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ERB > SEC Filings for ERB > Form 10-K on 14-Jun-2013All Recent SEC Filings

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Form 10-K for ERBA DIAGNOSTICS, INC.


14-Jun-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and the related Notes to Consolidated Financial Statements on pages 42 to 71 of this Annual Report on Form 10-K.

OVERVIEW

We are the parent corporation of the following five subsidiaries:

Delta Biologicals, S.r.l.;

Diamedix Corporation;

Drew Scientific, Inc.;

ImmunoVision, Inc.; and

JAS Diagnostics, Inc.

Through these subsidiaries, we develop, manufacture and market diagnostic test kits, or assays, and automated systems that are used to aid in the detection of disease markers primarily in the areas of autoimmune, infectious diseases, clinical chemistry, hematology and diabetes testing. In addition to diagnostic kits, we also design and manufacture laboratory instruments that perform the tests and provide fast and accurate results, while reducing labor costs. We also develop, manufacture and market raw materials, such as antigens used in the production of diagnostic kits.

Our management reviews financial information, allocates resources and manages the business as two segments defined by geographic region. One segment - the domestic region - contains Diamedix, ImmunoVision, Drew Scientific and JAS Diagnostics, our subsidiaries located in the United States and corporate operations. Our other segment - the European region - contains Delta Biologicals, our subsidiary located in Italy. The operations of Drew Scientific in the United Kingdom are not material to our consolidated operations for the year ended December 31, 2012.

ACQUISITION OF DREW SCIENTIFIC, INC.

On October 3, 2012, we acquired all of the issued and outstanding shares of capital stock of Drew Scientific from a subsidiary of Escalon Medical Corp. pursuant to a Stock Purchase Agreement between, among others, us and Escalon. Included in the acquired businesses were Drew Scientific's wholly-owned subsidiaries - JAS Diagnostics, Inc. and Drew Scientific Limited Co. For further details of this acquisition, see also Note 4, Acquisition of Drew Scientific, Inc., to the consolidated financial statements.

The acquired businesses, collectively referred to as Drew Scientific, were acquired with the purpose of integrating Drew Scientific's manufacturing and distribution capabilities with our legacy operations in an effort to achieve economies of scale and maximize the utilization of our assets and facilities. We paid $6,500,000 for all of the issued and outstanding shares of capital stock of Drew Scientific, which purchase price was funded through the purchase by ERBA Mannheim from us of 8,666,667 shares of our common stock at a purchase price of $0.75 per share, for an aggregate purchase price of $6,500,000.

Drew Scientific operates in the healthcare industry as a diagnostics company specializing in the design, manufacture and distribution of instruments for blood cell counting and blood analysis, focused on providing instrumentation and consumables for physician offices and veterinary office laboratories. Certain Drew Scientific subsidiaries also supply the reagent and other consumable materials needed to operate the instruments and manufacture a broad range of liquid stable, diagnostics chemistry reagents used in diabetes testing. Drew Scientific Limited Co. operated a similar business in the United Kingdom.

Drew Scientific, Inc. is a diagnostics company specializing in the design, manufacture and distribution of instruments for blood cell counting and blood analysis. Drew Scientific is focused on providing instrumentation and consumables for the physician office and veterinary office laboratories. Drew Scientific also supplies the reagent and other consumable materials needed to operate the instruments. JAS Diagnostics, Inc. specializes in the manufacture of a broad range of liquid stable, diagnostics chemistry reagents used for in


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vitro diagnostics testing. Many of these reagents are single vial stable, which we believe offer ease of use, increased speed of results and extended on-board stability. JAS Diagnostics' reagents are sold through distributors and directly to end users customers - physician, reference, hospital and veterinary diagnostic testing laboratories.

Prior to the October 3, 2012 acquisition date, our management decided to cease the operations of Drew Scientific and its subsidiaries at their facilities in both Dallas, Texas and the United Kingdom. As a result, we have accrued on the opening balance sheet as of October 3, 2012 estimated plant closing costs, including lease buy-out and severance costs, of $160,000 and $118,000, respectively. Regarding the Dallas, Texas facility, in May 2013, the Company's management announced that the closing would be effective in late September 2013. With respect to the United Kingdom facility, the closing was effective in late March 2013.

Included in the accompanying consolidated statement of operations and comprehensive loss are Drew Scientific revenues of approximately $3,391,000 and net loss of approximately $238,000 since October 3, 2012, the acquisition date. Unaudited pro forma information for the years ended December 31, 2012 and 2011, as though we had completed the acquisition of Drew Scientific as of the beginning of each period, would be approximately as follows: revenues of $29,264,000 and $30,148,000; net loss of $1,368,000 and $5,791,000; and net loss per share of $0.04 and $0.16. This unaudited pro forma financial information is presented for informational purposes only. The unaudited pro forma financial information may not necessarily reflect our future results of operations or what the results of operations would have been had we owned and operated Drew Scientific as of the beginning of the periods presented.

MAJORITY STOCKHOLDER

On July 25, 2005, IVAX Corporation, which then owned approximately 72.3% of the outstanding shares of our common stock, entered into a definitive agreement and plan of merger with Teva Pharmaceutical Industries Limited, or Teva, providing for IVAX Corporation to be merged into a wholly-owned subsidiary of Teva. On January 26, 2006, the merger was consummated and IVAX Corporation became a wholly-owned subsidiary of Teva. As a result of the merger, Teva, indirectly through its wholly-owned IVAX Corporation subsidiary, owned approximately 72.3% of the then outstanding shares of our common stock.

On September 2, 2008, a group comprised of Debregeas & Associes Pharma SAS, a company wholly-owned by Patrice R. Debregeas and members of his family, Paul F. Kennedy and Umbria LLC, a company wholly-owned by Mr. Kennedy, purchased from Teva all of the approximately 72.3% of the then outstanding shares of our common stock then owned by Teva, indirectly through its wholly-owned IVAX Corporation subsidiary. For purposes of this Annual Report on Form 10-K, Debregeas & Associes Pharma SAS, Patrice R. Debregeas, Paul F. Kennedy and Umbria LLC are collectively known as the Debregeas-Kennedy Group.

On September 1, 2010, ERBA Diagnostics Mannheim GmbH, or ERBA Mannheim, an in vitro diagnostics company headquartered in Germany, the parent company of which is Transasia Bio-Medicals Ltd., or Transasia, purchased all of the approximately 72.4% of the then outstanding shares of our common stock then owned by the Debregeas-Kennedy Group for an aggregate purchase price of approximately $15,000,000, or $0.75 per share. As a result of this share acquisition, the consummation of the various transactions contemplated by the investment made by ERBA Mannheim pursuant to that certain Stock Purchase Agreement, as further described below, including ERBA Mannheim's purchase from us, and our issuance to ERBA Mannheim, of an aggregate of 15,333,334 shares of our common stock, and ERBA Mannheim's exercise, in part, of the Warrant, as further described below, for 600,000 shares of our common stock, ERBA Mannheim now beneficially owns, directly or indirectly, approximately 82.4% of the outstanding shares of our common stock.


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RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2012 COMPARED TO YEAR ENDED DECEMBER 31, 2011 OVERVIEW

Net loss totaled $1,553,000 for the year ended December 30, 2012 compared to a net loss of $3,297,000 for the year ended December 30, 2011. Operating loss was $1,203,000 in 2012 compared to an operating loss of $3,228,000 in 2011. The decrease in operating loss in 2012 compared to 2011 resulted primarily from decreases in operating expenses, partially offset by the operating loss of $221,000 for Drew Scientific since the October 3, 2012 acquisition date. The decrease in net loss in 2012 compared to 2011 resulted primarily from decreases in operating expenses, partially offset by the net loss of $238,000 for Drew Scientific since the October 3, 2012 acquisition date.

Net revenues increased by $2,589,000 to $19,349,000 in 2012 from $16,760,000 in 2011. This net increase was attributed to the post-acquisition net revenues of $3,391,000 for Drew Scientific offset by other factors from recurring operations resulting in a decrease of $802,000. This decrease of $802,000 consisted of a decrease in net revenues from domestic operations of $581,000, to $10,926,000 in 2012 from $11,507,000 in 2011, and a decrease in net revenues from European operations of $221,000, including the effect of exchange rate fluctuations of the United States dollar relative to the Euro, to $5,032,000 in 2012 from $5,253,000 in 2011.

Gross profit increased by $490,000 to $9,092,000 in 2012 from $8,602,000 in 2011. This net increase was attributed to the post-acquisition gross profit of $881,000 for Drew Scientific offset by other factors from recurring operations resulting in a decrease of $391,000. This decrease of $391,000 from recurring operations was primarily the result of lower domestic and European revenues.

Total operating expenses decreased by $1,535,000 to $10,295,000 in 2012 from $11,830,000 in 2011. This net decrease was attributed to factors from recurring operations resulting in a decrease of $2,637,000, which was partially offset by the post-acquisition expenses of $1,102,000 for Drew Scientific. This net decrease of $1,535,000 was a result of decreases in all three expense categories. Comparing 2012 to 2011, selling expenses decreased by $437,000, general and administrative expenses decreased by $769,000 and research and development expenses decreased by $329,000.

NET REVENUES AND GROSS PROFIT (YEARS ENDED DECEMBER 31)

The following table presents comparative net revenues and gross profit for our
operations, including the operations for Drew Scientific since the October 3,
2012 date of acquisition (net revenues of $3,391,000, cost of sales of
$2,510,000 and gross profit of $881,000).

[[Image Removed]]   [[Image Removed]]      [[Image Removed]]      [[Image Removed]]
                            2012                   2011            Increase (Decrease)
Net Revenues:
Domestic            $       14,317,000     $       11,507,000     $         2,810,000
European                     5,032,000              5,253,000                (221,000 )
Total                       19,349,000             16,760,000               2,589,000
Cost of Sales               10,257,000              8,158,000               2,099,000
Gross Profit        $        9,092,000     $        8,602,000     $           490,000
% of Total                  47.0%                  51.3%

The net increase in revenues was attributed to the post-acquisition net revenues of $3,391,000 for Drew Scientific, a decrease of $581,000 in net revenues from our legacy domestic operations and a decrease of $221,000 in net revenues from European operations. Exchange rate differences resulting from the strength or weakness of the United States dollar against the Euro resulted in a decrease of approximately $442,000 in net revenues in 2012 as compared to 2011, as further discussed in "Currency Fluctuations" below. As measured in Euros, net revenues from European operations in 2012 decreased by Euro 32,000, or 0.8%, compared to 2011. The decrease in net revenues from European operations (as measured by the Euro) was mainly due to


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contract research and development revenue partially offset by the declines in reagent sales in Italy and other international markets. The decrease in the legacy domestic net revenues of $581,000, or 5.0%, was principally due to a decline in sales to international customers, principally in Latin America and Japan, partially offset by an increase in reagent sales.

The net increase in gross profit was attributed to the post-acquisition gross profit of $881,000 for Drew Scientific offset by a decrease in gross profit of $391,000 for our recurring operations. Gross profit as a percentage of net revenues decreased from 51.3% in 2011 to 47.0% in 2012, resulting principally from the lower gross profit percentage of 26.0% for the operations of Drew Scientific partially offset by an increase in reagent sales, which have a higher gross profit margin than instrument sales.

OPERATING EXPENSES (YEARS ENDED DECEMBER 31)

The following table presents comparative operating expenses for us, including
the amounts for Drew Scientific of $1,102,000 (selling expenses of $522,000,
general and administrative expenses of $320,000 and research and development
expenses of $260,000) since the October 3, 2012 date of acquisition. The
percentages below are based on the net revenues in the above table.

[[Image Removed]]   [[Image Removed]]      [[Image Removed]]      [[Image Removed]]      [[Image Removed]]      [[Image Removed]]
                            2012               % of Revenue               2011               % of Revenue            (Decrease)
Selling             $        4,617,000               23.9 %       $        5,054,000               30.1 %       $        (437,000 )
General and                  4,555,000               23.5 %                5,324,000               31.8 %                (769,000 )
Administrative
Research and                 1,123,000                5.8 %                1,452,000                8.7 %                (329,000 )
Development
Total Operating     $       10,295,000               53.2 %       $       11,830,000               70.6 %       $      (1,535,000 )
Expenses

The net decrease in total operating expenses was attributed to a decrease in expenses of $2,637,000 from $11,830,000 in 2011 to $9,193,000 in 2012 for our recurring operations, as a result of decreases in all three categories of expenses, which was partially offset by the post-acquisition expenses of $1,102,000 for Drew Scientific.

The net decrease of $437,000 in selling expenses in 2012 compared to 2011 was due to a decrease of $959,000 in our recurring operations, which was partially offset by the post-acquisition expenses of $522,000 for Drew Scientific. The decrease of $959,000 was due principally to open sales positions in the United States and, in Italy, reduction in workforce and lower commissions from lower sales in various commissionable categories.

The net decrease of $769,000 in general and administrative expenses was due to a decrease of $1,089,000 in our recurring operations, which was partially offset by the post-acquisition expenses of $320,000 for Drew Scientific. The decrease of $1,089,000 was due principally to reductions in workforce and building expenses in both the United States and Italy, partially offset by an increase in the provision for doubtful accounts in Italy.

The net decrease of $329,000 in research and development expenses was due to a decrease of $589,000 in our recurring operations, which was partially offset by the post-acquisition expenses of $260,000 for Drew Scientific. The decrease of $589,000 was due principally to the reduction of research and development activities in the United States and the funding by ERBA Mannheim (beginning in December 2011) of the research and development efforts in Italy, for which the relevant expenses are now included in cost of sales. See also Note 14, Related Party Transactions, to the consolidated financial statements.

LOSS FROM OPERATIONS

Including the operations of Drew Scientific since the acquisition date, loss from operations totaled $1,203,000 in 2012 as compared to an operating loss of $3,228,000 in 2011, primarily due to the net reduction in operating expenses as described above. Loss from operations in 2012 was composed of an operating loss of $221,000 for Drew Scientific, an operating loss of $600,000 from recurring domestic operations and an operating loss of $382,000 from our European operations. Loss from operations in 2011 was composed of a $1,371,000 loss from domestic operations and a $1,857,000 loss from European operations. Domestic operations include corporate expenditures, including costs required to maintain our status as a public company.


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OTHER INCOME (EXPENSE), NET

Other income (expense) totaled a net expense of $228,000 in 2012 as compared to a net expense of $361,000 in 2011. The 2012 amounts consist of foreign currency translation losses of $56,000, net interest expense of $40,000, expenses of $211,000 related to the acquisition of Drew Scientific and net other income of $79,000. The 2011 balance consists of foreign currency translation losses of $168,000, interest expense of $22,000 and net other expenses of $171,000.

INCOME TAX PROVISION

We recorded recurring income tax provisions of $122,000 for 2012 and a net benefit of $292,000 for 2011. The current portion of our tax provisions in both years relates to Italian local income taxes based upon applicable statutory rates effective in Italy. In addition, the domestic provision of $10,500 for 2012 represents an estimated charge for expected future expenditure to resolve a state tax matter. The deferred tax provisions in these years relate to domestic tax deductible goodwill. No current tax benefit was recorded during the two years on our losses because we had a full valuation allowance against the net deferred income tax assets.

During 2011, our wholly-owned subsidiary in Italy, Delta Biologicals, S.r.l., eliminated the balance of its intercompany loan of approximately $2,680,000 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 $406,000 of withholding tax liability was relieved during 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 2011 as a one-time credit to income tax expense in the accompanying consolidated financial statements.

See also Note 8, Income Taxes, to the consolidated financial statements regarding other tax matters.

NET LOSS

Including the net loss of $238,000 for Drew Scientific since the acquisition date, we generated a net loss of $1,553,000 in 2012 as compared to a net loss of $3,297,000 in 2011. Basic and diluted net loss per common share was $0.04 in 2012 as compared to $0.11 in 2011. The net loss for both years resulted from the various factors discussed above.


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LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2012, our working capital was $9,834,000 compared to $8,631,000 at December 31, 2011. Cash and cash equivalents totaled $4,126,000 at December 31, 2012 and $3,653,000 at December 31, 2011. As more fully described in Note 4, Acquisition of Drew Scientific, Inc., to the consolidated financial statements, during the year ended December 31, 2012, ERBA Mannheim paid $6,500,000 to us in consideration of the issuance, on October 3, 2012, of 8,666,667 shares of our common stock, which funds were used by us to fund the acquisition, on October 3, 2012, of Drew Scientific and its wholly-owned subsidiaries.

Operating activities

Net cash flows of $202,000 were provided by operating activities during the year ended December 31, 2012 as compared to $2,850,000 that was used in operating activities during the year ended December 30, 2011.

Cash provided by operating activities of $202,000 during 2012 was the result of the net loss of $1,553,000, offset by changes in operating assets and liabilities of $320,000 and non-cash items of $1,435,000. The non-cash items include principally depreciation, amortization of intangible assets, adjustments to both the allowances for doubtful accounts and inventory obsolescence and deferred income taxes. Cash provided by changes in operating assets and liabilities was due to changes in accounts receivable, inventories, other current assets, accounts payable and accrued expenses and other long-term liabilities.

Cash used in operating activities of $2,850,000 during 2011 was the result of the net loss of $3,297,000 and changes in operating assets and liabilities of $928,000, partially offset by non-cash items of $1,375,000. The non-cash items include principally depreciation and amortization, adjustments to both the allowances for doubtful accounts and inventory obsolescence and deferred income taxes.

Investing activities

As noted above and throughout this Annual Report on Form 10-K, we acquired Drew Scientific on October 3, 2012. As discussed in Note 4, Acquisition of Drew Scientific, Inc., to the consolidated financial statements, the fair value of assets acquired aggregated $8,261,000, including accounts receivable of $1,211,000, inventory of $2,093,000, identifiable intangible assets of $1,848,000, other assets of $485,000 and goodwill of $2,624,000. The fair value of liabilities assumed aggregated $1,761,000.

Net cash of $6,622,000 and $469,000 was used in investing activities during 2012 and 2011, respectively. The cash flows relating to investing activities in 2012 were principally for the acquisition of Drew Scientific ($6,453,000, net of cash acquired of $47,000), capital expenditures of $105,000, acquisition of equipment on lease of $77,000, offset by cash released from restricted deposits of $13,000. The cash flows relating to investing activities in 2011 were principally for capital expenditures (including the upgrade of our information technology infrastructure in the United States) and acquisition of equipment on lease, offset by cash released from restricted deposits.

Financing activities

Financing activities during 2012 reflect the receipt of proceeds of $6,950,000 from the issuances of common stock, net proceeds of $86,000 under the Line of Credit and capital lease payments of $79,000. In April 2012, we received $450,000 from ERBA Mannheim in connection with its partial exercise of the Warrant. In September 2012, we received $6,500,000 from ERBA Mannheim as an advance in connection with our issuance in October 2012 of shares to it under the Stock Purchase Agreement, as amended, between us and ERBA Mannheim. We used the proceeds from this advance to acquire, on October 3, 2012, Drew Scientific and its wholly-owned subsidiaries.

Financing activities during 2011 reflect the consummation of two significant financing arrangements - the Line of Credit under the Loan Agreement, under which we drew down $737,000 as of December 31, 2011, and the investment by ERBA Mannheim 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. In 2011, we also incurred capital lease payments of $72,000 and bank financing costs of $101,000.


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Other matters

Liquidity is expected to be sufficient for the next twelve months from the combination of the existing cash and cash equivalents at December 31, 2012, and the investment that ERBA Mannheim has agreed to make under the Stock Purchase Agreement, including the Warrant, as described throughout this Annual Report on Form 10-K.

A significant portion of our cash and cash equivalents is presently held at one international securities brokerage firm. Accordingly, we are subject to credit risk if this brokerage firm is unable to repay the balance in the account or deliver our securities or if the brokerage firm should become bankrupt or otherwise insolvent. We invest in only select money market instruments, United States treasury investments, municipal and other governmental agency securities and corporate issuers.

Our product research and development expenditures were $1,123,000 during the year ended December 31, 2012 and $1,452,000 for the year ended December 31, 2011. In the fourth quarter of 2011, Delta Biologicals entered into a contract research and development agreement, as amended, with ERBA Mannheim for a total of Euro 754,700 (equivalent to approximately $1,003,000). Totals of Euro 133,000 (equivalent to approximately $186,000) and Euro 621,700 (equivalent to approximately $799,000) were invoiced under the contract in the fourth quarter of 2011 and the year ended December 31, 2012, respectively. Actual expenditures will depend upon, among other things, the outcome of clinical testing of products under development, delays or changes in government required testing and approval procedures, technological and competitive developments, strategic marketing decisions and liquidity. There can be no assurance that these expenditures will result in the development of new products or product enhancements, which we will successfully complete products under development, that we will obtain regulatory approval or that any approved product will be produced in commercial quantities, at reasonable costs, and be successfully marketed.

In connection with our evaluation of our operating results, financial condition and cash position, and specifically considering our results of operations and cash utilization during 2012, we continue to implement measures expected to improve future cash flow. To this end, we expect operating results to continue to improve from the operating results achieved during 2012 based principally upon increases in revenue as a result of new channels of distribution in the United States and international markets.

We maintain allowances for doubtful accounts, particularly in Italy where payment cycles are longer than in the United States, for estimated losses resulting from the inability of our customers to make required or timely payments. Additionally, we periodically 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. We may anticipate collection of these amounts through a payment as described above, and, therefore, not provide an allowance for doubtful accounts for these amounts. If contemplated payments are not received, if existing agreements are not complied with or cancelled, or if we require additional allowances, 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.

We cannot guarantee that we can generate net income, increase revenues, improve our cash flow or successfully obtain debt or equity financing on acceptable terms, or at all, and, if we cannot do so, then we may not be able to survive and any investment in our company may be lost. For the long-term, we intend to utilize principally existing cash and cash equivalents, proceeds we expect to . . .

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