comparative periods presented in the year of adoption. An entity that elects this option will recognize a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption instead of the earliest period presented. The Company adopted the optional ASC 842 transition provisions beginning on July 1, 2019. Accordingly, the Company will continue to apply Topic 840 prior to July 1, 2019, including Topic 840 disclosure requirements, in the comparative periods presented. The Company elected the package of practical expedients for all its leases that commenced before July 1, 2019. The Company has evaluated its real estate lease, its copier leases and its generator rental agreements. The adoption of ASC 842 did not materially impact the Company’s balance sheet and had an immaterial impact on its results of operations. Based on the Company’s current agreements, upon the adoption of ASC 842 on July 1, 2019, the Company recorded an operating lease liability of approximately $436,000 and corresponding ROU assets based on the present value of the remaining minimum rental payments associated with the Company’s leases. As the Company’s leases do not provide an implicit rate, nor is one readily available, the Company used its incremental borrowing rate based on information available at July 1, 2019 to determine the present value of its future minimum rental payments.

Critical Accounting Policies and Use of Estimates

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.

2. Revenue Recognition

On July 1, 2018 the Company adopted Accounting Standards Codification (“ASC”) Topic 606 “Revenue from Contracts with Customers, as amended” (“ASC Topic 606”), using the modified retrospective method applied to those contracts which were not completed as of the adoption date. The reported results for the year ended June 30, 2019 reflect the application of Topic 606 guidance while the reported results for fiscal year 2018 were prepared under the guidance of ASC Topic 605, “Revenue Recognition”. The adoption of ASC Topic 606 resulted in a cumulative prior period adjustment in the amount of $960,000 related to the Company’s License and Exclusive Manufacturing Agreement described below, but the remainder of the adoption did not have a material impact on the timing or amount of revenue recognized.

The Company has made the following accounting policy elections and elected to use certain practical expedients, as permitted by the FASB, in applying ASC Topic 606: 1) the Company accounts for amounts collected from customers for sales and other taxes net of related amounts remitted to tax authorities; 2) the Company expenses costs to obtain a contract as they are incurred if the expected period of benefit, and therefore the amortization period, is one year or less; 3) the Company accounts for shipping and handling activities that occur after control transfers to the customer as a fulfillment cost rather than an additional promised service and these fulfillment costs fall within selling, general and administrative expenses; 4) the Company does not assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract with the customer; 5) the Company will utilize the right-to-invoice practical expedient with regard to the recognition of revenue upon the purchase of consumable goods in connection with a product placement/consignment arrangement.

Recognition of Revenue

The Company satisfies performance obligations either over time, or at a point in time, upon which control transfers to the customer.

Revenue derived from the shipping and billing of product is recorded upon shipment, when transfer of control occurs for products shipped freight on board (“F.O.B.”) shipping point. Products shipped F.O.B. destination point are recorded as revenue when received at the point of destination when the transfer of control is completed. 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 under the ship and bill process.

Revenue derived from the rental of equipment is recorded on a monthly basis over the term of the lease. Shipments of consumable products to these rental customers is recorded as orders are received and shipments are made F.O.B. destination or F.O.B. shipping point.

Revenue derived from consignment agreements is earned as consumables product orders are fulfilled. Therefore, revenue is recognized as shipments are made F.O B shipping point or F.O.B destination.

Revenue derived from service and maintenance contracts is recognized evenly over the life of the service agreement as the services are performed.

The Company generates revenue from the sale and leasing of medical equipment, from the sale of consumable products used with medical equipment in surgical procedures as well as through product licensing arrangements, and from the sale of Theraskin, a regenerative skin product. In the United States, the Company’s products are marketed primarily through a hybrid sales approach that includes direct sales representatives, managed by regional sales managers, along with independent distributors. Outside the United States, the Company sells BoneScalpel and SonaStar to specialty distributors who purchase products to resell to their clinical customer bases. The Company sells to all major markets in the Americas, Europe, Middle East, Asia Pacific, and Africa. Revenue is disaggregated from contracts between products under ship and bill arrangements and licensing agreements, and by geography, which the Company believes best depicts how the nature, amount, timing and uncertainty of revenues and cash flows are affected by economic factors. The Company also provides an immaterial amount of service revenue that is recognized over time, but not stated separately because the amounts are immaterial.

The following table disaggregates the Company’s product revenue by classification and geographic location: 

Beginning with the fiscal first quarter of 2020, Misonix adopted certain changes in the quarterly financial results related to the presentation of its sales performance supplemental data to more accurately reflect the Company’s two separate sales channels - its surgical and wound product divisions. The surgical division includes the Company's Nexus, BoneScalpel and SonaStar product lines, and the Wound division includes the Company's SonicOne and TheraSkin product lines. Going forward, the Company will present total, domestic and international sales performance supplemental data for its surgical and wound divisions. As a result, the Company will no longer present total, domestic and international sales performance supplemental data based on its consumables and equipment products.

Contract Assets

The timing of revenue recognition, customer invoicing, and collections produces accounts receivable and contract assets on the Company’s consolidated balance sheet. Contract liabilities are not material to the operations of the Company as of September 30, 2019. The Company invoices in accordance with contract payment terms. Invoices to customers represent an unconditional right of the Company to receive consideration. When revenue is recognized in advance of customer invoicing a contract asset is recorded. Unpaid customer invoices are reflected as accounts receivable.

The Company has established a contract asset in conjunction with the Company’s Licensing & Manufacturing Agreement based upon its assessment of the most likely variable consideration to be received by the Company as a result of the royalty provisions in the contract. The asset is recorded as a long-term asset as the Company believes that payment will be made on this asset in a duration exceeding one year. Contract assets as of September 30, 2019 and June 30, 2019 were $960,000, respectively.

 3. Fair Value of Financial Instruments

The Company follows a three-level fair value hierarchy that prioritizes the inputs to measure fair value of financial instruments. This hierarchy requires entities to maximize the use of “observable inputs” and minimize the use of “unobservable inputs.” The three levels of inputs used to measure fair value are as follows:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect assumptions that market participants would use in pricing an asset or liability.

At September 30, 2019 and June 30, 2019, all of the Company’s cash and cash equivalents, trade accounts receivable and trade accounts payable were short term in nature, and their carrying amounts approximate fair value.

4. Inventories

Inventories are summarized as follows:

5. Property, Plant and Equipment

Depreciation and amortization of property, plant and equipment was $428,000 and $333,000 for the three months ended September 30, 2019 and 2018, respectively. Inventory items used for demonstration purposes, rental or on consignment are included in property, plant and equipment and are depreciated using the straight-line method over estimated useful lives of 3 to 5 years. Depreciation of generators that are consigned to customers is expensed over a 5-year period, and depreciation is charged to selling expenses.

6. Goodwill

Under accounting guidelines, goodwill is not amortized, but must be tested for impairment annually, or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below the carrying amount. The Company reviews 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 these impairment tests 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 primarily utilizes the Company’s market capitalization and a discounted cash flow model in determining the fair value, which consists of Level 3 inputs. Changes in the projected cash flows and discount rate estimates and assumptions underlying the valuation of goodwill could materially affect the determination of fair value at acquisition or during subsequent periods when tested for impairment. The Company completed its annual goodwill impairment tests for fiscal 2019 and 2018 as of June 30 of each year. There were no triggering events identified during the quarter ended September 30, 2019. Goodwill increased by $109,086,682 at September 30, 2019 as a result of the Solsys Acquisition.

7. Patents

The costs of acquiring or processing patents are capitalized at cost. These amounts are being amortized using the straight-line method over the estimated useful lives of the underlying assets, which is approximately 17 years. Patents, net of accumulated amortization, totaled $774,010 and $773,668 at September 30, 2019 and June 30, 2019, respectively. Amortization expense for the three months ended September 30, 2019 and 2018 was $32,000 and $34,000, respectively. The following is a schedule of estimated future patent amortization expenses by fiscal year as of September 30, 2019:

8. Intangible Assets

In connection with the Solsys Acquisition, the Company acquired intangible assets primarily consisting of customer relationships, trade names and non-competition agreements. The table below summarizes the intangible assets acquired:

The following is a schedule of estimated future intangible asset amortization expense by fiscal year as of September 30, 2019:

9. Accrued Expenses and Other Current Liabilities

The following summarizes accrued expenses and other current liabilities:

10. Stock-Based Compensation Plans

Stock Option Awards

For the three months ended September 30, 2019 and 2018, the compensation cost relating to stock option awards that has been charged against income for the Company’s stock option plans, excluding the compensation cost for restricted stock, was $221,335 and $278,121 respectively. As of September 30, 2019, there was $2,141,145 of total unrecognized compensation cost related to non-vested share-based compensation arrangements to be recognized over a weighted-average period of 2.5 years.

Stock options typically expire 10 years from the date of grant and vest over service periods, which typically are 4 years. All options are granted at fair market value, as defined in the applicable plans. 

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. The expected volatility represents the historical price changes of the Company’s stock over a period equal to that of the expected term of the option. The Company uses the simplified method for determining the option term. The risk-free rate was based on the U.S. Treasury yield curve in effect at the time of grant. The expected dividend yield is based upon historical and projected dividends. The Company has historically not paid dividends, and is not expected to do so in the near term.

There were options to purchase 0 and 137,000 shares granted during the three months ended September 30, 2019 and 2018, respectively. The fair value was estimated based on the weighted average assumptions of:

A summary of option activity under the Company’s equity plans as of September 30, 2019, and changes during the three months ended September 30, 2019 is presented below:

The total fair value of stock options vested during the three months ended September 30, 2019 was $510,776. The number and weighted-average grant-date fair value of non-vested stock options at September 30, 2019 was 391,750 and $7.05, respectively. The number and weighted-average grant-date fair value of stock options which vested during the three months ended September 30, 2019 was 77,876 and $6.56, respectively.

Restricted Stock Awards

On December 15, 2016, the Company issued 400,000 shares of restricted stock to its Chief Executive Officer. These awards vest over a period of up to five years, subject to meeting certain service, performance and market conditions. These awards were valued at approximately $3.6 million. Compensation expense recorded in the three months ended September 30, 2019 and 2018 related to these awards was $123,749 and $726,377 respectively. As of September 30, 2019, there was approximately $1,009,994 of total unrecognized compensation cost related to non-vested restricted stock awards to be recognized over a weighted-average period of 2.07 years. The awards contain a combination of vesting terms that include time vesting, performance vesting relating to revenue achievement, and market vesting related to obtaining certain levels of Company stock prices. At September 30, 2019, the Company has estimated that it is probable that the performance conditions will be met. The awards were valued using a Monte Carlo valuation model using a stock price at the date of grant of $9.60, a term of 3 to 5 years, a risk free interest rate of 1.6% to 2.1% and a volatility factor of 66.5%. As of September 30, 2019, 186,600 shares from this set of awards have vested.

11. Commitments and Contingencies

Leases

The Company has entered into operating leases primarily for real estate and office copiers. These leases generally have terms that range from 1 year to 6 years. These operating leases are included in “Other current assets” and “Other non-current assets” on the Company’s September 30, 2019 consolidated balance sheet, and represent the Company’s right to use the underlying asset for the lease term. The Company’s obligation to make lease payments are included in “Accrued expenses and other liabilities” and “Other non-current liabilities” on the Company’s September 30, 2019 consolidated balance sheet.  Based on the present value of the lease payments for the remaining lease term of the Company’s existing leases, the Company recognized right-of-use assets of approximately $0.5 million and lease liabilities for operating leases of approximately $0.5 million on July 1, 2019. Operating lease right-of-use assets and liabilities commencing after January 1, 2019 are recognized at their commencement date based on the present value of lease payments over the lease term. As of September 30, 2019, total right-of-use assets and operating lease liabilities were approximately $1.3 million and $1.3 million, respectively. The Company has entered into various short-term operating leases with an initial term of twelve months or less. These leases are not recorded on the Company’s balance sheet. All operating lease expense is recognized on a straight-line basis over the lease term. During the three months ended September 30, 2019, the Company recognized approximately $0.1 million in total lease costs, which was composed of $0.1 million in operating lease costs for right-of-use assets and $-0- in short-term lease costs related to short-term operating leases.

Because the rate implicit in each lease is not readily determinable, the Company uses its incremental borrowing rate to determine the present value of the lease payments.

Information related to the Company’s right-of-use assets and related lease liabilities were as follows:

Maturities of lease liabilities as of September 30, 2019 were as follows:

Former Chinese Distributor - Litigation 

On March 23, 2017, the Company’s former distributor in China, Cicel (Beijing) Science & Technology Co., Ltd., filed a lawsuit against the Company and certain officers and directors of the Company in the United States District Court for the Eastern District of New York, alleging that the Company improperly terminated its contract with the former distributor. The complaint sought various remedies, including compensatory and punitive damages, specific performance and preliminary and post judgment injunctive relief, and asserted various causes of action, including breach of contract, unfair competition, tortious interference with contract, fraudulent inducement, and conversion. On October 7, 2017, the court granted the Company’s motion to dismiss all of the tort claims asserted against it, and also granted the individual defendants’ motion to dismiss all claims asserted against them. The only claim currently remaining in the case is for breach of contract against the Company; the plaintiff has moved to amend its complaint to add tort claims, which the Company has opposed. The court has not yet ruled on the motion to amend. The Company believes it has various legal and factual defenses to the allegations in the complaint, and intends to defend the action vigorously. Fact discovery in the case is ongoing, and there is no trial date currently set.

12. Financing Arrangements

Note payable consists of the following as of June 30, 2019 and December 31, 2018:

Following are the scheduled maturities of the notes payable for the twelve-month period ending June 30:

Revolving Credit Facility

Through the acquisition of Solsys, the Company became party to a $5,000,000 revolving line of credit loan agreement (LOC) with Silicon Valley Bank, originally effective January 22, 2019. Borrowings on the line are limited to 85% of eligible Solsys accounts receivable as defined in the LOC agreement. Interest is calculated at .25% over prime or 5.25%, whichever is higher, and is automatically paid on the last day of each month. The LOC calls for a final payment fee of 1.50% of the line, due upon termination or maturity of the LOC. The LOC also calls for an unused facility fee of .25% of average unused portion of the line paid quarterly. The Company is required to meet certain financial covenants related to the LOC. The line of credit matures January 22, 2021.

Notes Payable

On September 27, 2019, Misonix entered into an amended and restated credit agreement (“SWK Credit Agreement”) with SWK Holdings Corporation pursuant to a commitment letter whereby SWK (a) consented to the transactions contemplated by the Solsys merger agreement and (b) agreed to provide additional financing to Misonix. The SWK credit Facility provides for $25,095,761 in financing and matures on June 30, 2023. The interest rate applicable to the loans made under the SWK Credit Agreement will vary between LIBOR plus 7.00% and LIBOR plus 10.25%, depending on Misonix’s consolidated EBITDA or market capitalization. Interest is payable in cash. Principal payments are capped at $1,250,000 per quarter and commence during the quarter ended March 31, 2021. The Company may not prepay the loans under the SWK Credit Agreement until September 27, 2020. On and after September 27, 2020, the Company may prepay the loans subject to a prepayment fee of (a) $800,000 if such prepayment is made prior to September 27, 2021, (b) 1.00% of the amount prepaid if such prepayment is on or after September 27, 2021 and prior to September 27, 2022 and (c) $0 if such prepayment is made on or after September 27, 2022. The SWK Credit Agreement contains financial covenants requiring (a) a minimum amount of unencumbered liquid assets that will vary based on the Company’s market capitalization, (b) minimum annual revenue of $50 million (determined on a quarterly basis for the prior four fiscal quarters) and (c) minimum EBITDA at levels that will vary based on the Company’s market capitalization. The obligations of the Company under the SWK Credit Agreement are guaranteed by the Company and are secured by a lien on substantially all of its assets.

13. Related Party Transactions

Minoan Medical (Pty) Ltd. (“Minoan”) (formerly Applied BioSurgical) is an independent distributor for the Company in South Africa. The chief executive officer of Minoan is also the brother of Stavros G. Vizirgianakis, the Company’s Chief Executive Officer.

Set forth below is a table showing the Company’s net revenues for the three months ended September 30, 2019 and 2018 and accounts receivable at September 30, 2019 and 2018 with Minoan:

14. Income Taxes

For the three months ended September 30, 2019 and 2018, the Company recorded an income tax expense benefit, as follows:

For the three months ended September 30, 2019 and 2018, the Company recorded an income tax benefit of $4.1 million and $0, respectively. For the three months ended September 30, 2019 and 2018, the effective rate of 178% and 0%, respectively, varied from the U.S. federal statutory rate primarily due to the recording of a full valuation allowance on the deferred tax assets, and the business combination related to the Solsys Acquisition.

The acquisition of Solsys resulted in the recognition of deferred tax liabilities of approximately $4.1 million, related primarily to intangible assets. Prior to the business combination, the Company had a full valuation allowance on its deferred tax assets. The deferred tax liabilities generated from the business combination is netted against the Company’s pre-existing deferred tax assets. Consequently, this resulted in a release of $4.1 million of the pre-existing valuation allowance against the deferred tax assets and corresponding deferred tax benefit.

Valuation Allowance on Deferred Tax Assets

Deferred tax assets refer to assets that are attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets in essence represent future savings of taxes that would otherwise be paid in cash. The realization of the deferred tax assets is dependent upon the generation of sufficient future taxable income, including capital gains. If it is determined that the deferred tax assets cannot be realized, a valuation allowance must be established, with a corresponding charge to net income.

In accordance with ASC Topic 740, the Company establishes valuation allowances for deferred tax assets that, in its judgment are not more likely-than-not realizable. The guidance requires entities to evaluate all available positive and negative evidence, including cumulative results in recent periods, weighted based on its objectivity, in determining whether its deferred tax assets are more likely than not realizable.  

The Company regularly assesses its ability to realize its deferred tax assets. The Company is in a three-year cumulative loss position at June 30, 2019, and it expects to be in a cumulative pretax loss position as of June 30, 2020. Management evaluated available positive evidence, including the continued growth of the Company’s revenues and gross profit margins, the completion of the development of its next generation Nexus product, its SonaStar technology license to its Chinese partner and the reduction in investigative and professional fees, along with available negative evidence, including the Company’s continuing investment in building a direct sales force and payment of transaction fees for the Company’s Solsys acquisition. After weighing both the positive and negative evidence, management concluded that the Company’s deferred tax assets are not more likely-than-not realizable. Accordingly, the Company recorded an increase in the valuation allowance for the three months ended September 30, 2019 of $515,000 against its remaining deferred tax assets at September 30, 2019. As a result of the Solsys Acquisition, the Company recorded a valuation allowance release of $4.1 million. The remaining cumulative valuation allowance at September 30, 2019 is $1.8 million. The Company will continue to assess its ability to utilize its net operating loss carryforwards, and will reverse this valuation allowance when sufficient evidence is achieved to allow the realizability of such deferred tax assets.

As of September 30, 2019 and June 30, 2019, the Company had no material unrecognized tax benefits or accrued interest and penalties.

15. Segment Reporting

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated on a regular basis by the chief operating decision-maker (“CODM”) in deciding how to allocate resources to an individual segment and in assessing performance of the segment. The Company has concluded that its Chief Executive Officer is the CODM as he is the ultimate decision maker for key operating decisions, determining the allocation of resources and assessing the financial performance of the Company. These decisions, allocations and assessments are performed by the CODM using consolidated financial information. Consolidated financial information is utilized by the CODM as the Company’s current product offering primarily consists of minimally invasive therapeutic ultrasonic medical devices. The Company’s products are relatively consistent and manufacturing is centralized and consistent across product offerings. Based on these factors, key operating decisions and resource allocations are made by the CODM using consolidated financial data and as such the Company has concluded that it operates as one segment.

Worldwide revenue for the Company’s product revenue is categorized as follows:

Substantially all of the Company’s long-lived assets are located in the United States.

16. Acquisitions

Solsys Medical, LLC

On September 27, 2019, the Company completed the Solsys Acquisition. The purchase was approximately $108.6 million, representing 5,703,082 shares of Misonix common stock, valued at $19.05 per share. In addition, business transaction costs incurred in connection with the acquisition of $4.4 million, of which $1.8 million were incurred in the quarter ended September 30, 2019. These fees were charged to general and administrative expenses on the Statement of Operations. In addition, approximately $1.3 million of the transaction costs were capitalized to additional paid in capital, in connection with the registration of the underlying stock issued in the transaction.

The transaction was accounted for using the acquisition method of accounting in accordance with FASB ASC Topic 805. US GAAP requires that one of the companies in the transactions be designated as the acquirer for accounting purposes based on the evidence available. Misonix was treated as the acquiring entity for accounting purposes.

The preliminary Solsys purchase price allocation as of September 27, 2019, is shown in the following table:

The fair values of the Solsys assets and liabilities are provisional and were determined based on preliminary estimates and assumptions that management believes are reasonable. The preliminary purchase price allocation is subject to further refinement and may require significant adjustments to arrive at the final purchase price allocation. These adjustments will primarily relate to certain short-term assets, intangible assets, and certain liabilities. The final determination of the fair value of certain assets and liabilities will be completed as soon as the necessary information is available, including the completion of a valuation of the tangible and intangible assets, but no later than one year from the acquisition date.

The goodwill from the acquisition of Solsys, which is fully deductible for tax purposes, consists largely of synergies and economies of scale expected from combining the operations of Solsys and the Company’s existing business.

The estimate of fair value of the Solsys identifiable intangible assets was determined primarily using the “income approach,” which requires a forecast of all of the expected future cash flows either through the use of the multi-period excess earnings method or the relief-from-royalty method. Some of the more significant assumptions inherent in the development of intangible asset values include: the amount and timing of projected future cash flows, the discount rate selected to measure the risks inherent in the future cash flows, the assessment of the intangible asset’s life cycle, as well as other factors.  The following table summarizes key information underlying intangible assets related to the Solsys acquisition:

Solsys’ operations were consolidated with those of the Company for the period September 27, 2019 through September 30, 2019. For that period, revenue and operating loss were $0.3 million and ($0.1) million, respectively. Had the acquisition occurred as of the beginning of fiscal 2018, revenue and net loss, on a pro forma basis excluding transaction fees and the one time tax benefit, for the combined company would have been as follows: