Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, beliefs and expectations that involve risks and uncertainties. Our actual results and the timing of events could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in the sections of this report titled “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements.”
Overview
Since our inception, we have sustained significant operating losses in the course of our research and development activities and commercialization efforts and expect such losses to continue for the near future. We have generated limited revenue to date from product sales, research grants and licensing fees received under a former license. We have primarily funded our operations to date through the sale of equity securities, including convertible preferred stock, common stock and warrants to purchase common stock; and debt financing, consisting primarily of convertible notes.
Through December 31, 2022, we had received net proceeds of $84.3 million from our sales of common stock, preferred stock and issuance of convertible and other promissory notes, an aggregate of $1.7 million from research grants and licensing fees and an aggregate of $2.5 million in product sales. At December 31, 2022, we had an accumulated deficit of $122.2 million and cash and cash equivalents of $4.8 million.
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On April 15, 2020, we also received cash proceeds of $645,700 from the Paycheck Protection Program (or “PPP”) of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”). We used the proceeds from the PPP Loan to retain employees, maintain payroll and make lease, interest and utility payments. On June 18, 2021, the Company received notification from BMO Harris Bank National Association as the lender in a promissory note pursuant to the CARES Act, that such loan was forgiven in full under the terms of the program.
We have incurred significant operating losses every year since our inception. Our net losses were $9.7 million and $8.3 million for the years ended December 31, 2022 and 2021, respectively. We expect to continue to incur significant expenses and generate operating losses for at least the next 12 months.
We will need additional funding to continue to fund our operations, achieve profitability and become cash flow positive, we will continue to seek additional financing. If such equity or debt financing is not available at adequate levels or on acceptable terms, we may need to delay, limit or terminate commercialization and development efforts or discontinue operations.
While it is difficult to measure the effect and impact of the COVID-19 pandemic on revenue over time, the travel and other restrictions that started in March 2020 resulted in a significant slowdown in our proof-of-concept field studies and sales efforts. We continue to experience delays on certain projects with certain businesses and government entities that have not yet returned to pre-COVID-19 pandemic operations. We have concerns about distributor, pest control operator, individual consumer, and government entity spending as a result of continued financial strain on certain industries due to the COVID-19 pandemic. This may delay or impede near term purchases of our products by these potential consumers. Additionally, while we have stocked certain long lead time inventory raw material ingredients, any prolonged impact on the suppliers we rely on for the purchase of these items by the COVID-19 pandemic could impact future manufacturing operations.
We have historically utilized, and intend to continue to utilize, various forms of stock-based awards in order to hire, retain and motivate talented employees, consultants and directors and encourage them to devote their best efforts to our business and financial success. In addition, we believe that our ability to grant stock-based awards is a valuable and necessary compensation tool that aligns the long-term financial interests of our employees, consultants and directors with the financial interests of our stockholders. As a result, a significant portion of our operating expenses includes stock-based compensation expense. Stock-based compensation expense has been, and will continue to be for the foreseeable future, a significant recurring expense in our business and an important part of our compensation strategy. Specifically, our stock-based compensation expense for the year ended December 31, 2022 and December 31, 2021 was $0.7 million and $0.8 million, respectively, which represented 7.0% and 8.3%, respectively, of our total operating expenses for those periods.
Results of Operations
The following tables provide financial and operational information to be considered in conjunction with management’s discussion and analysis of results of operations.
The results of operations are as following for the years presented (dollars in thousands):
Years Ended December 31, % Increase (Decrease)
2022 2021
Revenues, net $ 1,019 $ 600 70 %
Cost of sales 555 356 56 %
Gross profit 464 244 90 %
Operating expenses:
Research and development 1,859 1,954 (5) %
Selling, general and administrative 8,279 7,224 15 %
Total operating expenses 10,138 9,178 10 %
Loss from operations (9,674) (8,934) 8 %
Other income (expense), net (21) 666 (103) %
Net loss $ (9,695) $ (8,268) 17 %
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Revenues, net
Sales, which are net of any discounts and promotions, were $1.0 million for the year ended December 31, 2022, compared to $576,000 for year ended December 31, 2021. Sales increased by $443,000 in 2022 driven by an increase of $282,000, or 60%, from our e-commerce vertical market, combined with a $161,000, or 28%, increase driven by sales to pest management professionals and zoos and sanctuaries.
Also included in revenues in 2021, was $24,000 of grant revenue for jobs created and related new employee training in the City of Phoenix, Arizona during the year.
Cost of Sales
Cost of sales consist primarily of the cost of products sold, including scrap and reserves for obsolescence and was $555,000, or 54.5% of sales, for the year ended December 31, 2022, compared to $356,000, or 61.8% of sales, exclusive of grant revenue, for the year ended December 31, 2021. Higher costs of sales is driven by increased sales combined with the modification of our shipping policies in April 2022 to significantly reduce free shipping to customers.
Gross Profit
Gross profit for the year ended December 31, 2022 was $464,200, or 45.5%, compared to a gross profit of $244,000, or 42.4%, excluding grant revenue, for the year ended December 31, 2021. The increase in gross profit was primarily due to increased sales volume, which reflects price increases implemented in April 2022, and the impact related to the significant reduction of free shipping to customers both contributed to the improvement in gross profit margin.
Research and Development Expenses
Research and development expenses are expensed as incurred and consist primarily of costs incurred in connection with the research and development of ContraPest and our other product candidates. Such costs include the following:
• employee related expenses, including salaries, related benefits, travel and stock-based compensation expense for employees engaged in research and development functions, including that portion of manufacturing not included in cost of goods sold;
• expenses incurred in connection with the development of our product candidates, including related regulatory and production expenses; and
• facilities, depreciation, and other expenses, which include direct and allocated expenses for rent and maintenance of facilities, insurance, and supplies.
Research and development expense consisted of the following (in thousands):
Years Ended December 31, Increase
(Decrease)
2022 2021
Personnel related, including stock-based compensation $ 996 $ 847 $ 149
Professional fees 284 371 (87)
Facility related 108 99 9
Depreciation expense 128 258 (130)
Other 343 379 (36)
Total $ 1,859 $ 1,954 $ (95)
Research and development expenses were $1.9 million for the year ended December 31, 2022, compared to $2.0 million for the year ended December 31, 2021. The $95,000 decrease was primarily driven by lower depreciation expense and lower legal fees related to research and development matters, offset by higher personnel costs, as personnel turnover was higher in 2022 compared to 2021, and higher utility costs related to increased production.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of salaries and related costs, including stock-based compensation, for personnel in executive, finance, sales, marketing and administrative functions. Selling, general and
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administrative expenses also include direct and allocated facility-related costs as well as professional fees for legal, consulting, accounting and audit services.
Selling, general and administrative expense consisted of the following (in thousands):
Years Ended December 31, Increase
(Decrease)
2022 2021
Personnel related, including stock-based compensation $ 3,851 $ 3,940 $ (89)
Professional fees 2,193 1,179 1,014
Marketing 631 584 47
Facility-related 155 156 (1)
Depreciation expense 55 46 9
Other 1,394 1,319 75
Total $ 8,279 $ 7,224 $ 1,055
Selling, general and administrative expenses were $8.3 million for the year ended December 31, 2022, compared to $7.2 million for the year ended December 31, 2021. The $1.1 million increase was driven by higher professional fees related to legal matters, consulting related to advertising and marketing and recruiting costs related to employee turnover. Additionally, costs related to software licenses and marketing efforts for digital and social media outlets were higher in 2022 when compared to 2021, which was partially offset by lower costs related to the timing of personnel changes. In 2022, personnel-related costs includes severance costs of $356,000 related to the termination of the former Chief Executive Officer, while 2021 includes severance-related costs related to certain employee terminations and bonuses.
Other Income (Expense), Net
Other income (expense), net, consists of interest income and expense, as well as any recognized gains or losses related to the sale of fixed assets and other miscellaneous items. For the year ended December 31, 2022, other expense, net largely consisted of a $28,000 loss realized on the sale of research and development equipment, while other income, net for the year ended December 31, 2021 largely consisted of the PPP loan forgiveness in the amount of $645,700.
Liquidity and Capital Resources
Since our inception, we have sustained significant operating losses in the course of our research and development activities and commercialization efforts and expect such losses to continue for the near future. We have generated limited revenue to date from product sales, research grants and licensing fees received under a former license. We have primarily funded our operations to date through the sale of equity securities, including convertible preferred stock, common stock and warrants to purchase common stock; and debt financing, consisting primarily of convertible notes.
Through December 31, 2022, we had received net proceeds of $84.3 million from our sales of common stock, preferred stock and issuance of convertible and other promissory notes, an aggregate of $1.7 million from research grants and licensing fees and an aggregate of $2.5 million in product sales. At December 31, 2022, we had an accumulated deficit of $122.2 million and cash and cash equivalents of $4.8 million.
In April 2020, we received cash proceeds of $645,700 from the PPP of the CARES Act, which we used to retain employees, maintain payroll and make lease, interest and utility payments. This loan was fully forgiven under terms of the PPP in June 2021.
Our ultimate success depends upon the outcome of a combination of factors, including the following: (i) successful commercialization of ContraPest and maintaining and obtaining regulatory approval of our products and product candidates; (ii) market acceptance, commercial viability and profitability of ContraPest and other products; (iii) the ability to market our products and establish an effective sales force and marketing infrastructure to generate significant revenue; (iv) the success of our research and development; (v) the ability to retain and attract key personnel to develop, operate and grow our business; and (vi) our ability to meet our working capital needs.
Based upon our current operating plan, we expect that cash and cash equivalents at December 31, 2022, in combination with anticipated revenue and any additional sales of our equity securities, will be sufficient to fund our current operations for at least the next 12 months. We have evaluated and will continue to evaluate our operating expenses and will concentrate our resources toward the successful commercialization of ContraPest in the United States. However, if
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anticipated revenue targets and margin targets are not achieved or expenses are more than we have budgeted, we may need to raise additional financing before that time. If we need more financing, including within the next 12 months, and we are unable to raise the necessary capital through the sale of our securities, we may be required to take other measures that could impair our ability to be successful and operate as a going concern. In any event, we may require additional capital in order to fund our operating losses and research and development activities before we become profitable and may opportunistically raise capital. We may never achieve profitability or generate positive cash flows, and unless and until we do, we will continue to need to raise capital through equity or debt financing. If such equity or debt financing is not available at adequate levels or on acceptable terms, we may need to delay, limit or terminate commercialization and development efforts or discontinue operations.
Additional Funding Requirements
We expect our expenses to continue or increase in connection with our ongoing activities, particularly as we focus on marketing and sales of ContraPest. Further, continuing effects of the COVID-19 pandemic may delay the completion of field studies and achievement of sales, which will further increase our need for financing. In addition, we will continue to incur costs associated with operating as a public company.
In particular, we expect to incur substantial and increased expenses as we:
• work to maximize market acceptance for, and generate sales of, our products, including by conducting field demonstrations at potential lead customers;
• explore strategic partnerships to enable us to penetrate additional target markets and geographical locations;
• manage the infrastructure for sales, marketing and distribution of ContraPest and any other product candidates for which we may receive regulatory approval;
• seek additional regulatory approvals for ContraPest, including to more fully expand the market and use for ContraPest and, if we believe there is commercial viability, for our other product candidates;
• further develop our manufacturing processes to contain costs while being able to scale to meet future demand of ContraPest and any other product candidates for which we receive regulatory approval;
• continue product development of ContraPest and advance our research and development activities and, as our operating budget permits, advance the research and development programs for other product candidates;
• maintain and protect our intellectual property portfolio; and
• add operational, financial and management information systems and personnel, including personnel to support our product development and commercialization efforts and operations as a public company.
We believe we will need additional financing to fund these continuing and additional expenses.
Cash Flows
The following table summarizes our sources and uses of cash for each of the years presented (in thousands):
Years Ended December 31,
2022 2021
Cash and cash equivalents, beginning of year $ 9,326 $ 3,643
Net cash provided by (used in):
Operating activities (8,577) (7,779)
Investing activities (170) (99)
Financing activities 4,196 13,561
Net change in cash and cash equivalents (4,551) 5,683
Cash and cash equivalents, end of year $ 4,775 $ 9,326
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Cash Flows from Operating Activities— Cash flows from operating activities are generally determined by the amount and timing of cash received from customers and payments made to vendors, as well as the nature and amount of non-cash items, including depreciation and amortization and stock-based compensation included in operating results during a given period.
During 2022, net cash flows used in operating activities consisted of our net loss of $9.7 million, offset by changes in our operating assets and liabilities of $191,000 and non-cash charges of $928,000. Our net loss was primarily attributed to research and development activities and our selling, general and administrative expenses, as we generated limited product sales and grant revenue during the year. Net cash generated by changes in our operating assets and liabilities consisted primarily of a $188,000 increase in accrued expenses and accounts payable, a $148,000 decrease in net inventories, and a $44,000 increase in deferred revenue, offset by increases of $148,000 in prepaid expenses and $42,000 in accounts receivable.
During 2021, net cash flows used in operating activities consisted of our net loss of $8.3 million, offset by changes in our operating assets and liabilities of $67,000 and non-cash charges of $422,000. Our net loss was primarily attributed to research and development activities and our selling, general and administrative expenses, as we generated limited product sales and grant revenue during the year. Net cash generated by changes in our operating assets and liabilities consisted primarily of a $215,000 increase in accrued expenses and accounts payable and a $12,000 decrease in other assets, offset by increases of $56,000 in net inventories, $52,000 in prepaid expenses and $52,000 in net accounts receivable.
Cash Flows from Investing Activities— Cash flows used in investing activities primarily consist of the purchase of property and equipment, offset by any proceeds received in connection with sales of property and equipment. In 2022, our purchases were $74,000 higher than 2021, slightly offset by an increase of $3,000 in proceeds received on sales of property and equipment.
Cash Flows from Financing Activities— Financing activities provide cash for both day-to-day operations and capital requirements as needed. In 2022, net cash provided by financing activities consisted of $4.2 million in net proceeds from the issuance of common stock, partially offset by $32,000 of repayments related to notes payable and finance lease obligations. In 2021, net cash provided by financing activities consisted of $12.4 million in net proceeds from the issuance of common stock and $1.3 million in proceeds from warrant exercises, partially offset by $93,000 of repayments related to notes payable and finance lease obligations.
Critical Accounting Policies and Estimates
Our financial statements are prepared in accordance with generally accepted accounting principles in the United States, or U.S. GAAP. The preparation of our financial statements and related disclosures requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and the disclosure of contingent assets and liabilities in our financial statements. We base our estimates on historical experience, known trends and events and various other factors 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. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions.
We believe that the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements:
Inventory Valuation. We value inventory at the lower of cost or net realizable value. In addition, we write down any obsolete, unmarketable or otherwise impaired inventory to net realizable value. The determination of obsolete, or excess inventory requires us to estimate the future demand for our products. The estimate of future demand is compared to inventory levels to determine the amount, if any, of obsolete or excess inventory. If actual market conditions are less favorable than those we projected at the time the inventory was written down, additional inventory write-downs may be required. Inventory valuation is re-evaluated on a quarterly basis.
Stock-Based Compensation. Stock-based compensation expenses is measured at the grant date, based on the estimated fair value of the award using the Black-Scholes option pricing model for stock options and market price for restricted stock units. The use of the Black-Scholes option pricing model, requires certain estimates, including expected term of options granted, the method of calculating expected volatilities and the risk-free interest rate used in the option-pricing model. The resulting calculated fair value of stock options is recognized as compensation expenses over the requisite service period, which is generally the vesting period. When there are changes to the assumptions used in the option-pricing model, including fluctuations in the market prices of our common stock, there will be variations in the calculated fair value of our
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future stock option awards, which results in variation in the stock-based compensation expensed recognized. Additionally, any modification of an award that increases its fair value will require us to recognize additional expense.
Income Taxes. We record deferred income taxes for temporary difference between the amounts of assets and liabilities for financial and tax reporting purposes and we record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. We also regularly conduct a comprehensive review of our uncertain tax positions. In this regard, an uncertain tax position represents our expected treatment of a tax position taken in a filed tax return, or planned to be taken in a future tax return, that has not been reflected in measuring income tax expense for financial reporting purposes. Until these positions are sustained by the taxing authorities, we do not recognize the tax benefit resulting from such positions and report the tax effect for uncertain tax positions in our balance sheets.
Off-Balance Sheet Arrangements
None.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.