Co-Diagnostics, Inc. 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS The following management’s discussion and analysis of financial condition and results of operations describes the principal factors affecting the results of our operations, financial condition, and changes in financial condition. This discussion should be read in conjunction with the accompanying audited financial statements, and notes thereto, included elsewhere in this report. In addition to historical information, this Annual Report contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to those set forth under the caption “Item 1A. Risk Factors” in this Annual Report on Form 10-K. 27 Business Overview Co-Diagnostics, Inc., a Utah corporation (the “Company” or “CODX”), develops, manufactures and sells reagents used for diagnostic tests that function via the detection and/or analysis of nucleic acid molecules (DNA or RNA), including robust and innovative molecular tools for detection of infectious diseases, liquid biopsy for cancer screening, and agricultural applications. In connection with the sale of our tests we may sell diagnostic equipment from other manufacturers as self-contained lab systems (which we refer to as the “MDx Device”). We are also developing a unique, groundbreaking portable PCR device and proprietary test cups (the “Co-Dx PCR Home platform”) that have been designed to bring affordable, reliable polymerase chain reaction (“PCR”) to patients in point-of-care and even at-home settings. This platform is subject to U.S. Food and Drug Administration (“FDA”) review and is not available for sale at the time of this filing. There is no guarantee the our Co-Dx PCR Home platform will receive the necessary regulatory approvals for commercialization, or that, if regulatory approval is received, we will be able to successfully commercialize this platform. Our diagnostics systems enable dependable, low-cost, molecular testing for organisms and genetic diseases by automating or simplifying historically complex procedures in both the development and administration of tests. CODX’s technical advance involves a novel, patented approach to PCR test design of primer and probe structure (“CoPrimers”) that eliminates one of the key vexing issues of PCR amplification: the exponential growth of primer-dimer pairs (false positives and false negatives) which adversely interferes with identification of the target DNA/RNA. We believe our proprietary molecular diagnostics technology is paving the way for innovation in disease detection and life sciences research through our enhanced detection of genetic material. For various reasons, including owning our own platform, we believe we will be able to accomplish this faster and more economically than some competitors, allowing for significant margins while still positioning ourselves as a low-cost provider of molecular diagnostics and screening services. In addition, continued development has demonstrated the unique properties of our CoPrimer technology that we believe makes it ideally suited for a variety of applications where specificity is key to optimal results, including multiplexing several targets, enhanced Single Nucleotide Polymorphism (“SNP”) detection and enrichment for next generation sequencing. Our scientists use the complex mathematics of DNA/RNA PCR test design to engineer and optimize PCR tests and to automate algorithms that rapidly screen millions of possible options to pinpoint the optimum design. Dr. Brent Satterfield, our founder, developed the intellectual property we use in our business, consisting of the predictive mathematical algorithms and patented molecular structure used in the testing process, which together represent a major advance in PCR testing systems. CODX technologies are now protected by more than 20 granted or pending US and foreign patents, as well as certain trade secrets and copyrights. Ownership of our proprietary platform permits us the advantage of avoiding payment of patent royalties required by other PCR test systems, which may allow the sale of diagnostic PCR tests at a lower price than competitors, while enabling us to maintain profit margins. Our proprietary test design process involves identifying the optimal locations on the target genes for amplification and pair the locations with the optimized primer and probe structure to achieve outputs that meet the design input requirements identified from market research. This is done by following planned and documented processes, procedures and testing. In other words, we use the data resulting from our tests to verify whether we succeeded in designing what we intended. Verification involves a series of testing that concludes that the product is ready to proceed to validation in an evaluation either in our laboratory or in an independent laboratory setting using initial production tests to confirm that the product as designed meets the user needs. We may either sell or lease the MDx Device to labs and diagnostic centers, through sale or lease agreements, and sell the reagents that comprise our proprietary tests to those laboratories and testing facilities. Using our proprietary test design system and proprietary reagents, we have designed and obtained regulatory approval in the European Community and/or in India to sell PCR diagnostic tests for the detection of COVID-19, influenza, tuberculosis, hepatitis B and C, human papillomavirus, malaria, chikungunya, dengue, and the Zika virus. In the United States, we obtained Emergency Use Authorization (“EUA”) for our Logix Smart COVID-19 detection test from the Food and Drug Administration, or FDA, and we sell that test to qualified labs. In addition, our COVID-19 detection test and certain of our other suite of COVID-19 products have been approved for sale in countries such as the United Kingdom, Australia and Mexico by the regulatory bodies in those countries and have been registered for sale in many more countries. 28 In addition to testing for infectious disease, the technology lends itself to identifying any section of a DNA or RNA strand that describes any type of genetic trait, which creates several significant applications. We, in conjunction with our customers, are active in designing and licensing tests that identify genetic traits in plant and animal genomes. We also have three multiplexed tests developed to test mosquitos for the identification of diseases carried by the mosquitos to enable municipalities to concentrate their efforts in managing mosquito populations on the specific areas known to be breeding the mosquitos that carry deadly viruses. RESULTS OF OPERATIONS Results of Operations for the Years Ended December 31, 2022 and 2021 The table below provides a comparison of our operating results for the year ended December 31, 2022 as compared to the year ended December 31, 2021. Years Ended December 31, Year Change 2022 2021 Change % Revenue $ 34,218,209 $ 97,885,603 $ (63,667,394 ) -65 % Cost of revenue 5,481,092 11,574,944 (6,093,852 ) -53 % Gross profit 28,737,117 86,310,659 (57,573,542 ) -67 % Operating expenses Sales and marketing 7,344,628 13,397,813 (6,053,185 ) -45 % General and administrative 14,262,963 11,550,615 2,712,348 23 % Research and development 17,438,098 14,961,916 2,476,182 17 % Depreciation and amortization 1,282,718 335,363 947,355 282 % Goodwill impairment charges 15,388,546 - 15,388,546 - Total operating expenses 55,716,953 40,245,707 15,471,246 38 % Income (loss) from operations (26,979,836 ) 46,064,952 (73,044,788 ) -159 % Other income (expense) Interest income 704,044 45,631 658,413 1443 % Loss on disposition of assets (138,117 ) (44,355 ) (93,762 ) 211 % Gain on remeasurement of acquisition contingencies 7,899,644 - 7,899,644 - Loss on equity method investment in joint venture (332,969 ) (430,433 ) 97,464 -23 % Total other income (expense) 8,132,602 (429,157 ) 8,561,759 -1995 % Income (loss) before income taxes (18,847,234 ) 45,635,795 (64,483,029 ) -141 % Income tax provision (benefit) (4,608,985 ) 8,977,231 (13,586,216 ) -151 % Net income (loss) $ (14,238,249 ) $ 36,658,564 $ (50,896,813 ) -139 % 29 Revenues For the year ended December 31, 2022, we generated $34.2 million of revenue compared to revenue of $97.9 million in the year ended December 31, 2021. The decrease in revenue of $63.7 million was primarily due to lower sales of our Logix Smart COVID-19 test throughout the world, which was developed in response to the current COVID-19 pandemic. As global attention and regulatory responses to the COVID-19 pandemic have eased, we have experienced significantly decreases in demand for our COVID-19 test. We anticipate that demand for our COVID-19 test will continue to normalize as concerns relating to COVID-19 further wane. Cost of Revenues and Gross Profit Cost of revenues decreased by $6.1 million from $11.6 million for the year ended December 31, 2021 to $5.5 million for the year ended December 31, 2022. The decrease in revenues combined with a larger percentage of fixed product manufacturing costs resulted in a lower cost of revenues and gross margin percentage. Our gross margin was 84.0% for the year ended December 31, 2022 compared to 88.2% for the year ended December 31, 2021. Operating Expenses We incurred total operating expenses of $55.7 million for the year ended December 31, 2022 compared to total operating expenses of $40.2 million for the year ended December 31, 2021. The increase in operating expenses was primarily due to the impairment of goodwill recorded in conjunction with the acquisitions of IdMo and ACI, increases in depreciation and amortization of capital and intangible assets, increased expenses related to personnel, including stock-based compensation, and increased investment in research and development, offset by decreased sales and marketing expenses, including third party sales commissions, in relation to the reduction of revenue. Sales and marketing expenses for the year ended December 31, 2022 were $7.3 million compared to $13.4 million for the year ended December 31, 2021. The decrease of $6.1 million was primarily a result of decreased variable compensation, such as bonuses and commissions, and decreased third-party sales commissions, partially offset by increased stock-based compensation expense. General and administrative expenses increased $2.7 million from $11.6 million for the year ended December 31, 2021 to $14.3 million for the year ended December 31, 2022. The increase in general and administrative expenses was primarily due to increased insurance expense and professional, legal, and advisory fees, as well as increased stock-based compensation expense, partially offset by decreased variable compensation expense. Our research and development expenses increased by $2.4 million from $15.0 million for the year ended December 31, 2021, to $17.4 million for the year ended December 31, 2022. The primary increase in expenses related to increased personnel expenses in conjunction with our acquisitions of IdMo and ACI on December 31, 2021, the primary focus of which relates to the point-of-care device development, as well as increased stock-based compensation expense. Additionally, there has been an increase in professional and lab services utilized to further help us in our research and product development activities. During the year ended December 31, 2022, the Company recognized impairment charges of $15,388,546 related to goodwill recorded in conjunction with the acquisitions of IdMo and ACI on December 31, 2021. Other Income (Expense) Other income was $8.1 million for the year ended December 31, 2022, compared to other expense of $0.4 million for the year ended December 31, 2021. The increase in other income of $8.6 million was primarily due to a change in the fair value of contingent consideration liabilities recorded in conjunction with the acquisitions of IdMo and ACI and driven by changes in the Company’s stock price, as well as increased interest income due to higher investment balances and interest rates in 2022 compared to 2021. 30 Net Income We realized a net loss for the year ended December 31, 2022 of $14.2 million compared to net income of $36.7 million for the year ended December 31, 2021. The decrease in net income of $50.9 million was primarily the result of reduced sales of our Logix Smart COVID-19 test, increased operating expenses as discussed above, and impairment of the goodwill recorded in conjunction with the acquisitions of IdMo and ACI, partially offset by gains related to change in the fair value of acquisition related contingent liabilities. Additionally, we recorded an income tax benefit of $4.6 million during the year ended December 31, 2022, compared to income tax expense of $9.0 million for the year ended December 31, 2021. LIQUIDITY AND CAPITAL RESOURCES At December 31, 2022, we had cash and cash equivalents of $23.0 million and marketable investment securities of $58.3 million. We consider our marketable investment securities an important part of our liquidity and focus such investments in securities that can readily be converted into cash if needed. Additionally, our total current assets at December 31, 2022, were $92.7 million compared to total current liabilities of $3.9 million. Net cash provided by operating activities during the year ended December 31, 2022 was $6.6 million, compared to $41.1 million for the year ended December 31, 2021. The decrease in cash from operating activities was primarily due to our decreased revenue and accounts receivable. We used $58.2 million of cash in investing activities during the year ended December 31, 2022 as compared to $4.1 million of cash from investing activities during the year ended December 31, 2021. The increase in cash used in investing activities is primarily due to purchases of marketable investment securities. Net cash used in financing activities was $14.0 million for the year ended December 31, 2022, compared to $0.5 million of cash from financing activities for the year ended December 31, 2021. The decrease is primarily due to the repurchase of outstanding common shares during the current fiscal year. Since commencing sales of our Logix Smart COVID-19 test in March 2020, we have used our cash generated from those sales to fund the purchase of inventories and the development of our point-of-care device, and to pay our operating expenses. We have increased our work force most significantly in research and development in order to continue development of a new device and additional tests that will enable continued use of our distributor network to sell additional products throughout the world. We believe that our existing capital resources and the cash generated from future sales will be sufficient to meet our projected operating requirements for the next 12 months. However, our available capital resources may be consumed more rapidly than currently expected and we may need or want to raise additional financing for strategic opportunities. If needed, we expect additional investment capital to come from (i) additional issuances of our common stock with existing and new investors or (ii) the private placement of other securities with investors similar to those that have provided funding in the past. We may not be able to secure such financing in a timely manner or on favorable terms, if at all. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in Item 8 of this Annual Report on Form 10-K, within Note 2 of our consolidated financial statements in the section titled “Summary of Significant Accounting Policies”, we believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates. Accounts Receivable Trade accounts receivable are recorded at the invoiced amount, net of any allowance. The Company maintains an allowance for doubtful accounts for amounts the Company does not expect to collect. In establishing the required allowance, management considers historical losses, current market condition, customers’ financial condition, the age of receivables, and current payment patterns. Account balances are written off against the allowance once the receivable is deemed uncollectible. If actual accounts receivable collections are less favorable than those projected by management at the time of the assessment, however, additional accounts receivable write-downs may be required, which could reduce our earnings. 31 Goodwill and Intangible Assets The useful lives of intangible assets with definite lives are based on the expected number of years the asset will generate revenue or otherwise be used by us and the related amortization is based on the straight-line method. Goodwill, which has an indefinite life, is not amortized but instead is tested at least annually for impairment, or more frequently when events or changes in circumstances indicate that the asset might be impaired. Examples of such events or circumstances include: ● the asset’s ability to continue to generate income from operations and positive cash flow in future periods; ● any volatility or significant decline in our stock price and market capitalization compared to our net book value; ● loss of legal ownership or title to an asset; ● significant changes in our strategic business objectives and utilization of our assets; and ● the impact of significant negative industry or economic trends. If a change were to occur in any of the above-mentioned factors or estimates, the likelihood of a material change in our reported results would increase. For goodwill, the entity has the option to first assess qualitative factors to determine whether it is necessary to perform the quantitative goodwill impairment test. The quantitative impairment test compares the fair value of a reporting unit with the carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill is considered not impaired; otherwise, goodwill is impaired and the loss is recorded. We completed our annual evaluation for impairment of goodwill as of December 31, 2022 and recorded a goodwill impairment charge of $15,388,546. Accounting for Business Combinations Under the acquisition method of accounting, the cost of an acquired business is assigned to the tangible and identifiable intangible assets acquired and liabilities assumed on the basis of the estimated fair values at the date of acquisition. We assess fair value, which is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, using a variety of methods including, but not limited to, an income approach and a market approach, such as the estimation of future cash flows of the acquired business and current selling prices of similar assets. These valuations require us to make estimates and assumptions, especially with respect to intangible assets. Fair value of the assets acquired and liabilities assumed, including intangible assets, in-process research and development, and contingent payments, are measured based on the assumptions and estimations with regards to variable factors such as the amount and timing of future cash flows for the asset or liability being measured, appropriate risk-adjusted discount rates, or other factors that market participants would consider. Upon acquisition, we determine the estimated economic lives of the acquired intangible assets for amortization purposes, which are based on the underlying expected cash flows of such assets. Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that is not individually identified and separately recognized. Actual results may vary from projected results and assumptions used in the fair value assessments. If the initial accounting for a business combination is incomplete by the end of a reporting period that falls within the measurement period, we report provisional amounts in our financial statements. During the measurement period, we adjust the provisional amounts recognized at the acquisition date to reflect new information obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. We record these adjustments to the provisional amounts with a corresponding offset to goodwill. Any adjustments identified after the measurement period are recorded in the Consolidated Statements of Operations and Comprehensive Income (Loss). Inventories We periodically review inventory for both potential obsolescence and potential declines in anticipated selling prices. In this review, we make assumptions about the future demand for and market value of the inventory and based on these assumptions estimate the amount of any obsolete, unmarketable, slow moving or overvalued inventory. We write down the value of our inventories by an amount equal to the difference between the cost of the inventory and the net realizable value. If actual market conditions are less favorable than those projected by management at the time of the assessment, however, additional inventory write-downs may be required, which could reduce our earnings. Income Taxes Significant judgment is required in determining our provision for income taxes, current tax assets and liabilities, deferred tax assets and liabilities, and our future taxable income, both as a whole and in various tax jurisdictions, for purposes of assessing our ability to realize future benefit from our deferred tax assets. We recognize in the financial statements the impact of a tax position if that position is more likely than not to be sustained during an audit, including resolution of related appeals or litigation processes, if any. While we believe that we have appropriate support for the positions taken on our tax returns, we regularly assess the potential outcome of examinations by tax authorities in determining the adequacy of our provision for income taxes. See Note 12 to our Consolidated Financial Statements for more information on income taxes. The foregoing estimates, expectations and forward-looking statements are subject to change as we make strategic operating decisions from time to time and as our revenue and expenses fluctuate from period to period. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not required. 32