| ITEM 2. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
GENERAL
This Quarterly Report on Form 10−Q (the “Form 10−Q”) contains “forward-looking statements”, as defined in Section 21E of the Securities Exchange Act of 1934, as amended. These statements reflect the Company’s current expectations of the future results of its operations, performance and achievements. Forward-looking statements are covered under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company has tried, wherever possible, to identify these statements by using words such as “anticipates”, “believes”, “estimates”, “expects”, “plans”, “intends” and similar expressions. These statements reflect management’s current beliefs and are based on information now available to it. Accordingly, these statements are subject to certain risks, uncertainties and contingencies that could cause the Company’s actual results, performance or achievements in 2011 and beyond to differ materially from those expressed in, or implied by, such statements. Such statements, include, but are not limited to, statements contained in this Form 10-Q relating to our business, financial performance, business strategy, recently announced transactions and capital outlook. Important factors that could cause actual results to differ materially from those in the forward- looking statements include: a continued decline in general economic conditions nationally and internationally; decreased demand for our products and services; market acceptance of our products; the ability to protect our intellectual property rights; the impact of any litigation or infringement actions brought against us; competition from other providers and products; risks in product development; the inability to raise capital to fund continuing operations; changes in government regulation; the ability to complete customer transactions, and other factors relating to our industry, our operations and results of operations and any businesses that may be acquired by us. Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly from those anticipated, believed, estimated, expected, intended or planned. Additional risks, uncertainties, and other factors are set forth under Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K filed with the Commission on March 16, 2011 and in future reports the Company files with the Commission. Readers of this Form 10−Q should not place undue reliance on any forward-looking statements. Except as required by federal securities laws, the Company undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties.
You should read the following discussion and analysis of the financial condition and results of operations of ChromaDex together with the financial statements and the related notes presented in Item 1 of this Form 10-Q.
Overview
ChromaDex Corporation and its subsidiaries (collectively, “ChromaDex”, or the “Company”) supplies phytochemical reference standards and reference materials, related contract services, and proprietary ingredients and products for the dietary supplement, nutraceutical, food and beverage, functional food, pharmaceutical and cosmetic markets. ChromaDex has also developed and launched a line of new retail products containing proprietary ingredients. Our business strategy is to identify, acquire, reduce-to-practice, and commercialize innovative new natural products and “green chemistry” (environmentally safe) technologies, with an initial industry focus on the dietary supplement, cosmetic, food and beverage markets, as well as novel pharmaceuticals. We plan to utilize our experienced management team to commercialize these natural product technologies by advancing them through the proper regulatory approval processes, arranging for reliable and cost-effective manufacturing, and ultimately either selling or licensing the product lines and intellectual property to third parties.
The discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires making estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues, if any, and expenses during the reporting periods. On an ongoing basis, we evaluate such estimates and judgments, including those described in greater detail below. We base our estimates on historical experience and on various other factors that we believe are 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.
We believe that our current cash, cash equivalents and cash generated from operations, will be sufficient to meet our projected operating plans through March 2012. We may, however, seek additional capital prior to the end of March 2012 both to meet our projected operating plans after March 2012 and to fund our longer term strategic objectives. To the extent we are unable to raise additional cash or generate sufficient net income prior to March 2012 to meet our projected operating plans, we will revise our projected operating plans accordingly. Additional capital may come from public and private stock or debt offerings, borrowings under lines of credit or other sources. These additional funds may not be available on favorable terms, or at all. Furthermore, if we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution and the new equity or debt securities we issue may have rights, preferences and privileges senior to those of our existing stockholders. In addition, if we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish valuable rights to our products or proprietary technologies, or grant licenses on terms that are not favorable to us. If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our products, obtain the required regulatory clearances or approvals, achieve long term strategic objectives, take advantage of future opportunities, or respond to competitive pressures or unanticipated customer requirements. Any of these events could adversely affect our ability to achieve our development and commercialization goals, which could have a material and adverse effect on our business, results of operations and financial condition. If we are unable to establish small to medium scale production capabilities through our own plant or though a collaboration, we may be unable to fulfill our customers’ requirements. This may cause a loss of future revenue streams as well as require us to look for third-party vendors to provide these services. These vendors may not be available, or may charge fees that prevent us from pricing competitively within our markets.
The Company’s new product line, BluScience, has been launched at GNC corporate stores nationwide. In addition, the Company is seeking to launch BluScience at three national drug store chains, two price clubs, and an everyday low pricing retailer. The Company has received purchase orders for a first quarter, Company-wide roll out from one of these retailers.
In June 2010, the FDA began to regulate the dietary supplement market and to hold accountable all dietary supplement manufacturers under new Good Manufacturing Practices (“GMPs”). GMPs require quality testing to be done on dietary supplement products throughout the manufacturing process, rather than only on finished products. The FDA has begun enforcing the regulations by issuing warning letters to companies who are in violation of GMPs but it is unknown to what extent the FDA will enforce the regulations and how the regulations will be interpreted upon enforcement. The outcome of these uncertainties may have a material adverse effect on our results of operations because a lack of enforcement or an interpretation of the regulations that lessens the burden of compliance for the dietary supplement marketplace may cause a reduced demand for our products and services.
Results of Operations
We generated net sales of $6,304,789 for the nine month period ended October 1, 2011 as compared to $5,533,805 for the nine month period ended October 2, 2010. We incurred a net loss of $5,403,866 for the nine month period ended October 1, 2011 and incurred a net loss of $1,153,010 for the nine month period ended October 2, 2010. This equated to a $0.08 loss per basic and diluted share for the nine month period ended October 1, 2011 versus a $0.03 loss per basic and diluted share for the nine month period ended October 2, 2010. For the three month period ended October 1, 2011, we generated net sales of $1,827,568 and a net loss of $2,404,912 as compared to net sales of $1,562,352 and a net loss of $883,223 for the three month period ended October 2, 2010. This was a $0.03 loss per basic and diluted share for the three month period ended October 1, 2011, versus a $0.01 loss per basic and diluted share for the three month period ended October 2, 2010.
Over the next two years, we plan to continue to increase research and development efforts for our line of proprietary ingredients and to increase marketing and sales related expenses for these products. We also intend to continue to expand our service capacity through hiring and to implement accreditation and certification programs related to quality initiatives. In addition, we plan to expand our chemical library program and to either establish a GMP compliant pilot plant to support small to medium scale production of target compounds or partner through a collaboration with a company that has these capabilities.
Net Sales
Net sales consist of gross sales less returns and discounts. Net sales increased by 17% to $1,827,568 for the three month period ended October 1, 2011 as compared to $1,562,352 for the three month period ended October 2, 2010. This increase was due to increased demand for our existing products and services and the increased sales of our proprietary ingredients. For the nine month period ended October 1, 2011, net sales increased by 14% to $6,304,789 as compared to $5,533,805 for the nine month period ended October 2, 2010. This increase was primarily due to increased sales of our proprietary ingredients and other bulk dietary supplement grade raw materials.
Costs of Sales
Costs of sales include raw materials, labor, overhead, and delivery costs. Cost of sales for the three and nine month periods ended October 1, 2011 were $1,361,101 and $4,237,008 versus $1,059,626 and $3,437,417 for the three and nine month periods ended October 2, 2010, respectively. As a percentage of net sales, this represented a 7% increase for the three month period ended October 1, 2011 compared to the three month period ended October 2, 2010 and a 5% increase for the nine month period ended October 1, 2011 compared to the nine month period ended October 2, 2010. This percentage increase in cost of sales is largely due to an increase in certain contract services sales which require outsourcing to third party vendors. ChromaDex outsources certain contract services that it has chosen to not perform internally. For the three and nine month periods ended October 1, 2011, there were more contract services sales that the Company outsourced to third parties as compared to previous periods. This caused the Company to experience lower overall gross margins on contract services sales for these respective periods. In addition, sales of proprietary ingredients and other bulk dietary supplement grade raw materials increased for the three and nine month periods ended October 1, 2011. These proprietary ingredients and bulk dietary supplement grade raw materials have significantly higher raw material costs than other products. The Company expects to see a significant increase in the sales of these proprietary ingredients and bulk dietary supplement grade raw materials over the next twelve months. Increases in sales of these types of products will likely cause the Company to experience lower gross margins as a percentage of sales during this time period.
Gross Profit
Gross profit is net sales less the cost of sales and is affected by a number of factors including product mix, competitive pricing and costs of products and services. Our gross profit decreased 7% to $466,467 for the three month period ended October 1, 2011 from $502,726 for the three month period ended October 2, 2010, and slightly decreased to $2,067,781 for the nine month period ended October 1, 2011 from $2,096,388 for the nine month period ended October 2, 2010. For the three and nine month periods ended October 1, 2011, increase in direct costs of sales as a percentage of net sales was the primary cause for the decrease in gross profit.
Operating Expenses-Sales and Marketing
Sales and Marketing Expenses consist of salaries, commissions to employees and advertising and marketing expenses. Sales and marketing expenses for the three and nine month periods ended October 1, 2011 were $650,516 and $1,661,998 as compared to $235,582 and $688,552 for the three and nine month periods ended October 2, 2010. This increase was largely due to our increased sales and marketing efforts for our line of proprietary ingredients, including the launch of new retail products containing these proprietary ingredients.
Operating Expenses-General and Administrative
General and Administrative Expenses consist of research and development, general company administration, IT, accounting and executive management. General and administrative expenses for the three and nine month periods ended October 1, 2011 were $2,213,636 and $5,786,204 as compared to $1,140,815 and $2,535,386 for the three and nine month periods ended October 2, 2010. One of the factors that contributed to this increase was an increase in share-based compensation expenses. Our share-based compensation expense increased to $964,104 for the three month period ended October 1, 2011 from $423,764 for the three month period ended October 2, 2010 and increased to $2,469,827 for the nine month period ended October 1, 2011 from $706,221 for the nine month period ended October 2, 2010. This large increase in share-based compensation expense was largely due to the Company issuing restricted stock to certain employees and consultants and was also the result of the stock options that were granted following consummation of the 2010 Private Placement. The Company will continue to incur significant share-based compensation expenses over the next two years, as the expenses for the restricted stock and the post-closing grants are recognized on a straight-line method over the expected vesting periods. Another factor that contributed to the increase in general and administrative expenses was the increase in investor relations expense for the purpose of increasing market and shareholder awareness. In addition, the Company incurred certain legal, research, and development expenses related to our line of proprietary ingredients.
Non-operating income- Interest Income
Interest income consists of interest earned on money market accounts. Interest income for the three and nine month periods ended October 1, 2011 were $295 and $1,159 as compared to $578 and $1,095 for the three and nine month periods ended October 2, 2010.
Non-operating Expenses- Interest Expense
Interest expense consists of interest on capital leases. Interest expense for the three and nine month periods ended October 1, 2011 were $7,522 and $24,604 as compared to $10,130 and $26,555 for the three and nine month periods ended October 2, 2010.
Depreciation and Amortization
Depreciation expense for the nine month period ended October 1, 2011 was approximately $247,024 as compared to $232,786 for the nine month period ended October 2, 2010. We depreciate our assets on a straight-line basis, based on the estimated useful lives of the respective assets. Amortization expense of intangible assets for the nine month period ended October 1, 2011 was approximately $55,843 as compared to $55,053 for the nine month period ended October 2, 2010. We amortize intangible assets using a straight-line method over 10 years.
Liquidity and Capital Resources
From inception and through October 1, 2011, we have incurred aggregate losses of approximately $15.6 million. These losses are primarily due to overhead costs and general and administrative expenses associated with the development and expansion of our operations. These operations have been financed through capital contributions and the issuance of common stock and warrants through private placement transactions.
The Board of Directors periodically reviews our capital requirements in light of our proposed business plan. Our future capital requirements will remain dependent upon a variety of factors, including cash flow from operations, the ability to increase sales, increasing our gross profits from current levels, reducing sales and administration expenses as a percentage of net sales, continued development of customer relationships, and our ability to market our new products successfully. However, based on our results from operations, we may determine that we need additional financing to implement our business plan, and there can be no assurance that it will be available on terms favorable to us or at all. If adequate financing is not available, we may have to delay, postpone or terminate product and service expansion and curtail general and administrative operations in order to maintain sufficient operating capital. The inability to raise additional financing may have a material adverse effect on us. While we believe that our current levels of capital will be sufficient to meet our projected operating plans through March 2012, we may seek additional capital prior to March 2012 both to meet our projected operating plans after March 2012 and to fund our longer term strategic objectives. To the extent we are unable to raise additional cash or generate net income to meet our projected operating plans prior to March 2012, we will revise our projected operating plans accordingly.
As of October 1, 2011, the Company had 8,553,564 warrants outstanding with an exercise price of $0.21 per share. Assuming the full exercise of the outstanding warrants for cash, we would receive additional proceeds of $1,796,248. There is no guarantee that the holders of these warrants will exercise any of the outstanding warrants for cash, and we will not receive any proceeds from any of the outstanding warrants until they are exercised for cash.
Net cash used in operating activities
Net cash used in operating activities for the nine months ended October 1, 2011 was $2,497,791 as compared to $1,814,741 for the nine months ended October 2, 2010. An increase in inventories and prepaid expenses for our new ingredients and retail product lines were the largest uses of cash during the nine month period ended October 1, 2011, while the payment of unpaid compensation from prior years to two officers was the largest use of cash during the nine month period ended October 2, 2010.
We expect our operating cash flows to fluctuate significantly in future periods as a result of fluctuations in our operating results, shipment timetables, accounts receivable collections, inventory management, and the timing of our payments, among other factors.
Net cash used in investing activities
Net cash used in investing activities was $152,369 for the nine months ended October 1, 2011, compared to $154,759 for the nine months ended October 2, 2010. The decrease in cash used in investing activities mainly reflects the timing of purchases of leasehold improvements and equipment as well as purchases of intangible assets.
Net cash provided by financing activities
Net cash provided by financing activities was $2,493,009 for the nine months ended October 1, 2011, compared to $4,483,754 for the nine months ended October 2, 2010. Net cash provided by financing activities for the nine months ended October 1, 2011 mainly consisted of proceeds from the exercise of warrants related to the 2010 Private Placement. Net cash provided by financing activities for the nine months ended October 2, 2010 mainly consisted of proceeds from both the issuance of common stock and the exercise of warrants related to the 2010 Private Placement.
Dividend policy
We have not declared or paid any dividends on our common stock. We presently intend to retain earnings for use in our operations and to finance our business. Any change in our dividend policy is within the discretion of our Board of Directors and will depend, among other things, on our earnings, debt service and capital requirements, restrictions in financing agreements, if any, business conditions, legal restrictions and other factors that our Board of Directors deems relevant.
Off-Balance Sheet Arrangements
During the nine months ended October 1, 2011, we had no off-balance sheet arrangements other than ordinary operating leases as disclosed in the “Financial Statements and Supplementary Data” section of the Company’s Annual Report on Form 10-K filed with the Commission on March 16, 2011.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated by the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934). Based on the Company’s evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of October 1, 2011.
Changes in Internal Controls
There was no change in internal controls over financial reporting (as defined in Rule 13a−15(f) promulgated under the Securities Exchange Act of 1934) that occurred during the Company’s third fiscal quarter that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On July 13, 2011, the Company awarded 40,000 shares of restricted stock at a purchase price of $0.14 per share to a certain consultant as compensation for services to the Company. These restricted shares will fully vest on July 13, 2012, provided that no termination event as defined in the related consulting agreement has occurred on or prior to such date and certain performance conditions have been met. These shares of restricted stock were issued to accredited investors only and sold by the Company in reliance upon the exemption from securities registration afforded by Section 4(2) of the Securities Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. [REMOVED AND RESERVED]
ITEM 5. OTHER INFORMATION
None.
| Exhibit No. | Description of Exhibits |
| | | |
| 10.1 | | Patent License Agreement, dated July 12, 2011 between Cornell University and the Company.* |
| 10.2 | | Patent License Agreement, dated September 8, 2011 between The Regents of the University of California and the Company.* |
| 31.1 | | Certification of the Chief Executive Officer pursuant to §240.13a−14 or §240.15d−14 of the Securities Exchange Act of 1934, as amended |
| 31.2 | | Certification of the Chief Financial Officer pursuant to §240.13a−14 or §240.15d−14 of the Securities Exchange Act of 1934, as amended |
| 32.1 | | Certification pursuant to 18 U.S.C. Section 1350 (as adopted pursuant to Section 906 of the Sarbanes−Oxley Act of 2002) |
| 101 | | The following financial information from the Company’s Quarterly Report on Form 10-Q for the quarter ended October 1, 2011, filed with the Securities and Exchange Commission on November 10, 2011, formatted in Extensible Business Reporting Language (XBRL): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Cash Flows, (iv) the Condensed Consolidated Statements of Stockholders’ Equity, (v) the Notes to Condensed Consolidated Financial Statements. |
| * | This Exhibit has been separately filed with the Commission pursuant to an application for confidential treatment. The confidential portions of this Exhibit have been omitted and are marked by an asterisk. |
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.
| | ChromaDex Corporation (Registrant) | |
| | | | |
| Date: November 10, 2011 | By: | /s/ THOMAS C. VARVARO | |
| | | Thomas C. Varvaro | |
| | | Duly Authorized Officer and Chief Financial Officer | |
| | | | |
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