UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


FORM 10-Q





(Mark One)


R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the quarterly period ended April 30, 2011





£
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 001-10382





SYNERGETICS USA, INC.


(Exact name of registrant as specified in its charter)




Delaware

20-5715943(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)3845 Corporate Centre DriveO’Fallon, Missouri

63368(Address of principal executive offices)

(Zip Code)(636) 939-5100(Registrant’s Telephone Number, Including Area Code)





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





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes £ No £





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




Large Accelerated Filer
£
Accelerated Filer
£Non-Accelerated Filer
£
Smaller Reporting Company
R


(Do not check if smaller reporting company)





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





The number of shares outstanding of the issuer’s common stock, $0.001 value per share, as of June 2, 2011 was 24,965,704 shares.










SYNERGETICSUSA, INC.


Index to Form 10-Q





PagePART I
Financial Information
3Item 1.
Unaudited Condensed Consolidated Financial Statements
3Balance Sheets as of April 30, 2011 and July 31, 2010
3Statements of Income for the three and nine months ended April 30, 2011 and 2010
4Statements of Cash Flows for the nine months ended April 30, 2011 and 2010
5Notes to Unaudited Condensed Consolidated Financial Statements
6Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
14Item 3.
Quantitative and Qualitative Disclosures about Market Risk
30Item 4.
Controls and Procedures
30PART II
Other Information
31Item 1.
Legal Proceedings
31Item 1A.
Risk Factors
31Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
31Item 3.
Defaults Upon Senior Securities
31Item 4.
[Removed and Reserved]
31Item 5.
Other Information
31Item 6.
Exhibits
31Trademark Acknowledgements
32Signatures

33Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002Certification of Chief Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002Certification of Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002





2
 Index





Part I — FinancialInformation


Item 1 — Unaudited Condensed Consolidated Financial Statements


Synergetics USA, Inc. and Subsidiaries


Condensed Consolidated Balance Sheets


As of April 30, 2011 (Unaudited) and July 31, 2010


(Dollars in thousands, except share data)





April 30,

2011


July 31,

2010AssetsCurrent AssetsCash and cash equivalents

$
16,991


$
18,669Accounts receivable, net of allowance for doubtful accounts of $310 and $282, respectively


9,361



9,056Inventories


13,523



11,891Prepaid expenses


1,156



792Deferred income taxes


739



658Total current assets


41,770



41,066Property and equipment, net


8,686



8,044Intangible and other assetsGoodwill


10,690



10,690Other intangible assets, net


11,922



12,353Patents, net


1,041



870Cash value of life insurance


72



72Total assets

$
74,181


$
73,095Liabilities and stockholders’ equityCurrent LiabilitiesCurrent maturities of long-term debt

$
1,206


$
1,398Current maturities of revenue bonds payable


--



116Accounts payable


1,686



1,800Accrued expenses


2,289



2,624Income taxes payable


43



11Deferred revenue


982



400Total current liabilities


6,206



6,349Long-Term LiabilitiesLong-term debt, less current maturities


--



939Revenue bonds payable, less current maturities


--



1,612Deferred revenue


18,061



18,630Deferred income taxes


1,287



1,339Total long-term liabilities


19,348



22,520Total liabilities


25,554



28,869Commitments and contingencies (Note 8)Stockholders’ EquityCommon stock at April 30, 2011 and July 31, 2010, $0.001 par value, 50,000,000 shares authorized; 24,969,508 and 24,772,155 shares issued and outstanding, respectively


25



25Additional paid-in capital


25,492



24,905Retained earnings


22,915



19,319Accumulated other comprehensive income (loss):Foreign currency translation adjustment


195



(23
)Total stockholders’ equity


48,627



44,226Total liabilities and stockholders’ equity

$
74,181


$
73,095





See Notes to Unaudited Condensed Consolidated Financial Statements.


3
 Index


SynergeticsUSA, Inc. and Subsidiaries


Consolidated Statements of Income


Three and Nine Months Ended April 30, 2011 and 2010


(Dollars in thousands, except share and per share data)





Three Months Ended

April 30, 2011


Three Months Ended

April 30, 2010


Nine Months Ended

April 30, 2011


Nine Months Ended

April 30, 2010Net sales

$
14,695


$
13,859


$
40,049


$
39,020Cost of sales


6,148



5,828



16,746



16,647Gross profit


8,547



8,031



23,303



22,373Operating expensesResearch and development


882



886



2,587



2,320Sales and marketing


2,771



2,896



8,528



9,200General and administrative


2,427



2,204



6,854



6,2866,080



5,986



17,969



17,806Operating income


2,467



2,045



5,334



4,567Other income (expenses)Investment income


22



--



82



2Interest expense


(37
)


(113
)


(182
)


(412
)Settlement gain


--



2,398



--



2,398Gain (Loss) on  sale of product line


--



893



(99
)


817Miscellaneous


--



(5
)


(11
)


23(15
)


3,173



(210
)


2,828Income before provision for income taxes


2,452



5,218



5,124



7,395Provision for income taxes


809



1,909



1,528



2,667Net income

$
1,643


$
3,309


$
3,596


$
4,728Earnings per share:Basic

$
0.07


$
0.13


$
0.14


$
0.19Diluted

$
0.07


$
0.13


$
0.14


$
0.19Basic weighted average common shares outstanding


24,945,707



24,701,260



24,878,768



24,579,928Diluted weighted average common shares outstanding


25,108,582



24,740,304



25,004,258



24,614,869





See Notes to Unaudited Condensed Consolidated Financial Statements.


4
 Index


SynergeticsUSA, Inc. and Subsidiaries


Consolidated Statements of Cash Flows


Nine Months Ended April 30, 2011 and 2010


(Dollars in thousands)





Nine Months Ended

April 30, 2011


Nine Months Ended

April 30, 2010Cash Flows from Operating ActivitiesNet income

$
3,596


$
4,728Adjustments to reconcile net income to net cash provided by operating activitiesDepreciation


822



784Amortization


490



667Provision for doubtful accounts receivable


15



(65
)Stock-based compensation


252



218Deferred income taxes


(134
)


(435
)Loss (gain) on sale of property and equipment


50



(15
)Loss (gain) on sale of product line


99



(817
)Changes in assets and liabilities(Increase) decrease in:Accounts receivable


(279
)


(1,963
)Inventories


(1,564
)


1,388Prepaid expenses


(337
)


(194
)(Decrease) increase in:Accounts payable


(135
)


27Accrued expenses


(346
)


(979
)Income taxes payable


32



1,618Deferred revenue


13



19,030Net cash provided by operating activities


2,574



23,992Cash Flows from Investing ActivitiesProceeds from the sale of equipment


11



15Purchase of property and equipment


(1,525
)


(594
)Acquisition of patents and other intangibles


(231
)


(146
)Proceeds from sale of product line


--



1,336Net cash used in (provided by) investing activities


(1,745
)


611Cash Flows from Financing ActivitiesExcess of outstanding checks over bank balance


--



(75
)Net (repayments) on lines-of-credit


--



(5,035
)Principal payments on revenue bonds payable


(1,728
)


(1,620
)Principal payments on long-term debt


(686
)


(175
)Payment on debt incurred for acquisition of trademark


(445
)


(420
)Tax benefit associated with the exercise of non-qualified stock options


125



--Proceeds from the issuance of common stock


211



12Net cash used in financing activities


(2,523
)


(7,313
)Foreign exchange rate effect on cash and cash equivalents


16



8Net (decrease) increase in cash and cash equivalents


(1,678
)


17,298Cash and cash equivalentsBeginning


18,669



160Ending

$
16,991


$
17,458





See Notes to Unaudited Condensed Consolidated Financial Statements.


5
 Index


SynergeticsUSA, Inc. and Subsidiaries


Notes to Unaudited Condensed Consolidated Financial Statements


(Tabular information reflects dollars in thousands, except share and per share information)





Note 1. General





Nature of business: Synergetics USA, Inc. (“Synergetics USA” or the “Company”) is a Delaware corporation incorporated on June 2, 2005, as a result of the reverse merger of Synergetics, Inc. (“Synergetics”) and Valley Forge Scientific Corp. (“Valley Forge”) and the subsequent reincorporation of Valley Forge (the predecessor to Synergetics USA) in Delaware. Synergetics USA is a medical device company.  Through continuous improvement and development of our people, our mission is to design, manufacture and market innovative microsurgical devices, capital equipment, accessories and disposables of the highest quality in order to enable surgeons who perform microsurgery around the world to provide a better quality of life for their patients.   The Company’s primary focus is on the microsurgical disciplines of ophthalmology and neurosurgery. Our distribution channels include a combination of direct and independent sales organizations and important strategic alliances with market leaders. The Company is located in O’Fallon, Missouri and King of Prussia, Pennsylvania.  During the ordinary course of its business, the Company grants unsecured credit to its domestic and international customers.





Basis of presentation:The unaudited condensed consolidated financial statements include the accounts of Synergetics USA, Inc., and its wholly owned subsidiaries: Synergetics, Synergetics Development Company, LLC, Synergetics Delaware, Inc. and Synergetics IP, Inc. All significant intercompany accounts 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 (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended April 30, 2011, are not necessarily indicative of the results that may be expected for the fiscal year ending July 31, 2011. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the year ended July 31, 2010, and notes thereto filed with the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on October 12, 2010 (the “Annual Report”).





Note 2.  Comprehensive Income





Comprehensive income was $1,829,000 and $3,814,000 for the three and nine months ended April 30, 2011.  The Company’s only component of other comprehensive income is the foreign currency translation adjustment.





Note 3. Summary of Significant Accounting Policies





Deferred revenue:  During the second quarter of fiscal 2011, the Company received a payment from Codman & Shurtleff, Inc. (“Codman”), a marketing partner, to establish exclusivity on certain generator products and accessories.  Revenue from the payment has been deferred and is being amortized over the expected term of the agreement.  The Company recognized $135,000 and $199,000, respectively, of this deferred revenue for the three and nine months ended April 30, 2011.  In addition, included in deferred revenue is an amount the Company received pursuant to a Confidential Settlement and License Agreement with Alcon, Inc. (“Alcon”).  This payment was accounted for as an up-front licensing fee.  Recognition of the revenue pursuant to this agreement has been deferred and is being recognized over a period of up to fifteen years based upon estimated shipments to Alcon under a related Supply Agreement executed pursuant to the settlement.  The Company recognized $157,000 and $388,000, respectively, of this deferred revenue as the estimate of these shipments has been revised for the three and nine months ended April 30, 2011.


6
 Index


The Company’s significant accounting policies are disclosed in the Annual Report. In the first nine months of fiscal 2011, no significant accounting policies were changed other than the deferred revenue policy discussed above.





Note 4. Marketing Partner Agreements





The Company sells most of its electrosurgery generators and neurosurgery instruments and accessories to two U.S. based, global marketing partners as described below:





Codman





In the neurosurgical market, the bipolar electrosurgical system manufactured by Valley Forge prior to the merger has been sold for over 25 years through a series of distribution agreements with Codman, an affiliate of Johnson & Johnson.  On April 2, 2009, the Company executed a new, three-year distribution agreement with Codman for the continued distribution by Codman of certain bipolar generators and related disposables and accessories effective January 1, 2009.  In addition, the Company entered into a new, three-year license agreement, which provides for the continued licensing of the Company’s Malis® trademark to Codman for use with certain Codman products, including those covered by the distribution agreement.  Both agreements expire on December 31, 2011 and may renew for an additional three year period.  In December 2010, Codman elected to exercise its option of exclusive distribution with respect to the bipolar generators and related disposables and accessories.





On November 16, 2009, the Company announced the signing of an addendum to its three-year agreement with Codman.  Under the terms of the revised agreement, Codman has the exclusive right to market and distribute the Company’s Malis® SpetzlerTM branded disposable forceps produced by Synergetics.  Codman began distribution of the disposable bipolar forceps on December 1, 2009, domestically and February 1, 2010, internationally.





Total sales to Codman and its respective percent of the Company’s net sales for the three and nine months ended April 30, 2011 and 2010, including the historical sales of generators, accessories and disposable cord tubing that the Company has supplied in the past, as well as the disposable bipolar forceps sales resulting from the addendum to the existing distribution agreement and revenue recognized from the exclusivity payment, were as follows (dollars in thousands):





Three Months Ended

April 30, 2011


Three Months Ended

April 30, 2010


Nine Months Ended

April 30, 2011


Nine Months Ended

April 30, 2010Net Sales

$
2,892


$
2,304


$
7,419


$
4,777Percent of net sales


19.7
%


16.6
%


18.5
%


12.2
%





Stryker Corporation (“Stryker”)





The Company supplies a lesion generator used for minimally invasive pain treatment to Stryker pursuant to a supply and distribution agreement dated as of October 25, 2004. The original term of the agreement was for slightly over five years, commencing on November 11, 2004 and ending on December 31, 2009. On August 1, 2007, the Company negotiated a one-year extension to the agreement through December 31, 2010 and increased the minimum purchase obligation to 300 units per year for the remaining contract period.  The Company has negotiated a four-year extension to the agreement through December 31, 2015.





On March 31, 2010, the Company entered into an additional strategic agreement with Stryker including the sale of accounts receivable, open sales orders, inventory and certain intellectual property related to the Omni® ultrasonic aspirator product line. For fiscal year 2010, the gain from the sale of the Omni® product line to Stryker was $817,000.  In the second quarter of fiscal 2011, the Company recorded an additional $99,000 loss on the sale of this product line, as certain receivables were deemed uncollectible.  In addition, the agreement provides for the Company to supply disposable ultrasonic instrument tips and certain other consumable products used in conjunction with the ultrasonic aspirator console and handpieces and to pursue certain development projects for new products associated with Stryker’s ultrasonic aspirator.  This agreement expires on March 31, 2014.


7
 Index


Total sales to Stryker and its respective percent of the Company’s net sales for the three and nine months ended April 30, 2011 and 2010, including the historical sales of pain control generators and accessories that the Company has supplied in the past, as well as the disposable ultrasonic instrument tips sales and certain other consumable products resulting from the new agreements, were as follows (dollars in thousands):





Three Months Ended

April 30, 2011


Three Months Ended

April 30, 2010


Nine Months Ended

April 30, 2011


Nine Months Ended

April 30, 2010Net Sales

$
1,943


$
1,640


$
5,299


$
2,898Percent of net sales


13.2
%


11.8
%


13.2
%


7.4
%





No other customer comprises more than 10 percent of sales in any given quarter.





Note 5. Stock-Based Compensation





Stock Option Plans





The following table provides information about stock-based awards outstanding at April 30, 2011:





Shares


Weighted Average Exercise Price


Weighted Average Fair ValueOptions outstanding beginning of period


576,695


$
2.08


$
1.71For the period August 1, 2010 through April 30, 2011Granted


108,751


$
4.43


$
3.56Forfeited


(27,000
)

$
3.21


$
2.71Exercised


(141,417
)

$
1.49


$
1.29Options outstanding, end of period


517,029


$
2.68


$
2.16Options exercisable, end of period


354,028


$
2.51


$
2.02





During the second quarter of fiscal 2011, there were 40,000 options granted to the Company’s independent directors, which vest pro-ratably on a quarterly basis over the next year of service.  Each independent director receives an option to purchase 10,000 shares of the Company’s Common Stock each year in which he or she is elected, appointed, or re-elected to serve as a director pursuant to the Amended and Restated 2005 Non-Employee Directors’ Stock Option Plan. The Company recorded $35,000 and $47,000, respectively, of compensation expense for each of the three and nine months ended April 30, 2011 related to these options.  In addition, the Company recorded $0 and $18,000, respectively, of compensation expense for the three and nine months ended April 30, 2011, for previously granted options.





During the second quarter of fiscal 2011, there were options to purchase 68,751 shares of Common Stock granted to the officers of the Company. These options were granted in conjunction with the Company’s annual review of compensation as of August 1, 2010 and vest pro-ratably on a quarterly basis over the next five years of service. The Company recorded $12,000 and $16,000, respectively, of compensation expense for the three and nine months ended April 30, 2011 related to these options.  In addition, the Company recorded $8,000 and $24,000, respectively, of compensation expense for the three and nine months ended April 30, 2011 for previously granted options.


8
 Index


The fair value of all options granted during the second fiscal quarter was determined at the date of the grant using the Black-Scholes options-pricing model and the following assumptions:





Expected average risk-free interest rate


3.30
%Expected average life (in years)


10Expected volatility


75.38
%Expected dividend yield


0.0
%





The expected average risk-free rate is based on the 10 year U.S. treasury yield curve in December of 2010.  The expected average life represents the period of time that the options granted are expected to be outstanding giving consideration to the vesting schedules, historical exercises and forfeiture patterns.  Expected volatility is based on historical volatilities of the Company’s Common Stock.  The expected dividend yield is based on historical information and management’s plan.





The intrinsic value of in-the-money stock options outstanding was $1.4 million and $24,000 at April 30, 2011 and 2010, respectively.  The intrinsic value of in-the-money exercisable stock options was $1.0 million and $296,000 at April 30, 2011 and 2010, respectively.





The Company expects to issue new shares as options are exercised. As of April 30, 2011, the future compensation cost expected to be recognized for currently outstanding stock options is approximately $55,000 for the remainder of fiscal 2011, $130,000 in fiscal 2012, $68,000 in fiscal 2013, $68,000 in fiscal 2014, $56,000 in fiscal 2015 and $20,000 in 2016.





Restricted Stock Plans





Under our Amended and Restated Synergetics USA, Inc. 2001 Stock Plan (“2001 Plan”), Common Stock may be granted at no cost to certain employees and consultants of the Company. Certain plan participants are entitled to cash dividends and voting rights for their respective shares. Restrictions limit the sale or transfer of these shares during a vesting period whereby the restrictions lapse either pro-ratably over a three to five-year vesting period or at the end of the fifth year. These shares also vest upon a change of control event. Upon issuance of stock under the 2001 Plan, unearned compensation equivalent to the market value at the date of the grant is charged to stockholders’ equity and subsequently amortized to expense over the applicable restriction period. As of April 30, 2011, there was approximately $452,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 2001 Plan. The cost is expected to be recognized over a weighted average period of three to five years. The following table provides information about restricted stock grants during the nine-month period ended April 30, 2011:





Number of Shares


Weighted Average Grant Date Fair ValueBalance as of July 31, 2010


286,961


$
2.04Granted


43,846


$
4.43Forfeited


--



--Balance as of April 30, 2011


330,807


$
2.36





Note 6. Fair Value Information





Fair value is an exit price that represents the amount that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants.





The Company has no financial assets which are required to be measured at fair value on a recurring basis. Non-financial assets such as goodwill, intangible assets and property, plant and equipment are measured at fair value when there is an indicator of impairment and recorded at fair value only when impairment is recognized. No impairment indicators existed as of April 30, 2011.


9
 Index


The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value because of the short maturity of these items. The carrying amount of the Company’s notes payable is estimated to approximate fair value because the variable interest rates or the fixed interest rates are based on estimated current rates offered to the Company for debt with similar terms and maturities.





Note 7. Supplemental Balance Sheet Information





Accounts Receivable and Allowance for Doubtful Accounts:The Company maintains allowances for doubtful accounts for estimated probable losses resulting from the inability of the Company’s customers to make required payments. The Company continues to assess the adequacy of the reserves for doubtful accounts based on the financial condition of the Company’s customers and other external factors that may impact collectability. The majority of the Company’s accounts receivable are due from trade customers, primarily in the hospital or ambulatory surgery center environment. Credit is extended based on an evaluation of the customers’ financial condition and generally, collateral is not required. Payment terms vary and accounts receivable are stated in the Condensed, Consolidated Financial Statements at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding for longer than the payment terms are considered past due. The Company considers a number of factors in determining the allowance for doubtful accounts, including the length of time trade accounts receivable are past due, the customers’ current ability to pay their obligations to the Company, the Company’s previous loss history, and the condition of the general economy and the medical industry as a whole. The Company writes off accounts receivable when they become uncollectible. The Company’s accounts receivable balance at April 30, 2011 reflects an allowance for doubtful accounts of $310,000 and at July 31, 2010 of $282,000.





Inventories:Inventories as of April 30, 2011 and July 31, 2010 were as follows (dollars in thousands):





April 30,

2011


July 31,

2010Raw material and component parts

$
5,962


$
5,225Work in progress


2,611



2,050Finished goods


4,950



4,616$
13,523


$
11,891





Property and Equipment: Property and equipment as of April 30, 2011 and July 31, 2010 were as follows (dollars in thousands):





April 30,

2011


July 31,

2010Land

$
730


$
730Building and improvements


5,965



5,929Machinery and equipment


6,858



6,136Furniture and fixtures


729



736Software


363



363Construction in progress


722



23215,367



14,126Less accumulated depreciation


6,681



6,082$
8,686


$
8,044


10
 Index


Other Intangible Assets:  Information regarding the Company’s other intangible assets as of April 30, 2011 and July 31, 2010 is as follows (dollars in thousands):





Gross Carrying Value


Accumulated Amortization


NetApril 30, 2011Proprietary know-how

$
4,057


$
1,730


$
2,327Trademark


5,923



--



5,923Licensing agreement


5,834



2,162



3,672Patents


1,617



576



1,041$
17,431


$
4,468


$
12,963July 31, 2010Proprietary know-how

$
4,057


$
1,544


$
2,513Trademark


5,923



--



5,923Licensing agreement


5,834



1,917



3,917Patents


1,387



517



870$
17,201


$
3,978


$
13,223





Goodwill of $10,660,000 and proprietary know-how of $4,057,000 are a result of the reverse merger transaction completed on September 21, 2005.





The Company did not incur costs to renew or extend the term of acquired intangible assets during the period ended April 30, 2011. Estimated amortization expense on other intangibles for the remaining three months of the fiscal year ending July 31, 2011, and the next four years thereafter is as follows (dollars in thousands):





AmountFiscal Year 2011 (remaining 3 months)

$
147Fiscal Year 2012


587Fiscal Year 2013


618Fiscal Year 2014


617Fiscal Year 2015


617





Amortization expense for the three and nine months ended April 30, 2011 was $147,000 and $490,000, respectively.





Pledged assets; short and long-term debt (excluding revenue bonds payable):  Short-term debt as of April 30, 2011 and July 31, 2010, consisted of the following:





Revolving Credit Facility:The Company has a credit facility with a bank which allows for borrowings of up to $9.5 million (collateral available on April 30, 2011 permits borrowings up to $7.3 million) with an interest rate based on either the one-, two- or three-month LIBOR plus 2.0 percent and adjusting each quarter based upon our leverage ratio. As of April 30, 2011, interest under the facility is charged at 2.21 percent. The unused portion of the facility is charged at a rate of 0.20 percent. There were no borrowings under this facility at April 30, 2011. Outstanding amounts are collateralized by the Company’s domestic receivables and inventory. This credit facility was amended on November 30, 2010, to extend the termination date through November 30, 2011.





The facility has two financial covenants: a maximum leverage ratio of 3.75 times and a minimum fixed charge coverage ratio of 1.1 times. As of April 30, 2011, the leverage ratio was 1.02 times and the minimum fixed charge coverage ratio was 3.17 times. Collateral availability under the line as of April 30, 2011, was approximately $7.3 million. The facility restricts the payment of dividends if, following the distribution, the fixed charge coverage ratio would fall below the required minimum.


11
 Index


Non-U.S. Receivables Revolving Credit Facility:The Company had a non-U.S. receivables credit facility with a bank which allowed for borrowings of up to $1.75 million with an interest rate based upon LIBOR plus 3.0 percent.  Pursuant to the terms of this facility, under no circumstances shall the rate be less than 3.5 percent per annum.  The facility charged an administrative fee of 1.0 percent.  Outstanding amounts were collateralized by the Company’s non-U.S. receivables.  This credit facility had no financial covenants or outstanding balance when it was terminated on November 30, 2010.





Equipment Line of Credit:Under this credit facility, the Company may borrow up to $1.0 million, with interest at one-month LIBOR plus 3.0 percent.  Pursuant to the terms of the equipment line of credit, under no circumstances shall the rate be less than 3.5 percent per annum.  The unused portion of the facility is not charged a fee. There were no borrowings under this facility at April 30, 2011. The equipment line of credit was amended on November 30, 2010, to extend the maturity date to November 30, 2011.





Long-term debt as of April 30, 2011 and July 31, 2010 consisted of the following (dollars in thousands):





April 30,

2011


July 31,

2010Note payable to the estate of the late Dr. Leonard I. Malis, due in quarterly installments of $159,904 which includes interest at an imputed rate of 6.0 percent; remaining balance of $480,000 including the effects of imputing interest, due December 2011, collateralized by the Malis® trademark

$
466


$
911Settlement obligation to Iridex Corporation (“Iridex”), due in annual installments of $800,000 which includes interest at an imputed rate of 8.0 percent; remaining balance of $800,000 including the effects of imputing interest, due April 15, 2012


740



1,426Total

$
1,206


$
2,337Less: current maturities


1,206



1,398Long-term portion

$
--


$
939





Deferred Revenue:  Deferred revenue as of April 30, 2011 and July 31, 2010, consisted of the following (dollars in thousands):





April 30,

2011


July 31,

2010Deferred revenue -  Alcon Settlement

$
18,642


$
19,030Deferred revenue – Codman Exclusivity


401



--Total

$
19,043


$
19,030Less: Short-term


982



400Long-term portion

$
18,061


$
18,630





Note 8. Commitments and Contingencies





Effective January 29, 2009, the Company’s Board of Directors appointed David M. Hable to serve as President and Chief Executive Officer (“CEO”). Also on that date, the Company entered into a change in control agreement with Mr. Hable. On December 9, 2009, the Company entered into a change in control agreement with each of its Chief Operating Officer and Chief Scientific Officer, which agreements were contemplated in conjunction with the Company’s annual review of compensation and therefore, the agreements were made effective with other compensation changes as of August 1, 2009. On October 12, 2010, the Company entered into a change of control agreement with its Chief Financial Officer (“CFO”), which agreement was contemplated in conjunction with the Company’s annual review of compensation; therefore, the agreement was made effective with other compensation changes as of August 1, 2010.  On March 3, 2011, the Company entered into a change of control agreement with each of its Vice President of Domestic Sales and Vice President of International Sales and Marketing, which agreements were contemplated in conjunction with the Company’s annual review of compensation; therefore, the agreements were made effective with other compensation changes as of August 1, 2010. The change in control agreements with its executive officers, Vice President of Domestic Sales and Vice President of International Sales and Marketing each provide that if employment is terminated within one year following a change in control for cause or disability (as each term is defined in the change in control agreement), as a result of the officer’s death, or by the officer other than as an involuntary termination (as defined in the change in control agreement), the Company shall pay the officer all compensation earned or accrued through his or her employment termination date, including (i) base salary; (ii) reimbursement for reasonable and necessary expenses; (iii) vacation pay; (iv) bonuses and incentive compensation; and (v) all other amounts to which they are entitled under any compensation or benefit plan of the Company (“Standard Compensation Due”).


12
 Index


If the officer’s employment is terminated within one year following a change in control without cause and for any reason other than death or disability, including an involuntary termination, and provided the officer enters into a separation agreement within 30 days of his or her employment termination, he or she  shall receive the following: (i) all Standard Compensation Due and any amount payable as of the termination date under the Company’s objectives-based incentive plan, the sum of which shall be paid in a lump sum immediately upon such termination; and (ii) an amount equal to one times his or her annual base salary at the rate in effect immediately prior to the change in control, to be paid in 12 equal monthly installments beginning in the month following his or her employment termination. Furthermore, all of the officer’s awards of shares or options shall immediately vest and be exercisable for one year after the date of his or her employment termination.





Various claims, incidental to the ordinary course of business, are pending against the Company.  In the opinion of management, after consultation with legal counsel, resolution of these matters is not expected to have a material effect on the accompanying financial statements.





The Company is subject to regulatory requirements throughout the world. In the normal course of business, these regulatory agencies may require companies in the medical device industry to change their products or operating procedures, which could affect the Company.  The Company regularly incurs expenses to comply with these regulations and may be required to incur additional expenses.  Management is not able to estimate any additional expenditures outside the normal course of operations which will be incurred by the Company in future periods in order to comply with these regulations.





Note 9. Enterprise-wide Sales Information





Enterprise-wide sales information for the three and nine months ended April 30, 2011 and 2010, respectively, consisted of the following (dollars in thousands):





Three Months Ended

April 30, 2011


Three Months Ended

April 30, 2010


Nine Months Ended

April 30, 2011


Nine Months Ended

April 30, 2010Net SalesOphthalmic

$
9,226


$
7,776


$
25,038


$
23,100Neurosurgery - Direct


339



2,038



1,383



7,767Marketing Partners (Codman, Stryker)


2,256



1,818



6,268



2,280Total Neurosurgery


2,595



3,856



7,651



10,047OEM (Codman, Stryker, Iridex)


2,840



2,195



7,289



5,776Other


34



32



71



97Total

$
14,695


$
13,859


$
40,049


$
39,020Net SalesDomestic

$
9,975


$
9,408


$
27,929


$
26,648International


4,720



4,451



12,120



12,372$
14,695


$
13,859


$
40,049


$
39,020


13
 Index


Note 10. Recent Accounting Pronouncements





In January 2010, the Financial Accounting Standards Board (“FASB”) issued the Accounting Standards Update (“ASU”) No. 2010-06, “Improving Disclosures about Fair Value Measurements,” which amends Accounting Standards Codification 820, “Fair Value Measurements and Disclosures.” This ASU requires disclosures of transfers into and out of Levels 1 and 2, more detailed roll forward reconciliations of Level 3 recurring fair value measurement on a gross basis, fair value information by class of assets and liabilities and descriptions of valuation techniques and inputs for Level 2 and 3 measurements. The effective date for the roll forward reconciliations is the first quarter of fiscal 2012. The Company does not believe the adoption of this ASU will have a material effect on its consolidated financial statements.





We have reviewed all other recently issued, but not yet effective, accounting pronouncements and do not believe any such pronouncements will have a material impact on our financial statements.





Item 2 — Management’sDiscussion and Analysis of Financial Condition and Results of Operations





Overview





Synergetics USA, Inc. is a leading supplier of precision microsurgical devices. The Company’s primary focus is on the microsurgical disciplines of ophthalmology and neurosurgery. Our distribution channels include a combination of direct and independent sales organizations and important strategic alliances with market leaders. The Company’s product lines focus upon precision engineered, microsurgical devices and the delivery of various energy modalities for the performance of minimally invasive microsurgery, including: (i) laser energy, (ii) ultrasonic energy, (iii) radio frequency energy for electrosurgery and lesion generation and (iv) visible light energy for illumination, and where applicable, simultaneous infusion (irrigation) of fluids into the operative field. Enterprise-wide sales information is included in Note 9 to the unaudited condensed consolidated financial statements.





The Company is a Delaware corporation incorporated on June 2, 2005, as a result of the reverse merger of Synergetics, Inc. and Valley Forge Scientific Corp. Synergetics was founded in 1991. Valley Forge was incorporated in 1980 and became a publicly-held company in November 1989. Prior to the reverse merger of Synergetics and Valley Forge, Valley Forge’s common stock was listed on The NASDAQ Small Cap Market (now known as The NASDAQ Capital Market) and the Boston Stock Exchange under the ticker symbol “VLFG.” On September 21, 2005, Synergetics Acquisition Corporation, a wholly owned Missouri subsidiary of Valley Forge, merged with and into Synergetics, and Synergetics thereby became a wholly owned subsidiary of Valley Forge. On September 22, 2005, Valley Forge reincorporated from a Pennsylvania corporation to a Delaware corporation and changed its name to Synergetics USA, Inc. Upon consummation of the merger, the Company’s securities began trading on The NASDAQ Capital Market under the ticker symbol “SURG,” and its shares were voluntarily delisted from the Boston Stock Exchange.





Recent Developments





We had several developments in fiscal 2010 and fiscal 2011 that we expect will contribute to the growth of our business in the foreseeable future.





On April 1, 2010, the Company announced the closing of a definitive agreement with Stryker in conjunction with the acquisition by Stryker of certain assets from Mutoh Co., Ltd. and its affiliates, used to produce the Sonopet Ultrasonic Aspirator control consoles and handpieces (previously marketed under the Omni® brand by Synergetics in the U.S., Canada and several other countries). The agreement included the sale of accounts receivable, open sales orders, inventory and certain intellectual property related to the Omni® product line. The gain from the sale of the Omni® product line to Stryker was $817,000 in fiscal 2010. In the second quarter of fiscal 2011, the Company recorded a $99,000 loss on the sale of this product line, as certain receivables were deemed to be uncollectible.  In addition, the agreement provides for the Company to supply disposable ultrasonic instrument tips and certain other consumable products used in conjunction with the Sonopet/Omni® ultrasonic aspirator console and handpieces, and pursue certain development projects for new products associated with Stryker’s ultrasonic aspirator products. The Company has negotiated a four-year extension to the agreement with Stryker through December 31, 2015.  The Stryker relationship has been proceeding well and is meeting the Company’s expectations for unit and dollar sales volumes.


14
 Index


On November 16, 2009, the Company announced the signing of an addendum to its three-year agreement (effective as of January 1, 2009) with Codman. Under the terms of the revised agreement, Codman has the exclusive right to market and distribute the Company’s Malis® branded disposable bipolar forceps. Codman began the domestic distribution of the disposable bipolar forceps on December 1, 2009 and the international distribution on February 1, 2010. The Codman relationship has been proceeding well and is meeting the Company’s expectations for unit and dollar sales volumes.





Contribution margins for the products supplied to Codman and Stryker have increased, as anticipated, primarily due to the elimination of commercial expenses associated with the distribution of these products.  However, sales and gross profit for these products have decreased, as the transfer prices to Codman and Stryker are lower than the previous average direct selling prices.





On April 27, 2010, the Company announced that it had entered into a Settlement and License Agreement with Alcon pursuant to which Alcon agreed to pay the Company $32.0 million, and the Company agreed to produce certain products for distribution by Alcon. The net proceeds to the Company were $21.4 million after contingency payments to attorneys. The Company recognized a gain from this agreement of $2.4 million in the third fiscal quarter of 2010. The remaining $19.0 million has been accounted for as deferred revenue on the balance sheet.  As units are shipped to Alcon under a Supply Agreement entered pursuant to the settlement, the Company will be paid an incremental transfer price.  In addition, the Company will recognize a portion of the deferred revenue as the estimate of these shipments to Alcon over a period of up to fifteen years is revised. The Company recognized $388,000 of this deferred revenue during the first nine months of fiscal 2011.  Shipments to Alcon of the first of two products covered by the agreement are expected to begin in the first quarter of fiscal 2012.





On October 26, 2010, the Company announced record sales leads generated from the presentation of recently released ophthalmic products at the 2010 Annual Meeting of the American Academy of Ophthalmology.





On November 30, 2010, the Company extended its revolving credit facility and its equipment line of credit through November 30, 2011.





On December 9, 2010, the Company announced that it signed a product development and consulting agreement with Retinal Solutions, LLC located in Michigan.





On December 22, 2010, Codman elected to exercise its option of exclusive distribution with respect to the bipolar generators and related disposables and accessories.





On February 16, 2011, the Company retired the debt on its O’Fallon, Missouri facility.





On March 10, 2011, the Company reported that it had begun selling the VersaPACKTM for use in the vitreoretinal operating room.  The launch of this product allows the Company to compete in an estimated $277 million segment of the vitreoretinal market in which we previously were unable to compete.


15
 Index


Summary of Financial Information





The following tables present net sales by category and our results of operations (dollars in thousands):





NET SALES BY CATEGORY





Three Months EndedApril 30, 2011


Mix


April 30, 2010


MixOphthalmology

$
9,226



62.8
%

$
7,776



56.1
%Direct Neurosurgery


339



2.3
%


2,038



14.7
%Marketing Partners (1)


2,256



15.4
%


1,818



13.1
%Total Neurosurgery


2,595



17.7
%


3,856



27.8
%Original Equipment Manufacturers (“OEM”) (2)


2,840



19.3
%


2,195



15.9
%Other


34



0.2
%


32



0.2
%Total

$
14,695






$
13,859





Nine Months EndedApril 30, 2011


Mix


April 30, 2010


MixOphthalmology

$
25,038



62.5
%

$
23,100



59.2
%Direct Neurosurgery


1,383



3.4
%


7,767



19.9
%Marketing Partners (1)


6,268



15.7
%


2,280



5.8
%Total Neurosurgery


7,651



19.1
%


10,047



25.7
%OEM


7,289



18.2
%


5,776



14.8
%Other


71



0.2
%


97



0.3
%Total

$
40,049






$
39,020





(1)
Marketing partners’ sales include disposable bipolar forceps, disposable ultrasonic instrument tips and accessories which were previously sold by our direct neurosurgery sales force and our distribution partners.  These products have been transitioned to our marketing partners.


(2)
Revenues from OEM represent sales of electrosurgical and pain control generators, related accessories, certain laser probes and deferred revenue to Codman, Stryker, Iridex and Alcon.





The increase in sales for the third quarter of fiscal 2011 compared with the third quarter of fiscal 2010 was primarily due to an increase of $1.5 million in ophthalmic sales and a $645,000 increase in OEM sales (including $292,000 of deferred revenue recognized), partially offset by a $1.3 million decrease in our neurosurgery sales due to the transition of the majority of our neurosurgery product sales to our marketing partners.  In the third quarter of fiscal 2010, the Company sold $187,000 of Omni® capital equipment that was previously included in our direct neurosurgery sales and which the Company no longer sells.  Overall sales of capital equipment in the third quarter of fiscal 2011, including the sales of Omni® capital equipment, declined by $707,000, or 25.1 percent, compared with the third quarter of fiscal 2010.  However, the sales of our disposable products grew $1.3 million, or 11.8 percent, in the third quarter of fiscal 2011 as compared to the third quarter fiscal 2010.


16
 Index


The increase in sales for the first nine months of fiscal 2011 compared with the first nine months of fiscal 2010 was primarily due to a $1.9 million increase in ophthalmology sales and a $1.5 million increase in OEM sales (including $587,000 of deferred revenue recognized), partially offset by a $2.4 million decrease in total neurosurgery sales due to the transition of the majority of our neurosurgery product sales to our marketing partners.  In the first nine months of fiscal 2010, the Company sold $1.1 million of Omni® capital equipment that was previously included in our direct neurosurgery sales and which the Company no longer sells.  Overall sales of our capital equipment in the first nine months of fiscal 2011, including the sales of Omni® capital equipment, declined by $2.2 million, or 23.9 percent, compared with the first nine months of fiscal 2010.  However, the sales of our disposable products grew $2.7 million, or 9.1 percent, in the first nine months of fiscal 2011 as compared to the first nine months of fiscal 2010.





RESULTS OF OPERATIONS


(Dollars in Thousands)





Three Months EndedApril 30, 2011


April 30, 2010(2)


Increase

(Decrease)Net Sales

$
14,695


$
13,859



6.0
%Gross Profit


8,547



8,031



6.4
%Gross Profit Margin %


58.2
%


57.9
%


0.5
%Commercial ExpensesSales and Marketing


2,771



2,896



(4.3
%)General and Administrative


2,427



2,204



10.1
%Research and Development


882



886



(0.5
%)Operating Income


2,467



2,045



20.6
%Operating Margin


16.8
%


14.8
%


13.5
%EBITDA (1)


2,899



5,815



(50.1
%)Net Income

$
1,643


$
3,309



(50.3
%)Earnings per share

$
0.07


$
0.13



(46.2
%)Return on equity (1)


3.4
%


8.0
%


(57.5
%)Return on assets (1)


2.2
%


5.2
%


(57.7
%)





Nine Months EndedApril 30, 2011


April 30, 2010(2)


Increase

(Decrease)Net Sales

$
40,049


$
39,020



2.6
%Gross Profit


23,303



22,373



4.2
%Gross Profit Margin %


58.2
%


57.3
%


1.6
%Commercial ExpensesSales and Marketing


8,528



9,200



(7.3
%)General and Administrative


6,854



6,286



9.0
%Research and Development


2,587



2,320



11.5
%Operating Income


5,334



4,567



16.8
%Operating Margin


13.3
%


11.7
%


13.7
%EBITDA (1)


6,618



9,258



(28.5
%)Net Income

$
3,596


$
4,728



(23.9
%)Earnings per share

$
0.14


$
0.19



(26.3
%)Return on equity (1)


7.8
%


11.8
%


(33.9
%)Return on assets (1)


5.1
%


8.3
%


(38.6
%)


_______


(1)
EBITDA, return on equity and return on assets are not financial measures recognized by U.S. GAAP.  EBITDA is defined as income before net interest expense, income taxes, depreciation and amortization.    Return on equity is defined as net income divided by average equity.  Return on assets is defined as net income plus interest expense divided by average assets.  See disclosure following regarding the use of non-GAAP financial measures.


(2)
In the three and nine months ended April 30, 2010, the Company experienced two one-time items:


(a)  gain from sale of product line to Stryker resulted in income of $893,000, net income of $566,000 and earnings per share of $0.02 and (b)  settlement proceeds from Alcon resulted in income of $2.4 million, net income of $1.5 million and earnings per share of $0.06.


17
 Index


Reconciliation of Non-GAAP Financial Measures





Three Months Ended

(Dollars in Thousands)


Nine Months Ended

(Dollars in Thousands)April 30,

2011


April 30,

2010


April 30,

2011


April 30,

2010EDITDA ReconciliationNet Income

$
1,643


$
3,309


$
3,596


$
4,728Interest


37



113



182



412Income taxes


809



1,909



1,528



2,667Depreciation and amortization


410



484



1,312



1,451EBITDA

$
2,899


$
5,815


$
6,618


$
9,256





Three Months Ended

(Dollars in Thousands)


Nine Months Ended

(Dollars in Thousands)April 30,

2011


April 30,

2010


April 30,

2011


April 30,

2010Return on Equity CalculationNet Income

$
1,643


$
3,309


$
3,596


$
4,728Average Equity:April 30, 2011

$
48,627






$
48,627January 31, 2011

$
46,621






$
46,621October 31, 2010









$
45,167July 31, 2010









$
44,226April 30, 2010





$
43,096






$
43,096January 31, 2010





$
39,708






$
39,708October 31, 2009













$
38,746July 31, 2009













$
38,130Average Equity

$
47,624


$
41,402


$
46,160


$
39,920Return on Equity


3.4
%


8.0
%


7.8
%


11.8
%




Three Months Ended

(Dollars in Thousands)


Nine Months Ended

(Dollars in Thousands)April 30,

2011


April 30,

2010


April 30,

2011


April 30,

2010Return on Assets CalculationNet Income

$
1,643


$
3,309


$
3,596


$
4,728Interest


37



113



182



412Net income + interest Expense

$
1,680


$
3,422


$
3,778


$
5,414Average Assets:April 30, 2011

$
74,181






$
74,181January 31, 2011

$
75,270






$
75,270October 31, 2010









$
74,143July 31, 2010









$
73,095April 30, 2011





$
75,085






$
75,085January 31, 2010





$
56,996






$
56,996October 31, 2009













$
56,737July 31, 2009













$
58,080Average Assets

$
74,726


$
66,041


$
73,806


$
61,725Return on Assets


2.2
%


5.2
%


5.1
%


8.3
%


18
 Index




Three Months Ended

(Dollars in Thousands)


Nine Months Ended

(Dollars in Thousands)April 30,

2011


April 30,

2010


April 30,

2011


April 30,

2010Table of Income and EPSIncome from Stryker gain (loss)

$
--


$
893


$
(99
)

$
817Income from Alcon settlement

$
--


$
2,398


$
--


$
2,398Income from Operations

$
2,452


$
1,927


$
5,223


$
4,180Total Income

$
2,452


$
5,218


$
5,124


$
7,395Effective Tax Rate


33.0
%


36.6
%


29.8
%


36.1
%Net Income from Stryker gain (loss)

$
--


$
566


$
(69
)

$
522Net income from Alcon settlement

$
--


$
1,521


$
--


$
1,533Net Income from Operations

$
1,643


$
1,222


$
3,665


$
2,673Total Net Income

$
1,643


$
3,309


$
3,596


$
4,728Average weighted shares outstanding


24,945,707



24,701,260



24,878,768



24,579,928Earnings per shares from Stryker gain (loss)

$
0.00


$
0.02


$
0.00


$
0.02Earnings per shares from Alcon settlement

$
0.00


$
0.06


$
0.00


$
0.06Net income from operations

$
0.07


$
0.05


$
0.14


$
0.11Total Earnings Per Share

$
0.07


$
0.13


$
0.14


$
0.19





We measure our performance primarily through our operating profit.  In addition to our consolidated financial statements presented in accordance with GAAP, management uses certain non-GAAP measures, including EBITDA, return on equity and return on assets, to measure our operating performance.  We provide a definition of the components of these measurements and a reconciliation to the most directly comparable GAAP financial measure.  In addition, there were two one-time events the Company experienced in fiscal 2010 which we believe needed to presented separately to accurate reflect the results of operations.





These non-GAAP measures are presented to enhance an understanding of our operating results and are not intended to represent cash flow or results of operations.  The use of these non-GAAP measures provides an indication of our ability to service debt and measure operating performance.  We believe these non-GAAP measures are useful in evaluating our operating performance compared to other companies in our industry. We believe these metrics are beneficial to investors, potential investors and other key stakeholders, including creditors who use this measure in their evaluation of our performance.





EBITDA, however, does have certain material limitations primarily due to the exclusion of certain amounts that are material to our results of operations, such as interest expense, income tax expense, depreciation and amortization.  Due to these limitations, EBITDA should not be considered a measure of discretionary cash available to us to invest in our business and should be utilized in conjunction with other information contained in our consolidated financial statements prepared in accordance with GAAP.


19
 Index


Results Overview





Product categories as a percentage of total sales were as follows:





Three Months EndedApril 30,

2011


April 30,

2010Ophthalmology


62.8
%


56.1
%Direct Neurosurgery


2.3
%


14.7
%Marketing Partners


15.4
%


13.1
%OEM


19.3
%


15.9
%Other


0.2
%


0.2
%Total


100.0
%


100.0
%





Nine Months EndedApril 30,

2011


April 30,

2010Ophthalmology


62.5
%


59.2
%Direct Neurosurgery


3.4
%


19.9
%Marketing Partners


15.7
%


5.8
%OEM


18.2
%


14.8
%Other


0.2
%


0.3
%Total


100.0
%


100.0
%





International revenues of $4.7 million, or 32.1 percent, of our total revenues for the three months ended April 30, 2011, as compared to $4.5 million, or 32.1 percent, as of the three months ended April 30, 2010. For the nine months ended April 30, 2011, international revenues were $12.1 million, or 30.3 percent, as compared to $12.4 million, or 31.7 percent, for the nine months ended April 30, 2010.  Many of the products we sell to our marketing partners and OEM customers are shipped to their non-U.S. customers in various countries around the world, but are included in our domestic revenues.





Our Business Strategy





The Company’s key strategy is to enhance shareholder value through profitable revenue growth in ophthalmology and neurosurgery markets. This is accomplished through the identification and development of reusable and disposable devices in conjunction with leading surgeons and marketing partners.  We are committed to establishing a strong operational infrastructure and financial foundation within which growth opportunities can be prudently evaluated, financed and implemented. We will remain vigilant and sensitive to new challenges which may arise from changes in the definition and delivery of appropriate healthcare in our fields of interest. In fiscal 2011, our strategic priorities are to drive the Company onto a higher growth trajectory and to continue to enhance the profitability of our operational platform by focusing on manufacturing efficiencies.





In fiscal 2011, we continue to be focused on the following strategies:





Improve Profitability and Cash Efficiency through:





Manufacturing Efficiencies





Lean Manufacturing — During the fiscal year ended July 31, 2010, we implemented lean manufacturing in virtually all of our disposable illumination and laser probe product lines. We restructured our production operations from a traditional departmental model into five value streams. Each value stream has a dedicated management team to support the production, technical and quality aspects of our products. Lean concepts were also implemented within select machining and instrument value streams with great success. We will continue to implement our lean initiative throughout the production value streams and expand into our accounting operations in fiscal 2011. We estimate that we realized approximately $1.4 million of direct labor cost savings from these initiatives during fiscal 2010 and $438,000 during the first nine months of fiscal 2011.  In addition, we have entered the phase in which we are conducting Kaizen events (Kaizen in Japanese means “change for the better”), which we anticipate will produce significant incremental cost savings.


20
 Index


Component Cost Savings — The Company’s most recent acquisition, Medimold, LLC, is producing plastic components which were previously supplied by outside vendors and realizing additional benefits related to the compression of time and costs in the new product development cycle.  We continue to save on the conversion of select high volume machined parts to injection molded, plastic parts. Our annual savings from these conversions was approximately $200,000 during fiscal year 2010 and 2011. In addition, the Company continues to pursue select outsourcing opportunities for high volume components.





Supply Chain Management — During fiscal 2009, the Company implemented Material Requirements Planning (“MRP”) in planning and controlling its production processes. The implementation of MRP helped reduce days of inventory on hand from 265 days at July 31, 2008 compared with 233 days at July 31, 2009 and 196 days at July 31, 2010. Days of inventory on hand increased to 222 days as of April 30, 2011 due to the Company’s preparation for new product launches and a decision to increase our domestic and international inventory to make sure customer demands are being fulfilled on a timely basis.  The Company is in the process of implementing a new Enterprise Resource Planning (“ERP”) System and is anticipated that it will be installed in the first quarter of fiscal 2012.





Human Resource Rationalization — Starting with a hiring freeze in October 2008 and ending with a reduction in force in July 2009 of approximately 40 people, including our direct neurosurgery sales force, the Company redeployed certain human resources and reduced the number of employees and temporary workers by 10.0 percent during fiscal 2009. These changes were made possible by the introduction of manufacturing efficiencies in certain product lines, the implementation of improvements in our enterprise-wide information system, the implementation of MRP and supply chain management and related consolidations, and the shift from direct sales of certain neurosurgery products in the U.S. to the sales of these same products through marketing partners. The hiring freeze has continued through the third quarter of fiscal 2011 and certain positions are only added based upon a specific resource need or a replacement hire. At April 30, 2011, our head count was 355 as compared with 356 at July 31, 2010. A fully staffed operation, including planned replacements, is approximately 360 employees.





Cash Management — The Company has been focused on its debt level which it reduced to $1.2 million as of April 30, 2011 and intends to continue to monitor its leverage by focusing on the reduction in days sales in accounts receivable and inventory. During the third quarter of fiscal 2011, the Company’s leverage ratio (defined as debt divided by debt plus total stockholders’ equity) was 2.4 percent, which was a decline from 8.4 percent as of July 31, 2010.





Accelerate Growth through:


Research & Development (“R&D”) —In order to focus resources on the most important projects, in October 2008, the Company completed a thorough review of its R&D efforts.  The process implemented at that time has led to a reduction in the number of active projects in the R&D pipeline to 27 at April 30, 2011. In addition, we developed a uniform policies and procedures manual for our top ten R&D initiatives. In July 2009, the Company reorganized its R&D resources into an advanced technology group which works on longer-term, highly complex R&D initiatives, a primary development group which works on strategically targeted products and a manufacturing engineering group which works on product line extensions. These three groups continue to focus on projects in both ophthalmology and neurosurgery. Additionally, the engineering team at the King of Prussia, Pennsylvania location has been strengthened to provide capacity for the development of new electrosurgery products.


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New Business Development —The Company’s core assets, including a history of customer driven innovation, quality differentiated products and an extensive distribution network, make it a logical component of value-creating business combinations. We continue to evaluate such potential opportunities that can expand the Company’s product offerings.


Assess Distribution Alternatives:


The Company competes in two distinct medical device markets, ophthalmology and neurosurgery. These markets are very different in terms of the number and size of the competitors in each and the size and maturity of their respective distribution networks. The Company has successfully effected the transition of the distribution of its neurosurgery products to its marketing partners.





Improve Sales Force Productivity:


The professionalism and productivity of the Company’s sales force is one of its  assets. Significant effort was made in the last fiscal year to align the incentives and promotional direction of the sales force with those of the Company. This change resulted in enhanced productivity during fiscal 2011.


In fiscal 2011, our driving strategic priorities are:





·
To move the Company onto a higher growth trajectory. This means, simply, new products, some in new categories. Our top four R&D projects will allow us access to different categories within the vitreoretinal and intracranial markets to drive organic growth, along with new business development opportunities that the Company is aggressively pursuing. We believe that this focus will revitalize the Company’s compound annual growth rate.





·
To continue to enhance the profitability of our operational platform by focusing on our manufacturing efficiencies, including lean manufacturing and select outsourcing of high quality components, and cost savings. In the third quarter of fiscal 2011, we enhanced our operating margins from 14.8 percent to 16.8 percent when compared to the third quarter of fiscal 2010.





New Product Sales





The Company’s business strategy has been, and is expected to continue to be, the development, manufacture and marketing of new technologies for microsurgery applications included in the ophthalmic and neurosurgical markets. New products, which management defines as products first available for sale within the prior 24-month period, accounted for approximately 11.9 percent of total sales for the Company for the nine months ended April 30, 2011, or approximately $4.8 million for the nine months ended April 30, 2011.  In order to focus resources on the most important projects, the Company completed a thorough review of its R&D efforts and reorganized these resources in fiscal 2009.  The Company currently has 27 active projects in its R&D pipeline, including a small core of significant projects.  Due to the advanced technical challenges presented by these core projects, it will take a longer time for a significant impact on revenue to come to fruition.





Demand Trends





The Company’s sales increased 2.6 percent during the first nine months of fiscal 2011 compared with the first nine months of fiscal 2010.  The two most significant factors impacting this increase were an additional $1.9 million in ophthalmology sales and a $1.5 million increase in OEM sales during the first nine months of fiscal 2011.  These increases were partially offset by a $2.4 million decrease in total neurosurgery sales due to the transition of the majority of our neurosurgery product sales to our marketing partners.  Overall sales of our capital equipment in the first nine months of fiscal 2011, including the sales of Omni® capital equipment, declined by $2.2 million, or 23.9 percent, compared with the first nine months of fiscal 2010.  However, the sales of our disposable products grew $2.7 million, or 9.1 percent, in the first nine months of fiscal 2011 as compared to the first nine months of fiscal 2010.


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A study performed by Market Scope LLC in February 2011 predicts a steady growth of 3.6 percent per year in vitrectomy surgery worldwide driven by an increase in the elderly population worldwide, an increase in the number of surgeons, an increase in the number of diseases treated with vitrectomy and an increase in frequency of diabetic complications due to the obesity epidemic.  Based upon this growth in procedures, sales of retinal surgical products are forecast to increase to $1.7 billion in 2016, reflecting a compound annual growth rate of 9.0 percent when compared to 2011.





Neurosurgical procedures on a global basis continue to rise at an estimated 2 to 3 percent growth rate driven by an aging global population, new technologies, advances in surgical techniques and a growing global market resulting from ongoing improvements in healthcare delivery in third world countries, among other factors.  Based upon this growth in procedures, sales of neurosurgical products are forecast to increase by 4 percent.





In addition, the demand for high quality, innovate products and new technologies consistent with the Company’s devices and disposables will continue to favorably impact procedure growth in the ophthalmic and neurosurgical markets.





Pricing Trends





The Company has generally been able to maintain the average selling prices for its products in the face of downward pressure in the healthcare industry. However, increased competition for the Company’s capital equipment market segments, in combination with customer budget constraints, capital scarcity and the transition of procedures to the ambulatory surgery center, has the potential to negatively impact the Company’s selling prices on these devices. The Company has no major domestic group purchasing agreements.





Economic Trends





Economic conditions may continue to negatively impact capital expenditures at the hospital or surgical center and physician level. Further, global economic conditions are negatively impacting the volume and average selling price of the Company’s capital equipment.


Results Overview





During the fiscal quarter ended April 30, 2011, the Company recorded net sales of $14.7 million, which generated $8.5 million in gross profit, operating income of $2.5 million and net income of approximately $1.6 million, or $0.07 earnings per share. The Company had $17.0 million in cash and $1.2 million in interest-bearing debt and revenue bonds as of April 30, 2011. Management anticipates that its available cash and cash flows from operations will be sufficient to meet working capital, capital expenditure and debt service needs for the next twelve months.


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Results of Operations





Three-Month Period Ended April 30, 2011 Compared to Three-Month Period Ended April 30, 2010





Net Sales





The following table presents net sales by category (dollars in thousands):








Quarter EndedApril 30, 2011


April 30, 2010


% Increase

(Decrease)Ophthalmic

$
9,226


$
7,776



18.6
%Direct Neurosurgery


339



2,038



(83.4
%)Marketing partners (Codman,Stryker)


2,256



1,818



24.1
%Total Neurosurgery


2,595



3,856



(32.7
%)OEM (Codman, Stryker, Iridex, Alcon)


2,840



2,195



29.4
%Other


34



32



6.3
%Total

$
14,695


$
13,859



6.0
%





Ophthalmic sales grew 18.6 percent in the third quarter of fiscal 2011 compared to the third quarter of fiscal 2010. Domestic and international ophthalmic sales increased 11.7 percent and 26.6 percent, respectively, primarily due to increased sales of disposable products.  Direct neurosurgery sales decreased $1.7 million, or 83.4 percent, to $339,000 in the third quarter of fiscal 2011 compared to the third quarter of fiscal 2010. This decline in neurosurgery sales was the result of the transition of the majority of our direct neurosurgery distribution to Codman and Stryker under marketing partner agreements.  Sales to our domestic marketing partners increased by $438,000 in the third quarter of fiscal 2011, partially offsetting the loss in direct neurosurgery sales. Total OEM rose 29.4 percent to $2.8 million (including $292,000 of deferred revenue recognized) compared with $2.2 million in the third quarter of fiscal 2010.





The increase in sales in the third quarter of fiscal 2011 compared with the third quarter of fiscal 2010 was primarily due to increased ophthalmic disposable, marketing partner and OEM sales.  Certain aspects of our capital equipment sales and the transition of our direct neurosurgery sales to our marketing partners partially offset these sales increases.  In the third quarter of fiscal 2010, the Company sold $187,000 of Omni® capital equipment, which was previously included in our direct neurosurgery sales and which the Company no longer sells.  Sales of capital equipment in the third quarter of fiscal 2011, including the sales of Omni® capital equipment, declined by $707,000, or 21.5 percent, compared with the third quarter of fiscal 2010.  However, the sales of our disposable products grew $1.3 million, or 11.8 percent, in the third quarter of fiscal 2011 as compared to the third fiscal quarter fiscal 2010.





The following table presents domestic and international net sales (dollars in thousands):





Three Months EndedApril 30, 2011


April 30, 2010


% Increase

(Decrease)Domestic (including Marketing Partner and OEM sales)

$
9,975


$
9,408



6.0
%International  (including Canada)


4,720



4,451



6.0
%Total

$
14,695


$
13,859



6.0
%





Domestic sales increased 6.0 percent due to increases in ophthalmic, OEM and marketing partner sales which are all, except for ophthalmic, recorded as domestic sales.  International sales increased 6.0 percent as the increase in international ophthalmology sales of 26.6 percent offset the decline in international neurosurgery sales due to the shift in sales from direct international neurosurgery sales to our marketing partners as these sales are included in domestic revenue.


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Gross Profit





Gross profit as a percentage of net sales was 58.2 percent in the third quarter of fiscal 2011, compared to 57.9 percent for the same period in fiscal 2010.  Gross profit as a percentage of net sales for the third quarter of fiscal 2011 compared to the third quarter of fiscal 2010 increased 0.3 percentage points due to the impact of the improved margins on our ophthalmology products and the recognition of deferred revenue from our OEM partners, partially offset by the margin impact of the transition of the majority of our direct neurosurgery sales to our marketing partners.  The Company continues to realize incremental savings from the lean manufacturing initiative and continues to develop our internal resources to expand the initiative throughout the entire organization.





Operating Expenses





R&D expenses as a percentage of net sales was 6.0 percent and 6.4 percent for the third quarter of fiscal 2011 and 2010, respectively. R&D costs remained flat in the third quarter of fiscal 2011 compared to the same period in fiscal 2010.  The Company’s pipeline included approximately 27 active projects in various stages of completion as of April 30, 2011.  The Company’s R&D investment is driven by the opportunities to develop new products to meet the needs of its customers, and reflecting the need to keep such spending in line with what the Company can afford to spend, results in an investment rate that the Company believes is comparable to such spending by other medical device companies.  The Company expects over the next few years to invest in R&D at a rate of approximately 5 to 7 percent of net sales.





Sales and marketing expenses decreased by approximately $125,000 to $2.8 million, or 18.9 percent of net sales, for the third fiscal quarter of 2011, compared to $2.9 million, or 20.9 percent of net sales, for the third fiscal quarter of 2010. The decrease in sales and marketing expenses as a percentage of net sales was primarily due to the elimination of our neurosurgery sales force as of July 31, 2009.





General and administrative expenses increased by approximately $223,000 to $2.4 million, or 16.5 percent of net sales, in the third fiscal quarter of 2011, compared to $2.2 million, or 15.9 percent of net sales, for the third fiscal quarter of 2010. The increase in general and administrative expenses as a percentage of net sales was primarily due to additional employees required to manage the implementation our lean manufacturing and quality improvement initiatives.





Other Income/(Expenses)





Other expense for the third quarter of fiscal 2011 increased to $15,000 compared to an income of $3.2 million for the third quarter of fiscal 2010.  The increase in other expenses was primarily due to the one-time gains recorded in the third quarter of fiscal 2010. In the three months ended April 30, 2010, the Company experienced two one-time items:  a gain from the sale of product line to Stryker resulted in income of $893,000 and a settlement with Alcon resulted in income of $2.4 million.





Operating Income, Income Taxes and Net Income





Operating income for the third quarter of fiscal 2011 was up $422,000 to $2.5 million, as compared to the comparable 2010 fiscal period. The higher operating income was primarily the result of a 6.0 percent increase in sales (including $292,000 in deferred revenue) and a 4.3 percent decrease in sales and marketing expense, partially offset by a 5.5 percent increase in cost of sales and a 10.1 percent increase in general and administrative expenses.





The Company recorded a $809,000 tax provision on pre-tax income of $2.5 million, a 33.0 percent tax provision, in the quarter ended April 30, 2011.  In the quarter ended April 30, 2010, the Company recorded a $1.9 million tax provision on pre-tax income of $5.2 million, a 36.6 percent tax provision.  The decrease in the effective tax rate was primarily due to the higher level of net income recorded in the third quarter of fiscal 2010 resulting from the two one-time items:  a gain from the sale of product line to Stryker and a settlement with Alcon.


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Net income decreased by $1.7 million to $1.6 million for the third quarter of fiscal 2011, from $3.3 million for the same period in fiscal 2010. The decrease in net income was primarily from the two one-time items which were recognized in the third quarter of fiscal 2010.  Basic and diluted earnings per share for the third quarter of fiscal 2011 decreased to $0.07 from $0.13 for the third quarter of fiscal 2010.  Basic weighted average shares outstanding increased from 24,701,260 at April 30, 2010, to 24,945,707 at April 30, 2011.





Nine-Month Period Ended April 30, 2011 Compared to Nine-Month Period Ended April 30, 2010





Net Sales





The following table presents net sales by category (dollars in thousands):





Nine Months EndedApril 30, 2011


April 30, 2010


% Increase

(Decrease)Ophthalmic

$
25,038


$
23,100



8.4
%Direct Neurosurgery


1,383



7,767



(82.2
%)Marketing partners (Codman,Stryker)


6,268



2,280



174.9
%Total Neurosurgery


7,651



10,047



(23.9
%)OEM (Codman, Stryker, Iridex, Alcon)


7,289



5,776



26.2
%Other


71



97



(26.8
%)Total

$
40,049


$
39,020



2.6
%





Ophthalmic sales grew 8.4 percent in the first nine months of fiscal 2011 compared to the first nine months of fiscal 2010. Domestic and international ophthalmic sales increased 1.7 percent and 17.3 percent, respectively, due to the increase in disposable sales.  Neurosurgery sales decreased $2.4 million, or 23.9 percent, to $7.7 million in the first nine months of fiscal 2011 compared the first nine months of fiscal 2010. This decline in neurosurgery sales was the result of the transition of the majority of our direct neurosurgery distribution to Codman and Stryker under marketing partner agreements.  Sales to our domestic marketing partners increased $4.0 million in the first nine months of fiscal 2011. Total OEM sales rose 26.2 percent to $7.3 million (including $587,000 of deferred revenue recognized) compared with $5.8 million in the first nine months of fiscal 2010.





The increase in sales in the first nine months of fiscal 2011 compared with the first nine months of fiscal 2010 was primarily due to increased ophthalmic disposables, marketing partner and OEM sales.  Certain aspects of our capital equipment sales and the transition of our direct neurosurgery sales to our marketing partners partially offset the sales increase.  In the first nine months of fiscal 2010, the Company sold $1.1 million of Omni® capital equipment, which was previously included in our direct neurosurgery sales and which the Company no longer sells.  Sales of capital equipment in the first nine months of fiscal 2011 declined by $2.2 million, or 23.9 percent, compared with the first nine months of fiscal 2010.  However, the sales of our disposable products grew $2.7 million, or 9.1 percent, in the first nine months of fiscal 2011 as compared to the first nine months of fiscal 2010.





The following table presents domestic and international net sales (dollars in thousands):





Nine Months EndedApril 30, 2011


April 30, 2010


% Increase

(Decrease)Domestic (including Marketing Partner and OEM sales)

$
27,929


$
26,648



4.8
%International  (including Canada)


12,120



12,372



(2.0
%)Total

$
40,049


$
39,020



2.6
%


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Domestic sales increased 4.8 percent due to increases in ophthalmic disposables, marketing partner and OEM sales which are all, except for ophthalmic, recorded as domestic sales.  The decline in international sales was due to the shift in sales from direct international neurosurgery sales to our marketing partners as these sales are included in domestic revenue.





Gross Profit





Gross profit as a percentage of net sales was 58.2 percent for the first nine months of fiscal 2011, compared to 57.3 percent for the same period in fiscal 2010.  Gross profit as a percentage of net sales for the first nine months of fiscal 2011 compared to the first nine months of fiscal 2010 increased 0.9 percentage points, due to the impact of the improved margins on our ophthalmology products and the recognition of deferred revenue from our OEM partners, partially offset by the margin impact of the transition of the majority of our direct neurosurgery sales to our marketing partners, inefficiencies associated with production of new products and the impact of winter weather.  The Company continues to realize incremental savings from the lean manufacturing initiative and continues to develop our internal resources to expand the lean initiative throughout the entire organization.





Operating Expenses





R&D expenses as a percentage of net sales were 6.5 percent and 5.9 percent for the first nine months of fiscal 2011 and 2010, respectively. R&D costs increased by $267,000 in the first nine months of fiscal 2011 compared to the same period in fiscal 2010.  The increase was due primarily to the direct costs of new products in the Company’s development pipeline.  The Company’s pipeline included approximately 27 active projects in various stages of completion as of April 30, 2011.  The Company’s R&D investment is driven by the opportunities to develop new products to meet the needs of its customers, and reflecting the need to keep such spending in line with what the Company can afford to spend, results in an investment rate that the Company believes is comparable to such spending by other medical device companies.  The Company expects over the next few years to invest in R&D at a rate of approximately 5 to 7 percent of net sales.





Sales and marketing expenses decreased by approximately $672,000 to $8.5 million, or 21.3 percent of net sales, for the first nine months of fiscal 2011, compared to $9.2 million, or 23.6 percent of net sales, for the first nine months of fiscal 2010. The decrease in sales and marketing expenses as a percentage of net sales was primarily due to the elimination of our neurosurgery sales force as of July 31, 2009.





General and administrative expenses increased by approximately $568,000 to $6.9 million, or 9.0 percent of net sales, in the first nine months of fiscal 2011, compared to $6.3 million, or 16.1 percent of net sales, for the first nine months of fiscal 2010. The increase in general and administrative expenses as a percentage of net sales was primarily due to additional employees required to manage the implementation our lean manufacturing and quality improvement initiatives.





Other Income/(Expenses)





Other expense for the first nine months of fiscal 2011 increased to $210,000 compared to an income of $2.8 million for the first nine months of fiscal 2010.  The decrease in other income was primarily due to the one-time gains recorded in the third quarter of fiscal 2010. In the three months ended April 30, 2010, the Company experienced two one-time items:  a gain from the sale of product line to Stryker resulting in income of $817,000 and a settlement with Alcon resulting in income of $2.4 million.





Operating Income, Income Taxes and Net Income





Operating income for the first nine months of fiscal 2011 increased $767,000 to $5.3 million, as compared to the comparable 2010 fiscal period. The higher operating income was primarily the result of a 2.6 percent increase in sales (including $587,000 in deferred revenue), a 7.3 percent decrease in sales and marketing expense, partially offset by an 11.5 percent increase in R&D and a 9.0 percent increase in general and administrative expenses.


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The Company recorded a $1.5 million tax provision on pre-tax income of $5.1 million, a 29.8 percent tax provision, in the nine months ended April 30, 2011.  In the nine months ended April 30, 2010, the Company recorded a $2.7 million tax provision on pre-tax income of $7.4 million, a 36.1 percent tax provision.  The decrease in the effective tax rate was primarily due to approximately $100,000 of R&D tax credit as this credit was re-enacted during the second quarter of fiscal 2011.  The increase in the R&D credit was for the period that the credit was expired (i.e. from January 1, 2010 through July 31, 2010) and the Company could not accrue the benefits the credit afforded.





Net income decreased by $1.1 million to $3.6 million for the first nine months of fiscal 2011, from $4.7 million for the same period in fiscal 2010. The decrease in net income was primarily from the two one-time items which were recognized in the third quarter of fiscal 2010.  Basic and diluted earnings per share for the first nine months of fiscal 2011 decreased to $0.14 from $0.19 for the first nine months of fiscal 2010.  Basic weighted average shares outstanding increased from 24,579,928 at April 30, 2010, to 24,878,768 at April 30, 2011.





Liquidity and Capital Resources





The Company had approximately $17.0 million in cash and $1.2 million in interest-bearing debt as of April 30, 2011.





Working capital, including the management of inventory and accounts receivable, is a key management focus. At April 30, 2011, the Company had an average of 64 days of sales outstanding utilizing the trailing twelve months’ sales for the period ended April 30, 2011. The 64 days of sales outstanding at April 30, 2011, was 1 day unfavorable to July 31, 2010, and flat when compared to April 30, 2010, utilizing the trailing twelve months of sales.





At April 30, 2011, the Company had 222 days of average cost of sales in inventory on hand utilizing the trailing twelve months’ cost of sales for the period ended April 30, 2011.  The 222 days of cost of sales in inventory was unfavorable to July 31, 2010, by 26 days and 17 days unfavorable to April 30, 2010, utilizing the trailing twelve months of cost of sales. Days of inventory on hand increased to 222 days as of April 30, 2011 due to the Company’s preparation for new product launches and a decision to increase our domestic and international inventory to make sure customer demands are being fulfilled on a timely basis.





Cash flows provided by operating activities were $2.6 million for the nine months ended April 30, 2011, compared to cash flows provided by operating activities of approximately $24.0 million for the comparable fiscal 2010 period. The decrease of $21.4 million was primarily attributable to the net decrease in deferred revenue of $19.0 million.  In addition, inventory, prepaid expenses, accounts payable, income taxes payable and other decreased $6.2 million during the first nine months of fiscal 2011, partially offset by increases in gain on sale of the product line to Stryker, deferred income taxes, net receivables, accrued expenses and other by approximately $3.8 million.





Cash flows used by investing activities were $1.7 million for the nine months ended April 30, 2011, compared to cash provided by investing activities of $611,000 for the comparable fiscal 2010 period. During the nine months ended April 30, 2011, cash additions to property and equipment were $1.5 million, compared to $594,000 during the nine months ended April 30, 2010. The additions to property and equipment were primarily an investment in the Company’s new ERP system and investments in equipment necessary to keep up with the growing disposable sales demand.  Cash additions from the gain on sale of the product line to Stryker for the first nine months of fiscal 2011 declined $1.3 million, as this is a one-time event which the Company experienced in 2010.





Cash flows used in financing activities were $2.5 million for the nine months ended April 30, 2011, compared to cash used in financing activities of $7.3 million for the nine months ended April 30, 2010. The decrease of $4.8 million was attributable primarily to a decrease in the balance of net borrowings on the line of credit of $5.0 million.


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The Company had the following committed financing arrangements as of April 30, 2011, but had no borrowings thereunder:





Revolving Credit Facility:  The Company has a credit facility with a bank which allows for borrowings of up to $9.5 million with interest at an interest rate based on either the one-, two- or three-month LIBOR plus 2.00 percent and adjusting each quarter based upon our leverage ratio. As of April 30, 2011, interest under the facility was charged at 2.21 percent. The unused portion of the facility is charged at a rate of 0.20 percent. There were no borrowings under this facility at April 30, 2011. Outstanding amounts, if any, are collateralized by the Company’s domestic receivables and inventory. This credit facility was amended on November 30, 2010, to extend the termination date through November 30, 2011.





The facility has two financial covenants:  a maximum leverage ratio of 3.75 times and a minimum fixed charge coverage ratio of 1.1 times. As of April 30, 2011, the Company’s leverage ratio was 1.02 times and the minimum fixed charge coverage ratio was 3.17 times. Collateral availability under the line as of April 30, 2011, was approximately $7.3 million. The facility restricts the payment of dividends if, following the distribution, the fixed charge coverage ratio would fall below the required minimum.





Equipment Line of Credit:   Under this credit facility, the Company may borrow up to $1.0 million, with interest currently at one-month LIBOR plus 3.0 percent. Under no circumstance shall the rate be less than 3.5 percent per annum. The unused portion of the facility is not charged a fee. There were no borrowings under this facility as of April 30, 2011. The equipment line of credit was amended on November 30, 2010, to extend the maturity date to November 30, 2011.





Management believes that cash flows from operations, together with available cash, will be sufficient to meet the Company’s working capital (including taxes due on the Alcon settlement), capital expenditure, and debt service needs for the next twelve months.





STATEMENT REGARDING FORWARD-LOOKING INFORMATION





The Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), provide a safe harbor for forward-looking statements made by or on behalf of the Company. The Company and its representatives may from time to time make written or oral statements that are “forward-looking,” including statements contained in this report and other filings with the Securities and Exchange Commission (“SEC”) and in our reports to stockholders. In some cases forward-looking statements can be identified by words such as “believe,” “expect,” “anticipate,” “plan,” “potential,” “continue” or similar expressions. Such forward-looking statements include risks and uncertainties and there are important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These factors, risks and uncertainties can be found in Part I, Item 1A, “Risk Factors” section of the Company’s Form 10-K for the fiscal year ended July 31, 2010.





Although we believe the expectations reflected in our forward-looking statements are based upon reasonable assumptions, it is not possible to foresee or identify all factors that could have a material effect on the future financial performance of the Company. The forward-looking statements in this report are made on the basis of management’s assumptions and analyses, as of the time the statements are made, in light of their experience and perception of historical conditions, expected future developments and other factors believed to be appropriate under the circumstances.





In addition, certain market data and other statistical information used throughout this report are based on independent industry publications. Although we believe these sources to be reliable, we have not independently verified the information and cannot guarantee the accuracy and completeness of such sources.





Except as otherwise required by the federal securities laws, we disclaim any obligation or undertaking to publicly release any updates or revisions to any forward-looking statement contained in this quarterly report on Form 10-Q and the information incorporated by reference in this report to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based.


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Critical Accounting Policies





The Company’s significant accounting policies which require management’s judgment are disclosed in our Annual Report on Form 10-K for the year ended July 31, 2010.  In the first nine months of fiscal 2011, there were no changes to the significant accounting policies.





Item 3 — Quantitativeand Qualitative Disclosures about Market Risk





The Company’s primary market risks include fluctuations in interest rates and exchange rate variability.





The Company has $17.0 million in cash and cash equivalents with a substantial portion of this cash held in short-term money market funds bearing interest at 70 basis points. Interest income from these funds is subject to market risk in the form of fluctuations in interest rates. A reduction in the interest on these funds to 35 basis points would decrease the amount of interest income from these funds by approximately $60,000.





The Company currently has a revolving credit facility and an equipment line of credit facility in place. The revolving credit facility had no outstanding balance at April 30, 2011, bearing interest at a current rate of LIBOR plus 2.0 percent. The equipment line of credit facility had no outstanding balance at April 30, 2011, bearing interest at one-month LIBOR plus 3.0 percent. Interest expense from these credit facilities is subject to market risk in the form of fluctuations in interest rates. Because the current levels of borrowings are zero, there is no market risk associated with the interest rates. The Company does not perform any interest rate hedging activities related to these facilities.





Additionally, the Company has exposure to non-U.S. currency fluctuations through export sales to international accounts. As only approximately 5.0 percent of our sales revenue is denominated in non-U.S. currencies, we estimate that a change in the relative strength of the dollar to non-U.S. currencies would not have a material impact on the Company’s results of operations. The Company does not conduct any hedging activities related to non-U.S. currency.





Item 4 — Controls and Procedures





Evaluation of Disclosure Controls and Procedures





Our management, under the supervision and with the participation of our CEO and CFO, has reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures as of April 30, 2011. Based on such review and evaluation, our CEO and CFO have concluded that, as of April 30, 2011, the disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, (a) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (b) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.





Changes in Internal Control over Financial Reporting





During the fiscal quarter ended April 30, 2011, there was no change in the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.


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PartII — Other Information





Item 1 — Legal Proceedings





From time to time, we may become subject to litigation claims that may greatly exceed our liability insurance limits.  An adverse outcome of such litigation may adversely impact our financial condition or liquidity.  We record a liability when a loss is known or considered probable and the amount can be reasonably estimated.  If a loss is not probable, a liability is not recorded.  As of April 30, 2011, the Company has no litigation reserve recorded.





Item 1A — Risk Factors





The Company’s business is subject to certain risks and events that, if they occur, could adversely affect our financial condition and results of operations and the trading price of our common stock. For a discussion of these risks, please refer to the “Risk Factors” section of the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2010. In connection with its preparation of this quarterly report, management has reviewed and considered these risk factors and has determined that there have been no material changes to the Company’s risk factors since the date of filing the Annual Report on Form 10-K for the fiscal year ended July 31, 2010.





Item 2 — Unregistered Sales of Equity Securitiesand Use of Proceeds





None





Item 3 — Defaults Upon Senior Securities





None





Item 4 — [Removed and Reserved]





Item 5 — Other Information





(a)
None.


(b)
There have been no material changes to the procedures by which security holders may recommend nominees to the Company’s Board of Directors since the filing of the Company’s Quarterly Report on Form 10-Q for the quarter ended January 31, 2011.





Item 6 — Exhibits





Exhibit No.

Description31.1

Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2

Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1

Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2

Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


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TrademarkAcknowledgements





Malis, the Malis waveform logo, Bident, Bi-Safe, Gentle Gel and Finest Energy Source for Surgery are our registered trademarks. Synergetics, the Synergetics’ logo, PHOTON, DualWave, COAG, Advantage, Microserrated, Microfiber, Solution, Tru-Micro, DDMS, Kryptonite, Diamond Black, Bullseye, Pinnacle 360°, Directional, Tru-Curve, Axcess, Veritas, VersaPACK, Lumen and Lumenator product names are our trademarks. All other trademarks or tradenames appearing in this Quarterly Report on Form 10-Q are the property of their respective owners.


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SIGNATURES





Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.





SYNERGETICS USA, INC.(Registrant)June 7, 2011
/s/David M. HableDavid M. Hable, President and

Chief Executive Officer

(Principal Executive Officer)June 7, 2011
/s/ Pamela G. BoonePamela G. Boone, Executive VicePresident, Chief Financial Officer, Secretaryand Treasurer (Principal Financial andPrincipal Accounting Officer)






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