##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 Form 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 FOR THE TRANSITION PERIOD FROM          TO          .
 COMMISSION FILE NUMBER: 001-15063
 Endocare, Inc.
 (Exact name of Registrant as Specified in Its Charter)
 DELAWARE
    
    33-0618093(State of Incorporation)
    
    (I.R.S. Employer I.D. No.)
 201 TECHNOLOGY DRIVE, IRVINE, CALIFORNIA 92618  (Address of Principal Executive Office, Including Zip Code)
 (949) 450-5400  (Registrants Telephone Number, Including Area Code)
 þ o þ o
  o þ o
 o þ




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##### 



Endocare, Inc.
  
 INDEX
 Part I. Financial InformationItem 1. Condensed Consolidated Financial Statements (Unaudited)
    
    
    3Condensed Consolidated Statements of Operations  Three months ended March 31, 2007 and 2006
    
    
    3Condensed Consolidated Balance Sheets  March 31, 2007 and December 31, 2006
    
    
    4Condensed Consolidated Statements of Cash Flows  Three months ended March 31, 2007 and 2006
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    24Item 4. Controls and Procedures
    
    
    25Part II. Other InformationItem 1. Legal Proceedings
    
    
    26Item 1A. Risk Factors
    
    
    26Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    26Item 3. Defaults Upon Senior Securities
    
    
    26Item 4. Submission of Matters to a Vote of Security Holders
    
    
    26Item 5. Other Information
    
    
    26Item 6. Exhibits
    
    
    26Signatures
    
    
    27EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. Condensed Consolidated Financial Statements
 ENDOCARE, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months Ended March 31,2007
    
    
    2006(Unaudited)(In thousands, exceptper share data)Total revenues
    
    $
    7,546
    
    
    $
    7,262Costs and expenses:Cost of revenues
    
    
    2,622
    
    
    
    3,766Research and development
    
    
    616
    
    
    
    1,012Selling and marketing
    
    
    3,763
    
    
    
    3,769General and administrative
    
    
    3,829
    
    
    
    3,994Total costs and expenses
    
    
    10,830
    
    
    
    12,541Loss from operations
    
    
    (3,284
    )
    
    
    (5,279
    )Interest expense, net
    
    
    25
    
    
    
    (46
    )Loss from continuing operations before taxes
    
    
    (3,259
    )
    
    
    (5,325
    )Tax benefit on continuing operations
    
    
    
    
    
    
    151Loss from continuing operations
    
    
    (3,259
    )
    
    
    (5,174
    )Income from discontinued operations
(including gain on disposal of $0.5 million in
2006), net of taxes
    
    
    
    
    
    
    245Net loss
    
    $
    (3,259
    )
    
    $
    (4,929
    )Net (loss) income per share  basic and diluted:Continuing operations
    
    $
    (0.11
    )
    
    $
    (0.17
    )Discontinued operations
    
    $
    
    
    
    $
    0.01Weighted average shares of common stock outstanding
    
    
    30,939
    
    
    
    30,143
  3




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##### Table of Contents



ENDOCARE, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 March 31,
    
    
    December 31,2007
    
    
    2006(Unaudited)(In thousands, exceptper share data)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    1,722
    
    
    $
    1,811Accounts receivable, net
    
    
    4,443
    
    
    
    4,161Inventories, net
    
    
    2,584
    
    
    
    2,260Prepaid expenses and other current assets
    
    
    982
    
    
    
    1,284Total current assets
    
    
    9,731
    
    
    
    9,516Property and equipment, net
    
    
    925
    
    
    
    1,040Intangibles, net
    
    
    3,486
    
    
    
    3,613Investments and other assets
    
    
    2,082
    
    
    
    2,077Total assets
    
    $
    16,224
    
    
    $
    16,246LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    3,771
    
    
    $
    3,393Accrued compensation
    
    
    2,496
    
    
    
    3,000Line of credit
    
    
    1,498
    
    
    
    Other accrued liabilities
    
    
    3,570
    
    
    
    3,594Total current liabilities
    
    
    11,335
    
    
    
    9,987Other long term liabilities
    
    
    132
    
    
    
    74Common stock warrants
    
    
    
    
    
    
    1,307Stockholders equity:Preferred stock, $0.001 par value; 1,000
shares authorized; none issued and
outstanding
    
    
    
    
    
    
    Common stock, $0.001 par value; 50,000
shares authorized; 31,216 and 30,679
issued and outstanding as of March 31,
2007 and December 31, 2006, respectively
    
    
    31
    
    
    
    31Additional paid-in capital
    
    
    188,800
    
    
    
    181,289Accumulated deficit
    
    
    (184,074
    )
    
    
    (176,442
    )Total stockholders equity
    
    
    4,757
    
    
    
    4,878Total liabilities and stockholders equity
    
    $
    16,224
    
    
    $
    16,246
  4




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ENDOCARE, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Three Months EndedMarch 31,2007
    
    
    2006(Unaudited)(In thousands)Cash flows from operating activities:Net loss
    
    $
    (3,259
    )
    
    $
    (4,929
    )Adjustments to reconcile net loss to net cash used in operating activities:Gain on divestiture
    
    
    
    
    
    
    (418
    )Depreciation and amortization
    
    
    309
    
    
    
    463Loss on sale of placement units and other fixed assets
    
    
    52
    
    
    
    Stock-based compensation
    
    
    783
    
    
    
    900Net interest expense related to common stock warrants
    
    
    
    
    
    
    212Changes in operating assets and liabilities:Accounts receivable
    
    
    (281
    )
    
    
    (271
    )Inventories
    
    
    (422
    )
    
    
    220Prepaid expenses and other assets
    
    
    297
    
    
    
    112Accounts payable
    
    
    378
    
    
    
    150Accrued compensation
    
    
    (456
    )
    
    
    (784
    )Other liabilities
    
    
    34
    
    
    
    6Net cash used in operating activities
    
    
    (2,565
    )
    
    
    (4,339
    )Cash flows from investing activities:Purchases of property and equipment
    
    
    (22
    )
    
    
    (51
    )Proceeds from divestitures
    
    
    
    
    
    
    7,277Net cash (used in) provided by investing activities
    
    
    (22
    )
    
    
    7,226Cash flows from financing activities:Stock options exercised
    
    
    
    
    
    
    52Net borrowings on line of credit
    
    
    1,498
    
    
    
    Proceeds from sale of common stock
    
    
    1,000
    
    
    
    Net cash provided by financing activities
    
    
    2,498
    
    
    
    52Net (decrease) increase in cash and cash equivalents
    
    
    (89
    )
    
    
    2,939Cash and cash equivalents, beginning of period
    
    
    1,811
    
    
    
    8,108Cash and cash equivalents, end of period
    
    $
    1,722
    
    
    $
    11,047Non-cash activities:Transfer of inventory to property and equipment for placements at customer sites
    
    $
    113
    
    
    $
    250Note receivable received in divestiture
    
    
    
    
    
    
    1,425Adoption of
FSP 00-19-2:Reduction of retained earnings
    
    $
    4,373
    
    
    $
    Increase in addition paid-in capital
    
    
    5,680
    
    
    
    Reduction of common stock warrant liability
    
    
    1,307
    
    
    
    
  5




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Endocare, Inc. and Subsidiary
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Tabular numbers in thousands, except per share data)
(Unaudited)
 1. Organization and Operations
  Sale of Timm Medical
 2. Basis of Presentation
   3. Recent Operating Results and Liquidity
  Legal Proceedings
 6




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Commitments and Contingencies.
    Private Placement of Common Stock and Warrants,
  Bank Line of Credit,
 7




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8




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4. Sale of Timm Medical
 Accounting for the
Impairment or Disposal of Long-Lived Assets,
   Assets:Cash, inventories and other current assets
    
    $
    1,041Property and equipment, net
    
    
    71Goodwill, net
    
    
    4,552Intangibles, net
    
    
    3,680Other assets
    
    
    65Total assets
    
    
    9,409Liabilities:Accounts payable and other current liabilities
    
    
    502Other accrued liabilities
    
    
    486Total liabilities
    
    
    988Net assets
    
    $
    8,421
  5. Private Placement of Common Stock and Warrants
 Fusion Capital Equity Purchase Agreement
 Recent Operating Results and Liquidity
 9




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March 2005 Private Placement
     10




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Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Companys Own Stock Accounting for Registration Payment Arrangements Accounting for
Contingencies.
 6. Bank Line of Credit
 Recent Operating Results and Liquidity
  11




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7. Capital Stock and Net Loss Per Share
  8. Stock-Based Compensation
 Accounting for Stock Issued to Employees Accounting for Stock Based
Compensation
 12




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Employee Deferred Stock Unit Program.
 Non-employee Directors Deferred Stock Unit Program.
  Restricted Stock Units
 13




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Share Based Payment
   Three Months Ended March 31,2007
    
    
    2006Volatility
    
    
    0.67
    
    
    
    0.71Average Risk Free Interest Rate
    
    
    4.72
    %
    
    
    4.83
    %Dividend yield
    
    
    
    
    
    
    Expected Term in years
    
    
    6.25
    
    
    
    6.25Forfeiture Rate
    
    
    25.00
    %
    
    
    25.00
    %
   14




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RemainingNumber of
    
    
    Weighted
    
    
    Contractual
    
    
    AggregateOptions
    
    
    Average
    
    
    Term
    
    
    Intrinsic Value(in thousands)
    
    
    Exercise Price
    
    
    (in years)
    
    
    (in thousands)Options
outstanding at
December 31, 2006
    
    
    5,909
    
    
    $
    4.13Granted
    
    
    178
    
    
    
    1.77Exercised
    
    
    
    
    
    
    Canceled/forfeited
    
    
    (69
    )
    
    
    3.29Options outstanding at
March 31, 2007
    
    
    6,018
    
    
    
    4.04
    
    
    
    7.08
    
    
    $
    132Options exercisable at
March 31, 2007
    
    
    3,824
    
    
    
    4.67
    
    
    
    6.30
    
    
    $
    26
  WeightedNumber
    
    AverageOutstanding As
    
    Remaining
    
    Weighted
    
    Number
    
    Weightedof March 31,
    
    Contractual
    
    Average
    
    Exercisable As of
    
    AverageRange of Exercise Prices
    
    2007
    
    Life (Years)
    
    Exercise Price
    
    March 31, 2007
    
    Exercise Price$1.65    $2.15
    
    
    605,000
    
    
    
    7.71
    
    
    $
    2.00
    
    
    
    250,105
    
    
    $
    2.12$2.17    $2.22
    
    
    331,652
    
    
    
    9.42
    
    
    $
    2.22
    
    
    
    1,152
    
    
    $
    2.17$2.25    $2.25
    
    
    625,000
    
    
    
    5.92
    
    
    $
    2.25
    
    
    
    625,000
    
    
    $
    2.25$2.36    $2.80
    
    
    909,042
    
    
    
    7.67
    
    
    $
    2.71
    
    
    
    495,705
    
    
    $
    2.68$2.83    $3.29
    
    
    616,995
    
    
    
    8.05
    
    
    $
    3.04
    
    
    
    367,477
    
    
    $
    3.04$3.30    $3.45
    
    
    684,750
    
    
    
    8.57
    
    
    $
    3.36
    
    
    
    224,459
    
    
    $
    3.38$3.69    $4.20
    
    
    420,250
    
    
    
    6.86
    
    
    $
    4.06
    
    
    
    326,039
    
    
    $
    4.08$4.27    $4.27
    
    
    1,000,000
    
    
    
    6.71
    
    
    $
    4.27
    
    
    
    731,250
    
    
    $
    4.27$4.69   $13.42
    
    
    614,632
    
    
    
    4.48
    
    
    $
    8.04
    
    
    
    591,299
    
    
    $
    8.17$13.49   $21.23
    
    
    211,050
    
    
    
    4.59
    
    
    $
    16.18
    
    
    
    211,050
    
    
    $
    16.18$1.65   $21.23
    
    
    6,018,371
    
    
    
    7.08
    
    
    $
    4.04
    
    
    
    3,823,536
    
    
    $
    4.67
  9. Inventories
   March 31,
    
    
    December 31,2007
    
    
    2006Raw materials
    
    $
    1,912
    
    
    $
    1,750Work in process
    
    
    369
    
    
    
    300Finished goods
    
    
    885
    
    
    
    778Total inventories
    
    
    3,166
    
    
    
    2,828Less: inventory reserve
    
    
    (582
    )
    
    
    (568
    )Inventories, net
    
    $
    2,584
    
    
    $
    2,260
 15




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10. Commitments and Contingencies
 Legal Proceedings
 Governmental Investigations and Legal Proceedings
   Lawsuit with KPMG LLP
  Other Litigation
   16




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11. Income Taxes
 Accounting for Uncertainty in Income Taxes an interpretation of SFAS No. 109 Accounting for
Income Taxes
  Balance as of January 1, 2007
    
    $
    240,000Additions based on tax positions related to the current year
    
    
    Additions for tax positions of prior years
    
    
    Reductions for tax positions of prior years
    
    
    Settlements
    
    
    Balance as of March 31, 2007
    
    $
    240,000
   12. Results of Operations
  Three Months EndedMarch 31,2007
    
    
    2006Revenues:Cryoablation disposable products
    
    $
    5,220
    
    
    $
    2,410Cryocare Surgical Systems
    
    
    476
    
    
    
    220Other
    
    
    (16
    )
    
    
    105,680
    
    
    
    2,640
 17




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Three Months EndedMarch 31,2007
    
    
    2006Cryoablation procedure fees
    
    
    1,776
    
    
    
    4,463Cardiac royalties (CryoCath)
    
    
    90
    
    
    
    159$
    7,546
    
    
    $
    7,262Costs of Revenues:Cryocare Surgical Systems
    
    $
    229
    
    
    $
    370Cryoablation disposable products and procedure fees
    
    
    2,393
    
    
    
    3,396$
    2,622
    
    
    $
    3,766
  13. Recent Accounting Pronouncements
  
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 The following discussion and analysis should be read in conjunction with the unaudited
condensed consolidated financial statements and notes thereto included in Part I  Item 1 of this
report, and the audited consolidated financial statements and notes thereto, and Managements
Discussion and Analysis of Financial Condition and Results of Operations contained in the Annual
Report on Form 10-K for the fiscal year ended December 31, 2006.
 This discussion contains forward-looking statements based on our current expectations. There
are various factors  many beyond our control  that could cause our actual results or the
occurrence or timing of expected events to differ materially from those anticipated in these
forward-looking statements. Some of these factors are described below and other factors are
described elsewhere in this Quarterly Report on Form 10-Q or under Risk Factors in our Annual
Report on Form 10-K referred to above. In addition, there are factors not described in this
Quarterly Report on Form 10-Q or in our Annual Report on Form 10-K that could cause our actual
results or the occurrence or timing of expected events to differ materially from those anticipated
in these forward-looking statements. All forward-looking statements included in this Quarterly
Report on Form 10-Q are based on information available to us as of the date hereof, and we assume
no obligation to update any such forward-looking statements.
 Overview
   18




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Strategy, Key Metrics and Developments
     19




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Results of Operations
  Three Months EndedMarch 31,2007
    
    
    2006Revenues:Cryoablation disposable products
    
    $
    5,220
    
    
    $
    2,410Cryocare Surgical Systems
    
    
    476
    
    
    
    220Other
    
    
    (16
    )
    
    
    105,680
    
    
    
    2,640Cryoablation procedure fees
    
    
    1,776
    
    
    
    4,463Cardiac royalties (CryoCath)
    
    
    90
    
    
    
    159$
    7,546
    
    
    $
    7,262Costs of Revenues:Cryocare Surgical Systems
    
    $
    229
    
    
    $
    370Cryoablation disposable products and procedure fees
    
    
    2,393
    
    
    
    3,396$
    2,622
    
    
    $
    3,766
     20




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Share Based Payment
 Three Months Ended March 31, 2007 Compared to Three Months Ended March 31, 2006
 Revenues.
   Cost of Revenues.
 21




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Gross Margins.
 Research and Development Expenses.
 Selling and Marketing Expenses.
 General and Administrative Expenses. Commitments
and Contingencies .
 Interest Expense, Net. Accounting for Registration
Payment Arrangements Accounting for Contingencies
 22




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Income from Discontinued Operations.
 Net Loss.
 Liquidity and Capital Resources
  Commitments and Contingencies Commitments and Contingencies.
  Private Placement of Common Stock and Warrants,
 23




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Item 3. Quantitative and Qualitative Disclosures About Market Risk
  24




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Item 4. Controls and Procedures
 Evaluation of Disclosure Controls and Procedures.
  Changes in Internal Controls.
 25




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PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
   
 Item 1A. Risk Factors
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. Exhibits
  26




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SIGNATURES
  ENDOCARE, INC.By:
    
    /s/ CRAIG T. DAVENPORTCraig T. DavenportChief Executive Officer, President andChairman of the Board(Duly Authorized Officer)By:
    
    /s/ MICHAEL R. RODRIGUEZMichael R. RodriguezSenior Vice President, Finance andChief Financial Officer(Principal Financial andAccounting Officer)
  27




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EXHIBIT INDEX
 ExhibitNo.
    
    Description2.1(1)
    
    Stock Purchase Agreement, dated as of January 13, 2006, by and among the Company, Plethora
Solutions Holdings plc and Timm Medical Technologies, Inc. The schedules and other
attachments to this exhibit were omitted. The Company agrees to furnish a copy of any
omitted schedules or attachments to the Securities and Exchange Commission upon request.2.2(2)
    
    $1,425,000 Secured Convertible Promissory Note, dated as of February 10, 2006, from
Plethora Solutions Holdings plc to the Company.3.1(3)
    
    Certificate of Amendment of Restated Certificate of Incorporation of the Company.3.2(3)
    
    Certificate of Designation of Series A Junior Participating Preferred Stock of the Company.3.3(3)
    
    Restated Certificate of Incorporation.3.4(4)
    
    Amended and Restated Bylaws of the Company.4.1(5)
    
    Form of Stock Certificate.4.2(6)
    
    Form of Series A Warrant.4.3(6)
    
    Form of Series B Warrant.4.4(7)
    
    Rights Agreement, dated as of March 31, 1999, between the Company and U.S. Stock Transfer
Corporation, which includes the form of Certificate of Designation for the Series A Junior
Participating Preferred Stock as Exhibit A, the form of Rights Certificate as Exhibit B
and the Summary of Rights to Purchase Series A Preferred Shares as Exhibit C.4.5(8)
    
    Amendment No. 1 to Rights Agreement, dated as of September 24, 2005, between the Company
and U.S. Stock Transfer Corporation.10.1(9)
    
    Standard Form of RSU Agreement under 2004 Stock Incentive Plan.10.2(9)
    
    Form of RSU Agreement used for Mr. Davenport under 2004 Stock Incentive Plan.10.3(9)
    
    Summary Description of 2007 MICP.10.4(10)
    
    Amendment to Loan Documents, dated as of February 23, 2007, by and between Endocare, Inc.
and Silicon Valley Bank.31.1
    
    Certification under Section 302 of the Sarbanes-Oxley Act of 2002 for Craig T. Davenport.31.2
    
    Certification under Section 302 of the Sarbanes-Oxley Act of 2002 for Michael R. Rodriguez.32.1
    
    Certification under Section 906 of the Sarbanes-Oxley Act of 2002 for Craig T. Davenport.32.2
    
    Certification under Section 906 of the Sarbanes-Oxley Act of 2002 for Michael R. Rodriguez.
 
 
    
    Management contract or compensatory plan or arrangement 28




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(1)
    
    Previously filed as an exhibit to our Form 8-K filed on January 18, 2006.(2)
    
    Previously filed as an exhibit to our Form 10-K filed on March 16, 2006.(3)
    
    Previously filed as an exhibit to our Registration Statement on Form S-3 filed on September 20, 2001.(4)
    
    Previously filed as an exhibit to our Form 10-K filed on March 15, 2004.(5)
    
    Previously filed as an exhibit to our Form 10-K for the year ended December 31, 1995.(6)
    
    Previously filed as an exhibit to our Form 8-K filed on March 16, 2005.(7)
    
    Previously filed as an exhibit to our Form 8-K filed on June 3, 1999.(8)
    
    Previously filed as an exhibit to our Form 8-K filed on June 28, 2005.(9)
    
    Previously filed as an exhibit to our Form 8-K filed on February 27, 2007.(10)
    
    Previously filed as an exhibit to our Form 8-K filed on February 28, 2007. 29