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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2017.

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     .

Commission File Number 001-16537

 

 

ORASURE TECHNOLOGIES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware   36-4370966
(State or Other Jurisdiction of
Incorporation or Organization)
 

(IRS Employer

Identification No.)

220 East First Street, Bethlehem, Pennsylvania   18015
(Address of Principal Executive Offices)   (Zip code)

(610) 882-1820

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer       
Non-accelerated filer   ☐  (Do not check if a smaller reporting company)    Smaller reporting company  
Accelerated filer      Emerging growth company  

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

Number of shares of Common Stock, par value $.000001 per share, outstanding as of August 3, 2017: 59,459,438 shares.

 

 

 


Table of Contents

PART I. FINANCIAL INFORMATION

 

     Page No.  

Item 1. Financial Statements (unaudited)

  

Consolidated Balance Sheets at June 30, 2017 and December 31, 2016

     3  

Consolidated Statements of Income for the three and six months ended June 30, 2017 and 2016

     4  

Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2017 and 2016

     5  

Consolidated Statements of Cash Flows for the six months ended June  30, 2017 and 2016

     6  

Notes to the Consolidated Financial Statements

     7  

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

     18  

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     30  

Item 4. Controls and Procedures

     31  

PART II. OTHER INFORMATION

  

Item 1. Legal Proceedings

     32  

Item 1A. Risk Factors

     32  

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     32  

Item 3. Defaults Upon Senior Securities

     32  

Item 4. Mine Safety Disclosures

     32  

Item 5. Other Information

     32  

Item 6. Exhibits

     33  

Signatures

     34  

 

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Table of Contents
Item 1. FINANCIAL STATEMENTS

ORASURE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except per share amounts)

 

     June 30, 2017     December 31, 2016  

ASSETS

    

CURRENT ASSETS:

    

Cash and cash equivalents

   $ 104,872     $ 107,959  

Restricted cash

     1,831       1,831  

Short-term investments

     55,354       11,160  

Accounts receivable, net of allowance for doubtful accounts of $637 and $484

     26,731       19,827  

Inventories

     14,548       11,799  

Prepaid expenses

     1,336       1,722  

Other current assets

     1,027       2,143  
  

 

 

   

 

 

 

Total current assets

     205,699       156,441  

PROPERTY AND EQUIPMENT, net

     20,291       20,033  

INTANGIBLE ASSETS, net

     9,343       10,337  

GOODWILL

     19,482       18,793  

OTHER ASSETS

     3,536       2,331  
  

 

 

   

 

 

 
   $ 258,351     $ 207,935  
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

CURRENT LIABILITIES:

    

Accounts payable

   $ 9,623     $ 4,633  

Deferred revenue

     1,477       1,388  

Accrued expenses

     12,092       11,314  
  

 

 

   

 

 

 

Total current liabilities

     23,192       17,335  
  

 

 

   

 

 

 

OTHER LIABILITIES

     3,538       2,304  
  

 

 

   

 

 

 

DEFERRED INCOME TAXES

     2,209       2,446  
  

 

 

   

 

 

 

COMMITMENTS AND CONTINGENCIES (Note 7)

    

STOCKHOLDERS’ EQUITY

    

Preferred stock, par value $.000001, 25,000 shares authorized, none issued

     —         —    

Common stock, par value $.000001, 120,000 shares authorized, 59,330 and 56,001 shares issued and outstanding

     —         —    

Additional paid-in capital

     373,964       350,528  

Accumulated other comprehensive loss

     (11,963     (14,220

Accumulated deficit

     (132,589     (150,458
  

 

 

   

 

 

 

Total stockholders’ equity

     229,412       185,850  
  

 

 

   

 

 

 
   $ 258,351     $ 207,935  
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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Table of Contents

ORASURE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(in thousands, except per share amounts)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2017      2016     2017     2016  

NET REVENUES:

         

Product

   $ 39,132      $ 27,582     $ 70,614     $ 52,827  

Other

     1,044        3,777       2,108       7,621  
  

 

 

    

 

 

   

 

 

   

 

 

 
     40,176        31,359       72,722       60,448  

COST OF PRODUCTS SOLD

     14,699        10,274       26,935       19,050  
  

 

 

    

 

 

   

 

 

   

 

 

 

Gross profit

     25,477        21,085       45,787       41,398  
  

 

 

    

 

 

   

 

 

   

 

 

 

OPERATING EXPENSES:

         

Research and development

     3,338        2,985       6,308       5,351  

Sales and marketing

     7,502        7,397       14,379       16,103  

General and administrative

     7,750        6,354       14,842       12,896  

Gain on litigation settlement

     —          —         (12,500     —    
  

 

 

    

 

 

   

 

 

   

 

 

 
     18,590        16,736       23,029       34,350  
  

 

 

    

 

 

   

 

 

   

 

 

 

Operating income

     6,887        4,349       22,758       7,048  

OTHER INCOME (EXPENSE)

     96        (340     563       (532
  

 

 

    

 

 

   

 

 

   

 

 

 

Income before income taxes

     6,983        4,009       23,321       6,516  

INCOME TAX EXPENSE

     1,555        173       5,452       234  
  

 

 

    

 

 

   

 

 

   

 

 

 

NET INCOME

   $ 5,428      $ 3,836     $ 17,869     $ 6,282  
  

 

 

    

 

 

   

 

 

   

 

 

 

EARNINGS PER SHARE:

         

BASIC

   $ 0.09      $ 0.07     $ 0.31     $ 0.11  
  

 

 

    

 

 

   

 

 

   

 

 

 

DILUTED

   $ 0.09      $ 0.07     $ 0.30     $ 0.11  
  

 

 

    

 

 

   

 

 

   

 

 

 

SHARES USED IN COMPUTING EARNINGS PER SHARE:

         

BASIC

     58,478        55,543       57,708       55,497  
  

 

 

    

 

 

   

 

 

   

 

 

 

DILUTED

     60,728        56,208       59,755       56,144  
  

 

 

    

 

 

   

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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Table of Contents

ORASURE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(in thousands)

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2017     2016      2017     2016  

NET INCOME

   $ 5,428     $ 3,836      $ 17,869     $ 6,282  

OTHER COMPREHENSIVE INCOME (LOSS)

         

Currency translation adjustments

     1,862       363        2,312       3,230  

Unrealized loss on marketable securities

     (55     —          (55     —    
  

 

 

   

 

 

    

 

 

   

 

 

 

COMPREHENSIVE INCOME

   $ 7,235     $ 4,199      $ 20,126     $ 9,512  
  

 

 

   

 

 

    

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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Table of Contents

ORASURE TECHNOLOGIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

     Six Months Ended June 30,  
     2017     2016  

OPERATING ACTIVITIES:

    

Net income

   $ 17,869     $ 6,282  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Stock-based compensation

     3,631       2,942  

Depreciation and amortization

     2,891       2,738  

Unrealized foreign currency loss

     178       115  

Deferred income taxes

     (322     (44

Changes in assets and liabilities

    

Accounts receivable

     (6,923     893  

Inventories

     (2,680     1,949  

Prepaid expenses and other assets

     1,525       17  

Accounts payable

     4,739       (782

Deferred revenue

     83       4,083  

Accrued expenses and other liabilities

     713       (1,452
  

 

 

   

 

 

 

Net cash provided by operating activities

     21,704       16,741  
  

 

 

   

 

 

 

INVESTING ACTIVITIES:

    

Purchases of short-term investments

     (62,233     (15,335

Proceeds from maturities and redemptions of short-term investments

     18,585       15,335  

Purchases of property and equipment

     (1,567     (2,729
  

 

 

   

 

 

 

Net cash used in investing activities

     (45,215     (2,729
  

 

 

   

 

 

 

FINANCING ACTIVITIES:

    

Proceeds from exercise of stock options

     21,014       209  

Repurchase of common stock

     (1,209     (3,311
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     19,805       (3,102
  

 

 

   

 

 

 

EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH

     619       697  

NET (DECREASE) INCREASE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH

     (3,087     11,607  

CASH, CASH EQUIVALENTS, AND RESTRICTED CASH, BEGINNING OF PERIOD

     109,790       94,094  
  

 

 

   

 

 

 

CASH, CASH EQUIVALENTS, AND RESTRICTED CASH, END OF PERIOD

   $ 106,703     $ 105,701  
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

    

Cash paid for income taxes

   $ 4,325     $ 556  
  

 

 

   

 

 

 

Noncash investing activities (accrued property and equipment purchases)

   $ 412     $ 287  
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

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Table of Contents

ORASURE TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to the Consolidated Financial Statements

(Unaudited)

(in thousands, except per share amounts, unless otherwise indicated)

1. The Company

We develop, manufacture, market and sell diagnostic products and specimen collection devices using our proprietary technologies, as well as other diagnostic products, including immunoassays and other in vitro diagnostic tests that are used on other specimen types. Our diagnostic products include tests that are performed on a rapid basis at the point-of-care, tests that are processed in a laboratory, a rapid point-of-care HIV in-home test approved for use in the domestic consumer retail or over-the-counter (“OTC”) market and a rapid point-of-care HIV self-test used in certain international markets. We also manufacture and sell devices used to collect, stabilize, transport and store samples of genetic material for molecular testing in the consumer genetic, clinical genetic, academic research, pharmacogenomic, personalized medicine, microbiome and animal genetic markets. Lastly, we manufacture and sell medical devices used for the removal of benign skin lesions by cryosurgery, or freezing. Our products are sold in the United States and internationally to various clinical laboratories, hospitals, clinics, community-based organizations, public health organizations, research and academic institutions, distributors, government agencies, physicians’ offices, commercial and industrial entities, retail pharmacies and mass merchandisers, and to consumers over the internet.

2. Summary of Significant Accounting Policies

Principles of Consolidation and Basis of Presentation. The consolidated financial statements include the accounts of OraSure Technologies, Inc. (“OraSure”) and its wholly-owned subsidiary, DNA Genotek, Inc. (“DNAG”). All intercompany transactions and balances have been eliminated. References herein to “we,” “us,” “our,” or the “Company” mean OraSure and its consolidated subsidiary, unless otherwise indicated.

The accompanying consolidated financial statements are unaudited and, in the opinion of management, include all adjustments (consisting only of normal and recurring adjustments) necessary for a fair presentation of our financial position and results of operations for these interim periods. These financial statements should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016. Results of operations for the three and six months ended June 30, 2017 are not necessarily indicative of the results of operations expected for the full year.

Use of Estimates. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions about future events. These estimates and underlying assumptions affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and reported amounts of revenues and expenses. Such estimates include the valuation of accounts receivable and inventories and assumptions utilized in impairment testing for intangible assets and goodwill, as well as calculations related to contingencies, accruals, and performance- based compensation expense, among others. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis, using historical experience and other factors, which management believes to be reasonable under the circumstances, including the current economic environment. We adjust such estimates and assumptions when facts and circumstances dictate. Illiquid credit markets, volatile equity and foreign currency markets, reductions in government funding, and declines in consumer spending have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in those estimates resulting from continuing changes in the economic environment and other factors will be reflected in the financial statements in those future periods.

Short-Term Investments. We consider all short-term investments to be available-for-sale securities. These securities are comprised of guaranteed investment certificates and corporate bonds with purchased maturities greater than ninety days. Available-for-sale securities are carried at fair value, based upon quoted market prices, with unrealized gains and losses, if any, reported in stockholders’ equity as a component of accumulated other comprehensive loss.

 

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Table of Contents

The following is a summary of our available-for-sale securities at June 30, 2017 and December 31, 2016:

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value  

June 30, 2017

           

Guaranteed investment certificates

   $ 19,281      $ —        $ —        $ 19,281  

Corporate bonds

     36,128        —          (55      36,073  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 55,409      $ —        $ (55    $ 55,354  
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2016

           

Guaranteed investment certificates

   $ 11,160      $ —        $ —        $ 11,160  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 11,160      $ —        $ —        $ 11,160  
  

 

 

    

 

 

    

 

 

    

 

 

 

At June 30, 2017 maturities of our available-for-sale securities were as follows:

           

Less than one year

   $ 55,409      $ —        $ (55    $ 55,354  
  

 

 

    

 

 

    

 

 

    

 

 

 

Fair Value of Financial Instruments. As of June 30, 2017 and December 31, 2016, the carrying values of cash and cash equivalents, restricted cash, accounts receivable, and accounts payable approximate their respective fair values based on their short-term nature.

Fair value measurements of all financial assets and liabilities that are being measured and reported on a fair value basis are required to be classified and disclosed in one of the following three categories:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2: Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability; and

Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

All of our available-for-sale securities are measured as Level 1 instruments as of June 30, 2017 and December 31, 2016.

Included in cash and cash equivalents at June 30, 2017 and December 31, 2016, was $60,987 and $83,704 invested in government money market funds. These funds hold investments in government securities and are measured as Level 1 instruments.

We offer a nonqualified deferred compensation plan for certain eligible employees and members of our Board of Directors. The assets of the plan are held in the name of the Company at a third-party financial institution. Separate accounts are maintained for each participant to reflect the amounts deferred by the participant and all earnings and losses on those deferred amounts. The assets of the plan are held in mutual funds and Company stock. The fair value of the plan assets as of June 30, 2017 and December 31, 2016 was $3,220 and $1,980, respectively, and was calculated using the quoted market prices of the assets as of those dates. All investments in the plan are classified as trading securities and measured as Level 1 instruments. The fair value of plan assets is included in other assets with the same amount included in other liabilities in the accompanying consolidated balance sheets.

In 2017, we purchased certificates of deposit (“CDs”) from a commercial bank. The CDs bear interest at rates ranging from 0.68% to 0.84% and mature monthly through February 28, 2018. The carrying values of the CDs approximate their fair value. These CDs serve as collateral for certain standby letters of credit and are reported as restricted cash on the accompanying consolidated balance sheets. Also see Note 7 – Commitments and Contingencies.

 

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Table of Contents

Inventories. Inventories are stated at the lower of cost and net realizable value determined on a first-in, first-out basis and are comprised of the following:

 

     June 30, 2017      December 31, 2016  

Raw materials

   $ 5,410      $ 5,399  

Work in process

     1,305        1,034  

Finished goods

     7,833        5,366  
  

 

 

    

 

 

 
   $ 14,548      $ 11,799  
  

 

 

    

 

 

 

Property and Equipment. Property and equipment are stated at cost. Additions or improvements are capitalized, while repairs and maintenance are charged to expense. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the related assets. Buildings are depreciated over twenty to forty years, while computer equipment, machinery and equipment, and furniture and fixtures are depreciated over two to ten years. Building improvements are amortized over their estimated useful lives. When assets are sold, retired, or discarded, the related property amounts are relieved from the accounts, and any gain or loss is recorded in the consolidated statements of income. Accumulated depreciation of property and equipment as of June 30, 2017 and December 31, 2016 was $37,709 and $36,067, respectively.

Intangible Assets. Intangible assets consist of a customer list, patents and product rights, acquired technology and tradenames. Patents and product rights consist of costs associated with the acquisition of patents, licenses, and product distribution rights. Intangible assets are amortized using the straight-line method over their estimated useful lives of seven to fifteen years. Accumulated amortization of intangible assets as of June 30, 2017 and December 31, 2016 was $16,928 and $15,197, respectively. The change in intangibles from $10,337 as of December 31, 2016 to $9,343 as of June 30, 2017 is a result of $1,295 in amortization expense and $301 in foreign currency translation gains.

Goodwill. Goodwill represents the excess of the purchase price we paid over the fair value of the net tangible and identifiable intangible assets acquired and liabilities assumed in our acquisition of DNAG in August 2011. Goodwill is not amortized but rather is tested annually for impairment or more frequently if we believe that indicators of impairment exist. Current U.S. generally accepted accounting principles permit us to make a qualitative evaluation about the likelihood of goodwill impairment. If we conclude that it is more likely than not that the carrying value of a reporting unit is greater than its fair value, then we would be required to recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, provided the impairment charge does not exceed the total amount of goodwill allocated to the reporting unit.

We performed our last annual impairment assessment as of July 31, 2016 utilizing a qualitative evaluation and concluded that it was more likely than not that the fair value of our DNAG reporting unit is greater than its carrying value. We believe we have made reasonable estimates and assumptions to calculate the fair value of our reporting unit. If actual future results are not consistent with management’s estimates and assumptions, we may have to take an impairment charge in the future related to our goodwill. Future impairment tests will continue to be performed annually in the fiscal third quarter, or sooner if a triggering event occurs. As of June 30, 2017, we believe no indicators of impairment exist.

The change in goodwill from $18,793 as of December 31, 2016 to $19,482 as of June 30, 2017 is a result of foreign currency translation gain.

Revenue Recognition. We recognize product revenues when there is persuasive evidence that an arrangement exists, the price is fixed or determinable, title has passed and collection is reasonably assured. Product revenues are recorded net of allowances for any discounts or rebates. Other than for sales of our OraQuick® In-Home HIV test to the retail trade, we do not grant price protection or product return rights to our customers except for warranty returns. Historically, returns arising from warranty issues have been infrequent and immaterial. Accordingly, we expense warranty returns as incurred.

 

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Table of Contents

Our net revenues recorded on sales of the OraQuick® In-Home HIV test represent total gross revenues, less an allowance for expected returns, and customer allowances for cooperative advertising, discounts, rebates, and chargebacks. The allowance for expected returns is an estimate established by management, based upon currently available information, and is adjusted to reflect known changes in the factors that impact this estimate. Other customer allowances are at contractual rates and are recorded as a reduction of gross revenue when recognized in our consolidated statements of income.

We record shipping and handling charges billed to our customers as product revenue and the related expense as cost of products sold. Taxes assessed by governmental authorities, such as sales or value-added taxes, are excluded from product revenues.

In June 2014, we entered into a Master Program Services and Co-Promotion Agreement with AbbVie Bahamas Ltd., a wholly-owned subsidiary of AbbVie Inc. (“AbbVie”), to co-promote our OraQuick® HCV test in the United States. On June 30, 2016, we mutually agreed to terminate our agreement with AbbVie effective December 31, 2016. Following the termination of the agreement, AbbVie was relieved of its co-promotion obligations, including its obligation to detail the OraQuick® HCV Rapid Test into physician offices, and has no further financial obligations to us. We are no longer obligated to compensate AbbVie for product detailing activities and are free to pursue arrangements with other pharmaceutical companies to market and promote our OraQuick® HCV Rapid Antibody Test in the U.S. Accordingly, during the second quarter and first six months of 2017 we did not record any revenue from this co-promotion agreement. During the second quarter and first six months of 2016, $3,360 and $6,722, respectively, of exclusivity revenue was recognized and recorded as other revenue in our consolidated statements of income.

On June 12, 2015, we were awarded a grant for up to $10,400 in total funding from the U.S. Department of Health and Human Services (“HHS”) Office of the Assistant Secretary for Preparedness and Response’s Biomedical Advanced Research and Development Authority (“BARDA”) related to our OraQuick® Ebola Rapid Antigen test. The three-year, multi-phased grant includes an initial commitment of $1,800 and options for up to an additional $8,600 to fund certain clinical and regulatory activities. In September 2015, BARDA exercised an option to provide $7,200 in additional funding for our OraQuick® Ebola Rapid Antigen test. Amounts related to this grant are recorded as other revenue in our consolidated statements of income as the activities are being performed and the related costs are incurred. During the second quarter and first six months of 2017, $454 and $874, respectively, was recognized in connection with this grant. During the second quarter and first six months of 2016, $417 and $899 respectively, was recognized in connection with this grant.

In August 2016, we were awarded a contract for up to $16,600 in total funding from BARDA related to our rapid Zika test. The six-year, multi-phased contract includes an initial commitment of $7,000 and options for up to an additional $9,600 to fund the evaluation of additional product enhancements, and clinical and regulatory activities. In May 2017, BARDA exercised an option to provide $2,600 in additional funding for our rapid Zika test. Funding received under this contract is recorded as other revenue in our consolidated statements of income as the activities are being performed and the related costs are incurred. During the second quarter and first six months of 2017, $590 and $1,234, respectively, was recognized in connection with this grant.

Customer Sales Returns and Allowances. We do not grant return rights to our customers for any product, except for our OraQuick® In-Home HIV test. Accordingly, we have recorded an estimate of expected returns as a reduction of gross OraQuick® In-Home HIV product revenues in our consolidated statements of income. This estimate reflects our historical sales experience to retailers and consumers, as well as other retail factors, and is reviewed regularly to ensure that it reflects potential product returns. As of June 30, 2017 and December 31, 2016, the reserve for sales returns and allowances was $183 and $217, respectively. If actual product returns differ materially from our reserve amount, or if a determination is made that this product’s distribution would be discontinued in whole or in part by certain retailers, then we would need to adjust our reserve. Should the actual level of product returns vary significantly from our estimates, our operating and financial results could be materially affected.

 

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Deferred Revenue. We record deferred revenue when funds are received prior to the recognition of the associated revenue. Deferred revenue as of June 30, 2017 and December 31, 2016 was comprised of customer prepayments of $1,477 and $1,388, respectively.

Customer and Vendor Concentrations. One of our customers accounted for 17% and 15% of our accounts receivable as of June 30, 2017 and December 31, 2016, respectively. Another customer accounted for 16% of our accounts receivable as of June 30, 2017. One of our customers accounted for approximately 20% and 15% of our net consolidated revenues for the three and six months ended June 30, 2017, respectively. Another customer accounted for 10% of our net consolidated revenues for the three months ended June 30, 2017. For the three and six months ended June 30, 2016, one of our customers accounted for approximately 11% of our net consolidated revenues, respectively.

We currently purchase certain products and critical components of our products from sole-supply vendors. If these vendors are unable or unwilling to supply the required components and products, we could be subject to increased costs and substantial delays in the delivery of our products to our customers. Also, our subsidiary, DNAG, uses two third-party suppliers to manufacture its products. Our inability to have a timely supply of any of these components and products could have a material adverse effect on our business, as well as our financial condition and results of operations.

Earnings Per Share. Basic earnings per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed in a manner similar to basic earnings per share except that the weighted average number of shares outstanding is increased to include shares from the assumed vesting or exercise of dilutive securities, such as common stock options, unvested restricted stock or performance stock units, unless the impact is antidilutive. The number of incremental shares is calculated by assuming that outstanding stock options were exercised and unvested restricted shares and performance stock units were vested, and the proceeds from such exercises or vesting were used to acquire shares of common stock at the average market price during the reporting period.

The computations of basic and diluted earnings per share are as follows:

 

     Three Months
Ended June 30,
     Six Months
Ended June 30,
 
     2017      2016      2017      2016  

Net income

   $ 5,428      $ 3,836      $ 17,869      $ 6,282  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares of common stock outstanding:

           

Basic

     58,478        55,543        57,708        55,497  

Dilutive effect of stock options, restricted stock, and performance units

     2,250        665        2,047        647  
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted

     60,728        56,208        59,755        56,144  
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per share:

           

Basic

   $ 0.09      $ 0.07      $ 0.31      $ 0.11  
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted

   $ 0.09      $ 0.07      $ 0.30      $ 0.11  
  

 

 

    

 

 

    

 

 

    

 

 

 

For the three-month periods ended June 30, 2017 and 2016, outstanding common stock options, unvested restricted stock, and unvested performance units representing 40 and 2,459 shares, respectively, were excluded from the computation of diluted earnings per share as their inclusion would have been anti-dilutive. For the six months ended June 30, 2017 and 2016, outstanding common stock options, unvested restricted stock and unvested performance units representing 353 and 3,191 shares, respectively, were similarly excluded from the computation of diluted earnings per share.

 

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Foreign Currency Translation. The assets and liabilities of our foreign operations are translated into U.S. dollars at current exchange rates as of the balance sheet date, and revenues and expenses are translated at average exchange rates for the period. Resulting translation adjustments are reflected in accumulated other comprehensive loss, which is a separate component of stockholders’ equity.

Transaction gains and losses resulting from exchange rate changes on transactions denominated in currencies other than functional currency are included in our consolidated statements of income in the period in which the change occurs. Net foreign exchange losses resulting from foreign currency transactions that are included in other income (expense) in our consolidated statements of income were $418 and $302 for the three months ended June 30, 2017 and 2016, respectively. Net foreign exchange losses were $618 and $648 for the six months ended June 30, 2017 and 2016, respectively.

Accumulated Other Comprehensive Income (Loss). We classify items of other comprehensive income (loss) by their nature and disclose the accumulated balance of other comprehensive income (loss) separately from accumulated deficit and additional paid-in capital in the stockholders’ equity section of our consolidated balance sheet.

We have defined the Canadian dollar as the functional currency of our Canadian subsidiary, DNAG, and as such, the results of its operations are translated into U.S. dollars, which is the reporting currency of the Company. The $2,312 and $3,230 currency translation adjustments recorded in the first six months of 2017 and 2016, respectively, are largely the result of the translation of our Canadian operation’s balance sheets into U.S. dollars. Other comprehensive income at June 30, 2017 also includes net unrealized losses on marketable securities of $55.

Recent Accounting Pronouncements. In May 2014, the Financial Accounting Standards Board (“FASB”) issued converged guidance on recognizing revenue in contracts with customers, ASU 2014-09, Revenue from Contracts with Customers. The intent of the new standard is to improve financial reporting and comparability of revenue globally. The core principle of the standard is for a company to recognize revenue in a manner that depicts the transfer of goods or services to customers in an amount that reflects the consideration which the company expects to receive in exchange for those goods or services. The standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2017, at which point we plan to adopt the standard.

The FASB allows two adoption methods under ASU 2014-09. We plan to adopt the standard using the “modified retrospective method.” Under that method, we will apply the rules to all contracts existing as of January 1, 2018, recognizing in beginning retained earnings an adjustment for the cumulative effective of the change and providing additional disclosures comparing results to previous accounting standards.

Upon initial evaluation, we believe the key changes in the standard that impact our revenue recognition relate to the allocation of the transaction price to performance obligations related to our device and lab services for drug testing. This revenue stream amounts to less than 1% of total consolidated revenues. We will continue to evaluate the impact that the adoption of ASU 2014-09 will have on our consolidated financial statements and related disclosures, but do not anticipate the adoption will have a material impact on our financial results.

In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory, which requires an entity that uses the first-in, first-out method for inventory measurement to report inventory cost at the lower of cost and net realizable value versus the current measurement principle of lower of cost or market. The ASU requires prospective adoption for inventory measurements for fiscal years beginning after December 15, 2016. We adopted ASU 2015-11 on January 1, 2017. The adoption of this standard did not have a material impact on our consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU 2016-02, Leases, which requires entities to begin recording assets and liabilities from leases on the balance sheet. The new guidance will also require significant additional disclosures about the amount, timing and uncertainty of cash flows from leases. The standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2018, using a modified retrospective approach. Early adoption is permitted. We are evaluating the effect that ASU 2016-02 may have on our consolidated financial statements and related disclosures.

 

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In March 2016, the FASB issued authoritative guidance under ASU 2016-09, Compensation-Stock Compensation (Topic 718) Improvements to Employee Share-Based Payment Accounting. ASU 2016-09 provides for simplification of several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. We adopted ASU 2016-09 on January 1, 2017. Since we have a full valuation allowance against our U.S. net deferred tax assets, the adoption of this standard for recognition of tax effects of deductions for employee share awards in excess of compensation costs (“windfall”) did not have a material impact on our consolidated financial statements and related disclosures. See Note 6 – Income Taxes, for additional information. Should our full valuation allowance be reversed in future periods, the adoption of this new guidance will introduce more volatility in the calculation of our effective tax rate, depending on the Company’s share price at exercise or vesting of share-based awards as compared to grant date. The other provisions of ASU 2016-09 did not have a material impact on our consolidated financial statements and related disclosures.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which provides guidance related to cash flows presentation and is effective for annual reporting periods beginning after December 15, 2017, subject to early adoption. The majority of the guidance in ASU 2016-15 is consistent with our current cash flow classifications and we do not expect the adoption of this standard will have a material impact on our consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which requires an entity to no longer perform a hypothetical purchase price allocation to measure goodwill impairment. Instead, impairment will be measured using the difference between the carrying amount and the fair value of the reporting unit. This update will be effective for annual and interim periods in fiscal years beginning after December 15, 2019. Early adoption is permitted. We adopted ASU 2017-04 in the second quarter of 2017. The adoption of this standard did not have a material impact on our consolidated financial statements and related disclosures.

3. Accrued Expenses

 

     June 30, 2017      December 31, 2016  

Payroll and related benefits

   $ 6,877      $ 7,685  

Income taxes payable (receivable)

     1,463        (39

Professional fees

     804        982  

Royalties

     761        715  

Other

     2,187        1,971  
  

 

 

    

 

 

 
   $ 12,092      $ 11,314  
  

 

 

    

 

 

 

4. Credit Facility

On September 30, 2016, we entered into a credit agreement (the “Credit Agreement”) with a commercial bank. The Credit Agreement provides for revolving extensions of credit in an initial aggregate amount of up to $10,000 (inclusive of a letter of credit subfacility of $2,500), with an option to request, prior to the second anniversary of the closing date, that the lender, at its election, provide up to $5,000 of additional revolving commitments. Obligations under the Credit Agreement are secured by a first priority security interest in certain eligible accounts receivable, 65% of the equity of our subsidiary, DNAG, and certain related assets. There were no borrowings outstanding under the Credit Agreement at June 30, 2017 and December 31, 2016.

Borrowings under the Credit Agreement are subject to compliance with borrowing base limitations tied to eligibility of accounts receivable. Interest under the Credit Agreement is payable at the London Interbank Offered Rate for one, two, three or six-month loans, as selected by the Company, plus 2.50% per year. The Credit Agreement is subject to an unused line fee of 0.375% per year on the unused portion of the commitment under the Credit Agreement during the revolving period. The maturity date of the Credit Agreement is September 30, 2019.

 

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In connection with the Credit Agreement, under certain circumstances, we must comply with a minimum fixed charge coverage ratio of 1.10 to 1.00, measured as of the last day of each fiscal month and for the twelve-fiscal month period ending on such date. As of June 30, 2017 and December 31, 2016, we were in compliance with all applicable covenants in the Credit Agreement.

5. Stockholders’ Equity

Stock-Based Awards

We grant stock-based awards under the OraSure Technologies, Inc. Stock Award Plan, as amended (the “Stock Plan”). The Stock Plan permits stock-based awards to employees, outside directors and consultants or other third-party advisors. Awards which may be granted under the Stock Plan include qualified incentive stock options, nonqualified stock options, stock appreciation rights, restricted awards, performance awards and other stock-based awards. We recognize compensation expense for stock option and restricted stock awards issued to employees and directors on a straight-line basis over the requisite service period of the award. We recognize compensation expense related to performance-based restricted stock units based on assumptions as to what percentage of each performance target will be achieved. We evaluate these target assumptions on a quarterly basis and adjust compensation expense related to these awards, as appropriate. To satisfy the exercise of options or to issue restricted stock, or redeem performance-based restricted stock units, we issue new shares rather than purchase shares on the open market.

Total compensation cost related to stock options for the six months ended June 30, 2017 and 2016 was $1,007 and $1,387, respectively. Net cash proceeds from the exercise of stock options were $21,014 and $209 for the six months ended June 30, 2017 and 2016, respectively. As a result of the Company’s net operating loss carryforward position, no actual income tax benefit was recognized in the consolidated statements of income from stock option exercises during these periods.

Compensation cost of $1,355 and $1,401 related to restricted shares was recognized during the six months ended June 30, 2017 and 2016, respectively. In connection with the vesting of restricted shares and options during the six months ended June 30, 2017 and 2016, we purchased and immediately retired 120 and 117 shares with aggregate values of $1,209 and $651, respectively, in satisfaction of minimum tax withholding obligations.

Commencing in 2016, we granted to certain executives performance-based restricted stock units (“PSUs”). Vesting of these PSUs is dependent upon achievement of performance-based metrics during a one-year or three-year period, from the date of grant. Assuming achievement of each performance-based metric, the executive must also remain in our service for three years from the grant date. Performance during the one-year period will be based on a one-year earnings per share target. If the one-year target is achieved, the PSUs will then vest three years from grant date. Performance during the three-year period will be based on achievement of a three-year compound annual growth rate for consolidated product revenues. If the three-year target is achieved, the corresponding PSUs will then vest three years from grant date. PSUs are converted into shares of our common stock once vested. Upon grant of the PSUs, we recognize compensation expense related to these awards based on assumptions as to what percentage of each target will be achieved. The Company evaluates these assumptions on a quarterly basis and adjusts compensation expense related to these awards, as appropriate. Compensation cost of $1,269 and $154 related to PSUs was recognized during the six months ended June 30, 2017 and 2016, respectively.

Stock Repurchase Program

On August 5, 2008, our Board of Directors approved a share repurchase program pursuant to which we are permitted to acquire up to $25,000 of our outstanding common shares. No shares were purchased and retired during the six months ended June 30, 2017. During the six months ended June 30, 2016, we purchased and retired 423 shares of common stock at an average price of $6.29 per share for a total cost of $2,660 under this share purchase agreement.

6. Income Taxes

During the three and six months ended June 30, 2017, we recorded tax expense of $1,555 and $5,452, respectively. During the three and six months ended June 30, 2016, we recorded tax expense of $173 and $234, respectively.

 

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Tax expense reflects taxes due to state and Canadian taxing authorities and the tax effects of temporary differences between the basis of assets and liabilities recognized for financial reporting and tax purposes, and net operating loss and tax credit carryforwards. The significant components of our total deferred tax liability as of June 30, 2017 relate to the tax effects of the basis difference between the intangible assets acquired in the DNAG acquisition for financial reporting and tax purposes. Tax expense in the first six months of 2017 reflects the additional Canadian taxes due as a result of the $12,500 gain from the settlement of our patent infringement and breach of contract litigation against Ancestry.com DNA LLC and its contract manufacturer.

In 2008, we established a full valuation allowance against our U.S. deferred tax asset. Management believes the full valuation allowance is still appropriate as of both June 30, 2017 and December 31, 2016 since the facts and circumstances necessitating the allowance have not changed. As a result, no U.S. federal or state deferred income tax expense or benefit was recorded for the three and six-month periods ended June 30, 2017 and 2016.

The new accounting guidance under ASU 2016-09 allows for the recognition of excess tax benefits regardless of whether the deduction reduces taxes payable. On January 1, 2017, we recorded a cumulative-effect adjustment to retained earnings of $3,391 to recognize the increase in our net operating loss carryforwards from the cumulative excess tax benefits not recognized in periods prior to January 1, 2017. A corresponding $3,391 increase to our valuation allowance associated with this tax benefit was also recorded to retained earnings thereby resulting in a net impact to retained earnings of $0.

7. Commitments and Contingencies

Standby Letters of Credit

In 2016, we established four standby letters of credit in the aggregate amount of $1,831, naming international customers as the beneficiaries. These letters of credit were required as a performance guarantee of our obligations under our product supply contracts with those customers and are collateralized by certificates of deposit maintained at a commercial bank.

Litigation

From time to time, we are involved in certain legal actions arising in the ordinary course of business. In management’s opinion, the outcomes of such actions, either individually or in the aggregate, are not expected to have a material adverse effect on our future financial position or results of operations.

8. Business Segment Information

We operate our business within two reportable segments: our “OSUR” business, which consists of the development, manufacture and sale of diagnostic products, specimen collection devices and medical devices; and our molecular collection systems or “DNAG” business, which primarily consists of the manufacture, development and sale of oral fluid collection devices that are used to collect, stabilize and store samples of genetic material for molecular testing. OSUR revenues are derived primarily from products sold in the United States and internationally to various clinical laboratories, hospitals, clinics, community-based organizations, public health organizations, distributors, government agencies, physicians’ offices, commercial and industrial entities, retail pharmacies and mass merchandisers, and to consumers over the internet. OSUR also derives other revenues, including exclusivity payments for co-promotion rights and other licensing and product development activities. DNAG revenues result primarily from products sold into the commercial market which consists of customers engaged in consumer genetics, clinical genetic testing, pharmacogenomics, personalized medicine, microbiome, and animal genetic testing. DNAG products are also sold into the academic research market, which consists of research laboratories, universities and hospitals.

We organized our operating segments according to the nature of the products included in those segments. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (see Note 2). We evaluate performance of our operating segments based on revenue and operating income.

 

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We do not allocate interest income, interest expense, other income, other expenses or income taxes to our operating segments. Reportable segments have no inter-segment revenues and inter-segment expenses have been eliminated.

The following table summarizes operating segment information for the three and six months ended June 30, 2017 and 2016, and asset information as of June 30, 2017 and December 31, 2016:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2017      2016      2017      2016  

Net revenues:

           

OSUR

   $ 24,119      $ 22,926      $ 45,958      $ 45,125  

DNAG

     16,057        8,433        26,764        15,323  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 40,176      $ 31,359      $ 72,722      $ 60,448  
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating income:

           

OSUR

   $ 438      $ 2,919      $ 218      $ 4,526  

DNAG

     6,449        1,430        22,540        2,522  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 6,887      $ 4,349      $ 22,758      $ 7,048  
  

 

 

    

 

 

    

 

 

    

 

 

 

Depreciation and amortization:

           

OSUR

   $ 678      $ 661      $ 1,334      $ 1,315  

DNAG

     793        727        1,557        1,423  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,471      $ 1,388      $ 2,891      $ 2,738  
  

 

 

    

 

 

    

 

 

    

 

 

 

Capital expenditures:

           

OSUR

   $ 553      $ 661      $ 1,337      $ 1,123  

DNAG

     136        460        230        1,606  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 689      $ 1,121      $ 1,567      $ 2,729  
  

 

 

    

 

 

    

 

 

    

 

 

 
     June 30, 2017      December 31, 2016                

Total assets:

           

OSUR

   $ 178,693      $ 151,719        

DNAG

     79,658        56,216        
  

 

 

    

 

 

       

Total

   $ 258,351      $ 207,935        
  

 

 

    

 

 

       

Our products are sold principally in the United States and Europe.

The following table represents total net revenues by geographic area, based on the location of the customer:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2017      2016      2017      2016  

United States

   $ 28,954      $ 24,021      $ 49,808      $ 46,191  

Europe

     2,436        2,957        5,561        6,836  

Other regions

     8,786        4,381        17,353        7,421  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 40,176      $ 31,359      $ 72,722      $ 60,448  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The following table represents total long-lived assets by geographic area:

 

     June 30, 2017      December 31, 2016  

United States

   $ 15,966      $ 15,737  

Canada

     4,317        4,286  

Other regions

     8        10  
  

 

 

    

 

 

 
   $ 20,291      $ 20,033  
  

 

 

    

 

 

 

 

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Statements below regarding future events or performance are “forward-looking statements” within the meaning of the Federal securities laws. These may include statements about our expected revenues, earnings/loss per share, net income (loss), expenses, cash flow or other financial performance or developments, clinical trial or development activities, expected regulatory filings and approvals, planned business transactions, views of future industry, competitive or market conditions, and other factors that could affect our future operations, results of operations or financial position. These statements often include the words “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates,” “may,” “will,” “should,” “could,” or similar expressions. Forward-looking statements are not guarantees of future performance or results. Known and unknown factors that could cause actual performance or results to be materially different from those expressed or implied in these statements include, but are not limited to: ability to market and sell products, whether through our internal, direct sales force or third parties; ability to manufacture products in accordance with applicable specifications, performance standards and quality requirements; ability to obtain, and timing and cost of obtaining, necessary regulatory approvals for new products or new indications or applications for existing products; ability to comply with applicable regulatory requirements; ability to effectively resolve warning letters, audit observations and other findings or comments from the U.S. Food and Drug Administration (“FDA”) or other regulators; changes in relationships, including disputes or disagreements, with strategic partners or other parties and reliance on strategic partners for the performance of critical activities under collaborative arrangements; ability to meet increased demand for our products; impact of increased reliance on U.S. government contracts; failure of distributors or other customers to meet purchase forecasts, historic purchase levels or minimum purchase requirements for our products; impact of replacing distributors; inventory levels at distributors and other customers; ability of the Company to achieve its financial and strategic objectives and continue to increase its revenues, including the ability to expand international sales; ability to identify, complete, integrate and realize the full benefits of future acquisitions; impact of competitors, competing products and technology changes; impact of negative economic conditions, high unemployment levels and poor credit conditions; reduction or deferral of public funding available to customers; competition from new or better technology or lower cost products; ability to develop, commercialize and market new products; market acceptance of oral fluid testing or other products; changes in market acceptance of products based on product performance or other factors, including changes in testing guidelines, algorithms or other recommendations by the Centers for Disease Control and Prevention (“CDC”) or other agencies; ability to fund research and development and other products and operations; ability to obtain and maintain new or existing product distribution channels; reliance on sole supply sources for critical products and components; availability of related products produced by third parties or products required for use of our products; history of losses and ability to achieve sustained profitability; ability to utilize net operating loss carry forwards or other deferred tax assets; volatility of the Company’s stock price; uncertainty relating to patent protection and potential patent infringement claims; uncertainty and costs of litigation relating to patents and other intellectual property; availability of licenses to patents or other technology; ability to enter into international manufacturing agreements; obstacles to international marketing and manufacturing of products; ability to sell products internationally, including the impact of changes in international funding sources and testing algorithms; adverse movements in foreign currency exchange rates; loss or impairment of sources of capital; ability to meet financial covenants in credit agreements; ability to attract and retain qualified personnel; exposure to product liability and other types of litigation; changes in international, federal or state laws and regulations; customer consolidations and inventory practices; equipment failures and ability to obtain needed raw materials and components; the impact of terrorist attacks and civil unrest; and general political, business and economic conditions. These and other factors are discussed more fully in our Securities and Exchange Commission (“SEC”) filings, including our registration statements, Annual Report on Form 10-K for the year ended December 31, 2016, Quarterly Reports on Form 10-Q, and other filings with the SEC. Although forward-looking statements help to provide information about future prospects, readers should keep in mind that forward-looking statements may not be reliable. The forward-looking statements are made as of the date of this Report, and we undertake no duty to update these statements.

Investors should also be aware that while we do, from time to time, communicate with securities analysts, it is against our policy to disclose any material non-public information or other confidential commercial information. Accordingly, stockholders should not assume that we agree with any statement or report issued by any analyst irrespective of the content of the statement or report. Furthermore, we have a policy against issuing or confirming financial forecasts or projections issued by others. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not the responsibility of OraSure.

 

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The following discussion should be read in conjunction with our consolidated financial statements contained herein and the notes thereto, along with the Section entitled “Critical Accounting Policies and Estimates,” set forth below.

Overview

We develop, manufacture, market and sell diagnostic products and specimen collection devices using our proprietary technologies, as well as other diagnostic products, including immunoassays and other in vitro diagnostic tests that are used on other specimen types. Our diagnostic products include tests that are performed on a rapid basis at the point-of-care, tests that are processed in a laboratory, a rapid point-of-care HIV test approved for use in the domestic consumer retail or over-the-counter (“OTC”) market and a rapid point-of-care HIV self-test used in certain international markets. We also manufacture and sell collection devices used to collect, stabilize, transport and store samples of genetic material for molecular testing in the consumer genetic, clinical genetic, academic research, pharmacogenomic, personalized medicine, microbiome and animal genetic markets. Lastly, we manufacture and sell medical devices used for the removal of benign skin lesions by cryosurgery, or freezing. Our products are sold in the United States and internationally to various clinical laboratories, hospitals, clinics, community-based organizations, public health organizations, research and academic institutions, distributors, government agencies, physicians’ offices, commercial and industrial entities, retail pharmacies and mass merchandisers, and to consumers over the internet.

Recent Developments

Gates Foundation

In June 2017, we entered into a charitable support agreement with the Bill & Melinda Gates Foundation (“Gates Foundation”) that will enable us to offer our OraQuick® HIV self-test at an affordable price in 50 developing countries in Africa and Asia with funding from the Gates Foundation. The funding will consist of support payments tied to the volume of product we sell and reimbursement of certain related costs. The agreement has a four-year term and will enable non-governmental organizations in the eligible countries that receive funding from government or public sector agencies and donors to access our HIV self-test at reduced pricing. The funding from the Gates Foundation will be in an aggregate amount not to exceed $20.0 million over the four-year term or $6.0 million each year of the agreement.

WHO Prequalification

In July 2017, our OraQuick® HIV self-test was prequalified by the World Health Organization (“WHO”). WHO prequalification aims to ensure that diagnostic tests for high burden diseases meet global standards of quality, safety, and efficacy, in order to optimize use of health resources and improve health outcomes. WHO prequalification enables governmental organizations implementing HIV self-test pilots and programs to access international funding to purchase our test.

Self-Testing Project in Africa

In July 2017, our OraQuick® HIV self-test was selected by UNITAID and Population Services International (“PSI”) for use in Phase II of the HIV Self-Testing in Africa (“STAR”) project. Phase II of the project will begin in the fourth quarter of 2017 and continue over a two-year period. Approximately 4 million HIV self-tests are expected to be deployed in Phase II. We believe that we will supply the vast majority of these tests. The OraQuick® HIV self-test has been used in Phase I of the STAR Project, which represented the largest evaluation of HIV self-testing to date. Under Phase I of the project, 750,000 OraQuick® HIV self-tests will have been distributed when this phase is completed.

 

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Current Consolidated Financial Results

During the six months ended June 30, 2017, our consolidated net revenues were $72.7 million, compared to $60.4 million for the six months ended June 30, 2016. Net product revenues during the six months ended June 30, 2017 increased 34% when compared to the first half of 2016, primarily due to higher sales of our molecular and OraQuick® HCV products and higher international sales of our OraQuick® HIV self-test, partially offset by lower domestic sales of our professional OraQuick® HIV product and lower sales of our cryosurgical products. Other revenues for the first six months of 2017 were $2.1 million compared to $7.6 million in the same period of 2016. Other revenues in the first six months of 2017 represent revenue recognized in connection with funding received from the U.S. Department of Health and Human Services Office of the Assistant Secretary for Preparedness and Response’s Biomedical Advanced Research and Development Authority (“BARDA”) for our Ebola and Zika products. Other revenues in the first six months of 2016 included $899,000 of BARDA funding and $6.7 million of exclusivity revenues recognized under our HCV co-promotion agreement with AbbVie, which terminated effective December 31, 2016.

Our consolidated net income for the six months ended June 30, 2017 was $17.9 million, or $0.30 per share on a fully-diluted basis, compared to consolidated net income of $6.3 million, or $0.11 per share on a fully-diluted basis, for the six months ended June 30, 2016. Results for the current six month period include a pre-tax gain of $12.5 million associated with the settlement of our litigation against Ancestry.com DNA LLC and its contract manufacturer in the first quarter of 2017.

Cash provided by operating activities for the six months ended June 30, 2017 was $21.7 million and included the $12.5 million litigation settlement noted above. Cash provided by operating activities during the six months ended June 30, 2016 was $16.7 million. As of June 30, 2017, we had $162.1 million in cash (including restricted cash), cash equivalents, and short-term investments, compared to $120.9 million at December 31, 2016.

Business Segments

We operate our business within two reportable segments: our “OSUR” business, which consists of the development, manufacture and sale of diagnostic products, specimen collection devices, and medical devices, and our “DNAG” or molecular collection systems business, which consists primarily of the development, manufacture and sale of oral fluid collection devices that are used to collect, stabilize, transport, and store samples of genetic material for molecular testing. OSUR revenues are derived primarily from products sold into the United States and internationally to various clinical laboratories, hospitals, clinics, community-based organizations, public health organizations, distributors, government agencies, physicians’ offices, commercial and industrial entities, retail pharmacies, mass merchandisers and consumers over the internet. DNAG revenues result primarily from products sold into the commercial market, which consists of customers engaged in consumer genetics, clinical genetic testing, pharmacogenomics, personalized medicine, microbiome and animal genetic testing, as well as products sold into the academic research market which consists of research laboratories, universities and hospitals.

 

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Results of Operations

Three months ended June 30, 2017 compared to June 30, 2016

CONSOLIDATED NET REVENUES

The table below shows a breakdown of total consolidated net revenues (dollars in thousands) generated by each of our business segments for the three months ended June 30, 2017 and 2016.

 

     Three Months Ended June 30,  
     Dollars      %     Percentage of Total
Net Revenues
 
     2017      2016      Change     2017     2016  

OSUR

   $ 23,075      $ 19,149        21     57     61

DNAG

     16,057        8,433        90       40       27  
  

 

 

    

 

 

      

 

 

   

 

 

 

Net product revenues

     39,132        27,582        42       97       88  

Other

     1,044        3,777        (72     3       12  
  

 

 

    

 

 

      

 

 

   

 

 

 

Net revenues

   $ 40,176      $ 31,359        28     100     100
  

 

 

    

 

 

      

 

 

   

 

 

 

Consolidated net product revenues increased 42% to $39.1 million in the second quarter of 2017 from $27.6 million in the comparable period of 2016. Higher sales of our molecular and OraQuick® HCV products were partially offset by lower domestic sales of our professional OraQuick® HIV product. In the second quarter of 2017, we recognized $1.0 million in other revenues in connection with funding from BARDA related to our Ebola and Zika products. Other revenues in the second quarter of 2016 were $3.8 million and included $3.4 million in exclusivity payments received under our HCV co-promotion agreement with AbbVie and $417,000 in BARDA funding. Our co-promotion agreement with AbbVie was terminated effective as of December 31, 2016 and no further revenues under this agreement will be recognized.

Consolidated net revenues derived from products sold to customers outside of the United States were $11.2 million and $7.3 million, or 28% and 23% of total net revenues, in the second quarters of 2017 and 2016, respectively. Because the majority of our international sales are denominated in U.S. dollars, the impact of fluctuating foreign currency exchange rates was not material to our total consolidated net revenues.

Net Revenues by Segment

OSUR Segment

The table below shows a breakdown of total net revenues (dollars in thousands) generated by our OSUR segment.

 

     Three Months Ended June 30,  
     Dollars      %     Percentage of Total
Net Revenues
 

Market

   2017      2016      Change     2017     2016  

Infectious disease testing

   $ 16,663      $ 12,949        29     70     57

Risk assessment testing

     3,238        3,159        3       13       14  

Cryosurgical

     3,174        3,041        4       13       13  
  

 

 

    

 

 

      

 

 

   

 

 

 

Net product revenues

     23,075        19,149        21       96       84  

Other

     1,044        3,777        (72     4       16  
  

 

 

    

 

 

      

 

 

   

 

 

 

Net revenues

   $ 24,119      $ 22,926        5     100     100
  

 

 

    

 

 

      

 

 

   

 

 

 

Infectious Disease Testing Market

Sales to the infectious disease testing market increased 29% to $16.7 million in the second quarter of 2017 from $12.9 million in the second quarter of 2016. This increase resulted from higher sales of our OraQuick® HCV product, partially offset by a decline in domestic sales of our professional OraQuick® HIV product.

 

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The table below shows a breakdown of our total net OraQuick® HIV and HCV product revenues (dollars in thousands) during the second quarters of 2017 and 2016.

 

     Three Months Ended June 30,  

Market

   2017      2016      % Change  

Domestic HIV

   $ 4,965      $ 5,886        (16 )% 

International HIV

     2,025        1,969        3  

Domestic OTC HIV

     1,894        1,739        9  
  

 

 

    

 

 

    

Net HIV revenues

     8,884        9,594        (7
  

 

 

    

 

 

    

Domestic HCV

     2,382        1,788        33  

International HCV

     5,261        1,428        268  
  

 

 

    

 

 

    

Net HCV revenues

     7,643        3,216        138  
  

 

 

    

 

 

    

Net OraQuick® HIV and HCV product revenues

   $ 16,527      $ 12,810        29
  

 

 

    

 

 

    

Domestic OraQuick® HIV sales decreased 16% to $5.0 million for the three months ended June 30, 2017 from $5.9 million for the three months ended June 30, 2016. This decrease was primarily the result of customer ordering patterns and continued price and product competition. We anticipate that future domestic sales of our professional HIV product will continue to be negatively affected as a result of the Centers for Disease Control and Prevention (“CDC”) testing guidelines recommending the use of competing fourth generation automated HIV immunoassays performed in a laboratory, changes in government funding and continued product and price competition. International sales of our OraQuick® HIV test during the second quarter of 2017 remained relatively consistent at $2.0 million compared to $1.9 million in the second quarter of 2016.

Sales of our OraQuick® In-Home HIV test during the second quarter of 2017 increased 9% to $1.9 million from $1.7 million in the second quarter of 2016 as a result of additional shelf placement in certain retail pharmacies and increased sales to public health customers.

Domestic OraQuick® HCV sales increased 33% to $2.4 million in the second quarter of 2017 from $1.8 million in the second quarter of 2016 primarily due to customer ordering patterns and an increase in the average size of customer orders. International OraQuick® HCV sales increased 268% to $5.3 million in the second quarter of 2017 from $1.4 million in the second quarter of 2016, largely due to continued product shipments to a foreign government to support a nationwide HCV testing and treatment program.

Risk Assessment Market

Sales to the risk assessment market remained relatively consistent at $3.2 million in the second quarter of 2017 compared to $3.1 million in the second quarter of 2016.

Cryosurgical Market

Sales of our cryosurgical products (which includes sales in both the physicians’ office and OTC markets) increased 4% to $3.2 million in the second quarter of 2017 from $3.0 million in the second quarter of 2016.

 

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The table below shows a breakdown of our total net cryosurgical revenues (dollars in thousands) generated in each market during the second quarters of 2017 and 2016.

 

     Three Months Ended June 30,  

Market

   2017      2016      % Change  

Domestic professional

   $ 1,445      $ 1,145        26

International professional

     243        211        15  

Domestic OTC

     347        345        1  

International OTC

     1,139        1,340        (15
  

 

 

    

 

 

    

Net cryosurgical revenues

   $ 3,174      $ 3,041        4
  

 

 

    

 

 

    

Sales of our Histofreezer® product to physicians’ offices in the United States increased 26% to $1.4 million in the second quarter of 2017 from $1.1 million in the second quarter of 2016, primarily due to the continued recovery of business previously lost to competition. International sales of Histofreezer® increased to $243,000 in the second quarter of 2017 from $211,000 in the same period of the prior year largely due to higher sales into Asia.

Sales of our private-label wart removal product in the U.S. retail market remained consistent at $347,000 in the second quarter of 2017 compared to $345,000 in the second quarter of 2016.

Sales of our international OTC cryosurgical products during the second quarter of 2017 decreased 15% to $1.1 million compared to $1.3 million in the second quarter of 2016, largely due to lower sales into Europe.

Other revenues

Other revenues in the second quarter of 2017 decreased 72% to $1.0 million from $3.8 million in the second quarter of 2016. Other revenues in the second quarter of 2016 included $3.4 million of AbbVie exclusivity revenues. There are no similar revenues in the second quarter of 2017 due to the termination of our HCV co-promotion agreement with AbbVie on December 31, 2016. Revenue from BARDA funding increased to $1.0 million in the second quarter of 2017 compared to $417,000 in the second quarter of 2016, largely due to the inclusion of funding related to our rapid Zika test.

DNAG Segment

Molecular Market

Net molecular revenues increased 90% to $16.1 million in the second quarter of 2017 from $8.4 million in the second quarter of 2016. Sales of our Oragene® product in the commercial market rose 122% in the second quarter of 2017 compared to the second quarter of 2016, largely as a result of higher customer demand, primarily in the consumer genetics market. Sales of our Oragene® product in the academic market increased 2% in the second quarter of 2017 compared to the second quarter of 2016 largely due to customer ordering patterns. The higher revenues in the second quarter of 2017 also included $843,000 in sales of our microbiome product compared to $218,000 in the same period of 2016. We believe interest in our microbiome product offering continues to grow with both new and existing customers.

CONSOLIDATED OPERATING RESULTS

Consolidated gross margin was 63% for the second quarter of 2017 compared to 67% for the second quarter of 2016. Gross margin in the second quarter of 2017 was negatively impacted by the absence of exclusivity revenues under our HCV co-promotion agreement with AbbVie.

Consolidated operating income for the second quarter of 2017 was $6.9 million, a $2.5 million improvement from $4.3 million of operating income reported in the second quarter of 2016. The operating income for the second quarter of 2017 benefited from higher product revenues in the current period as compared to last year, partially offset by an increase in staffing costs Company-wide.

 

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OPERATING INCOME BY SEGMENT

OSUR Segment

OSUR’s gross margin was 62% in the second quarter of 2017 compared to 67% in the second quarter of 2016. OSUR’s gross margin in the second quarter of 2017 was negatively impacted by the absence of exclusivity revenues under our HCV co-promotion agreement with AbbVie ($3.4 million was recorded in the second quarter of 2016 and none in 2017), partially offset by the benefit of increased product revenues in the quarter.

Research and development expenses increased 12% to $2.6 million in the second quarter of 2017 from $2.3 million in the second quarter of 2016, largely due to higher supply costs associated with the development of our Ebola and Zika products. Sales and marketing expenses increased 4% to $5.2 million in the second quarter of 2017 from $5.0 million in the second quarter of 2016 largely due to increased external commissions to be paid to our international distributors and increased staffing costs. General and administrative expenses increased 34% to $6.8 million in the second quarter of 2017 from $5.1 million in the second quarter of 2016 due to higher staffing costs which includes an increase in accrued bonuses as a result of Company performance.

All of the above contributed to OSUR’s second quarter 2017 operating income of $438,000, which included non-cash charges of $678,000 for depreciation and amortization and $1.9 million for stock-based compensation.

DNAG Segment

DNAG’s gross margin was 65% in the second quarter of 2017 compared to 68% in the second quarter of 2016. This decline was attributable to an increase in lower margin product sales in the second quarter of 2017 compared to the second quarter of 2016.

Research and development expenses increased 13% to $722,000 in the second quarter of 2017 from $639,000 in the second quarter of 2016, largely due to higher staffing costs. Sales and marketing expenses decreased 3% to $2.3 million in the second quarter of 2017 from $2.4 million in the second quarter of 2016 due to a reduction in our allowance for uncollectible accounts partially offset by higher staffing costs. General and administrative expenses decreased 25% to $949,000 in the second quarter of 2017 compared to $1.3 million in the second quarter of 2016 primarily due to lower legal costs partially offset by increased staffing expenses.

All of the above contributed to DNAG’s second quarter 2017 operating income of $6.4 million, which included non-cash charges of $793,000 for depreciation and amortization and $164,000 for stock-based compensation.

CONSOLIDATED INCOME TAXES

We continue to believe the full valuation allowance established in 2008 against OSUR’s total U.S. deferred tax asset is appropriate as the facts and circumstances necessitating the allowance have not changed. For the three months ended June 30, 2017, no state income tax expense was recorded as compared to $50,000 in the three months ended June 30, 2016. Canadian income tax expense of $1.6 million and $123,000 was recorded in the second quarters of 2017 and 2016, respectively.

 

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Six months ended June 30, 2017 compared to June 30, 2016

CONSOLIDATED NET REVENUES

The table below shows a breakdown of total consolidated net revenues (dollars in thousands) generated by each of our business segments for the six months ended June 30, 2017 and 2016.

 

     Six Months Ended June 30,  
     Dollars      %
Change
    Percentage of Total
Net Revenues
 
     2017      2016        2017     2016  

OSUR

   $ 43,850      $ 37,504        17     60     62

DNAG

     26,764        15,323        75       37       25  
  

 

 

    

 

 

      

 

 

   

 

 

 

Net product revenues

     70,614        52,827        34       97       87  

Other

     2,108        7,621        (72     3       13  
  

 

 

    

 

 

      

 

 

   

 

 

 

Net revenues

   $ 72,722      $ 60,448        20     100     100
  

 

 

    

 

 

      

 

 

   

 

 

 

Consolidated net product revenues increased 34% to $70.6 million in the first half of 2017 from $52.8 million in the comparable period of 2016. Higher sales of our molecular and OraQuick® HCV products and higher international sales of our OraQuick® HIV self-test were partially offset by lower domestic sales of our professional OraQuick® HIV product and lower sales of our cryosurgical products. In the first half of 2017, we recognized $2.1 million as other revenues in connection with funding from BARDA related to our Ebola and Zika products. Other revenues in the first half of 2016 were $7.6 million and included $6.7 million in exclusivity payments received under our HCV co-promotion agreement with AbbVie and $899,000 in BARDA funding. Our co-promotion agreement with AbbVie was terminated effective as of December 31, 2016 and no further revenues under this agreement will be recognized.

Consolidated net revenues derived from products sold to customers outside of the United States were $22.9 million and $14.3 million, or 32% and 24% of total net revenues, during the six months ended June 30, 2017 and 2016, respectively. Because the majority of our international sales are denominated in U.S. dollars, the impact of fluctuating foreign currency exchange rates was not material to our total consolidated net revenues.

Net Revenues by Segment

OSUR Segment

The table below shows a breakdown of total net revenues (dollars in thousands) generated by our OSUR segment.

 

     Six Months Ended June 30,  
     Dollars      %
Change
    Percentage of Total
Net Revenues
 

Market

   2017      2016        2017     2016  

Infectious disease testing

   $ 31,245      $ 24,317        28     67     54

Risk assessment testing

     6,368        6,265        2       14       14  

Cryosurgical systems

     6,237        6,922        (10     14       15  
  

 

 

    

 

 

      

 

 

   

 

 

 

Net product revenues

     43,850        37,504        17       95       83  

Other

     2,108        7,621        (72     5       17  
  

 

 

    

 

 

      

 

 

   

 

 

 

Net revenues

   $ 45,958      $ 45,125        2     100     100
  

 

 

    

 

 

      

 

 

   

 

 

 

 

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Infectious Disease Testing Market

Sales to the infectious disease testing market increased 28% to $31.2 million in the first half of 2017 from $24.3 million in the first half of 2016. This increase resulted from higher sales of our OraQuick® HCV product and higher international sales of our OraQuick® HIV self-test partially offset by a decline in domestic sales of our professional OraQuick® HIV product.

The table below shows a breakdown of our total net OraQuick® HIV and HCV product revenues (dollars in thousands) during the six months ended June 30, 2017 and 2016.

 

     Six Months Ended June 30,  

Market

   2017      2016      %
Change
 

Domestic HIV

   $ 8,779      $ 11,588        (24 )% 

International HIV

     4,669        2,824        65  

Domestic OTC HIV

     3,436        3,262        5  
  

 

 

    

 

 

    

Net HIV revenues

     16,884        17,674        (4
  

 

 

    

 

 

    

Domestic HCV

     4,091        3,689        11  

International HCV

     9,664        2,430        298  
  

 

 

    

 

 

    

Net HCV revenues

     13,755        6,119        125  
  

 

 

    

 

 

    

Net OraQuick® revenues

   $ 30,639      $ 23,793        29
  

 

 

    

 

 

    

Domestic OraQuick® HIV sales decreased 24% to $8.8 million for the six months ended June 30, 2017 from $11.6 million for the six months ended June 30, 2016. This decrease was primarily the result of continued price and product competition and customer ordering patterns. We anticipate that future domestic sales of our professional HIV product will continue to be negatively affected as a result of the Centers for Disease Control and Prevention (“CDC”) testing guidelines recommending the use of competing fourth generation automated HIV immunoassays performed in a laboratory, changes in government funding and continued product and price competition. International sales of our OraQuick® HIV products during the first half of 2017 rose 65% to $4.7 million from $2.8 million in the first half of 2016. This increase was largely due to the continued shipment of product in support of a HIV self-testing program in Africa and higher sales into the Middle East.

Sales of our OraQuick® In-Home HIV test during the first half of 2017 of $3.4 million increased 5% compared to $3.3 million in the first half of 2016.

Domestic OraQuick® HCV sales increased 11% to $4.1 million in the first half of 2017 from $3.7 million in the first half of 2016 primarily due to customer ordering patterns and an increase in the average size of customer orders. International OraQuick® HCV sales increased 298% to $9.7 million in the first half of 2017 from $2.4 million in the first half of 2016, largely due to continued product shipments to a foreign government to support a nationwide HCV testing and treatment program and increased sales in Africa.

Risk Assessment Market

Sales to the risk assessment market remained relatively consistent at $6.4 million in the first half of 2017 compared to $6.3 million in the first half of 2016.

Cryosurgical Market

Sales of our cryosurgical products (which includes sales in both the physicians’ office and OTC markets) decreased 10% to $6.2 million in the first half of 2017 from $6.9 million in the first half of 2016.

 

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The table below shows a breakdown of our total net cryosurgical revenues (dollars in thousands) generated in each market during the six months ended June 30, 2017 and 2016.

 

     Six Months Ended June 30,  

Market

   2017      2016      %
Change
 

Domestic professional

   $ 2,941      $ 2,699        9

International professional

     373        446        (16

Domestic OTC

     632        723        (13

International OTC

     2,291        3,054        (25
  

 

 

    

 

 

    

Net cryosurgical systems revenues

   $ 6,237      $ 6,922        (10 )% 
  

 

 

    

 

 

    

Sales of our Histofreezer® product to physicians’ offices in the United States increased 9% to $2.9 million in the first half of 2017 from $2.7 million in the first half of 2016, primarily due to the continued recovery of business previously lost to competition partially offset by the impact of distributor ordering patterns. International sales of our Histofreezer® product decreased to $373,000 in the first half of 2017 from $446,000 in the same period of the prior year largely due to lower sales into Europe.

Sales of our private-label wart removal product in the U.S. retail market decreased to $632,000 in the first half of 2017 from $723,000 in the first half of 2016. Sales volume in the first half of 2016 was higher as a result of initial stocking orders for a new large pharmacy customer during that period.

Sales of our international OTC cryosurgical products during the first half of 2017 decreased 25% to $2.3 million compared to $3.1 million in the first half of 2016, largely due to lower sales into Europe and Latin America.

Other revenues

Other revenues in the first half of 2017 decreased 72% to $2.1 million from $7.6 million in the first half of 2016.

Other revenues in the first half of 2016 included AbbVie exclusivity revenues of $6.7 million. There are no similar revenues in 2017 due to the termination of our HCV co-promotion agreement with AbbVie on December 31, 2016. Revenues related to funding from BARDA increased to $2.1 million in the first half of 2017 compared to $899,000 in the first half of 2016.

DNAG Segment

Molecular Market

Net molecular revenues increased 75% to $26.8 million in the first half of 2017 from $15.3 million in the first half of 2016. Sales of our Oragene® product in the commercial market rose 121% in the first half of 2017 compared to the first half of 2016, largely as a result of higher customer demand, primarily in the consumer genetics market. Sales of our Oragene® product in the academic market decreased 11% in the first half of 2017 compared to the first half of 2016 largely due to ordering patterns of existing customers. The higher revenues in the first half of 2017 also included $1.6 million in sales of our microbiome product compared to $381,000 in the same period of 2016. We believe interest in our microbiome product offering continues to grow with both new and existing customers.

CONSOLIDATED OPERATING RESULTS

Consolidated gross margin was 63% for the first half of 2017 compared to 68% for the first half of 2016. Gross margin in the first half of 2017 was negatively impacted by the absence of exclusivity revenues under our HCV co-promotion agreement with AbbVie, an increase in lower margin product sales, and an increase in scrap and spoilage costs.

 

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Consolidated operating income for the first half of 2017 was $22.7 million, a $15.7 million improvement from $7.0 million of operating income reported in the first half of 2016. The operating income for the first half of 2017 benefited from the Ancestry litigation settlement gain, increased product revenues, and lower sales and marketing costs, partially offset by higher research and development and general and administrative expenses.

OPERATING INCOME BY SEGMENT

OSUR Segment

OSUR’s gross margin was 61% in the first half of 2017 compared to 68% in the first half of 2016. OSUR’s gross margin in the first half of 2017 was negatively impacted primarily by the absence of exclusivity revenues under our HCV co-promotion agreement with AbbVie ($6.7 million was recorded in the first half of 2016 and none was recorded in 2017).

Research and development expenses increased 22% to $5.0 million in the first half of 2017 from $4.1 million in the first half of 2016, largely due to higher supply costs associated with the development of our Ebola and Zika products and increased staffing expenses. Sales and marketing expenses decreased 14% to $9.8 million in the first half of 2017 from $11.4 million in the same period of 2016. This decrease was primarily the result of the termination of our OraQuick® HCV co-promotion agreement with AbbVie on December 31, 2016 and lower staffing costs. General and administrative expenses increased 24% to $13.1 million in the first half of 2017 from $10.5 million in the first half of 2016 due to increased staffing costs, which includes an increase in accrued bonuses as a result of Company performance.

All of the above contributed to OSUR’s operating income of $218,000 in the first half of 2017, which included non-cash charges of $1.3 million for depreciation and amortization and $3.4 million for stock-based compensation.

DNAG Segment

DNAG’s gross margin was 66% in the first half of 2017 compared to 70% in the first half of 2016. This decline was attributable to an increase in lower margin sales in the first half of 2017 compared to the first half of 2016.

Research and development expenses remained consistent at $1.3 million in both the first six months of 2017 and the first six months of 2016. Sales and marketing expenses decreased 2% to $4.5 million in the first half of 2017 from $4.6 million in the first half of 2016 due to a reduction in our allowance for uncollectible accounts partially offset by higher staffing costs. General and administrative expenses decreased 24% to $1.8 million in the first half of 2017 compared to $2.3 million in the first half of 2016 primarily due to lower legal costs partially offset by increased staffing expenses. Operating expenses in the first half of 2017 were offset by the $12.5 million pre-tax gain associated with the settlement of our litigation with Ancestry.com DNA, LLC and its contract manufacturer.

All of the above contributed to DNAG’s operating income of $22.5 million in the first half of 2017, which included non-cash charges of $1.6 million for depreciation and amortization and $260,000 for stock-based compensation.

CONSOLIDATED INCOME TAXES

We continue to believe the full valuation allowance established in 2008 against OSUR’s total U.S. deferred tax asset is appropriate as the facts and circumstances necessitating the allowance have not changed. For the six months ended June 30, 2017, state income tax expense of $31,000 was recorded compared to $50,000 in the six months ended June 30, 2016. Canadian income tax expense of $5.4 million and $184,000 was recorded in the first half of 2017 and 2016, respectively. Taxes in the first half of 2017 included the additional taxes due as a result of the $12.5 million Ancestry litigation settlement payment.

 

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Liquidity and Capital Resources

 

     June 30,
2017
     December 31,
2016
 
     (In thousands)  

Cash, cash equivalents and restricted cash

   $ 106,703      $ 109,790  

Short-term investments

     55,354        11,160  

Working capital

     182,507        139,106  

Our cash, cash equivalents, restricted cash and short-term investment balances increased to $162.1 million at June 30, 2017 from $120.9 million at December 31, 2016. Our working capital increased to $182.5 million at June 30, 2017 from $139.1 million at December 31, 2016.

During the first half of 2017, we generated $21.7 million in cash from operating activities. Our net income of $17.9 million benefitted from non-cash stock-based compensation expense of $3.6 million and depreciation and amortization expense of $2.9 million, partially offset by a net reduction of other non-cash charges of $144,000. Additional sources of cash included an increase in accounts payable of $4.7 million largely due to inventory purchases that were invoiced at the end of the quarter, and a decrease in prepaid and other assets of $1.5 million largely due to the receipt of $1.4 million as payment of a claim from one of our raw material suppliers. This settlement was recorded as a receivable at December 31, 2016. Uses of cash in operating activities during the period include an increase in accounts receivable of $6.9 million largely resulting from the increase in orders placed near the end of the current quarter, an increase in inventory balances of $2.7 million required to meet expected demand, and a decrease in accrued expenses and other liabilities of $713,000 associated with payment of our 2016 management incentive bonuses partially offset by an increase in our Canadian income taxes payable.

Net cash used in investing activities was $45.2 million for the six months ended June 30, 2017, which reflects $62.2 million used to purchase short-term investments and $1.6 million to acquire property and equipment partially offset by $18.6 million in proceeds from the maturities of short-term investments.

Net cash provided by financing activities was $19.8 million for the six months ended June 30, 2017, which resulted from $21.0 million in proceeds received from the exercise of stock options partially offset by $1.2 million used for the repurchase of common stock to satisfy withholding taxes related to the vesting of restricted shares.

On September 30, 2016, we entered into a credit agreement (the “Credit Agreement”) with a commercial bank. The Credit Agreement provides for revolving extensions of credit in an initial aggregate amount of up to $10.0 million (inclusive of a letter of credit subfacility of $2.5 million), with an option to request, prior to the second anniversary of the closing date, that lenders, at their election, provide up to $5.0 million of additional revolving commitments. Obligations under the Credit Agreement are secured by a first priority security interest in certain eligible accounts receivable, 65% of the equity of our subsidiary, DNAG, and certain related assets. There were no borrowings outstanding at June 30, 2017 or December 31, 2016.

Borrowings under the Credit Agreement are subject to compliance with borrowing base limitations tied to eligibility of accounts receivable. Interest under the Credit Agreement is payable at the London Interbank Offered Rate for one, two, three or six-month loans, as selected by the Company, plus 2.50% per annum. The Credit Agreement will be subject to an unused line fee of 0.375% per annum on the unused portion of the commitment under the Credit Agreement during the revolving period. The maturity date of the Credit Agreement is September 30, 2019.

In connection with the Credit Agreement, under certain circumstances, we must comply with a minimum fixed charge coverage ratio of 1.10 to 1.00, measured as of the last day of each fiscal month and for the twelve-fiscal month period ending on such date. As of June 30, 2017 and December 31, 2016, we were in compliance with all applicable covenants under the Credit Agreement.

 

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Our current cash and cash equivalents balance and available borrowing capacity are expected to be sufficient to fund our current operating and capital needs for the foreseeable future. Our cash requirements, however, may vary materially from those now planned due to many factors, including, but not limited to, the scope and timing of future strategic acquisitions, the progress of our research and development programs, the scope and results of clinical testing, the cost of any future litigation, the magnitude of capital expenditures, changes in existing and potential relationships with business partners, the timing and cost of obtaining regulatory approvals, the timing and cost of future stock purchases, the costs involved in obtaining and enforcing patents, proprietary rights and any necessary licenses, the cost and timing of expansion of sales and marketing activities, market acceptance of new products, competing technological and market developments, the impact of the current economic environment and other factors.

Summary of Contractual Obligations

A summary of our obligations to make future payments under contracts existing at December 31, 2016 is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended December 31, 2016. As of June 30, 2017, there were no significant changes to this information, including the absence of any off-balance sheet arrangements.

Critical Accounting Policies and Estimates

This Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate our judgments and estimates, including those related to the valuation of accounts receivable, inventories and intangible assets, as well as calculations related to contingencies and accruals. We base our judgments and estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

A more detailed review of our critical accounting policies is contained in our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the SEC. During the first six months of 2017, there were no material changes in our critical accounting policies.

 

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not hold any amounts of derivative financial instruments or derivative commodity instruments and, accordingly, we have no material derivative risk to report under this Item.

As of June 30, 2017, we did not have any foreign currency exchange contracts or purchase currency options to hedge local currency cash flows. Sales denominated in foreign currencies comprised 5.1% of our total revenues for the six months ended June 30, 2017. We do have foreign currency exchange risk related to our operating subsidiary in Canada. While the majority of this subsidiary’s revenues are recorded in U.S. dollars, almost all of this subsidiary’s operating expenses are denominated in Canadian dollars. Fluctuations in the exchange rate between the U.S. dollar and the Canadian dollar could affect year-to-year comparability of operating results and cash flows. Our Canadian subsidiary had net assets, subject to translation, of $83.4 million CDN ($64.3 million USD), which are included in the Company’s consolidated balance sheet as of June 30, 2017. A 10% unfavorable change in the Canadian-to-U.S. dollar exchange rate would have decreased our comprehensive income by $6.4 million in the six months ended June 30, 2017.

 

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Item 4. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of June 30, 2017. Based on that evaluation, the Company’s management, including such officers, concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2017 to provide reasonable assurance that material information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 was accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure and was recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.

(b) Changes in Internal Control Over Financial Reporting. There was no change in the Company’s internal control over financial reporting that occurred during the three months ended June 30, 2017 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1. LEGAL PROCEEDINGS

From time to time, we are involved in certain legal actions arising in the ordinary course of business. In management’s opinion, based upon the advice of counsel, the outcomes of such actions are not expected, individually or in the aggregate, to have a material adverse effect on our future financial position or results of operations.

 

Item 1A. RISK FACTORS

There have been no material changes to the factors disclosed in Item 1A., entitled “Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2016.

 

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Period

   Total number
of shares
purchased
    Average price
paid per
Share
     Total number of
shares purchased
as part of publicly
announced plans
or programs
     Maximum number (or
approximate dollar
value) of shares that
may yet be repurchased
under the plans or
programs (2, 3)
 

April 1, 2017 - April 30, 2017

     2,335  (1)    $ 12.39        N/A      $ 11,984,720  

May 1, 2017 - May 31, 2017

     21,753  (1)      15.13        N/A        11,984,720  

June 1, 2017 - June 30, 2017

     —         —          —          11,984,720  
  

 

 

      

 

 

    
     24,088          —       
  

 

 

      

 

 

    

 

(1)  Pursuant to the OraSure Technologies, Inc. Stock Award Plan, and in connection with the vesting of restricted shares, these shares were retired to satisfy minimum tax withholdings.
(2)  On August 5, 2008, our Board of Directors approved a share repurchase program pursuant to which we are permitted to acquire up to $25.0 million of outstanding shares. This share repurchase program may be discontinued at any time.
(3)  This column represents the amount that remains available under the $25.0 million repurchase plan, as of the period indicated. We have made no commitment to purchase any shares under this plan.

 

Item 3. DEFAULTS UPON SENIOR SECURITIES

None

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable

 

ITEM 5. OTHER INFORMATION

In light of the results of the advisory vote on the frequency of say-on-pay votes at our Annual Meeting of Stockholders held on May 16, 2017, our Board of Directors determined that the Company will continue to hold an advisory say-on-pay vote each year. The Board of Directors will re-evaluate this determination no later than the next stockholder vote on the frequency of say-on-pay votes.

 

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Item 6. EXHIBITS

Exhibits are listed on the Exhibit Index following the signature page of this Report.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    ORASURE TECHNOLOGIES, INC.
    /s/ Ronald H. Spair
Date: August 9, 2017     Ronald H. Spair
    Chief Operating Officer and
    Chief Financial Officer
    (Principal Financial Officer)
    /s/ Mark L. Kuna
Date: August 9, 2017     Mark L. Kuna
    Senior Vice President, Finance and Controller
    (Principal Accounting Officer)

 

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EXHIBIT INDEX

 

Exhibit

Number

  

Exhibit

  10.1    Employment Agreement, dated as of January 7, 2008, as amended, between DNA Genotek, Inc. and Brian Smith.*
  31.1    Certification of Douglas A. Michels required by Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended.
  31.2    Certification of Ronald H. Spair required by Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended.
  32.1    Certification of Douglas A. Michels required by Rule 13a-14(b) or Rule 15d-14(b) under the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2    Certification of Ronald H. Spair required by Rule 13a-14(b) or Rule 15d-14(b) under the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS    XBRL Instance Document
101.SCH    XBRL Taxonomy Extension Schema Document
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB    XBRL Taxonomy Extension Labels Linkbase Document
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document

 

* Management contract or compensatory plan or arrangement.

 

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