CHEMBIO DIAGNOSTICS: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION AND RESULTS OF OPERATIONS (Form 10-K)
We develop, manufacture and commercialize point-of-care tests for the detection and diagnosis of infectious diseases, including COVID 19, sexually transmitted disease, and fever and tropical disease. Our product portfolio is based upon our proprietary DPP technology, a diagnostic platform that provides high-quality, cost-effective results in 15 to 20 minutes using fingertip blood, nasal swabs and other sample types. The DPP technology platform addresses the rapid diagnostic test market, which includes infectious diseases, cardiac markers, cholesterol and lipids, pregnancy and fertility, and drugs of abuse. Compared with traditional lateral flow technology, the DPP technology platform can provide enhanced sensitivity and specificity, advanced multiplexing capabilities and, with the DPP Micro Reader, quantitative results. We target the market for rapid diagnostic test solutions for infectious diseases, which is driven by the high prevalence of infectious diseases globally, an increase in the geriatric population, growing demand for rapid test results, and advancements in multiplexing. We have a broad portfolio of infectious disease products, which prior to 2020 were focused principally on sexually transmitted disease and fever and tropical disease. In
February 2020we began the process of shifting substantially all of our resources to leverage the DPP technology platform to address the acute and escalating need for diagnostic testing for COVID-19.
Our products are sold worldwide, directly and through distributors, to medical laboratories and hospitals, government and public health entities, non-governmental organizations, healthcare professionals and retail establishments. . We continue to seek to expand our commercial distribution channels.
In 2020 we continued to invest in automating our test manufacturing processes, all of which are now based in
the United States. Among other actions, we expanded our manufacturing capabilities by validating and implementing automated lines. Our transition from manual to automated assembly is intended to add capacity, reduce variable costs and improve product margins. In order to address challenging economic conditions and implement our business strategy, we continued to execute a program to reduce operating expenses and better align our costs with revenues, including by eliminating positions that were no longer aligned with our strategy.
Consolidated operating results
The results of operations for the years ended
December 31, 2020and 2019 were as follows: Year Ended December 31, (in thousands) 2020 2019 TOTAL REVENUES $ 32,470100 % $ 34,464100 % COSTS AND EXPENSES: Cost of product sales 23,874 74 % 22,394 65 % Research and development expenses 9,509 29 % 8,538 25 % Selling, general and administrative expenses 21,038 65 % 16,139 47 % Severance and related costs 1,122 3 % - 0 % Acquisition costs 63 0 % 721 2 % 55,606 171 % 47,792 139 % LOSS FROM OPERATIONS (23,136 ) (71 )% (13,328 ) (39 )% OTHER (EXPENSE) / INCOME (2,842 ) (9 )% (847 ) (2 )% LOSS BEFORE INCOME TAX BENEFIT (25,978 ) (80 )% (14,175 ) (41 )% Income tax benefit 457 1 % 500 1 % NET LOSS $ (25,521 )(79 )% $ (13,675 )(40 )%
The percentages in the table reflect the percentage of total income.
Total revenues during 2020 were
$32.5 million, a decrease of $2.0 million, or 5.8%, compared to 2019. The decrease in total revenues reflected a $4.1 million, or 14%, decrease in net product sales, which was principally comprised of (a) lower sales in Africa, Latin America, and the United Statesassociated with diminished funding and the closure of clinics for HIV testing due to the COVID-19 pandemic, offset in part by (b) The Company's success in achieving regulatory approvals for and selling the COVID-19 IgM/IgG Systems in Latin Americaand gains in Europeassociated with our long term agreement with UNICEFfor our DPP Zika IgM/IgG and DPP ZCD IgM/IgG multiplex tests and Micro Readers. The decrease in net product sales was offset in part by a $2.2 million, or 31.9%, increase in research and development and grant revenues relating to new government grants for the development, and submission for U.S.regulatory approval, of DPP SARS-CoV-2 Antigen and DPP Respiratory Paneltest systems.
Gross product margin
Cost of product sales is primarily comprised of material, labor, manufacturing overhead, depreciation and amortization, and freight and distribution costs. Gross product margin is net product sales less cost of product sales, and gross product margin percentage is gross product margin as a percentage of net product sales.
The gross margin on product decreased by
For the years ended December 31 Favorable/ 2020 2019 (unfavorable) % Change (in thousands) Net product sales $ 24,767 $ 28,845
$ (4,078 )(14.1 )% Less: Cost of product sales (23,874 ) (22,394 ) (1,480 ) 6.6 % Gross product margin $ 893 $ 6,451 $ (5,558 )(86.2 )% Gross product margin % 3.6 % 22.4 % 40
-------------------------------------------------------------------------------- Table of Contents In 2020 we invested in developing and offering products to address the COVID-19 pandemic, which we expect will have average selling prices greater than those of our legacy products. We also continued to invest in automation in order to reduce our reliance on manual labor and improve our product margins (see Q1'21 Restructuring Charge). The
$5.6 milliondecrease in gross product margin was comprised of (a) $4.7 millionfrom unfavorable product margins and (b) $0.9 millionfrom unfavorable product sales volume as described under "-Total Revenues" above. The $4.6 milliondecrease from unfavorable product margins principally reflected the following:
? We have incurred the cost of product sales for COVID-19 IgM / IgG systems that have been
returned by customers following the Revocation.
? Revocation prevented planned sales of COVID-19 IgM / IgG systems to customers
postponement of certain customer opportunities for the sale of COVID-19 IgM / IgG
we recorded (a) a significant drop in sales in
have our highest average selling prices, and (b) outside
higher combination of sales in geographic areas with lower average selling prices.
? We have experienced operational inefficiencies, including those triggered by the
Revocation and activities related to the qualification of automated lines for production
of certain products, which has resulted in an increase in the cost of sales of products as we
dramatically shifted our production of COVID-19 products towards legacy
-------------------------------------------------------------------------------- Table of Contents Research and Development
This category includes costs incurred for clinical and regulatory affairs and other research and development activities, as follows:
For the years ended December 31 Favorable/ 2020 2019 (unfavorable) % Change (in thousands) Clinical and regulatory affairs $ 1,061 $ 1,516 $ 455 30.0 % Other research and development 8,448 7,022 (1,426 ) (20.3 )% Total research and development $ 9,509 $
$ 8,538 (971) (11.4)%
The decrease in clinical and regulatory affairs costs for 2020 as compared to 2019 was primarily associated with reduced clinical trial costs following the
FDA'sgranting of premarket approval for the DPP HIV-Syphilis test during 2020, offset in part by expenditures related to the DPP SARS-CoV-2 Systems. The increase in other research and development costs was primarily related to costs associated with the development of the DPP SARS-CoV-2 Systems.
Selling, general and administrative expenses
Selling, general and administrative expenses include administrative expenses, sales and marketing costs (including commissions), and other corporate items. The
$4.9 million, or 30%, increase in selling, general and administrative expenses for 2020 as compared to 2019 primarily reflected legal costs arising subsequent to the Revocation, costs from expanding our U.S.commercial organization, a full year of our Brazilian facility (which was acquired during the fourth quarter of 2019), and facility costs related to the COVID-19 pandemic, offset in part by cost savings from retrenching our Malaysiafacility and other restructuring actions taken during the first quarter of 2020.
Severance pay, restructuring and other related costs
During the year ended
December 31, 2020, the Company recognized $0.7 millionin net severance expenses related to the departure of Chembio's former chief executive officer and the elimination of certain positions as part of its multi-faceted expense reduction program to reduce operating expenses. The Company undertook actions to adjust the size and composition of the organization, including by removing positions that were non-essential in light of its new business strategy, and to remove other expenses, all of which the Company expects will provide savings throughout, and after, 2020. In light of market dynamics, the Company retrenched its Malaysian operations, including the termination of employment of its Malaysian workforce. The Company will maintain its Malaysian subsidiary and sustain the product registrations that were obtained throughout southeast Asia, with the benefit of having that entity and the WHO prequalification certified facility. Based on these activities, the Company took restructuring actions totaling $0.4 millionto realign and resize its production capacity and cost structure. All expenses have been paid as of December 31, 2020.
Acquisition costs include legal, due diligence, audit, and related costs associated with acquisitions. The
$0.7 milliondecrease in acquisition costs for 2020 as compared to 2019 reflected the fact that we completed acquisitions in 2019 but not 2020. Other (Expense) / Income Other (expense) / income was principally comprised of interest expense net of interest income. Interest expense increased by $2.0 millionfor 2020 as compared to 2019, due to the interest paid on the term loan debt we incurred in September 2019. Income Tax Benefit For 2020 we recognized a tax benefit of $0.4 millionprimarily attributable to the loss generated by Chembio Diagnostics Germany. As of December 31, 2020and 2019, the Company recorded a full valuation allowance against its net deferred tax assets.
Liquidity and capital resources
During the year ended
December 31, 2020, we funded our business operations, including capital expenditures and working capital requirements, principally from a public offering of common stock, which generated proceeds of $28.4 million(net of expenses), and from cash and cash equivalents. Our operations used $18.9 millionof cash. As of December 31, 2020, we had outstanding indebtedness of $20 million(carrying amount of $18.2 million) pursuant to the Credit Agreement described under "-Sources of Funds-Credit Agreement" below. 42 -------------------------------------------------------------------------------- Table of Contents We continually evaluate our liquidity requirements, capital needs and availability of capital resources based on our operating needs and our planned growth initiatives, particularly in the light of our shift in business focus to the DPP SARS-CoV-2 Systems. We believe our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for at least the next twelve months. Our future working capital needs will depend on many factors, including: the fact and timing of our receipt from the FDA of an EUA award for the DPP SARS-CoV-2 Antigen System and/or the DPP Respiratory Panel System; the fact and timing of our receipt from the FDA of a CLIA waiver for the DPP HIV-Syphilis System; the rate of our business and revenue growth, including our ability to successfully build distribution channels and commercialize the COVID-19 Diagnostic Test Systems in geographies (principally Europe) covered by our CE-Marks for those products, particularly if we are able to resume commercialization of the COVID-19 Diagnostic Test Systems in the United States; the occurrence and timing of regulatory approvals for other new products; the timing of our continuing automation of U.S.manufacturing; and the timing of our investment in research and development as well as sales and marketing. If our sources of liquidity become insufficient to fund the growth of our business, we may need to reduce the level or slow the timing of our growth plans, which would likely curtail or delay the growth in our business contemplated by our operating plan and could impair or defer our ability to achieve profitability and generate cash flow, or to seek to raise additional funds through debt or equity financings, strategic relationships, or other arrangements, to the extent funding would be available to us on acceptable terms or at all. If we were to raise additional funds through the issuance of equity or convertible securities, the issuance could result in substantial dilution to existing stockholders, and the holders of those new securities may have rights, preferences and privileges senior to those of the holders of common stock.
Sources of funds
Credit agreement. At
? The principal amount. The credit agreement provides for a
secured term credit facility, which has been drawn in full from
2019. Under the terms of the credit agreement, we may use the proceeds to
for general working capital purposes and for other purposes authorized for the business, to
refinance some of our existing debts and pay the fees, costs and
expenses incurred under the Credit Agreement.
? Interest rate. The principal overdue under the credit agreement bears interest
at an annual rate equal to the sum of (a) the greater of the two months
Interbank rate offered and 2.5% plus (b) 8.75%. Any time an event
default (as described under “- Default Provisions” below) has occurred and is
Continuing, the interest rate will increase by 4.0%. The accrued interest is
? Scheduled reimbursement. No capital repayment is due before
2022, unless we decide to prepay the capital as described in the section “- Optional
Prepayment “below or the principal is accelerated in the event of default
as described under “- Default Provisions” below. The main payments in the
at maturity on
? Optional prepayment. We may prepay outstanding principal from time to time,
subject to payment of a premium on the prepaid principal equal to 10%
and 4% of
in respect of any prepayment made on or after
? Guarantees. Our subsidiaries
may require our other subsidiaries to guarantee our obligations under the
? Security. Our obligations under the credit agreement are secured by a first
priority and perfect privilege on almost all of our property and assets,
including our holdings in our subsidiaries. Our subsidiary Chembio
bonds with a lien on substantially all of its assets, and the lender of
from time to time may require
other subsidiaries that have guaranteed our credit agreement obligations to be made
? Representations and guarantees; Financial and other commitments. To credit
Agreement that we have made the usual representations and warranties as well as
positive and negative restrictive covenants, including restrictive covenants
debts, liens, sureties, mergers and acquisitions, substantial assets
sales, investments and loans, sale-leaseback, transactions with
affiliates and fundamental changes. The credit agreement also contains
financial commitments requiring that we maintain total unallocated liquidity of
no less than
total amount of income for the four quarters (“last twelve months”) at
2019 and the last day of each calendar quarter thereafter. The minimum total
income amounts, which range from
developed for the purposes of the credit agreement and do not reflect the
estimates and plans used by our management and board of directors to understand
and assess our operational performance, establish budgets and establish
operational objectives for the management of our company. So we do not think that
restrictive covenants provide useful information to investors or others
enhancing an understanding of our future prospects. 43
? Default provisions. The credit agreement provides for the usual events of
default, including events of default based on non-payment of sums due under
credit agreement, defaults on other debts, misrepresentation, commitment
violations, changes of control, insolvency, bankruptcy and the occurrence of a
material adverse effect on the Company. In the event of failure resulting from
voluntary or involuntary bankruptcy, insolvency or
receivership, the amounts unpaid under the credit agreement will become
immediately due and payable and the Lender’s commitments will automatically be
ended. In the event of the occurrence and continuation of any other event of default,
the lender can expedite the payment of all obligations and terminate the lender’s contract
commitments under the credit agreement. When accelerating payment
following an event of default that occurred before
due and payable by us will include a prepayment premium on accelerated principal in the amount described under "-Optional Prepayment" above.
We were in compliance with the financial covenants on cash and income balances at
Research and Development Awards. We routinely seek research and development programs that may be awarded by government, non-governmental organizations, and non-profit entities, including private foundations. Since 2015 we have received over
$14.2 millionof funding from some of the world's leading health organizations, which has helped us accelerate the expansion of our pipeline of infectious disease tests. Our collaborators have included Bill & Melinda Gates Foundation, The Paul G. Allen Family Foundation, FIOCRUZ and FIND, as well as U.S.government agencies such as Centers for Disease Control and Prevention, Biomedical Advanced Research and Development Authorityor BARDA, and the U.S. Department of Agriculture. See "Item 1. Business-Products" above. During the year ended December 31, 2020, we recognized grant revenue totaling $2 millionfrom government, non-governmental organizations, and non-profit entities. Working Capital. The following table sets forth selected working capital information: December 31, 2020 (in thousands) Cash and cash equivalents $ 23,066 Accounts receivable, net 3,377 Inventories, net 12,516 Prepaid expenses and other current assets 779 Total current assets 39,738 Less: Total current liabilities 12,351 Working capital $ 27,387 On December 2, 2020, we were awarded a contract of $12.7 millionfrom BARDA to assist us in (a) developing, and requesting an EUA from the FDA for, the DPP Respiratory Paneland (b) performing the clinical trials for and submitting the DPP SARS-CoV-2 Antigen system to the FDA for a 510(k). Our cash and cash equivalents at December 31, 2020, which included a restricted amount of $1.0 million, were held for working capital purposes. We currently intend to retain all available funds and any future earnings for use in the operation of our business and do not anticipate paying any cash dividends. We have not entered into, and do not expect to enter into, investments for trading or speculative purposes. Our accounts receivable and inventory balances fluctuate from period to period, which affects our cash flow from operating activities. Fluctuations vary depending on cash collections, client mix, raw material lead times, the mix of vendor terms, and the timing of shipment of our products and the invoicing of our research and development activities.
Uses of funds
Cash Flow Used in Operating Activities. Our operations used
$18.9 millionof cash during the year ended December 31, 2020, primarily due to the net loss adjusted for non-cash items of $7.3 millionand a $6.5 millionincrease in inventory related to supply chain timelines, including materials for COVID-19 systems that were ordered but could not be cancelled following the Revocation. Those uses of cash were offset in part by a $3.9 millionincrease in accounts payable and other accrued liabilities, a $1.5 millionincrease in deferred revenue, and a $0.3 millionreduction in accounts receivable. Capital Expenditures. Our capital expenditures totaled $4.2 millionin 2020, of which $4.0 millionrelated to investments in automated manufacturing equipment, facilities, and other fixed assets. 44 -------------------------------------------------------------------------------- Table of Contents We have capital purchase obligations of $1.3 millionrelated to additional automated manufacturing equipment with payments expected to come due during 2021 based on vendor performance milestones.
Effects of inflation
Other than the impact of increases in minimum wage levels in
New York, inflation and changing prices have not had a material effect on our business, and we do not expect that they will materially affect our business in the foreseeable future. Any impact of inflation on cost of revenue and operating expenses, especially employee compensation costs (including any effects of future increases in minimum wages levels in New York), may not be readily recoverable in the price of our product offerings.
Q1’21 restructuring charge
January 14, 2021, the Company's Board of Directors (the "Board") approved a restructuring plan ("2021 Plan") to better align its business priorities. The Plan comprises the termination of employees primarily in the manufacturing department. These actions were intended to better align the Company's cost structure with the skills and resources required to more effectively pursue opportunities in the marketplace and execute the Company's long-term growth strategy. Costs associated with the 2021 Plan are primarily related to Severance and Legal costs. Severance payouts are expected to be substantially completed by the end of the six months ending June 30, 2021. Under the 2021 Plan, the Company expects to incur pre-tax charges between approximately $0.1 millionand $0.2 million.
Off-balance sheet provisions
We have no off-balance sheet arrangements, as defined in Section 303 (a) (4) (ii) of Regulation SK under the Securities Exchange Act of 1934.
Significant accounting policies and critical accounting estimates
Our significant accounting policies are described in Note 2 - Significant Accounting Policies to the audited consolidated financial statements included herein. Certain of our accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, terms of existing contracts, our evaluation of trends in the industry, information provided by our customers and information available from other outside sources, as appropriate. We consider an accounting estimate to be critical if (a) it requires us to make assumptions about matters that were uncertain at the time we were making the estimate and (b) changes in the estimate or different estimates that we could have selected would have had a material impact on our financial condition or results of operations. The following listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in
the United States, with no need for management's judgment in their application. There are also areas in which management's judgment in selecting any viable alternative would not produce a materially different result.
We recognize revenue for product sales in accordance with Financial Accounting Standards Board Accounting Standards Codification, or ASC, 606, Revenue from Contracts with Customers. Revenues from product sales are recognized when the customer obtains control of our product, which occurs at a point in time, typically upon tendering to the customer. We expense incremental costs of obtaining a contract as and when incurred because the expected amortization period of the asset that it would have recognized is one year or less or the amount is immaterial. Freight and distribution activities on products are performed after the customer obtains control of the goods. We have made an accounting policy election to account for shipping and handling activities that occur either when or after goods are tendered to the customer as a fulfillment activity, and therefore recognizes freight and distribution expenses in cost of product sales. We exclude certain taxes from the transaction price (e.g., sales, value added and some excise taxes). Product revenue reserves, which are classified as a reduction in product revenue, are generally related to discounts and returns. Estimates of variable consideration and the determination of whether to include estimated amounts in the transaction price are based on all information (historical, current, and forecasted) that is reasonably available to the Company, taking into consideration the type of customer, the type of transaction, market events and trends, and the specific facts and circumstances of each arrangement. The transaction price, which includes variable consideration reflecting the impact of discounts, allowances and returns may be subject to constraint and is included in the net sales price only to the extent that it is probable that a significant reversal of the amount of the cumulative revenue recognized will not occur in a future period. Actual amounts may ultimately differ from the Company's estimates. If actual results vary, the Company adjusts these estimates, which could have an effect on revenue and earnings in the period of adjustment. For applicable contracts, we recognize revenue from research and development, milestone and grant revenues when earned. Grants are invoiced after expenses are incurred. Revenues from projects or grants funded in advance are deferred until earned. For certain collaborative research projects, we recognize revenue by defining milestones at the inception of the agreement and applying judgement and estimates in recognizing revenue for relevant contracts.
We recognize the fair value of equity-based awards as compensation expense in our consolidated statement of operations. The fair value of restricted stock and restricted stock unit awards are their fair value on the date of grant. The fair value of our stock option awards was estimated using a Black-Scholes option valuation model. This valuation model's computations incorporate subjective assumptions, such as the expected stock price volatility and the estimated life of each award. The fair value of equity-based awards, after considering the effect of expected forfeitures, is then amortized, generally on a straight-line basis, over the related vesting period of the option. 45 -------------------------------------------------------------------------------- Table of Contents Research and Development Costs
Research and development activities primarily consist of new product development, further engineering for existing products, and regulatory costs and clinical trials. Costs related to research and development efforts on existing or potential products are expensed / included as they are incurred.
Inventories are stated at the lower of cost or net realizable value with cost being determined using a standard cost method, which approximates average cost. Average cost consists primarily of material, labor and manufacturing overhead expenses (including fixed production-overhead costs). The Company analyzes its inventory levels quarterly and writes down, in the applicable period, inventory that has become obsolete, inventory that has a cost basis in excess of its expected net realizable value and inventory in excess of expected customer demand. The Company also writes off, in the applicable period, the costs related to expired inventory. Costs of purchased inventories are recorded using weighted-average costing.
Our policy is to review our accounts receivable on a periodic basis, no less frequently than monthly. On a quarterly basis an analysis is made of the adequacy of our allowance for doubtful accounts and adjustments are made accordingly. The allowance was approximately 0.6% of accounts receivable as of
December 31, 2020.
We periodically review goodwill for impairment indicators. We review goodwill for impairment annually in the fourth quarter or more frequently if events or changes in circumstances indicate that goodwill might be impaired. We perform the goodwill impairment review at the reporting unit level. We perform a qualitative assessment of whether it is more likely than not that a reporting unit's fair value is less than its carrying amount. If not, no further goodwill impairment testing is performed. If so, we perform the step discussed hereafter. Our qualitative assessment involves significant estimates, assumptions, and judgments, including, macroeconomic conditions, industry and market conditions, our financial performance, reporting unit specific events and changes in our share price. If the fair value of the reporting unit is greater than its carrying amount, goodwill is not considered to be impaired. We would recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, provided the impairment charge does not exceed the total amount of goodwill allocated to the reporting unit. Indefinite-lived intangible assets are tested for impairment annually during the first fiscal quarter of the year, and when events or changes in circumstances indicate the assets might be impaired. Impairment is indicated when the carrying value of the intangible asset exceeds its fair value.
Recently published accounting position papers
Refer to Note 2 - Significant Accounting Policies to the audited consolidated financial statements included herein for a complete description of recent accounting standards that we have not yet been required to implement which may be applicable to our operations. Additionally, the significant accounting standards that have been adopted during the year ended
December 31, 2020are described. 46
© Edgar online, source