ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Decision Diagnostics Corp. is a nationwide prescription and non-prescription diagnostics and home testing products distributor, selling a range of diagnostic test kits and at-home testing products. The U.S. FDA, in a manner similar to its prescription drug regulation, regulates diagnostic test kits and at-home patient testing products similarly to the regulation of prescription medicine. The company has, since 2005, contracted with independent pharmacies for use of their prescription drug distribution licenses. However, the products we currently distribute, for the most part, do not require a doctor’s prescription for anything other than insurance benefit compliance. Our business model works well in this regulated environment.
Our subsidiaries, Pharma Tech Solutions, Inc. and PDA Services, Inc. operate in several healthcare products distribution channels. We distribute brand name prescription and non-prescription diagnostics products, as well as several lines of ostomy, wound care and post-surgery medical products. We have also recently introduced, a seminal and proprietary diagnostic product named Shasta Genstrip, for at-home testing of blood glucose. The U.S. FDA cleared the Shasta Genstrip product for sale in the U.S. on November 30, 2012. The worldwide market for at-home blood glucose testing is an estimated $22.5 billion. Shasta Genstrip competes directly with one of the largest worldwide platform manufacturer for at-home blood glucose testing, a product currently used daily by over 3 million diabetes afflicted Americans. In addition, since the medical device employed by this legacy platform manufacturers, Genstrip also competes in the overall at-home testing market by offering an economical solution to former users of the legacy platform providers product. In that regard, Genstrip is unique as a major business focus is directed toward diabetics who have changed platforms due to escalating prices. The company continues to focus Genstrip as a value priced alternative to the existing legacy platforms.
Throughout 2012 in anticipation of the introduction of Genstrip, which received clearance from U.S. FDA on November 30, 2012, we have evaluated our brand-name distribution model, a model that provides streams of revenue but extremely low profit margins, and over the course of the last 15 months we have phased out sales of those brand name products that have been a backbone of our current distribution business but provide low profit margins, difficult collection challenges and if allowed to continue into the future. As of July 1, 2013, when parts of the Affordable Care Act were implemented by the Federal Medicare and Medicaid programs, effectively lowering payment rates for diabeted related products by almost 70%, we have ended our brand name distribution business. We are allowing our brand name products distribution arrangements to expire. The company’s major focus is now directed toward building the brand of its Genstrip product. We are not currently considering any distribution models that would compete directly with our Shasta Genstrip. Phasing out the sales of our brand name distribution business lowered our order intake by approximately $12,750,000 in FY2012 and by $9,650,000 in the 2013 period ended June 30, 2013. In addition, due to the many unknowns that resulted from the company’s on-going litigation with the divisions of Johnson and Johnson, Inc., the company has deferred $2,905,000 in Genstrip sales and has delayed the implementation of its Genstrip retail store strategy delaying an estimated $4,800,000 in additional revenues.
The company will continue to direct its marketing efforts to ambulatory and semi-ambulatory older Americans afflicted with diabetes and complications caused by diabetes and old age. The company, originally a medical IT company with proprietary IT product lines, acquired its medical products distribution business in late 2004 through a merger with Phoenix, Arizona based CareGeneration, Inc. We have grown the original CareGeneration business through subsequent acquisitions of private businesses and strategic partnerships with larger private pharmacies.
On November 1, 2011 we completed the acquisition of Diagnostic Newco LLC from its owner Kimberly Binder. Diagnostic Newco LLC is a design company that specializes in product packaging design, medical products advertising design and graphic art. Ms. Binder has joined the staff of the company’s Pharma Tech Solutions, Inc. subsidiary as an in-house consultant and has worked closely with the contract manufacturer for Genstrip, making subtle changes to packaging design among other of her responsibilities. She will also be responsible for the package design for new diagnostic products the company is currently working on. Ms. Binder is also owner and sole shareholder of GenstripDirect, LLC, her own distribution company, which she operates independently.
We also intend to acquire additional private companies, focusing on small engineering companies that have developed technology requiring either regulatory approval, distribution or both. In December 2011 we made another small acquisition, to acquire the services of Mr. Patrick DiParini. We are moving quickly to achieve our goal of becoming a vertically integrated, full service value added provider of products and services to an ever-growing market. The at-home diabetes testing market continues to grow as diabetics continue to be diagnosed. The market for diabetes testing products is expected to grow from a current $22.5+ billion worldwide base in 2010 to over $32 billion in 2017.
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The company’s current proprietary product offering, approved by the FDA for commercial distribution on November 30, 2012, is the Shasta Genstrip blood glucose diagnostic test strip for at-home testing. Shasta Genstrip is a product conceived and designed by Shasta Technologies LLC, and fits into a diagnostic product niche and will sell into the world-wide self-test (home test) market that is expected to grow to $32 billion worldwide by 2017. Since Genstrip is a unique offering, employing a razor blade only model (diagnostic test strip) into a razor (diagnostic meter)-razor blade (diagnostic test strip) market, the Genstrip 510(k) application presented some unusual challenges for the FDA and an educational challenge/opportunity for the company. Since the company plans additional similar products, including system products, in the future for other diagnostic platforms, the Genstrip experience, however slow and unresponsive it was, has provided lessons and experience. In February 2013 we began development efforts on a second product offering in the current market space.
Two years (and growing) is a standard development to market timeline for in-vitro diagnostic products similar to Genstrip. The process is somewhat less for system related products. As a result of previous delays by Shasta Technologies in completing its FDA approval application [510(k)] and then problems Shasta encountered in prosecuting its original application with FDA staff, the company changed its contractual responsibilities and obligations in June 2011 to include program management, regulatory process management, management of the manufacturing forecasting and distribution processes, and new products planning and development.
In June 2010 the company was approached by the largest retailer in the world for the distribution and sale of Genstrip at over 5,000 retail stores worldwide. A contract with this retailer was negotiated in September 2010 and subsequently renegotiated and renewed in April 2011 and then again in July 2013, and as soon as the retail contract was agreed to and as a means to conduct market research, the company began seeking pre-conditioned letters of intent (pre-orders) for Genstrip, while continuing the prosecution of the 510(k) application before the FDA. During this process it became clear that initial market interest in Genstrip outstripped the initially available manufacturing capacity. Thus the company quickly ended its pre-order initiative. Management is confident that there is a very large market available for Genstrip. Currently that market is dominated by four large pharmaceutical manufacturers who provide very similar and equally focused products, selling at essentially equal prices. Genstrip’s introduction should not only allow the company to achieve market share but because of the business model to be employed by Genstrip is different than those models employed by the major market players, the company may be able to change the market, lowering average price or allowing for increased testing by diabetics for a lesser price, thereby affecting all market segments.. In late April 2013 the company launched a second version of Genstrip directed primarily toward the Medicare, medical benefit and pharmacy benefits segments of the market, a market segment where much is changing and the plans of many of the company’s competitors are in flux.
The closing of the processes with the FDA, Genstrip’s FDA clearance, and its initial sales drew the attention of the platform manufacturer, the Johnson and Johnson, Inc. (“J&J”). In September 2011, J&J through its Lifescan Scotland Ltd. Subsidiary and later its Lifescan, Inc. subsidiary, brought suit against the company and others for patent infringement causes of action related to the clearance and launch of Genstrip. In December 2012, ten days after the company received notice of the FDA clearance, J&J and its Lifescan, Inc. subsidiary brought suit against the company and others for issues of trademark infringement and trade dress. Both of these suits, have complicated the company’s ability to launch Genstrip into the large and growing diabetic market, and to brand the product. At various times the company has been temporarily enjoined from selling the Genstrip product, or manufacturing the Genstrip product.
At various times J&J through its Lifescan subsidiary have contacted the company’s customers using information gained from the litigation (and thought to be under seal) and the customers of our customers through the mails using long threatening letters to impede Genstrip sales. All Genstrip distribution activities have been affected at various times.
In May 2013 the United States Circuit Court restored the company’s ability to sell Genstrip. In July 2013 the U.S. District Court agreed to hear a contempt charge against J&J’s Lifescan subsidiary for the threatening letter writing activities using (supposed) customer lists though to be under seal.
In April 2013, as a part of its defense in the September 2011 suit, the company filed with the USPTO the Institution of Inter Partes Review under 37 C.F.R. § 42.108, requesting that the USPTO review the claims in J&J’s Patent 7,250,105, the Patent that is J&J’s foundation in the September 2011 suit. On August 15, 2013 the company received notice from the U.S. Patent and Trademark Office (“USPTO”) that a four judge panel determined, in Case IPR2013-00247, (J&J) Patent 7,250,105, that “…(the company’s subsidiary) Pharmatech has demonstrated that there is a reasonable likelihood of its proving unpatentability of claims 1-3 of the [7,250,]105 patent by a preponderance of the evidence.” The J&J Patent 7,250,105 is the primary patent being litigated in the September 2011 suit. (also see PART II - OTHER INFORMATION, ITEM 1. LEGAL PROCEEDINGS).
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We also offer information technology solutions in several medical care market channels by providing physicians with information at the point of care. Our products, unlike those from many other medical information companies, make use of smart cell phones such as the Apple iPhone, the Palm Pre, the Google Droid and a wide selection of Microsoft Windows based smart phones and operate in either in a wireless or “wired” mode, which allow physicians to carry, access and update their patients’ histories, also known as electronic medical records or EMR, medication data, and best care guidelines - all at the point of care, or from any other location the physician may be located. In addition, the company’s products employ proprietary mathematical game theory features adapted by the company for medical use that allow acceptance of diagnoses and treatment protocols where the medical information may have originated from one or several locations and one time or several times.
On February 26, 2010 we filed a full utility patent application, Management and Communications System and Method, Serial No. 13/034,639. The patent application covers one hundred four (104) separate processes and encompasses the method, system and apparatus of our software technology and the integration of our software technology into commercial computer networks through commercial smart cell phone devices. In September 2011, the USPTO published our patent application. In April 2011 the patent reached the prosecution stage with the USPTO. Recently we received the first letter from USPTO concerning claims made in our application. Given that our patent application lists a substantial number of claims, and that the company’s technologies are truly unique, we felt it prudent to engage counsel to prosecute any of these claims against persons and entities that may have or will in the future breach our patent. The company has created an asset pool for the purpose of prosecuting any claims that may arise as a result of our patent approval. Claims prosecution is standard fare for high technology companies.
Over the last eight years we have entered into nine partnerships with freestanding pharmacies and Durable Medical Goods distributors in the states of New York, Maryland, New Jersey, Texas and Arizona.
We have received multiple inquiries from companies interested in perhaps collaborating with the company for the implementation of its cell phone centric technologies MD@Hand and MD@Work. However, the market available for products similar to MD@Hand and MD@Work has changed since its introduction in 2009. The legal challenges to the new health care law, which continue despite a landmark Supreme Court ruling, and the federal government’s inability to enact regulations have altered the landscape, again. We remain in discussions with multiple concerns for the marketing of our MD@ products, and any agreement we may enter will require us to provide contract software programming, providing a new source of revenue for the company. In addition to any proposed partnerships, we continue to discuss alternative propositions with other interested companies ranging from clinical laboratories, service organizations owned or aligned with medical health insurers, a medical content provider and legacy healthcare systems companies. There remains sustained interest in our MD@ products and technology. All of our discussions are with companies are much larger than Decision Diagnostics. We may or may not entertain additional proposed partnerships for our implementation of the cell phone centric technologies, which has been hindered, as has the overall market, by the slow implementation of regulations, protocols and data formats by the Federal government, as well as a change in previously announced Federal government monetary incentives.
In May 2010, we entered into agreement with Shasta Technologies, Inc. and Broadtree, Inc. This agreement granted our Pharma Tech Solutions, Inc. subsidiary the exclusive marketing rights to a new diagnostic product not yet on the market named Shasta Genstrip (“Genstrip”). The Genstrip product was developed to compete against the market leader in the $20 billion at home testing market. However, it is clear that since the at-home testing market is a functioning oligopoly where four large pharmaceutical companies control over 83% market share, we de-facto compete with all four of the leading manufacturers of at-hom,e testing products. In April 2011, the company renegotiated its agreement changing its many roles and adding responsibility for regulatory approval, manufacturing and forecasting, international sales and additional sales markets in the U.S.
We currently employ three full-time staff at our executive office located at 2660 Townsgate Road, Suite 300, Westlake Village, California 91361. In addition, we maintain one full-time and two part-time positions between our distribution centers. The company is currently hiring pharmaceutical detail representatives and medical technology trained college interns across the country and three additional interns to work out of its California office. All of our positions existing, and newly listed, are for sales and marketing, distribution, product development and customer service representatives. Our telephone number is (805) 446-1973 and our website addresses are www.decisiondiagnostics.com, www.pharmatechdirect.com and www.shastagenstrip.com.
Business activities throughout the next twelve months:
The company’s business on a day-to-day basis includes the distribution of of Shasta Genstrip. At the end of this 12-month period we plan to be selling two versions of Genstrip and (at the very end) a version of a second product. We are also working on a proposed unique system product.
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Beginning in November 2009, we introduced our cell-phone centric medical IT products that offer solutions in medical care and management by providing physicians with information at the point of care. Unlike other medical information systems using standard computer terminals or even palm-sized computers (PDA’s), our software applications operate on a series of late generation smart e-cell phones including the Apple iPhone, the Palm Pre, the Google Droid, several makes of RIM’s Blackberry and many versions of the Microsoft Windows smart phones. Our products allow physicians to access and update their patients’ histories, medication data, and best care guidelines - all at the point of care. The company’s Electronic Medical Records software is believed to be the first EMR application running on any palm sized mobile device. Recently we ported our software to run on a series of pad computers such as Apple iPad and the ‘Droid powered pads.
Our business objectives include:
1.
The practice of specializing in the distribution of Shasta Genstrip associated with the on-going care of diabetes-inflicted patients, and upon the conclusion of some of the current litigation, the world-wide distribution of of Shasta Genstrip.
2.
Combining our wholesale and retail drug distribution with our cell phone centric technologies, creating wholesale and retail ePharmacies similar in function to existing Internet pharmacies but directed to serving the large base of underinsured and uninsured Americans; and
3.
Providing medical communication and EMR medical history and storage devices based on networks of smart cell phones. These products are believed to provide benefits of on demand medical information to private practice physicians, licensed medical service providers such as diagnostic testing laboratories, and medical insurers. We have created cell phone-centric products and a suite of Internet enhanced software applications that include those features that specifically respond to the requirements of the practicing physician and the regulations currently being promulgated by the Federal government.
We also have adapted our medical communications and EMR technologies to service the real estate management and hotel/motel/convenience industries in their own commercial settings. In March 2010, our Board approved the sale of the company’s hotel/motel technologies and business base so we can focus on our core medical IT and medical distribution businesses. In past years when we had market focus on the hotel/motel industry, our real estate and hotel/motel objectives include building electronic commerce networks based on personal digital assistants (PDA) and pad based computers to the hotels, motels and single building, multi-unit apartment buildings with a desire to offer local advertising and electronic services to their tenants/guests. We still continue to provide service to this market for the existing installed base.
Financing Requirements
At June 30, 2013, we had cash of $160,527 and negative working capital of ($498,499). We anticipate that we will require $56 million in trade debt financing to finance our expected first year sales of Genstrip. In March 2012 we renewed our agreement with Alpha Credit Resources to obtain this debt financing. We have not drawn on this line despite its renewal. We will continue to seek a combination of equity and long-term debt financing as well as other traditional cash flow and asset backed financing to meet our financing needs and to reduce our overall cost of capital. Additionally, in order to accelerate our growth rate and to finance general corporate activities, we may supplement our existing sources of funds with financing arrangements at the operating system level or through additional short-term borrowings. As a further capital resource, we may sell or lease certain rights or assets from our portfolio as appropriate opportunities become available. However, there can be no assurance that we will be able to obtain any additional financing, on acceptable terms or at all.
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Results of Operations for the three months ended June 30, 2013 and 2012 compared.
The following tables summarize selected items from the statement of operations for the three months ended June 30, 2013 compared to 2012.
For the Three Months Ended
June 30,
2013
2012
3 Months
%?
Revenue
$
377,525
$
2,320,030
(1,942,505)
(83.73%)
Cost of sales
337,759
1,781,149
(1,443,390)
(81.04%)
Gross profit
39,766
538,881
(499,115)
(92.62%)
Expenses:
General & administrative expenses
83,814
72,101
11,713
16.25%
Bad debt expense
583,871
875,000
(292,129)
(33.27%)
Consulting
938,849
82,346
856,503
1,040.13%
Compensation expense
15,100
14,187
913
6.44%
Professional fees
39,500
121,972
(82,472)
(67.62%)
Total expenses
1,661,134
1,165,606
495,528
42.51%
Net operating loss
(1,621,368)
(626,725)
(994,643)
158.70%
Other expense:
Interest expense
159,515
129,159
30,356
23.50%
Total other expense
159,515
129,159
30,356
23.50%
Net loss
$
(1,780,883)
$
(755,884)
(1,024,999)
135.6%
The following discussion should be read in conjunction with the unaudited interim condensed consolidated financial statements (including the notes thereto) included under Item 1 in this Form 10-Q.
Revenues and cost of sales
During the 1st quarter of 2013, we experienced a decline in revenue compared to the same period in the previous year. We attribute the decline in revenue to the phasing out of sales of those brand name diagnostic products that will directly compete with our new Shasta Genstrip. In addition, the overall at home testing market is being hindered by the general poor economic conditions, longer payment cycles from insurers, and because the company’s business model does not include the sale of retail brand-name products. These conditions have continued into the current year. Our decrease in cost of sales is primarily the direct result of our revenue decline. However, we were able to achieve an increase in our overall gross profit margin based on our re-negotiated wholesale pricing.
Operational Expenses
Operational expenses include general and administration expenses, compensation expense consulting and professional fees.
General and administration expenses include office expenses (including rent, cleaning and maintenance, utilities, and telephone), insurance, and bank charges. During the 2nd quarter of 2013, general and administration expenses increased by $11,713 to 83,814 (2nd quarter 2012 - $72,101). General and administration expenses normally account for approximately 2% of our total revenue, however, for the six months ended June 30, 2013, they accounted for 22% of our total revenue because of the decrease in our revenues without a corresponding decrease in overhead expenses. As we experience growth in revenues, general and administration expenses are expected to decrease on a percentage of revenue basis.
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Bad debt expenses during the 2nd quarter 2013 decreased by $291,129 to $583,871 (2nd quarter 2012 – $875,000). This decrease is attributable to a decrease in overall revenues for the 2nd quarter 2013 as compared to 2nd quarter 2012.
Consulting expenses during the 2nd quarter 2013 increased by $856,503 to $938,849 (2nd quarter 2012 - $82,346). This increase is primarily attributable to the issuance of stock options for services to the company’s executives pursuant to its 2013 Executive Stock Option Plan.
Professional fees include accounting services, legal fees and regulatory reporting compliance. We anticipate our legal fees to continue until all ongoing litigation issues are resolved.
Other Income and Expense
Our other income and expense includes costs related to our financing activities, more specifically the interest expense associated with our line of credit with Alpha Credit Resources, LLC. (“Alpha”). Alpha has provided us a line of credit up to $2,500,000. The interest rate of our line of credit is 24% per annum. Interest expense increased by $30,356 to $159,515 (2nd quarter 2012 - $129,159).
Net Loss
We recorded a net loss for the 2nd quarter of 2013 of 1,780,883 compared $755,884 for the 2nd quarter of 2012, representing a change of $1,024,999.
Results of Operations for the six months ended June 30, 2013 and 2012 compared.
The following tables summarize selected items from the statement of operations for the six months ended June 30, 2013 compared to 2012.
For the Six Months Ended
June 30,
2013
2012
6 Months
%?
Revenue
$
1,488,990
$
4,826,410
(3,337,420)
(69.15%)
Cost of sales
1,059,218
3,814,887
(2,755,669)
(72.23%)
Gross profit
429,772
1,011,523
(581,751)
(57.51%)
Expenses:
General & administrative expenses
126,214
143,215
(17,001)
(11.87%)
Bad debt expense
1,051,072
1,126,136
(75,064)
(6.67%)
Consulting
1,546,997
189,902
1,357,095
714.63%
Compensation expense
29,341
25,522
3,819
14.96%
Professional fees
66,446
154,485
(88,039)
(56.99%
Total expenses
2,820,070
1,639,260
1,180,810
72.03%
Net operating loss
(2,390,298)
(627,737)
(1,762,561)
280.78%
Other expenses:
Financing costs
-
36
(36)
(100.00%)
Interest expense
309,940
215,956
93,984
43.52%
Settlement expense
12,500
17,500
(5,000)
(28.57%)
Total other expenses
322,440
233,492
88,948
38.09%
Net (loss)
$
(2,712,738)
$
(861,229)
(1,851,509)
214.98%
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The following discussion should be read in conjunction with the unaudited interim condensed consolidated financial statements (including the notes thereto) included under Item 1 in this Form 10-Q.
Revenues and cost of sales
During the six months ended June 30, 2013, we experienced a decline in revenue compared to the same period in the previous year. We attribute the decline in revenue to the phasing out of sales of those brand name diagnostic products that will directly compete with our new Shasta Genstrip. In addition, the overall at home testing market is being hindered by the general poor economic conditions, longer payment cycles from insurers, and because the company’s business model does not include the sale of retail brand-name products. These conditions have continued into the current year. Our decrease in cost of sales is primarily the direct result of our revenue decline. However, we were able to achieve an increase in our overall gross profit margin based on our re-negotiated wholesale pricing.
Operational Expenses
Operational expenses include general and administration expenses, compensation expense consulting and professional fees.
General and administration expenses include office expenses (including rent, cleaning and maintenance, utilities, and telephone), insurance, and bank charges. During the 6 months of 2013, general and administration expenses decreased by $17,001 to $126,214 (6 months 2012 - $143,215). General and administration expenses normally account for approximately 2% of our total revenue, however, for the six months ended June 30, 2013, they accounted for 8.5% of our total revenue because of the decrease in our revenues without a corresponding decrease in overhead expenses. As we experience growth in revenues, general and administration expenses are expected to decrease on a percentage of revenue basis.
Bad debt expenses during the 6 months 2013 decreased by $75,064 to $1,051,072 (2nd quarter 2012 – $1,126,136). This decrease is attributable to a decrease in overall revenues for the 6 months 2013 as compared to 6 months 2012.
Consulting expenses during the 6 months 2013 increased by $1,357,095 to 1,546,997 (6 months 2012 - $189,902). This increase is attributable to expensing 6 months 2013 portion of the prepaid consulting expense from contracts issued in 4thquarter 2012 and to the issuance of stock options for services to the company’s executives pursuant to its 2013 Executive Stock Option Plan.
Professional fees include accounting services, legal fees and regulatory reporting compliance. We anticipate our legal fees to continue until all ongoing litigation issues are resolved.
Other Income and Expense
Our other income and expense includes costs related to our financing activities, more specifically the interest expense associated with our line of credit with Alpha Credit Resources, LLC. (“Alpha”). Alpha has provided us a line of credit up to $2,500,000. The interest rate of our line of credit is 24% per annum. Interest expense increased by $93,984to $309,940 (6 months 2013 - $215,956).
Net Loss
We recorded a net loss for the 6 months of 2013 of $2,712,738 compared $861,229 for the 6 months of 2012, representing a change of $1,851,509.
Liquidity and Capital Resources
A critical component of our operating plan affecting our continued existence is the ability to obtain favorable capital through additional equity and/or debt financing. We do not anticipate generating sufficient positive internal operating cash flow until we can increase our existing market share and improve operating margins, which may take several years. In the event we cannot obtain the necessary capital to pursue our strategic plan, we may have to cease or significantly curtail our operations. This would materially impact our ability to continue operations.
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