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ERBA Diagnostics, Inc. 10-Q 2006

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2006

Commission File Number 1-14798

 


IVAX DIAGNOSTICS, INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware   11-3500746

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

2140 North Miami Avenue, Miami, Florida 33127

(Address of principal executive offices) (Zip Code)

(305) 324-2300

(Registrant’s telephone number, including area code)

 


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  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. Check one:

Large Accelerated Filer  ¨    Accelerated Filer  ¨    Non-Accelerated Filer  x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

27,631,887 shares of Common Stock, $ .01 par value, outstanding as of May 8, 2006.

 



Table of Contents

IVAX DIAGNOSTICS, INC.

INDEX

 

             PAGE NO.
PART I - FINANCIAL INFORMATION   
  Item 1 -   Financial Statements   
    Consolidated Balance Sheets as of March 31, 2006 (unaudited) and December 31, 2005    2
    Consolidated Statements of Operations (unaudited) for the three months ended March 31, 2006 and 2005    3
    Consolidated Statements of Shareholders’ Equity (unaudited) for the three months ended March 31, 2006    4
    Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2006 and 2005    5
    Condensed Notes to Consolidated Financial Statements (unaudited)    6
  Item 2 -   Management’s Discussion and Analysis of Financial Condition and Results of Operations    14
  Item 3 -   Quantitative and Qualitative Disclosures about Market Risk    25
  Item 4 -   Controls and Procedures    26
PART II - OTHER INFORMATION   
  Item 1 –   Legal Proceedings    28
  Item 6 -   Exhibits    28


Table of Contents

PART I - FINANCIAL INFORMATION

Item 1 - Financial Statements

IVAX DIAGNOSTICS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

    

March 31,

2006

   

December 31,

2005

 
     (Unaudited)        
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 4,474,560     $ 11,479,568  

Marketable securities

     5,825,011       122,045  

Accounts receivable, net of allowances for doubtful accounts of $1,003,537 in 2006 and $973,855 in 2005

     7,349,782       6,695,353  

Inventories, net

     5,773,653       5,608,584  

Other current assets

     996,422       1,164,890  
                

Total current assets

     24,419,428       25,070,440  

Property, plant and equipment, net

     2,531,734       2,213,581  

Equipment on lease

     559,267       585,295  

Product license

     1,255,936       1,255,936  

Goodwill, net

     6,707,569       6,722,725  

Other assets

     60,866       55,553  
                

Total assets

   $ 35,534,800     $ 35,903,530  
                
LIABILITIES AND SHAREHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 1,117,217     $ 1,190,204  

Accrued license payable

     969,932       947,920  

Accrued expenses and other current liabilities

     2,960,415       2,895,836  
                

Total current liabilities

     5,047,564       5,033,960  
                

Stock option compensation liability

     177,000       —    

Other long-term liabilities

     724,374       680,006  
                

Total liabilities

     5,948,938       5,713,966  
                

Commitments and contingencies

    

Shareholders’ equity:

    

Common stock, $0.01 par value, authorized 50,000,000 shares, issued and outstanding 27,631,887 in 2006 and 27,623,554 in 2005

     276,318       276,235  

Capital in excess of par value

     40,600,200       40,548,950  

Accumulated deficit

     (10,255,545 )     (9,458,371 )

Accumulated other comprehensive loss

     (1,035,111 )     (1,177,250 )
                

Total shareholders’ equity

     29,585,862       30,189,564  
                

Total liabilities and shareholders’ equity

   $ 35,534,800     $ 35,903,530  
                

The accompanying Notes to Consolidated Financial Statements are an integral part of these balance sheets.

 

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Table of Contents

IVAX DIAGNOSTICS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

Three Months Ended March 31,

   2006     2005  

Net revenues

   $ 4,718,385     $ 5,382,611  

Cost of sales

     1,984,653       2,136,239  
                

Gross profit

     2,733,732       3,246,372  
                

Operating expenses:

    

Selling

     1,491,835       1,513,457  

General and administrative

     1,438,797       1,152,100  

Research and development

     492,548       394,769  

Bad debt recovery

     —         (1,690,000 )
                

Total operating expenses

     3,423,180       1,370,326  
                

Income (loss) from operations

     (689,448 )     1,876,046  
                

Other income:

    

Interest income

     119,787       69,261  

Other expense, net

     (10,907 )     (64,243 )
                

Total other income, net

     108,880       5,018  
                

Income (loss) before income taxes

     (580,568 )     1,881,064  

Provision for income taxes

     15,606       1,043,006  
                

Income (loss) before cumulative effect of change in accounting principle

     (596,174 )     838,058  

Cumulative effect of change in accounting principle

     (201,000 )     —    
                

Net income (loss)

   $ (797,174 )   $ 838,058  
                

Net income (loss) per share, before cumulative effect of change in accounting principle

    

Basic and diluted

   $ (0.02 )   $ 0.03  
                

Cumulative effect of change in accounting principle, per share

    

Basic and diluted

   $ (0.01 )   $ —    
                

Net income (loss) per share

    

Basic and diluted

   $ (0.03 )   $ 0.03  
                

WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:

    

Basic

     27,623,832       27,019,829  
                

Diluted

     27,623,832       27,955,340  
                

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 

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IVAX DIAGNOSTICS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Unaudited)

 

     Common Stock   

Additional

Paid-in

Capital

  

Accumulated

Deficit

   

Accumulated

Other

Comprehensive

Loss

   

Total

Shareholders’

Equity

 
   Shares    Amount          

BALANCE, December 31, 2005

   27,623,554      276,235      40,548,950      (9,458,371 )     (1,177,250 )     30,189,564  

Comprehensive loss:

               

Net loss

   —        —        —        (797,174 )     —         (797,174 )

Translation adjustment

   —        —        —        —         142,139       142,139  
                     

Comprehensive loss

                  (655,035 )

Stock-based compensation

   —        —        30,000      —         —         30,000  

Exercise of stock options

   8,333      83      21,250      —         —         21,333  
                                           

BALANCE, March 31, 2006

   27,631,887    $ 276,318    $ 40,600,200    $ (10,255,545 )   $ (1,035,111 )   $ 29,585,862  
                                           

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 

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IVAX DIAGNOSTICS AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

Three Months Ended March 31,

   2006     2005  

Cash flows from operating activities:

    

Net (loss)/income

   $ (797,174 )   $ 838,058  

Adjustments to reconcile net income to net cash flows provided by (used in) operating activities:

    

Depreciation and amortization

     182,888       230,761  

Cumulative effect of change in accounting principle

     201,000       —    

Bad debt recovery

     —         (1,690,000 )

Provision for doubtful accounts receivable

     13,428       10,158  

Provision for inventory obsolescence

     120,464       24,000  

Non-cash compensation

     6,000       —    

Deferred income taxes

     —         1,020,143  

Changes in operating assets and liabilities:

    

Accounts receivable

     (549,699 )     (573,193 )

Inventories

     (224,635 )     90,756  

Other current assets

     190,955       128,473  

Other assets

     (3,918 )     —    

Accounts payable and accrued expenses

     (43,740 )     83,790  

Other long-term liabilities

     27,541       13,057  
                

Net cash flows provided by (used in) operating activities

     (876,890 )     176,003  
                

Cash flows from investing activities:

    

Capital expenditures

     (383,626 )     (18,374 )

Purchases of marketable securities

     (5,702,966 )     (8,500,000 )

Sales of marketable securities

     —         2,800,000  

Acquisition of product license

     —         (277,717 )

Acquisitions of equipment on lease

     (59,012 )     (75,550 )
                

Net cash flows used in investing activities

     (6,145,604 )     (6,071,641 )
                

Cash flows from financing activities:

    

Exercise of stock options

     21,333       —    
                

Net cash flows provided by financing activities

     21,333       —    
                

Effect of exchange rate changes on cash and cash equivalents

     (3,847 )     14,513  
                

Net decrease in cash and cash equivalents

     (7,005,008 )     (5,881,125 )

Cash and cash equivalents at the beginning of the period

     11,479,568       7,492,885  
                

Cash and cash equivalents at the end of the period

   $ 4,474,560     $ 1,611,760  
                

Supplemental disclosures:

    

Cash payment for interest

   $ —       $ —    
                

Cash payment for income taxes

   $ 87,147     $ —    
                

Noncash investing activities:

    

Acquisition of product license

   $ —       $ 1,030,000  
                

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 

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IVAX DIAGNOSTICS, INC. AND SUBSIDIARIES

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) GENERAL:

The accompanying unaudited interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q and, therefore, do not include all information normally included in audited financial statements. Certain prior period amounts have been reclassified to conform to the current period’s presentation. However, in the opinion of management, all adjustments necessary to present fairly the results of operations, financial position and cash flows have been made. The results of operations, financial position and cash flows for the three months ended March 31, 2006 are not necessarily indicative of the results of operations, financial position and cash flows which may be reported for the remainder of 2006. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes to consolidated financial statements included in the IVAX Diagnostics, Inc. (“IVAX Diagnostics,” “the Company,” “we,” “us,” “our”) Annual Report on Form 10-K for the year ended December 31, 2005.

On March 14, 2001, b2bstores.com Inc. (“b2bstores.com”), IVAX Corporation (“IVAX”) and IVAX Diagnostics, Inc., a wholly-owned subsidiary of IVAX at that date (the “pre-merger IVAX Diagnostics”), consummated a merger of the pre-merger IVAX Diagnostics into b2bstores.com pursuant to which all of the issued and outstanding shares of the pre-merger IVAX Diagnostics were converted into 20,000,000 shares of b2bstores.com stock and b2bstores.com’s name was changed to IVAX Diagnostics, Inc.

On July 25, 2005, IVAX, the Company’s approximately 72.4% stockholder, entered into a definitive agreement and plan of merger with Teva Pharmaceutical Industries Limited (“Teva”) providing for IVAX to be merged into a wholly-owned subsidiary of Teva. On January 26, 2006, the merger was consummated and IVAX became a wholly-owned subsidiary of Teva for an aggregate purchase price of approximately $3.8 billion in cash and 123 million Teva ADRs. The transaction was reported to be valued, for accounting purposes, at $7.9 billion, based on the value of the Teva ADRs during the five trading day period commencing two trading days before the date of the definitive agreement and plan of merger. As a result of the merger, Teva now, indirectly through its IVAX subsidiary, owns approximately 72.4% of the outstanding shares of the Company’s common stock.

(2) STOCK-BASED COMPENSATION:

At March 31, 2006 the Company had the two stock-based employee compensation plans described below. As a result of adopting Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”), on January 1, 2006, the Company recorded total compensation expense related to these plans of $6,000 for the three months ended March 31, 2006. Prior to January 1, 2006 the Company accounted for these plans under the recognition and measurement of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and the Company provided pro-forma disclosure amounts in accordance with SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, as if the fair value method defined by the original provisions of SFAS No. 123, Accounting for Stock-Based Compensation, had been applied to its stock-based compensation.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123(R), using the modified prospective transition method and therefore has not restated prior periods’ results. Under this transition method, stock-based compensation expense for the three months ended March 31, 2006 included compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimate in accordance with the

 

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original provisions of SFAS 123. Stock-based compensation expense for all share-based payment awards granted after January 1, 2006 is based on the grant-date fair value estimate in accordance with the provisions of SFAS 123(R). The Company estimates forfeitures for employee stock options and recognizes the compensation costs for only those options expected to vest. Forfeiture rates are determined for two groups, for directors and senior management and for all other employees, based upon historical experience. Estimated forfeitures are now adjusted to actual forfeiture experience as needed.

As a result of adopting SFAS 123(R), the impact to the accompanying consolidated statement of operations for the three months ended March 31, 2006 was $6,000 lower for income before taxes and $207,000 lower for net income, considering the cumulative effect adjustment disclosure below, than if the Company had continued to account for stock-based compensation under APB 25. The impact on both basic and diluted earnings per share for the three months ended March 31, 2006 was $(0.01).

Additionally the adoption of SFAS 123(R) resulted in a cumulative effect adjustment of $201,000, which reflects the change in classification of certain options granted in March 2001 from an equity award grant to a liability award in accordance with SFAS 123(R). The award has an acceleration provision, pursuant to which the holder of the award can accelerate the vesting by purchasing stock of the Company. Under SFAS 123(R), this award requires reclassification as a liability.

The pro forma table below reflects net earnings and basic and diluted earnings per share for the three months ended March 31, 2005, had the Company applied the fair value recognition provisions of the original SFAS 123 as follows:

 

     2005

Net income as reported

   $ 838,058

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards

     75,694
      

Pro forma net income

   $ 762,364
      

Pro forma basic and diluted income per share

   $ 0.03
      

Valuations are based on highly subjective assumptions about the future, including stock price volatility and exercise patterns. During the fourth quarter of 2005, it was determined that options granted in 2004 and that vested immediately were not fully expensed in the year ended December 31, 2004.

The Company maintains two stock option plans. The first, the IVAX Diagnostics, Inc. 1999 Stock Option Plan (the “1999 Plan”), became effective June 29, 1999 when approved by the Board of Directors and the sole stockholder of the pre-merger IVAX Diagnostics. The 1999 Plan permits the issuance of options to employees, non-employee directors and consultants to purchase up to 2,000,200 shares of common stock. At the effective time of the merger with b2bstores.com, automatically and without any action on the part of an option holder, the surviving company assumed the 1999 Plan and each outstanding option granted under the 1999 Plan as an option to purchase shares of the surviving company’s common stock under the same terms and conditions as the outstanding option. As of March 31, 2006, 18,000 options to purchase shares of common stock were outstanding under the 1999 Plan. The Company does not have any current intention of issuing any additional stock options under the 1999 Plan.

 

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The Company’s second stock option plan was created on September 30, 1999 when the Board of Directors and stockholders of b2bstores.com approved the 1999 Performance Equity Plan (the “Performance Plan”). The Performance Plan authorizes the grant of up to 2,000,000 shares of common stock to key employees, officers, directors and consultants. Both incentive and non-qualified options may be issued under the Performance Plan. As of March 31, 2006, 721,199 options to purchase shares of common stock were outstanding under the Performance Plan.

The fair value of share-based payment awards was estimated using the Black-Scholes option pricing model. Expected volatilities are based on the historical volatility of the Company’s stock. The Company uses historical data to estimate option exercise and employee terminations. The expected term of options granted represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods within the expected life of the option is based on the US Treasury yield curve in effect at the time of the grant.

Options granted under these option plans were granted at an option exercise price equal to the closing market value of the stock on the date of the grant and with vesting, primarily for Company employees, all at once after seven years or in equal annual amounts over a four year period, and, primarily for non-employee directors, immediately. The following charts summarize option activity under the Performance Plan for options granted by the Company after the consummation of the merger with b2bstores.com and transactions under the 1999 Plan as of March 31, 2006 and changes during the three months ended March 31, 2006:

 

    

Number of

Shares

  

Weighted

Average

Exercise Price

Outstanding at December 31, 2005

   739,199    $ 4.22

Granted

   —        —  

Cancellations

   —        —  

Terminated

   —        —  

Exercised

   —        —  
       

Outstanding at March 31, 2006

   739,199    $ 4.22
           

 

    Options Outstanding   Options Exercisable

Range of

Exercise Prices

 

Number

Outstanding

 

Weighted
Average

Remaining

Contractual Life

(In Years)

 

Weighted
Average

Exercise Price

  Number
Exercisable
 

Weighted
Average

Exercise Price

$0.73   18,000   0.3   $ 0.73   18,000   $ 0.73
$1.35 - $2.40   82,350   3.2   $ 2.10   73,050   $ 2.06
$2.88 - $3.00   235,000   2.0   $ 2.98   60,000   $ 2.93
$4.35 –   4.91   165,000   9.2   $ 4.37   145,000   $ 4.37
$5.20 –   7.12   238,849   5.0   $ 6.32   211,924   $ 6.29
               
  739,199   4.7     507,974   $ 4.54
               

 

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The aggregate intrinsic value of the outstanding options and exercisable options was $24,019 and $17,242, respectively, at March 31, 2006. No grants were made during the three months ended March 31, 2006 or 2005. No options were exercised during the three months ended March 31, 2006 and 2005.

A summary of the status of the Company’s non-vested options as of March 31, 2006 and changes during the three month period is presented below:

 

Non-vested Options

  

Number of

Shares

   

Weighted

Average

Grant-date

Fair Value

Outstanding at December 31, 2005

   237,187     $ 2.88

Granted

   —         —  

Vested

   (5,962 )     5.03

Terminated

   —         —  

Exercised

   —         —  
        

Outstanding at March 31, 2006

   231,225     $ 2.83
            

As of March 31, 2006 there was $245,000 of unrecognized compensation costs, based on the fair value of unvested awards, related to non-vested share-based compensation arrangements granted under the Performance Plan. This cost is expected to be recognized over a weighted average period of 2.3 years. No windfall tax benefits were recognized in the three months ended March 31, 2006 or 2005.

The $21,333 cash received from option exercises under share-based payment arrangements during the three months ended March 31, 2006 was from pre-merger options granted to employees of b2bstores.com. Pre-merger options granted to employees of b2bstores.com who never became employees of IVAX Diagnostics were not included in the Company’s calculations made in connection with the adoption of SFAS 123(R). As of March 31, 2006, no pre-merger options issued to former employees of b2bstores.com remain outstanding.

(3) BAD DEBT RECOVERY:

On May 12, 2005, the Company received a payment of approximately 2,000,000 Euro from a governmental region in Italy in satisfaction of previously outstanding accounts receivable balances from hospitals located in the region. A significant portion of this payment related to accounts receivable against which the Company had previously established allowances. Since this collection of these receivables occurred prior to the filing of the Company’s Quarterly Report on Form 10-Q for the three months ended March 31, 2005, and in order to recognize the impact of this collection of these receivables, the Company reduced its allowance for doubtful accounts on its consolidated balance sheet at March 31, 2005 and recognized a corresponding bad debt recovery of $1,690,000 in the accompanying consolidated statement of operations for the three months ended March 31, 2005.

(4) CASH EQUIVALENTS AND SHORT-TERM MARKETABLE SECURITIES:

The Company owns certain short-term investments in marketable debt securities with original maturities of three months or less that are classified as cash equivalents.

 

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Substantially all cash and cash equivalents are presently held at one national securities brokerage firm. Accordingly, the Company is subject to credit risk if this brokerage firm is unable to repay the balance in the account or deliver the Company’s securities or if the brokerage firm should become bankrupt or otherwise insolvent. It is the Company’s intent to maintain a liquid portfolio to take advantage of investment opportunities and it is the Company’s policy to invest in select money market instruments, municipal securities and corporate issuers. At March 31, 2006 and December 31, 2005, the Company owned short-term marketable securities totaling $5,825,011 and $122,045, respectively. Short-term investments in marketable debt securities are primarily auction rate securities with final maturities longer than one year, but with interest rates resetting every 28 or 35 days through an auction mechanism. These short-term marketable securities consist primarily of taxable municipal bonds and government agency securities and were deemed short-term, classified as available for sale securities and recorded at cost which approximates market value based on quoted market prices. Also included in marketable securities at March 31, 2006 and December 31, 2005 is $125,011 and $122,045, respectively, in Italian bank bonds held by the Company’s Italian subsidiary that are used to support guarantees provided by the Company.

The contractual maturity dates of the Company’s investments in marketable debt securities at March 31, 2006 range from 2028 to 2045. The expected maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with and without prepayment penalties.

(5) INVENTORIES, NET:

Inventories, net consist of the following:

 

    

March 31,

2006

  

December 31,

2005

Raw materials

   $ 1,676,565    $ 1,472,994

Work-in-process

     1,237,386      1,223,572

Finished goods

     2,859,702      2,912,018
             

Total inventories, net

   $ 5,773,653    $ 5,608,584
             

(6) PRODUCT LICENSE:

In September 2004, the Company entered into a license agreement with an Italian diagnostics company to obtain a perpetual, worldwide, royalty-free license of product technology presently used by the Italian diagnostics company to manufacture hepatitis products currently sold by them. In exchange, the Company agreed to pay four milestone payments totaling 1,000,000 Euro upon the Italian diagnostics company’s achievement of certain enumerated performance objectives. In March 2005, the Company paid the first of these milestone payments, in the amount of 200,000 Euro. As a result of the satisfaction of the first milestone, the Company determined that payment of the three remaining milestone payments was probable and, consequently, an accrued license payable for the remaining 800,000 Euro was recorded during the first quarter of 2005. The outstanding balance of this accrued license payable as of March 31, 2006 and December 31, 2005 in the accompanying consolidated balance sheets was $969,932 and $947,920, respectively. The three remaining milestone payments relate to two remaining performance objectives that the Italian diagnostics company is working to achieve on or prior to October 31, 2006 and one remaining performance objective that the Italian diagnostics company is working to achieve on or prior to March 31, 2007. Among the other events and actions included in these future milestones are requirements that training be provided to the Company. This training will be expensed as incurred, and a corresponding amount will be recognized as a reduction to the product license recorded in the accompanying consolidated balance sheet.

 

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(7) EARNINGS PER SHARE:

A reconciliation of the denominator of the basic and diluted earnings per share computation is as follows:

 

Three Months Ended March 31,

   2006    2005

Basic weighted average shares outstanding

   27,623,832    27,019,829

Effect of dilutive securities – stock options and warrants

   —      935,511
         

Diluted weighted average number of shares outstanding

   27,623,832    27,955,340
         

Not included in the calculation of diluted earnings per share because their impact is antidilutive:

     

Stock options and warrants outstanding

   739,199    465,349
         

(8) INCOME TAXES:

The provision for income taxes consists of the following:

 

Three Months Ended March 31,

   2006    2005

Current:

     

Foreign

   $ 15,606    $ 22,863

Deferred:

     

Foreign

     —        1,020,143
             

Total provision for income taxes

   $ 15,606    $ 1,043,006
             

The Company’s income tax provision for the three months ended March 31, 2006 was different from the amount computed on the income (loss) before income taxes at the statutory rate of 35% primarily due to the increase of the valuation allowance to offset the benefit of both domestic and foreign losses. The Company’s income tax provision for the three months ended March 31, 2005 was different from the amount computed on the income (loss) before income taxes at the statutory rate of 35% primarily due to deferred taxes related to the allowance for doubtful accounts that was reduced during the first quarter of 2005 as a result of the collection of certain previously reserved Italian accounts receivable and the creation of a valuation allowance to fully reserve the remaining foreign deferred tax asset of $467,511. This valuation allowance was created due to the recent losses by the Company’s Italian operation. No domestic tax provision was recorded for the three months ended March 31, 2005 due to the expected utilization of prior period net operating losses to offset current domestic taxable income. The current income tax provisions for the three months ended March 31, 2006 and 2005 were the result of Italian local income taxes based upon applicable statutory rates effective in Italy.

The Company has established a full valuation allowance on its net deferred tax assets, which are primarily comprised of net operating loss carryforwards. As of March 31, 2006 and December 31, 2005, the Company had no net domestic deferred tax asset, as domestic net operating losses generated prior to the merger with b2bstores.com were utilized by IVAX and a full valuation allowance has been established against domestic deferred tax assets generated subsequent to March 14, 2001. Additionally, as of March 31, 2006 and December 31, 2005, the Company had no net foreign deferred tax asset, as a full valuation allowance was provided during the first quarter of 2005 as a result of recent losses by the Company’s Italian operation. Subsequent revisions to the estimated net realizable value of the deferred tax asset could cause the provision for income taxes to vary significantly from period to period.

The Company’s net operating loss carryforwards may be limited in the future as a result of the acquisition of IVAX by Teva.

 

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(9) COMPREHENSIVE INCOME (LOSS):

The components of the Company’s comprehensive income (loss) are as follows:

 

Three Months Ended March 31,

   2006     2005  

Net income (loss)

   $ (797,174 )   $ 838,058  

Foreign currency translation adjustments

     142,139       (311,294 )
                

Comprehensive income (loss)

   $ (655,035 )   $ 526,764  
                

(10) CONCENTRATION OF CREDIT RISK:

The Company performs periodic credit evaluations of its customers’ financial condition and provides allowances for doubtful accounts as required. The Company’s accounts receivables are generated from sales made from both the United States and Italy. As of March 31, 2006 and December 31, 2005, $5,233,870 and $4,633,747, respectively, of the Company’s total net accounts receivable were due in Italy. Of the total net accounts receivable, 60.1% at March 31, 2006 and 57.0% at December 31, 2005 were due from hospitals and laboratories controlled by the Italian government.

(11) SEGMENT INFORMATION:

The Company’s management reviews financial information, allocates resources and manages its business by geographic region. The Domestic region, which includes corporate expenditures, contains the Company’s subsidiaries in the United States. The Italian region contains the Company’s subsidiary located in Italy. The information provided is based on internal reports and was developed and utilized by management for the sole purpose of tracking trends and changes in the results of the regions. The information, including the allocations of expense and overhead, was calculated based on a management approach and may not reflect the actual economic costs, contributions or results of operations of the regions as stand-alone businesses. If a different basis of presentation or allocation were utilized, the relative contributions of the regions might differ but the relative trends would, in management’s view, likely not be materially impacted. The table below sets forth net revenue, income (loss) from operations and assets by region.

 

      Three Months  

Net Revenues by Region Period Ended March 31,

   2006     2005  

Domestic

    

External net revenues

   $ 3,099,950     $ 3,573,868  

Intercompany revenues

     256,690       364,320  
                
     3,356,640       3,938,188  
                

Italian

    

External net revenues

     1,618,435       1,808,743  

Intercompany revenues

     126,469       55,810  
                
     1,744,904       1,864,553  
                

Eliminations

     (383,159 )     (420,130 )
                

Consolidated net revenues

   $ 4,718,385     $ 5,382,611  
                

 

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      Three Months  

Income (Loss) from Operations by Region Period Ended March 31,

   2006     2005  

Domestic

   $ (302,789 )   $ 284,008  

Italian

     (393,793 )     1,597,704  

Eliminations

     7,134       (5,666 )
                

Income (loss) from operations

   $ (689,448 )   $ 1,876,046  
                

Total Assets by Region

  

March 31,

2006

   

December 31,

2005

 

Domestic

   $ 19,919,018     $ 20,235,634  

Italian

     15,615,782       15,667,896  
                

Total assets

   $ 35,534,800     $ 35,903,530  
                

(12) COMMITMENTS AND CONTINGENCIES:

The Company is involved in various legal claims and actions and regulatory matters, and other notices and demand proceedings arising in the ordinary course of business. While it is not possible to predict or determine the outcome of these proceedings, in the opinion of management, based on a review with legal counsel, any losses resulting from such legal proceedings would not have a material adverse impact on the financial position, results of operations or cash flows of the Company.

(13) RECENTLY ISSUED ACCOUNTING STANDARDS:

Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123(R) using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, stock-based compensation expense for the first quarter of 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimate in accordance with the original provisions of SFAS 123. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant-date fair value estimate in accordance with the provisions of SFAS 123(R). The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of either immediately, all at once after seven years or in equal annual amounts over a four year period.

Prior to the adoption of SFAS 123(R), the Company accounted for stock-based compensation in accordance with APB 25.

 

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Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the consolidated financial statements and the related notes to consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 and the unaudited interim consolidated financial statements and the related notes to unaudited interim consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q. Certain prior period amounts have been reclassified to conform to the current period’s presentation.

We have made forward-looking statements, which are subject to risks and uncertainties, in this Quarterly Report on Form 10-Q. These statements are based on the beliefs and assumptions of our management and on the information currently available to it. Forward-looking statements may be preceded by, followed by, or otherwise include the words “may,” “will,” “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates,” “projects,” “could,” “would,” “should,” or similar expressions or statements that certain events or conditions may occur. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by these forward-looking statements. These forward-looking statements are based largely on our expectations and the beliefs and assumptions of our management and on the information currently available to it and are subject to a number of risks and uncertainties, including, but not limited to, the risks and uncertainties associated with:

 

    economic, competitive, political, governmental and other factors affecting us and our operations, markets and products;

 

    the success of technological, strategic and business initiatives, including our automation strategy and our development and commercial release of our new proprietary instrument system, named the PARSEC™ System;

 

    our ability to receive regulatory approval for the PARSEC™ System;

 

    the impact of the delay in the full commercial launch of the PARSEC™ System in the United States on our international activities associated with the PARSEC™ System;

 

    the ability of the PARSEC™ System to be available when or to perform as expected;

 

    the ability of the PARSEC™ System to be a factor in our growth;

 

    the ability of the PARSEC™ System to expand the menu of test kits we offer;

 

    making the PARSEC™ System our primary product;

 

    our ability to market the PARSEC™ System;

 

    our customers’ integration of the PARSEC™ System into their operations;

 

    constantly changing, and our compliance with, governmental regulation;

 

    our ability to update to ISO 13485:2003;

 

    the impact of our adoption or implementation of new accounting statements and pronouncements;

 

    our limited operating revenues and history of primarily operational losses;

 

    our ability to collect our accounts receivable and to make or change judgments and estimates regarding our allowances for doubtful accounts;

 

    our ability to utilize our deferred tax assets and to make or change judgments and estimates regarding our valuation allowances and reserves against our deferred tax assets;

 

    our ability to achieve cost advantages from our own manufacture of instrument systems, reagents and test kits;

 

    our ability to grow beyond the autoimmune and infectious disease markets and to expand into additional diagnostic test sectors;

 

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    our ability to internally manufacture our own hepatitis products and raw materials for these products, to obtain regulatory approval for these products and to become competitive in markets outside of the United States;

 

    our agreements with Teva, IVAX, third party distributors and key personnel;

 

    consolidation of our customers affecting our operations, markets and products;

 

    reimbursement policies of governmental and private third parties affecting our operations, markets and products;

 

    price constraints imposed by our customers and governmental and private third parties;

 

    our ability to increase the volume of our reagent production;

 

    our ability to consummate potential acquisitions of businesses or products;

 

    our ability to integrate acquired businesses or products;

 

    our ability to sell the current location of our Miami facility and to acquire a new location to which to relocate it;

 

    protecting our intellectual property;

 

    political and economic instability and foreign currency fluctuation affecting our foreign operations;

 

    the holding of substantially all of our cash and cash equivalents and marketable securities at a single brokerage firm, including risks relating to the bankruptcy or insolvency of such brokerage firm;

 

    litigation regarding products, distribution rights, intellectual property rights, product liability, and labor and employment matters;

 

    voting control of our common stock by Teva;

 

    conflicts of interest with Teva, IVAX and with our officers, directors and employees; and

 

    other factors discussed elsewhere in this Quarterly Report on Form 10-Q.

See the section entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, for further discussion of certain risks and uncertainties that could materially and adversely affect our business, operating results or financial condition. Many of these factors are beyond our control.

MAJORITY STOCKHOLDER

On July 25, 2005, IVAX, our approximately 72.4% stockholder, entered into a definitive agreement and plan of merger with Teva providing for IVAX to be merged into a wholly-owned subsidiary of Teva. On January 26, 2006, the merger was consummated and IVAX became a wholly-owned subsidiary of Teva for an aggregate purchase price of approximately $3.8 billion in cash and 123 million Teva ADRs. The transaction was reported to be valued, for accounting purposes, at $7.9 billion, based on the value of the Teva ADRs during the five trading day period commencing two trading days before the date of the definitive agreement and plan of merger. As a result of the merger, Teva now, indirectly through its IVAX subsidiary, owns approximately 72.4% of the outstanding shares of our common stock.

 

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RESULTS OF OPERATIONS

THREE MONTHS ENDED MARCH 31, 2006 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2005

OVERVIEW

Net loss for the three months ended March 31, 2006 was $797,000 compared to net income of $838,000 for the same period of 2005. The net loss for the three months ended March 31, 2006 includes the $201,000 cumulative effect of a change in accounting principle recorded in the three months ended March 31, 2006 as the result of our adoption of SFAS 123(R) on January 1, 2006. No cumulative effect of a change in accounting principle was recorded in the three months ended March 31, 2005. Operating loss was $689,000 in the three months ended March 31, 2006 compared to operating income of $1,876,000 in the same period of 2005. Net income and income from operations in 2006 significantly declined compared to 2005 principally due to an increase in operating expenses of $2,053,000, caused primarily by the 2005 bad debt recovery of $1,690,000 recorded when we reduced our allowance for doubtful accounts to recognize the impact of the May 12, 2005 collection of previously outstanding Italian accounts receivable from hospitals located within a particular region in Italy. Also contributing to the increase in operating expenses was an increase in research and development expenses of $98,000 and an increase in general and administrative expenses of $287,000. Revenue decreased by $665,000 to $4,718,000 in the three months ended March 31, 2006, with a corresponding decrease in gross profit of $512,000 to $2,734,000, primarily due to a decrease in domestic revenue from infectious disease products and, to a lesser extent, the effect of foreign currency fluctuations and a decrease in international antigen sales. Our tax provision was $16,000 for the three months ended March 31, 2006 compared to $1,043,000 in the same period last year. This decrease in the tax provision was primarily due to the recognition of deferred taxes in 2005 related to the impact of the collection of the Italian accounts receivable and the creation of a valuation allowance to fully reserve the remaining foreign deferred tax asset.

NET REVENUES AND GROSS PROFIT

 

Three months ended March 31,

   2006     2005    

Period over Period

Increase/(Decrease)

 

Net Revenues Excluding Intercompany Sales

      

Domestic

   $ 3,100,000     $ 3,574,000     $ (474,000 )

Italian

     1,618,000       1,809,000       (191,000 )
                        

Total

     4,718,000       5,383,000       (665,000 )

Cost of Sales

     1,984,000       2,137,000       153,000  
                        

Gross Profit

   $ 2,734,000     $ 3,246,000     $ (512,000 )

% of Total Net Revenues

     58.0 %     60.3 %  

Net revenues for the three months ended March 31, 2006 decreased $665,000, or 12.4%, from the three months ended March 31, 2005. This decrease was comprised of decreases in external net revenues of $474,000 from domestic operations and $191,000 from Italian operations. Domestic external net revenues in the three months ended March 31, 2006 decreased by 13.3% from the same period of 2005. This decrease was primarily due to a decrease in infectious disease net revenues caused principally by discontinued products and one-time sales that occurred in the first quarter of 2005, revenue lost due to the delay in the full commercial release of the PARSEC™ System and the effect of backorders. A decrease in antigen sales, caused by particularly strong sales to international customers in the first quarter of 2005, also contributed to the decrease. The decline in external net revenues from Italian operations of 10.6% was primarily attributable to a decrease in revenue due to fluctuations of the United States dollar relative to the Euro, as further discussed in “Currency Fluctuations” below. As measured in Euros, Italian revenues in the first three months of 2006 did not vary significantly from revenues generated in

 

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the first quarter of 2005. Gross profit in the three months ended March 31, 2006 decreased $512,000, or 15.8%, from the comparable period of 2005. The decrease in gross profit was primarily attributable to the decrease in net revenues. The principal factor in the decline in gross profit as a percentage of net revenues to 58.0% in the three months ended March 31, 2006 from 60.3% in the three months ended March 31, 2005 was an increase in the provision for inventory obsolescence.

OPERATING EXPENSES

 

Three months ended March 31,

   2006   

% of

Revenue

    2005    

% of

Revenue

   

Period over Period

Increase (Decrease)

 

Selling Expenses

           

Domestic

   $ 895,000    19.0 %   $ 899,000     16.7 %   $ (4,000 )

Italian

     _597,000    12.6 %     614,000     11.4 %     (17,000 )
                           

Total

     1,492,000    31.6 %     1,513,000     28.1 %     (21,000 )

General and Administrative

     1,439,000    30.5 %     1,152,000     21.4 %     287,000  

Research and Development

     492,000    10.4 %     395,000     7.3 %     97,000  

Bad Debt Recovery

     —      —   %     (1,690,000 )   (31.4 )%     1,690,000  
                           

Total Operating Expenses

   $ 3,423,000    72.6 %   $ 1,370,000     25.5 %   $ 2,053,000  

The most significant variation in operating expenses occurred as a result of a bad debt recovery of Italian accounts receivable in 2005 resulting from the payment of previously outstanding accounts receivable balances from hospitals located within a particular region in Italy. A significant portion of this approximately 2,000,000 Euro payment related to accounts receivable against which we had previously established allowances. As a result, we recognized a $1,690,000 bad debt recovery in 2005 as we reduced our allowance for doubtful accounts to recognize the impact of this collection of these receivables. Selling expenses decreased $21,000 in the three months ended March 31, 2006 compared to the same period of 2005. General and administrative expenses increased $287,000 in the three months ended March 31, 2006 compared to the same period of 2005 due most significantly to increased legal and accounting fees necessary for public company regulatory compliance and acquisition investigation related costs. Although, in the ordinary course of our business, we evaluate potential business acquisition opportunities, we may not be successful in finding or consummating any acquisitions. Research and development expenses increased $97,000 due to an increase in Italian research and development expenses to $314,000 in the three months ended March 31, 2006 from $195,000 in the three months ended March 31, 2005. This increase in Italian research expenses was principally due to increased payroll and consulting costs incurred as the result of the PARSEC™ System development as well as the transfer to us of the technology expected to enable us to manufacture certain hepatitis products. The future level of research and development expenditures will depend on, among other things, the outcome of ongoing testing of products and instrumentation under development, delays or changes in government required testing and approval procedures, technological and competitive developments, strategic marketing decisions and liquidity.

INCOME (LOSS) FROM OPERATIONS

Loss from operations was $689,000 in the three months ended March 31, 2006 compared to income from operations of $1,876,000 in the three months ended March 31, 2005. The loss from

 

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operations in the three months ended March 31, 2006 was composed of a loss from Italian operations of $394,000 and a loss from domestic operations of $303,000. Income from operations in the three months ended March 31, 2005 was composed of income from Italian operations of $1,598,000 and income from domestic operations of $284,000.

OTHER INCOME (EXPENSE) NET

Interest income increased to $120,000 in the three months ended March 31, 2006 from $69,000 in the same period of 2005 due to higher interest rates during the first three months of 2006. Other expense, net totaled $11,000 during the three months ended March 31, 2006, compared to $64,000 in the three months ended March 31, 2005. Amounts included in other expense, net in the periods ended March 31, 2006 and 2005 were primarily net foreign currency losses on transactions, particularly by our Italian subsidiary, which were denominated in currencies other than the subsidiary’s functional currency.

INCOME TAX PROVISION

During the three months ended March 31, 2006 we recorded an income tax provision of $16,000 compared to an income tax provision of $1,043,000 during the three months ended March 31, 2005. The tax provision from the first three months of 2006 relates to Italian local income taxes based upon applicable statutory rates effective in Italy, while the tax provision in the three months ended March 31, 2005 is primarily composed of deferred taxes related to the allowance for doubtful accounts that was reduced during the first quarter of 2005 as a result of the collection of certain previously reserved Italian accounts receivable and the creation of a valuation allowance to fully reserve the remaining foreign deferred tax asset. No domestic tax provision was recorded in 2006 due to the establishment of a full valuation allowance against the benefit of domestic losses or in 2005 due to the expected utilization of prior period net operating losses to offset domestic taxable income.

CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE

We recorded a cumulative effect of a change in accounting principle of $201,000 in the three months ended March 31, 2006 as a result of the change in classification of certain options granted in March 2001 from an equity award grant to a liability award in accordance with SFAS 123(R). The basic and diluted per common share effect of this change in accounting principle was $(0.01) in the three months ended March 31, 2006. A cumulative effect of a change in accounting principle was not recorded during the three months ended March 31, 2005.

NET INCOME (LOSS)

We generated a net loss in the three months ended March 31, 2006 of $797,000 compared to net income of $838,000 in the same period of 2005. Our basic and diluted net loss per common share was $0.03 in the three months ended March 31, 2006 compared to basic and diluted net income per common share of $0.03 in the three months ended March 31, 2005. Net income (loss) in the three months ended March 31, 2006 and 2005 resulted primarily from the various factors discussed above.

LIQUIDITY AND CAPITAL RESOURCES

At March 31, 2006, our working capital was $19,372,000 compared to $20,036,000 at December 31, 2005. Cash and cash equivalents totaled $4,475,000 at March 31, 2006, as compared to $11,480,000 at December 31, 2005. Short-term marketable securities totaled $5,825,000 at March 31, 2006 and $122,000 at December 31, 2005. Our short-term marketable securities are primarily investments in auction rate debt securities with final maturities longer than one year, but with interest rates typically

 

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resetting every 28 or 35 days through an auction mechanism. These short-term marketable securities consist primarily of taxable municipal bonds and government agency securities. Also included in marketable securities at March 31, 2006 is $125,000 in Italian bank bonds held by our Italian subsidiary that are used to support guarantees provided by us. Substantially all of our cash and cash equivalents and short-term marketable securities are presently held at one national securities brokerage firm. Accordingly, we are subject to credit risk if this brokerage firm is unable to repay the balance in the account or deliver our securities or if the brokerage firm should become bankrupt or otherwise insolvent. We only invest in select money market instruments, municipal securities and corporate issuers.

Net cash flows of $877,000 were used in operating activities during the three months ended March 31, 2006, compared to $176,000 that was provided by operating activities during the three months ended March 31, 2005. Cash used in operating activities during the first three months of 2006 was primarily the result of cash utilized by operating results, adjusted for non-cash items, of $273,000, as well as a net working capital decrease, excluding the change in cash balance, of $627,000. This decrease in net working capital was principally due to an increase in outstanding accounts receivable in Italy. Cash provided in the first three months of 2005 was principally the result of cash provided by operating results, adjusted for non-cash items, of $433,000 that were partially offset by a decrease in net working capital, excluding the change in cash, of $270,000. This decrease in net working capital was primarily due to increases in accounts receivable caused primarily by the increase in domestic reagent and antigen sales.

Net cash flows of $6,146,000 were used in investing activities during the three months ended March 31, 2006, as compared to $6,072,000 used during the same period of the prior year. The increase in cash used for investing activities was primarily the result of capital expenditures that occurred in Italy as a result of the move to a new facility and the purchase of equipment which we expect to be necessary for our anticipated production of certain hepatitis products resulting from the license agreement we entered into in September 2004 with an Italian diagnostics company to obtain a perpetual, worldwide, royalty-free license of product technology presently used by the Italian diagnostics company to manufacture hepatitis products currently sold by them. Under this license agreement, we agreed to pay four milestone payments totaling 1,000,000 Euro upon the Italian diagnostics company’s achievement of certain enumerated performance objectives. The payment of the approximately 200,000 Euro during the three months ended March 31, 2005 was the first of these milestone payments. As a result of the satisfaction of the first milestone, we determined that payment of the three remaining milestone payments was probable and, consequently, an accrued license payable of $970,000 is recorded in the accompanying consolidated balance sheet as of March 31, 2006. The three remaining milestone payments relate to two remaining performance objectives that the Italian diagnostics company is working to achieve on or prior to October 31, 2006 and one remaining performance objective that the Italian diagnostics company is working to achieve on or prior to March 31, 2007. Among other events and actions included in these future milestones are requirements that training be provided to us. This training has been, and will continue to be, expensed as incurred and a corresponding amount will be recognized as a reduction to the product license recorded in the accompanying consolidated balance sheet. While we determined that our payment of the three remaining milestone payments was probable and believe that capitalization as a recoverable asset is appropriate, there remains a risk that we will not be able to obtain product technology that would enable us to manufacture our own hepatitis products or, if we obtain such product technology, that we will not be able to manufacture our own hepatitis products.

Cash provided by financing activities during the three months ended March 31, 2006 of $21,000 resulted from the exercise of stock options. There were no financing activities during the three months ended March 31, 2005.

 

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Our product research and development expenditures are expected to be approximately $2,000,000 during 2006. Actual expenditures will depend upon, among other things, the outcome of clinical testing of products under development, delays or changes in government required testing and approval procedures, technological and competitive developments, strategic marketing decisions and liquidity. There can be no assurance that these expenditures will result in the development of new products or product enhancements, that we will successfully complete products under development, that we will obtain regulatory approval or that any approved product will be produced in commercial quantities, at reasonable costs, and be successfully marketed. In addition, we estimate that cash of approximately $1,400,000 will be required in fiscal 2006 to improve and expand our facilities, equipment and information systems. Included in these improvements are anticipated purchases of equipment that will be necessary to integrate the acquisition of technology expected to be received by us under our license agreement with an Italian diagnostics company for the license to us of product technology useful for our own manufacture of certain hepatitis products. This estimate does not include, however, expenditures relating to our previously reported plans to continue our search to relocate to a new location for our corporate headquarters and the operations of Diamedix Corporation. There can be no assurance that we will be successful in our plans to expand or relocate our operations.

Our principal source of short term liquidity is existing cash and cash equivalents and marketable securities, which we believe will be sufficient to meet our operating needs and anticipated capital expenditures over at least the next twelve months. For the long term, we intend to utilize principally existing cash and cash equivalents and marketable securities, as well as internally generated funds, which are anticipated to be derived primarily from the sale of existing diagnostic and instrumentation products and diagnostic and instrumentation products currently under development. To the extent that these sources of liquidity are insufficient, we may consider issuing debt or equity securities or curtailing or reducing our operations.

We maintain allowances for doubtful accounts, particularly in Italy where payment cycles are longer than in the United States, for estimated losses resulting from the inability of our customers to make required or timely payments. On May 12, 2005 we received a payment of approximately 2,000,000 Euro from a governmental region in Italy in satisfaction of previously outstanding accounts receivable balances from hospitals located in the region. A significant portion of this payment related to accounts receivable against which we had previously established allowances. In order to recognize the impact of this collection of these receivables, we reduced our allowance for doubtful accounts. Additional payments by governmental regions in Italy are possible, and, as a result, we may consider the potential receipt of those payments in determining our allowance for doubtful accounts. If contemplated payments are not received, or if we require additional allowances, our operating results could be materially adversely affected during the period in which the determination to increase the allowance for doubtful accounts is or was made.

We did not repurchase any of our common stock during the three months ended March 31, 2006 or 2005 as part of the common stock repurchase program approved by our Board of Directors in May 2002.

CRITICAL ACCOUNTING POLICIES

Our 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 accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to product returns, allowance for doubtful accounts, inventories, intangible assets, income, stock compensation and other tax accruals, warranty obligations, and contingencies and litigation.

 

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We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our assumptions and estimates may, however, prove to have been incorrect and our actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies and the judgments and estimates we make concerning their application have significant impact on our consolidated financial statements.

REVENUE RECOGNITION

A principal source of revenue is our “reagent rental” program in which customers make reagent kit purchase commitments with us that typically last for a period of three to five years. In exchange, we include a Mago® Plus instrument, which remains our property, and any required instrument service, which are paid for by the customer through these reagent kit purchases over the life of the commitment. We recognize revenue from the reagent kit sales when title passes, which is generally at the time of shipment. Should actual reagent kit or instrument failure rates significantly increase, our future operating results could be negatively impacted by increased warranty obligations and service delivery costs.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

We maintain allowances for doubtful accounts, particularly in Italy for the operations of our Italian subsidiary, for estimated losses resulting from the inability of our customers to make required payments. In many instances our receivables in Italy, while currently due and payable, take in excess of a year to collect. Additionally, the receipt of payments similar to those we received on May 12, 2005 (See Note 3, Bad Debt Recovery) from governmental regions in Italy are possible, and we may consider the potential receipt of those payments in determining our allowance for doubtful accounts. If contemplated payments are not received when expected, or if the financial condition of our customers were to deteriorate resulting in an impairment of their ability to make payments, our operating results could be materially adversely affected during the period in which the determination to increase the allowance for doubtful accounts is or was made. Our allowances for doubtful accounts were $1,004,000 and $974,000 at March 31, 2006 and December 31, 2005, respectively. A provision for losses on accounts receivable of $13,000 was recorded in the first quarter of 2006, while $10,000 was recorded in the first quarter of 2005.

INVENTORY

We regularly review inventory quantities on hand, including components for current and future versions of instrumentation, and, if necessary, record a provision for excess and obsolete inventory based primarily on our estimates of product demand and production requirements. These estimates of future instrumentation and diagnostic kit product demand may prove to be inaccurate, in which case any resulting adjustments to the value of inventory would be recognized in our cost of goods sold at the time of such determination and could adversely affect our operating results. Inventory reserves were $417,000 and $332,000 as of March 31, 2006 and December 31, 2005, respectively. A total of $120,000 was charged to cost and expenses during the first quarter of 2006, while $24,000 was charged in the first quarter of 2005. Included within our inventory balance at March 31, 2006 was approximately $1,076,000 in PARSEC™ instrumentation and instrument components in anticipation of our pending full commercial product launch.

GOODWILL AND OTHER INTANGIBLES

Pursuant to SFAS No. 142, Goodwill and Other Intangible Assets, we analyzed our goodwill for impairment issues and will continue to do so in future periods. In assessing the recoverability of our goodwill and other

 

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intangibles, we made assumptions regarding estimated future cash flows, including current and projected levels of income, business trends, prospects and market conditions, to determine the fair value of the respected assets. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets not previously recorded. Any resulting impairment loss would be recorded as a charge against our earnings and could have a material adverse impact of our financial condition and results of operations.

STOCK-BASED COMPENSATION

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123(R) using the modified prospective transition method and therefore have not restated results for prior periods. Under this transition method, stock-based compensation expense for the first quarter of 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimate in accordance with the original provisions of SFAS 123. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant-date fair value estimate in accordance with the provisions of SFAS 123(R). We recognize these compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of either immediately, all at once after seven years or in equal annual amounts over a four year period.

Prior to the adoption of SFAS 123(R), we accounted for stock-based compensation in accordance with APB 25.

INCOME TAXES

We accounted for income taxes on our consolidated financial statements on a stand-alone basis as if we had filed our own income tax returns. However, the pre-merger IVAX Diagnostics reported its income taxes until the merger with b2bstores.com as part of a consolidated group. Therefore, all domestic net operating losses generated prior to the merger were utilized by IVAX. Since the merger, we have experienced net domestic losses from operations. Accounting principles generally accepted in the United States require that we record a valuation allowance against the deferred tax asset associated with these losses if it is “more likely than not” that we will not be able to utilize the net operating loss to offset future taxes. Due to the cumulative net losses from the operations of our domestic operations since the merger, we have provided a full valuation allowance against domestic deferred tax assets. Additionally, as of March 31, 2005, we have recorded a full valuation allowance against our foreign deferred tax asset as a result of recent losses by our Italian operation. Over time we may reach levels of profitability that could cause our management to conclude that it is more likely than not that we will realize all or a portion of our net operating loss carryforwards. Upon reaching such a conclusion, and upon such time as when we reverse the valuation allowance against the deferred tax asset, we would then provide for income taxes at a rate equal to our effective tax rate.

The critical accounting policies discussed are not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result.

RECENTLY ISSUED ACCOUNTING STANDARDS

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123(R) using the modified prospective transition method and therefore have not restated results for prior periods. Under

 

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this transition method, stock-based compensation expense for the first quarter of 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimate in accordance with the original provisions of SFAS 123. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant-date fair value estimate in accordance with the provisions of SFAS 123(R). We recognize these compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term of either immediately, all at once after seven years or in equal annual amounts over a four year period.

Prior to the adoption of SFAS 123(R), we accounted for stock-based compensation in accordance with APB 25.

CURRENCY FLUCTUATIONS

For the three months ended March 31, 2006 and 2005, approximately 34.3% and 33.6%, respectively, of our net revenues were generated in currencies other than the United States dollar. Fluctuations in the value of foreign currencies relative to the United States dollar affect our reported results of operations. If the United States dollar weakens relative to the foreign currency, then our earnings generated in the foreign currency will, in effect, increase when converted into United States dollars and vice versa. Exchange rate differences resulting from the strength of the United States dollar against the Euro resulted in a decrease of approximately $149,000 in net revenues for the three months ended March 31, 2006 compared to the same period of the prior year. During the three months ended March 31, 2006 and 2005, none of our subsidiaries were domiciled in highly inflationary environments. The effects of inflation on consolidated net revenues and operating income were not significant.

Our Italian subsidiary represented 34.3% of our net revenues in the three months ended March 31, 2006. Conducting an international business inherently involves a number of difficulties, risks, and uncertainties, such as export and trade restrictions, inconsistent and changing regulatory requirements, tariffs and other trade barriers, cultural issues, longer payment cycles, problems in collecting accounts receivable, political instability, local economic downturns, seasonal reductions in business activity in Europe during the traditional summer vacation months, and potentially adverse tax consequences.

INCOME TAXES

We recognized a tax provision of $16,000 during the three months ended March 31, 2006 compared to a tax provision of $1,043,000 during the three months ended March 31, 2005, which related to foreign operations. Through March 14, 2001, the pre-merger IVAX Diagnostics reported its domestic income taxes as part of a consolidated group with IVAX. All domestic taxable losses generated prior to that date were utilized by IVAX. Effective March 14, 2001, as a result of the merger between b2bstores.com and the pre-merger IVAX Diagnostics, we were no longer included in the consolidated income tax returns of IVAX.

Our income tax provision for the three months ended March 31, 2006 was different from the amount computed on the income (loss) before income taxes at the statutory rate of 35% primarily due to the increase of the valuation allowance to offset the benefit of both domestic and foreign losses. The current income tax provisions for the three months ended March 31, 2006 and 2005 were the result of Italian local income taxes based upon applicable statutory rates effective in Italy.

As of March 31, 2006, we had no net domestic deferred tax asset, as domestic net operating losses generated prior to the merger were utilized by IVAX and a full valuation allowance has been established against domestic deferred tax assets generated subsequent to March 14, 2001. Additionally, as of March 31,

 

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2006, we had no net foreign deferred tax asset, as a full valuation allowance was provided during the first quarter of 2005 as a result of recent losses by our Italian operation. Subsequent revisions to the estimated net realizable value of the deferred tax asset could cause our provision for income taxes to vary significantly from period to period. Upon such time as we reverse the entire valuation allowance against the deferred tax asset, we would then provide for income taxes at a rate equal to our effective tax rate.

RISK OF PRODUCT LIABILITY CLAIMS

Developing, manufacturing and marketing diagnostic test kits, reagents and instruments subject us to the risk of product liability claims. We believe that we continue to maintain an adequate amount of product liability insurance, but there can be no assurance that our insurance will cover all existing and future claims. There can be no assurance that claims arising under any pending or future product liability cases, whether or not covered by insurance, will not have a material adverse effect on our business, results of operations or financial condition. Our current products liability insurance is a “claims made” policy.

 

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Item 3 - Quantitative and Qualitative Disclosures About Market Risk

Market risk represents the risk of loss that may impact the Company’s consolidated financial position, results of operations or cash flows. In the normal course of doing business, the Company is exposed to the risks associated with foreign currency exchange rates and changes in interest rates.

Foreign Currency Exchange Rate Risk – The Company is exposed to exchange rate risk when its Italian subsidiary enters into transactions denominated in currencies other than its functional currency. For additional information about foreign currency exchange rate risk, see “Currency Fluctuations” in the Company’s Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Interest Rate Risk – The Company does not have debt obligations, and it does not believe the interest rate exposure related to its investments to be material.

Commodity Price Risk – The Company does not believe it is subject to any material risk associated with commodity prices.

 

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Item 4 – Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company required to be included in the Company’s periodic filings with the Securities and Exchange Commission. That conclusion, however, should be considered in light of the various limitations described below on the effectiveness of those controls and procedures, some of which pertain to most, if not all, business enterprises, and some of which arise as a result of the nature of the Company’s business. The Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, does not expect that the Company’s disclosure controls and procedures will prevent all error and all improper conduct. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of improper conduct, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some person or persons, by collusion of two or more people or by management override of the control. Further, the design of any system of controls also is based in part upon assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate. Due to the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that would have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Exhibits 31.1 and 31.2 to this Quarterly Report on Form 10-Q are Certifications of the Chief Executive Officer and Chief Financial Officer of the Company which are required under Section 302 of the Sarbanes-Oxley Act of 2002. This Item 4, Controls and Procedures, is the information concerning the evaluation referred to in the Section 302 Certifications and this information should be read in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented.

Under the rules and regulations of the Securities and Exchange Commission, the Company is currently not required to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 until the Company files its Annual Report on Form 10-K for its fiscal year ending December 31, 2007, so long as the Company continues to meet the definition of a non-accelerated filer. In the Company’s Annual Report on Form 10-K for the year ending December 31, 2007, the Company’s management will be required to provide an assessment as to the effectiveness of the Company’s internal control over financial reporting and its independent registered public accounting firm will be required to attest as to the Company’s management’s assessment. The assessment and attestation processes required by Section 404 are relatively new and neither companies nor auditing firms have significant experience in testing or complying with these requirements. Accordingly, the Company may encounter problems or delays in completing its obligations and receiving an unqualified report on its internal control over financial reporting by its independent registered public accounting firm.

 

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While the Company believes that it will be able to timely meet its obligations under Section 404 and that the Company’s management will be able to certify as to the effectiveness of the Company’s internal controls over financial reporting, there is no assurance that the Company will do so. If the Company is unable to timely comply with Section 404, its management is unable to certify as to the effectiveness of its internal controls over financial reporting or its independent registered public accounting firm is unable to attest to that certification, the price of the Company’s common stock may be adversely affected. Even if the Company timely meets the certification and attestation requirements of Section 404, it is possible that its independent registered public accounting firm will advise the Company that they have identified significant deficiencies and/or material weaknesses.

 

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PART II - OTHER INFORMATION

Item 1 - Legal Proceedings

The Company is involved in various legal claims and actions and regulatory matters, and other notices and demand proceedings arising in the ordinary course of business. While it is not possible to predict or determine the outcome of these proceedings, in the opinion of management, based on a review with legal counsel, any losses resulting from such legal proceedings would not have a material adverse impact on the financial position, results of operations or cash flows of the Company.

Item 6 - Exhibits

 

Exhibit

Number

  

Description

31.1    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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Signatures

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

 

  IVAX Diagnostics, Inc.
Date: May 15, 2006   By:  

/s/ Mark Deutsch

    Mark Deutsch,
    Vice President-Finance and
    Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit

Number

  

Description

31.1

   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

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

32.2

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

 

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