CHEMBIO DIAGNOSTICS, INC. - Quarter Report: 2017 September (Form 10-Q)

  

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

_______________________________

 

FORM 10 - Q

 

_______________________________

 

 

For the quarterly period ended September 30, 2017

 

For the transition period from: ______ to ________

(Commission File Number)

(Exact name of registrant as specified in its charter)

3661 Horseblock Road

(Address of principal executive offices including zip code)

(631) 924-1135

(Registrant's telephone number, including area code)

(Former Name or Former Address, if Changed Since Last Report)

Indicate by check mark whether the 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 ☒ 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, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer", "accelerated filer", "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Yes □ No □

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes □ No ☒

As of November 6, 2017, the Registrant had 12,318,570 shares outstanding of its $.01 par value common stock.

Quarterly Report on FORM 10-Q

For The Quarterly Period Ended

September 30, 2017

Table of Contents

Chembio Diagnostics, Inc.

PART I

Item 1. FINANCIAL STATEMENTS

See accompanying notes to condensed consolidated financial statements

See accompanying notes to condensed consolidated financial statements

See accompanying notes to condensed consolidated financial statements

NOTE 1 — DESCRIPTION OF BUSINESS:

Chembio Diagnostics, Inc. (the "Company" or "Chembio") and its wholly-owned subsidiaries, Chembio Diagnostic Systems Inc., and Chembio Diagnostics Malaysia Sdn Bhd ("CDM"), (formerly known as RVR Diagnostics Sdn Bhd), develop, manufacture, and market rapid diagnostic tests that detect infectious diseases. The Company's main lateral flow products are three rapid tests for the detection of HIV antibodies in whole blood, serum and plasma samples, two of which were approved by the FDA in 2006; the third is sold for export only. In addition, the Company has several products based on its patented Dual Path Platform (DPP®) technology, including a HIV test approved by the FDA in 2013 and CLIA-Waived in 2014. Lateral Flow Rapid HIV tests represented 38% of the Company's product revenues in the first nine months of 2017. The Company's products based on its DPP® platform represented approximately 48% of the Company's product revenues in the first nine months of 2017. The Company also has other rapid tests and components that together represented approximately 14% of product sales in the first nine months of 2017. The Company's products are sold to medical laboratories and hospitals, governmental and public health entities, non-governmental organizations, medical professionals and retail establishments, both domestically and internationally. Chembio's products are sold under the Company's STAT PAK®, SURE CHECK®, STAT-VIEW® or DPP® registered trademarks, or under the private labels of its marketing partners. All of the Company's products that are currently being developed are based on its patented DPP®, which is a unique diagnostic point-of-care platform that has certain advantages over lateral flow technology.

NOTE 2 — ACQUISITION OF RVR DIAGNOSTICS SDN BHD NOW KNOWN AS CHEMBIO DIAGNOSTICS MALAYSIA SDN BHD:

On January 9, 2017, pursuant to a stock purchase agreement (the "Stock Purchase Agreement), the Company acquired all of the outstanding common stock of RVR Diagnostics Sdn Bhd, a Malaysia corporation ("RVR"), for $3,231,000, utilizing some of the proceeds from the funds raised by the Company in August 2016, the issuance of Chembio's common stock, and a contingent consideration, as described below, related to RVR reaching a milestone based on revenues that was valued at $148,000.  RVR, which subsequently changed its name to Chembio Diagnostics Malaysia Sdn Bhd ("CDM"), is a privately-held Malaysia based manufacturing company focused on assembly and sales of rapid medical assays.  The Company acquired CDM to have a better presence in Asia, access to lower cost, shorter approval time of in-country regulatory approvals, and a lower cost assembly operation.

Pursuant to the Stock Purchase Agreement, the Company acquired all of the issued and outstanding common stock and other equity interests of CDM for (i) a cash payment of $1,400,000, of which $550,000 was paid as a deposit in December 2016 and (ii) 269,236 shares of Chembio's common stock, with a value at closing of $1,683,000, of which 7,277 shares are being held back to satisfy certain potential claims under the Stock Purchase Agreement and will become issuable to the sellers, if at all, on the one-year anniversary of the closing.

In addition, the Stock Purchase Agreement provides that the sellers may become entitled to receive certain milestone payments based on the achievement of performance goals related to sales by CDM during the 12 months ending December 31, 2017. CDM's actual sales during that period will be used to determine the "Milestone Proration Amount," which is a fraction that (i) the numerator of which is the positive amount, if any, by which actual sales for calendar year 2017 are greater than $2,250,000, up to a maximum overage of $250,000, and (ii) the denominator of which is $250,000. Based on the actual sales achieved by CDM, the Sellers will be entitled to receive (i) a cash milestone payment equal to $100,000 multiplied by the Milestone Proration Amount, for a maximum cash milestone payment of $100,000, and (ii) a stock milestone payment equal to 21,830 shares of Chembio common stock multiplied by the Milestone Proration Amount, with a maximum stock milestone payment of 21,830 shares of Chembio common stock.  As of March 31, 2017 the Company had accrued $148,000 for the milestone.  This amount is the estimated value of the common stock of $85,000 based on the assumption of reaching the milestone of 74.5% and discounted by 15%, as well as the cash portion of the milestone payment valued at $63,000.  There was no change in the fair value of this contingent milestone payment through September 30, 2017.

As a result of the consideration paid exceeding the preliminary fair value of the net assets acquired, goodwill in the amount of $1,503,361 was recorded in connection with this acquisition, none of which will be deductible for tax purposes. In addition, the Company recorded $1,800,000 in intangible assets, which results largely from the addition of CDM's intellectual property, customer base and distribution channels, trade names, order backlog, industry reputation, and management talent and workforce. Our Condensed Consolidated Statements of Operations for the nine months ended September 30, 2017 include $25,000 of transaction costs related to the CDM acquisition, which are reflected as general and administrative expenses.

 

The acquisition was accounted for using the purchase method of accounting.  The following table summarizes the preliminary allocation of the purchase price to the estimated fair values of the assets acquired and liabilities assumed on the closing date of January 9, 2017:

* Total consideration includes the $1,400,000 paid in cash, $1,683,000 in shares of common stock and $148,000 in contingent consideration.

The Company calculated the fair value of the fixed assets based on the net book value of CDM as that approximates fair value.  The intellectual property, customer contracts and trade names were based on assumption by discounted cash flow using management estimates.  The order backlog was based on an order that CDM had at the closing, which was shipped in the first quarter of 2017, and valued at an estimated net income.

As indicated, the allocation of the purchase price and estimated useful lives of property, plant and equipment, intangible assets and deferred tax liability shown above is preliminary, pending final completion of valuations. Upon completion of this analysis, an adjustment may be required.

For the period from January 10, 2017 to September 30, 2017, net sales and loss before income taxes from the acquisition was approximately $1,489,500 and $438,000, respectively, which have been included in the Condensed Consolidated Statement of Operations for the nine months ended September 30, 2017.  The following represents unaudited pro forma operating results as if the operations of CDM had been included in the Company's Condensed Consolidated Statements of Operations as of January 1, 2016:

The pro forma financial information includes business combination accounting effects from the acquisition including amortization charges from acquired intangible assets of approximately $339,000. The unaudited pro forma information as presented above is for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of fiscal 2016.

NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

a)

Basis of Presentation:

The preceding (a) condensed consolidated balance sheet as of December 31, 2016, which has been derived from audited financial statements, and (b) the unaudited interim condensed consolidated financial statements as of September 30, 2017 and for the three and nine-month periods ended September 30, 2017 and 2016, respectively, have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Certain information and footnote disclosures, which are normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted pursuant to such rules and regulations, although we believe that the disclosures made are adequate to provide for fair presentation. The interim financial information should be read in conjunction with the Financial Statements and the notes thereto, included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2016, previously filed with the SEC.

In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the Company's condensed consolidated financial position as of September 30, 2017, its condensed consolidated results of operations for the three and nine-month periods ended September 30, 2017 and 2016, respectively, and its condensed consolidated cash flows for the nine-month periods ended September 30, 2017 and 2016, as applicable, have been made. The interim results of operations are not necessarily indicative of the operating results for the full fiscal year or any future periods.

Going Concern

A fundamental principle of the preparation of financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP") is the assumption that an entity will continue in existence as a going concern, which contemplates continuity of operations and the realization of assets and settlement of liabilities occurring in the ordinary course of business. This principle is applicable to all entities except for entities in liquidation or entities for which liquidation appears imminent. In accordance with this requirement, the Company has prepared its consolidated financial statements on a going concern basis.

The Company has incurred significant operating losses in the previous three years as well as negative cash flow from operations. The Company currently has a working capital surplus of $9.8 million. The Company's ability to continue as a going concern depends on its ability to execute its business plan, increase revenue and billings and reduce expenditures. During 2017, the Company began to focus on aligning its expense structure with revenue expectations which included tighter expense controls and overall operational efficiencies which better align the Company's current business plan on a run-rate basis. In addition, the Company recently increased its inventory in anticipation of orders which to date have not materialized and the plan includes reducing inventory levels to provide additional cash to fund operations.   Another focus is on the Company's receivable balance which also increased over the nine months, partially due to increased product sales, and we are focusing on reducing days outstanding.

The Company also has an ATM (At-The-Market) in place, of over twenty million dollars, and anticipates the ability to raise additional funding if needed through this vehicle.  In addition, the Company may be able to raise additional funds through a private offering.  With these options available and the steps outlined above, the Company expects it will be able continue as a going concern into and beyond 2018.  However, there can be no assurance that the Company will be able to obtain financing or that such financing will be on favorable terms. Any such financing would be dilutive to shareholders.  Failure to generate sufficient revenue, control or further reduce expenditures and/or the inability to obtain financing will result in an inability of the Company to continue as a going concern.

Fair Value of Financial Instruments

The carrying value for cash and cash equivalents, accounts receivable and accounts payable, approximate fair value because of the immediate or short-term maturity of these financial instruments.

b)

Revenue Recognition:

The Company recognizes revenue for product sales in accordance with ASC 605, which provides that revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is determinable, and collectability is reasonably assured. Revenue typically is recognized at time of shipment. Sales are recorded net of discounts, rebates and returns.

For certain contracts, the Company recognizes revenue from non-milestone payments and grant revenues when earned. Grants are invoiced after expenses are incurred. Revenues from projects or grants funded in advance are deferred until earned. Deferred revenues not earned were $- and $392,517 as of September 30, 2017 and December 31, 2016, respectively.

The Company follows Financial Accounting Standards Board ("FASB") authoritative guidance ("guidance") prospectively for the recognition of revenue under the milestone method. The Company applies the milestone method of revenue recognition for certain collaborative research projects defining milestones at the inception of the agreement.

c)

Inventories:

Inventories consist of the following at:

Inventories are stated net of reserves of approximately $245,000 as of September 30, 2017 and December 31, 2016.

d)

Earnings Per Share:

Basic earnings per share is computed by dividing net income or loss by the weighted-average number of common shares outstanding for the period. Diluted income per share reflects the potential dilution from the exercise or conversion of other securities into common stock, but only if dilutive. The following securities, presented on a common share equivalent basis for the three- and nine-month periods ended September 30, 2017 and 2016, have been included in the earnings per share computations:

As there were losses for the three and nine months ended September 30, 2017 and 2016, no common share equivalents are included in the diluted per share computations.

There were 699,663 and 614,949 weighted-average number of options outstanding as of September 30, 2017 and 2016, respectively, that were not included in the calculation of diluted per common share equivalent for the three months ended September 30, 2017 and 2016 respectively, because the effect would have been anti-dilutive. There were 668,510 and 677,050 weighted-average number of options outstanding as of September 30, 2017 and 2016, respectively, that were not included in the calculation of diluted per common share equivalent for the nine months ended September 30, 2017 and 2016, respectively, because the effect would have been anti-dilutive.

e)

Employee Stock Option Plans and Share-Based Compensation:

Effective June 3, 2008, the Company's stockholders voted to approve the 2008 Stock Incentive Plan ("SIP"), initially with 625,000 shares of Common Stock available to be issued. At the Annual Stockholder meeting on September 22, 2011, the Company's stockholders voted to approve an increase to the shares of Common Stock issuable under the SIP by 125,000 to 750,000. Under the terms of the SIP, the Compensation Committee of the Company's Board has the discretion to select the persons to whom awards are to be granted and the number of shares of common stock to be covered by each grant. Awards can be incentive stock options, restricted stock and/or restricted stock units. The awards become vested at such times and under such conditions as determined by the Compensation Committee at the time of the initial stock option grant. As of September 30, 2017, there were 228,177 options outstanding under the SIP, with 480,172 options previously having been exercised.

Effective June 19, 2014, the Company's stockholders voted to approve the 2014 Stock Incentive Plan ("2014-SIP"), with 800,000 shares of Common Stock available to be issued. Under the terms of the 2014-SIP, the Compensation Committee of the Company's Board has the discretion to select the persons to whom awards are to be granted and the number of shares of common stock to be covered by each grant. Awards can be incentive stock options, restricted stock and/or restricted stock units. The awards become vested at such times and under such conditions as determined by the Compensation Committee at the time of the initial stock option grant. As of September 30, 2017, there were 22,000 options exercised, 250,625 options outstanding and 527,375 options or shares still available to be issued under the 2014-SIP.

There were 142,875 and 106,875 stock options granted during the nine months ended September 30, 2017 and 2016, respectively.  The weighted average estimated fair value, at their respective dates of grant, of stock options granted in the nine months ended September 30, 2017 and September 30, 2016, was $2.22 and $2.77 per share, respectively.  The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model. The expected volatility is based upon the historical volatility of our stock. The expected term is based on historical information.

The assumptions made in calculating the fair values of options granted during the periods indicated are as follows:

The Company's results for the three-month periods ended September 30, 2017 and 2016 include share-based compensation expense, consisting solely of stock options, totaling $87,100 and $74,100, respectively. Such amounts have been included in the Condensed Consolidated Statements of Operations within cost of product sales ($12,800 and none), research and development ($12,100 and $27,300, respectively) and selling, general and administrative expenses ($62,200 and $46,800, respectively). The results for the nine-month periods ended September 30, 2017 and 2016 include share-based compensation expense, consisting solely of stock options, totaling approximately $296,700 and $220,300, respectively. Such amounts have been included in the Condensed Consolidated Statements of Operations within cost of product sales ($34,200 and none), research and development ($77,300 and $62,000, respectively) and selling, general and administrative expenses ($185,200 and $158,300, respectively). An operating expense, resulting in income tax benefit, has been recognized in the statement of operations for share-based compensation arrangements.

Stock option compensation expense for the three and nine months ended September 30, 2017 and 2016 is based on the estimated fair value, at the date of issuance, of options outstanding, which is being amortized on a straight-line basis over the requisite service period for each vesting portion of the award. Accordingly, for stock options that vested immediately, the estimated fair value was expensed immediately.

The following table provides stock option activity for the nine months ended September 30, 2017:

As of September 30, 2017, there was $387,192 of net unrecognized compensation cost related to stock options that have not vested, which is expected to be recognized over a weighted average period of approximately 2.34 years. The total fair value of stock options vested during the nine-month periods ended September 30, 2017 and 2016 was $323,113 and $237,095, respectively.

f)

Geographic Information:

U.S. GAAP establishes standards for the manner in which business enterprises report information about operating segments in financial statements and requires that those enterprises report selected information. It also establishes standards for related disclosures about products and services, geographic areas, and major customers.  The table below represents product revenues for different geographic regions.

g)

Accounts Payable and Accrued Liabilities:

Accounts payable and accrued liabilities consist of:

h)     Goodwill and Intangible Assets:

Goodwill represents the excess of the purchase price we paid over the fair value of the net tangible and identifiable intangible assets acquired in our acquisition of CDM in January 2017. Goodwill is not amortized but rather is tested annually for impairment or more frequently if we believe that indicators of impairment exist. Current U.S. generally accepted accounting principles permit us to make a qualitative evaluation about the likelihood of goodwill impairment. If we conclude that it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, then we would not be required to perform the two-step quantitative impairment test. Otherwise, performing the two-step impairment test is necessary. The first step of the two-step quantitative impairment test involves comparing the fair values of the applicable reporting unit with its aggregate carrying value, including goodwill. If the carrying value of a reporting unit exceeds the reporting unit's fair value, we perform the second step of the test to determine the amount of the impairment loss, if any. The second step involves measuring any impairment by comparing the implied fair values of the affected reporting unit's goodwill and intangible assets with the respective carrying values.

If actual future results are not consistent with management's estimates and assumptions, we may have to take an impairment charge in the future related to our goodwill. Future impairment tests will be performed annually in the first day of the fiscal fourth quarter, or sooner if a triggering event occurs. This is a change from our previously disclosed annual testing date of the fiscal first quarter of each annual period.  This change does not represent a material change to a method of applying an accounting principle. There was no impairment recorded for the three and nine months ended September 30, 2017.

In addition, the Company recorded certain intangible assets as part of the CDM acquisition which are as follows as of September 30, 2017.

Amortization expenses for the nine months ended September 30, 2017 was approximately $339,000.

i)

Recent Accounting Pronouncements Affecting the Company:

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, "Revenue from Contracts with Customers" (Topic 606), which supersedes nearly all existing revenue recognition guidance under accounting principles generally accepted in the United States ("U.S. GAAP"). The core principle of Topic 606 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. Topic 606 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. The new guidance also includes a cohesive set of disclosure requirements intended to provide users of financial statements with comprehensive information about the nature, amount, timing and uncertainty of revenue and cash flows arising from a company's contracts with customers.

The standard is effective for annual periods beginning after December 15, 2017, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients; or (ii) a retrospective approach with the cumulative effect of initially adopting Topic 606 recognized at the date of adoption (which includes additional footnote disclosures). We have evaluated the impact of our pending adoption of Topic 606 on our consolidated financial statements and have determined to use the modified retrospective method by which we will reflect the cumulative effect in the adoption of the standard in 2018.  The Company has hired an independent firm to assist the Company in analyzing its revenue streams based on its sales contracts with customers. Based on the analysis to date, the Company does not expect its product sales to have a material impact on its consolidated financial statements. Revenue from product sales are recognized when control of the goods transfer to the customer which we expect to be the date of shipment.  The Company will make the accounting policy election to treat shipping and handling as fulfillment activities. The Company is evaluating the impact of Topic 606 on its other revenue streams, including R&D, milestone and grants, and on its disclosures for its financial statement footnotes and expects to complete its implementation of the new standard in 2017.

In November 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2015-17, Income Taxes (Topic 740) Balance Sheet Classification of Deferred Assets. This ASU is intended to simplify the presentation of deferred taxes on the balance sheet and will require an entity to present all deferred tax assets and deferred tax liabilities as non-current on the balance sheet. Under the current guidance, entities are required to separately present deferred taxes as current or non-current. Netting deferred tax assets and deferred tax liabilities by tax jurisdiction will still be required under the new guidance. This guidance had no material effect in 2017. The Company does not believe this new accounting standard update will have a material impact on its consolidated financial statements in the future.

In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which will change certain aspects of accounting for share-based payments to employees.  ASU 2016-09 is effective for fiscal years (and interim reporting periods within those years) beginning after December 15, 2016.  The Company adopted the provisions of ASU 2016-09 on January 1, 2017.  The Company evaluated this standard and the adoption of it did not have a material impact on its consolidated financial statements.

In January 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2017-04 Intangibles - Goodwill and Other (Topic 350) which would eliminate the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, the amount of an impairment charge would be recognized if the carrying amount of a reporting unit is greater than its fair value. ASU 2017-04 is effective for public companies for fiscal years beginning after December 15, 2019.  Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.  The Company is currently evaluating the impact of the provisions of ASU 2017-04.

NOTE 4 — COLLABORATIVE RESEARCH AND DEVELOPMENT ARRANGEMENTS:

a)

Brain Injury agreement:

In January 2015, the Company entered into a technology development agreement with Perseus Science Group LLC for $946,000 and a follow-on agreements in December 2016 and during 2017 aggregating to $1,060,000. The Company earned $293,000 and $180,000 for the nine-month periods ended September 30, 2017 and 2016, respectively, from this agreement. The Company earned $1,060,000 from this grant from inception through September 30, 2017, so that as of September 30, 2017, the Company has received the entire amount of this grant.

b)

Malaria agreement:

In April 2016, the Company was awarded a grant from the Bill & Melinda Gates Foundation for $678,000.  The Company earned  $159,000 for the nine-month period ended September 30, 2017 from this agreement.  The Company earned $678,000 from this grant from inception through September 30, 2017, so that as of September 30, 2017, the Company has received the entire amount of this grant.

c)

Fever Panel agreement:

In October 2015, the Company entered into a technology development agreement with the Paul G. Allen Ebola Program for $2,118,000 and a follow-on agreement in February 2016 for $550,000. The Company earned none and $2,260,000 for the nine-month periods ended September 30, 2017 and 2016, respectively, from this agreement. The Company earned $2,668,000 from this grant from inception through September 30, 2017.

d)

BARDA Zika agreement:

In August 2016, the Company was awarded a grant for $5,934,000 from BARDA, which is part of the U.S. Department of Health And Human Resources. The Company earned $1,900,000 and none ,  for the nine-month period ended September 30, 2017 and 2016, respectively, from this agreement. The Company earned $2,373,000 from this grant from inception through September 30, 2017.

e)

USDA Bovid:

In September 2016, the Company entered into a Phase II agreement with the USDA for an additional $600,000 to develop a Bovid TB assay.  The Phase I agreement was for  $100,000.  Revenue for these agreements are being recognized under a proportional performance method. The Company earned $222,000 for the nine-month period ended September 30, 2017 from these agreements. The Company earned $274,000 from these agreements from inception through September 30, 2017.

f)

FIND agreement:

In March 2017, the Company entered into a technology development agreement with FIND  for $999,000. The Company earned $500,000 for the nine-month period ended September 30, 2017 from this agreement. The Company earned $500,000 from this grant from inception through September 30, 2017.

NOTE 5 — RIGHTS AGREEMENT:

In March 2016, the Company entered into a Rights Agreement dated as of March 8, 2016 (the "Rights Agreement") between the Company and Action Stock Transfer Corp., as Rights Agent. Pursuant to the Rights Agreement, the Company declared a dividend of one preferred share purchase right (a "Right") for each outstanding share of common stock, $0.01 par value (the "Common Stock"), of the Company. The Board of Directors set the payment date for the distribution of the Rights as March 8, 2016, and the Rights were distributed to the Company's shareholders of record on that date. The description and terms of the Rights are set forth in the Rights Agreement.

Rights Initially Not Exercisable. The Rights are not exercisable until a Distribution Date, which is defined below. Until a Right is exercised, the holder thereof, in his capacity as a holder of Rights, will have no rights as a shareholder of the Company, including, without limitation, the right to vote or to receive dividends.

Separation and Distribution of Rights. The Rights will be evidenced by the certificates for shares of Common Stock registered in the names of the holders thereof, and not by separate rights certificates until the earlier to occur of (i) the close of business on the tenth business day following a public announcement that an Acquiring Person (as defined in the Rights Agreement) acquired a Combined Ownership (as defined in the Rights Agreement) of 20% or more of the outstanding shares of the Common Stock (the "Shares Acquisition Date") or (ii) the later of (A) the close of business on the tenth business day (or such later date as may be determined by action of the Board of Directors prior to such time as any person or group of affiliated or associated persons becomes an Acquiring Person) after the date that a tender or exchange offer or intention to commence a tender or exchange offer by any person is first published, announced, sent or given within the meaning of Rule 14d-4(A) under the Securities Exchange Act of 1934, as amended, the consummation of which would result in any person having Combined Ownership of 20% or more of the outstanding shares of the Common Stock, or (B) if such a tender or exchange offer has been published, announced, sent or given before the date of the Rights Agreement, then the close of business on the tenth business day after the date the Rights Agreement was entered into (or such later date as may be determined by action of the Board of Directors prior to such time as any person becomes an Acquiring Person); (the earlier of such dates referred to in (i) and (ii), which date may include any such date that is after the date of the Rights Agreement but prior to the issuance of the Rights, being called the "Distribution Date").

NOTE 6 — COMMON STOCK, WARRANTS AND OPTIONS:

During the third quarter of 2017, options to purchase 46,000 shares of the Company's common stock were exercised for cash and on a cashless basis into 19,448 shares of common stock at an average exercise price of $4.24.  The exercise prices of the options exercised on a cashless basis were paid by the exercising option holders surrendering options and shares of common stock already owned as payment of the exercise price.

During the third quarter of 2017, the Company issued options to one of its directors pursuant to the Company's compensation policy for directors.  The director was issued options to purchase 46,875 shares of common stock.  The options become exercisable in five equal annual installments starting on the date of issue.  The options issued have an exercise price of $6.05 per share, which was  the last traded price of the common stock on the day issued.  The options expire five years from date of issue.

The Company entered into an employment agreement, effective as of May 22, 2017 (the "Klugewicz Employment Agreement"), with Sharon Klugewicz to serve as the Company's President of the Americas, for an additional term of one year through May 22, 2018. Pursuant to the Klugewicz Employment Agreement, the Company issued to Ms. Klugewicz incentive stock options to purchase 10,000 shares of the Company's common stock. Fifty percent of these options vest on each of the second and third anniversary of the effective date. The exercise price for these options was equal to the last trading price for the Company's common stock on September 17, 2017, which was $5.90 per share. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of Ms. Klugewicz's employment with the Company or (b) on the five year anniversary of the effective date of the grant.

During the second quarter of 2017, no options were granted or exercised.

During the first quarter of 2017, options to purchase 10,969 shares of the Company's common stock were exercised on a cashless basis into 3,039 shares of common stock at an exercise price of $4.19 by surrendering options and shares of common stock already owned as payment of the exercise price.

The Company entered into an employment agreement, effective as of March 13, 2017 (the "Sperzel Employment Agreement"), with John Sperzel to serve as the Company's Chief Executive Officer, for an additional term of three years through March 13, 2020. Pursuant to the Sperzel Employment Agreement, the Company issued to Mr. Sperzel incentive and non-qualified stock options to purchase 20,000 shares of the Company's common stock. These options vest on the third anniversary or March 31, 2020. The exercise price for these options was equal to the volume weighted trading price for the Company's common stock on March 31, 2017, which was $5.3666 per share. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of Mr. Sperzel's employment with the Company or (b) the seventh anniversary of the effective date of the grant.

During the first quarter of 2017, the Company issued options to purchase 5,000 shares of common stock to each of six members of the executive team.  The options became exercisable on the date of issue.  The options issued have an exercise price of $5.25 per share, which was  the last traded price of the common stock on the day issued.  The options expire five years from date of issue.

During the first quarter of 2017, the Company issued options to purchase 36,000 shares of common stock to a newly-hired vice-president of operations. The options are exercisable in three equal annual installments starting on the first anniversary of the date of issue. The options issued have an exercise price of $6.30 per share, which was the last traded price of the common stock on the day issued. The options expire five years from date of issue.

During the year 2016, options to purchase 191,804 shares of the Company's common stock were exercised for cash and on a cashless basis into 125,750 shares of common stock at exercise prices ranging from $2.80 to $5.56 by surrendering options and shares of common stock already owned.

During the fourth quarter of 2016, the Company issued options to purchase 36,000 shares of common stock to a newly-hired president of the EMEA and APAC regions. The options are exercisable in three equal annual installments starting on the first anniversary of the date of issue. The options issued have an exercise price of $7.15 per share, which was the last traded price of the common stock on the day issued. The options expire five years from date of issue.

The Company closed an underwritten public offering of 2,300,000 shares of its common stock on August 3, 2016. The price per share of common stock sold in the offering was $6.00 per share. The net proceeds of the offering, after deducting the underwriters' discounts and other offering expenses payable by the Company, was approximately $12,493,000.  The Company intends to use the net proceeds for business expansion and working capital, including product development, operational improvements, clinical trials, and sales and marketing.

During the second quarter of 2016, the Company issued options to one of its directors pursuant to the Company's compensation policy for directors.  The director was issued options to purchase 46,875 shares of common stock.  The options become exercisable in five equal annual installments starting on the date of issue.  The options issued have an exercise price of $8.86 per share, which was  the last traded price of the common stock on the day issued.  The options expire five years from date of issue.

The Company entered into an employment agreement, effective as of March 5, 2016 (the "Esfandiari  Employment Agreement"), with Javan Esfandiari to serve as the Company's Chief Scientific and Technical Officer, for an additional term of three years through March 5, 2019. Pursuant to the Esfandiari Employment Agreement, the Company issued to Mr. Esfandiari incentive and non-qualified stock options to purchase 60,000 shares of the Company's common stock. Of these stock options, options to purchase 20,000 shares vest on each of the first three anniversaries of March 11, 2016 which is the date on which the Esfandiari Employment Agreement was entered into. The exercise price for these options is equal to the trading price for the Company's common stock on March 11, 2016, which was $5.64 per share. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of Mr. Esfandiari's employment with the Company or (b) the fifth anniversary of the effective date of the grant.

NOTE 7 — COMMITMENTS, CONTINGENCIES, AND CONCENTRATIONS:

a)

Economic Dependency:

The following table discloses product sales and accounts receivable the Company had with respect to each customer that purchased in excess of 10% of the Company's net product sales for the periods indicated:

(*) Product sales did not exceed 10% for the period indicated.

Note that sales include product sales only while accounts receivable reflects the total due from the customer, which includes freight.

The following table discloses purchases and accounts payable that the Company had with respect to each vendor that sold to the  Company in excess of 10% of the Company's total purchases for the periods indicated:

(*) Purchases did not exceed 10% for the period indicated

The Company currently buys materials which are purchased under intellectual property rights agreements and are important components in its products. Management believes that other suppliers could provide similar materials on comparable terms as the vendors shown in this table. A change in suppliers, however, could cause a delay in manufacturing, either from the logistics of changing suppliers or from product changes attributable to new components, which could result in a possible loss of sales, and which could adversely affect operating results.

b)

Governmental Regulation:

All of the Company's existing and proposed diagnostic products are regulated by the United States Food and Drug Administration, United States Department of Agriculture, certain U.S., state and local agencies, and/or comparable regulatory bodies in other countries. Most aspects of development, production, and marketing, including product testing, authorizations to market, labeling, promotion, manufacturing, and record keeping, are subject to regulatory review. After marketing approval has been granted, Chembio must continue to comply with governmental regulations. Failure to comply with these regulations can result in significant penalties.

c)

Employment Agreements:

The Company has employment contracts with five key employees: CEO John J. Sperzel III; CSTO Javan Esfandiari; President of the Americas, Sharon Klugewicz; Managing Director of CDM, Magentiren Vajuram; and Vice-President of CDM Dr. Avijit Roy. The contracts call for salaries presently aggregating $1,280,000 per year. The Sperzel contract expires in March 2020, the Esfandiari contract expires in March 2019, the Klugewicz contract expires May 2018, and the Vajuram and Roy contracts expire in January 2018. In connection with the Sperzel contract that expires in March 2020, the Company issued, in March 2017, options to purchase 20,000 common shares of stock, which vest on the third anniversary of the grant. In connection with the Esfandiari contract that expires in March 2019, the Company issued, in March 2016, options to purchase 60,000 shares of common stock, with one-third vesting on each of the first, second and third anniversaries of the grant.   In connection with the Klugewicz contract that expires in May 2018, the Company issued, in September 2017, options to purchase 10,000 shares of common stock, with one half vesting on each of the second and third anniversaries of the grant.

NOTE 8 — LOAN PAYBLE:

In September 2017, the Company entered into an agreement with an equipment vendor to purchase automated assembly equipment for approximately $660,000.  The terms called for prepayments of 30% down, 60% at time of factory acceptance testing and 10% after delivery.  The vendor agreed to lend the Company certain portions of the prepayments, 15% of the first prepayment, 40% of the second prepayment and the last 10% on delivery.  The Company will pay interest only at an annual rate of 12% until delivery.  Thirty days after delivery the Company will begin making monthly payments of principal and interest of approximately $20,150, at an annual rate of twelve percent, over a twenty-four month period.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The terms "Chembio", "Company", "we", "us", and "our" refer to Chembio Diagnostics, Inc. and its subsidiaries as a consolidated entity, unless the context suggests otherwise.

Overview

This discussion and analysis should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and related notes. The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States ("U.S. GAAP"). The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent liabilities at the financial statement date, and reported amounts of revenue and expenses during the reporting period. On an ongoing basis, we review our estimates and assumptions. Our estimates are based on our historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results are likely to differ from those estimates under different assumptions or conditions, but we do not believe such differences will materially affect our financial position or results of operations. Our critical accounting policies, the policies we believe are most important to the presentation of our financial statements and require the most difficult, subjective and complex judgments, are outlined below in ''Critical Accounting Policies,'' and have not changed significantly from December 31, 2016, with the exception of goodwill.

In addition, certain statements made in this report may constitute "forward-looking statements". These forward-looking statements involve known or unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Specifically, 1) our ability to obtain necessary regulatory approvals for our products; and 2) our ability to increase revenues and operating income are dependent upon our ability to develop and sell our products, general economic conditions, and other factors. You can identify forward-looking statements by terminology such as "may," "could", "will," "should," "expects," "intends," "plans," "anticipates," "believes," "estimates," "predicts," "potential", "continues" or the negative of these terms, or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report, as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business.

All of the Company's future products that are currently being developed are based on its patented Dual Path Platform (DPP®), which is a unique diagnostic point-of-care platform that has certain advantages over lateral flow technology. The Company has completed development of several products that employ the DPP® technology which are currently marketed under Chembio's label (DPP® HIV 1/2 Screening Assay and DPP® HIV 1/2 –Syphilis Assay, which latter assay is not yet approved to be marketed in the U.S.), or which may be marketed pursuant to private label license or distribution agreements such as those with the Oswaldo Cruz Foundation ("FIOCRUZ"), Labtest, and Bio-Rad.

Research and development ("R&D"), milestone, and grant revenues for the nine months ended September 30, 2017 increased to $3.10 million from $3.03 million in the prior-year period, which was primarily the result of increased R&D project revenues in 2017.

R&D expenses in the nine months ended September 30, 2017 were $6.03 million, compared with $6.27 million in the prior-year period. Development work continues on several assays utilizing Chembio's DPP® platform, including the DPP® HIV multiplex tests that are designed to detect various infectious diseases such as Zika, Malaria, Dengue and other fever diseases partially funded by projects and grants.

 

Sexually Transmitted Disease

 

 

Fever & Tropical Disease

 

·         DPP® Malaria Assay: The DPP® Malaria Assay is a rapid, POC, multiplex test for the simultaneous detection of plasmodium falciparum and other plasmodium infections. In January 2015, we received a grant from the Bill & Melinda Gates Foundation to expedite the development and feasibility testing of a POC DPP® Malaria Assay. The Company completed this project, which compared the new DPP® malaria assay to the world's leading currently-available POC Malaria Assay with favorable results: a ten-fold improvement in sensitivity.  In April 2016, we received a second malaria grant from the Bill & Melinda Gates Foundation to expedite the feasibility testing and development of the world's first oral fluid/saliva POC diagnostic test to simply and accurately identify individuals infected with all species of malaria. We completed the feasibility and delivered DPP® Malaria Assay prototypes to a partner of the Bill & Melinda Gates Foundation for a lab evaluation, which was completed successfully during the third quarter of 2017.

 

·         DPP® Dengue Fever Assay: The DPP® Dengue Fever Assay is a rapid, POC, multiplex test for the simultaneous detection of IgG/IgM and NS1 antigens. During 2016, Chembio announced collaborations with Bio-Manguinhos, the unit of the Oswaldo Cruz Foundation (Fiocruz) responsible for the development and production of vaccines, diagnostics, and biopharmaceuticals, primarily to meet the demands of Brazil's national public health system related to the DPP® Dengue Fever Assay. We completed verification and validation studies, and production of pilot lots, to support preclinical studies. During 2016, we initiated registration in Southeast Asia and initiated commercialization of the DPP® Dengue Assay in Southeast Asia during the first quarter of 2017.

 

·         DPP® Zika Assay: The DPP® Zika Assay is a rapid POC stand-alone test for the simultaneous detection of IgM/IgG antibodies. In February 2016, we received a grant from The Paul G. Allen Family Foundation to initiate development of the DPP® Zika Assay. During 2016, Chembio announced collaborations with Bio-Manguinhos, the unit of the Oswaldo Cruz Foundation (Fiocruz) responsible for the development and production of vaccines, diagnostics, and biopharmaceuticals, primarily to meet the demands of Brazil's national public health system, related to the DPP® Zika Assay. In August 2016, the Company received an award from the U.S. Government (HHS/ASPR/BARDA), granting the Company up to $13.2 million ($5.9 million to develop DPP® Zika Assay and obtain U.S. regulatory approval). The Company obtained CE mark in July 2016, and then began selling in the Caribbean region via its distribution partner, Isla Lab, LLC. In September 2016, the Company received a contract award from CDC, to initiate a Zika surveillance program in India, Peru, Guatemala, and Haiti, and we began selling the DPP® Zika IgM/IgG Assay to CDC for field testing purposes during the first quarter of 2017. The Company received approval by the Brazilian health regulatory authority, Agência Nacional de Vigilância Sanitária (ANVISA), for the DPP® Zika IgM/IgG Assay in November 2016 and for the DPP® Micro Reader in July 2017, in collaboration with Bio-Manguinhos/Fiocruz. In September 2017, the Company became the first to receive FDA Emergency Use Authorization for a rapid Zika test.

 

·         DPP® Chikungunya Assay: The DPP® Chikungunya Assay is a rapid, POC, multiplex test for the simultaneous detection of IgG/IgM antibodies. During 2016, Chembio announced collaborations with Bio-Manguinhos, the unit of the Oswaldo Cruz Foundation (Fiocruz) responsible for the development and production of vaccines, diagnostics, and biopharmaceuticals, primarily to meet the demands of Brazil's national public health system, related to the DPP® Chikungunya Assay. During 2017, we initiated registration to begin initial commercialization in Southeast Asia.

 

·         DPP® Zika/Dengue/Chikungunya Assay: The DPP® Zika/Dengue/Chikungunya Assay is a rapid, POC, multiplex test for the simultaneous detection of IgM/IgG antibodies. In February 2016, we received a grant from The Paul G. Allen Family Foundation to initiate development of the DPP® Zika/Dengue/Chikungunya Assay. During 2016, Chembio announced collaborations with Bio-Manguinhos, the unit of the Oswaldo Cruz Foundation (Fiocruz) responsible for the development and production of vaccines, diagnostics and biopharmaceuticals, primarily to meet the demands of Brazil's national public health system, related to the DPP® Zika/Dengue/Chikungunya Assay. In August 2016, the Company received an award from the U.S. Government (HHS/ASPR/BARDA), granting the Company up to $13.2 million (including an option of $7.3 million to develop DPP® Zika/Dengue/Chikungunya Assay and obtain U.S. regulatory approval). In September 2016, the Company received a contract award from CDC to initiate a Zika, Dengue, and Chikungunya surveillance program in India, Peru, Guatemala, and Haiti, and we began selling the DPP® Zika/Dengue/Chikungunya IgM/IgG Assay to CDC during the first quarter of 2017. 

 

·         DPP® Fever Panel Assay (1): The DPP® Fever Panel Assay (1) is a rapid, POC, multiplex test for the simultaneous detection of Malaria, Dengue, Chikungunya, Zika, Ebola, Lassa, and Marburg. In October 2015, we received a $2.1 million grant from the Paul G. Allen Ebola Program to develop the DPP® Fever Panel Assay (1) and a $0.55 million follow-on grant to add a test for the detection of Zika virus. We completed the development of the DPP® Fever Panel Assay in 2016, including the addition of Zika, and we supplied 10,000 DPP® Fever Panel Assays (1) to FIND, which initiated field evaluation in Peru and Nigeria. The field evaluation is completed, FIND is analyzing the data, and expected to deliver the final report in the first quarter of 2018.

 

·         DPP® Fever Panel Assay (2): The DPP® Fever Panel Assay (2) is a rapid, POC, multiplex test for the simultaneous detection of Malaria, Dengue, Chikungunya, Zika, leptospirosis, Rickettsia typhi, Burkholderia pseudomallei, and Orientia tsutsugamushi. In April 2017, the Company announced collaboration with FIND, to develop a DPP® Fever Panel Assay (2) for the Asian market. Development is ongoing and on schedule.

 

·         DPP® Ebola Assay and DPP® Malaria-Ebola Assay: The DPP® Ebola Assay is a rapid POC test for the detection of Ebola, and the DPP® Malaria-Ebola Assay is a rapid, POC, multiplex test for the simultaneous detection of Malaria and Ebola. In October 2014, we announced plans to develop, validate, and commercialize POC DPP® Assays for Ebola and Febrile Illness. We completed the development of the DPP® Ebola Assay and submitted it for Emergency Use Authorization (EUA) with the Food & Drug Administration (FDA) and World Health Organization (WHO), and we are actively engaged with these regulatory agencies. During the third and fourth quarters of 2015, we sold DPP® Ebola and DPP® Malaria-Ebola Assays to the Centers for Disease Control & Prevention (CDC) for field studies in West Africa, which is ongoing.

 

Technology Collaboration

 

·         DPP® Cancer Assay: The DPP® Cancer Assay is a rapid, POC, multiplex test for the early detection and monitoring of a specific type of cancer. In October 2014, we entered into collaboration with an international diagnostics company to develop a POC diagnostic test for a specific type of cancer. This program is fully funded by this partner. However, under the terms of the agreement, neither Chembio's partner nor the specific type of cancer is being disclosed. The cancer project represents an application of the DPP® technology outside of the infectious disease field, and the scope of the agreement involves product development of a quantitative, reader-based cancer assay for two cancer markers, utilizing Chembio's DPP® technology and DPP® Micro Reader. During the third quarter of 2015, we completed successful feasibility, and our partner agreed to fund continued development and verification of the DPP® Cancer Assay, which are ongoing.

 

·         DPP® Traumatic Brain Injury Assay: The DPP® Traumatic Brain Injury Assay is a rapid POC test for the detection of traumatic brain injury (TBI) and sports-related concussion. In January 2015, we entered into an agreement with the Concussion Science Group (CSG) Division of Perseus Science Group LLC, to combine CSG's patented biomarker with our proprietary DPP® platform and DPP® Micro Reader, to develop a semi-quantitative or quantitative POC test, to diagnose TBI. The DPP® Traumatic Brain Injury Assay is in the feasibility and pre-clinical stage. Under institutional review board (IRB) agreements with multiple hospitals, we are conducting pre-clinical studies of the prototype DPP® Traumatic Brain Injury Assay using patient samples.

 

·         DPP® Bovine Tuberculosis: The DPP® BovidTB Assay is a rapid POC test for the detection of bovine tuberculosis (TB). In September 2016, the Company was awarded a $600,000 grant from the United States Department of Agriculture (USDA) to develop the DPP® BovidTB Assay. The grant is managed by the Small Business Innovation Research Program (SBIR) of the National Institute of Food and Agriculture (NIFA), a federal agency within the USDA, and the assay is being developed in collaboration with National Animal Disease Center (NADC) and Infectious Disease Research Institute (IDRI). Under the two-year grant, Chembio is using its patented DPP® technology to undertake to develop a simple, rapid, accurate and cost-effective test for bovine TB in cattle. The DPP® BovidTB Assay is being designed to provide results within 20 minutes, thereby significantly improving on the time-consuming, tedious and inadequate diagnostic methods currently in use.

 

 

·         DPP® HIV-Syphilis Assay: We have developed a U.S. version of the DPP® HIV-Syphilis Assay, designed to meet the performance requirements for the "reverse" algorithm that is currently in clinical use for syphilis testing in the United States. The clinical trial to support the FDA application for the DPP® HIV-Syphilis Assay, initiated during first quarter of 2016, has been completed. In March 2017, the FDA requested further studies in addition to the clinical studies recently completed, which are in progress and expected to be complete during the fourth quarter of 2017, in preparation for filing the Premarket Approval Application.

 

·         DPP® Zika IgM/IgG System: The DPP® Zika IgM/IgG System, which includes the DPP® Zika Assay and DPP® Micro Reader, obtained CE mark, allowing the product to be commercialized in Europe as well as the majority of the Caribbean nations. In November of 2016, the Company received approval from ANVISA, Brazil's regulatory Agency, for the DPP® Zika IgM/IgG Assay, and in July 2017, the Company received ANVISA approval for the DPP® Micro Reader, in collaboration with Bio-Manguinhos.  In September 2017, the Company received FDA Emergency Use Authorization, allowing the Company to commercialize the DPP® Zika System in the United States, Puerto Rico, and the U.S. Virgin Islands. The Company has also filed regulatory submissions with the World Health Organization (Emergency Use Assessment and Listing) and with COFEPRIS (Mexico), and we are actively engaged with these organizations.

 

There can be no assurance that any of the aforementioned Research & Development and/or regulatory products or activities will result in any product approvals or commercialization, nor that any of the existing research and development activities, or any new potential development programs or collaborations will materialize or that they will meet regulatory or any other technical requirements and specifications, and/or that if continued, will result in completed products, or that such products, if they are successfully completed, can or will be successfully commercialized.

Critical Accounting Policies and Estimates

 

We believe that there are several accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amounts of revenue and the more significant areas involving management's judgments and estimates. These significant accounting policies relate to revenue recognition, research and development costs, valuation of inventory, valuation of long-lived assets, goodwill, and income taxes. For a summary of our significant accounting policies, which have not changed from December 31, 2016, with the exception of goodwill, see our Annual Report on Form 10-K for the twelve months ended December 31, 2016, which was filed with the SEC on March 7, 2017.

 

 

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2017 AS COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2016

 

 

Income:

 

For the three months ended September 30, 2017, Loss before income taxes was $585,000 compared to $2,138,000 for the three months ended September 30, 2016. Net Loss for the 2017 period was $585,000 as compared to $2,138,000 for 2016. The decrease in Net Loss is primarily attributable to increased product revenues in the 2017 period over the 2016 period, together with smaller increases in R&D and royalty revenues, increased product gross margin, and a decrease in operating expenses. Product gross margin increased in the three months ended September 30, 2017, as compared with the three months ended September 30, 2016, by $1,360,000 or 192.19%.

Revenues for our lateral flow HIV (LF-HIV) tests and related components during the three months ended September 30, 2017 increased by approximately $819,000 from the same period in 2016. This was primarily attributable to increased sales to Africa of approximately $475,000, USA of approximately $272,000, and Europe of approximately $57,000. Revenues for our DPP® products during the three months ended September 30, 2017 increased by approximately $2,584,000 over the same period in 2016, primarily due to increased sales in Brazil. The increase in R&D, milestone and grant revenue, was primarily due to increased R&D project revenues in 2017.

Management is also focused on sales by region as well as sales by product types.  As a result, we are providing the following table which shows sales by region and by product type.

The overall gross margin dollar increase of $1,570,000 included a $1,360,000 increase in gross margin from product sales and an increase in non-product revenues of $210,000. The increase in net product sales gross margin of $1,360,000 is primarily attributable to the increase in sales compared to 2016. The net product sales gross margin increase is primarily affected by two components, one is the increase in product sales of $3,631,000, which, at the 28.3% margin percentage for September 30, 2016, contributed $1,027,000 to the increase, and the other is the increased change in margin percentage of 5.43%, which contributed $333,000 to the balance of the increase in our net product sales gross margin.

Research and development expenses include costs incurred for product development, regulatory approvals, clinical trials, and product evaluations.

Expenses for Clinical & Regulatory Affairs for the three months ended September 30, 2017 decreased by $18,000 as compared to the same period in 2016. This was primarily due to the decrease in clinical trial expenses of $29,000.

R&D expenses other than Clinical & Regulatory Affairs decreased by $440,000 in the three months ended September 30, 2017, as compared with the same period in 2016. The decreases were primarily related to a decrease in material and supplies, that resulted from the decrease in our sponsored research.

Selling, general and administrative expenses for the three months ended September 30, 2017, increased by $473,000 as compared with the same period in 2016, a 25.8% increase. This increase resulted primarily from increases in commissions, primarily due to increased sales to Brazil, wages and related costs due to an increase in sales staff, consulting, professional fees, travel, entertainment and trade shows, and other expenses which were partially offset by decreases in marketing material, and decreases in investor relations expense.

Other income for the three months ended September 30, 2017 decreased to $3,852, from income of $5,855 in the same period in 2016, primarily as a result of less interest income received as a result of less cash to invest.

The Company recorded a full valuation allowance for the three months ended September 30, 2017, on its deferred tax assets.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2017 AS COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2016

 

Income:

 

For the for the nine months ended September 30, 2017, Loss before income taxes was $4,373,000 compared to $4,988,000 for the for the nine months ended September 30, 2016, primarily as a result of higher net product sales, non-product revenues and reduction in R&D expenses partially offset by increased selling, general and administrative expenses. Net Loss for the 2017 period was $4,373,000 as compared to $10,789,000 for 2016. The decrease in Net Loss is primarily attributable to recording of a full valuation of approximately $5,801,000 on our Deferred Tax Asset (DTA) in the 2016 period, an increase in product revenues, an increase in R&D and royalty revenues, and increased product gross margin. Product gross margin increased in the nine months ended September 30, 2017, as compared with the nine months ended September 30, 2016, by $1,428,000 or 40.37%.

Revenues for our lateral flow HIV (LF-HIV) tests and related components for the nine months ended September 30, 2017 decreased by approximately $177,000 from the same period in 2016. This was primarily attributable to decreased sales in the U.S. of approximately $985,000, decreased sales to Latin America of approximately $61,000, and decreased sales to Asia of approximately $27,000, and partially offset by increased sales to Europe of approximately $768,000 and increased sales to Africa of approximately $140,000. Revenues for our DPP® products during the nine months ended September 30, 2017 increased by approximately $2,480,000 over the same period in 2016, primarily due to increased sales in Brazil, partially offset by decreased sales in Asia.  Revenues for our other products for the nine months ended September 30, 2017 increased by approximately $1,697,000, primarily as a result of sales from our Malaysia subsidiary. The increase in R&D, milestone and grant revenue, was primarily due to increased royalty revenues in 2017.

Management is also focused on sales by region as well as sales by product types.  As a result, we are providing the following table which shows sales by region and by product type.

The overall gross margin dollar increase of $1,842,000 included a $1,428,000 increase in gross margin from product sales and a $413,000 increase in non-product revenues. The increase in net product sales gross margin of $1,428,000 is primarily attributable to the increase in sales compared to 2016. The net product sales gross margin increase is primarily affected by two components, one is the increase in product sales of $4,000,000, which, at the 33.84% margin percentage for September 30, 2016, contributed $1,354,000 to the increase, and the other is the increased change in margin percentage of 0.51%, which contributed $74,000 to the balance of the increase in our net product sales gross margin.

Research and development expenses include costs incurred for product development, regulatory approvals, clinical trials, and product evaluations.

Expenses for Clinical & Regulatory Affairs for the nine months ended September 30, 2017 increased by $623,000 as compared to the same period in 2016. This was primarily due to the increase in clinical trial expenses of $598,000.

R&D expenses other than Clinical & Regulatory Affairs decreased by $854,000 for the nine months ended September 30, 2017, as compared with the same period in 2016. The decreases were primarily related to a decrease in material and supplies, that resulted from the decrease in our sponsored research.

Selling, general and administrative expenses for the nine months ended September 30, 2017, increased by $1,472,000 as compared with the same period in 2016, a 27.11% increase. This increase resulted primarily from increases in wages and related costs due to an increase in sales staff, professional fees, travel, entertainment and trade shows, increases in commissions, primarily due to increased sales to Brazil, stock-based compensation, and other expenses, primarily due to expenses from our Malaysian subsidiary, which were partially offset by decreases in marketing materials and deceases in investor relations expense.

Other income for the nine months ended September 30, 2017 increased to $ 24,956, from income of $ 9,729 in the same period in 2016, primarily as a result of interest income received as a result of more cash to invest.