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ERBA Diagnostics, Inc. 10-Q 2011

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
Unassociated Document
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 September 30, 2011

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
 
(I.R.S. Employer
incorporation or organization)
 
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 o

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 x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨
 
Accelerated filer ¨
     
Non-accelerated filer ¨
(Do not check if a smaller reporting company)
Smaller reporting company 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.

34,391,554 shares of Common Stock, $ .01 par value, outstanding as of November 11, 2011.

 
 

 

IVAX DIAGNOSTICS, INC.

INDEX
 
 
PAGE NO.
PART I - FINANCIAL INFORMATION
 
   
Item 1 -
Financial Statements
 
     
 
Consolidated Balance Sheets as of September 30, 2011 (unaudited) and December 31, 2010
3
     
 
Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2011 and 2010
4
     
 
Consolidated Statement of Shareholders’ Equity (unaudited) for the nine months ended September 30, 2011
5
     
 
Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2011 and 2010
6
     
 
Condensed Notes to Consolidated Financial Statements (unaudited)
7
     
Item 2 -
Management’s Discussion and Analysis of Financial Condition and Results of Operations
16
     
Item 4 -
Controls and Procedures
27
     
PART II - OTHER INFORMATION
 
     
Item 1 -
Legal Proceedings
28
     
Item 1A -
Risk Factors
28
     
Item 6 -
Exhibits
28

 
2

 
 
PART I - FINANCIAL INFORMATION

Item 1 - Financial Statements

IVAX DIAGNOSTICS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
   
September 30,
   
December 31,
 
  
 
2011
   
2010
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
  $ 3,939,189     $ 1,826,228  
Accounts receivable, net of allowances for doubtful accounts of $648,251 in 2011 and $399,376 in 2010
    5,775,146       5,344,205  
Inventories, net
    4,293,854       4,077,896  
Other current assets
    262,836       146,366  
Total current assets
    14,271,025       11,394,695  
                 
Property, plant and equipment, net
    1,532,155       1,618,136  
Equipment on lease, net
    693,683       679,438  
Product license
    282,936       282,936  
Goodwill
    870,290       870,290  
Restricted deposits
    107,066       228,680  
Other assets
    45,815       26,847  
Total assets
  $ 17,802,970     $ 15,101,022  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
                 
Current liabilities:
               
Accounts payable
  $ 2,235,539     $ 1,597,555  
Accrued license payable
    135,970       132,521  
Revolving line of credit
    379,661       -  
Accrued expenses and other current liabilities
    2,333,343       2,511,698  
Capital lease obligation, current
    76,795       71,826  
Total current liabilities
    5,161,308       4,313,600  
                 
Other long-term liabilities:
               
Capital lease obligation, long-term
    42,378       100,612  
Deferred income tax liabilities
    412,803       365,184  
Other long-term liabilities
    1,036,163       955,056  
Total other long-term liabilities
    1,491,344       1,420,852  
                 
Commitments and contingencies
               
                 
Shareholders’ equity:
               
Common stock, $0.01 par value, authorized 100,000,000 shares, issued and outstanding  34,391,554 in 2011 and 27,649,887 in 2010
    343,915       276,498  
Stock subscription receivable
    (10,000,000 )     -  
Capital in excess of par value
    56,035,037       41,389,404  
Accumulated deficit
    (34,707,653 )     (31,686,472 )
Accumulated other comprehensive loss
    (520,981 )     (612,860 )
Total shareholders’ equity
    11,150,318       9,366,570  
Total liabilities and shareholders’ equity
  $ 17,802,970     $ 15,101,022  

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

 
3

 

IVAX DIAGNOSTICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

Period Ended September 30,
 
Three months
   
Nine months
 
   
2011
   
2010
   
2011
   
2010
 
                         
Net  revenues
  $ 4,059,598     $ 3,952,606     $ 12,568,953     $ 13,001,930  
Cost of sales
    1,973,863       1,821,597       6,008,085       6,048,179  
Gross profit
    2,085,735       2,131,009       6,560,868       6,953,751  
                                 
Operating expenses:
                               
Selling and marketing
    1,320,244       1,097,877       4,054,260       3,655,070  
General and administrative
    1,350,734       1,794,444       4,274,806       5,337,478  
Research and development
    412,231       362,251       1,397,333       1,211,541  
Total operating expenses
    3,083,209       3,254,572       9,726,399       10,204,089  
                                 
Loss from operations
    (997,474 )     (1,123,563 )     (3,165,531 )     (3,250,338 )
                                 
Other income (expense):
                               
Interest income (expense)
    (1,892 )     2,352       (9,112 )     3,249  
Other expense, net
    (205,699 )     (28,044 )     (166,762 )     (115,197 )
Total other expense, net
    (207,591 )     (25,692 )     (175,874 )     (111,948 )
                                 
Loss before income taxes
    (1,205,065 )     (1,149,254 )     (3,341,405 )     (3,362,286 )
                                 
Provision (credit) for income taxes
    28,614       27,503       (320,224 )     83,189  
                                 
Net loss
  $ (1,233,679 )   $ (1,176,758 )   $ (3,021,181 )   $ (3,445,475 )
                                 
Net loss per share
                               
Basic and diluted
  $ (0.04 )   $ (0.04 )   $ (0.10 )   $ (0.12 )
                                 
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
                               
Basic
    34,391,554       27,649,887       29,943,392       27,649,887  
Diluted
    34,391,554       27,649,887       29,943,392       27,649,887  

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

 
4

 

IVAX DIAGNOSTICS, INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(Unaudited)
 
                                  
Accumulated
       
               
Additional
   
Stock
         
Other
   
Total
 
   
Common Stock
   
Paid-in
   
Subscription
   
Accumulated
   
Comprehensive
   
Shareholders'
 
   
Shares
   
Amount
   
Capital
   
Receivable
   
Deficit
   
Loss
   
Equity
 
                                           
BALANCE, December 31, 2010
    27,649,887     $ 276,498     $ 41,389,404           $ (31,686,472 )   $ (612,860 )   $ 9,366,570  
Stock subscription receivable
                    10,000,000     $ (10,000,000 )                     -  
                                                         
Issuance of common stock
    6,666,667       66,667       4,533,633                               4,600,300  
Exercise of stock options
    75,000       750       36,750                               37,500  
Comprehensive loss:
                                                       
                                                         
Net loss
    -       -       -               (3,021,181 )     -       (3,021,181 )
Translation adjustment
    -       -       -               -       91,879       91,879  
                                                         
Comprehensive loss
                                                    (2,929,302 )
                                                         
Stock compensation expense
    -       -       75,250       -       -       -       75,250  
                                                         
BALANCE, September 30, 2011
    34,391,554     $ 343,915     $ 56,035,037     $ (10,000,000 )   $ (34,707,653 )   $ (520,981 )   $ 11,150,318  

The accompanying Condensed Notes to Consolidated Financial Statements are an integral part of this statement.

 
5

 

IVAX DIAGNOSTICS, INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

Nine months Ended September 30,
 
2011
   
2010
 
             
Cash flows from operating activities:
           
Net loss
  $ (3,021,181 )   $ (3,445,475 )
Adjustments to reconcile net loss to net cash flows used in operating activities:
               
Depreciation and amortization
    535,550       553,145  
Net provision for doubtful accounts receivable
    330,718       28,977  
Provision for inventory obsolescence
    97,823       -  
Non-cash compensation expense
    75,250       184,692  
Deferred income taxes
    47,619       47,619  
Other, net
            6,085  
Changes in operating assets and liabilities:
               
Accounts receivable
    (674,189 )     (110,820 )
Inventories
    (279,527 )     79,755  
Other current assets
    (13,988 )     140,079  
Other assets
    (36,343 )     (9,426 )
Accounts payable and accrued expenses
    209,403       724,055  
Other long-term liabilities
    58,211       (48,155 )
Net cash flows used in operating activities
    (2,670,654 )     (1,849,469 )
                 
Cash flows from investing activities:
               
Capital expenditures
    (202,824 )     (237,875 )
Restricted deposits
    147,640       (39,633 )
Acquisition of equipment on lease
    ( 233,907 )     (336,806 )
Sale of equipment
    -       311,050  
Net cash flows used in investing activities
    (289,091 )     (303,264 )
                 
Cash flows from financing activities:
               
Proceeds of share offering
    4,600,300       -  
Proceeds of revolving line of credit
    379,661       -  
Bank financing related costs
    (101,000 )     -  
Exercise of stock options
    37,500       -  
Capital lease payments
    (53,265 )     (32,199 )
Net cash flows provided by (used in) financing activities
    4,863,196       (32,199 )
                 
Effect of exchange rate changes on cash and cash equivalents
    209,510       2,585  
Net increase (decrease) in cash and cash equivalents
    2,112,961       (2,182,347 )
Cash and cash equivalents at the beginning of the period
    1,826,228       4,198,913  
Cash and cash equivalents at the end of the period
  $ 3,939,189     $ 2,016,566  
                 
NONCASH INVESTING ACTIVITY:
               
Acquisition of equipment using capital lease
  $ -     $ 222,000  

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

 
6

 

IVAX DIAGNOSTICS, INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(1) ORGANIZATION AND OPERATIONS:

The accompanying unaudited interim consolidated financial statements of IVAX Diagnostics, Inc. (the “Company,” “IVAX Diagnostics,” we,” “us” or “our”) 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.  However, in the opinion of management, all adjustments necessary to state fairly the results of operations, financial position, changes in stockholders’ equity and cash flows have been made.  The results of operations, financial position, changes in stockholders’ equity and cash flows for the nine months ended September 30, 2011 are not necessarily indicative of the results of operations, financial position, changes in stockholders’ equity and cash flows which may be reported for the remainder of 2011. The balance sheet as of December 31, 2010 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”). The accompanying unaudited interim consolidated financial statements should be read in conjunction with the audited 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, 2010.

On September 1, 2010, ERBA Diagnostics Mannheim GmbH, an in vitro diagnostics company headquartered in Germany (“ERBA”), the parent company of which is Transasia Bio-Medicals Ltd. (“Transasia”), purchased all of the approximately 72.4% of the outstanding shares of the Company’s common stock owned by the prior group of the Company’s controlling stockholders for an aggregate purchase price of approximately $15,000,000, or $0.75 per share (the “Share Acquisition”).  See also Note 2, Going Concern, and Note 15, Related Party Transactions, with respect to subsequent transactions with ERBA, including ERBA’s purchase from the Company, and the Company’s issuance to ERBA, of 6,666,667 shares of the Company’s common stock. As a result of the Share Acquisition and the consummation of the initial transactions contemplated by the Investment, as defined below, ERBA now beneficially owns, directly or indirectly, approximately 77.6% of the outstanding shares of the Company’s common stock.

(2) GOING CONCERN:

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), assuming the Company’s ability to continue as a going concern.  The Company incurred a net loss of $4,214,679 during the year ended December 31, 2010 and a net loss of $3,021,181 for the nine months ended September 30, 2011 and used cash from operations of $1,882,867 during the year ended December 31, 2010 and $2,771,654 during the nine months ended September 30, 2011.

In view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying consolidated balance sheet is dependent upon continued operations of the Company, which in turn is dependent upon the Company’s ability to meet its operational cash flow demands on a continuing basis.  The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.

The Company has taken or is in the process of evaluating or undertaking certain actions which, if successful, it believes will be sufficient to provide the Company with the ability to continue in existence.  The Company expects operating results to improve from the operating results achieved during the year ended December 31, 2010 and the nine months ended September 30, 2011 based principally upon increases in revenue as a result of the commercial launch of the Mago® 4S in the United States during 2011 and increases in the United States and international revenue from new channels of distribution.  The Company also expects operating results to improve as a result of certain initiatives it has adopted or is considering adopting in order to reduce expenses.

As discussed below in Note 15, Related Party Transactions, the Company entered into a stock purchase agreement (the “Stock Purchase Agreement”) with ERBA, on April 8, 2011, pursuant to which the Company has agreed to sell and issue to ERBA an aggregate of 20,000,000 shares of the Company’s common stock for an aggregate purchase price of $15,000,000 and warrants to purchase an additional 20,000,000 shares of the Company’s common stock (collectively, the “Investment”).  The consummation of the Investment was subject to, among other things, the approval of holders of at least 66-2/3% of the issued and outstanding shares of the Company’s common stock (excluding any shares beneficially owned, directly or indirectly, by ERBA).  At the Company’s 2011 Annual Meeting of Stockholders held on June 10, 2011, the required approval of the Company’s stockholders was achieved.  On June 30, 2011, ERBA paid the Company $5,000,000 in order to consummate the initial transactions contemplated by the Investment.  As a result, the Company issued to ERBA 6,666,667 shares of the Company’s common stock and, in connection with the consummation of the initial transactions contemplated by the Investment, a warrant to purchase 20,000,000 shares of the Company’s common stock, with a five year term and an exercise price per share of the Company’s common stock equal to $0.75. As previously reported, pursuant to the Stock Purchase Agreement, the Company has also agreed to issue to ERBA an additional 6,666,667 shares of the Company’s common stock for an aggregate purchase price of $5,000,000, on or prior to January 1, 2012, as well as an additional 6,666,666 shares of the Company’s common stock for an aggregate purchase price of $5,000,000, on or prior to July 1, 2012.  The additional $10,000,000 has been recorded as a stock subscription receivable in the accompanying balance sheet.

 
7

 

As discussed below in Note 16, Revolving Line of Credit, on June 10, 2011, Diamedix Corporation (“Diamedix”), a wholly-owned subsidiary of the Company, entered into a loan agreement (the “Loan Agreement”) with City National Bank of Florida, which provides for a secured, revolving credit facility of up to $975,000 (the “Line of Credit”).  As of September 30, 2011, $379,661 had been drawn and was outstanding under the Line of Credit.

(3) STOCK-BASED COMPENSATION:

Valuations are based upon highly subjective assumptions about the future, including stock price volatility and exercise patterns. 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 U.S. Treasury yield curve in effect at the time of the grant.

The Company has historically granted options under the Company’s option plans with 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, ranging from all at once to equal annual amounts over a four year period, and, primarily for non-employee directors, immediately.

The following chart summarizes option activity as of September 30, 2011 and changes during the nine months ended September 30, 2011 for outstanding and exercisable options granted by the Company:

         
Weighted
 
         
Average
 
   
Number of
   
Exercise
 
   
Shares
   
Price
 
             
Outstanding at December 31, 2010
    1,173,198     $ 2.09  
Granted
    92,788       0.85  
Expired
    (170,116 )     6.50  
Terminated
    -       -  
Exercised
    (75,000 )     0.50  
Outstanding at September 30, 2011
    1,020,870     $ 1.36  

Stock compensation aggregated $10,000 and $75,250 for the three and nine months ended September 30, 2011, respectively.  Options to purchase a total of 17,788 shares were granted to a director during the three months ended September 30, 2011.

During the three and nine months ended September 30, 2010, stock-based compensation expense of $0 and $185,000, respectively, was recognized, including the impact of a modification to options previously granted to an employee to allow exercise through the original expiration date instead of one year from the date of termination.  Options to purchase a total of 125,000 shares were granted to employees and options to purchase a total of 100,000 shares were granted to directors during the nine months ended September 30, 2010.

(4) CASH EQUIVALENTS:

The Company considers certain short-term investments in marketable debt securities with original maturities of three months or less to be cash equivalents.

A significant portion of the Company’s cash and cash equivalents are presently held in accounts at one international 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 current policy to invest in select money market instruments, United States Treasury investments, municipal and other governmental agency securities and corporate issuers.

 
8

 

(5) FAIR VALUE MEASUREMENT:

ASC Section 820, Fair Value Measurements and Disclosures, formerly Statement of Financial Accounting Standard (“SFAS”) No. 157, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The three levels of inputs used to measure fair value are as follows:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

All of the Company’s financial assets, which do not include cash on hand, as of September 30, 2011 and December 31, 2010, were Level 1 assets composed of money market funds with balances of $217,000 and $993,916, respectively. Financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable and the Line of Credit. At September 30, 2011 and December 31, 2010, the fair value of these instruments approximates the carrying amount of these items due to the short-term maturities of these instruments.

(6) INVENTORIES, NET:

Inventories, net consist of the following:

   
September 30,
   
December 31,
 
   
2011
   
2010
 
             
Raw materials
  $ 689,249     $ 752,966  
Work-in-process
    867,803       751,992  
Finished goods
    2,736,802       2,572,938  
Total inventories, net
  $ 4,293,854     $ 4,077,896  

(7) 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 used by the Italian diagnostics company. This licensed hepatitis product technology is existing technology, which the Italian diagnostics company had developed and successfully commercialized to manufacture hepatitis products sold by them and for which it had already received “CE Marking” approval from the European Union.  Through the acquisition of this existing technology in its current form, the Company expects to be able to derive revenue from the manufacture and sale of new hepatitis products. In exchange for the Italian diagnostics company’s assistance in transferring the know-how of the manufacturing technology, the Company agreed to pay a total of 1,000,000 Euro in the form of four milestone payments upon the Italian diagnostics company’s achievement of certain enumerated performance objectives related to the transfer of such existing technology.  Three of the four milestone payments, totaling 900,000 Euro, were made in prior years. The remaining milestone payment of 100,000 Euro, or approximately $136,000, is included in accrued license payable in the accompanying consolidated balance sheet as of September 30, 2011.  The carrying value of the product license is $282,936 as of September 30, 2011, which is reflected in the accompanying consolidated balance sheets. Amortization of the product license will begin following the initial sale of the hepatitis products manufactured by the Company.  In October 2011, the Company received “CE Marking” approval from the European Union for its hepatitis products.

(8) LOSS PER SHARE:

Loss per share is computed by dividing net loss by the weighted average number of shares of common stock outstanding during the year.  All outstanding stock options and warrants are considered potential common stock.  The dilutive effect, if any, of stock options and warrants is calculated using the treasury stock method.  The effect of options and warrants is currently anti-dilutive and not included in diluted earnings per share.

 
9

 

Outstanding stock options (1,020,870 as of September 30, 2011 and 1,173,198 as of December 31, 2010) and warrants to ERBA for 20,000,000 shares of the Company’s common stock have not been included in the calculation of loss per share because their impact would be anti-dilutive.

(9) INCOME TAXES:

The provision for income taxes consists of the following:

Period Ended September 30,
 
Three months
   
Nine months
 
   
2011
   
2010
   
2011
   
2010
 
Current:
                       
Domestic
  $ -     $ -     $ -     $ -  
Foreign
    12,741       11,630       (367,843 )     35,570  
Deferred:
                               
Domestic
    15,873       15,873       47,619       47,619  
Foreign
    -       -       -       -  
Total provision for income taxes
  $ 28,614     $ 27,503     $ (320,224 )   $ 83,189  

The Company is susceptible to large fluctuations in its effective tax rate and has thereby recognized tax expense on a discrete pro-rata basis for the nine months ended September 30, 2011. No current domestic tax provision was recorded during the nine months ended September 30, 2011or September 30, 2010 due to the increase in the valuation allowance to offset the benefit of domestic losses. The foreign current income tax provisions for the three and nine months ended September 30, 2011 and 2010 were the result of Italian local income taxes based upon applicable statutory rates effective in Italy.

As of September 30, 2011 and December 31, 2010, the Company has established a full valuation allowance on both its domestic and foreign net deferred tax assets, which are primarily comprised of net operating loss carryforwards. Due to the cumulative net losses from the operations of both domestic and foreign operations, the Company had no net deferred tax asset as of September 30, 2011 or December 31, 2010. As of September 30, 2011 and December 31, 2010, the Company had net deferred tax liabilities relating to tax deductible goodwill of $412,803 and $365,184, respectively, and recorded corresponding deferred tax provisions of $15,873 during each of the three months ended September 30, 2011 and 2010 and $47,619 during each of the nine months ended September 30, 2011 and 2010. Subsequent revisions to the estimated net realizable value of the deferred tax asset or deferred tax liability could cause the provision for income taxes to vary significantly from period to period.

The net operating losses included in the domestic net deferred tax asset will begin to expire in 2022. The net operating losses included in the foreign net deferred tax asset will begin to expire in 2011.  Under Section 382 of the Internal Revenue Code, the Company’s use of its net operating loss carryforwards will be limited in the future as a result of the September 1, 2010 acquisition by ERBA of the approximately 72.4% of the outstanding shares of the Company’s common stock previously owned by the prior group of the Company’s controlling stockholders. As a result of that acquisition, the Company’s ability to utilize net operating loss carryforwards to offset any future taxable income is currently limited to approximately $825,000 per year, plus both any limitation unused since the acquisition and any unused net operating losses generated after the September 1, 2010 acquisition date.  The amount of the annual limitation will be adjusted upwards for any recognized built-in gains on certain assets sold during the five year period commencing with the ownership change. The limitations of these net operating loss carryforwards did not impact the Company’s results for the nine months ended September 30, 2011 and 2010.

United States income taxes will not be provided on undistributed earnings of foreign subsidiaries; as such earnings will be retained indefinitely by such subsidiaries for reinvestment.  The distribution of these earnings would first reduce the domestic valuation allowance before resulting in additional United States income taxes.

During the nine months ended September 30, 2011, the Company’s wholly-owned subsidiary in Italy – Delta Biologicals, S.R.L – eliminated the balance of its intercompany loan of approximately $1,900,000 due to the Company, as a result of converting the loan to capital (equity). The Company had accrued for a potential withholding tax that would have been due upon payment of the interest on the loan. With the conversion of the balance to equity, approximately $400,000 of withholding tax liability was relieved during the nine months ended September 30, 2011, as the accrued interest will not be paid and therefore no withholding tax should be accrued. This reversal of the tax liability was recorded in the nine months ended September 30, 2011 as a one-time credit to income tax expense in the accompanying consolidated financial statements.

 
10

 

(10) COMPREHENSIVE LOSS:

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

Period Ended September 30,
 
Three months
   
Nine months
 
   
2011
   
2010
   
2011
   
2010
 
                         
Net loss
  $ (1,233,679 )   $ (1,176,758 )   $ (3,021,181 )   $ (3,445,475 )
                                 
Foreign currency translation adjustments
    (163,889 )     395,424       91,879       (163,270 )
                                 
Comprehensive loss
  $ (1,397,568 )   $ (781,334 )   $ (2,929,302 )   $ (3,608,745 )

(11) 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 both domestically and abroad. As of September 30, 2011 and December 31, 2010, $4,285,825 and $3,833,268, respectively, of the Company's total net accounts receivable were due from customers of our Italian subsidiary, the majority of which are located in Italy. Due to the recent financial crisis and instability in Italy, it is reasonably possible that management’s estimate of uncollectable receivable balances located in Italy may change in the near term and the effect of the change could be material to the Company. Of the total net accounts receivable, 42% at September 30, 2011 and 39% at December 31, 2010 were due from hospitals and laboratories controlled by the Italian government.  The Company maintains allowances for doubtful accounts, particularly in Italy where payment cycles are longer than in the United States, for potential credit losses based on the age of the accounts receivable and the results of the Company’s periodic credit evaluations of its customers’ financial condition. Additionally, the Company periodically receives payments based upon negotiated agreements with governmental regions in Italy, acting on behalf of hospitals located in the region, in satisfaction of previously outstanding accounts receivable balances.

(12) 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 located in the United States. The European region contains the Company’s subsidiary located in Italy. The information provided is based on internal reports and was developed and utilized by management to track 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 revenues, loss from operations, total assets and goodwill by region.
 
Period Ended September 30,
Net Revenues by Region
           
   
Three months
   
Nine months
 
   
2011
   
2010
   
2011
   
2010
 
                         
Domestic
                       
External net revenues
  $ 2,729,513     $ 2,894,375     $ 8,562,816     $ 9,034,993  
Intercompany revenues
    154,987       159,566       424,739       574,688  
      2,884,500       3,053,941       8,987,555       9,609,681  
European
                               
External net revenues
    1,330,085       1,058,231       4,006,138       3,966,937  
Intercompany revenues
    33,842       39,258       121,160       176,738  
      1,363,927       1,097,489       4,127,298       4,143,675  
                                 
Elimination
    (188,829 )     (198,824 )     (545,900 )     (751,426 )
Consolidated net revenues
  $ 4,059,598     $ 3,952,606     $ 12,568,953     $ 13,001,930  

 
11

 

 
Period Ended September 30,  
(Loss) from Operations by Region
           
   
Three months
   
Nine months
 
   
2011
   
2010
   
2011
   
2010
 
                         
Domestic
  $ (365,260 )   $ (894,820 )   $ (1,428,116 )   $ (1,977,032 )
European
    (632,213 )     (207,313 )     (1,737,414 )     (1,268,154 )
Elimination
    -       (21,430 )     -       (5,152 )
(Loss) from operations
  $ (997,473 )   $ (1,123,563 )   $ (3,165,530 )   $ (3,250,338 )

Total Assets by Region
 
September 30,
   
December 31,
 
   
2011
   
2010
 
             
Domestic
  $ 10,892,396     $ 8,479,223  
European
    6,910,576       6,621,799  
Total assets
  $ 17,802,972     $ 15,101,022  
 
Goodwill by Region
   
September 30,
   
December 31,
 
   
2011
   
2010
 
             
Domestic
  $ 870,290     $ 870,290  
European
    -       -  
Total goodwill
  $ 870,290     $ 870,290  

(13) 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.

(14) RECENTLY ISSUED ACCOUNTING STANDARDS:

In July 2010, FASB issued disclosure requirements for companies to provide enhanced disclosures regarding the credit quality of their financing receivables and the credit reserves held against them.  The main objective in developing the new disclosures is to provide users of the financial statements with greater transparency about a company’s allowance for credit losses and the credit quality of its financing receivables.  The new standards are intended to provide additional information to assist users of the financial statements in assessing a company’s credit risk and evaluating the adequacy of any allowance for credit losses.  The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 31, 2010.    The disclosures about activities that occur during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010.  The adoption of these new requirements did not have a material impact on the Company’s consolidated financial statements.

In April 2010, the FASB issued amended recognition and disclosure requirements regarding the milestone method of revenue recognition. The new guidance is designed to assist management in determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. The amendments affect companies that provide research or development deliverables in an arrangement in which one or more payments are contingent upon achieving uncertain future events or circumstances. This guidance is effective on a prospective basis for milestones achieved in fiscal years beginning on or after June 15, 2010. The adoption of these new requirements did not have a material impact on the Company’s consolidated financial statements.

In January 2010, the FASB issued additional disclosure requirements for fair value measurements. According to the guidance, the fair value hierarchy disclosures are further disaggregated by class of assets and liabilities. A class is often a subset of assets or liabilities within a line item in the statement of financial position. In addition, significant transfers between Levels 1 and 2 of the fair value hierarchy are required to be disclosed. These additional requirements, which became effective January 1, 2010 for quarterly and annual reporting, did not have an impact on the Company’s consolidated financial results, as this guidance related only to additional disclosures. In addition, the guidance requires more detailed disclosures of the changes in Level 3 instruments. These changes were effective January 1, 2011 and did not have a material impact on the Company’s consolidated financial statements.

 
12

 

In October 2009, the FASB issued amended revenue recognition guidance for arrangements with multiple deliverables. The new guidance requires the use of management’s best estimate of selling price (BESP) for the deliverables in an arrangement when vendor specific objective evidence (VSOE), vendor objective evidence (VOE) or third party evidence (TPE) of the selling price is not available. In addition, excluding specific software revenue guidance, the residual method of allocating arrangement consideration is no longer permitted, and an entity is required to allocate arrangement consideration using the relative selling price method. This guidance was effective for all new or materially modified arrangements entered into on or after January 1, 2011, with earlier application permitted as of the beginning of any prior fiscal year. Full retrospective application of the new guidance is optional. The Company implemented the new guidance effective January 1, 2011. The adoption of these new requirements did not have a material impact on the Company’s consolidated financial statements.

In October 2009, the FASB also issued guidance which amended the scope of existing software revenue recognition guidance. Tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality is no longer within the scope of software revenue guidance and is accounted for based on other applicable revenue recognition guidance. In addition, the amendments exclude hardware components of a tangible product containing software components from the software revenue guidance. This guidance is effective for all new or materially modified arrangements entered into on or after January 1, 2011, with earlier application permitted as of the beginning of any prior fiscal year. Full retrospective application of the new guidance is optional. This guidance must be adopted in the same period that the Company adopts the amended accounting for arrangements with multiple deliverables described in the preceding paragraph. The Company implemented the new guidance effective January 1, 2011. These new requirements did not have a material impact on the Company’s consolidated financial statements.
 
In June 2011, the FASB issued ASU No. 2011-05 which requires an entity to present all nonowner changes in stockholders’ equity either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. This standard will become effective for the Company in fiscal years, and interim periods within those years, beginning after December 15, 2011 and should be applied retrospectively. The Company does not believe that the implementation of this standard will have a material impact on its financial position, results of operation and cash flows.

In May 2011, the FASB issued ASU No. 2011-04 which provides a consistent definition of fair value in GAAP and International Financial Reporting Standards and ensures that their respective fair value measurement and disclosure requirements are the same (except for minor differences in wording and style). The amendments change certain fair value measurement principles and enhance the disclosure requirements particularly for level 3 fair value measurements. The standard will become effective for the Company during interim and annual periods beginning after December 15, 2011 and should be applied prospectively. The Company does not believe that the implementation of this standard will have a material impact on its financial position, results of operation and cash flows.

In September 2011, the FASB issued ASU No. 2011-08, under which an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit.  If the carrying amount of a reporting unit exceeds its fair value, then the entity is required to perform the second step of the goodwill impairment test to measure the amount of the impairment loss, if any. Under the amendments in this Update, an entity has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test. An entity may resume performing the qualitative assessment in any subsequent period.  The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The Company is in the process of evaluating the impact of this standard on its financial statements.

 
13

 

(15) RELATED PARTY TRANSACTIONS:

During the three and nine months ended September 30, 2010, the Company paid $59,500 and $119,000, respectively, to Lawrence G. Meyer in consideration for his provision of certain legal services which he provided to the Company on an as-needed basis.  Mr. Meyer served on the Company’s Board of Directors until his resignation from the Board of Directors on September 1, 2010.

During the three and nine months ended September 30, 2010, ImmunoVision, Inc., the Company’s wholly-owned  subsidiary in Arkansas, paid $15,000 and $45,000, respectively, to John B. Harley, M.D., Ph.D., under that certain oral consulting agreement between Dr. Harley and ImmunoVision, pursuant to which Dr. Harley was paid $5,000 per month from January 2010 through June 2010 and $2,000 per month thereafter, in consideration for his provision of technical guidance and business assistance to ImmunoVision on an as-needed basis.  Dr. Harley continues to serve on the Company’s Board of Directors.    During the three and nine months ended September 30, 2011, Dr. Harley was paid $6,000 and $18,000, respectively, for his provision of technical guidance and business assistance to ImmunoVision.

The amounts paid to Mr. Meyer and Dr. Harley, in each case as described above, were in addition to the amounts they received for their service as members of the Company’s Board of Directors and the committees of the Board of Directors on which they served.

During the three and nine months ended September 30, 2011, the Company sold products to Transasia and a subsidiary of ERBA for a total amount of Euro 153,000, or approximately $215,000, and Euro 317,000, or approximately $446,000, respectively.  In addition, during the three and nine months ended September 30, 2011, Transasia reimbursed the Company for research and development expenses for a total amount of Euro 0 and Euro 60,000, or approximately $84,000, respectively.  During the three months ended September 30, 2011, Delta Biologicals accrued for a total amount of Euro 60,000, or approximately $84,000, from Transasia relating to due diligence expenses.

As discussed above in Note 2, Going Concern, the Company entered into the Stock Purchase Agreement with ERBA, on April 8, 2011, pursuant to which the Company has agreed to the Investment in which it would sell and issue to ERBA an aggregate of 20,000,000 shares of the Company’s common stock for an aggregate purchase price of $15,000,000, or $0.75 per share of the Company’s common stock, and warrants to purchase an additional 20,000,000 shares of the Company’s common stock.  The consummation of the Investment was subject to, among other things, the approval of holders of at least 66-2/3% of the issued and outstanding shares of the Company’s common stock (excluding any shares beneficially owned, directly or indirectly, by ERBA).  At the Company’s 2011 Annual Meeting of Stockholders held on June 10, 2011, the required approval of the Company’s stockholders was achieved.

On June 30, 2011, ERBA paid the Company $5,000,000 in order to consummate the initial transactions contemplated by the Investment. As a result, the Company issued to ERBA 6,666,667 shares of the Company’s common stock and, in connection with the consummation of the initial transactions contemplated by the Investment, a warrant to purchase 20,000,000 shares of the Company’s common stock. After giving effect to transaction costs of $399,700 relating to the Stock Purchase Agreement and the Investment, the Company received net proceeds of $4,600,300 at the consummation of the initial transactions contemplated by the Investment.  As previously reported, the warrant has a five year term and an exercise price per share of the Company’s common stock of $0.75.

As previously reported, pursuant to the Stock Purchase Agreement, the Company has also agreed to issue to ERBA an additional 6,666,667 shares of the Company’s common stock for an aggregate purchase price of $5,000,000, on or prior to January 1, 2012, as well as an additional 6,666,666 shares of the Company’s common stock for an aggregate purchase price of $5,000,000, on or prior to July 1, 2012.  The additional $10,000,000 has been recorded as a stock subscription receivable in the accompanying balance sheet.

(16) REVOLVING LINE OF CREDIT:

As discussed above in Note 2, Going Concern, on June 10, 2011, Diamedix, a wholly-owned subsidiary of the Company, entered into the Loan Agreement with City National Bank of Florida, which provides for a secured, revolving credit facility of up to $975,000 (the “Line of Credit”).  Amounts outstanding under the Line of Credit will accrue interest at an annual rate equal to the 30-day LIBOR plus 4.00%, and the loan will become due and payable on June 10, 2013, subject to acceleration upon the occurrence of certain specified events of default that the Company believes are customary for transactions of this type.  The interest rate will increase by two percentage points (2.00%) per annum if certain covenants contained in the Loan Agreement are not met.

Amounts outstanding under the Line of Credit are collateralized by all of the assets of Diamedix, including, without limitation, the Company’s corporate headquarters located in Miami, Florida.  In addition, the Company and its other wholly-owned domestic subsidiary – ImmunoVision, Inc. – have guaranteed the repayment of amounts drawn on the Line of Credit. 
 
 
14

 
 
The Loan Agreement also includes, among other things, the following financial covenants applicable to Diamedix:

 
·
Minimum Tangible Net Worth (as defined therein) of not less than $1,000,000 as of December 3l of each year.
 
·
Fixed Charge Coverage Ratio (as defined therein) of not less than 1.50 to 1.00 as of the last day of each fiscal quarter, as measured for compliance on a rolling four quarter basis.
 
·
Maximum Funded Debt to EBITDA Ratio (as defined therein) of not less than 2.50 to 1.00 as of the last day of each fiscal quarter.
 
As of September 30, 2011, the Company was in compliance with all of the above financial covenants.  Closing costs and other transaction costs aggregating $101,000 were incurred related to the Loan Agreement and the Line of Credit. These costs have been classified as debt issuance costs on the accompanying consolidated balance sheet and are being amortized over the 24-month term of the Line of Credit commencing in June 2011.

As of September 30, 2011, $380,000 was outstanding under the Line of Credit and this amount and related debt issuance costs have been classified as current due to the terms of the related lockbox arrangement. As of September 30, 2011, the availability after giving effect to amounts outstanding on the Line of Credit was $376,000.  The Company is in the process of seeking a modification which, if completed, would eliminate the borrowing base calculation to determine loan availability and replace it with a fixed maximum availability of $975,000 less outstanding borrowings.

 
15

 

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 our Annual Report on Form 10-K for the year ended December 31, 2010 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.

We have made forward-looking statements, which are subject to risks and uncertainties, in this Quarterly Report on Form 10-Q. 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:

 
·
our ability to continue as a going concern;
 
·
our ability to generate positive cash flow or otherwise improve our liquidity, whether from existing operations, strategic initiatives or possible future sources of liquidity, including, without limitation, from the Investment or the Line of Credit, issuing debt or equity securities, incurring indebtedness or curtailing or reducing our operations;
 
·
the remaining transactions contemplated by the Investment under the Stock Purchase Agreement may not be consummated on the contemplated terms, in the time frame anticipated, or at all;
 
·
the net proceeds of the Investment, whether or not the warrants are exercised, may not provide adequate cash resources to fund our operations or liquidity needs for the reasonably foreseeable future;
 
·
our ability to achieve or sustain profitability from our operations or otherwise secure funds to provide the basis for our long-term liquidity;
 
·
our broad discretion in our use of the net proceeds from the Investment;
 
·
the warrants may not be exercised, in whole or in part;
 
·
the decision to exercise the warrants will be made by ERBA based upon considerations it deems appropriate, which may include, among other things, the future market price of our common stock, which is subject to volatility and a number of other factors, many of which may be beyond our control, and, when making any such decision to exercise the warrants, ERBA’s interests may conflict with our interests;
 
·
our ability to pay when due the principal and interest on our outstanding indebtedness under the Line of Credit;
 
·
our ability to operate our business under the restrictions imposed by the positive and negative covenants to which we are subject under the Loan Agreement in connection with the Line of Credit;
 
·
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;
 
·
the ability of the Mago® 4S to perform as expected;
 
·
the impact of the commercial release of the Mago® 4S on the judgments and estimates we have made with respect to our financial condition, operating results and cash flows;
 
·
the impact on our financial condition and operating results of making or changing judgments and estimates as a result of future design changes to, or the development of improved instrument versions of, the Mago® 4 or Mago® 4S or as a result of future demand for the Mago® 4 or Mago® 4S;
 
·
the ability of the Mago® 4 or Mago® 4S to be a source of revenue growth for us;
 
·
our ability to receive financial benefits or achieve improved operating results as a result of the commercial release of the Mago® 4 or the Mago® 4S;
 
·
the ability of the Mago® 4 or Mago® 4S to be a factor in our growth;
 
·
the ability of the Mago® 4 or Mago® 4S to expand the menu of test kits we offer;
 
·
making derivations of and upgrades to the Mago® our primary platforms for marketing our kits;
 
·
our ability to successfully market the Mago® 4 or Mago® 4S;
 
·
our customers’ integration of the Mago® 4 or Mago® 4S into their operations;
 
·
our ability to successfully market the DSX™ and DS2™ instrument systems from Dynex Technologies in conjunction with our test kits on a worldwide basis;
 
·
the success of our comprehensive review of our business plans and operations and the initiatives that we have implemented or may implement based on the results of such review;
 
·
our ability to improve our competitive position to the extent anticipated, or at all, as a result of our comprehensive review of our business plans and operations and the initiatives that we have implemented or may implement based on the results of such review;

 
16

 

 
·
our ability to expand the menu of test kits that we offer to include other complementary infectious disease or autoimmune testing sectors or otherwise;
 
·
the response of our current customer base to an expansion of our menu of test kits;
 
·
our ability to achieve organic growth;
 
·
our ability to identify or consummate acquisitions of businesses or products;
 
·
our ability to integrate acquired businesses or products;
 
·
our ability to enhance our position in laboratory automation;
 
·
our ability to expand our product offerings and/or market reach, including, without limitation, our ability to increase our presence in key countries in Europe, South America, Asia as well as other international markets, or become a leader in the diagnostics industry;
 
·
the impact the existing global economic conditions may have on our financial condition, operating results and cash flows;
 
·
the impact of healthcare regulatory reform;
 
·
constantly changing, and our compliance with, governmental regulation;
 
·
the impact of our adoption or implementation of new accounting statements and pronouncements on our financial condition and operating results;
 
·
our limited operating revenues and history of primarily operational losses;
 
·
our ability to collect our accounts receivable, particularly in Italy, and the impact of making or changing judgments and estimates regarding our allowances for doubtful accounts on our financial condition and operating results;
 
·
our ability to utilize our net operating losses, whether subject to limitations or not, and its impact on our financial condition and operating results;
 
·
the impact of any future limitations on our ability to utilize our net operating losses in the event of any future change in control or similar transaction;
 
·
the impact of making or changing judgments and estimates regarding our deferred tax liabilities and our valuation allowances and reserves against our deferred tax assets on our financial condition and operating results;
 
·
the impact of making or changing judgments and estimates regarding our goodwill, including the remaining goodwill recorded at ImmunoVision, and other intangible assets, such as our hepatitis technology product license, on our financial condition and operating results;
 
·
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;
 
·
our ability to obtain product technology from the Italian diagnostics company that would enable us to manufacture our own hepatitis products;
 
·
our ability to introduce and market our own hepatitis products in the European Union when expected, or at all, including the potential that any further delays may require us to record an additional impairment charge with respect to the value of our hepatitis technology product license or pay all or a portion of our accrued payables relating to the product license;
 
·
our ability to internally manufacture our own hepatitis products and raw materials for these products and to become competitive in markets outside of the United States;
 
·
our ability to derive revenue from our manufacture and sale of our own hepatitis products;
 
·
the impact of the anticipated timing of the commercial launch of our own hepatitis products on the judgments and estimates we have made with respect to our financial condition, operating results and cash flows;
 
·
our production capacity at our facility in Miami, Florida;
 
·
our ability to successfully improve our facilities and upgrade or replace our equipment and information systems in the timeframe and utilizing the amount of funds anticipated or at all;
 
·
our dependence on agreements with IVAX Corporation, 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 to meet increased demand;
 
·
protecting our intellectual property;
 
·
political and economic instability and foreign currency fluctuation affecting our foreign operations;
 
·
the effects of utilizing cash to assist Delta Biologicals, S.R.L., our wholly-owned subsidiary in Italy, in maintaining its compliance with capital requirements established by Italian law;
 
·
the holding of a significant portion our cash and cash equivalents 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;

 
17

 

 
·
voting control of our common stock by ERBA;
 
·
conflicts of interest with ERBA and its affiliates, including Suresh Vazirani and/or Kishore “Kris” Dudani, and with our officers, employees and other directors; 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, 2010, as supplemented by Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and as supplemented by Part II, Item 1A of this Quarterly Report on Form 10-Q, 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 STOCKHOLDERS

On September 1, 2010, ERBA Diagnostics Mannheim GmbH, an in vitro diagnostics company headquartered in Germany (“ERBA”), the parent company of which is Transasia Bio-Medicals Ltd. (“Transasia”), purchased all of the approximately 72.4% of the outstanding shares of our common stock owned by the prior group of our controlling stockholders for an aggregate purchase price of approximately $15,000,000, or $0.75 per share (the “Share Acquisition”).  As a result of the Share Acquisition and the consummation of the initial transactions contemplated by the Investment, as defined above, including ERBA’s purchase from us, and our issuance to ERBA, of 6,666,667 shares of our common stock, ERBA now beneficially owns, directly or indirectly, approximately 77.6% of the outstanding shares of the Company’s common stock.

RESULTS OF OPERATIONS

NINE MONTHS ENDED SEPTEMBER 30, 2011 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2010

OVERVIEW

Net loss totaled $3,021,000 for the nine months ended September 30, 2011 compared to net loss of $3,446,000 for the nine months ended September 30, 2010.  Operating loss was $3,166,000 in the 2011 period compared to operating loss of $3,250,000 for the 2010 period.  The reduction in net loss in the 2011 period compared to the 2010 period resulted primarily from a credit for income taxes, discussed further below.  The decrease in operating loss in the 2011 period compared to the 2010 period resulted primarily from reductions in operating expenses, partially offset by decreases in revenue. Net revenues decreased by $433,000 to $12,569,000 in the 2011 period from $13,002,000 in the 2010 period, consisting of a decrease in net revenues from domestic operations of $472,000, from $9,035,000 in the 2010 period to $8,563,000 in the 2011 period, and an increase in net revenues from European operations of $39,000, including the effect of exchange rate fluctuations of the United States dollar relative to the Euro, from $3,967,000 in the 2010 period to $4,006,000 in the 2011 period.

Gross profit decreased by $393,000 to $6,561,000 in the 2011 period from $6,954,000 in the 2010 period, primarily as the result of the abovementioned decline in net revenues. Gross profit as a percentage of net revenues decreased to 52.2% for the 2011 period from 53.5% for the 2010 period, principally as a result of lower margins at our European subsidiary.

Operating expenses decreased by $478,000 to $9,726,000 in the 2011 period from $10,204,000 in the 2010 period, as a result of a decrease in general and administrative expenses of $1,062,000, an increase in selling and marketing expense of $399,000 and an increase in research and development expenses of $185,000.


               
Period over Period
 
Nine months ended September 30,
 
2011
   
2010
   
Increase (Decrease)
 
                   
Net Revenues:
                 
Domestic
  $ 8,563,000     $ 9,035,000     $ (472,000 )
European
    4,006,000       3,967,000       39,000  
Total
    12,569,000       13,002,000       (433,000 )
                         
Cost of Sales
    6,008,000       6,048,000       (40,000 )
                         
Gross Profit
  $ 6,561,000     $ 6,954,000     $ (393,000 )
% of Total Net Revenues
    52.2%       53.5%          
 
 
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Total net revenues in the nine months ended September 30, 2011 decreased by $433,000, or 3.3%, from the nine months ended September 30, 2010. This decrease was composed of a decrease of $472,000 in net revenues from domestic operations and an increase of $39,000 in net revenues from European operations. The impact on European revenues of fluctuation of the United States dollar relative to the Euro was an increase of approximately $275,000. As measured in Euros, net revenues from European operations in the 2011 period decreased by 6.9% compared to the 2010 period.  The decrease in net revenues from European operations was primarily due to reagent volume declines in Italy as well as volume declines in other international markets.  Net revenues from domestic operations in the 2011 period decreased by 5.2% compared to the 2010 period.  The decrease in net revenue from domestic operations was primarily due to declines in volumes of antigen and reagent sales.

Gross profit in the 2011 period decreased by $393,000, or 5.7%, from the 2010 period.   The decrease in gross profit was primarily attributable to the decline in net revenues. The decrease in gross profit as a percentage of net revenues to 52.2% in the 2011 period from 53.5% in the 2010 period resulted mainly from lower margins at our European subsidiary.

OPERATING EXPENSES

Nine months ended September 30,
 
2011
   
% of
Revenue
 
2010
   
% of
Revenue
 
Period over Period
Increase (Decrease)
 
                           
Selling
  $ 4,054,000       32.3%   $ 3,655,000       28.1%   $ 399,000  
                                     
General and Administrative
    4,275,000       34.0%     5,337,000       41.1%     (1,062,000 )
                                     
Research and Development
    1,397,000       11.1%     1,212,000       9.3%     185,000  
                                     
Total Operating Expenses
  $ 9,726,000       77.4%   $ 10,204,000       78.5%   $ (478,000 )

The increase of $399,000 in selling expenses during the 2011 period compared to the 2010 period was primarily due to salaries for newly hired sales personnel and marketing expenses related to the launch of new products and trade shows.

The decrease of $1,062,000 in general and administrative expenses during the 2011 period compared to the 2010 period was primarily due to severance costs included in the 2010 period and a decrease in the number of executive officers in the 2011 period, as well as other reductions in spending for general and administrative expenses.

The increase of $185,000 in research and development expenses was due principally to the increase in new product development activities in the current year, including additional staff allocated to research and development activities.

LOSS FROM OPERATIONS

Loss from operations totaled $3,166,000 in the 2011 period as compared to loss from operations of $3,250,000 in the 2010 period. Loss from operations in the 2011 period was composed of a $1,428,000 loss from domestic operations and a $1,737,000 loss from European operations. Loss from operations in the 2010 period was composed of a $1,977,000 loss from domestic operations and a $1,273,000 loss from European operations. Domestic operations include corporate expenditures, including costs required to maintain our status as a public company.

OTHER EXPENSE, NET

Other expense, net totaled $176,000 during the 2011 period and other expense, net totaled $112,000 during the 2010 period. Amounts included in other expense, net in the 2011 and 2010 periods were primarily net realized and unrealized foreign currency losses from transactions and balances which were denominated in currencies other than the functional currency.

INCOME TAX PROVISION

We recorded recurring income tax provisions of $87,000 for the 2011 period and $83,000 for the 2010 period. The current portion of our tax provisions in both the 2011 and 2010 periods relates to Italian local income taxes based upon applicable statutory rates effective in Italy, while the deferred tax provision in these same periods relates to domestic tax deductible goodwill.  No current tax benefit was recorded during the 2011 and 2010 periods on our losses because we had a full valuation allowance against the net deferred income tax assets.

 
19

 

During the 2011 period, our wholly-owned subsidiary in Italy – Delta Biologicals, S.R.L. – eliminated the balance of its intercompany loan of approximately $1,900,000 due to us, as a result of converting the loan to capital (equity). We had accrued for a potential withholding tax that would have been due upon payment of the interest on the loan. With the conversion of the balance to equity, approximately $400,000 of withholding tax liability was relieved during the 2011 period, as the accrued interest will not be paid and therefore no withholding tax should be accrued. This reversal of the tax liability was recorded in the 2011 period as a one-time credit to income tax expense in the accompanying consolidated financial statements.

NET LOSS

We generated a net loss of $3,021,000 in the 2011 period as compared to a net loss of $3,445,000 in the 2010 period.  Our basic and diluted loss per common share was $0.10 in the 2011 period as compared to a basic and diluted loss per common share of $0.12 in the 2010 period. The net loss for both periods resulted primarily from the various factors discussed above.

THREE MONTHS ENDED SEPTEMBER 30, 2011 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2010

OVERVIEW

Net loss totaled $1,234,000 for the three months ended September 30, 2011 compared to net loss of $1,177,000 for the three months ended September 30, 2010.  Operating loss was $997,000 in the 2011 period compared to operating loss of $1,124,000 for the 2010 period.  The reduction in operating loss in the 2011 period compared to the 2010 period resulted primarily from reductions in operating expenses, partially offset by reduction in net revenue.  Net loss increased due to an unrealized exchange loss on balances held in a non-dollar currency.  Net revenues increased by $107,000 to $4,060,000 in the 2011 period from $3,953,000 in the 2010 period, consisting of a decrease in net revenues from domestic operations of $165,000, from $2,895,000 in the 2010 period to $2,730,000 in the 2011 period, and an increase in net revenues from European operations of $272,000, including the effect of exchange rate fluctuations of the United States dollar relative to the Euro, from $1,058,000 in the 2010 period to $1,330,000 in the 2011 period.

Gross profit decreased by $45,000 to $2,086,000 in the 2011 period from $2,131,000 in the 2010 period. Gross profit as a percentage of net revenues decreased to 51.4% for the 2011 period from 53.9% for the 2010 period, principally as a result of higher sales of instruments by our European operations, which have much lower margins than reagent sales.

Operating expenses decreased by $172,000 to $3,083,000 in the 2011 period from $3,255,000 in the 2010 period.  Comparing the 2011 period to the 2010 period, general and administrative expenses decreased by $444,000, selling expenses increased by $222,000 and research and development expenses increased by $50,000.
 
NET REVENUES AND GROSS PROFIT
 
               
Period over Period
 
Three months ended September 30,
 
2011
   
2010
   
Increase (Decrease)
 
                   
Net Revenues:
                 
Domestic
  $ 2,730,000     $ 2,895,000     $ (165,000 )
European
    1,330,000       1,058,000       272,000  
Total
    4,060,000       3,953,000       107,000  
                         
Cost of Sales
    1,974,000       1,822,000       152,000  
                         
Gross Profit
  $ 2,086,000     $ 2,131,000     $ (45,000 )
% of Total Net Revenues
    51.4%       53.9%          

Total net revenues in the three months ended September 30, 2011 increased by $107,000, or 2.7%, from the three months ended September 30, 2010. This increase was composed of an increase of $272,000 in net revenues from European operations, partially offset by a decrease of $165,000 in net revenues from domestic operations. The impact on European revenues of fluctuation of the United States dollar relative to the Euro was an increase of $118,000. As measured in Euros, net revenues from European operations in the 2011 period increased by 11% compared to the 2010 period.  The increase in net revenues from European operations was due to higher instrument sales, net of declines in reagent sales.  Net revenues from domestic operations in the 2011 period decreased by 5.7% compared to the 2010 period.  The decrease in net revenue from domestic operations was primarily due to declines in volumes of reagent sales.

 
20

 

Gross profit in the 2011 period decreased by $45,000, or 2.1%, from the 2010 period.  The decrease in gross profit as a percentage of net revenues to 51.4% in the 2011 period from 53.9% in the 2010 period resulted mainly from instrument sales by our European subsidiary, which have a much lower gross margin percentage.

OPERATING EXPENSES

Three months ended September 30,
 
2011
   
% of
Revenue
 
2010
   
% of
Revenue
 
Period over Period
Increase (Decrease)
 
                           
Selling
  $ 1,320,000       32.5%   $ 1,098,000       27.8%   $ 222,000  
                                     
General and Administrative
    1,351,000       33.3%     1,795,000       45.4%     (444,000 )
                                     
Research and Development
    412,000       10.1%     362,000       9.1%     50,000  
                                     
Total Operating Expenses
  $ 3,083,000       75.9%   $ 3,255,000       82.3%   $ (172,000 )

The increase of $222,000 in selling expenses during the 2011 period compared to the 2010 period was primarily due to salaries for newly hired sales personnel.

The decrease of $444,000 in general and administrative expenses during the 2011 period compared to the 2010 period was primarily due to severance costs included in the 2010 period and a decrease in the number of executive officers in the 2011 period, as well as other reductions in spending for general and administrative expenses.

The increase of $50,000 in research and development expenses was due principally to the increase in new product development activities in the current year, including additional staff allocated to research and development activities.
 
LOSS FROM OPERATIONS

Loss from operations totaled $997,000 in the 2011 period as compared to loss from operations of $1,124,000 in the 2010 period. Loss from operations in the 2011 period was composed of a $365,000 loss from domestic operations and a $632,000 loss from European operations. Loss from operations in the 2010 period was composed of a $895,000 loss from domestic operations and a $229,000 loss from European operations. Domestic operations include corporate expenditures, including costs required to maintain our status as a public company.

OTHER EXPENSE, NET

Other expense, net totaled $218,000 during the 2011 period and other expense, net totaled $28,000 during the 2010 period. Amounts included in other expense, net in the 2011 and 2010 periods were primarily net unrealized foreign currency losses from cash balances which were denominated in currencies other than the functional currency.

INCOME TAX PROVISION

We recorded recurring income tax provisions of $29,000 for the 2011 period and $28,000 for the 2010 period. The current portion of our tax provisions in both the 2011 and 2010 periods relates to Italian local income taxes based upon applicable statutory rates effective in Italy, while the deferred tax provision in these same periods relates to domestic tax deductible goodwill.  No current tax benefit was recorded during the 2011 and 2010 periods on our losses because we had a full valuation allowance against the net deferred income tax assets.

NET LOSS

We generated a net loss of $1,234,000 in the 2011 period as compared to a net loss of $1,177,000 in the 2010 period.  Our basic and diluted loss per common share was $0.04 in the 2011 period as compared to a basic and diluted loss per common share of $0.04 in the 2010 period. The net loss for both periods resulted primarily from the various factors discussed above.

 
21

 

LIQUIDITY AND CAPITAL RESOURCES

While our consolidated financial statements included in this Quarterly Report on Form 10-Q have been prepared assuming that we will continue as a going concern, substantial doubt has arisen about our ability to continue as a going concern.  The independent auditors’ report issued in conjunction with our consolidated financial statements as of, and for the year ended, December 31, 2010, contained an explanatory paragraph indicating that certain matters raise substantial doubt about our ability to continue as a going concern.  In addition, we have included going concern disclosure in Note 2, Going Concern, to our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, which states that certain matters raise substantial doubt about our ability to continue as a going concern and which addresses the substantial doubt about our ability to continue as a going concern.

During the nine months ended September 30, 2011, we consummated two significant financing arrangements  –  the Line of Credit under the Loan Agreement, as described in more detail in Note 16, Revolving Line of Credit, to our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, and the Investment under the Stock Purchase Agreement, as described in more detail in Note 15, Related Party Transactions, to our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q. We expect that these arrangements will provide the necessary capital and liquidity to significantly enhance our ability to operate as a going concern for the foreseeable future.

As discussed above in Note 16, Revolving Line of Credit, to our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, on June 10, 2011, Diamedix, one of our wholly-owned subsidiaries, entered into the Loan Agreement with City National Bank of Florida, which provides for a secured, revolving credit facility of up to $975,000 (the “Line of Credit”).  Amounts outstanding under the Line of Credit will accrue interest at an annual rate equal to the 30-day LIBOR plus 4.00%, and will become due and payable on June 10, 2013, subject to acceleration upon the occurrence of certain specified events of default that we believe are customary for transactions of this type.  The interest rate will increase by two percentage points (2.00%) per annum if certain covenants contained in the Loan Agreement are not met.  Amounts outstanding under the Line of Credit are secured by all of the assets of Diamedix, including, without limitation, our corporate headquarters located in Miami, Florida.  In addition, we and our other wholly-owned domestic subsidiary – ImmunoVision, Inc. – have guaranteed the repayment of amounts drawn on the Line of Credit.    As of September 30, 2011, $380,000 was outstanding under the Line of Credit and the availability after giving effect to amounts outstanding on the Line of Credit was $376,000.  We are in the process of seeking a modification which, if completed, would eliminate the borrowing base calculation to determine loan availability and replace it with a fixed maximum availability of $975,000 less outstanding borrowings.

As discussed above in Note 15, Related Party Transactions, to our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q, on June 30, 2011, ERBA paid the Company $5,000,000 in order to consummate the initial transactions contemplated by the Investment. As a result, we issued to ERBA 6,666,667 shares of our common stock and, in connection with the consummation of the initial transactions contemplated by the Investment, a warrant to purchase 20,000,000 shares of our common stock. After giving effect to transaction costs of $352,000 relating to the Stock Purchase Agreement and the Investment, we received net proceeds of $4,648,000 at the consummation of the initial transactions contemplated by the Investment.  As previously reported, the warrant has a five year term and an exercise price per share of the Company’s common stock of $0.75.  As also previously reported, pursuant to the Stock Purchase Agreement, we have also agreed to issue to ERBA an additional 6,666,667 shares of our common stock for an aggregate purchase price of $5,000,000, on or prior to January 1, 2012, as well as an additional 6,666,666 shares of our common stock for an aggregate purchase price of $5,000,000, on or prior to July 1, 2012.

In connection with our evaluation of our operating results, financial condition and cash position, and specifically considering our results of operations and cash utilization during the year ended December 31, 2010 and the nine months ended September 30, 2011, we have enacted, or are considering enacting, various measures to improve future cash flow.  To this end, we expect operating results to improve from the operating results achieved during the year ended December 31, 2010 and the nine months ended September 30, 2011 based principally upon increases in revenue as a result of our commercial launch of the Mago® 4S in the United States and increases in the United States and international revenue from new channels of distribution.  We also expect operating results to improve as a result of certain initiatives we have adopted or are considering adopting in order to reduce expenses.

For the long-term, we intend to utilize principally existing cash and cash equivalents, 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 as well as the additional net proceeds we expect to receive from ERBA in connection with the Investment.

At September 30, 2011, our working capital was $9,110,000 compared to $7,081,000 at December 31, 2010.  Cash and cash equivalents totaled $3,939,000 at September 30, 2011 and $1,827,000 at December 31, 2010.

 
22

 

In September 2011, Delta Biologicals, S.R.L., formalized its arrangement with the applicable local trade union to commence an arrangement with the applicable Italian labor authorities in the Lazio region of Italy under "Cassa Integrazione," pursuant to which Delta Biologicals will temporarily reduce the number of its personnel for a period of three months, which period can be extended for one year.  Under the arrangement, certain employees and middle managers of Delta Biologicals will generally receive varying percentages of their salary from, and Delta Biologicals will pay only a certain percentage of such personnel’s social security to, appropriate government authorities.  Delta Biologicals will continue to make accruals to the “Trattamento di fine Rapporto,” or TFR program, with respect to such personnel.

OPERATING ACTIVITIES

Net cash flows of $2,671,000 were used in operating activities during the nine months ended September 30, 2011 as compared to $1,849,000 used in operating activities during the nine months ended September 30, 2010.

Cash used by operating activities during the nine months ended September 30, 2011 of $2,671,000 was primarily the result of the net loss of $3,021,000, partially offset by non-cash items of $1,087,000 and changes in operating assets and liabilities of $736,000. The non-cash items include depreciation and amortization, non-cash compensation, a provision for doubtful accounts receivable, a provision for inventory obsolescence and deferred income taxes.

Cash used by operating activities during the nine months ended September 30, 2010 of $1,849,000 was due to our net loss of $3,445,000 and cash provided due to changes in operating assets and liabilities of approximately $781,000, in addition to cash provided by non-cash items of $815,000. The non-cash items include depreciation and amortization, a net provision of doubtful accounts receivable, non-cash compensation and deferred income taxes.

INVESTING ACTIVITIES

Net cash flows of $289,000 were used by investing activities during the nine months ended September 30, 2011, as compared to $303,000 used in investing activities during the nine months ended September 30, 2010.  Cash used by investing activities during the nine months ended September 30, 2011 primarily consisted of acquisitions of equipment on lease and capital expenditures, offset by cash released from restricted deposits.

Cash used by investing activities during the nine months ended September 30, 2010 primarily consisted of acquisitions of equipment on lease and capital expenditures, partially offset by cash provided from the sale of diagnostic instrumentation originally acquired by us in the fourth quarter of 2009 and originally classified as equipment on lease. During the nine months ended September 30, 2010, we also acquired equipment aggregating $222,000 under a capital lease.

FINANCING ACTIVITIES

Financing activities during the nine months ended September 30, 2011 reflect the consummation of two significant financing arrangements – the Line of Credit under the Loan Agreement, under which we have drawn down an amount of $380,000 as of September 30, 2011, and the Investment under the Stock Purchase Agreement, resulting in our receipt of net proceeds (after expenses of $400,000 related to the offering) of $4,600,000.  We also incurred capital lease payments of $53,000 and bank financing costs in the nine months ended September 30, 2011.

Financing activities during the nine months ended September 30, 2010 included payments made beginning in February 2010 for a 36-month capital lease we entered into with a financing company for bottling equipment at our production facility in Miami, Florida.

We incurred approximately $203,000 in capital expenditures during the nine months ended September 30, 2011, including the upgrade of our information technology infrastructure in the United States and various other purchases.

We may need to utilize cash to assist our European subsidiary, Delta Biologicals, S.R.L., in maintaining its compliance with capital requirements established by Italian law.

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 GAAP. 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, stock compensation, income and other tax accruals, the realization of long-lived assets and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe 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.

 
23

 

REVENUE RECOGNITION

A principal source of revenue is our "reagent rental" program in which customers make reagent kit purchase commitments with us that will usually last for a period of three to five years. In exchange, we typically include an instrument system, which remains our property (or, in the case of a lease financing arrangement, that of the financing company).  We also include any required instrument service. Both the instrumentation and service 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 European subsidiary, for estimated losses based on historical loss percentages 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, we may receive payments based upon negotiated agreements with governmental regions in Italy, acting on behalf of hospitals located in the region, in satisfaction of previously outstanding accounts receivable balances. Consequently, we may consider the potential receipt of those types of payments in determining our allowance for doubtful accounts. We may have anticipated collection of these amounts through a payment as described above, and, therefore, not provided an allowance for doubtful accounts for these amounts. Future 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 when expected or at all, or if negotiated agreements are not complied with in a timely manner or cancelled, then the Company may provide additional allowances for doubtful accounts. If contemplated payments are not received when expected or at all, if negotiated agreements are not complied with in a timely manner or at all, or if the financial condition of our customers were to deteriorate resulting in an impairment of their ability to make payments, then our operating results could be materially adversely affected during the period in which we make the determination to increase the allowance for doubtful accounts. Due to the recent financial crisis and instability in Italy, it is reasonably possible that management’s estimate of uncollectable receivable balances located in Italy may change in the near term and the effect of the change could be material to the Company. Our allowances for doubtful accounts were $648,000 and $399,000 as of September 30, 2011 and December 31, 2010, respectively.

INVENTORY

We regularly review inventory quantities on hand, which include components for current or future versions of products and instrumentation.  If necessary, we record a provision for excess and obsolete inventory based primarily on our estimates of component obsolescence, product demand and production requirements and product expiration dates.

Our inventory balance as of September 30, 2011 included approximately $200,000 of inventory relating to our hepatitis product, substantially all of which has a shelf life exceeding five years.  In October 2011, we received “CE Marking” approval from the European Union for our hepatitis products.

Inventory reserves were $439,000 and $452,000 as of September 30, 2011 and December 31, 2010, respectively.

GOODWILL AND OTHER INTANGIBLES

The determination as to whether a write-down of goodwill is necessary involves significant judgment based upon our short-term and long-term projections for the company. The assumptions supporting the estimated future cash flows of the reporting unit, including profit margins, long-term forecasts, discount rates and terminal growth rates, reflect our best estimates. All of our goodwill is currently recorded at ImmunoVision, one of our domestic subsidiaries.  Although we consider our current market capitalization, we do not believe it to be an appropriate measure for the fair value of ImmunoVision, as ImmunoVision represents less than 10% of our net revenues and total assets, and we believe that it is more meaningful to compute fair value based primarily upon discounted cash flows.

Our product license is existing technology, obtained from an Italian diagnostics company that had developed and successfully commercialized this technology to manufacture hepatitis products sold by them and for which it had already received “CE Marking” approval from the European Union.  Through the acquisition of this existing technology in its current form, we expect to be able to derive revenue from the manufacture and sale of new hepatitis products. In exchange for the Italian diagnostics company’s assistance in transferring the know-how of the manufacturing technology, we agreed to pay a total of 1,000,000 Euros in the form of four milestone payments upon the Italian diagnostics company’s achievement of certain enumerated performance objectives related to the transfer of such existing technology.  We made the first three milestone payments upon the achievement of the enumerated performance objectives in prior years.  In October 2011, we received “CE Marking” approval from the European Union for our hepatitis products, and, accordingly, we expect to pay the fourth and final milestone payment in the fourth quarter of 2011 by offsetting this payment against amounts owed to us by the Italian diagnostics company.

 
24

 

During the fourth quarter of 2008, we determined that the carrying amount of the product license was in excess of its fair value and recorded a non-cash impairment charge to operations totaling $560,000, reducing the carrying value of the product license to $683,000 as of December 31, 2008, from $1,243,000 as of December 31, 2007. During the fourth quarter of 2009, we determined that the carrying amount of the product license was in excess of its fair value and recorded a non-cash impairment charge to operations totaling $400,000, reducing the carrying value of the product license to $283,000 as of December 31, 2009. Fair value was determined based upon the income approach, which estimates fair value based upon future discounted cash flows. Based upon amended regulatory standards adopted during the fourth quarter of 2009 and additional regulatory requirements specified during 2010, we revised our assumptions supporting our computation of discounted cash flows to reflect the further delay in product launch and the possibility of a decrease in projected market share as a result of this delay, as well as to estimate the impact of the current global economic conditions.  Based upon this methodology, estimated future cash flows generated by the technology granted by the product license was then calculated, reflecting our best estimate of fair value. While we determined that our payment of the final milestone payment is probable and believe that capitalization of the remaining recoverable asset is appropriate, given the recent “CE Marking” approval we received from the European Union, there remains a risk that we will not be able to manufacture our own hepatitis products or successfully bring these hepatitis kits to market.  If the progress of our efforts to begin marketing these kits is further adversely impacted, then we may be required to record an additional impairment charge with respect to all or a portion of the remaining $283,000 intangible product license of the hepatitis technology asset.
 
STOCK-BASED COMPENSATION

Stock-based compensation expense for all stock-based compensation awards is based on the grant-date fair value estimate calculated in accordance with applicable accounting guidance.  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 or in equal annual amounts over a four year period.

Valuations are based on highly subjective assumptions about the future, including stock price volatility and exercise patterns. 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 our stock.  We use historical data to estimate expected term, taking into account 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 United States Treasury yield curve in effect at the time of the grant.

INCOME TAXES

We have experienced net losses from domestic operations. In accordance with GAAP, we are required to 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 both our domestic and European operations, we have provided a full valuation allowance against our deferred tax assets as of September 30, 2011.  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 and other temporary differences.  Upon reaching such a conclusion, and upon such time as we reverse the entire amount or a portion of the valuation allowance against the deferred tax asset, we would then provide for income taxes at a rate equal to our effective tax rate.

Under Section 382 of the Internal Revenue Code, our ability to use our net operating loss carryforwards will be limited in the future as a result of the September 1, 2010 acquisition by ERBA of the approximately 72.4% of the outstanding shares of our common stock previously owned by the prior group of our controlling stockholders.  As a result of that acquisition, our ability to utilize net operating loss carryforwards to offset future taxable income is currently limited to approximately $825,000 per year, plus both any limitation unused since the acquisition and any unused net operating losses generated after the September 1, 2010 acquisition date.  The amount of the annual limitation will be adjusted upwards for any recognized built-in gains on certain assets sold during the five year period commencing with the September 1, 2010 ownership change, but may be further limited in the event of any future change in control or similar transaction.  Our results for the nine months ended September 30, 2011 and 2010 were not impacted by these limitations.
 
 
25

 
 
During the 2011 period, our wholly-owned subsidiary in Italy – Delta Biologicals, S.R.L. – eliminated the balance of its intercompany loan of approximately $1,900,000 due to us, as a result of converting the loan to capital (equity). We had accrued for a potential withholding tax that would have been due upon payment of the interest on the loan. With the conversion of the balance to equity, approximately $400,000 of withholding tax liability was relieved during the 2011 period, as the accrued interest will not be paid and therefore no withholding tax should be accrued. This reversal of the tax liability was recorded in the 2011 period as a one-time credit to income tax expense in the accompanying consolidated financial statements.
 
The critical accounting policies discussed above 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 GAAP, 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

Refer to Note 14, Recently Issued Accounting Standards, to our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further information regarding recently issued accounting standards applicable to us.

CURRENCY FLUCTUATIONS

During the nine months ended September 30, 2011 and 2010, approximately 31.9% and 30.5%, respectively, of our net revenues were generated in currencies other than the United States dollar.  We expect that this percentage may increase in the future as a result of our efforts to increase our international presence, particularly in key international markets. 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 weakness of the United States dollar against the Euro resulted in an increase of approximately $275,000 in net revenues for the nine months ended September 30, 2011 compared to the same period of the prior year and an increase of approximately $118,000 in net revenues for the three months ended September 30, 2011 compared to the same period of the prior year.  During the nine months ended September 30, 2011 and 2010, none of our subsidiaries was domiciled in a highly inflationary environment and the impact of inflation and changing prices on our net revenues and on our loss from continuing operations was not material.

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, labor and employment laws, 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 net tax credit of $320,000 for the nine months ended September 30, 2011 and a tax provision of $83,000 for the nine months ended September 30, 2010.

We are susceptible to large fluctuations in our effective tax rate and have thereby recognized tax expense on a discrete pro-rata basis for the nine months ended September 30, 2011. No current domestic tax provision was recorded during the nine months ended September 30, 2011 or 2010 due to the increase in the valuation allowance to offset the benefit of domestic losses. The foreign current income tax provisions for the nine months ended September 30, 2011 and 2010 were the result of Italian local income taxes based upon applicable statutory rates effective in Italy.

As of September 30, 2011, we had no net domestic or foreign deferred tax asset, as a full valuation allowance has been established against deferred tax assets.  As of September 30, 2011, we had net deferred tax liabilities of $413,000 relating to tax deductible goodwill at ImmunoVision, and we recorded a corresponding deferred tax provision of $48,000 during the nine months ended September 30, 2011.  Subsequent revisions to the estimated net realizable value of the deferred tax asset or deferred tax liability 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.

Under Section 382 of the Internal Revenue Code, our ability to use our net operating loss carryforwards will be limited in the future as a result of the September 1, 2010 acquisition by ERBA of the approximately 72.4% of the outstanding shares of our common stock previously owned by the prior group of our controlling stockholders.  As a result of that acquisition, our ability to utilize net operating loss carryforwards to offset any future taxable income is currently limited to approximately $825,000 per year, plus both any limitation unused since the acquisition and any unused net operating losses generated after the September 1, 2010 acquisition date.  The amount of the annual limitation will be adjusted upwards for any recognized built-in gains on certain assets sold during the five year period commencing with the ownership change. The limitations of these net operating loss carryforwards did not impact our results for the nine months ended September 30, 2011 and 2010.

 
26

 

During the 2011 period, our wholly-owned subsidiary in Italy – Delta Biologicals, S.R.L. – eliminated the balance of its intercompany loan of approximately $1,900,000 due to us, as a result of converting the loan to capital (equity). We had accrued for a potential withholding tax that would have been due upon payment of the interest on the loan. With the conversion of the balance to equity, approximately $400,000 of withholding tax liability was relieved during the 2011 period, as the accrued interest will not be paid and therefore no withholding tax should be accrued. This reversal of the tax liability was recorded in the 2011 period as a one-time credit to income tax expense in the accompanying consolidated financial statements.

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.

Item 4 – Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, our management evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934).  Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the third quarter of 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 
27

 

PART II - OTHER INFORMATION

Item 1 - Legal Proceedings

We are 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 our financial position, results of operations or cash flows.

Item 1A - Risk Factors

Except for the risk factor set forth below, there has not been any material change to the risk factors previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010 and in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2011.  You should carefully consider the risks described below.  These and other risks could materially and adversely affect our business, operating results or financial condition.  The risks described below are not the only risks we face.  Additional risks not presently known to us or other factors that we do not presently perceive to present significant risks to us at this time may also impair our operations.  You should also refer to the other risk factors previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010 and in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, subject to the modifications described below.

Concerns regarding the Italian government fiscal and debt crises could have a material adverse effect on our operating results.

A substantial portion of our accounts receivable are concentrated in Italy and may be affected by the recent fiscal and debt crises facing the Italian government.  As of September 30, 2011 and December 31, 2010, $4.3 million and $3.8 million, respectively, of our total net accounts receivable were due from customers of our Italian subsidiary, the majority of which are located in Italy.  Of our total net accounts receivable, 42% at September 30, 2011 and 39% at December 31, 2010 were due from hospitals and laboratories controlled by the Italian government.  We maintain allowances for doubtful accounts, particularly in Italy where payment cycles are longer than in the United States, for potential credit losses based on the age of the accounts receivable and the results of our periodic credit evaluations of our customers’ financial condition.  Recently, the Italian government has been experiencing severe fiscal and debt crises, including its increasingly uncertain ability to service its sovereign debt obligations, caused in part by the declining global markets and economic conditions.  Accordingly, we are subject to certain economic, business and, in particular, credit risk if our customers located in Italy which are hospitals or laboratories controlled by the Italian government do not pay amounts owed to us, extend payment cycles even further or ask us to accept a lower payment amount than is owed to us.  Our current allowances for doubtful accounts may not be adequate and we may be required to make additional allowances, which would adversely affect, and could materially adversely affect, our operating results in the period in which the determination or allowance is or was made.  Any of these factors could materially and adversely affect our business, prospects, operating results, financial condition and cash flows.

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 **
 
101.INS
 
XBRL Instance Document ***
     
101.SCH
 
XBRL Taxonomy Extension Schema Document ***
     
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document ***
     
101.LAB
 
XBRL Taxonomy Extension Labels Linkbase Document ***
     
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document ***
     
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document ***
 

*
Filed with this Quarterly Report on Form 10-Q.
**
Furnished with this Quarterly Report on Form 10-Q.
*** 
Pursuant to Rule 406T of SEC Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability under these sections.

 
 
28

 

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:  November 18, 2011
By:
/s/ Arthur R. Levine
   
Arthur R. Levine,
   
Chief Financial Officer
 
 
29

 

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 **
 
101.INS
 
XBRL Instance Document ***
     
101.SCH
 
XBRL Taxonomy Extension Schema Document ***
     
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document ***
     
101.LAB
 
XBRL Taxonomy Extension Labels Linkbase Document ***
     
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document ***
     
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document ***
 

*
Filed with this Quarterly Report on Form 10-Q.
** 
Furnished with this Quarterly Report on Form 10-Q.
*** 
Pursuant to Rule 406T of SEC Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability under these sections.

 
 
30

 
 
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