Re:
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Responses to Comments on Neoprobe Corporation Form 10-KSB for the year ended December 31, 2006 Filed March 16, 2007 Neoprobe Corporation Form 10-QSB for the quarter ended June 30, 2007 Filed August 9, 2007 File No. 000-26520 |
| 1. | Comment: We note your statement that your Chief Executive Officer and Chief Financial
Officer have “concluded that [your] disclosure controls and procedures are adequately designed
to ensure that information required to be disclosed by [you] in the reports that you file or
submit under the Securities Exchange Act of 1934 .” It does not appear that your certifying
officers have reached a conclusion that your disclosure controls and procedures are effective.
Please confirm to us that your controls and procedures are effective and that you will revise
future filings including interim filings to address your officers’ conclusions regarding the
effectiveness of your disclosure controls and procedures. |
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| Response: We have concluded that our disclosure controls and procedures, in addition to being adequately designed, are effective to provide reasonable assurance that the stated objectives are met. We will revise our disclosure related to Item 8A in future filings, starting with our upcoming Form 10-QSB for the quarter ended September 30, 2007, to include a statement regarding our conclusion as such. |
| 2. | Comment: We note that you capitalized certain inventory costs associated with your
Lymphoseek product prior to regulatory approval and product launch, based on management’s
judgment of probable future commercial use and net realizable value. Please explain to us how
the capitalization of certain costs associated with the Lymphoseek product is appropriate.
Tell us the amount capitalized in fiscal year 2005. Cite the accounting literature upon which
you relied upon. Refer to the definition of inventory in ARB 43, chapter 4 in your response. |
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| Response: Manufacturing radiopharmaceuticals such as Lymphoseek is difficult and complex,
and requires facilities specifically designed and validated to perform sterile
pharmaceutical production processes. The manufacture of radiopharmaceuticals also requires
developing and maintaining a process to reliably manufacture and formulate the product at
an appropriate scale, obtaining regulatory approval to manufacture the product, and is
subject to changes in regulatory requirements or standards that may require modifications
to the manufacturing process. As such, the process of developing and maintaining
commercial radiopharmaceutical production capacity is often lengthy and very costly. |
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| The manufacture of Lymphoseek involves two primary stages. First, a production lot of the
basic chemical compound that makes the drug “work” (i.e., the active pharmaceutical
ingredient or API) is manufactured in a bulk powder form. Second, the API is “mixed” into
a liquid form and filled into vials which are then lyophilized (i.e., freeze dried) in
batch sizes of several thousand vials per batch. The vials are then ready to be packaged
and shipped to specialized nuclear pharmacy distribution locations where the drug can be
reconstituted (i.e., made into liquid form), made radioactive and prepared for individual
patient dose administration. We will be required to complete three production lots of the
bulk API and process three batches of commercial-grade lyophilized finished vials prior to
filing for regulatory approval with FDA. A single production lot of API will support
multiple vialing and lyophilization batches. In completing the three API production lots
and three vialing batches required to obtain regulatory approval, we anticipate incurring
significant costs and producing several thousands of vials of finished drug product more
than will be required to obtain regulatory approval. We believe these vials will
ultimately be saleable based on current production validation activities and shelf-life
stability studies completed to-date. |
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| Thus far, we have manufactured all three of the required lots of API and completed two of
the three vialing and filling production runs. We have expensed those portions of the
production costs for lots of API and finished vials that we estimate will be used in the
clinical development, product validation and stability processes. The Lymphoseek
production costs that have been capitalized as inventory include only the direct
out-of-pocket costs paid to contract manufacturers to produce API and vial finished
lyophilized product that we estimate will ultimately be recoverable from the sale of
Lymphoseek. As of December 31, 2005, we had capitalized no inventory costs related to our
Lymphoseek product. |
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| We have recently completed a Phase 2 clinical trial for Lymphoseek in 80 patients with positive efficacy results and have met with the FDA and reached consensus on the design of two pivotal Phase 3 clinical trials necessary to obtain approval to market the drug. We believe the positive efficacy of Lymphoseek as evidenced by the successful completion of the Phase 2 clinical trial, coupled with the product manufacturing validation and stability results achieved thus far, support the management’s assertion that the API and finished |
| 3. | Comment: We note that you have a distribution arrangement with Ethicon Endo-Surgery, Inc.
(EES). Please explain and expand future filings to describe this arrangement in greater
detail. For example, please describe any discounts; return policies; post shipment
obligations; customer acceptance; warranties; price protection or similar privileges and how
these impact your revenue recognition. Also, tell us more about the “retroactive annual
adjustments” and your accounting. Demonstrate that your policies are SAB 104 and SFAS 48
compliant. |
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| Response: Neoprobe’s distribution agreement with EES does not include any discount provisions, other than reduced pricing on sales of demonstration units (see response to Comment 4 below). No early payment discounts or other discounts are available in the ordinary course of business. Also, as we discuss in Note 1.i.(1), paragraph 1, ”Our customers generally have no right to return products purchased in the ordinary course of business.” This policy applies to all of our customers, including EES (who accounted for 84% and 92% of our sales in 2006 and 2005, respectively). No customer acceptance provisions are included in the distribution arrangement with EES. As such, we believe that SFAS 48 is generally not applicable to our business. In the unlikely event that we would grant return privileges to a customer related to a specific sale, we would defer the revenue from the sale until we have determined that the revenue has been earned in accordance with SFAS 48 and SAB 104. As to post-shipment obligations, we believe we are obligated only with respect to the original warranty obligation associated with the sale of our device unless extended service is purchased under a separate agreement that is recognized ratably over the life of the agreement. We believe that such activities are inconsequential and perfunctory according to the guidance set forth in SAB 104 (a definitive arrangement exists, delivery has occurred, the seller’s price is determinable based on the contractual terms and collectability is reasonably assured). |
| 4. | Comment: Please explain in greater detail your policy with respect to the demonstration
equipment. Explain the contractual terms under which it has been loaned; and provide the
amount of demonstration equipment sold in each period presented in the most recent 10-KSB and
10-QSB. We assume that these were sold at lower margins than other equipment. If so, please
revise future MD&A to discuss if they have any material impact on gross margins. |
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| Response: Neoprobe has entered into agreements with several third-party distributors
related to the distribution of our gamma detection and blood flow measurement medical
devices. Under some of these arrangements, we have agreed to sell products to be used as
demonstration equipment by the distributors’ sales associates at a discounted price. The
discounted price is generally calculated as our fully-burdened cost plus a fixed percentage
as stated in each agreement. Note 1.i.(1), paragraph 3, currently states, “We recognize
revenue related to the sales of products to be used for demonstration units when products
are shipped and the earnings process has been completed. Our distribution agreements do
not permit return of purchased demonstration units in the ordinary course of business nor
do we have any performance obligations other than normal product warranty obligations.”
Revenue related to sales of demonstration equipment is recognized in the same manner as
described in our response to Comment 3 above. |
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| Under other distribution agreements, related only to our developing blood flow measurement
device line of business, we have retained ownership of demonstration units placed with
distributors’ representatives on a temporary basis. In such cases, we have transferred the
units’ cost to fixed assets and are depreciating the costs related to these units over the
expected useful life of the asset as a demonstration device. |
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| In 2006 and 2005, sales of demonstration units represented 0.7% ($43,000) and 0.0% ($0) of our total sales and had no material impact on our gross margins in either period. During the three-month and six-month periods ended June 30, 2007, sales of demonstration units represented 7.5% ($114,000) and 6.5% ($212,000) of our sales, |
| 5. | Comment: We note the disclosure on page F-18 that warrants issued to investors were valued
using a third-party valuation firm. While in future filings management may elect to take full
responsibility for valuing the equity instruments, if you choose to continue to refer to the
expert in any capacity, please revise future filings, beginning with your next 10-QSB, to name
the independent valuation firm. In addition, please note that if you intend to incorporate
your Form 10-KSB by reference into any registration statement you will be required to include
the consent of the independent valuation firm as an exhibit to the registration statement. |
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| Response: Management will revise our disclosure in our upcoming 10-QSB for the period ended September 30, 2007 to take full responsibility for valuing the equity instruments. |
| 6. | Comment: We note that in November 2006 you amended and modified key terms of your notes,
whereby cancelling and replacing the notes that were previously issued. It appears that the
note was modified and amended, but not cancelled. Please confirm that the debt was modified in
November 2006 and revise the disclosure in your future filings. Otherwise, please explain to
us how the remainder of the debt discounts in connection with the conversion feature and the
warrants was accounted upon the cancellation of the debt. Please refer the accounting
literature which you relied upon. |
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| Response: The disclosure in paragraph 5 of Note 6 currently reads: “In November 2006, we
amended the Agreement and modified several of the key terms in the related notes. The
original notes were thereby cancelled and replacement notes were issued to the
noteholders which bear interest . . .”. While our disclosure uses the term “cancelled”,
our intent was to indicate that the original physical note documents themselves were
cancelled and replaced with new physical documents embodying the new terms rather than
implying the underlying debt obligation itself was cancelled. |
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| In reviewing our accounting treatment for the transaction in question, we had determined that the net present value of the cash flows resulting from the new terms of the convertible debt instruments were less than 10% different from the net present values of the cash flows resulting from the original transaction and therefore the terms of the new obligation were not “substantially different” than the terms of the original obligation, as defined by EITF 96-19. We will revise our terminology in the Form 10-KSB to be filed for the year ending December 31, 2007 to more clearly describe the substance of our accounting treatment for this transaction. |
| 7. | Comment: We note that you issued various warrants under Series Q, R and S. Please tell us
and revise future filings to disclose the major terms of each series in greater detail, and
how you valued and accounted for them. We also note herein and elsewhere in the filing that
you reclassified the liability related to the warrants to equity in fiscal year 2005. Please
explain how the reclassification as equity is appropriate. Cite accounting literature upon
which you relied. |
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| Response: The Q, R, and S warrants about which you are inquiring were issued in 2003 and
2004. The major terms and valuation methods of warrants issued were disclosed in filings
that included the periods in which the warrants were issued and affected operating results.
In subsequent filings that do not reflect the issuance of or include operating results for
the periods affected by the warrants, we have disclosed, as required, the balance of the
warrants outstanding, exercise price, etc. We do not believe that continuing to disclose
valuation details of each series of warrants subsequent to periods in which they were issued or affected operating results is required, nor do we believe it
would it be useful to the readers of our financial statements and could possibly be
confusing. |
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| We have valued all warrants we have issued using the Black-Scholes valuation model as
permitted and/or recommended by the relevant accounting guidance governing such issuances
as of the date of those issuances. All of the warrants in Series Q, R or S were classified
as equity upon issuance as they are indexed to the company’s own stock and therefore
classified as equity under EITF 00-19. |
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| Warrants in Series T and U were issued in connection with our December 2004 placement of convertible promissory notes. In accordance with SFAS 133, the value of these warrants was initially classified as a liability due to penalty provisions contained in the purchase agreement under which the notes and warrants were issued dealing with the investors’ registration rights for the shares issuable on conversion of the notes or exercise of the warrants. As a result, the warrants were considered a derivative instrument that were required to be periodically “marked to market” on our consolidated balance sheet. In February 2005, Neoprobe and the investors confirmed in writing their intention that the penalty provisions which led to this accounting treatment were intended to apply only to the shares issuable on conversion of the notes and not to shares issuable on exercise of the warrants. Since this clarification removed the issue of whether there was a penalty associated with the warrants, which had originally led to their classification as a liability, the estimated fair value of the warrant liability was therefore reclassified to additional paid-in capital during the first quarter of 2005. |
| 8. | Comment: We note that you entered into a common stock purchase agreement with Fusion Capital
Fund II, LLC and issued 720,000 shares of common stock as an initial commitment fee in
December 2006. We also note that you issued additional 6,000 shares of your common stock as
additional commitment fees during 2006. Please explain to us how you valued and accounted for
the common stocks issued as commitment fees citing accounting literature you relied upon. |
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| Response: The initial commitment fee of 720,000 shares of our common stock that was issued in December 2006 was valued at the market price for our stock on the date of issuance ($0.25 per share). In accordance with SAB Topic 5A, $180,000 related to this issuance of our common stock as the initial commitment fee was recorded as a current asset (i.e., deferred stock offering costs) to be netted against future proceeds from sales of common stock under the Fusion agreement. All deferred stock offering costs related to the Fusion agreement were netted against proceeds from sales under the agreement by the end of April 2007. |
| 9. | Comment: We note that you are obligated to pay royalties to the Government of Israel on the
sale of products up to 300% of the total grant received from the Office of Chief Scientist.
Please explain what you mean when you state that “if the Israeli content of your blood flow
device products decrease below 10%”, your total royalty payments could increase to $2.3
million. Explain your accounting in greater detail and demonstrate whether and how it complies
with SFAS 5. |
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| Response: Our understanding is that current Israeli law with respect to research and development funded by the Office of the Chief Scientist (OCS) requires that a royalty be paid to the OCS with respect to sales of products developed using funding received from the OCS. The royalty is based on a percentage of revenue derived from products developed using such funding. The percentage rate of the royalty varies depending on the amount of the “Israeli content” of the product manufactured in Israel and is described in the following table: |
If the “Israeli content”
of a product is between: |
The royalty
percentage to be paid on revenue derived is: |
The total amount to
be repaid to the OCS |
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50% and 100%
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3 | % | 120% of the amount
of the grant (~$930,000) |
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>10% but less than 50%
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4 | % | 150% of the amount
of the grant (~$1.2 million) |
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<10%
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5 | % | 300% of the granted amount (~$2.3 million) |
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| • | it is responsible for the adequacy and accuracy of the disclosure in the filings; | ||
| • | staff comments or changes to disclosure in response to staff comments do not foreclose the Commission from taking any action with respect to the filings; and | ||
| • | the company may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States. |
Cc:
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Martin James Andri Boerman |