Form 10KSB for CORGENIX MEDICAL CORP.
25-Sep-2008
Annual Report
Item 6. Management's Discussion and Analysis or Plan of Operation.
The following discussion should be read in conjunction with the financial statements and accompanying notes included elsewhere herein.
General
Since our inception, we have been primarily involved in the research, development, manufacturing and marketing/distribution of diagnostic tests for sale to clinical laboratories. We currently market 52 products covering autoimmune disorders, vascular diseases and liver disease. Our products are sold in the U.S., the UK and other countries through our marketing and sales organization that includes employee and contract sales representatives, internationally through an extensive distributor network, and to several significant OEM partners. We manufacture products for inventory based upon expected sales demand, usually shipping products to customers within 24 hours of receipt of orders if in stock. Accordingly, we do not operate with a customer order backlog.
Except for the fiscal year ending June 30, 1997, we have experienced revenue growth every year since our inception, primarily from sales of products and contract revenues from strategic partners. Contract revenues consist of service fees from research and development agreements with strategic partners.
Beginning in fiscal year 1996, we began adding third-party OM licensed products to our diagnostic product line. We expect to expand our relationships with other companies in the future to gain access to additional products. This category comprises approximately 30-40 products, with an annual growth rate in excess of 10% annually. All of the third-party OM licensed products support our own manufactured products, adding to our competitive capabilities, especially in many international markets.
Although we have experienced growth in revenues every year since 1990, except for 1997, there can be no assurance that, in the future, we will sustain revenue growth, current revenue levels, or achieve or maintain profitability. Our results of operations may fluctuate significantly from period-to-period as the result of several factors, including: (i) whether and when new products are successfully developed and introduced, (ii) market acceptance of current or new products, (iii) seasonal customer demand, (iv) whether and when we receive research and development payments from strategic partners, (v) changes in reimbursement policies for the products that we sell, (vi) competitive pressures on average selling prices for the products that we sell, and (vii) changes in the mix of products that we sell.
Recently Issued Accounting Pronouncements
FAS 157, Fair Value Measurements. In September, 2007, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. We are currently assessing the impact that SFAS 157 will have on our results of operations and financial position.
SFAS 159, "The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115." In November 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an Amendment of FASB Statement No. 115 ("SFAS 159"). SFAS 159 is effective for fiscal years beginning after November 15, 2007. SFAS 159 permits an entity to choose to measure many financial instruments and certain other items at fair value at specified election dates. Subsequent unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. We do not believe that the adoption of SFAS 159 will have a material impact on our consolidated financial statements.
SFAS 141, "Business Combinations." In November 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combination (FAS 141(R)) and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (FAS 160). FAS 141(R) will change how business acquisitions are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. FAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. FAS 141(R) and FAS 160 are effective for both public and private companies for fiscal years beginning on or after December 15, 2008 (fiscal 2010 for the Company). FAS 141(R) will be applied prospectively. FAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of FAS 160 will be applied prospectively. Early adoption is prohibited for both standards. Management is currently evaluating the requirements of FAS 141(R) and FAS 160 and has not yet determined the impact on its financial statements.
Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S. ("GAAP") and our significant accounting policies are summarized in Note 1 to the accompanying consolidated financial statements. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts of assets, liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates.
We maintain an allowance for doubtful accounts based on its historical experience and provide for any specific collection issues that are identified. Such allowances have historically been adequate to provide for our doubtful accounts but involve a significant degree of management judgment and estimation. Worse than expected future economic conditions, unknown customer credit problems and other factors may require additional allowances for doubtful accounts to be provided for in future periods.
Equipment and software are recorded at cost. Equipment under capital leases is recorded initially at the present value of the minimum lease payments. Depreciation and amortization is calculated primarily using the straight-line method over the estimated useful lives of the respective assets which range from 3 to 7 years.
The internal and external costs of developing and enhancing software costs related to website development, other than initial design and other costs incurred during the preliminary project stage, are capitalized until the software has been completed. Such capitalized amounts began to be amortized commencing when the website was placed in service on a straight-line basis over a three-year period.
When assets are sold, retired or otherwise disposed of, the cost and related accumulated depreciation are eliminated from the accounts and a gain or loss is recognized. Repair and maintenance costs are expensed as incurred.
We evaluate the realizability of our long-lived assets, including property and equipment, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Revenue from sale of products is recognized upon shipment of products.
Revenue from research and development contracts represents amounts earned pursuant to agreements to perform research and development activities for third parties and is recognized as earned under the respective agreement. Because research and development services are provided evenly over the contract period, revenue is recognized ratably over the contract period. Research and development and advertising costs are expensed when incurred.
Inventories are recorded at the lower of cost or market, using the first-in, first-out method.
Results of Operations
Year Ended June 30, 2008 compared to 2007
Net sales Net sales for the fiscal year ended June 30, 2008 were $8,365,569 a 13.5% increase from $7,367,933 for fiscal 2007. Total North American sales increased $771,263 or 14.2% to $6,216,809 while total sales to international distributors increased $226,372 or 11.8% to $2,148,760 from $1,922,388 year to year. With respect to the Company's major revenue categories and product lines, North American direct product-only sales increased $474,178 or 11.8% to $4,016,852 whereas international direct product-only sales increased $30,622 or 1.9% to $1,611,623. Worldwide category results were as follows: Phospholipids kit sales increased $437,772 or 13.0% to $3,810,860. Coagulation kit sales increased $93,679 or 5.6% to $1,757,208. HA kit sales increased $109,563 or 11.1% to $1,099,660 while Autoimmune kit sales increased $8,661 or 7.4% to $125,371. The first year sales of AspirinWorks amounted to $136,319. Additionally, worldwide OEM/contract manufacturing revenues increased $19,004 or 1.5% to $1,329,310. And finally, non-product revenue increased $392,133 or 74.6% to $917,895.
Cost of sales. Cost of sales, as a percentage of sales, increased to 48.2% for the fiscal year ended June 30, 2008, from 38.4% in 2007, primarily due to the following: (1) An unexpected scrapping of numerous production lots of one of our larger product lines during the first fiscal quarter resulted in an approximately a 2.4% increase; (2) Contaminated sera received in the fourth quarter from one of our regular vendors which necessitated extensive product re-work, which resulted in an approximately 2.5% increase; (3) The write off of expired kits at the end of the fiscal year resulted in an approximately 1% increase, and (4) an increase in raw materials costs.
Selling and marketing. For the fiscal year ended June 30, 2008, selling and marketing expenses increased 3.3% to $2,132,843 from $2,065,573 in 2007. Material changes from the prior fiscal year included decreases in consulting fees, labor related costs, outside services, retention kits, and office supplies, partially offset by increases in advertising, conventions and seminars, dues and subscriptions, license fees, postage, promotional/sample products, property taxes, replacement product, royalties, laboratory supplies, and trade show expenses.
Research and development. Research and development expenses decreased 18.0% to $666,664 for the fiscal year ended June 30, 2008, from $812,531 in 2007. This decrease primarily involved decreases in scientific convention and seminar expenses, labor-related costs, and office supplies, partially offset by increases in the cost of clinical studies, legal fees, property taxes, and laboratory supplies.
General and administrative. For the fiscal year ended June 30, 2008, general and administrative expenses decreased $379,804 or 15.1% to $2,139,392 from $2,519,196 in 2007. This decrease was primarily attributable to decreases in outside services, legal fees, kitchen and office supplies, merger related expenses, and aborted licensing costs, partially offset by increases in bank charges, consulting fees, labor related costs, equipment leases, patent renewal fees, property taxes, and repairs and maintenance.
Interest expense. Interest expense decreased $184,849 or 10.7% to $1,544,518 for the fiscal year ended June 30, 2008, from $1,729,367 in 2007 due primarily to the reduction of the amortization of deferred financing costs and discount on the notes payable as a result of the November 2006 12 month principal payment deferral on the Company's convertible debt, partially offset by the additional discount and acceleration of the discount amortization on the convertible notes due to the contingent conversion feature, which was triggered by the recent PIPE financing.
Liquidity and Capital Resources
Cash used by operating activities was $107,432 for the current fiscal year compared to $895,351 cash used by operating activities in the prior fiscal year. The substantial reduction in cash used by operations for the current fiscal year resulted primarily from the lower net loss for the current fiscal year, plus increases in common stock issued for interest expense, in addition to decreases in accounts receivable and inventories, in addition to decreases in prepaid expenses and other assets. Net cash used by investing activities, the purchase of laboratory and computer equipment amounted to $103,021 for the current fiscal year, compared to $256,004 purchases of laboratory, computer and office equipment for the prior year. This decrease was due primarily to a clamp-down on capital expenditures compared to the prior year's move to a new and larger facility that occurred early in the prior fiscal year which necessitated increased spending on new furniture, computers, laboratory and refrigeration equipment and flooring.
Net cash provided by financing activities amounted to $406,818 for the current fiscl year compared to net cash used by financing activities of $657,236 for the prior year. This large difference in cash provided by financing activities versus the amount used in the comparable prior year was primarily due to the proceeds of the July and September 2007 common stock private placement, plus the decreased principal payments on notes payable in the current period as a result of the principal deferral agreement reached in November 2006.
In summary, for the current fiscal year, the net cash burn (cash used by operating activities plus payments on capital lease obligations and notes payable) amounted to $469,278 versus a net cash burn of $1,552,587 for the prior fiscal year.
Cash on the balance sheet amounted to $1,520,099 as of June 30, 2008 compared to $1,324,072 as of June 30, 2007.
Working capital as of June 30, 2008 amounted to $2,888,509 compared to $2,070,230 a year earlier.
Total liabilities were $3,485,830 as of June 30, 2008 compared to $5,645,796 a year earlier.
Stockholders' equity amounted to $4,152,584 as of June 30, 2008 compared to $2,992,880 a year earlier.
We have incurred operating losses and negative cash flow from operations for most of our history. Losses incurred since our inception, net of dividends on convertible preferred stock, have aggregated $11,640,235, and there can be no assurance that we will be able to generate positive cash flows to fund our operations in the future or to pursue our strategic objectives. Historically, we have financed our operations primarily through long-term debt and the sales of common, redeemable common, and preferred stock. We have also financed operations through sales of diagnostic products and agreements with strategic partners. Accounts receivable decreased 17.7% to $1,009,313 as of June 30, 2008, from $1,225,677 as of June 30, 2007 primarily as a result of accelerated collection procedures.
We have developed and are continuing to strive to implement an operating plan intended to eventually achieve sustainable profitability and positive cash flow from operations. Key components of this plan include accelerating revenue growth and the cash to be derived from existing product lines as well as new diagnostic products, expansion of our strategic alliances with other biotechnology and diagnostic companies, improving operating efficiencies to reduce cost of sales, thereby improving gross margins, and lowering overall operating expenses. Although we cannot yet conclude that the above objectives have been fully met, management has been successful in increasing revenues in the current fiscal year by $997,636 or 13.5%. In addition, management has been successful in reducing operating expenses by $458,401 or 8.5%, reducing the operating loss in the current year by 29.8% or $255,825 from an operating loss of $858,104 in the prior fiscal year to an operating loss of $602,279 in the current fiscal year in addition to substantially reducing our negative cash flow from operations.
Although the operating plan is intended to achieve sustainable profitability and positive cash flow from operations, it is possible that we may not be fully successful in our efforts, as it will take additional time for our strategic and operating initiatives to have a sustained positive effect on our business operations and cash flow. In view of this, in July 2007, we reported that we had entered into subscription and other agreements to complete a private placement with certain institutional and other accredited investors. As of September 30, 2007 we had sold the maximum $989,000 in interests in this placement. Should any significant negative events occur, our financial liquidity position would most likely be negatively impacted by our not achieving positive cash flow from operations. Given all of these circumstances, as noted above, we have secured additional equity financing. It is also possible that we may experience future defaults under the agreements with our convertible debt holders, e.g., for non payment of amounts due, in which case they would be entitled to accelerate the amounts payable to them. However, we do not believe that any defaults will occur in fiscal 2009 or thereafter. Management believes that we will have adequate resources to continue operations for longer than 12 months.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Contractual Obligations and Commitments
On February 8, 2006, we entered into a Lease Agreement (the "Lease") with York County, LLC, a California limited liability company ("Landlord") pursuant to which we leased approximately 32,000 rentable square feet (the "Property") of Landlord's approximately 102,400 square foot building, commonly known as Broomfield One and located at 11575 Main Street, Broomfield, Colorado 80020. The Property is part of Landlord's multi-tenant real property development known as the Broomfield Corporate Center. We use the Property for our headquarters, laboratory research and development facilities and production facilities.
On the following dates, we executed the following amendments to the Lease:
December 1, 2006-The First Amendment to the Lease Agreement (the "First Amendment") established July 6, 2006 as the date of the commencement of the Lease
June 19, 2007-The Second Amendment to the Lease Agreement (the "Second Amendment") redefined the amount of available rental space from 32,480 to 32,000 square feet and recalculated the lease rates per square foot; and
July 19, 2007-The Third Amendment to the Lease Agreement (the "Third Amendment") established the base rent matrix for the period 11/28/2013 to 12/05/2013, which was inadvertently omitted in the Second Amendment.
The term of the Lease (the "Term") is seven years and five months and commenced on July 6, 2006, with tenant options to extend the Term for up to two five-year periods. We have a one time right of first refusal to lease contiguous premises.
Initially, there was no base lease rate payable on 25,600 square feet of the Property, plus estimated operating expenses of $1.61 per square foot.
The base lease rate payable on 25,600 square feet of the Property increased to $4.00 per square foot on January 28, 2007, plus amortization of tenant improvements of $5.24 per square foot, plus estimated operating expenses of $1.61 per square foot. The base lease rate on 25,600 square feet of the Property increased to $5.64 per square foot on January 28, 2008, with fixed annual increases each January 28 thereafter during the initial Term, plus the amortization of tenant improvements of $5.26 per square foot, and estimated operating expenses of $2.77 per square foot.
Initially, there was no base lease rate payable on 6,400 square feet of the Property, plus estimated operating expenses of $1.61 per square foot. The base lease rate on 6,400 square feet of the Property increased to $3.00 per square foot commencing on August 28, 2007, and increased to $3.09 on January 28, 2008, with fixed annual increases each January 28 thereafter during the initial Term, plus estimated operating expenses of $2.77 per square foot.
Thus, the estimated total rent (this is dependent upon the actual operating expenses) on the entire 32,000 square feet of the Property is initially $1.61 per square foot, then increased to approximately $9.00 per square foot on January 28, 2007, then increased to approximately $9.60 per square foot on August 28 2007, then increased to approximately $12.11 per square foot on January 28, 2008, with annual increases in the base lease rate each January 28 thereafter during the initial Term, up to an estimated total rent of $14.358 per square foot during the final year of the initial Term.
The base lease rate for an extension period is 100% of the then prevailing market rental rate (but in no event less than the rent for the last month of the then current Term) and shall thereafter increase annually by 3% for the remainder of the applicable extension period.
The facility leased by our subsidiary, Corgenix UK Ltd., which commenced January 1, 2008, consists of "office park" type space with offices and storage space. They currently lease 2,292 square feet under a 10 year lease with an exit clause at the five year point. The rent payments, exclusive of utilities and taxes, will be approximately $3,991 per month for the first year of the lease, $4,323 per month for the second year, $4,656 per month for the third year, $4,989 for the fourth year, and $5,321 for the fifth year, with subsequent years to be determined.. The facility is rented on a month-by-month basis, with a 90 day notice require for termination of the lease.
We have not invested in any real estate or real estate mortgages.
Risk Factors
An investment in Corgenix entails certain risks that should be carefully considered. In addition, these risk factors could cause actual results to differ materially from those expected including the following:
We depend upon collaborative relationships and third parties for product development and commercialization.
We have historically entered into research and development agreements with collaborative partners, from which we derived revenues in past years. Pursuant to these agreements, our collaborative partners have specific responsibilities for the costs of development, promotion, regulatory approval and/or sale of our products. We will continue to rely on future collaborative partners for the development of products and technologies. There can be no assurance that we will be able to negotiate such collaborative arrangements on acceptable terms, if at all, or that current or future collaborative arrangements will be successful. To the extent that we are not able to establish such arrangements, we could be forced to undertake such activities entirely at our own expense. The amount and timing of resources that any of these partners devotes to these activities may be based on progress by us in our product development efforts. Collaborative arrangements may be terminated by the partner upon prior notice without cause and there can be no assurance that any of these partners will perform its contractual obligations or that it will not terminate its agreement. With respect to any products manufactured by third parties, there can be no assurance that any third-party manufacturer will perform acceptably or that failures by third parties will not delay clinical trials or the submission of products for regulatory approval or impair our ability to deliver products on a timely basis.
There can be no assurance of successful or timely development of additional products.
Our business strategy includes the development of additional diagnostic products for the diagnostic business. Our success in developing new products will depend on our ability to achieve scientific and technological advances and to translate these advances into commercially competitive products on a timely basis. Development of new products requires significant research, development and testing efforts. We have limited resources to devote to the development of products and, consequently, a delay in the development of one product or the use of resources for product development efforts that prove unsuccessful may delay or jeopardize the development of other products. Any delay in the development, introduction and marketing of future products could result in such products being marketed at a time when their cost and performance characteristics would not enable them to compete effectively in their respective markets. If we are unable, for technological or other reasons, to complete the development and introduction of any new product or if any new product is not approved or cleared for marketing or does not achieve a significant level of market acceptance, our ability to remain competitive in our product niches would be impaired.
We continue to incur losses and require additional financing.
We have incurred operating losses and negative cash flow from operations for most of our history. Losses incurred since inception, net of imputed dividends on convertible preferred stock, , have aggregated $11,640,235, and there can be no assurance that we will be able to generate positive cash flows to fund our operations in the future or to pursue our strategic objectives. Historically, we have financed its operations primarily through long-term debt and the sales of common, redeemable common, and preferred stock. We have also financed operations through sales of diagnostic products and agreements with strategic partners. Accounts receivable decreased 17.7% to $1,009,313 from $1,225,677 as of June 30, 2007, primarily as a result of more efficient collection procedures.
We have developed and are continuing to strive to implement an operating plan intended to eventually achieve sustainable profitability and positive cash flow from operations. Key components of this plan include accelerating revenue growth and the cash to be derived from existing product lines as well as new diagnostic products, expansion of our strategic alliances with other biotechnology and diagnostic companies, improving operating efficiencies to reduce cost of sales, thereby improving gross margins, and lowering overall operating expenses. Although we cannot yet conclude that the above objectives have been fully met, management has been successful in increasing revenues in the current fiscal year by $997,636 or 13.5%. In addition, management has been successful in reducing operating expenses by $458,401 or 8.5%, reducing the operating loss in the current year by $255,825 from an operating loss of $858,104 in the prior fiscal year to an operating loss of $602,279 in the current fiscal year in addition to substantially reducing our negative cash flow from operations.
Although the operating plan is intended to achieve sustainable profitability and positive cash flow from operations, it is possible that we may not be fully successful in our efforts, as it will take additional time for our strategic and operating initiatives to have a sustained positive effect on our business operations and cash flow. In view of this, in July 2007, we reported that we had entered into subscription and other agreements to complete a private placement with certain institutional and other accredited investors. As of September 30, 2007 we had sold the maximum $989,000 in interests in this placement. |
