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DSCI > SEC Filings for DSCI > Form 10-Q on 10-May-2016All Recent SEC Filings

Show all filings for DERMA SCIENCES, INC.

Form 10-Q for DERMA SCIENCES, INC.


10-May-2016

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

This Quarterly Report on Form 10-Q (this "Report") includes certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about the confidence, strategies, plans, expectations, intentions, objectives, technologies, opportunities, market demand or acceptance of new or existing products of Derma Sciences, Inc., a Delaware corporation, and its subsidiaries ("we" or "us" or the "Company"), and other statements contained in this Report that are not historical facts. Forward-looking statements in this Report or hereafter included in other publicly available documents filed with the Securities and Exchange Commission (the "Commission") reports to our stockholders and other publicly available statements issued or released by us involve known and unknown risks, uncertainties and other factors that could cause our actual results, performance (financial or operating) or achievements to differ from the future results, performance (financial or operating) or achievements expressed or implied by such forward-looking statements. Such future results are based upon management's best estimates, current conditions and the most recent results of operations. When used in this Report, the words "expect," "anticipate," "intend," "plan," "believe," "seek," "estimate" and similar expressions are generally intended to identify forward-looking statements, because these forward-looking statements involve risks and uncertainties. There are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including our plans, objectives, expectations and intentions, changes in political, economic, business, competitive, market and regulatory factors and other factors that are discussed under the section in this Report entitled "Risk Factors," as well as our Annual Report on Form 10-K for the fiscal year ended December 31, 2015 filed on March 15, 2016 (the "2015 Form 10-K") and other filings with the Commission. Neither we nor any other person assume responsibility for the accuracy or completeness of these forward-looking statements. We are under no duty to update any of the forward-looking statements after the date of this Report to conform these statements to actual results.

Three Months Ended March 31, 2016 Compared to Three Months Ended March 31, 2015



Overview



Operating Results of Three Months Ended March 31, 2016 and 2015



The following table highlights the operating results for the three months ended
March 31, 2016 and 2015:



                                          Three Months Ended March 31,
                                             2016               2015                   Variance
Gross sales                             $    22,766,903     $  21,897,074     $    869,829            4.0 %
Sales adjustments                            (2,524,346 )      (2,398,422 )       (125,924 )          5.3 %
Net sales                                    20,242,557        19,498,652          743,905            3.8 %
Cost of sales                                12,535,034        11,963,526          571,508            4.8 %
Gross profit                                  7,707,523         7,535,126          172,397            2.3 %
Selling, general and administrative
expense                                       9,953,114        13,258,405       (3,305,291 )        (24.9 %)
Research and development expense                      -           352,183         (352,183 )            *
Other (income) expense, net                    (268,040 )         367,788         (635,828 )            *
Total expenses                                9,685,074        13,978,376       (4,293,302 )        (30.7 %)
Loss from continuing operations
before income taxes                          (1,977,551 )      (6,443,250 )      4,465,699          (69.3 %)
Income tax (benefit) provision                 (219,798 )           8,051         (227,849 )            *
Net loss from continuing operations          (1,757,753 )      (6,451,301 )      4,693,548          (72.8 %)
Loss from discontinued operations,
net of taxes                                          -        (4,158,276 )     (4,158,276 )            *
Net loss                                $    (1,757,753 )   $ (10,609,577 )   $  8,851,824          (83.4 %)

* - not meaningful

Sales Adjustments



Gross to net sales adjustments comprise the following:



                                         Three Months Ended March 31,
                                            2016                2015
              Gross sales              $    22,766,903      $ 21,897,074
              Trade rebates                 (1,789,703 )      (1,583,576 )
              Distributor fees                (244,755 )        (181,772 )
              Sales incentives                (230,603 )        (302,406 )
              Returns and allowances           (86,052 )        (160,334 )
              Cash discounts                  (173,233 )        (170,334 )
              Total adjustments             (2,524,346 )      (2,398,422 )
              Net sales                $    20,242,557      $ 19,498,652

Trade rebates increased in 2016 versus 2015 principally due to increases in sales subject to rebate in the U.S. and Canada, and the rebate percentage as a result of changes in product mix towards higher rebated products in Canada. The increase in distributor fees was commensurate with the increase in Canadian sales upon which the fees were based. The decrease in sales incentives reflected lower sales subject to incentives. Sales returns and allowances decreased in 2016 due to quality control issues affecting 2015 sales that did not reoccur in 2016.

                                            2016                                               2015
                       Gross Sales       Sales Adj.       Net Sales       Gross Sales       Sales Adj.       Net Sales
By Entity Location

US                     $ 17,882,233     $ (1,147,257 )   $ 16,734,976     $ 17,585,495     $ (1,265,257 )   $ 16,320,238
Canada                    3,707,251       (1,375,634 )      2,331,617        3,174,126       (1,133,148 )      2,040,978
International             1,177,419           (1,455 )      1,175,964        1,137,453              (17 )      1,137,436

Total                  $ 22,766,903     $ (2,524,346 )   $ 20,242,557     $ 21,897,074     $ (2,398,422 )   $ 19,498,652

U.S. sales adjustments decreased due to lower returns and allowance and sales incentives partially offset by higher trade rebates. U.S. sales returns and allowances decreased in 2016 due to quality control issues affecting 2015 sales that did not reoccur in 2016. U.S. sales incentives decreased due to decreased sales upon which the fees are based. The U.S. rebate percentage increased as a result of increased sales of higher rebated products. Sales adjustments in Canada were higher in 2016 than 2015 due to higher trade rebates and distribution fees. The increase in Canadian sales rebates and distributor fees was commensurate with the increase in Canadian sales upon which the fees are based. The Canadian rebate percentage also increased due to increased sales of higher rebated products.

                                              2016                                               2015
                         Gross Sales       Sales Adj.       Net Sales       Gross Sales       Sales Adj.       Net Sales
By Segment

Advanced wound care      $ 11,266,419     $   (666,248 )   $ 10,600,171     $ 10,633,741     $   (862,717 )   $  9,771,024
Traditional wound care     11,500,484       (1,858,098 )      9,642,386       11,263,333       (1,535,705 )      9,727,628

Total                    $ 22,766,903     $ (2,524,346 )   $ 20,242,557     $ 21,897,074     $ (2,398,422 )   $ 19,498,652

Advanced wound care sales adjustments decreased due to lower returns and allowances, trade rebates and sales incentives. Advanced wound care sales returns and allowances decreased in 2016 due to the non-recurrence of the 2015 quality control issues. Advanced wound care rebates and sales incentives decreased due to decreased sales upon which the fees are based. The advanced wound care rebate percentage increased as a result of increased sales of higher rebated products. Traditional wound care sales adjustments increased in 2016 versus 2015 due to higher trade rebates and distribution fees. The increase in traditional wound care sales rebates and distributor fees was commensurate with the increase in sales upon which the fees are based. The traditional wound care rebate percentage also increased due to increased sales of higher rebated products.

Rebate Reserve Roll-Forward



A roll-forward of the trade rebate accruals for the three months ended March 31,
2016 and 2015 were as follows:



                                            Three Months Ended March 31,
                                               2016                2015
          Beginning balance - January 1   $     1,636,439      $  1,880,525
          Rebates paid                         (1,724,103 )      (1,842,163 )
          Rebates accrued                       1,789,703         1,583,576
          Ending balance - March 31       $     1,702,039      $  1,621,938

The $65,600 increase in the trade rebate reserve balance at March 31, 2016 from January 1, 2016 principally reflected the timing of rebate payments and increases in sales subject to rebate and the rebate percentage. There was no other significant change in the nature of our business during the three months ended March 31, 2016 as it related to the accrual and subsequent payment of rebates.

Net Sales



                                                                              $ Variance                               % Variance
                                 2016             2015           Non FX            FX           Total        Non FX        FX          Total
By Entity Location

US                           $ 16,734,976     $ 16,320,238     $   414,738     $        -     $ 414,738          2.5 %         - %        2.5 %
Canada                          2,331,617        2,040,978         559,473       (268,834 )     290,639         27.4       (13.2 )       14.2
International                   1,175,964        1,137,436         107,735        (69,207 )      38,528          9.5        (6.1 )        3.4

Total                        $ 20,242,557     $ 19,498,652     $ 1,081,946     $ (338,041 )   $ 743,905          5.5 %      (1.7 %)       3.8 %

The increase in net sales by the U.S. entity was driven by higher advanced wound care, first aid division ("FAD"), and specialty fixation devices sales, partially offset by lower private label sales. The lower private label sales were due to the loss of a significant customer in 2015 due to industry consolidation. The increase in net sales by the Canadian entity was driven by higher traditional wound care sales, partially offset by lower advanced wound care sales. Canadian entity net sales were favorably impacted by our exclusive distributor's rebalancing efforts. Canadian year over year market demand increased 3%. The increase in International sales was driven by higher advanced wound care sales partially offset by lower traditional wound care sales.

                                                                              $ Variance                               % Variance
                                 2016             2015           Non FX            FX           Total        Non FX        FX          Total
By Segment

Advanced wound care          $ 10,600,171     $  9,771,024     $   910,166     $  (81,019 )   $ 829,147          9.3 %      (0.8 %)       8.5 %
Traditional wound care          9,642,386        9,727,628         171,780       (257,022 )     (85,242 )        1.8        (2.6 )       (0.9 )

Total                        $ 20,242,557     $ 19,498,652     $ 1,081,946     $ (338,041 )   $ 743,905          5.5 %      (1.7 %)       3.8 %

The advanced wound care sales increase was led by Total Contact Casting ("TCC"), AMNIO products, and MEDIHONEY, partially offset by lower ALGICEL and XTRASORB sales in the U.S. The decrease in traditional wound care sales was driven by lower private label sales in the U.S., partially offset by higher traditional wound care sales in Canada.

Gross Profit



                                                                           $ Variance                               % Variance
                               2016            2015           Non FX           FX           Total        Non FX        FX          Total
By Segment

Advanced wound care         $ 5,385,146     $ 4,901,124     $  569,949     $  (85,927 )   $  484,022        11.6 %      (1.8 %)       9.9 %
Traditional wound care        2,322,377       2,634,002       (268,598 )      (43,027 )     (311,625 )     (10.2 )      (1.6 )      (11.8 )

Total                       $ 7,707,523     $ 7,535,126     $  301,351     $ (128,954 )   $  172,397         4.0 %      (1.7 %)       2.3 %

Gross Profit %
Advanced wound care                50.8 %          50.2 %
Traditional wound care             24.1 %          27.1 %

Total                              38.1 %          38.6 %

The increase in gross profit dollars for the advanced wound care segment was driven by higher sales and an increase in the gross profit percentage. The increase in gross profit percentage for the advanced wound care segment was driven by higher sales of higher margined products. The decrease in gross profit dollars for the traditional wound care segment was driven by lower sales and gross profit percentage. The decrease in gross profit percentage for the traditional wound care segment reflected higher sales of lower margined products, and higher product costs.

Selling, General and Administrative Expenses



The following table highlights selling, general and administrative expenses by
function for the three months ended March 31, 2016 versus 2015:



                                                                 $ Variance                                 % Variance
                  2016             2015            Non FX            FX            Total         Non FX         FX         Total

Distribution   $   632,089     $    669,024     $    (28,132 )   $   (8,803 )   $    (36,935 )      (4.2 %)     (1.3 %)      (5.5 %)
Marketing        1,346,771        2,282,217         (932,555 )       (2,891 )       (935,446 )     (40.9 )      (0.1 )      (41.0 )
Sales            4,829,498        6,251,356       (1,378,955 )      (42,903 )     (1,421,858 )     (22.1 )      (0.7 )      (22.7 )
G&A              3,144,756        4,055,808         (852,988 )      (58,064 )       (911,052 )     (21.0 )      (1.4 )      (22.5 )

Total          $ 9,953,114     $ 13,258,405     $ (3,192,630 )   $ (112,661 )   $ (3,305,291 )     (24.1 %)     (0.8 %)     (24.9 %)

The decrease in distribution expense was due to the Company's restructuring and overall expense reduction initiatives implemented in the fourth quarter of 2015.

The decrease in marketing expense reflected lower salaries, equity based compensation, and related travel expenses associated with the elimination of five positions, lower consulting costs, and promotional spend as a result of the Company's restructuring and expense reduction initiatives in the fourth quarter of 2015.

The decrease in sales expense reflected lower salaries, commissions, equity based compensation and related travel expenses as a result of the Company's reduction from 50 territory managers to 38 along with the elimination of four associated management and support staff in the U.S. and one International territory manager during the fourth quarter of 2015 as well as lower samples and trade show spend in connection with the restructuring and expense reduction initiatives.

The decrease in general and administrative expense reflected lower salaries, equity based compensation and related travel expenses in connection with the vacant position created by the CEO separation from the Company and four finance and information technology positions eliminated in the fourth quarter of 2015, lower consulting and public relations spend in connection with the restructuring and expense reduction initiatives implemented in the fourth quarter of 2015, partially offset by higher recruiting fees in connection with the search for a new CEO.

                                                                                 $ Variance                                   % Variance
                                  2016             2015            Non FX            FX            Total          Non FX          FX          Total
By Entity Location
US                             $ 8,672,355     $ 11,608,168     $ (2,935,813 )   $        -     $ (2,935,813 )      (25.3 %)          - %       (25.3 %)
Canada                             820,496        1,137,128         (230,788 )      (85,844 )       (316,632 )      (20.3 )        (7.5 )       (27.8 )
International                      460,263          513,109          (26,029 )      (26,817 )        (52,846 )       (5.1 )        (5.2 )       (10.3 )

Total                          $ 9,953,114     $ 13,258,405     $ (3,192,630 )   $ (112,661 )   $ (3,305,291 )      (24.1 %)       (0.8 %)      (24.9 %)

The decrease in expenses in the U.S. in 2016 reflected lower marketing, sales, and executive salaries and related equity based compensation, travel expenses, consulting costs and promotional spend in connection with the fourth quarter 2015 restructuring and expense reduction initiatives. The decrease in expenses in Canada in 2016 reflected lower compensation associated with the elimination of two positions, travel, and consulting costs. The decrease in International expenses during the first quarter reflected lower compensation and travel costs associated with the elimination of one position.

                                                                                   $ Variance                                   % Variance
                                    2016             2015            Non FX            FX            Total          Non FX          FX          Total
By SegmentDERMA SCIENCES, INC.
Advanced wound care              $ 5,985,243     $  8,044,666     $ (2,016,850 )   $  (42,573 )   $ (2,059,423 )      (25.1 %)       (0.5 %)      (25.6 %)
Traditional wound care             1,016,864        1,313,450         (284,562 )      (12,024 )       (296,586 )      (21.7 )        (0.9 )       (22.6 )
Other                              2,951,007        3,900,289         (891,218 )      (58,064 )       (949,282 )      (22.9 )        (1.5 )       (24.3 )

Total                            $ 9,953,114     $ 13,258,405     $ (3,192,630 )   $ (112,661 )   $ (3,305,291 )      (24.1 %)       (0.8 %)      (24.9 %)

The decrease in each segments' selling, general and administrative expenses principally reflected changes made in connection with the fourth quarter 2015 restructuring and expense reduction initiatives. Specifically, advanced wound care expenses reflected lower marketing and sales compensation, travel expenses, consulting costs and promotional spend, the traditional wound care expense decrease reflected lower sales compensation costs and promotional spend while the other segment expense decrease reflected lower executive, finance and information technology compensation, travel expenses, consulting and public relations costs partially offset by higher recruiting fees.

Research and Development Expense

The decrease in research and development expense reflected the completion of AMNIO post marketing clinical studies in the advanced wound care segment in 2015. No additional research and development projects have been initiated to date in 2016.

Other (Income) Expense, net

Other (income) expense, net increased $635,828 to income of $268,040 in 2016 from an expense of $367,788 in 2015 due principally to foreign exchange.

Income Tax (Benefit) Provision

Income tax (benefit) provision increased $227,849 to a benefit of $219,798 in 2016 from a provision of $8,051 in 2015 due principally to a reduction in the Company's U.S. valuation allowance due to the tax impact of the unrealized gain on the Company's investment in Comvita included in accumulated other comprehensive income, partially offset by tax expense incurred by the Company's Canadian operations.

Net Loss from Continuing Operations

For the three months ended March 31, 2016, we incurred a net loss from continuing operations of $1,757,753, or $0.07 per share (basic and diluted), compared to a net loss from continuing operations of $6,451,301, or $0.25 per share (basic and diluted), in 2015.

Net Loss from Discontinued Operations

Effective November 2015, management approved a plan to terminate the Company's Phase 3 (DSC127) clinical program for diabetic foot ulcer healing. The decision to end the program followed the recommendation by the independent Data Monitoring Committee to stop the program based on its interim assessment. Based on this recommendation, we initiated an orderly termination of all our existing pharmaceutical development programs comprised of the diabetic foot healing program and two other programs utilizing the DSC127 compound for other therapeutic indications.

In connection with this decision, our entire pharmaceutical development staff, comprised of six positions, was terminated and the process of closing down the programs commenced. The close down activities were substantially completed by the end of 2015.

There was no loss from discontinued operations during the first quarter of 2016 as the Company ceased expenditures on the project. For the three months ended March 31, 2015, we incurred a net loss from discontinued operations of $4,158,276, or $0.16 per share (basic and diluted).

Total Net Loss

For the three months ended March 31, 2016, we incurred a net loss of $1,757,753, or $0.07 per share (basic and diluted), compared to a net loss of $10,609,577, or $0.41 per share (basic and diluted), in 2015.

Liquidity and Capital Resources

Cash Flow and Working Capital

At March 31, 2016 and December 31, 2015, we had cash and cash equivalents of $11,778,942 and $15,814,205, respectively. The $4,035,263 decrease in cash and cash equivalents reflected net cash used in operating activities of $3,741,419, cash used in investing activities of $103,760, cash used in financing activities of $18,010, and the exchange rate effect on cash and cash equivalents which decreased cash and cash equivalents by $172,074.

Net cash used in operating activities of $3,741,419 during the three months ended March 31, 2016 resulted from $412,771 cash used in operations (net loss plus non-cash items) together with $3,328,648 cash used in the change in operating assets and liabilities. Lower accrued expenses and accounts payable, and higher inventory, were the main drivers behind the net cash used in the change in operating assets and liabilities. The lower accrued expenses and accounts payable principally reflects cash outflows in connection with the restructuring and wind down of the Phase 3 clinical program.

Net cash used in investing activities of $103,760 during the three months ended March 31, 2016 included capital expenditures of $107,750, partially offset by cash provided from the net sale of investments of $3,990.

Net cash used in financing activities of $18,010 during the three months ended March 31, 2016 reflected payment of payroll withholding taxes related to stock-based compensation in connection with net share settlements.

Working capital decreased $357,232 at March 31, 2016 to $57,211,259 from $57,568,491 at December 31, 2015. This decrease principally reflected the net cash used in operating activities.

Prospective Assessment

Our strategy for building the business is to continue to grow our higher margined AWC business segment while moving it to product contribution profitability. Our objective for the TWC business segment is to hold sales and product contribution profitability steady. We continue to work on our product pipeline to identify new products and product line extensions that are capable of contributing to future sales growth. The objective of our Operations' team is to find ways to maintain or reduce the cost of our products while optimizing the efficiency and reliability of our global supply chain. Our goal is to hold selling, general and administrative expenses at or below inflation levels, in the absence of a significant change in our business. We will continue to evaluate accretive external opportunities to leverage our core capabilities for growth. Overall, our objective is to become cash flow positive from operating activities on a quarterly run rate basis by the end of 2016.

Our AWC product business segment has historically been the benefactor of most of our sales and marketing growth investment. In 2015, due to an assessment of existing and prospective operating performance, it was decided that the current AWC business model was not sustainable in its present form. While our AWC sales continue to grow at above average market rates, our underlying operating cost base was too high. In the fourth quarter of 2015, we restructured the AWC business with the objective of reducing the cost base in a manner designed to minimize its prospective impact on the business. Going forward, we feel as a result of this restructuring we have achieved a better balance between projected sales growth and the cost base required to support it, thus putting us in a better position to leverage prospective sales growth.

We will continue to nurture our TWC business segment utilizing the appropriate amount of personnel and financial resources to sustain it. Maintenance of this mostly commodity product oriented business segment represents a challenge for us as we compete in a very competitive marketplace. While this segment of our business represents a significant, albeit decreasing percentage of our overall sales and realizes lower gross profit margins, it generates positive segment product contribution margin and cash flow. Our goal is to retain the sales and positive segment product contribution. Our strategy for the TWC business during the last two years has been to seek and nurture opportunities for the sale of private label wound care products to large U.S. retail pharmacy chains to replace lost business we have been experiencing due to industry consolidation.

We believe we have sufficient cash on hand to meet our objectives going forward. Principally through continued AWC segment growth and a stable TWC segment base, we expect the Company to be cash flow positive commencing in the fourth quarter of 2016, with continued improving financial performance thereafter. At March 31, 2016 we had $36.8 million of cash, cash equivalents and short-term investments on our balance sheet. We believe that our working capital is more than sufficient and we do not anticipate any appreciable change other than in response to normal changes in the business. In addition, we have a long-term equity investment worth $19.3 million at March 31, 2016 with one of our major suppliers, which represents an additional source of capital for the Company. No significant capital expenditures are required over the foreseeable future. Significant discretionary capital spending, if any, will be evaluated based on its return on investment and the availability of funds. Should we achieve our prospective sales growth objectives, product license related milestone payments . . .

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