Item 7. Management’s Discussion and Analysis
ITEM 7 — MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our
financial condition and results of operations should be read together with our audited financial statements and the related notes and
other financial information included in Part II, Item 8, “Financial
Statements and Supplementary Data” of this Annual Report on Form 10-K. Some of the information contained in this discussion and
analysis or set forth elsewhere in this Annual Report, including information with respect to our plans and strategy for our business,
includes forward-looking statements that involve risks and uncertainties. One should review Part I , Item 1A — “Risk
Factors” of this Annual Report for a discussion of some of the important factors that could cause actual results to differ materially
from the results, objectives or expectations described in or implied by the forward-looking statements contained in the following discussion
and analysis.
Liquidity and Capital Resources
Net cash (used for) operating activities was
($1.5) million during the year ended December 31, 2022 in contrast to net cash provided by operating activities of $954,000 during the
year ended December 31, 2021. The $2.5 million decrease in net cash provided by operating activities from period to period was largely
the net result of a $2.4 million increase in the net loss with $2 million more cash being used to build inventory being net against $1.8
million more cash being generated by the collection of accounts receivable. As we increased our production capacity to eliminate the backlog
of orders, our inventory balance increased to $6 million as of December 31, 2022 from $3.1 million as of December 31, 2021. Our total
depreciation and amortization expense was approximately $2.5 million during both of the years ended December 31, 2022 and 2021. We anticipate
that depreciation expense, while not affecting our cash flows from operations, will be a significant factor in creating annual net operating
losses until and unless product sales increase sufficiently to offset these non-cash expenses. Net cash (used for) investing activities
was ($4) million during the year ended December 31, 2022 in comparison to net cash (used for) investing activities of ($1.6) million during
the year ended December 31, 2021. Approximately $4 million and $2.6 million of cash was used to acquire property, plant and equipment
during the years ended December 31, 2022 and 2021, respectively, which payments were largely related to our ongoing investments to expand
our manufacturing facilities. Net cash provided by financing activities decreased to $1.1 million during the year ended December 31, 2022
in comparison to net cash provided by financing activities of $3.9 million during the year ended December 31, 2021. During 2022, we received
$2 million in debt proceeds compared to $400,000 in debt proceeds received during 2021. We raised no new equity during 2022, but during
2021, we raised $4.2 million from a public offering of common stock. Debt principal repayments will continue to reduce our cash flows.
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ImmuCell Corporation
We entered into several bank debt refinancings
and amendments with Gorham Savings Bank (GSB) from the first quarter of 2020 to the first quarter of 2022 that have improved our liquidity
by spreading our principal payments out over a longer period of time and pushing out balloon principal payment obligations that existed
under some of the repaid debt. Also, because all of this debt bears interest at fixed rates, we are avoiding the adverse effects of rising
interest rates on our debt service costs. The blended interest rate on this debt, including the State of Maine debt from the Maine Technology
Institute (MTI) described below, is 3.65% per annum (3.52% per annum excluding the MTI debt). As of December 31, 2022, we had total bank
debt outstanding (including the MTI debt) of approximately $10.2 million as compared to approximately $9.1 million as of December 31,
2021. Debt principal repayments aggregated approximately $897,000 and $768,000 during the years ended December 31, 2022 and 2021, respectively.
We anticipate that debt principal repayments will aggregate approximately $1 million during the year ending December 31, 2023. Interest
expense (excluding amortization of debt issuance costs) was approximately $341,000 and $307,000 during the years ended December 31, 2022
and 2021, respectively. We anticipate that interest expense will be approximately $352,000 during the year ending December 31, 2023. During
the first quarter of 2022, the availability of our $1.0 million line of credit, which bears interest at the National Prime Rate per annum,
was extended until March 11, 2024. These credit facilities are secured by substantially all of our assets, including our facility at 56
Evergreen Drive in Portland (which was independently appraised at $6.3 million in connection with the 2022 financing) and our facility
at 33 Caddie Lane in Portland (which was independently appraised at $3.2 million in connection with a 2017 financing and at $2.5 million
in connection with a 2020 refinancing). These credit facilities are subject to certain restrictions and financial covenants. We are required
to meet a minimum debt service coverage (DSC) ratio set by GSB of 1.35. Our actual DSC ratio was equal to 2.68, 2.03 and 1.57 during the
years ended December 31, 2021, 2020 and 2019, respectively. By negotiation with GSB in connection with the 2022 financing, the required
minimum DSC ratio was reduced to 1.0 for the year ending December 31, 2022. The actual DSC ratio during the year ended December 31, 2022
was 0.44. The compliance requirement with the DSC ratio was waived by GSB for 2022. During the first quarter of 2023, the DSC ratio covenant
for the year ending December 31, 2023 was waived by GSB. Instead, we are required to meet a minimum DSC ratio requirement of 1.35 for
the twelve-month periods ending June 30, 2024, September 30, 2024 and December 31, 2024 and then again annually after that.
During June 2020, we received a $500,000 loan
from the Maine Technology Institute (MTI). The first 2.25 years of this loan were interest-free with no interest accrual or required principal
payments. Principal and interest payments at a fixed rate of 5% per annum are due quarterly over the final 5 years of the loan, which
began during the fourth quarter of 2022 and continues through the third quarter of 2027. During July 2021, we received an additional $400,000
loan from the MTI. The first 2 years of this second loan are interest-free with no interest accrual or required principal payments. Principal
and interest payments at a fixed rate of 5% per annum are due quarterly over the final 5.5 years of the loan, beginning during the third
quarter of 2023 and continuing through the fourth quarter of 2028. Both loans are unsecured and subordinated to all other bank debt from
GSB and may be prepaid without penalty at any time. This support from the State of Maine through the MTI helps us move forward aggressively
with our investments while increasing our total employee count.
From the first quarter of 2016 through the second
quarter of 2021, we raised gross proceeds of approximately $26.7 million (net proceeds were approximately $24.8 million) from six different
common equity transactions priced between $5.25 and $8.25 per share with a weighted average price of approximately $5.87 per share. No
warrants were issued in connection with any of these transactions, and no convertible or preferred securities were issued. This capital,
together with our bank debt and gross margin from product sales, has allowed us to transform the Company. We are (and have been) investing
significantly to increase our capacity to produce the First Defense ® product line from approximately $16.5 million
to approximately $40 million in annual sales volume per year. The actual value of our production capacity varies based on biological and
process yields, product format mix, selling price and other factors. Based on our best estimates and projections, we believe that our
cash and cash equivalents, together with gross margin anticipated to be earned from ongoing product sales, will be sufficient to meet
our currently planned working capital and capital expenditure requirements and to finance our ongoing business operations for at least
12 months (which is the period of time required to be addressed for such purposes by accounting disclosure standards) from the date of
this filing. The table below summarizes the changes in selected, key accounts (in thousands, except for percentages):
As of
As of
(Decrease) Increase
December 31, 2022
December 31, 2021
Amount
%
Cash and cash equivalents
$ 5,792
$ 10,185
$ (4,394 )
(43 )%
Net working capital
$ 10,923
$ 13,730
$ (2,808 )
(20 )%
Total assets
$ 44,861
$ 44,466
$ 395
<1 %
Stockholders’ equity
$ 30,380
$ 32,577
$ (2,197 )
(7 )%
Common shares outstanding (1)
7,747
7,742
5
<1 %
(1) There were approximately 605,000 and 443,000 shares of common
stock reserved for issuance for stock options that were outstanding as of December 31, 2022 and 2021, respectively.
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ImmuCell Corporation
We have invested and continue to invest in eight
different capital expenditure projects to increase our production capacity for the First
Defense ® product line and complete the development of Re-Tain ® .
When we describe the production capacity for the First Defense ®
product line in this report, it should be noted that the actual value of this capacity varies based on biological and process yields,
product format mix, selling price and other factors. From 2014 to 2019, we initiated four capital expenditure investments, as described
in the following table (in thousands):
Cash Paid on Projects Initiated before 2021 During the
A
B
C
D
Total
Year Ended December 31, 2014
$ 1,041
$ —
$ —
$ —
$ 1,041
Year Ended December 31, 2015
1,991
265
—
—
2,256
Year Ended December 31, 2016
1,173
2,093
—
—
3,266
Year Ended December 31, 2017
—
17,686
—
—
17,686
Year Ended December 31, 2018
—
1,596
—
—
1,596
Year Ended December 31, 2019
—
—
279
538
817
Year Ended December 31, 2020
—
—
2,938
581
3,519
Year Ended December 31, 2021
—
—
432
886
1,318
Year Ended December 31, 2022
—
—
4
308
312
Total Paid through December 31, 2022
4,205
21,640
3,653
2,313
31,811
Estimate to Complete
—
—
—
1,687
1,687
Total Project Cost
$ 4,205
$ 21,640
$ 3,653
$ 4,000
$ 33,498
PROJECT A included a 7,100 square foot
facility addition at 56 Evergreen Drive and related equipment (including freeze-dryer #2) and cold storage capacity to increase the production
capacity for the First Defense ® product line. During the first quarter of 2016, we completed this investment, increasing
our freeze-drying capacity by 100% and making other improvements to our liquid processing capacity, which increased our annual production
capacity (in terms of annual sales dollars) to approximately $16.5 million. This investment also included the construction and equipping
of a pilot plant for small-scale Drug Substance production for Re-Tain ® within our First Defense ®
production facility at 56 Evergreen Drive. After PROJECT B was completed, this space was converted for use in the production
of the gel tube formats of the First Defense ® product line at 56 Evergreen Drive. After PROJECT C was completed,
this space was converted to double our liquid processing capacity at 56 Evergreen Drive.
PROJECT B was related to the Drug Substance
production facility for Re-Tain ® at 33 Caddie Lane. During the fourth quarter of 2017, we completed construction
of the Drug Substance production facility. We began equipment installation during the third quarter of 2017, and we completed this installation
during the third quarter of 2018. The total cost of this investment for the Drug Substance production facility and related processing
equipment was $20.8 million plus $331,000 for the land and $472,000 for the acquisition of an adjacent 4,080 square foot warehouse facility
at 14 Wedge Way, which will be used for packing, shipping and cold storage of Re-Tain ® and other warehousing needs.
(See PROJECT G , below).
PROJECT C consisted of significant renovations
to a 14,300 square foot leased facility at 175 Industrial Way, some facility modifications at 56 Evergreen Drive and the necessary production
equipment (including freeze-dryer #3) to increase the annual production capacity of the First Defense ® product line
(in terms of annual sales dollars) from approximately $16.5 million to approximately $23 million. This expansion involved a 50% increase
in our freeze-drying equipment and a 100% increase in our liquid processing capacity. Renovations to our leased facility at 175 Industrial
Way to enable this expansion were completed during the second quarter of 2020. By moving our powder and gel filling and assembly services
from 56 Evergreen Drive into this new space at 175 Industrial Way, we created space at 56 Evergreen Drive for the installation of the
expanded freeze-drying capacity. The new facilities are built to contemporary cGMP standards with good material and people flows. A site
license approval for this new facility at 175 Industrial Way was issued by the USDA during the third quarter of 2020. During the second
quarter of 2021, we completed the relocation of our gel formulation equipment from 56 Evergreen Drive to 175 Industrial Way, which created
the space necessary to double our liquid processing capacity at 56 Evergreen Drive. We obtained site license approval of the expanded
freeze-drying capacity at 56 Evergreen Drive from the USDA during the third quarter of 2021, and we obtained site license approval of
the expanded liquid processing capacity at 56 Evergreen Drive from the USDA during the third quarter of 2022. As part of this investment,
we also made the facility modifications at 56 Evergreen Drive to create the space necessary to expand our freeze-drying equipment (including
freeze-dryer #4) by an additional 33%, which would increase our annual production capacity from approximately $23 million to approximately
$30 million or more (together with the work involved in PROJECT F discussed below).
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ImmuCell Corporation
PROJECT D is a $4 million budgeted investment
to bring the formulation and aseptic filling capabilities for Re-Tain ® Drug Product into available space in our
Drug Substance facility to end our reliance on third-party Drug Product manufacturing services. We began initial equipment installation
during the first quarter of 2022. We have presently paused this installation work pending concurrence with the FDA pertaining to our third
submission of the CMC Technical Section, which is discussed in greater detail below. Due to the loss in gross margin during the first
quarter of 2023 caused by the slowdown in production output necessary to remediate a product contamination event, we have decided to defer
spending of approximately 42% of these funds for the time being. We anticipate FDA approval of this facility (which is a requirement for
commercial manufacturing) during 2025 if we resume spending on this project in the coming months.
During 2021, we initiated three more capital
expenditure investments, and during the second quarter of 2022, we initiated one additional capital expenditure investment, as described
in the following table (in thousands):
Cash Paid on Projects Initiated During 2021 or After During the
E
F
G
H
Total
Year Ended December 31, 2021
$ 452
$ 296
$ 282
$ —
$ 1,030
Year Ended December 31, 2022
213
661
1,904
33
2,811
Total Paid through December 31, 2022
665
957
2,186
33
3,841
Estimate to Complete
85
—
888
4,367
5,340
Total Project Cost
$ 750
$ 957
$ 3,074
$ 4,400
$ 9,181
PROJECT E represents a $750,000 budget
for equipment and vehicle investments necessary to expand and improve our colostrum collection capabilities and logistics. We largely
completed this investment during 2022 but have left the project open as we are considering the need to purchase an additional farm truck.
PROJECT F included installation of freeze-dryer
#4 for $957,000 to further increase the annual production capacity of the First Defense ® product line (in terms
of annual sales dollars) from approximately $23 million to approximately $30 million or more. We initiated PROJECT F during the
third quarter of 2021. Due to supply disruptions affecting key components and equipment, this investment was not completed until the end
of 2022.
PROJECT
G represents an increased budget estimate of $3,000,000 (from the previous budget estimate of $2,840,000). Of this total, approximately
$2,325,000 is for equipment and facility modifications to scale-up and upgrade our vaccine manufacturing capacity, improve our quality
laboratories and install new equipment for our gel filling operations and approximately $675,000 is to build packing and shipping facilities
for Re-Tain ® at 14 Wedge Way. This investment includes automation of our gel filling operations as part of our strategy
to increase our annual production capacity for the First Defense ®
product line (in terms of annual sales dollars) to approximately $30 million. This investment is running approximately $74,000 over its
increased budget amount of $3,000,000.
PROJECT H represents a new investment
in building modifications and equipment to further increase our annual First Defense ® production capacity from approximately
$30 million to approximately $40 million with options for further expansion. Given the long lead time required for investments like this,
during 2022 we initiated this project by entering into a lease during the third quarter of 2022 covering a to-be-constructed 15,400 square
foot building shell at 165 Industrial Way for approximately $250,000 per year, which operating cost is not included in the capital expenditure
table above. We anticipate a lease commencement date (after the landlord completes construction of the building shell) during the second
quarter of 2023. We made this lease commitment because of the unique proximity of the land adjacent to our currently leased space at 175
Industrial Way and the high level of demand for properties of this type in the Portland market. We did not want to risk losing this opportunity
to others. The anticipated benefits to us from this new lease include: i) space for the potential to install freeze-dryers #5, #6, #7
and #8 if justified by market demand in the future, ii) improved space and quality for our powder milling operations by separating our
upstream processes (liquid processing) at 56 Evergreen Drive from our clean downstream processes (milling, formulation, filling and packaging)
and iii) much needed additional warehouse space. Freeze-dryer #5 is the key piece of equipment required to allow us to increase our annual
production capacity to approximately $40 million. Based on past experience, we are planning for approximately 18 to 24 months of lead
time for fabrication, installation, qualification and implementation of freeze-dryer #5. We have been running our equipment and staff
near to 100% of capacity over the last couple of years in order to fill the backlog of orders. One of the objectives of PROJECT H
is to create a more sustainable production schedule. Due to the loss in gross margin during the first quarter of 2023 caused by the slowdown
in production output necessary to remediate a product contamination event, we have decided to defer, for the time being, approximately
95% of this investment.
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ImmuCell Corporation
We have been investing (and continue to invest)
significantly in equipment, infrastructure and operating expenses to increase our annual production capacity from approximately $16.5
million to approximately $30 million. Increased labor and other upfront costs were necessary to benefit from the scale-up of our production
output going forward. These investments have been (and are being) made to fulfill the current backlog and then materially reduce the risk
of another order backlog. We have been operating at very close to 100% of available capacity recently, which is not efficient or sustainable.
Going forward, we will be in a position to operate at the capacity level we choose to cover sales with adequate buffer stock. This allows
more time for necessary preventative maintenance and redundancy for when equipment failures occur. At the same time, we have been investing
(and continue to invest) in capital expenditures necessary to manufacture Re-Tain ® at commercial scale and to cease
our reliance on aseptic filling contractor services. The table below summarizes the investment made and to be made under PROJECT A
to PROJECT H by product (in thousands):
Product
Paid Through
December 31, 2022
Estimate to
Complete
Total
First Defense ®
$ 11,663
$ 4,701 (1)
$ 16,364
Re-Tain ®
23,989
2,326
26,315
Total
$ 35,652
$ 7,027
$ 42,679
(1) The
investment of approximately $4,200,000 of these funds has been deferred for the time being.
In addition to the specific projects listed above,
our budget for routine and miscellaneous capital expenditures for the year ended December 31, 2022 was $825,000. We spent approximately
$34,000 more than this budget amount during 2022, and we expect to spend approximately $97,000 during 2023 to complete these miscellaneous
expenditures from the 2022 budget. These routine and miscellaneous capital expenditures amounted to $260,000, $554,000 and $574,000 during
the years ended December 31, 2021, 2020 and 2019, respectively. The spend on this budget category during 2021 was lower than expected,
and, as a result, the spend during 2022 was higher than the historical norm. The budget for these miscellaneous capital expenditures during
2023 is $1,000,000. Due to the loss in gross margin during the first quarter of 2023 caused by the slowdown in production output necessary
to remediate a product contamination event, we have decided to reduce spending on these routine and miscellaneous capital expenditures
by 50% for the time being.
During the third quarter of 2016, the City of
Portland approved a Tax Increment Financing (TIF) credit enhancement package that reduces the real estate taxes on our Drug Substance
production facility for Re-Tain ® by 65% over the eleven-year period beginning on July 1, 2017 and ending June 30,
2028 and by 30% during the year ending June 30, 2029, at which time the rebate expires. During the second quarter of 2017, the TIF was
approved by the Maine Department of Economic and Community Development. The value of the tax savings will increase (decrease) in proportion
to any increases (decreases) in the assessment of the building for city real estate tax purposes or the City’s tax rate. The following
table discloses how much of the new taxes we have generated is being relieved by the TIF and how much is being paid by ImmuCell:
Assessed Value
Twelve-Month
Period Ended
Total New
Taxes
Generated
by the
Project
Less:
TIF Credit
Net Amount
Paid by
ImmuCell
$1.7 million @ April 1, 2017
June 30, 2018
$ 36,000
$ 22,000
$ 13,000
$4.0 million @ April 1, 2018
June 30, 2019
$ 90,000
$ 58,000
$ 32,000
$4.0 million @ April 1, 2019
June 30, 2020
$ 94,000
$ 60,000
$ 34,000
$4.0 million @ April 1, 2020
June 30, 2021
$ 94,000
$ 60,000
$ 34,000
$4.3 million @ April 1, 2021
June 30, 2022
$ 55,000
$ 36,000
$ 20,000
$4.3 million @ April 1, 2022
June 30, 2023
$ 58,000
$ 37,000
$ 21,000
Results of Operations
Business Segments
As detailed
in Note 17, “Segment Information”, to the accompanying audited financial statements, we operate in two business segments.
The Scours segment is dedicated to manufacturing and selling First
Defense ® , a product used to prevent scours in newborn calves, which is regulated
by the USDA. The Mastitis segment is focused on developing and commercializing Re-Tain ® ,
a product to treat subclinical mastitis in lactating dairy cows, which is regulated by the FDA.
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ImmuCell Corporation
Product Sales
Through continued growth in sales of the First
Defense ® product line, and as additional resources are dedicated to production, sales, marketing and technical services,
it is our objective to exceed our total product sales of approximately $19 million achieved during the year ended December 31, 2022 as
soon as possible. Our longer-term goal is to exceed $35 million of annual total product sales as soon as possible during the five-year
period after the market launch of Re-Tain ® . We
do not solely benchmark our sales expectations off trailing twelve-month sales results. Instead, we look at the sales of competitive products
to assess the size of the addressable market and plan for growth when projecting our future production capacity needs.
Sales decreased by 4%, or $675,000, to $18.6
million during the year ended December 31, 2022, in comparison to $19.2 million during the year ended December 31, 2021. Domestic sales
during the year ended December 31, 2022 increased by 2%, and international sales decreased by 41%, in comparison to the year ended December
31, 2021. International sales aggregated 8% and 14% of total sales during the years ended December 31, 2022 and 2021, respectively. The
annual sales results are summarized in the following table (in thousands, except for percentages):
During the Years Ended
December 31,
(Decrease)
2022
2021
Amount
%
Total product sales
$ 18,568
$ 19,243
$ (675 )
(4 )%
Sales of the First Defense ®
product line aggregated 99% and 98% of our total sales during the years ended December 31, 2022 and 2021, respectively. Our sales are
seasonal with highest sales expected during the first quarter of each year. Most of our growth (when not limited by backlog) is being
realized through increased demand and a deliberate strategy to prioritize production capacity towards Tri-Shield First Defense ®
(the trivalent format of our product delivered via a gel tube), which provides broader protection to calves. The compound annual growth
rate (CAGR) of our total product sales was 12.4%, 14.0% and 10.6% during the eleven-year, four-year, and three-year periods ended December
31, 2022, respectively.
Valuation of the backlog is a non-GAAP estimate
that is based on purchase orders on hand at the time that could not be met because of a lack of available inventory. Quantification of
the backlog during the current periods has become far less comparable to prior periods. At times, customers have placed orders for more
than a month’s worth of their demand, perhaps in reaction to our ongoing backlog situation, whereas in the past they ordered more
closely in line with their current demand. The backlog was reduced from approximately $2.4 million as of December 31, 2021 to approximately
$205,000 as of September 30, 2022. We had adequate finished goods inventory to ship most of this backlog during the third quarter, but
the product was held for cold shipping on the first Monday of October. In part because of a first contamination event experienced around
the end of the third quarter of 2022, our backlog increased to approximately $2.5 million as of December 31, 2022. In part because of
a second contamination event experienced during the first quarter of 2023, the backlog increased further to approximately $8 million as
of March 10, 2023. We are reporting this figure because it does reflect the orders on our books presently that we cannot ship. However,
we do not believe this backlog is highly relevant anymore as it includes very old orders, redundancy in demand and orders that may be
cancelled. We likely lost some business during 2022 as a result of the backlog. Our inability to timely meet the needs of our customers
could result in the loss of some customers who seek alternative scours management products during this period of short supply and who
may not resume purchasing our product when we have eliminated the backlog. While
we worked to allocate product directly to certain large customers during this period of short supply, we likely lost some customers that
could not access product. While backlog is a better problem to have than seeing product expiring on our shelves, it is nonetheless a significant
challenge when we do not get our customers everything that they want. Our sales team is preparing to resume more normal sales growth initiatives
with more inventory becoming available later in 2023. We will work to regain customers that we may have lost while we were short on product
and will aggressively compete for new business. As we emerge from an extended period of time on backlog, we anticipate higher than normal
sales fluctuations quarter to quarter. What is most important to us at this time is that we achieve sales growth over the longer periods
of time, even if we experience some quarter-to-quarter fluctuations.
A supply disruption pertaining to needed plastic
syringes used in our gel product format resulted in the drop in sales during the second quarter of 2022. This supply disruption was resolved
during the third quarter of 2022. The significant global supply-chain disruptions that almost all industries are experiencing presently
are a challenge to us and contribute to our order backlog. Prices for raw materials and critical supplies are increasing significantly,
and it is becoming increasingly more difficult to obtain timely delivery of the orders that we place. Therefore, we have little choice
but to pay the higher prices and try to take on more months of supply than we would have held previously if we could get our orders fulfilled
timely.
Effective January 1, 2023, we increased our selling
price of the First Defense ® product line by approximately
3% (range of 2% to 4%) and CMT by approximately 5%. Effective January 1, 2022, we increased our selling price of the First Defense ®
product line by approximately 5% and CMT by approximately 7%. Effective January 1, 2021, we increased our selling
price of the First Defense ® product line in the
domestic market by approximately 1.6% to 3%, depending on product format, and we increased our selling price of CMT by almost 4%.
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ImmuCell Corporation
We acquired a private label product (our second
leading source of product sales during 2021) in connection with our January 2016 acquisition of certain gel formulation technology. This
product was discontinued during the first quarter of 2022 because it was not a significant contributor to our total sales and it competed
for valuable time and space in our production schedule. We sell our own CMT (our third leading source of product sales during 2021),
which is used to detect somatic cell counts in milk. Sales of these products (other than the First Defense ® product
line) decreased by approximately 50%, or $154,000, to $156,000 during the year ended December 31, 2022, in comparison to the year ended
December 31, 2021. Sales of these other products aggregated approximately 1% and 2% of our total product sales during the years ended
December 31, 2022 and 2021, respectively.
Gross Margin
The change in our gross margin (product sales
less costs of goods sold) and our gross margin as a percentage of product sales are summarized in the following table (in thousands, except
for percentages):
During the Years Ended
December 31,
(Decrease)
2022
2021
Amount
%
Gross margin
$ 7,649
$ 8,656
$ (1,007 )
(12 )%
Percent of product sales
41 %
45 %
(4 )%
(8 )%
The gross margin as a percentage of product sales
was 41%, 45%, 45%, 49%, 47% and 50% during the years ended December 31, 2022, 2021, 2020, 2019, 2018 and 2017, respectively. The gross
margin during the year ended December 31, 2022 was significantly less than what we have experienced historically and significantly less
than what we anticipate going forward. We experienced several product contamination events that resulted in scrap during 2022. This resulted
in a total charge to costs of goods sold of approximately $588,000. Although these types of losses are expected to happen from time to
time in the production of a biological product such as ours, we believe we can mitigate the risk of reoccurrence of such losses through
the implementation of certain processes and facility improvements. Absent this contamination write-off, our gross margin as a percentage
of product sales would have been approximately 44% during the year ended December 31, 2022. While our biological and process yields can
be variable, we have seen a favorable improvement to our finished goods yield recently. The costs of our supplies, components, raw materials,
and services increased significantly during 2021 and that trend has continued. The Tri-Shield ®
product format is more complex (i.e., three antibodies versus two antibodies for Dual-Force ® )
making it more costly to produce, and both the bivalent and trivalent gel product formats are more expensive to produce than the bolus
format. These new formats are creating sales growth for us, and we are focused on increasing total gross margin dollars, even if that
is accomplished with a lower gross margin as a percentage of sales. A number of other factors contribute to the variability in our costs,
resulting in some fluctuations in gross margin percentages from quarter to quarter and from year to year. Like most U.S. manufacturers,
we have also been experiencing increases in the cost of labor and raw materials. We also invest to sustain compliance with current Good
Manufacturing Practices (cGMP) in our production processes. Increasing production can be more expensive in the initial stages. To achieve
our inventory production growth objectives, we are acquiring more raw material (colostrum) from many more cows at many new farms. During
this expansion phase, colostrum quality can be more variable. Additionally, the biological yields from our raw material are always variable,
which impacts our costs of goods sold in a similar way. Just as our customers’ cows respond differently to commercial dam-level
vaccines, depending on time of year and immune competency, our source cows have similar biological variances in response to our proprietary
vaccines. As is the case with any vaccine program, animals respond less effectively to their first exposure to a new vaccine, and thereafter
the effectiveness of their immune response improves in response to subsequent immunizations. While this variability impacts our costs
of producing inventory, the commercial value of our First Defense ® product line is that we compensate for the variability
in a cow’s immune response by standardizing each dose of finished product. This ensures that every calf is equally protected, which
is something that dam-level commercial scours vaccines cannot offer. We continue to work on processing and yield improvements and other
opportunities to reduce costs, while enhancing process knowledge and robustness. Over time, we have been able to reduce the impact of
cost increases by implementing yield improvements. We believe that gross margin results should be viewed over longer periods of time than
just one quarter. As we fully integrate and utilize our increased capacity and evaluate our product costs and selling price, one of our
goals is to achieve a gross margin (before related depreciation and amortization expenses) as a percentage of total sales approaching
50%.
Product Development Expenses and Strategy
Overview :
The majority of our product development expenses pertain to the development of Re-Tain ® . During the year ended
December 31, 2022, product development expenses increased by approximately $325,000 to approximately $4.5 million in comparison to
the approximately $4.2 million during year ended December 31, 2021. Product development expenses aggregated 24% and 22% of product
sales during the years ended December 31, 2022 and 2021, respectively. Product development expenses included approximately $1.4
million and $1.5 million of non-cash depreciation and stock-based compensation expenses during the years ended December 31, 2022 and
2021, respectively. We expect our product development expenses to decrease after Re-Tain ® is commercialized
and some of the costs incurred to maintain and run our Drug Substance production facility become part of our costs of goods
sold.
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Development objective : As
we work to revolutionize the way that mastitis is managed in the dairy industry, we aim to demonstrate that our bacteriocin, Nisin A,
which is designed specifically for subclinical mastitis, can provide producers the freedom to change when and how mastitis is treated.
Re-Tain ® is not a broad-spectrum antibiotic used in human health. Rather, it consists of a highly targeted active
ingredient without a milk discard or meat withhold requirement. While milk prices vary, the cost of the milk discard associated with
traditional antibiotics ranges from approximately $46.12 (for 3.5 days of milk at 60 pounds per day at the Class III milk price average
of $21.96 per hundredweight during 2022) to $193.25 (for 11 days of milk at 80 pounds per day at the Class III milk price average of
$21.96 per hundredweight during 2022) per treated animal. These high milk discard costs associated with traditional antibiotic treatments
lead producers to only treat mastitis after clinical signs develop. We expect that Re-Tain ® will be a first-of-its-kind
product that can be used to economically treat at the earliest stage of infection, giving producers the ability to get ahead of mastitis
before clinical signs develop so the best cows stay at their best performance level and in the herd longer. The final and most critical
development objective for Re-Tain ® is to scale-up and achieve regulatory approval of our manufacturing operations.
Development status :
Approval by the Center for Veterinary Medicine, U.S. Food and Drug Administration (FDA) of the New Animal Drug Application (NADA) for
Re-Tain ® is required before any sales of the product can be initiated. The NADA is comprised of five principal
Technical Sections plus a sixty-day administrative review at the end. Each Technical Section can be reviewed and approved separately.
By statute, each Technical Section submission is generally subject to one or more six-month review cycles by the FDA. Upon review and
assessment by the FDA that all requirements for a Technical Section have been met, the FDA may issue a Technical Section Complete Letter.
The current status of our work on these submissions to the FDA is as follows:
1) Environmental
Impact: During the third quarter of 2008, we received the Environmental Impact Technical Section Complete Letter from the FDA. During
the second quarter of 2021, we received further clarification through a new Environmental Impact Technical Section Complete Letter covering
the current dosage regimen and labeling.
2) Target
Animal Safety: During the second quarter of 2012, we received the Target Animal Safety Technical Section Complete Letter from the FDA.
3) Effectiveness:
During the third quarter of 2012, we received the Effectiveness Technical Section Complete Letter from the FDA. The anticipated product
label (which remains subject to FDA approval) carries claims for the treatment of subclinical mastitis associated with Streptococcus
agalactiae , Streptococcus dysgalactiae , Streptococcus uberis , and coagulase-negative
staphylococci in lactating dairy cattle.
4) Human
Food Safety: During the third quarter of 2018, we received the Human Food Safety Technical Section Complete Letter from the FDA confirming,
among other things, a zero milk discard period and a zero meat withhold period during and after treatment with our product. Achieving
this critical differentiating feature for our product encouraged us to continue the significant product development investment necessary
to bring Re-Tain ® to market. It would have been hard to justify an
ongoing investment of this nature in a product without this significant competitive advantage. During the second quarter of 2021, we updated
this Technical Section Complete Letter with FDA approval of the official analytical method to measure Nisin in milk.
5) Chemistry,
Manufacturing and Controls (CMC): The CMC Technical Section is very complex and comprehensive. Having previously achieved the four different
Technical Section Complete Letters from the FDA discussed above, approval of the CMC Technical Section is the fifth and final significant
step required before Re-Tain ® product sales can be initiated in the
United States. Implementing Nisin Drug Substance (the active pharmaceutical ingredient, or DS) production, which is a required component
of the CMC Technical Section, has been the most expensive and lengthy part of this project. We previously entered into an agreement with
a multi-national pharmaceutical ingredient manufacturer for our commercial-scale supplies of DS. However, we determined during 2014 that
the agreement did not offer us the most advantageous supply arrangement in terms of either cost or long-term dependability. As a result,
we presented this product development opportunity to a variety of large and small animal health companies. While such a corporate partnership
could have provided access to a much larger sales and marketing team and allowed us to avoid the large investment in a commercial-scale
production facility, we concluded that a partner would have taken an unduly large share of the gross margin from all future product sales
of Re-Tain ® . However, the regulatory and marketing feedback that
we received from prospective partners, following their due diligence, was positive. During the third quarter of 2014, we completed an
investment in facility modifications and processing equipment necessary to produce our DS at small-scale at our 56 Evergreen Drive facility.
This small-scale facility was used to: i) expand our process knowledge and controls, ii) establish operating ranges for critical process
parameters, iii) conduct product stability studies, iv) optimize process yields and v) verify the cost of production. We believe these
efforts have reduced the risks associated with our investment in the commercial-scale DS production facility. Having raised equity during
2016 and 2017, we were able to move away from these earlier partnering strategies and assume control over the commercial-scale manufacturing
process in our own facility. During the fourth quarter of 2015, we acquired land near our existing Portland facility for the construction
of a new commercial-scale DS production facility. We commenced construction of this facility during the third quarter of 2016 and completed
construction during the fourth quarter of 2017. Equipment installation and qualification was initiated during the third quarter of 2017
and completed during the third quarter of 2018. Total construction and equipment costs aggregated approximately $20.8 million. With construction
of the facility complete, we continue to work with outside parties to investigate improvements to our DS production yields as well as
potential efficacy enhancements.
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Under
the FDA’s phased submission process, we made a first-phased submission covering just the DS during the first quarter of 2019. The
first-phased DS submission included data from the DS Registration Batches produced at commercial scale in our new DS manufacturing facility.
This first-phased submission was followed by a second-phased submission covering both the DS and the formulated Drug Product (DP), during
the first quarter of 2021. This two-phased submission process allowed us to respond to identified queries and/or deficiencies from the
first-phased DS submission at the time of the second-phased combined DS and DP submission. The second-phased DS and DP submission responded
to comments raised by the FDA regarding the first-phased DS submission and included detailed information about the manufacturing process
and controls for DP. One of the key components of the second-phased DS and DP submission was also demonstrating stability of the product
through expiry. During the third quarter of 2021, the FDA issued a Technical Section Incomplete Letter with regard to this second-phased
DS and DP submission. This response was not unexpected as it is common for the FDA to issue queries and comments, especially related to
an aseptic DP submission with associated sterilization validation information. We made a second submission of the DS and DP Technical
Section during the first quarter of 2022. During the third quarter of 2022, we received a Technical Section Incomplete Letter from the
FDA with regards to this second DS and DP submission of the CMC Technical Section. We have been working diligently to make this third
submission during the first quarter of 2023. As previously disclosed, the submission requires that external laboratories complete several
critical path items regarding our analytical testing. While we have made significant progress in addressing these issues, we are still
reliant on the work of others to finalize the submission. To that end, we are adding another month to our timeline to complete the analysis
and, in our view, optimize the submission rather than forcing the submission to achieve a self-imposed first quarter deadline. We intend
to make a brief public disclosure after this submission has been made. The principal issue remaining is a successful pre-approval re-inspection
of our manufacturing facility. We are completing preparations for such and intend to notify the FDA of our readiness for the pre-approval
re-inspection as part of our third submission. Continued focus on these preparations is critical to a successful pre-approval re-inspection
outcome. We expect a response from the FDA to this submission after the statutory six-month review period. If the FDA issues a Technical
Section Complete Letter in response to this third submission, we believe that we could commence commercial sales around the end of 2023.
While
being prudent with how much cash we invest into inventory that would have short expiry dating if market launch is delayed, we have built
and are building more DS inventory during 2022 and 2023 to bridge the transition between DP supply from our contract manufacturer to our
own in-house services. Our contract manufacturer has agreed to convert this DS to DP during the middle of 2023 with associated product
expirations during the middle of 2025. This inventory must support the market needs and have sufficient dating to bridge the transition
from our contract manufacturing agreement to when our in-house DP production is approved by the FDA. We must consider short expiry dating
in the event that our NADA approval is delayed as well as manage the number of new customers we obtain at launch in order to minimize
potential supply disruptions.
Our DS
manufacturing facility and that of our DP contract manufacturer (and our future DP manufacturing facility) are subject to ongoing FDA
inspections. During the third quarter of 2019, the FDA conducted a pre-approval inspection of our DS facility. This resulted in the issuance
of certain deficiencies as identified on the FDA’s Form 483. We submitted responses and data summaries in a phased manner over the
fourth quarter of 2019 and first quarter of 2020. During the first quarter of 2022, the FDA conducted another pre-approval inspection
of our DS facility. This also resulted in the issuance of certain deficiencies as identified on the FDA’s Form 483. We have since
responded to all of the queries and are preparing for a re-inspection, which will likely take place during the six-month review period
for our third submission of the CMC Technical Section. This inspection process has been managed without significant cost.
We have
always believed that the fastest route to FDA approval and market launch is with the services of Norbrook Laboratories Limited of Newry,
Northern Ireland (an FDA-approved DP manufacturer) (Norbrook), reducing our risk by benefiting from their demonstrated expertise in aseptic
filling. From 2010 to the present, we have worked with Norbrook under several amended contract manufacturing agreements covering the DP
formulation, aseptic filling and final packaging services. Under our current agreement, Norbrook has agreed to provide the formulation,
aseptic filling and final packaging services as required in order for us to submit the CMC Technical Section to the FDA and to provide
a supply of product during the second half of 2023 that we believe will enable us to commence sales of Re-Tain ®
without delay upon receipt of the anticipated FDA approval and provide us with a supply bridge until
our own formulation and aseptic filling capacity is available, which is anticipated during 2025 (see discussion of PROJECT D above).
DP produced under this agreement during the second half of 2023 is expected to have expiry dating during the second half of 2025.
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Our potential
alternative third-party options for the formulation and aseptic filling services that are presently being performed by Norbrook are narrowed
considerably because our product cannot be formulated or filled in a facility that also processes traditional antibiotics (i.e., beta
lactams). Consequently, we have decided to perform these services internally (see discussion of PROJECT D above). We are investing
in the equipping and commencement of operations of our own DP formulation and aseptic filling facility. We began initial equipment installation
during the first quarter of 2022. Subject to the timing of our installation and validation work, we anticipate FDA approval of this facility
(which is a requirement for commercial manufacturing) during 2025, allowing for two six-month review cycles. This new facility will be
subject to FDA inspection and approval and will have enough formulation and aseptic filling capacity to exceed the expected production
capacity of our DS facility, which is at least $10 million in annual sales. This production capacity estimate is based on our assumptions
as to product pricing and does not yet reflect inventory build strategies in advance of product approval or ongoing yield improvement
initiatives. Establishing our own DP formulation and aseptic filling capability provides us with the longer-term advantage of controlling
the manufacturing process for Re-Tain ® in one facility, thereby potentially
reducing our manufacturing costs and eliminating international cold chain shipping logistics and costs. The DP formulation and aseptic
filling operation will be located in existing facility space that we had intended to utilize to double our DS production capacity if warranted
by sales volumes following market launch. As a result, we would need to explore alternative strategies (in parallel with ongoing DS yield
improvement initiatives) to expand our DS production capacity. This integrated manufacturing capability for Re-Tain ®
will substantially reduce our dependence on third parties. Upon completion of our formulation and aseptic
filling facility, the only significant third-party input for Re-Tain ® will
be the DP syringes. It is anticipated that Hubert De Backer of Belgium (HDB) will supply these syringes in accordance with purchase orders
that we submit. HDB is a syringe supplier for many of the largest participants in the human and veterinary medical industries, and with
whom Norbrook presently works. Based on HDB’s performance history and reputation in the industry, we are confident that HDB will
be a dependable supplier of syringes in the quantity and of the quality needed for Re-Tain ® .
Other product development initiatives :
Our second most important product development initiative has been focused on other improvements, extensions or additions to our First
Defense ® product line. We are currently working to establish USDA claims for our bivalent bulk powder formulation
of First Defense Technology ® . Subject to the availability of resources, we intend to begin new development projects
that are aligned with our core competencies and market focus. We also remain interested in acquiring, on suitable terms, other new products
and technologies that fit with our sales focus on the dairy and beef industries, subject to the availability of the needed funding.
Sales and Marketing Expenses and Selling Strategy
During the year ended December 31, 2022, sales
and marketing expenses increased by approximately 27%, or $686,000, to $3.2 million in comparison to $2.5 million during the year ended
December 31, 2021, amounting to 17% and 13% of product sales during the years ended December 31, 2022 and 2021, respectively. Sales and
marketing expenses included approximately $158,000 and $70,000 of non-cash depreciation and stock-based compensation expenses during the
years ended December 31, 2022 and 2021, respectively. Our budgetary guideline for 2023 and after is to keep these expenses under 20% of
total sales. We continue to leverage the efforts of our small sales force by using animal health distributors.
We
see ourselves as the “non-pharma” pharma company. Rather than offering variations of “copy-cat” technology like
vaccines and antibiotics, we have taken the path less traveled by developing first-of-their kind products fueled by novel active ingredients
such as polyclonal antibodies (for First Defense ® ) and bacteriocins (for Re-Tain ® ).
While we expect that Re-Tain ®
could be a significant market disrupter, we project the First Defense ® market could be larger, especially during
the first years of the commercial launch of Re-Tain ® .
We anticipate that these category developing innovations will drive greater value for the livestock industry and, in turn, for our stockholders.
The First Defense ® product
line serves dairy and beef producers by protecting their calf crop from scours, the leading cause of pre-weaning mortality and morbidity.
When calves are healthy during this crucial development period, they mature into more productive milking cows and more efficient beef
generators. Our primary competition in this category is vaccines that are also regulated for effectiveness and safety by the USDA. However,
vaccine results are inherently variable. COVID breakthrough infections in humans have reminded us that a vaccine does not guarantee immunity.
That is true for our competitors as well. In the most controlled research settings, only 80% of animals respond to a vaccine. This leaves
20% of the calf crop unprotected when the scour prevention program relies on scour vaccines. Those unprotected calves can be disease carriers.
Not only are they more susceptible to death or likely to require life-saving treatment (sometimes with antibiotics), but they also shed
pathogens into the environment creating a greater disease pressure for their herd mates. The First Defense ® product
line removes the inconsistency inherent with vaccine protection. We sell the only USDA-licensed products in the scour prevention category
that are therapeutic polyclonal antibodies. This technology eliminates a producer’s reliance on a variable vaccine response to generate
antibodies and, instead, can protect every calf equally with a measured dose of antibody-driven immunity against both bacterial and viral
scour pathogens.
In this space, we treat more calves than our
competitors where products are primarily vaccines administered directly to the calf at birth, and we are second in sales dollars to the
market leader within the dam-level competitor category, which constitutes vaccines given to the cow pre-calving. Despite these successes,
there remains significant opportunity to displace more competition within North America. There is also opportunity to grow our sales by
expanding into international markets. We are being strategic in how we invest in international market development in order not to divert
our limited resources away from achieving domestic growth, which is often more efficient to obtain.
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Our expanded sales and marketing team has proven
to be a worthy investment, validating that our message resonates well with customers. Now that our increased production capacity is in
place, we anticipate being able to escalate our growth curve after we recover from the brand damage that can come with an extended duration
of short supply. Unfortunately, just after we largely eliminated the backlog of orders, we experienced several contamination events in
our production process around the end of the third quarter of 2022. This loss of inventory has returned us to a backlog situation until
we fill the pipeline with new inventory from our expanded production capacity in 2023.
We believe that Re-Tain ® could
revolutionize the way that mastitis is managed by making earlier treatment of subclinical infections (while these cows are still producing
saleable milk) economically feasible by not requiring a milk discard or a meat withhold during, or for a period of time after, treatment.
No other FDA-approved mastitis treatment product on the market can offer this value proposition. We believe we can demonstrate a return
on investment to the dairy producer and the milk processor that will justify a premium over other mastitis treatments on the market today,
which are all sold subject to milk discard and meat withhold requirements. By creating this value for our customers, we believe we can,
in turn, create value for our stockholders.
Re-Tain ® could increase the
lifetime profitability of a cow and reduce disease transfer to herd mates. It is common practice to move sick cows from their regular
herd group to a sick cow group for treatment and the related milk discard. This movement causes stress on the cow and a reduction in milk
production. While practices may vary farm-to-farm, there would be no requirement to move cows treated with our product, allowing this
costly drop in production to be avoided. It is generally current practice to treat mastitis only when the disease has progressed to the
clinical stage where the milk from an infected cow cannot be sold, leaving most subclinically infected cows untreated. Without a milk
discard cost, we expect producers to be more motivated to identify and treat cows at the subclinical stage. This creates a substantial
animal welfare benefit. By treating mastitis early at the subclinical level, producers could preserve optimal milk yields. We also know
that animals infected with subclinical mastitis have higher abortion rates and often progress to the clinical disease state requiring
antibiotic treatment and milk discard. We believe that societal animal welfare objectives will put more and more pressure on the industry
to treat cows with subclinical infections.
The over-use of antibiotics that are medically
important to human healthcare is a growing public health concern of our society and an active issue with the FDA, largely because of the
growing evidence that this over-use contributes to antibiotic resistance and the rise of “super-bugs”. Sustainability objectives
require that less antibiotics be used in food producing animals, yet a new FDA-approved drug to treat mastitis has not been developed
in years. Our product improves sustainability by utilizing a bacteriocin as an alternative to traditional antibiotics that are used in
human medicine. In the big picture, we are introducing an entirely new class of antimicrobial as an animal drug, a bacteriocin, that does
not promote resistance against antibiotics used in human medicine making it more socially responsible. The industry could keep treating
this very significant disease with traditional antibiotics, but it takes innovation to bring a bacteriocin like Nisin to market. Re-Tain ®
would, when introduced, offer a needed alternative to these traditional antibiotics, while at the same time improving milk quality and
the quantity of milk produced by treated cows. We believe our product fits very well with where the industry is going to be in the coming
years. As the great NHL hockey player, Wayne Gretzky, is known to have said, “I skate to where the puck is going to be, not where
it has been.” This is motivational to us.
As
with all new products, the market determines the value. Our objective is to gain market acceptance of this new product concept as we develop
a new product category. Despite our product’s exciting benefits, it will take time to change this longstanding treatment
paradigm and develop this new market. It will take time for the market to understand, evaluate, implement and adapt to the use and benefits
of Re-Tain ® . Based
on consultations with industry experts and key opinion leaders, we have opted to carefully control the launch of this novel product over
the first eighteen to twenty-four months after FDA approval, as we seek to transform the way that mastitis is treated in the dairy industry
over the long term. Our goal is to help early adopters select treatment candidates, develop easy to use protocols, optimize treatment
results and realize a positive return on their investment. We intend to limit initial distribution of Re-Tain ® to
a level that enables our sales team to select the optimal dairy farms at which to introduce Re-Tain ® and to limit
the initial numbers of participating farms so that the desired levels of support and guidance relating to effective usage of Re-Tain ®
can be provided with our available resources. Our overarching objective is to minimize the risk of early stage unsatisfactory
outcomes that could harm the longer term prospects and market acceptance of Re-Tain ® . This strategy also reduces
the amount of inventory that we would need to build at risk before regulatory approval is achieved, and it reduces the amount of cash
we would need to spend to purchase inventory from our contract manufacturer before our in-house aseptic filling services are approved
by the FDA. This strategic choice means that we have elected not to pursue an alternative strategy that might have maximized short-term,
initial sales quickly through a mass market approach where we provide product to distribution and let them sell it to as many farms as
possible. While we are dedicated to increasing our sales revenue, we must consider the damage a mass market strategy could cause to the
long-term value of the product. We have seen products sold by much larger companies that were substantially damaged by such failed market
launch strategies. We continue to develop detailed launch plans, focusing on the readiness of dairy operators to successfully introduce
Re-Tain ® to their herds. We believe that these prudent steps, while potentially leading to lower initial Re-Tain ®
revenues, may create a smooth and successful launch and could safeguard the longer term performance of our investment in Re-Tain ® .
We also believe that the operational adjustments and accommodations that dairy farmers will need to make to effectively use Re-Tain ®
and avoid the potential problems described under PART I: ITEM 1A – RISK FACTORS , “Product Risks”, to this Annual
Report will not be so burdensome as to deter its adoption and usage. Our overarching objective is to minimize the risk of early-stage
unsatisfactory outcomes that could harm the longer-term prospects and market acceptance of Re-Tain ® .
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It
is difficult to accurately estimate the potential size of the subclinical mastitis market because presently this disease is largely left
untreated. We believe that approximately 20% to 40% of the U.S. dairy herd is infected with subclinical mastitis at any given time. This
compares to approximately 2% of the U.S. herd that is thought to be infected with clinical mastitis, where approximately $60 million per
year is spent on drug treatments. Rarely is an industry revolutionized overnight. Getting producers to change protocols to make subclinical
mastitis treatment a standard and routine procedure is going to take initiative, but we believe producers are eager for something new
and better since the FDA has not approved an intramammary treatment within the last 20 years. Similar market opportunities are
likely to exist outside the United States. We believe the use of Re-Tain ® could be expanded, with additional data
and regulatory approval, to support treatment late in lactation and possibly for clinical stage mastitis. We also believe there may be
a market for Re-Tain ® in small ruminants, where
the majority of mastitis cases are caused by strep-like organisms aligned with our effectiveness data.
We expect the Drug Substance production facility
that we constructed for approximately $20.8 million to have initial annual production capacity sufficient to meet at least $10 million
in sales of Re-Tain ® at current production yields. This production capacity estimate does not yet reflect any inventory
build strategies or ongoing yield improvement initiatives. Expansion of the estimated annual capacity of the Drug Substance facility beyond
approximately $10 million (without factoring in potential yield improvements) would require relocation of the Drug Product formulation
and aseptic filling module to another facility, or the acquisition and equipping of other Drug Substance production facilities or adopting
alternative manufacturing strategies.
In an effort to provide greater visibility into
the launch of Re-Tain ® , we have expanded Note 17, “Segment Information”, to the accompanying audited
financial statements to now display a break-out of our financial results among the following three components of our business: i) Scours,
ii) Mastitis and iii) Other. This will allow investors to see our progress with both products. We generally do not provide financial projections,
as we know such projections can prove to be materially inaccurate. However, in this case, we are providing a high-level projection for
Re-Tain ® that under our controlled launch plan strategy, we estimate that we can achieve sales of approximately
$1 million in 2024 and then achieve approximately twice that in 2025. This assumes FDA approval is achieved and that product launch is
initiated around the end of 2023. If we are successful with this launch strategy, we would aim to grow this curve in 2026 and after. We
believe this strategy lends itself to a more gradual adoption curve but higher and more sustainable sales over the long-term. Actual sales
results will vary from these projections up or down.
Administrative Expenses
During the year ended December 31, 2022, administrative
expenses increased by 31%, or approximately $538,000, to $2.3 million in comparison to $1.7 million during the year ended December 31,
2021. The increase in administrative expenses during the year ended December 31, 2022 compared to the year ended December 31, 2021 was
largely the result of the accrual of approximately $222,000 in deferred compensation expense (consisting of earned and unused paid time
off) during the first quarter of 2022. Administrative expenses included approximately $148,000 and $122,000 of non-cash depreciation and
stock-based compensation expenses during the years ended December 31, 2022 and 2021, respectively. We strive to be efficient with these
expenses while funding costs associated with complying with the Sarbanes-Oxley Act of 2002 and all the legal, audit and other costs associated
with being a publicly-held company. Given the growth in our business, our administrative staff has increased to four talented individuals
reporting to our CEO. Prior to 2014, we had limited our investment in investor relations spending. Beginning in the second quarter of
2014, we initiated an investment in a more active investor relations program. Given travel restrictions related to the COVID-19 pandemic,
this initiative has pivoted to a virtual meeting format, which is less expensive. Having experienced this efficiency, it is our intent
to continue with the same strategy, for the most part, even as travel restrictions continue to be reduced. At the same time, we continue
to provide full disclosure of the status of our business and financial condition in three quarterly reports and one annual report each
year, as well as in Current Reports on Form 8-K when legally required or deemed appropriate by management. We believe these efforts have
helped us access the capital markets to fund our growth objectives. Considering inflation and all the necessary support services that
fit into this category, we believe that approximately $2 million to $2.5 million per year is an efficient budget goal to fund the administrative
expenses of a publicly-held company.
Net Operating (Loss) Income
During the year ended December 31, 2022, our
net operating (loss) of ($2.3) million was in contrast to net operating income of $257,000 during the year ended December 31, 2021. The
$1.5 million increase in operating expenses and the $1 million decrease in gross margin made up most of the $2.6 million increase in the
net operating loss.
Other Expenses, net
During the year ended December 31, 2022 other
expenses, net, aggregated $187,000 in comparison to other expenses, net, of $327,000 during the year ended December 31, 2021. Interest
expense increased to $349,000 during the year ended December 31, 2022 from $314,000 during the year ended December 31, 2021. Non-cash
amortization of debt issuance costs (which is included as a component of interest expense) was $8,000 during both of the years ended December
31, 2022 and 2021. We anticipate that our interest expense will be approximately $352,000, $323,000 and $279,000 during the years
ending December 31, 2023, 2024 and 2025, respectively. Interest income was $153,000
and $19,000 during the years ended December 31, 2022 and 2021, respectively. More interest income was earned during 2022 largely
because of a higher interest rate environment. The (gain) loss on disposal of property,
plant and equipment was approximately ($7,000) and $31,000 during the years ended December 31, 2022 and 2021, respectively.
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Loss Before Income Taxes
During the year ended December 31, 2022, our
loss before income taxes was $2.5 million in comparison to a loss before income taxes of $69,000 during the year ended December 31, 2021.
Income Taxes and Net Loss
During the years ended December 31, 2022 and
2021, we recorded income tax expense of $8,000 and $9,000, respectively, which is comprised of minimum state tax liabilities. Our net
loss of $2.5 million, or $0.32 per basic share, during the year ended December 31, 2022 was in comparison to a net loss of $78,000, or
$0.01 per basic share, during the year ended December 31, 2021.
We have substantial net operating loss carryforwards
that largely offset our income tax expense. For tax return purposes only, our depreciation expense for the Nisin Drug Substance production
facility and equipment was approximately $425,000, $492,000, $464,000, $639,000, $9.2 million and $1.5 million for the years ended December
31, 2022, 2021, 2020, 2019, 2018 and 2017, respectively. The significant increase during 2018 was largely related to accelerated depreciation
allowed for tax purposes. As of December 31, 2022, our federal net operating loss carryforward was approximately $15.5 million, which
will be available to offset future taxable income, subject to possible annual limitations based on ownership changes. On December 22,
2017, the Tax Cuts and Jobs Act was signed into law. This legislation makes significant changes in the U.S. tax laws, including a reduction
in the corporate tax rates, changes to net operating loss carryforwards and carrybacks, and a repeal of the corporate alternative minimum
tax. The legislation reduced the U.S. corporate tax rate from 34% to 21%. Our income tax rate differs from this statutory tax rate primarily
because we are currently providing for a full valuation allowance against our deferred tax assets. While we are recording this full valuation
allowance, we are not recognizing the benefit of our tax losses.
In addition to the results discussed above from
our Statements of Operations, we believe it is important to consider our Statements of Cash Flows in the accompanying audited financial
statements to assess the cash generating ability of our operations.
Critical Accounting Policies
The financial statements are presented on the
basis of accounting principles that are generally accepted in the United States. All professional accounting standards that were effective
and applicable to us as of December 31, 2022 have been taken into consideration in preparing the financial statements. The preparation
of financial statements requires that we 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 revenue recognition, income taxes, contingencies and the useful lives and carrying values of intangible and long-lived
assets. We base our estimates on historical experience and on various other assumptions that we believe are 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. Actual results may differ from these estimates under different assumptions or conditions. We have chosen to highlight
certain policies that we consider critical to the operations of our business and understanding our financial statements.
We sell products that provide Immediate Immunity™
to newborn dairy and beef cattle. We recognize revenue in accordance with the five step model in ASC 606. These include the following:
i) identification of the contract with the customer, ii) identification of the performance obligations in the contract, iii) determination
of the transaction price, iv) allocation of the transaction price to the separate performance obligations in the contract and v) recognition
of revenue associated with performance obligations as they are satisfied. We recognize revenue at the time of shipment (including to distributors)
for substantially all products, as title and risk of loss pass to the customer on delivery to the common carrier after concluding that
collectability is reasonably assured. We do not bill for or collect sales tax because our sales are generally made to distributors and
thus our sales to them are not subject to sales tax. We generally have experienced an immaterial amount of product returns.
Inventory includes raw materials, work-in-process
and finished goods and is recorded at the lower of cost, on the first-in, first-out method, or net realizable value (determined as the
estimated selling price in the normal course of business, less reasonably predictable costs of completion, disposal and transportation).
Work-in-process and finished goods inventories include materials, labor and manufacturing overhead. The assumptions used by management
to determine the cost of inventory and costs of goods sold involve a significant level of estimation and uncertainties that could have
a material impact on our financial condition and results of operations largely because of the variability of the costs per dose due to
fluctuations in the biological yield from production batch to batch.
ITEM 7A — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
None
33
ImmuCell
Corporation