diff --git a/raw/filings/0001092662/2008/0001092662-09-000024/filing.txt b/raw/filings/0001092662/2008/0001092662-09-000024/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..b5f8e71fcfad77ec9bd871415b4391196a54acf3 --- /dev/null +++ b/raw/filings/0001092662/2008/0001092662-09-000024/filing.txt @@ -0,0 +1,7131 @@ +10-K +1 +form10_k.htm +FORM 10-K FOR 2008 +form10_k.htm +UNITED +STATES +Securities +and Exchange Commission +Washington, +D.C. 20549 +FORM +10-K +[X] +ANNUAL +REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF +1934 +For +the fiscal year ended December 31, +2008 +or +[ ] +TRANSITION +REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF +1934 +For the transition period +from to . +Commission File No. +0-30379 +CHEMBIO DIAGNOSTICS, +INC. +(Exact +name of registrant as specified in its charter) +Nevada +88-0425691 +(State +or other jurisdiction of incorporation or organization) +(I.R.S. +Employer Identification No.) +3661 +Horseblock Road, Medford, NY +11763 +(Address +of principal executive offices) +(Zip +Code) +Registrant’s +telephone number, including area code (631) +924-1135 +Securities registered pursuant to +Section 12(b) of the Act: +Title +of each class +Name +of each exchange on which registered +None +None +Securities +registered pursuant to section 12(g) of the Act: +Common +Stock, $0.01 par value +(Title +of Class) +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in +Rule 405 of the Securities Act. Yes __ No X +Indicate +by check mark if the registrant is not required to file reports pursuant to +Section 13 or Section 15(d) of the Act. Yes __ No X +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 X No__ +Indicate +by check mark if disclosure of delinquent filers pursuant to Item 405 of +Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not +be contained, to the best of registrant’s knowledge, in definitive proxy or +information statements incorporated by reference in Part III of this Form 10-K +or any amendment to this Form 10-K. [ ] +Indicate +by check mark whether the registrant is a large accelerated filer, an +accelerated filer, a non-accelerated filer, or a smaller reporting +company. See the definitions of “large accelerated filer,” +“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the +Exchange Act. +Large +accelerated filer [ +] +Accelerated filer [ +] +Non-accelerated +filer [ +] +Smaller reporting company [X] +(Do +not check if a smaller reporting company) +Indicate +by check mark whether the Registrant is a shell company (as defined in Rule +12b-2 of the Exchange Act). Yes __ No _X_ +As of the +last business day of the Company’s most recently completed second fiscal +quarter, the aggregate market value of voting and non-voting common equity held +by non-affiliates* was $5,970,000. +As of +March 17, 2009, the registrant had 61,944,901 common shares +outstanding. +* Without +asserting that any of the issuer’s directors or executive officers, or the +entities that own 38,252,448 shares +of common stock are affiliates, the shares of which they are beneficial owners +have been deemed to be owned by affiliates solely for this +calculation. +TABLE OF +CONTENTS +Page +PART +I +ITEM +1. +BUSINESS +3 +ITEM +1A. +RISK +FACTORS +14 +ITEM +2. +PROPERTIES +19 +ITEM +3. +LEGAL +PROCEEDINGS +19 +PART +II +ITEM +5. +MARKET +FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER +PURCHASES OF EQUITY SECURITIES +20 +ITEM +6. +SELECTED +FINANCIAL DATA +21 +ITEM +7. +MANAGEMENT’S +DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF +OPERATIONS +23 +ITEM +8. +FINANCIAL +STATEMENTS AND SUPPLEMENTARY DATA +32 +ITEM +9. +CHANGES +IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL +DISCLOSURE. +32 +ITEM +9A. +CONTROLS +AND PROCEDURES +32 +ITEM +9B. +OTHER +INFORMATION +33 +PART +III +ITEM +10. +DIRECTORS, +EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +34 +ITEM +11. +EXECUTIVE +COMPENSATION +36 +ITEM +12. +SECURITY +OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED +STOCKHOLDER MATTERS +40 +ITEM +13. +CERTAIN +RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR +INDEPENDENCE +42 +ITEM +14. +PRINCIPAL +ACCOUNTANT FEES AND SERVICES +44 +PART +IV +ITEM +15. +EXHIBITS, +FINANCIAL STATEMENT SCHEDULES +45 +SIGNATURES +47 +PART +I +ITEM +1. +BUSINESS +FORWARD-LOOKING +STATEMENTS +This report contains forward-looking +statements within the meaning of Section 21E of the Securities Exchange Act of +1934, and Section 27A of the Securities Act of 1933. Any statements contained in +this report that are not statements of historical fact may be forward-looking +statements. When we use the words “ intends,” “estimates,” “predicts,” +“potential,” “continues,” “ anticipates,” “plans,” “expects,” +“believes,” “should,” “could,” “may,” “will” or the negative of these +terms or other comparable terminology , we are identifying forward-looking +statements. Forward-looking statements involve risks and uncertainties, which +may cause our actual results, performance or achievements to be materially +different from those expressed or implied by forward-looking statements. +These factors include our research and development activities, distributor +channels, compliance with regulatory impositions; and our capital needs. +Although we believe that the expectations reflected in the forward-looking +statements are reasonable, we cannot guarantee future results, levels of +activity, performance or achievements. +Except +as may be required by applicable law, we do not undertake or intend to update or +revise our forward-looking statements, and we assume no obligation to update any +forward-looking statements contained in this report as a result of new +information or future events or developments. Thus, you should not assume that +our silence over time means that actual events are bearing out as expressed or +implied in such forward-looking statements. You should carefully review and +consider the various disclosures we make in this report and our other reports +filed with the Securities and Exchange Commission that attempt to advise +interested parties of the risks, uncertainties and other factors that may affect +our business. +For +further information about these and other risks, uncertainties and factors, +please review the disclosure included in this report under “Part I, Item 1A, +Risk Factors.” +General +Chembio +Diagnostics, Inc. (referred to collectively with its subsidiaries as the +“Company”) and its subsidiaries develop, manufacture and market rapid diagnostic +tests that detect infectious diseases. The Company’s main products presently +commercially available are three rapid tests for the detection of HIV antibodies +in whole blood, serum and plasma samples, all of which employ lateral flow +technology, and two of which were approved by the FDA in 2006. In +addition, we have a fourth rapid HIV test, developed on our patented Dual Path +Platform (DPP®) technology, for the detection of antibodies to HIV in oral fluid +samples, as well as whole blood, serum and plasma samples. The products which +employ lateral flow technology are manufactured and sold under a +non-exclusive license we have from Inverness Medical Innovations, Inc. +(“Inverness”), which is also our exclusive marketing partner for the +FDA-approved products in the United States (as well as Europe and Asia for the +product that is known as the “barrel” format product) under its Clearview® +brand. Inverness launched its marketing of these products in the +United States in February 2007. Chembio’s two HIV STAT-PAK® rapid HIV +tests (in cassette and dipstick formats) are marketed outside the United States +through different partners and channels under our license from +Inverness. +On March +13, 2007, we were issued United States patent #7,189,522 for our Dual Path +Platform (DPP®) rapid test system. Additional patent protection for +DPP® is pending worldwide. DPP® enables Chembio to participate in the +growing point–of-care diagnostics market with a patent-protected point-of-care +platform technology. DPP® devices enable the development of +products whose performance we believe exceeds that of comparable tests developed +with lateral flow technology. As stated above we have completed +development of an oral fluid HIV test on this new platform and are currently +pursuing the commercialization of this product in several markets. We +have also developed and/or are developing several other products on DPP®. We +believe that DPP® provides significant advantages as a point-of-care platform +particularly where challenging sample matrices, such as oral fluid, are +involved, or where multiplexing is desired. We are developing all of +our new products using this platform. Our strategy for the +development of this platform technology is also dual; we have entered and are +seeking to enter exclusive collaborations with large marketing partners for whom +we will develop and manufacture products on the DPP® and we are developing our +own products that we may choose to market through selected distribution partners +either under a Chembio, DPP® or other brand. +Our +products are sold to medical laboratories and hospitals, governmental and public +health entities, non-governmental organizations, and medical professionals. Our +products are sold either under our DPP®, STAT-PAK® or SURE CHECK® registered +trademarks and/or the private labels of our marketing partners, such as is the +case with the Inverness Clearview® label for our rapid HIV tests in the United +States. +3 +Rapid +HIV Tests +The major +component of our revenue growth in 2008 was increased sales of our rapid +HIV tests and related components. A large percentage of individuals +that are HIV positive worldwide are unaware of their status. Part of the reason +for this is that even those that do get tested in public health settings will +often not return or call back for their test results if samples have to be +sent out to a laboratory which can take at least several days to +process. The increased availability, greater efficacy and reduced +costs for anti-retroviral treatments (ARVs) for HIV is also having a tremendous +impact on the demand for testing, as the stigma associated with the disease is +lessened, and the ability to resume normal activities is substantially improved, +providing a positive message to those potentially infected. All +four of our rapid HIV tests are qualitative “yes/no” tests for the +detection of antibodies to HIV 1 & 2 with results available within +approximately 15 minutes. The tests differ principally only in the +method of sample collection and test procedure, flexibility with different +sample types, and cost of manufacture. Prior to our agreement with Inverness, +our rapid HIV tests had been marketed under either our SURE CHECK® or STAT-PAK® +trademarks. Pursuant to our agreement with Inverness Medical +Innovations, Inc., the SURE CHECK® product (which incorporates a proprietary +barrel format) is now being marketed by Inverness as Clearview® +Complete HIV 1/2 and the cassette format of our HIV 1/2 STAT-PAK (we also have a +third product known as HIV 1/2 STAT-PAK dipstick) is now being marketed by +Inverness in the United States as Clearview® HIV 1/2 STAT-PAK®. We +continue to market our STAT-PAK® cassette and dipstick outside the United States +through other marketing channels. In addition, in 2008 we amended the +agreement with Inverness, which previously had global exclusivity for the barrel +format product, to a non-exclusive in Africa and Latin +America. We will begin to market our DPP® oral fluid test +globally (including in the United States) as we establish required regulatory +clearances and authorizations, which we expect to receive during this year for +certain markets in the developing world, though there is no assurance that this +will occur. +Regulatory +Status: +Rapid +HIV Tests +The FDA +approved our Pre-Market Applications (hereinafter “PMA”; see “Governmental +Regulations” and Glossary) for our SURE CHECK HIV 1/2 (and also now Inverness’ +Clearview® Complete HIV 1/2 ) and HIV 1/2 STAT-PAK (now Inverness’ Clearview® +HIV 1/2 STAT-PAK in the United States only) products on May 25, +2006. A Clinical Laboratory Improvement Act (“CLIA”) waiver was +granted by the FDA for the HIV 1/2 STAT-PAK on November 20, +2006. Labeling changes to the Inverness Clearview® brands for both +products were approved during the first quarter of 2007. CLIA +waiver for the Clearview® Complete HIV 1/2 was granted on October 22, +2007. CLIA waiver is required in order to market the products for use +in hospital emergency rooms, public health clinics and physicians’ offices, +where the level of training is traditionally less than the training at clinical +laboratories and laboratories in hospitals. These settings constitute +the largest portion of the available market for our products. Our third lateral +flow rapid HIV test, HIV 1/2 STAT-PAK Dipstick and our DPP® oral fluid +HIV test, though not FDA approved, qualify under FDA export regulations to +sell, subject to any required approval by the importing country, to customers +outside the United States. The dipstick product is our most competitively +priced version of our three rapid HIV tests, and was designed primarily for +resource-constrained, donor-funded markets that have large test volume +needs. Although we have received approval from a number of potential +importing countries for three of our lateral flow HIV tests, Brazil, Mexico, +Nigeria, Ethiopia and Uganda are the countries in which we have realized +significant sales. As a result of favorable evaluations of our HIV +1/2 STAT-PAK and HIV 1/2 STAT-PAK Dipstick products by the World Health +Organization (the “WHO”), these products are qualified for procurement +by programs funded by the United Nations and their partners’ +programs. All three of our lateral flow HIV tests have qualified for +procurement under the President’s Emergency Plan for AIDS Relief +(“PEPFAR”). During the first quarter of 2009 we submitted our oral +fluid DPP® HIV 1/2 test, to these same agencies for inclusion in these +programs. We also have other evaluations ongoing for this new product +and anticipate commencement of clinical trials in the United States in support +of a PMA during this year. +Partners +Involved in Marketing Our Products +On +September 29, 2006 we executed marketing and license agreements with +Inverness. These agreements provide for the marketing of our +rapid HIV tests in the United States; the agreements also grant us a license +to Inverness’ lateral flow patents that may be applicable to certain of our +other products, including those that we had under development at the time of the +grant. As part of these agreements we also settled litigation that +had been ongoing with another company, StatSure Diagnostics, Inc., relating to +the proprietary barrel device that is incorporated into our Sure Check® HIV 1/2 +product, which is also marketed exclusively as Inverness Clearview® +Complete HIV 1/2 in the United States, Europe and Asia. +4 +We have +appointed distributors internationally so that we are positioned to service +those markets. Our focus is on those countries that have received or will +receive funding commitments for HIV prevention and treatment, of which rapid HIV +testing is an essential part. The most significant program +globally that funds HIV testing is the United States PEPFAR program, which +primarily is focused in 15 countries in sub-Saharan Africa that are at the +epicenter of the disease. During 2008 we shipped approximately +2.4 million test kits to Nigeria, 1.6 million test kits to Uganda, and +approximately 600,000 test kits to Ethiopia, or a total of approximately +4.6 million tests, mostly through the PEPFAR procurement agency known as the +Partnership for Supply Chain Management (“PSCM”). Lesser volumes were +shipped to several other countries in Asia, and Latin America. We also shipped +HIV test kit components to the Oswaldo Cruz Foundation for the manufacture of +tests in Brazil pursuant to our 2004 technology transfer agreement. +Effective +in January 2009, Nigeria changed from a parallel testing algorithm to a serial +algorithm, and in this change our test’s designation in two of their new +protocols was changed to that of a confirmatory test and a tie-breaker test in +the third protocol. This designation has resulted in a dramatic +reduction of sales to this country which decrease we anticipate will likely +continue for at least several months. During 2008, the implementation +of our HIV 1/2 STAT-PAK® as the confirmatory test in Ethiopia’s serial testing +algorithm resulted in significantly increased sales to that country, which +increases we anticipate may continue during 2009. We do not presently +anticipate however that the increased sales in Ethiopia will in any case fully +offset the decrease in Nigeria. +We are +pursuing new opportunities for distribution of our existing lateral flow HIV +tests and new DPP® oral fluid HIV test in a number of markets +globally. As stated earlier, during 2008 we amended our agreement +with Inverness so that we may now market the barrel product under Chembio’s +trademark, SURE CHECK® HIV 1/2 directly throughout South America and Africa, +subject to the payment of royalties to Inverness in accordance with our +license to their lateral flow patents. +OTHER +RAPID TESTS +We also +have commercially available lateral flow tests for Chagas Disease and also a +line of tests for the detection of tuberculosis in humans and certain animal +species. However, these products represented less than 4% of our product +revenues during 2008 and are not part of the central focus of our current +business and growth strategy. +Our +Rapid Test Technologies +All of +our commercially available current products employ either in-licensed lateral +flow technology or our own patented Dual Path Platform (DPP®) +technology. +Lateral +flow technology involves a sample flowing from the point of application on a +test strip to provide a test result, indicated with a labeling reagent that +allows the result to be visually or otherwise detected, on a portion of a strip +downstream from either the point of application of the +sample. Lateral flow technology is well established and widely +applied in the development of rapid diagnostic tests. The +functionality of our lateral flow tests is based on the ability of an antibody +to bind with a specific antigen (or vice versa) and for the binding to become +visible through the use of the colloidal gold and/or colored latex that we use +in our products. The colloidal gold or the colored latex produces a +colored line if the binding has occurred (the test line), in which case it means +there has been a reactive or positive result. In any case, a separate +line (the control line) will appear to confirm that the test has been validly +run in accordance with the instructions for use. +On March +13, 2007, we were issued United States patent number #7,189,522 describing a +Dual Path Immunoassay system which we believe provides several advantages over +lateral flow technology for certain applications (See “Intellectual +Property”). The Dual Path Platform technology, or DPP®, uniquely +provides for the sample application and migration toward the test zone area to +be from an independent strip. This system enables improved sample +control, multiplexing and certain other advantages. DPP® is providing +the Company with significant new product development and licensing +opportunities, and we are devoting all of our research and development +efforts toward these programs. +The +sensitivity of a test indicates how strong the sample must be before it can be +detected by the test. The specificity of a test measures the ability +of the test to analyze, isolate, and detect only the matters targeted by +the test. The sensitivity and specificity of our rapid HIV tests +during our clinical trials undertaken in connection with our FDA PMAs were 99.7% +and 99.9%, respectively. Both lateral flow technology and DPP® allow the +development of accurate, low cost, easy-to-perform, single-use diagnostic tests +for rapid, visual detection of specific antigen-antibody complexes on a test +strip. This format provides a test that is simple (requires neither +electricity nor expensive equipment for test execution or reading, nor skilled +personnel for test interpretation), rapid (turnaround time approximately 15 +minutes), safe (minimizes handling of potentially infected specimens), +non-invasive (requires 5-20 micro liters of whole blood easily obtained with a +finger prick, or alternatively, serum or plasma), stable (24 months at room +temperature storage in the case of our HIV tests), and highly +reproducible. +5 +Our HIV +tests are qualitative (reactive/non-reactive) tests. We have developed +proprietary techniques that enable us to achieve high levels of sensitivity and +specificity [see definition above] in our diagnostic tests using our proprietary +colloidal gold conjugates and buffer systems. These techniques +include the methods we employ in manufacturing and fusing the reagents with the +colored latex, or colloidal gold, blocking procedures used to reduce false +positives, and methods used in treating the materials used in our tests to +obtain maximum stability and resulting longer shelf life. We also +have extensive experience with a variety of lateral flow devices, including the +sample collection device used in our SURE CHECK rapid HIV test which eliminates +the need for transferring finger-stick whole blood samples from the fingertip +onto a test device, because the collection of the sample is performed within a +tubular test chamber that contains the lateral flow test strip. The +whole blood sample is absorbed directly onto the test strip through a small +opening in one end of the test chamber and an absorbent pad positioned just +inside this same end of the test chamber. +During +2007 and 2008 we entered collaborations with companies that have developed hand +held and desktop readers that can objectively measure, quantify, record and +report test results. Certain of the products we have and/or are developing for +our customer in Brazil, the Oswaldo Cruz Foundation, will incorporate some of +these readers, and we are developing other products that may be used with or +will require use of a reader. +Target +Market +Rapid +HIV Tests +The +marketing of our FDA-approved and CLIA-waived rapid HIV tests in the United +States was launched by Inverness during the first quarter of 2007, and we +estimate to have approximately a 10% share of the U.S. rapid HIV test +market. In the United States, the need for rapid HIV tests has been +developing first in the public health and hospital emergency room segments, and +also in the physicians’ office laboratories. Of the estimated +25-30 million HIV tests performed in clinical settings in the United +States, rapid HIV tests now account for approximately 20-25% of this +market, or approximately 5-6 million tests of this total. We believe +that the total number of HIV tests will continue to grow, and that the share +available to rapid HIV tests will also grow. +The pace +of the implementation of recommendations that were made in late 2006 +by the United States Centers for Disease Control +(“CDC”) for routine HIV testing of all individuals between the ages +of 13 and 64 will be a major factor in the rate of growth of the rapid HIV +testing market in the United States. Endorsement of these recommendations +by opinion leaders in the professional medical community are gradually helping +to increase the demand for HIV testing in the United States. In +addition, the revelation in a study disclosed in 2008 by CDC that annual new HIV +cases in the US, which disproportionately impact African-Americans, had been +under-reported for years by approximately 40%, underscored the need for improved +prevention efforts in the United States. Although the most recent efforts to +increase federal funding for STD prevention in the federal stimulus package were +unsuccessful, we still believe that there is a good prospect that the current +Congress and Administration will seek to increase these programs through other +legislative appropriations. +In the +international market, PEPFAR, the large United States funded international AIDS +relief program focused on fifteen countries, was reauthorized last year for up +to $48 billion for FY2009-2012 (up from $15 billion in 2004-2008); the +appropriation for 2009 is approximately $5.5 billion, of which approximately 12% +or $900 million is allocated to the Global Fund, the other large international +program created in 2001 to combat HIV/AIDS, TB and Malaria. PEPFAR, +The Global Fund and other global initiatives have succeeded in making +life-saving treatments available now to well in excess of one million +individuals. We believe that this is likely to have the effect of +further encouraging more people to get tested, because with the availability of +treatment, there is a clear reason to be tested. Other programs such +as UNAIDS are significant participants in the global effort to prevent further +transmission and save the lives of those already infected, as well as care for +their families that are impacted. +Marketing +Strategy +Our +marketing strategy is to: +· +Support, +review and assess the marketing and distribution efforts of our rapid HIV +tests by Inverness Medical Innovations, Inc. Inverness, which +is a leading marketer of point-of-care diagnostic products, has +significantly expanded its distribution footprint since we signed our +agreement with Inverness, and we believe that this will enhance +opportunities for Inverness to market our rapid HIV tests. In particular, +Inverness has been very active in acquiring point-of-care product lines +serving hospital emergency rooms and physicians’ +offices. +· +Leverage +our DPP® intellectual property and regulated product development and +manufacturing experience to create new collaborations where Chembio can be +the exclusive development and manufacturing partner with world class +marketing partners. +· +Develop +a small number of Chembio or DPP® branded products that capitalize on the +advantages of this newly patented point-of-care technology and select +distribution partners for such +products. +6 +Competition +The +diagnostics industry is a multi-billion dollar international industry and is +intensely competitive. Many of our competitors are substantially +larger and have greater financial, research, manufacturing and marketing +resources. +Industry +competition in general is based on the following: +· +Scientific +and technological capability; +· +Proprietary +know-how; +· +The +ability to develop and market products and +processes; +· +The +ability to obtain FDA or other required regulatory +approvals; +· +The +ability to manufacture products that meet applicable FDA requirements, +(i.e. FDA’s Quality System Regulations) (see Governmental Regulation +section); +· +The +ability to manufacture products +cost-effectively; +· +Access +to adequate capital; +· +The +ability to attract and retain qualified personnel; +and +· +The +availability of patent protection. +We +believe our scientific and technological capabilities and our proprietary +know-how relating to our in-licensed lateral flow technology rapid tests +and to our proprietary know-how related to our patented dual path platform +technology, particularly for the development and manufacture of tests for +the detection of antibodies to infectious diseases such as HIV, are very +strong. +Our +ability to develop and market other products is in large measure dependent on +our having additional resources and/or collaborative +relationships. Some of our product development efforts have been +funded on a project or milestone basis. We believe that our +proprietary know-how in lateral flow technology and in our dual path platform +technology has been instrumental in our obtaining the collaborations we have and +that we continue to pursue. We believe that the patent protection +that we have with our Dual Path Platform enhances our ability to develop more +profitable collaborative relationships and to license out the +technology. +We +believe our regulatory certifications are also a strong asset for developing new +products and collaborations. There are only two companies besides Chembio that +have approved PMA’s for lateral flow rapid tests, all HIV tests: Trinity Biotech +(Ireland) and Orasure Technologies, Inc. (PA). We believe that this +is a significant competitive advantage when considering new products and +collaborations. During 2006 and 2007 we obtained CLIA waivers +for each of our FDA PMA approved HIV tests. These products +therefore represent two of the four CLIA-waived rapid HIV +tests. During 2007 and 2008 we received facility and product licenses +from the USDA, became certified under ISO 13.485, and received our initial CE +mark (for our Chagas product). We anticipate receiving CE marks for our HIV +products during the first half of 2009. +Our +access to capital is much less than that of several of our competitors, +and to the extent we would need to access large amounts of capital, this is +a competitive disadvantage. We believe however that our access to +capital is likely to increase if we continue our trend of improved operating +results, and in the meantime we are focused on minimizing our capital +requirements. Establishment of strategic collaborations for our DPP® +technology also may provide us with access to funding that is potentially less +dilutive or non-dilutive. The simplification of our capital +structure that was completed in December 2007 should also improve our access to +capital (See Management’s Discussion and Analysis of Financial Condition and +Results of Operations – Overview). +To date, +we believe we have been competitive in the industry in attracting and retaining +qualified personnel. Because of the greater financial resources of +many of our competitors, we may not be able to compete effectively for the same +individuals to the extent that a competitor uses its substantial resources to +attract any such individuals. Also, in order to control costs and +conserve resources, we have implemented layoffs and salary reductions that +larger companies with greater resources may not need to implement. +7 +We have +been able to obtain patent protection by entering into licensing arrangements +for reagents and lateral flow technologies. The March 2007 issuance by the +United States Patent & Trademark Office of our Dual Path Platform™ patent +gives us our first patent protection for our own rapid test platform, which we +believe enhances our competitive position. Additional +protection of this intellectual property is pending worldwide. +Competitive +factors specifically related to our HIV tests are product quality, delivery, +sensitivity, specificity, ease-of-use, shelf life and price. Other +factors can be sample size required, the presence of a true IgG control, and +time to result. During the last few years, the competitive features +of certain products produced by some international competitors have +improved. Most of these companies, whose products are not and in +most cases probably could not be FDA approved, typically have substantially +lower costs of labor, regulatory approval and compliance, and intellectual +property (if any) as compared with Chembio. Price has become an increasingly +important factor since U.S. procurement rules still operate under a waiver +of Buy America provisions, described below. Also, as described below, +in most of the donor-funded markets in the developing world technical committees +controlled by host governments are empowered to make final decisions as to which +products will be used in screening programs. The leading +competitors in the international rapid HIV test market are Trinity Biotech +(Ireland), Inverness (U.S.) and Standard Diagnostics +(Korea). Uni-Gold® HIV, marketed by Trinity Biotech of Ireland and +Determine®, marketed by Inverness Medical, are the market leaders in the +developing world, particularly sub-Saharan Africa, which is where most of the +funding for rapid HIV tests is being allocated from donor funded programs such +as PEPFAR. Neither the Trinity or Inverness products are +FDA-approved, although Trinity does manufacture in Ireland an FDA-approved rapid +HIV test, Uni-Gold Recombigen, for marketing in the United States. Inverness’ +Orgenics subsidiary in Israel also has a rapid HIV test, Double-Check +Gold, as does its subsidiary in China, ABON; neither of these products +is FDA-approved. As such, while Inverness is our exclusive marketing +partner in the United States, it is also a principal competitor to our rapid HIV +tests outside the United States. Furthermore, in 2006 Trinity Biotech +settled litigation with Inverness, and as part of that settlement it committed +to have ABON, an Inverness subsidiary, to manufacture all of Trinity’s +Uni-Gold® HIV products primarily for the African +market. Standard Diagnostics of Korea also has a low-cost +product that is very competitive against each of the other competitors in the +developing world. There are a number of additional competitors, +including several based in China and India of varying quality, that produce +competitive rapid HIV tests. +Under +a now long-established waiver of Buy America provisions, products procured +with US taxpayer funds need not be FDA approved or even made in the US so long +as they meet reduced quality standards as compared to what would be required for +an FDA approved product. Under the waiver guidelines, all manufacturers are +invited by PEPFAR to be considered for procurement with United States taxpayer +funds. The waiver, which was initially made available because of a dearth of +suitable US-made or FDA approved products when PEPFAR was originally +authorized, has continued even though there are now several products, including +Chembio’s, that are FDA approved. Also, in addition to competing against +approximately thirty non-FDA approved, non-US made products that can be +purchased under U.S. procurement rules, in order to realize sales in the +markets where the donor (mostly U.S.) funds are allocated, the product must +additionally be selected by a country’s ministry of health or their designees to +be part of a national testing protocol or “algorithm”. The algorithms +typically use multiple rapid tests in sequence or in parallel to screen and +confirm patients at the point-of-care and are increasingly allowing for multiple +tests to be qualified in these algorithms. Chembio’s sales in Africa +and certain other markets are therefore based on the fact that its test has been +one of those selected. A product’s designation in a donor-funded +country’s algorithm is largely followed by most of the implementing agencies and +organizations, resulting in the selection process being critical to +participation in donor funded procurements in such market, and limiting the +impact of marketing activities once these selections have been made. The +selection process in each of these countries is not predictable and is based +upon a number of factors, including but not limited to product performance, +price, and supply chain. +In the +developed world, particularly the United States and Europe, the competitive +landscape and market dynamics are quite different. Due to the costs +of and quality system requirements associated with US FDA regulatory approval, +there are currently only two companies besides Chembio that have products that +are both FDA PMA-approved and also CLIA-waived: Orasure Technologies (Bethlehem, +PA) with OraQuick®, and Trinity Biotech Ltd. (Ireland) with +Uni-Gold® Recombigen. The regulatory costs for FDA approval and fewer +number of products in turn results in very different (higher) pricing in the US +market as compared with the developing world, with prices in the US averaging +$8-12 per test to end user. This compares to approximately $1.00 +per test in the developing world. As the requirements for the PMA and +CLIA waiver are difficult, costly, risky and time-consuming, particularly +relative to the size of the market, and because such approval is not required +for participation in PEPFAR under the above-described waiver guidelines, we +do not anticipate that Inverness has any plan to submit any of its products +produced outside the U.S. to the FDA. Further, our agreements +with Inverness provide that in the event one of those submissions is +made (or if Inverness acquires a competitive product in the United States), +we have the right to terminate our agreement with Inverness or make Inverness’ +marketing rights non-exclusive. In either case, we would retain a +license under the Inverness lateral flow patents to market the products under a +Chembio brand and/or through third party distribution partners. +8 +Orasure +has an estimated market share in the U.S. of approximately 70% with its Oraquick +® product. This product’s main advantages are that it was the +first test to market and also that, at least for certain market segments +(primarily public health), it can be performed with oral fluid samples, as +compared with only blood samples, which is the case for our products as well as +Trinity’s. The main disadvantage of the Orasure product is its +relatively higher price. Also, Orasure’s claimed sensitivity with oral fluid +samples is lower than with blood samples, and combined with some limited reports +of performance (false positive) problems on oral fluid samples, this has created +some opportunities for Inverness with our product, as well as for +Trinity. +Orasure +markets its products directly through its own sales organization to the public +health market, has made a significant investment in that market, and has nearly +100% of the three largest states in this market (New York, California and +Florida) that together constitute the majority of public health HIV testing in +the US. For the hospital market segment Orasure had an exclusive +marketing arrangement with Abbott Diagnostics, but as of January 2009 they +terminated this agreement and are expanding their direct sales organization to +market directly to the hospital market segment as well. Trinity also +relies on its own sales force to market its product, and does not have any other +rapid tests to sell to distributors. The Uni-Gold product that is marketed by +Trinity accounts for an estimated 10% of the market. This product +does not detect HIV-2, while our products and Orasure’s both do. Though HIV-2 is +a rare strain of HIV, it is an advantage to be able to detect, though there is a +cost of 15% of Net Sales to the license for this claim. Trinity’s +product also requires a much larger sample size, and does not have a true IgG +control. This means that a control line, which is intended to confirm +that the test procedure has been performed correctly, will appear on their +product so long as any liquid material is applied to its sampling area; +Chembio’s (and Orasure’s) control line will appear only if a biological sample +is applied. The shelf life of our HIV products is 24 months, which is +twice that of both the Uni-Gold and Orasure products. +We +believe that Inverness, as a leading marketer of a broad range +of point-of-care tests sold into all U.S. market segments, has a +superior marketing organization as compared to either of our U.S. market +competitors who are much smaller than Inverness. Inverness has made a +significant investment in its launch of our products, in the training of a large +marketing organization in the US, and in the acquisition of complementary +product lines and sales organizations. For example, Inverness has +significantly augmented its access to emergency room departments in hospitals +through its acquisition of Bio-Site, which was the leading company in +point-of-care tests for cardiac monitoring, and whose sales force can now +add our product to its product portfolio for this important market +segment. We believe that this is an example of the distribution +advantages of our marketing partner. +Chembio’s +HIV Tests +One of +our two product formats, the “barrel” format now marketed by Inverness as +Clearview® Complete HIV 1-2, is a unique product format inasmuch as it is a +unitized product, meaning that all components necessary to perform a single test +are contained in a single pouch. This “barrel” format provides for a +proprietary method of collecting finger-stick whole blood samples that +eliminates the need for the step that all other devices require of transferring +the sample from the fingertip to the sample well of the test. Also, +the buffer solution in the barrel format is in a unitized vial that is +pierced by the barrel tip to initiate the sample migration up the test strip +contained inside the “barrel”, and thereby creates a closed system that helps to +minimize possible exposure to potentially infectious samples. +Our other +FDA PMA approved rapid HIV test, marketed by Inverness as Clearview® HIV 1-2 +STAT PAK®, is a rectangular-shaped lateral flow plastic cassette format test +wherein the sample is transferred from the sample source (finger tip in the +case of finger-stick whole blood samples) to the sample port in the +cassette by means of a transfer loop. Though this step is not +required in the barrel format, the cassette is less costly to manufacture, is a +more familiar format to customers that have performed other standard +design lateral flow tests, and is a more flexible format that utilizes the same +procedure for all approved sample matrices (venous whole blood, finger-stick +whole blood, serum and plasma). To date this format has accounted for almost all +of the sales we have had through Inverness. However this is in part +due to the fact that the barrel format was not CLIA waived until October 2007, +approximately a year later than the cassette product, and we anticipate more +sales of this product in the future, though still less than the +cassette. +Research +and Development +During +2008 and 2007, $2.6 million and $1.9 million, respectively, were spent on +research and development activities. Substantially all of our new +product development activities involve employment of our Dual Path Platform +(DPP®) technology for which we were awarded a U.S patent in 2007. We +believe that this platform enables us to pursue many new product development and +licensing opportunities. The DPP® technology can provide improved features on +certain tests developed with it that include higher sensitivity, earlier +detection, improved performance with more challenging sample types (such as oral +fluid), and the improved ability to detect multiple analytes (multiplexing) in +one test device. +During +2008 we made substantial progress in developing a portfolio of products based on +the DPP® technology. These activities include completing development +of certain products and making significant progress toward the development of +additional products. These activities are further explained in Part +II Item 7. +9 +Regulatory +Activities +We +continue to make progress on obtaining a Community European (CE) marking for our +products to indicate conformity with European Union health, safety and +environmental requirements. We have submitted the HIV 1/2 STAT-PAK® technical +file to our notified body and should complete all required steps for CE Marking +of this product during the second quarter of 2009. Under +our agreement with Inverness we are to obtain a CE Marking for the Clearview® +Complete HIV 1/2. We are prepared to submit the technical file for +this product on behalf of Inverness once we received final proposed labeling +from Inverness. +We are +also pursuing registrations of our lateral flow and DPP® HIV products in a +number of other jurisdictions, and also pursing registrations with the USDA of +additional claims for our veterinary tuberculosis products. +During +2008 we received FDA approval for the lowering of the age limits that the tests +are approved for from 18 years to 13 years of age. This lowering of +the lower age limit put our approved product claims in line with the 2006 CDC +recommendations for routine test of all individuals between the ages of 13 and +64, and we believe that this additional marketing claim for the product will +assist Inverness in certain market opportunities with our products. +Employees +At +December 31, 2008, we employed 114 people, including 110 full-time +employees. Effective May 2006, we entered into an employment +agreement with Lawrence Siebert, President and Chairman. Effective +March 2007, we entered into an employment agreement with Javan Esfandiari, +Executive Vice-President of Research and Development. +Governmental +Regulation +The +manufacturing and marketing of the Company’s existing and proposed diagnostic +products are regulated by the United States Food and Drug Administration +(“FDA”), United States Department of Agriculture (“USDA”), certain state and +local agencies, and/or comparable regulatory bodies in other +countries. These regulations govern almost all aspects of +development, production and marketing, including product testing, authorizations +to market, labeling, promotion, manufacturing and record +keeping. The Company’s FDA and USDA regulated products require some +form of action by each agency before they can be marketed in the United States, +and, after approval or clearance, the Company must continue to comply with other +FDA requirements applicable to marketed products, e.g. Quality Systems (for +medical devices). Failure to comply with the FDA’s requirements can +lead to significant penalties, both before and after approval or +clearance. +Most +point-of-care diagnostic products are regulated as medical devices by the +FDA Centers of Device and Radiological Health, though some are regulated by the +FDA Center of Biologics Evaluation and Research. There are two review +procedures by which medical devices can receive FDA clearance or +approval. Some products may qualify for clearance under Section +510(k) of the Federal Food, Drug and Cosmetic Act, in which the manufacturer +provides a pre-market notification that it intends to begin marketing the +product, and shows that the product is substantially equivalent to another +legally marketed product (i.e., that it has the same intended use and is as safe +and effective as a legally marketed device and does not raise different +questions of safety and effectiveness). In some cases, the submission +must include data from human clinical studies. Marketing may commence +when the FDA issues a clearance letter finding such substantial +equivalence. An applicant must submit a 510(k) application at least +90 days before marketing of the affected product commences. Although +FDA clearance may be granted within that 90-day period, in some cases as much as +a year or more may be required before clearance is obtained, if at +all. +If the +medical device does not qualify for the 510(k) procedure (either because it is +not substantially equivalent to a legally marketed device or because it is +required by statute and the FDA’s implementing regulations to have an approved +application), the FDA must approve PMA application before marketing can +begin. PMA’s must demonstrate, among other matters, that the medical +device provides a reasonable assurance of safety and effectiveness. A +PMA application is typically a complex submission, including the results of +non-clinical and clinical studies. Preparing a PMA application is a +much more expensive, detailed and time-consuming process as compared with a +510(K) pre-market notification. Once a PMA has been submitted, the +FDA is required to review the submission within a statutory period of +time. However, the FDA’s review may be, and often is, much longer, +often requiring one year or more, and may include requests for additional +data. The Company has approved PMAs for the two rapid HIV tests now +marketed by Inverness Medical as Clearview® Complete HIV 1-2 and Clearview® HIV +1-2 STAT PAK®. +10 +Every +company that manufactures medical devices distributed in the United States must +comply with the FDA’s Quality System Regulations. These regulations +govern the manufacturing process, including design, manufacture, testing, +release, packaging, distribution, documentation and +purchasing. Compliance with the Quality System Regulations is +required before the FDA will approve an application, and these requirements also +apply to marketed products. Companies are also subject to other +post-market and general requirements, including compliance with restrictions +imposed on marketed products, compliance with promotional standards, record +keeping and reporting of certain adverse reactions or events. The FDA +regularly inspects companies to determine compliance with the Quality System +Regulations and other post-approval requirements. Failure to comply +with statutory requirements and the FDA’s regulations can lead to substantial +penalties, including monetary penalties, injunctions, product recalls, seizure +of products, and criminal prosecution. +The +Clinical Laboratory Improvement Act of 1988 (“CLIA”) prohibits laboratories from +performing in vitro tests for the purpose of providing information for the +diagnosis, prevention or treatment of any disease or impairment of, or the +assessment of, the health of human beings unless there is in effect for such +laboratories a certificate issued by the United States Department of Health and +Human Services (via the FDA) applicable to the category of examination or +procedure performed. Although a certificate is not required for the +Company, it considers the applicability of the requirements of CLIA in the +design and development of its products. The statutory definition of +“laboratory” is very broad, and many of our customers are considered +labs. A CLIA waiver will remove certain quality control and other +requirements that must be met for certain customers to use the Company’s +products and this is in fact critical to the marketability of a product into the +point-of-care diagnostics market. The Company has received a +CLIA waiver for each of the two rapid HIV tests now marketed by Inverness +Medical as Clearview® Complete HIV 1/2 and Clearview® HIV 1/2 STAT +PAK®. The CLIA waiver was granted by the FDA for HIV 1/2 STAT-PAK on +November 20, 2006 and for the Clearview® Complete HIV 1/2 on October 22, +2007. +In +addition, the FDA regulates the export of medical devices that have not been +approved for marketing in the United States. The Federal Food, Drug +and Cosmetic Act contains general requirements for any medical device that may +not be sold in the United States and is intended for +export. Specifically, a medical device intended for export is not +deemed to be adulterated or misbranded if the product: (1) complies with the +specifications of the foreign purchaser; (2) is not in conflict with the laws of +the country to which it is intended for export; (3) is prominently labeled on +the outside of the shipping package that it is intended for export; and (4) is +not sold or offered for sale in the United States. Some medical +devices face additional statutory requirements before they can be +exported. If an unapproved device does not comply with an applicable +performance standard or PMA requirement, is exempt from either such requirement +because it is an investigational device, or is a banned device, the device may +be deemed to be adulterated or misbranded unless the FDA has determined that +exportation of the device is not contrary to the public health and safety and +has the approval of the country to which it is intended for +export. However, the Federal Food, Drug and Cosmetic Act does permit +the export of devices to any country in the world, if the device complies with +the laws of the importing country and has valid marketing authorization in one +of several “listed” countries under the theory that these listed countries have +sophisticated mechanisms for the review of medical devices for safety and +effectiveness. +The +Company is also subject to regulations in foreign countries governing products, +human clinical trials and marketing, and may need to obtain approval or +evaluations by international public health agencies, such as the World Health +Organization, in order to sell diagnostic products in certain +countries. Approval processes vary from country to country, and the +length of time required for approval or to obtain other clearances may in some +cases be longer than that required for United States governmental approvals. On +the other hand, the fact that our HIV diagnostic tests are of value in the AIDS +epidemic may lead to some government process being expedited. The +extent of potentially adverse governmental regulation affecting Chembio that +might arise from future legislative or administrative action cannot be +predicted. +One or +more of the Company’s rapid HIV tests are also approved or pending approval for +marketing in several foreign jurisdictions, including but not limited to Brazil, +Mexico, and India, as well as a number of other nations in the developing +world. +Environmental +Laws +To date, +we have not encountered any costs relating to compliance with any environmental +laws. +Intellectual +Property +Intellectual +Property Strategy +Our +intellectual property strategy is to: (1) build our owned +intellectual property portfolio around our Dual Path Platform technology; (2) +pursue licenses, trade secrets and know-how within the area of lateral flow +technology and DPP®; and (3) develop and acquire proprietary positions to +reagents and new hardware platforms for the development and manufacture of rapid +diagnostic tests. +11 +Trade +Secrets and Know-How +We +believe that we have developed a substantial body of trade secrets and know-how +relating to the development of lateral flow and DPP® based diagnostic tests, +including but not limited to the sourcing and optimization of materials for such +tests, and how to maximize sensitivity, speed-to-result, specificity, stability +and reproducibility. The Company possesses proprietary know-how to develop +tests for multiple conditions using colored latex. Our buffer +formulations enable extremely long shelf lives of our rapid HIV tests and we +believe that this provides us with an important competitive +advantage. +Lateral +Flow Technology and Reagent Licenses +As part +of our agreements in 2006 with Inverness for the marketing of our HIV tests, we +were granted non-exclusive licenses to their lateral flow technology for certain +products manufactured and marketed by Chembio including but not limited to our +HIV tests. Although we believe our DPP® is outside of the scope of lateral +flow patents, we consult with patent counsel, and seek licenses and/or redesigns +of products that we believe to be in the best interests of the Company and our +stockholders. Because of the costs and other negative consequences of +time-consuming patent litigation, we often attempt to obtain a license on +reasonable terms. Nevertheless there is no assurance that Inverness’ +lateral flow patents will not be challenged or that other patents containing +claims relevant to the Company’s products will be not be granted and that +licenses to such patents, if any, will be available on reasonable terms, if +any. Inverness has aggressively enforced its lateral flow intellectual +property, and in 2008 brought a patent infringement lawsuit against +Orasure. Orasure has claimed that their Oraquick product does not +infringe the Inverness patent and that the Inverness patent is +invalid. The lawsuit is in the discovery phase. +In the +event that it is determined that a license to any patent is required and it +is not possible to negotiate a license agreement under a necessary patent, we +may be able to modify the applicable product such that a license would not be +necessary. However, this alternative could delay or limit our ability to sell +these products in the United States and/or other markets, and/or increase +penalties, all of which would adversely affect our results of operations, cash +flows and business. +The DPP® +technology provides us with our own intellectual property and we believe it +also enables tests to be developed with improved sensitivity as compared +with comparable tests on lateral flow platforms. The Company has +signed and anticipates signing new development projects based upon the DPP® +technology that will provide new manufacturing and marketing +opportunities. We have several other patents issued or pending +related to other point-of-care technologies or applications +thereof. The DPP® patent protection is being prosecuted in many +foreign jurisdictions as well. +The +peptides used in our rapid HIV tests are patented by Adaltis Inc. and are +licensed to us under a 10-year non-exclusive license agreement dated August 30, +2002, which was recently amended to reduce the royalty rate. We +also have licensed the antigens used in other tests including our +Chagas, Tuberculosis and Leishmaniasis tests. In prior years we +concluded license agreements related to intellectual property rights owned +by the United States associated with HIV- 1, and during the first quarter +of 2008 we entered into a sub-license agreement for HIV-2 with Bio-Rad +Laboratories N.A., the exclusive licensee of the Pasteur Institute’s HIV-2 +intellectual property estate. +Corporate +History +On May 5, +2004, we completed a merger with Chembio Diagnostic Systems Inc. through which +Chembio Diagnostics Systems Inc. became our wholly-owned subsidiary, and through +which the management and business of Chembio Diagnostic Systems Inc. became our +management and business. As part of this transaction, we changed our +name to Chembio Diagnostics, Inc. In 2003, we had sold our prior +business, and as a result, we had no specific business immediately prior to the +merger. +Since the +formation of Chembio Diagnostic Systems Inc. in 1985, it has been involved in +developing, manufacturing, selling and distributing in-vitro diagnostic tests, +including rapid tests beginning in 1995, for a number of conditions in humans +and animals. +On March +12, 2004, we implemented a 1-for-17 reverse split of our common +stock. All references in this Form 10-K to shares of our common stock +have been adjusted to reflect this reverse split. +12 +Glossary +AIDS +Acquired +Immunodeficiency Syndrome. AIDS is caused by the Human +Immunodeficiency Virus, HIV. +ALGORITHM +(parallel or serial) +For +rapid HIV testing this refers both to method or protocol (in developing +countries to date) for using rapid tests from different manufacturers in +combination to screen and confirm patients at the point-of-care, and may +also refer to the specific tests that have been selected by an agency or +ministry of health to be used in this way. A parallel algorithm +uses two screening tests from different manufacturers and a tie-breaker +test only if there is a discrepancy between the screening tests results. A +serial algorithm only uses a second confirmatory test if there is a +positive result from the screening test, meaning that the number of +confirmatory tests used is equal to the positivity rate in the testing +venue. A tie-breaker test resolves discrepancies between the screen and +the confirmatory test. +ANTIBODY +A +protein which is a natural part of the human immune system produced by +specialized cells to neutralize antigens, including viruses and bacteria +that invade the body. Each antibody producing cell manufactures +a unique antibody that is directed against, binds to and eliminates one, +and only one, specific type of antigen. +ANTIGEN +Any +substance which, upon entering the body, stimulates the immune system +leading to the formation of antibodies. Among the more common antigens are +bacteria, pollens, toxins, and viruses. +ARVs +Anti-Retroviral +Treatments for AIDS +CD-4 +The +CD4+ T-lymphocyte is the primary target for HIV infection because of the +affinity of the virus for the CD4 surface marker. Measures of +CD4+ T-lymphocytes are used to guide clinical and therapeutic management +of HIV-infected persons. +CDC +United +States Centers for Disease Control and Prevention +CLIA +waiver +Clinical +Laboratory Improvement Act designation that allows simple tests to be +performed in point-of-care settings such as doctors offices, walk-in +clinics and emergency rooms. +DIAGNOSTIC +Pertaining +to the determination of the nature or cause of a disease or +condition. Also refers to reagents or procedures used in +diagnosis to measure proteins in a clinical sample. +EITF +Emerging +Issues Task Force +FASB +Financial +Accounting Standards Board +FDA +United +States Food and Drug Administration +FDIC +Federal +Deposit Insurance Corporation +FAS +Financial +Accounting Standard +HIV +Human +Immunodeficiency Virus. HIV (also called HIV-1), a retrovirus, +causes AIDS. A similar retrovirus, HIV-2, causes a variant +disease, sometimes referred to as West African AIDS. HIV +infection leads to the destruction of the immune +system. +IgG +IgG +or Immunoglobulin are proteins found in human blood. This protein is +called an “antibody” and is an important part of the body’s defense +against disease. When the body is attacked by harmful bacteria or viruses, +antibodies help fight these invaders. +MOH +Ministry +of Health +MOU +Memoranda +of Understanding +NGO +Non-Governmental +Organization +OTC +Over-the-Counter +PEPFAR +The +President’s Emergency Plan for AIDS Relief +PMA +Pre-Marketing +Approval –FDA approval classification for a medical device that is +not substantially equivalent to a legally marketed device or is otherwise +required by statute to have an approved application. Rapid HIV +tests must have an approved PMA application before marketing of such a +product can begin. +PROTOCOL +A +procedure pursuant to which an immunodiagnostic test is performed on a +particular specimen in order to obtain the desired +reaction. +REAGENT +A +chemical added to a sample under investigation in order to cause a +chemical or biological reaction which will enable measurement or +identification of a target substance. +RETROVIRUS +A +type of virus which contains the enzyme Reverse Transcriptase and is +capable of transforming infected cells to produce diseases in the host +such as AIDS. +SAB +Staff +Accounting Bulletin +SENSITIVITY +Refers +to the ability of an assay to detect and measure small quantities of a +substance of interest. The greater the sensitivity, the smaller the +quantity of the substance of interest the assay can +detect. Also refers to the likelihood of detecting the antigen +when present. +SPECIFICITY +The +ability of an assay to distinguish between similar +materials. The greater the specificity, the better an assay is +at identifying a substance in the presence of substances of similar +makeup. +SPUTUM +Expectorated +matter; saliva mixed with discharges from the respiratory +passages +TB +Tuberculosis +(TB) is a disease caused by bacteria called Mycobacterium tuberculosis. +The bacteria usually attack the lungs. But, TB bacteria can attack any +part of the body such as the kidney, spine, and brain. If not treated +properly, TB disease can be fatal. TB is spread through the air +from one person to another. The bacteria are put into the air when a +person with active TB disease of the lungs or throat coughs or sneezes. +People nearby may breathe in these bacteria and become +infected. +UNAIDS +Joint +United Nations Program on HIV/AIDS +USAID +United +States Agency for International Development +USDA +U.S +Department of Agriculture +WHO +World +Health Organization +13 +ITEM +1A. +RISK +FACTORS +You +should carefully consider each of the following risk factors and all of the +other information provided in this Annual Report. The risks described +below are those we currently believe may materially affect us. An +investment in our Common Stock involves a high degree of risk, and should be +considered only by persons who can afford the loss of their entire +investment. +Risks +related to our industry, business and strategy +Because +we may not be able to obtain necessary regulatory approvals for some of our +products, we may not generate revenues in the amounts we expect, or in the +amounts necessary to continue our business. +All of +our proposed and existing products are subject to regulation in the U.S. by the +U.S. Food and Drug Administration, the U.S. Department of Agriculture and/or +other domestic and international governmental, public health agencies, +regulatory bodies or non-governmental organizations. In particular, +we are subject to strict governmental controls on the development, manufacture, +labeling, distribution and marketing of our products. The process of +obtaining required approvals or clearances varies according to the nature of, +and uses for, a specific product. These processes can involve lengthy +and detailed laboratory testing, human or animal clinical trials, sampling +activities, and other costly, time-consuming procedures. The +submission of an application to a regulatory authority does not guarantee that +the authority will grant an approval or clearance for product. Each +authority may impose its own requirements and can delay or refuse to grant +approval or clearance, even though a product has been approved in another +country. +The time +taken to obtain approval or clearance varies depending on the nature of the +application and may result in the passage of a significant period of time from +the date of submission of the application. Delays in the approval or +clearance processes increase the risk that we will not succeed in introducing or +selling the subject products, and we may determine to devote our resources to +different products. +Changes +in government regulations could increase our costs and could require us to +undergo additional trials or procedures, or could make it impractical or +impossible for us to market our products for certain uses, in certain markets, +or at all. +Changes +in government regulations may adversely affect our financial condition and +results of operations because we may have to incur additional expenses if we are +required to change or implement new testing, manufacturing and control +procedures. If we are required to devote resources to develop such +new procedures, we may not have sufficient resources to devote to research and +development, marketing, or other activities that are critical to our +business. +For +example, the European Union and other jurisdictions have a requirement that +diagnostic medical devices used to test human biological specimens must receive +regulatory approval known as a CE mark, or be registered under the ISO 13.485 +medical device directive. The letters “CE” are the abbreviation of +the French phrase “Conforme Européene,” which means “European +conformity.” ISO (“International Organization for Standardization”) +is the world’s largest developer of standards with 148 member +countries. As such, export to the European and other jurisdictions +without the CE or ISO 13.485 mark is not possible. In 2007, we +received ISO 13.485 certification, in 2008, we received a CE registration for +our Chagas test, and during 2009 we expect to receive CE registration for our +two FDA approved HIV tests. However, there are no assurances that we +will be able to secure this certification although we are not aware of any +material reason why such approval will not be granted. However, if +for any reason a CE registration is not granted, our ability to export our +products could be adversely impacted. +We can +manufacture and sell our products only if we comply with regulations of +government agencies such as the FDA and the USDA. We have implemented +a quality system that is intended to comply with applicable +regulations. Although FDA approval is not required for the export of +our products, there are export regulations promulgated by the FDA that +specifically relate to the export of our products. Although we +believe that we meet the regulatory standards required for the export of our +products, these regulations could change in a manner that could adversely impact +our ability to export our products. +14 +Our +products may not be able to compete with new diagnostic products or existing +products developed by well-established competitors, which would negatively +affect our business. +The +diagnostic industry is focused on the testing of biological specimens in a +laboratory or at the point-of-care and is highly competitive and rapidly +changing. Our principal competitors often have considerably greater +financial, technical and marketing resources than we do. Several +companies produce diagnostic tests that compete directly with our testing +product line, including but not limited to, Orasure Technologies, Inverness +Medical and Trinity Biotech. As new products enter the market, our +products may become obsolete or a competitor’s products may be more effective or +more effectively marketed and sold than ours. Although we have no +specific knowledge of any competitor’s product that will render our products +obsolete, if we fail to maintain and enhance our competitive position or fail to +introduce new products and product features, our customers may decide to use +products developed by our competitors, which could result in a loss of revenues +and cash flow. +We are +developing an oral fluid rapid HIV test as well as other applications utilizing +our Dual Path Platform technology, which we believe could enhance our +competitive position in HIV rapid testing and other fields. During +2008 we completed development of our initial DPP® products for the detection of +antibodies to HIV 1 & 2 in oral fluid as well as blood samples, and a +product for the detection of canine leishmaniasis. However we still +have technical, manufacturing, regulatory and marketing challenges to meet +before we will know whether we can successfully commercialize products +incorporating this technology. There can be no assurance that we will +overcome these challenges. +We have +granted Inverness exclusive rights to market our SURE CHECK® HIV 1/2 in the +United States, Europe and Asia and our HIV 1/2 STAT PAK® in the +U.S. Inverness has no rapid HIV tests that are approved for marketing +in the U.S., we are not aware of any rapid HIV products that Inverness is even +contemplating for the U.S., and Inverness is obligated to inform us of any such +products as soon as it is able to do so. Inverness does have rapid +HIV tests manufactured by certain of its subsidiaries outside the U.S. that are +being actively marketed outside the U.S., primarily in developing +countries. Our HIV 1/2 STAT PAK cassette and dipstick products +compete against these Inverness products, and we specifically acknowledge in our +agreements with Inverness the existence of such other +products. Moreover, except for a product in the HIV barrel field as +defined in our agreement with Inverness, Inverness is permitted under our +agreements to market certain types of permitted competing rapid HIV tests in the +U.S. Under these conditions, we could choose to terminate the +applicable agreement with Inverness or change the agreement to a non-exclusive +agreement, and Inverness would expand the lateral flow license granted to the +Company to allow the Company to market the product independently or through +other marketing partners. While we believe that Inverness is +committed to successfully marketing our products particularly in the U.S. and +other developed countries where our products are or become approved for +marketing, Inverness may choose to develop or acquire competing products for +marketing in the U.S. as well as other markets where they are marketing our SURE +CHECK® HIV 1/2 product, and such an action could have at least a temporary +material adverse effect on the marketing of these products until such time as +alternative marketing arrangements could be implemented. While we +also believe that the expansion of our license to the Inverness lateral flow +patents substantially facilitates our ability to make alternative marketing +arrangements, there can be no assurance that the modification of marketing +arrangements and the possible corresponding delays or suspension of sales would +not have a material adverse effect on our business. +In +addition, the point-of-care diagnostics industry is undergoing rapid +technological changes, with frequent introductions of new technology-driven +products and services. As new technologies become introduced into the +point-of-care diagnostic testing market, we may be required to commit +considerable additional efforts, time and resources to enhance our current +product portfolio or develop new products. We may not have the +available time and resources to accomplish this and many of our competitors have +substantially greater financial and other resources to invest in technological +improvements. We may not be able to effectively implement new +technology-driven products and services or be successful in marketing these +products and services to our customers, which would materially harm our +operating results. +We own no +issued patents covering lateral flow technology, and the field of lateral flow +technology is complex and characterized by a substantial amount of litigation, +so the risk of potential patent challenges is ongoing for us in spite of our +pending patent applications. +Although +we have been granted non-exclusive licenses to the lateral flow patents owned by +Inverness Medical Innovations, Inc. , there is no assurance that their lateral +flow patents will not be challenged or that licenses from other parties may not +be required, if available at all. In the event that it is determined +that a license is required and it is not possible to negotiate a license +agreement under a necessary patent, we may be able to modify our HIV rapid test +products and other products such that a license would not be +necessary. However, this alternative could delay or limit our ability +to sell these products in the U.S. and other markets, which would adversely +affect our results of operations, cash flows and business. +15 +During +2008 Inverness and Church & Dwight commenced a patent infringement suit +against Orasure Technologies, Inc. based on Orasure’s alleged infringement of +one of Church & Dwight’s and Inverness’ (the parties have joint rights to +this patent) main patents covering lateral flow technology. Orasure +has alleged that it does not infringe such patent and that such patent is +invalid. A judgment adverse to Inverness stating that Orasure’s +product does not infringe the Inverness patent or invalidating the Inverness +patent, which patent Inverness has successfully used to restrict competition in +selected product areas core to Inverness’ business, could potentially open up +the US rapid HIV test market to other competitors, and thereby have a material +and adverse effect on our business. A settlement by Inverness with +Orasure, depending on its terms, could also have a material effect on our +business, which effect could be beneficial or detrimental. +On +March 13, 2007, our Dual Path Platform Immunoassay Device patent +application was issued as United States patent +no. 7,189,522. Additional protection for this intellectual +property is pending worldwide. This platform has shown improved +sensitivity as compared with conventional platforms in a number of preliminary +studies using well characterized samples. We believe that this new +platform is outside of the scope of currently issued patents in the field of +lateral flow technology, thereby offering the possibility of a greater freedom +to operate. However there can be no assurance that our patents or our +products incorporating the patent claims will not be challenged at some time in +the future. +New +developments in health treatments or new non-diagnostic products may reduce or +eliminate the demand for our products. +The +development and commercialization of products outside of the diagnostics +industry could adversely affect sales of our products. For example, +the development of a safe and effective vaccine to HIV or treatments for other +diseases or conditions that our products are designed to detect, could reduce, +or eventually eliminate, the demand for our HIV or other diagnostic products and +result in a loss of revenues. +We +may not have sufficient resources to effectively introduce and market our +products, which could materially harm our operating results. +Introducing +and achieving market acceptance for our rapid HIV tests and other new products +will require substantial marketing efforts and will require us or our contract +partners, sales agents, or distributors to make significant expenditures of time +and money. In some instances we will be significantly or +totally reliant on the marketing efforts and expenditures of our contract +partners, sales agents, distributors. If they do not have or commit +the expertise and resources to effectively market the products that we +manufacture, our operating results will be materially harmed. +The +success of our business depends, in addition to the market success of our +products, on our ability to raise additional capital through the sale of debt or +equity or through borrowing, and we may not be able to raise capital or borrow +funds in amounts necessary to continue our business, or at all. +Our +revenues and gross margins have increased significantly in recent periods, and +our operating and net losses have decreased significantly in recent +periods. Nevertheless we have sustained significant operating losses +in 2008, 2007 and 2006. At December 31, 2008, we had a stockholders’ +equity of $2.58 million and a working capital surplus of $1.66 million . The Company +estimates that its resources are sufficient to fund its needs through the end of +2009 and beyond or that, in the alternative, it could raise additional capital +although the terms under which that capital could be raised would likely be very +dilutive to current shareholders. The Company’s liquidity +and cash requirements will depend on several factors. These factors include (1) +the level of revenues (the Company received $340,000 in 2009 for license fees +for which we need to meet certain milestones to earn); (2) the extent to which, +if any, that revenue level improves operating cash flows; (3) the Company’s +investments in research and development, facilities, marketing, regulatory +approvals, and other investments it may determine to make; and (4) the +investment in capital equipment (including production equipment of $323,500 that +the Company has contracted for) and the extent to which it improves cash flow +through operating efficiencies. There are no assurances that the Company will +become profitable or generate positive cash flow by the end of 2009 or, in the +alternative, be successful in raising sufficient capital to fund its needs +through 2009. +Our +objective of increasing international sales is critical to our business plan and +if we fail to meet this objective, we may not generate revenues in the amounts +we expect, or in amounts necessary to continue our business. +We intend +to attempt to increase international sales of our products. A number +of factors can slow or prevent international sales, or substantially increase +the cost of international sales, including: +· +regulatory +requirements and customs +regulations; +· +cultural +and political differences; +· +foreign +exchange rates, currency fluctuations and +tariffs; +· +dependence +on and difficulties in managing international distributors or +representatives; +· +the +creditworthiness of foreign +entities; +· +difficulties +in foreign accounts receivable collection; +and +· +economic +conditions and the absence of available funding +sources. +If we are +unable to increase our revenues from international sales, our operating results +will be materially harmed. +16 +We +rely on trade secret laws and agreements with our key employees and other third +parties to protect our proprietary rights, and we cannot be sure that these laws +or agreements adequately protect our rights. +We +believe that factors such as the technological and creative skills of our +personnel, strategic relationships, new product developments, frequent product +enhancements and name recognition are essential to our success. All +our management personnel are bound by non-disclosure agreements. If +personnel leave our employment, in some cases we would be required to protect +our intellectual property rights pursuant to common law theories which may be +less protective than provisions of employment, non-competition or non-disclosure +agreements. +We seek +to protect our proprietary products under trade secret and copyright laws, enter +into license agreements for various materials and methods employed in our +products, and enter into strategic relationships for distribution of the +products. These strategies afford only limited +protection. We currently have no foreign patents, though we are +seeking patent protection in several foreign jurisdictions for our DPP® +technology. We have licenses to reagents (antigens and peptides) used +in several of our products and products under development We also +have a license to manufacture, use and sell products used to screen for +antibodies to HIV-2. In addition, our SURE CHECK®, DPP® and STAT-PAK® +trademarks have been registered in the U.S. Despite our efforts to +protect our proprietary assets, and respect the intellectual property rights of +others, we participate in several markets where intellectual property rights +protections are of little or no value. This can place our products +and our company at a competitive disadvantage. +During +2008 and in the first quarter of 2009 we terminated a number of employees who +have had access to proprietary and confidential information. In +connection with the termination of several of these employees whose positions +were terminated, individuals executed severance agreements that include strong +covenants by these former employees to keep our proprietary information +confidential. Despite these and other efforts we make to protect our +confidential information, unauthorized parties may attempt to copy aspects of +our products or to obtain information that we regard as +proprietary. We may be required to expend substantial resources in +asserting or protecting our intellectual property rights, or in defending suits +related to intellectual property rights. Disputes regarding +intellectual property rights could substantially delay product development or +commercialization activities because some of our available funds would be +diverted away from our business activities. Disputes regarding +intellectual property rights might include state, federal or foreign court +litigation as well as patent interference, patent reexamination, patent reissue, +or trademark opposition proceedings in the U.S. Patent and Trademark +Office. +To +facilitate development and commercialization of a proprietary technology base, +we may need to obtain additional licenses to patents or other proprietary rights +from other parties. Obtaining and maintaining these licenses, which +may not be available, may require the payment of up-front fees and +royalties. In addition, if we are unable to obtain these types of +licenses, our product development and commercialization efforts may be delayed +or precluded. +Our +continued growth depends on retaining our current key employees and attracting +additional qualified personnel, and we may not be able to do so. +Our +success will depend to a large extent upon the skills and experience of our +executive officers, management and sales, marketing, operations and scientific +staff. We may not be able to attract or retain qualified employees in +the future due to the intense competition for qualified personnel among medical +products businesses, geographic considerations, our ability to offer competitive +compensation , relocation packages, benefits, and/or other reasons. +If we are +not able to attract and retain the necessary personnel to accomplish our +business objectives, we may experience constraints that will adversely affect +our ability to effectively manufacture, sell and market our products to meet the +demands of our strategic partners in a timely fashion, or to support internal +research and development programs. Although we believe we will be +successful in attracting and retaining qualified personnel, competition for +experienced scientists and other personnel from numerous companies and academic +and other research institutions may limit our ability to do so on acceptable +terms. +17 +We have +entered into employment contracts with our President, Lawrence Siebert, and our +Senior Vice President of Research and Development, Javan +Esfandiari. Due to the specific knowledge and experience of these +executives regarding the industry, technology and market, the loss of the +services of either one of them would likely have a material adverse effect on +the Company. The contract with Mr. Siebert had a term of two years +ending May 2008, which the board of directors extended for one year, and +the contract with Mr. Esfandiari has a term of three years ending +March 2010. We have obtained a key man insurance policy for Mr. +Esfandiari. +We +believe our success depends on our ability to participate in large government +programs in the U.S. and worldwide and we may not be able to do so. +We +believe it to be in our best interests to meaningfully participate in the PEPFAR +Program, UN Global Fund initiatives and other programs funded by large +donors. We have initiated several strategies to participate in these +programs. Participation in these programs requires alignment and +engagement with the many other participants in these programs including the +World Health Organization, U.S. Center for Disease Control, U.S. Agency for +International Development, foreign governments and their agencies, +non-governmental organizations, and HIV service organizations. If we +are unsuccessful in our efforts to participate in these programs, our operating +results could be materially harmed. +We +have a history of incurring net losses and we cannot be certain that we will be +able to achieve profitability. +Since the +inception of Chembio Diagnostic Systems, Inc. in 1985 and through the period +ended December 31, 2008, we have incurred net losses. As of +December 31, 2008, we have an accumulated deficit of $37 +million. We incurred net losses of $1.9 million and $2.6 million in +2008 and 2007, respectively. +We expect +to continue to make substantial expenditures for sales and marketing, regulatory +submissions, product development and other purposes, though within reasonable +limitations that we believe are necessary in order to continue our making +progress toward profitability without requiring additional +capital. Our ability to achieve profitability in the future will +primarily depend on our ability to increase sales of our products, reduce +production and other costs and successfully introduce new products and enhanced +versions of our existing products into the marketplace. If we are +unable to increase our revenues at a rate that is sufficient to achieve +profitability, or adequately control and reduce our operating costs, our +operating results would be materially harmed. +To +the extent that we are unable to obtain sufficient product liability insurance +or that we incur product liability exposure that is not covered by our product +liability insurance, our operating results could be materially +harmed. +We may be +held liable if any of our products, or any product which is made with the use or +incorporation of any of the technologies belonging to us, causes injury of any +type or is found otherwise unsuitable during product testing, manufacturing, +marketing, sale or usage. We have obtained product liability +insurance, we have never received a product liability claim, and have generally +not seen product liability claims for screening tests that are accompanied by +appropriate disclaimers. Nevertheless, in the event there is a claim, +this insurance may not fully cover our potential liabilities. In +addition, as we attempt to bring new products to market, we may need to increase +our product liability coverage which would be a significant additional expense +that we may not be able to afford. If we are unable to obtain +sufficient insurance coverage at an acceptable cost to protect us, we may be +forced to abandon efforts to commercialize our products or those of our +strategic partners, which would reduce our revenues. +Risks +related to our Common Stock +In +the past, our Common Stock has been classified as penny stock, and it continues +to be extremely illiquid, so investors may not be able to sell as much stock as +they want at prevailing market prices. +In the +past, our Common Stock has been classified as penny stock. Penny +stocks generally are equity securities with a price of less than $5.00 and trade +on the over-the-counter market. As a result, an investor may find it +more difficult to dispose of or obtain accurate quotations as to the price of +the securities that are classified as penny stocks. The “penny stock” +rules adopted by the Commission under the Securities Exchange Act of 1934, as +amended (the “Exchange Act”), subject the sale of the shares of penny stock +issuers to regulations that impose sales practice requirements on +broker-dealers, causing many broker-dealers to not trade penny stocks or to only +offer the stocks to sophisticated investors that meet specified net worth or net +income criteria identified by the Commission. These regulations +contribute to the lack of liquidity of penny stocks. +18 +At the +present time, transactions in our Common Stock are not subject to the “penny +stock” rules because our average revenue for 2006, 2007 and 2008 exceeded $6 +million per year. However, there can be no assurance that +transactions in our Common Stock will not be subject to the “penny stock” rules +in the future. +The +average daily trading volume of our Common Stock on the over-the-counter market +was less than 16,000 shares per day over the three months ended March 16, +2009. If limited trading in our stock continues, it may be difficult +for investors to sell their shares in the public market at any given time at +prevailing prices. +Our +management and larger stockholders exercise significant control over our Company +and may approve or take actions that may be adverse to your +interests. +As of +March 17, 2009, our named executive officers, directors and 5% stockholders +beneficially owned approximately 63.7% of our voting power. For the +foreseeable future, to the extent that our current stockholders vote similarly, +they will be able to exercise control over many matters requiring approval by +the board of directors or our stockholders. As a result, they will be +able to: +· +control +the composition of our board of +directors; +· +control +our management and policies; +· +determine +the outcome of significant corporate transactions, including changes in +control that may be beneficial to stockholders; +and +· +act +in each of their own interests, which may conflict with, or be different +from, the interests of each other or the interests of the other +stockholders. +ITEM +2. +PROPERTIES +Our +administrative offices and research facilities are located in Medford, New +York. We lease approximately 18,200 square feet of industrial space +for $11,987 per month. The space is utilized for research and +development activities (approximately 2,660 square feet), offices (approximately +1,820 square feet) and production (approximately 13,720 square +feet). The lease term expires on April 30, 2009, and the Company has +an option to renew for an additional two +years. Additional space may be required as we expand our +research and development activities. We do not foresee any +significant difficulties in obtaining any required additional +facilities. +As of the +filing date of this Annual Report, the Company is in discussion +for a lease extension for its administrative offices and research +facilities. The principle terms being discussed are as +follows: (a) a lease term of five years; (b) an initial rent of +$11,350 per month; (c) the monthly rent for year two of the lease will +increase by the lower of (i) the change in the consumer price index, or +(ii) five percent; and (d) the monthly rent for years three through +five of the lease will increase each year by the lower of (i) the change in +the consumer price index, or (ii) two and one half percent. Although +the Company believes that the extension will be entered into on terms that are +substantially similar to the terms being discussed, there is no assurance +that this will occur. +ITEM +3. +LEGAL +PROCEEDINGS +From time +to time, we may be involved in litigation relating to claims arising out of our +operations in the normal course of business. We know of no material, +existing or pending legal proceedings against us, nor are we involved as a +plaintiff in any material proceeding or pending litigation. There are +no proceedings in which any of our directors, officers or affiliates, or any +registered or beneficial shareholder, is an adverse party or has a material +interest that is adverse to our interest. +19 +PART +II +ITEM +5. +MARKET +FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER +PURCHASES OF EQUITY SECURITIES +Market +Information +Our +common stock is quoted on the OTC Bulletin Board under the symbol +“CEMI.” The table below sets forth the high and low bid prices per +share of our common stock for each quarter of our two most recently completed +fiscal years. These prices represent inter-dealer quotations without +retail markup, markdown, or commission and may not necessarily represent actual +transactions. +Fiscal +Year 2008 +High +Bid +Low +Bid +First +Quarter +$0.30 +$0.11 +Second +Quarter +$0.26 +$0.08 +Third +Quarter +$0.28 +$0.15 +Fourth +Quarter +$0.21 +$0.10 +Fiscal +Year 2007 +High +Bid +Low +Bid +First +Quarter +$0.93 +$0.61 +Second +Quarter +$0.65 +$0.47 +Third +Quarter +$0.65 +$0.37 +Fourth +Quarter +$0.57 +$0.26 +Rule +15g-9 of the Securities and Exchange Commission, known as the Penny Stock Rule, +imposes requirements on broker/dealers who sell securities subject to the rule +to persons other than established customers and accredited +investors. For transactions covered by the rule, brokers/dealers must +make a special suitability determination for purchasers of the securities and +receive the purchaser’s written agreement to the transaction prior to +sale. The Securities and Exchange Commission also has rules that +regulate broker/dealer practices in connection with transactions in “penny +stocks.” Penny stocks generally are equity securities with a price of +less than $5.00 (other than securities registered on certain national securities +exchanges or quoted on the NASDAQ system, provided that current price and volume +information with respect to transactions in that security is provided by the +exchange or system), except for securities of companies that have tangible net +assets in excess of $2,000,000 or average revenue of at least $6,000,000 for the +previous three years. The Penny Stock Rule requires a broker/ dealer, +prior to a transaction in a penny stock not otherwise exempt from the rules, to +deliver a standardized risk disclosure document prepared by the Commission that +provides information about penny stocks and the nature and level of risks in the +penny stock market. The broker/dealer also must provide the customer +with current bid and offer quotations for the penny stock, the compensation of +the broker/dealer and its salesperson in the transaction, and monthly account +statements showing the market value of each penny stock held in the customer’s +account. The bid and offer quotations, and the broker/dealer and +salesperson compensation information, must be given to the customer orally or in +writing prior to effecting the transaction and must be given to the customer in +writing before or with the customer’s confirmation. These disclosure +requirements have the effect of reducing the level of trading activity in the +secondary market for penny stock issues. As a result of these rules, +investors sometimes find it difficult to sell shares of penny stock +issuers. At the present time, transactions in our common stock are +not subject to the Penny Stock Rule because our average revenue for 2006, 2007 +and 2008 exceeded $6 million per year. However, there can be no +assurance that transactions in our common stock will not be subject to the Penny +Stock Rule in the future. +20 +Holders +As of +January 15, 2009, there were approximately 875 record owners of our common +stock. +Dividends +The +Company has never paid cash dividends on its common stock and has no plans to do +so in the foreseeable future. +Equity +Compensation Plan Information +Combined +Equity Compensation Plans - Information as of December 31, +2008 +Plan +Category +Number +of Securities to be Issued Upon Exercise of Outstanding Options, Warrants +and Rights +Weighted-Average +Exercise Price of Outstanding Options, Warrants and +Rights +Number +of Securities Remaining Available for Future Issuance under Equity +Compensation Plans (Excluding Securities Reflected in Column +(a)) +(a) +(b) +(c) +Equity +compensation plans approved by security holders 1 +2,416,650 1 +$0.366 +4,566,350 +Equity +compensation plans not approved by security holders +-- +-- +-- +Total +2,416,650 +$0.366 +4,566,350 +1 The +“Number of Securities to be Issued Upon Exercise of Outstanding Warrants and +Rights” represents 1,983,000 from the 1999 Stock Option Plan and +433,650 under the 2008 Stock Incentive Plan. The “Number of +Securities Remaining Available for Future Issuance Under Equity Compensation +Plans” represents shares issuable under the 2008 Stock Incentive +Plan. The Company currently has no intention to issue additional +securities under the 1999 Stock +Option Plan . +ITEM +6. SELECTED FINANCIAL DATA +Presented +in this table are selected financial data for the past five years ending +December 31, 2008. Prior year’s financial statements have been +reclassified to conform to current year presentation (See discussion in ITEM 7. +MANAGEMENT’S +DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS , +Gross Margin). As of the year ended December 31, 2008 the Company +reclassified its royalty and license expenses to cost of goods sold, instead of +selling, general and administrative expenses. +21 +CHEMBIO DIAGNOSTICS, +INC. AND SUBSIDIARIES +SELECTED +FINANCIAL DATA +Statement +of Operations Data: +December +31, 2008 +December +31, 2007 +December +31, 2006 +December +31, 2005 +December +31, 2004 +TOTAL +REVENUES +$ +11,049,571 +$ +9,230,948 +$ +6,502,480 +$ +3,940,730 +$ +3,305,932 +GROSS +PROFIT +3,851,721 +35 +% +2,795,710 +30 +% +1,608,272 +25 +% +944,648 +24 +% +623,242 +19 +% +OVERHEAD +COSTS: +Research +and development expenses +2,605,343 +24 +% +1,906,653 +21 +% +1,401,472 +22 +% +1,364,898 +35 +% +1,508,849 +46 +% +Selling, +general and administrative expenses +3,317,046 +30 +% +3,765,221 +41 +% +4,786,993 +74 +% +2,877,737 +73 +% +2,217,755 +67 +% +5,922,389 +5,671,874 +6,188,465 +4,242,635 +3,726,604 +LOSS +FROM OPERATIONS +(2,070,668 +) +(2,876,164 +) +(4,580,193 +) +(3,297,987 +) +(3,103,362 +) +OTHER +INCOME (EXPENSES): +121,898 +249,272 +(414,827 +) +45,987 +4,471 +NET +LOSS +(1,948,770 +) +-18 +% +(2,626,892 +) +-28 +% +(4,995,020 +) +-77 +% +(3,252,000 +) +-83 +% +(3,098,891 +) +-94 +% +Dividends +accreted/payable in stock to preferred stockholders and a beneficial +conversion feature +- +5,645,310 +3,210,046 +3,517,022 +1,943,073 +NET +LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS +$ +(1,948,770 +) +-18 +% +$ +(8,272,202 +) +-90 +% +$ +(8,205,066 +) +-126 +% +$ +(6,769,022 +) +-172 +% +$ +(5,041,964 +) +-153 +% +Basic +and diluted loss per share +$ +(0.03 +) +$ +(0.57 +) +$ +(0.80 +) +$ +(0.88 +) +$ +(0.85 +) +Weighted +average number of shares outstanding, basic and diluted +61,266,954 +14,608,478 +10,293,168 +7,705,782 +5,966,769 +Balance +Sheet Data: +Working +capital +$ +1,663,914 +$ +3,228,724 +$ +5,113,233 +$ +4,707,957 +$ +(504,825 +) +Total +assets +5,914,941 +6,584,997 +7,906,577 +7,074,644 +1,373,760 +Total +liabilities +3,337,609 +2,322,171 +2,297,193 +1,963,703 +1,950,413 +Shareholders' +equity (deficit) +2,577,332 +4,262,826 +(939,807 +) +1,052,703 +(523,964 +) +22 +ITEM +7. +MANAGEMENT’S +DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF +OPERATIONS +Overview +This +discussion and analysis should be read in conjunction with the accompanying +Consolidated Financial Statements and related notes. Our discussion +and analysis of our financial condition and results of operations are based upon +our consolidated financial statements, which have been prepared in accordance +with accounting principles generally accepted in the United States. The +preparation of financial statements in conformity with accounting principles +generally accepted in the United States of America requires us to make estimates +and assumptions that affect the reported amounts of assets and liabilities, +disclosure of any contingent liabilities at the financial statement date and +reported amounts of revenue and expenses during the reporting period. On an +ongoing basis we review our estimates and assumptions. Our estimates were based +on our historical experience and other assumptions that we believe to be +reasonable under the circumstances. Actual results are likely to differ from +those estimates under different assumptions or conditions, but we do not believe +such differences will materially affect our financial position or results of +operations. Our critical accounting policies, the policies we believe are most +important to the presentation of our financial statements and require the most +difficult, subjective and complex judgments, are outlined below in ‘‘Critical +Accounting Policies,’’ and have not changed significantly. +In +addition, certain statements made in this report may constitute “forward-looking +statements”. These forward-looking statements involve known or +unknown risks, uncertainties and other factors that may cause the actual +results, performance or achievements of the Company to be materially different +from any future results, performance or achievements expressed or implied by the +forward-looking statements. Specifically, 1) our ability to obtain necessary +regulatory approvals for our products; and 2) our ability to increase revenues +and operating income, is dependent upon our ability to develop and sell our +products, general economic conditions, and other factors. You can identify +forward-looking statements by terminology such as “may,” “could”, “will,” +“should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” +“predicts,” “potential,” “continues” or the negative of these terms or other +comparable terminology. Although we believe that the expectations reflected-in +the forward-looking statements are reasonable, we cannot guarantee future +results, levels of activity, performance or achievements. +Except as +may be required by applicable law, we do not undertake or intend to update or +revise our forward-looking statements, and we assume no obligation to update any +forward-looking statements contained in this report as a result of new +information or future events or developments. Thus, you should not +assume that our silence over time means that actual events are bearing out as +expressed or implied in such forward-looking statements. You should +carefully review and consider the various disclosures we make in this report and +our other reports filed with the Securities and Exchange Commission that attempt +to advise interested parties of the risks, uncertainties and other factors that +may affect our business. +The +following management discussion and analysis relates to the business of the +Company, including its subsidiaries, which develop, manufacture, and market +rapid diagnostic tests that detect infectious diseases. The Company’s main +products presently commercially available are three rapid tests for the +detection of HIV antibodies in whole blood, serum and plasma samples, all of +which employ lateral flow technology and two of which were approved by the FDA +in 2006. In addition, we have a fourth rapid HIV test, more recently +developed on our patented Dual Path Platform (DPP®) technology, for the +detection of antibodies to HIV in oral fluid samples, as well as in whole blood, +serum and plasma samples. The products which employ lateral flow technology are +manufactured and sold under a non-exclusive license we +have from Inverness Medical Innovations, Inc. (“Inverness”), which is +also our exclusive marketing partner for +the FDA-approved products in the United States (as well as +Europe and Asia for the product that is known as the “barrel” format product) +under its Clearview® brand. Inverness launched its marketing of these +products in the United States in February 2007. Chembio’s two HIV +STAT-PAK® rapid HIV tests (in cassette and dipstick formats) are marketed +outside the United States through different partners and channels under our +license from Inverness. +Rapid HIV +tests represented nearly 90% of the Company’s product revenues in 2008. The +Company also has other rapid tests that together represented approximately 10% +of sales in 2008. The Company’s products are sold to medical laboratories and +hospitals, governmental and public health entities, non-governmental +organizations, medical professionals and retail establishments. Chembio’s +products are sold under the Company’s STAT PAK® or SURE CHECK ® registered +trademarks or under the private labels of its marketing partners, for example +the Clearview® label owned by Inverness Medical Innovations, Inc. +23 +All of +the Company’s future products that are currently being developed are based on +its patented Dual Path Platform (DPP®), which is a unique diagnostic +point-of-care platform that has certain advantages over lateral flow +technology. In 2008 the Company completed development of its first +two products that employ the DPP® technology and it has a number of additional +products under development that employ the DPP® technology. These +product development activities are further explained below. +Oswaldo +Cruz Foundation Agreements +During +2008 we signed four agreements with the Oswaldo Cruz Foundation (FIOCRUZ) in +Brazil relating to products for Leptospirosis, Leishmaniasis, screening for HIV +1/2 with oral fluid samples, and confirmation of HIV 1. We have +completed development of two of the products (Leishmaniasis and HIV oral fluid +screening test), and substantially completed development of the other +two. All four of these products are or will be undergoing regulatory +approval evaluations in Brazil; we expect that all of these products will be +approved by ANVISA for distribution by FIOCRUZ in Brazil during 2009, triggering +initial orders as well as approximately $1MM in technology transfer fee payments +to the Company in 2009. We received purchase orders from FIOCRUZ in +the fourth quarter of 2008 for approximately $500,000 of the Leishmaniasis +product; however due to the delay in FIOCRUZ receiving necessary import +authorizations for the second and larger portion of this order, approximately +$380,000 of this amount could not be shipped in December and was instead shipped +during the first quarter of 2009. Also, based upon additional +features that we are adding to the HIV confirmatory test, we are finalizing a +revised agreement for this product which we believe will provide us with a +larger market opportunity for this product in Brazil subject to regulatory +approval and other conditions. +On April +16, 2008, we announced a new development agreement with Bio-Rad Laboratories +N.A.., a part of Bio-Rad Laboratories Inc, a leading in-vitro diagnostic and +life science company. The agreement with Bio-Rad is for the +development of a new multiplex product that is being developed on DPP® and which +would be marketed by Bio-Rad under a limited exclusive license from Chembio to +Bio-Rad that is limited to this field of application. Our agreement with Bio-Rad +contemplated that we would enter into a license agreement effective no later +than December 2008 subject to Bio-Rad being satisfied with development progress +and other conditions. We in fact did enter into this license +agreement in January 2009 with a December 31, 2008 effective date and have +received a $340,000 payment for this license. Development of this +product is anticipated to continue through 2009, funded by Bio-Rad at a cost of +$125,000 every six months. The agreement is terminable at any time by +Bio Rad and, under certain circumstances, some or all of the $340,000 license +fee is refundable. +DPP® +HIV Oral Fluid Test Status +Having +completed development of this product in 2008 for international sales, we are +now in the initial stages of commercializing it to participate in the US and +global markets. We are initially pursuing approval and registration +of this product in the large markets globally including but not limited to those +markets where we have been successful with our current lateral flow tests that +only use finger-stick whole blood and other blood matrices (venous whole blood, +serum and plasma). Our product is being included in a study in Africa +that is being conducted by a governmental organization interested in the +possibility of expanded use of oral fluid based tests. We are also +negotiating an agreement with a large global in-vitro diagnostic products +company that would have exclusive marketing rights to this product in the United +States market under a co-branding of the product that would include the DPP® +trademark in the name of the product. (See RECENT DEVELOPMENTS AND +CHEMBIO’S PLAN OF OPERATIONS FOR THE NEXT TWELVE MONTHS). +Progress +on DPP® Syphilis Screen and Confirm Multiplex Test +During +2008 and 2009 year to date, we made substantial progress on this product, with +extensive collaborative efforts with the CDC and others. We are +currently evaluating whether this product meets the performance objectives for +the US market while we continue to assess and focus on the market opportunity +for this product in the United States. +Other +DPP® Development Projects +Our +patented DPP® technology, combined with our development and manufacturing +experience and know-how, has enabled us to attract and enter into and pursue +third-party-funded product development opportunities that in turn add further to +our capabilities while subsidizing some of our R&D personnel and overall +overhead costs. This allows us to maintain a larger R&D staff +than we could otherwise justify, which also gives us some flexibility in how and +when we allocate resources. Included in our research and development +organization is a technical team that we created in 2008. This team +is able to transfer products from R&D into production and assist in +validation, is involved in supporting our manufacturing organization when the +need arises, and is also able to assist in pure development +activities. Creation of this team was an important accomplishment in +2008. +24 +Chembio +continues to work with commercial, governmental and private organizations in +order to obtain research grants and other funding for development +projects. In this regard, we have entered into a development +agreement with Bio-Rad, which, subject to continued achievement of milestones +and other conditions, could result in approximately $200,000 of development +funds for Chembio in 2009. We also have DPP Ò grants from governmental +agencies for $55,000 for leprosy research and $110,000 for Human TB Serology +research in 2009. Our four technology transfer, supply and license +agreements with Oswaldo Cruz Foundation of Brazil could result in as much as +$1,050,000 of advance royalty payments. In addition to the projects +described, Chembio has applied for other research grants and is working on +entering into a number of other development agreements. +There can +be no assurance that any of these projects will continue, meet regulatory or +other technical requirements and specifications, and/or that if continued, will +result in completed products, or that such products, if successfully completed, +will be successfully commercialized. +Regulatory +Activities +We +continue to make progress on obtaining a Community European (CE) marking for our +products to indicate conformity with European Union health, safety and +environmental requirements. We have submitted the HIV 1/2 STAT-PAK® technical +file to our notified body and should complete all required steps for CE Marking +of this product during the second quarter of 2009. Under +our agreement with Inverness we are to obtain a CE Marking for the Clearview® +Complete HIV 1/2. We are prepared to submit the technical file for +this product on behalf of Inverness once we have received final proposed +labeling from Inverness. +We are +pursuing registrations of our lateral flow and DPP® HIV products in a number of +other jurisdictions, and also pursing registrations with the USDA of additional +claims for our veterinary tuberculosis products. +Recent +Events +During +the quarter ended December 31, 2008, Inverness Medical Innovations, Inc. +(“Inverness”) notified the Company that Inverness had entered into a contract +with Bio-Rad Laboratories, Inc. (“Bio-Rad”) for royalties on Bio-Rad’s patent +for the detection of HIV-2 antibodies. The agreement also provided +for Inverness to pay past royalties. The agreements between the +Company and Inverness provide that the Company is to share in these past +royalties and Inverness requested it be reimbursed for the Company’s share of +these past royalties. The Company and Inverness have agreed that this +liability, which is approximately $500,000, is to be paid from future revenues +over approximately the next 18 months. +For the +year ended December 31, 2008 the Company reclassified its royalty and license +expenses to cost of goods sold, instead of selling, general and administrative +expenses. +On +December 19, 2007 (the “Closing Date”), amendments to the governing documents +for the Company’s Series A, Series B and Series C Convertible Preferred Stock +(collectively, the “Preferred Stock”) and for certain warrants and options +(collectively, the “Non-Employee Warrants”), not including options or warrants +issued to employees or directors in their capacity as such (these actions +collectively, the “Plan”), were approved by the Company and the requisite +percentages of the holders of the Preferred Stock and of the Non-Employee +Warrants. Subsequent to these amendments, among other matters, all the +Preferred Stock and certain of the Non-Employee Warrants were converted to +shares of the Company’s common stock. +25 +RESULTS +OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2008 AS COMPARED WITH THE YEAR +ENDED DECEMBER 31, 2007 +Revenues: +Selected +Product Categories: +For +the years ended +December +31, 2008 +December +31, 2007 +$ +Change +% +Change +HIV +$ +9,192,297 +$ +7,927,676 +$ +1,264,621 +15.95 +% +TB +281,555 +111,403 +170,152 +152.74 +% +Other +881,916 +725,798 +156,118 +21.51 +% +Net +Product Sales +10,355,768 +8,764,877 +1,590,891 +18.15 +% +Research +grant income +693,803 +466,071 +227,732 +48.86 +% +Total +Revenues +$ +11,049,571 +$ +9,230,948 +$ +1,818,623 +19.70 +% +Revenues +for our HIV tests and related components during the year ended December 31, 2008 +increased by $1.26 million over the same period in 2007. This was +primarily attributable to increased sales in Brazil and sales to our distributor +in the United States, offset by the reduction of sales to Mexico from 2007 that +were not repeated in 2008. Sales of our TB product increased because +of additional products being approved. The increase in research grant +income was for grants and feasibility studies involving our patented DPP® +technology of which $651,000 was received and $694,000 was earned in 2008, +utilizing $43,000 in deferred revenues as of December 31, 2007. Sales +to Africa (see Note 13 of the financial statements) were primarily from Nigeria +of approximately $2.86 million. We have been advised recently that +our designation in Nigeria as one of the screening tests has changed to that of +the confirmatory test as this country moves from a parallel to a serial testing +algorithm, which we expect will significantly reduce our sales to Nigeria in +2009. +Gross +Margin: +Gross +Margin related to +For the years ended +Net +Product Sales: +December +31, 2008 +December +31, 2007 +$ +Change +% +Change +Gross +Margin per Statement of Operations +$ +3,851,721 +$ +2,795,710 +$ +1,056,011 +37.77 +% +Less: +Research grant income +693,803 +466,071 +227,732 +48.86 +% +Gross +Margin from Net Product Sales +$ +3,157,918 +$ +2,329,639 +$ +828,279 +35.55 +% +Gross +Margin % +30.49 +% +26.58 +% +The +increase in our gross margin resulted primarily from increased quantities of our +product sales and increased average unit prices on product sales and component +sales. +For the +year ended December 31, 2008, the Company reclassified its royalty and license +expenses to cost of goods sold. For all periods prior to the quarter +ended December 31, 2008 these expenses were previously reflected in selling, +general and administrative expenses. Without this reclassification of +royalty and license expenses from SG&A expense to Cost of Goods Sold, the +gross margin from product sales would have been $4.465 million, or 43.1%, and +$3.396 million, or 38.7%, for the years ended December 31, 2008 and 2007, +respectively. +26 +Research and +Development: +This +category includes costs incurred for product research and development, +regulatory approvals, technical support, evaluations and +registrations. +Selected +expense lines: +For the years ended +December +31, 2008 +December +31, 2007 +$ +Change +% +Change +Clinical & +Regulatory Affairs: +Wages +and related costs +$ +262,191 +$ +188,050 +$ +74,141 +39.43 +% +Consulting +27,231 +87,763 +(60,532 +) +-68.97 +% +Clinical +trials +138,792 +29,664 +109,128 +367.88 +% +Other +60,821 +(35,915 +) +96,736 +-269.35 +% +Total +Regulatory +$ +489,035 +$ +269,562 +$ +219,473 +81.42 +% +R&D Other than +Regulatory: +Wages +and related costs +$ +1,354,557 +$ +959,679 +$ +394,878 +41.15 +% +Consulting +138,436 +102,075 +36,361 +35.62 +% +Share-based +compensation +84,935 +189,843 +(104,908 +) +-55.26 +% +Materials +and supplies +307,662 +268,566 +39,096 +14.56 +% +Other +230,718 +116,928 +113,790 +97.32 +% +Total +other than Regulatory +$ +2,116,308 +$ +1,637,091 +$ +479,217 +29.27 +% +Total +Research and Development +$ +2,605,343 +$ +1,906,653 +$ +698,690 +36.64 +% +Expenses +for Clinical & Regulatory Affairs for the year ended December 31, +2008 increased by $219,500 as compared to the same period in 2007. This was +primarily due to an increase in expenses related to internal DPP +testing, external clinical trials we contracted for in order to lower the +age limitation of our FDA approved rapid HIV tests from 18 to 13 years of age, +and also due to an increase in wages and related costs as we added to our +regulatory staff, offset by a decrease in the use of consultants +Expenses +other than Clinical & Regulatory Affairs increased by $479,200 in the +year ended December 31, 2008 as compared with the same period in 2007 and were +primarily related to an increase in personnel and material costs required to +perform the work related to funded feasibility studies and grants received, +all related to our patented DPP® technology, and to the establishment of a +technical group within the R&D department in order to support product +validations and transfers to production. These increases were +partially offset by a decrease in the cost of share-based compensation related +to the value of common stock and employee stock options issued to an employee +pursuant to a contract. +Subject +to the continuation of grant and feasibility income, the Company currently +plans to continue research and development spending at levels that will, net of +grant and feasibility study income, result in a net decrease in this spending +category. +27 +Selling, General and +Administrative Expense: +Selected +expense lines: +For the years ended +December +31, 2008 +December +31, 2007 +$ +Change +% +Change +Wages +and related costs +$ +1,261,511 +$ +1,642,185 +$ +(380,674 +) +-23.18 +% +Consulting +187,494 +232,184 +(44,690 +) +-19.25 +% +Commissons +365,774 +31,762 +334,012 +1051.61 +% +Share-based +compensation +187,908 +152,319 +35,589 +23.36 +% +Marketing +materials +38,379 +75,570 +(37,191 +) +-49.21 +% +Investor +relations +123,654 +224,843 +(101,189 +) +-45.00 +% +Legal, +accounting and SOX 404 compliance +551,335 +643,562 +(92,227 +) +-14.33 +% +Travel, +entertainment and trade shows +92,576 +154,819 +(62,243 +) +-40.20 +% +Other +508,415 +607,977 +(99,562 +) +-16.38 +% +Total +S, G &A +$ +3,317,046 +$ +3,765,221 +$ +(448,175 +) +-11.90 +% +Selling, +general and administrative expenses for the year ended December 31, 2008 +decreased by 12% as compared with the same period in 2007. Reduced +personnel expenses, investor relations expenses, and professional fees were +partially offset by increases in sales commissions that resulted from +commissionable sales in Brazil that increased significantly in 2008 as compared +with 2007. The decreased cost of professional fees (legal, accounting +and section 404 of Sarbanes-Oxley) were related to the reduction of legal fees +related to the Plan (see Recent Events above), which were almost all incurred in +2007. These decreased costs were partially offset by increased fees +to our independent auditors. +Other Income and +Expense: +Other +Income and Expense +For +the years ended +December +31, 2008 +December +31, 2007 +$ +Change +% +Change +Other +income +$ +95,812 +$ +120,862 +$ +(25,050 +) +-20.73 +% +Interest +income +34,403 +145,289 +(110,886 +) +-76.32 +% +Interest +expense +(8,317 +) +(16,879 +) +8,562 +-50.73 +% +Total +Other Income and Expense +$ +121,898 +$ +249,272 +$ +(127,374 +) +-51.10 +% +Other +income for the year ended December 31, 2008 decreased 21% as compared with the +same period in 2007 primarily as a result of a decrease in the net amounts +received from New York State related to a program for qualified emerging +technology companies. Interest income for the year ended +December 31, 2008 decreased due to a decrease in available funds to invest in +interest bearing accounts. Decreased interest expense in 2008 +as compared with 2007 reflects the impact of lower interest payments for capital +leases nearing the end of their terms +28 +LIQUIDITY +AND CAPITAL RESOURCES +For +the years ended +December +31, 2008 +December +31, 2007 +$ +Change +% +Change +Net +cash used in operating activities +$ +(1,194,227 +) +$ +(1,345,796 +) +$ +151,569 +-11.26 +% +Net +cash used in investing activities +(397,462 +) +(410,425 +) +12,963 +-3.16 +% +Net +cash (used in) provided by financing activities +(23,458 +) +293,204 +(316,662 +) +-108.00 +% +NET +(DECREASE) IN CASH AND CASH EQUIVALENTS +$ +(1,615,147 +) +$ +(1,463,017 +) +$ +(152,130 +) +10.40 +% +The +Company had a decrease in cash for the year ended December 31, 2008 as compared +to a lesser decrease in cash for the same period in 2007. The decrease during +the 2008 and 2007 periods is primarily attributable to the cash used in +operations. +The +Company had a working capital surplus of $1,664,000 at December 31, 2008 and a +working capital surplus of $3,229,000 at December 31, 2007. The +Company estimates that its resources are sufficient to fund its needs through +the end of 2009 and beyond or that, in the alternative, it could raise +additional capital although the terms under which that capital could be raised +would likely be very dilutive to current shareholders. The Company’s +liquidity and cash requirements will depend on several factors. These factors +include (1) the level of revenues (the Company received $340,000 in 2009 for +license fees for which we need to meet certain milestones to earn); (2) the +extent to which, if any, that revenue level improves operating cash flows; (3) +the Company’s investments in research and development, facilities, marketing, +regulatory approvals, and other investments it may determine to make; and (4) +the investment in capital equipment (including production equipment of $323,500 +that the Company has contracted for) and the extent to which it improves cash +flow through operating efficiencies. There are no assurances that the Company +will become profitable or generate positive cash flow by the end of 2009 or, in +the alternative, be successful in raising sufficient capital to fund its +needs through 2009. +RECENT +DEVELOPMENTS AND CHEMBIO’S PLAN OF OPERATIONS FOR THE NEXT TWELVE +MONTHS +Please +see section entitled Recent Events above. +2008 +During +2008 Chembio increased total revenues by 20% to $11.05MM, increased gross profit +by 38% to $3.85MM (based on the presentation in Item 6 Selected Financial Data +wherein our reclassification of Royalty Expense and License Fees, reclassified +to Cost of Goods Sold in our audited statements for 2008, were also +reclassified, for 2004-2007 for comparative purposes), and decreased Selling, +General & Administrative Expense by 12% to $3.32MM. Research and +Development Expense, net of Research Grant Income, increased 33% to +$1.91MM. +2008 +revenue growth was attributable to our continued collaboration in Brazil with +Oswaldo Cruz Foundation and to strong sales growth to Africa, including but not +limited to Nigeria, to and through major programs led by the Global Fund and +PEPFAR. Even though our sales to Inverness were less in 2008 than in +2007, this was primarily a result of purchases made by Inverness at the time of +the launch in 2007 in excess of the actual demand from their customers in 2007, +which in turn was in part a result of delays in our obtaining both the age claim +amendment and the CLIA waiver for the barrel product (See Item 1. Business: +Regulatory Activities). We believe Inverness’ sales of our products +increased significantly in 2008 versus 2007, notwithstanding a voluntary +component (control kit) recall that occurred during the first half of 2008. With +continued sales increases by Inverness to its customers in 2009, which we +believe is likely, we would expect to see commensurate increases in our sales to +Inverness, as we believe that Inverness’ inventories have been substantially +reduced as compared to 2008. +Our +improved gross margin percentage, even after the fourth quarter 2008 royalty +expenses related to prior quarters, occurred as a result of continued cost and +efficiency improvements as well as improved product mix, primarily as a result +of lower unit production costs for components sold to +Brazil. Decreased SG&A costs were achieved through termination of +positions within these departments and reduction in other costs throughout this +cost area. Our net increase in Research & Development +expenses included our costs of completing the lowering of the age limit of our +FDA approved rapid HIV tests, as well as the cost of establishing a technical +department within R&D that can alternatively support operations, transfer +new products to operations, research process improvements, and to the extent +there is available capacity within this group, support traditional R&D +activities. +29 +2009 +Based +upon (1) the growing base of business we have in the United States for our two +FDA-approved CLIA-waived rapid HIV tests, resulting both from the expansion of +the market and from market share gains by our marketing partner Inverness +Medical; (2) continued growth opportunities for our rapid HIV test products +globally, and; (3) our expectation that 2009 will bring our first significant +revenues from our DPP® technology, primarily as a result of the contracts we +signed with the Oswaldo Cruz Foundation in 2008, we believe we are positioned +for increases in our revenues and improvement in our overall operating results +in 2009. +Our base +plan for 2009 assumes the following: (1) Growth in our sales to Inverness, as it +makes gains in hospital and public health markets and because inventory levels +that it brought into 2008 have been normalized, (2) conservative +assumptions with regard to our international HIV business, primarily +including a significant reduction from Nigeria, partially offset by expected +growth from our HIV business through new distribution opportunities in Asia, +Africa, South America and, upon receipt of our CE Mark, Europe, and (3) +successful execution for approval and sales of our DPP® products pursuant to the +contracts we signed with Oswaldo Cruz Foundation in 2008. +We intend +to continue improving our manufacturing efficiencies and controlling our +SG&A expenses, resulting in continued anticipated improvements in our +operating results. Even though we made significant cost reductions +during 2008, given the reduced sales from Nigeria, an extremely uncertain +economy, and the most challenging financing environment for debt or equity of +our time, during the first quarter of 2009 we made additional cost reductions in +all departments of the Company, including elimination of a number of salaried +positions and implementation of a company-wide pay reduction program for all +salaried employees earning at least $30,000, with appropriately larger +reductions for those earning higher amounts. During 2008 and 2009 year-to-date +we have also eliminated salaries in our sales and marketing and administrative +areas, which represented annualized costs in excess of $500,000, exclusive of +benefits and other attendant costs. Though this limits some new +business development opportunities, many of our new sales opportunities are +being developed either through OEM customer relationships, exclusive +distribution arrangements, and/or commissioned agents, all of which have enabled +us to reduce our sales and marketing costs significantly. +Research +& Development expenses in 2009 are budgeted as flat overall when compared +with 2008. However, based upon current and pending research and +development income from grants, development contracts and feasibility studies +(and associated staffing requirements for such commitments), our net R&D +cost in 2009 (R&D income less total R&D expense) should decrease +substantially as well. Having these external funds for R&D is +helping us to increase our experience and capabilities while limiting our cash +investment. Should pending contracts not materialize, we will make +commensurate adjustments to our Research & Development +expenses. +In +addition to the DPP® products we anticipate launching in Brazil through Oswaldo +Cruz Foundation this year, our contract development work for Bio-Rad +Laboratories, and several other research and development programs, our main DPP® +products that we are focusing our R&D activities on are our DPP® HIV 1/2 +screening test for use with oral fluids and our DPP® Syphilis Screen +and Confirm test We are in discussions with a large in vitro +diagnostics marketing organization that, if an actual agreement is completed, +would fund all external regulatory costs, co-brand this product with our DPP® +trademark, and commit to minimum sales of the product in exchange for our +granting to it exclusive U.S. marketing rights to this product. We +are also actively pursuing opportunities for our oral fluid HIV test in the +international markets that we already participate in, as well as others, and we +are very encouraged by the interest we have received in this product +offering. +Equipment +Purchase Commitment: +In +January of 2009, the Company entered into an agreement with an equipment +manufacturer to design and build equipment that will be used to automate the +assembling of our tests and lower our production costs. The estimated +cost of $323,500 is being paid in installments. +30 +Critical +Accounting Policies and Estimates +The +preparation of the financial statements in conformity with accounting principles +generally accepted in the United States of America requires management to make +estimates and assumptions that affect the amounts reported in the financial +statements and accompanying notes. Actual results could differ +materially from those estimates. +We +believe that there are several accounting policies that are critical to +understanding our historical and future performance, as these policies affect +the reported amounts of revenue and the more significant areas involving +management’s judgments and estimates. These significant accounting +policies relate to revenue recognition, research and development costs, +valuation of inventory, valuation of long-lived assets and income +taxes. These policies, and the related procedures, are described in +detail below. +Revenue +Recognition – +We sell +our products directly through our sales force and through +distributors. Revenue from direct sales of our product are recognized +upon shipment to the customer. Income from research grants are +recognized in +earnings in the period in which the related expenditures are +incurred . Sales are recorded net of discounts, rebates and +returns. +Research +& Development Costs – +Research +and development activities consist primarily of new product development, +continuing engineering for existing products, regulatory and clinical trial +costs. Costs related to research and development efforts on existing +or potential products are expensed as incurred. +Valuation +of Inventories – +Inventories +are stated at the lower of cost or market, using the first-in, first-out method +(FIFO) to determine cost. Our policy is to periodically evaluate the +market value of the inventory and the stage of product life cycle, and record a +reserve for any inventory considered slow moving or +obsolete. For example, each additional 1% of obsolete +inventory would reduce such inventory by approximately $18,000. +Allowance +for doubtful accounts – +Our +policy is to review our accounts receivable on a periodic basis, no less than +monthly. On a quarterly basis an analysis is made of the adequacy of +our allowance for doubtful accounts and adjustments are made +accordingly. The current allowance is approximately .83% of +accounts receivable. For example each additional 1% of accounts +receivable that becomes uncollectible would reduce such balance of accounts +receivable by approximately $12,000. +Income Taxes – +Income +taxes are accounted for under FAS No. 109, “Accounting for Income +Taxes.” FAS No. 109 requires the asset and liability method of +accounting for deferred income taxes. Deferred tax assets and +liabilities are determined based on the difference between the financial +statement and tax bases of assets and liabilities. Deferred tax +assets or liabilities at the end of each period are determined using the tax +rate expected to be in effect when taxes are actually paid or +recovered. For example, if we do not become profitable, we may be +unable to utilize our deferred tax asset, which approximates $8,598,000 at +December 31, 2008. +FAS 109 +also requires that a valuation allowance be established when it is more likely +than not that all or a portion of a deferred tax asset will not be +realized. A review of all available positive and negative evidence +needs to be considered, including a company’s current and past performance, the +market environment in which the company operates, length of carryback and +carryforward periods and existing contracts that will result in future +profits. +Forming a +conclusion that a valuation allowance is not needed is difficult when there is +negative objective evidence such as cumulative losses in recent +years. Cumulative losses weigh heavily in the overall +assessment. As a result, we determined that it was appropriate to +establish a valuation allowance for the full amount of our deferred tax +assets. +The +Company adopted the provisions of FASB Interpretation No. 48, Accounting +for Uncertainty in Income Taxes (“FIN 48”) on January 1, 2007. FIN 48 prescribes +a comprehensive model for recognizing, measuring, presenting and disclosing in +the consolidated financial statements tax positions taken or expected to be +taken on a tax return, including a decision whether to file or not to file in a +particular jurisdiction. +The +calculation of our tax liabilities involves the inherent uncertainty associated +with the application of complex tax laws. We are subject to examination by +various taxing authorities. We believe that as a result of our losses sustained +to date, any examination would result in a reduction of our net operating losses +rather than a tax liability. As such, we have not provided for +additional taxes estimated under FIN 48, Accounting for Uncertainty in Income +Taxes. +The above +listing is not intended to be a comprehensive list of all of our accounting +policies. In many cases, the accounting treatment of a particular +transaction is specifically dictated by accounting principles, generally +accepted in the United States of America, with no need for management’s judgment +in their application. There are also areas in which management’s +judgment in selecting any viable alternative would not produce a materially +different result. See our audited financial statements and notes +thereto which contain accounting policies and other disclosures required by +accounting principles generally accepted in the United States of +America. +31 +ITEM +8. +FINANCIAL +STATEMENTS AND SUPPLEMENTARY DATA +The +Consolidated Financial Statements and schedules that constitute Item 8 are +attached at the end of this Annual Report on Form 10-K. An index to +these Financial Statements and schedules is also included on page F-1 of this +Annual Report on Form 10-K. +ITEM +9. +CHANGES +IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL +DISCLOSURE. +There +have been no disagreements, or transactions or events similar to those which +involved such disagreements or reportable events, with former accountants on any +matter of accounting principles or practices, financial statement disclosure or +auditing scope or procedure, which disagreements, if not resolved to the +satisfaction of the former accountant, would have caused it to make reference to +the subject matter disagreements in connection with any of its +reports. +ITEM +9A. +CONTROLS +AND PROCEDURES +(a) Disclosure +Controls and Procedures. Under the supervision and with the +participation of our senior management, consisting of our chief executive +officer and our chief financial officer, we conducted an evaluation of the +effectiveness of the design and operation of our disclosure controls and +procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities +Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the +period covered by this report (the "Evaluation Date"). Based on that +evaluation, the Company’s management, including our chief executive officer and +chief financial officer, concluded that as of the Evaluation Date our disclosure +controls and procedures were effective to ensure that information required to be +disclosed by us in the reports that we file under the Exchange Act is recorded, +processed, summarized and reported within the time periods specified in SEC +rules and forms. Our disclosure controls and procedures include, +without limitation, controls and procedures designed to ensure that information +required to be disclosed by us in our Exchange Act reports is accumulated and +communicated to our management, including our chief executive officer and chief +financial officer, as appropriate to allow timely decisions regarding required +disclosure. +Management's +Annual Report on Internal Control Over Financial Reporting. The +Company's management is responsible for establishing and maintaining an adequate +system of internal control over financial reporting (as defined in Exchange Act +Rule 13a-15(f)). Our internal control over financial reporting is a +process, under the supervision of our chief executive officer and chief +financial officer, designed to provide reasonable assurance regarding the +reliability of financial reporting and the preparation of financial statements +for external purposes in accordance with generally accepted accounting +principles in the United States. These internal controls over +financial reporting processes include policies and procedures that: +(1) +Pertain +to the maintenance of records that in reasonable detail accurately and +fairly reflect the transactions and dispositions of the assets of the +Company; +(2) +Provide +reasonable assurance that transactions are recorded as necessary to permit +preparation of financial statements in accordance with generally accepted +accounting principles, and that receipts and expenditures of the Company +are being made only in accordance with authorizations of management and +directors of the Company; and +(3) +Provide +reasonable assurance regarding prevention or timely detection of +unauthorized acquisition, use or disposition of the Company's assets that +could have a material effect on the financial +statements. +Because +of its inherent limitations, internal control over financial reporting may not +prevent or detect misstatements. Therefore, even those systems +determined to be effective can provide only reasonable assurance of achieving +their control objectives. +32 +In +evaluating the effectiveness of our internal control over financial reporting, +our management used the criteria set forth by the Committee of Sponsoring +Organizations of the Treadway Commission (COSO) in Internal Control - Integrated +Framework. Based on this evaluation, our management concluded that +our internal control over financial reporting was effective as of +December 31, 2008. +This +annual report does not include an attestation report of our registered public +accounting firm regarding internal control over financial +reporting. Management's report was not subject to attestation by our +registered public accounting firm pursuant to temporary rules of the Securities +and Exchange Commission that permit the Company to provide only management's +report in this annual report. +(b) Changes +in Internal Control over Financial Reporting. There were no changes +in our internal control over financial reporting identified in connection with +the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the +Exchange Act that occurred during the Company’s last fiscal quarter of the +period covered by this report that have materially affected, or are reasonably +likely to materially affect, our internal control over financial +reporting. +ITEM +9B. +OTHER +INFORMATION +Not +applicable. +33 +PART +III +ITEM +10. +DIRECTORS, +EXECUTIVE OFFICERS AND CORPORATE +GOVERNANCE +Directors +and Executive Officers +Lawrence A. Siebert ( 5 2 ), President, Chief Executive +Officer and Director. Mr. Siebert was appointed President of Chembio +Diagnostics, Inc. and a member of our board of directors upon consummation of +the merger. Mr. Siebert has been Chairman of Chembio Diagnostic +Systems Inc. for approximately thirteen years and it’s President since May +2002. Mr. Siebert’s background is in private equity and venture +capital investing. From 1982 to 1991, Mr. Siebert was associated with +Stanwich Partners, Inc, which during that period invested in middle market +manufacturing and distribution companies. From 1992 to 1999, Mr. +Siebert was an investment consultant and business broker with Siebert Capital +Corp. and Siebert Associates LLC, and was a principal investor in a privately +held test and measurement company which was sold in 2002. Mr. Siebert +received a JD from Case Western Reserve University School of Law in 1981 and a +BA with Distinction in Economics from the University of Connecticut in +1978. +Richard J. Larkin (5 2 ), Chief Financial +Officer. Mr. Larkin was appointed as Chief Financial Officer of +Chembio Diagnostics, Inc. upon consummation of the merger. Mr. Larkin +oversees our financial activities and information systems. Mr. Larkin +has been the Chief Financial Officer of Chembio Diagnostic Systems Inc. since +September 2003. Prior to joining Chembio Diagnostic Systems Inc., Mr. +Larkin served as CFO at Visual Technology Group from May 2000 to September +2003, and also led their consultancy program that provided hands-on expertise in +all aspects of financial service, including the initial assessment of client +financial reporting requirements within an Enterprise Resource +Planning (Manufacturing) environment through training and +implementation. Prior to joining VTG, he served as CFO at Protex +International Corporation from May 1987 to January 2000. Mr. Larkin +holds a BBA in Accounting from Dowling College and is a member of the +American Institute of Certified Public Accountants. +Javan Esfandiari (4 2 ), Executive VP of Research +and Development. Mr. Esfandiari joined Chembio Diagnostic Systems, +Inc, in 2000. Mr. Esfandiari co-founded, and became a co-owner of +Sinovus Biotech AB where he served as Director of Research and Development +concerning lateral flow technology until Chembio Diagnostic Systems Inc. +acquired Sinovus Biotech AB in 2000. From 1993 to 1997, Mr. +Esfandiari was Director of Research and Development with On-Site +Biotech/National Veterinary Institute, Uppsala, Sweden, which was working in +collaboration with Sinovus Biotech AB on development of veterinary lateral flow +technology. Mr. Esfandiari received his B.Sc. in Clinical Chemistry +and his M. Sc. in Molecular Biology from Lund University, Sweden. He +has published articles in various veterinary journals and has co-authored +articles on tuberculosis serology with Dr. Lyashchenko. +Richard Bruce ( 5 5 ), Vice President, Operations. +Mr. Bruce was hired in April 2000 as Director of Operations. He is responsible +for manufacturing, maintenance, inventory, shipping, receiving, and warehouse +operations. Prior to joining Chembio Diagnostic Systems Inc., he held +director level positions at Wyeth Laboratories from 1984 to 1993. From 1993 +to 1998, he held various management positions in the Operations department +at Biomerieux. From 1998 to 2000, he held a management position at +V.I. Technologies. Mr. Bruce has over thirty years of operations +management experience with Fortune 500 companies in the field of in-vitro +diagnostics and blood fractionation. Mr. Bruce received his BS in +Management from National Louis University in 1997. +Tom Ippoli to ( 4 6 ), VP of Regulatory Affairs, +QA and QC. Mr. Ippolito joined Chembio in June 2005. He has over +twenty years experience with in vitro diagnostics for infectious diseases, +protein therapeutics, vaccine development, Process Development, Regulatory +Affairs and Quality Management. Over the years, Mr. Ippolito has held Vice +President level positions at Biospecific Technologies, Corp. from 2000 - 2005, +Director level positions in Quality Assurance, Quality Control, Process +Development and Regulatory Affairs at United Biomedical, Inc. from 1987 - 2000. +Mr. Ippolito is the Course Director for “drug development process” and “FDA +Regulatory Process” for the BioScience Certificate Program at the New York State +University of Stony Brook, a program he has been a part of since its inception +in 2003. +Dr. Gary Meller (5 8 ), Director. Dr. +Meller was elected to our Board of Directors on March 15, 2005, and currently +serves on the Company’s Audit, Compensation and Nominating and Corporate +Governance Committees, including as Chairman of the Compensation +Committee. Dr. Meller has been the president of CommSense Inc., a +healthcare business development company, since 2001. CommSense Inc. +works with clients in Europe, Asia, North America, and the Middle East on +medical information technology, medical records, pharmaceutical product +development and financing, health services operations and strategy, and new +product and new market development. From 1999 until 2001 Dr. Meller +was the executive vice president, North America, of NextEd Ltd., a leading +internet educational services company in the Asia Pacific region. Dr. +Meller also is a limited partner and a member of the Advisory Board of +Crestview Capital Master LLC, which is our largest stockholder. Dr. Meller is a +graduate of the University of New Mexico School of Medicine and has an MBA from +the Harvard Business School. +34 +Kathy D avis ( 5 2 ), Director. Ms. +Davis was elected to the Company’s Board of Directors in May 2007, and currently +serves on the Company’s Audit, Compensation and Nominating And Corporate +Governance Committees, including as Chairman of each of the Audit Committee and +the Nominating And Corporate Governance Committee. Ms. Davis is +presently the owner of Davis Design Group LLC, a company that provides +analytical and visual tools for public policy design. Previously she +served as the Chief Executive Officer of Global Access Point, a start up company +with products for data transport, data processing, and data storage network and +hub facilities. From October 2003 to January 2005, Ms. Davis was +Lieutenant Governor of the State of Indiana, and from January 2000 to October +2003 was Controller of the City of Indianapolis. From 1989 to 2003, Ms. +Davis held leadership positions with agencies and programs in the State of +Indiana including State Budget Director, Secretary of Family & Social +Services Administration, and Deputy Commissioner of Transportation. From 1982 to +1989 Ms. Davis held increasingly senior positions with Cummins Engine, where she +managed purchasing, product cost, manufacturing, engineering, and assembly of +certain engine product lines. Ms. Davis also led the startup of and +initial investments by a $50 million Indiana state technology fund, serves on +the not-for-profit boards of Noble of Indiana, Indiana Museum of African +American History, University of Evansville Institute of Global Enterprise, and +Purdue College of Science Dean’s Leadership Council. She has a Masters of +Business Administration from Harvard Business School and a Bachelor of +Science in Mechanical Engineering from the Massachusetts Institute of +Technology. +Section +16(a) Beneficial Ownership Reporting Compliances +Section +16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), +requires the Company’s directors, executive officers and beneficial owners of +more than 10% of the Company’s common stock to file with the Securities and +Exchange Commission initial reports of ownership and reports of changes in +ownership of common stock and other equity securities of the +Company. The Company believes that during the year ended December 31, +2008, each person who was an officer, director and beneficial owner of more than +10% of the Company’s common stock complied with all Section 16(a) filing +requirements, except for the following: (i) Form 4 for Former Director +James D. Merselis, due on March 24, 2008, was filed on March 25, +2008. +Code +of Ethics +The +Company has adopted a code of ethics that applies to its principal executive +officer, principal financial officer, principal accounting officer, controller, +and persons performing similar functions. A copy of the Company’s +code of ethics is filed as Exhibit 14.1 to this Form 10-K. +Identification +of Audit Committee; Audit Committee Financial Expert +The +Company’s board of directors has established an audit +committee. Katherine L. Davis and Dr. Gary Meller each serves on the +audit committee, with Ms. Davis serving as chairman. The Company’s +board of directors has determined that Ms. Davis is an audit committee financial +expert and is independent. +35 +ITEM +11. EXECUTIVE +COMPENSATION +The +following table summarizes all compensation recorded by the Company in each of +the last two completed fiscal years for our principal executive officer, our two +most highly compensated executive officers other than our principal executive +officer whose annual compensation exceeded $100,000, and two additional +individuals for whom disclosure would have been made in this table but for the +fact that the individual was not serving as an executive officer of our company +at December 31, 2008. +Name +/ +Principal +Position +Year +Salary 1 +($) +Bonus 2 +($) +Option +Awards 3 +($) +Stock +Awards +($) +All +Other Compensation 5 +($) +Total +($) +Lawrence +A. Siebert 4 +2008 +$265,000 +$ +26,000 +$ 36,695 +$ - +$ 8,267 +$335,962 +CEO +2007 +243,135 +26,000 +- +- +9,314 +278,448 +Richard +J. Larkin +2008 +$163,076 +$ +15,000 +$ 12,193 +$ - +$ 1,781 +$192,050 +CFO +2007 +153,654 +15,000 +- +- +1,304 +169,958 +Javan +Esfandiari +2008 +$215,692 +$ +16,000 +$ 45,297 +$ 28,702 +$ 5,872 +$311,564 +VP-R&D +2007 +171,192 +21,000 +99,993 +89,850 +5,510 +387,546 +Tom +Ippolito +2008 +$173,631 +$ +12,000 +$ 8,129 +$ - +$ 1,708 +$195,467 +VP-Regulatory +2007 +152,481 +12,000 +- +381 +164,862 +Richard +Bruce +2008 +$151,923 +$ +12,000 +$ 8,129 +$ - +$ 933 +$172,984 +VP-Operations +2007 +140,654 +12,000 +- +990 +153,644 +1 Salary +is total base salary. +2 Any +bonus earned was paid solely on a discretionary basis, and not pursuant to any +bonus plan. +3 The +estimated fair value of any option or common stock granted was determined at the +date of grant by using the Black-Scholes option pricing model. +4 Mr. +Siebert also serves as a director on the Company’s board of +directors. Mr. Siebert does not receive any compensation for this +director role. +5 Other +compensation includes an employer match to 401(K) contributions and car +allowances where applicable. +Employment +Agreements +Mr. +Siebert. Effective May 11, 2008, the Company’s Board of +Directors approved the Company’s extension of the June 15, 2006 employment +agreement (the “Employment Agreement”) with Lawrence A. Siebert, the Company’s +President and Chief Executive Officer, for an additional one-year +term. On June 15, 2006, Mr. Siebert and the Company entered into an +Employment Agreement, effective May 10, 2006, which was to terminate on May +10, 2008. Pursuant to the Employment Agreement, Mr. Siebert serves as +the President and Chief Executive Officer of the Company and received an initial +salary of $240,000 per year, which had been increased to $265,000 per year until +Mr. Siebert agreed to a 15 percent reduction, to $225,000, effective January 19, +2009. Mr. Siebert also is eligible for a bonus of up to 50% of his +salary, consisting of (i) a bonus of up to 25% of his salary that is at the +complete discretion and determination of the board of directors, and (ii) a +bonus of up to an additional 25% of his salary that will be determined based +upon revenue and earnings performance criteria established each year by the +board of directors. Mr. Siebert is eligible to participate in any +profit sharing, stock option, retirement plan, medical and/or hospitalization +plan, and/or other benefit plans except for disability and life insurance that +the Company may from time to time place in effect for the Company’s executives +during the term of Mr. Siebert’s employment agreement. If Mr. +Siebert’s Employment Agreement is terminated by the Company without cause, or if +Mr. Siebert terminates his Employment Agreement for a reasonable basis, +including within 12 months of a change in control, the Company is required to +pay as severance Mr. Siebert’s salary for six months. Mr. Siebert has +agreed for a period of two years after the termination of his employment with +the Company not to induce customers, agents, or other sources of distribution of +the Company’s business under contract or doing business with the Company to +terminate, reduce, alter, or divert business with or from the +Company. The terms of the extended May 1, 2008 Employment +Agreement are identical to the June 15, 2006 Employment Agreement, except that +under the extended Employment Agreement, Mr. Siebert received additional +consideration in the form of incentive stock options to purchase 250,000 shares +of the Company’s common stock exercisable at $0.13 per share, which was the +closing price of the Company's common stock on June 3, 2008. The +incentive stock options are immediately exercisable and they expire on the June +3, 2013. +36 +Mr. Esfandiari. The +Company entered into an employment agreement dated April 23, 2007, and to be +effective March 5, 2007 (the "Employment Agreement"), with Mr. Esfandiari to +continue as the Company's Senior Vice President of Research and Development for +an additional term of three years. Mr. Esfandiari's salary under the +Employment Agreement is $185,000 for the first year, $210,000 for the second +year, and $235,000 for the final year. Mr. Esfandiari is eligible for +a cash bonus of up to 50% of his base salary for each respective year, +consisting of (i) a cash bonus of up to 37.5% of his calendar year base salary +based on the performance of the Company's Dual Path Platform Technology, which +is directly related to certain annual revenue targets budgeted by management of +the Company, and (ii) a cash bonus of up to 12.5% of his calendar year base +salary that is at the complete discretion and determination of the board of +directors. The Company also granted Mr. Esfandiari a stock grant of +200,000 shares of the Company's common stock. 100,000 shares vested when the +employment agreement was executed, 50,000 shares vested on the first anniversary +date of the Employment Agreement, and 50,000 shares vested on the second +anniversary of the Employment Agreement. In addition, although none were +granted, the Employment Agreement provided that Mr. Esfandiari could have been +granted up to 50,000 shares of the Company's common stock for 2007 and 2008 +based upon the performance of the Company's Dual Path Platform Technology, which +is directly related to certain annual revenue targets budgeted by management of +the Company. Pursuant to the Company's 1999 Stock Option Plan, the +Company also granted Mr. Esfandiari incentive stock options to purchase 300,000 +shares of the Company's common stock. The price per share of these options is +equal to the fair market value of the Company's common stock on April 23, 2007, +which is the date on which the Agreement was entered into. 100,000 shares of the +stock options vested when the employment agreement was executed, 100,000 shares +of the stock options vested on the first anniversary of the Employment +Agreement, and 100,000 shares of the stock options vested on the second +anniversary of the Employment Agreement. Mr. Esfandiari is eligible to +participate in any profit sharing, stock option, retirement plan, medical and/or +hospitalization plan, and/or other benefit plans except for disability and life +insurance that the Company may from time to time place in effect for the +Company’s executives during the term of Mr. Esfandiari’s employment +agreement. If Mr. Esfandiari’s employment agreement is terminated by +the Company without cause, or if Mr. Esfandiari terminates his employment +agreement for a reasonable basis, as defined in the Employment Agreement +including within 12 months of a change in control, the Company is required to +pay as severance Mr. Esfandiari’s salary for twelve months. +Neither +Mr. Larkin, Mr. Ippolito nor Mr. Bruce has an employment contract with the +Company. +37 +OUTSTANDING +EQUITY AWARDS AT FISCAL YEAR-END 2008 +Option +Awards +Stock +Awards +Name +Number +of Securities Underlying Unexcercised Options Excerciseable +(#) +Number +of Securities Underlying Unexcercised Options Unexcersable +(#) +Option +Exercise Price +($) +Option +Expiration Date +Option +Vesting Date +Number +of Shares of Stock That Have Not Vest +(#) +Market +Value of Shares of Stock That Have Not Vested +($) +Foot- +note +Lawrence +A. Siebert +250,000 +0.13 +6/3/2013 +6/3/2008 +3 +75,000 +0.22 +2/15/2013 +2/15/2008 +1 +10,000 +0.48 +12/31/2008 +4/17/2006 +2 +10,000 +0.48 +5/4/2011 +4/17/2006 +2, +5 +50,000 +0.48 +5/28/2011 +4/17/2006 +2, +3, 5 +50,000 +0.48 +5/28/2011 +1/1/2007 +2, +3, 5 +50,000 +0.48 +5/4/2011 +5/5/2004 +2, +5 +Richard +J. Larkin +75,000 +0.22 +2/15/2013 +2/15/2008 +1 +25,000 +0.48 +5/17/2010 +4/17/2006 +2, +5 +25,000 +0.48 +5/17/2010 +1/1/2007 +2, +5 +18,750 +0.48 +3/24/2011 +3/24/2006 +2, +5 +18,750 +0.48 +3/24/2011 +1/1/2007 +2, +5 +50,000 +0.45 +9/15/2010 +5/5/2004 +4 +Javan +Esfandiari +60,000 +0.22 +2/15/2013 +2/15/2008 +1 +5,000 +0.48 +12/31/2008 +4/17/2006 +2, +5 +25,000 +0.48 +5/17/2010 +4/17/2006 +2, +5 +25,000 +0.48 +5/17/2010 +1/1/2007 +2, +5 +18,750 +0.48 +3/24/2011 +3/24/2006 +2, +5 +18,750 +0.48 +3/24/2011 +1/1/2007 +2, +5 +5,000 +0.48 +5/4/2011 +4/17/2006 +2, +5 +25,000 +0.48 +5/28/2011 +4/17/2006 +2, +5 +25,000 +0.48 +5/28/2011 +4/17/2006 +2, +5 +25,000 +0.48 +5/28/2011 +5/28/2007 +2, +5 +30,000 +0.48 +5/4/2011 +5/5/2004 +2, +5 +100,000 +0.48 +4/23/2012 +4/23/2007 +2, +3, 5 +100,000 +0.48 +4/23/2012 +3/5/2008 +2, +3, 5 +100,000 +0.48 +4/23/2012 +3/5/2009 +2, +3, 5 +50,000 +5,500 +6 +Tom +Ippolito +50,000 +0.22 +2/15/2013 +2/15/2008 +2 +15,000 +0.48 +3/24/2011 +3/24/2006 +2, +5 +Richard +Bruce +50,000 +0.22 +2/15/2013 +2/15/2008 +2 +5,000 +0.48 +12/31/2008 +4/17/2006 +2, +5 +12,500 +0.48 +5/17/2010 +4/17/2006 +2, +5 +12,500 +0.48 +5/17/2010 +1/1/2007 +2, +5 +12,500 +0.48 +3/24/2011 +3/24/2006 +2, +5 +12,500 +0.48 +3/24/2011 +1/1/2007 +2, +5 +5,000 +0.48 +5/4/2011 +4/17/2006 +2, +5 +10,000 +0.48 +5/4/2011 +5/5/2004 +2, +5 +20,000 +0.48 +5/4/2011 +5/5/2004 +2, +5 +38 +1 All +options issued with a $.62 exercise price were issued during 2006 as part of the +Company’s 1999 Stock Option Plan. Pursuant to this plan, the Company +granted 244,000 options to all employees. +2 All +options issued with a $.75 exercise price and an April 17, 2006 vesting date +were issued on April 17, 2006 as part of the Company’s 1999 Stock Option +Plan. Pursuant to this plan, the Company granted 244,000 options to +all employees. On April 17, 2006, the Company’s Compensation +Committee approved the cancellation of each employee stock option award issued +under the 1999 Stock Option Plan where the exercise price was greater than $0.75 +per share of the Company’s common stock, and the issuance of a new stock option +award under the 1999 Stock Option Plan, for the same number of shares of the +Company’s common stock, with an exercise price of $0.75 per share of the +Company’s common stock for each cancelled stock option award. The market price +of the common stock of the Company on April 17, 2006 was $0.72 per share. In +total, stock option awards to acquire 795,000 shares of Company common stock +were cancelled, and stock option awards to acquire 795,000 shares of Company +common stock were issued. Other than the change in the exercise price, all of +the terms and conditions in each newly issued stock option award are identical +to the cancelled stock option award it replaced, with the following exceptions: +(i) Lawrence A. Siebert’s stock option award for 50,000 shares of the Company’s +common stock, exercisable on May 28, 2006 and terminating on May 28, 2011, was +replaced with a stock option award for 50,000 shares of the Company’s common +stock, exercisable on January 1, 2007 and terminating on May 28, 2011;(ii) Avi +Pelossof’s stock option awards for 72,500 shares of the Company’s common stock, +exercisable on May 28, 2005 and on May 28, 2006 and both terminating on May 28, +2011 was replaced with a stock option award for 72,500 shares of the Company’s +common stock, exercisable on January 1, 2007 and terminating on May 28, +2011. +3 Options +issued in connection with an employment contract and under the 2008 Stock Incentive +Plan . +4 All +other options shown were issued prior to 2006 as part of the Company's 1999 +Stock Option Plan. +5 On February 15, 2008, the Company’s +Compensation Committee approved the reduction of the exercise price to $0.48 per +share of each employee stock option award issued under the 1999 Stock Option +Plan for which the exercise price was greater than $0.48 per share . +6 Stock issued in +connection with an employment contract and under the 2008 Stock Incentive +Plan. +DIRECTOR +COMPENSATION +Name +Fees +Earned or Paid in Cash +($) 1 +Option +Awards +($) 2 +Total +($) +Katherine +L. Davis +$ +25,750 +$ +22,987 +$ +48,737 +Gary +Meller +24,250 +23,316 +47,566 +James +D. Merselis 3 +20,500 +7,816 +28,316 +Al +Carus 4 +14,750 +23,635 +38,385 +1 Fees earned or paid in +cash represents an annual retainer and fees for meeting expenses: (a) Mr. +Carus received $9,000 in an annual retainer for the portion of the year that he +served as a member of the board of directors, a $1,250 annual retainer as audit +committee chairman and $4,500 in meeting fees paid during 2008; (b) Mr. Merselis +received an $18,000 annual retainer as a member of the board of +directors, and $2,500 in meeting fees paid during 2008; (c) Dr. Meller received +an $18,000 annual retainer as a member of the board of directors, and $6,250 in +meeting fees; (d) Ms. Davis received an $18,000 annual retainer as a member of +the board of directors, a $1,250 retainer as audit committee chairman +and $6,500 in meeting fees. +2 Each outside member of the board of +directors is granted an option to purchase 180,000 shares of the company’s +common stock with an exercise price equal to the market price on the date of the +grant as part of their annual compensation. One-fifth of these options are +exercisable on the date of grant, one-fifth become exercisable on the first +anniversary of the date of grant, and additional one-fifths become exercisable +on the second through fourth anniversary of the date of grant. The +fair value of options at the date of grant was estimated using the Black-Scholes +option pricing model. +3 Mr. Merselis resigned from +our Board of Directors on February 9, 2009. +4 Mr. Carus resigned from our Board of +Directors on July 20, 2008. +Director +Compensation +All +non-employee directors are paid an $18,000 annual retainer, semi-annually, and +once every five years stock options to acquire 180,000 shares of the Company's +common stock, with an exercise price equal to the market price on the date of +the grant. Stock options to acquire 36,000 shares become exercisable +on the date of grant, and options to acquire an additional 36,000 shares become +exercisable on the date of each of the four succeeding annual meetings of +stockholders if and to the extent that the non-employee director is reelected as +a director at each such annual meeting. The audit committee chairman +is paid an annual retainer of $2,500, paid semi-annually. In +addition, the non-employee directors are paid $1,000 in cash for each board of +directors' meeting attended, and paid $500 in cash for each telephonic board of +directors meeting. The non-employee directors who are members of a +committee of the board of directors are paid $500 in cash for each committee +meeting attended, or $750 in cash for each committee meeting attended if that +non-employee director is the committee chairman. +39 +ITEM +12. +SECURITY +OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED +STOCKHOLDER MATTERS +The +following table sets forth certain information regarding the beneficial +ownership of our common stock by each person or entity known by us to be the +beneficial owner of more than 5% of the outstanding shares of common stock, each +of our directors and each of our “named executive officers” and all of our +directors and executive officers as a group as of March 17, 2009. +Name +and Address of Beneficial Owner +Amount +and Nature of Beneficial Owner +Percent +of Class +Siebert, +Lawrence (1) +3661 +Horseblock Road +Medford, +NY 11763 +6,933,615 +11.11 +% +Esfandiari, +Javan (2) +3661 +Horseblock Road +Medford, +NY 11763 +779,580 +1.25 +% +Larkin, +Richard (3) +3661 +Horseblock Road +Medford, +NY 11763 +267,672 +0.43 +% +Ippolito, +Tom (4) +3661 +Horseblock Road +Medford, +NY 11763 +65,000 +0.10 +% +Bruce, +Richard (5) +3661 +Horseblock Road +Medford, +NY 11763 +135,075 +0.22 +% +Meller, +Gary (6) +3661 +Horseblock Road +Medford, +NY 11763 +354,300 +0.57 +% +Davis, +Katherine L. (7) +3661 +Horseblock Road +Medford, +NY 11763 +75,650 +0.12 +% +GROUP (8) +8,610,892 +13.53 +% +Vicis +Capital Master Fund +126 +East 56th Street, Tower 56, Suite 700 +New +York, NY 10022 +4,608,707 +7.44 +% +Millenium +3 Opportunity Fund, LLC (9) +4 +Becker Farm Road +Roseland, +NJ 07068 +4,006,610 +6.31 +% +Inverness +Medical Innovations, Inc . +51 +Sawyer Road, Suite 200 +Waltham, +MA 02453 +5,367,840 +8.67 +% +Crestview +Capital Master, LLC +95 +Revere Drive, Suite A +Northbrook, +IL 60062 +18,907,432 +30.52 +% +Beneficial +ownership is determined in accordance with the Rule 13d-3(a) of the Securities +Exchange Act of 1934, as amended, and generally includes voting or investment +power with respect to securities. Except as subject to community +property laws, where applicable, the person named above has sole voting and +investment power with respect to all shares of our common stock shown as +beneficially owned by him. +The +beneficial ownership percent in the table is calculated with respect to the +number of outstanding shares (61,944,901) of the Company's common stock +outstanding as of March 17, 2009. Each stockholder's ownership is +calculated as the number of shares of common stock owned plus the number of +shares of common stock into which any preferred stock, warrants, options or +other convertible securities owned by that stockholder can be converted within +60 days. +40 +The term +“named executive officer” refers to our principal executive officer, our two +most highly compensated executive officers other than the principal executive +officer who were serving as executive officers at the end of 2008, and two +additional individuals for whom disclosure would have been provided but for the +fact that the individuals were not serving as executive officers of the Company +at the end of 2008. +(1) +Includes +495,000 shares issuable upon exercise of options exercisable within 60 +days. +(2) +Includes +562,500 shares issuable upon exercise of options exercisable within 60 +days and 2,007 shares issuable upon exercise of +warrants. +(3) +Includes +212,500 shares issuable upon exercise of options exercisable within 60 +days. +(4) +Includes +65,000 shares issuable upon exercise of options exercisable within 60 +days. +(5) +Includes +140,000 shares issuable upon exercise of options exercisable within 60 +days. +(6) +Includes +159,000 shares issuable upon exercise of options exercisable within 60 +days. Does not include 108,000 shares issuable upon exercise of +options that are not exercisable within the next 60 +days. +(7) +Includes +75,650 shares issuable upon exercise of options exercisable within 60 +days. Does not include 108,000 shares issuable upon exercise of options +that are not exercisable within the next 60 +days. +(8) +Includes +footnotes (1)-(8) +(9) +Includes +1,557,376 shares issuable upon exercise of +warrants. +Equity +Compensation Plan Information +Combined +Equity Compensation Plans - Information as of December 31, +2008 +Plan +Category +Number +of Securities to be Issued Upon Exercise of Outstanding Options, Warrants +and Rights +Weighted-Average +Exercise Price of Outstanding Options, Warrants and +Rights +Number +of Securities Remaining Available for Future Issuance under Equity +Compensation Plans (Excluding Securities Reflected in Column +(a)) +(a) +(b) +(c) +Equity +compensation plans approved by security holders 1 +2,416,650 +$0.366 +4,566,350 +Equity +compensation plans not approved by security holders +-- +-- +-- +Total +2,416,650 +$0.366 +4,566,350 +1 The +“Number of Securities to be Issued Upon Exercise of Outstanding Options, +Warrants and Rights” represents 1,983,000 from the 1999 Stock Option Plan and +433,650 under the 2008 Stock Incentive Plan. The “Number of +Securities Remaining Available for Future Issuance under Equity Compensation +Plans” includes shares issuable under the 2008 Stock Incentive +Plan. The Company currently has no intention to issue additional +securities under the 1999 Stock +Option Plan . +41 +ITEM +13. +CERTAIN +RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR +INDEPENDENCE. +The +executive officers of the Company are as follows: Lawrence A. Siebert, president +and chairman of the board of directors of the Company, Richard J. Larkin, chief +financial officer of the Company, and Javan Esfandiari, executive vice president +of Research and Development of the Company. +On +February 15, 2008, the Compensation Committee approved the reduction of the +exercise price to $0.48 per share of each employee stock option award issued +under the 1999 Stock Option Plan for which the exercise price was greater than +$0.48 per share. As a result of this price reduction, the following +number of employee stock options owned by the Company’s officers and directors +at that time under the 1999 Stock Option Plan qualified for this price +reduction: (i) Mr. Siebert: 170,000 options; (ii) Mr. Larkin: 87,500 options; +(iii) Mr. Esfandiari: 532,500 options; (iv) Mr. Aromando: 100,000 options; (v) +Mr. Ippolito: 15,000 options; (vi) Mr. Bruce: 90,000 options; (vii) Mr. Carus: +252,000 options; (viii) Dr. Meller: 252,000 options; and (ix) Ms. Davis: 180,000 +options. +In +addition, on February 15, 2008 the Compensation Committee granted, to certain of +the Company’s existing officers at that time options to purchase the Company’s +common stock under the 1999 Stock Option Plan as follows: (i) Mr. Siebert, +75,000 options; (ii) Mr. Larkin, 75,000 options; (iii) Mr. Esfandiari, 60,000 +options; (iv) Mr. Bruce, 50,000 options; (v) Mr. Ippolito, 50,000 options; and +(vi) Mr. Aromando, 25,000 options. The exercise price for each of +these options is $0.22 per share, which was the closing market price for the +Company’s common stock on February 15, 2008. The options vest on the +date of the grant, and each option granted will expire and terminate, if not +exercised sooner, upon the earlier to occur of (a) 30 days after termination of +the employee’s employment with the Company or (b) the fifth anniversary of the +date of grant. +Avi +Pelossof, the Company’s Vice President of Sales and Marketing from May 5, 2004 +to January 31, 2007, exercised 100,000 options in December 2006 at $0.60 per +share, and another 50,000 options in January 2007 at $0.75 per +share. +Robert +Aromando, the Company’s Executive Vice President of Commercial Operations was +hired in May of 2007. In June 2007 in connection with his joining the +Company, he was granted options to purchase 100,000 shares of common stock at an +exercise price of $0.62 per share. These options will become +exercisable one year from the date of grant. As discussed above, on +February 15, 2008, the exercise price for these options was reduced to +$0.48. Mr. Aromando left the employ of the Company in August 2008 and +since then his options have expired. +Dr. Gary Meller, a non-employee +director of the Company, currently serves as a limited partner and a member of +the Advisory Board of Crestview Capital Master LLC, referred to herein as +Crestview, which was the lead investor, investing $3 million, in our Series B +Preferred Stock private placement in January 2005, and which subsequently +invested an additional $1 million in our Series B Preferred Stock private +placement in March 2006. Crestview also invested $2 million in our +Series C Preferred Stock private placement in September 2006. Details +of these transactions are set forth below. Crestview currently is the largest +stockholder of the Company, with beneficial ownership of approximately 30.5 +percent of our common stock. +As +referred to above, in January 2005, for a purchase price of $3 million, +Crestview acquired 60 shares of our Series B Preferred Stock, and warrants to +purchase 4,672,130 shares of our common stock at a warrant exercise price of +$0.61 per share. As described below, in December 2007, these shares +of Preferred Stock and warrants were exchanged for shares of the Company’s +common stock. +In March +2006, for a purchase price of $1 million, Crestview acquired 20 shares of Series +B Preferred Stock with warrants to purchase 1,557,377 shares of common stock at +a warrant exercise price of $0.61 per share. These shares were issued +in connection with the Company’s January 2005 private placement as described +herein. In September 2006, for a purchase price of $2 million, we +issued 40 shares of Series C Preferred Stock to Crestview together with warrants +to purchase 625,000 shares of common stock at an exercise price of $1.00 per +share. +In +January 2007, because of comments from the staff of the SEC concerning the +Company’s registration statement No. 333-138266 (the “Prospectus”), Crestview +agreed to reduce the number of its shares of common stock covered by the +Prospectus to 2,000,000. Crestview also agreed to waive any penalties +that the Company would otherwise owe Crestview because of the failure to +register all of Crestview’s shares in the Prospectus. In +consideration for this waiver, the Company agreed that, upon request by +Crestview, the Company will file one or more registration statements with the +SEC in order to register the resale of other shares beneficially owned by +Crestview. The cost of any such registration statements shall be +borne by the Company. +In +addition to Crestview’s $2,000,000 investment in the Company’s September 2006 +private placement of Series C Preferred Stock, the Company also received an +investment of $2,000,000 on that date from Inverness Medical Innovations, Inc. +(“Inverness”). At that time, a Certificate of Designation for the +Series C Preferred Stock was filed with the Secretary of State of Nevada +reflecting the agreed upon conversion price of $0.85 per share of common +stock. This private placement of Series C Preferred Stock was +completed on October 5, 2006, and it raised an aggregate of $8,150,000 +(including the $2,000,000 invested by each of Crestview and +Inverness). During the period between September 29, 2006 and October +5, 2006, we requested the assistance of Crestview and others in identifying +prospective investors for us. +42 +On +December 19, 2007 (the “Closing Date”), amendments to the governing documents +for the Company’s Series A, Series B and Series C Convertible Preferred Stock +(collectively, the “Preferred Stock”) and for certain warrants and options +(collectively, the “Non-Employee Warrants”), not including options or warrants +issued to employees or directors in their capacity as such (these actions +collectively, the “Plan”), were approved by the Company and the requisite +percentages of the holders of the Preferred Stock and of the Non-Employee +Warrants. Subsequent to these amendments, all shares of Preferred +Stock were converted to common stock and certain of the Non-Employee Warrants +were exercised, including the following: Mr. Siebert’s 38.74442 shares of Series +A Preferred Stock were converted into 2,421,526 shares of common stock at $0.48 +per share, his 1.08545 shares of Series B Preferred Stock were converted into +113,067 shares of common stock at $0.48 per share, and Mr. Siebert purchased +337,500 shares of common stock through the exercise of warrants at an exercise +price of $0.40 per share, for a total of $135,000 in cash; Mr. Larkin on +December 19, 2007 pursuant to the Plan converted .50392 shares of his Series A +Preferred Stock into 37,794 shares of common stock at $.40 per share, in +addition he received 369 shares of common stock as payment of dividends on the +series A preferred. He also received 3,050 shares of common stock in +the exercise of warrants pursuant to the Plan at $.40 per share, or a total of +$1,220 in cash, Inverness’ 40 shares of Series C Preferred Stock were converted +into 4,166,666 shares of common stock, and Inverness exercised all of +its Series C Warrants to purchase a total of 625,000 shares of common stock for +an aggregate purchase price of $250,000 and Crestview’s 82.32274 shares of +Series B Preferred Stock were converted into 10,290,342 shares of the +Company’s common stock, Crestview’s 40 shares of Series C Preferred Stock were +converted into 4,166,666 shares of common stock, Crestview exercised a portion +of its Series B Warrants to purchase a total of 60,451 shares of common stock +for an aggregate purchase price of $24,180.40, and Crestview exercised all of +its Series C Warrants to purchase a total of 625,000 shares of common stock for +an aggregate purchase price of $250,000. +In June +2008, pursuant to the Plan (see above), Mr. Siebert, exercised 2,205,731 +warrants, on a cashless basis, into 332,940 shares of common stock, Mr. Larkin +exercised 27,436 warrants, on a cashless basis, into 4,141 shares of common +stock, and Crestview exercised 6,169,055 warrants, on a cashless basis, into +931,177 shares of common stock. +During +the quarter ended December 31, 2008, Inverness notified the Company that +Inverness had entered into a contract with Bio-Rad Laboratories, Inc. +(“Bio-Rad”) for royalties on Bio-Rad’s patent for the detection of HIV-2 +antibodies. The agreement also provided for Inverness to pay past +royalties. The agreements between the Company and Inverness provide +that the Company is to share in this expense and as such Inverness requested it +be reimbursed for the Company’s share of past royalties. The Company +negotiated with Inverness that this liability is to be paid from future revenues +over approximately the next 18 months. In addition Inverness agreed +to allow Chembio to pay its royalty obligation to Inverness on Chembio’s sales +to third parties in the same way and over the same period. +Director +Independence +Our +common stock trades on the OTC Bulletin Board. As such, we are not +currently subject to corporate governance standards of listed companies, which +require, among other things, that the majority of the board of directors be +independent. +We are not currently subject to +corporate governance standards defining the independence of our directors, and +we have chosen to define an “independent” director in accordance with the NASDAQ +Global Market's requirements for independent directors (NASDAQ Marketplace Rule +4200). Under this definition, we have determined that Katherine L. +Davis currently qualifies as independent director. We do not list the +“independent” definition we use on our Internet website . +43 +ITEM +14. +PRINCIPAL +ACCOUNTANT FEES AND SERVICES +All +fees discussed below were paid to Lazar Levine & Felix +LLP. Remaining fees for the December 31, 2008 audit will be paid in +2009 to Parente Randolph, LLC. In February 2009, Lazar Levine & +Felix LLP merged its practice into Parente Randolph, LLC. +Audit +Fees +For the +years ended December 31, 2008 and 2007, the Company’s independent +accounting firm, billed the Company $136,000 and $119,000, respectively, for +fees for the audit of the Company’s annual financial statements and review of +financial statements included in the Company’s Forms 10-Q and 10-K. +Audit-Related +Fees +For the +years ended December 31, 2008 and 2007, the independent accounting firm, did not +provide the Company with any assurance and related services reasonably related +to the performance of the audit or review of the Company’s financial statements +that are not reported above under “Audit Fees.” +Tax +Fees +For the +years ended December 31, 2008 and 2007, the independent accounting firm billed +the Company $13,500 and $10,000, respectively, for professional services for tax +compliance, tax advice and tax planning. +All +Other Fees +For the +years ended December 31, 2008 and 2007, the independent accounting firm billed +the Company $2,500 and $8,500 for fees associated with the preparation and +filing of the Company’s registration statements, responses to SEC comment +letters and other related matters. +Audit +Committee Pre-Approval Policies +The Audit +Committee (and prior to the adoption of the Audit Committee, the Board of +Directors) approves in advance all audit and non-audit services performed by the +independent accounting firm. There are no other specific policies or +procedures relating to the pre-approval of services performed by the independent +accounting firm. +As +disclosed in the Company's Amendment No. 2 to Form 8-K/A filed with the SEC on +March 3, 2009, on February 15, 2009, the practice of Lazar Levine & Felix +LLP was acquired by Parente Randolph, LLC (“Parente”) in a transaction pursuant +to which Lazar merged its operations into Parente and certain of the +professional staff and principals of Lazar joined Parente either as employees or +partners of Parente. On February 19, 2009, as a result of this +transaction, Lazar resigned from its role as principal auditor of the Company’s +financial statements. The Company, through and with the approval of +the Audit Committee of the Company’s Board of Directors, engaged Parente as its +independent registered public accounting firm. +Lazar’s +reports regarding the Company’s financial statements for the fiscal years ended +December 31, 2007 and 2006 did not contain any adverse opinion or disclaimer of +opinion and were not qualified or modified as to uncertainty, audit scope or +accounting principles. During the years ended December 31, 2008 and +2007, and during the interim period from the end of the most recently completed +fiscal year through February 19, 2009, the date of resignation, there were no +disagreements with Lazar on any matter of accounting principles or practices, +financial statement disclosure or auditing scope or procedures, which +disagreements, if not resolved to the satisfaction of Lazar would have caused it +to make reference to such disagreement in its reports. +During +the years ended December 31, 2008 and 2007, and during the interim period from +the end of the most recently completed fiscal year through February 19, 2009, +the date of engagement, the Company did not consult with Parente regarding the +application of accounting principles to a specified transaction, either +completed or proposed, or the type of audit opinions that might be rendered by +Parente on the Company’s financial statements. Parente did not +provide the Company a written report or any oral advice that was an important +factor considered by the Company in reaching a decision as to any accounting, +auditing or financial reporting issue. +In +addition, during the years ended December 31, 2008 and 2007, and during the +interim period from the end of the most recently completed fiscal year through +February 19, 2009, the date of engagement, the Company did not consult with +Parente on any matter that was either the subject of a disagreement (as defined +in Item 304(a)(1)(iv) of Regulation S-K and the related instructions to this +item) or a reportable event (as described in Item304(a)(1)(v) of Regulation +S-K). As such none of the required disclosures under Item +304(a)(2)(ii) apply. +44 +ITEM +15. EXHIBITS, +FINANCIAL STATEMENT SCHEDULES +Number Description +3.1 +Articles +of Incorporation, as amended. (3) +3.2 +Amended +and Restated Bylaws. (1) +4.2 +Registration +Rights Agreement, dated as of May 5, 2004, by and among the Registrant and +the Purchasers listed therein. (2) +4.4 +Amended +Form of Common Stock Warrant issued pursuant to the May 4, 2004 Stock and +Warrant Purchase Agreement. (16) +4.5 +Form +of $0.90 Warrant issued to Mark L. Baum pursuant to the Consulting +Agreement dated as of May 5, 2004 between the Registrant and Mark L. Baum. +(2) +4.6 +Form +of $0.60 Warrant issued to Mark L. Baum pursuant to the Consulting +Agreement dated as of May 5, 2004 between the Registrant and Mark L. Baum. +(2) +4.8 +Form +of Common Stock Warrant issued pursuant to the January 26, 2005 Securities +Purchase Agreement. (9) +4.9 +Amended +Form of Common Stock Warrant issued pursuant to the January 26, 2005 +Securities Purchase Agreement. (16) +4.10 +Registration +Rights Agreement, dated as of January 26, 2005, by and among the +Registrant and the purchasers listed therein. +(9) +4.11 +Form +of Warrant, dated June 29, 2006, issued pursuant to Company and purchasers +of the Company’s Secured +Debentures. (4) +4.12 +Registration +Rights Agreement, dated June 29, 2006. +(4) +4.14 +Registration +Rights Agreement, dated as of September 29, 2006, by and among the +Registrant and the Purchasers listed therein. +(6) +4.15 +Form +of Common Stock Warrant issued pursuant to the Securities Purchase +Agreements dated September 29, 2006 +(6). +4.16 +Amended +Form of Common Stock Warrant issued pursuant to the Securities Purchase +Agreements dated October 5, 2006. +(16) +4.17 +Amended +Form of Common Stock Warrant issued to Placement Agents pursuant to the +October 5, 2005 Securities Purchase Agreement. +(16) +4.18* +Form +of Employee Option Agreement. (16) +4.19 +Amended +Form of Warrant used for Consultant Services, and in connection with the +Company’s 2004 merger. (16) +4.20 +1999 +Equity Incentive Plan. (14) +4.20 +2008 +Stock Incentive Plan. (15) +10.1* +Employment +Agreement dated June 15, 2006 with Lawrence A. Siebert. +(5) +10.2* +Employment +Agreement dated April 23, 2007 with Javan Esfandiari. +(13) +10.3 +Series +A Convertible Preferred Stock and Warrant Purchase Agreement (the “Stock +and Warrant Purchase Agreement”), dated as of May 5, 2004, by and among +the Registrant and the purchasers listed therein. +(2) +10.4 +Securities +Purchase Agreement (the “Securities Purchase Agreement”), dated as of +January 26, 2005, by and among the Registrant and the purchasers listed +therein. (9) +10.5 +Amendment +No. 1 to Securities Purchase Agreement, dated as of January 28, 2005 by +and among the Registrant and the purchasers listed therein. +(10) +10.7 +Security +Purchase Agreement, dated June 29, 2006, among the Company and purchasers +of the Company’s Secured Debentures. +(4) +10.11 +Securities +Purchase Agreement (the “Securities Purchase Agreement”), dated as of +September 29, 2006, by and among the Registrant and the Purchasers listed +therein. (6) +10.12 +Letter +of Amendment to Securities Purchase Agreements dated as of September 29, +2006 by and among the Registrant and the Purchasers listed therein. +(6) +10.13 +HIV +Barrel License, Marketing and Distribution Agreement, dated as of +September 29, 2006, by and among the Registrant, Inverness and StatSure. +(6) +10.14 +HIV +Cassette License, Marketing and Distribution Agreement, dated as of +September 29, 2006, between the Registrant and Inverness. +(6) +10.15 +Non-Exclusive +License, Marketing and Distribution Agreement, dated as of September 29, +2006, between the Registrant and Inverness. +(6) +10.16 +Joint +HIV Barrel Product Commercialization Agreement, dated as of September 29, +2006, between the Registrant and StatSure. +(6) +10.19 +License +and Supply Agreement dated as of August 30, 2002 by and between Chembio +Diagnostic Systems Inc. and Adaltis Inc. +(8) +14.1 +Ethics +Policy (11) +21 +List +of Subsidiaries. +23.1 +Consent +of Parente Randolph LLC, Independent +Accountants. +23.2 +Consent +of Lazar Levine & Felix LLP, Independent +Accountants. +31.1 +Certification +of the Chief Executive Officer pursuant to Section 302 of the +Sarbanes-Oxley Act of 2002. +31.2 +Certification +of the Chief Financial Officer pursuant to Section 302 of the +Sarbanes-Oxley Act of 2002. +32 +Certification +of Chief Executive Officer and Chief Financial Officer pursuant to 18 +U.S.C. Section 1350 as adopted pursuant to Section 906 of the +Sarbanes-Oxley Act of 2002. +45 +(1) +Incorporated +by reference to the Registrant’s registration statement on Form SB-2 filed +with the Commission on August 23, 1999 and the Registrant’s Form 8-K +filed on December 20, 2007. +(2) +Incorporated +by reference to the Registrant’s Current Report on Form 8-K filed with the +Commission on May 14, 2004. +(3) +Incorporated +by reference to the Registrant’s annual report on Form 10-KSB filed with +the Commission on March 31, 2005. +(4) +Incorporated +by reference to the Registrant’s Current Report on Form 8-K filed with the +Commission on July 3, 2006. +(5) +Incorporated +by reference to the Registrant’s Current Reports on Form 8-K filed with +the Commission on June 21, 2006 and June 5, +2008. +(6) +Incorporated +by reference to the Registrant’s Current Report on Form 8-K filed with the +Commission on October 5, 2006. +(7) +Incorporated +by reference to the Registrant’s registration statement on Form SB-2/A +filed with the Commission on August 4, +2004. +(8) +Incorporated +by reference to the Registrant’s registration statement on Form SB-2 filed +with the Commission on June 7, +2004. +(9) +Incorporated +by reference to the Registrant’s Current Report on Form 8-K filed with the +Commission on January 31, 2005. +(10) +Incorporated +by reference to the Registrant’s registration statement on Form SB-2 filed +with the Commission on March 28, +2005. +(11) +Incorporated +by reference to the Registrant’s annual report on Form 10-KSB filed with +the Commission on March 30, 2006. +(12) +Incorporated +by reference to the Registrant’s Current Report on Form 8-K filed with the +Commission on January 30, 2007. +(13) +Incorporated +by reference to the Registrant’s Current Report on Form 8-K/A filed with +the Commission on May 3, 2007. +(14) +Incorporated +by reference to the Registrant’s definitive proxy statement on Schedule +14A filed with the Commission on May 11, +2005. +(15) +Incorporated +by reference to the Registrant’s definitive proxy statement on Schedule +14A filed with the Commission on April 14, +2008. +(16) +Incorporated +by reference to the Registrant’s annual report on Form 10-KSB filed with +the Commission on March 12, 2008. +(*) +An +asterisk (*) beside an exhibit number indicates the exhibit contains a +management contract, compensatory plan or arrangement which is required to +be identified in this report. +46 +SIGNATURES +In +accordance with Section 13 or 15(d) of the Exchange Act, the registrant has +caused this report to be signed on its behalf by the undersigned, thereunto duly +authorized. +CHEMBIO DIAGNOSTICS, +INC. +Date: March +18, +2009 By +/s/ Lawrence A. +Siebert +Lawrence +A. Siebert +President, +Chief Executive Officer and +Chairman +of the Board +In +accordance with the requirements of the Exchange Act, this report has been +signed below by the following persons on behalf of the registrant and in the +capacities and on the dates indicated. +Signatures +Title +Date +/s/ Lawrence A. +Siebert +Lawrence +A. Siebert +Chief +Executive Officer, President and Chairman Of The Board +(Principal +Executive Officer) +March +18, 2009 +/s/ Richard J. +Larkin +Richard +J. Larkin +Chief +Financial Officer (Principal Financial & Accounting +Officer) +March +18, 2009 +/s/ Gary +Meller +Dr. +Gary Meller +Director +March +18, 2009 +/s/ Katherine L. +Davis +Katherine +L. Davis +Director +March +18, 2009 +47 +CHEMBIO DIAGNOSTICS, +INC. AND SUBSIDIARIES +Index to Consolidated +Financial Statements +—INDEX— +Page(s) +Report +of Registered Independent Public Accounting Firm - +Successor +F-2 +Report +of Registered Independent Public Accounting Firm - +Predecessor +F-3 +Consolidated +Financial Statements: +Balance +Sheets +December +31, 2008 and 2007 +F-4 +Statements +of Operations +Years +ended December 31, 2008 and 2007 +F-5 +Statements +of Changes in Stockholders’ Equity +Years +ended December 31, 2008 and 2007 +F-6 +Statements +of Cash Flows +Years +ended December 31, 2008 and 2007 +F-7 +Notes +to Consolidated Financial Statements +F-8 +- F-23 +F - +1 +REPORT OF REGISTERED +INDEPENDENT PUBLIC ACCOUNTING FIRM +To The +Board of Directors +Chembio +Diagnostics, Inc. and Subsidiaries +Medford, +New York +We have +audited the consolidated balance sheet of Chembio Diagnostics, Inc. and +Subsidiaries (the “Company”) as of December 31, 2008 and the consolidated +statements of operations, stockholders' equity and cash flows for the year ended +December 31, 2008. These financial statements are the responsibility +of the Company's management. Our responsibility is to express an opinion on +these financial statements based on our audit. +We +conducted our audit in accordance with the standards of the Public Company +Accounting Oversight Board (United States). Those standards require +that we plan and perform the audit to obtain reasonable assurance about whether +the financial statements are free of material misstatement. The +Company is not required to have, nor were we engaged to perform, an audit of its +internal control over financial reporting. Our audit included +consideration of internal control over financial reporting as a basis for +designing audit procedures that are appropriate in the circumstances, but not +for the purpose of expressing an opinion on the effectiveness of the Company's +internal control over financial reporting. Accordingly, we express no +such opinion. An audit also includes examining, on a test basis, +evidence supporting the amounts and disclosures in the financial statements, +assessing the accounting principles used and significant estimates made by +management, as well as evaluating the overall financial statement +presentation. We believe that our audit provides a reasonable basis +for our opinion. +In our +opinion, the financial statements referred to above present fairly, in all +material respects, the consolidated financial position of Chembio Diagnostics, +Inc. and Subsidiaries as of December 31, 2008, and the consolidated results of +its operations and its cash flows for the year ended December 31, 2008 in +conformity with accounting principles generally accepted in the United States of +America. +PARENTE +RANDOLPH, LLC +/s/ PARENTE RANDOLPH, +LLC +New York, +New York +March 18, +2009 +F - +2 +REPORT OF REGISTERED +INDEPENDENT PUBLIC ACCOUNTING FIRM +To The +Board of Directors +Chembio +Diagnostics, Inc. and Subsidiaries +Medford, +New York +We have +audited the consolidated balance sheet of Chembio Diagnostics, Inc. and +Subsidiaries (the “Company”) as of December 31, 2007 and the consolidated +statements of operations, stockholders' equity and cash flows for the year ended +December 31, 2007. These financial statements are the responsibility +of the Company's management. Our responsibility is to express an opinion on +these financial statements based on our audit. +We +conducted our audit in accordance with the standards of the Public Company +Accounting Oversight Board (United States). Those standards require +that we plan and perform the audit to obtain reasonable assurance about whether +the financial statements are free of material misstatement. The +Company is not required to have, nor were we engaged to perform, an audit of its +internal control over financial reporting. Our audit included +consideration of internal control over financial reporting as a basis for +designing audit procedures that are appropriate in the circumstances, but not +for the purpose of expressing an opinion on the effectiveness of the Company's +internal control over financial reporting. Accordingly, we express no +such opinion. An audit also includes examining, on a test basis, +evidence supporting the amounts and disclosures in the financial statements, +assessing the accounting principles used and significant estimates made by +management, as well as evaluating the overall financial statement +presentation. We believe that our audit provides a reasonable basis +for our opinion. +In our +opinion, the financial statements referred to above present fairly, in all +material respects, the consolidated financial position of Chembio Diagnostics, +Inc. and Subsidiaries as of December 31, 2007, and the consolidated results of +its operations and its cash flows for the year ended December 31, 2007 in +conformity with accounting principles generally accepted in the United States of +America. +LAZAR +LEVINE & FELIX LLP +/s/ LAZAR LEVINE & FELIX +LLP +New York, +New York +March 7, +2008 +F - +3 +CHEMBIO DIAGNOSTICS, +INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE +SHEETS +AS +OF +- +ASSETS - +December +31, 2008 +December +31, 2007 +CURRENT +ASSETS: +Cash +and cash equivalents +$ +1,212,222 +$ +2,827,369 +Accounts +receivable, net of allowance for doubtful accounts of $10,000 for 2008 and +2007 +809,303 +946,340 +Inventories +1,819,037 +1,453,850 +Prepaid +expenses and other current assets +225,153 +243,748 +TOTAL +CURRENT ASSETS +4,065,715 +5,471,307 +FIXED ASSETS , net of +accumulated depreciation +881,406 +829,332 +OTHER +ASSETS: +License +agreements, net of current portion +940,000 +255,948 +Deposits +and other assets +27,820 +28,410 +$ +5,914,941 +$ +6,584,997 +- +LIABILITIES AND STOCKHOLDERS’ EQUITY - +CURRENT +LIABILITIES: +Accounts +payable and accrued liabilities +$ +2,383,021 +$ +2,175,791 +Deferred +research and development revenue +- +43,334 +Current +portion of obligations under capital leases +18,780 +23,458 +TOTAL +CURRENT LIABILITIES +2,401,801 +2,242,583 +OTHER +LIABILITIES: +Obligations +under capital leases - net of current portion +60,808 +79,588 +License +fee payable - net of current portion +875,000 +- +TOTAL +LIABILITIES +3,337,609 +2,322,171 +COMMITMENTS +AND CONTINGENCIES +STOCKHOLDERS’ +EQUITY: +Preferred +stock – 10,000,000 shares authorized, none outstanding +- +- +Common +stock - $.01 par value; 100,000,000 shares authorized 61,944,901 and +60,537,534 shares issued and outstanding as of 2008 and 2007, +respectively +619,449 +605,375 +Additional +paid-in capital +39,252,350 +39,003,148 +Accumulated +deficit +(37,294,467 +) +(35,345,697 +) +TOTAL +STOCKHOLDERS’ EQUITY +2,577,332 +4,262,826 +$ +5,914,941 +$ +6,584,997 +See +accompanying notes +F - +4 +CHEMBIO DIAGNOSTICS, +INC. AND SUBSIDIARIES +CONSOLIDATED +STATEMENTS OF OPERATIONS +FOR THE YEARS +ENDED +December +31, 2008 +December +31, 2007 +REVENUES: +Net +sales +$ +10,355,768 +$ +8,764,877 +Research +grant income +693,803 +466,071 +TOTAL +REVENUES +11,049,571 +9,230,948 +Cost +of sales +7,197,850 +6,435,238 +GROSS +PROFIT +3,851,721 +2,795,710 +OPERATING +EXPENSES: +Research +and development expenses +2,605,343 +1,906,653 +Selling, +general and administrative expenses +3,317,046 +3,765,221 +TOTAL +OPERATING EXPENSES +5,922,389 +5,671,874 +LOSS +FROM OPERATIONS +(2,070,668 +) +(2,876,164 +) +OTHER +INCOME (EXPENSES): +Other +income - net +95,812 +120,862 +Interest +income +34,403 +145,289 +Interest +expense +(8,317 +) +(16,879 +) +121,898 +249,272 +LOSS +BEFORE INCOME TAXES +(1,948,770 +) +(2,626,892 +) +Provision +for income taxes +- +- +NET +LOSS +(1,948,770 +) +(2,626,892 +) +Dividends +payable in stock to preferred stockholders +- +5,645,310 +NET +LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS +$ +(1,948,770 +) +$ +(8,272,202 +) +Basic +and diluted loss per share +$ +(0.03 +) +$ +(0.57 +) +Weighted +average number of shares outstanding, basic and diluted +61,266,954 +14,608,478 +See +accompanying notes +F - +5 +CHEMBIO DIAGNOSTICS, +INC. AND SUBSIDIARIES +CONSOLIDATED +STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +FOR THE YEARS ENDED +DECEMBER 31, 2008 AND 2007 +Series +A Preferred Stock +Series +B Preferred Stock +Common +Stock +Additional +paid in capital +Accumulated +Deficit +Total +Shares +Amount +Shares +Amount +Shares +Amount +Amount +Amount +Amount +Balance +at December 31, 2006 +149.92119 +$ +2,504,313 +113.93591 +$ +3,555,786 +11,296,961 +$ +112,970 +$ +19,960,618 +$ +(27,073,494 +) +$ +(939,807 +) +Preferred +Stock related: +Accretion +of preferred dividend +- +331,375 +- +491,302 +- +- +- +(1,385,594 +) +(562,917 +) +Payment +of dividends +- +(391,343 +) +- +(758,087 +) +3,442,467 +34,425 +1,705,505 +- +590,500 +Common +Stock Issued: +Common +converted from preferred (including Series C) +(149.92119 +) +(2,444,345 +) +(113.93591 +) +(3,289,001 +) +41,861,540 +418,615 +16,425,733 +(4,259,717 +) +6,851,285 +For +services +- +- +- +- +200,000 +2,000 +117,800 +- +119,800 +Warrants +and options: +Consultants/Advisory +Board +- +- +- +- +- +- +20,000 +- +20,000 +Exercised +- +- +- +- +3,736,566 +37,365 +1,082,996 +- +1,120,361 +Fee +for plan +- +- +- +- +- +- +(561,816 +) +- +(561,816 +) +Stock +option compensation +- +- +- +- +- +- +252,312 +- +252,312 +Net +loss for 2007 +- +- +- +- +- +- +- +(2,626,892 +) +(2,626,892 +) +Balance +at December 31, 2007 +- +- +- +- +60,537,534 +605,375 +39,003,148 +(35,345,697 +) +4,262,826 +Warrants +and options: +Excercised +- +- +- +- +1,407,367 +14,074 +(14,074 +) +- +- +Stock +option compensation +- +- +- +- +- +- +263,276 +- +263,276 +Net +loss for 2008 +- +- +- +- +- +- +- +(1,948,770 +) +(1,948,770 +) +Balance +at December 31, 2008 +- +$ +- +- +$ +- +61,944,901 +$ +619,449 +$ +39,252,350 +$ +(37,294,467 +) +$ +2,577,332 +See +accompanying notes +F - +6 +CHEMBIO DIAGNOSTICS, +INC. AND SUBSIDIARIES +CONSOLIDATED +STATEMENTS OF CASH FLOWS +FOR THE YEARS +ENDED +December +31, 2008 +December +31, 2007 +INCREASE +(DECREASE) IN CASH AND CASH EQUIVALENTS: +CASH +FLOWS FROM OPERATING ACTIVITIES: +Cash +received from customers +$ +11,186,608 +$ +9,802,348 +Cash +paid to suppliers and employees +(12,406,921 +) +(11,276,554 +) +Interest +received +34,403 +145,289 +Interest +paid +(8,317 +) +(16,879 +) +Net +cash used in operating activities +(1,194,227 +) +(1,345,796 +) +CASH +FLOWS FROM INVESTING ACTIVITIES: +Acquisition +of fixed assets +(397,462 +) +(410,425 +) +Net +cash used in investing activities +(397,462 +) +(410,425 +) +CASH +FLOWS FROM FINANCING ACTIVITIES: +Proceeds +from exercise of options and warrants, net of cash cost of financing of +$561,816 in 2007 +- +558,545 +Payment +of accrued interest +- +(93,160 +) +Payment +of dividends +- +(120,000 +) +Payment +of capital lease obligation +(23,458 +) +(52,181 +) +Net +cash used in financing activities +(23,458 +) +293,204 +NET +(DECREASE) IN CASH AND CASH EQUIVALENTS +(1,615,147 +) +(1,463,017 +) +Cash +and cash equivalents - beginning of the period +2,827,369 +4,290,386 +Cash +and cash equivalents - end of the period +$ +1,212,222 +$ +2,827,369 +RECONCILIATION +OF NET LOSS TO NET CASH USED IN OPERATING ACTIVITIES: +Net +Loss +$ +(1,948,770 +) +$ +(2,626,892 +) +Adjustments: +Depreciation +and amortization +345,388 +283,359 +Loss +on retirement of fixed assets +- +12,146 +Provision +for doubtful accounts +- +(32,922 +) +Common +stock, options and warrants issued as compensation +291,979 +342,163 +Changes +in assets and liabilities: +Accounts +receivable +137,037 +436,822 +Inventories +(365,187 +) +(344,900 +) +Prepaid +expenses and other assets +(10,108 +) +(9,706 +) +Other +assets and deposits +(683,462 +) +64,948 +Deferred +revenue +(43,334 +) +- +Accounts +payable and accrued expenses +207,230 +529,186 +Licenses +fee payable +875,000 +- +Net +cash used in operating activities +$ +(1,194,227 +) +$ +(1,345,796 +) +Supplemental +disclosures for non-cash investing and financing +activities: +Value +of common stock issued upon cashless warrant exercise +$ +14,074 +$ +- +Value +of warrants/options/stock issued allocated to additional paid-in +capital +- +61,181 +Accreted +dividend to preferred stock +- +1,385,594 +Value +of Common stock issued as payment of dividend +- +1,739,930 +Value +of Preferred stock converted to common stock +- +5,733,346 +Assets +acquired under capital leases +- +110,810 +See +accompanying notes +F - +7 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +NOTE +1 +— DESCRIPTION +OF BUSINESS: +Chembio +Diagnostics, Inc. (the “Company” or “Chembio”) and its subsidiaries develop, +manufacture, and market rapid diagnostic tests that detect infectious diseases. +The Company’s main products are three rapid tests for the detection of HIV +antibodies in whole blood, serum and plasma samples, two of which were approved +by the FDA in 2006; the third is sold for export only. Rapid HIV +tests represented nearly 90% of the Company’s product revenues in +2008. The Company also has other rapid tests that together +represented approximately 10% of sales in 2008. The Company’s +products are sold to medical laboratories and hospitals, governmental and public +health entities, non-governmental organizations, medical professionals and +retail establishments. Chembio’s products are sold under the Company’s STAT PAK® +or SURE CHECK ® registered trademarks or under the private labels of its +marketing partners, for example the Clearview® label owned by Inverness Medical +Innovations, Inc., which is the Company’s exclusive marketing partner for its +rapid HIV lateral flow test products in the United States. These +products employ lateral flow technologies that are proprietary and/or licensed +to the Company. All of the Company’s products that are currently +being developed are based on its patented Dual Path Platform (DPP®), which is a +unique diagnostic point-of-care platform that has certain advantages over +lateral flow technology. In 2008, the Company completed development +of its first two products that employ the DPP® and has a number of additional +products under development that employ the DPP®. +The +accompanying consolidated financial statements have been prepared in conformity +with accounting principles generally accepted in the United States of America, +which contemplate continuation of the Company as a going concern. Although +revenues and gross margins increased in the year ended December 31, 2008 as +compared to the same period in 2007, the Company continues to generate +significant operating losses. At December 31, 2008, the Company had a positive +stockholders’ equity of $2,577,000 and working capital of $1,664,000. The +Company estimates that its resources are sufficient to fund its needs through +the end of 2009 and beyond or that, in the alternative, it could raise +additional capital although the terms under which that capital could be raised +would likely be very dilutive to current shareholders . The Company’s liquidity +and cash requirements will depend on several factors. These factors include (1) +the level of revenues (the Company received $340,000 in 2009 for license fees +for which we need to meet certain milestones to earn); (2) the extent to which, +if any, that revenue level improves operating cash flows; (3) the Company’s +investments in research and development, facilities, marketing, regulatory +approvals, and other investments it may determine to make; and (4) the +investment in capital equipment (including production equipment of $323,500 that +the Company has contracted for) and the extent to which it improves cash flow +through operating efficiencies. There are no assurances that the Company will +become profitable or generate positive cash flow by the end of 2009 or, in the +alternative, be successful in raising sufficient capital to fund its needs +through 2009. +NOTE +2 +— SIGNIFICANT +ACCOUNTING POLICIES: +(a) +Principles +of Consolidation: +The +consolidated financial statements include the accounts of the Company, and its +wholly owned subsidiary. All intercompany transactions and balances +have been eliminated in consolidation. +(b) +Use +of Estimates: +The +preparation of financial statements in conformity with accounting principles +generally accepted in the United States of America requires management to make +estimates and assumptions that affect the reported amounts of assets and +liabilities and 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. Actual results could differ from those +estimates. +F - +8 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +(c) +Fair +Value of Financial Instruments: +Fair +values of cash and cash equivalents, accounts receivable, prepaid expenses and +other current assets and accounts payable and accrued expenses reflected in +these financial statements approximate carrying value as these are short-term in +nature. +(d) +Statements +of Cash Flows: +For +purposes of the statements of cash flows the Company considers all highly liquid +investments with an original maturity of three months or less to be cash +equivalents. +(e) +Concentrations +of Credit Risk: +Financial +instruments which potentially subject the Company to concentrations of credit +risk consist principally of temporary cash investments and trade receivables. +The Company places its temporary cash instruments with well-known financial +institutions and, at times, may maintain balances in excess of the $250,000 FDIC +Insurance limit. The Company monitors the credit ratings of the +financial institutions to mitigate this risk. The Company maintains +three accounts with a well established multi-national bank and as of December +31, 2008 had approximately $1.1 million above these limits. Concentration of +credit risk with respect to trade receivables is principally mitigated by the +Company’s obtaining of letters of credit from certain foreign customers, and its +diverse customer base both in number of customers and geographic +locations. We currently do not require collateral. +(f) +Inventories: +Inventories, +consisting +of material, labor and manufacturing overhead, are stated at the +lower of cost or market. Cost is determined on the first-in, +first-out method. +(g) +Fixed +Assets: +Fixed +assets are stated at cost less accumulated depreciation. Depreciation +is computed using the straight line method over the estimated useful lives of +the respective assets, which range from three to seven +years. Leasehold improvements are amortized over the useful life of +the asset or the lease term, whichever is shorter. +(h) +License +Agreement: +In +February 2008, the Company entered into a sublicense agreement (see Note 6) for +which it has recorded an asset of $1,000,000. This asset is being +expensed over an estimated economic life of ten years. The current +portion of this asset is $100,000 and is reported in prepaid expenses and other +current assets. The long-term portion as of December 31, 2008 is +$800,000 and is reflected in other assets along with other unexpensed long-term +license fees of $140,000. +(i) +Impairment +of Long-Lived Assets and Intangible +Assets +In +accordance with FAS No. 144, "Accounting for the Impairment or Disposal of +Long-Lived Assets", long-lived assets to be held and used are analyzed for +impairment whenever events or changes in circumstances indicate that the related +carrying amounts may not be recoverable. The Company evaluates at +each balance sheet date whether events and circumstances have occurred that +indicate possible impairment. If there are indications of impairment, +the Company uses future undiscounted cash flows of the related asset or asset +grouping over the remaining life in measuring whether the assets are +recoverable. In the event such cash flows are not expected to be +sufficient to recover the recorded asset values, the assets are written down to +their estimated fair value. We +believe that the carrying values of our long-lived tangible and intangible +assets were realizable at December 31, 2008. +F - +9 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +(j) +Revenue +Recognition: +The +Company recognizes revenue in accordance with Securities and Exchange Commission +Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB +104”). Under SAB 104, revenue is recognized when there is persuasive +evidence of an arrangement, delivery has occurred or services have been +rendered, the sales price is determinable, and collectability is reasonably +assured. Revenue typically is recognized at time of +shipment. Sales are recorded net of discounts, rebates and +returns. +The +Company recognizes income from research projects and grants when +earned. Grants are invoiced after expenses are +incurred. Any projects or grants funded in advance are deferred until +earned. +(k) +Shipping +and Handling Costs: +We incur +shipping and handling costs associated with the shipment of goods to customer +and independent distributors. All shipping and handling amounts +billed to customers are included in net sales. All shipping and +handling costs associated with the shipment of goods to customers are netted +against the amounts billed and are reflected in net sales. All other +shipping and handling costs are included in selling, general and administrative +expenses. +(l) +Research +and Development: +Research +and development costs are charged to expense as incurred. +(m) +Stock +Based Compensation: +The +Company’s 2008 Stock Incentive Plan and 1999 Stock Option Plan (“Plans”) +are accounted for in accordance with the recognition and measurement provisions +of Statement of Financial Accounting Standards ("FAS") No. 123 (revised 2004), +Share-Based Payment ("FAS 123(R)"). FAS 123(R) requires compensation costs +related to share-based payment transactions, including employee stock options, +to be recognized in the financial statements. In addition, the Company adheres +to the guidance set forth within Securities and Exchange Commission ("SEC") +Staff Accounting Bulletin No. 107 ("SAB 107"), which provides the Staff's views +regarding the interaction between FAS No. 123(R) and certain SEC rules and +regulations and provides interpretations with respect to the valuation of +share-based payments for public companies. See Note 12 for further +details. +(n) +Income +Taxes: +The +Company accounts for income taxes under the provisions of Statement of Financial +Accounting Standards No. 109, “Accounting for Income Taxes” (FAS +109). Under FAS 109, deferred tax assets and liabilities are +determined based on the difference between the financial statement carrying +amounts and the tax bases of assets and liabilities using enacted tax rates in +effect in the years in which the differences are expected to +reverse. +Effective +January 1, 2007, we adopted the Financial Accounting Standards Board (“FASB”) +Interpretation No. 48, Accounting for Uncertainty in Income Taxes, +an interpretation of FASB Statement No. 109 (“FIN 48”). +FIN 48 prescribes a more-likely-than-not threshold for financial statement +recognition and measurement of a tax position taken, or expected to be taken, in +a tax return. FIN 48 also provides guidance related to, among other things, +classification, accounting for interest and penalties associated with tax +positions, and disclosure requirements. Any interest and penalties accrued +related to unrecognized tax benefits will be recorded in tax +expense. The adoption of FIN 48 had no impact on the Company’s +financial statements for the year ended December 31, 2007. +F - +10 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +(o) +Earnings +Per Share +The +following weighted average shares were used for the computation of basic and +diluted earnings per share: +For the years ended +December +31, 2008 +December +31, 2007 +Basic +61,266,954 +14,608,478 +Diluted +61,266,954 +14,608,478 +Basic +loss per share is computed by dividing net loss attributable to common +stockholders by the weighted-average number of common shares outstanding for the +period. Diluted loss per share reflects the potential dilution from the exercise +or conversion of other securities into common stock, but only if dilutive. +Diluted loss per share for the years ended December 31, 2008 and 2007 is the +same as basic loss per share, since the effects of the calculation were +anti-dilutive due to the fact that the Company incurred losses for all periods +presented. The following securities, presented on a common share equivalent +basis, have been excluded from the per share computations: +For the years ended +December +31, 2008 +December +31, 2007 +1999 +& 2008 Plan Stock Options +2,555,837 +2,015,352 +Other +Stock Options +124,625 +124,625 +Warrants +14,657,050 +25,972,223 +Convertible +Preferred Stock +- +25,872,315 +17,337,512 +53,984,515 +(p) +Recent +Accounting Pronouncements Affecting the +Company: +In +September 2006, the Financial Accounting Standards Board (“FASB”) issued +Statement of Financial Accounting Standards (“FAS”) No. 157, Fair Value +Measurements, which defines fair value, establishes a framework for measuring +fair value in generally accepted accounting principles, and expands disclosures +about fair value measurements. This statement does not require any new fair +value measurements, but provides guidance on how to measure fair value by +providing a fair value hierarchy used to classify the source of the information. +FAS No. 157 is effective for fiscal years beginning after November 15, +2007, and all interim periods within those fiscal years. In February 2008, the +FASB released FASB Staff Position (FSP FAS 157-2 – Effective Date of FASB +Statement No. 157) which delays the effective date of FAS No. 157 for +all nonfinancial assets and nonfinancial liabilities, except those that are +recognized or disclosed at fair value in the financial statements on a recurring +basis (at least annually), to fiscal years beginning after November 15, 2008 and +interim periods within those fiscal years. The implementation of FAS +No. 157 for financial assets and liabilities, effective January 1, +2008, did not have an impact on the Company’s financial position and results of +operations. The Company is currently evaluating the impact of +adoption of this statement on its nonfinancial assets and liabilities which is +expected to be determined by the first quarter of fiscal 2009. +In +February 2007, the FASB issued FAS No. 159, “The Fair Value Option for Financial +Assets and Financial Liabilities” (“FAS No. 159”). FAS No. 159 permits entities +to choose to measure, on an item-by-item basis, specified financial instruments +and certain other items at fair value. Unrealized gains and losses on +items for which the fair value option has been elected are required to be +reported in earnings at each reporting date. FAS No. 159 is effective +for fiscal years beginning after November 15, 2007, the provisions of which are +required to be applied prospectively. The Company adopted this +statement as of January 1, 2008 and has elected not to apply the fair value +option to any of its financial instruments. +F - +11 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +In +December 2007, the FASB issued FAS No. 141 (revised 2007), Business +Combinations, which replaces FAS No 141. The statement retains the purchase +method of accounting for acquisitions, but requires a number of changes, +including changes in the way assets and liabilities are recognized in the +purchase accounting. It also changes the recognition of assets acquired and +liabilities assumed arising from contingencies, requires the capitalization of +in-process research and development at fair value, and requires the expensing of +acquisition-related costs as incurred. FAS No. 141R is effective +for business combinations for which the acquisition date is on or after the +beginning of the first annual reporting period beginning on or after December +15, 2008. The +adoption of FAS 141R is not expected to have an impact on the Company’s +financial statements. +In +December 2007, the FASB issued FAS No. 160, “Noncontrolling Interests in +Consolidated Financial Statements – an Amendment of ARB No. 51.” FAS +160 establishes accounting and reporting standards pertaining to ownership +interests in subsidiaries held by parties other than the parent, the amount of +net income attributable to the parent and to the noncontrolling interest, +changes in a parent’s ownership interest, and the valuation of any retained +noncontrolling equity investment when a subsidiary is +deconsolidated. This statement also establishes disclosure +requirements that clearly identify and distinguish between the interests of the +parent and the interests of the noncontrolling owners. FAS 160 is +effective for fiscal years beginning on or after December 15, +2008. The adoption of FAS 160 is not currently expected to have a +material effect on the Company’s consolidated financial position, results of +operations, or cash flows. +In March +2008, the FASB issued FAS No. 161, “Disclosures about Derivative Instruments and +Hedging Activities – an Amendment of FASB Statement No. 133.” The new standard +is intended to improve financial reporting about derivative instruments and +hedging activities by requiring enhanced disclosures to enable investors to +better understand their effects on an entity’s financial position, financial +performance, and cash flows. It is effective for financial statements issued for +fiscal years and interim periods beginning after November 15, 2008, with early +application encouraged. The Company is currently evaluating the impact of +adopting FAS No. 161 on its financial statements. +In +December 2007, the Emerging Issues Task Force (“EITF”) reached a consensus with +respect to Issue No. 07-1 “Accounting for Collaborative Arrangements”. This EITF +applies to participants in a collaborative arrangement. A collaborative +arrangement is a contractual arrangement that involves a joint operating +activity. These arrangements involve two (or more) parties who are both (a) +active participants in the activity and (b) exposed to significant risks and +rewards dependent on the commercial success of the activity. Many collaborative +arrangements involve licenses of intellectual property, and the participants may +exchange consideration related to the license at the inception of the +arrangement. Participants in a collaborative arrangement shall report costs +incurred and revenue generated from transactions with third parties (that is, +parties that do not participate in the arrangement) in each entity's respective +income statement pursuant to the guidance in EITF No. 99-19. An entity should +not apply the equity method of accounting under APB 18 to activities of +collaborative arrangements. This EITF, which can be applied retrospectively, is +effective for financial statements issued for fiscal years beginning after +December 15, 2008, and interim periods within those fiscal +years. The +guidance in this EITF is not expected to have an impact on the Company’s +financial statements. +In June +2007, EITF reached a consensus with respect to Issue No. 07-3 “Accounting for +Nonrefundable Advance Payments for Goods or Services Received for Use in Future +Research and Development Activities”. EITF 07-3 confirms that +nonrefundable advance payments for goods or services that will be used or +rendered for future research and development activities should be deferred and +capitalized. Such amounts should be recognized as an expense as the +related goods are delivered or the related services are performed. If +an entity does not expect the goods to be delivered or services to be rendered, +the capitalized advance payment should be charged to expense. This +EITF is effective for financial statements issued for fiscal years beginning +after December 15, 2007. The guidance in this EITF had no impact on +the Company’s financial statements in 2008. +F - +12 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +(q) +Reclassifications +As of the +year ended December 31, 2008 the Company reclassified its royalty and license +expenses to cost of goods sold, instead of selling, general and administrative +expenses. +NOTE +3 +— INVENTORIES: +Inventories +consist of the following at December 31: +2008 +2007 +Raw +materials +$ 836,446 +$ 705,873 +Work +in process +300,986 +234,077 +Finished +goods +681,605 +513,900 +$ 1,819,037 +$ 1,453,850 +NOTE +4 +— FIXED +ASSETS: +Fixed +assets consist of at December 31: +2008 +2007 +Machinery +and equipment +$ 1,195,975 +$982,440 +Furniture +and fixtures +195,611 +156,313 +Computer +and telephone equipment +329,865 +308,591 +Leasehold +improvements +400,589 +306,676 +Automobiles +29,442 +- +2,151,482 +1,754,020 +Less +accumulated depreciation and amortization +(1,270,076) +(924,688) +$ 881,406 +$829,332 +Included +in the above fixed assets is $70,500 and $121,000, net of accumulated +depreciation of $40,000 and $69,000 of assets held under capital leases as of +December 31, 2008 and 2007, respectively. Depreciation expense +for the 2008 and 2007 years aggregated $345,388 and $283,359, +respectively. +F - +13 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +NOTE +5 +— ACCOUNTS +PAYABLE AND ACCRUED LIABILITIES: +Accounts +payable and accrued liabilities as of December 31: +2008 +2007 +Accounts +payable – suppliers +$ 634,083 +$ 726,174 +Accrued +commissions +67,857 +14,251 +Accrued +royalties / license fees (see Note 8) +1,400,941 +852,119 +Accrued +payroll +95,135 +279,598 +Accrued +vacation +91,895 +155,480 +Accrued +legal and accounting +18,000 +10,000 +Accrued +expenses – other +75,110 +138,169 +TOTAL +$ 2,383,021 +$ 2,175,791 +NOTE +6 +— LICENSE +FEE PAYABLE: +In +February 2008, the Company entered into a sublicense agreement (the “Agreement”) +with Bio-Rad Laboratories, Inc. and Bio-Rad Pasteur (collectively, +“Bio-Rad”). Bio-Rad is the exclusive licensee of the HIV-2 patent +portfolio held by Institute Pasteur of Paris, France. Pursuant to the +terms of the Agreement, Bio-Rad sublicensed to the Company patents related to +the manufacture, use or sale of HIV-2 in the Company’s HIV screening +assays. In exchange for global non-exclusive rights to the patents, +the Agreement provides that the Company will pay Bio-Rad a $1,000,000 sublicense +fee, $500,000 payable during 2008, of which $125,000 has been paid and $375,000 +was payable by December 31, 2008, with the additional $500,000 being payable by +December 31, 2009. On January 29, 2009, the Company and Bio-Rad +agreed to defer the remaining $875,000 of payments due under the HIV-2 +sub-license originally granted by Bio-Rad to Chembio in February 2008 to one +payment due in December 2010. The Company will also pay Bio-Rad a +royalty on net sales in the United States and Canada, if any, of rapid test +immunoassay tests sold under the Company’s brands of Licensed Products as +defined in the Agreement. The Agreement will continue until the expiration of +the last-to-expire of the sublicensed patents, unless otherwise terminated at an +earlier date by the Company or Bio-Rad (see Note 2(h)). +NOTE +7 — OBLIGATIONS UNDER +CAPITAL LEASES: +The +Company is obligated under capitalized leases for certain manufacturing and +computer equipment. +Future +minimum lease payments under these capitalized lease obligations, including +interest as of December 31, 2008 were as follows: +Year +ending December 31, +2009 +$28,572 +2010 +28,572 +2011 +28,572 +2012 +15,204 +100,920 +Less: +imputed interest +(21,332 +) +Present +value of future minimum lease payments +79,588 +Less: +current maturities +(18,780 +) +$ +60,808 +These +leases have annual interest rates ranging from 13% - 15%. +F - +14 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +NOTE +8 +— RELATED +PARTIES: +In +September 2006, the Company received an investment of $2,000,000 from Inverness +Medical Innovations, Inc. (“Inverness”). Inverness markets the +Company’s FDA-approved rapid HIV tests under Inverness’ Clearview® brand, +Chembio received a nonexclusive license to Inverness’ lateral flow +patents. The distribution agreements with Inverness contain gross +margin sharing formulae among Inverness, the Company and, in the case of the HIV +barrel product, StatSure Diagnostic Systems, Inc. +During +the quarter ended December 31, 2008, Inverness Medical Innovations, Inc. +(“Inverness”) notified the Company that Inverness had entered into a contract +with Bio-Rad Laboratories, Inc. (“Bio-Rad”) for royalties on Bio-Rad’s patent +for the detection of HIV-2 antibodies. The agreement also provided +for Inverness to pay past royalties. The agreements between the +Company and Inverness provide that the Company is to share in these past +royalties and Inverness requested it be reimbursed for the Company’s share of +these past royalties. The Company and Inverness have agreed that this +liability, which is approximately $500,000 as of December 31, 2008 (included in +accounts payable and accrued expenses – see Note 5), is to be paid from future +revenues over approximately the next 18 months. +NOTE +9 +— RESEARCH +GRANTS AND DEVELOPMENT CONTRACTS: +In 2008 +and 2007, the Company earned $694,000 and $466,000, respectively from research +grants, feasibility and development contracts. The Company is +now involved in additional feasibility and development contracts related to its +DPP® technology. +NOTE +10 +— INCOME +TAXES: +No +provision for Federal income taxes was required for the years ended December 31, +2008 or 2007, due to the Company’s operating losses. At December 31, +2008 and 2007, the Company has unused net operating loss carry-forwards of +approximately $22,200,000 and $21,000,000 which expire at various dates through +2028. Most of this amount is subject to annual limitations under +certain provisions of the Internal Revenue Code related to “changes in +ownership”. In addition the Company has a research and development +credit carryforward of approximately $505,000 and $460,000 for the years ended +December 31, 2008 and 2007, respectively which expire at various dates through +2028. +As of +December 31, 2008 and 2007, the deferred tax assets related to the +aforementioned carry-forwards have been fully offset by valuation allowances, +since significant utilization of such amounts is not presently expected in the +foreseeable future. +Deferred +tax assets and valuation allowances consist of: +2008 +2007 +Net +operating loss carry-forwards +$7,750,000 +$7,300,000 +Research +and development credit +505,000 +551,000 +Other +343,000 +137,000 +Gross +deferred tax assets +8,598,000 +7,988,000 +Valuation +allowances +(8,598,000 +) +(7,988,000 +) +Net +deferred tax assets +$ — +$ — +We file +income tax returns in the U.S. federal and New York state +jurisdictions. Tax years for fiscal 2005 through 2007 are open and +potentially subject to examination by the federal and New York state taxing +authorities. +F - +15 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +NOTE 11 +— STOCKHOLDERS’ +EQUITY: +(a) Common S to ck +During +the June 30, 2008 quarter, warrants to purchase 9,323,854 shares of the +Company’s common stock were exercised on a cashless basis, resulting in the +issuance of 1,407,367 shares of common stock. These warrants were exercised +on a cashless basis in connection with the Company’s preferred stock and warrant +amendments that were completed on December 19, 2007 (“Plan”), and the Company +received no cash consideration for these issuances of common stock. +On +December 19, 2007 the Company issued pursuant to the Plan: +i) 99,086, +599,331, and 574,818 shares of common stock for the payment of dividends for the +Series A, B and C preferred stock, respectively. These shares were +valued, in the aggregate at $558,000, using the respective conversion price at +the time of the conversion of the preferred stock; +ii) 10,134,954, +13,938,118, and 17,187,496 shares of common stock for the conversion of the +Series A, B and C preferred stock, respectively. These shares were valued, in +the aggregate at $16,504,000, using the market price on December 19, +2007; +iii) 963,163 +shares of common stock for the cashless exercise of 6,381,052 warrants, +and +iv) 2,723,403 +shares of common stock for the cash exercise of warrants where the Company +received $1,089,000 less $562,000 paid in fees. +During +the year ended December 31, 2007, the Company issued 200,000 shares of its +Common Stock upon the execution of an employment agreement, of which 100,000 +shares vested immediately, 50,000 shares will vest on March 5, 2008 and 50,000 +shares will vest on March 5, 2009. These shares were valued at +the market price on the date of grant and aggregated $119,800 and are being +expensed over the vesting periods. +During +year ended December 31, 2007 the Company issued 50,000 shares of its Common +Stock upon the exercise of options and received cash of $31,000. +During +the year ended December 31, 2007 Series A Preferred shareholders, other than in +the Plan, converted 8.33092 shares of Series A Preferred Stock into 416,546 +shares of Common Stock. +During +the year ended December 31, 2007 Series B Preferred shareholders, other than in +the Plan, converted 2.25 shares of Series B Preferred Stock into 184,426 shares +of Common Stock. +In the +year ended December 31, 2007, other than in the Plan, the Company issued +897,896, 835,577 and 435,759 shares of its Common Stock as payment of dividends +on its Series C Preferred Stock, Series B Preferred Stock and Series A Preferred +Stock, respectively. These shares were valued, in the aggregate at $1,182,000, +using a volume weighted average price (VWAP) for the ten trading days +immediately preceding the issue date. +(b) Warrants +On +December 19, 2007, in connection with the Plan certain holders of the +Non-Employee Warrants did not consent to the Plan +transactions. Pursuant to the anti-dilution terms existing in certain +of the Non-Employee Warrants held by these non-consenting holders, the number of +warrants that these non-consenting holders are permitted to exercise has been +increased by 2,395,466. In addition, the exercise prices of certain +of the Non-Employee Warrants held by non-consenting holders was reduced to $0.40 +pursuant to the terms of these warrants, and these non-consenting holders are +permitted to exercise their warrants for cash only at $0.40 per share until the +expiration of the warrants. The increased warrants expire as follows: +a) 1,303,928 on January 29, 2010; b) 149,350 on June 29, 2011; and c) 942,188 on +October 5, 2011. +F - +16 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +During +the year ended December 31, 2007, the Company issued warrants to purchase 33,381 +shares of Common Stock at an exercise price of $0.81 per share to a sales agent +as payment for commissions accrued at year end 2006 (value +$20,000). These warrants have a five-year life. +The above +warrants were valued using a Black-Scholes option pricing model based on +assumptions for expected volatility of 104.8%, expected life of 5 years and +expected risk-free interest rate of 4.54%. +( c ) Series A 8% +Convertible Preferred S to ck : +On +December 19, 2007 (the “Closing Date”) amendments to the governing documents for +the Company’s Series A, Series B and Series C Convertible Preferred Stock +(collectively, the “Preferred Stock”) and for certain warrants and options +(collectively, the “Non-Employee Warrants”) not including options or warrants +issued to employees or directors in their capacity as such (these actions +collectively, the “Plan”) were approved by the Company and the requisite +percentages of the holders of the Preferred Stock and of the Non-Employee +Warrants. +On +December 19, 2007, according to the Plan, all of the Series A preferred stock +was converted into common stock. The common stock issued was valued +at the market price on December 19, 2007 of $.40 per share. This +value was adjusted against the carrying value of the Series A Preferred Stock +and the difference of $1,726,000 was charged to deemed dividends. +The +Series A Preferred Stock was issued in 2004 at a face value of $30,000 per share +with detachable warrants. The recorded amount of the preferred shares was +calculated using a fair value allocation between the preferred shares and +detachable warrants. +( d ) Series B 9% +Convertible Preferred S to ck : +On +December 19, 2007, according to the Plan, all of the Series B preferred stock +was converted into common stock. The common stock issued was valued +at the market price on December 19, 2007 of $.40 per share. This +value was adjusted against the carrying value of the Series B Preferred Stock +and the difference of $2,349,000 was charged to deemed dividends. +The +Series B Preferred Stock was issued in January 2005 at a face value of $50,000 +per share with detachable warrants. The recorded amount of the preferred shares +was calculated using a fair value allocation between the preferred shares and +detachable warrants. On March 30, 2006, the Company sold $1 million of +additional Series B Preferred Stock to a Series B Preferred shareholder pursuant +to provisions of the January 2005 Series B 9% Preferred Stock financing +agreements. Such provisions were exclusive to said +shareholder. Approximately $140,000 of these proceeds was used to pay +cash dividends which were accrued as of December 31, 2005. The +recorded amount of the preferred shares was calculated using a fair value +allocation between the preferred shares and detachable warrants. +( e ) Series +C +7 % +Convertible Preferred S to ck : +On +December 19, 2007, according to the Plan, all of the Series C preferred stock +was converted into common stock. The common stock issued was valued +at the market price on December 19, 2007 of $.40 per share. This +value was adjusted against the carrying value of the Series C Preferred Stock +and the difference of $185,102 was charged to deemed dividends. +On +September 29, 2006 and October 5, 2006, the Company sold $8.25 million of Series +C Preferred Stock (see Note 1) pursuant to provisions of the September 29, 2006 +as amended on October 5, 2006 Series C 7% Preferred Stock financing +agreements. In addition the Company issued 2,578,125 warrants to the +investors. +F - +17 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +NOTE +12 +— +EMPLOYEE +STOCK OPTION PLAN: +The +Company had a 1999 Stock Option Plan (“SOP”) originally covering 1,500,000 +shares of Common Stock. Under the terms of the SOP, the Compensation Committee +of the Company’s board is authorized to grant incentive options to key employees +and to grant non-qualified options to key employees and key individuals. The +options become exercisable at such times and under such conditions as determined +by the Compensation Committee. The SOP was amended at the Company’s +2005 stockholders’ meeting. The number of options under the SOP was +increased to cover 3,000,000 shares of common stock. It was also +amended to allow independent directors to be eligible for grants under the +portion of the SOP concerning non-qualified options. +Effective June 3, 2008, +the Company’s stockholders voted to approve the 2008 Stock Incentive Plan +(“SIP”). Under the terms of the SIP, the Compensation Committee of +the Company’s board shall have the discretion to select the persons to whom +Awards are to be granted. Awards can be incentive stock options, restricted +stock and/or restricted stock units. The Awards become vested at such times and +under such conditions as determined by the Compensation Committee. +As a +result of the adoption of FAS 123(R), the Company's results for the years ended +December 31, 2008 and 2007 include share-based compensation expense totaling +$263,000 and $252,000, respectively. Such amounts have been included +in the Consolidated Statements of Operations within cost of goods sold ($19,000 +and none, respectively), research and development ($56,000 and $100,000, +respectively) and selling, general and administrative expenses ($188,000 and +$152,000, respectively). No income tax benefit has been recognized in +the income statement for share-based compensation arrangements due to the +history of operating losses. +Stock +option compensation expense in the years ended December 31, 2008 and +2007 represent the estimated fair value of options outstanding which are +being amortized on a straight-line basis over the requisite vesting period of +the entire award. +The +weighted average estimated fair value of stock options granted in the years +ended December 31, 2008 and 2007 was $.37 and $.46 per share, +respectively. The fair value of options at the date of grant was +estimated using the Black-Scholes option pricing model. The expected volatility +is based upon historical volatility of our stock and other contributing factors. +The expected term is determined using the simplified method as permitted by SAB +107, as the Company has no history of employee exercise of options +to-date. +The +assumptions made in calculating the fair values of options are as +follows: +For the years ended +December +31, 2008 +December +31, 2007 +Expected +term (in years) +1 +to 4 +5 +Expected +volatility +109.33-112.33% +102.84-104.80% +Expected +dividend yield +n/a +n/a +Risk-free +interest rate +1.91 +to 2.98% +4.50-5.06% +The +Company granted 967,650 new options under the Plans during the year ended +December 31, 2008 at prices ranging from $.13 to $0.22 per share (534,000 were +issued under the SOP and 433,650 were issued under the SIP). As of February +15, 2008, the board of directors voted to re-price any SOP options in excess of +$.48 to $.48, the estimated expense related to this re-price is +$20,000. +F - +18 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +The +following table provides stock options activity for the years ended December 31, +2008 and 2007: +Stock +Options +Number +of Shares +Weighted +Average Exercise Price per Share +Weighted +Average Remaining Contractual Term +Aggregate +Intrinsic Value +Outstanding +at January 1, 2007 +1,529,750 +$0.65 +Granted +960,000 +$0.57 +Exercised +(50,000) +$0.62 +Forfeited/expired +/cancelled +(238,250) +$0.67 +Outstanding +at December 31, 2007 +2,201,500 +$0.64 +3.52 +years +$ - +Impact of re-price +(for accounting purposes treated as a cancelation and +re-issue): +effect +as if cancelled +(1,846,500) +$0.64 +effect +as if re-issiued +1,846,500 +$0.48 +Granted +967,650 +$0.18 +Exercised +- +- +Forfeited/expired +(752,500) +$0.58 +Outstanding +at December 31, 2008 +2,416,650 +$0.36 +3.23 +years +$ - +Exercisable +at December 31, 2008 +1,956,650 +$0.36 +3.11 +years +$ - +The +following table summarizes information about stock options outstanding as of +December 31, 2008: +Stock +Options Outstanding +Stock +Options Exercisable +Range +of Exercise Prices +Shares +Average +Remaining Contract Life (Year) +Weighted +Average Exercise Price +Aggregate +Intrinsic Value +Shares +Weighted +Average Exercise Price +Aggregate +Intrinsic Value +$ +0.13 +- 0.21 +442,650 +4.42 +0.130 +$ +- +298,650 +0.131 +$ +- +$ +0.22 +- 0.34 +465,000 +4.13 +0.220 +- +465,000 +0.220 +- +$ +0.35 +- 0.45 +65,000 +1.77 +0.427 +- +15,000 +0.350 +- +$ +0.46 +- 0.88 +1,444,000 +2.65 +0.483 +- +1,178,000 +0.482 +- +Total +2,416,650 +0.366 +$ +- +1,956,650 +0.365 +$ +- +As of +December 31, 2008, there was $74,000 of net unrecognized compensation cost +related to stock options that are not vested, which is expected to be recognized +over a weighted average period of approximately 1.25 years. The total +fair value of shares vested during the years ended December 31, 2008 and 2007, +was $273,000 and $276,000, respectively. +NOTE +13 — +GEOGRAPHIC +INFORMATION: +FAS No. +131, “Disclosures about Segments of an Enterprise and Related Information” +establishes standards for the way that business enterprises report information +about operating segments in financial statements and requires that those +enterprises report selected information. It also establishes standards for +related disclosures about product and services, geographic areas, and major +customers. +F - +19 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +The +Company produces only one group of similar products known collectively as “rapid +medical tests”. As per the provisions of FAS 131, management believes that it +operates in a single business segment. Net sales by geographic area are as +follows: +For the years ended +December +31, 2008 +December +31, 2007 +Africa +$ +4,740,858 +$ +3,784,791 +Asia +227,049 +158,577 +Europe +160,824 +153,808 +Middle +East +308,053 +239,838 +North +America +2,415,344 +4,226,442 +South +America +2,503,640 +201,421 +$ +10,355,768 +$ +8,764,877 +Sales to +Africa in 2008 were primarily from Nigeria of approximately $2.86 +million. We have been advised recently that our designation in +Nigeria as one of the screening tests has changed to that of the confirmatory +test as this country moves from a parallel to a serial testing algorithm, which +we expect will significantly reduce our sales to Nigeria in 2009, In addition +sales to North America and South America in 2008 were primarily from sales into +the U.S. and Brazil, respectively. +NOTE +14 +— +COMMITMENTS +AND CONTINGENCIES: +Employment +Contracts: +The +Company has contracts with two key employees. The contracts call for +salaries presently aggregating $500,000 per year. One contract +expires in May of 2009 and one contract expires in March of 2010. The +following table is a schedule of future minimum salary commitments: +2009 +$ +319,166 +2010 +39,167 +$ +358,333 +Pension Plan : +The +Company has a 401(k) plan established for its employees. The Company +elected to match 20% of the first 5% (or 1% of salary) that an employee +contributes to their 401(k) plan. Expenses related to this matching +contribution aggregated $23,850 and $20,500 for the years ended December 31, +2008 and 2007, respectively. +As of +January 19, 2009, the Company suspended the matching contribution. +Obligations +Under Operating Leases: +The +Company leases office, R&D and manufacturing facilities, currently with a +monthly rent of $11,987. The current lease expires on April 30, +2009. The following is a schedule of future minimum rental +commitments: +Year +ending December 31,2009 +$ +47,948 +F - +20 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +As of the +filing date of this Annual Report, the Company is in discussion +for a lease extension for its administrative offices and research +facilities. The principle terms being discussed are as +follows: (a) a lease term of five years; (b) an initial rent of +$11,350 per month; (c) the monthly rent for year two of the lease will +increase by the lower of (i) the change in the consumer price index, or +(ii) five percent; and (d) the monthly rent for years three through +five of the lease will increase each year by the lower of (i) the change in +the consumer price index, or (ii) two and one half percent. Although +the Company believes that the extension will be entered into on terms that are +substantially similar to the terms being discussed, there is no assurance +that this will occur. After this lease is executed the following +would be the schedule of future minimum rental commitments (assuming 5% increase +the first year and 2.5% thereafter): +Year +ending December 31, +2009 +$ +138,748 +2010 +140,740 +2011 +145,394 +2012 +149,029 +2013 +152,754 +2014 +51,473 +$ +778,138 +Rent +expense aggregated $130,300 and $123,500 for the years ended December 31, 2008 +and 2007, respectively. +Economic +Dependency: +The +following table delineates sales the Company had to customers in excess of 10% +of total sales for the periods indicated: +For +the years ended +Accounts +Receivable +December +31, 2008 +December +31, 2007 +As +of +Sales +% +of Sales +Sales +% +of Sales +Dec +31, 2008 +Dec +31, 2007 +Customer +1 +$ +2,434,420 +24 +* +* +$ +265,276 +* +Customer +2 +$ +3,502,737 +34 +$ +2,248,992 +26 +- +- +Customer +3 +$ +2,183,510 +21 +$ +2,456,071 +28 +$ +283,722 +$ +222,396 +Customer +4 +* +* +$ +1,398,125 +16 +* +- +In the +table above the asterisk (*) indicates that sales to the customer did not exceed +10% for the period indicated. +The +following table delineates purchases the Company had to vendors in excess of 10% +of total purchases for the periods indicated: +For +the years ended +Accounts +Payable +December +31, 2008 +December +31, 2007 +As +of +Purchases +% +of Purc. +Purchases +% +of Purc. +Dec. +31, 2008 +Dec. +31, 2007 +Vendor +1 +$ +627,637 +21 +$ +356,136 +15 +$ +17,460 +$ +19,469 +Vendor +2 +$ +303,750 +10 +* +* +$ +87,840 +* +In the +table above the asterisk (*) indicates that purchases from the vendor’s did not +exceed 10% for the period indicated. +The +Company currently buys materials which are purchased under intellectual property +rights agreements and are important components in its +products. Management believes that other suppliers could provide +similar materials on comparable terms. A change in suppliers, +however, could cause a delay in manufacturing and a possible loss of sales, +which would affect operating results adversely. +F - +21 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +Governmental +Regulation: +All of +the Company’s existing and proposed diagnostic products are regulated by the +United States Food and Drug Administration (FDA), United States Department of +Agriculture, certain state and local agencies, and/or comparable regulatory +bodies in other countries. Most aspects of development, production, +and marketing, including product testing, authorizations to market, labeling, +promotion, manufacturing, and record keeping are subject to +review. After marketing approval has been granted, Chembio must +continue to comply with governmental regulations. Failure to comply +with these regulations can result in significant penalties. +Voluntary +Component Recall: +In April +2008, we initiated a voluntary recall of two lots of Control kits used with our +HIV 1-2 Stat Pak® Assay distributed by Inverness under its Clearview® brand. +Control kits are to be used in order to verify the operator’s ability to +properly perform the test and to interpret the results. These kits are supplied +directly to Inverness by our vendor in accordance with our specifications and +instructions. In the case of these two lots of Control kits, although +they met our specifications, they were at the lower limit of such +specifications, and this produced some issues with the interpretation of the +Control kit results by certain customers. Chembio has provided the kit supplier +with a more clearly defined specification and has reviewed copies of revised +manufacturing and testing procedures to ensure implementation of the new +specification. Based upon this new specification, packaged HIV Rapid Test +Control Packs containing the new HIV Controls have been in distribution since +May 2008. The FDA has classified this voluntary recall as a Class II recall, “a +situation in which the use of, or exposure to, a violative product may cause +temporary or medically reversible adverse health consequences or where the +probability of serious adverse health consequences are +remote”. Approximately $22,000 in costs were incurred in 2008. We +have completed all of our recall activity, including monitoring and final +product disposition and the FDA has issued a letter to the Company confirming +that this investigation is officially closed. +Nigeria: +During +the first quarter of 2008, the Nigerian Ministry of Health published a report +indicating that our designation in Nigeria as one of the screening tests would +be changed to that of a confirmatory and/or tie-breaker test (Many countries use +a serial algorithm with tests from different manufacturers. A serial +algorithm uses a screening test from one manufacturer, a second confirmatory +test, from another manufacturer, if there is a positive result from the +screening test, meaning that the number of confirmatory tests used is equal to +the positivity rate in the testing venue. A tie-breaker test, from a third +manufacturer, resolves discrepancies between the screen and the confirmatory +test) which change has become effective in the first quarter of +2009. Consequently we expect our sales to Nigeria to decrease +significantly in 2009 as compared to 2008. +Equipment +Purchase Commitment: +In +January of 2009, the Company entered into an agreement with an equipment +manufacturer to design and build equipment that will be used to automate the +assembling of our tests and lower our production costs. The estimated +cost of $323,500 is being paid in installments over a five month +period. +F - +22 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARIES +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2008 AND +2007 +DPP® +Agreements: +a. +Brazil: +On +January 29, 2008 we signed three new technology transfer, supply and license +agreements with the Bio-Manguinhos unit of the Oswaldo Cruz Foundation of Brazil +(“FIOCRUZ”) for products we have developed or are have nearly completed +development of. +On +October 2, 2008 the Company announced a fourth technology +transfer supply and license agreement with FIOCRUZ for it’s DPP® HIV 1/2 rapid +test (for use with oral fluid or whole blood samples). Based upon the four +agreements we signed with FIOCRUZ in 2008, together with revenues that are +anticipated under the original agreement we signed with FIOCRUZ in 2004 for our +STAT PAK® rapid test, and subject to required regulatory approval and Ministry +of Health funding of the screening programs these tests are designated +for. +b. +Bio-Rad: +On April +16, 2008 we announced a new development agreement with Bio-Rad Laboratories, +N.A. (“Bio-Rad”). The agreement with Bio-Rad is for the development +of a new multiplex product that would be developed on DPP® and which would be +marketed exclusively by Bio-Rad under an exclusive limited DPP® license from +Chembio to Bio-Rad limited to the field of application of this +product. Our agreement with Bio-Rad contemplates that we will enter +into a license agreement no later than December 2008 subject to the satisfaction +of certain development and other conditions. On January 19, 2009 +Chembio granted, effective December 31, 2008, a limited exclusive license within +a defined field of application for Chembio’s Dual Path Platform technology to +Bio-Rad Laboratories, Inc. (“Bio-Rad”). The license was granted following +development milestones as set forth in the agreement mentioned above. As part of +this agreement, in 2009, +subsequent to the balance sheet date, Chembio received $340,000 from +Bio-Rad as a license fee. +F - 23 \ No newline at end of file diff --git a/raw/filings/0001092662/2008/0001092662-09-000024/filing_metadata.csv b/raw/filings/0001092662/2008/0001092662-09-000024/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..b8e148d3f6bd91a8eca9f25ad64e15bf23e9eee1 --- /dev/null +++ b/raw/filings/0001092662/2008/0001092662-09-000024/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001092662,CEMI,"CHEMBIO DIAGNOSTICS, INC.",10-K,2009-03-18,2008-12-31,2009-03-18T20:55:23.000Z,0001092662-09-000024,form10_k.htm,FORM 10-K FOR 2008,1894761,0,0,https://www.sec.gov/Archives/edgar/data/1092662/000109266209000024/form10_k.htm,https://www.sec.gov/Archives/edgar/data/1092662/000109266209000024/,2008,2008,1 diff --git a/raw/filings/0001092662/2008/0001092662-09-000024/item1.txt b/raw/filings/0001092662/2008/0001092662-09-000024/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001092662/2008/0001092662-09-000024/item13.txt b/raw/filings/0001092662/2008/0001092662-09-000024/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001092662/2008/0001092662-09-000024/item9a.txt b/raw/filings/0001092662/2008/0001092662-09-000024/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001092662/2008/0001092662-09-000024/rp_note.txt b/raw/filings/0001092662/2008/0001092662-09-000024/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001092662/2008/0001092662-09-000024/rpt_disclosure.txt b/raw/filings/0001092662/2008/0001092662-09-000024/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001092662/2009/0001092662-10-000007/filing.txt b/raw/filings/0001092662/2009/0001092662-10-000007/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..55d29bf00b9914eca6bbab3c910b893ccc5fd8bd --- /dev/null +++ b/raw/filings/0001092662/2009/0001092662-10-000007/filing.txt @@ -0,0 +1,7166 @@ +10-K +1 +form10_k.htm +FORM 10-K 2009 +form10_k.htm +UNITED +STATES +Securities +and Exchange Commission +Washington, +D.C. 20549 +FORM +10-K +[X] +ANNUAL +REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF +1934 +For +the fiscal year ended December 31, +2009 +or +[ ] +TRANSITION +REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF +1934 +For the transition period +from to . +Commission File No. +0-30379 +CHEMBIO DIAGNOSTICS, +INC. +(Exact +name of registrant as specified in its charter) +Nevada +88-0425691 +(State +or other jurisdiction of incorporation or organization) +(I.R.S. +Employer Identification No.) +3661 +Horseblock Road, Medford, NY +11763 +(Address +of principal executive offices) +(Zip +Code) +Registrant’s +telephone number, including area code (631) +924-1135 +Securities registered pursuant to +Section 12(b) of the Act: +Title +of each class +Name +of each exchange on which registered +None +None +Securities +registered pursuant to section 12(g) of the Act: +Common +Stock, $0.01 par value +(Title +of Class) +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in +Rule 405 of the Securities Act. Yes __ No X +Indicate +by check mark if the registrant is not required to file reports pursuant to +Section 13 or Section 15(d) of the Act. Yes __ No X +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 X No__ +Indicate +by check mark whether the registrant has submitted electronically and posted on +its corporate Website, 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 if disclosure of delinquent filers pursuant to Item 405 of +Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not +be contained, to the best of registrant’s knowledge, in definitive proxy or +information statements incorporated by reference in Part III of this Form 10-K +or any amendment to this Form 10-K. [ ] +Indicate +by check mark whether the registrant is a large accelerated filer, an +accelerated filer, a non-accelerated filer, or a smaller reporting +company. See the definitions of “large accelerated filer,” +“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the +Exchange Act. +Large accelerated filer [ +] +Accelerated filer [ +] +Non-accelerated +filer [ +] +Smaller reporting company [X] +(Do +not check if a smaller reporting company) +Indicate +by check mark whether the Registrant is a shell company (as defined in Rule +12b-2 of the Exchange Act). Yes __ No _ X _ +As of the +last business day of the Company’s most recently completed second fiscal +quarter, the aggregate market value of voting and non-voting common equity held +by non-affiliates* was $3,550,000. +As of +March 3, 2010, the registrant had 61,989,901 common shares +outstanding. +* Without +asserting that any of the issuer’s directors or executive officers, or the +entities that own more than five percent of the outstanding shares of the +Registrant’s common stock, are affiliates, the shares of which they are +beneficial owners have not been included in shares held by non-affiliates solely +for this calculation. +TABLE OF CONTENTS +Page +PART +I +ITEM +1. +BUSINESS +3 +ITEM +1A. +RISK +FACTORS +12 +ITEM +2. +PROPERTIES +17 +ITEM +3. +LEGAL +PROCEEDINGS +17 +PART +II +ITEM +5. +MARKET +FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER +PURCHASES OF EQUITY SECURITIES +18 +ITEM +6. +SELECTED +FINANCIAL DATA +19 +ITEM +7. +MANAGEMENT’S +DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF +OPERATIONS +20 +ITEM +8. +FINANCIAL +STATEMENTS AND SUPPLEMENTARY DATA +33 +ITEM +9. +CHANGES +IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL +DISCLOSURE. +33 +ITEM +9A. +CONTROLS +AND PROCEDURES +34 +ITEM +9B. +OTHER +INFORMATION +34 +PART +III +ITEM +10. +DIRECTORS, +EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +35 +ITEM +11. +EXECUTIVE +COMPENSATION +37 +ITEM +12. +SECURITY +OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED +STOCKHOLDER MATTERS +41 +ITEM +13. +CERTAIN +RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR +INDEPENDENCE +43 +ITEM +14. +PRINCIPAL +ACCOUNTANT FEES AND SERVICES +44 +PART +IV +ITEM +15. +EXHIBITS, +FINANCIAL STATEMENT SCHEDULES +45 +SIGNATURES +46 +PART +I +ITEM +1. +BUSINESS +FORWARD-LOOKING +STATEMENTS +This +report contains forward-looking statements within the meaning of Section 21E of +the Securities Exchange Act of 1934, and Section 27A of the Securities Act of +1933. Any statements contained in this report that are not statements of +historical fact may be forward-looking statements. When we use the words +“intends,” “estimates,” “predicts,” “potential,” “continues,” “anticipates,” +“plans,” “expects,” “believes,” “should,” “could,” “may,” “will” or the negative +of these terms or other comparable terminology, we are identifying +forward-looking statements. Forward-looking statements involve risks and +uncertainties, which may cause our actual results, performance or achievements +to be materially different from those expressed or implied by forward-looking +statements. These factors include our research and development activities, +distributor channels, compliance with regulatory impositions; and our capital +needs. Although we believe that the expectations reflected in the +forward-looking statements are reasonable, we cannot guarantee future results, +levels of activity, performance or achievements. +Except +as may be required by applicable law, we do not undertake or intend to update or +revise our forward-looking statements, and we assume no obligation to update any +forward-looking statements contained in this report as a result of new +information or future events or developments. Thus, you should not assume that +our silence over time means that actual events are bearing out as expressed or +implied in such forward-looking statements. You should carefully review and +consider the various disclosures we make in this report and our other reports +filed with the Securities and Exchange Commission that attempt to advise +interested parties of the risks, uncertainties and other factors that may affect +our business. +For +further information about these and other risks, uncertainties and factors, +please review the disclosure included in this report under “Part I, Item 1A, +Risk Factors.” +General +Chembio +Diagnostics, Inc. (referred to collectively with its subsidiary as the +“Company”) and its subsidiary develop, manufacture and market rapid +point-of-care diagnostic tests (POCTs) that detect infectious diseases. The +Company’s main products presently commercially available are four rapid tests +for the detection of HIV antibodies. Three of these products employ lateral flow +technology, can be used with all blood matrices as samples, and are manufactured +in a standard cassette format, a dipstick format, and a proprietary barrel +format. The tests employing the cassette and proprietary barrel formats were +approved by the FDA in 2006 and are distributed by Inverness Medical +Innovations, Inc. (“Inverness”) in the United States. Our +fourth rapid HIV test, which we more recently developed on our patented Dual +Path Platform (DPP®) technology, detects antibodies to HIV in oral fluid +samples, as well as all blood matrices. +On March +13, 2007, we were issued United States patent #7,189,522 for our Dual Path +Platform (DPP®) rapid test system. Additional patent protection for +DPP® has issued or is pending worldwide. We participate in the +point-of-care segment of the nearly $40 billion global in-vitro diagnostic +market. The global point-of-care segment of the IVD industry is estimated to be +$6-8 billion with an overall growth rate of 7% per annum. POCTs, by +providing prompt and early diagnosis, can reduce patient stays, lower overall +costs, improve therapeutic interventions and improve patient outcomes as a +result of prompt and early diagnosis. They can also prevent needless +hospital admissions, simplify testing procedures, avoid delays from central lab +batching, and eliminate the need for return visits. This is not to +say that every test should be done at the point-of-care. A careful +analysis needs to be performed when evaluating whether there is a need for a +rapid point-of-care test versus a laboratory test. +In the +areas of infectious and sexually transmitted diseases (such as Influenza and HIV +for example), the utility of a rapid point–of-care test has been well +established, and large markets have been established for these kinds of tests +globally. It is within these areas of infectious diseases and +sexually transmitted diseases, which tend to have the higher growth rates in the +point-of-care segment where we have focused and will continue to focus our +business, with an emphasis on the U.S. market. +3 +PRODUCTS +Lateral +Flow Rapid HIV Tests +The major +component of our revenue growth in 2009 was increased sales of our lateral flow +rapid HIV tests and related components. A large percentage of +individuals that are HIV positive worldwide are unaware of their status. Part of +the reason for this is that even those that do get tested in public health +settings will often not return or call back for their test results if samples +have to be sent out to a laboratory which can take at least several days to +process. The increased availability, greater efficacy and reduced +costs for anti-retroviral treatments (ARVs) for HIV is also having a tremendous +impact on the demand for testing, as the stigma associated with the disease is +lessened, and the ability to resume normal activities is substantially improved, +providing a positive message to those potentially infected. All four +of our rapid HIV tests are qualitative “yes/no” tests for the detection of +antibodies to HIV 1 & 2 with results available within approximately 15 +minutes. The tests differ principally only in the method of sample +collection and test procedure, flexibility with different sample types, and cost +of manufacture. Prior to our agreement with Inverness and, more recently, the +development of our DPP® HIV 1/2 Screening Assay for use with oral fluid or blood +samples, our rapid HIV tests had been marketed under either our SURE CHECK® or +STAT-PAK® trademarks. Pursuant to our agreement with Inverness, the +SURE CHECK® product (which incorporates a proprietary barrel format) is now +being marketed by Inverness as Clearview® Complete HIV 1/2 and the cassette +format of our HIV 1/2 STAT-PAK (we also have a third product known as HIV 1/2 +STAT-PAK dipstick) is now being marketed by Inverness in the United States as +Clearview® HIV 1/2 STAT-PAK®. We continue to market our STAT-PAK® +cassette and dipstick outside the United States through other marketing +channels. In addition, in 2009 we amended the agreement with +Inverness, which previously had global exclusivity for the barrel format +product, to a non-exclusive outside of North America. +Regulatory +Status: The FDA approved our Pre-Market Applications +(hereinafter “PMA”; see “Governmental Regulations” and Glossary) in April 2006 +for our SURE CHECK HIV 1/2 (and also now Inverness’ Clearview® Complete HIV 1/2) +and for our HIV 1/2 STAT-PAK (now Inverness’ Clearview® HIV 1/2 STAT-PAK in the +United States only) products. A Clinical Laboratory Improvement Act +(“CLIA”) waiver was granted by the FDA for the HIV 1/2 STAT-PAK in November 2006 +and for the two Inverness Clearview® brands in October +2007. CLIA waiver is required in order to market the products +for use in hospital emergency rooms, public health clinics and physicians’ +offices, where the level of training is traditionally less than the training at +clinical laboratories and laboratories in hospitals. These settings +constitute the largest portion of the available market for our products. Our +third lateral flow rapid HIV test, HIV 1/2 STAT-PAK Dipstick and our DPP® oral +fluid HIV test, though not FDA approved, qualify under FDA export regulations to +sell, subject to any required approval by the importing country, to customers +outside the United States. The dipstick product is our most competitively priced +version of our three rapid HIV tests, and was designed primarily for +resource-constrained, donor-funded markets that have large test volume +needs. In addition, we have received approval from a number of +potential importing countries for our three lateral flow HIV tests. +. All three of our lateral flow HIV tests have qualified for +procurement under the President’s Emergency Plan for AIDS Relief +(“PEPFAR”). In October 2009 we submitted supplemental documentation +that had been requested to our Notified Body in connection with our efforts to +obtain CE marking for the two FDA-approved rapid HIV test +products. In late January 2010 we were informed that additional data +was being requested, and we are determining the time and cost. +DPP® +HIV 1&2 Assay for Use with Oral Fluid (or Blood) Samples +We have +also completed development of and are now commercializing our DPP® HIV 1&2 +Assay for use with oral fluid samples. Oral fluid testing is an +established alternative to blood testing for diagnostic tests, including HIV +tests. It provides a fast and easy method for sample collection, +enabling non-medical professionals to collect samples for testing. It +is also often patient preferred, providing a more comfortable +test. In certain public health clinics, staffs choose not to handle +blood specimens; thus, oral sample collection provides a viable +alternative. The DPP® HIV test, which is based on our patented DPP® +technology, also includes a patent-pending system comprised of an oral fluid +swab and sample buffer vial. This feature enables samples to be fully extracted +in buffer solution before application to the test device, and also allows the +extracted sample to be stored and retested. Internal and field +studies have shown sensitivity and specificity well in excess of FDA +requirements on oral fluid as well as all blood matrices. +Regulatory +Status: During 2008 Chembio conducted extensive internal panel +studies of this product and a limited field study that suggested outstanding +performance; two much larger field evaluations were completed in 2009 that will +supplement our pending U.S. clinical studies. During the second half of 2009 we +prepared a proposed clinical trial protocol and submitted it to the FDA in +support of our application for an Investigational Device Exemption (IDE) which +we submitted and was granted during the fourth quarter of 2009. This +approved protocol permits us to move forward with the clinical trials +performance data, along with other required product and manufacturing data, in +support of a Pre-Marketing Approval (PMA) application to the FDA. We anticipate +commencing and completing the clinical trials and submitting the PMA application +during 2010 and receiving approval of the PMA during 2011. +4 +PARTNERS +INVOLVED IN MARKETING OUR HIV PRODUCTS +On +September 29, 2006 we executed marketing and license agreements with +Inverness. The marketing agreements (one for each of the two +FDA approved products) each provide Inverness with a 10-year exclusive right for +the marketing of our rapid HIV tests in the United States. The +agreements also grant us a license to Inverness’ lateral flow patents that may +be applicable to certain of our other products, including those that we had +under development at the time of the grant of the license. As part of +these agreements, we also settled litigation that had been ongoing with another +company, StatSure Diagnostics, Inc.(SDS), relating to the proprietary barrel +device that is incorporated into our Sure Check® HIV 1/2 product, which +is also marketed exclusively as Inverness Clearview® Complete HIV 1/2 +in the United States, Europe and Asia. SDS is a party to the marketing agreement +with Inverness and Chembio that pertains to that product. +We are +beginning to register our DPP® oral fluid HIV test in selected markets receiving +funding from the U.S. President’s Emergency Plan for AIDS Relief (PEPFAR). +PEPFAR recently approved our product as qualified for procurement pursuant to +the USAID waiver procedure (for use with oral fluid or blood +samples). Also, as described above, our DPP® oral fluid HIV test is +one of three products pending regulatory approval in Brazil pursuant to OEM +technology transfer, supply and license agreements we have in place with FIOCRUZ +as described below. We are considering various options for marketing +this product in the United States including a direct sales model for certain or +all market segments. +We have +appointed distributors and OEM partners internationally for our lateral flow HIV +tests. Our largest markets for our lateral flow HIV rapid tests +outside the United States are several countries in Africa, Brazil (OEM) and +Mexico. During 2009 we appointed Bio-Rad Laboratories, Inc. as our distributor +of our HIV 1/2 STAT-PAK® product in Mexico. We have distributors +interested in distributing our products in Europe once we receive the CE +Marking, for which there can be no assurance. +OTHER +LATERAL FLOW RAPID TESTS +We also +have commercially available lateral flow tests for Chagas Disease and a line of +tests for the detection of tuberculosis in humans and certain animal species. +These products represented approximately 1.5% of our product revenues during +2009. . The Company entered the rapid test market segment with lateral flow +technology and for many years, even before the development of our lateral flow +HIV tests, our revenues were almost entirely based on this technology, primarily +pregnancy tests. Because of the limited license we entered with +Inverness to manufacture and market only certain applications of lateral flow +technology, and also because we have now developed our own patent-protected +rapid point-of-care technology platform (DPP®) which we believe provides certain +advantages over lateral flow technologies, all of our other products and +products that we are developing utilize this patented platform. +OTHER +DPP® PRODUCTS +Chembio-Branded +DPP® Products +DPP® Syphilis Screen & +Confirm - DPP® Syphilis Screen & Confirm is a simple multiplex +point-of-care test that can detect both non-treponemal and treponemal antibodies +to syphilis from a whole blood sample within 20 minutes. Studies have +been performed at the CDC on a total of 459 banked specimens of +which 219 were characterized as positive and 240 as negative by RPR +(standard lab test for non-treponemal). Out of the 459 samples, 289 +were characterized as positive and 170 characterized as negative by the TPPA +test (standard lab treponemal test). DPP® Syphilis Screen & +Confirm non-treponemal had a sensitivity of 90.5% and a specificity of 100% +compared to RPR and a sensitivity of 93% and a specificity of 92% compared to +TPPA. This assay offers several market advantages over the current +two-tier system of screening and confirmatory testing. This is the first assay +in the United States that would afford the opportunity for a single-visit +diagnosis and treatment. Retrospective studies +have been performed at Chembio and CDC during 2008 and 2009. A +multi-phase field study sponsored by the WHO and with participation by CDC is +ongoing. Interference and cross-reactivity studies have been +completed at an external laboratory. FDA regulatory clearance for this test is +available through a 510(K) submission. The FDA has approved our +proposed protocol (IDE) for the prospective clinical trials that will be part of +this. We plan to commence the regulatory activities for FDA clearance +during the second quarter of 2010 and anticipate that clearance will be granted +in the first quarter of 2011. +OEM +DPP® Products +Oswaldo +Cruz Foundation OEM DPP® Agreements +During +2008 we signed four agreements with the Oswaldo Cruz Foundation (FIOCRUZ) in +Brazil relating to products based on our DPP® technology for Leptospirosis, +Canine Leishmaniasis, screening for HIV 1/2 with oral fluid samples, and a +5-band multiplex point-of-care confirmation test for HIV +1&2. These products will initially be manufactured by Chembio but +will be distributed by FIOCRUZ under its Bio-Manguinhos Division’s +label. These entities are affiliated with the Brazilian Ministry of +Health. We have completed development of three of these products +(Leishmaniasis and the HIV screening and confirmation tests), and we have +substantially completed development of the Leptospirosis test. The +leishmaniasis and confirmatory tests have been submitted for and are still +pending regulatory approval in Brazil; the HIV screening test regulatory +submission has not been made yet. We now expect that these products +will be approved by Brazilian regulatory authorities during the second quarter +of 2010. These agreements contemplate an eventual transfer of the manufacture of +the subject products to FIOCRUZ over stipulated periods of time subject to +Chembio first receiving orders for a minimum amount of products for manufacture +by Chembio; thereafter Chembio will receive royalty payments for a number of +years based on product sold by FIOCRUZ to the public health programs in +Brazil. In December 2009 Chembio received purchase orders from +FIOCRUZ for the three products for which development has been completed and that +are pending regulatory approval in the aggregate amount of approximately $2.4 +million. The orders are of course in each case subject to the +attainment of regulatory approval for the relevant product, of which there can +be no assurance. In addition, upon attainment of regulatory approval +of these three products, Chembio will be due fees from FIOCRUZ stipulated in +these agreements in the aggregate amount of approximately +$900,000. +5 +Our +Rapid Test Technologies +All of +our commercially available current products employ either in-licensed lateral +flow technology or our own patented Dual Path Platform (DPP®) technology and are +visually read. Certain of our new DPP® products will incorporate reader +technologies that can help record and report test results and reduce +subjectivity of results sometimes found with visually read tests. Both lateral +flow technology and DPP® allow the development of accurate, low cost, +easy-to-perform, single-use diagnostic tests for rapid, visual detection of +specific antigen-antibody complexes on a test strip. This format +provides a test that is simple (requires neither electricity nor expensive +equipment for test execution or reading, nor skilled personnel for test +interpretation), rapid (turnaround time approximately 15 minutes), safe +(minimizes handling of potentially infected specimens), non-invasive (requires +5-20 micro liters of whole blood easily obtained with a finger prick, or +alternatively, serum or plasma), stable (24 months at room temperature storage +in the case of our HIV tests), and highly reproducible. +We can +also use hand held and desktop readers to objectively measure, quantify, record +and report test results. Certain of the products we have and/or are developing +incorporate some of these readers, and we are developing other products that may +be used with or will require use of a reader. +Target +Market +Rapid +HIV Tests +There are +approximately 53,000 new diagnoses of HIV infection in the United States each +year, according to the CDC. In time, most of these infections +progress to AIDS. The CDC estimates that approximately 1.1 million +individuals in the U.S. are living with HIV, with an estimated 250,000 +Americans, or more than 25%, unaware that they are infected. It is +these 250,000 infected people that account for 54% of all new infections per +year. Part of the reason for this is that even those that do get tested in +public health settings will often not return or call back for their test results +if samples have to be sent out to a laboratory which can take at least several +days to process. Healthcare officials believe that by making more +people aware of their HIV status, it will reduce the number of HIV +transmissions. +Rapid HIV +testing in the United States has now developed into a 5-6 million test market. +This is from zero in 2003 when Orasure received FDA approval for the first rapid +HIV test. We believe that the US professional HIV rapid test market +(not including the OTC market) has the potential to increase to 15-18 million +tests over the next several years, which would represent about 50% of all HIV +tests done in the United States for clinical purposes. Assuming an +average price to the manufacturers of $10.00 per test, a total potential market +of $180 million U.S. market is inferred. +In 2006, +the outlook for HIV testing was given a big boost with the release by the CDC of +new guidelines for HIV testing. These new CDC recommendations now in place +provide that an HIV test should be given as a routine test like any other for +all patients between 13 and 64 years of age, regardless of risk, with an opt-out +screening option and focused testing procedural (pre and post test counseling) +guidelines. Adoption of the 2006 CDC recommendations by a number of +states has begun to have an impact. +In +addition, in December 2009 Medicare issued new rules that now require it to pay +for HIV tests for individuals covered by Medicare. +In the +United States, the need for rapid HIV tests has been developing first in the +public health and hospital emergency room and labor and delivery room segments, +and to some extent also in the physicians’ office +laboratories. Of the estimated 25-30 million HIV tests +performed in clinical settings in the United States, rapid HIV tests now account +for approximately 20-25% of this market, or approximately 6 million tests of +this total. We believe that the United States market share available +to rapid HIV tests will grow by approximately 15-20% per +annum. +In the +international market, PEPFAR, the large United States funded international AIDS +relief program focused on fifteen countries, was reauthorized in 2008 for up to +$48 billion for FY2009-2012 (up from $15 billion in +2004-2008). PEPFAR, The Global Fund and other global initiatives have +succeeded in making life-saving treatments available now to well in excess of +one million individuals. PEPFAR has a goal by 2013 of treating three million +infected individuals and averting 12 million new cases. To achieve these goals +more and more people are likely to get tested. As more effective +treatments become available at lower costs there is a clearer reason to be +tested. Other programs such as UNAIDS are significant participants in +the global effort to prevent further transmission and save the lives of those +already infected, as well as care for their families that are +impacted. +6 +For oral +fluid testing we believe that in several markets there is a meaningful segment +of individuals who will be more inclined to be tested for HIV when offered a +non-invasive test. The most well-established market for oral fluid HIV testing +is the United States. There is also now an opportunity to participate in the +over-the-counter market for HIV tests. This opportunity received +important support by the FDA and CDC in November 2009. While initial +support from public health and regulatory officials was indicated in 2006, a +follow-up November 2009 meeting of the FDA Blood Products Advisory Committee on +this subject confirmed the support by public health and HIV positive community +advocates, and provided further clarity as to the regulatory pathway for such +market. +Syphilis +Rapid Test +Recent +data indicate that approximately 70,000-100,000 new cases of syphilis are +occurring annually in the U.S. The CDC's latest Sexually Transmitted Disease +study, released in November 2009, reported that: 1) although only 13,500 of new +syphilis cases were reported in 2008 (<20% of total amount of estimated new +cases), that is still an 18 percent increase from 2007, suggesting increased +numbers of new cases, 2) 63 percent of syphilis cases were among men who have +sex with men, and 3) syphilis rates among women increased 36 percent from 2007 +to 2008. +Syphilis +can be treated with antibiotics, but untreated can cause pelvic inflammatory +disease, infertility, ectopic pregnancy and can infect +newborns. Treatment cannot be provided without a confirmed diagnosis +of an active, previously untreated case of syphilis. +Current +testing algorithms require two different tests (called non-treponemal and +treponemal markers), each requiring trained personnel in laboratory settings and +several days to receive back results, in order to confirm an active, previously +untreated case. This product is able to accurately detect the presence or +absence of each of these markers in one rapid point-of-care test device, thereby +enabling prescription of antibiotics at the point-of-care where there is the +presence of both markers. +Development +of the POC market for syphilis testing is expected to be comparable to the +development of the POC market for HIV testing, as there is a significant public +health value to being able to provide results at the +point-of-care. There are several ways to assess the market +opportunity for this unique rapid test, although we believe the U.S. rapid test +opportunity is a minimum of 3 million tests, which is approximately 20% of the +total number syphilis tests performed in the United States +today. Unlike HIV testing, where a positive result first requires a +confirmatory test, and even then further tests to measure viral load before +expensive treatment decisions are made, an individual with a confirmed active +case of syphilis can be prescribed antibiotics immediately. +Marketing +Strategy +Our +marketing strategy is to: +· +Support, +review and assess the marketing and distribution efforts of our rapid HIV +tests by Inverness Medical Innovations, Inc. Inverness, which +is a leading marketer of point-of-care diagnostic products, has +significantly expanded its distribution footprint since we signed our +agreement with Inverness, and we believe that this will enhance +opportunities for Inverness to market our rapid HIV tests. In particular, +Inverness has been very active in acquiring point-of-care product lines +serving hospital emergency rooms and physicians’ +offices. +· +Leverage +our DPP® intellectual property and regulated product development and +manufacturing experience to continue creating new collaborations where +Chembio can be the exclusive development and manufacturing partner +supporting leading marketing +organizations. +· +Establish +strong distribution relationships for our Chembio-branded products in the +U.S and abroad and establish a direct sales and marketing organization +that is focused in the public health market +segment. +7 +Competition +The +diagnostics industry is a multi-billion dollar international industry and is +intensely competitive. Many of our competitors are substantially +larger and have greater financial, research, manufacturing and marketing +resources. +Industry +competition in general is based on the following: +· +Scientific +and technological capability; +· +Proprietary +know-how; +· +The +ability to develop and market products and +processes; +· +The +ability to obtain FDA or other required regulatory +approvals; +· +The +ability to manufacture products that meet applicable FDA requirements, +(i.e. FDA’s Quality System Regulations) (see Governmental Regulation +section); +· +The +ability to manufacture products +cost-effectively; +· +Access +to adequate capital; +· +The +ability to attract and retain qualified personnel; +and +· +The +availability of patent protection. +We +believe our scientific and technological capabilities and our proprietary +know-how relating to our in-licensed lateral flow technology rapid tests and to +our proprietary know-how related to our patented dual path platform technology, +particularly for the development and manufacture of tests for the detection of +antibodies to infectious diseases such as HIV, are very strong. +Our +ability to develop and market other products is in large measure dependent on +our having additional resources and/or collaborative +relationships. Some of our product development efforts have been +funded on a project or milestone basis. We believe that our +proprietary know-how in lateral flow technology and in our Dual Path Platform +(DPP®) technology has been instrumental in our obtaining the collaborations we +have and that we continue to pursue. We believe that the patent +protection that we have with our Dual Path Platform (DPP®) enhances our ability +to develop more profitable collaborative relationships and to license out the +technology. +Research +and Development +During +2009 and 2008, $2.9 million and $2.6 million, respectively, were spent on +research and development (including regulatory activities). These +expenses were in part underwritten by funding from R&D contracts and grants +of $1.3 million in 2009 and $.7 million in 2008. All of our new +product development activities involve employment of our Dual Path Platform +(DPP®) technology. These activities include completing +development of certain products and making significant progress toward the +development of additional products. Research and development and +regulatory activities are explained in detail in Part II Item 7. +Employees +At +December 31, 2009, we employed 104 people, including 103 full-time +employees. We have entered into employment contracts with our +President, Lawrence Siebert, and our Senior Vice President of Research and +Development, Javan Esfandiari. Due to the specific knowledge and +experience of these executives regarding the industry, technology and market, +the loss of the services of either one of them would likely have a material +adverse effect on the Company. The contract with Mr. Siebert, +provides that Mr. Siebert will serve as the Chief Executive Officer and +President of the Company for an additional three-year term through May 11, +2012. The contract with Mr. Esfandiari has a term of three years +ending March 2013. We have obtained a key man insurance policy +for Mr. Esfandiari. +Governmental +Regulation +The +manufacturing and marketing of the Company’s existing and proposed diagnostic +products are regulated by the United States Food and Drug Administration +(“FDA”), United States Department of Agriculture (“USDA”), certain state and +local agencies, and/or comparable regulatory bodies in other +countries. These regulations govern almost all aspects of +development, production and marketing, including product testing, authorizations +to market, labeling, promotion, manufacturing and record keeping. The +Company’s FDA and USDA regulated products require some form of action by each +agency before they can be marketed in the United States, and, after approval or +clearance, the Company must continue to comply with other FDA requirements +applicable to marketed products, e.g. Quality Systems (for medical +devices). Failure to comply with the FDA’s requirements can lead to +significant penalties, both before and after approval or clearance. +There are +two review procedures by which medical devices can receive FDA clearance or +approval. Some products may qualify for clearance under Section +510(k) of the Federal Food, Drug and Cosmetic Act, in which the manufacturer +provides a pre-market notification that it intends to begin marketing the +product, and shows that the product is substantially equivalent to another +legally marketed product (i.e., that it has the same intended use and is as safe +and effective as a legally marketed device and does not raise different +questions of safety and effectiveness). In some cases, the submission +must include data from human clinical studies. Marketing may commence +when the FDA issues a clearance letter finding such substantial +equivalence. FDA clearance of our DPP® Syphilis Screen & Confirm +test will be by means of a 510(k) submission. +8 +If the +medical device does not qualify for the 510(k) procedure (either because it is +not substantially equivalent to a legally marketed device or because it is +required by statute and the FDA’s implementing regulations to have an approved +application), the FDA must approve a Pre-Marketing Application (“PMA”) +application before marketing can begin. PMA’s must demonstrate, among +other matters, that the medical device provides a reasonable assurance of safety +and effectiveness. A PMA application is typically a complex +submission, including the results of non-clinical and clinical +studies. Preparing a PMA application is a much more expensive, +detailed and time-consuming process as compared with a 510(K) pre-market +notification. The Company has approved PMAs for the two rapid HIV +tests now marketed by Inverness Medical as Clearview® Complete HIV 1-2 and +Clearview® HIV 1-2 STAT PAK®. FDA approval of our DPP® HIV screening assay for +use with oral fluid or blood samples will be pursued by means of a PMA +application. +The +Clinical Laboratory Improvement Act of 1988 (“CLIA”) prohibits laboratories from +performing in vitro tests for the purpose of providing information for the +diagnosis, prevention or treatment of any disease or impairment of, or the +assessment of, the health of human beings unless there is in effect for such +laboratories a certificate issued by the United States Department of Health and +Human Services (via the FDA) applicable to the category of examination or +procedure performed. Although a certificate is not required for the +Company, it considers the applicability of the requirements of CLIA in the +design and development of its products. The statutory definition of +“laboratory” is very broad, and many of our customers are considered +labs. A CLIA waiver will remove certain quality control and other +requirements that must be met for certain customers to use the Company’s +products and this is in fact critical to the marketability of a product into the +point-of-care diagnostics market. The Company has received a +CLIA waiver for each of the two rapid HIV tests now marketed by Inverness +Medical as Clearview® Complete HIV 1/2 and Clearview® HIV 1/2 STAT +PAK®. The CLIA waiver was granted by the FDA for HIV 1/2 STAT-PAK on +November 20, 2006 and for the Clearview® Complete HIV 1/2 on October 22, +2007. +In +addition, the FDA regulates the export of medical devices that have not been +approved for marketing in the United States. The Federal Food, Drug +and Cosmetic Act contains general requirements for any medical device that may +not be sold in the United States and is intended for +export. Specifically, a medical device intended for export is not +deemed to be adulterated or misbranded if the product: (1) complies with the +specifications of the foreign purchaser; (2) is not in conflict with the laws of +the country to which it is intended for export; (3) is prominently labeled on +the outside of the shipping package that it is intended for export; and (4) is +not sold or offered for sale in the United States. However, the +Federal Food, Drug and Cosmetic Act does permit the export of devices to any +country in the world, if the device complies with the laws of the importing +country and has valid marketing authorization in one of several “listed” +countries under the theory that these listed countries have sophisticated +mechanisms for the review of medical devices for safety and +effectiveness. +The +Company is also subject to regulations in foreign countries governing products, +human clinical trials and marketing, and may need to obtain approval or +evaluations by international public health agencies, such as the World Health +Organization, in order to sell diagnostic products in certain +countries. Approval processes vary from country to country, and the +length of time required for approval or to obtain other clearances may in some +cases be longer than that required for United States governmental approvals. On +the other hand, the fact that our HIV diagnostic tests are of value in the AIDS +epidemic may lead to some government process being expedited. The +extent of potentially adverse governmental regulation affecting Chembio that +might arise from future legislative or administrative action cannot be +predicted. +One or +more of the Company’s rapid HIV tests are also approved or pending approval for +marketing in several foreign jurisdictions, including but not limited to Brazil, +Mexico, and India, as well as a number of other nations in the developing +world. +Environmental +Laws +To date, +we have not encountered any costs relating to compliance with any environmental +laws. +Intellectual +Property +Intellectual +Property Strategy +Our +intellectual property strategy is to: (1) build our owned +intellectual property portfolio around our Dual Path Platform technology; (2) +pursue licenses, trade secrets and know-how within the area of rapid +point-of-care testing, and (3) develop and acquire proprietary positions to +reagents and new hardware platforms for the development and manufacture of rapid +diagnostic tests. +Trade +Secrets and Know-How +We +believe that we have developed a substantial body of trade secrets and know-how +relating to the development of lateral flow and DPP® based diagnostic tests, +including but not limited to the sourcing and optimization of materials for such +tests, and how to maximize sensitivity, speed-to-result, specificity, stability +and reproducibility. The Company possesses proprietary know-how to develop tests +for multiple conditions using colored latex. Our buffer formulations +enable extremely long shelf lives of our rapid HIV tests and we believe that +this provides us with an important competitive advantage. +9 +Lateral +Flow Technology and Reagent Licenses +As part +of our agreements in 2006 with Inverness for the marketing of our HIV tests, we +were granted non-exclusive licenses to their lateral flow technology for certain +products manufactured and marketed by Chembio including but not limited to our +HIV tests. Although we believe our DPP® is outside of the scope of +lateral flow patents, we consult with patent counsel, and seek licenses and/or +redesigns of products that we believe to be in the best interests of the Company +and our stockholders. Because of the costs and other negative +consequences of time-consuming patent litigation, we often attempt to obtain a +license on reasonable terms. Nevertheless there is no assurance that +Inverness’ lateral flow patents will not be challenged or that other patents +containing claims relevant to the Company’s lateral flow or DPP® products will +be not be granted and that licenses to such patents, if any, will be available +on reasonable terms, if any. Inverness has aggressively +enforced its lateral flow intellectual property. Most recently in +2008 Inverness brought a patent infringement lawsuit against Orasure. The suit +was settled in late 2009 with a $3 million payment by Orasure to Inverness and +other considerations. +The DPP® +technology provides us with our own intellectual property and we believe it also +enables tests to be developed with improved sensitivity as compared with +comparable tests on lateral flow platforms. The Company has signed +and anticipates signing new development projects based upon the DPP® technology +that will provide new manufacturing and marketing opportunities. We +have several other patents issued or pending related to other point-of-care +technologies or applications thereof. The DPP® patent has been issued +in certain other jurisdictions and is being prosecuted in many +others. +The +peptides used in our rapid HIV tests are patented by Adaltis Inc. and are +licensed to us under a 10-year non-exclusive license agreement dated August 30, +2002. In connection with their bankruptcy, during the third quarter +of 2009 we bought out all of our remaining obligations under that +agreement. We also have licensed the antigens used in other tests +including our Chagas, Tuberculosis and Leishmaniasis tests. In prior +years we concluded license agreements related to intellectual property rights +owned by the United States associated with HIV- 1, and during the first quarter +of 2008 we entered into a sub-license agreement for HIV-2 with Bio-Rad +Laboratories N.A., the exclusive licensee of the Pasteur Institute’s HIV-2 +intellectual property estate. +Corporate +History +On May 5, +2004, we completed a merger with Chembio Diagnostic Systems Inc. through which +Chembio Diagnostics Systems Inc. became our wholly-owned subsidiary, and through +which the management and business of Chembio Diagnostic Systems Inc. became our +management and business. As part of this transaction, we changed our +name to Chembio Diagnostics, Inc. In 2003, we had sold our prior +business, and as a result, we had no specific business immediately prior to the +merger. +Since the +formation of Chembio Diagnostic Systems Inc. in 1985, it has been involved in +developing, manufacturing, selling and distributing in-vitro diagnostic tests, +including rapid tests beginning in 1995, for a number of conditions in humans +and animals. +On March +12, 2004, we implemented a 1-for-17 reverse split of our common +stock. All references in this Form 10-K to shares of our common stock +have been adjusted to reflect this reverse split. +In +February 2010, Crestview Capital Master, L.L.C. ("Crestview Master), a Delaware +limited liability company that held 18,907,431 shares of Chembio's common stock, +spun off all these shares, constituting approximately 30.5% of Chembio's +outstanding shares, to its three equity holders. One of the three +equity holders of Crestview Master immediately spun off, to its approximately +126 equity holders, all of the 12,990,569 shares of Chembio stock that it +received in this distribution. As a result, as of February 24, 2010, +Crestview Master no longer owned any shares. The former direct and +indirect equity holders of Crestview Master owned all these shares, with none of +these individual stockholders having beneficial ownership of more than 5.61% of +the outstanding common stock of Chembio. Approximately 12,208,505 of +the shares distributed are free of restrictions and may be sold or otherwise +transferred immediately. An additional 2,560,822 of the distributed +shares are expected to become eligible for resale on March 24. The +other approximately 4,138,104 shares are expected to become eligible for resale +on May 25, 2010. +10 +Glossary +AIDS +Acquired +Immunodeficiency Syndrome. AIDS is caused by the Human +Immunodeficiency Virus, HIV. +ALGORITHM +(parallel or serial) +For +rapid HIV testing this refers both to method or protocol (in developing +countries to date) for using rapid tests from different manufacturers in +combination to screen and confirm patients at the point-of-care, and may +also refer to the specific tests that have been selected by an agency or +ministry of health to be used in this way. A parallel algorithm +uses two screening tests from different manufacturers and a tie-breaker +test only if there is a discrepancy between the screening tests results. A +serial algorithm only uses a second confirmatory test if there is a +positive result from the screening test, meaning that the number of +confirmatory tests used is equal to the positivity rate in the testing +venue. A tie-breaker test resolves discrepancies between the screen and +the confirmatory test. +ANTIBODY +A +protein which is a natural part of the human immune system produced by +specialized cells to neutralize antigens, including viruses and bacteria +that invade the body. Each antibody producing cell manufactures +a unique antibody that is directed against, binds to and eliminates one, +and only one, specific type of antigen. +ANTIGEN +Any +substance which, upon entering the body, stimulates the immune system +leading to the formation of antibodies. Among the more common antigens are +bacteria, pollens, toxins, and viruses. +ARVs +Anti-Retroviral +Treatments for AIDS +CD-4 +The +CD4+ T-lymphocyte is the primary target for HIV infection because of the +affinity of the virus for the CD4 surface marker. Measures of +CD4+ T-lymphocytes are used to guide clinical and therapeutic management +of HIV-infected persons. +CDC +United +States Centers for Disease Control and Prevention +CLIA +waiver +Clinical +Laboratory Improvement Act designation that allows simple tests to be +performed in point-of-care settings such as doctors offices, walk-in +clinics and emergency rooms. +DIAGNOSTIC +Pertaining +to the determination of the nature or cause of a disease or +condition. Also refers to reagents or procedures used in +diagnosis to measure proteins in a clinical sample. +EITF +Emerging +Issues Task Force +FASB +Financial +Accounting Standards Board +FDA +United +States Food and Drug Administration +FDIC +Federal +Deposit Insurance Corporation +FAS +Financial +Accounting Standard +HIV +Human +Immunodeficiency Virus. HIV (also called HIV-1), a retrovirus, +causes AIDS. A similar retrovirus, HIV-2, causes a variant +disease, sometimes referred to as West African AIDS. HIV +infection leads to the destruction of the immune +system. +IgG +IgG +or Immunoglobulin are proteins found in human blood. This protein is +called an “antibody” and is an important part of the body’s defense +against disease. When the body is attacked by harmful bacteria or viruses, +antibodies help fight these invaders. +MOH +Ministry +of Health +MOU +Memoranda +of Understanding +NGO +Non-Governmental +Organization +OTC +Over-the-Counter +PEPFAR +The +President’s Emergency Plan for AIDS Relief +PMA +Pre-Marketing +Approval –FDA approval classification for a medical device that is not +substantially equivalent to a legally marketed device or is otherwise +required by statute to have an approved application. Rapid HIV +tests must have an approved PMA application before marketing of such a +product can begin. +PROTOCOL +A +procedure pursuant to which an immunodiagnostic test is performed on a +particular specimen in order to obtain the desired +reaction. +REAGENT +A +chemical added to a sample under investigation in order to cause a +chemical or biological reaction which will enable measurement or +identification of a target substance. +RETROVIRUS +A +type of virus which contains the enzyme Reverse Transcriptase and is +capable of transforming infected cells to produce diseases in the host +such as AIDS. +SAB +Staff +Accounting Bulletin +SENSITIVITY +Refers +to the ability of an assay to detect and measure small quantities of a +substance of interest. The greater the sensitivity, the smaller the +quantity of the substance of interest the assay can +detect. Also refers to the likelihood of detecting the antigen +when present. +SPECIFICITY +The +ability of an assay to distinguish between similar +materials. The greater the specificity, the better an assay is +at identifying a substance in the presence of substances of similar +makeup. +SPUTUM +Expectorated +matter; saliva mixed with discharges from the respiratory +passages +TB +Tuberculosis +(TB) is a disease caused by bacteria called Mycobacterium tuberculosis. +The bacteria usually attack the lungs. But, TB bacteria can attack any +part of the body such as the kidney, spine, and brain. If not treated +properly, TB disease can be fatal. TB is spread through the air +from one person to another. The bacteria are put into the air when a +person with active TB disease of the lungs or throat coughs or sneezes. +People nearby may breathe in these bacteria and become +infected. +UNAIDS +Joint +United Nations Program on HIV/AIDS +USAID +United +States Agency for International Development +USDA +U.S +Department of Agriculture +WHO +World +Health Organization +11 +ITEM +1A. +RISK +FACTORS +You +should carefully consider each of the following risk factors and all of the +other information provided in this Annual Report. The risks described +below are those we currently believe may materially affect us. An +investment in our Common Stock involves a high degree of risk, and should be +considered only by persons who can afford the loss of their entire +investment. +Risks +related to our industry, business and strategy +Because +we may not be able to obtain necessary regulatory approvals for some of our +products, we may not generate revenues in the amounts we expect, or in the +amounts necessary to continue our business. +All of +our proposed and existing products are subject to regulation in the U.S. by the +U.S. Food and Drug Administration, the U.S. Department of Agriculture and/or +other domestic and international governmental, public health agencies, +regulatory bodies or non-governmental organizations. In particular, +we are subject to strict governmental controls on the development, manufacture, +labeling, distribution and marketing of our products. The process of +obtaining required approvals or clearances varies according to the nature of, +and uses for, a specific product. These processes can involve lengthy +and detailed laboratory testing, human or animal clinical trials, sampling +activities, and other costly, time-consuming procedures. The +submission of an application to a regulatory authority does not guarantee that +the authority will grant an approval or clearance for product. Each +authority may impose its own requirements and can delay or refuse to grant +approval or clearance, even though a product has been approved in another +country. +The time +taken to obtain approval or clearance varies depending on the nature of the +application and may result in the passage of a significant period of time from +the date of submission of the application. Delays in the approval or +clearance processes increase the risk that we will not succeed in introducing or +selling the subject products, and we may determine to devote our resources to +different products. +Changes +in government regulations could increase our costs and could require us to +undergo additional trials or procedures, or could make it impractical or +impossible for us to market our products for certain uses, in certain markets, +or at all. +Changes +in government regulations may adversely affect our financial condition and +results of operations because we may have to incur additional expenses if we are +required to change or implement new testing, manufacturing and control +procedures. If we are required to devote resources to develop such +new procedures, we may not have sufficient resources to devote to research and +development, marketing, or other activities that are critical to our +business. +For +example, the European Union and other jurisdictions have a requirement that +diagnostic medical devices used to test human biological specimens must receive +regulatory approval known as a CE mark, or be registered under the ISO 13.485 +medical device directive. The letters “CE” are the abbreviation of +the French phrase “Conforme Européene,” which means “European +conformity.” ISO (“International Organization for Standardization”) +is the world’s largest developer of standards with 148 member +countries. As such, export to the European and other jurisdictions +without the CE or ISO 13.485 mark is not possible. In 2007, we +received ISO 13.485 certification, in 2008, we received a CE registration for +our Chagas test, and during 2009 we expected to receive CE registration for our +two FDA approved HIV tests. However, additional data and +documentation has been requested and there are no assurances that we will be +able to secure this certification although we are not aware of any material +reason why such approval will not be granted. However, if for any +reason a CE registration is not granted, our ability to export our products +could be adversely impacted. +We can +manufacture and sell our products only if we comply with regulations of +government agencies such as the FDA and the USDA. We have implemented +a quality system that is intended to comply with applicable +regulations. Although FDA approval is not required for the export of +our products, there are export regulations promulgated by the FDA that +specifically relate to the export of our products. Although we +believe that we meet the regulatory standards required for the export of our +products, these regulations could change in a manner that could adversely impact +our ability to export our products. +12 +Our +products may not be able to compete with new diagnostic products or existing +products developed by well-established competitors, which would negatively +affect our business. +The +diagnostic industry is focused on the testing of biological specimens in a +laboratory or at the point-of-care and is highly competitive and rapidly +changing. Our principal competitors often have considerably greater +financial, technical and marketing resources than we do. Several +companies produce diagnostic tests that compete directly with our testing +product line, including but not limited to, Orasure Technologies, Inverness +Medical and Trinity Biotech. As new products enter the market, our +products may become obsolete or a competitor’s products may be more effective or +more effectively marketed and sold than ours. Although we have no +specific knowledge of any competitor’s product that will render our products +obsolete, if we fail to maintain and enhance our competitive position or fail to +introduce new products and product features, our customers may decide to use +products developed by our competitors, which could result in a loss of revenues +and cash flow. +We +have developed an oral fluid rapid HIV test as well as other applications +utilizing our Dual Path Platform technology, which we believe could enhance our +competitive position in HIV rapid testing and other +fields. However we still have technical, manufacturing, +regulatory and marketing challenges to meet before we will know whether we can +successfully commercialize products incorporating this +technology. There can be no assurance that we will overcome these +challenges. +We have +granted Inverness exclusive rights to market our SURE CHECK® HIV 1/2 in the +United States and non-exclusive rights in the rest of the world and exclusive +rights to market our HIV 1/2 STAT PAK® in the U.S. only. Inverness has no rapid +HIV tests that are approved for marketing in the U.S., we are not aware of any +rapid HIV products that Inverness is even contemplating for the U.S., and +Inverness is obligated to inform us of any such products as soon as it is able +to do so. Inverness does have rapid HIV tests manufactured by several +subsidiaries outside the U.S. that are being actively marketed outside the U.S., +primarily in developing countries. Our HIV 1/2 STAT PAK cassette and dipstick +products compete against these Inverness products, and we specifically +acknowledge in our agreements with Inverness the existence of such other +products. Moreover, except for a product in the HIV barrel field as +defined in our agreement with Inverness, Inverness is permitted under our +agreements to market certain types of permitted competing rapid HIV tests in the +U.S. Under these conditions, we could choose to terminate the +applicable agreement with Inverness or change the agreement to a non-exclusive +agreement, and Inverness would expand the lateral flow license granted to the +Company to allow the Company to market the product independently or through +other marketing partners. While we believe that Inverness is +committed to successfully marketing our products particularly in the U.S. and +other developed countries where our products are or become approved for +marketing, Inverness may choose to develop or acquire competing products for +marketing in the U.S. as well as other markets where they are marketing our SURE +CHECK® HIV 1/2 product, and such an action could have at least a temporary +material adverse effect on the marketing of these products until such time as +alternative marketing arrangements could be implemented. While we +also believe that the expansion of our license to the Inverness lateral flow +patents substantially facilitates our ability to make alternative marketing +arrangements, there can be no assurance that the modification of marketing +arrangements and the possible corresponding delays or suspension of sales would +not have a material adverse effect on our business. +In +addition, the point-of-care diagnostics industry is undergoing rapid +technological changes, with frequent introductions of new technology-driven +products and services. As new technologies become introduced into the +point-of-care diagnostic testing market, we may be required to commit +considerable additional efforts, time and resources to enhance our current +product portfolio or develop new products. We may not have the +available time and resources to accomplish this and many of our competitors have +substantially greater financial and other resources to invest in technological +improvements. We may not be able to effectively implement new +technology-driven products and services or be successful in marketing these +products and services to our customers, which would materially harm our +operating results. +Although +we own our DPP® patent, we own no issued patents covering lateral flow +technology, and the field of lateral flow technology is complex and +characterized by a substantial amount of litigation, so the risk of potential +patent challenges is ongoing for us in spite of our DPP® patent. +Although +we have been granted non-exclusive licenses to the lateral flow patents owned by +Inverness Medical Innovations, Inc. , there is no assurance that their lateral +flow patents will not be challenged or that licenses from other parties may not +be required, if available at all. In the event that it is determined +that a license is required and it is not possible to negotiate a license +agreement under a necessary patent, we may be able to modify our HIV rapid test +products and other products such that a license would not be +necessary. However, this alternative could delay or limit our ability +to sell these products in the U.S. and other markets, which would adversely +affect our results of operations, cash flows and business. +13 +On +March 13, 2007, our Dual Path Platform Immunoassay Device patent +application was issued as United States patent +no. 7,189,522. Additional protection for this intellectual +property is pending worldwide. This platform has shown improved +sensitivity as compared with conventional platforms in a number of +studies. We believe that this new platform is outside of the scope of +currently issued patents in the field of lateral flow technology, thereby +offering the possibility of a greater freedom to operate. However +there can be no assurance that our patents or our products incorporating the +patent claims will not be challenged at some time in the future. +New +developments in health treatments or new non-diagnostic products may reduce or +eliminate the demand for our products. +The +development and commercialization of products outside of the diagnostics +industry could adversely affect sales of our products. For example, +the development of a safe and effective vaccine to HIV or treatments for other +diseases or conditions that our products are designed to detect, could reduce, +or eventually eliminate, the demand for our HIV or other diagnostic products and +result in a loss of revenues. +We +may not have sufficient resources to effectively introduce and market our +products, which could materially harm our operating results. +Introducing +and achieving market acceptance for our rapid HIV tests and other new products +will require substantial marketing efforts and will require us or our contract +partners, sales agents, or distributors to make significant expenditures of time +and money. In some instances we will be significantly or +totally reliant on the marketing efforts and expenditures of our contract +partners, sales agents, distributors. If they do not have or commit +the expertise and resources to effectively market the products that we +manufacture, our operating results will be materially harmed. +The +success of our business depends, in addition to the market success of our +products, on our ability to raise additional capital through the sale of debt or +equity or through borrowing, and we may not be able to raise capital or borrow +funds in amounts necessary to continue our business, or at all. +Our +revenues and gross margins have increased significantly in recent periods, and +our operating and net losses have decreased significantly in recent +periods. Nevertheless, prior to 2009 we sustained significant +operating losses since 2004. At December 31, 2009, we had a +stockholders’ equity of $3.08 million and a working capital surplus of $1.49 +million . The +Company estimates that its resources are sufficient to fund its needs through +the end of 2010 and beyond or that, in the alternative, it could raise +additional capital although the terms under which that capital could be raised +would likely be very dilutive to current shareholders. The Company’s liquidity +and cash requirements will depend on several factors. These factors include (1) +the level of revenues (the Company received $340,000 in 2009 for license fees +for which we need to meet certain milestones to earn); (2) the extent to which, +if any, that revenue level improves operating cash flows; (3) the Company’s +investments in research and development, facilities, marketing, regulatory +approvals, and other investments it may determine to make; and (4) the Company’s +investment in capital equipment (including production equipment of $323,500 that +the Company has contracted for) and the extent to which it improves cash flow +through operating efficiencies. There are no assurances that the Company will +remain profitable or generate positive cash flow in 2010 or, in the alternative, +be successful in raising sufficient capital to fund its needs through +2010. +Approval +and launch of our DPP® products in Brazil during 2010 and increased sales to +other developing world markets in 2010 is critical to our business +plan and if we fail to meet this objective, we may not generate revenues in the +amounts we expect, or in amounts necessary to fund our planned research, +development and regulatory expenses in 2010. +We intend +to attempt to increase international sales of our products. A number +of factors can slow or prevent international sales, or substantially increase +the cost of international sales, including: +· +regulatory +requirements and customs +regulations; +· +cultural +and political differences; +· +foreign +exchange rates, currency fluctuations and +tariffs; +· +dependence +on and difficulties in managing international distributors or +representatives; +· +the +creditworthiness of foreign +entities; +· +difficulties +in foreign accounts receivable collection; +and +· +competition +· +pricing +· +economic +conditions and the absence of available funding +sources. +If we are +unable to increase our revenues from international sales, our operating results +will be materially harmed. +14 +We +rely on trade secret laws and agreements with our key employees and other third +parties to protect our proprietary rights, and we cannot be sure that these laws +or agreements adequately protect our rights. +We +believe that factors such as the technological and creative skills of our +personnel, strategic relationships, new product developments, frequent product +enhancements and name recognition are essential to our success. All +our management personnel are bound by non-disclosure agreements. If +personnel leave our employment, in some cases we would be required to protect +our intellectual property rights pursuant to common law theories which may be +less protective than provisions of employment, non-competition or non-disclosure +agreements. +We seek +to protect our proprietary products under trade secret and copyright laws, enter +into license agreements for various materials and methods employed in our +products, and enter into strategic relationships for distribution of the +products. These strategies afford only limited +protection. We currently have some foreign patents issued, and we are +seeking additional patent protection in several other foreign jurisdictions for +our DPP® technology. We have licenses to reagents (antigens and +peptides) used in several of our products and products under +development We also have a license to manufacture, use and sell +products used to screen for antibodies to HIV-2. In addition, our +SURE CHECK®, DPP® and STAT-PAK® trademarks have been registered in the +U.S. Despite our efforts to protect our proprietary assets, and +respect the intellectual property rights of others, we participate in several +markets where intellectual property rights protections are of little or no +value. This can place our products and our company at a competitive +disadvantage. +During +2008 and in the first quarter of 2009 we terminated a number of employees who +have had access to proprietary and confidential information. In +connection with the termination of several of these employees whose positions +were terminated, individuals executed severance agreements that include strong +covenants by these former employees to keep our proprietary information +confidential. Despite these and other efforts we make to protect our +confidential information, such as entering confidentiality agreements in +connection with new business opportunities, unauthorized parties may attempt to +copy aspects of our products or to obtain information that we regard as +proprietary. We may be required to expend substantial resources in +asserting or protecting our intellectual property rights, or in defending suits +related to intellectual property rights. Disputes regarding +intellectual property rights could substantially delay product development or +commercialization activities because some of our available funds would be +diverted away from our business activities. Disputes regarding +intellectual property rights might include state, federal or foreign court +litigation as well as patent interference, patent reexamination, patent reissue, +or trademark opposition proceedings in the U.S. Patent and Trademark +Office. +To +facilitate development and commercialization of a proprietary technology base, +we may need to obtain additional licenses to patents or other proprietary rights +from other parties. Obtaining and maintaining these licenses, which +may not be available, may require the payment of up-front fees and +royalties. In addition, if we are unable to obtain these types of +licenses, our product development and commercialization efforts may be delayed +or precluded. +Our +continued growth depends on retaining our current key employees and attracting +additional qualified personnel, and we may not be able to do so. +Our +success will depend to a large extent upon the skills and experience of our +executive officers, management and sales, marketing, operations and scientific +staff. We may not be able to attract or retain qualified employees in +the future due to the intense competition for qualified personnel among medical +products businesses, geographic considerations, our ability to offer competitive +compensation , relocation packages, benefits, and/or other reasons. +If we are +not able to attract and retain the necessary personnel to accomplish our +business objectives, we may experience constraints that will adversely affect +our ability to effectively manufacture, sell and market our products to meet the +demands of our strategic partners in a timely fashion, or to support internal +research and development programs. Although we believe we will be +successful in attracting and retaining qualified personnel, competition for +experienced scientists and other personnel from numerous companies and academic +and other research institutions may limit our ability to do so on acceptable +terms. +We have +entered into employment contracts with our President, Lawrence Siebert, and our +Senior Vice President of Research and Development, Javan +Esfandiari. Due to the specific knowledge and experience of these +executives regarding the industry, technology and market, the loss of the +services of either one of them would likely have a material adverse effect on +the Company. The contract with Mr. Siebert, provides that Mr. Siebert +will serve as the Chief Executive Officer and President of the Company for an +additional three-year term through May 11, 2012. The contract with +Mr. Esfandiari has a term of three years ending March 2013. We +have obtained a key man insurance policy for Mr. Esfandiari. +15 +We +believe our success depends on our ability to participate in large government +programs in the U.S. and worldwide and we may not be able to do so. +We +believe it to be in our best interests to meaningfully participate in the PEPFAR +Program, UN Global Fund initiatives and other programs funded by large +donors. We have initiated several strategies to participate in these +programs, such as introduction of our DPP® HIV test for use with oral fluid +samples. Participation in these programs requires alignment and +engagement with the many other participants in these programs including the +World Health Organization, U.S. Center for Disease Control, U.S. Agency for +International Development, foreign governments and their agencies, +non-governmental organizations, and HIV service organizations. If we +are unsuccessful in our efforts to participate in these programs, our operating +results could be materially harmed. +Although +we were profitable in 2009, we have a history of incurring net losses and we +cannot be certain that we will be able to sustain profitability. +Since the +inception of Chembio Diagnostic Systems, Inc. in 1985 and through the period +ended December 31, 2008, we have incurred net losses. As of +December 31, 2009, we have an accumulated deficit of $37 +million. We incurred net losses of $1.9 million and $2.6 million in +2008 and 2007, respectively, while showing a net profit of $309,000 in +2009. +We expect +to make substantial expenditures for sales and marketing, and continue to make +expenditures for regulatory submissions, product development and other purpose +that may make it more difficult to maintain profitability for any given period +or periods. Our ability to continue profitability in the future will +primarily depend on our ability to increase sales of our products, reduce +production and other costs and successfully introduce new products and enhanced +versions of our existing products into the marketplace. If we are +unable to increase our revenues at a rate that is sufficient to achieve +profitability, or adequately control and reduce our operating costs, our +operating results would be materially harmed. +To +the extent that we are unable to obtain sufficient product liability insurance +or that we incur product liability exposure that is not covered by our product +liability insurance, our operating results could be materially +harmed. +We may be +held liable if any of our products, or any product which is made with the use or +incorporation of any of the technologies belonging to us, causes injury of any +type or is found otherwise unsuitable during product testing, manufacturing, +marketing, sale or usage. We have obtained product liability +insurance, we have never received a product liability claim, and have generally +not seen product liability claims for screening tests that are accompanied by +appropriate disclaimers. Nevertheless, in the event there is a claim, +this insurance may not fully cover our potential liabilities. In +addition, as we attempt to bring new products to market, we may need to increase +our product liability coverage which would be a significant additional expense +that we may not be able to afford. If we are unable to obtain +sufficient insurance coverage at an acceptable cost to protect us, we may be +forced to abandon efforts to commercialize our products or those of our +strategic partners, which would reduce our revenues. +Risks +related to our Common Stock +In +the past, our Common Stock has been classified as penny stock, and it continues +to be extremely illiquid, so investors may not be able to sell as much stock as +they want at prevailing market prices. +In the +past, our Common Stock has been classified as penny stock. Penny +stocks generally are equity securities with a price of less than $5.00 and trade +on the over-the-counter market. As a result, an investor may find it +more difficult to dispose of or obtain accurate quotations as to the price of +the securities that are classified as penny stocks. The “penny stock” +rules adopted by the Commission under the Securities Exchange Act of 1934, as +amended (the “Exchange Act”), subject the sale of the shares of penny stock +issuers to regulations that impose sales practice requirements on +broker-dealers, causing many broker-dealers to not trade penny stocks or to only +offer the stocks to sophisticated investors that meet specified net worth or net +income criteria identified by the Commission. These regulations +contribute to the lack of liquidity of penny stocks. +At the +present time, transactions in our Common Stock are not subject to the “penny +stock” rules because our average revenue for 2007, 2008 and 2009 exceeded $6 +million per year. However, there can be no assurance that +transactions in our Common Stock will not be subject to the “penny stock” rules +in the future. +The +average daily trading volume of our Common Stock on the over-the-counter market +was less than 101,000 shares per day over the three months ended March 1, +2010. If limited trading in our stock continues, it may be difficult +for investors to sell their shares in the public market at any given time at +prevailing prices. +16 +Our +management and larger stockholders exercise significant control over our Company +and may approve or take actions that may be adverse to your +interests. +As of +March 1, 2010, our named executive officers, directors and 5% stockholders +beneficially owned approximately 13.9% of our voting power. For the +foreseeable future, to the extent that our current stockholders vote similarly, +they will be able to exercise control over many matters requiring approval by +the board of directors or our stockholders. As a result, they will be +able to: +· +control +the composition of our board of +directors; +· +control +our management and policies; +· +determine +the outcome of significant corporate transactions, including changes in +control that may be beneficial to stockholders; +and +· +act +in each of their own interests, which may conflict with, or be different +from, the interests of each other or the interests of the other +stockholders. +ITEM +2. +PROPERTIES +Our +administrative offices and research facilities are located in Medford, New +York. We lease approximately 23,400 square feet of industrial space +for $14,683 per month. The space is utilized for research and +development activities (approximately 2,600 square feet), offices (approximately +2,640 square feet) and production (approximately 18,160 square +feet). The lease term expires on April 30, +2014. Additional space may be required as we expand our +research and development activities. We do not foresee any +significant difficulties in obtaining any required additional +facilities. We entered into a second lease effective February 1st of +2010, the principle terms of this lease are the same as the one entered +into in 2009 and are as follows: (a) a lease term ending April 30, +2014; (b) an initial rent of $11,350 per month plus $3,333 for the +second lease (March and April of 2010 are free and the month of April in 2011, +2012 and 2013 is also free) ; (c) the monthly rent for year two of the +lease (does not apply to second lease) will increase by the lower of (i) the +change in the consumer price index, or (ii) five percent; and (d) the +monthly rent for years three through five of the lease (years two through four +of the second lease) will increase each year by the lower of (i) the change +in the consumer price index, or (ii) two and one half +percent. +ITEM +3. +LEGAL +PROCEEDINGS +From time +to time, we may be involved in litigation relating to claims arising out of our +operations in the normal course of business. We know of no material, +existing or pending legal proceedings against us, nor are we involved as a +plaintiff in any material proceeding or pending litigation. There are +no proceedings in which any of our directors, officers or affiliates, or any +registered or beneficial shareholder, is an adverse party or has a material +interest that is adverse to our interest. +17 +PART +II +ITEM +5. +MARKET +FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER +PURCHASES OF EQUITY SECURITIES +Market +Information +Our +common stock is quoted on the OTC Bulletin Board under the symbol +“CEMI.” The table below sets forth the high and low bid prices per +share of our common stock for each quarter of our two most recently completed +fiscal years. These prices represent inter-dealer quotations without +retail markup, markdown, or commission and may not necessarily represent actual +transactions. +Fiscal +Year 2009 +High +Bid +Low +Bid +First +Quarter +$.135 +$.075 +Second +Quarter +$.18 +$.085 +Third +Quarter +$.23 +$.12 +Fourth +Quarter +$.39 +$.20 +Fiscal +Year 2008 +High +Bid +Low +Bid +First +Quarter +$0.30 +$0.11 +Second +Quarter +$0.26 +$0.08 +Third +Quarter +$0.28 +$0.15 +Fourth +Quarter +$0.21 +$0.10 +Rule +15g-9 of the Securities and Exchange Commission, known as the Penny Stock Rule, +imposes requirements on broker/dealers who sell securities subject to the rule +to persons other than established customers and accredited +investors. For transactions covered by the rule, brokers/dealers must +make a special suitability determination for purchasers of the securities and +receive the purchaser’s written agreement to the transaction prior to +sale. The Securities and Exchange Commission also has rules that +regulate broker/dealer practices in connection with transactions in “penny +stocks.” Penny stocks generally are equity securities with a price of +less than $5.00 (other than securities registered on certain national securities +exchanges or quoted on the NASDAQ system, provided that current price and volume +information with respect to transactions in that security is provided by the +exchange or system), except for securities of companies that have tangible net +assets in excess of $2,000,000 or average revenue of at least $6,000,000 for the +previous three years. The Penny Stock Rule requires a broker/ dealer, +prior to a transaction in a penny stock not otherwise exempt from the rules, to +deliver a standardized risk disclosure document prepared by the Commission that +provides information about penny stocks and the nature and level of risks in the +penny stock market. The broker/dealer also must provide the customer +with current bid and offer quotations for the penny stock, the compensation of +the broker/dealer and its salesperson in the transaction, and monthly account +statements showing the market value of each penny stock held in the customer’s +account. The bid and offer quotations, and the broker/dealer and +salesperson compensation information, must be given to the customer orally or in +writing prior to effecting the transaction and must be given to the customer in +writing before or with the customer’s confirmation. These disclosure +requirements have the effect of reducing the level of trading activity in the +secondary market for penny stock issues. As a result of these rules, +investors sometimes find it difficult to sell shares of penny stock +issuers. At the present time, transactions in our common stock are +not subject to the Penny Stock Rule because our average revenue for 2007, 2008 +and 2009 exceeded $6 million per year. However, there can be no +assurance that transactions in our common stock will not be subject to the Penny +Stock Rule in the future. +Holders +As of +February 2, 2010, there were approximately 1,100 record owners of our common +stock. +Dividends +The +Company has never paid cash dividends on its common stock and has no plans to do +so in the foreseeable future. +18 +ITEM +6. SELECTED FINANCIAL DATA +Presented +in this table are selected financial data for the past five years ending +December 31, 2009. Prior year’s financial statements have been +reclassified to conform to current year presentation As of the +year ended December 31, 2008 the Company reclassified its royalty and license +expenses to cost of goods sold, instead of selling, general and administrative +expenses. +CHEMBIO +DIAGNOSTICS, INC. AND SUBSIDIARIES +SELECTED +HISTORICAL +FINANCIAL DATA +Statement +of Operations Data: +December +31, 2009 +December +31, 2008 +December +31, 2007 +December +31, 2006 +December +31, 2005 +TOTAL +REVENUES +$ +13,834,248 +$ +11,049,571 +$ +9,230,948 +$ +6,502,480 +$ +3,940,730 +GROSS +PROFIT +5,860,405 +42 +% +3,851,721 +35 +% +2,795,710 +30 +% +1,608,272 +25 +% +944,648 +24 +% +OVERHEAD +COSTS: +Research +and development expenses +2,883,696 +21 +% +2,605,343 +24 +% +1,906,653 +21 +% +1,401,472 +22 +% +1,364,898 +35 +% +Selling, +general and administrative expenses +2,659,382 +19 +% +3,317,046 +30 +% +3,765,221 +41 +% +4,786,993 +74 +% +2,877,737 +73 +% +5,543,078 +5,922,389 +5,671,874 +6,188,465 +4,242,635 +INCOME +(LOSS) FROM OPERATIONS +317,327 +(2,070,668 +) +(2,876,164 +) +(4,580,193 +) +(3,297,987 +) +OTHER +INCOME (EXPENSES): +(8,267 +) +121,898 +249,272 +(414,827 +) +45,987 +NET +INCOME (LOSS) +309,060 +2 +% +(1,948,770 +) +-18 +% +(2,626,892 +) +-28 +% +(4,995,020 +) +-77 +% +(3,252,000 +) +-83 +% +Dividends +accreted/payable in stock to preferred stockholders and a beneficial +conversion feature +- +- +5,645,310 +3,210,046 +3,517,022 +NET +INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS +$ +309,060 +$ +(1,948,770 +) +-18 +% +$ +(8,272,202 +) +-90 +% +$ +(8,205,066 +) +-126 +% +$ +(6,769,022 +) +-172 +% +Basic +income (loss) per share +$ +0.00 +$ +(0.03 +) +$ +(0.57 +) +$ +(0.80 +) +$ +(0.88 +) +Diluted +income (loss) per share +$ +0.00 +$ +(0.03 +) +$ +(0.57 +) +$ +(0.80 +) +$ +(0.88 +) +Weighted +average number of shares outstanding, basic +61,946,435 +61,266,954 +14,608,478 +10,293,168 +7,705,782 +Weighted +average number of shares outstanding, diluted +75,041,932 +61,266,954 +14,608,478 +10,293,168 +7,705,782 +19 +ITEM +7. +MANAGEMENT’S +DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF +OPERATIONS +Overview +This +discussion and analysis should be read in conjunction with the accompanying +Consolidated Financial Statements and related notes. Our discussion +and analysis of our financial condition and results of operations are based upon +our consolidated financial statements, which have been prepared in accordance +with accounting principles generally accepted in the United States. The +preparation of financial statements in conformity with accounting principles +generally accepted in the United States of America requires us to make estimates +and assumptions that affect the reported amounts of assets and liabilities, +disclosure of any contingent liabilities at the financial statement date and +reported amounts of revenue and expenses during the reporting period. On an +ongoing basis we review our estimates and assumptions. Our estimates were based +on our historical experience and other assumptions that we believe to be +reasonable under the circumstances. Actual results are likely to differ from +those estimates under different assumptions or conditions, but we do not believe +such differences will materially affect our financial position or results of +operations. Our critical accounting policies, the policies we believe are most +important to the presentation of our financial statements and require the most +difficult, subjective and complex judgments, are outlined below in ‘‘Critical +Accounting Policies,’’ and have not changed significantly. +In +addition, certain statements made in this report may constitute “forward-looking +statements”. These forward-looking statements involve known or +unknown risks, uncertainties and other factors that may cause the actual +results, performance or achievements of the Company to be materially different +from any future results, performance or achievements expressed or implied by the +forward-looking statements. Specifically, 1) our ability to obtain necessary +regulatory approvals for our products; and 2) our ability to increase revenues +and operating income, is dependent upon our ability to develop and sell our +products, general economic conditions, and other factors. You can identify +forward-looking statements by terminology such as “may,” “could”, “will,” +“should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” +“predicts,” “potential,” “continues” or the negative of these terms or other +comparable terminology. Although we believe that the expectations reflected-in +the forward-looking statements are reasonable, we cannot guarantee future +results, levels of activity, performance or achievements. +Except as +may be required by applicable law, we do not undertake or intend to update or +revise our forward-looking statements, and we assume no obligation to update any +forward-looking statements contained in this report as a result of new +information or future events or developments. Thus, you should not +assume that our silence over time means that actual events are bearing out as +expressed or implied in such forward-looking statements. You should +carefully review and consider the various disclosures we make in this report and +our other reports filed with the Securities and Exchange Commission that attempt +to advise interested parties of the risks, uncertainties and other factors that +may affect our business. +All of +the Company’s future products that are currently being developed are based on +its patented Dual Path Platform (DPP®), which is a unique diagnostic +point-of-care platform that has certain advantages over lateral flow +technology. The Company has completed development of four products +that employ the DPP® technology, two of which will be marketed under Chembio’s +label (DPP® HIV 1/2 Screening Assay and DPP® Syphilis Screen & Confirm) and +two that have been developed specifically related to private label agreements +with The Oswaldo Cruz Foundation (“FIOCRUZ”) for the Brazilian public +health market, as explained below. The DPP® HIV Screening Assay, will be +manufactured as an OEM product for the Brazilian market pursuant to one of our +agreements with FIOCRUZ. +The +Company has a number of additional products under development that employ the +DPP® technology. These product development activities are further +described below. +Oswaldo Cruz Foundation OEM DPP® +Agreements - During 2008 we signed four agreements with the Oswaldo Cruz +Foundation (FIOCRUZ) in Brazil relating to products based on our DPP® technology +for Leptospirosis, Canine Leishmaniasis, screening for HIV 1/2 with oral fluid +samples, and a 5-band multiplex point-of-care confirmation test for HIV +1&2. We have completed development of three of these products +(Leishmaniasis and the HIV screening and confirmation tests), and we have +substantially completed development of the Leptospirosis test. Two of +the three products developed have been submitted for regulatory approval +evaluations in Brazil and we expect the third will be filed very shortly; we +expect that these products will be approved by Brazilian regulatory authorities +(ANVISA for HIV tests and MAPA for canine test) , +although there can be no assurance, during the first part of 2010, +triggering initial orders as well as approximately $1 million in technology +transfer fee payments to the Company. +During +2009, we received purchase orders from FIOCRUZ for the three products for which +development has been completed and that are pending regulatory approval in the +aggregate of approximately $2.4 million. These orders are subject to +regulatory approval, of which there can be no assurance. If +regulatory approval is obtained, we anticipate additional orders in +2011. We are currently considering entering additional agreements +based on a similar model with them in 2010. +20 +Bio-Rad Laboratories OEM DPP® +Agreement - On April 6, 2008, we entered a development agreement with +Bio-Rad Laboratories N.A., a division of Bio-Rad Laboratories Inc (NYSE:BIO), a +leading in-vitro diagnostic and life science company. The agreement +with Bio-Rad is for the development of a six band multiplex product on our +DPP®. We will complete development of this product by the +middle of 2010, by which time Bio Rad will have paid us approximately $600,000 +in development costs plus $340,000 for a DPP® license limited to this product. +Thereupon, CE marking and FDA approval will be sought by Bio-Rad with Chembio in +a supporting role as manufacturer. We believe that +Bio-Rad has begun discussions with the FDA to discuss this product, its proposed +performance claims and the intended clinical protocol to support its regulatory +submission. +Battelle/CDC DPP® Influenza Immunity +Test – In December 2009 Chembio entered into a milestone-based +development agreement for up to approximately $900,000 in connection with the +development and initial supply of a multiplex, rapid point-of-care ("POC") +influenza immunity test. The agreement contemplates a period of approximately +nine months in which the development activity is to be completed. Chembio +entered this agreement with Battelle Memorial Institute which has a master +contract with the United States Centers for Disease Control and Prevention +("CDC") to enter into, implement and provide technical oversight of agreements +relating to pandemic preparedness on behalf of CDC. Our work +plan has been delivered and been approved, which are the first two milestones +triggering approximately $178,000 in payments to Chembio. No +agreement is in place for the manufacture, commercialization or license for this +product assuming it is successfully developed in accordance with the +specifications. +The +objective of the project is to develop a product that can determine an +individual's immunity to seasonal and novel influenza viruses, including novel +swine H1N1, either in the field or in an outpatient setting. The test will have +six different parameters (representing different influenza strains) plus a +control line on a single POC DPP® device. The test will allow visual +interpretation of results and/or will be used with a portable digital reader +that will be customized for this application. Public health experts believe that +rapid responses in the field require a POC test for influenza immunity, as well +as infection. Current test platform technologies for infection and immunity are +not suitable for reliable POC testing. +DPP® Hepatitis C and DPP® Hepatitis +C/HIV Oral Fluid Antibody Tests - Prototypes of these products have been +developed and are being evaluated in a study that has been organized by the +National Center for HIV/AIDS, Viral Hepatitis, STD, and TB Prevention (NCHHSTP) +at the Centers for Disease Control and Prevention (CDC) of the Department Of +Health and Human Services. The evaluation will be completed during +2010 and the results should be useful in helping to ascertain the performance +characteristics of these products in comparison to other products that will also +be in this evaluation. Chembio’s DPP® HIV 1/2 test is also being +evaluated in this study. +DPP® Influenza –We have +developed a prototype multiplex test for FLU A/B Antigen +Detection. [This is not to be confused with the immune status +antibody detection test we are developing for the U.S. CDC]. This prototype, if +successfully developed into a commercial product, would be competitive to the +current point-of-care FLU A/B products marketed by Quidel, Meridian, Binax +(Inverness) and others. We believe that we can develop a test that +performs better than the current market leaders, and so that there is therefore +a significant opportunity to participate in this market. We are also +considering additional parameters for this product that would further +differentiate it in the market. This product will be our first commercial +antigen detection test on DPP® and we believe that this has independent value to +demonstrate the capabilities of our technology to access large markets beyond +serological antibody detection markets. Our current plan is for +development to be completed and initiation of our FDA 510(k) submission +activities during 2010. +DPP® +Leptospirosis – In June, as we previously reported, we were awarded a +three-year $3 million Small Business Innovative Research (SBIR) Phase II grant +from the United States National Institutes of Health (NIH) to fully develop, +validate, and commercialize a rapid diagnostic test for Leptospirosis for +general use worldwide, and our work is progressing on schedule. The test will be +developed with DPP® and will utilize proprietary reagents developed by Cornell +University and the Oswaldo Cruz Foundation at the Brazilian Ministry of Health. +Development of the test will be in collaboration with the Division of Infectious +Diseases, Weill Medical College, Cornell University in New York and the Oswaldo +Cruz Foundation, the largest biomedical research institution in Latin +America. In the Phase I work completed in 2008, which occurred with +this same collaborative group, novel diagnostic targets were identified and +evaluated in a prototype test in Chembio’s patented DPP® format. The studies +demonstrated that the test prototype had an overall sensitivity of 85% and a +specificity of 90% using serum samples of Leptospirosis patients from Brazil and +Thailand. Furthermore, the DPP® prototype had a sensitivity of 78% in +identifying Leptospirosis in the first 7 days of illness, the +"window-of-opportunity" during which initiation of antimicrobial therapy +provides the greatest benefit. +21 +Other Research & Development +Activities - Chembio continues to work with commercial, governmental and +private organizations in order to obtain R&D contracts & grant funding +for development projects. These programs have subsidized the +Company’s development expenses while expanding the applications for and know-how +related to DPP® and creating important collaborative +relationships. We have other grant applications pending. In April +2009 we entered into a Services Agreement with the Infectious Disease Research +Institute to develop DPP® products for Leishmaniasis and Leprosy for which we +have received $125,000 and which, subject to attainment of development +milestones, will additionally provide us with approximately $125,000 within the +next six months. The second year provides for another $150,000, +subject to the attainment of development milestones. During the first +quarter of 2009 we entered into a funded feasibility study agreement with the +Foundation for Innovative and Novel Diagnostics (FIND), a non-profit +organization funded by the Gates Foundation, related to development of +serological tests for Tuberculosis and Malaria using our DPP®. The +Company received $165,000 from FIND and as a result of our achievement of all +milestones, we recognized revenue of $99,000 in the first and second quarters as +well as $66,000 during the third quarter with further development activity +pending a full evaluation and comparison of results. +There can +be no assurance that any of these projects will continue, meet regulatory or +other technical requirements and specifications, and/or that if continued, will +result in completed products, or that such products, if successfully completed, +will be successfully commercialized. +Platform Enhancements - In addition to the specific +products we plan to commercialize we also are pursuing enhancements to our DPP® +technology platform during 2010 and 2011. These enhancements include +enabling a simplified test procedure, lowering the overall manufacturing costs, +enabling development of combination antibody and antigen assays, and integrating +molecular sample amplification systems with our detection +system. We are active in each of these areas and also are +pursuing patent protection where applicable. +Regulatory +Activities +CE Mark for FDA approved HIV +tests – we provided all testing and related documentation that was +requested by our Notified Body during the second quarter, however additional +data was requested in correspondence we received in January and we are +evaluating the cost/benefit of producing this information at this time. Under +our agreement with Inverness, as now amended, we no longer have the obligation +to obtain a CE Marking for the Clearview® Complete HIV 1/2. +Regulatory Approvals in Brazil +through the Oswaldo Cruz Foundation (FIOCRUZ) – We anticipate that +FIOCRUZ will receive required approvals from its regulatory agencies during the +first and/or second quarter of 2010 for the DPP® Leishmaniasis, HIV +Confirmatory, and the DPP® HIV screening tests. +DPP® HIV 1/2 Screening Assay for Oral +Fluid - Field evaluations in Africa have been completed of this product +that will supplement our pending U.S. clinical studies: During the second half +of 2009 we prepared a proposed clinical trial protocol and submitted it to the +FDA in support of our application for an Investigational Device Exemption (IDE) +which we submitted and was approved during the fourth quarter of +2009. This approved protocol permits us to move forward with the +clinical trials performance data, along with other required product and +manufacturing data, in support of a Pre-Marketing Approval (PMA) application to +the FDA. We have commenced the clinical trials at two sites and we anticipate +completing the clinical trials and submitting the PMA application during 2010 +and receiving approval of the PMA during 2011. +DPP® Syphilis Screen & Confirm +- The first phase of a multi-center evaluation sponsored by the World +Health Organization commenced during the third quarter and we have received only +limited first phase results. During the third quarter, we submitted a +proposed clinical plan to the FDA (Pre-IDE “Investigational Device Exemption”) +and we are currently reviewing the FDA response. We have also begun +to identify clinical testing sites, have performed additional validation, +interfering substance, and cross-reactivity studies on the product at Chembio +and at external laboratories. There is no point-of-care test for syphilis +cleared for marketing in the United States, and we believe that our product, +with its multiplexed capacity to identify both treponemal and non-treponemal +markers, provides a reliable indication of an active, untreated case of syphilis +at the point-of-care. +22 +The table +below provides a preliminary summary estimated timetable for the regulatory +approval and commercialization of the DPP® HIV Screening Assay and the DPP® +Syphilis Screen & Confirm Assay in major markets. There can be no +assurance that these dates will be accurate. +Market +DPP® +HIV 1/2 Screening Assay +DPP® +Syphilis Screen & Confirm +Developing +World +2010 +2010 +CE +Mark0 +2 nd +Half 2011 +First +Half 2010 +US +FDA +2 nd Half +2011 +First +Half 2011 +Recent +Events +In May +2009, certain warrants to purchase an aggregate of 2,489,120 shares of common +stock expired, at an average exercise price of $.764. These warrants +were related to the Series A Preferred Stock Offering and other warrants related +to the 2004 merger. +In +January 2010, certain warrants to purchase an aggregate of 4,960,370 shares of +common stock expired, at an average exercise price of $.474. These +warrants were related to the initial 2005 Series B Preferred Stock Offering (see +Form 8-K filed on January 31, 2005 with the SEC for further details on this +offering). +We +entered into a lease effective February 1, 2010 for additional warehouse space; +see Item 2 for more information. +In +February 2010, the Company took possession of the automated assembly equipment +(mentioned below under Equipment Purchase Commitment). This equipment +is expected to provide for faster throughput and thereby increasing capacity of +our manufacturing facility, in addition to reducing labor costs. The +machine will need to go through a validation process and is expected to be in +serviced during the second quarter of 2010. +The +Company entered into an employment agreement dated March 4, 2010, and to be +effective March 5, 2010 (the "Employment Agreement"), with Mr. Esfandiari to +continue as the Company's Senior Vice President of Research and Development for +an additional term of three years. Please see Item 11 of this Form +10-K for further details. +23 +RESULTS +OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2009 AS COMPARED WITH THE YEAR +ENDED DECEMBER 31, 2008 +Revenues: +Selected +Product Categories: +For the years ended +December +31, 2009 +December +31, 2008 +$ +Change +% +Change +HIV +$ +10,792,947 +$ +9,192,297 +$ +1,600,650 +17.41 +% +DPP +619,530 +126,000 +493,530 +391.69 +% +Other +960,016 +1,037,471 +(77,455 +) +-7.47 +% +Net +Product Sales +12,372,493 +10,355,768 +2,016,725 +19.47 +% +License +and royalty income +121,896 +- +121,896 +100.00 +% +R&D +contracts and grants +1,339,859 +693,803 +646,056 +93.12 +% +Total +Revenues +$ +13,834,248 +$ +11,049,571 +$ +2,784,677 +25.20 +% +Revenues +for our HIV tests and related components during the year ended December 31, 2009 +increased by $1.60 million over the same period in 2008. This was +primarily attributable to increased sales to our distributor in the United +States which increased 148%, or $3.13 million, to $5.24 million in 2009 as +compared with $2.11 million in 2008. This increase offset reduced +sales to Africa, which decreased by 21.6%, or $1.53 million, to $5.55 million in +2009 as compared with $7.08 million in 2008. Sales of our DPP product +increased because we are working with our partner in Brazil to get several +products approved in Brazil. The increase in R&D contracts and +grants involving our patented DPP® technology, of which $1,161,000 was received +and $1,340,000 was earned in 2009, adding $21,000 to deferred revenues as of +December 31, 2009. +Gross +Margin: +Gross +Margin related to Net +Product Sales: +For the years ended +December +31, 2009 +December +31, 2008 +$ +Change +% +Change +Gross +Margin per Statement of Operations +$ +5,860,405 +$ +3,851,721 +$ +2,008,684 +52.15 +% +Less:R&D +contracts and grants, license and royalties +1,461,755 +693,803 +767,952 +110.69 +% +Gross +Margin from Net Product Sales +$ +4,398,650 +$ +3,157,918 +$ +1,240,732 +39.29 +% +Gross +Margin % +35.55 +% +30.49 +% +The +increase in our gross margin resulted primarily from increased average unit +prices on product sales as a result of the increased sales to Inverness, which +are at higher average unit prices, and decreased sales to Africa, which are at +lower average unit prices. +24 +Research and +Development: +This +category includes costs incurred for product research and development, +regulatory approvals, technical support, evaluations and +registrations. +Selected +expense lines: +For the years ended +December +31, 2009 +December +31, 2008 +$ +Change +% +Change +Clinical & Regulatory +Affairs: +Wages +and related costs +$ +321,830 +$ +262,191 +$ +59,639 +22.75 +% +Consulting +35,560 +27,231 +8,329 +30.59 +% +Share-based +compensation +12,916 +- +12,916 +100.00 +% +Clinical +trials +69,499 +138,792 +(69,293 +) +-49.93 +% +Other +32,056 +60,822 +(28,766 +) +-47.30 +% +Total +Regulatory +$ +471,861 +$ +489,036 +$ +(17,175 +) +-3.51 +% +R&D Other than +Regulatory: +Wages +and related costs +$ +1,541,295 +$ +1,354,557 +$ +186,738 +13.79 +% +Consulting +74,194 +138,436 +(64,242 +) +-46.41 +% +Share-based +compensation +62,180 +84,935 +(22,755 +) +-26.79 +% +Materials +and supplies +462,806 +282,281 +180,525 +63.95 +% +Other +271,360 +256,098 +15,262 +5.96 +% +Total +other than Regulatory +$ +2,411,835 +$ +2,116,307 +$ +295,528 +13.96 +% +Total +Research and Development +$ +2,883,696 +$ +2,605,343 +$ +278,353 +10.68 +% +Expenses +for Clinical & Regulatory Affairs for the year ended December 31, 2009 +decreased by $17,000 as compared to the same period in 2008. This was primarily +due to expenses we incurred in 2008 for external clinical trials conducted in +order to lower the age limitation of our FDA approved rapid HIV tests from 18 to +13 years of age in 2008, which did not recur. This decrease was +partially offset by an increase in wages and related costs. +R&D +expenses other than Clinical & Regulatory Affairs increased by $295,000 in +the year ended December 31, 2009 as compared with the same period in 2008 and +were primarily related to an increase in personnel and material costs required +to perform the work related to funded research and development contracts and +grants all related to our patented DPP® technology. These increases +were partially offset by a decrease in consulting cost and the reduced cost of +share-based compensation related to the value of employee stock options issued +and amortized. +25 +Selling, General and +Administrative Expense: +Selected +expense lines: +For the years ended +December +31, 2009 +December +31, 2008 +$ +Change +% +Change +Wages +and related costs +$ +1,075,532 +$ +1,261,511 +$ +(185,979 +) +-14.74 +% +Consulting +165,371 +187,494 +(22,123 +) +-11.80 +% +Commissons +302,515 +365,774 +(63,259 +) +-17.29 +% +Share-based +compensation +98,356 +187,908 +(89,552 +) +-47.66 +% +Marketing +materials +22,779 +38,379 +(15,600 +) +-40.65 +% +Investor +relations +72,888 +123,654 +(50,766 +) +-41.05 +% +Legal, +accounting and Sox 404 compliance +470,843 +556,118 +(85,275 +) +-15.33 +% +Travel, +entertainment and trade shows +61,316 +92,576 +(31,260 +) +-33.77 +% +Other +389,782 +503,632 +(113,850 +) +-22.61 +% +Total +S, G &A +$ +2,659,382 +$ +3,317,046 +$ +(657,664 +) +-19.83 +% +Selling, +general and administrative expenses for the year ended December 31, 2009 +decreased by 20% as compared with the same period in 2008. During the +second half of 2008 and continuing in 2009 the Company implemented a series of +cost reductions that have resulted in lower S,G&A expenses in almost every +category in 2009 year to date with the exception of sales commissions which, +decreased as a result of a decrease in commissionable sales (and not from the +Company’s cost reductions) as compared with the 2008 period. +Other Income and +Expense: +For the years ended +December +31, 2009 +December +31, 2008 +$ +Change +% +Change +Other +income +$ +(6,696 +) +$ +95,812 +$ +(102,508 +) +-106.99 +% +Interest +income +9,032 +34,403 +(25,371 +) +-73.75 +% +Interest +expense +(10,603 +) +(8,317 +) +(2,286 +) +-27.49 +% +Total +Other Income and (Expense) +$ +(8,267 +) +$ +121,898 +$ +(130,165 +) +-106.78 +% +Other +income and (expense) for the year ended December 31, 2009 decreased 107% as +compared with the same period in 2008 primarily as a result of a decrease in the +net amounts received from New York State related to a program for qualified +emerging technology companies. Interest income for the year +ended December 31, 2009 decreased due to a decrease in available funds to invest +in interest bearing accounts. +26 +RESULTS +OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2009 AS COMPARED WITH THE +THREE MONTHS ENDED DECEMBER 31, 2008 +CHEMBIO DIAGNOSTICS, INC. AND +SUBSIDIARY +CONSOLIDATED STATEMENTS OF +OPERATIONS +FOR THE THREE MONTHS +ENDED +(UNAUDITED) +December +31, 2009 +December +31, 2008 +REVENUES: +Net +product sales +$ +3,127,454 +$ +2,244,753 +License +and royalty income +38,186 +- +Research +grant income +385,801 +206,141 +TOTAL +REVENUES +3,551,441 +2,450,894 +Cost +of product sales +1,920,636 +1,835,604 +GROSS +PROFIT +1,630,805 +615,290 +OPERATING +EXPENSES: +Research +and development expenses +755,836 +652,906 +Selling, +general and administrative expenses +657,310 +620,695 +1,413,146 +1,273,601 +INCOME +(LOSS) FROM OPERATIONS +217,659 +(658,311 +) +OTHER +INCOME (EXPENSES): +Other +income +- +107,363 +Interest +income +1,949 +4,446 +Interest +expense +(2,394 +) +(3,901 +) +(445 +) +107,908 +INCOME +(LOSS) BEFORE INCOME TAXES +217,214 +(550,403 +) +Provision +for income taxes +- +- +NET +INCOME (LOSS) +$ +217,214 +$ +(550,403 +) +Basic +earnings (loss) per share +$ +0.00 +$ +(0.01 +) +Diluted +earnings (loss) per share +$ +0.00 +$ +(0.01 +) +Weighted +average number of shares outstanding, basic +61,950,988 +61,944,901 +Weighted +average number of shares outstanding, diluted +75,365,550 +61,944,901 +See +accompanying notes to consolidated financial +statements +27 +Revenues: +Product +Categories: +For +the three months ended +December +31, 2009 +December +31, 2008 +$ +Change +% +Change +HIV +$ +2,963,671 +$ +1,963,383 +$ +1,000,288 +50.95 +% +DPP +- +126,000 +(126,000 +) +-100.00 +% +Other +163,783 +155,370 +8,413 +5.41 +% +Net +Product Sales +3,127,454 +2,244,753 +882,701 +39.32 +% +License +and royalty income +38,186 +- +38,186 +100.00 +% +R&D +contracts and grants +385,801 +206,141 +179,660 +87.15 +% +Total +Revenues +$ +3,551,441 +$ +2,450,894 +$ +1,100,547 +44.90 +% +Revenues +for our HIV tests during the three months ended December 31, 2009 increased by +approximately 51% or $1,000,000 over the same period in 2008. This +was primarily attributable to increased sales in North America, primarily from +sales to Inverness of our HIV products which increased by $1,292,000 to +$1,833,000, and partially offset by a decrease in sales to Brazil of +$374,000. The increase in R&D contracts and grants was primarily +due to revenue our recent NIH grant for Leptospirosis, which was effective as of +June 1, 2009. License and royalty income represents our royalties +from Brazil under our 2004 technology transfer and license +agreement. +Gross +Margin: +Gross +Margin related to Net +Product Sales: +For +the three months ended +December +31, 2009 +December +31, 2008 +$ +Change +% +Change +Gross +Margin per Statement of Operations +$ +1,630,805 +$ +615,290 +$ +1,015,515 +160.05 +% +Less:R&D +contracts and grants, license and royalties +423,987 +206,141 +217,846 +105.68 +% +Gross +Margin from Net Product Sales +$ +1,206,818 +$ +409,149 +$ +797,669 +194.96 +% +Gross +Margin % +38.59 +% +18.23 +% +The +increase in our gross margin resulted primarily from increased sales volume and +average unit prices as a result of the increased sales to Inverness, which are +at higher average unit prices and decreased sales to Africa, which are at lower +average unit prices. The increase in our gross margin in the three +months ended December 31, 2009 also includes a decrease of $225,000 in the +royalty expense paid to Inverness as partial reimbursement for Inverness’ +royalty payments to Bio-Rad Laboratories, Inc. pursuant to Inverness’ HIV-2 +sublicense agreement with Bio-Rad. +28 +Research and +Development: +This +category includes costs incurred for regulatory approvals, product evaluations +and registrations. +For +the three months ended +December +31, 2009 +December +31, 2008 +$ +Change +% +Change +Clinical & Regulatory +Affairs: +Wages +and related costs +$ +96,284 +$ +67,294 +$ +28,990 +43.08 +% +Consulting +5,610 +2,548 +3,062 +120.17 +% +Share-based +compensation +4,667 +- +4,667 +100.00 +% +Clinical +trials +23,448 +- +23,448 +100.00 +% +Other +7,852 +7,727 +125 +1.62 +% +Total +Regulatory +$ +137,861 +$ +77,569 +$ +60,292 +77.73 +% +R&D Other than +Regulatory: +Wages +and related costs +$ +420,088 +$ +361,630 +$ +58,458 +16.17 +% +Consulting +10,646 +33,455 +(22,809 +) +-68.18 +% +Share-based +compensation +9,722 +9,738 +(16 +) +-0.16 +% +Materials +and supplies +102,491 +91,536 +10,955 +11.97 +% +Other +75,028 +78,978 +(3,950 +) +-5.00 +% +Total +other than Regulatory +$ +617,975 +$ +575,337 +$ +42,638 +7.41 +% +Total +Research and Development +$ +755,836 +$ +652,906 +$ +102,930 +15.76 +% +Total +expenses for Clinical & Regulatory Affairs for the three months ended +December 31, 2009 increased by approximately $60,000 as compared to the same +period in 2008. An increase in compensation in Clinical and +Regulatory Affairs of $29,000, was the primary reason for the increase in wages +and related costs. In addition, start up costs for clinical trials of +our DPP® oral fluid HIV test also contributed to this increase. +Total +expenses for R&D Other than Clinical & Regulatory Affairs increased by +approximately $43,000 in the three months ended December 31, 2009 as compared +with the same period in 2008. These increases were primarily related +to an increase in compensation, materials and supplies related to R&D +contracts and grants, partially offset by a reduction in the use of consultants +and other expenses. +Selling, General and +Administrative Expenses: +Selected +expense lines: +For +the three months ended +December +31, 2009 +December +31, 2008 +$ +Change +% +Change +Wages +and related costs +$ +324,131 +$ +257,778 +$ +66,353 +25.74 +% +Consulting +22,250 +45,912 +(23,662 +) +-51.54 +% +Commissons +15,952 +50,894 +(34,942 +) +-68.66 +% +Share-based +compensation +30,414 +14,082 +16,332 +115.98 +% +Marketing +materials +5,419 +15,831 +(10,412 +) +-65.77 +% +Investor +relations +35,839 +11,906 +23,933 +201.02 +% +Legal, +accounting and Sox 404 compliance +123,500 +81,562 +41,938 +51.42 +% +Travel, +entertainment and trade shows +13,849 +20,730 +(6,881 +) +-33.19 +% +Other +85,956 +122,000 +(36,044 +) +-29.54 +% +Total +S, G &A +$ +657,310 +$ +620,695 +$ +36,615 +5.90 +Selling, +general and administrative expenses (S,G&A) for the three months ended +December 31, 2009 increased by 5.9% as compared with the same period in +2008. This was primarily due to increased wages and related expenses +related to bonuses paid to compensate employees who had taken pay reductions +during the first six months of the 2009 year. +29 +Other Income and +(Expense): +For +the three months ended +December +31, 2009 +December +31, 2008 +$ +Change +% +Change +Other +income (expense) +$ +- +$ +107,363 +$ +(107,363 +) +-100.00 +% +Interest +income +1,949 +4,446 +(2,497 +) +-56.16 +% +Interest +expense +(2,394 +) +(3,901 +) +1,507 +-38.63 +% +Total +Other Income and (Expense) +$ +(445 +) +$ +107,908 +$ +(108,353 +) +-100.41 +% +Other +income and (expenses) for the three months ended December 31, 2009 decreased +approximately $108,000 as compared with the same period in 2008, primarily as a +result of a decrease in the net amounts received from New York State related to +a program for qualified emerging technology companies. +LIQUIDITY +AND CAPITAL RESOURCES +For +the years ended +December +31, 2009 +December +31, 2008 +$ +Change +% +Change +Net +cash provided by (used in) operating activities +$ +251,927 +$ +(1,194,227 +) +$ +1,446,154 +-121.10 +% +Net +cash used in investing activities +(376,988 +) +(397,462 +) +(8,754 +) +2.20 +% +Net +cash provided by (used) in financing activities +(18,926 +) +(23,458 +) +33,760 +-143.92 +% +NET +DECREASE IN CASH AND CASH EQUIVALENTS +$ +(143,987 +) +$ +(1,615,147 +) +$ +1,471,160 +-91.09 +% +The +Company had a decrease in cash for the year ended December 31, 2009 as compared +to a greater decrease in cash for the same period in 2008. The decrease during +the 2009 period is primarily attributable to cash used on deposits and +acquisition of fixed assets, partially offset by cash provided from operations. +The decrease in the 2008 period is primarily attributable to the cash used in +operations. +The +Company had a working capital surplus of $1,494,000 at December 31, 2009 and a +working capital surplus of $1,664,000 at December 31, 2008. The +Company estimates that its resources are sufficient to fund its needs through +the end of 2010 and beyond or that, in the alternative, it could raise +additional capital although the terms under which that capital could be raised +would likely be very dilutive to current shareholders. The Company’s +liquidity and cash requirements will depend on several factors. These factors +include (1) the level of revenues (the Company received $340,000 in 2009 for +license fees for which we need to meet certain milestones to earn and the +Company expects to receive up to $1 million in license fees from Brazil, +although there can be no assurance); (2) the extent to which, if any, that +revenue level improves operating cash flows; (3) the Company’s investments in +research and development, facilities, marketing, regulatory approvals, and other +investments it may determine to make; (5) the payment of obligations and +commitments (including a license fee payable of $875,000 due at the end of +2010); and (4) the investment in capital equipment (including production +equipment of $323,500 that the Company has contracted for) and the extent to +which it improves cash flow through operating efficiencies. There are no +assurances that the Company will become profitable or generate positive cash +flow by the end of 2010 or, in the alternative, be successful in raising +sufficient capital to fund its needs through 2010. +RECENT +DEVELOPMENTS AND CHEMBIO’S PLAN OF OPERATIONS FOR THE NEXT TWELVE +MONTHS +Please +see section entitled Recent Events above. +In 2009 +Chembio achieved record revenues, gross margin, operating results and cash flow, +including its first ever quarterly and full year profits since its reverse +merger in 2004. Following net losses from 2004-2008, including our smallest loss +in 2008 of nearly $2 million, we swung to net income of $309,000 in +2009. This was a notable achievement given that 2009 was the worst +economy since World War II. We believe this achievement was +attributable to several factors, including: (1) the $3.13 million, or 148%, +increase in our rapid HIV test sales to Inverness more than offset a $1.53 +million, or 21.6%, decrease in our international HIV rapid test +sales. Higher average selling prices in the U.S. market for rapid HIV +tests helped to produce a 36.8%, or $1.16 million, increase in our gross margin +on product sales, from $3.16 million in 2008 to $4.32 million in +2009. These increased U.S. market revenues reflect the continued +expansion in the U.S. rapid HIV test market, and relatively stable funding as +rapid testing has taken hold, and expanded into more hospitals and public health +testing venues. The increased average selling prices for our FDA PMA +approved HIV rapid test products that are sold in the U.S. market as compared +with those in the developing world provide us with a much more attractive return +on the manufacturing, regulatory compliance and other costs (patent license fees +and such as royalty expense) that are applicable to these +products. This return is much lower on our international sales +primarily due to the lower average selling prices of competitive products +manufactured in Asia that do not have the same costs of regulatory compliance, +labor and other items that we have in the United States with our products; (2) a +392%, or $494,000, increase in DPP® product sales attributable to our OEM +agreements for new DPP® products with FIOCRUZ in Brazil. While such +amount was significantly less than what we had anticipated, and this product was +used by FIOCRUZ for regulatory submissions for the three DPP® products that have +been submitted for regulatory approval in Brazil, these shipments at least +allowed us to bring these products through our manufacturing +process. We are optimistic that the four DPP® products we have under +agreement will produce significant DPP® product and technology revenues during +2010 and beyond, although there can be no assurance of this; (3) A 93%, or +$646,000, increase in R&D contracts and grants to $1.34 million in 2009 from +$694,000 in 2008 more than offset the $278,000 increase in our research and +development expenses from $2.61 million in 2008 to $2.88 million in 2009, as +more commercial, governmental and non-governmental organizations entered into +development programs with us related to our DPP® technology as we reported +during 2009; and (4) 20% reduction in our SG&A expenses from $3.32 million +in 2008 to $2.66 million in 2009, which decrease followed an 11.9% reduction in +2008 over 2007 and a 21.3% reduction in 2007 over 2006. +30 +The +December 31, 2009 cash balance was $144,000 less than at December 31, +2008. This was primarily due to $792,000 that was paid to Inverness +pursuant to our agreement of December 2008 in which we agreed to amortize a +$1.01 million liability to Inverness based on a percentage of their sales of our +products beginning in 2009. Based on Inverness’ anticipated sales of our +products in 2010, we anticipate that the liability mentioned above will be fully +amortized in the first part of 2010, thereby freeing up this cash flow +used to extinguish the obligation to Inverness for other corporate purposes. +Also contributing to the cash decrease was a $675,000 account receivable balance +that was outstanding at the year end (which amount was paid in January 2010) and +$400,000 that we invested during 2009 in new equipment and facilities (primarily +our new assembly system that we took delivery of in February 2010). Partially +offsetting these cash outflows were our net income, non-cash expenses, and +receipt of a $340,000 license fee deposit from Bio-Rad Laboratories, +Inc. +Our +results in 2009 clearly guide our strategy for growth in 2010 and beyond. We +believe we can best leverage our DPP® intellectual property together with our +U.S.-based manufacturing and regulatory credentials by bringing proprietary +products (such as our DPP® oral fluid HIV test and our Screen and Confirm +Syphilis test) to the U.S. public health and other markets. Based on +our current year and long range plan, we are optimistic that revenues will grow +significantly in the foreseeable future, although there can be no assurance of +this. +Significant +revenue growth in 2010 could be realized, based on the following assumptions: +(1) Increased sales of our rapid HIV tests in the U.S. market as the total +market and our products’ market share increases; (2) increased international +sales of our HIV rapid tests primarily based on maintaining current accounts, +increased sales to Nigeria where we resumed sales activity in the fourth quarter +of 2009 for the first time since 2008; (3) DPP® product sales and license fees +from our contracts with FIOCRUZ (including regulatory approvals required in +Brazil) and completion of the product development phase in our program with +Bio-Rad Laboratories, Inc. which would result in recognizing the $340,000 +license fee we received in 2009; (4) a substantial increase in our R&D +contracts and grants primarily based on the $900,000 development contract we +entered in December 2009 with Battelle Memorial Institute and having a full year +of the $2.9 million NIH grant for Leptospirosis we received in June 2009, +and; (5) improved manufacturing efficiencies based on the delivery in +February of our customized automated assembly system which we invested in during +2009 for both our lateral flow and DPP® products, and lower costs for certain +raw materials used in our HIV tests which we will realize as a result of our +having bought out a license agreement in connection with the insolvency +procedures of the licensor in 2009. +We have +received purchase orders from FIOCRUZ for the three products pending regulatory +approval for an aggregate of over $2 million, and have an aggregate of +approximately $1 million in license fees that will be payable when the products +are approved. However the fees will not be paid and these orders +cannot be processed and shipped unless and until regulatory approval is obtained +in Brazil, which we believe will occur during the first half of 2010, but for +which there can be no assurance. +The +anticipated increased product and research and development revenues, if realized +will be accompanied by increased product costs and research and development +expenses which will be attributable to the increased R&D work primarily +required by the above-mentioned R&D contracts & grants; such expenses +may also increase as a result of other initiatives that we have identified that +we may be undertaking to further expand and enhance our technology +portfolio. +In +addition, we have commenced training for the conduct of clinical trials related +to our planned FDA PMA application for our DPP® oral fluid HIV +test. We anticipate that the total costs for thee trials during 2010 +for this and related regulatory activities could approach $2 +million. Moreover, additional regulatory expenses for preparing our +DPP® Syphilis Screen & Confirm test and our DPP® Flu A/B tests for 510(k) +submissions will also require significant resources, though not nearly as much +as the aforementioned PMA. We may attempt to enter an agreement with +a marketing partner for one more of these products which could result in our +being reimbursed for a portion of our regulatory expenses for one or more of +these products, but there can be no assurance of this occurring or if +it occurs, its timing. We can also defer some or all of +these costs to ensure that we can finance them with operating cash flow, though +this would impact commercialization timetables. +Although +we believe that there are still opportunities to increase our international HIV +test sales and we plan to do so in 2010, we are cognizant that these markets +will continue to be largely driven by price and therefore difficult for our +U.S.-based cost structure (though still contributing margin), and very difficult +to forecast due to their reliance on host governments’ decisions which can +suddenly and arbitrarily result in changes even though they are funded by +foreign aid budgets, mainly PEPFAR. On the other hand, based on the +outstanding data from a recent field study by the United States Centers for +Disease Control of our oral fluid HIV test in Africa, where it was compared with +two leading blood tests and an oral fluid test of a competitor’s, we believe +that there could well be significant opportunities for this product in the +international market, in which we are one of only two oral fluid HIV tests +approved for procurement by PEPFAR, as compared with dozens now that only work +on blood matrices. Further, we believe that if studies that having +been completed can show that oral fluid tests can improve prevention strategies +by encouraging more people to be tested, and particularly if we can continue to +lower our productions costs for this product to be more competitively priced for +this market, the international opportunity for this product will be significant +indeed. +31 +If the +assumptions set forth above hold true, of which there is no assurance – +particularly where timing is concerned – we believe that our operating cash flow +from our existing business will likely be sufficient to fund a substantial +portion of the research and development and regulatory expenses required in +order to begin commercializing these new products in 2011, though there can no +assurance of this. We believe that we must invest in these new +product approvals in order to meet our long range plan for significant +growth. +We will +endeavor to time the increases in our research and development expenses, with +the increased R&D contracts and grants we anticipate receiving as described +above. However, delays in achievement of milestones and/or their +approval for the purpose of funding of payments that may be due to us can +occur. +We also +anticipate that our SG&A expenses, after having decreased in each of the +last three years, will not continue this trend into 2010. This is +attributable to: a) our having reduced this expense so significantly over +the last three years; b) expenses we may incur in 2010 that are associated with +the potential establishment of our own Chembio/DPP® branded product line in +2011; and c) expenses we may incur related to expansion of our board of +directors and investor relations activities as compared to 2009. +Accordingly, +in order to increase the likelihood that the regulatory approvals and +commercialization of new DPP® products occur on a timely basis, we may choose to +raise some additional capital if we believe such capital will best ensure our +ability to execute our business plan on a timely basis. +Equipment +Purchase Commitment: +In +January 2009, the Company entered into an agreement with an equipment +manufacturer to design and build equipment that will be used to automate the +assembling of our tests and lower our production costs. The estimated +cost of $323,500 is being paid in installments. In addition in June +and November of 2009, the Company entered into an agreement with an equipment +manufacturer to design and build a mold for its DPP® tests. The +estimated cost of $113,800 is being paid in installments. +Critical +Accounting Policies and Estimates +The +preparation of the financial statements in conformity with accounting principles +generally accepted in the United States of America requires management to make +estimates and assumptions that affect the amounts reported in the financial +statements and accompanying notes. Actual results could differ +materially from those estimates. +We +believe that there are several accounting policies that are critical to +understanding our historical and future performance, as these policies affect +the reported amounts of revenue and the more significant areas involving +management’s judgments and estimates. These significant accounting +policies relate to revenue recognition, research and development costs, +valuation of inventory, valuation of long-lived assets and income +taxes. These policies, and the related procedures, are described in +detail below. +Revenue +Recognition – +We sell +our products directly through our sales force and through +distributors. Revenue from direct sales of our product are recognized +upon shipment to the customer. Income from R&D contracts and +grants are recognized in earnings in the period in which the related +expenditures are incurred. Sales are recorded net of discounts, +rebates and returns. +Research +& Development Costs – +Research +and development activities consist primarily of new product development, +continuing engineering for existing products, regulatory and clinical trial +costs. Costs related to research and development efforts on existing +or potential products are expensed as incurred. +Valuation +of Inventories – +Inventories +are stated at the lower of cost or market, using the first-in, first-out method +(FIFO) to determine cost. Our policy is to periodically evaluate the +market value of the inventory and the stage of product life cycle, and record a +reserve for any inventory considered slow moving or +obsolete. For example, each additional 1% of obsolete +inventory would reduce such inventory by approximately $15,000. +32 +Allowance +for doubtful accounts – +Our +policy is to review our accounts receivable on a periodic basis, no less than +monthly. On a quarterly basis an analysis is made of the adequacy of +our allowance for doubtful accounts and adjustments are made +accordingly. The current allowance is approximately 1.1% of +accounts receivable. For example each additional 1% of accounts +receivable that becomes uncollectible would reduce such balance of accounts +receivable by approximately $18,000. +Income Taxes – +Income +taxes are accounted for under ASC740 "Accounting for Income +Taxes.” ASC740 requires the asset and liability method of accounting +for deferred income taxes. Deferred tax assets and liabilities are +determined based on the difference between the financial statement and tax bases +of assets and liabilities. Deferred tax assets or liabilities at the +end of each period are determined using the tax rate expected to be in effect +when taxes are actually paid or recovered. For example, even though +we have become profitable, we may be unable to utilize our deferred tax asset, +which approximates $8,418,000 at December 31, 2009. +ASC740 +also requires that a valuation allowance be established when it is more likely +than not that all or a portion of a deferred tax asset will not be +realized. A review of all available positive and negative evidence +needs to be considered, including a company’s current and past performance, the +market environment in which the company operates, length of carryback and +carryforward periods and existing contracts that will result in future +profits. +Forming a +conclusion that a valuation allowance is not needed is difficult when there is +negative objective evidence such as cumulative losses in recent +years. Cumulative losses weigh heavily in the overall +assessment. As a result, we determined that it was appropriate to +establish a valuation allowance for the full amount of our deferred tax +assets. +ASC740 +also prescribes a comprehensive model for recognizing, measuring, presenting and +disclosing in the consolidated financial statements tax positions taken or +expected to be taken on a tax return, including a decision whether to file or +not to file in a particular jurisdiction. +The +calculation of our tax liabilities involves the inherent uncertainty associated +with the application of complex tax laws. We are subject to examination by +various taxing authorities. We believe that as a result of our losses sustained +to date, any examination would result in a reduction of our net operating losses +rather than a tax liability. As such, we have not provided for +additional taxes estimated under ASC740, Accounting for Uncertainty in Income +Taxes. +The above +listing is not intended to be a comprehensive list of all of our accounting +policies. In many cases, the accounting treatment of a particular +transaction is specifically dictated by accounting principles, generally +accepted in the United States of America, with no need for management’s judgment +in their application. There are also areas in which management’s +judgment in selecting any viable alternative would not produce a materially +different result. See our audited financial statements and notes +thereto which contain accounting policies and other disclosures required by +accounting principles generally accepted in the United States of +America. +ITEM +8. +FINANCIAL +STATEMENTS AND SUPPLEMENTARY DATA +The +Consolidated Financial Statements and schedules that constitute Item 8 are +attached at the end of this Annual Report on Form 10-K. An index to +these Financial Statements and schedules is also included on page F-1 of this +Annual Report on Form 10-K. +ITEM +9. +CHANGES +IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL +DISCLOSURE. +There +have been no disagreements, or transactions or events similar to those which +involved such disagreements or reportable events, with former accountants on any +matter of accounting principles or practices, financial statement disclosure or +auditing scope or procedure, which disagreements, if not resolved to the +satisfaction of the former accountant, would have caused it to make reference to +the subject matter disagreements in connection with any of its +reports. +33 +ITEM +9A. +CONTROLS +AND PROCEDURES +(a) Disclosure +Controls and Procedures. Under the supervision and with the +participation of our senior management, consisting of our chief executive +officer and our chief financial officer, we conducted an evaluation of the +effectiveness of the design and operation of our disclosure controls and +procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities +Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the +period covered by this report (the "Evaluation Date"). Based on that +evaluation, the Company’s management, including our chief executive officer and +chief financial officer, concluded that as of the Evaluation Date our disclosure +controls and procedures were effective to ensure that information required to be +disclosed by us in the reports that we file under the Exchange Act is recorded, +processed, summarized and reported within the time periods specified in SEC +rules and forms. Our disclosure controls and procedures include, +without limitation, controls and procedures designed to ensure that information +required to be disclosed by us in our Exchange Act reports is accumulated and +communicated to our management, including our chief executive officer and chief +financial officer, as appropriate to allow timely decisions regarding required +disclosure. +Management's +Annual Report on Internal Control Over Financial Reporting. The +Company's management is responsible for establishing and maintaining an adequate +system of internal control over financial reporting (as defined in Exchange Act +Rule 13a-15(f)). Our internal control over financial reporting is a +process, under the supervision of our chief executive officer and chief +financial officer, designed to provide reasonable assurance regarding the +reliability of financial reporting and the preparation of financial statements +for external purposes in accordance with generally accepted accounting +principles in the United States. These internal controls over +financial reporting processes include policies and procedures that: +(1) +Pertain +to the maintenance of records that in reasonable detail accurately and +fairly reflect the transactions and dispositions of the assets of the +Company; +(2) +Provide +reasonable assurance that transactions are recorded as necessary to permit +preparation of financial statements in accordance with generally accepted +accounting principles, and that receipts and expenditures of the Company +are being made only in accordance with authorizations of management and +directors of the Company; and +(3) +Provide +reasonable assurance regarding prevention or timely detection of +unauthorized acquisition, use or disposition of the Company's assets that +could have a material effect on the financial +statements. +Because +of its inherent limitations, internal control over financial reporting may not +prevent or detect misstatements. Therefore, even those systems +determined to be effective can provide only reasonable assurance of achieving +their control objectives. +In +evaluating the effectiveness of our internal control over financial reporting, +our management used the criteria set forth by the Committee of Sponsoring +Organizations of the Treadway Commission (COSO) in Internal Control - Integrated +Framework. Based on this evaluation, our management concluded that +our internal control over financial reporting was effective as of +December 31, 2009. +This +annual report does not include an attestation report of our registered public +accounting firm regarding internal control over financial +reporting. Management's report was not subject to attestation by our +registered public accounting firm pursuant to temporary rules of the Securities +and Exchange Commission that permit the Company to provide only management's +report in this annual report. +(b) Changes +in Internal Control over Financial Reporting. There were no changes +in our internal control over financial reporting identified in connection with +the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the +Exchange Act that occurred during the Company’s last fiscal quarter of the +period covered by this report that have materially affected, or are reasonably +likely to materially affect, our internal control over financial +reporting. +ITEM +9B. +OTHER +INFORMATION +Not +applicable. +34 +PART +III +ITEM +10. +DIRECTORS, +EXECUTIVE OFFICERS AND CORPORATE +GOVERNANCE +Directors +and Executive Officers +Lawrence A. Siebert (53), +President, Chief Executive Officer and Director. Mr. Siebert was +appointed President of Chembio Diagnostics, Inc. and a member of our board of +directors upon consummation of the merger. Mr. Siebert has been +Chairman of Chembio Diagnostic Systems Inc. for approximately thirteen years and +its President since May 2002. Mr. Siebert’s background is in private +equity and venture capital investing. From 1982 to 1991, Mr. Siebert +was associated with Stanwich Partners, Inc, which during that period invested in +middle market manufacturing and distribution companies. From 1992 to +1999, Mr. Siebert was an investment consultant and business broker with Siebert +Capital Corp. and Siebert Associates LLC, and was a principal investor in a +privately held test and measurement company which was sold in +2002. Mr. Siebert received a JD from Case Western Reserve University +School of Law in 1981 and a BA with Distinction in Economics from the University +of Connecticut in 1978. Mr. Siebert as president and CEO is an +integral part of the Chembio management team. His experience in the +rapid test field and financing markets made him an excellent candidate for +serving on the board and as its chairman. +Richard J. Larkin (53), Chief +Financial Officer. Mr. Larkin was appointed as Chief Financial +Officer of Chembio Diagnostics, Inc. upon consummation of the +merger. Mr. Larkin oversees our financial activities and information +systems. Mr. Larkin has been the Chief Financial Officer of Chembio +Diagnostic Systems Inc. since September 2003. Prior to joining +Chembio Diagnostic Systems Inc., Mr. Larkin served as CFO at Visual Technology +Group from May 2000 to September 2003, and also led their consultancy program +that provided hands-on expertise in all aspects of financial service, including +the initial assessment of client financial reporting requirements within an Enterprise Resource +Planning (Manufacturing) environment through training and +implementation. Prior to joining VTG, he served as CFO at Protex +International Corporation from May 1987 to January 2000. Mr. Larkin +holds a BBA in Accounting from Dowling College and is a member of the American +Institute of Certified Public Accountants. +Javan Esfandiari (43), Executive VP of Research +and Development. Mr. Esfandiari joined Chembio Diagnostic Systems, +Inc, in 2000. Mr. Esfandiari co-founded, and became a co-owner of +Sinovus Biotech AB where he served as Director of Research and Development +concerning lateral flow technology until Chembio Diagnostic Systems Inc. +acquired Sinovus Biotech AB in 2000. From 1993 to 1997, Mr. +Esfandiari was Director of Research and Development with On-Site +Biotech/National Veterinary Institute, Uppsala, Sweden, which was working in +collaboration with Sinovus Biotech AB on development of veterinary lateral flow +technology. Mr. Esfandiari received his B.Sc. in Clinical Chemistry +and his M. Sc. in Molecular Biology from Lund University, Sweden. He +has published articles in various veterinary journals and has co-authored +articles on tuberculosis serology with Dr. Lyashchenko. +Richard Bruce (56), Vice +President, Operations. Mr. Bruce was hired in April 2000 as Director of +Operations. He is responsible for manufacturing, maintenance, inventory, +shipping, receiving, and warehouse operations. Prior to joining +Chembio Diagnostic Systems Inc., he held director level positions at Wyeth +Laboratories from 1984 to 1993. From 1993 to 1998, he held various management +positions in the Operations department at Biomerieux. From 1998 to +2000, he held a management position at V.I. Technologies. Mr. Bruce +has over thirty years of operations management experience with Fortune 500 +companies in the field of in-vitro diagnostics and blood +fractionation. Mr. Bruce received his BS in Management from National +Louis University in 1997. +Tom Ippolito (47), VP of +Regulatory Affairs, QA and QC. Mr. Ippolito joined Chembio in June +2005. He has over twenty years experience with in vitro diagnostics for +infectious diseases, protein therapeutics, vaccine development, Process +Development, Regulatory Affairs and Quality Management. Over the years, Mr. +Ippolito has held Vice President level positions at Biospecific Technologies, +Corp. from 2000 - 2005, Director level positions in Quality Assurance, Quality +Control, Process Development and Regulatory Affairs at United Biomedical, Inc. +from 1987 - 2000. Mr. Ippolito is the Course Director for “drug development +process” and “FDA Regulatory Process” for the BioScience Certificate Program at +the New York State University of Stony Brook, a program he has been a part of +since its inception in 2003. +Dr. Gary Meller (59), +Director. Dr. Meller was elected to our Board of Directors on March +15, 2005, and currently serves on the Company’s Audit, Compensation and +Nominating and Corporate Governance Committees, including as Chairman of the +Compensation Committee. Dr. Meller has been the president of +CommSense Inc., a healthcare business development company, since +2001. CommSense Inc. works with clients in Europe, Asia, North +America, and the Middle East on medical information technology, medical records, +pharmaceutical product development and financing, health services operations and +strategy, and new product and new market development. From 1999 until +2001 Dr. Meller was the executive vice president, North America, of NextEd Ltd., +a leading internet educational services company in the Asia Pacific +region. Dr. Meller also was a limited partner and a member of the +Advisory Board of Crestview Capital Master LLC, which was our largest +stockholder. Dr. Meller is a graduate of the University of New Mexico School of +Medicine and has an MBA from the Harvard Business School. Dr. +Meller’s experience in the medical field both domestic and foreign (especially +his experience with CommSense Inc.) as well as his financing experience made him +an excellent candidate for serving on the board. +35 +Kathy Davis (53), +Director. Ms. Davis was elected to the Company’s Board of Directors +in May 2007, and currently serves on the Company’s Audit, Compensation and +Nominating And Corporate Governance Committees, including as Chairman of each of +the Audit Committee and the Nominating And Corporate Governance +Committee. Since January 2007, Ms. Davis has been the owner of Davis +Design Group LLC, a company that provides analytical and visual tools for public +policy design. Previously, from February 2005 to December 2006, she served +as the Chief Executive Officer of Global Access Point, a start up company with +products for data transport, data processing, and data storage network and hub +facilities. From October 2003 to January 2005, Ms. Davis was Lieutenant +Governor of the State of Indiana, and from January 2000 to October 2003 was +Controller of the City of Indianapolis. From 1989 to 2003, Ms. Davis held +leadership positions with agencies and programs in the State of Indiana +including State Budget Director, Secretary of Family & Social Services +Administration, and Deputy Commissioner of Transportation. From 1982 to 1989 Ms. +Davis held increasingly senior positions with Cummins Engine, where she managed +purchasing, manufacturing, engineering, and assembly of certain engine product +lines. Ms. Davis also led the startup of and initial investments by a $50 +million Indiana state technology fund, serves on the not-for-profit boards of +Noble of Indiana, University of Evansville Institute of Global Enterprise, +Purdue College of Science Dean’s Leadership Council and Indiana University +School of Public and Environmental Affairs Dean’s Advisory Council. She has a +Masters of Business Administration from Harvard Business School and a Bachelor +of Science in Mechanical Engineering from the Massachusetts Institute of +Technology. Ms. Davis has varied experience in business, political +and financial areas made her an excellent candidate for serving on the +board. +Section +16(a) Beneficial Ownership Reporting Compliances +Section +16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), +requires the Company’s directors, executive officers and beneficial owners of +more than 10% of the Company’s common stock to file with the Securities and +Exchange Commission initial reports of ownership and reports of changes in +ownership of common stock and other equity securities of the +Company. The Company believes that during the year ended December 31, +2009, each person who was an officer, director and beneficial owner of more than +10% of the Company’s common stock complied with all Section 16(a) filing +requirements, except for the following: (i) one Form 4 for Gary Meller +filed on October 30, 2009 that covered two reports and three transactions that +were not reported on a timely basis; and (ii) one Form 4 for Lawrence Siebert +filed on October 30, 2009 that covered one report and seven transactions; (iii) +one Form 4 for Richard Larkin filed on October 30, 2009 that covered one report +and seven transactions; (iv) one Form 4 for Katherine Davis that covered one +report and two transactions; and (iv) one Form 4 for Javan Esfandiari that +covered one report and eleven transactions. +Code +of Ethics +The +Company has adopted a code of ethics that applies to its principal executive +officer, principal financial officer, principal accounting officer, controller, +and persons performing similar functions. A copy of the Company’s +code of ethics is available on the Company’s website at +www.chembio.com. +Identification +of Audit Committee; Audit Committee Financial Expert +The +Company’s board of directors has established an audit +committee. Katherine L. Davis and Dr. Gary Meller each serves on the +audit committee, with Ms. Davis serving as chairman. The Company’s +board of directors has determined that Ms. Davis is an audit committee financial +expert and is independent. +36 +ITEM +11. EXECUTIVE +COMPENSATION +The +following table summarizes all compensation recorded by the Company in each of +the last two completed fiscal years for our principal executive officer, our two +most highly compensated executive officers other than our principal executive +officer whose annual compensation exceeded $100,000. +Name +/ +Principal +Position +Year +Salary 1 +($) +Bonus 2 +($) +Option +Awards 3 +($) +Stock +Awards +($) +All +Other Compensation 5 +($) +Total +($) +Lawrence +A. Siebert 4 +2009 +$ 265,000 +$ 110,200 +$ 37,950 +$ - +$ 7,200 +$ 420,350 +CEO +2008 +265,000 +26,000 +36,695 +- +8,267 +335,962 +Javan +Esfandiari +2009 +$ 230,192 +$ 29,400 +$ 28,200 +$ 5,000 +$ 4,883 +$ 297,675 +VP-R&D +2008 +215,692 +16,000 +45,297 +28,702 +5,872 +311,563 +Tom +Ippolito +2009 +$ 181,500 +$ 35,600 +$ 21,150 +$ - +$ 140 +$ 238,390 +VP-Regulatory +2008 +173,631 +12,000 +8,129 +- +1,708 +195,468 +1 Salary +is total base salary. +2 Bonuses +earned in 2009 were partially based on reaching certain objectives, which +included revenue dollar levels and operating profit levels, additional amounts +earned were discretionary. Bonuses earned in 2008 were paid solely on +a discretionary basis, and not pursuant to any bonus plan. +3 The estimated +fair value of any option or common stock granted was determined in accordance +with ASC 718, "Share-Based Payment". +4 Mr. +Siebert also serves as a director on the Company’s board of +directors. Mr. Siebert does not receive any compensation for this +director role. +5 Other +compensation includes an employer match to 401(K) contributions and car +allowances where applicable. +Employment +Agreements +Mr. +Siebert. Effective May 11, 2009, the Company’s Board of +Directors approved the Company’s extension of the June 15, 2006 employment +agreement (the “Employment Agreement”) with Lawrence A. Siebert, the Company’s +President and Chief Executive Officer, for an additional three-year +term. On June 15, 2006, Mr. Siebert and the Company entered into an +Employment Agreement, effective May 10, 2006, which was to terminate on May +10, 2008, extended in 2008 to May 10, 2009. Pursuant to the +Employment Agreement, Mr. Siebert serves as the President and Chief Executive +Officer of the Company and received an initial salary of $240,000 per year, +which had been increased to $265,000 per year until Mr. Siebert agreed to a 15 +percent reduction, to $225,000, effective January 19, 2009. Mr. +Siebert’s salary was restored to $265,000 per annum effective in July +2009. Mr. Siebert also is eligible for a bonus of up to 50% of his +salary, consisting of (i) a bonus of up to 25% of his salary that is at the +complete discretion and determination of the board of directors, and (ii) a +bonus of up to an additional 25% of his salary that will be determined based +upon revenue and earnings performance criteria established each year by the +board of directors. Mr. Siebert is eligible to participate in any +profit sharing, stock option, retirement plan, medical and/or hospitalization +plan, and/or other benefit plans except for disability and life insurance that +the Company may from time to time place in effect for the Company’s executives +during the term of Mr. Siebert’s employment agreement. If Mr. +Siebert’s Employment Agreement is terminated by the Company without cause, or if +Mr. Siebert terminates his Employment Agreement for a reasonable basis, +including within 12 months of a change in control, the Company is required to +pay as severance Mr. Siebert’s salary for six months. Mr. Siebert has +agreed for a period of two years after the termination of his employment with +the Company not to induce customers, agents, or other sources of distribution of +the Company’s business under contract or doing business with the Company to +terminate, reduce, alter, or divert business with or from the +Company. The terms of the extended May 11, 2009 and May 11, 2008 +Employment Agreements are identical to the June 15, 2006 Employment Agreement, +except that under the May 11, 2008 extended Employment Agreement, Mr. Siebert +received additional consideration in the form of incentive stock options to +purchase 250,000 shares of the Company’s common stock exercisable at $0.13 per +share, which was the closing price of the Company's common stock on June 3, +2008. The incentive stock options are immediately exercisable and +they expire on the June 3, 2013. +37 +Mr. Esfandiari. The +Company entered into an employment agreement dated March 4, 2010, and to be +effective March 5, 2010 (the "Employment Agreement"), with Mr. Esfandiari +to continue as the Company's Senior Vice +President of Research and +Development for +an additional term of three years. Mr. Esfandiari's salary under the +Employment Agreement is $245,000 for the first year, $255,000 for the second +year, and $265,000 for the final +year. Mr. Esfandiari is eligible for a cash bonus of up to 50% of his +base salary for each respective year, consisting of (i) a cash bonus of up to +30% of his calendar year base salary based on the performance of the Company's +Dual Path Platform Technology, which is directly related to certain annual +revenue targets budgeted by management of the Company; (ii) a cash bonus of up +to 10% of his calendar year base salary based on the attainment of certain +specific research and development objectives, as determined by the Board, and +(iii) a cash bonus of up to 10% of his calendar year base salary that is at the +complete discretion and determination of the board of directors. +The Company also granted Mr. +Esfandiari, pursuant to the Company's 2008 Stock Incentive Plan, +incentive stock options to purchase 300,000 +shares of the Company's common stock. The price per share of these options is +equal to the fair market value of the Company's common stock as of the close of +the market on March 5, 2010, which is the date on which the Agreement was +effective. Of these stock options to purchase 100,000 shares vest on the +effective date, options to purchase an additional 100,000 shares of the stock +options vested on the second anniversary of the Employment Agreement, and +options to purchase an additional 100,000 shares of the stock options vested on +the third anniversary of the Employment Agreement. Mr. Esfandiari is +eligible to participate in any profit sharing, stock option, retirement plan, +medical and/or hospitalization plan, and/or other benefit plans except for +disability and life insurance that the Company may from time to time place in +effect for the Company’s executives during the term of Mr. Esfandiari’s +employment agreement. If Mr. Esfandiari’s employment agreement is terminated by +the Company without cause, or if Mr. Esfandiari terminates his employment +agreement for a reasonable basis, as defined in the Employment Agreement +including within 12 months of a change in control, the Company is required to +pay as severance Mr. Esfandiari’s salary for twelve months. +Mr. +Ippolito does not have an employment contract with the Company. +Executive +Bonus Plan +The +Company has established a bonus plan for its executives who do not have a +contract. For the fiscal year ended December 31, 2010, there were +three executives eligible for this bonus plan. Each executive can +earn up to 25% of that executive’s salary in the form of a +bonus. Half of the amount, or 12.5%, is determined by the +Compensation Committee in its discretion, and the other half is subject to the +Company’s attaining certain objectives based on revenue and operating profit +levels for the fiscal year for which the bonus is paid. The plan, +during 2009, called for a sliding percentage of the executive’s salary, from +zero to 6.25% for attaining 85% to 100% of revenue goals, and from zero to 6.25% +of the executive’s salary for attaining between zero percent to 150% of the +designated operating profit goals. The Company achieved 98.3% of its +revenue goals for 2009, resulting in a bonus of 5.5% of each executive’s salary, +and achieved greater than 150% of its operating profit goal, resulting in a +bonus of 6.25% of salary, for a total of 11.75% of salary. In +addition, the Compensation Committee approved approximately 8% of salary in +discretionary bonuses for the subject executives, bringing the total bonus to +approximately 20% of salary. Goals for 2010 have not yet been +established. +38 +OUTSTANDING +EQUITY AWARDS AT FISCAL YEAR-END 2009 +Option +Awards +Stock +Awards +Name +Number +of Securities Underlying Unexcercised Options Excerciseable +(#) +Number +of Securities Underlying Unexcercised Options Unexcersable +(#) +Option +Exercise Price +($) +Option +Expiration Date +Option +Vesting Date +Number +of Shares of Stock That Have Not Vest +(#) +Market +Value of Shares of Stock That Have Not Vested +($) +Foot- +note +Lawrence +A. Siebert +133,333 +0.13 +5/6/2014 +5/6/2012 +5 +133,333 +0.13 +5/6/2014 +5/7/2011 +5 +133,333 +0.13 +5/6/2014 +5/6/2010 +5 +250,000 +0.13 +6/3/2013 +6/3/2008 +3 +75,000 +0.22 +2/15/2013 +2/15/2008 +2 +50,000 +0.13 +5/28/2011 +1/1/2007 +1, +4 +50,000 +0.13 +5/28/2011 +4/17/2006 +1, +4 +10,000 +0.13 +5/4/2011 +4/17/2006 +4 +50,000 +0.13 +5/4/2011 +5/5/2004 +4 +Javan +Esfandiari +100,000 +0.13 +5/6/2014 +5/6/2012 +5 +100,000 +0.13 +5/6/2014 +5/7/2011 +5 +100,000 +0.13 +5/6/2014 +5/6/2010 +5 +100,000 +0.13 +4/23/2012 +3/5/2009 +1, +4 +100,000 +0.13 +4/23/2012 +3/5/2008 +1, +4 +60,000 +0.22 +2/15/2013 +2/15/2008 +2 +25,000 +0.13 +5/28/2011 +5/28/2007 +4 +100,000 +0.13 +4/23/2012 +4/23/2007 +1, +4 +18,750 +0.13 +3/24/2011 +1/1/2007 +4 +25,000 +0.13 +5/17/2010 +1/1/2007 +4 +25,000 +0.13 +5/28/2011 +4/17/2006 +1, +4 +25,000 +0.13 +5/28/2011 +4/17/2006 +1, +4 +5,000 +0.13 +5/4/2011 +4/17/2006 +4 +25,000 +0.13 +5/17/2010 +4/17/2006 +4 +18,750 +0.13 +3/24/2011 +3/24/2006 +4 +30,000 +0.13 +5/4/2011 +5/5/2004 +4 +Tom +Ippolito +75,000 +0.13 +5/6/2014 +5/6/2012 +5 +75,000 +0.13 +5/6/2014 +5/7/2011 +5 +75,000 +0.13 +5/6/2014 +5/6/2010 +5 +50,000 +0.22 +2/15/2013 +2/15/2008 +2 +15,000 +0.13 +3/24/2011 +3/24/2006 +4 +1 Stock issued in connection +with an employment contract and under the 1999 Stock Option Plan. +2 On February 15, 2008 the +Company granted options under the 1999 Stock Option Plan. +3 Options issued in connection +with an employment contract and under the 2008 Stock Incentive +Plan. +4 On May 7, 2009, the +Compensation Committee of the Company reduced, to $0.13 per share, the exercise +price of each outstanding employee option that was issued under the 1999 Equity +Incentive Plan (the “1999 Plan”) for which the exercise price was greater than +$0.44 per share of the Company’s common stock. There was no other +change made to the terms of the stock options other than the reduction in the +exercise price. A total of 1,036,750 options were affected and the fair value +difference of the options before and after the reduction was $31,660 and was +expensed in the three months ended June 30, 2009. +5 On May 7, 2009 in accordance +with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted +certain employees of the Company, options to purchase an aggregate of 2,925,000 +shares of the Company’s common stock. The exercise price for these +options is equal to $0.13 per share. The options become exercisable +in thirds on the first, second and third anniversaries of the date of the +grant. Each option granted will expire and terminate, if not +exercised sooner, upon the earlier to occur of (a) 30 days after termination of +the employee’s employment with the Company or (b) the fifth anniversary of the +date of grant. The fair value of these options is being amortized +over the vesting life of the options. +39 +DIRECTOR +COMPENSATION +Name +Fees +Earned or Paid in Cash +($) 1 +Option +Awards +($) 2 +Total +($) +Katherine +L. Davis +$ +29,500 +$ +31,950 +$ +61,450 +Gary +Meller +26,500 +$ +31,950 +58,450 +James +D. Merselis 3 +1,000 +- +1,000 +1 Fees earned or paid in cash represents +a yearly fee and fees for meeting expenses: (a) Ms. Davis received an $18,000 +annual fee as a member of the board of directors, a $2,500 annual fee as audit +committee chairman and $9,000 in meeting fees paid during 2009; (b) Mr. Meller +received an $18,000 annual fee as a member of the board of directors, and $8,500 +in meeting fees; (d) Mr. Merselis received $1,000 in meeting +fees. +2 Each outside member of the board of +directors is granted, once every five years, the right to purchase 375,000 +shares of the company’s common stock with an exercise price equal to the market +price on the date of the grant as part of their annual compensation. One-fifth +of these options are exercisable on the date of grant, one-fifth become +exercisable on the first anniversary of the date of grant, and additional +one-fifths become exercisable on the second through fourth anniversary of the +date of grant. The fair value of options at the date of grant was +estimated using the Black-Scholes option pricing model. +3 Mr. +Merselis resigned from our Board of Directors on February 9, 2009. +Director +Compensation +All +non-employee directors are paid an $18,000 annual retainer, semi-annually, and +once every five years, on the date of the annual meeting of stockholders that +directors are elected or re-elected (every 5 years), receive stock options to +acquire 375,000 shares of the Company's common stock, with an exercise price +equal to the market price on the date of the grant. Stock options to +acquire 75,000 shares become exercisable on the date of grant, and options to +acquire an additional 75,000 shares become exercisable on the date of each of +the four succeeding annual meetings of stockholders if and to the extent that +the non-employee director is reelected as a director at each such annual +meeting. The audit committee chairman is paid an annual retainer of +$2,500, paid semi-annually. In addition, the non-employee directors +are paid $1,000 in cash for each board of directors' meeting attended, and paid +$500 in cash for each telephonic board of directors meeting. The +non-employee directors who are members of a committee of the board of directors +are paid $500 in cash for each committee meeting attended, or $750 in cash for +each committee meeting attended if that non-employee director is the committee +chairman. +Compensation +Committee Interlocks and +Insider Participation +No +executive officer of the Company served as a member of the Board of any other +public company during the year ended December 31, 2009. No member of the +Compensation Committee serves as an executive officer of any other public +company during the year ended December 31, 2009. No interlocking relationship +exists between the members of our Compensation Committee and the Board or +compensation committee of any other company. +40 +ITEM +12. +SECURITY +OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED +STOCKHOLDER MATTERS +The +following table sets forth certain information regarding the beneficial +ownership of our common stock by each person or entity known by us to be the +beneficial owner of more than 5% of the outstanding shares of common stock, each +of our directors and each of our “named executive officers” and all of our +directors and executive officers as a group as of March 1, 2010. +Name +and Address of Beneficial Owner +Amount +and Nature of Beneficial Owner +Percent +of Class +Siebert, +Lawrence (1) +3661 +Horseblock Road +Medford, +NY 11763 +6,933,615 +11.10 +% +Esfandiari, +Javan (2) +3661 +Horseblock Road +Medford, +NY 11763 +777,573 +1.24 +% +Larkin, +Richard (3) +3661 +Horseblock Road +Medford, +NY 11763 +267,672 +0.43 +% +Ippolito, +Tom (4) +3661 +Horseblock Road +Medford, +NY 11763 +65,000 +0.10 +% +Bruce, +Richard (5) +3661 +Horseblock Road +Medford, +NY 11763 +135,075 +0.22 +% +Meller, +Gary (6) +3661 +Horseblock Road +Medford, +NY 11763 +534,300 +0.86 +% +Davis, +Katherine L. (7) +3661 +Horseblock Road +Medford, +NY 11763 +150,650 +0.24 +% +GROUP (8) +8,863,585 +13.89 +% +Inverness +Medical Innovations, Inc . +51 +Sawyer Road, Suite 200 +Waltham, +MA 02453 +5,367,840 +8.66 +% +Crestview +Capital Offshore Fund, Inc. +95 +Revere Drive, Suite A +Northbrook, +IL 60062 +3,356,040 +5.41 +% +Beneficial +ownership is determined in accordance with the Rule 13d-3(a) of the Securities +Exchange Act of 1934, as amended, and generally includes voting or investment +power with respect to securities. Except as subject to community +property laws, where applicable, the person named above has sole voting and +investment power with respect to all shares of our common stock shown as +beneficially owned by him. +The +beneficial ownership percent in the table is calculated with respect to the +number of outstanding shares (61,944,901) of the Company's common stock +outstanding as of March 17, 2009. Each stockholder's ownership is +calculated as the number of shares of common stock owned plus the number of +shares of common stock into which any preferred stock, warrants, options or +other convertible securities owned by that stockholder can be converted within +60 days. +The term +“named executive officer” refers to our principal executive officer, our two +most highly compensated executive officers other than the principal executive +officer who were serving as executive officers at the end of 2008, and two +additional individuals for whom disclosure would have been provided but for the +fact that the individuals were not serving as executive officers of the Company +at the end of 2008. +41 +(1) +Includes +485,000 shares issuable upon exercise of options exercisable within 60 +days. Does not include 400,000 shares issuable upon exercise of +options that are not exercisable within the next 60 +days. +(2) +Includes +557,500 shares issuable upon exercise of options exercisable within 60 +days. Does not include 300,000 shares issuable upon exercise of +options that are not exercisable within the next 60 +days. +(3) +Includes +212,500 shares issuable upon exercise of options exercisable within 60 +days. Does not include 275,000 shares issuable upon exercise of +options that are not exercisable within the next 60 +days. +(4) +Includes +65,000 shares issuable upon exercise of options exercisable within 60 +days. Does not include 225,000 shares issuable upon exercise of +options that are not exercisable within the next 60 +days. +(5) +Includes +135,000 shares issuable upon exercise of options exercisable within 60 +days. Does not include 225,000 shares issuable upon exercise of +options that are not exercisable within the next 60 +days. +(6) +Includes +234,000 shares issuable upon exercise of options exercisable within 60 +days. Does not include 300,000 shares issuable upon exercise of +options that are not exercisable within the next 60 +days. +(7) +Includes +150,650 shares issuable upon exercise of options exercisable within 60 +days. Does not include 300,000 shares issuable upon exercise of options +that are not exercisable within the next 60 +days. +(8) +Includes +footnotes (1)-(8) +. +Equity +Compensation Plan Information +Combined +Equity Compensation Plans - Information as of December 31, +2009 +Plan +Category +Number +of Securities to be Issued Upon Exercise of Outstanding Options, Warrants +and Rights +(a) +Weighted-Average +Exercise Price of Outstanding Options, Warrants and Rights +(b) +Number +of Securities Remaining Available for Future Issuance under Equity +Compensation Plans (Excluding Securities Reflected in Column (a) +(c) +Equity +compensation plans approved by security holders 1 +5,586,900 +1 +$ +0.152 +1,821,350 +Equity +compensation plans not approved by security holders +-- +-- +-- +Total +5,586,900 +$ +0.152 +1,821,350 +1 The +“Number of Securities to be Issued Upon Exercise of Outstanding Warrants and +Rights” represents 2,408,250 from the 1999 Stock Option Plan and +3,178,650 under the 2008 Stock Incentive Plan. The “Number of +Securities Remaining Available for Future Issuance Under Equity Compensation +Plans” represents shares issuable under the 2008 Stock Incentive +Plan. +42 +ITEM +13. +CERTAIN +RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR +INDEPENDENCE. +The +executive officers of the Company are as follows: Lawrence A. Siebert, president +and chairman of the board of directors of the Company, Richard J. Larkin, chief +financial officer of the Company, and Javan Esfandiari, executive vice president +of Research and Development of the Company. +On May 7, +2009, the Compensation Committee of the Company reduced, to $0.13 per share, the +exercise price of each outstanding employee option that was issued under the +1999 Equity Incentive Plan (the “1999 Plan”) for which the exercise price was +greater than $0.44 per share of the Company’s common stock. There was +no other change made to the terms of the stock options other than +the reduction in the exercise price. A total of 1,036,750 options were +affected. Mr. Siebert, Mr. Esfandiari and Mr. Larkin had options to +purchase common stock that were so reduced of 160,000, 497,500 and 137,500, +respectively. +In +addition, on May 7, 2009 in accordance with the terms of the Company’s 2008 +Stock Incentive Plan, the Company granted certain employees of the Company, +options to purchase an aggregate of 2,925,000 shares of the Company’s common +stock. The exercise price for these options is equal to $0.13 per +share. The options become exercisable in thirds on the first, second +and third anniversaries of the date of the grant. Each option granted will +expire and terminate, if not exercised sooner, upon the earlier to occur of (a) +30 days after termination of the employee’s employment with the Company or (b) +the fifth anniversary of the date of grant. Mr. Siebert, Mr. Esfandiari +and Mr. Larkin received options to purchase common stock of 400,000, 300,000 and +275,000, respectively. +During +the quarter ended December 31, 2008, Inverness notified the Company that +Inverness had entered into a contract with Bio-Rad Laboratories, Inc. +(“Bio-Rad”) for royalties on Bio-Rad’s patent for the detection of HIV-2 +antibodies. The agreement also provided for Inverness to pay past +royalties. On June 25, 2009, the Company and Inverness Medical +Innovations, Inc. (Inverness) entered into a letter agreement whereby certain +obligations aggregating approximately $1,010,000 as of December 31, 2008 were +agreed to be paid from future revenues. The obligations include the +Company’s share under its agreements with Inverness for the amount of HIV-2 +royalties that Inverness paid when Inverness entered into an HIV-2 license +agreement with Bio-Rad Laboratories, Inc. of approximately $485,000 and +royalties owed by Chembio on lateral flow licenses to Inverness of approximately +$525,000 as of December 31, 2008. Under the agreement Inverness will retain an +additional 10% of Clearview® HIV 1/2 STAT-PAK® net sales and 5% of Clearview® +Complete HIV 1/2 net sales until these obligations are +extinguished. The approximate aggregate balance due is $242,000 +as of December 31, 2009. +Director +Independence +Our +common stock trades on the OTC Bulletin Board. As such, we are not +currently subject to corporate governance standards of listed companies, which +require, among other things, that the majority of the board of directors be +independent. +We are not currently subject to +corporate governance standards defining the independence of our directors, and +we have chosen to define an “independent” director in accordance with the NASDAQ +Global Market's requirements for independent directors. Under this +definition, we have determined that Katherine L. Davis currently qualifies as +independent director. We do not list the “independent” definition we +use on our internet website . +43 +ITEM +14. +PRINCIPAL +ACCOUNTANT FEES AND SERVICES +All fees +discussed below were paid to ParenteBeard LLC, except 2008 amounts, which were +paid to Lazar Levine & Felix LLP. In February 2009, Lazar Levine +& Felix LLP merged its practice into Parente Randolph, LLC, which +subsequently changed their name to ParenteBeard LLC. +Audit +Fees +For the +years ended December 31, 2009 and 2008, the Company’s independent accounting +firm billed the Company $100,000 and $136,000, respectively, for fees for the +audit of the Company’s annual financial statements and review of financial +statements included in the Company’s Forms 10-Q and 10-K. +Audit-Related +Fees +For the +years ended December 31, 2009 and 2008, the independent accounting firm, did not +provide the Company with any assurance and related services reasonably related +to the performance of the audit or review of the Company’s financial statements +that are not reported above under “Audit Fees.” +Tax +Fees +For the +years ended December 31, 2009 and 2008, the independent accounting firm billed +the Company $20,000 and $13,500, respectively, for professional services for tax +compliance, tax advice and tax planning. +All +Other Fees +For the +years ended December 31, 2009 and 2008, the independent accounting firm billed +the Company none and $2,500 for fees associated with the preparation and filing +of the Company’s registration statements, responses to SEC comment letters and +other related matters. +Audit +Committee Pre-Approval Policies +The Audit +Committee approves in advance all audit and non-audit services performed by the +independent accounting firm. There are no other specific policies or +procedures relating to the pre-approval of services performed by the independent +accounting firm. +44 +ITEM +15. EXHIBITS, +FINANCIAL STATEMENT SCHEDULES +Number Description +3.1 +Articles +of Incorporation, as amended. (2) +3.2 +Amended +and Restated Bylaws. (1) +4.8 +Form +of Common Stock Warrant issued pursuant to the January 26, 2005 Securities +Purchase Agreement. (7) +4.9 +Amended +Form of Common Stock Warrant issued pursuant to the January 26, 2005 +Securities Purchase Agreement. +4.10 +Registration +Rights Agreement, dated as of January 26, 2005, by and among the +Registrant and the purchasers listed therein. +(9) +4.11 +Form +of Warrant, dated June 29, 2006, issued pursuant to Company and purchasers +of the Company’s Secured +Debentures. (7) +4.12 +Registration +Rights Agreement, dated June 29, 2006. +(3) +4.14 +Registration +Rights Agreement, dated as of September 29, 2006, by and among the +Registrant and the Purchasers listed therein. +(3) +4.15 +Form +of Common Stock Warrant issued pursuant to the Securities Purchase +Agreements dated September 29, 2006 +(5). +4.16 +Amended +Form of Common Stock Warrant issued pursuant to the Securities Purchase +Agreements dated October 5, 2006. +(5) +4.17 +Amended +Form of Common Stock Warrant issued to Placement Agents pursuant to the +October 5, 2005 Securities Purchase Agreement. +(9) +4.18* +Form +of Employee Option Agreement. (9) +4.20 +1999 +Equity Incentive Plan. (11) +4.20 +2008 +Stock Incentive Plan. (12) +10.1* +Employment +Agreement dated June 15, 2006 with Lawrence A. Siebert. +(4) +10.2* +Employment +Agreement dated April 23, 2007 with Javan Esfandiari. +(10) +10.4 +Securities +Purchase Agreement (the “Securities Purchase Agreement”), dated as of +January 26, 2005, by and among the Registrant and the purchasers listed +therein. (7) +10.5 +Amendment +No. 1 to Securities Purchase Agreement, dated as of January 28, 2005 by +and among the Registrant and the purchasers listed therein. +(8) +10.7 +Security +Purchase Agreement, dated June 29, 2006, among the Company and purchasers +of the Company’s Secured Debentures. +(3) +10.11 +Securities +Purchase Agreement (the “Securities Purchase Agreement”), dated as of +September 29, 2006, by and among the Registrant and the Purchasers listed +therein. (5) +10.11 +Securities +Purchase Agreement (the “Securities Purchase Agreement”), dated as of +September 29, 2006, by and among the Registrant and the Purchasers listed +therein. (5) +10.12 +Letter +of Amendment to Securities Purchase Agreements dated as of September 29, +2006 by and among the Registrant and the Purchasers listed therein. +(5) +10.13 +HIV +Barrel License, Marketing and Distribution Agreement, dated as of +September 29, 2006, by and among the Registrant, Inverness and StatSure. +(5) +10.14 +HIV +Cassette License, Marketing and Distribution Agreement, dated as of +September 29, 2006, between the Registrant and Inverness. +(5) +10.15 +Non-Exclusive +License, Marketing and Distribution Agreement, dated as of September 29, +2006, between the Registrant and Inverness. +(5) +10.16 +Joint +HIV Barrel Product Commercialization Agreement, dated as of September 29, +2006, between the Registrant and StatSure. +(5) +14.1 +Ethics +Policy (13) +21 +List +of Subsidiaries. +23.1 +Consent +of ParenteBeard LLC, Independent +Accountants. +31.1 +Certification +of the Chief Executive Officer pursuant to Section 302 of the +Sarbanes-Oxley Act of 2002. +31.2 +Certification +of the Chief Financial Officer pursuant to Section 302 of the +Sarbanes-Oxley Act of 2002. +32 +Certification +of Chief Executive Officer and Chief Financial Officer pursuant to 18 +U.S.C. Section 1350 as adopted pursuant to Section 906 of the +Sarbanes-Oxley Act of 2002. +(1) +Incorporated +by reference to the Registrant’s registration statement on Form SB-2 filed +with the Commission on August 23, 1999 and the Registrant's Forms 8-K +filed on May 14, 2004, December 20, 2007 and April 18, +2008. +(2) +Incorporated +by reference to the Registrant’s annual report on Form 10-KSB filed with +the Commission on March 31, 2005. +(3) +Incorporated +by reference to the Registrant’s Current Report on Form 8-K filed with the +Commission on July 3, 2006. +(4) +Incorporated +by reference to the Registrant’s Current Report on Form 8-K filed with the +Commission on June 21, 2006. +(5) +Incorporated +by reference to the Registrant’s Current Report on Form 8-K filed with the +Commission on October 5, 2006. +(6) +Incorporated +by reference to the Registrant’s registration statement on Form SB-2 filed +with the Commission on June 7, +2004. +(7) +Incorporated +by reference to the Registrant’s Current Report on Form 8-K filed with the +Commission on January 31, 2005. +(8) +Incorporated +by reference to the Registrant’s registration statement on Form SB-2 filed +with the Commission on March 28, +2005. +(9) +Incorporated +by reference to the Registrant’s annual report on Form 10-KSB filed with +the Commission on March 12, 2008. +(10) +Incorporated +by reference to the Registrant’s Current Report on Form 8-K/A filed with +the Commission on May 3, 2007. +(11) +Incorporated +by reference to the Registrant’s definitive proxy statement on Schedule +14A filed with the Commission on May 11, +2005. +(12) +Incorporated +by reference to the Registrant’s definitive proxy statement on Schedule +14A filed with the Commission on April 14, +2008. +(13) +Incorporated +by reference to the Registrant’s annual report on Form 10-KSB filed with +the Commission on March 30, 2006. +(*) +An +asterisk (*) beside an exhibit number indicates the exhibit contains a +management contract, compensatory plan or arrangement which is required to +be identified in this report. +45 +SIGNATURES +In +accordance with Section 13 or 15(d) of the Exchange Act, the registrant has +caused this report to be signed on its behalf by the undersigned, thereunto duly +authorized. +CHEMBIO DIAGNOSTICS, +INC. +Date: March +5, +2010 By +/s/ Lawrence A. +Siebert +Lawrence +A. Siebert +President, +Chief Executive Officer and +Chairman +of the Board +In +accordance with the requirements of the Exchange Act, this report has been +signed below by the following persons on behalf of the registrant and in the +capacities and on the dates indicated. +Signatures +Title +Date +/s/ Lawrence A. +Siebert +Lawrence +A. Siebert +Chief +Executive Officer, President and Chairman Of The Board +(Principal +Executive Officer) +March +5, 2010 +/ s/ +Richard J. Larkin +Richard +J. Larkin +Chief +Financial Officer (Principal Financial & Accounting +Officer) +March +5, 2010 +/s/ Gary +Meller +Dr. +Gary Meller +Director +March +5, 2010 +/s/ Katherine L. +Davis +Katherine +L. Davis +Director +March +5, 2010 +46 +CHEMBIO DIAGNOSTICS, INC. AND +SUBSIDIARY +Index to Consolidated Financial +Statements +—INDEX— +Page(s) +Report +of Independent Registered Public Accounting Firm +F-2 +Consolidated +Financial Statements: +Balance +Sheets +December +31, 2009 and 2008 +F-3 +Statements +of Operations +Years +ended December 31, 2009 and 2008 +F-4 +Statements +of Changes in Stockholders’ Equity +Years +ended December 31, 2009 and 2008 +F-5 +Statements +of Cash Flows +Years +ended December 31, 2009 and 2008 +F-6 +Notes +to Consolidated Financial Statements +F-7 +- F-22 +F-1 +REPORT OF INDEPENDENT +REGISTERED PUBLIC ACCOUNTING FIRM +To The +Board of Directors +Chembio +Diagnostics, Inc. and Subsidiary +Medford, +New York 11763 +We have +audited the accompanying consolidated balance sheets of Chembio Diagnostics, +Inc. and Subsidiary (the “Company”) as of December 31, 2009 and 2008 and the +related consolidated statements of operations, stockholders' equity and cash +flows for each of the two years in the period ended December 31, +2009. These financial statements are the responsibility of the +Company's management. Our responsibility is to express an opinion on these +financial statements based on our audits. +We +conducted our audits in accordance with the standards of the Public Company +Accounting Oversight Board (United States). Those standards require +that we plan and perform the audit to obtain reasonable assurance about whether +the financial statements are free of material misstatement. The +Company is not required to have, nor were we engaged to perform, an audits of +its internal control over financial reporting. Our audit included +consideration of internal control over financial reporting as a basis for +designing audit procedures that are appropriate in the circumstances, but not +for the purpose of expressing an opinion on the effectiveness of the Company's +internal control over financial reporting. Accordingly, we express no +such opinion. An audit also includes examining, on a test basis, +evidence supporting the amounts and disclosures in the financial statements, +assessing the accounting principles used and significant estimates made by +management, as well as evaluating the overall financial statement +presentation. We believe that our audits provides a reasonable basis +for our opinion. +In our +opinion, the financial statements referred to above present fairly, in all +material respects, the consolidated financial position of Chembio Diagnostics, +Inc. and Subsidiary as of December 31, 2009 and 2008, and their consolidated +results of its operations and their cash flows for each of the two years in +the period ended December 31, 2009 in conformity with accounting principles +generally accepted in the United States of America. +PARENTEBEARD +LLC +/s/ PARENTE BEARD LLC +New York, +New York +March 4, +2010 +F-2 +CHEMBIO DIAGNOSTICS, INC. AND +SUBSIDIARY +CONSOLIDATED BALANCE +SHEETS +AS OF +- +ASSETS - +December +31, 2009 +December +31, 2008 +CURRENT +ASSETS: +Cash +and cash equivalents +$ +1,068,235 +$ +1,212,222 +Accounts +receivable, net of allowance for doubtful accounts of $20,000 and $10,301 +for 2009 and 2008, respectively +1,776,327 +809,303 +Inventories +1,555,903 +1,819,037 +Prepaid +expenses and other current assets +266,637 +225,153 +TOTAL +CURRENT ASSETS +4,667,102 +4,065,715 +FIXED ASSETS , net of +accumulated depreciation +580,213 +881,406 +OTHER +ASSETS: +License +agreements, net of current portion +700,000 +940,000 +Deposits +on manufacturing equipment +338,375 +- +Deposits +and other assets +29,560 +27,820 +TOTAL +ASSETS +$ +6,315,250 +$ +5,914,941 +- +LIABILITIES AND STOCKHOLDERS’ EQUITY - +CURRENT +LIABILITIES: +Accounts +payable and accrued liabilities +$ +1,906,163 +$ +2,383,021 +Current +portion of loan payable +9,600 +- +Deferred +research and development revenue +360,833 +- +License +fee payable +875,000 +- +Current +portion of obligations under capital leases +21,536 +18,780 +TOTAL +CURRENT LIABILITIES +3,173,132 +2,401,801 +OTHER +LIABILITIES: +Loan +payable - net of current portion +14,931 +- +Obligations +under capital leases - net of current portion +39,273 +60,808 +License +fee payable - net of current portion +- +875,000 +TOTAL +LIABILITIES +3,227,336 +3,337,609 +COMMITMENTS +AND CONTINGENCIES +STOCKHOLDERS’ +EQUITY: +Preferred +stock – 10,000,000 shares authorized, none outstanding +- +- +Common +stock - $.01 par value; 100,000,000 shares authorized, 61,979,901 and +61,944,901 shares issued and outstanding for 2009 and 2008, +respectively +619,799 +619,449 +Additional +paid-in capital +39,453,522 +39,252,350 +Accumulated +deficit +(36,985,407 +) +(37,294,467 +) +TOTAL +STOCKHOLDERS’ EQUITY +3,087,914 +2,577,332 +TOTAL +LIABILITIES AND STOCKHOLDERS' EQUITY +$ +6,315,250 +$ +5,914,941 +See +accompanying notes to consolidated financial +statements +F-3 +CHEMBIO DIAGNOSTICS, INC. AND +SUBSIDIARY +CONSOLIDATED STATEMENTS OF +OPERATIONS +FOR THE YEARS ENDED +December +31, 2009 +December +31, 2008 +REVENUES: +Net +product sales +$ +12,372,493 +$ +10,355,768 +License +and royalty income +121,896 +- +Research +grant income +1,339,859 +693,803 +TOTAL +REVENUES +13,834,248 +11,049,571 +Cost +of product sales +7,973,843 +7,197,850 +GROSS +PROFIT +5,860,405 +3,851,721 +OPERATING +EXPENSES: +Research +and development expenses +2,883,696 +2,605,343 +Selling, +general and administrative expenses +2,659,382 +3,317,046 +5,543,078 +5,922,389 +INCOME +(LOSS) FROM OPERATIONS +317,327 +(2,070,668 +) +OTHER +INCOME (EXPENSES): +Other +income (expense) +(6,696 +) +95,812 +Interest +income +9,032 +34,403 +Interest +expense +(10,603 +) +(8,317 +) +(8,267 +) +121,898 +INCOME +(LOSS) BEFORE INCOME TAXES +309,060 +(1,948,770 +) +Provision +for income taxes +- +- +NET +INCOME (LOSS) +$ +309,060 +$ +(1,948,770 +) +- +- +Basic +earnings (loss) per share +$ +0.00 +$ +(0.03 +) +Diluted +earnings (loss) per share +$ +0.00 +$ +(0.03 +) +Weighted +average number of shares outstanding, basic +61,946,435 +61,266,594 +- +- +Weighted +average number of shares outstanding, diluted +75,041,932 +61,266,594 +See +accompanying notes to consolidated financial +statements +F-4 +CHEMBIO DIAGNOSTICS, INC. AND +SUBSIDIARY +CONSOLIDATED STATEMENTS OF CHANGES IN +STOCKHOLDERS’ EQUITY +FOR THE YEARS ENDED DECEMBER 31, 2009 AND +2008 +Common +Stock +Additional +Paid in Capital +Accumulated +Deficit +Total +Shares +Amount +Amount +Amount +Amount +Balance +at December 31, 2007 +60,537,534 +$ +605,375 +$ +39,003,148 +$ +(35,345,697 +) +$ +4,262,826 +Warrants +and options: +Excercised +1,407,367 +14,074 +(14,074 +) +- +- +Stock +option compensation +- +- +263,276 +- +263,276 +Net +loss for 2008 +- +- +- +(1,948,770 +) +(1,948,770 +) +Balance +at December 31, 2008 +61,944,901 +619,449 +39,252,350 +(37,294,467 +) +2,577,332 +Warrants +and options: +Excercised +35,000 +350 +4,200 +- +4,550 +Stock +option compensation +- +- +196,972 +- +196,972 +Net +income for 2009 +- +- +- +309,060 +309,060 +Balance +at December 31, 2009 +61,979,901 +$ +619,799 +$ +39,453,522 +$ +(36,985,407 +) +$ +3,087,914 +See +accompanying notes to consolidated financial +statements +F-5 +CHEMBIO DIAGNOSTICS, INC. AND +SUBSIDIARY +CONSOLIDATED STATEMENTS OF CASH +FLOWS +FOR THE YEARS ENDED +December +31, 2009 +December +31, 2008 +INCREASE +(DECREASE) IN CASH AND CASH EQUIVALENTS: +CASH +FLOWS FROM OPERATING ACTIVITIES: +Cash +received from customers +$ +12,871,921 +$ +11,186,608 +Cash +paid to suppliers and employees +(12,618,423 +) +(12,406,921 +) +Interest +received +9,032 +34,403 +Interest +paid +(10,603 +) +(8,317 +) +Net +cash provided by (used in) operating activities +251,927 +(1,194,227 +) +CASH +FLOWS FROM INVESTING ACTIVITIES: +Proceeds +from sale of fixed assets +13,750 +- +Acquisition +of and deposits on fixed assets +(390,738 +) +(397,462 +) +Net +cash used in investing activities +(376,988 +) +(397,462 +) +CASH +FLOWS FROM FINANCING ACTIVITIES: +Proceeds +from option exercises +4,550 +- +Payment +of loan obligation +(4,697 +) +- +Payment +of capital lease obligation +(18,779 +) +(23,458 +) +Net +cash provided by (used in) financing activities +(18,926 +) +(23,458 +) +NET +DECREASE IN CASH AND CASH EQUIVALENTS +(143,987 +) +(1,615,147 +) +Cash +and cash equivalents - beginning of the period +1,212,222 +2,827,369 +Cash +and cash equivalents - end of the period +$ +1,068,235 +$ +1,212,222 +RECONCILIATION +OF NET LOSS TO NET CASH PROVIDED BY (USED IN) OPERATING +ACTIVITIES: +Net +income (loss) +$ +309,060 +$ +(1,948,770 +) +Adjustments: +Depreciation +and amortization +362,338 +345,388 +Provision +for doubtful accounts +9,699 +- +Loss +on sale of fixed asset +6,696 +- +Share +based compensation +198,220 +291,979 +Changes +in assets and liabilities: +Accounts +receivable +(976,723 +) +137,037 +Inventories +263,134 +(365,187 +) +Prepaid +expenses and other assets +(42,732 +) +(10,108 +) +Deposits +and other assets +238,260 +(683,462 +) +Deferred +revenue +360,833 +(43,334 +) +Accounts +payable and accrued expenses +(476,858 +) +207,230 +Licenses +fee payable +- +875,000 +Net +cash provided by (used in) operating activities +$ +251,927 +$ +(1,194,227 +) +Supplemental +disclosures for non-cash investing and financing +activities: +Value +of common stock issued upon cashless warrant exercise +$ +- +$ +14,074 +Purchase +of fixed assets through a loan +29,228 +See +accompanying notes to consolidated financial +statements +F-6 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +NOTE +1—DESCRIPTION OF BUSINESS: +Chembio +Diagnostics, Inc. (the “Company” or “Chembio”) and its subsidiary, Chembio +Diagnostic Systems, Inc., develop, manufacture, and market rapid diagnostic +tests that detect infectious diseases. The Company’s main products are three +rapid tests for the detection of HIV antibodies in whole blood, serum and plasma +samples, two of which were approved by the FDA in 2006; the third is sold for +export only. Rapid HIV tests represented nearly 88% of the Company’s +product revenues in 2009. The Company also has other rapid +tests that together represented approximately 12% of sales in +2009. The Company’s products are sold to medical laboratories +and hospitals, governmental and public health entities, non-governmental +organizations, medical professionals and retail establishments both domestically +and internationally. Chembio’s products are sold under the Company’s STAT PAK®, +SURE CHECK® or DPP® registered trademarks, or under the private labels of its +marketing partners, for example the Clearview® label owned by Inverness Medical +Innovations, Inc., which is the Company’s exclusive marketing partner for its +rapid HIV lateral flow test products in the United States. These +products employ lateral flow technologies that are proprietary and/or licensed +to the Company. All of the Company’s products that are currently +being developed are based on its patented Dual Path Platform (DPP®), which is a +unique diagnostic point-of-care platform that has certain advantages over +lateral flow technology. In 2008 and 2009 to date, the Company has +completed development of its first four products that employ the DPP®, and the +Company has a number of additional products under development that employ the +DPP®. +NOTE +2—SIGNIFICANT ACCOUNTING POLICIES: +(a) +Principles +of Consolidation: +The +consolidated financial statements include the accounts of the Company, and its +wholly owned subsidiary. All intercompany transactions and balances +have been eliminated in consolidation. +(b) +Use +of Estimates: +The +preparation of consolidated financial statements in conformity with accounting +principles generally accepted in the United States requires management to make +assumptions and estimates that affect the reported amounts of assets and +liabilities and disclosure of contingent assets and liabilities at the dates of +the consolidated financial statements and the reported amounts of revenues and +expenses during the reporting periods covered thereby. Actual results could +differ from these estimates. Judgments and estimates of uncertainties are +required in applying the Company’s accounting policies in certain areas. The +following are some of the areas requiring significant judgments and estimates: +determinations of the useful lives of assets, estimates of allowances for +doubtful accounts, cash flow and valuation assumptions in performing asset +impairment tests of long-lived assets, estimates of the realizability of +deferred tax assets and inventory reserves. +(c) +Fair +Value of Financial Instruments: +Fair +values of cash and cash equivalents, accounts receivable, prepaid expenses and +other current assets and accounts payable, loans and accrued expenses reflected +in these financial statements approximate carrying value as these are short-term +in nature. +(d) +Statements +of Cash Flows: +For +purposes of the statements of cash flows the Company considers all highly liquid +investments with an original maturity of three months or less to be cash +equivalents. +F-7 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +(e) +Concentrations +of Credit Risk: +Financial +instruments which potentially subject the Company to concentrations of credit +risk consist principally of temporary cash investments and trade receivables. +The Company places its temporary cash instruments with well-known financial +institutions and, at times, may maintain balances in excess of the $250,000 FDIC +Insurance limit. The Company monitors the credit ratings of the +financial institutions to mitigate this risk. The Company maintains +three accounts with a well established multi-national bank and as of December +31, 2009 had approximately an aggregate of $818,000 above the federally insured +limit. Concentration of credit risk with respect to trade receivables is +principally mitigated by the Company’s ability to obtain letters of credit from +certain foreign customers, and its diverse customer base both in number of +customers and geographic locations. We currently do not require +collateral. +(f) +Inventories: +Inventories, +consisting of material, labor and manufacturing overhead, are stated at the +lower of cost or market. Cost is determined on the first-in, +first-out method. +(g) +Fixed +Assets: +Fixed +assets are stated at cost less accumulated depreciation. Depreciation +is computed using the straight-line method over the estimated useful lives of +the respective assets, which range from three to seven +years. Leasehold improvements are amortized over the useful life of +the asset or the lease term, whichever is shorter. +(h) +License +Agreement: +In +February 2008, the Company entered into a sublicense agreement (see Note 6) for +which it had initially recorded an asset of $1,000,000. This +asset is being expensed over an estimated economic life of ten +years. The current portion of this asset is $100,000 and is reported +in prepaid expenses and other current assets. The long-term portion +as of December 31, 2009 is $700,000 and is reflected in other +assets. +(i) +Impairment +of Long-Lived Assets and Intangible +Assets +In +accordance with ASC 360, "Accounting for the Impairment or Disposal of +Long-Lived Assets", long-lived assets to be held and used are analyzed for +impairment whenever events or changes in circumstances indicate that the related +carrying amounts may not be recoverable. The Company evaluates at +each balance sheet date whether events and circumstances have occurred that +indicate possible impairment. If there are indications of impairment, +the Company uses future undiscounted cash flows of the related asset or asset +grouping over the remaining life in measuring whether the assets are +recoverable. In the event such cash flows are not expected to be +sufficient to recover the recorded asset values, the assets are written down to +their estimated fair value. We believe that the carrying values of +our long-lived tangible and intangible assets were realizable at December 31, +2009. +(j) +Revenue +Recognition: +The +Company recognizes revenue in accordance with Securities and Exchange Commission +Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB +104”). Under SAB 104, revenue is recognized when there is persuasive +evidence of an arrangement, delivery has occurred or services have been +rendered, the sales price is determinable, and collectability is reasonably +assured. Revenue typically is recognized at time of +shipment. Sales are recorded net of discounts, rebates and +returns. +The +Company recognizes income from R&D contracts and grants when +earned. Grants are invoiced after expenses are +incurred. Revenues from projects or grants funded in advance are +deferred until earned. +F-8 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +(k) +Research +and Development: +Research +and development costs are expensed as incurred. +(l) +Stock +Based Compensation: +The +Company’s 2008 Stock Incentive Plan and 1999 Stock Option Plan (“Plans”) +are accounted for in accordance with the recognition and measurement provisions +of ASC 718. ASC 718 requires compensation costs related to share-based payment +transactions, including employee stock options, to be recognized in the +financial statements. In addition, the Company adheres to the guidance set forth +within Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. +107 ("SAB 107"), which provides the Staff's views regarding the interaction +between ASC 718 and certain SEC rules and regulations and provides +interpretations with respect to the valuation of share-based payments for public +companies. See Note 12 for further details. +(m) +Income +Taxes: +The +Company accounts for income taxes under the provisions of ASC 740 "Accounting +for +Income +Taxes". Under ASC 740, deferred tax assets and liabilities are +determined based on the difference between the financial statement carrying +amounts and the tax bases of assets and liabilities using enacted tax rates in +effect in the years in which the differences are expected to +reverse. +ASC 740 +also prescribes a more-likely-than-not threshold for financial statement +recognition and measurement of a tax position taken, or expected to be taken, in +a tax return. ASC 740 also provides guidance related to, among other things, +classification, accounting for interest and penalties associated with tax +positions, and disclosure requirements. Any interest and penalties accrued +related to unrecognized tax benefits will be recorded in tax +expense. +(n) +Earnings +Per Share +The +following weighted average shares were used for the computation of basic and +diluted earnings per share: +December +31, 2009 +December +31, 2008 +Basic +61,946,435 +61,266,594 +Diluted +75,041,932 +61,266,594 +Basic +loss per share is computed by dividing net loss attributable to common +stockholders by the weighted-average number of common shares outstanding for the +period. Diluted earnings per share for the year ended December 31, 2009 reflects +the potential dilution from the exercise or conversion of other securities into +common stock. Diluted loss per share for the year ended December 31, 2008 is the +same as basic loss per share, since the effects of the calculation were +anti-dilutive due to the fact that the Company incurred losses for that period. +The following securities, presented on a common share equivalent basis, have +been excluded from the per share computations: +For the years ended +December +31, 2009 +December +31, 2008 +1999 +and 2008 Plan Stock Options +4,451,129 +2,555,837 +Other +Stock +Options +124,625 +124,625 +Warrants +8,519,743 +14,657,050 +13,095,497 +17,337,512 +F-9 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +(o) +Recent +Accounting Pronouncements Affecting the +Company: +Codification +In July +2009, the Financial Accounting Standards Board’s (FASB) Accounting Standards +Codification (ASC) became the single official source of authoritative, +nongovernmental generally accepted accounting principles (“US-GAAP” or “GAAP”) +in the United States. This guidance is contained in ASC Topic 105 “Generally +Accepted Accounting Principles.” The historical GAAP hierarchy was eliminated +and the ASC became the only level of authoritative GAAP, other than guidance +issued by the Securities and Exchange Commission. This guidance is effective for +interim and annual periods ending after September 15, 2009. The Company adopted +the provisions of this guidance as of September 30, 2009. The Company’s +accounting policies were not affected by the conversion to the ASC. However, +references to specific accounting standards have been changed to refer to the +appropriate section of the ASC. +Fair +Value Measurements +In +September 2006, the FASB issued guidance that defines fair value, establishes a +framework for measuring fair value and expands disclosures about fair value +measurements. This guidance is contained in ASC Topic 820 “Fair Value +Measurements and Disclosures.” This guidance does not require any new fair value +measurements, but applies under other accounting pronouncements that require or +permit fair value measurements. The effective date of this guidance for +financial assets and liabilities that are recognized or disclosed at fair value +on a recurring basis was January 1, 2008, and the Company did adopt the +provisions of this guidance at that time as it related to financial assets and +liabilities recognized or disclosed at fair value on a recurring basis. +Effective January 1, 2009, pursuant to this guidance, the Company adopted the +provisions of this guidance as it relates to non financial assets and +liabilities that are not recognized or disclosed at fair value on a recurring +basis. The adoption of this guidance had no impact on the Company’s financial +statements. +In April +2009, the FASB issued guidance that extends the disclosure requirements +regarding the fair value of financial instruments to interim financial +statements of publicly traded companies. This guidance is primarily contained in +ASC Topic 825 “Financial Instruments” and ASC Topic 270 “Interim Reporting.” +This guidance is effective for interim periods ending after June 15, 2009. The +adoption of this guidance had no impact on the Company’s financial +statements. +Collaborative +Arrangements +In +December 2007, the FASB issued guidance to participants in a collaborative +arrangement which is contained in ASC Topic 808. A collaborative +arrangement is a contractual arrangement that involves a joint operating +activity. These arrangements involve two (or more) parties who are both (a) +active participants in the activity and (b) exposed to significant risks and +rewards dependent on the commercial success of the activity. Many collaborative +arrangements involve licenses of intellectual property, and the participants may +exchange consideration related to the license at the inception of the +arrangement. Participants in a collaborative arrangement shall report costs +incurred and revenue generated from transactions with third parties (that is, +parties that do not participate in the arrangement) in each entity's respective +income statement pursuant to such guidance. An entity should not apply the +equity method of accounting to activities of collaborative arrangements. This +guidance is effective for financial statements issued for fiscal years beginning +after December 15, 2008, and interim periods within those fiscal years. The +adoption of this guidance had no material impact on the Company’s financial +statements. +F-10 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +Business +Combinations +On +January 1, 2009, we adopted the accounting pronouncements relating to +business combinations (primarily contained in ASC Topic 805 “Business +Combinations”), including assets acquired and liabilities assumed arising from +contingencies. These pronouncements established principles and requirements for +how the acquirer of a business recognizes and measures in its financial +statements the identifiable assets acquired, the liabilities assumed, and any +non-controlling interest in the acquiree as well as provides guidance for +recognizing and measuring the goodwill acquired in the business combination and +determines what information to disclose to enable users of the financial +statements to evaluate the nature and financial effects of the business +combination. In addition, these pronouncements eliminate the +distinction between contractual and non-contractual contingencies, including the +initial recognition and measurement criteria and require an acquirer to develop +a systematic and rational basis for subsequently measuring and accounting for +acquired contingencies depending on their nature. Our adoption of +these pronouncements will have an impact on the manner in which we account for +any future acquisitions. +Non-Controlling +Interests in Consolidated Financial Statements +On +January 1, 2009, we adopted the accounting pronouncement on non-controlling +interests in consolidated financial statements, which establishes accounting and +reporting standards for the non-controlling interest in a subsidiary and for the +deconsolidation of a subsidiary. This guidance is primarily contained +in ASC Topic 810 “Consolidation”. It clarifies that a non-controlling +interest in a subsidiary is an ownership interest in the consolidated entity +that should be reported as equity in the consolidated financial +statements. The adoption of this standard has not had a material +impact on our consolidated financial statements. +Subsequent +Events +In May +2009, the FASB issued guidance that is intended to establish general standards +of accounting for and disclosure of events that occur after the balance sheet +date but before the financial statements are issued or are available to be +issued. This guidance is contained in ASC Topic 855 “Subsequent Events.” It +requires the disclosure of the date through which an entity has evaluated +subsequent events and the basis for that date. This guidance is effective for +interim and annual periods ending after June 15, 2009. The Company adopted the +provisions of this guidance as of June 30, 2009. +In June +2009, an update was made to “Consolidation – Consolidation of Variable +Interest Entities.” Among other things, the update replaces the calculation for +determining which entities, if any, have a controlling financial interest in a +variable interest entity (VIE) from a quantitative based risks and rewards +calculation, to a qualitative approach that focuses on identifying which +entities have the power to direct the activities that most significantly impact +the VIE’s economic performance and the obligation to absorb losses of the VIE or +the right to receive benefits from the VIE. The update also requires ongoing +assessments as to whether an entity is the primary beneficiary of a VIE +(previously, reconsideration was only required upon the occurrence of specific +events), modifies the presentation of consolidated VIE assets and liabilities, +and requires additional disclosures about a Company’s involvement in VIEs. This +update will be effective for the Company beginning January 1, 2010. The +Company is evaluating the impact that this guidance will have on its financial +statements, if any. +F-11 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +NOTE +3—INVENTORIES: +Inventories +consist of the following at December 31: +December +31, 2009 +December +31, 2008 +Raw +materials +$ +1,031,567 +$ +836,446 +Work +in process +184,081 +300,986 +Finished +goods +340,255 +681,605 +$ +1,555,903 +$ +1,819,037 +NOTE +4—FIXED ASSETS: +Fixed +assets consist of the following at December 31: +2009 +2008 +Machinery +and equipment +$ +1,222,216 +$ +1,195,975 +Furniture +and fixtures +212,106 +195,611 +Computer +and telephone equipment +329,491 +329,865 +Leasehold +improvements +400,589 +400,589 +Automobiles +29,228 +29,442 +2,203,630 +2,151,482 +Less +accumulated depreciation and amortization +(1,623,417 +) +(1,270,076 +) +$ +580,213 +$ +881,406 +Included +in fixed assets is $70,500 and $70,500, net of accumulated depreciation of +$62,600 and $40,000 of assets held under capital leases as of December 31, 2009 +and 2008, respectively. Depreciation expense for the 2009 and +2008 years aggregated $362,338 and $345,388, respectively. +NOTE +5—ACCOUNTS PAYABLE AND ACCRUED LIABILITIES: +Accounts +payable and accrued liabilities at December 31: +December +31, 2009 +December +31, 2008 +Accounts +payable – suppliers +$ +662,739 +$ +634,083 +Accrued +royalties / license fees +612,709 +1,400,941 +Accrued +payroll +114,234 +95,135 +Accrued +vacation +99,057 +91,895 +Accrued +bonuses +238,600 +- +Accrued +expenses – other +178,824 +160,967 +TOTAL +$ +1,906,163 +$ +2,383,021 +NOTE +6—DEFERRED RESEARCH AND DEVELOPMENT REVENUE: +In +January 2009, the Company received a refundable license fee of $340,000 from +Bio-Rad Laboratories, Inc., pursuant to an exclusive license of our DPP® +technology for a specific field of use. The license fee will become +fully earned and non-refundable based upon certain future conditions being met +and is currently classified as deferred revenue. In addition, the +Company recognizes income from R&D contracts and grants when +earned. Grants are invoiced after expenses are incurred. Any projects +or grants funded in advance are deferred until earned. As of December 31, 2009, +an aggregate of $360,833 of advanced revenues was unearned. +F-12 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +NOTE +7—VEHICLE FINANCING AND LICENSE FEE PAYABLE: +In June +2009, the Company purchased a vehicle for use by the CEO and obtained financing +in the amount of $29,228. The financing is for a period of 3 years, +is secured by the vehicle and is guaranteed by the CEO. The financing +agreement provides for monthly principal and interest payments of $849 and +carries an interest rate of 2.9% per annum. The balance due on this +loan as of December 31, 2009 was $24,531. +Future +minimum payments under this obligation, including interest as of December 31, +2009 were as follows: +Year +ending December 31, +2010 +$ +9,600 +2011 +9,882 +2012 +5,049 +24,531 +Less: +current maturities +(9,600 +) +$ +14,931 +In +February 2008, the Company entered into a sublicense agreement (the +“Agreement”), with Bio-Rad Laboratories, Inc. and Bio-Rad Pasteur (collectively, +“Bio-Rad”). Bio-Rad is the exclusive licensee of the HIV-2 patent +portfolio held by Institute Pasteur of Paris, France. Pursuant to the +terms of the Agreement, Bio-Rad sublicensed to the Company patents related to +the manufacture, use or sale of screening assays that detect +HIV-2. In exchange for global non-exclusive rights to these patents, +the Agreement initially provided that the Company will pay Bio-Rad a $1,000,000 +sublicense fee, $500,000 payable during 2008, of which $125,000 was paid and +$375,000 was payable by December 31, 2008, with the remaining $500,000 being +payable by December 31, 2009. On January 29, 2009, the Company and +Bio-Rad agreed to amend the Agreement so as to defer the remaining $875,000 of +payments due under the Agreement to one payment due in December +2010. The Company will also pay Bio-Rad a royalty on net sales in the +United States and Canada, if any, of rapid test immunoassay tests sold under the +Company’s brands of Licensed Products as defined in the Agreement. The Agreement +will continue until the expiration of the last-to-expire of the sublicensed +patents, unless otherwise terminated at an earlier date by the Company or +Bio-Rad. +NOTE +8— OBLIGATIONS UNDER CAPITAL +LEASES: +The +Company is obligated under capitalized leases for certain manufacturing and +computer equipment. +Future +minimum lease payments under these capitalized lease obligations, including +interest as of December 31, 2009 were as follows: +Year +ending December 31, +2010 +$ +28,572 +2011 +28,572 +2012 +15,204 +72,348 +Less: +imputed interest +(11,539 +) +Present +value of future minimum lease payments +60,809 +Less: +current maturities +(21,536 +) +$ +39,273 +These +leases have annual interest rates ranging from 13% - 15%. +F-13 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +NOTE +9—RELATED PARTIES: +In September of 2006, the Company entered into distribution and +licensing agreements with Inverness Medical Innovations, Inc. +(“Inverness”). As of December 31, 2009 Inverness owned 8.7% of the +Company. See Note 14 where Inverness is listed as customer 1. +During +the quarter ended December 31, 2008, Inverness Medical Innovations, Inc. +(“Inverness”) notified the Company that Inverness had entered into a contract +with Bio-Rad Laboratories, Inc. (“Bio-Rad”) for royalties on Bio-Rad’s patent +for the detection of HIV-2 antibodies. The agreement also provided +for Inverness to pay past royalties. On June 25, 2009, the Company +and Inverness entered into a letter agreement whereby certain obligations +aggregating approximately $1,010,000 as of December 31, 2008 (included in +accounts payable and accrued expenses – see Note 5) were agreed to be paid from +future revenues. The obligations include the Company’s royalties owed +under its agreements with Inverness on lateral flow licenses . The approximate +aggregate balance due is $242,000 as of December 31, 2009 and is included in +accounts payable and accrued expenses – see Note 5. +NOTE +10—INCOME TAXES: +No +provision for Federal or state income taxes was required for the years ended +December 31, 2009 or 2008, due to the Company’s utilization of net operating +loss carryfoward in 2009 and its operating loss in 2008. State and local +minimum taxes are included in selling, general and administrative +expenses. +At +December 31, 2009, the Company has unused net operating loss carry-forwards of +approximately $21,500,000 which expire between 2012 and 2029. Most of this +amount may be subject to annual limitations under certain provisions of the +Internal Revenue Code related to “changes in ownership”. In addition the +Company has a research and development credit carryforward of approximately +$628,000 for the year ended December 31, 2009 which expire between 2012 and +2029. +As of +December 31, 2009 and 2008, the deferred tax assets related to the +aforementioned net operating loss carry-forwards have been fully offset by a +valuation allowance, since significant utilization of such amounts is not +presently expected in the foreseeable future. +Deferred +tax assets and valuation allowances consist of: +2009 +2008 +Current +assets +Inventory +$ +124,000 +$ +169,000 +Less +valuation allowance +(124,000 +) +(169,000 +) +Net +current deferred asset +$ +— +$ +— +Noncurrent +assets +Net +operating loss carry-forwards +$ +7,490,000 +$ +7,750,000 +Research +and development credit +628,000 +505,000 +Other +176,000 +174,000 +Gross +deferred tax assets +8,294,000 +8,429,000 +Less +valuation allowances +(8,294,000 +) +(8,429,000 +) +Net +deferred tax assets +$ +— +$ +— +The +change in the valuation allowances between 2009 and 2008 are mainly due to the +utilization of net operating loss carryfowards. +F-14 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +A +reconciliation of the Federal statutory rate to the total effective rate +applicable to income (loss) from continuing operations before income taxes is as +follows: +Year Ending December 31, +2009 +2008 +Federal +income tax (benefit) at statutory rates +34.0 +% +(34.0 +)% +State +income taxes, net of federal benefit +- +% +- +% +Nondeductible +expenses +17.8 +% +3.3 +% +Change +in valuation allowance +(52.3 +) +% +31.2 +% +Other +.5 +% +(.5 +) +% +Income +tax (benefit) +- +% +- +% +The +Company adopted the provisions of ASC 740 in January 1, 2007. The cumulative +effect of adopting ASC 740 did not have a material impact on the Company’s +financial position or results of operations. +Interest +and penalties, if any, related to income tax liabilities are included in income +tax expense. As of December 31, 2009, the Company does not have a +liability for unrecognized tax benefits. +The +Company files Federal and New York state income tax returns. Tax years for +fiscal 2006 through 2008 are open and potentially subject to examination by the +federal and New York state taxing authorities. +NOTE +11—STOCKHOLDERS’ EQUITY: +(a) Common +Stock +During +the December 31, 2009 quarter, options to purchase 35,000 shares of the +Company’s common stock were exercised at an exercise price of $.13. +During +the June 30, 2008 quarter, warrants to purchase 9,323,854 shares of the +Company’s common stock were exercised on a cashless basis, resulting in the +issuance of 1,407,367 shares of common stock. These warrants were exercised +on a cashless basis in connection with the Company’s preferred stock and warrant +amendments that were completed on December 19, 2007 (“Plan”), and the Company +received no cash consideration for these issuances of common stock. +On +December 19, 2007 (the “Closing Date”), amendments to the governing documents +for the Company’s Series A, Series B and Series C Convertible Preferred Stock +(collectively, the “Preferred Stock”) and for certain warrants and options +(collectively, the “Non-Employee Warrants”), not including options or warrants +issued to employees or directors in their capacity as such (these actions +collectively, the “Plan”), were approved by the Company and the requisite +percentages of the holders of the Preferred Stock and of the Non-Employee +Warrants. Subsequent to these amendments, among other matters, all the +Preferred Stock and certain of the Non-Employee Warrants were converted to +shares of the Company’s common stock. +(b) +Preferred Stock +The +Company has 10,000,000 shares of preferred stock authorized and none +outstanding. These shares can become issuable upon an approved resolution +by the board of directors and the filing of a Certificate of Designation with +the state of Nevada. +(c) Warrants +During +2009 certain warrants to purchase an aggregated 2,489,120 shares of common stock +expired, at an average exercise price of $.764. +In +January, 2010 certain warrants to purchase an aggregated 4,960,370 shares of +common stock expired, at an average exercise price of $.474 +F-15 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +NOTE +12—EMPLOYEE STOCK OPTION PLAN: +The +Company has a 1999 Stock Option Plan (“SOP”) originally covering 1,500,000 +shares of Common Stock. Under the terms of the SOP, the Compensation Committee +of the Company’s board is authorized to grant incentive options to key employees +and to grant non-qualified options to key employees and key individuals. The +options become exercisable at such times and under such conditions as determined +by the Compensation Committee. The SOP was amended at the Company’s +2005 stockholders’ meeting. The number of options under the SOP was +increased to cover 3,000,000 shares of common stock. It was also +amended to allow independent directors to be eligible for grants under the +portion of the SOP concerning non-qualified options. +Effective June 3, 2008, +the Company’s stockholders voted to approve the 2008 Stock Incentive Plan +(“SIP”). Under the terms of the SIP, the Compensation Committee of +the Company’s board shall have the discretion to select the persons to whom +Awards are to be granted. Awards can be incentive stock options, restricted +stock and/or restricted stock units. The Awards become vested at such times and +under such conditions as determined by the Compensation Committee. +As a +result of the adoption of ASC 718, the Company's results for the years ended +December 31, 2009 and 2008 include share-based compensation expense totaling +$198,000 and $292,000, respectively. Such amounts have been included +in the Consolidated Statements of Operations within cost of goods sold ($25,000 +and $19,000, respectively), research and development ($75,000 and $56,000, +respectively) and selling, general and administrative expenses ($98,000 and +$217,000, respectively). No income tax benefit has been recognized in +the income statement for share-based compensation arrangements due to the +history of operating losses. +Stock +option compensation expense in the years ended December 31, 2009 and 2008 +represent the estimated fair value of options outstanding which is being +amortized on a straight-line basis over the requisite vesting period of the +entire award. +The +weighted average estimated fair value of stock options granted in the years +ended December 31, 2009 and 2008 was $.13 and $.37 per share, +respectively. The fair value of options at the date of grant was +estimated using the Black-Scholes option pricing model. The expected volatility +is based upon historical volatility of our stock and other contributing factors. +The expected term is determined using the simplified method as permitted by SAB +107, as the Company has no history of employee exercise of options to +date. +The +assumptions made in calculating the fair values of options are as +follows: +For the years ended +December +31, 2009 +December +31, 2008 +Expected +term (in years) +1 +to 4 +1 +to 4 +Expected +volatility +123.81 +% +109.33-112.33 +% +Expected +dividend yield +n/a +n/a +Risk-free +interest rate +.54% +to 1.95% +1.91 +to 2.98% +The +Company granted 3,675,000 new options under the plans during the year ended +December 31, 2009 at an exercise price of $.13 per share (750,000 were issued +under the SOP and 2,925,000 were issued under the SIP). +On May 7, +2009, the Compensation Committee of the Company reduced, to $0.13 per share, the +exercise price of each outstanding employee option that was issued under the +1999 Equity Incentive Plan (the “1999 Plan”) for which the exercise price was +greater than $0.44 per share of the Company’s common stock. There was +no other change made to the terms of the stock options other than +the reduction in the exercise price. A total of 1,036,750 options were +affected and the fair value difference of the options before and after the +reduction was $31,660 and was expensed in the three months ended June 30, +2009. +F-16 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +In +addition, on May 7, 2009 in accordance with the terms of the Company’s 2008 +Stock Incentive Plan, the Company granted certain employees of the Company, +options to purchase an aggregate of 2,925,000 shares of the Company’s common +stock. The exercise price for these options is equal to $0.13 per +share. The options become exercisable in thirds on the first, second +and third anniversaries of the date of the grant. Each option granted will +expire and terminate, if not exercised sooner, upon the earlier to occur of (a) +30 days after termination of the employee’s employment with the Company or (b) +the fifth anniversary of the date of grant. The fair value of these +options is being amortized over the vesting life of the options. +On May 7, +2009, the Board of Directors of the Company revised the compensation of +non-employee directors to increase the number of options to purchase the +Company’s common stock issued to directors once every five years from 180,000 to +375,000. To accommodate the transition, on June 3, 2009 at the annual +meeting, non-employee directors that were re-elected were issued their five-year +allotment of options and those options previously granted but not exercisable as +of June 3, 2009 were cancelled. The number issued was 750,000 and the +number cancelled was 216,000. The 216,000 options were treated as a +re-price for accounting purposes. The fair value of these options +granted is being amortized over the vesting life of the options. +The +following table provides stock options activity for the years ended December 31, +2009 and 2008: +Stock +Options +Number +of Shares +Weighted +Average Exercise Price per Share +Weighted +Average Remaining Contractual Term +Aggregate +Intrinsic Value +Outstanding +at January 1, 2008 +2,201,500 +$ +0.64 +3.52 +years +$ +- +Impact of re-price (for accounting purposes +treated as a cancellation and re-issue): +effect +as if cancelled +(1,846,500 +) +$ +0.64 +effect +as if re-issiued +1,846,500 +$ +0.48 +Granted +967,650 +$ +0.18 +Exercised +- +- +Forfeited/expired +/cancelled +(752,500 +) +$ +0.58 +Outstanding +at December 31, 2008 +2,416,650 +$ +0.36 +3.23 +years +$ +- +Impact of re-price (for accounting purposes +treated as a cancellation and re-issue): +effect +as if cancelled +(1,252,750 +) +$ +0.48 +effect +as if re-issiued +1,252,750 +$ +0.13 +Granted +3,459,000 +$ +0.13 +Exercised +(35,000 +) +$ +0.13 +Forfeited/expired/cancelled +(253,750 +) +$ +0.17 +Outstanding +at December 31, 2009 +5,586,900 +$ +0.15 +3.59 +years +$ +756,990 +Exercisable +at December 31, 2009 +2,061,900 +$ +0.19 +2.27 +years +$ +234,240 +The +following table summarizes information about stock options outstanding at +December 31, 2009: +Stock +Options Outstanding +Stock Options +Exercisable +Range +of Exercise Prices +Shares +Average +Remaining Contract Life (Year) +Weighted +Average Exercise Price +Aggregate +Intrinsic Value +Shares +Weighted +Average Exercise Price +Aggregate +Intrinsic Value +$ +0.13 +- .13 +4,930,400 +3.72 +$ +0.130 +$ +739,560 +1,405,400 +$ +0.130 +$ +210,810 +$ +0.14 +- .22 +415,500 +3.13 +$ +0.220 +24,930 +415,500 +$ +0.220 +24,930 +$ +0.23 +- .45 +15,000 +0.96 +$ +0.350 +- +15,000 +$ +0.350 +- +$ +0.46 +- .88 +226,000 +1.84 +$ +0.498 +- +226,000 +$ +0.498 +- +Total +5,586,900 +3.59 +$ +0.152 +$ +764,490 +2,061,900 +$ +0.190 +$ +235,740 +As of +December 31, 2009, there was $208,000 of net unrecognized compensation cost +related to stock options that are not vested, which is expected to be recognized +over a weighted average period of approximately 1.58 years. The total +fair value of shares vested during the years ended December 31, 2009 and 2008, +was $60,000 and $273,000, respectively. +F-17 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +NOTE +13—GEOGRAPHIC INFORMATION: +ASC 280, +“Disclosures about Segments of an Enterprise and Related Information” +establishes standards for the way that business enterprises report information +about operating segments in financial statements and requires that those +enterprises report selected information. It also establishes standards for +related disclosures about product and services, geographic areas, and major +customers. +The +Company produces only one group of similar products known collectively as “rapid +medical tests”. As per the provisions of ASC 280, management believes that it +operates in a single business segment. Net sales by geographic area are as +follows: +For the years ended +December +31, 2009 +December +31, 2008 +Africa +$ +3,351,115 +$ +4,740,858 +Asia +165,293 +227,049 +Europe +111,755 +160,824 +Middle +East +185,700 +308,053 +North +America +6,129,789 +2,415,344 +South +America +2,428,841 +2,503,640 +$ +12,372,493 +$ +10,355,768 +Sales to +Africa in 2009 were primarily to Ethiopia of approximately $1,700.000 and +Nigeria of approximately $608,000. Sales in 2009 to North America +were primarily from sales in the U.S of approximately $5,200,000 and sales in +2009 to South America were primarily from sales in Brazil of approximately +$2,300,000. +During +the first quarter of 2008, the Nigerian Ministry of Health published a report +indicating that our designation in Nigeria as one of the screening tests in a +parallel testing algorithm (wherein each patient is tested with two rapid tests +from different manufacturers) to a confirmatory and/or tie-breaker test in a +serial algorithm in which only positive results are confirmed with a +confirmatory test, and only discrepant results between those are tested with a +confirmatory test. Consequently, our sales to Nigeria decreased +significantly in 2009 as compared to 2008. +NOTE +14—COMMITMENTS AND CONTINGENCIES: +Employment +Contracts: +The +Company has contracts with two key employees. The contracts call for +salaries presently aggregating $510,000 per year. One contract +expires in May 2012 and one contract expires in March 2013. The +following table is a schedule of future minimum salary commitments: +2010 +$ +508,300 +2011 +518,300 +2012 +373,750 +2013 +44,200 +$ +1,444,550 +Pension Plan : +The +Company has a 401(k) plan established for its employees. The Company +elected to match 20% of the first 5% (or 1% of salary) that an employee +contributes to their 401(k) plan. Expenses related to this matching +contribution aggregated $1,534 and $23,850 for the years ended December 31, 2009 +and 2008, respectively. +As of +January 19, 2009, the Company suspended the matching contribution. +F-18 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +Agreement +with Adaltis +In +October 2009, the Company entered into a letter agreement (“Agreement”) with the +Trustee of Adaltis, Inc, a Canadian company that filed for bankruptcy in Canada +in August 2009. Pursuant to a License and Supply Agreement (“L&S +Agreement”) dated August 30, 2002 by and between Chembio Diagnostic Systems Inc. +and Adaltis Inc., Adaltis licensed and supplied certain HIV 1&2 peptides +that the Company used in certain HIV tests manufactured and sold by the +Company. Under the terms of the Agreement, the Company purchased for a +lump-sum amount a paid-up license to the patents through their expiration dates, +thereby cancelling its obligation to pay any additional liabilities under the +L&S Agreement. The Company also acquired the right to purchase +the peptides from any supplier chosen by Chembio, including but not limited to +the current supplier that previously supplied the Company through Adaltis +pursuant to the L&S Agreement with Adaltis. The Agreement further provides +for a full mutual release of all claims, including any and all obligations under +the L&S Agreement. +Obligations +Under Operating Leases: +The +Company leases approximately 23,400 square feet of industrial space used for +office, R&D and manufacturing facilities, currently with a monthly rent of +$14,683. The current lease expires on April 30, 2014. We +entered into a second lease effective February 1, 2010, the principal terms of +this lease are the same as the one entered into in 2009 and are as +follows: (a) a lease term ending April 30, 2014; (b) an initial +rent of $11,350 per month plus $3,333 for the second lease (March and April of +2010 are free and the month of April in 2011, 2012 and 2013 is also free) ; +(c) the monthly rent for year two of the lease (does not apply to +second lease) will increase by the lower of (i) the change in the consumer price +index, or (ii) five percent; and (d) the monthly rent for years three +through five of the lease (years two through four of the second lease) will +increase each year by the lower of (i) the change in the consumer price +index, or (ii) two and one half percent. The following is a +schedule of future minimum rental commitments (assuming no +increases): +Year +ending December 31, +2010 +$ +166,197 +2011 +172,863 +2012 +172,863 +2013 +172,863 +2014 +55,399 +$ +740,185 +Rent +expense was $145,300 and $130,300 for the years ended December 31, 2009 and +2008, respectively. +F-19 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +Economic +Dependency: +The +following table delineates sales the Company had to customers in excess of 10% +of total sales for the periods indicated: +For +the years ended +Accounts +Receivable +December +31, 2009 +December +31, 2008 +As +of +Sales +% +of Sales +Sales +% +of Sales +December +31, 2009 +Customer +1 +$ +5,240,996 +42 +$ +2,111,151 +26 +$ +609,605 +Customer +2 +1,292,640 +10 +* +* +- +Customer +3 +2,293,770 +19 +2,434,420 +30 +- +Customer +4 +* +* +3,732,615 +46 +* +In the +table above the asterisk (*) indicates that sales to the customer did not exceed +10% for the period indicated. +The +following table delineates purchases the Company had with vendors in excess of +10% of total purchases for the periods indicated: +For +the years ended +Accounts +Payable +December +31, 2009 +December +31, 2008 +As +of +Purchases +% +of Purc. +Purchases +% +of Purc. +December +31, 2009 +Vendor +1 +$ +575,362 +20 +$ +627,637 +21 +$ +- +Vendor +2 +* +* +303,750 +10 +* +In the +table above the asterisk (*) indicates that purchases from the vendor’s did not +exceed 10% for the period indicated. +The +Company currently buys materials which are purchased under intellectual property +rights agreements and are important components in its +products. Management believes that other suppliers could provide +similar materials on comparable terms. A change in suppliers, +however, could cause a delay in manufacturing and a possible loss of sales, +which would affect operating results adversely. +Governmental +Regulation: +All of +the Company’s existing and proposed diagnostic products are regulated by the +United States Food and Drug Administration (FDA), United States Department of +Agriculture, certain state and local agencies, and/or comparable regulatory +bodies in other countries. Most aspects of development, production, +and marketing, including product testing, authorizations to market, labeling, +promotion, manufacturing, and record keeping are subject to +review. After marketing approval has been granted, Chembio must +continue to comply with governmental regulations. Failure to comply +with these regulations can result in significant penalties. +Voluntary +Component Recall: +In April +2008, we initiated a voluntary recall of two lots of Control kits used with our +HIV 1-2 Stat Pak® Assay distributed by Inverness under its Clearview® brand. +Control kits are to be used in order to verify the operator’s ability to +properly perform the test and to interpret the results. These kits are supplied +directly to Inverness by our vendor in accordance with our specifications and +instructions. In the case of these two lots of Control kits, although +they met our specifications, they were at the lower limit of such +specifications, and this produced some issues with the interpretation of the +Control kit results by certain customers. Chembio has provided the kit supplier +with a more clearly defined specification and has reviewed copies of revised +manufacturing and testing procedures to ensure implementation of the new +specification. Based upon this new specification, packaged HIV Rapid Test +Control Packs containing the new HIV Controls have been in distribution since +May 2008. The FDA has classified this voluntary recall as a Class II recall, “a +situation in which the use of, or exposure to, a violative product may cause +temporary or medically reversible adverse health consequences or where the +probability of serious adverse health consequences are +remote”. Approximately $22,000 in costs were incurred in 2008. We +completed all of our recall activity in 2008, including monitoring and final +product disposition and in 2008 the FDA issued a letter to the Company +confirming that this investigation is officially closed. +F-20 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +Equipment +Purchase Commitment: +In +January of 2009, the Company entered into an agreement with an equipment +manufacturer to design and build equipment that will be used to automate the +assembling of our tests and lower our production costs. The estimated +cost of $323,500 is being paid in installments. In addition in June and November +of 2009, the Company entered into an agreement with a tooling manufacturer to +design and build a tool for cassettes that house, its DPP® tests. The +estimated cost of $113,800 is being paid in installments. As of December 31, +2009, an aggregate of $338,375 has been paid for these two items and is included +in deposits and other assets on the Company’s balance sheet. +R&D contracts & +grants: +In 2009 +and 2008, the Company earned $1,340,000 and $694,000, respectively from research +grants, feasibility and development contracts. The Company is +now involved in additional feasibility and development contracts related to its +DPP® technology. The total expended on R&D in 2009 and 2008, not +including regulatory, was approximately $2,400,000 and $2,100,000, +respectively. +a. +NIH +Grant: +In June +2009, the Company received a $3 million, three-year grant from the United States +National Institutes of Health to complete development of a test for +Leptospirosis. Grants are invoiced after expenses are +incurred. In addition the Company has several development contracts +with third parties related to its DPP® technology. These development +projects are funded in advance and are presented as deferred revenue until +earned. +b. +Brazil: +On +January 29, 2008 we signed three new technology transfer, supply and license +agreements with the Bio-Manguinhos unit of the Oswaldo Cruz Foundation of Brazil +(“FIOCRUZ”) for products we have developed or are have nearly completed +development of. +On +October 2, 2008 the Company signed a fourth technology transfer +supply and license agreement with FIOCRUZ for it’s DPP® HIV 1/2 rapid test (for +use with oral fluid or whole blood samples). +c. +Bio-Rad: +On April +16, 2008 we announced a new development agreement with Bio-Rad Laboratories, +N.A. (“Bio-Rad”). The agreement with Bio-Rad is for the development +of a new multiplex product that would be developed on DPP® and which would be +marketed exclusively by Bio-Rad under an exclusive limited DPP® license from +Chembio to Bio-Rad limited to the field of application of this +product. Our agreement with Bio-Rad contemplated that we were to +enter into a license agreement no later than December 2008 subject to the +satisfaction of certain development and other conditions. On January +19, 2009 Chembio granted, effective December 31, 2008, a limited exclusive +license within a defined field of application for Chembio’s Dual Path Platform +technology to Bio-Rad Laboratories, Inc. (“Bio-Rad”). The license was +granted following development milestones as set forth in the agreement mentioned +above. As part of this agreement, in 2009, Chembio received $340,000 from +Bio-Rad as a license fee. +F-21 +CHEMBIO DIAGNOSTICS, INC. +AND SUBSIDIARY +NOTES TO CONSOLIDATED +FINANCIAL STATEMENTS +DECEMBER 31, 2009 AND +2008 +d. +Battelle/CDC DPP® +Influenza Immunity Test: +In +December 2009, Chembio entered into a milestone-based development agreement for +up to approximately $900,000 in connection with the development and initial +supply of a multiplex, rapid point-of-care ("POC") influenza immunity test. The +agreement contemplates a period of approximately nine months in which the +development activity is to be completed. Chembio entered this agreement with +Battelle Memorial Institute which has a master contract with the United States +Centers for Disease Control and Prevention ("CDC") to enter into, implement and +provide technical oversight of agreements relating to pandemic preparedness on +behalf of CDC. +NOTE +15—SUBSEQUENT EVENTS: +In +January 2010, after the balance sheet date, certain warrants to purchase an +aggregated 4,960,370 shares of common stock expired, at an average exercise +price of $.474. These warrants were related to the initial 2005 +Series B Preferred stock Offering (see Form 8-K filed on January 31, 2005 with +the SEC for further details on this offering). +Subsequent +to the balance sheet date the Company entered into a lease effective February +2010 for additional warehouse space, see Item 2 of our 2009 10-K for more +information. +In +February 2010, after the balance sheet date, the Company took possession of the +automated assembly equipment (mentioned in MD&A under Equipment Purchase +Commitment and Note 15). This equipment is expected to provide for +faster throughput and thereby increasing capacity of our manufacturing facility, +in addition to reducing labor costs. The machine will need to go +through a validation process and is expected to be in serviced during the second +quarter of 2010. +Subsequent +to the balance sheet date the Company entered into an employment agreement dated +March 4, 2010, and to be effective March 5, 2010 (the "Employment Agreement"), +with Mr. Esfandiari to continue as the Company's Senior Vice President of +Research and Development for an additional term of three +years. Please see Item 11 of this Form 10-K for further +details. +F-22 \ No newline at end of file diff --git a/raw/filings/0001092662/2009/0001092662-10-000007/filing_metadata.csv b/raw/filings/0001092662/2009/0001092662-10-000007/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..409048711ce2f14ca4d26e34200f4713da7ad5f6 --- /dev/null +++ b/raw/filings/0001092662/2009/0001092662-10-000007/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001092662,CEMI,"CHEMBIO DIAGNOSTICS, INC.",10-K,2010-03-05,2009-12-31,2010-03-05T11:50:35.000Z,0001092662-10-000007,form10_k.htm,FORM 10-K 2009,1998109,0,0,https://www.sec.gov/Archives/edgar/data/1092662/000109266210000007/form10_k.htm,https://www.sec.gov/Archives/edgar/data/1092662/000109266210000007/,2009,2009,1 diff --git a/raw/filings/0001092662/2009/0001092662-10-000007/item1.txt b/raw/filings/0001092662/2009/0001092662-10-000007/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001092662/2009/0001092662-10-000007/item13.txt b/raw/filings/0001092662/2009/0001092662-10-000007/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001092662/2009/0001092662-10-000007/item9a.txt b/raw/filings/0001092662/2009/0001092662-10-000007/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001092662/2009/0001092662-10-000007/rp_note.txt b/raw/filings/0001092662/2009/0001092662-10-000007/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001092662/2009/0001092662-10-000007/rpt_disclosure.txt b/raw/filings/0001092662/2009/0001092662-10-000007/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001092662/2010/0001293462-11-000011/filing.txt b/raw/filings/0001092662/2010/0001293462-11-000011/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..e40ab9e7a69dec1e36e6bb32083e8e56ce19d0a3 --- /dev/null +++ b/raw/filings/0001092662/2010/0001293462-11-000011/filing.txt @@ -0,0 +1,3317 @@ +10-K +1 +form10_k.htm +FORM 10-K FOR 2010 +form10_k.htm +UNITED STATES +Securities and Exchange Commission +Washington, D.C. 20549 +FORM 10-K +[X] +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2010 +or +[ ] +TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to . +Commission File No. 0-30379 +CHEMBIO DIAGNOSTICS, INC. +(Exact name of registrant as specified in its charter) +Nevada +88-0425691 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +3661 Horseblock Road, Medford, NY +11763 +(Address of principal executive offices) +(Zip Code) +Registrant’s telephone number, including area code (631) 924-1135 +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +None +None +Securities registered pursuant to section 12(g) of the Act: +Common Stock, $0.01 par value +(Title of Class) +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes __ No X +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes __ No X +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 X No__ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 X +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer [ ] Accelerated filer [ ] +Non-accelerated filer [ ] Smaller reporting company [X] +(Do not check if a smaller reporting company) +Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes __ No _X_ +As of the last business day of the Company’s most recently completed second fiscal quarter, the aggregate market value of voting and non-voting common equity held by non-affiliates* was $3,550,000. +As of March 1, 2011, the registrant had 62,240,483 common shares outstanding. +* Without asserting that any of the issuer’s directors or executive officers, or the entities that own more than five percent of the outstanding shares of the Registrant’s common stock, are affiliates, the shares of which they are beneficial owners have not been included in shares held by non-affiliates solely for this calculation. +TABLE OF CONTENTS +Page +PART I +ITEM 1. +BUSINESS +3 +ITEM 1A. +RISK FACTORS +12 +ITEM 2. +PROPERTIES +16 +ITEM 3. +LEGAL PROCEEDINGS +16 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +17 +ITEM 6. +SELECTED FINANCIAL DATA +18 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +19 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +32 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. +32 +ITEM 9A. +CONTROLS AND PROCEDURES +32 +ITEM 9B. +OTHER INFORMATION +32 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +33 +ITEM 11. +EXECUTIVE COMPENSATION +35 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +38 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +40 +ITEM 14. +PRINCIPAL ACCOUNTANT FEES AND SERVICES +41 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +42 +SIGNATURES +43 +2 +PART I +ITEM 1. +BUSINESS +FORWARD-LOOKING STATEMENTS +This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, and Section 27A of the Securities Act of 1933. Any statements contained in this report that are not statements of historical fact may be forward-looking statements. When we use the words “intends,” “estimates,” “predicts,” “potential,” “continues,” “anticipates,” “plans,” “expects,” “believes,” “should,” “could,” “may,” “will” or the negative of these terms or other comparable terminology, we are identifying forward-looking statements. Forward-looking statements involve risks and uncertainties, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by forward-looking statements. These factors include our research and development activities, distributor channels, compliance with regulatory impositions; and our capital needs. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business. +For further information about these and other risks, uncertainties and factors, please review the disclosure included in this report under “Part I, Item 1A, Risk Factors.” +General +The Company (Chembio Diagnostics, Inc. and its wholly-owned subsidiary Chembio Diagnostic Systems, Inc. are collectively referred to herein as the “Company”) develops, manufactures, markets and licenses rapid point-of-care diagnostic tests (POCTs) that detect infectious diseases. The Company’s main products presently commercially available are four rapid tests for the detection of HIV antibodies. Three of these products employ in-licensed and proprietary lateral flow technologies (see “Our Rapid Test Technologies”), can be used with all blood matrices as samples, and are manufactured in a standard cassette format, a dipstick format, and a proprietary barrel format. The tests employing the cassette and proprietary barrel formats were approved by the FDA in 2006 and are distributed by Alere, Inc., formerly Inverness Medical Innovations, Inc. (“Alere”), in the United States. Our fourth rapid HIV test, which we more recently developed on our patented Dual Path Platform (DPP®) and does not require in-licensing, detects antibodies to HIV in oral fluid samples as well as in all blood matrices. We anticipate launching this product under Chembio’s brand in 2012. +Our new product pipeline is based on this DPP® technology for which we were issued a United States patent in 2007 and for which additional patent protection has issued or is pending worldwide. With the DPP® proprietary platform, we can participate in the point-of-care market segment of the nearly $40 billion global in-vitro diagnostic market that is estimated to be $6-8 billion with an overall growth rate of 7% per annum. POCTs, by providing prompt and early diagnosis, can reduce patient stays, lower overall costs, improve therapeutic interventions and improve patient outcomes as a result of prompt and early diagnosis. They can also prevent needless hospital admissions, simplify testing procedures, avoid delays from central lab batching, and eliminate the need for return visits. +In the areas of infectious and sexually transmitted diseases (such as Influenza and HIV for example), the utility of a rapid point–of-care test has been well established, and large markets have been established for these kinds of tests globally. We have focused our product development activity within these areas as they tend to have the higher growth rates within the point-of-care segment. +PRODUCTS +Lateral Flow Rapid HIV Tests +All three of our lateral flow rapid HIV tests are qualitative “yes/no” tests for the detection of antibodies to HIV 1 & 2 with visually interpreted results (one line “negative”; two lines “positive”) available within approximately 15 minutes. The tests are simple to use, have a shelf life of 24 months, and do not require refrigeration. The tests differ principally only in the method of test procedure, convenience and cost. One of our FDA-approved lateral flow HIV tests incorporates a proprietary plastic “barrel” device that houses the lateral flow strip. This barrel format enables collection of samples directly (for example directly from a finger-stick whole blood sample) into the barrel’s capillary tip. A sealed unitized buffer vial, assembled onto the top of the barrel, is removed and seated into a stand; the seal is then pierced by the barrel’s capillary tip thereby initiating the upward flow of the resulting sample-buffer solution through a filter, up into the vertical device’s chamber and onto the lateral flow strip. This results in a unique unitized and closed device system that can reduce the chance of exposure to potentially infectious samples. Our other FDA-approved lateral flow HIV test uses a more conventional rectangular plastic cassette format that houses the lateral flow strip. In this case a sample is transferred by use of a separately provided transfer device (“loop”) into a sample well or port of the cassette which houses the lateral flow strip which is positioned horizontally or flat. +3 +Both of the above-described products are marketed exclusively in the United States by Alere as Clearview Complete HIV 1/2 (the barrel format) and Clearview HIV 1/2 STAT PAK® (the cassette format), and by Chembio in all other markets as Chembio Sure Check® HIV 1/2 and Chembio HIV 1/2 STAT PAK®. Alere has non-exclusive rights to the barrel product outside the United States. +Our third lateral flow HIV test, HIV 1/2 STAT PAK DIPSTICK is our most cost competitive and compact format. It does not have any plastic housing so that 30 test strips can be packaged into a small vial that is ideal for transporting into remote settings. The test procedure is similar to the cassette format; an adhesive backing is provided as a more cost-effective and compact “housing” on which to run the test. +Regulatory Status: The FDA approved our Pre-Market Applications (hereinafter “PMA”; see “Governmental Regulations” and Glossary) in April 2006 for our SURE CHECK HIV 1/2 (and also now Alere’ Clearview® Complete HIV 1/2) and for our HIV 1/2 STAT-PAK (now Alere’ Clearview® HIV 1/2 STAT-PAK in the United States only) products. A Clinical Laboratory Improvement Act (hereinafter “CLIA”; see Governmental Regulations) waiver was granted by the FDA for the HIV 1/2 STAT-PAK in November 2006 and for the two Alere Clearview® brands in October 2007. Our HIV 1/2 STAT-PAK Dipstick, though not FDA-approved, qualifies under FDA export regulations to sell, subject to any required approval by the importing country, to customers outside the United States. +All three of our lateral flow HIV tests have qualified for procurement under the President’s Emergency Plan for AIDS Relief (“PEPFAR”). The STAT PAK (both the cassette and dipstick versions) are also qualified for the second largest global program, known as the Global Fund (see Glossary), through qualification with the WHO bulk procurement scheme. +DPP® HIV Test +We have completed development of and are now commercializing our DPP® HIV 1&2 Assay. As in the case of our lateral flow HIV tests, the DPP® HIV test is also a qualitative “yes/no” test for the detection of antibodies to HIV 1 & 2, delivers visual results within approximately 15 minutes, is simple to use, has a shelf life of 24 months, and does not require refrigeration. However this product, which is our first product incorporating our patented DPP® technology, can be used with oral fluid samples, as well as all blood matrices. This product also incorporates our patent-pending oral fluid collection and storage system that enables samples to be fully extracted in buffer solution before application to the test device, and also enables the extracted sample to be stored and retested or tested for multiple conditions. Most importantly, clinical and laboratory studies conducted over the last couple of years have shown this product to have improved performance compared with all of the current FDA-approved CLIA-waived rapid tests, even including our own. +Regulatory Status: In the first half of 2010 we commenced clinical studies with this product in the United States pursuant to an investigational device exemption and in support of an anticipated Pre-Marketing Approval application to the FDA. During the first quarter of 2011 we submitted the first module of such PMA application, and we anticipate submitting the final module later this year. We believe that approval of our PMA application will be within approximately six months after we submit the final module. Thereupon we would apply for CLIA waiver of this product. +The Company conducted laboratory and field studies with this product in 2007-2009 prior to our commencing the clinical trials in the United States. One of the international clinical studies was conducted by the United States Centers for Disease Control, Global AIDS Program in Mozambique (“CDC GAP”). CDC GAP is responsible for evaluating products seeking to participate in PEPFAR, and CDC GAP had already performed its standard laboratory study in 2009 that resulted in the approval for the use of the product in the U.S. government’s international AIDS relief program known as PEPFAR (see Glossary) with blood matrices; the Mozambique study facilitated approval of this product for procurements by PEPFAR for use with oral fluid samples. The other study was sponsored by Chembio and was conducted at the National Hospital in Abuja Nigeria. In both of these studies the DPP® product’s performance equaled or exceeded the sensitivity and specificity of each of the other rapid tests in the study, including the only oral fluid HIV test that is currently FDA-approved. During the first quarter of 2011 we also received additional data from the CDC that further supports the previously reported performance. In order to capitalize on the PEPFAR and WHO approvals, this product still has to be registered and approved for export to a PEPFAR or Global Fund beneficiary country, and to also be one of the tests selected by such country for incorporation in such country’s national testing protocol. This is a process we are undertaking in selected markets. +In June 2010 ANVISA (see Glossary) approved the DPP® HIV test in Brazil. We are also seeking to have this product approved by WHO pursuant to its bulk procurement scheme as such approval is necessary to pursue certain international donor-funded markets. +PARTNERS INVOLVED IN MARKETING OUR HIV PRODUCTS +On September 29, 2006 we executed marketing and license agreements with Alere. The marketing agreements (one for each of the two FDA approved products) provide Alere with a 10-year exclusive right (i.e. until September 2016) to market our rapid HIV tests in the United States under Alere’s brand. The agreements provide Chembio a non-exclusive license to certain Alere lateral flow patents that may be applicable to our lateral flow products, principally including our lateral flow HIV tests we have continued to market outside the United States. Simultaneous with the execution of the agreements, we also settled litigation with StatSure Diagnostics, Inc.(SDS) that had been ongoing relating to the proprietary barrel device which is incorporated into one of our two FDA-approved rapid HIV tests (See Lateral Flow HIV Tests above). +The agreements with Alere have allowed the Company to participate in the growth of the rapid HIV test market in the United States in an OEM (Original Equipment Manufacturer) capacity. This collaboration has been successful as it has allowed the company to invest in its product development, regulatory and manufacturing activities, and to avoid investing in a United States marketing organization. +We have appointed distributors internationally for our lateral flow HIV tests. Our largest markets for our lateral flow HIV rapid tests outside the United States are certain countries in Africa and Mexico. +4 +Our DPP® HIV test was approved by ANVISA in June 2010. This approval was granted to our Brazilian partner, the Oswaldo Cruz Foundation (“FIOCRUZ”), pursuant to one of six technology transfer, supply and license agreements we have entered with this public health organization since 2004 (See OEM DPP® products). +OTHER LATERAL FLOW RAPID TESTS +The Company entered the rapid test market segment with lateral flow technology and for many years our revenues were almost entirely based on this technology, primarily pregnancy tests before we developed the HIV lateral flow tests. Because of the limited license we entered into with Alere to manufacture and market only certain applications of lateral flow technology, we developed our own patent-protected rapid point-of-care technology platform, DPP®, that does not require a lateral flow license, all of our other products and products under development are based on the DPP®. Revenues from products based on lateral flow technologies other than our HIV tests were 3.9% of sales in 2010, substantially all of which are primarily attributable to our niche product line relating to veterinary tuberculosis and Chagas. We developed the veterinary tuberculosis tests as a result of and development program we did pursuant to a National Institute Health grant. This grant work enabled us to have our facility approved for the manufacture of products regulated by the United States Department of Agriculture. We are pursuing new opportunities in the veterinary diagnostics field in order to leverage this capability together with our development capabilities and proprietary point-of-care platform, DPP®. +OTHER DPP® PRODUCTS +Our strategy with respect to our DPP® technology has evolved as the Company has evolved. Initially, following the issuance of our DPP® patent in the United States in 2007, our strategy entirely involved efforts in developing third party funded OEM research and development contracts and grants. This strategy enabled us to conserve our own capital resources, while at the same time acquire important know-how and experience with the platform while also developing third party references and implicit endorsements of the technology. As our capabilities to develop and manufacture DPP® products expanded, and as our financial position has improved, so have our strategic options expanded and improved. While we will continue to employ the strategy of seeking OEM development and manufacturing agreements as a way to participate in markets that we cannot and/or choose not serve (e.g., veterinary) , we believe that we can also develop our own branded line of products, and we plan to do this in the public health area. This brand will be launched with our DPP® HIV Screening Assay in the United States market in 2012, to be followed by our Syphilis test (See RECENT DEVELOPMENTS AND CHEMBIO’S PLAN OF OPERATIONS FOR THE NEXT TWELVE MONTHS). +Following is a discussion of the OEM DPP® products for which we have completed our development activity pursuant to our OEM contracts with FIOCRUZ, Bio-Rad Laboratories, and the Battelle Memorial Institute. The status of those OEM and Chembio-branded products that are still under development are described in Part II Item 7. +OEM DPP® Products +Oswaldo Cruz Foundation OEM DPP® Agreements +During 2008 we signed four agreements and in 2010 one additional agreement with the Oswaldo Cruz Foundation (FIOCRUZ) in Brazil relating to products based on our DPP® technology. FIOCRUZ is the leading public health organization in Brazil and it is affiliated with Brazil’s Ministry of Health and has basic research and educational divisions as well as extensive manufacturing facilities that manufacture drugs and vaccines, as well as diagnostic products. +During 2010, two of the products under agreement with FIOCRUZ, the DPP® HIV Screening Assay and the 5-band multiplex point-of-care confirmation test for HIV 1&2, were approved by ANVISA. We believe that FIOCRUZ is seeking to have these products used in a new serial testing algorithm to be deployed by the Ministry of Health in Brazil; an evaluation concerning this new algorithm is underway. During the fourth quarter of 2010, we shipped $537,500 of DPP® HIV Screening Assays to FIOCRUZ. Under the two agreements we have for the recently approved products, there is a potential for aggregate sales of $13.5 million. The agreements between the Company and FIOCRUZ are unique examples of technology transfer collaborations between a private sector rapid test manufacturer and a public health organization. The other products under agreement with FIOCRUZ are for DPP® products for Leishmaniasis, Leptospirosis and Syphilis. These products are still pending regulatory approval in Brazil and their status is briefly discussed in Part II Item 7. +All of the agreements with FIOCRUZ contemplate a technology transfer license to FIOCRUZ for the manufacture of the subject products over stipulated periods of time. These technology transfers, and the provision by Chembio of the information and training that is required for this to occur, are subject to Chembio receiving orders for a minimum amount of products for manufacture by Chembio; thereafter Chembio may receive royalty payments for a defined period based on product sold by FIOCRUZ to the public health programs in Brazil. During 2010 Chembio received $92,000 of royalties from FIOCRUZ pursuant to the 2004 agreement with FIOCRUZ. +Bio-Rad Laboratories OEM DPP® Agreement - On April 6, 2008, we entered a milestone-based development agreement with Bio-Rad Laboratories N.A., a division of Bio-Rad Laboratories Inc (NYSE:BIO), a leading in-vitro diagnostic and life science company. The agreement with Bio-Rad was for the development of a six-band multiplex product (the specific application is confidential) on our DPP®. Based on achieving the proof of concept for this product during 2008, in January 2009 we entered a limited exclusive license agreement with Bio-Rad related to the field of use for this application, and we continued the development work during all of 2009 and until Bio-Rad confirmed that the product specifications were met in the second quarter of 2010. In June 2010, Bio-Rad exercised its option to have Chembio transfer the manufacturing of this product to Bio-Rad, which process was completed in October 2010. Chembio believes that Bio-Rad is proceeding with the regulatory approvals of this product, with CE Mark likely by the end of 2010, although there can be no assurance of this. We further believe that Bio-Rad has begun discussions with the FDA to discuss this product, its proposed performance claims and the intended clinical protocol to support its regulatory submission. +5 +During 2008 to 2010, Chembio earned approximately $460,000 for product development work rendered to Bio-Rad under this agreement, plus an additional $490,000 in license and other fees related to the manufacturing transfer. +Battelle/CDC DPP® Influenza Immunity Test – In December 2009 Chembio entered into a milestone-based development agreement for the development and initial supply of a multiplex, rapid point-of-care ("POC") influenza immunity test. The agreement contemplated a period of approximately nine months in which the development activity was to be completed. Chembio entered this agreement with Battelle Memorial Institute, which has a master contract with the United States Centers for Disease Control and Prevention ("CDC") to enter into, implement and provide technical oversight of agreements relating to pandemic preparedness on behalf of CDC. The objective of the project was to develop a product that can determine an individual's immunity to seasonal and novel influenza viruses, including novel swine H1N1, either in the field or in an outpatient setting. Development work with respect to the contract development specification is substantially completed and our contract partners are assessing the prototype product and determining potential additional funded development activity. +Our Rapid Test Technologies +All of our commercially available current products employ either in-licensed lateral flow technology or our own patented Dual Path Platform (DPP®) technology and are visually read. Certain of our new DPP® products will incorporate reader technologies that can help record and report test results and reduce subjectivity of results sometimes found with visually read tests. Both lateral flow technology and DPP® allow the development of accurate, low cost, easy-to-perform, single-use diagnostic tests for rapid, visual detection of specific antigen-antibody complexes on a test strip. This format provides a test that is simple (requires neither electricity nor expensive equipment for test execution or reading, nor skilled personnel for test interpretation), rapid (turnaround time approximately 15 minutes), safe (minimizes handling of potentially infected specimens), non-invasive (requires 5-20 micro liters of whole blood easily obtained with a finger prick, or alternatively, serum or plasma), stable (24 months at room temperature storage in the case of our HIV tests), and highly reproducible. +We believe that products developed using DPP® technology can provide superior diagnostic performance as compared with products that use lateral flow technology. The reason for this is that one of the major differences between the two platforms is that in DPP® samples are allowed to incubate with the target analyte in the test zone before introduction of the labeling reagent/conjugate whereas in lateral flow samples are combined with the labeling reagent to form a complex before coming in contact with the target analyte. Also, because of the usage in DPP® of a separately connected sample strip, the control and delivery of sample material is substantially improved. This is critical in the development of multiplex tests, as well as tests that involve viscous sample material (such as oral fluid) that can be impeded when forced to combine with labeling reagents before migration on the test strip to the test zone area. +We can also use hand held and desktop readers to objectively measure, quantify, record and report test results. Certain of the products we have and/or are developing incorporate some of these readers, and we are developing other products that may be used with or will require use of a reader. +Target Markets +Rapid HIV Tests +A large percentage of individuals that are HIV positive worldwide are unaware of their status. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results if samples have to be sent out to a laboratory which can take at least several days to process. However, the increased availability, greater efficacy and reduced costs for anti-retroviral treatments (ARVs) for HIV has increased the demand for testing, as the stigma associated with the disease is lessened, and the ability to resume normal activities is substantially improved, providing a positive message to those potentially infected. +There are approximately 53,000 new diagnoses of HIV infection in the United States each year, according to the CDC. In time, most of these infections progress to AIDS. The CDC estimates that approximately 1.1 million individuals in the U.S. are living with HIV, with an estimated 250,000 Americans, or more than 25%, unaware that they are infected. It is these 250,000 infected people that account for 54% of all new infections per year. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results from samples that have to be sent out to a laboratory and that can take at least several days to process. Healthcare officials believe that by making more people aware of their HIV status, it will reduce the number of HIV transmissions. +Rapid HIV testing in the United States has now developed into a 6-7 million test market. This is from zero in 2003 when Orasure received FDA approval for the first rapid HIV test. We believe that the US professional HIV rapid test market (not including the OTC market) has the potential to increase to 15-18 million tests over the next several years, which would represent about 50% of all HIV tests done today in the United States for clinical purposes. Assuming an average price to the manufacturers of $10.00 per test, a total potential market of $180 million U.S. market is inferred. +In 2006, the outlook for HIV testing was given a big boost with the release by the CDC of new guidelines for HIV testing. These new CDC recommendations are that an HIV test should be given as a routine test like any other for all patients between 13 and 64 years of age, regardless of risk, with an opt-out screening option and focused testing procedural (pre and post test counseling) guidelines. Adoption of the 2006 CDC recommendations by a number of states continues to have an increasing impact. +In the international market, PEPFAR, the large United States funded international AIDS relief program focused on fifteen countries, was reauthorized in 2008 for up to $48 billion for FY2009-2012 (up from $15 billion in 2004-2008). PEPFAR, and the Global Fund are the largest of the global initiatives that have helped to make life-saving treatments available to those that need them. For example PEPFAR has the goal that by 2013 three million infected individuals will be provided treatment and 12 million new cases will be averted. To achieve these goals more and more people are likely to get tested. As more effective treatments become available at lower costs there is a clearer reason to be tested. +6 +Oral fluid testing is an established alternative to blood testing for diagnostic tests, including HIV tests. It is also often patient preferred, providing a more comfortable test. In certain public health clinics, staffs choose not to handle blood specimens; thus, oral sample collection provides a viable alternative. The most well-established market for oral fluid HIV testing is the United States. There is also now an opportunity to participate in the over-the-counter market for HIV tests. This opportunity received important support by the FDA and CDC in November 2009. +Rapid Syphilis Tests +Recent data indicate that approximately 70,000-100,000 new cases of syphilis are occurring annually in the U.S. Syphilis can be treated with antibiotics, but untreated can cause pelvic inflammatory disease, infertility, ectopic pregnancy and can infect newborns. Treatment cannot be provided without a confirmed diagnosis of an active, previously untreated case of syphilis. Current testing algorithms in the United States require two different tests (called non-treponemal and treponemal markers), each requiring trained personnel in laboratory settings and several days to receive back results, in order to confirm an active, previously untreated case. +Development of the POC market for syphilis testing is expected to be comparable to the development of the POC market for HIV testing, as there is a significant public health value to being able to provide results at the point-of-care. There are several ways to assess the market opportunity for this unique rapid test, although we believe the U.S. rapid test market opportunity is a minimum of 3 million tests, which is approximately 20% of the total number syphilis tests performed in the United States today. Unlike HIV testing, where a positive result first requires a confirmatory test, and even then further tests to measure viral load before expensive treatment decisions are made, an individual with a confirmed active case of syphilis can be prescribed antibiotics immediately. +In February 2011 a study was released by the CDC that suggested that the “newest” laboratory screening tests, which are using technologies developed in the 1980s (i.e. Enzyme-linked Immunoassays), are resulting in a large number of suspected false positive test results, which are test results that are not in fact representing active cases of Syphilis. This study involved tests done in high throughput blood screening laboratory settings, and not necessarily clinical settings. Nevertheless we believe that the study suggests that if public health clinicians could have what is effectively the CDC-recommended laboratory testing algorithm in a point-of-care test, this could be an invaluable public health tool in higher risk testing (higher STD prevalence) settings. We believe this is the opportunity we have with this product. +Marketing Strategy +Our marketing strategy is to: +· +Support, review and assess the marketing and distribution efforts of our rapid HIV tests by Alere. Alere, which is a leading marketer of point-of-care diagnostic products, has significantly expanded its distribution footprint since we signed our agreement with them, and although we believe that this will enhance opportunities for Alere to market our rapid HIV tests, the product line is a very small one for them notwithstanding the strong growth they have enjoyed with respect to our products. +· +Leverage our DPP® intellectual property and regulated product development and manufacturing experience to continue creating new collaborations where Chembio can be the exclusive development and manufacturing partner supporting leading marketing organizations. +· +Establish strong distribution relationships for our Chembio-branded products in the U.S and abroad and establish a direct sales and marketing organization that is focused in the public health market segment. +Competition +The diagnostics industry is a multi-billion dollar international industry and is intensely competitive. Many of our competitors are substantially larger and have greater financial, research, manufacturing and marketing resources. +Industry competition in general is based on the following: +· +Scientific and technological capability; +· +Proprietary know-how; +· +The ability to develop and market products and processes; +· +The ability to obtain FDA or other required regulatory approvals; +· +The ability to manufacture products that meet applicable FDA requirements, (i.e. FDA’s Quality System Regulations) (see Governmental Regulation section); +· +The ability to manufacture products cost-effectively; +· +Access to adequate capital; +· +The ability to attract and retain qualified personnel; and +· +The availability of patent protection. +7 +We believe our scientific and technological capabilities and our proprietary know-how relating to our in-licensed lateral flow technology rapid tests and to our proprietary know-how related to our patented dual path platform technology, particularly for the development and manufacture of tests for the detection of antibodies to infectious diseases such as HIV, are very strong. +Our ability to develop and market other products is in large measure dependent on our having additional resources and/or collaborative relationships. Some of our product development efforts have been funded on a project or milestone basis. We believe that our proprietary know-how in lateral flow technology and in our Dual Path Platform (DPP®) technology has been instrumental in our obtaining the collaborations we have and that we continue to pursue. We believe that the patent protection that we have with our Dual Path Platform (DPP®) enhances our ability to develop more profitable collaborative relationships and to license out the technology. +Research and Development +During 2010 and 2009, $4.1 million ($2.6 million, net of Qualified Therapeutic Discovery Project (“QTDP”) grants) and $2.9 million, respectively, were spent on research and development (including regulatory activities). These expenses were in part underwritten by funding from R&D and milestones revenues of $2.8 million in 2010 and $1.3 million in 2009. All of our new product development activities involve employment of our Dual Path Platform (DPP®) technology. These activities include completing development of certain products and making significant progress toward the development of additional products. Research and development and regulatory activities are explained in detail in Part II Item 7. +Employees +At December 31, 2010, we employed 118 people, including 115 full-time employees. We have entered into employment contracts with our President, Lawrence Siebert, and our Senior Vice President of Research and Development, Javan Esfandiari. Due to the specific knowledge and experience of these executives regarding the industry, technology and market, the loss of the services of either one of them would likely have a material adverse effect on the Company. The contract with Mr. Siebert provides that Mr. Siebert will serve as the Chief Executive Officer and President of the Company for an additional three-year term through May 11, 2012. The contract with Mr. Esfandiari has a term of three years ending March 2013. We have obtained a key man insurance policy for Mr. Esfandiari. +Governmental Regulation +The manufacturing and marketing of the Company’s existing and proposed diagnostic products are regulated by the United States Food and Drug Administration (“FDA”), United States Department of Agriculture (“USDA”), certain state and local agencies, and/or comparable regulatory bodies in other countries. These regulations govern almost all aspects of development, production and marketing, including product testing, authorizations to market, labeling, promotion, manufacturing and record keeping. The Company’s FDA and USDA regulated products require some form of action by each agency before they can be marketed in the United States, and, after approval or clearance, the Company must continue to comply with other FDA requirements applicable to marketed products, e.g. Quality Systems (for medical devices). Failure to comply with the FDA’s requirements can lead to significant penalties, both before and after approval or clearance. +There are two review procedures by which medical devices can receive FDA clearance or approval. Some products may qualify for clearance under Section 510(k) of the Federal Food, Drug and Cosmetic Act, in which the manufacturer provides a pre-market notification that it intends to begin marketing the product, and shows that the product is substantially equivalent to another legally marketed product (i.e., that it has the same intended use and is as safe and effective as a legally marketed device and does not raise different questions of safety and effectiveness). In some cases, the submission must include data from human clinical studies. Marketing may commence when the FDA issues a clearance letter finding such substantial equivalence. FDA clearance of our DPP® Syphilis Screen & Confirm test will be by means of a 510(k) submission. +If the medical device does not qualify for the 510(k) procedure (either because it is not substantially equivalent to a legally marketed device or because it is required by statute and the FDA’s implementing regulations to have an approved application), the FDA must approve a Pre-Marketing Application (“PMA”) before marketing can begin. PMA’s must demonstrate, among other matters, that the medical device provides a reasonable assurance of safety and effectiveness. A PMA application is typically a complex submission, including the results of non-clinical and clinical studies. Preparing a PMA application is a much more expensive, detailed and time-consuming process as compared with a 510(K) pre-market notification. The Company has approved PMAs for the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1-2 and Clearview® HIV 1-2 STAT PAK®. FDA approval of our DPP® HIV screening assay for use with oral fluid or blood samples will be pursued by means of a PMA application. +The Clinical Laboratory Improvement Act of 1988 (“CLIA”) prohibits laboratories from performing in vitro tests for the purpose of providing information for the diagnosis, prevention or treatment of any disease or impairment of, or the assessment of, the health of human beings unless there is in effect for such laboratories a certificate issued by the United States Department of Health and Human Services (via the FDA) applicable to the category of examination or procedure performed. Although a certificate is not required for the Company, it considers the applicability of the requirements of CLIA in the design and development of its products. The statutory definition of “laboratory” is very broad, and many of our customers are considered labs. A CLIA waiver will remove certain quality control and other requirements that must be met for certain customers to use the Company’s products and this is in fact critical to the marketability of a product into the point-of-care diagnostics market. The Company has received a CLIA waiver for each of the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1/2 and Clearview® HIV 1/2 STAT PAK®. The CLIA waiver was granted by the FDA for HIV 1/2 STAT-PAK on November 20, 2006 and for the Clearview® Complete HIV 1/2 on October 22, 2007. +8 +In addition, the FDA regulates the export of medical devices that have not been approved for marketing in the United States. The Federal Food, Drug and Cosmetic Act contains general requirements for any medical device that may not be sold in the United States and is intended for export. Specifically, a medical device intended for export is not deemed to be adulterated or misbranded if the product: (1) complies with the specifications of the foreign purchaser; (2) is not in conflict with the laws of the country to which it is intended for export; (3) is prominently labeled on the outside of the shipping package that it is intended for export; and (4) is not sold or offered for sale in the United States. However, the Federal Food, Drug and Cosmetic Act does permit the export of devices to any country in the world, if the device complies with the laws of the importing country and has valid marketing authorization in one of several “listed” countries under the theory that these listed countries have sophisticated mechanisms for the review of medical devices for safety and effectiveness. +The Company is also subject to regulations in foreign countries governing products, human clinical trials and marketing, and may need to obtain approval or evaluations by international public health agencies, such as the World Health Organization, in order to sell diagnostic products in certain countries. Approval processes vary from country to country, and the length of time required for approval or to obtain other clearances may in some cases be longer than that required for United States governmental approvals. On the other hand, the fact that our HIV diagnostic tests are of value in the AIDS epidemic may lead to some government process being expedited. The extent of potentially adverse governmental regulation affecting Chembio that might arise from future legislative or administrative action cannot be predicted. +One or more of the Company’s rapid HIV tests are also approved or pending approval for marketing in several foreign jurisdictions, including but not limited to Brazil, Mexico, and a number of other nations in the developing world. +Environmental Laws +To date, we have not encountered any costs relating to compliance with any environmental laws. +Intellectual Property +Intellectual Property Strategy +Our intellectual property strategy is to: (1) build our owned intellectual property portfolio around our Dual Path Platform technology; (2) pursue licenses, trade secrets and know-how within the area of rapid point-of-care testing, and (3) develop and acquire proprietary positions to reagents and new hardware platforms for the development and manufacture of rapid diagnostic tests. +The Company has obtained patent coverage on the DPP® product line, including three U.S. patents, and patents in China, Malaysia, Eurasia, Mexico, Singapore, and the U.K. Additional patent applications on the DPP® product line are pending in the U.S., as well as in many foreign countries such as Australia, Brazil, Canada, the European Union, India, Indonesia, Israel, Japan, Korea, and South Africa. Patents have also been filed on extensions to the DPP® product line concept such as 4th generation assays. +The Company has also filed for patents and obtained some patents in the U.S. for other inventions such as its multiple host species veterinary TB test, and patent applications for the other inventions are in various stages from being recently filed and not yet examined, to already examined and allowed but not yet issued. The Company selectively and strategically foreign files its patent applications based on the importance of the invention to the Company. +Trademarks +The Company has filed and obtained trademarks for its products including DPP®, SURE CHECK® and STAT-PAK®. The DPP® trademark is also registered under the European convention (ECT). +Trade Secrets and Know-How +We believe that we have developed a substantial body of trade secrets and know-how relating to the development of lateral flow and DPP® based diagnostic tests, including but not limited to the sourcing and optimization of materials for such tests, and how to maximize sensitivity, speed-to-result, specificity, stability and reproducibility. The Company possesses proprietary know-how to develop tests for multiple conditions using colored latex. Our buffer formulations enable extremely long shelf lives of our rapid HIV tests and we believe that this provides us with an important competitive advantage. +Lateral Flow Technology and Reagent Licenses +As part of our agreements in 2006 with Alere for the marketing of our HIV tests, we were granted non-exclusive licenses to certain lateral flow technology for certain products manufactured and marketed by Chembio including but not limited to our HIV tests. Although we believe our DPP® is outside of the scope of all lateral flow patents of which we are aware, we consult with patent counsel, and seek licenses and/or redesigns of products that we believe to be in the best interests of the Company and our stockholders. Because of the costs and other negative consequences of time-consuming patent litigation, we often attempt to obtain a license on reasonable terms. Nevertheless there is no assurance that the Alere lateral flow patents we have licensed will not be challenged or that other patents containing claims relevant to the Company’s lateral flow or DPP® products will not be granted and that licenses to such patents, will be available on reasonable terms, if any. Alere has aggressively enforced its lateral flow intellectual property, although some of the main patents will expire within the next few years. +9 +Regardless, the DPP® technology provides us with our own intellectual property, we believe it provides us with a freedom to operate, and that it also enables tests to be developed with improved sensitivity as compared with comparable tests on lateral flow platforms. The Company has signed and anticipates signing new development projects based upon the DPP® technology that will provide new manufacturing and marketing opportunities. We have filed other patents that we believe will strengthen the DPP® intellectual property and have also filed for patent protection for certain other point-of-care technologies or applications thereof. +The peptides used in our rapid HIV tests are patented by Adaltis Inc. and are licensed to us under a 10-year non-exclusive license agreement dated August 30, 2002. In connection with Adaltis’ bankruptcy, during the third quarter of 2009 we bought out all of our remaining obligations under that agreement. We also have licensed the antigens used in other tests including our Syphilis, Tuberculosis, Leptospirosis and Leishmaniasis tests. In prior years we concluded license agreements related to intellectual property rights owned by the United States associated with HIV- 1, and during the first quarter of 2008 we entered into a sub-license agreement for HIV-2 with Bio-Rad Laboratories N.A., the exclusive licensee of the Pasteur Institute’s HIV-2 intellectual property estate. +Corporate History +On May 5, 2004, we completed a merger with Chembio Diagnostic Systems Inc. through which Chembio Diagnostics Systems Inc. became our wholly-owned subsidiary, and through which the management and business of Chembio Diagnostic Systems Inc. became our management and business. As part of this transaction, we changed our name to Chembio Diagnostics, Inc. In 2003, we had sold our prior business, and as a result, we had no specific business immediately prior to the merger. +Since the formation of Chembio Diagnostic Systems Inc. in 1985, it has been involved in developing, manufacturing, selling and distributing in-vitro diagnostic tests, including rapid tests beginning in 1995, for a number of conditions in humans and animals. +On March 12, 2004, we implemented a 1-for-17 reverse split of our common stock. All references in this Form 10-K to shares of our common stock have been adjusted to reflect this reverse split. +In February 2010, Crestview Capital Master, L.L.C. ("Crestview Master), a Delaware limited liability company that held 18,907,431 shares of Chembio's common stock, spun off all these shares, constituting approximately 30.5% of Chembio's outstanding shares, to its three equity holders. One of the three equity holders of Crestview Master immediately spun off, to its approximately 126 equity holders, all of the 12,990,569 shares of Chembio stock that it received in this distribution. As a result, as of February 24, 2010, Crestview Master no longer owned any shares. The former direct and indirect equity holders of Crestview Master owned all these shares, with none of these individual stockholders having beneficial ownership of more than 5.61% of the outstanding common stock of Chembio. +10 +Glossary +AIDS +Acquired Immunodeficiency Syndrome. AIDS is caused by the Human Immunodeficiency Virus, HIV. +ALGORITHM (parallel or serial) +For rapid HIV testing this refers both to method or protocol (in developing countries to date) for using rapid tests from different manufacturers in combination to screen and confirm patients at the point-of-care, and may also refer to the specific tests that have been selected by an agency or ministry of health to be used in this way. A parallel algorithm uses two screening tests from different manufacturers and a tie-breaker test only if there is a discrepancy between the screening tests results. A serial algorithm only uses a second confirmatory test if there is a positive result from the screening test, meaning that the number of confirmatory tests used is equal to the positivity rate in the testing venue. A tie-breaker test resolves discrepancies between the screen and the confirmatory test. +ANTIBODY +A protein which is a natural part of the human immune system produced by specialized cells to neutralize antigens, including viruses and bacteria that invade the body. Each antibody producing cell manufactures a unique antibody that is directed against, binds to and eliminates one, and only one, specific type of antigen. +ANTIGEN +Any substance which, upon entering the body, stimulates the immune system leading to the formation of antibodies. Among the more common antigens are bacteria, pollens, toxins, and viruses. +ANVISA +ARVs +Anti-Retroviral Treatments for AIDS +The National Health Surveillance Agency of Brazil +Anti-retroviral medications developed to fight AIDS +CDC +United States Centers for Disease Control and Prevention +CLIA waiver +Clinical Laboratory Improvement Act designation that allows simple tests to be performed in point-of-care settings such as doctor’s offices, walk-in clinics and emergency rooms. +DIAGNOSTIC +Pertaining to the determination of the nature or cause of a disease or condition. Also refers to reagents or procedures used in diagnosis to measure proteins in a clinical sample. +EITF +Emerging Issues Task Force +FASB +FIOCRUZ +Financial Accounting Standards Board +The Oswaldo Cruz Foundation of Brazil +FDA +United States Food and Drug Administration +FDIC +Federal Deposit Insurance Corporation +FAS +Financial Accounting Standard +IgG +IgG or Immunoglobulin are proteins found in human blood. This protein is called an “antibody” and is an important part of the body’s defense against disease. When the body is attacked by harmful bacteria or viruses, antibodies help fight these invaders. +NGO +Non-Governmental Organization +OTC +Over-the-Counter +PEPFAR +The President’s Emergency Plan for AIDS Relief +PMA +Pre-Marketing Approval –FDA approval classification for a medical device that is not substantially equivalent to a legally marketed device or is otherwise required by statute to have an approved application. Rapid HIV tests must have an approved PMA application before marketing of such a product can begin. +PROTOCOL +A procedure pursuant to which an immunodiagnostic test is performed on a particular specimen in order to obtain the desired reaction. +REAGENT +A chemical added to a sample under investigation in order to cause a chemical or biological reaction which will enable measurement or identification of a target substance. +RETROVIRUS +A type of virus which contains the enzyme Reverse Transcriptase and is capable of transforming infected cells to produce diseases in the host such as AIDS. +SAB +Staff Accounting Bulletin +SENSITIVITY +Refers to the ability of an assay to detect and measure small quantities of a substance of interest. The greater the sensitivity, the smaller the quantity of the substance of interest the assay can detect. Also refers to the likelihood of detecting the antigen when present. +SPECIFICITY +The ability of an assay to distinguish between similar materials. The greater the specificity, the better an assay is at identifying a substance in the presence of substances of similar makeup. +USDA +U.S Department of Agriculture +WHO +World Health Organization +11 +ITEM 1A. +RISK FACTORS +You should carefully consider each of the following risk factors and all of the other information provided in this Annual Report. The risks described below are those we currently believe may materially affect us. An investment in our Common Stock involves a high degree of risk, and should be considered only by persons who can afford the loss of their entire investment. +Risks related to our industry, business and strategy +Because we may not be able to obtain or maintain the necessary regulatory approvals for some of our products, we may not generate revenues in the amounts we expect, or in the amounts necessary to continue our business. Our existing products as well as our manufacturing facility must meet quality standards and are subject to inspection by a number of domestic regulatory and other governmental and non-governmental agencies. +All of our proposed and existing products are subject to regulation in the U.S. by the U.S. Food and Drug Administration, the U.S. Department of Agriculture and/or other domestic and international governmental, public health agencies, regulatory bodies or non-governmental organizations. In particular, we are subject to strict governmental controls on the development, manufacture, labeling, distribution and marketing of our products. The process of obtaining required approvals or clearances varies according to the nature of, and uses for, a specific product. These processes can involve lengthy and detailed laboratory testing, human or animal clinical trials, sampling activities, and other costly, time-consuming procedures. The submission of an application to a regulatory authority does not guarantee that the authority will grant an approval or clearance for product. Each authority may impose its own requirements and can delay or refuse to grant approval or clearance, even though a product has been approved in another country. +The time taken to obtain approval or clearance varies depending on the nature of the application and may result in the passage of a significant period of time from the date of submission of the application. Delays in the approval or clearance processes increase the risk that we will not succeed in introducing or selling the subject products, and we may determine to devote our resources to different products. +Changes in government regulations could increase our costs and could require us to undergo additional trials or procedures, or could make it impractical or impossible for us to market our products for certain uses, in certain markets, or at all. +Changes in government regulations may adversely affect our financial condition and results of operations because we may have to incur additional expenses if we are required to change or implement new testing, manufacturing and control procedures. If we are required to devote resources to develop such new procedures, we may not have sufficient resources to devote to research and development, marketing, or other activities that are critical to our business. +We can manufacture and sell our products only if we comply with regulations and quality standards established by government agencies such as the FDA and the USDA as well as by non-governmental organizations such as the ISO and WHO. We have implemented a quality system that is intended to comply with applicable regulations. Although FDA approval is not required for the export of our products, there are export regulations promulgated by the FDA that specifically relate to the export of our products. Although we believe that we meet the regulatory standards required for the export of our products, these regulations could change in a manner that could adversely impact our ability to export our products. +Our products may not be able to compete with new diagnostic products or existing products developed by well-established competitors, which would negatively affect our business. +The diagnostic industry is focused on the testing of biological specimens in a laboratory or at the point-of-care and is highly competitive and rapidly changing. Our principal competitors often have considerably greater financial, technical and marketing resources than we do. Several companies produce diagnostic tests that compete directly with our testing product line, including but not limited to, Orasure Technologies, Alere Medical and Trinity Biotech. As new products enter the market, our products may become obsolete or a competitor’s products may be more effective or more effectively marketed and sold than ours. Although we have no specific knowledge of any competitor’s product that will render our products obsolete, if we fail to maintain and enhance our competitive position or fail to introduce new products and product features, our customers may decide to use products developed by our competitors, which could result in a loss of revenues and cash flow. +12 +We have developed an oral fluid rapid HIV test as well as other applications utilizing our Dual Path Platform technology, which we believe will enhance our competitive position in HIV rapid testing and other fields. During 2010 we made significant progress toward the commercialization of this product. However we still have technical, manufacturing, regulatory and marketing challenges to meet before we will know whether we can successfully commercialize products incorporating this technology. There can be no assurance that we will overcome these challenges. +We have granted Alere exclusive rights to market our SURE CHECK® HIV 1/2 in the United States and non-exclusive rights in the rest of the world and exclusive rights to market our HIV 1/2 STAT PAK® in the U.S. only. Alere has no rapid HIV tests that are approved for marketing in the U.S., we are not aware of any rapid HIV products that Alere is even contemplating for the U.S., and Alere is obligated to inform us of any such products as soon as it is able to do so. Alere does have rapid HIV tests manufactured by several subsidiaries outside the U.S. that are being actively marketed outside the U.S., primarily in developing countries. Our HIV 1/2 STAT PAK cassette and dipstick products compete against these Alere products, and we specifically acknowledge in our agreements with Alere the existence of such other products. Moreover, except for a product in the HIV barrel field as defined in our agreement with Alere, Alere is permitted under our agreements to market certain types of permitted competing rapid HIV tests in the U.S. Under these conditions, we could choose to terminate the applicable agreement with Alere or change the agreement to a non-exclusive agreement, and Alere would expand the lateral flow license granted to the Company to allow the Company to market the product independently or through other marketing partners. While we believe that Alere is committed to successfully marketing our products particularly in the U.S. and other developed countries where our products are or become approved for marketing, Alere may choose to develop or acquire competing products for marketing in the U.S. as well as other markets where they are marketing our SURE CHECK® HIV 1/2 product, and such an action could have at least a temporary material adverse effect on the marketing of these products until such time as alternative marketing arrangements could be implemented. While we also believe that the expansion of our license to the Alere lateral flow patents substantially facilitates our ability to make alternative marketing arrangements, there can be no assurance that the modification of marketing arrangements and the possible corresponding delays or suspension of sales would not have a material adverse effect on our business. +We plan to introduce our DPP® oral fluid HIV test, which test also can be used with blood samples, in the U.S. market under a Chembio brand once it is FDA approved, currently anticipated in 2012 but for which there can be no assurance. Under our 2006 Agreement with Alere, Alere has a right of first negotiation for the right to market any new rapid HIV antibody detection test that we develop. In accordance with this provision in our agreement, we presented this product to Alere in 2007 and in 2007 Alere waived its right of first negotiation under the agreement. While such waiver does not prevent Alere from reconsidering the marketing of this product, we have no reason to believe that they will. Also, although we believe that the main market opportunity for the DPP® HIV product is for those customers that have a clear preference for an oral fluid HIV test the product is also likely to compete with our FDA approved rapid HIV tests being marketed by Alere. Therefore this could have a material and adverse effect on our business with Alere. +More generally, the point-of-care diagnostics industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. As new technologies become introduced into the point-of-care diagnostic testing market, we may be required to commit considerable additional efforts, time and resources to enhance our current product portfolio or develop new products. We may not have the available time and resources to accomplish this and many of our competitors have substantially greater financial and other resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers, which would materially harm our operating results. +Although we own our DPP® patent, we own no issued patents covering lateral flow technology, and the field of lateral flow technology is complex and characterized by a substantial amount of litigation, so the risk of potential patent challenges is ongoing for us in spite of our DPP® patent. +Although we have been granted non-exclusive licenses to the lateral flow patents owned by Alere, there is no assurance that its lateral flow patents will not be challenged or that licenses from other parties may not be required, if available at all. In addition, certain of the Alere patents will expire in the next couple of years which expiration could open the market to certain competitors. In the event that it is determined that a license is required and it is not possible to negotiate a license agreement under a necessary patent, we may be able to modify our HIV rapid test products and other products such that a license would not be necessary. However, this alternative could delay or limit our ability to sell these products in the U.S. and other markets, which would adversely affect our results of operations, cash flows and business. +On March 13, 2007, our Dual Path Platform Immunoassay Device patent application was issued as United States patent no. 7,189,522. Additional protection for this intellectual property is pending worldwide. This platform has shown improved sensitivity as compared with conventional platforms in a number of studies. We believe that this new platform is outside of the scope of currently issued patents in the field of lateral flow technology, thereby offering the possibility of a greater freedom to operate. However there can be no assurance that our patents or our products incorporating the patent claims will not be challenged at some time in the future. +New developments in health treatments or new non-diagnostic products may reduce or eliminate the demand for our products. +The development and commercialization of products outside of the diagnostics industry could adversely affect sales of our products. For example, the development of a safe and effective vaccine to HIV or treatments for other diseases or conditions that our products are designed to detect, could reduce, or eventually eliminate the demand for our HIV or other diagnostic products and result in a loss of revenues. +We may not have sufficient resources to effectively introduce and market our products, which could materially harm our operating results. +Introducing and achieving market acceptance for our rapid HIV tests and other new products will require substantial marketing efforts and will require us or our contract partners, sales agents, or distributors to make significant expenditures of time and money. In some instances we will be significantly or totally reliant on the marketing efforts and expenditures of our contract partners, sales agents, distributors. If they do not have or commit the expertise and resources to effectively market the products that we manufacture, our operating results will be materially harmed. +13 +The success of our business depends, in addition to the market success of our products, on our ability to raise additional capital through the sale of debt or equity or through borrowing, and we may not be able to raise capital or borrow funds in amounts necessary to continue our business, or at all. +Our revenues and gross margins have increased significantly in recent periods, and we have been profitable for two consecutive years. Nevertheless, prior to 2009 we sustained significant operating losses since 2004. At December 31, 2010, we had a stockholders’ equity of $5.8 million and a working capital surplus of $4.6 million . The Company estimates that its resources are sufficient to fund its needs through the end of 2011 and beyond or that, in the alternative, it could raise additional capital although the terms under which that capital could be raised would likely be very dilutive to current shareholders. The Company’s liquidity and cash requirements will depend on several factors. These factors include (1) the level of revenues; (2) the extent to which, if any, that revenue level improves operating cash flows; (3) the Company’s investments in research and development, facilities, marketing, regulatory approvals, and other investments it may determine to make; and (4) the Company’s investment in capital equipment and the extent to which it improves cash flow through operating efficiencies. There are no assurances that the Company will remain profitable or generate positive cash flow in 2011 or, in the alternative, be successful in raising sufficient capital to fund its needs through 2011. +The launch of our DPP® products in Brazil, increased revenues from Alere, increased sales to developing world markets, and continued strength in our contract development and grant revenues are all critical for us to continue to fund our new product regulatory approval and commercialization programs. If we fail to meet any of these objectives, we may not generate revenues in the amounts necessary to fund our planned research, development and regulatory expenses in 2011 . +We intend to attempt to increase international sales of our products. A number of factors can slow or prevent international sales, or substantially increase the cost of international sales, including: +· +regulatory requirements and customs regulations; +· +cultural and political differences; +· +foreign exchange rates, currency fluctuations and tariffs; +· +dependence on and difficulties in managing international distributors or representatives; +· +the creditworthiness of foreign entities; +· +difficulties in foreign accounts receivable collection; +· +competition; +· +pricing; and +· +economic conditions and the absence of available funding sources. +If we are unable to increase our revenues from international sales, our operating results will be materially harmed. +Although we have an ethics and anti-corruption policy in place, and have no knowledge or reason to know of any practices by our employees, agents or distributors that could be construed as in violation of such policies, our business includes sales of products to countries where there is or may be widespread corruption. +Chembio has a policy in place prohibiting its employees, distributors and agents from engaging in corrupt business practices, including activities prohibited by the United States Foreign Corrupt Practices Act (FCPA). Nevertheless, because we work through independent sales agents and distributors (and do not have any employees or subsidiaries) outside the United States, we do not have control over the day-to-day activities of such independent agents and distributors. In addition, in the donor- funded markets in Africa where we sell our products, there is significant oversight from PEPFAR, the Global Fund, and advisory committees comprised of technical experts concerning the development and establishment of national testing protocols. This is a process that includes an overall assessment of a product which includes extensive product performance evaluations, a manufacturer’s quality systems, as well as price and delivery. In Brazil where we have six product collaborations with FIOCRUZ, those programs that our products are or may be deployed in are all funded by the Brazilian Ministry of Health. Although FIOCRUZ is affiliated with the Brazilian Ministry of Health, it is not its exclusive supplier. However because each of our collaborations with FIOCRUZ incorporates a technology transfer aspect, we believe we have a competitive advantage versus other suppliers to the Brazilian Ministry of Health, assuming other aspects of our product offering through FIOCRUZ are otherwise competitive in comparison. We have no knowledge or reason to know of any activities by our employees, distributors or sales agents of any actions which could be in violation of the FCPA, although there can be no assurance of this. +We rely on trade secret laws and agreements with our key employees and other third parties to protect our proprietary rights, and we cannot be sure that these laws or agreements adequately protect our rights. +We believe that factors such as the technological and creative skills of our personnel, strategic relationships, new product developments, frequent product enhancements and name recognition are essential to our success. All our management personnel are bound by non-disclosure agreements. If personnel leave our employment, in some cases we would be required to protect our intellectual property rights pursuant to common law theories which may be less protective than provisions of employment, non-competition or non-disclosure agreements. +We seek to protect our proprietary products under trade secret and copyright laws, enter into license agreements for various materials and methods employed in our products, and enter into strategic relationships for distribution of the products. These strategies afford only limited protection. We currently have some foreign patents issued, and we are seeking additional patent protection in several other foreign jurisdictions for our DPP® technology. We have licenses to reagents (antigens and peptides) used in several of our products and products under development Despite our efforts to protect our proprietary assets, and respect the intellectual property rights of others, we participate in several markets where intellectual property rights protections are of little or no value. This can place our products and our company at a competitive disadvantage. +14 +Despite efforts we make to protect our confidential information, such as entering confidentiality agreements in connection with new business opportunities, unauthorized parties may attempt to copy aspects of our products or to obtain information that we regard as proprietary. We may be required to expend substantial resources in asserting or protecting our intellectual property rights, or in defending suits related to intellectual property rights. Disputes regarding intellectual property rights could substantially delay product development or commercialization activities because some of our available funds would be diverted away from our business activities. Disputes regarding intellectual property rights might include state, federal or foreign court litigation as well as patent interference, patent reexamination, patent reissue, or trademark opposition proceedings in the U.S. Patent and Trademark Office. +To facilitate development and commercialization of a proprietary technology base, we may need to obtain additional licenses to patents or other proprietary rights from other parties. Obtaining and maintaining these licenses, which may not be available, may require the payment of up-front fees and royalties. In addition, if we are unable to obtain these types of licenses, our product development and commercialization efforts may be delayed or precluded. +Our continued growth depends on retaining our current key employees and attracting additional qualified personnel, and we may not be able to do so. +Our success will depend to a large extent upon the skills and experience of our executive officers, management and sales, marketing, operations and scientific staff. We may not be able to attract or retain qualified employees in the future due to the intense competition for qualified personnel among medical products businesses, geographic considerations, our ability to offer competitive compensation, relocation packages, benefits, and/or other reasons. +If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will adversely affect our ability to effectively manufacture, sell and market our products to meet the demands of our strategic partners in a timely fashion, or to support internal research and development programs. Although we believe we will be successful in attracting and retaining qualified personnel, competition for experienced scientists and other personnel from numerous companies and academic and other research institutions may limit our ability to do so on acceptable terms. +We have entered into employment contracts with our President, Lawrence Siebert, and our Senior Vice President of Research and Development, Javan Esfandiari. Due to the specific knowledge and experience of these executives regarding the industry, technology and market, the loss of the services of either one of them would likely have a material adverse effect on the Company. The contract with Mr. Siebert provides that Mr. Siebert will serve as the Chief Executive Officer and President of the Company through May 11, 2012. The contract with Mr. Esfandiari has a term of three years ending March 2013. We have obtained a key man insurance policy for Mr. Esfandiari. +We believe our success depends in part on our ability to participate in large testing programs in the U.S. and worldwide and we may not be able to do so. +We believe it to be in our best interests to meaningfully participate in large testing programs. Participation in these programs requires alignment and engagement with the many other participants in these programs including the World Health Organization, U.S. Center for Disease Control, U.S. Agency for International Development, foreign governments and their agencies, non-governmental organizations, and HIV service organizations. If we are unsuccessful in our efforts to participate in these programs, our operating results could be materially harmed. +Although we were profitable in 2009 and 2010 we cannot be certain that we will be able to sustain profitability in 2011. +From the inception of Chembio Diagnostic Systems, Inc. in 1985 through the period ended December 31, 2008, we incurred net losses and we have only become profitable during the last two years. While we anticipate growth in our product revenues in 2011 as compared with 2010, there can be no assurance of this. Moreover in 2011 we expect to make substantial expenditures for regulatory submissions, product development and other purpose that may make it more difficult to maintain profitability in 2011. Our ability to continue profitability in the future will primarily depend on our ability to increase sales of our products, reduce production and other costs and to successfully introduce new products and enhanced versions of our existing products into the marketplace. If we are unable to increase our revenues at a rate that is sufficient to achieve profitability, or adequately control and reduce our operating costs, our operating results would be materially harmed. +To the extent that we are unable to obtain sufficient product liability insurance or that we incur product liability exposure that is not covered by our product liability insurance, our operating results could be materially harmed. +We may be held liable if any of our products, or any product which is made with the use or incorporation of any of the technologies belonging to us, causes injury of any type or is found otherwise unsuitable during product testing, manufacturing, marketing, sale or usage. We have obtained product liability insurance we have never received a product liability claim, and have generally not seen product liability claims for screening tests that are accompanied by appropriate disclaimers. Nevertheless, in the event there is a claim, this insurance may not fully cover our potential liabilities. In addition, as we attempt to bring new products to market, we may need to increase our product liability coverage which would be a significant additional expense that we may not be able to afford. If we are unable to obtain sufficient insurance coverage at an acceptable cost to protect us, we may be forced to abandon efforts to commercialize our products or those of our strategic partners, which would reduce our revenues. +15 +Risks related to our Common Stock +In the past, our Common Stock has been classified as penny stock, and it continues to be extremely illiquid, so investors may not be able to sell as much stock as they want at prevailing market prices. +In the past, our Common Stock has been classified as penny stock. Penny stocks generally are equity securities with a price of less than $5.00 and trade on the over-the-counter bulletin board market (OTCBB). As a result, an investor may find it more difficult to dispose of or obtain accurate quotations as to the price of the securities that are classified as penny stocks. The “penny stock” rules adopted by the Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), subject the sale of the shares of penny stock issuers to regulations that impose sales practice requirements on broker-dealers, causing many broker-dealers to not trade penny stocks or to only offer the stocks to sophisticated investors that meet specified net worth or net income criteria identified by the Commission. These regulations contribute to the lack of liquidity of penny stocks. +At the present time, transactions in our Common Stock are not subject to the “penny stock” rules because our average revenue for 2008, 2009 and 2010 exceeded $6 million per year. However, there can be no assurance that transactions in our Common Stock will not be subject to the “penny stock” rules in the future. +The average daily trading volume of our Common Stock on the over-the-counter market was less than 45,000 shares per day over the three months ended March 1, 2011. If limited trading in our stock continues, it may be difficult for investors to sell their shares in the public market at any given time at prevailing prices. +Our management and larger stockholders exercise significant control over our Company. +As of March 1, 2011, our named executive officers, directors and 5% stockholders beneficially owned approximately 28.3% of our voting power. For the foreseeable future, to the extent that these parties vote similarly, they may be able to exercise significant control over many matters requiring approval by the board of directors or our stockholders. As a result, they may be able to: +· +control the composition of our board of directors; +· +control our management and policies; +· +determine the outcome of significant corporate transactions, including changes in control that may be beneficial to stockholders; and +· +act in each of their own interests, which may conflict with, or be different from, the interests of each other or the interests of the other stockholders. +ITEM 2. +PROPERTIES +Our administrative offices and research facilities are located in Medford, New York. We lease approximately 23,400 square feet of industrial space for $14,683 per month. The space is utilized for research and development activities (approximately 2,600 square feet), offices (approximately 2,640 square feet) and production (approximately 18,160 square feet). The lease term expires on April 30, 2014. Additional space may be required as we expand our research and development activities. We do not foresee any significant difficulties in obtaining any required additional facilities. We entered into a second lease effective February 1st of 2010, the principal terms of this lease are the same as the one entered into in 2009 and are as follows: (a) a lease term ending April 30, 2014; (b) an initial rent of $11,350 per month plus $3,333 for the second lease (March and April of 2010 are free and the month of April in 2011, 2012 and 2013 is also free) ; (c) the monthly rent for year two of the lease (does not apply to second lease) will increase by the lower of (i) the change in the consumer price index, or (ii) five percent; and (d) the monthly rent for years three through five of the lease (years two through four of the second lease) will increase each year by the lower of (i) the change in the consumer price index, or (ii) two and one half percent. +ITEM 3. +LEGAL PROCEEDINGS +From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. We know of no material, existing or pending legal proceedings against us, nor are we involved as a plaintiff in any material proceeding or pending litigation. There are no proceedings in which any of our directors, officers or affiliates, or any registered or beneficial shareholder, is an adverse party or has a material interest that is adverse to our interest. +16 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Until February 23, 2011, our common stock was quoted on the OTC Bulletin Board under the symbol “CEMI.” The table below sets forth the high and low bid prices per share of our common stock for each quarter of our two most recently completed fiscal years. These prices represent inter-dealer quotations without retail markup, markdown, or commission and may not necessarily represent actual transactions. +Fiscal Year 2010 +High Bid +Low Bid +First Quarter +$.33 +$.20 +Second Quarter +$.28 +$.159 +Third Quarter +$.29 +$.21 +Fourth Quarter +$.49 +$.225 +Fiscal Year 2009 +High Bid +Low Bid +First Quarter +$.135 +$.075 +Second Quarter +$.18 +$.085 +Third Quarter +$.23 +$.12 +Fourth Quarter +$.39 +$.20 +On February 24, 2011, and since that date, our stock has not been quoted on the OTC Bulletin Board, and is now being quoted on the OTCQB, which is the second of the three tiers of the OTC Market Group. The situation is in a state of flux and we are trying to determine what market we believe is best for our stock, considering the relative costs, liquidity, market strategy, etc. The other markets that we will consider are (1) the higher tier of the OTC Market Group called OTC-QX; (2) the NYSE-AMEX, and; (3) NASDAQ. +Our stock is no longer trading on the OTC Bulletin Board because the market maker that had filed originally to quote our stock on the OTC Bulletin Board is no longer providing quotes on the OTC Bulletin Board. It is our understanding that a large number of other market makers also have ceased to provide quotes on the OTC Bulletin Board and that 300 to 500 other companies have ceased being quoted on the OTC Bulletin Board during the past few months for the same reason. +This change has nothing to do with Chembio or the quality of our company. It is solely related to the desire of the market makers to save costs related to providing quotes on the OTC Bulletin Board. +Rule 15g-9 of the Securities and Exchange Commission, known as the Penny Stock Rule, imposes requirements on broker/dealers who sell securities subject to the rule to persons other than established customers and accredited investors. For transactions covered by the rule, brokers/dealers must make a special suitability determination for purchasers of the securities and receive the purchaser’s written agreement to the transaction prior to sale. The Securities and Exchange Commission also has rules that regulate broker/dealer practices in connection with transactions in “penny stocks.” Penny stocks generally are equity securities with a price of less than $5.00 (other than securities registered on certain national securities exchanges or quoted on the NASDAQ system, provided that current price and volume information with respect to transactions in that security is provided by the exchange or system), except for securities of companies that have tangible net assets in excess of $2,000,000 or average revenue of at least $6,000,000 for the previous three years. The Penny Stock Rule requires a broker/ dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document prepared by the Commission that provides information about penny stocks and the nature and level of risks in the penny stock market. The broker/dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker/dealer and its salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer’s account. The bid and offer quotations, and the broker/dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer’s confirmation. These disclosure requirements have the effect of reducing the level of trading activity in the secondary market for penny stock issues. As a result of these rules, investors sometimes find it difficult to sell shares of penny stock issuers. At the present time, transactions in our common stock are not subject to the Penny Stock Rule because our average revenue for 2008, 2009 and 2010 exceeded $6 million per year. However, there can be no assurance that transactions in our common stock will not be subject to the Penny Stock Rule in the future. +17 +Holders +As of March 1, 2011, there were approximately 1,350 record owners of our common stock. +Dividends +The Company has never paid cash dividends on its common stock and has no plans to do so in the foreseeable future. +ITEM 6. SELECTED FINANCIAL DATA +Presented in this table are selected financial data for the past five years ending December 31, 2010. As of the year ended December 31, 2008 the Company reclassified its royalty and license expenses to cost of goods sold, instead of selling, general and administrative expenses, all years shown conform to this presentation. +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARIES +SELECTED HISTORICAL FINANCIAL DATA +Statement of Operations Data: +December 31, 2010 +December 31, 2009 +December 31, 2008 +December 31, 2007 +December 31, 2006 +TOTAL REVENUES +$ +16,704,703 +$ +13,834,248 +$ +11,049,571 +$ +9,230,948 +$ +6,502,480 +GROSS MARGIN +$ +8,100,699 +48 +% +$ +5,860,405 +42 +% +$ +3,851,721 +35 +% +$ +2,795,710 +30 +% +$ +1,608,272 +25 +% +OPERATING COSTS: +Research and development expenses +$ +2,586,308 +15 +% +$ +2,883,696 +21 +% +$ +2,605,343 +24 +% +$ +1,906,653 +21 +% +$ +1,401,472 +22 +% +Selling, general and administrative expenses +$ +2,940,721 +18 +% +$ +2,659,382 +19 +% +$ +3,317,046 +30 +% +$ +3,765,221 +41 +% +$ +4,786,993 +74 +% +$ +5,527,029 +$ +5,543,078 +$ +5,922,389 +$ +5,671,874 +$ +6,188,465 +INCOME (LOSS) FROM OPERATIONS +$ +2,573,670 +$ +317,327 +$ +(2,070,668 +) +$ +(2,876,164 +) +$ +(4,580,193 +) +OTHER INCOME (EXPENSES): +(14,503 +) +(8,267 +) +121,898 +249,272 +(414,827 +) +NET INCOME (LOSS) +$ +2,559,167 +15 +% +$ +309,060 +2 +% +$ +(1,948,770 +) +-18 +% +$ +(2,626,892 +) +-28 +% +$ +(4,995,020 +) +-77 +% +Dividends accreted/payable in stock to preferred stockholders and a beneficial conversion feature +$ +- +- +- +5,645,310 +3,210,046 +NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS +$ +2,513,344 +$ +309,060 +-1,948,770 +-18 +% +-8,272,202 +-90 +% +-8,205,066 +-126 +% +Basic income (loss) per share +$ +0.04 +$ +(0 +) +$ +(0.03 +) +$ +(0.57 +) +$ +(0.80 +) +Diluted income (loss) per share +$ +0.04 +$ +(0 +) +$ +(0.03 +) +$ +(0.57 +) +$ +(0.80 +) +Weighted average number of shares outstanding, basic +$ +62,102,861 +$ +61,946,435 +$ +61,266,954 +$ +14,608,478 +$ +10,293,168 +Weighted average number of shares outstanding, diluted +$ +70,920,915 +$ +75,041,932 +$ +61,266,954 +$ +14,608,478 +$ +10,293,168 +Balance Sheet Data: +Working capital +$ +4,560,277 +$ +1,493,970 +$ +1,663,914 +$ +3,228,724 +$ +5,113,233 +Total assets +$ +9,086,174 +$ +6,315,250 +$ +5,914,941 +$ +6,584,997 +$ +7,906,577 +Total liabilities +$ +3,277,230 +$ +3,227,336 +$ +3,337,609 +$ +2,322,171 +$ +2,297,193 +Shareholders' equity (deficit) +$ +5,808,944 +$ +3,087,914 +$ +2,577,332 +$ +4,262,826 +$ +(939,807 +) +18 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +Overview +This discussion and analysis should be read in conjunction with the accompanying Consolidated Financial Statements and related notes. Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent liabilities at the financial statement date and reported amounts of revenue and expenses during the reporting period. On an ongoing basis we review our estimates and assumptions. Our estimates were based on our historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results are likely to differ from those estimates under different assumptions or conditions, but we do not believe such differences will materially affect our financial position or results of operations. Our critical accounting policies, the policies we believe are most important to the presentation of our financial statements and require the most difficult, subjective and complex judgments, are outlined below in ‘‘Critical Accounting Policies,’’ and have not changed significantly. +In addition, certain statements made in this report may constitute “forward-looking statements”. These forward-looking statements involve known or unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Specifically, 1) our ability to obtain necessary regulatory approvals for our products; and 2) our ability to increase revenues and operating income, is dependent upon our ability to develop and sell our products, general economic conditions, and other factors. You can identify forward-looking statements by terminology such as “may,” “could”, “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continues” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected-in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business. +All of the Company’s future products that are currently being developed are based on its patented Dual Path Platform (DPP®), which is a unique diagnostic point-of-care platform that has certain advantages over lateral flow technology. The Company has completed development of four products that employ the DPP® technology, two of which will be marketed under Chembio’s label (DPP® HIV 1/2 Screening Assay and DPP® Syphilis Screen & Confirm) and two that have been developed specifically related to private label agreements with The Oswaldo Cruz Foundation (“FIOCRUZ”) for the Brazilian public health market, as explained below. The DPP® HIV 1/2 Screening Assay will be manufactured as an OEM product for the Brazilian market pursuant to one of our agreements with FIOCRUZ. +The Company has a number of additional products under development that employ the DPP® technology. These product development activities are further described below. +All of the Company’s products other than its lateral flow tests (see PRODUCTS and Our Rapid Test Technologies) are based on the Company’s patented Dual Path Platform (DPP®) technology. The Company has had a very active research and development effort and has significantly increased its spending on research and development programs during the last three years. However, third party funding from research and development contracts and grants have more than offset these increased research and development expenses (excluding the $654,000 of 2010 clinical trials expenses and also excluding the benefit of the $1.467MM in QTDP grants awarded in 2010). These externally funded R&D programs have been instrumental in a number of very important ways: first, it has helped the Company to avoid raising capital during 2008-2010, which was a very difficult period for fundraising. Second, it has resulted in significant third party validations of our DPP® technology. Third, it has subsidized the Company in developing an increasing capability to develop, manufacture, validate, and scale up current and future DPP® products and product features. +19 +Research and development activity has been completed on seven DPP® products to date. Four were completed during 2007-2009 and three were completed during 2010. +The four DPP® products completed prior to 2010 are as follows: +1) +DPP® HIV 1/2 Confirmatory Test – See OEM DPP® Products, Oswaldo Cruz Foundation OEM DPP® Agreements +2) +DPP® HIV 1/2 Screening Test – See Regulatory Status below and OEM DPP® Products, Oswaldo Cruz Foundation Agreements +3) +DPP® Syphilis Screen & Confirm Test – See Regulatory Status below and OEM DPP® Products, Oswaldo Cruz Foundation Agreements +4) +DPP® Canine Leishmaniasis – See Regulatory Status and OEM DPP® Products, Oswaldo Cruz Foundation Agreements +Of the three DPP® products we completed development of during 2010, two relate to agreements we have with the Oswaldo Cruz Foundation (“FIOCRUZ”) for the Brazilian public health market. These are the DPP® products for Leptospirosis and a new Syphilis product (this is a single-parameter, treponemal-only version we developed for FIOCRUZ; our agreement further contemplates providing our Screen & Confirm product as soon as practicable. The third product we completed development of during 2010 is the multiplex product developed pursuant to a funded product development agreement we entered in 2008 with Bio-Rad Laboratories, Inc. (see OEM DPP® Products). +During 2010 we also completed the prototype of a six-parameter influenza immune-status product as per the specifications in a funded development contract we signed in December 2009 with the Battelle Memorial Institute (See OEM DPP® Products). +As we look forward in 2011, the Company has a number of ongoing and new development programs that employ the DPP® technology. These product development activities are further described below. +DPP® Influenza – We have developed a prototype multiplex test for FLU A/B Antigen Detection and we are on schedule to complete development and validation of this product by the end of the second quarter of 2011. Achievement of this plan will enable us begin clinical testing during the upcoming 2011-12 Flu season, submit the 510(k) application to the FDA in early 2012, and launch the product in the U.S. market in mid-2012. +DPP® Leptospirosis – In 2009 we were awarded a Small Business Innovative Research (SBIR) Phase II grant from the United States National Institutes of Health (NIH) to fully develop, validate, and commercialize a rapid diagnostic test for Leptospirosis for general use worldwide, and our work is progressing on schedule. As of March 1, 2011, we have identified several novel leptospiral proteins cloned from a variety of strains that are prevalent in different countries. These antigens will supplement the current test prototype and thus enhance the potential for its use worldwide as a universal point-of-care test for leptospirosis. +DPP® Tuberculosis – In February 2011 we were awarded an SBIR Phase II grant from the NIH to continue development of a simple, rapid, accurate, and cost-effective serological test for active tuberculosis that can be utilized in resource-limited settings. Chembio developed a prototype of this test in the Phase I work in collaboration with the Infectious Disease Research Institute (“IDRI”), a Seattle-based biotechnology research organization dedicated to technologies that address diseases in the developing world; this collaboration will continue in this second phase of the research and development grant as well. The grant is effective March 1, 2011. The prototype test developed during the Phase I work uses the Dual Path Platform (DPP®) technology together with selected antigens from a large panel of novel recombinant antigens identified at IDRI. The Phase I studies demonstrated the feasibility of developing a rapid and accurate test for tuberculosis with required diagnostic performance characteristics (sensitivity >80%, specificity >95%). In Phase II, the proposed rapid (15 minutes) point-of-care DPP® test for tuberculosis will be fully developed, optimized, and evaluated in multi-center clinical trials in several countries, followed by validation of production protocols, preparation for regulatory approval and commercialization +DPP® Hepatitis C and DPP® Hepatitis C (HCV) /HIV Oral Fluid Antibody Tests – In 2010 we received data from a study sponsored by the CDC that assessed the performance of our HCV product. The data confirmed that we had achieved good performance with this HCV antibody detection test prototype. We have recently been invited to participate in some additional CDC studies this year with this and certain other related prototype products that we have in development in this area. We have also determined however that the market opportunity for a point-of-care HCV antibody only (i.e., without antigen detection) test is very limited, and so in addition to improving our antibody detection test, we are also working on including antigen detection as well in a new DPP® format that we have in development, which format incorporates some of our platform enhancements (see below). We believe this could result in a more commercially viable market opportunity for this market. +Platform Enhancements - During 2010 and increasingly during 2011 we are improving and enhancing the capabilities of our DPP® technology. For example, we are further simplifying the procedure to run certain kinds of tests developed with DPP® and we are also making antibody and antigen detection available in a single test device. This is possible utilizing DPP® without certain limitations that are presented when this is attempted with lateral flow technology. We have also fully integrated the new automated assembly system into our manufacturing operation, which will make all of our production, both lateral flow and DPP®, more cost effective. +20 +Other Research & Development Activities - Chembio continues to work with commercial, governmental and private organizations in order to obtain R&D contracts & grant funding for development projects. These programs have subsidized the Company’s development expenses while expanding the applications for and know-how related to DPP® and creating important collaborative relationships. +There can be no assurance that any of these projects will continue, meet regulatory or other technical requirements and specifications, and/or that if continued, will result in completed products, or that such products, if successfully completed, will be successfully commercialized. +Regulatory Activities +Regulatory Approvals in Brazil through the Oswaldo Cruz Foundation (FIOCRUZ) – We have five active projects with FIOCRUZ. Two have obtained regulatory approval (See OEM DPP® Products, Oswaldo Cruz Foundation OEM). The three that are pending regulatory approval are updated as follows. +DPP® Canine Leishmaniasis: +In January 2011 FIOCRUZ was requested by MAPA for the second time to provide additional information. This will further delay the approval process and based upon recent experience it is difficult to predict timing. We believe there is strong support for this product within FIOCRUZ based on our discussions with them. +DPP® Leptospirosis: +Chembio has sent three production lots of this product to FIOCRUZ and FIOCRUZ is completing preparation of the technical file in order to submit it to ANVISA. FIOCRUZ estimates ANVISA approval will be granted during the second quarter of 2011. +DPP® Syphilis Treponemal: +Chembio has sent three production lots of this product to FIOCRUZ and FIOCRUZ is completing preparation of the technical file in order to submit it to ANVISA. FIOCRUZ estimates ANVISA approval will be granted during the second quarter of 2011. +DPP® HIV 1/2 Screening Assay for Oral Fluid – During 2010 we made significant progress toward commercializing this product. In March 2010, we obtained approval of this product from the United States PEPFAR program, and more recently we commenced clinical trials in the United States in support of, a planned Pre-Marketing Approval (PMA) application to the FDA. We have enrolled about half of the patients of the clinical protocol and are planning on completing this clinical trial this summer. We recently submitted a request to file a modular PMA to the FDA. This modular PMA approach provides a mechanism of submitting preclinical data and manufacturing information for review while still collecting, compiling and analyzing clinical data. The modular PMA is a compilation of three sections (“modules”); the first, second and third modules are being planned for submission to FDA in the first, second and third quarter, respectively. +DPP® Syphilis Screen & Confirm – We are completing the validation lots intended for clinical studies in the United States. Clinical studies are being scheduled for 2nd Quarter 2011 to support the FDA pre-market clearance (510k). The completion of these lots will also allow us to finish the required studies for self-certification of a CE Mark which we anticipate to file in 2nd quarter 2011. +CE Mark for Lateral Flow HIV tests – In order to meet the final requirement of the Common Technical Specifications we are required to collect data on blood donors at a blood donation center within the European Community. We experienced setbacks as many of the European blood centers experienced budget cutbacks resulting in reduced resources. We have currently identified a blood donation center in Europe and are in the process of scheduling with the site, which is anticipated to start the study sometime in the 2nd/3rd Quarter 2011. +Recent Events +During the fourth quarter of 2010 the Company was awarded $1.467 million in Qualified Therapeutic Discovery Project grants (“QTDP”) under Section 48D of the Internal Revenue Code, as enacted under the Patient Protection and Affordable Care Act of 2010. This was for six of the seven projects the Company submitted for consideration. This was reflected as a reduction in research and development expenses. +In November 2010, the Company entered into a new Technology Transfer Agreement with the Oswaldo Cruz Foundation of Brazil ("FIOCRUZ") relating to its DPP(R) point-of-care tests for Syphilis. Under the agreement, the Company will transfer technology to FIOCRUZ for two DPP® syphilis products. The transfer is anticipated to occur over a three-year period, requiring purchases by FIOCRUZ from the Company of these products and related components aggregating a minimum of $5.7 million over that period and also requiring a total of approximately $1.8 million of additional revenues to the Company during the fourth and fifth years This is the sixth technology transfer agreement, each covering a different product, entered into between Chembio and FIOCRUZ since 2004. +21 +RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2010 AS COMPARED WITH THE YEAR ENDED DECEMBER 31, 2009 +Net income : +Net income for the year ended December 31, 2010 increased to $2,513,300 from 309,060 for the year ended December 31, 2009. The primary factors for this increase are described below. +Revenues: +Selected Product Categories: +For the years ended +December 31, 2010 +December 31, 2009 +$ Change +% Change +HIV +$ +12,111,560 +$ +10,792,947 +$ +1,318,613 +12.22 +% +DPP +628,101 +619,530 +8,571 +1.38 +% +Other +776,698 +960,016 +(183,318 +) +-19.10 +% +Net Product Sales +13,516,359 +12,372,493 +1,143,866 +9.25 +% +License and royalty revenue +432,238 +121,896 +310,342 +254.60 +% +R&D, milestone and grant revenue +2,756,106 +1,339,859 +1,416,247 +105.70 +% +Total Revenues +$ +16,704,703 +$ +13,834,248 +$ +2,870,455 +20.75 +% +Revenues for our lateral flow HIV tests and related components during the year ended December 31, 2010 increased by $1.32 million over the same period in 2009. This was primarily attributable to increased sales to Ethiopia of $2.40 million, to $3.69 million in 2010, as compared with $1.29 million in 2009. This increase was partially offset by reduced sales to Brazil of lateral flow HIV tests, which decreased by 64.2%, or $1.47 million to $.82 million in 2010, as compared with $2.29 million in 2009. Sales of our DPP® products in 2010 were similar to levels in 2009. However most of the DPP® product sold in 2010 related to products that were approved for sale in Brazil as compared to products sold in 2009 which were used by FIOCRUZ in submissions to regulatory agencies for approval. The increase in R&D, milestone and grant revenue was primarily due to $1.55 million earned as a result of the completion of certain milestones. The milestones include $125,000 earned in June 2010 as a result of the completion of the milestone in our Bio-Rad agreement, $804,000 from Battelle for influenza immunity test and milestone fees of $400,000 and $225,000 from FIOCRUZ that were triggered upon the approval of the Company’s DPP® HIV 1/2 Screening Assay and its DPP® HIV 1/2 Confirmatory rapid tests, respectively. R&D revenues also include funds, recognized on an “as expenses are incurred” basis, from Phase II NIH grant for Leptospirosis, which was effective as of June 1, 2009. License and royalty revenue includes fee payments of $340,000 from Bio-Rad pursuant to the License Agreement we signed with them in January 2009 and for royalties from Brazil under our 2004 technology transfer and license agreement. +Gross Margin: +Gross Margin related to +For the years ended +Net Product Sales: +December 31, 2010 +December 31, 2009 +$ Change +% Change +Gross Margin per Statement of Operations +$ +8,100,699 +$ +5,860,405 +$ +2,240,294 +38.23 +% +Less: R&D, milestone, grant, license and royalties +3,188,344 +1,461,755 +1,726,589 +118.12 +% +Gross Margin from Net Product Sales +$ +4,912,355 +$ +4,398,650 +$ +513,705 +11.68 +% +Gross Margin % +36.34 +% +35.55 +% +The increase in our gross margin was primarily due to the increase in non-product revenues (see revenue items other than product sales - see revenues above). The increase in our product gross margin resulted primarily from reduced royalty expense due to product sold in 2010 to countries where a lower rate applies than in 2009. +22 +Research and Development: +This category includes costs incurred for product research and development, regulatory approvals, technical support, evaluations and registrations. +Selected expense lines: +For the years ended +December 31, 2010 +December 31, 2009 +$ Change +% Change +Clinical and Regulatory Affairs: +Wages and related costs +$ +424,038 +$ +321,830 +$ +102,208 +31.76 +% +Consulting +30,525 +35,560 +(5,035 +) +-14.16 +% +Share-based compensation +11,881 +12,916 +(1,035 +) +-8.01 +% +Clinical trials +654,253 +69,499 +584,754 +841.38 +% +Other +74,254 +32,056 +42,198 +131.64 +% +Total Regulatory +$ +1,194,951 +$ +471,861 +$ +723,090 +153.24 +% +R&D Other than Regulatory: +Wages and related costs +$ +1,889,702 +$ +1,541,295 +$ +348,407 +22.60 +% +Consulting +19,430 +88,600 +(69,170 +) +-78.07 +% +Share-based compensation +73,656 +62,180 +11,476 +18.46 +% +Materials and supplies +635,911 +462,806 +173,105 +37.40 +% +Other +239,534 +256,954 +(17,421 +) +-6.78 +% +Total other than Regulatory +$ +2,858,233 +$ +2,411,835 +$ +446,398 +18.51 +% +$ +4,053,184 +$ +2,883,696 +$ +1,169,488 +40.56 +% +Less: QTDP grant +1,466,876 +- +1,466,876 +100.00 +% +Total Research and Development +$ +2,586,308 +$ +2,883,696 +$ +(297,388 +) +-10.31 +% +Expenses for Clinical & Regulatory Affairs for the year ended December 31, 2010 increased by $723,000 as compared to the same period in 2009. This was primarily due to expenses we incurred in 2010 for clinical trials conducted for our DPP® HIV Screen Assay. In addition, wages and related costs also contributed to the increase. +R&D expenses other than Clinical & Regulatory Affairs increased by $446,000 in the year ended December 31, 2010 as compared with the same period in 2009 and were primarily related to an increase in personnel and material costs required to perform the work related to funded research and development contracts and grants all related to our patented DPP® technology. These increases were partially offset by a decrease in consulting cost. +On November 1, 2010, the Company was notified by the IRS that it received awards in the total amount of $1.467 million relating to six “Qualifying Therapeutic Discovery Projects” under the U.S. Patient Protection and Affordable Care Act of 2010 (P.L. 111-148), a program that was created as part of the major United States federal health care reform legislation enacted earlier this year. The $1.467 million reduced R&D expenses in the fourth quarter of 2010. +23 +Research and development expenses, before the QTDP grant, net of revenues from R&D, milestones and grants (see sub-heading Revenues above) was $1,297,000 for the year ended December 31, 2010 ($4,053,000 less $2,756,000, this includes clinical trials of $654,000 and does not include the QTDP reduction) compared to $1,174,000 ($2,884,000 less $1,340,000, this includes clinical trials of $69,000) for the same period in 2009. +Selling, General and Administrative Expense: +Selected expense lines: +For the years ended +December 31, 2010 +December 31, 2009 +$ Change +% Change +Wages and related costs +$ +1,076,446 +$ +1,075,532 +$ +914 +0.08 +% +Consulting +215,391 +165,371 +50,020 +30.25 +% +Commissons +183,762 +302,515 +(118,753 +) +-39.26 +% +Share-based compensation +64,429 +98,356 +(33,927 +) +-34.49 +% +Marketing materials +17,627 +22,779 +(5,152 +) +-22.62 +% +Investor relations/investment bankers +197,183 +72,888 +124,295 +170.53 +% +Legal, accounting and SOX 404 compliance +563,277 +470,843 +92,434 +19.63 +% +Travel, entertainment and trade shows +59,003 +61,316 +(2,313 +) +-3.77 +% +Other +563,603 +389,782 +173,821 +44.59 +% +Total S, G &A +$ +2,940,721 +$ +2,659,382 +$ +281,339 +10.58 +% +Selling, general and administrative expenses for the year ended December 31, 2010 increased by 10.6% as compared with the same period in 2009. This was primarily due to the recording of $94,000 in Brazilian tax withholdings on the milestone payments, an increase in investor relations and an increase in legal, accounting and SOX 404 expenses for compliance and for pursuing possible strategic opportunities, partially offset by a decrease in commissions as a result of lower sales in Brazil. +Other Income and Expense: +For the years ended +December 31, 2010 +December 31, 2009 +$ Change +% Change +Other income (expense) +$ +(3,923 +) +$ +(6,696 +) +$ +2,773 +-41.41 +% +Interest income +4,147 +9,032 +(4,885 +) +-54.09 +% +Interest expense +(14,727 +) +(10,603 +) +(4,124 +) +38.89 +% +Total Other Income and (Expense) +$ +(14,503 +) +$ +(8,267 +) +$ +(6,236 +) +75.43 +% +Other income and (expense) for the year ended December 31, 2010 decreased approximately $6,200 to $14,500 as compared with $8,300 for the same period in 2009, primarily as a result of an increase in interest expense due to the term loan with HSBC and a decrease in interest income due to a decrease in interest rates in interest-bearing accounts, both of which were partially offset by a lower loss on the sale of an asset in 2009 compared to a retirement of an asset in 2010. +24 +RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2010 AS COMPARED WITH THE THREE MONTHS ENDED DECEMBER 31, 2009 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF OPERATIONS +FOR THE THREE MONTHS ENDED +(UNAUDITED) +December 31, 2010 +December 31, 2009 +REVENUES: +Net product sales +$ +5,179,226 +$ +3,127,454 +License and royalty revenue +31,480 +38,186 +R&D, milestone and grant revenue +456,136 +385,801 +TOTAL REVENUES +5,666,842 +3,551,441 +Cost of product sales +3,175,984 +1,920,636 +GROSS MARGIN +2,490,858 +1,630,805 +OPERATING EXPENSES: +Research and development expenses +(236,147 +) +755,837 +Selling, general and administrative expenses +797,006 +657,309 +560,859 +1,413,146 +INCOME FROM OPERATIONS +1,929,999 +217,659 +OTHER INCOME (EXPENSES): +Other expense +- +- +Interest income +1,400 +1,949 +Interest expense +(4,800 +) +(2,394 +) +(3,400 +) +(445 +) +INCOME BEFORE INCOME TAXES +1,926,599 +217,214 +Provision for income taxes +45,823 +- +NET INCOME +$ +1,880,776 +$ +217,214 +Basic earnings per share +$ +0.03 +$ +0.00 +Diluted earnings per share +$ +0.03 +$ +0.00 +Weighted average number of shares outstanding, basic +62,204,742 +61,950,988 +Weighted average number of shares outstanding, diluted +70,513,280 +75,365,550 +See accompanying notes to consolidated financial statements +25 +Net Income : +Net income, on an unaudited basis, increased to $1,880,800 for the three months ended December 31, 2010 from $217,200 for the three months ended December 31, 2009. The primary factors for this increase are described below. +Revenues: +Selected Product Categories: +For the three months ended +December 31, 2010 +December 31, 2009 +$ Change +% Change +HIV +$ +4,379,098 +$ +2,963,671 +$ +1,415,427 +47.76 +% +DPP +621,580 +- +621,580 +100.00 +% +Other +178,548 +163,783 +14,765 +9.01 +% +Net Product Sales +5,179,226 +3,127,454 +2,051,772 +65.61 +% +License and royalty revenue +31,480 +38,186 +(6,706 +) +-17.56 +% +R&D, milestone and grant revenue +456,136 +385,801 +70,335 +18.23 +% +Total Revenues +$ +5,666,842 +$ +3,551,441 +$ +2,115,401 +59.56 +% +Revenues for our lateral flow HIV tests during the three months ended December 31, 2010 increased by approximately 48% or $1,415,000 over the same period in 2009. This was primarily attributable to increased sales in Africa which increased by $1,638,000 to $2,537,000, and partially offset by a decrease in sales to North America of $93,000. The increase in DPP® revenues was principally due to sales of our DPP® HIV Screen test. The increase in R&D revenues was primarily due to revenue from our contract development agreement with Bio-Rad and IDRI. License and royalty income represents our royalties from Brazil under our 2004 technology transfer and license agreement. +Gross Margin: +Gross Margin related to +For the three months ended +Net Product Sales: +December 31, 2010 +December 31, 2009 +$ Change +% Change +Gross Margin per Statement of Operations +$ +2,490,858 +$ +1,630,805 +$ +860,053 +52.74 +% +Less: R&D, milestone, grant, license and royalties +487,616 +423,987 +63,629 +15.01 +% +Gross Margin from Net Product Sales +$ +2,003,242 +$ +1,206,818 +$ +796,424 +65.99 +% +Gross Margin % +38.68 +% +38.59 +% +The increase in our product gross margin resulted primarily from reduced royalty expense due to product sold in 2010 to countries where a lower rate applies than in 2009. +26 +Research and Development: +This category includes costs incurred for regulatory approvals, product evaluations and registrations. +Selected expense lines: +For the three months ended +December 31, 2010 +December 31, 2009 +$ Change +% Change +Clinical and Regulatory Affairs: +Wages and related costs +$ +145,265 +$ +96,284 +$ +48,981 +50.87 +% +Consulting +- +5,610 +(5,610 +) +-100.00 +% +Share-based compensation +2,122 +4,667 +(2,545 +) +-54.53 +% +Clinical trials +253,461 +23,448 +230,013 +980.95 +% +Other +5,845 +7,852 +(2,007 +) +-25.56 +% +Total Regulatory +406,693 +137,861 +268,832 +195.00 +% +R&D Other than Regulatory: +Wages and related costs +583,285 +420,088 +163,197 +38.85 +% +Consulting +240 +25,052 +(24,812 +) +-99.04 +% +Share-based compensation +10,950 +9,722 +1,228 +12.63 +% +Materials and supplies +158,041 +102,491 +55,550 +54.20 +% +Other +71,520 +60,623 +10,897 +17.97 +% +Total other than Regulatory +$ +824,036 +617,976 +206,060 +33.34 +% +$ +1,230,729 +$ +755,837 +$ +474,892 +62.83 +% +Less: QTDP grant +1,466,876 +- +1,466,876 +100.00 +% +Total Research and Development +$ +(236,147 +) +$ +755,837 +$ +(991,984 +) +-131.24 +% +Expenses for Clinical & Regulatory Affairs for the three months ended December 31, 2010 increased by $269,000 as compared to the same period in 2009. This was primarily due to expenses we incurred in 2010 for clinical trials conducted for our DPP® HIV Screen Assay. In addition, wages and related costs also contributed to the increase. +R&D expenses other than Clinical & Regulatory Affairs increased by $206,000 in the year three months December 31, 2010 as compared with the same period in 2009 and were primarily related to an increase in personnel and material costs required to perform the work related to funded research and development contracts and grants all related to our patented DPP® technology. These increases were partially offset by a decrease in consulting cost. +On November 1, 2010, the Company was notified by the IRS that it received awards in the total amount of $1.467 million relating to six “Qualifying Therapeutic Discovery Projects” under the U.S. Patient Protection and Affordable Care Act of 2010 (P.L. 111-148), a program that was created as part of the major United States federal health care reform legislation enacted earlier this year. The $1.467 million reduced R&D expenses in the fourth quarter of 2010. +Research and development expenses, before the QTDP grant, net of revenues from R&D, milestones and grants (see sub-heading Revenues above) was $775,000 for the year three months December 31, 2010 ($1,231,000 less $456,000, this includes clinical trials of $253,000 and does not include the QTDP reduction) compared to $370,000 ($756,000 less $386,000, this includes clinical trials of $23,000) for the same period in 2009. +27 +Selling, General and Administrative Expenses: +Selected expense lines: +For the three months ended +December 31, 2010 +December 31, 2009 +$ Change +% Change +Wages and related costs +$ +332,824 +$ +324,131 +$ +8,693 +2.68 +% +Consulting +43,377 +22,250 +21,127 +94.95 +% +Commissons +83,526 +15,952 +67,574 +423.61 +% +Share-based compensation +11,549 +30,414 +(18,865 +) +-62.03 +% +Marketing materials +3,917 +5,419 +(1,502 +) +-27.72 +% +Investor relations/investment bankers +36,411 +35,839 +572 +1.60 +% +Legal, accounting and SOX 404 compliance +123,048 +123,500 +(452 +) +-0.37 +% +Travel, entertainment and trade shows +9,676 +13,849 +(4,173 +) +-30.13 +% +Other +152,678 +85,955 +66,723 +77.63 +% +Total S, G &A +$ +797,006 +$ +657,309 +$ +139,697 +21.25 +% +Selling, general and administrative expenses for the three months ended December 31, 2010 increased by 21.3% as compared with the same period in 2009. This was primarily due to an increase in commissions for the increased sales made to Brazil of our DPP® products, increase in consulting and an increase in board fees, partially offset by a decrease in share-based compensation. +Other Income and (Expense): +For the three months ended +December 31, 2010 +December 31, 2009 +$ Change +% Change +Other income +$ +- +$ +- +$ +- +100.00 +% +Interest income +1,400 +1,949 +(549 +) +-28.17 +% +Interest expense +(4,800 +) +(2,394 +) +(2,406 +) +100.50 +% +Total Other Income and (Expense) +$ +(3,400 +) +$ +(445 +) +$ +(2,955 +) +664.04 +% +Other income and (expenses) for the three months ended December 31, 2010 decreased approximately $3,000 as compared with the same period in 2009, primarily from an increase in interest expense due to the term loan with HSBC and a decrease in interest income due to a decrease in interest rates in interest-bearing accounts. +28 +LIQUIDITY AND CAPITAL RESOURCES +For the three months ended +December 31, 2010 +December 31, 2009 +$ Change +% Change +Net cash provided by operating activities +$ +1,016,850 +$ +251,927 +$ +810,746 +321.82 +% +Net cash used in investing activities +(182,292 +) +(376,988 +) +194,696 +-51.65 +% +Net cash provided by financing activities +233,558 +(18,926 +) +252,484 +-1334.06 +% +NET INCREASE IN CASH AND CASH EQUIVALENTS +$ +1,068,116 +$ +(143,987 +) +$ +1,257,926 +-873.64 +% +The Company had an increase in cash for the year ended December 31, 2010 which is primarily attributable to cash provided by operations and cash provided by financing activities ($250,000 term loan from HSBC). The decrease in the 2009 period is primarily attributable to the cash used in investing activities, which includes the purchase of fixed assets. The increased cash from operations in 2010 was primarily attributable to net income along with non-cash expenses aggregating $2,986,000. Net income includes the reduction of R&D expenses from the QTDP grants of $1,467,000, which if not granted in 2010, would result in the cash from net income, along with non-cash expenses, aggregating $1,519,000. In addition, operating activities included increase in accruals and payables of $150,000, a decrease in inventories of $207,000, a decrease in prepaid expenses of $62,000 and a decrease in other assets of $93,000, which were offset by an increase in receivables of $2,185,000 and a decrease in deferred revenue of $296,000. The decrease in deferred revenue was primarily due to the achievement of a milestone for which payment was received in January 2009 and for which there was no counterpart in 2010. The Company’s non-cash expenses totaled $554,000, which consisted of $284,000 from depreciation expense, $170,000 in share-based compensation expense and $100,000 in the amortization of licenses. Investing activities represent the Company’s investment in fixed assets. The cash provided from financing activities is primarily due to the term loan from HSBC of $250,000. +The increase in accounts receivable was due to the Company making most of the quarter's sales in December and has collected 67% as of March 1, 2011. +In addition on January 3, 2011, the Company made payment to Bio-Rad for the $875,000 due under the HIV-2 license agreement. +RECENT DEVELOPMENTS AND CHEMBIO’S PLAN OF OPERATIONS FOR THE NEXT TWELVE MONTHS +Chembio achieved record financial results in 2010 in every respect. The Company recorded a nearly 21% increase in total revenues in 2010 versus 2009. This increase was on the strength of a 118% increase of non-product revenues to a total of $3.19 million (license, royalty, R&D, milestone and grant revenues) versus $1.46 million in 2009, and also due to a 9.2% increase in Net Product Sales to $13.52 million from $12.37 million in 2009. Fourth quarter 2010 Total Revenues of $5.67 million represented an increase of 65% compared with the same period in 2009, and also represented an increase of 25.8% over the Company’s previous record quarterly revenues which were $4.51 million in the third quarter of 2010. The Net Product sales in the fourth quarter included strong performance from both international and US market sales of our lateral flow products, as well as from the first commercial shipment of our DPP® HIV oral fluid HIV test to FIOCRUZ in Brazil. +These strong top line results produced record gross profits, both in dollars and also as a percentage of sales. Our 2010 gross profit dollars increased over 38% from last year’s record gross profit dollars of $5.86 million, to $8.10 million or 49% of Total Revenues. Fourth quarter Gross profit was $2.49 million, also a record, and this was primarily based on the strength of our Net Product Sales in the quarter. +The record non-product revenues are attributable to continued progress in a number of development programs, all based on our DPP® technology, including significant accomplishments which further validated our platform and our capability to develop diagnostic products serving large markets and/or important health care objectives. These accomplishments include two regulatory approvals in Brazil, completion of performance specifications for multiplex products we were contracted to develop for Bio-Rad Laboratories, Inc. and for the US government’s contractor for pandemic flu preparedness, and several evaluations that were completed on our DPP® HIV Screening Assay for use with oral fluid or blood samples. +29 +Operating Expenses as reported in our audited results, which include Research & Development (R&D) Expenses as well as Selling, General and Administrative Expenses (“SGA”) were essentially unchanged from 2009. However these audited numbers include three uncommon expense items as compared to prior periods that need to be pointed out. First, SG&A expenses in 2010 included approximately $275,000 of expenses incurred in connection with two specific potential strategic opportunities, including approximately $100,000 for legal fees, including patent research and due diligence, $100,000 for outside directors' Special Committee fees, $37,500 for a valuation consultant deposit, $25,000 for investment consulting fees and $12,500 in various other expenses. One of these potential opportunities, which was unsolicited, involved due diligence, travel and negotiation, and preparation of an written agreement which was not finalized, and the other involved travel and extensive negotiations and due diligence. Both opportunities involved numerous meetings, conferences and discussions by and with management, Chembio's outside directors and counsel, both for internal strategy sessions and with the proposed strategic partner. Neither of the potential opportunities ultimately resulted in any material agreement. The Company’s senior management and board believes strongly in the value that has been created and the opportunities there are for further increasing shareholder value, particularly once it begins to commercialize the products in its development and clinical pipeline. Second, we recorded the benefit of the $1.467 million we received in Qualified Therapeutic Discovery Project (QTDP) grants in the fourth quarter of 2010, which amount was accounted for as a reduction in R&D Expense in that period. Finally, we expended approximately $650,000 of clinical trial expenses in 2010 related to our oral fluid HIV test PMA, including $250,000 in the fourth quarter. The $275,000 in strategic investigation costs in SG&A expenses, $1.467 million QTDP benefit (expense reduction), and the $650,000 clinical trial expense each had a material impact on our 2010 net income. +Our operating results in 2011 are likely to benefit from continued growth in sales to those customers and markets that we participated in during 2010, although there can be no assurance of this. We have recently reviewed the 2010 results with the marketing team we work with at Alere and we believe they are well positioned to deliver additional growth this year. We believe that Alere achieved at least 25% revenue growth with our products on their books in 2010 versus 2009, however due to inventory level changes at Alere this fact is not reflected in our 2010 results. Based on the two product approvals we received in Brazil in 2010, as well as three product approvals that are pending in Brazil, we anticipate significant revenues from this customer in 2011 as well, though there can be no assurance of this. We have additional opportunities in other markets for our products that we are developing which, if realized, would provide additional revenues for our products. +The $2.9 million Phase II grant award we received from the NIH in February, which is effective March 1, 2011, will help to subsidize our Operating Expenses, while also advancing the specific research and development aims of such grant. Chembio is budgeted to receive approximately 63.5% of the awarded amount, or approximately $1,842,700, if award funding continues over the full three years as is expected; IDRI would receive the balance as a subcontractor to Chembio. The grant award budget is approximately equal in each grant year, or approximately $967,000 per year. As in all such grants, award funding in the second and third years is subject to satisfactory progress and availability of funds. +We believe that the above-described anticipated product sales, as well as proceeds already received and/or anticipated from development fees, grants (including the QTDP grants), and milestone fees will be sufficient to fund our clinical and regulatory programs, which may exceed $2.0 million in costs during 2011, however there can be no assurance of this. Accordingly we need to manage all aspects of our costs to ensure that we do not compromise the timetable for commercializing our new products. The automated assembly equipment we installed and validated in 2010 is fully operational and should help us to reduce our manufacturing costs or offset other increases, as it already did in 2010. We believe certain quality control measures that we have implemented will also help to increase production yields, also lowering unit costs. We will nonetheless continually assess our Operating Expenses so as to ensure that our expenditures are aligned with our strategy and within our means. Our cash position, working capital, and shareholder equity is stronger than ever. As of March 1, 2011 we had a cash balance in excess of the balance reflected in our 2010 audited statements as a result of our collection, in January and February, of large accounts receivable balances reflected on our December 31 balance sheet, and even after paying off the $875,000 balance due to Bio-Rad Laboratories, Inc., which occurred in early January. We also have a $250,000 line of credit with our bank which has a zero balance. +We have made significant progress in completing the requirements for submitting our Pre-Marketing Approval (PMA) Application to the FDA for our DPP® HIV Screening Assay and the rate of progress is accelerating. We are approximately halfway through the clinical trials for this product and the trials are proceeding well. We recently submitted the first module in our PMA application to the FDA, we plan to submit our second module during the second quarter, and the third and final module during the third quarter. This timetable, if maintained, could result in an approval before the end of this year, although approval in 2012 is a much more likely scenario, although there can be no assurance even of this. We have also made significant progress in our Syphilis and Flu programs, even though we are delayed from the timetable we had previously anticipated. We are very excited about the opportunity we have to potentially be the first dual marker (treponemal and non-treponemal) POCT for syphilis in the United States. +We believe that our strategy of developing a core public health brand, initially with our DPP® HIV Oral Fluid test and our DPP® Syphilis Screen & Confirm test, supplemented by OEM opportunities in all other market segments, is sound, based upon what we have in our pipeline today. Recent studies published by the CDC confirm the value of our dual marker DPP® Syphilis Screen & Confirm test, and we believe that there are sales opportunities in the U.S. and international rapid HIV test markets for our DPP® oral fluid HIV test that are not available to our lateral flow whole blood tests. We may identify other product opportunities that cause us to modify this strategy. +We will also need to begin to develop our sales and marketing organization, and brand, as we get closer to commercialization of our products. While this is a costly investment, it should enable us to retain a larger portion of our unit selling prices which, if that occurs, will result in our having higher sales and gross margins, though also higher marketing expenses. +30 +Critical Accounting Policies and Estimates +The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates. +We believe that there are several accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amounts of revenue and the more significant areas involving management’s judgments and estimates. These significant accounting policies relate to revenue recognition, research and development costs, valuation of inventory, valuation of long-lived assets and income taxes. These policies, and the related procedures, are described in detail below. +Revenue Recognition – +We recognize revenue for product sales in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). Under SAB 104, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is determinable, and collectability is reasonably assured. Revenue typically is recognized at time of shipment. Sales are recorded net of discounts, rebates and returns. +For certain contracts, we recognize revenue from R&D, milestone and grant revenues when earned. Grants are invoiced after expenses are incurred. Revenues from projects or grants funded in advance are deferred until earned. +For certain collaborative research projects, we recognize revenue by defining milestones at the inception of the agreement and applying the milestone method of revenue recognition for relevant contracts. +Research & Development Costs – +Research and development activities consist primarily of new product development, continuing engineering for existing products, regulatory and clinical trial costs. Costs related to research and development efforts on existing or potential products are expensed as incurred. +Valuation of Inventories – +Inventories are stated at the lower of cost or market, using the first-in, first-out method (FIFO) to determine cost. Our policy is to periodically evaluate the market value of the inventory and the stage of product life cycle, and record a reserve for any inventory considered slow moving or obsolete. For example, each additional 1% of obsolete inventory would reduce such inventory by approximately $14,000. +Allowance for doubtful accounts – +Our policy is to review our accounts receivable on a periodic basis, no less than monthly. On a quarterly basis an analysis is made of the adequacy of our allowance for doubtful accounts and adjustments are made accordingly. The current allowance is approximately 1% of accounts receivable. For example each additional 1% of accounts receivable that becomes uncollectible would reduce such balance of accounts receivable by approximately $40,000. +Income Taxes – +Income taxes are accounted for under Financial Accounting Standards Board (“FASB”) authoritative guidance (“Guidance”) which requires the asset and liability method of accounting for deferred income taxes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities. Deferred tax assets or liabilities at the end of each period are determined using the tax rate expected to be in effect when taxes are actually paid or recovered. For example, even though we have become profitable, we may be unable to utilize our deferred tax asset, which approximates $7,246,000 at December 31, 2010. +The Guidance also requires that a valuation allowance be established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence needs to be considered, including a company’s current and past performance, the market environment in which the company operates, length of carryback and carryforward periods and existing contracts that will result in future profits. +Forming a conclusion that a valuation allowance is not needed is difficult when there is negative objective evidence such as cumulative losses in recent years. Cumulative losses weigh heavily in the overall assessment. As a result, we determined that it was appropriate to establish a valuation allowance for the full amount of our deferred tax assets. +The Guidance also prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the consolidated financial statements tax positions taken or expected to be taken on a tax return, including a decision whether to file or not to file in a particular jurisdiction. +The calculation of our tax liabilities involves the inherent uncertainty associated with the application of complex tax laws. We are subject to examination by various taxing authorities. We believe that as a result of our losses sustained to date, any examination would result in a reduction of our net operating losses rather than a tax liability. As such, we have not provided for additional taxes. +31 +The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles, generally accepted in the United States of America, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any viable alternative would not produce a materially different result. See our audited financial statements and notes thereto which contain accounting policies and other disclosures required by accounting principles generally accepted in the United States of America. +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The Consolidated Financial Statements and schedules that constitute Item 8 are attached at the end of this Annual Report on Form 10-K. An index to these Financial Statements and schedules is also included on page F-1 of this Annual Report on Form 10-K. +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. +There have been no disagreements, or transactions or events similar to those which involved such disagreements or reportable events, with former accountants on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of the former accountant, would have caused it to make reference to the subject matter disagreements in connection with any of its reports. +ITEM 9A. +CONTROLS AND PROCEDURES +(a) Disclosure Controls and Procedures. Under the supervision and with the participation of our senior management, consisting of our chief executive officer and our chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report (the "Evaluation Date"). Based on that evaluation, the Company’s management, including our chief executive officer and chief financial officer, concluded that as of the Evaluation Date our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our Exchange Act reports is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. +Management's Annual Report on Internal Control Over Financial Reporting. The Company's management is responsible for establishing and maintaining an adequate system of internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)). Our internal control over financial reporting is a process, under the supervision of our chief executive officer and chief financial officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. These internal controls over financial reporting processes include policies and procedures that: +(1) +Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(2) +Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(3) +Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives. +In evaluating the effectiveness of our internal control over financial reporting, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2010. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. +Management's report was not subject to attestation by our registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report. +(b) Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the Company’s last fiscal quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +ITEM 9B. +OTHER INFORMATION +Not applicable. +32 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +Directors and Executive Officers +Lawrence A. Siebert (54), President, Chief Executive Officer and Director. Mr. Siebert was appointed President of Chembio Diagnostics, Inc. and a member of our board of directors upon consummation of the merger. Mr. Siebert has been Chairman of Chembio Diagnostic Systems Inc. for approximately thirteen years and its President since May 2002. Mr. Siebert’s background is in private equity and venture capital investing. From 1982 to 1991, Mr. Siebert was associated with Stanwich Partners, Inc, which during that period invested in middle market manufacturing and distribution companies. From 1992 to 1999, Mr. Siebert was an investment consultant and business broker with Siebert Capital Corp. and Siebert Associates LLC, and was a principal investor in a privately held test and measurement company which was sold in 2002. Mr. Siebert received a JD from Case Western Reserve University School of Law in 1981 and a BA with Distinction in Economics from the University of Connecticut in 1978. Mr. Siebert as president and CEO is an integral part of the Chembio management team. His experience in the rapid test field and financing markets made him an excellent candidate for serving on the board and as its chairman. +Richard J. Larkin (54), Chief Financial Officer. Mr. Larkin was appointed as Chief Financial Officer of Chembio Diagnostics, Inc. upon consummation of the merger in 2004. Mr. Larkin oversees our financial activities and information systems. Mr. Larkin has been the Chief Financial Officer of Chembio Diagnostic Systems Inc. since September 2003. Prior to joining Chembio Diagnostic Systems Inc., Mr. Larkin served as CFO at Visual Technology Group from May 2000 to September 2003, and also led their consultancy program that provided hands-on expertise in all aspects of financial service, including the initial assessment of client financial reporting requirements within an Enterprise Resource Planning (Manufacturing) environment through training and implementation. Prior to joining VTG, he served as CFO at Protex International Corporation from May 1987 to January 2000. Mr. Larkin holds a BBA in Accounting from Dowling College and is a member of the American Institute of Certified Public Accountants. +Javan Esfandiari (44), Executive VP of Research and Development. Mr. Esfandiari joined Chembio Diagnostic Systems, Inc, in 2000. Mr. Esfandiari co-founded, and became a co-owner of Sinovus Biotech AB where he served as Director of Research and Development concerning lateral flow technology until Chembio Diagnostic Systems Inc. acquired Sinovus Biotech AB in 2000. From 1993 to 1997, Mr. Esfandiari was Director of Research and Development with On-Site Biotech/National Veterinary Institute, Uppsala, Sweden, which was working in collaboration with Sinovus Biotech AB on development of veterinary lateral flow technology. Mr. Esfandiari received his B.Sc. in Clinical Chemistry and his M. Sc. in Molecular Biology from Lund University, Sweden. He has published articles in various veterinary journals and has co-authored articles on tuberculosis serology with Dr. Lyashchenko. +Richard Bruce (57), Vice President, Operations. Mr. Bruce was hired in April 2000 as Director of Operations. He is responsible for manufacturing, maintenance, inventory, shipping, receiving, and warehouse operations. Prior to joining Chembio Diagnostic Systems Inc., he held director level positions at Wyeth Laboratories from 1984 to 1993. From 1993 to 1998, he held various management positions in the Operations department at Biomerieux. From 1998 to 2000, he held a management position at V.I. Technologies. Mr. Bruce has over thirty years of operations management experience with Fortune 500 companies in the field of in-vitro diagnostics and blood fractionation. Mr. Bruce received his BS in Management from National Louis University in 1997. +Tom Ippolito (48), VP of Regulatory Affairs, QA and QC. Mr. Ippolito joined Chembio in June 2005. He has over twenty years experience with in vitro diagnostics for infectious diseases, protein therapeutics, vaccine development, Process Development, Regulatory Affairs and Quality Management. Over the years, Mr. Ippolito has held Vice President level positions at Biospecific Technologies, Corp. from 2000 - 2005, Director level positions in Quality Assurance, Quality Control, Process Development and Regulatory Affairs at United Biomedical, Inc. from 1987 - 2000. Mr. Ippolito is the Course Director for “drug development process” and “FDA Regulatory Process” for the BioScience Certificate Program at the New York State University of Stony Brook, a program he has been a part of since its inception in 2003. +Dr. Gary Meller (60), Director. Dr. Meller was elected to our Board of Directors on March 15, 2005, and currently serves on the Company’s Audit, Compensation and Nominating and Corporate Governance Committees, including as Chairman of the Compensation Committee. Dr. Meller also served as Chairman of the Board of Directors’ Special Committee for handling certain strategic opportunities. Dr. Meller has been the president of CommSense Inc., a healthcare business development company, since 2001. CommSense Inc. works with clients in Europe, Asia, North America, and the Middle East on medical information technology, medical records, pharmaceutical product development and financing, health services operations and strategy, and new product and new market development. From 1999 until 2001 Dr. Meller was the executive vice president, North America, of NextEd Ltd., a leading internet educational services company in the Asia Pacific region. Dr. Meller also was a limited partner and a member of the Advisory Board of Crestview Capital Master LLC, which was our largest stockholder. Dr. Meller is a graduate of the University of New Mexico School of Medicine and has an MBA from the Harvard Business School. Dr. Meller’s experience in the medical field both domestic and foreign (especially his experience with CommSense Inc.) as well as his financing experience made him an excellent candidate for serving on the board. +33 +Kathy Davis (54), Director. Ms. Davis was elected to the Company’s Board of Directors in May 2007, and currently serves on the Board of Director’s Audit, Compensation and Nominating And Corporate Governance Committees, including as Chairman of each of the Audit Committee and the Nominating And Corporate Governance Committee. Ms. Davis also served on the Boards’ Special Committee for handling certain strategic opportunities. Since January 2007, Ms. Davis has been the owner of Davis Design Group LLC, a company that provides analytical and visual tools for public policy design. Previously, from February 2005 to December 2006, she served as the Chief Executive Officer of Global Access Point, a start-up company with products for data transport, data processing, and data storage network and hub facilities. From October 2003 to January 2005, Ms. Davis was Lieutenant Governor of the State of Indiana, and from January 2000 to October 2003 was Controller of the City of Indianapolis. From 1989 to 2003, Ms. Davis held leadership positions with agencies and programs in the State of Indiana including State Budget Director, Secretary of Family & Social Services Administration, and Deputy Commissioner of Transportation. From 1982 to 1989 Ms. Davis held increasingly senior positions with Cummins Engine, where she managed purchasing, manufacturing, engineering, and assembly of certain engine product lines. Ms. Davis also led the startup of and initial investments by a $50 million Indiana state technology fund, serves on the not-for-profit boards of Noble of Indiana, University of Evansville Institute of Global Enterprise, Purdue College of Science Dean’s Leadership Council and Indiana University School of Public and Environmental Affairs Dean’s Advisory Council. She has a Masters of Business Administration from Harvard Business School and a Bachelor of Science in Mechanical Engineering from the Massachusetts Institute of Technology. Ms. Davis has varied experience in business, political and financial areas made her an excellent candidate for serving on the board. +Section 16(a) Beneficial Ownership Reporting Compliances +Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires the Company’s directors, executive officers and beneficial owners of more than 10% of the Company’s common stock to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of common stock and other equity securities of the Company. The Company believes that during the year ended December 31, 2010, each person who was an officer, director and beneficial owner of more than 10% of the Company’s common stock complied with all Section 16(a) filing requirements, except for the following: (i) One Form 4 for Gary Meller filed on May 18, 2010 that covered one report and one transaction and one Form 4/A filed on December 20, 2010 covering one report with one transaction that were not reported on a timely basis; (ii) one Form 4 for Lawrence Siebert filed on December 21, 2010 that covered one report and two transactions; (iii) one Form 4 for Javan Esfandiari filed on March 18, 2010 that covered one report and one transaction; and (iv) one Form 4 for Katherine Davis that covered one report and two transactions. +Code of Ethics +The Company has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer, controller, and persons performing similar functions. A copy of the Company’s code of ethics is available on the Company’s website at www.chembio.com. +Identification of Audit Committee; Audit Committee Financial Expert +The Company’s board of directors has established an audit committee. Katherine L. Davis and Dr. Gary Meller each serves on the audit committee, with Ms. Davis serving as chairman. The Company’s board of directors has determined that Ms. Davis is an audit committee financial expert and is independent. +34 +ITEM 11. EXECUTIVE COMPENSATION +The following table summarizes all compensation recorded by the Company in each of the last two completed fiscal years for our principal executive officer and our two most highly compensated executive officers other than our principal executive officer whose annual compensation exceeded $100,000. +Name / Principal Position +Year +Salary 1 +($) +Bonus 2 +($) +Option Awards 3 +($) +Stock Awards +($) +All Other Compensation 5 +($) +Total +($) +Lawrence A. Siebert 4 +2010 +$ +265,000 +$ +99,375 +$ +- +$ +- +$ +7,200 +$ +371,575 +CEO +2009 +265,000 +110,200 +37,950 +- +7,200 +420,350 +Javan Esfandiari +2010 +$ +230,192 +$ +80,850 +$ +66,030 +$ +- +$ +4,800 +$ +381,872 +VP-R&D +2009 +230,192 +29,400 +28,200 +5,000 +4,883 +297,675 +Tom Ippolito +2010 +$ +185,815 +$ +42,656 +$ +- +$ +- +$ +- +$ +228,471 +VP-Regulatory +2009 +181,500 +35,600 +21,150 +- +140 +238,390 +1 Salary is total base salary. +2 Bonuses earned in 2010 and 2009 were partially based on reaching certain objectives, which included revenue dollar levels and operating profit levels, additional amounts earned were discretionary. +3 The estimated fair value of any option or common stock granted was determined in accordance with ASC 718, "Share-Based Payment". +4 Mr. Siebert also serves as a director on the Company’s board of directors. Mr. Siebert does not receive any compensation for this director role. +5 Other compensation includes an employer match to 401(K) contributions and car allowances where applicable. +Employment Agreements +Mr. Siebert. Effective May 11, 2009, the Company’s Board of Directors approved the Company’s extension of the June 15, 2006 employment agreement (the “Employment Agreement”) with Lawrence A. Siebert, the Company’s President and Chief Executive Officer, for an additional three-year term through May 11, 2012. On June 15, 2006, Mr. Siebert and the Company entered into an Employment Agreement, effective May 10, 2006, which was to terminate on May 10, 2008, extended in 2008 to May 10, 2009. Pursuant to the Employment Agreement, Mr. Siebert serves as the President and Chief Executive Officer of the Company and received an initial salary of $240,000 per year, which had been increased to $265,000 per year until Mr. Siebert agreed to a 15 percent reduction, to $225,000, effective January 19, 2009. Mr. Siebert’s salary was restored to $265,000 per annum effective in July 2009. Mr. Siebert also is eligible for a bonus of up to 50% of his salary, consisting of (i) a bonus of up to 25% of his salary that is at the complete discretion and determination of the board of directors, and (ii) a bonus of up to an additional 25% of his salary that will be determined based upon revenue and earnings performance criteria established each year by the board of directors. Mr. Siebert is eligible to participate in any profit sharing, stock option, retirement plan, medical and/or hospitalization plan, and/or other benefit plans except for disability and life insurance that the Company may from time to time place in effect for the Company’s executives during the term of Mr. Siebert’s employment agreement. If Mr. Siebert’s Employment Agreement is terminated by the Company without cause, or if Mr. Siebert terminates his Employment Agreement for a reasonable basis, as defined in the Employment Agreement, including within 12 months of a change in control, the Company is required to pay as severance Mr. Siebert’s salary for six months. Mr. Siebert has agreed for a period of two years after the termination of his employment with the Company not to induce customers, agents, or other sources of distribution of the Company’s business under contract or doing business with the Company to terminate, reduce, alter, or divert business with or from the Company. The terms of the extended May 11, 2009 and May 11, 2008 Employment Agreements are identical to the June 15, 2006 Employment Agreement, except that under the May 11, 2008 extended Employment Agreement, Mr. Siebert received additional consideration in the form of incentive stock options to purchase 250,000 shares of the Company’s common stock exercisable at $0.13 per share, which was the closing price of the Company's common stock on June 3, 2008. The incentive stock options are immediately exercisable and they expire on the June 3, 2013. +Mr. Esfandiari. The Company entered into an employment agreement dated March 4, 2010, and to be effective March 5, 2010 (the "Employment Agreement"), with Mr. Esfandiari to continue as the Company's Senior Vice President of Research and Development for an additional term of three years through May 5, 2013. Mr. Esfandiari's salary under the Employment Agreement is $245,000 for the first year, $255,000 for the second year, and $265,000 for the final year. Mr. Esfandiari is eligible for a cash bonus of up to 50% of his base salary for each respective year, consisting of (i) a cash bonus of up to 30% of his calendar year base salary based on the performance of the Company's Dual Path Platform Technology, which is directly related to certain annual revenue targets budgeted by management of the Company; (ii) a cash bonus of up to 10% of his calendar year base salary based on the attainment of certain specific research and development objectives, as determined by the Board, and (iii) a cash bonus of up to 10% of his calendar year base salary that is at the complete discretion and determination of the board of directors. The Company also granted Mr. Esfandiari, pursuant to the Company's 2008 Stock Incentive Plan, incentive stock options to purchase 300,000 shares of the Company's common stock. The price per share of these options is equal to the fair market value of the Company's common stock as of the close of the market on March 5, 2010, which is the date on which the Agreement was effective. Of these stock options, options to purchase 100,000 shares vest on the effective date, options to purchase an additional 100,000 shares of the stock options vest on the second anniversary of the Employment Agreement, and options to purchase an additional 100,000 shares of the stock options vest on the third anniversary of the Employment Agreement. Mr. Esfandiari is eligible to participate in any profit sharing, stock option, retirement plan, medical and/or hospitalization plan, and/or other benefit plans except for disability and life insurance that the Company may from time to time place in effect for the Company’s executives during the term of Mr. Esfandiari’s employment agreement. If Mr. Esfandiari’s employment agreement is terminated by the Company without cause, or if Mr. Esfandiari terminates his employment agreement for a reasonable basis, as defined in the Employment Agreement, including within 12 months of a change in control, the Company is required to pay as severance Mr. Esfandiari’s salary for twelve months. +35 +Mr. Ippolito does not have an employment contract with the Company. +Executive Bonus Plan +The Company has established a bonus plan for its executives who do not have a contract. For the fiscal year ended December 31, 2010, there were three executives eligible for this bonus plan. Each executive can earn up to 25% of that executive’s salary in the form of a bonus. The Compensation Committee determined that 40% of the executive’s bonus will be quantitative factors, based on the budget. 60% will be based on other factors; with one-half of the 60% (or 30%) based on management objectives, and the other one-half of the 60% (or 30%) will be discretionary. The plan, during 2010 for the 40%, called for a sliding percentage of the executive’s salary, from zero to 5% for attaining 85% to 100% of revenue goals, and from zero to 5% of the executive’s salary for attaining between zero percent to 150% of the designated operating profit goals. The Company achieved 93% of its revenue goals for 2010, resulting in a bonus of 2.75 of each executive’s salary, and achieved greater than 95% of its operating profit goal, resulting in a bonus of 2.25% of salary, for a total of 5% of salary. In addition, the Compensation Committee approved 7.5% of salary in discretionary bonuses for the subject executives and 7.5% in management objectives, bringing the total plan bonus to approximately 20% of salary. In addition, outside of the plan, the compensation committee awarded an additional 2.75% in bonuses in recognition outstanding overall efforts and accomplishments, making the total bonus for 2010 equal to 22.75% of base pay. Goals for 2011 have not yet been established. +OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END 2010 +Option Awards +Stock Awards +Name +Number of Securities Underlying Unexcercised Options Excerciseable (#) +Number of Securities Underlying Unexcercised Options Unexcersable (#) +Option Exercise Price ($) +Option Expiration Date +Option Vesting Date +Number of Shares of Stock That Have Not Vested (#) +Market Value of Shares of Stock That Have Not Vested ($) +Foot- +note +Lawrence A. Siebert +133,333 +0.13 +5/6/2014 +5/6/2012 +5 +133,333 +0.13 +5/6/2014 +5/7/2011 +5 +133,333 +0.13 +5/6/2014 +5/6/2010 +5 +250,000 +0.13 +6/3/2013 +6/3/2008 +3 +75,000 +0.22 +2/15/2013 +2/15/2008 +2 +50,000 +0.13 +5/28/2011 +1/1/2007 +1, 4 +50,000 +0.13 +5/28/2011 +4/17/2006 +1, 4 +10,000 +0.13 +5/4/2011 +4/17/2006 +4 +50,000 +0.13 +5/4/2011 +5/5/2004 +4 +Javan Esfandiari +100,000 +0.13 +5/6/2014 +5/6/2012 +5 +100,000 +0.13 +5/6/2014 +5/7/2011 +5 +100,000 +0.13 +5/6/2014 +5/6/2010 +5 +100,000 +0.13 +4/23/2012 +3/5/2009 +1, 4 +100,000 +0.13 +4/23/2012 +3/5/2008 +1, 4 +60,000 +0.22 +2/15/2013 +2/15/2008 +2 +25,000 +0.13 +5/28/2011 +5/28/2007 +4 +100,000 +0.13 +4/23/2012 +4/23/2007 +1, 4 +18,750 +0.13 +3/24/2011 +1/1/2007 +4 +25,000 +0.13 +5/17/2010 +1/1/2007 +4 +25,000 +0.13 +5/28/2011 +4/17/2006 +1, 4 +25,000 +0.13 +5/28/2011 +4/17/2006 +1, 4 +5,000 +0.13 +5/4/2011 +4/17/2006 +4 +25,000 +0.13 +5/17/2010 +4/17/2006 +4 +18,750 +0.13 +3/24/2011 +3/24/2006 +4 +30,000 +0.13 +5/4/2011 +5/5/2004 +4 +Tom Ippolito +75,000 +0.13 +5/6/2014 +5/6/2012 +5 +75,000 +0.13 +5/6/2014 +5/7/2011 +5 +75,000 +0.13 +5/6/2014 +5/6/2010 +5 +50,000 +0.22 +2/15/2013 +2/15/2008 +2 +15,000 +0.13 +3/24/2011 +3/24/2006 +4 +1 Stock issued in connection with an employment contract and under the 1999 Stock Option Plan. +2 On February 15, 2008 the Company granted options under the 1999 Stock Option Plan. +3 Options issued in connection with an employment contract and under the 2008 Stock Incentive Plan. +4 On May 7, 2009, the Compensation Committee of the Company reduced, to $0.13 per share, the exercise price of each outstanding employee option that was issued under the 1999 Equity Incentive Plan (the “1999 Plan”) for which the exercise price was greater than $0.44 per share of the Company’s common stock. There was no other change made to the terms of the stock options other than the reduction in the exercise price. A total of 1,036,750 options were affected and the fair value difference of the options before and after the reduction was $31,660 and was expensed in the three months ended June 30, 2009. +5 On May 7, 2009 in accordance with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 2,925,000 shares of the Company’s common stock. The exercise price for these options is equal to $0.13 per share. The options become exercisable in thirds on the first, second and third anniversaries of the date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the date of grant. The fair value of these options is being amortized over the vesting life of the options. +36 +DIRECTOR COMPENSATION +Name +Fees Earned or Paid in Cash ($) 1 +Option Awards +($) 2 +Total +($) +Katherine L. Davis +$ +69,500 +$ +- +$ +69,500 +Gary Meller +86,500 +$ +- +86,500 +1 Fees earned or paid in cash represents a yearly fee and fees for meeting expenses: (a) Ms. Davis received an $18,000 annual fee as a member of the board of directors, a $2,500 annual fee as audit committee chairman, $40,000 as a member of a special committee and $9,000 in meeting fees paid during 2010; (b) Mr. Meller received an $18,000 annual fee as a member of the board of directors, $60,000 as a member of a special committee and $9,000 in meeting fees. +2 Each outside member of the board of directors is granted, once every five years, the right to purchase 375,000 shares of the company’s common stock with an exercise price equal to the market price on the date of the grant as part of their annual compensation. One-fifth of these options are exercisable on the date of grant, one-fifth become exercisable on the first anniversary of the date of grant, and additional one-fifths become exercisable on the second through fourth anniversary of the date of grant. The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model. +Director Compensation +All non-employee directors are paid an $18,000 annual retainer in semi-annual payments, and once every five years, on the date of the annual meeting of stockholders that directors are elected or re-elected (every 5 years), receive stock options to acquire, subject to vesting as described below, 375,000 shares of the Company's common stock, with an exercise price equal to the market price on the date of the grant. Stock options to acquire 75,000 shares become exercisable on the date of grant, and options to acquire an additional 75,000 shares become exercisable on the date of each of the four succeeding annual meetings of stockholders if and to the extent that the non-employee director is reelected as a director at each such annual meeting. The audit committee chairman is paid an annual retainer of $2,500, paid semi-annually. In addition, the non-employee directors are paid $1,000 in cash for each board of directors' meeting attended, and paid $500 in cash for each telephonic board of directors meeting. The non-employee directors who are members of a committee of the board of directors are paid $500 in cash for each committee meeting attended, or $750 in cash for each committee meeting attended if that non-employee director is the committee chairman. Directors also may be paid for serving ad hoc committees of the Board. In fact, when the Board established its Special Committee in 2010 to handle the possible sale of the Company, the Chairman of the Committee was paid $12,000 per month, and the other director-member of the Committee was paid $8,000 per month. +Compensation Committee Interlocks and Insider Participation +No executive officer of the Company served as a member of the Board of any other public company during the year ended December 31, 2010. No member of the Compensation Committee serves as an executive officer of any other public company during the year ended December 31, 2010. No interlocking relationship exists between the members of our Compensation Committee and the Board or compensation committee of any other company. +37 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The following table sets forth certain information regarding the beneficial ownership of our common stock by each person or entity known by us to be the beneficial owner of more than 5% of the outstanding shares of common stock, each of our directors and each of our “named executive officers” and all of our directors and executive officers as a group as of March 1, 2011. +Name and Address of Beneficial Owner +Amount and Nature of Beneficial Owner +Percent of Class +Siebert, Lawrence (1) +3661 Horseblock Road +Medford, NY 11763 +6,871,715 +10.93% +Esfandiari, Javan (2) +3661 Horseblock Road +Medford, NY 11763 +977,573 +1.55% +Larkin, Richard (3) +3661 Horseblock Road +Medford, NY 11763 +359,338 +0.58% +Ippolito, Tom (4) +3661 Horseblock Road +Medford, NY 11763 +140,000 +0.22% +Bruce, Richard (5) +3661 Horseblock Road +Medford, NY 11763 +210,075 +0.34% +Meller, Gary (6) +3661 Horseblock Road +Medford, NY 11763 +598,000 +0.96% +Davis, Katherine L. (7) +3661 Horseblock Road +Medford, NY 11763 +238,366 +0.38% +GROUP (8) +9,395,067 +14.58% +Alere, Inc. +51 Sawyer Road, Suite 200 +Waltham, MA 02453 +5,367,840 +8.62% +Crestview Capital Offshore Fund, Inc. +95 Revere Drive, Suite A +Northbrook, IL 60062 +3,177,950 +5.11% +Beneficial ownership is determined in accordance with the Rule 13d-3(a) of the Securities Exchange Act of 1934, as amended, and generally includes voting or investment power with respect to securities. Except as subject to community property laws, where applicable, the person named above has sole voting and investment power with respect to all shares of our common stock shown as beneficially owned by him. +The beneficial ownership percent in the table is calculated with respect to the number of outstanding shares (62,240,483) of the Company's common stock outstanding as of March 1 , 2011. Each stockholder's ownership is calculated as the number of shares of common stock owned plus the number of shares of common stock into which any preferred stock, warrants, options or other convertible securities owned by that stockholder can be converted within 60 days. +The term “named executive officer” refers to our principal executive officer, our two most highly compensated executive officers other than the principal executive officer who were serving as executive officers at the end of 2010, and two additional individuals for whom disclosure would have been provided but for the fact that the individuals were not serving as executive officers of the Company at the end of 2010. +38 +(1) +Includes 618,333 shares issuable upon exercise of options exercisable within 60 days. Does not include 266,667 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(2) +Includes 707,500 shares issuable upon exercise of options exercisable within 60 days. Does not include 400,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(3) +Includes 204,166 shares issuable upon exercise of options exercisable within 60 days. Does not include 183,334 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(4) +Includes 140,000 shares issuable upon exercise of options exercisable within 60 days. Does not include 150,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(5) +Includes 185,000 shares issuable upon exercise of options exercisable within 60 days. Does not include 150,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(6) +Includes 198,000 shares issuable upon exercise of options exercisable within 60 days. Does not include 300,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(7) +Includes 150,650 shares issuable upon exercise of options exercisable within 60 days. Does not include 300,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(8) +Includes footnotes (1)-(8) +. +Equity Compensation Plan Information +Combined Equity Compensation Plans - Information as of December 31, 2010 +Plan Category +Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights +Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights +Number of Securities Remaining Available for Future Issuance under Equity Compensation Plans (Excluding Securities Reflected in Column (a) +(a) +(b) +(c) +Equity compensation plans approved by security holders 1 +5,530,568 1 +$0.156 +1,571,350 +Equity compensation plans not approved by security holders +-- +-- +-- +Total +5,530,568 +$0.156 +1,571,350 +1 The “Number of Securities to be Issued Upon Exercise of Outstanding Warrants and Rights” represents 2,130,250 from the 1999 Stock Option Plan and 3,400,318 under the 2008 Stock Incentive Plan. The “Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans” represents shares issuable under the 2008 Stock Incentive Plan. +39 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +The executive officers of the Company are as follows: Lawrence A. Siebert, president and chairman of the board of directors of the Company, Richard J. Larkin, chief financial officer of the Company, and Javan Esfandiari, executive vice president of Research and Development of the Company. +On May 7, 2009, the Compensation Committee of the Company reduced, to $0.13 per share, the exercise price of each outstanding employee option that was issued under the 1999 Equity Incentive Plan (the “1999 Plan”) for which the exercise price was greater than $0.44 per share of the Company’s common stock. There was no other change made to the terms of the stock options other than the reduction in the exercise price. A total of 1,036,750 options were affected. Mr. Siebert, Mr. Esfandiari and Mr. Larkin had options to purchase common stock that were so reduced of 160,000, 497,500 and 137,500, respectively. +In addition, on May 7, 2009 in accordance with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 2,925,000 shares of the Company’s common stock. The exercise price for these options is equal to $0.13 per share. The options become exercisable in thirds on the first, second and third anniversaries of the date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the date of grant. Mr. Siebert, Mr. Esfandiari and Mr. Larkin received options to purchase common stock of 400,000, 300,000 and 275,000, respectively. +During the quarter ended December 31, 2008, Alere notified the Company that Alere had entered into a contract with Bio-Rad Laboratories, Inc. (“Bio-Rad”) for royalties on Bio-Rad’s patent for the detection of HIV-2 antibodies. The agreement also provided for Alere to pay past royalties. On June 25, 2009, the Company and Alere entered into a letter agreement whereby certain obligations aggregating approximately $1,010,000 as of December 31, 2008 were agreed to be paid from future revenues. The obligations include the Company’s share under its agreements with Alere for the amount of HIV-2 royalties that Alere paid when Alere entered into an HIV-2 license agreement with Bio-Rad Laboratories, Inc. of approximately $485,000 and royalties owed by Chembio on lateral flow licenses to Alere of approximately $525,000 as of December 31, 2008. Under the agreement Alere will retain an additional 10% of Clearview® HIV 1/2 STAT-PAK® net sales and 5% of Clearview® Complete HIV 1/2 net sales until these obligations are extinguished. As of December 31, 2010 this balance was fully paid. +Director Independence +Our common stock trades on the OTC Bulletin Board. As such, we are not currently subject to corporate governance standards of listed companies, which require, among other things, that the majority of the board of directors be independent. +We are not currently subject to corporate governance standards defining the independence of our directors, and we have chosen to define an “independent” director in accordance with the NASDAQ Global Market's requirements for independent directors. Under this definition, we have determined that Gary Meller and Katherine L. Davis currently qualify as independent directors. We do not list the “independent” definition we use on our internet website . +40 +ITEM 14. +PRINCIPAL ACCOUNTANT FEES AND SERVICES +All fees discussed below were paid to ParenteBeard LLC. +Audit Fees +For the years ended December 31, 2010 and 2009, the Company’s independent accounting firm billed the Company $154,620 and $160,000, respectively, for fees for the audit of the Company’s annual financial statements and review of financial statements included in the Company’s Forms 10-Q and 10-K. +Audit-Related Fees +For the years ended December 31, 2010 and 2009, the independent accounting firm, did not provide the Company with any assurance and related services reasonably related to the performance of the audit or review of the Company’s financial statements that are not reported above under “Audit Fees.” +Tax Fees +For the years ended December 31, 2010 and 2009, the independent accounting firm billed the Company $9,415 and $20,000, respectively, for professional services for tax compliance, tax advice and tax planning. +All Other Fees +For the years ended December 31, 2010 and 2009, the independent accounting firm billed the Company $19,208 and none for fees associated with the preparation and filing of the Company’s registration statements, responses to SEC comment letters and other related matters. +Audit Committee Pre-Approval Policies +The Audit Committee approves in advance all audit and non-audit services performed by the independent accounting firm. There are no other specific policies or procedures relating to the pre-approval of services performed by the independent accounting firm. +41 +ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES +Number +Description +3.1 +Articles of Incorporation, as amended. (2) +3.2 +Amended and Restated Bylaws. (1) +4.1 +Form of Common Stock Warrant issued pursuant to the January 26, 2005 Securities Purchase Agreement. (6) +4.2 +Amended Form of Common Stock Warrant issued pursuant to the January 26, 2005 Securities Purchase Agreement. (8) +4.3 +Registration Rights Agreement, dated as of January 26, 2005, by and among the Registrant and the purchasers listed therein. (8) +4.4 +Form of Warrant, dated June 29, 2006, issued pursuant to Company and purchasers of the Company’s Secured Debentures. (6) +4.5 +Registration Rights Agreement, dated June 29, 2006. (3) +4.6 +Registration Rights Agreement, dated as of September 29, 2006, by and among the Registrant and the Purchasers listed therein. (5) +4.7 +Form of Common Stock Warrant issued pursuant to the Securities Purchase Agreements dated September 29, 2006 (5). +4.8 +Amended Form of Common Stock Warrant issued pursuant to the Securities Purchase Agreements dated October 5, 2006. (5) +4.9 +Amended Form of Common Stock Warrant issued to Placement Agents pursuant to the October 5, 2005 Securities Purchase Agreement. (8) +4.10* +Form of Employee Option Agreement. (8) +4.11 +1999 Equity Incentive Plan. (9) +4.12 +2008 Stock Incentive Plan. (10) +4.21 +Rights Agreement, dated March 8, 2010 (11) +4.22 +Form of Warrant (to be filed by amendment) +10.1* +Employment Agreement dated June 15, 2006 with Lawrence A. Siebert. (4) +10.2* +Employment Agreement dated March 5, 2010 with Javan Esfandiari. (12) +10.3 +Securities Purchase Agreement (the “Securities Purchase Agreement”), dated as of January 26, 2005, by and among the Registrant and the purchasers listed therein. (6) +10.4 +Amendment No. 1 to Securities Purchase Agreement, dated as of January 28, 2005 by and among the Registrant and the purchasers listed therein. (7) +10.5 +Security Purchase Agreement, dated June 29, 2006, among the Company and purchasers of the Company’s Secured Debentures. (3) +10.6 +Securities Purchase Agreement (the “Securities Purchase Agreement”), dated as of September 29, 2006, by and among the Registrant and the Purchasers listed therein. (5) +10.7 +Securities Purchase Agreement (the “Securities Purchase Agreement”), dated as of September 29, 2006, by and among the Registrant and the Purchasers listed therein. (5) +10.8 +Letter of Amendment to Securities Purchase Agreements dated as of September 29, 2006 by and among the Registrant and the Purchasers listed therein. (5) +10.9 +HIV Barrel License, Marketing and Distribution Agreement, dated as of September 29, 2006, by and among the Registrant, Alere and StatSure. (5) +10.1 +HIV Cassette License, Marketing and Distribution Agreement, dated as of September 29, 2006, between the Registrant and Alere. (5) +10.11 +Non-Exclusive License, Marketing and Distribution Agreement, dated as of September 29, 2006, between the Registrant and Alere. (5) +10.12 +Joint HIV Barrel Product Commercialization Agreement, dated as of September 29, 2006, between the Registrant and StatSure. (5) +10.13 +Secured Term Note, dated as of June 14, 2010, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (13) +10.14 +Secured Revolving Demand Note, dated as of June 14, 2010, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (13) +10.15 +Loan and Security Agreement, dated as of June 14, 2010, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (13) +14.1 +Ethics Policy (14) +21 +List of Subsidiaries +23.1 +Consent of ParenteBeard LLC, Independent Accountants. +31.1 +Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2 +Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. +1 +Incorporated by reference to the Registrant’s registration statement on Form SB-2 (File No. 333-85787) filed with the Commission on August 23, 1999 and the Registrant's Forms 8-K filed on May 14, 2004, December 20, 2007 and April 18, 2008. +2 +Incorporated by reference to the Registrant’s annual report on Form 10-KSB filed with the Commission on March 31, 2005. +3 +Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the Commission on July 3, 2006. +4 +Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the Commission on June 21, 2006. +5 +Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the Commission on October 5, 2006. +6 +Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the Commission on January 31, 2005. +7 +Incorporated by reference to the Registrant’s registration statement on Form SB-2 filed with the Commission on March 28, 2005. +8 +Incorporated by reference to the Registrant’s annual report on Form 10-KSB filed with the Commission on March 12, 2008. +9 +Incorporated by reference to the Registrant’s definitive proxy statement on Schedule 14A filed with the Commission on May 11, 2005. +10 +Incorporated by reference to the Registrant’s definitive proxy statement on Schedule 14A filed with the Commission on April 14, 2008. +11 +Incorporated by reference to the Registrant’s registration statement on Form 8-A filed with the Commission on March 11, 2010. +12 +Incorporated by reference to the Registrant’s registration statement on Form S-1/A filed with the Commission on March 11, 2010. +13 +Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on July 29, 2010. +14 +Incorporated by reference to the Registrant’s annual report on Form 10-KSB filed with the Commission on March 30, 2006. +(*) +An asterisk (*) beside an exhibit number indicates the exhibit contains a management contract, compensatory plan or arrangement which is required to be identified in this registration statement. +42 +SIGNATURES +In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +CHEMBIO DIAGNOSTICS, INC. +Date: March 3, 2011 By /s/ Lawrence A. Siebert +Lawrence A. Siebert +President, Chief Executive Officer and +Chairman of the Board +In accordance with the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signatures +Title +Date +/s/ Lawrence A. Siebert +Lawrence A. Siebert +Chief Executive Officer, President and Chairman Of The Board +(Principal Executive Officer) +March 3, 2011 +/ s/ Richard J. Larkin +Richard J. Larkin +Chief Financial Officer (Principal Financial & Accounting Officer) +March 3, 2011 +/s/ Gary Meller +Dr. Gary Meller +Director +March 3, 2011 +/s/ Katherine L. Davis +Katherine L. Davis +Director +March 3, 2011 +43 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +Index to Consolidated Financial Statements +—INDEX— +Page(s) +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Financial Statements: +Balance Sheets +December 31, 2010 and 2009 +F-3 +Statements of Operations +Years ended December 31, 2010 and 2009 +F-4 +Statements of Changes in Stockholders’ Equity +Years ended December 31, 2010 and 2009 +F-5 +Statements of Cash Flows +Years ended December 31, 2010 and 2009 +F-6 +Notes to Consolidated Financial Statements +F-7 - F-21 +F-1 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To The Board of Directors and Stockholders of +Chembio Diagnostics, Inc. and Subsidiary +Medford, New York 11763 +We have audited the accompanying consolidated balance sheets of Chembio Diagnostics, Inc. and Subsidiary (the “Company”) as of December 31, 2010 and 2009 and the related consolidated statements of operations, stockholders' equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Chembio Diagnostics, Inc. and Subsidiary as of December 31, 2010 and 2009, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. +PARENTEBEARD LLC +/s/ PARENTEBEARD LLC +New York, New York +March 3, 2011 +F-2 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED BALANCE SHEETS +AS OF +- ASSETS - +December 31, 2010 +December 31, 2009 +CURRENT ASSETS: +Cash and cash equivalents +$ +2,136,351 +$ +1,068,235 +Accounts receivable, net of allowance for doubtful accounts of $35,000 and $20,000 for 2010 and 2009, respectively +3,946,398 +1,776,327 +Inventories +1,349,161 +1,555,903 +Prepaid expenses and other current assets +204,824 +266,637 +TOTAL CURRENT ASSETS +7,636,734 +4,667,102 +FIXED ASSETS , net of accumulated depreciation +813,214 +580,213 +OTHER ASSETS: +License agreements, net of current portion +600,000 +700,000 +Deposits on manufacturing equipment +- +338,375 +Deposits and other assets +36,226 +29,560 +TOTAL ASSETS +$ +9,086,174 +$ +6,315,250 +- LIABILITIES AND STOCKHOLDERS’ EQUITY - +CURRENT LIABILITIES: +Accounts payable and accrued liabilities +$ +2,055,943 +$ +1,906,163 +Current portion of loans payable +55,817 +9,600 +Deferred research and development revenue +65,000 +360,833 +License fee payable +875,000 +875,000 +Current portion of obligations under capital leases +24,697 +21,536 +TOTAL CURRENT LIABILITIES +3,076,457 +3,173,132 +OTHER LIABILITIES: +Loans payable - net of current portion +186,197 +14,931 +Obligations under capital leases - net of current portion +14,576 +39,273 +TOTAL LIABILITIES +3,277,230 +3,227,336 +COMMITMENTS AND CONTINGENCIES +STOCKHOLDERS’ EQUITY: +Preferred stock – 10,000,000 shares authorized, none outstanding +- +- +Common stock - $.01 par value; 100,000,000 shares authorized, 62,238,983 and 61,979,901 shares issued and outstanding for 2010 and 2009, respectively +622,390 +619,799 +Additional paid-in capital +39,658,617 +39,453,522 +Accumulated deficit +(34,472,063 +) +(36,985,407 +) +TOTAL STOCKHOLDERS’ EQUITY +5,808,944 +3,087,914 +TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY +$ +9,086,174 +$ +6,315,250 +See accompanying notes to consolidated financial statements +F-3 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF OPERATIONS +FOR THE YEARS ENDED +December 31, 2010 +December 31, 2009 +REVENUES: +Net product sales +$ +13,516,359 +$ +12,372,493 +License and royalty revenue +432,238 +121,896 +R&D, milestone and grant revenue +2,756,106 +1,339,859 +TOTAL REVENUES +16,704,703 +13,834,248 +Cost of product sales +8,604,004 +7,973,843 +GROSS MARGIN +8,100,699 +5,860,405 +OPERATING EXPENSES: +Research and development expenses +2,586,308 +2,883,696 +Selling, general and administrative expenses +2,940,721 +2,659,382 +5,527,029 +5,543,078 +INCOME FROM OPERATIONS +2,573,670 +317,327 +OTHER INCOME (EXPENSES): +Other expense +(3,923 +) +(6,696 +) +Interest income +4,147 +9,032 +Interest expense +(14,727 +) +(10,603 +) +(14,503 +) +(8,267 +) +INCOME BEFORE INCOME TAXES +2,559,167 +309,060 +Provision for income taxes +45,823 +- +NET INCOME +$ +2,513,344 +$ +309,060 +Basic earnings per share +$ +0.04 +$ +0.00 +Diluted earnings per share +$ +0.04 +$ +0.00 +Weighted average number of shares outstanding, basic +62,102,861 +61,946,435 +Weighted average number of shares outstanding, diluted +70,920,915 +75,041,932 +See accompanying notes to consolidated financial statements +F-4 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +FOR THE YEARS ENDED DECEMBER 31, 2010 AND 2009 +Common Stock +Additional Paid in Capital +Accumulated Deficit +Total +Shares +Amount +Amount +Amount +Amount +Balance at December 31, 2008 +61,944,901 +$ +619,449 +$ +39,252,350 +$ +(37,294,467 +) +$ +2,577,332 +Warrants and options: +Excercised +35,000 +350 +4,200 +- +4,550 +Stock option compensation +- +- +196,972 +- +196,972 +Net income +- +- +- +309,060 +309,060 +Balance at December 31, 2009 +61,979,901 +$ +619,799 +$ +39,453,522 +$ +(36,985,407 +) +$ +3,087,914 +Warrants and options: +Excercised +259,082 +2,591 +35,020 +37,611 +Stock option compensation +170,075 +170,075 +Net income +2,513,344 +2,513,344 +Balance at December 31, 2010 +62,238,983 +$ +622,390 +$ +39,658,617 +$ +(34,472,063 +) +$ +5,808,944 +See accompanying notes to consolidated financial statements +F-5 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF CASH FLOWS +FOR THE YEARS ENDED +December 31, 2010 +December 31, 2009 +INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS: +CASH FLOWS FROM OPERATING ACTIVITIES: +Cash received from customers +$ +14,534,632 +$ +12,871,921 +Cash paid to suppliers and employees +(13,507,202 +) +(12,618,423 +) +Interest received +4,147 +9,032 +Interest paid +(14,727 +) +(10,603 +) +Net cash provided by operating activities +1,016,850 +251,927 +CASH FLOWS FROM INVESTING ACTIVITIES: +Proceeds from sale of fixed assets +- +13,750 +Acquisition of fixed assets +(182,292 +) +(390,738 +) +Net cash used in investing activities +(182,292 +) +(376,988 +) +CASH FLOWS FROM FINANCING ACTIVITIES: +Proceeds from option exercises +37,611 +- +Proceeds from loan +250,000 +4,550 +Payment of loan obligation +(32,517 +) +(4,697 +) +Payment of capital lease obligation +(21,536 +) +(18,779 +) +Net cash provided by financing activities +233,558 +(18,926 +) +INCREASE IN CASH AND CASH EQUIVALENTS +1,068,116 +(143,987 +) +Cash and cash equivalents - beginning of the period +1,068,235 +1,212,222 +Cash and cash equivalents - end of the period +$ +2,136,351 +$ +1,068,235 +RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: +Net income +$ +2,513,344 +$ +309,060 +Adjustments: +Depreciation and amortization +283,743 +362,338 +Provision for doubtful accounts` +15,000 +9,699 +Loss on retirement/sale of fixed asset +3,923 +6,696 +Share based compensation +170,075 +198,220 +Changes in assets and liabilities: +Accounts receivable +(2,185,071 +) +(976,723 +) +Inventories +206,742 +263,134 +Prepaid expenses and other current assets +61,813 +(42,732 +) +Deposits and other assets +93,334 +238,260 +Accounts payable and accrued liabilities +149,780 +360,833 +Deferred research and development revenue +(295,833 +) +(476,858 +) +Net cash provided by operating activities +$ +1,016,850 +$ +251,927 +Supplemental disclosures for non-cash investing and financing activities: +Deposits on manufacturing equipment transferred to fixed assets +$ +338,375 +$ +- +Purchase of fixed asset through a loan +- +29,228 +See accompanying notes to consolidated financial statements +F-6 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +NOTE 1— +DESCRIPTION OF BUSINESS: +Chembio Diagnostics, Inc. (the “Company” or “Chembio”) and its subsidiary, Chembio Diagnostic Systems, Inc., develop, manufacture, and market rapid diagnostic tests that detect infectious diseases. The Company’s main products are three rapid tests for the detection of HIV antibodies in whole blood, serum and plasma samples, two of which were approved by the FDA in 2006; the third is sold for export only. Rapid HIV tests represented nearly 90% of the Company’s product revenues in 2010. The Company also has other rapid tests that together represented approximately 10% of sales in 2010. The Company’s products are sold to medical laboratories and hospitals, governmental and public health entities, non-governmental organizations, medical professionals and retail establishments both domestically and internationally. Chembio’s products are sold under the Company’s STAT PAK®, SURE CHECK® or DPP® registered trademarks, or under the private labels of its marketing partners, for example the Clearview® label owned by Alere, Inc. (“Alere”), which is the Company’s exclusive marketing partner for its rapid HIV lateral flow test products in the United States. These products employ lateral flow technologies that are proprietary and/or licensed to the Company. All of the Company’s products that are currently being developed are based on its patented Dual Path Platform (DPP®), which is a unique diagnostic point-of-care platform that has certain advantages over lateral flow technology. In 2009 and 2010 to date, the Company has completed development of its first four products that employ the DPP®, and the Company has a number of additional products under development that employ the DPP®. +NOTE 2— +SIGNIFICANT ACCOUNTING POLICIES: +(a) +Principles of Consolidation: +The consolidated financial statements include the accounts of the Company, and its wholly owned subsidiary. All intercompany transactions and balances have been eliminated in consolidation. +(b) +Use of Estimates: +The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make assumptions and estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods covered thereby. Actual results could differ from these estimates. Judgments and estimates of uncertainties are required in applying the Company’s accounting policies in certain areas. The following are some of the areas requiring significant judgments and estimates: determinations of the useful lives of assets, estimates of allowances for doubtful accounts and inventory reserves. +(c) +Fair Value of Financial Instruments: +Fair values of cash and cash equivalents, accounts receivable, prepaid expenses and other current assets and accounts payable, short-term portion of loans and accrued expenses reflected in these financial statements approximate carrying value as these are short-term in nature. +(d) +Statements of Cash Flows: +For purposes of the statements of cash flows the Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. +(e) +Concentrations of Credit Risk: +Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade receivables. The Company places its temporary cash instruments with well-known financial institutions and, at times, may maintain balances in excess of the $250,000 FDIC Insurance limit. The Company monitors the credit ratings of the financial institutions to mitigate this risk. The Company maintains four accounts with a well established multi-national bank and as of December 31, 2010 and 2009 had approximately an aggregate of $1,866,000 and $818,000, respectively above the federally insured limit. Concentration of credit risk with respect to trade receivables is principally mitigated by the Company’s ability to obtain letters of credit from certain foreign customers, and its diverse customer base both in number of customers and geographic locations. We currently do not require collateral for accounts receivable. +F-7 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +(f) +Inventories: +Inventories, consisting of material, labor and manufacturing overhead, are stated at the lower of cost or market. Cost is determined on the first-in, first-out method. +(g) +Fixed Assets: +Fixed assets are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets, which range from three to seven years. Leasehold improvements are amortized over the useful life of the asset or the lease term, whichever is shorter. +(h) +License Agreement: +In February 2008, the Company entered into a sublicense agreement (see Note 6) for which it had initially recorded an asset of $1,000,000. This asset is being expensed over an estimated economic life of ten years, based on the expected lifespan of our then current HIV products. The current portion of this asset is $100,000 and is reported in prepaid expenses and other current assets. The long-term portion as of December 31, 2010 is $600,000 and is reflected in other assets. +(i) +Impairment of Long-Lived Assets and Intangible Assets +Long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment. If there are indications of impairment, the Company uses future undiscounted cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. In the event such cash flows are not expected to be sufficient to recover the recorded asset values, the assets are written down to their estimated fair value. We believe that the carrying values of our long-lived tangible and intangible assets were realizable at December 31, 2010 and 2009, respectively. +(j) +Revenue Recognition: +The Company recognizes revenue for product sales in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). Under SAB 104, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is determinable, and collectability is reasonably assured. Revenue typically is recognized at time of shipment. Sales are recorded net of discounts, rebates and returns. +For certain contracts, the Company recognizes revenue from non-milestone contracts and grant revenues when earned. Grants are invoiced after expenses are incurred. Revenues from projects or grants funded in advance are deferred until earned. +On June 15, 2010, the Company adopted Financial Accounting Standards Board (“FASB”) issued authoritative guidance (“guidance”) prospectively for the recognition of revenue under the milestone method. The Company applies the milestone method of revenue recognition for certain collaborative research projects defining milestones at the inception of the agreement. +Any projects or grants funded in advance are deferred until earned. As of December 31, 2010 and 2009, an aggregate of $65,000 and $361,000, respectively of advanced revenues was unearned. +(k) +Research and Development: +Research and development (R&D) costs are expensed as incurred. During the fourth quarter of 2010 the Company was awarded $1,466,875 in Qualified Therapeutic Discovery Project grants (“QTDP”) for the years 2010 and 2009 under Section 48D of the Internal Revenue Code, as enacted under the Patient Protection and Affordable Care Act of 2010. This was reflected as a reduction of R&D costs for the year ended December 31, 2010. +F-8 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +(l) +Stock Based Compensation: +The Company’s 2008 Stock Incentive Plan and 1999 Stock Option Plan (“Plans”) are accounted for in accordance with the recognition and measurement provisions FASB Guidance. The Guidance requires compensation costs related to share-based payment transactions, including employee stock options, to be recognized in the financial statements. In addition, the Company adheres to the guidance set forth within Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 107 ("SAB 107"), which provides the Staff's views regarding the interaction between the Guidance and certain SEC rules and regulations and provides interpretations with respect to the valuation of share-based payments for public companies. See Note 12 for further details. +(m) +Income Taxes: +The Company accounts for income taxes under the provisions of FASB Guidance. The deferred tax assets and liabilities are determined based on the difference between the financial statement carrying amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. +The Guidance also prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. The Guidance also provides guidance related to, among other things, classification, accounting for interest and penalties associated with tax positions, and disclosure requirements. Any interest and penalties accrued related to unrecognized tax benefits will be recorded in tax expense. +(n) +Earnings Per Share +The following weighted average shares were used for the computation of basic and diluted earnings per share: +For the years ended +December 31, 2010 +December 31, 2009 +Basic +62,102,861 +61,946,435 +Diluted +70,920,915 +75,041,932 +Basic loss per share is computed by dividing net loss attributable to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share for the year ended December 31, 2010 and 2009 reflects the potential dilution from the exercise or conversion of other securities into common stock. The following securities, presented on a common share equivalent basis, have been used in the diluted per share computations: +For the years ended +December 31, 2010 +December 31, 2009 +1999 and 2008 Plan Stock Options +5,638,310 +4,451,129 +Other Stock Options +124,625 +124,625 +Warrants +3,055,119 +8,519,743 +8,818,054 +13,095,497 +(o) +Recent Accounting Pronouncements Affecting the Company: +Revenue Arrangements with Multiple Deliverables +In October 2009, the FASB issued authoritative guidance (“guidance”) that amends existing guidance for identifying separate deliverables in a revenue-generating transaction where multiple deliverables exist, and provides guidance for allocating and recognizing revenue based on those separate deliverables. The guidance is expected to result in more multiple- deliverable arrangements being separable than under current guidance. This guidance is effective for the Company beginning January 1, 2011. The Company is evaluating the impact, if any this guidance may have on its consolidated financial statements. +F-9 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +Intangibles – Goodwill and Other +In December 2010, the FASB amended the existing guidance to modify Step 1 of the goodwill impairment test for a reporting unit with a zero or negative carrying amount. Upon adoption of the amendment, an entity with a reporting unit that has a carrying amount that is zero or negative is required to assess whether it is more likely than not that the reporting unit’s goodwill is impaired. If the entity determines that it is more likely than not that the goodwill of the reporting unit is impaired, the entity should perform Step 2 of the goodwill impairment test for the reporting unit. Any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings in the period of adoption. Any goodwill impairments occurring after the initial adoption of the amendment should be included in earnings. This guidance is effective for the Company beginning January 1, 2011. The Company is currently assessing the impact, if any, this may have on their consolidated financial statements. +Broad Transactions – Business Combination +In December 2010, the FASB amended the existing guidance to require a public entity, which presents comparative financial statements, to disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. +The amendment also expanded the required supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination, which are included in the reported pro forma revenue and earnings. The amendments are effective for the Company beginning January 1, 2011. The Company is currently assessing the impact, if any, this may have on their consolidated financial statements. +NOTE 3— +INVENTORIES: +Inventories consist of the following at: +December 31, 2010 +December 31, 2009 +Raw materials +$ +785,693 +$ +1,031,567 +Work in process +235,548 +184,081 +Finished goods +327,920 +340,255 +$ +1,349,161 +$ +1,555,903 +NOTE 4— +FIXED ASSETS: +Fixed assets consist of the following at December 31: +December 31, 2010 +December 31, 2009 +Machinery and equipment +$ +1,635,466 +$ +1,222,216 +Furniture and fixtures +207,485 +212,106 +Computer and telephone equipment +348,503 +329,491 +Leasehold improvements +482,215 +400,589 +Automobiles +29,228 +29,228 +2,702,897 +2,203,630 +Less accumulated depreciation and amortization +(1,889,683 +) +(1,623,417 +) +$ +813,214 +$ +580,213 +Included in fixed assets is $24,000 and $44,000, net of accumulated depreciation of $87,000 and $66,000 of assets held under capital leases as of December 31, 2010 and 2009, respectively. Depreciation expense for the 2010 and 2009 years aggregated $283,743 and $362,338, respectively. +F-10 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +NOTE 5— +ACCOUNTS PAYABLE AND ACCRUED LIABILITIES: +Accounts payable and accrued liabilities consist of the following at December 31,: +December 31, 2010 +December 31, 2009 +Accounts payable – suppliers +$ +883,719 +$ +662,739 +Accrued commissions +114,451 +43,931 +Accrued royalties / license fees +352,285 +612,709 +Accrued payroll +162,740 +114,234 +Accrued vacation +129,732 +99,057 +Accrued bonuses +140,325 +238,600 +Accrued expenses – other +272,691 +134,893 +TOTAL +$ +2,055,943 +$ +1,906,163 +NOTE 6— +DEFERRED RESEARCH AND DEVELOPMENT REVENUE: +In January 2009, the Company received a refundable license fee of $340,000 from Bio-Rad Laboratories, Inc., pursuant to an exclusive license of our DPP® technology for a specific field of use. The license fee become fully earned and non-refundable based upon certain conditions being met in June of 2010. In addition, the Company recognizes income from R&D milestones when those milestones are reached and non-milestone contracts and grants when earned. Grants are invoiced after expenses are incurred. Any projects or grants funded in advance are deferred until earned. As of December 31, 2010 and 2009, an aggregate of $65,000 and $361,000 of advanced revenues was unearned. +NOTE 7— +TERM NOTE, REVOLVING DEMAND NOTE, VEHICLE FINANCING AND LICENSE FEE PAYABLE: +In June 2010, the Company entered into three agreements with HSBC Bank, NA (“HSBC”). The three agreements were: 1) a secured term note (“Term Note”) of $250,000 to be repaid over sixty months; 2) a secured revolving demand note (“Demand Note”) up to $250,000; and 3) a loan and security agreement (“Security Agreement”). +The Term Note is payable at $4,775 of principal and interest per month in arrears. The payment was calculated by amortizing the $250,000 note over 60 months at an interest rate of 5.5% per annum. The Term Note matures June, 2015 and is secured under the terms of the Security Agreement. +The Demand Note allows the Company to draw on the line from time to time an amount up to an aggregate of $250,000 outstanding at any one time. The accrued interest on the Demand Note is payable monthly at an interest rate equal to one-quarter percent above prime per annum. The Company can repay any or all of the principal balance outstanding at any time. This is a demand note and is subject to annual reviews, as well as a 30-day clean-up, during which there can be no amounts outstanding. +The Security Agreement contains covenants that place annual restrictions on the Company’s assets and operations, including covenants relating to mergers, debt restrictions, capital expenditures, tangible net worth, net profit, leverage, fixed charge coverage, employee loan restrictions, distribution restrictions (common stock and preferred stock), dividend restrictions, restrictions on lease payments to affiliates, restrictions on changes in business, asset sale restrictions, restrictions on acquisitions and intercompany transactions, restrictions on fundamental changes. The Security Agreement also requires that the Company maintain a minimum tangible net worth at all times of greater than $3,000,000 and EBITDA to CMLTD plus interest cannot be less than 1.25 to 1.00 for any fiscal year. (CMLTD is defined as any one-year period, the current scheduled principal payments required to be paid for the applicable period.). The Company was in compliance with all required financial covenants at December 31, 2010. The Security Agreement requires that the Demand Note has an annual 30-day clean-up, during which there can be no amounts outstanding. +The Company currently maintains its operating, payroll, and primary cash accounts at HSBC. The balance due on the Term Note as of December 31, 2010 was $228,000 and nothing was drawn down on the Demand Note as of December 31, 2010. +F-11 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +Future minimum payments under the Term Note, excluding interest, as of December 31, 2010 were as follows: +Periods ending December 31, +2011 +$45,911 +2012 +48,501 +2013 +51,236 +2014 +54,126 +2015 +28,121 +227,895 +Less: current maturities +(45,911 +) +$ 181,984 +In June 2009, the Company purchased a vehicle for use by the CEO and obtained financing in the amount of $29,228. The financing is for a period of 3 years, is secured by the vehicle and is guaranteed by the CEO. The financing agreement provides for monthly principal and interest payments of $849 and carries an interest rate of 2.9% per annum. The balance due on this loan as of December 31, 2010 was $14,119. +Future minimum payments under this obligation, excluding interest as of December 31, 2010 were as follows: +Year ending December 31, +2011 +$9,906 +2012 +4,213 +14,119 +Less: current maturities +(9,906 +) +$ 4,213 +In February 2008, the Company entered into a sublicense agreement (the “Agreement”), with Bio-Rad Laboratories, Inc. and Bio-Rad Pasteur (collectively, “Bio-Rad”). Bio-Rad is the exclusive licensee of the HIV-2 patent portfolio held by Institute Pasteur of Paris, France. On January 29, 2009, the Company and Bio-Rad agreed to amend the Agreement so as to defer the remaining $875,000 of payments due under the Agreement to one payment due in December 2010 which was paid on January 3, 2011. The Company will also pay Bio-Rad a royalty on net sales in the United States and Canada, if any, of rapid test immunoassay tests sold under the Company’s brands of Licensed Products as defined in the Agreement. The Agreement will continue until the expiration of the last-to-expire of the sublicensed patents, unless otherwise terminated at an earlier date by the Company or Bio-Rad. +NOTE 8 — OBLIGATIONS UNDER CAPITAL LEASES: +The Company is obligated under capitalized leases for certain manufacturing and computer equipment. +Future minimum lease payments under these capitalized lease obligations, including interest as of December 31, 2010 were as follows: +Year ending December 31, +2011 +$28,572 +2012 +15,203 +43,775 +Less imputed interest +(4,502 +) +Present value of future minimum lease payments +39,273 +Less current maturities +(24,697 +) +$ 14,576 +These leases have annual interest rates ranging from 13% - 15%. +F-12 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +NOTE 9— +RELATED PARTIES: +In September 2006, the Company entered into distribution and licensing agreements with Alere, Inc. (“Alere”). As of December 31, 2010 Alere owned 8.62% of the Company. See Note 15 where Alere is listed as customer 1. +During the quarter ended December 31, 2008, Alere notified the Company that they had entered into a contract with Bio-Rad Laboratories, Inc. (“Bio-Rad”) for royalties on Bio-Rad’s patent for the detection of HIV-2 antibodies. The agreement also provided for Alere to pay past royalties. On June 25, 2009, the Company and Alere entered into a letter agreement whereby certain obligations aggregating approximately $1,010,000 as of December 31, 2008 (included in accounts payable and accrued expenses – see Note 5) were agreed to be paid from future revenues. The obligations included the Company’s royalties owed under its agreements with Alere on lateral flow licenses. This amount was fully paid in 2010. +NOTE 10— +INCOME TAXES: +The provision for income taxes for the years ended December 31, 2010 and 2009, are comprised of the following: +2010 +2009 +Current +Federal +$ 45,122 +$ - +State +702 +- +Total current provision +45,824 +- +Deferred +Federal +- +- +State +- +- +Total deferred provision +- +- +Total provision +$ 45,824 +$ - +At December 31, 2010, the Company has unused net operating loss carry-forwards of approximately $19,000,000 which expire between 2018 and 2028. Most of this amount may be subject to annual limitations under certain provisions of the Internal Revenue Code related to “changes in ownership”. In addition the Company has a research and development credit carryforward of approximately $594,000 for the year ended December 31, 2010 which expires between 2011 and 2029. +As of December 31, 2010 and 2009, the deferred tax assets related to the aforementioned net operating loss carry-forwards have been fully offset by a valuation allowance, since significant utilization of such amounts is not presently expected in the foreseeable future. +Deferred tax assets and valuation allowances consist of: +2010 +2009 +Current assets +Inventory +$ +198,000 +$ +124,000 +Less valuation allowance +(198,000 +) +(124,000 +) +Net current deferred asset +$ +— +$ +— +Noncurrent assets +Net operating loss carry-forwards +$ +6,618,000 +$ +7,490,000 +Research and development credit +594,000 +628,000 +Other +34,000 +176,000 +Gross deferred tax assets +7,246,000 +8,294,000 +Less valuation allowances +(7,246,000 +) +(8,294,000 +) +Net deferred tax assets +$ +— +$ +— +The change in the valuation allowances between 2010 and 2009 are mainly due to the utilization of net operating loss carryfowards. +F-13 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +A reconciliation of the Federal statutory rate to the effective rate applicable to income (loss) before income taxes is as follows: +Year Ending December 31, +2010 +2009 +Federal income tax (benefit) at statutory rates +34.0 +% +34.0 +% +State income taxes, net of federal benefit +- +% +- +% +Nondeductible expenses +2.0 +% +17.8 +% +Change in valuation allowance +(34.4 +) % +(52.3 +) % +Other +.2 +% +.5 +% +Income tax (benefit) +1.8 +% +- +% +Interest and penalties, if any, related to income tax liabilities are included in income tax expense. As of December 31, 2010, the Company does not have a liability for unrecognized tax benefits. +The Company files Federal and New York state income tax returns. Tax years for fiscal 2007 through 2009 are open and potentially subject to examination by the federal and New York state taxing authorities. +NOTE 11— +STOCKHOLDERS’ EQUITY: +(a) Common Stock +During 2010, options to purchase 259,082 shares of the Company’s common stock were exercised at exercise prices ranging from of $.13 to $.22. +During 2009, options to purchase 35,000 shares of the Company’s common stock were exercised at an exercise price of $.13. +(b) +P referred Stock +The Company has 10,000,000 shares of preferred stock authorized and none outstanding. These shares can become issuable upon an approved resolution by the board of directors and the filing of a Certificate of Designation with the state of Nevada. +(c) Warrants +In January 2010, certain warrants to purchase an aggregated 4,960,370 shares of common stock expired, at an average exercise price of $.474. In August 2010, certain warrants to purchase an aggregated 94,650 shares of common stock expired, at an average exercise price of $.687. +During 2009 certain warrants to purchase an aggregated 2,489,120 shares of common stock expired, at an average exercise price of $.764. +NOTE 12— +RIGHTS AGREEMENT: +In March 2010, the Company entered into a Rights Agreement dated March 8, 2010 (the "Rights Agreement") between the Company and Action Stock Transfer Corp., as Rights Agent. Pursuant to the Rights Agreement, the Company declared a dividend distribution of one preferred share purchase right (a "Right") for each outstanding share of Common Stock, $0.01 par value (the "Common Stock"), of the Company. The Board of Directors set the payment date for the distribution of the Rights as March 8, 2010, and the Rights were distributed to the Company’s shareholders of record on that date. The description and terms of the Rights are set forth in the Rights Agreement. +F-14 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +Rights Initially Not Exercisable. The Rights are not exercisable until a Distribution Date. Until a Right is exercised, the holder thereof, as such, will have no rights as a shareholder of the Company, including, without limitation, the right to vote or to receive dividends. +Separation and Distribution of Rights . The Rights will be evidenced by the certificates for shares of Common Stock registered in the names of the holders thereof, and not by separate rights certificates until the earlier to occur of (i) the close of business on the tenth business day following a public announcement that an Acquiring Person (as defined in the Rights Agreement) acquired a Combined Ownership (as defined in the Rights Agreement) of 15% or more of the outstanding shares of the Common Stock (the "Shares Acquisition Date") or (ii) the later of (A) the close of business on the tenth business day (or such later date as may be determined by action of the Board of Directors prior to such time as any person or group of affiliated or associated persons becomes an Acquiring Person) after the date that a tender or exchange offer or intention to commence a tender or exchange offer by any person is first published, announced, sent or given within the meaning of Rule 14d-4(A) under the Securities Exchange Act of 1934, as amended, the consummation of which would result in any person having Combined Ownership of 15% or more of the outstanding shares of the Common Stock, or (B) if such a tender or exchange offer has been published, announced, sent or given before the date of the Rights Agreement, then the close of business on the tenth business day after the date the Rights Agreement was entered into (or such later date as may be determined by action of the Board of Directors prior to such time as any person becomes an Acquiring Person); (the earlier of such dates referred to in (i) and (ii), which date may include any such date that is after the date of the Rights Agreement but prior to the issuance of the Rights, being called the "Distribution Date"). +NOTE 13— +EMPLOYEE STOCK OPTION PLAN: +The Company has a 1999 Stock Option Plan (“SOP”) originally covering 1,500,000 shares of Common Stock. Under the terms of the SOP, the Compensation Committee of the Company’s board is authorized to grant incentive options to key employees and to grant non-qualified options to key employees and key individuals. The options become exercisable at such times and under such conditions as determined by the Compensation Committee. The SOP was amended at the Company’s 2005 stockholders’ meeting. The number of options under the SOP was increased to cover 3,000,000 shares of common stock. It was also amended to allow independent directors to be eligible for grants under the portion of the SOP concerning non-qualified options. +Effective June 3, 2008, the Company’s stockholders voted to approve the 2008 Stock Incentive Plan (“SIP”). Under the terms of the SIP, the Compensation Committee of the Company’s board shall have the discretion to select the persons to whom Awards are to be granted. Awards can be incentive stock options, restricted stock and/or restricted stock units. The Awards become vested at such times and under such conditions as determined by the Compensation Committee. +The Company's results for the years ended December 31, 2010 and 2009 include share-based compensation expense totaling $170,000 and $198,000, respectively. Such amounts have been included in the Consolidated Statements of Operations within cost of goods sold ($20,000 and $25,000, respectively), research and development ($86,000 and $75,000, respectively) and selling, general and administrative expenses ($64,000 and $98,000, respectively). No income tax benefit has been recognized in the income statement for share-based compensation arrangements due to the history of operating losses. +Stock option compensation expense in the years ended December 31, 2010 and 2009 represents the estimated fair value of options outstanding which is being amortized on a straight-line basis over the requisite vesting period of the entire award. +The weighted average estimated fair value of stock options granted in the years ended December 31, 2010 and 2009 was $.22 and $.13 per share, respectively. The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model. The expected volatility is based upon historical volatility of our stock and other contributing factors. The expected term is determined using the simplified method as permitted by SAB 107, as the Company has no history of employee exercise of options to date. +F-15 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +The assumptions made in calculating the fair values of options are as follows: +For the years ended +December 31, 2010 +December 31, 2009 +Expected term (in years) +4 +1 to 4 +Expected volatility +116.82% +123.81% +Expected dividend yield +n/a +n/a +Risk-free interest rate +1.43% +.54 - 1.95% +The Company granted 300,000 new options under the SIP plan during the year ended December 31, 2010 at an exercise price of $.27 per share. +On May 7, 2009, the Compensation Committee of the Company reduced, to $0.13 per share, the exercise price of each outstanding employee option that was issued under the 1999 Equity Incentive Plan (the “1999 Plan”) for which the exercise price was greater than $0.44 per share of the Company’s common stock. There was no other change made to the terms of the stock options other than the reduction in the exercise price. A total of 1,036,750 options were affected and the fair value difference of the options before and after the reduction was $31,660 and was expensed in the three months ended June 30, 2009. +In addition, on May 7, 2009 in accordance with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 2,925,000 shares of the Company’s common stock. The exercise price for these options is equal to $0.13 per share. The options become exercisable in thirds on the first, second and third anniversaries of the date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the date of grant. The fair value of these options is being amortized over the vesting life of the options. +On May 7, 2009, the Board of Directors of the Company revised the compensation of non-employee directors to increase the number of options to purchase the Company’s common stock issued to directors once every five years from 180,000 to 375,000. To accommodate the transition, on June 3, 2009 at the annual meeting, non-employee directors that were re-elected were issued their five-year allotment of options and those options previously granted but not exercisable as of June 3, 2009 were cancelled. The number issued was 750,000 and the number cancelled was 216,000. The 216,000 options were treated as a re-price for accounting purposes. The fair value of these options granted is being amortized over the vesting life of the options. +The following table provides stock options activity for the years ended December 31, 2010 and 2009: +Stock Options +Number of Shares +Weighted Average Exercise Price per Share +Weighted Average Remaining Contractual Term +Aggregate Intrinsic Value +Outstanding at January 1, 2009 +2,416,650 +$0.36 +3.23 years +$ - +I mpact of re-price (for accounting purposes treated as a cancellation and re-issue): +effect as if cancelled +(1,252,750) +$0.48 +effect as if re-issiued +1,252,750 +$0.13 +Granted +3,459,000 +$0.13 +Exercised +(35,000) +$0.13 +Forfeited/expired /cancelled +(253,750) +$0.17 +Outstanding at December 31, 2009 +5,586,900 +$0.15 +3.59 years +$ 756,990 +Granted +300,000 +$0.27 +Exercised +(259,082) +$0.15 +Forfeited/expired/cancelled +(97,250) +$0.26 +Outstanding at December 31, 2010 +5,530,568 +$0.16 +2.82 years +$ 1,497,063 +Exercisable at December 31, 2010 +2,963,893 +$0.17 +2.30 years +$ 767,893 +F-16 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +The following table summarizes information about stock options outstanding at December 31, 2010: +Stock Options Outstanding +Stock Options Exercisable +Range of Exercise Prices +Shares +Average Remaining Contract Life (Year) +Weighted Average Exercise Price +Aggregate Intrinsic Value +Shares +Weighted Average Exercise Price +Aggregate Intrinsic Value +$ +0.13 - 0.13 +4,636,068 +3.86 +$ +0.130 +$ +1,367,640 +2,269,393 +$ +0.130 +$ +669,471 +$ +0.14 - 0.22 +404,500 +3.13 +0.220 +46,500 +404,500 +0.220 +82,923 +$ +0.23 - 0.45 +300,000 +5.18 +0.270 +82,923 +100,000 +0.270 +15,500 +$ +0.46 - 0.88 +190,000 +2.15 +0.501 +- +190,000 +0.501 +- +Total +5,530,568 +3.82 +$ +0.157 +$ +1,497,063 +2,963,893 +$ +0.171 +$ +767,894 +As of December 31, 2010, there was $102,000 of net unrecognized compensation cost related to stock options that are not vested, which is expected to be recognized over a weighted average period of approximately .88 years. The total fair value of shares vested during the years ended December 31, 2010 and 2009, was $124,000 and $60,000, respectively. +NOTE 14— +GEOGRAPHIC INFORMATION: +FASB Guidance establishes standards for the way that business enterprises report information about operating segments in financial statements and requires that those enterprises report selected information. It also establishes standards for related disclosures about product and services, geographic areas, and major customers. +The Company produces only one group of similar products known collectively as “rapid medical tests”. Management believes that it operates in a single business segment. Net sales by geographic area are as follows: +For the years ended +December 31, 2010 +December 31, 2009 +Africa +$ +6,129,167 +$ +3,351,115 +Asia +120,212 +165,293 +Europe +107,060 +111,755 +Middle East +135,000 +185,700 +North America +5,977,108 +6,129,789 +South America +1,047,812 +2,428,841 +$ +13,516,359 +$ +12,372,493 +Sales to Africa in 2010 were primarily to Ethiopia of approximately $3.69 million and Nigeria of approximately $.87 million. Sales in 2010 to North America were primarily from sales in the U.S of approximately $5.28 million and sales in 2010 to South America were primarily from sales in Brazil of approximately $.82 million. +During 2009, the Nigerian Ministry of Health reverted back to a parallel testing algorithm (wherein each patient is tested with two rapid tests from different manufacturers) and re-instated our designation in Nigeria as one of the screening tests. Consequently, our sales to Nigeria increased by $209,000 in 2010 as compared to 2009. +F-17 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +NOTE 15— +COMMITMENTS AND CONTINGENCIES: +Employment Contracts: +The Company has contracts with two key employees. The contracts call for salaries presently aggregating $510,000 per year. One contract expires in May 2012 and one contract expires in March 2013. The following table is a schedule of future minimum salary commitments: +2011 +$ 518,300 +2012 +373,750 +2013 +44,200 +$ 963,250 +Pension Plan: +The Company has a 401(k) plan established for its employees. The Company elected to match 20% of the first 5% (or 1% of salary) that an employee contributes to their 401(k) plan. Expenses related to this matching contribution aggregated none and $1,534 for the years ended December 31, 2010 and 2009, respectively. +As of January 19, 2009, the Company suspended the matching contribution. +Obligations Under Operating Leases: +The Company leases approximately 23,400 square feet of industrial space used for office, R&D and manufacturing facilities, currently with a monthly rent of $14,683. The current lease expires on April 30, 2014. We entered into a second lease effective February 1, 2010, the principal terms of this lease are the same as the one entered into in 2009 and are as follows: (a) a lease term ending April 30, 2014; (b) an initial rent of $11,350 per month plus $3,333 for the second lease (March and April of 2010 are free and the month of April in 2011, 2012 and 2013 is also free) ; (c) the monthly rent for year two of the lease (does not apply to second lease) will increase by the lower of (i) the change in the consumer price index, or (ii) five percent; and (d) the monthly rent for years three through five of the lease (years two through four of the second lease) will increase each year by the lower of (i) the change in the consumer price index, or (ii) two and one half percent. The following is a schedule of future minimum rental commitments (assuming no increases): +Year ending December 31, +2011 +$ 179,329 +2012 +179,329 +2013 +179,329 +2014 +59,776 +$ 597,763 +Rent expense was $174,200 and $145,300 for the years ended December 31, 2010 and 2009, respectively. +Economic Dependency: +The following table delineates sales the Company had to customers in excess of 10% of total sales for the periods indicated: +For the years ended +Accounts Receivable +December 31, 2010 +December 31, 2009 +As of +Sales +% of Sales +Sales +% of Sales +December 31, 2010 +Customer 1 +5,281,111 +39 +5,240,996 +42 +724,983 +Customer 2 +3,689,865 +27 +1,292,640 +10 +1,424,563 +Customer 3 +* +* +2,293,770 +19 +741,089 +F-18 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +In the table above the asterisk (*) indicates that sales to the customer did not exceed 10% for the period indicated. +The following table delineates purchases the Company had with vendors in excess of 10% of total purchases for the periods indicated: +For the years ended +Accounts Payable +December 31, 2010 +December 31, 2009 +As of +Purchases +% of Purc. +Purchases +% of Purc. +December 31, 2010 +Vendor 1 +596,556 +18 +575,362 +20 +45,035 +The Company currently buys materials which are purchased under intellectual property rights agreements and are important components in its products. Management believes that other suppliers could provide similar materials on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would affect operating results adversely. +NOTE 16— +COLLABORATIVE RESEARCH AND DEVELOPMENT ARRANGEMENTS: +In 2010 and 2009, the Company earned $2.8 million and $1.3 million, respectively from research revenues and milestones. The Company is now involved in additional feasibility and development contracts related to its DPP® technology. The total expended on R&D in 2010 and 2009, not including regulatory and QTDP, was approximately $2.9 million and $2.4 million, respectively. During the fourth quarter of 2010 the Company was awarded $1.47 million from the Qualified Therapeutic Discovery Project grant, which reduced 2010 R&D expenses to $1.4 million. +a. +Bio-Rad: +On April 16, 2008, the Company entered into a development agreement (“Bio-Rad Agreement”) with Bio-Rad Laboratories, N.A. (“Bio-Rad”). The Bio-Rad Agreement is for the development of a new multiplex product (“product”) that would be developed on DPP® and which would be marketed exclusively by Bio-Rad under an exclusive limited DPP® license from Chembio to Bio-Rad limited to the field of application of this product. The agreement with Bio-Rad contemplated that the Company would enter into a license agreement subject to the satisfaction of certain initial development milestones. +In accoradnace with guidance, management has concluded the Bio-Rad events recorded this year meet the definition of milestone events. The Company earned $615,000 and $0 for the years ended December 31, 2010 and 2009, respectively. +There are additional royalties and purchase commitments due to the Company to be executed in the future which will result in a larger revenue stream. Under the Bio-Rad agreement, the Company granted to Bio-Rad a royalty free license when the Company manufactures the product, and when Bio-Rad manufactures the product a seven percent royalty payment on net sales in those countries and other jurisdictions where Chembio has filed the relevant patent. +F-19 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +b. +Oswaldo Cruz Foundation/Fiocruz: +During 2008, the Company signed four Agreements with the Bio-Manguinhos unit of the Oswaldo Cruz Foundation of Brazil (“FIOCRUZ”) for the supply, license and transfer of certain products and related technologies from the Company to FIOCRUZ. The agreements are for the following rapid test products: i) DPP® HIV 1/2 Screen, ii) DPP® HIV 1/2 Confirmatory, iii) DPP® Leptospirosis and iv) DPP® Leishmaniasis. These Agreements provide for a staged technology transfer collaboration pursuant to which FIOCRUZ will ultimately be able to fully manufacture the applicable product for supply in Brazil provided certain minimum purchases of products and related components have occurred. +In accordance with guidance, management has concluded the FIOCRUZ events recorded this year meet the definition of milestone events. The Company earned $625,000 for the year ended December 31, 2010. Future milestone revenues expected from the agreements are $405,000. +There are additional royalties and purchase commitments due to the Company to be executed in the future which will result in a larger revenue stream. +c. +Infectious Disease Research Institute (IDRI) Agreement : +In April 2009, Chembio entered into a development agreement for up to approximately $400,000 in connection with the development and initial supply of a low-cost, rapid point-of-care ("POC") test for infectious diseases. The agreement contemplates a period of approximately two years in which the development activity is to be completed. Chembio entered this agreement with IDRI. +As of December 31, 2010, the Company received $138,000 in research and development payments from this agreement and $65,000 is reflected in deferred revenue. +d. +National Institutes of Health (NIH) Grant: +In June 2009, the Company received a $3 million, three-year grant from the United States National Institutes of Health to complete development of a test for Leptospirosis. Grants are invoiced after expenses are incurred. +e. +Battelle/CDC DPP® Influenza Immunity Test: +In December 2009, Chembio entered into a development agreement for up to approximately $900,000 in connection with the development and initial supply of a multiplex, rapid point-of-care ("POC") influenza immunity test. The agreement contemplates a period of approximately nine months in which the development activity is to be completed. Chembio entered this agreement with Battelle Memorial Institute, which has a master contract with the United States Centers for Disease Control and Prevention ("CDC"), to enter into, implement and provide technical oversight of agreements relating to pandemic preparedness on behalf of CDC. +F-20 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2010 AND 2009 +Based on the following events, in accordance with guidance, management has concluded the Battelle milestones recorded this quarter meet the definition of milestone events. +As of December 31, 2010, the Company recognized $803,900 in milestone revenues from this agreement. +Governmental Regulation: +All of the Company’s existing and proposed diagnostic products are regulated by the United States Food and Drug Administration (FDA), United States Department of Agriculture, certain state and local agencies, and/or comparable regulatory bodies in other countries. Most aspects of development, production, and marketing, including product testing, authorizations to market, labeling, promotion, manufacturing, and record keeping are subject to review. After marketing approval has been granted, Chembio must continue to comply with governmental regulations. Failure to comply with these regulations can result in significant penalties. +F-21 \ No newline at end of file diff --git a/raw/filings/0001092662/2010/0001293462-11-000011/filing_metadata.csv b/raw/filings/0001092662/2010/0001293462-11-000011/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..652bc4daf0f1d1c1d6c6674e606697e7ca6b86f4 --- /dev/null +++ b/raw/filings/0001092662/2010/0001293462-11-000011/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001092662,CEMI,"CHEMBIO DIAGNOSTICS, INC.",10-K,2011-03-03,2010-12-31,2011-03-03T11:36:58.000Z,0001293462-11-000011,form10_k.htm,FORM 10-K FOR 2010,1949245,0,0,https://www.sec.gov/Archives/edgar/data/1092662/000129346211000011/form10_k.htm,https://www.sec.gov/Archives/edgar/data/1092662/000129346211000011/,2010,2010,1 diff --git a/raw/filings/0001092662/2010/0001293462-11-000011/item1.txt b/raw/filings/0001092662/2010/0001293462-11-000011/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..eb54fb8858bf744f65ece7f8bab5b3043366ab48 --- /dev/null +++ b/raw/filings/0001092662/2010/0001293462-11-000011/item1.txt @@ -0,0 +1,186 @@ +ITEM 1. +BUSINESS +FORWARD-LOOKING STATEMENTS +This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, and Section 27A of the Securities Act of 1933. Any statements contained in this report that are not statements of historical fact may be forward-looking statements. When we use the words “intends,” “estimates,” “predicts,” “potential,” “continues,” “anticipates,” “plans,” “expects,” “believes,” “should,” “could,” “may,” “will” or the negative of these terms or other comparable terminology, we are identifying forward-looking statements. Forward-looking statements involve risks and uncertainties, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by forward-looking statements. These factors include our research and development activities, distributor channels, compliance with regulatory impositions; and our capital needs. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business. +For further information about these and other risks, uncertainties and factors, please review the disclosure included in this report under “Part I, Item 1A, Risk Factors.” +General +The Company (Chembio Diagnostics, Inc. and its wholly-owned subsidiary Chembio Diagnostic Systems, Inc. are collectively referred to herein as the “Company”) develops, manufactures, markets and licenses rapid point-of-care diagnostic tests (POCTs) that detect infectious diseases. The Company’s main products presently commercially available are four rapid tests for the detection of HIV antibodies. Three of these products employ in-licensed and proprietary lateral flow technologies (see “Our Rapid Test Technologies”), can be used with all blood matrices as samples, and are manufactured in a standard cassette format, a dipstick format, and a proprietary barrel format. The tests employing the cassette and proprietary barrel formats were approved by the FDA in 2006 and are distributed by Alere, Inc., formerly Inverness Medical Innovations, Inc. (“Alere”), in the United States. Our fourth rapid HIV test, which we more recently developed on our patented Dual Path Platform (DPP®) and does not require in-licensing, detects antibodies to HIV in oral fluid samples as well as in all blood matrices. We anticipate launching this product under Chembio’s brand in 2012. +Our new product pipeline is based on this DPP® technology for which we were issued a United States patent in 2007 and for which additional patent protection has issued or is pending worldwide. With the DPP® proprietary platform, we can participate in the point-of-care market segment of the nearly $40 billion global in-vitro diagnostic market that is estimated to be $6-8 billion with an overall growth rate of 7% per annum. POCTs, by providing prompt and early diagnosis, can reduce patient stays, lower overall costs, improve therapeutic interventions and improve patient outcomes as a result of prompt and early diagnosis. They can also prevent needless hospital admissions, simplify testing procedures, avoid delays from central lab batching, and eliminate the need for return visits. +In the areas of infectious and sexually transmitted diseases (such as Influenza and HIV for example), the utility of a rapid point–of-care test has been well established, and large markets have been established for these kinds of tests globally. We have focused our product development activity within these areas as they tend to have the higher growth rates within the point-of-care segment. +PRODUCTS +Lateral Flow Rapid HIV Tests +All three of our lateral flow rapid HIV tests are qualitative “yes/no” tests for the detection of antibodies to HIV 1 & 2 with visually interpreted results (one line “negative”; two lines “positive”) available within approximately 15 minutes. The tests are simple to use, have a shelf life of 24 months, and do not require refrigeration. The tests differ principally only in the method of test procedure, convenience and cost. One of our FDA-approved lateral flow HIV tests incorporates a proprietary plastic “barrel” device that houses the lateral flow strip. This barrel format enables collection of samples directly (for example directly from a finger-stick whole blood sample) into the barrel’s capillary tip. A sealed unitized buffer vial, assembled onto the top of the barrel, is removed and seated into a stand; the seal is then pierced by the barrel’s capillary tip thereby initiating the upward flow of the resulting sample-buffer solution through a filter, up into the vertical device’s chamber and onto the lateral flow strip. This results in a unique unitized and closed device system that can reduce the chance of exposure to potentially infectious samples. Our other FDA-approved lateral flow HIV test uses a more conventional rectangular plastic cassette format that houses the lateral flow strip. In this case a sample is transferred by use of a separately provided transfer device (“loop”) into a sample well or port of the cassette which houses the lateral flow strip which is positioned horizontally or flat. +3 +Both of the above-described products are marketed exclusively in the United States by Alere as Clearview Complete HIV 1/2 (the barrel format) and Clearview HIV 1/2 STAT PAK® (the cassette format), and by Chembio in all other markets as Chembio Sure Check® HIV 1/2 and Chembio HIV 1/2 STAT PAK®. Alere has non-exclusive rights to the barrel product outside the United States. +Our third lateral flow HIV test, HIV 1/2 STAT PAK DIPSTICK is our most cost competitive and compact format. It does not have any plastic housing so that 30 test strips can be packaged into a small vial that is ideal for transporting into remote settings. The test procedure is similar to the cassette format; an adhesive backing is provided as a more cost-effective and compact “housing” on which to run the test. +Regulatory Status: The FDA approved our Pre-Market Applications (hereinafter “PMA”; see “Governmental Regulations” and Glossary) in April 2006 for our SURE CHECK HIV 1/2 (and also now Alere’ Clearview® Complete HIV 1/2) and for our HIV 1/2 STAT-PAK (now Alere’ Clearview® HIV 1/2 STAT-PAK in the United States only) products. A Clinical Laboratory Improvement Act (hereinafter “CLIA”; see Governmental Regulations) waiver was granted by the FDA for the HIV 1/2 STAT-PAK in November 2006 and for the two Alere Clearview® brands in October 2007. Our HIV 1/2 STAT-PAK Dipstick, though not FDA-approved, qualifies under FDA export regulations to sell, subject to any required approval by the importing country, to customers outside the United States. +All three of our lateral flow HIV tests have qualified for procurement under the President’s Emergency Plan for AIDS Relief (“PEPFAR”). The STAT PAK (both the cassette and dipstick versions) are also qualified for the second largest global program, known as the Global Fund (see Glossary), through qualification with the WHO bulk procurement scheme. +DPP® HIV Test +We have completed development of and are now commercializing our DPP® HIV 1&2 Assay. As in the case of our lateral flow HIV tests, the DPP® HIV test is also a qualitative “yes/no” test for the detection of antibodies to HIV 1 & 2, delivers visual results within approximately 15 minutes, is simple to use, has a shelf life of 24 months, and does not require refrigeration. However this product, which is our first product incorporating our patented DPP® technology, can be used with oral fluid samples, as well as all blood matrices. This product also incorporates our patent-pending oral fluid collection and storage system that enables samples to be fully extracted in buffer solution before application to the test device, and also enables the extracted sample to be stored and retested or tested for multiple conditions. Most importantly, clinical and laboratory studies conducted over the last couple of years have shown this product to have improved performance compared with all of the current FDA-approved CLIA-waived rapid tests, even including our own. +Regulatory Status: In the first half of 2010 we commenced clinical studies with this product in the United States pursuant to an investigational device exemption and in support of an anticipated Pre-Marketing Approval application to the FDA. During the first quarter of 2011 we submitted the first module of such PMA application, and we anticipate submitting the final module later this year. We believe that approval of our PMA application will be within approximately six months after we submit the final module. Thereupon we would apply for CLIA waiver of this product. +The Company conducted laboratory and field studies with this product in 2007-2009 prior to our commencing the clinical trials in the United States. One of the international clinical studies was conducted by the United States Centers for Disease Control, Global AIDS Program in Mozambique (“CDC GAP”). CDC GAP is responsible for evaluating products seeking to participate in PEPFAR, and CDC GAP had already performed its standard laboratory study in 2009 that resulted in the approval for the use of the product in the U.S. government’s international AIDS relief program known as PEPFAR (see Glossary) with blood matrices; the Mozambique study facilitated approval of this product for procurements by PEPFAR for use with oral fluid samples. The other study was sponsored by Chembio and was conducted at the National Hospital in Abuja Nigeria. In both of these studies the DPP® product’s performance equaled or exceeded the sensitivity and specificity of each of the other rapid tests in the study, including the only oral fluid HIV test that is currently FDA-approved. During the first quarter of 2011 we also received additional data from the CDC that further supports the previously reported performance. In order to capitalize on the PEPFAR and WHO approvals, this product still has to be registered and approved for export to a PEPFAR or Global Fund beneficiary country, and to also be one of the tests selected by such country for incorporation in such country’s national testing protocol. This is a process we are undertaking in selected markets. +In June 2010 ANVISA (see Glossary) approved the DPP® HIV test in Brazil. We are also seeking to have this product approved by WHO pursuant to its bulk procurement scheme as such approval is necessary to pursue certain international donor-funded markets. +PARTNERS INVOLVED IN MARKETING OUR HIV PRODUCTS +On September 29, 2006 we executed marketing and license agreements with Alere. The marketing agreements (one for each of the two FDA approved products) provide Alere with a 10-year exclusive right (i.e. until September 2016) to market our rapid HIV tests in the United States under Alere’s brand. The agreements provide Chembio a non-exclusive license to certain Alere lateral flow patents that may be applicable to our lateral flow products, principally including our lateral flow HIV tests we have continued to market outside the United States. Simultaneous with the execution of the agreements, we also settled litigation with StatSure Diagnostics, Inc.(SDS) that had been ongoing relating to the proprietary barrel device which is incorporated into one of our two FDA-approved rapid HIV tests (See Lateral Flow HIV Tests above). +The agreements with Alere have allowed the Company to participate in the growth of the rapid HIV test market in the United States in an OEM (Original Equipment Manufacturer) capacity. This collaboration has been successful as it has allowed the company to invest in its product development, regulatory and manufacturing activities, and to avoid investing in a United States marketing organization. +We have appointed distributors internationally for our lateral flow HIV tests. Our largest markets for our lateral flow HIV rapid tests outside the United States are certain countries in Africa and Mexico. +4 +Our DPP® HIV test was approved by ANVISA in June 2010. This approval was granted to our Brazilian partner, the Oswaldo Cruz Foundation (“FIOCRUZ”), pursuant to one of six technology transfer, supply and license agreements we have entered with this public health organization since 2004 (See OEM DPP® products). +OTHER LATERAL FLOW RAPID TESTS +The Company entered the rapid test market segment with lateral flow technology and for many years our revenues were almost entirely based on this technology, primarily pregnancy tests before we developed the HIV lateral flow tests. Because of the limited license we entered into with Alere to manufacture and market only certain applications of lateral flow technology, we developed our own patent-protected rapid point-of-care technology platform, DPP®, that does not require a lateral flow license, all of our other products and products under development are based on the DPP®. Revenues from products based on lateral flow technologies other than our HIV tests were 3.9% of sales in 2010, substantially all of which are primarily attributable to our niche product line relating to veterinary tuberculosis and Chagas. We developed the veterinary tuberculosis tests as a result of and development program we did pursuant to a National Institute Health grant. This grant work enabled us to have our facility approved for the manufacture of products regulated by the United States Department of Agriculture. We are pursuing new opportunities in the veterinary diagnostics field in order to leverage this capability together with our development capabilities and proprietary point-of-care platform, DPP®. +OTHER DPP® PRODUCTS +Our strategy with respect to our DPP® technology has evolved as the Company has evolved. Initially, following the issuance of our DPP® patent in the United States in 2007, our strategy entirely involved efforts in developing third party funded OEM research and development contracts and grants. This strategy enabled us to conserve our own capital resources, while at the same time acquire important know-how and experience with the platform while also developing third party references and implicit endorsements of the technology. As our capabilities to develop and manufacture DPP® products expanded, and as our financial position has improved, so have our strategic options expanded and improved. While we will continue to employ the strategy of seeking OEM development and manufacturing agreements as a way to participate in markets that we cannot and/or choose not serve (e.g., veterinary) , we believe that we can also develop our own branded line of products, and we plan to do this in the public health area. This brand will be launched with our DPP® HIV Screening Assay in the United States market in 2012, to be followed by our Syphilis test (See RECENT DEVELOPMENTS AND CHEMBIO’S PLAN OF OPERATIONS FOR THE NEXT TWELVE MONTHS). +Following is a discussion of the OEM DPP® products for which we have completed our development activity pursuant to our OEM contracts with FIOCRUZ, Bio-Rad Laboratories, and the Battelle Memorial Institute. The status of those OEM and Chembio-branded products that are still under development are described in Part II Item 7. +OEM DPP® Products +Oswaldo Cruz Foundation OEM DPP® Agreements +During 2008 we signed four agreements and in 2010 one additional agreement with the Oswaldo Cruz Foundation (FIOCRUZ) in Brazil relating to products based on our DPP® technology. FIOCRUZ is the leading public health organization in Brazil and it is affiliated with Brazil’s Ministry of Health and has basic research and educational divisions as well as extensive manufacturing facilities that manufacture drugs and vaccines, as well as diagnostic products. +During 2010, two of the products under agreement with FIOCRUZ, the DPP® HIV Screening Assay and the 5-band multiplex point-of-care confirmation test for HIV 1&2, were approved by ANVISA. We believe that FIOCRUZ is seeking to have these products used in a new serial testing algorithm to be deployed by the Ministry of Health in Brazil; an evaluation concerning this new algorithm is underway. During the fourth quarter of 2010, we shipped $537,500 of DPP® HIV Screening Assays to FIOCRUZ. Under the two agreements we have for the recently approved products, there is a potential for aggregate sales of $13.5 million. The agreements between the Company and FIOCRUZ are unique examples of technology transfer collaborations between a private sector rapid test manufacturer and a public health organization. The other products under agreement with FIOCRUZ are for DPP® products for Leishmaniasis, Leptospirosis and Syphilis. These products are still pending regulatory approval in Brazil and their status is briefly discussed in Part II Item 7. +All of the agreements with FIOCRUZ contemplate a technology transfer license to FIOCRUZ for the manufacture of the subject products over stipulated periods of time. These technology transfers, and the provision by Chembio of the information and training that is required for this to occur, are subject to Chembio receiving orders for a minimum amount of products for manufacture by Chembio; thereafter Chembio may receive royalty payments for a defined period based on product sold by FIOCRUZ to the public health programs in Brazil. During 2010 Chembio received $92,000 of royalties from FIOCRUZ pursuant to the 2004 agreement with FIOCRUZ. +Bio-Rad Laboratories OEM DPP® Agreement - On April 6, 2008, we entered a milestone-based development agreement with Bio-Rad Laboratories N.A., a division of Bio-Rad Laboratories Inc (NYSE:BIO), a leading in-vitro diagnostic and life science company. The agreement with Bio-Rad was for the development of a six-band multiplex product (the specific application is confidential) on our DPP®. Based on achieving the proof of concept for this product during 2008, in January 2009 we entered a limited exclusive license agreement with Bio-Rad related to the field of use for this application, and we continued the development work during all of 2009 and until Bio-Rad confirmed that the product specifications were met in the second quarter of 2010. In June 2010, Bio-Rad exercised its option to have Chembio transfer the manufacturing of this product to Bio-Rad, which process was completed in October 2010. Chembio believes that Bio-Rad is proceeding with the regulatory approvals of this product, with CE Mark likely by the end of 2010, although there can be no assurance of this. We further believe that Bio-Rad has begun discussions with the FDA to discuss this product, its proposed performance claims and the intended clinical protocol to support its regulatory submission. +5 +During 2008 to 2010, Chembio earned approximately $460,000 for product development work rendered to Bio-Rad under this agreement, plus an additional $490,000 in license and other fees related to the manufacturing transfer. +Battelle/CDC DPP® Influenza Immunity Test – In December 2009 Chembio entered into a milestone-based development agreement for the development and initial supply of a multiplex, rapid point-of-care ("POC") influenza immunity test. The agreement contemplated a period of approximately nine months in which the development activity was to be completed. Chembio entered this agreement with Battelle Memorial Institute, which has a master contract with the United States Centers for Disease Control and Prevention ("CDC") to enter into, implement and provide technical oversight of agreements relating to pandemic preparedness on behalf of CDC. The objective of the project was to develop a product that can determine an individual's immunity to seasonal and novel influenza viruses, including novel swine H1N1, either in the field or in an outpatient setting. Development work with respect to the contract development specification is substantially completed and our contract partners are assessing the prototype product and determining potential additional funded development activity. +Our Rapid Test Technologies +All of our commercially available current products employ either in-licensed lateral flow technology or our own patented Dual Path Platform (DPP®) technology and are visually read. Certain of our new DPP® products will incorporate reader technologies that can help record and report test results and reduce subjectivity of results sometimes found with visually read tests. Both lateral flow technology and DPP® allow the development of accurate, low cost, easy-to-perform, single-use diagnostic tests for rapid, visual detection of specific antigen-antibody complexes on a test strip. This format provides a test that is simple (requires neither electricity nor expensive equipment for test execution or reading, nor skilled personnel for test interpretation), rapid (turnaround time approximately 15 minutes), safe (minimizes handling of potentially infected specimens), non-invasive (requires 5-20 micro liters of whole blood easily obtained with a finger prick, or alternatively, serum or plasma), stable (24 months at room temperature storage in the case of our HIV tests), and highly reproducible. +We believe that products developed using DPP® technology can provide superior diagnostic performance as compared with products that use lateral flow technology. The reason for this is that one of the major differences between the two platforms is that in DPP® samples are allowed to incubate with the target analyte in the test zone before introduction of the labeling reagent/conjugate whereas in lateral flow samples are combined with the labeling reagent to form a complex before coming in contact with the target analyte. Also, because of the usage in DPP® of a separately connected sample strip, the control and delivery of sample material is substantially improved. This is critical in the development of multiplex tests, as well as tests that involve viscous sample material (such as oral fluid) that can be impeded when forced to combine with labeling reagents before migration on the test strip to the test zone area. +We can also use hand held and desktop readers to objectively measure, quantify, record and report test results. Certain of the products we have and/or are developing incorporate some of these readers, and we are developing other products that may be used with or will require use of a reader. +Target Markets +Rapid HIV Tests +A large percentage of individuals that are HIV positive worldwide are unaware of their status. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results if samples have to be sent out to a laboratory which can take at least several days to process. However, the increased availability, greater efficacy and reduced costs for anti-retroviral treatments (ARVs) for HIV has increased the demand for testing, as the stigma associated with the disease is lessened, and the ability to resume normal activities is substantially improved, providing a positive message to those potentially infected. +There are approximately 53,000 new diagnoses of HIV infection in the United States each year, according to the CDC. In time, most of these infections progress to AIDS. The CDC estimates that approximately 1.1 million individuals in the U.S. are living with HIV, with an estimated 250,000 Americans, or more than 25%, unaware that they are infected. It is these 250,000 infected people that account for 54% of all new infections per year. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results from samples that have to be sent out to a laboratory and that can take at least several days to process. Healthcare officials believe that by making more people aware of their HIV status, it will reduce the number of HIV transmissions. +Rapid HIV testing in the United States has now developed into a 6-7 million test market. This is from zero in 2003 when Orasure received FDA approval for the first rapid HIV test. We believe that the US professional HIV rapid test market (not including the OTC market) has the potential to increase to 15-18 million tests over the next several years, which would represent about 50% of all HIV tests done today in the United States for clinical purposes. Assuming an average price to the manufacturers of $10.00 per test, a total potential market of $180 million U.S. market is inferred. +In 2006, the outlook for HIV testing was given a big boost with the release by the CDC of new guidelines for HIV testing. These new CDC recommendations are that an HIV test should be given as a routine test like any other for all patients between 13 and 64 years of age, regardless of risk, with an opt-out screening option and focused testing procedural (pre and post test counseling) guidelines. Adoption of the 2006 CDC recommendations by a number of states continues to have an increasing impact. +In the international market, PEPFAR, the large United States funded international AIDS relief program focused on fifteen countries, was reauthorized in 2008 for up to $48 billion for FY2009-2012 (up from $15 billion in 2004-2008). PEPFAR, and the Global Fund are the largest of the global initiatives that have helped to make life-saving treatments available to those that need them. For example PEPFAR has the goal that by 2013 three million infected individuals will be provided treatment and 12 million new cases will be averted. To achieve these goals more and more people are likely to get tested. As more effective treatments become available at lower costs there is a clearer reason to be tested. +6 +Oral fluid testing is an established alternative to blood testing for diagnostic tests, including HIV tests. It is also often patient preferred, providing a more comfortable test. In certain public health clinics, staffs choose not to handle blood specimens; thus, oral sample collection provides a viable alternative. The most well-established market for oral fluid HIV testing is the United States. There is also now an opportunity to participate in the over-the-counter market for HIV tests. This opportunity received important support by the FDA and CDC in November 2009. +Rapid Syphilis Tests +Recent data indicate that approximately 70,000-100,000 new cases of syphilis are occurring annually in the U.S. Syphilis can be treated with antibiotics, but untreated can cause pelvic inflammatory disease, infertility, ectopic pregnancy and can infect newborns. Treatment cannot be provided without a confirmed diagnosis of an active, previously untreated case of syphilis. Current testing algorithms in the United States require two different tests (called non-treponemal and treponemal markers), each requiring trained personnel in laboratory settings and several days to receive back results, in order to confirm an active, previously untreated case. +Development of the POC market for syphilis testing is expected to be comparable to the development of the POC market for HIV testing, as there is a significant public health value to being able to provide results at the point-of-care. There are several ways to assess the market opportunity for this unique rapid test, although we believe the U.S. rapid test market opportunity is a minimum of 3 million tests, which is approximately 20% of the total number syphilis tests performed in the United States today. Unlike HIV testing, where a positive result first requires a confirmatory test, and even then further tests to measure viral load before expensive treatment decisions are made, an individual with a confirmed active case of syphilis can be prescribed antibiotics immediately. +In February 2011 a study was released by the CDC that suggested that the “newest” laboratory screening tests, which are using technologies developed in the 1980s (i.e. Enzyme-linked Immunoassays), are resulting in a large number of suspected false positive test results, which are test results that are not in fact representing active cases of Syphilis. This study involved tests done in high throughput blood screening laboratory settings, and not necessarily clinical settings. Nevertheless we believe that the study suggests that if public health clinicians could have what is effectively the CDC-recommended laboratory testing algorithm in a point-of-care test, this could be an invaluable public health tool in higher risk testing (higher STD prevalence) settings. We believe this is the opportunity we have with this product. +Marketing Strategy +Our marketing strategy is to: +· +Support, review and assess the marketing and distribution efforts of our rapid HIV tests by Alere. Alere, which is a leading marketer of point-of-care diagnostic products, has significantly expanded its distribution footprint since we signed our agreement with them, and although we believe that this will enhance opportunities for Alere to market our rapid HIV tests, the product line is a very small one for them notwithstanding the strong growth they have enjoyed with respect to our products. +· +Leverage our DPP® intellectual property and regulated product development and manufacturing experience to continue creating new collaborations where Chembio can be the exclusive development and manufacturing partner supporting leading marketing organizations. +· +Establish strong distribution relationships for our Chembio-branded products in the U.S and abroad and establish a direct sales and marketing organization that is focused in the public health market segment. +Competition +The diagnostics industry is a multi-billion dollar international industry and is intensely competitive. Many of our competitors are substantially larger and have greater financial, research, manufacturing and marketing resources. +Industry competition in general is based on the following: +· +Scientific and technological capability; +· +Proprietary know-how; +· +The ability to develop and market products and processes; +· +The ability to obtain FDA or other required regulatory approvals; +· +The ability to manufacture products that meet applicable FDA requirements, (i.e. FDA’s Quality System Regulations) (see Governmental Regulation section); +· +The ability to manufacture products cost-effectively; +· +Access to adequate capital; +· +The ability to attract and retain qualified personnel; and +· +The availability of patent protection. +7 +We believe our scientific and technological capabilities and our proprietary know-how relating to our in-licensed lateral flow technology rapid tests and to our proprietary know-how related to our patented dual path platform technology, particularly for the development and manufacture of tests for the detection of antibodies to infectious diseases such as HIV, are very strong. +Our ability to develop and market other products is in large measure dependent on our having additional resources and/or collaborative relationships. Some of our product development efforts have been funded on a project or milestone basis. We believe that our proprietary know-how in lateral flow technology and in our Dual Path Platform (DPP®) technology has been instrumental in our obtaining the collaborations we have and that we continue to pursue. We believe that the patent protection that we have with our Dual Path Platform (DPP®) enhances our ability to develop more profitable collaborative relationships and to license out the technology. +Research and Development +During 2010 and 2009, $4.1 million ($2.6 million, net of Qualified Therapeutic Discovery Project (“QTDP”) grants) and $2.9 million, respectively, were spent on research and development (including regulatory activities). These expenses were in part underwritten by funding from R&D and milestones revenues of $2.8 million in 2010 and $1.3 million in 2009. All of our new product development activities involve employment of our Dual Path Platform (DPP®) technology. These activities include completing development of certain products and making significant progress toward the development of additional products. Research and development and regulatory activities are explained in detail in Part II Item 7. +Employees +At December 31, 2010, we employed 118 people, including 115 full-time employees. We have entered into employment contracts with our President, Lawrence Siebert, and our Senior Vice President of Research and Development, Javan Esfandiari. Due to the specific knowledge and experience of these executives regarding the industry, technology and market, the loss of the services of either one of them would likely have a material adverse effect on the Company. The contract with Mr. Siebert provides that Mr. Siebert will serve as the Chief Executive Officer and President of the Company for an additional three-year term through May 11, 2012. The contract with Mr. Esfandiari has a term of three years ending March 2013. We have obtained a key man insurance policy for Mr. Esfandiari. +Governmental Regulation +The manufacturing and marketing of the Company’s existing and proposed diagnostic products are regulated by the United States Food and Drug Administration (“FDA”), United States Department of Agriculture (“USDA”), certain state and local agencies, and/or comparable regulatory bodies in other countries. These regulations govern almost all aspects of development, production and marketing, including product testing, authorizations to market, labeling, promotion, manufacturing and record keeping. The Company’s FDA and USDA regulated products require some form of action by each agency before they can be marketed in the United States, and, after approval or clearance, the Company must continue to comply with other FDA requirements applicable to marketed products, e.g. Quality Systems (for medical devices). Failure to comply with the FDA’s requirements can lead to significant penalties, both before and after approval or clearance. +There are two review procedures by which medical devices can receive FDA clearance or approval. Some products may qualify for clearance under Section 510(k) of the Federal Food, Drug and Cosmetic Act, in which the manufacturer provides a pre-market notification that it intends to begin marketing the product, and shows that the product is substantially equivalent to another legally marketed product (i.e., that it has the same intended use and is as safe and effective as a legally marketed device and does not raise different questions of safety and effectiveness). In some cases, the submission must include data from human clinical studies. Marketing may commence when the FDA issues a clearance letter finding such substantial equivalence. FDA clearance of our DPP® Syphilis Screen & Confirm test will be by means of a 510(k) submission. +If the medical device does not qualify for the 510(k) procedure (either because it is not substantially equivalent to a legally marketed device or because it is required by statute and the FDA’s implementing regulations to have an approved application), the FDA must approve a Pre-Marketing Application (“PMA”) before marketing can begin. PMA’s must demonstrate, among other matters, that the medical device provides a reasonable assurance of safety and effectiveness. A PMA application is typically a complex submission, including the results of non-clinical and clinical studies. Preparing a PMA application is a much more expensive, detailed and time-consuming process as compared with a 510(K) pre-market notification. The Company has approved PMAs for the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1-2 and Clearview® HIV 1-2 STAT PAK®. FDA approval of our DPP® HIV screening assay for use with oral fluid or blood samples will be pursued by means of a PMA application. +The Clinical Laboratory Improvement Act of 1988 (“CLIA”) prohibits laboratories from performing in vitro tests for the purpose of providing information for the diagnosis, prevention or treatment of any disease or impairment of, or the assessment of, the health of human beings unless there is in effect for such laboratories a certificate issued by the United States Department of Health and Human Services (via the FDA) applicable to the category of examination or procedure performed. Although a certificate is not required for the Company, it considers the applicability of the requirements of CLIA in the design and development of its products. The statutory definition of “laboratory” is very broad, and many of our customers are considered labs. A CLIA waiver will remove certain quality control and other requirements that must be met for certain customers to use the Company’s products and this is in fact critical to the marketability of a product into the point-of-care diagnostics market. The Company has received a CLIA waiver for each of the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1/2 and Clearview® HIV 1/2 STAT PAK®. The CLIA waiver was granted by the FDA for HIV 1/2 STAT-PAK on November 20, 2006 and for the Clearview® Complete HIV 1/2 on October 22, 2007. +8 +In addition, the FDA regulates the export of medical devices that have not been approved for marketing in the United States. The Federal Food, Drug and Cosmetic Act contains general requirements for any medical device that may not be sold in the United States and is intended for export. Specifically, a medical device intended for export is not deemed to be adulterated or misbranded if the product: (1) complies with the specifications of the foreign purchaser; (2) is not in conflict with the laws of the country to which it is intended for export; (3) is prominently labeled on the outside of the shipping package that it is intended for export; and (4) is not sold or offered for sale in the United States. However, the Federal Food, Drug and Cosmetic Act does permit the export of devices to any country in the world, if the device complies with the laws of the importing country and has valid marketing authorization in one of several “listed” countries under the theory that these listed countries have sophisticated mechanisms for the review of medical devices for safety and effectiveness. +The Company is also subject to regulations in foreign countries governing products, human clinical trials and marketing, and may need to obtain approval or evaluations by international public health agencies, such as the World Health Organization, in order to sell diagnostic products in certain countries. Approval processes vary from country to country, and the length of time required for approval or to obtain other clearances may in some cases be longer than that required for United States governmental approvals. On the other hand, the fact that our HIV diagnostic tests are of value in the AIDS epidemic may lead to some government process being expedited. The extent of potentially adverse governmental regulation affecting Chembio that might arise from future legislative or administrative action cannot be predicted. +One or more of the Company’s rapid HIV tests are also approved or pending approval for marketing in several foreign jurisdictions, including but not limited to Brazil, Mexico, and a number of other nations in the developing world. +Environmental Laws +To date, we have not encountered any costs relating to compliance with any environmental laws. +Intellectual Property +Intellectual Property Strategy +Our intellectual property strategy is to: (1) build our owned intellectual property portfolio around our Dual Path Platform technology; (2) pursue licenses, trade secrets and know-how within the area of rapid point-of-care testing, and (3) develop and acquire proprietary positions to reagents and new hardware platforms for the development and manufacture of rapid diagnostic tests. +The Company has obtained patent coverage on the DPP® product line, including three U.S. patents, and patents in China, Malaysia, Eurasia, Mexico, Singapore, and the U.K. Additional patent applications on the DPP® product line are pending in the U.S., as well as in many foreign countries such as Australia, Brazil, Canada, the European Union, India, Indonesia, Israel, Japan, Korea, and South Africa. Patents have also been filed on extensions to the DPP® product line concept such as 4th generation assays. +The Company has also filed for patents and obtained some patents in the U.S. for other inventions such as its multiple host species veterinary TB test, and patent applications for the other inventions are in various stages from being recently filed and not yet examined, to already examined and allowed but not yet issued. The Company selectively and strategically foreign files its patent applications based on the importance of the invention to the Company. +Trademarks +The Company has filed and obtained trademarks for its products including DPP®, SURE CHECK® and STAT-PAK®. The DPP® trademark is also registered under the European convention (ECT). +Trade Secrets and Know-How +We believe that we have developed a substantial body of trade secrets and know-how relating to the development of lateral flow and DPP® based diagnostic tests, including but not limited to the sourcing and optimization of materials for such tests, and how to maximize sensitivity, speed-to-result, specificity, stability and reproducibility. The Company possesses proprietary know-how to develop tests for multiple conditions using colored latex. Our buffer formulations enable extremely long shelf lives of our rapid HIV tests and we believe that this provides us with an important competitive advantage. +Lateral Flow Technology and Reagent Licenses +As part of our agreements in 2006 with Alere for the marketing of our HIV tests, we were granted non-exclusive licenses to certain lateral flow technology for certain products manufactured and marketed by Chembio including but not limited to our HIV tests. Although we believe our DPP® is outside of the scope of all lateral flow patents of which we are aware, we consult with patent counsel, and seek licenses and/or redesigns of products that we believe to be in the best interests of the Company and our stockholders. Because of the costs and other negative consequences of time-consuming patent litigation, we often attempt to obtain a license on reasonable terms. Nevertheless there is no assurance that the Alere lateral flow patents we have licensed will not be challenged or that other patents containing claims relevant to the Company’s lateral flow or DPP® products will not be granted and that licenses to such patents, will be available on reasonable terms, if any. Alere has aggressively enforced its lateral flow intellectual property, although some of the main patents will expire within the next few years. +9 +Regardless, the DPP® technology provides us with our own intellectual property, we believe it provides us with a freedom to operate, and that it also enables tests to be developed with improved sensitivity as compared with comparable tests on lateral flow platforms. The Company has signed and anticipates signing new development projects based upon the DPP® technology that will provide new manufacturing and marketing opportunities. We have filed other patents that we believe will strengthen the DPP® intellectual property and have also filed for patent protection for certain other point-of-care technologies or applications thereof. +The peptides used in our rapid HIV tests are patented by Adaltis Inc. and are licensed to us under a 10-year non-exclusive license agreement dated August 30, 2002. In connection with Adaltis’ bankruptcy, during the third quarter of 2009 we bought out all of our remaining obligations under that agreement. We also have licensed the antigens used in other tests including our Syphilis, Tuberculosis, Leptospirosis and Leishmaniasis tests. In prior years we concluded license agreements related to intellectual property rights owned by the United States associated with HIV- 1, and during the first quarter of 2008 we entered into a sub-license agreement for HIV-2 with Bio-Rad Laboratories N.A., the exclusive licensee of the Pasteur Institute’s HIV-2 intellectual property estate. +Corporate History +On May 5, 2004, we completed a merger with Chembio Diagnostic Systems Inc. through which Chembio Diagnostics Systems Inc. became our wholly-owned subsidiary, and through which the management and business of Chembio Diagnostic Systems Inc. became our management and business. As part of this transaction, we changed our name to Chembio Diagnostics, Inc. In 2003, we had sold our prior business, and as a result, we had no specific business immediately prior to the merger. +Since the formation of Chembio Diagnostic Systems Inc. in 1985, it has been involved in developing, manufacturing, selling and distributing in-vitro diagnostic tests, including rapid tests beginning in 1995, for a number of conditions in humans and animals. +On March 12, 2004, we implemented a 1-for-17 reverse split of our common stock. All references in this Form 10-K to shares of our common stock have been adjusted to reflect this reverse split. +In February 2010, Crestview Capital Master, L.L.C. ("Crestview Master), a Delaware limited liability company that held 18,907,431 shares of Chembio's common stock, spun off all these shares, constituting approximately 30.5% of Chembio's outstanding shares, to its three equity holders. One of the three equity holders of Crestview Master immediately spun off, to its approximately 126 equity holders, all of the 12,990,569 shares of Chembio stock that it received in this distribution. As a result, as of February 24, 2010, Crestview Master no longer owned any shares. The former direct and indirect equity holders of Crestview Master owned all these shares, with none of these individual stockholders having beneficial ownership of more than 5.61% of the outstanding common stock of Chembio. +10 +Glossary +AIDS +Acquired Immunodeficiency Syndrome. AIDS is caused by the Human Immunodeficiency Virus, HIV. +ALGORITHM (parallel or serial) +For rapid HIV testing this refers both to method or protocol (in developing countries to date) for using rapid tests from different manufacturers in combination to screen and confirm patients at the point-of-care, and may also refer to the specific tests that have been selected by an agency or ministry of health to be used in this way. A parallel algorithm uses two screening tests from different manufacturers and a tie-breaker test only if there is a discrepancy between the screening tests results. A serial algorithm only uses a second confirmatory test if there is a positive result from the screening test, meaning that the number of confirmatory tests used is equal to the positivity rate in the testing venue. A tie-breaker test resolves discrepancies between the screen and the confirmatory test. +ANTIBODY +A protein which is a natural part of the human immune system produced by specialized cells to neutralize antigens, including viruses and bacteria that invade the body. Each antibody producing cell manufactures a unique antibody that is directed against, binds to and eliminates one, and only one, specific type of antigen. +ANTIGEN +Any substance which, upon entering the body, stimulates the immune system leading to the formation of antibodies. Among the more common antigens are bacteria, pollens, toxins, and viruses. +ANVISA +ARVs +Anti-Retroviral Treatments for AIDS +The National Health Surveillance Agency of Brazil +Anti-retroviral medications developed to fight AIDS +CDC +United States Centers for Disease Control and Prevention +CLIA waiver +Clinical Laboratory Improvement Act designation that allows simple tests to be performed in point-of-care settings such as doctor’s offices, walk-in clinics and emergency rooms. +DIAGNOSTIC +Pertaining to the determination of the nature or cause of a disease or condition. Also refers to reagents or procedures used in diagnosis to measure proteins in a clinical sample. +EITF +Emerging Issues Task Force +FASB +FIOCRUZ +Financial Accounting Standards Board +The Oswaldo Cruz Foundation of Brazil +FDA +United States Food and Drug Administration +FDIC +Federal Deposit Insurance Corporation +FAS +Financial Accounting Standard +IgG +IgG or Immunoglobulin are proteins found in human blood. This protein is called an “antibody” and is an important part of the body’s defense against disease. When the body is attacked by harmful bacteria or viruses, antibodies help fight these invaders. +NGO +Non-Governmental Organization +OTC +Over-the-Counter +PEPFAR +The President’s Emergency Plan for AIDS Relief +PMA +Pre-Marketing Approval –FDA approval classification for a medical device that is not substantially equivalent to a legally marketed device or is otherwise required by statute to have an approved application. Rapid HIV tests must have an approved PMA application before marketing of such a product can begin. +PROTOCOL +A procedure pursuant to which an immunodiagnostic test is performed on a particular specimen in order to obtain the desired reaction. +REAGENT +A chemical added to a sample under investigation in order to cause a chemical or biological reaction which will enable measurement or identification of a target substance. +RETROVIRUS +A type of virus which contains the enzyme Reverse Transcriptase and is capable of transforming infected cells to produce diseases in the host such as AIDS. +SAB +Staff Accounting Bulletin +SENSITIVITY +Refers to the ability of an assay to detect and measure small quantities of a substance of interest. The greater the sensitivity, the smaller the quantity of the substance of interest the assay can detect. Also refers to the likelihood of detecting the antigen when present. +SPECIFICITY +The ability of an assay to distinguish between similar materials. The greater the specificity, the better an assay is at identifying a substance in the presence of substances of similar makeup. +USDA +U.S Department of Agriculture +WHO +World Health Organization +11 \ No newline at end of file diff --git a/raw/filings/0001092662/2010/0001293462-11-000011/item13.txt b/raw/filings/0001092662/2010/0001293462-11-000011/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..cc5232bd40c5334785bd18eeed6f43a6685fb774 --- /dev/null +++ b/raw/filings/0001092662/2010/0001293462-11-000011/item13.txt @@ -0,0 +1,10 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +The executive officers of the Company are as follows: Lawrence A. Siebert, president and chairman of the board of directors of the Company, Richard J. Larkin, chief financial officer of the Company, and Javan Esfandiari, executive vice president of Research and Development of the Company. +On May 7, 2009, the Compensation Committee of the Company reduced, to $0.13 per share, the exercise price of each outstanding employee option that was issued under the 1999 Equity Incentive Plan (the “1999 Plan”) for which the exercise price was greater than $0.44 per share of the Company’s common stock. There was no other change made to the terms of the stock options other than the reduction in the exercise price. A total of 1,036,750 options were affected. Mr. Siebert, Mr. Esfandiari and Mr. Larkin had options to purchase common stock that were so reduced of 160,000, 497,500 and 137,500, respectively. +In addition, on May 7, 2009 in accordance with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 2,925,000 shares of the Company’s common stock. The exercise price for these options is equal to $0.13 per share. The options become exercisable in thirds on the first, second and third anniversaries of the date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the date of grant. Mr. Siebert, Mr. Esfandiari and Mr. Larkin received options to purchase common stock of 400,000, 300,000 and 275,000, respectively. +During the quarter ended December 31, 2008, Alere notified the Company that Alere had entered into a contract with Bio-Rad Laboratories, Inc. (“Bio-Rad”) for royalties on Bio-Rad’s patent for the detection of HIV-2 antibodies. The agreement also provided for Alere to pay past royalties. On June 25, 2009, the Company and Alere entered into a letter agreement whereby certain obligations aggregating approximately $1,010,000 as of December 31, 2008 were agreed to be paid from future revenues. The obligations include the Company’s share under its agreements with Alere for the amount of HIV-2 royalties that Alere paid when Alere entered into an HIV-2 license agreement with Bio-Rad Laboratories, Inc. of approximately $485,000 and royalties owed by Chembio on lateral flow licenses to Alere of approximately $525,000 as of December 31, 2008. Under the agreement Alere will retain an additional 10% of Clearview® HIV 1/2 STAT-PAK® net sales and 5% of Clearview® Complete HIV 1/2 net sales until these obligations are extinguished. As of December 31, 2010 this balance was fully paid. +Director Independence +Our common stock trades on the OTC Bulletin Board. As such, we are not currently subject to corporate governance standards of listed companies, which require, among other things, that the majority of the board of directors be independent. +We are not currently subject to corporate governance standards defining the independence of our directors, and we have chosen to define an “independent” director in accordance with the NASDAQ Global Market's requirements for independent directors. Under this definition, we have determined that Gary Meller and Katherine L. Davis currently qualify as independent directors. We do not list the “independent” definition we use on our internet website . +40 \ No newline at end of file diff --git a/raw/filings/0001092662/2010/0001293462-11-000011/item9a.txt b/raw/filings/0001092662/2010/0001293462-11-000011/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..ab81c732f076b69c1b43a3da120498a8f0c09147 --- /dev/null +++ b/raw/filings/0001092662/2010/0001293462-11-000011/item9a.txt @@ -0,0 +1,15 @@ +ITEM 9A. +CONTROLS AND PROCEDURES +(a) Disclosure Controls and Procedures. Under the supervision and with the participation of our senior management, consisting of our chief executive officer and our chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report (the "Evaluation Date"). Based on that evaluation, the Company’s management, including our chief executive officer and chief financial officer, concluded that as of the Evaluation Date our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our Exchange Act reports is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. +Management's Annual Report on Internal Control Over Financial Reporting. The Company's management is responsible for establishing and maintaining an adequate system of internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)). Our internal control over financial reporting is a process, under the supervision of our chief executive officer and chief financial officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. These internal controls over financial reporting processes include policies and procedures that: +(1) +Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; +(2) +Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +(3) +Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives. +In evaluating the effectiveness of our internal control over financial reporting, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2010. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. +Management's report was not subject to attestation by our registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report. +(b) Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the Company’s last fiscal quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001092662/2010/0001293462-11-000011/rp_note.txt b/raw/filings/0001092662/2010/0001293462-11-000011/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001092662/2010/0001293462-11-000011/rpt_disclosure.txt b/raw/filings/0001092662/2010/0001293462-11-000011/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..cc5232bd40c5334785bd18eeed6f43a6685fb774 --- /dev/null +++ b/raw/filings/0001092662/2010/0001293462-11-000011/rpt_disclosure.txt @@ -0,0 +1,10 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +The executive officers of the Company are as follows: Lawrence A. Siebert, president and chairman of the board of directors of the Company, Richard J. Larkin, chief financial officer of the Company, and Javan Esfandiari, executive vice president of Research and Development of the Company. +On May 7, 2009, the Compensation Committee of the Company reduced, to $0.13 per share, the exercise price of each outstanding employee option that was issued under the 1999 Equity Incentive Plan (the “1999 Plan”) for which the exercise price was greater than $0.44 per share of the Company’s common stock. There was no other change made to the terms of the stock options other than the reduction in the exercise price. A total of 1,036,750 options were affected. Mr. Siebert, Mr. Esfandiari and Mr. Larkin had options to purchase common stock that were so reduced of 160,000, 497,500 and 137,500, respectively. +In addition, on May 7, 2009 in accordance with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 2,925,000 shares of the Company’s common stock. The exercise price for these options is equal to $0.13 per share. The options become exercisable in thirds on the first, second and third anniversaries of the date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the date of grant. Mr. Siebert, Mr. Esfandiari and Mr. Larkin received options to purchase common stock of 400,000, 300,000 and 275,000, respectively. +During the quarter ended December 31, 2008, Alere notified the Company that Alere had entered into a contract with Bio-Rad Laboratories, Inc. (“Bio-Rad”) for royalties on Bio-Rad’s patent for the detection of HIV-2 antibodies. The agreement also provided for Alere to pay past royalties. On June 25, 2009, the Company and Alere entered into a letter agreement whereby certain obligations aggregating approximately $1,010,000 as of December 31, 2008 were agreed to be paid from future revenues. The obligations include the Company’s share under its agreements with Alere for the amount of HIV-2 royalties that Alere paid when Alere entered into an HIV-2 license agreement with Bio-Rad Laboratories, Inc. of approximately $485,000 and royalties owed by Chembio on lateral flow licenses to Alere of approximately $525,000 as of December 31, 2008. Under the agreement Alere will retain an additional 10% of Clearview® HIV 1/2 STAT-PAK® net sales and 5% of Clearview® Complete HIV 1/2 net sales until these obligations are extinguished. As of December 31, 2010 this balance was fully paid. +Director Independence +Our common stock trades on the OTC Bulletin Board. As such, we are not currently subject to corporate governance standards of listed companies, which require, among other things, that the majority of the board of directors be independent. +We are not currently subject to corporate governance standards defining the independence of our directors, and we have chosen to define an “independent” director in accordance with the NASDAQ Global Market's requirements for independent directors. Under this definition, we have determined that Gary Meller and Katherine L. Davis currently qualify as independent directors. We do not list the “independent” definition we use on our internet website . +40 \ No newline at end of file diff --git a/raw/filings/0001092662/2011/0001092662-12-000013/filing.txt b/raw/filings/0001092662/2011/0001092662-12-000013/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..b3eb0054edb2242c891735abc38e78dde9850749 --- /dev/null +++ b/raw/filings/0001092662/2011/0001092662-12-000013/filing.txt @@ -0,0 +1,3006 @@ +10-K +1 +form10_k.htm +FORM 10-K FOR 2011 +form10_k.htm +UNITED STATES +Securities and Exchange Commission +Washington, D.C. 20549 +FORM 10-K +[X] +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2011 +or +[ ] +TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to . +Commission File No. 0-30379 +CHEMBIO DIAGNOSTICS, INC. +(Exact name of registrant as specified in its charter) +Nevada +88-0425691 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +3661 Horseblock Road, Medford, NY +11763 +(Address of principal executive offices) +(Zip Code) +Registrant’s telephone number, including area code (631) 924-1135 +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +None +None +Securities registered pursuant to section 12(g) of the Act: +Common Stock, $0.01 par value +(Title of Class) +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes __ No X +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes __ No X +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 X No__ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 X No __ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer [ ] Accelerated filer [ ] +Non-accelerated filer [ ] Smaller reporting company [X] +(Do not check if a smaller reporting company) +Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes __ No _X_ +As of the last business day of the Company’s most recently completed second fiscal quarter, the aggregate market value of voting and non-voting common equity held by non-affiliates* was $22,598,000. +As of March 6, 2012, the registrant had 63,668,096 common shares outstanding. +* Without asserting that any of the issuer’s directors or executive officers, or the entities that own more than five percent of the outstanding shares of the Registrant’s common stock, are affiliates, the shares of which they are beneficial owners have not been included in shares held by non-affiliates solely for this calculation. +TABLE OF CONTENTS +Page +PART I +ITEM 1. +BUSINESS +3 +ITEM 1A. +RISK FACTORS +13 +ITEM 2. +PROPERTIES +18 +ITEM 3. +LEGAL PROCEEDINGS +18 +ITEM 4 . +MINE SAFETY DISCLOSURES +18 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +19 +ITEM 6. +SELECTED FINANCIAL DATA +20 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +22 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +31 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. +32 +ITEM 9A. +CONTROLS AND PROCEDURES +32 +ITEM 9B. +OTHER INFORMATION +32 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +33 +ITEM 11. +EXECUTIVE COMPENSATION +35 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +39 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +41 +ITEM 14. +PRINCIPAL ACCOUNTANT FEES AND SERVICES +42 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +43 +SIGNATURES +44 +PART I +ITEM 1. +BUSINESS +FORWARD-LOOKING STATEMENTS +This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, and Section 27A of the Securities Act of 1933. Any statements contained in this report that are not statements of historical fact may be forward-looking statements. When we use the words “intends,” “estimates,” “predicts,” “potential,” “continues,” “anticipates,” “plans,” “expects,” “believes,” “should,” “could,” “may,” “will” or the negative of these terms or other comparable terminology, we are identifying forward-looking statements. Forward-looking statements involve risks and uncertainties, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by forward-looking statements. These factors include our research and development activities, distributor channels, compliance with regulatory impositions; and our capital needs. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business. +For further information about these and other risks, uncertainties and factors, please review the disclosure included in this report under “Part I, Item 1A, Risk Factors.” +General +The Company (Chembio Diagnostics, Inc. and its wholly-owned subsidiary Chembio Diagnostic Systems, Inc. are collectively referred to herein as the “Company”) develops, manufactures, markets and licenses rapid point-of-care diagnostic tests (POCTs) that detect infectious diseases. The Company’s main products presently commercially available are four rapid tests for the detection of HIV antibodies, two rapid tests for the detection of syphilis, and a rapid test for the detection of canine leishmaniasis. Three of the HIV rapid tests employ in-licensed and proprietary lateral flow technologies (see “Our Rapid Test Technologies”), can be used with all blood matrices as samples, and are manufactured in a standard cassette format, a dipstick format, and a proprietary barrel format. The tests employing the cassette and proprietary barrel formats were approved by the FDA in 2006 and are exclusively distributed by Alere, Inc. (“Alere”) in the United States and by Chembio outside the United States. Our fourth rapid HIV test, as well as our syphilis and canine leishmaniasis tests have been developed on our patented Dual Path Platform (DPP®), does not require in-licensing. The DPP® HIV test, detects antibodies to HIV in oral fluid samples as well as in all blood matrices. We anticipate completing United States FDA regulatory submissions for this product, which we anticipate launching under Chembio’s brand, in 2013. +Our new product pipeline is based on this DPP® technology for which we were issued a United States patent in 2007 and for which additional patent protection has issued or is pending worldwide. With the DPP® proprietary platform, we can participate in the point-of-care market segment of the nearly $40 billion global in-vitro diagnostic market that is estimated to be $6-8 billion with an overall growth rate of 7% per annum. POCTs, by providing prompt and early diagnosis, can reduce patient stays, lower overall costs, improve therapeutic interventions and improve patient outcomes as a result of prompt and early diagnosis. They can also prevent needless hospital admissions, simplify testing procedures, avoid delays from central lab batching, and eliminate the need for return visits. +In the areas of infectious and sexually transmitted diseases (such as HIV and syphilis for example), the utility of a rapid point–of-care test particularly in identifying patients unaware of their disease status has been well established. Large and growing markets have been established for these kinds of tests, initially in high prevalence regions where they are indispensable for large scale prevention and treatment programs. More recently introduced in the United States in 2004, rapid HIV tests now also present a significant segment of the U.S. market for HIV clinical testing, which is still dominated by laboratory tests. We have focused our product development activity within areas, such as these products where the availability of rapid, point-of-care screening, diagnostic, or confirmatory results can improve health outcomes. +3 +PRODUCTS +Lateral Flow Rapid HIV Tests +All three of our lateral flow rapid HIV tests are qualitative “yes/no” tests for the detection of antibodies to HIV 1 & 2 with visually interpreted results (one line “negative”; two lines “positive”) available within approximately 15 minutes. The tests are simple to use, have a shelf life of 24 months, and do not require refrigeration. The tests differ principally only in the method of test procedure, convenience and cost. One of our FDA-approved lateral flow HIV tests incorporates a proprietary plastic “barrel” device that houses the lateral flow strip. This barrel format enables collection of samples directly (for example directly from a finger-stick whole blood sample) into the barrel’s capillary tip. A sealed unitized buffer vial, assembled onto the top of the barrel, is removed and seated into a stand; the seal is then pierced by the barrel’s capillary tip, thereby initiating the upward flow of the resulting sample-buffer solution through a filter, up into the vertical device’s chamber and onto the lateral flow strip. This results in a unique unitized and closed device system that can reduce the chance of exposure to potentially infectious samples. We believe that this format may be an ideal candidate as an over-the-counter HIV test and we are participating in certain studies that should help to better ascertain this. Our other FDA-approved lateral flow HIV test uses a more conventional rectangular plastic cassette format that houses the lateral flow strip. In this case, a sample is transferred by use of a separately provided transfer device (“loop”) into a sample well or port of the cassette that houses the lateral flow strip, which is positioned horizontally or flat. +Both of the above-described products are marketed exclusively in the United States by Alere as Clearview® Complete HIV 1/2 (the barrel format) and Clearview® HIV 1/2 STAT PAK® (the cassette format), and by Chembio in all other markets as Chembio Sure Check® HIV 1/2 and Chembio HIV 1/2 STAT PAK®. Alere has non-exclusive rights to the barrel product outside the United States. +Our third lateral flow HIV test, HIV 1/2 STAT PAK® Dipstick is our most cost competitive and compact format. It does not have any plastic housing so that 30 test strips can be packaged into a small vial that is ideal for transporting into remote settings. The test procedure is similar to the cassette format; an adhesive backing is provided as a more cost-effective and compact “housing” on which to run the test. +Regulatory Status: The FDA approved our Pre-Market Applications (hereinafter “PMA”; see “Governmental Regulations” and Glossary) in April 2006 for our SURE CHECK HIV 1/2 (and also now Alere Clearview® Complete HIV 1/2) and for our HIV 1/2 STAT-PAK (now Alere’ Clearview® HIV 1/2 STAT-PAK in the United States only) products. A Clinical Laboratory Improvement Act (hereinafter “CLIA”; see Governmental Regulations) waiver was granted by the FDA for the two FDA- approved products in 2006 and 2007, respectively. The CLIA waiver is required in order for health care providers to administer these tests in the settings where they are most suited and needed, such as public health testing clinics, hospital emergency rooms and physicians’ offices. Our HIV 1/2 STAT-PAK Dipstick, though not FDA-approved, qualifies under FDA export regulations to sell to customers outside the United States subject to any required approval by the importing country. +All three of our lateral flow HIV tests have qualified for procurement under the President’s Emergency Plan for AIDS Relief (“PEPFAR”). The STAT PAK (both the cassette and dipstick versions) are also qualified by the World Health Organization (WHO) for procurements by the second largest global program, known as the Global Fund, as well as other related programs funded by agencies affiliated with the United Nations, such as UNICEF and UNITAIDS (see Glossary), through qualification with the WHO bulk procurement scheme. +DPP® HIV Test +As in the case of our lateral flow HIV tests, our DPP® HIV test is also a qualitative “yes/no” test for the detection of antibodies to HIV 1 & 2, delivers visual results within approximately 15 minutes, is simple to use, has a shelf life of 24 months, and does not require refrigeration. Additionally this product, which is our first product incorporating our patented DPP® technology, can be used with oral fluid samples, as well as with all blood matrices. This product also incorporates our patent-pending oral fluid collection and storage system that enables samples to be fully extracted in buffer solution before application to the test device, and also enables the extracted sample to be stored and retested or tested for multiple conditions. Clinical and laboratory studies have shown this product to have improved performance compared with all of the current FDA-approved CLIA-waived rapid tests including our own. +Regulatory Status: In 2010 we began a 3,000 patient clinical study with our DPP® HIV test in the United States which is one of the elements required to support a Pre-Marketing Approval (“PMA”) application to the FDA. The trial is 98% complete and we anticipate completing the trial as soon as possible. We have already submitted two of the three modules required for a modular PMA application, and we anticipate submitting the final module containing the clinical and other required information within 30 days of completing the clinical trials. We believe that approval of our PMA application will be within approximately six months after we submit the final module. At that time, we plan to apply for CLIA waiver of this product. +4 +The product is qualified for procurement under the President’s Emergency Plan for AIDS Relief (“PEPFAR”) for use with all sample matrices and we are pursuing WHO qualification in order to enable procurement of this product by the Global Fund and United Nations agencies, including programs underwritten by them. +In June 2010 ANVISA (see Glossary) approved the DPP® HIV test that is being marketed in Brazil through our collaboration with the Oswaldo Cruz Foundation, Brazil’s leading public health institute. Given the oral fluid feature, we believe this product can be marketed as a premium-priced product that will address those market segments in the U.S. and globally that express a preference for a less invasive testing experience. +OTHER DPP® PRODUCTS +Our strategy with respect to our DPP® technology has evolved as the Company has evolved. Initially, following the issuance of our DPP® patent in the United States in 2007, our strategy was necessarily limited to developing third-party-funded OEM research and development contracts and grants. This strategy enabled us to conserve capital resources, while at the same time acquiring know-how and experience with the platform and developing third party references and implicit endorsements of the technology. As our capabilities to develop and manufacture DPP® products expanded, and as our financial position has improved, so have our strategic options expanded and improved. While we will continue to employ the strategy of seeking OEM development and manufacturing agreements as a way to participate in markets that we cannot and/or choose not to serve (e.g., veterinary) , we believe that we can also develop our own branded line of products, and we plan to do this in the public health area. This brand will be launched with our DPP® HIV Screening Assay in the United States market in 2013, to be followed by our Syphilis test and potentially other related products (See RECENT DEVELOPMENTS AND CHEMBIO’S PLAN OF OPERATIONS FOR THE NEXT TWELVE MONTHS). +Following is a discussion of the DPP® products for which we have completed our development activity pursuant to OEM agreements with FIOCRUZ and Bio-Rad Laboratories, Inc. The statuses of products that are still under development are described in Part II Item 7. +PARTNERS INVOLVED IN MARKETING OUR PRODUCTS +On September 29, 2006, we executed marketing and license agreements with Alere. The marketing agreements (one for each of the two FDA-approved products) provide Alere with a 10-year exclusive right (until September 2016) to market our rapid HIV tests in the United States under Alere’s brand. The agreements provide Chembio a non-exclusive license to certain Alere lateral flow patents that may be applicable to our lateral flow products, principally including our lateral flow HIV tests that we have continued to market outside the United States. Simultaneous with the execution of the agreements, we also settled litigation with StatSure Diagnostics, Inc.(SDS) that had been ongoing relating to the proprietary barrel device which is incorporated into one of our two FDA-approved rapid HIV tests (See Lateral Flow HIV Tests above). As a result, it is through the agreements with Alere, that we have been participating in the growth of the rapid HIV test market in the United States. +We have appointed distributors internationally for our lateral flow HIV tests. Our largest markets for our lateral flow HIV rapid tests outside the United States are certain countries in Africa and Asia as well as Mexico. Internationally, most of the demand for our products is based on governmental and non-governmental prevention and treatment efforts. Given this, these programs can and do often result in large orders, but also in periods of relatively lower demand, based on the variations associated with this kind of demand. +Our DPP® HIV test was approved by ANVISA in June 2010. This approval was granted to our Brazilian partner, the Oswaldo Cruz Foundation (“FIOCRUZ”), pursuant to one of five technology transfer, supply and license agreements that we entered into with this public health organization in 2008 and 2010 (See OEM DPP® products). +OEM DPP® Products +Oswaldo Cruz Foundation OEM DPP® Agreements +During 2008-2010 we signed five agreements with the Oswaldo Cruz Foundation (FIOCRUZ) in Brazil relating to products based on our DPP® technology. FIOCRUZ is the leading public health organization in Brazil, and it is affiliated with Brazil’s Ministry of Health which is its principal client. It has extensive research, educational and manufacturing facilities for drugs and vaccines, as well as diagnostic products. +5 +During 2010 and 2011 all of the initial products contemplated under the five agreements were approved for marketing by the applicable regulatory agencies in Brazil. As a result, during 2011, we shipped approximately $4.25 million of products to FIOCRUZ pursuant to the agreements. The agreements between the Company and FIOCRUZ are unique examples of technology transfer collaborations between a private sector rapid test manufacturer and a public health organization. The five products under agreement with FIOCRUZ are for DPP® products for HIV screening, HIV confirmatory, Leishmaniasis, Leptospirosis and Syphilis. All of the agreements with FIOCRUZ contemplate a technology transfer and license to FIOCRUZ for the manufacture of the subject products over stipulated periods of time. These technology transfers, and the provision by Chembio of the information and training that is required for this to occur, are subject to Chembio receiving orders from FIOCRUZ for a minimum amount of products for manufacture by Chembio, which is approximately $23 million. The actual demand for these products may be more or less than this amount. The actual amount will depend on the actual demand for the products by the specific programs for each product funded by the Brazilian Ministry of Health as well as the whether and when FIOCRUZ is able to implement the technology transfer steps including, for example, the readiness of new production facilities currently under construction that are schedule to be completed in mid-2013; thereafter Chembio may receive royalty payments under some of the agreements for a defined period based on product sold by FIOCRUZ to the public health programs in Brazil. +Bio-Rad Laboratories OEM DPP® Agreement - On April 6, 2008, we entered a milestone-based development agreement with Bio-Rad Laboratories N.A., a division of Bio-Rad Laboratories Inc. (NYSE:BIO), a leading in-vitro diagnostic and life science company. The agreement with Bio-Rad was for the development of a six-band multiplex product on our DPP®. Based on achieving the proof of concept for this product during 2008, in January 2009 we entered a limited exclusive license agreement with Bio-Rad related to the field of use for this application, and we continued the development work during all of 2009 and until Bio-Rad confirmed that the product specifications were met in the second quarter of 2010. In June 2010, Bio-Rad exercised its option to have Chembio transfer the manufacturing of this product to Bio-Rad subject to a royalty payment payable to Chembio pursuant to a license agreement with Bio-Rad based on Bio-Rad’s net sales of the licensed product, which process was completed in October 2010. Chembio believes that Bio-Rad is proceeding with the regulatory approvals of this product, with CE Mark likely by the end of 2012, although there can be no assurance of this. We further believe that Bio-Rad has begun discussions with the FDA to discuss this product, its proposed performance claims and the intended clinical protocol to support its regulatory submission. +During 2008 to 2010, Chembio earned approximately $460,000 for product development work rendered to Bio-Rad under this agreement, plus an additional $490,000 in license and other fees related to the manufacturing transfer. +Our Rapid Test Technologies +All of our commercially available current products employ either in-licensed lateral flow technology or our own patented Dual Path Platform (DPP®) technology and are visually read. We can also use hand held and desktop readers with our DPP® products to objectively measure, quantify, record and report DPP® test results. Certain of the products we have and/or are developing incorporate some of these readers, and we are developing other products that may be used with or will require use of a reader. +Both lateral flow technology and DPP® allow the development of accurate, low cost, easy-to-perform, single-use diagnostic tests for rapid, visual detection of specific antigen-antibody complexes on a test strip. These formats provide a test that is simple (requires neither electricity nor expensive equipment for test execution or reading, nor skilled personnel for test interpretation), rapid (turnaround time approximately 15 minutes), safe (minimizes handling of potentially infected specimens), non-invasive (requires 5-20 micro liters of whole blood easily obtained with a finger prick, or alternatively, serum or plasma,), stable (24 months at room temperature storage in the case of our HIV tests), and highly reproducible. +We believe that products developed using DPP® technology can provide superior diagnostic performance as compared with products that use lateral flow technology. The reason for this is that one of the major differences between the two platforms is that in DPP® samples are allowed to incubate with the target analyte in the test zone before introduction of the labeling reagent/conjugate, whereas in lateral flow, samples are combined with the labeling reagent to form a complex before coming in contact with the target analyte. Also, because of the usage in DPP® of a separately connected sample strip, the control and delivery of sample material is substantially improved. This is critical in the development of multiplex tests, as well as tests that involve viscous sample material (such as oral fluid) that can be impeded when forced to combine with labeling reagents before migration on the test strip to the test zone area. +Target Markets +Rapid HIV Tests +A large percentage of individuals that are HIV positive worldwide are unaware of their status. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results if samples have to be sent out to a laboratory which can take at least several days to process. However, the increased availability, greater efficacy and reduced costs for anti-retroviral treatments (ARVs) for HIV has increased the demand for testing, as the stigma associated with the disease is lessened, and the ability to resume normal activities is substantially improved, providing a positive message to those potentially infected. +6 +There are approximately 53,000 new diagnoses of HIV infection in the United States each year, according to the CDC. In time, most of these infections progress to AIDS. The CDC estimates that approximately 1.1 million individuals in the U.S. are living with HIV, with an estimated 250,000 Americans, or more than 2 0 %, unaware that they are infected. It is these 250,000 infected people that are reported to account for 54% of all new infections per year. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results from samples that have to be sent out to a laboratory and that can take at least several days to process. Making more people aware of their HIV status at the point-of-care will reduce the number of HIV transmissions. +Rapid HIV testing in the United States has now developed into an estimated 7 million test market. This is from zero in 2003 when Orasure Technologies, Inc. received the first FDA approval for a rapid HIV test. We believe that the US professional HIV rapid test market (not including the OTC market) has the potential to increase to 15-18 million tests over the next several years, which would represent 40-50% of all HIV tests done today in the United States for clinical purposes. Assuming an average price to the manufacturers of $8.00 per test, a total potential U.S. market of nearly $120-$150 million is implied. +In 2006, the outlook for HIV testing was given a big boost with the release by the CDC of new guidelines for HIV testing. These new CDC recommendations are that an HIV test should be given as a routine test like any other for all patients between 13 and 64 years of age, regardless of risk, with an opt-out screening option and focused testing procedural (pre and post - test counseling) guidelines. Adoption of the 2006 CDC recommendations by a number of states continues to have an increasing impact. +In the international market, PEPFAR, the large United States funded international AIDS relief program focused on fifteen countries, was reauthorized in 2008 for up to $48 billion for FY2009-2012 (up from $15 billion in 2004-2008). PEPFAR and the Global Fund are the largest of the global initiatives that have helped to make prevention, care and life-saving treatments available to those that need them. For example , PEPFAR has the goal that by 2013 three million infected individuals will be provided treatment and 12 million new cases will be averted. To achieve these goals , more and more people are likely to get tested. As more effective treatments become available at lower costs , there is a clearer reason to be tested. +The U.S. and international economics crisis of the last few years has impacted the growth in funding of these large programs, though private donations have supplemented the governmental and non-governmental programs. Still, accountability, alleged corruption, and the eligibility of lower quality and lower cost products make these markets challenging. Throughout we believe that Chembio has remained, and is increasingly recognized as, a reputable and dependable supplier of high quality products that are available at reasonably competitive prices. +Oral fluid testing is an established alternative to blood testing for diagnostic tests, including HIV tests. It is also often patient preferred, providing a more comfortable, less invasive test. In certain public health clinics, staffs choose not to handle blood specimens; thus, oral sample collection provides a viable alternative. The most well-established market for oral fluid HIV testing is the United States. +There is also now a potential over-the-counter market for HIV tests and we are well positioned to participate in this market, should we believe the investment is justified. After years of debate, this potential market has received increasing support by the FDA Blood Products Advisory Committee, the United States Centers for Disease Control, as well as key opinion leaders in the public health and HIV advocacy community. In 2011 Orasure Technologies Inc. announced that it had submitted its final application to the FDA for its oral fluid HIV test, which may result in FDA approval of the first over-the-counter HIV test during 2012. +Based on the fact that FDA has required any over the counter HIV test to have first been approved for the professional market, we believe that Chembio is the only other company that can participate in this market opportunity if it chooses to. Although there is a third company, Trinity Biotech that meets that condition, due to certain features of Trinity’s product Unigold®, we do not believe they intend to pursue this potential market, particularly since Trinity has stated this themselves. Therefore Chembio is carefully monitoring developments in this market, which may be significant during 2012. Currently we could initiate the over the counter approval process with either of our two blood tests. Provided we received approval of our pre-marketing application for our DPP® oral fluid HIV test, we could additionally, or alternatively, pursue over the counter approval for that product upon receiving such approval. However, the requirements for such approval are estimated to be approximately $4-6 million, and may take two to three years to complete. +Rapid Syphilis Tests +Recent data indicate that approximately 70,000-100,000 new cases of syphilis are occurring annually in the U.S. Syphilis can be treated with antibiotics, but untreated it can cause pelvic inflammatory disease, infertility, ectopic pregnancy and can infect newborns. Treatment cannot be provided without a confirmed diagnosis of an active case of syphilis. Current testing algorithms in the United States require two different tests (called non-treponemal and treponemal markers), each requiring trained personnel in laboratory settings and several days to receive back results, in order to confirm an active, previously untreated case. The screening test still employed in the United States is known as RPR; it utilizes an old technology that has a high degree of false positive results. +Development of the POC market for syphilis testing is expected to be comparable to the development of the POC market for HIV testing, as there is a significant public health value to being able to provide results at the point-of-care. There are several ways to assess the market opportunity for this unique rapid test, although we believe the U.S. rapid test market opportunity may exceed 8 million tests, which is approximately 20% of the total number of syphilis tests performed in the United States for clinical use today. Unlike HIV testing, where a positive result first requires a confirmatory test, and even then further tests to measure viral load before expensive treatment decisions are made, an individual with a confirmed active case of syphilis can be prescribed antibiotics immediately. +7 +In February 2011 a study was released by the CDC that suggested that the “newest” laboratory screening tests, which are using technologies developed in the 1980s (i.e. Enzyme-linked Immunoassays), are resulting in a large number of suspected false positive test results, which are test results that are not in fact representing active cases of Syphilis. This study involved tests done in high throughput blood screening laboratory settings, and not necessarily clinical settings. Nevertheless we believe that the study suggests that if public health clinicians could have what is effectively the CDC-recommended laboratory testing algorithm in a point-of-care test, this could be an invaluable public health tool in higher risk testing (higher STD prevalence) settings. We believe this is the opportunity we have with this product. +Marketing Strategy +Our marketing strategy is to: +· +Support, review and assess the marketing and distribution efforts of our rapid HIV tests by Alere. Alere, which is a leading marketer of point-of-care diagnostic products, has significantly expanded its distribution footprint since we signed our agreement with them, and although we believe that this will enhance opportunities for Alere to market our rapid HIV tests, the product line is a very small one for them, notwithstanding the strong growth they have enjoyed with respect to our products. +· +Leverage our DPP® intellectual property and regulated product development and manufacturing experience to continue creating new collaborations where Chembio can be the exclusive development and manufacturing partner supporting leading marketing organizations. +· +Establish strong distribution relationships for our Chembio-branded products in the U.S and abroad and establish a direct sales and marketing organization that is focused in the public health market segment, and that utilizes distributors for other market segments, primarily the acute care market which, together with public health, are the main market segments for rapid HIV tests in the United States. We believe that creation of a Chembio public health brand and marketing organization is fundamental to long term creation of shareholder value. +Competition +The diagnostics industry is a multi-billion dollar international industry and is intensely competitive. Many of our competitors are substantially larger and have greater financial, research, manufacturing and marketing resources. +Industry competition in general is based on the following: +· +Scientific and technological capability; +· +Proprietary know-how; +· +The ability to develop and market products and processes; +· +The ability to obtain FDA or other required regulatory approvals; +· +The ability to manufacture products that meet applicable FDA requirements, (i.e. FDA’s Quality System Regulations) (see Governmental Regulation section); +· +The ability to manufacture products cost-effectively; +· +Access to adequate capital; +· +The ability to attract and retain qualified personnel; and +· +The availability of patent protection. +We believe our scientific and technological capabilities and our proprietary know-how relating to our in-licensed lateral flow technology rapid tests and to our proprietary know-how related to our patented dual path platform technology, particularly for the development and manufacture of tests for the detection of antibodies to infectious diseases such as HIV, are very strong. +Our ability to develop and market other products is in large measure dependent on our having additional resources and/or collaborative relationships. Some of our product development efforts have been funded on a project or milestone basis. We believe that our proprietary know-how in lateral flow technology and in our Dual Path Platform (DPP®) technology has been instrumental in our obtaining the collaborations we have and that we continue to pursue. We believe that the patent protection that we have with our Dual Path Platform (DPP®) enhances our ability to develop more profitable collaborative relationships and to license out the technology. However there are number of competitive technologies used and/or seeking to be used in point-of-care settings. These technologies may be based on immunoassay principles such as the Company’s products or other technologies such as molecular-based technologies. +8 +Research and Development +During 2011 and 2010, $4.9 million and $4.1 million ($2.6 million, net of Qualified Therapeutic Discovery Project (“QTDP”) grants), respectively, were spent on research and development (including regulatory activities). These expenses were in part underwritten by funding from R&D and milestones revenues of $1.8 million in 2011 and $2.8 million in 2010. All of our new product development activities involve employment of our Dual Path Platform (DPP®) technology. These activities include completing development of certain products and making significant progress toward the development of additional products. Research and development and regulatory activities are explained in detail in Part II Item 7. +Employees +At December 31, 2011, we employed 140 people, including 137 full-time employees. We have entered into employment contracts with our President, Lawrence Siebert, and our Senior Vice President of Research and Development, Javan Esfandiari. Due to the specific knowledge and experience of these executives regarding the industry, technology and market, the loss of the services of either one of them would likely have a material adverse effect on the Company. The contract with Mr. Siebert provides that Mr. Siebert will serve as the Chief Executive Officer and President of the Company through May 11, 2013. The contract with Mr. Esfandiari has a term of three years ending March 2013. We have obtained a key man insurance policy for Mr. Esfandiari. +Governmental Regulation +The manufacturing and marketing of the Company’s existing and proposed diagnostic products are regulated by the United States Food and Drug Administration (“FDA”), United States Department of Agriculture (“USDA”), certain state and local agencies, and/or comparable regulatory bodies in other countries. These regulations govern almost all aspects of development, production and marketing, including product testing, authorizations to market, labeling, promotion, manufacturing and record keeping. The Company’s FDA and USDA regulated products require some form of action by each agency before they can be marketed in the United States, and, after approval or clearance, the Company must continue to comply with other FDA requirements applicable to marketed products, e.g. Quality Systems (for medical devices). Failure to comply with the FDA’s requirements can lead to significant penalties, both before and after approval or clearance. +There are two review procedures by which medical devices can receive FDA clearance or approval. Some products may qualify for clearance under Section 510(k) of the Federal Food, Drug and Cosmetic Act, in which the manufacturer provides a pre-market notification that it intends to begin marketing the product, and shows that the product is substantially equivalent to another legally marketed product (i.e., that it has the same intended use and is as safe and effective as a legally marketed device and does not raise different questions of safety and effectiveness). In some cases, the submission must include data from human clinical studies. Marketing may commence when the FDA issues a clearance letter finding such substantial equivalence. FDA clearance of our DPP® Syphilis Screen & Confirm test will be by means of a 510(k) submission. +If the medical device does not qualify for the 510(k) procedure (either because it is not substantially equivalent to a legally marketed device or because it is required by statute and the FDA’s implementing regulations to have an approved application), the FDA must approve a Pre-Marketing Application (“PMA”) before marketing can begin. PMA’s must demonstrate, among other matters, that the medical device provides a reasonable assurance of safety and effectiveness. A PMA application is typically a complex submission, including the results of non-clinical and clinical studies. Preparing a PMA application is a much more expensive, detailed and time-consuming process as compared with a 510(K) pre-market notification. The Company has approved PMAs for the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1-2 and Clearview® HIV 1-2 STAT PAK®. +FDA approval of our DPP® HIV screening assay for use with oral fluid or blood samples is being pursued by means of a PMA application. The Clinical Laboratory Improvement Act of 1988 (“CLIA”) prohibits laboratories from performing in vitro tests for the purpose of providing information for the diagnosis, prevention or treatment of any disease or impairment of, or the assessment of, the health of human beings unless there is in effect for such laboratories a certificate issued by the United States Department of Health and Human Services (via the FDA) applicable to the category of examination or procedure performed. Although a certificate is not required for the Company, it considers the applicability of the requirements of CLIA in the design and development of its products. The statutory definition of “laboratory” is very broad, and many of our customers are considered labs. A CLIA waiver will remove certain quality control and other requirements that must be met for certain customers to use the Company’s products and this is in fact critical to the marketability of a product into the point-of-care diagnostics market. The Company has received a CLIA waiver for each of the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1/2 and Clearview® HIV 1/2 STAT PAK®. The CLIA waiver was granted by the FDA for HIV 1/2 STAT-PAK on November 20, 2006 and for the Clearview® Complete HIV 1/2 on October 22, 2007. +9 +In addition, the FDA regulates the export of medical devices that have not been approved for marketing in the United States. The Federal Food, Drug and Cosmetic Act contains general requirements for any medical device that may not be sold in the United States and is intended for export. Specifically, a medical device intended for export is not deemed to be adulterated or misbranded if the product: (1) complies with the specifications of the foreign purchaser; (2) is not in conflict with the laws of the country to which it is intended for export; (3) is prominently labeled on the outside of the shipping package that it is intended for export; and (4) is not sold or offered for sale in the United States. However, the Federal Food, Drug and Cosmetic Act does permit the export of devices to any country in the world, if the device complies with the laws of the importing country and has valid marketing authorization in one of several “listed” countries under the theory that these listed countries have sophisticated mechanisms for the review of medical devices for safety and effectiveness. +The Company is also subject to regulations in foreign countries governing products, human clinical trials and marketing, and may need to obtain approval or evaluations by international public health agencies, such as the World Health Organization, in order to sell diagnostic products in certain countries. Approval processes vary from country to country, and the length of time required for approval or to obtain other clearances may in some cases be longer than that required for United States governmental approvals. On the other hand, the fact that our HIV diagnostic tests are of value in the AIDS epidemic may lead to some government process being expedited. The extent of potentially adverse governmental regulation affecting Chembio that might arise from future legislative or administrative action cannot be predicted. +One or more of the Company’s rapid HIV tests are also approved or pending approval for marketing in several foreign jurisdictions, including but not limited to Brazil, Mexico, and a number of other nations in the developing world. +Environmental Laws +To date, we have not encountered any costs relating to compliance with any environmental laws. +Intellectual Property +Intellectual Property Strategy +Our intellectual property strategy is to: (1) build our own intellectual property portfolio around our Dual Path Platform technology; (2) pursue licenses, trade secrets and know-how within the area of rapid point-of-care testing, and (3) develop and acquire proprietary positions to reagents and new hardware platforms for the development and manufacture of rapid diagnostic tests. +The Company has obtained patent coverage on the DPP® technology, including three U.S. patents, and patents in China, Malaysia, Eurasia, Mexico, Singapore, Japan and the U.K. Additional patent applications on the DPP® product line are pending in the U.S., as well as in many foreign countries such as Australia, Brazil, Canada, the European Union, India, Indonesia, Israel, Korea, and South Africa. Patents have also been filed on extensions to the DPP® product line concept such as 4th generation assays. +The Company has also filed for patents and obtained some patents in the U.S. for other inventions such as its multiple host species veterinary TB test, and patent applications for the other inventions are in various stages from being recently filed and not yet examined, to already examined and allowed but not yet issued. The Company selectively and strategically foreign files its patent applications based on a number of economic and strategic factors related to the invention. +Trademarks +The Company has filed and obtained trademarks for its products including DPP®, SURE CHECK® and STAT-PAK®. The DPP® trademark is also registered under the European convention (ECT). +Trade Secrets and Know-How +We believe that we have developed a substantial body of trade secrets and know-how relating to the development of lateral flow and DPP® based diagnostic tests, including but not limited to the sourcing and optimization of materials for such tests, and how to maximize sensitivity, speed-to-result, specificity, stability and reproducibility. The Company possesses proprietary know-how to develop tests for multiple conditions using colored latex. Our buffer formulations enable extremely long shelf lives of our rapid HIV and other tests and we believe that this provides us with an important competitive advantage. +Lateral Flow Technology and Reagent Licenses +As part of our agreements in 2006 with Alere for the marketing of our HIV tests, we were granted non-exclusive licenses to certain lateral flow technology for certain products manufactured and marketed by Chembio including but not limited to our HIV tests. Although we believe our DPP® is outside of the scope of all lateral flow patents of which we are aware, we consult with patent counsel, and seek licenses and/or redesigns of products that we believe to be in the best interests of the Company and our stockholders. Because of the costs and other negative consequences of time-consuming patent litigation, we often attempt to obtain a license on reasonable terms. Nevertheless there is no assurance that the Alere lateral flow patents we have licensed will not be challenged or that other patents containing claims relevant to the Company’s lateral flow or DPP® products will not be granted to third parties and that licenses to such patents, will be available on reasonable terms, if any. In the past Alere has aggressively enforced its lateral flow intellectual property, although some of the main patents will expire within the next couple of years and we are not aware of any patent enforcement litigation that is ongoing with respect to the Alere lateral flow intellectual property. +10 +Regardless, the DPP® technology provides us with our own intellectual property, we believe it provides us with a freedom to operate, and that it also enables tests to be developed with improved sensitivity as compared with comparable tests on lateral flow platforms. The Company has signed and anticipates signing new development projects based upon the DPP® technology that will provide new manufacturing and marketing opportunities. We have filed other patents that we believe will strengthen the DPP® intellectual property and have also filed for patent protection for certain other point-of-care technologies or applications thereof. +The peptides used in our rapid HIV tests were patented by Adaltis Inc. and were licensed to us under a 10-year non-exclusive license agreement dated August 30, 2002. However, in connection with Adaltis’ bankruptcy, during the third quarter of 2009 we bought out all of our remaining obligations under that agreement. We also have licensed the antigens used in other tests including our Syphilis, Tuberculosis, Leptospirosis, Leishmaniasis and Chagas tests, and we may enter other license agreements. In prior years we concluded license agreements related to intellectual property rights owned by the United States associated with HIV- 1, and during the first quarter of 2008 we entered into a sub-license agreement for HIV-2 with Bio-Rad Laboratories N.A., the exclusive licensee of the Pasteur Institute’s HIV-2 intellectual property estate. +Corporate History +On May 5, 2004, we completed a merger with Trading Solutions, Inc. through which Chembio Diagnostic Systems Inc. became our wholly-owned subsidiary, and through which the management and business of Chembio Diagnostic Systems Inc. became our management and business. As part of this transaction, we changed our name to Chembio Diagnostics, Inc. In 2003, we had sold our prior business, and as a result, we had no specific business immediately prior to the merger. +Since the formation of Chembio Diagnostic Systems Inc. in 1985, it has been involved in developing, manufacturing, selling and distributing in-vitro diagnostic tests, including rapid tests beginning in 1995, for a number of conditions in humans and animals. +On March 12, 2004, we implemented a 1-for-17 reverse split of our common stock. All references in this Form 10-K to shares of our common stock have been adjusted to reflect this reverse split. +In February 2010, Crestview Capital Master, L.L.C. ("Crestview Master"), a Delaware limited liability company that held 18,907,431 shares of Chembio's common stock, spun off all these shares, constituting approximately 30.5% of Chembio's outstanding shares, to its three equity holders. One of the three equity holders of Crestview Master immediately spun off, to its approximately 126 equity holders, all of the 12,990,569 shares of Chembio stock that it received in this distribution. As a result, as of February 24, 2010, Crestview Master no longer owned any shares. The former direct and indirect equity holders of Crestview Master owned all these shares, with none of these individual stockholders having beneficial ownership of more than 5.61% of the outstanding common stock of Chembio. +11 +Glossary +AIDS +Acquired Immunodeficiency Syndrome. AIDS is caused by the Human Immunodeficiency Virus, HIV. +ALGORITHM (parallel or serial) +For rapid HIV testing this refers both to method or protocol (in developing countries to date) for using rapid tests from different manufacturers in combination to screen and confirm patients at the point-of-care, and may also refer to the specific tests that have been selected by an agency or ministry of health to be used in this way. A parallel algorithm uses two screening tests from different manufacturers and a tie-breaker test only if there is a discrepancy between the screening tests results. A serial algorithm only uses a second confirmatory test if there is a positive result from the screening test, meaning that the number of confirmatory tests used is equal to the positivity rate in the testing venue. A tie-breaker test resolves discrepancies between the screen and the confirmatory test. +ANTIBODY +A protein which is a natural part of the human immune system produced by specialized cells to neutralize antigens, including viruses and bacteria that invade the body. Each antibody producing cell manufactures a unique antibody that is directed against, binds to and eliminates one, and only one, specific type of antigen. +ANTIGEN +Any substance which, upon entering the body, stimulates the immune system leading to the formation of antibodies. Among the more common antigens are bacteria, pollens, toxins, and viruses. +ANVISA +ARVs +Anti-Retroviral Treatments for AIDS +The National Health Surveillance Agency of Brazil +Anti-retroviral medications developed to fight AIDS +CDC +United States Centers for Disease Control and Prevention +CLIA waiver +Clinical Laboratory Improvement Act designation that allows simple tests to be performed in point-of-care settings such as doctor’s offices, walk-in clinics and emergency rooms. +DIAGNOSTIC +Pertaining to the determination of the nature or cause of a disease or condition. Also refers to reagents or procedures used in diagnosis to measure proteins in a clinical sample. +EITF +Emerging Issues Task Force +FASB +FIOCRUZ +Financial Accounting Standards Board +The Oswaldo Cruz Foundation of Brazil +FDA +United States Food and Drug Administration +FDIC +Federal Deposit Insurance Corporation +FAS +Financial Accounting Standard +IgG +IgG or Immunoglobulin are proteins found in human blood. This protein is called an “antibody” and is an important part of the body’s defense against disease. When the body is attacked by harmful bacteria or viruses, antibodies help fight these invaders. +NGO +Non-Governmental Organization +OTC +Over-the-Counter +PEPFAR +The President’s Emergency Plan for AIDS Relief +PMA +Pre-Marketing Approval –FDA approval classification for a medical device that is not substantially equivalent to a legally marketed device or is otherwise required by statute to have an approved application. Rapid HIV tests must have an approved PMA application before marketing of such a product can begin. +PROTOCOL +A procedure pursuant to which an immunodiagnostic test is performed on a particular specimen in order to obtain the desired reaction. +REAGENT +A chemical added to a sample under investigation in order to cause a chemical or biological reaction which will enable measurement or identification of a target substance. +RETROVIRUS +A type of virus which contains the enzyme Reverse Transcriptase and is capable of transforming infected cells to produce diseases in the host such as AIDS. +SAB +Staff Accounting Bulletin +SENSITIVITY +Refers to the ability of an assay to detect and measure small quantities of a substance of interest. The greater the sensitivity, the smaller the quantity of the substance of interest the assay can detect. Also refers to the likelihood of detecting the antigen when present. +SPECIFICITY +The ability of an assay to distinguish between similar materials. The greater the specificity, the better an assay is at identifying a substance in the presence of substances of similar makeup. +USDA +U.S Department of Agriculture +WHO +World Health Organization +12 +ITEM 1A. +RISK FACTORS +You should carefully consider each of the following risk factors and all of the other information provided in this Annual Report. The risks described below are those we currently believe may materially affect us. An investment in our Common Stock involves a high degree of risk, and should be considered only by persons who can afford the loss of their entire investment. +Risks related to our industry, business and strategy +Because we may not be able to obtain or maintain the necessary regulatory approvals for some of our products, we may not generate revenues in the amounts we expect, or in the amounts necessary to continue our business. Our existing products as well as our manufacturing facility must meet quality standards and are subject to inspection by a number of domestic regulatory and other governmental and non-governmental agencies. +All of our proposed and existing products are subject to regulation in the U.S. by the U.S. Food and Drug Administration, the U.S. Department of Agriculture and/or other domestic and international governmental, public health agencies, regulatory bodies or non-governmental organizations. In particular, we are subject to strict governmental controls on the development, manufacture, labeling, distribution and marketing of our products. The process of obtaining required approvals or clearances varies according to the nature of, and uses for, a specific product. These processes can involve lengthy and detailed laboratory testing, human or animal clinical trials, sampling activities, and other costly, time-consuming procedures. The submission of an application to a regulatory authority does not guarantee that the authority will grant an approval or clearance for product. Each authority may impose its own requirements and can delay or refuse to grant approval or clearance, even though a product has been approved in another country. +The time taken to obtain approval or clearance varies depending on the nature of the application and may result in the passage of a significant period of time from the date of submission of the application. Delays in the approval or clearance processes increase the risk that we will not succeed in introducing or selling the subject products, and we may determine to devote our resources to different products. +Changes in government regulations could increase our costs and could require us to undergo additional trials or procedures, or could make it impractical or impossible for us to market our products for certain uses, in certain markets, or at all. +Changes in government regulations may adversely affect our financial condition and results of operations because we may have to incur additional expenses if we are required to change or implement new testing, manufacturing and control procedures. If we are required to devote resources to develop such new procedures, we may not have sufficient resources to devote to research and development, marketing, or other activities that are critical to our business. +We can manufacture and sell our products only if we comply with regulations and quality standards established by government agencies such as the FDA and the USDA as well as by non-governmental organizations such as the ISO and WHO. We have implemented a quality system that is intended to comply with applicable regulations. Although FDA approval is not required for the export of our products, there are export regulations promulgated by the FDA that specifically relate to the export of our products. Although we believe that we meet the regulatory standards required for the export of our products, these regulations could change in a manner that could adversely impact our ability to export our products. +Our products may not be able to compete with new diagnostic products or existing products developed by well-established competitors, which would negatively affect our business. +The diagnostic industry is focused on the testing of biological specimens in a laboratory or at the point-of-care and is highly competitive and rapidly changing. Our principal competitors often have considerably greater financial, technical and marketing resources than we do. Several companies produce diagnostic tests that compete directly with our testing product line, including but not limited to, Orasure Technologies, Alere Medical and Trinity Biotech. As new products enter the market, our products may become obsolete or a competitor’s products may be more effective or more effectively marketed and sold than ours. +13 +We have granted Alere exclusive rights to market our SURE CHECK® HIV 1/2 in the United States and non-exclusive rights in the rest of the world and exclusive rights to market our HIV 1/2 STAT PAK® in the U.S. only. Alere has no rapid HIV tests that are approved for marketing in the U.S. and Alere is obligated to inform us of any such products within certain time frames We believe that Alere is committed to successfully marketing our products in the U.S. Alere may however choose to develop or acquire competing products for marketing in the U.S. and such an action could have at least a temporary material adverse effect on the marketing of these products until such time as alternative marketing arrangements could be implemented. In particular Alere manufactures and markets a rapid HIV test product called Determine® that, with its 3 rd generation test, is the leading product used in the developing world. The Determine HIV test product line, which was until 2006 a division of Abbott Diagnostics in Japan that was then sold to Alere, has had at least a few versions, the newest of which is the so called “4 th Generation” Determine test which, according to its claims, detects HIV antibodies and HIV antigen. The claim of such a 4 th generation product is that it detects infection earlier than tests that solely rely on antibody detection, which required immune response before detection can occur. Alere has made statements that it is or will be seeking FDA approval of this product which, if approval is granted, could potentially be a competitive product to the Chembio products that Alere markets as Clearview® Complete (barrel) and Clearview HIV ½ STAT PAK® (cassette). Under our agreements, Alere is in fact expressly permitted to “exploit” such a product in the United States without breaching the agreement, though there are defined consequences in such case: for the cassette product, Chembio may either terminate Alere or make the agreement with Alere non-exclusive, and for the barrel product, Chembio and StatSure Diagnostics (the other party to the Alere 3-way agreement pertaining to the barrel product) can jointly agree to either continue the agreement with Alere or to also make the barrel agreement non-exclusive. As part of any decision by Chembio to market either product, Alere would expand the lateral flow license granted to allow Chembio to market the product under Chembio brands. +Although we have no specific knowledge of any other competitor’s product that will render our products obsolete, if we fail to maintain and enhance our competitive position or fail to introduce new products and product features, our customers may decide to use products developed by our competitors, which could result in a loss of revenues and cash flow. +We have developed an oral fluid rapid HIV test as well as other applications utilizing our Dual Path Platform technology, which we believe will enhance our competitive position in HIV rapid testing and other fields. During 2011 we made significant progress toward the commercialization of this product. However we still have technical, manufacturing, regulatory and marketing challenges to meet before we will know whether we can successfully commercialize products incorporating this technology. There can be no assurance that we will overcome these challenges. +We plan to introduce our DPP® oral fluid HIV test, which test also can be used with blood samples, in the U.S. market under a Chembio brand once it is FDA approved, currently anticipated in 2013, but for which there can be no assurance. Under our 2006 Agreement with Alere, Alere has a right of first negotiation for the right to market any new rapid HIV antibody detection test that we develop. In accordance with this provision in our agreement, we presented this product to Alere in 2007, and in 2007 Alere waived its right of first negotiation under the agreement. While such waiver does not prevent Alere from reconsidering the marketing of this product, we have no reason to believe that they will. Also, although we believe that the primary market opportunity for the DPP® HIV product is for those customers that have a clear preference for an oral fluid HIV test, the product is also likely to compete to some extent with our FDA-approved rapid HIV tests being marketed by Alere. Therefore this could have a material and adverse effect on our business with Alere. +More generally, the point-of-care diagnostics industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. As new technologies become introduced into the point-of-care diagnostic testing market, we may be required to commit considerable additional efforts, time and resources to enhance our current product portfolio or develop new products. We may not have the available time and resources to accomplish this, and many of our competitors have substantially greater financial and other resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers, which would materially harm our operating results. +Although we own our DPP® patent, we own no issued patents covering lateral flow technology, and the field of lateral flow technology is complex and characterized by a substantial amount of litigation, so the risk of potential patent challenges is ongoing for us in spite of our DPP® patent. Moreover, we believe that certain lateral flow patents are going to expire in the next couple of years which may materially impact the competitive landscape. +Although we have been granted non-exclusive licenses to the lateral flow patents owned by Alere, there is no assurance that its lateral flow patents will not be challenged or that licenses from other parties may not be required, if available at all. In addition, certain of the Alere patents will expire in the next couple of years which expiration could open the market to certain competitors. In the event that it is determined that a license is required and it is not possible to negotiate a license agreement under a necessary patent, we may be able to modify our HIV rapid test products and other products such that a license would not be necessary. However, there is no assurance that we would be able to do so, and even if accomplished, this alternative could delay or limit our ability to sell these products in the U.S. and other markets, which would adversely affect our results of operations, cash flows and business. +14 +On March 13, 2007, our Dual Path Platform Immunoassay Device patent application was issued as United States patent no. 7,189,522. Additional protection for this intellectual property is pending in a number of other countries. This platform has shown improved sensitivity as compared with conventional platforms in a number of studies. We believe that this new platform is outside of the scope of currently issued patents in the field of lateral flow technology, thereby offering the possibility of a greater freedom to operate. However there can be no assurance that our patents or our products incorporating the patent claims will not be challenged at some time in the future. +New developments in health treatments or new non-diagnostic products may reduce or eliminate the demand for our products. +The development and commercialization of products outside of the diagnostics industry could adversely affect sales of our products. For example, the development of a safe and effective vaccine to HIV or treatments for other diseases or conditions that our products are designed to detect, could reduce, or eventually eliminate the demand for our HIV or other diagnostic products and result in a loss of revenues. +We may not have sufficient resources to effectively introduce and market our products, which could materially harm our operating results. +Introducing and achieving market acceptance for our rapid HIV tests and other new products will require substantial marketing efforts and will require us or our contract partners, sales agents, or distributors to make significant expenditures of time and money. In some instances we will be significantly or totally reliant on the marketing efforts and expenditures of our contract partners, sales agents, and/or distributors. If they do not have or commit the expertise and resources to effectively market the products that we manufacture, our operating results will be materially harmed. +The success of our business depends on, in addition to the market success of our products, our ability to raise additional capital through the sale of debt or equity or through borrowing, and we may not be able to raise capital or borrow funds on attractive terms and/or in amounts necessary to continue our business, or at all. +Our revenues and gross margins have increased significantly in recent periods, and we have been profitable for three consecutive years. Nevertheless, prior to 2009 we sustained significant operating losses since 2004. At December 31, 2011, we had a stockholders’ equity of $12.5 million and a working capital surplus of $6.1 million . The Company estimates that its resources are sufficient to fund its needs through the end of 2012 and beyond. The Company’s liquidity and cash requirements will depend on several factors. These factors include (1) the level of revenues; (2) the extent to which, if any, that revenue level improves operating cash flows; (3) the Company’s investments in research and development, facilities, marketing, regulatory approvals, and other investments it may determine to make; and (4) the Company’s investment in capital equipment and the extent to which it improves cash flow through operating efficiencies. There are no assurances that the Company will remain profitable or generate positive cash flow in 2012 or, in the alternative, be successful in raising sufficient capital to fund its needs through 2012 and thereafter. +The increase in revenues anticipated in 2012 from the launch of our DPP® products in Brazil, continued revenues from Alere from the U.S. rapid HIV test market, increased sales to developing world markets, and continued strength in our contract development and grant revenues are all critical for us to continue to maintain and increase our profitability while funding our new product regulatory approval and commercialization programs. If we fail to meet any of these objectives, we may not generate revenues in the amounts necessary to maintain and increase our profitability and/or to fund our planned research, development, regulatory, selling, general and administrative expenses in 2012 . +We intend to attempt to increase international sales of our products. A number of factors can slow or prevent international sales, or substantially increase the cost of international sales, including: +· +regulatory requirements and customs regulations; +· +cultural and political differences; +· +foreign exchange rates, currency fluctuations and tariffs; +· +dependence on and difficulties in managing international distributors or representatives; +· +the creditworthiness of foreign entities; +· +difficulties in foreign accounts receivable collection; +· +competition; +· +pricing; and +· +economic conditions and the absence of available funding sources. +If we are unable to increase our revenues from international sales, our operating results will be materially harmed. +15 +Although we have an ethics and anti-corruption policy in place, and have no knowledge or reason to know of any practices by our employees, agents or distributors that could be construed as in violation of such policies, our business includes sales of products to countries where there is or may be widespread corruption. +Chembio has a policy in place prohibiting its employees, distributors and agents from engaging in corrupt business practices, including activities prohibited by the United States Foreign Corrupt Practices Act (FCPA). Nevertheless, because we work through independent sales agents and distributors (and do not have any employees or subsidiaries) outside the United States, we do not have control over the day-to-day activities of such independent agents and distributors. In addition, in the donor- funded markets in Africa where we sell our products, there is significant oversight from PEPFAR, the Global Fund, and advisory committees comprised of technical experts concerning the development and establishment of national testing protocols. This is a process that includes an overall assessment of a product which includes extensive product performance evaluations including five active collaborations and manufacturer’s quality systems, as well as price and delivery. In Brazil where we have had a total of six product collaborations with FIOCRUZ, those programs that our products are or may be deployed in are all funded by the Brazilian Ministry of Health. Although FIOCRUZ is affiliated with the Brazilian Ministry of Health, it is not its exclusive supplier. However because each of our collaborations with FIOCRUZ incorporates a technology transfer aspect, we believe we have a competitive advantage versus other suppliers to the Brazilian Ministry of Health, assuming other aspects of our product offering through FIOCRUZ are otherwise competitive in comparison. We have no knowledge or reason to know of any activities by our employees, distributors or sales agents of any actions which could be in violation of the FCPA, although there can be no assurance of this. +We rely on trade secret laws and agreements with our key employees and other third parties to protect our proprietary rights, and we cannot be sure that these laws or agreements adequately protect our rights. +We believe that factors such as the technological and creative skills of our personnel, strategic relationships, new product developments, frequent product enhancements and name recognition are essential to our success. All our management personnel are bound by non-disclosure agreements. If personnel leave our employment, in some cases we would be required to protect our intellectual property rights pursuant to common law theories which may be less protective than provisions of employment, non-competition or non-disclosure agreements. +We seek to protect our proprietary products under trade secret and copyright laws, enter into license agreements for various materials and methods employed in our products, and enter into strategic relationships for distribution of the products. These strategies afford only limited protection. We currently have some foreign patents issued, and we are seeking additional patent protection in several other foreign jurisdictions for our DPP® technology. We have licenses to reagents (antigens and peptides) used in several of our products and products under development Despite our efforts to protect our proprietary assets, and respect the intellectual property rights of others, we participate in several markets where intellectual property rights protections are of little or no value. This can place our products and our company at a competitive disadvantage. +Despite efforts we make to protect our confidential information, such as entering confidentiality agreements in connection with new business opportunities, unauthorized parties may attempt to copy aspects of our products or to obtain information that we regard as proprietary. We may be required to expend substantial resources in asserting or protecting our intellectual property rights, or in defending suits related to intellectual property rights. Disputes regarding intellectual property rights could substantially delay product development or commercialization activities because some of our available funds would be diverted away from our business activities. Disputes regarding intellectual property rights might include state, federal or foreign court litigation as well as patent interference, patent reexamination, patent reissue, or trademark opposition proceedings in the U.S. Patent and Trademark Office. +To facilitate development and commercialization of a proprietary technology base, we may need to obtain additional licenses to patents or other proprietary rights from other parties. Obtaining and maintaining these licenses, which may not be available, may require the payment of up-front fees and royalties. In addition, if we are unable to obtain these types of licenses, our product development and commercialization efforts may be delayed or precluded. +16 +Our continued growth depends on retaining our current key employees and attracting additional qualified personnel, and we may not be able to do so. +Our success will depend to a large extent upon the skills and experience of our executive officers, management and sales, marketing, operations and scientific staff. We may not be able to attract or retain qualified employees in the future due to the intense competition for qualified personnel among medical products businesses, geographic considerations, our ability to offer competitive compensation, relocation packages, benefits, and/or other reasons. +If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will adversely affect our ability to effectively manufacture, sell and market our products to meet the demands of our strategic partners in a timely fashion, or to support internal research and development programs. Although we believe we will be successful in attracting and retaining qualified personnel, competition for experienced scientists and other personnel from numerous companies and academic and other research institutions may limit our ability to do so on acceptable terms. +We have entered into employment contracts with our Chief Executive Officer and President, Lawrence Siebert, and our Senior Vice President of Research and Development, Javan Esfandiari. Due to the specific knowledge and experience of these executives regarding the industry, technology and market, the loss of the services of either one of them would likely have a material adverse effect on the Company. The contract with Mr. Siebert provides that Mr. Siebert will serve as the Chief Executive Officer and President of the Company through May 11, 2013. The contract with Mr. Esfandiari has a term of three years ending March 2013. We have obtained a key man insurance policy for Mr. Esfandiari. +We believe our success depends in part on our ability to participate in large testing programs in the U.S. and worldwide and we may not be able to do so. +We believe it to be in our best interests to meaningfully participate in large testing programs. Participation in these programs requires alignment and engagement with the many other participants in these programs including the World Health Organization, U.S. Center for Disease Control, U.S. Agency for International Development, foreign governments and their agencies, non-governmental organizations, and HIV service organizations. If we are unsuccessful in our efforts to participate in these programs, our operating results could be materially harmed. +Although we were profitable in 2009, 2010 and 2011, we cannot be certain that we will be able to sustain profitability in 2012. +From the inception of Chembio Diagnostic Systems, Inc. in 1985 through the period ended December 31, 2008, we incurred net losses and we have only become profitable during the last three years. While we anticipate growth in our product revenues in 2012 as compared with 2011, there can be no assurance of this. Moreover in 2012 we expect to make substantial expenditures for regulatory submissions, product development and other purposes which may impact profitability. Our ability to continue profitability in the future will primarily depend on our ability to increase sales of our products, reduce production and other costs, and to successfully introduce new products and enhanced versions of our existing products into the marketplace. If we are unable to increase our revenues at a rate that is sufficient to achieve profitability, or adequately control and reduce our operating costs, our operating results would be materially harmed. +To the extent that we are unable to obtain sufficient product liability insurance or that we incur product liability exposure that is not covered by our product liability insurance, our operating results could be materially harmed. +We may be held liable if any of our products, or any product which is made with the use or incorporation of any of the technologies belonging to us, causes injury of any type or is found otherwise unsuitable during product testing, manufacturing, marketing, sale or usage. We have obtained product liability insurance we have never received a product liability claim, and have generally not seen product liability claims for screening tests that are accompanied by appropriate disclaimers. Nevertheless, in the event there is a claim, this insurance may not fully cover our potential liabilities. In addition, as we attempt to bring new products to market, we may need to increase our product liability coverage which would be a significant additional expense that we may not be able to afford. If we are unable to obtain sufficient insurance coverage at an acceptable cost to protect us, we may be forced to abandon efforts to commercialize our products or those of our strategic partners, which would reduce our revenues. +17 +Risks related to our Common Stock +In the past, our Common Stock has been classified as penny stock, and it continues to be extremely illiquid, so investors may not be able to sell as much stock as they want at prevailing market prices. +In the past, our Common Stock has been classified as penny stock. Penny stocks generally are equity securities with a price of less than $5.00 and trade on the over-the-counter bulletin board market (OTCBB, currently on the QTCQB). As a result, an investor may find it more difficult to dispose of or obtain accurate quotations as to the price of the securities that are classified as penny stocks. The “penny stock” rules adopted by the Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), subject the sale of the shares of penny stock issuers to regulations that impose sales practice requirements on broker-dealers, causing many broker-dealers to not trade penny stocks or to only offer the stocks to sophisticated investors that meet specified net worth or net income criteria identified by the Commission. These regulations contribute to the lack of liquidity of penny stocks. +At the present time, transactions in our Common Stock are not subject to the “penny stock” rules because our average revenue for 2009, 2010 and 2011 exceeded $6 million per year. However, there can be no assurance that transactions in our Common Stock will not be subject to the “penny stock” rules in the future. +The average daily trading volume of our Common Stock on the over-the-counter market was less than 35,000 shares per day over the three months ended March 6, 2012. If limited trading in our stock continues, it may be difficult for investors to sell their shares in the public market at any given time at prevailing prices. +Our management and larger stockholders exercise significant control over our Company. +As of March 6, 2012, our named executive officers, directors and 5% stockholders beneficially owned approximately 24.3% of our voting power. For the foreseeable future, to the extent that these parties vote similarly, they may be able to exercise significant control over many matters requiring approval by the board of directors or our stockholders. As a result, they may be able to: +· +control the composition of our board of directors; +· +control our management and policies; +· +determine the outcome of significant corporate transactions, including changes in control that may be beneficial to stockholders; and +· +act in each of their own interests, which may conflict with, or be different from, the interests of each other or the interests of the other stockholders. +ITEM 2. +PROPERTIES +Our administrative offices and research facilities are located in Medford, New York. We lease approximately 28,000 square feet of industrial space for $18,223 per month. The space is utilized for research and development activities (approximately 4,160 square feet), offices (approximately 4,640 square feet) and production (approximately 19,200 square feet). The lease term expires on April 30, 2014. We have entered into two additional leases: the first effective on November 1, 2011, covering 2,000 additional square feet; and the second signed on December 18, 2011, effective January 1, 2012, covering 2,600 additional square feet; principal terms of these leases are the same as the one entered into in 2009 which was as follows: (a) a lease term ending April 30, 2014; (b) an initial rent of $11,350 per month ; (c) the monthly rent for year two of the lease will increase by the lower of (i) the change in the consumer price index, or (ii) five percent; and (d) the monthly rent for years three through five of the lease will increase each year by the lower of (i) the change in the consumer price index, or (ii) two and one half percent. Additional space may be required as we expand our production and research and development activities. We do not foresee any significant difficulties in obtaining any required additional facilities. +ITEM 3. +LEGAL PROCEEDINGS +From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. We know of no material, existing or pending legal proceedings against us, nor are we involved as a plaintiff in any material proceeding or pending litigation. There are no proceedings in which any of our directors, officers or affiliates, or any registered or beneficial shareholder, is an adverse party or has a material interest that is adverse to our interest. +ITEM 4. +MINE SAFETY DISCLOSURES +Not Applicable. +18 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Our stock is quoted on the OTCQB, which is the second of the three tiers of the OTC Market Group, under the symbol “CEMI.” Prior to February 24, 2011, our stock was quoted on the OTC Bulletin Board. The table below sets forth the high and low bid prices per share of our common stock for each quarter of our two most recently completed fiscal years. These prices represent inter-dealer quotations without retail markup, markdown, or commission and may not necessarily represent actual transactions. +Fiscal Year 2011 +High Bid +Low Bid +First Quarter +$ +.500 +$ +.390 +Second Quarter +$ +.580 +$ +.410 +Third Quarter +$ +.480 +$ +.410 +Fourth Quarter +$ +.480 +$ +.360 +Fiscal Year 2010 +High Bid +Low Bid +First Quarter +$ +.330 +$ +.200 +Second Quarter +$ +.280 +$ +.159 +Third Quarter +$ +.290 +$ +.210 +Fourth Quarter +$ +.490 +$ +.225 +We are considering alternative markets for our stock, including but not limited to NASDAQ and NYSE-Amex. At the most recent annual meeting of Chembio shareholders in September 2011, shareholders granted authority to our board of directors to effectuate a reverse split of the Company’s common stock without further shareholder approval required. This authority was granted for the two year period following the date of the authorization, for a reverse split in the range between, and including, five-to-one and fifteen-to-one. At the current level of its stock price, the Company would need to undertake a reverse stock split in order to have a stock price sufficient to qualify for listing on NASDAQ or NYSE-Amex. +19 +Rule 15g-9 of the Securities and Exchange Commission, known as the Penny Stock Rule, imposes requirements on broker/dealers who sell securities that are subject to this rule to persons other than established customers and accredited investors (As indicated below, the Penny Stock Rule currently does not apply tp Chembio.) For transactions covered by the rule, brokers/dealers must make a special suitability determination for purchasers of the securities and receive the purchaser’s written agreement to the transaction prior to sale. The Securities and Exchange Commission also has rules that regulate broker/dealer practices in connection with transactions in “penny stocks.” Penny stocks generally are defined under this rule as equity securities with a price of less than $5.00 (other than securities registered on certain national securities exchanges or quoted on the NASDAQ system, provided that current price and volume information with respect to transactions in that security is provided by the exchange or system), except for securities of companies that have tangible net assets in excess of $2,000,000 or average revenue of at least $6,000,000 for the previous three years. The Penny Stock Rule requires a broker/ dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document prepared by the Commission that provides information about penny stocks and the nature and level of risks in the penny stock market. The broker/dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker/dealer and its salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer’s account. The bid and offer quotations, and the broker/dealer and salesperson compensation information, must be given to the customer orally or in writing prior to effecting the transaction and must be given to the customer in writing before or with the customer’s confirmation. These disclosure requirements have the effect of reducing the level of trading activity in the secondary market for penny stock issues. As a result of these rules, investors sometimes find it difficult to sell shares of penny stock issuers. At the present time, transactions in our common stock are not subject to the Penny Stock Rule because our average revenue for 2009, 2010 and 2011 exceeded $6 million per year. However, there can be no assurance that transactions in our common stock will not be subject to the Penny Stock Rule in the future. +Holders +As of March 1, 2012, there were approximately 1,550 record owners of our common stock . +Dividends +The Company has never paid cash dividends on its common stock and has no plans to do so in the foreseeable future. +ITEM 6. SELECTED FINANCIAL DATA +Presented in this table are selected financial data for the past five years ended December 31, 2011. +20 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARIES +SELECTED HISTORICAL FINANCIAL DATA +As of and For the Years Ended +Statement of Operations Data: +December 31, 2011 +December 31, 2010 +December 31, 2009 +December 31, 2008 +December 31, 2007 +TOTAL REVENUES +$ +19,388,036 +$ +16,704,703 +$ +13,834,248 +$ +11,049,571 +$ +9,230,948 +GROSS MARGIN +9,390,303 +48 +% +8,100,699 +48 +% +5,860,405 +42 +% +3,851,721 +35 +% +2,795,710 +30 +% +OPERATING COSTS: +Research and development expenses +4,878,119 +25 +% +2,586,308 +15 +% +2,883,696 +21 +% +2,605,343 +24 +% +1,906,653 +21 +% +Selling, general and administrative expenses +3,424,297 +18 +% +2,940,721 +18 +% +2,659,382 +19 +% +3,317,046 +30 +% +3,765,221 +41 +% +8,302,416 +5,527,029 +5,543,078 +5,922,389 +5,671,874 +INCOME (LOSS) FROM OPERATIONS +1,087,887 +2,573,670 +317,327 +(2,070,668 +) +(2,876,164 +) +OTHER INCOME (EXPENSES): +(12,325 +) +(14,503 +) +(8,267 +) +121,898 +249,272 +INCOME (LOSS) BEFORE INCOME TAXES +1,075,562 +6 +% +2,559,167 +15 +% +309,060 +2 +% +(1,948,770 +) +-18 +% +(2,626,892 +) +-28 +% +Income tax (benefit) provision +(5,133,229 +) +45,823 +- +- +- +Effect of preferred stock conversion in 2007 +- +- +- +- +5,645,310 +NET INCOME (LOSS) +$ +6,208,791 +$ +2,513,344 +$ +309,060 +$ +(1,948,770 +) +-18 +% +$ +(8,272,202 +) +-90 +% +Basic income (loss) per share +$ +0.10 +$ +0.04 +$ +0.00 +$ +(0.03 +) +$ +(0.57 +) +Diluted income (loss) per share +$ +0.09 +$ +0.04 +$ +0.00 +$ +(0.03 +) +$ +(0.57 +) +Weighted average number of shares outstanding, basic +62,998,402 +62,102,861 +61,946,435 +61,266,954 +14,608,478 +Weighted average number of shares outstanding, diluted +68,450,220 +70,920,915 +75,041,932 +61,266,954 +14,608,478 +Balance Sheet Data: +Working capital +$ +6,133,956 +$ +4,560,277 +$ +1,493,970 +$ +1,663,914 +$ +3,228,724 +Total assets +15,485,744 +9,086,174 +6,315,250 +5,914,941 +6,584,997 +Total liabilities +2,991,110 +3,277,230 +3,227,336 +3,337,609 +2,322,171 +Shareholders' equity +12,494,634 +5,808,944 +3,087,914 +2,577,332 +4,262,826 +21 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +Overview +This discussion and analysis should be read in conjunction with the accompanying Consolidated Financial Statements and related notes. Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent liabilities at the financial statement date and reported amounts of revenue and expenses during the reporting period. On an ongoing basis, we review our estimates and assumptions. Our estimates are based on our historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results are likely to differ from those estimates under different assumptions or conditions, but we do not believe such differences will materially affect our financial position or results of operations. Our critical accounting policies, the policies we believe are most important to the presentation of our financial statements and require the most difficult, subjective and complex judgments, are outlined below in ‘‘Critical Accounting Policies,’’ and have not changed significantly. +In addition, certain statements made in this report may constitute “forward-looking statements”. These forward-looking statements involve known or unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. These factors include, among others, 1) our ability to obtain necessary regulatory approvals for our products; and 2) our ability to increase revenues and operating income, which is dependent upon our ability to develop and sell our products, general economic conditions, and other factors. You can identify forward-looking statements by terminology such as “may,” “could”, “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continues” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business. +All of the Company’s future products that are currently being developed are based on its patented Dual Path Platform (DPP®), which is a unique diagnostic point-of-care platform that has certain advantages over lateral flow technology. The Company has completed development of several products that employ the DPP® technology, two of which will be marketed under Chembio’s label (DPP® HIV 1/2 Screening Assay and DPP® Syphilis Screen & Confirm) and several others that have been developed specifically related to private label agreements with The Oswaldo Cruz Foundation (“FIOCRUZ”) for the Brazilian public health market, as explained below. +All of the Company’s products other than its lateral flow tests (see PRODUCTS and Our Rapid Test Technologies) are based on the Company’s patented Dual Path Platform (DPP®) technology. The Company has had very active research and development programs and has significantly increased its spending on research and development during the last three years. Third-party funding from research and development contracts and grants have offset a significant portion of these increased research and development expenses. Externally funded R&D programs were particularly instrumental in helping the Company to avoid raising capital during 2008-2010, which was a very difficult period for fundraising. Moreover these collaborations have resulted in significant third party validations of our DPP® technology and an increasing capability to develop, manufacture, validate, and improve current and future DPP® products and product features. +The Company has a number of additional products under development that employ the DPP® technology. These product development activities are further described below. +DPP® Leptospirosis – Our work under the three-year $3 million Small Business Innovative Research (SBIR) Phase II grant we were awarded in 2009 by the United States National Institutes of Health (NIH) to fully develop, validate, and commercialize a rapid diagnostic test for Leptospirosis for general use worldwide is progressing on schedule and we expect to complete this grant in the second quarter of 2012. The test is being developed with our DPP® technology utilizes proprietary reagents developed by Yale University and the Oswaldo Cruz Foundation at the Brazilian Ministry of Health. Development of the test has been in collaboration with the Division of Infectious Diseases, Yale University in New Haven, CT and the Oswaldo Cruz Foundation, the largest biomedical research institution in Latin America. +22 +DPP® Tuberculosis – As reported in February 2011, we were awarded a three-year $2.9 million, subsequently reduced to $2.4 million, Small Business Innovative Research (SBIR) Phase II grant from the United States National Institutes of Health (NIH) to continue development of a simple, rapid, accurate, and cost-effective serological test for active tuberculosis that can be utilized in resource-limited settings. During 2011 we have screened and identified TB antigens useful for serological assay in co-operation with Infectious Disease Research Institute (IDRI) and during 2012 we intend to continue development of a POC test work with DPP technology. +Battelle/CDC DPP® Influenza Immunity Test – In 2010, we received approximately $804,000 from Battelle Memorial Institute pursuant to a development contract for an Influenza Immunity test. This is a multiplex antibody detection test that could be used in connection with pandemic influenza preparedness strategies to determine exposure to various strains of influenza in different geographic regions or in different population or demographic segments. Upon completing this work in early 2011 we provided prototype tests kits as required by the contract. These prototypes were evaluated by Battelle and by the CDC and, based on the satisfactory results of these prototypes, we entered into an amendment of this contract that was to begin in November 2011 to continue additional development work for this product in the fourth quarter of 2011 and the first quarter of 2012. However, due to a delay in our contract partners obtaining access to certain biomarkers necessary for the project to proceed, this development work has been postponed at least through the first quarter of 2012. +Qualifying Therapeutic Discovery Projects - On November 1, 2010, the Company was notified by the IRS that it received awards in the total amount of $1.467 million relating to six "Qualifying Therapeutic Discovery Projects" under the U.S. Patient Protection and Affordable Care Act of 2010 (P.L. 111-148), a program that was created as part of the major United States federal health care reform legislation enacted earlier that year. +Under the award guidelines, qualified therapeutic discovery projects had to show a reasonable potential to result in new therapies to treat areas of unmet medical need or to prevent, detect or treat chronic or acute diseases and conditions, reduce the long-term growth of health care costs in the United States, or significantly advance the goal of curing cancer within 30 years. Chembio's projects that received awards include products based on the Company's patented DPP(r) point-of-care diagnostic platform that are in various stages of its development pipeline such as its products for the rapid diagnosis of HIV, Hepatitis-C, and Syphilis. +Other Research & Development Activities - We are considering certain new DPP® product opportunities, either as OEM development projects and/or as Chembio-branded products. These products are being identified based upon our assessment of opportunities in the market and upon whether they can be addressed with our proprietary technology, along with our development and manufacturing capabilities and experience. We are also identifying and assessing additional technologies that we believe could provide us with additional products, and capabilities, and thereby provide additional revenue streams. +Chembio continues to work with commercial, governmental and private organizations in order to obtain R&D contracts and grant funding for development projects. These programs have subsidized the Company’s development expenses while expanding the applications for and know-how related to DPP®, while also creating important collaborative relationships. +There can be no assurance that any of these grant applications will result in any funding awards to the Company, nor that any of the existing research and development contracts or grants will continue or that they will meet regulatory or any other technical requirements and specifications, and/or that if continued, will result in completed products, or that such products, if they are successfully completed, can or will be successfully commercialized. +Regulatory Activities +CE Mark for FDA-approved HIV tests – The final studies for the CE Marking requirements, which we have been pursuing for some time, were submitted to our notified body during October 2011. However, due to the length of time it has taken to achieve this regulatory approval, and the additional fees requested by our notified body to review our file again with the supplemental data requested, we decided to reassess the justification of this. During this reassessment we also became aware of a new submissions strategy, as well as potential new marketing opportunities for rapid HIV testing in certain markets in Europe. As a result we are in discussions with respect to this new submission strategy and we are more optimistic both on our prospects for CE Marking and for the outlook for commercial opportunities in Europe. We expect to have an updated timetable and outlook for this project during the second quarter. +Regulatory Approvals in Brazil through the Oswaldo Cruz Foundation (FIOCRUZ) – During 2011 we received notification from FIOCRUZ that our DPP â Syphilis Treponemal screening test and our DPP® Leptospirosis tests were each approved by Brazil's National Health Surveillance Agency (ANVISA). Also during 2011 our DPP® visceral canine leishmania rapid test was approved by Brazil’s Ministry of Agriculture, Livestock and Food Supply ("MAPA"). This is the first diagnostic product that FIOCRUZ has successfully submitted for approval to MAPA in Brazil. +23 +FDA Approval for DPP® HIV 1/2 Screening Assay - We began submitting the PMA (Pre-Marketing Approval) application to the FDA using the Modular PMA option, and we have thus far submitted Module I containing manufacturing information and Module II containing non-clinical data, which was submitted in the beginning of October 2011. We have enrolled 98% of the 3,000 patient clinical trial. We expect the trial to be completed as soon as possible depending on the recruitment rate of the remaining pediatric enrolees. We continue to be satisfied with the results and believe they continue to support product performance that will meet or exceed requirement for a PMA approval on oral fluid, finger-stick whole blood, venous whole blood, serum and plasma samples. Assuming early May completion, we would submit Module III to the FDA during the second quarter of 2012. Based on statutory FDA timetables, we would anticipate an FDA approval at least on an approvable PMA decision well before year end. We would then immediately apply for CLIA waiver, which is expected to take approximately three months to be granted. +Syphilis - As a result of our having received a CE Mark for the product in Q3'11 and our business development efforts during Q4'11, we have now established several European distributors for this product. Product evaluations are being completed in France and the UK. In the U.S. we have decided to incorporate a reader for the U.S. market product and as an option in Europe. We believe this will better ensure that there will be an acceptable agreement of our test results to the legacy RPR test results which is the reference for the non-treponemal marker on our dual marker test. We already are manufacturing large volumes of a visually read, treponemal-only test for Brazil with outstanding performance. This product would be an alternative pathway to bringing a syphilis POCT to the U.S. market. However such a test, like the laboratory treponemal tests, would not differentiate between active and previous infections, which are a preferred feature at least for testing in higher prevalence and risk groups. Assuming we can successfully incorporate the reader, we believe we can complete the clinical trials and make the 510(k) submission to the FDA for this product in 2012. Therefore FDA 510(k) clearance could be within the first half of 2013 followed by commercial launch in the US. +Sure Check® HIV OTC Study - We have made progress toward completing the requirements for submitting an IDE (“Investigational Device Exemption”) application. This exemption must be granted in order to begin clinical studies that would be necessary to gain FDA approval of this product, which approval could take two or three years from the time that we initiate such clinical studies. We believe that this year (2012) there will be external events that will help us to better define the market opportunity. This principally includes a meeting of the FDA's Blood Products Advisory Committee (date not determined yet) that is likely to result in a final recommendation concerning the application by Orasure Technologies for OTC use of its oral fluid HIV test. Assuming it is recommended, and the product is actually launched, we will be able to assess the market approach and its reception by their targeted consumers. This information will help us before we commit additional significant sums to this program. We can do this knowing that we are the only company other than this competitor that has a device that is qualified to begin the studies necessary to gain OTC approval. +Since our meeting with the FDA in October 2011 which clarified the regulatory pathway to commercialization, we continue to make progress towards the HIV rapid test for Over-the-Counter (OTC) market. We have completed the “instructional manual” for home-testing using the Flesch-Kincaid readability tests. The initial validation on the comprehension of the manual has been initiated in the first quarter of 2012 using groups identified during our market research (completed in 2011), this group will comprise of individuals with limited education and/or English as a second language. +In addition to making progress towards the regulatory path for commercialization, we are actively working with public health agencies to begin studies in 2012. The objective of these studies is to understand the barriers and facilitators to uptake home testing and other strategies that can be employed to prevention and care of certain demographics at risk to HIV infection. These studies, while providing invaluable health care strategies, can provide feedback to Chembio to improve upon or validate the design of the product to assure it remains safe and effective in a non-professional laboratory setting. +Recent Events +In accordance with the terms of the Company’s 2008 Stock Incentive Plan, on February 16, 2012, the Company determined to grant on February 16, 2012, to certain employees of the Company, options to purchase an aggregate of 203,125 shares of the Company’s common stock. The exercise price for these options was to be equal to the last traded price for the Company’s common stock on February 16, 2012, which was at $.50 per share. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of the grant. The following table identifies the portions of these options issued to officers of the Company. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +20,500 +Javan Esfandiari – Executive Vice President of R&D +63,750 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +24,000 +Richard J. Larkin – Chief Financial Officer +22,375 +Lawrence A. Siebert – Chief Executive Officer +72,500 +24 +RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2011 AS COMPARED WITH THE YEAR ENDED DECEMBER 31, 2010 +Income : +Income before income taxes for the year ended December 31, 2011 decreased to $1,076,000 from $2,559,000 for the year ended December 31, 2010. Net Income increased from $2.5 million for 2010 to $6.2 million for 2011 despite the decrease in income before taxes. The increase in income is attributable to a $5.1 million addition resulting from the partial elimination of the tax valuation allowance. In 2011, as a result of a 28.9% increase in Net Product sales and a 38.4% decrease in non-product revenues, the Company had a $1,290,000, or 15.9%, increase in its gross margin, to $9,390,000. This increased gross margin funded increased operating expenses, the most significant of which was increase clinical trial expenses of $590,000. Also, during the fourth quarter of 2010, the Company was awarded $1,467,000 of Qualified Therapeutic Discovery Project grants which reduced R&D Expense in 2010. +Revenues: +Selected Product Categories: +For the years ended +December 31, 2011 +December 31, 2010 +$ Change +% Change +Lateral Flow HIV Tests and Components +$ +12,865,541 +$ +12,111,560 +$ +753,981 +6.23 +% +DPP Tests and Components +4,255,032 +628,101 +3,626,931 +577.44 +% +Other +301,738 +776,698 +(474,960 +) +-61.15 +% +Net Product Sales +17,422,311 +13,516,359 +3,905,952 +28.90 +% +License and royalty revenue +140,322 +432,238 +(291,916 +) +-67.54 +% +R&D, milestone and grant revenue +1,825,403 +2,756,106 +(930,703 +) +-33.77 +% +Total Revenues +$ +19,388,036 +$ +16,704,703 +$ +2,683,333 +16.06 +% +Revenues for our lateral flow HIV tests and related components during the year ended December 31, 2011 increased by $754,000 over the same period in 2010. This was primarily attributable to increased sales in the U.S., through Alere, of $1,928,000, in Asia of $1,665,000, and increased sales to Mexico of $874,000, partially offset by decreased sales to Africa of $3,789,000. These increases were partially offset by reduced other sales, which decreased by 61%, or $475,000. Sales of our DPP® products in 2011 increased by $3,627,000, or 577%, compared to levels in 2010. Most of the DPP® product sold in 2011 related to products that were approved for sale in Brazil as compared to products sold in 2010, which sales primarily related to products used by FIOCRUZ in evaluations and submissions to Brazilian regulatory agencies for approval. The decrease in R&D, milestone and grant revenue was primarily due to $1,221,000 earned in 2010 as a result of the completion of certain milestones, versus $570,000 in 2011. In addition $804,000 in 2010 from Battelle for influenza immunity test was not repeated in 2011. R&D revenues in 2011 also include funds, recognized on an “as expenses are incurred” basis, from a Phase II NIH grant for Leptospirosis, which was effective as of June 1, 2009, and from a Phase II grant for Tuberculosis which was effective March 1, 2011. License and royalty revenue in 2010 includes fee payments of $340,000 from Bio-Rad pursuant to the License Agreement we signed with them in January 2009, partially offsetting this decrease was increased royalties of $48,000 from Brazil under our 2004 technology transfer and license agreement. +Gross Margin: +Gross Margin related to Net Product Sales: +For the years ended +December 31, 2011 +December 31, 2010 +$ Change +% Change +Gross Margin per Statement of Operations +$ +9,390,303 +$ +8,100,699 +$ +1,289,604 +15.92 +% +Less: R&D, milestone, grant, license and royalties +1,965,725 +3,188,344 +(1,222,619 +) +-38.35 +% +Gross Margin from Net Product Sales +$ +7,424,578 +$ +4,912,355 +$ +2,512,223 +51.14 +% +Gross Margin % +42.62 +% +36.34 +% +The gross margin increase included a 51.14% increase in gross margin from product sales, thereby more than offsetting a 38.35% decrease in non-product revenues. The 51.14% increase in our product gross margin was primarily due to the increase in product sales and from the mix of products sold in 2011, which included more products sold in the U.S, Brazilian, and Asian markets, at more favorable margins, as compared to 2010, when more products were sold to the African region which sales tend to be at somewhat lower margins. +25 +Research and Development: +This category includes costs incurred for product research and development, regulatory approvals, technical support, evaluations and registrations. +Selected expense lines: +For the years ended +December 31, 2011 +December 31, 2010 +$ Change +% Change +Clinical and Regulatory Affairs: +Wages and related costs +$ +465,688 +$ +424,038 +$ +41,650 +9.82 +% +Consulting +7,677 +30,525 +(22,848 +) +-74.85 +% +Stock-based compensation +18,858 +11,881 +6,977 +58.72 +% +Clinical trials +1,244,239 +654,253 +589,986 +90.18 +% +Other +58,191 +74,254 +(16,063 +) +-21.63 +% +Total Regulatory +1,794,653 +1,194,951 +599,702 +50.19 +% +R&D Other than Regulatory: +Wages and related costs +2,145,377 +1,889,702 +255,675 +13.53 +% +Consulting +68,791 +19,430 +49,361 +254.05 +% +Stock-based compensation +36,765 +73,656 +(36,891 +) +-50.09 +% +Materials and supplies +552,456 +635,911 +(83,455 +) +-13.12 +% +Other +280,077 +239,535 +40,543 +16.93 +% +Total other than Regulatory +3,083,466 +2,858,234 +225,233 +7.88 +% +$ +4,878,119 +$ +4,053,184 +$ +824,935 +20.35 +% +Less: QTDP grant +- +1,466,876 +(1,466,876 +) +-100.00 +% +Total Research and Development +$ +4,878,119 +$ +2,586,308 +$ +2,291,811 +88.61 +% +Expenses for Clinical & Regulatory Affairs for the year ended December 31, 2011 increased by $600,000 as compared to the same period in 2010. This was primarily due to expenses we incurred in 2011 for clinical trials conducted for our DPP® HIV Screen Assay. In addition, wages and related costs also contributed to the increase. +R&D expenses other than Clinical & Regulatory Affairs increased by $225,000 in the year ended December 31, 2011 as compared with the same period in 2010 and were primarily related to an increase in personnel and consulting expenses, partially offset by decreases in material costs and stock-based compensation. +On November 1, 2010, the Company was notified by the IRS that it received awards in the total amount of $1.467 million relating to six “Qualifying Therapeutic Discovery Projects” under the U.S. Patient Protection and Affordable Care Act of 2010 (P.L. 111-148), a program that was created as part of the major United States federal health care reform legislation enacted earlier in 2010. The $1.467 million reduced R&D expenses in the fourth quarter of 2010. This grant was not renewed for 2011. +Research and development expenses, before the QTDP grant, net of revenues from R&D, milestones and grants (see sub-heading Revenues above) was $3,053,000 for the year ended December 31, 2011 ($4,878,000 less $1,825,000, this includes clinical trials of $1,244,000 and does not include the QTDP reduction) compared to $1,297,000 ($4,053,000 less $2,756,000, this includes clinical trials of $654,000) for the same period in 2010. This demonstrates that the Company has not just maintained, but in fact has increased its investment in Research & Development personnel and materials, after accounting for outside clinical trial expenses, even with lower revenues supporting these activities. This has enabled work to be done on developing a pipeline of Chembio branded products, and also to support the transfer and validation of such new products into our manufacturing operation. +26 +Selling, General and Administrative Expense: +Selected expense lines: +For the years ended +December 31, 2011 +December 31, 2010 +$ Change +% Change +Wages and related costs +$ +1,249,907 +$ +1,076,446 +$ +173,461 +16.11 +% +Consulting +199,658 +215,391 +(15,733 +) +-7.30 +% +Commissons +603,377 +183,762 +419,615 +228.35 +% +Stock-based compensation +115,476 +64,429 +51,047 +79.23 +% +Marketing materials +50,900 +17,627 +33,273 +188.76 +% +Investor relations/investment bankers +176,297 +197,183 +(20,886 +) +-10.59 +% +Legal, accounting and SOX 404 compliance +448,676 +563,277 +(114,601 +) +-20.35 +% +Travel, entertainment and trade shows +67,504 +59,003 +8,501 +14.41 +% +Bad Debt Allowance +(5,000 +) +- +(5,000 +) +100.00 +% +Other +517,502 +563,603 +(46,101 +) +-8.18 +% +Total S, G &A +$ +3,424,297 +$ +2,940,721 +$ +483,576 +16.44 +% +Selling, general and administrative expenses for the year ended December 31, 2011 increased by 16.4% as compared with the same period in 2010. This was primarily due to increases in commission expense of $420,000 primarily on sales to Brazil, wages and related expenses of $173,000, stock-based compensation of $51,000 and marketing materials of $33,000, partially offset by decreases in investor relations of $21,000, consulting of $16,000 and legal, accounting and SOX 404 expenses of $115,000. +Other Income and Expense: +For the years ended +December 31, 2011 +December 31, 2010 +$ Change +% Change +Other income (expense) +$ +- +$ +(3,923 +) +$ +3,923 +-100.00 +% +Interest income +6,298 +4,147 +2,151 +51.87 +% +Interest expense +(18,623 +) +(14,727 +) +(3,896 +) +26.45 +% +Total Other Income and (Expense) +$ +(12,325 +) +$ +(14,503 +) +$ +2,178 +-15.02 +% +Other (expense) for the year ended December 31, 2011 increased approximately $2,200 to $12,300 as compared with $14,500 for the same period in 2010, primarily as a result of the loss on the sale of an asset in 2010 of $3,900 not repeated in 2011 and an increase in interest income of $2,100, partially offset by increased interest expense of $3,900 due to the term loan with HSBC. +Income tax (benefit) provision: +Prior to 2011 and through September 30, 2011, the Company had a full valuation allowance recorded against deferred tax assets. In the fourth quarter of 2011, based on our sustained profitable operating performance over the past three years and our positive outlook for taxable income in the future, the Company reevaluated its deferred tax asset. Based upon the guidance under ASC 740, we concluded that it was more likely than not that the Company would realize the benefit of such deferred tax assets, the Company reversed $5,156,000 of the valuation allowance previously recorded against its deferred tax assets, which resulted in a tax benefit increase to net income of that amount. It also increased the Company's book value by that amount. The deferred tax asset will be amortized against future income tax expense that would be payable in the absence of the net operating loss carryforward. The Company still maintains a full valuation allowance on research and development tax credits. +27 +MATERIAL CHANGES IN FINANCIAL CONDITION +Selected Changes in Financial Condition +As of +December 31, 2011 +December 31, 2010 +$ Change +% Change +Cash and cash equivalents +$ +3,010,954 +$ +2,136,351 +$ +874,603 +40.94 +% +Accounts receivable, net of allowance for doubtful accounts of $30,000 and $35,000 for 2011 and 2010, respectively +2,998,449 +3,946,398 +(947,949 +) +-24.02 +% +Inventories +2,300,286 +1,349,161 +951,125 +70.50 +% +Prepaid expenses and other current assets +681,893 +204,824 +477,069 +232.92 +% +Fixed assets, net of accumulated depreciation +1,062,276 +813,214 +249,062 +30.63 +% +Deposits on manufacturing equipment +139,790 +- +139,790 +100.00 +% +Deferred tax asset, net of valuation allowance +4,749,622 +- +4,749,622 +100.00 +% +Accounts payable and accrued liabilities +2,789,500 +2,055,943 +733,557 +35.68 +% +License fee payable +- +875,000 +(875,000 +) +-100.00 +% +Cash increased by $875,000 from December 31, 2010, primarily due to the collection of accounts receivable which decreased by $948,000 along with an increase in accounts payable of $734,000, partially offset by an increase in inventories of $951,000 and by the payment to Bio-Rad of $875,000 (see reduction in license fee payable). Prepaid expenses increased primarily due to the current portion of the deferred tax asset. The Company invested $289,000 in fixed assets and deposits in fixed assets. +The decrease in accounts receivable was primarily attributable to a large amount of credit sales in December of 2010 which were collected in 2011 compared to a large amount of December 2011 sales, some of which were prepaid. The increase in accounts payable and in inventories were both primarily due to a larger amount of materials ordered and manufactured for orders due to ship in the first quarter of 2012. +In addition, the increase in deferred tax asset in 2011, net of valuation allowance, was a direct result of the Company's reversal of $5,156,000 in valuation allowance previously recorded against its deferred tax assets as discussed earlier. +LIQUIDITY AND CAPITAL RESOURCES +For the years ended +December 31, 2011 +December 31, 2010 +$ Change +% Change +Net cash provided by operating activities +$ +2,268,408 +$ +1,016,850 +$ +1,251,558 +123.08 +% +Net cash used in investing activities +(726,680 +) +(182,292 +) +(544,388 +) +298.64 +% +Net cash (used in) provided by financing activities +(667,125 +) +233,558 +(900,683 +) +-385.64 +% +INCREASE IN CASH AND CASH EQUIVALENTS +$ +874,603 +$ +1,068,116 +$ +(193,513 +) +-18.12 +% +The Company had an increase in cash for each of the years ended December 31, 2011 and 2010 which were primarily attributable to cash provided by operations. The increased cash from operations in 2011 was primarily attributable to net income from operations of $1,088,000. In addition, operating activities contributing to the increase in cash in 2011 included an increase in accruals and payables of $734,000 and a decrease in receivables of $953,000. These increases were partially offset by an increase in inventories of $951,000, an increase in prepaid expenses of $71,000 and an increase in other assets of $6,000, as well as a decrease in deferred revenue of $65,000. The Company’s non-cash expenses totaled $622,000, which consisted of $338,000 from depreciation expense, $189,000 in stock-based compensation expense and $100,000 in the amortization of licenses, partially offset by a decrease in allowance for doubtful accounts of $5,000. Investing activities represent the Company’s investment in fixed assets. The cash used in financing activities is primarily due to the payment to Bio-Rad of $875,000 (see reduction in license fee payable) and partially offset by proceeds from the exercise of options and warrants of $288,000. +As of December 31, 2011, the Company had paid deposits on various pieces of equipment aggregating $140,000, which is reflected in Other Assets on the balance sheet. The Company is further committed to an additional equipment-purchase obligation of $152,000 as various milestones are achieved by the various vendors +28 +RECENT DEVELOPMENTS AND CHEMBIO’S PLAN OF OPERATIONS FOR THE NEXT TWELVE MONTHS +2011 RESULTS +In 2011 Chembio achieved record product revenue growth of 28.9%, funded increased development expenses, and delivered strong Income before income taxes of $1,076,000. A $3,906,000, or 28.9%, increase in Net Product sales offset a $1,223,000 decrease in non-product revenues. This resulted in the Company producing a $1,290,000, or 15.9%, increase in its gross margin, to a record $9,390,000. +In the fourth quarter of 2011, based on our sustained profitable operating performance over the past three years and our positive outlook for taxable income in the future, the Company reevaluated its deferred tax asset. Based on anticipated continued profitability the Company believes it is more likely than not that it will realize these tax benefits and accordingly has reversed $5,156,000 of the valuation allowance previously recorded against the deferred tax assets. This reversal of the tax valuation allowance resulted in an addition of $5.1 million to the Company’s net income for 2011. The Company still maintains a full valuation allowance on research and development tax credits. +The Company generated $2,268,000 in cash flow from operations in 2011, more than doubling its previous record of $1,107,000 in 2010. The Company utilized portions of this cash flow from operations to fund an $875,000 license obligation and to invest $727,000 in new equipment and facility improvements that are expected to improve efficiencies and increase capacity to serve current and anticipated demand. +The record product and resulting record total revenues were achieved as a result of the launch of four of our DPP® products in Brazil combined with strong sales growth for our two FDA-approved rapid HIV tests in the US market. We increased sales to FIOCRUZ to $4,255,000 in 2011 from $628,000 in 2010, a 577% increase, substantially exceeding the $3 million we anticipated in June 2011. Sales of our FDA approved rapid HIV tests in the US through our agreements with Alere increased $1,928,000 to a record $7,209,000, a 36.5% increase over 2010. This strong increase provides us with strong evidence of continued growth in the U.S. rapid HIV test market, and that growth is being captured at this time by our two outstanding lateral flow products distributed by Alere under their Clearview® label, as our competitors’ sales were essentially flat during 2011. Our international lateral flow HIV test revenues decreased somewhat as donor-funded markets experienced uncertainties generally and in the markets we were participating in particular. Nevertheless during the year we significantly strengthened and expanded our distribution network and resulting marketing opportunities, giving us some optimism for a potential resurgence in these sales during 2012. +PLAN OF OPERATIONS FOR THE NEXT TWELVE MONTHS +The 3,000 patient study we commenced in 2010 in support of a Pre-Marketing Application approval for our DPP® HIV Screening Assay for use with oral fluid or blood samples is nearly complete. Once we complete these trials we will need approximately 30 days to submit the third and final module of the PMA to the FDA. Within 180 days we expect that the FDA will respond to our PMA application. The intent of the modular submission is to increase the possibility that we will receive such response sooner than the 180 day statutory period though this is not required and cannot be assured. Nevertheless, we believe that we will submit and get this response well within the 2012 calendar year. +29 +As a result of our having received a CE Mark for our Syphilis Screen & Confirm product in Q3'11 and our business development efforts during Q4'11, we have now established several European distributors for this product. Product evaluations are being completed in France and the UK. Assuming we can successfully incorporate the reader into our U.S. clinical trials, we believe that we can complete the clinical trials and make the 510(k) submission to the FDA for this product during 2012. Therefore FDA 510(k) clearance could be within the first half of 2013 followed by commercial launch in the US. Alternatively we could decide to pursue a treponemal-only product in the U.S. We are already producing large quantities of the treponemal-only screening test for FIOCRUZ with excellent performance. +The Company has a number of new product opportunities and new product features that could result in new revenue streams in future periods. In each case these would utilize our patented DPP® platform to develop proprietary products, and could also combine additional proprietary features such as biomarkers in collaboration with others or other features we may add to our platform technology. These products will be developed either under the Chembio DPP® brand or the brands of potential OEM customers that incorporate our DPP® trademark. We are working on a number of new potential projects in this regard and in some cases conducting feasibility studies. These include potential products with application to the areas of women’s health, veterinary diagnostics, and blood viruses. We believe that these projects can ultimately result in potential new revenue streams in future periods, although there can be no assurance of this. +In the meantime, based on substantially increased revenues that are anticipated this year from our DPP® OEM products with FIOCRUZ in Brazil, combined with even modest growth in the US rapid HIV test market and/or our market share with our FDA-approved rapid HIV tests marketed by Alere, as well as possible gains from existing and/or new international distributors for our lateral flow and DPP® products. We are overall very optimistic in regards to Chembio’s financial outlook for 2012, which we believe will include strong improvements to our revenues and net income. Our recording of the value of our net operating loss carry forward as a financial asset is a reflection of our optimism. +Fixed Asset Commitments +As of December 31, 2011, the Company had paid deposits on various pieces of equipment aggregating $139,790, which is reflected in Other Assets on the balance sheet. The Company is further committed to additional equipment-purchase obligation of $151,910 as various milestones are achieved by the various vendors. +Critical Accounting Policies and Estimates +The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates. +We believe that there are several accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amounts of revenue and the more significant areas involving management’s judgments and estimates. These significant accounting policies relate to revenue recognition, research and development costs, valuation of inventory, valuation of long-lived assets and income taxes. These policies, and the related procedures, are described in detail below. +Revenue Recognition – +We recognize revenue for product sales in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). Under SAB 104, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is determinable, and collectability is reasonably assured. Revenue typically is recognized at time of shipment. Sales are recorded net of discounts, rebates and returns. +For certain contracts, we recognize revenue from R&D, milestone and grant revenues when earned. Grants are invoiced after expenses are incurred. Revenues from projects or grants funded in advance are deferred until earned. +For certain collaborative research projects, we recognize revenue by defining milestones at the inception of the agreement and applying the milestone method of revenue recognition for relevant contracts. +30 +Stock-Based Compensation – +We recognize the fair value of equity-based awards as compensation expense in our statement of operations. The fair value of our stock option awards was estimated using a Black-Scholes option valuation model. This valuation model’s computations incorporate highly subjective assumptions, such as the expected stock price volatility and the estimated life of each award. The fair value of the options, after considering the effect of expected forfeitures, is then amortized, generally on a straight-line basis, over the related vesting period of the option. The fair value of our restricted shares is based on the market value of the shares at the date of grant and is recognized on a straight-line basis over the related vesting period of the award. +Research & Development Costs – +Research and development activities consist primarily of new product development, continuing engineering for existing products, regulatory and clinical trial costs. Costs related to research and development efforts on existing or potential products are expensed as incurred. +Valuation of Inventories – +Inventories are stated at the lower of cost or market, using the first-in, first-out method (FIFO) to determine cost. Our policy is to periodically evaluate the market value of the inventory and the stage of product life cycle, and record a reserve for any inventory considered slow moving or obsolete. For example, each additional 1% of obsolete inventory would reduce such inventory by approximately $23,000. +Allowance for doubtful accounts – +Our policy is to review our accounts receivable on a periodic basis, no less than monthly. On a quarterly basis an analysis is made of the adequacy of our allowance for doubtful accounts and adjustments are made accordingly. The current allowance is approximately 1% of accounts receivable. For example each additional 1% of accounts receivable that becomes uncollectible would reduce such balance of accounts receivable by approximately $30,000. +Income Taxes – +Income taxes are accounted for under ASC 740 authoritative guidance (“Guidance”) which requires the asset and liability method of accounting for deferred income taxes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities. Deferred tax assets or liabilities at the end of each period are determined using the tax rate expected to be in effect when taxes are actually paid or recovered. +The Guidance also requires that a valuation allowance be established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence needs to be considered, including a company’s current and past performance, the market environment in which the company operates, length of carryback and carryforward periods and existing contracts that will result in future profits. Prior to 2011 and through September 30, 2011, the Company had a full valuation allowance recorded against deferred tax assets since it was not more likely than not that the Company would realize the benefits of such deferred tax assets. During 2011, the Company determined based upon the guidance under ASC 740 that it was more likely than not that it would realize the benefit of such deferred tax assets. As result, the Company reversed the valuation allowance previously recorded against the deferred tax assets. The Company still maintains a full valuation allowance on research and development tax credits +The Guidance also prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the consolidated financial statements tax positions taken or expected to be taken on a tax return, including a decision whether to file or not to file in a particular jurisdiction. +The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles, generally accepted in the United States of America, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any viable alternative would not produce a materially different result. See our audited financial statements and notes thereto which contain accounting policies and other disclosures required by accounting principles generally accepted in the United States of America. +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The Consolidated Financial Statements and schedules that constitute Item 8 are attached at the end of this Annual Report on Form 10-K. An index to these Financial Statements and schedules is also included on page F-1 of this Annual Report on Form 10-K. +31 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. +There have been no disagreements, or transactions or events similar to those which involved such disagreements or reportable events, with former accountants on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of the former accountant, would have caused it to make reference to the subject matter disagreements in connection with any of its reports. +ITEM 9A. +CONTROLS AND PROCEDURES +(a) Disclosure Controls and Procedures. Under the supervision and with the participation of our senior management, consisting of our chief executive officer and our chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report (the "Evaluation Date"). Based on that evaluation, the Company’s management, including our chief executive officer and chief financial officer, concluded that as of the Evaluation Date our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our Exchange Act reports is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. +Management's Annual Report on Internal Control Over Financial Reporting. The Company's management is responsible for establishing and maintaining an adequate system of internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)). Our internal control over financial reporting is a process, under the supervision of our chief executive officer and chief financial officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. These internal controls over financial reporting processes include policies and procedures that: +a. +Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; +b. +Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +c. +Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives. +In evaluating the effectiveness of our internal control over financial reporting, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2011. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. +Management's report was not subject to attestation by our registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report. +(b) Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the Company’s last fiscal quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +ITEM 9B. +OTHER INFORMATION +Not applicable. +32 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +Directors and Executive Officers +Lawrence A. Siebert (55), President, Chief Executive Officer and Chairman. Mr. Siebert was appointed President of Chembio Diagnostics, Inc. and a member of our board of directors upon consummation of the merger in 2004. Mr. Siebert has been Chairman of Chembio Diagnostic Systems Inc. for approximately thirteen years and its President since May 2002. Mr. Siebert’s background is in private equity and venture capital investing. From 1982 to 1991, Mr. Siebert was associated with Stanwich Partners, Inc, which during that period invested in middle market manufacturing and distribution companies. From 1992 to 1999, Mr. Siebert was an investment consultant and business broker with Siebert Capital Corp. and Siebert Associates LLC, and was a principal investor in a privately held test and measurement company which was sold in 2002. Mr. Siebert received a JD from Case Western Reserve University School of Law in 1981 and a BA with Distinction in Economics from the University of Connecticut in 1978. Mr. Siebert as president and CEO is an integral part of the Chembio management team. His experience in the rapid test field and financing markets made him an excellent candidate for serving on the board and as its chairman. +Richard J. Larkin (55), Chief Financial Officer. Mr. Larkin was appointed as Chief Financial Officer of Chembio Diagnostics, Inc. upon consummation of the merger in 2004. Mr. Larkin oversees our financial activities and information systems. Mr. Larkin has been the Chief Financial Officer of Chembio Diagnostic Systems Inc. since September 2003. Prior to joining Chembio Diagnostic Systems Inc., Mr. Larkin served as CFO at Visual Technology Group from May 2000 to September 2003, and also led their consultancy program that provided hands-on expertise in all aspects of financial service, including the initial assessment of client financial reporting requirements within an Enterprise Resource Planning (Manufacturing) environment through training and implementation. Prior to joining VTG, he served as CFO at Protex International Corporation from May 1987 to January 2000. Mr. Larkin holds a BBA in Accounting from Dowling College and is a member of the American Institute of Certified Public Accountants. +Javan Esfandiari (45), Executive VP of Research and Development. Mr. Esfandiari joined Chembio Diagnostic Systems, Inc, in 2000. Mr. Esfandiari co-founded, and became a co-owner of Sinovus Biotech AB where he served as Director of Research and Development concerning lateral flow technology until Chembio Diagnostic Systems Inc. acquired Sinovus Biotech AB in 2000. From 1993 to 1997, Mr. Esfandiari was Director of Research and Development with On-Site Biotech/National Veterinary Institute, Uppsala, Sweden, which was working in collaboration with Sinovus Biotech AB on development of veterinary lateral flow technology. Mr. Esfandiari received his B.Sc. in Clinical Chemistry and his M. Sc. in Molecular Biology from Lund University, Sweden. He has published articles in various veterinary journals and has co-authored articles on tuberculosis serology with Dr. Lyashchenko. +Richard Bruce (58), Vice President, Operations. Mr. Bruce was hired in April 2000 as Director of Operations. He is responsible for manufacturing, maintenance, inventory, shipping, receiving, and warehouse operations. Prior to joining Chembio Diagnostic Systems Inc., he held director level positions at Wyeth Laboratories from 1984 to 1993. From 1993 to 1998, he held various management positions in the Operations Department at Biomerieux. From 1998 to 2000, he held a management position at V.I. Technologies. Mr. Bruce has over thirty years of operations management experience with Fortune 500 companies in the field of in-vitro diagnostics and blood fractionation. Mr. Bruce received his BS in Management from National Louis University in 1997. +Tom Ippolito (49), VP of Regulatory Affairs, QA and QC. Mr. Ippolito joined Chembio in June 2005. He has over twenty years’ experience with in vitro diagnostics for infectious diseases, protein therapeutics, vaccine development, Process Development, Regulatory Affairs and Quality Management. Over the years, Mr. Ippolito has held Vice President level positions at Biospecific Technologies, Corp. from 2000 - 2005, Director level positions in Quality Assurance, Quality Control, Process Development and Regulatory Affairs at United Biomedical, Inc. from 1987 - 2000. Mr. Ippolito is the Course Director for “drug development process” and “FDA Regulatory Process” for the BioScience Certificate Program at the New York State University of Stony Brook, a program he has been a part of since its inception in 2003. +Dr. Gary Meller, M.D. (61), Director. Dr. Meller was elected to our Board of Directors in March 15, 2005, and currently serves on the Board’s Audit, Compensation and Nominating and Corporate Governance Committees, including as Chairman of the Compensation Committee. Dr. Meller also served as Chairman of the Board’s Special Committee for handling certain strategic opportunities. Dr. Meller has been the president of CommSense Inc., a healthcare business development company, since 2001. CommSense Inc. works with clients in Europe, Asia, North America, and the Middle East on medical information technology, medical records, pharmaceutical product development and financing, health services operations and strategy, and new product and new market development. From 1999 until 2001 Dr. Meller was the executive vice president, North America, of NextEd Ltd., a leading internet educational services company in the Asia Pacific region. Dr. Meller also was a limited partner and a member of the Advisory Board of Crestview Capital Master LLC, which at one time was our largest stockholder. Dr. Meller is a graduate of the University of New Mexico School of Medicine and has an MBA from the Harvard Business School. Dr. Meller’s experience in the medical field both domestic and foreign (especially his experience with CommSense Inc.) as well as his financing experience made him an excellent candidate for serving on the board. +33 +Kathy Davis (55), Director. Ms. Davis was elected to the Company’s Board of Directors in May 2007, and currently serves on the Board of Director’s Audit, Compensation and Nominating And Corporate Governance Committees, including as Chairman of each of the Audit Committee and the Nominating And Corporate Governance Committee. Ms. Davis also served on the Boards’ Special Committee for handling certain strategic opportunities. Since January 2007, Ms. Davis has been the owner of Davis Design Group LLC, a company that provides analytical and visual tools for public policy design. Previously, from February 2005 to December 2006, she served as the Chief Executive Officer of Global Access Point, a start-up company with products for data transport, data processing, and data storage network and hub facilities. From October 2003 to January 2005, Ms. Davis was Lieutenant Governor of the State of Indiana, and from January 2000 to October 2003 was Controller of the City of Indianapolis. From 1989 to 2003, Ms. Davis held leadership positions with agencies and programs in the State of Indiana including State Budget Director, Secretary of Family & Social Services Administration, and Deputy Commissioner of Transportation. From 1982 to 1989 Ms. Davis held increasingly senior positions with Cummins Engine, where she managed purchasing, manufacturing, engineering, and assembly of certain engine product lines. Ms. Davis also led the startup of and initial investments by a $50 million Indiana state technology fund, serves on the not-for-profit boards of Noble of Indiana, University of Evansville Institute of Global Enterprise, Purdue College of Science Dean’s Leadership Council and Indiana University School of Public and Environmental Affairs Dean’s Advisory Council. She has a Masters of Business Administration from Harvard Business School and a Bachelor of Science in Mechanical Engineering from the Massachusetts Institute of Technology. Ms. Davis has varied experience in business, political and financial areas made her an excellent candidate for serving on the board. +Dr. Barbara DeBuono, M.D., M.P.H., (56), Director . Dr. DeBuono, who was elected to the Company’s Board of Directors in June 2011, is a renowned expert in public health innovation, health policy, education and research. In May 2011, Dr. DeBuono was appointed President and CEO of ORBIS International, which is dedicated to saving sight and eliminating avoidable blindness worldwide with headquarters in New York City. Previously, from 2009-2011, Dr. DeBuono was Chief Medical Officer, Partner and Global Director of Health and Social Marketing at Porter Novelli, and from 2000-2008 she was Executive Director, Public Health and Government at Pfizer Inc. Dr. DeBuono has served as Commissioner of Health for the state of New York and as Director of Health in Rhode Island and she was honored by the CDC Foundation in 2005 as one of five Public Health Heroes nationwide. She serves as adjunct professor at The George Washington University School of Public Health, and is a co-founder of The MAIA Foundation, a charity dedicated to women’s health in sub-Saharan Africa. A Fellow of the American College of Physicians, Dr. DeBuono received her B.A. from the University of Rochester, her M.D. from the University of Rochester, School of Medicine, and a Masters in Public Health (M.P.H.) from Harvard University School of Public Health. Dr. DeBuono’s experience in and knowledge of, both domestic and international, public health services, public health innovations, and the medical field make her an excellent candidate for serving on the board. +Dr. Peter Kissinger , Ph.D. (67), Director. Dr. Kissinger, who was elected to the Company’s Board of Directors in June 2011, is a scientist, entrepreneur and academic, with a multi-faceted career in biotechnology and biomedical technologies. He is the founder of Bioanalytical Systems, Inc. (NASDAQ: BASI), which he led from 1974-2007, and is Professor of Chemistry and Associate Department Head at Purdue University, West Lafayette, Indiana. Dr. Kissinger’s academic research has involved the study of modern liquid chromatography techniques, and in vivo methodology for drug metabolism and the neurosciences. Dr. Kissinger has published more than 230 scientific papers and is a Fellow of the American Association of Pharmaceutical Scientists and the American Association for the Advancement of Science. In 2005, he became the Chairman of Prosolia, which markets mass spectrometry innovations for life science, industrial and homeland security applications. In 2007, he and Candice Kissinger founded Phlebotics, Inc., a medical device company focused on diagnostic information for intensive care medicine. He is a columnist for the trade publication Drug Discovery News. Dr. Kissinger received a B.S. in Chemistry from Union College, Schenectady, N.Y. and a Ph.D. in Analytical Chemistry from the University of North Carolina in Chapel Hill. Dr. Kissinger has knowledge of and experience in biotechnology and biomedical technologies as well as publicly-traded companies, all of which make him an excellent candidate for serving on the board. +Section 16(a) Beneficial Ownership Reporting Compliances +Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires the Company’s directors, executive officers and beneficial owners of more than 10% of the Company’s common stock to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of common stock and other equity securities of the Company. The Company believes that during the year ended December 31, 2011, each person who was an officer, director and beneficial owner of more than 10% of the Company’s common stock complied with all Section 16(a) filing requirements . +Code of Ethics +The Company has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer, controller, and persons performing similar functions. A copy of the Company’s code of ethics is available on the Company’s website at www.chembio.com. +34 +Identification of Audit Committee; Audit Committee Financial Expert +The Company’s board of directors has established an audit committee. Katherine L. Davis, Dr. Pete Kissinger and Dr. Gary Meller each serves on the audit committee, with Ms. Davis serving as chairman. The Company’s board of directors has determined that Ms. Davis is an audit committee financial expert and is independent. +ITEM 11. EXECUTIVE COMPENSATION +The following table summarizes all compensation recorded by the Company in each of the last two completed fiscal years for our principal executive officer and our two most highly compensated executive officers other than our principal executive officer whose annual compensation exceeded $100,000. +Name / +Principal +Position +Year +Salary 1 +($) +Bonus 2 +($) +Option Awards 3 +($) +Stock +Awards +($) +All Other Compensation 5 +($) +Total +($) +Lawrence A. Siebert 4 +2011 +$ +281,346 +$ +101,500 +$ +- +$ +- +$ +12,600 +$ +395,446 +CEO +2010 +265,000 +87,450 +- +- +7,200 +359,650 +Javan Esfandiari +2011 +$ +253,077 +$ +89,250 +$ +- +$ +- +$ +8,540 +$ +350,867 +VP-R&D +2010 +242,923 +80,850 +66,030 +- +4,800 +394,603 +Tom Ippolito +2011 +$ +190,702 +$ +33,600 +$ +42,724 +$ +- +$ +3,958 +$ +270,984 +VP-Regulatory +2010 +185,815 +40,300 +- +- +- +226,115 +1 Salary is total base salary. +2 Bonuses earned in 2011 and 2010 were partially based on reaching certain objectives, which included revenue dollar levels and operating profit levels, additional amounts earned were discretionary. +3 The estimated fair value of any option or common stock granted was determined in accordance with ASC 718, "Stock-Based Payment". +4 Mr. Siebert also serves as a director on the Company’s board of directors. Mr. Siebert does not receive any compensation for this director role. +5 Other compensation includes an employer match to 401(K) contributions and car allowances where applicable. +Employment Agreements +Mr. Siebert. Effective, May 11, 2011, the Compensation Committee of the Board of Directors extended the Company’s employment agreement (the “Employment Agreement”) with Lawrence A. Siebert, the Company’s President and Chief Executive Officer, for an additional one-year term through May 11, 2013, with an increase in salary to $290,000 per year. Previously, effective May 11, 2009, the Company’s Board of Directors had approved the Comapany’s extension of the June 15, 2006 Employment Agreement for an additional three-year term through May 11, 2012. On June 15, 2006, Mr. Siebert and the Company entered into an Employment Agreement, effective May 10, 2006, which was to terminate on May 10, 2008, extended in 2008 to May 10, 2009. Pursuant to the Employment Agreement, Mr. Siebert serves as the President and Chief Executive Officer of the Company and received an initial salary of $240,000 per year, which had been increased to $265,000 per year until Mr. Siebert agreed to a 15 percent reduction, to $225,000, effective January 19, 2009. Mr. Siebert’s salary was restored to $265,000 per annum effective in July 2009. Mr. Siebert also is eligible for a bonus of up to 50% of his salary, consisting of (i) a bonus of up to 25% of his salary that is at the complete discretion and determination of the board of directors, and (ii) a bonus of up to an additional 25% of his salary that will be determined based upon revenue and earnings performance criteria established each year by the board of directors. Mr. Siebert is eligible to participate in any profit sharing, stock option, retirement plan, medical and/or hospitalization plan, and/or other benefit plans except for disability and life insurance that the Company may from time to time place in effect for the Company’s executives during the term of Mr. Siebert’s employment agreement. If Mr. Siebert’s Employment Agreement is terminated by the Company without cause, or if Mr. Siebert terminates his Employment Agreement for a reasonable basis, as defined in the Employment Agreement, including within 12 months of a change in control, the Company is required to pay as severance Mr. Siebert’s salary for six months. Mr. Siebert has agreed for a period of two years after the termination of his employment with the Company not to induce customers, agents, or other sources of distribution of the Company’s business under contract or doing business with the Company to terminate, reduce, alter, or divert business with or from the Company. The terms of the extended May 11, 2011, May 11, 2009 and May 11, 2008 Employment Agreements are identical to the June 15, 2006 Employment Agreement, except that under the May 11, 2008 extended Employment Agreement, Mr. Siebert received additional consideration in the form of incentive stock options to purchase 250,000 shares of the Company’s common stock exercisable at $0.13 per share, which was the closing price of the Company's common stock on June 3, 2008. The incentive stock options are immediately exercisable and they expire on the June 3, 2013. +35 +Mr. Esfandiari. The Company entered into an employment agreement dated March 4, 2010, and to be effective March 5, 2010 (the "Employment Agreement"), with Mr. Esfandiari to continue as the Company's Senior Vice President of Research and Development for an additional term of three years through May 5, 2013. Mr. Esfandiari's salary under the Employment Agreement is $245,000 for the first year, $255,000 for the second year, and $265,000 for the final year. Mr. Esfandiari is eligible for a cash bonus of up to 50% of his base salary for each respective year, which, on June 29, 2011, was amended, effective March 5, 2011, to consist of the same components in the same percentages as the bonus components as those described immediately above for Mr. Siebert. Prior to that amendment, and since March 5, 2010, Mr. Esfandiari’s bonus consisted of the following: (i) a cash bonus of up to 30% of his calendar year base salary based on the performance of the Company's Dual Path Platform Technology, which is directly related to certain annual revenue targets budgeted by management of the Company; (ii) a cash bonus of up to 10% of his calendar year base salary based on the attainment of certain specific research and development objectives, as determined by the Board, and (iii) a cash bonus of up to 10% of his calendar year base salary that is at the complete discretion and determination of the board of directors. The Company also granted Mr. Esfandiari, pursuant to the Company's 2008 Stock Incentive Plan, incentive stock options to purchase 300,000 shares of the Company's common stock. The price per share of these options is equal to the fair market value of the Company's common stock as of the close of the market on March 5, 2010, which is the date on which the Agreement was effective. Of these stock options, options to purchase 100,000 shares vest on the effective date, options to purchase an additional 100,000 shares of the stock options vest on the second anniversary of the Employment Agreement, and options to purchase an additional 100,000 shares of the stock options vest on the third anniversary of the Employment Agreement. Mr. Esfandiari is eligible to participate in any profit sharing, stock option, retirement plan, medical and/or hospitalization plan, and/or other benefit plans except for disability and life insurance that the Company may from time to time place in effect for the Company’s executives during the term of Mr. Esfandiari’s employment agreement. If Mr. Esfandiari’s employment agreement is terminated by the Company without cause, or if Mr. Esfandiari terminates his employment agreement for a reasonable basis, as defined in the Employment Agreement, including within 12 months of a change in control, the Company is required to pay as severance Mr. Esfandiari’s salary for twelve months. +Mr. Ippolito does not have an employment contract with the Company. +Executive Bonus Plan +The Company has established a bonus plan for its executives who do not have a contract. For the fiscal year ended December 31, 2011, there were three executives eligible for this bonus plan. Each executive can earn up to 25% of that executive’s salary in the form of a bonus. The Compensation Committee determined that 40% of the executive’s bonus will be quantitative factors, based on the budget. 60% will be based on other factors; with one-half of the 60% (or 30%) based on management objectives, and the other one-half of the 60% (or 30%) will be discretionary. The plan, during 2011 for the 40%, called for a sliding percentage of the executive’s salary, from zero to 5% for attaining 85% to 100% of revenue goals, and from zero to 5% of the executive’s salary for attaining between zero percent to 150% of the designated operating profit goals. The Company achieved nearly 99% of its revenue goals for 2011, resulting in a bonus of 4.5% of each executive’s salary, and achieved nearly 93% of its operating profit goal, resulting in a bonus of 2.25% of salary, for a total of 6.75% of salary. In addition, the Compensation Committee approved 5.25% of salary in discretionary bonuses for the subject executives and 5.50% in management objectives, bringing the total plan bonus to approximately 17.5% of salary. Goals for 2012 have not yet been established. +36 +OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END 2011 +Option Awards +Stock Awards +Name +Number of Securities Underlying Unexercised Options Exercisable (#) +Number of Securities Underlying Unexercised Options Unexercisable +(#) +Option Exercise Price +($) +Option Expiration Date +Option Vesting Date +Number of Shares of Stock That Have Not Vested +(#) +Market Value of Shares of Stock That Have Not Vested +($) +Foot- +note +Lawrence A. Siebert +133,333 +0.13 +5/6/2014 +5/6/2012 +5 +133,333 +0.13 +5/6/2014 +5/7/2011 +5 +133,333 +0.13 +5/6/2014 +5/6/2010 +5 +250,000 +0.13 +6/3/2013 +6/3/2008 +3 +75,000 +0.22 +2/15/2013 +2/15/2008 +2 +50,000 +0.13 +5/28/2011 +1/1/2007 +1, 4 +50,000 +0.13 +5/28/2011 +4/17/2006 +1, 4 +10,000 +0.13 +5/4/2011 +4/17/2006 +4 +50,000 +0.13 +5/4/2011 +5/5/2004 +4 +Javan Esfandiari +100,000 +0.27 +3/4/2015 +3/5/2013 +3 +100,000 +0.27 +3/4/2015 +3/5/2012 +3 +100,000 +0.27 +3/4/2015 +3/5/2012 +3 +100,000 +0.13 +5/6/2014 +5/6/2011 +5 +100,000 +0.13 +5/6/2014 +5/7/2010 +5 +100,000 +0.13 +5/6/2014 +5/6/2010 +5 +100,000 +0.13 +4/23/2012 +3/5/2009 +1, 4 +100,000 +0.13 +4/23/2012 +3/5/2008 +1, 4 +60,000 +0.22 +2/15/2013 +2/15/2008 +2 +25,000 +0.13 +5/28/2011 +5/28/2007 +4 +100,000 +0.13 +4/23/2012 +4/23/2007 +1, 4 +18,750 +0.13 +3/24/2011 +1/1/2007 +4 +25,000 +0.13 +5/28/2011 +4/17/2006 +1, 4 +25,000 +0.13 +5/28/2011 +4/17/2006 +1, 4 +5,000 +0.13 +5/4/2011 +4/17/2006 +4 +18,750 +0.13 +3/24/2011 +3/24/2006 +4 +30,000 +0.13 +5/4/2011 +5/5/2004 +4 +Tom Ippolito +62,500 +0.54 +5/9/2016 +5/9/2014 +6 +62,500 +0.54 +5/9/2016 +5/9/2013 +6 +75,000 +0.13 +5/6/2014 +5/6/2012 +5 +75,000 +0.13 +5/6/2014 +5/7/2011 +5 +75,000 +0.13 +5/6/2014 +5/6/2010 +5 +50,000 +0.22 +2/15/2013 +2/15/2008 +2 +15,000 +0.13 +3/24/2011 +3/24/2006 +4 +1 Stock issued in connection with an employment contract and under the 1999 Stock Option Plan. +2 On February 15, 2008 the Company granted options under the 1999 Stock Option Plan. +3 Options issued in connection with an employment contract and under the 2008 Stock Incentive Plan. +4 On May 7, 2009, the Compensation Committee of the Company reduced, to $0.13 per share, the exercise price of each outstanding employee option that was issued under the 1999 Equity Incentive Plan (the “1999 Plan”) for which the exercise price was greater than $0.44 per share of the Company’s common stock. There was no other change made to the terms of the stock options other than the reduction in the exercise price. A total of 1,036,750 options were affected and the fair value difference of the options before and after the reduction was $31,660 and was expensed in the three months ended June 30, 2009. +5 On May 7, 2009 in accordance with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 2,925,000 shares of the Company’s common stock. The exercise price for these options is equal to $0.13 per share. The options become exercisable in thirds on the first, second and third anniversaries of the date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the date of grant. The fair value of these options is being amortized over the vesting life of the options. +6 On May 3, 2011 and effective May 9, 2011 in accordance with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 500,000 shares of the Company’s common stock exercise price for these options was to be equal to the VWAP (Volume Weighted Average Price) market price for the Company’s common stock on May 9, 2011. The options become exercisable evenly on the second and third anniversaries of the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. +37 +Director Compensation +All non-employee directors are paid an $18,000 annual retainer in semi-annual payments, and once every five years, on the date of the annual meeting of stockholders that directors are elected or re-elected (every 5 years), receive stock options to acquire, subject to vesting as described below, 375,000 shares of the Company's common stock, with an exercise price equal to the market price on the date of the grant. Stock options to acquire 75,000 shares become exercisable on the date of grant, and options to acquire an additional 75,000 shares become exercisable on the date of each of the four succeeding annual meetings of stockholders if and to the extent that the non-employee director is reelected as a director at each such annual meeting. The audit committee chairman is paid an annual retainer of $2,500, paid semi-annually. In addition, the non-employee directors are paid $1,000 in cash for each board of directors' meeting attended, and paid $500 in cash for each telephonic board of directors meeting. The non-employee directors who are members of a committee of the board of directors are paid $500 in cash for each committee meeting attended, or $750 in cash for each committee meeting attended if that non-employee director is the committee chairman. Directors also may be paid for serving ad hoc committees of the Board. In fact, when the Board established its Special Committee in 2010 to handle the possible sale of the Company, the Chairman of the Committee was paid $12,000 per month, and the other director-member of the Committee was paid $8,000 per month. +DIRECTOR COMPENSATION +Name +Fees Earned or Paid in Cash +($) 1 +Option Awards +($) 2 +Total +($) +Katherine L. Davis +$ +38,500 +$ +- +$ +38,500 +Barbara DeBuono +10,500 +27,722 +38,222 +Pete Kissinger +10,500 +27,722 +38,222 +Gary Meller +40,250 +- +40,250 +1 Fees earned or paid in cash represents a yearly fee and fees for meeting expenses: (a) Ms. Davis received an $18,000 annual fee as a member of the board of directors, a $2,500 annual fee as audit committee chairman, $40,000 as a member of a special committee and $9,000 in meeting fees paid during 2010; (b) Mr. Meller received an $18,000 annual fee as a member of the board of directors, $60,000 as a member of a special committee and $9,000 in meeting fees. +2 Each outside member of the board of directors is granted, once every five years, the right to purchase 375,000 shares of the company’s common stock with an exercise price equal to the market price on the date of the grant as part of their annual compensation. One-fifth of these options are exercisable on the date of grant, one-fifth become exercisable on the first anniversary of the date of grant, and additional one-fifths become exercisable on the second through fourth anniversary of the date of grant. The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model. +Compensation Committee Interlocks and Insider Participation +No executive officer of the Company served as a member of the Board of any other public company during the year ended December 31, 2011. No member of the Compensation Committee serves as an executive officer of any other public company during the year ended December 31, 2011. No interlocking relationship exists between the members of our Compensation Committee and the Board or compensation committee of any other company. +38 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The following table sets forth certain information regarding the beneficial ownership of our common stock by each person or entity known by us to be the beneficial owner of more than 5% of the outstanding shares of common stock, each of our directors, each of our “named executive officers”, and all of our directors and executive officers as a group as of March 6, 2012. +Name and Address of +Beneficial Owner +Amount and Nature of Beneficial Ownership +Percent of Class +Siebert, Lawrence (1) +3661 Horseblock Road +Medford, NY 11763 +7,203,273 +11.26 +% +Esfandiari, Javan (2) +3661 Horseblock Road +Medford, NY 11763 +1,011,323 +1.58 +% +Larkin, Richard (3) +3661 Horseblock Road +Medford, NY 11763 +565,047 +.89 +% +Ippolito, Tom (4) +3661 Horseblock Road +Medford, NY 11763 +314,000 +.49 +% +Bruce, Richard (5) +3661 Horseblock Road +Medford, NY 11763 +405,575 +.64 +% +Meller, Gary (6) +3661 Horseblock Road +Medford, NY 11763 +738,000 +1.16 +% +Davis, Katherine L. (7) +3661 Horseblock Road +Medford, NY 11763 +388,366 +.61 +% +DeBuono, Barbara (8) +3661 Horseblock Road +Medford, NY 11763 +90,625 +.14 +% +Kissinger, Peter (9) +3661 Horseblock Road +Medford, NY 11763 +90,625 +.14 +% +GROUP (10) +10,806,834 +16.27 +% +Alere, Inc. +51 Sawyer Road, Suite 200 +Waltham, MA 02453 +5,367,840 +8.48 +% +Beneficial ownership is determined in accordance with the Rule 13d-3(a) of the Securities Exchange Act of 1934, as amended, and generally includes voting or investment power with respect to securities. Except as subject to community property laws, where applicable, the person named above has sole voting and investment power with respect to all shares of our common stock shown as beneficially owned by him. +39 +The beneficial ownership percent in the table is calculated with respect to the number of outstanding shares (62,240,483) of the Company's common stock outstanding as of March 6, 2012; and with respect to each stockholder, the denominator is the sum of the number of common shares outstanding and the number, if any, of outstanding options included in that stockholder’s beneficial ownership. Each stockholder's ownership is calculated as the number of shares of common stock owned plus the number of shares of common stock into which any preferred stock, warrants, options or other convertible securities owned by that stockholder can be converted within 60 days. +The term “named executive officer” refers to our principal executive officer, our two most highly compensated executive officers other than the principal executive officer who were serving as executive officers at the end of 2011, and two additional individuals for whom disclosure would have been provided but for the fact that the individuals were not serving as executive officers of the Company at the end of 2011. +(1) +Includes 591,666 shares issuable upon exercise of options exercisable within 60 days. Does not include 133,334 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(2) +Includes 360,000 shares issuable upon exercise of options exercisable within 60 days. Does not include 300,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(3) +Includes 350,000 shares issuable upon exercise of options exercisable within 60 days. Does not include 150,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(4) +Includes 275,000 shares issuable upon exercise of options exercisable within 60 days. Does not include 125,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(5) +Includes 275,000 shares issuable upon exercise of options exercisable within 60 days. Does not include 100,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(6) +Includes 273,000 shares issuable upon exercise of options exercisable within 60 days. Does not include 150,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(7) +Includes 300,650 shares issuable upon exercise of options exercisable within 60 days. Does not include 150,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(8) +Includes 90,625 shares issuable upon exercise of options exercisable within 60 days. Does not include 300,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(9) +Includes 90,625 shares issuable upon exercise of options exercisable within 60 days. Does not include 300,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(10) +Includes footnotes (1)-(9). +Equity Compensation Plan Information +Combined Equity Compensation Plans - Information as of December 31, 2011 +Plan Category +Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights +Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights +Number of Securities Remaining Available for Future Issuance under Equity Compensation Plans (Excluding Securities Reflected in Column (a) +(a) +(b) +(c) +Equity compensation plans approved by security holders 1 +6,127,068 +1 +$ +0.213 +1,313,435 +Equity compensation plans not approved by security holders +- +- +- +Total +6,127,068 +$ +0.213 +1,313,435 +1 The “Number of Securities to be Issued Upon Exercise of Outstanding Warrants and Rights” represents 1,575,500 from the 1999 Stock Option Plan and 4,551,568 under the 2008 Stock Incentive Plan. The 2008 Stock Incentive Plan was increased by 1,000,000 units at the Annual Stockholder meeting hekd September 23, 2011. The “Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans” represents shares issuable under the 2008 Stock Incentive Plan. +40 +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +The executive officers of the Company are as follows: Lawrence A. Siebert, president, chief executive officer and chairman of the board of directors of the Company, Richard J. Larkin, chief financial officer of the Company, and Javan Esfandiari, executive vice president of Research and Development of the Company. +On May 7, 2009, the Compensation Committee of the Company reduced, to $0.13 per share, the exercise price of each outstanding employee option that was issued under the 1999 Equity Incentive Plan (the “1999 Plan”) for which the exercise price was greater than $0.44 per share of the Company’s common stock. There was no other change made to the terms of the stock options other than the reduction in the exercise price. A total of 1,036,750 options were affected. Mr. Siebert, Mr. Esfandiari and Mr. Larkin had options to purchase common stock that were so reduced of 160,000, 497,500 and 137,500, respectively. +In addition, on May 7, 2009 in accordance with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 2,925,000 shares of the Company’s common stock. The exercise price for these options is equal to $0.13 per share. The options become exercisable in thirds on the first, second and third anniversaries of the date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the date of grant. Mr. Siebert, Mr. Esfandiari and Mr. Larkin received options to purchase common stock of 400,000, 300,000 and 275,000, respectively. +In accordance with the terms of the Company’s 2008 Plan, on May 3, 2011, the Company determined to grant on May 9, 2011, to certain employees of the Company options to purchase an aggregate of 500,000 shares of the Company’s common stock. The exercise price for these options was to be equal to the VWAP (Volume Weighted Average Price) market price for the Company’s common stock on May 9, 2011. The options become exercisable evenly on the second and third anniversaries of the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. Mr. Ippolito, Mr. Bruce and Mr. Larkin received options to purchase common stock of 125,000, 100,000 and 150,000, respectively +During the quarter ended December 31, 2008, Alere notified the Company that Alere had entered into a contract with Bio-Rad Laboratories, Inc. (“Bio-Rad”) for royalties on Bio-Rad’s patent for the detection of HIV-2 antibodies. The agreement also provided for Alere to pay past royalties. On June 25, 2009, the Company and Alere entered into a letter agreement whereby certain obligations aggregating approximately $1,010,000 as of December 31, 2008 were agreed to be paid from future revenues. The obligations include the Company’s share under its agreements with Alere for the amount of HIV-2 royalties that Alere paid when Alere entered into an HIV-2 license agreement with Bio-Rad Laboratories, Inc. of approximately $485,000 and royalties owed by Chembio on lateral flow licenses to Alere of approximately $525,000 as of December 31, 2008. Under the agreement Alere will retain an additional 10% of Clearview® HIV 1/2 STAT-PAK® net sales and 5% of Clearview® Complete HIV 1/2 net sales until these obligations are extinguished. As of December 31, 2011 this balance was fully paid. +On February 16, 2012, the Company granted options to purchase the following numbers of shares of the Company’s common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company’s common stock on February 16, 2012, which was $.50 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +20,500 +Javan Esfandiari – Executive Vice President of R&D +63,750 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +24,000 +Richard J. Larkin – Chief Financial Officer +22,375 +Lawrence A. Siebert – Chief Executive Officer +72,500 +Director Independence +Our stock is quoted on the OTCQB, which is the second of the three tiers of the OTC Market Group under the symbol “CEMI.” . As such, we are not currently subject to corporate governance standards of listed companies, which require, among other things, that the majority of the board of directors be independent. +We are not currently subject to corporate governance standards defining the independence of our directors, and we have chosen to define an “independent” director in accordance with the NASDAQ Global Market's requirements for independent directors. Under this definition, we have determined that Gary Meller, Katherine L. Davis, Pete Kissinger and Barbara DeBuono currently qualify as independent directors. We do not list the “independent” definition we use on our internet website . +41 +ITEM 14. +PRINCIPAL ACCOUNTANT FEES AND SERVICES +Audit Fees +For the year ended December 31, 2011, the Company engaged BDO USA, LLP as its independent accounting firm to audit the Company’s annual financial statements and review of financial statements included in the Company’s Forms 10-Q and 10-K for the year ended December 31, 2011, for $110,000 in fees. +Audit-Related Fees +For the year ended December 31, 2011, the Company’s independent accounting firm, BDO USA, LLP, did not provide the Company with any assurance and related services reasonably related to the performance of the audit or review of the Company’s financial statements that are not reported above under “Audit Fees.” +Tax Fees +For the year ended December 31, 2011, the Company’s independent accounting firm, BDO USA, LLP, billed the Company $44,000 for professional services for tax compliance, tax advice and tax planning. +All Other Fees +For the year ended December 31, 2011, the Company’s independent accounting firm, BDO USA, LLP, did not provide the Company with any other matters. +Audit Committee Pre-Approval Policies +The Audit Committee approves in advance all audit and non-audit services performed by the independent accounting firm. There are no other specific policies or procedures relating to the pre-approval of services performed by the independent accounting firm. +42 +ITEM 15. +Number +Description +3.1 +Articles of Incorporation, as amended. (1) +3.2 +Amended and Restated Bylaws. (2) +4.1* +Form of Employee Option Agreement. (3) +4.2 +1999 Equity Incentive Plan. (4) +4.3 +2008 Stock Incentive Plan. (5) +4.4 +Rights Agreement, dated March 8, 2010 (6) +4.5 +Form of Warrant (to be filed by amendment) [to be revised] +10.1* +Employment Agreement dated June 15, 2006 with Lawrence A. Siebert. (7) +10.2* +Employment Agreement dated March 5, 2010 with Javan Esfandiari. (8) +10.3 +HIV Barrel License, Marketing and Distribution Agreement, dated as of September 29, 2006, by and among the Registrant, Alere and StatSure. (9) +10.4 +HIV Cassette License, Marketing and Distribution Agreement, dated as of September 29, 2006, between the Registrant and Alere. (9) +10.5 +Non-Exclusive License, Marketing and Distribution Agreement, dated as of September 29, 2006, between the Registrant and Alere. (9) +10.6 +Joint HIV Barrel Product Commercialization Agreement, dated as of September 29, 2006, between the Registrant and StatSure. (9) +10.7 +Secured Term Note, dated as of June 14, 2010, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (10) +10.8 +Secured Revolving Demand Note, dated as of June 14, 2010, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (10) +10.9 +Loan and Security Agreement, dated as of June 14, 2010, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (10) +10.10 +Revolving Term Note, dated as of July 22, 2011, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (11) +10.11 +Loan and Security Agreement, dated as of July 22, 2011, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (11) +14.1 +Ethics Policy (12) +21 +List of Subsidiaries +23.1 +Consent of BDO USA, LLP, Independent Registered Public Accountants. +23.2 +Consent of ParenteBeard LLC, Independent Registered Public Accountants. +31.1 +Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2 +Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 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.DEF +XBRL Taxonomy Definition Linkbase Document +101.LAB +XBRL Taxonomy Label Linkbase Document +101.PRE +XBRL Taxonomy Presentation Linkbase Document +1 +Incorporated by reference to the Registrant’s annual report on Form 10-KSB filed with the Commission on March 31, 2005 . +2 +Incorporated by reference to the Registrant’s registration statement on Form SB-2 (File No. 333-85787) filed with the Commission on August 23, 1999 and the Registrant's Forms 8-K filed on May 14, 2004, December 20, 2007 and April 18, 2008. +3 +Incorporated by reference to the Registrant’s annual report on Form 10-KSB filed with the Commission on March 12, 2008. +4 +Incorporated by reference to the Registrant’s definitive proxy statement on Schedule 14A filed with the Commission on May 11, 2005. +5 +Incorporated by reference to the Registrant’s definitive proxy statement on Schedule 14A filed with the Commission on April 14, 2008. +6 +Incorporated by reference to the Registrant’s registration statement on Form 8-A filed with the Commission on March 11, 2010. +7 +Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the Commission on June 21, 2006. +8 +Incorporated by reference to the Registrant’s registration statement on Form S-1/A filed with the Commission on March 11, 2010. +9 +Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the Commission on October 5, 2006. +10 +Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on July 29, 2010. +11 +Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on November 3, 2011. +12 +Incorporated by reference to the Registrant’s annual report on Form 10-KSB filed with the Commission on March 30, 2006. +(*) +An asterisk (*) beside an exhibit number indicates the exhibit contains a management contract, compensatory plan or arrangement which is required to be identified in this registration statement. +43 +SIGNATURES +In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +CHEMBIO DIAGNOSTICS, INC. +Date: March 8, 2012 By /s/ Lawrence A. Siebert +Lawrence A. Siebert +President, Chief Executive Officer and +Chairman of the Board +In accordance with the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signatures +Title +Date +/s/ Lawrence A. Siebert +Lawrence A. Siebert +Chief Executive Officer, President and Chairman Of The Board (Principal Executive Officer) +March 8, 2012 +/s/ Richard J. Larkin +Richard J. Larkin +Chief Financial Officer (Principal Financial & Accounting Officer) +March 8, 2012 +/s/ Gary Meller +Dr. Gary Meller +Director +March 8, 2012 +/s/ Katherine L. Davis +Katherine L. Davis +Director +March 8, 2012 +/s/ Pete Kissinger +Pete Kissinger +Director +March 8, 2012 +/s/ Barbara DeBuono +Barbara DeBuono +Director +March 8, 2012 +44 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +Index to Consolidated Financial Statements +—INDEX— +Page(s) +Report of Independent Registered Public Accounting Firms +F-1, F-2 +Consolidated Financial Statements: +Balance Sheets +December 31, 2011 and 2010 +F-3 +Statements of Operations +Years ended December 31, 2011 and 2010 +F-4 +Statements of Changes in Stockholders’ Equity +Years ended December 31, 2011 and 2010 +F-5 +Statements of Cash Flows +Years ended December 31, 2011 and 2010 +F-6 +Notes to Consolidated Financial Statements +F-7 - F-20 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To The Board of Directors and Stockholders of +Chembio Diagnostics, Inc. and Subsidiary +Medford, New York +We have audited the accompanying consolidated balance sheet of Chembio Diagnostics, Inc. and Subsidiary (the “Company”) as of December 31, 2011 and the related consolidated statements of operations, stockholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Chembio Diagnostics, Inc. and Subsidiary as of December 31, 2011, and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. +BDO USA, LLP +/s/ BDO USA, LLP +Melville, New York +March 8, 2012 +F-1 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To The Board of Directors and Stockholders of +Chembio Diagnostics, Inc. and Subsidiary +Medford, New York +We have audited the accompanying consolidated balance sheet of Chembio Diagnostics, Inc. and Subsidiary (the “Company”) as of December 31, 2010 and the related consolidated statements of operations, stockholders' equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Chembio Diagnostics, Inc. and Subsidiary as of December 31, 2010, and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. +PARENTEBEARD LLC +/s/ PARENTEBEARD LLC +New York, New York +March 8, 2012 +F-2 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED BALANCE SHEETS +AS OF +- ASSETS - +December 31, 2011 +December 31, 2010 +CURRENT ASSETS: +Cash and cash equivalents +$ +3,010,954 +$ +2,136,351 +Accounts receivable, net of allowance for doubtful accounts of $30,000 and $35,000 for 2011 and 2010, respectively +2,998,449 +3,946,398 +Inventories +2,300,286 +1,349,161 +Prepaid expenses and other current assets +681,893 +204,824 +TOTAL CURRENT ASSETS +8,991,582 +7,636,734 +FIXED ASSETS , net of accumulated depreciation +1,062,276 +813,214 +OTHER ASSETS: +Deferred tax asset, net of valuation allowance +4,749,622 +- +License agreements, net of current portion +500,000 +600,000 +Deposits on manufacturing equipment +139,790 +- +Deposits and other assets +42,474 +36,226 +TOTAL ASSETS +$ +15,485,744 +$ +9,086,174 +- LIABILITIES AND STOCKHOLDERS’ EQUITY - +CURRENT LIABILITIES: +Accounts payable and accrued liabilities +$ +2,789,500 +$ +2,055,943 +Current portion of loans payable +53,550 +55,817 +Deferred revenue +- +65,000 +License fee payable +- +875,000 +Current portion of obligations under capital leases +14,576 +24,697 +TOTAL CURRENT LIABILITIES +2,857,626 +3,076,457 +OTHER LIABILITIES: +Loans payable - net of current portion +133,484 +186,197 +Obligations under capital leases - net of current portion +- +14,576 +TOTAL LIABILITIES +2,991,110 +3,277,230 +COMMITMENTS AND CONTINGENCIES +STOCKHOLDERS’ EQUITY: +Preferred stock – 10,000,000 shares authorized, none outstanding +- +- +Common stock - $.01 par value; 100,000,000 shares authorized, 63,368,096 and 62,238,983 shares issued and outstanding for 2011 and 2010, respectively +633,681 +622,390 +Additional paid-in capital +40,124,225 +39,658,617 +Accumulated deficit +(28,263,272 +) +(34,472,063 +) +TOTAL STOCKHOLDERS’ EQUITY +12,494,634 +5,808,944 +TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY +$ +15,485,744 +$ +9,086,174 +See accompanying notes to consolidated financial statements +F-3 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF INCOME +FOR THE YEARS ENDED +December 31, 2011 +December 31, 2010 +REVENUES: +Net product sales +$ +17,422,311 +$ +13,516,359 +License and royalty revenue +140,322 +432,238 +R&D, milestone and grant revenue +1,825,403 +2,756,106 +TOTAL REVENUES +19,388,036 +16,704,703 +Cost of product sales +9,997,733 +8,604,004 +GROSS MARGIN +9,390,303 +8,100,699 +OPERATING EXPENSES: +Research and development expenses +4,878,119 +2,586,308 +Selling, general and administrative expenses +3,424,297 +2,940,721 +8,302,416 +5,527,029 +INCOME FROM OPERATIONS +1,087,887 +2,573,670 +OTHER INCOME (EXPENSES): +Other expense +- +(3,923 +) +Interest income +6,298 +4,147 +Interest expense +(18,623 +) +(14,727 +) +(12,325 +) +(14,503 +) +INCOME BEFORE INCOME TAXES +1,075,562 +2,559,167 +Income tax (benefit) provision +(5,133,229 +) +45,823 +NET INCOME +$ +6,208,791 +$ +2,513,344 +Basic net income per share +$ +0.10 +$ +0.04 +Diluted net income per share +$ +0.09 +$ +0.04 +Weighted average number of shares outstanding, basic +62,998,402 +62,102,861 +Weighted average number of shares outstanding, diluted +68,450,220 +70,920,915 +See accompanying notes to consolidated financial statements +F-4 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010 +Common Stock +Additional Paid in Capital +Accumulated Deficit +Total +Shares +Amount +Amount +Amount +Amount +Balance at December 31, 2009 +61,979,901 +$ +619,799 +$ +39,453,522 +$ +(36,985,407 +) +$ +3,087,914 +Warrants and options: +Excercised +259,082 +2,591 +35,020 +- +37,611 +Stock option compensation +- +- +170,075 +- +170,075 +Net income +- +- +- +2,513,344 +2,513,344 +Balance at December 31, 2010 +62,238,983 +$ +622,390 +$ +39,658,617 +$ +(34,472,063 +) +$ +5,808,944 +Warrants and options: +Excercised +1,129,113 +11,291 +276,261 +- +287,552 +Stock option compensation +- +- +189,347 +- +189,347 +Net income +- +- +- +6,208,791 +6,208,791 +Balance at December 31, 2011 +63,368,096 +$ +633,681 +$ +40,124,225 +$ +(28,263,272 +) +$ +12,494,634 +See accompanying notes to consolidated financial statements +F-5 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF CASH FLOWS +FOR THE YEARS ENDED +December 31, 2011 +December 31, 2010 +INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS: +CASH FLOWS FROM OPERATING ACTIVITIES: +Cash received from customers and grants +$ +20,335,985 +$ +14,534,632 +Cash paid to suppliers and employees +(18,055,252 +) +(13,507,202 +) +Interest received +6,298 +4,147 +Interest paid +(18,623 +) +(14,727 +) +Net cash provided by operating activities +2,268,408 +1,016,850 +CASH FLOWS FROM INVESTING ACTIVITIES: +Acquisition of and deposits on fixed assets +(726,680 +) +(182,292 +) +Net cash used in investing activities +(726,680 +) +(182,292 +) +CASH FLOWS FROM FINANCING ACTIVITIES: +Proceeds from option and warrant exercises +287,552 +37,611 +Proceeds from loan +- +250,000 +Payment of license obligation +(875,000 +) +- +Payment of loan obligation +(54,980 +) +(32,517 +) +Payment of capital lease obligation +(24,697 +) +(21,536 +) +Net cash (used in) provided by financing activities +(667,125 +) +233,558 +INCREASE IN CASH AND CASH EQUIVALENTS +874,603 +1,068,116 +Cash and cash equivalents - beginning of the period +2,136,351 +1,068,235 +Cash and cash equivalents - end of the period +$ +3,010,954 +$ +2,136,351 +RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: +Net Income +$ +6,208,791 +$ +2,513,344 +Adjustments: +Depreciation and amortization +437,828 +283,743 +Provision for deferred taxes +(5,155,713 +) +- +Provision for doubtful accounts +(5,000 +) +15,000 +Loss on retirement/sale of fixed asset +- +3,923 +Share based compensation +189,347 +170,075 +Changes in assets and liabilities : +Accounts receivable +952,949 +(2,185,071 +) +Inventories +(951,125 +) +206,742 +Prepaid expenses and other current assets +(70,978 +) +61,813 +Deposits and other assets +(6,248 +) +93,334 +Accounts payable and accrued liabilities +733,557 +149,780 +Deferred research and development revenue +(65,000 +) +(295,833 +) +Net cash provided by operating activities +$ +2,268,408 +$ +1,016,850 +Supplemental disclosures for non-cash investing and financing activities: +Deposits on manufacturing equipment transferred to fixed assets +$ +- +$ +338,375 +See accompanying notes to consolidated financial statements +F-6 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +NOTE 1 — DESCRIPTION OF BUSINESS: +Chembio Diagnostics, Inc. (the “Company” or “Chembio”) and its subsidiary, Chembio Diagnostic Systems, Inc., develop, manufacture, and market rapid diagnostic tests that detect infectious diseases. The Company’s main products are three rapid tests for the detection of HIV antibodies in whole blood, serum and plasma samples, two of which were approved by the FDA in 2006; the third is sold for export only. Lateral Flow Rapid HIV tests represented nearly 74% of the Company’s product revenues in 2011. The Company’s products based on its patented DPP® platform represented approximately 24% of the Company’s product revenues in 2011. The Company also has other rapid tests that together represented approximately 2% of sales in 2011. The Company’s products are sold to medical laboratories and hospitals, governmental and public health entities, non-governmental organizations, medical professionals and retail establishments both domestically and internationally. Chembio’s products are sold under the Company’s STAT PAK®, SURE CHECK® or DPP® registered trademarks, or under the private labels of its marketing partners, for example the Clearview® label owned by Alere, Inc. (“Alere”), which is the Company’s exclusive marketing partner for its rapid HIV lateral flow test products in the United States. These products employ lateral flow technologies that are proprietary and/or licensed to the Company. All of the Company’s products that are currently being developed are based on its patented Dual Path Platform (DPP®), which is a unique diagnostic point-of-care platform that has certain advantages over lateral flow technology. +NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES: +(a) +Principles of Consolidation: +The consolidated financial statements include the accounts of the Company, and its wholly owned subsidiary. All intercompany transactions and balances have been eliminated in consolidation. +(b) +Use of Estimates: +The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make assumptions and estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods covered thereby. Actual results could differ from these estimates. Judgments and estimates of uncertainties are required in applying the Company’s accounting policies in certain areas. The following are some of the areas requiring significant judgments and estimates: determinations of the useful lives of assets, estimates of allowances for doubtful accounts, inventory reserves and deferred tax assets. +(c) +Fair Value of Financial Instruments: +The carrying value for cash and cash equivalents, accounts receivable and accounts payable, approximate fair value because of the immediate or short-term maturity of these financial instruments. The Company’s debt relates to borrowings under its credit facilities and term loan (see Note 7), which approximates fair value due to market interest rates. +(d) +Statements of Cash Flows: +For purposes of the statements of cash flows the Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. +(e) +Concentrations of Credit Risk: +Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade receivables. The Company places its temporary cash instruments with well-known financial institutions and, at times, may maintain balances in excess of the FDIC Insurance limit. The Company monitors the credit ratings of the financial institutions to mitigate this risk. Concentration of credit risk with respect to trade receivables is principally mitigated by the Company’s ability to obtain letters of credit from certain foreign customers, and its diverse customer base both in number of customers and geographic locations. We currently do not require collateral for accounts receivable. +F-7 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2011 AND 2010 +(f) +Inventories: +Inventories, consisting of material, labor and manufacturing overhead, are stated at the lower of cost or market. Cost is determined on the first-in, first-out method. +(g) +Fixed Assets: +Fixed assets are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets, which range from three to seven years. Leasehold improvements are amortized over the useful life of the asset or the lease term, whichever is shorter. +(h) +License Agreement: +In February 2008, the Company entered into a sublicense agreement (see Note 6) for which it had initially recorded an asset of $1,000,000. This asset is being expensed over an estimated economic life of ten years, based on the expected lifespan of our then current HIV products. The current portion of this asset is $100,000 as of December 31, 2011 and 2010 and is reported in prepaid expenses and other current assets. The long-term portion as of December 31, 2011 and 2010 is $500,000 and $600,000, respectively and is reflected in other assets on the consolidated balance sheet. +(i) +Impairment of Long-Lived Assets and Intangible Assets +Long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment. If there are indications of impairment, the Company uses future undiscounted cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. In the event such cash flows are not expected to be sufficient to recover the recorded asset values, the assets are written down to their estimated fair value. We believe that the carrying values of our long-lived tangible and intangible assets were realizable at December 31, 2011 and 2010, respectively. +(j) +Revenue Recognition: +The Company recognizes revenue for product sales in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). Under SAB 104, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is determinable, and collectability is reasonably assured. Revenue typically is recognized at time of shipment. Sales are recorded net of discounts, rebates and returns. +For certain contracts, the Company recognizes revenue from non-milestone contracts and grant revenues when earned. Grants are invoiced after expenses are incurred. Revenues from projects or grants funded in advance are deferred until earned. As of December 31, 2011 and 2010, an aggregate of none and $65,000, respectively of advanced revenues was unearned. +On June 15, 2010, the Company adopted Financial Accounting Standards Board (“FASB”) issued authoritative guidance (“guidance”) prospectively for the recognition of revenue under the milestone method. The Company applies the milestone method of revenue recognition for certain collaborative research projects defining milestones at the inception of the agreement. +(k) +Research and Development: +Research and development (R&D) costs are expensed as incurred. During the fourth quarter of 2010 the Company was awarded $1,466,875 in Qualified Therapeutic Discovery Project grants (“QTDP”) for the years 2010 and 2009 under Section 48D of the Internal Revenue Code, as enacted under the Patient Protection and Affordable Care Act of 2010. This was reflected as a reduction of R&D costs for the year ended December 31, 2010. +F-8 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2011 AND 2010 +(l) +Stock-Based Compensation: +Stock-based compensation expense is calculated using the Black-Sholes valuation model based on awards ultimately expected to vest, reduced for forfeitures, and expensed on a straight-line basis over the requisite service period of the grant. +(m) +Income Taxes: +The Company accounts for income taxes under the provisions of FASB Guidance. The deferred tax assets and liabilities are determined based on the difference between the financial statement carrying amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. +The Guidance also prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. The Guidance also provides guidance related to, among other things, classification, accounting for interest and penalties associated with tax positions, and disclosure requirements. Any interest and penalties accrued related to uncertain tax positions will be recorded in tax expense. +(n) +Earnings Per Share +The following weighted average shares were used for the computation of basic and diluted earnings per share: +For the years ended +December 31, 2011 +December 31, 2010 +Basic +62,998,402 +62,102,861 +Diluted +68,450,220 +70,920,915 +Basic earnings per share is computed by dividing net earnings attributable to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share for the year ended December 31, 2011 and 2010 reflects the potential dilution from the exercise or conversion of other securities into common stock. +The following securities, presented on a common share equivalent basis, have been used in the diluted per share computations: +For the years ended +December 31, 2011 +December 31, 2010 +1999 and 2008 Plan Stock Options +5,451,818 +5,638,310 +Other Stock Options +- +124,625 +Warrants +- +3,055,119 +5,451,818 +8,818,054 +There were 708,631 and none options and warrants outstanding as of December 31, 2011 and 2010, respectively, which were not included in the calculation of diluted income per share for the years ended because their effect would have been anti-dilutive. +(o) +Recent Accounting Pronouncements Affecting the Company: +Revenue Arrangements with Multiple Deliverables +In October 2009, the FASB issued authoritative guidance that amends existing guidance for identifying separate deliverables in a revenue-generating transaction where multiple deliverables exist, and provides guidance for allocating and recognizing revenue based on those separate deliverables. The guidance is expected to result in more multiple-deliverable arrangements being separable than under current guidance. This guidance became effective for the Company on January 1, 2011. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements. +F-9 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2011 AND 2010 +NOTE 3 — INVENTORIES: +Inventories consist of the following at: +December 31, 2011 +December 31, 2010 +Raw materials +$ +1,340,177 +$ +785,693 +Work in process +390,162 +235,548 +Finished goods +569,947 +327,920 +$ +2,300,286 +$ +1,349,161 +NOTE 4 — FIXED ASSETS: +Fixed assets consist of the following at December 31: +December 31, 2011 +December 31, 2010 +Machinery and equipment +$ +1,982,926 +$ +1,635,466 +Furniture and fixtures +221,299 +207,485 +Computer and telephone equipment +460,842 +348,503 +Leasehold improvements +595,492 +482,215 +Automobiles +29,228 +29,228 +3,289,787 +2,702,897 +Less accumulated depreciation and amortization +(2,227,511 +) +(1,889,683 +) +$ +1,062,276 +$ +813,214 +Included in fixed assets is $8,000 and $24,000, net of accumulated depreciation of $103,000 and $87,000 of assets held under capital leases as of December 31, 2011 and 2010, respectively. Fixed assets also include $223,000 in equipment, which has been delivered and set-up but is undergoing validation and as such is currently not being depreciated. Depreciation expense for the 2011 and 2010 years aggregated $338,000 and $284,000, respectively. +As of December 31, 2011, the Company had paid deposits on various pieces of equipment aggregating $139,790 and is reflected in Other Assets on the balance sheet. The Company is further committed to an additional obligation of $151,910 as various milestones are achieved by the various vendors. +NOTE 5 — ACCOUNTS PAYABLE AND ACCRUED LIABILITIES: +Accounts payable and accrued liabilities consist of the following at December 31,: +December 31, 2011 +December 31, 2010 +Accounts payable – suppliers +$ +1,258,465 +$ +883,719 +Accrued commissions +205,588 +114,451 +Accrued royalties / license fees +480,297 +352,285 +Accrued payroll +174,398 +162,740 +Accrued vacation +156,884 +129,732 +Accrued bonuses +284,375 +140,325 +Accrued income taxes +11,523 +- +Accrued expenses – other +217,970 +272,691 +TOTAL +$ +2,789,500 +$ +2,055,943 +F-10 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2011 AND 2010 +NOTE 6 — DEFERRED RESEARCH AND DEVELOPMENT REVENUE: +In January 2009, the Company received a refundable license fee of $340,000 from Bio-Rad Laboratories, Inc., pursuant to an exclusive license of our DPP® technology for a specific field of use. The license fee become fully earned and non-refundable based upon certain conditions being met in June of 2010. In addition, the Company recognizes income from R&D milestones when those milestones are reached and non-milestone contracts and grants when earned. Grants are invoiced after expenses are incurred. Any projects or grants funded in advance are deferred until earned. As of December 31, 2011 and 2010, an aggregate of none and $65,000 of advanced revenues was unearned. +NOTE 7 — TERM NOTE, REVOLVING DEMAND NOTE, VEHICLE FINANCING AND LICENSE FEE PAYABLE: +In June 2010, the Company entered into three agreements with HSBC Bank, NA (“HSBC”). The three agreements were: 1) a secured term note (“Term Note”) of $250,000 to be repaid over sixty months; 2) a secured revolving demand note (“Demand Note”) up to $250,000; and 3) a loan and security agreement (“Security Agreement”). +The Term Note is payable at $4,775 per month in arrears. The payment was calculated by amortizing the $250,000 note over 60 months at an interest rate of 5.5% per annum. The Term Note matures June, 2015 and is secured under the terms of the Security Agreement. +The Demand Note allows the Company to draw on the line from time to time an amount up to an aggregate of $250,000 outstanding at any one time. The accrued interest on the Demand Note is payable monthly at an interest rate equal to one-quarter percent above prime per annum. The Company can repay any or all of the principal balance outstanding at any time. This is a demand note and is subject to annual reviews, as well as a 30-day clean-up, during which there can be no amounts outstanding. +The Security Agreement contains covenants that place restrictions on the Company’s operations, including covenants relating to mergers, debt restrictions, capital expenditures, tangible net worth, net profit, leverage, fixed charge coverage, employee loan restrictions, distribution restrictions (common stock and preferred stock), dividend restrictions, restrictions on lease payments to affiliates, restrictions on changes in business, asset sale restrictions, restrictions on acquisitions and intercompany transactions, restrictions on fundamental changes. The Security Agreement also requires that the Company maintain a minimum tangible net worth at all times of greater than $3,000,000 and EBITDA to CMLTD plus interest cannot be less than 1.25 to 1.00 for any fiscal year. (EBITDA is earnings before interest, taxes, depreciation and amortization; CMLTD is defined as, for any one-year period, the current scheduled principal payments required to be paid for the applicable period.). The Company was in compliance with all required financial covenants at December 31, 2011. +In July 2011, the Company entered into additional agreements with HSBC Bank, NA (“HSBC”). The agreements were: 1) a secured revolving demand note for equipment (“Equipment Note”) up to $500,000, convertible to a term note after one year; and 2) a loan and security agreement (“Security Agreement”). +The Equipment Note allows the Company to draw on the line from time to time an amount up to an aggregate of $500,000 outstanding at any one time. The accrued interest on the Equipment Note is payable monthly at an interest rate equal to one-quarter percent above prime per annum. The Company can repay any or all of the principal balance outstanding at any time. The Equipment Note will be converted into a 60-month term note at the end of one year. +The Security Agreement contains covenants that place restrictions on the Company’s operations, including covenants relating to mergers, debt restrictions, capital expenditures, tangible net worth, net profit, leverage, fixed charge coverage, employee loan restrictions, distribution restrictions (common stock and preferred stock), dividend restrictions, restrictions on lease payments to affiliates, restrictions on changes in business, asset sale restrictions, restrictions on acquisitions and intercompany transactions, restrictions on fundamental changes. The Company was in compliance with all required financial covenants at December 31, 2011. +F-11 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2011 AND 2010 +The Company currently maintains its operating, payroll, and primary cash accounts at HSBC. The balance due on the Term Note as of December 31, 2011 was $182,000 and nothing was drawn down on the Demand or equipment Note as of December 31, 2011. +Future minimum payments under the Term Note, excluding interest, as of December 31, 2011 were as follows: +Periods ending December 31, +2012 +$ +48,501 +2013 +51,236 +2014 +54,126 +2015 +28,122 +181,985 +Less: current maturities +(48,501 +) +$ +133,484 +In June 2009, the Company purchased a vehicle for use by the CEO and obtained financing in the amount of $29,000. The financing is for a period of 3 years, is secured by the vehicle and is guaranteed by the CEO. The financing agreement provides for monthly principal and interest payments of $849 and carries an interest rate of 2.9% per annum. The balance due on this loan as of December 31, 2011 was $5,000. +Future minimum payments under this obligation, excluding interest as of December 31, 2011 were as follows: +Year ending December 31, +2012 +$ +5,049 +5,049 +Less: current maturities +(5,049 +) +$ +- +In February 2008, the Company entered into a sublicense agreement (the “Agreement”), with Bio-Rad Laboratories, Inc. and Bio-Rad Pasteur (collectively, “Bio-Rad”). Bio-Rad is the exclusive licensee of the HIV-2 patent portfolio held by Institute Pasteur of Paris, France. On January 29, 2009, the Company and Bio-Rad agreed to amend the Agreement so as to defer the remaining $875,000 of payments due under the Agreement to one payment due in December 2010 which was paid on January 3, 2011. The Company will also pay Bio-Rad a royalty on net sales in the United States and Canada, if any, of rapid test immunoassay tests sold under the Company’s brands of Licensed Products as defined in the Agreement. The Agreement will continue until the expiration of the last-to-expire of the sublicensed patents, unless otherwise terminated at an earlier date by the Company or Bio-Rad. +NOTE 8 — OBLIGATIONS UNDER CAPITAL LEASES: +The Company is obligated under capitalized leases for certain manufacturing and computer equipment. +Future minimum lease payments under these capitalized lease obligations, including interest as of December 31, 2011 were as follows: +Year ending December 31, +2012 +$ +15,203 +15,203 +Less imputed interest +(627 +) +Present value of future minimum lease payments +14,576 +Less current maturities +(14,576 +) +$ +- +These leases have annual interest rates ranging from 13% - 15%. +F-12 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2011 AND 2010 +NOTE 9 — RELATED PARTIES: +In September 2006, the Company entered into distribution and licensing agreements with Alere, Inc. (“Alere”). As of December 31, 2011, Alere owns 8.48% of the Company. See Note 15 where Alere is listed as customer 1. +During the quarter ended December 31, 2008, Alere notified the Company that they had entered into a contract with Bio-Rad Laboratories, Inc. (“Bio-Rad”) for royalties on Bio-Rad’s patent for the detection of HIV-2 antibodies. The agreement also provided for Alere to pay past royalties. On June 25, 2009, the Company and Alere entered into a letter agreement whereby certain obligations were agreed to be paid from future revenues. The obligations included the Company’s royalties owed under its agreements with Alere on lateral flow licenses. All such royalty obligations were fully paid in 2010. +NOTE 10 — INCOME TAXES: +The provision (benefit) for income taxes for the years ended December 31, 2011 and 2010, is comprised of the following: +2011 +2010 +Current +Federal +$ +22,082 +$ +45,122 +State +402 +701 +Total current provision +22,484 +45,823 +Deferred +Federal +(5,155,713 +) +- +State +- +- +Total deferred provision +(5,155,713 +) +- +Total provision +$ +(5,133,229 +) +$ +45,823 +The Company had an ownership change as described in Internal Revenue Code Sec. 382 during 2004 (“2004 change”). As a result, the Company’s net operating losses prior to the 2004 change of $5,832,516 are subject to an annual limitation of $150,608 and for the first five (5) years are entitled to a BIG (Built-In-Gains) of $488,207 per year. These net operating losses expire in 2018 through 2024. +The Company had a second ownership change during 2006 (“2006 change”). The net operating losses incurred between the 2004 change and the 2006 change of $8,586,861 are subject to an annual limitation of $1,111,831 and for the first five (5) years are entitled to a BIG of $1,756,842 per year. These net operating losses expire in 2018 through 2028. +After applying the above limitations, at December 31, 2011, the Company has post-change net operating loss carry-forwards of approximately $14,225,901 which expire between 2020 and 2028. In addition the Company has research and development tax credit carryforwards of approximately $582,000 for the year ended December 31, 2011, which expire between 2025 and 2031. +F-13 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2011 AND 2010 +Prior to 2011 and through September 30, 2011, the Company had a full valuation allowance recorded against deferred tax assets. In the fourth quarter of 2011, based on our sustained profitable operating performance over the past three years and our positive outlook for taxable income in the future, the Company reevaluated its deferred tax asset. Based upon the guidance under ASC 740 that it was more likely than not that the Company would realize the benefit of such deferred tax assets, the Company reversed $5,156,000 of the valuation allowance previously recorded against its deferred tax assets. The Company still maintains a full valuation allowance on research and development tax credits. +Deferred tax assets consist of at December 31, +2011 +2010 +Current assets +Inventory reserves +$ +260,665 +$ +198,000 +Accrued expenses +145,426 +- +Less valuation allowance +- +(198,000 +) +Net current deferred asset +$ +406,091 +$ +- +Noncurrent assets +Net operating loss carry-forwards +$ +4,837,466 +$ +6,618,000 +Research and development credit +581,576 +594,000 +Other +132,734 +34,000 +Gross noncurrent deferred tax assets +5,551,776 +7,246,000 +Depreciation +(220,578 +) +- +Noncurrent deferred tax assets +5,331,198 +7,246,000 +Less valuation allowances +(581,576 +) +(7,246,000 +) +Net noncurrent deferred tax assets +$ +4,749,622 +$ +- +A reconciliation of the Federal statutory rate to the effective rate applicable to income (loss) before income taxes is as follows: +Year Ending December 31, +2011 +2010 +Federal income tax (benefit) at statutory rates +34 +% +34 +% +State income taxes, net of federal benefit +0 +% +0 +% +Nondeductible expenses +6.4 +% +2 +% +Change in valuation allowance +-514.3 +% +-34.4 +% +Other +-0.7 +% +0.2 +% +Income tax (benefit) +-474.6 +% +1.8 +% +Interest and penalties, if any, related to income tax liabilities are included in income tax expense. As of December 31, 2011, the Company does not have a liability for uncertain tax positions. +The Company files Federal and New York state income tax returns. Tax years for fiscal 2008 through 2010 are open and potentially subject to examination by the federal and New York state taxing authorities. +F-14 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2011 AND 2010 +NOTE 11 — STOCKHOLDERS’ EQUITY: +(a) Common Stock +During 2011, options to purchase 615,415 shares of the Company’s common stock were exercised at exercise prices ranging from of $.13 to $.22. +During 2010, options to purchase 259,082 shares of the Company’s common stock were exercised at exercise prices ranging from of $.13 to $.22. +(b) P referred Stock +The Company has 10,000,000 shares of preferred stock authorized and none outstanding. These shares can become issuable upon an approved resolution by the board of directors and the filing of a Certificate of Designation with the state of Nevada. +(c) Warrants +On April 26, 2011, warrants to purchase 513,698 shares of common stock were exercised at $.40 per share. The Company received $205,479 for this exercise. +As of December 31, 2011, the Company had warrants outstanding to purchase 33,381 shares of common stock at a price of $.81. On February 5, 2012 these warrants to purchase shares of common stock expired. +In January 2010, certain warrants to purchase an aggregated 4,960,370 shares of common stock expired, at an average exercise price of $.474. In August 2010, certain warrants to purchase an aggregated 94,650 shares of common stock expired, at an average exercise price of $.687. +NOTE 12 — RIGHTS AGREEMENT: +In March 2010, the Company entered into a Rights Agreement dated March 8, 2010 (the "Rights Agreement") between the Company and Action Stock Transfer Corp., as Rights Agent. Pursuant to the Rights Agreement, the Company declared a dividend distribution of one preferred share purchase right (a "Right") for each outstanding share of Common Stock, $0.01 par value (the "Common Stock"), of the Company. The Board of Directors set the payment date for the distribution of the Rights as March 8, 2010, and the Rights were distributed to the Company’s shareholders of record on that date. The description and terms of the Rights are set forth in the Rights Agreement. +Rights Initially Not Exercisable. The Rights are not exercisable until a Distribution Date. Until a Right is exercised, the holder thereof, as such, will have no rights as a shareholder of the Company, including, without limitation, the right to vote or to receive dividends. +F-15 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2011 AND 2010 +Separation and Distribution of Rights . The Rights will be evidenced by the certificates for shares of Common Stock registered in the names of the holders thereof, and not by separate rights certificates until the earlier to occur of (i) the close of business on the tenth business day following a public announcement that an Acquiring Person (as defined in the Rights Agreement) acquired a Combined Ownership (as defined in the Rights Agreement) of 15% or more of the outstanding shares of the Common Stock (the "Shares Acquisition Date") or (ii) the later of (A) the close of business on the tenth business day (or such later date as may be determined by action of the Board of Directors prior to such time as any person or group of affiliated or associated persons becomes an Acquiring Person) after the date that a tender or exchange offer or intention to commence a tender or exchange offer by any person is first published, announced, sent or given within the meaning of Rule 14d-4(A) under the Securities Exchange Act of 1934, as amended, the consummation of which would result in any person having Combined Ownership of 15% or more of the outstanding shares of the Common Stock, or (B) if such a tender or exchange offer has been published, announced, sent or given before the date of the Rights Agreement, then the close of business on the tenth business day after the date the Rights Agreement was entered into (or such later date as may be determined by action of the Board of Directors prior to such time as any person becomes an Acquiring Person); (the earlier of such dates referred to in (i) and (ii), which date may include any such date that is after the date of the Rights Agreement but prior to the issuance of the Rights, being called the "Distribution Date"). +NOTE 13 — EMPLOYEE STOCK OPTION PLAN: +The Company has a 1999 Stock Option Plan (“SOP”) originally covering 1,500,000 shares of Common Stock. Under the terms of the SOP, the Compensation Committee of the Company’s board is authorized to grant incentive options to key employees and to grant non-qualified options to key employees and key individuals. The options become exercisable at such times and under such conditions as determined by the Compensation Committee. The SOP was amended at the Company’s 2005 stockholders’ meeting. The number of options under the SOP was increased to cover 3,000,000 shares of common stock. It was also amended to allow independent directors to be eligible for grants under the portion of the SOP concerning non-qualified options. As of December 31, 2011, there were 1,575,500 outstanding options under this SOP. No additional options may be issued under the SOP more than 10 years after its adoption +Effective June 3, 2008, the Company’s stockholders voted to approve the 2008 Stock Incentive Plan (“SIP”), with 5,000,000 shares of Common Stock available to be issued. At the Annual Stockholder meeting on September 22, 2011 the Company’s stockholders voted to approve an increase to the shares of Common Stock issuable under the SIP by 1,000,000 to 6,000,000. Under the terms of the SIP, the Compensation Committee of the Company’s Board has the discretion to select the persons to whom awards are to be granted. Awards can be incentive stock options, restricted stock and/or restricted stock units. The awards become vested at such times and under such conditions as determined by the Compensation Committee. As of December 31, 2011, there were 134,997 options exercised, 4,551,568 options outstanding and 1,313,435 options still available to be issued under the SIP. +The Company's results for the years ended December 31, 2011 and 2010 include stock-based compensation expense totaling $189,000 and $170,000, respectively. Such amounts have been included in the Consolidated Statements of Operations within cost of goods sold ($18,000 and $20,000, respectively), research and development ($56,000 and $86,000, respectively) and selling, general and administrative expenses ($115,000 and $64,000, respectively). In accordance with ASC 718 the Company has not recorded a deferred tax asset related to the net operating losses resulting from the exercise of disqualifying stock options in the accompanying financial statements. The cumulative amount of unrecognized tax benefits at December 31, 2011 was immaterial, and if the Company is able to utilize this benefit in the future it would result in a credit to additional paid in capital. +Stock option compensation expense in the years ended December 31, 2011 and 2010 represents the estimated fair value of options outstanding which is being amortized on a straight-line basis over the requisite vesting period of the entire award. +The weighted average estimated fair value of stock options granted in the years ended December 31, 2011 and 2010 was $.29 and $.22 per share, respectively. The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model. The expected volatility is based upon historical volatility of our stock and other contributing factors. The expected term is determined using the simplified method as permitted by SAB 107, as the Company has minimal history of employee exercise of options to date. +F-16 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2011 AND 2010 +The weighted-average assumptions made in calculating the fair values of options are as follows: +For the years ended +December 31, 2011 +December 31, 2010 +Expected term (in years) +3.75 +4 +Expected volatility +111.45% +116.82% +Expected dividend yield +n/a +n/a +Risk-free interest rate +0.78% +1.43% +The Company granted 500,000 and 781,250 new options during the year ended December 31, 2011 to employees and members of the board of directors, respectively at an average exercise price of $.54 and $.35, respectively per share. +On May 3, 2011 and effective May 9, 2011 in accordance with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 500,000 shares of the Company’s common stock exercise price for these options was to be equal to the VWAP (Volume Weighted Average Price) market price for the Company’s common stock on May 9, 2011. The options become exercisable evenly on the second and third anniversaries of the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. +The following table provides stock options activity for the years ended December 31, 2011 and 2010: +Stock Options +Number of Shares +Weighted Average Exercise Price per Share +Weighted Average Remaining Contractual Term +Aggregate Intrinsic Value +Outstanding at January 1, 2010 +5,586,900 +$ +0.15 +3.59 years +$ +756,990 +Granted +300,000 +$ +0.27 +Exercised +(259,082 +) +$ +0.15 +$ +27,900 +Forfeited/expired /cancelled +(97,250 +) +$ +0.26 +Outstanding at December 31, 2010 +5,530,568 +$ +0.16 +2.82 years +$ +1,497,063 +Granted +1,281,250 +$ +0.43 +Exercised +(615,416 +) +$ +0.13 +$ +192,500 +Forfeited/expired/cancelled +(69,334 +) +$ +0.36 +Outstanding at December 31, 2011 +6,127,068 +$ +0.21 +2.61 years +$ +1,339,693 +Exercisable at December 31, 2011 +3,580,394 +$ +0.17 +2.03 years +$ +906,157 +The following table summarizes information about stock options outstanding at December 31, 2011: +Stock Options Outstanding +Stock Options Exercisable +Range of Exercise Prices +Shares +Average Remaining Contract Life (Year) +Weighted Average Exercise Price +Aggregate Intrinsic Value +Shares +Weighted Average Exercise Price +Aggregate Intrinsic Value +$ +0.13 - 0.13 +4,020,318 +2.15 +$ +0.13 +$ +1,165,892 +2,773,644 +$ +0.13 +$ +804,357 +$ +0.14 - 0.22 +381,500 +1.13 +0.22 +76,300 +381,500 +0.22 +76,300 +$ +0.23 - 0.45 +1,081,250 +4.29 +0.33 +96,563 +281,250 +0.33 +24,563 +$ +0.46 - 0.54 +644,000 +3.48 +0.52 +- +144,000 +0.48 +- +Total +6,127,068 +2.61 +$ +0.21 +$ +1,338,755 +3,580,394 +$ +0.17 +$ +905,219 +F-17 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2011 AND 2010 +As of December 31, 2011, there was $287,000 of net unrecognized compensation cost related to stock options that are not vested, which is expected to be recognized over a weighted average period of approximately 1.17 years. The total fair value of shares vested during the years ended December 31, 2011 and 2010, was $149,000 and $124,000, respectively. +NOTE 14 — GEOGRAPHIC INFORMATION: +FASB Guidance establishes standards for the way that business enterprises report information about operating segments in financial statements and requires that those enterprises report selected information. It also establishes standards for related disclosures about product and services, geographic areas, and major customers. +The Company produces only one group of similar products known collectively as “rapid medical tests”. Management believes that it operates in a single business segment. Net sales by geographic area are as follows: +For the years ended +December 31, 2011 +December 31, 2010 +Africa +$ +2,340,635 +$ +6,129,167 +Asia +1,784,817 +255,212 +Europe +57,206 +107,060 +North America +8,522,878 +5,977,108 +South America +4,716,775 +912,812 +$ +17,422,311 +$ +13,516,359 +Sales to Africa decreased in 2011 primarily due to less sales in Ethiopia of approximately $3.08 million and Nigeria of approximately $.64 million. Sales in Asia increased from a new distributer in the Middle East of $1.70 million. Sales in 2011 and 2010 to North America were primarily from sales in the U.S of approximately $7.21 million and $5.28 million, respectively and sales in 2011 and 2010 to South America were primarily from sales in Brazil of approximately $4.66 million and $822,000, respectively. +NOTE 15 — COMMITMENTS AND CONTINGENCIES: +Employment Contracts: +The Company has contracts with two key employees. The contracts call for salaries presently aggregating $510,000 per year. One contract expires in May 2013 and one contract expires in March 2013. The following table is a schedule of future minimum salary commitments: +2012 +$ +545,000 +2013 +172,500 +$ +717,500 +Pension Plan: +The Company has a 401(k) plan established for its employees. Effective January 1, 2011 the Company elected to match 40% of the first 5% (or 2% of salary) that an employee contributes to their 401(k) plan. Expenses related to this matching contribution aggregated $74,464 and none for the years ended December 31, 2011 and 2010, respectively. +Obligations Under Operating Leases: +The Company leases industrial space used for office, R&D and manufacturing facilities, currently with a monthly rent of $18,223. The current lease expires on April 30, 2014. We entered into two additional leases in 2011, one effective November 1, 2011 and the second, signed in December, effective January 1, 2012, the principal terms of these leases are the same as the one entered into in 2009 which was as follows: (a) a lease term ending April 30, 2014; (b) an initial rent of $11,350 per month ; (c) the monthly rent for year two of the lease will increase by the lower of (i) the change in the consumer price index, or (ii) five percent; and (d) the monthly rent for years three through five of the lease will increase each year by the lower of (i) the change in the consumer price index, or (ii) two and one half percent. +F-18 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2011 AND 2010 +The following is a schedule of future minimum rental commitments (assuming no increases): +Years ending December 31, +2012 +$ +217,899 +2013 +217,899 +2014 +70,355 +$ +506,153 +Rent expense was $177,200 and $174,200 for the years ended December 31, 2011 and 2010, respectively. +Economic Dependency: +The following table delineates sales the Company had to customers in excess of 10% of total sales for the periods indicated: +For the years ended +Accounts +Receivable +December 31, 2011 +December 31, 2010 +As of +Sales +% of Sales +Sales +% of Sales +December 31, 2011 +Customer 1 +$ +7,208,712 +41 +$ +5,281,111 +39 +$ +782,300 +Customer 2 +4,662,607 +27 +* +* +685,692 +Customer 3 +1,713,390 +10 +- +- +450,000 +Customer 4 +* +* +3,689,865 +27 +- +In the table above the asterisk (*) indicates that sales to the customer did not exceed 10% for the period indicated. +The Company had no vendor in excess of 10% of total purchases for the period ended December 31, 2011. +The Company currently buys materials which are purchased under intellectual property rights agreements and are important components in its products. Management believes that other suppliers could provide similar materials on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would affect operating results adversely. +NOTE 16 — COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS: +In 2011 and 2010, the Company earned $1.8 million and $2.8 million, respectively from research revenues and milestones. The Company is now involved in additional feasibility and development contracts related to its DPP® technology. The total expended on R&D in 2011 and 2010, not including regulatory and QTDP, was approximately $3.1 million and $2.9 million, respectively. During the fourth quarter of 2010 the Company was awarded $1.47 million from the Qualified Therapeutic Discovery Project grant, which reduced 2010 R&D expenses to $1.4 million. +a. +Oswaldo Cruz Foundation/Fiocruz: +During 2008, the Company signed four Agreements with the Bio-Manguinhos unit of the Oswaldo Cruz Foundation of Brazil (“FIOCRUZ”) for the supply, license and transfer of certain products and related technologies from the Company to FIOCRUZ. The agreements are for the following rapid test products: i) DPP® HIV 1/2 Screen, ii) DPP® HIV 1/2 Confirmatory, iii) DPP® Leptospirosis and iv) DPP® Leishmaniasis. These Agreements provide for a staged technology transfer collaboration pursuant to which FIOCRUZ will ultimately be able to fully manufacture the applicable product for supply in Brazil provided certain minimum purchases of products and related components have occurred. +F-19 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2011 AND 2010 +In 2011, FIOCRUZ informed the Company that ANVISA (the Brazilian regulatory agency) had approved the DPP® Leishmaniasis, Syphilis Screen and Leptospirosis assays for use in Brazil. This approval triggered milestone events of $305,000, $100,000 and $100,000, respectively. In accordance with guidance, management has concluded the FIOCRUZ events recorded in 2011 met the definition of milestone events. The Company earned an aggregate of $505,000 and $625,000 in milestone revenues from FIOCRUZ for the year ended December 31, 2011 and 2010, respectively. +Under these contracts, there are additional royalties and purchase commitments due to the Company over the remaining life of the Agreement. +c. +Infectious Disease Research Institute (IDRI) Agreement : +In April 2009, Chembio entered into a development agreement for up to approximately $400,000 in connection with the development and initial supply of a low-cost, rapid point-of-care ("POC") test for infectious diseases. The agreement contemplated a period of approximately two years in which the development activity is to be completed. +As of December 31, 2011, the Company received an aggregate of $390,000 in research and development payments from this agreement. Future milestone payments of $10,000 are expected over the next year and will be recognized when the milestone is met. +d. +National Institutes of Health (NIH) Grant: +In June 2009, the Company received a $3 million, three-year grant from the United States National Institutes of Health to complete development of a test for Leptospirosis. Grants are invoiced after expenses are incurred. The Company earned, for the years ended December 31, 2011 and 2010, $690,000 and $656,000, respectively from this grant. The Company has earned an aggregate of $2,389,000 from this grant from inception through December 31, 2011, of which $800,000 was paid to sub-contractors. +In March 2011, the Company received a $2.4 million, three-year grant from the United States National Institutes of Health to complete development of a test for Tuberculosis. Grants are invoiced after expenses are incurred. The Company earned, for the year ended December 31, 2011, $350,000, from this grant. The Company has earned $429,000 from this grant from inception through December 31, 2011, of which $79,000 was paid to sub-contractors. +Governmental Regulation: +All of the Company’s existing and proposed diagnostic products are regulated by the United States Food and Drug Administration (FDA), United States Department of Agriculture, certain state and local agencies, and/or comparable regulatory bodies in other countries. Most aspects of development, production, and marketing, including product testing, authorizations to market, labeling, promotion, manufacturing, and record keeping are subject to review. After marketing approval has been granted, Chembio must continue to comply with governmental regulations. Failure to comply with these regulations can result in significant penalties. +F-20 \ No newline at end of file diff --git a/raw/filings/0001092662/2011/0001092662-12-000013/filing_metadata.csv b/raw/filings/0001092662/2011/0001092662-12-000013/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..99c7d3c04d6718c4aacba86f6cae3dd5fc6c71e0 --- /dev/null +++ b/raw/filings/0001092662/2011/0001092662-12-000013/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001092662,CEMI,"CHEMBIO DIAGNOSTICS, INC.",10-K,2012-03-08,2011-12-31,2012-03-08T13:06:52.000Z,0001092662-12-000013,form10_k.htm,FORM 10-K FOR 2011,4059455,1,0,https://www.sec.gov/Archives/edgar/data/1092662/000109266212000013/form10_k.htm,https://www.sec.gov/Archives/edgar/data/1092662/000109266212000013/,2011,2011,1 diff --git a/raw/filings/0001092662/2011/0001092662-12-000013/item1.txt b/raw/filings/0001092662/2011/0001092662-12-000013/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..f7f5f5c16b698d28e0a46ff1e02658574d863c1b --- /dev/null +++ b/raw/filings/0001092662/2011/0001092662-12-000013/item1.txt @@ -0,0 +1,185 @@ +ITEM 1. +BUSINESS +FORWARD-LOOKING STATEMENTS +This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, and Section 27A of the Securities Act of 1933. Any statements contained in this report that are not statements of historical fact may be forward-looking statements. When we use the words “intends,” “estimates,” “predicts,” “potential,” “continues,” “anticipates,” “plans,” “expects,” “believes,” “should,” “could,” “may,” “will” or the negative of these terms or other comparable terminology, we are identifying forward-looking statements. Forward-looking statements involve risks and uncertainties, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by forward-looking statements. These factors include our research and development activities, distributor channels, compliance with regulatory impositions; and our capital needs. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business. +For further information about these and other risks, uncertainties and factors, please review the disclosure included in this report under “Part I, Item 1A, Risk Factors.” +General +The Company (Chembio Diagnostics, Inc. and its wholly-owned subsidiary Chembio Diagnostic Systems, Inc. are collectively referred to herein as the “Company”) develops, manufactures, markets and licenses rapid point-of-care diagnostic tests (POCTs) that detect infectious diseases. The Company’s main products presently commercially available are four rapid tests for the detection of HIV antibodies, two rapid tests for the detection of syphilis, and a rapid test for the detection of canine leishmaniasis. Three of the HIV rapid tests employ in-licensed and proprietary lateral flow technologies (see “Our Rapid Test Technologies”), can be used with all blood matrices as samples, and are manufactured in a standard cassette format, a dipstick format, and a proprietary barrel format. The tests employing the cassette and proprietary barrel formats were approved by the FDA in 2006 and are exclusively distributed by Alere, Inc. (“Alere”) in the United States and by Chembio outside the United States. Our fourth rapid HIV test, as well as our syphilis and canine leishmaniasis tests have been developed on our patented Dual Path Platform (DPP®), does not require in-licensing. The DPP® HIV test, detects antibodies to HIV in oral fluid samples as well as in all blood matrices. We anticipate completing United States FDA regulatory submissions for this product, which we anticipate launching under Chembio’s brand, in 2013. +Our new product pipeline is based on this DPP® technology for which we were issued a United States patent in 2007 and for which additional patent protection has issued or is pending worldwide. With the DPP® proprietary platform, we can participate in the point-of-care market segment of the nearly $40 billion global in-vitro diagnostic market that is estimated to be $6-8 billion with an overall growth rate of 7% per annum. POCTs, by providing prompt and early diagnosis, can reduce patient stays, lower overall costs, improve therapeutic interventions and improve patient outcomes as a result of prompt and early diagnosis. They can also prevent needless hospital admissions, simplify testing procedures, avoid delays from central lab batching, and eliminate the need for return visits. +In the areas of infectious and sexually transmitted diseases (such as HIV and syphilis for example), the utility of a rapid point–of-care test particularly in identifying patients unaware of their disease status has been well established. Large and growing markets have been established for these kinds of tests, initially in high prevalence regions where they are indispensable for large scale prevention and treatment programs. More recently introduced in the United States in 2004, rapid HIV tests now also present a significant segment of the U.S. market for HIV clinical testing, which is still dominated by laboratory tests. We have focused our product development activity within areas, such as these products where the availability of rapid, point-of-care screening, diagnostic, or confirmatory results can improve health outcomes. +3 +PRODUCTS +Lateral Flow Rapid HIV Tests +All three of our lateral flow rapid HIV tests are qualitative “yes/no” tests for the detection of antibodies to HIV 1 & 2 with visually interpreted results (one line “negative”; two lines “positive”) available within approximately 15 minutes. The tests are simple to use, have a shelf life of 24 months, and do not require refrigeration. The tests differ principally only in the method of test procedure, convenience and cost. One of our FDA-approved lateral flow HIV tests incorporates a proprietary plastic “barrel” device that houses the lateral flow strip. This barrel format enables collection of samples directly (for example directly from a finger-stick whole blood sample) into the barrel’s capillary tip. A sealed unitized buffer vial, assembled onto the top of the barrel, is removed and seated into a stand; the seal is then pierced by the barrel’s capillary tip, thereby initiating the upward flow of the resulting sample-buffer solution through a filter, up into the vertical device’s chamber and onto the lateral flow strip. This results in a unique unitized and closed device system that can reduce the chance of exposure to potentially infectious samples. We believe that this format may be an ideal candidate as an over-the-counter HIV test and we are participating in certain studies that should help to better ascertain this. Our other FDA-approved lateral flow HIV test uses a more conventional rectangular plastic cassette format that houses the lateral flow strip. In this case, a sample is transferred by use of a separately provided transfer device (“loop”) into a sample well or port of the cassette that houses the lateral flow strip, which is positioned horizontally or flat. +Both of the above-described products are marketed exclusively in the United States by Alere as Clearview® Complete HIV 1/2 (the barrel format) and Clearview® HIV 1/2 STAT PAK® (the cassette format), and by Chembio in all other markets as Chembio Sure Check® HIV 1/2 and Chembio HIV 1/2 STAT PAK®. Alere has non-exclusive rights to the barrel product outside the United States. +Our third lateral flow HIV test, HIV 1/2 STAT PAK® Dipstick is our most cost competitive and compact format. It does not have any plastic housing so that 30 test strips can be packaged into a small vial that is ideal for transporting into remote settings. The test procedure is similar to the cassette format; an adhesive backing is provided as a more cost-effective and compact “housing” on which to run the test. +Regulatory Status: The FDA approved our Pre-Market Applications (hereinafter “PMA”; see “Governmental Regulations” and Glossary) in April 2006 for our SURE CHECK HIV 1/2 (and also now Alere Clearview® Complete HIV 1/2) and for our HIV 1/2 STAT-PAK (now Alere’ Clearview® HIV 1/2 STAT-PAK in the United States only) products. A Clinical Laboratory Improvement Act (hereinafter “CLIA”; see Governmental Regulations) waiver was granted by the FDA for the two FDA- approved products in 2006 and 2007, respectively. The CLIA waiver is required in order for health care providers to administer these tests in the settings where they are most suited and needed, such as public health testing clinics, hospital emergency rooms and physicians’ offices. Our HIV 1/2 STAT-PAK Dipstick, though not FDA-approved, qualifies under FDA export regulations to sell to customers outside the United States subject to any required approval by the importing country. +All three of our lateral flow HIV tests have qualified for procurement under the President’s Emergency Plan for AIDS Relief (“PEPFAR”). The STAT PAK (both the cassette and dipstick versions) are also qualified by the World Health Organization (WHO) for procurements by the second largest global program, known as the Global Fund, as well as other related programs funded by agencies affiliated with the United Nations, such as UNICEF and UNITAIDS (see Glossary), through qualification with the WHO bulk procurement scheme. +DPP® HIV Test +As in the case of our lateral flow HIV tests, our DPP® HIV test is also a qualitative “yes/no” test for the detection of antibodies to HIV 1 & 2, delivers visual results within approximately 15 minutes, is simple to use, has a shelf life of 24 months, and does not require refrigeration. Additionally this product, which is our first product incorporating our patented DPP® technology, can be used with oral fluid samples, as well as with all blood matrices. This product also incorporates our patent-pending oral fluid collection and storage system that enables samples to be fully extracted in buffer solution before application to the test device, and also enables the extracted sample to be stored and retested or tested for multiple conditions. Clinical and laboratory studies have shown this product to have improved performance compared with all of the current FDA-approved CLIA-waived rapid tests including our own. +Regulatory Status: In 2010 we began a 3,000 patient clinical study with our DPP® HIV test in the United States which is one of the elements required to support a Pre-Marketing Approval (“PMA”) application to the FDA. The trial is 98% complete and we anticipate completing the trial as soon as possible. We have already submitted two of the three modules required for a modular PMA application, and we anticipate submitting the final module containing the clinical and other required information within 30 days of completing the clinical trials. We believe that approval of our PMA application will be within approximately six months after we submit the final module. At that time, we plan to apply for CLIA waiver of this product. +4 +The product is qualified for procurement under the President’s Emergency Plan for AIDS Relief (“PEPFAR”) for use with all sample matrices and we are pursuing WHO qualification in order to enable procurement of this product by the Global Fund and United Nations agencies, including programs underwritten by them. +In June 2010 ANVISA (see Glossary) approved the DPP® HIV test that is being marketed in Brazil through our collaboration with the Oswaldo Cruz Foundation, Brazil’s leading public health institute. Given the oral fluid feature, we believe this product can be marketed as a premium-priced product that will address those market segments in the U.S. and globally that express a preference for a less invasive testing experience. +OTHER DPP® PRODUCTS +Our strategy with respect to our DPP® technology has evolved as the Company has evolved. Initially, following the issuance of our DPP® patent in the United States in 2007, our strategy was necessarily limited to developing third-party-funded OEM research and development contracts and grants. This strategy enabled us to conserve capital resources, while at the same time acquiring know-how and experience with the platform and developing third party references and implicit endorsements of the technology. As our capabilities to develop and manufacture DPP® products expanded, and as our financial position has improved, so have our strategic options expanded and improved. While we will continue to employ the strategy of seeking OEM development and manufacturing agreements as a way to participate in markets that we cannot and/or choose not to serve (e.g., veterinary) , we believe that we can also develop our own branded line of products, and we plan to do this in the public health area. This brand will be launched with our DPP® HIV Screening Assay in the United States market in 2013, to be followed by our Syphilis test and potentially other related products (See RECENT DEVELOPMENTS AND CHEMBIO’S PLAN OF OPERATIONS FOR THE NEXT TWELVE MONTHS). +Following is a discussion of the DPP® products for which we have completed our development activity pursuant to OEM agreements with FIOCRUZ and Bio-Rad Laboratories, Inc. The statuses of products that are still under development are described in Part II Item 7. +PARTNERS INVOLVED IN MARKETING OUR PRODUCTS +On September 29, 2006, we executed marketing and license agreements with Alere. The marketing agreements (one for each of the two FDA-approved products) provide Alere with a 10-year exclusive right (until September 2016) to market our rapid HIV tests in the United States under Alere’s brand. The agreements provide Chembio a non-exclusive license to certain Alere lateral flow patents that may be applicable to our lateral flow products, principally including our lateral flow HIV tests that we have continued to market outside the United States. Simultaneous with the execution of the agreements, we also settled litigation with StatSure Diagnostics, Inc.(SDS) that had been ongoing relating to the proprietary barrel device which is incorporated into one of our two FDA-approved rapid HIV tests (See Lateral Flow HIV Tests above). As a result, it is through the agreements with Alere, that we have been participating in the growth of the rapid HIV test market in the United States. +We have appointed distributors internationally for our lateral flow HIV tests. Our largest markets for our lateral flow HIV rapid tests outside the United States are certain countries in Africa and Asia as well as Mexico. Internationally, most of the demand for our products is based on governmental and non-governmental prevention and treatment efforts. Given this, these programs can and do often result in large orders, but also in periods of relatively lower demand, based on the variations associated with this kind of demand. +Our DPP® HIV test was approved by ANVISA in June 2010. This approval was granted to our Brazilian partner, the Oswaldo Cruz Foundation (“FIOCRUZ”), pursuant to one of five technology transfer, supply and license agreements that we entered into with this public health organization in 2008 and 2010 (See OEM DPP® products). +OEM DPP® Products +Oswaldo Cruz Foundation OEM DPP® Agreements +During 2008-2010 we signed five agreements with the Oswaldo Cruz Foundation (FIOCRUZ) in Brazil relating to products based on our DPP® technology. FIOCRUZ is the leading public health organization in Brazil, and it is affiliated with Brazil’s Ministry of Health which is its principal client. It has extensive research, educational and manufacturing facilities for drugs and vaccines, as well as diagnostic products. +5 +During 2010 and 2011 all of the initial products contemplated under the five agreements were approved for marketing by the applicable regulatory agencies in Brazil. As a result, during 2011, we shipped approximately $4.25 million of products to FIOCRUZ pursuant to the agreements. The agreements between the Company and FIOCRUZ are unique examples of technology transfer collaborations between a private sector rapid test manufacturer and a public health organization. The five products under agreement with FIOCRUZ are for DPP® products for HIV screening, HIV confirmatory, Leishmaniasis, Leptospirosis and Syphilis. All of the agreements with FIOCRUZ contemplate a technology transfer and license to FIOCRUZ for the manufacture of the subject products over stipulated periods of time. These technology transfers, and the provision by Chembio of the information and training that is required for this to occur, are subject to Chembio receiving orders from FIOCRUZ for a minimum amount of products for manufacture by Chembio, which is approximately $23 million. The actual demand for these products may be more or less than this amount. The actual amount will depend on the actual demand for the products by the specific programs for each product funded by the Brazilian Ministry of Health as well as the whether and when FIOCRUZ is able to implement the technology transfer steps including, for example, the readiness of new production facilities currently under construction that are schedule to be completed in mid-2013; thereafter Chembio may receive royalty payments under some of the agreements for a defined period based on product sold by FIOCRUZ to the public health programs in Brazil. +Bio-Rad Laboratories OEM DPP® Agreement - On April 6, 2008, we entered a milestone-based development agreement with Bio-Rad Laboratories N.A., a division of Bio-Rad Laboratories Inc. (NYSE:BIO), a leading in-vitro diagnostic and life science company. The agreement with Bio-Rad was for the development of a six-band multiplex product on our DPP®. Based on achieving the proof of concept for this product during 2008, in January 2009 we entered a limited exclusive license agreement with Bio-Rad related to the field of use for this application, and we continued the development work during all of 2009 and until Bio-Rad confirmed that the product specifications were met in the second quarter of 2010. In June 2010, Bio-Rad exercised its option to have Chembio transfer the manufacturing of this product to Bio-Rad subject to a royalty payment payable to Chembio pursuant to a license agreement with Bio-Rad based on Bio-Rad’s net sales of the licensed product, which process was completed in October 2010. Chembio believes that Bio-Rad is proceeding with the regulatory approvals of this product, with CE Mark likely by the end of 2012, although there can be no assurance of this. We further believe that Bio-Rad has begun discussions with the FDA to discuss this product, its proposed performance claims and the intended clinical protocol to support its regulatory submission. +During 2008 to 2010, Chembio earned approximately $460,000 for product development work rendered to Bio-Rad under this agreement, plus an additional $490,000 in license and other fees related to the manufacturing transfer. +Our Rapid Test Technologies +All of our commercially available current products employ either in-licensed lateral flow technology or our own patented Dual Path Platform (DPP®) technology and are visually read. We can also use hand held and desktop readers with our DPP® products to objectively measure, quantify, record and report DPP® test results. Certain of the products we have and/or are developing incorporate some of these readers, and we are developing other products that may be used with or will require use of a reader. +Both lateral flow technology and DPP® allow the development of accurate, low cost, easy-to-perform, single-use diagnostic tests for rapid, visual detection of specific antigen-antibody complexes on a test strip. These formats provide a test that is simple (requires neither electricity nor expensive equipment for test execution or reading, nor skilled personnel for test interpretation), rapid (turnaround time approximately 15 minutes), safe (minimizes handling of potentially infected specimens), non-invasive (requires 5-20 micro liters of whole blood easily obtained with a finger prick, or alternatively, serum or plasma,), stable (24 months at room temperature storage in the case of our HIV tests), and highly reproducible. +We believe that products developed using DPP® technology can provide superior diagnostic performance as compared with products that use lateral flow technology. The reason for this is that one of the major differences between the two platforms is that in DPP® samples are allowed to incubate with the target analyte in the test zone before introduction of the labeling reagent/conjugate, whereas in lateral flow, samples are combined with the labeling reagent to form a complex before coming in contact with the target analyte. Also, because of the usage in DPP® of a separately connected sample strip, the control and delivery of sample material is substantially improved. This is critical in the development of multiplex tests, as well as tests that involve viscous sample material (such as oral fluid) that can be impeded when forced to combine with labeling reagents before migration on the test strip to the test zone area. +Target Markets +Rapid HIV Tests +A large percentage of individuals that are HIV positive worldwide are unaware of their status. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results if samples have to be sent out to a laboratory which can take at least several days to process. However, the increased availability, greater efficacy and reduced costs for anti-retroviral treatments (ARVs) for HIV has increased the demand for testing, as the stigma associated with the disease is lessened, and the ability to resume normal activities is substantially improved, providing a positive message to those potentially infected. +6 +There are approximately 53,000 new diagnoses of HIV infection in the United States each year, according to the CDC. In time, most of these infections progress to AIDS. The CDC estimates that approximately 1.1 million individuals in the U.S. are living with HIV, with an estimated 250,000 Americans, or more than 2 0 %, unaware that they are infected. It is these 250,000 infected people that are reported to account for 54% of all new infections per year. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results from samples that have to be sent out to a laboratory and that can take at least several days to process. Making more people aware of their HIV status at the point-of-care will reduce the number of HIV transmissions. +Rapid HIV testing in the United States has now developed into an estimated 7 million test market. This is from zero in 2003 when Orasure Technologies, Inc. received the first FDA approval for a rapid HIV test. We believe that the US professional HIV rapid test market (not including the OTC market) has the potential to increase to 15-18 million tests over the next several years, which would represent 40-50% of all HIV tests done today in the United States for clinical purposes. Assuming an average price to the manufacturers of $8.00 per test, a total potential U.S. market of nearly $120-$150 million is implied. +In 2006, the outlook for HIV testing was given a big boost with the release by the CDC of new guidelines for HIV testing. These new CDC recommendations are that an HIV test should be given as a routine test like any other for all patients between 13 and 64 years of age, regardless of risk, with an opt-out screening option and focused testing procedural (pre and post - test counseling) guidelines. Adoption of the 2006 CDC recommendations by a number of states continues to have an increasing impact. +In the international market, PEPFAR, the large United States funded international AIDS relief program focused on fifteen countries, was reauthorized in 2008 for up to $48 billion for FY2009-2012 (up from $15 billion in 2004-2008). PEPFAR and the Global Fund are the largest of the global initiatives that have helped to make prevention, care and life-saving treatments available to those that need them. For example , PEPFAR has the goal that by 2013 three million infected individuals will be provided treatment and 12 million new cases will be averted. To achieve these goals , more and more people are likely to get tested. As more effective treatments become available at lower costs , there is a clearer reason to be tested. +The U.S. and international economics crisis of the last few years has impacted the growth in funding of these large programs, though private donations have supplemented the governmental and non-governmental programs. Still, accountability, alleged corruption, and the eligibility of lower quality and lower cost products make these markets challenging. Throughout we believe that Chembio has remained, and is increasingly recognized as, a reputable and dependable supplier of high quality products that are available at reasonably competitive prices. +Oral fluid testing is an established alternative to blood testing for diagnostic tests, including HIV tests. It is also often patient preferred, providing a more comfortable, less invasive test. In certain public health clinics, staffs choose not to handle blood specimens; thus, oral sample collection provides a viable alternative. The most well-established market for oral fluid HIV testing is the United States. +There is also now a potential over-the-counter market for HIV tests and we are well positioned to participate in this market, should we believe the investment is justified. After years of debate, this potential market has received increasing support by the FDA Blood Products Advisory Committee, the United States Centers for Disease Control, as well as key opinion leaders in the public health and HIV advocacy community. In 2011 Orasure Technologies Inc. announced that it had submitted its final application to the FDA for its oral fluid HIV test, which may result in FDA approval of the first over-the-counter HIV test during 2012. +Based on the fact that FDA has required any over the counter HIV test to have first been approved for the professional market, we believe that Chembio is the only other company that can participate in this market opportunity if it chooses to. Although there is a third company, Trinity Biotech that meets that condition, due to certain features of Trinity’s product Unigold®, we do not believe they intend to pursue this potential market, particularly since Trinity has stated this themselves. Therefore Chembio is carefully monitoring developments in this market, which may be significant during 2012. Currently we could initiate the over the counter approval process with either of our two blood tests. Provided we received approval of our pre-marketing application for our DPP® oral fluid HIV test, we could additionally, or alternatively, pursue over the counter approval for that product upon receiving such approval. However, the requirements for such approval are estimated to be approximately $4-6 million, and may take two to three years to complete. +Rapid Syphilis Tests +Recent data indicate that approximately 70,000-100,000 new cases of syphilis are occurring annually in the U.S. Syphilis can be treated with antibiotics, but untreated it can cause pelvic inflammatory disease, infertility, ectopic pregnancy and can infect newborns. Treatment cannot be provided without a confirmed diagnosis of an active case of syphilis. Current testing algorithms in the United States require two different tests (called non-treponemal and treponemal markers), each requiring trained personnel in laboratory settings and several days to receive back results, in order to confirm an active, previously untreated case. The screening test still employed in the United States is known as RPR; it utilizes an old technology that has a high degree of false positive results. +Development of the POC market for syphilis testing is expected to be comparable to the development of the POC market for HIV testing, as there is a significant public health value to being able to provide results at the point-of-care. There are several ways to assess the market opportunity for this unique rapid test, although we believe the U.S. rapid test market opportunity may exceed 8 million tests, which is approximately 20% of the total number of syphilis tests performed in the United States for clinical use today. Unlike HIV testing, where a positive result first requires a confirmatory test, and even then further tests to measure viral load before expensive treatment decisions are made, an individual with a confirmed active case of syphilis can be prescribed antibiotics immediately. +7 +In February 2011 a study was released by the CDC that suggested that the “newest” laboratory screening tests, which are using technologies developed in the 1980s (i.e. Enzyme-linked Immunoassays), are resulting in a large number of suspected false positive test results, which are test results that are not in fact representing active cases of Syphilis. This study involved tests done in high throughput blood screening laboratory settings, and not necessarily clinical settings. Nevertheless we believe that the study suggests that if public health clinicians could have what is effectively the CDC-recommended laboratory testing algorithm in a point-of-care test, this could be an invaluable public health tool in higher risk testing (higher STD prevalence) settings. We believe this is the opportunity we have with this product. +Marketing Strategy +Our marketing strategy is to: +· +Support, review and assess the marketing and distribution efforts of our rapid HIV tests by Alere. Alere, which is a leading marketer of point-of-care diagnostic products, has significantly expanded its distribution footprint since we signed our agreement with them, and although we believe that this will enhance opportunities for Alere to market our rapid HIV tests, the product line is a very small one for them, notwithstanding the strong growth they have enjoyed with respect to our products. +· +Leverage our DPP® intellectual property and regulated product development and manufacturing experience to continue creating new collaborations where Chembio can be the exclusive development and manufacturing partner supporting leading marketing organizations. +· +Establish strong distribution relationships for our Chembio-branded products in the U.S and abroad and establish a direct sales and marketing organization that is focused in the public health market segment, and that utilizes distributors for other market segments, primarily the acute care market which, together with public health, are the main market segments for rapid HIV tests in the United States. We believe that creation of a Chembio public health brand and marketing organization is fundamental to long term creation of shareholder value. +Competition +The diagnostics industry is a multi-billion dollar international industry and is intensely competitive. Many of our competitors are substantially larger and have greater financial, research, manufacturing and marketing resources. +Industry competition in general is based on the following: +· +Scientific and technological capability; +· +Proprietary know-how; +· +The ability to develop and market products and processes; +· +The ability to obtain FDA or other required regulatory approvals; +· +The ability to manufacture products that meet applicable FDA requirements, (i.e. FDA’s Quality System Regulations) (see Governmental Regulation section); +· +The ability to manufacture products cost-effectively; +· +Access to adequate capital; +· +The ability to attract and retain qualified personnel; and +· +The availability of patent protection. +We believe our scientific and technological capabilities and our proprietary know-how relating to our in-licensed lateral flow technology rapid tests and to our proprietary know-how related to our patented dual path platform technology, particularly for the development and manufacture of tests for the detection of antibodies to infectious diseases such as HIV, are very strong. +Our ability to develop and market other products is in large measure dependent on our having additional resources and/or collaborative relationships. Some of our product development efforts have been funded on a project or milestone basis. We believe that our proprietary know-how in lateral flow technology and in our Dual Path Platform (DPP®) technology has been instrumental in our obtaining the collaborations we have and that we continue to pursue. We believe that the patent protection that we have with our Dual Path Platform (DPP®) enhances our ability to develop more profitable collaborative relationships and to license out the technology. However there are number of competitive technologies used and/or seeking to be used in point-of-care settings. These technologies may be based on immunoassay principles such as the Company’s products or other technologies such as molecular-based technologies. +8 +Research and Development +During 2011 and 2010, $4.9 million and $4.1 million ($2.6 million, net of Qualified Therapeutic Discovery Project (“QTDP”) grants), respectively, were spent on research and development (including regulatory activities). These expenses were in part underwritten by funding from R&D and milestones revenues of $1.8 million in 2011 and $2.8 million in 2010. All of our new product development activities involve employment of our Dual Path Platform (DPP®) technology. These activities include completing development of certain products and making significant progress toward the development of additional products. Research and development and regulatory activities are explained in detail in Part II Item 7. +Employees +At December 31, 2011, we employed 140 people, including 137 full-time employees. We have entered into employment contracts with our President, Lawrence Siebert, and our Senior Vice President of Research and Development, Javan Esfandiari. Due to the specific knowledge and experience of these executives regarding the industry, technology and market, the loss of the services of either one of them would likely have a material adverse effect on the Company. The contract with Mr. Siebert provides that Mr. Siebert will serve as the Chief Executive Officer and President of the Company through May 11, 2013. The contract with Mr. Esfandiari has a term of three years ending March 2013. We have obtained a key man insurance policy for Mr. Esfandiari. +Governmental Regulation +The manufacturing and marketing of the Company’s existing and proposed diagnostic products are regulated by the United States Food and Drug Administration (“FDA”), United States Department of Agriculture (“USDA”), certain state and local agencies, and/or comparable regulatory bodies in other countries. These regulations govern almost all aspects of development, production and marketing, including product testing, authorizations to market, labeling, promotion, manufacturing and record keeping. The Company’s FDA and USDA regulated products require some form of action by each agency before they can be marketed in the United States, and, after approval or clearance, the Company must continue to comply with other FDA requirements applicable to marketed products, e.g. Quality Systems (for medical devices). Failure to comply with the FDA’s requirements can lead to significant penalties, both before and after approval or clearance. +There are two review procedures by which medical devices can receive FDA clearance or approval. Some products may qualify for clearance under Section 510(k) of the Federal Food, Drug and Cosmetic Act, in which the manufacturer provides a pre-market notification that it intends to begin marketing the product, and shows that the product is substantially equivalent to another legally marketed product (i.e., that it has the same intended use and is as safe and effective as a legally marketed device and does not raise different questions of safety and effectiveness). In some cases, the submission must include data from human clinical studies. Marketing may commence when the FDA issues a clearance letter finding such substantial equivalence. FDA clearance of our DPP® Syphilis Screen & Confirm test will be by means of a 510(k) submission. +If the medical device does not qualify for the 510(k) procedure (either because it is not substantially equivalent to a legally marketed device or because it is required by statute and the FDA’s implementing regulations to have an approved application), the FDA must approve a Pre-Marketing Application (“PMA”) before marketing can begin. PMA’s must demonstrate, among other matters, that the medical device provides a reasonable assurance of safety and effectiveness. A PMA application is typically a complex submission, including the results of non-clinical and clinical studies. Preparing a PMA application is a much more expensive, detailed and time-consuming process as compared with a 510(K) pre-market notification. The Company has approved PMAs for the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1-2 and Clearview® HIV 1-2 STAT PAK®. +FDA approval of our DPP® HIV screening assay for use with oral fluid or blood samples is being pursued by means of a PMA application. The Clinical Laboratory Improvement Act of 1988 (“CLIA”) prohibits laboratories from performing in vitro tests for the purpose of providing information for the diagnosis, prevention or treatment of any disease or impairment of, or the assessment of, the health of human beings unless there is in effect for such laboratories a certificate issued by the United States Department of Health and Human Services (via the FDA) applicable to the category of examination or procedure performed. Although a certificate is not required for the Company, it considers the applicability of the requirements of CLIA in the design and development of its products. The statutory definition of “laboratory” is very broad, and many of our customers are considered labs. A CLIA waiver will remove certain quality control and other requirements that must be met for certain customers to use the Company’s products and this is in fact critical to the marketability of a product into the point-of-care diagnostics market. The Company has received a CLIA waiver for each of the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1/2 and Clearview® HIV 1/2 STAT PAK®. The CLIA waiver was granted by the FDA for HIV 1/2 STAT-PAK on November 20, 2006 and for the Clearview® Complete HIV 1/2 on October 22, 2007. +9 +In addition, the FDA regulates the export of medical devices that have not been approved for marketing in the United States. The Federal Food, Drug and Cosmetic Act contains general requirements for any medical device that may not be sold in the United States and is intended for export. Specifically, a medical device intended for export is not deemed to be adulterated or misbranded if the product: (1) complies with the specifications of the foreign purchaser; (2) is not in conflict with the laws of the country to which it is intended for export; (3) is prominently labeled on the outside of the shipping package that it is intended for export; and (4) is not sold or offered for sale in the United States. However, the Federal Food, Drug and Cosmetic Act does permit the export of devices to any country in the world, if the device complies with the laws of the importing country and has valid marketing authorization in one of several “listed” countries under the theory that these listed countries have sophisticated mechanisms for the review of medical devices for safety and effectiveness. +The Company is also subject to regulations in foreign countries governing products, human clinical trials and marketing, and may need to obtain approval or evaluations by international public health agencies, such as the World Health Organization, in order to sell diagnostic products in certain countries. Approval processes vary from country to country, and the length of time required for approval or to obtain other clearances may in some cases be longer than that required for United States governmental approvals. On the other hand, the fact that our HIV diagnostic tests are of value in the AIDS epidemic may lead to some government process being expedited. The extent of potentially adverse governmental regulation affecting Chembio that might arise from future legislative or administrative action cannot be predicted. +One or more of the Company’s rapid HIV tests are also approved or pending approval for marketing in several foreign jurisdictions, including but not limited to Brazil, Mexico, and a number of other nations in the developing world. +Environmental Laws +To date, we have not encountered any costs relating to compliance with any environmental laws. +Intellectual Property +Intellectual Property Strategy +Our intellectual property strategy is to: (1) build our own intellectual property portfolio around our Dual Path Platform technology; (2) pursue licenses, trade secrets and know-how within the area of rapid point-of-care testing, and (3) develop and acquire proprietary positions to reagents and new hardware platforms for the development and manufacture of rapid diagnostic tests. +The Company has obtained patent coverage on the DPP® technology, including three U.S. patents, and patents in China, Malaysia, Eurasia, Mexico, Singapore, Japan and the U.K. Additional patent applications on the DPP® product line are pending in the U.S., as well as in many foreign countries such as Australia, Brazil, Canada, the European Union, India, Indonesia, Israel, Korea, and South Africa. Patents have also been filed on extensions to the DPP® product line concept such as 4th generation assays. +The Company has also filed for patents and obtained some patents in the U.S. for other inventions such as its multiple host species veterinary TB test, and patent applications for the other inventions are in various stages from being recently filed and not yet examined, to already examined and allowed but not yet issued. The Company selectively and strategically foreign files its patent applications based on a number of economic and strategic factors related to the invention. +Trademarks +The Company has filed and obtained trademarks for its products including DPP®, SURE CHECK® and STAT-PAK®. The DPP® trademark is also registered under the European convention (ECT). +Trade Secrets and Know-How +We believe that we have developed a substantial body of trade secrets and know-how relating to the development of lateral flow and DPP® based diagnostic tests, including but not limited to the sourcing and optimization of materials for such tests, and how to maximize sensitivity, speed-to-result, specificity, stability and reproducibility. The Company possesses proprietary know-how to develop tests for multiple conditions using colored latex. Our buffer formulations enable extremely long shelf lives of our rapid HIV and other tests and we believe that this provides us with an important competitive advantage. +Lateral Flow Technology and Reagent Licenses +As part of our agreements in 2006 with Alere for the marketing of our HIV tests, we were granted non-exclusive licenses to certain lateral flow technology for certain products manufactured and marketed by Chembio including but not limited to our HIV tests. Although we believe our DPP® is outside of the scope of all lateral flow patents of which we are aware, we consult with patent counsel, and seek licenses and/or redesigns of products that we believe to be in the best interests of the Company and our stockholders. Because of the costs and other negative consequences of time-consuming patent litigation, we often attempt to obtain a license on reasonable terms. Nevertheless there is no assurance that the Alere lateral flow patents we have licensed will not be challenged or that other patents containing claims relevant to the Company’s lateral flow or DPP® products will not be granted to third parties and that licenses to such patents, will be available on reasonable terms, if any. In the past Alere has aggressively enforced its lateral flow intellectual property, although some of the main patents will expire within the next couple of years and we are not aware of any patent enforcement litigation that is ongoing with respect to the Alere lateral flow intellectual property. +10 +Regardless, the DPP® technology provides us with our own intellectual property, we believe it provides us with a freedom to operate, and that it also enables tests to be developed with improved sensitivity as compared with comparable tests on lateral flow platforms. The Company has signed and anticipates signing new development projects based upon the DPP® technology that will provide new manufacturing and marketing opportunities. We have filed other patents that we believe will strengthen the DPP® intellectual property and have also filed for patent protection for certain other point-of-care technologies or applications thereof. +The peptides used in our rapid HIV tests were patented by Adaltis Inc. and were licensed to us under a 10-year non-exclusive license agreement dated August 30, 2002. However, in connection with Adaltis’ bankruptcy, during the third quarter of 2009 we bought out all of our remaining obligations under that agreement. We also have licensed the antigens used in other tests including our Syphilis, Tuberculosis, Leptospirosis, Leishmaniasis and Chagas tests, and we may enter other license agreements. In prior years we concluded license agreements related to intellectual property rights owned by the United States associated with HIV- 1, and during the first quarter of 2008 we entered into a sub-license agreement for HIV-2 with Bio-Rad Laboratories N.A., the exclusive licensee of the Pasteur Institute’s HIV-2 intellectual property estate. +Corporate History +On May 5, 2004, we completed a merger with Trading Solutions, Inc. through which Chembio Diagnostic Systems Inc. became our wholly-owned subsidiary, and through which the management and business of Chembio Diagnostic Systems Inc. became our management and business. As part of this transaction, we changed our name to Chembio Diagnostics, Inc. In 2003, we had sold our prior business, and as a result, we had no specific business immediately prior to the merger. +Since the formation of Chembio Diagnostic Systems Inc. in 1985, it has been involved in developing, manufacturing, selling and distributing in-vitro diagnostic tests, including rapid tests beginning in 1995, for a number of conditions in humans and animals. +On March 12, 2004, we implemented a 1-for-17 reverse split of our common stock. All references in this Form 10-K to shares of our common stock have been adjusted to reflect this reverse split. +In February 2010, Crestview Capital Master, L.L.C. ("Crestview Master"), a Delaware limited liability company that held 18,907,431 shares of Chembio's common stock, spun off all these shares, constituting approximately 30.5% of Chembio's outstanding shares, to its three equity holders. One of the three equity holders of Crestview Master immediately spun off, to its approximately 126 equity holders, all of the 12,990,569 shares of Chembio stock that it received in this distribution. As a result, as of February 24, 2010, Crestview Master no longer owned any shares. The former direct and indirect equity holders of Crestview Master owned all these shares, with none of these individual stockholders having beneficial ownership of more than 5.61% of the outstanding common stock of Chembio. +11 +Glossary +AIDS +Acquired Immunodeficiency Syndrome. AIDS is caused by the Human Immunodeficiency Virus, HIV. +ALGORITHM (parallel or serial) +For rapid HIV testing this refers both to method or protocol (in developing countries to date) for using rapid tests from different manufacturers in combination to screen and confirm patients at the point-of-care, and may also refer to the specific tests that have been selected by an agency or ministry of health to be used in this way. A parallel algorithm uses two screening tests from different manufacturers and a tie-breaker test only if there is a discrepancy between the screening tests results. A serial algorithm only uses a second confirmatory test if there is a positive result from the screening test, meaning that the number of confirmatory tests used is equal to the positivity rate in the testing venue. A tie-breaker test resolves discrepancies between the screen and the confirmatory test. +ANTIBODY +A protein which is a natural part of the human immune system produced by specialized cells to neutralize antigens, including viruses and bacteria that invade the body. Each antibody producing cell manufactures a unique antibody that is directed against, binds to and eliminates one, and only one, specific type of antigen. +ANTIGEN +Any substance which, upon entering the body, stimulates the immune system leading to the formation of antibodies. Among the more common antigens are bacteria, pollens, toxins, and viruses. +ANVISA +ARVs +Anti-Retroviral Treatments for AIDS +The National Health Surveillance Agency of Brazil +Anti-retroviral medications developed to fight AIDS +CDC +United States Centers for Disease Control and Prevention +CLIA waiver +Clinical Laboratory Improvement Act designation that allows simple tests to be performed in point-of-care settings such as doctor’s offices, walk-in clinics and emergency rooms. +DIAGNOSTIC +Pertaining to the determination of the nature or cause of a disease or condition. Also refers to reagents or procedures used in diagnosis to measure proteins in a clinical sample. +EITF +Emerging Issues Task Force +FASB +FIOCRUZ +Financial Accounting Standards Board +The Oswaldo Cruz Foundation of Brazil +FDA +United States Food and Drug Administration +FDIC +Federal Deposit Insurance Corporation +FAS +Financial Accounting Standard +IgG +IgG or Immunoglobulin are proteins found in human blood. This protein is called an “antibody” and is an important part of the body’s defense against disease. When the body is attacked by harmful bacteria or viruses, antibodies help fight these invaders. +NGO +Non-Governmental Organization +OTC +Over-the-Counter +PEPFAR +The President’s Emergency Plan for AIDS Relief +PMA +Pre-Marketing Approval –FDA approval classification for a medical device that is not substantially equivalent to a legally marketed device or is otherwise required by statute to have an approved application. Rapid HIV tests must have an approved PMA application before marketing of such a product can begin. +PROTOCOL +A procedure pursuant to which an immunodiagnostic test is performed on a particular specimen in order to obtain the desired reaction. +REAGENT +A chemical added to a sample under investigation in order to cause a chemical or biological reaction which will enable measurement or identification of a target substance. +RETROVIRUS +A type of virus which contains the enzyme Reverse Transcriptase and is capable of transforming infected cells to produce diseases in the host such as AIDS. +SAB +Staff Accounting Bulletin +SENSITIVITY +Refers to the ability of an assay to detect and measure small quantities of a substance of interest. The greater the sensitivity, the smaller the quantity of the substance of interest the assay can detect. Also refers to the likelihood of detecting the antigen when present. +SPECIFICITY +The ability of an assay to distinguish between similar materials. The greater the specificity, the better an assay is at identifying a substance in the presence of substances of similar makeup. +USDA +U.S Department of Agriculture +WHO +World Health Organization +12 \ No newline at end of file diff --git a/raw/filings/0001092662/2011/0001092662-12-000013/item13.txt b/raw/filings/0001092662/2011/0001092662-12-000013/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..1d717f6ac6a51862503ccc9b47eaf98c9391c28a --- /dev/null +++ b/raw/filings/0001092662/2011/0001092662-12-000013/item13.txt @@ -0,0 +1,23 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +The executive officers of the Company are as follows: Lawrence A. Siebert, president, chief executive officer and chairman of the board of directors of the Company, Richard J. Larkin, chief financial officer of the Company, and Javan Esfandiari, executive vice president of Research and Development of the Company. +On May 7, 2009, the Compensation Committee of the Company reduced, to $0.13 per share, the exercise price of each outstanding employee option that was issued under the 1999 Equity Incentive Plan (the “1999 Plan”) for which the exercise price was greater than $0.44 per share of the Company’s common stock. There was no other change made to the terms of the stock options other than the reduction in the exercise price. A total of 1,036,750 options were affected. Mr. Siebert, Mr. Esfandiari and Mr. Larkin had options to purchase common stock that were so reduced of 160,000, 497,500 and 137,500, respectively. +In addition, on May 7, 2009 in accordance with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 2,925,000 shares of the Company’s common stock. The exercise price for these options is equal to $0.13 per share. The options become exercisable in thirds on the first, second and third anniversaries of the date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the date of grant. Mr. Siebert, Mr. Esfandiari and Mr. Larkin received options to purchase common stock of 400,000, 300,000 and 275,000, respectively. +In accordance with the terms of the Company’s 2008 Plan, on May 3, 2011, the Company determined to grant on May 9, 2011, to certain employees of the Company options to purchase an aggregate of 500,000 shares of the Company’s common stock. The exercise price for these options was to be equal to the VWAP (Volume Weighted Average Price) market price for the Company’s common stock on May 9, 2011. The options become exercisable evenly on the second and third anniversaries of the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. Mr. Ippolito, Mr. Bruce and Mr. Larkin received options to purchase common stock of 125,000, 100,000 and 150,000, respectively +During the quarter ended December 31, 2008, Alere notified the Company that Alere had entered into a contract with Bio-Rad Laboratories, Inc. (“Bio-Rad”) for royalties on Bio-Rad’s patent for the detection of HIV-2 antibodies. The agreement also provided for Alere to pay past royalties. On June 25, 2009, the Company and Alere entered into a letter agreement whereby certain obligations aggregating approximately $1,010,000 as of December 31, 2008 were agreed to be paid from future revenues. The obligations include the Company’s share under its agreements with Alere for the amount of HIV-2 royalties that Alere paid when Alere entered into an HIV-2 license agreement with Bio-Rad Laboratories, Inc. of approximately $485,000 and royalties owed by Chembio on lateral flow licenses to Alere of approximately $525,000 as of December 31, 2008. Under the agreement Alere will retain an additional 10% of Clearview® HIV 1/2 STAT-PAK® net sales and 5% of Clearview® Complete HIV 1/2 net sales until these obligations are extinguished. As of December 31, 2011 this balance was fully paid. +On February 16, 2012, the Company granted options to purchase the following numbers of shares of the Company’s common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company’s common stock on February 16, 2012, which was $.50 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +20,500 +Javan Esfandiari – Executive Vice President of R&D +63,750 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +24,000 +Richard J. Larkin – Chief Financial Officer +22,375 +Lawrence A. Siebert – Chief Executive Officer +72,500 +Director Independence +Our stock is quoted on the OTCQB, which is the second of the three tiers of the OTC Market Group under the symbol “CEMI.” . As such, we are not currently subject to corporate governance standards of listed companies, which require, among other things, that the majority of the board of directors be independent. +We are not currently subject to corporate governance standards defining the independence of our directors, and we have chosen to define an “independent” director in accordance with the NASDAQ Global Market's requirements for independent directors. Under this definition, we have determined that Gary Meller, Katherine L. Davis, Pete Kissinger and Barbara DeBuono currently qualify as independent directors. We do not list the “independent” definition we use on our internet website . +41 \ No newline at end of file diff --git a/raw/filings/0001092662/2011/0001092662-12-000013/item9a.txt b/raw/filings/0001092662/2011/0001092662-12-000013/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..d9b58389f7b8061026a339691015a3c7b21ee631 --- /dev/null +++ b/raw/filings/0001092662/2011/0001092662-12-000013/item9a.txt @@ -0,0 +1,15 @@ +ITEM 9A. +CONTROLS AND PROCEDURES +(a) Disclosure Controls and Procedures. Under the supervision and with the participation of our senior management, consisting of our chief executive officer and our chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report (the "Evaluation Date"). Based on that evaluation, the Company’s management, including our chief executive officer and chief financial officer, concluded that as of the Evaluation Date our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our Exchange Act reports is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. +Management's Annual Report on Internal Control Over Financial Reporting. The Company's management is responsible for establishing and maintaining an adequate system of internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)). Our internal control over financial reporting is a process, under the supervision of our chief executive officer and chief financial officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. These internal controls over financial reporting processes include policies and procedures that: +a. +Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; +b. +Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +c. +Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives. +In evaluating the effectiveness of our internal control over financial reporting, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2011. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. +Management's report was not subject to attestation by our registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report. +(b) Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the Company’s last fiscal quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001092662/2011/0001092662-12-000013/rp_note.txt b/raw/filings/0001092662/2011/0001092662-12-000013/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..9e607a446601150c0ccb9c9c41faf7d35cb0d5d3 --- /dev/null +++ b/raw/filings/0001092662/2011/0001092662-12-000013/rp_note.txt @@ -0,0 +1,3 @@ +NOTE 9 — RELATED PARTIES: +In September 2006, the Company entered into distribution and licensing agreements with Alere, Inc. (“Alere”). As of December 31, 2011, Alere owns 8.48% of the Company. See Note 15 where Alere is listed as customer 1. +During the quarter ended December 31, 2008, Alere notified the Company that they had entered into a contract with Bio-Rad Laboratories, Inc. (“Bio-Rad”) for royalties on Bio-Rad’s patent for the detection of HIV-2 antibodies. The agreement also provided for Alere to pay past royalties. On June 25, 2009, the Company and Alere entered into a letter agreement whereby certain obligations were agreed to be paid from future revenues. The obligations included the Company’s royalties owed under its agreements with Alere on lateral flow licenses. All such royalty obligations were fully paid in 2010. \ No newline at end of file diff --git a/raw/filings/0001092662/2011/0001092662-12-000013/rpt_disclosure.txt b/raw/filings/0001092662/2011/0001092662-12-000013/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..1d717f6ac6a51862503ccc9b47eaf98c9391c28a --- /dev/null +++ b/raw/filings/0001092662/2011/0001092662-12-000013/rpt_disclosure.txt @@ -0,0 +1,23 @@ +ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +The executive officers of the Company are as follows: Lawrence A. Siebert, president, chief executive officer and chairman of the board of directors of the Company, Richard J. Larkin, chief financial officer of the Company, and Javan Esfandiari, executive vice president of Research and Development of the Company. +On May 7, 2009, the Compensation Committee of the Company reduced, to $0.13 per share, the exercise price of each outstanding employee option that was issued under the 1999 Equity Incentive Plan (the “1999 Plan”) for which the exercise price was greater than $0.44 per share of the Company’s common stock. There was no other change made to the terms of the stock options other than the reduction in the exercise price. A total of 1,036,750 options were affected. Mr. Siebert, Mr. Esfandiari and Mr. Larkin had options to purchase common stock that were so reduced of 160,000, 497,500 and 137,500, respectively. +In addition, on May 7, 2009 in accordance with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 2,925,000 shares of the Company’s common stock. The exercise price for these options is equal to $0.13 per share. The options become exercisable in thirds on the first, second and third anniversaries of the date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the date of grant. Mr. Siebert, Mr. Esfandiari and Mr. Larkin received options to purchase common stock of 400,000, 300,000 and 275,000, respectively. +In accordance with the terms of the Company’s 2008 Plan, on May 3, 2011, the Company determined to grant on May 9, 2011, to certain employees of the Company options to purchase an aggregate of 500,000 shares of the Company’s common stock. The exercise price for these options was to be equal to the VWAP (Volume Weighted Average Price) market price for the Company’s common stock on May 9, 2011. The options become exercisable evenly on the second and third anniversaries of the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. Mr. Ippolito, Mr. Bruce and Mr. Larkin received options to purchase common stock of 125,000, 100,000 and 150,000, respectively +During the quarter ended December 31, 2008, Alere notified the Company that Alere had entered into a contract with Bio-Rad Laboratories, Inc. (“Bio-Rad”) for royalties on Bio-Rad’s patent for the detection of HIV-2 antibodies. The agreement also provided for Alere to pay past royalties. On June 25, 2009, the Company and Alere entered into a letter agreement whereby certain obligations aggregating approximately $1,010,000 as of December 31, 2008 were agreed to be paid from future revenues. The obligations include the Company’s share under its agreements with Alere for the amount of HIV-2 royalties that Alere paid when Alere entered into an HIV-2 license agreement with Bio-Rad Laboratories, Inc. of approximately $485,000 and royalties owed by Chembio on lateral flow licenses to Alere of approximately $525,000 as of December 31, 2008. Under the agreement Alere will retain an additional 10% of Clearview® HIV 1/2 STAT-PAK® net sales and 5% of Clearview® Complete HIV 1/2 net sales until these obligations are extinguished. As of December 31, 2011 this balance was fully paid. +On February 16, 2012, the Company granted options to purchase the following numbers of shares of the Company’s common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company’s common stock on February 16, 2012, which was $.50 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +20,500 +Javan Esfandiari – Executive Vice President of R&D +63,750 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +24,000 +Richard J. Larkin – Chief Financial Officer +22,375 +Lawrence A. Siebert – Chief Executive Officer +72,500 +Director Independence +Our stock is quoted on the OTCQB, which is the second of the three tiers of the OTC Market Group under the symbol “CEMI.” . As such, we are not currently subject to corporate governance standards of listed companies, which require, among other things, that the majority of the board of directors be independent. +We are not currently subject to corporate governance standards defining the independence of our directors, and we have chosen to define an “independent” director in accordance with the NASDAQ Global Market's requirements for independent directors. Under this definition, we have determined that Gary Meller, Katherine L. Davis, Pete Kissinger and Barbara DeBuono currently qualify as independent directors. We do not list the “independent” definition we use on our internet website . +41 \ No newline at end of file diff --git a/raw/filings/0001092662/2012/0001092662-13-000024/filing.txt b/raw/filings/0001092662/2012/0001092662-13-000024/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..19c6bd8319d03909f64c4ad790933fc711e53b5c --- /dev/null +++ b/raw/filings/0001092662/2012/0001092662-13-000024/filing.txt @@ -0,0 +1,2809 @@ +10-K +1 +form10_k.htm +FORM 10-K 2012 CHEMBIO +form10_k.htm +UNITED STATES +Securities and Exchange Commission +Washington, D.C. 20549 +FORM 10-K +[X] +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2012 +or +[ ] +TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to . +Commission File No. 0-30379 +CHEMBIO DIAGNOSTICS, INC. +(Exact name of registrant as specified in its charter) +Nevada +88-0425691 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +3661 Horseblock Road, Medford, NY +11763 +(Address of principal executive offices) +(Zip Code) +Registrant’s telephone number, including area code (631) 924-1135 +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +None +None +Securities registered pursuant to section 12(g) of the Act: +Common Stock, $0.01 par value +(Title of Class) +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes __ No X +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes __ No X +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 X No__ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 X No __ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +Large accelerated filer [ ] Accelerated filer [ ] +Non-accelerated filer [ ] Smaller reporting company [X] +(Do not check if a smaller reporting company) +Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes __ No _X_ +As of the last business day of the Company’s most recently completed second fiscal quarter, the aggregate market value of voting and non-voting common equity held by non-affiliates* was $28,500,000. +As of March 6, 2013, the registrant had 8,086,114 common shares outstanding. +* Without asserting that any of the issuer’s directors or executive officers, or the entities that own more than five percent of the outstanding shares of the Registrant’s common stock, are affiliates, the shares of which they are beneficial owners have not been included in shares held by non-affiliates solely for this calculation. +TABLE OF CONTENTS +Page +PART I +ITEM 1. +BUSINESS +3 +ITEM 1A. +RISK FACTORS +14 +ITEM 2. +PROPERTIES +20 +ITEM 3. +LEGAL PROCEEDINGS +20 +ITEM 4 . +MINE SAFETY DISCLOSURES +20 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +21 +ITEM 6. +SELECTED FINANCIAL DATA +22 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +24 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +33 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. +33 +ITEM 9A. +CONTROLS AND PROCEDURES +33 +ITEM 9B. +OTHER INFORMATION +34 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +35 +ITEM 11. +EXECUTIVE COMPENSATION +37 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +40 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +42 +ITEM 14. +PRINCIPAL ACCOUNTANT FEES AND SERVICES +43 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +44 +SIGNATURES +45 +PART I +ITEM 1. +BUSINESS +FORWARD-LOOKING STATEMENTS +This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, and Section 27A of the Securities Act of 1933. Any statements contained in this report that are not statements of historical fact may be forward-looking statements. When we use the words “intends,” “estimates,” “predicts,” “potential,” “continues,” “anticipates,” “plans,” “expects,” “believes,” “should,” “could,” “may,” “will” or the negative of these terms or other comparable terminology, we are identifying forward-looking statements. Forward-looking statements involve risks and uncertainties, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by forward-looking statements. These factors include our research and development activities, distributor channels, market demand for our products, compliance with regulatory impositions; and our capital needs. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business. +For further information about these and other risks, uncertainties and factors, please review the disclosure included in this report under “Part I, Item 1A, Risk Factors.” +Our Business +General +The Company (Chembio Diagnostics, Inc. and its wholly-owned subsidiary Chembio Diagnostic Systems, Inc. are collectively referred to herein as the “Company”) develops, manufactures, markets and licenses rapid point-of-care diagnostic tests (POCTs) that detect infectious diseases. The Company’s main products presently commercially available are four rapid tests for the detection of HIV antibodies, two rapid tests for the detection of syphilis, and a rapid test for the detection of canine leishmaniasis. Three of the HIV rapid tests employ in-licensed and proprietary lateral flow technologies (see “Our Rapid Test Technologies”), can be used with all blood matrices as samples, and are manufactured in a standard cassette format, a dipstick format, and a proprietary barrel format. The tests employing the cassette and proprietary barrel formats were approved by the FDA in 2006 and are exclusively distributed by Alere, Inc. (“Alere”) in the United States and by Chembio outside the United States. Our fourth rapid HIV test incorporates our patented Dual Path Platform® (DPP®), and does not require in-licensing. The DPP® HIV test, detects antibodies to HIV 1 & 2 in oral fluid samples as well as in all blood matrices. We received United States FDA regulatory approval for this product on December 19, 2012 and we anticipate launching it under Chembio’s brand in 2013. +Our new product pipeline, which currently includes rapid tests for Syphilis and Hepatitis-C, as well as a multiplex test that detects HIV and Syphilis specific antibodies, is based on this DPP® technology for which we were issued a United States patent in 2007 and for which additional patent protection has issued or is pending worldwide. With the DPP® proprietary platform, we can participate in the estimated $8-10 billion point-of-care market segment of the estimated nearly $50 billion global in-vitro diagnostic market that has an overall growth rate of approximately 7% per annum. POCTs, by providing prompt and early diagnosis, can reduce patient stays, lower overall costs, improve therapeutic interventions and improve patient outcomes as a result of prompt and early diagnosis. They can also prevent needless hospital admissions, simplify testing procedures, avoid delays from central lab batching, and eliminate the need for return visits. +3 +In the areas of infectious and sexually transmitted diseases (such as HIV and syphilis for example), the utility of a rapid point–of-care test, particularly in identifying patients unaware of their disease status, has been well established. Large and growing markets have been established for these kinds of tests, initially in high prevalence regions where they are indispensable for large scale prevention and treatment programs. More recently introduced in the United States in 2004, rapid HIV tests now also present a significant segment of the U.S. market for HIV clinical testing, which is still dominated by laboratory tests. We have focused our product development activity within areas where the availability of rapid, point-of-care screening, diagnostic, or confirmatory results can improve health outcomes. +PRODUCTS +Lateral Flow Rapid HIV Tests +All three of our lateral flow rapid HIV tests are qualitative “yes/no” tests for the detection of antibodies to HIV 1 & 2 with visually interpreted results (one line “negative”; two lines “positive”) available within approximately 15 minutes. The tests are simple to use, have a shelf life of 24 months, and do not require refrigeration. The tests differ principally only in the method of test procedure, convenience and cost. One of our FDA-approved lateral flow HIV tests incorporates a proprietary plastic “barrel” device that houses the lateral flow strip. This barrel format enables collection of samples directly (for example directly from a finger-stick whole blood sample) into the barrel’s capillary tip. A sealed unitized buffer vial, assembled onto the top of the barrel, is removed and seated into a stand; the seal is then pierced by the barrel’s capillary tip, thereby initiating the upward flow of the resulting sample-buffer solution through a filter, up into the vertical device’s chamber and onto the lateral flow strip. This results in a unique unitized and closed device system that can reduce the chance of exposure to potentially infectious samples. We believe that this format may be an ideal candidate as an over-the-counter HIV test and we are participating in certain studies that should help to better ascertain this. Our other FDA-approved lateral flow HIV test uses a more conventional rectangular plastic cassette format that houses the lateral flow strip. In this case, a sample is transferred by use of a separately provided transfer device (“loop”) into a sample well or port of the cassette that houses the lateral flow strip, which is positioned horizontally or flat. +Both of the above-described products are marketed exclusively in the United States by Alere as Clearview® Complete HIV 1/2 (the barrel format) and Clearview® HIV 1/2 STAT PAK® (the cassette format), and by Chembio in all other markets under the names Chembio Sure Check® HIV 1/2 and Chembio HIV 1/2 STAT PAK®. Alere has non-exclusive rights to the barrel product outside the United States. +Our third lateral flow HIV test, HIV 1/2 STAT PAK® Dipstick is our most cost competitive and compact format. It does not have any plastic housing so that 30 test strips can be packaged into a small vial that is ideal for transporting into remote settings. The test procedure is similar to the cassette format; an adhesive backing is provided as a more cost-effective and compact “housing” on which to run the test. +Regulatory Status of the lateral flow HIV tests +The FDA approved our Pre-Market Applications (hereinafter “PMA”; see “Governmental Regulations” and Glossary) in April 2006 for our SURE CHECK HIV 1/2 (and also now Alere Clearview® Complete HIV 1/2) and for our HIV 1/2 STAT-PAK (now Alere’ Clearview® HIV 1/2 STAT-PAK in the United States only) products. Waivers under the Clinical Laboratory Improvement Act (hereinafter “CLIA”; see Governmental Regulations) were granted by the FDA for the two FDA -approved products in 2006 and 2007, respectively. The CLIA waiver is required in order for health care providers to administer these tests in the settings where they are most suited and needed, such as public health testing clinics, hospital emergency rooms and physicians’ offices. Our HIV 1/2 STAT-PAK Dipstick, although not FDA-approved, qualifies under FDA export regulations to sell to customers outside the United States subject to any required approval by the importing country. +All three of our lateral flow HIV tests have qualified for procurement under the President’s Emergency Plan for AIDS Relief (“PEPFAR”). Both the cassette and dipstick versions of the STAT-PAK® are also qualified by the World Health Organization (WHO) for procurements by the second largest global program, known as the Global Fund, as well as other related programs funded by agencies affiliated with the United Nations, such as UNICEF and UNITAIDS (see Glossary), through qualification with the WHO bulk procurement scheme. +4 +DPP® HIV Test +As in the case of our lateral flow HIV tests, our DPP® HIV test is also a qualitative “yes/no” test for the detection of antibodies to HIV 1 & 2, delivers visual results within as little as 15 minutes, is simple to use, has a shelf life of 24 months, and does not require refrigeration. This product, which is our first product incorporating our patented DPP® technology, can be used with oral fluid samples, as well as with all blood matrices. This product also incorporates our patent-pending oral fluid collection and storage system that enables samples to be fully extracted in buffer solution before application to the test device, and also enables the extracted sample to be stored and retested or potentially tested for multiple conditions. Clinical and laboratory studies, which uniquely included test subjects down to two years of age, have shown this product to have improved performance compared with all of the current FDA-approved CLIA-waived rapid tests, even including our own lateral flow tests. FDA -approved label claims include sensitivity/specificity on oral fluid and finger-stick whole blood of 98.9%/99.9% and 99.9%/100% respectively. Oral fluid sensitivity was 100% amongst HIV-positive patients not taking anti-retroviral medication. Due to the low HIV prevalence in the U.S., clinical trials are performed on known HIV-positive patients, more of whom are on more effective medications, and for longer periods than when competitors performed their trials. We believe that this fact, combined with our product’s superior performance in a direct comparative evaluation, and earlier detection than our main competitors on well characterized serum samples, combine to provide us with a significant market opportunity with this product. +Regulatory Status: In April 2012 we completed a 3,000 patient clinical study with our DPP® HIV test in the United States which we had begun in 2010. In June 2012 we submitted the third of three modules required for a modular PMA application to the FDA. On December 19, 2012 we received FDA approval of our Pre-Marketing Approval. During the first quarter of 2013, we plan to commence the additional testing necessary in order to complete a CLIA waiver application for this product. We anticipate that we will be able to complete this testing and complete this application in order to launch the product in the third or fourth quarter of 2013. +The DPP® HIV test product is qualified for procurement under the President’s Emergency Plan for AIDS Relief (“PEPFAR”) for use with all sample matrices, and we are pursuing WHO qualification in order to enable procurement of this product by the Global Fund and United Nations agencies, including programs underwritten by them. +In June 2010, ANVISA approved the DPP® HIV test that is being marketed in Brazil through our collaboration with the Oswaldo Cruz Foundation, Brazil’s leading public health institute. Given the oral fluid feature, we believe this product can be marketed as a premium-priced product that will address those market segments in the U.S. and globally that express a preference for a less invasive testing experience. +OTHER DPP® PRODUCTS +Our product pipeline currently includes a multiplex Syphilis Screen & Confirm test, a multiplex test for the separate detection of antibodies to HIV and Syphilis, and a rapid test for the detection of Hepatitis-C antibodies and antigens. We anticipate completing clinical and other requirements in order to make submissions to the FDA for the Syphilis Screen & Confirm test and the multiplex HIV-Syphilis test in 2013 for U.S. market clearance in 2014. This timetable is subject to the FDA’s confirming the regulatory requirements that we believe will be applicable to these products, of which there can be no assurance. As mentioned below (“Our Rapid Test Technologies”), we also are considering development of so-called “Fourth Generation” tests that are able to detect disease prior to seroconversion to antibodies. This would allow earlier detection of diseases at an acute stage. We have completed initial feasibility studies with technologies (owned by other parties) that complement our DPP® technology and that will further enable even lower limits of analyte detection, which is a capability we believe is essential to have in order to develop new products and markets over the long term. +Our strategy with respect to our DPP® technology has evolved as the Company has evolved. Initially, following the issuance of our DPP® patent in the United States in 2007, our strategy was necessarily limited to developing third-party-funded OEM research and development contracts and grants. This strategy enabled us to conserve capital resources, while at the same time acquiring know-how and experience with the platform and developing third-party references and implicit endorsements of the technology. As our capabilities to develop and manufacture DPP® products expanded, and as our financial position has improved, so have our strategic options expanded and improved. While we may continue the strategy of seeking OEM development and manufacturing agreements as a way to participate in markets that we cannot and/or choose not to serve, we believe that we can also develop our own branded line of products, and we plan to do this in the public health area. We plan to launch this brand with our DPP® HIV Screening Assay in the United States market in 2013, to be followed by our Syphilis test and potentially other related products. +Following is a discussion of the DPP® products for which we have completed our development activity pursuant to OEM agreements with FIOCRUZ and Bio-Rad Laboratories, Inc. The statuses of products that are still under development are described in Part II Item 7 of this report. +5 +PARTNERS INVOLVED IN MARKETING OUR PRODUCTS +On September 29, 2006, we executed marketing and license agreements with Alere. The marketing agreements (one for each of the two FDA-approved products) provide Alere with a 10-year exclusive right (until September 2016) to market our rapid HIV tests in the United States under Alere’s brand. The agreements provide Chembio a non-exclusive license to certain Alere lateral flow patents that may be applicable to our lateral flow products, including for the HIV tests in the United States should Alere enter the U.S. market with a competitive rapid HIV test product and we choose to market our products directly as provided in the agreements. Simultaneous with the execution of the agreements, we also settled litigation with StatSure Diagnostics, Inc. (SDS) that had been ongoing relating to the proprietary barrel device which is incorporated into one of our two FDA-approved rapid HIV tests (See Lateral Flow HIV Tests above). As a result, it is through the agreements with Alere that we have been participating in the growth of the rapid HIV test market in the United States. +We have appointed distributors internationally for our lateral flow HIV tests. Our largest markets outside the U.S. for our lateral flow HIV rapid tests are certain countries in Africa, Asia, and South America, as well as Mexico. Internationally, most of the demand for our products is based on governmental and non-governmental prevention and treatment efforts. Given this, these programs can and do often result in large orders, but also can result in periods of relatively lower demand, based on the variations associated with this kind of demand. +Our DPP® HIV test was approved by ANVISA, Brazil’s regulatory authority, in June 2010. This approval was granted to our Brazilian partner, the Oswaldo Cruz Foundation (“FIOCRUZ”), pursuant to one of five technology transfer, supply and license agreements that we entered into with this public health organization in 2008 and 2010. See “OEM DPP® Products,” below. +OEM DPP® Products +Oswaldo Cruz Foundation OEM DPP® Agreements +During 2008-2010 we signed five agreements with the Oswaldo Cruz Foundation (FIOCRUZ) in Brazil relating to products based on our DPP® technology. FIOCRUZ is the leading public health organization in Brazil, and it is affiliated with Brazil’s Ministry of Health which is its principal client. It has extensive research, educational and manufacturing facilities for drugs and vaccines, as well as for diagnostic products. +During 2010 and 2011 all of the initial products contemplated under the five agreements were approved for marketing by the applicable regulatory agencies in Brazil. As a result, during 2011, we shipped approximately $4.25 million of products to FIOCRUZ pursuant to the agreements, and approximately $10.86 million for fiscal year 2012. The agreements between the Company and FIOCRUZ are unique examples of technology transfer collaborations between a private sector rapid test manufacturer and a public health organization. The five products under agreement with FIOCRUZ are for DPP® products for HIV screening, HIV confirmatory, Leishmaniasis, Leptospirosis and Syphilis. All of the agreements with FIOCRUZ contemplate a technology transfer and license to FIOCRUZ for the manufacture of the subject products over stipulated periods of time. These technology transfers, and the provision by Chembio of the information and training that is required for this to occur, are subject to Chembio receiving orders from FIOCRUZ for a minimum amount of products for manufacture by Chembio, which is approximately $23 million in the aggregate under the five agreements. The actual demand for these products may be more or less than this amount. The actual amount will depend on the demand for the products by the specific programs for each product funded by the Brazilian Ministry of Health for its programs as well as whether and when FIOCRUZ is able to implement the technology transfer steps including, for example, the readiness of new production facilities currently under construction that are scheduled to be completed in mid-2013; thereafter Chembio may continue to supply certain product components or receive royalty payments under some of the agreements for a defined period based on product sold by FIOCRUZ to the public health programs in Brazil. +Our Rapid Test Technologies +All of our commercially available current products employ either in-licensed lateral flow technology or our own patented Dual Path Platform® (DPP®) technology and are visually read. We can also use handheld and desktop readers with our DPP® products to objectively measure, quantify, record and report DPP® test results. Certain of the products we have and/or are developing incorporate some of these readers, and we are developing other products that may be used with or will require use of a reader. +Both lateral flow technology and DPP® allow the development of accurate, low cost, easy-to-perform, single-use diagnostic tests for rapid, visual detection of specific antigen-antibody complexes on a test strip. These formats provide a test that is simple (requires neither electricity nor expensive equipment for test execution or reading, nor skilled personnel for test interpretation), rapid (turnaround time approximately 15 minutes), safe (minimizes handling of potentially infected specimens), non-invasive (requires 5-20 micro liters of whole blood easily obtained with a finger prick, or alternatively, serum or plasma,), stable (24 months at room temperature storage in the case of our HIV tests), and highly reproducible. +6 +We believe that products developed using DPP® technology can provide superior diagnostic performance as compared with products that use lateral flow technology. The reason for this is that one of the major differences between the two platforms is that in DPP® samples are allowed to incubate with the target analyte in the test zone before introduction of the labeling reagent/conjugate, whereas in lateral flow, samples are combined with the labeling reagent to form a complex before coming in contact with the target analyte. We believe that this complex can compromise test performance. Also, because of the usage in DPP® of a separately connected sample strip, the control and delivery of sample material is substantially improved. This feature is critical in the development of multiplex tests, as well as tests that involve viscous sample material (such as oral fluid) that can be impeded when forced to combine with labeling reagents before migration on the test strip to the test zone area. +Multiplexing is significantly improved as a result of the design of DPP® and this provides a significant advantage. The HIV confirmatory test we developed for Bio-Rad employs six different markers. We have a contract development program that involves the use of eight bands, and we have another funded multiplex product program that is pending. Our intellectual property also extends to the use of multiple test membranes that through a common sample strip utilize a single sample. Employing this feature we can develop so-called “Fourth Generation” tests that are able to detect antigens prior to seroconversion to antibodies, as well as antibodies. If developed successfully, this would allow earlier detection of diseases at an acute stage, which improves health outcomes. We have completed initial feasibility studies with technologies (owned by others) that uniquely complement our DPP® technology and that will assist in these efforts by enabling even lower limits of analyte detection. This is a capability which we believe is essential to have in order to develop new products and market opportunities over the long term. +Target Markets +Rapid HIV Tests +A large percentage of individuals that are HIV positive worldwide are unaware of their status. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results when samples have to be sent out to a laboratory which can take up to several days to process. However, the increased availability, greater efficacy and reduced costs for anti-retroviral treatments (ARVs) for HIV has increased the demand for testing, as the stigma associated with the disease is lessened, and the ability to resume normal activities is substantially improved, providing a positive message to those potentially infected. +There are approximately 53,000 new diagnoses of HIV infection in the United States each year, according to the CDC. In time, most of these infections progress to AIDS. The CDC estimates that approximately 1.2 million individuals in the U.S. are living with HIV, with an estimated 250,000 Americans, or more than 20%, unaware that they are infected. It is these 250,000 infected people that are reported to account for 54% of all new infections per year. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results from samples that have to be sent out to a laboratory and that can take up to several days to process. Making more people aware of their HIV status at the point-of-care reduces the number of HIV transmissions. +Rapid HIV testing in the United States has now developed into an estimated 7.5 million test market. This is from zero in 2003 when Orasure Technologies, Inc. received the first FDA approval for a rapid HIV test. We believe that the US professional HIV rapid test market (not including the OTC market) has the potential to increase to 15-18 million tests over the next several years, which would represent 40-50% of all HIV tests done today in the United States for clinical purposes. Assuming an average price to the manufacturers of $8.00 per test, a total potential U.S. market of nearly $120-$150 million is implied. +In 2006, the outlook for HIV testing was given a big boost with the release by the CDC of new recommendations for HIV testing. These new CDC recommendations are that an HIV test should be given as a routine test like any other for all patients between 13 and 64 years of age, regardless of risk, with an opt-out screening option and focused testing procedural (pre- and post-test counseling) guidelines. Though not mandatory, gradual adoption in whole or in part of the 2006 CDC recommendations by a number of states continues to have an increasing impact. Importantly, in November 2012 the United States Preventive Services Task Force (“USPSTF”) finally fully embraced these CDC routine HIV testing recommendations. This USPSTF draft recommendation, which was given an A grade under their recommendation grading system based on the benefits of this practice and the nearly 600,000 AIDS-related deaths in the United States, requires insurance coverage under the Affordable Care Act (the “ACA”) . If finalized as anticipated, we expect this to result in an increase in HIV testing in the United States in the coming years, which we believe will include point-of-care HIV testing utilizing the Company’s products. Currently most public health testing in the United States is funded by grants allocated to high prevalence areas by the CDC, but we believe this will shift to an insurance-funded model under the ACA in the years to come. +7 +In the international market , we sell our products directly and through distributors to large screening programs overseen by ministries of health and NGOs, most but not all of which are funded by large bi-lateral and multi-lateral AIDS relief programs, the largest of which is the U.S. President’s Emergency Plan for AIDS Relief (PEPFAR). PEPFAR directly supported HIV testing and counseling for more than 11 million pregnant women in fiscal year 2012 and testing and counseling for more than 49 million people. The U.S. is the first and largest donor to the Global Fund to Fight AIDS, Tuberculosis and Malaria. To date, the U.S. has provided more than $7 billion to the Fund. +For FY 2012, President Obama requested $7.2 billion, including $5.6 billion for bilateral HIV/AIDS programs, $1.3 billion for the Global Fund, and $254 million for bilateral TB programs. For FY 2013, President Obama is requesting $6.4 billion, including more than $4.5 billion for bilateral HIV/AIDS programs, $1.6 billion for the Global Fund, and $232 million for bilateral TB programs. The U.S. deficit crisis is likely to impact funding of these large programs, and the eligibility of lower quality, non-U.S. sourced products make these markets challenging. +Chembio, is unique with four U.S.-manufactured rapid HIV tests, three FDA-approved, and is recognized as a reputable and dependable supplier of high quality products that are available at reasonably competitive prices. As a result certain of our products have been selected in the testing protocols in countries (national algorithms) that are large beneficiaries of PEPFAR and the Global Fund. As mentioned above, these programs can and do often result in large orders, but also can result in periods of relatively lower demand, based on the variations associated with this kind of demand. +Oral fluid testing is an established alternative to blood testing for diagnostic tests, including HIV tests. It is also often patient preferred, providing a more comfortable, less invasive test. In certain public health clinics, staffs choose not to handle blood specimens; thus, oral sample collection provides a viable alternative. The most well-established market for oral fluid HIV testing is the United States. +There is also now an over-the-counter market for HIV self-testing and we are uniquely positioned to participate in this market, should we believe the investment is justified. So far one company, Orasure Technologies Inc., received FDA approval for an over-the-counter (self-testing) version of its previously professional-market-approved HIV test. The FDA approval was granted in July 2012, the product was launched in October, and Orasure is investing heavily in developing this market, with the initial results modest though with some promise even if not nearly for the levels speculated by some . +Based on the fact that FDA requires that any over-the-counter HIV test to have first been approved for the professional market, we believe that Chembio is the only other company that can participate in this market opportunity if it chooses to. Although there is a third company, Trinity Biotech, that meets that condition, they have stated that they do not intend to pursue this market. Therefore Chembio is carefully monitoring developments in this market, which may be significant during 2013. Currently we could initiate the over-the-counter approval process with either of our two blood tests. We have completed a preliminary self-study for our Sure Check “barrel” device as the final component to our preparing and submitting an Investigational Device Exemption (“IDE”) application to the FDA during the first quarter of 2013. Provided we submit this application and it is granted, that would enable us to begin clinical trials by the time we gather better information as to how the Orasure product is doing in the market. And now that we have received approval of our pre-marketing application for our DPP® oral fluid HIV test, we could additionally, or alternatively, pursue over-the-counter approval for that product once we receive the CLIA waiver grant for that product. We believe that we will wait at least some additional months before commencing these clinical trials because (1) the costs for such over-the-counter approval, including primarily the associated clinical trials, are estimated to be at least $5 million and they may take two to three years to complete; (2) Orasure’s initial results are not convincing of a large market, though this possibility remains and Orasure is likely to spend heavily on this for some time and (3) we are well positioned versus any other competitors. +Rapid Syphilis Tests +Recent data indicate that approximately 70,000-100,000 new cases of syphilis are occurring annually in the U.S. Syphilis can be treated with antibiotics, but untreated it can cause pelvic inflammatory disease, infertility, ectopic pregnancy and can infect newborns. Treatment cannot be provided without a confirmed diagnosis of an active case of syphilis. Current testing algorithms in the United States require two different tests (called non-treponemal and treponemal markers), each requiring trained personnel in laboratory settings and several days to receive back results, in order to confirm an active, previously untreated case. The screening test still employed in the United States is known as RPR; it utilizes an old technology that has a high degree of false positive results. +Development of the POC market for syphilis testing is expected to be comparable to the development of the POC market for HIV testing, as there is a significant public health value to being able to provide results at the point-of-care. There are several ways to assess the market opportunity for this unique rapid test, although we believe the U.S. rapid test market opportunity may exceed 8 million tests, which is approximately 20% of the total number of syphilis tests performed in the United States for clinical use today. Unlike HIV testing, where a positive result first requires a confirmatory test, and then further tests to measure viral load before expensive treatment decisions are made, an individual with a confirmed active case of syphilis can be prescribed antibiotics immediately. +8 +We believe the opportunity for our recently developed combination HIV-Syphilis test is significant in the U.S. and globally, and we anticipate making significant progress in 2013 in order to capitalize on these opportunities. +Marketing Strategy +Our marketing strategy is to: +● Support, review and assess the marketing and distribution efforts of our rapid HIV tests by Alere in the U.S., as well as our distributors worldwide, and to engage in sales and marketing activities that allow us to engage with our target markets and customers. Alere, which is a leading marketer of point-of-care diagnostic products, has significantly expanded its distribution footprint since we signed our agreement with them, and although we believe that this will enhance opportunities for Alere to market our rapid HIV tests, the product line is a very small one for them, notwithstanding the strong growth they have enjoyed with respect to our products. +● Leverage our DPP® intellectual property and regulated product development and manufacturing experience to continue creating new collaborations where Chembio can be the exclusive development and manufacturing partner supporting leading marketing organizations. +● Establish strong distribution relationships for our Chembio-branded products in the U.S and abroad and establish a direct sales and marketing organization that is focused in the public health market segment, and that utilizes distributors for other market segments, primarily the acute care market which, together with public health, are the main market segments for rapid HIV tests in the United States. We believe that creation of a Chembio public health brand and marketing organization is fundamental to the creation of shareholder value over the long term +Competition +The diagnostics industry is a multi-billion dollar international industry and is intensely competitive. Many of our competitors are substantially larger and have greater financial, research, manufacturing and marketing resources. +Industry competition in general is based on the following: +● Scientific and technological capability; +● Proprietary know-how; +● The ability to develop and market products and processes; +● The ability to obtain FDA or other required regulatory approvals ; +● The ability to manufacture products that meet applicable FDA requirements, (i.e. FDA’s Quality System Regulations) (see Governmental Regulation section); +● The ability to manufacture products cost-effectively; +● Access to adequate capital; +● The ability to attract and retain qualified personnel; and +● The availability of patent protection. +We believe our scientific and technological capabilities and our proprietary know-how relating to our in-licensed lateral flow technology rapid tests and to our proprietary know-how related to our patented dual path platform® technology, particularly for the development and manufacture of tests for the detection of antibodies to infectious diseases such as HIV, are very strong. +Our ability to develop and market other products is in large measure dependent on our having additional resources and/or collaborative relationships. Some of our product development efforts have been funded on a project or milestone basis. We believe that our proprietary know-how in lateral flow technology and in our Dual Path Platform® (DPP®) technology has been instrumental in our obtaining the collaborations we have and that we continue to pursue. We believe that the patent protection that we have with our Dual Path Platform® (DPP®) enhances our ability to develop more profitable collaborative relationships and to license out the technology. However there are a number of competitive technologies used and/or seeking to be used in point-of-care settings. These technologies may be based on immunoassay principles such as the Company’s products or other technologies such as molecular-based technologies. +9 +Research and Development +During 2012 and 2011, $4.5 million and $4.9 million, respectively, were spent on research and development (including regulatory activities). These expenses were in part underwritten by funding from R&D and milestones revenues of $1.3 million in 2012 and $1.8 million in 2011. All of our new product development activities involve employment of our Dual Path Platform® (DPP®) technology. These activities include completing development of certain products and making significant progress toward the development of additional products. +Employees +At December 31, 2012, we employed 174 people. We have entered into employment contracts with our President, Lawrence Siebert, and our Senior Vice President of Research and Development, Javan Esfandiari. Due to the specific knowledge and experience of these executives regarding the industry, technology and market, the loss of the services of either one of them would likely have a material adverse effect on the Company. The contract with Mr. Siebert provides that Mr. Siebert will serve as the Chief Executive Officer and President of the Company through May 11, 2013. The contract with Mr. Esfandiari has a term of three years ending March 2016. We have obtained a key man insurance policy for Mr. Esfandiari. +Governmental Regulation +The manufacturing and marketing of the Company’s existing and proposed diagnostic products are regulated by the United States Food and Drug Administration (“FDA”), United States Department of Agriculture (“USDA”), certain state and local agencies, and/or comparable regulatory bodies in other countries. These regulations govern almost all aspects of development, production and marketing, including product testing, authorizations to market, labeling, promotion, manufacturing and record keeping. The Company’s FDA and USDA regulated products require some form of action by each agency before they can be marketed in the United States, and, after approval or clearance, the Company must continue to comply with other FDA requirements applicable to marketed products, e.g. Quality Systems (for medical devices). Failure to comply with the FDA’s requirements can lead to significant penalties, both before and after approval or clearance. +There are two review procedures by which medical devices can receive FDA clearance or approval. Some products may qualify for clearance under Section 510(k) of the Federal Food, Drug and Cosmetic Act, in which the manufacturer provides a pre-market notification that it intends to begin marketing the product, and shows that the product is substantially equivalent to another legally marketed product (i.e., that it has the same intended use and is as safe and effective as a legally marketed device and does not raise different questions of safety and effectiveness). In some cases, the submission must include data from human clinical studies. Marketing may commence when the FDA issues a clearance letter finding such substantial equivalence. FDA clearance of our DPP® Syphilis Screen & Confirm test will be by means of a 510(k) submission. +If the medical device does not qualify for the 510(k) procedure (either because it is not substantially equivalent to a legally marketed device or because it is required by statute and the FDA’s implementing regulations have an approved application), the FDA must approve a Pre-Marketing Application (“PMA”) before marketing can begin. PMA’s must demonstrate, among other matters, that the medical device provides a reasonable assurance of safety and effectiveness. A PMA application is typically a complex submission, including the results of non-clinical and clinical studies. Preparing a PMA application is a much more expensive, detailed and time-consuming process as compared with a 510(K) pre-market notification. The Company has approved PMAs for the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1-2 and Clearview® HIV 1-2 STAT PAK®. +FDA approval of our DPP® HIV screening assay for use with oral fluid or blood samples was achieved by means of a PMA application. The Clinical Laboratory Improvement Act of 1988 (“CLIA”) prohibits laboratories from performing in-vitro tests for the purpose of providing information for the diagnosis, prevention or treatment of any disease or impairment of, or the assessment of, the health of human beings unless there is in effect for such laboratories a certificate issued by the United States Department of Health and Human Services (via the FDA) applicable to the category of examination or procedure performed. Although a certificate is not required for the Company, it considers the applicability of the requirements of CLIA in the design and development of its products. The statutory definition of “laboratory” is very broad, and many of our customers are considered labs. A CLIA waiver will remove certain quality control and other requirements that must be met for certain customers to use the Company’s products and this is critical to the marketability of a product into the point-of-care diagnostics market. The Company has received a CLIA waiver for each of the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1/2 and Clearview® HIV 1/2 STAT PAK®. The CLIA waiver was granted by the FDA for HIV 1/2 STAT-PAK on November 20, 2006 and for the Clearview® Complete HIV 1/2 on October 22, 2007. In 2008 the FDA revised its CLIA waiver requirements so that an additional prospective trial need be conducted in order to demonstrate clinical utility by showing that the device is capable of identifying new infections. Given the low prevalence of HIV, the FDA will require 30 new HIV cases to be identified, supplemented by additional data and this is the study the Company will perform during 2013. +10 +In addition, the FDA regulates the export of medical devices that have not been approved for marketing in the United States. The Federal Food, Drug and Cosmetic Act contains general requirements for any medical device that may not be sold in the United States and is intended for export. Specifically, a medical device intended for export is not deemed to be adulterated or misbranded if the product: (1) complies with the specifications of the foreign purchaser; (2) is not in conflict with the laws of the country to which it is intended for export; (3) is prominently labeled on the outside of the shipping package that it is intended for export; and (4) is not sold or offered for sale in the United States. However, the Federal Food, Drug and Cosmetic Act does permit the export of devices to any country in the world, if the device complies with the laws of the importing country and has valid marketing authorization in one of several “listed” countries under the theory that these listed countries have sophisticated mechanisms for the review of medical devices for safety and effectiveness. +The Company is also subject to regulations in foreign countries governing products, human clinical trials and marketing, and may need to obtain approval or evaluations by international public health agencies, such as the World Health Organization, in order to sell diagnostic products in certain countries. Approval processes vary from country to country, and the length of time required for approval or to obtain other clearances may in some cases be longer than that required for United States governmental approvals. On the other hand, the fact that our HIV diagnostic tests are of value in the AIDS epidemic may lead to some government process being expedited. The extent of potentially adverse governmental regulation affecting Chembio that might arise from future legislative or administrative action cannot be predicted. +One or more of the Company’s rapid HIV tests are also approved or pending approval for marketing in several foreign jurisdictions, including but not limited to Brazil, Mexico, and a number of other nations in the developing world. +Environmental Laws +To date, we have not encountered any costs relating to compliance with any environmental laws. +Intellectual Property +Intellectual Property Strategy +Our intellectual property strategy is to: (1) build our own intellectual property portfolio around our Dual Path Platform® technology; (2) pursue licenses, trade secrets and know-how within the area of rapid point-of-care testing, and (3) develop and acquire proprietary positions to reagents and new hardware platforms for the development and manufacture of rapid diagnostic tests. +The Company has obtained patent coverage on the DPP® technology, including three U.S. patents, and patents in China, Malaysia, Eurasia, Mexico, Singapore, Japan and the U.K. Additional patent applications on the DPP® product line are pending in the U.S., as well as in many foreign countries such as Australia, Brazil, Canada, the European Union, India, Indonesia, Israel, Korea, and South Africa. Patents have also been filed on extensions to the DPP® product line concept such as 4th generation assays. +The Company has also filed for patents and obtained some patents in the U.S. for other inventions such as its multiple host species veterinary TB test, and patent applications for the other inventions are in various stages from being recently filed and not yet examined, to already examined and allowed but not yet issued. The Company selectively and strategically foreign files its patent applications based on a number of economic and strategic factors related to the invention. +Trademarks +The Company has filed and obtained trademarks for its products including DPP®, SURE CHECK® and STAT-PAK®. The DPP® trademark is also registered under the European convention (ECT). +Trade Secrets and Know-How +We believe that we have developed a substantial body of trade secrets and know-how relating to the development of lateral flow and DPP® based diagnostic tests, including but not limited to the sourcing and optimization of materials for such tests, and how to maximize sensitivity, speed-to-result, specificity, stability and reproducibility. The Company possesses proprietary know-how to develop tests for multiple conditions using colored latex. Our buffer formulations enable extremely long shelf lives of our rapid HIV and other tests and we believe that this provides us with an important competitive advantage. +11 +Lateral Flow Technology and Reagent Licenses +As part of our agreements in 2006 with Alere for the marketing of our HIV tests, we were granted non-exclusive licenses to certain lateral flow technology for certain products manufactured and marketed by Chembio including but not limited to our HIV tests. Although we believe our DPP® is outside of the scope of all lateral flow patents of which we are aware, we consult with patent counsel, and seek licenses and/or redesigns of products that we believe to be in the best interests of the Company and our stockholders. Because of the costs and other negative consequences of time-consuming patent litigation, we often attempt to obtain a license on reasonable terms. Nevertheless there is no assurance that the Alere lateral flow patents we have licensed will not be challenged or that other patents containing claims relevant to the Company’s lateral flow or DPP® products will not be granted to third parties and that licenses to such patents, will be available on reasonable terms, if any. In the past Alere has aggressively enforced its lateral flow intellectual property, although some of the main patents will expire within the next couple of years and we are not aware of any patent enforcement litigation that is ongoing with respect to the Alere lateral flow intellectual property. +Regardless, the DPP® technology provides us with our own intellectual property. We believe it provides us with a freedom to operate, and that it also enables tests to be developed with improved sensitivity as compared with comparable tests on lateral flow platforms. The Company has signed and anticipates signing new development projects based upon the DPP® technology that will provide new manufacturing and marketing opportunities. We have filed other patents that we believe will strengthen the DPP® intellectual property and have also filed for patent protection for certain other point-of-care technologies or applications thereof. +The peptides used in our rapid HIV tests were patented by Adaltis Inc. and were licensed to us under a 10-year non-exclusive license agreement dated August 30, 2002. However, in connection with Adaltis’ bankruptcy, during the third quarter of 2009 we bought out all of our remaining obligations under that agreement. We also have licensed the antigens used in other tests including our Syphilis, Tuberculosis, Leptospirosis, Leishmaniasis and Chagas tests, and we may enter other license agreements. In prior years we concluded license agreements related to intellectual property rights owned by the United States associated with HIV- 1, and during the first quarter of 2008 we entered into a sub-license agreement for HIV-2 with Bio-Rad Laboratories N.A., the exclusive licensee of the Pasteur Institute’s HIV-2 intellectual property estate. +Corporate History +On May 5, 2004, we completed a merger with Trading Solutions, Inc. through which Chembio Diagnostic Systems Inc. became our wholly-owned subsidiary, and through which the management and business of Chembio Diagnostic Systems Inc. became our management and business. As part of this transaction, we changed our name to Chembio Diagnostics, Inc. In 2003, we had sold our prior business, and as a result, we had no specific business immediately prior to the merger. +Since the formation of Chembio Diagnostic Systems Inc. in 1985, it has been involved in developing, manufacturing, selling and distributing in-vitro diagnostic tests, including rapid tests beginning in 1995, for a number of conditions in humans and animals. +On March 12, 2004, we implemented a 1-for-17 reverse split of our common stock. All references in this Form 10-K to shares of our common stock have been adjusted to reflect this reverse split. +In February 2010, Crestview Capital Master, L.L.C. ("Crestview Master”), a Delaware limited liability company that held 18,907,431 shares of Chembio's common stock, spun off all these shares, constituting approximately 30.5% of Chembio's outstanding shares, to its three equity holders. One of the three equity holders of Crestview Master immediately spun off, to its approximately 126 equity holders, all of the 12,990,569 shares of Chembio stock that it received in this distribution. As a result, as of February 24, 2010, Crestview Master no longer owned any shares. The former direct and indirect equity holders of Crestview Master owned all these shares, with none of these individual stockholders having beneficial ownership of more than 5.61% of the outstanding common stock of Chembio. +On May 30, 2012, the Company effected a 1-for-8 reverse split of its common stock. This was done to allow the Company to move to the NASDAQ trading market from the OTCQB market, which occurred on June 7, 2012. As a result of the stock split, the outstanding 63,967,263 common shares were reduced to 7,995,918 outstanding common shares on May 30, 2012. The effect of the reverse stock split has been retroactively reflected for all periods in these financial statements. +12 +Glossary +AIDS +Acquired Immunodeficiency Syndrome. AIDS is caused by the Human Immunodeficiency Virus, HIV. +ALGORITHM (parallel or serial) +For rapid HIV testing this refers both to method or protocol (in developing countries to date) for using rapid tests from different manufacturers in combination to screen and confirm patients at the point-of-care, and may also refer to the specific tests that have been selected by an agency or ministry of health to be used in this way. A parallel algorithm uses two screening tests from different manufacturers and a tie-breaker test only if there is a discrepancy between the screening tests results. A serial algorithm only uses a second confirmatory test if there is a positive result from the screening test, meaning that the number of confirmatory tests used is equal to the positivity rate in the testing venue. A tie-breaker test resolves discrepancies between the screen and the confirmatory test. +ANTIBODY +A protein which is a natural part of the human immune system produced by specialized cells to neutralize antigens, including viruses and bacteria that invade the body. Each antibody producing cell manufactures a unique antibody that is directed against, binds to and eliminates one, and only one, specific type of antigen. +ANTIGEN +Any substance which, upon entering the body, stimulates the immune system leading to the formation of antibodies. Among the more common antigens are bacteria, pollens, toxins, and viruses. +ANVISA +ARVs +Anti-Retroviral Treatments for AIDS +The National Health Surveillance Agency of Brazil +Anti-retroviral medications developed to fight AIDS +CDC +United States Centers for Disease Control and Prevention +CLIA waiver +Clinical Laboratory Improvement Act designation that allows simple tests to be performed in point-of-care settings such as doctor’s offices, walk-in clinics and emergency rooms. +DIAGNOSTIC +Pertaining to the determination of the nature or cause of a disease or condition. Also refers to reagents or procedures used in diagnosis to measure proteins in a clinical sample. +EITF +Emerging Issues Task Force +FASB +FIOCRUZ +Financial Accounting Standards Board +The Oswaldo Cruz Foundation of Brazil +FDA +United States Food and Drug Administration +FDIC +Federal Deposit Insurance Corporation +FAS +Financial Accounting Standard +IgG +IgG or Immunoglobulin are proteins found in human blood. This protein is called an “antibody” and is an important part of the body’s defense against disease. When the body is attacked by harmful bacteria or viruses, antibodies help fight these invaders. +NGO +Non-Governmental Organization +OTC +Over-the-Counter +PEPFAR +The President’s Emergency Plan for AIDS Relief +PMA +Pre-Marketing Approval –FDA approval classification for a medical device that is not substantially equivalent to a legally marketed device or is otherwise required by statute to have an approved application. Rapid HIV tests must have an approved PMA application before marketing of such a product can begin. +PROTOCOL +A procedure pursuant to which an immunodiagnostic test is performed on a particular specimen in order to obtain the desired reaction. +REAGENT +A chemical added to a sample under investigation in order to cause a chemical or biological reaction which will enable measurement or identification of a target substance. +RETROVIRUS +A type of virus which contains the enzyme Reverse Transcriptase and is capable of transforming infected cells to produce diseases in the host such as AIDS. +SAB +Staff Accounting Bulletin +SENSITIVITY +Refers to the ability of an assay to detect and measure small quantities of a substance of interest. The greater the sensitivity, the smaller the quantity of the substance of interest the assay can detect. Also refers to the likelihood of detecting the antigen when present. +SPECIFICITY +The ability of an assay to distinguish between similar materials. The greater the specificity, the better an assay is at identifying a substance in the presence of substances of similar makeup. +USDA +U.S Department of Agriculture +WHO +World Health Organization +13 +ITEM 1A. +RISK FACTORS +You should carefully consider each of the following risk factors and all of the other information provided in this Annual Report. The risks described below are those we currently believe may materially affect us. An investment in our Common Stock involves a high degree of risk, and should be considered only by persons who can afford the loss of their entire investment. +Risks related to our industry, business and strategy +Because we may not be able to obtain or maintain the necessary regulatory approvals for some of our products, we may not generate revenues in the amounts we expect, or in the amounts necessary to continue our business. Our existing products as well as our manufacturing facility must meet quality standards and are subject to inspection by a number of domestic regulatory and other governmental and non-governmental agencies. +All of our proposed and existing products are subject to regulation in the U.S. by the U.S. Food and Drug Administration, the U.S. Department of Agriculture and/or other domestic and international governmental, public health agencies, regulatory bodies or non-governmental organizations. In particular, we are subject to strict governmental controls on the development, manufacture, labeling, distribution and marketing of our products. The process of obtaining required approvals or clearances varies according to the nature of, and uses for, a specific product. These processes can involve lengthy and detailed laboratory testing, human or animal clinical trials, sampling activities, and other costly, time-consuming procedures. The submission of an application to a regulatory authority does not guarantee that the authority will grant an approval or clearance for product. Each authority may impose its own requirements and can delay or refuse to grant approval or clearance, even though a product has been approved in another country. +The time taken to obtain approval or clearance varies depending on the nature of the application and may result in the passage of a significant period of time from the date of submission of the application. Delays in the approval or clearance processes increase the risk that we will not succeed in introducing or selling the subject products, and we may determine to devote our resources to different products. +Changes in government regulations could increase our costs and could require us to undergo additional trials or procedures, or could make it impractical or impossible for us to market our products for certain uses, in certain markets, or at all. +Changes in government regulations may adversely affect our financial condition and results of operations because we may have to incur additional expenses if we are required to change or implement new testing, manufacturing and control procedures. If we are required to devote resources to develop such new procedures, we may not have sufficient resources to devote to research and development, marketing, or other activities that are critical to our business. +We can manufacture and sell our products only if we comply with regulations and quality standards established by government agencies such as the FDA and the USDA as well as by non-governmental organizations such as the ISO and WHO. We have implemented a quality system that is intended to comply with applicable regulations. Although FDA approval is not required for the export of our products, there are export regulations promulgated by the FDA that specifically relate to the export of our products. Although we believe that we meet the regulatory standards required for the export of our products, these regulations could change in a manner that could adversely impact our ability to export our products. +Our products may not be able to compete with new diagnostic products or existing products developed by well-established competitors, which would negatively affect our business. +The diagnostic industry is focused on the testing of biological specimens in a laboratory or at the point-of-care and is highly competitive and rapidly changing. Our principal competitors often have considerably greater financial, technical and marketing resources than we do. Several companies produce diagnostic tests that compete directly with our testing product line, including but not limited to, Orasure Technologies, Alere and Trinity Biotech. Furthermore these and/or other companies have or may have products incorporating molecular and/or other superior technologies that over time could directly compete with our testing product line. As new products incorporating new technologies enter the market, our products may become obsolete or a competitor’s products may be more effective or more effectively marketed and sold than ours. +14 +We have granted Alere exclusive rights to market our SURE CHECK® HIV 1/2 in the United States and non-exclusive rights in the rest of the world and exclusive rights to market our HIV 1/2 STAT PAK® in the U.S. only. Alere has no rapid HIV tests that are approved for marketing in the U.S. and Alere is obligated to inform us of any such products within certain time frames. We believe that Alere is committed to successfully marketing our products in the U.S.. Alere may however choose to develop or acquire competing products for marketing in the U.S. and such an action could have at least a temporary material adverse effect on the marketing of these products until such time as alternative marketing arrangements could be implemented. In particular Alere manufactures and markets outside the United States a rapid HIV test product called Determine® that, with its widely available so-called “3 rd generation” test, is the leading screening product used in a large majority of the national algorithms of countries funded by PEPFAR and the Global Fund, as well as many other countries in the world. The newest Determine HIV version is the so called “4 th Generation” version Determine test which, according to its claims, detects HIV antibodies and the P24 HIV antigen which is present in HIV positive individuals’ blood samples before antibodies are, and therefore is able to detect HIV infection earlier than tests that solely rely on antibody detection, such as Chembio’s and all of the other currently FDA approved rapid HIV tests, which all require an immune response before detection can occur. The actual performance of the 4 th generation Alere product has been inconsistent with regard to meeting these and other performance claims, although recently it has been reformulated, though limited data has been published since such reformulation. Regardless Alere continues to make statements that it is seeking FDA approval of this product which, if approval is granted, would make it a competitive product to the Chembio products that Alere markets as Clearview® Complete (barrel) and Clearview HIV ½ STAT PAK® (cassette). Under our agreements, Alere is in fact expressly permitted to “exploit” such a product (a “permitted competing product”) in the United States without breaching the agreement, though there are defined alternative consequences that would follow in such case: for the cassette product, Chembio may at any time after Alere begins to “exploit” the Determine product in the United States either terminate the agreement with Alere or make the agreement with Alere non-exclusive; for the barrel product, Chembio and StatSure Diagnostics (the other party to the Alere 3-way agreement pertaining to the barrel product) will need to jointly agree to either continue the agreement with Alere or to make the barrel agreement with Alere non-exclusive in the United States. As part of any decision by Chembio to market either product, Alere would expand the lateral flow license granted to allow Chembio to market the product under Chembio brands, if necessary. +During 2011 Biolytical, Inc. of Vancouver, Canada received FDA approval and in 2012 received CLIA waiver of a flow-through rapid HIV test called “INSTI”. The technology used in the INSTI test is older than lateral flow, which requires handling of multiple components (3 vials of solution) to perform the test in multiple steps. However, these steps can be accomplished in less than ten minutes, and the actual test results occur in only one minute after those steps are completed. Therefore sample-to-result time is shorter than any of the competitive products. There are settings where that reduce total test time may be a distinct advantage. However, thus far Biolytical’s market penetration has been negligible. +Although we have no specific knowledge of any other competitor’s product that are a competitive threat to our product, or that will render our products obsolete, if we fail to maintain and enhance our competitive position or fail to introduce new products and product features, our customers may decide to use products developed by our competitors, which could result in a loss of revenues and cash flow. +We have developed an oral fluid rapid HIV test as well as other applications utilizing our Dual Path Platform technology, which we believe will enhance our competitive position in HIV rapid testing and other fields. During 2012 we made significant progress toward the commercialization of this product. However we still have technical, manufacturing, regulatory and marketing challenges to meet before we will know whether we can successfully commercialize products incorporating this technology. There can be no assurance that we will overcome these challenges. +We plan to introduce our recently FDA -approved DPP® oral fluid HIV test, which test also can be used with blood samples, in the U.S. market under a Chembio brand once it is CLIA-waiver, currently anticipated by the end of 2013, but for which there can be no assurance. Under our 2006 Agreement with Alere, Alere has a right of first negotiation for the right to market any new rapid HIV antibody detection test that we develop. In accordance with this provision in our agreement, we presented this product to Alere in 2007, and in 2007 Alere waived its right of first negotiation under the agreement. While such waiver does not prevent Alere from reconsidering the marketing of this product, we have no reason to believe that they will. Also, although we believe that the primary market opportunity for the DPP® HIV product is for those customers that have a clear preference for an oral fluid HIV test, the product is also likely to compete to some extent with our FDA-approved rapid HIV tests being marketed by Alere. Therefore this could have a material and adverse effect on our business with Alere. +15 +More generally, the point-of-care diagnostics industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. As new technologies become introduced into the point-of-care diagnostic testing market, we may be required to commit considerable additional efforts, time and resources to enhance our current product portfolio or develop new products. We may not have the available time and resources to accomplish this, and many of our competitors have substantially greater financial and other resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers, which would materially harm our operating results. +Although we own our DPP® patent, we own no issued patents covering lateral flow technology, and the field of lateral flow technology is complex and characterized by a substantial amount of litigation, so the risk of potential patent challenges is ongoing for us in spite of our DPP® patent. Moreover, we believe that certain lateral flow patents are going to expire in the next couple of years which may materially impact the competitive landscape. +Although we have been granted non-exclusive licenses to the lateral flow patents owned by Alere, there is no assurance that its lateral flow patents will not be challenged or that licenses from other parties may not be required, if available at all. In addition, certain of the Alere patents will expire in the next couple of years which expiration could open the market to certain competitors. In the event that it is determined that a license is required and it is not possible to negotiate a license agreement under a necessary patent, we may be able to modify our HIV rapid test products and other products such that a license would not be necessary. However, there is no assurance that we would be able to do so, and even if accomplished, this alternative could delay or limit our ability to sell these products in the U.S. and other markets, which would adversely affect our results of operations, cash flows and business. +On March 13, 2007, our Dual Path Platform Immunoassay Device patent application was issued as United States patent no. 7,189,522. Additional protection for this intellectual property is pending in a number of other countries. This platform has shown improved sensitivity as compared with conventional platforms in a number of studies. However several factors go into the development and performance attributes of products, and the ability of our products to successfully compete will depend on several other factors including but not limited to our having a patent rapid test platform technology. +We believe that our Dual Path Platform is outside of the scope of currently issued patents in the field of lateral flow technology, thereby offering the possibility of a greater freedom to operate. However there can be no assurance that our patents or our products incorporating the patent claims will not be challenged at some time in the future. +New developments in health treatments or new non-diagnostic products may reduce or eliminate the demand for our products. +The development and commercialization of products outside of the diagnostics industry could adversely affect sales of our products. For example, the development of a safe and effective vaccine to HIV or treatments for other diseases or conditions that our products are designed to detect, could reduce, or eventually eliminate the demand for our HIV or other diagnostic products and result in a loss of revenues. +We may not have sufficient resources to effectively introduce and market our products, which could materially harm our operating results. +Introducing and achieving market acceptance for our rapid HIV tests and other new products will require substantial marketing efforts and will require us and/or our contract partners, sales agents, and/or distributors to make significant expenditures of time and money. In some instances we will be significantly or totally reliant on the marketing efforts and expenditures of our contract partners, sales agents, and/or distributors. If they do not have or commit the expertise and resources to effectively market the products that we manufacture, our operating results will be materially harmed. +The success of our business depends on, in addition to the market success of our products, our ability to raise additional capital through the sale of debt or equity or through borrowing, and we may not be able to raise capital or borrow funds on attractive terms and/or in amounts necessary to continue our business, or at all. +Our revenues and gross margins have increased significantly in recent periods, and we have been profitable for four consecutive years. Nevertheless, prior to 2009 we sustained significant operating losses since 2004, and we incurred an operating and net loss as recently as the third quarter of 2012. At December 31, 2012, we had a stockholders’ equity of $13.9 million and a working capital surplus of$7.6 million . The Company estimates that its resources are sufficient to fund its needs through the end of 2013 and beyond. The Company’s liquidity and cash requirements will depend on several factors. These factors include (1) the level of revenues; (2) the extent to which, if any, that revenue level improves operating cash flows; (3) the Company’s investments in research and development, facilities, marketing, regulatory approvals, and other investments it may determine to make; and (4) the Company’s investment in capital equipment and the extent to which it improves cash flow through operating efficiencies. There are no assurances that the Company will remain profitable or generate positive cash flow in 2013 or, in the alternative, be successful in raising sufficient capital to fund its needs through 2013 and thereafter. +16 +The increase in revenues we experienced in 2012 was almost entirely attributable to the distribution of our DPP® products in Brazil by the Ministry of Health as supplied by our contract partner, the Oswaldo Cruz Foundation (FIOCRUZ). However the agreements we have with FIOCRUZ have limited purchase requirements remaining for most of the five products that, in the aggregate, are less than our revenues realized from FIOCRUZ in 2012, and even these requirements pertain only in order to trigger a technology transfer right for the applicable product. Moreover, we have recently been advised by FIOCRUZ that the scale-up of the Brazilian Ministry of Health’s programs that are utilizing our HIV and Syphilis tests is going more slowly than anticipated., Taken together, this is likely to result in significantly reduced revenues to FIOCRUZ in 2013 versus 2012. +Therefore, in order for our 2013 revenues to be of the same level as in 2012 we would need to increase revenues from other customers in excess of the decreased 2013 sales to FIOCRUZ, which is possible. +We anticipate increased revenues from Alere in 2013 and we are attempting to increase international sales of our products. However, a number of factors can slow or prevent these increases, or substantially increase the cost of achieving these increases assuming they are achieved: +● economic conditions and the absence of or reduction in available funding sources ; +● regulatory requirements and customs regulations; +● cultural and political differences; +● foreign exchange rates, currency fluctuations and tariffs ; +● dependence on and difficulties in managing international distributors or representatives ; +● the creditworthiness of foreign entities; +● difficulties in foreign accounts receivable collection; +● competition; and +● pricing. +If we are unable to increase our revenues from domestic and/or international sales to make up for the decreases in sales to FIOCRUZ, our operating results will be materially harmed. +Although we have an ethics and anti-corruption policy in place, and have no knowledge or reason to know of any practices by our employees, agents or distributors that could be construed as in violation of such policies, our business includes sales of products to countries where there is or may be widespread corruption. +Chembio has a policy in place prohibiting its employees, distributors and agents from engaging in corrupt business practices, including activities prohibited by the United States Foreign Corrupt Practices Act (FCPA). Nevertheless, because we work through independent sales agents and distributors (and do not have any employees or subsidiaries) outside the United States, we do not have control over the day-to-day activities of such independent agents and distributors. In addition, in the donor- funded markets in Africa where we sell our products, there is significant oversight from PEPFAR, the Global Fund, and advisory committees comprised of technical experts concerning the development and establishment of national testing protocols. This is a process that includes an overall assessment of a product which includes extensive product performance evaluations including five active collaborations and manufacturer’s quality systems, as well as price and delivery. In Brazil where we have had a total of six product collaborations with FIOCRUZ, those programs that our products are or may be deployed in are all funded by the Brazilian Ministry of Health. Although FIOCRUZ is affiliated with the Brazilian Ministry of Health, it is not its exclusive supplier. However because each of our collaborations with FIOCRUZ incorporates a technology transfer aspect, we believe we have a competitive advantage versus other suppliers to the Brazilian Ministry of Health, assuming other aspects of our product offering through FIOCRUZ are otherwise competitive in comparison. We have no knowledge or reason to know of any activities by our employees, distributors or sales agents of any actions which could be in violation of the FCPA, although there can be no assurance of this. +We rely on trade secret laws and agreements with our key employees and other third parties to protect our proprietary rights, and we cannot be sure that these laws or agreements adequately protect our rights. +We believe that factors such as the technological and creative skills of our personnel, strategic relationships, new product developments, frequent product enhancements and name recognition are essential to our success. All our management personnel are bound by non-disclosure agreements. If personnel leave our employment, in some cases we would be required to protect our intellectual property rights pursuant to common law theories which may be less protective than provisions of employment, non-competition or non-disclosure agreements. +17 +We seek to protect our proprietary products under trade secret and copyright laws, enter into license agreements for various materials and methods employed in our products, and enter into strategic relationships for distribution of the products. These strategies afford only limited protection. We currently have some foreign patents issued, and we are seeking additional patent protection in several other foreign jurisdictions for our DPP® technology. We have licenses to reagents (antigens and peptides) used in several of our products and products under development Despite our efforts to protect our proprietary assets, and respect the intellectual property rights of others, we participate in several markets where intellectual property rights protections are of little or no value. This can place our products and our company at a competitive disadvantage. +Despite efforts we make to protect our confidential information, such as entering confidentiality agreements in connection with new business opportunities, unauthorized parties may attempt to copy aspects of our products or to obtain information that we regard as proprietary. We may be required to expend substantial resources in asserting or protecting our intellectual property rights, or in defending suits related to intellectual property rights. Disputes regarding intellectual property rights could substantially delay product development or commercialization activities because some of our available funds would be diverted away from our business activities. Disputes regarding intellectual property rights might include state, federal or foreign court litigation as well as patent interference, patent reexamination, patent reissue, or trademark opposition proceedings in the U.S. Patent and Trademark Office. +To facilitate development and commercialization of a proprietary technology base, we may need to obtain additional licenses to patents or other proprietary rights from other parties. Obtaining and maintaining these licenses, which may not be available, may require the payment of up-front fees and royalties. In addition, if we are unable to obtain these types of licenses, our product development and commercialization efforts may be delayed or precluded. +Our continued growth depends on retaining our current key employees and attracting additional qualified personnel, and we may not be able to do so. +Our success will depend to a large extent upon the skills and experience of our executive officers, management and sales, marketing, operations and scientific staff. We may not be able to attract or retain qualified employees in the future due to the intense competition for qualified personnel among medical products businesses, geographic considerations, our ability to offer competitive compensation, relocation packages, benefits, and/or other reasons. +If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will adversely affect our ability to effectively manufacture, sell and market our products to meet the demands of our strategic partners in a timely fashion, or to support internal research and development programs. Although we believe we will be successful in attracting and retaining qualified personnel, competition for experienced scientists and other personnel from numerous companies and academic and other research institutions may limit our ability to do so on acceptable terms. +We have entered into employment contracts with our Chief Executive Officer and President, Lawrence Siebert, and our Senior Vice President of Research and Development, Javan Esfandiari. Due to the specific knowledge and experience of these executives regarding the industry, technology and market, the loss of the services of either one of them would likely have a material adverse effect on the Company. The contract with Mr. Siebert provides that Mr. Siebert will serve as the Chief Executive Officer and President of the Company through May 11, 2013. The contract with Mr. Esfandiari has a term of three years ending March 2016. We have obtained a key man insurance policy for Mr. Esfandiari. +We believe our success depends in part on the continued funding of and our ability to participate in large testing programs in the U.S. and worldwide and funding may be reduced, or discontinued and/or we may not be able to participate for other reasons. +We believe it to be in our best interests to meaningfully participate in large testing programs. Moreover many of these programs are funded by governments and other donors and there can be no assurance that funding will not be reduced or completely discontinued. Participation in these programs also requires alignment and engagement with the many other participants in these programs including the World Health Organization, U.S. Center for Disease Control, U.S. Agency for International Development, foreign governments and their agencies, non-governmental organizations, and HIV service organizations. If we are unsuccessful in our efforts to participate in these programs, our operating results could be materially harmed. +18 +Although we were profitable in 2009, 2010, 2011 and 2012, we cannot be certain that we will be able to sustain profitability in 2013. +From the inception of Chembio Diagnostic Systems, Inc. in 1985 through the period ended December 31, 2008, we incurred net losses and we have only become profitable during the last four years. Moreover in 2013 we expect to make substantial expenditures for regulatory submissions, product development and other purposes which may impact profitability. Our ability to continue profitability in the future will primarily depend on our ability to increase sales of our products, reduce production and other costs, and to successfully introduce new products and enhanced versions of our existing products into the marketplace. If we are unable to increase our revenues at a rate that is sufficient to achieve profitability, or adequately control and reduce our operating costs, our operating results would be materially harmed. +To the extent that we are unable to obtain sufficient product liability insurance or that we incur product liability exposure that is not covered by our product liability insurance, our operating results could be materially harmed. +We may be held liable if any of our products, or any product which is made with the use or incorporation of any of the technologies belonging to us, causes injury of any type or is found otherwise unsuitable during product testing, manufacturing, marketing, sale or usage. We have obtained product liability insurance even though we have never received a product liability claim, and have generally not seen product liability claims for screening tests that are accompanied by appropriate disclaimers. Nevertheless, in the event there is a claim, this insurance may not fully cover our potential liabilities. In addition, as we attempt to bring new products to market, we may need to increase our product liability coverage which could be a significant additional expense that we may not be able to afford. If we are unable to obtain sufficient insurance coverage at an acceptable cost to protect us, we may be forced to abandon efforts to commercialize our products or those of our strategic partners, which would reduce our revenues. +Risks related to our Common Stock +Our Common Stock continues to be illiquid, so investors may not be able to sell as much stock as they want at prevailing market prices. +The average daily trading volume of our Common Stock on the NASDAQ market was 44,000 share per day over the three months ended March 1, 2013 as compared to less than 4,375 shares per day (after accounting for the 1 for 8 reverse split that was effectuated on May 30, 2012) over the three months ended March 6, 2012. Therefore, there has been a significant increase in the liquidity of our stock based on this comparison, and our stock began trading on NASDAQ in early June, 2012. However, continued improvements in the liquidity of our stock depends on several factors, including but not limited to the financial results of the Company and overall market conditions, so there can be no assurance that this improvement will continue, or even be maintained. +Decreased trading volume in our stock would make it more difficult for investors to sell their shares in the public market at any given time at prevailing prices. +Our management and larger stockholders exercise significant control over our Company. +As of March 6, 2013, our named executive officers, directors and 5% stockholders beneficially owned approximately 16.4% of our voting power. In addition, we have one large institutional investor that beneficially owned 8.3% of the stock. For the foreseeable future, and assuming these ownership percentages continue to pertain, to the extent that these parties vote similarly, they may be able to exercise significant control over many matters requiring approval by the board of directors or our stockholders. As a result, they may be able to: +● control the composition of our board of directors ; +● control our management and policies; +● determine the outcome of significant corporate transactions, including changes in control that may be beneficial to stockholders; and +● act in each of their own interests, which may conflict with, or be different from, the interests of each other or the interests of the other stockholders. +19 +ITEM 2. +PROPERTIES +Our administrative offices and research facilities are located in Medford, New York. We lease approximately 30,600 square feet of industrial space for $20,530 per month. The space is utilized for research and development activities (approximately 4,160 square feet), offices (approximately 4,640 square feet) and production (approximately 21,800 square feet). The lease term expires on April 30, 2014. The monthly rent for the year ending April 30, 2014 will increase by the lower of (i) the change in the consumer price index, or (ii) five percent; and (d) the monthly rent for years three through five of the lease will increase each year by the lower of (i) the change in the consumer price index, or (ii) two and one half percent. Additional space may be required as we expand our production and research and development activities. We do not foresee any significant difficulties in obtaining any required additional facilities. +ITEM 3. +LEGAL PROCEEDINGS +From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. We know of no material, existing or pending legal proceedings against us, nor are we involved as a plaintiff in any material proceeding or pending litigation. There are no proceedings in which any of our directors, officers or affiliates, or any registered or beneficial shareholder, is an adverse party or has a material interest that is adverse to our interest. +ITEM 4. +MINE SAFETY DISCLOSURES +Not Applicable. +20 +PART II +ITEM 5. +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Our stock is quoted on the NASDAQ, under the symbol “CEMI.” Prior to June 8, 2012, our stock was quoted on the OTCQB and prior to February 24, 2011 on the OTC Bulletin Board. On May 30, 2012, a reverse split was effected at a ratio of 8 for 1. The table below sets forth the high and low bid prices per share of our common stock for each quarter of our two most recently completed fiscal years, quarters prior to June 2012 were adjusted for the split.. These prices represent inter-dealer quotations without retail markup, markdown, or commission and may not necessarily represent actual transactions. +Fiscal Year 2012 +High Bid +Low Bid +First Quarter +$ +4.08 +$ +3.12 +Second Quarter +$ +4.96 +$ +3.52 +Third Quarter +$ +5.30 +$ +4.11 +Fourth Quarter +$ +5.80 +$ +3.61 +Fiscal Year 2011 +High Bid +Low Bid +First Quarter +$ +4.00 +$ +3.12 +Second Quarter +$ +4.64 +$ +3.28 +Third Quarter +$ +3.84 +$ +3.28 +Fourth Quarter +$ +3.84 +$ +2.88 +On May 30, 2012, the Company undertook an 8-for-1 reverse stock split in order to have a stock price sufficient to qualify for listing on NASDAQ, which occurred on June 7, 2012. +Holders +As of March 1, 2013, there were approximately 1,800 record owners of our common stock. +Dividends +The Company has never paid cash dividends on its common stock and has no plans to do so in the foreseeable future. +21 +Recent Sales of Unregistered Securities +During 2012, we issued unregistered securities, including 3,752 unregistered shares of our common stock and options to purchase 3,750 unregistered shares of our common stock to The Benchmark Company, LLC (“Benchmark”). The shares were issued to Benchmark in four installments under the below terms. The options granted to Benchmark the right to purchase up to 3,750 unregistered shares of our common stock at the purchase price of $4.00 per share on or before March 19, 2015. One-quarter of the options granted vested on each of the dates set forth in the chart below. These securities were issued to Benchmark in consideration for services provided to the Company and were not subject to any underwriting discounts or commissions. +Unregistered Shares Issued to Benchmark +Date +Number of Shares +Market Price Per Share +Consideration +March 19, 2012 +938 +$ +3.84 +$ +3,601.92 +June 19, 2012 +938 +$ +4.80 +$ +4,502.40 +September 19, 2012 +938 +$ +4.31 +$ +4,042.78 +December 19, 2012 +938 +$ +4.58 +$ +4,296.04 +The issuance of these securities was not registered under the Securities Act of 1933, as amended (the “Act”). These securities were issued in reliance on an exemption from registration under Section 3(b) or Section 4(2) of the Act, and Rule 506 promulgated under the Act, based on the fact that Benchmark is an “accredited investor” as such term is defined in Rule 501 of Regulation D. +ITEM 6. SELECTED FINANCIAL DATA +Presented in this table are selected financial data for the past five years ended December 31, 2012. +22 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARIES +SELECTED HISTORICAL FINANCIAL DATA +As of and For the Years Ended +Statement of Operations Data: +December 31, 2012 +December 31, 2011 +December 31, 2010 +December 31, 2009 +December 31, 2008 +TOTAL REVENUES +$ +25,610,595 +$ +19,388,036 +$ +16,704,703 +$ +13,834,248 +$ +11,049,571 +GROSS MARGIN +10,789,991 +42 +% +9,390,303 +48 +% +8,100,699 +48 +% +5,860,405 +42 +% +3,851,721 +35 +% +OPERATING COSTS: +Research and development expenses +4,486,302 +18 +% +4,878,119 +25 +% +2,586,308 +15 +% +2,883,696 +21 +% +2,605,343 +24 +% +Selling, general and administrative expenses +4,851,587 +19 +% +3,424,297 +18 +% +2,940,721 +18 +% +2,659,382 +19 +% +3,317,046 +30 +% +9,337,889 +8,302,416 +5,527,029 +5,543,078 +5,922,389 +INCOME (LOSS) FROM OPERATIONS +1,452,102 +1,087,887 +2,573,670 +317,327 +(2,070,668 +) +OTHER INCOME (EXPENSES): +(1,584 +) +(12,325 +) +(14,503 +) +(8,267 +) +121,898 +INCOME (LOSS) BEFORE INCOME TAXES +1,450,518 +6 +% +1,075,562 +6 +% +2,559,167 +15 +% +309,060 +2 +% +(1,948,770 +) +-18 +% +Income tax (benefit) provision +509,237 +(5,133,229 +) +45,823 +- +- +NET INCOME (LOSS) +$ +941,281 +$ +6,208,791 +$ +2,559,167 +$ +309,060 +$ +(1,948,770 +) +-18 +% +Basic income (loss) per share +$ +0.12 +$ +0.79 +$ +0.33 +$ +0.04 +$ +(0.25 +) +Diluted income (loss) per share +$ +0.11 +$ +0.73 +$ +0.29 +$ +0.03 +$ +(0.25 +) +Weighted average number of shares outstanding, basic +7,986,030 +7,874,807 +7,762,858 +7,743,304 +7,658,369 +Weighted average number of shares outstanding, diluted +8,614,944 +8,556,284 +8,865,114 +9,380,242 +7,658,369 +23 +ITEM 7. +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +Overview +This discussion and analysis should be read in conjunction with the accompanying Consolidated Financial Statements and related notes. Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent liabilities at the financial statement date and reported amounts of revenue and expenses during the reporting period. On an ongoing basis, we review our estimates and assumptions. Our estimates are based on our historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results are likely to differ from those estimates under different assumptions or conditions, but we do not believe such differences will materially affect our financial position or results of operations. Our critical accounting policies, the policies we believe are most important to the presentation of our financial statements and require the most difficult, subjective and complex judgments, are outlined below in ‘‘Critical Accounting Policies,’’ and have not changed significantly. +In addition, certain statements made in this report may constitute “forward-looking statements”. These forward-looking statements involve known or unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. These factors include, among others, 1) our ability to obtain necessary regulatory approvals for our products; and 2) our ability to increase revenues and operating income, which is dependent upon our ability to develop and sell our products, general economic conditions, demand for our products, and other factors. You can identify forward-looking statements by terminology such as “may,” “could”, “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continues” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business. +All of the Company’s future products that are currently being developed are based on its patented Dual Path Platform (DPP®), which is a unique diagnostic point-of-care platform that has certain advantages over lateral flow technology. The Company has completed development of several products that employ the DPP® technology, two of which will be marketed under Chembio’s label (DPP® HIV 1/2 Screening Assay and DPP® Syphilis Screen & Confirm) and several others that have been developed specifically related to private label agreements with The Oswaldo Cruz Foundation (“FIOCRUZ”) for the Brazilian public health market, as explained below. +All of the Company’s products other than its lateral flow tests (see PRODUCTS and Our Rapid Test Technologies) are based on the Company’s patented Dual Path Platform (DPP®) technology. The Company has had very active research and development programs and has significantly increased its spending on research and development during the last three years. Third-party funding from research and development contracts and grants have offset a significant portion of these increased research and development expenses. Externally funded R&D programs were particularly instrumental in helping the Company to avoid raising capital during 2008-2010, which was a very difficult period for fundraising. Moreover these collaborations have resulted in significant third party validations of our DPP® technology and an increasing capability to develop, manufacture, validate, and improve current and future DPP® products and product features. +The Company has a number of additional products under development that employ the DPP® technology. These product development activities are further described below. +Multiplex Influenza Immunity Test – In July 2012 we entered into a follow-on, milestone-based development agreement of up to $480,000 based on Chembio’s previous successful initial development of a multiplex rapid point-of-care (“POC”) influenza immunity test utilizing our patented Dual Path Platform (DPP®) technology. The agreement contemplates a period of approximately six months in which the follow-on development activity is to be completed. +Chembio entered this agreement with a private contracting organization that is engaged to enter into, implement and provide technical oversight of agreements relating to pandemic preparedness on behalf of its client, the United States Centers for Disease Control and Prevention (“CDC”). +24 +As a result of pandemic planning activities, the United States Department of Health and Human Services (“HHS”) and CDC identified POC and high-throughput testing as a gap in influenza diagnostics. Rapid responses in the field, such as the vaccination, prophylactic treatment, or isolation of patients, require POC diagnostic tests for influenza infection and immunity. Ideally, these tests should be fast, portable, self-contained, and non-technical. Development of these tests is especially critical for military forces, as evidenced by previous influenza outbreaks that spread rapidly through densely populated barracks and have killed thousands of soldiers. +The previous development work for this product was completed by Chembio in 2011 pursuant to an initial $900,000 contract with this same organization. The objective of this follow-on project is to further develop a rapid influenza immunity test which can be administered in the field to determine a person’s influenza immunity status or in an outpatient setting incorporating certain additional subunits of influenza virus proteins. Work commenced on this follow-on development project during the third quarter, accelerated during the fourth quarter, and will be completed during the first quarter of 2013. +DPP® Hepatitis-C (HCV) Test – Development work on our DPP® HCV point-of-care rapid test continues. In June, we reported data from a study evaluating performance characteristics (sensitivity and specificity) of our first generation test, which data was published in the Journal of Clinical Virology. The study authors concluded that the Chembio blood rapid assay demonstrated acceptable sensitivity and specificity, and was comparable to conventional assays currently in use. The study results showed that the Chembio DPP® HCV finger-stick blood test had a sensitivity of 92.8% against a laboratory-based enzyme immunoassay (EIA) screening assay reference while it demonstrated 97.1% sensitivity against The Centers for Disease Control and Prevention (CDC) reference method algorithm which utilizes a third generation recombinant immunoblot assay (RIBA). The DPP® finger-stick blood test achieved 99.0% specificity on both reference methods. +During the third quarter of 2012 we completed a feasibility study on proprietary materials which we believe will enable us to develop an HCV rapid test that is equivalent to the only directly competitive product; however we were waiting to receive additional proprietary materials that we believe could enable us to improve performance and features of the test as compared to the competitive product. We have recently received these materials which are enabling us to continue our development activities with respect to the improved performance features. If these objectives are achieved, we will proceed with a full development program, and we could complete development and commence clinical trials before the end of 2013. +In July 2012, the U.S. Centers for Disease Control finalized the recommendations for testing all individuals in the United States between the ages of 45 and 65 for HCV, which age cohort represents a substantial portion of the estimated over three million individuals in the United States that are infected with HCV infection but unaware. With a number of new anti-retroviral therapies approved, and even more pending approval in the years ahead by the FDA, we believe that over time these new recommendations will be implemented. However, it is unclear how much of these recommendations will be funded by public health programs or under the Affordable Care Act. Regardless if these recommendations are implemented, we believe that they will take time to be funded. +DPP® Syphilis/HIV Combination Test – We have developed a combination Syphilis and HIV test and we are considering various opportunities with respect to this product for the international market at least. This is an example of the multiplexing capabilities that we expect to drive the Company’s revenues and growth. We will manufacture this product as a Chembio-branded product and as a component for final assembly in other markets where we are considering collaborations. We believe there are opportunities for this product in donor-funded pre-natal testing programs aimed at the prevention of mother-to-child transmission, and the United States as well. +DPP® Tuberculosis – In February 2011, we were awarded a three-year $2.9 million, Small Business Innovative Research (SBIR) Phase II grant from the United States National Institutes of Health (NIH) to continue our successful Phase I grant work to develop a simple, rapid, accurate, and cost-effective serological test for active tuberculosis that can be utilized in resource-limited settings. During 2012, we continued this development work with our DPP® technology. Several additional antigens have been identified recently to enhance antibody detection by the DPP® test prototype designed in our Phase I studies. In addition, new detection technologies are being evaluated to further increase sensitivity. +Other Potential Products and Collaborations - We are currently completing development of certain other products for single parameter and multiplex tests, utilizing our patented DPP®. We also are discussing exclusive collaborations for these products or proprietary components thereof, with certain potential international partners that, if consummated, would provide us with local assembly and distribution, a co-branded DPP® product in the designated market, and a more meaningful stake in the success of the distribution program. +25 +In general, we are considering certain new DPP® product opportunities, either as OEM development projects and/or as Chembio-branded products. These products are being identified based upon our assessment of opportunities in the market and upon whether they can be addressed with our proprietary technology, along with our development and manufacturing capabilities and experience. We are also identifying and assessing additional technologies that we believe could provide us with additional products and capabilities, and thereby provide additional revenue streams, although there is no assurance that we will be able to obtain or utilize any of them profitably. +Regulatory Activities +CE Mark for FDA-approved HIV tests – We were audited by our notified body in September and our technical file is being reviewed. We expect a decision on CE Marking of these products soon. +FDA Approval for DPP® HIV 1/2 Screening Assay for Use with oral fluid or blood samples – We received FDA approval of our Pre-Marketing Application (PMA) for this product on December 19, 2012 as we announced. We are now working towards a CLIA waiver with the expectation that it will be granted before the end of 2013. Our current plan is to initiate the CLIA study in March 2013, have the submission into FDA by July, and have a CLIA waiver during the fourth quarter. +DPP® Syphilis Screen & Confirm - During the fourth quarter of 2012 we received data that we had been pursuing that we believe support a De Novo FDA 510(K) clearance regulatory pathway for the product. As a result we submitted this data and other information to the FDA so that we could re-initiate clinical trials and submit our 510(k) application by the middle of 2013. In addition to a scientific journal publication in December 2012 of the results of a large study that was conducted with this product in 2010-2011 in China, we have received additional data from other studies of this product that we believe will also be useful in supporting our regulatory file. There is no point-of-care test for Syphilis that differentiates between active and past, previously treated cases, and there continues to be a substantial interest in this product by public health groups in the United States and abroad. We are confident that our DPP® Syphilis Screen & Confirm test detects primary infections more accurately than the legacy laboratory test known as Rapid Plasma Reagin (“RPR”). +In late February we received a response from the FDA that will enable us to pursue the regulatory pathway that we outlined in our submission. However there were some questions that we have concerning the FDA response and we intend to have those clarified in a meeting being scheduled this month. While we confirm our intended study approach with FDA, we are completing our protocol, have identified three clinical sites and their contracts, with the expectation that we will commence the studies in May, submit the 510(k) application to FDA by the end of the third quarter, and have an FDA clearance by mid-2014. +DPP® HIV-Syphilis – We have submitted this product for evaluation by the CDC and the WHO has accepted this product for pre-qualification in their global procurement scheme. Other international registrations are pending. We have not yet submitted a guidance request to the FDA for determining the pathways for getting this multiplex combination product approved/cleared by the FDA, but plan to soon. However we still plan to initiate the syphilis studies (the HIV component of this test is already approved pursuant to the PMA approval received in December 2012), in May, submit the 510(k) application to FDA by the end of the third quarter, and have an FDA clearance by mid-2014. +SURE CHECK® HIV OTC Study - We completed the self-testing study to meet the requirements for submitting an IDE (“Investigational Device Exemption”) application in order to commence clinical trials for this product in 2013. The IDE application can be filed now and we plan to do this soon. Thereafter, assuming the IDE is granted, the Phase II observed user clinical trials could be commenced during 2013 and the pivotal trial could be completed during 2014. This would enable a PMA approval by late-2015. +There have been very significant recent developments related to this market opportunity, as the first rapid HIV test for home use was recommended for approval by the FDA’s Blood Products Advisory Committee (“BPAC”) in a unanimous vote, and the test was in fact approved by the FDA in early July with widespread media attention. The manufacturer of this product, OraSure Technologies, Inc. (“OraSure”), launched this product in retail drug stores during October. +OraSure’s final clinical trial for the home-use version enrolled 5,798 subjects from 17 high prevalence sites and three low prevalence sites across the country. OraSure gave subjects the test to take home and perform themselves, but also collected blood samples to compare to the results of the home-based testing. The specificity of the test remained relatively high, 99.98% (95% CI: 99.90–100%), and above BPAC’s recommended threshold. However, sensitivity dropped in comparison to professional use of the kit to 92.98% from 99.3%. +26 +Given this low performance threshold, we believe we are very well positioned with our SURE CHECK® HIV 1/2 blood test as well as our other FDA-approved products. However we believe that the development of this market will take time, and that its development will likely require OraSure to invest significantly in its development, as it is now. Orasure’s first-three month period results for this product, which was in the fourth quarter of 2012, reported in February 2013 did nothing to change this expectation. Although we still believe that Chembio is the only other company that for all practical purposes has a product, let alone multiple products, that can participate in this new market, we have serious reservations about the size of the opportunity, particularly in relation to the significant investment of funds required in order to achieve regulatory approval and then commercialize the product. Nevertheless, because OraSure’s product was approved with lower sensitivity than was previously expected by the FDA, this provides an opportunity for Chembio’s product(s) to achieve improved performance – either with its blood and/or oral fluid HIV tests. We believe it is critical to go to this market with a substantially improved sensitivity and comparable specificity to OraSure’s product, and a lower price (which would include lower packaging and distribution costs as compared with Orasure), and our current efforts are focused in this direction. +There can be no assurance that any of the aforementioned Research & Development and/or Regulatory products or activities will result in any product approvals or commercialization, nor that any of the existing research and development activities, or any new potential development programs or collaborations will materialize or that they will meet regulatory or any other technical requirements and specifications, and/or that if continued, will result in completed products, or that such products, if they are successfully completed, can or will be successfully commercialized. +Recent Events +The Company entered into an employment agreement effective March 5, 2013 (the "Employment Agreement"), with Mr. Esfandiari to continue as the Company's Senior Vice President of Research and Development for an additional term of three years through March 5, 2016. See Item 11 for more details. +In accordance with the terms of the Company’s 2008 Stock Incentive Plan, on February 26, 2013, the Company granted, to certain employees of the Company, options to purchase an aggregate of 16,360 shares of the Company’s common stock. The exercise price for these options was to be equal to the last traded price for the Company’s common stock on February 26, 2013, which was at $5.56 per share. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of the grant. The following table identifies the portions of these options issued to officers of the Company. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +1,520 +Javan Esfandiari – Executive Vice President of R&D +4,765 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +1,775 +Richard J. Larkin – Chief Financial Officer +1,670 +Lawrence A. Siebert – Chief Executive Officer +5,215 +Michael Steele – Vice President of Sales and Marketing +785 +Sharon Klugewicz – Vice President of QA/QC +630 +On May 30, 2012, the Company effected a 1-for-8 reverse split of its common stock. This was done to allow the Company to move to the NASDAQ trading market from the OTCQB market, which occurred on June 7, 2012. As a result of the reverse stock split, the 63,967,265 outstanding common shares were reduced to 7,995,918 outstanding common shares on May 30, 2012. +27 +RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2012 AS COMPARED WITH THE YEAR ENDED DECEMBER 31, 2011 +Income : +Income before income taxes for the year ended December 31, 2012 increased to $1,451,000 from $1,076,000 for the year ended December 31, 2011. Net Income decreased from $6.2 million for 2011 to $.94 million for 2012 despite the increase in income before taxes. The decrease in net income is primarily attributable to a $5.1 million benefit resulting from the partial elimination of the deferred tax asset valuation allowance in 2011. In 2012, as a result of a 39.6% increase in Net Product sales and a 34.7% decrease in non-product revenues, the Company had a $1,400,000, or 14.9%, increase in its gross margin, to $10,790,000. This increased gross margin funded increased operating expenses, the most significant of which was an increase in commission expenses of $606,000, due to the increased sales in Brazil. +Revenues: +Selected Product Categories: +For the years ended +December 31, 2012 +December 31, 2011 +$ Change +% Change +Lateral Flow HIV Tests and Components +$ +13,505,849 +$ +12,865,541 +$ +640,308 +4.98 +% +DPP Tests and Components +10,086,459 +4,255,032 +5,831,427 +137.05 +% +Other +735,047 +301,738 +433,309 +143.60 +% +Net Product Sales +24,327,355 +17,422,311 +6,905,044 +39.63 +% +License and royalty revenue +- +140,322 +(140,322 +) +-100.00 +% +R&D, milestone and grant revenue +1,283,240 +1,825,403 +(542,163 +) +-29.70 +% +Total Revenues +$ +25,610,595 +$ +19,388,036 +$ +6,222,559 +32.09 +% +Revenues for our lateral flow HIV tests and related components during the year ended December 31, 2012 increased by $640,000 over the same period in 2011. This was primarily attributable to increased sales in the U.S., through Alere, of $515,000, and increased sales in Africa of $329,000; and was partially offset by decreased sales in other regions. Adding to these increases were increased other sales, which increased by 144%, or $433,000, primarily from increased sales of Chagas. Sales of our DPP® products in 2012 increased by $5,831,000, or 137%, compared to levels in 2011 as Brazil began ramping up their programs in 2012 for the five ANVISA-approved DPP® products. The decrease in R&D, milestone and grant revenue was primarily due to a decrease in grants and other development projects of $542,000 along with a decrease in royalty income of $140,000. R&D revenues in 2012 include funds, recognized on an “as expenses are incurred” basis, from a Phase II NIH grant for Leptospirosis, which was effective as of June 1, 2009, and from a Phase II grant for Tuberculosis which was effective March 1, 2011. The decrease in R&D, milestone and grant revenue was due to revenue from milestones and certain development projects in 2011, which were not repeated. License and royalty revenue in 2011 is from royalties from Brazil under our 2004 technology transfer and license agreement, which ended prior to January 1, 2012. +Gross Margin: +Gross Margin related to Net Product Sales: +For the years ended +December 31, 2012 +December 31, 2011 +$ Change +% Change +Gross Margin per Statement of Operations +$ +10,789,991 +$ +9,390,303 +$ +1,399,688 +14.91 +% +Less: R&D, milestone, grant, license and royalties +1,283,240 +1,965,725 +(682,485 +) +-34.72 +% +Gross Margin from Net Product Sales +$ +9,506,751 +$ +7,424,578 +$ +2,082,173 +28.04 +% +Product Gross Margin % +39.08 +% +42.62 +% +The gross margin dollar increase of $1.40 million included a 28% increase in gross margin from product sales, thereby more than offsetting a 35% decrease in non-product revenues. The 3.5% decrease in our product gross margin percentage was primarily due to increased overhead items, especially in the fourth quarter. In the fourth quarter we went to a third shift, increased overtime and had to hire temporary employees (all who needed training) in order to fulfill the large back orders we had going into the quarter. In addition, during 2012 we incurred more scrap than expected and we have taken steps to correct this and many other issues to reduce costs in the future. DPP® sales represented approximately 41% of sales in the year ended December 31, 2012 as compared to approximately 24% in the year ended December 31, 2011. +28 +Research and Development: +This category includes costs incurred for product research and development, regulatory approvals, technical support, evaluations and registrations. +Selected expense lines: +For the years ended +December 31, 2012 +December 31, 2011 +$ Change +% Change +Clinical and Regulatory Affairs: +Wages and related costs +$ +436,668 +$ +465,688 +$ +(29,020 +) +-6.23 +% +Consulting +61,664 +7,677 +53,987 +703.23 +% +Stock-based compensation +28,278 +18,858 +9,420 +49.95 +% +Clinical trials +820,083 +1,244,239 +(424,156 +) +-34.09 +% +Other +46,217 +58,191 +(11,974 +) +-20.58 +% +Total Regulatory +1,392,910 +1,794,653 +(401,743 +) +-22.39 +% +R&D Other than Regulatory: +Wages and related costs +1,956,536 +2,145,377 +(188,841 +) +-8.80 +% +Consulting +137,789 +68,791 +68,998 +100.30 +% +Stock-based compensation +41,838 +36,765 +5,073 +13.80 +% +Materials and supplies +646,271 +552,456 +93,815 +16.98 +% +Other +310,958 +280,077 +30,881 +11.03 +% +Total other than Regulatory +3,093,392 +3,083,466 +9,926 +0.32 +% +Total Research and Development +$ +4,486,302 +$ +4,878,119 +$ +(391,817 +) +-8.03 +% +Expenses for Clinical & Regulatory Affairs for the year ended December 31, 2012 decreased by $402,000 as compared to the same period in 2011. This was primarily due to the higher expenses we incurred in 2011 for clinical trials conducted for our DPP® HIV Screen Assay. +R&D expenses other than Clinical & Regulatory Affairs increased by $10,000 in the year ended December 31, 2012 as compared with the same period in 2011 and were primarily related to an increase in consulting, material and supply and other expenses, partially offset by decreases in personnel costs. +Selling, General and Administrative Expense: +Selected expense lines: +For the years ended +December 31, 2012 +December 31, 2011 +$ Change +% Change +Wages and related costs +$ +1,534,440 +$ +1,249,907 +$ +284,533 +22.76 +% +Consulting +261,054 +199,658 +61,396 +30.75 +% +Commissions +1,208,946 +603,377 +605,569 +100.36 +% +Stock-based compensation +174,462 +115,476 +58,986 +51.08 +% +Marketing materials +65,249 +50,900 +14,349 +28.19 +% +Investor relations/investment bankers +282,058 +176,297 +105,761 +59.99 +% +Legal, accounting and compliance +559,569 +448,676 +110,893 +24.72 +% +Travel, entertainment and trade shows +163,704 +67,504 +96,200 +142.51 +% +Bad debt allowance (recovery) +28,000 +(5,000 +) +33,000 +-660.00 +% +Other +574,105 +517,502 +56,603 +10.94 +% +Total S, G &A +$ +4,851,587 +$ +3,424,297 +$ +1,427,290 +41.68 +% +Selling, general and administrative expenses for the year ended December 31, 2012 increased by 41.7% as compared with the same period in 2011. This was primarily due to increases in commission expense of $606,000 primarily on sales to Brazil, wages and related expenses of $285,000, stock-based compensation of $59,000, consulting expenses of $61,000, professional fees of $111,000 and investor related expenses, including NASDAQ fees, of $106,000. +29 +Other Income and Expense: +For the years ended +December 31, 2012 +December 31, 2011 +$ Change +% Change +Interest income +$ +7,911 +$ +6,298 +$ +1,613 +25.61 +% +Interest expense +(9,495 +) +(18,623 +) +9,128 +-49.01 +% +Total Other Income and (Expense) +$ +(1,584 +) +$ +(12,325 +) +$ +10,741 +-87.15 +% +Other expense for the year ended December 31, 2012 decreased approximately $10,700 to $1,600 as compared with $12,300 for the same period in 2011, primarily as a result of decreased interest expense of $9,100 due to the term loan with HSBC and an increase in interest income of $1,600. +Income tax (benefit) provision: +Prior to 2011 and through September 30, 2011, the Company had a full valuation allowance recorded against deferred tax assets. In the fourth quarter of 2011, based on our sustained profitable operating performance over the past three years and our positive outlook for taxable income in the future, the Company reevaluated its deferred tax asset. Based upon the guidance under ASC 740, we concluded that it was more likely than not that the Company would realize the benefit of such deferred tax assets, the Company reversed $5,156,000 of the valuation allowance previously recorded against its deferred tax assets, which resulted in a tax benefit increase to net income of that amount. It also increased the Company’s book value by that amount. The deferred tax asset will be amortized against future income tax expense that would be payable in the absence of the net operating loss carryfoward. For the year ended December 31, 2012 the Company charged $509,000 to income tax expense and reduced the deferred tax assets by $471,085. The Company still maintains a full valuation allowance on research and development tax credits. +MATERIAL CHANGES IN FINANCIAL CONDITION +Selected Changes in Financial Condition +As of +December 31, 2012 +December 31, 2011 +$ Change +% Change +Cash and cash equivalents +$ +2,951,859 +$ +3,010,954 +$ +(59,095 +) +-1.96 +% +Accounts receivable, net of allowance for doubtful accounts of $58,000 and $30,000 at December 31, 2012 and December 31, 2011, respectively +4,821,357 +2,998,449 +1,822,908 +60.80 +% +Inventories +2,488,071 +2,300,286 +187,785 +8.16 +% +Fixed assets, net of accumulated depreciation +1,427,646 +1,062,276 +365,370 +34.40 +% +Deferred tax asset, net of valuation allowance +4,233,194 +4,749,622 +(516,428 +) +-10.87 +% +Accounts payable and accrued liabilities +3,303,923 +2,789,500 +514,423 +18.44 +% +Cash decreased by $59,000 from December 31, 2011, primarily due to the increase in accounts receivable, net of allowance change which increased by $1,823,000 along with an increase in inventories of $188,000, partially offset by an increase in accounts payable and accrued liabilities of $514,000 and utilization of the long-term deferred tax asset of $516,000 (short-term change of $45,000 nets to $471,000 overall change), (see liquidity section for more details). Net fixed assets increased primarily due to increases in manufacturing equipment and improvements. +The increase in accounts receivable was primarily attributable to a larger amount of credit sales in December of 2012 compared to December 2011. The increase in accounts payable and in inventories were both primarily due to a larger amount of materials ordered and manufactured for orders due to ship in the first quarter of 2013. +30 +LIQUIDITY AND CAPITAL RESOURCES +For the years ended +December 31, 2012 +December 31, 2011 +$ Change +% Change +Net cash provided by operating activities +$ +761,084 +$ +2,268,408 +$ +(1,507,324 +) +-66.45 +% +Net cash used in investing activities +(872,442 +) +(726,680 +) +(145,762 +) +20.06 +% +Net cash provided by (used in) financing activities +52,263 +(667,125 +) +719,388 +-107.83 +% +(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS +$ +(59,095 +) +$ +874,603 +$ +(933,698 +) +-106.76 +% +The Company had a decrease in cash for the year ended December 31, 2012 as compared to a cash increase in the year ended December 31, 2011. The cash from operations in 2012 was primarily attributable to net income from operations of $941,000. In addition, other operating activities contributing to the increase in cash from operating activities in 2012 included an increase in accruals and payables of $514,000 and an increase in customer deposits of $23,000. These increases were partially offset by an increase in inventories of $188,000, an increase in prepaid expenses of $20,000 and an increase in accounts receivable of $1,851,000, as well as non-cash expenses totaling $1,340,000. The non-cash expenses consisted of $423,000 from depreciation expense, $318,000 in stock-based compensation expense, $100,000 in the amortization of licenses, utilization of $471,000 in deferred tax assets and an increase in allowance for doubtful accounts of $28,000. Investing activities represent the Company’s investment in fixed assets. The cash provided in financing activities is primarily due to the exercise of options of $120,000 and partially offset by the payment of debt of $68,000. +Fixed Asset Commitments +As of December 31, 2012, the Company had paid deposits on various pieces of equipment aggregating $223,584, which is reflected in Other Assets on the balance sheet. The Company is further committed to additional equipment-purchase obligation of $61,071 as various milestones are achieved by the various vendors. +RECENT DEVELOPMENTS AND CHEMBIO’S PLAN OF OPERATIONS FOR THE NEXT TWELVE MONTHS +Having received in December 2012 FDA approval of our Pre-Marketing Application for our DPP® HIV 1/2 Assay for use with oral fluid or blood samples, we are now focused on completing the requirements for a Clinical Laboratory Improvement Act (CLIA) waiver for this product in order to enable the product to be sold in the point-of-care market segments where these tests are primarily used. We anticipate this process to be completed in 2013. We believe the availability of an alternative oral fluid HIV rapid test, which test also performs very well on all blood matrices, will enable Chembio to participate in market segments not currently addressed by the blood POCT products sold through Alere. +We will address the public health market for the DPP HIV product through a small direct sales organization and the hospital and physician office market through distribution relationships. We are increasingly optimistic that this sales organization will also be able to market, by mid-2014, our DPP® Syphilis Screen & Confirm test and DPP® HIV-Syphilis multiplex test, and, in 2015, our Hepatitis- C (HCV) test. However each of these products has substantial development or regulatory steps ahead before they can be commercialized, even though significant progress is being made. Nevertheless, we are making significant progress toward commercializing these products. +We believe the quality, ease of use and reliability of our FDA approved products, together with their cost competitiveness, has enabled us to gain additional market share opportunities globally in 2012. However although we gained some significant new international accounts, other accounts had lower sales. This is primarily due to lower amounts of funding for the screening programs in such countries. Budgets can change dramatically from one period to the next and this can significantly impact our revenues. Also, given the nature of these large screening programs in developing world countries, large swings in orders from quarter to quarter can occur based on the sizes of orders, as evidenced in the third and fourth quarters of 2012. Our supply, technology transfer and license program to FIOCRUZ in Brazil for five different products produced over $10 million revenues for the Company, though it is not anticipated that 2013 sales to FIOCRUZ will recur at the 2012 level. We believe we will have strong sales growth of our FDA approved products sold by Alere in the United States, and we look forward to introducing our DPP® HIV 1/2 Assay, which has outstanding performance on all matrices including oral fluid samples, as soon as it is CLIA waived, which we anticipate by the end of 2013 , although there is no assurance . +31 +The Company has a number of new product and technology opportunities in addition to the aforementioned oral fluid HIV test, including two Syphilis multiplex tests. We are completing in the next month or two the application to the FDA for an Investigational Device Exemption for our Sure Check HIV 1/2 for home use so that we can begin clinical trials to pursue FDA approval for home use if and when we determine the investment is warranted. +We are working on a number of other projects based on, and/or that complement, our patented DPP® point-of-care technology, and in some cases we are now conducting feasibility studies in order to move these opportunities forward. These include potential products with application to the areas of women’s health, veterinary diagnostics, and blood viruses, as well as technologies that improve the detection limits of our technology platform. We believe that these projects can ultimately result in potential new revenue streams in future periods, although there can be no assurance of this. +In addition to the core development programs that we have in place that we believe will drive long-term growth and shareholder value, we have also developed new distribution and OEM collaborations for existing products which, if successful, will help to produce additional revenue opportunities in markets where we already have an established record of success, including but not limited to Africa, Asia, and South America. +Critical Accounting Policies and Estimates +The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates. +We believe that there are several accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amounts of revenue and the more significant areas involving management’s judgments and estimates. These significant accounting policies relate to revenue recognition, research and development costs, valuation of inventory, valuation of long-lived assets and income taxes. These policies, and the related procedures, are described in detail below. +Revenue Recognition – +We recognize revenue for product sales in accordance with ASC 605, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is determinable, and collectability is reasonably assured. Revenue typically is recognized at time of shipment. Sales are recorded net of discounts, rebates and returns. +For certain contracts, we recognize revenue from R&D, milestone and grant revenues when earned. Grants are invoiced after expenses are incurred. Revenues from projects or grants funded in advance are deferred until earned. +For certain collaborative research projects, we recognize revenue by defining milestones at the inception of the agreement and applying the milestone method of revenue recognition for relevant contracts. +Stock-Based Compensation – +We recognize the fair value of equity-based awards as compensation expense in our statement of operations. The fair value of our stock option awards was estimated using a Black-Scholes option valuation model. This valuation model’s computations incorporate highly subjective assumptions, such as the expected stock price volatility and the estimated life of each award. The fair value of the options, after considering the effect of expected forfeitures, is then amortized, generally on a straight-line basis, over the related vesting period of the option. The fair value of our restricted shares is based on the market value of the shares at the date of grant and is recognized on a straight-line basis over the related vesting period of the award. +Research & Development Costs – +Research and development activities consist primarily of new product development, continuing engineering for existing products, regulatory and clinical trial costs. Costs related to research and development efforts on existing or potential products are expensed as incurred. +Valuation of Inventories – +Inventories are stated at the lower of cost or market, using the first-in, first-out method (FIFO) to determine cost. Our policy is to periodically evaluate the market value of the inventory and the stage of product life cycle, and record a reserve for any inventory considered slow moving or obsolete. For example, each additional 1% of obsolete inventory would reduce such inventory by approximately $25,000. +32 +Allowance for doubtful accounts – +Our policy is to review our accounts receivable on a periodic basis, no less than monthly. On a quarterly basis an analysis is made of the adequacy of our allowance for doubtful accounts and adjustments are made accordingly. The current allowance is approximately 1% of accounts receivable. For example each additional 1% of accounts receivable that becomes uncollectible would reduce such balance of accounts receivable by approximately $48,000. +Income Taxes – +Income taxes are accounted for under ASC 740 authoritative guidance (“Guidance”) which requires the asset and liability method of accounting for deferred income taxes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities. Deferred tax assets or liabilities at the end of each period are determined using the tax rate expected to be in effect when taxes are actually paid or recovered. +The Guidance also requires that a valuation allowance be established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence needs to be considered, including a company’s current and past performance, the market environment in which the company operates, length of carryback and carryforward periods and existing contracts that will result in future profits. Prior to 2011 and through September 30, 2011, the Company had a full valuation allowance recorded against deferred tax assets since it was not more likely than not that the Company would realize the benefits of such deferred tax assets. During 2011, the Company determined based upon the guidance under ASC 740 that it was more likely than not that it would realize the benefit of such deferred tax assets. As result, the Company reversed the valuation allowance previously recorded against the deferred tax assets. The Company still maintains a full valuation allowance on research and development tax credits +The Guidance also prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the consolidated financial statements tax positions taken or expected to be taken on a tax return, including a decision whether to file or not to file in a particular jurisdiction. +The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles, generally accepted in the United States of America, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any viable alternative would not produce a materially different result. See our audited financial statements and notes thereto which contain accounting policies and other disclosures required by accounting principles generally accepted in the United States of America. +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The Consolidated Financial Statements and schedules that constitute Item 8 are attached at the end of this Annual Report on Form 10-K. An index to these Financial Statements and schedules is also included on page F-1 of this Annual Report on Form 10-K. +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. +Not Applicable. +ITEM 9A. +CONTROLS AND PROCEDURES +(a) Disclosure Controls and Procedures. Under the supervision and with the participation of our senior management, consisting of our chief executive officer and our chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report (the "Evaluation Date"). Based on that evaluation, the Company’s management, including our chief executive officer and chief financial officer, concluded that as of the Evaluation Date our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our Exchange Act reports is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. +33 +Management's Annual Report on Internal Control Over Financial Reporting. The Company's management is responsible for establishing and maintaining an adequate system of internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)). Our internal control over financial reporting is a process, under the supervision of our chief executive officer and chief financial officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. These internal controls over financial reporting processes include policies and procedures that: +a. +Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; +b. +Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +c. +Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives. +In evaluating the effectiveness of our internal control over financial reporting, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on this evaluation, our Chief Executive and Chief Financial Officers concluded that our internal control over financial reporting was effective as of December 31, 2012. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. +Management's report was not subject to attestation by our registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report. +(b) Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the Company’s last fiscal quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +ITEM 9B. +OTHER INFORMATION +Not applicable. +34 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +Directors and Executive Officers +Lawrence A. Siebert (56), President, Chief Executive Officer and Chairman. Mr. Siebert was appointed President of Chembio Diagnostics, Inc. and a member of our board of directors upon consummation of the merger in 2004. Mr. Siebert has been Chairman of Chembio Diagnostic Systems Inc. for approximately thirteen years and its President since May 2002. Mr. Siebert’s background is in private equity and venture capital investing. From 1982 to 1991, Mr. Siebert was associated with Stanwich Partners, Inc, which during that period invested in middle market manufacturing and distribution companies. From 1992 to 1999, Mr. Siebert was an investment consultant and business broker with Siebert Capital Corp. and Siebert Associates LLC, and was a principal investor in a privately held test and measurement company which was sold in 2002. Mr. Siebert received a JD from Case Western Reserve University School of Law in 1981 and a BA with Distinction in Economics from the University of Connecticut in 1978. Mr. Siebert as president and CEO is an integral part of the Chembio management team. His experience in the rapid test field and financing markets made him an excellent candidate for serving on the board and as its chairman. +Richard J. Larkin (56), Chief Financial Officer. Mr. Larkin was appointed as Chief Financial Officer of Chembio Diagnostics, Inc. upon consummation of the merger in 2004. Mr. Larkin oversees our financial activities and information systems. Mr. Larkin has been the Chief Financial Officer of Chembio Diagnostic Systems Inc. since September 2003. Prior to joining Chembio Diagnostic Systems Inc., Mr. Larkin served as CFO at Visual Technology Group from May 2000 to September 2003, and also led their consultancy program that provided hands-on expertise in all aspects of financial service, including the initial assessment of client financial reporting requirements within an Enterprise Resource Planning (Manufacturing) environment through training and implementation. Prior to joining VTG, he served as CFO at Protex International Corporation from May 1987 to January 2000. Mr. Larkin holds a BBA in Accounting from Dowling College and is a member of the American Institute of Certified Public Accountants. +Javan Esfandiari (46), Executive VP of Research and Development. Mr. Esfandiari joined Chembio Diagnostic Systems, Inc, in 2000. Mr. Esfandiari co-founded, and became a co-owner of Sinovus Biotech AB where he served as Director of Research and Development concerning lateral flow technology until Chembio Diagnostic Systems Inc. acquired Sinovus Biotech AB in 2000. From 1993 to 1997, Mr. Esfandiari was Director of Research and Development with On-Site Biotech/National Veterinary Institute, Uppsala, Sweden, which was working in collaboration with Sinovus Biotech AB on development of veterinary lateral flow technology. Mr. Esfandiari received his B.Sc. in Clinical Chemistry and his M. Sc. in Molecular Biology from Lund University, Sweden. He has published articles in various veterinary journals and has co-authored articles on tuberculosis serology with Dr. Lyashchenko. +Richard Bruce (59), Vice President, Operations. Mr. Bruce was hired in April 2000 as Director of Operations. He is responsible for manufacturing, maintenance, inventory, shipping, receiving, and warehouse operations. Prior to joining Chembio Diagnostic Systems Inc., he held director level positions at Wyeth Laboratories from 1984 to 1993. From 1993 to 1998, he held various management positions in the Operations Department at Biomerieux. From 1998 to 2000, he held a management position at V.I. Technologies. Mr. Bruce has over thirty years of operations management experience with Fortune 500 companies in the field of in-vitro diagnostics and blood fractionation. Mr. Bruce received his BS in Management from National Louis University in 1997. +Tom Ippolito (50), VP of Regulatory Affairs, QA and QC. Mr. Ippolito joined Chembio in June 2005. He has over twenty years’ experience with in vitro diagnostics for infectious diseases, protein therapeutics, vaccine development, Process Development, Regulatory Affairs and Quality Management. Over the years, Mr. Ippolito has held Vice President level positions at Biospecific Technologies, Corp. from 2000 - 2005, Director level positions in Quality Assurance, Quality Control, Process Development and Regulatory Affairs at United Biomedical, Inc. from 1987 - 2000. Mr. Ippolito is the Course Director for “drug development process” and “FDA Regulatory Process” for the BioScience Certificate Program at the New York State University of Stony Brook, a program he has been a part of since its inception in 2003. +Dr. Gary Meller M.D. (62), Director. Dr. Meller was elected to our Board of Directors in March 15, 2005, and currently serves on the Board’s Audit, Compensation and Nominating And Corporate Governance Committees, including as Chairman of the Compensation Committee. Dr. Meller also served as Chairman of the Board’s Special Committee for handling certain strategic opportunities. Dr. Meller has been the president of CommSense Inc., a healthcare business development company, since 2001. CommSense Inc. works with clients in Europe, Asia, North America, and the Middle East on medical information technology, medical records, pharmaceutical product development and financing, health services operations and strategy, and new product and new market development. From 1999 until 2001 Dr. Meller was the executive vice president, North America, of NextEd Ltd., a leading internet educational services company in the Asia Pacific region. Dr. Meller also was a limited partner and a member of the Advisory Board of Crestview Capital Master LLC, which at one time was our largest stockholder. Dr. Meller is a graduate of the University of New Mexico School of Medicine and has an MBA from the Harvard Business School. Dr. Meller’s experience in the medical field both domestic and foreign (especially his experience with CommSense Inc.) as well as his financing experience made him an excellent candidate for serving on the board. +35 +Kathy Davis (56), Director. Ms. Davis was elected to the Company’s Board of Directors in May 2007, and currently serves on the Board of Director’s Audit, Compensation and Nominating And Corporate Governance Committees, including as Chairman of each of the Audit Committee and the Nominating And Corporate Governance Committee. Ms. Davis also served on the Board’s Special Committee for handling certain strategic opportunities. Since January 2007, Ms. Davis has been the owner of Davis Design Group LLC, a company that provides analytical and visual tools for public policy design. Previously, from February 2005 to December 2006, she served as the Chief Executive Officer of Global Access Point, a start-up company with products for data transport, data processing, and data storage network and hub facilities. From October 2003 to January 2005, Ms. Davis was Lieutenant Governor of the State of Indiana, and from January 2000 to October 2003 was Controller of the City of Indianapolis. From 1989 to 2003, Ms. Davis held leadership positions with agencies and programs in the State of Indiana including State Budget Director, Secretary of Family & Social Services Administration, and Deputy Commissioner of Transportation. From 1982 to 1989 Ms. Davis held increasingly senior positions with Cummins Engine, where she managed purchasing, manufacturing, engineering, and assembly of certain engine product lines. Ms. Davis also led the startup of and initial investments by a $50 million Indiana state technology fund, serves on the not-for-profit boards of Noble of Indiana, University of Evansville Institute of Global Enterprise, Purdue College of Science Dean’s Leadership Council and Indiana University School of Public and Environmental Affairs Dean’s Advisory Council. She has a Masters of Business Administration from Harvard Business School and a Bachelor of Science in Mechanical Engineering from the Massachusetts Institute of Technology. Ms. Davis has varied experience in business, political and financial areas made her an excellent candidate for serving on the board. +Dr. Barbara DeBuono M.D., M.P.H., (57), Director . Dr. DeBuono, who was elected to the Company's Board of Directors in June 2011, is a renowned expert in public health innovation, health policy, education and research. Dr. DeBuono currently serves as Senior Vice President for Market Development at TREO Solutions, a data analytics and health system transformation company based in New York. Previously she held the post of President and CEO of ORBIS International, which is dedicated to saving sight and eliminating avoidable blindness worldwide. From 2009-2011, Dr. DeBuono was Chief Medical Officer, Partner and Global Director of Health and Social Marketing at Porter Novelli, and from 2000-2008 she was Executive Director, Public Health and Government at Pfizer Inc. Dr. DeBuono has served as Commissioner of Health for the state of New York and as Director of Health in Rhode Island and she was honored by the CDC Foundation in 2005 as one of five Public Health Heroes nationwide. She serves as adjunct professor at The George Washington University School of Public Health, and is a co-founder of The MAIA Foundation, a charity dedicated to women's health in sub-Saharan Africa. A Fellow of the American College of Physicians, Dr. DeBuono received her B.A. from the University of Rochester, her M.D. from the University of Rochester, School of Medicine, and a Masters in Public Health (M.P.H.) from Harvard University School of Public Health. Dr. DeBuono's experience in and knowledge of, both domestic and international, public health services, public health innovations, and the medical field make her an excellent candidate for serving on the board. +Dr. Peter Kissinger, Ph.D. (68), Director. Dr. Kissinger, who was elected to the Company’s Board of Directors in June 2011 , is a scientist, entrepreneur and academic, with a multi-faceted career in biotechnology and biomedical technologies. He is a Professor of Chemistry and Associate Department Head at Purdue University, West Lafayette, Indiana, and is the founder of Bioanalytical Systems, Inc. (NASDAQ: BASI), which he led from 1974-2007. Dr. Kissinger’s academic research has involved the study of modern liquid chromatography techniques, and in vivo methodology for drug metabolism and the neurosciences. Dr. Kissinger has published more than 230 scientific papers and is a Fellow of the American Association of Pharmaceutical Scientists and the American Association for the Advancement of Science. In 2005, he became the Chairman of Prosolia, which markets mass spectrometry innovations for life science, industrial and homeland security applications. In 2007, he and Candice Kissinger founded Phlebotics, Inc., a medical device company focused on diagnostic information for intensive care medicine. He is a columnist for the trade publication Drug Discovery News. Dr. Kissinger received a B.S. in Chemistry from Union College, Schenectady, N.Y. and a Ph.D. in Analytical Chemistry from the University of North Carolina in Chapel Hill. Dr. Kissinger has knowledge of and experience in biotechnology and biomedical technologies as well as publicly-traded companies, all of which make him an excellent candidate for serving on the board. +Section 16(a) Beneficial Ownership Reporting Compliances +Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires the Company’s directors, executive officers and beneficial owners of more than 10% of the Company’s common stock to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of common stock and other equity securities of the Company. The Company believes that during the year ended December 31, 2012, each person who was an officer, director and beneficial owner of more than 10% of the Company’s common stock complied with all Section 16(a) filing requirements . +Code of Ethics +The Company has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer, controller, and persons performing similar functions. A copy of the Company’s code of ethics is available on the Company’s website at www.chembio.com. +36 +Identification of Audit Committee; Audit Committee Financial Expert +The Company’s board of directors has established an audit committee. Katherine L. Davis, Dr. Pete Kissinger and Dr. Gary Meller each serves on the audit committee, with Ms. Davis serving as chairman. The Company’s board of directors has determined that Ms. Davis is an audit committee financial expert and is independent. +ITEM 11. EXECUTIVE COMPENSATION +The following table summarizes all compensation recorded by the Company in each of the last two completed fiscal years for our principal executive officer and our two most highly compensated executive officers other than our principal executive officer whose annual compensation exceeded $100,000. +Name / +Principal +Position +Year +Salary 1 +($) +Bonus 2 +($) +Stock +Awards +($) +Option Awards 3 +($) +All Other Compensation 5 +($) +Total +($) +Lawrence A. Siebert 4 +2012 +$ +290,000 +$ +101,500 +$ +- +$ +28,217 +$ +10,400 +$ +430,1217 +CEO +2011 +281,346 +101,500 +- +- +12,600 +395,446 +Javan Esfandiari +2012 +$ +263,077 +$ +89,250 +$ +- +$ +24,811 +$ +7,608 +384,746 +VP-R&D +2011 +253,077 +89,250 +$ +- +- +8,540 +350,867 +Tom Ippolito +2012 +$ +196,187 +$ +33,600 +$ +- +$ +9,340 +$ +4,367 +$ +243,494 +VP-Regulatory +2011 +190,702 +33,600 +- +41,997 +3,958 +270,257 +1 Salary is total base salary. +2 Bonuses earned in 2012 and 2011 were partially based on reaching certain objectives, which included revenue dollar levels and operating profit levels, additional amounts earned were discretionary. +3 The estimated fair value of any option or common stock granted was determined in accordance with ASC 718, "Stock-Based Payment". +4 Mr. Siebert also serves as a director on the Company’s board of directors. Mr. Siebert does not receive any compensation for this director role. +5 Other compensation includes an employer match to 401(K) contributions and car allowances where applicable. +Employment Agreements +Mr. Siebert. Effective, May 11, 2011, the Compensation Committee of the Board of Directors extended the Company’s employment agreement (the “Employment Agreement”) with Lawrence A. Siebert, the Company’s President and Chief Executive Officer, for an additional one-year term through May 11, 2013, with an increase in salary to $290,000 per year. Previously, effective May 11, 2009, the Company’s Board of Directors had approved the Company’s extension of the June 15, 2006 Employment Agreement for an additional three-year term through May 11, 2012. On June 15, 2006, Mr. Siebert and the Company entered into an Employment Agreement, effective May 10, 2006, which was to terminate on May 10, 2008, extended in 2008 to May 10, 2009. Pursuant to the Employment Agreement, Mr. Siebert serves as the President and Chief Executive Officer of the Company and received an initial salary of $240,000 per year, which had been increased to $265,000 per year until Mr. Siebert agreed to a 15 percent reduction, to $225,000, effective January 19, 2009. Mr. Siebert’s salary was restored to $265,000 per annum effective in July 2009. Mr. Siebert also is eligible for a bonus of up to 50% of his salary, consisting of (i) a bonus of up to 25% of his salary that is at the complete discretion and determination of the board of directors, and (ii) a bonus of up to an additional 25% of his salary that will be determined based upon revenue and earnings performance criteria established each year by the board of directors. Mr. Siebert is eligible to participate in any profit sharing, stock option, retirement plan, medical and/or hospitalization plan, and/or other benefit plans except for disability and life insurance that the Company may from time to time place in effect for the Company’s executives during the term of Mr. Siebert’s employment agreement. If Mr. Siebert’s Employment Agreement is terminated by the Company without cause, or if Mr. Siebert terminates his Employment Agreement for a reasonable basis, as defined in the Employment Agreement, including within 12 months of a change in control, the Company is required to pay as severance Mr. Siebert’s salary for six months. Mr. Siebert has agreed for a period of two years after the termination of his employment with the Company not to induce customers, agents, or other sources of distribution of the Company’s business under contract or doing business with the Company to terminate, reduce, alter, or divert business with or from the Company. The terms of the extended May 11, 2011, May 11, 2009 and May 11, 2008 Employment Agreements are identical to the June 15, 2006 Employment Agreement, except that under the May 11, 2008 extended Employment Agreement, Mr. Siebert received additional consideration in the form of incentive stock options to purchase 31,250 shares of the Company’s common stock exercisable at $1.04 per share, which was the closing price of the Company's common stock on June 3, 2008. The incentive stock options are immediately exercisable and they expire on the June 3, 2013. +37 +Mr. Esfandiari. The Company entered into an employment agreement effective March 5, 2013 (the "Employment Agreement"), with Mr. Esfandiari to continue as the Company's Senior Vice President of Research and Development for an additional term of three years through March 5, 2016. Mr. Esfandiari's salary under the Employment Agreement is $300,000 for the first year, with possible increases for the second year and /or for the third year. Mr. Esfandiari is eligible for a performance-based bonus of up to 50% of his base salary for each respective year, which is in the same proportions as described below under “Executive Bonus Plan”. The Company also granted Mr. Esfandiari, pursuant to the Company's 2008 Stock Incentive Plan, incentive stock options to purchase 30,000 shares of the Company's common stock. The price per share of these options is equal to the fair market value of the Company's common stock as of the close of the market on March 5, 2013, which is the date on which the Agreement was effective. Of these stock options, options to purchase 10,000 shares vest on each of the first three anniversaries of the effective date of the Employment Agreement. Mr. Esfandiari is eligible to participate in any profit sharing, stock option, retirement plan, medical and/or hospitalization plan, and/or other benefit plans except for disability and life insurance that the Company may from time to time place in effect for the Company’s executives during the term of Mr. Esfandiari’s employment agreement. If Mr. Esfandiari’s employment agreement is terminated by the Company without cause, or if Mr. Esfandiari terminates his employment agreement for a reasonable basis, as defined in the Employment Agreement, including within 12 months of a change in control, the Company is required to pay as severance Mr. Esfandiari’s salary for twelve months. +Mr. Ippolito does not have an employment contract with the Company. +Executive Bonus Plan +The Company has established a bonus plan for its executives who do not have a contract. For the fiscal year ended December 31, 2012, there were five executives eligible for this bonus plan. Each executive can earn up to 25% of that executive’s salary in the form of a cash bonus. The Compensation Committee determined that 60% of the executive’s bonus will be quantitative factors, based on the budget. 40% will be based on other factors and will be discretionary. In addition they are eligible for stock options based on a percentage of the total potential bonus earned. The plan, during 2012 for the 60%, called for a sliding percentage of the executive’s salary, from zero to 7.5% for attaining 85% to 100% of revenue goals, and from zero to 7.5% of the executive’s salary for attaining 70% to 100% of the designated operating profit goals. The Company achieved approximately 94% of its revenue goals for 2012, which would result in a bonus of 4.5% of each executive’s salary, and did not achieve 70% of its operating profit goal, which would result in a bonus of 0% of salary, for a total of 4.5% of salary. The Compensation Committee determined that the target goals were aggressive and considering the greater than 30% increase in revenues along with an increase in operating income it approved approximately 17% of salary in bonuses for the subject executives. +38 +OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END 2012 +Option Awards +Stock Awards +Name +Number of Securities Underlying Unexercised Options Exercisable (#) +Number of Securities Underlying Unexercised Options Unexercisable +(#) +Option Exercise Price +($) +Option Expiration Date +Option Vesting Date +Number of Shares of Stock That Have Not Vested +(#) +Market Value of Shares of Stock That Have Not Vested +($) +Foot- +note +Lawrence A. Siebert +9,063 +$ +4.00 +2/16/2017 +2/16/2012 +5 +16,667 +1.04 +5/6/2014 +5/6/2012 +3 +16,667 +1.04 +5/6/2014 +5/7/2011 +3 +16,667 +1.04 +5/6/2014 +5/6/2010 +3 +31,250 +1.04 +6/3/2013 +6/3/2008 +2 +9,375 +1.76 +2/15/2013 +2/15/2008 +1 +Javan Esfandiari +7,969 +4.00 +2/16/2017 +2/16/2012 +5 +12,500 +2.16 +3/4/2015 +3/5/2013 +2 +12,500 +2.16 +3/4/2015 +3/5/2012 +2 +12,500 +2.16 +3/4/2015 +3/5/2010 +2 +12,500 +1.04 +5/6/2014 +5/6/2012 +3 +7,500 +1.04 +2/15/2013 +2/15/2008 +1 +Tom Ippolito +3,000 +4.00 +2/16/2017 +2/16/2012 +5 +7,812 +4.32 +5/9/2016 +5/9/2014 +4 +7,812 +4.32 +5/9/2016 +5/9/2013 +4 +9,375 +1.04 +5/6/2014 +5/6/2012 +3 +9,375 +1.04 +5/6/2014 +5/7/2011 +3 +9,375 +1.04 +5/6/2014 +5/6/2010 +3 +6,250 +1.76 +2/15/2013 +2/15/2008 +1 +1 On February 15, 2008 the Company granted options under the 1999 Stock Option Plan. +2 Options issued in connection with an employment contract and under the 2008 Stock Incentive Plan. +3 On May 7, 2009 in accordance with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 365,625 shares of the Company’s common stock. The exercise price for these options is equal to $1.04 per share. The options become exercisable in thirds on the first, second and third anniversaries of the date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the date of grant. The fair value of these options is being amortized over the vesting life of the options. +4 On May 3, 2011 and effective May 9, 2011 in accordance with the terms of the Company’s 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 62,500 shares of the Company’s common stock exercise price for these options was to be equal to the VWAP (Volume Weighted Average Price) market price for the Company’s common stock on May 9, 2011. The options become exercisable evenly on the second and third anniversaries of the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. +5 On February 16, 2012, the Company granted to certain employees of the Company, options to purchase an aggregate of 25,392 shares of the Company’s common stock. The exercise price for these options was the last traded market price for the Company’s common stock on February 16, 2012, which was $.50 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. +39 +Director Compensation +All non-employee directors are paid an $18,000 annual retainer in semi-annual payments, and once every five years, on the date of the annual meeting of stockholders that directors are elected or re-elected (every 5 years), receive stock options to acquire, subject to vesting as described below, 46,875 shares of the Company's common stock, with an exercise price equal to the market price on the date of the grant. Stock options to acquire 9,375 shares become exercisable on the date of grant, and options to acquire an additional 9,375 shares become exercisable on the date of each of the four succeeding annual meetings of stockholders if and to the extent that the non-employee director is reelected as a director at each such annual meeting. The audit committee chairman is paid an annual retainer of $2,500, paid semi-annually. In addition, the non-employee directors are paid $1,000 in cash for each board of directors' meeting attended, and paid $500 in cash for each telephonic board of directors meeting. The non-employee directors who are members of a committee of the board of directors are paid $500 in cash for each committee meeting attended, or $750 in cash for each committee meeting attended if that non-employee director is the committee chairman. Directors also may be paid for serving ad hoc committees of the Board. In fact, when the Board established its Special Committee in 2010 to handle the possible sale of the Company, the Chairman of the Committee was paid $12,000 per month, and the other director-member of the Committee was paid $8,000 per month. +DIRECTOR COMPENSATION +Name +Fees Earned or Paid in Cash +($) 1 +Option Awards +($) 2 +Total +($) +Katherine L. Davis +$ +30,250 +$ +- +$ +30,250 +Barbara DeBuono +24,500 +- +24,500 +Pete Kissinger +25,500 +- +25,500 +Gary Meller +27,500 +- +27,500 +1 Fees earned or paid in cash represents a yearly fee and fees for meeting expenses: (a) Ms. Davis received an $18,000 annual fee as a member of the board of directors, a $2,500 annual fee as audit committee chairman and $9,750 in meeting fees paid during 2012; (b) Dr. DeBuono received an $18,000 annual fee as a member of the board of directors and $6,500 in meeting fees; (c) Dr. Kissinger received an $18,000 annual fee as a member of the board of directors for and $7,500 in meeting fees; (d) Dr. Meller received an $18,000 annual fee as a member of the board of directors and $9,500 in meeting fees. +2 Each outside member of the board of directors is granted, once every five years, options to purchase 46,875 shares of the company’s common stock with an exercise price equal to the market price on the date of the grant as part of their annual compensation. One-fifth of these options are exercisable on the date of grant, one-fifth become exercisable on the first anniversary of the date of grant, and additional one-fifths become exercisable on the second through fourth anniversary of the date of grant. The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model. +Compensation Committee Interlocks and Insider Participation +No executive officer of the Company served as a member of the Board of any other public company during the year ended December 31, 2012. No member of the Compensation Committee serves as an executive officer of any other public company during the year ended December 31, 2012. No interlocking relationship exists between the members of our Compensation Committee and the Board or compensation committee of any other company. As of March 1, 2013, the members of the Compensation Committee were Gary Meller (Chairman), Katherine Davis, and Barbara DeBuono, all of whom are deemed by the Board of Directors to be independent. +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The following table sets forth certain information regarding the beneficial ownership of our common stock by each person or entity known by us to be the beneficial owner of more than 5% of the outstanding shares of common stock, each of our directors, each of our “named executive officers”, and all of our directors and executive officers as a group as of March 6, 2013. +Name and Address of +Beneficial Owner +Amount and Nature of Beneficial Ownership +Percent of Class +Siebert, Lawrence (1) +3661 Horseblock Road +Medford, NY 11763 +890,954 +10.89% +Esfandiari, Javan (2) +3661 Horseblock Road +Medford, NY 11763 +143,735 +1.77% +Larkin, Richard (3) +3661 Horseblock Road +Medford, NY 11763 +69,245 +.85% +Ippolito, Tom (4) +3661 Horseblock Road +Medford, NY 11763 +38,987 +.48% +Bruce, Richard (5) +3661 Horseblock Road +Medford, NY 11763 +49,717 +.61% +Steele, Michael (6) +3661 Horseblock Road +Medford, NY 11763 +785 +.01% +Klugewicz, Sharon (7) +3661 Horseblock Road +Medford, NY 11763 +630 +.01% +Meller, Gary (8) +3661 Horseblock Road +Medford, NY 11763 +95,625 +1.18% +Davis, Katherine L. (9) +3661 Horseblock Road +Medford, NY 11763 +48,922 +.60% +DeBuono, Barbara (10) +3661 Horseblock Road +Medford, NY 11763 +20,704 +.26% +Kissinger, Peter (11) +3661 Horseblock Road +Medford, NY 11763 +20,704 +.26% +GROUP (12) +1,380,008 +16.36% +Wellington Management Company, LLP +280 Congress Street +Boston, MA 02210 +670,980 +8.30% +40 +Beneficial ownership is determined in accordance with the Rule 13d-3(a) of the Securities Exchange Act of 1934, as amended, and generally includes voting or investment power with respect to securities. Except as subject to community property laws, where applicable, the person named above has sole voting and investment power with respect to all shares of our common stock shown as beneficially owned by him. +The beneficial ownership percent in the table is calculated with respect to the number of outstanding shares (8,086,114) of the Company's common stock outstanding as of March 6, 2013; and with respect to each stockholder, the denominator is the sum of the number of common shares outstanding and the number, if any, of outstanding options included in that stockholder’s beneficial ownership. Each stockholder's ownership is calculated as the number of shares of common stock owned plus the number of shares of common stock into which any preferred stock, warrants, options or other convertible securities owned by that stockholder can be converted within 60 days. +The term “named executive officer” refers to our principal executive officer, our two most highly compensated executive officers other than the principal executive officer who were serving as executive officers at the end of 2012, and two additional individuals for whom disclosure would have been provided but for the fact that the individuals were not serving as executive officers of the Company at the end of 2012. +(1) +Includes 95,529 shares issuable upon exercise of options exercisable within 60 days. +(2) +Includes 50,234 shares issuable upon exercise of options exercisable within 60 days. Does not include 12,500 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(3) +Includes 38,842 shares issuable upon exercise of options exercisable within 60 days. Does not include 18,750 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(4) +Includes 32,900 shares issuable upon exercise of options exercisable within 60 days. Does not include 15,624 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(5) +Includes 13,458 shares issuable upon exercise of options exercisable within 60 days. Does not include 12,500 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(6) +Includes 785 shares issuable upon exercise of options exercisable within 60 days. Does not include 36,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(7) +Includes 630 shares issuable upon exercise of options exercisable within 60 days. Does not include 36,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(8) +Includes 37,500 shares issuable upon exercise of options exercisable within 60 days. Does not include 9,375 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(9) +Includes 37,957 shares issuable upon exercise of options exercisable within 60 days. Does not include 9,375 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(10) +Includes 20,704 shares issuable upon exercise of options exercisable within 60 days. Does not include 28,125 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(11) +Includes 20,704 shares issuable upon exercise of options exercisable within 60 days. Does not include 28,125 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(12) +Includes footnotes (1)-(11) +Equity Compensation Plan Information +Combined Equity Compensation Plans - Information as of December 31, 2012 +Plan Category +Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights +Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights +Number of Securities Remaining Available for Future Issuance under Equity Compensation Plans (Excluding Securities Reflected in Column (a) +(a) +(b) +(c) +Equity compensation plans approved by security holders 1 +731,646 +1 +$ +0.212 +68,961 +Equity compensation plans not approved by security holders +- +- +- +Total +731,646 +$ +0.212 +68,961 +1 The “Number of Securities to be Issued Upon Exercise of Outstanding Warrants and Rights” represents 135,191 from the 1999 Stock Option Plan and 596,455 under the 2008 Stock Incentive Plan. The 2008 Stock Incentive Plan was increased by 125,000 units at the Annual Stockholder meeting held September 23, 2011. The “Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans” represents shares issuable under the 2008 Stock Incentive Plan. +41 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +The executive officers of the Company are as follows: Lawrence A. Siebert, president, chief executive officer and chairman of the board of directors of the Company, Richard J. Larkin, chief financial officer of the Company, and Javan Esfandiari, executive vice president of Research and Development of the Company. +In accordance with the terms of the Company’s 2008 Plan, on May 9, 2011, the Company granted to certain employees of the Company options to purchase an aggregate of 62,500 shares of the Company’s common stock. The exercise price for these options was to be equal to the VWAP (Volume Weighted Average Price) market price for the Company’s common stock on May 9, 2011. The options become exercisable evenly on the second and third anniversaries of the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. Mr. Ippolito, Mr. Bruce and Mr. Larkin received options to purchase common stock of 15,625, 12,500 and 18,750 shares, respectively. +On February 16, 2012, the Company granted options to purchase the following numbers of shares of the Company’s common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company’s common stock on February 16, 2012, which was $4.00 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +2,563 +Javan Esfandiari – Executive Vice President of R&D +7,969 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +3,000 +Richard J. Larkin – Chief Financial Officer +2,797 +Lawrence A. Siebert – Chief Executive Officer +9,063 +On February 25, 2013, the Company granted options to purchase the following numbers of shares of the Company’s common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company’s common stock on February 26, 2013, which was $5.56 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +1,520 +Javan Esfandiari – Executive Vice President of R&D +4,765 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +1,775 +Richard J. Larkin – Chief Financial Officer +1,670 +Lawrence A. Siebert – Chief Executive Officer +5,215 +Michael Steele – Vice President of Sales and Marketing +785 +Sharon Klugewicz – Vice President of QA/QC +630 +The Company entered into an employment agreement effective March 5, 2013 (the "Employment Agreement"), with Mr. Esfandiari to continue as the Company's Senior Vice President of Research and Development for an additional term of three years through March 5, 2016. See Item 11 for more details. +Director Independence +Our common stock trades on the NASDAQ. Accordingly, we are subject to the corporate the governance standards of NASDAQ, which require, among other things, that the majority of the board of directors be independent. We define an “independent” director in accordance with the NASDAQ Global Market's requirements for independent directors. Under this definition, we have determined that each of Katherine Davis, Barbara DeBuono, Peter Kissinger, and Gary Meller currently qualify as independent directors. We do not list the “independent” definition we use on our internet website . +42 +ITEM 14. +PRINCIPAL ACCOUNTANT FEES AND SERVICES +Audit Fees +For the years ended December 31, 2012 and 2011, the Company engaged BDO USA, LLP as its independent accounting firm to audit the Company’s annual financial statements and review of financial statements included in the Company’s Forms 10-Q and 10-K for the years ended December 31, 2012 and 2011, for $109,000 and $110,000, respectively in fees. +Audit-Related Fees +For the years ended December 31, 2012 and 2011, the Company’s independent accounting firm, BDO USA, LLP, did not provide the Company with any assurance and related services reasonably related to the performance of the audit or review of the Company’s financial statements that are not reported above under “Audit Fees.” +Tax Fees +For the years ended December 31, 2012 and 2011, the Company’s independent accounting firm, BDO USA, LLP, billed the Company $30,000 and $44,000, respectively for professional services for tax compliance, tax advice and tax planning. +All Other Fees +For the years ended December 31, 2012 and 2011, the Company’s independent accounting firm, BDO USA, LLP, did not provide the Company with any other matters. +Audit Committee Pre-Approval Policies +The Audit Committee approves in advance all audit and non-audit services performed by the independent accounting firm. There are no other specific policies or procedures relating to the pre-approval of services performed by the independent accounting firm. +43 +ITEM 15. EXHIBITS +Number +Description +3.1 +Articles of Incorporation, as amended. (1) +3.2 +Amended and Restated Bylaws. (2) +4.1* +Form of Employee Option Agreement. (3) +4.2 +1999 Equity Incentive Plan. (4) +4.3 +2008 Stock Incentive Plan. (5) +4.4 +Rights Agreement, dated March 8, 2010 (6) +4.5 +Form of Warrant (to be filed by amendment) [to be revised] +10.1* +Employment Agreement dated June 15, 2006 with Lawrence A. Siebert. (7) +10.2* +Employment Agreement dated March 5, 2013 with Javan Esfandiari. +10.3 +HIV Barrel License, Marketing and Distribution Agreement, dated as of September 29, 2006, by and among the Registrant, Alere and StatSure. (8) +10.4 +HIV Cassette License, Marketing and Distribution Agreement, dated as of September 29, 2006, between the Registrant and Alere. (8) +10.5 +Non-Exclusive License, Marketing and Distribution Agreement, dated as of September 29, 2006, between the Registrant and Alere. (8) +10.6 +Joint HIV Barrel Product Commercialization Agreement, dated as of September 29, 2006, between the Registrant and StatSure. (8) +10.7 +Secured Term Note, dated as of June 14, 2010, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (9) +10.8 +Secured Revolving Demand Note, dated as of June 14, 2010, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (9) +10.9 +Loan and Security Agreement, dated as of June 14, 2010, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (9) +10.10 +Revolving Term Note, dated as of July 22, 2011, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (10) +10.11 +Loan and Security Agreement, dated as of July 22, 2011, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (10) +14.1 +Ethics Policy (11) +21 +List of Subsidiaries +23.1 +Consent of BDO USA, LLP, Independent Registered Public Accountants. +31.1 +Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2 +Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 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.DEF +XBRL Taxonomy Definition Linkbase Document +101.LAB +XBRL Taxonomy Label Linkbase Document +101.PRE +XBRL Taxonomy Presentation Linkbase Document +1 +Incorporated by reference to the Registrant’s annual report on Form 10-KSB filed with the Commission on March 31, 2005. +2 +Incorporated by reference to the Registrant’s registration statement on Form SB-2 (File No. 333-85787) filed with the Commission on August 23, 1999 and the Registrant's Forms 8-K filed on May 14, 2004, December 20, 2007 and April 18, 2008. +3 +Incorporated by reference to the Registrant’s annual report on Form 10-KSB filed with the Commission on March 12, 2008. +4 +Incorporated by reference to the Registrant’s definitive proxy statement on Schedule 14A filed with the Commission on May 11, 2005. +5 +Incorporated by reference to the Registrant’s definitive proxy statement on Schedule 14A filed with the Commission on April 14, 2008. +6 +Incorporated by reference to the Registrant’s registration statement on Form 8-A filed with the Commission on March 11, 2010. +7 +Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the Commission on June 21, 2006. +8 +Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the Commission on October 5, 2006. +9 +Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on July 29, 2010. +10 +Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on November 3, 2011. +11 +Incorporated by reference to the Registrant’s annual report on Form 10-KSB filed with the Commission on March 30, 2006. +(*) +An asterisk (*) beside an exhibit number indicates the exhibit contains a management contract, compensatory plan or arrangement which is required to be identified in this registration statement. +44 +SIGNATURES +In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +CHEMBIO DIAGNOSTICS, INC. +Date: March 7, 2013 By /s/ Lawrence A. Siebert +Lawrence A. Siebert +President, Chief Executive Officer and +Chairman of the Board +In accordance with the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signatures +Title +Date +/s/ Lawrence A. Siebert +Lawrence A. Siebert +Chief Executive Officer, President and Chairman Of The Board +(Principal Executive Officer) +March 7, 2013 +/s/ Richard J. Larkin +Richard J. Larkin +Chief Financial Officer (Principal Financial & Accounting Officer) +March 7, 2013 +/s/ Gary Meller +Dr. Gary Meller +Director +March 7, 2013 +/s/ Katherine L. Davis +Katherine L. Davis +Director +March 7, 2013 +/s/ Pete Kissinger +Pete Kissinger +Director +March 7, 2013 +/s/ Barbara DeBuono +Barbara DeBuono +Director +March 7, 2013 +45 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +Index to Consolidated Financial Statements +—INDEX— +Page(s) +Report of Independent Registered Public Accounting Firm +F-1 +Consolidated Financial Statements: +Balance Sheets +December 31, 2012 and 2011 +F-2 +Statements of Operations +Years ended December 31, 2012 and 2011 +F-3 +Statements of Changes in Stockholders’ Equity +Years ended December 31, 2012 and 2011 +F-4 +Statements of Cash Flows +Years ended December 31, 2012 and 2011 +F-5 +Notes to Consolidated Financial Statements +F-6 - F-18 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +Board of Directors and Stockholders of +Chembio Diagnostics, Inc. +Medford, New York +We have audited the accompanying consolidated balance sheets of Chembio Diagnostics, Inc. and Subsidiary (the “Company”) as of December 31, 2012 and 2011 and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Chembio Diagnostics, Inc. and Subsidiary as of December 31, 2012 and 2011, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. +BDO USA, LLP +/s/ BDO USA, LLP +Melville, New York +March 7, 2013 +F-1 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED BALANCE SHEETS +AS OF +- ASSETS - +December 31, 2012 +December 31, 2011 +CURRENT ASSETS: +Cash and cash equivalents +$ +2,951,859 +$ +3,010,954 +Accounts receivable, net of allowance for doubtful accounts of $58,000 and $30,000 at December 31, 2012 and 2011, respectively +4,821,357 +2,998,449 +Inventories +2,488,071 +2,300,286 +Prepaid expenses and other current assets +747,463 +681,893 +TOTAL CURRENT ASSETS +11,008,750 +8,991,582 +FIXED ASSETS , net of accumulated depreciation +1,427,646 +1,062,276 +OTHER ASSETS: +Deferred tax asset, net of valuation allowance +4,233,194 +4,749,622 +License agreements, net of current portion +400,000 +500,000 +Deposits on manufacturing equipment +223,584 +139,790 +Deposits and other assets +41,976 +42,474 +TOTAL ASSETS +$ +17,335,150 +$ +15,485,744 +- LIABILITIES AND STOCKHOLDERS’ EQUITY - +CURRENT LIABILITIES: +Accounts payable and accrued liabilities +$ +3,303,923 +$ +2,789,500 +Current portion of loans payable +51,236 +53,550 +Customer deposits +23,224 +- +Current portion of obligations under capital leases +- +14,576 +TOTAL CURRENT LIABILITIES +3,378,383 +2,857,626 +OTHER LIABILITIES: +Loans payable - net of current portion +82,247 +133,484 +TOTAL LIABILITIES +3,460,630 +2,991,110 +COMMITMENTS AND CONTINGENCIES +STOCKHOLDERS’ EQUITY: +Preferred stock – 10,000,000 shares authorized, none outstanding +- +Common stock - $.01 par value; 100,000,000 shares authorized, 8,036,232 and 7,921,021 shares issued and outstanding for 2012 and 2011, respectively +80,362 +79,210 +Additional paid-in capital +41,116,149 +40,678,696 +Accumulated deficit +(27,321,991 +) +(28,263,272 +) +TOTAL STOCKHOLDERS’ EQUITY +13,874,520 +12,494,634 +TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY +$ +17,335,150 +$ +15,485,744 +See accompanying notes to condensed consolidated financial statements +F-2 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF OPERATIONS +FOR THE YEARS ENDED +For the years ended +December 31, 2012 +December 31, 2011 +REVENUES: +Net product sales +$ +24,327,355 +$ +17,422,311 +License and royalty revenue +- +140,322 +R&D, milestone and grant revenue +1,283,240 +1,825,403 +TOTAL REVENUES +25,610,595 +19,388,036 +Cost of product sales +14,820,604 +9,997,733 +GROSS MARGIN +10,789,991 +9,390,303 +OPERATING EXPENSES: +Research and development expenses +4,486,302 +4,878,119 +Selling, general and administrative expenses +4,851,587 +3,424,297 +9,337,889 +8,302,416 +INCOME (LOSS) FROM OPERATIONS +1,452,102 +1,087,887 +OTHER INCOME (EXPENSE): +Interest income +7,911 +6,298 +Interest expense +(9,495 +) +(18,623 +) +(1,584 +) +(12,325 +) +INCOME BEFORE INCOME TAXES +1,450,518 +1,075,562 +Income tax provision (benefit) +509,237 +(5,133,229 +) +NET INCOME +$ +941,281 +$ +6,208,791 +Basic earnings per share +$ +0.12 +$ +0.79 +Diluted earnings per share +$ +0.11 +$ +0.73 +Weighted average number of shares outstanding, basic +7,986,030 +7,874,807 +Weighted average number of shares outstanding, diluted +8,614,944 +8,556,284 +See accompanying notes to condensed consolidated financial statements +F-3 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY +FOR THE YEARS ENDED DECEMBER 31, 2012 AND 2011 +Common Stock +Additional Paid in Capital +Accumulated Deficit +Total +Shares +Amount +Amount +Amount +Amount +Balance at December 31, 2010 +7,779,882 +$ +77,799 +$ +40,203,208 +$ +(34,472,063 +) +$ +5,808,944 +Warrants and options: +Excercised +141,139 +1,411 +286,141 +- +287,552 +Stock option compensation +- +- +189,347 +- +189,347 +Net income +- +- +- +6,208,791 +6,208,791 +Balance at December 31, 2011 +7,921,021 +$ +79,210 +$ +40,678,696 +$ +(28,263,272 +) +$ +12,494,634 +Common Stock: +Consulting Services +3,752 +38 +16,441 +16,479 +Options: +Consulting Services +8,010 +8,010 +Excercised +111,459 +1,114 +119,276 +- +120,390 +Stock option compensation +- +- +293,726 +- +293,726 +Net income +- +- +- +941,281 +941,281 +Balance at December 31, 2012 +8,036,232 +$ +80,362 +$ +41,116,149 +$ +(27,321,991 +) +$ +13,874,520 +See accompanying notes to consolidated financial statements +F-4 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF CASH FLOWS +FOR THE YEARS ENDED +December 31, 2012 +December 31, 2011 +CASH FLOWS FROM OPERATING ACTIVITIES: +Cash received from customers and grants +$ +23,810,911 +$ +20,335,985 +Cash paid to suppliers and employees +(23,048,243 +) +(18,055,252 +) +Interest received +7,911 +6,298 +Interest paid +(9,495 +) +(18,623 +) +Net cash provided by operating activities +761,084 +2,268,408 +CASH FLOWS FROM INVESTING ACTIVITIES: +Acquisition of and deposits on fixed assets +(872,442 +) +(726,680 +) +Net cash used in investing activities +(872,442 +) +(726,680 +) +CASH FLOWS FROM FINANCING ACTIVITIES: +Proceeds from option and warrant exercises +120,390 +287,552 +Payment of license obligation +- +(875,000 +) +Payment of loan obligation +(53,551 +) +(54,980 +) +Payment of capital lease obligation +(14,576 +) +(24,697 +) +Net cash provided by (used in) financing activities +52,263 +(667,125 +) +(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS +(59,095 +) +874,603 +Cash and cash equivalents - beginning of the period +3,010,954 +2,136,351 +Cash and cash equivalents - end of the period +$ +2,951,859 +$ +3,010,954 +RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: +Net Income +$ +941,281 +$ +6,208,791 +Adjustments: +Depreciation and amortization +523,278 +437,828 +Provision for deferred taxes +471,085 +(5,155,713 +) +Provision for doubtful accounts +28,000 +(5,000 +) +Share based compensation +318,215 +189,347 +Changes in assets and liabilities: +Accounts receivable +(1,850,908 +) +952,949 +Inventories +(187,785 +) +(951,125 +) +Prepaid expenses and other current assets +(20,227 +) +(70,978 +) +Deposits and other assets +498 +(6,248 +) +Accounts payable and accrued liabilities +514,423 +733,557 +Customer deposits and deferred revenue +23,224 +(65,000 +) +Net cash provided by operating activities +$ +761,084 +$ +2,268,408 +Supplemental disclosures for non-cash investing and financing activities: +Deposits on manufacturing equipment transferred to fixed assets +$ +229,042 +$ +- +See accompanying notes to condensed consolidated financial statements +F-5 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2012 AND 2011 +NOTE 1 — DESCRIPTION OF BUSINESS: +Chembio Diagnostics, Inc. (the “Company” or “Chembio”) and its subsidiary, Chembio Diagnostic Systems, Inc., develop, manufacture, and market rapid diagnostic tests that detect infectious diseases. The Company’s main lateral flow products are three rapid tests for the detection of HIV antibodies in whole blood, serum and plasma samples, two of which were approved by the FDA in 2006; the third is sold for export only. Lateral Flow Rapid HIV tests represented nearly 56% of the Company’s product revenues in 2012. The Company’s products based on its patented DPP® platform represented approximately 41% of the Company’s product revenues in 2012. The Company also has other rapid tests that together represented approximately 3% of sales in 2012. The Company’s products are sold to medical laboratories and hospitals, governmental and public health entities, non-governmental organizations, medical professionals and retail establishments both domestically and internationally. Chembio’s products are sold under the Company’s STAT-PAK®, SURE CHECK® or DPP® registered trademarks, or under the private labels of its marketing partners, for example the Clearview® label owned by Alere, Inc. (“Alere”), which is the Company’s exclusive marketing partner for its rapid HIV lateral flow test products in the United States. These products employ lateral flow technologies that are proprietary and/or licensed to the Company. All of the Company’s products that are currently being developed are based on its patented Dual Path Platform (DPP®), which is a unique diagnostic point-of-care platform that has certain advantages over lateral flow technology. In December 2012, the Company received FDA approval for its DPP® HIV 1/2 Assay for the detection of HIV antibodies in saliva, whole blood, serum and plasma samples. +NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES: +(a) +Principles of Consolidation: +The consolidated financial statements include the accounts of the Company, and its wholly owned subsidiary. All intercompany transactions and balances have been eliminated in consolidation. +(b) +Use of Estimates: +The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make assumptions and estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods covered thereby. Actual results could differ from these estimates. Judgments and estimates of uncertainties are required in applying the Company’s accounting policies in certain areas. The following are some of the areas requiring significant judgments and estimates: determinations of the useful lives of assets, estimates of allowances for doubtful accounts, inventory reserves, stock-based compensation and deferred tax assets. +(c) +Fair Value of Financial Instruments: +The carrying value for cash and cash equivalents, accounts receivable and accounts payable, approximate fair value because of the immediate or short-term maturity of these financial instruments. The Company’s debt relates to borrowings under its credit facilities and term loan (see Note 7), which approximates fair value due to market interest rates. +(d) +Statements of Cash Flows: +For purposes of the statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. +(e) +Concentrations of Credit Risk: +Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade receivables. The Company places its temporary cash instruments with well-known financial institutions and, at times, may maintain balances in excess of the FDIC insurance limit. The Company monitors the credit ratings of the financial institutions to mitigate this risk. Concentration of credit risk with respect to trade receivables is principally mitigated by the Company’s ability to obtain letters of credit from certain foreign customers, and its diverse customer base both in number of customers and geographic locations. We currently do not require collateral for accounts receivable. +F-6 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2012 AND 2011 +(f) +Inventories: +Inventories, consisting of material, labor and manufacturing overhead, are stated at the lower of cost or market. Cost is determined on the first-in, first-out method. +(g) +Fixed Assets: +Fixed assets are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets, which range from three to seven years. Leasehold improvements are amortized over the useful life of the asset or the lease term, whichever is shorter. Deposits paid for fixed assets are capitalized and not depreciated until the related asset is placed in service. +(h) +License Agreement: +In February 2008, the Company entered into a sublicense agreement for which it had initially recorded an asset of $1,000,000. This asset is being expensed over an estimated economic life of ten years, based on the expected lifespan of our then current HIV products. The current portion of this asset is $100,000 as of December 31, 2012 and 2011 and is reported in prepaid expenses and other current assets. The long-term portion as of December 31, 2012 and 2011 is $400,000 and $500,000, respectively and is reflected in other assets on the consolidated balance sheet. +(i) +Impairment of Long-Lived Assets and Intangible Assets +Long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment. If there are indications of impairment, the Company uses future undiscounted cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. In the event such cash flows are not expected to be sufficient to recover the recorded asset values, the assets are written down to their estimated fair value. We believe that the carrying values of our long-lived tangible and intangible assets were realizable at December 31, 2012 and 2011, respectively. +(j) +Revenue Recognition: +The Company recognizes revenue for product sales in accordance with ASC 605, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is fixed and determinable, and collectability is reasonably assured. Revenue typically is recognized at time of shipment. Sales are recorded net of discounts, rebates and returns. As of December 31, 2012 and 2011, an aggregate of $23,000 and none, respectively, of customer deposits were not recognized. +For certain contracts, the Company recognizes revenue from non-milestone contracts and grant revenues when earned. Grants are invoiced after expenses are incurred. Revenues from projects or grants funded in advance are deferred until earned. As of December 31, 2012 and 2011, all advanced revenues were earned. +The Company follows Financial Accounting Standards Board (“FASB”) issued authoritative guidance (“guidance”) prospectively for the recognition of revenue under the milestone method. The Company applies the milestone method of revenue recognition for certain collaborative research projects defining milestones at the inception of the agreement. +(k) +Research and Development: +Research and development (R&D) costs are expensed as incurred. +(l) +Stock-Based Compensation: +Stock-based compensation expense is calculated using the Black-Scholes valuation model based on awards ultimately expected to vest, reduced for forfeitures, and expensed on a straight-line basis over the requisite service period of the grant. +(m) +Income Taxes: +The Company accounts for income taxes under an asset and liability approach which recognizes deferred tax assets and liabilities based on the difference between the financial statement carrying amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. +The Company follows a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. The guidance relates to, among other things, classification, accounting for interest and penalties associated with tax positions, and disclosure requirements. Any interest and penalties accrued related to uncertain tax positions will be recorded in tax expense. +F-7 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2012 AND 2011 +a +(n) +Earnings Per Share +On May 30, 2012, the Company effected a 1-for-8 reverse split of its common stock. This was done to allow the Company to move to the NASDAQ trading market from the OTCQB market, which occurred on June 7, 2012. As a result of the stock split, the outstanding 63,967,263 common shares were reduced to 7,995,918 outstanding common shares on May 30, 2012. The effect of the reverse stock split has been retroactively reflected for all periods in these financial statements. +The following weighted average shares were used for the computation of basic and diluted earnings per share: +For the years ended +December 31, 2012 +December 31, 2011 +Basic +7,986,030 +7,874,807 +- +- +Diluted +8,614,944 +8,556,284 +Basic earnings per share is computed by dividing net earnings attributable to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share for the year ended December 31, 2012 and 2011 reflects the potential dilution from the exercise or conversion of other securities into common stock. +The following securities, presented on a common share equivalent basis, have been used in the diluted per share computations: +For the years ended +December 31, 2012 +December 31, 2011 +1999 and 2008 Plan Stock Options +628,914 +681,477 +There were 161,464 and 182,343 options and warrants outstanding as of December 31, 2012 and 2011, respectively, which were not included in the calculation of diluted income per share for the years ended because their effect would have been anti-dilutive. +(o) +Recent Accounting Pronouncements Affecting the Company: +New accounting pronouncements are issued by the Financial Accounting Standards Board (“FASB”) or other standards setting bodies that we adopt according to the various timetables the FASB specifies. The Company does not expect the adoption of recently issued accounting pronouncements to have a significant impact on the Company’s results of operations, financial position or cash flow. +F-8 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2012 AND 2011 +NOTE 3 — INVENTORIES: +Inventories consist of the following at: +December 31, 2012 +December 31, 2011 +Raw materials +$ +1,418,071 +$ +1,340,177 +Work in process +561,530 +390,162 +Finished goods +508,470 +569,947 +$ +2,488,071 +$ +2,300,286 +NOTE 4 — FIXED ASSETS: +Fixed assets consist of the following at: +December 31, 2012 +December 31, 2011 +Machinery and equipment +$ +2,439,596 +$ +1,982,926 +Furniture and fixtures +287,412 +221,299 +Computer and telephone equipment +151,737 +460,842 +Leasehold improvements +798,049 +595,492 +Automobiles +29,228 +29,228 +3,706,022 +3,289,787 +Less accumulated depreciation and amortization +(2,278,376 +) +(2,227,511 +) +$ +1,427,646 +$ +1,062,276 +There were no capital leases at the end of December 31, 2012. Included in fixed assets is $24,000, net of accumulated depreciation of assets held under capital leases as of December 31, 2011. Fixed assets at December 31, 2012 also include $323,000 in equipment, which has been delivered and set-up but is undergoing validation and as such is currently not being depreciated. Depreciation expense for the 2012 and 2011 years aggregated $423,000 and $338,000, respectively. +As of December 31, 2012 and 2011, the Company had paid deposits on various pieces of equipment aggregating $223,584 and $139,790, respectively. The Company is further committed to an additional obligation of $61,071 as various milestones are achieved by the various vendors. +NOTE 5 — ACCOUNTS PAYABLE AND ACCRUED LIABILITIES: +Accounts payable and accrued liabilities consist of the following at: +December 31, 2012 +December 31, 2011 +Accounts payable – suppliers +$ +1,686,431 +$ +1,258,465 +Accrued commissions +238,150 +205,588 +Accrued royalties / license fees +583,923 +480,297 +Accrued payroll +262,439 +174,398 +Accrued vacation +181,636 +156,884 +Accrued bonuses +155,663 +284,375 +Accrued expenses – other +195,681 +229,493 +TOTAL +$ +3,303,923 +$ +2,789,500 +F-9 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2012 AND 2011 +NOTE 6 — DEFERRED RESEARCH AND DEVELOPMENT REVENUE: +The Company recognizes income from R&D milestones when those milestones are reached and non-milestone contracts and grants when earned. Grants are invoiced after expenses are incurred. Any projects or grants funded in advance are deferred until earned. As of December 31, 2012 and 2011, there were no unearned advanced revenues. +NOTE +7 — TERM NOTE, REVOLVING DEMAND NOTE, VEHICLE FINANCING AND LICENSE FEE PAYABLE: +In June 2010, the Company entered into three agreements with HSBC Bank, NA (“HSBC”). The three agreements were: 1) a secured term note (“Term Note”) of $250,000 to be repaid over sixty months; 2) a secured revolving demand note (“Demand Note”) up to $250,000; and 3) a loan and security agreement (“Security Agreement”). +The Term Note is payable at $4,775 per month in arrears. The payment was calculated by amortizing the $250,000 note over 60 months at an interest rate of 5.5% per annum. The Term Note matures June 2015 and is secured under the terms of the Security Agreement. In January 2013, the Company repaid this Term Note in full without penalty. +The Demand Note allows the Company to draw on the line from time to time an amount up to an aggregate of $250,000 outstanding at any one time. The accrued interest on the Demand Note is payable monthly at an interest rate equal to one-quarter percent above prime per annum. The Company can repay any or all of the principal balance outstanding at any time. This is a demand note and is subject to annual reviews, as well as a 30-day clean-up, during which there can be no amounts outstanding. +The Security Agreement contains covenants that place restrictions on the Company’s operations, including covenants relating to mergers, debt restrictions, capital expenditures, tangible net worth, net profit, leverage, fixed charge coverage, employee loan restrictions, distribution restrictions (common stock and preferred stock), dividend restrictions, restrictions on lease payments to affiliates, restrictions on changes in business, asset sale restrictions, restrictions on acquisitions and intercompany transactions, restrictions on fundamental changes. The Security Agreement also requires that the Company maintain a minimum tangible net worth at all times of greater than $3,000,000 and EBITDA to CMLTD plus interest cannot be less than 1.25 to 1.00 for any fiscal year. (EBITDA is earnings before interest, taxes, depreciation and amortization; CMLTD is defined as, for any one-year period, the current scheduled principal payments required to be paid for the applicable period.). The Company was in compliance with all required financial covenants at December 31, 2012. +In July 2011, the Company entered into additional agreements with HSBC Bank, NA (“HSBC”). The agreements were: 1) a secured revolving demand note for equipment (“Equipment Note”) up to $500,000, convertible to a term note after one year; and 2) a loan and security agreement (“Security Agreement”). +The Equipment Note allows the Company to draw on the line from time to time an amount up to an aggregate of $500,000 outstanding at any one time. The accrued interest on the Equipment Note is payable monthly at an interest rate equal to one-quarter percent above prime per annum. The Company can repay any or all of the principal balance outstanding at any time. The Equipment Note will be converted into a 60-month term note at the end of one year. As the Company did not draw down on this line the Demand Note and the Equipment Note expired in July of 2012. +The Security Agreement contains covenants that place restrictions on the Company’s operations, including covenants relating to mergers, debt restrictions, capital expenditures, tangible net worth, net profit, leverage, fixed charge coverage, employee loan restrictions, distribution restrictions (common stock and preferred stock), dividend restrictions, restrictions on lease payments to affiliates, restrictions on changes in business, asset sale restrictions, restrictions on acquisitions and intercompany transactions, restrictions on fundamental changes. The Company was in compliance with all required financial covenants when the notes expired. +F-10 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2012 AND 2011 +The Company currently maintains its operating, payroll, and primary cash accounts at HSBC. The balance due on the Term Note as of December 31, 2012 was $133,000. +Future minimum payments under the Term Note, excluding interest, as of December 31, 2012 is not shown as the balance was paid in full on January 17, 2013 in the amount of $129,349. +In June 2009, the Company purchased a vehicle for use by the CEO and obtained financing in the amount of $29,000. The financing is for a period of 3 years, is secured by the vehicle and is guaranteed by the CEO. The financing agreement provides for monthly principal and interest payments of $849 and carries an interest rate of 2.9% per annum. There was no balance due on this loan as of December 31, 2012. +NOTE 8 — INCOME TAXES: +The provision (benefit) for income taxes for the years ended December 31, 2012 and 2011, is comprised of the following: +2012 +2011 +Current +Federal +$ +33,054 +$ +22,082 +State +5,098 +402 +Total current provision +38,152 +22,484 +Deferred +Federal +464,005 +(5,155,713 +) +State +7,080 +- +Total deferred provision +471,085 +(5,155,713 +) +Total provision +$ +509,237 +$ +(5,133,229 +) +The Company had an ownership change as described in Internal Revenue Code Sec. 382 during 2004 (“2004 change”). As a result, the Company’s net operating losses prior to the 2004 change of $5,832,516 are subject to an annual limitation of $150,608 and for the first five (5) years are entitled to a BIG (Built-In-Gains) of $488,207 per year. These net operating losses expire in 2018 through 2024. +The Company had a second ownership change during 2006 (“2006 change”). The net operating losses incurred between the 2004 change and the 2006 change of $8,586,861 are subject to an annual limitation of $1,111,831 and for the first five (5) years are entitled to a BIG of $1,756,842 per year. These net operating losses expire in 2018 through 2028. +After applying the above limitations, at December 31, 2012, the Company has post-change net operating loss carry-forwards of approximately $12,274,761 which expire between 2020 and 2028. In addition the Company has research and development tax credit carryforwards of approximately $711,000 for the year ended December 31, 2012, which expire between 2025 and 2032. +Prior to 2011 and through September 30, 2011, the Company had a full valuation allowance recorded against deferred tax assets. In the fourth quarter of 2011, based on the Company’s sustained profitable operating performance over the past three years and its positive outlook for taxable income in the future, the Company reevaluated its deferred tax asset. Based upon the guidance under ASC 740 that it was more likely than not that the Company would realize the benefit of such deferred tax assets, the Company reversed $5,156,000 of the valuation allowance previously recorded against its deferred tax assets. The Company still maintains a full valuation allowance on research and development tax credits. +F-11 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2012 AND 2011 +Deferred tax assets consist of at December 31, +2012 +2011 +Current assets +Inventory reserves +$ +224,694 +$ +260,665 +Accrued expenses +226,740 +145,426 +Net current deferred asset +$ +451,434 +$ +406,091 +Noncurrent assets +Net operating loss carry-forwards +$ +4,236,008 +$ +4,837,466 +Research and development credit +711,444 +581,576 +Other credits +97,234 +- +Other +99,097 +132,734 +Gross noncurrent deferred tax assets +5,143,783 +5,551,776 +Depreciation +(199,145 +) +(220,578 +) +Noncurrent deferred tax assets +4,944,638 +5,331,198 +Less valuation allowances +(711,444 +) +(581,576 +) +Net noncurrent deferred tax assets +$ +4,233,194 +$ +4,749,622 +A reconciliation of the Federal statutory rate to the effective rate applicable to income (loss) before income taxes is as follows: +Year Ending December 31, +2012 +2011 +Federal income tax at statutory rates +34% +34% +State income taxes, net of federal benefit +.7% +0% +Nondeductible expenses +5.4% +6.4% +Change in valuation allowance +8.9% +(514.3)% +Tax credits +(8.9)% +- +Change in tax rates +(5.2)% +- +Other +.2% +(.7)% +Income tax (benefit) +35.1% +(474.6)% +Interest and penalties, if any, related to income tax liabilities are included in income tax expense. As of December 31, 2012, the Company does not have a liability for uncertain tax positions. +The Company files Federal and New York state income tax returns. Tax years for fiscal 2009 through 2011 are open and potentially subject to examination by the federal and New York state taxing authorities. +F-12 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2012 AND 2011 +NOTE 9 — STOCKHOLDERS’ EQUITY: +(a) Common Stock +During 2012, options to purchase 111,459 shares of the Company’s common stock were exercised at exercise prices ranging from of $1.04 to $1.76. +In March 2012, June 2012, September 2012 and December 2012, the Company issued 938 shares of common stock on each date to a consultant as part of the consultant’s compensation. +During 2011, options to purchase 76,927 shares of the Company’s common stock were exercised at exercise prices ranging from of $1.04 to $1.76. +(b) +Preferred Stock +The Company has 10,000,000 shares of preferred stock authorized and none outstanding. These shares can become issuable upon an approved resolution by the board of directors and the filing of a Certificate of Designation with the state of Nevada. +(c) +Options +On February 16, 2012, the Company issued 25,392 options to purchase common stock to executives of the Company as part of their 2011 bonus. The options are exercisable immediately at $4.00 per share, which was the last traded price of the common stock on that day, and they expire five years from date of issue. +In March 2012, the Company issued 3,750 options to purchase shares of the Company’s common at an exercise price of $4.00 per share to a consultant as part of the consultant’s compensation. On each of March 19, 2012, June 19, 2012, September 19, 2012 and December 19, 2012, 938 of these options vested. These options were valued using a Black-Scholes model at $8,010, all of which was expensed in the year ended December 31, 2012. The options are being accounted for under the variable method as per ASC 505 and $50 of the expense was reduced attributable to this method. +During the third quarter of 2012, the Company issued 72,000 options to purchase common stock to newly-hired vice-presidents of the Company. The options are exercisable in three equal annual installments on the anniversary of the issuance starting one year from date of issue. An allotment of 36,000 options issued to one of the new vice presidents have an exercise price of $5.11 per share, and the 36,000 options that were issued to the other new vice president have an exercise price of $4.45 per share, which in each case was the last traded price of the common stock on the day issued. The options expire five years from date of issue. +(d) Warrants +As of December 31, 2012, the Company had no warrants outstanding to purchase shares of common stock. +On April 26, 2011, warrants to purchase 513,698 shares of common stock were exercised at $.40 per share. The Company received $205,479 for this exercise. +As of December 31, 2011, the Company had warrants outstanding to purchase 33,381 shares of common stock at a price of $.81. On February 5, 2012 these warrants to purchase shares of common stock expired. +F-13 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2012 AND 2011 +NOTE 10 — RIGHTS AGREEMENT: +In March 2010, the Company entered into a Rights Agreement (the "Rights Agreement") between the Company and Action Stock Transfer Corp., as Rights Agent. Pursuant to the Rights Agreement, the Company declared a dividend distribution of one preferred share purchase right (a "Right") for each outstanding share of Common Stock, $0.01 par value (the "Common Stock"), of the Company. The Board of Directors set the payment date for the distribution of the Rights as March 8, 2010, and the Rights were distributed to the Company’s shareholders of record on that date. The description and terms of the Rights are set forth in the Rights Agreement. +Rights Initially Not Exercisable. The Rights are not exercisable until a Distribution Date. Until a Right is exercised, the holder thereof, as such, will have no rights as a shareholder of the Company, including, without limitation, the right to vote or to receive dividends. +Separation and Distribution of Rights . The Rights will be evidenced by the certificates for shares of Common Stock registered in the names of the holders thereof, and not by separate rights certificates until the earlier to occur of (i) the close of business on the tenth business day following a public announcement that an Acquiring Person (as defined in the Rights Agreement) acquired a Combined Ownership (as defined in the Rights Agreement) of 15% or more of the outstanding shares of the Common Stock (the "Shares Acquisition Date") or (ii) the later of (A) the close of business on the tenth business day (or such later date as may be determined by action of the Board of Directors prior to such time as any person or group of affiliated or associated persons becomes an Acquiring Person) after the date that a tender or exchange offer or intention to commence a tender or exchange offer by any person is first published, announced, sent or given within the meaning of Rule 14d-4(A) under the Securities Exchange Act of 1934, as amended, the consummation of which would result in any person having Combined Ownership of 15% or more of the outstanding shares of the Common Stock, or (B) if such a tender or exchange offer has been published, announced, sent or given before the date of the Rights Agreement, then the close of business on the tenth business day after the date the Rights Agreement was entered into (or such later date as may be determined by action of the Board of Directors prior to such time as any person becomes an Acquiring Person); (the earlier of such dates referred to in (i) and (ii), which date may include any such date that is after the date of the Rights Agreement but prior to the issuance of the Rights, being called the "Distribution Date"). +NOTE 11 — EMPLOYEE STOCK OPTION PLAN: +The Company has a 1999 Stock Option Plan (“SOP”) originally covering 187,500 shares of Common Stock. Under the terms of the SOP, the Compensation Committee of the Company’s board is authorized to grant incentive options to key employees and to grant non-qualified options to key employees and key individuals. The options become exercisable at such times and under such conditions as determined by the Compensation Committee. The SOP was amended at the Company’s 2005 stockholders’ meeting. The number of options under the SOP was increased to cover 375,000 shares of common stock. It was also amended to allow independent directors to be eligible for grants under the portion of the SOP concerning non-qualified options. As of December 31, 2012, there were 135,191 outstanding options under this SOP. No additional options may be issued under the SOP more than 10 years after its adoption +Effective June 3, 2008, the Company’s stockholders voted to approve the 2008 Stock Incentive Plan (“SIP”), with 625,000 shares of Common Stock available to be issued. At the Annual Stockholder meeting on September 22, 2011 the Company’s stockholders voted to approve an increase to the shares of Common Stock issuable under the SIP by 125,000 to 750,000. Under the terms of the SIP, the Compensation Committee of the Company’s Board has the discretion to select the persons to whom awards are to be granted. Awards can be stock options, restricted stock and/or restricted stock units. The awards become vested at such times and under such conditions as determined by the Compensation Committee. As of December 31, 2012, there were 84,584 options exercised, 596,455 options outstanding and 68,961 options still available to be issued under the SIP. +F-14 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2012 AND 2011 +The Company's results for the years ended December 31, 2012 and 2011 include stock-based compensation expense totaling $294,000 and $189,000, respectively. Such amounts have been included in the Consolidated Statements of Operations within cost of goods sold ($49,000 and $18,000, respectively), research and development ($71,000 and $56,000, respectively) and selling, general and administrative expenses ($174,000 and $115,000, respectively). In accordance with ASC 718 the Company has not recorded a deferred tax asset related to the net operating losses resulting from the exercise of disqualifying stock options in the accompanying financial statements. The cumulative amount of unrecognized tax benefits at December 31, 2012 was immaterial, and if the Company is able to utilize this benefit in the future it would result in a credit to additional paid-in capital. +Stock option compensation expense in the years ended December 31, 2012 and 2011 represents the estimated fair value of options outstanding which is being amortized on a straight-line basis over the requisite vesting period of the entire award. +The weighted average estimated fair value of stock options granted in the years ended December 31, 2012 and 2011 was $3.27 and $1.76 per share, respectively. The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model. The expected volatility is based upon historical volatility of our stock and other contributing factors. The expected term is based on the Company’s historical experience with similar type options. +The weighted-average assumptions made in calculating the fair values of options are as follows: +For the years ended +December 31, 2012 +December 31, 2011 +Expected term (in years) +4-5 +3.75 +Expected volatility +99.6-115.77% +92.11-117.9% +Expected dividend yield +n/a +n/a +Risk-free interest rate +.33-.37% +.57-1.39% +The Company granted 97,392 and 3,750 new options during the year ended December 31, 2012 to employees and a consultant (non-plan options), respectively at an average exercise price of $4.58 and $4.00, respectively per share. +The following table provides stock options activity for the year ended December 31, 2012 : +Stock Options +Number of Shares +Weighted Average Exercise Price per Share +Weighted Average Remaining Contractual Term +Aggregate Intrinsic Value +Outstanding at December 31, 2011 +765,903 +$ +1.68 +2.61 years +$ +1,339,693 +Granted +97,392 +$ +4.58 +Exercised +(111,459 +) +$ +1.08 +Forfeited/expired/cancelled +(20,190 +) +$ +3.89 +Outstanding at December 31, 2012 +731,646 +$ +2.23 +2.19 years +$ +3,460,686 +Exercisable at December 31, 2012 +511,824 +$ +1.45 +1.57 years +$ +2,438,665 +The following table summarizes information about stock options outstanding at December 31, 2012: +Stock Options Outstanding +Stock Options Exercisable +Range of Exercise Prices +Shares +Average Remaining Contract Life (Year) +Weighted Average Exercise Price +Aggregate Intrinsic Value +Shares +Weighted Average Exercise Price +Aggregate Intrinsic Value +$ 0 to 1.50 +397,333 +1.29 +$ +1.04 +$ +1,466,159 +378,583 +$ +1.04 +$ +1,396,971 +1.5001 to 2 +41,441 +0.13 +1.76 +123,080 +41,441 +1.76 +123,080 +2.0001 to 3.50 +131,250 +3.28 +2.62 +277,318 +62,500 +2.54 +136,625 +3.5001 to 4.50 +125,622 +3.83 +4.26 +59,042 +29,300 +3.95 +22,775 +4.5001 to 8 +36,000 +4.60 +5.11 +- +- +- +- +Total +731,646 +2.18 +$ +2.12 +$ +1,925,599 +511,824 +$ +1.45 +$ +1,679,451 +As of December 31, 2012, there was $305,000 of net unrecognized compensation cost related to stock options that are not vested, which is expected to be recognized over a weighted average period of approximately .81 years. The total fair value of shares vested during the years ended December 31, 2012 and 2011, was $144,000 and $149,000, respectively. +NOTE 12 — GEOGRAPHIC INFORMATION: +FASB Guidance establishes standards for the way that business enterprises report information about operating segments in financial statements and requires that those enterprises report selected information. It also establishes standards for related disclosures about product and services, geographic areas, and major customers. +The Company produces only one group of similar products known collectively as “rapid medical tests”. Management believes that it operates in a single business segment. Net sales by geographic area are as follows: +For the years ended +December 31, 2012 +December 31, 2011 +Africa +$ +2,669,140 +$ +2,340,635 +Asia +658,831 +1,784,817 +Europe +54,280 +57,206 +North America +8,630,956 +8,522,878 +South America +12,314,148 +4,716,775 +$ +24,327,355 +$ +17,422,311 +Sales to Africa increased in 2012 primarily due to increased sales in Uganda by approximately $106,000 and Nigeria by approximately $298,000. Sales in Asia decreased from sales in the Middle East by $1.22 million. Sales in 2012 and 2011 to North America were primarily from sales in the U.S of approximately $7.72 million and $7.21 million, respectively and sales in 2012 and 2011 to South America were primarily from sales in Brazil of approximately $10.30 million and $4.66 million, respectively. +F-15 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2012 AND 2011 +NOTE 13 — COMMITMENTS AND CONTINGENCIES: +Employment Contracts: +The Company has contracts with two key employees. The contracts call for salaries presently aggregating $590,000 per year. One contract expires in May 2013 and one contract expires in March 2016. The following table is a schedule of future minimum salary commitments: +2013 +$ +422,500 +2014 +300,000 +2015 +300,000 +2016 +50,000 +Pension Plan: +The Company has a 401(k) plan established for its employees. Effective January 1, 2011 the Company elected to match 40% of the first 5% (or 2% of salary) that an employee contributes to their 401(k) plan. Expenses related to this matching contribution aggregated $64,604 and $61,628 for the years ended December 31, 2012 and 2011, respectively. +Obligations Under Operating Leases: +The Company leases industrial space used for office, R&D and manufacturing facilities, currently with a monthly rent of $20,530. The current leases expire on April 30, 2014. The monthly rent for the year will increase by the lower of (i) the change in the consumer price index, or (ii) two and one half percent. +The following is a schedule of future minimum rental commitments (assuming no increases): +Years ending December 31, +2013 +$ +246,360 +2014 +82,120 +$ +328,480 +Rent expense was $231,700 and $177,200 for the years ended December 31, 2012 and 2011, respectively. +Economic Dependency: +The following table delineates sales the Company had to customers in excess of 10% of total sales for the periods indicated: +For the years ended +Accounts +Receivable As of +December 31, 2012 +December 31, 2011 +December 31, 2012 +December 31, 2011 +Sales +% of Sales +Sales +% of Sales +Customer 1 +$ +7,778,688 +32 +$ +7,208,712 +41 +$ +879,089 +$ +782,300 +Customer 2 +10,299,216 +42 +4,662,607 +27 +1,668,156 +685,692 +Customer 3 +* +* +1,713,390 +10 +596 +450,000 +In the table above the asterisk (*) indicates that sales to the customer did not exceed 10% for the period indicated. +F-16 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2012 AND 2011 +The following table delineates purchases the Company had with vendors in excess of 10% of total purchases for the periods indicated. +For the years ended +Accounts +Payable As of +December 31, 2012 +December 31, 2011 +December 31, 2012 +December 31, 2011 +Purchases +% of Purc. +Purchases +% of Purc. +Vendor 1 +$ +817,293 +13 +* +* +$ +114,892 +$ +3,380 +Vendor 2 +778,793 +12 +* +* +76,932 +23,327 +In the table above the asterisk (*) indicates that purchases from the vendor did not exceed 10% for the period indicated. +The Company currently buys materials which are purchased under intellectual property rights agreements and are important components in its products. Management believes that other suppliers could provide similar materials on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would affect operating results adversely. +NOTE 14 — COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS: +In 2012 and 2011, the Company earned $1.3 million and $1.8 million, respectively, from research revenues and milestones. The Company is now involved in additional feasibility and development contracts related to its DPP® technology. The total expended on R&D in 2012 and 2011, was approximately $3.1 million and $3.1 million, respectively. +a. +Oswaldo Cruz Foundation/Fiocruz: +During 2008, the Company signed four Agreements with the Bio-Manguinhos unit of the Oswaldo Cruz Foundation of Brazil (“FIOCRUZ”) for the supply, license and transfer of certain products and related technologies from the Company to FIOCRUZ. The agreements are for the following rapid test products: i) DPP® HIV 1/2 Screen, ii) DPP® HIV 1/2 Confirmatory, iii) DPP® Leptospirosis and iv) DPP® Leishmaniasis. These Agreements provide for a staged technology transfer collaboration pursuant to which FIOCRUZ will ultimately be able to fully manufacture the applicable product for supply in Brazil provided certain minimum purchases of products and related components have occurred. +In 2011, FIOCRUZ informed the Company that ANVISA (the Brazilian regulatory agency) had approved the DPP® Leishmaniasis, Syphilis Screen and Leptospirosis assays for use in Brazil. This approval triggered milestone events of $305,000, $100,000 and $100,000, respectively. In accordance with guidance, management has concluded that the FIOCRUZ events recorded in 2011 met the definition of milestone events. The Company earned an aggregate of none and $505,000 in milestone revenues from FIOCRUZ for the years ended December 31, 2012 and 2011, respectively. +Under these contracts, there are additional royalties and purchase commitments due to the Company over the remaining life of the Agreement. +b. +National Institutes of Health (NIH) Grant: +In June 2009, the Company received a $3 million, three-year grant from the United States National Institutes of Health to complete development of a test for Leptospirosis. Grants are invoiced after expenses are incurred. The Company earned, for the years ended December 31, 2012 and 2011, $270,000 and $690,000, respectively from this grant. The Company has earned an aggregate of $2, 756,000 from this grant from inception through December 31, 2012, of which $898,000 was paid to sub-contractors. +F-17 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2012 AND 2011 +In March 2011, the Company received a $2.4 million, three-year grant from the United States National Institutes of Health to complete development of a test for Tuberculosis. Grants are invoiced after expenses are incurred. The Company earned, for the years ended December 31, 2012 and 2011, $682,000 and $350,000, respectively from this grant. The Company has earned $1,377,000 from this grant from inception through December 31, 2012, of which $345,000 was paid to sub-contractors. +c. +Battelle/CDC DPP® Influenza Immunity Test: +In July 2012, the Company entered into a follow-on, milestone-based development agreement of up to $480,000 based on Chembio’s previous successful initial development of a multiplex rapid point-of-care (“POC”) influenza immunity test utilizing its patented Dual Path Platform (DPP®) technology. The agreement contemplates a period of approximately nine months in which the follow-on development activity is to be completed. As of December 31, 2012 the Company has earned $278,000. +Governmental Regulation: +All of the Company’s existing and proposed diagnostic products are regulated by the United States Food and Drug Administration (FDA), United States Department of Agriculture, certain state and local agencies, and/or comparable regulatory bodies in other countries. Most aspects of development, production, and marketing, including product testing, authorizations to market, labeling, promotion, manufacturing, and record keeping are subject to review. After marketing approval has been granted, Chembio must continue to comply with governmental regulations. Failure to comply with these regulations can result in significant penalties. +F-18 \ No newline at end of file diff --git a/raw/filings/0001092662/2012/0001092662-13-000024/filing_metadata.csv b/raw/filings/0001092662/2012/0001092662-13-000024/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..e7a7e630d71f9b630e27679cd8f453f81b2d6cf0 --- /dev/null +++ b/raw/filings/0001092662/2012/0001092662-13-000024/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001092662,CEMI,"CHEMBIO DIAGNOSTICS, INC.",10-K,2013-03-07,2012-12-31,2013-03-07T21:01:59.000Z,0001092662-13-000024,form10_k.htm,FORM 10-K 2012 CHEMBIO,7257743,1,0,https://www.sec.gov/Archives/edgar/data/1092662/000109266213000024/form10_k.htm,https://www.sec.gov/Archives/edgar/data/1092662/000109266213000024/,2012,2012,1 diff --git a/raw/filings/0001092662/2012/0001092662-13-000024/item1.txt b/raw/filings/0001092662/2012/0001092662-13-000024/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..b52c60a40154c45f8689d7b2fead5d78196099fd --- /dev/null +++ b/raw/filings/0001092662/2012/0001092662-13-000024/item1.txt @@ -0,0 +1,178 @@ +ITEM 1. +BUSINESS +FORWARD-LOOKING STATEMENTS +This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, and Section 27A of the Securities Act of 1933. Any statements contained in this report that are not statements of historical fact may be forward-looking statements. When we use the words “intends,” “estimates,” “predicts,” “potential,” “continues,” “anticipates,” “plans,” “expects,” “believes,” “should,” “could,” “may,” “will” or the negative of these terms or other comparable terminology, we are identifying forward-looking statements. Forward-looking statements involve risks and uncertainties, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by forward-looking statements. These factors include our research and development activities, distributor channels, market demand for our products, compliance with regulatory impositions; and our capital needs. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business. +For further information about these and other risks, uncertainties and factors, please review the disclosure included in this report under “Part I, Item 1A, Risk Factors.” +Our Business +General +The Company (Chembio Diagnostics, Inc. and its wholly-owned subsidiary Chembio Diagnostic Systems, Inc. are collectively referred to herein as the “Company”) develops, manufactures, markets and licenses rapid point-of-care diagnostic tests (POCTs) that detect infectious diseases. The Company’s main products presently commercially available are four rapid tests for the detection of HIV antibodies, two rapid tests for the detection of syphilis, and a rapid test for the detection of canine leishmaniasis. Three of the HIV rapid tests employ in-licensed and proprietary lateral flow technologies (see “Our Rapid Test Technologies”), can be used with all blood matrices as samples, and are manufactured in a standard cassette format, a dipstick format, and a proprietary barrel format. The tests employing the cassette and proprietary barrel formats were approved by the FDA in 2006 and are exclusively distributed by Alere, Inc. (“Alere”) in the United States and by Chembio outside the United States. Our fourth rapid HIV test incorporates our patented Dual Path Platform® (DPP®), and does not require in-licensing. The DPP® HIV test, detects antibodies to HIV 1 & 2 in oral fluid samples as well as in all blood matrices. We received United States FDA regulatory approval for this product on December 19, 2012 and we anticipate launching it under Chembio’s brand in 2013. +Our new product pipeline, which currently includes rapid tests for Syphilis and Hepatitis-C, as well as a multiplex test that detects HIV and Syphilis specific antibodies, is based on this DPP® technology for which we were issued a United States patent in 2007 and for which additional patent protection has issued or is pending worldwide. With the DPP® proprietary platform, we can participate in the estimated $8-10 billion point-of-care market segment of the estimated nearly $50 billion global in-vitro diagnostic market that has an overall growth rate of approximately 7% per annum. POCTs, by providing prompt and early diagnosis, can reduce patient stays, lower overall costs, improve therapeutic interventions and improve patient outcomes as a result of prompt and early diagnosis. They can also prevent needless hospital admissions, simplify testing procedures, avoid delays from central lab batching, and eliminate the need for return visits. +3 +In the areas of infectious and sexually transmitted diseases (such as HIV and syphilis for example), the utility of a rapid point–of-care test, particularly in identifying patients unaware of their disease status, has been well established. Large and growing markets have been established for these kinds of tests, initially in high prevalence regions where they are indispensable for large scale prevention and treatment programs. More recently introduced in the United States in 2004, rapid HIV tests now also present a significant segment of the U.S. market for HIV clinical testing, which is still dominated by laboratory tests. We have focused our product development activity within areas where the availability of rapid, point-of-care screening, diagnostic, or confirmatory results can improve health outcomes. +PRODUCTS +Lateral Flow Rapid HIV Tests +All three of our lateral flow rapid HIV tests are qualitative “yes/no” tests for the detection of antibodies to HIV 1 & 2 with visually interpreted results (one line “negative”; two lines “positive”) available within approximately 15 minutes. The tests are simple to use, have a shelf life of 24 months, and do not require refrigeration. The tests differ principally only in the method of test procedure, convenience and cost. One of our FDA-approved lateral flow HIV tests incorporates a proprietary plastic “barrel” device that houses the lateral flow strip. This barrel format enables collection of samples directly (for example directly from a finger-stick whole blood sample) into the barrel’s capillary tip. A sealed unitized buffer vial, assembled onto the top of the barrel, is removed and seated into a stand; the seal is then pierced by the barrel’s capillary tip, thereby initiating the upward flow of the resulting sample-buffer solution through a filter, up into the vertical device’s chamber and onto the lateral flow strip. This results in a unique unitized and closed device system that can reduce the chance of exposure to potentially infectious samples. We believe that this format may be an ideal candidate as an over-the-counter HIV test and we are participating in certain studies that should help to better ascertain this. Our other FDA-approved lateral flow HIV test uses a more conventional rectangular plastic cassette format that houses the lateral flow strip. In this case, a sample is transferred by use of a separately provided transfer device (“loop”) into a sample well or port of the cassette that houses the lateral flow strip, which is positioned horizontally or flat. +Both of the above-described products are marketed exclusively in the United States by Alere as Clearview® Complete HIV 1/2 (the barrel format) and Clearview® HIV 1/2 STAT PAK® (the cassette format), and by Chembio in all other markets under the names Chembio Sure Check® HIV 1/2 and Chembio HIV 1/2 STAT PAK®. Alere has non-exclusive rights to the barrel product outside the United States. +Our third lateral flow HIV test, HIV 1/2 STAT PAK® Dipstick is our most cost competitive and compact format. It does not have any plastic housing so that 30 test strips can be packaged into a small vial that is ideal for transporting into remote settings. The test procedure is similar to the cassette format; an adhesive backing is provided as a more cost-effective and compact “housing” on which to run the test. +Regulatory Status of the lateral flow HIV tests +The FDA approved our Pre-Market Applications (hereinafter “PMA”; see “Governmental Regulations” and Glossary) in April 2006 for our SURE CHECK HIV 1/2 (and also now Alere Clearview® Complete HIV 1/2) and for our HIV 1/2 STAT-PAK (now Alere’ Clearview® HIV 1/2 STAT-PAK in the United States only) products. Waivers under the Clinical Laboratory Improvement Act (hereinafter “CLIA”; see Governmental Regulations) were granted by the FDA for the two FDA -approved products in 2006 and 2007, respectively. The CLIA waiver is required in order for health care providers to administer these tests in the settings where they are most suited and needed, such as public health testing clinics, hospital emergency rooms and physicians’ offices. Our HIV 1/2 STAT-PAK Dipstick, although not FDA-approved, qualifies under FDA export regulations to sell to customers outside the United States subject to any required approval by the importing country. +All three of our lateral flow HIV tests have qualified for procurement under the President’s Emergency Plan for AIDS Relief (“PEPFAR”). Both the cassette and dipstick versions of the STAT-PAK® are also qualified by the World Health Organization (WHO) for procurements by the second largest global program, known as the Global Fund, as well as other related programs funded by agencies affiliated with the United Nations, such as UNICEF and UNITAIDS (see Glossary), through qualification with the WHO bulk procurement scheme. +4 +DPP® HIV Test +As in the case of our lateral flow HIV tests, our DPP® HIV test is also a qualitative “yes/no” test for the detection of antibodies to HIV 1 & 2, delivers visual results within as little as 15 minutes, is simple to use, has a shelf life of 24 months, and does not require refrigeration. This product, which is our first product incorporating our patented DPP® technology, can be used with oral fluid samples, as well as with all blood matrices. This product also incorporates our patent-pending oral fluid collection and storage system that enables samples to be fully extracted in buffer solution before application to the test device, and also enables the extracted sample to be stored and retested or potentially tested for multiple conditions. Clinical and laboratory studies, which uniquely included test subjects down to two years of age, have shown this product to have improved performance compared with all of the current FDA-approved CLIA-waived rapid tests, even including our own lateral flow tests. FDA -approved label claims include sensitivity/specificity on oral fluid and finger-stick whole blood of 98.9%/99.9% and 99.9%/100% respectively. Oral fluid sensitivity was 100% amongst HIV-positive patients not taking anti-retroviral medication. Due to the low HIV prevalence in the U.S., clinical trials are performed on known HIV-positive patients, more of whom are on more effective medications, and for longer periods than when competitors performed their trials. We believe that this fact, combined with our product’s superior performance in a direct comparative evaluation, and earlier detection than our main competitors on well characterized serum samples, combine to provide us with a significant market opportunity with this product. +Regulatory Status: In April 2012 we completed a 3,000 patient clinical study with our DPP® HIV test in the United States which we had begun in 2010. In June 2012 we submitted the third of three modules required for a modular PMA application to the FDA. On December 19, 2012 we received FDA approval of our Pre-Marketing Approval. During the first quarter of 2013, we plan to commence the additional testing necessary in order to complete a CLIA waiver application for this product. We anticipate that we will be able to complete this testing and complete this application in order to launch the product in the third or fourth quarter of 2013. +The DPP® HIV test product is qualified for procurement under the President’s Emergency Plan for AIDS Relief (“PEPFAR”) for use with all sample matrices, and we are pursuing WHO qualification in order to enable procurement of this product by the Global Fund and United Nations agencies, including programs underwritten by them. +In June 2010, ANVISA approved the DPP® HIV test that is being marketed in Brazil through our collaboration with the Oswaldo Cruz Foundation, Brazil’s leading public health institute. Given the oral fluid feature, we believe this product can be marketed as a premium-priced product that will address those market segments in the U.S. and globally that express a preference for a less invasive testing experience. +OTHER DPP® PRODUCTS +Our product pipeline currently includes a multiplex Syphilis Screen & Confirm test, a multiplex test for the separate detection of antibodies to HIV and Syphilis, and a rapid test for the detection of Hepatitis-C antibodies and antigens. We anticipate completing clinical and other requirements in order to make submissions to the FDA for the Syphilis Screen & Confirm test and the multiplex HIV-Syphilis test in 2013 for U.S. market clearance in 2014. This timetable is subject to the FDA’s confirming the regulatory requirements that we believe will be applicable to these products, of which there can be no assurance. As mentioned below (“Our Rapid Test Technologies”), we also are considering development of so-called “Fourth Generation” tests that are able to detect disease prior to seroconversion to antibodies. This would allow earlier detection of diseases at an acute stage. We have completed initial feasibility studies with technologies (owned by other parties) that complement our DPP® technology and that will further enable even lower limits of analyte detection, which is a capability we believe is essential to have in order to develop new products and markets over the long term. +Our strategy with respect to our DPP® technology has evolved as the Company has evolved. Initially, following the issuance of our DPP® patent in the United States in 2007, our strategy was necessarily limited to developing third-party-funded OEM research and development contracts and grants. This strategy enabled us to conserve capital resources, while at the same time acquiring know-how and experience with the platform and developing third-party references and implicit endorsements of the technology. As our capabilities to develop and manufacture DPP® products expanded, and as our financial position has improved, so have our strategic options expanded and improved. While we may continue the strategy of seeking OEM development and manufacturing agreements as a way to participate in markets that we cannot and/or choose not to serve, we believe that we can also develop our own branded line of products, and we plan to do this in the public health area. We plan to launch this brand with our DPP® HIV Screening Assay in the United States market in 2013, to be followed by our Syphilis test and potentially other related products. +Following is a discussion of the DPP® products for which we have completed our development activity pursuant to OEM agreements with FIOCRUZ and Bio-Rad Laboratories, Inc. The statuses of products that are still under development are described in Part II Item 7 of this report. +5 +PARTNERS INVOLVED IN MARKETING OUR PRODUCTS +On September 29, 2006, we executed marketing and license agreements with Alere. The marketing agreements (one for each of the two FDA-approved products) provide Alere with a 10-year exclusive right (until September 2016) to market our rapid HIV tests in the United States under Alere’s brand. The agreements provide Chembio a non-exclusive license to certain Alere lateral flow patents that may be applicable to our lateral flow products, including for the HIV tests in the United States should Alere enter the U.S. market with a competitive rapid HIV test product and we choose to market our products directly as provided in the agreements. Simultaneous with the execution of the agreements, we also settled litigation with StatSure Diagnostics, Inc. (SDS) that had been ongoing relating to the proprietary barrel device which is incorporated into one of our two FDA-approved rapid HIV tests (See Lateral Flow HIV Tests above). As a result, it is through the agreements with Alere that we have been participating in the growth of the rapid HIV test market in the United States. +We have appointed distributors internationally for our lateral flow HIV tests. Our largest markets outside the U.S. for our lateral flow HIV rapid tests are certain countries in Africa, Asia, and South America, as well as Mexico. Internationally, most of the demand for our products is based on governmental and non-governmental prevention and treatment efforts. Given this, these programs can and do often result in large orders, but also can result in periods of relatively lower demand, based on the variations associated with this kind of demand. +Our DPP® HIV test was approved by ANVISA, Brazil’s regulatory authority, in June 2010. This approval was granted to our Brazilian partner, the Oswaldo Cruz Foundation (“FIOCRUZ”), pursuant to one of five technology transfer, supply and license agreements that we entered into with this public health organization in 2008 and 2010. See “OEM DPP® Products,” below. +OEM DPP® Products +Oswaldo Cruz Foundation OEM DPP® Agreements +During 2008-2010 we signed five agreements with the Oswaldo Cruz Foundation (FIOCRUZ) in Brazil relating to products based on our DPP® technology. FIOCRUZ is the leading public health organization in Brazil, and it is affiliated with Brazil’s Ministry of Health which is its principal client. It has extensive research, educational and manufacturing facilities for drugs and vaccines, as well as for diagnostic products. +During 2010 and 2011 all of the initial products contemplated under the five agreements were approved for marketing by the applicable regulatory agencies in Brazil. As a result, during 2011, we shipped approximately $4.25 million of products to FIOCRUZ pursuant to the agreements, and approximately $10.86 million for fiscal year 2012. The agreements between the Company and FIOCRUZ are unique examples of technology transfer collaborations between a private sector rapid test manufacturer and a public health organization. The five products under agreement with FIOCRUZ are for DPP® products for HIV screening, HIV confirmatory, Leishmaniasis, Leptospirosis and Syphilis. All of the agreements with FIOCRUZ contemplate a technology transfer and license to FIOCRUZ for the manufacture of the subject products over stipulated periods of time. These technology transfers, and the provision by Chembio of the information and training that is required for this to occur, are subject to Chembio receiving orders from FIOCRUZ for a minimum amount of products for manufacture by Chembio, which is approximately $23 million in the aggregate under the five agreements. The actual demand for these products may be more or less than this amount. The actual amount will depend on the demand for the products by the specific programs for each product funded by the Brazilian Ministry of Health for its programs as well as whether and when FIOCRUZ is able to implement the technology transfer steps including, for example, the readiness of new production facilities currently under construction that are scheduled to be completed in mid-2013; thereafter Chembio may continue to supply certain product components or receive royalty payments under some of the agreements for a defined period based on product sold by FIOCRUZ to the public health programs in Brazil. +Our Rapid Test Technologies +All of our commercially available current products employ either in-licensed lateral flow technology or our own patented Dual Path Platform® (DPP®) technology and are visually read. We can also use handheld and desktop readers with our DPP® products to objectively measure, quantify, record and report DPP® test results. Certain of the products we have and/or are developing incorporate some of these readers, and we are developing other products that may be used with or will require use of a reader. +Both lateral flow technology and DPP® allow the development of accurate, low cost, easy-to-perform, single-use diagnostic tests for rapid, visual detection of specific antigen-antibody complexes on a test strip. These formats provide a test that is simple (requires neither electricity nor expensive equipment for test execution or reading, nor skilled personnel for test interpretation), rapid (turnaround time approximately 15 minutes), safe (minimizes handling of potentially infected specimens), non-invasive (requires 5-20 micro liters of whole blood easily obtained with a finger prick, or alternatively, serum or plasma,), stable (24 months at room temperature storage in the case of our HIV tests), and highly reproducible. +6 +We believe that products developed using DPP® technology can provide superior diagnostic performance as compared with products that use lateral flow technology. The reason for this is that one of the major differences between the two platforms is that in DPP® samples are allowed to incubate with the target analyte in the test zone before introduction of the labeling reagent/conjugate, whereas in lateral flow, samples are combined with the labeling reagent to form a complex before coming in contact with the target analyte. We believe that this complex can compromise test performance. Also, because of the usage in DPP® of a separately connected sample strip, the control and delivery of sample material is substantially improved. This feature is critical in the development of multiplex tests, as well as tests that involve viscous sample material (such as oral fluid) that can be impeded when forced to combine with labeling reagents before migration on the test strip to the test zone area. +Multiplexing is significantly improved as a result of the design of DPP® and this provides a significant advantage. The HIV confirmatory test we developed for Bio-Rad employs six different markers. We have a contract development program that involves the use of eight bands, and we have another funded multiplex product program that is pending. Our intellectual property also extends to the use of multiple test membranes that through a common sample strip utilize a single sample. Employing this feature we can develop so-called “Fourth Generation” tests that are able to detect antigens prior to seroconversion to antibodies, as well as antibodies. If developed successfully, this would allow earlier detection of diseases at an acute stage, which improves health outcomes. We have completed initial feasibility studies with technologies (owned by others) that uniquely complement our DPP® technology and that will assist in these efforts by enabling even lower limits of analyte detection. This is a capability which we believe is essential to have in order to develop new products and market opportunities over the long term. +Target Markets +Rapid HIV Tests +A large percentage of individuals that are HIV positive worldwide are unaware of their status. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results when samples have to be sent out to a laboratory which can take up to several days to process. However, the increased availability, greater efficacy and reduced costs for anti-retroviral treatments (ARVs) for HIV has increased the demand for testing, as the stigma associated with the disease is lessened, and the ability to resume normal activities is substantially improved, providing a positive message to those potentially infected. +There are approximately 53,000 new diagnoses of HIV infection in the United States each year, according to the CDC. In time, most of these infections progress to AIDS. The CDC estimates that approximately 1.2 million individuals in the U.S. are living with HIV, with an estimated 250,000 Americans, or more than 20%, unaware that they are infected. It is these 250,000 infected people that are reported to account for 54% of all new infections per year. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results from samples that have to be sent out to a laboratory and that can take up to several days to process. Making more people aware of their HIV status at the point-of-care reduces the number of HIV transmissions. +Rapid HIV testing in the United States has now developed into an estimated 7.5 million test market. This is from zero in 2003 when Orasure Technologies, Inc. received the first FDA approval for a rapid HIV test. We believe that the US professional HIV rapid test market (not including the OTC market) has the potential to increase to 15-18 million tests over the next several years, which would represent 40-50% of all HIV tests done today in the United States for clinical purposes. Assuming an average price to the manufacturers of $8.00 per test, a total potential U.S. market of nearly $120-$150 million is implied. +In 2006, the outlook for HIV testing was given a big boost with the release by the CDC of new recommendations for HIV testing. These new CDC recommendations are that an HIV test should be given as a routine test like any other for all patients between 13 and 64 years of age, regardless of risk, with an opt-out screening option and focused testing procedural (pre- and post-test counseling) guidelines. Though not mandatory, gradual adoption in whole or in part of the 2006 CDC recommendations by a number of states continues to have an increasing impact. Importantly, in November 2012 the United States Preventive Services Task Force (“USPSTF”) finally fully embraced these CDC routine HIV testing recommendations. This USPSTF draft recommendation, which was given an A grade under their recommendation grading system based on the benefits of this practice and the nearly 600,000 AIDS-related deaths in the United States, requires insurance coverage under the Affordable Care Act (the “ACA”) . If finalized as anticipated, we expect this to result in an increase in HIV testing in the United States in the coming years, which we believe will include point-of-care HIV testing utilizing the Company’s products. Currently most public health testing in the United States is funded by grants allocated to high prevalence areas by the CDC, but we believe this will shift to an insurance-funded model under the ACA in the years to come. +7 +In the international market , we sell our products directly and through distributors to large screening programs overseen by ministries of health and NGOs, most but not all of which are funded by large bi-lateral and multi-lateral AIDS relief programs, the largest of which is the U.S. President’s Emergency Plan for AIDS Relief (PEPFAR). PEPFAR directly supported HIV testing and counseling for more than 11 million pregnant women in fiscal year 2012 and testing and counseling for more than 49 million people. The U.S. is the first and largest donor to the Global Fund to Fight AIDS, Tuberculosis and Malaria. To date, the U.S. has provided more than $7 billion to the Fund. +For FY 2012, President Obama requested $7.2 billion, including $5.6 billion for bilateral HIV/AIDS programs, $1.3 billion for the Global Fund, and $254 million for bilateral TB programs. For FY 2013, President Obama is requesting $6.4 billion, including more than $4.5 billion for bilateral HIV/AIDS programs, $1.6 billion for the Global Fund, and $232 million for bilateral TB programs. The U.S. deficit crisis is likely to impact funding of these large programs, and the eligibility of lower quality, non-U.S. sourced products make these markets challenging. +Chembio, is unique with four U.S.-manufactured rapid HIV tests, three FDA-approved, and is recognized as a reputable and dependable supplier of high quality products that are available at reasonably competitive prices. As a result certain of our products have been selected in the testing protocols in countries (national algorithms) that are large beneficiaries of PEPFAR and the Global Fund. As mentioned above, these programs can and do often result in large orders, but also can result in periods of relatively lower demand, based on the variations associated with this kind of demand. +Oral fluid testing is an established alternative to blood testing for diagnostic tests, including HIV tests. It is also often patient preferred, providing a more comfortable, less invasive test. In certain public health clinics, staffs choose not to handle blood specimens; thus, oral sample collection provides a viable alternative. The most well-established market for oral fluid HIV testing is the United States. +There is also now an over-the-counter market for HIV self-testing and we are uniquely positioned to participate in this market, should we believe the investment is justified. So far one company, Orasure Technologies Inc., received FDA approval for an over-the-counter (self-testing) version of its previously professional-market-approved HIV test. The FDA approval was granted in July 2012, the product was launched in October, and Orasure is investing heavily in developing this market, with the initial results modest though with some promise even if not nearly for the levels speculated by some . +Based on the fact that FDA requires that any over-the-counter HIV test to have first been approved for the professional market, we believe that Chembio is the only other company that can participate in this market opportunity if it chooses to. Although there is a third company, Trinity Biotech, that meets that condition, they have stated that they do not intend to pursue this market. Therefore Chembio is carefully monitoring developments in this market, which may be significant during 2013. Currently we could initiate the over-the-counter approval process with either of our two blood tests. We have completed a preliminary self-study for our Sure Check “barrel” device as the final component to our preparing and submitting an Investigational Device Exemption (“IDE”) application to the FDA during the first quarter of 2013. Provided we submit this application and it is granted, that would enable us to begin clinical trials by the time we gather better information as to how the Orasure product is doing in the market. And now that we have received approval of our pre-marketing application for our DPP® oral fluid HIV test, we could additionally, or alternatively, pursue over-the-counter approval for that product once we receive the CLIA waiver grant for that product. We believe that we will wait at least some additional months before commencing these clinical trials because (1) the costs for such over-the-counter approval, including primarily the associated clinical trials, are estimated to be at least $5 million and they may take two to three years to complete; (2) Orasure’s initial results are not convincing of a large market, though this possibility remains and Orasure is likely to spend heavily on this for some time and (3) we are well positioned versus any other competitors. +Rapid Syphilis Tests +Recent data indicate that approximately 70,000-100,000 new cases of syphilis are occurring annually in the U.S. Syphilis can be treated with antibiotics, but untreated it can cause pelvic inflammatory disease, infertility, ectopic pregnancy and can infect newborns. Treatment cannot be provided without a confirmed diagnosis of an active case of syphilis. Current testing algorithms in the United States require two different tests (called non-treponemal and treponemal markers), each requiring trained personnel in laboratory settings and several days to receive back results, in order to confirm an active, previously untreated case. The screening test still employed in the United States is known as RPR; it utilizes an old technology that has a high degree of false positive results. +Development of the POC market for syphilis testing is expected to be comparable to the development of the POC market for HIV testing, as there is a significant public health value to being able to provide results at the point-of-care. There are several ways to assess the market opportunity for this unique rapid test, although we believe the U.S. rapid test market opportunity may exceed 8 million tests, which is approximately 20% of the total number of syphilis tests performed in the United States for clinical use today. Unlike HIV testing, where a positive result first requires a confirmatory test, and then further tests to measure viral load before expensive treatment decisions are made, an individual with a confirmed active case of syphilis can be prescribed antibiotics immediately. +8 +We believe the opportunity for our recently developed combination HIV-Syphilis test is significant in the U.S. and globally, and we anticipate making significant progress in 2013 in order to capitalize on these opportunities. +Marketing Strategy +Our marketing strategy is to: +● Support, review and assess the marketing and distribution efforts of our rapid HIV tests by Alere in the U.S., as well as our distributors worldwide, and to engage in sales and marketing activities that allow us to engage with our target markets and customers. Alere, which is a leading marketer of point-of-care diagnostic products, has significantly expanded its distribution footprint since we signed our agreement with them, and although we believe that this will enhance opportunities for Alere to market our rapid HIV tests, the product line is a very small one for them, notwithstanding the strong growth they have enjoyed with respect to our products. +● Leverage our DPP® intellectual property and regulated product development and manufacturing experience to continue creating new collaborations where Chembio can be the exclusive development and manufacturing partner supporting leading marketing organizations. +● Establish strong distribution relationships for our Chembio-branded products in the U.S and abroad and establish a direct sales and marketing organization that is focused in the public health market segment, and that utilizes distributors for other market segments, primarily the acute care market which, together with public health, are the main market segments for rapid HIV tests in the United States. We believe that creation of a Chembio public health brand and marketing organization is fundamental to the creation of shareholder value over the long term +Competition +The diagnostics industry is a multi-billion dollar international industry and is intensely competitive. Many of our competitors are substantially larger and have greater financial, research, manufacturing and marketing resources. +Industry competition in general is based on the following: +● Scientific and technological capability; +● Proprietary know-how; +● The ability to develop and market products and processes; +● The ability to obtain FDA or other required regulatory approvals ; +● The ability to manufacture products that meet applicable FDA requirements, (i.e. FDA’s Quality System Regulations) (see Governmental Regulation section); +● The ability to manufacture products cost-effectively; +● Access to adequate capital; +● The ability to attract and retain qualified personnel; and +● The availability of patent protection. +We believe our scientific and technological capabilities and our proprietary know-how relating to our in-licensed lateral flow technology rapid tests and to our proprietary know-how related to our patented dual path platform® technology, particularly for the development and manufacture of tests for the detection of antibodies to infectious diseases such as HIV, are very strong. +Our ability to develop and market other products is in large measure dependent on our having additional resources and/or collaborative relationships. Some of our product development efforts have been funded on a project or milestone basis. We believe that our proprietary know-how in lateral flow technology and in our Dual Path Platform® (DPP®) technology has been instrumental in our obtaining the collaborations we have and that we continue to pursue. We believe that the patent protection that we have with our Dual Path Platform® (DPP®) enhances our ability to develop more profitable collaborative relationships and to license out the technology. However there are a number of competitive technologies used and/or seeking to be used in point-of-care settings. These technologies may be based on immunoassay principles such as the Company’s products or other technologies such as molecular-based technologies. +9 +Research and Development +During 2012 and 2011, $4.5 million and $4.9 million, respectively, were spent on research and development (including regulatory activities). These expenses were in part underwritten by funding from R&D and milestones revenues of $1.3 million in 2012 and $1.8 million in 2011. All of our new product development activities involve employment of our Dual Path Platform® (DPP®) technology. These activities include completing development of certain products and making significant progress toward the development of additional products. +Employees +At December 31, 2012, we employed 174 people. We have entered into employment contracts with our President, Lawrence Siebert, and our Senior Vice President of Research and Development, Javan Esfandiari. Due to the specific knowledge and experience of these executives regarding the industry, technology and market, the loss of the services of either one of them would likely have a material adverse effect on the Company. The contract with Mr. Siebert provides that Mr. Siebert will serve as the Chief Executive Officer and President of the Company through May 11, 2013. The contract with Mr. Esfandiari has a term of three years ending March 2016. We have obtained a key man insurance policy for Mr. Esfandiari. +Governmental Regulation +The manufacturing and marketing of the Company’s existing and proposed diagnostic products are regulated by the United States Food and Drug Administration (“FDA”), United States Department of Agriculture (“USDA”), certain state and local agencies, and/or comparable regulatory bodies in other countries. These regulations govern almost all aspects of development, production and marketing, including product testing, authorizations to market, labeling, promotion, manufacturing and record keeping. The Company’s FDA and USDA regulated products require some form of action by each agency before they can be marketed in the United States, and, after approval or clearance, the Company must continue to comply with other FDA requirements applicable to marketed products, e.g. Quality Systems (for medical devices). Failure to comply with the FDA’s requirements can lead to significant penalties, both before and after approval or clearance. +There are two review procedures by which medical devices can receive FDA clearance or approval. Some products may qualify for clearance under Section 510(k) of the Federal Food, Drug and Cosmetic Act, in which the manufacturer provides a pre-market notification that it intends to begin marketing the product, and shows that the product is substantially equivalent to another legally marketed product (i.e., that it has the same intended use and is as safe and effective as a legally marketed device and does not raise different questions of safety and effectiveness). In some cases, the submission must include data from human clinical studies. Marketing may commence when the FDA issues a clearance letter finding such substantial equivalence. FDA clearance of our DPP® Syphilis Screen & Confirm test will be by means of a 510(k) submission. +If the medical device does not qualify for the 510(k) procedure (either because it is not substantially equivalent to a legally marketed device or because it is required by statute and the FDA’s implementing regulations have an approved application), the FDA must approve a Pre-Marketing Application (“PMA”) before marketing can begin. PMA’s must demonstrate, among other matters, that the medical device provides a reasonable assurance of safety and effectiveness. A PMA application is typically a complex submission, including the results of non-clinical and clinical studies. Preparing a PMA application is a much more expensive, detailed and time-consuming process as compared with a 510(K) pre-market notification. The Company has approved PMAs for the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1-2 and Clearview® HIV 1-2 STAT PAK®. +FDA approval of our DPP® HIV screening assay for use with oral fluid or blood samples was achieved by means of a PMA application. The Clinical Laboratory Improvement Act of 1988 (“CLIA”) prohibits laboratories from performing in-vitro tests for the purpose of providing information for the diagnosis, prevention or treatment of any disease or impairment of, or the assessment of, the health of human beings unless there is in effect for such laboratories a certificate issued by the United States Department of Health and Human Services (via the FDA) applicable to the category of examination or procedure performed. Although a certificate is not required for the Company, it considers the applicability of the requirements of CLIA in the design and development of its products. The statutory definition of “laboratory” is very broad, and many of our customers are considered labs. A CLIA waiver will remove certain quality control and other requirements that must be met for certain customers to use the Company’s products and this is critical to the marketability of a product into the point-of-care diagnostics market. The Company has received a CLIA waiver for each of the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1/2 and Clearview® HIV 1/2 STAT PAK®. The CLIA waiver was granted by the FDA for HIV 1/2 STAT-PAK on November 20, 2006 and for the Clearview® Complete HIV 1/2 on October 22, 2007. In 2008 the FDA revised its CLIA waiver requirements so that an additional prospective trial need be conducted in order to demonstrate clinical utility by showing that the device is capable of identifying new infections. Given the low prevalence of HIV, the FDA will require 30 new HIV cases to be identified, supplemented by additional data and this is the study the Company will perform during 2013. +10 +In addition, the FDA regulates the export of medical devices that have not been approved for marketing in the United States. The Federal Food, Drug and Cosmetic Act contains general requirements for any medical device that may not be sold in the United States and is intended for export. Specifically, a medical device intended for export is not deemed to be adulterated or misbranded if the product: (1) complies with the specifications of the foreign purchaser; (2) is not in conflict with the laws of the country to which it is intended for export; (3) is prominently labeled on the outside of the shipping package that it is intended for export; and (4) is not sold or offered for sale in the United States. However, the Federal Food, Drug and Cosmetic Act does permit the export of devices to any country in the world, if the device complies with the laws of the importing country and has valid marketing authorization in one of several “listed” countries under the theory that these listed countries have sophisticated mechanisms for the review of medical devices for safety and effectiveness. +The Company is also subject to regulations in foreign countries governing products, human clinical trials and marketing, and may need to obtain approval or evaluations by international public health agencies, such as the World Health Organization, in order to sell diagnostic products in certain countries. Approval processes vary from country to country, and the length of time required for approval or to obtain other clearances may in some cases be longer than that required for United States governmental approvals. On the other hand, the fact that our HIV diagnostic tests are of value in the AIDS epidemic may lead to some government process being expedited. The extent of potentially adverse governmental regulation affecting Chembio that might arise from future legislative or administrative action cannot be predicted. +One or more of the Company’s rapid HIV tests are also approved or pending approval for marketing in several foreign jurisdictions, including but not limited to Brazil, Mexico, and a number of other nations in the developing world. +Environmental Laws +To date, we have not encountered any costs relating to compliance with any environmental laws. +Intellectual Property +Intellectual Property Strategy +Our intellectual property strategy is to: (1) build our own intellectual property portfolio around our Dual Path Platform® technology; (2) pursue licenses, trade secrets and know-how within the area of rapid point-of-care testing, and (3) develop and acquire proprietary positions to reagents and new hardware platforms for the development and manufacture of rapid diagnostic tests. +The Company has obtained patent coverage on the DPP® technology, including three U.S. patents, and patents in China, Malaysia, Eurasia, Mexico, Singapore, Japan and the U.K. Additional patent applications on the DPP® product line are pending in the U.S., as well as in many foreign countries such as Australia, Brazil, Canada, the European Union, India, Indonesia, Israel, Korea, and South Africa. Patents have also been filed on extensions to the DPP® product line concept such as 4th generation assays. +The Company has also filed for patents and obtained some patents in the U.S. for other inventions such as its multiple host species veterinary TB test, and patent applications for the other inventions are in various stages from being recently filed and not yet examined, to already examined and allowed but not yet issued. The Company selectively and strategically foreign files its patent applications based on a number of economic and strategic factors related to the invention. +Trademarks +The Company has filed and obtained trademarks for its products including DPP®, SURE CHECK® and STAT-PAK®. The DPP® trademark is also registered under the European convention (ECT). +Trade Secrets and Know-How +We believe that we have developed a substantial body of trade secrets and know-how relating to the development of lateral flow and DPP® based diagnostic tests, including but not limited to the sourcing and optimization of materials for such tests, and how to maximize sensitivity, speed-to-result, specificity, stability and reproducibility. The Company possesses proprietary know-how to develop tests for multiple conditions using colored latex. Our buffer formulations enable extremely long shelf lives of our rapid HIV and other tests and we believe that this provides us with an important competitive advantage. +11 +Lateral Flow Technology and Reagent Licenses +As part of our agreements in 2006 with Alere for the marketing of our HIV tests, we were granted non-exclusive licenses to certain lateral flow technology for certain products manufactured and marketed by Chembio including but not limited to our HIV tests. Although we believe our DPP® is outside of the scope of all lateral flow patents of which we are aware, we consult with patent counsel, and seek licenses and/or redesigns of products that we believe to be in the best interests of the Company and our stockholders. Because of the costs and other negative consequences of time-consuming patent litigation, we often attempt to obtain a license on reasonable terms. Nevertheless there is no assurance that the Alere lateral flow patents we have licensed will not be challenged or that other patents containing claims relevant to the Company’s lateral flow or DPP® products will not be granted to third parties and that licenses to such patents, will be available on reasonable terms, if any. In the past Alere has aggressively enforced its lateral flow intellectual property, although some of the main patents will expire within the next couple of years and we are not aware of any patent enforcement litigation that is ongoing with respect to the Alere lateral flow intellectual property. +Regardless, the DPP® technology provides us with our own intellectual property. We believe it provides us with a freedom to operate, and that it also enables tests to be developed with improved sensitivity as compared with comparable tests on lateral flow platforms. The Company has signed and anticipates signing new development projects based upon the DPP® technology that will provide new manufacturing and marketing opportunities. We have filed other patents that we believe will strengthen the DPP® intellectual property and have also filed for patent protection for certain other point-of-care technologies or applications thereof. +The peptides used in our rapid HIV tests were patented by Adaltis Inc. and were licensed to us under a 10-year non-exclusive license agreement dated August 30, 2002. However, in connection with Adaltis’ bankruptcy, during the third quarter of 2009 we bought out all of our remaining obligations under that agreement. We also have licensed the antigens used in other tests including our Syphilis, Tuberculosis, Leptospirosis, Leishmaniasis and Chagas tests, and we may enter other license agreements. In prior years we concluded license agreements related to intellectual property rights owned by the United States associated with HIV- 1, and during the first quarter of 2008 we entered into a sub-license agreement for HIV-2 with Bio-Rad Laboratories N.A., the exclusive licensee of the Pasteur Institute’s HIV-2 intellectual property estate. +Corporate History +On May 5, 2004, we completed a merger with Trading Solutions, Inc. through which Chembio Diagnostic Systems Inc. became our wholly-owned subsidiary, and through which the management and business of Chembio Diagnostic Systems Inc. became our management and business. As part of this transaction, we changed our name to Chembio Diagnostics, Inc. In 2003, we had sold our prior business, and as a result, we had no specific business immediately prior to the merger. +Since the formation of Chembio Diagnostic Systems Inc. in 1985, it has been involved in developing, manufacturing, selling and distributing in-vitro diagnostic tests, including rapid tests beginning in 1995, for a number of conditions in humans and animals. +On March 12, 2004, we implemented a 1-for-17 reverse split of our common stock. All references in this Form 10-K to shares of our common stock have been adjusted to reflect this reverse split. +In February 2010, Crestview Capital Master, L.L.C. ("Crestview Master”), a Delaware limited liability company that held 18,907,431 shares of Chembio's common stock, spun off all these shares, constituting approximately 30.5% of Chembio's outstanding shares, to its three equity holders. One of the three equity holders of Crestview Master immediately spun off, to its approximately 126 equity holders, all of the 12,990,569 shares of Chembio stock that it received in this distribution. As a result, as of February 24, 2010, Crestview Master no longer owned any shares. The former direct and indirect equity holders of Crestview Master owned all these shares, with none of these individual stockholders having beneficial ownership of more than 5.61% of the outstanding common stock of Chembio. +On May 30, 2012, the Company effected a 1-for-8 reverse split of its common stock. This was done to allow the Company to move to the NASDAQ trading market from the OTCQB market, which occurred on June 7, 2012. As a result of the stock split, the outstanding 63,967,263 common shares were reduced to 7,995,918 outstanding common shares on May 30, 2012. The effect of the reverse stock split has been retroactively reflected for all periods in these financial statements. +12 +Glossary +AIDS +Acquired Immunodeficiency Syndrome. AIDS is caused by the Human Immunodeficiency Virus, HIV. +ALGORITHM (parallel or serial) +For rapid HIV testing this refers both to method or protocol (in developing countries to date) for using rapid tests from different manufacturers in combination to screen and confirm patients at the point-of-care, and may also refer to the specific tests that have been selected by an agency or ministry of health to be used in this way. A parallel algorithm uses two screening tests from different manufacturers and a tie-breaker test only if there is a discrepancy between the screening tests results. A serial algorithm only uses a second confirmatory test if there is a positive result from the screening test, meaning that the number of confirmatory tests used is equal to the positivity rate in the testing venue. A tie-breaker test resolves discrepancies between the screen and the confirmatory test. +ANTIBODY +A protein which is a natural part of the human immune system produced by specialized cells to neutralize antigens, including viruses and bacteria that invade the body. Each antibody producing cell manufactures a unique antibody that is directed against, binds to and eliminates one, and only one, specific type of antigen. +ANTIGEN +Any substance which, upon entering the body, stimulates the immune system leading to the formation of antibodies. Among the more common antigens are bacteria, pollens, toxins, and viruses. +ANVISA +ARVs +Anti-Retroviral Treatments for AIDS +The National Health Surveillance Agency of Brazil +Anti-retroviral medications developed to fight AIDS +CDC +United States Centers for Disease Control and Prevention +CLIA waiver +Clinical Laboratory Improvement Act designation that allows simple tests to be performed in point-of-care settings such as doctor’s offices, walk-in clinics and emergency rooms. +DIAGNOSTIC +Pertaining to the determination of the nature or cause of a disease or condition. Also refers to reagents or procedures used in diagnosis to measure proteins in a clinical sample. +EITF +Emerging Issues Task Force +FASB +FIOCRUZ +Financial Accounting Standards Board +The Oswaldo Cruz Foundation of Brazil +FDA +United States Food and Drug Administration +FDIC +Federal Deposit Insurance Corporation +FAS +Financial Accounting Standard +IgG +IgG or Immunoglobulin are proteins found in human blood. This protein is called an “antibody” and is an important part of the body’s defense against disease. When the body is attacked by harmful bacteria or viruses, antibodies help fight these invaders. +NGO +Non-Governmental Organization +OTC +Over-the-Counter +PEPFAR +The President’s Emergency Plan for AIDS Relief +PMA +Pre-Marketing Approval –FDA approval classification for a medical device that is not substantially equivalent to a legally marketed device or is otherwise required by statute to have an approved application. Rapid HIV tests must have an approved PMA application before marketing of such a product can begin. +PROTOCOL +A procedure pursuant to which an immunodiagnostic test is performed on a particular specimen in order to obtain the desired reaction. +REAGENT +A chemical added to a sample under investigation in order to cause a chemical or biological reaction which will enable measurement or identification of a target substance. +RETROVIRUS +A type of virus which contains the enzyme Reverse Transcriptase and is capable of transforming infected cells to produce diseases in the host such as AIDS. +SAB +Staff Accounting Bulletin +SENSITIVITY +Refers to the ability of an assay to detect and measure small quantities of a substance of interest. The greater the sensitivity, the smaller the quantity of the substance of interest the assay can detect. Also refers to the likelihood of detecting the antigen when present. +SPECIFICITY +The ability of an assay to distinguish between similar materials. The greater the specificity, the better an assay is at identifying a substance in the presence of substances of similar makeup. +USDA +U.S Department of Agriculture +WHO +World Health Organization +13 \ No newline at end of file diff --git a/raw/filings/0001092662/2012/0001092662-13-000024/item13.txt b/raw/filings/0001092662/2012/0001092662-13-000024/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..01abf0ecfe40cd56895b1d0307198f92ac82ef98 --- /dev/null +++ b/raw/filings/0001092662/2012/0001092662-13-000024/item13.txt @@ -0,0 +1,38 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +The executive officers of the Company are as follows: Lawrence A. Siebert, president, chief executive officer and chairman of the board of directors of the Company, Richard J. Larkin, chief financial officer of the Company, and Javan Esfandiari, executive vice president of Research and Development of the Company. +In accordance with the terms of the Company’s 2008 Plan, on May 9, 2011, the Company granted to certain employees of the Company options to purchase an aggregate of 62,500 shares of the Company’s common stock. The exercise price for these options was to be equal to the VWAP (Volume Weighted Average Price) market price for the Company’s common stock on May 9, 2011. The options become exercisable evenly on the second and third anniversaries of the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. Mr. Ippolito, Mr. Bruce and Mr. Larkin received options to purchase common stock of 15,625, 12,500 and 18,750 shares, respectively. +On February 16, 2012, the Company granted options to purchase the following numbers of shares of the Company’s common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company’s common stock on February 16, 2012, which was $4.00 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +2,563 +Javan Esfandiari – Executive Vice President of R&D +7,969 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +3,000 +Richard J. Larkin – Chief Financial Officer +2,797 +Lawrence A. Siebert – Chief Executive Officer +9,063 +On February 25, 2013, the Company granted options to purchase the following numbers of shares of the Company’s common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company’s common stock on February 26, 2013, which was $5.56 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +1,520 +Javan Esfandiari – Executive Vice President of R&D +4,765 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +1,775 +Richard J. Larkin – Chief Financial Officer +1,670 +Lawrence A. Siebert – Chief Executive Officer +5,215 +Michael Steele – Vice President of Sales and Marketing +785 +Sharon Klugewicz – Vice President of QA/QC +630 +The Company entered into an employment agreement effective March 5, 2013 (the "Employment Agreement"), with Mr. Esfandiari to continue as the Company's Senior Vice President of Research and Development for an additional term of three years through March 5, 2016. See Item 11 for more details. +Director Independence +Our common stock trades on the NASDAQ. Accordingly, we are subject to the corporate the governance standards of NASDAQ, which require, among other things, that the majority of the board of directors be independent. We define an “independent” director in accordance with the NASDAQ Global Market's requirements for independent directors. Under this definition, we have determined that each of Katherine Davis, Barbara DeBuono, Peter Kissinger, and Gary Meller currently qualify as independent directors. We do not list the “independent” definition we use on our internet website . +42 \ No newline at end of file diff --git a/raw/filings/0001092662/2012/0001092662-13-000024/item9a.txt b/raw/filings/0001092662/2012/0001092662-13-000024/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..aacd8815e15dce9d5c2a63957c756d4f97cd33fb --- /dev/null +++ b/raw/filings/0001092662/2012/0001092662-13-000024/item9a.txt @@ -0,0 +1,16 @@ +ITEM 9A. +CONTROLS AND PROCEDURES +(a) Disclosure Controls and Procedures. Under the supervision and with the participation of our senior management, consisting of our chief executive officer and our chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report (the "Evaluation Date"). Based on that evaluation, the Company’s management, including our chief executive officer and chief financial officer, concluded that as of the Evaluation Date our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our Exchange Act reports is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. +33 +Management's Annual Report on Internal Control Over Financial Reporting. The Company's management is responsible for establishing and maintaining an adequate system of internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)). Our internal control over financial reporting is a process, under the supervision of our chief executive officer and chief financial officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. These internal controls over financial reporting processes include policies and procedures that: +a. +Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; +b. +Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +c. +Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives. +In evaluating the effectiveness of our internal control over financial reporting, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on this evaluation, our Chief Executive and Chief Financial Officers concluded that our internal control over financial reporting was effective as of December 31, 2012. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. +Management's report was not subject to attestation by our registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report. +(b) Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the Company’s last fiscal quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001092662/2012/0001092662-13-000024/rp_note.txt b/raw/filings/0001092662/2012/0001092662-13-000024/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001092662/2012/0001092662-13-000024/rpt_disclosure.txt b/raw/filings/0001092662/2012/0001092662-13-000024/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..01abf0ecfe40cd56895b1d0307198f92ac82ef98 --- /dev/null +++ b/raw/filings/0001092662/2012/0001092662-13-000024/rpt_disclosure.txt @@ -0,0 +1,38 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +The executive officers of the Company are as follows: Lawrence A. Siebert, president, chief executive officer and chairman of the board of directors of the Company, Richard J. Larkin, chief financial officer of the Company, and Javan Esfandiari, executive vice president of Research and Development of the Company. +In accordance with the terms of the Company’s 2008 Plan, on May 9, 2011, the Company granted to certain employees of the Company options to purchase an aggregate of 62,500 shares of the Company’s common stock. The exercise price for these options was to be equal to the VWAP (Volume Weighted Average Price) market price for the Company’s common stock on May 9, 2011. The options become exercisable evenly on the second and third anniversaries of the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. Mr. Ippolito, Mr. Bruce and Mr. Larkin received options to purchase common stock of 15,625, 12,500 and 18,750 shares, respectively. +On February 16, 2012, the Company granted options to purchase the following numbers of shares of the Company’s common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company’s common stock on February 16, 2012, which was $4.00 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +2,563 +Javan Esfandiari – Executive Vice President of R&D +7,969 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +3,000 +Richard J. Larkin – Chief Financial Officer +2,797 +Lawrence A. Siebert – Chief Executive Officer +9,063 +On February 25, 2013, the Company granted options to purchase the following numbers of shares of the Company’s common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company’s common stock on February 26, 2013, which was $5.56 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee’s employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +1,520 +Javan Esfandiari – Executive Vice President of R&D +4,765 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +1,775 +Richard J. Larkin – Chief Financial Officer +1,670 +Lawrence A. Siebert – Chief Executive Officer +5,215 +Michael Steele – Vice President of Sales and Marketing +785 +Sharon Klugewicz – Vice President of QA/QC +630 +The Company entered into an employment agreement effective March 5, 2013 (the "Employment Agreement"), with Mr. Esfandiari to continue as the Company's Senior Vice President of Research and Development for an additional term of three years through March 5, 2016. See Item 11 for more details. +Director Independence +Our common stock trades on the NASDAQ. Accordingly, we are subject to the corporate the governance standards of NASDAQ, which require, among other things, that the majority of the board of directors be independent. We define an “independent” director in accordance with the NASDAQ Global Market's requirements for independent directors. Under this definition, we have determined that each of Katherine Davis, Barbara DeBuono, Peter Kissinger, and Gary Meller currently qualify as independent directors. We do not list the “independent” definition we use on our internet website . +42 \ No newline at end of file diff --git a/raw/filings/0001092662/2013/0001092662-14-000018/filing.txt b/raw/filings/0001092662/2013/0001092662-14-000018/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..2c6696392b4b8efea33398c3ab6d1c90f3d38728 --- /dev/null +++ b/raw/filings/0001092662/2013/0001092662-14-000018/filing.txt @@ -0,0 +1,2989 @@ +10-K +1 +form10_k.htm +UNITED STATES +Securities and Exchange Commission +Washington, D.C. 20549 +FORM 10-K +[X] +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2013 +or +[ ] +TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from _______ to ______ . +Commission File No. 0-30379 +CHEMBIO DIAGNOSTICS, INC. +(Exact name of registrant as specified in its charter) +Nevada +88-0425691 +(State or other jurisdiction of incorporation or organization) +(I.R.S. Employer Identification No.) +3661 Horseblock Road, Medford, NY +11763 +(Address of principal executive offices) +(Zip Code) +Registrant's telephone number, including area code (631) 924-1135 +Securities registered pursuant to Section 12(b) of the Act: +Title of each class +Name of each exchange on which registered +None +None +Securities registered pursuant to section 12(g) of the Act: +Common Stock, $0.01 par value +(Title of Class) +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes __ No X +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes __ No X +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 X No__ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 X No __ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. +Large accelerated filer [ ] +Accelerated filer [ ] +Non-accelerated filer [ ] +Smaller reporting company [X] +(Do not check if a smaller reporting company) +Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes __ No _X_ +As of the last business day of the Company's most recently completed second fiscal quarter, the aggregate market value of voting and non-voting common equity held by non-affiliates* was $38,000,000. +As of March 4, 2014, the registrant had 9,324,783 common shares outstanding. +* Without asserting that any of the issuer's directors or executive officers, or the entities that own more than five percent of the outstanding shares of the Registrant's common stock, are affiliates, the shares of which they are beneficial owners have not been included in shares held by non-affiliates solely for this calculation. +TABLE OF CONTENTS +Page +PART I +ITEM 1. +BUSINESS +2 +ITEM 1A. +RISK FACTORS +18 +ITEM 2. +PROPERTIES +25 +ITEM 3. +LEGAL PROCEEDINGS +25 +ITEM 4 . +MINE SAFETY DISCLOSURES +25 +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +25 +ITEM 6. +SELECTED FINANCIAL DATA +26 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +27 +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +36 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. +37 +ITEM 9A. +CONTROLS AND PROCEDURES +37 +ITEM 9B. +OTHER INFORMATION +37 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +38 +ITEM 11. +EXECUTIVE COMPENSATION +40 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +44 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +46 +ITEM 14. +PRINCIPAL ACCOUNTANT FEES AND SERVICES +47 +PART IV +ITEM 15. +EXHIBITS, FINANCIAL STATEMENT SCHEDULES +48 +SIGNATURES +49 +PART I +ITEM 1. +BUSINESS +FORWARD-LOOKING STATEMENTS +This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, and Section 27A of the Securities Act of 1933. Any statements contained in this report that are not statements of historical fact may be forward-looking statements. When we use the words "intends," "estimates," "predicts," "potential," "continues," "anticipates," "plans," "expects," "believes," "should," "could," "may," "will" or the negative of these terms or other comparable terminology, we are identifying forward-looking statements. Forward-looking statements involve risks and uncertainties, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by forward-looking statements. These factors include our research and development activities, distributor channels, market demand for our products, compliance with regulatory impositions; and our capital needs. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business. +For further information about these and other risks, uncertainties and factors, please review the disclosure included in this report under "Part I, Item 1A, Risk Factors." +Our Business +General +The Company (Chembio Diagnostics, Inc. and its wholly-owned subsidiary, Chembio Diagnostic Systems, Inc., are collectively referred to herein as the "Company") develops, manufactures, markets and licenses rapid point-of-care diagnostic tests (POCTs) that detect infectious diseases. The Company's main products presently commercially available are four rapid tests for the detection of HIV 1/2 antibodies, two rapid tests for the detection of syphilis antibodies, and a multiplex rapid test for the detection of HIV and Syphilis antibodies. Three of the HIV 1/2 rapid tests employ in-licensed and proprietary lateral flow technologies (see "Our Rapid Test Technologies"), can be used with all blood matrices as samples, and are manufactured in a standard cassette format, a dipstick format, and a proprietary barrel format. The tests employing the cassette and proprietary barrel formats were approved by the FDA in 2006 and are exclusively distributed by Alere, Inc. ("Alere") in the United States and by Chembio outside the United States. As discussed below (see Partners Involved in Marketing Our Products), we are considering changes to our exclusive agreements with Alere based on Alere's introduction of a competitive product, which introduction has triggered provisions in those agreements, permitting us to make certain changes. Our fourth HIV 1/2 rapid antibody detection test incorporates our patented Dual Path Platform® (DPP®) POCT technology, and this POCT platform does not require in-licensing. The DPP® HIV 1/2 Assay detects antibodies to HIV 1 & 2 in oral fluid samples as well as in all blood matrices. We have sold this product in Brazil since 2009 where it was approved by ANVISA, through our agreement with the Oswaldo Cruz Foundation ("FIOCRUZ"), and we received United States FDA regulatory approval for this product on December 19, 2012. We anticipate launching it in the United States under Chembio's brand in 2014. +Our product pipeline, which currently includes a multiplex rapid test for earlier detection of HIV by detecting P-24 antigen as well as antibodies, a test for Hepatitis-C, and a multiplex test that detects HIV and Syphilis specific antibodies (which we are already selling internationally), is based on this DPP® technology for which we were issued a United States patent in 2007 and for which additional patent protection has issued or is pending in a number of other countries. With the patented DPP® and the lateral flow platform, we participate in the estimated $8-10 billion point-of-care market segment of the estimated nearly $50 billion global in-vitro diagnostic market that has an overall growth rate exceeding 5% per annum. POCTs, by providing prompt and early diagnosis, can reduce patient stays, lower overall costs, improve therapeutic interventions and improve patient outcomes. POCTs can also prevent needless hospital admissions, simplify testing procedures, avoid delays from central lab batching, and eliminate the need for return visits. +2 +In the areas of infectious and sexually transmitted diseases (such as HIV and syphilis), the utility of a rapid point–of-care test, particularly in identifying patients unaware of their disease status, has been well established. Large and growing markets have been established for these kinds of tests, initially in high prevalence regions where they are indispensable for large scale prevention and treatment programs. More recently introduced in the United States in 2004, rapid HIV tests now also present a significant segment of the U.S. market for HIV clinical testing, which is still dominated by laboratory tests. We have focused our product development activity within areas where the availability of rapid, point-of-care screening, diagnostic, or confirmatory results can improve health outcomes. More generally we believe there is and will continue to be a growing demand for diagnostic products that can provide accurate, actionable diagnostic information in a rapid, cost-effective manner at the point of care. +PRODUCTS +Lateral Flow Rapid HIV Tests +All three of our lateral flow rapid HIV antibody detection tests are qualitative "yes/no" tests for the detection of antibodies to HIV 1 & 2 with visually interpreted results (one line "negative"; two lines "positive") available within approximately 15 minutes. The tests are simple to use, have a shelf life of 24 months, and do not require refrigeration. The tests differ principally only in the method of test procedure, convenience and cost. One of our FDA-approved lateral flow HIV tests incorporates a proprietary plastic "barrel" device that houses the lateral flow strip. This barrel format enables collection of samples directly (usually from a finger-stick whole blood sample) into the barrel's capillary tip. A sealed unitized buffer vial, assembled onto the top of the barrel, is removed and seated into a stand; the seal is then pierced by the barrel's capillary tip, thereby initiating the upward flow of the resulting sample-buffer solution through a filter, up into the vertical device's chamber and onto the lateral flow strip. This results in a unique unitized and closed device system that can reduce the chance of exposure to potentially infectious samples. Our other FDA-approved lateral flow HIV test uses a more conventional rectangular plastic cassette format that houses the lateral flow strip. In this case, a sample is transferred by use of a separately provided transfer device ("loop") into a sample well or port of the cassette that houses the lateral flow strip, which is positioned horizontally or flat. +Both of the above-described products are marketed exclusively in the United States by Alere (see Partners Involved in Marketing Our Products) as Clearview® Complete HIV 1/2 (the barrel format as governed by the Barrel Agreement) and Clearview® HIV 1/2 STAT PAK® (the cassette format as governed by the Cassette Agreement), and in all other markets by Chembio under the names Chembio SURE CHECK® HIV 1/2 and Chembio HIV 1/2 STAT PAK®. Alere has non-exclusive rights to the barrel product outside the United States. In addition to the above-referenced agreements for Alere to market our products, Alere also licensed their lateral flow technology patents to Chembio for our international rapid HIV test sales and certain other Chembio lateral flow product sales. Also this license would extend to sales by Chembio of the cassette and barrel products in the United States should we decide to exercise certain rights now exercisable by us based on Alere's notice to us of their having a Permitted Competing Product (see Partners Involved in Marketing Our Products). +Our third lateral flow HIV test, the HIV 1/2 STAT PAK® Dipstick, is our most cost competitive and compact format. It does not have any plastic housing so that 30 test strips can be packaged into a small vial that is ideal for transporting into remote settings. The test procedure is similar to the cassette format except that a user-applied adhesive backing is provided as a more cost-effective and compact "surface" on which to run the test. +Regulatory Status of the lateral flow HIV tests +The FDA approved our Pre-Market Applications (hereinafter "PMA"; see "Governmental Regulations" and Glossary) in April 2006 for our SURE CHECK HIV 1/2 (and also now Alere Clearview® Complete HIV 1/2) and for our HIV 1/2 STAT-PAK® (now Alere' Clearview® HIV 1/2 STAT-PAK® in the United States only) products. Waivers under the Clinical Laboratory Improvement Act (hereinafter "CLIA"; see Governmental Regulations) were granted by the FDA for these two FDA-approved products in 2006 and 2007, respectively. A CLIA waiver is required in order for health care providers to administer these tests in the settings where they are most suited and needed, such as public health testing clinics, hospital emergency rooms and physicians' offices. The SURE CHECK® product received a CE Mark in July 2013 and the CE Markings for the HIV 1/2 STAT-PAK® (as well as the DPP® HIV 1/2 Assay described below) are expected in 2014. Our HIV 1/2 STAT-PAK® Dipstick, although not FDA-approved, qualifies under FDA export regulations [See Government Regulation] to sell to customers outside the United States, subject to any required approval by the importing country. CE Mark has not been pursued for this product. +All three of our lateral flow HIV tests have qualified for procurement under the President's Emergency Plan for AIDS Relief ("PEPFAR"). Both the cassette and dipstick versions of the STAT-PAK® are also qualified by the World Health Organization (WHO) for procurements by the second largest global program, known as the Global Fund, as well as other related programs funded by agencies affiliated with the United Nations, such as UNICEF and UNITAIDS (see Glossary), through qualification with the WHO bulk procurement scheme. +3 +DPP® HIV 1/2 Assay +As in the case of our lateral flow HIV tests, our DPP® HIV 1/2 Assay is also a qualitative "yes/no" test for the detection of antibodies to HIV 1& 2, delivers visual results within as little as 15 minutes, is simple to use, has a shelf life of 24 months, and does not require refrigeration. This product, which is our first FDA-approved product incorporating our patented DPP® technology, can be used with oral fluid samples, as well as with all blood matrices. This product also incorporates our patent-pending oral fluid collection and storage system that enables samples to be fully extracted in buffer solution before application to the test device, and also enables the extracted sample to be stored and retested or potentially tested for multiple conditions in future product applications. Clinical and laboratory studies demonstrated the ability of the test to accurately detect the presence of antibodies in individuals down to two years of age. Studies have also shown this product to have improved performance compared with all of the current FDA-approved CLIA-waived lateral flow rapid tests, even including our own lateral flow tests. FDA-approved label claims include sensitivity/specificity on oral fluid and finger-stick whole blood of 98.9%/99.9% and 99.9%/100% respectively. Oral fluid sensitivity was 100% among HIV-positive patients not taking anti-retroviral medication: Due to the low HIV prevalence in the U.S., clinical trials are performed on known HIV-positive patients, and more and more of these individuals are on more highly active anti-retroviral treatments (known as "HAART") for much longer periods than when we and our competitors Orasure and Trinity performed their clinical trials ten to fifteen years ago. We believe that this fact, combined with our product's superior performance in a direct comparative evaluation that was conducted by the United States CDC Global AIDS Program, together with analytical studies that confirm earlier detection with our DPP® product than our main competitors on well characterized serum samples, all combine to provide us with a significant market opportunity with this product. +Regulatory Status of the DPP® HIV 1/2 Assay +In April 2012 we completed a 3,000 patient clinical study with our DPP® HIV 1/2 Assay in the United States which we had begun in 2010. In June 2012 we submitted the third of three modules required for a modular PMA application to the FDA. On December 19, 2012 we received FDA approval of our Pre-Marketing Approval. During 2013, we completed a 1,000 patient clinical study in order to submit a CLIA waiver application to the FDA, which was submitted at the end of November 2013. In February 2014 we received a letter from the FDA on the current status of review of our CLIA waiver application. The FDA determined that additional information is needed to complete their review of the Company's DPP® HIV 1/2 Assay CLIA waiver application. During the blinded prospective clinical study, a disproportionate number of new infections were found at one clinical site due to the lower than expected prevalence at two other sites. We are currently in discussion with the FDA to finalize the protocol to collect additional data. Upon receiving guidance on our proposed protocol, we anticipate that we will be able to update the timeline of activities for the CLIA waiver of the DPP HIV1/2 Assay. +The DPP® HIV 1/2 Assay product is qualified for procurement under the President's Emergency Plan for AIDS Relief ("PEPFAR") for use with all sample matrices, and we are pursuing WHO qualification in order to enable procurement of this product by the Global Fund and United Nations agencies, including programs underwritten by them. We are also pursuing CE Marking, anticipated during 2014, as stated above. +In June 2010, ANVISA approved the DPP® HIV 1/2 Assay that is being marketed in Brazil through our collaboration with the Oswaldo Cruz Foundation, Brazil's leading public health institute (see Oswaldo Cruz Foundation OEM DPP® Agreements). +DPP® HIV-Syphilis Multiplex Test +This product, launched in 2013, allows for the detection of antibodies to both HIV and Syphilis on a single test device within approximately 15 minutes. In certain global/public health settings (see Target Markets) this product may provide a more convenient and cost effective means of rapid detecting both markers in a single test procedure at the point of care as compared with performing separate rapid tests for each indication. This product takes advantage of the multiplexing feature of DPP® which provides for a more robust reaction between the sample and biomarkers being tested for (HIV and Syphilis antibodies in this case), resulting in a greater ability by the user to visually interpret test results. We launched this product in Mexico in the fourth quarter of 2013 as a unitized product, meaning that each test kit was separately packaged to include each of the other components necessary to run this test, as compared with other configurations where a test kit of 20 or 30 devices is accompanied by one bottle of running buffer. The initial results of this launch have been very positive, and we anticipate good results in Mexico during 2014 from the program. Building on this initial success, we are pursuing commercialization efforts for this product in a number of additional international markets. +4 +Regulatory Status of the DPP® HIV-Syphilis Test +The DPP® HIV-Syphilis multiplex test development was completed in 2013, and commercialization activities commenced in 2013 and are moving well as stated above. Also as mentioned above, a unitized version of this product was approved and launched in Mexico during the fourth quarter of 2013, and the product has been well received. In addition, this product is the first such product to have been approved by the USAID for procurement with U.S. foreign aid program funds (such as PEPFAR). We are pursuing pre-qualification of this product with the World Health Organization (WHO) in order to allow procurement through programs such as the Global Fund. Simultaneously we are pursuing registration of this product in a number of foreign jurisdictions where we believe there is an opportunity for this product. +In 2013, and 2014 year to date, we have made significant efforts on pursuing an FDA submission for this product. However, FDA has advised thus far that performance specifications for this product must be substantially equivalent both in comparison to the traditional algorithm and the "reverse" algorithms that are both now in use in the United States for syphilis testing, as well as meet the requirements for HIV sensitivity and specificity. It is possible to that other pathways to receiving FDA approval may be available by limiting the performance claims and/or the settings in which the tests could be used. We are conducting further studies now, and we are in dialog with the FDA and others, to see whether and how we may be able to meet their requirements without making changes to this product, which would result in further delays. +OTHER DPP® PRODUCTS +Our product pipeline includes a multiplex test that detects P24 HIV antigen as well as HIV 1/2 antibodies, and a rapid test for the detection of Hepatitis-C antibodies. These products are still in a development stage and have not been commercialized in any markets. The Company has a robust research and development department that is involved in a number of ongoing collaborations, some of which are sponsored, with public and private organizations. During 2013 we conduct sponsored research and development activities for two programs sponsored by agencies of the United States government; One is for the development of a 9-band influenza immune status test and the other is for a multiplex febrile illness test that could help identify and differentiate, in remote settings, symptoms that could be attributable to a variety of tropical diseases, including malaria, dengue, and the bubonic plague. We have also continued to conduct research and development activities on a serological test for tuberculosis pursuant to a Phase II SBIRR grant from the National Institutes of Health (NIH). All of these projects are based on our patented DPP® technology. +PARTNERS INVOLVED IN MARKETING OUR PRODUCTS +Alere +On September 29, 2006, we executed marketing and license agreements with Alere. The marketing agreements (the Barrel Agreement and the Cassette Agreement) provide Alere with a 10-year exclusive right (until September 2016) to market our rapid HIV tests in the United States under Alere's brands. The agreements also provide Chembio a non-exclusive license to certain Alere lateral flow patents that may be applicable to our lateral flow products, including for manufacture of the HIV tests in the United States for sales outside the United States and even for sale in the United States should Alere enter the U.S. market with a competitive rapid HIV test product and in such case we choose to market our products directly as provided in the agreements in such event of a competitive rapid HIV test product. Simultaneous with the execution of the agreements, we also settled litigation with StatSure Diagnostics, Inc. (SDS), that had been ongoing relating to the proprietary barrel device which is incorporated into one of our two FDA-approved rapid HIV tests (See Lateral Flow HIV Tests above). SDS, pursuant to the settlement, is a party to the 3-way Barrel Agreement. As a result, until now, it is through the agreements with Alere that we have been participating in the growth of the rapid HIV test market in the United States. +In late July 2013, we received notice from Alere that they intend to commercialize their own rapid HIV test (see Competition), which test had just received FDA approval as a moderate complexity product (i.e. not CLIA-waived though this is being pursued and anticipated during 2014), in the United States. Under the Barrel Agreement and the Cassette Agreement such product is considered to be a Permitted Competing Product (PCP). Each of the two aforementioned agreements provides that, in the case of notice of a PCP, Chembio may make certain elections (jointly with SDS in the case of the Barrel Agreement), or elect to continue each agreement without taking any further action. Under the Cassette Agreement, Chembio may, at any time, terminate such agreement, which termination would become effective 60 days after the date notice was made. Under the Barrel Agreement, Chembio and SDS may jointly issue a non-exclusivity notice, which notice shall be effective immediately. In the event that Chembio (and SDS) makes this election with respect to either (or both) of these products, Chembio could sell that respective (or both) product(s) in the United States market under Chembio/SDS brands and in such case, the lateral flow license that Chembio has from Alere for international sales would be expanded to include sales in the United States, which would require the payment of a royalty to Alere at the time of any sales. See Lateral Flow Technology and Reagent Licenses. +5 +We have appointed distributors internationally for our lateral flow HIV tests. Our largest markets outside the U.S. for our lateral flow HIV rapid tests are certain countries in Africa, Asia, and South America, as well as Mexico. Internationally, most of the demand for our products is based on governmental and non-governmental prevention and treatment efforts. Given this, these programs can and do often result in large orders, but also can result in periods of relatively lower demand, based on the variations associated with this kind of demand. +OEM DPP® Products +Oswaldo Cruz Foundation OEM DPP® Agreements +During 2008-2010 we signed five separate agreements, each of which is titled and constitutes a "Technology Transfer Agreement", with the Oswaldo Cruz Foundation (FIOCRUZ) in Brazil. FIOCRUZ includes the Institute of Technology on Immunobiologicals/Bio- Manguinhos, which is the FIOCRUZ unit that produces vaccines and diagnostic kits. FIOCRUZ and Bio-Manguinhos are referred to herein interchangeably. Each of the five agreements relates to a different specific product or group of products based on our DPP® technology. FIOCRUZ is the leading public health organization in Brazil, and it is affiliated with Brazil's Ministry of Health, which is its principal client. It has extensive research, educational and manufacturing facilities for drugs and vaccines, as well as for diagnostic products. +Each of the agreements grants to FIOCRUZ the right, but not the obligation, to earn the right to request a technology transfer to be able to license and manufacture that product on its own. FIOCRUZ is not required to earn this right, but if it desires to do so, then it needs to purchase a stated amount of the product as set forth in the respective agreement for that product. +During 2010 and 2011, all of the initial products contemplated under the five agreements were approved for marketing by the applicable regulatory agencies in Brazil. The agreements between the Company and FIOCRUZ are unique examples of technology transfer collaborations between a private sector rapid test manufacturer and a public health organization. The five products categories for which FIOCRUZ can earn a separate right to request a technology transfer for that product only are: DPP® products for HIV screening, HIV Confirmatory, Leishmaniasis, Leptospirosis and Syphilis. Each technology transfer, and the provision by Chembio of the information and training that is required for this to occur, will occur only if FIOCRUZ purchases from Chembio the amount of that product that is specified in the respective agreement for that product. The actual amount of purchases for each product is totally at the discretion and option of FIOCRUZ and may be more or less than the amount needed to qualify for a technology transfer. +More specifically, the five agreements, although separate and independent of one another, are structurally similar according to the following: +· +Each agreement states: "the object of this Agreement is for the Transfer of Technology from Chembio to Bio-Manguinhos, the license by Chembio to Bio-Manguinhos [of] the Chembio Patents applied or granted in Brazil or other Mercosur countries for the term of the patents and the transfer of all the technical information related to the DPP technology and the process to obtain the product by the DPP® technology. This Agreement contemplates the scientific and technological co-operation between Chembio and Bio-Manguinhos for such activities so that Bio-Manguinhos will be able to manufacture the Product in Brazil." +· +Each agreement provides that Chembio will supply free of charge to Bio-Manguinhos prototypes of the product to demonstrate performance characteristics that are necessary for evaluation by the Brazilian Ministry of Health and for registration with ANVISA. ANVISA is the Agencia Nacional de Vigliancia Sanitaria, or the National Sanitary Vigilance Agency. The number of prototypes ranges from 15,000 to 45,000 in the various agreements. +· +Each agreement provides that the prototypes will be utilized both for a performance study that follows a protocol prepared and approved by Bio-Manguinhos and the Brazilian Ministry of Health, and also will be used for studies in Brazil for the registration procedures at ANVISA. Bio-Manguinhos will then apply to ANVISA to register the product. Within 120 days of the registration of the product with ANVISA, Bio-Manguinhos will make an advance technology transfer payment to Chembio (the "Advance Payment"), in an amount specified in that particular agreement. All five of the Advance Payments provided for in the agreements were made in 2010 and 2011. +· +At such time, if any, that the product for a particular agreement has been successfully registered with ANVISA, then Bio-Manguinhos has the right to qualify for the full technology transfer for that product by purchasing the amount of the product, and at the price, specified in the agreement. +· +Bio-Manguinhos is not required to purchase any amount of any product. For each product, it only needs to purchase that product, in the amount specified in the agreement, only if it desires to be able to complete the technology transfer process in order to manufacture and sell that product on its own. Chembio does not have recourse against Bio-Manguinhos if Bio-Manguinhos does not purchase the qualifying purchase amount of any product. In that case, Chembio can only suspend further phases of the technology transfer, attempt to renegotiate the agreement, and/or retain any amounts previously paid by Bio-Manguinhos. Chembio cannot force Bio-Manguinhos to purchase any amount of any product. +6 +· +As a result of the terms of these agreements, Bio-Manguinhos has never been required to, and is not now required to, purchase any amount of any of the products. +· +As of December 31, 2013 Bio-Manguinhos had earned the status described below with respect to each of the five products: +1. +With respect to Chembio's DPP® HIV1/2 Screen test, Bio-Manguinhos had qualified to request the technology transfer. It has requested, and has received, the technology transfer information. Bio-Manguinhos purchased $880,175 of this product in 2011, and $4,990,840 in 2012, all of which applied to the qualifying amount to obtain the right to the technology transfer (the "Qualifying Amount") for this product. In 2013, Bio-Manguinhos made $291,235 of purchases that applied to the Qualifying Amount for this product, and $3,320,010 of purchases in excess of the Qualifying Amount. +2. +With respect to Chembio's Canine Leishmania test, Bio-Manguinhos had qualified to request the technology transfer and did so request. Submission of the technology transfer information is in process at this time. Bio-Manguinhos purchased $2,000,817 of this product in 2011 and $99,183 of this product in 2012 that applied to the Qualifying Amount. In addition, Bio-Manguinhos made purchases in excess of the Qualifying Amount equal to $1,314,117 in 2012 and $1,736,700 in 2013. +3. +a. +With respect to the three variations of Chembio's DPP® Syphilis test, all of which are covered by a single agreement, Bio-Manguinhos had qualified to request the technology transfer with respect to Trep only, and intends to do so in the near future. Bio-Manguinhos purchased $1,194,250 of this product in 2011 and $165,750 of this product in 2012 that applied to the Qualifying Amount. In addition, Bio-Manguinhos made purchases in excess of the Qualifying Amount equal to $2,817,750 in 2012, and equal to an estimated $646,340 in 2013. +b. +With respect to the two variations of Chembio's Screen & Confirm Test, Bio-Manguinhos had not made any purchases in 2011, 2012, or 2013, and therefore had not qualified to request the technology transfer for either of them. In order to qualify, Bio-Manguinhos would need to purchase an additional $2.2 million of one of these tests, and an additional $2.08 million of the other test. +4. +With respect to Chembio's DPP® Confirmatory test, Bio-Manguinhos had not qualified to request the technology transfer. Bio-Manguinhos made purchases of $560,000 of this product in 2011, $819,000 in 2012, and $390,000 in 2013, all of which applied to the Qualifying Amount. In order to qualify for the technology transfer, Bio-Manguinhos would need to purchase an additional $585,000 of this product. +5. +With respect to Chembio's DPP® Leptospirosis test, Bio-Manguinhos had not qualified to request the technology transfer. Bio-Manguinhos made purchases of $135,000 of this product in 2011, and it made -0- purchases in 2012 and $45,000 in 2013. In order to qualify for the technology transfer, Bio-Manguinhos would need to purchase an additional $225,000 of this product. +· +As stated above, Bio-Manguinhos is not obligated to make any purchases. After the specified level of sales for a particular product has been achieved, FIOCRUZ may request that the technology for that product be transferred to FIOCRUZ together with an exclusive license to produce and sell that product in a defined territory. The license is to provide that Chembio will receive a royalty on all sales. Chembio does not release the amount of this royalty because it could have an adverse effect on negotiations concerning royalties in potential transactions with other parties. +· +All the agreements expire five years after the date of the technology transfer. If terminated earlier by default of FIOCRUZ, FIOCRUZ must stop all activity; if terminated earlier by default of Chembio, or if terminated by natural expiry, FIOCRUZ can continue to produce and commercialize the product without paying royalties." +Other OEM And License Agreements Related to DPP® Technology +In addition to our agreement with FIOCRUZ, we have entered into certain other OEM and License agreements with other parties with respect to certain products that we have developed based on our DPP® technology. In 2008 we entered into a product development and license agreement with Bio-Rad Laboratories, Inc. (Bio-Rad), a leading multinational life sciences company, for the first ever POC test for the confirmation of HIV (reflex test used after initial screening test(s) are positive). This product utilizes our DPP® technology, capitalizing on its multiplexing advantages, and is much simpler to perform than the legacy confirmatory platform, known as western blot, which requires a substantial amount of technical training and hands-on time and which is more expensive to manufacture and distribute. This product was CE marked and was launched by Bio-Rad in the second quarter of 2013 in Europe under their Geenius® brand; and an FDA submission is underway. +7 +In 2013 we entered into collaboration with Labtest, a private company in Brazil, for the distribution of a number of products in Brazil that would be co-branded with Labtest and Chembio trademarks. Under this agreement, upon request from Labtest, for which there is no requirement, Chembio will sell the appropriate DPP® components to Labtest for further manufacture and assembly in Brazil. +Most recently, in February 2014, Chembio entered into a technology transfer and license agreement with RVR Diagnostics SDN BHD ("RVR"), a privately-held company in Malaysia. The agreement supports Chembio's strategy of establishing a market presence in Asia, in collaboration with RVR as a licensee, distributor, and contract manufacturer. The agreements grant exclusive distribution rights to RVR in certain countries in the region and enable RVR to manufacture Chembio's DPP® HIV 1/2 Assay and DPP® HIV-Syphilis Assay and potentially other products developed by Chembio incorporating its patented DPP® technology. +Our strategy with respect to our DPP® technology has evolved as the Company has evolved. Initially, following the issuance of our DPP® patent in the United States in 2007, our strategy was necessarily limited to developing third-party-funded OEM research and development contracts and grants. This strategy enabled us to conserve capital resources, while at the same time acquiring know-how and experience with the platform and developing third-party references and implicit endorsements of the technology. As our capabilities to develop and manufacture DPP® products expanded, and as our financial position has improved, so have our strategic options expanded and improved. Although we have employed and may continue to employ the strategy of seeking OEM development and manufacturing agreements as a way to participate in markets that we cannot and/or choose not to serve with Chembio-branded products, we believe that we can also develop our own branded line of products, and we plan to do this in the public health area. We plan to launch this brand with our DPP® HIV 1/2 Assay in the United States market in 2014, to be followed by the other products in our pipeline in 2015 and beyond. +Our Rapid Test Technologies +All of our commercially available current products employ either in-licensed lateral flow technology or our own patented Dual Path Platform® (DPP®) technology. Both lateral flow technology and DPP® allow the development of accurate, low cost, easy-to-perform, single-use diagnostic tests for rapid, visual detection of specific antigen-antibody complexes on a test strip. These formats provide a test that is simple (requires neither electricity nor expensive equipment for test execution or reading, nor skilled personnel for test interpretation), rapid (turnaround time approximately 15 minutes), safe (minimizes handling of potentially infected specimens), non-invasive (requires 5-20 micro liters of whole blood easily obtained with a finger prick, or alternatively, serum or plasma,), stable (24 months at room temperature storage in the case of our HIV tests), and highly reproducible. +We believe that products developed using DPP® technology can provide superior diagnostic performance as compared with products that use lateral flow technology. The reason for this is that one of the major differences between the two platforms is that in DPP® samples are allowed to incubate with the target analyte in the test zone before introduction of the labeling reagent/conjugate, whereas in lateral flow, samples are combined with the labeling reagent to form a complex before coming in contact with the target analyte. We believe that this complex can compromise test performance. Also, because of the usage in DPP® of a separately connected sample strip, the control and delivery of sample material is substantially improved. This feature is critical in the development of multiplex tests, as well as tests that involve viscous sample material (such as oral fluid) that can be impeded when forced to combine with labeling reagents before migration on the test strip to the test zone area. +Multiplexing is significantly improved as a result of the design of DPP® and this provides a significant advantage. For example, the HIV confirmatory test we developed for Bio-Rad that is described above employs six different markers related to various epitopes of the HIV antigen. We have a number of other products in development, including those being developed in sponsored development programs, that involve the use of multiple (e.g. eight) test bands. Although all of these products could be visually read, we can also use handheld and desktop readers with our DPP® products to objectively measure, quantify, record and report DPP® test results. Certain of the products we have and/or are developing incorporate some of these readers, and we are developing other products that may be used with or will require use of a reader. Also, platforms can incorporate labeling reagents that cannot be visually read except by employing a reader, such as fluorescence, though no products are currently utilizing such reagents. +We are pursuing additional capabilities and technologies that will complement our current product portfolio and business strategy. This activity includes pursing development, license or acquisition of diagnostic technologies that complement our existing platforms, proprietary biomarkers that can result in new product applications of our existing platforms, and new platforms that would complement our commercial strategy. +8 +Target Markets +Rapid HIV Tests +A large percentage of individuals that are HIV positive worldwide are unaware of their status. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results when samples have to be sent out to a laboratory which can take up to several days to process. The increased availability, greater efficacy and reduced costs for anti-retroviral treatments (ARVs) for HIV has increased the demand for testing, as the stigma associated with the disease is lessened, and the ability to resume normal activities is substantially improved, providing a positive message to those potentially infected. The impact that rapid HIV testing has had on prevention efforts has in turn increased the demand for testing, particularly by public health programs worldwide, which have also become more effective in reducing the number of annual new infections in many, but by no means, all high prevalence regions. +Despite less attention to HIV by the media as compared with prior years, there are still approximately 50,000 new diagnoses of HIV infection in the United States each year, according to the CDC. CDC estimates that approximately 1.2 million individuals in the U.S. are living with HIV, with an estimated 250,000 of these U.S. individuals, or more than 20%, unaware that they are infected. It is transmissions from these 250,000 infected people that are reported to account for 54% of all new infections per year. Part of the reason for this is that even those individuals that do get tested in public health settings will often not return or call back for their test results if their blood samples have to be sent out to and tested in a laboratory and then reported back, a process which can take up to several days to complete. Making more people aware of their HIV status at the point-of-care reduces the number of HIV transmissions. +Rapid HIV testing in the United States has now developed into an estimated 7.5 million test market at an average price of $10, or a total of $75 million. Public health programs, currently funded by grants distributed to states by the CDC, account for an estimated 45% of the market, with hospitals (40%) and doctor's offices (15%) comprising the other estimated market segments. Chembio's lateral flow rapid HIV tests, the cassette and barrel, together represent approximately a 25% share of this market. Orasure Technologies, Inc., which was the first FDA-approved rapid HIV test, has lost nearly half its market share, now estimated to be approximately 55%. Trinity Biotech has an estimated 15% market share and Biolytical Laboratories, Medmira and Bio-Rad share the remaining 5%. +We believe that the US professional HIV rapid test market has the potential to increase to 15-18 million tests over the next several years, which would represent 40-50% of all HIV tests done today in the United States for clinical purposes. Assuming an average price to the manufacturers of $8.00 per test, a total potential U.S. market of nearly $120-$145 million is implied. +In 2006, the outlook for HIV testing was given a big boost with the release by the CDC of new recommendations for HIV testing. These new CDC recommendations were/are that an HIV test should be given as a routine test like any other for all patients between 13 and 64 years of age, regardless of risk, with an opt-out screening option and focused testing procedural (pre- and post-test counseling) guidelines. Though not mandatory, gradual adoption in whole or in part of the 2006 CDC recommendations by a number of states continues to have an increasing impact. Finally, in 2013, the United States Preventive Services Task Force ("USPSTF") fully embraced these CDC routine HIV testing recommendations. This USPSTF recommendation, which was given an A grade under their recommendation grading system based on the benefits of this practice and the nearly 600,000 AIDS-related deaths in the United States, requires insurance coverage under the Affordable Care Act (the "ACA") as a preventive screening test without any co-payment required. We expect this to result in an increase in HIV testing in the United States in the coming years, which we believe will include point-of-care HIV testing utilizing the Company's products. Although as stated above currently most public health testing in the United States is funded by grants allocated to high prevalence areas by the CDC, we believe this will shift to an insurance-funded model under the ACA in the years to come, increasing the amount of testing done in doctor's offices and community health centers. +In the international market , we sell our products directly and through distributors to large screening programs overseen by ministries of health and NGOs, most but not all of which are funded by large bi-lateral and multi-lateral AIDS relief programs, the largest of which is the U.S. President's Emergency Plan for AIDS Relief (PEPFAR). Established by President George Bush as a 5-year $15 billion program in 2003, PEPFAR was reauthorized in 2008 and again in 2013. In 2012 PEPFAR directly supported HIV testing and counseling for more than 11 million pregnant women, and testing and counseling for more than 49 million people overall. The U.S. is also the first and largest donor to the Global Fund to Fight AIDS, Tuberculosis and Malaria. To date, the U.S. has provided more than $7 billion to the Fund. +9 +In December 2013 President Obama signed into law the PEPFAR Stewardship and Oversight Act, which is the most recent reauthorization of PEPFAR. However, unlike the 2008 PEPFAR authorization, which authorized approximately $45 billion, the new law doesn't authorize a specific dollar amount for funding. Nevertheless it is widely anticipated that PEPFAR will continue to enjoy strong funding; the FY14 budget has $6 billion for global HIV/AIDS assistance, including $4 billion for PEPFAR. +Chembio, with its four U.S.-manufactured rapid HIV tests, three of which are FDA-approved, is recognized as a reputable and dependable supplier of high quality products that are available at reasonably competitive prices. As a result, certain of our products have been selected in the testing protocols in countries (national algorithms) that are large beneficiaries of PEPFAR and the Global Fund. As mentioned above, these programs can and do often result in large orders, but also can result in periods of relatively lower demand, based on the variations associated with this kind of demand. Also, even though the United States taxpayer is funding the largest share of global AIDS relief, U.S. companies do not receive any preference for these procurements, and therefore must compete with foreign suppliers that manufacture competitive products with lower costs, including those related to quality, regulatory, intellectual property, and costs of manufacturing. +Oral fluid testing is an established alternative to blood testing for diagnostic tests, including HIV tests. It is also often patient preferred, providing a more comfortable, less invasive test. In certain public health clinics, staffs choose not to handle blood specimens; thus, oral sample collection provides a viable alternative. The most well-established market for oral fluid HIV testing is the United States. Given the premium price required for an oral fluid test as compared with blood tests, the higher volume programs will not specify an oral fluid test. However, segments of these programs may want to have an oral fluid testing option, and certain programs that have greater resources may also choose to incorporate oral fluid testing into the testing protocol. +There is also now an over-the-counter market for HIV self-testing in the United States. Orasure Technologies Inc. received FDA approval for an over-the-counter (self-testing) version of its previously professional-market-approved (test performed on an individual by a health care professional) HIV test. The FDA approval was granted in July 2012, and Orasure has been investing heavily in developing this market. Initial results after over a year of marketing are well below expectations. The costs for such over-the-counter approval, including primarily the associated clinical trials, are estimated to be at least $5 million and they may take two to three years to complete, not to mention the cost of distribution. Orasure's initial results are not convincing of a large market, although this possibility remains. In any case, Orasure is likely to spend heavily on this for some time, and if it appears that there is an attractive market, we believe we are very well positioned versus any other competitors. +Rapid Syphilis Tests +Recent data indicate that approximately 70,000-100,000 new cases of syphilis are occurring annually in the U.S. Syphilis can be treated with antibiotics, but if untreated, it can cause pelvic inflammatory disease, infertility, ectopic pregnancy and can infect newborns. Treatment cannot be provided without a confirmed diagnosis of an active case of syphilis. Current testing algorithms in the United States require two different laboratory tests (called non-treponemal and treponemal), as neither test alone has the required specificity to rule out certain other conditions (i.e., other infection or past infection), but in combination they can provide reasonably reliable results. However each requires trained personnel in laboratory settings and can take several days to receive results, in order to confirm an active, previously untreated case. +Development of the POC market for syphilis testing is expected to be comparable to the development of the POC market for HIV testing, as there is a significant public health value to being able to provide results at the point-of-care. There are several ways to assess the market opportunity for this unique rapid test, although we believe the U.S. rapid test market opportunity may exceed 8 million tests, which is approximately 20% of the total number of syphilis tests performed in the United States for clinical use today. +Rapid HIV-Syphilis Test +There are significant risks relating to transmission of Syphilis from a pregnant mother to child, just as there are for transmission of HIV. Therefore we believe there is a significant opportunity to improve prevention efforts in pregnant mother to child transmission testing programs (PMTCT) that are currently not doing any or nearly enough testing for syphilis even though they are testing for HIV. In the United States, we believe there is also a significant need for this product in some of the highest HIV prevalence populations, such as among men that have sex with men (MSM), as data show high degrees of HIV and Syphilis co-infection in this segment of the population. +10 +Marketing Strategy +Our marketing strategy is to: +· +Depending on our decision based on Alere's introduction of a PCP: +o +If we remain status quo: Support, review and assess the marketing and distribution efforts of our rapid HIV tests by Alere in the U.S., as well as our distributors worldwide, and to engage in sales and marketing activities that allow us to engage with our target markets and customers. Alere, which is a leading marketer of point-of-care diagnostic products, has significantly expanded its distribution footprint and product portfolio since we signed our agreement with them, and although we believe that this will enhance opportunities for Alere to market our rapid HIV tests, our product line is a very small one for them, notwithstanding the strong growth they have enjoyed with respect to our products. In this case we would not have to bear the expense of establishing our own sales and marketing organization and we would continue to share a substantial portion of the net sales proceeds of the products with Alere as we have been. However, since Alere now has their own product to sell, they are likely to have a greater financial incentive to sell that product depending upon the market acceptance of that product and other factors. Therefore this could have a material and adverse effect on the sales Alere makes of our products. +o +If we decide to make certain elections available to us now such as to assume direct sales by Chembio under Chembio brands of the lateral flow products that we developed and that we manufacture but have been and continue to be marketed by Alere under their brands, then we will need to establish a commercial organization that is capable of assuming the distribution of these products. In this case Chembio would not have to share any portion of the net sales proceeds with Alere, except for the 8.5% lateral flow royalties applicable to the sales of the products, which royalty is only applicable until February 2015 at which time the applicable lateral flow patent of Alere's expires. This will immediately result in higher gross margins than if we continue with the status quo . However this decision will involve our incurring expenditures related to hiring sales representatives, establishing agreements and associated discounts with distributors, incurring advertising and marketing expenditures, warehousing, customer service and technical support. If Alere's new product is indeed successful, our ability to retain a significant share of the market that has been established for our products may be enhanced by our having control of the marketing of our products, rather than having Alere sell our products. We have been developing contingency plans so that we can activate this strategy in a timely manner, including the possibility of ultimately utilizing the same sales force that we would use for U.S. Sales of DPP® HIV 1/2 Assay. +· +Leverage our DPP® intellectual property and product development and manufacturing experience to continue creating new collaborations where Chembio can be the exclusive development and manufacturing partner supporting leading marketing organizations. +· +Establish strong distribution relationships for our Chembio-branded products in the U.S and abroad, and establish a direct sales and marketing organization that is focused in the public health market segment, and that utilizes distributors for other market segments, primarily the acute care market which, together with public health, are the main market segments for rapid HIV tests in the United States. We believe that creation of a Chembio public health brand and marketing organization is fundamental to the creation of shareholder value over the long term. +During 2013 we increased our commercial activities and efforts in Africa and Europe for our HIV tests by establishing a sales representative in each of these markets. We believe the sales representative in Africa will enable us to be more closely engaged with opportunities to participate in the national testing algorithms that are established and revised from time to time by countries that are beneficiaries of PEPFAR, Global Fund and/or other bilateral or multilateral donor funding. In Europe, where there are a larger percentage of HIV positive people unaware of their status than in the United States, we believe that there is an emerging public health outreach opportunity, and there are relatively few strong competitors that are CE marked. Most recently we have established new sales and marketing positions in the Company to support our efforts to increase brand awareness globally and to lead our direct sales effort in the U.S. market. +Competition +The diagnostics industry is a multi-billion dollar international industry and is intensely competitive. Many of our competitors are substantially larger and have greater financial, research, manufacturing and marketing resources. +Industry competition in general is based on the following: +· +Scientific and technological capability; +· +Proprietary know-how; +· +The ability to develop and market products and processes; +11 +· +The ability to obtain FDA or other required regulatory approvals; +· +The ability to manufacture products that meet applicable FDA requirements, (i.e. FDA's Quality System Regulations) (see Governmental Regulation section); +· +The ability to manufacture products cost-effectively; +· +Access to adequate capital; +· +The ability to attract and retain qualified personnel; and +· +The availability of patent protection. +We believe our scientific and technological capabilities and our proprietary know-how relating to our in-licensed lateral flow technology rapid tests and to our proprietary know-how related to our patented dual path platform® technology, particularly for the development and manufacture of tests for the detection of antibodies to infectious diseases such as HIV, are very strong. +Our ability to develop and market other products is in large measure dependent on our having additional resources and/or collaborative relationships. Some of our product development efforts have been funded on a project or milestone basis. We believe that our proprietary know-how in lateral flow technology and in our Dual Path Platform® (DPP®) technology has been instrumental in our obtaining the collaborations we have and that we continue to pursue. We believe that the patent protection that we have with our Dual Path Platform® (DPP®) enhances our ability to develop more profitable collaborative relationships and to license out the technology. However there are a number of competitive technologies used and/or seeking to be used in point-of-care settings. These technologies may be based on immunoassay principles such as the Company's products or other technologies such as molecular-based technologies. +We plan to introduce our FDA-approved DPP® oral fluid HIV test, which test also can be used with blood samples, in the U.S. market under a Chembio brand. Until it is CLIA-waived, this product will serve a very small market segment. Orasure Technologies manufactures the only other oral fluid HIV test that is FDA-approved, and Orasure has enjoyed this position for approximately 10 years. Orasure has lost a significant share of this market as certain customers have been indifferent to using blood or oral fluid samples, because the blood tests, including those made by Chembio and marketed by Alere, are priced lower and/or are as or more accurate than the performance of Orasure's product on blood samples. Orasure has primarily retained those customers for whom the oral fluid sample feature is a strong preference, and this is an estimated $35 million business for Orasure. Although we believe we can capture a meaningful portion of this Orasure market share, we also anticipate that Orasure will defend this business aggressively. +In 2006 Alere acquired a division from Abbott Diagnostic located in Japan that manufactured and marketed a rapid HIV test product line called Determine®. The Determine® format is was developed for developing world and remote settings and,central to the needs of that market, the format is essentially a test strip that is integrated into a thin foil wrapper that, when opened, the underside of the wrapper serves as the test surface for applying the blood sample and performing the test. This design reduces costs and shipping weights and volumes and is an advantage for the developing world markets it has served. Some of the disadvantages of the platform are the amount of blood sample that is needed (50 microliters versus 2.5, 5 and 10 for our lateral flow barrel, lateral flow cassette, and DPP® products respectively), the open nature of the test surface, and the absence of a true control that differentiates biological from other kinds of samples. +The so-called "3 rd generation" version of this product has been marketed for many years and is the leading rapid HIV test that is used in a large majority of the national algorithms of countries funded by PEPFAR and the Global Fund, as well as many other countries in the world. That product is not FDA-approved though it is CE marked. The newest Determine® HIV version, which was developed and manufactured at Alere's subsidiary in Israel, Orgenics, is the so-called "4 th Generation" version Determine® test. According to its claims, this product detects HIV antibodies and P24 HIV antigens. Since the P24 antigen is known to occur in HIV-positive individuals' blood samples before antibodies do, based on its performance claims, the 4 th generation Determine® test is therefore able to detect HIV infection earlier than tests that solely rely on antibody detection. Chembio's tests, as well as all of the other currently FDA-approved rapid HIV tests, only detect antibodies. There are however laboratory tests that are FDA-approved that are "4thgeneration" tests, but they are of course neither rapid nor point-of-care. +The initial "4 th generation" Alere Determine® rapid test product that was also CE marked and that Alere launched internationally some years ago has not been successfully commercialized to the best of our knowledge and at least certain published studies were not favorable for this product. However the 4 th generation product that is now FDA-approved was apparently modified as compared to the initial international version of it, and it may perform more satisfactorily. Alere received FDA approval of this modified product in August 2013 and Alere is seeking CLIA-waiver for it. Alere is also aggressively pursuing development of the market for this product in anticipation of receiving CLIA waiver. Although the product can now be sold to moderate complexity certified laboratories, there is very limited supply of the product thus far, and there is no assessment thus far concerning the actual performance of this product in the hands of customers. We believe the price that Alere is charging for this product is substantially higher than our and our competitors' antibody tests, as the antigen claim avails some customers of an additional reimbursement code. Moreover there is support by a number of key opinion leaders for the public health value of such 4th generation tests, and if Alere is able to successfully launch this product, it represents a significant competitive threat to Chembio as well as to each of the other rapid HIV test manufacturers (Orasure and Trinity primarily). +12 +During 2011 Biolytical, Inc. of Vancouver, Canada received FDA approval and in 2012 received CLIA waiver of a flow-through rapid HIV test called "INSTI". The technology used in the INSTI test, flow-through, is older than lateral flow, and it requires handling of multiple components (3 vials of solution) to perform the test in multiple steps. However, these steps can be accomplished in less than ten minutes, and the actual test results occur in only one minute after those steps are completed. Therefore sample-to-result time is shorter than any of the competitive products. The product also has good performance claims. There are settings where that reduced total test time, despite the multiple steps required, may be a distinct advantage, and we believe Biolytical has made some progress in penetrating certain public health markets. +Although we have no specific knowledge of any other competitors' products that are a competitive threat to our products, or that will render our products obsolete, if we fail to maintain and enhance our competitive position or fail to introduce new products and product features, our customers may decide to use the products developed by our competitors, which could result in a loss of revenues and cash flow. +Research and Development +During 2013 and 2012, $5.8 million and $4.5 million, respectively, were spent on research and development (including regulatory activities). These expenses were in part underwritten by funding from R&D and milestones revenues of $2.0 million in 2013 and $1.3 million in 2012. All of our new product development activities involve employment of our Dual Path Platform® (DPP®) technology. These activities include completing development of certain products and making significant progress toward the development of additional products. +Employees +At December 31, 2013, we employed 206 people. We have entered into employment contracts with our President, Lawrence Siebert, our Chief Operating Officer Sharon Klugewicz and our Senior Vice President of Research and Development, Javan Esfandiari. Due to the specific knowledge and experience of these executives regarding the industry, technology and market, the loss of the services of either one of them would likely have a material adverse effect on the Company. The contract with Ms. Klugewicz, has a term of two years ending May 2015. The contract with Mr. Esfandiari has a term of three years ending March 2016. We have obtained a key man insurance policy for Mr. Esfandiari. The contract with Mr. Siebert provides that Mr. Siebert will serve as the Chief Executive Officer and President of the Company through May 11, 2014, and Mr. Siebert has advised the Company that he intends to retire from the Company on or before that date. Upon Mr. Siebert's announcement in 2013, of his retirement plans, the Company began a search for a new CEO. +Governmental Regulation +The manufacturing and marketing of the Company's existing and proposed diagnostic products are regulated by the United States Food and Drug Administration ("FDA"), United States Department of Agriculture ("USDA"), certain state and local agencies, and/or comparable regulatory bodies in other countries. These regulations govern almost all aspects of development, production and marketing, including product testing, authorizations to market, labeling, promotion, manufacturing and record keeping. The Company's FDA and USDA regulated products require some form of action by each agency before they can be marketed in the United States, and, after approval or clearance, the Company must continue to comply with other FDA requirements applicable to marketed products, e.g. Quality Systems (for medical devices). Failure to comply with the FDA's requirements can lead to significant penalties, both before and after approval or clearance. +There are two review procedures by which medical devices can receive FDA clearance or approval. Some products may qualify for clearance under Section 510(k) of the Federal Food, Drug and Cosmetic Act, in which the manufacturer provides a pre-market notification that it intends to begin marketing the product, and shows that the product is substantially equivalent to another legally marketed product (i.e., that it has the same intended use and is as safe and effective as a legally marketed device and does not raise different questions of safety and effectiveness). In some cases, the submission must include data from human clinical studies. Marketing may commence when the FDA issues a clearance letter finding such substantial equivalence. FDA clearance of our DPP® Syphilis Screen & Confirm test will be by means of a 510(k) submission. +If the medical device does not qualify for the 510(k) procedure (either because it is not substantially equivalent to a legally marketed device or because it is required by statute and the FDA's implementing regulations have an approved application), the FDA must approve a Pre-Marketing Application ("PMA") before marketing can begin. PMA's must demonstrate, among other matters, that the medical device provides a reasonable assurance of safety and effectiveness. A PMA application is typically a complex submission, including the results of non-clinical and clinical studies. Preparing a PMA application is a much more expensive, detailed and time-consuming process as compared with a 510(K) pre-market notification. The Company has approved PMAs for the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1-2 and Clearview® HIV 1-2 STAT PAK®. +13 +FDA approval of our DPP® HIV screening assay for use with oral fluid or blood samples was achieved by means of a PMA application. The Clinical Laboratory Improvement Act of 1988 ("CLIA") prohibits laboratories from performing in-vitro tests for the purpose of providing information for the diagnosis, prevention or treatment of any disease or impairment of, or the assessment of, the health of human beings unless there is in effect for such laboratories a certificate issued by the United States Department of Health and Human Services (via the FDA) applicable to the category of examination or procedure performed. Although a certificate is not required for the Company, it considers the applicability of the requirements of CLIA in the design and development of its products. The statutory definition of "laboratory" is very broad, and many of our customers are considered labs. A CLIA waiver will remove certain quality control and other requirements that must be met for certain customers to use the Company's products and this is critical to the marketability of a product into the point-of-care diagnostics market. The Company has received a CLIA waiver for each of the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1/2 and Clearview® HIV 1/2 STAT PAK®. The CLIA waiver was granted by the FDA for HIV 1/2 STAT-PAK® on November 20, 2006 and for the Clearview® Complete HIV 1/2 on October 22, 2007. In 2008 the FDA revised its CLIA waiver requirements so that an additional prospective trial need be conducted in order to demonstrate accuracy of the device when used by untrained users. +In addition, the FDA regulates the export of medical devices that have not been approved for marketing in the United States. The Federal Food, Drug and Cosmetic Act contain general requirements for any medical device that may not be sold in the United States and is intended for export. Specifically, a medical device intended for export is not deemed to be adulterated or misbranded if the product: (1) complies with the specifications of the foreign purchaser; (2) is not in conflict with the laws of the country to which it is intended for export; (3) is prominently labeled on the outside of the shipping package that it is intended for export; and (4) is not sold or offered for sale in the United States. However, the Federal Food, Drug and Cosmetic Act does permit the export of devices to any country in the world, if the device complies with the laws of the importing country and has valid marketing authorization in one of several "listed" countries under the theory that these listed countries have sophisticated mechanisms for the review of medical devices for safety and effectiveness. +The Company is also subject to regulations in foreign countries governing products, human clinical trials and marketing, and may need to obtain approval or evaluations by international public health agencies, such as the World Health Organization, in order to sell diagnostic products in certain countries. Approval processes vary from country to country, and the length of time required for approval or to obtain other clearances may in some cases be longer than that required for United States governmental approvals. On the other hand, the fact that our HIV diagnostic tests are of value in the AIDS epidemic may lead to some government process being expedited. The extent of potentially adverse governmental regulation affecting Chembio that might arise from future legislative or administrative action cannot be predicted. +Environmental Laws +To date, we have not encountered any costs relating to compliance with any environmental laws. +Intellectual Property +Intellectual Property Strategy +Our intellectual property strategy is to: (1) build our own intellectual property portfolio around our Dual Path Platform® technology; (2) pursue licenses, trade secrets and know-how within the area of rapid point-of-care testing, and (3) develop and acquire proprietary positions to reagents and new hardware platforms for the development and manufacture of rapid diagnostic tests. +The Company has obtained patent coverage on the DPP® technology, including four U.S. patents, and patents in China, Malaysia, Eurasia, Mexico, Singapore, Japan, Australia, Indonesia, Korea and the U.K. Additional patent applications on the DPP® technology are pending in the U.S., as well as in many foreign countries such as Brazil, Canada, the European Union, India, Israel, and South Africa. Patents have also been filed on extensions to the DPP® product line concept such as 4th generation assays. The four U.S. patents are as follows: +U.S. Patent No. +Issued +Expires +Nature +Type +Description +7,189,522 +3/13/2007 +3/11/2025 +test device +utility +a test device for determining the presence +of a ligand in a sample +7,682,801 +3/23/2010 +3/11/2025 +test device +and method +utility +a test device and a method for determining +the presence of a ligand in a sample +7,879,597 +2/1/2011 +3/11/2025 +test device +utility +a test device for determining multiple +ligands in a sample +8,507,259 +8/13/2013 +3/11/2025 +test device +utility +a test device for determining the +presence of a ligand in a sample +The Company also licenses a group of lateral flow technology patents from Alere. Our lateral flow products, which are primarily our STAT-PAK®, SURE CHECK®, and DIPSTICK® product lines, may incorporate methods that are claimed under one of the patents licensed from Alere that we use in our tests. That U.S. Patent #6,485,982 is also referred to as the Charlton patent, which patent expires on February 3, 2015. This patent describes a test device and method for a colored particle immunoassay that determines the presence of an analyte in a sample +14 +The Company has also filed for patents and obtained some patents in the U.S. for other inventions such as its multiple host species veterinary TB test, and patent applications for the other inventions are in various stages from being recently filed and not yet examined, to already examined and allowed but not yet issued. The Company selectively and strategically foreign files its patent applications based on a number of economic and strategic factors related to the invention. +Trademarks +The Company has filed and obtained trademarks for its products including DPP®, SURE CHECK® and STAT-PAK® and also for the SampleTainer® used in certain DPP® products. The DPP® trademark is also registered under the European convention (ECT). +Trade Secrets and Know-How +We believe that we have developed a substantial body of trade secrets and know-how relating to the development and manufacture of lateral flow and DPP® based diagnostic tests, including but not limited to the sourcing and optimization of materials for such tests, and how to maximize sensitivity, speed-to-result, specificity, stability and reproducibility. The Company possesses proprietary know-how to develop tests for multiple conditions using colored latex. Our buffer formulations enable extremely long shelf lives of our rapid HIV and other tests and we believe that this provides us with an important competitive advantage. +Lateral Flow Technology and Reagent Licenses +As part of the agreements executed in 2006 with Alere for the marketing of our HIV tests, we were granted non-exclusive licenses to certain lateral flow patents for certain products manufactured and marketed by Chembio including but not limited to our lateral flow HIV tests. This license allows us to produce, market and sell assays using lateral flow technologies specifically including our STAT-PAK®, SURE CHECK®, DIPSTICK®, and veterinary product lines. Under this license agreement, we pay royalties to Alere ranging from 5% to 8½%, depending upon the country in which the products are sold. Even though the relevant patent has expired in most other jurisdictions, or were never issued in markets where we have sold these products, our manufacture of the products in the United States has required that we pay royalties under this license, which has been a substantial expense. In 2013 our lateral flow royalty expense to Alere was $822,000, and since 2007 we have incurred a total of $2.65 million in lateral flow royalty expenses. As of February 3, 2015 this royalty expense will no longer be payable as the applicable patent expires at that time. The license we have from Alere to their lateral flow patents will expand to include the barrel and cassette products in the United States, if we elect to sell those products under Chembio brands prior to the expiration of the applicable patent; that is until February of 2015. +Although we believe our DPP® is outside of the scope of all lateral flow patents of which we are aware, we consult with patent counsel, and seek licenses and/or redesigns of products that we believe to be in the best interests of the Company and our stockholders. Because of the costs and other negative consequences of time-consuming patent litigation, we often attempt to obtain a license on reasonable terms. Nevertheless there is no assurance that the Alere lateral flow patents we have licensed will not be challenged or that other patents containing claims relevant to the Company's lateral flow or DPP® products will not be granted to third parties and that licenses to such patents, will be available on reasonable terms, if any. In the past Alere has aggressively enforced its lateral flow intellectual property, although some of the main patents will expire within the next couple of years and we are not aware of any patent enforcement litigation that is ongoing with respect to the Alere lateral flow intellectual property. +Regardless, the DPP® technology provides us with our own intellectual property. We believe it provides us with a freedom to operate, and that it also enables tests to be developed with improved sensitivity as compared with comparable tests on lateral flow platforms. The Company has signed and anticipates signing new development projects based upon the DPP® technology that will provide new manufacturing and marketing opportunities. We have filed other patent applications that we believe will strengthen the DPP® intellectual property and have also filed for patent protection for certain other point-of-care technologies or applications thereof. +The peptides used in our rapid HIV tests were patented by Adaltis Inc. and were licensed to us under a 10-year non-exclusive license agreement dated August 30, 2002. However, in connection with Adaltis' bankruptcy, during the third quarter of 2009 we bought out all of our remaining obligations under that agreement. We also have licensed the antigens used in other tests including our Syphilis, Tuberculosis, Leptospirosis, Leishmaniasis and Chagas tests, and we may enter other license agreements. In prior years we concluded license agreements related to intellectual property rights owned by the United States associated with HIV- 1, and during the first quarter of 2008 we entered into a sub-license agreement for HIV-2 with Bio-Rad Laboratories N.A., the exclusive licensee of the Pasteur Institute's HIV-2 intellectual property estate. +15 +Corporate History +On May 5, 2004, we completed a merger with Trading Solutions, Inc. through which Chembio Diagnostic Systems Inc. became our wholly-owned subsidiary, and through which the management and business of Chembio Diagnostic Systems Inc. became our management and business. As part of this transaction, we changed our name to Chembio Diagnostics, Inc. +Since the formation of Chembio Diagnostic Systems Inc. in 1985, it has been involved in developing, manufacturing, selling and distributing in-vitro diagnostic tests, including rapid tests beginning in 1995, for a number of conditions in humans and animals. +On March 12, 2004, we implemented a 1-for-17 reverse split of our common stock. All references in this Form 10-K to shares of our common stock have been adjusted to reflect this reverse split. +In February 2010, Crestview Capital Master, L.L.C. ("Crestview Master"), a Delaware limited liability company that held 18,907,431 shares of Chembio's common stock, spun off all these shares, constituting approximately 30.5% of Chembio's outstanding shares, to its three equity holders. One of the three equity holders of Crestview Master immediately spun off, to its approximately 126 equity holders, all of the 12,990,569 shares of Chembio stock that it received in this distribution. As a result, as of February 24, 2010, Crestview Master no longer owned any shares. The former direct and indirect equity holders of Crestview Master owned all these shares, with none of these individual stockholders having beneficial ownership of more than 5.61% of the outstanding common stock of Chembio. +On May 30, 2012, the Company effected a 1-for-8 reverse split of its common stock. This was done to allow the Company to move to the NASDAQ trading market from the OTCQB market, which occurred on June 7, 2012. As a result of the stock split, the outstanding 63,967,263 common shares were reduced to 7,995,918 outstanding common shares on May 30, 2012. The effect of the reverse stock split has been retroactively reflected for all periods in these financial statement. +16 +Glossary +AIDS +Acquired Immunodeficiency Syndrome. AIDS is caused by the Human Immunodeficiency Virus, HIV. +ALGORITHM (parallel or serial) +For rapid HIV testing this refers both to method or protocol (in developing countries to date) for using rapid tests from different manufacturers in combination to screen and confirm patients at the point-of-care, and may also refer to the specific tests that have been selected by an agency or ministry of health to be used in this way. A parallel algorithm uses two screening tests from different manufacturers and a tie-breaker test only if there is a discrepancy between the screening tests results. A serial algorithm only uses a second confirmatory test if there is a positive result from the screening test, meaning that the number of confirmatory tests used is equal to the positivity rate in the testing venue. A tie-breaker test resolves discrepancies between the screen and the confirmatory test. +ANTIBODY +A protein which is a natural part of the human immune system produced by specialized cells to neutralize antigens, including viruses and bacteria that invade the body. Each antibody producing cell manufactures a unique antibody that is directed against, binds to and eliminates one, and only one, specific type of antigen. +ANTIGEN +Any substance which, upon entering the body, stimulates the immune system leading to the formation of antibodies. Among the more common antigens are bacteria, pollens, toxins, and viruses. +ANVISA +Anti-Retroviral Treatments for AIDS +The National Health Surveillance Agency of Brazil +ARVs +Anti-retroviral medications developed to fight AIDS +CDC +United States Centers for Disease Control and Prevention +CLIA waiver +Clinical Laboratory Improvement Act designation that allows simple tests to be performed in point-of-care settings such as doctor's offices, walk-in clinics and emergency rooms. +DIAGNOSTIC +Pertaining to the determination of the nature or cause of a disease or condition. Also refers to reagents or procedures used in diagnosis to measure proteins in a clinical sample. +EITF +Emerging Issues Task Force +FASB +Financial Accounting Standards Board +FIOCRUZ +The Oswaldo Cruz Foundation of Brazil +FDA +United States Food and Drug Administration +FDIC +Federal Deposit Insurance Corporation +FAS +Financial Accounting Standard +IgG +IgG or Immunoglobulin are proteins found in human blood. This protein is called an "antibody" and is an important part of the body's defense against disease. When the body is attacked by harmful bacteria or viruses, antibodies help fight these invaders. +NGO +Non-Governmental Organization +OTC +Over-the-Counter +PEPFAR +The President's Emergency Plan for AIDS Relief +PMA +Pre-Marketing Approval –FDA approval classification for a medical device that is not substantially equivalent to a legally marketed device or is otherwise required by statute to have an approved application. Rapid HIV tests must have an approved PMA application before marketing of such a product can begin. +PROTOCOL +A procedure pursuant to which an immunodiagnostic test is performed on a particular specimen in order to obtain the desired reaction. +REAGENT +A chemical added to a sample under investigation in order to cause a chemical or biological reaction which will enable measurement or identification of a target substance. +RETROVIRUS +A type of virus which contains the enzyme Reverse Transcriptase and is capable of transforming infected cells to produce diseases in the host such as AIDS. +SAB +Staff Accounting Bulletin +SENSITIVITY +Refers to the ability of an assay to detect and measure small quantities of a substance of interest. The greater the sensitivity, the smaller the quantity of the substance of interest the assay can detect. Also refers to the likelihood of detecting the antigen when present. +SPECIFICITY +The ability of an assay to distinguish between similar materials. The greater the specificity, the better an assay is at identifying a substance in the presence of substances of similar makeup. +USDA +U.S Department of Agriculture +WHO +World Health Organization +17 +ITEM 1A. +RISK FACTORS +You should carefully consider each of the following risk factors and all of the other information provided in this Annual Report. We currently believe that the risks described below may materially affect us. An investment in our Common Stock involves a high degree of risk, and should be considered only by persons who can afford the loss of their entire investment. +Risks related to our industry, business and strategy +Because we may not be able to obtain or maintain the necessary regulatory approvals for some of our products, we may not generate revenues in the amounts we expect, or in the amounts necessary to continue our business. Our existing products as well as our manufacturing facility must meet quality standards and are subject to inspection by a number of domestic regulatory and other governmental and non-governmental agencies. +All of our proposed and existing products are subject to regulation in the U.S. by the U.S. Food and Drug Administration, the U.S. Department of Agriculture and/or other domestic and international governmental, public health agencies, regulatory bodies or non-governmental organizations. In particular, we are subject to strict governmental controls on the development, manufacture, labeling, distribution and marketing of our products. The process of obtaining required approvals or clearances varies according to the nature of, and uses for, a specific product. These processes can involve lengthy and detailed laboratory testing, human or animal clinical trials, sampling activities, and other costly, time-consuming procedures. The submission of an application to a regulatory authority does not guarantee that the authority will grant an approval or clearance for that product. Each authority may impose its own requirements and can delay or refuse to grant approval or clearance, even though a product has been approved in another country. +The time taken to obtain approval or clearance varies depending on the nature of the application and may result in the passage of a significant period of time from the date of submission of the application. Delays in the approval or clearance processes increase the risk that we will not succeed in introducing or selling the subject products, and we may determine to devote our resources to different products. +Changes in government regulations could increase our costs and could require us to undergo additional trials or procedures, or could make it impractical or impossible for us to market our products for certain uses, in certain markets, or at all. +Changes in government regulations may adversely affect our financial condition and results of operations because we may have to incur additional expenses if we are required to change or implement new testing, manufacturing and control procedures. If we are required to devote resources to develop such new procedures, we may not have sufficient resources to devote to research and development, marketing, or other activities that are critical to our business. +We can manufacture and sell our products only if we comply with regulations and quality standards established by government agencies such as the FDA and the USDA as well as by non-governmental organizations such as the ISO and WHO. We have implemented a quality system that is intended to comply with applicable regulations. Although FDA approval is not required for the export of our products, there are export regulations promulgated by the FDA that specifically relate to the export of our products that require compliance with FDA quality system regulation (QSRs) and that also require meeting certain documentary requirements regarding the approval of the product in export markets. Although we believe that we meet the regulatory standards required for the export of our products, these regulations could change in a manner that could adversely impact our ability to export our products. +Our products may not be able to compete with new diagnostic products or existing products developed by well-established competitors, which would negatively affect our business. +The diagnostic industry is focused on the testing of biological specimens in a laboratory or at the point-of-care and is highly competitive and rapidly changing. Our principal competitors often have considerably greater financial, technical and marketing resources than we do. Several companies produce diagnostic tests that compete directly with our testing product line, including but not limited to, Orasure Technologies, Alere and Trinity Biotech. Furthermore these and/or other companies have or may have products incorporating molecular and/or other advanced technologies that over time could directly compete with our testing product line. As new products incorporating new technologies enter the market, our products may become obsolete or a competitor's products may be more effective or more effectively marketed and sold than ours. +Alere's planned introduction of a competing product in the U.S., as well as other competitors, could significantly reduce our U.S. sales. +We have granted Alere exclusive rights to market our SURE CHECK® HIV 1/2 in the United States and non-exclusive rights in the rest of the world and exclusive rights to market our HIV 1/2 STAT PAK® in the U.S. only. However Alere now has a "Permitted Competing Product" which, if it becomes CLIA waived and successfully launched, will be a significant competitive threat. While we have the option to terminate the Cassette Agreement and to convert Alere's rights under the Barrel Agreement to becoming non-exclusive, there are costs, risks and uncertainties associated with our doing this, particularly because we have not had a commercial organization in the U.S. market. If we were to assume the marketing of these products, we would retain that portion of the selling price of these products that Alere is now receiving, and we would have a potentially significant base of customers in the United States that are familiar with our products (although under Alere's trade names) and that could be introduced to Chembio and potentially to additional products to be marketed to them by Chembio. However, in that case we will incur costs not previously incurred related tos sales, marketing, distribution, and customer/technical support, and these costs are likely to be substantial. In addition, we would face the risk that a significant portion of these customers would not open accounts with us and would instead purchase competing products from Alere or other competitors. +18 +In 2006 Alere acquired a division from Abbott Diagnostic located in Japan that manufactured and marketed a rapid HIV test product line called Determine®. The Determine® format is was developed for developing world and remote settings and, central to the needs of that market, the format is essentially a test strip that is integrated into a thin foil wrapper that, when opened, the underside of the wrapper serves as the test surface for applying the blood sample and performing the test. This design reduces costs and shipping weights and volumes and is an advantage for the developing world markets it has served. Some of the disadvantages of the platform are the amount of blood sample that is needed (50 microliters versus 2.5, 5 and 10 for our lateral flow barrel, lateral flow cassette, and DPP® products respectively), the open nature of the test surface, and the absence of a true control that differentiates biological from other kinds of samples. +The so-called "3 rd generation" version of this product has been marketed for many years and is the leading rapid HIV test that is used in a large majority of the national algorithms of countries funded by PEPFAR and the Global Fund, as well as many other countries in the world. That product is not FDA-approved though it is CE marked. The newest Determine® HIV version, which was developed and manufactured at Alere's subsidiary in Israel, Orgenics, is the so-called "4 th Generation" version Determine® test. According to its claims, this product detects HIV antibodies and P24 HIV antigens. Since the P24 antigen is known to occur in HIV-positive individuals' blood samples before antibodies do, based on its performance claims, the 4 th generation Determine® test is therefore able to detect HIV infection earlier than tests that solely rely on antibody detection. Chembio's tests, as well as all of the other currently FDA-approved rapid HIV tests, only detect antibodies. There are however laboratory tests that are FDA-approved that are "4th generation" tests, but they are of course neither rapid nor point-of-care. +The initial "4 th generation" Alere Determine® rapid test product that was also CE marked and that Alere launched internationally some years ago has not been successfully commercialized to the best of our knowledge and at least certain published studies were not favorable for this product. However the 4 th generation product that is now FDA-approved was apparently modified as compared to the initial international version of it, and it may perform more satisfactorily. Alere received FDA approval of this modified product in August 2013 and is seeking CLIA-waiver for it. Alere is also aggressively pursuing development of the market for this product in anticipation of receiving CLIA waiver. Although the product can now be sold to moderate complexity certified laboratories, there is very limited supply of the product thus far, and there is no assessment thus far concerning the actual performance of this product in the hands of customers. We believe the price that Alere is charging for this product is substantially higher than our and our competitors' antibody tests, as the antigen claim avails some customers of an additional reimbursement code. Moreover there is support by a number of key opinion leaders for the public health value of such 4th generation tests, and if Alere is able to successfully launch this product, it represents a significant competitive threat to Chembio as well as to each of the other rapid HIV test manufacturers (Orasure and Trinity primarily). +During 2011 Biolytical, Inc. of Vancouver, Canada received FDA approval and in 2012 received CLIA waiver of a flow-through rapid HIV test called "INSTI". The technology used in the INSTI test, flow-through, is older than lateral flow, and it requires handling of multiple components (3 vials of solution) to perform the test in multiple steps. However, these steps can be accomplished in less than ten minutes, and the actual test results occur in only one minute after those steps are completed. Therefore sample-to-result time is shorter than any of the competitive products. The product also has good performance claims. There are settings where that reduced total test time, despite the multiple steps required, may be a distinct advantage, and we believe Biolytical has made some progress in penetrating certain public health markets. +Therefore, even though our lateral flow products currently enjoy a substantial market share in the U.S. rapid HIV test market of approximately 30%, and we have an additional rapid HIV test, the DPP® HIV 1/2 Assay, there a number of risks and uncertainties concerning current and anticipated developments in this market. Although we have no specific knowledge of any other new product that is a significant competitive threat to our product, or that will render our products obsolete, if we fail to maintain and enhance our competitive position or fail to introduce new products and product features, our customers may decide to use products developed by our competitors, which could result in a loss of revenues and cash flow. +More generally, the point-of-care diagnostics industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. As new technologies become introduced into the point-of-care diagnostic testing market, we may be required to commit considerable additional efforts, time and resources to enhance our current product portfolio or develop new products. We may not have the available time and resources to accomplish this, and many of our competitors have substantially greater financial and other resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers, which would materially harm our operating results. +Although we own our DPP® patent, lateral flow technology is still a competitive platform to DPP®, and lateral flow technology has a lower cost of manufacture than DPP® products. Although the DPP® platform has shown improved sensitivity as compared with conventional lateral flow platforms in a number of studies, several factors go into the development and performance attributes of products. Therefore the ability of our products to successfully compete will depend on several other factors including but not limited to our having a patented rapid test platform technology, that differentiate DPP® from lateral flow as well as from other diagnostic platform technologies. +19 +We believe that our Dual Path Platform® is outside of the scope of currently issued patents in the field of lateral flow technology, thereby offering the possibility of a greater freedom to operate. However there can be no assurance that our patents or our products incorporating the patent claims will not be challenged at some time in the future. +New developments in health treatments or new non-diagnostic products may reduce or eliminate the demand for our products. +The development and commercialization of products outside of the diagnostics industry could adversely affect sales of our products. For example, the development of a safe and effective vaccine to HIV or treatments for other diseases or conditions that our products are designed to detect, could reduce, or eventually eliminate the demand for our HIV or other diagnostic products and result in a loss of revenues. +We may not have sufficient resources to effectively introduce and market our products, which could materially harm our operating results. +Introducing and achieving market acceptance for our rapid HIV tests and other new products will require substantial marketing efforts and will require us and/or our contract partners, sales agents, and/or distributors to make significant expenditures of time and money. In some instances we will be significantly or totally reliant on the marketing efforts and expenditures of our contract partners, sales agents, and/or distributors. If they do not have or commit the expertise and resources to effectively market the products that we manufacture, our operating results will be materially harmed. +The success of our business depends on, in addition to the market success of our products, our ability to raise additional capital through the sale of debt or equity or through borrowing, and we may not be able to raise capital or borrow funds on attractive terms and/or in amounts necessary to continue our business, or at all. +We have been profitable for five consecutive years. Nevertheless, prior to 2009 we sustained significant operating losses since 2004, and we have incurred operating losses during certain quarterly periods, as recently as the fourth quarter of 2013. At December 31, 2013, we had a stockholders' equity of $20.3 million and a working capital surplus of $14.0 million . The Company estimates that its resources are sufficient to fund its needs through the end of 2014 and beyond, particularly due to the fact that it issued new common shares in 2013 in an equity financing that resulted in net proceeds to the company of approximately $5.4 million. Nevertheless we may have to make significant financial commitments to invest in a sales and marketing organization, regulatory approvals, research and development including new technologies, and production capacity. +The Company's liquidity and cash requirements will depend on several factors. These factors include (1) the level of revenues; (2) the extent to which, if any, that revenue level improves operating cash flows; (3) the Company's investments in research and development, facilities, marketing, regulatory approvals, and other investments it may determine to make; and (4) the Company's investment in capital equipment and the extent to which it improves cash flow through operating efficiencies. There are no assurances that the Company will remain profitable or generate positive cash flow in 2014 or, in the alternative, be successful in raising sufficient capital to fund its needs after 2014. +We experienced an increase in revenues in 2013, though this increase was primarily attributable to a single purchase order in the approximate amount of $5.3 million that we received from a leading international procurement organization on behalf of a large screening initiative that was being undertaken by one country. Increased sales to Alere and increased non-product revenues attributable to sponsored research and development programs also contributed to our increased revenues in 2013. +In order for our 2014 revenues to be at the same level as in 2013, or increase from that level, we would need for the large international purchase order to be renewed, or to be able to replace this purchase order with other revenues from other customers. There can be no assurance that this will occur. A similar situation occurred in 2013 when we experienced a significant decrease in our revenues from FIOCRUZ, and we were able to more than offset this decrease with the above-mentioned purchase order. Nevertheless there can be no assurance that we will have a repeat in 2014 of the large order received in 2013, or that we will be able to replace it with other revenues from other sources. +Moreover, our U.S. market sales will be difficult to predict in 2014 given the anticipated introduction of a new rapid test by Alere, and the uncertainty as to whether or to what extent it will be successful in cannibalizing sales of our products, regardless of whether we modify or terminate our agreements with Alere. If we terminate our cassette agreement with Alere and/or if we convert the barrel agreement to a non-exclusive agreement with Alere, we would expect to experience higher average revenue per unit for the associated products due to the fact that, under the Cassette Agreement and the Barrel Agreement, we currently sell these products to Alere at a significantly lower price than the price at which Alere then resells to customers (including re-sellers and distributors) in the United States. However this could only occur after any inventory that Alere has accumulated of our products is run off, which may take several months. Moreover, Alere could heavily discount these products, although we don't believe it is in Alere's interest to do so. In addition, if we are marketing either or both of these products we will incur substantial costs associated with establishing a sales and marketing organization for these products and in establishing channel distribution partners. Finally, we would need to pay a royalty of 8.5% to Alere on sales of these products in the United States for the duration of the relevant lateral flow patent, which is until February 2015. +20 +We believe that underlying demand for HIV rapid testing in the United States remains strong, and that the restoration of some of the funding cutbacks from sequestration and the implementation of the Affordable Care Act and of the United States Preventive Services Task Force recommendations will have a positive impact on the development of the market. Further, Chembio's products are well established and relied upon by a large installed base of customers over many years of use in the U.S. global market, and we believe this is a strong advantage. We also believe that upon attainment of CLIA waiver, of which there can be no assurance, that our DPP® HIV 1/2 Assay for use with oral fluid or bloods samples will be able to address new customers that were previously not available to Chembio with its lateral blood tests marketed by Alere. However the timing of the CLIA waiver has been delayed and it cannot be assured, and development of new customers with this product is costly and time-consuming. Finally, we believe that short-term reductions in sales attributable to sales by Alere of inventory already purchased from Chembio will eventually be offset by stocking orders placed by certain distributors, although there can be no assurance of this. +We are attempting to increase international sales of our products, and we have invested in additional resources in connection with this effort; but as we have experienced for many years, the nature of our international business is such that it can be volatile from period to period, depending on ordering patterns of donor-funded programs. +Furthermore, a number of factors can slow or prevent sales increases or cause sales decreases, or substantially increase the cost of achieving sales assuming they are achieved: +· +economic conditions and the absence of or reduction in available funding sources; +· +regulatory requirements and customs regulations; +· +cultural and political differences; +· +foreign exchange rates, currency fluctuations and tariffs; +· +dependence on and difficulties in managing international distributors or representatives; +· +the creditworthiness of foreign entities; +· +difficulties in foreign accounts receivable collection; +· +competition; +· +pricing; and +· +any inability we may have in maintaining or increasing revenues. +If we are unable to maintain or increase our revenues from domestic and/or international customers our operating results will be materially harmed. +21 +Although we have an ethics and anti-corruption policy in place, and have no knowledge or reason to know of any practices by our employees, agents or distributors that could be construed as in violation of such policies, our business includes sales of products to countries where there is or may be widespread corruption. +Chembio has a policy in place prohibiting its employees, distributors and agents from engaging in corrupt business practices, including activities prohibited by the United States Foreign Corrupt Practices Act (FCPA). Nevertheless, because we work through independent sales agents and distributors (and do not have any employees or subsidiaries) outside the United States, we do not have control over the day-to-day activities of such independent agents and distributors. In addition, in the donor- funded markets in Africa where we sell our products, there is significant oversight from PEPFAR, the Global Fund, and advisory committees comprised of technical experts concerning the development and establishment of national testing protocols. This is a process that includes an overall assessment of a product which includes extensive product performance evaluations including five active collaborations and manufacturer's quality systems, as well as price and delivery. In Brazil where we have had a total of six product collaborations with FIOCRUZ, those programs that our products are or may be deployed in are all funded by the Brazilian Ministry of Health. Although FIOCRUZ is affiliated with the Brazilian Ministry of Health, and is its sole customer, FIOCRUZ is not the exclusive supplier for the Ministry of Health. However because each of our collaborations with FIOCRUZ incorporates a technology transfer aspect, we believe we have a competitive advantage versus other suppliers to the Brazilian Ministry of Health, assuming other aspects of our product offering through FIOCRUZ are otherwise competitive in comparison. We have no knowledge or reason to know of any activities by our employees, distributors or sales agents of any actions which could be in violation of the FCPA, although there can be no assurance of this. +We rely on trade secret laws and agreements with our key employees and other third parties to protect our proprietary rights, and we cannot be sure that these laws or agreements adequately protect our rights. +We believe that factors such as the technological and creative skills of our personnel, strategic relationships, new product developments, frequent product enhancements and name recognition are essential to our success. All our management personnel are bound by non-disclosure agreements. If personnel leave our employment, in some cases we would be required to protect our intellectual property rights pursuant to common law theories which may be less protective than provisions of employment, non-competition or non-disclosure agreements. +We seek to protect our proprietary products under trade secret and copyright laws, enter into license agreements for various materials and methods employed in our products, and enter into strategic relationships for distribution of the products. These strategies afford only limited protection. We currently have some foreign patents issued, and we are seeking additional patent protection in several other foreign jurisdictions for our DPP® technology. We have licenses to reagents (antigens and peptides) used in several of our products and products under development. Despite our efforts to protect our proprietary assets, and respect the intellectual property rights of others, we participate in several markets where intellectual property rights protections are of little or no value. This can place our products and our company at a competitive disadvantage. +Despite efforts we make to protect our confidential information, such as entering confidentiality agreements in connection with new business opportunities, unauthorized parties may attempt to copy aspects of our products or to obtain information that we regard as proprietary. We may be required to expend substantial resources in asserting or protecting our intellectual property rights, or in defending suits related to intellectual property rights. Disputes regarding intellectual property rights could substantially delay product development or commercialization activities because some of our available funds would be diverted away from our business activities. Disputes regarding intellectual property rights might include state, federal or foreign court litigation as well as patent interference, patent reexamination, patent reissue, or trademark opposition proceedings in the U.S. Patent and Trademark Office. +To facilitate development and commercialization of a proprietary technology base, we may need to obtain additional licenses to patents or other proprietary rights from other parties. Obtaining and maintaining these licenses, which may not be available, may require the payment of up-front fees and royalties. In addition, if we are unable to obtain these types of licenses, our product development and commercialization efforts may be delayed or precluded. +22 +Our continued growth depends on retaining our current key employees and attracting additional qualified personnel, and we may not be able to do so. +Our success will depend to a large extent upon the skills and experience of our executive officers, management and sales, marketing, operations and scientific staff. We may not be able to attract or retain qualified employees in the future due to the intense competition for qualified personnel among medical products businesses, geographic considerations, our ability to offer competitive compensation, relocation packages, benefits, and/or other reasons. +If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will adversely affect our ability to effectively manufacture, sell and market our products to meet the demands of our strategic partners in a timely fashion, or to support internal research and development programs. Although we believe we will be successful in attracting and retaining qualified personnel, competition for experienced scientists and other personnel from numerous companies and academic and other research institutions may limit our ability to do so on acceptable terms. +We have entered into employment contracts with our Chief Executive Officer and President, Lawrence Siebert, our Chief Operating Officer Sharon Klugewicz and our Senior Vice President of Research and Development, Javan Esfandiari. Due to the specific knowledge and experience of these executives regarding the industry, technology and market, the loss of the services of any one of them could have a material adverse effect on the Company. The contract with Ms. Klugewicz has a term of two years ending May 2015. The contract with Mr. Esfandiari has a term of three years ending March 2016. The Company has obtained a key man insurance policy on Mr. Esfandiari. The contract with Mr. Siebert provides that Mr. Siebert will serve as the Chief Executive Officer and President of the Company through May 11, 2014, and Mr. Siebert has advised the Company that he intends to retire from the Company on or before that date. Upon Mr. Siebert's announcement in 2013, of his retirement plans, the Company began a search for a new CEO. +We believe our success depends in part on the continued funding of and our ability to participate in large testing programs in the U.S. and worldwide. Funding of these and or similar programs may be reduced, discontinued and/or we may not be able to participate for other reasons. +We believe it to be in our best interests to meaningfully participate in large testing programs. Moreover many of these programs are funded by governments and other donors, and there can be no assurance that funding will not be reduced or completely discontinued. Participation in these programs also requires alignment and engagement with the many other participants in these programs, including the World Health Organization, U.S. Center for Disease Control, U.S. Agency for International Development, foreign governments and their agencies, non-governmental organizations, and HIV service organizations. If we are unsuccessful in our efforts to participate in these programs, our operating results could be materially harmed. +In December 2013 President Obama signed into law the PEPFAR Stewardship and Oversight Act, which is the most recent reauthorization of PEPFAR. However, unlike the 2008 PEPFAR authorization, which authorized approximately $45 billion, the new law doesn't authorize a specific dollar amount for funding. Nevertheless it is widely anticipated that PEPFAR will continue to enjoy strong funding; the FY14 budget has $6 billion for global HIV/AIDS assistance, including $4 billion for PEPFAR. +Although we were profitable in 2009, 2010, 2011, 2012 and 2013, we cannot be certain that we will be able to sustain profitability in 2014. +From the inception of Chembio Diagnostic Systems, Inc. in 1985 through the period ended December 31, 2008, we incurred net losses, and we have only become profitable during the last five years. In 2014, we expect to make substantial expenditures for sales and marketing, regulatory submissions, product development, and production and warehouse capacity and other purposes. Without a substantial increase in revenues, this will impact profitability at least in the short term. Our ability to continue profitability in the future will primarily depend on our ability to increase sales of our products based on having made the aforementioned expenditures to reduce production and other costs, and to successfully introduce new products and enhanced versions of our existing products into the marketplace. If we are unable to increase our revenues at a rate that is sufficient to achieve profitability, or adequately control and reduce our operating costs, our operating results would be materially harmed. +To the extent that we are unable to obtain sufficient product liability insurance or that we incur product liability exposure that is not covered by our product liability insurance, our operating results could be materially harmed. +We may be held liable if any of our products, or any product which is made with the use or incorporation of any of the technologies belonging to us, causes injury of any type or is found otherwise unsuitable during product testing, manufacturing, marketing, sale or usage. We have obtained product liability insurance even though we have never received a product liability claim, and have generally not seen product liability claims for screening tests that are accompanied by appropriate disclaimers. Nevertheless, in the event there is a claim, this insurance may not fully cover our potential liabilities. In addition, as we attempt to bring new products to market, we may need to increase our product liability coverage which could be a significant additional expense that we may not be able to afford. If we are unable to obtain sufficient insurance coverage at an acceptable cost to protect us, we may be forced to abandon efforts to commercialize our products or those of our strategic partners, which would reduce our revenues. +23 +Risks related to our Common Stock +Our Common Stock continues to be illiquid, so investors may not be able to sell as much stock as they want at prevailing market prices. +The average daily trading volume of our Common Stock on the NASDAQ market was 50 ,000 shares per day over the three months ended March 1, 2014 as compared to less than 44,000 shares per day over the three months ended March 1, 2013. Therefore, there has been consistency in the liquidity of our stock based on this comparison, and our stock began trading on NASDAQ in early June, 2012. However, improvements in the liquidity of our stock depends on several factors, including but not limited to the financial results of the Company and overall market conditions, so there can be no assurance that this improvement will continue, or even be maintained. +Decreased trading volume in our stock would make it more difficult for investors to sell their shares in the public market at any given time at prevailing prices. +Our management and larger stockholders exercise significant control over our Company. +As of March 3, 2014, our named executive officers, directors and 5% stockholders beneficially owned approximately 14.6 % of our voting power. In addition, we have two large institutional investors that beneficially owned 7.2% and 4.8%, respectively of the stock. For the foreseeable future, and assuming these ownership percentages continue to pertain, to the extent that these parties vote similarly, they may be able to exercise significant control over many matters requiring approval by the board of directors or our stockholders. As a result, they may be able to: +· +control the composition of our board of directors; +· +control our management and policies; +· +determine the outcome of significant corporate transactions, including changes in control that may be beneficial to stockholders; and +· +act in each of their own interests, which may conflict with, or be different from, the interests of each other or the interests of the other stockholders. +24 +ITEM 2. +PROPERTIES +Our manufacturing, administrative offices and research facilities are located in Medford, New York. In addition we have warehousing space as well as some additional administrative offices located in Holbrook, New York. We lease approximately 39,660 square feet of industrial space in Medford for $27,305 per month. The space is utilized for research and development activities (approximately 4,160 square feet), offices (approximately 3,100 square feet) and production (approximately 32,400 square feet). The lease term expires on April 30, 2017. The lease provides for annual increases of two and one half percent each year starting May 1, 2015. We lease approximately 21,450 square feet of industrial space in Holbrook for $14,657 per month. The space is utilized for offices (approximately 2,500 square feet) and warehousing (approximately 18,950 square feet). The lease term expires on April 30, 2018. The lease provides for annual increases of three percent each year starting March 1, 2015. The Company believes this space should be sufficient for its needs in the foreseeable future. +ITEM 3. +LEGAL PROCEEDINGS +From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. We know of no material, existing or pending legal proceedings against us, nor are we involved as a plaintiff in any material proceeding or pending litigation. There are no proceedings in which any of our directors, officers or affiliates, or any registered or beneficial shareholder, is an adverse party or has a material interest that is adverse to our interest. +ITEM 4. +MINE SAFETY DISCLOSURES +Not Applicable. +PART II +ITEM 5. +MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Our stock is quoted on the NASDAQ, under the symbol "CEMI." Prior to June 8, 2012, our stock was quoted on the OTCQB and prior to February 24, 2011 on the OTC Bulletin Board. On May 30, 2012, a reverse split was effected at a ratio of 8 for 1. The table below sets forth the high and low bid prices per share of our common stock for each quarter of our two most recently completed fiscal years. Quarters prior to June 2012 were adjusted for the split. These prices represent inter-dealer quotations without retail markup, markdown, or commission and may not necessarily represent actual transactions. +Fiscal Year 2013 +High Bid +Low Bid +First Quarter +$ +5.75 +$ +4.61 +Second Quarter +$ +5.10 +$ +4.10 +Third Quarter +$ +5.32 +$ +3.00 +Fourth Quarter +$ +3.95 +$ +3.19 +Fiscal Year 2012 +High Bid +Low Bid +First Quarter +$ +4.08 +$ +3.12 +Second Quarter +$ +4.96 +$ +3.52 +Third Quarter +$ +5.30 +$ +4.11 +Fourth Quarter +$ +5.80 +$ +3.61 +On May 30, 2012, the Company undertook an 8-for-1 reverse stock split in order to have a stock price sufficient to qualify for listing on NASDAQ, which occurred on June 7, 2012. +Holders +As of March 1, 2014, there were approximately 149 record owners of our common stock. +Dividends +The Company has never paid cash dividends on its common stock and has no plans to do so in the foreseeable future. +Recent Sales of Unregistered Securities +Not applicable. +25 +ITEM 6. +SELECTED FINANCIAL DATA +Presented in this table are selected financial data for the past five years ended December 31, 2013. +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARIES +SELECTED HISTORICAL FINANCIAL DATA +As of and For the Years Ended +Statement of Operations Data: +December 31, 2013 +December 31, 2012 +December 31, 2011 +December 31, 2010 +December 31, 2009 +TOTAL REVENUES +$ +29,549,609 +$ +25,610,595 +$ +19,388,036 +$ +16,704,703 +$ +13,834,248 +GROSS MARGIN +12,300,159 +42 +% +10,789,991 +42 +% +9,390,303 +48 +% +8,100,699 +48 +% +5,860,405 +42 +% +OPERATING COSTS: +Research and development expenses +5,834,249 +20 +% +4,486,302 +18 +% +4,878,119 +25 +% +2,586,308 +15 +% +2,883,696 +21 +% +Selling, general and administrative expenses +5,461,083 +18 +% +4,851,587 +19 +% +3,424,297 +18 +% +2,940,721 +18 +% +2,659,382 +19 +% +11,295,332 +9,337,889 +8,302,416 +5,527,029 +5,543,078 +INCOME FROM OPERATIONS +1,004,827 +1,452,102 +1,087,887 +2,573,670 +317,327 +OTHER INCOME (EXPENSES): +12,943 +(1,584 +) +(12,325 +) +(14,503 +) +(8,267 +) +INCOME BEFORE INCOME TAXES +1,017,770 +3 +% +1,450,518 +6 +% +1,075,562 +6 +% +2,559,167 +15 +% +309,060 +2 +% +Income tax (benefit) provision +486,952 +509,237 +(5,133,229 +) +- +- +NET INCOME +$ +530,818 +$ +941,281 +$ +6,208,791 +$ +2,559,167 +$ +309,060 +Basic income per share +$ +0.06 +$ +0.12 +$ +0.79 +$ +0.33 +$ +0.04 +Diluted income per share +$ +0.06 +$ +0.11 +$ +0.73 +$ +0.29 +$ +0.03 +Weighted average number of shares outstanding, basic +8,994,080 +7,986,030 +7,874,807 +7,762,858 +7,743,304 +Weighted average number of shares outstanding, diluted +9,519,968 +8,614,944 +8,556,284 +8,865,114 +9,380,242 +Balance Sheet Data: +Working capital +$ +14,221,011 +$ +7,630,368 +$ +6,133,956 +$ +4,560,277 +$ +1,493,970 +Total assets +24,486,592 +17,335,150 +15,485,744 +9,086,174 +6,315,250 +Total liabilities +4,309,490 +3,460,630 +2,991,110 +3,277,230 +3,227,336 +Shareholders' equity +20,177,102 +13,874,520 +12,494,634 +5,808,944 +3,087,914 +26 +ITEM 7. +MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +Overview +This discussion and analysis should be read in conjunction with the accompanying Consolidated Financial Statements and related notes. Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of any contingent liabilities at the financial statement date and reported amounts of revenue and expenses during the reporting period. On an ongoing basis, we review our estimates and assumptions. Our estimates are based on our historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results are likely to differ from those estimates under different assumptions or conditions, but we do not believe such differences will materially affect our financial position or results of operations. Our critical accounting policies, the policies we believe are most important to the presentation of our financial statements and require the most difficult, subjective and complex judgments, are outlined below in ''Critical Accounting Policies,'' and have not changed significantly. +In addition, certain statements made in this report may constitute "forward-looking statements". These forward-looking statements involve known or unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. These factors include, among others, 1) our ability to obtain necessary regulatory approvals for our products; and 2) our ability to increase revenues and operating income, which is dependent upon our ability to develop and sell our products, general economic conditions, demand for our products, and other factors. You can identify forward-looking statements by terminology such as "may," "could", "will," "should," "expects," "intends," "plans," "anticipates," "believes," "estimates," "predicts," "potential," "continues" or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business. +All of the Company's future products that are currently being developed are based on its patented Dual Path Platform (DPP®), which is a unique diagnostic point-of-care platform that has certain advantages over lateral flow technology. The Company has completed development of several products that employ the DPP® technology which will be marketed under Chembio's label or pursuant to private label license or distribution agreements such as those with FIOCRUZ, Labtest, RVR and Bio-Rad. +The Company has had very active research and development programs and has significantly increased its spending on research and development during the last three years. Third-party funding from research and development contracts and grants have offset a significant portion of these increased research and development expenses. Moreover these collaborations have resulted in significant third party validations of our DPP® technology and an increasing capability to develop, manufacture, validate, and improve current and future DPP® products and product features. +The Company has a number of products under development that employ the DPP® technology. These product development activities are further described below. +DPP® HIV Multiplex Antigen-Antibody "Fourth Generation" Test - Development work continues on a DPP® HIV multiplex test that is being designed to detect acute (early stage) HIV infection by means of detecting P24 antigen, as well as antibodies, to HIV1/2, in whole blood samples. Recently the FDA approved the first point-of-care test that claims to detect acute HIV infection, and there are also two FDA-approved laboratory tests with such claims. The point-of-care test approved by the FDA, manufactured in Israel by a subsidiary of Alere, is called Determine® HIV Ag/Ab Combo. This test, which Alere has reported is now undergoing CLIA waiver studies, claims earlier detection due to the ability to detect unbound p24 antigen. We believe that our development of such a test, combined with our patented DPP® point-of-care platform may better help identify HIV infections that cannot be identified by any of the currently FDA-approved rapid HIV tests, including the new Alere Determine test. Such a test may serve an unmet market need, and may help to maintain and potentially grow the already strong position Chembio's products have in the U.S. rapid HIV test market. We are in an early stage of design development of this product including feasibility to meet or exceed the target specifications of product that is commercially available on the market. +27 +DPP® Hepatitis-C (HCV) – Development work on our DPP® HCV point-of-care rapid test continues. Our development activity has been focused on creating a differentiated product that is at least capable of identifying antibody response in a more comprehensive manner than the currently available point-of-care test is able to do. +In July 2012, the U.S. Centers for Disease Control finalized the recommendations for testing all individuals in the United States born between the years of 1945 and 1965 for HCV, which age cohort represents a substantial portion of the estimated over three million individuals in the United States that are infected with HCV infection, but unaware of their status. With a number of new anti-retroviral therapies approved, and even more anticipated pending approval in the years ahead by the FDA, we believe that over time, these new recommendations will be implemented. In fact, in May the United States Preventive Services Task Force revised its November 2012 recommendations to endorse the CDC recommendations by giving both hepatitis-C (HCV) screening for at-risk individuals and age-cohort screening a 'B' grade; under the Affordable Care Act, preventive services that have received an 'A' or 'B' grade from the USPSTF must be covered by insurance policies without cost-sharing, and be part of the essential health benefits for those individuals eligible for Medicare. +We plan to complete development activities of the antibody detection assay in 2014, and to begin activities to commercialize product, including regulatory submission, in the US by the end of 2015 or early 2016. +International Distribution & Manufacturing Agreements – +Labtest +In 2013 the Company entered into an international assembly and distribution agreement with Labtest Diagnostica SA (Labtest), a leading diagnostics manufacturer and marketing organization based in Brazil, for products based upon Chembio's patented Dual Path Platform® (DPP ®) in Brazil and potentially other markets outside the U.S. +Pursuant to the agreement, upon receipt of an order from, Chembio will manufacture and sell certain specialized test components to Labtest and also will receive a royalty based on sales by Labtest of DPP ® products. Labtest will produce certain reagents and perform assembly and packaging operations in a dedicated space at Labtest's manufacturing facilities near Belo Horizonte, Brazil. Chembio will provide Labtest with the training necessary to perform the operations specific to the DPP ® products. Labtest will also have responsibility for marketing, promotion and distribution of the products in Brazil. +All products will be marketed under brand names that will include Chembio's DPP ® trademark together with trade names selected by Labtest, and each test kit will state that Chembio Diagnostic Systems, Inc. is the licensor of the DPP ® trademark and technology. The products selected for inclusion in this agreement will address both private as well as public health markets, and will enable Chembio to participate in significant market opportunities in Brazil. This agreement addresses market opportunities that are independent of those addressed by Chembio's ongoing collaboration with the Oswaldo Cruz Foundation. +Labtest is installing the assembly equipment that it received during the fourth quarter so that it can begin product validation and registration activities for an initial group of infectious disease products with sales expected to commence in 2015. The agreement contemplates additional products and territories to be added by mutual agreement. In addition, the agreement offers the possibility for Labtest to assemble products for other global Chembio customers as a contract manufacturer. +Sponsored Research & Development +Multiplex Influenza Immunity Test – +As a result of pandemic planning activities, the United States Department of Health and Human Services and the CDC have identified POC and high-throughput testing as a gap in influenza diagnostics. Rapid responses in the field — such as the vaccination, prophylactic treatment or isolation of patients — require POC diagnostic tests for influenza infection and immunity. Ideally, these tests should be fast, portable, self-contained and non-technical. Development of this test is especially critical for the military, as evidenced by previous influenza outbreaks that spread rapidly through densely populated barracks and killed thousands of soldiers. +Further to this identified gap in influenza diagnostics, in 2013 the Company entered into a follow-on, milestone-based development agreement with the private contracting organization that is engaged to enter into, implement and provide technical oversight of agreements relating to pandemic influenza preparedness on behalf of its client, the United States Centers for Disease Control and Prevention (CDC), for a multiplex, rapid, POC influenza immunity test utilizing Chembio's patented Dual Path Platform® (DPP®) technology. The objective of this follow-on project is to further develop a rapid influenza immunity test that can determine a person's influenza immunity status in the field or in an outpatient setting, while incorporating certain additional subunits of influenza virus proteins. The follow-on agreement was for up to approximately $472,000 and was completed during the first quarter of 2014. New prototypes have been delivered to our customer and we are waiting for next steps. +28 +DPP® Febrile Illness Multiplex test – During 2013 we entered into a cooperative research project agreement with a U.S. government agency for up to $750,000 for an eight-month development project. The project is to develop a rapid POC diagnostic test for five infectious diseases associated with febrile illness and to multiplex them into one assay. The project also contemplates that the test would be optimized for use with a mobile reader that incorporates cell phone technology to enable the results to be recorded, transmitted and monitored remotely via a cloud system, in real-time. This research project supports our efforts in developing multiplex products using our proprietary DPP ® technology. Our DPP ® technology, when combined with the mobile reader being used in the project, will enable real time data collection and monitoring capabilities. As these infectious diseases can all exhibit similar clinical symptoms, a rapid multiplex test that could distinguish them would be very useful, particularly in field conditions, so that correct diagnosis and treatment could be provided on a timely basis. We completed R&D activities for this project during 2013, including supplying the U.S. government agency that this test was developed for with approximately 10,000 prototype devices for clinical trials. +DPP® Tuberculosis – In 2011, we were awarded a three-year, $2.9 million, Small Business Innovative Research (SBIR) Phase II grant from the United States National Institutes of Health (NIH) to continue our successful Phase I grant work to develop a simple, rapid, accurate, and cost-effective serological test for active tuberculosis that can be utilized in resource-limited settings. During 2012, several additional antigens were identified to enhance antibody detection by the DPP® test prototype designed in our Phase I studies. Antigen reagents have been finalized and test prototype evaluation using well-characterized clinical specimens is in progress. Funding for the third and final year of this Phase II grant was confirmed with a reduction of approximately 1%. Chembio's work to finalize DPP assay design using various fusion proteins has been completed and production of an evaluation lot is in progress; these tests will be used for verification studies, internal and external evaluations at the selected collaborative sites (see below), QC protocol validation, and accelerated stability study. The target sensitivity is 80% and specificity is 95%. Study sites for external evaluations of DPP assay include Bangladesh, Brazil, China, Haiti, Peru, Venezuela, and South Africa. The grant is expected to be completed by early July 2014. +In addition to the above-mentioned research and development work sponsored by governmental agencies and/or their contractors for the influenza, febrile illnesses, and tuberculosis projects, we are discussing additional opportunities for sponsored research and development activity. We endeavor to select sponsored research projects where we believe there is an identifiable commercial opportunity and/or where other benefits to the Company are anticipated in connection with these projects. +In general, we are considering certain new DPP® product opportunities, either as OEM development projects and/or as Chembio-branded products. These products are being identified based upon our assessment of opportunities in the market and upon whether they can be addressed with our proprietary technology, along with our development and manufacturing capabilities and experience. We are also identifying and assessing additional technologies that we believe can enhance or expand our current product portfolio, and thereby provide additional revenue streams, although there is no assurance that we will be able to obtain or utilize any of them profitably. +Regulatory Activities +CE Mark for FDA-Approved HIV Tests – The Company's SURE CHECK® HIV 1/2 Assay has received CE Mark approval from European regulators and is therefore now cleared for commercialization within the European Union (EU) for rapid, point-of-care detection of HIV. Chembio is currently working with commercialization partners in Europe. We expect that our HIV 1/2 STAT PAK® lateral flow HIV test will receive the CE mark during the first quarter of 2014. We anticipate that the DPP® HIV 1/2 test will receive CE Mark approval in early 2014. +FDA Approval for DPP® HIV 1/2 Assay for Use with Oral Fluid or Blood Samples – We received FDA approval of our Pre-Marketing Application (PMA) for this product on December 19, 2012 as we previously announced. The CLIA waiver application was submitted at the end of November 2013. In February 2014 we received a letter from the FDA on the current status of review of our CLIA waiver application. The FDA determined that additional information is needed to complete their review of the Company's DPP® HIV 1/2 Assay CLIA waiver application. During the blinded prospective clinical study, a disproportionate number of new infections were found at one clinical site due to the lower than expected prevalence at two other sites. We are currently in discussion with the FDA to finalize the protocol to collect additional data. Upon receiving guidance on our proposed protocol, we anticipate that we will be able to update the timeline of activities for the CLIA waiver of the DPP HIV1/2 Assay. +DPP® HIV-Syphilis – We have developed this product for international and US marketing. For the international market, the product has been registered in Mexico. We have submitted this product both for evaluation by the CDC, acting on behalf of the United States Agency of International Development, and the WHO, which has accepted this product to be evaluated for pre-qualification in its global procurement scheme. +29 +The FDA review timeline for this product, which we originally anticipated would be in mid-2014, has now been shifted to late 2014, with CLIA waiver now anticipated in 2015. This development is due to this product being characterized by FDA as a PMA, not a 510(K), as the syphilis component performance will be compared to actual patient infection status, as compared to a predicate device allowed in 510(K). This change will be more time consuming due to the increased statutory review time, and potentially more costly. We collected and completed phase I of the clinical study and found that the patient infected status varied dependent on the comparator assay used for the serological clinical diagnosis of syphilis. Due to the complex nature of the disease state of syphilis as well as the varying algorithms used for diagnosis, the original requirement discussed with the FDA may not be appropriate. FDA has requested the submission of preliminary data collected during the clinical study, which we did in February 2014, to further the discussion regarding the requirement for the DPP HIV-Syphilis Assay. +There can be no assurance that any of the aforementioned Research & Development and/or Regulatory products or activities will result in any product approvals or commercialization, nor that any of the existing research and development activities, or any new potential development programs or collaborations will materialize or that they will meet regulatory or any other technical requirements and specifications, and/or that if continued, will result in completed products, or that such products, if they are successfully completed, can or will be successfully commercialized. +30 +RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2013 AS COMPARED WITH THE YEAR ENDED DECEMBER 31, 2012 +Income : +Income before income taxes for the year ended December 31, 2013 decreased to $1,018,000 from $1,451,000 for the year ended December 31, 2012. Net Income decreased from $941,000 for 2012 to $531,000 for 2013. The decrease in net income is primarily attributable to a $695,000 increase in clinical trial expenses, along with other increased operating expenses, offset by a higher gross margin. In 2013, as a result of a 13.1% increase in Net Product sales and a 58.5% increase in non-product revenues, the Company had a $1,510,000, or 14.0%, increase in its gross margin, to $12,300,000. This increased gross margin funded most of the increased operating expenses, the most significant of which was an increase in clinical trial expenses of $695,000, due to the CLIA trials for our DPP HIV 1/2 product. +Revenues: +Selected Product Categories: +For the years ended +December 31, 2013 +December 31, 2012 +$ Change +% Change +Lateral Flow HIV Tests and Components +$ +20,248,364 +$ +13,505,849 +$ +6,742,515 +49.92 +% +DPP Tests and Components +6,592,660 +10,086,459 +(3,493,799 +) +-34.64 +% +Other +674,762 +735,047 +(60,285 +) +-8.20 +% +Net Product Sales +27,515,786 +24,327,355 +3,188,431 +13.11 +% +License and royalty revenue +4,906 +- +4,906 +100.00 +% +R&D, milestone and grant revenue +2,028,917 +1,283,240 +745,677 +58.11 +% +Total Revenues +$ +29,549,609 +$ +25,610,595 +$ +3,939,014 +15.38 +% +Revenues for our lateral flow HIV tests and related components during the year ended December 31, 2013 increased by $6.7 million over the same period in 2012. This was primarily attributable to increased sales in South America, of $4.6 million, in Africa of $1.7 million, and in the U.S. of $1.1 million; and was partially offset by decreased sales in other regions. Partially offsetting these increases were decreased other sales, which decreased by 8.2%, or $60,000. Sales of our DPP® products in 2013 decreased by $3,494,000, or 34.6%, compared to levels in 2012 as Brazil reduced purchases for the five ANVISA-approved DPP® products. The increase in R&D, milestone and grant revenue was primarily due to an increase in grants and other development projects of $746,000 along with an increase in royalty income of $5,000. R&D revenues in 2013 include funds, recognized on an "as expenses are incurred" basis, from a Phase II NIH grant for Leptospirosis, which was effective as of June 1, 2009, and from a Phase II grant for Tuberculosis which was effective March 1, 2011 as well as from two milestone based projects. +Gross Margin: +Gross Margin related to Net Product Sales: +For the years ended +December 31, 2013 +December 31, 2012 +$ Change +% Change +Gross Margin per Statement of Operations +$ +12,300,159 +$ +10,789,991 +$ +1,510,168 +14.00 +% +Less: R&D, milestone, grant, license and royalties +2,033,823 +1,283,240 +750,583 +58.49 +% +Gross Margin from Net Product Sales +$ +10,266,336 +$ +9,506,751 +$ +759,585 +7.99 +% +Product Gross Margin % +37.31 +% +39.08 +% +The gross margin dollar increase of $1,510,000 included a $760,000 increase in gross margin from product sales and a $751,000 increase in non-product revenues. The increase in product gross margin dollars is primarily attributable to the higher product sales compared to the 2012 period which resulted in $1,246,000 (this is calculated by taking the increase in sales times the gross margin percentage from 2012)and was partially offset by the 1.8% decrease in our product gross margin percentage, from 39.1% in 2012 to 37.3% in 2013, accounting for the $486,000 balance, which was primarily due to increased costs of royalties from 7.4% of product sales in 2012 to 9.0% in 2013. +31 +Research and Development: +This category includes costs incurred for product research and development, regulatory approvals, technical support, evaluations and registrations. +Selected expense lines: +For the years ended +December 31, 2013 +December 31, 2012 +$ Change +% Change +Clinical and Regulatory Affairs: +Wages and related costs +$ +436,088 +$ +436,668 +$ +(580 +) +-0.13 +% +Consulting +53,493 +61,664 +(8,171 +) +-13.25 +% +Stock-based compensation +19,478 +28,278 +(8,800 +) +-31.12 +% +Clinical trials +1,515,212 +820,083 +695,129 +84.76 +% +Other +82,852 +46,217 +36,635 +79.27 +% +Total Regulatory +2,107,123 +1,392,910 +714,213 +51.27 +% +R&D Other than Regulatory: +Wages and related costs +2,224,882 +1,956,536 +268,346 +13.72 +% +Consulting +106,155 +137,789 +(31,634 +) +-22.96 +% +Stock-based compensation +86,023 +41,838 +44,185 +105.61 +% +Materials and supplies +975,503 +646,271 +329,232 +50.94 +% +Other +334,563 +310,958 +23,605 +7.59 +% +Total other than Regulatory +3,727,126 +3,093,392 +633,734 +20.49 +% +Total Research and Development +$ +5,834,249 +$ +4,486,302 +$ +1,347,947 +30.05 +% +Expenses for Clinical & Regulatory Affairs increased by $714,000 for the year ended December 31, 2013, as compared to the same period in 2013. This was primarily due to an increase of $695,000 in clinical trial expenses which in 2013 are mostly associated with CLIA waiver studies for our DPP® HIV 1/2 Assay. +R&D expenses other than Clinical & Regulatory Affairs increased by $634,000 in the year ended December 31, 2013, as compared with the same period in 2012. The increases were primarily related to an increase in wages and related costs and in material and supplies to support our sponsored research and internal development programs. +Selling, General and Administrative Expense: +Selected expense lines: +For the years ended +December 31, 2013 +December 31, 2012 +$ Change +% Change +Wages and related costs +$ +2,068,173 +$ +1,534,440 +$ +533,733 +34.78 +% +Consulting +279,688 +261,054 +18,634 +7.14 +% +Commissions +902,393 +1,208,946 +(306,553 +) +-25.36 +% +Stock-based compensation +169,502 +174,462 +(4,960 +) +-2.84 +% +Marketing materials +112,326 +65,249 +47,077 +72.15 +% +Investor relations/investment bankers +214,786 +282,058 +(67,272 +) +-23.85 +% +Legal, accounting and compliance +621,429 +559,569 +61,860 +11.05 +% +Travel, entertainment and trade shows +190,698 +163,704 +26,994 +16.49 +% +Bad debt allowance (recovery) +(33,450 +) +28,000 +(61,450 +) +-219.46 +% +Other +935,538 +574,105 +361,433 +62.96 +% +Total S, G &A +$ +5,461,083 +$ +4,851,587 +$ +609,496 +12.56 +% +Selling, general and administrative expenses for the year ended December 31, 2013, increased by $609,000 as compared with the same period in 2012. The primary factor of this increase was a $534,000 increase in wages and related expenses, primarily attributable to the hiring of a COO and a VP of sales and marketing, and a new Medical Device tax of $72,000, along with other increases. These increases were partially offset by decreases in commissions due to decreased sales to Brazil, bad debt allowance and other decreases. +32 +Other Income and Expense: +For the years ended +December 31, 2013 +December 31, 2012 +$ Change +% Change +Gain on sale of fixed asset +$ +7,500 +- +7,500 +100 +% +Interest income +$ +5,778 +$ +7,911 +$ +(2,133 +) +-26.96 +% +Interest expense +(335 +) +(9,495 +) +9,160 +-96.47 +% +Total Other Income and (Expense) +$ +12,943 +$ +(1,584 +) +$ +14,527 +-917.11 +% +Other income for the year ended December 31, 2013 increased approximately $15,000 from an expense of $2,000 in the same period in 2012, primarily as a result of a gain on the sale of fixed assets and a decrease in interest expense due on the term loan with HSBC. +Income tax (benefit) provision: +For the years ended December 31, 2013 and 2012, the Company charged $487,000 and $509,000, respectively to income tax expense and reduced the deferred tax asset by $458,000 and $471,000, respectively . The Company still maintains a full valuation allowance on research and development tax credits. +MATERIAL CHANGES IN FINANCIAL CONDITION +Selected Changes in Financial Condition +As of +December 31, 2013 +December 31, 2012 +$ Change +% Change +Cash and cash equivalents +$ +9,650,275 +$ +2,951,859 +$ +6,698,416 +226.92 +% +Accounts receivable, net of allowance for doubtful accounts of $24,000 and $58,000 at December 31, 2013 and 2012, respectively +4,592,121 +4,821,357 +(229,236 +) +-4.75 +% +Inventories +3,188,726 +2,488,071 +700,655 +28.16 +% +Fixed assets, net of accumulated depreciation +1,978,232 +1,427,646 +550,586 +38.57 +% +Deferred tax asset, net of valuation allowance +3,590,207 +4,233,194 +(642,987 +) +-15.19 +% +Accounts payable and accrued liabilities +4,309,490 +3,303,923 +1,005,567 +30.44 +% +Cash increased by $6,698,000 from December 31, 2012, primarily due to the common stock funding completed in April 2013 which added $5,409,000. Excluding the common stock funding, the cash increased by $1,289,000. In addition there were decreases in accounts receivable, net of allowance, of $229,000 and deferred taxes of $643,000. We experienced increases in inventories of $701,000, fixed assets of $551,000 and accounts payable and accrued expenses of $1,006,000. +The increase in inventories is due to production for orders received to be shipped in the first quarter of 2014, which partially explains the increase in accounts payable and other accrued expenses. The increase in fixed assets is due in part to delivery of equipment for which we had made deposits, this equipment included vial filling equipment, a reel-to-reel printer for R&D, some leasehold improvements, and other pieces of equipment. Deferred tax asset decrease is related to the provision for income tax expense. +33 +LIQUIDITY AND CAPITAL RESOURCES +For the years ended +December 31, 2013 +December 31, 2012 +$ Change +% Change +Net cash provided by operating activities +$ +2,243,164 +$ +761,084 +$ +1,667,862 +223.99 +% +Net cash used in investing activities +(851,159 +) +(872,442 +) +(148,020 +) +16.97 +% +Net cash provided by financing activities +5,306,411 +52,263 +5,237,669 +7619.31 +% +(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS +$ +6,698,416 +$ +(59,095 +) +$ +6,757,511 +-11435.00 +% +The Company's cash increased by $6,698,000 from December 31, 2012, primarily due to the common stock funding completed in April 2013 which added $5,409,000 and was slightly offset by other uses of cash from financing activities, compared to a decrease in cash of $59,000 in the 2012 period. +The cash provided from operations in 2013 was $2,243,000, primarily due to net income plus non-cash expenses of $1,898,000, along with a decrease in accounts receivable of $650,000 and an increase of $1,006,000 in accounts payable and other accrued liabilities which were partially offset by an increase of $701,000 in inventory. The $1,898,000 of net income plus non-cash expenses includes net income of $531,000, plus $611,000 in depreciation and amortization, $332,000 in share-based compensation, $458,000 in provision for deferred taxes and a reduction for the change in the provision for doubtful accounts of $34,000. The use of cash from investing activities is primarily the purchase of fixed assets. +The increase in cash from operations in 2012 was $761,000, primarily due to net income plus non-cash expenses of $2,282,000 and an increase of $514,000 in accounts payable and accrued liabilities and other items aggregating $24,000, which were partially offset by an increase in accounts receivable of $1,851,000, and an increase of $188,000 in inventory and other items aggregating $20,000. The $2,282,000 net income plus non-cash expenses includes net income of $941,000, plus $523,000 in depreciation and amortization, $318,000 in share-based compensation, $471,000 in provision for deferred taxes and a change in the provision for doubtful accounts of $28,000. The use of cash from investing activities is primarily the purchase of fixed assets. +Fixed Asset Commitments +As of December 31, 2013, the Company had paid deposits on various pieces of equipment aggregating $16,410 which is reflected in Other Assets on the balance sheet. The Company is further committed to additional equipment-purchase obligation of $31,990 as various milestones are achieved by the various vendors. +34 +RECENT DEVELOPMENTS AND CHEMBIO'S PLAN OF OPERATIONS FOR THE NEXT TWELVE MONTHS +With over 10 consecutive years of double-digit revenue growth and five consecutive years of profitability, and with our strongest balance sheet ever, Chembio is well positioned for continued growth. A growing number of markets are now available to and being actively pursued for our products in North America (including significant near term new business opportunities in Mexico), South America and Africa. We are now also entering the European and Asian markets as a result of investments begun in 2013. Chembio is addressing the global health market mor than ever. +Having received, in December 2012, FDA approval of our Pre-Marketing Application for our DPP® HIV 1/2 Assay for use with oral fluid or blood samples, one of our priorities is to complete the requirements for a Clinical Laboratory Improvement Act (CLIA) waiver for this product. Receipt of a CLIA waiver will enable the product to be sold in the U.S. professional point-of-care market segments where these tests are primarily used. We anticipate this process to be completed in 2014. We believe the availability of an alternative oral fluid HIV rapid test, which test also performs very well on all blood matrices, will enable Chembio to participate in market segments not currently addressed by the lateral flow blood POCT products that have been sold through Alere. +While we continue to pursue and develop successful private label license and distribution agreements in a number of markets such as we have done with FIOCRUZ and Labtest in Brazil, Alere in North America and, as recently announced, RVR in Asia, we believe our long-term success will be primarily driven by providing our customers with the best value and the most direct relationship with our high quality organization and products and by doing so through further development of a Chembio brand in the United States and other key markets. This is fundamental to the strategic plan that we developed last year. +We intend to sell, under the Chembio brand, our DPP® HIV 1/2 Assay for use with oral fluid or blood samples. While we have a robust pipeline of products that will complement this initial offering, we may also seek to distribute additional products that we can license or acquire. +We believe 2014 will be a transformative year for Chembio, as we both bring in a new chief executive and we establish a commercial sales organization for the first time. Our commitment to provide our customers the best value and support under a Chembio brand in the U.S. will require not only investing in a commercial sales organization, but also ensuring that the commercial organization will have a growing pipeline of products to sell, whether they are developed in-house, in-licensed or acquired. Investments will need to be made in sales and marketing, research and development, regulatory submissions, and manufacturing in order to realize our long-term strategic plan. We are committed to doing that. These investments were one of the primary reasons we raised capital in 2013. +We are optimistic that, with a strong track record, and an ongoing business and financial position in place, an outstanding organization, the support of our board of directors, and strong leadership, this transformation will be successful. +Critical Accounting Policies and Estimates +The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates. +We believe that there are several accounting policies that are critical to understanding our historical and future performance, as these policies affect the reported amounts of revenue and the more significant areas involving management's judgments and estimates. These significant accounting policies relate to revenue recognition, research and development costs, valuation of inventory, valuation of long-lived assets and income taxes. These policies, and the related procedures, are described in detail below. +Revenue Recognition – +We recognize revenue for product sales in accordance with ASC 605, Revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is determinable, and collectability is reasonably assured. Revenue typically is recognized at time of shipment. Sales are recorded net of discounts, rebates and returns. +For certain contracts, we recognize revenue from R&D, milestone and grant revenues when earned. Grants are invoiced after expenses are incurred. Revenues from projects or grants funded in advance are deferred until earned. +For certain collaborative research projects, we recognize revenue by defining milestones at the inception of the agreement and applying the milestone method of revenue recognition for relevant contracts. +35 +Stock-Based Compensation – +We recognize the fair value of equity-based awards as compensation expense in our statement of operations. The fair value of our stock option awards was estimated using a Black-Scholes option valuation model. This valuation model's computations incorporate highly subjective assumptions, such as the expected stock price volatility and the estimated life of each award. The fair value of the options, after considering the effect of expected forfeitures, is then amortized, generally on a straight-line basis, over the related vesting period of the option. The fair value of our restricted shares is based on the market value of the shares at the date of grant and is recognized on a straight-line basis over the related vesting period of the award. +Research & Development Costs – +Research and development activities consist primarily of new product development, continuing engineering for existing products, regulatory and clinical trial costs. Costs related to research and development efforts on existing or potential products are expensed as incurred. +Valuation of Inventories – +Inventories are stated at the lower of cost or market, using the first-in, first-out method (FIFO) to determine cost. Our policy is to periodically evaluate the market value of the inventory and the stage of product life cycle, and record a reserve for any inventory considered slow moving or obsolete. For example, each additional 1% of obsolete inventory would reduce such inventory by approximately $32,000. +Allowance for doubtful accounts – +Our policy is to review our accounts receivable on a periodic basis, no less than monthly. On a quarterly basis an analysis is made of the adequacy of our allowance for doubtful accounts and adjustments are made accordingly. The current allowance is approximately 1% of accounts receivable. For example each additional 1% of accounts receivable that becomes uncollectible would reduce such balance of accounts receivable by approximately $46,000. +Income Taxes – +Income taxes are accounted for under ASC 740 authoritative guidance ("Guidance") which requires the asset and liability method of accounting for deferred income taxes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities. Deferred tax assets or liabilities at the end of each period are determined using the tax rate expected to be in effect when taxes are actually paid or recovered. +The Guidance also requires that a valuation allowance be established when it is more likely than not that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence needs to be considered, including a company's current and past performance, the market environment in which the company operates, length of carryback and carryforward periods and existing contracts that will result in future profits. Prior to 2011 and through September 30, 2011, the Company had a full valuation allowance recorded against deferred tax assets since it was not more likely than not that the Company would realize the benefits of such deferred tax assets. During 2011, the Company determined based upon the guidance under ASC 740 that it was more likely than not that it would realize the benefit of such deferred tax assets. As result, the Company reversed the valuation allowance previously recorded against the deferred tax assets. The Company still maintains a full valuation allowance on research and development tax credits +The Guidance also prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the consolidated financial statements tax positions taken or expected to be taken on a tax return, including a decision whether to file or not to file in a particular jurisdiction. +The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles, generally accepted in the United States of America, with no need for management's judgment in their application. There are also areas in which management's judgment in selecting any viable alternative would not produce a materially different result. See our audited financial statements and notes thereto which contain accounting policies and other disclosures required by accounting principles generally accepted in the United States of America. +ITEM 8. +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +The Consolidated Financial Statements and schedules that constitute Item 8 are attached at the end of this Annual Report on Form 10-K. An index to these Financial Statements and schedules is also included on page F-1 of this Annual Report on Form 10-K. +36 +ITEM 9. +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. +Not Applicable. +ITEM 9A. +CONTROLS AND PROCEDURES +(a) Disclosure Controls and Procedures. Under the supervision and with the participation of our senior management, consisting of our chief executive officer and our chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this report (the "Evaluation Date"). Based on that evaluation, the Company's management, including our chief executive officer and chief financial officer, concluded that as of the Evaluation Date our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our Exchange Act reports is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. +Management's Annual Report on Internal Control Over Financial Reporting. The Company's management is responsible for establishing and maintaining an adequate system of internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)). Our internal control over financial reporting is a process, under the supervision of our chief executive officer and chief financial officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. These internal controls over financial reporting processes include policies and procedures that: +a. +Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; +b. +Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +c. +Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives. +In evaluating the effectiveness of our internal control over financial reporting, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on this evaluation, our Chief Executive and Chief Financial Officers concluded that our internal control over financial reporting was effective as of December 31, 2013. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. +Management's report was not subject to attestation by our registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report. +(b) Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the Company's last fiscal quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +ITEM 9B. +OTHER INFORMATION +Not applicable. +37 +PART III +ITEM 10. +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +Directors and Executive Officers +Lawrence A. Siebert (57), President, Chief Executive Officer and Chairman. Mr. Siebert was appointed President of Chembio Diagnostics, Inc. and a member of our board of directors upon consummation of the merger in 2004. Mr. Siebert has been Chairman of Chembio Diagnostic Systems Inc. for approximately thirteen years and its President since May 2002. Mr. Siebert's background is in private equity and venture capital investing. From 1982 to 1991, Mr. Siebert was associated with Stanwich Partners, Inc, which during that period invested in middle market manufacturing and distribution companies. From 1992 to 1999, Mr. Siebert was an investment consultant and business broker with Siebert Capital Corp. and Siebert Associates LLC, and was a principal investor in a privately held test and measurement company which was sold in 2002. Mr. Siebert received a JD from Case Western Reserve University School of Law in 1981 and a BA with Distinction in Economics from the University of Connecticut in 1978. Mr. Siebert as president and CEO is an integral part of the Chembio management team. His experience in the rapid test field and financing markets made him an excellent candidate for serving on the board and as its chairman. In September 2013, Mr. Siebert announced his retirement from his positions as CEO and President of Chembio, effective when his current employment agreement expires in May 2014. +Richard J. Larkin (57), Chief Financial Officer. Mr. Larkin was appointed as Chief Financial Officer of Chembio Diagnostics, Inc. upon consummation of the merger in 2004. Mr. Larkin oversees our financial activities and information systems. Mr. Larkin has been the Chief Financial Officer of Chembio Diagnostic Systems Inc. since September 2003. Prior to joining Chembio Diagnostic Systems Inc., Mr. Larkin served as CFO at Visual Technology Group ("VTG") from May 2000 to September 2003, and also led VTG's consultancy program that provided hands-on expertise in all aspects of financial service, including the initial assessment of client financial reporting requirements within an Enterprise Resource Planning (Manufacturing) environment through training and implementation. Prior to joining VTG, he served as CFO at Protex International Corporation from May 1987 to January 2000. Mr. Larkin holds a BBA in Accounting from Dowling College and is a member of the American Institute of Certified Public Accountants. +Javan Esfandiari (47), Executive VP of Research and Development. Mr. Esfandiari joined Chembio Diagnostic Systems, Inc, in 2000. Mr. Esfandiari co-founded, and became a co-owner of Sinovus Biotech AB where he served as Director of Research and Development concerning lateral flow technology until Chembio Diagnostic Systems Inc. acquired Sinovus Biotech AB in 2000. From 1993 to 1997, Mr. Esfandiari was Director of Research and Development with On-Site Biotech/National Veterinary Institute, Uppsala, Sweden, which was working in collaboration with Sinovus Biotech AB on development of veterinary lateral flow technology. Mr. Esfandiari received his B.Sc. in Clinical Chemistry and his M. Sc. in Molecular Biology from Lund University, Sweden. He has published articles in various veterinary journals and has co-authored articles on tuberculosis serology with Dr. Lyashchenko. +Sharon Klugewicz (46), Chief Operating Officer. Prior to joining the Company in September 2012, Ms. Klugewicz, served as Senior Vice President, Scientific & Laboratory Services at Pall Corporation (NYSE:PLL), a world leader in filtration, separation and purification technologies. Prior to that, Ms. Klugewicz held a number of positions at Pall Corporation over her 20-year tenure there, including in the Pall Life Sciences Division, in Marketing Product Management, and Field Technical Services, which included a position as Senior Vice President, Global Quality Operations. Ms. Klugewicz holds an M.S. in Biochemistry from Adelphi University and a B.S. in Neurobiology from Stony Brook University. +Tom Ippolito (51), VP of Regulatory Affairs, QA and QC. Mr. Ippolito joined Chembio in June 2005. He has over twenty years' experience with in vitro diagnostics for infectious diseases, protein therapeutics, vaccine development, Process Development, Regulatory Affairs and Quality Management. Over the years, Mr. Ippolito has held Vice President level positions at Biospecific Technologies, Corp. from 2000 - 2005, Director level positions in Quality Assurance, Quality Control, Process Development and Regulatory Affairs at United Biomedical, Inc. from 1987 - 2000. Mr. Ippolito is the Course Director for "drug development process" and "FDA Regulatory Process" for the BioScience Certificate Program at the New York State University of Stony Brook, a program he has been a part of since its inception in 2003. +Dr. Gary Meller M.D. (64), Director. Dr. Meller was elected to our Board of Directors in March 15, 2005, and currently serves on the Board's Audit, Compensation and Nominating And Corporate Governance Committees, including as Chairman of the Compensation Committee. Dr. Meller also served as Chairman of the Board's Special Committee for handling certain strategic opportunities. Dr. Meller has been the president of CommSense Inc., a healthcare business development company, since 2001. CommSense Inc. works with clients in Europe, Asia, North America, and the Middle East on medical information technology, medical records, pharmaceutical product development and financing, health services operations and strategy, and new product and new market development. From 1999 until 2001 Dr. Meller was the executive vice president, North America, of NextEd Ltd., a leading internet educational services company in the Asia Pacific region. Dr. Meller also was a limited partner and a member of the Advisory Board of Crestview Capital Master LLC, which at one time was our largest stockholder. Dr. Meller is a graduate of the University of New Mexico School of Medicine and has an MBA from the Harvard Business School. Dr. Meller's experience in the medical field both domestic and foreign (especially his experience with CommSense Inc.) as well as his financing experience made him an excellent candidate for serving on the board. +38 +Kathy Davis (56), Director. Ms. Davis was elected to the Company's Board of Directors in May 2007, and currently serves on the Company's Audit, Compensation and Nominating And Corporate Governance Committees, including as Chairman of each of the Audit Committee and the Nominating And Corporate Governance Committee. She also is serving on the Company's CEO Search Committee. Since January 2007, Ms. Davis has been the owner of Davis Design Group LLC, a company that provides analytical and visual tools for public policy design. Previously, from February 2005 to December 2006, she served as the Chief Executive Officer of Global Access Point, a startup company with products for data transport, data processing, and data storage network and hub facilities. From October 2003 to January 2005, Ms. Davis was Lieutenant Governor of the State of Indiana, and from January 2000 to October 2003 was Controller of the City of Indianapolis. From 1989 to 2003, Ms. Davis held leadership positions with agencies and programs in the State of Indiana including State Budget Director, Secretary of Family & Social Services Administration, and Deputy Commissioner of Transportation. From 1982 to 1989 Ms. Davis held increasingly senior positions with Cummins Engine, where she managed purchasing, manufacturing, engineering, and assembly of certain engine product lines. Ms. Davis also led the startup of and initial investments by a $50 million Indiana state technology fund, Kathy serves as vice chair of the board of Noble of Indiana, director of Lumina Foundation for Education, Indiana University School of Public and Environmental Affairs Dean's Advisory Council, IU Public Policy Institute Advisory Council, WGU Indiana Advisory Council, Co-chair of the Shepherd Tech Arts Resource Team, columnist for Indianapolis Business Journal Forefront. She has a Masters of Business Administration from Harvard Business School and a Bachelor of Science in Mechanical Engineering from the Massachusetts Institute of Technology. Ms. Davis has varied experience in business, political and financial areas make her an excellent candidate for serving on the board. +Dr. Barbara DeBuono M.D., M.P.H., (58), Director . Dr. DeBuono, who was elected to the Company's Board of Directors in June 2011, serves on the Company's Compensation Committee and also as Chair of the CEO Search Committee. Dr. DeBuono is a renowned expert in public health innovation, health policy, education and research. She currently serves as Senior Vice President for Market Development at TREO Solutions, a data analytics and health system transformation company based in New York. Previously she held the post of President and CEO of ORBIS International, which is dedicated to saving sight and eliminating avoidable blindness worldwide. From 2009-2011, Dr. DeBuono was Chief Medical Officer, Partner and Global Director of Health and Social Marketing at Porter Novelli, and from 2000-2008 she was Executive Director, Public Health and Government at Pfizer Inc. Dr. DeBuono has served as Commissioner of Health for the state of New York and as Director of Health in Rhode Island and she was honored by the CDC Foundation in 2005 as one of five Public Health Heroes nationwide. She serves as adjunct professor at The George Washington University School of Public Health, and is a co-founder of The MAIA Foundation, a charity dedicated to women's health in sub-Saharan Africa. A Fellow of the American College of Physicians, Dr. DeBuono received her B.A. from the University of Rochester, her M.D. from the University of Rochester, School of Medicine, and a Masters in Public Health (M.P.H.) from Harvard University School of Public Health. Dr. DeBuono's experience in and knowledge of, both domestic and international, public health services, public health innovations, and the medical field make her an excellent candidate for serving on the board. +Dr. Peter Kissinger, Ph.D. (69), Director. Dr. Kissinger, who was elected to the Company's Board of Directors in June 2011 , serves on the Company's Audit Committee and is a member of the CEO Search Committee. Dr. Kissinger is a scientist, entrepreneur and academic, with a multi-faceted career in biotechnology and biomedical technologies. He is a Professor of Chemistry at Purdue University, West Lafayette, Indiana, and is the founder of Bioanalytical Systems, Inc. (NASDAQ: BASI), which he led from 1974-2007. Dr. Kissinger's academic research has involved the study of modern liquid chromatography techniques, and in vivo methodology for drug metabolism and the neurosciences. Dr. Kissinger has published more than 240 scientific papers and is a Fellow of the American Association of Pharmaceutical Scientists and the American Association for the Advancement of Science. In 2005, he became the Chairman of Prosolia, which markets mass spectrometry innovations for life science, industrial and homeland security applications. In 2007, he and Candice Kissinger founded Phlebotics, Inc., a medical device company focused on diagnostic information for intensive care medicine. He is a columnist for the trade publication Drug Discovery News. Dr. Kissinger received a B.S. in Chemistry from Union College, Schenectady, N.Y. and a Ph.D. in Analytical Chemistry from the University of North Carolina in Chapel Hill. Dr. Kissinger has knowledge of and experience in biotechnology and biomedical technologies as well as publicly-traded companies, all of which make him an excellent candidate for serving on the board. +Section 16(a) Beneficial Ownership Reporting Compliances +Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), requires the Company's directors, executive officers and beneficial owners of more than 10% of the Company's common stock to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of common stock and other equity securities of the Company. The Company believes that during the year ended December 31, 2012, each person who was an officer, director and beneficial owner of more than 10% of the Company's common stock complied with all Section 16(a) filing requirements . +Code of Ethics +The Company has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer, controller, and persons performing similar functions. A copy of the Company's code of ethics is available on the Company's website at www.chembio.com. +39 +Identification of Audit Committee; Audit Committee Financial Expert +The Company's board of directors has established an audit committee. Katherine L. Davis, Dr. Pete Kissinger and Dr. Gary Meller each serves on the audit committee, with Ms. Davis serving as chairman. The Company's board of directors has determined that Ms. Davis is an audit committee financial expert and is independent. +ITEM 11. +EXECUTIVE COMPENSATION +The following table summarizes all compensation recorded by the Company in each of the last two completed fiscal years for our principal executive officer and our two most highly compensated executive officers other than our principal executive officer whose annual compensation exceeded $100,000. +Name / +Principal +Position +Year +Salary 1 +($) +Bonus 2 +($) +Stock +Awards +($) +Option Awards 3 +($) +All Other Compensation 5 +($) +Total +($) +Lawrence A. Siebert 4 +2013 +$ +290,000 +$ +50,750 +$ +- +$ +21,610 +$ +10,240 +$ +372,600 +CEO +2012 +$ +290,000 +$ +101,500 +$ +- +$ +28,217 +$ +10,400 +$ +430,117 +Javan Esfandiari +2013 +$ +292,462 +$ +44,625 +$ +- +$ +141,078 +$ +8,697 +$ +486,862 +VP-R&D +2012 +$ +263,077 +$ +89,250 +$ +- +$ +24,811 +$ +7,608 +$ +384,746 +Sharon Klugewicz +2013 +$ +233,642 +$ +5,950 +$ +- +$ +18,551 +$ +3,542 +$ +261,685 +COO +2012 +$ +59,769 +$ +5,950 +$ +- +$ +109,451 +$ +- +$ +175,170 +1 Salary is total base salary. +2 Bonuses earned in 2013 were partially based on reaching certain objectives, which included revenue dollar levels and operating profit levels, additional amounts earned were discretionary. +3 The estimated fair value of any option or common stock granted was determined in accordance with ASC 718, "Stock-Based Payment". +4 Mr. Siebert also serves as a director on the Company's board of directors. Mr. Siebert does not receive any compensation for this director role. +5 Other compensation includes an employer match to 401(K) contributions and car allowances where applicable. +40 +Employment Agreements +Mr. Siebert. Effective, April 19, 2013, the Compensation Committee of the Board of Directors extended the Company's employment agreement (the "Employment Agreement") with Lawrence A. Siebert, the Company's President and Chief Executive Officer, for an additional one-year term through May 11, 2014, with all other terms and conditions of the Employment Agreement remaining the same. In September 2013, Mr. Siebert informed the Company that he intends to retire from his positions as President and CEO upon expiration of his contract in May 2014. Previously, effective, May 11, 2011, the Compensation Committee of the Board of Directors extended the Company's employment agreement (the "Employment Agreement") with Lawrence A. Siebert, the Company's President and Chief Executive Officer, for an additional one-year term through May 11, 2013, with an increase in salary to $290,000 per year. Previously, effective May 11, 2009, the Company's Board of Directors had approved the Company's extension of the June 15, 2006 Employment Agreement for an additional three-year term through May 11, 2012. On June 15, 2006, Mr. Siebert and the Company entered into an Employment Agreement, effective May 10, 2006, which was to terminate on May 10, 2008, extended in 2008 to May 10, 2009. Pursuant to the Employment Agreement, Mr. Siebert serves as the President and Chief Executive Officer of the Company and received an initial salary of $240,000 per year, which had been increased to $265,000 per year until Mr. Siebert agreed to a 15 percent reduction, to $225,000, effective January 19, 2009. Mr. Siebert's salary was restored to $265,000 per annum effective in July 2009. Mr. Siebert also is eligible for a bonus of up to 50% of his salary, consisting of (i) a bonus of up to 25% of his salary that is at the complete discretion and determination of the board of directors, and (ii) a bonus of up to an additional 25% of his salary that will be determined based upon revenue and earnings performance criteria established each year by the board of directors. Mr. Siebert is eligible to participate in any profit sharing, stock option, retirement plan, medical and/or hospitalization plan, and/or other benefit plans except for disability and life insurance that the Company may from time to time place in effect for the Company's executives during the term of Mr. Siebert's employment agreement. If Mr. Siebert's Employment Agreement is terminated by the Company without cause, or if Mr. Siebert terminates his Employment Agreement for a reasonable basis, as defined in the Employment Agreement, including within 12 months of a change in control, the Company is required to pay as severance Mr. Siebert's salary for six months. Mr. Siebert has agreed for a period of two years after the termination of his employment with the Company not to induce customers, agents, or other sources of distribution of the Company's business under contract or doing business with the Company to terminate, reduce, alter, or divert business with or from the Company. The terms of the extended May 11, 2011, May 11, 2009 and May 11, 2008 Employment Agreements are identical to the June 15, 2006 Employment Agreement, except that under the May 11, 2008 extended Employment Agreement, Mr. Siebert received additional consideration in the form of incentive stock options to purchase 31,250 shares of the Company's common stock exercisable at $1.04 per share, which was the closing price of the Company's common stock on June 3, 2008. The incentive stock options are immediately exercisable and they expire on the June 3, 2013. +Mr. Esfandiari. The Company entered into an employment agreement effective March 5, 2013 (the "Employment Agreement"), with Mr. Esfandiari to continue as the Company's Senior Vice President of Research and Development for an additional term of three years through March 5, 2016. Mr. Esfandiari's salary under the Employment Agreement is $300,000 for the first year, with possible increases for the second year and /or for the third year. Mr. Esfandiari is eligible for a performance-based bonus of up to 50% of his base salary for each respective year, which is in the same proportions as described below under "Executive Bonus Plan". The Company also granted Mr. Esfandiari, pursuant to the Company's 2008 Stock Incentive Plan, incentive stock options to purchase 30,000 shares of the Company's common stock. The price per share of these options is equal to the fair market value of the Company's common stock as of the close of the market on March 5, 2013, which is the date on which the Agreement was effective. Of these stock options, options to purchase 10,000 shares vest on each of the first three anniversaries of the effective date of the Employment Agreement. Mr. Esfandiari is eligible to participate in any profit sharing, stock option, retirement plan, medical and/or hospitalization plan, and/or other benefit plans except for disability and life insurance that the Company may from time to time place in effect for the Company's executives during the term of Mr. Esfandiari's employment agreement. If Mr. Esfandiari's employment agreement is terminated by the Company without cause, or if Mr. Esfandiari terminates his employment agreement for a reasonable basis, as defined in the Employment Agreement, including within 12 months of a change in control, the Company is required to pay as severance Mr. Esfandiari's salary for twelve months. +Ms. Klugewicz. The Company entered into an employment agreement dated May 22, 2013 with Ms. Klugewicz's (the "Employment Agreement"), effective May 22, 2013 (the "Effective Date"). The Agreement provides that she will serve as the Company's COO for a term of two years. Ms. Klugewicz will receive an annual salary of $250,000, with the option of a discretionary, performance-based annual cash bonus of up to 37.5% of her base salary. The Employment Agreement also provides for a grant of 5,000 options to purchase shares of the Company's common stock, vesting at a rate of 2,500 shares on each of the first and second anniversaries of the Effective Date. In the event Ms. Klugewicz's employment is terminated by reason of disability or for "cause", as defined in the Employment Agreement, all compensation including her base salary, her right to receive a performance bonus, and the vesting of any unvested options, will cease as of her termination date, and Ms. Klugewicz will receive no severance benefits. If the Company terminates Ms. Klugewicz's employment without cause or Ms. Klugewicz terminates her employment for a reasonable basis, as defined in the Employment Agreement (which definition includes involuntary termination within a six-month period upon a "Change of Control"), then the Company will pay Ms. Klugewicz her base salary for a period of six months as severance, and all her unvested stock options shall immediately become vested. The Employment Agreement also contains provisions prohibiting Ms. Klugewicz from (i) soliciting the Company's employees for a period of twenty-four months following her termination, (ii) soliciting the Company's customers, agents, or other sources of distribution of the Company's business for a period of twelve months following her termination, and (iii) for a period of twelve months following termination of this Agreement, except where termination is involuntary upon a "Change in Control," engaging or participating in any business that directly competes with the business activities of the Company in any market in which the Company is in business or plans to do business. The foregoing description of the Employment Agreement is qualified in its entirety by reference to the full text of the Employment Agreement. +Neither Mr. Larkin, Mr. Ippolito nor Mr. Steele has an employment contract with the Company. +41 +Executive Bonus Plan +The Company has established a bonus plan for its executives who do not have a contract. For the fiscal year ended December 31, 2013, there were three executives eligible for this bonus plan. Each executive can earn up to 25% of that executive's salary in the form of a cash bonus. The Compensation Committee determined that 80% of the executive's bonus will be quantitative factors, based on the budget. 20% will be based on other factors and will be discretionary. The plan, during 2013 for the 80%, called for a sliding percentage of the executive's salary, from zero to 10% for attaining certain revenue goals, and from zero to 10% of the executive's salary for attaining certain operating profit goals. The Company achieved approximately 98.75% of its revenue goals for 2013, which would result in a bonus of 7% of each executive's salary, and achieved 110% of its operating profit goal, which would result in a bonus of 1% of salary, for a total of 8% of salary. The Compensation Committee granted approximately 15% of salary in bonuses for the three subject executives. +OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END 2013 +Option Awards +Stock Awards +Name +Number of Securities Underlying Unexercised Options Exercisable (#) +Number of Securities Underlying Unexercised Options Unexercisable +(#) +Option Exercise Price +($) +Option Expiration Date +Option Vesting Date +Number of Shares of Stock That Have Not Vested +(#) +Market Value of Shares of Stock That Have Not Vested +($) +Foot- +note +Lawrence A. Siebert +5,215 +5.56 +2/26/2018 +2/16/2013 +4 +9,063 +4.00 +2/16/2017 +2/16/2012 +3 +16,667 +1.04 +5/6/2014 +5/6/2012 +2 +16,667 +1.04 +5/6/2014 +5/7/2011 +2 +16,667 +1.04 +5/6/2014 +5/6/2010 +2 +Javan Esfandiari +10,000 +5.44 +3/5/2018 +3/5/2014 +1 +10,000 +5.44 +3/5/2018 +3/5/2015 +1 +10,000 +5.44 +3/5/2018 +3/5/2016 +1 +4,765 +5.56 +2/26/2018 +2/16/13 +4 +7,969 +4.00 +2/16/2017 +2/16/2012 +3 +12,500 +2.16 +3/4/2015 +3/5/2013 +1 +12,500 +2.16 +3/4/2015 +3/5/2012 +1 +12,500 +2.16 +3/4/2015 +3/5/2010 +1 +12,500 +1.04 +5/6/2014 +5/6/2012 +2 +Sharon Klugewicz +2,500 +4.50 +5/22/2018 +5/22/2014 +1 +2,500 +4.50 +5/22/2018 +5/22/2015 +1 +630 +5.56 +2/6/2018 +2/6/2013 +4 +12,000 +4.45 +9/4/2017 +9/4/2013 +5 +12,000 +4.45 +9/4/2017 +9/4/2014 +5 +12,000 +4.45 +9/4/2017 +9/4/2015 +5 +1 Options issued in connection with an employment contract and under the 2008 Stock Incentive Plan. +2 On May 7, 2009 in accordance with the terms of the Company's 2008 Stock Incentive Plan, the Company granted certain employees of the Company, options to purchase an aggregate of 365,625 shares of the Company's common stock. The exercise price for these options is equal to $1.04 per share. The options become exercisable in thirds on the first, second and third anniversaries of the date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee's employment with the Company or (b) the fifth anniversary of the date of grant. The fair value of these options is being amortized over the vesting life of the options. +3 On February 16, 2012, the Company determined to grant on February 16, 2012, to certain employees of the Company, options to purchase an aggregate of 203,125 shares of the Company's common stock. The exercise price for these options was the last traded market price for the Company's common stock on February 16, 2012, which was $4.00 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee's employment with the Company or (b) the fifth anniversary of the effective date of grant. +4 On February 26, 2013, the Company determined to grant on February 26, 20123 to certain employees of the Company, options to purchase an aggregate of 16,360 shares of the Company's common stock. The exercise price for these options was the last traded market price for the Company's common stock on February 26, 2013, which was $5.56 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee's employment with the Company or (b) the fifth anniversary of the effective date of grant. +5 Options issued in connection with the start of employment with the Company and under the 2008 Stock Incentive Plan. +42 +Director Compensation +All non-employee directors are paid an $18,000 annual retainer in semi-annual payments, and once every five years, on the date of the annual meeting of stockholders that directors are elected or re-elected (every 5 years), receive stock options to acquire, subject to vesting as described below, 46,875 shares of the Company's common stock, with an exercise price equal to the market price on the date of the grant. Stock options to acquire 9,375 shares become exercisable on the date of grant, and options to acquire an additional 9,375 shares become exercisable on the date of each of the four succeeding annual meetings of stockholders if and to the extent that the non-employee director is reelected as a director at each such annual meeting. The audit committee chairman is paid an annual retainer of $2,500, paid semi-annually. In addition, the non-employee directors are paid $1,000 in cash for each board of directors' meeting attended, and paid $500 in cash for each telephonic board of directors meeting. The non-employee directors who are members of a committee of the board of directors are paid $500 in cash for each committee meeting attended, or $750 in cash for each committee meeting attended if that non-employee director is the committee chairman. Directors also may be paid for serving ad hoc committees of the Board. In fact, when the Board established its Special Committee in 2013 to handle the search for a new CEO, the Chairman of the Committee was paid $12,000 per month, and the other two director-members of the Committee was paid $8,000 per month. +DIRECTOR COMPENSATION +Name +Fees Earned +or Paid in +Cash +($) 1 +Option +Awards +($) 2 +Total +($) +Katherine L. Davis +$ +62,500 +$ +- +$ +62,500 +Barbara DeBuono +67,000 +- +67,000 +Pete Kissinger +56,500 +- +56,500 +Gary Meller +29,500 +- +29,500 +1 Fees earned or paid in cash represents a yearly fee and fees for meeting expenses: (a) Ms.Davis received an $18,000 annual fee as a member of the board of directors, a $2,500 annual fee as Audit Committee chairman, $30,000 in fees as a member of the CEO Search Committee and $12,000 in meeting fees earned during 2013; (b) Dr. DeBuono received an $18,000 annual fee as a member of the board of directors, $40,000 in fees as chairperson of the CEO Search Committee and 9,000 in meeting fees; (c) Dr. Kissinger received an $18,000 annual fee as a member of the board of directors, $30,000 in fees as a member of the CEO Search Committee and $8,500 in meeting fees; (d) Dr. Meller received an $18,000 annual fee as a member of the board of directors, and $11,500 in meeting fees. +2 Each outside member of the board of directors is granted, once every five years, the right to purchase 375,000 shares of the company's common stock with an exercise price equal to the market price on the date of the grant as part of their annual compensation. One-fifth of these options are exercisable on the date of grant, one-fifth become exercisable on the first anniversary of the date of grant, and additional one-fifths become exercisable on the second through fourth anniversary of the date of grant. The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model. +Compensation Committee Interlocks and Insider Participation +No executive officer of the Company served as a member of the Board of any other public company during the year ended December 31, 2013. No member of the Compensation Committee served as an executive officer of any other public company during the year ended December 31, 2013. No interlocking relationship exists between the members of our Compensation Committee and the Board or compensation committee of any other company. As of March 1, 2014, the members of the Compensation Committee were Gary Meller (Chairman), Katherine Davis, and Barbara DeBuono, all of whom are deemed by the Board of Directors to be independent. +43 +ITEM 12. +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The following table sets forth certain information regarding the beneficial ownership of our common stock by each person or entity known by us to be the beneficial owner of more than 5% of the outstanding shares of common stock, each of our directors, each of our "named executive officers", and all of our directors and executive officers as a group as of March 1, 2014. +Name and Address of +Beneficial Owner +Amount and Nature +of Beneficial +Ownership +Percent of Class +Siebert, Lawrence (1) +3661 Horseblock Road +Medford, NY 11763 +853,789 +9.09% +Esfandiari, Javan (2) +3661 Horseblock Road +Medford, NY 11763 +156,235 +1.66% +Larkin, Richard (3) +3661 Horseblock Road +Medford, NY 11763 +68,620 +.73% +Ippolito, Tom (4) +3661 Horseblock Road +Medford, NY 11763 +46,799 +.50% +Steele, Michael (5) +3661 Horseblock Road +Medford, NY 11763 +12,785 +.14% +Klugewicz, Sharon (6) +3661 Horseblock Road +Medford, NY 11763 +22,630 +.24% +Meller, Gary (7) +3661 Horseblock Road +Medford, NY 11763 +95,625 +1.02% +Davis, Katherine L. (8) +3661 Horseblock Road +Medford, NY 11763 +48,922 +.52% +DeBuono, Barbara (9) +3661 Horseblock Road +Medford, NY 11763 +30,079 +.32% +Kissinger, Peter (10) +3661 Horseblock Road +Medford, NY 11763 +30,079 +.32% +GROUP (11) +1,365,562 +14.06% +Wellington Management Company, LLP +280 Congress Street +Boston, MA 02210 +670,980 +7.20% +Norman H. Pessin +366 Madison Ave, 14 th Floor +New York, NY 10017 +449,770 +4.82% +44 +Beneficial ownership is determined in accordance with the Rule 13d-3(a) of the Securities Exchange Act of 1934, as amended, and generally includes voting or investment power with respect to securities. Except as subject to community property laws, where applicable, the person named above has sole voting and investment power with respect to all shares of our common stock shown as beneficially owned by him. +The beneficial ownership percent in the table is calculated with respect to the number of outstanding shares (8,086,114) of the Company's common stock outstanding as of March 6, 2013; and with respect to each stockholder, the denominator is the sum of the number of common shares outstanding and the number, if any, of outstanding options included in that stockholder's beneficial ownership. Each stockholder's ownership is calculated as the number of shares of common stock owned plus the number of shares of common stock into which any preferred stock, warrants, options or other convertible securities owned by that stockholder can be converted within 60 days. +The term "named executive officer" refers to our principal executive officer, our two most highly compensated executive officers other than the principal executive officer who were serving as executive officers at the end of 2012, and two additional individuals for whom disclosure would have been provided but for the fact that the individuals were not serving as executive officers of the Company at the end of 2012. +(1) +Includes 64,279 shares issuable upon exercise of options exercisable within 60 days. +(2) +Includes 72,734 shares issuable upon exercise of options exercisable within 60 days. Does not include 20,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(3) +Includes 48,217 shares issuable upon exercise of options exercisable within 60 days. Does not include 9,375 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(4) +Includes 40,712 shares issuable upon exercise of options exercisable within 60 days. Does not include 7,812 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(5) +Includes 12,785 shares issuable upon exercise of options exercisable within 60 days. Does not include 24,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(6) +Includes 12,630 shares issuable upon exercise of options exercisable within 60 days. Does not include 29,000 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(7) +Includes 37,500 shares issuable upon exercise of options exercisable within 60 days. Does not include 9,375 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(8) +Includes 37,500 shares issuable upon exercise of options exercisable within 60 days. Does not include 9,375 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(9) +Includes 30,079 shares issuable upon exercise of options exercisable within 60 days. Does not include 18,750 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(10) +Includes 30,079 shares issuable upon exercise of options exercisable within 60 days. Does not include 18,750 shares issuable upon exercise of options that are not exercisable within the next 60 days. +(11) +Includes footnotes (1)-(10). +Equity Compensation Plan Information +Combined Equity Compensation Plans - Information as of December 31, 2013 +Plan Category +Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights +Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights +Number of Securities Remaining Available for Future Issuance under Equity Compensation Plans (Excluding Securities Reflected in Column (a) +(a) +(b) +(c) +Equity compensation plans approved by security holders 1 +656,398 +$ +2.57 +43,132 +Equity compensation plans not approved by security holders +- +- +- +Total +656,398 +$ +2.57 +43,132 +1 The "Number of Securities to be Issued Upon Exercise of Outstanding Warrants and Rights" represents 93,750 from the 1999 Stock Option Plan and 562,648 under the 2008 Stock Incentive Plan. The 2008 Stock Incentive Plan was increased by 125,000 units at the Annual Stockholder meeting held September 23, 2011. The "Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans" represents shares issuable under the 2008 Stock Incentive Plan. +45 +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +The executive officers of the Company are as follows: Lawrence A. Siebert, president, chief executive officer and chairman of the board of directors of the Company, Sharon Klugewicz, chief operating officer, Richard J. Larkin, chief financial officer of the Company, and Javan Esfandiari, executive vice president of Research and Development of the Company. +On February 16, 2012, the Company granted options to purchase the following numbers of shares of the Company's common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company's common stock on February 16, 2012, which was $4.00 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee's employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +2,563 +Javan Esfandiari – Executive Vice President of R&D +7,969 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +3,000 +Richard J. Larkin – Chief Financial Officer +2,797 +Lawrence A. Siebert – Chief Executive Officer +9,063 +On February 25, 2013, the Company granted options to purchase the following numbers of shares of the Company's common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company's common stock on February 26, 2013, which was $5.56 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee's employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +1,520 +Javan Esfandiari – Executive Vice President of R&D +4,765 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +1,775 +Sharon Klugewicz – Vice President of QA/QC +630 +Richard J. Larkin – Chief Financial Officer +1,670 +Lawrence A. Siebert – Chief Executive Officer +5,215 +Michael Steele – Vice President of Sales and Marketing +785 +The Company entered into an employment agreement effective March 5, 2013 (the "Employment Agreement"), with Mr. Esfandiari to continue as the Company's Senior Vice President of Research and Development for an additional term of three years through March 5, 2016. The Company entered into an employment agreement, effective May 22, 2013 (the "Employment Agreement"), with Ms. Klugewicz to become the Company's Chief Operating Officer for a term of two years through May 22, 2015. See Item 11 for more details. +Director Independence +Our common stock trades on the NASDAQ. Accordingly, we are subject to the corporate the governance standards of NASDAQ, which require, among other things, that the majority of the board of directors be independent. We define an "independent" director in accordance with the NASDAQ Global Market's requirements for independent directors. Under this definition, we have determined that each of Katherine Davis, Barbara DeBuono, Peter Kissinger, and Gary Meller currently qualify as independent directors. We do not list the "independent" definition we use on our internet website. +46 +ITEM 14. +PRINCIPAL ACCOUNTANT FEES AND SERVICES +Audit Fees +For the years ended December 31, 2013 and 2012 the Company engaged BDO USA, LLP as its independent accounting firm to audit of the Company's annual financial statements included on Form 10-K, including reviews of the quarterly financial statements and assistance with and review of documents filed with the SEC, for $159,950 and $119,000 respectively in fees. +Audit-Related Fees +For the years ended December 31, 2013 and 2012, the Company's independent accounting firm, BDO USA, LLP, did not provide the Company with any assurance and related services reasonably related to the performance of the audit or review of the Company's financial statements that are not reported above under "Audit Fees." +Tax Fees +For the years ended December 31, 2013 and 2012, the Company's independent accounting firm, BDO USA, LLP, billed the Company $17,500 and $20,000, respectively for professional services for tax compliance, tax advice and tax planning. +All Other Fees +For the years ended December 31, 2013 and 2012, the Company's independent accounting firm, BDO USA, LLP, did not provide the Company with any services for other matters. +Audit Committee Pre-Approval Policies +The Audit Committee approves in advance all audit and non-audit services performed by the independent accounting firm. There are no other specific policies or procedures relating to the pre-approval of services performed by the independent accounting firm. +47 +ITEM 15. +EXHIBITS INDEX +Number +Description +3.1 +Articles of Incorporation, as amended. (1) +3.2 +Amended and Restated Bylaws. (2) +4.1* +Form of Employee Option Agreement. (3) +4.2 +1999 Equity Incentive Plan, as amended. (5) +4.3 +2008 Stock Incentive Plan, as amended. (5) +4.4 +Rights Agreement, dated March 8, 2010 (6) +4.5 +Form of Warrant (to be filed by amendment) +10.1* +Employment Agreement dated June 15, 2006 with Lawrence A. Siebert, as extended. (7)(11) +10.2* +Employment Agreement dated March 5, 2013 with Javan Esfandiari (10). +10.3* +Employment Agreement dated May 22, 2013 with Sharon Klugewicz (12) +10.3 +HIV Barrel License, Marketing and Distribution Agreement, dated as of September 29, 2006, by and among the Registrant, Alere and StatSure. (8) +10.4 +HIV Cassette License, Marketing and Distribution Agreement, dated as of September 29, 2006, between the Registrant and Alere. (8) +10.5 +Non-Exclusive License, Marketing and Distribution Agreement, dated as of September 29, 2006, between the Registrant and Alere. (8) +10.6 +Joint HIV Barrel Product Commercialization Agreement, dated as of September 29, 2006, between the Registrant and StatSure. (8) +10.8 +Secured Revolving Demand Note, dated as of April 30, 2013, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (12) +10.9 +Loan and Security Agreement, dated as of April 30, 2013, by and among the Registrant, Chembio Diagnostics Systems, Inc. and HSBC Bank, NA (12) +14.1 +Ethics Policy (9) +21 +List of Subsidiaries +23.1 +Consent of BDO USA, LLP, Independent Registered Public Accountants. +31.1 +Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2 +Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32 +Certification of Chief Executive Officer and Chief Financial Officer pursuant to 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.DEF +XBRL Taxonomy Definition Linkbase Document +101.LAB +XBRL Taxonomy Label Linkbase Document +101.PRE +XBRL Taxonomy Presentation Linkbase Document +1 +Incorporated by reference to the Registrant's annual report on Form 10-KSB filed with the Commission on March 31, 2005. +2 +Incorporated by reference to the Registrant's registration statement on Form SB-2 (File No. 333-85787) filed with the Commission on August 23, 1999 and the Registrant's Forms 8-K filed on May 14, 2004, December 20, 2007 and April 18, 2008. +3 +Incorporated by reference to the Registrant's annual report on Form 10-KSB filed with the Commission on March 12, 2008. +4 +Incorporated by reference to the Registrant's definitive proxy statement on Schedule 14A filed with the Commission on May 11, 2005. +5 +Incorporated by reference to the Registrant's definitive proxy statement on Schedule 14A filed with the Commission on Auguust 3, 2012. +6 +Incorporated by reference to the Registrant's registration statement on Form 8-A filed with the Commission on March 11, 2010. +7 +Incorporated by reference to the Registrant's Current Report on Form 8-K filed with the Commission on June 21, 2006. +8 +Incorporated by reference to the Registrant's Current Report on Form 8-K filed with the Commission on October 5, 2006. +9 +Incorporated by reference to the Registrant's Annual Report on Form 10-KSB filed with the Commission on March 30, 2006. +10 +Incorporated by reference to the Registrant's Annual Report on Form 10-K filed with the Commission on March 7, 2013. +11 +Incorporated by reference to the Registrant's Current Report on Form 8-K filed with the Commission on April 25, 2013. +12 +Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q filed with the Commission on August 8, 2013. +(*) +An asterisk (*) beside an exhibit number indicates the exhibit contains a management contract, compensatory plan or arrangement which is required to be identified in this report. +48 +SIGNATURES +In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +CHEMBIO DIAGNOSTICS, INC. +Date: March 6, 2013 +By +/s/ Lawrence A. Siebert +Lawrence A. Siebert +President, Chief Executive Officer and +Chairman of the Board +In accordance with the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. +Signatures +Title +Date +/s/ Lawrence A. Siebert +Chief Executive Officer, President and +March 6, 2014 +Lawrence A. Siebert +Chairman Of The Board +(Principal Executive Officer) +/s/ Richard J. Larkin +Chief Financial Officer (Principal Financial & +March 6, 2014 +Richard J. Larkin +Accounting Officer) +/s/ Gary Meller +Director +March 6, 2014 +Dr. Gary Meller +/s/ Katherine L. Davis +Director +March 6, 2014 +Katherine L. Davis +/s/ Pete Kissinger +Director +March 6, 2014 +Pete Kissinger +/s/ Barbara DeBuono +Director +March 6, 2014 +Barbara DeBuono +49 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +Index to Consolidated Financial Statements +—INDEX— +Page(s) +Report of Independent Registered Public Accounting Firm +F-1 +Consolidated Financial Statements: +Balance Sheets December 31, 2013 and 2012 +F-2 +Statements of Operations Years ended December 31, 2013 and 2012 +F-3 +Statements of Changes in Stockholders' Equity Years ended December 31, 2013 and 2012 +F-4 +Statements of Cash Flows Years ended December 31, 2013 and 2012 +F-5 +Notes to Consolidated Financial Statements +F-6 - F-18 +51 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +Board of Directors and Stockholders of +Chembio Diagnostics, Inc. +Medford, New York +We have audited the accompanying consolidated balance sheets of Chembio Diagnostics, Inc. and Subsidiary (the "Company") as of December 31, 2013 and 2012 and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Chembio Diagnostics, Inc. and Subsidiary as of December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. +BDO USA, LLP +/s/ BDO USA, LLP +Melville, New York +March __ , 2014 +F-1 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED BALANCE SHEETS +AS OF +- ASSETS - +December 31, 2013 +December 31, 2012 +CURRENT ASSETS: +Cash and cash equivalents +$ +9,650,275 +$ +2,951,859 +Accounts receivable, net of allowance for doubtful accounts of $24,000 and $58,000 at December 31, 2013 and 2012, respectively +4,592,121 +4,821,357 +Inventories +3,188,726 +2,488,071 +Prepaid expenses and other current assets +1,099,379 +747,463 +TOTAL CURRENT ASSETS +18,530,501 +11,008,750 +FIXED ASSETS , net of accumulated depreciation +1,978,232 +1,427,646 +OTHER ASSETS: +Deferred tax asset, net of valuation allowance +3,590,207 +4,233,194 +License agreements, net of current portion +326,875 +400,000 +Deposits on manufacturing equipment +16,410 +223,584 +Deposits and other assets +44,367 +41,976 +TOTAL ASSETS +$ +24,486,592 +$ +17,335,150 +- LIABILITIES AND STOCKHOLDERS' EQUITY - +CURRENT LIABILITIES: +Accounts payable and accrued liabilities +$ +4,309,490 +$ +3,303,923 +Current portion of loans payable +- +51,236 +Customer deposits +- +23,224 +Current portion of obligations under capital leases +- +- +TOTAL CURRENT LIABILITIES +4,309,490 +3,378,383 +OTHER LIABILITIES: +Loans payable - net of current portion +- +82,247 +TOTAL LIABILITIES +4,309,490 +3,460,630 +COMMITMENTS AND CONTINGENCIES +STOCKHOLDERS' EQUITY: +Preferred stock – 10,000,000 shares authorized, none outstanding +- +- +Common stock - $.01 par value; 100,000,000 shares authorized, 9,324,783 and 8,036,232 shares issued and outstanding for 2013 and 2012, respectively +93,248 +80,362 +Additional paid-in capital +46,875,027 +41,116,149 +Accumulated deficit +(26,791,173 +) +(27,321,991 +) +TOTAL STOCKHOLDERS' EQUITY +20,177,102 +13,874,520 +TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY +$ +24,486,592 +$ +$ 17,335,150 +See accompanying notes to condensed consolidated financial statements +F-2 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF OPERATIONS +FOR THE YEARS ENDED +For the years ended +December 31, 2013 +December 31, 2012 +REVENUES: +Net product sales +$ +27,515,786 +$ +24,327,355 +License and royalty revenue +4,906 +- +R&D, milestone and grant revenue +2,028,917 +1,283,240 +TOTAL REVENUES +29,549,609 +25,610,595 +Cost of product sales +17,249,450 +14,820,604 +GROSS MARGIN +12,300,159 +10,789,991 +OPERATING EXPENSES: +Research and development expenses +5,834,249 +4,486,302 +Selling, general and administrative expenses +5,461,083 +4,851,587 +11,295,332 +9,337,889 +INCOME FROM OPERATIONS +1,004,827 +1,452,102 +OTHER INCOME (EXPENSE): +Other income +7,500 +- +Interest income +5,778 +7,911 +Interest expense +(335 +) +(9,495 +) +12,943 +(1,584 +) +INCOME BEFORE INCOME TAXES +1,017,770 +1,450,518 +Income tax provision +486,952 +509,237 +NET INCOME +$ +530,818 +$ +941,281 +Basic earnings per share +$ +0.06 +$ +0.12 +Diluted earnings per share +$ +0.06 +$ +0.11 +Weighted average number of shares outstanding, basic +8,994,080 +7,986,030 +Weighted average number of shares outstanding, diluted +9,519,968 +8,614,944 +See accompanying notes to condensed consolidated financial statements +F-3 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY +FOR THE YEARS ENDED DECEMBER 31, 2013 AND 2012 +Common Stock +Additional Paid +in Capital +Accumulated +Deficit +Total +Shares +Amount +Amount +Amount +Amount +Balance at December 31, 2011 +7,921,021 +$ +79,210 +$ +40,678,696 +$ +(28,263,272 +) +$ +12,494,634 +Common Stock: +Consulting Services +3,752 +38 +16,441 +- +16,479 +Options: +Exercised +111,459 +1,114 +119,276 +- +120,390 +Stock option compensation +- +- +293,726 +- +293,726 +Consulting Services-options +- +- +8,010 +- +8,010 +Net income +- +- +- +941,281 +941,281 +Balance at December 31, 2012 +8,036,232 +$ +80,362 +$ +41,116,149 +$ +(27,321,991 +) +$ +13,874,520 +Common Stock: +New Stock from Offering +1,200,000 +12,000 +5,396,462 +- +5,408,462 +Options: +Exercised +88,551 +886 +30,546 +- +31,432 +Stock option compensation +- +- +331,870 +- +331,870 +Net income +- +- +- +530,818 +530,818 +Balance at December 31, 2013 +9,324,783 +$ +93,248 +$ +46,875,027 +$ +(26,791,173 +) +$ +20,177,102 +See accompanying notes to consolidated financial statements +F-4 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +CONSOLIDATED STATEMENTS OF CASH FLOWS +FOR THE YEARS ENDED +December 31, 2013 +December 31, 2012 +CASH FLOWS FROM OPERATING ACTIVITIES: +Cash received from customers and grants +$ +29,778,845 +$ +23,810,911 +Cash paid to suppliers and employees +(27,506,674 +) +(23,048,243 +) +Interest received +5,778 +7,911 +Interest paid +(335 +) +(9,495 +) +Net cash provided by operating activities +2,277,614 +761,084 +CASH FLOWS FROM INVESTING ACTIVITIES: +Acquisition of and deposits on fixed assets +(885,609 +) +(872,442 +) +Net cash used in investing activities +(885,609 +) +(872,442 +) +CASH FLOWS FROM FINANCING ACTIVITIES: +Proceeds from option and warrant exercises +31,432 +120,390 +Proceeds from sale of common stock, net +5,408,462 +Payment of loan obligation +(133,483 +) +(53,551 +) +Payment of capital lease obligation +- +(14,576 +) +Net cash provided by (used in) financing activities +5,306,411 +52,263 +(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS +6,698,416 +(59,095 +) +Cash and cash equivalents - beginning of the period +2,951,859 +3,010,954 +Cash and cash equivalents - end of the period +$ +9,650,275 +$ +2,951,859 +RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: +Net Income +$ +530,818 +$ +941,281 +Adjustments: +Depreciation and amortization +607,822 +523,278 +Provision for deferred taxes +458,154 +471,085 +Provision for doubtful accounts +(34,000 +) +28,000 +Share based compensation +331,870 +318,215 +Changes in assets and liabilities: +Accounts receivable +263,236 +(1,850,908 +) +Inventories +(700,655 +) +(187,785 +) +Prepaid expenses and other current assets +(159,583 +) +(20,227 +) +Deposits and other assets +(2,391 +) +498 +Accounts payable and accrued liabilities +1,005,567 +514,423 +Customer deposits and deferred revenue +(23,224 +) +23,224 +Net cash provided by operating activities +$ +2,277,614 +$ +761,084 +Supplemental disclosures for non-cash investing and financing activities: +Deposits on manufacturing equipment transferred to fixed assets +$ +521,561 +$ +229,042 +See accompanying notes to condensed consolidated financial statements +F-5 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2013 AND 2012 +NOTE 1 — DESCRIPTION OF BUSINESS: +Chembio Diagnostics, Inc. (the "Company" or "Chembio") and its subsidiary, Chembio Diagnostic Systems, Inc., develop, manufacture, and market rapid diagnostic tests that detect infectious diseases. The Company's main lateral flow products are three rapid tests for the detection of HIV antibodies in whole blood, serum and plasma samples, two of which were approved by the FDA in 2006; the third is sold for export only. Lateral Flow Rapid HIV tests represented nearly 74% of the Company's product revenues in 2013. The Company's products based on its patented DPP® platform represented approximately 24% of the Company's product revenues in 2013. The Company also has other rapid tests that together represented approximately 2% of sales in 2013. The Company's products are sold to medical laboratories and hospitals, governmental and public health entities, non-governmental organizations, medical professionals and retail establishments both domestically and internationally. Chembio's products are sold under the Company's STAT-PAK®, SURE CHECK® or DPP® registered trademarks, or under the private labels of its marketing partners, for example the Clearview® label owned by Alere, Inc. ("Alere"), which is the Company's exclusive marketing partner for its rapid HIV lateral flow test products in the United States. These products employ lateral flow technologies that are proprietary and/or licensed to the Company. All of the Company's products that are currently being developed are based on its patented Dual Path Platform® (DPP®), which is a unique diagnostic point-of-care platform that has certain advantages over lateral flow technology. In December 2012, the Company received FDA approval for its DPP® HIV 1/2 Assay for the detection of HIV antibodies in saliva, whole blood, serum and plasma samples. +NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES: +(a) +Principles of Consolidation: +The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary. All intercompany transactions and balances have been eliminated in consolidation. +(b) +Use of Estimates: +The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make assumptions and estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods covered thereby. Actual results could differ from these estimates. Judgments and estimates of uncertainties are required in applying the Company's accounting policies in certain areas. The following are some of the areas requiring significant judgments and estimates: determinations of the useful lives of assets, estimates of allowances for doubtful accounts, inventory reserves, stock-based compensation and deferred tax assets. +(c) +Fair Value of Financial Instruments: +The carrying value for cash and cash equivalents, accounts receivable and accounts payable, approximate fair value because of the immediate or short-term maturity of these financial instruments. The Company's debt relates to borrowings under its credit facilities and term loan (see Note 7), which approximates fair value due to market interest rates. +(d) +Statements of Cash Flows: +For purposes of the statements of cash flows, the Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. +(e) +Concentrations of Credit Risk: +Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade receivables. The Company places its temporary cash instruments with well-known financial institutions and, at times, may maintain balances in excess of the FDIC insurance limit. The Company monitors the credit ratings of the financial institutions to mitigate this risk. Concentration of credit risk with respect to trade receivables is principally mitigated by the Company's ability to obtain letters of credit from certain foreign customers, and its diverse customer base both in number of customers and geographic locations. We currently do not require collateral for accounts receivable. +F-6 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2013 AND 2012 +(f) +Inventories: +Inventories, consisting of material, labor and manufacturing overhead, are stated at the lower of cost or market. Cost is determined on the first-in, first-out method. +(g) +Fixed Assets: +Fixed assets are stated at cost, less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets, which range from three to seven years. Leasehold improvements are amortized over the useful life of the asset or the lease term, whichever is shorter. Deposits paid for fixed assets are capitalized and not depreciated until the related asset is placed in service. +(h) +License Agreement: +In February 2008, the Company entered into a sublicense agreement for which it had initially recorded an asset of $1,000,000. This asset is being expensed over an estimated economic life of ten years, based on the expected lifespan of our then current HIV products. The current portion of this asset is $100,000 as of December 31, 2013 and 2012 and is reported in prepaid expenses and other current assets. The long-term portion as of December 31, 2013 and 2012 is $300,000 and $400,000, respectively and is reflected in other assets on the consolidated balance sheet. +(i) +Impairment of Long-Lived Assets and Intangible Assets +Long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment. If there are indications of impairment, the Company uses future undiscounted cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. In the event such cash flows are not expected to be sufficient to recover the recorded asset values, the assets are written down to their estimated fair value. We believe that the carrying values of our long-lived tangible and intangible assets were realizable at December 31, 2013 and 2012, respectively. +(j) +Revenue Recognition: +The Company recognizes revenue for product sales in accordance with ASC 605, revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the sales price is fixed and determinable, and collectability is reasonably assured. Revenue typically is recognized at time of shipment. Sales are recorded net of discounts, rebates and returns. As of December 31, 2013 and 2012, an aggregate of none and $23,224, respectively, of customer deposits were not recognized. +For certain contracts, the Company recognizes revenue from non-milestone contracts and grant revenues when earned. Grants are invoiced after expenses are incurred. Revenues from projects or grants funded in advance are deferred until earned. As of December 31, 2013 and 2012, all advanced revenues were earned. +The Company follows Financial Accounting Standards Board ("FASB") issued authoritative guidance ("guidance") prospectively for the recognition of revenue under the milestone method. The Company applies the milestone method of revenue recognition for certain collaborative research projects defining milestones at the inception of the agreement. +(k) +Research and Development: +Research and development (R&D) costs are expensed as incurred. +F-7 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2013 AND 2012 +(l) +Stock-Based Compensation: +Stock-based compensation expense is calculated using the Black-Scholes valuation model based on awards ultimately expected to vest, reduced for forfeitures, and expensed on a straight-line basis over the requisite service period of the grant. +(m) +I ncome Taxes: +The Company accounts for income taxes under an asset and liability approach which recognizes deferred tax assets and liabilities based on the difference between the financial statement carrying amounts and the tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. +The Company follows a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. The guidance relates to, among other things, classification, accounting for interest and penalties associated with tax positions, and disclosure requirements. Any interest and penalties accrued related to uncertain tax positions will be recorded in tax expense. +(n) +Earnings Per Share +On May 30, 2012, the Company effected a 1-for-8 reverse split of its common stock. This was done to allow the Company to move to the NASDAQ trading market from the OTCQB market, which occurred on June 7, 2012. As a result of the stock split, the outstanding 63,967,263 common shares were reduced to 7,995,918 outstanding common shares on May 30, 2012. The effect of the reverse stock split has been retroactively reflected for all periods in these financial statements. +The following weighted average shares were used for the computation of basic and diluted earnings per share: +For the years ended +December 31, 2013 +December 31, 2012 +Basic +8,994,080 +7,986,030 +- +- +Diluted +9,519,968 +8,614,944 +Basic earnings per share is computed by dividing net earnings attributable to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share for the year ended December 31, 2013 and 2012 reflects the potential dilution from the exercise or conversion of other securities into common stock. +The following securities, presented on a common share equivalent basis, have been used in the diluted per share computations: +For the years ended +December 31, 2013 +December 31, 2012 +1999 and 2008 Plan Stock Options +525,888 +628,914 +There were 169,662 and 161,464 options and warrants outstanding as of December 31, 2013 and 2012, respectively, which were not included in the calculation of diluted income per share for the years ended because their effect would have been anti-dilutive. +F-8 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2013 AND 2012 +(o) +Recent Accounting Pronouncements Affecting the Company: +New accounting pronouncements are issued by the Financial Accounting Standards Board ("FASB") or other standards setting bodies that we adopt according to the various timetables the FASB specifies. The Company does not expect the adoption of recently issued accounting pronouncements to have a significant impact on the Company's results of operations, financial position or cash flow. +NOTE 3 — INVENTORIES: +Inventories consist of the following at: +December 31, 2013 +December 31, 2012 +Raw materials +$ +1,710,627 +$ +1,418,071 +Work in process +464,481 +561,530 +Finished goods +1,013,618 +508,470 +$ +3,188,726 +$ +2,488,071 +NOTE 4 — FIXED ASSETS: +Fixed assets consist of the following at: +December 31, 2013 +December 31, 2012 +Machinery and equipment +$ +3,158,265 +$ +2,439,596 +Furniture and fixtures +352,923 +287,412 +Computer and telephone equipment +167,045 +151,737 +Leasehold improvements +1,016,783 +798,049 +Automobiles +37,061 +29,228 +4,732,077 +3,706,022 +Less accumulated depreciation and amortization +(2,753,845 +) +(2,278,376 +) +$ +1,978,232 +$ +1,427,646 +There were no capital leases at the end of December 31, 2013. Fixed assets at December 31, 2013 also include $493,000 in equipment, which has been delivered and set-up but is undergoing validation and as such is currently not being depreciated. Depreciation expense for the 2013 and 2012 years aggregated $505,000 and $423,000, respectively. +As of December 31, 2013 and 2012, the Company had paid deposits on various pieces of equipment aggregating $16,410 and $223,584, respectively. The Company is further committed to an additional obligation of $31,990 as various milestones are achieved by the various vendors. +NOTE 5 — ACCOUNTS PAYABLE AND ACCRUED LIABILITIES: +Accounts payable and accrued liabilities consist of the following at: +December 31, 2013 +December 31, 2012 +Accounts payable – suppliers +$ +1,815,369 +$ +1,686,431 +Accrued commissions +371,905 +238,150 +Accrued royalties / license fees +1,028,286 +583,923 +Accrued payroll +328,564 +262,439 +Accrued vacation +203,444 +181,636 +Accrued bonuses +317,372 +155,663 +Accrued expenses – other +244,550 +195,681 +TOTAL +$ +4,309,490 +$ +3,303,923 +F-9 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2013 AND 2012 +NOTE 6 — DEFERRED RESEARCH AND DEVELOPMENT REVENUE: +The Company recognizes income from R&D milestones when those milestones are reached and non-milestone contracts and grants when earned. Grants are invoiced after expenses are incurred. Any projects or grants funded in advance are deferred until earned. As of December 31, 2013 and 2012, there were no unearned advanced revenues. +NOTE 7 — TERM NOTE, REVOLVING DEMAND NOTE, VEHICLE FINANCING AND LICENSE FEE PAYABLE: +On April 30, 2013, the Company entered into a new demand loan agreement ("Demand Note") with HSBC Bank, USA ("HSBC"). The Demand Note allows the Company to draw on the line from time to time an amount up to an aggregate of $2,000,000 outstanding at any one time. The accrued interest on the Demand Note is payable monthly at an interest rate equal to one-quarter percent above prime per annum. The Company can repay any or all of the principal balance outstanding at any time. This is a demand note for which the bank lender can demand repayment of the entire loan, with accrued interest, at any time. The loan is subject to annual reviews, as well as an annual 30-day clean-up, during which there can be no amounts outstanding. +The Security Agreement, related to the Demand Note, contains covenants that place restrictions on the Company's operations, including covenants relating to mergers, debt restrictions, capital expenditures, tangible net worth, net profit, leverage, fixed charge coverage, employee loan restrictions, distribution restrictions (common stock and preferred stock), dividend restrictions, restrictions on lease payments to affiliates, restrictions on changes in business, asset sale restrictions, restrictions on acquisitions and intercompany transactions, and restrictions on fundamental changes in the Company and in its business. +The Company currently maintains its operating, payroll, and primary cash accounts at HSBC. As of December 31, 2013, nothing had been drawn down on the Demand Note and all covenants were met. +NOTE 8 — INCOME TAXES: +The provision for income taxes for the years ended December 31, 2013 and 2012, is comprised of the following: +2013 +2012 +Current +Federal +$ +27,175 +$ +33,054 +State +1,623 +5,098 +Total current provision +28,798 +38,152 +Deferred +Federal +454,439 +464,005 +State +3,715 +7,080 +Total deferred provision +458,154 +471,085 +Total provision +$ +486,952 +$ +509,237 +The Company had an ownership change as described in Internal Revenue Code Sec. 382 during 2004 ("2004 change"). As a result, the Company's net operating losses prior to the 2004 change of $5,832,516 were subject to an annual limitation of $150,608 and for the first five (5) years are entitled to a BIG (Built-In-Gains) of $488,207 per year. These net operating losses expire in 2018 through 2024. +The Company had a second ownership change during 2006 ("2006 change"). The net operating losses incurred between the 2004 change and the 2006 change of $8,586,861 were subject to an annual limitation of $1,111,831 and for the first five (5) years are entitled to a BIG of $1,756,842 per year. These net operating losses expire in 2018 through 2028. +F-10 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2013 AND 2012 +After applying the above limitations, at December 31, 2013, the Company has post-change net operating loss carry-forwards of approximately $10,551,034 which expire between 2020 and 2028. In addition the Company has research and development tax credit carryforwards of approximately $1,052,000 for the year ended December 31, 2013, which expire between 2025 and 2033. +2013 +2012 +Current assets +Inventory reserves +$ +307,080 +$ +224,694 +Accrued expenses +329,187 +226,740 +Net current deferred asset +$ +636,267 +$ +451,434 +Noncurrent assets +Net operating loss carry-forwards +$ +3,616,089 +$ +4,236,008 +Research and development credit +1,052,166 +711,444 +Other credits +124,413 +97,234 +Other +107,808 +99,097 +Gross noncurrent deferred tax assets +4,900,476 +5,143,783 +Depreciation +(258,103 +) +(199,145 +) +Noncurrent deferred tax assets +4,642,373 +4,944,638 +Less valuation allowances +(1,052,166 +) +(711,444 +) +Net noncurrent deferred tax assets +$ +3,590,207 +$ +4,233,194 +A reconciliation of the Federal statutory rate to the effective rate applicable to income (loss) before income taxes is as follows: +Year Ending December 31, +2013 +2012 +Federal income tax at statutory rates +34.00% +34.00% +State income taxes, net of federal benefit +.47% +0.70% +Nondeductible expenses +10.27% +5.40% +Change in valuation allowance +33.48% +8.90% +Tax credits +(33.48)% +(8.90)% +Change in tax rates +3.10% +(5.20)% +Other +(.01)% +0.20% +Income tax (benefit) +47.83% +35.10% +Interest and penalties, if any, related to income tax liabilities are included in income tax expense. As of December 31, 2013, the Company does not have a liability for uncertain tax positions. +The Company files Federal and New York state income tax returns. Tax years for fiscal 2010 through 2012 are open and potentially subject to examination by the federal and New York state taxing authorities. +F-11 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2013 AND 2012 +NOTE 9 — STOCKHOLDERS' EQUITY: +(a) +Common Stock +The Company closed on an underwritten public offering of 1,200,000 shares of its common stock at $5.00 per share on April 3, 2013. The net proceeds of the offering, after deducting the underwriters' discounts and other offering expenses payable by the Company, was approximately $5,408,000. The Company intends to use the net proceeds for business expansion and working capital. +During 2013, options to purchase 88,551 shares of the Company's common stock were exercised at exercise prices ranging from of $1.04 to $1.76 +During 2012, options to purchase 111,459 shares of the Company's common stock were exercised at exercise prices ranging from of $1.04 to $1.76. +In March 2012, June 2012, September 2012 and December 2012, the Company issued 938 shares of common stock on each date to a consultant as part of the consultant's compensation. +(b) +Preferred Stock +The Company has 10,000,000 shares of preferred stock authorized and none outstanding. These shares can become issuable upon an approved resolution by the board of directors and the filing of a Certificate of Designation with the state of Nevada. +(c) +Options +The Company entered into an employment agreement effective May 22, 2013 ("Employment Agreement"), with Ms. Klugewicz to serve as the Company's Chief Operating Officer, which included issuing incentive stock options to purchase 5,000 shares of the Company's common stock. The options are exercisable in two equal annual installments starting on the first anniversary of the date of issue. The exercise price for these options was to be equal to the last traded price for the Company's common stock on May 22, 2013, which was $4.50 per share. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee's employment with the Company or (b) the fifth anniversary of the effective date of the grant. +On February 26, 2013, the Company issued 16,360 options to purchase common stock to executives of the Company as part of their 2012 bonus. The options are exercisable immediately at $5.56 per share, which was the last traded price of the common stock on that day, and they expire five years from the date of issue. +The Company entered into an employment agreement effective March 5, 2013 ("Employment Agreement"), with Mr. Esfandiari to continue as the Company's Senior Vice President of Research and Development, which included issuing incentive stock options to purchase 30,000 shares of the Company's common stock. The options are exercisable in three equal annual installments starting on the first anniversary of the date of issue. The exercise price for these options was to be equal to the last traded price for the Company's common stock on March 5, 2013, which was $5.44 per share. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee's employment with the Company or (b) the fifth anniversary of the effective date of the grant. +On February 16, 2012, the Company issued 25,392 options to purchase common stock to executives of the Company as part of their 2011 bonus. The options are exercisable immediately at $4.00 per share, which was the last traded price of the common stock on that day, and they expire five years from date of issue. +F-12 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2013 AND 2012 +In March 2012, the Company issued 3,750 options to purchase shares of the Company's common at an exercise price of $4.00 per share to a consultant as part of the consultant's compensation. On each of March 19, 2012, June 19, 2012, September 19, 2012 and December 19, 2012, 938 of these options vested. These options were valued using a Black-Scholes model at $8,010, all of which was expensed in the year ended December 31, 2012. The options are being accounted for under the variable method as per ASC 505 and $50 of the expense was reduced attributable to this method. +During the third quarter of 2012, the Company issued 72,000 options to purchase common stock to newly-hired vice-presidents of the Company. The options are exercisable in three equal annual installments starting on the first anniversary of the date of issue. An allotment of 36,000 options issued to one of the new vice presidents have an exercise price of $5.11 per share, and the 36,000 options that were issued to the other new vice president have an exercise price of $4.45 per share, which in each case was the last traded price of the common stock on the day issued. The options expire five years from date of issue. +(d) +Warrants +As of December 31, 2013 and 2012, the Company had no warrants outstanding to purchase shares of common stock. +NOTE 10 — RIGHTS AGREEMENT: +In March 2010, the Company entered into a Rights Agreement (the "Rights Agreement") between the Company and Action Stock Transfer Corp., as Rights Agent. Pursuant to the Rights Agreement, the Company declared a dividend distribution of one preferred share purchase right (a "Right") for each outstanding share of Common Stock, $0.01 par value (the "Common Stock"), of the Company. The Board of Directors set the payment date for the distribution of the Rights as March 8, 2010, and the Rights were distributed to the Company's shareholders of record on that date. The description and terms of the Rights are set forth in the Rights Agreement. +Rights Initially Not Exercisable. The Rights are not exercisable until a Distribution Date. Until a Right is exercised, the holder thereof, as such, will have no rights as a shareholder of the Company, including, without limitation, the right to vote or to receive dividends. +Separation and Distribution of Rights . The Rights will be evidenced by the certificates for shares of Common Stock registered in the names of the holders thereof, and not by separate rights certificates until the earlier to occur of (i) the close of business on the tenth business day following a public announcement that an Acquiring Person (as defined in the Rights Agreement) acquired a Combined Ownership (as defined in the Rights Agreement) of 15% or more of the outstanding shares of the Common Stock (the "Shares Acquisition Date") or (ii) the later of (A) the close of business on the tenth business day (or such later date as may be determined by action of the Board of Directors prior to such time as any person or group of affiliated or associated persons becomes an Acquiring Person) after the date that a tender or exchange offer or intention to commence a tender or exchange offer by any person is first published, announced, sent or given within the meaning of Rule 14d-4(A) under the Securities Exchange Act of 1934, as amended, the consummation of which would result in any person having Combined Ownership of 15% or more of the outstanding shares of the Common Stock, or (B) if such a tender or exchange offer has been published, announced, sent or given before the date of the Rights Agreement, then the close of business on the tenth business day after the date the Rights Agreement was entered into (or such later date as may be determined by action of the Board of Directors prior to such time as any person becomes an Acquiring Person); (the earlier of such dates referred to in (i) and (ii), which date may include any such date that is after the date of the Rights Agreement but prior to the issuance of the Rights, being called the "Distribution Date"). +F-13 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2013 AND 2012 +NOTE 11 — EMPLOYEE STOCK OPTION PLAN: +The Company has a 1999 Stock Option Plan ("SOP") originally covering 187,500 shares of Common Stock. Under the terms of the SOP, the Compensation Committee of the Company's board is authorized to grant incentive options to key employees and to grant non-qualified options to key employees and key individuals. The options become exercisable at such times and under such conditions as determined by the Compensation Committee. The SOP was amended at the Company's 2005 stockholders' meeting. The number of options under the SOP was increased to cover 375,000 shares of common stock. It was also amended to allow independent directors to be eligible for grants under the portion of the SOP concerning non-qualified options. As of December 31, 2013, there were 93,750 outstanding options under this SOP. No additional options may be issued under the SOP more than 10 years after its adoption +Effective June 3, 2008, the Company's stockholders voted to approve the 2008 Stock Incentive Plan ("SIP"), with 625,000 shares of Common Stock available to be issued. At the Annual Stockholder meeting on September 22, 2011 the Company's stockholders voted to approve an increase to the shares of Common Stock issuable under the SIP by 125,000 to 750,000. Under the terms of the SIP, the Compensation Committee of the Company's Board has the discretion to select the persons to whom awards are to be granted. Awards can be stock options, restricted stock and/or restricted stock units. The awards become vested at such times and under such conditions as determined by the Compensation Committee. As of December 31, 2013, there were 144,220 options exercised, 562,648 options outstanding and 43,132 options still available to be issued under the SIP. +The Company's results for the years ended December 31, 2013 and 2012 include stock-based compensation expense totaling $332,000 and $294,000, respectively. Such amounts have been included in the Consolidated Statements of Operations within cost of goods sold ($78,000 and $49,000, respectively), research and development ($106,000 and $71,000, respectively) and selling, general and administrative expenses ($148,000 and $174,000, respectively). In accordance with ASC 718 the Company has not recorded a deferred tax asset related to the net operating losses resulting from the exercise of disqualifying stock options in the accompanying financial statements. The cumulative amount of unrecognized tax benefits at December 31, 2013 was immaterial, and if the Company is able to utilize this benefit in the future it would result in a credit to additional paid-in capital. +Stock option compensation expense in the years ended December 31, 2013 and 2012 represents the estimated fair value of options outstanding which is being amortized on a straight-line basis over the requisite vesting period of the entire award. +The weighted average estimated fair value of stock options granted in the years ended December 31, 2013 and 2012 was $3.99 and $3.27 per share, respectively. The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model. The expected volatility is based upon historical volatility of our stock and other contributing factors. The expected term is based on the Company's historical experience with similar type options. +The weighted-average assumptions made in calculating the fair values of options are as follows: +For the years ended +December 31, 2013 +December 31, 2012 +Expected term (in years) +4-5 +4- 5 +Expected volatility +99.6-115.77% +99.60-115.77% +Expected dividend yield +n/a +n/a +Risk-free interest rate +.34-.40% +.33-0.37% +The Company granted 51,360 new options during the year ended December 31, 2013 to employees at an average exercise price of $5.39 per share. +F-14 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2013 AND 2012 +The following table provides stock options activity for the year ended December 31, 2013: +Stock Options +Number of +Shares +Weighted +Average +Exercise Price per +Share +Weighted +Average +Remaining +Contractual +Term +Aggregate Intrinsic +Value +Outstanding at December 31, 2012 +731,646 +$ +2.22 +2.19 years +$ +3,460,686 +Granted +51,360 +$ +5.39 +Exercised +(88,551 +) +$ +1.33 +341,729 +Forfeited/expired/cancelled +(38,057 +) +$ +2.59 +Outstanding at December 31, 2013 +656,398 +$ +2.57 +1.65 years +$ +801,888 +Exercisable at December 31, 2013 +504,022 +$ +2.04 +1.16 years +$ +780,513 +The following table summarizes information about stock options outstanding at December 31, 2013: +Stock Options Outstanding +Stock Options Exercisable +Range of +Exercise +Prices +Shares +Average +Remaining +Contract Life +(Year) +Weighted +Average +Exercise +Price +Aggregate +Intrinsic +Value +Shares +Weighted +Average +Exercise +Price +Aggregate +Intrinsic +Value +$0.000 to 1.500 +328,749 +0.37 +$ +1.04 +$ +765,985 +328,749 +$ +1.04 +$ +765,985 +1.501 to 2.000 +- +- +- +- +- +- +- +2.001 to 3.500 +131,250 +2.28 +2.62 +98,818 +93,750 +2.54 +77,438 +3.501 to 4.500 +128,059 +2.83 +4.24 +- +67,183 +4.13 +- +4.501 to 8.000 +80,840 +3.92 +5.32 +- +26,840 +5.36 +- +Total +668,898 +1.64 +$ +2.48 +$ +864,803 +516,522 +$ +1.94 +$ +843,423 +As of December 31, 2013, there was $172,000 of net unrecognized compensation cost related to stock options that are not vested, which is expected to be recognized over a weighted average period of approximately 0.64 years. The total fair value of shares vested during the years ended December 31, 2013 and 2012, was $118,000 and $144,000, respectively. +NOTE 12 — GEOGRAPHIC INFORMATION: +FASB Guidance establishes standards for the way that business enterprises report information about operating segments in financial statements and requires that those enterprises report selected information. It also establishes standards for related disclosures about product and services, geographic areas, and major customers. +The Company produces only one group of similar products known collectively as "rapid medical tests". Management believes that it operates in a single business segment. Net sales by geographic area are as follows: +For the years ended +December 31, 2013 +December 31, 2012 +Africa +$ +4,352,731 +$ +2,669,140 +Asia +115,889 +658,831 +Europe +99,146 +54,280 +North America +9,730,557 +8,630,956 +South America +13,217,463 +12,314,148 +$ +27,515,786 +$ +24,327,355 +F-15 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2013 AND 2012 +Sales to Africa increased in 2013 primarily due to increased sales in Uganda by approximately $1,236,000 and Ethiopia by approximately $262,000. Sales in Asia decreased from decreased sales in the Middle East by $483,000. Sales in 2013 and 2012 to North America were primarily from sales in the U.S of approximately $9.10 million and $7.72 million, respectively and sales in 2013 and 2012 to South America were primarily from sales in Brazil of approximately $6.10 million and $10.30 million, respectively. +NOTE 13 — COMMITMENTS AND CONTINGENCIES: +Employment Contracts: +The Company has contracts with three key employees. The contracts call for salaries presently aggregating $840,000 per year. One contract expires in May 2014, one expires in May 2015 and one contract expires in March 2016. The following table is a schedule of future minimum salary commitments: +2014 +$ +683,000 +2015 +415,000 +2016 +300,000 +2017 +50,000 +Pension Plan: +The Company has a 401(k) plan established for its employees. Effective January 1, 2011 the Company elected to match 40% of the first 5% (or 2% of salary) that an employee contributes to their 401(k) plan. Expenses related to this matching contribution aggregated $83,000 and $64,600 for the years ended December 31, 2013 and 2012, respectively. +Obligations Under Operating Leases: +The Company leases industrial space used for office, R&D and manufacturing facilities, currently with a monthly rent of $21,814. The current lease expires on April 30, 2017. The lease provides for annual increases of 2 1/2 percent each year starting May 1, 2015. In February of 2014, the Company entered into a lease, effective March 1, 2014, for another facility located a short distance from its current facility currently with a monthly rent of $14,658. The space will be used primarily for warehousing and provides for additional office space. The lease expires on April 30, 2018. The lease provides for annual increases of three percent each year starting March 1, 2015. +The following is a schedule of future minimum rental commitments (assuming no increases): +Years ending December 31, +2014 +$ +463,258 +2015 +513,414 +2016 +527,151 +2 017 +306,018 +2 018 +64,066 +$ +1,873,907 +Rent expense was $250,700 and $231,700 for the years ended December 31, 2013 and 2012, respectively. +F-16 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2013 AND 2012 +Economic Dependency: +The following table delineates sales the Company had to customers in excess of 10% of total sales for the periods indicated: +For the years ended +Accounts +Receivable As of +December 31, 2013 +December 31, 2012 +December 31, 2013 +December 31, 2012 +Sales +% of +Sales +Sales +% of +Sales +Customer 1 +$ +8,894,969 +32 +% +$ +7,778,688 +32 +% +$ +547,887 +$ +879,089 +Customer 2 +6,449,385 +23 +% +10,299,216 +42 +% +2,064,940 +1,668,156 +Customer 3 +6,745,939 +25 +% +* +* +- +* +In the table above the asterisk (*) indicates that sales to the customer did not exceed 10% for the period indicated. +The following table delineates purchases the Company had with vendors in excess of 10% of total purchases for the periods indicated. +For the years ended +Accounts +Payable As of +December 31, 2013 +December 31, 2012 +December 31, 2013 +December 31, 2012 +Purchases +% of +Purc. +Purchases +% of +Purc. +Vendor 1 +$ +* +* +% +$ +817,293 +13 +% +$ +105,095 +$ +114,892 +Vendor 2 +1,114,810 +10 +% +$ +778,793 +12 +% +84,161 +76,932 +In the table above the asterisk (*) indicates that purchases from the vendor did not exceed 10% for the period indicated. +The Company currently buys materials which are purchased under intellectual property rights agreements and are important components in its products. Management believes that other suppliers could provide similar materials on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would affect operating results adversely. +NOTE 14 — COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS: +In 2013 and 2012 the Company earned $2.0 million and $1.3 million, respectively, from research revenues and milestones. The Company is now involved in additional feasibility and development contracts related to its DPP® technology. The total expended on R&D in 2013 and 2012, was approximately $3.7 million and $3.1 million, respectively. +a. +National Institutes of Health (NIH) Grant: +In June 2009, the Company received a $3 million, three-year grant from the United States National Institutes of Health to complete development of a test for Leptospirosis. Grants are invoiced after expenses are incurred. The Company earned, for the years ended December 31, 2013 and 2012, $- and $270,000, respectively from this grant. The Company has earned an aggregate of $2,756,000 from this grant from inception through December 31, 2013, of which $898,000 was paid to sub-contractors. +F-17 +CHEMBIO DIAGNOSTICS, INC. AND SUBSIDIARY +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +DECEMBER 31, 2013 AND 2012 +In March 2011, the Company received a $2.4 million, three-year grant from the United States National Institutes of Health to complete development of a test for Tuberculosis. Grants are invoiced after expenses are incurred. The Company earned, for the years ended December 31, 2013 and 2012, $1,089,000 and $682,000, respectively from this grant. The Company has earned $2,466,000 from this grant from inception through December 31, 2013, of which $829,000 was paid to sub-contractors. +b. +Battelle/CDC DPP® Influenza Immunity Test: +In July 2012 as amended in 2013, the Company entered into a follow-on, milestone-based development agreement bringing the total up to $946,000 based on Chembio's previous successful initial development of a multiplex rapid point-of-care ("POC") influenza immunity test utilizing its patented Dual Path Platform® (DPP®) technology. The follow on-agreement contemplates a period of approximately nine months in which the follow-on development activity is to be completed. The Company earned, for the years ended December 31, 2013 and 2012, $643,500 and $277,500, respectively from this grant. The Company has earned $921,000 from this grant from inception through December 31, 2013. +c. +Cooperative research agreement with a U.S. government agency: +In May 2013, the Company was awarded a cooperative research agreement with a U.S. government agency for up to $766,000 for an eight-month development project to develop rapid POC diagnostic tests for five infectious diseases associated with febrile illness. The Company earned $766,000 for the year ended December 31, 2013 from this agreement. +Governmental Regulation: +All of the Company's existing and proposed diagnostic products are regulated by the United States Food and Drug Administration (FDA), United States Department of Agriculture, certain state and local agencies, and/or comparable regulatory bodies in other countries. Most aspects of development, production, and marketing, including product testing, authorizations to market, labeling, promotion, manufacturing, and record keeping are subject to review. After marketing approval has been granted, Chembio must continue to comply with governmental regulations. Failure to comply with these regulations can result in significant penalties. +F-18 \ No newline at end of file diff --git a/raw/filings/0001092662/2013/0001092662-14-000018/filing_metadata.csv b/raw/filings/0001092662/2013/0001092662-14-000018/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..eaaf580ed7874723c290d184d28c21d7a8e88917 --- /dev/null +++ b/raw/filings/0001092662/2013/0001092662-14-000018/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001092662,CEMI,"CHEMBIO DIAGNOSTICS, INC.",10-K,2014-03-06,2013-12-31,2014-03-06T13:08:49.000Z,0001092662-14-000018,form10_k.htm,,7319135,1,0,https://www.sec.gov/Archives/edgar/data/1092662/000109266214000018/form10_k.htm,https://www.sec.gov/Archives/edgar/data/1092662/000109266214000018/,2013,2013,1 diff --git a/raw/filings/0001092662/2013/0001092662-14-000018/item1.txt b/raw/filings/0001092662/2013/0001092662-14-000018/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..f55daeaeabf95f1e231503bb1db165edde945f98 --- /dev/null +++ b/raw/filings/0001092662/2013/0001092662-14-000018/item1.txt @@ -0,0 +1,286 @@ +ITEM 1. +BUSINESS +FORWARD-LOOKING STATEMENTS +This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, and Section 27A of the Securities Act of 1933. Any statements contained in this report that are not statements of historical fact may be forward-looking statements. When we use the words "intends," "estimates," "predicts," "potential," "continues," "anticipates," "plans," "expects," "believes," "should," "could," "may," "will" or the negative of these terms or other comparable terminology, we are identifying forward-looking statements. Forward-looking statements involve risks and uncertainties, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by forward-looking statements. These factors include our research and development activities, distributor channels, market demand for our products, compliance with regulatory impositions; and our capital needs. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. +Except as may be required by applicable law, we do not undertake or intend to update or revise our forward-looking statements, and we assume no obligation to update any forward-looking statements contained in this report as a result of new information or future events or developments. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in such forward-looking statements. You should carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business. +For further information about these and other risks, uncertainties and factors, please review the disclosure included in this report under "Part I, Item 1A, Risk Factors." +Our Business +General +The Company (Chembio Diagnostics, Inc. and its wholly-owned subsidiary, Chembio Diagnostic Systems, Inc., are collectively referred to herein as the "Company") develops, manufactures, markets and licenses rapid point-of-care diagnostic tests (POCTs) that detect infectious diseases. The Company's main products presently commercially available are four rapid tests for the detection of HIV 1/2 antibodies, two rapid tests for the detection of syphilis antibodies, and a multiplex rapid test for the detection of HIV and Syphilis antibodies. Three of the HIV 1/2 rapid tests employ in-licensed and proprietary lateral flow technologies (see "Our Rapid Test Technologies"), can be used with all blood matrices as samples, and are manufactured in a standard cassette format, a dipstick format, and a proprietary barrel format. The tests employing the cassette and proprietary barrel formats were approved by the FDA in 2006 and are exclusively distributed by Alere, Inc. ("Alere") in the United States and by Chembio outside the United States. As discussed below (see Partners Involved in Marketing Our Products), we are considering changes to our exclusive agreements with Alere based on Alere's introduction of a competitive product, which introduction has triggered provisions in those agreements, permitting us to make certain changes. Our fourth HIV 1/2 rapid antibody detection test incorporates our patented Dual Path Platform® (DPP®) POCT technology, and this POCT platform does not require in-licensing. The DPP® HIV 1/2 Assay detects antibodies to HIV 1 & 2 in oral fluid samples as well as in all blood matrices. We have sold this product in Brazil since 2009 where it was approved by ANVISA, through our agreement with the Oswaldo Cruz Foundation ("FIOCRUZ"), and we received United States FDA regulatory approval for this product on December 19, 2012. We anticipate launching it in the United States under Chembio's brand in 2014. +Our product pipeline, which currently includes a multiplex rapid test for earlier detection of HIV by detecting P-24 antigen as well as antibodies, a test for Hepatitis-C, and a multiplex test that detects HIV and Syphilis specific antibodies (which we are already selling internationally), is based on this DPP® technology for which we were issued a United States patent in 2007 and for which additional patent protection has issued or is pending in a number of other countries. With the patented DPP® and the lateral flow platform, we participate in the estimated $8-10 billion point-of-care market segment of the estimated nearly $50 billion global in-vitro diagnostic market that has an overall growth rate exceeding 5% per annum. POCTs, by providing prompt and early diagnosis, can reduce patient stays, lower overall costs, improve therapeutic interventions and improve patient outcomes. POCTs can also prevent needless hospital admissions, simplify testing procedures, avoid delays from central lab batching, and eliminate the need for return visits. +2 +In the areas of infectious and sexually transmitted diseases (such as HIV and syphilis), the utility of a rapid point–of-care test, particularly in identifying patients unaware of their disease status, has been well established. Large and growing markets have been established for these kinds of tests, initially in high prevalence regions where they are indispensable for large scale prevention and treatment programs. More recently introduced in the United States in 2004, rapid HIV tests now also present a significant segment of the U.S. market for HIV clinical testing, which is still dominated by laboratory tests. We have focused our product development activity within areas where the availability of rapid, point-of-care screening, diagnostic, or confirmatory results can improve health outcomes. More generally we believe there is and will continue to be a growing demand for diagnostic products that can provide accurate, actionable diagnostic information in a rapid, cost-effective manner at the point of care. +PRODUCTS +Lateral Flow Rapid HIV Tests +All three of our lateral flow rapid HIV antibody detection tests are qualitative "yes/no" tests for the detection of antibodies to HIV 1 & 2 with visually interpreted results (one line "negative"; two lines "positive") available within approximately 15 minutes. The tests are simple to use, have a shelf life of 24 months, and do not require refrigeration. The tests differ principally only in the method of test procedure, convenience and cost. One of our FDA-approved lateral flow HIV tests incorporates a proprietary plastic "barrel" device that houses the lateral flow strip. This barrel format enables collection of samples directly (usually from a finger-stick whole blood sample) into the barrel's capillary tip. A sealed unitized buffer vial, assembled onto the top of the barrel, is removed and seated into a stand; the seal is then pierced by the barrel's capillary tip, thereby initiating the upward flow of the resulting sample-buffer solution through a filter, up into the vertical device's chamber and onto the lateral flow strip. This results in a unique unitized and closed device system that can reduce the chance of exposure to potentially infectious samples. Our other FDA-approved lateral flow HIV test uses a more conventional rectangular plastic cassette format that houses the lateral flow strip. In this case, a sample is transferred by use of a separately provided transfer device ("loop") into a sample well or port of the cassette that houses the lateral flow strip, which is positioned horizontally or flat. +Both of the above-described products are marketed exclusively in the United States by Alere (see Partners Involved in Marketing Our Products) as Clearview® Complete HIV 1/2 (the barrel format as governed by the Barrel Agreement) and Clearview® HIV 1/2 STAT PAK® (the cassette format as governed by the Cassette Agreement), and in all other markets by Chembio under the names Chembio SURE CHECK® HIV 1/2 and Chembio HIV 1/2 STAT PAK®. Alere has non-exclusive rights to the barrel product outside the United States. In addition to the above-referenced agreements for Alere to market our products, Alere also licensed their lateral flow technology patents to Chembio for our international rapid HIV test sales and certain other Chembio lateral flow product sales. Also this license would extend to sales by Chembio of the cassette and barrel products in the United States should we decide to exercise certain rights now exercisable by us based on Alere's notice to us of their having a Permitted Competing Product (see Partners Involved in Marketing Our Products). +Our third lateral flow HIV test, the HIV 1/2 STAT PAK® Dipstick, is our most cost competitive and compact format. It does not have any plastic housing so that 30 test strips can be packaged into a small vial that is ideal for transporting into remote settings. The test procedure is similar to the cassette format except that a user-applied adhesive backing is provided as a more cost-effective and compact "surface" on which to run the test. +Regulatory Status of the lateral flow HIV tests +The FDA approved our Pre-Market Applications (hereinafter "PMA"; see "Governmental Regulations" and Glossary) in April 2006 for our SURE CHECK HIV 1/2 (and also now Alere Clearview® Complete HIV 1/2) and for our HIV 1/2 STAT-PAK® (now Alere' Clearview® HIV 1/2 STAT-PAK® in the United States only) products. Waivers under the Clinical Laboratory Improvement Act (hereinafter "CLIA"; see Governmental Regulations) were granted by the FDA for these two FDA-approved products in 2006 and 2007, respectively. A CLIA waiver is required in order for health care providers to administer these tests in the settings where they are most suited and needed, such as public health testing clinics, hospital emergency rooms and physicians' offices. The SURE CHECK® product received a CE Mark in July 2013 and the CE Markings for the HIV 1/2 STAT-PAK® (as well as the DPP® HIV 1/2 Assay described below) are expected in 2014. Our HIV 1/2 STAT-PAK® Dipstick, although not FDA-approved, qualifies under FDA export regulations [See Government Regulation] to sell to customers outside the United States, subject to any required approval by the importing country. CE Mark has not been pursued for this product. +All three of our lateral flow HIV tests have qualified for procurement under the President's Emergency Plan for AIDS Relief ("PEPFAR"). Both the cassette and dipstick versions of the STAT-PAK® are also qualified by the World Health Organization (WHO) for procurements by the second largest global program, known as the Global Fund, as well as other related programs funded by agencies affiliated with the United Nations, such as UNICEF and UNITAIDS (see Glossary), through qualification with the WHO bulk procurement scheme. +3 +DPP® HIV 1/2 Assay +As in the case of our lateral flow HIV tests, our DPP® HIV 1/2 Assay is also a qualitative "yes/no" test for the detection of antibodies to HIV 1& 2, delivers visual results within as little as 15 minutes, is simple to use, has a shelf life of 24 months, and does not require refrigeration. This product, which is our first FDA-approved product incorporating our patented DPP® technology, can be used with oral fluid samples, as well as with all blood matrices. This product also incorporates our patent-pending oral fluid collection and storage system that enables samples to be fully extracted in buffer solution before application to the test device, and also enables the extracted sample to be stored and retested or potentially tested for multiple conditions in future product applications. Clinical and laboratory studies demonstrated the ability of the test to accurately detect the presence of antibodies in individuals down to two years of age. Studies have also shown this product to have improved performance compared with all of the current FDA-approved CLIA-waived lateral flow rapid tests, even including our own lateral flow tests. FDA-approved label claims include sensitivity/specificity on oral fluid and finger-stick whole blood of 98.9%/99.9% and 99.9%/100% respectively. Oral fluid sensitivity was 100% among HIV-positive patients not taking anti-retroviral medication: Due to the low HIV prevalence in the U.S., clinical trials are performed on known HIV-positive patients, and more and more of these individuals are on more highly active anti-retroviral treatments (known as "HAART") for much longer periods than when we and our competitors Orasure and Trinity performed their clinical trials ten to fifteen years ago. We believe that this fact, combined with our product's superior performance in a direct comparative evaluation that was conducted by the United States CDC Global AIDS Program, together with analytical studies that confirm earlier detection with our DPP® product than our main competitors on well characterized serum samples, all combine to provide us with a significant market opportunity with this product. +Regulatory Status of the DPP® HIV 1/2 Assay +In April 2012 we completed a 3,000 patient clinical study with our DPP® HIV 1/2 Assay in the United States which we had begun in 2010. In June 2012 we submitted the third of three modules required for a modular PMA application to the FDA. On December 19, 2012 we received FDA approval of our Pre-Marketing Approval. During 2013, we completed a 1,000 patient clinical study in order to submit a CLIA waiver application to the FDA, which was submitted at the end of November 2013. In February 2014 we received a letter from the FDA on the current status of review of our CLIA waiver application. The FDA determined that additional information is needed to complete their review of the Company's DPP® HIV 1/2 Assay CLIA waiver application. During the blinded prospective clinical study, a disproportionate number of new infections were found at one clinical site due to the lower than expected prevalence at two other sites. We are currently in discussion with the FDA to finalize the protocol to collect additional data. Upon receiving guidance on our proposed protocol, we anticipate that we will be able to update the timeline of activities for the CLIA waiver of the DPP HIV1/2 Assay. +The DPP® HIV 1/2 Assay product is qualified for procurement under the President's Emergency Plan for AIDS Relief ("PEPFAR") for use with all sample matrices, and we are pursuing WHO qualification in order to enable procurement of this product by the Global Fund and United Nations agencies, including programs underwritten by them. We are also pursuing CE Marking, anticipated during 2014, as stated above. +In June 2010, ANVISA approved the DPP® HIV 1/2 Assay that is being marketed in Brazil through our collaboration with the Oswaldo Cruz Foundation, Brazil's leading public health institute (see Oswaldo Cruz Foundation OEM DPP® Agreements). +DPP® HIV-Syphilis Multiplex Test +This product, launched in 2013, allows for the detection of antibodies to both HIV and Syphilis on a single test device within approximately 15 minutes. In certain global/public health settings (see Target Markets) this product may provide a more convenient and cost effective means of rapid detecting both markers in a single test procedure at the point of care as compared with performing separate rapid tests for each indication. This product takes advantage of the multiplexing feature of DPP® which provides for a more robust reaction between the sample and biomarkers being tested for (HIV and Syphilis antibodies in this case), resulting in a greater ability by the user to visually interpret test results. We launched this product in Mexico in the fourth quarter of 2013 as a unitized product, meaning that each test kit was separately packaged to include each of the other components necessary to run this test, as compared with other configurations where a test kit of 20 or 30 devices is accompanied by one bottle of running buffer. The initial results of this launch have been very positive, and we anticipate good results in Mexico during 2014 from the program. Building on this initial success, we are pursuing commercialization efforts for this product in a number of additional international markets. +4 +Regulatory Status of the DPP® HIV-Syphilis Test +The DPP® HIV-Syphilis multiplex test development was completed in 2013, and commercialization activities commenced in 2013 and are moving well as stated above. Also as mentioned above, a unitized version of this product was approved and launched in Mexico during the fourth quarter of 2013, and the product has been well received. In addition, this product is the first such product to have been approved by the USAID for procurement with U.S. foreign aid program funds (such as PEPFAR). We are pursuing pre-qualification of this product with the World Health Organization (WHO) in order to allow procurement through programs such as the Global Fund. Simultaneously we are pursuing registration of this product in a number of foreign jurisdictions where we believe there is an opportunity for this product. +In 2013, and 2014 year to date, we have made significant efforts on pursuing an FDA submission for this product. However, FDA has advised thus far that performance specifications for this product must be substantially equivalent both in comparison to the traditional algorithm and the "reverse" algorithms that are both now in use in the United States for syphilis testing, as well as meet the requirements for HIV sensitivity and specificity. It is possible to that other pathways to receiving FDA approval may be available by limiting the performance claims and/or the settings in which the tests could be used. We are conducting further studies now, and we are in dialog with the FDA and others, to see whether and how we may be able to meet their requirements without making changes to this product, which would result in further delays. +OTHER DPP® PRODUCTS +Our product pipeline includes a multiplex test that detects P24 HIV antigen as well as HIV 1/2 antibodies, and a rapid test for the detection of Hepatitis-C antibodies. These products are still in a development stage and have not been commercialized in any markets. The Company has a robust research and development department that is involved in a number of ongoing collaborations, some of which are sponsored, with public and private organizations. During 2013 we conduct sponsored research and development activities for two programs sponsored by agencies of the United States government; One is for the development of a 9-band influenza immune status test and the other is for a multiplex febrile illness test that could help identify and differentiate, in remote settings, symptoms that could be attributable to a variety of tropical diseases, including malaria, dengue, and the bubonic plague. We have also continued to conduct research and development activities on a serological test for tuberculosis pursuant to a Phase II SBIRR grant from the National Institutes of Health (NIH). All of these projects are based on our patented DPP® technology. +PARTNERS INVOLVED IN MARKETING OUR PRODUCTS +Alere +On September 29, 2006, we executed marketing and license agreements with Alere. The marketing agreements (the Barrel Agreement and the Cassette Agreement) provide Alere with a 10-year exclusive right (until September 2016) to market our rapid HIV tests in the United States under Alere's brands. The agreements also provide Chembio a non-exclusive license to certain Alere lateral flow patents that may be applicable to our lateral flow products, including for manufacture of the HIV tests in the United States for sales outside the United States and even for sale in the United States should Alere enter the U.S. market with a competitive rapid HIV test product and in such case we choose to market our products directly as provided in the agreements in such event of a competitive rapid HIV test product. Simultaneous with the execution of the agreements, we also settled litigation with StatSure Diagnostics, Inc. (SDS), that had been ongoing relating to the proprietary barrel device which is incorporated into one of our two FDA-approved rapid HIV tests (See Lateral Flow HIV Tests above). SDS, pursuant to the settlement, is a party to the 3-way Barrel Agreement. As a result, until now, it is through the agreements with Alere that we have been participating in the growth of the rapid HIV test market in the United States. +In late July 2013, we received notice from Alere that they intend to commercialize their own rapid HIV test (see Competition), which test had just received FDA approval as a moderate complexity product (i.e. not CLIA-waived though this is being pursued and anticipated during 2014), in the United States. Under the Barrel Agreement and the Cassette Agreement such product is considered to be a Permitted Competing Product (PCP). Each of the two aforementioned agreements provides that, in the case of notice of a PCP, Chembio may make certain elections (jointly with SDS in the case of the Barrel Agreement), or elect to continue each agreement without taking any further action. Under the Cassette Agreement, Chembio may, at any time, terminate such agreement, which termination would become effective 60 days after the date notice was made. Under the Barrel Agreement, Chembio and SDS may jointly issue a non-exclusivity notice, which notice shall be effective immediately. In the event that Chembio (and SDS) makes this election with respect to either (or both) of these products, Chembio could sell that respective (or both) product(s) in the United States market under Chembio/SDS brands and in such case, the lateral flow license that Chembio has from Alere for international sales would be expanded to include sales in the United States, which would require the payment of a royalty to Alere at the time of any sales. See Lateral Flow Technology and Reagent Licenses. +5 +We have appointed distributors internationally for our lateral flow HIV tests. Our largest markets outside the U.S. for our lateral flow HIV rapid tests are certain countries in Africa, Asia, and South America, as well as Mexico. Internationally, most of the demand for our products is based on governmental and non-governmental prevention and treatment efforts. Given this, these programs can and do often result in large orders, but also can result in periods of relatively lower demand, based on the variations associated with this kind of demand. +OEM DPP® Products +Oswaldo Cruz Foundation OEM DPP® Agreements +During 2008-2010 we signed five separate agreements, each of which is titled and constitutes a "Technology Transfer Agreement", with the Oswaldo Cruz Foundation (FIOCRUZ) in Brazil. FIOCRUZ includes the Institute of Technology on Immunobiologicals/Bio- Manguinhos, which is the FIOCRUZ unit that produces vaccines and diagnostic kits. FIOCRUZ and Bio-Manguinhos are referred to herein interchangeably. Each of the five agreements relates to a different specific product or group of products based on our DPP® technology. FIOCRUZ is the leading public health organization in Brazil, and it is affiliated with Brazil's Ministry of Health, which is its principal client. It has extensive research, educational and manufacturing facilities for drugs and vaccines, as well as for diagnostic products. +Each of the agreements grants to FIOCRUZ the right, but not the obligation, to earn the right to request a technology transfer to be able to license and manufacture that product on its own. FIOCRUZ is not required to earn this right, but if it desires to do so, then it needs to purchase a stated amount of the product as set forth in the respective agreement for that product. +During 2010 and 2011, all of the initial products contemplated under the five agreements were approved for marketing by the applicable regulatory agencies in Brazil. The agreements between the Company and FIOCRUZ are unique examples of technology transfer collaborations between a private sector rapid test manufacturer and a public health organization. The five products categories for which FIOCRUZ can earn a separate right to request a technology transfer for that product only are: DPP® products for HIV screening, HIV Confirmatory, Leishmaniasis, Leptospirosis and Syphilis. Each technology transfer, and the provision by Chembio of the information and training that is required for this to occur, will occur only if FIOCRUZ purchases from Chembio the amount of that product that is specified in the respective agreement for that product. The actual amount of purchases for each product is totally at the discretion and option of FIOCRUZ and may be more or less than the amount needed to qualify for a technology transfer. +More specifically, the five agreements, although separate and independent of one another, are structurally similar according to the following: +· +Each agreement states: "the object of this Agreement is for the Transfer of Technology from Chembio to Bio-Manguinhos, the license by Chembio to Bio-Manguinhos [of] the Chembio Patents applied or granted in Brazil or other Mercosur countries for the term of the patents and the transfer of all the technical information related to the DPP technology and the process to obtain the product by the DPP® technology. This Agreement contemplates the scientific and technological co-operation between Chembio and Bio-Manguinhos for such activities so that Bio-Manguinhos will be able to manufacture the Product in Brazil." +· +Each agreement provides that Chembio will supply free of charge to Bio-Manguinhos prototypes of the product to demonstrate performance characteristics that are necessary for evaluation by the Brazilian Ministry of Health and for registration with ANVISA. ANVISA is the Agencia Nacional de Vigliancia Sanitaria, or the National Sanitary Vigilance Agency. The number of prototypes ranges from 15,000 to 45,000 in the various agreements. +· +Each agreement provides that the prototypes will be utilized both for a performance study that follows a protocol prepared and approved by Bio-Manguinhos and the Brazilian Ministry of Health, and also will be used for studies in Brazil for the registration procedures at ANVISA. Bio-Manguinhos will then apply to ANVISA to register the product. Within 120 days of the registration of the product with ANVISA, Bio-Manguinhos will make an advance technology transfer payment to Chembio (the "Advance Payment"), in an amount specified in that particular agreement. All five of the Advance Payments provided for in the agreements were made in 2010 and 2011. +· +At such time, if any, that the product for a particular agreement has been successfully registered with ANVISA, then Bio-Manguinhos has the right to qualify for the full technology transfer for that product by purchasing the amount of the product, and at the price, specified in the agreement. +· +Bio-Manguinhos is not required to purchase any amount of any product. For each product, it only needs to purchase that product, in the amount specified in the agreement, only if it desires to be able to complete the technology transfer process in order to manufacture and sell that product on its own. Chembio does not have recourse against Bio-Manguinhos if Bio-Manguinhos does not purchase the qualifying purchase amount of any product. In that case, Chembio can only suspend further phases of the technology transfer, attempt to renegotiate the agreement, and/or retain any amounts previously paid by Bio-Manguinhos. Chembio cannot force Bio-Manguinhos to purchase any amount of any product. +6 +· +As a result of the terms of these agreements, Bio-Manguinhos has never been required to, and is not now required to, purchase any amount of any of the products. +· +As of December 31, 2013 Bio-Manguinhos had earned the status described below with respect to each of the five products: +1. +With respect to Chembio's DPP® HIV1/2 Screen test, Bio-Manguinhos had qualified to request the technology transfer. It has requested, and has received, the technology transfer information. Bio-Manguinhos purchased $880,175 of this product in 2011, and $4,990,840 in 2012, all of which applied to the qualifying amount to obtain the right to the technology transfer (the "Qualifying Amount") for this product. In 2013, Bio-Manguinhos made $291,235 of purchases that applied to the Qualifying Amount for this product, and $3,320,010 of purchases in excess of the Qualifying Amount. +2. +With respect to Chembio's Canine Leishmania test, Bio-Manguinhos had qualified to request the technology transfer and did so request. Submission of the technology transfer information is in process at this time. Bio-Manguinhos purchased $2,000,817 of this product in 2011 and $99,183 of this product in 2012 that applied to the Qualifying Amount. In addition, Bio-Manguinhos made purchases in excess of the Qualifying Amount equal to $1,314,117 in 2012 and $1,736,700 in 2013. +3. +a. +With respect to the three variations of Chembio's DPP® Syphilis test, all of which are covered by a single agreement, Bio-Manguinhos had qualified to request the technology transfer with respect to Trep only, and intends to do so in the near future. Bio-Manguinhos purchased $1,194,250 of this product in 2011 and $165,750 of this product in 2012 that applied to the Qualifying Amount. In addition, Bio-Manguinhos made purchases in excess of the Qualifying Amount equal to $2,817,750 in 2012, and equal to an estimated $646,340 in 2013. +b. +With respect to the two variations of Chembio's Screen & Confirm Test, Bio-Manguinhos had not made any purchases in 2011, 2012, or 2013, and therefore had not qualified to request the technology transfer for either of them. In order to qualify, Bio-Manguinhos would need to purchase an additional $2.2 million of one of these tests, and an additional $2.08 million of the other test. +4. +With respect to Chembio's DPP® Confirmatory test, Bio-Manguinhos had not qualified to request the technology transfer. Bio-Manguinhos made purchases of $560,000 of this product in 2011, $819,000 in 2012, and $390,000 in 2013, all of which applied to the Qualifying Amount. In order to qualify for the technology transfer, Bio-Manguinhos would need to purchase an additional $585,000 of this product. +5. +With respect to Chembio's DPP® Leptospirosis test, Bio-Manguinhos had not qualified to request the technology transfer. Bio-Manguinhos made purchases of $135,000 of this product in 2011, and it made -0- purchases in 2012 and $45,000 in 2013. In order to qualify for the technology transfer, Bio-Manguinhos would need to purchase an additional $225,000 of this product. +· +As stated above, Bio-Manguinhos is not obligated to make any purchases. After the specified level of sales for a particular product has been achieved, FIOCRUZ may request that the technology for that product be transferred to FIOCRUZ together with an exclusive license to produce and sell that product in a defined territory. The license is to provide that Chembio will receive a royalty on all sales. Chembio does not release the amount of this royalty because it could have an adverse effect on negotiations concerning royalties in potential transactions with other parties. +· +All the agreements expire five years after the date of the technology transfer. If terminated earlier by default of FIOCRUZ, FIOCRUZ must stop all activity; if terminated earlier by default of Chembio, or if terminated by natural expiry, FIOCRUZ can continue to produce and commercialize the product without paying royalties." +Other OEM And License Agreements Related to DPP® Technology +In addition to our agreement with FIOCRUZ, we have entered into certain other OEM and License agreements with other parties with respect to certain products that we have developed based on our DPP® technology. In 2008 we entered into a product development and license agreement with Bio-Rad Laboratories, Inc. (Bio-Rad), a leading multinational life sciences company, for the first ever POC test for the confirmation of HIV (reflex test used after initial screening test(s) are positive). This product utilizes our DPP® technology, capitalizing on its multiplexing advantages, and is much simpler to perform than the legacy confirmatory platform, known as western blot, which requires a substantial amount of technical training and hands-on time and which is more expensive to manufacture and distribute. This product was CE marked and was launched by Bio-Rad in the second quarter of 2013 in Europe under their Geenius® brand; and an FDA submission is underway. +7 +In 2013 we entered into collaboration with Labtest, a private company in Brazil, for the distribution of a number of products in Brazil that would be co-branded with Labtest and Chembio trademarks. Under this agreement, upon request from Labtest, for which there is no requirement, Chembio will sell the appropriate DPP® components to Labtest for further manufacture and assembly in Brazil. +Most recently, in February 2014, Chembio entered into a technology transfer and license agreement with RVR Diagnostics SDN BHD ("RVR"), a privately-held company in Malaysia. The agreement supports Chembio's strategy of establishing a market presence in Asia, in collaboration with RVR as a licensee, distributor, and contract manufacturer. The agreements grant exclusive distribution rights to RVR in certain countries in the region and enable RVR to manufacture Chembio's DPP® HIV 1/2 Assay and DPP® HIV-Syphilis Assay and potentially other products developed by Chembio incorporating its patented DPP® technology. +Our strategy with respect to our DPP® technology has evolved as the Company has evolved. Initially, following the issuance of our DPP® patent in the United States in 2007, our strategy was necessarily limited to developing third-party-funded OEM research and development contracts and grants. This strategy enabled us to conserve capital resources, while at the same time acquiring know-how and experience with the platform and developing third-party references and implicit endorsements of the technology. As our capabilities to develop and manufacture DPP® products expanded, and as our financial position has improved, so have our strategic options expanded and improved. Although we have employed and may continue to employ the strategy of seeking OEM development and manufacturing agreements as a way to participate in markets that we cannot and/or choose not to serve with Chembio-branded products, we believe that we can also develop our own branded line of products, and we plan to do this in the public health area. We plan to launch this brand with our DPP® HIV 1/2 Assay in the United States market in 2014, to be followed by the other products in our pipeline in 2015 and beyond. +Our Rapid Test Technologies +All of our commercially available current products employ either in-licensed lateral flow technology or our own patented Dual Path Platform® (DPP®) technology. Both lateral flow technology and DPP® allow the development of accurate, low cost, easy-to-perform, single-use diagnostic tests for rapid, visual detection of specific antigen-antibody complexes on a test strip. These formats provide a test that is simple (requires neither electricity nor expensive equipment for test execution or reading, nor skilled personnel for test interpretation), rapid (turnaround time approximately 15 minutes), safe (minimizes handling of potentially infected specimens), non-invasive (requires 5-20 micro liters of whole blood easily obtained with a finger prick, or alternatively, serum or plasma,), stable (24 months at room temperature storage in the case of our HIV tests), and highly reproducible. +We believe that products developed using DPP® technology can provide superior diagnostic performance as compared with products that use lateral flow technology. The reason for this is that one of the major differences between the two platforms is that in DPP® samples are allowed to incubate with the target analyte in the test zone before introduction of the labeling reagent/conjugate, whereas in lateral flow, samples are combined with the labeling reagent to form a complex before coming in contact with the target analyte. We believe that this complex can compromise test performance. Also, because of the usage in DPP® of a separately connected sample strip, the control and delivery of sample material is substantially improved. This feature is critical in the development of multiplex tests, as well as tests that involve viscous sample material (such as oral fluid) that can be impeded when forced to combine with labeling reagents before migration on the test strip to the test zone area. +Multiplexing is significantly improved as a result of the design of DPP® and this provides a significant advantage. For example, the HIV confirmatory test we developed for Bio-Rad that is described above employs six different markers related to various epitopes of the HIV antigen. We have a number of other products in development, including those being developed in sponsored development programs, that involve the use of multiple (e.g. eight) test bands. Although all of these products could be visually read, we can also use handheld and desktop readers with our DPP® products to objectively measure, quantify, record and report DPP® test results. Certain of the products we have and/or are developing incorporate some of these readers, and we are developing other products that may be used with or will require use of a reader. Also, platforms can incorporate labeling reagents that cannot be visually read except by employing a reader, such as fluorescence, though no products are currently utilizing such reagents. +We are pursuing additional capabilities and technologies that will complement our current product portfolio and business strategy. This activity includes pursing development, license or acquisition of diagnostic technologies that complement our existing platforms, proprietary biomarkers that can result in new product applications of our existing platforms, and new platforms that would complement our commercial strategy. +8 +Target Markets +Rapid HIV Tests +A large percentage of individuals that are HIV positive worldwide are unaware of their status. Part of the reason for this is that even those that do get tested in public health settings will often not return or call back for their test results when samples have to be sent out to a laboratory which can take up to several days to process. The increased availability, greater efficacy and reduced costs for anti-retroviral treatments (ARVs) for HIV has increased the demand for testing, as the stigma associated with the disease is lessened, and the ability to resume normal activities is substantially improved, providing a positive message to those potentially infected. The impact that rapid HIV testing has had on prevention efforts has in turn increased the demand for testing, particularly by public health programs worldwide, which have also become more effective in reducing the number of annual new infections in many, but by no means, all high prevalence regions. +Despite less attention to HIV by the media as compared with prior years, there are still approximately 50,000 new diagnoses of HIV infection in the United States each year, according to the CDC. CDC estimates that approximately 1.2 million individuals in the U.S. are living with HIV, with an estimated 250,000 of these U.S. individuals, or more than 20%, unaware that they are infected. It is transmissions from these 250,000 infected people that are reported to account for 54% of all new infections per year. Part of the reason for this is that even those individuals that do get tested in public health settings will often not return or call back for their test results if their blood samples have to be sent out to and tested in a laboratory and then reported back, a process which can take up to several days to complete. Making more people aware of their HIV status at the point-of-care reduces the number of HIV transmissions. +Rapid HIV testing in the United States has now developed into an estimated 7.5 million test market at an average price of $10, or a total of $75 million. Public health programs, currently funded by grants distributed to states by the CDC, account for an estimated 45% of the market, with hospitals (40%) and doctor's offices (15%) comprising the other estimated market segments. Chembio's lateral flow rapid HIV tests, the cassette and barrel, together represent approximately a 25% share of this market. Orasure Technologies, Inc., which was the first FDA-approved rapid HIV test, has lost nearly half its market share, now estimated to be approximately 55%. Trinity Biotech has an estimated 15% market share and Biolytical Laboratories, Medmira and Bio-Rad share the remaining 5%. +We believe that the US professional HIV rapid test market has the potential to increase to 15-18 million tests over the next several years, which would represent 40-50% of all HIV tests done today in the United States for clinical purposes. Assuming an average price to the manufacturers of $8.00 per test, a total potential U.S. market of nearly $120-$145 million is implied. +In 2006, the outlook for HIV testing was given a big boost with the release by the CDC of new recommendations for HIV testing. These new CDC recommendations were/are that an HIV test should be given as a routine test like any other for all patients between 13 and 64 years of age, regardless of risk, with an opt-out screening option and focused testing procedural (pre- and post-test counseling) guidelines. Though not mandatory, gradual adoption in whole or in part of the 2006 CDC recommendations by a number of states continues to have an increasing impact. Finally, in 2013, the United States Preventive Services Task Force ("USPSTF") fully embraced these CDC routine HIV testing recommendations. This USPSTF recommendation, which was given an A grade under their recommendation grading system based on the benefits of this practice and the nearly 600,000 AIDS-related deaths in the United States, requires insurance coverage under the Affordable Care Act (the "ACA") as a preventive screening test without any co-payment required. We expect this to result in an increase in HIV testing in the United States in the coming years, which we believe will include point-of-care HIV testing utilizing the Company's products. Although as stated above currently most public health testing in the United States is funded by grants allocated to high prevalence areas by the CDC, we believe this will shift to an insurance-funded model under the ACA in the years to come, increasing the amount of testing done in doctor's offices and community health centers. +In the international market , we sell our products directly and through distributors to large screening programs overseen by ministries of health and NGOs, most but not all of which are funded by large bi-lateral and multi-lateral AIDS relief programs, the largest of which is the U.S. President's Emergency Plan for AIDS Relief (PEPFAR). Established by President George Bush as a 5-year $15 billion program in 2003, PEPFAR was reauthorized in 2008 and again in 2013. In 2012 PEPFAR directly supported HIV testing and counseling for more than 11 million pregnant women, and testing and counseling for more than 49 million people overall. The U.S. is also the first and largest donor to the Global Fund to Fight AIDS, Tuberculosis and Malaria. To date, the U.S. has provided more than $7 billion to the Fund. +9 +In December 2013 President Obama signed into law the PEPFAR Stewardship and Oversight Act, which is the most recent reauthorization of PEPFAR. However, unlike the 2008 PEPFAR authorization, which authorized approximately $45 billion, the new law doesn't authorize a specific dollar amount for funding. Nevertheless it is widely anticipated that PEPFAR will continue to enjoy strong funding; the FY14 budget has $6 billion for global HIV/AIDS assistance, including $4 billion for PEPFAR. +Chembio, with its four U.S.-manufactured rapid HIV tests, three of which are FDA-approved, is recognized as a reputable and dependable supplier of high quality products that are available at reasonably competitive prices. As a result, certain of our products have been selected in the testing protocols in countries (national algorithms) that are large beneficiaries of PEPFAR and the Global Fund. As mentioned above, these programs can and do often result in large orders, but also can result in periods of relatively lower demand, based on the variations associated with this kind of demand. Also, even though the United States taxpayer is funding the largest share of global AIDS relief, U.S. companies do not receive any preference for these procurements, and therefore must compete with foreign suppliers that manufacture competitive products with lower costs, including those related to quality, regulatory, intellectual property, and costs of manufacturing. +Oral fluid testing is an established alternative to blood testing for diagnostic tests, including HIV tests. It is also often patient preferred, providing a more comfortable, less invasive test. In certain public health clinics, staffs choose not to handle blood specimens; thus, oral sample collection provides a viable alternative. The most well-established market for oral fluid HIV testing is the United States. Given the premium price required for an oral fluid test as compared with blood tests, the higher volume programs will not specify an oral fluid test. However, segments of these programs may want to have an oral fluid testing option, and certain programs that have greater resources may also choose to incorporate oral fluid testing into the testing protocol. +There is also now an over-the-counter market for HIV self-testing in the United States. Orasure Technologies Inc. received FDA approval for an over-the-counter (self-testing) version of its previously professional-market-approved (test performed on an individual by a health care professional) HIV test. The FDA approval was granted in July 2012, and Orasure has been investing heavily in developing this market. Initial results after over a year of marketing are well below expectations. The costs for such over-the-counter approval, including primarily the associated clinical trials, are estimated to be at least $5 million and they may take two to three years to complete, not to mention the cost of distribution. Orasure's initial results are not convincing of a large market, although this possibility remains. In any case, Orasure is likely to spend heavily on this for some time, and if it appears that there is an attractive market, we believe we are very well positioned versus any other competitors. +Rapid Syphilis Tests +Recent data indicate that approximately 70,000-100,000 new cases of syphilis are occurring annually in the U.S. Syphilis can be treated with antibiotics, but if untreated, it can cause pelvic inflammatory disease, infertility, ectopic pregnancy and can infect newborns. Treatment cannot be provided without a confirmed diagnosis of an active case of syphilis. Current testing algorithms in the United States require two different laboratory tests (called non-treponemal and treponemal), as neither test alone has the required specificity to rule out certain other conditions (i.e., other infection or past infection), but in combination they can provide reasonably reliable results. However each requires trained personnel in laboratory settings and can take several days to receive results, in order to confirm an active, previously untreated case. +Development of the POC market for syphilis testing is expected to be comparable to the development of the POC market for HIV testing, as there is a significant public health value to being able to provide results at the point-of-care. There are several ways to assess the market opportunity for this unique rapid test, although we believe the U.S. rapid test market opportunity may exceed 8 million tests, which is approximately 20% of the total number of syphilis tests performed in the United States for clinical use today. +Rapid HIV-Syphilis Test +There are significant risks relating to transmission of Syphilis from a pregnant mother to child, just as there are for transmission of HIV. Therefore we believe there is a significant opportunity to improve prevention efforts in pregnant mother to child transmission testing programs (PMTCT) that are currently not doing any or nearly enough testing for syphilis even though they are testing for HIV. In the United States, we believe there is also a significant need for this product in some of the highest HIV prevalence populations, such as among men that have sex with men (MSM), as data show high degrees of HIV and Syphilis co-infection in this segment of the population. +10 +Marketing Strategy +Our marketing strategy is to: +· +Depending on our decision based on Alere's introduction of a PCP: +o +If we remain status quo: Support, review and assess the marketing and distribution efforts of our rapid HIV tests by Alere in the U.S., as well as our distributors worldwide, and to engage in sales and marketing activities that allow us to engage with our target markets and customers. Alere, which is a leading marketer of point-of-care diagnostic products, has significantly expanded its distribution footprint and product portfolio since we signed our agreement with them, and although we believe that this will enhance opportunities for Alere to market our rapid HIV tests, our product line is a very small one for them, notwithstanding the strong growth they have enjoyed with respect to our products. In this case we would not have to bear the expense of establishing our own sales and marketing organization and we would continue to share a substantial portion of the net sales proceeds of the products with Alere as we have been. However, since Alere now has their own product to sell, they are likely to have a greater financial incentive to sell that product depending upon the market acceptance of that product and other factors. Therefore this could have a material and adverse effect on the sales Alere makes of our products. +o +If we decide to make certain elections available to us now such as to assume direct sales by Chembio under Chembio brands of the lateral flow products that we developed and that we manufacture but have been and continue to be marketed by Alere under their brands, then we will need to establish a commercial organization that is capable of assuming the distribution of these products. In this case Chembio would not have to share any portion of the net sales proceeds with Alere, except for the 8.5% lateral flow royalties applicable to the sales of the products, which royalty is only applicable until February 2015 at which time the applicable lateral flow patent of Alere's expires. This will immediately result in higher gross margins than if we continue with the status quo . However this decision will involve our incurring expenditures related to hiring sales representatives, establishing agreements and associated discounts with distributors, incurring advertising and marketing expenditures, warehousing, customer service and technical support. If Alere's new product is indeed successful, our ability to retain a significant share of the market that has been established for our products may be enhanced by our having control of the marketing of our products, rather than having Alere sell our products. We have been developing contingency plans so that we can activate this strategy in a timely manner, including the possibility of ultimately utilizing the same sales force that we would use for U.S. Sales of DPP® HIV 1/2 Assay. +· +Leverage our DPP® intellectual property and product development and manufacturing experience to continue creating new collaborations where Chembio can be the exclusive development and manufacturing partner supporting leading marketing organizations. +· +Establish strong distribution relationships for our Chembio-branded products in the U.S and abroad, and establish a direct sales and marketing organization that is focused in the public health market segment, and that utilizes distributors for other market segments, primarily the acute care market which, together with public health, are the main market segments for rapid HIV tests in the United States. We believe that creation of a Chembio public health brand and marketing organization is fundamental to the creation of shareholder value over the long term. +During 2013 we increased our commercial activities and efforts in Africa and Europe for our HIV tests by establishing a sales representative in each of these markets. We believe the sales representative in Africa will enable us to be more closely engaged with opportunities to participate in the national testing algorithms that are established and revised from time to time by countries that are beneficiaries of PEPFAR, Global Fund and/or other bilateral or multilateral donor funding. In Europe, where there are a larger percentage of HIV positive people unaware of their status than in the United States, we believe that there is an emerging public health outreach opportunity, and there are relatively few strong competitors that are CE marked. Most recently we have established new sales and marketing positions in the Company to support our efforts to increase brand awareness globally and to lead our direct sales effort in the U.S. market. +Competition +The diagnostics industry is a multi-billion dollar international industry and is intensely competitive. Many of our competitors are substantially larger and have greater financial, research, manufacturing and marketing resources. +Industry competition in general is based on the following: +· +Scientific and technological capability; +· +Proprietary know-how; +· +The ability to develop and market products and processes; +11 +· +The ability to obtain FDA or other required regulatory approvals; +· +The ability to manufacture products that meet applicable FDA requirements, (i.e. FDA's Quality System Regulations) (see Governmental Regulation section); +· +The ability to manufacture products cost-effectively; +· +Access to adequate capital; +· +The ability to attract and retain qualified personnel; and +· +The availability of patent protection. +We believe our scientific and technological capabilities and our proprietary know-how relating to our in-licensed lateral flow technology rapid tests and to our proprietary know-how related to our patented dual path platform® technology, particularly for the development and manufacture of tests for the detection of antibodies to infectious diseases such as HIV, are very strong. +Our ability to develop and market other products is in large measure dependent on our having additional resources and/or collaborative relationships. Some of our product development efforts have been funded on a project or milestone basis. We believe that our proprietary know-how in lateral flow technology and in our Dual Path Platform® (DPP®) technology has been instrumental in our obtaining the collaborations we have and that we continue to pursue. We believe that the patent protection that we have with our Dual Path Platform® (DPP®) enhances our ability to develop more profitable collaborative relationships and to license out the technology. However there are a number of competitive technologies used and/or seeking to be used in point-of-care settings. These technologies may be based on immunoassay principles such as the Company's products or other technologies such as molecular-based technologies. +We plan to introduce our FDA-approved DPP® oral fluid HIV test, which test also can be used with blood samples, in the U.S. market under a Chembio brand. Until it is CLIA-waived, this product will serve a very small market segment. Orasure Technologies manufactures the only other oral fluid HIV test that is FDA-approved, and Orasure has enjoyed this position for approximately 10 years. Orasure has lost a significant share of this market as certain customers have been indifferent to using blood or oral fluid samples, because the blood tests, including those made by Chembio and marketed by Alere, are priced lower and/or are as or more accurate than the performance of Orasure's product on blood samples. Orasure has primarily retained those customers for whom the oral fluid sample feature is a strong preference, and this is an estimated $35 million business for Orasure. Although we believe we can capture a meaningful portion of this Orasure market share, we also anticipate that Orasure will defend this business aggressively. +In 2006 Alere acquired a division from Abbott Diagnostic located in Japan that manufactured and marketed a rapid HIV test product line called Determine®. The Determine® format is was developed for developing world and remote settings and,central to the needs of that market, the format is essentially a test strip that is integrated into a thin foil wrapper that, when opened, the underside of the wrapper serves as the test surface for applying the blood sample and performing the test. This design reduces costs and shipping weights and volumes and is an advantage for the developing world markets it has served. Some of the disadvantages of the platform are the amount of blood sample that is needed (50 microliters versus 2.5, 5 and 10 for our lateral flow barrel, lateral flow cassette, and DPP® products respectively), the open nature of the test surface, and the absence of a true control that differentiates biological from other kinds of samples. +The so-called "3 rd generation" version of this product has been marketed for many years and is the leading rapid HIV test that is used in a large majority of the national algorithms of countries funded by PEPFAR and the Global Fund, as well as many other countries in the world. That product is not FDA-approved though it is CE marked. The newest Determine® HIV version, which was developed and manufactured at Alere's subsidiary in Israel, Orgenics, is the so-called "4 th Generation" version Determine® test. According to its claims, this product detects HIV antibodies and P24 HIV antigens. Since the P24 antigen is known to occur in HIV-positive individuals' blood samples before antibodies do, based on its performance claims, the 4 th generation Determine® test is therefore able to detect HIV infection earlier than tests that solely rely on antibody detection. Chembio's tests, as well as all of the other currently FDA-approved rapid HIV tests, only detect antibodies. There are however laboratory tests that are FDA-approved that are "4thgeneration" tests, but they are of course neither rapid nor point-of-care. +The initial "4 th generation" Alere Determine® rapid test product that was also CE marked and that Alere launched internationally some years ago has not been successfully commercialized to the best of our knowledge and at least certain published studies were not favorable for this product. However the 4 th generation product that is now FDA-approved was apparently modified as compared to the initial international version of it, and it may perform more satisfactorily. Alere received FDA approval of this modified product in August 2013 and Alere is seeking CLIA-waiver for it. Alere is also aggressively pursuing development of the market for this product in anticipation of receiving CLIA waiver. Although the product can now be sold to moderate complexity certified laboratories, there is very limited supply of the product thus far, and there is no assessment thus far concerning the actual performance of this product in the hands of customers. We believe the price that Alere is charging for this product is substantially higher than our and our competitors' antibody tests, as the antigen claim avails some customers of an additional reimbursement code. Moreover there is support by a number of key opinion leaders for the public health value of such 4th generation tests, and if Alere is able to successfully launch this product, it represents a significant competitive threat to Chembio as well as to each of the other rapid HIV test manufacturers (Orasure and Trinity primarily). +12 +During 2011 Biolytical, Inc. of Vancouver, Canada received FDA approval and in 2012 received CLIA waiver of a flow-through rapid HIV test called "INSTI". The technology used in the INSTI test, flow-through, is older than lateral flow, and it requires handling of multiple components (3 vials of solution) to perform the test in multiple steps. However, these steps can be accomplished in less than ten minutes, and the actual test results occur in only one minute after those steps are completed. Therefore sample-to-result time is shorter than any of the competitive products. The product also has good performance claims. There are settings where that reduced total test time, despite the multiple steps required, may be a distinct advantage, and we believe Biolytical has made some progress in penetrating certain public health markets. +Although we have no specific knowledge of any other competitors' products that are a competitive threat to our products, or that will render our products obsolete, if we fail to maintain and enhance our competitive position or fail to introduce new products and product features, our customers may decide to use the products developed by our competitors, which could result in a loss of revenues and cash flow. +Research and Development +During 2013 and 2012, $5.8 million and $4.5 million, respectively, were spent on research and development (including regulatory activities). These expenses were in part underwritten by funding from R&D and milestones revenues of $2.0 million in 2013 and $1.3 million in 2012. All of our new product development activities involve employment of our Dual Path Platform® (DPP®) technology. These activities include completing development of certain products and making significant progress toward the development of additional products. +Employees +At December 31, 2013, we employed 206 people. We have entered into employment contracts with our President, Lawrence Siebert, our Chief Operating Officer Sharon Klugewicz and our Senior Vice President of Research and Development, Javan Esfandiari. Due to the specific knowledge and experience of these executives regarding the industry, technology and market, the loss of the services of either one of them would likely have a material adverse effect on the Company. The contract with Ms. Klugewicz, has a term of two years ending May 2015. The contract with Mr. Esfandiari has a term of three years ending March 2016. We have obtained a key man insurance policy for Mr. Esfandiari. The contract with Mr. Siebert provides that Mr. Siebert will serve as the Chief Executive Officer and President of the Company through May 11, 2014, and Mr. Siebert has advised the Company that he intends to retire from the Company on or before that date. Upon Mr. Siebert's announcement in 2013, of his retirement plans, the Company began a search for a new CEO. +Governmental Regulation +The manufacturing and marketing of the Company's existing and proposed diagnostic products are regulated by the United States Food and Drug Administration ("FDA"), United States Department of Agriculture ("USDA"), certain state and local agencies, and/or comparable regulatory bodies in other countries. These regulations govern almost all aspects of development, production and marketing, including product testing, authorizations to market, labeling, promotion, manufacturing and record keeping. The Company's FDA and USDA regulated products require some form of action by each agency before they can be marketed in the United States, and, after approval or clearance, the Company must continue to comply with other FDA requirements applicable to marketed products, e.g. Quality Systems (for medical devices). Failure to comply with the FDA's requirements can lead to significant penalties, both before and after approval or clearance. +There are two review procedures by which medical devices can receive FDA clearance or approval. Some products may qualify for clearance under Section 510(k) of the Federal Food, Drug and Cosmetic Act, in which the manufacturer provides a pre-market notification that it intends to begin marketing the product, and shows that the product is substantially equivalent to another legally marketed product (i.e., that it has the same intended use and is as safe and effective as a legally marketed device and does not raise different questions of safety and effectiveness). In some cases, the submission must include data from human clinical studies. Marketing may commence when the FDA issues a clearance letter finding such substantial equivalence. FDA clearance of our DPP® Syphilis Screen & Confirm test will be by means of a 510(k) submission. +If the medical device does not qualify for the 510(k) procedure (either because it is not substantially equivalent to a legally marketed device or because it is required by statute and the FDA's implementing regulations have an approved application), the FDA must approve a Pre-Marketing Application ("PMA") before marketing can begin. PMA's must demonstrate, among other matters, that the medical device provides a reasonable assurance of safety and effectiveness. A PMA application is typically a complex submission, including the results of non-clinical and clinical studies. Preparing a PMA application is a much more expensive, detailed and time-consuming process as compared with a 510(K) pre-market notification. The Company has approved PMAs for the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1-2 and Clearview® HIV 1-2 STAT PAK®. +13 +FDA approval of our DPP® HIV screening assay for use with oral fluid or blood samples was achieved by means of a PMA application. The Clinical Laboratory Improvement Act of 1988 ("CLIA") prohibits laboratories from performing in-vitro tests for the purpose of providing information for the diagnosis, prevention or treatment of any disease or impairment of, or the assessment of, the health of human beings unless there is in effect for such laboratories a certificate issued by the United States Department of Health and Human Services (via the FDA) applicable to the category of examination or procedure performed. Although a certificate is not required for the Company, it considers the applicability of the requirements of CLIA in the design and development of its products. The statutory definition of "laboratory" is very broad, and many of our customers are considered labs. A CLIA waiver will remove certain quality control and other requirements that must be met for certain customers to use the Company's products and this is critical to the marketability of a product into the point-of-care diagnostics market. The Company has received a CLIA waiver for each of the two rapid HIV tests now marketed by Alere Medical as Clearview® Complete HIV 1/2 and Clearview® HIV 1/2 STAT PAK®. The CLIA waiver was granted by the FDA for HIV 1/2 STAT-PAK® on November 20, 2006 and for the Clearview® Complete HIV 1/2 on October 22, 2007. In 2008 the FDA revised its CLIA waiver requirements so that an additional prospective trial need be conducted in order to demonstrate accuracy of the device when used by untrained users. +In addition, the FDA regulates the export of medical devices that have not been approved for marketing in the United States. The Federal Food, Drug and Cosmetic Act contain general requirements for any medical device that may not be sold in the United States and is intended for export. Specifically, a medical device intended for export is not deemed to be adulterated or misbranded if the product: (1) complies with the specifications of the foreign purchaser; (2) is not in conflict with the laws of the country to which it is intended for export; (3) is prominently labeled on the outside of the shipping package that it is intended for export; and (4) is not sold or offered for sale in the United States. However, the Federal Food, Drug and Cosmetic Act does permit the export of devices to any country in the world, if the device complies with the laws of the importing country and has valid marketing authorization in one of several "listed" countries under the theory that these listed countries have sophisticated mechanisms for the review of medical devices for safety and effectiveness. +The Company is also subject to regulations in foreign countries governing products, human clinical trials and marketing, and may need to obtain approval or evaluations by international public health agencies, such as the World Health Organization, in order to sell diagnostic products in certain countries. Approval processes vary from country to country, and the length of time required for approval or to obtain other clearances may in some cases be longer than that required for United States governmental approvals. On the other hand, the fact that our HIV diagnostic tests are of value in the AIDS epidemic may lead to some government process being expedited. The extent of potentially adverse governmental regulation affecting Chembio that might arise from future legislative or administrative action cannot be predicted. +Environmental Laws +To date, we have not encountered any costs relating to compliance with any environmental laws. +Intellectual Property +Intellectual Property Strategy +Our intellectual property strategy is to: (1) build our own intellectual property portfolio around our Dual Path Platform® technology; (2) pursue licenses, trade secrets and know-how within the area of rapid point-of-care testing, and (3) develop and acquire proprietary positions to reagents and new hardware platforms for the development and manufacture of rapid diagnostic tests. +The Company has obtained patent coverage on the DPP® technology, including four U.S. patents, and patents in China, Malaysia, Eurasia, Mexico, Singapore, Japan, Australia, Indonesia, Korea and the U.K. Additional patent applications on the DPP® technology are pending in the U.S., as well as in many foreign countries such as Brazil, Canada, the European Union, India, Israel, and South Africa. Patents have also been filed on extensions to the DPP® product line concept such as 4th generation assays. The four U.S. patents are as follows: +U.S. Patent No. +Issued +Expires +Nature +Type +Description +7,189,522 +3/13/2007 +3/11/2025 +test device +utility +a test device for determining the presence +of a ligand in a sample +7,682,801 +3/23/2010 +3/11/2025 +test device +and method +utility +a test device and a method for determining +the presence of a ligand in a sample +7,879,597 +2/1/2011 +3/11/2025 +test device +utility +a test device for determining multiple +ligands in a sample +8,507,259 +8/13/2013 +3/11/2025 +test device +utility +a test device for determining the +presence of a ligand in a sample +The Company also licenses a group of lateral flow technology patents from Alere. Our lateral flow products, which are primarily our STAT-PAK®, SURE CHECK®, and DIPSTICK® product lines, may incorporate methods that are claimed under one of the patents licensed from Alere that we use in our tests. That U.S. Patent #6,485,982 is also referred to as the Charlton patent, which patent expires on February 3, 2015. This patent describes a test device and method for a colored particle immunoassay that determines the presence of an analyte in a sample +14 +The Company has also filed for patents and obtained some patents in the U.S. for other inventions such as its multiple host species veterinary TB test, and patent applications for the other inventions are in various stages from being recently filed and not yet examined, to already examined and allowed but not yet issued. The Company selectively and strategically foreign files its patent applications based on a number of economic and strategic factors related to the invention. +Trademarks +The Company has filed and obtained trademarks for its products including DPP®, SURE CHECK® and STAT-PAK® and also for the SampleTainer® used in certain DPP® products. The DPP® trademark is also registered under the European convention (ECT). +Trade Secrets and Know-How +We believe that we have developed a substantial body of trade secrets and know-how relating to the development and manufacture of lateral flow and DPP® based diagnostic tests, including but not limited to the sourcing and optimization of materials for such tests, and how to maximize sensitivity, speed-to-result, specificity, stability and reproducibility. The Company possesses proprietary know-how to develop tests for multiple conditions using colored latex. Our buffer formulations enable extremely long shelf lives of our rapid HIV and other tests and we believe that this provides us with an important competitive advantage. +Lateral Flow Technology and Reagent Licenses +As part of the agreements executed in 2006 with Alere for the marketing of our HIV tests, we were granted non-exclusive licenses to certain lateral flow patents for certain products manufactured and marketed by Chembio including but not limited to our lateral flow HIV tests. This license allows us to produce, market and sell assays using lateral flow technologies specifically including our STAT-PAK®, SURE CHECK®, DIPSTICK®, and veterinary product lines. Under this license agreement, we pay royalties to Alere ranging from 5% to 8½%, depending upon the country in which the products are sold. Even though the relevant patent has expired in most other jurisdictions, or were never issued in markets where we have sold these products, our manufacture of the products in the United States has required that we pay royalties under this license, which has been a substantial expense. In 2013 our lateral flow royalty expense to Alere was $822,000, and since 2007 we have incurred a total of $2.65 million in lateral flow royalty expenses. As of February 3, 2015 this royalty expense will no longer be payable as the applicable patent expires at that time. The license we have from Alere to their lateral flow patents will expand to include the barrel and cassette products in the United States, if we elect to sell those products under Chembio brands prior to the expiration of the applicable patent; that is until February of 2015. +Although we believe our DPP® is outside of the scope of all lateral flow patents of which we are aware, we consult with patent counsel, and seek licenses and/or redesigns of products that we believe to be in the best interests of the Company and our stockholders. Because of the costs and other negative consequences of time-consuming patent litigation, we often attempt to obtain a license on reasonable terms. Nevertheless there is no assurance that the Alere lateral flow patents we have licensed will not be challenged or that other patents containing claims relevant to the Company's lateral flow or DPP® products will not be granted to third parties and that licenses to such patents, will be available on reasonable terms, if any. In the past Alere has aggressively enforced its lateral flow intellectual property, although some of the main patents will expire within the next couple of years and we are not aware of any patent enforcement litigation that is ongoing with respect to the Alere lateral flow intellectual property. +Regardless, the DPP® technology provides us with our own intellectual property. We believe it provides us with a freedom to operate, and that it also enables tests to be developed with improved sensitivity as compared with comparable tests on lateral flow platforms. The Company has signed and anticipates signing new development projects based upon the DPP® technology that will provide new manufacturing and marketing opportunities. We have filed other patent applications that we believe will strengthen the DPP® intellectual property and have also filed for patent protection for certain other point-of-care technologies or applications thereof. +The peptides used in our rapid HIV tests were patented by Adaltis Inc. and were licensed to us under a 10-year non-exclusive license agreement dated August 30, 2002. However, in connection with Adaltis' bankruptcy, during the third quarter of 2009 we bought out all of our remaining obligations under that agreement. We also have licensed the antigens used in other tests including our Syphilis, Tuberculosis, Leptospirosis, Leishmaniasis and Chagas tests, and we may enter other license agreements. In prior years we concluded license agreements related to intellectual property rights owned by the United States associated with HIV- 1, and during the first quarter of 2008 we entered into a sub-license agreement for HIV-2 with Bio-Rad Laboratories N.A., the exclusive licensee of the Pasteur Institute's HIV-2 intellectual property estate. +15 +Corporate History +On May 5, 2004, we completed a merger with Trading Solutions, Inc. through which Chembio Diagnostic Systems Inc. became our wholly-owned subsidiary, and through which the management and business of Chembio Diagnostic Systems Inc. became our management and business. As part of this transaction, we changed our name to Chembio Diagnostics, Inc. +Since the formation of Chembio Diagnostic Systems Inc. in 1985, it has been involved in developing, manufacturing, selling and distributing in-vitro diagnostic tests, including rapid tests beginning in 1995, for a number of conditions in humans and animals. +On March 12, 2004, we implemented a 1-for-17 reverse split of our common stock. All references in this Form 10-K to shares of our common stock have been adjusted to reflect this reverse split. +In February 2010, Crestview Capital Master, L.L.C. ("Crestview Master"), a Delaware limited liability company that held 18,907,431 shares of Chembio's common stock, spun off all these shares, constituting approximately 30.5% of Chembio's outstanding shares, to its three equity holders. One of the three equity holders of Crestview Master immediately spun off, to its approximately 126 equity holders, all of the 12,990,569 shares of Chembio stock that it received in this distribution. As a result, as of February 24, 2010, Crestview Master no longer owned any shares. The former direct and indirect equity holders of Crestview Master owned all these shares, with none of these individual stockholders having beneficial ownership of more than 5.61% of the outstanding common stock of Chembio. +On May 30, 2012, the Company effected a 1-for-8 reverse split of its common stock. This was done to allow the Company to move to the NASDAQ trading market from the OTCQB market, which occurred on June 7, 2012. As a result of the stock split, the outstanding 63,967,263 common shares were reduced to 7,995,918 outstanding common shares on May 30, 2012. The effect of the reverse stock split has been retroactively reflected for all periods in these financial statement. +16 +Glossary +AIDS +Acquired Immunodeficiency Syndrome. AIDS is caused by the Human Immunodeficiency Virus, HIV. +ALGORITHM (parallel or serial) +For rapid HIV testing this refers both to method or protocol (in developing countries to date) for using rapid tests from different manufacturers in combination to screen and confirm patients at the point-of-care, and may also refer to the specific tests that have been selected by an agency or ministry of health to be used in this way. A parallel algorithm uses two screening tests from different manufacturers and a tie-breaker test only if there is a discrepancy between the screening tests results. A serial algorithm only uses a second confirmatory test if there is a positive result from the screening test, meaning that the number of confirmatory tests used is equal to the positivity rate in the testing venue. A tie-breaker test resolves discrepancies between the screen and the confirmatory test. +ANTIBODY +A protein which is a natural part of the human immune system produced by specialized cells to neutralize antigens, including viruses and bacteria that invade the body. Each antibody producing cell manufactures a unique antibody that is directed against, binds to and eliminates one, and only one, specific type of antigen. +ANTIGEN +Any substance which, upon entering the body, stimulates the immune system leading to the formation of antibodies. Among the more common antigens are bacteria, pollens, toxins, and viruses. +ANVISA +Anti-Retroviral Treatments for AIDS +The National Health Surveillance Agency of Brazil +ARVs +Anti-retroviral medications developed to fight AIDS +CDC +United States Centers for Disease Control and Prevention +CLIA waiver +Clinical Laboratory Improvement Act designation that allows simple tests to be performed in point-of-care settings such as doctor's offices, walk-in clinics and emergency rooms. +DIAGNOSTIC +Pertaining to the determination of the nature or cause of a disease or condition. Also refers to reagents or procedures used in diagnosis to measure proteins in a clinical sample. +EITF +Emerging Issues Task Force +FASB +Financial Accounting Standards Board +FIOCRUZ +The Oswaldo Cruz Foundation of Brazil +FDA +United States Food and Drug Administration +FDIC +Federal Deposit Insurance Corporation +FAS +Financial Accounting Standard +IgG +IgG or Immunoglobulin are proteins found in human blood. This protein is called an "antibody" and is an important part of the body's defense against disease. When the body is attacked by harmful bacteria or viruses, antibodies help fight these invaders. +NGO +Non-Governmental Organization +OTC +Over-the-Counter +PEPFAR +The President's Emergency Plan for AIDS Relief +PMA +Pre-Marketing Approval –FDA approval classification for a medical device that is not substantially equivalent to a legally marketed device or is otherwise required by statute to have an approved application. Rapid HIV tests must have an approved PMA application before marketing of such a product can begin. +PROTOCOL +A procedure pursuant to which an immunodiagnostic test is performed on a particular specimen in order to obtain the desired reaction. +REAGENT +A chemical added to a sample under investigation in order to cause a chemical or biological reaction which will enable measurement or identification of a target substance. +RETROVIRUS +A type of virus which contains the enzyme Reverse Transcriptase and is capable of transforming infected cells to produce diseases in the host such as AIDS. +SAB +Staff Accounting Bulletin +SENSITIVITY +Refers to the ability of an assay to detect and measure small quantities of a substance of interest. The greater the sensitivity, the smaller the quantity of the substance of interest the assay can detect. Also refers to the likelihood of detecting the antigen when present. +SPECIFICITY +The ability of an assay to distinguish between similar materials. The greater the specificity, the better an assay is at identifying a substance in the presence of substances of similar makeup. +USDA +U.S Department of Agriculture +WHO +World Health Organization +17 \ No newline at end of file diff --git a/raw/filings/0001092662/2013/0001092662-14-000018/item13.txt b/raw/filings/0001092662/2013/0001092662-14-000018/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..7d183e448b99932eceb79ec9f642a91ad39ee38a --- /dev/null +++ b/raw/filings/0001092662/2013/0001092662-14-000018/item13.txt @@ -0,0 +1,37 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +The executive officers of the Company are as follows: Lawrence A. Siebert, president, chief executive officer and chairman of the board of directors of the Company, Sharon Klugewicz, chief operating officer, Richard J. Larkin, chief financial officer of the Company, and Javan Esfandiari, executive vice president of Research and Development of the Company. +On February 16, 2012, the Company granted options to purchase the following numbers of shares of the Company's common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company's common stock on February 16, 2012, which was $4.00 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee's employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +2,563 +Javan Esfandiari – Executive Vice President of R&D +7,969 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +3,000 +Richard J. Larkin – Chief Financial Officer +2,797 +Lawrence A. Siebert – Chief Executive Officer +9,063 +On February 25, 2013, the Company granted options to purchase the following numbers of shares of the Company's common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company's common stock on February 26, 2013, which was $5.56 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee's employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +1,520 +Javan Esfandiari – Executive Vice President of R&D +4,765 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +1,775 +Sharon Klugewicz – Vice President of QA/QC +630 +Richard J. Larkin – Chief Financial Officer +1,670 +Lawrence A. Siebert – Chief Executive Officer +5,215 +Michael Steele – Vice President of Sales and Marketing +785 +The Company entered into an employment agreement effective March 5, 2013 (the "Employment Agreement"), with Mr. Esfandiari to continue as the Company's Senior Vice President of Research and Development for an additional term of three years through March 5, 2016. The Company entered into an employment agreement, effective May 22, 2013 (the "Employment Agreement"), with Ms. Klugewicz to become the Company's Chief Operating Officer for a term of two years through May 22, 2015. See Item 11 for more details. +Director Independence +Our common stock trades on the NASDAQ. Accordingly, we are subject to the corporate the governance standards of NASDAQ, which require, among other things, that the majority of the board of directors be independent. We define an "independent" director in accordance with the NASDAQ Global Market's requirements for independent directors. Under this definition, we have determined that each of Katherine Davis, Barbara DeBuono, Peter Kissinger, and Gary Meller currently qualify as independent directors. We do not list the "independent" definition we use on our internet website. +46 \ No newline at end of file diff --git a/raw/filings/0001092662/2013/0001092662-14-000018/item9a.txt b/raw/filings/0001092662/2013/0001092662-14-000018/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..a17bd92e5ed093042be0dabbf83286dddfe79082 --- /dev/null +++ b/raw/filings/0001092662/2013/0001092662-14-000018/item9a.txt @@ -0,0 +1,15 @@ +ITEM 9A. +CONTROLS AND PROCEDURES +(a) Disclosure Controls and Procedures. Under the supervision and with the participation of our senior management, consisting of our chief executive officer and our chief financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of the end of the period covered by this report (the "Evaluation Date"). Based on that evaluation, the Company's management, including our chief executive officer and chief financial officer, concluded that as of the Evaluation Date our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our Exchange Act reports is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. +Management's Annual Report on Internal Control Over Financial Reporting. The Company's management is responsible for establishing and maintaining an adequate system of internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)). Our internal control over financial reporting is a process, under the supervision of our chief executive officer and chief financial officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States. These internal controls over financial reporting processes include policies and procedures that: +a. +Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; +b. +Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and +c. +Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives. +In evaluating the effectiveness of our internal control over financial reporting, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on this evaluation, our Chief Executive and Chief Financial Officers concluded that our internal control over financial reporting was effective as of December 31, 2013. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. +Management's report was not subject to attestation by our registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report. +(b) Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the Company's last fiscal quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0001092662/2013/0001092662-14-000018/rp_note.txt b/raw/filings/0001092662/2013/0001092662-14-000018/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001092662/2013/0001092662-14-000018/rpt_disclosure.txt b/raw/filings/0001092662/2013/0001092662-14-000018/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..7d183e448b99932eceb79ec9f642a91ad39ee38a --- /dev/null +++ b/raw/filings/0001092662/2013/0001092662-14-000018/rpt_disclosure.txt @@ -0,0 +1,37 @@ +ITEM 13. +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE. +The executive officers of the Company are as follows: Lawrence A. Siebert, president, chief executive officer and chairman of the board of directors of the Company, Sharon Klugewicz, chief operating officer, Richard J. Larkin, chief financial officer of the Company, and Javan Esfandiari, executive vice president of Research and Development of the Company. +On February 16, 2012, the Company granted options to purchase the following numbers of shares of the Company's common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company's common stock on February 16, 2012, which was $4.00 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee's employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +2,563 +Javan Esfandiari – Executive Vice President of R&D +7,969 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +3,000 +Richard J. Larkin – Chief Financial Officer +2,797 +Lawrence A. Siebert – Chief Executive Officer +9,063 +On February 25, 2013, the Company granted options to purchase the following numbers of shares of the Company's common stock set forth below to the executive officers of the Company named below. The exercise price for these options was the last traded market price for the Company's common stock on February 26, 2013, which was $5.56 per option. The options become exercisable on the effective date of the grant. Each option granted will expire and terminate, if not exercised sooner, upon the earlier to occur of (a) 30 days after termination of the employee's employment with the Company or (b) the fifth anniversary of the effective date of grant. +Name of Executive Officer +Number of Shares of Common Stock Options +Richard Bruce - Vice President of Operations +1,520 +Javan Esfandiari – Executive Vice President of R&D +4,765 +Tom Ippolito - Vice President of Regulatory Affairs, QA & QC +1,775 +Sharon Klugewicz – Vice President of QA/QC +630 +Richard J. Larkin – Chief Financial Officer +1,670 +Lawrence A. Siebert – Chief Executive Officer +5,215 +Michael Steele – Vice President of Sales and Marketing +785 +The Company entered into an employment agreement effective March 5, 2013 (the "Employment Agreement"), with Mr. Esfandiari to continue as the Company's Senior Vice President of Research and Development for an additional term of three years through March 5, 2016. The Company entered into an employment agreement, effective May 22, 2013 (the "Employment Agreement"), with Ms. Klugewicz to become the Company's Chief Operating Officer for a term of two years through May 22, 2015. See Item 11 for more details. +Director Independence +Our common stock trades on the NASDAQ. Accordingly, we are subject to the corporate the governance standards of NASDAQ, which require, among other things, that the majority of the board of directors be independent. We define an "independent" director in accordance with the NASDAQ Global Market's requirements for independent directors. Under this definition, we have determined that each of Katherine Davis, Barbara DeBuono, Peter Kissinger, and Gary Meller currently qualify as independent directors. We do not list the "independent" definition we use on our internet website. +46 \ No newline at end of file diff --git a/raw/filings/0001334036/2006/0001104659-07-025001/filing.txt b/raw/filings/0001334036/2006/0001104659-07-025001/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..ef87597187a0cf5ef47bc9f0fe11adc98883adfd --- /dev/null +++ b/raw/filings/0001334036/2006/0001104659-07-025001/filing.txt @@ -0,0 +1,6567 @@ +10-K +1 +a07-7262_110k.htm +10-K +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR +15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2006 +or +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR +15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission File No. 0-51754 +CROCS, INC. +(Exact name of registrant as specified in its +charter) +Delaware +20-2164234 +(State or other jurisdiction of +(I.R.S. Employer +incorporation or organization) +Identification No.) +6328 Monarch Park Place +Niwot, Colorado 80503 +(303) 848-7000 +(Address, including zip code and telephone number, +including area code, of Registrant’s of principal executive office) +Securities registered pursuant to Section 12(b) of +the Act: +Title of each class: +Name of each exchange on which registered: +Common Stock, par value $0.001 per share +The Nasdaq Global Select Market +Securities registered pursuant to Section 12(g) of the Act: +None +Indicate by check mark if +the registrant is a well-known seasoned issuer, as defined in Rule 405 of +the Securities Act. Yes o No x +Indicate by check mark if +the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of +the Act. Yes o No x +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 x No o +Indicate by check mark if +disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is +not contained herein, and will not be contained, to the best of the registrant’s +knowledge, in definitive proxy or information statements incorporated by +reference in Part III of the Form 10-K or any amendment to the Form 10-K. +x . +Indicate +by check mark whether the registrant is a large accelerated filer, an +accelerated filer, or a non-accelerated filer. See definition of “accelerated +filer and large accelerated filer” in Rule 12b-2 of the Exchange +Act. (Check one): +Large accelerated filer o +Accelerated +filer o +Non-accelerated +filer x +Indicate by check mark +whether the registrant is shell company (as defined in Rule 12b-2 of +the Exchange Act). Yes o No x +The aggregate market value +of the voting common stock held by non-affiliates of the Registrant as of June 30, +2006 was $755,762,983. For the purpose of the foregoing calculation only, all +directors and executive officers of the Registrant and owners of more than 5% +of the Registrant’s common stock are assumed to be affiliates of the +Registrant. This determination of affiliate status is not necessarily +conclusive for any other purpose. +The number of shares of the +Registrant’s common stock outstanding as of February 28, 2007 was 39,909,132. +DOCUMENTS INCORPORATED BY +REFERENCE +Part III incorporates certain information by +reference from the registrant’s proxy statement for the 2007 annual meeting of +stockholders to be filed no later than 120 days after the end of the registrant’s +fiscal year ended December 31, 2006. +Crocs Inc. +2006 Annual Report on Form 10-K +Table +of Contents +PART I +Item 1. +Business +2 +Item +1A. +Risk +Factors +11 +Item 1B. +Unresolved Staff Comments +23 +Item 2. +Properties +23 +Item +3. +Legal +Proceedings +23 +Item 4. +Submission of Matters to a Vote of Security Holders +25 +PART II +Item 5. +Market for the Registrant’s Common Equity, Related +Stockholder Matters and Issuer Purchases of Equity Securities +26 +Item +6. +Selected +Financial Data +27 +Item 7. +Management’s Discussion and Analysis of Financial +Condition and Results of Operations +29 +Item 7A. +Quantitative and Qualitative Disclosures About Market +Risk +40 +Item 8. +Financial Statements and Supplementary Data +40 +Item 9. +Changes in and Disagreements with Accountants on +Accounting and Financial Disclosure +40 +Item 9A. +Controls and Procedures +40 +Item +9B. +Other +Information +41 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +41 +Item 11. +Executive Compensation +41 +Item 12. +Security Ownership of Certain Beneficial Owners and +Management and Related Stockholder Matters +41 +Item 13. +Certain Relationships and Related Transactions, and +Director Independence +42 +Item 14. +Principal Accounting Fees and Services +42 +PART IV +Item 15. +Exhibits, Financial Statement Schedules +43 +Signatures +46 +FORWARD-LOOKING +INFORMATION +Throughout this report, references to the “Company,” “we” +and “our” refer to Crocs, Inc. and its consolidated subsidiaries, unless +the context indicates otherwise. +Statements in this Form 10-K (or otherwise +made by us or on our behalf) contain various forward-looking statements +within the meaning of Section 27A of the Securities Act of 1933, as +amended, or the Securities Act, and Section 21E of the Securities Exchange +Act of 1934, as amended, or the “Exchange Act,” which represent our management’s +beliefs and assumptions concerning future events. When used in this document +and in documents incorporated by reference, forward-looking statements +include, without limitation, statements regarding financial forecasts or projections, +and our expectations, beliefs, intentions or future strategies that are +signified by the words “expects,” “anticipates,” “intends,” “believes,” “plans,” +or similar language. These forward-looking statements are subject to +risks, uncertainties and assumptions that could cause our actual results and +the timing of certain events to differ materially from those expressed in the +forward-looking statements. It is routine for our internal projections +and expectations to change as the year or each quarter in the year progresses, +and therefore it should be clearly understood that the internal projections, +beliefs and assumptions on which we base our expectations may change prior to +the end of each quarter or year. Although these expectations may change, we may +not inform you if they do. +You should understand that +many important factors, in addition to those discussed or incorporated by +reference in this report, could cause our results to differ materially from +those expressed in the forward-looking statements. Potential factors that +could affect our results include, in addition to others not described in this +report, those described in Item 1A “Risk Factors” of this report. In light of +these risks and uncertainties, the forward-looking events discussed in +this report might not occur. +PART I +ITEM I. Business +Overview +We are a rapidly growing +designer, manufacturer and marketer of footwear for men, women and children +under the Crocs brand. All of our footwear products incorporate our proprietary +closed-cell resin material, which we believe represents a substantial +innovation in footwear comfort and functionality. Our proprietary closed-cell +resin, which we refer to as croslite, enables us to produce a soft and +lightweight, non-marking, slip- and odor-resistant shoe. These unique +properties make our footwear ideal for casual wear, as well as for recreational +uses such as boating, hiking, fishing or gardening, and have enabled us to +successfully market our products to a broad range of consumers. We have +combined the unique properties of croslite with fun colors and innovative +designs to provide a new level of comfort, functionality and style in the +casual lifestyle footwear category at attractive retail price points ranging +from $19.99 to $59.99. In 2007, we acquired substantially all of the assets of Ocean +Minded, LLC (“Ocean Minded”), a leading designer and manufacture of high +quality leather and EVA (Ethylene Vinyl Acetate) based sandals. In addition to +our footwear products, we recently acquired Jibbitz LLC (“Jibbitz”) a unique +accessory brand with colorful snap-on products specifically suited for Crocs +shoes. We also recently acquired 55 Hockey Products Inc., which operates under +the brand name Fury Hockey (“Fury”), a producer and distributor of hockey and +lacrosse equipment for adults and children and EXO Italia (“EXO”), an Italian +designer and producer of EVA based finished products, primarily for the +footwear industry. We also use croslite to manufacture non-branded products +that we sell to original equipment manufacturers. We have also introduced +several Crocs-branded apparel and accessory items that complement the fun +styling, colors, and image of our footwear and that we believe will appeal to a +similar demographic base. +2 +Our History +We were organized as a limited liability company in +1999, and began marketing and distributing footwear products in the U.S. under +the Crocs brand in November 2002, shortly after completing the +modification and improvement of a shoe produced by Foam Creations Inc. (“Foam +Creations”), formerly known as Finproject N.A., Inc. The unique +characteristics of croslite developed by Foam Creations enabled us to offer +consumers an innovative shoe unlike any other footwear model then available. +Initially, we targeted our products to water sports enthusiasts, but the +comfort and functionality of our products appealed to a more diverse group of +consumers who used our footwear in a wide range of activities. To capitalize on +the broad appeal of our footwear, we expanded our sales infrastructure, +strengthened our senior management team, and developed relationships with a +range of retailers in the U.S. through 2003 and 2004. In June 2004, we +acquired Foam Creations, including its manufacturing operations, product lines, +and rights to the trade secrets for croslite. We converted to a Colorado +corporation in January 2005 and reincorporated in Delaware in June 2005. +Since June 2004, we have significantly expanded +all aspects of our operations in order to take advantage of what we believe to +be an attractive market opportunity. We have substantially increased the depth +and breadth of our distribution and currently sell our products in over 11,000 +domestic store locations and in over 80 countries worldwide. Additionally, we +have expanded our product line to include more than 25 models in a wide variety +of colors, color combinations, and patterns. +In December 2006, we acquired Jibbitz, a company +that specializes in accessories for Crocs footwear. Jibbitz now features over +900 different stock keeping units, or SKUs, being sold through 4,000 retail +accounts in the U.S., Canada, Asia, and Europe. In October 2006, we +acquired Fury, which produces and distributes hockey and lacrosse equipment for +adults and children and EXO, which designs and produces EVA based finished +products. +In February 2007, we +acquired Ocean Minded, a designer and manufacture of high quality leather and +EVA (Ethylene Vinyl Acetate) based sandals primarily for the beach, adventure +and action sports market. Ocean Minded utilizes recycled and recyclable +materials whenever possible and is well known in the action sports industry as +a leading advocate for environmental awareness and responsibility. +Product Overview +Our primary product line +is Crocs-branded footwear for men, women and children, which we first +introduced in 2002 with a single model in six colors. We have since expanded +our line of footwear to include more than 25 models in a wide variety of +colors, color combinations and patterns and a range of sizes, representing over +5,800 SKUs and we intend to continue diversifying our footwear portfolio with +new model introductions. In addition to our footwear products, we market a line +of Crocs-branded apparel and accessory items that are intended to increase +awareness of our brand and our products and have added Jibbitz accessories to +our product line, which are specifically suited to snap on to Crocs shoes. To +further diversify our product line we added Fury, which produces and +distributes hockey and lacrosse equipment, which will be manufactured with +croslite beginning in 2007. We also selectively use croslite to manufacture a +variety of other non-branded products, such as spa pillows and kayak seats, +which are marketed to original equipment manufacturers. +Footwear +A key differentiating feature of our footwear products +is croslite, which is uniquely suited for comfort and functionality. We have +carefully formulated croslite to be of a density that creates a comfortable +shoe with a high coefficient of friction, allowing for slip-resistant, +non-marking footwear that is extremely lightweight. For example, our size large +Beach model weighs approximately six ounces, which is significantly lighter +than more traditional casual footwear products. Croslite softens as it warms to +better +3 +conform to the wearer’s +feet. Croslite is a closed cell resin, which makes them water resistant and +virtually odor-free, and allows them to be cleaned simply with water or bleach. +We have combined the unique properties of croslite +with designs that are intended to be functional across a broad range of +activities. As a result, we believe our products appeal to a wide range of +consumers. We introduced Crocs as a footwear brand in the U.S. with the launch +of our Beach model in 2002. Based on our initial success, we made refinements +to the Beach model and introduced a second generation of footwear that +incorporated a broader range of sizing, provided different levels of +ventilation for various climates, and offered slightly different styling. We +have further broadened our footwear line into new product categories, such as +the Athens, a flip-flop with a soft footbed; the Scutes, an open toe sport +slide; the Off Road, an evolution of our Beach model with a rugged sole for +added traction; the Islander, a deck shoe integrating a base made from croslite +with a stitched leather upper, and the Mary Jane, our version of the classic +woman’s shoe. We also introduced several other new models in 2006. Additionally, +we introduced three footwear models marketed under our Crocs Rx line. These +models are designed for consumers who require specialized footwear that +provides relief from certain medical conditions. +We entered into an arrangement with Disney in June 2006 +under which we introduced a limited edition line of footwear and Jibbtiz charms +featuring some of Disney’s most popular characters. This new Disney by Crocs +line is targeted towards children and adults, and debuted with special-edition +Mickey Mouse die-cut adult Beach and children’s Cayman models. These styles are +available in a broad range of two-toned color combinations, including Mickey +Mouse’s signature black and red. Other models scheduled to be introduced +include an array of unique designs emphasizing the distinctive personalities of +Disney’s characters including Mickey and Friends, Winnie the Pooh and Friends, +Disney Princesses, Disney Fairies, as well as Pirates of the Caribbean and +Disney*Pixar’s Toy Story and Cars. We have entered into licensing agreements to +market a line of shoes and Jibbitz charms featuring the names and logos of +various universities and colleges. These shoes feature the school colors and +are sold on college campuses and through our sales and distribution network. In +addition, we have entered into sponsorship and marketing agreements with +various colleges and universities, which allow us to advertise in their arenas +and stadiums and sell our products on campus and at sporting events. +We currently sell our shoes in an assortment of +colors, styles, and sizes to provide consumers and retailers a wide variety of +options at suggested retail prices ranging from $19.99 to $59.99. We have +designed our shoes to offer a number of beneficial structural features to +provide maximum comfort and functionality, such as Italian-designed orthotic +heels, built-in arch supports and tarsal bars. We also offer models that are +based on either general shoe sizing ranging from XXS through 4XL, or specific +shoe sizing ranging from children’s 6-7 through men’s 13. This allows +retailers to offer a complete range of sizes or carry a more limited number of +SKUs, enabling them to tailor their offerings to their particular clientele and +more efficiently allocate limited floor space. +As part of our strategy of expanding into new footwear +categories, we are continually designing new footwear using our in-house design +team as well as recognized footwear design experts. As part of this strategy, +we acquired EXO in 2006,which expanded the capabilities of our in-house design +team. +Footwear sales made up +96.5%, 94.4%, and 80.7% of total revenues for the years ended December 31, +2006, 2005, and 2004, respectively. +Apparel and +Accessories +We have introduced several Crocs-branded accessory +items that complement the fun styling, colors, and image of our footwear and +that we believe will appeal to a similar demographic base. We also intend to +develop additional Crocs accessories for certain targeted markets. For example, +we have developed a line of lightweight, colorful kneepads made from croslite, +which we are marketing to gardening retailers +4 +and hardware stores. Our +strategy is to develop accessory items that benefit from our unique material +and complement the market positioning of our Crocs footwear. +As part of our strategy to increase awareness of our +brand, we have also introduced a line of branded logo apparel which is +complementary to our footwear line and embodies the functional and fun aspects +of the Crocs brand. These products include t-shirts, sweatshirts, hats, +beanies, and socks, most of which come in various colors and prominently +feature the Crocs logo. +In December 2006, we +acquired Jibbitz, a company that specializes in accessories for Crocs footwear. +Jibbitz is a unique accessory brand with colorful snap-on products specifically +suited for Crocs shoes. As of December 31, 2006, more than 900 Jibbitz +SKUs were available to consumers for personalizing and customizing their Crocs +footwear. +Other Products +Croslite is well suited to +a number of other applications and, in many cases, is superior to materials +currently used in such applications. Foam Creations, our wholly owned +subsidiary, manufactures spa pillows for the home spa market, seats and pads +for use in kayaks and canoes, and scuba diving fins as croslite is highly +functional for other water sports products. In addition, Fury produces and +distributes hockey and lacrosse equipment, which will be manufactured with +croslite beginning in 2007. These products employ croslite, but we do not +market them under the Crocs brand name. +Sales and +Distribution +Financial information +regarding our revenues, profits, total assets, and geographic operations +appears in note 20 of our consolidated financial statements. +Domestic Sales +In the U.S., we sell our products through over 11,000 +domestic retail store locations representing over 4,500 customer accounts. Our +footwear is currently sold through traditional retail channels, including +specialty footwear stores such as Brown’s Shoe Fit and Journeys, sporting goods +and outdoor retailers such as The Sports Authority, Dick’s Sporting Goods, REI, +Bass Pro Shops, and West Marine, and department stores, including Dillard’s, +Nordstrom, and Von Maur. No customer accounted for more than 10% of our +revenues for the year ended December 31, 2006. Our products are also sold +through a variety of other specialty channels, including gift shops, bicycle +retailers, specialty food retailers, health and beauty stores, catalogs, +uniform suppliers, and kiosks. +Our domestic accounts are primarily serviced through +our internal sales force, who focus on selling the appropriate mix and quantity +of our products to our retail accounts. They ensure our products are displayed +effectively at retail locations and educate our retailers about our Crocs brand +and the quality of our products. In late 2006, we began transitioning +compensation of our internal sales representatives from a commission basis to +salary. +International Sales +Outside of the U.S., we sell our products through over +8,000 international retail store locations, including five company-operated +retail stores. Our strategy is to sell through a broad range of sporting goods +and department stores, as well as through specialty retailers, similar to the +retail sales channels we have established in the U.S. We established a direct +sales presence in most major foreign markets, rather than relying on +distributors, which we believe will improve our margins and allow us to better +control our marketing and distribution. As of December 31, 2006, we have +established direct sales efforts in 37 countries including, Australia, Austria, +the Caribbean, France, Germany, Hong Kong, Japan, the Netherlands, Singapore, +and the United Kingdom. +5 +We also use distributors +in select foreign markets where we believe such arrangements are preferable to +direct sales. In markets where we use third party distributors, these +distributors purchase products pursuant to a price list and are granted the +right to resell such products in a defined territory, usually a country or +group of countries. Our typical distribution agreements have terms of one to +four years, are terminable on 60 days’ notice prior to the end of the term or +on six months prior notice at any time, and require our distributors to meet a +minimum sales threshold. In 2006, all of our distributors exceeded their +minimum sales thresholds. +Retail Sales +We are currently expanding our direct sales efforts to +consumers. We believe that direct sales provide us with an opportunity to +showcase our entire line of footwear, apparel, and accessory offerings, and +believe this strategy will serve as an important and effective means to enhance +our product and brand awareness. We also believe that our 2006 direct sales +initiatives required low levels of capital investment while enabling us to sell +our products at retail, rather than wholesale prices, resulting in higher gross +margins. +Retail +Sites. As of December 31, 2006, we operated +83 retail kiosks located in malls and other high foot traffic areas. With +bright and colorful displays, efficient use of retail space, and limited +initial capital investment, we believe that kiosks are an effective outlet for +marketing our products. Kiosks enable us to highlight a wide range of our +products, more effectively interact with potential consumers, and enhance our +brand awareness among both consumers and local retailers. We plan to continue +to open and operate additional kiosk sites in select, high foot traffic +locations. +Internet. We +currently offer our products domestically and internationally through our +website at www.crocs.com and have our European website at www.crocs.eu. Our +internet presence enables us to educate consumers about our products and brand. +As we expand our international marketing efforts, we intend to create local +websites targeting consumers in each major market. +Distribution and +Logistics +In July 2005, we engaged Expeditors International +of Washington, Inc. (“Expeditors”), a global supply chain management and logistics +provider, to operate our warehouse, distribution and fulfillment process for a +significant portion of our domestic sales. Expeditors operates a distribution +center in Aurora, Colorado through which we distributed a substantial portion +of our products in the U.S. We had the use of up to 320,000 square feet of the +distribution center to accommodate fluctuations in our inventory. We did not +have a long-term contract with Expeditors, and the relationship was terminated +in January 2007. +A substantial portion of our products were shipped to +Expeditors’ distribution center in Aurora, Colorado during 2006. From there, +Expeditors packaged orders and generally shipped by package express or truck to +our customers, depending on size of order, customer location, and availability +of inventory. Many of our large customers received shipments of footwear +directly from the manufacturing facilities. We also engaged Colorado +Distribution Group, LLC to provide warehouse and inventory management, and +distribution and fulfillment services. Colorado Distribution has leased a +125,000 square foot distribution facility in Denver, Colorado to help perform +these services. +In December 2006, we began operating a warehouse and +order processing and customer order fullfillment facility in Aurora, Colorado, +which has enabled us to terminate our relationship with Expeditors in January 2007 +reducing our reliance on third party distribution facilities. Our lease +agreement for the facility permits us to use up to 264,000 square feet for our +distribution activities and we anticipate that most of our domestic product +fullfillment will be managed by this facility during 2007. We have additional +company-operated warehouse and fulfillment operations in Canada, China, Italy, +Hawaii, Mexico, the Netherlands, New Zealand, Puerto Rico and Singapore, and +are developing relationships with +6 +third parties in Australia +and Japan to provide such services to us. We expanded our company-operated +distribution facility in China and entered into a rental arrangement for a +100,000 square foot facility. In addition, we have established a +company-operated warehouse facility and customer order facility in Niwot, +Colorado, and we are currently processing our internet, accessories, and +apparel orders from this facility. +Raw Materials +Our proprietary closed-cell resin, which we refer to +as croslite, is the primary raw material used in all of our footwear, some of +our accessories, and non-branded products, including spa pillows, and seats and +pads for kayaks and canoes. Croslite is also used in our Crocs-branded +accessory items, such as our kneepads and will be featured in Fury hockey +equipment beginning in 2007. We have formulated croslite to offer a number of +unique properties that make our material suitable for a wide range of +commercial uses including those mentioned above. Our material is soft and +durable and is of a density that provides a high coefficient of friction +allowing our material to be slip-resistant and non-marking in addition to being +extremely lightweight. Additionally, the closed-cell nature of croslite makes +it resistant to the bacteria and fungus that cause shoe and foot odor. We +continue to invest in research and development in order to refine our materials +to enhance these properties as well as target the development of new properties +for specific applications. +Croslite is produced by compounding elastomer resins +that we or one of our third party processors purchase from a major chemical +manufacturer together with certain other production inputs, such as color dyes. +Other than the elastomer resins, all of the raw materials we use to produce +croslite are readily available for purchase from multiple suppliers. At this +time, we have identified two suppliers that produce the particular elastomer +resins used in croslite. However, we may in the future identify and utilize +materials produced by other suppliers as an alternative to the elastomer resins +we currently use in the production of our proprietary material. +We have historically +contracted to have croslite compounded by a third party manufacturer in Italy. +We began compounding croslite ourselves in 2006 at our manufacturing facilities +in Canada and China. We have also engaged a third-party processor in Canada to +compound a portion of our croslite requirements. We engaged a third party in +the United States to compound certain subcomponents of croslite. We also +developed production capacity at one of our third-party factories in China +where the subcomponents are compounded into croslite. We believe that our +production strategy, including in-house production, for the compounding of +croslite will lower our production costs, reduce the risk of supply shortages +from our third party processors and provide us with greater production +flexibility to meet changing retail demand. However, we will continue to +purchase a portion of our croslite requirements from a third party in +accordance with the terms of our supply agreement. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally +diversified, low-cost manufacturing base. We operate our own production +facilities in North America and Italy, and we also contract with third party +manufacturers located around the world. We believe our in-house manufacturing +capabilities enable us to rapidly make changes to production, providing us with +the flexibility to quickly respond to orders for high-demand models and colors +throughout the year, while outsourcing allows us to capitalize on the +efficiencies and cost benefits of using contract manufacturing. We believe that +this production strategy will enable us to continue to minimize our production +costs and increase overall operating efficiencies as well as shorten production +and development times to better serve our retail customers. +The process for manufacturing our footwear was +developed over an eight year period of continual refinement to improve +consistency, softness, durability, and yield. Prior to October 2004, all +of our footwear was manufactured at Foam Creations’ facility in Quebec City, +Canada. In the year ended December 31, 2006, we manufactured approximately +20.5% of our footwear products at our company- +7 +operated manufacturing +facilities in Canada, Mexico and Italy. We obtain the remainder of our footwear +products from third party manufacturers in China, Italy, Romania and the United +States. In the year ended December 31, 2006, our largest supplier in China +produced approximately 55.4% of our footwear unit volume. We have a long-term +contract with our third party manufacturer in Florida, but do not have written +supply agreements with our primary third party manufacturers in China. We +intend to further expand our manufacturing capacity at the facilities we +operate in Canada and Mexico in 2007. We also expect to open a new +manufacturing facility in Brazil in the first half of 2007. +While we are currently dependent on a limited number +of third party manufacturers to produce a majority of our footwear products, we +have evaluated and qualified over 15 alternative third party manufacturers that +have the current ability and capacity to manufacture our footwear products in +the event that one or more of our current third party manufacturers were to +reduce or cease production of our footwear. For example, to meet the growing +demand for our footwear, in August 2005, we engaged a new third party +manufacturer capable of commencing production of our footwear products within +two months of entering into discussions with us regarding a manufacturing +arrangement. +Our manufacturing facility +in Quebec City produces our non-footwear products made from croslite, such as +kayak seats and spa pillows. We purchase our apparel and accessories from +various suppliers that source our products from manufacturers in the U.S., +Latin America, and Asia. +Intellectual +Property and Trademarks +We rely on a combination of trademark, copyright, +trade secret, trade dress, and patent protection to establish, protect, and +enforce our intellectual property rights in our product designs, brand, +materials, and research and development efforts, although no such methods can +afford complete protection. +In the U.S., our patents are generally in effect for +up to 20 years from the date of the filing of the patent application. Our +trademarks are generally valid as long as they are in use and their +registrations are properly maintained and have not been found to become +generic. Trademarks registered outside of the U.S. generally have a duration of +ten years depending on the jurisdiction and are also generally subject to an +indefinite number of renewals for a like period on appropriate application. We +believe our trademarks are crucial to the successful marketing and sale of our +products, and we intend to vigorously prosecute and defend our rights +throughout the world. +We consider the formulation of croslite used to +produce our products to be a valuable trade secret. Prior to our acquisition of +Foam Creations in June 2004, Foam Creations developed the formula for +croslite, and we believe that they did not publish or otherwise make the +formula available to third parties without the protection of confidentiality or +similar agreements. Since the acquisition, we continue to protect the formula +by using confidentiality agreements with our third party processors and by +requiring our employees who have access to the formula to execute +confidentiality agreements or to be bound by similar agreements concerning the +protection of our confidential information. Neither we nor Foam Creations have +attempted to seek patent protection for the formula but we are not aware of any +third party that has independently developed the formula or that otherwise has +the right to use the formula in their products other than Finproject, our third +party supplier of croslite in Italy. Under the terms of our supply agreement +with Finproject, Finproject has certain limited rights to use croslite, which +were originally negotiated in connection with our purchase of Foam Creations +from Finproject’s parent company. We believe the comfort and utility of our +shoes depend on the properties achieved from the compounding of croslite and is +a key competitive advantage for us, and we intend to vigorously protect this +trade secret. +We also actively combat +counterfeiting through monitoring of the global marketplace. We use our +employees, sales representatives, distributors, and retailers to police against +infringing products by encouraging them to notify us of any suspect products +and to assist law enforcement agencies. Our sales representatives are also +educated on our patents, pending patents, and trade dress and assist in +preventing +8 +potentially +infringing products from obtaining retail shelf space. The laws of certain +countries do not protect intellectual property rights to the same extent or in +the same manner as do the laws of the U.S., and therefore we may have +difficulty obtaining legal protection for our intellectual property in certain +jurisdictions. +Seasonality +Due to our significant +sales growth since our inception, we cannot assess with certainty the degree to +which sales of our footwear products will be subject to seasonality. However, +we expect that our business, similar to other vendors of footwear and related +merchandise, will be subject to seasonal variation. We believe many vendors +that market footwear products suited for warm weather normally experience their +highest sales activity during the second and third quarters of the calendar +year. While we have introduced footwear models that are more suitable for cold +weather uses, such as the Endeavor, Georgie, All Terrain, Highland, and +Snowmini, we expect demand for our products, and therefore our sales, may +continue to be subject to seasonal variations and significantly impacted by +weather conditions, as over 76.6% of our total revenues during the year ended December 31, +2006 were attributable to our Beach and Cayman (classic) models and our +flip-flops and other open-toed models, which are more suitable for warm +weather. In addition, our quarterly results of operations may fluctuate +significantly as a result of a variety of other factors, including the timing +of new model introductions or general economic or consumer conditions. +Accordingly, results for any one quarter are not necessarily indicative of +results to be expected for any other quarter or for any year, and revenues for +any particular period may decrease. +Backlog +As of December 31, +2006, our backlog was approximately $74.6 million compared to +$6.7 million as of December 31, 2005. Although orders in the backlog +are subject to cancellation by customers, we have not experienced any material +levels of cancellation of orders by our customers in the past. For a variety of +reasons, including our short operating history, continued growth in customer +demand for our products, the addition of new customers in each of our channels, +the timing of production and shipments, seasonality, product mix of customer +orders, and a shift toward shorter lead times for orders, backlog may not be a +reliable measure of future sales for any succeeding period. In addition, our +historical cancellation experience may not be indicative of future cancellation +rates. +Competition +The global casual footwear +and apparel industry is highly competitive. The principal elements of +competition in this industry include brand awareness, product functionality, +design, quality, pricing, marketing and distribution. We believe that our +unique footwear designs, croslite, and our expanding product offering and +distribution network position us well in the marketplace. However, some +companies in the casual footwear and apparel industry have substantially +greater financial, distribution and marketing resources than we have. +Furthermore, the unique designs and resulting success of our footwear products +have attracted new players in the market with imitation products that are +similar to ours, and we face competition from these new market entrants. +Product Design and +Development +Our primary goal in product design and development is +to create and introduce new and innovative footwear products that combine our +standards of comfort, functionality, and style, and enhance the awareness of +the Crocs brand. Our footwear product line is designed by a combination of our +internal design and development staff supported by outside designers. By +introducing outside sources to the design process, we believe we are able to +capture a variety of different design perspectives on a cost-efficient basis +and anticipate trends more quickly. To expand our internal design capabilities, +we acquired EXO, an +9 +Italian company that has +been involved in the design of several of our new styles. We are committed to +continuing to dedicate significant resources to product design and development +to sustain our commitment to innovation, execute on our growth strategy, and +support our goal of becoming a well recognized global brand. +We develop footwear models +based on what we identify as opportunities in the marketplace. Once a design +has been identified and demand in the marketplace has been validated, the +designs are then translated into product specifications by our developers and +made into prototypes in our facility in Quebec City, Canada or Italy or by one +of our third party manufacturers in China. Our designers and developers work +closely with each other to develop product prototypes, test and refine products +and provide quality assurance throughout the manufacturing process. Our design +and development process is highly collaborative as members of the design team frequently +meet with our sales and marketing staff, production and supply managers and +certain of our retail customers to further refine our products to meet the +particular needs of our target market. We continually strive to improve our +development function so we can bring products to market quickly and reduce +costs while maintaining product quality. We spent $1.8 million, $534,000, and +$80,000 in company-sponsored design and development activities for the years +ended December 31, 2006, 2005, and 2004, respectively. +Employees +As of December 31, +2006, we employed approximately 2,900 persons, including 1,200 employees in the +U.S., 700 employees in Canada, 600 employees in Mexico, 300 employees in Asia, +and 100 employees in Europe. Approximately 650 of our U.S. employees are +employed on an hourly or part-time basis at our retail kiosk locations. As of December 31, +2006, none of our employees were represented by a union, other than 642 of our +Canadian employees who were represented by the Teamsters Union. We believe our +relationship with our employees is good. +Public Filings & +Corporate Information +Our internet address is www.crocs.com. On our web +site, we post the following filings as soon as reasonably practicable after +they are electronically filed with or furnished to the Securities and Exchange +Commission: our annual report on Form 10-K, our quarterly reports on +Form 10-Q, our current reports on Form 8-K and any +amendments to those reports filed or furnished pursuant to Section 13(a) or +15(d) of the Securities and Exchange Act of 1934. All such filings on our +web site are available free of charge. Also available on our web site are the +charters of the committees of our board of directors, as well as our corporate +governance guidelines and code of ethics; copies of any of these documents will +be provided in print to any stockholder who submits a request in writing to +Integrated Corporate Relations, 450 Post Road East, Westport, CT 06880. +10 +ITEM +1A. Risk Factors +If any of the following +risks, as well as any risks described elsewhere in this Form 10-K, actually +occurs, our business, financial condition or results of operations could +suffer. Other risks not presently known to us or not presently thought to be +material could also effect our business, our financial condition or results of +operations. +We have +significantly expanded the nature and scope of our operations over the past two +years, and if we fail to manage any future growth effectively we may experience +greater difficulty in filling customer orders, declines in product quality, +increases in costs or other operating difficulties. +We +have significantly expanded the nature and scope of our operations over the +past two years, and we anticipate that substantial further expansion will be +required to address potential growth in our customer base and new market +opportunities. Prior to June 2004, we distributed in the U.S. under our Crocs +brand a limited range of footwear products manufactured and sold to us by Foam +Creations. In June 2004, we acquired Foam Creations. Since that +acquisition, we have expanded our product line to include more than 25 footwear +models, and in addition, over the last two years, we expanded from: +· 136 +employees at June 30, 2004, to approximately 2,900 employees at December 31, +2006; and +· $13.5 million +in revenues in the year ended December 31, 2004, to $354.7 million in +revenues in the year ended December, 2006. +The expansion of the scope +and nature of our business and the growth in the number of employees, customers +and other third parties with whom we have relationships, and in the number of +facilities we use for manufacturing, distribution, and corporate operations, +have placed and will continue to place a significant strain on our management +and our information systems and resources. To manage growth in our operations, +we will need to increase the number of people we employ, upgrade our existing +financial and reporting systems as well as improve our business processes and controls. +Failure to effectively manage growth could result in greater difficulty in +completely filling customer orders, declines in product quality or increases in +costs or other production and distribution difficulties, any of which could +adversely impact our business performance and operating results. +The popularity of +our Crocs footwear may not continue to grow as rapidly as it has in the recent +past or may decline, which would have a negative impact on our sales and +results of operations. +Our +recent growth is substantially attributable to sales of Crocs footwear, which +represented approximately 96.5% of our revenues for the year ended December 31, +2006. We expect that footwear will constitute our principal product line for +the foreseeable future. The footwear industry is subject to rapidly changing +consumer demands and preferences and fashion trends, and our Crocs footwear may +not remain popular or we may fail to develop additional models that appeal to +consumers. If the popularity of our Crocs footwear declines or does not expand +in the future, we may experience, among other things: +· lower +sales; +· loss +of retail customers; +· excess +inventories; +· inventory +markdowns and discounts provided to retailers; +· deterioration +of our brand image; and +· lower +gross and operating margins, as a result of price reductions. +11 +Given the limited history +of our Crocs brand, it is especially difficult to evaluate whether our products +will hold long-term consumer appeal. +Our current +management information systems may not be sufficient for the growth of our +business, and planned system improvements may not be successfully implemented +on a timely basis or be sufficient for our growing business. +We used approximately +$8.7 million of the net proceeds from our initial public offering to +upgrade our financial reporting systems and to implement new information +technology systems to better track our business, streamline our financial +reporting, and improve our internal controls. However, for certain business +planning, finance and accounting functions, we still rely on manual processes +that are difficult to control and are subject to human error. We may experience +difficulties in transitioning to our new or upgraded systems, including loss of +data and decreases in productivity as our personnel become familiar with new +systems. In addition, our management information systems will require +modification and refinement as we grow and our business needs change, which +could prolong difficulties we experience with systems transitions, and we may +not always employ the most effective systems for our purposes. If we experience +difficulties in implementing new or upgraded information systems or experience +significant system failures, or if we are unable to successfully modify our +management information systems to respond to changes in our business needs, our +ability to properly run our business could be adversely affected. +If we are unable to +establish and protect our trademarks and other intellectual property rights, we +may be unable to use the Crocs name or logo, and competitors may sell products +that are substantially similar to our Crocs footwear, or may produce +counterfeit versions of our products, and such competing or counterfeit +products could divert sales and may damage our brand image. +We believe our trademarks, +trade names, copyrights, trade secrets, issued and pending patents, trade dress +and designs are valuable and integral to our success and competitive position. +From time to time, we have identified competitors selling products that are +very similar in design to certain of our Crocs footwear models, and that are +manufactured from what may be comparable materials to our products. We believe +that some of these products may infringe our intellectual property rights. +Given the increased popularity of our Crocs brand, we believe there is a high +likelihood that counterfeit products or other products infringing on our +intellectual property rights will continue to emerge, seeking to benefit from +the consumer demand for Crocs footwear. In order to protect our brand, we may +be required to spend significant resources to monitor and police our +intellectual property rights. We may not be able to detect infringement and may +lose our competitive position in the market before we are able to do so. In +addition, enforcing rights to our intellectual property may be difficult and +expensive, and we may not be successful in combating counterfeit products and +stopping infringement of our intellectual property rights, particularly in some +foreign countries, which could make it easier for competitors to capture market +share. Intellectual property rights may also be unavailable or limited in the +United States and some foreign countries. Furthermore, our efforts to enforce +our trademark and other intellectual property rights may be met with defenses, +counterclaims, and countersuits attacking the validity and enforceability of +our trademark and other intellectual property rights. For example, our attempts +to register Crocs and our Crocs logo as trademarks have been challenged by a +large apparel company, and certain jurisdictions have rejected our attempted +registration of our logo as a trademark based upon such challenge and based +upon trademarks owned by the same company and at least one other large apparel company. +If we are unsuccessful in protecting and enforcing our intellectual property +rights, or if we were required to change our name or use a different logo, +continued sales of such competing products by third parties could harm our +brand and adversely impact our business, financial condition, and results of +operations. Similarly, in our enforcement litigation against manufacturers of +knock-off products, at least one manufacturer has alleged counterclaims +12 +challenging +the validity and enforceability of our patents and we expect that other +defendants in the litigation may assert similar claims. +We have registered Crocs +as a trademark for footwear in Aruba, Australia, the European Union, Israel, +Japan, Mexico, Netherlands, Antilles, New Zealand, Panama, and the World +Intellectual Property Office. As of December 31, 2006, we have also +applied to register Crocs and the Crocs logo as trademarks in 43 jurisdictions +around the world, including the U.S., but such applications have not been +approved and are currently pending. In addition, we have recently extended the +scope of our trademark registrations and applications for both the Crocs mark +and logo to cover non-footwear products such as sunglasses, goggles, knee pads, +watches, luggage, and some of our internet sales activities. Although we +believe that we have applied for trademark registrations in all jurisdictions +where we are doing or intend to do business, there is a possibility that we +have not applied to register the Crocs mark, the company logos, the individual +brand names for our products or our marketing slogans in countries where we +will do business in the future, and we have elected not to apply for trademark +registrations for some marks in some jurisdictions. Furthermore, we may not +obtain trademark registrations in connection with any applications that we do +file and trademark protection, whether registered or common law, may not be +available in every country in which we offer or intend to offer our products. +Failure to adequately protect our trademark rights could damage or even destroy +our Crocs brand, expose us to trademark liability and impair our ability to +compete effectively. In addition, defending or enforcing our trademark rights +could result in the expenditure of significant financial and managerial +resources. +We believe our success may +be enhanced by our ability to obtain and enforce patent protection for our +products, and therefore have elected to pursue patent protection for our +products in the U.S. and other countries. Currently, we have been issued one +Community Design Registration and three Community Multiple Design Registrations +in the European Union covering a total of ten shoe designs. Additional shoe +design applications have received registrations in Australia, Brazil, China, Hong +Kong, India, Israel, Japan, Singapore, South Africa, and South Korea, and we +have been issued one utility patent and four design patents in the U.S., but we +have not been granted any other utility patents or design patents in the U.S. +or any utility patents in other countries. We do not know whether any of our +pending or future patent applications will result in the issuance of patents, +and competitors may challenge the validity or scope of our issued patents, or +our registered designs or patent applications that proceed to issuance. We +cannot predict how the patent claims in our issued patents, or any patents +issued from any pending or future patent application, will be construed, and +such patents may not provide us with the ability to prevent the development, +manufacturing, and/or marketing of competing products, or may be challenged by +third parties on the basis of validity and enforceability. +We also rely on trade +secrets, confidential information, and other unpatented proprietary information +related to, among other things, the formulation of croslite and product +development, especially where we do not believe patent protection is +appropriate or obtainable. Using third party manufacturers may increase the risk +of misappropriation of our trade secrets, confidential information and other +unpatented proprietary information. The agreements we use to try to protect our +intellectual property, confidential information and other unpatented +proprietary information may not effectively protect such intellectual property +and information and may not be sufficient to prevent unauthorized use or +disclosure of such trade secrets and information. A party to one of these +agreements may breach the agreement and we may not have adequate remedies for +such breach. As a result, our trade secrets, confidential information, and +other unpatented proprietary information may become known to others, including +our competitors. Furthermore, as with any trade secret, confidential +information, or other proprietary information, others, including our +competitors, may independently develop or discover such trade secrets and +information, which would render them less valuable to us. +13 +We use our own +warehouse, distribution, and fulfillment capabilities, and utilize third +parties to conduct order fulfillment services for us. Any additional expenses +incurred in connection with, or any disruption in the supply of our products +that is caused by changes in our logistical infrastructure could adversely +affect our business. +In December 2006, we began +operating a warehouse and order processing and customer order facility in +Aurora, Colorado which has enabled us to move a portion of our distribution and +fulfillment capabilities from Expeditors and Colorado Distribution to a +company-operated warehouse reducing our reliance on third party distribution +facilities. In May 2005, we began operating a warehouse and order +processing and customer order facility in Niwot, Colorado that manages all +internet, apparel, and accessories orders and shipments. We have established +additional company-operated warehouse and fulfillment operations in Canada, +China, Italy, Colorado, Hawaii, Mexico, the Netherlands, New Zealand, Puerto +Rico, and Singapore, and utilize third parties in Australia and Japan to +provide such services to us. In recent periods, our third party vendors and +company-operated warehouse, distribution, and fulfillment operations have been +unable to entirely satisfy the increased demand for our products. The inability +to process and deliver sufficient quantities of our products has prevented us +from completely filling in a timely manner orders placed by our customers. +Other +possible interruptions which could prohibit us from timely customer deliveries +could include the following: +· Damage +or destruction to the warehouse and distribution center used for our products +due to fire, earthquake, or any other natural disaster; or +· Disruptions +in commercial shipping channels +In the event that we or a +third party are unable to conduct warehousing, distribution, and fulfillment +activities in a cost effective, timely, and accurate manner, the distribution +of our products may be adversely affected, which could result in harm to our +relationships with our retail customers and consumers, a reduction in demand +for our products, and additional expenses to us. +Because we depend +on third party manufacturers, we may face challenges in maintaining a +sufficient supply of goods to meet sales demand, and we may experience +interruptions in our supply chain. Any shortfall in the supply of our products +may decrease our sales and have an adverse impact on our customer +relationships. +In the year ended December 31, +2006, third party manufacturers produced approximately 79.5% of our footwear +products as measured by number of units, and one such manufacturer produced +approximately 55.4% of our footwear products. Currently, we have footwear +manufacturing arrangements with third party manufacturers located in China, Romania +and the United States. We depend on these manufacturers’ ability to finance the +production of goods ordered and to maintain adequate manufacturing capacity. We +do not exert direct control over the third party manufacturers, so we may be +unable to obtain timely delivery of acceptable products. +In addition, we do not +have long-term supply contracts with most of these third party manufacturers, +including the third party manufacturer that produced the majority of our +footwear products in the year ended December 31, 2006, and any of them may +unilaterally terminate their relationship with us at any time or seek to +increase the prices they charge us. As a result, we are not assured of an +uninterrupted supply of products of an acceptable quality and price from our +third party manufacturers. We may not be able to offset any interruption or +decrease in supply of our products by increasing production in our +company-operated manufacturing facilities due to capacity constraints, and we +may not be able to substitute suitable alternative third party manufacturers in +a timely manner or at acceptable prices. Any disruption in the supply of +products from our third party manufacturers may harm our business and could +14 +result +in a loss of sales and an increase in production costs, which would adversely +affect our results of operations. +We manufacture a +portion of our Crocs products, and any difficulties or disruptions in our +manufacturing operations could adversely affect our sales and results of +operations. +In the year ended December 31, +2006, we produced approximately 20.5% of our Crocs footwear production at our +company-operated manufacturing facilities in Canada, Mexico, and Italy. The +manufacturing of our products from our proprietary closed-cell resin, which we +refer to as croslite, requires the use of a complex process, and we may +experience difficulty in producing footwear that meets our high quality control +standards. We will be required to absorb the costs of manufacturing and +disposing of products that do not meet our quality standards. These costs are +primarily incurred in connection with the initial production of new products, +although we may also experience increases in training costs when we initiate +production of new products. Additionally, we may incur increased costs as a +result of the introduction of new manufacturing equipment such as molds and +injection molding machines. Any increases in our manufacturing costs could +adversely impact our margins. Furthermore, our manufacturing capabilities are +subject to many of the same risks and challenges noted above with respect to +our third party manufacturers, including our ability to scale our production +capabilities to meet the needs of our customers, and our manufacturing may be +disrupted for reasons beyond our control, including work stoppages, fires, +earthquakes, floods, or other natural disasters. Any disruption to our +manufacturing operations will hinder our ability to deliver products to our +customers in a timely manner, and could have a material and adverse effect on +our business. +We continued to invest in +our own manufacturing facility in Mexico acquired in April 2005, and +subsequently added capacity at our adjacent facility that we leased. The +expansion of our company-operated manufacturing capabilities will increase our +fixed cost base, and could adversely impact our margins and results of +operations in the event our sales decline or do not continue to grow. +We depend on a +limited number of suppliers for key production materials, and any disruption in +the supply of such materials could interrupt product manufacturing and increase +product costs. +We depend on a limited +number of sources for the primary materials used to make our Crocs footwear. We +source the elastomer resins that constitute the primary raw materials used in +compounding croslite, which we use to produce our footwear products, from one +supplier. We do not have any formal purchase agreement with the provider of the +elastomer resins, and we purchase these elastomer resins on a purchase order +basis. If the supplier we rely on for elastomer resins were to cease production +of these materials, we may not be able to obtain suitable substitute materials +in time to avoid interruption of our production cycle, if at all. We may also +have to pay materially higher prices in the future for the elastomer resins or +any substitute materials we use, which would increase our production costs and +could have a materially adverse impact on our margins and results of +operations. +If we are unable to obtain +suitable elastomer resins or if we are unable to procure sufficient quantities +of croslite, we may not be able to meet our production requirements in a timely +manner. Such failure could result in lost potential sales, delays in shipments +to customers, strained relationships with customers, and diminished brand +loyalty. +We are dependent on +sales of a small number of products and the absence of continued market demand +for these products would have a significant adverse effect on our operating +results. +We generated approximately +96.5% of our revenues for the year ended December 31, 2006 from sales of +our Crocs footwear, which consisted of more than 25 models. Sales of our Beach +and Cayman (classics) +15 +models +accounted for approximately 62.2% of our footwear revenues in the year ended December 31, +2006. Most of our Crocs footwear models are developed from the same base design +as our Beach and Cayman models, and we expect to continue to derive a +substantial portion of our revenues from these models or related products in +the foreseeable future. Because we are dependent on a line of footwear models +that have substantial similarities, factors such as changes in consumer +preferences and general market conditions in the footwear industry may have a +disproportionately greater impact on us than on our competitors. In addition, +other footwear companies have introduced products that are substantially +similar to our footwear models, which may reduce sales of our footwear +products. In the event that consumer preferences evolve away from our footwear +models or from casual lifestyle footwear in general, or our retail customers +purchase similar products sold by our competitors, the resulting loss of sales, +increase in inventories and discounting of our products are likely to be +significant, and this could have a material and adverse impact on our business +and operations. +Expanding our Crocs +footwear product line may be difficult and expensive, and if we are unable to +successfully continue such expansion, our brand may be adversely affected, and +we may not achieve our planned sales growth. +Our growth strategy is +founded primarily on the continued growth in sales of Crocs footwear, and we +intend to continue to expand the number of models offered in our Crocs footwear +product line to broaden the appeal of our products to consumers. To +successfully expand our footwear product line, we must anticipate, understand, +and react to the rapidly changing tastes of consumers and provide appealing +merchandise in a timely manner. New footwear models that we introduce may not +be successful with consumers or our brand may fall out of favor with consumers. +If we are unable to anticipate, identify, or react appropriately to changes in +consumer preferences, we may not grow as fast as we plan or our sales may +decline, and our brand image and operating performance may suffer. +Furthermore, achieving +market acceptance for new products will likely require us to exert substantial +product development and marketing efforts, which could result in a material +increase in our selling, general, and administrative expense, and there can be +no assurance that we will have the resources necessary to undertake such +efforts. Material increases in our selling, general, and administrative +expenses could adversely impact our results of operations. +We may also encounter +difficulties in producing new Crocs footwear models that we did not anticipate +during the development stage. Our development schedules for new products are +difficult to predict and are subject to change as a result of shifting +priorities in response to consumer preferences and competing products. For +example, once we begin to design a new footwear model, it can take six to nine +months to progress to full production because of the need to fabricate new +molds and to implement modified production tooling and revised manufacturing +techniques. If we are not able to efficiently manufacture newly-developed +products in quantities sufficient to support retail distribution, we may not be +able to recoup our investment in the development of new models and product +lines, and we would continue to be subject to the risks inherent in having a +limited product line. Even if we develop and manufacture new footwear products +that consumers find appealing, the ultimate success of a new model may depend +on our pricing. We have a limited history of introducing new products, and we +may set the prices of new models too high for the market to bear. Failure to +gain market acceptance for new products that we introduce could impede our +growth, reduce our profits, adversely affect the image of our brands, erode our +competitive position, and result in long term harm to our business. +Sales of our +products are likely to be subject to seasonal variations, which could increase +the volatility of the price of our common stock. +The footwear industry +generally is characterized by significant seasonality of sales. Due to the +growth in sales of our products in the past three years we cannot assess with +certainty the degree to which sales of +16 +our +footwear products will be subject to seasonal variation, but a majority of our +footwear is more suited for fair weather use, so we expect some degree of +seasonality in the future. In addition, extended periods of unusually cold +weather during the spring and summer could reduce demand for our footwear. +Seasonal variations in consumer demand may result in fluctuations in our +results of operations from quarter to quarter, and the effect of favorable or +unfavorable weather on sales may be significant enough to materially affect our +quarterly results. Wide variations in our quarterly operating results may +increase the volatility of the price of our common stock. +We will incur +significant time and expense in documenting, testing and certifying our +internal control over financial reporting, and any deficiencies in our +financial reporting or internal controls could adversely affect our business +and the price of our common stock. +Beginning with our Annual +Report on Form 10-K for our fiscal year ending on December 31, 2007, +the Securities and Exchange Commission (“SEC”), rules require that our +chief executive officer and chief financial officer periodically certify the +existence and effectiveness of our internal control over financial reporting. +Our independent auditors will be required, beginning with our Annual Report on Form 10-K +for our fiscal year ending on December 31, 2007, to attest to our officers’ +assessment of our internal controls. This process generally requires +significant documentation of policies, procedures, and systems, review of that +documentation by our internal accounting staff and our outside auditors, and +testing of our internal control over financial reporting by our internal +accounting staff and our outside auditors. Continued documentation and testing +of our internal controls will involve considerable time and expense, and may +strain our internal resources and have an adverse impact on our costs. +During the course of our +testing, we may identify deficiencies which we may not be able to remediate in +time to meet the deadline imposed by SEC rules for certification of our +internal control over financial reporting. As a consequence, we may have to +disclose in periodic reports we file with the SEC any material weaknesses in +our system of internal controls. The existence of such material weaknesses +would preclude management from concluding that our internal control over +financial reporting is effective and would preclude our independent auditors +from issuing an unqualified opinion that internal controls are effective. In +addition, disclosures of this type in our SEC reports could cause investors to +lose confidence in our financial reporting and may negatively affect the price +of our common stock. Moreover, effective internal controls are necessary to +produce reliable financial reports and to prevent fraud. If we have +deficiencies in our internal control over financial reporting it may negatively +impact our business, results of operations and reputation. +17 +Third parties may +claim that we are infringing their intellectual property rights, and such +claims may be costly to defend, may require us to pay licensing fees, damages, +or other amounts, and may prevent, or otherwise impose limitations on, the +manufacture, distribution or sale of our products. +From time to time, third +parties may claim that we are infringing their intellectual property rights, +and we may be found to infringe those intellectual property rights. While we do +not believe that any of our products infringe the valid intellectual property +rights of third parties, we may be unaware of the intellectual property rights +of others that may cover some of our technology or products. If we are forced +to defend against such third party claims, whether or not such claims are +resolved in our favor, we could encounter expensive and time consuming +litigation, which could divert our management and key personnel from business +operations. For example, a company has filed a lawsuit against us claiming that +our Aspen model infringed its trademark rights, and that by using the Aspen +name and intellectual property we committed acts of false designation of +origin, trademark dilution, unfair competition and unfair or deceptive trade +practices. We subsequently changed the name of our Aspen model to the Endeavor +and entered into a settlement agreement with the company. If we are found to be +infringing on the intellectual property rights of other companies, we may be +required to pay damages or ongoing royalty payments, or comply with other +unfavorable terms. Additionally, if we are found to be infringing on the +intellectual property rights of other companies, we may not be able to obtain +license agreements on terms acceptable to us, and this may prevent us from +manufacturing, marketing or selling our products. Thus, such third party claims +may significantly reduce the sales of our products or increase our cost of +goods sold. Any such reductions in sales or cost increases could be +significant, and could have a material and adverse affect on our business. +Our business could +suffer if our third party manufacturers violate labor laws or fail to conform +to generally accepted ethical standards. +We require our third party +manufacturers to meet our standards for working conditions and other matters +before we are willing to place business with them. As a result, we may not +always obtain the lowest cost production. Moreover, we do not control our third +party manufacturers or their respective labor practices. If one of our third +party manufacturers violates generally accepted labor standards by, for +example, using forced or indentured labor or child labor, failing to pay +compensation in accordance with local law, failing to operate its factories in +compliance with local safety regulations, or diverging from other labor +practices generally accepted as ethical, we likely would cease dealing with +that manufacturer, and we could suffer an interruption in our product supply. +In addition, such a manufacturer’s actions could result in negative publicity +and may damage our reputation and the value of our brand and discourage retail +customers and consumers from buying our products. +If we are unable to +recruit and retain key personnel necessary to operate our business, our ability +to successfully manage our business and develop and market our products may be +harmed. +To expand our business we +will need to attract, retain, and motivate highly skilled design, development, +management, accounting, sales, merchandising, marketing, and customer service +personnel. We plan to hire additional personnel in all areas of our business. +Competition for many of these types of personnel is intense. As a result, we +may be unable to successfully attract or retain qualified personnel. +Additionally, any of our officers or employees can terminate their employment +with us at any time, and we do not maintain key person life insurance on any of +our employees, including any member of our management team. The loss of any key +employee or our inability to attract or retain other qualified employees could +harm our business and results of operations. +18 +Our financial +success may be limited to the strength of our relationships with our retail +customers and to the success of such retail customers. +Our financial success is +significantly related to the willingness of our retail customers to continue to +carry our products, the expansion to new retail customers, and to the success +of such customers. We do not have long term contracts with any of our retail +customers, and sales to our retail customers are generally on an order-by-order +basis and are subject to rights of cancellation and rescheduling by the +customer. If we cannot fill our retail customers’ orders in a timely manner, +the sales of our products and our relationships with those customers may +suffer, and this could have a material adverse effect on our product sales and +ability to grow our product line. +In the year ended +December 31, 2006, our ten largest retail customers accounted for +approximately 26.1% of our revenues. If any of our major retail customers +experiences a significant downturn in their business or fails to remain +committed to our products or brand, then these customers may reduce or +discontinue purchases from us. +Furthermore, many of our +retail customers compete with each other, and if they perceive that we are +offering their competitors better pricing and support, they may reduce +purchases of our products. In addition, we compete directly with our retail +customers by selling our products to consumers via the internet and through our +company-operated kiosks and stores. If our retail customers believe that our +direct sales to consumers divert sales from their stores, this may weaken our +relationships with such customers and cause them to reduce purchases of our +products. +We face significant +competition and if we are unable to compete effectively, sales of our products +may decline and our business could be harmed. +The footwear industry is +highly competitive. Recent growth in the market for casual footwear has +encouraged the entry of new competitors into the marketplace and has increased +competition from established companies. Some of our competitors are offering +products that are substantially similar, in design and materials, to our Crocs-branded +footwear. In addition, access to offshore manufacturing is also making it +easier for new companies to enter the markets in which we compete. +Our +competitors include most major athletic and footwear companies, branded apparel +companies, and retailers with their own private labels. A number of our +competitors: +· have +significantly greater financial resources than we have; +· have +more comprehensive product lines than ours; +· have +broader market presence than we have in, or have their own, retail outlets; +· have +longer-standing relationships with retailers than we have; +· have +a longer operating history than ours; +· have +greater distribution capabilities than we have; +· have +stronger brand recognition than we have; and +· spend +substantially more on product advertising and sales than we do. +Our competitors’ greater +capabilities in these areas may enable them to better withstand periodic +downturns in the footwear industry, compete more effectively on the basis of +price and production, and more quickly develop new products. If we fail to +compete successfully in the future, our sales and profits may decline, our +financial condition may deteriorate, and the market price of our common stock +is likely to fall. +19 +If we do not +accurately forecast consumer demand, we may have excess inventory to liquidate +or have greater difficulty filling our customers’ orders, either of which could +adversely affect our business. +The footwear industry is +subject to cyclical variations and declines in performance, as well as fashion +risks, rapid changes in consumer preferences, the effects of weather, general +economic conditions, and other factors affecting demand. These factors make it +difficult to forecast consumer demand, and if we overestimate demand for our +products, we may be forced to liquidate excess inventories at a discount to +customers, resulting in markdowns and lower gross margins. Conversely, if we +underestimate consumer demand, we could have inventory shortages, which can +result in lost potential sales, delays in shipments to customers, strains on +our relationships with customers and diminished brand loyalty. Moreover, +because our product line is limited, we may be disproportionately affected by +cyclical downturns in the footwear industry, changes in consumer preferences, +and other factors affecting demand, which may make it more difficult for us to +accurately forecast our production needs, exacerbating these risks. A decline +in demand for our products, or any failure on our part to satisfy increased +demand for our products, could adversely affect our business and results of +operations. +We may fail to +successfully expand our distribution network or introduce our products +internationally, and this may cause our results of operations to fall short of +expectations. +As +part of our growth strategy, we plan to expand our distribution network and +expand the sales of our products into new locations internationally. +Successfully executing this strategy will depend on many factors, including: +· the +strength of the Crocs brand and competitive conditions in new markets that we +attempt to enter; +· our +ability to attract and retain qualified distributors or agents or to develop +direct sales channels; +· our +ability to use and protect the Crocs brand, and our other intellectual +property, in these new markets and territories; and +· our +ability to successfully enter and compete in markets and territories, +especially internationally, where we have little distribution experience and +where our Crocs brand is not well known. +If we are unable to +successfully expand our distribution channels and sell our Crocs-branded +products internationally, our business may fail to grow, our brand may suffer, +and our results of operations may be adversely impacted. +We conduct, and in +the future expect to conduct, a significant portion of our activities outside +the U.S., and therefore we are subject to the risks of international commerce. +We use +third party manufacturers located in foreign countries, we operate +manufacturing facilities located in Canada, Mexico, and Italy and we sell our +products to retailers outside of the U.S. Foreign manufacturing and sales +activities are subject to numerous risks, including the following: +· tariffs, +import and export controls, and other non-tariff barriers such as quotas and +local content rules; +· increased +transportation costs due to distance, energy prices, or other factors; +· delays +in the transportation and delivery of goods due to increased security concerns; +· foreign +currency fluctuations, for which we do not currently engage in any material +hedging transactions; +· restrictions +on the transfer of funds; +20 +· changing +economic conditions; +· restrictions, +due to privacy laws, on the handling and transfer of consumer and other +personal information; +· changes +in governmental policies and regulations; +· political +unrest, terrorism, or war, any of which can interrupt commerce; +· expropriation +and nationalization; +· difficulties +in managing foreign operations effectively and efficiently from the U.S.; and +· difficulties +in understanding and complying with local laws, regulations, and customs in +foreign jurisdictions. +Furthermore, our +manufacturing activity outside of the U.S., including the production of our +products by third party manufacturers, is subject to risks of poor +infrastructure, shortages of equipment, and labor unrest, in addition to those +risks noted above. Once our products are manufactured, we may also suffer +delays in distributing our products due to work stoppages, strikes, or lockouts +at the ports where our products arrive. Such labor disruptions could result in +product shortages and delays in distributing our products to retailers. These +factors and the failure to properly respond to them could make it difficult to +obtain adequate supplies of quality products when we need them, resulting in +reduced sales and harm to our business. +In addition, during 2005, +we generated approximately $8.1 million, or 7.5% of our revenues outside +of the U.S., and in the year ended December 31, 2006, we generated +approximately $112.5 million, or 31.7% of our revenues outside of the +U.S., and we expect to expand our international sales and marketing operations +in the future. Our ability to capitalize on growth in new international markets +and to maintain the current level of operations in our existing international +markets is subject to risks associated with international sales operations, as +noted above, as well as the difficulties associated with promoting products in +unfamiliar cultures. +Acquisitions may be +difficult to identify and successfully integrate into our business and could +have other adverse consequences. +We have made, and may in +the future make, acquisitions of, or investments in, other companies. For +example, in June 2004, we acquired Foam Creations; in October 2006, +we acquired Fury and EXO, in December 2006, we acquired Jibbitz, and in +February 2007, we acquired Ocean Minded. We expect to consider other +opportunities to acquire or make investments in other businesses and products +that could enhance our manufacturing capabilities, complement our current +products or expand the breadth of our markets or customer base. The pursuit of +acquisitions may divert the attention of management and cause us to incur +various expenses in identifying, investigating and pursuing suitable +acquisitions, whether or not they are consummated. In the event we finance +acquisitions by issuing equity or convertible debt securities, our stockholders +may be diluted. +In +addition, we have limited experience in acquiring other businesses. If we +acquire additional businesses, we may not be able to integrate the acquired +operations successfully with our business or effectively manage the combined +business following completion of the acquisition. We may also not achieve the +anticipated benefits from the acquired business due to any of the following +factors: +· unanticipated +costs associated with the acquisition; +· diversion +of management’s attention from our core business; +· harm +to our existing business relationships with manufacturers and customers as a +result of the acquisition; +21 +· the +potential loss of key employees; or +· risks +associated with entering new product lines or markets in which we have little +or no prior experience. +If we are unable to integrate +any new business successfully, we could be required either to dispose of the +acquired operations or to undertake changes to the acquired operations in an +effort to integrate them with our business. If we experience any of the +difficulties noted above, our business and financial condition could be +materially and adversely affected. +We may be adversely +affected by currency exchange rate fluctuations. +We purchase products and +supplies from third parties in U.S. dollars and receive payments from certain of +our international customers in foreign currencies. The cost of these products +and supplies sourced overseas, and payments received from customers, may be +affected by changes in the value of the relevant currencies. Price increases +caused by currency exchange rate fluctuations could make our products less +competitive or have an adverse effect on our profitability. Currency exchange +rate fluctuations could also disrupt the business of the third-party +manufacturers that produce our products by making their purchases of raw +materials more expensive and more difficult to finance. Foreign currency +fluctuations could have a material adverse effect on our results of operations +and financial condition. We intend to use derivative instruments and engage in +hedging activities beginning in 2007. +We can issue shares +of preferred stock without stockholder approval, which could adversely affect +the rights of common stockholders. +Our restated certificate +of incorporation permits us to establish the rights, privileges, preferences, +and restrictions, including voting rights, of future series of our preferred +stock and to issue such stock without approval from our stockholders. The +rights of holders of our common stock may suffer as a result of the rights +granted to holders of preferred stock that we may issue in the future. In +addition, we could issue preferred stock to prevent a change in control of our +company, depriving common stockholders of an opportunity to sell their stock at +a price in excess of the prevailing market price. +Our restated +certificate of incorporation, amended and restated bylaws and Delaware law +contain provisions that could discourage a third party from acquiring us and +consequently decrease the market value of an investment in our stock. +Our +restated certificate of incorporation, amended and restated bylaws, and +Delaware corporate law each contain provisions that could delay, defer, or +prevent a change in control of our company or changes in our management. Among +other things, these provisions: +· authorize +us to issue preferred stock that can be created and issued by the board of +directors without prior stockholder approval, with rights senior to those of +common stock; +· do +not permit cumulative voting in the election of directors, which would +otherwise allow less than a majority of stockholders to elect director +candidates; +· prohibit +stockholders from calling special meetings of stockholders; +· prohibit +stockholder action by written consent, thereby requiring all stockholder +actions to be taken at a meeting of our stockholders; +· allow +the authorized number of directors to be changed only by resolution of the +board of directors; +· establish +advance notice requirements for submitting nominations for election to the +board of directors and for proposing matters that can be acted upon by +stockholders at a meeting; and +22 +· classify +our board of directors so that only some of our directors are elected each +year. +These provisions could +discourage proxy contests and make it more difficult for our stockholders to +elect directors and take other corporate actions, which may prevent a change of +control or changes in our management that a stockholder might consider +favorable. In addition, Section 203 of the Delaware General Corporation +Law may discourage, delay, or prevent a change in control of us. Any delay or +prevention of a change of control or change in management that stockholders +might otherwise consider to be favorable could cause the market price of our +common stock to decline. +ITEM 1B. Unresolved +Staff Comments +Not Applicable. +ITEM +2. Properties +Our principal executive +and administrative offices and internet distribution center are located at 6328 +Monarch Park Place, Niwot, Colorado. We also operate a 264,000 square foot +warehouse and distribution facility in Aurora, Colorado, a 76,000 square foot +manufacturing facility in Quebec City, Canada, a 115,000 square foot +manufacturing facility in Purísima del Rincón, Mexico, a 100,000 square foot +distribution facility in Shenzhen, China, a 10,000 square foot administrative +office and distribution center in Boulder, Colorado, a 28,000 square foot +administrative office and manufacturing facility in Padova, Italy, 117,000 +square feet warehouses in Rijswijk, the Netherlands, and a 162,000 square foot +warehouse in Rotterdam, the Netherlands. We lease, rather than own, all of our +facilities. We consider our facilities to be suitable for our needs. +The general location, use +and approximate size of our principal properties are given below: +Location +Use +Approximate +Square Feet +Niwot, Colorado +Corporate +offices/warehouse +86,000 +Aurora, Colorado +Warehouse +264,000 +Boulder, Colorado +Jibbitz’s +office/warehouse +10,000 +Purísima del +Rincón, Mexico +Manufacturing +facility +115,000 +Quebec City, +Canada +Manufacturing +facility +76,000 +Shenzhen, China +Distribution +facility +100,000 +Padova, Italy +EXO’s +office/manufacturing facility +28,000 +Rijswijk, the +Netherlands +Warehouses +117,000 +Rotterdam, the +Netherlands +Warehouse +162,000 +We also maintain small +branch sales offices in Hong Kong, Tokyo, Melbourne, Singapore and The Hague. +All of these sales offices are leased. We enter into short-term leases for +kiosks domestically and internationally with fixed monthly rents subject to +certain covenants with contingent rents based on percentage of revenues. We +also lease retail space at two domestic and five international retail stores. +Our leases for our retail stores expire through July 2026. +ITEM +3. Legal Proceedings +In January 2005, our +direct subsidiary Foam Creations filed a lawsuit against Holey Soles Holdings +Ltd. (“Holey Soles”) in the Federal Court of Canada, Trial Division (at +Toronto, Ontario). The complaint alleges trademark and copyright infringement +relating to the design of some of our shoe models. We are seeking a permanent +injunction with respect to any further acts of infringement on our intellectual +property, as well as damages and attorneys’ fees. This action is still pending. +In August 2005, Holey +Soles filed a lawsuit against us in the United States District Court for the +Southern District of New York. Holey Soles seeks a declaratory judgment that we +do not have any valid copyright or trade dress rights with respect to the +design of our footwear. In addition, Holey Soles seeks a +23 +declaratory +judgment that the manufacture, sale and distribution of its footwear products +does not constitute unfair competition and does not infringe on our copyrights +or trade dress rights. On our motion, the action has been transferred to the +United States District of Colorado where it has been stayed pending the outcome +of The International Trade Commission (“ITC”) Investigation No. 337-TA-567 +discussed below. We do not expect the ultimate resolution of this matter will +have a material adverse impact on our business. +On March 31, 2006, we +filed a complaint with the ITC against Acme Ex-Im, Inc., Australia +Unlimited, Inc., Cheng’s Enterprises, Inc., Collective Licensing +International, LLC, D. Myers & Sons, Inc., Double Diamond +Distribution, Ltd., Effervescent, Inc., Gen-X Sports, Inc., Holey +Soles Holdings, Ltd., Inter-Pacific Trading Corporation, and Shaka Holdings, Inc., +alleging patent and trade dress infringement and seeking an exclusion order +banning the importation and sale of infringing products. The utility and design +patents asserted in the complaint were issued to us on February 7, 2006 +and March 28, 2006 respectively, by the United States Patent and Trademark +Office. The ITC has issued final determinations terminating Shaka Holdings, Inc., +Inter-Pacific Trading Corporation, Acme Ex-Im, Inc., D. Myers & +Sons, Inc., and Australia Unlimited, Inc. from the ITC investigation No. 337-TA-567 +on the basis of settlement and Cheng’s Enterprises, Inc. on the suspension +of accused activities. The ITC Administrative Law Judge issued an Initial +Determination of non-infringement related to one of the patents at issue. +Crocs filed a petition with the Commission to review this determination. The Commission granted us a petition and on February 15, +2007, after briefing by the parties, the Commission vacated the ALJ’s +determination of non-infringement with respect to the remaining respondents and +remanded it to the ALJ for further proceedings consistent with the Commission’s +order. On February 22, 2007, the ALJ issued an order scheduling an +administrative trial on all issues, which had previously been postponed, for January 14, +2008. On March 1, 2007 we petitioned the Commission to review the ALJ’s +scheduling order and set an earlier trial date. +On April 3, 2006, we +filed a complaint in the U.S. District Court for the District of Colorado +alleging patent and trade dress infringement and seeking injunctive relief +against Acme EX-IM, Inc., Australia Unlimited, Inc., Cheng’s +Enterprises, Inc., Collective Licensing International, LLC, D. Myers & +Sons, Inc., Double Diamond Distribution, Ltd., Effervescent, Inc., +Gen-X Sports, Inc., Holey Soles Holdings, Ltd., Inter-Pacific Trading +Corporation, Shaka Holdings, Inc., and Does 1-10. The utility and +design patents asserted in the complaint were issued to us on February 7, +2006 and March 28, 2006 respectively, by the United States Patent and +Trademark Office. Consent judgments have been entered against Shaka Holdings, Inc., +Interpacific Trading Corporation and Acme Ex-Im, Inc. We have entered into +a settlement agreement with Australia Unlimited, Inc., and on January 25, +2007 have filed a stipulation for dismissal of all claims and counterclaims. We +have entered into a settlement agreement with D. Myers & Sons, Inc. +and plan to file a consent judgment with the court related to D. Myers & +Sons, Inc. We do not expect the ultimate resolution of this matter will +have a material adverse impact on our business. +On January 29, 2007, we +filed an action in Colorado District Court, Boulder County, alleging breach of +contract by Australia Unlimited. We allege Australia Unlimited breached the +settlement agreement from the prior litigation by introducing a new shoe design +not approved by us. We obtained a temporary restraining order enjoining +Australia Unlimited sale of the new shoe; however, our motion for preliminary +injunction was denied. Australia Unlimited removed the case to federal court, +Case No. 07CV00221, and alleged a counterclaim for breach of contract +and that it is entitled to recover damages for the time that the temporary +restraining order was in effect. +Although we are subject to +other litigation from time to time in the ordinary course of business, we are +not party to any other pending legal proceedings that we believe will have a +material adverse impact on our business. +24 +ITEM +4. Submission of +Matters to a Vote of Security Holders +At the +annual meeting of stockholders held on October 30, 2006 the following +matters were submitted to a vote: +1. Election +of two Class I directors to serve for a three year term expiring at the +2009 annual meeting of stockholders: +In Favor +Withheld +Ronald L. Frasch +22,967,515 +292,740 +Marie Holman-Rao +22,621,003 +639,252 +Our continuing +directors are Ronald R. Snyder (Class III), Raymond D. Croghan (Class II), +Michael E. Marks (Class II), Richard L. Sharp (Class II), and Thomas +J. Smach (Class III). +2. Ratification +of the appointment of Deloitte & Touche LLP as our independent +registered public accounting firm for fiscal year 2006: +Affirmative votes +23,237,982 +Negative votes +13,859 +Abstain +8,413 +Non-votes +1 +25 +PART II +ITEM +5. Market for the +Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of +Equity Securities +Market Information +Our common stock, par +value $0.001, has been listed on the Nasdaq Global Select Market (formerly the +Nasdaq National Market) under the stock symbol “CROX” since February 8, +2006, the date our shares began to trade publicly. Prior to that time, there +was no public market for our stock. The following table sets forth for the +indicated periods the high and low sales prices per share for our common stock +on the Nasdaq Global Select Market. +Fiscal Year 2006 Quarters Ended +High +Low +March 31, +2006 +$ +32.50 +$ +20.32 +June 30, +2006 +37.00 +21.56 +September 30, +2006 +35.05 +22.65 +December 31, +2006 +50.25 +31.66 +Performance Graph +The +following performance graph compares the cumulative total return of our common +shares with that of the Nasdaq Composite Index and the Dow Jones US Footwear +Index from February 8, 2006 (the date our common shares began to trade +publicly) through December 31, 2006. The graph assumes that the value of +the investment was $100 on February 8, 2006 and all dividends and other +distributions were reinvested. The comparisons in this graph are provided in +accordance with SEC disclosure requirements and are not intended to forecast or +be indicative of the future performance of our common shares. +Comparison +of Cumulative Total Return on Investment +* $100 +invested at the opening price of our common stock on 2/8/06. +Holders +The approximate number of +stockholders of record of our common stock was 280 as of February 28, 2007. Because many of the shares of +our common stock are held by brokers and other institutions on +26 +behalf +of stockholders, we are unable to estimate the total number of beneficial +owners represented by these stockholders of record. +Dividends +We have never declared or +paid cash dividends on our common stock. We currently intend to retain all +available funds and any future earnings for use in the operation of our +business and do not anticipate paying any cash dividends in the foreseeable +future. Any future determination to declare cash dividends will be made at the +discretion of our board of directors, subject to compliance with covenants +under any existing financing agreements, which may restrict or limit our +ability to declare or pay dividends, and will depend on our financial +condition, results of operations, capital requirements, general business +conditions, and other factors that our board of directors may deem relevant. +Use of Proceeds from Sales of Registered Securities +On February 13, 2006, +we closed an initial public offering of 11,385,000 shares of common stock. Of +these shares, 4,950,000 were newly issued shares sold by us and 6,435,000 were +existing shares sold by certain selling stockholders, including 1,485,000 +shares pursuant to an exercise by the underwriters of their over-allotment option. +The offering was effected pursuant to a Registration Statement on Form S-1 +(File No. 333-127526), which the SEC declared effective on February 8, +2006. Piper Jaffrey & Co. and Thomas Weisel Partners, LLC acted as +managing underwriters. +The public offering price +was $21.00 per share and $239.1 million in the aggregate. Underwriting +discounts and commissions were $1.42 per share and $16.2 million in the +aggregate. Proceeds, before expenses, to us were $19.58 per share and +$96.9 million in the aggregate. Proceeds, before expenses, to the selling +stockholders were $19.58 per share and $126.0 million in the aggregate. +We did +not receive any of the proceeds from the sale of shares by selling stockholders +or on any exercise of the underwriters’ over-allotment option. The net proceeds +received by us in the offering were $94.5 million as follows: +Aggregate +offering proceeds to us +$ +104.0 million +Underwriting +discounts and commissions +7.0 million +Other expenses +2.5 million +Total expenses +9.5 million +Net proceeds to us +$ +94.5 million +We used approximately $14.1 million +of the proceeds from the offering to repay all amounts outstanding under our +revolving credit facility and Canadian bank loans, $8.7 million to expand +and upgrade our existing information technology systems, $23.8 million for capital +expenditures and $15.4 million for acquisitions and the remaining proceeds +for the continual development of our global infrastructure, facility upgrades, +working capital, and other general corporate purposes. +ITEM +6. Selected Financial Data +The following table presents selected historical +financial data of Crocs, Inc. and its subsidiaries for each of the years +in the five-year period ended December 31, 2006. This data was derived +from our audited consolidated financial statements and reflects our operations +and financial position at the dates and for the periods indicated, with the +exception of the summary financial data presented below under the heading “Consolidated +Balance Sheet Data” as of and for the year ended December 31, 2002, which +was derived from our unaudited consolidated financial statements. The +information in this table should be read with the consolidated financial +statements and accompanying notes and other financial data included herein. +27 +Year Ended December 31, +2006 +2005(1) +2004(2) +2003 +2002 +(in thousands, except share and per share data) +Consolidated Statements of +Operations Data +Revenues +$ +354,728 +$ +108,581 +$ +13,520 +$ +1,165 +$ +24 +Cost of sales +154,158 +47,773 +7,162 +891 +16 +Gross profit +200,570 +60,808 +6,358 +274 +8 +Selling, general +and administrative expenses +105,224 +33,916 +7,929 +1,471 +453 +Income (loss) +from operations +95,346 +26,892 +(1,571 +) +(1,197 +) +(445 +) +Interest expense +567 +611 +47 +3 +— +Other (income) +expenses—net +(1,847 +) +(8 +) +19 +— +— +Income (loss) +before income taxes +96,626 +26,289 +(1,637 +) +(1,200 +) +(445 +) +Income tax +expense (benefit)(2) +32,209 +9,317 +(143 +) +— +— +Net income (loss) +64,417 +16,972 +(1,494 +) +(1,200 +) +(445 +) +Dividend on +redeemable convertible preferred shares(3) +33 +275 +142 +— +— +Net income (loss) +attributable to common stockholders +$ +64,384 +$ +16,697 +$ +(1,636 +) +$ +(1,200 +) +$ +(445 +) +Income (loss) per common +share: +Basic +$ +1.73 +$ +0.51 +$ +(0.07 +) +$ +(0.06 +) +$ +(0.05 +) +Diluted +$ +1.61 +$ +0.51 +$ +(0.07 +) +$ +(0.06 +) +$ +(0.05 +) +Weighted average common +shares: +Basic +37,229,200 +25,493,577 +24,641,953 +20,855,385 +8,288,710 +Diluted +40,085,256 +33,570,000 +24,641,953 +20,855,385 +8,288,710 +As of December 31, +2006 +2005 +2004 +2003 +2002 +(in thousands) +Consolidated +Balance Sheets Data +Cash, cash +equivalents, and marketable securities +$ +67,871 +$ +4,787 +$ +1,054 +$ +326 +$ +73 +Total assets +299,457 +78,032 +16,224 +1,304 +454 +Long term +obligations +3,290 +5,513 +3,660 +400 +— +Redeemable common +shares +— +1,800 +1,800 +1,800 +— +Redeemable +convertible preferred stock +— +5,500 +5,500 +— +— +Total stockholders’ +equity (deficit) +208,258 +18,914 +(3,591 +) +(1,642 +) +389 +(1) On January 4, 2005, +we converted from a limited liability company to a taxable corporation. For the +tax years beginning on January 1, 2005 and afterward, we are subject to +corporate-level U.S. federal, state and foreign income taxes. The +statement of operations for the year ended December 31, 2005 reflects a +one-time income tax benefit of $797,000 to record the net deferred tax assets +at the date of conversion. +(2) The income tax benefit +recognized in 2004 represents the tax benefit recognized by Foam Creations +subsequent to its acquisition. +(3) Dividends accrued in +2004 were paid to holders of our Class C convertible preferred membership +units. Our Class C membership units were converted into shares of our Series A +preferred stock in connection with our conversion from a limited liability +company to a corporation on January 4, 2005. +28 +ITEM 7. Management’s +Discussion and Analysis of Financial Condition and Results of Operations +This annual report on Form 10-K +contains “forward-looking statements” within the meaning of the Private +Securities Litigation Reform Act of 1995. In addition, we may make other +written and oral communications from time to time that contain such statements. +Forward-looking statements include statements as to industry trends and future +expectations and other matters that do not relate strictly to historical facts +and are based on certain assumptions by management. These statements are often +identified by the use of words such as “may,” “will,” “expect”, “believe,” “anticipate,” +intend,” “could,” “estimate,” or “continue,” and similar expressions or +variations. These statements are based on the beliefs and assumptions of our management based on information currently +available to management. Such forward-looking statements are subject to risks, uncertainties and +other factors that could cause actual results to differ materially from future results expressed or implied by such +forward looking statements. These forward-looking statements include statements in this Item 7, “ Management Discussion and Analysis of Financial Condition and Results +of Operations.” Important factors that could cause actual results to differ +materially from the forward-looking statements include, among others, the risks +described in the section entitled “Risk Factors” under Item 1A. We caution the +reader to carefully consider such factors. Furthermore, such forward-looking +statements speak only as of the date of this report. We undertake no obligation +to update any forward-looking statements to reflect events or circumstances +after the date of such statements. The following discussion should be read in +conjunction with our consolidated financial statements and notes thereto +included elsewhere in this report. +Overview +We are a rapidly growing designer, manufacturer, and +marketer of footwear for men, women, and children. All of our footwear products +incorporate croslite, which enables us to produce a soft and lightweight, +non-marking, slip- and odor-resistant shoe that retails at attractive price +points ranging from $19.99 to $59.99. In addition to our footwear products, we +recently acquired Jibbitz a unique accessory brand with colorful snap-on +products specifically suited for Crocs shoes and introduced a line of Crocs-branded +apparel and accessory items. We also recently acquired Fury, which produces and +distributes hockey and lacrosse equipment for adults and children, and EXO, a +Italian designer and producer of EVA (Ethylene Vinyl Acetate) based finished +products, primarily for the footwear industry. In January 2007, we +acquired substantially all of the assets of Ocean Minded, a leading designer +and manufacture of high quality leather and EVA based sandals primarily for the +beach, adventure and action sports market. We also use croslite to manufacture +non-branded products that we sell to original equipment manufacturers. +We currently sell our Crocs-branded products +throughout the U.S. and in over 80 countries worldwide. Outside the U.S., we +sell our products directly to retailers or through distributors where we +believe they offer a preferable alternative to direct sales. We also sell +directly to consumers through our website and our company-operated kiosks +and retail stores. The broad appeal of our footwear has allowed us to market +our products to a wide range of distribution channels in the U.S., including +traditional footwear retailers as well as a variety of specialty channels. As +of December 31, 2006, our retail customer base in the U.S. included over +11,000 sales locations selling our products. +We have achieved significant growth since our +inception, driven largely by the popularity of our footwear products and our +ability to significantly expand the breadth and depth of our distribution +network. For the year ended December 31, 2006, we recorded revenues of +$354.7 million and net income of $64.4 million, compared to +$108.6 million of revenues and net income of $17.0 million for the +year ended December 31, 2005. We have achieved strong gross profit margins +on sales of our Crocs footwear. +For the year ended December 31, 2006, our gross profit was +$200.6 million, or 56.5% of revenues, compared to $60.8 million, or 56.0% of revenues , for the year ended December 31, +2005. We believe a number of factors have contributed to our ability to achieve +gross profit margins at these levels. Generally, we have not discounted the +sale price of our Crocs footwear +due to high levels of demand for our products. +29 +Additionally, our use of +third party manufacturers as well as company-operated manufacturing facilities +has allowed us to maintain a relatively low cost structure while enabling us to +achieve significant production flexibility. +We currently manufacture some of our footwear products +and accessories, and all non-branded products for original equipment +manufacturers at Foam Creations’ facility in Quebec City, Canada. We also manufacture +our footwear products at our company-owned and operated facilities located in +Mexico and Italy. In addition, we contract with third party manufacturers in +China, Romania and the United States for the production of our footwear +products and accessories. We believe our in-house production capabilities +enable us to make rapid changes to manufacturing schedules and provide us the +flexibility to quickly ship in-demand models and colors, while outsourcing +allows us to lower our capital investment and retain the cost-effectiveness of +using third party manufacturing. +On February 13, 2006, we completed an initial +public offering of our common stock in which we sold 4,950,000 shares and our +selling shareholders sold 6,435,000 shares. Our net proceeds from the offering +totaled approximately $94.5 million, after payment of underwriters’ +commissions and offering expenses. We used the net proceeds from the offering +to repay all amounts outstanding under our amended and restated credit facility +and amounts outstanding under Foam Creations loans from the National Bank of +Canada and for capital expenditures related to increasing our manufacturing +capacity and infrastructure improvements as well as to develop our +international operations and increase our marketing activities. We did not +receive any of the proceeds from the sale of shares of our common stock by the +selling shareholders. +In August 2006, we +completed a secondary offering of our common stock in which existing +stockholders, including certain members of the Company’s management, sold +8,290,000 shares. We did not receive any proceeds from the sale of the shares +sold in the offering. We incurred expenses from the offering. +General +Revenues are recorded when products are shipped and +the customer takes title and assumes risk of loss, collection of related +receivables are probable, persuasive evidence of an arrangement exists, and the +sales price is fixed or determinable. Title passes on shipment or on receipt by +the customer depending on the country of the sale and the agreement with the +customer. Allowances for estimated returns and discounts are recognized when +related revenue is recorded. Because we use both internal manufacturing and +contract with third parties to manufacture our products, our cost of sales +represents our costs to manufacture products in our own facilities, including +raw materials costs and all overhead expenses related to production, as well as +the cost to purchase finished products from our third party manufacturers. Cost +of sales also includes the cost to transport these products to our facilities +and all warehouse and outbound freight expenses. Our selling, general and +administrative expense consists primarily of selling, marketing, wages and +related payroll and employee benefit costs, travel and insurance expenses, +depreciation, amortization, professional fees, facility expenses, bank charges +and non-cash charges for stock-based compensation. +We were initially +organized as a limited liability company and until January 4, 2005 were treated +as a partnership for U.S. federal and state income tax purposes for each of the +tax years ended December 31, 2003 and 2004. Under U.S. tax law, +partnerships are treated as pass-through entities and are not subject to direct +taxation. However, partners are subject to income tax on their allocable share +of the partnership’s income. On January 4, 2005, we converted from a +limited liability company to a taxable corporation. For tax years beginning on January 1, +2005 and afterward, we have been subject to corporate-level U.S. federal, +state and foreign income taxes. +30 +Factors Affecting +Comparability +Set forth below are +selected factors that we believe have had, or are expected to have, a +significant affect on the comparability of recent or future results of operations: +Stock-Based +Compensation Expenses +In December 2004, the Financial Accounting +Standards Board (“FASB”) issued a revision to Statement of Financial Accounting +Standards (“SFAS”) No. 123, Accounting +for Stock-Based Compensation +(“SFAS 123”), which requires the calculation of the fair value of +stock-based compensation, estimation of future forfeitures and income taxes, +and recognition of the fair value as a non-cash expense over the vesting period +of the underlying instruments. SFAS No. 123R, Share-Based Payment +(“SFAS 123R”), eliminates the ability to account for stock-based +compensation transactions using the footnote disclosure-only provisions of +Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and instead requires +that such transactions be recognized and reflected in our financial statements +using a fair-value-based method. +We adopted SFAS +123R effective as of January 1, 2006 using the prospective method for +option grants and restricted stock issued prior to August 15, 2005, which +was the date we filed our initial Registration Statement on Form S-1 +in connection with our initial public offering and the modified prospective +method for option grants issued after August 15, 2005. The adoption of the +SFAS 123R fair-value-based method had a significant impact on our results of +operations, although it will have no impact on our overall cash flow. The +effect of applying SFAS 123R for the year ending December 31, 2006 was a +decrease of $5.4 million of pre-tax income. We recognized additional +stock-based compensation expense in 2006 based on the fair value of any share +based payments made in 2006. The amount of compensation expense recognized +depends on numerous factors and estimates, including the number and vesting +period of option grants, the publicly traded price of our common stock, +estimated volatility of the stock price, estimates of the timing and volume of +exercises and forfeitures of the options, and fluctuations in future interest +and income tax rates. +Effects of Initial +Public Offering +In February 2006, we +completed an initial public offering of our common stock. As a part of the +initial public offering, we issued 4,950,000 shares of our common stock and +received net proceeds of approximately $94.5 million. In connection with +the initial public offering, all of our then-outstanding shares of redeemable +convertible preferred stock, which was not included in stockholders’ equity in +our balance sheet, converted into 7,452,492 shares of our common stock, of +which a portion was sold in our initial public offering, and accrued dividends +aggregating $171,000 were paid with a portion of our net proceeds from the +offering. In addition, the put options on our redeemable shares of common stock +terminated and such shares were also not previously included in stockholders’ +equity in our balance sheet. Therefore, the immediate result of our initial +public offering was a significant increase in cash and stockholders’ equity on +our balance sheet, and the elimination of the accrual of dividends on the +preferred stock. In addition, our common stock outstanding increased +significantly because of the conversion of the preferred stock, the termination +of the put options on the redeemable shares of common stock and our issuance of +shares of common stock. As a result, the basis for the calculation of net +income per share on both a basic and diluted basis has changed significantly. +Acquisitions +In September 2006 we entered into an endorsement +agreement with Jibbitz providing that we would publicly endorse the products of +Jibbitz and license to Jibbitz certain Company trademarks. We allowed Jibbitz +to access our network of distribution and retailers as well as utilize our +warehousing and logistics +31 +infrastructure. We acquired +Jibbitz on December 1, 2006 with an aggregate purchase price of +$13.5 million, which included $109,000 in costs related to the acquisition. +The cash purchase price is subject to adjustment based on the closing date +balance sheet of Jibbitz, to be agreed on by both parties in the second quarter +of 2007. The consolidated financial statements referred to in this report +reflect the acquisition of Jibbitz as of December 1, 2006, the date of +acquisition. +In October 2006, we +acquired for $1.5 million and € 6.0 million (approximately +$7.5 million), Fury and EXO, respectively, as part of the Company’s effort to +expand into new markets and expand our internal design capabilities. The +consolidated financial statements referred to in this report reflect the +acquisitions of Fury and EXO as of the date of acquisition. +Results of +Operations +Comparison of the +Years Ended December 31, 2006 and 2005 +Revenues. Revenues +increased 226.6%, or $246.1 million, to $354.7 million, in the year +ended December 31, 2006, from $108.6 million in the year ended December 31, +2005. This increase was primarily a result of significantly higher unit sales +of our footwear products. The higher unit sales resulted from an increase in +the number of retail stores selling our products, additional sales resulting +from new product offerings, stronger sales to our existing wholesale customers +and increases in sales at retail locations owned by us and through our +webstore. In addition, our revenues from sales outside of the United States +were $112.5 million for the year ended December 31, 2006, compared to $8.1 +million in the year ended December 31, 2005. We expect our sales to +continue to grow as we enter new domestic and international markets and +introduce new products. +Gross +profit. Gross profit increased 229.9%, or +$139.8 million, to $200.6 million, in the year ended December 31, +2006, from $60.8 million in the year ended December 31, 2005 due +primarily to higher revenues. Our gross profit margin improved to 56.5% in the +year ended December 31, 2006, from 56.0% in the year ended December 31, +2005. We do not consider this to be a material change. During 2006, we +increased the percentage of orders shipped factory direct reducing average +order fulfillment costs. This increase was partially offset by a decrease in +margin related to product mix. +Selling, +general and administrative expenses. Selling, +general and administrative expenses increased 210.3% or $71.3 million, to +$105.2 million in the year ended December 31, 2006, from +$33.9 million in the year ended December 31, 2005. This increase was +primarily a result of higher costs associated with increased sales volumes, +including an increase in selling and marketing expenses of $10 million, +increases in personnel expenses of $40.9 million due to our growth and +expanding operations. In addition, professional and consulting fees increased +approximately $14.5 million, primarily as a result of increased legal fees +related to our secondary offering and defending our intellectual property, +accounting, contract labor and consultants. In addition, stock-based +compensation expense was $10.3 million for the year ended December 31, +2006, compared to $4.8 million for the year ended December 31, 2005. +As a percentage of revenues, selling, general and administrative expense +decreased to 29.7% in the year ended December 31, 2006, from 31.2% in the +year ended December 31, 2005, primarily due to the effect of the improved +leverage of operating expenses resulting from higher sales. +Interest +expense. Interest expense was $567,000 in the +year ended December 31, 2006, compared to $611,000 in the year ended December 31, +2005. Interest expense decreased due to our use of a portion of the proceeds +from our initial public offering to retire bank loans. This debt retirement led +to a decrease in average borrowings outstanding on our line of credit and long +term debt during the year ended December 31, 2006 compared to average +borrowings outstanding under those arrangements during the year ended December 31, +2005. +32 +Other +income/expense, net. Other income was $1.8 +million in the year ended December 31, 2006, compared to income of $8,000 +in the year ended December 31, 2005. The increase resulted from an +increase in interest income related to an increase in interest bearing cash and +cash equivalents and short-term investments resulting from proceeds received +upon completion of our initial public offering in February 2006. +Income +tax expense. In the year ended December 31, +2006, income tax expense was $32.2 million, representing an effective +income tax rate of 33.3%, compared to income tax expense of $9.3 million in the +year ended December 31, 2005, representing an effective income tax rate of +35.4%. The decrease relates primarily to an increase in the pre-tax earnings in +jurisdictions with lower relative income tax rates as a percentage of total +pre-tax earnings. +Dividends on redeemable +convertible preferred stock. Dividends on our +outstanding redeemable convertible preferred stock were $33,000 for the year +ended December 31, 2006 compared to $275,000 for the year ended December 31, +2005. Our Class C membership units, issued in June 2004, had +preferred liquidation and dividend rights. In connection with our conversion +from a limited liability company to a corporation, our Class C membership +units converted into shares of our Series A preferred stock. Our Series A +preferred stock provided for a dividend at the rate of five percent per annum +on the initial investment amount per share. All of our Series A preferred +stock converted into shares of our common stock in connection with the closing +of the initial public offering on February 13, 2006. +Comparison of the +Years Ended December 31, 2005 and 2004 +Revenues. Revenues +increased $95.1 million, to $108.6 million, in the year ended December 31, +2005, from $13.5 million in the year ended December 31, 2004. This +increase was primarily a result of significantly higher unit sales of our +footwear products, which increased to 6.0 million pairs for the year ended December 31, +2005, from 649,000 pairs for the year ended December 31, 2004. The higher +unit sales resulted from an increase to 8,000 retail stores domestically and +internationally selling our products and stronger sales to our existing +customers. During the year ended December 31, 2005, our results included +revenues of $5.2 million from sales by Foam Creations. Revenues from sales by +Foam Creations that were included in our results of operations for the date of +acquisition to December 31, 2004 were $2.7 million. In addition, our +revenues from sales outside of the United States were $8.1 million in the year +ended December 31, 2005. +Gross +profit. Gross profit increased $54.4 million, +to $60.8 million, in the year ended December 31, 2005, from +$6.4 million in the year ended December 31, 2004. Our gross profit +margin improved to 56.0% in the year ended December 31, 2005, from 47.0% +in the year ended December 31, 2004. The increase in gross profit margin +was primarily due to lower unit costs resulting from the addition of a third +party manufacturer located in China, partially offset by higher freight and +duty costs, from which we did not obtain footwear products in the year ended December 31, +2004. +Selling, +general and administrative expenses. Selling, +general and administrative expenses increased $26.0 million, to +$33.9 million in the year ended December 31, 2005, from +$7.9 million in the year ended December 31, 2004. This increase was +primarily a result of higher costs associated with increased sales volumes, +including an increase in selling and marketing expenses of $6.9 million, +increases in personnel expenses of $7.4 million. In addition, professional +and consulting fees increased approximately $2.5 million, primarily as a +result of increased legal fees, as well as settlement costs with consultants. +In addition, stock-based compensation expense was $4.8 million for +the year ended December 31, 2005, compared to $1.8 million for the +year ended December 31, 2004. As a percentage of revenues, selling, +general and administrative expenses decreased to 31.2% in the year ended December 31, +2005, from 58.6% in the year ended December 31, 2004, primarily due to +substantially higher revenues in 2005. +33 +Interest +expense. Interest expense was $611,000 in the +year ended December 31, 2005, compared to $47,000 in the year ended December 31, +2004. The increase is related to the interest expense associated with the +indebtedness incurred under our line of credit during 2005 and the long term +debt at our subsidiary Foam Creations, which we acquired in June 2004. +Other +income/expense, net. Other income was $8,000 in +the year ended December 31, 2005, compared to expense of $19,000 in the +year ended December 31, 2004, which primarily related to a minority +interest associated with Foam Creations, which was acquired in June 2004 +and an increase in interest income related to the increase in cash and cash +equivalents. +Income +tax expense (benefit). In the year ended December 31, +2005, income tax expense was $9.3 million, representing an effective +income tax rate of 35%, compared to a benefit of $143,000 in the year ended December 31, +2004. In the year ended December 31, 2004, we were not a tax-paying entity +for U.S. income tax purposes and therefore did not record any income tax +expense for the U.S. entity for this period. However, we acquired Foam +Creations, a Canadian corporation, in June 2004. During the period +subsequent to the acquisition, Foam Creations recorded a tax benefit of +$143,000. We recognized a tax benefit of $797,000 in the year ended December 31, +2005 to establish our deferred tax assets in connection with the conversion +from a limited liability company to a taxable corporation. +Dividends on redeemable +convertible preferred stock. Dividends on our +outstanding redeemable convertible preferred stock were $275,000 for the year +ended December 31, 2005 compared to $142,000 for the year ended December 31, +2004. Our Class C membership units, issued in June 2004, had +preferred liquidation and dividend rights. In connection with our conversion +from a limited liability company to a corporation, our Class C membership +units converted into shares of our Series A preferred stock. Our Series A +preferred stock provided for a dividend at the rate of five percent per annum +on the initial investment amount per share. All of our Series A preferred +stock converted into shares of our common stock in connection with the closing +of the initial public offering on February 13, 2006. +Liquidity and +Capital Resources +Our primary cash needs are working capital, capital +expenditures and acquisitions. Other principal uses of cash have been for the +distribution in April 2005 of $3.0 million in cash to the members of +our predecessor limited liability company pursuant to its operating agreement, +for the purchase of our manufacturing operation in Mexico and associated +operating assets in April 2005 for approximately $1.3 million, and +for capital expenditures to increase manufacturing capacity and improve our +global infrastructure. Prior to our initial public offering, we generally +financed these needs through sales of our securities, borrowings under our +credit facility and cash provided by operating activities. +As of December 31, 2006, we had $67.9 million in +cash and cash equivalents, restricted cash and short-term investments compared +to $4.8 million as of December 31, 2005. The increase in cash and cash +equivalents reflects the completion of our initial public offering of our +common stock in February 2006 whereby we received proceeds of $94.5 +million, net of underwriters’ fees and commissions and related offering costs +of $2.5 million. To date, we have used $14.1 million of the net proceeds +from the offering to pay down our revolving line of credit and long-term debt, +$23.8 million of the net proceeds for capital expenditures related to +increasing our manufacturing capacity and improving our infrastructure, $8.7 +million to expand and upgrade our existing information technology systems and +$15.4 million for acquisitions, net of cash received. We intend to use the +remaining net proceeds for the continual development of our global +infrastructure, facility upgrades, working capital, and other general corporate +purposes. In addition, we may use a portion of the remaining proceeds to +acquire products or businesses that are complimentary to our own. +The significant components of our working capital are +cash, accounts receivable and inventory, reduced by accounts payable and +accrued expenses. Capital requirements related to manufacturing include +34 +compounding and injection +molding equipment for facilities we operate, as well as footwear molds used in +facilities operated by us or purchased for our third-party manufacturers. +Cash provided by, or used in, operating activities +consists primarily of net income or net loss adjusted for certain non-cash +items including depreciation, amortization, deferred income taxes, provision +for bad debts, stock compensation expense and for the effect of changes in +working capital and other activities. Cash provided by operating activities for +the year ended December 31, 2006 was $12.3 million, primarily related +to net income of $64.4 million plus non-cash items of depreciation and +amortization of $8.1 million and share-based compensation expense of $10.3 million, +which was offset by increases in working capital resulting from increases in +accounts receivable of $44.0 million, inventory of $55.0 million, and +a increase in accounts payable and accrued expenses and other liabilities of $53.8 million. +Cash provided by operating activities in the +year ended December 31, 2005 was $10.5 million and was primarily +related to net income of $17.0 million plus non-cash items of depreciation +and amortization of $3.3 million and share-based compensation expense of +$4.8 million, partially offset by increases in working capital resulting +from significant increases in prepaid expenses and other assets of $3.5 million, +inventory of $26.0 million and accounts receivable of $14.7 million offset by increases in +accounts payable of $17.7 million and accrued expenses and other +liabilities of $14.0 million, all related to our sales growth and expanded +operations. +Cash used in investing activities for the year ended December 31, +2006 was $69.5 million, which was related to the net purchases of +investments of $22.3 million, capital expenditures for molds, machinery and +equipment of $23.8 million and $5.2 million related to the upgrade and +expansion of our information technology systems. Cash used in i nvesting activities for the year ended December 31, +2005 was $12.2 million, which was related to capital expenditures for +molds, machinery and equipment of $11.5 million and $636,000 related to +the acquisition of a non-compete +agreement. +Cash provided by financing activities was $94.6 +million for the year ended December 31, 2006 compared to cash provided by +financing activities of $5.5 million +for the year ended December 31, 2005. The $89.1 million increase in +cash provided by financing activities primarily resulted from the completion of +the initial public offering of our common stock whereby we received net +proceeds of $94.5 million, after deducting underwriting discounts and +commissions and offering costs of $2.5 million, all partially offset by +the repayment of borrowings on our line of credit and long term debt of $14.1 million. +On April 8, 2005 we entered into a +$5.0 million secured revolving credit facility, and on October 26, +2005 we amended and restated the credit facility increasing the amount +available under this credit facility to $20.0 million. The effective +annual interest rate, on borrowings outstanding under the credit facility was +7.25% as of December 31, 2005. Our obligations under the revolving credit +facility were secured by substantially all of our property, including, among +other things, our accounts receivable, inventory, equipment and fixtures. The +credit facility also contained financial covenants that required us to meet a +specified consolidated fixed charge coverage ratio and specified levels of +consolidated EBITDA. The credit facility was subject to an early termination +fee of 1% if we terminated the facility on or prior to October 26, 2006. +In February 2006, we terminated the credit facility and repaid all amounts +outstanding under the credit facility, together with accrued interest thereon, +with a portion of the proceeds from our initial public offering, and we are no +longer able to borrow against the facility. +We have considered our +anticipated operating cash flows in 2007, cash and cash equivalents, marketable +securities, and access to capital markets and believes that these are +sufficient to fund our operating needs, including commitments and contingencies, +capital and investing commitments for at least the next twelve months. Any +future acquisitions or other similar transactions may require additional +capital. There can be no assurance that any such capital will be available to +us on acceptable terms or at all. Our ability to fund working capital needs, +planned capital expenditures and scheduled debt payments, depends on our future +operating performance and cash flow, which in turn are subject to prevailing +economic conditions and to financial, business and other factors, some of which +are beyond our control. +35 +Off-Balance Sheet +Arrangements +We have no off-balance +sheet arrangements. +Contractual +Obligations +The +following table discloses aggregate information about our contractual cash +obligations as of December 31, 2006 and the periods in which payments are +due (in thousands): +Payments due by period +Total +Less than +1 year +1-3 +years +3-5 +years +More than +5 years +Additional Purchase +Price related to EXO +2,890 +2,890 +— +— +— +Capital Lease +Obligations +639 +519 +120 +— +— +Operating Lease +Obligations +29,022 +6,380 +12,073 +9,209 +1,360 +Corporate Sponsorship +8,400 +4,200 +4,200 +Purchase +obligations +525 +525 +— +— +— +Contractual +severance commitment +336 +168 +168 +— +— +Total +41,812 +14,682 +16,561 +9,209 +1,360 +Excluded from the table +above is the contingent cash purchase price of up to $10.0 million for Jibbitz, +related to the earn-out provisions of the agreement, see note 3 in the +consolidated financial statements for further discussion. +Seasonality +Due to our significant +sales growth since our inception, we cannot assess with certainty the degree to +which sales of our footwear products will be subject to seasonality. However, +we expect that our business, similar to other vendors of footwear and related +merchandise, will be subject to seasonal variation. We believe many vendors +that market footwear products suited for warm weather normally experience their +highest sales activity during the second and third quarters of the calendar +year. While we have introduced footwear models that are more suitable for cold +weather uses, such as the Endeavor, Georgie, All Terrain, Highland and +Snowmini, we expect demand for our products, and therefore our sales, may be +subject to seasonal variations and significantly impacted by weather +conditions, as over 76.6% of our revenues during the year ended December 31, +2006 were attributable to our Beach and Cayman (classic) models and our +flip-flops and other open-toed models, which are more suitable for warm +weather. In addition, our quarterly results of operations may fluctuate +significantly as a result of a variety of other factors, including the timing +of new model introductions or general economic or consumer conditions. +Accordingly, results for any one quarter are not necessarily indicative of +results to be expected for any other quarter or for any year, and revenues for +any particular period may decrease. +Critical Accounting +Policies and Estimates +Our financial statements have been prepared in +accordance with accounting principles generally accepted in the U.S., which +require us to make estimates and judgments that affect the reported amounts of +assets, liabilities, revenues and expenses and related disclosure at the date +of our financial statements. On an ongoing basis, we evaluate our estimates and +judgments, including those related to revenue, intangible assets, and stock +compensation. We base our estimates and judgments on historical experience and +on various other factors that we believe to be reasonable under the +circumstances, the results of which form the basis of our judgments about the +carrying values of assets and liabilities that are not readily apparent from +other sources. Actual results or changes in the estimates or other judgments of +matters inherently uncertain that are included within these accounting policies +could result in a significant change to the information presented in the +consolidated financial statements. We believe that the estimates and +36 +assumptions below are +among those most important to an understanding of our consolidated financial +statements contained in this report. +We consider certain accounting policies related to +revenue recognition, reserves for uncollectible accounts receivable and +inventories, share-based compensation and goodwill and other intangible assets +to be critical policies due to the estimates and judgments involved in each. +Revenue Recognition. Our revenues are derived principally from +wholesale sales to retailers. Our standard arrangement for our customers +includes a valid purchase order or contract with no customer acceptance +provisions. We recognize revenues from sales of products when: +· we +enter into a legally binding arrangement with a customer; +· delivery +has occurred; +· customer +payment is deemed fixed or determinable and free of contingencies or +significant uncertainties; and +· collection +is reasonably assured. +Title passes on shipment or on receipt by the customer +depending on the arrangement with the customer. Allowances for estimated +returns and claims are provided for when related revenue is recorded. We base +our estimates on historical rates of product returns and claims, and specific +identification of outstanding claims and outstanding returns not yet received +from customers. Since inception, actual returns and claims have not exceeded +our reserves. However, actual returns and claims in any future period are +inherently uncertain and thus may differ from our estimates. If actual returns +and claims exceed reserves, we would need to reduce our revenues at the time of +such determination. +Reserve +for Uncollectible Accounts Receivable. We make ongoing +estimates relating to the collectibility of our accounts receivable and +maintain a reserve for estimated losses resulting from the inability of our +customers to make required payments. In determining the amount of the reserve, +we consider our historical level of credit losses and make judgments about the +creditworthiness of significant customers based on ongoing credit evaluations. +Since we cannot predict future changes in the financial stability of our +customers, actual future losses from uncollectible accounts may differ from our +estimates. If the financial condition of some of our customers were to +deteriorate, resulting in their inability to make payments, a larger reserve +might be required. In the event we determine that a smaller or larger reserve +is appropriate, we would record a credit or a charge to selling, general and +administrative expense in the period in which we made such a determination. +Inventory +Write-Downs. We also make ongoing estimates +relating to the net realizable value of inventories, based on our assumptions +about future demand and market conditions. If we estimate that the net +realizable value of our inventory is less than the cost of the inventory +recorded on our books, we record a write-down equal to the difference between +the cost of the inventory and the estimated net realizable value. This +write-down is recorded to cost of sales. If changes in market conditions result +in reductions in the estimated net realizable value of our inventory below our +previous estimate, we would increase our write-down in the period in which we +made such a determination and record it to cost of sales. +Share-Based +Compensation. Effective +January 1, 2006, we adopted SFAS 123R which requires recognition of the +fair value of stock-based compensation over the vesting period of the option. +We adopted the prospective method for all stock option grants issued prior to August 15, +2005, which was the date we initially filed a Registration Statement on Form S-1 +in connection with our initial public offering. As a non-public company we used +the minimum value method of measuring equity share options and similar +instruments for either recognition or pro forma disclosure purposes. We +continue to account for any portion of awards outstanding at the date of +initial application using the accounting principles +37 +originally applied to +those awards which were the provisions of APB 25 and its related interpretive +guidance. +For stock option grants issued after the filing of our +initial Registration Statement on Form S-1 on August 15, 2005, +we have applied the modified prospective method. Under this method we use the +Black-Scholes valuation model to determine the fair value of our stock options, +which requires assumptions to be made regarding our stock price volatility, the +expected life of the option and expected dividend rates. The volatility +assumptions were derived from our historical volatilities and historical +volatilities of competitors whose shares are traded in the public markets. Had +we arrived at different assumptions of stock price volatility or expected lives +of our options, our stock-based compensation expense and results of operations +could have been different. +Goodwill +and Other Intangible Asset Valuation. We +classify intangible assets as finite-lived or indefinite-lived intangible +assets, as well as goodwill. Finite-lived intangibles include customer +relationships, core technology, capitalized software, patents and non-compete +agreements. We periodically review the appropriateness of the amortization +periods related to our definite-lived assets. These assets are stated at cost. +Indefinite-lived intangibles include tradenames. The excess cost over fair +value of net assets acquired is classified as goodwill. The indefinite-lived +intangibles and goodwill are not subject to amortization, but are tested for +impairment at least annually. +We test for possible impairment of finite-lived +intangible assets whenever events or changes in circumstances, such as a +reduction in operating cash flow or a dramatic change in the manner that the +asset is intended to be used indicate that the carrying amount of the asset may +not be recoverable. If indicators exist, we compare the undiscounted cash flows +related to the asset to the carrying value of the asset. If the carrying value +is greater than the undiscounted cash flow amount, an impairment charge is +recorded in the statement of operations for amounts necessary to reduce the +carrying value of the asset to fair value. +At least annually, we perform our impairment test for +each reporting unit’s indefinite-lived intangibles and goodwill using a +discounted cash flow model to determine if the carrying value of the reporting +unit, including indefinite-lived intangibles and goodwill, is less than the +fair value of the reporting unit. Certain assumptions are used in determining +the fair value, including assumptions about cash flow rates, discount rates, +and terminal values. If the fair value of our reporting unit is less than the +carrying value of the reporting unit, an impairment charge is recorded in the +statement of operations for amounts necessary to reduce the carrying value of +the asset to fair value. +Acquisitions. We account for +business acquisitions under the purchase method of accounting as required by +SFAS No. 141, Business Combinations +(“SFAS 141”). The total cost of acquisitions is allocated to the underlying net +assets, based on their respective estimated fair values. The excess of the +purchase price over the estimated fair values of the net assets acquired is +recorded as goodwill. Determining the fair value of assets acquired and +liabilities assumed requires judgment and often involves the use of significant +estimates and assumptions, including assumptions with respect to future cash +inflows and outflows, discount rates, asset lives and market multiples, among +other items. These estimates and assumptions affect future amortization expense +and gains or losses recorded on the sale of properties. +Recent Accounting Pronouncements +In June 2006, the Financial Accounting Standards +Board (“FASB”) Emerging Issues Task Force issued EITF No. 06-3, How +Sales Taxes Collected from Customers and Remitted to Governmental Authorities +Should Be Presented in the Income Statement (That Is, Gross Versus Net +Presentation) (“EITF No. 06-3”), which states a company must +disclose its accounting policy (i.e., gross or net presentation) regarding +presentation of taxes within the scope of this Issue. If taxes included in +gross revenues are significant, a company must disclose the amount of such +taxes for each period for which an income statement is presented. The Issue is +effective for the first annual or interim reporting period +38 +beginning after +December 15, 2006. The disclosures are required for annual and interim +financial statements for each period for which an income statement is +presented. We adopted this Issue effective January 1, 2007. Based on the our +current evaluation of this Issue, we do not expect the adoption of EITF +No. 06-3 to have a significant impact on our consolidated results of +operations or financial position. +In July 2006, the FASB issued Interpretation +No. 48, Accounting for Uncertainty in Income Taxe s +(“FIN 48”). FIN 48 requires the use of a two-step approach for recognizing and +measuring tax benefits taken or expected to be taken in a tax return and +disclosures regarding uncertainties in income tax positions. The Interpretation +is effective for fiscal years beginning after December 15, 2006. The cumulative +effect of initially adopting FIN 48 will be recorded as an adjustment to +opening retained earnings in the year of adoption and will be presented +separately. Only tax positions that meet the more likely than not recognition +threshold at the effective date may be recognized on adoption of FIN 48. The +Company adopted FIN 48 on January 1, 2007, and we are still in the process of +evaluating this Interpretation. We expect that the requirements of FIN 48 may +add volatility to our effective tax rate and therefore our expected income tax +expense in future periods. +In September 2006, the FASB issued SFAS +No. 157, Fair Value Measurement (“SFAS +157”), which defines fair value, establishes a framework for measuring fair +value in accordance with generally accepted accounting principles, and expands +disclosures about fair value measurements. The Statement is effective for +financial statements issued for the first annual or interim reporting period +beginning after November 15, 2007. We will adopt SFAS 157 effective +January 1, 2008. We are currently evaluating the impact this new standard will +have on our future results of operations and financial position. +On September 13, 2006, the SEC issued Staff +Accounting Bulletin No. 108 (“SAB 108”). SAB 108 provides interpretive +guidance on how the effects of the carryover or reversal of prior year +misstatements should be considered in quantifying a potential current year +misstatement. Prior to SAB 108, companies could evaluate the materiality of financial +statement misstatements using either the income statement or balance sheet +approach, with the income statement approach focusing on new misstatements +added in the current year, and the balance sheet approach focusing on the +cumulative amount of misstatement present in a company’s balance sheet. +Misstatements that would be material under one approach could be viewed as +immaterial under another approach, and not be corrected. SAB 108 now requires +companies to view financial statement misstatements as material if they are +material according to either the income statement or balance sheet approach. +The Bulletin is effective for annual financial statements covering the first +fiscal year ending after November 15, 2006. We adopted SAB 108 for the fiscal year +ending December 31, 2006. The adoption of SAB 108 did not to have a significant +impact our consolidated results of operations or financial position. +In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities +(“SFAS 159”). SFAS 159 permits entities to choose to measure many financial +instruments and certain other items at fair value. SFAS 159 will be effective +at the beginning of fiscal 2008. We are currently evaluating the impact this +new standard will have on our future results of operations and financial +position. +39 +ITEM 7A. Quantitative +and Qualitative Disclosures About Market Risk +Interest Rate Risk +We earn interest income on +both our cash and cash equivalents and our investment portfolio. Our investment +portfolio generally consists of readily marketable investment-grade debt +securities of various issuers and maturities. All investments are denominated +in U.S. dollars and are classified as “available for sale.” These instruments +are not leveraged, and are not held for trading purposes. As interest rates +change, the amount of realized and unrealized gain or loss on these securities +will change. We have performed a sensitivity analysis to estimate our exposure +to market risk of interest rates and if the weighted average rate of return on +cash and cash equivalents, restricted cash, and marketable securities were to +increase or decrease by 1%, the impact on interest income would be $523,000, +net of tax during the year ended December 31, 2006. +Credit Risk +We do not have any +variable rate debt instruments and we are not exposed to market risk due to +changes in interest rates such as the prime rate and LIBOR. +Foreign Currency +Exchange Risk +We pay the majority of our +overseas third party manufacturers in U.S. dollars and have had significant +revenues from foreign sales in recent periods. Our ability to sell our products +in foreign markets and the U.S. dollar value of the sales made in foreign +currencies can be significantly influenced by foreign currency fluctuations. A +decrease in the value of foreign currencies relative to the U.S. dollar could +result in downward price pressure for our products or losses from currency +exchange rates. We have performed a sensitivity analysis to estimate our exposure +to market risk of foreign exchange rates. If the U.S. dollar were to increase +or decrease in value by 10%, the impact on international sales of $112.5 +million during the year ended December 31, 2006 would have been an +increase or decrease in consolidated revenues by $7.5 million, net of tax. The +volatility of the applicable rates and prices are dependent on many factors +that cannot be forecast with reliable accuracy. In the event our foreign sales +and purchases increase and are denominated in currencies other than the U.S. +dollar, our operating results may be affected by fluctuations in the exchange +rate of currencies we receive for such sales. We intend to use derivative +instruments and engage in hedging activities beginning in 2007. +ITEM 8. Financial +Statements and Supplementary Data +The consolidated financial +statements and supplementary data are as set forth in the “Index To +Consolidated Financial Statements” on page F-1. +ITEM 9. Changes +in and Disagreements With Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls +and Procedures +Our management has evaluated, under the supervision +and with the participation of our Chief Executive Officer and Chief Financial +Officer, the effectiveness of our disclosure controls and procedures as of the +end of the period covered by this report pursuant to Rule 13a-15(b) under +the Securities Exchange Act of 1934. Based on that evaluation, our Chief +Executive Officer and Chief Financial Officer have concluded that, as of December 31, +2006, our disclosure controls and procedures are effective in ensuring that +information required to be disclosed in our Exchange Act reports is (1) recorded, +processed, summarized and reported in a timely manner, and (2) accumulated +and communicated to our +40 +management, including our +Chief Executive Officer and Chief Financial Officer, as appropriate to allow +timely decisions regarding required disclosure. +We are currently undergoing a comprehensive effort in +preparation for compliance with Section 404 of the Sarbanes-Oxley Act of +2002. This effort includes the documentation, testing and review of our +internal controls under the direction of senior management. During the course +of these activities, we have identified certain opportunities to improve our +internal control. As a result, we are evaluating and implementing improvements +to our internal control over financial reporting and will continue to do so. +These improvements include further formalization of accounting standards and +guidelines, improved segregation of duties, hiring additional competent +accounting managers and staff, and improving information technology system +controls. Any further opportunities to improve our internal controls identified +by our continued compliance efforts will be addressed accordingly. +During the fiscal year and +three months ended December 31, 2006, we made changes to our internal +control over financial reporting that have materially affected, or are +reasonably likely to materially affect, our internal control over financial +reporting. On April 1, 2006, we implemented a new accounting and +operational software package for our U.S. operations and on October 1, +2006, we implemented the new accounting and operational software package for +our Asia operations. Certain processes and controls were changed to accommodate +the needs and requirements of our growth and the new financial reporting +system. +ITEM 9B. Other +Information +Not applicable. +PART III +ITEM 10. Directors, +Executive Officers and Corporate Governance +The information required +by this item is incorporated by reference in our definitive proxy statement for +the 2007 Annual Meeting of Stockholders to be filed with the SEC within 120 +days after the end of the fiscal year ended December 31, 2006. +Code of Ethics +We have a written code of +ethics in place that applies to all our employees, including our principal +executive officer, principal financial officer, and controller. A copy of our +ethics policy is available on our website: www.crocs.com. We are required to +disclose any change to, or waiver from, our code of ethics for our senior +financial officers. We intend to use our website as a method of disseminating any +change to, or waiver from, our code of ethics as permitted by applicable SEC +rules. +ITEM 11. Executive +Compensation +The information required +by this item is incorporated by reference in our definitive proxy statement for +the 2007 Annual Meeting of Stockholders to be filed with the SEC within 120 +days after the end of the fiscal year ended December 31, 2006. +ITEM 12. Security +Ownership of Certain Beneficial Owners and Management and Related Stockholder +Matters +The information required +by this item is incorporated by reference in our definitive proxy statement for +the 2007 Annual Meeting of Stockholders to be filed with the SEC within 120 +days after the end of the fiscal year ended December 31, 2006. +41 +Securities +Authorized for Issuance under Equity Compensation Plans +As +shown in the table below, as of December 31, 2006, we reserved 4,542,718 +shares of common stock for future issuance on exercise of outstanding options +under equity compensation plans. +Number of +Securities +to be Issued +on Exercise of +Outstanding Options +Weighted Average +Exercise Price of +Outstanding +Options +Number of Shares +Remaining Available +for Issuance Under +Equity Compensation +Plans, Excluding +Securities Available +in First Column +Equity +compensation plans approved by stockholders(1) +3,783,454 +$ +18.89 +3,225,146 +(3) +Equity +compensation plans not approved by stockholders(2) +759,264 +1.02 +— +Total +4,542,718 +3,225,146 +(1) On April 27, 2005, +our board of directors adopted the 2005 Equity Incentive Plan, referred to as +the 2005 Plan. On January 10, 2006, our board of directors amended the +2005 Plan to increase the number of shares of our common stock available for +issuance under the 2005 Plan from 5,840,500 shares to 7,008,600 shares. The +2005 Plan provides for the grant of incentive stock options, within the meaning +of Section 422 of the Internal Revenue Code of 1986, as amended, to our +employees, and nonstatutory stock options, restricted stock, performance units, +and other stock based awards to our employees, directors, and consultants. +(2) Represents non-plan +stock options granted to our officers, directors and employees prior to the +adoption of the 2005 Equity Incentive Plan. +(3) Includes +441,098 shares of common stock reserved for issuance under our 2005 Plan to +employees and consultants in the future under restricted stock award +agreements. +ITEM 13. Certain +Relationships and Related Transactions, and Director Independence +The information required +by this item is incorporated by reference in our definitive proxy statement for +the 2007 Annual Meeting of Stockholders to be filed with the SEC within 120 +days after the end of the fiscal year ended December 31, 2006. +ITEM 14. Principal +Accounting Fees and Services +The information required by this item is incorporated +by reference in our definitive proxy statement for the 2007 Annual Meeting of +Stockholders to be filed with the SEC within 120 days after the end of the +fiscal year ended December 31, 2006. +42 +PART IV +ITEM 15. Exhibits, +Financial Statement Schedules +(1) Financial +Statements +The financial statements +filed as part of this report are listed on the index to financial statements on +page F-1. +(2) Financial +Statement Schedules +All financial statement schedules +have been omitted because they are not required, are not applicable or the +information is included in the Financial Statements or Notes thereto. +(3) Exhibit list +Exhibit +Number +Description +3.1** +Restated +Certificate of Incorporation of Crocs, Inc. +3.2** +Amended +and Restated Bylaws of Crocs, Inc. +4.1 +Reference +is made to Exhibits 3.1 through 3.4. +4.2* +Specimen +common stock certificate. +10.1*@ +Form of +Indemnity Agreement between Crocs, Inc. and each of its directors and +executive officers. +10.2*@ +Crocs, Inc. +2005 Equity Incentive Plan +10.2.2*@ +Amendment +No. 1 to the 2005 Plan. +10.3*@ +Form of +Notice of Grant of Stock Option under the 2005 Plan. +10.4*@ +Form of +Notice of Grant of Stock Option for Non-Exempt Employees under the 2005 +Plan. +10.5*@ +Form of +Stock Purchase Agreement under the 2005 Plan. +10.6*@ +Form of +Stock Option Agreement under the 2005 Plan. +10.7*@ +Form of +Restricted Stock Award Grant Notice under the 2005 Plan. +10.8*@ +Form of +Restricted Stock Award Agreement under the 2005 Plan. +10.9*@ +Form of +Non-Statutory Stock Option Agreement. +10.10* +Commercial +Lease between DiiG, LLP and the Registrant dated as of December 26, +2004. +10.11* +Sublease +between Flextronics USA, Inc. and the Registrant dated as of +May 19, 2005. +10.12* +Lease +Agreement between 9077-7152 Québec Inc. and Foam Creations dated as of +August 17, 2005. +10.13* +Lease +Agreement between Jose Pablo Hernandez Gonzalez and Crocs Mexico, S.de.R.L. +de C.V. dated as of May 1, 2005, as amended in August, 2005, for the +facility located in Emiliano Zapata, Primer Sector, No. 204, zona +centro, C.P. 36400 in the city of Purísima del Rincón, Guanajuato. +10.14* +Stock +Purchase Agreement among 4246519 Canada, Inc., Finproject Group S.p.A., +3107019 Canada, Inc. and Daniel J. Hunter dated as of June 29, +2004. +10.15* +Asset +Purchase and Property Transfer Agreement between Hana Phylon Tech S.A. de +C.V. and Crocs Mexico, S.de.R.L. de C.V. dated as of April 23, 2005. +10.16* +Asset +Purchase and Property Transfer Agreement between St. Vrain Trading, LLC, +d/b/a Crocs Hawaii, LLC and the Registrant dated May 19, 2005. +10.17* +Amended +and Restated Credit Agreement between the Registrant and Bank of America, +N.A., dated as of October 26, 2005. +10.18* +Amended +and Restated Security Agreement between the Registrant and Bank of America, +N.A., dated as of October 26, 2005. +10.19* +Distribution +Agreement between Crocodile Distribution and the Registrant dated as of +April 1, 2005. +10.20* +Kiosk +Agreement between Crocodile Kiosk, LLC and the Registrant dated as of +July 1, 2005. +43 +10.21†* +Amended +and Restated Agreement for Supply between Finproject S.p.A. and the +Registrant dated as of July 26, 2005. +10.22* +Lease +Agreement between Jose Pablo Hernandez Gonzalez and Crocs Mexico, S.de.R.L. +de C.V. dated as of May 1, 2005, as amended in August, 2005, for the +facilities located in Emiliano Zapata, Primer Sector, Nos. 208 and 212, zona +centro, C.P. 36400 in the city of Purísima del Rincón, Guanajuato. +10.23*@ +Employment +Letter Agreement of Caryn D. Ellison. +10.24* +First +Amendment to Amended and Restated Credit Agreement, dated as of +January 18, 2006, among Crocs, Inc., Crocs Retail, Inc., +Western Brands Holding Company, Inc. and Bank of America, N.A. +10.25*@ +Offer +Letter between Peter Case and the Registrant dated as of February 2, +2006. +10.26**@ +Nonstatutory +Stock Option Agreement between the Registrant and Raymond D. Croghan dated +September 1, 2004. +10.27**@ +Nonstatutory +Stock Option Agreement between the Registrant and Michael E. Marks dated +September 1, 2004. +10.28**@ +Nonstatutory +Stock Option Agreement between the Registrant and Mark A. Retzloff dated +September 1, 2004. +10.29**@ +Nonstatutory +Stock Option Agreement between the Registrant and Ronald R. Snyder dated +September 1, 2004. +10.30**@ +Nonstatutory +Stock Option Agreement between the Registrant and Brad L. Stoffer dated +September 1, 2004. +10.31**@ +Nonstatutory +Stock Option Agreement between the Registrant and George B. +Boedecker, Jr. dated January 4, 2005. +10.32**@ +Nonstatutory +Stock Option Agreement between the Registrant and Lyndon V. Hanson, III +dated January 4, 2005. +10.33**@ +Nonstatutory +Stock Option Agreement between the Registrant and Erik Rebich dated +January 4, 2005. +10.34**@ +Nonstatutory +Stock Option Agreement between the Registrant and Scott Seamans dated +January 4, 2005. +10.35**@ +Nonstatutory +Stock Option Agreement between the Registrant and Andy Reddyhoff dated +January 4, 2005. +10.36***@ +2006 +Executive Incentive Bonus Plan. +10.37****@ +Director +Compensation Plan. +10.38**** +Membership +Interest Purchase Agreement among Crocs, Inc. and the Members of +Jibbitz, LLC, dated September 29, 2006. +21†† +Subsidiaries +of the Registrant. +23†† +Consent +of Deloitte & Touche LLP. +31.1†† +Certification +of the Chief Executive Officer pursuant to Rule 13a-14(a) or +Rule 15d-14(a) of the Securities Exchange Act of 1934 as +adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2†† +Certification +of the Chief Financial Officer pursuant to Rule 13a-14(a) or +Rule 15d-14(a) of the Securities Exchange Act of 1934 as +adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +32†† +Certification +of the Chief Executive Officer and Chief Financial Officer pursuant to 18 +U.S.C. Section 1350 as adopted pursuant to Section 906 of the +Sarbanes-Oxley Act. +* Incorporated +herein by reference to Crocs, Inc.’s Registration Statement on Form S-1 +(File No. 333-127526). +** Incorporated +by reference to Crocs, Inc.’s Registration Statement on Form S-8, +filed on March 9, 2006 (File NO. 333-132312). +*** Incorporated +by reference to Crocs, Inc.’s Quarterly Report on Form 10-Q, +filed on August 14, 2006 (File No. 000-51754). +44 +**** Incorporated +by reference to Crocs, Inc.’s Quarterly Report on Form 10-Q, +filed on November 13, 2006 (File No. 000-51754). +@ Management +contract or compensatory plan or arrangement. +† The +Registrant has been granted confidential treatment with respect to portions of +these exhibits. +†† Filed herewith. +45 +SIGNATURES +Pursuant +to the requirements of Section 13 or 15(d) 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, as of April 2, 2007. +CROCS INC. +a Delaware Corporation +By: +/s/ RONALD R. SNYDER +Name: Ronald R. Snyder +Title: President and Chief +Executive Officer +Pursuant +to the requirements of the Securities Exchange Act of 1934, this report has +been signed below as of April 2, 2007 by the following persons on behalf +of the registrant and in the capacities indicated. +Signature +Title +/s/ RONALD +R. SNYDER +President and Chief +Executive Officer +Ronald +R. Snyder +(Principal +Executive Officer) +/s/ PETER +S. CASE +Senior Vice President of +Finance and Chief Financial Officer +Peter +S. Case +(Principal +Financial and Accounting Officer) +/s/ RAYMOND +D. CROGHAN +Raymond +D. Croghan +Director +/s/ RONALD +L. FRASCH +Ronald +L. Frasch +Director +Marie +Holman-Rao +Director +/s/ MICHAEL +E. MARKS +Michael +E. Marks +Director +/s/ RICHARD +L. SHARP +Richard +L. Sharp +Chairman +of the Board +/s/ THOMAS +J. SMACH +Thomas J. Smach +Director +46 +REPORT OF +INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We have audited the accompanying consolidated balance +sheets of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, +2006 and 2005, and the related consolidated statements of operations, +stockholders’ equity (deficit), and cash flows for each of the three years in +the period ended December 31, 2006. These financial statements are the +responsibility of the Company’s management. Our responsibility is to express an +opinion on these financial statements based on our audits. +We conducted our audits in accordance with the +standards of the Public Company Accounting Oversight Board (United States). +Those standards require that we plan and perform the audit to obtain reasonable +assurance about whether the financial statements are free of material +misstatement. The Company is not required to have, nor were we engaged to +perform, an audit of its internal control over financial reporting. Our audits +included consideration of internal control over financial reporting as a basis +for designing audit procedures that are appropriate in the circumstances, but +not for the purpose of expressing an opinion on the effectiveness of the Company’s +internal control over financial reporting. Accordingly, we express no such +opinion. An audit also includes examining, on a test basis, evidence supporting +the amounts and disclosures in the financial statements, assessing the +accounting principles used and significant estimates made by management, as +well as evaluating the overall financial statement presentation. We believe +that our audits provide a reasonable basis for our opinion. +In our opinion, such consolidated financial statements +present fairly, in all material respects, the financial position of Crocs, Inc. +and subsidiaries as of December 31, 2006 and 2005, and the results of +their operations and their cash flows for each of the three years in the period +ended December 31, 2006 in conformity with accounting principles generally +accepted in the United States of America. +As discussed in Note 2 to +the consolidated financial statements, the Company changed its method of +accounting for share-based payments on January 1, 2006 in accordance with +Statement of Financial Accounting Standard No. 123(R), Share-Based +Payments. +/s/ Deloitte & Touche LLP +Denver, Colorado +April 2, 2007 +F-1 +CROCS, INC. +CONSOLIDATED BALANCE SHEETS +(In thousands, except share and per share data) +December 31, +2006 +2005 +ASSETS +Current assets: +Cash and cash +equivalents +$ +42,656 +$ +4,787 +Restricted cash +2,890 +— +Short-term investments +22,325 +— +Accounts receivable, +less allowance for doubtful accounts of $1,690 and $566, respectively +65,588 +17,641 +Inventories +86,210 +28,494 +Deferred tax assets +3,690 +1,939 +Prepaid income tax +4,715 +— +Prepaid expenses and +other current assets +9,617 +3,492 +Total current assets +237,691 +56,353 +Property and +equipment—net +34,849 +14,765 +Goodwill +11,552 +336 +Intangible assets—net +12,210 +5,311 +Deferred tax assets—net +1,280 +1,084 +Other assets +1,875 +183 +Total Assets +$ +299,457 +$ +78,032 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +43,794 +$ +20,829 +Accrued expenses and +other current liabilities +31,109 +8,178 +Income taxes payable +12,465 +8,697 +Notes payable and +current installments of long-term debt +541 +8,601 +Total current +liabilities +87,909 +46,305 +Long-term debt, +less current installments of long-term debt +116 +3,422 +Deferred tax liabilities +1,688 +1,772 +Other liabilities +1,486 +319 +Total liabilities +91,199 +51,818 +Commitments and contingencies (Notes 3, 15, 16 and +23) +Redeemable common +shares, 8,410,320 shares issued and outstanding in 2005 (Note 19) +— +1,800 +Redeemable convertible +preferred shares, par value $0.001 per share; 8,000,000 shares authorized, +7,452,492 shares issued and outstanding in 2005—preference in liquidation of +$5,500 (Note 18) +— +5,500 +Stockholders’ equity: +Preferred stock, par +value $0.001 per share; 5,000,000 authorized, no shares issued or outstanding +in 2006 and 2005 +— +— +Common shares, par value +$0.001 per share; 125,000,000 and 42,000,000 shares authorized, 39,340,709 +and 17,449,699 shares issued and outstanding in 2006 and 2005 +39 +17 +Additional paid-in +capital +131,834 +13,976 +Deferred compensation +(5,702 +) +(12,364 +) +Retained earnings +81,081 +16,697 +Accumulated other +comprehensive income +1,006 +588 +Total stockholders’ +equity +208,258 +18,914 +Total Liabilities and Stockholders’ Equity +$ +299,457 +$ +78,032 +See notes to consolidated financial statements. +F-2 +CROCS, INC. +CONSOLIDATED STATEMENTS OF OPERATIONS +(In thousands, except share and per share data) +Year Ended December 31, +2006 +2005 +2004 +Revenues +$ +354,728 +$ +108,581 +$ +13,520 +Cost of sales +154,158 +47,773 +7,162 +Gross profit +200,570 +60,808 +6,358 +Selling, general +and administrative expense +105,224 +33,916 +7,929 +Income from +operations +95,346 +26,892 +(1,571 +) +Interest expense +567 +611 +47 +Other (income) +expense—net +(1,847 +) +(8 +) +19 +Income (loss) +before income taxes +96,626 +26,289 +(1,637 +) +Income tax +expense (benefit) +32,209 +9,317 +(143 +) +Net income (loss) +64,417 +16,972 +(1,494 +) +Dividends on +redeemable convertible preferred shares +33 +275 +142 +Net income (loss) +attributable to common stockholders +$ +64,384 +$ +16,697 +$ +(1,636 +) +Income (loss) per common +share: +Basic +$ +1.73 +$ +0.51 +$ +(0.07 +) +Diluted +$ +1.61 +$ +0.51 +$ +(0.07 +) +Weighted average common +shares: +Basic +37,229,200 +25,493,577 +24,641,953 +Diluted +40,085,256 +33,570,000 +24,641,953 +See notes to consolidated financial statements. +F-3 +CROCS, INC. +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) +(In thousands) +Members’ Interest +Common Stock +Additional +Paid in +Deferred +Retained +Earnings +(Accumulated +Accumulated +Other +Comprehensive +Total +Stockholders’ +Equity +Comprehensive +Income +Class A +Class B +Total +Shares +Amount +Capital +Compensation +Deficit) +Income +(Deficit) +(Loss) +BALANCE—December 31, +2003 +$ 394 +$ — +$ 394 +— +$ — +$ — +$ — +$ (2,036 +) +$ — +$ (1,642 +) +Members’ investments +— +525 +525 +— +— +— +— +— +— +525 +Repurchase of members’ +investment +— +(150 +) +(150 +) +— +— +— +— +— +— +(150 +) +Accrued distribution to +members +(380 +) +(2,620 +) +(3,000 +) +— +— +— +— +— +— +(3,000 +) +Deferred equity +compensation +— +2,686 +2,686 +— +— +— +(2,686 +) +— +— +— +Amortization of equity +compensation +— +1,464 +1,464 +— +— +— +328 +— +— +1,792 +Accrued preferred dividend +— +— +— +— +— +— +— +(142 +) +— +(142 +) +Net loss +— +— +— +— +— +— +— +(1,494 +) +— +(1,494 +) +$ (1,494 +) +Foreign currency +translation +— +— +— +— +— +— +— +— +520 +520 +520 +Total comprehensive loss +$ (974 +) +BALANCE—December 31, +2004 +$ 14 +$ 1,905 +$ 1,919 +— +$ — +$ — +$ (2,358 +) +$ (3,672 +) +$ 520 +$ (3,591 +) +Conversion to C corporation +(14 +) +(1,905 +) +(1,919 +) +16,746 +17 +(1,770 +) +— +3,672 +— +— +Deferred stock compensation +— +— +— +— +— +14,516 +(14,516 +) +— +— +— +Amortization of stock +compensation +— +— +— +— +— +320 +4,437 +— +— +4,757 +Forfeitures +— +— +— +— +— +(73 +) +73 +— +— +— +Excess tax benefit on +share-based compensation +— +— +— +703 +— +983 +— +— +— +983 +Accrued preferred dividend +— +— +— +— +— +— +— +(275 +) +— +(275 +) +Net income +— +— +— +— +— +— +— +16,972 +— +16,972 +$ 16,972 +Foreign currency +translation +— +— +— +— +— +— +— +— +68 +68 +68 +Total comprehensive income +$ 17,040 +BALANCE—December 31, +2005 +$ — +$ — +$ — +17,449 +$ 17 +$ 13,976 +$ (12,364 +) +$ 16,697 +$ 588 +$ 18,914 +Issuance of common stock in +connection with initial public offering, net of offering costs +— +— +— +4,950 +5 +94,450 +— +— +— +94,455 +Conversion of redeemable +convertible preferred shares to common shares +— +— +— +15,863 +16 +7,284 +— +— +— +7,300 +Adjustment for adoption of +SFAS 123R (note 5) +— +— +— +— +— +(1,442 +) +1,442 +— +— +— +Amortization of stock +compensation +— +— +— +— +— +6,233 +4,022 +— +— +10,255 +Exercises of stock options +and vesting of share-based awards +— +— +— +1,079 +1 +2,283 +— +— +— +2,284 +Forfeitures +— +— +— +— +— +(1,198 +) +1,198 +— +— +— +Excess tax benefit on share-based +compensation +— +— +— +— +— +10,248 +— +— +— +10,248 +Accrued preferred dividend +— +— +— +— +— +— +— +(33 +) +— +(33 +) +Net income +— +— +— +— +— +— +— +64,417 +— +64,417 +$ 64,417 +Foreign currency +translation +— +— +— +— +— +— +— +— +418 +418 +418 +Total comprehensive income +$ 64,835 +BALANCE—December 31, 2006 +$ — +$ — +$ — +39,341 +$ 39 +$ 131,834 +$ (5,702 +) +$ 81,081 +$ 1,006 +$ 208,258 +See notes to +consolidated financial statements. +F- 4 +CROCS, INC. +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2006 +2005 +2004 +Cash flows from operating +activities: +Net income (loss) +$ +64,417 +$ +16,972 +$ +(1,494 +) +Adjustments +to reconcile net income (loss) to net cash provided by operating activities: +Depreciation and amortization +8,053 +3,334 +700 +Loss (gain) on disposal of fixed assets +137 +(7 +) +— +Deferred tax benefit +(2,037 +) +(3,090 +) +(191 +) +Share based compensation +10,255 +4,757 +1,792 +Excess tax benefit on share-based compensation +(10,248 +) +983 +— +Changes +in operating assets and liabilities—net of effect of acquired businesses: +Accounts receivable +(43,983 +) +(14,700 +) +(1,101 +) +Inventories +(54,960 +) +(26,035 +) +(859 +) +Prepaid expenses and other assets +(13,049 +) +(3,472 +) +(287 +) +Accounts payable +19,959 +17,711 +1,499 +Accrued expenses and other liabilities +33,799 +14,049 +718 +Cash provided by operating activities +12,343 +10,502 +777 +Cash flows from investing +activities: +Purchases of short-term investments +(52,600 +) +— +— +Sales of short-term investments +30,275 +— +— +Cash paid for purchases of property and equipment +(23,828 +) +(11,531 +) +(1,551 +) +Proceeds from disposal of property and equipment +155 +— +— +Cash paid for intangible assets +(5,216 +) +— +— +Restricted cash +(2,890 +) +— +— +Acquisition of non-competition agreement +— +(636 +) +— +Acquisition of businesses, net of cash acquired +(15,399 +) +— +(5,166 +) +Cash used in investing activities +(69,503 +) +(12,167 +) +(6,717 +) +Cash flows from financing +activities: +Proceeds from note payable, net +1,808 +6,949 +314 +Proceeds from long-term debt +— +2,009 +853 +Payments on long-term debt +(14,072 +) +(158 +) +— +Proceeds from initial public offering, net of offering costs +94,454 +— +— +Distribution payment to members +— +(3,000 +) +— +Payment of preferred dividends +(171 +) +(275 +) +— +Excess tax benefit on share-based compensation +10,248 +— +— +Exercise of stock options +2,284 +— +— +Repurchase of members’ investments +— +— +(150 +) +Proceeds from equity issuances +— +— +6,025 +Payments on member loan +— +— +(400 +) +Cash provided by financing activities +94,551 +5,525 +6,642 +Effect of exchange rate changes on cash +478 +(127 +) +26 +Net increase in cash and cash equivalents +37,869 +3,733 +728 +Cash and cash equivalents—beginning of year +4,787 +1,054 +326 +Cash and cash equivalents—end of year +$ +42,656 +$ +4,787 +$ +1,054 +Supplemental disclosure of +cash flow information—cash paid during the year for: +Interest +$ +353 +$ +252 +$ +73 +Income taxes +$ +24,789 +$ +2,510 +$ +585 +Supplemental disclosure of +noncash, investing, and financing activities: +In +conjunction with the acquisitions made, liabilities were assumed as follows: +Fair value of assets acquired +$ +21,566 +$ +— +$ +9,936 +Cash paid for capital stock +15,399 +— +5,166 +Liabilities assumed +$ +6,167 +$ +— +$ +4,770 +Accrued purchase price related to EXO +2,890 +— +— +Accrued members’ distribution +$ +— +$ +— +$ +3,000 +Accrued preferred stock dividends +$ +— +$ +161 +$ +142 +Assets acquired under capitalized leases +$ +282 +$ +307 +$ +— +Accrued purchases of property and equipment +$ +1,011 +$ +836 +$ +— +See notes to consolidated financial statements. +F-5 +CROCS, INC. +NOTES +TO CONSOLIDATED FINANCIAL STATEMENTS +1. FORMATION +AND BUSINESS OF THE COMPANY +Crocs, Inc. and its subsidiaries (collectively, +the “Company”) are engaged in the design, development, and manufacturing of +consumer products from specialty resins. The Company was organized as a limited +liability company in Colorado in 1999 under the name of Western Brands, LLC. In +January 2005, the Company changed its name to Crocs, Inc. and +converted to a Colorado corporation. The Company reincorporated in Delaware in +June 2005. +The Company’s wholly owned subsidiary, Foam +Creations, Inc. (“Foam Creations”), formerly Finproject N.A. Inc., +located in Quebec, Canada, has designed, developed, and manufactured consumer +products from specialty resins since 1995. In 2000, Foam Creations completed +the formulation of, and began manufacturing, a footwear model made from the +proprietary closed-cell resin the Company currently uses in its footwear +product line, which it refers to as croslite . +In 2002, the Company established a business relationship with Foam Creations to +distribute footwear in the United States. In October 2002, the Company +modified and improved the design of this shoe and began marketing and +distributing it under the Crocs brand in the United States. In June 2004, +Crocs Inc. acquired Foam Creations, including its manufacturing +operations, product lines and rights to the trade secrets for croslite . +In October 2006, the Company acquired 55 Hockey +Products Inc., and EXO Italia as part of the Company’s effort to expand into +new markets and expand the Company’s internal design capabilities. 55 Hockey +Products, which operates under the brand name Fury Hockey, produces and +distributes hockey and lacrosse equipment for adults and children. EXO Italia, +headquartered in Padova, Italy, designs and develops EVA (Ethylene Vinyl +Acetate) based finished products, primarily for the footwear industry. Since +1993, EXO Italia has worked with several leading branded consumer companies to +produce high quality EVA based footwear for the global marketplace. +In December 2006, the +Company acquired Jibbitz, LLC (“Jibbitz”), a company that specializes in +accessories for Crocs footwear. Jibbitz now features over 900 different stock +keeping units, or SKUs, being sold through 4,000 retail accounts both in the US +and Europe. +2. SUMMARY +OF SIGNIFICANT ACCOUNTING POLICIES +Basis of Consolidation —The +consolidated financial statements include the accounts of Crocs, Inc. and +all of its subsidiaries. All intercompany transactions and balances are +eliminated in consolidation. The consolidated financial statements include the +accounts of the Company and all entities that are wholly-owned by the +Company, variable interest entities for which the Company is the primary +beneficiary, and entities that are not variable interest entities but are +voting-controlled subsidiaries or affiliates of the Company. +Variable Interest Entities —Under +Financial Accounting Standards Board (“FASB”) Interpretation No. 46 +(revised December 2003), Consolidation +of Variable Interest Entities (“FIN 46R”) , once an entity is +determined to be a variable interest entity, the party with the controlling +financial interest, the primary beneficiary, is required to consolidate it. In +connection with the acquisition of Foam Creations in 2004 the Company has an +interest in Les Plastiques Fintech Inc. (“Fintech”) in which the Company +is the primary beneficiary under FIN 46R. Fintech is a joint venture with the +President of Foam Creations, in which the Company holds a 50% interest. Fintech +carries out research and development for Crocs and produces the raw materials +for the Company’s products. At December 2006 and 2005, this entity was +consolidated and the effect on the Company’s financial statements is immaterial. +F-6 +Recognition of Revenues —Revenues +are recognized when products are shipped and the customer takes title and +assumes risk of loss, collection of related receivables is probable, persuasive +evidence of an arrangement exists, and the sales price is fixed or +determinable. Title passes on shipment or on receipt by the customer depending +on the country of the sale and the agreement with the customer. Allowances for +estimated returns and discounts are recognized as a reduction of the related revenue +when it is recorded. +Shipping and Handling Costs —Amounts +billed for shipping and handling costs are recorded as a component of revenues +and totaled $5.2 million, $2.5 million, and $678,000 for the years ended +December 31, 2006, 2005, and 2004, respectively. Related costs paid to +third party shipping companies are recorded in cost of sales and totaled $35.3 +million, $10.4 million, and $1.2 million for the years ended +December 31, 2006, 2005, and 2004, respectively. +Earnings per Share —Basic +earnings per common share (“EPS”) is computed by dividing the net income (loss) +available to common stockholders by the weighted average number of common +shares outstanding for the period. Diluted EPS reflects the potential dilution +from securities that could share in the earnings of the Company. Antidilutive +securities are excluded from diluted EPS. +In January 2005, in connection with the change +from a limited liability company to a corporation, the Company converted the +Class A and B units into common stock on a one for one basis. On +January 10, 2006, the Board of Directors approved a 233.62-for-1 +stock split of the Company’s common stock and preferred stock. All 2005 and +2004 share and per share amounts related to common stock, preferred stock and +stock options included in the accompanying financial statements and footnotes +have been restated to reflect the stock split. See Note 6 for further +discussion. +Cash and Cash Equivalents —Cash +and cash equivalents represent cash and short-term, highly liquid investments +with maturities of three months or less at date of purchase. The Company +considers receivables from credit card companies to be cash equivalents. The +carrying amounts reflected in the consolidated balance sheet for cash and cash +equivalents approximate fair value due to the short maturities. +Restricted Cash —Restricted +cash represents cash commitments for certain purchase obligations. The +classification of restricted cash on the consolidated balance sheet as current +or noncurrent is dependent on the duration of the restriction and the purpose for +which the restriction exists. +Investments —The +Company accounts for investments in accordance with FASB Statement of Financial +Accounting Standards (“SFAS”) No. 115, Accounting for Certain +Investments in Debt and Equity Securities (“SFAS 115”). The +Company invests in certain investments, which consist primarily of short to +intermediate-term fixed income securities issued by U.S. government agencies +and municipalities. The Company also invests in certain auction rate debt +securities that have been classified as short-term investments in the +accompanying balance sheets. All investments are classified as +available-for-sale and are reported at fair value with unrealized gains and +losses, net of tax, included in accumulated other comprehensive income as a separate +component of stockholders’ equity. The specific-identification method is used +to determine the cost of all investments and the basis by which amounts are +reclassified from accumulated other comprehensive income into earnings. There +were no unrealized gains or losses recorded during 2006. See Note 7 for +further discussion. +Inventories —Raw +materials and supplies are valued at the lower of cost, replacement cost, or +net realizable value. Work in process and finished goods are valued at the +lower of cost and net realizable value. Cost is determined on the first in, +first out basis. The cost of work in process and finished goods consists of the +cost of raw materials and an applicable share of the cost of labor and manufacturing +overhead. See Note 8 for further discussion. +Property and Equipment —Depreciation +of machinery and equipment is computed using the straight-line method based on +estimated useful lives ranging from 3 to 5 years. Leasehold improvements +are +F-7 +amortized on the +straight-line basis over their estimated economic useful lives or the lease +term, whichever is shorter. See Note 9 for further discussion. +Intangible Assets Finite-Lived —SFAS +No. 142, Goodwill and Other Intangible +Assets , (“SFAS 142”) requires that intangible assets with finite +lives be amortized over their estimated useful lives and reviewed for +impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of +Long-Lived Assets , (“SFAS 144”). The Company is currently amortizing +its acquired intangible assets with finite lives over periods ranging from five +to ten years. Intangible assets are comprised of capitalized software, core +technology, customer relationships, a non-competition agreement entered into in +connection with the acquisition of assets in Mexico, and capitalized costs +related to pending patents that the Company is pursuing related to its +technology. Patents are amortized on approval of the patent registration +application over their estimated useful lives. See Note 4 for further +discussion. +Capitalized Software —The +Company capitalizes certain internal and external software acquisition and +development costs that benefit future years in accordance with SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for +Internal Use . For software developed for internal use, the Company +expenses the costs of developing computer software until the software has +reached the application development stage and then capitalizes all costs +incurred from that time until the software has been installed at which time +amortization of the capitalized costs begins. Determination of when the +software has reached the application development stage is based on completion +of conceptual designs, evaluation of alternative designs and performance +requirements. Costs of major +enhancements to internal use software are capitalized while routine maintenance +of existing software is charged to expense as incurred. The determination of +when the software is in the application development stage and the ongoing +assessment of the recoverability of capitalized computer software development +costs requires considerable judgment by management with respect to certain +factors, including but not limited to, estimated economic life and changes in +software and hardware technology. The Company also contracts with third parties +to help develop or test internal use software and generally capitalizes these +costs. Internal-use capitalized software costs are amortized over their +expected useful life, which is generally five to seven years. +Goodwill —In +accordance with SFAS 142, goodwill represents the excess purchase price paid +over the fair value of assets acquired and liabilities assumed in the +acquisition of Foam Creations, Jibbitz, and other businesses. The Company +assesses goodwill for impairment annually on the last day of the fourth +quarter, or more frequently if events and circumstances indicate impairment may +have occurred. If the carrying value of goodwill exceeds its implied fair +value, the Company records an impairment loss equal to the difference. There +was no impairment of goodwill at December 31, 2006 or 2005. See Note 4 for +further discussion. +Impairment of Long-Lived Assets —In +accordance with SFAS 144, the Company estimates the future undiscounted cash +flows to be derived from an asset to assess whether or not a potential +impairment exists when events or circumstances indicate the carrying value of a +long-lived asset may be impaired. If the carrying value exceeds the estimate of +future undiscounted cash flows, the Company calculates the impairment as the +excess of the carrying value of the asset over the estimate of its fair value. +There were no impairments recorded during 2006 or 2005. +Research and Development —Research +and development costs are expensed as incurred. Research and development +expenses amounted to $1.8 million, $534,000, and $80,000 for the years ended +December 31, 2006, 2005, and 2004, respectively and are included in selling, +general, and administrative expenses. +Advertising —Advertising +costs are expensed as incurred and production costs are generally expensed when +the advertising is first run. Advertising expenses were $1.2 million, $545,000, +and $41,000 for the years ended December 31, 2006, 2005, and 2004, +respectively and are included in selling, general, and administrative expenses. +F-8 +Foreign Currency Translation and +Foreign Currency Transactions —The U.S. dollar is the +Company’s reporting currency. Assets and liabilities of foreign operations +denominated in local currencies are translated at the rate of exchange at the +balance sheet date. Revenues and expenses are translated at the weighted +average rate of exchange during the applicable period. Adjustments resulting from +translating foreign functional currency financial statements into U.S. dollars +are included in the foreign currency translation adjustment, a component of +accumulated other comprehensive income in stockholders’ equity. Gains and +losses generated by transactions denominated in a currency different from the +functional currency of the applicable entity are recorded in selling, general +and administrative expense in the period in which they occur. +Net realized losses on foreign currency transactions +were $747,000 for the year ended December 31, 2006 and were immaterial for +the years ended December 31, 2005 and 2004. Unrealized gains and losses +for foreign currency transactions were immaterial for the years ended +December 31, 2006, 2005 and 2004. +Derivative Foreign Currency +Contracts —Foam Creations, a wholly-owned subsidiary +of the Company, used derivative foreign exchange contracts to hedge the +variability in cash flows from the forecasted payment or receipt of currencies +other than the functional currency. The Company exited the contracts during +2006. These contracts were not designated as hedges under SFAS No. 133, Accounting for Derivative Instruments and Hedging +Activities (“SFAS 133”). The futures contracts were marked to market +and gains and losses were recognized in earnings. The mark to market value of +these contracts was not material for the years ended December 31, 2006, +2005 and 2004. The Company has no other derivative contracts as of +December 31, 2006 or 2005. +Fair Value of Financial +Instruments —The carrying value of financial instruments, +including cash equivalents, accounts receivable, accounts payable and accrued +liabilities, approximate fair value due to their short maturities. Based on borrowing +rates currently available to the Company, with similar terms, the carrying +values of the capital lease obligations approximate their fair values. The fair +values of the Company’s investments are determined using quoted market prices +for those securities. +Share-Based Compensation —The +Company issues restricted stock and stock option grants to employees and +non-employees with vesting schedules of varying lengths. Typically, these +grants range from immediate vesting to vesting periods of up to four years. +Effective January 1, 2006, the Company adopted SFAS No. 123R, Share-Based Payment (“SFAS 123R”), which establishes +accounting guidelines for share-based awards exchanged for employee services, +using the prospective method for option grants and restricted stock issued +prior to August 15, 2005, the date which the Company filed its initial +Registration Statement on Form S-1, and the modified prospective +method for option grants issued after August 15, 2005. The Company was +required to adopt the prospective method for grants prior to August 15, +2005 as the Company had elected to value employee grants using the minimum +value method under SFAS No. 123, Accounting for Stock-Based +Compensation (“SFAS 123”). For option grants and restricted +stock accounted for under the prospective method, the Company will continue to +account for the grants under the intrinsic value-based method prescribed by +Accounting Principles Board Opinion (“APB”) No. 25, Accounting +for Stock Issued to Employees (“APB 25”), and the related interpretations +in accounting for employee stock options. Therefore, the Company does not +record any compensation expense for stock options granted to employees, prior +to August 15, 2005, if the exercise price equaled the fair market value of +the stock option on the date of grant, and the exercise price, number of shares +eligible for issuance under the options and vesting periods were fixed. +Compensation expense is recognized over the vesting +term for employees and non-employees on a straight-line basis. Deferred +compensation represents the unvested portion of employee grants made prior to +August 15, 2005 and is recorded as a reduction of equity. The fair value +of employee grants is fixed at date of grant, or the measurement date, if +later, while grants to non-employees are remeasured to fair value at each +reporting period until vesting occurs. During 2004, the Company granted 549,007 +restricted +F-9 +units for which the +measurement date did not occur until April 27, 2005. Consequently, the +value of these grants were remeasured at each reporting period, based on the +fair value of the underlying stock, until such measurement date. The related +compensation expense is recognized over the vesting period. See Note 5 for +further discussion. +Income Taxes —The +Company accounts for income taxes using the asset and liability method. This +approach requires the recognition of deferred tax assets and liabilities for +the expected future tax consequences of temporary differences between the +carrying amounts and the tax bases of other assets and liabilities. The Company +provides for income taxes at the current and future enacted tax rates and laws +applicable in each taxing jurisdiction. Prior to the Company’s conversion to a +C corporation on January 4, 2005, the Company was not a taxpaying entity +for U.S. federal and state income tax purposes. See Note 14 for further +discussion. +Management Estimates —Management +of the Company has made certain estimates and assumptions relating to the +reporting of assets, liabilities, net sales and expenses and the disclosure of +contingent assets and liabilities to prepare these consolidated financial +statements in conformity with accounting principles generally accepted in the +United States of America. Significant areas requiring the use of management estimates +relate to the allowance for doubtful accounts, returns and discounts, +impairment assessments and charges, deferred taxes, stock-based +compensation expense, fair value of acquired intangibles, assessment of lower +of cost or market on inventory, and useful lives assigned to long-lived assets. +Actual results could differ from these estimates and the differences could be +material. +Concentration of Risk —The +Company’s cash and cash equivalents are maintained in several different +financial institutions in amounts that typically exceed federally insured +limits. The Company has not experienced any losses in such accounts and +believes it is not exposed to significant credit risk. +The Company considers its concentration risk related +to accounts receivable to be mitigated by the Company’s credit policy, the +significance of outstanding balances owed by each individual customer at any +point in time and the geographic dispersion of these customers. +The Company relies on both internal and external +manufacturers for its products. Establishing a replacement source for the +Company’s product offerings could require significant additional time and +expense. +Reclassifications —Certain +reclassifications have been made to the 2005 financial statements to conform to +2006 presentation. +Recent Accounting Pronouncements —In +June 2006, the Financial Accounting Standards Board (“FASB”) Emerging +Issues Task Force issued EITF No. 06-3, How Sales +Taxes Collected from Customers and Remitted to Governmental Authorities Should +Be Presented in the Income Statement (That Is, Gross Versus Net Presentation) +(“EITF No. 06-3”), which states a company must disclose its +accounting policy (i.e., gross or net presentation) regarding presentation of +taxes within the scope of this Issue. If taxes included in gross revenues are +significant, a company must disclose the amount of such taxes for each period +for which an income statement is presented. The Issue is effective for the +first annual or interim reporting period beginning after December 15, +2006. The disclosures are required for annual and interim financial statements +for each period for which an income statement is presented. The Company adopted +this Issue effective January 1, 2007. Based on the Company’s current +evaluation of this Issue, the Company does not expect the adoption of EITF +No. 06-3 to have a significant impact on its consolidated results of +operations or financial position. +In July 2006, the FASB issued Interpretation +No. 48, Accounting for Uncertainty in Income Taxe s +(“FIN 48”). FIN 48 requires the use of a two-step approach for recognizing and +measuring tax benefits taken or expected to be taken in a tax return and +disclosures regarding uncertainties in income tax positions. The Interpretation +is effective for fiscal years beginning after December 15, 2006. The +F-10 +cumulative effect of +initially adopting FIN 48 will be recorded as an adjustment to opening retained +earnings in the year of adoption and will be presented separately. Only tax +positions that meet the more likely than not recognition threshold at the +effective date may be recognized on adoption of FIN 48. The Company adopted FIN +48 on January 1, 2007, and is still in process of evaluating this +Interpretation. We expect that the requirements of FIN 48 may add volatility to +our effective tax rate and therefore our expected income tax expense in future +periods. +In September 2006, the FASB issued SFAS +No. 157, Fair Value Measurement (“SFAS +157”), which defines fair value, establishes a framework for measuring fair +value in accordance with generally accepted accounting principles, and expands +disclosures about fair value measurements. The Statement is effective for +financial statements issued for the first annual or interim reporting period +beginning after November 15, 2007. The Company will adopt SFAS 157 +effective January 1, 2008. The Company is currently evaluating the impact +this new standard will have on its future results of operations and financial +position. +On September 13, 2006, the SEC issued Staff +Accounting Bulletin No. 108 (“SAB 108”). SAB 108 provides interpretive +guidance on how the effects of the carryover or reversal of prior year +misstatements should be considered in quantifying a potential current year +misstatement. Prior to SAB 108, companies could evaluate the materiality of +financial statement misstatements using either the income statement or balance +sheet approach, with the income statement approach focusing on new misstatements +added in the current year, and the balance sheet approach focusing on the +cumulative amount of misstatement present in a company’s balance sheet. +Misstatements that would be material under one approach could be viewed as +immaterial under another approach, and not be corrected. SAB 108 now requires +companies to view financial statement misstatements as material if they are +material according to either the income statement or balance sheet approach. +The Bulletin is effective for annual financial statements covering the first +fiscal year ending after November 15, 2006. The Company adopted SAB 108 +for the fiscal year ending December 31, 2006. The adoption of SAB 108 did +not have a significant impact on the Company’s consolidated results of +operations or financial position. +In February 2007, the +FASB issued SFAS No. 159, The Fair Value Option for +Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 +permits entities to choose to measure many financial instruments and certain +other items at fair value. SFAS 159 will be effective at the beginning of +fiscal 2008. The Company is currently evaluating the impact this new standard +will have on its future results of operations and financial position. +3. ACQUISITIONS +On December 1, 2006, the Company acquired 100% of +the membership interests of Jibbitz, headquartered in Boulder, Colorado. +Jibbitz specializes in accessories for Crocs footwear. Jibbitz is a unique +accessory brand with colorful snap-on products specifically suited for Crocs +shoes. In September 2006, the Company entered into an endorsement +agreement with Jibbitz providing that the Company would publicly endorse the +products of Jibbitz and license to Jibbitz certain Company trademarks. Pursuant +to this agreement the Company allowed Jibbitz to access the Company’s network +of distribution and retailers as well as utilize the Company’s warehouse and +logistics infrastructure. The Company recorded $1.2 million of revenue +related to this agreement in the year ended December 31, 2006. +The aggregate purchase price for Jibbitz was $13.5 million, +which included $109,000 in costs related to the acquisition. The cash purchase +price is subject to adjustment based on the closing date balance sheet of +Jibbitz, which is scheduled to be finalized in the second quarter of 2007. The +membership interest purchase agreement also provides for potential earn-out +consideration for the former Jibbitz members of up to an additional $10 million +based on Jibbitz’s earnings before interest and taxes over the three years +following the closing of the acquisition. +F-11 +Under +business combination accounting, the total preliminary purchase price was +allocated to Jibbitz’s assets acquired and liabilities assumed based on their +estimated fair values as of December 1, 2006 as set forth below. Any +additional consideration paid in the future as part of the earn-out provisions +will be recorded as an increase in goodwill. The estimated fair values of +identifiable intangibles assets have been determined with the assistance of an +independent third-party valuation firm. Except for identified intangible +assets, assets and liabilities were valued at their respective carrying +amounts, as the Company’s management believes that these amounts approximate +their current fair values. The excess of the purchase price over the assets +acquired and liabilities assumed is recorded as goodwill. The following table +summarizes the estimated fair value of the assets acquired and liabilities +assumed at the date of acquisition (in thousands). +Assets +Current assets +$ +5,150 +Property and equipment +403 +Goodwill +8,164 +Intangible Assets +1,670 +Other Assets +14 +Total Assets +15,401 +Liabilities +Current liabilities +1,934 +Purchase Price +$ +13,467 +The intangible assets acquired include customer +relationships and the Jibbitz trade name. The customer relationships have an +estimated fair value of $1.5 million and the Jibbitz trade name has an +estimated fair value of $150,000. The Company has determined the customer +relationships will be amortized over its estimated useful life of four years +and the Jibbitz trade name has an indefinite life. The amortization of the +customer relationships is based on the projected income of continuing +customers. The preliminary amount assigned to goodwill was $8.2 million. The +Company expects all of the goodwill to be deductible for tax purposes. +The results of operations for Jibbitz have been +included in the consolidated financial statements since the date of its +acquisition. +In October 2006, the Company acquired 55 Hockey +Products Inc., and EXO Italia as part of the Company’s effort to expand into +new markets and expand the Company’s internal design capabilities. 55 Hockey +Products Inc., which operates under the brand name Fury Hockey, produces and +distributes hockey and lacrosse equipment for adults and children. EXO Italia, +headquartered in Padova, Italy, designs and develops EVA (Ethylene Vinyl +Acetate) based finished products, primarily for the footwear industry. Since +1993, EXO Italia has worked with several leading branded consumer companies to +produce high quality EVA based footwear for the global marketplace. The results +of operations for each of these companies have been included in the Company’s +consolidated financial statements since the dates of acquisition. +The aggregate purchase +price for the above acquisitions was $9.6 million in cash, which includes +$243,000 in costs related to the acquisitions. Goodwill recognized in those +transactions is $3.0 million, which is not deductible for tax purposes. +F-12 +Pro Forma Financial +Information +The following table +summarizes supplemental statement of operations information for the years ended +December 31, 2006 and 2005 on a pro forma basis as if all acquisitions had +occurred on January 1, 2006 and 2005. The pro forma financial information +is presented for informational purposes only and is not indicative of the +results of operations that would have been achieved if the acquisitions had +taken place at the beginning of each of the periods presented. +December 31, +2006 +2005 +(Unaudited) +(in thousands, except per +share data) +Net sales +$ +372,750 +$ +117,532 +Gross profit +211,112 +63,623 +Income from +operations +100,576 +27,368 +Net income +67,372 +17,304 +Net income per common +share: +Basic +$ +1.81 +$ +0.52 +Diluted +$ +1.68 +$ +0.52 +4. GOODWILL +AND INTANGIBLE ASSETS +The +following table summarizes the Company’s identifiable intangible assets as of December 31, +2006 and 2005 (in thousands): +2006 +2005 +Gross +Carrying +Amount +Accumulated +Amortization +Net Carrying +Amount +Gross +Carrying +Amount +Accumulated +Amortization +Net Carrying +Amount +Finite lived assets: +Patents +$ +1,441 +$ +12 +$ +1,429 +$ +604 +$ +— +$ +604 +Customer relationships +3,547 +657 +2,889 +1,569 +336 +1,233 +Core technology +4,154 +2,082 +2,073 +4,154 +1,248 +2,906 +Non-competition agreement +636 +212 +424 +636 +86 +550 +Capitalized software +5,516 +274 +5,242 +18 +— +18 +Total finite +lived assets +$ +15,294 +$ +3,237 +$ +12,057 +$ +6,981 +$ +1,670 +$ +5,311 +Indefinite lived +intangible assets: +Jibbitz trade name +$ +153 +— +$ +153 +— +— +— +Total intangible assets +$ +15,447 +$ +3,237 +$ +12,210 +$ +6,981 +$ +1,670 +$ +5,311 +Certain software held under a capital lease in the +amount of $642,000 at December 31, 2006 is classified as capitalized +software and amortized using the straight-line method over the lease term. +Amortization of capitalized software under capitalized leases is included in +amortization expense. +Intangible +assets that are determined to have finite lives are amortized over their useful +lives on a straight-line basis. Amortization expense of intangible assets with finite +lives, which is included in selling, general and administrative expense, was +$1.6 million, $1.1 million and $488,000 for the years ended December 31, +2006, 2005 and 2004, respectively. For amortizable intangible assets +denominated in a foreign currency, the Company translates the ending asset and +accumulated amortization at the balance sheet rate and records amortization +expense using the weighted average rate of exchange for the applicable period, +a difference between the recorded amortization expense and the change in +accumulated amortization exists. The Company has determined that the Jibbitz +trade name has an indefinite useful life +F-13 +and should not be amortized. Estimated future annual +amortization of intangible assets is as follows (in thousands): +Fiscal years ending December 31, +Amortization +2007 +$ +3,309 +2008 +2,515 +2009 +2,271 +2010 +1,069 +2011 +1,018 +Thereafter +1,875 +Total +$ +12,057 +The +following table summarizes the activity in the Company’s goodwill account +during the years ended December 31, 2006 and 2005 (in thousands): +Balance at +January 1, 2005 +$ +326 +Foreign currency +translation adjustments +10 +Balance at +December 31, 2005 +336 +Jibbitz acquisition +8,164 +Other +acquisitions +3,052 +Balance at +December 31, 2006 +$ +11,552 +5. EQUITY +In January 2005, in connection with the change +from a limited liability company to a corporation, the Company converted the Class A +and B units into common stock on a one for one basis. On January 10, 2006, +the Board of Directors approved a 233.62-for-1 stock split of the +Company’s common stock and preferred stock. All 2005 and 2004 share and per +share amounts related to common stock, preferred stock and stock options +included in the accompanying financial statements and footnotes have been +restated to reflect the stock split. +On February 13, 2006, +the Company issued 4,950,000 shares of common stock on the closing of its +initial public offering for $94.5 million, net of underwriting discounts and +commissions and related offering costs of $2.5 million. In connection with +the completion of the offering, the Company’s redeemable common and preferred +shares were converted to common shares and those balances were reclassified to +permanent equity. +Share-Based Compensation +Under the modified prospective method, compensation +expense recognized in the year ended December 31, 2006, includes: (i) compensation +expense of all share-based payments granted after August 15, 2005 but not +yet vested as of January 1, 2006, based on the grant-date fair value +estimated in accordance with the provisions of SFAS 123R and (ii) compensation +expense for all share-based payments granted subsequent to January 1, +2006, based on the grant date fair value estimated in accordance with the +provisions of SFAS 123R. Results for prior periods have not been +retrospectively adjusted. The Company records compensation expense related to +non-employees under the provisions of SFAS 123R and Emerging Issues Task Force +EITF 96-18, Accounting for Equity Instruments that are Issued to +Other than Employees for Acquiring, or in conjunction with Selling, Goods or +Services (“EITF 96-18”), and recognizes compensation expense over +the vesting periods of such awards. Total pre-tax share-based compensation +expense recognized was $10.3 million, $4.8 million, and $1.8 million for the +years ended December 31, 2006, 2005, and 2004 with associated tax benefits +of approximately $3.8 million, and $1.8 +F-14 +million and zero, +respectively. The cumulative effect of applying the modified prospective method +was to reduce deferred compensation by $1.4 million and the effect on the +statement of operations was immaterial. The effect of applying SFAS 123R was to +reduce pre-tax income by $5.4 million for the year ended December 31, +2006. +SFAS 123R also required the Company to change the +classification, in its consolidated statement of cash flows, of any excess tax +benefits realized on the exercise of stock options or issuance of restricted +stock unit awards in excess of that which is associated with the expense +recognized for financial reporting purposes. These amounts are presented as a +financing cash inflow rather than as a reduction of income taxes paid in the +consolidated statement of cash flows. +The +Company has computed the fair value of options granted using the Black-Scholes +option pricing model. In order to calculate the fair value of the options, +certain assumptions are made regarding components of the model, including +risk-free interest rate, volatility, expected dividend yield rate, and expected +option life. Changes to the assumptions could cause significant adjustments to +the valuation. For options granted before August 15, 2005, expected +volatility was not considered for employee grants as the Company was a +non-public entity at the grant date of these options. For stock option grants +issued after the filing of the Company’s initial Registration Statement on Form S-1 +on August 15, 2005, the minimum value method is no longer used and the +Company used a volatility rate of 50% and began to include estimated forfeiture +rates. The Company estimated the volatility of its common stock at the date of +grant based on the historical volatility of comparable companies. The Company +factored in expected retention rates combined with vesting periods to determine +the average expected life. The risk-free interest rate for periods within the +contractual life of the options is based on the U.S. Treasury yield curve in +effect at the time of each grant. Accordingly, the Company has computed the +fair values of all options granted during the year ended December 31, 2006 +and in 2005 subsequent to August 15, using the Black-Scholes option +pricing model and the following weighted average assumptions: +2006 +2005 +Expected +volatility +50 +% +50 +% +Dividend yield +— +— +Risk-free +interest rate +4.71 +% +3.97 +% +Expected life (in years) +5 +5 +Because the Company applied the minimum value method +of valuing employee stock options prior to becoming a public company, as +allowed by SFAS 123, the Company is precluded from presenting pro forma +historical statement of operations information under SFAS 123R. +The fair value of the +equity units granted in 2004 was originally estimated by the Company’s board of +directors based on information available to them on the dates of grant, +including third party sales of these units. The Company did not obtain +contemporaneous valuations by valuation specialists because, at the time of the +issuances of stock options in 2004, the Company’s efforts were focused on +acquiring new customers, developing its operational infrastructure and +executing its business plan. The Company engaged an independent third party +valuation specialist to perform a retrospective valuation of common stock at December 31, +2004. Additionally, the Company engaged a third party valuation specialist to +perform retrospective valuations of common stock at May 1, 2005, June 30, +2005, August 1, 2005, September 1, 2005 and October 1, 2005. At December 31, +2005 the Company used the initial public offering price of $21.00 for the +valuation of common stock. +F-15 +Stock Option Activity +The +following summarizes stock option transactions for the year ended December 31, +2006: +Options +Shares +Weighted +Average +Exercise +Price +Weighted Average +Remaining +Contractual Life +(Years) +Aggregate +Intrinsic Value +(in thousands) +Outstanding at +December 31, 2005 +2,923,754 +$ +5.60 +7.6 +Granted +2,563,814 +26.50 +Exercised +(446,955 +) +5.11 +Forfeited or +expired +(497,895 +) +8.10 +Outstanding at +December 31, 2006 +4,542,718 +$ +15.91 +7.9 +$ +124,002 +Exercisable at +December 31, 2006 +3,575,173 +$ +15.03 +8.2 +$ +100,702 +Vested at +December 31, 2006 +757,205 +$ +2.83 +5.8 +$ +30,569 +Vested and expected to +vest at December 31, 2006 +4,203,852 +$ +15.51 +7.9 +$ +116,407 +Options awarded under the Company’s 2005 Equity +Incentive Plan (the “Plan”) prior to September 30, 2006 are exercisable +immediately on the date of grant with the exception of 233,624 shares granted +to members of the Board of Directors. In order to preserve the vesting +provisions of the immediately exercisable options, the options that are +exercised early are subject to a repurchase right by the Company at the lower +of exercise price or fair market value of the underlying stock at the date of +repurchase. This repurchase right expires on vesting of the underlying option. +Total immediately exercisable stock options outstanding under the Plan were 3,023,734 +at December 31, 2006 of which 558,949 are fully vested and no longer +subject to the repurchase right. Options awarded after October 1, 2006 are +exercisable as they vest. +The weighted average fair value of options granted +during the year ended December 31, 2006 and the period August 15, +2005 through December 31, 2005, was approximately $12.97 and $7.40 +respectively. +The aggregate intrinsic value of all options exercised +during 2006 was $15.2 million. No options were exercised in 2005 or 2004. Cash +received and the income tax benefit from stock option exercises for fiscal year +2006 were $2.3 million and $4.3 million, respectively. The total grant date +fair value of stock options vested during 2006 and 2005 was $8.5 million, $1.4 +million, respectively. No options vested during 2004. +The +status of total stock options outstanding at December 31, 2006 was as +follows: +Options Outstanding +Options Exercisable +Exercise Prices +Number of +Shares +Weighted +Average Remaining +Contractual Life +(Years) +Weighted +Average +Exercise +Price +Number +Exercisable +Weighted +Average +Exercise Price +Fair Value +Determination +$1.02 +759,264 +4.7 +$ +1.02 +438,035 +$ +1.02 +Black-Scholes +$1.70-5.69 +1,055,121 +7.5 +3.86 +933,773 +4.14 +Black-Scholes +$7.15-10.74 +281,265 +7.7 +8.28 +215,556 +8.25 +Black-Scholes +$21.00 +1,182,609 +9.1 +21.00 +1,182,609 +21.00 +Black-Scholes +$26.00-29.95 +892,809 +9.3 +28.40 +805,200 +28.34 +Black-Scholes +$33.97-43.25 +371,650 +8.9 +40.06 +— +— +Black-Scholes +4,542,718 +7.9 +$ +15.91 +3,575,173 +$ +15.03 +As of December 31, +2006, the Company issued unvested options to purchase 3.8 million shares of the +Company’s common stock with a weighted average grant date fair value of $11.34. +As of December 31, 2006, the Company had $35.9 million of total +unrecognized share-based compensation expense related to +F-16 +unvested options, net of expected forfeitures, which +is expected to be amortized over the weighted average period of 3.0 years. +Non-vested Stock Awards +The +following summarizes restricted stock transactions for the year ended December 31, +2006: +Non-vested +Shares +Weighted +Average Grant +Date Fair Value +Outstanding at +December 31, 2005 +1,072,431 +$ +2.75 +Granted +— +— +Vested +(631,333 +) +2.33 +Forfeited or +expired +— +— +Outstanding at +December 31, 2006 +441,098 +$ +3.36 +At December 31, 2006, +the Company had $1.0 million and $70,000 of total unrecognized share-based +compensation expense related to non-vested stock awards for employees and +non-employees, respectively. The non-vested stock awards are expected to be +amortized over the weighted average period of 0.7 years. +F-17 +6. EARNINGS PER SHARE +In April 2005, +the Company amended its articles of incorporation to allow the holders of its +redeemable preferred stock to participate in dividends paid on the Company’s +common stock. Under the amended articles, if the Company were to pay a dividend +on any share of common stock, the Company must pay a dividend on all +outstanding shares of its redeemable preferred stock on an as if converted +basis in a per share amount equal to the amount paid on each share of common +stock. In accordance with Emerging Issues Task Force No. 03-6, “Participating +Securities and the Two Class Method Under SFAS 128,” the Company has +presented basic and diluted earnings per share for common shares using the two +class method for the year ended December 31, 2005 (in thousands, except +share and per share data). For purposes of computing income (loss) per common +share, the Company has reflected the conversion of the membership interests +into units, and the subsequent conversion of units into shares of the Company’s +stock. +December 31, +2006 +2005 +2004 +(in thousands, except share and per share data) +Reconciliation of net income +(loss) attributable to common stockholders for basic computation: +Net income attributable to common stockholders +$ +64,384 +$ +16,697 +$ +(1,636 +) +Less: Undistributed net income allocated to +redeemable convertible preferred stockholders +— +(3,736 +) +— +Undistributed net income allocated to common +stockholders +$ +64,384 +$ +12,961 +$ +(1,636 +) +Reconciliation +of net income (loss) for dilutive computation: +Net income (loss) attributable to common +stockholders +$ +64,384 +$ +16,697 +$ +(1,636 +) +Preferred dividend +33 +275 +142 +Net income (loss) for dilutive computation +$ +64,417 +$ +16,972 +$ +(1,494 +) +Basic +income (loss) per common share: +Weighted average common shares outstanding +37,299,200 +25,493,577 +24,641,953 +Basic income (loss) per common share +$ +1.73 +$ +0.51 +$ +(0.07 +) +Diluted +income (loss) per common share: +Weighted average common shares outstanding +37,299,200 +25,493,577 +24,641,953 +Dilutive effect of preferred stock +796,326 +7,452,492 +— +Dilutive effect of stock options +1,499,078 +220,034 +— +Dilutive effect of unvested stock +490,652 +403,897 +— +Weighted average diluted common shares outstanding +40,085,256 +33,570,000 +24,641,953 +Diluted income +(loss) per common share +$ +1.61 +$ +0.51 +$ +(0.07 +) +F-18 +The +effect of assumed conversion of the Class C preferred units was +antidilutive in 2004. Stock options, preferred stock and restricted units that +are antidilutive due to the Company’s net loss for the year ended +December 31, 2004 were excluded from the diluted (loss) per common share +computation. For the year ended December 31, 2006 there were options +outstanding to purchase 654,350 shares of the Company’s common stock with a +weighted-average exercise price per share of $33.53, which could potentially +dilute basic earnings per share in the future, but which were not included in +diluted earnings per share as their effect was antidilutive. There were no +antidilutive securities in the year ended December 31, 2005. The following +table summarizes the antidilutive securities: +December 31, +2006 +2005 +2004 +Antidilutive effect: +Preferred stock +— +— +3,879,372 +Stock options +654,350 +— +— +Unvested stock +— +— +686,761 +654,350 +— +4,566,133 +7. SHORT-TERM +INVESTMENTS +At December 31, 2006, the Company’s short-term +investments consisted exclusively of auction rate securities. The Company did +not hold any short-term investments at December 31, 2005. Auction rate +securities are variable rate bonds of States and joint municipal agencies tied +to short-term interest rates with maturities on the face of the underlying +securities in excess of 90 days. Auction rate securities have interest rate +resets through a modified Dutch auction, at pre-determined short-term +intervals, usually every 7, 28, or 35 days. They trade at par and are callable +at par on any interest payment date at the option of the issuer. Interest paid +during a given period is based on the interest rate determined during the prior +auction. The Company records such securities as short-term investments based on +the short-term nature and structure, the frequency with which the interest rate +resets, and the ability to sell auction rate securities at par and at the +Company’s discretion with the intent of meeting the Company’s short-term +working capital requirements. +Investments in auction +rate securities are classified as available-for-sale and are reported at fair +value in the Company’s consolidated balance sheets. There were no unrealized +gains or losses as of December 31, 2006. The following table summarizes +the contractual maturities of available-for-sale securities at December 31, +2006 (in thousands). +December 31, +2006 +Within one year +$ +— +After one year +through five years +— +After five years +through ten years +— +After ten years +22,325 +$ +22,325 +Proceeds from sales of +short-term investments totaled $30.3 million in the year ended December 31, +2006. There were no realized gains or losses related to the sales of short-term +investments in the year ended December 31, 2006. +8. INVENTORIES +Inventories by major +classification are as follows (in thousands): +F-19 +December 31, +2006 +2005 +Finished goods +$ +78,938 +$ +25,449 +Work-in-progress +445 +6 +Raw materials +6,827 +3,039 +$ +86,210 +$ +28,494 +9. PROPERTY +AND EQUIPMENT +Property and equipment +includes the following (in thousands): +December 31, +2006 +2005 +Machinery and +equipment +$ +40,195 +$ +16,790 +Leasehold +improvements +3,529 +664 +Subtotal +43,724 +17,454 +Less accumulated +depreciation and amortization +(8,875 +) +(2,689 +) +$ +34,849 +$ +14,765 +Depreciation expense of +$6.2 million, $2.0 million and $211,000 was recorded for the years ended December 31, +2006, 2005 and 2004, respectively. As the Company translates the ending fixed +assets and accumulated depreciation at the balance sheet rate and records +depreciation expense using the weighted average rate of exchange for the +applicable period, a difference between the recorded depreciation expense and +the change in accumulated depreciation exists. Certain equipment held under +capital leases in the amounts of $322,000 and $307,000 at December 31, +2006 and 2005, respectively, are classified as equipment and amortized using +the straight-line method over the lease term. Amortization of assets under +capitalized leases is included in depreciation expense. +10. ACCRUED +EXPENSES AND OTHER LIABILITIES +Accrued +expenses and other liabilities include the following (in thousands): +December 31, +2006 +2005 +Accrued +compensation and benefits +$ +9,724 +$ +1,936 +Professional +services +2,866 +2,110 +Fulfillment and +freight +4,374 +1,695 +Sales/Use tax +payable +2,300 +307 +Accrued purchase +price related to EXO +2,890 +— +Preferred +dividends +— +161 +Other +8,955 +1,969 +$ +31,109 +$ +8,178 +11. NOTES +PAYABLE +Notes Payable include the +following (in thousands): +December 31, +2006 +2005 +Westland note +payable +$ +122 +$ +— +Foam Creations +demand note payable +— +2,016 +Revolving credit +facility +— +5,941 +$ +122 +$ +7,957 +F-20 +Jibbitz, a wholly owned subsidiary, holds a demand +note payable to Westland Development Services for $122,000 bearing interest at +a rate of 7.5%. The note is for construction costs for leasehold improvements +to its headquarters building. +Foam Creations, a wholly owned subsidiary, holds a +demand note payable to a bank in the amount of up to $2.1 million, bearing +interest at base rate plus 0.50%. No amounts were outstanding on this loan as +of December 31, 2006. Foam Creations also has an authorized credit line of +$300,000 for currency exchanges. No amounts were outstanding on this line as of +December 31, 2006. The demand note is secured by the accounts receivable +and inventories associated with Foam Creations. Annually, in April, the note is +required to be renewed by the bank. Under the terms of the demand note, Foam +Creations must satisfy certain restrictive covenants as to minimum financial +ratios. Foam Creations was in compliance with these covenants as of December 31, +2006. +In April 2005, Crocs, Inc. entered into a +$5.0 million secured revolving credit facility. In October 2005, the +Company amended and restated the existing credit facility increasing the amount +available under the original facility to $20.0 million. The total amount +available at any time was subject to a borrowing base calculation based on +various percentage of accounts receivable, inventory and fixed assets. The +revolving credit facility bore interest at floating rates based on the higher +of the lender’s prime rate plus 1.0% or the Federal Funds rate plus 1.5%. The +revolving credit facility was secured by all of the Company’s assets and was +scheduled to terminate on October 26, 2008. Debt issue costs incurred in +connection with the issuance of the revolving credit facility were included in +other non-current assets and were amortized over the term of the related +agreements on the interest method. The funds were drawn primarily to fund +accrued members’ distributions, to purchase manufacturing operations in Mexico, +and to make inventory purchases. +In January 2006, in connection with the +preparation of a compliance certificate for the secured revolving credit +facility entered into in October 2005, the Company determined it was not +in compliance with certain covenants including its monthly EBITDA and capital +expenditure financial covenants. On January 18, 2006, the Company received +a waiver of all non-compliance with its covenants under this revolving credit +facility. +In February 2006, the +Company terminated the credit facility and repaid all amounts borrowed against +its $20 million revolving credit facility and is no longer able to borrow +against the facility. The repayment was funded with proceeds from the Company’s +initial public offering. +12. LONG-TERM +DEBT +Long-term +debt consists of the following (in thousands): +December 31, +2006 +2005 +Loan from +Development Bank of Canada +$ +— +$ +2,433 +Loan from +National Bank of Canada for the purchase of fixed assets +— +796 +Loan from +National Bank of Canada +— +530 +Capital lease +obligations for equipment due on various dates through 2009 with interest +rates ranging from 4.25% to 8.97% per annum +218 +307 +Capital lease +obligations for capitalized software due on December 1, 2007 with an +effective interest rate of 6.75% per annum +317 +— +535 +4,066 +Less current +portion +419 +644 +Total long-term debt +116 +$ +3,422 +F-21 +In March 2006, the Company repaid the loan from +the Development Bank of Canada and loans from the National Bank of Canada. +These repayments were funded with proceeds from the Company’s initial public +offering. At September 30, 2006, the Company had an additional loan from +the National Bank of Canada that was scheduled to mature in May 2011, +which the Company repaid in October 2006. +See note 16 for maturities +of capital lease obligations. +13. ALLOWANCES +The +changes in the Company’s allowance for doubtful accounts and reserve for sales +returns and allowances for the years ended December 31, 2006, 2005 and +2004, are as follows (in thousands): +Balance at +Beginning +of Year +Charged to costs +and expenses +Deductions and +write-offs +Balance at +End +of Year +Year ended +December 31, 2004: +Allowance for +doubtful accounts +$ +24 +$ +193 +$ +58 +$ +159 +Reserve for sales +returns and allowances +— +46 +— +46 +Year ended +December 31, 2005: +Allowance for doubtful accounts +159 +594 +187 +566 +Reserve for sales returns and allowances +46 +2,977 +2,461 +562 +Year ended +December 31, 2006: +Allowance for doubtful accounts +566 +1,719 +595 +1,690 +Reserve for sales +returns and allowances +562 +3,266 +1,014 +2,814 +14. INCOME +TAXES +Prior +to the Company’s conversion to a C corporation in January 2005, the Company +was treated as a partnership for U.S. federal and state income tax purposes. +Under U.S. tax law, partnerships are treated as flow-through entities and are +not subject to direct taxation. The provision for income taxes consisted of the +following (in thousands): +December 31, +2006 +2005 +2004 +Current—U.S. +federal +$ +20,196 +$ +10,223 +$ +— +Current—U.S. +state +1,009 +1,451 +— +Current—foreign +13,041 +733 +48 +Total current +income taxes +34,246 +12,407 +48 +Deferred—U.S. +federal +(1,741 +) +(2,779 +) +— +Deferred—U.S. +state +(8 +) +(244 +) +— +Deferred—foreign +(288 +) +(67 +) +(191 +) +Total deferred +income taxes +(2,037 +) +(3,090 +) +(191 +) +Total income tax +expense (benefit) +$ +32,209 +$ +9,317 +$ +(143 +) +Pre-tax income +(loss) U.S. +52,429 +25,138 +(1,337 +) +Pre-tax income (loss) +foreign +44,197 +1,151 +(300 +) +F-22 +The +Company’s income tax payable (receivable) balances are as follows as of +December 31, 2006 (in thousands): +December 31, +December 31, +2006 +2005 +Federal income +tax payable +$ +— +$ +7,266 +Federal prepaid income +tax +(3,747 +) +— +State income tax +payable +351 +1,126 +State prepaid income +tax +(968 +) +— +Foreign income +tax payable +12,114 +305 +$ +7,750 +$ +8,697 +On October 22, 2004, the American Jobs Creation +Act was signed into law. This Act created a temporary incentive for U.S. multinational +corporations to repatriate accumulated income earned outside the U.S. by +providing an 85% dividend received deduction for certain dividends from +controlled foreign corporations. The Company elected not to repatriate any +earnings under the Act. The Company has indefinitely reinvested approximately +$32.4 million of the cumulative undistributed earnings of its foreign +subsidiaries. Such earnings would be subject to U.S. taxation if repatriated to +the U.S. +Reconciliations +of the statutory federal income tax rate to the Company’s actual rates based on +income or loss before income tax are summarized as follows: +December 31, +2006 +2005 +2004 +Consolidated pre +tax book income +35.0 +% +35.0 +% +35.0 +% +State taxes +1.1 +2.8 +— +Deferred tax +benefit from conversion to C Corporation +— +(3.0 +) +— +Foreign rate +differential +(2.8 +) +(0.3 +) +(0.1 +) +Partnership +income not subject to tax +— +— +(26.2 +) +Other +— +0.9 +— +33.3 +% +35.4 +% +8.7 +% +The Company’s deferred +income tax assets and liabilities are as follows (in thousands): +December 31, +2006 +2005 +Current deferred tax +assets: +Accrued expenses +$ +1,487 +$ +747 +Inventory +2,206 +1,192 +Total current +deferred tax assets +$ +3,693 +$ +1,939 +Long-term deferred +tax assets: +Stock compensation expense +$ +2,643 +1,367 +Other +311 +121 +Total non-current +deferred tax assets +$ +2,954 +$ +1,488 +Long-term deferred +tax liabilities: +Property and equipment +$ +2,343 +$ +856 +Intangible assets +995 +1,320 +Other +27 +— +Total non-current +deferred tax liabilities +$ +3,365 +$ +2,176 +F-23 +Deferred tax liabilities arise from temporary +differences in the remaining depreciable basis of assets for financial and tax +reporting purposes. The purchase of Foam Creations, Inc. gave rise to +adjustments to the asset values on allocation of the purchase price for +financial reporting purposes. These adjustments are not recorded for income tax +reporting purposes. As a result, the Company will record greater depreciation +and amortization on the acquired assets for financial reporting purposes than +it will for tax reporting purposes and consequently has recorded a deferred tax +liability for purchase price adjustments of $1.5 million. During the years +ended December 31, 2006 and 2005, $10.3 million and $983,000 +respectively were recorded as additional paid-in capital related to the excess +tax benefit of stock-based compensation, respectively. +On January 3, 2005, +the Company converted from a limited liability company to a C corporation. For +tax years beginning and subsequent to January 1, 2005, the Company is +subject to corporate-level U.S. federal and state income taxes. The +Company recognized an income tax benefit of $797,000 in 2005 related to the net +deferred tax assets of the partnership existing as of December 31, 2004. +15. COMMITMENTS +AND CONTINGENCIES +The Company leases space for certain of its offices, +warehouses, vehicles and equipment under leases expiring at various dates +through 2026. Certain leases also contain rent escalation clauses (step rents) +that require additional rental amounts in the later years of the term. Rent +expense for leases with step rents is recognized on a straight-line basis over +the minimum lease term. Certain leases also contain escalation clauses based on +an existing rate, such as the consumer price index. These items are factored +into the minimum lease payment and recognized on a straight-line basis over the +minimum lease term. Deferred rent is included in the balance sheet in accrued +expenses. Rent expense was $8.3 million, $1.9 million, and $208,000 for +the years ended December 31, 2006, 2005, and 2004, respectively. +Minimum +future annual rental commitments under non-cancelable operating leases for each +of the five succeeding years as of December 31, 2006, are as follows (in +thousands): +Fiscal years ending December 31, +2007 +$ +6,380 +2008 +6,207 +2009 +5,866 +2010 +4,891 +2011 +4,318 +Thereafter +1,360 +Total +$ +29,022 +On September 17, 2004, the Company entered into a +manufacturing supply agreement with MDI Products, LLC (“MDI”), a Florida +limited liability company under which the Company agreed to purchase 15,000 +pairs of shoes per month for 36 months to maintain exclusivity. The pricing +will be agreed on every twelve months. Termination fees apply for losses +incurred by MDI for premature termination by the Company. +On July 26, 2005, the Company entered into an +amended and restated four year supply agreement with Finproject S.P.A., the +former majority owner of Foam Creations, where the Company has the exclusive +right to purchase the material for the manufacture of finished shoe products, +except for certain current customer dealings (including boot manufacturers). +Based on the supply agreement, the Company has contractual purchase +requirements to maintain exclusivity throughout the agreement. The pricing is +to be agreed on each quarter and fluctuates based on order volume, currency +fluctuations, and raw material prices. +F-24 +The Company indemnifies certain of its vendors and its +directors and executive officers for specified claims. To date, the Company has +not paid or been required to defend any indemnification claims, and +accordingly, has not accrued any amounts for its indemnification obligations. +The Company guarantees the +payment of its third party manufacturer in China for purchases of material for +the manufacture of finished shoe products. The maximum potential amount of +future payments the Company could be required to make under the guarantee is € 2.1 +million (approximately $2.8 million). The Company evaluates the estimated +loss for the guarantee under SFAS No. 5, Accounting +for Contingencies (“SFAS 5”), as interpreted by FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, +Including Indirect Guarantees of Indebtedness of Others (“FIN 45”). +The Company considers such factors as the degree of probability of an +unfavorable outcome and the ability to make a reasonable estimate of the amount +of loss. The Company has recourse as a matter of common law. To date, the +Company has not made any payments under the guarantee and as of December 31, +2006, has not recorded a liability related to the guarantee in its financial +statements as the Company does not believe the potential obligation under this +guarantee is material. +16. CAPITALIZED +LEASE OBLIGATIONS +The Company had capitalized lease obligations for +equipment due on various dates through 2009 of $535,000 as of December 31, +2006. The interest rates range from 4.25% to 8.97% per annum. These lease +obligations are collateralized by the related assets with a net book value of +$815,000 as of December 31, 2006. +Maturities +of capital lease obligations as of December 31, 2006, are as follows (in +thousands): +2007 +$ +519 +2008 +111 +2009 +9 +Total minimum lease payments +$ +639 +Less—amount +related to interest +104 +Principal portion +of future obligations +535 +Less—current +portion +419 +$ +116 +The +following table summarizes the assets recorded in intangible assets (Note 4) +and property and equipment (Note 9) that are recorded as capital leases +(in thousands): +December 31, +Classes of property +2006 +2005 +Capitalized +software +$ +642 +$ +— +Equipment +322 +307 +Less accumulated +amortization/depreciation +(149 +) +— +$ +815 +$ +307 +F-25 +17. RELATED +PARTIES +The +Company entered into the following related party transactions (in thousands): +December 31, +2006 +2005 +2004 +Flextronics: +Rent Expense +$ +159 +$ +91 +$ +— +Crocs Hawaii (owned by a +former director): +Period-end accounts receivable balance due to +the Company +— +— +117 +Sales +— +250 +142 +In May 2005, the Company subleased an office +building from Flextronics USA, Inc. Two of our directors, Messrs. Marks +and Sharp, also serve as directors of Flextronics and Messrs. Smach serves +as the Chief Financial Officer. The Company paid Flextronics $159,000 and +$91,000 for lease payments for the years ended December 31, 2006 and 2005, +respectively. This lease expired on March 31, 2007. The Company paid +$40,000 in lease payments in 2007. +The Company executed a separation agreement with its +former chief executive officer and director on January 1, 2005. The terms +of the arrangement were agreed to by the Company and the former chief executive +officer as of December 31, 2004, consequently, the Company has recorded +the present value of the severance and health insurance continuation in the +2004 financial statements. The total amount recorded was $606,000, which has +been reflected in selling, general and administrative expenses. The amount +recorded has been discounted over the future payment terms at 6%. The +corresponding liability is recorded in other current and non-current +liabilities, for amounts due in 2007 and beyond, and accrued expenses and other +liabilities for amounts due in 2006. +In connection with the +separation agreement discussed above, the Company and former chief executive +officer entered into an exclusive distribution agreement that commenced July 1, +2005. The distribution agreement is for specified territories in Central +America and has an initial term of two years. The agreement provides for +renewal periods at the former chief executive officer’s option, if specified +sales volumes are attained. Pricing under this agreement is set at a discount +off the Company’s then current wholesale pricing. Additionally, effective July 1, +2005, the Company and the former chief executive officer entered into an +agreement providing him the right to license and/or franchise airport kiosks +selling the Company’s products for a period of 10 years, subject to the +Company’s right to terminate the agreement if specified numbers of kiosks are +not opened in timeframes specified. +18. REDEEMABLE +CONVERTIBLE PREFERRED SHARES +In June 2004, the Company issued 7,452,492 Class C +Redeemable Preferred Membership Units (“Class C Units”) in the aggregate +amount of $5.5 million. The proceeds were used to fund the acquisition of +Foam Creations. Holders of Class C Units were entitled to receive out of +the net profits of the Company, a dividend at the rate of five percent (5%) per +annum on their initial investment payable semi-annually on the first day of June and +December of each year beginning December 1, 2004; the dividends were +cumulative and payable before any dividend or distribution is set apart or paid +to common stockholders. +In January 2005, in connection with the change +from a limited liability company to a corporation, the Company redesignated the +Class C Units as Series A Redeemable Preferred Shares (“Series A +Shares”). Although there were no redesignation features on the original Class C +Units, the redesignation was on a one for one basis and the rights and +privileges were substantially the same for the old and new securities, except +as follows. The redemption feature of the Series A Shares consisted of the +right of the holder, commencing on July 1, 2009, to put any unconverted Series A +Shares to the Company for the original +F-26 +issuance amount plus all +accumulated and unpaid dividends. The redesignation had no impact on the +Company’s accounting for this issuance. In April 2005, the Series A +Shares were amended to participate in dividends with common stock and in February 2006 +converted to common stock in connection with the Company’s initial public +offering. +The Series A Shares had a preference in +liquidation equal to the amount of the initial investment, $5.5 million +plus all accumulated and unpaid dividends. The shares were convertible at any +time at the option of the holder for common shares on a one for one basis and +were automatically converted to common stock in February 2006 on the +Company’s initial public offering. +Because the Series A +Shares included a redemption feature that was outside of the control of the +Company, the Company classified the Series A Shares outside of +stockholders’ equity in accordance with Emerging Issues Task Force (“EITF”) +Topic D-98, “Classification and Measurement of Redeemable Securities.” In +accordance with EITF Topic D-98, the fair value at date of issuance, +$5.5 million was recorded outside of stockholders’ equity in the +accompanying balance sheet. Dividends on the Series A Shares are reflected +as a reduction of net income (loss) attributable to common stockholders. +19. REDEEMABLE +COMMON SHARES +In May 2003, the +Company granted certain holders of its Class B Units the right to put the +units back to the Company commencing in the second quarter of 2006. Under the +terms of the agreements, the purchase price was the greater of the holder’s +original investment or the holder’s then current percentage ownership of the +Company multiplied by the aggregate of the prior three fiscal years’ net +income. At December 31, 2005, a total of 8,410,320 shares were subject to +this put right. In accordance with EITF Topic D-98, the Company +reclassified the estimated fair value of these units, $1.8 million, +outside of stockholders’ equity as of the date of the agreements. In connection +with the reclassification, there was a deficit of the carrying value of Class B +units in the amount of $391,000 which was recorded in accumulated deficit. In February 2006, +in connection with the initial public offering of the Company’s common stock, +this put right expired and these shares were converted to common stock on a one +for one basis and classified in stockholders’ equity. +20. OPERATING +SEGMENTS AND RELATED INFORMATION +The Company operates in the consumer products industry +in which the Company designs, manufactures, markets and distributes footwear, +apparel and accessories. Operating results are assessed on an aggregate basis +to make decisions about necessary resources and in assessing performance. +Consequently, under the provisions of SFAS No. 131, Disclosure About +Segments of an Enterprise and Related Information (“SFAS 131”), and based on +the nature of the financial information that is received by the chief executive +officer as chief operating decision maker, the Company has one reportable +segment for financial statement purposes. +The +Company’s sales by product line are as follows (in thousands): +December 31, +2006 +2005 +2004 +Shoes +$ +342,437 +$ +102,490 +$ +10,909 +Other +12,291 +6,091 +2,611 +$ +354,728 +$ +108,581 +$ +13,520 +Geographic information about the United States and +international territories is presented below, the Company has allocated +revenues to the geographic locations based on the location of the customer (in +thousands): +F-27 +December 31, +Revenue +2006 +2005 +2004 +United States +$ +242,227 +$ +100,475 +$ +13,520 +Canada +21,779 +2,214 +— +Mexico +1,499 +79 +— +North America Total +265,505 +102,768 +13,520 +Asia +54,382 +4,671 +— +Europe +30,286 +1,042 +— +All other +4,555 +100 +— +$ +354,728 +$ +108,581 +$ +13,520 +Total for countries +outside the United States +$ +112,501 +$ +8,106 +— +December 31, +Long-lived assets +2006 +2005 +United States +$ +36,146 +$ +8,504 +Canada +13,636 +10,892 +Mexico +1,204 +832 +North America Total +50,986 +20,228 +Asia +3,132 +164 +Europe +4,494 +20 +$ +58,612 +$ +20,412 +Total for countries +outside the United States +$ +22,466 +$ +11,908 +Revenues from one customer +totaled approximately 12% of consolidated revenues during the year ended December 31, +2005. There were no customers who represented 10% or more of consolidated +revenues during the years ended December 31, 2006 and 2004. +21. LEGAL +PROCEEDINGS +In January 2005, Crocs’ direct subsidiary Foam +Creations filed a lawsuit against Holey Soles Holdings Ltd. (“Holey Soles”) in +the Federal Court of Canada, Trial Division (at Toronto, Ontario). The +complaint alleges trademark and copyright infringement relating to the design +of some of Crocs’ shoe models. Crocs is seeking a permanent injunction with +respect to any further acts of infringement on its intellectual property, as +well as damages and attorneys’ fees. This action is still pending. +In August 2005, Holey Soles filed a lawsuit +against Crocs in the United States District Court for the Southern District of +New York. Holey Soles seeks a declaratory judgment that Crocs does not have any +valid copyright or trade dress rights with respect to the design of its +footwear. In addition, Holey Soles seeks a declaratory judgment that the +manufacture, sale and distribution of its footwear products does not constitute +unfair competition and does not infringe on Crocs’ copyrights or trade dress +rights. On Crocs’ motion, the action has been transferred to the United States +District of Colorado where it has been stayed pending the outcome of The +International Trade Commission (“ITC”) Investigation No. 337-TA-567 +discussed below. The Company does not expect the ultimate resolution of this +matter will have a material adverse impact on its business. +On March 31, 2006, Crocs filed a complaint with +the ITC against Acme Ex-Im, Inc., Australia Unlimited, Inc., Cheng’s +Enterprises, Inc., Collective Licensing International, LLC, D. Myers & +Sons, Inc., Double Diamond Distribution, Ltd., Effervescent, Inc., +Gen-X Sports, Inc., Holey Soles Holdings, Ltd., Inter-Pacific Trading +Corporation, and Shaka Holdings, Inc., alleging patent and trade dress +infringement and seeking an exclusion order banning the importation and sale of +infringing products. The utility and design patents asserted in the complaint +were issued to Crocs, Inc. on February 7, 2006 and March 28, +2006 +F-28 +respectively, by the +United States Patent and Trademark Office. The ITC has issued final +determinations terminating Shaka Holdings, Inc., Inter-Pacific Trading +Corporation, Acme Ex-Im, Inc., D. Myers & Sons, and Australia +Unlimited, Inc. from the ITC investigation No. 337-TA-567 +on the basis of settlement and Cheng’s Enterprises, Inc. on the suspension +of accused activities. The ITC Administrative Law Judge (“ALJ”) issued an +Initial Determination of non-infringement related to one of the patents +at issue. Crocs filed a petition with the Commission to review this +determination. The Commission granted Crocs’s petition and on February 15, +2007, after briefing by the parties, the Commission vacated the ALJ’s +determination of non-infringement with respect to the remaining respondents and +remanded it to the ALJ for further proceedings consistent with the Commission’s +order. On February 22, 2007, the ALJ issued an order scheduling an +administrative trial on all issues, which had previously been postponed, for January 14, +2008. On March 1, 2007, the Company petitioned the Commission to review +the ALJ’s scheduling order and set an earlier trial date. +On April 3, 2006, Crocs filed a complaint in the +U.S. District Court for the District of Colorado alleging patent and trade +dress infringement and seeking injunctive relief against Acme EX-IM, Inc., +Australia Unlimited, Inc., Cheng’s Enterprises, Inc., Collective +Licensing International, LLC, D. Myers & Sons, Inc., Double +Diamond Distribution, Ltd., Effervescent, Inc., Gen-X Sports, Inc., +Holey Soles Holdings, Ltd., Inter-Pacific Trading Corporation, Shaka Holdings, Inc., +and Does 1-10 the utility and design patents asserted in the complaint +were issued to Crocs, Inc. on February 7, 2006 and March 28, 2006 +respectively, by the United States Patent and Trademark Office. Consent +judgments have been entered against Shaka Holdings, Inc., Interpacific +Trading Corporation and Acme Ex-Im, Inc. Crocs has entered into settlement +agreements with Australia Unlimited, Inc., and on January 25, 2007 filed +a stipulation for dismissal of all claims and counterclaims. Crocs has entered +into settlement agreement with D. Myers & Sons, Inc. and plans to +file a consent judgment with the court related to D. Myers & Sons, Inc. +The Company does not expect the ultimate resolution of this matter will have a +material adverse impact on its business. +On January 29, 2007, +Crocs filed an action in Colorado District Court, Boulder County, alleging +breach of contract by Australia Unlimited. Crocs alleges Australia Unlimited +breached the settlement agreement from the prior litigation by introducing a +new shoe design not approved by Crocs. Crocs obtained a temporary restraining +order enjoining Australia Unlimited sale of the new shoe; however, Crocs’ +motion for preliminary injunction was denied. Australia Unlimited removed the +case to federal court, Case No. 07CV00221, and alleged a counterclaim for +breach of contract and that it is entitled to recover damages for the time +that the temporary restraining order was in effect. +Although the Company is +subject to other litigation from time to time in the ordinary course of its +business, the Company is not party to any other pending legal proceedings that +the Company believes will have a material adverse impact on its business. +F-29 +22. UNAUDITED +QUARTERLY FINANCIAL INFORMATION +Quarter Ended +March 31,(a) +Quarter Ended +June 30, +Quarter Ended +September 30, +Quarter Ended +December 31, +Year Ended December 31, +2006 +Revenues +$ +44,844 +$ +85,635 +$ +111,345 +$ +112,904 +Gross profit +23,681 +46,970 +64,824 +65,095 +Income from +operations +9,992 +23,658 +31,480 +30,216 +Net income +6,440 +15,666 +21,526 +20,785 +Net +income attributable to common stockholders +6,407 +15,666 +21,526 +20,785 +Basic income per +common share +$ +0.19 +$ +0.41 +$ +0.56 +$ +0.53 +Diluted income +per common share +$ +0.17 +$ +0.39 +$ +0.53 +$ +0.51 +Year +Ended December 31, 2005 +Revenues +$ +10,958 +$ +25,769 +$ +38,294 +$ +33,560 +Gross profit +6,839 +13,969 +22,181 +17,819 +Income from +operations +2,166 +5,417 +12,347 +6,962 +Net income +2,040 +3,350 +7,411 +4,171 +Net income attributable to common stockholders +1,972 +3,282 +7,341 +4,102 +Basic income per +common share +$ +0.08 +$ +0.13 +$ +0.22 +$ +0.12 +Diluted income per +common share +$ +0.06 +$ +0.10 +$ +0.22 +$ +0.12 +(a) On +January 4, 2005, the Company converted from a limited liability company to +a taxable corporation. For the tax years beginning on January 1, 2005 +and afterward, the Company is subject to corporate-level U.S. federal and +state income taxes. Additionally, the statement of operations for the +three months ended March 31, 2005 reflects a one-time income tax +benefit of $797,000 to record the net deferred tax assets at the date of +conversion. +23. SUBSEQUENT +EVENTS +On January 31, 2007, the Company acquired substantially +all of the assets of Ocean Minded, LLC for $1.75 million in cash, plus a +potential earn-out of up to $3.75 million based on Ocean Minded hitting certain +earnings targets over a three year period. Ocean Minded is a designer and manufacturer +of high quality leather and EVA based sandals primarily for the beach, +adventure and action sports markets. Ocean Minded utilizes recycled and +recyclable materials whenever possible and is well known in the action sports +industry as a leading advocate for environmental awareness and responsibility. +Ocean Minded’s sandals target primarily young men and women who seek high +quality fashion sandals with an emphasis on style and comfort. +F-30 \ No newline at end of file diff --git a/raw/filings/0001334036/2006/0001104659-07-025001/filing_metadata.csv b/raw/filings/0001334036/2006/0001104659-07-025001/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..1f014fcf0757d8a105b2a422eca2b286f6076e72 --- /dev/null +++ b/raw/filings/0001334036/2006/0001104659-07-025001/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2007-04-02,2006-12-31,2007-04-02T21:28:31.000Z,0001104659-07-025001,a07-7262_110k.htm,10-K,2103274,0,0,https://www.sec.gov/Archives/edgar/data/1334036/000110465907025001/a07-7262_110k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000110465907025001/,2006,2006,1 diff --git a/raw/filings/0001334036/2006/0001104659-07-025001/item1.txt b/raw/filings/0001334036/2006/0001104659-07-025001/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..77881c98e71fdf5ada7ada5b7fa323a750de4b5f --- /dev/null +++ b/raw/filings/0001334036/2006/0001104659-07-025001/item1.txt @@ -0,0 +1,8 @@ +Item 1. +Business +2 +Item +1A. +Risk +Factors +11 \ No newline at end of file diff --git a/raw/filings/0001334036/2006/0001104659-07-025001/item13.txt b/raw/filings/0001334036/2006/0001104659-07-025001/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..ccd7ddf4b51d9570470f531b6e52e931c6da3a55 --- /dev/null +++ b/raw/filings/0001334036/2006/0001104659-07-025001/item13.txt @@ -0,0 +1,6 @@ +ITEM 13. Certain +Relationships and Related Transactions, and Director Independence +The information required +by this item is incorporated by reference in our definitive proxy statement for +the 2007 Annual Meeting of Stockholders to be filed with the SEC within 120 +days after the end of the fiscal year ended December 31, 2006. \ No newline at end of file diff --git a/raw/filings/0001334036/2006/0001104659-07-025001/item9a.txt b/raw/filings/0001334036/2006/0001104659-07-025001/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..93723d8c68a035e57ef345dfccfadb82d1e102f2 --- /dev/null +++ b/raw/filings/0001334036/2006/0001104659-07-025001/item9a.txt @@ -0,0 +1,38 @@ +ITEM 9A. Controls +and Procedures +Our management has evaluated, under the supervision +and with the participation of our Chief Executive Officer and Chief Financial +Officer, the effectiveness of our disclosure controls and procedures as of the +end of the period covered by this report pursuant to Rule 13a-15(b) under +the Securities Exchange Act of 1934. Based on that evaluation, our Chief +Executive Officer and Chief Financial Officer have concluded that, as of December 31, +2006, our disclosure controls and procedures are effective in ensuring that +information required to be disclosed in our Exchange Act reports is (1) recorded, +processed, summarized and reported in a timely manner, and (2) accumulated +and communicated to our +40 +management, including our +Chief Executive Officer and Chief Financial Officer, as appropriate to allow +timely decisions regarding required disclosure. +We are currently undergoing a comprehensive effort in +preparation for compliance with Section 404 of the Sarbanes-Oxley Act of +2002. This effort includes the documentation, testing and review of our +internal controls under the direction of senior management. During the course +of these activities, we have identified certain opportunities to improve our +internal control. As a result, we are evaluating and implementing improvements +to our internal control over financial reporting and will continue to do so. +These improvements include further formalization of accounting standards and +guidelines, improved segregation of duties, hiring additional competent +accounting managers and staff, and improving information technology system +controls. Any further opportunities to improve our internal controls identified +by our continued compliance efforts will be addressed accordingly. +During the fiscal year and +three months ended December 31, 2006, we made changes to our internal +control over financial reporting that have materially affected, or are +reasonably likely to materially affect, our internal control over financial +reporting. On April 1, 2006, we implemented a new accounting and +operational software package for our U.S. operations and on October 1, +2006, we implemented the new accounting and operational software package for +our Asia operations. Certain processes and controls were changed to accommodate +the needs and requirements of our growth and the new financial reporting +system. \ No newline at end of file diff --git a/raw/filings/0001334036/2006/0001104659-07-025001/rp_note.txt b/raw/filings/0001334036/2006/0001104659-07-025001/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2006/0001104659-07-025001/rpt_disclosure.txt b/raw/filings/0001334036/2006/0001104659-07-025001/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..004d4236fc99796be7af721a84b6d74daf115db5 --- /dev/null +++ b/raw/filings/0001334036/2006/0001104659-07-025001/rpt_disclosure.txt @@ -0,0 +1,29 @@ +Transactions with Related Persons +Our audit committee has adopted a written policy which +requires that any transaction involving us in which one of our directors, +nominees for director, executive officers, or greater than five percent +stockholders, or their immediate family members, have a material interest be +approved or ratified by the audit committee if the amount involved exceeds +$100,000. The full board of directors reviews ordinary course of business +transactions in which directors have an interest as part of the board’s annual +director independence review. In determining whether to approve or ratify any +such transaction, the audit committee must consider, in addition to other +factors it deems appropriate, whether the transaction is on terms no less +favorable to us than those involving unrelated parties. +All transactions disclosed +above were reviewed and approved or ratified in accordance with +this policy. +Director and +Officer Indemnification +We have entered into +agreements to indemnify our directors and executive officers, in addition to +the indemnification provided for in our certificate of incorporation and +bylaws. These agreements, among other things, provide for indemnification of +our directors and executive officers for certain expenses (including attorneys’ +fees), judgments, fines and settlement amounts incurred by any such person in +any action or proceeding, including any action by or in the right of our +company, arising out of such person’s services as a director or executive +officer of ours, any subsidiary of ours or any other company or enterprise to +which the person provided services at our request. We believe that these +provisions and agreements are necessary to attract and retain qualified persons +as directors and executive officers. \ No newline at end of file diff --git a/raw/filings/0001334036/2008/0001047469-09-002818/filing.txt b/raw/filings/0001334036/2008/0001047469-09-002818/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..cbf13a2eb8274af00ae43a67f2a0f91979ea82ab --- /dev/null +++ b/raw/filings/0001334036/2008/0001047469-09-002818/filing.txt @@ -0,0 +1,5881 @@ +10-K +1 +a2190961z10-k.htm +10-K +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2008 +or +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission File No. 0-51754 +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware +20-2164234 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +6328 Monarch Park Place +Niwot, Colorado 80503 +(303) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant's of principal executive office) +Securities +registered pursuant to Section 12(b) of the Act: +Title of each class: +Name of each exchange on which registered: +Common Stock, par value $0.001 per share +The NASDAQ Global Select Market +Securities +registered pursuant to Section 12(g) of the Act: +None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Act. Yes o No ý +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 ý No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be +contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to +the Form 10-K. o . +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting +company. See the definitions of "large accelerated filer", "accelerated filer", "non-accelerated filer", and "smaller reporting company" in Rule 12b-2 of the Exchange +Act. +Large accelerated filer ý +Accelerated filer o +Non-accelerated filer o +Smaller Reporting Company o +Indicate +by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the Exchange +Act). Yes o No ý +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2008 was approximately +$578,519,126. For the purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 5% of the registrant's common stock are assumed to be +affiliates of the registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The +number of shares of the registrant's common stock outstanding as of January 31, 2009 was 83,019,495. +DOCUMENTS INCORPORATED BY REFERENCE +Part III +incorporates certain information by reference from the registrant's proxy statement for the 2009 annual meeting of stockholders to be filed no later than 120 days +after the end of the registrant's fiscal year ended December 31, 2008. +Table of Contents +Crocs, Inc. +2008 Annual Report on Form 10-K +Table of Contents +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +13 +Item 1B. +Unresolved Staff Comments +27 +Item 2. +Properties +28 +Item 3. +Legal Proceedings +28 +Item 4. +Submission of Matters to a Vote of Security Holders +30 +PART II +Item 5. +Market for the Registrant's Common Equity and Related Stockholder Matters +31 +Item 6. +Selected Financial Data +33 +Item 7. +Management's Discussion and Analysis of Financial Condition and Results of +Operations +34 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +57 +Item 8. +Financial Statements and Supplementary Data +58 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial +Disclosure +58 +Item 9A. +Controls and Procedures +58 +Item 9B. +Other Information +61 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +61 +Item 11. +Executive Compensation +61 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related +Stockholder Matters +61 +Item 13. +Certain Relationships and Related Transactions, and Director +Independence +62 +Item 14. +Principal Accounting Fees and Services +62 +PART IV +Item 15. +Exhibits, Financial Statement Schedules +62 +Signatures +67 +Table of Contents +FORWARD-LOOKING INFORMATION +Throughout this report, references to the "Company," "we," "us" and "our" refer to Crocs, Inc. and its consolidated +subsidiaries, unless the context indicates otherwise. +Statements +in this Form 10-K and in documents incorporated by reference (or otherwise made by us or on our behalf) contain "forward looking statements" within the +meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications from time to time that contain such statements. Forward looking +statements include statements as to industry trends and our future expectations and other matters that do not relate strictly to historical facts and are based on certain assumptions of our +management. These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue," and similar expressions or +variations. These statements are based on the beliefs and assumptions of our management based on information currently available to us. Such forward looking statements are subject to risks, +uncertainties and other factors that could cause actual results to differ materially from future results expressed or implied by such forward looking statements. Important factors that could cause +actual results to differ materially from the forward looking statements include, without limitation, the following risk factors: +• macroeconomic issues, including, but not limited to, the current global financial crisis; +• our ability to obtain adequate financing; +• our significant recent expansion; +• our ability to effectively manage our future growth or declines in revenue; +• changing fashion trends; +• our defense and the ultimate outcome of a pending class action lawsuit; +• our ability to accurately anticipate and respond to seasonal or quarterly fluctuations in demand for our products; +• our management and information systems infrastructure; +• our ability to obtain and protect intellectual property rights; +• our reliance on third party manufacturing and logistics providers for the production and distribution of products; +• our reliance on a single source supply for certain raw materials; +• inherent risks associated with the manufacture, distribution and sale of our products overseas; +• our ability to develop and sell new products; +• our limited operating history; +• our ability to accurately forecast consumer demand for our products; +• our ability to maintain effective internal controls; +• our ability to attract, assimilate and retain management talent; +• our ability to respond to further adverse changes in the retail environment; +• our ability to effectively market and maintain a positive brand image; +• the effect of competition in our industry; and +• the effect of potential adverse currency exchange rate fluctuations. +1 +Table of Contents +We +caution the reader to carefully consider all such factors, including those described in Item 1A. "Risk Factors". Furthermore, such forward looking statements speak only as of +the date of this report. We undertake no obligation to update any forward looking statements to reflect events or circumstances after the date of such statements. +PART I +ITEM I. Business +Overview +We are a designer, manufacturer, distributor, worldwide marketer and brand manager of footwear for men, women, and children. We aspire +to be the global leader in molded footwear design and development. Crocs shoes combine fun colors and innovative design and we manufacture a product offering that provides new and exciting molded +footwear products that feature fun, comfort and functionality. We design and sell a broad offering of footwear, apparel, gear and accessories that utilize our proprietary closed +cell-resin, called Croslite. Croslite is a unique material that enables us to produce an innovative, soft, lightweight, non-marking, slip and odor-resistant shoe. +Shoes made with Croslite have been certified by US Ergonomics to reduce peak pressure on the foot, reduce muscular fatigue while standing and walking and to relieve the musculoskeletal system. +Since +the initial introduction and popularity of our Beach and Cayman models, we have expanded our Croslite products to include a variety of new styles and products and have extended our +product reach through the acquisitions of new brand platforms such as Jibbitz, LLC ("Jibbitz") and Ocean Minded, LLC ("Ocean Minded"). We intend to continue branching out into other +types of footwear, bringing a unique and original perspective to the consumer in styles that may be unexpected from Crocs. All of our products are designed to allow the product to be defined by +comfort, fun, and function. In part, we believe this will help us to continue to build a stable year-round business as we look to offer more winter-oriented styles. +Our +marketing approach is also becoming significantly more focused on a defined target consumer. All marketing efforts are integrated around specific product launches and the majority of +our marketing efforts moving forward will be focused on our retail partners, ensuring that our presentation and story are first class and drive purchasing at point of sale. +We +currently sell our Crocs-branded products throughout the U.S. and in 128 countries. We sell our products through domestic and international retailers and distributors and directly to +end-user consumers through our webstores, Company-operated retail stores, outlets and kiosks. The broad appeal of our footwear has allowed us to market our products to a wide range of +distribution channels, including department stores and traditional footwear retailers as well as a variety of specialty channels. +Our History +We were organized as a limited liability company in 1999 and began marketing and distributing footwear products in the U.S. under the +Crocs brand in 2002, shortly after completing our first footwear design produced by Crocs Canada Inc. ("Crocs Canada"), formerly known as Foam Creations Inc., and Finproject +N.A., Inc. The unique characteristics of Croslite, developed by Crocs Canada, enabled us to offer consumers an innovative shoe unlike any other footwear model then available. Initially, we +targeted our products to water sports enthusiasts, but the comfort and functionality of our products appealed to a more diverse group of consumers who used our footwear for a wide range of activities. +To capitalize on the broad appeal of our footwear, we expanded our sales infrastructure, strengthened our senior management team, and developed relationships with a range of retailers in the U.S. In +June 2004, we acquired Crocs Canada, including its manufacturing operations, product lines, and rights to the trade secrets for Croslite. We converted to a Colorado corporation in +2 +Table of Contents +January +2005 and reincorporated in Delaware in June 2005. Beginning in June 2004, we significantly expanded all aspects of our operations in order to take advantage of what we believed was an +attractive market opportunity. +From +2002 until 2007, our business grew tremendously, both organically and through acquisitions that we believe leveraged our business model. +In +2006, we added: +• Jibbitz, which produces unique charms specifically suited to fit into Crocs shoes; +• Fury Hockey Inc., formerly 55 Hockey Products Inc. ("Fury"), which produces and distributes hockey, soccer +and lacrosse equipment manufactured with Croslite. In June 2008, the Company decided to liquidate Fury after efforts to sell the entity were unsuccessful; and +• EXO Italia, which designs and develops EVA (Ethylene Vinyl Acetate) based finished products, primarily for the footwear +industry. +In +2007, we added: +• Ocean Minded, which produces sandals primarily for the beach, action and adventure market; +• Bite, LLC ("Bite"), a manufacturer of performance shoes and sports sandals sold worldwide in five categories, +including, golf, adventure, healthy lifestyle, travel and water sports; and +• YOU by Crocs™, a women's fashion line that combines the comfort of Croslite with fashionable styles. +In +2008, we added: +• Tagger International B.V. ("Tagger"), a manufacturer of messenger bags. +Recent Events +From our inception through the year ended December 31, 2007, we experienced rapid revenue growth and had difficulty meeting +demand for our footwear products. During this period, we significantly increased production capacity, warehouse space and inventory in an effort to meet demand. This pattern changed in 2008. Our +revenue growth moderated in the three month period ended March 31, 2008. This trend continued and accelerated throughout 2008. Our total revenues declined from $847.4 million in the year +ended December 31, 2007 to $721.6 million during the year ended December 31, 2008. +Should +the global economic conditions deteriorate further, we may experience further revenue declines in the Americas, European, and Asian markets. Should we fail to develop and +effectively merchandise new products that appeal to the consumer, we may not be able to compete effectively and may experience further declines in revenues. +During +2008, we incurred significant charges related to restructuring and other activities undertaken to right-size our business. These charges include inventory write-downs, +incremental sales returns and mark down allowances, fixed asset impairments, goodwill and intangible asset impairments, and severance, facility exit and other related expenses. +See +Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for further discussion of our financial conditions and outlooks, including +inventory write-downs, restructuring activities and reductions in selling, general and administrative costs. +We +may continue to incur operating losses during fiscal year 2009 particularly if our revenues fall short of current expectations. In the event that revenues and product demand fall +short of our current expectations, we will need to take further actions to reduce operating costs. +3 +Table of Contents +Product Overview +The Crocs product range is divided into three categories: everyday, style and sport. Our everyday product range is composed of fully +molded products, which are closest to our core products and targeted widely to several distribution channels. Our style product range consists of more fashionable silhouettes targeted towards +higher-end department stores. Our sport product range includes sport inspired products that offer a Crocs point of view for active end uses like boating, walking, and hiking. +In +addition to our footwear products, we market a line of Crocs-branded apparel and other accessory items that are intended to increase awareness of our brand. +Footwear +A key differentiating feature of our footwear products is Croslite, which is uniquely suited for comfort and functionality. We have +carefully formulated Croslite to be of a density that creates a comfortable shoe with a high coefficient of friction, allowing for slip-resistant, non-marking footwear that is +extremely lightweight. For example, our size large Beach model weighs approximately six ounces, which is significantly lighter than more traditional casual footwear products. Croslite softens as it +warms to better conform to the wearer's feet. Croslite is a closed cell resin, which is water resistant and virtually odor-free, and allows many of our footwear products to be cleaned +simply with water or bleach. As we have expanded our Crocs brand product offering, we have incorporated traditional materials such as textile fabric and leather into our products. However, we continue +to utilize Croslite for the foot bed, sole and other key structural components for these new products. +Our +footwear business has grown significantly since we first introduced our Crocs product line in 2002 with a single model in six colors. Over the past few years +we: +• Expanded our Crocs product line to 25 models in 2006, over 250 models in 2007 and over 270 models in 2008, including Ocean +Minded, YOU by Crocs™ and Bite footwear models; +• Introduced our SolesUnited program, the first-of-its-kind recycled footwear donation +program that allows customers to give back their worn-out Crocs shoes to be recycled into new shoes which are then donated to people in need around the world. Collected +worn-out Crocs shoes are sorted, cleaned, ground and manufactured into new SolesUnited recycled footwear; +• Established licensing agreements with Disney, Nickelodeon, Marvel, DC Comics and Warner Bros., and introduced a limited +edition line of footwear and Jibbitz charms featuring such popular characters as Cinderella, Ariel, Mickey Mouse, Sponge Bob Square Pants, Dora the Explorer, Spiderman and Batman; +• Introduced our Crocs at Work line that offers Crocs shoes targeted towards healthcare and food industry professionals and +is marketed toward the mid-tier distribution channel. We continue to expand the offerings in our Work category, including the introduction of an ESD (electro-static discharge) shoe, which +is designed for medical personnel; +• Developed our Crocs Rx line, which offers five models, the Relief, the Silver Relief, the Cloud, the Silver Cloud and the +Silver Fox, targeted towards consumers who require specialized footwear that provides relief from certain medical conditions, such as diabetes, plantar pain, heel pain, metatarsalgia, achy feet and +post-op conditions. Our Crocs Rx line was rated the #1 Rx shoe in the industry, we received the 2008 company of the year award from the American Podiatric Medical Association (the only +shoe company to ever receive this award) and in 2008 we broadened our distribution into drugstore chains; +• Entered into and extended our existing collegiate licensing agreements with various colleges and universities, and our +sports licensing agreements with, among others, NFL, MLB, AVP and more recently, the Gaelic Athletic Association and Australian football leagues; +4 +Table of Contents +• Expanded into new footwear categories by designing new footwear using our in-house design team as well as +recognized footwear design experts. As part of this strategy, we acquired EXO Italia ("EXO") in 2006, which expanded the capabilities of our in-house design team. EXO is based in Padova, +Italy and is an Italian producer of EVA (Ethylene Vinyl Acetate) based finished products, primarily for the footwear industry; +• Acquired Bite ( www.biteshoes.com ), an adventure driven designer and +manufacturer of comfortable and supportive performance shoes and sports sandals sold worldwide in five categories, including, golf, adventure, healthy lifestyle, travel and water sports. In 2008, the +decision was made to discontinue the Bite line and we have suspended new product introductions. All of Bite's design and development know-how has been integrated into the design and +development of Crocs' sport products; +• Introduced YOU by Crocs™ ( www.youbycrocs.com ), a women's +fashion line that combines the comfort of Croslite with 24 designs including various boots, slides, and high heels composed of suede, smooth napa leather, metallic leather and patent leather. All +styles include the "Soleful™" comfort foot bed, which is manufactured with Croslite and has extra padding on the ball of the foot and heel to provide increased comfort. We will continue to +offer a limited offering of the YOU by Crocs™ styles targeting a distribution in the Crocs operated retail stores at competitive price points; +• Acquired substantially all of the assets of Ocean Minded +( www.oceanminded.com ), a designer and manufacturer of high quality leather and EVA based sandals primarily for the beach, adventure and action sports +market. Ocean Minded is headquartered in Santa Clemente, California and strives to be innovative in style and design in order to produce the most comfortable sandals in the market. In 2008, Ocean +Minded introduced a product line that includes Croslite foot beds to provide increased comfort. As the name, "Ocean Minded" implies, the brand takes an active role in protecting the oceans and beaches +through beach clean ups, support of the Surfrider Foundation and various other environmental efforts. Ocean Minded utilizes recycled and recyclable materials whenever possible and is well known in the +action sports industry as a leading advocate for environmental awareness and responsibility. +Footwear +sales made up 91.6%, 90.1%, and 96.5% of total revenues for the years ended December 31, 2008, 2007, and 2006, respectively. Sales of our classic Beach and Cayman models +accounted for 25%, 30%, and 62.2% of total revenues for the years ended December 31, 2008, 2007 and 2006, respectively. For the year ended December 31, 2008 sales of our Mammoth model +accounted for 10.1% of our total sales. We intend to continue to evaluate our product offerings to develop product collections in assortments that can be merchandised effectively to the consumer at +our retailer and Company operated stores. As such, we expect that our future product offerings will be more focused by category and for color palette and the number of color combinations will be +reduced in our seasonal offerings. +During +the year ended December 31, 2008, approximately 70% of our sales consisted of products geared towards adults compared to 30% of sales for products geared towards children. +Apparel and Accessories +Apparel. In 2007, we expanded our clothing line and launched a new clothing line for boys, girls and men featuring Croslite +material. We added a +small amount of Croslite to the material to ensure that each piece is lightweight, durable, breathable, versatile and fade resistant. In 2008, we scaled back our apparel product offering. +Accessories. In addition to our footwear products, we own Jibbitz ( www.jibbitz.com ), a unique +accessory brand with colorful snap-on charms specifically suited for Crocs shoes. We acquired Jibbitz in +5 +Table of Contents +December +2006 and have expanded the product line to include a wide variety of charms in varying shapes and sizes, with designs such as flowers, sports gear, seasonal and holiday designs, animals, +symbols, letters and rhinestones. Crocs licensing agreements also extend to Jibbitz, allowing Jibbitz to create designs bearing logos and emblems of Disney, NFL, MLB and the Crocs collegiate line. +Jibbitz designs allow Crocs consumers to personalize their footwear to creatively express their individuality. As of December 31, 2008, approximately 1,800 unique Jibbitz charm designs were +available to consumers for personalizing their Crocs footwear. +We +have also introduced several Crocs-branded accessory items that complement the styling, colors, and image of our footwear, which we believe will appeal to a similar demographic base. +For example, we have developed a line of lightweight and durable backpacks and messenger bags that are marketed to a wide range of consumers, from professionals to students. The backpacks and bags +incorporate bright colors, Croslite shoulder pads for comfort and various holes for Jibbitz so the bags can be personally decorated. +Sales and Distribution +Financial information regarding our revenues, profits and total assets is included in our consolidated financial statements beginning +on page F-1. Information relating to our geographic operations is included in Note 17 of our consolidated financial statements. +Domestic Sales +In 2008, sales in the U.S. accounted for approximately 44% of total revenues, compared to 52% in 2007 and 68% in 2006. In the U.S., we +sell our products through 148 Crocs branded retail store locations, including Company-operated kiosks and retail stores in such locations as New York, Boston, Chicago, and Maui, and through our +webstores. We also sell through a broad range of sporting goods and department stores, as well as through specialty retailers. We do not have long term contracts with any of our retail customers, and +sales to our retail customers are generally on an order-by-order basis and are subject to rights of cancellation and rescheduling by the customer. +International Sales +In 2008, international sales accounted for approximately 56% of total revenues, compared to 48% in 2007 and 32% in 2006. Outside of the +U.S., we sell our products through over 314 Crocs branded retail store locations, including 131 Company-operated retail stores in a variety of locations including Canada, Finland, United Kingdom, +Singapore, Hong Kong, Japan, China and the Netherlands, as well as through our kiosks and webstores. We also sell through a broad range of retailers, similar to the retail sales channels we have +established in the U.S. We occasionally utilize sales agents and buying groups in our international locations to service our retail customers. We established a direct sales presence in most major +international markets, rather than relying on distributors, which we believe enables us to obtain better margins and allows us to better control our marketing and distribution. As of +December 31, 2008, we established direct sales efforts in 31 countries. Outside of our direct sales markets, we utilize third-party distributors. +Wholesale and Distributor Sales +In 2008, approximately 76.5% of our net revenues were derived from sales to our wholesale customers and distributors compared to 91% in +2007 and 89.8% in 2006. Our principal wholesale customers include national and regional retail chains, department stores, sporting goods stores and specialty retailers, such as Nordstrom, Finish Line, +Dicks Sporting Goods, The Sports Authority, Dillard's, The Forzani Group and Journeys. No single customer accounted for 10% or more of our +6 +Table of Contents +revenues +for the year ended December 31, 2008. We believe we have established strong domestic and international wholesale customer channels. +We +use distributors in select markets where we believe such arrangements are preferable to direct sales. In markets where we use third-party distributors, these distributors purchase +products pursuant to a price list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of +one to four years, are terminable on 60 days' notice prior to the end of the term or on six months' prior notice at any time, and require our distributors to meet a minimum sales threshold. Our +agreements with distributors do not contain contractual rights of returns or price protection features. We will accept returns from wholesale and distributor customers for defective products, quality +issues, and shipment errors on an exception basis at the sole discretion of our management. We may also accept returns from our wholesale and distributor customers, on an exception basis at the sole +discretion of management, for the purpose of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, at the sole discretion of management, +we may provide markdown allowances to key wholesale and distributor customers to facilitate the "in-channel" markdown of products where we have experienced less than anticipated +sell-through. +Our +domestic accounts are primarily serviced through our internal sales force, which focuses on selling the appropriate mix and quantity of our products to our retail accounts. They +ensure our products are displayed effectively at retail locations and educate our retailers about our Crocs brand and the quality of our products. +Our +financial success is significantly related to the willingness of our retail customers to continue to carry our products, the expansion to new retail customers and the success of such +customers, which factors are directly impacted by the slowdown in the global economy, including reduced foot traffic in shopping malls and lessening consumer demand for our products. We do not have +long term contracts with any of our retail customers, and sales to our retail customers are generally on an order-by-order basis and are subject to rights of cancellation and +rescheduling by the customer. If we cannot fill our customers' orders in a timely manner, the sales of +our products and our relationships with those customers may suffer, and this could have a material adverse effect on our product sales and ability to grow our product line. +Retail Sales +We are currently expanding our direct sales efforts to consumers. We believe that direct sales provide us with an opportunity to +showcase our entire line of footwear, apparel, gear and accessory offerings, and that this strategy will serve as an important and effective means to enhance our product and brand awareness. As of +December 31, 2008, we operated the following retail stores: +U.S Retail Stores +Crocs Kiosk +110 +Crocs Retail Stores +8 +Crocs Outlet Stores +30 +Total +148 +International Retail Stores +Crocs Kiosk/Store in Store +67 +Crocs Retail Stores +62 +Crocs Outlet Stores +2 +Total +131 +7 +Table of Contents +Kiosks. As of December 31, 2008, we operated 177 domestic and international retail kiosks located in malls and other high foot +traffic areas. +With bright and colorful displays, efficient use of retail space, and limited initial capital investment, we believe that kiosks are an effective outlet for marketing our products. Kiosks enable us to +highlight a wide range of our products; more effectively interact with potential consumers, and enhance our brand awareness among both consumers and local retailers. We plan to continue to open and +operate additional kiosk sites in select, high foot traffic locations. Our kiosk opening plans are subject to adjustment based on the impact of economic conditions and demand for our products. +Retail Stores. As of December 31, 2008, we operated 70 domestic and international retail stores. During 2008, we opened retail +stores in a +variety of locations, including, but not limited to, New York, Boston, Chicago, England, Finland, Canada, Australia, Panama, Japan and China. Company-operated retail stores are designed with colorful +displays and allow us to effectively market our new and existing products and interact with customers in order to enhance brand awareness. We plan to continue to open additional Company-operated +retail stores in the future. Our retail store opening plans are subject to adjustment based on the impact of economic conditions and demand for our products. +Outlet Stores. As of December 31, 2008, we operated 32 domestic and international outlet stores. During 2008, we opened outlet +stores in a +variety of locations, including, but not limited to, Texas, Arizona, Chicago, California, Florida, Missouri, and Hong Kong. The outlet stores help us profitably move older products in an orderly +fashion. We plan to open more Company operated outlet stores in early 2009. Our outlet store opening plans are subject to adjustment based on the impact of economic conditions and demand for our +products. +Internet. We currently offer our products domestically and internationally through our webstores. Our internet presence enables us to +educate +consumers about our products and brand. We continue to expand our web-based international marketing efforts to continue to drive consumer awareness regarding the availability of our full +product range on our market-specific websites. +Raw Materials +Our proprietary closed-cell resin, Croslite, is the primary raw material used in most of our footwear and some of our +accessories. Our material is soft and durable and is of a density that provides a high coefficient of friction allowing our material to be slip-resistant and non-marking in +addition to being extremely lightweight. The closed-cell nature of Croslite makes it resistant to the bacteria and fungus that cause shoe and foot odor. We continue to invest in research +and development in order to refine our materials to enhance these properties and to target the development of new properties for specific applications. +Croslite +is produced by compounding elastomer resins that we or one of our third-party processors purchase from major chemical manufacturers together with certain other production +inputs, such as color dyes. At this time, we have identified two suppliers that produce the particular elastomer resins used in Croslite. We may, however, in the future identify and utilize materials +produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use to produce Croslite are +readily available for purchase from multiple suppliers. +We +transitioned Croslite compounding from our former manufacturing facilities in Canada to other operations and third party facilities during the second quarter of 2008. We compound +Croslite internally in Mexico and China utilizing subcomponent materials produced by a third party in the U.S. We also outsource the compounding of Croslite and continue to purchase a portion of our +compounded raw materials from a third party in Europe in accordance with the terms of a supply agreement that expires in July in 2009. +8 +Table of Contents +Since +our inception, we have substantially increased the number of footwear products that we offer. Many of our new products are constructed using leather, textile fabrics or other +materials. We, or our third party factories, obtain these materials from a number of third-party sources and we believe these materials to be broadly available. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We have Company operated +production facilities in Mexico and Italy and we also contract with third-party manufacturers located around the world. We believe that our in-house manufacturing capabilities enable us to +rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high-demand models and colors throughout the year, while outsourcing allows us to +capitalize on the efficiencies and cost benefits of using contract manufacturing. We believe that this production strategy will enable us to continue to minimize our production costs, increase overall +operating efficiencies and shorten production and development times to better serve our retail customers. +The +process for manufacturing our footwear was developed over an eight year period of continual refinement to improve consistency, softness, durability, and yield. In the year ended +December 31, 2008, we manufactured approximately 17% of our footwear products at our Company operated manufacturing facilities in Mexico and Italy and, for a portion of the year, from our +facilities in Brazil and Canada. We obtained the remaining 83% of our footwear products from third-party manufacturers in China and Bosnia. In the year ended December 31, 2008, our largest +third-party supplier in China produced approximately 49% of our footwear unit volume. We do not have written supply agreements with our primary third-party manufacturers in China. During 2008, we +consolidated our manufacturing capacities at the facilities we operate in Mexico and with our third-party manufacturers and shut down our manufacturing facilities in Canada and Brazil to align our +production capacities and cost structure to decreased demand and declining revenues. +Distribution and Logistics +We continue to make enhancements to our distribution and logistics network that will streamline our supply chain increasing our speed +to market. Over the past year we have consolidated our network to leverage resources and simplify our fulfillment processes while driving down costs in our operations. During the year ended +December 31, 2008, we continued to adjust our strategy based upon projected economic conditions and demand for our products. We continued to consolidate our global distribution centers and +warehousing, thereby decreasing our fixed costs. +In +2008, approximately 24% of our products were shipped from our internal and third-party manufacturers directly to the customer. The other 76% of our products were fulfilled from the 21 +distribution locations strategically located throughout the world. We operated distribution centers in Australia, Colorado, Finland, the Netherlands, India, Japan, Mexico, Shanghai and Singapore as of +December 31, 2008. Our Company-operated distribution centers had approximately 1,368,000 square feet of space. We also utilized third-party operated distribution centers. The third-party +centers were located in Brazil, Colorado, Dubai, Hong Kong, Korea, and Taiwan. These distribution centers gave us approximately 744,000 additional square feet of space. We believe the combined total +of 34 distribution locations and 2.1 million square feet of space gives us the flexibility to meet our rapidly changing business requirements and positions us to support the current level of +revenue and any growth of our brands. +In +December 2007, we entered into an agreement with Manhattan Associates to provide warehouse management systems within all of our Company-operated distribution centers. We plan to +continue to implement the Manhattan software in strategic locations during the next 12 months. +9 +Table of Contents +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress, and patent protection to establish, protect, and enforce +our intellectual property rights in our product designs, brand, materials, and research and development efforts, although no such methods can afford complete protection. We own the material trademarks +used in connection with the marketing, distribution and sale of all of our products, both domestically and internationally, where our products are currently either sold or manufactured. Our major +trademarks include the Crocs logo and design and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China and Canada among other +places. We also own common law trademark registrations or pending trademark applications for Jibbitz, Jibbitz Logo, YOU by Crocs™, YOU by Crocs Logo, Ocean Minded, Fury, Fury Mambaz Logo, +Tail Logo, Bite and Bite Logo, as well as for our proprietary material Croslite and the Croslite logo, globally. We intend to continue to strategically register, both domestically and internationally, +the trademarks and copyrights we utilize today and those we develop in the future. We will also continue to aggressively police our trademarks and copyrights and pursue those who infringe, both +domestically and internationally as we deem necessary. +In +the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks are generally valid as long as they are +in use and their registrations +are properly maintained and have not been found to become generic. Trademarks registered outside of the U.S. generally have a duration of 10 years depending on the jurisdiction and are also +generally subject to an indefinite number of renewals for a like period upon appropriate application. We believe our trademarks are crucial to the successful marketing and sale of our products, and we +intend to vigorously prosecute and defend our intellectual property rights throughout the world. +We +consider the formulation of Croslite used to produce our products to be a valuable trade secret. Prior to our acquisition of Crocs Canada in June 2004, Crocs Canada developed the +formula for Croslite, and we believe that it did not publish or otherwise make the formula available to third parties without the protection of confidentiality or similar agreements. Post acquisition, +we continue to protect the formula by using confidentiality agreements with our third-party processors and by requiring our employees who have access to the formula to execute confidentiality +agreements or to be bound by similar agreements concerning the protection of our confidential information. Neither we nor Crocs Canada have attempted to seek patent protection for the formula. We are +not aware of any third-party that has independently developed the formula or that otherwise has the right to use the formula in their products other than Finproject, our third-party supplier of +Croslite in Italy. Under the terms of our supply agreement with Finproject, Finproject has certain limited rights to use Croslite, which were originally negotiated in connection with our purchase of +Crocs Canada from Finproject's parent company. We believe the comfort and utility of our products depend on the properties achieved from the compounding of Croslite and constitute a key competitive +advantage for us, and we intend to vigorously protect this trade secret. +We +also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers to police against infringing +products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives are also educated on our patents, pending patents, trademarks and +trade dress and assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or +in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain jurisdictions. +10 +Table of Contents +Seasonality +Due to our significant sales growth from our inception through 2007, there is still uncertainty in the degree to which sales of our +footwear products will be subject to seasonality. For the year ended December 31, 2008, we experienced a 40% increase in sales in the first quarter of 2008 compared to 2007. However, due to +declining economic conditions and declining +demand for our products, our sales were flat in the second quarter of 2008 compared to 2007 and our sales declined in the third and fourth quarters of 2008 compared to 2007. We expect that our +business, similar to other vendors of footwear and related merchandise, will be subject to seasonal variation. We believe many vendors that market footwear products suited for warm weather normally +experience their highest sales activity during the second and third quarters of the calendar year. We intend to continue branching out into other types of footwear, bringing unique and original +perspective, to the consumer in styles that may be unexpected from Crocs. While we have introduced footwear models that are more suitable for cold weather, such as the Mammoth, Endeavor, Georgie, All +Terrain, Snowmini, and YOU by Crocs™ styles, we believe that demand for our products, and therefore our sales, may be subject to seasonal variations and may be significantly impacted by +weather conditions. The majority of our revenues during the year ended December 31, 2008 were attributable to our footwear styles more suitable for fair weather. However, we believe that the +expansion into other types of footwear products will help us build a stable year-round business as we look to offer more winter-oriented styles. In addition, our quarterly results of +operations may fluctuate significantly as a result of a variety of other factors, including the timing of new model introductions or general economic or consumer conditions or fluctuating consumer +preferences. +In +addition, our quarterly results of operations may fluctuate significantly as a result of a variety of other factors, including the timing of new model introductions or general +economic or consumer conditions. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year, and revenues for any +particular period may fluctuate. We believe that the changes in our business resulting from the deteriorating global economic conditions as well as the lessening demand for our products were so +significant in 2008 that we cannot reasonably determine the extent of the seasonality of our business. However, we have observed that our first and fourth quarter revenues are less than our second and +third quarter revenues and we expect this seasonality trend to continue. +Backlog +As of December 31, 2008, our backlog, which consists of open orders as of December 31 2008, was approximately +$113.3 million, compared to $145.4 million as of December 31, 2007. The backlog decreased as a result of the current economic conditions and the change in purchasing practices by +our customers as they work to aggressively manage risk through reduced inventory levels as well the decreased demand for our products. Backlog may not be a reliable measure of future sales for any +succeeding period and are subject to cancellation by customers at any time. In addition, our historical cancellation experience may not be indicative of future cancellation rates. We expect the +majority of these orders to be fulfilled within the year. +Competition +The global casual footwear and apparel industry is highly competitive. Although we believe that we do not compete directly with any +single company with respect to the entire spectrum of our products, portions of our business compete with companies such as, but not limited to, Nike Inc., Heelys Inc., Deckers Outdoor +Corp., Sketchers USA Inc. and Wolverine World Wide, Inc. Our retail locations also compete with footwear retailers such as Macy's Inc., Nordstrom Inc., Dicks Sporting +Goods Inc., and Collective Brands Inc. +11 +Table of Contents +The +principal elements of competition in this industry include brand awareness, product functionality, design, quality, pricing, marketing and distribution. We believe that our unique +footwear designs, Croslite, and our expanding product offering and distribution network position us well in the marketplace. However, some companies in the casual footwear and apparel industry have +substantially greater brand awareness, financial, distribution, and marketing resources than we currently have. Furthermore, the unique designs and resulting success of our footwear products have +attracted new players in the market with imitation products that are similar to ours, and we face competition from these new market entrants. +Product Design and Development +Our primary goal in product design and development is to create and introduce new and innovative footwear products that combine our +standards of comfort, functionality, and style, and enhance the awareness of the Crocs brand. We aspire to be the global leader in active casual footwear products. Our footwear product line is +designed by a combination of our internal design and development staff supported by outside designers. By introducing outside sources to the design process, we believe that we are able to capture a +variety of different design perspectives on a cost-efficient basis and anticipate trends more quickly. To expand our internal design capabilities, we acquired EXO in 2006, an Italian +company that has been involved in the design of several of our new styles. We are committed to continuing to dedicate significant resources to product design and development to sustain our commitment +to innovation, maintain or grow our current level of revenue and drive our global brand. +We +develop footwear models based on what we identify as opportunities in the marketplace. Once a design has been identified and demand in the marketplace has been validated, the designs +are then translated into product specifications by our developers and made into prototypes at our facility in Italy or by one of our third-party manufacturers in China. Our designers and developers +work closely with each other to develop product prototypes, test and refine products and provide quality assurance throughout the manufacturing process. Our design and development process is highly +collaborative, as members of the design team frequently meet with our sales and marketing staff, production and supply managers and certain of our retail customers to further refine our products to +meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs while maintaining product quality. +We spent $6.4 million, $5.3 million and $1.8 million in Company-sponsored research, design and development activities for the years ended December 31, 2008, 2007, and 2006, +respectively. +Employees +As of December 31, 2008, we employed approximately 3,700 persons, compared to 5,300 as of December 31, 2007. This +included 1,940 employees in the U.S., 80 employees in Canada, 220 employees in Mexico, 990 employees in Asia, 90 employees in South America, and 380 employees in Europe. Due to declining economic +conditions and the reduced demand for our products, we reduced our headcount by approximately 1,600 persons from 2007, primarily due to closings of our Canadian and Brazilian manufacturing facilities +and other reductions in staffing, partially offset by increases in staffing due to expansion of our Company operated retail locations. As of December 31, 2008, none of our employees were +represented by a union. +Public Filings and Corporate Information +Our internet address is www.crocs.com. On our website, we post the following filings as soon as reasonably practicable after they are +electronically filed with or furnished to the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current +reports on Form 8-K and any amendments to those reports filed or furnished pursuant to +12 +Table of Contents +Section 13(a) +or 15(d) of the Securities and Exchange Act of 1934. All such filings on our website are available free of charge. Also available on our website are the charters of the committees +of our board of directors, as well as our corporate governance guidelines and code of ethics. Copies of any of these documents will be provided in print to any stockholder who submits a request in +writing to Integrated Corporate Relations, 450 Post Road East, Westport, CT 06880. +ITEM 1A. Risk Factors +Our short and long-term success is subject to many factors beyond our control. If any of the following risks, as well as +any risks described elsewhere in this Form 10-K, actually occur, our business, financial condition or results of operations could suffer. Additional risk factors could exist that we +are not presently aware of which could also affect our business, our financial condition or results of operations. Given these risks and uncertainties, investors should not place undue reliance on +forward-looking statements as a prediction of actual results. +Our auditors have expressed substantial doubt about our ability to continue as a going concern. +The accompanying consolidated financial statements for the year ended December 31, 2008 were prepared under the assumption that +we will continue to operate as a going concern. The report of our registered independent public accounting firm on our consolidated financial statements for the year ended December 31, 2008 +includes an explanatory paragraph concerning conditions that raise substantial doubt about our ability to continue as a going concern. We incurred losses of $185.1 million in the year ended +December 31, 2008 and experienced a decline in revenues from $847.4 million for the year ended December 31, 2007 to $721.6 million for the year ended December 31, +2008. Continued operations are dependent on our ability to secure adequate financing and maintain a reasonable level of liquidity such that we can timely pay our obligations when due. As of +December 31, 2008, we had $22.4 million in borrowings under our loan agreement with the Union Bank of California, N.A. ("Revolving Credit Facility"), which currently has a maturity date +of April 2, 2009, and we had $51.6 million in cash and cash equivalents. +We +are currently in discussions with lending institutions to secure an asset backed borrowing arrangement to replace our current Revolving Credit Facility. The time period required to +procure a new asset backed credit facility may extend beyond the maturity date of our current Revolving Credit Facility requiring us to seek an extension of that maturity date with our current +lenders. If we cannot obtain a new arrangement prior to the maturity date on our current Revolving Credit Facility and we are unable to obtain an extension of our current Revolving Credit Facility, we +will be required to repay all borrowed funds on the maturity date. There can be no assurance that we will be able to secure additional debt or equity financing or receive an extension of the current +Revolving Credit Facility by or before the date of maturity of the Revolving Credit Facility and, accordingly, our liquidity and ability to timely pay our obligations when due could be adversely +affected. Additionally, we may incur operating losses during fiscal year 2009 if our revenues continue to decline, which may be accelerated by the current economic crisis resulting in less demand for +our products. In the event that revenues and product demand fall short of our current expectations, we will need to take further actions to reduce operating costs. There can be no assurance that such +actions, if taken, will result in cash flows that will be sufficient to meet our ongoing operating needs. +Our +financial statements do not include any adjustments that may result from the outcome of this uncertainty. If we cannot secure additional financing and continue to incur losses, we +may be unable to maintain a level of liquidity necessary to continue operating our business. +13 +Table of Contents +The recent financial crisis and general economic conditions may adversely affect consumer spending and the overall general health of our retail customers, which, in turn, +may adversely affect our financial condition, results of operations and cash resources. +Uncertainty about the current and future global economic conditions may cause consumers and retailers to defer purchases or cancel +purchase orders for our products in response to tighter credit, decreased cash availability and declining consumer confidence. Our financial success is sensitive to changes in general economic +conditions, both globally and nationally. Recessionary economic cycles, higher interest borrowing rates, higher fuel and other energy costs, inflation, increases in commodity prices, higher levels of +unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws or other economic factors that may affect consumer spending or buying habits could adversely affect the demand +for our products. In addition, a number of our third-party retailers may be impacted by the significant decrease in available credit that has resulted from the current financial crisis. If credit +pressures or other financial difficulties result in insolvency for these third parties it could adversely impact our estimated reserves and financial results. There can be no assurances that +government and consumer responses to the disruptions in the financial markets will restore consumer confidence. +We may not be able to obtain the financing required to operate our business, particularly when the credit and capital markets are unstable, which could limit cash flow +available for operations. +Due to recent turmoil in the credit markets and the continued decline in the economy, we may not be able to obtain additional financing +on terms that are acceptable to us or at all. Also, we may be impacted by factors relating to or affecting our liquidity and capital resources due to perception in the market that may restrict our +flexibility under certain conditions. We anticipate that existing cash balances and cash flows from operations will be sufficient to meet the ongoing needs of our business through March 31, +2009. As of December 31, 2008, we had $22.4 million outstanding on our Revolving Credit Facility. Pursuant to Amendment 9 to the Revolving Credit Facility, we will be required to pay all +amounts outstanding on April 2, 2009. +Our +debt could have important consequences to our business, including the following: +• requiring that we use a large portion of our cash flow to pay principal and interest, which will reduce the availability +of cash to fund working capital, capital expenditures and other business activities; +• increasing our vulnerability to general adverse economic and industry conditions; +• limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; +• restricting us from making strategic acquisitions or exploiting business opportunities; +• placing us at a competitive disadvantage relative to competitors that have less debt; and +• limiting our ability to borrow additional monies in the future to fund working capital and capital expenditures, sell +assets, acquire other businesses, or repurchase capital stock. +We +also may incur additional debt in the future. Although the terms of our Revolving Credit Facility contain restrictions on the incurrence of additional debt, these restrictions are +subject to a number of qualifications and exceptions, and debt incurred in compliance with these restrictions could be significant. In addition, we may refinance all or a portion of our debt, +including borrowings under our Revolving Credit Facility, and incur more debt as a result. If we incur new debt, the risks described above would intensify. +14 +Table of Contents +We anticipate that existing cash resources and cash flows from operations will be sufficient to meet the ongoing needs of our business through March 31, +2009. In order to provide liquidity beyond March 31, 2009, we are exploring alternatives for a new borrowing arrangement or an extension of our existing Revolving Credit Facility and are +currently negotiating with financial institutions to obtain an asset backed lending arrangement. We may also explore other sources for capital to meet our ongoing needs. There can be no assurance that +any such capital will be available to us on acceptable terms or at all especially due to current conditions and uncertainty in the global credit markets. Our ability to fund working capital needs, +planned capital expenditures and scheduled debt payments depends on our future operating performance and cash flow, which in turn are subject to prevailing economic conditions and to financial, +business and other factors, some of which are beyond our control. Our inability to secure financing before the April 2, 2009 maturity date of our Revolving Credit Facility or obtain an +additional extension may result in a material adverse effect on our financial condition. +Our +future operating performance and our ability to meet our cash requirements and service our debt is dependent on many factors, some of which are beyond our control, including +prevailing economic, financial and industry conditions. Our operating performance is also dependent on our ability to continue to realize cost savings and synergies and drive profitable growth. If +these initiatives are not met within the time frame we expect, our cash flow could be impacted. A default under our Revolving Credit Facility could restrict or terminate our access to our borrowing +capacity under our Revolving Credit Facility and materially impair our ability to meet our obligations as they come due. Any default, or the failure to generate sufficient cash from operations, may +require us to seek additional capital or modifications to our credit facility which may not be available. Our suppliers may require us to pay cash in advance or obtain letters of credit as a condition +to selling us their products and services. Any +of these risks and uncertainties could have a material adverse effect on our financial position, results of operations or cash flow. +We may be unable to successfully execute our growth strategy or maintain our current revenue levels. +Although we have generally exhibited significant growth since we began operations, revenues decreased from $847.4 million for +the year ended December 31, 2007 to $721.6 million for the year ended December 31, 2008. We may experience similar decreases in revenues in the future. +Our +ability to maintain our revenue levels or to grow in the future depends upon, among other things, the continued success of our efforts to maintain our brand image and expand our +footwear offerings and distribution channels. To effectively maintain or grow our current revenue levels in our operations, we will need to continue to streamline our supply chain efforts to increase +operation efficiencies and decrease costs. Failure to manage our operations in a cost efficient manner could result in greater difficulty in completely filling customer orders, declines in product +quality, difficulty with product acceptance or other production and distribution difficulties, any of which could adversely impact our business performance and operating results. We had net losses for +the year ended December 31, 2008 and we may continue to incur losses unless our expenses are reduced or demand for our product improves. +The popularity of our Crocs footwear may not grow as rapidly as it has in the past and may decline, which would have a negative impact on our sales and results of +operations. +Our footwear sales, which represented approximately 91.6% of our revenues for the year ended December 31, 2008, contributed to +our significant growth through 2007. We expect that footwear will constitute our principal product line for the foreseeable future. The footwear industry is subject to rapidly changing consumer +demands, preferences and fashion trends, and our footwear may not remain popular or we may fail to develop additional models that appeal to consumers. As our products begin to mature in certain +markets, we have generally experienced less demand. Likewise, we may experience a decline in demand for our products as counterfeit or imitation products begin to gain market share. +15 +Table of Contents +If +the popularity of our footwear declines or does not expand in the future, we may experience, among other things: +• lower sales; +• loss of retail customers; +• excess inventories; +• inventory markdowns and discounts provided to retailers; +• deterioration of our brand image; and +• lower revenues and gross and operating margins, as a result of price reductions. +Further, +we could experience a decline in our revenues and earnings from any or all of the above. Given the limited history of our Crocs brand, it is especially difficult to evaluate +whether our products will hold long-term consumer appeal. +We have been named as a defendant in a securities class action lawsuit that may result in substantial costs and could divert management's attention. +In January 2008, plaintiffs filed a shareholder derivative action in the Colorado District Court for the City and County of Boulder +alleging that certain of our officers and directors breached their fiduciary duties, wasted corporate assets, and were unjustly enriched. This derivative action purports to state a claim on behalf of +the corporation. The complaint alleges that the claims arise from the same conduct as is alleged in the federal shareholder class action discussed below. We are in the process of responding. +Starting +in November 2007, certain stockholders filed several purported shareholder class actions in the U.S. District Court for the District of Colorado alleging violations of +Sections 10(b) and 20(a) of the Exchange Act based on alleged statements made by us between July 27, 2007 and October 31, 2007. We and certain of our current and former officers +and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of Colorado. The first complaint was filed in November 2007; several +other complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the Court appointed a lead plaintiff and counsel. An amended consolidated complaint was filed in +December 2008. The amended complaint purports to state claims under Section 10(b), 20(a), and 20A of the Exchange Act on behalf of a class of all persons who purchased our stock between +April 2, 2007 and April 14, 2008 (the "Class Period"). The amended complaint alleges that, during the Class Period, defendants made false and misleading public statements about us and +our business and prospects and that, as a result, the market price of our stock was artificially inflated. The amended complaint also claims that certain current and former officers and directors +traded our stock on the basis of material non-public information. The amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified amount, interest, and an +award of attorneys' fees and costs of litigation. Due to the inherent uncertainties of litigation and because the litigation is at a preliminary stage, we cannot at this time accurately predict the +ultimate outcome of the matter, or of the amount or range of potential loss, if any. +In +December 2007, a plaintiff filed a shareholder derivative action in the Colorado District Court for the City and County of Boulder alleging that certain officers and directors of the +Company breached their fiduciary duties, wasted corporate assets, and were unjustly enriched. This derivative action purported to state a claim on behalf of the Company. Plaintiff filed an amended +complaint in July 2008, which alleged claims that arise from the conduct alleged in the federal shareholder class action and allegations regarding additional statements made by the Company between +November 2007 and May 2008. The Company and the individual defendants filed motions to dismiss the derivative +16 +Table of Contents +complaint. +On February 26, 2009, the Court dismissed the derivative compliant with prejudice and denied plaintiff leave to amend. The order is subject to appeal. +We +are not able to predict the ultimate outcomes of these actions. It is possible that they could be resolved adversely to us, could result in substantial costs, and could divert +management's attention and resources, which could harm our business. Risks associated with legal liability are often difficult to assess or quantify, and their existence and magnitude can remain +unknown for significant periods of time. While we maintain director and officer insurance, the amount of insurance coverage may not be sufficient to cover a claim, and the continued availability of +this insurance cannot be assured. We may, in the future, be the target of additional proceedings, and these proceedings may result in substantial costs and divert management's attention and resources +that are needed to successfully run our business. +We may fail to meet analyst expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly, and various securities analysts follow our financial results and issue reports on us and the value +of our common stock. These reports include information about our historical financial results as well as the analysts' estimates of our future performance. The analysts' estimates are based upon their +own opinions and are often different from our estimates or expectations. If our operating results are below the estimates or expectations of public market analysts and investors, our stock price could +decline. +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers' orders, either of which could +adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction, and closings, as well as fashion trends, rapid +changes in consumer preferences, the effects of weather, general economic conditions, and other factors affecting demand. These factors make it difficult to forecast consumer demand, and if we +overestimate demand for our products, we may be forced to liquidate excess inventories at a discount to customers, resulting in markdowns and lower gross margins. Conversely, if we underestimate +consumer demand, we could have inventory shortages, which can result in lost potential sales, delays in shipments to customers, strains on our relationships with customers and diminished brand +loyalty. Moreover, because our product line is limited, we may be disproportionately affected by cyclical downturns in the footwear industry, changes in consumer preferences, and other factors +affecting demand, which may make it more difficult for us to accurately forecast our production needs, exacerbating these risks. A decline in demand for our products, or any failure on our part to +satisfy increased demand for our products, could adversely affect our business and results of operations. +Our current management information systems may not be sufficient for our business, and planned system improvements may not be successfully implemented on a timely basis or +be sufficient for our growing business. +We have made significant improvements to our management information systems over the past several years, specifically to upgrade our +financial reporting systems and to implement new information technology systems to better track our business, streamline our financial reporting, and improve our internal controls. However, for +certain business planning, finance and accounting functions, we still rely on manual processes that are difficult to control and are subject to human error. We may experience difficulties in +transitioning to our new or upgraded systems, including loss of data and decreases in productivity as our personnel become familiar with new systems. In addition, our management information systems +will require modification and refinement as our business needs change, which could prolong difficulties we experience with systems transitions, and we may not always employ the most effective systems +for our purposes. If we experience difficulties in implementing new or upgraded information systems or experience significant system failures, or if we are unable to successfully modify our management +information systems to respond to changes in our business needs, our ability to properly run our business could be adversely affected. +17 +Table of Contents +We have substantial cash requirements in the U.S. while a majority of our cash is generated and held outside of the U.S. The risks attendant to holding cash abroad could +adversely affect our financial condition and results of operations. +We have substantial cash requirements in the U.S., but a majority of our cash is generated and held abroad. Since repatriation of such +cash is subject to limitations and may be subject to significant taxation, we cannot be certain that we will be able to repatriate such cash on favorable terms or in a timely manner. If we continue to +incur operating losses and require cash held in international accounts for use in our U.S. operations, a failure to repatriate such cash in a timely and cost-effective manner could +adversely affect our business, financial condition, and results of operations. +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our brand image and adversely +affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents, and trade dress and designs on nearly all of +our products and believe that having +distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us, and in distinguishing our goods from the goods of others. We believe that +our trademarks, patents, and other intellectual property rights are important to our brand, our success and our competitive position. We periodically discover products that are counterfeit +reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party's products on the basis of trademark or design or +utility patent infringement, or if we are required to change our name or use a different logo, continued sales of such competing products by third parties could harm our brand and adversely impact our +business, financial condition, and results of operations by resulting in the shift of consumer preference away from our products. We have taken actions to protect our intellectual property rights, +some of which are described in Part I, Item 3 Legal Proceedings. The actions we have taken or those we will take to establish and protect +trademarks, patents, and other intellectual property rights may not be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as +violations of proprietary rights. +In +addition, the laws of certain foreign countries may not protect intellectual property rights to the same extent as do the laws of the U.S. We have registered Crocs as a trademark for +footwear in Aruba, Australia, the European Union, Israel, Japan, Mexico, Netherlands, Antilles, New Zealand, Panama, and the World Intellectual Property Office. As of December 31, 2008, we have +applied to register Crocs and the Crocs logo as trademarks in over 67 other jurisdictions around the world, including the U.S., but such applications have not been approved and are currently pending. +In addition, we have recently extended the scope of our trademark registrations and applications for both the Crocs mark and logo to cover non-footwear products such as sunglasses, +goggles, knee pads, watches, luggage, and some of our internet sales activities. We cannot assure you that the actions we have taken to establish and protect our trademarks and other intellectual +property rights outside the U.S. will be adequate to prevent imitation of our products by others or, if necessary, successfully challenge another party's counterfeit products or products that +otherwise infringe on our intellectual property rights on the basis of trademark or patent infringement. We may face significant expenses and liability in connection with the protection of our +intellectual property rights outside the U.S., and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could +be adversely affected. +We +also rely on trade secrets, confidential information, and other unpatented proprietary information related to, among other things, the formulation of Croslite and product development, +especially where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation of our trade +secrets, confidential information and other unpatented proprietary information. The agreements we use to try to protect our intellectual property, confidential information and other unpatented +proprietary +18 +Table of Contents +information +may not effectively protect such intellectual property and information and may not be sufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to +one of these agreements may breach the agreement and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other unpatented proprietary +information may become known to others, including our competitors. Furthermore, as with any trade secret, confidential information, or other proprietary information, others, including our competitors, +may independently develop or discover such trade secrets and information, which would render them less valuable to us. +Because we depend on third-party manufacturers, we may face challenges in maintaining a sufficient supply of goods to meet sales demand, and we may experience interruptions +in our supply chain. Any shortfall in the supply of our products may decrease our sales and have an adverse impact on our customer relationships. +In the year ended December 31, 2008, third-party manufacturers produced approximately 83% of our footwear products as measured +by number of units, and one such manufacturer in China produced approximately 49% of our third-party footwear products. Currently, we have footwear manufacturing arrangements with third-party +manufacturers located in China and Bosnia. We depend on these manufacturers' ability to finance the production of goods ordered and to maintain adequate manufacturing capacity. We do not exert direct +control over the third-party manufacturers and as such, have experienced at times, delays or inabilities to fulfill customer demand and orders. While we are increasing our communication and +relationships with our third-party manufacturers, we cannot guarantee that we will be able to fully mitigate any delays in the production and shipment of our products. +In +addition, we do not have long-term supply contracts with most of these third-party manufacturers, including the third-party manufacturer that produced the majority of our +footwear products in the year ended December 31, 2008, and any of them may unilaterally terminate their relationship with us at any time or seek to increase the prices they charge us. As a +result, we are not assured of an uninterrupted supply of products of an acceptable quality and price from our third-party manufacturers. We may not be able to offset any interruption or decrease in +supply of our products by increasing production in our Company-operated manufacturing facilities due to capacity constraints, and we may not be able to substitute suitable alternative third-party +manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in a loss of sales and an +increase in production costs, which would adversely affect our results of operations. +We manufacture a portion of our Crocs products, and any difficulties or disruptions in our manufacturing operations could adversely affect our sales and results of +operations. +In the year ended December 31, 2008, we produced approximately 17% of our footwear products at our Company-operated +manufacturing facilities in North America, Brazil and Italy. The manufacturing of our products from our proprietary closed-cell resin, which we refer to as Croslite, requires the use of a +complex process, and we may experience difficulty in producing footwear that meets our high quality control standards. We will be required to absorb the costs of manufacturing and disposing of +products that do not meet our quality standards. These costs are primarily incurred in connection with the initial production of new products, although we may also experience increases in training +costs when we initiate production of new products. We may incur increased costs as a result of the introduction of new manufacturing equipment, such as molds and injection molding machines. Any +increases in our manufacturing costs could adversely impact our margins. Furthermore, our manufacturing capabilities are subject to many of the same risks and challenges noted above with respect to +our third-party manufacturers, including our ability to scale our production capabilities to meet the needs of our customers, and our manufacturing may be disrupted for reasons beyond our +19 +Table of Contents +control, +including work stoppages, fires, earthquakes, floods, or other natural disasters. Any disruption to our manufacturing operations will hinder our ability to deliver products to our customers +in a timely manner, and could have a material and adverse effect on our business. +We depend on a limited number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and +increase product costs. +We depend on a limited number of sources for the primary materials used to make our footwear. We source the elastomer resins that +constitute the primary raw materials used in compounding Croslite, which we use to produce our footwear products, from two suppliers. We do not have any formal purchase agreement with the providers of +the elastomer resins, and we purchase these elastomer resins on a purchase order basis. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able +to obtain suitable substitute materials in time to avoid interruption of our production cycle, if at all. We may also have to pay materially higher prices in the future for the elastomer resins or any +substitute materials we use, which would increase our production costs and could have a materially adverse impact on our margins and results of operations. +If +we are unable to obtain suitable elastomer resins or if we are unable to procure sufficient quantities of Croslite, we may not be able to meet our production requirements in a timely +manner. Such failure could result in lost potential sales, delays in shipments to customers, strained relationships with customers, and diminished brand loyalty. +Our products are subject to risks associated with overseas sourcing, manufacturing, shipping and financing. +Because independent manufacturers manufacture a majority of our products outside of our principal sales market, our products must be +transported by third parties over large geographic distances. Delays in the shipment or delivery of our products due to the availability of transportation, work stoppages, port strikes, infrastructure +congestion, or other factors, and costs and delays associated with transitioning between manufacturers, could adversely impact our financial performance. In addition, manufacturing delays or +unexpected demand for our products may require us to use faster, but more expensive, transportation methods such as aircraft, which could adversely affect our profit margins. The cost of fuel is a +significant component in transportation costs, so increases in the price of petroleum products can adversely affect our profit margins. +We are dependent on sales of a small number of products, and the absence of continued market demand for these products would have a significant adverse effect on our +operating results. +We generated approximately 91.6% of our revenues for the year ended December 31, 2008 from sales of our footwear products, which +consisted of more than 270 models, including Ocean Minded, Bite, YOU by Crocs™ and our Crocs footwear models. Sales of our classic Beach and Cayman models accounted for approximately 25% +of our footwear revenues in the year ended December 31, 2008. A high portion of our Crocs footwear models are developed from the same base design as our Beach and Cayman models, and we expect +to continue to derive a substantial portion of our revenues from these models or related products in the foreseeable future. Because we are dependent on a line of footwear models that have substantial +similarities, factors such as changes in consumer preferences and general market conditions in the footwear industry may have a disproportionately greater impact on us than on our competitors. In +addition, other footwear companies have introduced products that are substantially similar to our footwear models, which may reduce sales of our footwear products. In the event that consumer +preferences evolve away from our footwear models or from casual lifestyle footwear in general, or if our retail customers purchase similar products sold by our competitors, the resulting loss of +sales, increase in inventories and discounting of our products are likely to be significant, which could have a material and adverse impact on our business and operations. +20 +Table of Contents +Expanding our footwear product line may be difficult and expensive, and if we are unable to successfully continue such expansion, our brand may be adversely affected, and we +may not maintain or grow our current revenue levels and our revenues may continue to decline. +Our ability to maintain or grow our current revenue levels is founded primarily on the continued sales of our footwear, and we intend +to continue to refine the number of models offered in our footwear product line to broaden the appeal of our products to consumers. To successfully expand our footwear product line, we must +anticipate, understand, and react to the rapidly changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce, may not be successful with +consumers, or our brand may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, we may not continue to grow and our +revenues may decline further, and our brand image and operating performance may suffer. +We +may also encounter difficulties in producing new footwear models that we did not anticipate during the development stage. Our development schedules for new products are difficult to +predict and are subject to change as a result of shifting priorities in response to consumer preferences and competing products. For example, once we begin to design a new footwear model, it can take +six to nine months to progress to full production because of the need to fabricate new molds and to implement modified production tooling and revised manufacturing techniques. If we are not able to +efficiently manufacture newly-developed products in quantities sufficient to support retail distribution, we may not be able to recoup our investment in the development of new models and product +lines, and we would continue to be subject to the risks inherent in having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate +success of a new model may depend on our pricing. We have a limited history of introducing new products, and we may set the prices of new models too high for the market to bear or not provide the +appropriate level of marketing in order to educate the market and potential consumers of new products. Achieving market acceptance will require us to exert substantial product development and +marketing efforts, which could result in a material increase in our selling, general, and administrative expense, and there can be no assurance that we will have the resources necessary to undertake +such efforts effectively. Failure to gain market acceptance for new products that we introduce could impede our ability to maintain or grow our current revenues, reduce our profits, adversely affect +the image of our brands, erode our competitive position, and result in long term harm to our business +Sales of our products are likely to be subject to seasonal variations, which could increase the volatility of the price of our common stock. +Due to our significant sales growth since our inception, followed by the global economic crisis in 2008, there is still uncertainty in +the degree to which sales of our footwear products will be subject to seasonality. For the year ended December 31, 2008, we experienced a 40% increase in sales in the first quarter of 2008 +compared to 2007. However, due to declining economic conditions and declining demand for our products, our sales were flat in the second quarter of 2008 compared to 2007 and our sales declined in the +third and fourth quarters of 2008 compared to 2007. We expect that our business, similar to other vendors of footwear and related merchandise, will be +subject to seasonal variation. We believe many vendors that market footwear products suited for warm weather normally experience their highest sales activity during the second and third quarters of +the calendar year. While we have introduced footwear models that are more suitable for cold weather, such as the Mammoth, Endeavor, Georgie, All Terrain, Snowmini, and YOU by Crocs tm +styles, we expect that demand for our products, and therefore our sales, may be subject to seasonal variations and significantly impacted by weather conditions because the majority of our revenues +during the year ended December 31, 2008 were attributable to our footwear styles more suitable for fair weather. +21 +Table of Contents +In +addition, our quarterly results of operations may fluctuate significantly as a result of a variety of other factors, including the timing of new model introductions or general +economic or consumer conditions. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year, and revenues for any +particular period may fluctuate. This could lead to results outside of analyst and investor expectations which could cause the volatility in our stock price to increase. +We will incur significant time and expense in documenting, testing and certifying our internal control over financial reporting, and any deficiencies in our financial +reporting or internal controls could adversely affect our business and the price of our common stock. +Beginning with our Annual Report on Form 10-K for our fiscal year ended on December 31, 2007, the Securities +and Exchange Commission ("SEC") rules require that our chief executive officer and chief financial officer periodically certify the existence and effectiveness of our internal control over financial +reporting. This process generally requires significant documentation of policies, procedures, and systems, review of that documentation by our internal accounting staff and our outside auditors, and +testing of our internal control over financial reporting by our internal accounting staff and the independent auditors. Continued documentation and testing of our internal controls will involve +considerable time and expense, and may strain our internal resources and have an adverse impact on our costs. +During +the ongoing course of our testing, we may identify deficiencies which we may not be able to remediate in time to meet the annual deadlines imposed by SEC rules for certification +of our internal control over financial reporting. As a consequence, we may have to disclose in periodic reports we file with the SEC any material weaknesses in our system of internal controls. For +example, during the three months ended March 31, 2008, we identified a control deficiency that was determined to be a material weakness in our system of internal controls. The material weakness +identified related to controls over the preparation and calculation of the consolidated income tax provision and related reserves. +The +existence of such material weaknesses would preclude management from concluding that our internal control over financial reporting is effective and would preclude our independent +auditors from issuing an unqualified opinion that our internal controls are effective. In addition, disclosures of this type in our SEC reports could cause investors to lose confidence in our +financial reporting and may negatively affect the price of our common stock. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud. If we have +deficiencies in our internal control over financial reporting, such deficiencies may negatively impact our business, results of operations and reputation. +Third parties may claim that we are infringing their intellectual property rights, and such claims may be costly to defend, may require us to pay licensing fees, damages, or +other amounts, and may prevent, or otherwise impose limitations on, the manufacture, distribution or sale of our products. +From time to time, third parties may claim that we are infringing their intellectual property rights, and we may be found to infringe +those intellectual property rights. While we do not believe that any of our products infringe the valid intellectual property rights of third parties, we may be unaware of the intellectual property +rights of others that may cover some of our technology or products. If we are forced to defend against such third-party claims, whether or not such claims are resolved in our favor, we could encounter +expensive and time consuming litigation, which could divert our management and key personnel from business operations. If we are found to be infringing on the intellectual property rights of other +companies, we may be required to pay damages or ongoing royalty payments, or comply with other unfavorable terms. If we are found to be infringing on the intellectual property rights of other +companies, we may not be able to obtain license agreements on terms acceptable to us, or at all, +22 +Table of Contents +and +this may prevent us from manufacturing, marketing or selling our products. Thus, such third-party claims may significantly reduce the sales of our products or increase our cost of goods sold. Any +such reductions in sales or cost increases could be significant, and could have a material and adverse affect on our business. +Our business could suffer if our third-party manufacturers violate labor laws or fail to conform to generally accepted ethical standards. +We require our third-party manufacturers to meet our standards for working conditions and other matters before we are willing to do +business with them. As a result, we may not always obtain the lowest cost production. Moreover, we do not control our third-party manufacturers or their respective labor practices. If one of our +third-party manufacturers violates generally accepted labor standards by, for example, using forced or indentured labor or child labor, +failing to pay compensation in accordance with local law, failing to operate its factories in compliance with local safety regulations, or diverging from other labor practices generally accepted as +ethical, we likely would cease dealing with that manufacturer, and we could suffer an interruption in our product supply. In addition, such a manufacturer's actions could result in negative publicity, +damage to our reputation and the value of our brand, and discourage retail customers and consumers from buying our products. +If we are unable to recruit and retain key personnel necessary to operate our business, our ability to successfully manage our business and develop and market our products +may be harmed. +We are reliant on key personnel and our officers, including our new Chief Executive Officer, John Duerden. To expand our business we +will need to attract, retain, and motivate highly skilled design, development, management, accounting, sales, merchandising, marketing, and customer service personnel. Competition for many of these +types of personnel is intense. As a result, we may be unable to successfully attract or retain qualified personnel. Any of our officers or employees can terminate their employment with us at any time, +and we do not maintain key person life insurance on any of our employees. The loss of any key employee or our inability to attract or retain other qualified employees could harm our business and +results of operations. +As a result of the difficult global macroeconomic conditions and extremely challenging retail environments, particularly in the U.S. and Europe, we implemented restructuring +and workforce reductions, which may adversely affect the morale and performance of our personnel and our ability to hire new personnel. +Our business has been adversely affected by challenging retail environments in many of the markets in which we operate due in large +part to the current global economic downturn. Accordingly, we made the decision in 2008 to right-size our operations to better align with our lower sales volumes and revenues, resulting in +us reducing our workforce in North America and Europe. Additionally, we made the decision in 2008 to close our manufacturing plants in Brazil and Canada. This restructuring plan, or any restructuring +plans undertaken in the future, may yield unintended consequences, such as attrition beyond our intended reduction in workforce and reduced employee morale, which may cause our employees who were not +affected by the reduction in workforce to seek employment elsewhere. We run the risk that our restructuring efforts may not sufficiently reduce costs to maintain profitability, or, in the alternative, +our restructuring efforts may result in too many reductions, which could adversely affect our operations and may potentially stunt our growth. Additional attrition or an inability to find adequate +replacements for lost personnel could adversely affect our ability to meet our operational or financial goals. +23 +Table of Contents +Our financial success may be limited to the strength of our relationships with our retail customers and to the success of such retail customers. +Our financial success is significantly related to the willingness of our retail customers to continue to carry our products, the +expansion to new retail customers, and to the success of such customers. We do not have long term contracts with any of our retail customers, and sales to our retail customers are generally on an +order-by-order basis and are subject to rights of cancellation and rescheduling by the customer. If we cannot fill our retail customers' orders in a timely manner, the sales of +our products and our relationships with those customers may suffer, and this could have a material adverse effect on our product sales and ability to grow our product line. +Furthermore, +many of our retail customers compete with each other, and if they perceive that we are offering their competitors better pricing and support, they may reduce purchases of +our products. In addition, we compete directly with our retail customers by selling our products to consumers via the internet and through our Company-operated kiosks and stores. If our retail +customers believe that our direct sales to consumers divert sales from their stores, this may weaken our relationships with such customers and cause them to reduce purchases of our products. +The +changes in the global economy could also affect our customers' liquidity and capital resources and their ability to meet their payment obligations to us, which in turn would decrease +their credit terms and our ability to collect our accounts receivable, which may have a material adverse impact on our cash flows and capital resources. We continue to monitor our accounts receivable +aging and have recorded appropriate reserves as we deem appropriate. +We face significant competition, and if we are unable to compete effectively, sales of our products may decline and our business could be harmed. +The footwear industry is highly competitive. Recent growth in the market for casual footwear has encouraged the entry of new +competitors into the marketplace and has increased competition from established companies. Some of our competitors are offering products that are substantially similar, in design and materials, to our +Crocs-branded footwear. In addition, access to offshore manufacturing is also making it easier for new companies to enter the markets in which we compete. +Our +competitors include most major athletic and footwear companies, branded apparel companies, and retailers with their own private labels. A number of our +competitors: +• have significantly greater financial resources than us; +• have more comprehensive product lines than ours; +• have broader market presence than we have in retail stores, or have more Company-operated retail stores than us; +• have longer-standing relationships with retailers than us; +• have a longer operating history than ours; +• have greater distribution capabilities than us; +• have stronger brand recognition than us; and +• spend substantially more on product advertising and sales than us. +Our +competitors' greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and +production, and more quickly develop new products. If we fail to compete successfully in the future, our sales and profits may decline, our financial condition may deteriorate, and the market price of +our common stock is likely to fall. +24 +Table of Contents +We may fail to successfully streamline our distribution network or introduce our products internationally, and this may cause our results of operations to fall short of +expectations. +As part of our strategy, we plan to streamline our supply chain network and expand the sales of our products into new locations +internationally. Successfully executing this strategy will depend on many factors, including: +• the strength of the Crocs brand and competitive conditions in new markets that we attempt to enter; +• our ability to attract and retain qualified distributors or agents or to develop direct sales channels; +• our ability to use and protect the Crocs brand, and our other intellectual property, in these new markets and territories; +and +• our ability to consolidate our network to leverage resources and simplify our fulfillment process. +If +we are unable to successfully streamline our supply chain and sell our Crocs-branded products internationally, our business may fail to grow, our brand may suffer, and our results of +operations may be adversely impacted. +We conduct, and in the future expect to conduct, a significant portion of our activities outside the U.S., and, therefore, we are subject to the risks of international +commerce. +We use third-party manufacturers located in foreign countries; we operate manufacturing facilities located in North America, Brazil and +Italy; and we sell our products to retailers outside of the U.S. Foreign manufacturing and sales activities are subject to numerous risks, including the following: +• tariffs, import and export controls, and other non-tariff barriers such as quotas and local content rules; +• delays associated with the manufacture, transportation and delivery of foreign-sourced products; +• increased transportation costs due to distance, energy prices, or other factors; +• delays in the transportation and delivery of goods due to increased security concerns; +• foreign currency fluctuations, for which we do not currently engage in any material hedging transactions; +• restrictions on the transfer of funds; +• changing economic conditions; +• restrictions, due to privacy laws, on the handling and transfer of consumer and other personal information; +• changes in governmental policies and regulations; +• political unrest, terrorism, or war, any of which can interrupt commerce; +• expropriation and nationalization; +• difficulties in managing foreign operations effectively and efficiently from the U.S.; and +• difficulties in understanding and complying with local laws, regulations, and customs in foreign jurisdictions. +Furthermore, +our manufacturing activity outside of the U.S., including the production of our products by third-party manufacturers, particularly in China, is subject to risks of poor +infrastructure, +25 +Table of Contents +shortages +of equipment, and labor unrest, in addition to those risks noted above. Once our products are manufactured, we may also suffer delays in distributing our products due to work stoppages, +strikes, or lockouts at the ports where our products arrive. Such labor disruptions could result in product shortages and delays in distributing our products to retailers. These factors and the +failure to properly respond to them could make it difficult to obtain adequate supplies of quality products when we need them, resulting in reduced sales and harm to our business. +In +addition, during 2008, we generated $400.3 million, or 56%, of our revenues outside of the U.S., and in the year ended December 31, 2007, we generated approximately +$407.8 million, or 48% of our revenues outside of the U.S. Our ability to maintain the current level of operations in our existing international markets is subject to risks associated with +international sales operations, as noted above, as well as the difficulties associated with promoting products in unfamiliar cultures. +We may be adversely affected by currency exchange rate fluctuations. +The market has recently seen significant volatility in the value of the dollar against other foreign markets and currency. We purchase +products and supplies from third parties in U.S. dollars and receive payments from certain of our international customers in foreign currencies. The cost of these products and supplies sourced +overseas, and payments received from customers, may be affected by changes in the value of the relevant currencies. Price increases caused by currency exchange rate fluctuations could make our +products less competitive or have an adverse effect on our profitability. Currency exchange rate fluctuations could also disrupt the business of the third-party manufacturers that produce our products +by making their purchases of raw materials more expensive and more difficult to finance. Foreign currency fluctuations could have a material adverse effect on our results of operations and financial +condition. For the year ended December 31, 2008, we experienced $25.5 million in non-cash foreign currency exchange rate losses primarily on intercompany balances. +Acquisitions may be difficult to identify and successfully integrate into our business and could have other adverse consequences. +We have made, and may in the future make, acquisitions of, or investments in, other companies. We expect to consider other +opportunities to acquire or make investments in other businesses and products that could enhance our manufacturing capabilities, complement our current products or expand the breadth of our markets or +customer base. The pursuit of acquisitions may divert the attention of management and cause us to incur various expenses in identifying, investigating and pursuing suitable acquisitions, whether or +not they are consummated. In the event we finance acquisitions by issuing equity or convertible debt securities, our stockholders may be diluted. +If +we acquire additional businesses, we may not be able to integrate the acquired operations successfully with our business or effectively manage the combined business following +completion of the acquisition. We may not achieve the anticipated benefits from the acquired business due to any of the following factors: +• unanticipated costs associated with the acquisition; +• diversion of management's attention from our core business; +• harm to our existing business relationships with manufacturers and customers as a result of the acquisition; +• the potential loss of key employees; or +• risks associated with entering new product lines or markets in which we have little or no prior experience. +26 +Table of Contents +If +we are unable to integrate any new business successfully, we could be required either to dispose of the acquired operations or to undertake changes to the acquired operations in an +effort to integrate them with our business. If we experience any of the difficulties noted above, our business and financial condition could be materially and adversely affected. +We can issue shares of preferred stock without stockholder approval, which could adversely affect the rights of common stockholders. +Our restated certificate of incorporation permits us to establish the rights, privileges, preferences, and restrictions, including +voting rights, of future series of our preferred stock and to issue such stock without approval from our stockholders. The rights of holders of our common stock may suffer as a result of the rights +granted to holders of preferred stock that we may issue in the future. In addition, we could issue preferred stock to prevent a change in control of us, depriving common stockholders of an opportunity +to sell their stock at a price in excess of the prevailing market price. +Our restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could discourage a third-party from acquiring us and +consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could +delay, defer, or prevent a change in control of us or changes in our management. Among other things, these provisions: +• authorize us to issue preferred stock that can be created and issued by the board of directors without prior stockholder +approval, with rights senior to those of common stock; +• do not permit cumulative voting in the election of directors, which would otherwise allow less than a majority of +stockholders to elect director candidates; +• prohibit stockholders from calling special meetings of stockholders; +• prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our +stockholders; +• allow the authorized number of directors to be changed only by resolution of the board of directors; +• establish advance notice requirements for submitting nominations for election to the board of directors and for proposing +matters that can be acted upon by stockholders at a meeting; and +• classify our board of directors so that only some of our directors are elected each year. +These +provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of +control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in +control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to +decline. +ITEM 1B. Unresolved Staff Comments +None. +27 +Table of Contents +ITEM 2. Properties +Our principal executive and administrative offices are located at 6328 Monarch Park Place, Niwot, Colorado. We lease, rather than own, +all of our facilities. We consider our facilities to be suitable for our needs. +The +general location, use and approximate size of our principal properties are given below: +Location +Use +Approximate Square Feet +Rotterdam, the Netherlands +Warehouse +357,000 +Aurora, Colorado +Warehouse +264,000 +Narita, Japan +Warehouse +260,000 +Leon, Mexico +Warehouse/office +207,000 +Niwot, Colorado +Corporate offices/warehouse +147,000 +Zhangbei, China +Manufacturing facility +100,000 +Shanghai, China +Warehouse +81,000 +Longmont, Colorado +Warehouse +72,000 +Boulder, Colorado +Jibbitz's Corporate offices/warehouse +52,000 +Melbourne, Australia +Warehouse +48,000 +Den Haag, the Netherlands +Corporate office +40,000 +Sorrecaba, Brazil +Corporate office +39,000 +Singapore +Warehouse +32,000 +Singapore +Corporate offices +26,000 +Tempere, Finland +Corporate office and storage +34,000 +Shanghai, China +Corporate office +18,000 +Haryana, India +Warehouse +17,000 +Padova, Italy +EXO's corporate offices/manufacturing facility +10,000 +We +also maintain small branch sales offices in Hong Kong, Taiwan, Korea, Australia, Puerto Rico, Hawaii, California and India. We enter into short-term leases for kiosks +domestically and internationally with fixed monthly rents subject to certain covenants with contingent rents based on percentage of revenues. We also lease retail space at 8 domestic and 62 +international retail stores and 30 domestic and 2 international outlet stores. Our short term and long term leases expire at various dates throughout the year 2026. We also still hold a lease on +facilities in Quebec City, however, as a result of our restructuring efforts during 2008, we have shut down these facilities and taken the appropriate lease termination charges. +ITEM 3. Legal Proceedings +On March 31, 2006, Crocs filed a complaint with the ITC against Acme Ex-Im, Inc., Australia +Unlimited, Inc., Cheng's Enterprises, Inc., Collective Licensing International, LLC, D. Myers & Sons, Inc., Double Diamond Distribution, Ltd., +Effervescent, Inc., Gen-X Sports, Inc., Holey Soles Holdings, Ltd., Inter-Pacific Trading Corporation, and Shaka Holdings, Inc., alleging patent and trade dress +infringement and seeking an exclusion order banning the importation and sale of infringing products. On August 10, 2006, Crocs filed a motion to voluntarily remove its trade dress claim from +the investigation to focus on the patent claims. Crocs' motion was granted by Order No. 20 on August 24, 2006. The utility and design patents asserted in the complaint were issued to +Crocs, Inc. on February 7, 2006 and March 28, 2006 respectively, by the United States Patent and Trademark Office. The ITC has issued final determinations terminating Shaka +Holdings, Inc., Inter-Pacific Trading Corporation, Acme Ex-Im, Inc., D. Myers & Sons, Inc. and Australia Unlimited, Inc. from the ITC investigation +No. 337-TA-567 on the basis of settlement and Cheng's Enterprises, Inc. on the suspension of accused activities. The ITC Administrative Law Judge ("ALJ") issued +an Initial Determination of +28 +Table of Contents +non-infringement +related to one of the patents at issue. Crocs filed a petition with the Commission to review this determination. The Commission granted Crocs' petition and on +February 15, 2007, after briefing by the parties, the Commission vacated the ALJ's determination of non-infringement with respect to the remaining respondents and remanded it to the +ALJ for further proceedings consistent with the Commission's order. In light of the Commission's Order, the procedural schedule and hearing date were reset pursuant to Order No. 38. A trial was +held before the ALJ from September 7 to14, 2007. The ALJ issued an Initial Determination on April 11, 2008 with a finding of no violation, finding infringement of the utility patent by +certain accused products, but also finding that the utility patent was invalid as obvious. The ALJ also found that the design patent was valid, but not infringed by the accused products. Crocs filed a +Petition for Review of the Initial Determination which was due on April 24, 2008. On June 18, 2008, the Commission issued a Notice that it would review the ALJ's findings in the Initial +Determination with respect to the determination of non-infringement of the design patent and the determination of invalidity of the utility patent. On July 25, 2008, the Commission +issued a Notice of its decision to terminate the Investigation with a finding of no violation as to either patent. Crocs filed a Petition for Review of the decision with the United States Court of +Appeals for the Federal Circuit on September 22, 2008, and filed its initial brief on January 21, 2009. Briefing before the Federal Circuit is expected to be completed in March 2009 and +oral argument has not yet been scheduled. +On +April 3, 2006, Crocs filed a complaint in the U.S. District Court for the District of Colorado alleging patent and trade dress infringement and seeking injunctive relief +against Acme EX-IM, Inc., Australia Unlimited, Inc., Cheng's Enterprises, Inc., Collective Licensing International, LLC, D. Myers & Sons, Inc., +Double Diamond Distribution, Ltd., Effervescent, Inc., Gen-X Sports, Inc., Holey Soles Holdings, Ltd, Inter-Pacific Trading Corporation, Shaka +Holdings, Inc., and Does 1-10 based upon certain utility and design patents that were issued to Crocs, Inc. on February 7, 2006 and March 28, 2006 respectively, +by the United States Patent and Trademark Office. Consent judgments have been entered against Shaka Holdings, Inc., Interpacific Trading Corporation and Acme Ex-Im, Inc. +Crocs entered into a settlement with Australia Unlimited, and filed a stipulation for dismissal of all claims and counterclaims on January 25, 2007. Crocs has entered into a settlement +agreement with D. Myers & Sons and obtained a consent judgment in connection therewith on May 23, 2007. This action has been stayed pending resolution in the ITC Proceeding, +Investigation No. 337-TA-567, which is currently on +appeal to the U.S. Court of Appeals for the Federal Circuit. The Company does not expect that the ultimate resolution of this matter will have a material adverse impact on its business. +The +Company and certain current and former officers and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of +Colorado. The first complaint was filed in November 2007; several other complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the Court appointed a lead +plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purports to state claims under Section 10(b), 20(a), and 20A of the Exchange Act on +behalf of a class of all persons who purchased the Company's stock between April 2, 2007 and April 14, 2008 (the "Class Period"). The amended complaint alleges that, during the Class +Period, defendants made false and misleading public statements about the Company and its business and prospects and that, as a result, the market price of the Company's stock was artificially +inflated. The amended complaint also claims that certain current and former officers and directors traded in the Company's stock on the basis of material non-public information. The +amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified amount, interest, and an award of attorneys' fees and costs of litigation. The Company believes the claims +lack merit and intends to defend the action vigorously. Due to the inherent uncertainties of litigation and because the litigation is at a preliminary stage, the Company cannot at this time accurately +predict the ultimate outcome of the matter. +29 +Table of Contents +In +December 2007, a plaintiff filed a shareholder derivative action in the Colorado District Court for the City and County of Boulder alleging that certain officers and directors of the +Company breached their fiduciary duties, wasted corporate assets, and were unjustly enriched. This derivative action purported to state a claim on behalf of the Company. Plaintiff filed an amended +complaint in July 2008, which alleges claims that arise from the conduct alleged in the federal shareholder class action and allegations regarding additional statements made by the Company between +November 2007 and May 2008. The Company and the individual defendants filed motions to dismiss the derivative complaint. On February 26, 2009, the Court dismissed the derivative compliant with +prejudice and denied plaintiff leave to amend. The order is subject to appeal. +Due +to the inherent uncertainties of litigation and because the litigation is at a preliminary stage, the Company cannot at this time accurately predict the ultimate outcome of the +matter. +On +March 17, 2008, Cellect LLC and Sentinel Products Corp. filed a complaint against Crocs, Inc. in the U.S. District Court for the Northern District of New York +alleging that Crocs' Croslite materials infringe U.S. Patent No. 5,932,659. Crocs filed an answer on July 11, 2008. On January 12, 2009, the Court entered an order dismissing the +action without prejudice. The court's order became a dismissal with prejudice on February 10, 2009. +Although +the Company is subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, the +Company is not party to any other pending legal proceedings that the Company believes will have a material adverse impact on its business. +ITEM 4. Submission of Matters to a Vote of Security Holders +Not Applicable. +30 +Table of Contents +PART II +ITEM 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock, par value $0.001, is listed on the NASDAQ Global Select Market and trades under the stock symbol CROX. The following +table sets forth, for each of the quarterly periods indicated, the high and low sales prices of our common stock as reported on the NASDAQ Global Select Market. Prices prior to June 14, 2007 +have been adjusted to reflect the 2-for-1 stock split, which was effected as a 100% common stock dividend distributed on that date. +Fiscal Year 2008 Three Months Ended +High +Low +March 31, 2008 +$ +39.29 +$ +16.14 +June 30, 2008 +$ +20.98 +$ +7.67 +September 30, 2008 +$ +10.55 +$ +3.51 +December 31, 2008 +$ +3.69 +$ +0.79 +Fiscal Year 2007 Three Months Ended +High +Low +March 31, 2007 +$ +29.29 +$ +21.43 +June 30, 2007 +47.40 +23.41 +September 30, 2007 +68.12 +41.18 +December 31, 2007 +75.21 +33.75 +On +November 1, 2007, our board of directors approved an authorization to repurchase up to one million shares of our common stock. On April 14, 2008 , the board of directors +also approved an additional authorization to repurchase an additional 5,000,000 shares of our common stock. Share repurchases under these authorizations may be made in the open market or in privately +negotiated transactions. The timing and actual number of shares repurchased will depend on a variety of factors, including price, corporate and regulatory requirements and other market conditions. The +repurchase authorizations do not have an expiration date and do not oblige us to acquire any particular amount of shares of our common stock. The repurchase authorizations may be modified, suspended +or discontinued at any time. The Company did not repurchase any shares in the year ended December 31, 2008. +Performance Graph +The following performance graph compares the cumulative total return of our common stock with that of the NASDAQ Composite Index and +the Dow Jones US Footwear Index from February 8, 2006 through December 31, 2008. Our stock was initially listed on NASDAQ on February 8, 2006, the date our shares began to trade +publicly. Prior to that time, there was no public market for our stock. The graph assumes an investment of $100 on February 8, 2006 and reinvestments of all dividends and other distributions. +31 +Table of Contents +Comparison of Cumulative Total Return on Investment +Year Ended December 31, +February 8, 2006 +2006 +2007 +2008 +Crocs, Inc. +$ +100.00 +$ +144.00 +$ +245.40 +$ +8.27 +Nasdaq Composite Index +$ +100.00 +$ +106.86 +$ +117.35 +$ +69.77 +Dow Jones US Footwear Index +$ +100.00 +$ +114.93 +$ +143.58 +$ +102.81 +The +Dow Jones U.S. Footwear Index consists of Crocs, Inc., NIKE, Deckers Outdoor Corp., Timberland Co. and Wolverine World Wide, Inc. Because Crocs, Inc. is +part of the Dow Jones U.S. Footwear Index, the price and returns of Crocs, Inc. stock have a significant effect on this index. The Dow Jones U.S. Footwear Index include companies in the major +line of business in which the Company competes. This index does not encompass all of the Company's competitors, nor all product categories and lines of business in which the Company is engaged. +The +stock performance shown on the performance graph above is not necessarily indicative of future performance. The Company will not make nor endorse any predictions as to future stock +performance. +Holders +The approximate number of stockholders of record of our common stock was 115 as of January 31, 2009. Because many of the shares +of our common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial owners represented by these stockholders of record. +Dividends +We have never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future +earnings for use in the operation of our business and do not anticipate paying any cash dividends in the foreseeable future. Any future determination to declare cash dividends will be made at the +discretion of our board of directors, subject to compliance with covenants under any then existing financing agreements, which may restrict or limit our ability to declare or pay dividends, and will +depend on our financial condition, results of operations, capital requirements, general business conditions, and other factors that our board of directors may deem relevant. We issued a stock dividend +in connection with our 2-for-1 stock split, which was effected in the form of a 100% common stock dividend distributed on June 14, 2007. +32 +Table of Contents +ITEM 6. Selected Financial Data +The following table presents selected historical financial data of the Company for each of the last five fiscal years. The information +in this table should be read in conjunction with the consolidated financial statements and accompanying notes beginning on page F-1 and with "Management's Discussion and Analysis of +Financial Conditions and Results of Operations," which is included in Item 7 of this Form 10-K. +Year Ended December 31, +2008 +2007 +2006 +2005 +2004 +(in thousands, except per share data) +Consolidated Statements of Operations Data +Revenues +$ +721,589 +$ +847,350 +$ +354,728 +$ +108,581 +$ +13,520 +Cost of sales +486,722 +349,701 +154,158 +47,773 +7,162 +Restructuring charges +901 +— +— +— +— +Gross profit +233,966 +497,649 +200,570 +60,808 +6,358 +Selling, general and administrative expenses +368,800 +259,882 +105,224 +33,916 +7,929 +Restructuring charges +7,664 +— +— +— +— +Impairment charges +45,784 +— +— +— +— +Income (loss) from operations +(188,282 +) +237,767 +95,346 +26,892 +(1,571 +) +Interest expense +1,793 +438 +567 +611 +47 +Other (income) expenses—net +(565 +) +(2,997 +) +(1,847 +) +(8 +) +19 +Income (loss) before income taxes +(189,510 +) +240,326 +96,626 +26,289 +(1,637 +) +Income tax expense (benefit)(1)(2) +(4.434 +) +72,098 +32,209 +9,317 +(143 +) +Net income (loss) +(185,076 +) +168,228 +64,417 +16,972 +(1,494 +) +Dividend on redeemable convertible preferred shares(3) +— +— +33 +275 +142 +Net income (loss) attributable to common stockholders +$ +(185,076 +) +$ +168,228 +$ +64,384 +$ +16,697 +$ +(1,636 +) +Income (loss) per common share: +Basic +$ +(2.24 +) +$ +2.08 +$ +0.87 +$ +0.26 +$ +(0.04 +) +Diluted +$ +(2.24 +) +$ +2.00 +$ +0.81 +$ +0.26 +$ +(0.04 +) +Weighted average common shares:(4) +Basic +82,767,540 +80,759,077 +74,598,400 +50,987,154 +49,283,906 +Diluted +82,767,540 +84,194,883 +80,170,512 +67,140,000 +49,283,906 +As of December 31, +2008 +2007 +2006 +2005 +2004 +(in thousands) +Consolidated Balance Sheets Data +Cash, cash equivalents, and marketable securities +$ +51,665 +$ +36,335 +$ +64,981 +$ +4,787 +$ +1,054 +Total assets +455,999 +627,425 +299,457 +78,032 +16,224 +Long term obligations +35,303 +15,864 +3,290 +5,513 +3,660 +Redeemable common shares +— +— +— +1,800 +1,800 +Redeemable convertible preferred stock +— +— +— +5,500 +5,500 +Total stockholders' equity (deficit) +287,163 +444,113 +208,258 +18,914 +(3,591 +) +(1) On +January 4, 2005, we converted from a limited liability company to a taxable corporation. For the tax years beginning on January 1, 2005 and +afterward, we are subject to corporate-level U.S. federal, state and foreign income taxes. The statement of operations for the year ended +33 +Table of Contents +December 31, +2005 reflects a one-time income tax benefit of $797,000 to record the net deferred tax assets at the date of conversion. +(2) The +income tax benefit recognized in 2004 represents the tax benefit recognized by Crocs Canada subsequent to its acquisition. +(3) Dividends +accrued in 2004 were paid to holders of our Class C convertible preferred membership units. Our Class C membership units were +converted into shares of our Series A preferred stock in connection with our conversion from a limited liability company to a corporation on January 4, 2005. +(4) We +issued a stock dividend in connection with our 2-for-1 stock split, which was effected in the form of a 100% common stock +dividend distributed on June 14, 2007. All share and per share amounts prior to June 14, 2007 have been adjusted to reflect the 2-for-1 stock split. Diluted +weighted average shares have been calculated excluding the dilutive effect of stock options and awards in years where the Company was in a net loss position as their inclusion would have been +anti-dilutive. +ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations +Basis of Presentation +This Management Discussion and Analysis should be read in conjunction with the accompanying consolidated financial statements which +have been prepared assuming we will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the maturity of our Revolving Credit Facility in April, 2009 +and losses from operations raise substantial doubt about our ability to continue as a going concern. Management's plans concerning these matters are also described in Note 1. The consolidated +financial statements do not include any adjustments that might result from this uncertainty. +Overview +We are a designer, manufacturer, distributor, worldwide marketer, and brand manager of footwear and accessories for men, women, and +children. We primarily design and sell a broad offering of products that use our proprietary closed-cell resin, called Croslite. Croslite is a unique material that enables us to produce an +innovative, soft, lightweight, non-marking, slip and odor-resistant shoe. Crocs shoes combine fun colors and innovative designs to provide a new level of comfort, functionality +and style in the casual lifestyle footwear category. +Since +the initial introduction and popularity of our Beach and Cayman models, we have expanded our Croslite products to include a variety of new styles and products and have extended our +product reach and appeal through acquisitions of companies with complementary accessories and other footwear. We continue to actively promote brand recognition through various licensing agreements, +sponsorships and print and media commercials. +We +currently sell our Crocs branded products in 128 countries. We sell our products through domestic and international retailers and distributors and directly to end-user +consumers through our web stores, Company operated retail stores, outlets and kiosks. The broad appeal of our footwear has allowed us to market our products to a wide range of distribution channels, +including department stores and traditional footwear retailers as well as a variety of specialty channels. +We +currently manufacture our footwear products at our Company-operated facilities located in Mexico and Italy in addition to contracting with third-party manufacturers in China, and +Bosnia for production of our footwear products and accessories. We believe our in-house production capabilities and the geographic proximity of our in-house production +facilities to certain markets enables us to make rapid changes to manufacturing schedules and provide us the flexibility to quickly ship in-demand models and colors, while outsourcing +allows us to lower our capital investment and retain the +34 +Table of Contents +cost-effectiveness +of using third-party manufacturing. During 2008, we closed our manufacturing facilities in Canada and Brazil in conjunction with our restructuring activities. See +"Recent Events" below for further discussion. +Recent Events +From our inception through the year ended December 31, 2007, we experienced rapid revenue growth and had difficulty meeting +demand for our footwear products. During this period, we significantly increased production capacity, warehouse space and inventory in an effort to meet demand. This pattern changed in 2008. Our +revenue growth moderated in the three month period ended March 31, 2008 and decreased from 2007 in the three months ended June 30, 2008. This trend continued and accelerated throughout +the remainder of 2008 and our total revenues declined 14.8% during the year ended December 31, 2008 compared to the year ended December 31, 2007. +In +the year ended December 31, 2008, our revenues declined 28.3% in the Americas, and 13.2% in the European market compared to the year ended December 31, 2007. In the +Asian market, our revenue growth slowed throughout 2008, and declined slightly on a year-over-year basis in the fourth quarter of 2008. We believe the decline in revenues in +the Americas and in the European market and the moderation of Asian revenue growth are largely attributable to the following factors: +• the economic conditions in the United States, Europe and Asia, namely reduced consumer spending and decreased foot traffic +at shopping malls; and +• the challenges we face in merchandising our expanded product lines in existing wholesale channels as well as lessening +demand for our products as such products reach a more mature stage in their product life and competitors enter the market with imitation products that are sold at substantially lower prices. +Should +the global economic conditions deteriorate further, we may experience further revenue declines in the Americas, European, and Asian markets. Should we fail to develop and +effectively merchandise new products that appeal to the consumer, we may not be able to compete effectively and may experience further declines in revenues. +During +2008 we incurred significant charges related to restructuring and other activities undertaken to right-size our business. These charges include inventory write-downs, +incremental sales returns and mark down allowances, fixed asset impairments, goodwill and intangible asset impairments, and severance, facility exit and other related expenses. +During +the year ended December 31, 2008, we experienced challenges related to the build up of inventory of our products at many of our North and South American and European +customers because sales were lower than the initial internal projections of many of our wholesale customers and distributors. Certain major retailers and distributors have curtailed orders to reduce +their inventories to target levels. We also observed increased discounting of certain product styles and colors at a number of our resellers. We are working closely with each of our key wholesale +customers and distributors to provide support to facilitate a well structured work-down of their inventories. As a result of customer inventory build up, we incurred further declines in +revenue during the year ended December 31, 2008 because of increases in sales returns and allowances. +Our +inventory included certain styles and colors with substantially diminished demand during the year ended December 31, 2008. Based on decreased demand for these products, we +discontinued certain styles and certain colors of other styles from our product portfolio and implemented our plan for the disposal of our discontinued product inventories. This plan includes +structured sales to established discount retailers, sales through our Company-operated outlet stores, warehouse sales and other disposition activities as well as donations to our Soles United +charitable organization. These actions were designed to minimize adverse impacts to our resellers, distributors, and Company-operated +35 +Table of Contents +retail +channels. We recorded write-downs of $76.3 million and an additional $4.2 million in charges related to losses on future purchase commitments for inventory with a market value +lower than cost, of which $2.1 million remains accrued for the year ended December 31, 2008. +As +a result of these changes in demand, we evaluated our production capacity and operations structure, and during the year ended December 31, 2008, we took the following actions +with respect to our operations: +• we restructured our Canadian operations by discontinuing our Canadian manufacturing operations and consolidating our +Canadian distribution activities with other existing North American distribution operations; +• we abandoned certain manufacturing equipment and molds that represent excess capacity; +• we discontinued manufacturing operations at our Brazilian manufacturing facility; +• we continued to consolidate our global distribution centers and warehousing, thereby decreasing our fixed costs through +the reduction of our global footprint of warehouse space; and +• we reduced our non- retail global headcount by approximately 2,000 people in 2008. +We +believe these actions were necessary in order to align our production and distribution capacities with our revised demand projections. Furthermore, we have taken actions to reduce our +selling, general and administrative costs, including reductions in personnel, reducing our space costs by consolidating certain offices and reducing other discretionary spending. +We +may incur operating losses during fiscal year 2009 if our revenues continue to decline, which may be accelerated by the current economic crisis resulting in less demand for our +products. In the event that revenues and product demand fall short of our current expectations, we will need to take further actions to reduce operating costs. +During +the three month period ended September 30, 2008, our stock price declined substantially, which represented a triggering event for potential goodwill impairment. As of +September 30, 2008, we performed an interim goodwill impairment evaluation. Based on that evaluation we concluded our goodwill was impaired and we recorded a charge of $22.8 million, +which was our entire goodwill balance as of September 30, 2008. +36 +Table of Contents +The following table summarizes our restructuring, asset impairment, including goodwill and other intangible assets, and inventory write-down charges +for the year ended December 31, 2008: +Brazilian +Restructuring +Canadian +Restructuring +Asset +Impairments +Inventory +Write-downs +Total +Inventory write-downs +$ +— +$ +— +$ +— +$ +76,258 +$ +76,258 +Estimated losses on purchase commitments +— +— +— +4,200 +4,200 +Asset impairment charges +Goodwill +— +— +23,867 +— +23,867 +Equipment and molds +— +— +20,885 +— +20,885 +Intangible assets +— +— +882 +— +882 +Jibbitz trade name +— +— +150 +— +150 +Restructuring charges +Operating lease exit costs +87 +1,766 +— +— +1,853 +Other restructuring costs(1) +70 +2,056 +— +— +2,126 +Termination benefits +676 +3,849 +— +— +4,525 +$ +833 +$ +7,671 +$ +45,784 +$ +80,458 +$ +134,746 +(1) Other +restructuring costs include cancellation of purchase obligations and freight and duty charges related to transferring inventory and equipment to our +United States and Mexico facilities. +At +December 31, 2008, we had $51.6 million in cash and cash equivalents compared to $36.3 million at December 31, 2007. Our primary sources of cash are +working capital from operations and borrowings under our Revolving Credit Facility. Our primary uses of cash are working capital for operations, capital expenditures, and repayments of borrowing +against our Revolving Credit Facility. As of December 31, 2008, we can no longer borrow under our Revolving Credit Facility. At December 31, 2008 we had $22.4 million outstanding +on the Revolving Credit Facility. Our current Revolving Credit Facility matures on April 2, 2009. +General +Revenues are recorded when products are shipped and the customer takes title and assumes risk of loss, collection of related +receivables are probable, persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer depending on the country of +the sale and the agreement with the customer. Allowances for estimated returns and discounts are recognized when related revenue is recorded. Because we use both internal manufacturing and contract +with third parties to manufacture our products, our cost of sales represents our costs to manufacture products in our Company-operated facilities, including raw materials costs and all overhead +expenses related to production, as well as the cost to purchase finished products from our third-party manufacturers. Cost of sales also includes the cost to transport these products to our facilities +and all warehouse and outbound freight expenses. Our selling, general and administrative expense consists primarily of selling, marketing, wages and related payroll and employee benefit costs for +selling, marketing and administrative employees, travel and insurance expenses, depreciation, amortization, unrealized gains or losses on foreign currency exchange, all retail related expenses, +including rent and depreciation, and professional fees, facility expenses, bank charges and non-cash charges for share-based compensation. +Acquisitions +On April 1, 2008, we acquired substantially all of the assets of Tidal Trade, Inc. ("Tidal Trade"), the Company's third +party distributor in South Africa, for $4.6 million. We recorded $1.4 million in +37 +Table of Contents +customer +relationships on the date of acquisition. As part of the acquisition, we repurchased inventory previously sold to Tidal Trade and accordingly recognized a reduction of revenue of +approximately $2.1 million. +On +April 2, 2008, we acquired substantially all of the assets of Tagger International B.V. ("Tagger"), a private limited liability company incorporated under the laws of +the Netherlands that manufactures messenger bags. Tagger was partially operated by the Managing Director of Crocs Europe B.V. We acquired all of the assets of Tagger for $2.0 million, of +which approximately $90,000 was assigned to inventory and the remaining $1.9 million was assigned to the value of the Tagger trademark on the date of acquisition. +On +January 31, 2007, we acquired substantially all of the assets of Ocean Minded, LLC ("Ocean Minded") for $1.75 million in cash, plus a potential +earn-out of up to $3.75 million based on Ocean Minded achieving certain earnings targets over a three year period. Ocean Minded is a designer and manufacturer of high quality +leather and EVA (Ethylene Vinyl Acetate) based sandals primarily for the beach, adventure and action sports markets. We recorded $600,000 in customer relationships and other identifiable intangible +assets and $953,000 in goodwill on the date we acquired Ocean Minded. +On +June 26, 2007, we amended the membership interest purchase agreement with Jibbitz, LLC ("Jibbitz") ("Purchase Agreement") to amend the terms of the potential +earn-out consideration included in the Purchase Agreement. The amendment removed the earnings targets for payment of the earn-out with $3.5 million payable on the +effective date of the amended Purchase Agreement and the remaining $6.5 million payable in equal monthly installments of $500,000 due on the first business day of each month until July 2008. We +recorded the additional $9.8 million, net of discounting on future payments, to goodwill in the second quarter of 2007 as an additional cost of the acquisition. +On +July 27, 2007, we acquired all of the assets of Bite, LLC ("Bite") for $1.75 million in cash and the assumption of $1.3 million in debt, plus a potential +earn out of up to $1.75 million based on Bite achieving certain earnings targets over a three year period. Bite is a designer and manufacturer of comfortable and supportive performance shoes +and sports sandals sold worldwide in five categories including, golf, adventure, healthy lifestyle, travel and water sports. We recorded $512,000 in customer relationships and $530,000 in goodwill on +the date of acquisition for Bite. +In +October 2006, the Company acquired Fury Hockey Inc., formerly 55 Hockey Products Inc. ("Fury"), and EXO Italia ("EXO") as part of the Company's effort to expand into new +markets and expand the Company's internal design capabilities. Fury produces and distributes hockey, soccer and lacrosse equipment for adults and children. In June 2008, the Company decided to +liquidate Fury after efforts to sell the entity were unsuccessful. EXO, headquartered in Padova, Italy, designs and develops EVA (Ethylene Vinyl Acetate) based finished products, primarily for the +footwear industry. +Goodwill +related to these acquisitions was fully impaired as of September 30, 2008 and no balance existed at December 31, 2008. See "Recent Trends, Risks and Uncertainties" +above. Our goodwill balance of $23.8 million as of December 31, 2007, related predominately to the acquisitions of Bite and Ocean Minded in 2007, Jibbitz, Fury and EXO in 2006 as well as +the acquisition of Crocs Canada in 2004. +As +a result of the Company's evaluation of indefinite lived intangible assets in accordance with SFAS 142, the Jibbitz trade name of $150,000 was fully impaired as of +December 31, 2008. +38 +Table of Contents +Results of Operations +Comparison of the Years Ended December 31, 2008 and 2007 +Set forth below are the results of operations for the year ended December 31, 2008, as compared to the year ended +December 31, 2007 (in thousands, except for percentages). +(Year Ended December 31,) +2008 +2007 +$ Change +% Change +Revenues +$ +721,589 +$ +847,350 +$ +(125,761 +) +(14.8 +)% +Cost of sales +486,722 +349,701 +137,021 +39.2 +Restructuring charges +901 +— +901 +* +Gross profit +233,966 +497,649 +(263,683 +) +(53.0 +) +Selling, general and administrative expenses +368,800 +259,882 +108,918 +41.9 +Restructuring charges +7,664 +— +7,664 +* +Impairment charges +45,784 +— +45,784 +* +Income (loss) from operations +(188,282 +) +237,767 +(426,049 +) +(179.2 +) +Interest expense +1,793 +438 +1,355 +309.4 +Other (income) expenses—net +(565 +) +(2,997 +) +2,432 +(81.2 +) +Income (loss) before income taxes +(189,510 +) +240,326 +(429,836 +) +(178.9 +) +Income tax expense (benefit) +(4,434 +) +72,098 +(77,804 +) +(108.0 +) +Net income (loss) attributable to common stockholders +$ +(185,076 +) +$ +168,228 +$ +(352,032 +) +(209.3 +)% +* Percentage +change is not relevant as prior year amounts were zero. +Revenues. Revenues decreased 14.8%, or $125.8 million, to $721.6 million, in the year ended December 31, 2008, from +$847.4 million in the year ended December 31, 2007. The decline is primarily attributed to a decrease in our revenues in our Americas and European markets, specifically driven by a +decrease in +unit sales of our footwear and Jibbitz products. Unit sales of footwear products decreased 24.7% or 11.6 million pairs, to 35.3 million pairs in the year ended December 31, 2008, +from 46.9 million pairs in the year ended December 31, 2007. Sales of our Jibbitz products decreased 30.2% to $47.2 million in the year ended December 31, 2008, from +$67.5 million in the year ended December 31, 2007. +Our +wholesale channel revenues decreased 25.3%, or $186.8 million, to $552.1 million, in the year ended December 31, 2008, from $738.9 million in the year +ended December 31, 2007. We believe that this decrease is due to lower unit sales primarily resulting from lessening consumer demand due to the global economic downturn. We believe unit sales +of our footwear also declined due to the challenges we face in merchandising our expanded product lines in existing wholesale channels as well as lessening consumer demand for our products as such +products reach a more mature stage in their product life and competitors enter the market with imitation products that are sold at substantially lower prices. Declines in revenue are also attributable +to an increase in sales returns and allowances which are recorded as a reduction of net revenue as sales returns and allowance increased from $32.2 million for the year ended +December 31, 2007 to $83.6 million for the year ended December 31, 2008. +Our +Company operated retail locations, including retail stores, kiosks and outlets, increased to 279 locations at December 31, 2008, which is up from 209 at December 31, +2007. Total revenue from Company operated retail locations increased 68.5%, or $51.6 million, to $125.8 million in the year ended December 31, 2008, from $74.2 million for +the year ended December 31, 2007. We expect +39 +Table of Contents +revenues +from our Company operated retail stores to increase in the future as we continue to increase the number of our retail locations and focus on expanding our visual and fixture merchandising +platforms. Our plans for expanding retail locations in future periods may be adjusted, or suspended should economic conditions worsen or demand for our products decline. +Revenues +from our webstores increased $9.8 million, or 28.8%, to $43.7 million in the year ended December 31, 2008 from $33.9 million in the year ended +December 31, 2007. The increase in revenues during 2008 is due primarily to increased web-based and other marketing efforts aimed at driving consumer awareness of our webstores. We +intend to expand our webstores and web-based and other marketing initiatives into other markets depending on business and economic conditions. +The +majority of our revenues during the year ended December 31, 2008 were attributable to our non-classic footwear models. Sales of our classic models, Beach and +Cayman, represented 25% of total revenues for the year ended December 31, 2008, compared to 30% for the year ended December 31, 2007. Sales of new 2008 footwear product lines represented +approximately 15% of our overall revenues for the year ended December 31, 2008. We intend to continue to diversify our product offerings in order to expand our brand and expect that sales of +our classic models will represent a smaller portion of our overall revenues in the future. We also intend to segment our product offerings into our various sales channels and to enhance our visual and +fixture merchandising +platforms in Company operated and wholesale customers' stores to more effectively display our expanded product portfolio. +Changes +in foreign currency exchange rates since December 31, 2007 contributed $31.3 million to our revenues in the year ended December 31, 2008. We expect that +sales in international markets in foreign currencies will continue to represent a substantial portion of our overall revenues. Accordingly, changes in foreign currency exchange rates could materially +affect our overall revenues or the comparability of those revenues from period to period as a result of translating our financial statements into our reporting currency, the U.S. dollar. +Americas Market. Our revenues from the Americas decreased 28.3%, or $144.7 million, to $365.9 million in the year ended +December 31, 2008 compared to $510.6 million for the year ended December 31, 2007. We believe the decline is reflective of economic conditions in the United States coupled with +the challenges we face in merchandising our expanded product lines as well as the maturity of our core products in the consumer market and lessening demand for such products, as discussed in "Recent +Events" above. +We +experienced an increase in sales returns and allowances, which are included as a net adjustment to revenue, of 94.4% or $20.2 million, to $41.6 million in the year ended +December 31, 2008 from $21.4 million for the year ended December 31, 2007. The increase in sales returns and allowances is primarily attributable to known and anticipated returns +as well as price mark down allowances for certain product styles and colors for which we have experienced less than anticipated sell through in our wholesales customer channel, as discussed in the +"Recent Events" above. +The +number of Company operated retail locations in the Americas, including retail stores, kiosks and outlets, increased slightly to 157 locations at December 31, 2008 from 153 +locations at December 31, 2007. Revenue from Company operated retail locations increased 45.0%, or $21.3 million, to $68.7 million in the year ended December 31, 2008, from +$47.4 million for the year ended December 31, 2007. Our Company operated retail locations allow us to showcase our entire product offering, which we believe results in better sales of +new product offerings and increased brand awareness. +Asian Market. Our revenues in Asia increased 25.7%, or $41.9 million, to $204.9 million in the year ended December 31, +2008 from +$163.0 million for the year ended December 31, 2007. The increase is attributable to higher unit sales period over period as we increased our direct sales in China and expanded our +product offerings as well as our increase in door openings in 2008. Although we +40 +Table of Contents +continue +to experience revenue growth in the Asian market as we expand into new countries, we believe the global economic downturn and the maturity of our core products could affect our ability to +grow revenues in this region and we could experience declines in revenues similar to those that we have recently experienced in the Americas and European markets. +The +overall increase in revenues in our Asian region was partially offset by an increase in sales returns and allowances of 329.8%, or $12.2 million, to $15.9 million in +the year ended December 31, 2008 from $3.7 million for the year ended December 31, 2007. The increase in sales returns and allowances is primarily related to returns which enabled +our wholesale customers to properly balance their portfolios of our products with respect to size, color and style. +We +increased the number of Company operated retail venues in Asia to 107 locations at December 31, 2008, from 53 locations at December 31, 2007. Revenue from Company +operated retail locations increased 85.5%, or $23.0 million, to $49.9 million in the year ended December 31, 2008, from $26.9 million for the year ended December 31, +2007. +European Market. Our revenues in Europe decreased 13.2%, or $23.0 million, to $150.7 million in the year ended +December 31, 2008 +from $173.7 million for the same period in 2007. We have noted a decline in revenues in certain European countries, particularly in those which represent a more mature market for our products. +We believe a portion of this decline is due to an increased number of imitation products that we believe infringe on our intellectual property as well as the maturity of our core products in the +consumer market and lessening demand for such product. We believe the decline in revenues in our European market may result from the challenge of increased competition from producers of imitation +products that are sold at lower products. We expect to continue defending our intellectual property rights in the European and other markets to mitigate such impacts, as we deem necessary. +Sales +returns and allowances, which is recorded as a net adjustment to revenue, increased 263.9%, or $19.0 million, to $26.2 million in the year ended December 31, +2008 from $7.2 million in the year ended December 31, 2007. The increase in sales returns and allowances is primarily attributable to known and anticipated returns as well as price mark +down allowances for certain products and other products in certain colors for which we have experienced less than anticipated sales in our wholesales customer channel, as discussed in the "Recent +Events" above. +As +of December 31, 2008, we operated 15 retail locations in Europe versus 3 in the same period of 2007. Revenue from Company operated retail locations was $7.2 million in +the year ended December 31, 2008 versus $262 thousand for the year ended December 31, 2007. +Gross profit. Gross profit decreased 53.0% to $234.0 million in the year ended December 31, 2008. Gross margin declined to +32.4% in the +year ended December 31, 2008, compared to 58.7% for the year ended December 31, 2007. The decrease in gross profit was partially the result of excess capacity in our Company-operated +manufacturing and distribution facilities, which are recognized in our results of operations as period costs. As of December 31, 2008, we recorded accrued losses on purchase commitments for +inventory with a market lower than cost of $4.2 million, our write-down of inventories relates to certain products that were or are going to be discontinued of $76.3 million, +including core products in colors that have experienced substantial declines in consumer demand, as discussed in "Recent Events" above. Likewise, we recorded $0.9 million in +restructuring-related costs in cost of sales as a result of the closure of our Canadian manufacturing operation, as explained more fully in "restructuring charges" below. For the year ended +December 31, 2008, we also experienced a change in our sales mix to include products with lower profit margins when compared to the sales mix for the year ended December 31, 2007. We now +manufacture a wide range of products which require additional materials, such as canvas, cloth lining and suede, and additional processes, such as stitching, to manufacture. As we continue to expand +our portfolio and nonclassic models become a larger portion of our business, we expect this trend to continue. The additional costs in raw materials, duties and +41 +Table of Contents +processes +associated with these styles ultimately result in lower gross profit margins. These changes in our manufacturing structure, coupled with the inventory write-downs, decrease in revenues and +increase in returns and allowances were primarily responsible for the decrease in gross profit for the year ended December 31, 2008 compared to the year ended December 31, 2007. +Changes +in foreign currency exchange rates since December 31, 2007 increased our gross margin by $16.4 million, in the year ended December 31, 2008. We expect that +sales at subsidiary companies with functional currencies other than the U.S. dollar will continue to generate a substantial portion of our overall gross profit. Accordingly, changes in foreign +currency exchange rates could materially affect our overall gross profit or the comparability of our gross profit from period to period as a result of translating our financial statements into our +reporting currency, the U.S. dollar. +Selling, general and administrative expenses. Selling, general and administrative expense increased 41.9% to $368.8 million in the +year ended +December 31, 2008, from $259.9 million for the year ended December 31, 2007. As a percentage of net revenues, selling, general and administrative expenses increased to 51.1% in +the year ended December 31, 2008 from 30.7% for the year ended December 31, 2007. This increase was primarily attributable to increases in marketing expenses of $22.3 million, of +which $5.4 million is related to corporate sponsorships and $12.0 million is related to advertising expenses, increases in building expenses of $19.6 million related to additional +retail and office space, increases in salaries and wages of $10.3 million and increases in legal expenses of $16.8 million as a result of increased legal fees for ongoing litigation and +intellectual property enforcement. In addition, total share-based compensation expense was $18.8 million for the year ended December 31, 2008, compared to $21.7 million for the +year ended December 31, 2007. Also included in selling, general and administrative expenses for the year ended December 31, 2008 is a net loss on changes in currency exchange rates for +transactions denominated, and settled or to be settled, in a currency other than the functional currency of the consolidated entity of $25.5 million compared to a net gain on changes in +currency exchange rates of $10.1 for the year ended December 31, 2007. +Changes +in the average foreign currency exchange rates used to translate expenses from our functional currencies to our reporting currency, the U.S. dollar, from 2007 fiscal year to 2008 +fiscal year contributed approximately $3.8 million to our change in selling, general and administrative expenses. We expect operations at consolidated companies with functional currencies other +than the U.S. dollar will continue to represent a substantial portion of our overall business. Accordingly, changes in foreign currency exchange rates could materially affect our overall selling, +general and administrative expenses, or the comparability of our selling, general and administrative expenses from period to period as a result of translating our financial statements into our +reporting currency, the U.S. dollar. +During +the 2008 fiscal year, we took certain actions to reduce our selling, general and administrative expenses. Those actions included; workforce reductions, office space reductions, +and reductions in certain discretionary spending, including discontinuation of certain sponsorship and consulting arrangements. We are continuing to evaluate our operating expenses, including selling, +general and administrative expenses. Should economic conditions further deteriorate or demand for our products decline further, we may experience further declines in revenues and we may take +additional actions to reduce our selling, general and administrative expenses further. +Restructuring charges. We recorded $8.5 million in restructuring charges in the year ended December 31, 2008, of which +$7.6 million was reflected in restructuring charges and $0.9 million was reflected in cost of sales. We did not recognize any restructuring charges during the year ended +December 31, 2007. +During +2008, we announced our decision to restructure our North American operations. This decision included the closure of our Canadian and Brazilian manufacturing facilities and the +consolidation of distribution activities into other existing North American operations. Accordingly, restructuring charges of $1.9 million related to our facility operating leases were +established during the +42 +Table of Contents +year +ended December 31, 2008, as a firm "cease use" date was established relating to these leases. This is our estimated future expense related to the future abandonment of facilities under the +operating leases in accordance with FASB Statement No. 146, Accounting for Costs Associated with Exit or +Disposal Activities. We recorded $2.1 million in the year ended December 31, 2008 related to early termination costs for certain equipment operating leases, cancellation of purchase +obligations and freight and duty charges related to transferring inventory and equipment to the United States and Mexico facilities. Furthermore, we recorded $4.5 million in termination +benefits accounted for in accordance with SFAS 112, Employers' Accounting for Post Employment Benefits—an amendment of FASB Statements No. 5 and 43. +We +established reserves covering future known obligations related to the closure of our Canadian and Brazilian manufacturing operations and the move of our Canadian distribution +operations. Reserves at December 31, 2008 were $2.4 million and have been included in the line items accrued restructuring charges and long-term restructuring in our +consolidated balance sheets. +Impairment charges. Impairment charges were $45.8 million during the year ended December 31, 2008. We did not recognize any +impairment +charges during the year ended December 31, 2007. During 2008, we recognized the following impairment charges: +• A $20.9 million impairment charge on fixed assets, primarily related to equipment and shoe molds. We evaluated our +production capacity at our facilities compared with demand projections and capacity requirements and decided to abandon certain manufacturing equipment that clearly represents excess capacity. The +impairment charge on molds relate to shoe styles that we either no longer intend to manufacture or styles for which we have more molds on hand than necessary to meet projected demand. +• A $0.6 million impairment charge related to patents which we no longer intend to utilize. +• A $0.3 million impairment charge related to the Fury trade name and customer relationships and $0.2 million +related to the Jibbitz trade name. +• $23.8 million write-off of goodwill and other indefinite lived intangible assets, consisting of +$1.0 million in goodwill related to the closure of Fury, and $22.8 million in goodwill written off as a result of an impairment analysis. +Interest expense. Interest expense increased 350.0%, or $1.4 million, to $1.8 million in the year ended December 31, +2008. The +increase in interest expense is the result of larger borrowings against our revolving credit facility for a larger portion of the year in 2008 compared to 2007. +Other income/expense, net. Other income decreased 80.0%, or $2.4 million, to $0.6 million in the year ended December 31, +2008. +The decrease resulted primarily from a decrease in interest bearing cash and cash equivalents. +Income tax expense. During the year ended December 31, 2008, we recognized an income tax benefit of $4.4 million on a +pre-tax loss of $189.5 million, compared to income tax expense of $72.1 million on pre-tax income of $240.3 million for the year ended December 31, +2007. The effective income tax rate was a 2.3% tax benefit rate during the year ended December 31, 2008 compared to a 30.0% tax expense rate during the year ended December 31, 2007. The +decrease in effective tax rate is primarily the result of valuation allowances being recorded on net deferred tax assets in tax jurisdictions where we believe it is not more likely than not that those +tax benefits will be realized, due to our financial outlook as of December 31, 2008 and increases in reserves for uncertain tax positions. +43 +Table of Contents +Comparison of the Years Ended December 31, 2007 and 2006 +Set forth below are the results of operations for the year ended December 31, 2007, as compared to the year ended +December 31, 2006 (in thousands, except for percentages). +(Year Ended December 31,) +2007 +2006 +$ Change +% Change +Revenues +$ +847,350 +$ +354,728 +$ +492,622 +138.9 +% +Cost of sales +349,701 +154,158 +(195,543 +) +(126.8 +) +Gross profit +497,649 +200,570 +297,079 +148.1 +Selling, general and administrative expenses +259,882 +105,224 +(154,658 +) +(147.0 +) +Income (loss) from operations +237,767 +95,346 +142,421 +149.4 +Interest expense +438 +567 +129 +22.8 +Other (income) expenses—net +(2,997 +) +(1,847 +) +1,150 +62.3 +Income (loss) before income taxes +240,326 +96,626 +143,700 +148.7 +Income tax expense (benefit) +72,098 +32,209 +(39,889 +) +(123.8 +) +Net income (loss) +168,228 +64,417 +103,811 +161.2 +Dividend on redeemable convertible preferred shares +— +33 +33 +100.0 +Net income (loss) attributable to common stockholders +$ +168,228 +$ +64,384 +$ +103,844 +161.3 +% +Revenues. Revenues increased 138.9%, or $492.6 million, to $847.4 million, in the year ended December 31, 2007, from +$354.7 million in the year ended December 31, 2006. This increase was primarily a result of significantly higher unit sales of our footwear products in our Asian and European markets +driven by growing awareness and increased acceptance of our brands and products. Unit sales of footwear products increased 117.1% or 25.3 million pairs, to 46.9 million pairs in the year +ended December 31, 2007, from 21.6 million pairs in the year ended December 31, 2006. Sales of our Jibbitz products were $67.5 million in the year ended December 31, +2007. +Our +wholesale channel revenues increased 132.0%, or $420.3 million, to $738.9 million, in the year ended December 31, 2007, from $318.5 million in the year +ended December 31, 2006. This increase was primarily a result of significantly higher unit sales of our footwear products in our Asian and European markets driven by growing awareness and +increased acceptance of our brands and products. +Our +Company-operated retail locations, including retail stores, kiosks and outlets, increased to over 200 locations at December 31, 2007 from just over 95 at December 31, +2006. Total revenue from Company-operated retail locations was $74.2 million in the year ended December 31, 2007, compared to $22.2 million in the year ended December 31, +2006. Revenues from our webstores increased $19.9 million, or 142.1%, to $33.9 million in the year ended December 31, 2007 from $14.0 million in the year ended +December 31, 2006. The increase in revenues during 2007 is due primarily to increased web-based and other marketing efforts aimed at driving consumer awareness of our webstores. +The +majority of our revenues during the year ended December 31, 2007 were attributable to the sale of our classic footwear models. Sales of our classic models increased by +approximately 46.3% during the year ended December 31, 2007 when compared to sales in the year ended December 31, 2006 and now amounted to approximately 30% of total sales, compared to +50% during the year ended December 31, 2006. Sales of footwear product styles introduced in 2007 represented approximately 18.2% or $154.1 million of our overall revenues for the year +ended December 31, 2007. Businesses acquired in 2006 and 2007 contributed approximately $78.6 million to our revenues during the year ended December 31, 2007. +44 +Table of Contents +Changes +in foreign currency exchange rates since December 31, 2006 contributed $22.1 million to our revenues in the year ended December 31, 2007. We expect that +sales in international markets in foreign currencies will continue to represent a substantial portion of our overall revenues. Accordingly, changes in foreign currency exchange rates could materially +affect our overall revenues or the comparability of those revenues from period to period as a result of translating our financial statements into our reporting currency, the U.S. dollar. +Americas Market. Our revenues from domestic sales increased 89.1%, or $240.6 million, to $510.6 million in the year ended +December 31, 2007 compared to $270.0 million for the year ended December 31, 2006. We believe the increase is due to an increase in the number of doors selling our product, new +product offerings, and our business acquisitions. +The +number of Company operated retail locations in the Americas, including retail stores, kiosks and outlets, increased to 153 locations at December 31, 2007 from 83 locations at +December 31, 2006. Revenue from Company operated retail locations increased 126.8%, or $26.5 million, to $47.4 million in the year ended December 31, 2007, from +$20.9 million for the year ended December 31, 2006. Our Company operated retail locations allow us to showcase our entire product offering, which we believe results in better sell +through of new product offerings and increased brand awareness. +Asian Market. Our revenues in Asia increased 199.6%, or $108.6 million, to $163.10 million in the year ended December 31, +2007 +from $54.4 million for the year ended December 31, 2006. Sales in Asia were led by Japan where sales increased 579.2% or $69.5 million, to $81.5 million in the year ended +December 31, 2007, from $12.0 million in the year ended December 31, 2006. We believe this increase can be attributed to the increase in number of doors selling our products, +increased brand awareness and the introduction of our new footwear and other product offerings. +We +increased the number of Company operated retail venues in Asia to 53 locations at December 31, 2007, from 20 locations at December 31, 2006. Revenue from Company +operated retail locations was $26.9 million in the year ended December 31, 2007, up from $1.3 million for the year ended December 31, 2006. +European Market. Our revenues in Europe increased 473.3% or $143.4 million, to $173.7 million in the year ended +December 31, +2007 from $30.3 million for the same period in 2006 We believe this increase can be attributed to the increase in number of doors selling our products, increased brand awareness and the +introduction of our new footwear and other product offerings. +As +of December 31, 2007, we operated 3 retail locations in Europe. Revenue from these Company operated retail locations was $0.3 million in the year ended +December 31, 2007. We did not have any Company operated retail locations in the year ended December 31, 2006. +Gross profit. Gross profit increased 148.1%, or $297.1 million, to $497.6 million, in the year ended December 31, 2007, +from +$200.6 million in the year ended December 31, 2006 due primarily to higher revenues. Our gross profit margin increased to 58.7% in the year ended December 31, 2007, compared to +56.6% in the year ended December 31, 2006. This increase in margin was primarily attributable to increases in direct and international sales and the addition of Jibbitz, where we recognize +higher margins on sales. +Changes +in foreign currency exchange rates since December 31, 2006 increased our gross margin by $11.8 million while causing our gross profit margin to decline in the year +ended December 31, 2007 to 58.6%. We expect that sales at subsidiary companies with functional currencies other than the U.S. dollar will continue to generate a substantial portion of our +overall gross profit. Accordingly, changes in foreign currency exchange rates could materially affect our overall gross profit or the comparability of our gross profit from period to period as a +result of translating our financial statements into our reporting currency, the U.S. dollar. +45 +Table of Contents +Selling, general and administrative expenses. SG&A increased 147.0% or $154.7 million, to $259.9 million, or 30.7% of +sales, in the +year ended December 31, 2007, from $105.2 million, or 29.7% of sales in the year ended December 31, 2006. The increase in SG&A as a percentage of sales is a result of our +strategic decision to increase our global marketing spend and increased expenses associated with developing market opportunities in Brazil, China, Russia and India. This increase was also a result of +higher costs associated with increased sales volumes, and expanding operations, including an increase in selling and marketing expenses of $40.4 million and increases in personnel expenses of +$70.9 million. In addition, professional and consulting fees increased approximately $20.8 million, primarily as a result of increased legal fees related to defending our intellectual +property, accounting fees, contract labor and consultants. In addition, share-based compensation expense was $21.7 million for the year ended December 31, 2007, compared to +$10.3 million for the year ended December 31, 2006. +Changes +in the average foreign currency exchange rates used to translate expenses from our functional currencies to our reporting currency, the U.S. dollar, from 2006 fiscal year to 2007 +fiscal year contributed approximately $5.6 million to our change in selling, general and administrative expenses. We expect operations at consolidated companies with functional currencies other +than the U.S. dollar will continue to represent a substantial portion of our overall business. Accordingly, changes in foreign currency exchange rates could materially affect our overall selling, +general and administrative expenses, or the comparability of our selling, general and administrative expenses from period to period as a result of translating our financial statements into our +reporting currency, the U.S. dollar. +Interest expense. Interest expense was approximately $438,000 in the year ended December 31, 2007, compared to approximately +$567,000 in the +year ended December 31, 2006. Interest expense decreased due to our use of a portion of the proceeds from our initial public offering in 2006 to retire bank loans. This debt retirement led to a +decrease in average borrowings outstanding on our line of credit and long term debt during the year ended December 31, 2007 compared to average borrowings outstanding under those arrangements +during the year ended December 31, 2006. +Other income/expense, net. Other income was $3.0 million in the year ended December 31, 2007, compared to income of +$1.8 million +in the year ended December 31, 2006. The increase primarily resulted from a refund due to a change in our tax filing position related to value added taxes in our international locations. +Income tax expense. In the year ended December 31, 2007, income tax expense was $72.1 million, representing an effective +income tax +rate of 30.0%, compared to income tax expense of $32.2 million in the year ended December 31, 2006, representing an effective income tax rate of 33.3%. The decrease relates primarily to +an increase in the pre-tax earnings in jurisdictions with lower relative income tax rates as a percentage of total pre-tax earnings. +Liquidity and Capital Resources +The accompanying audited consolidated financial statements for the year ended December 31, 2008 were prepared under the +assumption that we will continue to operate as a going concern, which contemplates the realization of assets and the liquidation of liabilities in the normal course of business. At December 31, +2008, we had $51.6 million in cash and cash equivalents. We have $22.4 million in borrowings outstanding under our Revolving Credit Facility which has no further available borrowings. On +February 13, 2009, we entered into Amendment No. 9 to the Revolving Credit Facility, extending the maturity date on this facility to April 2, 2009, at which time we will be +required to pay all amounts then outstanding. Prior to April 2, 2009, we are required to make five installment payments of $0.2 million each on dates agreed upon by us and Union Bank of +California, N.A. +46 +Table of Contents +We +are currently in discussions to obtain an asset backed credit facility to replace the existing Revolving Credit Facility. The time period required to procure a new asset backed credit +facility may extend beyond the maturity date of our current Revolving Credit Facility, requiring us to seek an extension of that maturity date with our current lenders. We are also exploring other +means of raising capital including equity financing. There can be no assurance that we will be able to secure additional debt or equity financing or receive an extension of the current Revolving +Credit Facility by or before the date of maturity of the Revolving Credit Facility and, accordingly, our liquidity and ability to timely pay its obligations when due could be adversely affected. +Additionally, +we are currently evaluating our operating plans for 2009 and considering certain restructuring and right-sizing activities to address the potential for continued decreases +in revenues. Our ability to continue as a going concern is dependent upon achieving a cost structure which supports the levels of revenues we are able to achieve. Our ability to return to +profitability is dependent on the timely completion of these activities and there can be no assurance that any actions taken by us will result in a return to profitability. As discussed in the +previous paragraphs, we face various uncertainties that raise substantial doubt about our ability to continue as a going concern. These accompanying consolidated financial statements do not include +any adjustments that may result from the outcome of these uncertainties. +We +incurred losses of $185.1 million in the year ended December 31, 2008 and experienced a decline in revenues from $847.4 million for the year ended +December 31, 2007 to $721.6 million for the year ended December 31, 2008. During the year ended December 31, 2008, we took certain actions to reduce our operating cost +structure in response to declining revenues. Those actions included the closing of our Canadian and Brazilian manufacturing operations, personnel reductions, and reductions in certain +discretionary spending. Should revenues continue to decline in future periods, we may be required to take further cost reduction actions in order to maintain a level of liquidity necessary to meet our +ongoing operational needs. +We +experienced rapid growth in our revenues and earnings from our inception through December 31, 2007 and had difficulty meeting customer demand for our footwear products. During +this period, we significantly increased production capacity, warehouse space and inventory in an effort to meet demand. This pattern changed in 2008. During the three months ended March 31, +2008 revenue growth moderated and during the three months ended June 30, 2008, revenues declined compared to 2007. This trend continued and accelerated during the remainder of 2008. Our total +revenues declined during the year ended December 31, 2008 on a 24.7% decline in the total number of footwear units sold compared to the previous year, which was attributable in large part to +deteriorating global economic conditions, lessened demand for our products and difficulty marketing our expanded product line. Due to the decline in revenues, we incurred various one-time +cash and non-cash restructuring and impairment costs as we took steps to right-size our production and distribution capacity. We incurred losses of $185.1 million in the +year ended December 31, 2008 and we expect to incur additional operating losses during the quarter ended March 31, 2009 as year-over-year revenue declines +continue to occur. We may incur additional losses through 2009. +Continued +declines in revenues could have a material adverse effect on our operating results, cash flow and our ability to raise capital. We cannot fully anticipate future conditions +given the substantial uncertainties in the credit markets and the economy in general. We may have unexpected costs and liabilities; revenue and cash provided by operations may decline; economic +conditions may continue to weaken; and competitive pressures may increase, resulting in difficulty maintaining liquidity. Due to recent turmoil in the credit markets and the continued decline in the +economy, we may not be able to obtain additional financing on terms that are acceptable to us or at all. +Seasonal +variations in product demand and the associated changes in operating assets and liabilities in response to such seasonal variations may directly and adversely affect our cash +flows from +47 +Table of Contents +operating +activities. Accordingly, cash flows from operating activities for any period are not necessarily indicative of cash flows from operating activities to be expected for any other period. We +are actively reviewing our expenses to ensure that future operations reflect expenses, both in cost of sales and selling, general and administrative expenses, which are commensurate with our revenues. +We will continue to evaluate the need for additional restructuring of our business in order to meet this objective. Any such restructuring activities may have a material adverse impact on our cash +flows and capital resources. +The +changes in the global economy could also affect our customers' liquidity and capital resources and their ability to meet their payment obligations to us, which in turn would decrease +their credit terms and our ability to collect our accounts receivable, which may have a material adverse impact on our +cash flows and capital resources. We continue to monitor our accounts receivable aging and have recorded reserves as we deem appropriate. +We +are a global business with operations in many different countries, which requires cash accounts to be held in various different currencies. The global market has recently experienced +many fluctuations in foreign currency exchange rates which impacts our results of operations and cash positions. The future fluctuations in foreign currencies may have a material impact on our cash +flows and capital resources. Cash balances held in foreign countries have additional restrictions and covenants associated with them, which adds increased strains on our liquidity and ability to +timely access and transfer cash balances between entities. +Most +of the amounts held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal income taxes, less applicable foreign tax credits. +In some countries repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. Certain countries, +including China, may have monetary laws which may limit our ability to utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully +utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. +We +have entered into various sponsorship agreements and operating leases that require cash payments on a specified scheduled. Over the next five years we will make payments of +$137.1 million related to our operating lease agreements and $22.7 million related to our corporate sponsorship agreements. See "Contractual Obligations" below. We plan to continue to +enter into operating leases related to our retail stores. Our evaluation of cost reduction opportunities will include an evaluation of contracts for sponsorships, operating lease contracts and other +contracts that require future minimum payments resulting in fixed operating costs. Any changes to these contracts may require early termination fees or other charges that could result in significant +cash expenditures. +Our +inventories decreased to $143.2 million at December 31, 2008, from $248.4 million as of December 31, 2007. In 2008, as the result of +less-than-previously-anticipated sales, we have been actively managing our inventory levels through decreased production and actively selling through our existing inventory +with the goals of decreasing inventories and increasing our cash position. We expect new product introductions, limitations on production capacities and seasonal variations may cause our inventory to +increase or decrease materially in the future as we adjust to meet changing market conditions. We believe our inventory levels will continue to decrease in 2009 due to projected sales and inventory +management plans. In addition to these activities to manage our inventory, we recognized $76.3 million of inventory write-down charges and an additional $4.2 million in +charges related to losses on future purchase commitments for inventory with a market value lower than cost, of which $2.1 million was included as an accrued expense, for the year ended +December 31, 2008. +We +intend to continue to evaluate our product offerings to develop product collections in assortments that can be merchandised effectively to the consumer at our retailer and Company +operated stores. As such, we expect that our future product offerings will be more focused by category +48 +Table of Contents +and +for color palette and the number of color combinations will be reduced in our seasonal offerings. During the years ended December 31, 2008 and 2007, we had capital expenditures of +$55.6 million and $57.4 million, respectively, related to the build out our global infrastructure and to support our planned future growth. We also had expenditures of +$10.7 million and $16.5 million for the years ended December 31, 2008 and 2007, respectively, in related capital costs for internally developed software intangibles. We will +continue to make ongoing capital investments in molds and other tooling equipment related to manufacturing new products and footwear styles as well as those related to opening additional retail +stores; however, we plan to reduce our expenditures in our distribution, manufacturing and software development efforts due to our reduction in revenues. We plan to continue to selectively invest in +information technology systems that will increase efficiencies as well as increase the operating effectiveness of our manufacturing, warehousing, and distribution operations. We expect to continue to +invest in our global information systems infrastructure to further strengthen our management information and financial reporting capabilities. +Over +the past two years we have developed or acquired businesses, such as Jibbitz, Bite, Tagger, Ocean Minded and EXO and we may acquire other business in the future that we believe are +complementary to our own. On June 26, 2007, we amended the membership interest purchase agreement ("Purchase Agreement") with Jibbitz, to amend the terms of the potential earn-out +consideration included in the Purchase Agreement. The amendment removed the earnings targets for payment of the earn-out with $3.5 million payable on the effective date of the +amended Purchase Agreement and the remaining $6.5 million payable over the following thirteen months, for a total payment of $10.0 million. The earn-out was fully paid as of +July 2008. The agreements for the acquisitions of Ocean Minded and Bite contain contingent earn-out amounts of up to $3.75 million and $1.75 million, respectively, which are +required to be paid as an additional cost of the acquisition if the business units achieve certain specified earnings targets in future periods. No material amounts have been paid or accrued in +relation to the Ocean Minded or Bite acquisitions as earning targets were not achieved. We may have to make future payments under these earn-out arrangements. +In +April 2008, we acquired substantially all of the assets of Tidal Trade, Inc ("Tidal Trade"), our third party distributor in South Africa, for $4.6 million and acquired +substantially all of the assets of Tagger, a private limited liability company incorporated under the laws of The Netherlands, for $2.0 million. There are no contingent earn-out +provisions related to these two acquisitions. +We +anticipate that cash flows from operations will be sufficient to meet the ongoing needs of our business through March 31, 2009. In order to provide liquidity beyond +March 31, 2009, we are exploring alternatives for a new borrowing arrangement or an extension of our existing Revolving Credit Facility and are currently negotiating with financial institutions +to obtain an asset backed lending arrangement. We may also explore other sources for capital to meet our ongoing needs. There can be no assurance that any such capital will be available to us on +acceptable terms or at all especially due to current +conditions and uncertainty in the global credit markets. Our ability to fund working capital needs, planned capital expenditures and scheduled debt payments depends on our future operating performance +and cash flow, which in turn are subject to prevailing economic conditions and to financial, business and other factors, some of which are beyond our control. Our inability to secure financing before +the April 2, 2009 maturity date of our Revolving Credit Facility or obtain an extension may result in a material adverse effect on our financial condition. +49 +Table of Contents +Off-Balance Sheet Arrangements +Our operating lease obligations, which include various building and equipment transactions, are not reflected on our balance sheet. See +"Contractual Obligations" below for further detail. +We +also guarantee payments to our third-party manufacturer in China for purchases of material for the manufacture of finished shoe products, which is not reflected on our balance sheet. +The maximum potential amount of future payments that we could be required to make under the guarantee is € 2.1 million (approximately $3.0 million). See +Note 15 in the consolidated financial statements for further discussion. +At +December 31, 2008, we had purchase commitments with our third party manufacturers for $14.0 million in inventory. Approximately $2.1 million of this commitment +was for certain products at prices in excess of net realizable value, given our plans for sales of the product. Accordingly, $2.1 million was recorded related to expected losses on future +purchase commitments and is included in accrued expenses at December 31, 2008. On July 26, 2005, we entered into an amended and restated four-year supply agreement with +Finproject S.P.A., the former majority owner of Crocs +Canada, in which we have the exclusive right to purchase the material for the manufacture of finished shoe products, except for certain current customer dealings (including boot manufacturers). Based +on the supply agreement, we have contractual purchase requirements to maintain exclusivity throughout the term of the agreement. The pricing is to be agreed upon each quarter and fluctuates based on +order volume, currency fluctuations, and raw material prices. +We +do not believe that these arrangements are material to our current or future financial condition, results of operations, liquidity, capital resources or capital expenditures. +Contractual Obligations +The following table discloses aggregate information about our contractual cash obligations as of December 31, 2008 and the +periods in which payments are due (in thousands): +Payments due by period +Total +Less than +1 year +1-3 +years +3-5 +years +More than +5 years +Operating Lease Obligations +$ +179,316 +$ +47,559 +$ +62,630 +$ +26,915 +$ +42,212 +Corporate Sponsorships(1) +22,737 +6,662 +10,760 +5,315 +— +Revolving Credit Facility(2) +23,123 +23,123 +— +— +— +Minimum Licensing Royalties(3) +3,830 +2,753 +1,051 +26 +— +Purchase Obligations(4) +19,261 +19,261 +— +— +— +FIN 48 estimated liability(5) +28,210 +— +24,456 +1,905 +1,849 +Capital Lease Obligations +9 +9 +— +— +— +Total +$ +276,486 +$ +99,367 +$ +98,897 +$ +34,161 +$ +44,061 +(1) Includes +sponsorships such as AVP and collegiate sports teams. +(2) On +February 13, 2009, we signed Amendment No. 9 to the Revolving Credit Facility, thereby extending the maturity date of the Revolving Credit +Facility to April 2, 2009. The facility bore interest at a rate of 12.25% per annum at December 31, 2008. Amount includes $0.7 million in projected interest based on the best +known interest rates at the date of filing. +(3) Includes +royalties relating to licensing agreements with companies such as Disney, MLB, MBA and Nickelodeon. +(4) Represents +our purchase obligation to buy back inventory from a distributor as a result of the termination of our distributor agreement, which will be paid +during the first 9 months of 2009 and the current purchase commitments with third party manufacturers. +50 +Table of Contents +(5) Represents +estimated liabilities as a result of the our adoption of the Financial Accounting Standards Board ("FASB") issued FASB Interpretation +No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"). +Excluded +from the table above is the contingent cash purchase price of up to $3.75 million for Ocean Minded and $1.75 million for Bite, related to the earn-out +provisions of the agreements, see Note 6—Acquisitions in the consolidated financial statements for further discussion. These amounts were excluded from the above contractual +obligations table as Ocean Minded and Bite have not achieved the earnings targets for the earn-out provisions of the agreement as of December 31, 2008. +We +also guarantee payments to our third-party manufacturer in China for purchases of material for the manufacture of finished shoe products, which is also excluded from the table. The +maximum potential amount of future payments the Company could be required to make under the guarantee is € 2.1million, approximately $3.0 million. See +Note 15—Commitments and Contingencies in the consolidated financial statements for further discussion. +Critical Accounting Policies and Estimates +Our financial statements have been prepared in accordance with accounting principles generally accepted in the U.S., which require us +to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure at the date of our financial statements. On an ongoing basis, we +evaluate our estimates and judgments, including those related to revenue, intangible assets, and stock compensation. We base our estimates and judgments on historical experience and on various other +factors that we believe to be reasonable under the circumstances, the results of which form the basis of our judgments about the carrying values of assets and liabilities that are not readily apparent +from other sources. Actual results or changes in the estimates or other judgments of matters inherently uncertain that are included within these accounting policies could result in a significant +change to the information presented in the consolidated financial statements. We believe that the estimates and assumptions below are among those most important to an understanding of our consolidated +financial statements contained in this report. +We +consider certain accounting policies related to revenue recognition, reserves for uncollectible accounts receivable, sales returns, allowances and discounts, inventory valuation, +share-based compensation, income taxes and goodwill and other intangible assets, impairment of long-lived assets, acquisitions and restructuring charges to be critical policies due to the +estimates and judgments involved in each. +Revenue Recognition. The majority of our revenues are derived from wholesale sales to retailers. Our standard arrangement for our +customers includes +a valid purchase order or contract with no customer acceptance provisions. We recognize revenues from sales of products when: +• we enter into an agreement with a customer or persuasive evidence of an arrangement exists; +• delivery has occurred; +• customer payment is deemed fixed or determinable and free of contingencies or significant uncertainties; +• collection is reasonably assured; and +• title passes on shipment or on receipt by the customer depending on the arrangement with the customer. +Reserves for uncollectible accounts receivable. We make ongoing estimates relating to the collectability of our accounts receivable and +maintain a +reserve for estimated losses resulting from the inability of our customers to make required payments. In determining the amount of the reserve, we consider our historical level of credit losses and +make judgments about the creditworthiness of significant customers based on ongoing credit evaluations. Since we cannot predict future changes in +51 +Table of Contents +the +financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates and we may experience changes in the amount of reserves we recognize for +accounts +receivable we deem uncollectible. If the financial condition of some of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the +event we determine that a smaller or larger reserve is appropriate, we would record a credit or a charge to selling, general and administrative expenses in the period in which we made such a +determination. We may also accept returns from our wholesale and distributor customers, on an exception basis at the sole discretion of management for the purpose of stock re-balancing to +ensure that our products are merchandised in the proper assortments. Additionally, at the sole discretion of management, we may provide markdown allowances to key wholesale and distributor customers +to facilitate the "in-channel" markdown of products where we have experienced less than anticipated sell-through. +Sales Returns, Allowances and Discounts. We record reductions to revenue for estimated customer returns, allowances and discounts. We +base our +estimates on historical rates of customer returns and allowances as well as the specific identification of outstanding returns that have not yet been received by us. We base our estimates for customer +returns and allowances primarily on anticipated sales volume throughout the year. The actual amount of customer returns and allowances, which is inherently uncertain, may differ from our estimates. If +we determined that actual or expected returns or allowances were significantly greater or lower than the reserves we had established, we would record a reduction or increase, as appropriate, to net +sales in the period in which we made such a determination. Provisions for customer specific discounts based on contractual obligations with certain major customers are recorded as reductions to net +sales. We also record reductions to revenue for estimated customer credits as a result of price mark-downs in certain markets. Fluctuations in our estimates for sales returns, allowances +and discounts may be caused by many factors, including, but not limited to, fluctuations in our sales revenue, changes in demand for our products and customer acceptance of new products we offer. +Inventory Valuation. At least quarterly, we analyze our inventory positions and make estimates regarding the net realizable value of +our inventories +and, if necessary, adjust them to the lower of cost or market. Our estimate of the net realizable value for our excess and discontinued products is based on significant judgments made by management +based on industry experience considering only limited company-specific historical experience with the sell-through of such products to liquidation or other "off-price" +channels. The ultimate results achieved in selling excess and discontinued products in future periods may differ significantly from management's estimates of net realizable value as of +December 31, 2008. Fluctuations in our estimated net realizable value of our inventory may be caused by multiple factors, including, but not limited to, changes in company-specific experience +with the sell-through of products, global and regional economic conditions, and demand for our products or shifting demand between the products we offer. Declines in the estimated net +realizable value of our inventory, if the declines result in a write-down of our inventory balance, could have a significant effect on our reported financial results. +From +our inception and through 2007, we experienced substantial growth due to the high consumer demand for our core products and our expansion into new markets globally. During the year +ended December 31, 2008, we experienced a decline in demand due to the current economic downturn and the challenges we face in merchandising our expanded product lines in existing wholesale +channels as well as lessening demand for our products as such products reach a more mature stage in their product life and competitors enter the market with imitation products that are sold at +substantially lower prices. Based on our estimate, we recorded additional inventory write-downs during the year ended December 31, 2008, of $76.3 million and an additional +$4.2 million in charges related to losses on future purchase commitments for inventory with a market value lower than cost, of which $2.1 million was included as accrued expenses, for +the year ended December 31, 2008. Please refer to +52 +Table of Contents +Note 3 +of our Consolidated Financial Statements set forth in the "Index To Consolidated Financial Statements" of this Form 10-K. +Stock-Based Compensation. Effective January 1, 2006, we adopted Statement of Financial Accounting Standards ("SFAS") No. 123R, +Share-Based Payment, ("SFAS 123R"), which requires recognition of the fair value of share-based compensation over the vesting period of the +option. We adopted the prospective method for all stock option grants issued prior to August 15, 2005, which was the date we initially filed a Registration Statement on +Form S-1 with the SEC in connection with our initial public offering. Prior to August 15, 2005, we used the minimum value method of measuring equity share options and similar +instruments for either recognition or pro forma disclosure purposes. We continue to account for any portion of awards outstanding at the date of initial application using the accounting principles +originally applied to those awards which were the provisions of APB 25 and its related interpretive guidance. +For +stock option grants issued after August 15, 2005, we applied the modified prospective method. Under this method we use the Black-Scholes valuation model to determine the fair +value of our stock options, which requires assumptions to be made regarding our stock price volatility, the expected life of the option and expected dividend rates. The volatility assumptions were +derived from our historical volatilities and historical volatilities of competitors whose shares are traded in the public markets. If factors change and we use different assumptions for estimating +share-based compensation in future periods, share-based compensation expense may differ materially in the future from that recorded in the current period. The amount of stock-based compensation +expense recognized during any fiscal period can fluctuate based on, among other things, future stock option grants, changes in our estimated forfeiture rate pursuant to SFAS 123R, and changes +in the assumptions used in the Black-Scholes valuation model for future stock option grants. Because the calculation of the estimate for stock-based compensation is reliant on multiple inputs, which +in some cases are, themselves, estimates, an increase or decrease in any of these variables could have a significant effect on the amount of expense recognized during a reporting period. +Income Taxes. In July 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"). Effective January 1, 2007, we adopted FIN 48, which prescribes a +comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. +Though the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. Because of +this, whether a tax position will ultimately be sustained may be uncertain. Under FIN 48, the impact of an uncertain tax position that is more likely than not of being sustained upon +examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the +position has less than a 50% likelihood of being sustained. Also, under FIN 48, interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. The adoption +of FIN 48 did not have a material impact on our consolidated balance sheet, statement of operations or cash flows. +Our +annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is +required in determining our annual tax expense and in evaluating our tax positions. We establish reserves at the time we determine it is probable we will be liable to pay additional taxes related to +certain matters. We adjust these reserves, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. +Tax +laws require items to be included in our tax returns at different times than when these items are reflected in the consolidated financial statements. As a result, the annual tax rate +reflected in our consolidated financial statements is different than that reported in our tax return (our cash tax rate). +53 +Table of Contents +Some +of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences +create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax basis of assets and liabilities. +The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year in which the differences are expected to reverse. Based on the evaluation of all +available information, we recognize future tax benefits, such as net operating loss carry forwards, to the extent that realizing these benefits is considered more likely than not. +We +evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating +results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to +be established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. +Undistributed +earnings of a subsidiary are accounted for as a temporary difference, except that deferred tax liabilities are not recorded for undistributed earnings of a foreign +subsidiary that are deemed to be indefinitely reinvested in the foreign jurisdiction. We have formulated a specific plan for reinvestment of undistributed earnings of our foreign subsidiaries which +demonstrates that such earnings will be indefinitely reinvested in the applicable tax jurisdictions. Should we change our plans, we would be required to record a significant amount of deferred tax +liabilities. +We +recognize interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statement of operations. Accrued interest and +penalties are included within the related tax liability line in the consolidated balance sheet. +Goodwill and Other Intangible Assets. In accordance with SFAS No. 142, Goodwill and Other Intangible +Assets ("SFAS 142"), goodwill and intangible assets with indefinite lives are not amortized but are instead measured for impairment at least annually, or when events +indicate that an impairment exists. As required by SFAS 142, in our impairment tests for goodwill and other indefinite-lived intangible assets, we compare the estimated fair value of goodwill +and other intangible assets to their carrying value. If the carrying value exceeds our estimate of fair value, we calculate impairment as the excess of the carrying value over our estimate of fair +value. Our estimates of fair value utilized in goodwill and other indefinite-lived intangible asset tests may be based upon a number of factors, including our assumptions about the expected future +operating performance of our reporting units. Our estimates may change in future periods due to, among other things, technological change, economic conditions, and changes to our business operations +or inability to meet business plans. +During +the three month period ended September 30, 2008, our stock price declined substantially, which represented a triggering event for potential goodwill impairment. As of +September 30, 2008, we performed an interim goodwill impairment evaluation, as required under FASB Statement No. 142, Goodwill and Other Intangible +Assets ("SFAS 142"). Based on that evaluation we concluded our goodwill was impaired and we recorded a charge of $22.8 million, which was our entire goodwill +balance as of September 30, 2008. Please refer to Note 5 of our Condensed Consolidated Financial Statements set forth in the "Index To Consolidated Financial Statements" of this +Form 10-K. +Intangible +assets that are determined to have definite lives, such as customer relationships, core technology, capitalized software, patents and non-compete agreements are +amortized over their useful lives and are measured for impairment only when events or circumstances indicate the carrying value may be impaired. In these cases, we estimate the future undiscounted +cash flows to be derived from the asset to determine whether or not a potential impairment exists. If the carrying value exceeds our estimate of future undiscounted cash flows, we then calculate the +impairment as the excess of the carrying value of the asset over our estimate of its fair value. +54 +Table of Contents +Impairment of Long-Lived Assets. In accordance with SFAS No. 144, Accounting for the Impairment of +Disposal of Long-Lived Assets, ("SFAS 144"), we estimate the future undiscounted cash flows to be derived from an asset to assess whether or not a potential +impairment exists when events or circumstances indicate the carrying value of a long-lived asset may be impaired. If the carrying value exceeds the estimate of future undiscounted cash +flows, we calculate the impairment as the excess of the carrying value of the asset over the estimate of its fair value. Recoverability of assets to be held and used is measured by a comparison of the +carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by +the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. +Fair value is determined by independent third party appraisals, projected discounted cash flows, or other valuation techniques as appropriate. +During +the year ended December 31, 2008, we recognized an impairment charge of $20.9 million on fixed assets, primarily related to equipment and shoe molds. Management +evaluated the production capacity at Company-operated facilities compared with demand projections and capacity requirements and made the decision to abandon certain manufacturing equipment that +represented excess capacity. The impairment charge on molds relates primarily to shoe styles that we either no longer intends to manufacture or to styles for which we have more molds on hand than is +necessary to meet projected demand. These charges are recorded in the impairment charges line item of the consolidated statement of operations for the year ended December 31, 2008, and are +accounted for as assets to be abandoned in accordance with SFAS 144. Also refer to Note 8 of our Consolidated Financial Statements set forth in the "Index To Consolidated Financial +Statements", of this Form 10-K. +Due +to the nature of impairment charges, changes in the liabilities and expenses related to these charges incurred between reporting periods can be significant as they are driven by, +among other things, changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product or shifting demand between different products we offer +and other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets. Likewise, significant impairment charges +recognized during a reporting period could have adversely affected our reported financial results. +Restructuring Charges. We recognize restructuring charges related to our plans to close manufacturing and administrative facilities +according to SFAS +No. 112, Employers' Accounting for Postemployment Benefits—an amendment of FASB Statements No. 5 and 43 ("SFAS 112"). +In connection +with these activities, we recognize restructuring charges for employee termination costs, long-lived asset impairment and other restructuring-related costs. We also recognize restructuring +charges related to our future expense related to the future abandonment of facilities under the operating leases in accordance with FASB Statement No. 146, Accounting +for Costs Associated with Exit or Disposal Activities ("SFAS 146"). During the year ended December 31, 2008, we recorded $8.6 million in restructuring +charges associated with the closure of the Canadian and Brazilian manufacturing facilities. Please refer to Note 8 of our Consolidated Financial Statements set forth in the "Index To +Consolidated Financial Statements" of this Form 10-K. +The +recognition of these restructuring charges require that we make certain judgments and estimates regarding the nature, timing and amount of costs associated with the planned exit +activity. To the extent our actual results in exiting these facilities differ from our estimates and assumptions, we may be required to revise the estimates of future liabilities, requiring the +recognition of additional restructuring charges or the reduction of liabilities already recognized. At the end of each reporting period, we will evaluate the remaining accrued balances to ensure that +no excess accruals are retained and the utilization of the provisions are for their intended purpose in accordance with developed exit plans. Due to the nature of restructuring charges, changes in the +liabilities and expenses related to these charges incurred between reporting periods can be significant as they are driven by, among other +55 +Table of Contents +things, +our strategic operational and financial decisions, global and regional economic conditions, staffing levels relative to demand for our products and other corporate initiatives which may +eliminate the need for certain assets or staff positions in our locations. Significant restructuring charges could adversely affect our reported financial results in the reporting period in which the +charges are recognized and, to the extent we are required to make future cash payments for items such as severance and lease buyouts or penalties, could adversely affect our liquidity. +Recent Accounting Pronouncements +In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement +("SFAS 157"), which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value +measurements. SFAS 157 is effective for financial statements issued for the first annual or interim reporting period beginning after November 15, 2007. We have adopted SFAS 157 +effective January 1, 2008. We have evaluated the impact of this new standard and the adoption did not have a material impact on our consolidated financial position or results of operations. +In +February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities +("SFAS 159"). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. We have adopted SFAS 159 beginning January 1, +2008. +We have evaluated the impact of this new standard and the adoption did not have a material impact on our consolidated financial position or results of operations. +In +December 2007, the FASB issued SFAS No. 141(R), Business Combinations ("SFAS 1411(R)"), which amends SFAS No. 141, +and provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any non-controlling interest in the acquiree. It also +provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for the fiscal +year beginning January 1, 2009 and is to be applied prospectively. We are currently evaluating the potential impact of adopting this statement on its consolidated financial position, results of +operations and cash flows. We do not expect that the adoption will have a material impact on our consolidated financial position or results of operations. +In +December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements- an amendment of ARB +No. 51 ("SFAS 160") which establishes accounting and reporting standards pertaining to ownership interests in subsidiaries held by parties other than the parent, +the amount of net income attributable to the parent and to the non-controlling interest, changes in a parent's ownership interest, and the valuation of any retained +non-controlling equity investment when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests +of the parent and the interests of the non-controlling owners. SFAS 160 is effective for the fiscal year beginning January 1, 2009. We are currently evaluating the impact +this new standard will have on our consolidated financial position, results of operations and cash flows. We do not expect that the adoption will have a material impact on our consolidated financial +position or results of operations. +In +March 2008, the FASB issued FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities +("SFAS 161"), which is intended to improve financial reporting regarding derivative instruments and hedging activities by requiring enhanced disclosures to provide transparency to these +activities and their effects on an entity's financial position, financial performance and cash flows. The provisions of SFAS 161 are effective for our fiscal year beginning January 1, +2009. We are currently evaluating the impact this new standard will have on its consolidated financial position, results of operations and cash flows. We do not expect that the adoption of +SFAS 161 will have a material impact on its consolidated financial position or results of operations. +56 +Table of Contents +In +May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles ("SFAS 162"), which +identifies the sources of accounting principles and the framework for selecting principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity +with GAAP. SFAS 162 emphasizes that an organization's management and not +its auditors has the responsibility to follow GAAP and categorizes sources of accounting principles that are generally accepted in descending order of authority. We will be required to adopt +SFAS 162 within 60 days following the Securities and Exchange Commission's ("SEC") approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The +Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. AU Section 411 has not yet been approved by the SEC. We do not expect SFAS 162 to materially impact +our consolidated financial statements. +In +December, 2008, the FASB issued FASB Staff Positions ("FSP") FIN 46(R)-8, Interests in Variable Interest Entities and FSP +FAS 140- 4, Disclosures about Transfers of Financial Assets, which will increase disclosure requirements for public reporting companies for reporting periods +that end after December 15, 2008. This FSP amends SFAS 140, to require public entities to provide additional disclosures about transfers of financial assets and variable interests in +qualifying special-purpose entities. It also amends FIN 46(R) to require public enterprises to provide additional disclosures about their involvement with variable interest entities. We adopted +the requirements of FSP FAS 140-4 and FSP FIN 46(R) beginning January 1, 2008. The adoption of FSP FAS 140-4 and FSP FIN 46(R) did not have a +material impact on our consolidated balance sheet, statement of operations or cash flows. +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Credit and Interest Rate Risk +We are exposed to interest rate risk to the extent that interest rates change due to inflation or other factors. This exposure is +directly related to our normal operating and funding activities. As of December 31, 2008, the effective interest rate on our Revolving Credit Facility was 12.25%. The interest payable on our +Revolving Credit Facility is determined based on the lender's applicable reference rate plus 9.0%, and, therefore, is affected by changes in market interest rates. As of December 31, 2008, we +had $22.4 million outstanding on our Revolving Credit Facility. Based on this aggregate amount borrowed as of December 31, 2008, we would have a resulting decline in future annual +earnings and cash flows of approximately $0.2 million for every 1% increase in the lender's reference lending rate. +We +earned interest income of $0.4 million on our cash and cash equivalents during the year ended December 31, 2008. We have performed a sensitivity analysis to estimate our +exposure to market risk of interest rates, and if the weighted average rate of return on cash and cash equivalents, and restricted +cash, were to increase or decrease by 1%, the impact on interest income would be approximately $0.6 million, net of tax during the year ended December 31, 2008. +Please +also refer to Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations, Liquidity," for a discussion of risks related to the recent +global economic downturn and the current state of the credit markets +Foreign Currency Exchange Risk +We have significant revenues from foreign sales in recent periods. While the majority of expenses attributable to our foreign +operations are paid in the functional currency of the country in which such operations are conducted, we pay the majority of our overseas third-party manufacturers in U.S. dollars. Our ability to sell +our products in foreign markets and the U.S. dollar value of the sales made in foreign currencies can be significantly influenced by foreign currency fluctuations. A decrease in the value of foreign +currencies relative to the U.S. dollar could result in downward price pressure for our products or losses from currency exchange rates. We have performed a sensitivity analysis to estimate our +exposure to market risk of foreign exchange rates. If the U.S. dollar were to increase or decrease, +57 +Table of Contents +as +applicable, in value by 1%, the impact on international sales of $403.7 million during the year ended December 31, 2008 would have been an increase or decrease in consolidated +revenues by $3.9 million. The volatility of the applicable exchange rates are dependent on many factors that cannot be forecast with reliable accuracy. In the event our foreign sales and +purchases increase and are denominated in currencies other than the U.S. dollar, our operating results may be affected by fluctuations in the exchange rate of currencies we receive for such sales. +Please see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for a discussion of the impact of foreign exchange rate variances experienced in the +year ended December 31, 2008. We may, in the future, engage in foreign exchange hedging contracts to reduce our economic exposure to changes in exchange rates. If we do engage in foreign +exchange hedging, the foreign exchange hedging contracts will be entered into to hedge specific commitments and anticipated transactions but not for speculative or trading purposes. As of +December 31, 2008, we did not have any foreign exchange hedging contracts. +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the "Index To Consolidated Financial Statements" on +page F-1. +ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial +Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and +15d-15(e) under the Exchange Act, as of the end of the period covered by this annual report (the "Evaluation Date"). Based on this evaluation, our Chief Executive Officer and Chief +Financial Officer concluded that as of the Evaluation Date, our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, +required to be disclosed in our Securities and Exchange Commission ("SEC") reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, +and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required +disclosure. +Management's Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate control over financial reporting, as defined in Exchange Act +Rules 13a-15(f) and 15d-15(f). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2008, using the +criteria set forth in the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway +Commission (COSO). Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2008. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting, which is +included herein. +Changes in Internal Control Over Financial Reporting +During the three months ended December 31, 2008, we did not make any changes to our internal control over financial reporting +that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +58 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2008, based on criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's +management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the +accompanying "Management Report on Internal Control Over Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our +audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control +over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or +persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting +and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those +policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material +misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to +future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In +our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year +ended December 31, 2008 of the Company and our report dated March 17, 2009 expressed an unqualified opinion on those financial statements and included (a) an explanatory paragraph +expressing substantial doubt about the Company's ability to continue as a going concern; and (b) an explanatory paragraph +59 +Table of Contents +regarding +the Company's accounting for uncertain tax positions on January 1, 2007 in accordance with the Financial Accounting Standards Board's Interpretation No. 48, Accounting for Uncertainty in Income Taxes . +/s/ +Deloitte & Touche LLP +Denver, +Colorado +March 17, 2009 +60 +Table of Contents +ITEM 9B. Other Information +Not applicable. +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2009 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2008. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer, principal +financial officer, and controller. A copy of our business code of conduct and ethics policy is available on our website: www.crocs.com. We are required to disclose any change to, or waiver from, our +code of ethics for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our business code of conduct and ethics policy as permitted +by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2009 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2008. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2009 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2008. +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, as of December 31, 2008, we reserved 9,808,876 shares of common stock for future issuance on +exercise of outstanding options under equity compensation plans. +Plan Category +Number of +Securities +to be Issued +on Exercise of +Outstanding Options +Weighted Average +Exercise Price of +Outstanding +Options +Number of Securities +Remaining Available +for Future +Issuance Under +Plans, Excluding +Securities Available +in First Column +Equity compensation plans approved by stockholders(1)(2) +9,506,871 +$ +15.10 +3,709,287 +Equity compensation plans not approved by stockholders(3) +302,005 +$ +0.60 +— +Total +9,808,876 +3,709,287 +(1) On +July 9, 2007, at the annual stockholders' meeting, our stockholders approved the 2007 Equity Incentive Plan (the "2007 Plan"), which previously +had been approved by our board of directors. The 2007 Plan was effective as of July 9, 2007. The total number of shares of our common stock +61 +Table of Contents +available +for distribution under the 2007 Plan is 9,000,000, subject to adjustment for future stock splits, stock dividends and similar changes in our capitalization. +(2) On +April 27, 2005, our board of directors adopted the 2005 Equity Incentive Plan ("the 2005 Plan"). On January 10, 2006, our board of +directors amended the 2005 Plan to increase the number of shares of our common stock available for issuance under the 2005 Plan from 11,681,000 shares to 14,017,200 shares. Following the adoption of +the 2007 Plan, no future grants may be made from the 2005 Plan. +(3) Represents +non-plan stock options granted to our officers, directors and employees prior to the adoption of the 2005 Equity Incentive Plan. +Following the adoption of the 2007 Plan, no future grants may be made from this plan. +ITEM 13. Certain Relationships and Related Transactions, and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2009 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2008. +ITEM 14. Principal Accounting Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2009 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2008. +PART IV +ITEM 15. Exhibits, Financial Statement Schedules +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to financial statements on page F-1. +(2) Financial Statement Schedules +All financial statement schedules have been omitted because they are not required, are not applicable or the information is included in the Financial Statements +or Notes thereto. +(3) Exhibit list +Exhibit +Number +Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (Incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File +No. 333-132312)) +3.1 +Certificate of Amendment to the Restated Certificate of Incorporate of Crocs, Inc. (Incorporated herein by reference to Exhibit 3.1 to Crocs, Inc. Current Report on Form 8-K, filed on July 12, +2007 (File No. 000-51754)). +3.2 +Amended and Restated Bylaws of Crocs, Inc. (Incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File +No. 333-132312)) +62 +Table of Contents +Exhibit +Number +Description +4.1 +Specimen common stock certificate (Incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.1* +Form of Indemnity Agreement between Crocs, Inc. and each of its directors and executive officers (Incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.2* +Crocs, Inc. 2005 Equity Incentive Plan (the "2005 Plan") (Incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.3* +Amendment No.1 to the 2005 Plan (Incorporated herein by reference to Exhibit 10.2.2 to Crocs, Inc.'s Registration Statement on Form S-1/A [Amendment No. 4], filed on January 19, 2006 (File +No. 333-127526)). +10.4* +Form of Notice of Grant of Stock Option under the 2005 Plan (Incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.5* +Form of Notice of Grant of Stock Option for Non-Exempt Employees under the 2005 Plan (Incorporated herein by reference to Exhibit 10.4 to Crocs, Inc.'s Registration Statement on Form S-1, filed on +August 15, 2005 (File No. 333-127526)). +10.6* +Form of Stock Purchase Agreement under the 2005 Plan (Incorporated herein by reference to Exhibit 10.5 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.7* +Form of Stock Option Agreement under the 2005 Plan (Incorporated herein by reference to Exhibit 10.6 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.8* +Form of Restricted Stock Award Grant Notice under the 2005 Plan (Incorporated herein by reference to Exhibit 10.7 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.9* +Form of Restricted Stock Award Agreement under the 2005 Plan (Incorporated herein by reference to Exhibit 10.8 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.10* +Form of Non-Statutory Stock Option Agreement under the 2005 Plan (Incorporated herein by reference to Exhibit 10.9 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 +(File No. 333-127526)). +10.11 +Stock Purchase Agreement among 4246519 Canada, Inc., Finproject Group S.p.A., 3107019 Canada, Inc. and Daniel J. Hunter dated as of June 29, 2004 (Incorporated herein by reference to +Exhibit 10.14 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.12 +Asset Purchase and Property Transfer Agreement between Hana Phylon Tech S.A. de C.V. and Crocs Mexico, S.de.R.L de C.V. dated as of April 23, 2005 (Incorporated herein by reference to Exhibit 10.15 to +Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +63 +Table of Contents +Exhibit +Number +Description +10.13. +Asset Purchase and Property Transfer Agreement between St. Vrain Trading, LLC, d/b/a Crocs Hawaii, LLC and the Registrant dated May 19, 2005 (Incorporated herein by reference to Exhibit 10.16 to +Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.14*†† +Board of Directors Compensation Plan dated June 26, 2008. +10.15*†† +Amended and Restated 2007 Senior Executive Deferred Compensation Plan and Non-Qualified Plan Trust +10.16 +Distribution Agreement between Crocodile Distribution and the Registrant dated as of April 1, 2005 (Incorporated herein by reference to Exhibit 10.19 to Crocs, Inc.'s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.17 +Kiosk Agreement between Crocodile Kiosk, LLC and the Registrant dated as of July 1, 2005 (Incorporated herein by reference to Exhibit 10.20 to Crocs, Inc.'s Registration Statement on Form S-1, +filed on August 15, 2005 (File No. 333-127526)). +10.18† +Amended and Restated Agreement for Supply between Finproject S.p.A. and the Registrant dated as of July 26, 2005 (Incorporated herein by reference to Exhibit 10.21 to Crocs, Inc.'s Registration +Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.21* +Nonstatutory Stock Option Agreement between the Registrant and Raymond D. Croghan dated September 1, 2004 (Incorporated herein by reference to Exhibit 99.9 to Crocs, Inc.'s Registration Statement on +Form S-8, filed on March 9, 2006 (File No. 333-132312)). +10.23* +Nonstatutory Stock Option Agreement between the Registrant and Ronald R. Snyder dated September 1, 2004 (Incorporated herein by reference to Exhibit 99.12 to Crocs, Inc.'s Registration Statement on +Form S-8, filed on March 9, 2006 (File No. 333-132312). +10.26 +Membership Interest Purchase Agreement among Crocs, Inc. and the Members of Jibbitz, LLC, dated September 13, 2006 (File No. 000-51754)). +10.27* +2008 Cash Incentive Plan (Incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 12, 2007 (File No. 000-51754)). +10.28* +2007 Equity Incentive Plan (Incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 12, 2007 (File No. 000-51754)). +10.29* +Form of Incentive Stock Option Agreement under the 2007 Plan (Incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007 (File +No. 000-51754)). +10.30* +Form of Non-Statutory Stock Option Agreement under the 2007 Plan (Incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007 (File +No. 000-51754)). +10.31* +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (Incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on +November 14, 2007 (File No. 000-51754)). +10.32* +Employment Agreement dated as of January 16, 2008 by and between Crocs, Inc. And Russell Hammer (Incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, +filed on May 15, 2009 (File No. 000-51754)). +64 +Table of Contents +Exhibit +Number +Description +10.33 +Loan Agreement, dated as of May 8, 2007, by and between Crocs, Inc. and Union Bank of California, N.A. (Incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on +Form 10-Q, filed on May 15, 2009 (File No. 000-51754)). +10.34 +Amendment No. 1 to Loan Agreement, dated as of November 21, 2007, by and between Crocs, Inc. and Union Bank of California, N.A. (Incorporated herein by reference to Exhibit 10.3 to Crocs, +Inc.'s Quarterly Report on Form 10-Q, filed on May 15, 2009 (File No. 000-51754)). +10.35 +Amendment No. 2 to Loan Agreement, dated as of January 4, 2008, by and between Crocs, Inc. and Union Bank of California, N.A. (Incorporated herein by reference to Exhibit 10.4 to Crocs, Inc.'s +Quarterly Report on Form 10-Q, filed on May 15, 2009 (File No. 000-51754)). +10.36 +Amendment No. 3 to Loan Agreement, dated as of March 4, 2008, by and between Crocs, Inc. and Union Bank of California, N.A. (Incorporated herein by reference to Exhibit 10.5 to Crocs, Inc.'s +Quarterly Report on Form 10-Q, filed on May 12, 2008 (File No. 000-51754)). +10.37 +Amendment No. 4 to Loan Agreement, dated as of August 7, 2008 by and between Crocs, Inc. and Union Bank of California, N.A. (Incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s +Quarterly Report on Form 10-Q, filed on August 14, 2008 (File No. 000-51754)). +10.38†† +Amendment No 5 to Loan Agreement, dated as of November 17, 2008 by and between Crocs, Inc. and Union Bank of California, N.A. +10.39†† +Amendment No 6 to Loan Agreement, dated as of December 1, 2008 by and between Crocs, Inc. and Union Bank of California, N.A. +10.40†† +Amendment No 7 to Loan Agreement, dated as of December 19, 2008 by and between Crocs, Inc. and Union Bank of California, N.A. +10.41†† +Amendment No 8 to Loan Agreement, dated as of January 27, 2009 by and between Crocs, Inc. and Union Bank of California, N.A. +10.42†† +Amendment No 9 to Loan Agreement, dated as of February 13, 2009 by and between Crocs, Inc. and Union Bank of California, N.A. +10.43* +Employment Agreement dated February 9, 2009 by and between Crocs, Inc. and John McCarvel (Incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on +February 13, 2009 (File No. 000-51754)). +21†† +Subsidiaries of the Registrant. +23†† +Consent of Deloitte & Touche LLP. +31.1†† +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2†† +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +65 +Table of Contents +Exhibit +Number +Description +32†† +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +* Compensatory +plan or arrangement +† The +Registrant has been granted confidential treatment with respect to portions of these exhibits. +†† Filed +herewith. +66 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) 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, as of March 17, 2009. +CROCS, INC. +a Delaware Corporation +By: +/s/ RONALD R. SNYDER +Name: Ronald R. Snyder +Title: President and Chief Executive Officer +Pursuant +to the requirements of the Securities Exchange Act of 1934, this report has been signed below as of March 17, 2009 by the following persons on behalf of the registrant +and in the capacities indicated. +Signature +Title +/s/ RONALD R. SNYDER +Ronald R. Snyder +President, Chief Executive Officer and Director +(Principal Executive Officer) +/s/ RUSSELL C. HAMMER +Russell C. Hammer +Senior Vice President of Finance, +Treasurer and Chief Financial Officer +(Principal Financial and Accounting Officer) +/s/ W. STEPHEN CANNON +W. Stephen Cannon +Director +/s/ RAYMOND D. CROGHAN +Raymond D. Croghan +Director +/s/ RONALD L. FRASCH +Ronald L. Frasch +Director +/s/ PETER A. JACOBI +Peter A. Jacobi +Director +/s/ RICHARD L. SHARP +Richard L. Sharp +Chairman of the Board +/s/ THOMAS J. SMACH +Thomas J. Smach +Director +67 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2008 and 2007, and the related consolidated +statements of operations, stockholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of +the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. +We +conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in +the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement +presentation. We believe that our audits provide a reasonable basis for our opinion. +In +our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Crocs, Inc. and subsidiaries as of December 31, +2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally +accepted in the United States of America. +The +accompanying consolidated financial statements for the year ended December 31, 2008 have been prepared assuming that the Company will continue as a going concern. As discussed +in Note 1 to the consolidated financial statements, the maturity of the Company's Revolving Credit Facility on April 2, 2009 and losses from operations raise substantial doubt about its +ability to continue as a going concern. Management's plans concerning these matters are also described in Note 1 to the consolidated financial statements. The consolidated financial statements +do not include any adjustments that might result from the outcome of this uncertainty. +As +discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for uncertain tax positions on January 1, 2007 in accordance +with the Financial Accounting Standards Board's Interpretation No. 48, Accounting for Uncertainty in Income Taxes . +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of +December 31, 2008, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring +Organizations of the Treadway Commission and our report dated March 17, 2009 expressed an unqualified opinion on the Company's internal control over financial reporting. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +March 17, 2009 +F-1 +Table of Contents +CROCS, INC. +CONSOLIDATED BALANCE SHEETS +(In thousands, except share data) +December 31, +2008 +2007 +ASSETS +Current assets: +Cash and cash equivalents +$ +51,665 +$ +36,335 +Restricted cash +— +300 +Accounts receivable, less allowance for doubtful accounts of $5,262 and $3,795, respectively +35,305 +152,919 +Inventories +143,205 +248,391 +Deferred tax assets, net +11,364 +12,140 +Income tax receivable +24,417 +— +Prepaid expenses and other current assets +13,415 +17,865 +Total current assets +279,371 +467,950 +Property and equipment, net +95,892 +88,184 +Restricted cash +2,922 +1,014 +Goodwill +— +23,759 +Intangible assets, net +40,892 +31,634 +Deferred tax assets, net +21,231 +8,051 +Other assets +15,691 +6,833 +Total Assets +$ +455,999 +$ +627,425 +LIABILITIES AND STOCKHOLDERS' EQUITY +Current liabilities: +Accounts payable +$ +35,137 +$ +82,979 +Accrued expenses and other current liabilities +50,076 +57,246 +Deferred tax liabilities, net +30 +265 +Accrued restructuring charges +1,439 +— +Income taxes payable +24,420 +19,851 +Notes payable and capital lease obligations +22,431 +7,107 +Total current liabilities +133,533 +167,448 +Long-term capital lease obligations, net of current portion +— +9 +Deferred tax liabilities, net +2,917 +1,858 +Long term restructuring. +959 +— +Other liabilities +31,427 +13,997 +Total liabilities +168,836 +183,312 +Commitments and contingencies (Notes 6, 9 and 15) +Stockholders' equity: +Common shares, par value $0.001 per share; 250,000,000 authorized 83,543,501 issued and 83,019,501 shares issued and outstanding in 2008, 82,722,426 issued +and 82,198,426 issued and outstanding in 2007 +84 +83 +Treasury Stock, 524,000 shares, at cost +(25,022 +) +(25,022 +) +Additional paid-in capital +232,037 +211,936 +Deferred compensation +(246 +) +(2,402 +) +Retained earnings +64,233 +249,309 +Accumulated other comprehensive income +16,077 +10,209 +Total stockholders' equity +287,163 +444,113 +Total Liabilities and Stockholders' Equity +$ +455,999 +$ +627,425 +See +notes to consolidated financial statements. +F-2 +Table of Contents +CROCS, INC. +CONSOLIDATED STATEMENTS OF OPERATIONS +(In thousands, except share and per share data) +Year Ended December 31, +2008 +2007 +2006 +Revenues +$ +721,589 +$ +847,350 +$ +354,728 +Cost of sales +486,722 +349,701 +154,158 +Restructuring charges +901 +— +— +Gross profit +233,966 +497,649 +200,570 +Selling, general and administrative expenses +368,800 +259,882 +105,224 +Restructuring charges +7,664 +— +— +Goodwill impairment charges +23,867 +— +— +Asset impairment charges +21,917 +— +— +Income (loss) from operations +(188,282 +) +237,767 +95,346 +Interest expense +1,793 +438 +567 +Other (income)—net +(565 +) +(2,997 +) +(1,847 +) +Income (loss) before income taxes +(189,510 +) +240,326 +96,626 +Income tax expense (benefit) +(4,434 +) +72,098 +32,209 +Net income (loss) +(185,076 +) +168,228 +64,417 +Dividends on redeemable convertible preferred shares +— +— +33 +Net income (loss) attributable to common stockholders +$ +(185,076 +) +$ +168,228 +$ +64,384 +Income (loss) per common share: +Basic +$ +(2.24 +) +$ +2.08 +$ +0.87 +Diluted +$ +(2.24 +) +$ +2.00 +$ +0.81 +Weighted average common shares: +Basic +82,767,540 +80,759,077 +74,598,400 +Diluted +82,767,540 +84,194,883 +80,170,512 +See +notes to consolidated financial statements. +F-3 +Table of Contents +CROCS, INC. +CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT) +(In Thousands) +Common Stock +Treasury Stock +Accummulated +Other +Comprehensive +Income +Additional +Paid in +Capital +Deferred +Compensation +Retained +Earnings +Total Stock- +Holders' Equity +Comprehensive +Income (Loss) +Shares +Amount +Shares +Amount +BALANCE—December 31, 2005 +34,898 +$ +34 +— +$ +— +$ +13,959 +$ +(12,364 +) +$ +16,697 +$ +588 +$ +18,914 +Issuance of common stock in connection with initial public offering, net of offering costs +9,900 +10 +— +— +94,445 +— +— +— +94,455 +Conversion of redeemable convertible preferred shares to common shares +31,726 +32 +— +— +7,268 +— +— +— +7,300 +Adjustment for adoption of SFAS 123R (note 5) +— +— +— +— +(1,442 +) +1,442 +— +— +— +Amortization of stock compensation +— +— +— +— +6,233 +4,022 +— +— +10,255 +Exercises of stock options and vesting of share-based awards +2,158 +3 +— +— +2,281 +— +— +— +2,284 +Forfeitures +— +— +— +— +(1,198 +) +1,198 +— +— +— +Excess tax benefit on share-based compensation +— +— +— +— +10,248 +— +— +— +10,248 +Accrued preferred dividend +— +— +— +— +— +— +(33 +) +— +(33 +) +Net income +— +— +— +— +— +— +64,417 +— +64,417 +$ +64,417 +Foreign currency translation +— +— +— +— +— +— +— +418 +418 +418 +Total comprehensive income +$ +64,835 +BALANCE—December 31, 2006 +78,682 +$ +79 +— +$ +— +$ +131,794 +$ +(5,702 +) +$ +81,081 +$ +1,006 +$ +208,258 +Amortization of stock compensation +— +— +— +— +18,578 +3,105 +— +— +21,683 +Excess tax benefit stock based compensation +— +— +— +— +43,216 +— +— +— +43,216 +Exercises of stock options and vesting of share-based awards +4,040 +4 +— +— +18,543 +— +— +— +18,547 +Forfeitures +— +— +— +— +(195 +) +195 +— +— +— +Treasury Stock +(524 +) +— +524 +(25,022 +) +— +— +— +— +(25,022 +) +Net income +— +— +— +— +— +— +168,228 +— +168,228 +$ +168,228 +Foreign currency translation +— +— +— +— +— +— +— +9,203 +9,203 +9,203 +Total comprehensive income +$ +177,431 +BALANCE—December 31, 2007 +82,198 +$ +83 +524 +$ +(25,022 +) +$ +211,936 +$ +(2,402 +) +$ +249,309 +$ +10,209 +$ +444,113 +Amortization of stock compensation +— +— +— +— +16,951 +1,388 +— +— +18,339 +Excess tax benefit stock based compensation +— +— +— +— +— +— +— +— +— +Exercises of stock options and vesting of share-based awards +821 +1 +— +— +3,281 +637 +— +— +3,919 +Forfeitures +— +— +— +— +(131 +) +131 +— +— +— +Treasury Stock +— +— +— +— +— +— +— +— +— +Net loss +— +— +— +— +— +— +(185,076 +) +— +(185,076 +) +$ +(185,076 +) +Foreign currency translation +— +— +— +— +— +— +— +5,868 +5,868 +5,868 +Total comprehensive loss +$ +(179,208 +) +BALANCE—December 31, 2008 +83,019 +$ +84 +524 +$ +(25,022 +) +$ +232,037 +$ +(246 +) +$ +64,233 +$ +16,077 +$ +287,163 +F-4 +Table of Contents +CROCS, INC. +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2008 +2007 +2006 +Cash flows from operating activities: +Net (loss) income +$ +(185,076 +) +$ +168,228 +$ +64,417 +Adjustments to reconcile net (loss) income to net cash provided by operating activities: +Depreciation and amortization +37,450 +20,949 +8,053 +Loss on disposal of fixed assets +633 +199 +137 +Unrealized loss (gain) on foreign exchange rates +21,570 +(8,583 +) +— +Deferred income taxes +(5,429 +) +(14,866 +) +(2,037 +) +Goodwill impairment +23,837 +— +— +Asset impairment +21,927 +— +— +Inventory write-down charges +76,258 +1,829 +588 +Loss on purchase commitments +4,200 +— +— +Bad debt expense +3,153 +4,671 +1,719 +Share based compensation +18,976 +21,683 +10,255 +Excess tax benefit on share-based compensation +— +(43,216 +) +(10,248 +) +Changes in operating assets and liabilities—net of effect of acquired businesses: +Accounts receivable +111,318 +(83,948 +) +(45,702 +) +Inventories +18,239 +(153,419 +) +(55,548 +) +Prepaid expenses and other assets +(4,342 +) +(10,912 +) +(13,049 +) +Accounts payable +(60,168 +) +27,149 +19,959 +Accrued expenses and other liabilities +13,951 +79,174 +33,799 +Income taxes receivable +(23,634 +) +— +— +Cash provided by operating activities +72,863 +8,938 +12,343 +Cash flows from investing activities: +Purchases of short-term investments +— +(64,880 +) +(52,600 +) +Sales of short-term investments +— +87,205 +30,275 +Cash paid for purchases of property and equipment +(55,559 +) +(57,379 +) +(23,828 +) +Proceeds from disposal of property and equipment +2,383 +— +155 +Cash paid for intangible assets +(10,659 +) +(16,525 +) +(5,216 +) +Restricted cash +(1,624 +) +1,753 +(2,890 +) +Acquisition of businesses, net of cash acquired +(7,977 +) +(12,391 +) +(15,399 +) +Cash used in investing activities +(73,436 +) +(62,217 +) +(69,503 +) +Cash flows from financing activities: +Proceeds from note payable, net +76,024 +7,000 +1,808 +Repayment of note payable and capital lease obligations +(60,707 +) +(541 +) +(14,072 +) +Proceeds from initial public offering, net of offering costs +— +— +94,454 +Payment of preferred dividends +— +— +(171 +) +Excess tax benefit on share-based compensation +— +43,216 +10,248 +Exercise of stock options +3,283 +18,547 +2,284 +Purchase of Treasury Stock +— +(25,022 +) +— +Cash provided by financing activities +18,600 +43,200 +94,551 +Effect of exchange rate changes on cash +(2,697 +) +3,758 +478 +Net (decrease) increase in cash and cash equivalents +15,330 +(6,321 +) +37,869 +Cash and cash equivalents—beginning of year +36,335 +42,656 +4,787 +Cash and cash equivalents—end of year +$ +51,665 +$ +36,335 +$ +42,656 +Supplemental disclosure of cash flow information—cash paid during the year for: +Interest +1,581 +$ +44 +$ +353 +Income taxes +16,367 +$ +19,991 +$ +24,789 +Supplemental disclosure of non-cash, investing, and financing activities: +In conjunction with the acquisitions made, liabilities were assumed as follows: +Fair value of assets acquired +— +$ +7,074 +$ +21,566 +Cash paid +— +5,093 +15,399 +Liabilities assumed +— +$ +1,981 +$ +6,167 +Accrued acquisitions purchase price +— +3,429 +2,890 +Assets acquired under capitalized leases +— +— +$ +282 +Accrued purchases of property and equipment and intangibles +$ +12,596 +$ +11,165 +$ +1,011 +See notes to consolidated financial statements. +F-5 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. FORMATION AND BUSINESS OF THE COMPANY +Crocs, Inc. and its subsidiaries (collectively, the "Company") are engaged in the design, development, and manufacturing of consumer products from specialty resins. The Company +was organized as a limited liability company in Colorado in 1999 under the name of Western Brands, LLC. In January 2005, the Company changed its name to Crocs, Inc. and converted to a +Colorado corporation. The Company reincorporated in Delaware in June 2005. +The +Company's wholly owned subsidiary, Crocs Canada, Inc. ("Crocs Canada"), formerly known as Foam Creations, Inc., and Finproject N.A. Inc., located in Quebec, +Canada, designed, developed, and manufactured consumer products from specialty resins since 1995. In 2000, Crocs Canada completed the formulation of, and began manufacturing, a footwear model made +from the proprietary closed-cell resin the Company currently uses in its footwear product line, which it refers to as Croslite. In 2002, the Company established a business relationship +with Crocs Canada to distribute footwear in the U.S. In October 2002, the Company modified and improved the design of the footwear and began marketing and distributing it under the Crocs brand in the +U.S. In June 2004, Crocs, Inc. acquired Crocs Canada, including its manufacturing operations, product lines and rights to the trade secrets for Croslite. +In +October 2006, the Company acquired Fury Hockey Inc., formerly 55 Hockey Products Inc. ("Fury"), and EXO Italia ("EXO") as part of the Company's effort to expand into new +markets and expand the Company's internal design capabilities. Fury produced and distributed hockey, soccer and lacrosse equipment for adults and children. In June 2008, the Company decided to +liquidate Fury after efforts to sell the entity were unsuccessful. EXO, headquartered in Padova, Italy, designs and develops EVA (Ethylene Vinyl Acetate) based finished products, primarily for the +footwear industry. Since 1993, EXO has worked with several leading branded consumer companies to produce high quality EVA based footwear for the global marketplace. +In +December 2006, the Company acquired Jibbitz, LLC ("Jibbitz"), a unique accessory brand with colorful snap-on charms specifically suited for Crocs shoes. Today, over +1,800 Jibbitz designs are available to consumers for personalizing and customizing their Crocs footwear. +In +January 2007, the Company acquired substantially all of the assets of Ocean Minded, LLC ("Ocean Minded"). Ocean Minded is a designer and manufacturer of high quality leather +and EVA based sandals primarily for the beach, adventure and action sports markets. Ocean Minded utilizes recycled and recyclable materials whenever possible and is well known in the action sports +industry as a leading advocate for environmental awareness and responsibility. +In +July 2007, the Company acquired all of the assets of Bite, LLC ("Bite"), an adventure driven designer and manufacturer of comfortable and supportive performance shoes and +sports sandals sold worldwide in five categories, including, golf, adventure, healthy lifestyle, travel and water sports. In 2008, the Company decided to discontinue the Bite line. +In +April 2008, the Company acquired substantially all of the assets of Tidal Trade, Inc. ("Tidal Trade"), the Company's third party distributor in South Africa. As part of the +acquisition, the Company repurchased inventory previously sold to Tidal Trade. +In +April 2008, the Company acquired substantially all of the assets of Tagger International B.V. ("Tagger"), a private limited liability company incorporated under the laws of the +Netherlands that manufactures messenger bags. Tagger was partially operated by the Managing Director of Crocs Europe B.V. The Company acquired all of the assets of Tagger. +F-6 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. FORMATION AND BUSINESS OF THE COMPANY (Continued) +Going Concern +From its inception through the year ended December 31, 2007, the Company experienced rapid revenue growth and had difficulty +meeting demand for its footwear products. During this period, the Company significantly increased production capacity, warehouse space and inventory in an effort to meet demand. This pattern changed +in 2008. During the three months ended March 31, 2008 revenue growth moderated and during the three months ended June 30, 2008 +revenues declined compared to 2007. This trend continued and accelerated during the remainder of 2008. The Company's total revenues declined during the year ended December 31, 2008 on a 24.7% +decline in the total number of footwear units sold compared to the previous year, which was attributable in large part to deteriorating global economic conditions, lessened demand for the Company's +products and difficulty marketing the Company's expanded product line. Due to the decline in revenues, the Company incurred various one-time cash and non-cash restructuring and +impairment costs as the Company took steps to right-size our production and distribution capacity. The Company incurred losses of $185.1 million in the year ended +December 31, 2008 and the Company expects to incur additional operating losses during the quarter ended March 31, 2009 as year-over-year revenue declines continue +to occur and we may incur additional losses through 2009. +Continued +declines in revenues could have a material adverse effect on the Company's operating results, cash flow and its ability to raise capital. The Company cannot fully anticipate +future conditions given the substantial uncertainties in the credit markets and the economy in general. The Company may have unexpected costs and liabilities including costs related to further +restructuring and right-sizing should that be necessary; revenue and cash provided by operations may decline; economic conditions may continue to weaken; and competitive pressures may increase, +resulting in difficulty maintaining liquidity. Due to recent turmoil in the credit markets and the continued decline in the economy, the Company may not be able to obtain additional financing on terms +that are acceptable to the Company or at all. +At +December 31, 2008, the Company had $51.6 million in cash and cash equivalents. The Company has $22.4 million in borrowings outstanding under its Revolving Credit +Facility which has no further available borrowings. On February 13, 2009, the Company entered into Amendment No. 9 to the Revolving Credit Facility, extending the maturity date on this +facility to April 2, 2009, at which time the Company will be required to pay all amounts then outstanding. Prior to April 2, 2009, the Company is required to make five installment +payments of $0.2 million each on dates agreed upon by the Company and Union Bank of California, N.A. +The +Company is currently in discussions to obtain an asset backed credit facility to replace the existing Revolving Credit Facility. The time period required to procure a new asset +backed credit facility may extend beyond the maturity date of its current Revolving Credit Facility requiring the Company to seek an extension of that maturity date with its current lenders. The +Company is also exploring other means of raising capital including equity financing. There can be no assurance that the Company will be able to secure additional debt or equity financing or receive an +extension of the current Revolving Credit Facility by or before the date of maturity of the Revolving Credit Facility and, accordingly, the Company's liquidity and ability to timely pay its +obligations when due could be adversely affected. +Additionally, +the Company is currently evaluating its operating plans for 2009 and considering certain restructuring and right-sizing activities to address the potential for continued +decreases in +F-7 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. FORMATION AND BUSINESS OF THE COMPANY (Continued) +revenues. +The Company's ability to continue as a going concern is dependent upon achieving a cost structure which supports the levels of revenues the Company is able to achieve. The ability of the +Company to return to profitability is dependent on the timely completion of these activities and there can be no assurance that any actions taken by the Company will result in a return to +profitability. +The +accompanying consolidated financial statements for the year ended December 31, 2008 were prepared under the assumption that the Company will continue to operate as a going +concern, which contemplates the realization of assets and the liquidation of liabilities in the ordinary course of business. As discussed in the previous paragraphs, the Company faces various +uncertainties that raise substantial doubt about its ability to continue as a going concern. These financial statements do not include any adjustments that may result from the outcome of these +uncertainties. +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Basis of Consolidation —The consolidated financial statements include the accounts of Crocs, Inc. and all of its subsidiaries. All of the +Company's subsidiaries are 100% operated except for Crocs India Private Limited. The minority interest in this subsidiary is immaterial and are included in Other (income) expenses—net on +the Company's consolidated statements of income and in Other liabilities on the Company's consolidated balance sheets. All intercompany transactions and balances are eliminated in consolidation. The +consolidated financial statements include the accounts of the Company and all entities that are wholly-operated by the Company, variable interest entities for which the Company is the primary +beneficiary, and entities that are not variable interest entities but are voting-controlled subsidiaries of the Company. +Management Estimates —The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United +States of America, ("GAAP"). These accounting principles require management of the Company to make certain estimates, judgments and assumptions. Management believes that the estimates, judgments and +assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, returns and discounts, impairment assessments and charges, recoverability of +assets, including deferred tax assets, uncertain tax positions, share-based compensation expense, fair value of acquired intangibles, assessment of lower of cost or market on inventory, useful lives +assigned to long-lived assets, depreciation and provisions for contingencies, are reasonable, based on information available at the time they are made. These estimates, judgments and +assumptions can affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements, as well as the reported amounts of revenue and expenses during the +periods presented. Management also makes estimates in our assessments of potential losses in relation to threatened or pending legal and tax matters. See Note 18—Legal Proceedings. +Actual results could materially differ from these estimates. For matters not related to income taxes, if a loss is considered probable and the amount can be reasonably estimated, the Company +recognizes an expense for the estimated loss. If there is the potential to recover a portion of the estimated loss from a third party, the Company makes a separate assessment of recoverability and +reduces the estimated loss if recovery is also deemed probable. +Effective +January 1, 2007, for matters related to income taxes, the Company applies Financial Accounting Standards Board ("FASB") Interpretation No. ("FIN") 48, Accounting for Uncertainty in Income Taxes +("FIN 48"). See Note 13—Income Taxes for further discussion. +F-8 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Concentration of Risk —The Company's cash and cash equivalents are maintained in several different financial institutions in amounts that typically +exceed U.S. federally insured limits or in financial institutions in international jurisdictions where insurance is not provided. The Company has not experienced any losses in such accounts and +believes it is not exposed to significant credit risk. +The +Company considers its concentration risk related to accounts receivable to be mitigated by the Company's credit policy, the insignificance of outstanding balances owed by each +individual customer at any point in time and the geographic dispersion of these customers. +The +Company relies on both internal and external manufacturers for its products. Establishing a replacement source for the Company's product offerings could require significant +additional time and expense. +Variable Interest Entities —According to Financial Accounting Standards Board ("FASB") Interpretation ("FIN") No. 46R, Consolidation of +Variable +Interest Entities ("FIN 46R"), Variable Interest Entities ("VIEs") lack one or more of the characteristics of a voting interest entity as described above. FIN 46R provides that a +controlling financial interest in an entity is present when an entity has one or more variable interests that are expected to absorb a majority of the entity's expected losses, receive a majority of +the entity's residual returns, or both. The entity that is determined to be the primary beneficiary holds the controlling financial interest and is required to consolidate the VIE. Accordingly, the +Company consolidates VIEs in which the Company is deemed to be the primary beneficiary. +Fair Value of Financial Instruments —The carrying value of financial instruments, including cash equivalents, accounts receivable, accounts payable +and +accrued liabilities, approximate fair value due to their short maturities. Based on borrowing rates currently available to the Company, with similar terms, the carrying values of the capital lease +obligations and the line of credit approximate their fair values. +Cash and Cash Equivalents —Cash and cash equivalents represent cash and short-term, highly liquid investments with maturities of three +months or less at date of purchase. The Company considers receivables from credit card companies to be cash equivalents, if received within five days. The carrying amounts reflected in the +consolidated balance sheet for cash and cash equivalents approximate fair value due to the short maturities. +Restricted Cash —Restricted cash represents cash commitments related to building and lease deposits. The classification of restricted cash on the +consolidated balance sheet as current or noncurrent is dependent on the duration of the restriction and the purpose for which the restriction exists. +Accounts Receivable —Accounts receivable represent amounts due from customers. Accounts receivable are recorded at invoiced amounts, net of +reserves +and allowances, are not collateralized and do not bear interest. The Company uses its best estimate to determine the required +allowance for doubtful accounts based on a variety of factors, including the length of time receivables are past due, economic trends and conditions affecting our customer base, significant +one-time events and historical write-off experience. Specific provisions are recorded for individual receivables when we become aware of a customer's inability to meet its +financial obligations. +Inventories —Raw materials and supplies are valued at the lower of cost, replacement cost, or net realizable value. Work in process and finished +goods +are valued at the lower of cost or net realizable +F-9 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +value. +Cost is determined on the first in, first out basis. The cost of work in process and finished goods consists of the cost of raw materials and an applicable share of the cost of labor and +manufacturing overhead. See Note 3—Inventories for a discussion of inventory write-down charges recorded in 2008. +Property and Equipment —Depreciation of machinery and equipment is computed using the straight-line method based on estimated useful lives +ranging from three to five years. Leasehold improvements are amortized on the straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. See +Note 4—Property and Equipment for further discussion. +Impairment of Long-Lived Assets —In accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets , ("SFAS 144"), the Company estimates the future undiscounted cash +flows to be derived from an asset to assess whether or not a potential impairment exists when events or circumstances indicate the carrying value of a long-lived asset, including property +and equipment and finite-lived intangible assets, may be impaired. If the carrying value exceeds the estimate of future undiscounted cash flows, the Company calculates the impairment as the excess of +the carrying value of the asset over the estimate of its fair value. See Note 4—Property and Equipment and Note 5—Goodwill and Intangibles for impairment charges +recorded in 2008. There were no impairments recorded during 2007 or 2006. +Intangible Assets Finite-Lived —SFAS 142, requires that intangible assets with finite lives be amortized over their estimated useful lives and +reviewed for impairment in accordance with SFAS 144. +The Company is currently amortizing its acquired intangible assets with finite lives over periods ranging from five to ten years. Intangible assets are comprised of capitalized software, core +technology, customer relationships, a non-competition agreement entered into in connection with the acquisition of assets in Mexico, and capitalized costs related to pending patents that +the Company is pursuing related to its technology. Patents are amortized on approval of the patent registration application over their estimated useful lives. See Note 5—Goodwill +and Intangible Assets for discussion of impairment charges recorded in 2008. There was no impairment of finite-lived intangible assets at December 31, 2007. +Capitalized Software —The Company capitalizes certain internal and external software acquisition and development costs that benefit future years in +accordance with Standards of Practice ("SOPs") SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal +Use. Internal-use capitalized software costs are amortized over their expected useful life, which is generally seven years. The Company capitalizes certain costs +associated with software such as costs of employees devoting time to the projects and external direct costs for materials and services. Costs associated with internally developed software to be used +internally are expensed until the point at which the project has reached the application development stage. Subsequent additions, modifications or upgrades to internal-use software are +capitalized only to the extent that they allow the software to perform a task it previously did not perform. Software maintenance and training costs are expensed in the period in which they are +incurred. The determination of when the software is in the application development stage and the ongoing assessment of the recoverability of capitalized computer software development costs requires +considerable judgment by management with respect to certain factors, including but not limited to, estimated economic life and changes in software and hardware technology. See +Note 5—Goodwill and Intangibles Assets for further discussion. +F-10 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Goodwill —In accordance with SFAS 142, Goodwill and Other Intangible Assets , +("SFAS 142"), goodwill represents the excess purchase price paid over the fair value of assets acquired and liabilities assumed in acquisitions. The Company assesses goodwill for impairment +annually on the last day of the fourth quarter, or more frequently if events and circumstances indicate impairment may have occurred. If the carrying value of goodwill exceeds its implied fair value, +the Company records an impairment loss equal to the difference. See Note 5-Goodwill and Intangible Assets for discussion of impairment charges recorded in 2008. There was no +impairment of goodwill at December 31, 2007. +Earnings per Share —Basic earnings (loss) per common share ("EPS") is computed by dividing the net income available to common stockholders by the +weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from securities that could share in the earnings of the Company. +Anti-dilutive securities are excluded from diluted EPS. +On +May 2, 2007, the Board of Directors of the Company declared a two-for-one stock split of the Company's common shares, which was effected in the form of +a 100% common stock dividend distributed on June 14, 2007 to stockholders of record on May 31, 2007. All references to share and per share amounts in the consolidated financial +statements and in these notes to the consolidated financial statements have been retroactively restated to reflect the two-for-one stock split. +Recognition of Revenues —Revenues are recognized when the customer takes title and assumes risk of loss, collection of related receivables is +reasonably assured, persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer depending on the country of the +sale and the agreement with the customer. Allowances for estimated returns, allowances and discounts are recognized as a reduction of the related revenue when it is recorded. +Shipping and Handling Costs —Shipping and handling costs are expensed as incurred and included in cost of sales. Freight billed to customers is +included in revenues. +Share-Based Compensation —The Company grants restricted stock and stock option grants to employees and non-employees with vesting schedules +of varying lengths. Typically, these grants range from immediate vesting to vesting periods of up to four years. Effective January 1, 2006, the Company adopted SFAS No. 123R, Share-Based Payment ("SFAS 123R"), which establishes accounting guidelines for share-based awards exchanged for employee services, using the +prospective method for option grants and restricted stock issued prior to August 15, 2005, the date on which the Company filed its initial Registration Statement on Form S-1, +and the modified prospective method for option grants issued after August 15, 2005. The Company was required to adopt the prospective method for grants prior to August 15, 2005 as the +Company had elected to value employee grants using the minimum value method under SFAS No. 123, Accounting for Share-based Compensation +("SFAS 123"). For option grants and restricted stock accounted for under the prospective method, the Company will continue to account for the grants under the intrinsic value-based method +prescribed by Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees ("APB 25"), and the related +interpretations in accounting for employee stock options. Therefore, the Company does not record any compensation expense for stock options granted to employees prior to August 15, 2005 if the +exercise price equaled the fair market value of the stock +option on the date of grant, and the exercise price, number of shares eligible for issuance under the options and vesting periods were fixed. +F-11 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Compensation +expense is recognized over the vesting term for employees and non-employees on a straight-line basis. Deferred compensation represents the unvested +portion of employee grants made prior to August 15, 2005 and is recorded as a reduction of equity. The fair value of employee grants is fixed at date of grant, or the measurement date, if +later, while grants to non-employees are remeasured to fair value at each reporting period until vesting occurs. The related compensation expense is recognized over the vesting period. See +Note 10-Equity for further discussion. +Advertising —Advertising costs are expensed as incurred and production costs are generally expensed when the advertising is first run. Advertising +expenses were $16.8 million, $5.5 million, and $1.2 million for the years ended December 31, 2008, 2007, and 2006, respectively and are included in selling, general, and +administrative expenses. +Research and Development —Research and development costs are expensed as incurred. Research and development expenses amounted to $6.4 million, +$5.3 million, and $1.8 million for the years ended December 31, 2008, 2007, and 2006, respectively, and are included in selling, general, and administrative expenses. +Foreign Currency Translation and Foreign Currency Transactions —The U.S. dollar is the Company's reporting currency. Assets and liabilities of +foreign +operations denominated in local currencies are translated at the rate of exchange at the balance sheet date. Revenues and expenses are translated at the weighted average rate of exchange during the +applicable period. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are included in the foreign currency translation adjustment, a component of +accumulated other comprehensive income in stockholders' equity. Gains and losses generated by transactions denominated in foreign currencies are recorded in selling, general and administrative expense +in the period in which they occur. +Net +realized gains and losses on foreign currency transactions was a $3.9 million loss for the year ended December 31, 2008, a $1.5 million gain for the year ended +December 31, 2007 and a $747,000 loss for the year ended December 31, 2006. Net unrealized gains and losses on foreign currency transactions was a $21.6 million loss for 2008, a +$8.6 million gain for 2007 and immaterial for the year ended December 31, 2006. +Derivative Foreign Currency Contracts —The Company is exposed to global market risks, including the effect of changes in foreign currency exchange +rates. During the year ended December 31, 2007, the Company used derivatives to manage financial exposures that occur in the normal course of business. The Company does not hold or issue +derivatives for trading purposes. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for +undertaking hedge transactions. This process includes linking all derivatives to either specific assets and liabilities on the balance sheet, specific firm commitments or forecasted transactions. The +Company has entered into forward exchange contracts to hedge certain portions of future cash flows denominated in foreign currencies. These contracts were not designated as hedges under SFAS +No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"). The futures contracts were marked to market and gains +and losses were recognized in earnings. The net realized gains and losses for these contracts were not material for the years ended December 31, 2008, 2007 and 2006. The Company has no +unsettled derivative contracts as of December 31, 2008. +F-12 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Income Taxes —The Company accounts for income taxes using the asset and liability method. This approach requires the recognition of deferred tax +assets +and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. The Company provides for income taxes +at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. Prior to the Company's conversion to a C corporation on January 4, 2005, the Company was not a +taxpaying entity for U.S. federal and state income tax purposes. +Effective +January 1, 2007, the Company adopted FIN 48, Accounting for Uncertainty in Income Taxes . FIN 48 requires +the use of a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The +adoption of FIN 48 did not have a material impact on the Company's consolidated balance sheet, statement of operations or cash flows. See Note 13—Income Taxes for further +details. +Reclassifications —The Company reclassified inventory write-down charges in the statement of cash flows from changes in inventories to +non-cash adjustments within operating activities. These write-down charges were previously included within changes in inventories because they were immaterial. There was no +change to operating cash flows as a result of this reclassification. The Company reclassified bad debt expense in the statement of cash flows from changes in operating assets and liabilities to +non-cash adjustments within operating activities. These charges were previously included within changes in accounts receivable because they were immaterial. There was no change to the +operating cash flows as a result of these reclassifications. +Recent Accounting Pronouncements —In September 2006, the FASB issued SFAS No. 157, Fair Value +Measurement ("SFAS 157"), which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and +expands disclosures about fair value measurements. The Company adopted SFAS 157 beginning January 1, 2008. The adoption of SFAS 157 did not have a material impact on the Company's +consolidated financial statements. +In +February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities +("SFAS 159"). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The Company adopted SFAS 159 beginning +January 1, 2008. The adoption of SFAS 159 did not have a material impact on the Company's consolidated financial statements. +In +December 2007, the FASB issued SFAS No. 141(R), Business Combinations ("SFAS 1411(R)"), which amends SFAS No. 141 +and provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any non-controlling interest in the acquiree. It also +provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for the fiscal +year beginning January 1, 2009 and is to be applied prospectively. The Company is currently evaluating the potential impact of adopting this statement on its consolidated financial statements. +In +December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements—an amendment of ARB +No. 51 ("SFAS 160"), which establishes accounting and reporting standards pertaining to ownership interests in subsidiaries held by parties other than the parent, +the amount of net income attributable to the parent and to the non-controlling interest, changes in a parent's ownership interest, and the valuation of any retained +non-controlling equity investment when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that +F-13 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +clearly +identify and distinguish between the interests of the parent and the interests of the non-controlling owners. SFAS 160 is effective for the Company's fiscal year beginning +January 1, 2009. The Company is currently evaluating the impact this new standard will have on its consolidated financial statements, but does not expect that the adoption will have a material +impact on the Company's consolidated financial position or results of operations. +In +March 2008, the FASB issued FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities +("SFAS 161"), which is intended to improve financial reporting regarding derivative instruments and hedging activities by requiring enhanced disclosures to provide transparency to these +activities and their effects on an entity's financial position, financial performance and cash flows. The provisions of SFAS 161 are effective for the Company's fiscal year beginning +January 1, 2009. The Company is currently evaluating the impact this new standard will have on its consolidated statements but does not expect that the adoption of SFAS 161 will have a +material impact on its consolidated financial statements. +In +May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles ("SFAS 162"), which +identifies the sources of accounting principles and the framework for selecting principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity +with GAAP. SFAS 162 emphasizes that an organization's management and not its auditors has the responsibility to follow GAAP and categorizes sources of accounting principles that are generally +accepted in descending order of authority. The Company will be required to adopt SFAS 162 within 60 days following the Securities and Exchange Commission's ("SEC") approval of the Public +Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting +Principles . SFAS 162 will not impact the Company's consolidated financial statements. +In +December, 2008, the FASB issued FASB Staff Positions ("FSP") FIN 46(R)-8, Interests in Variable Interest Entities and FSP +FAS 140-4, Disclosures about Transfers of Financial Assets , which will increase disclosure requirements for public reporting companies for reporting periods +that end after December 15, 2008. This FSP amends SFAS 140, Disclosures about Transfers of Financial Assets, to require public entities to +provide additional disclosures about transfers of financial assets and variable interests in qualifying special-purpose entities. It also amends FIN 46(R) to require public enterprises to +provide additional disclosures about their involvement with variable interest entities. The Company adopted the requirements of FSP FAS 140-4 and FSP FIN 46(R) beginning +January 1, 2008. The adoption of FSP FAS 140-4 and FSP FIN 46(R) did not have a material impact on the Company's consolidated financial statements. +3. INVENTORIES +Inventories by major classification are as follows (in thousands): +December 31, +2008 +2007 +Finished goods +$ +126,078 +$ +224,658 +Work-in-progress +184 +3,346 +Raw materials +16,943 +20,387 +$ +143,205 +$ +248,391 +F-14 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +3. INVENTORIES (Continued) +In the year ended December 31, 2008, the Company recorded approximately $76.3 million of inventory write-down charges and an additional $4.2 million in +charges related to losses on future purchase commitments for inventory with a market value lower than cost, of which $2.1 million was included as an accrued expense, as of December 31, +2008. These charges are reported in the cost of sales line item in the consolidated statement of operations for the year ended December 31, 2008. +4. PROPERTY AND EQUIPMENT +Property and equipment includes the following (in thousands): +December 31, +2008 +2007 +Machinery and equipment +$ +108,552 +$ +103,049 +Leasehold improvements +32,771 +12,322 +Subtotal +141,323 +115,371 +Less accumulated depreciation and amortization +(45,431 +) +(27,187 +) +$ +95,892 +$ +88,184 +Depreciation +expense of $30.7 million, $17.0 million and $6.2 million was recorded for the years ended December 31, 2008, 2007 and 2006, respectively. As the +Company translates the ending fixed assets and accumulated depreciation balances utilizing the balance sheet exchange rate and records depreciation expense using the weighted average of exchange rates +for the applicable period, a difference between the recorded depreciation expense and the change in accumulated depreciation exists. Certain equipment held under capital leases in the amounts of +$9,000 and $116,000 at December 31, 2008 and 2007, respectively, are classified as equipment and amortized using the straight-line method over the lease term. Amortization of assets +under capitalized leases is included in depreciation expense. +During +the year ended December 31, 2008, the Company recognized an impairment charge of $20.9 million on fixed assets, primarily related to equipment and shoe molds. +Management evaluated the production capacity at Company-operated facilities compared with demand projections and capacity requirements and made the decision to abandon certain manufacturing equipment +that represented excess capacity. The impairment charge on molds relates primarily to shoe styles that the Company either no longer intends to manufacture or to styles for which the Company has more +molds on hand than is necessary to meet projected demand. These charges are recorded in the impairment charges line item of the consolidated statement of operations for the year ended +December 31, 2008. +5. GOODWILL AND INTANGIBLE ASSETS +Goodwill +The Company's goodwill balance of $23.8 million as of December 31, 2007, was primarily related to the acquisitions of +Ocean Minded and Bite in 2007, Jibbitz and Fury in 2006, and Crocs Canada in 2004. +The +goodwill balance of Fury in the amount of $1.0 million was written off in the three months ended March 31, 2008 prior to its liquidation in June 2008. +F-15 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +5. GOODWILL AND INTANGIBLE ASSETS (Continued) +During +the three months ended September 30, 2008, the Company's stock price declined substantially, which represented a triggering event for potential goodwill impairment. +Accordingly, at September 30, 2008, the Company performed an interim goodwill impairment evaluation. Goodwill and intangible assets with indefinite lives must be tested for impairment at least +once a year or more frequently if management believes indicators of impairment exist. Carrying values are compared with fair values, and when the carrying value exceeds the fair value, the carrying +value of the impaired asset is reduced to its fair value. +Management +reviewed the results of the preliminary analysis and concluded that the entire $22.8 million balance of the Company's goodwill was impaired at September 30, +2008. Management reviewed the results of the final analysis completed during the fourth quarter of 2008 and concluded that the provisional impairment adjustment recorded at September 30, 2008 +should not be revised and that the Company's goodwill was fully impaired as of December 31, 2008, the Company's annual goodwill impairment evaluation date. +The +following table summarizes the activity in the Company's goodwill account during the years ended December 31, 2008 and 2007 (in thousands): +Balance at January 1, 2007 +$ +11,552 +Bite acquisition +530 +Ocean Minded acquisition +953 +Jibbitz earn out +10,191 +Foreign currency translation adjustment +533 +Balance at December 31, 2007 +23,759 +Less: Goodwill impairment charges +(23,867 +) +Impact of foreign currency translation +108 +Balance at December 31, 2008 +$ +— +Intangible Assets +In June 2008, the Company decided to liquidate Fury after efforts to sell the entity were unsuccessful. As a result, the Company wrote +off $0.3 million related to the remaining customer relationships intangible asset and trademarks. +As +a result of the Company's evaluation of indefinite lived intangible assets, the Jibbitz trade name, with a book value of approximately $0.2 million, and patents the Company no +longer intends to utilize, with a book value of approximately $0.6 million, were fully impaired. +F-16 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +5. GOODWILL AND INTANGIBLE ASSETS (Continued) +The +following table summarizes the Company's identifiable intangible assets at December 31, 2008 and 2007 (in thousands): +2008 +2007 +Gross +Carrying +Amount +Accumulated +Amortization +Net +Carrying +Amount +Gross +Carrying +Amount +Accumulated +Amortization +Net +Carrying +Amount +Finite lived intangible assets: +Patents and trademarks +$ +8,190 +$ +694 +$ +7,496 +$ +4,344 +$ +201 +$ +4,143 +Customer relationships +6,075 +3,685 +2,390 +5,437 +2,437 +3,000 +Core technology +4,001 +3,602 +399 +4,931 +3,455 +1,476 +Non-competition agreement +636 +466 +170 +636 +339 +297 +Capitalized software +35,309 +4,872 +30,437 +24,177 +1,612 +22,565 +Total finite lived assets +54,211 +13,319 +40,892 +39,525 +8,044 +31,481 +Indefinite lived intangible assets: +Jibbitz trade name +— +— +— +153 +— +153 +Total +$ +54,211 +$ +13,319 +$ +40,892 +$ +39,678 +$ +8,044 +$ +31,634 +Intangible +assets that are determined to have finite lives are amortized over their useful lives on a straight-line basis for patents, core technology, +non-competition agreement and capitalized software. Customer relationships are amortized on a straight-line basis or an accelerated basis. Amortization expense of intangible +assets with finite lives, which is included in selling, general and administrative expense, was $5.6 million, $4.1 million and $1.6 million for the years ended December 31, +2008, 2007 and 2006, respectively. For amortizable intangible assets denominated in a foreign currency, the Company translates the ending asset and accumulated amortization at the balance sheet rate +and records amortization expense using the weighted average rate of exchange for the applicable period. A difference between the recorded amortization expense and the change in accumulated +amortization exists. Below are the weighted average amortization period by major intangible asset class and the total weighted average amortization period for the Company as of December 31, +2008. +Intangible Asset Class +Weighted Average +Amortization Period +Patents +10 years +Customer Relationships +7 years +Core Technology +7 years +Non-competition Agreement +5 years +Capitalized Software +7 years +F-17 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +5. GOODWILL AND INTANGIBLE ASSETS (Continued) +Estimated +future annual amortization of intangible assets is as follows (in thousands): +Fiscal years ending December 31, +Amortization +2009 +$ +7,014 +2010 +6,898 +2011 +6,592 +2012 +6,337 +2013 +5,937 +Thereafter +8,114 +Total +$ +40,892 +6. ACQUISITIONS +On April 1, 2008, the Company acquired substantially all of the assets of Tidal Trade, Inc. ("Tidal Trade"), the Company's third party distributor in South Africa, for +$4.6 million. The Company recorded $1.4 million in customer relationships on the date of acquisition. As part of the acquisition, the +Company repurchased inventory previously sold to Tidal Trade and accordingly recognized a reduction of revenue of approximately $2.1 million. +On +April 2, 2008, the Company acquired substantially all of the assets of Tagger, a private limited liability company incorporated under the laws of the Netherlands that +manufactures messenger bags. Tagger was partially operated by the Managing Director of Crocs Europe B.V. The Company acquired all of the assets of Tagger for $2.0 million, of which +approximately $90,000 was assigned to inventory and the remaining $1.9 million was assigned to the value of the Tagger trademark on the date of acquisition. +On +January 31, 2007, the Company acquired substantially all of the assets of Ocean Minded for $1.75 million in cash, plus a potential earn-out of up to +$3.75 million based on Ocean Minded achieving certain earnings targets over a three year period. The Company recorded $600,000 in customer relationships and other identifiable intangible assets +and $1.0 million in goodwill on the date of acquisition. +On +June 26, 2007, the Company amended the membership interest purchase agreement ("Purchase Agreement") with Jibbitz to amend the terms of the potential earn-out +consideration included in the Purchase Agreement. The amendment replaced the earnings targets for payment of the earn-out with absolute rights to receive $3.5 million payable on the +effective date of the amended Purchase Agreement and the remaining $6.5 million payable in equal monthly installments of $0.5 million due on the first business day of each of the +13 months following the effective date of the amended Purchase Agreement. The Company recorded the additional $9.8 million, net of discounting on future payments, to goodwill in the +second quarter of 2007 as an additional cost of the acquisition. +On +July 27, 2007, the Company acquired all of the assets of Bite for $1.75 million in cash and the assumption of $1.3 million in debt, plus a potential earnout of up +to $1.75 million based on Bite achieving certain earnings targets over a three year period. The Company recorded $512,000 in customer relationships and other identifiable intangible assets and +$530,000 in goodwill on the date of acquisition for Bite. +F-18 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +6. ACQUISITIONS (Continued) +In +October 2006, the Company acquired Fury, and EXO. In June 2008, the Company decided to liquidate Fury after efforts to sell the entity were unsuccessful. +See +Note 5—Goodwill and Intangible Assets for further discussion of impairment of goodwill and intangible assets originally recorded in connection with the +aforementioned acquisitions. +7. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES +Accrued expenses and other liabilities include the following (in thousands): +December 31, +2008 +2007 +Accrued compensation and benefits +$ +10,178 +$ +22,416 +Fulfillment and freight and duties +7,832 +4,065 +Professional services +4,340 +5,625 +Sales/Use tax payable +3,577 +2,573 +Accrued loss on purchase commitments +2,102 +— +Pforce inventory buyback +5,260 +— +Accrued purchase price related to Acquisitions +150 +3,429 +Other +16,637 +19,138 +$ +50,076 +$ +57,246 +8. RESTRUCTURING ACTIVITIES +During the year ended December 31, 2008, the Company announced its decision to restructure its operations. This decision included the closure of its Canadian and Brazilian +manufacturing facilities and the consolidation of Canadian distribution activities into other existing North American operations. The +Company has established reserves to cover future known obligations related to the closure of the Canadian and Brazilian manufacturing operations and the move of the Canadian distribution operations. +Reserves +are included in the line items accrued restructuring and long-term restructuring in the Company's consolidated balance sheets and are recorded under the line items +restructuring charges and cost of sales on the Company's consolidated statement of operations. +Reserves +at December 31, 2008, were $2.4 million, consisting of $0.7 million of accrued termination benefits, $1.5 million of rent obligations for leased +facilities, net of expected sublease income, and $0.2 million of contract termination fees and termination benefits accounted for in accordance with SFAS 112, Employers' Accounting for Post Employment +Benefits—an amendment of FASB Statements No. 5 and 43, and FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities. +During +2008, the Company sold assets relating to the Company's Canadian manufacturing operations for a net gain of approximately $779,000. The gain on disposal of assets is recorded in +the selling, general and administrative expenses on the consolidated statement of operations for the year ended December 31, 2008. There were no assets held for sale as of December 31, +2008 or December 31, 2007. +F-19 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +8. RESTRUCTURING ACTIVITIES (Continued) +The +Company recorded $7.7 million and $0.8 million of expenses associated with the closure of the Canadian facilities and Brazilian facilities, respectively, in the year +ended December 31, 2008. The expenses consisted of the following: +(i) termination +benefits of $3.8 million and $0.7 million for Canada and Brazil, respectively; +(ii) rent +obligations for leased facilities, net of expected sublease income of $1.8 million and $0.1 million for Canada and Brazil, respectively; and +(iii) early +termination costs for operating leases, cancellation of purchase obligations and freight and duty charges related to transferring inventory and equipment to +facilities in the United States and Mexico of $2.1 million, of which $0.9 million was recorded in cost of sales. +The +following table details the changes in the restructuring accruals during the year ended December 31, 2008 (in thousands): +Description +Year Ended +December 31, +2007 +Additions +Cash +Payments +Adjustments +Year Ended +December 31, +2008 +Termination benefits +$ +— +$ +4,525 +$ +(3,849 +) +$ +— +$ +676 +Operating lease exit costs +— +1,853 +(365 +) +— +$ +1,488 +Other restructuring costs(1) +— +2,126 +(1,892 +) +— +234 +$ +— +$ +8,504 +(6,106 +) +$ +— +$ +2,398 +(1) Other +restructuring costs include early termination costs for operating leases, cancellation of purchase obligations and freight and duty charges related to +transferring inventory and equipment to the other Company facilities. +9. NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS +Notes payable and capital lease obligations consist of the following (in thousands): +December 31, +2008 +2007 +Revolving credit facility +$ +22,422 +$ +7,000 +Capital lease obligations +9 +116 +Long-term portion of capital lease obligations +— +(9 +) +Total notes payable and capital lease obligations +$ +22,431 +$ +7,107 +Notes Payable +On May 8, 2007, the Company entered into the Revolving Credit Facility, which initially consisted of a $15.0 million +revolving loan facility. Borrowings under the Revolving Credit Facility are unsecured and initially bore an interest rate based, at the option of the Company, on (i) a base rate defined as the +higher of the Fed Funds rate less 0.50%, or the rate of interest most recently announced by the lender, or (ii) the Libor rate plus 0.875%. +F-20 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS (Continued) +On +November 21, 2007, the Company amended the Revolving Credit Facility, increasing the available borrowing amount to $25.0 million. Under the amended Revolving Credit +Facility, the Company was required to satisfy specified financial covenants, such as a minimum level of consolidated EBITDA, minimum net worth requirement and a minimum adjusted quick ratio. +On +January 4, 2008, the Company entered into a second amendment of the Revolving Credit Facility to increase the borrowing amount to $50.0 million. No financing fees were +incurred as part of the amendment. In addition, terms of specified financial covenants were modified. +On +March 6, 2008, the Company entered into a third amendment of the Revolving Credit Facility to increase the borrowing amount to $60.0 million. No financing fees were +incurred as part of the amendment. +As +of June 30, 2008, the Company was not in compliance with the financial covenants of the Revolving Credit Facility related to the minimum quarterly EBITDA test. The Company +obtained a waiver of such covenants, effective June 30, 2008, and was required to pay a fee to Union Bank in the amount of $40,000. The fee addressed charges associated with the covenant +violation and those necessary to amend the then current agreement. +On +August 7, 2008, the Company entered into a fourth amendment of the Revolving Credit Facility to decrease the borrowing amount to $40.0 million. As part of this +amendment, the borrowing amount further decreased to $30.0 million as of October 1, 2008, and the maturity date was extended to December 31, 2008. Borrowings under the Revolving +Credit Facility were unsecured and bore an interest rate based, at the option of the Company, on (i) a base rate defined as the Bank's LIBOR rate plus 3.0%, or (ii) 1.0% in excess of the +Reference Rate. In addition, terms of specified financial covenants were modified. +On +November 17, 2008, the Company entered into a fifth amendment of the Revolving Credit Facility. The amendment removed all financial covenants in the Revolving Credit Facility +as of September 30, 2008. In addition, the amendment limited the available borrowings to $19.8 million plus an outstanding $2.6 million letter of credit, subject to the total +outstanding amount not being in excess of the "borrowing base," defined as the sum of 70% of the Company's U.S. receivables plus 40% of the Company's U.S. inventories. If at any time the amount +outstanding is in excess of the borrowing base, the Company must pay down the loan to the borrowing base. Any amounts repaid on the Revolving Credit Facility cannot be borrowed again. The amendment +also required that the Company pay a fee of $112,000 to Union Bank. On December 1, 2008, the Company entered into a sixth amendment of the Revolving Credit Facility. The sixth amendment +modified the Revolving Credit Facility by reducing the committed loan amount to $22.4 million, eliminating loan advances and requiring that all principal and interest be repaid no later than +December 31, 2008. +On +December 19, 2008 and January 27, 2009, the Company entered into the seventh and eighth amendments, respectively, of the Revolving Credit Facility. The seventh amendment +modifies the Revolving Credit Facility by extending the maturity date to February 16, 2009. The seventh amendment, also limited to borrowings of $22.4 million, modified the interest rate +on the loan to 9% above the bank's reference rate and required the Company to perform certain non-financial covenants and pay certain fees. The Bank's Reference rate as of +December 31, 2008 was 3.25%, which generated a total modified interest rate of 12.25%. This amendment does not allow for new borrowings. The eighth amendment did not amend any material terms. +F-21 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS (Continued) +In connection with the seventh amendment, the Company entered into an Intellectual Property Security Agreement ("the IP Security Agreement") in favor of the bank. Pursuant to the IP +Security Agreement, the Company pledged to the bank substantially all of the Company's intellectual property. The IP Security Agreement specifies that the collateral includes all after-acquired +assets, damage claims, license fees, royalties and all proceeds and products generated from these assets. +On +February 13, 2009, the Company entered into Amendment No. 9 to the Loan Agreement, extending the maturity date on this facility to April 2, 2009, at which time +the Company will be required to pay all amounts then outstanding. Until April 2, 2009, the Company is required to make five installment payments of $0.2 million each on dates agreed upon +by the Company and Union Bank of California, N.A. The Company is currently exploring alternatives for a new borrowing arrangement or an extension of the existing credit facility and may seek other +sources of capital for ongoing needs. There can be no assurance that any such lending arrangement of capital will be available on terms acceptable to the Company or at all. +10. EQUITY +On November 1, 2007, the Company's board of directors approved an authorization to repurchase up to one million shares of its common stock. On April 14, 2008 , the board of +directors also approved an additional authorization to repurchase an additional 5,000,000 shares of our common stock. Share repurchases under these authorizations may be made in the open market or in +privately negotiated transactions. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements and other market +conditions. The repurchase authorizations do not have an expiration date and do not obligate the Company to acquire any particular amount of shares of its common stock. The repurchase authorizations +may be modified, suspended or discontinued at any time. On November 7, 2007, the Company repurchased approximately 524,000 shares for a total of approximately $25.0 million. +Share-Based Compensation +Under the modified prospective method, compensation expense recognized in the year ended December 31, 2008, includes: +(i) compensation expense of all share-based payments granted after August 15, 2005 but not yet vested as of January 1, 2006, based on the grant-date fair value +estimated in accordance with the provisions of SFAS 123R and (ii) compensation expense for all share-based payments granted subsequent to January 1, 2006, based on the grant date +fair value estimated in accordance with the provisions of SFAS 123R. Results for prior +periods have not been retrospectively adjusted. The Company records compensation expense related to non-employees under the provisions of SFAS 123R and Emerging Issues Task Force +EITF 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in conjunction with Selling, Goods or +Services ("EITF 96-18"), and recognizes compensation expense over the vesting periods of such awards. Total pre-tax share-based compensation +expense recognized was $19.0, $21.7 million, and $10.3 million for the years ended December 31, 2008, 2007, and 2006. Due to our loss position in the year ended +December 31, 2008, the Company did not recognize any associated tax benefits. Associated tax benefits in the years ended December 31, 2007 and 2006 were approximately $6.4 million +and $3.8 million, respectively. Capitalization of the stock based compensation into inventory and intangibles as part of the overhead allocation was $150,000 and $49,000, respectively, for 2008 +and $ 3.3 million and $160,000, respectively, for 2007. +F-22 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. EQUITY (Continued) +SFAS 123R +also required the Company to change the classification of any excess tax benefits realized on the exercise of stock options or issuance of restricted stock unit awards +in excess of that which is associated with the expense recognized for financial reporting purposes in its consolidated statement of cash flows. These amounts are presented as a financing cash inflow +rather than as a reduction of income taxes paid in the consolidated statement of cash flows. +The +Company has computed the fair value of options granted using the Black-Scholes option pricing model. In order to calculate the fair value of the options, certain assumptions are made +regarding components of the model, including risk-free interest rate, volatility, expected dividend yield rate, and expected option term. Changes to the assumptions could cause significant +adjustments to the valuation. For options granted before August 15, 2005, expected volatility was not considered for employee grants as the Company was a non-public entity at the +grant date of these options. For stock option grants issued after the filing of the Company's initial Registration Statement on Form S-1 on August 15, 2005, the minimum value +method is no longer used and the Company used a volatility rate of 50% and began to include estimated forfeiture rates. The Company estimated the volatility of its common stock at the date of grant +based on the historical volatility of the underlying shares of common stock as well as the historical volatility of comparable companies. The Company factored in historical forfeiture rates, expected +future retention rates, and vesting periods of the options to determine the average expected term. The risk-free interest rate for periods within the contractual life of the options is +based on the U.S. Treasury yield curve in effect at the time of each grant. Accordingly, the Company has computed the fair values of all options granted during the years ended December 31, +2008, 2007 and in 2006 using the Black-Scholes option pricing model and the following weighted average assumptions: +Year Ended December 31, +2008 +2007 +2006 +Expected volatility +50 +% +50 +% +50 +% +Dividend yield +— +— +— +Risk-free interest rate +2.81 +% +4.58 +% +4.71 +% +Expected life (in years) +4.59 +5.0 +5.0 +Because +the Company applied the minimum value method of valuing employee stock options prior to becoming a public company, as allowed by SFAS 123, the Company is precluded from +presenting pro forma historical statement of operations information under SFAS 123R. +Equity Incentive Plans +The Company adopted the 2005 Equity Incentive Plan (the "2005 Plan") on August 15, 2005. The Plan permits the grant of +non-qualified stock options, incentive stock options, and restricted stock to eligible employees, consultants and non-employee members of our Board of Directors. As of +December 31, 2008, approximately 5,546,617 options were outstanding under the 2005 Plan and no shares were available for future issuance under the 2005 Plan. +The +Company adopted the 2007 Equity Incentive Plan (the "2007 Plan") on July 19, 2007. The Plan permits the grant of non-qualified stock options, incentive stock +options, restricted stock, restricted stock units, stock appreciation rights, performance units, common stock or any other stock-based award +F-23 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. EQUITY (Continued) +to +eligible employees, consultants and non-employee members of our Board of Directors. As of December 31, 2008, approximately 5,201,259 options and awards were outstanding under the +2007 Plan and approximately 3,709,287 shares were available for future issuance under the 2007 Plan. +Stock +options under both the 2005 Plan and the 2007 Plan generally vest ratably over four years with the first year vesting on a "cliff" basis followed by monthly vesting for the +remaining three years. Restricted stock awards generally vest ratably over three years. +Stock Option Activity +The following summarizes stock option transactions under the 2005 and 2007 Plans for the year ended December 31, 2008: +Options +Shares +Weighted +Average +Exercise +Price +Weighted Average +Remaining +Contractual Life +(Years) +Aggregate +Intrinsic Value +(in thousands) +Outstanding at December 31, 2007 +8,292,497 +$ +16.76 +7.8 +$ +176,911 +Granted +4,069,900 +11.16 +Exercised +644,063 +5.21 +Forfeited or expired +1,909,458 +19.68 +Outstanding at December 31, 2008 +9,808,876 +$ +14.62 +7.65 +$ +293 +Exercisable at December 31, 2008 +3,281,276 +$ +14.02 +7.49 +$ +266 +Vested and expected to vest at December 31, 2008 +7,713,559 +$ +14.43 +6.01 +$ +192 +Options +awarded under the 2005 Plan prior to September 30, 2006 are exercisable immediately on the date of grant with the exception of 467,248 shares granted to members of the +Board of Directors. In order to preserve the vesting provisions of the immediately exercisable options, the options that are +exercised early are subject to a repurchase right by the Company at the lower of exercise price or fair market value of the underlying stock at the date of repurchase. This repurchase right expires on +vesting of the underlying option. Immediately exercisable stock options outstanding under the 2005 Plan were 2,966,729 at December 31, 2007 of which 1,744,168 are fully vested and no longer +subject to the repurchase right. Options awarded after October 1, 2006 are exercisable as they vest. To date, no options have been exercised early. +The +weighted average fair value of options granted during the years ended December 31, 2008 and 2007 and 2006 was approximately $4.90, $15.83, and $6.49, respectively. +The +aggregate intrinsic value of all options exercised during the years ended December 31, 2008, 2007 and 2006 was $9.4 million, $113.7 million and +$15.2 million, respectively. Cash received from stock option exercises for fiscal year 2008 was $3.3 million with no income tax benefit due to the Company's loss position, and cash +received from stock option exercises for fiscal year 2007 was $18.5 million with an income tax benefit of $43.2 million. The total grant date fair value of stock options vested during +2008, 2007, and 2006 was $22.5 million, $19.2 million and $8.5 million, respectively. +F-24 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. EQUITY (Continued) +The +outstanding options at December 31, 2008 had the following characteristics: +Options Outstanding +Options Exercisable +Exercise Prices +Number of +Shares +Weighted Average +Remaining +Contractual Life +(Years) +Weighted +Average +Exercise +Price +Number +Exercisable +Weighted +Average +Exercise Price +Fair Value +Determination +$0.51 - 1.69 +2,128,893 +7.15 +$ +1.24 +736,453 +$ +1.25 +Black-Scholes +$1.70 - 10.50 +3,373,324 +8.00 +7.24 +971,950 +7.41 +Black-Scholes +$10.51 - 14.98 +932,642 +6.12 +14.23 +467,250 +14.19 +Black-Scholes +$14.99 - 22.92 +1,283,635 +7.38 +22.39 +621,928 +22.42 +Black-Scholes +$22.93 - 47.88 +1,811,448 +8.43 +32.48 +390,076 +31.26 +Black-Scholes +$47.89 - 59.98 +278,934 +8.50 +56.75 +93,619 +56.74 +Black-Scholes +9,808,876 +7.65 +$ +14.62 +3,281,276 +$ +14.02 +As +of December 31, 2008, the Company issued unvested options to purchase 6.5 million shares of the Company's common stock with a weighted average grant date fair value of +$7.22. As of December 31, 2008, the Company had $40.1 million of total unrecognized share-based compensation expense related to unvested options, net of expected forfeitures, which is +expected to be amortized over the weighted average period of 2.8 years. +Non-vested Stock Awards +The following summarizes stock award transactions for the year ended December 31, 2008: +Non-vested +Shares +Weighted +Average +Grant Date +Fair Value +Outstanding at December 31, 2007 +87,558 +$ +2.96 +Granted +1,062,454 +$ +4.11 +Vested +(177,012 +) +$ +0.51 +Forfeited or expired +(34,000 +) +$ +10.77 +Outstanding at December 31, 2008 +939,000 +$ +3.87 +At +December 31, 2008, the Company had $2.4 million of total unrecognized share-based compensation expense related to non-vested stock awards, net of expected +forfeitures. The non-vested stock awards are expected to be amortized over the weighted average period of 2.7 years. +11. VARIABLE INTEREST ENTITIES +The Company established a relationship with Shanghai Shengyiguan Trade, Ltd Co ("ST") for the purpose of serving as a distributor of the Company's products in the People's +Republic of China ("PRC"). The Company has determined that ST is a variable interest entity for which it is the primary beneficiary and there are no other non-controlling interests. The +Company currently controls all business activities and absorbs substantially all of the expected residual returns and substantially all of the expected losses of ST based on agreements with ST. The +Company determined that it is the +F-25 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. VARIABLE INTEREST ENTITIES (Continued) +primary +beneficiary of ST by virtue of its variable interest in the equity of ST. All voting rights have been assigned to the Company and there is a transfer agreement between ST and the Company under +which all of the equity, assets, and liabilities are to be transferred to the Company at the Company's +sole discretion, subject to certain conditions. Accordingly, the Company's consolidation of ST does not reflect a non-controlling interest. +The +Company provided $4.0 million of financial support in 2008 for the funding of ST's operations. The consolidated financial statements include $15.8 million in total +assets as of December 31, 2008, primarily consisting of cash, inventory and receivables partially offset by $2.0 million in liabilities as of December 31, 2008 primarily +consisting of accounts payable and accrued expenses and excluding liabilities related to the support provided by the Company. The amounts in 2007 were not significant. +12. ALLOWANCES +The changes in the Company's allowance for doubtful accounts and reserve for sales returns and allowances for the years ended December 31, 2008, 2007 and 2006, are as follows (in +thousands): +Balance at +Beginning of +Year +Charged to +costs and +expenses +Deductions +and +write-offs +Balance at +End of Year +Year ended December 31, 2006: +Allowance for doubtful accounts +$ +566 +$ +1,719 +$ +595 +$ +1,690 +Reserve for sales returns and allowances +$ +562 +$ +3,266 +$ +1,014 +$ +2,814 +Year ended December 31, 2007: +Allowance for doubtful accounts +$ +1,690 +$ +4,671 +$ +2,566 +$ +3,795 +Reserve for sales returns and allowances +$ +2,814 +$ +7,168 +$ +3,991 +$ +5,991 +Year ended December 31, 2008: +Allowance for doubtful accounts +$ +3,795 +$ +3,091 +$ +1,624 +$ +5,262 +Reserve for sales returns and allowances +$ +5,991 +$ +52,597 +$ +38,777 +$ +18,836 +F-26 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES +Income Tax Provision +The expense (benefit) for income taxes consisted of the following (in thousands): +December 31, +2008 +2007 +2006 +Current—U.S. federal +(9,162 +) +$ +38,399 +$ +20,196 +Current—U.S. state +206 +3,646 +1,009 +Current—foreign +9,951 +44,919 +13,041 +Total current income taxes +995 +86,964 +34,246 +Deferred—U.S. federal +7,276 +(5,269 +) +(1,741 +) +Deferred—U.S. state +723 +(727 +) +(8 +) +Deferred—foreign +(13,428 +) +(8,870 +) +(288 +) +Total deferred income taxes +(5,429 +) +(14,866 +) +(2,037 +) +Total income tax expense (benefit) +(4,434 +) +$ +72,098 +$ +32,209 +Income +(loss) before taxes is as follows (in thousands): +December 31, +2008 +2007 +2006 +U.S. +(124,502 +) +$ +95,048 +$ +52,429 +Foreign +(65,008 +) +145,278 +44,197 +Total +(189,510 +) +$ +240,326 +$ +96,626 +Reconciliations +of the statutory federal income tax rate to the Company's actual rates based on income or loss before income taxes are summarized as follows: +December 31, +2008 +2007 +2006 +Consolidated income before taxes +35.0 +% +35.0 +% +35.0 +% +State income taxes net of federal benefit +1.4 +0.8 +1.1 +Foreign tax rate differential +(8.8 +) +(6.7 +) +(2.8 +) +Permanent portion of equity compensation +— +0.7 +— +Other +.8 +0.2 +— +Change in valuation allowance +(26.1 +) +— +— +2.3 +% +30.0 +% +33.3 +% +F-27 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES (Continued) +The Company's deferred income tax assets and liabilities are as follows (in thousands): +December 31, +2008 +2007 +Current deferred tax assets: Accrued expenses +$ +18,980 +$ +2,733 +Inventory +14,317 +9,087 +Intangible assets +374 +— +Other +739 +— +Valuation Allowance +(25,330 +) +— +Total current deferred tax assets +$ +9,080 +$ +11,820 +Non-current deferred tax assets: Accrued expenses +6,143 +158 +Stock compensation expense +7,203 +2,439 +Inventory +— +496 +Long-term accrued expenses +1,119 +506 +Net operating loss carryovers +13,844 +1,349 +Intangible assets +3,319 +— +Property and equipment +1,211 +— +Other +— +— +Future uncertain tax position offset +12,586 +6,436 +Valuation Allowance +(23,784 +) +— +Total non-current deferred tax assets +$ +21,641 +$ +11,384 +Non-current deferred tax liabilities: Property and equipment +— +$ +3,932 +Intangible assets +— +1,088 +Other +(1,073 +) +116 +Total non-current deferred tax liabilities +$ +(1,073 +) +$ +5,136 +At +December 31, 2008 and 2007, U.S. income and foreign withholding taxes have not been provided on approximately $114.5 million and $143.8 million, respectively, of +unremitted earnings of subsidiaries operating outside of the U.S. These earnings are estimated to represent the excess of the financial reporting over the tax basis in our investments in those +subsidiaries. These earnings, which are considered to be indefinitely reinvested, would become subject to U.S. income tax if they were remitted to the U.S. The amount of unrecognized deferred U.S. +income tax liability on the unremitted earnings has not been determined because the hypothetical calculation is not practicable. +The +Company has deferred tax assets related to certain deductible temporary differences in various tax jurisdictions for which the Company has recorded a valuation allowance of +$40.5 million against these deferred tax assets because the Company believes that it is not more likely than not that the Company will be able to realize these deferred tax assets. +The +Company has recorded a foreign deferred tax asset of $4.3 million reflecting the benefit of $12.6 million in foreign net operating loss carryforwards. Such deferred tax +assets expire at various dates between 2013 and 2028. The Company believes it is not more likely than not that the benefit from certain foreign net operating loss carryforwards will be realized. The +Company has provided a +F-28 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES (Continued) +valuation +allowance of $3.3 million on the deferred tax assets relating to these foreign net operating loss carryforwards. +The +Company has U.S.federal and state net operating loss carryforwards of $21.8 million and $2.0 million which will expire at various dates between 2013 and 2028. The +Company believes that it is not more likely than not that the benefit from certain U.S. federal and state net operating losses will be realized. The Company has provided a valuation allowance of +$5.3 million on the deferred tax assets relating to these federal and state net operating loss carryforwards. +As +a result of certain realization requirements under SFAS 123(R), the table of deferred tax assets and liabilities shown above does not include certain deferred tax assets at +December 31, 2008 that arose directly from tax deductions related to equity compensation in excess of compensation recognized for financial reporting. Equity will be increased by +$2.9 million if and when such deferred tax assets are ultimately realized. The Company uses tax law ordering for purposed of determining when excess tax benefits have been realized. +A +reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands): +2008 +2007 +Unrecognized tax benefit—January 1 +$ +11,264 +$ +— +Gross increases—tax positions in prior period +13,063 +4,838 +Gross decreases—tax positions in prior period +— +— +Gross increases—tax positions in current period +4,868 +6,877 +Settlements +(985 +) +— +Lapse of statute of limitations +— +— +Unrecognized tax benefit +$ +28,210 +$ +11,715 +The +unrecognized tax benefits of $28.2 million and $11.7 million at December 31, 2008 and 2007, respectively, if recognized, would reduce the Company's annual +effective tax rate. +Interest +and penalties related to income tax liabilities are included in income tax expense in the Company's consolidated statement of operations. During 2008 and 2007, the Company +recorded approximately $1.6 million and $0.5 million, respectively, of penalties and interest which resulted in a cumulative accrued balance of penalties and interest of +$2.1 million and $0.5 at December 31, 2008 and 2007, respectively. +The +Company's unrecognized tax benefits consist primarily of tax positions related to intercompany transfer pricing in multiple international jurisdictions. The gross increase for tax +positions in prior periods of $13.1 million primarily includes specific transfer pricing exposures for which the filing positions were changed on the returns completed and filed in 2008 based +on changes in transfer pricing methodology. This increase was offset entirely by a reduction in current income taxes payable, accordingly there was no impact to the statement of operations resulting +from these adjustments. The Company believes that it is reasonably possible that no increases or decreases or immaterial increases or decreases to unrecognized tax benefits will occur in the next +twelve months. +F-29 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES (Continued) +As +of December 31, 2008, the following tax years remain subject to examination for the major jurisdictions where the Company conducts business: +United States +2005 to 2008 +Canada +2004 to 2008 +Netherlands +2005 to 2008 +Singapore +2004 to 2008 +State +income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective return. The state impact of any federal changes remains +subject to examination by various state jurisdictions for a period up to 2 years after formal notification to the states. +14. EARNINGS PER SHARE +Basic income (loss) per common share ("EPS") is computed by dividing the net income available to common stockholders by the weighted average number of common shares outstanding for the +period. Diluted EPS reflects the potential dilution that could occur if certain outstanding stock options are exercised, restrictions lapse on restricted stock awards and preferred stock is converted. +Anti-dilutive securities are excluded from diluted EPS. +The +following is a reconciliation of the number of shares used in the basic and diluted EPS computations for the years ended December 31, 2008, 2007 and 2006: +Years Ended December 31, +2008 +2007 +2006 +(in thousands, except share and per share data) +Net income (loss) attributable to common stockholders for basic computation +$ +(185,076 +) +$ +168,228 +$ +64,384 +Reconciliation of net income (loss) for dilutive computation: +Net income (loss) attributable to common stockholders +$ +(185,076 +) +$ +168,228 +$ +64,384 +Preferred dividend +— +— +33 +Net income (loss) for dilutive computation +$ +(185,076 +) +$ +168,228 +$ +64,417 +Basic income (loss) per common share: +Weighted average common shares outstanding +82,767,540 +80,759,077 +74,598,400 +Basic income (loss) per common share +$ +(2.24 +) +$ +2.08 +$ +0.87 +Diluted income (loss) per common share: +Weighted average common shares outstanding +82,767,540 +80,759,077 +74,598,400 +Dilutive effect of preferred stock +— +— +1,592,652 +Dilutive effect of stock options +— +3,144,607 +2,998,156 +Dilutive effect of unvested stock +— +291,199 +981,304 +Weighted average diluted common shares outstanding +82,767,540 +84,194,883 +80,170,512 +Diluted income (loss) per common share +$ +(2.24 +) +$ +2.00 +$ +0.81 +F-30 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. EARNINGS PER SHARE (Continued) +Due +to the Company's net loss for the year ended December 31, 2008, the dilutive effect of stock options and awards were not included in the computation of EPS, as their inclusion +would have been anti-dilutive. +For +the years ended December 31, 2008, 2007 and 2006 there were options outstanding and unvested restricted stock, which could potentially dilute basic EPS in the future, but +which were not included in diluted EPS as their effect was anti-dilutive. The weighted-average exercise price per share for the options was $4.42, $48.35, and $33.53 for 2008, 2007, and +2006, respectively. The following table summarizes the anti-dilutive securities: +Years Ended December 31. +2008 +2007 +2006 +Anti-dilutive effect: +Stock options +9,808,876 +906,700 +654,350 +Unvested stock +294,500 +— +— +10,103,376 +906,700 +654,350 +15. COMMITMENTS AND CONTINGENCIES +The Company leases space for certain of its offices, warehouses, vehicles and equipment under leases expiring at various dates through 2027. Certain leases also contain rent escalation +clauses (step rents) that require additional rental amounts in the later years of the term. Rent expense for leases with step rents is recognized on a straight-line basis over the minimum +lease term. Deferred rent is included in the consolidated balance sheet in accrued expenses. Rent expense was $52.7 million, $26.0 million, and $8.3 million for the years ended +December 31, 2008, 2007, and 2006, respectively. +Minimum +future annual rental commitments under non-cancelable operating leases for each of the five succeeding years as of December 31, 2008, are as follows (in +thousands): +Fiscal years ending December 31, +2009 +$ +47,559 +2010 +37,009 +2011 +25,621 +2012 +15,750 +2013 +11,165 +Thereafter +42,212 +Total +$ +179,316 +At +December 31, 2008, the Company had purchase commitments with our third party manufacturers for $14.0 million in inventory. Approximately $2.1 million of this +commitment was for certain products at prices in excess of net realizable value, given our plans for sales of the product. Accordingly, $2.1 million was recorded related to expected losses on +future purchase commitments and is included in accrued expenses at December 31, 2008. +F-31 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. COMMITMENTS AND CONTINGENCIES (Continued) +The +Company indemnifies certain of its vendors and its directors and executive officers for specified claims. To date, the Company has not paid or been required to defend any +indemnification claims, and accordingly, has not accrued any amounts for its indemnification obligations. +The +Company guarantees the payment of its third-party manufacturer in China for purchases of material for the manufacture of finished shoe products. The maximum potential amount of +future payments the Company could be required to make under the guarantee is €2.1 million (approximately $3.0 million) as of December 31, 2008. The Company +evaluates the estimated loss for the guarantee under SFAS No. 5, Accounting for Contingencies ("SFAS 5"), as interpreted by FIN +No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others +("FIN 45"). The Company considers such factors as the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. The Company has +recourse as a matter of common law. To date, the Company has not made any payments under the guarantee and as of December 31, 2008, has not recorded a liability related to the guarantee in its +financial statements as the Company does not believe the potential obligation under this guarantee is material. +The +Company has a commitments for corporate sponsorships for each of the four succeeding years as of December 31, 2008, are as follows (in thousands): +Fiscal years ending December 31, +2009 +$ +6,662 +2010 +5,460 +2011 +5,300 +2012 +5,315 +Total +$ +22,737 +16. RELATED PARTIES +The Company entered into the following related party transactions: +In +May 2005, the Company subleased an office building from Flextronics USA, Inc. One of our directors, Mr. Sharp, and our former director, Mr. Marks, also served as +directors of Flextronics and another of our directors, Mr. Smach, served as Flextronics' Chief Financial Officer, at such time. The Company paid Flextronics $111,000 and $159,000 for lease +payments for the years ended December 31, 2007 and 2006, respectively. This lease expired on March 31, 2007 and was not renewed. +In +connection with a separation agreement, the Company and its former Chief Executive Officer entered into an exclusive distribution agreement that commenced July 1, 2005. The +distribution agreement is for specified territories in Central America and has an initial term of two years. The agreement provides for renewal periods at the former Chief Executive Officer's option, +if specified sales volumes are attained. Pricing under this agreement is set at a discount off the Company's then current wholesale pricing. Additionally, effective July 1, 2005, the Company +and the former Chief Executive Officer entered into an agreement providing him the right to license and/or franchise airport kiosks selling the Company's products for a period of 10 years, +subject to the Company's right to terminate the agreement if specified numbers of kiosks are not opened in timeframes specified. +F-32 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. RELATED PARTIES (Continued) +On +February 24, 2009, the Company's board of directors appointed Mr. John Duerden to serve as the Company's president and Chief Executive Officer effective March 16, +2009. Concurrent with his appointment, the Company entered into an employment agreement with Mr. Duerden, as described more fully in Note 20—Subsequent Events. +The +Company owns, operates and maintains its own aircraft. From time to time, the Company's directors and executive officers have used the aircraft for personal purposes. These directors +and executive officers have fully reimbursed the Company for expenses related to their personal use of this aircraft during the year ended December 31, 2008, determined based on the cost of +fuel and other variable costs associated with the flights under FAR 91-501(d). +17. OPERATING SEGMENTS AND RELATED INFORMATION +The Company operates in the consumer products industry in which the Company designs, manufactures, markets and distributes footwear, apparel and accessories. Operating results are +assessed on an aggregate basis to make decisions about necessary resources and in assessing performance. Consequently, under the provisions of SFAS No. 131, Disclosure +About Segments of an Enterprise and Related Information ("SFAS 131"), and based on the nature of the financial information that is received by the chief executive +officer as chief operating decision maker, the Company has one reportable segment for financial statement purposes. +The +Company's sales by product line are as follows (in thousands): +Year Ended December 31, +2008 +2007 +2006 +Footwear +$ +660,734 +$ +763,303 +$ +342,437 +Other +60,855 +84,047 +12,291 +$ +721,589 +$ +847,350 +$ +354,728 +Geographic +information about the U.S. and international territories is presented below. The Company has allocated revenues to the geographic locations based on the location of the +customer (in thousands): +December 31, +Revenue +2008 +2007 +2006 +United States +$ +321,241 +$ +439,486 +$ +242,227 +Canada +23,214 +41,113 +21,779 +Mexico +7,295 +6,995 +1,499 +North America Total +351,750 +487,694 +265,505 +Asia-Pacific +204,943 +163,046 +54,382 +Europe +150,717 +173,671 +30,286 +All other +14,179 +22,939 +4,555 +$ +721,589 +$ +847,350 +$ +354,728 +Total for countries outside the United States +$ +400,348 +$ +407,764 +$ +112,501 +F-33 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +17. OPERATING SEGMENTS AND RELATED INFORMATION (Continued) +December 31, +Long-lived assets +2008 +2007 +United States +$ +64,340 +$ +47,144 +Canada +1,857 +14,111 +Mexico +2,302 +2,988 +North America Total +68,499 +64,243 +Asia-Pacific +12,720 +7,793 +Europe +14,024 +12,379 +Other +649 +3,769 +$ +95,892 +$ +88,184 +Total for countries outside the United States +$ +31,552 +$ +41,040 +There +were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2008, 2007 and 2006. +18. LEGAL PROCEEDINGS +On March 31, 2006, Crocs filed a complaint with the ITC against Acme Ex-Im, Inc., Australia Unlimited, Inc., Cheng's Enterprises, Inc., Collective +Licensing International, LLC, D. Myers & Sons, Inc., Double Diamond Distribution, Ltd., Effervescent, Inc., Gen-X Sports, Inc., Holey Soles +Holdings, Ltd., Inter-Pacific Trading Corporation, and Shaka Holdings, Inc., alleging patent and trade dress infringement and seeking an exclusion order banning the importation and sale +of infringing products. On August 10, 2006 Crocs filed a motion to voluntarily remove its trade dress claim from the investigation to focus on the patent claims. Crocs' motion was granted by +Order No. 20 on August 24, 2006. The utility and design patents asserted in the complaint were issued to Crocs, Inc. on February 7, 2006 and March 28, 2006 +respectively, by the United States Patent and Trademark Office. The ITC has issued final determinations terminating Shaka Holdings, Inc., Inter-Pacific Trading Corporation, Acme +Ex-Im, Inc., D. Myers & Sons, Inc. and Australia Unlimited, Inc. from the ITC investigation No. 337-TA-567 on the basis of +settlement and Cheng's Enterprises, Inc. on the suspension of accused activities. The ITC Administrative Law Judge ("ALJ") issued an Initial Determination of non-infringement +related to one of the patents at issue. Crocs filed a petition with the Commission to review this determination. The Commission granted Crocs' petition and on February 15, 2007, after briefing +by the parties, the Commission vacated the ALJ's determination of non-infringement with respect to the remaining respondents and remanded it to the ALJ for further proceedings consistent +with the Commission's order. In light of the Commission's Order, the procedural schedule and hearing date were reset pursuant to Order No. 38. A trial was held before the ALJ from +September 7-14, 2007. The ALJ issued an Initial Determination on April 11, 2008 with a finding of no violation, finding infringement of the utility patent by certain accused +products, but also finding that the utility patent was invalid as obvious. The ALJ also found that the design patent was valid, but not infringed by the accused products. Crocs filed a Petition for +Review of the Initial Determination which was due on April 24, 2008. On June 18, 2008, the Commission issued a Notice that it would review the ALJ's findings in the Initial Determination +with respect to the determination of non-infringement of the design patent and the determination of invalidity of the utility patent. On July 25, 2008, the Commission issued a +Notice of its decision to terminate the Investigation with a finding of no violation +F-34 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +18. LEGAL PROCEEDINGS (Continued) +as +to either patent. Crocs filed a Petition for Review of the decision with the United States Court of Appeals for the Federal Circuit on September 22, 2008, and filed its initial brief on +January 21, 2009. +Briefing before the Federal Circuit is expected to be completed in March 2009 and oral argument has not yet been scheduled. +On +April 3, 2006, Crocs filed a complaint in the U.S. District Court for the District of Colorado alleging patent and trade dress infringement and seeking injunctive relief +against Acme EX-IM, Inc., Australia Unlimited, Inc., Cheng's Enterprises, Inc., Collective Licensing International, LLC, D. Myers & Sons, Inc., +Double Diamond Distribution, Ltd., Effervescent, Inc., Gen-X Sports, Inc., Holey Soles Holdings, Ltd, Inter-Pacific Trading Corporation, Shaka +Holdings, Inc., and Does 1-10 based upon certain utility and design patents that were issued to Crocs, Inc. on February 7, 2006 and March 28, 2006 respectively, +by the United States Patent and Trademark Office. Consent judgments have been entered against Shaka Holdings, Inc., Interpacific Trading Corporation and Acme Ex-Im, Inc. +Crocs entered into a settlement with Australia Unlimited, and filed a stipulation for dismissal of all claims and counterclaims on January 25, 2007. Crocs has entered into a settlement +agreement with D. Myers & Sons and obtained a consent judgment in connection therewith on May 23, 2007. This action has been stayed pending resolution in the ITC Proceeding, +Investigation No. 337-TA-567, which is currently on appeal to the U.S. Court of Appeals for the Federal Circuit. The Company does not expect the ultimate resolution of +this matter will have a material adverse impact on its business. +The +Company and certain current and former officers and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of +Colorado. The first complaint was filed in November 2007; several other complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the Court appointed a lead +plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purports to state claims under Section 10(b), 20(a), and 20A of the Exchange Act on +behalf of a class of all persons who purchased the Company's stock between April 2, 2007 and April 14, 2008 (the "Class Period"). The amended complaint alleges that, during the Class +Period, defendants made false and misleading public statements about the Company and its business and prospects and that, as a result, the market price of the Company's stock was artificially +inflated. The amended complaint also claims that certain current and former officers and directors traded in the Company's stock on the basis of material non-public information. The +amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified amount, interest, and an award of attorneys' fees and costs of litigation. The Company believes the claims +lack merit and intends to defend the action vigorously. Due to the inherent uncertainties of litigation and because the litigation is at a preliminary stage, the Company cannot at this time accurately +predict the ultimate outcome of the matter, or of the amount or range of potential loss, if any. +In +December 2007, a plaintiff filed a shareholder derivative action in the Colorado District Court for the City and County of Boulder alleging that certain officers and directors of the +Company breached their fiduciary duties, wasted corporate assets, and were unjustly enriched. This derivative action purported to state a claim on behalf of the Company. Plaintiff filed an amended +complaint in July 2008, which alleges claims that arise from the conduct alleged in the federal shareholder class action and allegations regarding additional statements made by the Company between +November 2007 and May 2008. The Company and the individual defendants filed motions to dismiss the derivative +F-35 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +18. LEGAL PROCEEDINGS (Continued) +complaint. +On February 26, 2009, the Court dismissed the derivative compliant with prejudice and denied plaintiff leave to amend. The order is subject to appeal. +On +March 17, 2008, Cellect LLC and Sentinel Products Corp. filed a complaint against Crocs, Inc. with the U.S. District Court for the Northern District of New York +alleging that Crocs' Croslite materials infringe U.S. Patent No. 5,932,659. Crocs filed an answer on July 11, 2008. Discovery is ongoing and Plaintiff's preliminary infringement +contentions were due on November 17, 2008. On January 12, 2009, the Court entered an order dismissing the action without prejudice. The Court's Order became a dismissal with prejudice on +February 10, 2009. This matter is considered closed. +Although +the Company is subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, the +Company is not party to any other pending legal proceedings that the Company believes will have a material adverse impact on its business. +As +of December 31, 2008, the Company has not accrued any amounts related to estimated losses for legal contingencies. While there is a reasonable possibility that certain legal +matters may result in an unfavorable outcome and loss, the Company's estimated potential losses, or range of losses, when aggregated, would be immaterial to the financial statements. +19. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +Quarter Ended +March 31 +Quarter Ended +June 30 +Quarter Ended +September 30 +Quarter Ended +December 31 +Year Ended December 31, 2008 +Revenues +$ +198,540 +$ +222,770 +$ +174,187 +$ +126,092 +Gross profit +85,235 +90,288 +2,399 +(a) +56,044 +Restructuring charges +3,849 +1,371 +2,450 +895 +Goodwill impairment charges +1,036 +— +22,831 +— +Asset impairment charges +9,777 +2,903 +8,753 +484 +Loss from operations +(6,404 +) +(2,942 +) +(136,026 +) +(42,910 +) +Net income (loss) +(4,527 +) +2,132 +(147,980 +) +(34,701 +) +Basic income (loss) per common share +$ +(0.05 +) +$ +0.03 +$ +(1.79 +) +$ +(0.42 +) +Diluted income (loss) per common share +$ +(0.05 +) +$ +0.03 +$ +(1.79 +) +$ +(0.42 +) +Year Ended December 31, 2007 +Revenues +$ +142,002 +$ +224,273 +$ +256,275 +$ +224,800 +Gross profit +84,485 +131,944 +155,392 +125,828 +Income from operations +37,158 +68,472 +78,236 +53,901 +Net income +24,945 +48,451 +56,548 +38,284 +Basic income per common share +$ +0.31 +$ +0.60 +$ +0.69 +$ +0.47 +Diluted income per common share +$ +0.30 +$ +0.58 +$ +0.66 +$ +0.45 +(a) For +the three months ended September 30, 2008, the Company had significant inventory write-down charges, asset abandonment, and +write-down of goodwill which effects the comparability between periods. +F-36 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +20. SUBSEQUENT EVENTS +February 13, 2009, the Company entered into Amendment No. 9 to the Loan Agreement, extending the maturity date on the Revolving Credit Facility to April 2, 2009, at +which time the Company will be required to pay all amounts then outstanding. As part of the ninth amendment, the Company agreed to make five payments of $0.2 million on dates agreed upon in the +Amendment. +On +February 24, 2009, the Company's current Chief Executive Officer, Mr. Ron Snyder, announced he would be retiring and resigning as President and Chief Executive Officer +from the Company. Mr. Snyder will continue to serve as a member of the Company's board of directors and will stay with the Company to assist with the transition until at least April 1, +2009. +Also +on February 24, 2009, the Company's board of directors appointed Mr. John Duerden to serve as the Company's President and Chief Executive Officer effective +March 18, 2009. The board also intends to appoint Mr. Duerden to the board of directors on March 18, 2009. The Company also entered into an employment agreement with +Mr. Duerden which provides for an annual salary of $850,000, subject to annual adjustments, as well as a $350,000 signing bonus and relocation benefits. Mr. Duerden is also eligible for +an annual bonus at a target rate of 100% of his annual base salary. Mr. Duerden was granted 400,000 options to purchase shares of the Company's common stock at $1.37 per share, the closing +price of the Company's common stock on the NASDAQ Global Select Market on the date of grant, as well as 400,000 shares of restricted common stock of the Company. The employment agreement also provides +for certain termination benefits if Mr. Duerden is terminated by the Company involuntarily and without cause. +On +February 24, 2009, the Company's board of directors appointed Mr. W. Stephen Cannon as a Director. Mr. Cannon is expected to serve on the Compensation Committee +and the Governance and Nominating Committee of the Company's board of directors. +F-37 \ No newline at end of file diff --git a/raw/filings/0001334036/2008/0001047469-09-002818/filing_metadata.csv b/raw/filings/0001334036/2008/0001047469-09-002818/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..dfa26cac2dcaa0627960df58c7f20a10474d09d6 --- /dev/null +++ b/raw/filings/0001334036/2008/0001047469-09-002818/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2009-03-17,2008-12-31,2009-03-17T21:01:03.000Z,0001047469-09-002818,a2190961z10-k.htm,10-K,1832163,0,0,https://www.sec.gov/Archives/edgar/data/1334036/000104746909002818/a2190961z10-k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000104746909002818/,2008,2008,1 diff --git a/raw/filings/0001334036/2008/0001047469-09-002818/item1.txt b/raw/filings/0001334036/2008/0001047469-09-002818/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..2b9a6f7ac7d23d91e97975ae8d7a151ebdcee885 --- /dev/null +++ b/raw/filings/0001334036/2008/0001047469-09-002818/item1.txt @@ -0,0 +1,3 @@ +Item 1. +Business +2 \ No newline at end of file diff --git a/raw/filings/0001334036/2008/0001047469-09-002818/item13.txt b/raw/filings/0001334036/2008/0001047469-09-002818/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..fdb10ea54f362c50262434b710da3de42838ac35 --- /dev/null +++ b/raw/filings/0001334036/2008/0001047469-09-002818/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. Certain Relationships and Related Transactions, and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2009 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2008. \ No newline at end of file diff --git a/raw/filings/0001334036/2008/0001047469-09-002818/item9a.txt b/raw/filings/0001334036/2008/0001047469-09-002818/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e1b5222756dadab571745d3feadd30a60f2d37af --- /dev/null +++ b/raw/filings/0001334036/2008/0001047469-09-002818/item9a.txt @@ -0,0 +1,68 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial +Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and +15d-15(e) under the Exchange Act, as of the end of the period covered by this annual report (the "Evaluation Date"). Based on this evaluation, our Chief Executive Officer and Chief +Financial Officer concluded that as of the Evaluation Date, our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, +required to be disclosed in our Securities and Exchange Commission ("SEC") reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, +and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required +disclosure. +Management's Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate control over financial reporting, as defined in Exchange Act +Rules 13a-15(f) and 15d-15(f). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2008, using the +criteria set forth in the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway +Commission (COSO). Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2008. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting, which is +included herein. +Changes in Internal Control Over Financial Reporting +During the three months ended December 31, 2008, we did not make any changes to our internal control over financial reporting +that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +58 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2008, based on criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's +management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the +accompanying "Management Report on Internal Control Over Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our +audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control +over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or +persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting +and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those +policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material +misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to +future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In +our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year +ended December 31, 2008 of the Company and our report dated March 17, 2009 expressed an unqualified opinion on those financial statements and included (a) an explanatory paragraph +expressing substantial doubt about the Company's ability to continue as a going concern; and (b) an explanatory paragraph +59 +Table of Contents +regarding +the Company's accounting for uncertain tax positions on January 1, 2007 in accordance with the Financial Accounting Standards Board's Interpretation No. 48, Accounting for Uncertainty in Income Taxes . +/s/ +Deloitte & Touche LLP +Denver, +Colorado +March 17, 2009 +60 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2008/0001047469-09-002818/rp_note.txt b/raw/filings/0001334036/2008/0001047469-09-002818/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..39966ffb7937289333cd9e27777503c1a8d89c86 --- /dev/null +++ b/raw/filings/0001334036/2008/0001047469-09-002818/rp_note.txt @@ -0,0 +1,24 @@ +16. RELATED PARTIES +The Company entered into the following related party transactions: +In +May 2005, the Company subleased an office building from Flextronics USA, Inc. One of our directors, Mr. Sharp, and our former director, Mr. Marks, also served as +directors of Flextronics and another of our directors, Mr. Smach, served as Flextronics' Chief Financial Officer, at such time. The Company paid Flextronics $111,000 and $159,000 for lease +payments for the years ended December 31, 2007 and 2006, respectively. This lease expired on March 31, 2007 and was not renewed. +In +connection with a separation agreement, the Company and its former Chief Executive Officer entered into an exclusive distribution agreement that commenced July 1, 2005. The +distribution agreement is for specified territories in Central America and has an initial term of two years. The agreement provides for renewal periods at the former Chief Executive Officer's option, +if specified sales volumes are attained. Pricing under this agreement is set at a discount off the Company's then current wholesale pricing. Additionally, effective July 1, 2005, the Company +and the former Chief Executive Officer entered into an agreement providing him the right to license and/or franchise airport kiosks selling the Company's products for a period of 10 years, +subject to the Company's right to terminate the agreement if specified numbers of kiosks are not opened in timeframes specified. +F-32 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. RELATED PARTIES (Continued) +On +February 24, 2009, the Company's board of directors appointed Mr. John Duerden to serve as the Company's president and Chief Executive Officer effective March 16, +2009. Concurrent with his appointment, the Company entered into an employment agreement with Mr. Duerden, as described more fully in Note 20—Subsequent Events. +The +Company owns, operates and maintains its own aircraft. From time to time, the Company's directors and executive officers have used the aircraft for personal purposes. These directors +and executive officers have fully reimbursed the Company for expenses related to their personal use of this aircraft during the year ended December 31, 2008, determined based on the cost of +fuel and other variable costs associated with the flights under FAR 91-501(d). \ No newline at end of file diff --git a/raw/filings/0001334036/2008/0001047469-09-002818/rpt_disclosure.txt b/raw/filings/0001334036/2008/0001047469-09-002818/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..cd56fa164c9bc5848b9db695058dc832bbebc04e --- /dev/null +++ b/raw/filings/0001334036/2008/0001047469-09-002818/rpt_disclosure.txt @@ -0,0 +1,22 @@ +CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS +Related Party Transactions +In 2008, we sponsored Germain Racing Truck #9 in the NASCAR Craftsman Truck Series. Justin Marks is employed by Germain Racing as the +driver of Truck #9. Justin Marks is the son of Michael Marks who, at the time we entered into the sponsorship agreement, was a director. Mr. Marks resigned as a director on July 29, +2008. The total amount of our sponsorship of Germain Racing for 2008 was $480,000. We believe that Justin Marks, a related person, had a material interest in the sponsorship by virtue of his +employment with Germain Racing as the driver of Truck #9. The sponsorship was part of our larger auto racing sponsorship and sports marketing efforts and was negotiated at an arms-length +basis with terms similar to those of our other auto racing sponsorships. The sponsorship agreement ended in the fourth quarter of 2008 and was not renewed. +Policy on Transactions with Related Persons +Our Business Code of Conduct and Ethics requires that any transaction involving us in which one of our directors, nominees for +director, executive officers, or greater than five percent stockholders, or their immediate family members (each, a "related person"), have a material +interest be approved or ratified by the Audit Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a +fiscal year. The full Board reviews ordinary course of business transactions in which directors have an interest as part of the Board's annual director independence review, and our Business Code of +Conduct and Ethics permits the full Board to waive any conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit +Committee must consider, in addition to other factors it deems appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. +All +transactions disclosed above were reviewed and approved in accordance with this policy. +Director and Officer Indemnification +We have entered into agreements to indemnify our directors and executive officers, in addition to the indemnification provided for in +our certificate of incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys' fees), +judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by or in the right of the Company, arising out of such person's services as a +director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We believe that these provisions and agreements +are necessary to attract and retain qualified persons as directors and executive officers. \ No newline at end of file diff --git a/raw/filings/0001334036/2009/0001047469-10-001357/filing.txt b/raw/filings/0001334036/2009/0001047469-10-001357/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..8984658f81c4f1a2c28b981531722c225dedb620 --- /dev/null +++ b/raw/filings/0001334036/2009/0001047469-10-001357/filing.txt @@ -0,0 +1,6213 @@ +10-K +1 +a2196634z10-k.htm +10-K +Use these links to rapidly review the document +Table of Contents +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2009 +or +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission File No. 0-51754 +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware +20-2164234 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +6328 Monarch Park Place +Niwot, Colorado 80503 +(303) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant's principal executive offices) +Securities +registered pursuant to Section 12(b) of the Act: +Title of each class: +Name of each exchange on which registered: +Common Stock, par value $0.001 per share +The NASDAQ Global Select Market +Securities +registered pursuant to Section 12(g) of the Act: +None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Act. Yes o No ý +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 ý No o +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 o No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be +contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to +the Form 10-K. ý . +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting +company. See definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer o +Accelerated filer ý +Non-accelerated filer o +Smaller reporting company o +Indicate +by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the +Act). Yes o No ý +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2009 was $239,530,428. For the +purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 5% of the registrant's common stock are assumed to be affiliates of the +registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The +number of shares of the registrant's common stock outstanding as of January 31, 2010 was 85,670,762. +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by reference from the registrant's proxy statement for the 2010 annual meeting of stockholders to be filed no +later than 120 days after the end of the registrant's fiscal year ended December 31, 2009. +Table of Contents +Crocs, Inc. +2009 Annual Report on Form 10-K +Table of Contents +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +13 +Item 1B. +Unresolved Staff Comments +28 +Item 2. +Properties +28 +Item 3. +Legal Proceedings +29 +Item 4. +Submission of Matters to a Vote of Security Holders +31 +PART II +Item 5. +Market for the Registrant's Common Equity and Related Stockholder Matters +32 +Item 6. +Selected Financial Data +35 +Item 7. +Management's Discussion and Analysis of Financial Condition and Results of Operations +36 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +61 +Item 8. +Financial Statements and Supplementary Data +62 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +62 +Item 9A. +Controls and Procedures +63 +Item 9B. +Other Information +65 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +65 +Item 11. +Executive Compensation +65 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +65 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +66 +Item 14. +Principal Accounting Fees and Services +66 +PART IV +Item 15. +Exhibits, Financial Statement Schedules +67 +Signatures +71 +Table of Contents +FORWARD-LOOKING INFORMATION +Throughout this report, references to the "Company," "we," "us" and "our" refer to Crocs, Inc. and its consolidated +subsidiaries, unless the context indicates otherwise. +Statements +in this Form 10-K and in documents incorporated by reference herein (or otherwise made by us or on our behalf) contain "forward looking statements" within +the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications from time to time that contain such statements. Forward looking +statements include statements as to industry trends and our future expectations and other matters that do not relate strictly to historical facts and are based on certain assumptions of our +management. These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," "are likely" or "continue," and similar +expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to us. Such forward looking statements are subject to +risks, uncertainties and other factors that could cause actual results to differ materially from future results expressed or implied by such forward looking statements. Important factors that could +cause actual results to differ materially from the forward looking statements include, without limitation, the following risk factors: +• macroeconomic issues, including, but not limited to, the current global financial crisis; +• our ability to effectively manage our future growth or declines in revenue; +• changing fashion trends; +• our ability to maintain and expand revenues and gross margin, net of the impact of sales of impaired inventories; +• our management and information systems infrastructure; +• our ability to repatriate cash held in foreign locations in a timely and cost-effective manner; +• our ability to maintain compliance with our debt covenants; +• our ability to maintain sufficient liquidity; +• our ability to develop and sell new products; +• our ability to obtain and protect intellectual property rights; +• our reliance on third-party manufacturing and logistics providers for the production and distribution of products; +• our ability to anticipate difficulties or disruptions to our manufacturing operations; +• our reliance on a limited source supply for certain raw materials; +• inherent risks associated with the manufacture, distribution and sale of our products overseas; +• our ability to meet the estimates or expectations of public market analysts and investors; +• seasonal variations in our business; +• our ability to accurately anticipate and respond to seasonal or quarterly fluctuations in demand for our products; +• our ability to maintain effective internal controls; +• our defense and the ultimate outcome of a pending class action lawsuit; +• our ability to attract, assimilate and retain adequate talent; +1 +Table of Contents +• our ability to maintain and improve business relationships with third parties selling our products; +• the effect of competition in our industry; +• our ability to successfully integrate and grow acquired businesses and brands; and +• the effect of potential adverse currency exchange rate fluctuations. +We +caution the reader to carefully consider all such factors, including those described in Item 1A. "Risk Factors". Furthermore, such forward looking statements speak only as of +the date of this report. We undertake no obligation to update any forward looking statements to reflect events or circumstances after the date of such statements. +PART I +ITEM 1. Business +Overview +We are a designer, manufacturer, distributor, worldwide marketer and brand manager of footwear for men, women, and children. We aspire +to bring comfort, fun and innovation to the world's feet. We strive to be the global leader in molded footwear design and development. We manufacture a product offering that provides new and exciting +molded footwear products that feature fun, comfort and functionality. We also design and sell a broad offering of footwear and accessories that utilize our proprietary closed cell-resin, +called Croslite. Our Croslite material is unique in that it enables us to produce an innovative, lightweight, non-marking, and odor-resistant shoe. Certain shoes made with the +Croslite material have been certified by U.S. Ergonomics to reduce peak pressure on the foot, reduce muscular fatigue while standing and walking and to relieve the musculoskeletal system. +Since +the initial introduction and popularity of our Beach and Cayman (soon to be renamed Crocs Classic) designs, we have expanded our Croslite products to include a variety of new +styles and products and have extended our product reach through the acquisition of new brand platforms such as Jibbitz, LLC ("Jibbitz") and Ocean Minded, Inc. ("Ocean Minded"). We intend +to continue branching out into other types of footwear, bringing a unique and original perspective to the consumer in styles that may be unexpected from Crocs. In part, we believe this will help us to +continue to build a stable year-round business as we look to offer more winter-oriented styles. All of our products are designed to allow the product to be defined by comfort, fun, and +function. +Our +marketing approach is also becoming significantly more focused on a defined target consumer. The majority of our marketing efforts surround specific product launches and employ a +fully integrated approach utilizing a variety of media outlets. Our marketing efforts strive to drive business to both our +wholesale partners and our company-owned retail and internet stores, ensuring that our presentation and story are first class and drive purchasing at the point of sale. +We +currently sell our Crocs-branded products throughout the U.S. and in more than 100 countries. We sell our products through domestic and international retailers and distributors and +directly to end-user consumers through our webstores, Company-operated retail stores, outlets and kiosks. The broad appeal of our footwear has allowed us to market our products to a wide +range of distribution channels, including department stores and traditional footwear retailers as well as a variety of specialty and independent retail channels. +Our History +We were organized as a limited liability company in 1999 and began marketing and distributing footwear products in the U.S. under the +Crocs brand in 2002, shortly after completing our first footwear design produced by Foam Creations, Inc. and Finproject N.A., Inc. (now known as Crocs +2 +Table of Contents +Canada Inc.) +("Crocs Canada"). The unique characteristics of the Croslite material, developed by Crocs Canada, enabled us to offer consumers an innovative shoe unlike any other footwear model +then available. Initially, we targeted our products to water sports enthusiasts, but the comfort and functionality of our products appealed to a more diverse group of consumers who used our footwear +for a wide range of activities. To capitalize on the broad appeal of our footwear, we expanded our sales infrastructure, strengthened our senior management team, and developed relationships with a +range of retailers in the U.S. In June 2004, we acquired Crocs Canada, including its manufacturing operations, product lines, and rights to the trade secrets for the Croslite material. Beginning in +June 2004, we significantly expanded all aspects of our operations in order to take advantage of what we believed was an attractive market opportunity. We converted to a Colorado corporation in +January 2005 and reincorporated in Delaware in June 2005. We completed our initial public offering on February 8, 2006. +From +2002 until 2007, our business grew tremendously, both organically and through acquisitions that we believe leveraged our business model. +In +2006, we added: +• Jibbitz, LLC which produces unique charms specifically suited to fit into Crocs shoes; +• Fury Hockey Inc., formerly 55 Hockey Products Inc. ("Fury"), which produced and distributed hockey, soccer +and lacrosse equipment manufactured with Croslite. In June 2008, the Company decided to liquidate Fury after efforts to sell the entity were unsuccessful; and +• EXO Italia ("EXO"), which designs and develops EVA (Ethylene Vinyl Acetate) based finished products, primarily for the +footwear industry. +In +2007, we added: +• Ocean Minded, Inc. which produces sandals primarily for the beach, action and adventure market; +• Bite, LLC ("Bite"), a manufacturer of performance shoes and sports sandals sold worldwide in five categories, +including, golf, adventure, healthy lifestyle, travel and water sports; and +• YOU by Crocs™, a women's fashion line that combines comfort with fashionable styles. +In +2008, we added: +• Tagger International B.V. ("Tagger"), a manufacturer of messenger bags. +As +of December 31, 2009, we continued to operate and sell our products through the Crocs, Jibbitz, Ocean Minded, and YOU by Crocs brands. Other brands, including Fury, Bite, and +Tagger have been discontinued. +Recent Events +From our inception through the year ended December 31, 2007, we experienced rapid revenue growth and had difficulty meeting +demand for our footwear products. During this period, we significantly increased production capacity, warehouse space and inventory in an effort to meet demand. This pattern changed in 2008. Our +revenue growth moderated in the three month period ended March 31, 2008 and began to decline through the balance of our 2008 fiscal year. This trend continued into 2009. During this time, our +total revenues declined from $847.4 million in the year ended December 31, 2007 to $645.8 million during the year ended December 31, 2009. Should the global economic +conditions deteriorate further, we may experience further revenue declines in the Americas, European and Asian markets. Should we fail to develop and effectively merchandise new products that appeal +to the consumer, we may not be able to compete effectively and may experience further declines in revenues. See Item IA, "Risk Factors," for further discussion. +3 +Table of Contents +During +2008 and 2009, we incurred significant charges related to restructuring and other activities undertaken to right-size our business and migrate away from +non-brand processes. These charges include fixed asset impairments, intangible asset impairments, contract termination charges, severance, facility consolidation and other related +expenses. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for further discussion of our financial condition and outlook, including asset +impairments, restructuring activities and reductions in selling, general and administrative costs. While it is not currently our expectation to do so, we may continue to incur operating losses during +fiscal year 2010, particularly if our revenues fall short of current expectations. In the event that revenues and product demand fall short of our current expectations, we will need to take further +actions to reduce operating costs. +Product Overview +While the majority of our products consist of footwear, we also offer accessories and apparel which consisted of 4.7% of our total +revenue during the year ended December 31, 2009. The Crocs footwear products are divided into four categories: Core, Active, Casual and Style. Our Core product range is composed of primarily +molded products that are derivatives of the original Beach and Cayman (soon to be renamed Crocs Classic) designs. The Core product range is targeted toward a wide range of distribution channels and +consumers. Our Active product range is composed of footwear intended for healthy living. It includes sport-inspired products that offer active end uses like boating, walking, and hiking as well as for +recovery after workouts. The Active products are targeted primarily toward our wholesale and consumer direct channels focusing on customers interested in healthy lifestyle products. The Casual product +range offers sporty and relaxed design inspirations. Casual products are targeted towards a broad range of customers. The Style product range is comprised of stylish products which are intended to +broaden the wearing occasion for Crocs lovers. These designs are targeted towards department stores and fashion and specialty retail accounts. +Footwear +A key differentiating feature of our footwear products is the Croslite material, which is uniquely suited for comfort and +functionality. We have carefully formulated the Croslite material to be of a density that creates a comfortable shoe with non-marking footwear that is extremely lightweight. Croslite +material conforms to the shape of the foot, often reducing pressure points on the foot to increase comfort. Croslite material is a closed cell resin, which is water resistant and virtually odor free, +and allows many of our footwear products to be cleaned simply with water. As we have expanded our Crocs brand product offering, we have incorporated traditional materials such as textile fabric and +leather into our products. However, we continue to utilize the Croslite material for the foot bed, sole and other key structural components for the majority of these new products. +Our +footwear offering has grown significantly since we first introduced our Crocs product line in 2002 with a single model in six colors. Some of the more notable developments are listed +below. +• We expanded our Crocs product line from 25 models in 2006 to over 230 models in 2009, including Ocean Minded, and YOU by +Crocs™ footwear models. +• We introduced a shoe donation program currently operating under our "Crocs Cares" program. We have donated millions of +Crocs shoes to those in need in both the local and global communities we serve. Another goal of the Crocs Cares program is to establish a comprehensive program focused on internal team building and +community impact by providing our employees the opportunity to volunteer in their community. +• We extended licensing agreements with Disney, Nickelodeon, Marvel, DC Comics, Warner Bros., and select college and +professional leagues, among others, for Crocs branded footwear and Jibbitz shoe charms. We also introduced a limited edition line of footwear and Jibbitz charms +4 +Table of Contents +featuring +such popular characters as Cinderella, Ariel, Mickey Mouse, Sponge Bob Square Pants, Dora the Explorer, Spiderman and Batman. +• We expanded our Crocs Work product selection to include 12 styles (including both molded and leather footwear) for the +hospital, restaurant, hotel and hospitality markets, effectively broadening sales in the commercial footwear industry. We received industry certifications on slip-resistance and +electro-static discharge on various work styles. We have diversified and expanded our sales by engaging our three primary channels: wholesale, retail and internet, including establishing distribution +with leading uniform supply companies to penetrate large hospitality chains, laboratories and clean-rooms. +• We expanded our medical-needs footwear (Crocs Rx) to six styles, capturing broader markets for general footcare and +diabetic needs. We achieved a landmark by becoming the number one selling medical footwear in the U.S. with distribution in 3,800+ podiatry offices and medical shoe stores. We also received the 2008 +"Company of the Year" award from the American Podiatric Medical Association and are the first shoe company to ever receive this award for "greatest impact on the field of podiatry." We have expanded +our Crocs Rx sales in Europe, Asia and India with low-cost, lightweight footwear appropriate for people with diabetes. We have also received Medicare approval for reimbursement on custom +diabetic shoes. +• We expanded into new footwear categories, including our Style and Active categories, by designing new footwear using our +in-house design team as well as recognized footwear design experts. As part of this strategy, we acquired EXO in 2006, which expanded the capabilities of our in-house design +team. EXO is based in Padova, Italy and is an Italian producer of EVA (Ethylene Vinyl Acetate) based finished products, primarily for the footwear industry. +• We acquired substantially all of the assets of Ocean Minded, a designer and manufacturer of high quality leather and EVA +footwear, sandals and printed apparel. Headquartered in San Clemente, California, Ocean Minded is positioned as an "ocean lifestyle" brand with deep roots in the beach and surf culture. The brand is +also gaining traction within the inland outdoor and mainstream footwear channels. Ocean Minded utilizes recycled materials throughout its entire product line and engages in environmental manufacturing +processes whenever possible. In addition, as the name implies, the brand takes an active role in protecting the oceans, rivers and beaches through beach clean-ups, support of the Surfrider +Foundation and through various other charitable efforts. +Footwear +sales made up 94.6%, 91.6%, and 90.1% of total revenues for the years ended December 31, 2009, 2008, and 2007, respectively. Sales of our Beach and Cayman (soon to be +renamed Crocs Classic) models accounted for 16%, 25%, and 30% of total unit sales for the years ended December 31, 2009, 2008 and 2007, respectively. We believe that the declining percentage of +our original styles is reflective of our efforts to diversify our product offering and reduce reliance on original styles. We intend to continue to evaluate our product offerings to develop product +collections in assortments that can be merchandised effectively to the consumer through wholesale and consumer direct channels. As such, we expect that our future product offerings will be more +focused by category and segmented by channel. As a result, we expect our style count to increase as we better service our channels with differentiated products. +During +the year ended December 31, 2009, approximately 77% of our sales consisted of products geared towards adults compared to 23% of sales for products geared towards children. +Accessories and Apparel +Accessories. In addition to our footwear products, we own the Jibbitz brand, a unique accessory brand with colorful snap-on +charms +specifically suited for Crocs shoes. We acquired Jibbitz in +5 +Table of Contents +December +2006 and have expanded the product line to include a wide variety of charms in varying shapes and sizes, with designs such as flowers, sports gear, seasonal and holiday designs, animals, +symbols, letters and rhinestones. Crocs licensing agreements also extend to Jibbitz, which allows Jibbitz to create designs bearing logos and emblems of Disney, MLB and the Crocs collegiate line, +among others. Jibbitz designs allow Crocs consumers to personalize their footwear to creatively express their individuality. As of December 31, 2009, approximately 1,200 unique Jibbitz charm +designs were available to consumers for personalizing their Crocs footwear. +Apparel. In 2007, we expanded our clothing line and launched a new clothing line for boys, girls and men featuring Croslite +material. In 2009, we +continued to scale back our apparel product offering, making it available in only in a few, select markets on a limited basis. +Operating Segments +We have three reportable segments: Americas, Europe and Asia. All of the reportable segments derive their revenue from the sale of +footwear, apparel and accessories. Within each segment, we sell our products through our wholesale, retail and internet channels, which are described more fully below. +We +evaluate the performance of our segments based primarily on the results of the segment without allocating corporate expenses, or indirect general, administrative and other expenses. +The corporate and other category includes (i) Ocean Minded, (ii) Colorado Footwear CV and (iii) corporate category, which maintains corporate costs such as stock-based +compensation, research and development, brand marketing, legal expenses, depreciation on global long-lived assets such as molds, tooling, IT systems, and other global costs that are not +allocated to the regions. Segment profits or losses include adjustments to eliminate intercompany profit or losses on intercompany sales. Net revenues as shown below represent sales to external +customers for each segment. +Financial +information regarding our consolidated revenues, profits and total assets is included in our consolidated financial statements beginning on page F-1. +Information relating to our operating segments is included in Note 17 of our consolidated financial statements. +Americas Segment +The Americas Segment consists of revenue and expenses related to the sale of our products in North and South America. Our Americas +wholesale channel consists of sales to a broad range of sporting goods and department stores as well as specialty retailers. We also sell our products directly to the consumer through 182 +company-owned store locations, including company-operated kiosks and retail stores in such locations as New York, Boston and Maui in the U.S., Montreal, Quebec in Canada, as well as through our +webstores. In 2009, our Americas segment constituted 46.1% of our consolidated revenues compared to 50.1% in 2008 and 59.0% in 2007. In 2009, 83.9% of our Americas revenues were generated in the U.S., +the largest sales territory in the Americas region, compared to 86.5% in 2008 and 88.0% in 2007. +Asia Segment +The Asia Segment consists of revenue and expenses related to the sale of our products throughout Asia, Australia, New Zealand, the +Middle East and South Africa. Our Asia wholesale channel consists of sales to a broad range of retailers, similar to the wholesale channel we have established in our Americas Segment. We also sell our +products directly to the consumer through 119 company-owned store locations, including Company-operated kiosks and retail stores in such locations as Beijing, Johannesburg and Yokohama City as well as +through our webstores. In 2009, our Asia segment constituted 36.8% of our consolidated revenues compared to 28.4% in 2008 and 19.8% in 2007. In 2009, 41.7% of our Asia revenues were generated in +Japan, the largest sales territory in the Asia region, compared to 47.4% in 2008 and 48.6% in 2007. We occasionally utilize sales agents and buying +6 +Table of Contents +groups +in our international locations to service our wholesale customers. We established a direct sales presence in most major international markets, rather than relying on distributors, which we +believe enables us to obtain better margins and allows us to better control our marketing and distribution. +Europe Segment +The Europe Segment consists of revenue and expenses related to the sale of our products throughout Europe and Russia. Our Europe +wholesale channel consists of sales to a broad range of retailers, similar to the wholesale channel we have established in our Americas Segment. We also sell our products directly to the consumer +through 16 company-owned store locations, including company-operated kiosks and retail stores in such locations as London, England, Hamburg, Germany, and Turku, Finland as well as through our +webstores. In 2009, our Europe segment constituted 16.6% of our consolidated revenues compared to 20.9% in 2008 and 21.2% in 2007. We occasionally utilize sales agents and buying groups in our +international locations to service our wholesale customers. We established a direct sales presence in most major international markets, rather than relying on distributors, which we believe enables us +to obtain better margins and allows us to better control our marketing and distribution. +Sales and Distribution +In each of our segments, we sell our products through three channels: wholesale, retail and internet. Financial information regarding +our revenues, profits and total assets is included in our consolidated financial statements beginning on page F-1. Information relating to our operating segments is included in +Note 17 of our consolidated financial statements. +Wholesale and Distributor Sales +In 2009, approximately 62.6% of our net revenues were derived from sales through our wholesale channel compared to 76.5% in 2008 and +90.8% in 2007. Our wholesale channel consists of sales to distributors and third-party retailers including national and regional retail chains, department stores, sporting goods stores and specialty +retailers, such as Nordstrom, Dick's Sporting Goods, The Sports Authority, Dillard's, The Forzani Group and Journeys. No single customer accounted for 10% or more of our revenues for the year ended +December 31, 2009, 2008 or 2007. We believe we have established strong domestic and international wholesale customer channels. +We +use distributors in select markets where we believe such arrangements are preferable to direct sales. In markets where we use third-party distributors, these distributors purchase +products pursuant to a price list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of +one to four years, are generally terminable on 30 days' notice prior to the end of the term or on thirty days prior notice at any time, +and require our distributors to meet a minimum sales threshold. We will accept returns from wholesale and distributor customers for defective products, quality issues, and shipment errors on an +exception basis at the sole discretion of our management. We may also accept returns from our wholesale and distributor customers, on an exception basis at the sole discretion of management, for the +purpose of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, at the sole discretion of management, we may provide markdown allowances +to key wholesale and distributor customers to facilitate the "in-channel" markdown of products where we have experienced less than anticipated sell-through. +Our +domestic accounts are primarily serviced through our internal sales force, which focuses on selling the appropriate mix and quantity of our products to our retail accounts. They +ensure our products are displayed effectively at retail locations and educate our retailers about our Crocs brand and the quality of our products. +7 +Table of Contents +Our financial success in the wholesale channel is significantly related to the willingness of our wholesale customers to continue to carry our products, the +expansion to new wholesale customers and the success of such customers. Our wholesale customers are directly impacted by fluctuations in the broader economy, including the recent global economic +downturn, which, during 2008 and 2009, reduced foot traffic in shopping malls and lessened consumer demand for our products. We do not have long term contracts with any of our wholesale customers, and +sales to our wholesale customers are generally on an order-by-order basis and are subject to rights of cancellation and rescheduling by the customer. If we cannot fill our +customers' orders in a timely manner, the sales of our products and our relationships with those customers may suffer, and this could have a material adverse effect on our product sales and ability to +grow our product line. +Retail Sales +In recent quarters, our consumer-direct sales efforts have performed well. As a result, we are currently expanding our direct sales +efforts to consumers through our retail channel, which consists of company-operated global retail locations, and our internet channel, which consists of company-operated webstores worldwide. We +believe that direct sales provide us direct access to our consumers and an opportunity to showcase our entire line of footwear and accessory offerings, and that this strategy will serve as an +important and effective means to enhance our product and brand +awareness. We view our consumer-direct channels to be complementary to our wholesale channel. As of December 31, 2009, we operated the following retail stores: +U.S Retail Stores +Crocs Kiosk +95 +Crocs Retail Stores +30 +Crocs Outlet Stores +50 +Total +175 +International Retail Stores +Crocs Kiosk/Store in Store +75 +Crocs Retail Stores +54 +Crocs Outlet Stores +13 +Total +142 +Kiosks. As of December 31, 2009, we operated 170 domestic and international retail kiosks located in malls and other high foot +traffic areas. +With bright and colorful displays, efficient use of retail space, and limited initial capital investment, we believe that kiosks are an effective outlet for marketing our products. Kiosks enable us to +highlight a wide range of our products, more effectively interact with potential consumers and enhance our brand awareness among both consumers and local retailers. We plan to continue to operate +certain kiosk sites in select, high foot traffic locations; however, during 2010, we anticipate closing certain kiosk locations where the locations are either underperforming, are posing problems for +relationships with our wholesale customers or where we do not view the kiosk as the best representation of the brand. Our plans to open and/or close kiosks are subject to adjustment based on the +impact of economic conditions and demand for our products. +Retail Stores. As of December 31, 2009, we operated 84 domestic and international retail stores. During 2009, we opened retail +stores in a +variety of locations, including, among others, Miami, Beijing, and Johannesburg. Company-operated retail stores are designed with colorful displays and allow us to effectively market our new and +existing products and interact with customers in order to enhance brand awareness. We plan to continue to open additional Company-operated retail stores in the future where +8 +Table of Contents +we +foresee adequate demand and an ability to meet certain internal hurdle rates. Our plans to open more retail stores are subject to adjustment based on the impact of economic conditions and demand +for our products. +Outlet Stores. As of December 31, 2009, we operated 63 domestic and international outlet stores. During 2009, we opened outlet +stores in a +variety of locations, including, but not limited to, Myrtle Beach, Berlin and Rehoboth Beach. The outlet stores help us move older products in an orderly fashion. We also sell full priced products in +our outlet stores. We plan to open more Company operated outlet stores in early 2010 where we foresee adequate demand and an ability to meet certain internal hurdle rates. Our plans to open new outlet +stores are subject to adjustment based on the impact of economic conditions and demand for our products. +Internet. We currently offer our products domestically and internationally through our 23 webstores worldwide. Our internet presence +enables us to +educate consumers about our products and brand. We continue to expand our web-based marketing efforts to continue to drive consumer awareness regarding the availability of our full product +range on our market-specific websites. +Raw Materials +Croslite material, our proprietary closed-cell resin, is the primary raw material used in most of our footwear and some of +our accessories. Croslite material is soft and durable and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and +development in order to refine our materials to enhance these properties and to target the development of new properties for specific applications. +Croslite +material is produced by compounding elastomer resins that we or one of our third-party processors purchase from major chemical manufacturers together with certain other +production inputs, such as color dyes. At this time, we have identified two suppliers that produce the particular elastomer resins used in the Croslite material. We may, however, in the future +identify and utilize materials produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that +we use to produce the Croslite material are readily available for purchase from multiple suppliers. +Since +our inception, we have substantially increased the number of footwear products that we offer. Many of our new products are constructed using leather, textile fabrics or other +materials. We or our third-party manufacturers obtain these materials from a number of third-party sources and we believe these materials are broadly available. We transitioned the Croslite material +compounding from our former manufacturing facilities in Canada to other facilities and third-party facilities during the second quarter of 2008. We also transitioned the Croslite material compounding +from our former manufacturing facilities in China to third-party facilities during the fourth quarter of 2009. We +compound Croslite material internally in Mexico utilizing subcomponent materials produced by a third party in the U.S. We also outsource the compounding of Croslite material and continue to purchase a +portion of our compounded raw materials from a third party in Europe in accordance with the terms of a continuously renewing supply agreement. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We have Company-operated +production facilities in Mexico and Italy and we also contract with third-party manufacturers located around the world. We believe that our in-house manufacturing capabilities enable us to +rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high demand models and colors throughout the year, while outsourcing allows us to capitalize on +the efficiencies and cost benefits of using contract manufacturing. We believe that this production strategy will enable us to continue to minimize our production costs, increase overall +9 +Table of Contents +operating +efficiencies and shorten production and development times to better serve our retail customers. +The +process for manufacturing our footwear was developed over an eight year period of continual refinement to improve consistency, softness, durability, and yield. In the years ended +December 31, 2009 and 2008, we manufactured approximately 27% and 17%, respectively, of our footwear products at our Company-operated manufacturing facilities primarily in Mexico and Italy. +During the years ended December 31, 2009 and 2008, we obtained the remaining 73% and 83%, respectively, of our footwear products from multiple third-party manufacturers in China and Bosnia. Our +largest third-party supplier in China produced approximately 36% of our footwear unit volume during the year ended December 31, 2009. We do not have written supply agreements with our primary +third-party manufacturers in China. During 2008, we consolidated our manufacturing capacities at the facilities we operate in Mexico and with our third-party manufacturers and shut down our +manufacturing facilities in Canada and Brazil to align our production capacities and cost structure to decreased demand and declining revenues. +Distribution and Logistics +We continue to make enhancements to our distribution and logistics network that will streamline our supply chain, increasing our speed +to market. Over the past year, we +have consolidated our distribution and logistics network to leverage resources and simplify our fulfillment processes while driving down costs in our operations. During the year ended +December 31, 2009, we continued to adjust our strategy based upon projected economic conditions and demand for our products. We continued to consolidate our global distribution centers and +warehousing, thereby decreasing our fixed costs. +During +the year ended December 31, 2009, we stored our raw material and finished goods inventories in Company-operated warehouse and distribution facilities located in Colorado, +California, Hawaii, Puerto Rico, Mexico, the Netherlands, Australia, Japan, China and South Africa. We also utilized distribution centers which were operated by third parties located in Brazil, +Finland, Dubai, Hong Kong, Korea, Singapore, India, Taiwan and China. Throughout 2009, we engaged in efforts to close and consolidate our global warehouse and distribution facilities. As a result, we +vacated several of our facilities; however, as of December 31, 2009, we had not yet been able to sublease certain facilities, including our facilities in Aurora, Colorado, Narita, Japan and +Rotterdam, Netherlands. Once these facilities have been sublet, we will have decreased our global warehouse and distribution footprint by approximately 0.7 million square feet. We believe our +more agile cost structure gives us the flexibility to meet our rapidly changing business requirements and positions us to support the current level of revenue as well as anticipate future growth. As +of December 31, 2009, our Company-operated warehouse and distribution facilities provided us with 1.5 million square feet and our third-party operated distribution facilities provided us +with 0.2 million square feet. We also ship a portion of our products directly to our customers from our internal and third party manufacturers. We are actively pursuing initiatives aimed at +shipping more of our product directly to our customers, which, if successful, is expected to lower our cost of sales in the future. +In +December 2007, we entered into an agreement with Manhattan Associates to provide warehouse management systems within all of our Company-operated distribution centers. As we look +toward streamlining our distribution operations and reducing our global warehouse footprint, we will continue to implement the Manhattan software in locations that support this strategic aim. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress, and patent protection to establish, protect, and enforce +our intellectual property rights in our product designs, brand, +10 +Table of Contents +materials, +and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution +and sale of all of our products, both domestically and internationally, where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and design and the +Crocs word mark, both of which are registered or pending registration in the U.S., the +European Union, Japan, Taiwan, China and Canada among other places. We also claim common law trademark rights or have pending trademark applications for Jibbitz, Jibbitz Logo, YOU by +Crocs™, YOU by Crocs Logo, Ocean Minded, Fury, Fury Logo, Mambaz, Tail Logo, Bite and Bite Logo, as well as for our proprietary material Croslite and the Croslite logo, globally. We intend +to continue to strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the future. We will also continue to aggressively +police our trademarks and copyrights and pursue those who infringe, both domestically and internationally as we deem necessary. +In +the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks are generally valid as long as they are +in use and their registrations are properly maintained and have not been found to become generic. Trademarks registered outside of the U.S. generally have a duration of 10 years depending on +the jurisdiction and are also generally subject to an indefinite number of renewals for a like period upon appropriate application. We believe our trademarks are crucial to the successful marketing +and sale of our products, and we intend to vigorously prosecute and defend our intellectual property rights throughout the world. +We +consider the formulation of the Croslite material used to produce our products to be a valuable trade secret. Prior to our acquisition of Crocs Canada in June 2004, Crocs Canada +developed the formula for the Croslite material, and we believe that it did not publish or otherwise make the formula available to third parties without the protection of confidentiality or similar +agreements. Post acquisition, we continue to protect the formula by using confidentiality agreements with our third-party processors and by requiring our employees who have access to the formula to +execute confidentiality agreements or to be bound by similar agreements concerning the protection of our confidential information. Neither we nor Crocs Canada have attempted to seek patent protection +for the formula. We are not aware of any third party that has independently developed the formula or that otherwise has the right to use the formula in their products other than Finproject, our +third-party supplier of Croslite in Italy and another third-party licensee. Under the terms of our supply agreement with Finproject, Finproject has certain limited rights to use the Croslite material, +which were originally negotiated in connection with our purchase of Crocs Canada from Finproject's parent company. We believe the comfort and utility of our products depend on the properties achieved +from the compounding of the Croslite material and constitute a key competitive advantage for us, and we intend to vigorously protect this trade secret. +We +also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers to police against infringing +products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives are also educated on our patents, pending patents, trademarks and +trade dress and assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or +in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain jurisdictions. +Seasonality +Due to our significant sales growth from our inception through 2007 coupled with the contraction in the business due to the global +economic turmoil and lessening demand for our products in 2008 and 2009, there is still uncertainty in the degree to which sales of our footwear products will be subject to +11 +Table of Contents +seasonality. +During 2008 and 2009, we observed that revenues generated during our first and fourth quarter are less than revenues generated during our second and third quarter, when the northern +hemisphere is experiencing warmer weather. We believe this revenue trend is due to the fact that the majority of our footwear styles during 2008 and 2009 were more suited for warm weather and, +accordingly, we expect this trend to continue. However, we intend to continue branching out into other types of footwear, including offering more winter-oriented styles, and this product expansion may +help us mitigate some of this seasonality in the future. Our quarterly results of operations may fluctuate significantly as a result of a variety of other factors, including the timing of new model +introductions or general economic or consumer conditions. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year. +Backlog +As of December 31, 2009, our backlog, which consists of open orders as of December 31 2009, was approximately +$165.0 million, compared to $113.3 million as of December 31, 2008. The backlog increased year-over-year as a result of what we believe to be strong +acceptance of our 2010 spring/summer styles (for which some customers have already placed orders) and an improvement in the overall economic conditions resulting in an easing of our customer's +tightened purchasing practices from a year ago. Backlog may not be a reliable measure of future sales for any succeeding period and are subject to cancellation by customers at any time. In addition, +our historical cancellation experience may not be indicative of future cancellation rates. We expect the majority of these orders to be fulfilled within the year. +Competition +The global casual footwear and apparel industry is highly competitive. Although we believe that we do not compete directly with any +single company with respect to the +entire spectrum of our products, we believe portions of our business compete with companies such as, but not limited to, Nike Inc., Heelys Inc., Deckers Outdoor Corp., Skechers +USA Inc. and Wolverine World Wide, Inc. Our company-owned retail locations also compete with footwear retailers such as Macy's Inc., Nordstrom Inc., Dick's Sporting +Goods Inc. and Collective Brands Inc. +The +principal elements of competition in this industry include brand awareness, product functionality, design, quality, pricing, customer service, marketing and distribution. We believe +that our unique footwear designs, the Croslite material, our prices and our expanding product offering and distribution network position us well in the marketplace. However, some companies in the +casual footwear and apparel industry have greater financial resources, more comprehensive product lines, broader market presence, longer-standing relationships with wholesalers, longer operating +histories, greater distribution capabilities, stronger brand recognition and greater marketing resources than we currently have. Furthermore, the unique designs and resulting success of our footwear +products have attracted new players in the market with imitation products that are similar to ours; we face competition from these new market entrants. +Product Design and Development +Our primary goal in product design and development is to create and introduce new and innovative footwear products that combine our +standards of comfort, functionality, and style, and enhance the awareness of the Crocs brand. We aspire to be the global leader in active casual footwear products. Our footwear product line is +designed by a combination of our internal design and development staff supported by outside designers. By introducing outside sources to the design process, we believe that we are able to capture a +variety of different design perspectives on a cost-efficient basis and anticipate trends more quickly. To expand our internal design capabilities, EXO has been involved in the design of +several of our new styles. We are committed to continuing to dedicate significant resources to product design and development to sustain our commitment to innovation, maintain or grow our current +level of revenue and drive our global brand. +12 +Table of Contents +We develop footwear models based on what we identify as opportunities in the marketplace. Once a design has been identified and demand in the marketplace has been +validated, the designs are then translated into product specifications by our developers and made into prototypes at our facility in Italy or by one of our third-party manufacturers in China. Our +designers and developers work closely with each other to develop product prototypes, test and refine products and provide quality assurance throughout the manufacturing process. Our design and +development process is highly collaborative, as members of the design team frequently meet with our sales and marketing staff, production and supply managers and certain of our retail customers to +further refine our products to meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs +while maintaining product quality. We spent $7.7 million, $6.4 million and $5.3 million in Company-sponsored research, design and development activities for the years ended +December 31, 2009, 2008, and 2007, respectively. +Employees +As of December 31, 2009, we employed approximately 3,560 persons, compared to 3,700 as of December 31, 2008. This +included 2,030 employees in the U.S. and Canada, 220 employees in Mexico, 890 employees in Asia, 30 employees in South America, and 390 employees in Europe. Globally, as of December 31, 2009, +we had 2,061 persons employed in our consumer-direct channels. While our headcount in the consumer-direct channels grew to accommodate our business, we +reduced our non-consumer-direct headcount by approximately 300 persons since 2008, primarily due to consolidation of our company-operated distribution centers and other reductions in +staffing. As of December 31, 2009, none of our employees were represented by a union. +Public Filings and Corporate Information +Our corporate headquarters are located at 6328 Monarch Park Place, Niwot, Colorado 80503. Our internet address is www.crocs.com. On our +website, we post the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission: our annual report on +Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports filed or furnished pursuant +to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934. All such filings on our website are available free of charge. Also available on our website are the charters of the +committees of our board of directors, as well as our corporate governance guidelines and code of ethics. Copies of any of these documents will be provided in print to any stockholder who submits a +request in writing to Integrated Corporate Relations, 450 Post Road East, Westport, CT 06880. +ITEM 1A. Risk Factors +Our short and long-term success is subject to many factors beyond our control. If any of the following risks, as well as +any risks described elsewhere in this Form 10-K, actually occur, our business, financial condition or results of operations could suffer. Given these risks and uncertainties, +investors should not place undue reliance on forward-looking statements as a prediction of actual results. +Current economic conditions may adversely affect consumer spending and the overall general health of our retail customers, which, in turn, may adversely affect our financial +condition, results of operations and cash resources. +Uncertainty about the current and future global economic conditions may cause consumers and retailers to defer purchases or cancel +purchase orders for our products in response to tighter credit, decreased cash availability and weakened consumer confidence. Our financial success is sensitive to changes in general economic +conditions, both globally and nationally. Recessionary economic cycles, higher interest borrowing rates, higher fuel and other energy costs, inflation, increases in commodity +13 +Table of Contents +prices, +higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws or other economic factors that may affect consumer spending or buying habits could +continue to adversely affect the demand for our products. In addition, a number of our third-party retailers may be impacted by the significant decrease in available credit that has resulted from the +current financial crisis. If credit pressures or other financial difficulties result in insolvency for these third parties it could adversely impact our estimated reserves and financial results. There +can be no assurances that government and consumer responses to the disruptions in the financial markets will restore consumer confidence. +We may be unable to successfully execute our long-term growth strategy or maintain our current revenue levels. +Although we exhibited significant growth from our inception through 2007, revenues have declined in recent years, from +$847.4 million for the year ended December 31, 2007 to $721.6 million for the year ended December 31, 2008 to $645.8 million for the year ended December 31, +2009. We may experience similar decreases in revenues in the future. Our ability to maintain our revenue levels or to grow in the future depends upon, among other things, the continued success of our +efforts to maintain our brand image and bring compelling and revenue-enhancing footwear offerings to market and our ability to expand within our current distribution channels. Likewise, in order to +effectively execute against our current turnaround strategy and our long-term growth strategy, we will need to continue to streamline our supply chain in an effort to increase operating +efficiencies and decrease costs. Failure to manage our operations in a cost efficient manner could result in greater difficulty in completely filling customer orders, declines in product quality, +difficulty with product acceptance or other production and distribution difficulties, any of which could adversely impact our business performance and operating results. We had net losses for the +years ended December 31, 2009 and 2008 and we may continue to incur losses unless our expenses are reduced or demand for our product improves. +The popularity of our Crocs footwear may not grow as rapidly as it has in the past and may decline, which would have a negative impact on our sales and results of +operations. +Our footwear sales, which represented approximately 94.6% of our revenues for the year ended December 31, 2009, contributed to +our significant growth through 2007. We expect that footwear will constitute our principal product line for the foreseeable future. The footwear industry is subject to rapidly changing consumer +demands, preferences and fashion trends, and our footwear may not remain popular or we may fail to develop additional footwear designs that appeal to consumers. As our core products have matured in +certain markets, we have generally experienced less demand for those core products. Likewise, we may experience a decline in demand for our products if counterfeit or imitation products gain market +share. If the popularity of our footwear declines, if we are unable to successfully expand our footwear line or if new designs do not generate wide customer appeal,we may experience, among other +things: +• lower sales; +• loss of retail customers; +• excess inventories; +• inventory markdowns and discounts provided to retailers; +• deterioration of our brand image; and +• lower revenues and gross and operating margins, as a result of price reductions. +14 +Table of Contents +Further, +we could experience a decline in our revenues and earnings from any or all of the above. Given the limited history of our Crocs brand, it is difficult to evaluate whether our +products will hold long-term consumer appeal. +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers' orders, either of which could +adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction, and closings, as well as fashion trends, rapid +changes in consumer preferences, the effects of weather, general economic conditions, and other factors affecting demand. These factors make it difficult to forecast consumer demand and, if we +overestimate demand for our products, we may be forced to liquidate excess inventories at a discount to customers, resulting in markdowns and lower gross margins. Conversely, if we underestimate +consumer demand, we could have inventory shortages, which can result in lost potential sales, delays in shipments to customers, strains on our relationships with customers and diminished brand +loyalty. Moreover, because our product line is limited, we may be disproportionately affected by cyclical downturns in the footwear industry, changes in consumer preferences, and other factors +affecting demand, which may make it more difficult for us to accurately forecast our production needs, exacerbating these risks. A decline in demand for our products, or any failure on our part to +satisfy increased demand for our products, could adversely affect our business and results of operations. +In 2009, we sold a significant amount of inventory that was being carried at low or no cost, which was accretive to our gross margin during the year. We may not be able to +repeat this revenue, or gross margins, at this level in the future. +During the third quarter of 2008, consistent with our quarterly practice, we evaluated the value of our inventory on hand. In light of +the negative economic conditions due to the global economic downturn, the forecasts prevailing at the time and the amount of inventory that we were carrying after what has traditionally been our +strongest selling season, we forecasted that 8.3 million pairs of shoes were impaired because we estimated that the market value of these shoes was less than their cost. We wrote this inventory +down to a level that we believed was realizable. These write-downs depended in part on estimates of our ability to sell or dispose of the product through various channels, some of which were +undeveloped or were not previously used by our Company. For example, our company-owned retail channel was relatively immature and undeveloped at the time. +During +the remainder of 2008 and in 2009, we sold substantially all of the impaired inventory primarily through our retail and internet channels, which grew rapidly and exceeded our +expectations during the year. Much of this impaired inventory sold at prices higher than what we had previously estimated. The gross profit amount related to the sales of these units was accretive to +our gross profit percentage during the year. The net positive effect of these sales on our gross profit during the year ended December 31, 2009 was $49.8 million. In addition, because we +were executing against a plan to reduce inventories—particularly impaired inventories—during 2009, sales were higher during the year. During the year ended December 31, +2009, we generated $58.3 million in revenue from sales of impaired inventory units. The revenue and gross margin generated by sales of the previously impaired units and through our plan to +reduce inventory reflect an unusual event and are not likely to be repeated in future periods. +We +believe that the macroeconomic conditions that arose in 2008 and that played a significant role in the estimates used in 2008 to calculate the net realizable value of our inventory +were unusual. Going forward, we are making greater use of our now-established internal outlet channels (i.e. retail and internet) to address any impaired inventory. Further, we +believe our retail and internet channels will provide us with greater visibility into and greater control of pricing on excess inventory. We believe that these changes are likely to lessen any future +adjustments to inventory and reduce the impact of these issues on our gross margins. +15 +Table of Contents +Our current management information systems may not be sufficient for our business, and planned system improvements may not be successfully implemented on a timely basis or +be sufficient for our business. +We are in the process of implementing numerous information systems designed to support several areas of our business, including +warehouse management, order management, retail point-of-sale and internet point-of-sale as well as various systems that provide interfaces between these +systems. These systems are intended to assist in streamlining our operational processes and eliminating certain manual processes. However, for certain business planning, finance and accounting +functions, we still rely on manual processes that are difficult to control and are subject to human error. We may experience difficulties in transitioning to our new or upgraded systems, including +loss of data and decreases in productivity as our personnel become familiar with new systems. In addition, our management information systems will require modification and refinement as our business +needs change, which could prolong difficulties we experience with systems transitions, and we may not always employ the most effective systems for our purposes. If we experience difficulties in +implementing new or upgraded information systems or experience significant system failures, or if we are unable to successfully modify our management information systems to respond to changes in our +business needs, our ability to properly run our business could be adversely affected. +We have substantial cash requirements in the U.S.; however, a majority of our cash is generated and held outside of the U.S. The risks attendant to holding cash abroad could +adversely affect our financial condition and results of operations. +We have substantial cash requirements in the U.S., but the majority of our cash is generated and held abroad. We consider unremitted +earnings of subsidiaries operating outside of the U.S. to be indefinitely reinvested and it is not our current intent to change this position. Cash held outside of the U.S. is primarily used for the +ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to +U.S. federal and state income taxes, less applicable foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax +consequences if we were to move the cash to another country. Certain countries, including China, may have monetary laws which may limit our ability to utilize cash resources in those countries for +operations in other countries. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. Since +repatriation of such cash is subject to limitations and may be subject to significant taxation, we cannot be certain that we will be able to repatriate such cash on favorable terms or in a timely +manner. If we continue to incur operating losses and require cash held in international accounts for use in our U.S. operations, a failure to repatriate such cash in a timely and +cost-effective manner could adversely affect our business, financial condition, and results of operations. +Our asset-backed revolving credit facility contains financial covenants that require us to maintain certain financial metrics and ratios and restrictive covenants that limit +our flexibility. A breach of those covenants may cause us to be in default under the facility, and our lenders could foreclose on our assets. +The credit agreement for our asset-backed revolving credit facility requires us to maintain a certain level of tangible net worth and a +minimum fixed-charge coverage ratio on a quarterly basis. A lack of revenue growth, a failure to meet our tangible net worth level or an inability to control costs could negatively impact our ability +to meet these financial covenants and, if we breach such covenants or any of the restrictive covenants described below, the lenders could either refuse to lend funds to us or accelerate the repayment +of any outstanding borrowings under the revolving credit facility. We might not have sufficient assets to repay such indebtedness upon a default. If we are unable to repay the indebtedness, the +lenders could initiate a bankruptcy proceeding against us or collection proceedings with respect to our assets, all of which secure our indebtedness under the revolving credit facility. +16 +Table of Contents +The credit agreement also contains certain restrictive covenants that limit, and in some circumstances prohibit, our ability to, among other +things: +• incur additional debt; +• sell, lease or transfer our assets; +• pay dividends; +• make capital expenditures and investments; +• guarantee debts or obligations; +• create liens; +• enter into transactions with our affiliates; and +• enter into certain merger, consolidation or other reorganizations transactions. +These +restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business or the economy in +general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors that have less +debt and are not subject to such restrictions. +We have had issues maintaining sufficient liquidity in the past, and if we are unable to maintain sufficient liquidity or obtain any additional capital necessary to meet our +requirements, our business may be adversely affected. +Although we obtained an asset-backed revolving credit facility of up to $30 million during the year ended December 31, +2009 and we had approximately $180.6 million in working capital as of December 31, 2009, we may need to seek additional capital if we incur operating losses during fiscal year 2010, our +revenues continue to decline or we are unable to reduce operating costs, resulting in a failure to meet the financial covenants under our credit agreement or to otherwise maintain cash flows that will +be sufficient to meet our ongoing operating needs. A default under our revolving credit facility could restrict or terminate our access to our borrowing capacity under the facility and materially +impair our ability to meet our obligations as they come due. Any default, or a failure to generate sufficient cash from operations, may require us to seek additional capital or modifications to our +revolving credit facility, which may not be available. There can be no assurance that any such capital will be available to us on acceptable terms or at all, especially due to current conditions and +uncertainty in the global credit markets. Our ability to fund working capital needs, planned capital expenditures and scheduled debt payments depends on our future operating performance and cash flow, +which, in turn, are subject to prevailing economic conditions and to +financial, business and other factors, some of which are beyond our control. Any of these risks and uncertainties could have a material adverse effect on our financial position, results of operations +or cash flow. +We are dependent on sales of a small number of products, and the absence of continued market demand for these products would have a significant adverse effect on our +operating results. +We generated approximately 94.6% of our revenues for the year ended December 31, 2009 from sales of our footwear products, which +consisted of more than 230 models, including Ocean Minded, Bite, YOU by Crocs™ and our Crocs footwear models. Sales of our Beach and Cayman (soon to be renamed Crocs Classic) models +accounted for approximately 16% of our total footwear unit sales in the year ended December 31, 2009. A high portion of our Crocs footwear models are developed from the same base design as +these classic models and we expect to continue to derive a substantial portion of our revenues from these models or related products in the foreseeable future. Because we are +17 +Table of Contents +dependent +on a line of footwear models that have substantial similarities, factors such as changes in consumer preferences and general market conditions in the footwear industry may have a +disproportionately greater impact on us than on our competitors. In addition, other footwear companies have introduced products that are substantially similar to our footwear models, which may reduce +sales of our footwear products. In the event that consumer preferences evolve away from our footwear models or from casual lifestyle footwear in general, or if our retail customers purchase similar +products sold by our competitors, the resulting loss of sales, increase in inventories and discounting of our products are likely to be significant, which could have a material and adverse impact on +our business and operations. +Expanding our footwear product line may be difficult and expensive. If we are unable to successfully continue such expansion, our brand may be adversely affected and we may +not be able to maintain or grow our current revenue levels or our revenues may continue to decline. +Our ability to maintain or grow our current revenue levels is founded primarily on the continued sales of our footwear, and we intend +to continue to refine the number of models offered in our footwear product line to broaden the appeal of our products to consumers. To successfully expand our footwear product line, we must +anticipate, understand, and react to the rapidly changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with +consumers or our brand may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decline further, our +brand image may suffer, our operating performance may decline and we may not be able to execute upon our growth plans. +In +producing new footwear models, we may encounter difficulties that we did not anticipate during the development stage. Our development schedules for new products are difficult to +predict and are subject to change as a result of shifting priorities in response to consumer preferences and competing products. For example, once we begin to design a new footwear model, it can take +six to nine months to progress to full production because of the need to fabricate new molds and to implement modified production tooling and revised manufacturing techniques. If we are not able to +efficiently manufacture newly-developed products in quantities sufficient to support retail and wholesale distribution, we may not be able to recover our investment in the development of new models +and product lines and we would continue to be subject to the risks inherent in having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, +the ultimate success of a new model may depend on our pricing. We have a limited history of introducing new products in certain target markets; as such, we may set the prices of new models too high +for the market to bear or we may not provide the appropriate level of marketing in order to educate the market and potential consumers about new products. Achieving market acceptance will require us +to exert substantial product development and marketing efforts, which could result in a material increase in our selling, general, and administrative expense, and there can be no assurance that we +will have the resources necessary to undertake such efforts effectively. Failure to gain market acceptance for new products that we introduce could impede our ability to maintain or grow our current +revenues, reduce our profits, adversely affect the image of our brands, erode our competitive position, and result in long-term harm to our business. +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our brand image and adversely +affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents, and trade dress and designs on nearly all of +our products and believe that having distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us, and in distinguishing our goods from +the goods of others. We believe that our trademarks, patents, and other +18 +Table of Contents +intellectual +property rights are important to our brand, our success and our competitive position. We periodically discover products that are counterfeit reproductions of our products or that +otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party's products on the basis of trademark or design or utility patent infringement, or if we are +required to change our name or use a different logo, continued sales of such competing products by third parties could harm our brand and adversely impact our business, financial condition, and +results of operations by resulting in the shift of consumer preference away from our products. We have taken actions to protect our intellectual property rights, some of which are described in +Part I, Item 3 Legal Proceedings. The actions we have taken or those we will take to establish and protect trademarks, patents, and other +intellectual property rights may not be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as violations of proprietary or other +rights. +In +addition, the laws of certain foreign countries may not protect intellectual property rights to the same extent as do the laws of the U.S. We have registered Crocs as a trademark for +footwear in over 45 countries, including Aruba, Australia, the European Union, Israel, Indonesia, Jamaica, Japan, Mexico, Netherlands, Antilles, New Zealand, Norway, Panama, Peru, Romania, +Switzerland, Taiwan, the United Kingdom and Vietnam. As of December 31, 2009, we have applied to register Crocs and the Crocs logo as trademarks in over 30 other jurisdictions around the world, +including the U.S., but such applications have not been approved and are currently pending. In addition, in certain countries we have extended the scope of our trademark registrations and applications +for both the Crocs mark and logo to cover non-footwear products such as sunglasses, goggles, knee pads, watches, luggage, and some of our internet sales activities. We cannot assure you +that the actions we have taken to establish and protect our trademarks and other intellectual property rights outside the U.S. will be adequate to prevent imitation of our products by others or, if +necessary, successfully challenge another party's counterfeit products or products that otherwise infringe on our intellectual property rights on the basis of trademark or patent infringement. We may +face significant expenses and liability in connection with the protection of our intellectual property rights outside the U.S., and if we are unable to successfully protect our rights or resolve +intellectual property conflicts with others, our business or financial condition could be adversely affected. +We +also rely on trade secrets, confidential information, and other unpatented proprietary information related to, among other things, the formulation of the Croslite material and product +development, especially where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation of +our trade secrets, confidential information and other unpatented proprietary information. The agreements we use to try to protect our intellectual property, confidential information and other +unpatented proprietary information may not effectively protect such intellectual property and information and may not be sufficient to prevent unauthorized use or disclosure of such trade secrets and +information. A party to one of these agreements may breach the agreement and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other +unpatented proprietary information may become known to others, including our competitors. Furthermore, as with any trade secret, confidential information, or other proprietary information, others, +including our competitors, may independently develop or discover such trade secrets and information, which would render them less valuable to us. +Because we depend on third-party manufacturers located in China, we may face challenges in maintaining a sufficient supply of goods to meet sales demand, and we may +experience interruptions in our supply chain. Any shortfall in the supply of our products may decrease our sales and have an adverse impact on our customer relationships. +In the year ended December 31, 2009, third-party manufacturers produced approximately 73% of our footwear products as measured +by number of units; one such manufacturer in China produced +19 +Table of Contents +approximately +36% of our third-party footwear products. We depend on these manufacturers' ability to finance the production of goods ordered and to maintain adequate manufacturing capacity. We do not +exert direct control over the third-party manufacturers and as such, have experienced at times, delays or inabilities to fulfill customer demand and orders. While we are increasing our communication +and relationships with our third-party manufacturers, we cannot guarantee that we will be able to fully mitigate any delays in the production and shipment of our products. +In +addition, we do not have long-term supply contracts with these third-party manufacturers, including the third-party manufacturer that produced the majority of our footwear +products in the year ended December 31, 2009, and any of them may unilaterally terminate their relationship with us at any time or seek to increase the prices they charge us. As a result, we +are not assured of an uninterrupted supply of products of an acceptable quality and price from our third-party manufacturers. We may not be able to offset any interruption or decrease in supply of our +products by increasing production in our Company-operated manufacturing facilities due to capacity constraints, and we may not be able to substitute suitable alternative third-party manufacturers in a +timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers, including those stemming from political risk, may harm our business and could result +in a loss of sales and an increase in production costs, which would adversely affect our results of operations. +We manufacture a portion of our Crocs products, which represents a fixed cost for the company. Any difficulties or disruptions in our manufacturing operations could +adversely affect our sales and results of operations. +In the year ended December 31, 2009, we produced approximately 27% of our footwear products at our Company-operated +manufacturing facilities in North America and Italy. Our ownership of these facilities adds fixed costs to our cost structure which are not as easily scalable as variable costs. The manufacturing of +our products from Croslite requires the use of a complex process and we may experience difficulty in producing footwear that meets our high quality control standards. We will be required to absorb the +costs of manufacturing and disposing of products that do not meet our quality standards. These costs are primarily incurred in connection with the initial production of new products, although we may +also experience increases in training costs when we +initiate production of new products. We may incur increased costs as a result of the introduction of new manufacturing equipment, such as molds and injection molding machines. Any increases in our +manufacturing costs could adversely impact our margins. Furthermore, our manufacturing capabilities are subject to many of the same risks and challenges noted above with respect to our third-party +manufacturers, including our ability to scale our production capabilities to meet the needs of our customers, and our manufacturing may be disrupted for reasons beyond our control, including work +stoppages, fires, earthquakes, floods, or other natural disasters. Any disruption to our manufacturing operations will hinder our ability to deliver products to our customers in a timely manner, and +could have a material and adverse effect on our business. +We depend on a limited number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and +increase product costs. +We depend on a limited number of sources for the primary materials used to make our footwear. We source the elastomer resins that +constitute the primary raw materials used in compounding Croslite, which we use to produce our footwear products, from two suppliers. We do not have any formal purchase agreement with the providers of +the elastomer resins, and we purchase these elastomer resins on a purchase order basis. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able +to obtain suitable substitute materials in time to avoid interruption of our production cycle, if at all. We may also have to pay materially higher prices in the future for the +20 +Table of Contents +elastomer +resins or any substitute materials we use, which would increase our production costs and could have a materially adverse impact on our margins and results of operations. +If +we are unable to obtain suitable elastomer resins or if we are unable to procure sufficient quantities of the Croslite material, we may not be able to meet our production requirements +in a timely manner. Such failure could result in lost potential sales, delays in shipments to customers, strained relationships with customers, and diminished brand loyalty. +Our products are subject to risks associated with overseas sourcing, manufacturing, shipping and financing. +Because third-party manufacturers manufacture a majority of our products outside of our principal sales market, our products must be +transported by third parties over large geographic distances. Delays in the shipment or delivery of our products due to the availability of transportation, work stoppages, port strikes, infrastructure +congestion, or other factors, and costs and +delays associated with transitioning between manufacturers, could adversely impact our financial performance. In addition, manufacturing delays or unexpected demand for our products may require us to +use faster, but more expensive, transportation methods such as aircraft, which could adversely affect our profit margins. The cost of fuel is a significant component in transportation costs, so +increases in the price of petroleum products can adversely affect our profit margins. +Sales of our products are likely to be subject to seasonal variations, which could increase the volatility of the price of our common stock. +From our inception through 2007, we experienced significant growth in our business. Beginning in 2008, our business contracted due in +part to the global economic crisis. As a result of these growth patterns, there is still uncertainty of the degree to which sales of our footwear products will be subject to seasonality. We expect +that our business, similar to other vendors of footwear and related merchandise, will be subject to seasonal variation. During the years ended December 31, 2009, 2008 and 2007, the majority of +our revenues were attributable to our footwear styles that are more suitable for fair weather. We believe many vendors that market footwear products suited for warm weather normally experience their +highest sales activity during the second and third quarters of the calendar year, particularly when there is a revenue concentration in countries in the northern hemisphere. While we have introduced +footwear models that are more suitable for cold weather, such as the Mammoth, Blitzen, Claire and Gretel styles, we expect that demand for our products, and therefore our sales, may continue to be +subject to seasonal variations and significantly impacted by weather conditions. +In +addition, our quarterly results of operations may fluctuate significantly as a result of a variety of other factors, including the timing of new model introductions or general +economic or consumer conditions. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year, and revenues for any +particular period may fluctuate. This could lead to results outside of analyst and investor expectations which could cause the volatility in our stock price to increase. +We may fail to meet analyst expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly and various securities analysts follow our financial results and frequently issue reports on us. +These reports include information about our historical financial results as well as the analysts' estimates of our future performance. The analysts' estimates are based upon their own opinions and are +often different from our estimates or expectations of our business. If our operating results are below the estimates or expectations of public market analysts and investors, our stock price could +decline. +21 +Table of Contents +We will incur significant time and expense in documenting, testing and certifying our internal control over financial reporting. Any deficiencies in our financial reporting +or internal controls could adversely affect our business and the price of our common stock. +Beginning with our Annual Report on Form 10-K for our fiscal year ended on December 31, 2007, the Securities +and Exchange Commission ("SEC") rules require that our chief executive officer and chief financial officer periodically certify the existence and effectiveness of our internal control over financial +reporting. This process generally requires significant documentation of policies, procedures, and systems, review of that documentation by our internal accounting staff and our outside auditors, and +testing of our internal control over financial reporting by our internal accounting staff and the independent auditors. Continued documentation and testing of our internal controls will involve +considerable time and expense, and may strain our internal resources and have an adverse impact on our costs. +During +the ongoing course of our testing, we may identify deficiencies which we may not be able to remediate in time to meet the annual deadlines imposed by SEC rules for certification +of our internal control over financial reporting. As a consequence, we may have to disclose in periodic reports we file with the SEC any material weaknesses in our system of internal controls. +The +existence of such material weaknesses would preclude management from concluding that our internal control over financial reporting is effective and would preclude our independent +auditors from issuing an unqualified opinion that our internal controls are effective. In addition, disclosures of this type in our SEC reports could cause investors to lose confidence in our +financial reporting and may negatively affect the price of our common stock. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud. If we have +deficiencies in our internal control over financial reporting, such deficiencies may negatively impact our business, results of operations and reputation. +Third parties may claim that we are infringing their intellectual property rights, and such claims may be costly to defend, may require us to pay licensing fees, damages, or +other amounts, and may prevent, or otherwise impose limitations on, the manufacture, distribution or sale of our products. +From time to time, third parties may claim that we are infringing their intellectual property rights, and we may be found to infringe +those intellectual property rights. While we do not believe that any of our products infringe the valid intellectual property rights of third parties, we may be unaware of the intellectual property +rights of others that may cover some of our technology or products. If we are forced to defend against such third-party claims, whether or not such claims are resolved in our favor, we could encounter +expensive and time-consuming litigation, which could divert our management and key personnel from business operations. If we are found to be infringing on the intellectual property rights +of other companies, we may be required to pay damages or ongoing royalty payments, or comply with other unfavorable terms. If we are found to be infringing on the intellectual property rights of other +companies, we may not be able to obtain license agreements on terms acceptable to us, or at all, and this may prevent us from manufacturing, marketing or selling certain products. Thus, such +third-party claims may significantly reduce the sales of our products or increase our cost of goods sold. Any such reductions in sales or cost increases could be significant, and could have a material +and adverse affect on our business. +We have been named as a defendant in a securities class action lawsuit that may result in substantial costs and could divert management's attention. +Starting in November 2007, certain stockholders filed several purported shareholder class actions in the U.S. District Court for the +District of Colorado alleging violations of Sections 10(b) and 20(a) of the Exchange Act based on alleged statements made by us between July 27, 2007 and October 31, 2007. +22 +Table of Contents +We +and certain of our current and former officers and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of Colorado. The +first complaint was filed in November 2007; several other complaints were filed shortly thereafter. These +actions were consolidated and, in September 2008, the Court appointed a lead plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purports to +state claims under Section 10(b), 20(a), and 20A of the Exchange Act on behalf of a class of all persons who purchased our stock between April 2, 2007 and April 14, 2008 (the +"Class Period"). The amended complaint alleges that, during the Class Period, defendants made false and misleading public statements about us and our business and prospects and that, as a result, the +market price of our stock was artificially inflated. The amended complaint also claims that certain current and former officers and directors traded our stock on the basis of material +non-public information. The amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified amount, interest, and an award of attorneys' fees and costs of +litigation. The Company believe the claims lack merit and intends to defend the action vigorously. Motions to dismiss are currently pending with the Court. Due to the inherent uncertainties of +litigation and because the litigation is at a preliminary stage, we cannot at this time accurately predict the ultimate outcome of the matter, or of the amount or range of potential loss, if any. It +is possible that this action could be resolved adversely to us. +Risks +associated with legal liability are often difficult to assess or quantify, and their existence and magnitude can remain unknown for significant periods of time. While we maintain +director and officer insurance, the amount of insurance coverage may not be sufficient to cover a claim, and the continued availability of this insurance cannot be assured. We may, in the future, be +the target of additional proceedings, and the present or future proceedings may result in substantial costs and divert management's attention and resources that are needed to successfully run our +business. +Our business could suffer if our third-party manufacturers violate labor laws or fail to conform to generally accepted ethical standards. +We require our third-party manufacturers to meet our standards for working conditions and other matters before we are willing to do +business with them. As a result, we may not always obtain the lowest cost production. Moreover, we do not control our third-party manufacturers or their respective labor practices. If one of our +third-party manufacturers violates generally accepted labor standards by, for example, using forced or indentured labor or child labor, failing to pay compensation in accordance with local law, +failing to operate its factories in compliance with local safety regulations, or diverging from other labor practices generally accepted as ethical, we likely would cease dealing with that +manufacturer, and we could suffer an interruption in our product supply. In addition, such a manufacturer's actions could result in negative publicity, damage to our reputation and the value of our +brand, and discourage retail customers and consumers from buying our products. +We have experienced significant management turnover. +Effective March 18, 2009, John H. Duerden was appointed President and Chief Executive Officer as a successor to our former +President and Chief Executive Officer, Ron Snyder. Mr. Snyder remained a Director until June 30, 2009. Effective December 31, 2009, Erik Rebich resigned as Vice President, General +Counsel and Secretary. Effective January 1, 2010, Daniel P. Hart was appointed as our Executive Vice President, Chief Legal and Administrative Officer and Secretary. In addition, we have +experienced a significant amount of turnover in our extended leadership team as we seek to reorganize our internal reporting structure. High turnover of senior management can adversely impact our +stock price, our results of operations and our client relationships and may make recruiting for future management positions more difficult. In some cases, we may be required to pay significant amounts +of severance to terminated management employees. In addition, we must successfully integrate any new management personnel that we hire within our organization in order to achieve our operating +23 +Table of Contents +objectives, +and changes in other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. Accordingly, +our future financial performance will depend to a significant extent on our ability to motivate and retain key management personnel. +If we are unable to recruit and retain key personnel necessary to operate our business, our ability to successfully manage our business and develop and market our products +may be harmed. +We are reliant on key personnel and our officers, including our new Chief Executive Officer, John Duerden. To expand our business we +will need to attract, retain, and motivate highly skilled design, development, management, accounting, sales, merchandising, marketing, and customer service personnel. Competition for many of these +types of personnel is intense. As a result, we may be unable to successfully attract or retain qualified personnel. Any of our officers or employees can terminate their employment with us at any time, +and we do not maintain key person life insurance on any of our employees. The loss of any key employee or our inability to attract or retain other qualified employees could harm our business and +results of operations. +As a result of the difficult global macroeconomic conditions and extremely challenging retail environments, we implemented restructuring initiatives and workforce +reductions, which required us to incur restructuring charges. Our restructuring initiatives may adversely affect the morale and performance of our personnel and our ability to hire new personnel. We +may also need to take additional restructuring charges in the future. +Our business has been adversely affected by challenging retail environments in many of the markets in which we operate due in large +part to the current global economic downturn. Accordingly, in 2008 and 2009, we took actions to reduce our cost structure to better align with our lower sales volumes and revenues including, but not +limited to, the closure and consolidation of certain warehouse, manufacturing and distribution space; headcount reductions; and termination of certain sponsorship contracts that no longer met our +longer-term marketing strategy. These actions, among other things, resulted in a reduction to our global workforce and required us to incur restructuring charges. We recognized +restructuring charges of approximately $14.7 million and $8.6 million in 2009 and 2008, respectively. These restructuring plans, or any restructuring plans undertaken in the future, may +yield unintended consequences, such as attrition beyond our intended reduction in workforce and reduced employee morale, which may cause our employees who were not affected by the reduction in +workforce to seek employment elsewhere. We run the risk that our restructuring efforts may not sufficiently reduce costs to maintain profitability, or, in the alternative, our restructuring efforts +may result in too many reductions, which could adversely affect our operations and may potentially stunt our growth. Additional attrition or an inability to find adequate replacements for lost +personnel could adversely affect our ability to meet our operational or financial goals. Although we have no current plans to do so, it is possible that we may need to implement additional +restructuring in the future, which may adversely affect our operating results, financial condition and cash flows. +Our financial success may be limited to the strength of our relationships with our wholesale customers and to the success of such wholesale customers. +Our financial success is significantly related to the willingness of our wholesale customers to continue to carry our products, the +expansion to new wholesale customers, and to the success of such customers. We do not have long term contracts with any of our wholesale customers, and sales to our wholesale customers are generally +on an order-by-order basis and are subject to rights of cancellation and rescheduling by the customer. If we cannot fill our customers' orders in a timely manner, the sales of +our products and our relationships with those customers may suffer, and this could have a material adverse effect on our product sales and ability to grow our product line. +24 +Table of Contents +Furthermore, +many of our wholesale customers compete with each other and if they perceive that we are offering their competitors better pricing and support, they may reduce purchases of +our products. In addition, we compete directly with our wholesale customers by selling our products to consumers via the internet and through our company-owned retail locations. If our wholesale +customers believe that our direct sales to consumers divert sales from their stores, this may weaken our relationships with such customers and cause them to reduce purchases of our products. Likewise, +our consumer-direct channels (company-owned retail and internet) grew 42% in 2009 and we plan to further grow these channels in the future, which could exacerbate this issue. +The +changes in the global economy could also affect our customers' liquidity and capital resources and their ability to meet their payment obligations to us, which in turn would decrease +their credit terms and our ability to collect our accounts receivable, which may have a material adverse impact on our cash flows and capital resources. We continue to monitor our accounts receivable +aging and have recorded appropriate reserves as we deem appropriate. +We face significant competition, and if we are unable to compete effectively, sales of our products may decline and our business could be harmed. +The footwear industry is highly competitive. Recent growth in the market for casual footwear has encouraged the entry of new +competitors into the marketplace and has increased competition from established companies. Some of our competitors are offering products that are substantially similar, in design and materials, to our +Crocs-branded footwear. In addition, access to offshore manufacturing is also making it easier for new companies to enter the markets in which we compete. +Our +competitors include most major athletic and footwear companies, branded apparel companies, and retailers with their own private labels. A number of our +competitors: +• have significantly greater financial resources than us; +• have more comprehensive product lines than ours; +• have broader market presence than we have in wholesale stores, or have more Company-operated retail stores than we do; +• have longer-standing relationships with wholesalers than us; +• have a longer operating history than ours; +• have greater distribution capabilities than us; +• have stronger brand recognition than us; and +• spend substantially more than we do on product advertising and sales. +Our +competitors' greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and +production, and more quickly develop new products. If we fail to compete successfully in the future, our sales and profits may decline, our financial condition may deteriorate, and the market price of +our common stock is likely to fall. +25 +Table of Contents +We may fail to successfully streamline our distribution network or introduce our products in new markets abroad and this may cause our results of operations to fall short of +expectations. +As part of our strategy, we plan to streamline our supply chain network and expand the sales of our products into new locations +internationally. Successfully executing this strategy will depend on many factors, including: +• the strength of the Crocs brand and competitive conditions in new markets that we attempt to enter; +• our ability to attract and retain qualified distributors or agents or to develop direct sales channels; +• our ability to use and protect the Crocs brand, and our other intellectual property, in these new markets and territories; +and +• our ability to consolidate our network to leverage resources and simplify our fulfillment process. +If +we are unable to successfully streamline our supply chain and sell our Crocs-branded products in new markets abroad, our business may fail to grow, our brand may suffer, and our +results of operations may be adversely impacted. +We conduct, and in the future expect to conduct, a significant portion of our activities outside the U.S., and, therefore, we are subject to the risks of international +commerce. +We use third-party manufacturers located in foreign countries; we operate manufacturing facilities located in North America and Italy; +and we sell our products to retailers outside of the U.S. Foreign manufacturing and sales activities are subject to numerous risks, including the following: +• tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as +quotas and local content rules; +• delays associated with the manufacture, transportation and delivery of foreign-sourced products; +• increased transportation costs due to distance, energy prices, or other factors; +• delays in the transportation and delivery of goods due to increased security concerns; +• foreign currency fluctuations, for which we do not currently engage in any material hedging transactions; +• restrictions on the transfer of funds; +• changing economic conditions; +• restrictions, due to privacy laws, on the handling and transfer of consumer and other personal information; +• changes in governmental policies and regulations; +• political unrest, changes in law, terrorism, or war, any of which can interrupt commerce; +• expropriation and nationalization; +• difficulties in managing foreign operations effectively and efficiently from the U.S.; and +• difficulties in understanding and complying with local laws, regulations, and customs in foreign jurisdictions. +Furthermore, +our manufacturing activity outside of the U.S., including the production of our products by third-party manufacturers, particularly in China, is subject to risks of poor +infrastructure, +26 +Table of Contents +shortages +of equipment, and labor unrest, in addition to those risks noted above. Once our products are manufactured, we may also suffer delays in distributing our products due to work stoppages, +strikes, or lockouts at the ports where our products arrive. Such labor disruptions could result in product shortages and delays in distributing our products to retailers. These factors and the +failure to properly respond to them could make it difficult to obtain adequate supplies of quality products when we need them, resulting in reduced sales and harm to our business. +In +addition, during 2009, we generated $389.1 million, or 60.2%, of our revenues outside of the U.S., and in the year ended December 31, 2008, we generated approximately +$400.3 million, or 55.5% of our revenues outside of the U.S. Our ability to maintain the current level of operations in our existing international markets is subject to risks associated with +international sales operations, as noted above, as well as the difficulties associated with promoting products in unfamiliar cultures. +We may be adversely affected by currency exchange rate fluctuations. +The market has recently seen significant volatility in the value of the dollar against other foreign markets and currency. We purchase +products and supplies from third parties in U.S. dollars and receive payments from certain of our international customers in foreign currencies. The cost of these products and supplies sourced +overseas, and payments received from customers, may be affected by changes in the value of the relevant currencies. Price increases caused by currency exchange rate fluctuations could make our +products less competitive or have an adverse effect on our profitability. Currency exchange rate fluctuations could also disrupt the business of the third-party manufacturers that produce our products +by making their purchases of raw materials more expensive and more difficult to finance. Foreign currency fluctuations could have a material adverse effect on our results of operations and financial +condition. For the year ended December 31, 2009, we experienced $0.7 million net in foreign currency exchange rate gains. Likewise, foreign currency exchange rate fluctuations had the +effect of decreasing our U.S. dollar basis revenue by $14.9 million during the year ended December 31, 2009. We are exploring new opportunities to hedge our foreign currency risk. +Acquisitions may be difficult to identify and successfully integrate into our business and could have other adverse consequences. +We have made, and may in the future make, acquisitions of, or investments in, other companies, provided we may do so under our current +bank arrangements. We expect to consider other opportunities to acquire or make investments in other businesses and products that could enhance our manufacturing capabilities, complement our current +products or expand the breadth of our markets or customer base. The pursuit of acquisitions may divert the attention of management and cause us to incur various expenses in identifying, investigating +and pursuing suitable acquisitions, whether or not they are consummated. In the event we finance acquisitions by issuing equity or convertible debt securities, our stockholders may be diluted. +If +we acquire additional businesses, we may not be able to integrate the acquired operations successfully with our business or effectively manage the combined business following +completion of the acquisition. We may not achieve the anticipated benefits from the acquired business due to any of the following factors: +• unanticipated costs associated with the acquisition; +• diversion of management's attention from our core business; +• harm to our existing business relationships with manufacturers and customers as a result of the acquisition; +• the potential loss of key employees; or +27 +Table of Contents +• risks associated with entering new product lines or markets in which we have little or no prior experience. +If +we are unable to integrate any new business successfully, we could be required either to dispose of the acquired operations, which, among other things, may result in restructuring or +impairment charges, or to undertake changes to the acquired operations in an effort to integrate them with our business. If we experience any of the difficulties noted above, our business and +financial condition could be materially and adversely affected. +Our restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could discourage a third-party from acquiring us and +consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could +delay, defer, or prevent a change in control of us or changes in our management. Among other things, these provisions: +• authorize us to issue preferred stock that can be created and issued by the board of directors without prior stockholder +approval, with rights senior to those of common stock; +• do not permit cumulative voting in the election of directors, which would otherwise allow less than a majority of +stockholders to elect director candidates; +• prohibit stockholders from calling special meetings of stockholders; +• prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our +stockholders; +• allow the authorized number of directors to be changed only by resolution of the board of directors; +• establish advance notice requirements for submitting nominations for election to the board of directors and for proposing +matters that can be acted upon by stockholders at a meeting; and +• classify our board of directors so that only some of our directors are elected each year. +These +provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of +control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in +control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to +decline. +ITEM 1B. Unresolved Staff Comments +None. +ITEM 2. Properties +Our principal executive and administrative offices are located at 6328 Monarch Park Place, Niwot, Colorado. We lease, rather than own, +all of our facilities. We consider our facilities to be suitable for our needs. +28 +Table of Contents +The +general location, use and approximate size of our principal properties are given below: +Location +Use +Approximate +Square Feet +Ontario, California +Warehouse +399,000 +Rotterdam, the Netherlands +Warehouse +357,000 +Narita, Japan +Warehouse +289,000 +Aurora, Colorado +Warehouse +264,000 +Shenzhen, China +Warehouse +231,000 +Leon, Mexico +Manufacturing/offices +226,000 +Leon, Mexico +Warehouse/offices +214,000 +Niwot, Colorado +Corporate headquarters and regional offices +126,000 +Shanghai, China +Warehouse +86,000 +Tampere, Finland(1) +Warehouse/offices +60,000 +Melbourne, Australia +Warehouse +48,000 +Den Haag, the Netherlands +Regional offices +40,000 +Padova, Italy +EXO's Regional offices/manufacturing facility +28,000 +Singapore +Regional offices +26,000 +Gordon's Bay, South Africa +Warehouse/offices +24,000 +Boulder, Colorado +Warehouse +16,000 +Shanghai, China +Regional offices +13,000 +Shenzhen, China +Manufacturing/offices +13,000 +(1) Our +Facility in Tampere, Finland is partially subleased. +We +also maintain small branch sales offices in Hong Kong, Taiwan, Korea, Australia, Puerto Rico, and India. We enter into short-term leases for kiosks domestically and +internationally with fixed monthly rents subject to certain covenants with contingent rents based on percentage of revenues. We also lease retail space for 30 domestic and 54 international retail +stores and 50 domestic and 13 international outlet stores. Our short term and long term leases expire at various dates throughout the year 2026. We still hold leases on facilities in Aurora, Colorado +and Rotterdam, Netherlands, however, as a result of our restructuring efforts during 2009, we have shut down all or a portion of these facilities and the appropriate lease termination charges are +reflected in our consolidated financial statements. We intend to sublet warehouse and distribution space that has been vacated including our facilities in Aurora, Colorado, Narita, Japan and in +Rotterdam, Netherlands. +ITEM 3. Legal Proceedings +On March 31, 2006, the Company filed a complaint with the ITC against Acme Ex-Im, Inc., Australia +Unlimited, Inc., Cheng's Enterprises, Inc., Collective Licensing International, LLC, D. Myers & Sons, Inc., Double Diamond Distribution, Ltd., +Effervescent, Inc., Gen-X Sports, Inc., Holey Soles Holdings, Ltd., Inter-Pacific Trading Corporation, and Shaka Holdings, Inc., alleging patent and trade dress +infringement and seeking an exclusion order banning the importation and sale of infringing products. On August 10, 2006, the Company filed a motion to voluntarily remove its trade dress claim +from the investigation to focus on the patent claims. The Company's motion was granted by Order No. 20 on August 24, 2006. The utility and design patents asserted in the complaint were +issued to the Company on February 7, 2006 and March 28, 2006 respectively, by the United States Patent and Trademark Office. The ITC has issued final determinations terminating Shaka +Holdings, Inc., Inter-Pacific Trading Corporation, Acme Ex-Im, Inc., D. Myers & Sons, Inc., Australia Unlimited, Inc. and Gen-X +Sports, Inc. from the ITC investigation No. 337-TA-567 on the basis of settlement and Cheng's Enterprises, Inc. on the suspension of accused activities. +The ITC Administrative Law Judge ("ALJ") issued an Initial Determination of non-infringement related to one of the patents at issue. The +29 +Table of Contents +Company +filed a petition with the Commission to review this determination. The Commission granted the Company's petition and on February 15, 2007, after briefing by the parties, the Commission +vacated the ALJ's determination of non-infringement with respect to the remaining respondents +and remanded it to the ALJ for further proceedings consistent with the Commission's order. In light of the Commission's Order, the procedural schedule and hearing date were reset pursuant to Order +No. 38. A trial was held before the ALJ from September 7 to 14, 2007. The ALJ issued an Initial Determination on April 11, 2008 with a finding of no violation, finding +infringement of the utility patent by certain accused products, but also finding that the utility patent was invalid as obvious. The ALJ also found that the design patent was valid, but not infringed +by the accused products. The Company filed a Petition for Review of the Initial Determination which was due on April 24, 2008. On June 18, 2008, the Commission issued a Notice that it +would review the ALJ's findings in the Initial Determination with respect to the determination of non-infringement of the design patent and the determination of invalidity of the utility +patent. On July 25, 2008, the Commission issued a Notice of its decision to terminate the Investigation with a finding of no violation as to either patent. Crocs filed a Petition for Review of +the decision with the United States Court of Appeals for the Federal Circuit on September 22, 2008, and filed its initial brief on January 21, 2009. Briefing before the Federal Circuit +was completed in April 2009 and oral arguments were heard on July 10, 2009. On October 4, 2009, the Company and Collective Licensing, International, LLC reached a settlement. +Collective Licensing, International, LLC agreed to cease and desist infringing on the Company's patents and to pay the Company certain monetary damages, which was recorded upon receipt. On +February 24, 2010, the Federal Circuit found that the Commission erred in finding that the utility patent was obvious and reversed the Commission's determination of non-infringement of the +design patent. The case has been remanded back to the Commission for a determination of infringement of the utility patent and any appropriate remedies. +On +April 3, 2006, the Company filed a complaint in the U.S. District Court for the District of Colorado alleging patent and trade dress infringement and seeking injunctive relief +against Acme EX-IM, Inc., Australia Unlimited, Inc., Cheng's Enterprises, Inc., Collective Licensing International, LLC, D. Myers & Sons, Inc., +Double Diamond Distribution, Ltd., Effervescent, Inc., Gen-X Sports, Inc., Holey Soles Holdings, Ltd, Inter-Pacific Trading Corporation, Shaka +Holdings, Inc., and Does 1-10 based upon certain utility and design patents that were issued to the Company on February 7, 2006 and March 28, 2006 respectively, by the +United States Patent and Trademark Office. Consent judgments have been entered against Shaka Holdings, Inc., Interpacific Trading Corporation and Acme Ex-Im, Inc. The Company +entered into a settlement with Australia Unlimited, and filed a stipulation for dismissal of all claims and counterclaims on January 25, 2007. The Company has entered into a settlement +agreement with D. Myers & Sons and obtained a consent judgment in connection therewith on May 23, 2007. This action has been stayed pending resolution in the ITC Proceeding, +Investigation No. 337-TA-567, which is currently on appeal to the U.S. Court of Appeals for the Federal Circuit. On June 11, 2009, the Company filed a Notice of +Voluntary Dismissal of Gen-X Sports, Inc. on the basis of settlement and on November 4, 2009, the Company filed a Notice of Voluntary Dismissal with prejudice of Collective +Licensing International, LLC on the basis of settlement. +The +Company and certain current and former officers and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of +Colorado. The first complaint was filed in November 2007; several other complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the Court appointed a lead +plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purports to state claims under Section 10(b), 20(a), and 20A of the Exchange Act on +behalf of a class of all persons who purchased the Company's stock between April 2, 2007 and April 14, 2008 (the "Class Period"). The amended complaint alleges that, during the Class +Period, defendants made false and misleading public statements about the Company and its business and prospects and that, as a result, the market price of the Company's stock was artificially +inflated. The amended complaint also +30 +Table of Contents +claims +that certain current and former officers and directors traded in the Company's stock on the basis of material non-public information. The amended complaint seeks compensatory +damages on behalf of the alleged class in an unspecified amount, interest, and an award of attorneys' fees and costs of litigation. The Company believes the claims lack merit and intends to defend the +action vigorously. Motions to dismiss are currently pending with the Court. Due to the inherent uncertainties of litigation and because the litigation is at a preliminary stage, the Company cannot at +this time accurately predict the ultimate outcome of the matter. +On +May 11, 2009, Crocs Europe B.V. received a letter from Dr. Ing. H.c.F. Porsche AG ("Porsche") claiming that the Company's use of the "Cayman" shoe model +designator infringes upon their Community Trademark Registration of the mark "CAYMAN" in class 25. Porsche is requesting that Crocs Europe B.V. immediately cease and desist use of the +Cayman mark and pay Porsche's attorney's fees in conjunction with the issuance of the notice letter. On July 30, 2009 the Company was served with notice of an injunction against Crocs Europe +BV's use of the Cayman mark in Germany. On December 16, 2009, a settlement was entered into where Crocs Europe B.V. has agreed to pay Porsche certain damages and cease using the mark +CAYMAN as a style designator. This matter is considered closed. +On +December 8, 2009, Columbia Sportswear Company ("Columbia") filed an Amended Complaint adding the Company as a defendant in a case between Columbia and Brian P. O'Boyle and 1 +Pen. Inc. in the Multnomah County Circuit Court in the State of Oregon. Columbia has asserted claims against the Company for misappropriation of trade secrets, aiding and abetting breach of +fiduciary duty, intentional interference with contract, injunctive relief, disgorgement and an accounting. The Amended Complaint also seeks damages in an unspecified amount, return of patent rights, +reasonable attorney's fees and costs and expenses against the Company. On January 25, 2010, the Company filed an Answer to the Amended Complaint. The Company denies Columbia's claims in the +Amended Complaint and intends to defend this action vigorously. Due to the inherent uncertainties of litigation and because the litigation is at a preliminary stage, the Company cannot at this time +accurately predict the ultimate outcome of the matter. +Although +the Company is subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, the +Company is not +party to any other pending legal proceedings that the Company believes will have a material adverse impact on its business. +ITEM 4. Submission of Matters to a Vote of Security Holders +Not Applicable. +31 +Table of Contents +PART II +ITEM 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock, par value $0.001, is listed on the NASDAQ Global Select Market and trades under the stock symbol CROX. The following +table sets forth, for each of the quarterly periods indicated, the high and low sales prices of our common stock as reported on the NASDAQ Global Select Market. +Fiscal Year 2009 Three Months Ended +High +Low +March 31, 2009 +$ +1.63 +$ +1.00 +June 30, 2009 +$ +4.50 +$ +1.19 +September 30, 2009 +$ +7.45 +$ +2.55 +December 31, 2009 +$ +8.20 +$ +4.33 +Fiscal Year 2008 Three Months Ended +High +Low +March 31, 2008 +$ +39.29 +$ +16.14 +June 30, 2008 +$ +20.98 +$ +7.67 +September 30, 2008 +$ +10.55 +$ +3.51 +December 31, 2008 +$ +3.69 +$ +0.79 +On +November 1, 2007, our board of directors approved an authorization to repurchase up to one million shares of our common stock. On April 14, 2008, the board of directors +approved an additional authorization to repurchase an additional five million shares of our common stock. As of December 31, 2009, 5,476,000 shares remained under our share repurchase +authorizations. Share repurchases under these authorizations may be made in the open market or in privately negotiated transactions. The timing and actual number of shares repurchased will depend on a +variety of factors, including price, corporate and regulatory requirements and other market conditions. The repurchase authorizations do not have an expiration date and do not oblige us to acquire any +particular amount of shares of our common stock. The repurchase authorizations may be modified, suspended or discontinued at any time. We did not repurchase any shares in the year ended +December 31, 2009 under our publicly announced repurchase plan. We did, however, repurchase certain shares as a tax payment for certain Named Executive Officers (NEOs), as shown in the table +below. These purchases were not part of a publicly announced repurchase plan. +32 +Table of Contents +Issuer Purchases of Equity Securities +Period +Total +Number +of Shares +(or Units) +Purchased +Average +Price +Paid per +Share +(or Unit) +Total Number +of Shares +(or Units) +Purchased as +Part of +Publicly +Announced +Plans or +Programs +Maximum Number +(or Approximate +Dollar Value) of +Shares (or Units) +that May Yet Be +Purchased Under +the Plans or +Programs +November 1, 2009—November 30, 2009(a) +27,487 +$ +5.77 +— +— +December 1, 2009—December 31, 2009(a) +13,692 +$ +5.75 +— +— +Total +41,179 +(a) On +November 11, 2009 the Compensation Committee approved "withhold to cover" as a tax payment method for NEOs vesting in restricted stock awards. +Four elections, which were outside of a publicly announced repurchase plan, were made in 2009, as summarized in the table above, in which a total of 41,179 shares were withheld upon restricted stock +vesting to cover tax withholding obligations. These shares were placed in treasury, increasing the treasury reserve balance to 565,179 at December 31, 2009. +Performance Graph +The following performance graph compares the cumulative total return of our common stock with that of the NASDAQ Composite Index and +the Dow Jones US Footwear Index from February 8, 2006 through December 31, 2009. Our stock was initially listed on NASDAQ on February 8, 2006, the date our shares began to trade +publicly. Prior to that time, there was no public market for our stock. The graph assumes an investment of $100 on February 8, 2006 and reinvestments of all dividends and other distributions +and is reflecting our stock prices post-stock split. +Comparison of Cumulative Total Return on Investment +For the Year Ended December 31, +2/8/2006 +2006 +2007 +2008 +2009 +Crocs, Inc. +$ +100.00 +$ +144.00 +$ +245.40 +$ +8.27 +$ +38.33 +Nasdaq Composite Index +$ +100.00 +$ +106.86 +$ +117.35 +$ +69.77 +$ +100.40 +Dow Jones US Footwear Index +$ +100.00 +$ +114.93 +$ +143.58 +$ +102.81 +$ +131.46 +33 +Table of Contents +The +Dow Jones U.S. Footwear Index consists of Crocs, Inc., NIKE, Inc., Deckers Outdoor Corp., Timberland Co. and Wolverine World Wide, Inc. Because +Crocs, Inc. is part of the Dow Jones U.S. Footwear Index, the price and returns of Crocs, Inc. stock have an effect on this index. The Dow Jones U.S. Footwear Index include companies in +the major line of business in which the Company competes. This index does not encompass all of our competitors nor all of our product categories and lines of business. +The +stock performance shown on the performance graph above is not necessarily indicative of future performance. We do not make nor endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 166 as of January 31, 2010. Because many of the shares +of our common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial owners represented by these stockholders of record. +Dividends +We have never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future +earnings for use in the operation of our business and do not anticipate paying any cash dividends in the foreseeable future. At present, we have restrictions associated with our financing arrangements +that impede our ability to pay cash dividends. Any future determination to declare cash dividends will be made at the discretion of our board of directors, subject to compliance with covenants under +any then existing financing agreements, which may restrict or limit our ability to declare or pay dividends, and will depend on our financial condition, results of operations, capital requirements, +general business conditions, and other factors that our board of directors may deem relevant. We issued a stock dividend in connection with our 2-for-1 stock split, which was +effected in the form of a 100% common stock dividend distributed on June 14, 2007. +34 +Table of Contents +ITEM 6. Selected Financial Data +The following table presents selected historical financial data of the Company for each of the last five fiscal years. The information +in this table should be read in conjunction with the consolidated financial statements and accompanying notes beginning on page F-1 and with "Management's Discussion and Analysis of +Financial Conditions and Results of Operations," which is included in Item 7 of this Form 10-K. +Year Ended December 31, +2009 +2008 +2007 +2006 +2005 +(in thousands, except per share data) +Consolidated Statements of Operations Data +Revenues +$ +645,767 +$ +721,589 +$ +847,350 +$ +354,728 +$ +108,581 +Cost of sales +337,720 +486,722 +349,701 +154,158 +47,773 +Restructuring charges +7,086 +901 +— +— +— +Gross profit +300,961 +233,966 +497,649 +200,570 +60,808 +Selling, general and administrative expenses +311,592 +341,418 +268,978 +104,172 +33,903 +Foreign currency transaction losses (gains), net +(665 +) +25,438 +(10,055 +) +776 +(33 +) +Charitable Contributions +7,510 +1,844 +959 +276 +46 +Restructuring charges +7,623 +7,664 +— +— +— +Impairment charges +26,085 +45,784 +— +— +— +Income (loss) from operations +(51,184 +) +(188,282 +) +237,767 +95,346 +26,892 +Gain (loss) on Charitable Contributions +(3,163 +) +— +— +— +— +Interest expense +1,495 +1,793 +438 +567 +611 +Other (income) expenses—net +(895 +) +(565 +) +(2,997 +) +(1,847 +) +(8 +) +Income (loss) before income taxes +(48,621 +) +(189,510 +) +240,326 +96,626 +26,289 +Income tax expense (benefit)(1) +(6,543 +) +(4.434 +) +72,098 +32,209 +9,317 +Net income (loss) +(42,078 +) +(185,076 +) +168,228 +64,417 +16,972 +Dividend on redeemable convertible preferred shares +— +— +— +33 +275 +Net income (loss) attributable to common stockholders +$ +(42,078 +) +$ +(185,076 +) +$ +168,228 +$ +64,384 +$ +16,697 +Income (loss) per common share: +Basic +$ +(0.49 +) +$ +(2.24 +) +$ +2.08 +$ +0.87 +$ +0.26 +Diluted +$ +(0.49 +) +$ +(2.24 +) +$ +2.00 +$ +0.81 +$ +0.26 +Weighted average common shares:(2) +Basic +85,112,461 +82,767,540 +80,759,077 +74,598,400 +50,987,154 +Diluted +85,112,461 +82,767,540 +84,194,883 +80,170,512 +67,140,000 +35 +Table of Contents +As of December 31, +2009 +2008 +2007 +2006 +2005 +(in thousands) +Consolidated Balance Sheets Data +Cash, cash equivalents, and marketable securities +$ +77,343 +$ +51,665 +$ +36,335 +$ +64,981 +$ +4,787 +Total assets +409,738 +455,999 +627,425 +299,457 +78,032 +Long term obligations +35,462 +35,303 +15,864 +3,290 +5,513 +Redeemable common shares +— +— +— +— +1,800 +Redeemable convertible preferred stock +— +— +— +— +5,500 +Total stockholders' equity (deficit) +287,620 +287,163 +444,113 +208,258 +18,914 +(1) On +January 4, 2005, we converted from a limited liability company to a taxable corporation. For the tax years beginning on January 1, 2005 and +afterward, we are subject to corporate-level U.S. federal, state and foreign income taxes. The statement of operations for the year ended December 31, 2005 reflects a +one-time income tax benefit of $797,000 to record the net deferred tax assets at the date of conversion. +(2) We +issued a stock dividend in connection with our 2-for-1 stock split, which was effected in the form of a 100% common stock +dividend distributed on June 14, 2007. All share and per share amounts prior to June 14, 2007 have been adjusted to reflect the 2-for-1 stock split. Diluted +weighted average shares have been calculated excluding the dilutive effect of stock options and awards in years where the Company was in a net loss position as their inclusion would have been +anti-dilutive. +ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations +Overview +We aspire to bring comfort, fun and innovation to the world's feet. We strive to be the global leader in molded footwear design and +development. We manufacture a product offering that provides new and exciting molded footwear products that feature fun, comfort and functionality. We also design and sell a broad offering of footwear +and accessories that utilize our proprietary closed cell-resin, called Croslite. Our Croslite material is unique in that it enables us to produce an innovative, lightweight, +non-marking, and odor-resistant shoe. Certain shoes made with the Croslite material have been certified by U.S. Ergonomics to reduce peak pressure on the foot, reduce muscular +fatigue while standing and walking and to relieve the musculoskeletal system. +Since +the initial introduction and popularity of our Beach and Cayman (soon to be renamed Crocs Classic) designs, we have expanded our Croslite products to include a variety of new +styles and products and have extended our product reach through the acquisition of new brand platforms such as Jibbitz, LLC ("Jibbitz") and Ocean Minded, Inc. ("Ocean Minded"). We intend +to continue branching out into other types of footwear, bringing a unique and original perspective to the consumer in styles that may be unexpected from Crocs. In part, we believe this will help us to +continue to build a stable year-round business as we look to offer more winter-oriented styles. All of our products are designed to allow the product to be defined by comfort, fun, and +function. Our marketing approach is also becoming significantly more focused on a defined target consumer. The majority of our marketing efforts surround specific product launches and employ a fully +integrated approach utilizing a variety of media outlets. Our marketing efforts strive to drive business to both our wholesale partners and our company-owned retail and internet stores, ensuring that +our presentation and story are first class and drive purchasing at the point of sale. +36 +Table of Contents +We currently sell our Crocs-branded products throughout the U.S. and in more than 100 countries. We sell our products through domestic and international retailers +and distributors and directly to end-user consumers through our webstores, Company-operated retail stores, outlets and kiosks. The broad appeal of our footwear has allowed us to market our +products to a wide range of distribution channels, including department stores and traditional footwear retailers as well as a variety of specialty and independent retail channels. +Recent Events +From our inception through the year ended December 31, 2007, we experienced rapid revenue growth and had difficulty meeting +demand for our footwear products. During this period, we significantly increased our production capacity, warehouse space and inventory in an effort to meet demand. This pattern changed in 2008. Our +revenue growth moderated and then began to decline during 2008 when compared to 2007. Accordingly, we evaluated our production capacity and operations structure and, in 2008, we discontinued our +Canadian manufacturing operations and consolidated our Canadian distribution activities with other existing North American distribution operations; we abandoned certain equipment and molds that +represented excess capacity; we wrote down the value of certain units in inventory that we felt we may not be able to sell for a price above cost; and we discontinued manufacturing operations at our +Brazilian manufacturing facility. During 2008 and 2009, we decreased our fixed costs by consolidating our global distribution centers and +reducing our warehouse space; we took additional impairments on goodwill, intangible assets, molds, tooling, equipment and other assets related to manufacturing, distribution and sales; we executed +against a plan to dispose of previously-impaired inventory (see below); and we reduced our global headcount by approximately 33%. We believe these actions were necessary in order to align our +production and distribution capacities with our revised demand projections. Furthermore, we have taken actions to reduce our selling, general and administrative costs by reducing personnel, reducing +our space costs by consolidating certain offices and reducing other discretionary spending. As a result of these and other actions taken by management as part of our turnaround strategy, we achieved +improved year-over-year gross margin in 2009 as well as improved operating margin and net loss, despite weakened economic conditions during 2009. We may, in the future, take +further actions to align our cost structure with general demand for our products. +The +following table summarizes our restructuring and asset impairment, including intangible assets, charges for the year ended December 31, 2009: +Warehouse and +Distribution +Consolidation +Other(1) +Total +Asset impairment charges +Equipment and molds +$ +3,026 +$ +15,124 +$ +18,150 +Leasehold Improvements +— +327 +327 +Capitalized Software +— +4,514 +4,514 +Other Intangible assets +— +3,095 +3,095 +Restructuring charges +Operating lease exit costs(2) +$ +5,356 +$ +231 +$ +5,587 +Other restructuring costs(3) +— +5,306 +5,306 +Termination benefits +376 +3,439 +3,815 +$ +8,758 +$ +32,036 +$ +40,794 +(1) During +the year ended December 31, 2009, we took certain actions to reduce our global cost structure. Actions included in the "Other" column include +the write-off of obsolete molds, tooling, manufacturing equipment and sales and marketing assets and the writeoff +37 +Table of Contents +of +capitalized software, patents and tradenames and other intangible assets we no longer intend to utilize. +(2) Operating +lease exit costs include lease termination charges for our facilities in Aurora and Rotterdam and freight and labor charges related to the +transfer of inventory and equipment as a result of the Company's decision to close and consolidate its distribution centers. +(3) Other +restructuring costs include cancellation of a manufacturing agreement with a third party in Bosnia, termination of the Company's sponsorship agreement +with the Association of Volleyball Professionals ("AVP"), $1.1 million related to obtaining a release from any further obligations under the purchase agreement with Bite, LLC and +$0.5 million in charges relating to termination of consulting arrangements with former key company employees. +Throughout +the year ended December 31, 2009, we executed against a plan for the disposal of our discontinued and impaired product inventories. This plan included structured sales +to established discount retailers, sales through our company-owned outlet stores, warehouse sales and other disposition activities as well as donations to our Crocs +Cares! charitable organization. These actions were designed to minimize adverse impacts to our resellers, distributors and company-owned retail channels. As a result of our +execution against this plan, the average selling price of our products declined during the year. However, because we were able to sell much of the previously-impaired product at prices higher than +what we had previously estimated would be the net realizable value of that product, the net effect of these sales during the year was accretive to our gross margin. +Additionally, +during the second quarter of 2009, we offered to purchase stock options with exercise prices equal to or greater than $10.50 per share for cash from certain eligible +employees (the "Tender Offer") in order to restore the incentive value of our long-term performance award programs and in response to the fact that the exercise prices of a substantial +number of outstanding stock options held by our employees far exceeded the market price of our common stock. As part of the Tender Offer, we repurchased 2,315,951 stock options from our employees and +non-employee directors. Accordingly, we recorded a charge of $16.3 million in the quarter ending June 30, 2009 related to previously unrecognized share-based compensation +expense for these tendered and cancelled options. Of this $16.3 million charge, $13.3 million was recorded to selling, general and administrative expenses and $3.0 million was +recorded to cost of sales. +During +the fourth quarter of 2009, the Company identified an error in the calculation of stock-based compensation expense for prior periods. The errors were identified after +the Company's third-party equity accounting software provider notified its clients, including the Company, that it made a change to how its software program calculates +stock-based compensation expense. Specifically, the prior version of this software calculated stock-based compensation expense by incorrectly continuing to apply a weighted +average forfeiture rate to the vested portion of stock option awards until the grant's final vest date rather than reflecting actual forfeitures as vested, resulting in an understatement of +stock-based compensation expense in certain periods prior to the grant's final vest date in 2008 and 2009. Because the Company's stock option awards generally vest on a monthly basis after +the first anniversary date of the award, the Company under-recognized stock-based compensation expense in certain periods. This error changes the timing of +stock-based compensation expense recognition, but does not change the total stock-based compensation expense. As stock-based compensation expense is a +non-cash item, this error did not impact net cash provided by operations in any period. This error resulted in the understatement of stock-based compensation expense, with a +corresponding understatement of additional paid in capital, in the approximate amounts of $4.5 million in 2008, $1.0 million in the 1 st quarter of 2009 and +$0.5 million in the 3 rd quarter of 2009. Note that $2.0 million of the then existing cumulative error was offset as a consequence of adjustments made pursuant to the +38 +Table of Contents +tender +offer in the second quarter of 2009. The Company recorded an additional $3.9 million in stock-based compensation during the fourth quarter of 2009 to correct the balance of +this error. The Company does not believe that these errors or related corrections are material to its previously issued historical consolidated financial statements for 2008 or its quarterly or annual +results for 2009. +At +December 31, 2009, we had $77.3 million in cash and cash equivalents compared to $51.6 million at December 31, 2008. Our primary source of cash is working +capital from operations. Our primary uses of cash are working capital for operations and capital expenditures. During the year ended December 31, 2009, the Company fully repaid its remaining +obligation on its Revolving Credit Facility with Union Bank of California N.A. (the "Revolving Credit Facility") and entered into a Revolving Credit and Security Agreement with PNC Bank, N.A. (the +"Credit Agreement"). At December 31, 2009, there was an immaterial amount outstanding under the Credit Agreement. See Note 9—Notes Payable and Capital Lease Obligations for +further discussion. +Presentation of Operating Segments +Commencing with this Annual Report on Form 10-K for the year ended December 31, 2009, we have begun reporting +our results of operations by operating segment. We have three operating segments: Americas, Europe and Asia. All of the reportable segments derive their revenue from the sale of footwear, apparel and +accessories. We evaluate +performance and make decisions about allocating resources to our operating segments based on financial measures such as revenue and gross margin. +Gross +margin and operating income is the primary measure used by our chief operating decision maker to evaluate segment operating performance and to decide how to allocate resources to +segments. Operating income is defined as operating income before asset impairment charges and restructuring charges. We evaluate the performance of our segments based primarily on the results of the +segment without allocating corporate expenses or indirect general, administrative and other expenses. The corporate and other category includes (i) Ocean Minded, (ii) Colorado Footwear +CV, and (iii) corporate category, which maintains corporate costs such as stock-based compensation, research and development, brand marketing, legal expenses, depreciation on global +long-lived assets such as molds, tooling, IT systems, and other global costs that are not allocated to the regions. +Segment +profits or losses include adjustments to eliminate intercompany profit or losses on intercompany sales. Segment assets include the elimination of any intersegment profits or +losses in inventory, however, include the elimination of intercompany receivables. Segment assets, primarily in the Americas, include certain long-lived assets that are depreciated in +corporate due to their global functionality. Net revenues in the discussion that follows represent sales to external customers for each segment. +General +Revenues are recorded when products are shipped and the customer takes title and assumes risk of loss, collection of related +receivables are probable, persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer depending on the country of +the sale and the agreement with the customer. Allowances for estimated returns and discounts are recognized when related revenue is recorded. Because we use both internal manufacturing and contract +with third parties to manufacture our products, our cost of sales represents our costs to manufacture products in our Company-owned facilities, including raw materials costs and all overhead expenses +related to production, as well as the cost to purchase finished products from our third-party manufacturers and costs to transport these products to our facilities, inclusive of all warehouse and +outbound freight expenses. Cost of sales also includes the wages of our retail-related employees as well as depreciation and amortization of manufacturing assets such as molds and tooling. +39 +Table of Contents +Our +selling, general and administrative expense consists primarily of wages and related payroll and employee benefit costs for selling, marketing and administrative employees, unrealized gains or +losses on foreign currency exchange, all non-product retail-related expenses (including rent and depreciation) and professional fees, facility expenses, bank charges and +non-cash charges for share-based compensation. Selling, general and administrative expenses also include depreciation +and amortization related to non-product, non-manufacturing assets such as our global information systems. +Results of Operations +Comparison of the Years Ended December 31, 2009 and 2008 +Set forth below are the results of operations for the year ended December 31, 2009 as compared to the year ended +December 31, 2008 (in thousands, except for percentages). +(Year Ended December 31,) +2009 +2008 +$ Change +% Change +Revenues +$ +645,767 +$ +721,589 +$ +(75,822 +) +(10.5 +)% +Cost of sales +337,720 +486,722 +(149,002 +) +(30.6 +) +Restructuring charges +7,086 +901 +6,185 +686.5 +% +Gross profit +300,961 +233,966 +66,995 +28.6 +% +Selling, general and administrative expenses and foreign currency gains/losses +310,927 +366,956 +(56,029 +) +(15.3 +) +Charitable Contributions +7,510 +1,844 +5,666 +307.3 +Restructuring charges +7,623 +7,664 +(41 +) +(1.0 +) +Impairment charges +26,085 +45,784 +(19,699 +) +(43 +) +Loss (income) from operations +(51,184 +) +(188,282 +) +137,098 +(72.8 +) +Interest expense +1,495 +1,793 +(298 +) +(16.6 +) +Gain (loss) on Charitable Contributions +(3,163 +) +— +(3,163 +) +* +Other (income) expenses—net +(895 +) +(565 +) +(330 +) +58.4 +Income (loss) before income taxes +(48,621 +) +(189,510 +) +140,889 +(74.3 +) +Income tax expense (benefit) +(6,543 +) +(4,434 +) +(2,109 +) +47.6 +Net income (loss) attributable to common stockholders +$ +(42,078 +) +$ +(185,076 +) +142,998 +(77.2 +)% +* Percentage +change is not relevant as prior year amounts were zero. +Revenues. Revenues decreased 10.5%, or $75.8 million, to $645.8 million, in the year ended December 31, 2009, from +$721.6 million in the year ended December 31, 2008. The decline is primarily attributed to a decrease in our revenues in our Americas and European markets. Total unit sales of footwear +products increased from 35.3 million pairs during the year ended December 31, 2008 to 36.8 million pairs in the year ended December 31, 2009. The decrease in revenues, +despite the increase in unit sales, was the result of the execution against our plan to sell inventories of discontinued and impaired product. Sales of our discontinued and impaired product were at a +lower selling price, thereby causing a decline in revenue despite the increase in units sold, as well as a decline in the average selling price of our shoes. The average selling price of our shoes +during the year ended December 31, 2009 was $16.60 compared to $18.35 during the year ended December 31, 2008. Sales of our Jibbitz products decreased 46.6% to $25.2 million in +the year ended December 31, 2009, from $47.2 million in the year ended December 31, 2008. +Our +wholesale channel revenues decreased 26.7%, or $147.6 million, to $404.5 million, in the year ended December 31, 2009, from $552.1 million in the year +ended December 31, 2008. We believe that this decrease arose as a result of the global economic downturn, which has lessened consumer demand +40 +Table of Contents +and +caused some retailers to choose to operate at leaner inventory levels. In addition, during the latter portion of 2009, we implemented a more disciplined wholesale approach and, accordingly, have +taken measures to reduce the number of wholesalers selling our product in order to better position the brand in the marketplace. These measures have resulted in fewer wholesale customers. We also +believe sales of our footwear at wholesale has declined due to the challenges we face in merchandising our expanded product lines in existing wholesale channels and lessening consumer demand for our +products as such products reach a more mature stage in their product life. We have also been affected by competitors entering the market with imitation products that are sold at substantially lower +prices. +Our +company-owned retail locations, including retail stores, kiosks and outlets, increased to 317 locations at December 31, 2009, which is up from 279 at December 31, 2008. +Total revenue from company-owned retail locations increased 21.1%, or $26.5 million, to $152.3 million in the year ended December 31, 2009, from $125.8 million for the year +ended December 31, 2008. We believe that this year-over-year increase in revenue is driven by an increase in the number of stores as well as the fact that we are able to +merchandise the full breadth and depth of our product line. As our retail business becomes a larger portion of our business, we expect to see some improvements in total revenue and gross margin as we +have traditionally been able to achieve a higher average selling price in this channel. We plan to close certain kiosks and selectively open more branded stores. Our plans for expanding retail +locations in future periods may be adjusted or suspended should economic conditions worsen or should management determine that a different course of action for our future retail strategy is necessary. +Revenues +from our internet channel increased $45.3 million, or 103.7%, to $89 million in the year ended December 31, 2009 from $43.7 million in the year ended +December 31, 2008. The increase in revenues during 2009 is due primarily to increased web-based and other marketing efforts aimed at driving consumer awareness of our webstores as +well as the launches of several new sites serving international markets. We intend to expand our webstores and web-based and other marketing efforts as this channel enables us to showcase +our entire product offering directly to the consumer, which we believe to be advantageous to us in terms of sales volume and brand awareness. As a percentage of total revenue, revenue from our +internet channel was 13.7% and 6.1% for the years ended December 31, 2009 and 2008, respectively. While still a relatively small percentage of our overall business, as our internet business +becomes a larger portion of our total revenue, we expect to experience some improvements in total revenue and gross margin as we have traditionally been able to achieve a higher average selling price +in this channel. Our plans for future expansion may be adjusted or suspended should economic conditions worsen or should management determine that a different course of action for our future internet +strategy is necessary. +The +majority of our revenues during the year ended December 31, 2009 were attributable to our non-classic footwear models. Sales of our classic models, Beach and +Cayman (to be +renamed Crocs Classic) represented 16% of total unit sales for the year ended December 31, 2009, compared to 25% for the year ended December 31, 2008. Sales of our core products, which +includes Beach, Crocs Classic, Kids Cayman (to be renamed Kids Crocs Classic), Athens, Kids Athens, Mary Jane, Girls Mary Jane, Mammoth and Kids Mammoth, represented 33% of our overall unit sales in +2009 compared to 57% in 2008. Sales of new 2009 footwear product lines represented approximately 17% of our overall unit sales for the year ended December 31, 2009. We intend to continue to +diversify our product offerings in order to expand our brand and expect that sales of our classic and core models will represent a smaller portion of our overall revenues in the future. We also intend +to segment our product offerings into our various sales channels and to enhance our visual and fixture merchandising platforms in company-owned and wholesale customers' stores to more effectively +display our expanded product portfolio. +Changes +in foreign currency exchange rates since December 31, 2008 contributed $14.9 million to our revenues in the year ended December 31, 2009. We expect that +sales in international markets in foreign currencies will continue to represent a substantial portion of our overall revenues. Accordingly, +41 +Table of Contents +changes +in foreign currency exchange rates could materially affect our overall revenues or the comparability of those revenues from period to period as a result of translating our financial statements +into our reporting currency, the U.S. dollar. +Americas Segment—Revenue. Our revenues from the Americas decreased 17.6%, or $63.7 million, to $298.0 million in the year +ended December 31, 2009 compared to $361.7 million for the year ended December 31, 2008. This decline was driven by declines in our wholesale channel, offset somewhat by increases +in our retail and internet channels. We believe the net decline in revenues is reflective of economic conditions in the United States coupled with the challenges we face in merchandising our expanded +product lines as well as the maturity of our core products in the consumer market and lessening demand for such products. Likewise, we believe a portion of the decline was driven by sales of end of +life and impaired units, which were sold at lower prices. See "Recent Events" above. We have begun executing against plans to re-invigorate revenue in the U.S. wholesale channel and +anticipate continuing to invest in these plans, which include, but are not limited to, investments in cooperative advertising and merchandising assistance for select locations at our largest U.S. +wholesale accounts. +We +experienced a decrease in sales returns and allowances, which are included as a net adjustment to revenue, of 59.1% or $24.6 million, to $17 million in the year ended +December 31, 2009 from $41.6 million for the year ended December 31, 2008. The decrease in sales returns and allowances is due to a higher 2008 balance, when management, in light +of then-prevailing economic conditions, granted certain return requests and allowances to a number of customers it believed were strategically important to our ongoing business. +Accordingly, our estimate for sales returns and allowances for the year ended December 31, 2008 was significantly higher than historical estimates as a result of specific reserves related to +those granted return and allowance requests. See also "Recent Events" above. +The +number of company-owned retail locations in the Americas, including retail stores, kiosks and outlets, increased slightly to 182 locations at December 31, 2009 from 157 +locations at December 31, 2008. Revenue from company-owned retail locations in the Americas increased 54.7%, or $37.6 million, to $106.3 million in the year ended +December 31, 2009, from $68.7 million for the year ended December 31, 2008. +Asia Segment—Revenue. Our revenues in Asia increased 15.9%, or $32.6 million, to $237.5 million in the year ended +December 31, 2009 from $204.9 million for the year ended December 31, 2008. Revenue in the region increased as a result of strong demand in all channels, particularly in the +wholesale and retail channels, offset somewhat by a lower average selling price in 2009 compared to 2008, which we believe to be primarily driven by sales of end of life and impaired units, which were +sold at lower prices, as discussed in "Recent Events" above. +We +experienced a decline in sales returns and allowances of 43.4%, or $6.9 million, to $9.0 million in the year ended December 31, 2009 from $15.9 million for +the year ended December 31, 2008. The decrease in sales returns and allowances is primarily related to a higher 2008 balance, when management, in light of then-prevailing economic +conditions, granted certain returns and allowances to some of our wholesale customers to properly balance their portfolios of our products with respect to size, color and style. +We +increased the number of company-operated retail locations in Asia to 119 locations at December 31, 2009, from 107 locations at December 31, 2008. Revenue from Company +operated retail locations in Asia increased 27.5%, or $13.7 million, to $63.6 million in the year ended December 31, 2009, from $49.9 million for the year ended +December 31, 2008. +Europe Segment—Revenue. Our revenues in Europe decreased 29.1%, or $43.8 million, to $106.9 million in the year ended +December 31, 2009 from $150.7 million for the same period in 2008. This decline was led by a decline at wholesale, where we experienced a drop in demand due in part to +42 +Table of Contents +economic +conditions and an increased number of imitation products in the region. Partially offsetting this decline were increases in revenue from our company-owned retail locations (partially driven +by an additional retail location) and an increase in revenue from our internet channel. +Sales +returns and allowances, which are recorded as a net adjustment to revenue, decreased 71%, or $18.6 million, to $7.6 million in the year ended December 31, 2009 +from $26.2 million in the year ended December 31, 2008. The decline in sales returns and allowances is due to a higher 2008 balance, when management, in light of +then-prevailing economic conditions, granted certain return requests and allowances to a number of customers it believed were strategically important to the Company's ongoing business. +Accordingly, our estimate for sales returns and allowances for the year ended December 31, 2008 was significantly higher than historical estimates as a result of specific reserves related to +those granted return and allowance requests. See also "Recent Events" above. +As +of December 31, 2009, we operated 16 retail locations in Europe versus 15 in the same period of 2008. Revenue from Company operated retail locations was $11.0 million in +the year ended December 31, 2009 versus $7.2 million for the year ended December 31, 2008. +Gross profit. Gross profit increased 28.6% to $301.0 million in the year ended December 31, 2009. Gross margin increased to +46.6% in +the year ended December 31, 2009 compared to 32.4% for the year ended December 31, 2008. During 2009, we sold $58.3 million of impaired product (see "Recent Events"). Much of this +product had been written down to a level that we considered realizable; however, we were able to sell this product at prices substantially higher than what we had previously estimated. The gross +profit amount related to these units was accretive to our gross profit percentage during the year ended December 31, 2009. The net effect of these sales on our gross profit during the year +ended December 31, 2009 was $49.8 million. During 2009, we also experienced an increase in retail and internet sales as a percentage of our total revenue, as discussed previously. This +trend has contributed to higher gross margins as we have traditionally been able to achieve a higher average selling price in these channels while many of the fixed costs associated with operating our +company-owned retail stores are included in selling, general and administrative expenses. Partially offsetting these increases in gross profit were restructuring charges of $7.1 million +associated with the consolidation of our warehouse and distribution space and cancellation of our warehousing agreement. See "Restructuring" below for further discussion. In addition, as a result of +our Tender Offer (see "Recent Events"), we recognized $3.0 million in additional stock-based compensation expense through cost of sales during 2009. In addition, we now sell a wide range of +products which require additional materials, such as canvas, cloth lining and suede, and additional processes, such as stitching, to manufacture, thereby increasing our direct costs and lowering our +gross margins on those products. As we continue to expand our portfolio and non-classic models become a larger portion of our business, we expect that our profit margins will be adversely +affected. By comparison, during 2008, we recorded charges of $76.3 million related to inventory write-downs and $4.2 million related to losses on future purchase commitments. We also +recorded $0.9 million in restructuring costs in cost of sales as a result of the closure of our Canadian manufacturing operation (See "Restructuring" below). +Changes +in foreign currency exchange rates since December 31, 2008 decreased our gross margin by $4.4 million in the year ended December 31, 2009. We expect that +sales at subsidiary companies with functional currencies other than the U.S. dollar will continue to generate a substantial portion of our overall gross profit. Accordingly, changes in foreign +currency exchange rates could materially affect our overall gross profit or the comparability of our gross profit from period to period as a result of translating our financial statements into our +reporting currency, the U.S. dollar. +43 +Table of Contents +Selling, general and administrative expenses. Selling, general and administrative expense decreased 15.3% to $310.9 million in the +year ended +December 31, 2009, from $366.9 million for the year ended December 31, 2008. As a percentage of net revenues, selling, general and administrative expenses declined to 48.1% in the +year ended December 31, 2009 from 50.8% for the year ended December 31, 2008. This decline was primarily attributable to our execution against cost-savings initiatives during +2009, offset somewhat by growth in our retail-related expenses as we continued to expand our retail channel. Specifically, compared to 2008, 2009 advertising and marketing expense declined by +$27.9 million, of which $11.1 million was related to corporate sponsorships and $16.8 million was related to advertising expenses, as we exited corporate sponsorships and changed +our approach to marketing our products towards a more integrated, consumer-focused program. In addition, legal expense declined $24.1 million during 2009 compared to 2008. Also included in +selling, general and administrative expenses for the year ended December 31, 2009 is a net gain on changes in currency exchange rates for transactions denominated, and settled or to be settled, +in a currency other than the functional currency of the consolidated entity of $0.7 million compared to a net loss on changes in currency exchange rates of $25.4 million for the year +ended December 31, 2008. Offsetting these declines were increases in stock compensation due to the tender offer of $13.3 million and $4.5 million due to the equity accounting +software error discussed earlier, rent expense of $7.4 million and salaries and wages of $4.1 million. As our retail channel becomes a larger portion of our total business, as discussed +previously, we expect that selling, general and administrative expenses will increase as a percentage of total revenue as certain fixed costs associated with the retail channel are recognized in +selling, general and administrative expenses. +Changes +in the average foreign currency exchange rates used to translate expenses from our functional currencies to our reporting currency, the U.S. dollar, from 2008 fiscal year to 2009 +fiscal year contributed approximately $4.0 million to our decrease in selling, general and administrative expenses. +During +the 2008 and 2009 fiscal years, we took certain actions to reduce our selling, general and administrative expenses. Those actions included, but were not limited to, workforce +reductions, office space reductions and reductions in certain discretionary spending, including discontinuation of certain sponsorship and consulting arrangements. We continue to evaluate our +operating expenses, including selling, general and administrative expenses. Should economic conditions further deteriorate or demand for our products decline further, we may experience further +declines in revenues and we may take additional actions to reduce our selling, general and administrative expenses further. +Restructuring charges. We recorded $14.7 million in restructuring charges in the year ended December 31, 2009, of which +$7.6 million was reflected in restructuring charges and $7.1 million was reflected in cost of sales. In the year ended December 31, 2008, we recorded $8.5 million in +restructuring charges related to the closure of our facilities in Canada and Brazil, $7.6 million of which was recorded in restructuring charges and $0.9 million of which was reflected +in cost of sales. These restructuring charges arose primarily as a result of the Company's execution against a plan to better align costs with current revenue streams. The 2009 restructuring charges +consisted of: +• $5.6 million related to the termination of operating leases and other costs associated with the consolidation of +our warehousing, distribution and office space worldwide; +• $3.8 million related to the termination of our manufacturing agreement with a third party in Bosnia and our +sponsorship agreement with Association of Volleyball Professionals ("AVP"); +• $3.7 million in severance costs; +• $1.1 million related to the release from further obligation under the earn-out provisions of our +acquisition of Bite, LLC; +• $0.5 million in other restructuring charges +44 +Table of Contents +We +established reserves covering future known obligations related to the consolidation of our global distribution facilities. Reserves at December 31, 2009 were +$3.1 million and have been included in the line items accrued restructuring charges and long-term restructuring in our consolidated balance sheets. +Impairment charges. During the year ended December 31, 2009, we recorded $26.1 million in impairment charges which consisted +of the +following items: +• $18.1 million related to the write-off of obsolete molds, tooling, manufacturing and distribution +equipment, sales and marketing assets and other distribution and manufacturing assets, primarily associated with the consolidation of warehouse and distribution space as well as other +cost-savings initiatives undertaken during the year; +• $7.6 million related to the write-off of capitalized software, patents, trade names and other +intangible assets that we no longer intend to utilize; and +• $0.4 million related to the write-off of other items. +During +2008, we recognized impairment charges of $45.8 million which consisted of the following: +• $20.9 million related to the write-down of fixed assets, primarily related to equipment and shoe molds for shoes we +no longer intend to manufacture or styles for which we had more molds on hand than necessary to meet projected demand; +• $0.6 million related to the impairment of patents which we no longer intend to utilize; +• $0.3 million related to the impairment of the Fury trade name and customer relationships and $0.2 million +related to the Jibbitz trade name; and +• $23.8 million related to the write-off of goodwill and other indefinite lived intangible assets, +consisting of $1.0 million in goodwill related to the closure of Fury, and $22.8 million in goodwill written off as a result of an impairment analysis. +Loss from Operations. During the year ended December 31, 2009, our loss from operations was $51.2 million compared to a loss +of +$188.3 million during the year ended December 31, 2008, for the reasons stated above. Our operating segments, combined, generated $90.1 million in operating income during 2009, +which was offset by $7.6 million in restructuring costs that were recorded in selling, general and administrative expenses; $26.1 million in asset impairment charges; and an operating +loss of $107.6 million related primarily to unallocated corporate costs in our corporate and other category, described previously in "Operating Segments." +Our +Americas segment generated operating income of $21.2 million during the year ended December 31, 2009 compared to an operating loss of $43.5 million during the +year ended December 31, 2008. During 2008, the operating loss in our Americas segment was driven primarily by declines in gross profit as a result of inventory write-downs and excess capacity +in our Company-operated manufacturing and distribution facilities. In addition, we experienced foreign currency exchange losses related to fluctuations in the Canadian dollar, Mexican peso and +Brazilian real in 2008. During 2009, we executed against a plan to reduce and consolidate our global warehouse footprint, which increased our Americas gross margin compared to 2008, and we experienced +declines in marketing and advertising expenses as we exited corporate sponsorships and changed our approach to marketing our products. +Our +Asia segment generated operating income of $57.8 million during 2009 compared to operating income of $16.6 million during 2008. During 2008, our Asia operating income +was affected by foreign exchange losses and inventory impairments. In 2009, we experienced higher gross margins in Asia, driven largely by growth in our Asia retail channel as well as an overall +increase in total revenues from +45 +Table of Contents +the +Asia segment. We also experienced an increase in gains from fluctuations in foreign currency exchange rates during 2009 in our Asia segment. +Our +Europe segment generated operating income of $11.0 million during 2009 compared to operating income of $1.0 million in 2008. During 2008, our Europe operating income +was affected by foreign exchange losses and inventory impairments. In 2009, we experienced higher gross margins in Europe as a result of the reduction and consolidation of our global warehouse and +distribution footprint; however, these higher margins were achieved at lower sales volumes. We also experienced a lower loss from fluctuations in foreign currency exchange rates during 2009 in our +Europe segment. +Interest expense. Interest expense decreased 16.6%, or $0.3 million, to $1.5 million in the year ended December 31, +2009. The +decline in interest expense during the year was driven by lower debt balances, as we fully repaid our previous Revolving Credit Facility on August 3, 2009 and had an immaterial amount of bank +debt outstanding on our Credit Agreement as of the end of the year. Despite lower debt balances during 2009, interest rates on our borrowings under the Revolving Credit Facility were higher in 2009 +than in 2008, resulting in only a slight decrease in interest expense for the year. Also partially offsetting the aforementioned decline was additional interest from a new capitalized lease obligation +which financed certain equipment and internally developed software during 2009. +Income tax expense. During the year ended December 31, 2009, we recognized an income tax benefit of $6.5 million on a +pre-tax loss of $48.6 million, compared to income tax benefit of $4.4 million on pre-tax loss of $189.5 million for the year ended December 31, +2008. The effective tax benefit rate was a 13.4% during the year ended December 31, 2009 compared to a 2.3% tax benefit rate during the year ended December 31, 2008. We restructured our +international operations and cost-sharing arrangements which increased the tax benefit for 2009. +Comparison of the Years Ended December 31, 2008 and 2007 +Set forth below are the results of operations for the year ended December 31, 2008, as compared to the year ended +December 31, 2007 (in thousands, except for percentages). +(Year Ended December 31,) +2008 +2007 +$ Change +% Change +Revenues +$ +721,589 +$ +847,350 +$ +(125,761 +) +(14.8 +)% +Cost of sales +486,722 +349,701 +137,021 +39.2 +Restructuring charges +901 +— +901 +* +Gross profit +233,966 +497,649 +(263,683 +) +(53.0 +) +Selling, general and administrative expenses and foreign currency gains/losses +366,956 +258,923 +108,033 +41.7 +Charitable Contributions +1,844 +959 +885 +92.3 +Restructuring charges +7,664 +— +7,664 +* +Impairment charges +45,784 +— +45,784 +* +Income (loss) from operations +(188,282 +) +237,767 +(426,049 +) +(179.2 +) +Interest expense +1,793 +438 +1,355 +309.4 +Gain (loss) Charitable Contribution +— +— +— +* +Other (income) expenses—net +(565 +) +(2,997 +) +2,432 +(81.2 +) +Income (loss) before income taxes +(189,510 +) +240,326 +(429,836 +) +(178.9 +) +Income tax expense (benefit) +(4,434 +) +72,098 +(76,532 +) +(106.2 +) +Net income (loss) attributable to common stockholders +$ +(185,076 +) +$ +168,228 +$ +(353,304 +) +(210 +)% +* Percentage +change is not relevant as prior year amounts were zero. +46 +Table of Contents +Revenues. Revenues decreased 14.8%, or $125.8 million, to $721.6 million, in the year ended December 31, 2008, from +$847.4 million in the year ended December 31, 2007. The decline is primarily attributed to a decrease in our revenues in our Americas and European markets, specifically driven by a +decrease in unit sales of our footwear and Jibbitz products. Unit sales of footwear products decreased 24.7% or 11.6 million pairs, to 35.3 million pairs in the year ended +December 31, 2008, from 46.9 million pairs in the year ended December 31, 2007. Sales of our Jibbitz products decreased 30.2% to $47.2 million in the year ended +December 31, 2008, from $67.5 million in the year ended December 31, 2007. +Our +wholesale channel revenues decreased 25.3%, or $186.8 million, to $552.1 million, in the year ended December 31, 2008, from $738.9 million in the year +ended December 31, 2007. We believe that this decrease is due to lower unit sales primarily resulting from lessening consumer demand due to the global economic downturn. We believe unit sales +of our footwear also declined due to the challenges we face in merchandising our expanded product lines in existing wholesale channels as well as lessening consumer demand for our products as such +products reach a more mature stage in their product life and competitors enter the market with imitation products that are sold at substantially lower prices. Declines in revenue are also attributable +to an increase in sales returns and allowances which are recorded as a reduction of net revenue as sales returns and allowance increased from $32.2 million for the year ended +December 31, 2007 to $83.6 million for the year ended December 31, 2008. +Our +Company operated retail locations, including retail stores, kiosks and outlets, increased to 279 locations at December 31, 2008, which is up from 209 at December 31, +2007. Total revenue from Company operated retail locations increased 68.5%, or $51.6 million, to $125.8 million in the year ended December 31, 2008, from $74.2 million for +the year ended December 31, 2007. +Revenues +from our webstores increased $9.8 million, or 28.8%, to $43.7 million in the year ended December 31, 2008 from $33.9 million in the year ended +December 31, 2007. The increase in revenues during 2008 is due primarily to increased web-based and other marketing efforts aimed at driving consumer awareness of our webstores. +The +majority of our revenues during the year ended December 31, 2008 were attributable to our non-classic footwear models. Sales of our classic models, Beach and +Cayman (soon to be renamed Crocs Classic), represented 25% of total unit sales for the year ended December 31, 2008, compared to 30% for the year ended December 31, 2007. Sales of new +2008 footwear product lines represented approximately 15% of our overall revenues for the year ended December 31, 2008. +Changes +in foreign currency exchange rates since December 31, 2007 contributed $31.3 million to our revenues in the year ended December 31, 2008. We expect that +sales in international markets in foreign currencies will continue to represent a substantial portion of our overall revenues. Accordingly, changes in foreign currency exchange rates could materially +affect our overall revenues or the comparability of those revenues from period to period as a result of translating our financial statements into our reporting currency, the U.S. dollar. +Americas Market. Our revenues from the Americas decreased 28.3%, or $144.7 million, to $365.9 million in the year ended +December 31, 2008 compared to $510.6 million for the year ended December 31, 2007. We believe the decline is reflective of economic conditions in the United States coupled with +the challenges we face in merchandising our expanded product lines as well as the maturity of our core products in the consumer market and lessening demand for such products, as discussed in "Recent +Events" above. +We +experienced an increase in sales returns and allowances, which are included as a net adjustment to revenue, of 94.4% or $20.2 million, to $41.6 million in the year ended +December 31, 2008 from $21.4 million for the year ended December 31, 2007. The increase in sales returns and allowances is primarily attributable to known and anticipated returns +as well as price mark down +47 +Table of Contents +allowances +for certain product styles and colors for which we have experienced less than anticipated sell through in our wholesales customer channel, as discussed in the "Recent Events" above. +The +number of Company operated retail locations in the Americas, including retail stores, kiosks and outlets, increased slightly to 157 locations at December 31, 2008 from 153 +locations at December 31, 2007. Revenue from Company operated retail locations increased 45.0%, or $21.3 million, to $68.7 million in the year ended December 31, 2008, from +$47.4 million for the year ended December 31, 2007. Our Company operated retail locations allow us to showcase our entire product offering, which we believe results in better sales of +new product offerings and increased brand awareness. +Asian Market. Our revenues in Asia increased 25.7%, or $41.9 million, to $204.9 million in the year ended December 31, +2008 from +$163.0 million for the year ended December 31, 2007. The increase is attributable to higher unit sales period over period as we increased our direct sales in China and expanded our +product offerings as well as our increase in door openings in 2008. +The +overall increase in revenues in our Asian region was partially offset by an increase in sales returns and allowances of 329.8%, or $12.2 million, to $15.9 million in +the year ended December 31, 2008 from $3.7 million for the year ended December 31, 2007. The increase in sales returns and allowances is primarily related to returns which enabled +our wholesale customers to properly balance their portfolios of our products with respect to size, color and style. +We +increased the number of Company operated retail venues in Asia to 107 locations at December 31, 2008, from 53 locations at December 31, 2007. Revenue from Company +operated retail locations increased 85.5%, or $23.0 million, to $49.9 million in the year ended December 31, 2008, from $26.9 million for the year ended December 31, +2007. +European Market. Our revenues in Europe decreased 13.2%, or $23.0 million, to $150.7 million in the year ended +December 31, 2008 +from $173.7 million for the same period in 2007. We have noted a decline in revenues in certain European countries, particularly in those which represent a more mature market for our products. +We believe a portion of this decline is due to an increased number of imitation products that we believe infringe on our intellectual property as well as the maturity of our core products in the +consumer market and lessening demand for such product. We believe the decline in revenues in our European market may result from the challenge of increased competition from producers of imitation +products that are sold at lower products. +Sales +returns and allowances, which is recorded as a net adjustment to revenue, increased 263.9%, or $19.0 million, to $26.2 million in the year ended December 31, +2008 from $7.2 million in the year ended December 31, 2007. The increase in sales returns and allowances is primarily attributable to known and anticipated returns as well as price mark +down allowances for certain products and other products in certain colors for which we have experienced less than anticipated sales in our wholesales customer channel, as discussed in the "Recent +Events" above. +As +of December 31, 2008, we operated 15 retail locations in Europe versus 3 in the same period of 2007. Revenue from Company operated retail locations was $7.2 million in +the year ended December 31, 2008 versus $262 thousand for the year ended December 31, 2007. +Gross profit. Gross profit decreased 53.0% to $234.0 million in the year ended December 31, 2008. Gross margin declined to +32.4% in the +year ended December 31, 2008, compared to 58.7% for the year ended December 31, 2007. The decrease in gross profit was partially the result of excess capacity in our Company-operated +manufacturing and distribution facilities, which are recognized in our results of operations as period costs. As of December 31, 2008, we recorded accrued losses on purchase commitments for +inventory with a market lower than cost of $4.2 million, our write-down of inventories relates to certain products that were or are going to be discontinued of $76.3 million, +48 +Table of Contents +including +core products in colors that have experienced substantial declines in consumer demand, as discussed in "Recent Events" above. Likewise, we recorded $0.9 million in +restructuring-related costs in cost of sales as a result of the closure of our Canadian manufacturing operation, as explained more fully in "restructuring charges" below. For the year ended +December 31, 2008, we also experienced a change in our sales mix to include products with lower profit margins when compared to the sales mix for the year ended December 31, 2007. We now +manufacture a wide range of products which require additional materials, such as canvas, cloth lining and suede, and additional processes, such as stitching, to manufacture. As we continue to expand +our portfolio and non-classic models become a larger portion of our business, we expect this trend to continue. The additional costs in raw materials, duties and processes associated with +these styles ultimately result in lower gross profit margins. These changes in our manufacturing structure, coupled with the inventory write-downs, decrease in revenues and increase in returns and +allowances were primarily responsible for the decrease in gross profit for the year ended December 31, 2008 compared to the year ended December 31, 2007. +Changes +in foreign currency exchange rates since December 31, 2007 increased our gross margin by $16.4 million, in the year ended December 31, 2008. We expect that +sales at subsidiary companies with functional currencies other than the U.S. dollar will continue to generate a substantial portion of our overall gross profit. Accordingly, changes in foreign +currency exchange rates could materially affect our overall gross profit or the comparability of our gross profit from period to period as a result of translating our financial statements into our +reporting currency, the U.S. dollar. +Selling, general and administrative expenses. Selling, general and administrative expense increased 41.9% to $368.8 million in the +year ended +December 31, 2008, from $259.9 million for the year ended December 31, 2007. As a percentage of net revenues, selling, general and administrative expenses increased to 51.1% in +the year ended December 31, 2008 from 30.7% for the year ended December 31, 2007. This increase was primarily attributable to increases in marketing expenses of $22.3 million, of +which $5.4 million is related to corporate sponsorships and $12.0 million is related to advertising +expenses, increases in building expenses of $19.6 million related to additional retail and office space, increases in salaries and wages of $10.3 million and increases in legal expenses +of $16.8 million as a result of increased legal fees for ongoing litigation and intellectual property enforcement. In addition, total share-based compensation expense was $18.8 million +for the year ended December 31, 2008, compared to $21.7 million for the year ended December 31, 2007. Also included in selling, general and administrative expenses for the year +ended December 31, 2008 is a net loss on changes in currency exchange rates for transactions denominated, and settled or to be settled, in a currency other than the functional currency of the +consolidated entity of $25.5 million compared to a net gain on changes in currency exchange rates of $10.1 million for the year ended December 31, 2007. +Changes +in the average foreign currency exchange rates used to translate expenses from our functional currencies to our reporting currency, the U.S. dollar, from 2007 fiscal year to 2008 +fiscal year contributed approximately $3.8 million to our change in selling, general and administrative expenses. +During +the 2008 fiscal year, we took certain actions to reduce our selling, general and administrative expenses. Those actions included; workforce reductions, office space reductions, +and reductions in certain discretionary spending, including discontinuation of certain sponsorship and consulting arrangements. We are continuing to evaluate our operating expenses, including selling, +general and administrative expenses. Should economic conditions further deteriorate or demand for our products decline further, we may experience further declines in revenues and we may take +additional actions to reduce our selling, general and administrative expenses further. +Restructuring charges. We recorded $8.5 million in restructuring charges in the year ended December 31, 2008, of which +$7.6 million was reflected in restructuring charges and $0.9 million was reflected in cost of sales. We did not recognize any restructuring charges during the year ended +December 31, 2007. +49 +Table of Contents +During +2008, we announced our decision to restructure our North American operations. This decision included the closure of our Canadian and Brazilian manufacturing facilities and the +consolidation of distribution activities into other existing North American operations. Accordingly, restructuring charges of $1.9 million related to our facility operating leases were +established during the year ended December 31, 2008, as a firm "cease use" date was established relating to these leases. This is our estimated future expense related to the future abandonment +of facilities under the operating leases in accordance with ASC Topic 420 "Exit or Disposal Cost Obligations" , Accounting for Costs Associated with Exit +or Disposal Activities. We recorded $2.1 million in the year ended December 31, 2008 related to early termination costs for certain equipment operating leases, cancellation of purchase +obligations and freight and duty charges related to transferring inventory and equipment to the United States and Mexico facilities. Furthermore, we recorded $4.5 million in termination +benefits accounted for in +accordance with SFAS 112, "Employers' Accounting for Post Employment Benefits—an amendment of FASB Statements No. 5 and 43" , +included in ASC Topic 712 "Compensation—Nonretirement Post Employment Benefits" . +We +established reserves covering future known obligations related to the closure of our Canadian and Brazilian manufacturing operations and the move of our Canadian distribution +operations. Reserves at December 31, 2008 were $2.4 million and have been included in the line items accrued restructuring charges and long-term restructuring in our +consolidated balance sheets. +Impairment charges. Impairment charges were $45.8 million during the year ended December 31, 2008. We did not recognize any +impairment +charges during the year ended December 31, 2007. During 2008, we recognized the impairment charges listed below. +• A $20.9 million impairment charge on fixed assets, primarily related to equipment and shoe molds. We evaluated our +production capacity at our facilities compared with demand projections and capacity requirements and decided to abandon certain manufacturing equipment that clearly represents excess capacity. The +impairment charge on molds relate to shoe styles that we either no longer intend to manufacture or styles for which we have more molds on hand than necessary to meet projected demand. +• A $0.6 million impairment charge related to patents which we no longer intend to utilize. +• A $0.3 million impairment charge related to the Fury trade name and customer relationships and $0.2 million +related to the Jibbitz trade name. +• A $23.8 million write-off of goodwill and other indefinite lived intangible assets, consisting of +$1.0 million in goodwill related to the closure of Fury, and $22.8 million in goodwill written off as a result of an impairment analysis. +Interest expense. Interest expense increased 350.0%, or $1.4 million, to $1.8 million in the year ended December 31, +2008. The +increase in interest expense is the result of larger borrowings against our Revolving Credit Facility for a larger portion of the year in 2008 compared to 2007. +Other income/expense, net. Other income decreased 80.0%, or $2.4 million, to $0.6 million in the year ended December 31, +2008. +The decrease resulted primarily from a decrease in interest bearing cash and cash equivalents. +Income tax expense. During the year ended December 31, 2008, we recognized an income tax benefit of $4.4 million on a +pre-tax loss of $189.5 million, compared to income tax expense of $72.1 million on pre-tax income of $240.3 million for the year ended December 31, +2007. The effective income tax rate was a 2.3% tax benefit rate during the year ended December 31, 2008 compared to a 30.0% tax expense rate during the year ended December 31, 2007. The +decrease in effective tax rate is primarily the result of valuation allowances being recorded on net deferred tax assets in tax +50 +Table of Contents +jurisdictions +where we believe it is not more likely than not that those tax benefits will be realized, due to our financial outlook as of December 31, 2008 and increases in reserves for +uncertain tax positions. +Liquidity and Capital Resources +At December 31, 2009, we had $77.3 million in cash and cash equivalents. In August 2009, we fully repaid our Revolving +Credit Facility with Union Bank of California, N.A. We anticipate that cash flows from operations will be sufficient to meet the ongoing needs of our business for the next 12 months. However, +in order to provide additional liquidity in the future and to help support our strategic goals, we secured an asset-backed revolving line of credit, which provides us with up to $30 million in +borrowings, as described below. Additional future financing may be necessary; however, due to current macroeconomic conditions and their affect on the global credit markets, there can be no assurance +that we will be able to secure additional debt or equity financing on acceptable terms to us or at all. +On +September 25, 2009, we entered into a Revolving Credit and Security Agreement with PNC Bank, N.A. (the "Credit Agreement"), which matures on September 25, 2012. The +Credit Agreement provides for an asset-backed revolving credit facility of up to $30 million in total, which includes a $17.5 million +sublimit for borrowings against our eligible inventory, a $2 million sublimit for borrowings against our eligible inventory in-transit, and a $4 million sublimit for letters +of credit. The total borrowings available under the Credit Agreement at any given time are subject to customary reserves and reductions to the extent our asset borrowing base changes. Borrowings under +the Credit Agreement are secured by all of our assets, including all receivables, equipment, general intangibles, inventory, investment property, subsidiary stock and leasehold interests. The Credit +Agreement requires us to prepay borrowings under the Credit Agreement in the event of certain dispositions of property. +Principal +amounts outstanding under the Credit Agreement bear interest at a two percent (2%) premium over a rate that is the greater of either (i) PNC's published reference rate, +(ii) the Federal Funds Open Rate in effect on such day plus one half of one percent (0.5%) or, (iii) the sum of the daily LIBOR rate and one percent (1.0%), with respect to domestic rate +loans. Eurodollar denominated principal amounts outstanding under the Credit Agreement bear interest at the sum of three and one half percent (3.50%) premium over a rate that is the greater of +(i) the Eurodollar rate, or (ii) one and one half percent (1.50%) with respect to Eurodollar loans, as applicable. The Credit Agreement requires monthly interest payments with respect to +domestic rate loans and at the end of each period with respect to Eurodollar rate loans. +As +of December 31, 2009, an immaterial amount was outstanding under the Credit Agreement. During 2009, $0.5 million in fees and third-party costs incurred to secure the +Credit Agreement were capitalized as deferred financing costs. The Credit Agreement contains certain customary restrictive and financial covenants. We were in compliance with these financial covenants +as December 31, 2009. +Our +ability to fund working capital needs and planned capital expenditures depends on our future operating performance and cash flow, which in turn are subject to prevailing economic +conditions and to financial, business and other factors, some of which are beyond our control. +Due +to the decline in revenues and income we experienced in 2008 and 2009, we took certain actions to right-size our production and distribution capacity in those years. We +may take additional steps to right-size our business during 2010 to be commensurate with current revenue streams. Likewise, should revenues continue to decline in future periods, we may be +required to take further cost reduction actions in order to maintain a level of liquidity necessary to meet our ongoing operational needs. Our ability to return to profitability is dependent on the +timely completion of these activities and there can be no assurance that any actions taken by us will result in a return to profitability. +51 +Table of Contents +Seasonal +variations in product demand and the associated changes in operating assets and liabilities in response to such seasonal variations may directly and adversely affect our cash +flows from operating activities. Accordingly, cash flows from operating activities for any period are not necessarily indicative of cash flows from operating activities to be expected for any other +period. +The +changes in the global economy could also affect our customers' liquidity and capital resources and their ability to meet their payment obligations to us which, in turn, would +decrease their credit terms and our ability to collect our accounts receivable, which may have a material adverse impact on our cash flows and capital resources. We continue to monitor our accounts +receivable aging and have recorded reserves as we deem appropriate. Our accounts receivable balance as of December 31, 2009 was $50.5 million, an increase of $15.2 million +compared to the balance as of December 31, 2008. The increase in accounts receivable was largely the result of higher sales in the fourth quarter of 2009 compared to the fourth quarter of 2008. +Days sales outstanding increased from 25.8 days at December 31, 2008 to 34.1 days at December 31, 2009. This increase was driven by the granting of return request and +allowances to customers in the fourth quarter of 2008, which we felt was a necessary action in response to the severe economic downturn and its impact on consumer demand for our products and, +accordingly, our wholesale customers. The granting of return requests and allowances to customers resulted in a higher allowance for these matters, causing a lower net accounts receivable balance for +2008. The combination of these factors artificially lowered our days sales outstanding for the fourth quarter of 2008 by approximately 10 days. +We +are a global business with operations in many different countries, which requires cash accounts to be held in various different currencies. The global market has recently experienced +many fluctuations in foreign currency exchange rates which impacts our results of operations and cash positions. The future fluctuations in foreign currencies may have a material impact on our cash +flows and capital resources. Cash balances held in foreign countries have additional restrictions and covenants associated with them, which adds increased strains on our liquidity and ability to +timely access and transfer cash balances between entities. +As +of December 31, 2009, we had $77.3 million in cash and cash equivalents. We consider unremitted earnings of subsidiaries operating outside of the U.S. to be indefinitely +reinvested and it is not our current intent to change this position. However, most of the cash held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to +U.S. federal and state income taxes, less applicable foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax +consequences if we were to move the cash to another country. Certain countries, including China, have monetary laws which may limit our ability to utilize cash resources in those countries for +operations in other countries. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. As of +December 31, 2009, we held $64.8 million of our total $77.3 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in +the locations in which the cash is held. Of the $64.8 million, $16.0 million could potentially be restricted, as described above. If the remaining $48.8 million were to be +repatriated to the U.S., we would be required to pay approximately $1.7 million in international withholding taxes with no offsetting credit. We believe that there will be sufficient U.S. net +operating losses ("NOLs") to absorb any increases to U.S. net income (and therefore, U.S. federal income tax) brought about by potential cash repatriation. There are full valuation allowances on the +NOLs that would be released to result in no tax effect or cash tax payments for the U.S. if we were to repatriate $46.3 million in cash to the U.S. as of December 31, 2009. +We +have entered into various operating leases that require cash payments on a specified schedule. Over the next five years we will make payments of $127.2 million related to our +operating lease. See "Contractual Obligations" below. We plan to continue to enter into operating leases related to our retail stores. Our evaluation of cost reduction opportunities will include an +evaluation of contracts for +52 +Table of Contents +sponsorships, +operating lease contracts and other contracts that require future minimum payments resulting in fixed operating costs. Any changes to these contracts may require early termination fees +or other charges that could result in significant cash expenditures. +Our +inventories decreased to $93.3 million at December 31, 2009, from $143.2 million as of December 31, 2008. Since early 2008, we have been actively managing +our inventory levels through decreased production and actively selling through our existing inventory with the goals of decreasing inventories and increasing our cash position. We expect that new +product introductions, limitations on production capacities and seasonal variations may cause our inventory to increase or decrease materially in the future as we adjust to meet changing market +conditions. +During +the years ended December 31, 2009 and 2008, we had net capital expenditures of $29.8 million and $76.2 million, respectively. During 2008, most of our capital +expenditures were dedicated to infrastructure expansion to meet our expected sales volume, particularly during the first half of the year. Due to the revenue decline we experienced in the latter half +of 2008 and in 2009, we altered our capital expenditure strategy and, accordingly, during 2009, spent primarily on certain infrastructure that we considered to be critical to executing our business +strategy, rather than on expansion. We will continue to make ongoing capital investments in molds and other tooling equipment related to manufacturing new products and footwear styles as well as those +related to opening additional retail stores; however, we have slowed the pace at which we are opening new retail stores. We plan to reduce our expenditures in our distribution and manufacturing due to +our reduction in revenues and are currently in the process of implementing new software systems which we hope will bring greater efficiencies to our distribution strategy in the long term. We expect +to continue to invest in our global information systems infrastructure to further strengthen our management information and financial reporting capabilities. +Off-Balance Sheet Arrangements +Our operating lease obligations, which include various building and equipment transactions, are not reflected on our balance sheet. See +"Contractual Obligations" below for further detail. +We +also guarantee payments to our third-party manufacturer in China for purchases of material for the manufacture of finished shoe products, which is not reflected on our balance sheet. +The maximum potential amount of future payments that we could be required to make under the guarantee is € 2.1 million (approximately $3.0 million). See +Note 15, "Commitments and Contingencies," in the consolidated financial statements for further discussion. +At +December 31, 2009, we had purchase commitments with our third-party manufacturers for $52.1 million in inventory. +On +July 26, 2005, we entered into an amended and restated four-year supply agreement with Finproject S.P.A., the former majority owner of Crocs Canada, pursuant to +which hawse have the exclusive right to purchase the material for the manufacture of finished shoe products, except for certain current customer dealings (including boot manufacturers). The supply +agreement was extended through June 30, 2010, and provides that we meet minimum purchase requirements to maintain exclusivity throughout the term of the agreement. The pricing is to be agreed +upon each quarter and fluctuates based on order volume, currency fluctuations, and raw material prices. +53 +Table of Contents +Contractual Obligations +The following table discloses aggregate information about our contractual cash obligations as of December 31, 2009 and the +periods in which payments are due (in thousands): +Payments due by period +Total +Less than +1 year +1-3 +years +3-5 +years +More than +5 years +Operating Lease Obligations +$ +170,772 +$ +44,749 +$ +48,862 +$ +33,647 +$ +43,514 +Long-Term Debt Obligations +— +— +— +— +— +Corporate Sponsorships +240 +212 +14 +14 +— +Minimum Licensing Royalties(1) +1,337 +1,301 +35 +1 +— +Purchase Obligations +52,116 +52,116 +— +— +— +FIN 48 estimated liability(2) +29,163 +19,664 +9,499 +Capital Lease Obligations +1,551 +640 +904 +7 +— +Total +$ +255,179 +$ +118,682 +$ +59,314 +$ +33,669 +$ +43,514 +(1) Includes +royalties relating to licensing agreements with companies such as Disney, MLB, and Nickelodeon. +(2) Represents +estimated liabilities as a result of the our adoption of the Financial Accounting Standards Board ("FASB") issued FASB Interpretation +No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"), as codified in Accounting Standards Codification Topic 740 "Income Taxes" . +We +also guarantee payments to our third-party manufacturer in China for purchases of material for the manufacture of finished shoe products, which is also excluded from the table. The +maximum potential amount of future payments the Company could be required to make under the guarantee is € 2.1million, approximately $3.0 million. See +Note 15- Commitments and Contingencies in the consolidated financial statements for further discussion. +Critical Accounting Policies and Estimates +Our financial statements have been prepared in accordance with accounting principles generally accepted in the U.S., which require us +to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure at the date of our financial statements. On an ongoing basis, we +evaluate our estimates and judgments, including those related to revenue, intangible assets, and stock compensation. We base our estimates and judgments on historical experience and on various other +factors that we believe to be reasonable under the circumstances, the results of which form the basis of our judgments about the carrying values of assets and liabilities that are not readily apparent +from other sources. Actual results or changes in the estimates or other judgments of matters inherently uncertain that are included within these accounting policies could result in a significant +change to the information presented in the consolidated financial statements. We believe that the estimates and assumptions below are among those most important to an understanding of our consolidated +financial statements contained in this report. +We +consider certain accounting policies related to revenue recognition, reserves for uncollectible accounts receivable, sales returns, allowances and discounts, inventory valuation, +share-based compensation, income taxes and goodwill and other intangible assets, impairment of long-lived assets, acquisitions and restructuring charges to be critical policies due to the +estimates and judgments involved in each. +54 +Table of Contents +Revenue Recognition. The majority of our revenues are derived from wholesale sales to retailers. Our standard arrangement for our +customers includes +a valid purchase order or contract with no customer acceptance provisions. We recognize revenues from sales of products when: +• we enter into an agreement with a customer or persuasive evidence of an arrangement exists; +• delivery has occurred; +• customer payment is deemed fixed or determinable and free of contingencies or significant uncertainties; +• collection is reasonably assured; and +• title passes on shipment or on receipt by the customer depending on the arrangement with the customer. +Reserves for uncollectible accounts receivable. We make ongoing estimates relating to the collectability of our accounts receivable and +maintain a +reserve for estimated losses resulting from the inability of our customers to make required payments. In determining the amount of the reserve, we consider our historical level of credit losses and +make judgments about the creditworthiness of significant customers based on ongoing credit evaluations. Since we cannot predict future changes in the financial stability of our customers, actual +future losses from uncollectible accounts may differ from our estimates and we may experience changes in the amount of reserves we recognize for accounts receivable we deem uncollectible. If the +financial condition of some of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the event we determine that a smaller or larger +reserve is appropriate, we would record a credit or a charge to selling, general and administrative expenses in the period in which we made such a determination. We may also accept returns from our +wholesale and distributor customers, on an exception basis at the sole discretion of management for the purpose of stock re-balancing to ensure that our products are merchandised in the +proper assortments. Additionally, at the sole discretion of management, we may provide markdown allowances to key wholesale and distributor customers to facilitate the "in-channel" +markdown of products where we have experienced less than anticipated sell-through. +Sales Returns, Allowances and Discounts. We record reductions to revenue for estimated customer returns, allowances and discounts. We +base our +estimates of returns on historical rates of customer returns and allowances as well as the specific identification of outstanding returns that have not yet been received by us. We also consider other +factors in forming our judgments to arrive at these estimates, including the number and success of new style introductions, customer inventory levels and macroeconomic factors affecting our customers, +the extent to which we experience shipping delays or errors, known or suspected product defects and the seasonal nature of our business and products. Certain of these assumptions, including the impact +of macroeconomic factors, the effects of seasonality, and the success of new style introductions, require significant judgment by management. Accordingly, the actual amounts of customer returns and +allowances, which are inherently uncertain, may differ from our estimates. We have, in the past, found our estimates to be reasonable in light of actual experience. If we determined that actual or +expected returns and allowances were significantly greater or lower than the reserves we had established, we would record a reduction or increase, as appropriate, to net sales in the period in which +we made such a determination. Provisions for customer specific discounts based on contractual obligations with certain major customers are recorded as reductions to net sales. We also record +reductions to revenue for estimated customer credits as a result of price mark-downs in certain markets. Fluctuations in our estimates for sales returns, allowances and discounts may be +caused by many factors, including, but not limited to, fluctuations in our sales revenue, changes in demand for our products and customer acceptance of new products we offer. During the year ended +December 31, 2008, we received a substantial number of return and allowance requests from its +55 +Table of Contents +wholesale +customers that management believes were due, in large part, to wholesaler response to rapid declines in consumer spending on a macroeconomic level as a result of the global economic downturn +as well as less-than-anticipated sell-through during the spring/summer season in 2008. Management granted certain return requests and allowances to customers that +it believed were strategically important to our ongoing business. Accordingly, our estimate for sales returns and allowances for the year ended December 31, 2008, was significantly higher than +historical estimates as a result of specific reserves related to these granted return and allowance requests. +Management +believes that the granting of return requests and allowances to customers in response to the severe economic downturn was strategically important to our business. We cannot +predict changes in macroeconomic trends, but our sell-through has since improved in the wholesale channel. Accordingly, we do not expect to grant return requests and allowances to +customers in the future to the extent that we did during the year ended December 31, 2008. However, we may grant such requests in the future, on a limited basis, should management determine +returns are necessary to the future success of our business. We are not currently aware of any circumstances that would, in the future, give rise to a significant change in sales returns and +allowances as a result of the other aforementioned factors that we take into consideration when forming our judgments regarding the adequacy of our sales returns and allowances reserves. +Inventory Valuation. At least quarterly, we evaluate our inventory positions and make estimates regarding the net realizable value of +our inventories +and, if necessary, adjust them to the lower of cost or market. In our evaluation, we use standard categories to classify inventory based on the degree to which we believe that the products may need to +be discounted to sell within a reasonable period. Certain classifications result in an impairment of inventory because the Net Realizable Value ("NRV") is less than the carrying value of the +inventory. Our estimate of the NRV of our impaired products is based on significant judgments made by management, including assumptions about future demand and market conditions. Management considers, +among other things, current sell-through of our products, recent changes in demand for our product as well as shifting demand between the products we offer, global and regional economic +conditions, historical experience selling through liquidation and "off-price" channels and the amount of inventory on hand. The ultimate results achieved in selling excess and discontinued +products in future periods may differ significantly from management's estimates of net realizable value. Fluctuations in our estimated NRV of our inventory may be caused by multiple factors, +particularly given the sensitivity of certain qualitative factors including those regarding global and regional economic conditions as well as our ability to estimate future demand and prices based on +historical experience and current sell-through. If we estimate that the NRV of our inventory is less than the current carrying cost of that inventory, we record a write-down +equal to the difference between the cost of the inventory and the estimated NRV. This write-down is recorded in cost of sales in the period in which such a determination is made. Declines +in the estimated NRV of our inventory, if the declines result in a write-down of our inventory balance, could have a significant effect on our reported financial results. +From +our inception and through 2007, we experienced substantial growth due to the high consumer demand for our core products and our expansion into new markets globally. During the year +ended December 31, 2008, we experienced a decline in demand due to the current economic downturn and the challenges we face in merchandising our expanded product lines in existing wholesale +channels as well as lessening demand for our products as such products reach a more mature stage in their product life and competitors enter the market with imitation products that are sold at +substantially lower prices. Based on our estimate, we recorded inventory write-downs of $76.3 million during the year ended December 31, 2008 with an additional $4.2 million in +charges related to losses on future purchase commitments for inventory with a market value lower than cost, of which $2.1 million was included as accrued expenses, for the year ended +December 31, 2008. Please refer to Note 3 of our Consolidated Financial Statements set forth in the "Index To Consolidated Financial Statements" of +56 +Table of Contents +this +Form 10-K. During the year ended December 31, 2009, we executed against a plan to reduce our inventory of impaired product and have been successful in selling or +otherwise disposing of more than 91% of the product that was impaired during the year ended December 31, 2008. +Stock-Based Compensation. Effective January 1, 2006, we adopted Statement of Financial Accounting Standards Statement 123R, +"Share Based Payment" , as codified in ASC Topic 718 "Compensation—Stock Compensation" , which +requires recognition of the fair value of share-based compensation over the vesting period of the option. We adopted the prospective method for all stock option grants issued prior to +August 15, 2005, which was the date we initially filed a +Registration Statement on Form S-1 with the SEC in connection with our initial public offering. Prior to August 15, 2005, we used the minimum value method of measuring equity +share options and similar instruments for either recognition or pro forma disclosure purposes. We continue to account for any portion of awards outstanding at the date of initial application using the +accounting principles originally applied to those awards which were the provisions of APB 25, as codified in ASC 718 "Compensation—Stock +Compensation" and its related interpretive guidance. +For +stock option grants issued after August 15, 2005, we applied the modified prospective method. Under this method we use the Black-Scholes valuation model to determine the fair +value of our stock options, which requires assumptions to be made regarding our stock price volatility, the expected life of the option and expected dividend rates. The volatility assumptions were +derived from our historical volatilities and historical volatilities of competitors whose shares are traded in the public markets. If factors change and we use different assumptions for estimating +share-based compensation in future periods, share-based compensation expense may differ materially in the future from that recorded in the current period. The amount of stock-based compensation +expense recognized during any fiscal period can fluctuate based on, among other things, future stock option grants, changes in our estimated forfeiture rate pursuant to Topic 718 "Compensation—Stock +Compensation" ("ASC 718"), and changes in the assumptions used in the Black-Scholes valuation model for future stock +option grants. Because the calculation of the estimate for stock-based compensation is reliant on multiple inputs, which in some cases are, themselves, estimates, an increase or decrease in any of +these variables could have a significant effect on the amount of expense recognized during a reporting period. +During +the fourth quarter of 2009 we identified an error in the calculation of stock based compensation for prior periods. To correct these errors, we recorded additional stock based +compensation expense of $4.5 million during the year ended December 31, 2009. See "Recent Events" for further discussion. +Income Taxes. In July 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"), as codified in Accounting Standards Codification Topic 740 "Income +Taxes" ("ASC 740"). Effective January 1, 2007, we adopted ASC 740, which prescribes a comprehensive model for how a company should recognize, measure, present and +disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. Though the validity of any tax position is a matter of tax law, the body of +statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. Because of this, whether a tax position will ultimately be sustained may be uncertain. +Under ASC 740, the impact of an uncertain tax position that is more likely than not of being sustained upon examination by the relevant taxing authority must be recognized at the largest amount that +is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. Also, under ASC 740, interest +expense is recognized on the full amount of deferred benefits for uncertain tax positions. The adoption of FIN 48, as codified in ASC 740, did not have a material impact on our consolidated +balance sheet, statement of operations or cash flows. +57 +Table of Contents +Our +annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is +required in determining our annual tax expense and in evaluating our tax positions. We establish reserves at the time we determine it is probable we will be liable to pay additional taxes related to +certain matters. We adjust these reserves, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit. +Tax +laws require items to be included in our tax returns at different times than when these items are reflected in the consolidated financial statements. As a result, the annual tax rate +reflected in our consolidated financial statements is different than that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not +deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and +liabilities are determined based on temporary differences between the financial reporting and tax basis of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities +are the enacted tax rates in effect for the year in which the differences are expected to reverse. Based on the evaluation of all available information, we recognize future tax benefits, such as net +operating loss carry forwards, to the extent that realizing these benefits is considered more likely than not. +We +evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating +results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to +be established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. +Undistributed +earnings of a subsidiary are accounted for as a temporary difference, except that deferred tax liabilities are not recorded for undistributed earnings of a foreign +subsidiary that are deemed to be indefinitely reinvested in the foreign jurisdiction. We have formulated a specific plan for reinvestment of undistributed earnings of our foreign subsidiaries which +demonstrates that such earnings will be indefinitely reinvested in the applicable tax jurisdictions. Should we change our plans, we would be required to record a significant amount of deferred tax +liabilities. +We +recognize interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statement of operations. Accrued interest and +penalties are included within the related tax liability line in the consolidated balance sheet. +Goodwill and Other Intangible Assets. In accordance with FASB Statement No. 142, " Goodwill and Other +Intangible +Assets ", as codified in ASC Topic 350 " Intangibles—Goodwill and Other " ("ASC Topic 350"), goodwill and intangible +assets with indefinite lives are not amortized but are instead measured for impairment at least annually, or when events indicate that an impairment exists. As required by ASC Topic 350, in our +impairment tests for goodwill and other indefinite-lived intangible assets, we compare the estimated fair value of goodwill and other intangible assets to their carrying value. If the carrying value +exceeds our estimate of fair value, we calculate impairment as the excess of the carrying value over our estimate of fair value. Our estimates of fair value utilized in goodwill and other +indefinite-lived intangible asset tests may be based upon a number of factors, including our assumptions about the expected future operating performance of our reporting units. Our estimates may +change in future periods due to, among other things, technological change, economic conditions, and changes to our business operations or inability to meet business plans. +During +the three month period ended September 30, 2008, our stock price declined substantially, which represented a triggering event for potential goodwill impairment. As of +September 30, 2008, we performed an interim goodwill impairment evaluation, as required under ASC Topic 350. Based on that evaluation we concluded our goodwill was impaired and we recorded a +charge of $22.8 million, which +58 +Table of Contents +was +our entire goodwill balance as of September 30, 2008. Please refer to Note 5, "Goodwill and Intangible Assets," of our consolidated financial statements. +Intangible +assets that are determined to have definite lives, such as customer relationships, core technology, capitalized software, patents and non-compete agreements are +amortized over their useful lives and are measured for impairment only when events or circumstances indicate the carrying value may be impaired. In these cases, we estimate the future undiscounted +cash flows to be derived from the asset to determine whether or not a potential impairment exists. If the carrying value exceeds our estimate of future undiscounted cash flows, we then calculate the +impairment as the excess of the carrying value of the asset over our estimate of its fair value. +Impairment of Long-Lived Assets. In accordance with ASC Topic 360-10-35, Impairment or +Disposal of Long-Lived Assets, we test long-lived assets to be held and used for recoverability when events or circumstances indicate the carrying value +of a long-lived asset (asset group) may be impaired. Events that may indicate the impairment of long-lived assets include; (i) a significant decrease in the market price +of a long-lived asset (asset group), (ii) a significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical +condition, (iii) a significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse +action or assessment by a regulator, (iv) an accumulation of costs significantly in +excess of the amount originally expected for the acquisition or construction of a long-lived asset (asset group), (v) current period operating or cash flow losses combined with +historical operating or cash flow losses of a particular long-lived asset group or a forecast of cash flows that demonstrates continuing losses associated with the use of a +long-lived asset group, and (vi) a current expectation that, more likely than not, a long-lived asset (asset group) will be sold or otherwise disposed of significantly +before the end of its previously estimated useful life. We evaluate for these types of events or circumstances at least quarterly. Recoverability of assets to be held and used is measured by a +comparison of the carrying amount of an asset group to future undiscounted cash flows expected to be generated by the asset group. An asset group is the lowest level of assets and liabilities for +which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. If an asset group is considered to be impaired, the impairment to be recognized is measured by +the amount by which the carrying amount of the asset group exceeds the fair value of the asset group. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs +to sell. Fair value is determined by independent third-party appraisals, the net present value of expected cash flows, or other valuation techniques as appropriate. Assets to be abandoned or from +which no further benefit is expected are written down to zero at the time that the determination is made and the assets are removed entirely from service. +During +the year ended December 31, 2009, we recognized an impairment charge of $18.5 million on fixed assets, primarily related to equipment and shoe molds, sales and +marketing assets and assets that we no longer intend to use as we consolidate our warehouse and distribution space. These charges are recorded in the impairment charges line item of the consolidated +statement of operations for the year ended December 31, 2009, and are accounted for as assets to be abandoned in accordance with ASC Topic 360 "Property, Plant and +Equipment" . Also refer to Note 8, "Restructuring Activities," of our consolidated financial statements. +We +consider our recent operating and cash flow losses to indicate that the carrying value of assets to be held and used may not be recoverable. Through September 30,2009, we had +determined that we had one asset group in support of its footwear manufacturing, distribution and sales business as this is the lowest level of assets and liabilities for which identifiable cash flows +are largely independent of the cash flows of other assets and liabilities. Beginning in Q4 2009, we have determined that the lowest level of assets and liabilities for which identifiable cash flows +are largely independent of the cash flows of other assets and liabilities is at the retail store level for assets involved in our retail business. Assets not included in our retail business are +considered one asset group. We estimated the future +59 +Table of Contents +undiscounted +cash flows to be generated by our asset group and compared the future undiscounted cash flows to the carrying amount of the asset group to determine whether the asset group was +recoverable. Our estimates of future cash flows over the remaining useful life of the asset group were based on management's operating budgets and forecasts. These budgets and forecasts take into +consideration inputs from our regional management related to growth rates, pricing, new markets and other factors expected to affect the business, as well as management's forecasts for inventory, +receivables, capital spending, and other cash needs. These considerations and expectations are inherently uncertain and, given our limited operating history of as well as the global economic downturn, +estimates included in our operating forecasts beyond a three to six month future period are extremely subjective. Accordingly, actual cash flows may differ significantly from our estimated future +cash flows. Based on our analysis the carrying value of our asset group was recoverable and there was no impairment indicated. Accordingly, we did not prepare estimates of the fair value of the asset +group to be held and used. +Due +to the nature of impairment charges, changes in the reserves and expenses related to these charges incurred between reporting periods can be significant as they are driven by, among +other things, changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product or shifting demand between different products we offer and +other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets and result in additional impairment charges in +future periods. Likewise, significant impairment charges recognized during a reporting period could have an adverse affect on our reported financial results. +Restructuring Charges. We recognize restructuring charges related to our plans to close distribution and administrative facilities +according to SFAS +No. 112, " Employers' Accounting for Postemployment Benefits—an amendment of FASB Statements No. 5 and 43" as codified in ASC +Topic 712 " Compensation—Nonretirement Post Employment Benefits ". In connection with these activities, we recognize restructuring charges for +employee termination costs and other restructuring-related costs. We also recognize restructuring charges related to our future expense related to the future abandonment of facilities under the +operating leases in accordance with FASB Statement No. 146, " Accounting for Costs Associated with Exit or Disposal Activities ", included in ASC +Topic 420 "Exit or Disposal Cost Obligations" . During the year ended December 31, 2009, we recorded $14.7 million in restructuring charges +for the closure of various warehouses and office buildings and employee severances as well as settlement and termination of contracts prior to term. Please refer to Note 8, "Restructuring +Activities," of our consolidated financial statements. +The +recognition of these restructuring charges require that we make certain judgments and estimates regarding the nature, timing and amount of costs associated with the planned exit +activity. To the extent our actual results in exiting these facilities differ from our estimates and assumptions, we may be required to revise the estimates of future liabilities, requiring the +recognition of additional restructuring charges or the reduction of liabilities already recognized. At the end of each reporting period, we will evaluate the remaining accrued balances to ensure that +no excess accruals are retained and the utilization of the provisions are for their intended purpose in accordance with developed exit plans. Due to the nature of restructuring charges, changes in the +liabilities and expenses related to these charges incurred between reporting periods can be significant as they are driven by, among other things, our strategic operational and financial decisions, +global and regional economic conditions, staffing levels relative to demand for our products and other corporate initiatives which may eliminate the need for certain assets or staff positions in our +locations. Significant restructuring charges could adversely affect our reported financial results in the reporting period in which the charges are recognized and, to the extent we are required to +make future cash payments for items such as severance and lease buyouts or penalties, our liquidity. +60 +Table of Contents +Recent Accounting Pronouncements +In June 2009, the FASB issued FASB Statement No. 167, Amendments to FASB Interpretation +No. 46(R ), which amends FASB Interpretation No. FIN46(R), Consolidation of Variable Interest Entities, ("FIN 46 +(R)") and is incorporated into ASC Topic 810, Consolidation , to require an enterprise to perform an analysis to determine whether the enterprise's +variable interest gives it a controlling financial interest in a variable interest entity and to require ongoing reassessments of this nature. The standard amends certain guidance in FIN 46 +(R) for determining whether an entity is a variable interest entity and adds additional reconsideration for making this determination when facts or circumstances change. The standard requires +enhanced disclosures that will provide more transparent information about an entity's involvement in a variable interest entity. The standard is effective for the fiscal year that begins after +November 15, 2009. We do not expect the adoption of this standard to have a material impact on our consolidated financial statements. +In +June 2009, the FASB issued Accounting Standards Update ("ASU") 2009-01, Generally Accepted Accounting Principles; Amendments based on Statement of +Financial Accounting Standards No. 168-The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles ("ASU +2009-01"), to amend the ASC Topic 105, Generally Accepted Accounting Principles , to establish the FASB Accounting Standards Codification as +the source of authoritative accounting principles recognized by the FASB to be applied in the preparation of financial statements. The codification also contains interpretive releases of the SEC under +federal securities laws and is a source of authoritative GAAP for SEC registrants. ASU 2009-01 is effective for financial statements issued for interim and annual periods ending after +September 15, 2009 and shall be applied prospectively. The adoption of this standard did not have a material impact on our consolidated financial statements. +In +August 2009, the FASB issued ASU 2009-05, Measuring Liabilities at Fair Value ("ASU 2009-05"), an update to ASC +Topic 820-10, Fair Value Measurements and Disclosures—Other. ASU 2009-05 provides amendments to the fair value +measurement of liabilities and provides clarification on valuation techniques for liabilities for which a quoted price for an identical liability in an active market is not available. The amendments +also clarify that, when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a +restriction that prevents the transfer of the liability. ASU 2009-05 also provides amendments to clarify that both a quoted price in an active market for the identical liability at the +measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair +value measurements. The guidance provided in ASU 2009-05 is effective for the first reporting period (including interim periods) beginning +after September 1, 2009 and shall be applied prospectively. We do not expect the adoption of this standard to have a material impact on our consolidated financial statements. +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Credit and Interest Rate Risk +We are exposed to interest rate risk to the extent that interest rates change due to inflation or other factors. This exposure is +directly related to our normal operating and funding activities. On August 3, 2009, we fully repaid our remaining obligation on our Revolving Credit Facility with Union Bank of California, N.A. +prior to its maturity date of September 30, 2009. The Revolving Credit Facility effectively terminated upon full repayment. On September 25, 2009, we entered into a Credit Agreement with +PNC Bank N.A. (the "Bank") for an asset-backed revolving credit facility which provides for borrowings of up to $30.0 million in total, subject to certain restrictions. Principal amounts +outstanding under the Credit Agreement will bear interest at a two percent (2%) premium over a rate that is the greater of either (i) the Bank's published reference rate, (ii) the +Federal Funds Open Rate +61 +Table of Contents +in +effect on such day plus one half of one percent (0.5%), or (iii) the sum of the daily LIBOR rate and one percent (1.0%), with respect to domestic rate loans. Eurodollar denominated principal +amounts outstanding under the Credit Agreement will bear interest at the sum of three and one half percent (3.50%) premium over a rate that is the greater of (i) the Eurodollar rate, or +(ii) one and one half percent (1.50%) with respect to Eurodollar loans, as applicable. The Credit Agreement requires monthly interest payments with respect to domestic rate loans and at the end +of each period with respect to Eurodollar rate loans. As of December 31, 2009, an immaterial amount was outstanding under the Credit Agreement, accordingly, there is minimal impact from +interest rate risk related to our Credit Agreement. +We +earned interest income of $0.5 million on our cash and cash equivalents during the year ended December 31, 2009. We have performed a sensitivity analysis to estimate our +exposure to market risk of interest rates, and if the weighted average rate of return on cash and cash equivalents and restricted +cash were to increase or decrease by 1%, the impact on interest income would be approximately $0.8 million, net of tax during the year ended December 31, 2009. +Foreign Currency Exchange Risk +We have significant revenues from foreign sales in recent periods. While the majority of expenses attributable to our foreign +operations are paid in the functional currency of the country in which such operations are conducted, we pay the majority of our overseas third-party manufacturers in U.S. dollars. Our ability to sell +our products in foreign markets and the U.S. dollar value of the sales made in foreign currencies can be significantly influenced by foreign currency fluctuations. A decrease in the value of foreign +currencies relative to the U.S. dollar could result in downward price pressure for our products or losses from currency exchange rates. We have performed a sensitivity analysis to estimate our +exposure to market risk of foreign exchange rates. If the U.S. dollar were to increase or decrease, as applicable, in value by 1%, the impact on international sales of $389.1 million during the +year ended December 31, 2009 would have been an increase or decrease, as applicable, in consolidated revenues by $3.9 million. The volatility of the applicable exchange rates is +dependent on many factors that cannot be forecast with reliable accuracy. In the event our foreign sales and purchases increase and are denominated in currencies other than the U.S. dollar, our +operating results may be affected by fluctuations in the exchange rate of currencies we receive for such sales. Please see Item 7, "Management's Discussion and Analysis of Financial Condition +and Results of Operations," for a discussion of the impact of foreign exchange rate variances experienced in the year ended December 31, 2009. We intend to, in the future, engage in foreign +exchange hedging contracts to reduce our economic exposure to changes in exchange rates. If we do engage in foreign exchange hedging, the foreign exchange hedging contracts will be entered into to +hedge specific commitments and anticipated transactions but not for speculative or trading purposes. As of December 31, 2009, we did not have any unsettled foreign exchange hedging contracts. +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the "Index To Consolidated Financial Statements" on +page F-1. +ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure +None. +62 +Table of Contents +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial +Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and +15d-15(e) under the Exchange Act, as of the end of the period covered by this annual report (the "Evaluation Date"). Based on this evaluation, our Chief Executive Officer and Chief +Financial Officer concluded that as of the Evaluation Date, our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, +required to be disclosed in our Securities and Exchange Commission ("SEC") reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, +and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required +disclosure. +Management's Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate control over financial reporting, as defined in Exchange Act +Rules 13a-15(f) and 15d-15(f). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2008, using the +criteria set forth in the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway +Commission (COSO). Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2009. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting, which is +included herein. +Changes in Internal Control Over Financial Reporting +During the three months ended December 31, 2009, we did not make any material changes to our internal control over financial +reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +63 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2009, based on criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's +management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the +accompanying "Management Report on Internal Control Over Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our +audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control +over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or +persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting +and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those +policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material +misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to +future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In +our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year +ended December 31, 2009 of the Company and our report dated February 25, 2010 expressed an unqualified opinion on those financial statements. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +February 25, 2010 +64 +Table of Contents +ITEM 9B. Other Information +Not applicable. +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2010 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2009. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer, principal +financial officer, and controller. A copy of our business code of conduct and ethics policy is available on our website: www.crocs.com. We are required to disclose any change to, or waiver from, our +code of ethics for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our business code of conduct and ethics policy as permitted +by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2010 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2009. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2010 Annual Meeting +of Stockholders to be filed with the +SEC within 120 days after the end of the fiscal year ended December 31, 2009, with the exception of those items listed below. +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, as of December 31, 2009, we reserved 7,755,254 shares of common stock for future issuance on +exercise of outstanding options under equity compensation plans. +Plan Category +Number of +Securities +to be Issued +on Exercise of +Outstanding Options +Weighted Average +Exercise Price of +Outstanding +Options +Number of Securities +Remaining Available +for Future +Issuance Under +Plans, Excluding +Securities Available +in First Column +Equity compensation plans approved by stockholders(1)(2) +7,621,026 +$ +7.79 +1,756,874 +Equity compensation plans not approved by stockholders(3) +134,228 +$ +0.58 +— +Total +7,775,254 +1,756,874 +(1) On +July 9, 2007, at the annual stockholders' meeting, our stockholders approved the 2007 Equity Incentive Plan (the "2007 Plan"), which previously +had been approved by our board of directors. The 2007 Plan was effective as of July 19, 2007. The total number of shares of our common stock +65 +Table of Contents +available +for distribution under the 2007 Plan is 9,000,000, subject to adjustment for future stock splits, stock dividends and similar changes in our capitalization. +(2) On +April 27, 2005, our board of directors adopted the 2005 Equity Incentive Plan ("the 2005 Plan"). On January 10, 2006, our board of +directors amended the 2005 Plan to increase the number of shares of our common stock available for issuance under the 2005 Plan from 11,681,000 shares to 14,017,200 shares. Following the adoption of +the 2007 Plan, no future grants may be made from the 2005 Plan. +(3) Represents +non-plan stock options granted to our officers, directors and employees prior to the adoption of the 2005 Equity Incentive Plan. +Following the adoption of the 2007 Plan, no future grants may be made from this plan. +ITEM 13. Certain Relationships and Related Transactions, and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2010 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2009. +ITEM 14. Principal Accounting Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2010 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2009. +66 +Table of Contents +PART IV +ITEM 15. Exhibits, Financial Statement Schedules +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to financial statements on page F-1. +(2) Financial Statement Schedules +All financial statement schedules have been omitted because they are not required, are not applicable or the information is included in the Financial Statements +or Notes thereto. +(3) Exhibit list +Exhibit Number +Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (Incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File +No. 333-132312)). +3.1 +Certificate of Amendment to the Restated Certificate of Incorporate of Crocs, Inc. (Incorporated herein by reference to Exhibit 3.1 to Crocs, Inc. Current Report on Form 8-K, filed on July 12, +2007 (File No. 000-51754)). +3.2 +Amended and Restated Bylaws of Crocs, Inc. (Incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File +No. 333-132312)). +4.1 +Specimen common stock certificate (Incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.1* +Form of Indemnity Agreement between Crocs, Inc. and each of its directors and executive officers (Incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.2* +Crocs, Inc. 2005 Equity Incentive Plan (the "2005 Plan") (Incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.3* +Amendment No.1 to the 2005 Plan (Incorporated herein by reference to Exhibit 10.2.2 to Crocs, Inc.'s Registration Statement on Form S-1/A [Amendment No. 4], filed on January 19, 2006 (File +No. 333-127526)). +10.4* +Form of Notice of Grant of Stock Option under the 2005 Plan (Incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.5* +Form of Notice of Grant of Stock Option for Non-Exempt Employees under the 2005 Plan (Incorporated herein by reference to Exhibit 10.4 to Crocs, Inc.'s Registration Statement on Form S-1, filed on +August 15, 2005 (File No. 333-127526)). +10.6* +Form of Stock Purchase Agreement under the 2005 Plan (Incorporated herein by reference to Exhibit 10.5 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +67 +Table of Contents +Exhibit Number +Description +10.7* +Form of Stock Option Agreement under the 2005 Plan (Incorporated herein by reference to Exhibit 10.6 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.8* +Form of Restricted Stock Award Grant Notice under the 2005 Plan (incorporated herein by reference to Exhibit 10.7 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.9* +Form of Restricted Stock Award Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.8 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.10* +Form of Non-Statutory Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.9 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 +(File No. 333-127526)). +10.11 +Stock Purchase Agreement among 4246519 Canada, Inc., Finproject Group S.p.A., 3107019 Canada, Inc. and Daniel J. Hunter dated as of June 29, 2004 (incorporated herein by reference to +Exhibit 10.14 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.12 +Asset Purchase and Property Transfer Agreement between Hana Phylon Tech S.A. de C.V. and Crocs Mexico, S.de.R.L de C.V. dated as of April 23, 2005 (incorporated herein by reference to Exhibit 10.15 to +Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.13 +Asset Purchase and Property Transfer Agreement between St. Vrain Trading, LLC, d/b/a Crocs Hawaii, LLC and the Registrant dated May 19, 2005 (incorporated herein by reference to Exhibit 10.16 +to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.14* +Board of Directors Compensation Plan dated June 25, 2009, (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on August 6, +2009). +10.15* +Amended and Restated 2007 Senior Executive Deferred Compensation Plan and Non-Qualified Plan Trust (incorporated herein by reference to Exhibit 10.15 to Crocs, Inc.'s Annual Report on Form 10-K, filed +on March 17, 2010) +10.16† +Distribution Agreement between Crocodile Distribution and the Registrant dated as of April 1, 2005 (incorporated herein by reference to Exhibit 10.19 to Crocs, Inc.'s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.17 +Kiosk Agreement between Crocodile Kiosk, LLC and the Registrant dated as of July 1, 2005 (incorporated herein by reference to Exhibit 10.20 to Crocs, Inc.'s Registration Statement on Form S-1, +filed on August 15, 2005 (File No. 333-127526)). +10.18† +Amended and Restated Agreement for Supply between Finproject S.p.A. and the Registrant dated as of July 26, 2005 (incorporated herein by reference to Exhibit 10.21 to Crocs, Inc.'s Registration +Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.21* +Nonstatutory Stock Option Agreement between the Registrant and Raymond D. Croghan dated September 1, 2004 (incorporated herein by reference to Exhibit 99.9 to Crocs, Inc.'s Registration Statement on +Form S-8, filed on March 9, 2006 (File No. 333-132312)). +68 +Table of Contents +Exhibit Number +Description +10.23* +Nonstatutory Stock Option Agreement between the Registrant and Ronald R. Snyder dated September 1, 2004 (incorporated herein by reference to Exhibit 99.12 to Crocs, Inc.'s Registration Statement on +Form S-8, filed on March 9, 2006 (File No. 333-132312). +10.26 +Membership Interest Purchase Agreement among Crocs, Inc. and the Members of Jibbitz, LLC, dated September 13, 2006 (incorporated herein by reference to Exhibit 10.40 to Crocs, Inc.'s Quarterly +Report on Form 10-Q, filed on November 13, 2006 (File No. 000-51754)). +10.27* +2008 Cash Incentive Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 12, 2007 (File No. 000-51754)). +10.28* +2007 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 12, 2007 (File No. 000-51754)). +10.29* +Form of Incentive Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007 (File +No. 000-51754)). +10.30* +Form of Non-Statutory Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007 (File +No. 000-51754)). +10.31* +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on +November 14, 2007 (File No. 000-51754)). +10.32* +Employment Agreement dated as of January 16, 2008 by and between Crocs, Inc. And Russell Hammer (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, +filed on May 15, 2009 (File No. 000-51754)). +10.43* +Employment Agreement dated February 9, 2009 by and between Crocs, Inc. and John McCarvel (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on +February 13, 2009 (File No. 000-51754)). +10.44* +Employment Agreement dated February 9, 2009 by and between Crocs, Inc. and John Duerden (incorporated herein by reference to Current Report on Form 8-K filed with the Securities and Exchange Commission +on March 2, 2009) +10.47* +Board of Directors compensation plan dated June 25, 2009 (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on May 7, 2009 (File +No. 000-51754)) +10.48* +Separation agreement between Ronald R. Snyder and Crocs, Inc. dated June 30, 2009 (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on +May 7, 2009 (File No. 000-51754)). +10.49 +Revolving Credit and Security Agreement, dated September 25, 2009, by and among Crocs, Inc., Crocs Retail, Inc., Crocs Online, Inc., Ocean Minded, Inc., Jibbitz LLC, Bite, Inc. and +PNC Bank, N.A. (incorporated herein by reference to Current Report on Form 8-K filed with the Securities and ExchangeCommission on September 30, 2009). +69 +Table of Contents +Exhibit Number +Description +10.50 +First Amendment to Revolving Credit and Security Agreement, dated October 14, 2009, by and among Crocs, Inc., Crocs Retail, Inc., Crocs Online, Inc., Ocean Minded, Inc., Jibbitz LLC, Bite, +Inc. and PNC Bank, N.A. (incorporated herein by reference to Current Report on Form 8-K filed with the Securities and Exchange Commission on October 15, 2009) +10.51†† +Confidential separation agreement and General release by and between Crocs, Inc. and Erik Rebich, dated December 31, 2009 +21†† +Subsidiaries of the Registrant. +23.1†† +Consent of Deloitte & Touche LLP. +31.1†† +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2†† +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +32†† +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +* Compensatory +plan or arrangement +† The +Registrant has been granted confidential treatment with respect to portions of these exhibits. +†† Filed +herewith. +70 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) 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, as of February 25, 2010. +CROCS, INC. +a Delaware Corporation +By: +/s/ JOHN H. DUERDEN +Name: John H. Duerden +Title: President and Chief Executive Officer +Pursuant +to the requirements of the Securities Exchange Act of 1934, this report has been signed below as of February 25, 2010 by the following persons on behalf of the registrant +and in the capacities indicated. +Signature +Title +Date +/s/ JOHN H. DUERDEN +John H. Duerden +President, Chief Executive Officer and Director +(Principal Executive Officer) +February 25, 2010 +/s/ RUSSELL C. HAMMER +Russell C. Hammer +Senior Vice President—Finance, Treasurer and Chief Financial Officer +(Principal Financial and Accounting Officer) +February 25, 2010 +/s/ W. STEPHEN CANNON +W. Stephen Cannon +Director +February 25, 2010 +/s/ RAYMOND D. CROGHAN +Raymond D. Croghan +Director +February 25, 2010 +/s/ RONALD L. FRASCH +Ronald L. Frasch +Director +February 25, 2010 +/s/ PETER A. JACOBI +Peter A. Jacobi +Director +February 25, 2010 +/s/ RICHARD L. SHARP +Richard L. Sharp +Chairman of the Board +February 25, 2010 +/s/ THOMAS J. SMACH +Thomas J. Smach +Director +February 25, 2010 +71 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2009 and 2008, and the related consolidated +statements of operations, stockholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of +the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. +We +conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in +the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement +presentation. We believe that our audits provide a reasonable basis for our opinion. +In +our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Crocs, Inc. and subsidiaries as of December 31, +2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally +accepted in the United States of America. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of +December 31, 2009, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring +Organizations of the Treadway Commission and our report dated February 25, 2010 expressed an unqualified opinion on the Company's internal control over financial reporting. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +February 25, 2010 +F-1 +Table of Contents +CROCS, INC. +CONSOLIDATED STATEMENTS OF OPERATIONS +(In thousands, except share and per share data) +Year Ended December 31, +2009 +2008 +2007 +Revenues +$ +645,767 +$ +721,589 +$ +847,350 +Cost of sales +337,720 +486,722 +349,701 +Restructuring charges +7,086 +901 +— +Gross profit +300,961 +233,966 +497,649 +Selling, general and administrative expenses +311,592 +341,518 +268,978 +Foreign currency transaction losses (gains), net +(665 +) +25,438 +(10,055 +) +Restructuring charges +7,623 +7,664 +— +Goodwill impairment charges +— +23,867 +— +Asset impairment charges +26,085 +21,917 +— +Charitable Contributions +7,510 +1,844 +959 +Income (loss) from operations +(51,184 +) +(188,282 +) +237,767 +Interest expense +1,495 +1,793 +438 +Gain on Charitable Contribution +(3,163 +) +— +— +Other expense (income), net +(895 +) +(565 +) +(2,997 +) +Income (loss) before income taxes +(48,621 +) +(189,510 +) +240,326 +Income tax expense (benefit) +(6,543 +) +(4,434 +) +72,098 +Net (loss) income +$ +(42,078 +) +$ +(185,076 +) +$ +168,228 +Income (loss) per common share: +Basic +$ +(0.49 +) +$ +(2.24 +) +$ +2.08 +Diluted +$ +(0.49 +) +$ +(2.24 +) +$ +2.00 +Weighted average common shares: +Basic +85,112,461 +82,767,540 +80,759,077 +Diluted +85,112,461 +82,767,540 +84,194,883 +See +accompanying notes to consolidated financial statements. +F-2 +Table of Contents +CROCS, INC. +CONSOLIDATED BALANCE SHEETS +(In thousands, except share data) +December 31, +2009 +2008 +ASSETS +Current assets: +Cash and cash equivalents +$ +77,343 +$ +51,665 +Restricted cash +1,144 +— +Accounts receivable, less allowance for doubtful accounts of $3,973 and $5,262, respectively +50,458 +35,305 +Inventories +93,329 +143,205 +Deferred tax assets, net +7,358 +11,364 +Income tax receivable +8,611 +24,417 +Other receivables +16,140 +4,642 +Prepaid expenses and other current assets +12,871 +8,773 +Total current assets +267,254 +279,371 +Property and equipment, net +71,084 +95,892 +Restricted cash +1,506 +2,922 +Intangible assets, net +35,984 +40,892 +Deferred tax assets, net +18,479 +21,231 +Other assets +15,431 +15,691 +Total Assets +$ +409,738 +$ +455,999 +LIABILITIES AND STOCKHOLDERS' EQUITY +Current liabilities: +Accounts payable +$ +23,434 +$ +35,137 +Accrued expenses and other current liabilities +53,580 +50,076 +Deferred tax liabilities, net +9 +30 +Accrued restructuring charges +2,616 +1,439 +Income taxes payable +6,377 +24,420 +Note payable, current portion of long-term debt and capital lease obligations +640 +22,431 +Total current liabilities +86,656 +133,533 +Long term debt and capital lease obligations, net of current portion +912 +— +Deferred tax liabilities, net +2,192 +2,917 +Long term restructuring. +520 +959 +Other liabilities +31,838 +31,427 +Total liabilities +122,118 +168,836 +Commitments and contingencies (Notes 6, 9 and 15) +Stockholders' equity: +Common shares, par value $0.001 per share; 250,000,000 authorized 86,224,760 issued and 85,659,581 shares issued and outstanding in 2009, 83,543,501 issued +and 83,019,501 issued and outstanding in 2008 +85 +84 +Treasury Stock, at cost, 565,179 and 524,000 shares, respectively +(25,260 +) +(25,022 +) +Additional paid-in capital +266,472 +232,037 +Deferred compensation +— +(246 +) +Retained earnings +22,155 +64,233 +Accumulated other comprehensive income +24,168 +16,077 +Total stockholders' equity +287,620 +287,163 +Total Liabilities and Stockholders' Equity +409,738 +$ +455,999 +See +accompanying notes to consolidated financial statements. +F-3 +Table of Contents +CROCS, INC. +CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT) +(In Thousands) +Common Stock +Treasury Stock +Accummulated +Other +Comprehensive +Income +Total Stock +Holders +Equity +(Deficit) +Additional +Paid in +Capital +Deferred +Compensation +Retained +Earnings +Comprehensive +Income (Loss) +Shares +Amount +Shares +Amount +BALANCE—December 31, 2006 +78,682 +$ +79 +— +$ +— +$ +131,795 +$ +(5,702 +) +$ +81,081 +$ +1,006 +$ +208,258 +Amortization of stock compensation +— +— +— +— +18,578 +3,105 +— +— +21,683 +Excess tax benefit stock based compensation +— +— +— +— +43,216 +— +— +— +43,216 +Forfeitures +— +— +— +— +(195 +) +195 +— +— +— +Exercises of stock options and vesting of share-based awards +4,040 +4 +— +— +18,543 +— +— +— +18,547 +Treasury Stock +(524 +) +— +524 +(25,022 +) +— +— +— +— +(25,022 +) +Net income +— +— +— +— +— +— +168,228 +— +168,228 +$ +168,228 +Foreign currency translation +— +— +— +— +— +— +— +9,203 +9,203 +9,203 +Total comprehensive loss +$ +177,431 +BALANCE—December 31, 2007 +82,198 +$ +83 +524 +$ +(25,022 +) +$ +211,936 +$ +(2,402 +) +$ +249,309 +$ +10,209 +$ +444,113 +Amortization of stock compensation +— +— +— +— +16,951 +1,388 +— +— +18,339 +Forfeitures +— +— +— +— +(131 +) +131 +— +— +— +Exercises of stock options and vesting of share-based awards +821 +1 +— +— +3,281 +637 +— +— +3,919 +Net loss +— +— +— +— +— +— +(185,076 +) +— +(185,076 +) +$ +(185,076 +) +Foreign currency translation +— +— +— +— +— +— +— +5,868 +5,868 +5,868 +Total comprehensive loss +$ +(179,208 +) +BALANCE—December 31, 2008 +83,019 +$ +84 +524 +$ +(25,022 +) +$ +232,037 +$ +(246 +) +$ +64,233 +$ +16,077 +$ +287,163 +Amortization of stock compensation +— +— +17,189 +208 +— +— +17,397 +Tender Offer +— +— +16,197 +— +— +— +16,197 +Excess tax benefit stock based compensation +— +— +— +— +— +— +— +Forfeitures +(116 +) +— +— +— +(199 +) +38 +— +— +(161 +) +Exercises of stock options and vesting of share-based awards +1,858 +1 +— +— +1,248 +— +— +— +1,249 +Adjustment for prior period RSA Grants +939 +— +Treasury Stock +(41 +) +— +41 +(238 +) +— +— +— +— +(238 +) +Net loss +— +— +— +— +(42,078 +) +— +(42,078 +) +$ +(42,078 +) +Foreign currency translation +— +— +— +— +— +8,091 +8,091 +8,091 +Total comprehensive loss +$ +(33,987 +) +BALANCE—December 31, 2009 +85,659 +$ +85 +565 +$ +(25,260 +) +$ +266,472 +$ +— +$ +22,155 +$ +24,168 +$ +287,620 +See notes to consolidated financial statements. +F-4 +Table of Contents +CROCS, INC. +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2009 +2008 +2007 +Cash flows from operating activities: +Net (loss) income +$ +(42,078 +) +$ +(185,076 +) +$ +168,228 +Adjustments to reconcile net (loss) income to net cash provided by operating activities: +Depreciation and amortization +36,671 +37,450 +20,949 +Loss on disposal of fixed assets +(776 +) +633 +199 +Unrealized loss (gain) on foreign exchange +(11,267 +) +21,570 +(8,583 +) +Deferred income taxes +5,399 +(5,429 +) +(14,866 +) +Goodwill impairment +— +23,837 +— +Asset impairment +26,027 +21,927 +— +Inventory write-down charges +2,568 +76,258 +1,829 +Loss on purchase commitments +— +4,200 +— +Charitable contributions +7,424 +1,844 +959 +Gain on charitable contributions +(3,148 +) +— +— +Non-cash restructuring charges +2,196 +— +— +Bad debt expense +1,316 +3,153 +4,671 +Share based compensation +15,237 +18,976 +21,683 +Share based compensation from tender offer +16,197 +— +— +Excess tax benefit on share-based compensation +— +— +(43,216 +) +Changes in operating assets and liabilities—net of effect of acquired businesses: +Accounts receivable +(13,251 +) +111,318 +(83,948 +) +Inventories +44,828 +16,395 +(154,378 +) +Prepaid expenses and other assets +(13,914 +) +(4,342 +) +(10,912 +) +Accounts payable +(17,387 +) +(60,168 +) +27,149 +Accrued expenses and other liabilities +(19,304 +) +11,553 +79,174 +Accrued restructuring +1,208 +2,398 +— +Income taxes receivable +23,163 +(23,634 +) +— +Cash provided by operating activities +61,109 +72,863 +8,938 +Cash flows from investing activities: +Purchases of marketable securities +(1,502 +) +— +(64,880 +) +Sales of marketable securities +— +— +87,205 +Cash paid for purchases of property and equipment +(20,054 +) +(55,559 +) +(57,379 +) +Proceeds from disposal of property and equipment +2,476 +2,383 +— +Cash paid for intangible assets +(6,973 +) +(10,659 +) +(16,525 +) +Restricted cash +322 +(1,624 +) +1,753 +Acquisition of businesses, net of cash acquired +— +(7,977 +) +(12,391 +) +Cash used in investing activities +(25,731 +) +(73,436 +) +(62,217 +) +Cash flows from financing activities: +Proceeds from note payable, net +293 +76,024 +7,000 +Repayment of note payable and capital lease obligations +(23,078 +) +(60,707 +) +(541 +) +Debt issuance costs +(458 +) +— +— +Excess tax benefit on share-based compensation +— +— +43,216 +Exercise of stock options +1,290 +3,283 +18,547 +Purchase of treasury stock +(238 +) +— +(25,022 +) +Cash (used in) provided by financing activities +(22,191 +) +18,600 +43,200 +Effect of exchange rate changes on cash +12,491 +(2,697 +) +3,758 +Net (decrease) increase in cash and cash equivalents +25,678 +15,330 +(6,321 +) +Cash and cash equivalents—beginning of year +51,665 +36,335 +42,656 +Cash and cash equivalents—end of year +$ +77,343 +$ +51,665 +$ +36,335 +F-5 +Table of Contents +CROCS, INC. +CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) +(In thousands) +Year Ended December 31, +2009 +2008 +2007 +Supplemental disclosure of cash flow information—cash paid during the year for: +Interest +$ +1,491 +$ +1,581 +$ +44 +Income taxes +$ +12,392 +$ +16,367 +$ +19,991 +Supplemental disclosure of non-cash, investing, and financing activities: +In conjunction with the acquisitions made, liabilities were assumed as follows: +Fair value of assets acquired +$ +— +$ +— +$ +7,074 +Cash paid +$ +— +$ +— +5,093 +Liabilities assumed +$ +— +$ +— +$ +1,981 +Accrued acquisitions purchase price +$ +— +$ +— +3,429 +Assets acquired under capitalized leases +$ +1,760 +— +— +Accrued purchases of property and equipment +$ +2,826 +$ +10,331 +$ +9,779 +Accrued purchases of intangibles +$ +2,411 +$ +2,265 +$ +1,386 +See notes to consolidated financial statements. +F-6 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. FORMATION AND BUSINESS OF THE COMPANY +Crocs, Inc. and its subsidiaries (collectively, the "Company") are engaged in the design, development, manufacturing, marketing and distribution of consumer products, primarily +casual and athletic shoes and shoe charms, from specialty resins referred to as Croslite. Wholly-operated subsidiaries include EXO Italia ("EXO"), which designs and develops EVA (Ethylene Vinyl +Acetate) based finished products, primarily for the footwear industry; Jibbitz, LLC ("Jibbitz"), a unique accessory brand with colorful snap-on charms specifically suited for the +Company's shoes; and Ocean Minded, LLC ("Ocean Minded"), which designs, manufactures, markets and distributes high quality leather and EVA based sandals primarily for the beach, adventure and +action sports markets. +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Basis of Consolidation —The consolidated financial statements include the accounts of Crocs, Inc. and all of its subsidiaries. All of the +Company's subsidiaries are 100% operated except for Crocs India Private Limited. The non-controlling interest in this subsidiary are immaterial and are included in Other (income) +expenses—net on the Company's consolidated statements of income and in Other liabilities on the Company's consolidated balance sheets. All intercompany transactions and balances are +eliminated in consolidation. The consolidated financial statements include the accounts of the Company and all entities that are wholly-operated by the Company, variable interest entities for which +the Company is the primary beneficiary, and entities that are not variable interest entities but are voting-controlled subsidiaries of the Company. +Management Estimates —The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United +States of America, ("GAAP"). These accounting principles require management of the Company to make certain estimates, judgments and assumptions. Management believes that the estimates, judgments and +assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, sales-returns and discounts, impairment assessments and charges, recoverability +of assets, including deferred tax assets, uncertain tax positions, share-based compensation expense, fair value of acquired intangibles, assessment of lower of cost or market on inventory, useful +lives assigned to long-lived assets, depreciation and provisions for contingencies, are reasonable, based on information available at the time they are made. These estimates, judgments and +assumptions can affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements, as well as the reported amounts of revenue and expenses during the +periods presented. Management also makes estimates in our assessments of potential losses in relation to threatened or pending legal and tax matters. See Note 18—Legal Proceedings. +Actual results could materially differ from these estimates. For matters not related to income taxes, if a loss is considered probable and the amount can be reasonably estimated, the Company +recognizes an expense for the estimated loss. If there is the potential to recover a portion of the estimated loss from a third party, the Company makes a separate assessment of recoverability and +reduces the estimated loss if recovery is also deemed probable. +Concentration of Risk —The Company's cash and cash equivalents are maintained in several different financial institutions in amounts that typically +exceed U.S. federally insured limits or in financial institutions in international jurisdictions where insurance is not provided. The Company has not experienced any losses in such accounts and +believes it is not exposed to significant credit risk. +F-7 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +The +Company considers its concentration risk related to accounts receivable to be mitigated by the Company's credit policy, the insignificance of outstanding balances owed by each +individual customer at any point in time and the geographic dispersion of these customers. +The +Company relies on both internal and external manufacturers for its products. Establishing a replacement source for the Company's product offerings could require significant +additional time and expense. +Variable Interest Entities —According to Financial Accounting Standards Board ("FASB") Interpretation ("FIN") No. 46R, "Consolidation of Variable Interest Entities" , incorporated in Accounting Standards Codification Topic 810 "Consolidations" ("ASC 810"), Variable Interest Entities +("VIEs") lack one or more of the characteristics of a voting interest entity as described +above. ASC 810 provides that a controlling financial interest in an entity is present when an entity has one or more variable interests that are expected to absorb a majority of the entity's expected +losses, receive a majority of the entity's residual returns, or both. The entity that is determined to be the primary beneficiary holds the controlling financial interest and is required to +consolidate the VIE. Accordingly, the Company consolidates VIEs in which the Company is deemed to be the primary beneficiary. +Fair Value of Financial Instruments —The carrying value of financial instruments, including cash equivalents, accounts receivable, accounts payable +and +accrued liabilities, approximate fair value due to their short maturities. Based on borrowing rates currently available to the Company, with similar terms, the carrying values of the capital lease +obligations and the line of credit approximate their fair values. +Cash and Cash Equivalents —Cash and cash equivalents represent cash and short-term, highly liquid investments with maturities of three +months or less at date of purchase. The Company considers receivables from credit card companies to be cash equivalents, if received within five days. The carrying amounts reflected in the +consolidated balance sheet for cash and cash equivalents approximate fair value due to the short maturities. +Restricted Cash —Restricted cash represents cash commitments primarily related to building and lease deposits. The classification of restricted cash +on +the consolidated balance sheet as current or noncurrent is dependent on the duration of the restriction and the purpose for which the restriction exists. +Accounts Receivable —Accounts receivable represent amounts due from customers. Accounts receivable are recorded at invoiced amounts, net of +reserves +and allowances, are not collateralized and do not bear interest. The Company uses its best estimate to determine the required allowance for doubtful accounts based on a variety of factors, including +the length of time receivables are past due, economic trends and conditions affecting our customer base, significant one-time events and historical write-off experience. +Specific provisions are recorded for individual receivables when we become aware of a customer's inability to meet its financial obligations. +Inventories —Raw materials and supplies are valued at the lower of cost, replacement cost, or net realizable value. Work in process and finished +goods +are valued at the lower of cost or net realizable value. Cost is determined on the first in, first out basis. The cost of work in process and finished goods consists of the cost of raw materials and +an applicable share of the cost of labor and manufacturing overhead. See Note 3—Inventories for further discussion. +F-8 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Marketable Securities —Marketable securities consist of certificates of deposit with maturities greater than three months and up to three years at +the +time of purchase. These securities, which are classified as available for sale, are carried at fair value, with unrealized gains and losses net of any tax effect reported in stockholders' equity as +accumulated other comprehensive loss, and are held at financial institutions. As of December 31, 2009, marketable securities of $0.9 million and $0.9 million are included in the +Prepaid and Other Assets and the long-term Other Assets line items, respectively, of the Company's consolidated balance sheets. The Company did not have any marketable securities as of +December 31, 2008. +Property and Equipment —Depreciation of machinery and equipment is computed using the straight-line method based on estimated useful lives +ranging from two to five years. Leasehold improvements are amortized on the straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. During +the years ended December 31, 2009, 2008 and 2007, we recorded depreciation expense of $29.7 million, $30.7 million and $17.0 million, respectively, of which +$15.6 million, $18.3 million and $11.3 million, were recorded in cost of sales, with the remaining amounts recorded in selling, general and administrative expenses. See +Note 4—Property and Equipment for further discussion. +Impairment of Long-Lived Assets —In accordance with ASC Topic 360 "Property, Plant and +Equipment" ("ASC 360"), the Company estimates the future undiscounted cash flows to be derived from an asset to assess whether or not a potential impairment exists when events +or circumstances indicate the carrying value of a long-lived asset, including property and equipment and finite-lived intangible assets, may be impaired. If the carrying value exceeds the +estimate of future undiscounted cash flows, the Company calculates the impairment as the excess of the carrying value of the asset over the estimate of its fair value. See +Note 4—Property and Equipment and Note 5—Goodwill and Intangibles for further discussion. +Capitalized Software —The Company capitalizes certain internal and external software acquisition and development costs that benefit future years in +accordance ASC Topic 350 " Intangibles—Goodwill and Other " ("ASC 350"). Internal-use capitalized software costs are amortized +over their expected useful life, which is generally seven years. The Company capitalizes certain costs associated with software such as costs of employees and contractors devoting time to the software +development projects and external direct costs for materials and services. Initial costs associated with internally-developed-and-used software are expensed until management +determines, based on its judgment, that the project has reached the application development stage. After the application development stage is achieved, subsequent additions, modifications or upgrades +to internal-use software are capitalized only to the extent that they allow the software to perform a task it previously did not perform. Software maintenance and training costs are +expensed in the period in which they are incurred. As of December 31, 2009, capitalized software consisted primarily of our enterprise resource system software, warehouse management software +and point of sale software. Ongoing assessments of the recoverability of capitalized software development costs require management to make judgments. At least annually, we consider the potential +impairment of capitalized software using guidance in ASC 360. In accordance with this guidance, we consider the substantive service potential of the software, changes in the extent or manner in which +the software is used or is expected to be used, significant changes made or planned to be made to the software, and the actual cost of software development or modification compared to expected cost. +As a result of this analysis, we determined that an impairment should be recorded +F-9 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +related +to capitalized software as of December 31, 2009. See Note 5—Goodwill and Intangibles Assets for further discussion. +Identifiable Intangible Assets and Goodwill —In accordance with ASC Topic 350, goodwill represents the excess purchase price paid over the fair +value +of assets acquired and liabilities assumed in acquisitions. The Company assesses goodwill for impairment annually on the last day of the fourth quarter, or more frequently if events and circumstances +indicate impairment may have occurred. If the carrying value of goodwill, including intangibles with indefinite lives, exceeds its implied fair value, the +Company records an impairment loss equal to the difference. Indefinite-lived intangible assets primarily consist of acquired trade names. See Note 5—Goodwill and Intangible Assets +for further discussion. +Earnings per Share —Basic earnings (loss) per common share ("EPS") is computed by dividing the net income available to common stockholders by the +weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from securities that could share in the earnings of the Company. +Anti-dilutive securities are excluded from diluted EPS. +Recognition of Revenues —Revenues are recognized when the customer takes title and assumes risk of loss, collection of related receivables is +reasonably assured, persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer depending on the country of the +sale and the agreement with the customer. Allowances for estimated returns, allowances and discounts are recognized as a reduction of the related revenue when it is recorded. +Shipping and Handling Costs —Shipping and handling costs are expensed as incurred and included in cost of sales. Freight billed to customers is +included in revenues. +Share-Based Compensation —In accordance with ASC Topic 718 "Compensation—Stock +Compensation" ("ASC 718"), we use the prospective method for option grants and restricted stock issued prior to August 15, 2005, the date on which the Company filed its +initial Registration Statement on Form S-1, and the modified prospective method for option grants issued after August 15, 2005. The Company was required to adopt the +prospective method for grants prior to August 15, 2005 as the Company had elected to value employee grants using the minimum value method under ASC 718. For option grants and restricted +stock accounted for under the prospective method, the Company will continue to account for the grants under the intrinsic value-based method. Therefore, the Company does not record any compensation +expense for stock options granted to employees prior to August 15, 2005 if the exercise price equaled the fair market value of the stock option on the date of grant, and the exercise price, +number of shares eligible for issuance under the options and vesting periods were fixed. +ASC +718 generally requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their +grant-date fair +values. ASC 718 also requires the fair value of outstanding options vesting after the date of initial adoption to be recognized as a charge to operations over the remaining vesting period. +As +a result of the adoption of ASC 718, we began (i) using the fair value method to recognize share-based compensation and (ii) estimating forfeitures for purposes of +recognizing the remaining fair value of all unvested awards. In addition, we use the straight-line method to recognize stock-based +F-10 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +compensation +expense over the vesting term for employees and non-employees for our outstanding stock awards granted after January 1, 2006. +Deferred +compensation represents the unvested portion of employee grants made prior to August 15, 2005 and is recorded as a reduction of equity. The fair value of employee grants +is fixed at date of grant, or the measurement date, if later, while grants to non-employees are remeasured to fair value at each reporting period until vesting occurs. See +Note 10—Equity for further discussion. +During +the fourth quarter of 2009, the Company identified an error in the calculation of stock-based compensation expense that effected its previously issued 2008 consolidated financial +statements. The error was identified after the Company's third-party equity accounting software provider notified its clients, including the Company, that it made a change to how its software program +calculates stock-based compensation expense. Specifically, the prior version of this software calculated stock-based compensation expense by incorrectly continuing to apply a weighted average +forfeiture rate to the vested portion of stock option awards until the grant's final vest date rather than reflecting actual forfeitures as vested, resulting in an understatement of stock-based +compensation expense in certain periods prior to the grant's final vest date in 2008 and 2009. Because the Company's stock option awards generally vest on a monthly basis after the first anniversary +date of the award, the Company under-recognized stock-based compensation expense in certain periods. This error changes the timing of stock-based compensation expense recognition, but does not change +the total stock-based compensation expense. As stock-based compensation expense is a non-cash item, this error did not impact net cash provided by operations in any period. This error +resulted in the understatement of stock-based compensation expense, with a corresponding understatement of additional paid in capital, in the approximate amounts of $4.5 million in 2008 which +has been corrected in 2009. The Company does not believe that either the understatement of stock-based compensation expense in 2008 or the related effect of correcting the error in 2009 are material. +Advertising —Advertising costs are expensed as incurred and production costs are generally expensed when the advertising is first run. Advertising +expenses were $7.4 million, $16.8 million, and $5.5 million for the years ended December 31, 2009, 2008, and 2007, respectively and are included in selling, general, and +administrative expenses. +Research and Development —Research and development costs are expensed as incurred. Research and development expenses amounted to $7.7 million, +$6.4 million, and $5.3 million for the years ended December 31, 2009, 2008, and 2007, respectively, and are included in Selling, general, and administrative expenses in our +Consolidated Statement of Operations. +Foreign Currency Translation and Foreign Currency Transactions —The U.S. dollar is the Company's reporting currency. Assets and liabilities of +foreign +operations denominated in local currencies are translated at the rate of exchange at the balance sheet date. Revenues and expenses are translated at the weighted average rate of exchange during the +applicable period. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are included in the foreign currency translation adjustment, a component of +accumulated other comprehensive income in stockholders' equity. Gains and losses generated by transactions denominated in foreign currencies are recorded in Selling, general and administrative expense +in our Consolidated Statement of Operations in the period in which they occur. +F-11 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +For +the year ended December 31, 2009, the Company recognized realized losses and unrealized gains on foreign currency transactions of $10.6 million and +$11.3 million, respectively. For the year ended December 31, 2008, the Company recognized realized losses and unrealized losses on foreign currency transactions of $3.8 million +and $21.6 million, respectively. For the year ended December 31, 2007, the Company recognized realized losses and unrealized gains on foreign currency transactions of $1.5 million +and $8.6 million, respectively. These foreign currency exposures are primarily associated with payables and receivables arising from intercompany transactions. As these costs are associated +with operational activities, the associated realized and unrealized gains and losses have been included within Foreign currency transaction loss (gains), net in our Consolidated Statement of +Operations. +Derivative Foreign Currency Contracts —The Company is exposed to global market risks, including the effect of changes in foreign currency exchange +rates. During the year ended December 31, 2007, the Company used derivatives to manage financial exposures that occur in the normal course of business. The Company does not hold or issue +derivatives for trading purposes. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for +undertaking hedge transactions. This process includes linking all derivatives to either specific assets and liabilities on the balance sheet, specific firm commitments or forecasted transactions. The +Company has entered into forward exchange contracts to +hedge certain portions of future cash flows denominated in foreign currencies. These contracts were not designated as hedges under ASC 815 "Derivatives and +Hedging" . The futures contracts were marked to market and gains and losses were recognized in earnings. The net realized gains and losses for these contracts were not material +for the years ended December 31, 2009, 2008 and 2007. The Company has no unsettled derivative contracts as of December 31, 2009. +Income Taxes —The Company accounts for income taxes using the asset and liability method. This approach requires the recognition of deferred tax +assets +and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. The Company provides for income taxes +at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. Prior to the Company's conversion to a C corporation on January 4, 2005, the Company was not a +taxpaying entity for U.S. federal and state income tax purposes. +Effective +January 1, 2007, the Company adopted FIN 48, " Accounting for Uncertainty in Income Taxes", which has been +incorporated in ASC Topic 740 "Income Taxes" ("ASC 740"). ASC 740 requires the use of a two-step approach for recognizing and measuring tax +benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The adoption of ASC 740 did not have a material impact on the Company's +consolidated balance sheet, statement of operations or cash flows. We recognize interest and penalties related to income tax matters in Income tax expense in our Consolidated Statement of Operations. +See Note 13—Income Taxes for further discussion. +Taxes Assessed by Governmental Authorities —Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, +including +value added tax, are recorded on a net basis and are therefore excluded from sales, as allowed under ASC 605-45-50-3, "Taxes Collected from +Customers and Remitted to Governmental Authorities" . +F-12 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Reclassifications —The Company reclassified foreign currency transaction losses (gains), net and charitable contributions in the statement of +operations from selling, general, and administrative expenses. There was no change to income (loss) from continuing operations as a result of these reclassifications. +Recent Accounting Pronouncements —In June 2009, the FASB issued FASB Statement No. 167, Amendments to FASB +Interpretation No. 46(R ), which amends FASB Interpretation No. FIN46(R), Consolidation of Variable Interest Entities, +("FIN 46 (R)") and is incorporated into ASC Topic 810, Consolidation , to require an enterprise to perform an analysis to determine whether the +enterprise's variable interest gives it a controlling financial interest in a variable interest entity and to require ongoing reassessments of this nature. The standard amends certain guidance in +FIN 46 (R) for determining whether an entity is a variable interest entity and adds additional reconsideration for making this determination when facts or circumstances change. The +standard requires enhanced disclosures that will provide more transparent information about an entity's involvement in a variable interest entity. The standard is effective for the fiscal year that +begins after November 15, 2009. The Company does not expect the adoption of this standard to have a material impact on the Company's consolidated financial statements. +In +June 2009, the FASB issued Accounting Standards Update ("ASU") 2009-01, Generally Accepted Accounting Principles; Amendments based on Statement of +Financial Accounting Standards No. 168—The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles ("ASU +2009-01"), to amend the ASC Topic 105, Generally Accepted Accounting Principles , to establish the FASB Accounting Standards Codification as +the source of authoritative accounting principles recognized by the FASB to be applied in the preparation of financial statements. The codification also contains interpretive releases of the SEC under +federal securities laws and is a source of authoritative GAAP for SEC registrants. ASU 2009-01 is effective for financial statements issued for interim and annual periods ending after +September 15, 2009 and shall be applied prospectively. The adoption of this standard did not have a material impact on the Company's consolidated financial statements. +F-13 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +In August 2009, the FASB issued ASU 2009-05, Measuring Liabilities at Fair Value ("ASU 2009-05"), an update to ASC +Topic 820-10, Fair Value Measurements and Disclosures—Other. ASU 2009-05 provides amendments to the fair value +measurement of liabilities and provides clarification on valuation techniques for liabilities for which a quoted price for an identical liability in an active market is not available. The amendments +also clarify that, when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a +restriction that prevents the transfer of the liability. ASU 2009-05 also provides amendments to clarify that both a quoted price in an active market for the identical liability at the +measurement date and the quoted price for +the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. The guidance provided +in ASU 2009-05 is effective for the first reporting period (including interim periods) beginning after September 1, 2009 and shall be applied prospectively. The Company does not +expect the adoption of this standard to have a material impact on the Company's consolidated financial statements. +3. INVENTORIES +Inventories by major classification are as follows (in thousands): +December 31, +2009 +2008 +Finished goods +$ +88,775 +$ +126,078 +Work-in-progress +220 +184 +Raw materials +4,334 +16,943 +$ +93,329 +$ +143,205 +During +the year ended December 31, 2009, the Company donated certain inventory items to charitable organizations. The inventory items consisted of end of life units, some of which +were fully valued, partially impaired or fully impaired. The contributions made were expensed at their fair value of $7.5 million for the year ended December 31, 2009, in accordance with +ASC Sub-Topic 720-25, Contributions Made. As the fair value of the inventory contributed exceeded its carrying amount, a gain +was recognized of $3.2 million for the year ended December 31, 2009, resulting in a net reduction of inventory of $4.3 million as of December 31, 2009. +In +the year ended December 31, 2008, the Company recorded approximately $76.3 million of inventory write-down charges and an additional $4.2 million in +charges related to losses on future purchase commitments for inventory with a market value lower than cost, of which $2.1 million was included as an accrued expense as of December 31, +2008. These charges are reported in the cost of sales line item in the consolidated statement of operations for the year ended December 31, 2008. As of December 31, 2009, no amount +remains accrued for losses on purchase commitments. +F-14 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +4. PROPERTY AND EQUIPMENT +Property and equipment includes the following (in thousands): +December 31, +2009 +2008 +Machinery and equipment +$ +82,733 +$ +108,552 +Leasehold improvements +38,436 +32,771 +Subtotal +121,169 +141,323 +Less accumulated depreciation and amortization +(50,085 +) +(45,431 +) +Total Property and Equipment +$ +71,084 +$ +95,892 +Depreciation +of machinery and equipment is computed using the straight-line method based on estimated useful lives ranging from two to five years. Leasehold improvements are +amortized on the straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. During the years ended December 31, 2009, 2008 and 2007, we +recorded depreciation expense of $29.7 million, $30.7 million and $17.0 million, respectively, of which $15.6 million, $18.3 million and $11.3 million, were +recorded in cost of sales, with the remaining amounts recorded in selling, general and administrative expenses. As the Company translates the ending fixed assets and accumulated depreciation balances +utilizing the balance sheet exchange rate and records depreciation expense using the weighted average of exchange rates for the applicable period, a difference between the recorded depreciation +expense and the change in accumulated depreciation exists. +Certain +equipment held under capital leases in the amounts of $0.4 million and $9,000 net of accumulated depreciation at December 31, 2009 and 2008, respectively, are +classified as equipment and amortized using the straight-line method over the lease term. Amortization of equipment under capitalized leases is included in depreciation expense. +During +the year ended December 31, 2009, the Company recognized an impairment charge of $18.5 million on fixed assets, primarily related to shoe molds and distribution +facility assets. Of the impairment charge recognized, $2.1 million was in the Europe segment, $4.8 million was in the Americas segment and $11.6 million was in the Corporate and +other group. The impairment charge on molds related primarily to shoe styles that the Company either no longer intends to manufacture or styles for which the Company has more molds on hand than +necessary to meet projected demand. The impairment charge on distribution facility assets related to equipment and fixtures for the Company's warehouse and distribution centers that were closed and +consolidated. These charges are recorded in the impairment charges line item of the consolidated statement of operations for the year ended December 31, 2009. The impairments are accounted for +as assets to be abandoned, in accordance with ASC Section 360-35-15, Impairment or Disposal of Long-Lived +Assets . +During +the year ended December 31, 2008, the Company recognized an impairment charge of $20.9 million on fixed assets, primarily related to equipment and shoe molds. Of the +impairment charge recognized, $11.3 million was in the Americas segment, $4.4 million was in the Europe segment and $5.2 million was in the Corporate and other group. Management +evaluated the production capacity at Company-operated facilities compared with demand projections and capacity requirements and made the decision to abandon certain tooling and equipment that +represented excess capacity. These charges are recorded in the impairment charges line item of the consolidated statement of operations for the year ended December 31, 2008. +F-15 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +4. PROPERTY AND EQUIPMENT (Continued) +At +December 31, 2009, the Company classified $0.3 million as assets held for sale, primarily in connection with the closure and consolidation of certain of the Company's +distribution and manufacturing facilities. The assets held for sale consist of equipment, vehicles and fixtures and were recorded on the consolidated balance sheet at the lower of carrying value or +fair value less costs to sell, in accordance with ASC Paragraph 360-10-35-43, Accounting While Held for Sale , +and are included in the line item prepaid expenses and other current assets on the Company's consolidated balance sheet. During the year ended December 31, 2009, $0.5 million in proceeds +were received on the sale of assets previously classified as held for sale, and a $0.2 million gain was recognized on the sale and recorded in the line item selling, general and administrative +expenses on the Company's consolidated statements of operations. +5. GOODWILL AND INTANGIBLE ASSETS +Goodwill +The Company's goodwill balance of $23.8 million as of December 31, 2007, was primarily related to the acquisitions of +Ocean Minded and Bite in 2007, Jibbitz and Fury in 2006, and Crocs Canada in 2004. +The +goodwill balance of Fury in the amount of $1.0 million was written off in the three months ended March 31, 2008 prior to its liquidation in June 2008. +During +the three months ended September 30, 2008, the Company's stock price declined substantially, which represented a triggering event for potential goodwill impairment. +Accordingly, at September 30, 2008, the Company performed an interim goodwill impairment evaluation. Goodwill and intangible assets with indefinite lives must be tested for impairment at least +once a year or more frequently if management believes indicators of impairment exist. Carrying values are compared with fair values, and when the carrying value exceeds the fair value, the carrying +value of the impaired asset is reduced to its fair value. +Management +reviewed the results of the preliminary analysis and concluded that the entire $22.8 million balance of the Company's goodwill was impaired at September 30, +2008. Management reviewed the results of the final analysis completed during the fourth quarter of 2008 and concluded that the provisional impairment adjustment recorded at September 30, 2008 +should not be revised and that the Company's goodwill was fully impaired as of December 31, 2008, the Company's annual goodwill impairment evaluation date. +The +following table summarizes the activity in the Company's goodwill account during the year ended December 31, 2008 (in thousands): +Balance at December 31, 2007 +$ +23,759 +Less: Goodwill impairment charges +(23,867 +) +Impact of foreign currency translation +108 +Balance at December 31, 2008 +$ +— +F-16 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +5. GOODWILL AND INTANGIBLE ASSETS (Continued) +Intangible Assets +During the year ended December 31, 2009, the Company recognized an impairment charge of $7.6 million on intangible +assets. The impairment charge is primarily related to the Company's decision to no longer pursue the Tagger International B.V ("Tagger") brand and the decision to discontinue the use of certain +capitalized software assets as part of the Company's restructuring activities and is included with the Americas segment. These charges are recorded in the impairment charges line item of the +consolidated statement of operations for the year ended December 31, 2009, and are accounted for as assets to be abandoned, in accordance with ASC +Section 360-35-15, Impairment or Disposal of Long-Lived Assets. +In +June 2008, the Company decided to liquidate Fury after efforts to sell the entity were unsuccessful. As a result, the Company wrote off $0.3 million related to the remaining +customer relationship intangible assets and trademarks. Fury is included within the Americas segment. +As +a result of the Company's evaluation of indefinite lived intangible assets, performed for the year ended December 31, 2008, the Jibbitz trade name, with a book value of +approximately $0.2 million, and patents the Company no longer intends to utilize, with a book value of approximately $0.6 million, were fully impaired. Jibbitz is included within the +Americas segment. +The +following table summarizes the Company's identifiable intangible assets at December 31, 2009 and 2008 (in thousands): +2009 +2008 +Gross +Carrying +Amount +Accumulated +Amortization +Net +Carrying +Amount +Gross +Carrying +Amount +Accumulated +Amortization +Net +Carrying +Amount +Intangible assets: +Patents, copyrights, and trademarks +$ +5,673 +$ +1,396 +$ +4,277 +$ +8,190 +$ +694 +$ +7,496 +Customer relationships +5,928 +4,912 +1,016 +6,075 +3,685 +2,390 +Core technology +4,614 +4,614 +— +4,001 +3,602 +399 +Non-competition agreement +636 +594 +42 +636 +466 +170 +Capitalized software +38,884 +8,235 +30,649 +35,309 +4,872 +30,437 +Total Intangible assets +$ +55,735 +$ +19,751 +$ +35,984 +$ +54,211 +$ +13,319 +$ +40,892 +Intangible +assets that are determined to have finite lives are amortized over their useful lives on a straight-line basis for patents, core technology, +non-competition agreement and capitalized software. Customer relationships are amortized on a straight-line basis or an accelerated basis. For the years ended +December 31, 2009, 2008 and 2007, amortization expense recorded for intangible assets with finite lives was $7.0 million, $6.6 million and $4.1 million, respectively, of +which $1.6 million, $0.9 million and nil was recorded in cost of sales, respectively,with the remaining amounts recorded in selling, general and administrative expenses. For amortizable +intangible assets denominated in a foreign currency, the Company translates the ending asset and accumulated amortization at the balance sheet rate and records amortization expense using the weighted +average rate of exchange for the applicable period. A difference between the recorded amortization expense and the change in accumulated +F-17 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +5. GOODWILL AND INTANGIBLE ASSETS (Continued) +amortization +exists. Below are the weighted average amortization periods by major intangible asset class for the Company as of December 31, 2009. +Intangible Asset Class +Weighted Average Amortization Period +Patents +10 years +Customer Relationships +estimated customer life +Core Technology +5 years +Non-competition Agreement +Contractual term +Capitalized Software +Shorter of 7 years or remaining life of technology +Estimated +future annual amortization of intangible assets is as follows (in thousands): +Fiscal years ending December 31, +Amortization +2010 +$ +7.3 +2011 +7.0 +2012 +6.6 +2013 +6.0 +2014 +4.6 +Thereafter +4.5 +Total +$ +36.0 +Certain +software held under a capital lease in the amount of $1.5 million net of accumulated amortization is classified as capitalized software and amortized using the +straight-line method over the useful life. Amortization of capitalized software under capitalized leases is included in amortization expense on the Company's consolidated statements of +operations. +6. ACQUISITIONS +On April 1, 2008, the Company acquired substantially all of the assets of Tidal Trade, Inc. ("Tidal Trade"), the Company's third-party distributor in South Africa, for +$4.6 million. The Company recorded $1.4 million in customer relationships on the date of acquisition. As part of the acquisition, the Company repurchased inventory previously sold to +Tidal Trade and accordingly recognized a reduction of revenue of approximately $2.1 million. +On +April 2, 2008, the Company acquired substantially all of the assets of Tagger, a private limited liability company incorporated under the laws of the Netherlands that +manufactures messenger bags. Tagger was partially operated by the Managing Director of Crocs Europe B.V. The Company acquired all of the assets of Tagger for $2.0 million, of which +approximately $90,000 was assigned to inventory and the remaining $1.9 million was assigned to the value of the Tagger trademark on the date of acquisition. For the year ended +December 31, 2009, we made the decision to no longer pursue the Tagger International B.V ("Tagger") brand and, accordingly, recorded an impairment charge of $1.9 million to impair the +assets related to the acquisition as discussed in Note 5—Goodwill and Intangible Assets. +F-18 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +6. ACQUISITIONS (Continued) +See +Note 5—Goodwill and Intangible Assets for further discussion of impairment of goodwill and intangible assets originally recorded in connection with the +aforementioned acquisitions. +7. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES +Accrued expenses and other liabilities include the following (in thousands): +December 31, +2009 +2008 +Accrued compensation and benefits +$ +21,007 +$ +10,178 +Fulfillment and freight and duties +10,765 +7,832 +Professional services +4,329 +4,340 +Sales/Use tax payable +4,330 +3,577 +Accrued loss on purchase commitments +— +2,102 +Distributor inventory buyback +— +5,260 +Other +13,149 +16,787 +$ +53,580 +$ +50,076 +8. RESTRUCTURING ACTIVITIES +During the year ended December 31, 2009, the Company announced its decision to further restructure its operations and has made certain organizational changes in order to better +align costs with revenues. This decision included the closure of various warehouses and office buildings as well as settlement and termination of contracts prior to term. During the year ended +December 31, 2009, the Company incurred restructuring charges of $14.7 million, of which $7.1 million is included in costs of sales. Of the restructuring charges taken, +$5.6 million related to the termination of operating leases and other costs associated with closing the facilities and relocating employees; $3.8 million related to the termination of +its manufacturing agreement with a third party in Bosnia and its sponsorship agreement with Association of Volleyball Professionals ("AVP"); $1.1 million related to obtaining a release from any +further obligations under the purchase agreement with Bite, LLC; and $0.5 million relating to the termination of consulting arrangements with former key employees. Additional +restructuring charges included $3.7 million in severance costs, consisting primarily of $0.4 million for the restructuring of the Company's distribution facilities in Europe and Asia; +$0.4 million in severance and $0.4 million in stock compensation expense related to the Company's separation agreement with its former General Counsel; and $1.6 million of stock +compensation and $0.2 million in deferred compensation expense in connection with the Company's separation agreement with its former Chief Executive Officer in which certain stock options, +restricted stock awards and deferred compensation were accelerated. See Note 10—Equity for further discussion. +Of +the restructuring charges discussed above, $6.3 million was in the Americas segment, $3.4 million was in the Europe segment, $0.4 million was in the Asia segment +and $4.5 million was in the Corporate and other group. +During +the year ended December 31, 2008, the Company announced its decision to restructure its operations. This decision included the closure of its Canadian and Brazilian +manufacturing facilities and the consolidation of Canadian distribution activities into other existing North American operations. The +F-19 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +8. RESTRUCTURING ACTIVITIES (Continued) +Company +has established reserves to cover future known obligations related to the closure of the Canadian and Brazilian manufacturing operations and the move of the Canadian distribution operations. +During +2008, the Company sold assets relating to the Company's Canadian manufacturing operations for a net gain of approximately $0.8 million. The gain on disposal of assets is +recorded in the selling, general and administrative expenses on the consolidated statement of operations for the year ended December 31, 2008. There were no assets held for sale as of +December 31, 2008. +Reserves +are included in the line items accrued restructuring charges and long-term restructuring in the Company's consolidated balance sheets and are recorded under the line +item restructuring charges within costs of sales and selling, general and administrative expenses on the Company's consolidated statements of operations. +Reserves +at December 31, 2009, were $3.1 million, consisting of $0.5 million of accrued termination benefits, $2.2 million of rent obligations for leased +facilities, net of expected sublease income, and $0.4 million of contract termination fees and termination benefits accounted for in accordance with ASC Topic 712 +" Compensation—Nonretirement Post Employment Benefits" and ASC Topic 420 "Exit or Disposal Cost +Obligations ". +The +following table details the changes in the restructuring accruals during the year ended December 31, 2009 (in thousands): +Description +Year Ended +December 31, +2008 +Additions +Cash +Payments +Adjustments(1) +Year Ended +December 31, +2009 +Termination benefits +$ +676 +$ +1,711 +$ +(2,111 +) +$ +240 +$ +516 +Operating lease exit costs +$ +1,488 +5,586 +(4,089 +) +(752 +) +$ +2,233 +Other restructuring costs +$ +234 +5,306 +(5,192 +) +39 +$ +387 +$ +2,398 +$ +12,603 +$ +(11,392 +) +$ +(473 +) +$ +3,136 +(1) Adjustments +relate primarily to the exit of a portion of a facility lease in Canada and differences resulting from the translation of the liability balance +at the balance sheet rate and restructuring expense translated at the weighted average rate of exchange for the applicable period. +F-20 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS +Notes payable and capital lease obligations consist of the following (in thousands): +December 31, +2009 +2008 +Revolving credit facility +$ +— +$ +22,422 +Capital lease obligations +640 +9 +Long-term portion of capital lease obligations +911 +— +Total notes payable and capital lease obligations +$ +1,551 +$ +22,431 +Notes Payable +As of December 31, 2008, the Company had $22.4 million in outstanding borrowings on its Revolving Credit Facility with +Union Bank of California, N.A. The Company initially entered into the Revolving Line of Credit agreement on May 8, 2007, the agreement was amended eleven times to extend the maturity date and +adjust the interest rate, as well as to modify the agreement from an unsecured line of credit to be secured by substantially all of the Company's intellectual property. On August 3, 2009, the +Company fully repaid its remaining obligation on its Revolving Credit Facility prior to its maturity date of September 30, 2009. The Revolving Credit Facility was effectively terminated upon +full repayment. The Company did not incur any penalties for the early payment and termination of the Revolving Credit Facility. +On +September 25, 2009, the Company entered into a Revolving Credit and Security Agreement (the "Credit Agreement") with PNC Bank, N.A., which matures on September 25, 2012. +The Credit Agreement provides for an asset-backed revolving credit facility of up to $30 million in total, which includes a $17.5 million sublimit for borrowings against the Company's +eligible inventory, a $2 million sublimit for borrowings against the Company's eligible inventory in-transit, and a $4 million sublimit for letters of credit. The total +borrowings available under the Credit Agreement at any given time are subject to customary reserves and reductions to the extent the Company's asset borrowing base changes. Borrowings under the Credit +Agreement are secured by all of the assets of the +Company, including all receivables, equipment, general intangibles, inventory, investment property, subsidiary stock and leasehold interests. The Credit Agreement requires the Company to prepay +borrowings under the Credit Agreement in the event of certain dispositions of property. +Principal +amounts outstanding under the Credit Agreement bear interest at a two percent (2%) premium over a rate that is the greater of either (i) PNC's published reference rate, +(ii) the Federal Funds Open Rate in effect on such day plus one half of one percent (0.5%) or, (iii) the sum of the daily LIBOR rate and one percent (1.0%), with respect to domestic rate +loans. Eurodollar denominated principal amounts outstanding under the Credit Agreement bear interest at the sum of three and one half percent (3.50%) premium over a rate that is the greater of +(i) the Eurodollar rate, or (ii) one and one half percent (1.50%) with respect to Eurodollar loans, as applicable. The Credit Agreement requires monthly interest payments with respect to +domestic rate loans and at the end of each period with respect to Eurodollar rate loans. +The +Credit Agreement contains certain customary restrictive and financial covenants. The Company was in compliance with these financial covenants as of December 31, 2009. +F-21 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS (Continued) +As +of December 31, 2009, the Company had an immaterial amount of outstanding borrowings under the Credit Agreement and had issued and outstanding letters of credit of +$1.1 million which were reserved against the borrowing base. During the year ended December 31, 2009, $0.5 million in fees and third-party costs incurred in connection with the +Credit Agreement were capitalized as deferred financing costs. +10. EQUITY +On November 1, 2007, the Company's board of directors approved an authorization to repurchase up to one million shares of its common stock. On April 14, 2008, the board of +directors also approved an additional authorization to repurchase an additional 5,000,000 shares of our common stock. Share repurchases under these authorizations may be made in the open market or in +privately negotiated transactions. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements and other market +conditions. The repurchase authorizations do not have an expiration date and do not obligate the Company to acquire any particular amount of shares of its common stock. The repurchase authorizations +may be modified, suspended or discontinued at any time. On November 7, 2007, the Company repurchased approximately 524,000 shares for a total of approximately $25.0 million. +On +November 11, 2009, the Compensation Committee approved "withhold to cover" as a tax payment method for certain named executive officers (NEOs) vesting in restricted stock +awards. Four elections were made in 2009 in which a total of 41,179 shares were withheld and placed in treasury, increasing the treasury share balance to 565,179 at December 31, 2009. +Share-Based Compensation +Under the modified prospective method, compensation expense recognized in the year ended December 31, 2009, includes: +(i) compensation expense of all share-based payments granted after August 15, 2005 but not yet vested as of January 1, 2006, based on the grant-date fair value +estimated in accordance with ASC Topic 718 " Compensation—Stock Compensation " ("ASC 718"), and (ii) compensation expense for all +share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of ASC 718. Results for prior periods have not been +retrospectively adjusted. The Company records compensation expense related to non-employees under the provisions of ASC 718 and Emerging Issues Task Force EITF 96-18, Accounting for Equity Instruments that are Issued to +Other than Employees for Acquiring, or in conjunction with Selling, Goods or Services +("EITF 96-18"), as codified in ASC Topic 505 "Equity" , and recognizes compensation expense over the vesting periods of such awards. +Total pre-tax share-based compensation expense, including options and non-vested shares, was $33.6 million, including $2.2 which is included in restructuring charges, +for the twelve months ended December 31, 2009. Included in this is $16.3 million related to the Company's tender offer that was completed in April 2009. Also included in the +$33.6 million of share-based compensation expense is $2.0 million of accelerated vesting charges related to the separation agreements with the Company's former Chief Executive Officer +and former Vice President, General Counsel and Secretary, which are included as restructuring charges, and are discussed further below. Total pre-tax share-based compensation expense +recognized was $19.0 million, and $21.7 million for the years ended December 31, 2008, and 2007. Due to our loss position in the year ended December 31, 2009 and 2008, the +Company did not recognize any associated tax benefits. Associated tax benefits in the year ended December 31, 2007 were approximately $6.4 million. +F-22 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. EQUITY (Continued) +Capitalization +of the stock based compensation into inventory and intangibles as part of the overhead allocation was $528,267 and $117,707, respectively, for 2009 and $150,000 and $49,000 for 2008. +ASC +718 also required the Company to change the classification of any excess tax benefits realized on the exercise of stock options or issuance of restricted stock unit awards in excess +of that which is associated with the expense recognized for financial reporting purposes in its consolidated statement of cash flows. These amounts are presented as a financing cash inflow rather than +as a reduction of income taxes paid in the consolidated statement of cash flows. +The +Company has computed the fair value of options granted using the Black-Scholes option pricing model. In order to calculate the fair value of the options, certain assumptions are made +regarding components of the model, including risk-free interest rate, volatility, expected dividend yield rate, and expected option term. Changes to the assumptions could cause significant +adjustments to the valuation. For options granted before August 15, 2005, expected volatility was not considered for employee grants as the Company was a non-public entity at the +grant date of these options. For stock option grants issued after the filing of the Company's initial Registration Statement +on Form S-1 on August 15, 2005, the minimum value method is no longer used and the Company used a volatility rate of 50-60% and began to include estimated +forfeiture rates. The Company estimated the volatility of its common stock at the date of grant based on the historical volatility of the underlying shares of common stock as well as the historical +volatility of comparable companies. The Company factored in historical forfeiture rates, expected future retention rates, and vesting periods of the options to determine the average expected term. The +risk-free interest rate for periods within the contractual life of the options is based on the U.S. Treasury yield curve in effect at the time of each grant. Accordingly, the Company has +computed the fair values of all options granted during the years ended December 31, 2009, 2008 and in 2007 using the Black-Scholes option pricing model and the following assumptions: +Year Ended December 31, +2009 +2008 +2007 +Expected volatility +50 - 60% +50 +% +50 +% +Dividend yield +— +— +— +Risk-free interest rate +1.44% - 2.75% +2.81 +% +4.58 +% +Expected life (in years) +4.59 - 6.86 +4.59 +5.0 +Equity Incentive Plans +There were 134,228 stock options outstanding as of December 31, 2009 that were granted to officers, directors and employees +prior to the adoption of the 2005 Equity Incentive Plan. Following the adoption of the 2007 Plan, no future grants may be made from this Plan. +The +Company adopted the 2005 Equity Incentive Plan (the "2005 Plan") on August 15, 2005. The Plan permits the grant of non-qualified stock options, incentive stock +options, and restricted stock to eligible employees, consultants and non-employee members of our Board of +Directors. As of December 31, 2009, 2,663,625 options were outstanding under the 2005 Plan and no shares were available for future issuance under the 2005 Plan. +The +Company adopted the 2007 Equity Incentive Plan (the "2007 Plan") on July 19, 2007. The Plan permits the grant of non-qualified stock options, incentive stock +options, restricted stock, restricted +F-23 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. EQUITY (Continued) +stock +units, stock appreciation rights, performance units, common stock or any other stock-based award to eligible employees, consultants and non-employee members of our Board of +Directors. As of December 31, 2009, 5,906,417 options, restricted stock and awards were outstanding under the 2007 Plan and 1,756,874 shares were available for future issuance under the 2007 +Plan. +Stock +options under both the 2005 Plan and the 2007 Plan generally vest ratably over four years with the first year vesting on a "cliff" basis followed by monthly vesting for the +remaining three years. Restricted stock awards generally vest ratably over three years. +Stock Option Activity +The following summarizes stock option transactions under the 2005 and 2007 Plans for the year ended December 31, 2009: +Options +Shares +Weighted +Average +Exercise Price +Weighted Average +Remaining +Contractual Life +(Years) +Aggregate +Intrinsic Value +(in thousands) +Outstanding at December 31, 2008 +9,898,462 +$ +14.62 +7.65 +$ +293 +Granted +2,412,000 +3.64 +Exercised +(575,817 +) +2.17 +Forfeited or expired +(3,979,391 +) +23.29 +Outstanding at December 31, 2009 +7,755,254 +$ +7.67 +7.48 +$ +15,290 +Exercisable at December 31, 2009 +3,723,422 +$ +9.33 +5.95 +$ +6,456 +Vested and expected to vest at December 31, 2009 +6,052,995 +$ +7.94 +7.11 +$ +11,697 +Options +awarded under the 2005 Plan prior to September 30, 2006 are exercisable immediately on the date of grant with the exception of 408,842 shares granted to members of the +Board of Directors. In order to preserve the vesting provisions of the immediately exercisable options, the options that are exercised early are subject to a repurchase right by the Company at the +lower of exercise price or fair market value of the underlying stock at the date of repurchase. This repurchase right expires on vesting of the underlying option. Immediately exercisable stock options +outstanding under the 2005 Plan were 1,603,413 at December 31, 2009 of which 1,499,950 are fully vested and no longer subject to the repurchase right. Options awarded after October 1, +2006 are exercisable as they vest. As of December 31, 2009, no options have been exercised early. +The +weighted average fair value of options granted during the years ended December 31, 2009 and 2008 and 2007 was approximately $2.01, $4.90, and $15.83, respectively. +The +aggregate intrinsic value of all options exercised during the years ended December 31, 2009, 2008 and 2007 was $1.0 million, $9.4 million and +$113.7 million, respectively. Cash received from stock option exercises for the years ended December 31, 2009 and 2008 was $1.2 million and $3.3 million, respectively with +no income tax benefit due to the Company's loss position. The total grant date fair value of stock options vested during 2009, 2008, and 2007 was $13.0. million, $22.5 million and +$19.2 million, respectively. +F-24 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. EQUITY (Continued) +The +outstanding options at December 31, 2009 had the following characteristics: +Options Outstanding +Options Exercisable +Exercise Prices +Number of +Shares +Weighted Average +Remaining +Contractual Life +(Years) +Weighted +Average +Exercise +Price +Number +Exercisable +Weighted +Average +Exercise +Price +Fair Value +Determination +$0.51 - 1.69 +2,835,846 +7.30 +$ +1.28 +1,301,471 +$ +1.35 +Black-Scholes +$1.70 - 10.50 +3,689,350 +7.99 +7.10 +1,533,814 +18.43 +Black-Scholes +$10.51 - 14.98 +569,763 +5.90 +14.32 +455,431 +14.27 +Black-Scholes +$14.99 - 22.92 +234,069 +5.84 +22.22 +176,999 +22.23 +Black-Scholes +$22.93 - 47.88 +320,934 +7.26 +32.25 +193,869 +31.64 +Black-Scholes +$47.89 - 59.98 +105,292 +7.49 +56.0 +61,838 +56.20 +Black-Scholes +7,755,254 +7.48 +$ +7.67 +3,723,422 +$ +9.33 +As +of December 31, 2009, the Company had issued unvested options to purchase 4.0 million shares of the Company's common stock with a weighted average grant date fair value +of $3.05. As of December 31, 2009, the Company had $12.3 million of total unrecognized share-based compensation expense related to unvested options, net of expected forfeitures, which is +expected to be amortized over the weighted average period of 2.95 years. +Tender Offer. Due to declines in the market price of the Company's common stock, the exercise prices of a substantial number of +outstanding stock +options held by the Company's employees far exceeded the market price of our common stock as of April 2, 2009 (referred to as "underwater options"). This decline in the Company's common stock +price substantially eliminated the incentive and retention value of the options previously granted to the Company's employees. Accordingly, on April 2, 2009, after a comprehensive review of our +compensation program, the Company offered to purchase stock options with exercise prices equal to or greater than $10.50 per share for cash from certain eligible employees (the "Tender Offer") in +order to restore the incentive value of the Company's long-term performance award programs. Individuals eligible to participate in the Tender Offer were those employees, including officers +and non-employee directors, who continued to be employees or directors of the Company from the April 2, 2009 offer date to the offer's expiration date on April 30, 2009. +Participation in the Tender Offer was voluntary. As a result of the Tender Offer, the Company made an aggregate cash payment of $0.1 million to repurchase 2,315,951 options that were tendered +to the Company. Accordingly, the Company recorded a charge of $16.3 million in the quarter ended June 30, 2009 related to previously unrecognized share-based compensation expense for +these tendered options. Of this $16.3 million charge, $13.3 million was recorded to selling, general and administrative expenses and $3.0 million was recorded to cost of sales. +Additionally, the pool of shares available for future grant under the 2007 Equity Incentive Plan (the "2007 Plan") increased by 817,700 shares as a result of the Tender Offer. Shares tendered that +were originally granted from the 2005 Equity Incentive Plan (the "2005 Plan") are not available for future grant. +F-25 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +10. EQUITY (Continued) +Non-vested Stock Awards +The following summarizes stock award transactions for the year ended December 31, 2009: +Non-vested +Shares +Weighted Average +Grant Date +Fair Value +Outstanding at December 31, 2008 +939,000 +$ +3.87 +Granted +1,282,110 +2.43 +Vested +(783,202 +) +2.88 +Forfeited or expired +(115,668 +) +4.08 +Outstanding at December 31, 2009 +1,322,240 +$ +3.04 +At +December 31, 2009, the Company had $2.4 million of total unrecognized share-based compensation expense related to non-vested stock awards, net of expected +forfeitures. The non-vested stock awards are expected to be amortized over the weighted average period of 2.08 years. +Separation Agreement +During the twelve months ending December 31, 2009, the Company entered into two separation agreements, the first with its former Chief +Executive Officer and the second with its former Vice President, General Counsel and Secretary. Pursuant to these agreements, vesting of 321,195 options to purchase Company common stock and 148,251 +restricted stock awards were accelerated during the twelve months ended December 31, 2009 and 62,604 options to purchase +Company Common stock will vest during 2010. Additionally, pursuant to the terms of the separation agreement, the Company's former Chief Executive Officer forfeited 267,707 options to purchase Company +common stock. The Company recorded a charge of $2.0 million and $0.2 million to restructuring charges related to the acceleration of the vesting of these options and restricted stock +awards, and the acceleration of deferred compensation expense, respectively. +F-26 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. VARIABLE INTEREST ENTITIES +The Company established a relationship with Shanghai Shengyiguan Trade, Ltd Co ("ST") for the purpose of serving as a distributor of the Company's products in the People's +Republic of China. The Company has determined that ST is a variable interest entity for which it is the primary beneficiary and there are no other non-controlling interests. The Company +currently controls all business activities and absorbs substantially all of the expected residual returns and substantially all of the expected losses of ST based on agreements with ST. The Company +determined that it is the primary beneficiary of ST by virtue of its variable interest in the equity of ST. All voting rights have been assigned to the Company and there is a transfer agreement +between ST and the Company under which all of the equity, assets, and liabilities are to be transferred to the Company at the Company's sole +discretion, subject to certain conditions. Accordingly, the Company's consolidation of ST does not reflect a non-controlling interest. +The +Company did not provide material financial support in 2009 for the funding of ST's operations. The consolidated financial statements include $6.4 million in total assets as of +December 31, 2009, primarily consisting of cash, inventory and receivables, partially offset by $0.3 million in liabilities as of December 31, 2009, primarily consisting of +accounts payable and accrued expenses, and excluding liabilities related to the support provided by the Company. For the year ended December 31, 2008, the Company provided $4.0 million +of financial support for the funding of ST's operations. As of December 31, 2008, the consolidated financial statements include $15.8 million in total assets, primarily consisting of +cash, inventory and receivables, partially offset by $2.0 million in liabilities, primarily consisting of accounts payable and accrued expenses, and excluding liabilities related to the support +provided by the Company. +12. ALLOWANCES +The changes in the Company's allowance for doubtful accounts and reserve for sales returns and allowances for the years ended December 31, 2009, 2008 and 2007, are as follows (in +thousands): +Balance at +Beginning +of Year +Charged +to costs and +expenses +Deductions +and +write-offs +Balance at +End +of Year +Year ended December 31, 2007: +Allowance for doubtful accounts +$ +1,690 +$ +4,671 +$ +2,566 +$ +3,795 +Reserve for sales returns and allowances +$ +2,814 +$ +7,168 +$ +3,991 +$ +5,991 +Year ended December 31, 2008: +Allowance for doubtful accounts +$ +3,795 +$ +3,091 +$ +1,624 +$ +5,262 +Reserve for sales returns and allowances +$ +5,991 +$ +52,597 +$ +39,752 +$ +18,836 +Year ended December 31, 2009: +Allowance for doubtful accounts +$ +5,262 +$ +1,262 +$ +2,551 +$ +3,973 +Reserve for sales returns and allowances +$ +18,836 +$ +8,368 +$ +21,338 +$ +5,866 +The +amounts reflected as "charged to costs and expenses" in the table for sales returns and allowances above are net of the original sale less the value of the inventories expected to be +returned. +F-27 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES +Income Tax Provision +The expense (benefit) for income taxes consisted of the following (in thousands): +December 31, +2009 +2008 +2007 +Current—U.S. federal +$ +(5,452 +) +$ +(9,162 +) +$ +38,399 +Current—U.S. state +— +206 +3,646 +Current—foreign +(6,490 +) +9,951 +44,919 +Total current income taxes +(11,942 +) +995 +86,964 +Deferred—U.S. federal +(1,330 +) +7,276 +(5,269 +) +Deferred—U.S. state +— +723 +(727 +) +Deferred—foreign +6,729 +(13,428 +) +(8,870 +) +Total deferred income taxes +5,399 +(5,429 +) +(14,866 +) +Total income tax expense (benefit) +$ +(6,543 +) +$ +(4,434 +) +$ +72,098 +Income +(loss) before taxes is as follows (in thousands): +December 31, +2009 +2008 +2007 +U.S. +$ +(63,961 +) +$ +(124,502 +) +$ +95,048 +Foreign +15,340 +(65,008 +) +145,278 +Total +$ +(48,621 +) +$ +(189,510 +) +$ +240,326 +Reconciliations +of the statutory federal income tax rate to the Company's actual rates based on income or loss before income taxes are summarized as follows: +December 31, +2009 +2008 +2007 +Consolidated income before taxes +35.0 +% +35.0 +% +35.0 +% +State income taxes net of federal benefit +9.0 +1.4 +0.8 +Foreign tax rate differential +(12.0 +) +(11.4 +) +(6.7 +) +Permanent portion of equity compensation +(13.6 +) +— +0.7 +Charitable donations of inventory +11.1 +0.8 +— +Change in valuation allowance +(36.5 +) +(26.1 +) +— +Benefit of international restructuring +28.7 +— +— +Other +(8.3 +) +2.6 +0.2 +13.4 +% +2.3 +% +30.0 +% +F-28 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES (Continued) +The +Company's deferred income tax assets and liabilities are as follows (in thousands): +December 31, +2009 +2008 +Current deferred tax assets: +Accrued expenses +$ +18,163 +$ +18,980 +Inventory +1,391 +14,317 +Intangible assets +257 +374 +Other +1,476 +739 +Valuation Allowance +(12,858 +) +(25,330 +) +Total current deferred tax assets +$ +8,429 +$ +9,080 +Current deferred tax liabilities: +Property and equipment. +$ +(1,080 +) +$ +— +Total current deferred tax liabilities. +$ +(1,080 +) +$ +— +Non-current deferred tax assets: +Accrued expenses +$ +— +$ +6,143 +Stock compensation expense +11,348 +7,203 +Inventory +433 +— +Long-term accrued expenses +10,062 +1,119 +Net operating loss and charitable contribution carryovers +35,207 +13,844 +Intangible assets +1,334 +3,319 +Property and equipment +1,722 +1,211 +Future uncertain tax position offset +13,501 +12,586 +Valuation Allowance +(51,569 +) +(23,784 +) +Total non-current deferred tax assets +$ +22,038 +$ +21,641 +Non-current deferred tax liabilities: +Accrued expenses +$ +(4,615 +) +$ +— +Other +(1,136 +) +(1,073 +) +Total non-current deferred tax liabilities +$ +(5,751 +) +$ +(1,073 +) +At +December 31, 2009 and 2008, U.S. income and foreign withholding taxes have not been provided on approximately $178.7 million and $114.5 million, respectively, of +unremitted earnings of subsidiaries operating outside of the U.S. These earnings are estimated to represent the excess of the financial reporting over the tax basis in our investments in those +subsidiaries. These earnings, which are considered to be indefinitely reinvested, would become subject to U.S. income tax if they were remitted to the U.S. The amount of unrecognized deferred U.S. +income tax liability on the unremitted earnings has not been determined because the hypothetical calculation is not practicable. +The +Company has deferred tax assets related to certain deductible temporary differences in various tax jurisdictions for which the Company has recorded a valuation allowance of +$64.4 million against these deferred tax assets because the Company believes that it is not more likely than not that the Company will be able to realize these deferred tax assets. The +significant components of the deferred tax assets for which a valuation allowance has been applied consist of net operating losses in certain tax +F-29 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES (Continued) +jurisdictions +for which management believes there is not sufficient positive evidence that such net operating losses will be realized against future income and book expenses not deductible for tax +purposes in the current year such as inventory impairment reserves, equity compensation and unrealized foreign exchange loss that would increase such net operating losses in the same jurisdictions. +These temporary differences are amounts which arose in jurisdictions where (i) current losses exist, (ii) such losses are in excess of any loss carryback potential, (iii) no tax +planning strategies exist with which to overcome such losses, and (iv) no profits are projected for the following year. For these reasons it is determined that it is more likely than not that +these deferred tax assets will not be realized and a valuation allowance has been provided with respect to these deferred tax assets. +At +December 31, 2009, the Company has U.S. federal and state net operating loss and charitable contribution carryforwards of $69.1 million and $130.6 million which +will expire at various dates between 2013 and 2029. The Company believes that it is not more likely than not that the benefit from certain U.S. federal and state net operating losses will be realized. +The Company has provided a valuation allowance of $25.9 million on the deferred tax assets relating to these federal and state net operating loss carryforwards. +At +December 31, 2009, the Company has recorded a foreign deferred tax asset of $5.7 million reflecting the benefit of $30.8 million in foreign net operating loss +carryforwards. Such deferred tax assets expire at various dates between 2013 and 2029. The Company believes it is not more likely than not that the benefit from certain foreign net operating loss +carryforwards will be realized. The Company has provided a valuation allowance of $5.7 million on the deferred tax assets relating to these foreign net operating loss carryforwards. +The +Company had approximately $23.6 million in net deferred tax assets at December 31, 2009. Approximately $7.4 million of the net deferred tax assets are located in +foreign jurisdictions for which a strong earnings history and expected future profits indicated that it is more likely than not that such deferred tax assets will be realized. Pre-tax +profit of approximately $20.5 million is required to realize the net deferred tax assets. +At +December 31, 2009, approximately $13.5 million of net deferred tax assets consist of deferred tax assets related to FIN 48 liabilities, under ASC Topic 740, that +would be realized if such liabilities are actually incurred. The deferred tax assets represent primarily the reduction in withholding tax expense that would occur upon a disallowance of intercompany +royalty expense by various taxing authorities. Approximately $42.5 million of unrecognized tax benefits would have to be recognized to realize these deferred tax assets. +As +a result of certain realization requirements under ASC 718, the table of deferred tax assets and liabilities shown above does not include certain deferred tax assets at +December 31, 2009 that arose directly from tax deductions related to equity compensation in excess of compensation recognized for financial reporting. Equity will be increased by +$2.9 million if and when such deferred tax assets are ultimately realized. The Company uses tax law ordering for purposed of determining when excess tax benefits have been realized. +F-30 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES (Continued) +A +reconciliation of the beginning and ending amount of unrecognized tax benefits pursuant to ASC 740 (formerly FIN 48) is as follows (in thousands): +2009 +2008 +2007 +Unrecognized tax benefit—January 1 +$ +28,210 +$ +11,264 +$ +— +Gross increases—tax positions in prior period +1,440 +13,063 +4,387 +Gross decreases—tax positions in prior period +(4,868 +) +— +— +Gross increases—tax positions in current period +4,381 +4,868 +6,877 +Settlements +— +(985 +) +— +Lapse of statute of limitations +— +— +— +Unrecognized tax benefit +$ +29,163 +$ +28,210 +$ +11,264 +The +unrecognized tax benefits of $29.2 million, $28.2 million and $11.3 million at December 31, 2009, 2008 and 2007, respectively, if recognized, would reduce +the Company's annual effective tax rate. +Interest +and penalties related to income tax liabilities are included in income tax expense in the Company's consolidated statement of operations. During 2009, 2008 and 2007, the Company +recorded approximately $0.8 million, $1.6 million and $0.5 million, respectively, of penalties and interest which resulted in a cumulative accrued balance of penalties and +interest of $2.8 million, $2.1 million and $0.5 million at December 31, 2009, 2008 and 2007, respectively. +The +Company's unrecognized tax benefits consist primarily of tax positions related to intercompany transfer pricing in multiple international jurisdictions. The gross increase for tax +positions in current and prior periods in 2009 of $5.8 million primarily includes specific transfer pricing exposures in various jurisdictions. The gross decrease for tax positions in prior +periods in 2009 of $4.9 million relates to a restructuring of international operations resulting in a remeasurement of related uncertain tax positions previously recorded. The Company believes +that it is reasonably possible that no increases or decreases to unrecognized tax benefits will occur in the next twelve months. +As +of December 31, 2009, the following tax years remain subject to examination for the major jurisdictions where the Company conducts business: +United States +2005 to 2009 +Canada +2005 to 2009 +Netherlands +2005 to 2009 +Singapore +2004 to 2009 +Japan +2005 to 2009 +State +income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective return. The state impact of any federal changes remains +subject to examination by various state jurisdictions for a period up to 2 years after formal notification to the states. +14. EARNINGS PER SHARE +Basic income (loss) per common share ("EPS") is computed by dividing the net income available to common stockholders by the weighted average number of common shares outstanding for the +period. Diluted EPS reflects the potential dilution that could occur if certain outstanding stock options +F-31 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. EARNINGS PER SHARE (Continued) +are +exercised, restrictions lapse on restricted stock awards and preferred stock is converted. Anti-dilutive securities are excluded from diluted EPS. +The +following is a reconciliation of the number of shares used in the basic and diluted EPS computations for the years ended December 31, 2009, 2008 and 2007: +Years Ended December 31, +2009 +2008 +2007 +(in thousands, except share and per share data) +Net income (loss) attributable to common stockholders for basic computation +$ +(42,078 +) +$ +(185,076 +) +$ +168,228 +Reconciliation of net income (loss) for dilutive computation: +Net income (loss) attributable to common stockholders +$ +(42,078 +) +$ +(185,076 +) +$ +168,228 +Preferred dividend +— +— +— +Net income (loss) for dilutive computation +$ +(42,078 +) +$ +(185,076 +) +$ +168,228 +Basic income (loss) per common share: +Weighted average common shares outstanding +85,112,461 +82,767,540 +80,759,077 +Basic income (loss) per common share +$ +(0.49 +) +$ +(2.24 +) +$ +2.08 +Diluted income (loss) per common share: +Weighted average common shares outstanding +85,112,461 +82,767,540 +80,759,077 +Dilutive effect of stock options +— +— +3,144,607 +Dilutive effect of unvested stock +— +— +291,199 +Weighted average diluted common shares outstanding +85,112,461 +82,767,540 +84,194,883 +Diluted income (loss) per common share +$ +(0.49 +) +$ +(2.24 +) +$ +2.00 +Due +to the Company's net loss for the years ended December 31, 2009 and 2008, the dilutive effect of stock options and awards were not included in the computation of EPS, as their +inclusion would have been anti-dilutive. +For +the years ended December 31, 2008, 2007 and 2006 there were options outstanding which could potentially dilute basic EPS in the future, but which were not included in diluted +EPS as their effect was anti-dilutive. The weighted-average exercise price per share for the options was $5.94, $4.42, and $48.35 for 2009, 2008, and 2007, respectively. The following +table summarizes the anti-dilutive securities: +Years Ended December 31. +2009 +2008 +2007 +Anti-dilutive effect: +Stock options +4,020,574 +10,103,376 +906,700 +F-32 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. COMMITMENTS AND CONTINGENCIES +The Company leases space for certain of its offices, warehouses, vehicles and equipment under leases expiring at various dates through 2026. Certain leases contain rent escalation +clauses (step rents) that require additional rental amounts in the later years of the term. Rent expense for leases with step rents or rent holidays is recognized on a straight-line basis +over the minimum lease term. Deferred rent is included in the consolidated balance sheet in accrued expenses. Total rent expense was $59.6 million, $52.7 million, and +$26.0 million for the years ended December 31, 2009, 2008, and 2007, respectively. Included in such amounts are contingent rents of $7.1 million, $4.2 million and +$1.8 million in 2009, 2008, and 2007, respectively. +Minimum +future annual rental commitments under non-cancelable operating leases for each of the five succeeding years as of December 31, 2009, are as follows (in +thousands): +Fiscal years ending December 31, +2010 +$ +44,749 +2011 +29,760 +2012 +19,102 +2013 +19,088 +2014 +14,559 +Thereafter +43,514 +Total Minimum Lease Payments(1) +$ +170,772 +(1) Minimum +payments have not been reduced by minimum sublease rentals of $0.6 million due in the future under noncancelable subleases. They also do not +include contingent rentals which may be paid under certain retail leases on a basis of percentage of sales in excess of stipulated amounts. +At +December 31, 2009, the Company had purchase commitments with its third-party manufacturers for $52.1 million in inventory. +On +July 26, 2005, the Company entered into an amended and restated four-year supply agreement with Finproject S.P.A., the former majority owner of Crocs Canada, +pursuant to which the Company has the exclusive right to purchase the material for the manufacture of finished shoe products, except for certain current customer dealings (including boot +manufacturers). The supply agreement was extended through June 30, 2010, and provides that the Company meet minimum purchase requirements to maintain exclusivity throughout the term of the +agreement. The pricing is to be agreed upon each quarter and fluctuates based on order volume, currency fluctuations, and raw material prices. +The +Company indemnifies certain of its vendors and its directors and executive officers for specified claims. As of December 31, 2009, the Company has not paid or been required to +defend any indemnification claims, and accordingly, has not accrued any amounts for its indemnification obligations. +The +Company guarantees the payment of its third-party manufacturer in China for purchases of material for the manufacture of finished shoe products. The maximum potential amount of +future payments the Company could be required to make under the guarantee is €2.1 million (approximately $3.0 million) as of December 31, 2009. The Company +evaluates the estimated loss for the guarantee under ASC Topic 450 "Contingencies" , and as interpreted by ASC Topic 460 "Guarantees" . The +F-33 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. COMMITMENTS AND CONTINGENCIES (Continued) +Company +considers such factors as the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. The Company has recourse as a matter of +common law. As of December 31, 2009, the Company has not made any payments under the guarantee and as of December 31, 2009, has not recorded a liability related to the guarantee in its +financial statements as the Company does not believe the potential obligation under this guarantee is material. +16. RELATED PARTIES +The Company entered into the following related party transactions: +In +connection with a separation agreement, the Company and its former Chief Executive Officer entered into an exclusive distribution agreement that commenced July 1, 2005. The +distribution agreement is for specified territories in Central America and has an initial term of two years. The agreement provides for renewal periods at the former Chief Executive Officer's option, +if specified sales volumes are attained. Pricing under this agreement is set at a discount off the Company's then current wholesale pricing. Additionally, effective July 1, 2005, the Company +and the former Chief Executive Officer entered into an agreement providing him the right to license and/or franchise airport kiosks selling the Company's products for a period of 10 years, +subject to the Company's right to terminate the agreement if specified numbers of kiosks are not opened in timeframes specified. +17. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +The Company operates in the consumer products industry internationally in which the Company designs, manufactures, markets and distributes footwear, apparel and accessories. During 2009 +the +Company changed the information that was presented to the chief operating decision maker and has restated its revenues, depreciation and amortization, operating income and long-lived +assets below. The Company identifies its reportable segments as those geographic regions that represent 10% or more of its revenue, operating income (as defined below), or total assets. The Company +has three reportable segments: Americas, Europe and Asia. All of the reportable segments derive their revenue from the sale of footwear, apparel and accessories. The Company evaluates performance and +makes decisions about allocating resources to its operating segments based on financial measures such as revenue and operating income. +Operating +income is the primary measure used by the Company's chief operating decision maker to evaluate segment operating performance and to decide how to allocate resources to +segments. Operating income is defined as operating income before asset impairment charges and restructuring charges. The Company evaluates the performance of its segments based primarily on the +results of the segment without allocating corporate expenses, or indirect general, administrative and other expenses. The corporate and other category includes (i) Ocean Minded, +(ii) Colorado Footwear CV, and (iii) corporate category, which maintains corporate costs such as stock-based compensation, research and development, brand marketing, legal expenses, +depreciation on global long-lived assets such as molds, tooling, IT systems, and other global costs that are not allocated to the regions. +Segment +profits or losses include adjustments to eliminate intercompany profit or losses on intercompany sales. Segment assets include the elimination of any intersegment profits or +losses in inventory, however, include the elimination of intercompany receivables. Segment assets, primarily the Americas, include certain long-lived assets that are depreciated in the +corporate category due to their global functionality. Negative assets within Corporate and other primarily include eliminations of +F-34 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +17. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +investments +made from the Americas segment in the other reportable segments. Net revenues as shown below represent sales to external customers for each segment. +Year Ended December 31, +2009 +2008 +2007 +Revenues: +Americas +$ +298,004 +$ +361,665 +$ +498,502 +Europe +106,900 +150,717 +179,703 +Asia +237,502 +204,943 +167,480 +Total segments +642,406 +717,325 +845,685 +Corporate and other +3,361 +4,264 +1,665 +Total consolidated revenues +$ +645,767 +$ +721,589 +$ +847,350 +Operating Income: +Americas +$ +21,228 +$ +(43,525 +) +$ +166,179 +Europe +11,026 +990 +77,132 +Asia +57,836 +16,634 +75,221 +Total segments +90,090 +(25,901 +) +318,532 +SG&A Restructuring +(7,623 +) +(7,664 +) +— +Asset Impairment +(26,085 +) +(45,784 +) +— +Corporate and other +(107,566 +) +(108,933 +) +(80,765 +) +Total consolidated operating income (loss) +(51,184 +) +(188,282 +) +237,767 +Interest Expense +1,495 +1,793 +438 +Gain on charitable contributions +(3,163 +) +— +— +Other expense (income), net +(895 +) +(565 +) +(2,997 +) +Income (loss) before income taxes +(48,621 +) +(189,510 +) +240,326 +Depreciation and Amortization: +Americas +$ +10,456 +$ +10,465 +$ +8,159 +Europe +3,437 +3,802 +1,363 +Asia +6,659 +5,638 +1,135 +Total segments +20,552 +19,905 +10,657 +Corporate and other +16,119 +17,545 +10,292 +Total consolidated depreciation and amortization +$ +36,671 +$ +37,450 +$ +20,949 +Assets: +Americas +$ +277,454 +$ +284,380 +Europe +66,838 +60,708 +Asia +151,052 +127,822 +Total segments +495,344 +472,911 +Corporate and other +(85,606 +) +(16,912 +) +Total consolidated assets +$ +409,738 +$ +455,999 +F-35 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +17. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +The +Company's sales by product line are as follows (in thousands): +Year Ended December 31, +2009 +2008 +2007 +Footwear +$ +611,139 +$ +660,734 +$ +763,303 +Other +34,629 +60,855 +84,047 +$ +645,768 +$ +721,589 +$ +847,350 +December 31, +Long-lived assets +2009 +2008 +United States +$ +33,342 +$ +64,340 +Canada +2,101 +1,857 +Mexico +7,280 +2,302 +North America Total +42,723 +68,499 +Asia-Pacific +19,594 +12,720 +Europe +8,189 +14,024 +Other +578 +649 +$ +71,084 +$ +95,892 +Total for countries outside the United States +$ +37,742 +$ +31,552 +There +were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2009, 2008 and 2007. +18. LEGAL PROCEEDINGS +On March 31, 2006, the Company filed a complaint with the ITC against Acme Ex-Im, Inc., Australia Unlimited, Inc., Cheng's Enterprises, Inc., +Collective Licensing International, LLC, D. Myers & Sons, Inc., Double Diamond Distribution, Ltd., Effervescent, Inc., Gen-X Sports, Inc., +Holey Soles Holdings, Ltd., Inter-Pacific Trading Corporation, and Shaka Holdings, Inc., alleging patent and trade dress infringement and seeking an exclusion order banning the +importation and sale of infringing products. On August 10, 2006, the Company filed a motion to voluntarily remove its trade dress claim from the investigation to focus on the patent claims. The +Company's motion was granted by Order No. 20 on August 24, 2006. The utility and design patents asserted in the complaint were issued to the Company on February 7, 2006 and +March 28, 2006 respectively, by the United States Patent and Trademark Office. The ITC has issued final determinations terminating Shaka Holdings, Inc., Inter-Pacific Trading +Corporation, Acme Ex-Im, Inc., D. Myers & Sons, Inc., Australia Unlimited, Inc. and Gen-X Sports, Inc. from the ITC investigation +No. 337-TA-567 on the basis of settlement and Cheng's Enterprises, Inc. on the suspension of accused activities. The ITC Administrative Law Judge ("ALJ") issued +an Initial Determination of non-infringement related to one of the patents at issue. The Company filed a petition with the Commission to review this determination. The Commission granted +the Company's petition and on February 15, 2007, after briefing by the parties, the Commission vacated the ALJ's determination of non-infringement with respect to the remaining +respondents and remanded it to the ALJ for further proceedings consistent with the Commission's order. In light of the +F-36 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +18. LEGAL PROCEEDINGS (Continued) +Commission's +Order, the procedural schedule and hearing date were reset pursuant to Order No. 38. A trial was held before the ALJ from September 7 to 14, 2007. The ALJ issued an Initial +Determination on April 11, 2008 with a finding of no violation, finding infringement of the utility patent by certain accused products, but also finding that the utility patent was invalid as +obvious. The ALJ also found that the design patent was valid, but not infringed by the accused products. The Company filed a +Petition for Review of the Initial Determination which was due on April 24, 2008. On June 18, 2008, the Commission issued a Notice that it would review the ALJ's findings in the Initial +Determination with respect to the determination of non-infringement of the design patent and the determination of invalidity of the utility patent. On July 25, 2008, the Commission +issued a Notice of its decision to terminate the Investigation with a finding of no violation as to either patent. Crocs filed a Petition for Review of the decision with the United States Court of +Appeals for the Federal Circuit on September 22, 2008, and filed its initial brief on January 21, 2009. Briefing before the Federal Circuit was completed in April 2009 and oral arguments +were heard on July 10, 2009. On October 4, 2009, the Company and Collective Licensing, International, LLC reached a settlement. Collective Licensing, International, LLC +agreed to cease and desist infringing on the Company's patents and to pay the Company certain monetary damages, which was recorded upon receipt. On February 24, 2010, the Federal Circuit found +the Commission erred in finding that the utility patent was obvious and reversed the Commission's determination of non-infringement of the design patent. The case has been remanded back to the +Commission for a determination of infringement of the utility patent and any appropriate remedies. +On +April 3, 2006, the Company filed a complaint in the U.S. District Court for the District of Colorado alleging patent and trade dress infringement and seeking injunctive relief +against Acme EX-IM, Inc., Australia Unlimited, Inc., Cheng's Enterprises, Inc., Collective Licensing International, LLC, D. Myers & +Sons, Inc., Double Diamond Distribution, Ltd., Effervescent, Inc., Gen-X Sports, Inc., Holey Soles Holdings, Ltd, Inter-Pacific Trading Corporation, +Shaka Holdings, Inc., and Does 1-10 based upon certain utility and design patents that were issued to the Company on February 7, 2006 and March 28, 2006 respectively, +by the United States Patent and Trademark Office. Consent judgments have been entered against Shaka Holdings, Inc., Interpacific Trading Corporation and Acme Ex-Im, Inc. The +Company entered into a settlement with Australia Unlimited, and filed a stipulation for dismissal of all claims and counterclaims on January 25, 2007. The Company has entered into a settlement +agreement with D. Myers & Sons and obtained a consent judgment in connection therewith on May 23, 2007. This action has been stayed pending resolution in the ITC Proceeding, +Investigation No. 337-TA-567, which is currently on appeal to the U.S. Court of Appeals for the Federal Circuit. On June 11, 2009, the Company filed a Notice of +Voluntary Dismissal of Gen-X Sports, Inc. on the basis of settlement and on November 4, 2009, the Company filed a Notice of Voluntary Dismissal with prejudice of Collective +Licensing International, LLC on the basis of settlement. +The +Company and certain current and former officers and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of +Colorado. The first complaint was filed in November 2007; several other complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the Court appointed a lead +plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purports to state claims under Section 10(b), 20(a), and 20A of the Exchange Act on +behalf of a class of all persons who purchased the Company's stock between April 2, 2007 and April 14, 2008 (the "Class Period"). The amended complaint alleges that, during the Class +Period, defendants made +F-37 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +18. LEGAL PROCEEDINGS (Continued) +false +and misleading public statements about the Company and its business and prospects and that, as a result, the market price of the Company's stock was artificially inflated. The amended complaint +also claims that certain current and former officers and directors traded in the Company's stock on the basis +of material non-public information. The amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified amount, interest, and an award of attorneys' fees and +costs of litigation. The Company believes the claims lack merit and intends to defend the action vigorously. Motions to dismiss are currently pending with the Court. Due to the inherent uncertainties +of litigation and because the litigation is at a preliminary stage, the Company cannot at this time accurately predict the ultimate outcome of the matter. +On +May 11, 2009, Crocs Europe B.V. received a letter from Dr. Ing. H.c.F. Porsche AG ("Porsche") claiming that the Company's use of the "Cayman" shoe model +designator infringes upon their Community Trademark Registration of the mark "CAYMAN" in class 25. Porsche is requesting that Crocs Europe B.V. immediately cease and desist use of the +Cayman mark and pay Porsche's attorney's fees in conjunction with the issuance of the notice letter. On July 30, 2009 the Company was served with notice of an injunction against Crocs Europe +BV's use of the Cayman mark in Germany. On December 16, 2009, a settlement was entered into where Crocs Europe B.V. has agreed to pay Porsche certain damages and cease using the mark +CAYMAN as a style designator. This matter is considered closed. +On +December 8, 2009, Columbia Sportswear Company ("Columbia") filed an Amended Complaint adding the Company as a defendant in a case between Columbia and Brian P. O'Boyle and 1 +Pen. Inc. in the Multnomah County Circuit Court in the State of Oregon. Columbia has asserted claims against the Company for misappropriation of trade secrets, aiding and abetting breach of +fiduciary duty, intentional interference with contract, injunctive relief, disgorgement and an accounting. The Amended Complaint also seeks damages in an unspecified amount, return of patent rights, +reasonable attorney's fees and costs and expenses against the Company. On January 25, 2010, the Company filed an Answer to the Amended Complaint. The Company denies Columbia's claims in the +Amended Complaint and intends to defend this action vigorously. Due to the inherent uncertainties of litigation and because the litigation is at a preliminary stage, the Company cannot at this time +accurately predict the ultimate outcome of the matter. +Although +the Company is subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, the +Company is not party to any other pending legal proceedings that the Company believes will have a material adverse impact on its business. +F-38 +Table of Contents +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +19. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +Quarter Ended +March 31 +Quarter Ended +June 30(a) +Quarter Ended +September 30 +Quarter Ended +December 31(a) +Year Ended December 31, 2009 +Revenues +$ +134,892 +$ +197,722 +$ +177,141 +$ +136,012 +Cost of Sales—Restructuring Charges +— +5,266 +513 +1,307 +Gross profit +49,731 +101,112 +89,850 +60,268 +Restructuring charges +38 +5,915 +17 +1,653 +Asset impairment charges +69 +23,655 +1,722 +639 +Income (loss) from operations +(22,563 +) +(24,519 +) +8,970 +(13,072 +) +Net income (loss) +(22,417 +) +(30,281 +) +22,068 +(11,448 +) +Basic income (loss) per common share +$ +(0.27 +) +$ +(0.36 +) +$ +0.26 +$ +(0.13 +) +Diluted income (loss) per common share +$ +(0.27 +) +$ +(0.36 +) +$ +0.25 +$ +(0.13 +) +Year Ended December 31, 2008 +Revenues +$ +198,540 +$ +222,770 +$ +174,187 +$ +126,092 +Cost of Sales—Restructuring Charges +— +901 +— +— +Gross profit(b) +85,235 +90,288 +2,399 +56,044 +Restructuring charges +3,849 +1,371 +2,450 +895 +Goodwill impairment charges +1,036 +— +22,831 +— +Asset impairment charges +9,777 +2,903 +8,753 +484 +Loss from operations +(6,404 +) +(2,942 +) +(136,026 +) +(42,910 +) +Net income (loss) +(4,527 +) +2,132 +(147,980 +) +(34,701 +) +Basic income (loss) per common share +$ +(0.05 +) +$ +0.03 +$ +(1.79 +) +$ +(0.42 +) +Diluted income (loss) per common share +$ +(0.05 +) +$ +0.03 +$ +(1.79 +) +$ +(0.42 +) +(a) As +disclosed in Note 2, the Company identified an error during the fourth quarter of 2009 in the calculation of stock-based compensation. This error +resulted in the understatement of stock-based compensation expense, with a corresponding understatement of additional paid in capital, in the approximate amounts of $4.5 million as of +December 31, 2008. Additional amounts of stock-based compensation of approximately $1.0 million and $0.5 million should have been recognized in the 1 st and +3 rd quarters, respectively. In connection with the Tender Offer during the 2 nd quarter, the Company inadvertently corrected approximately $2.0 million +of the then existing cumulative error of approximately $6.0 million. The Company recorded an additional $3.9 million in stock-based compensation during the fourth quarter of 2009 to +correct the balance of this error. +(b) For +the three months ended September 30, 2008, the Company had significant inventory write-down charges, asset abandonment, and +write-down of goodwill which effects the comparability between periods. +20. SUBSEQUENT EVENTS +Accounting Standards Update No. 2010-09 to ASC Topic 855, Subsequent Events , requires the Company to disclose the date through +which subsequent events have been evaluated. The Company has evaluated subsequent events through the date the financial statements were issued, and has determined there are no other subsequent events +to be reported, other than as follows: On February 25, 2010, the Company announced that John McCarvel was appointed as Chief Executive Officer and Director of the Company effective +March 1, 2010. Mr. McCarvel succeeds John H. Duerden, who left his position as President, Chief Executive Officer and Director of the Company. +F-39 \ No newline at end of file diff --git a/raw/filings/0001334036/2009/0001047469-10-001357/filing_metadata.csv b/raw/filings/0001334036/2009/0001047469-10-001357/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..63bfbe7acab44ccd98882bd7b324250c5a317e03 --- /dev/null +++ b/raw/filings/0001334036/2009/0001047469-10-001357/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2010-02-25,2009-12-31,2010-02-25T21:39:46.000Z,0001047469-10-001357,a2196634z10-k.htm,10-K,1471809,0,0,https://www.sec.gov/Archives/edgar/data/1334036/000104746910001357/a2196634z10-k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000104746910001357/,2009,2009,1 diff --git a/raw/filings/0001334036/2009/0001047469-10-001357/item1.txt b/raw/filings/0001334036/2009/0001047469-10-001357/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..1b84c7c25afa52918d4796d464a01de321dba8ac --- /dev/null +++ b/raw/filings/0001334036/2009/0001047469-10-001357/item1.txt @@ -0,0 +1,391 @@ +ITEM 1. Business +Overview +We are a designer, manufacturer, distributor, worldwide marketer and brand manager of footwear for men, women, and children. We aspire +to bring comfort, fun and innovation to the world's feet. We strive to be the global leader in molded footwear design and development. We manufacture a product offering that provides new and exciting +molded footwear products that feature fun, comfort and functionality. We also design and sell a broad offering of footwear and accessories that utilize our proprietary closed cell-resin, +called Croslite. Our Croslite material is unique in that it enables us to produce an innovative, lightweight, non-marking, and odor-resistant shoe. Certain shoes made with the +Croslite material have been certified by U.S. Ergonomics to reduce peak pressure on the foot, reduce muscular fatigue while standing and walking and to relieve the musculoskeletal system. +Since +the initial introduction and popularity of our Beach and Cayman (soon to be renamed Crocs Classic) designs, we have expanded our Croslite products to include a variety of new +styles and products and have extended our product reach through the acquisition of new brand platforms such as Jibbitz, LLC ("Jibbitz") and Ocean Minded, Inc. ("Ocean Minded"). We intend +to continue branching out into other types of footwear, bringing a unique and original perspective to the consumer in styles that may be unexpected from Crocs. In part, we believe this will help us to +continue to build a stable year-round business as we look to offer more winter-oriented styles. All of our products are designed to allow the product to be defined by comfort, fun, and +function. +Our +marketing approach is also becoming significantly more focused on a defined target consumer. The majority of our marketing efforts surround specific product launches and employ a +fully integrated approach utilizing a variety of media outlets. Our marketing efforts strive to drive business to both our +wholesale partners and our company-owned retail and internet stores, ensuring that our presentation and story are first class and drive purchasing at the point of sale. +We +currently sell our Crocs-branded products throughout the U.S. and in more than 100 countries. We sell our products through domestic and international retailers and distributors and +directly to end-user consumers through our webstores, Company-operated retail stores, outlets and kiosks. The broad appeal of our footwear has allowed us to market our products to a wide +range of distribution channels, including department stores and traditional footwear retailers as well as a variety of specialty and independent retail channels. +Our History +We were organized as a limited liability company in 1999 and began marketing and distributing footwear products in the U.S. under the +Crocs brand in 2002, shortly after completing our first footwear design produced by Foam Creations, Inc. and Finproject N.A., Inc. (now known as Crocs +2 +Table of Contents +Canada Inc.) +("Crocs Canada"). The unique characteristics of the Croslite material, developed by Crocs Canada, enabled us to offer consumers an innovative shoe unlike any other footwear model +then available. Initially, we targeted our products to water sports enthusiasts, but the comfort and functionality of our products appealed to a more diverse group of consumers who used our footwear +for a wide range of activities. To capitalize on the broad appeal of our footwear, we expanded our sales infrastructure, strengthened our senior management team, and developed relationships with a +range of retailers in the U.S. In June 2004, we acquired Crocs Canada, including its manufacturing operations, product lines, and rights to the trade secrets for the Croslite material. Beginning in +June 2004, we significantly expanded all aspects of our operations in order to take advantage of what we believed was an attractive market opportunity. We converted to a Colorado corporation in +January 2005 and reincorporated in Delaware in June 2005. We completed our initial public offering on February 8, 2006. +From +2002 until 2007, our business grew tremendously, both organically and through acquisitions that we believe leveraged our business model. +In +2006, we added: +• Jibbitz, LLC which produces unique charms specifically suited to fit into Crocs shoes; +• Fury Hockey Inc., formerly 55 Hockey Products Inc. ("Fury"), which produced and distributed hockey, soccer +and lacrosse equipment manufactured with Croslite. In June 2008, the Company decided to liquidate Fury after efforts to sell the entity were unsuccessful; and +• EXO Italia ("EXO"), which designs and develops EVA (Ethylene Vinyl Acetate) based finished products, primarily for the +footwear industry. +In +2007, we added: +• Ocean Minded, Inc. which produces sandals primarily for the beach, action and adventure market; +• Bite, LLC ("Bite"), a manufacturer of performance shoes and sports sandals sold worldwide in five categories, +including, golf, adventure, healthy lifestyle, travel and water sports; and +• YOU by Crocs™, a women's fashion line that combines comfort with fashionable styles. +In +2008, we added: +• Tagger International B.V. ("Tagger"), a manufacturer of messenger bags. +As +of December 31, 2009, we continued to operate and sell our products through the Crocs, Jibbitz, Ocean Minded, and YOU by Crocs brands. Other brands, including Fury, Bite, and +Tagger have been discontinued. +Recent Events +From our inception through the year ended December 31, 2007, we experienced rapid revenue growth and had difficulty meeting +demand for our footwear products. During this period, we significantly increased production capacity, warehouse space and inventory in an effort to meet demand. This pattern changed in 2008. Our +revenue growth moderated in the three month period ended March 31, 2008 and began to decline through the balance of our 2008 fiscal year. This trend continued into 2009. During this time, our +total revenues declined from $847.4 million in the year ended December 31, 2007 to $645.8 million during the year ended December 31, 2009. Should the global economic +conditions deteriorate further, we may experience further revenue declines in the Americas, European and Asian markets. Should we fail to develop and effectively merchandise new products that appeal +to the consumer, we may not be able to compete effectively and may experience further declines in revenues. See Item IA, "Risk Factors," for further discussion. +3 +Table of Contents +During +2008 and 2009, we incurred significant charges related to restructuring and other activities undertaken to right-size our business and migrate away from +non-brand processes. These charges include fixed asset impairments, intangible asset impairments, contract termination charges, severance, facility consolidation and other related +expenses. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," for further discussion of our financial condition and outlook, including asset +impairments, restructuring activities and reductions in selling, general and administrative costs. While it is not currently our expectation to do so, we may continue to incur operating losses during +fiscal year 2010, particularly if our revenues fall short of current expectations. In the event that revenues and product demand fall short of our current expectations, we will need to take further +actions to reduce operating costs. +Product Overview +While the majority of our products consist of footwear, we also offer accessories and apparel which consisted of 4.7% of our total +revenue during the year ended December 31, 2009. The Crocs footwear products are divided into four categories: Core, Active, Casual and Style. Our Core product range is composed of primarily +molded products that are derivatives of the original Beach and Cayman (soon to be renamed Crocs Classic) designs. The Core product range is targeted toward a wide range of distribution channels and +consumers. Our Active product range is composed of footwear intended for healthy living. It includes sport-inspired products that offer active end uses like boating, walking, and hiking as well as for +recovery after workouts. The Active products are targeted primarily toward our wholesale and consumer direct channels focusing on customers interested in healthy lifestyle products. The Casual product +range offers sporty and relaxed design inspirations. Casual products are targeted towards a broad range of customers. The Style product range is comprised of stylish products which are intended to +broaden the wearing occasion for Crocs lovers. These designs are targeted towards department stores and fashion and specialty retail accounts. +Footwear +A key differentiating feature of our footwear products is the Croslite material, which is uniquely suited for comfort and +functionality. We have carefully formulated the Croslite material to be of a density that creates a comfortable shoe with non-marking footwear that is extremely lightweight. Croslite +material conforms to the shape of the foot, often reducing pressure points on the foot to increase comfort. Croslite material is a closed cell resin, which is water resistant and virtually odor free, +and allows many of our footwear products to be cleaned simply with water. As we have expanded our Crocs brand product offering, we have incorporated traditional materials such as textile fabric and +leather into our products. However, we continue to utilize the Croslite material for the foot bed, sole and other key structural components for the majority of these new products. +Our +footwear offering has grown significantly since we first introduced our Crocs product line in 2002 with a single model in six colors. Some of the more notable developments are listed +below. +• We expanded our Crocs product line from 25 models in 2006 to over 230 models in 2009, including Ocean Minded, and YOU by +Crocs™ footwear models. +• We introduced a shoe donation program currently operating under our "Crocs Cares" program. We have donated millions of +Crocs shoes to those in need in both the local and global communities we serve. Another goal of the Crocs Cares program is to establish a comprehensive program focused on internal team building and +community impact by providing our employees the opportunity to volunteer in their community. +• We extended licensing agreements with Disney, Nickelodeon, Marvel, DC Comics, Warner Bros., and select college and +professional leagues, among others, for Crocs branded footwear and Jibbitz shoe charms. We also introduced a limited edition line of footwear and Jibbitz charms +4 +Table of Contents +featuring +such popular characters as Cinderella, Ariel, Mickey Mouse, Sponge Bob Square Pants, Dora the Explorer, Spiderman and Batman. +• We expanded our Crocs Work product selection to include 12 styles (including both molded and leather footwear) for the +hospital, restaurant, hotel and hospitality markets, effectively broadening sales in the commercial footwear industry. We received industry certifications on slip-resistance and +electro-static discharge on various work styles. We have diversified and expanded our sales by engaging our three primary channels: wholesale, retail and internet, including establishing distribution +with leading uniform supply companies to penetrate large hospitality chains, laboratories and clean-rooms. +• We expanded our medical-needs footwear (Crocs Rx) to six styles, capturing broader markets for general footcare and +diabetic needs. We achieved a landmark by becoming the number one selling medical footwear in the U.S. with distribution in 3,800+ podiatry offices and medical shoe stores. We also received the 2008 +"Company of the Year" award from the American Podiatric Medical Association and are the first shoe company to ever receive this award for "greatest impact on the field of podiatry." We have expanded +our Crocs Rx sales in Europe, Asia and India with low-cost, lightweight footwear appropriate for people with diabetes. We have also received Medicare approval for reimbursement on custom +diabetic shoes. +• We expanded into new footwear categories, including our Style and Active categories, by designing new footwear using our +in-house design team as well as recognized footwear design experts. As part of this strategy, we acquired EXO in 2006, which expanded the capabilities of our in-house design +team. EXO is based in Padova, Italy and is an Italian producer of EVA (Ethylene Vinyl Acetate) based finished products, primarily for the footwear industry. +• We acquired substantially all of the assets of Ocean Minded, a designer and manufacturer of high quality leather and EVA +footwear, sandals and printed apparel. Headquartered in San Clemente, California, Ocean Minded is positioned as an "ocean lifestyle" brand with deep roots in the beach and surf culture. The brand is +also gaining traction within the inland outdoor and mainstream footwear channels. Ocean Minded utilizes recycled materials throughout its entire product line and engages in environmental manufacturing +processes whenever possible. In addition, as the name implies, the brand takes an active role in protecting the oceans, rivers and beaches through beach clean-ups, support of the Surfrider +Foundation and through various other charitable efforts. +Footwear +sales made up 94.6%, 91.6%, and 90.1% of total revenues for the years ended December 31, 2009, 2008, and 2007, respectively. Sales of our Beach and Cayman (soon to be +renamed Crocs Classic) models accounted for 16%, 25%, and 30% of total unit sales for the years ended December 31, 2009, 2008 and 2007, respectively. We believe that the declining percentage of +our original styles is reflective of our efforts to diversify our product offering and reduce reliance on original styles. We intend to continue to evaluate our product offerings to develop product +collections in assortments that can be merchandised effectively to the consumer through wholesale and consumer direct channels. As such, we expect that our future product offerings will be more +focused by category and segmented by channel. As a result, we expect our style count to increase as we better service our channels with differentiated products. +During +the year ended December 31, 2009, approximately 77% of our sales consisted of products geared towards adults compared to 23% of sales for products geared towards children. +Accessories and Apparel +Accessories. In addition to our footwear products, we own the Jibbitz brand, a unique accessory brand with colorful snap-on +charms +specifically suited for Crocs shoes. We acquired Jibbitz in +5 +Table of Contents +December +2006 and have expanded the product line to include a wide variety of charms in varying shapes and sizes, with designs such as flowers, sports gear, seasonal and holiday designs, animals, +symbols, letters and rhinestones. Crocs licensing agreements also extend to Jibbitz, which allows Jibbitz to create designs bearing logos and emblems of Disney, MLB and the Crocs collegiate line, +among others. Jibbitz designs allow Crocs consumers to personalize their footwear to creatively express their individuality. As of December 31, 2009, approximately 1,200 unique Jibbitz charm +designs were available to consumers for personalizing their Crocs footwear. +Apparel. In 2007, we expanded our clothing line and launched a new clothing line for boys, girls and men featuring Croslite +material. In 2009, we +continued to scale back our apparel product offering, making it available in only in a few, select markets on a limited basis. +Operating Segments +We have three reportable segments: Americas, Europe and Asia. All of the reportable segments derive their revenue from the sale of +footwear, apparel and accessories. Within each segment, we sell our products through our wholesale, retail and internet channels, which are described more fully below. +We +evaluate the performance of our segments based primarily on the results of the segment without allocating corporate expenses, or indirect general, administrative and other expenses. +The corporate and other category includes (i) Ocean Minded, (ii) Colorado Footwear CV and (iii) corporate category, which maintains corporate costs such as stock-based +compensation, research and development, brand marketing, legal expenses, depreciation on global long-lived assets such as molds, tooling, IT systems, and other global costs that are not +allocated to the regions. Segment profits or losses include adjustments to eliminate intercompany profit or losses on intercompany sales. Net revenues as shown below represent sales to external +customers for each segment. +Financial +information regarding our consolidated revenues, profits and total assets is included in our consolidated financial statements beginning on page F-1. +Information relating to our operating segments is included in Note 17 of our consolidated financial statements. +Americas Segment +The Americas Segment consists of revenue and expenses related to the sale of our products in North and South America. Our Americas +wholesale channel consists of sales to a broad range of sporting goods and department stores as well as specialty retailers. We also sell our products directly to the consumer through 182 +company-owned store locations, including company-operated kiosks and retail stores in such locations as New York, Boston and Maui in the U.S., Montreal, Quebec in Canada, as well as through our +webstores. In 2009, our Americas segment constituted 46.1% of our consolidated revenues compared to 50.1% in 2008 and 59.0% in 2007. In 2009, 83.9% of our Americas revenues were generated in the U.S., +the largest sales territory in the Americas region, compared to 86.5% in 2008 and 88.0% in 2007. +Asia Segment +The Asia Segment consists of revenue and expenses related to the sale of our products throughout Asia, Australia, New Zealand, the +Middle East and South Africa. Our Asia wholesale channel consists of sales to a broad range of retailers, similar to the wholesale channel we have established in our Americas Segment. We also sell our +products directly to the consumer through 119 company-owned store locations, including Company-operated kiosks and retail stores in such locations as Beijing, Johannesburg and Yokohama City as well as +through our webstores. In 2009, our Asia segment constituted 36.8% of our consolidated revenues compared to 28.4% in 2008 and 19.8% in 2007. In 2009, 41.7% of our Asia revenues were generated in +Japan, the largest sales territory in the Asia region, compared to 47.4% in 2008 and 48.6% in 2007. We occasionally utilize sales agents and buying +6 +Table of Contents +groups +in our international locations to service our wholesale customers. We established a direct sales presence in most major international markets, rather than relying on distributors, which we +believe enables us to obtain better margins and allows us to better control our marketing and distribution. +Europe Segment +The Europe Segment consists of revenue and expenses related to the sale of our products throughout Europe and Russia. Our Europe +wholesale channel consists of sales to a broad range of retailers, similar to the wholesale channel we have established in our Americas Segment. We also sell our products directly to the consumer +through 16 company-owned store locations, including company-operated kiosks and retail stores in such locations as London, England, Hamburg, Germany, and Turku, Finland as well as through our +webstores. In 2009, our Europe segment constituted 16.6% of our consolidated revenues compared to 20.9% in 2008 and 21.2% in 2007. We occasionally utilize sales agents and buying groups in our +international locations to service our wholesale customers. We established a direct sales presence in most major international markets, rather than relying on distributors, which we believe enables us +to obtain better margins and allows us to better control our marketing and distribution. +Sales and Distribution +In each of our segments, we sell our products through three channels: wholesale, retail and internet. Financial information regarding +our revenues, profits and total assets is included in our consolidated financial statements beginning on page F-1. Information relating to our operating segments is included in +Note 17 of our consolidated financial statements. +Wholesale and Distributor Sales +In 2009, approximately 62.6% of our net revenues were derived from sales through our wholesale channel compared to 76.5% in 2008 and +90.8% in 2007. Our wholesale channel consists of sales to distributors and third-party retailers including national and regional retail chains, department stores, sporting goods stores and specialty +retailers, such as Nordstrom, Dick's Sporting Goods, The Sports Authority, Dillard's, The Forzani Group and Journeys. No single customer accounted for 10% or more of our revenues for the year ended +December 31, 2009, 2008 or 2007. We believe we have established strong domestic and international wholesale customer channels. +We +use distributors in select markets where we believe such arrangements are preferable to direct sales. In markets where we use third-party distributors, these distributors purchase +products pursuant to a price list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of +one to four years, are generally terminable on 30 days' notice prior to the end of the term or on thirty days prior notice at any time, +and require our distributors to meet a minimum sales threshold. We will accept returns from wholesale and distributor customers for defective products, quality issues, and shipment errors on an +exception basis at the sole discretion of our management. We may also accept returns from our wholesale and distributor customers, on an exception basis at the sole discretion of management, for the +purpose of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, at the sole discretion of management, we may provide markdown allowances +to key wholesale and distributor customers to facilitate the "in-channel" markdown of products where we have experienced less than anticipated sell-through. +Our +domestic accounts are primarily serviced through our internal sales force, which focuses on selling the appropriate mix and quantity of our products to our retail accounts. They +ensure our products are displayed effectively at retail locations and educate our retailers about our Crocs brand and the quality of our products. +7 +Table of Contents +Our financial success in the wholesale channel is significantly related to the willingness of our wholesale customers to continue to carry our products, the +expansion to new wholesale customers and the success of such customers. Our wholesale customers are directly impacted by fluctuations in the broader economy, including the recent global economic +downturn, which, during 2008 and 2009, reduced foot traffic in shopping malls and lessened consumer demand for our products. We do not have long term contracts with any of our wholesale customers, and +sales to our wholesale customers are generally on an order-by-order basis and are subject to rights of cancellation and rescheduling by the customer. If we cannot fill our +customers' orders in a timely manner, the sales of our products and our relationships with those customers may suffer, and this could have a material adverse effect on our product sales and ability to +grow our product line. +Retail Sales +In recent quarters, our consumer-direct sales efforts have performed well. As a result, we are currently expanding our direct sales +efforts to consumers through our retail channel, which consists of company-operated global retail locations, and our internet channel, which consists of company-operated webstores worldwide. We +believe that direct sales provide us direct access to our consumers and an opportunity to showcase our entire line of footwear and accessory offerings, and that this strategy will serve as an +important and effective means to enhance our product and brand +awareness. We view our consumer-direct channels to be complementary to our wholesale channel. As of December 31, 2009, we operated the following retail stores: +U.S Retail Stores +Crocs Kiosk +95 +Crocs Retail Stores +30 +Crocs Outlet Stores +50 +Total +175 +International Retail Stores +Crocs Kiosk/Store in Store +75 +Crocs Retail Stores +54 +Crocs Outlet Stores +13 +Total +142 +Kiosks. As of December 31, 2009, we operated 170 domestic and international retail kiosks located in malls and other high foot +traffic areas. +With bright and colorful displays, efficient use of retail space, and limited initial capital investment, we believe that kiosks are an effective outlet for marketing our products. Kiosks enable us to +highlight a wide range of our products, more effectively interact with potential consumers and enhance our brand awareness among both consumers and local retailers. We plan to continue to operate +certain kiosk sites in select, high foot traffic locations; however, during 2010, we anticipate closing certain kiosk locations where the locations are either underperforming, are posing problems for +relationships with our wholesale customers or where we do not view the kiosk as the best representation of the brand. Our plans to open and/or close kiosks are subject to adjustment based on the +impact of economic conditions and demand for our products. +Retail Stores. As of December 31, 2009, we operated 84 domestic and international retail stores. During 2009, we opened retail +stores in a +variety of locations, including, among others, Miami, Beijing, and Johannesburg. Company-operated retail stores are designed with colorful displays and allow us to effectively market our new and +existing products and interact with customers in order to enhance brand awareness. We plan to continue to open additional Company-operated retail stores in the future where +8 +Table of Contents +we +foresee adequate demand and an ability to meet certain internal hurdle rates. Our plans to open more retail stores are subject to adjustment based on the impact of economic conditions and demand +for our products. +Outlet Stores. As of December 31, 2009, we operated 63 domestic and international outlet stores. During 2009, we opened outlet +stores in a +variety of locations, including, but not limited to, Myrtle Beach, Berlin and Rehoboth Beach. The outlet stores help us move older products in an orderly fashion. We also sell full priced products in +our outlet stores. We plan to open more Company operated outlet stores in early 2010 where we foresee adequate demand and an ability to meet certain internal hurdle rates. Our plans to open new outlet +stores are subject to adjustment based on the impact of economic conditions and demand for our products. +Internet. We currently offer our products domestically and internationally through our 23 webstores worldwide. Our internet presence +enables us to +educate consumers about our products and brand. We continue to expand our web-based marketing efforts to continue to drive consumer awareness regarding the availability of our full product +range on our market-specific websites. +Raw Materials +Croslite material, our proprietary closed-cell resin, is the primary raw material used in most of our footwear and some of +our accessories. Croslite material is soft and durable and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and +development in order to refine our materials to enhance these properties and to target the development of new properties for specific applications. +Croslite +material is produced by compounding elastomer resins that we or one of our third-party processors purchase from major chemical manufacturers together with certain other +production inputs, such as color dyes. At this time, we have identified two suppliers that produce the particular elastomer resins used in the Croslite material. We may, however, in the future +identify and utilize materials produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that +we use to produce the Croslite material are readily available for purchase from multiple suppliers. +Since +our inception, we have substantially increased the number of footwear products that we offer. Many of our new products are constructed using leather, textile fabrics or other +materials. We or our third-party manufacturers obtain these materials from a number of third-party sources and we believe these materials are broadly available. We transitioned the Croslite material +compounding from our former manufacturing facilities in Canada to other facilities and third-party facilities during the second quarter of 2008. We also transitioned the Croslite material compounding +from our former manufacturing facilities in China to third-party facilities during the fourth quarter of 2009. We +compound Croslite material internally in Mexico utilizing subcomponent materials produced by a third party in the U.S. We also outsource the compounding of Croslite material and continue to purchase a +portion of our compounded raw materials from a third party in Europe in accordance with the terms of a continuously renewing supply agreement. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We have Company-operated +production facilities in Mexico and Italy and we also contract with third-party manufacturers located around the world. We believe that our in-house manufacturing capabilities enable us to +rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high demand models and colors throughout the year, while outsourcing allows us to capitalize on +the efficiencies and cost benefits of using contract manufacturing. We believe that this production strategy will enable us to continue to minimize our production costs, increase overall +9 +Table of Contents +operating +efficiencies and shorten production and development times to better serve our retail customers. +The +process for manufacturing our footwear was developed over an eight year period of continual refinement to improve consistency, softness, durability, and yield. In the years ended +December 31, 2009 and 2008, we manufactured approximately 27% and 17%, respectively, of our footwear products at our Company-operated manufacturing facilities primarily in Mexico and Italy. +During the years ended December 31, 2009 and 2008, we obtained the remaining 73% and 83%, respectively, of our footwear products from multiple third-party manufacturers in China and Bosnia. Our +largest third-party supplier in China produced approximately 36% of our footwear unit volume during the year ended December 31, 2009. We do not have written supply agreements with our primary +third-party manufacturers in China. During 2008, we consolidated our manufacturing capacities at the facilities we operate in Mexico and with our third-party manufacturers and shut down our +manufacturing facilities in Canada and Brazil to align our production capacities and cost structure to decreased demand and declining revenues. +Distribution and Logistics +We continue to make enhancements to our distribution and logistics network that will streamline our supply chain, increasing our speed +to market. Over the past year, we +have consolidated our distribution and logistics network to leverage resources and simplify our fulfillment processes while driving down costs in our operations. During the year ended +December 31, 2009, we continued to adjust our strategy based upon projected economic conditions and demand for our products. We continued to consolidate our global distribution centers and +warehousing, thereby decreasing our fixed costs. +During +the year ended December 31, 2009, we stored our raw material and finished goods inventories in Company-operated warehouse and distribution facilities located in Colorado, +California, Hawaii, Puerto Rico, Mexico, the Netherlands, Australia, Japan, China and South Africa. We also utilized distribution centers which were operated by third parties located in Brazil, +Finland, Dubai, Hong Kong, Korea, Singapore, India, Taiwan and China. Throughout 2009, we engaged in efforts to close and consolidate our global warehouse and distribution facilities. As a result, we +vacated several of our facilities; however, as of December 31, 2009, we had not yet been able to sublease certain facilities, including our facilities in Aurora, Colorado, Narita, Japan and +Rotterdam, Netherlands. Once these facilities have been sublet, we will have decreased our global warehouse and distribution footprint by approximately 0.7 million square feet. We believe our +more agile cost structure gives us the flexibility to meet our rapidly changing business requirements and positions us to support the current level of revenue as well as anticipate future growth. As +of December 31, 2009, our Company-operated warehouse and distribution facilities provided us with 1.5 million square feet and our third-party operated distribution facilities provided us +with 0.2 million square feet. We also ship a portion of our products directly to our customers from our internal and third party manufacturers. We are actively pursuing initiatives aimed at +shipping more of our product directly to our customers, which, if successful, is expected to lower our cost of sales in the future. +In +December 2007, we entered into an agreement with Manhattan Associates to provide warehouse management systems within all of our Company-operated distribution centers. As we look +toward streamlining our distribution operations and reducing our global warehouse footprint, we will continue to implement the Manhattan software in locations that support this strategic aim. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress, and patent protection to establish, protect, and enforce +our intellectual property rights in our product designs, brand, +10 +Table of Contents +materials, +and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution +and sale of all of our products, both domestically and internationally, where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and design and the +Crocs word mark, both of which are registered or pending registration in the U.S., the +European Union, Japan, Taiwan, China and Canada among other places. We also claim common law trademark rights or have pending trademark applications for Jibbitz, Jibbitz Logo, YOU by +Crocs™, YOU by Crocs Logo, Ocean Minded, Fury, Fury Logo, Mambaz, Tail Logo, Bite and Bite Logo, as well as for our proprietary material Croslite and the Croslite logo, globally. We intend +to continue to strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the future. We will also continue to aggressively +police our trademarks and copyrights and pursue those who infringe, both domestically and internationally as we deem necessary. +In +the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks are generally valid as long as they are +in use and their registrations are properly maintained and have not been found to become generic. Trademarks registered outside of the U.S. generally have a duration of 10 years depending on +the jurisdiction and are also generally subject to an indefinite number of renewals for a like period upon appropriate application. We believe our trademarks are crucial to the successful marketing +and sale of our products, and we intend to vigorously prosecute and defend our intellectual property rights throughout the world. +We +consider the formulation of the Croslite material used to produce our products to be a valuable trade secret. Prior to our acquisition of Crocs Canada in June 2004, Crocs Canada +developed the formula for the Croslite material, and we believe that it did not publish or otherwise make the formula available to third parties without the protection of confidentiality or similar +agreements. Post acquisition, we continue to protect the formula by using confidentiality agreements with our third-party processors and by requiring our employees who have access to the formula to +execute confidentiality agreements or to be bound by similar agreements concerning the protection of our confidential information. Neither we nor Crocs Canada have attempted to seek patent protection +for the formula. We are not aware of any third party that has independently developed the formula or that otherwise has the right to use the formula in their products other than Finproject, our +third-party supplier of Croslite in Italy and another third-party licensee. Under the terms of our supply agreement with Finproject, Finproject has certain limited rights to use the Croslite material, +which were originally negotiated in connection with our purchase of Crocs Canada from Finproject's parent company. We believe the comfort and utility of our products depend on the properties achieved +from the compounding of the Croslite material and constitute a key competitive advantage for us, and we intend to vigorously protect this trade secret. +We +also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers to police against infringing +products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives are also educated on our patents, pending patents, trademarks and +trade dress and assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or +in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain jurisdictions. +Seasonality +Due to our significant sales growth from our inception through 2007 coupled with the contraction in the business due to the global +economic turmoil and lessening demand for our products in 2008 and 2009, there is still uncertainty in the degree to which sales of our footwear products will be subject to +11 +Table of Contents +seasonality. +During 2008 and 2009, we observed that revenues generated during our first and fourth quarter are less than revenues generated during our second and third quarter, when the northern +hemisphere is experiencing warmer weather. We believe this revenue trend is due to the fact that the majority of our footwear styles during 2008 and 2009 were more suited for warm weather and, +accordingly, we expect this trend to continue. However, we intend to continue branching out into other types of footwear, including offering more winter-oriented styles, and this product expansion may +help us mitigate some of this seasonality in the future. Our quarterly results of operations may fluctuate significantly as a result of a variety of other factors, including the timing of new model +introductions or general economic or consumer conditions. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year. +Backlog +As of December 31, 2009, our backlog, which consists of open orders as of December 31 2009, was approximately +$165.0 million, compared to $113.3 million as of December 31, 2008. The backlog increased year-over-year as a result of what we believe to be strong +acceptance of our 2010 spring/summer styles (for which some customers have already placed orders) and an improvement in the overall economic conditions resulting in an easing of our customer's +tightened purchasing practices from a year ago. Backlog may not be a reliable measure of future sales for any succeeding period and are subject to cancellation by customers at any time. In addition, +our historical cancellation experience may not be indicative of future cancellation rates. We expect the majority of these orders to be fulfilled within the year. +Competition +The global casual footwear and apparel industry is highly competitive. Although we believe that we do not compete directly with any +single company with respect to the +entire spectrum of our products, we believe portions of our business compete with companies such as, but not limited to, Nike Inc., Heelys Inc., Deckers Outdoor Corp., Skechers +USA Inc. and Wolverine World Wide, Inc. Our company-owned retail locations also compete with footwear retailers such as Macy's Inc., Nordstrom Inc., Dick's Sporting +Goods Inc. and Collective Brands Inc. +The +principal elements of competition in this industry include brand awareness, product functionality, design, quality, pricing, customer service, marketing and distribution. We believe +that our unique footwear designs, the Croslite material, our prices and our expanding product offering and distribution network position us well in the marketplace. However, some companies in the +casual footwear and apparel industry have greater financial resources, more comprehensive product lines, broader market presence, longer-standing relationships with wholesalers, longer operating +histories, greater distribution capabilities, stronger brand recognition and greater marketing resources than we currently have. Furthermore, the unique designs and resulting success of our footwear +products have attracted new players in the market with imitation products that are similar to ours; we face competition from these new market entrants. +Product Design and Development +Our primary goal in product design and development is to create and introduce new and innovative footwear products that combine our +standards of comfort, functionality, and style, and enhance the awareness of the Crocs brand. We aspire to be the global leader in active casual footwear products. Our footwear product line is +designed by a combination of our internal design and development staff supported by outside designers. By introducing outside sources to the design process, we believe that we are able to capture a +variety of different design perspectives on a cost-efficient basis and anticipate trends more quickly. To expand our internal design capabilities, EXO has been involved in the design of +several of our new styles. We are committed to continuing to dedicate significant resources to product design and development to sustain our commitment to innovation, maintain or grow our current +level of revenue and drive our global brand. +12 +Table of Contents +We develop footwear models based on what we identify as opportunities in the marketplace. Once a design has been identified and demand in the marketplace has been +validated, the designs are then translated into product specifications by our developers and made into prototypes at our facility in Italy or by one of our third-party manufacturers in China. Our +designers and developers work closely with each other to develop product prototypes, test and refine products and provide quality assurance throughout the manufacturing process. Our design and +development process is highly collaborative, as members of the design team frequently meet with our sales and marketing staff, production and supply managers and certain of our retail customers to +further refine our products to meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs +while maintaining product quality. We spent $7.7 million, $6.4 million and $5.3 million in Company-sponsored research, design and development activities for the years ended +December 31, 2009, 2008, and 2007, respectively. +Employees +As of December 31, 2009, we employed approximately 3,560 persons, compared to 3,700 as of December 31, 2008. This +included 2,030 employees in the U.S. and Canada, 220 employees in Mexico, 890 employees in Asia, 30 employees in South America, and 390 employees in Europe. Globally, as of December 31, 2009, +we had 2,061 persons employed in our consumer-direct channels. While our headcount in the consumer-direct channels grew to accommodate our business, we +reduced our non-consumer-direct headcount by approximately 300 persons since 2008, primarily due to consolidation of our company-operated distribution centers and other reductions in +staffing. As of December 31, 2009, none of our employees were represented by a union. +Public Filings and Corporate Information +Our corporate headquarters are located at 6328 Monarch Park Place, Niwot, Colorado 80503. Our internet address is www.crocs.com. On our +website, we post the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission: our annual report on +Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports filed or furnished pursuant +to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934. All such filings on our website are available free of charge. Also available on our website are the charters of the +committees of our board of directors, as well as our corporate governance guidelines and code of ethics. Copies of any of these documents will be provided in print to any stockholder who submits a +request in writing to Integrated Corporate Relations, 450 Post Road East, Westport, CT 06880. \ No newline at end of file diff --git a/raw/filings/0001334036/2009/0001047469-10-001357/item13.txt b/raw/filings/0001334036/2009/0001047469-10-001357/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..d07e2cf1be611eb3465ccc466648b22570249bea --- /dev/null +++ b/raw/filings/0001334036/2009/0001047469-10-001357/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. Certain Relationships and Related Transactions, and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2010 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2009. \ No newline at end of file diff --git a/raw/filings/0001334036/2009/0001047469-10-001357/item9a.txt b/raw/filings/0001334036/2009/0001047469-10-001357/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..f245038736815c87e812dbec6a846868b08e597f --- /dev/null +++ b/raw/filings/0001334036/2009/0001047469-10-001357/item9a.txt @@ -0,0 +1,63 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial +Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and +15d-15(e) under the Exchange Act, as of the end of the period covered by this annual report (the "Evaluation Date"). Based on this evaluation, our Chief Executive Officer and Chief +Financial Officer concluded that as of the Evaluation Date, our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, +required to be disclosed in our Securities and Exchange Commission ("SEC") reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, +and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required +disclosure. +Management's Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate control over financial reporting, as defined in Exchange Act +Rules 13a-15(f) and 15d-15(f). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2008, using the +criteria set forth in the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway +Commission (COSO). Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2009. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting, which is +included herein. +Changes in Internal Control Over Financial Reporting +During the three months ended December 31, 2009, we did not make any material changes to our internal control over financial +reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. +63 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2009, based on criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's +management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the +accompanying "Management Report on Internal Control Over Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our +audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control +over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or +persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting +and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those +policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material +misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to +future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In +our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year +ended December 31, 2009 of the Company and our report dated February 25, 2010 expressed an unqualified opinion on those financial statements. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +February 25, 2010 +64 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2009/0001047469-10-001357/rp_note.txt b/raw/filings/0001334036/2009/0001047469-10-001357/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e4cdf9a6738c379a25305c4351d4657f5e904161 --- /dev/null +++ b/raw/filings/0001334036/2009/0001047469-10-001357/rp_note.txt @@ -0,0 +1,8 @@ +16. RELATED PARTIES +The Company entered into the following related party transactions: +In +connection with a separation agreement, the Company and its former Chief Executive Officer entered into an exclusive distribution agreement that commenced July 1, 2005. The +distribution agreement is for specified territories in Central America and has an initial term of two years. The agreement provides for renewal periods at the former Chief Executive Officer's option, +if specified sales volumes are attained. Pricing under this agreement is set at a discount off the Company's then current wholesale pricing. Additionally, effective July 1, 2005, the Company +and the former Chief Executive Officer entered into an agreement providing him the right to license and/or franchise airport kiosks selling the Company's products for a period of 10 years, +subject to the Company's right to terminate the agreement if specified numbers of kiosks are not opened in timeframes specified. \ No newline at end of file diff --git a/raw/filings/0001334036/2009/0001047469-10-001357/rpt_disclosure.txt b/raw/filings/0001334036/2009/0001047469-10-001357/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..814cc4de34ac93c09b96e3fbc5dc528986fa6dc3 --- /dev/null +++ b/raw/filings/0001334036/2009/0001047469-10-001357/rpt_disclosure.txt @@ -0,0 +1,19 @@ +CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS +Related Party Transactions +None. +Policy on Transactions with Related Persons +Our Business Code of Conduct and Ethics requires that any transaction involving us in which one of our directors, nominees for +director, executive officers, or greater than five percent stockholders, or one of the aforementioned's immediate family members (each, a "related person"), have a material interest be approved or +ratified by the Audit Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board +reviews ordinary course of business transactions in which directors have an interest as part of the Board's annual director independence review, and our Business Code of Conduct and Ethics permits the +full Board to waive any conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, in addition +to other factors it deems appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. +All +transactions disclosed above were reviewed and approved in accordance with this policy. +Director and Officer Indemnification +We have entered into agreements to indemnify certain directors and executive officers in addition to the indemnification provided for +in our certificate of incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys' +fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by or in the right of the Company, arising out of such person's services as +a director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We believe that these provisions and agreements +are necessary to attract and retain qualified persons as directors and executive officers. +29 \ No newline at end of file diff --git a/raw/filings/0001334036/2013/0001047469-14-001323/filing.txt b/raw/filings/0001334036/2013/0001047469-14-001323/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..798a1e6b436c8732f43188fb83d3d73bd2a146a0 --- /dev/null +++ b/raw/filings/0001334036/2013/0001047469-14-001323/filing.txt @@ -0,0 +1,8057 @@ +10-K +1 +a2218528z10-k.htm +10-K +Use these links to rapidly review the document +Crocs, Inc. Table of Contents to the Annual Report on Form 10-K For the Year Ended December 31, 2013 +TABLE OF CONTENTS 2 +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2013 +or +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission File No. 0-51754 +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware +(State or other jurisdiction of +incorporation or organization) +20-2164234 +(I.R.S. Employer Identification No.) +7477 East Dry Creek Parkway +Niwot, Colorado 80503 +(303) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant's principal executive offices) +Securities +registered pursuant to Section 12(b) of the Act: +Title of each class: +Name of each exchange on which registered: +Common Stock, par value $0.001 per share +The NASDAQ Global Select Market +Securities +registered pursuant to Section 12(g) of the Act: None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý +No o +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. +Yes o No ý +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 ý No o +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 ý No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and +will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to +the Form 10-K. ý +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the +definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer ý +Accelerated filer o +Non-accelerated filer o +(do not check if a +smaller reporting company) +Smaller reporting company o +Indicate +by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the Act). Yes o No +ý +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2013 was $1.4 billion. For the purpose +of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of the registrant's common stock are assumed to be affiliates of the registrant. +This determination of affiliate status is not necessarily conclusive for any other purpose. +The +number of shares of the registrant's common stock outstanding as of January 31, 2014 was 88,546,729. +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by reference from the registrant's proxy statement for the 2014 annual +meeting of stockholders to be filed no later than 120 days after the end of the registrant's fiscal year ended December 31, 2013. +Table of Contents +Special Note Regarding Forward Looking Statements +Statements in this Form 10-K and in documents incorporated by reference herein (or otherwise made by us or on our behalf) may +contain "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications from time to time that +contain such statements. Forward looking statements include statements as to industry trends, our future expectations and other matters that do not relate strictly to historical facts and are based on +certain assumptions of our management. These statements, which express management's current views concerning future events or results, use words like "anticipate," "assume," "believe," "continue," +"estimate," "expect," "future," "intend," "plan," "project," "strive," and future or conditional tense verbs like "could," "may," "might," "should," "will," "would" and similar expressions. Forward +looking statements are subject to risks, uncertainties and other factors which may cause actual results to differ materially from future results expressed or implied by such forward looking +statements. Important factors that could cause actual results to differ materially from the forward looking statements include, without limitation, those described in the section titled "Risk Factors" +(Item 1A of this Form 10-K). Moreover, such forward looking statements speak only as of the date of this report. We undertake no obligation to update any forward looking statements to +reflect events or circumstances after the date of such statements. +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2013 +PART I +Item 1. +Business +2 +Item 1A. +Risk Factors +14 +Item 1B. +Unresolved Staff Comments +27 +Item 2. +Properties +28 +Item 3. +Legal Proceedings +28 +Item 4. +Mine Safety Disclosures +30 +PART II +Item 5. +Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +31 +Item 6. +Selected Financial Data +34 +Item 7. +Management's Discussion and Analysis of Financial Condition and Results of Operations +35 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +65 +Item 8. +Financial Statements and Supplementary Data +67 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +67 +Item 9A. +Controls and Procedures +67 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +70 +Item 11. +Executive Compensation +70 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +70 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +71 +Item 14. +Principal Accountant Fees and Services +71 +PART IV +Item 15. +Exhibits and Financial Statement Schedules +72 +Signatures +77 +1 +Table of Contents +PART I +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the "Company," "we," "our" or "us") are engaged in the design, +development, manufacturing, worldwide marketing and distribution of casual lifestyle footwear, apparel and accessories for men, women and children. We strive to be the global leader in the sale of +molded footwear featuring fun, comfort, color and functionality. Our products include footwear and accessories that utilize our proprietary closed-cell resin, called Croslite. The use of this unique +material enables us to produce innovative, lightweight, non-marking, and odor-resistant footwear. We currently sell our products in more than 90 countries through domestic and international retailers +and distributors and directly to end-user consumers through our company-operated retail stores, outlets, kiosks and webstores. +In +2002, we launched the marketing and distribution of our original clog style footwear in the United States. The unique characteristics of Croslite enabled us to offer consumers a shoe +unlike any other footwear model then available. Since the initial introduction and popularity of the Beach and Crocs Classic designs, we have expanded our Croslite products to include a variety of new +styles and products and have further extended our product reach through the acquisition of brand platforms such as Jibbitz, LLC ("Jibbitz") and Ocean Minded, Inc. ("Ocean Minded"). We +intend to continue to expand the breadth of our footwear product lines, bringing a unique and original perspective to the consumer in styles that may be unexpected from Crocs. We believe this will +help us to continue to build a stable year-round business as we move toward becoming a four-season brand. +The +broad appeal of our footwear has allowed us to market our products to a wide range of distribution channels, including department stores and traditional footwear retailers as well as +a variety of specialty and independent retail channels. Our marketing efforts surround specific product launches and employ a fully integrated approach utilizing a variety of media outlets, including +print and websites. Our marketing efforts drive business to both our wholesale partners and our company-operated retail and internet stores, ensuring that our presentation and story are first class +and drive purchasing at the point of sale. +As +a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. Sales in international markets in foreign currencies are expected to +continue to represent a substantial portion of our revenues. Likewise, we expect our subsidiaries with functional currencies other than the U.S. dollar will continue to represent a substantial portion +of our overall gross margin and related expenses. Accordingly, changes in foreign currency exchange rates could materially affect revenues and costs or the comparability of revenues and costs from +period to period as a result of translating our financial statements into our reporting currency. +Products +Footwear +Our footwear product offerings have grown significantly since we first introduced the single-style clog in six colors, in 2002. We +currently offer a wide variety of footwear products, some of which includes boots, sandals, sneakers, mules and flats, which are made of materials like leather and textile fabrics as well as Croslite. +Footwear sales made up 96.9%, 95.8% and 95.6% of total revenues for the years ended December 31, 2013, 2012 and 2011, respectively. During the years ended December 31, 2013, 2012 and +2011, approximately 71.1%, 75.3% and 73.1%, respectively, of unit sales consisted of products geared toward adults compared to 28.9%, 24.7% and 26.9%, respectively, of unit sales of products geared +towards children. +2 +Table of Contents +A +key differentiating feature of our footwear products is the Croslite material, which is uniquely suited for comfort and functionality. Croslite is carefully formulated to be of a +density that creates extremely lightweight, comfortable and non-marking footwear which conforms to the shape of the foot and increases comfort. Croslite is a closed-cell resin material which is water +resistant, virtually odor free and allows many of our footwear styles to be cleaned simply with water. As we have expanded our product offering, we have incorporated traditional materials such as +textile fabric and leather into many new styles; however, we continue to utilize the Croslite material for the foot bed, sole and other key structural components for many of these styles. +We +strive to provide our global consumer with a year-round product assortment featuring comfort, fun, color and innovation. Our collections are designed to meet the needs of the family +by focusing on their key wearing occasions. Our goal is to deliver world-class product assortments for the family with all of the comfort features and benefits Crocs is known for. Our products are +divided into three product offerings: Core, Style and Active. +Core Products +At the heart of our brand resides the Classic, our first and most iconic style for adults and kids that embodies our innovation in +molding and design, delivers all-day comfort, and has established a new category in the footwear marketplace. The unique look and feel of the Classic can be experienced throughout our entire product +line due to the design and application of our proprietary material Croslite. Dual density technology, warm lined styles, seasonal flips and slides drive additional business to our core molded product +line introduced in 2002. Licensed style partnerships from Disney, Sanrio, Nickelodeon and Warner Bros. provide popularity to our kids core line along with our kids-only product innovations including +color-change materials, lights and interactive elements. In addition, we have extended our licensing partnerships to sports leagues such as Major League Baseball and the NCAA and artists such as Van +Gogh, Mondo Guerra and Jon Burgerman. Our core molded products are available to all channels of distribution and span both stylish and active wearing occasions for the entire family. +Style Products +Our Style Category showcases collections designed for the family around casual and stylish wearing occasions with a relaxed and fun +point of view. This category is primarily designed for our consumers shopping in footwear, department stores, specialty/independent and our own direct-to-consumer channel. +Stretch +Sole +Launched +in Spring 2014, Stretch Sole featuring Fit2U technology represents the ultimate of 360 degree fit-to-you comfort and molding innovation. Our new proprietary platform is intended +to raise the bar of combined comfort and style. Launched exclusively in our direct-to-consumer channel and premium wholesale accounts, Stretch Sole is the latest addition to our collection of +comfort-enhancing technologies and designs. +Translucents +The +beauty of molding is best expressed in our Translucents collection, first introduced in 2011 with the goal of providing our female consumer with new and innovative styles. +Translucents, a beautiful and opaquely colorful collection of flats, sandals, flips and clogs, have become a summer staple for women and girls looking for the ultimate combination of comfort and style +for the spring and summer months. +3 +Table of Contents +A'Leigh +This +day-to-night collection showcases traditionally stylish and natural materials including leather, canvas, cork and wood combined with our proprietary Croslite material in a variety +of simple, fashionable wedge silhouettes. This combination of comfort and style has proven to be compelling for our female consumers looking to expand their wearing occasions with our brand. +Canvas +Collection +A +staple for the family, our collection of casual canvas loafers including Walu, Santa Cruz and the Cabo provide industry-leading comfort cushioning via our Croslite footbeds and +outsoles combined with simple, easy to wear, casually stylish uppers suitable for a day at the office and a night at the movies. +Active Products +Our Active Category showcases collections designed with an active-casual point of view, catering to on-the-go families with busy +lifestyles. These collections are primarily found in sport, footwear, specialty/independent retailers and our own direct-to-consumer channel. +Busy +Day +Designed +with the busy mom in mind, the Busy Day collection drives a casually active design through a wide variety of silhouettes including flats, Mary Janes, sneakers and slip-ons. This +collection is instantly recognizable from its simple sleek styling, easy on-and-off designs, Croslite outsole and drop-in Croslite footbed designed for maximum comfort and cushioning for all-day wear. +The collection will expand in 2014 to include Busy Day styles designed for active boys and girls. +Outdoor/Active +Sandals and Boots +Season +after season, our Outdoor/Active Sandals and Boot Collections provide opportunities for wearing occasions for the family celebrating the outdoors and the change of seasons from +sun to rain to snow. Our collections around Yukon Sport, Real Tree™, Swiftwater Sandals, Handle It and Jaunt Rain Boots and Crocband and Gust Winter Boots offer a variety of fun and +comfortable seasonal options for every member of the family. +Crocs +Golf +Introduced +in 2012, our Crocs Golf Collection won the Best New Product at the 2012 PGA Show and Editor's Pick at the 2013 PGA Show. Combining the best of casual golf styles and +outstanding underfoot comfort via our proprietary Croslite material, the Crocs Golf line provides a number of outstanding styles for casual golfers. +Crocs +Professional Footwear Division (PFD) +Providing +solutions to our consumers in Healthcare, Food and Beverage and Light Industrial, we combine the comfort of Croslite with purpose-built benefits including slip-resistance, +seamless uppers and electrical hazard safety in our Professional Footwear Division product collection. +As +a global leader in casual footwear, we recognize the responsibility we have to our employees and the global communities we serve. We strive to maintain a spirit of "giving back" as a +part of the Crocs culture and worldwide reputation. With the help of our donation partners, we are able to provide shoes to millions of individuals. We have donated over three million pairs of shoes +to individuals in need both domestically and internationally in more than 40 countries including Democratic Republic of +4 +Table of Contents +The +Congo, Haiti, Iraq, and Malawi. These donations and other social responsibility initiatives, form the Crocs Cares program. Crocs is dedicated to providing robust programs, donations, and community +work opportunities designed to make a difference in the lives of our employees as well as both local and global communities. +Accessories +In addition to our footwear brands, we own the Jibbitz brand, a unique accessory product-line with colorful snap-on charms specifically +suited for Crocs shoes. We acquired Jibbitz in December 2006 and have expanded the product line to include a wide variety of charms in varying shapes and sizes, with designs such as flowers, sports +gear, seasonal and holiday designs, animals, symbols, letters and rhinestones. Crocs licensing agreements also extend to Jibbitz, which allows Jibbitz to create designs bearing logos and emblems of +Disney, Nickelodeon and the Crocs collegiate line, among others. Jibbitz designs allow Crocs consumers to personalize their footwear to creatively express their individuality. More than 3,000 unique +Jibbitz charm designs have been sold to consumers for personalizing their Crocs footwear. Sales from Jibbitz designs made up 2.8%, 3.5% and 3.7% of total revenues for the years ended +December 31, 2013, 2012 and 2011, respectively. +Sales and Marketing +Each season, we focus on presenting a compelling "brand story and experience" for our new product collections and our broader casual +lifestyle assortment. Our marketing efforts center on multi-level story-telling across diverse wearing occasions and product silhouettes. +As +we are a global brand, our marketing model is based on global relevance while still allowing for regional flexibility in execution and message. At the regional or market level, +campaigns are initiated using a mix of digital, social, and traditional media outlets that align with local marketplaces and target consumer dynamics. This strategy allows for relevant cross-channel +input coordinated through our global brand objectives to drive an aligned global marketing and brand strategy. +We +utilize an in-house creative team to execute our marketing efforts. Local marketing teams focus on localizing campaigns by establishing and executing marketing programs to effectively +engage target customers in a meaningful manner. We utilize a proprietary Brand Performance System to help prioritize demand generation initiatives and optimize local marketing activities. The Brand +Performance System integrates multiple research and consumer database platforms across key markets to provide guidance on highest yielding customer growth opportunities and market performance +analysis. +We +have three primary sales channels: wholesale, retail and internet (discussed at a more detailed level below). Our marketing efforts are aimed toward driving business to both our +wholesale partners and our company-operated retail and internet stores. Our marketing efforts in the wholesale and retail channels are focused on visual product merchandising with alignment on key +stories, activation materials and creative materials. Retail stores provide a unique opportunity to engage with customers in a three-dimensional manner. Strong emphasis is placed on making the store +experience a meaningful and memorable showcase of our larger assortment of casual lifestyle footwear and key new product launches. Our marketing, merchandising, and visual merchandising departments +work closely together to ensure the store environment and merchandise are aligned to support key seasonal product stories while promoting the larger product lines and iconic product collections. +We +have an in-house digital marketing team that oversees digital marketing programs and platforms that include paid-and-organic search, display, re-targeting, email and affiliate +marketing to drive new customers to the brand and retain existing customers. Under our universal seasonal brand campaign, the team helps to adapt key brand story content and produces additional +web-specific content for our internet channel. +5 +Table of Contents +Wholesale Channel +During the years ended December 31, 2013, 2012 and 2011, approximately 56.5%, 57.5% and 59.8% of net revenues, respectively, +were derived from sales through the wholesale channel which consists of sales to distributors and third party retailers. Wholesale customers include +national and regional retail chains, department stores, sporting goods stores, independent footwear retailers and family footwear retailers, such as Academy, Rack Room Shoes, Famous Footwear, Kohl's, +DSW, Shoe Carnival, Dick's Sporting Goods, Nordstrom, Xebio and Murasaki Sports, as well as on-line retailers such as Amazon and Zappos. No single customer accounted for 10% or more of our revenues +for any of the years ended December 31, 2013, 2012 and 2011. +We +use third party distributors in select markets where we believe such arrangements are preferable to direct sales. These third party distributors purchase products pursuant to a price +list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to four years, are +generally terminable on 30 days prior notice and have minimum sales requirements. Many of our agreements allow us to accept returns from wholesale customers at our discretion for defective +products, quality issues and shipment errors on an exception basis or, for certain wholesale customers, extend pricing discounts in lieu of defective product returns. We also may accept returns from +our wholesale customers, on an exception basis, for the purpose of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, we may provide markdown +allowances to key wholesale customers to facilitate in-channel product markdowns where sell-through is less than anticipated. +Consumer Direct Channels +Consumer direct sales channels include retail and internet channels and serve as an important and effective means to enhance our +product and brand awareness as they provide direct access to our consumers and an opportunity to showcase our entire line of footwear and accessory offerings. Consequently, we view the consumer direct +channels to be complementary to our wholesale channel. +Retail Channel +During the years ended December 31, 2013, 2012 and 2011, approximately 35.0%, 33.4% and 30.6%, respectively, of our net revenues +were derived from sales through our retail channel. We operate our retail channel through three integrated platforms: full retail locations, outlet locations, and kiosk/store-in-store locations. Our +three types of store platforms enable us to organically promote the breadth of our product in high-traffic, highly visible locations. Our strategy for expanding our global retail business is to +increase our market share in a disciplined manner, by selectively opening additional stores in new and existing markets, as well as increasing sales in existing stores, to support our long-term +strategic growth objective to further build Crocs into the leading casual lifestyle footwear brand in the world. As store growth will vary in new and existing markets due to many factors, including +maturity of the market and brand recognition, we periodically evaluate the fixed assets and leasehold improvements related to our retail locations for impairment. +• Full Retail Locations +Our +company-operated retail locations allow us to effectively showcase the full extent of our new and existing products to customers at retail pricing. In addition, our full retail locations enable us +to interact with our customers on a personal level in order to guarantee a satisfying shopping experience as well as to obtain key retail metrics to better fulfill customer demands. On average, the +optimal space for our retail locations is between approximately 1,500 and 1,800 square feet, depending on the geographical vicinity of the property, and typically located in high-traffic shopping +malls or districts. In early 2014, we opened a three-story flagship location with approximately 4,500 square feet of selling space in a 13,600 square foot building located on +6 +Table of Contents +34 th Street +in New York. As of December 31, 2013, 2012, and 2011, we operated 327, 287 and 180 global full retail stores, respectively. +• Outlet Locations +Our +company-operated outlet locations allow us to sell discontinued and overstock merchandise directly to consumers at discounted prices. We additionally sell full priced products in certain of our +outlet stores. Outlet locations follow a similar size model as our full retail stores; however, they are generally located within outlet shopping locations. As of December 31, 2013, 2012 and +2011, we operated 170, 129 and 92 global outlet stores, respectively. +• Kiosk/Store-in-Store Locations +Our +company-operated kiosks and store-in-store locations allow us to market specific product lines with the further flexibility to tailor products to consumer preferences in shopping malls and other +high foot traffic areas. With bright and colorful displays, efficient use of retail space, and limited initial capital investment, we believe that kiosks can be an effective outlet for marketing our +products. As part of our overall retail strategy, we continue to close certain kiosks/store-in-store locations, as we believe our full retail and outlet locations allow us to better merchandise the +full extent and depth of our product line. As of December 31, 2013, 2012 and 2011, we operated 122, 121 and 158 global kiosks and store-in-stores, respectively. +7 +Table of Contents +The +following table illustrates the net growth in 2013 with respect to the number of our company-operated retail locations by reportable operating segment and country: +Company-operated retail locations: +December 31, +2012 +Opened +Closed +December 31, +2013 +Americas +U.S. +170 +30 +(14 +) +186 +Canada +12 +2 +(1 +) +13 +Brazil +8 +1 +(1 +) +8 +Puerto Rico +7 +— +— +7 +Argentina +1 +1 +— +2 +Chile +1 +— +(1 +) +— +Total Americas +199 +34 +(17 +) +216 +Asia Pacific +Korea +63 +17 +(4 +) +76 +Taiwan +39 +27 +(8 +) +58 +China +43 +2 +(7 +) +38 +Hong Kong +17 +8 +(4 +) +21 +Singapore +14 +2 +(1 +) +15 +Australia +11 +1 +(1 +) +11 +United Arab Emirates (UAE) +8 +2 +(1 +) +9 +South Africa +6 +2 +— +8 +Total Asia Pacific +201 +61 +(26 +) +236 +Japan +40 +11 +(2 +) +49 +Europe +Russia +29 +7 +— +36 +Germany +18 +6 +(4 +) +20 +Great Britain +16 +2 +(1 +) +17 +France +7 +7 +— +14 +Netherlands +8 +1 +— +9 +Finland +6 +1 +— +7 +Spain +6 +— +— +6 +Belgium +3 +— +— +3 +Italy +— +2 +— +2 +Sweden +2 +— +— +2 +Ireland +1 +— +— +1 +Portugal +1 +— +— +1 +Total Europe +97 +26 +(5 +) +118 +Total company-operated retail locations +537 +132 +(50 +) +619 +Internet Channel +As of December 31, 2013, we offered our products through 43 company-operated internet webstores worldwide. During the years +ended December 31, 2013, 2012 and 2011, approximately 8.5%, 9.1% and 9.6%, respectively, of our net revenues were derived from sales through our internet channel. Our internet presence enables +us to have increased access to our customers and provides us with an opportunity to educate them about our products and brand. We continue to expand our web-based marketing efforts to increase +consumer awareness of our full product range and have begun expanding the implementation of locally executed internet web stores at the regional level. +8 +Table of Contents +Business Segments and Geographic Information +During the first quarter of 2013, we adjusted our operating segment structure for internal reports reviewed by the chief operating +decision maker ("CODM") by presenting Japan separate from the Asia Pacific segment. This change was made due to recurring amounts of substantial business activity as well as the macroeconomic +environment within Japan, which resulted in the need for a regular review of Japan operating results by management and the CODM in order to better evaluate performance and allocate resources for the +consolidated business. See Note 14—Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements for additional financial +information regarding our operating segments. Segment information for all periods presented has been reclassified to conform to the fiscal 2013 presentation. +As +a result of the changes discussed above, we have four reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, Japan and Europe. We also +have an "Other businesses" category which aggregates insignificant operating segments that do not meet the reportable segment threshold and represents manufacturing operations located in Mexico, Italy +and Asia. The composition of our reportable operating segments is consistent with that used by our CODM to evaluate performance and allocate resources. +Each +of our reportable operating segments derives its revenues from the sale of footwear, apparel and accessories to external customers as well as intersegment sales. Revenues of the +"Other businesses" category are primarily made up of intersegment sales. The remaining revenues for the "Other businesses" represent non-footwear product sales to external customers. Intersegment +sales are not included in the measurement of segment operating income or regularly reviewed by the CODM and are eliminated when deriving total consolidated revenues. +The +primary financial measure utilized by the CODM to evaluate performance and allocate resources is segment operating income. Segment performance evaluation is based primarily on +segment results without allocating corporate expenses, or indirect general, administrative and other expenses. Segment profits or losses of our reportable operating segments include adjustments to +eliminate intersegment profit or losses on intersegment sales. As such, reconciling items for segment operating income represent unallocated corporate and other expenses as well as intersegment +eliminations. Segment assets consist of cash and cash equivalents, accounts receivable and inventory as these balances are regularly reviewed by the CODM. +Americas +The Americas segment consists of revenues and expenses related primarily to product sales in the North and South America geographic +regions. Regional wholesale channel customers consist of a broad range of sporting goods and department stores as well as specialty retailers and distributors. The regional retail channel sells +directly to the consumer through 216 company-operated store locations as well as through webstores. During the years ended December 31, 2013, 2012 and 2011, revenues from the Americas segment +constituted approximately 41.9%, 44.1% and 44.7% of our consolidated revenues, respectively. +Asia Pacific +The Asia Pacific segment consists of revenues and expenses related primarily to product sales throughout Asia (excluding Japan), +Australia, New Zealand, the Middle East and South Africa. The Asia Pacific wholesale channel consists of sales to a broad range of retailers similar to the wholesale channel we have established in the +Americas segment. We also sell products directly to the consumer through 236 company-operated stores as well as through our webstores. During the years ended December 31, 2013, 2012 and 2011, +revenues from the Asia segment constituted 28.7%, 26.1% and 22.7% of our consolidated revenues, respectively. +9 +Table of Contents +Japan +The Japan segment consists of revenues and expenses related to product sales in Japan. The Japan wholesale channel consists of sales to +a broad range of retailers similar to the wholesale channel we have established in the Americas segment. The regional retail channel sells directly to the consumer through 49 company-operated store +locations as well as through webstores. During the years ended December 31, 2013, 2012 and 2011, revenues from the Japan segment constituted approximately 11.3%, 14.7% and 15.5% of our +consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related primarily to product sales throughout Europe and Russia. The Europe +segment wholesale channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas segment. We also sell our products directly to the +consumer through 118 company-operated stores as well as through our webstores. During the years ended December 31, 2013, 2012 and 2011, revenues from the Europe segment constituted 18.1%, 15.1% +and 17.1% of our consolidated revenues, respectively. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network so as to further streamline our supply chain, increase +our speed to market and lower operating costs. During the year ended December 31, 2013, we stored our raw material and finished goods inventories in company-operated warehouse and distribution +facilities located in the United States, Mexico, the Netherlands, Japan, Finland, South Africa, Russia and Italy. We also utilize distribution centers which are operated by third parties located in +the United States, China, Japan, Hong Kong, Australia, Korea, Singapore, India, Taiwan, the United Arab Emirates, Russia, Brazil, Argentina, Chile, Puerto Rico and Italy. Throughout 2013, we continued +to engage in efforts to consolidate our global warehouse and distribution facilities to maintain a lean cost structure. As of December 31, 2013, our company-operated warehouse and distribution +facilities provided us with approximately 1.0 million square feet and our third party operated distribution facilities provided us with approximately 0.4 million square feet. We also +ship a portion of our products directly to our customers from our internal and third party manufacturers. We are actively pursuing initiatives aimed at shipping more of our product directly to our +customers in an effort to lower future cost of sales. +Raw Materials +"Croslite", our branded proprietary closed-cell resin, is the primary raw material used in the majority of our footwear and some of our +accessories. Croslite is soft and durable and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and development in order to refine our +materials to enhance these properties and to target the development of new properties for specific applications. +Croslite +material is produced by compounding elastomer resins, that we or one of our third party processors purchase from major chemical manufacturers, together with certain other +production inputs such as color dyes. At this time, we have identified multiple suppliers that produce the elastomer resins used in the Croslite material. We may, however, in the future identify and +utilize materials produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use to +produce the Croslite products are readily available for purchase from multiple suppliers. +Since +our inception, we have substantially increased the number of footwear products that we offer. Many of our new products are constructed using leather, textile fabrics or other +non-Croslite materials. We, or our third party manufacturers, obtain these materials from a number of third party +10 +Table of Contents +sources +and we believe these materials are broadly available. We also outsource the compounding of the Croslite material and continue to purchase a portion of our compounded raw materials from a third +party in Europe. +Design and Development +We continue to dedicate significant resources to product design and development as we develop footwear styles based on opportunities we +identify in the marketplace. Our design and development process is highly collaborative, as members of the regional design teams, including our EXO Italia ("EXO") location, which specializes in EVA +(Ethylene Vinyl Acetate) based finish products for the footwear industry, frequently meet with sales and marketing staff, production and supply managers and certain of our retail customers to further +refine our products to meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs while +maintaining product quality. We spent $15.4 million, $12.0 million and $10.8 million in research, design and development activities for the years ended December 31, 2013, +2012 and 2011, respectively. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have company-operated +production facilities in Mexico and Italy. We also contract with third party manufacturers to produce certain of our footwear styles or provide support to our internal production processes. We believe +that our internal manufacturing capabilities enable us to rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high demand models and colors +throughout the year, while outsourcing allows us to capitalize on the efficiencies and cost benefits of using contracted manufacturing services. We believe this strategy will continue to minimize our +production costs, increase overall operating efficiencies and shorten production and development times. +In +the years ended December 31, 2013, 2012 and 2011, we manufactured approximately 15.1%, 21.1% and 20.6%, respectively, of our footwear products internally. We sourced the +remaining footwear production from multiple third party manufacturers primarily in China, Vietnam, Eastern Europe and South America. During the years ended December 31, 2013, 2012 and 2011, our +largest third-party manufacturer in China produced approximately 28.0%, 31.7% and 33.1%, respectively, of our footwear +unit volume. We do not have written supply agreements with our primary third party manufacturers in Asia. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress and patent protection to establish, protect and enforce our +intellectual property rights in our product designs, brand, materials and research and development efforts, although no such methods can afford complete protection. We own or license the material +trademarks used in connection with the marketing, distribution and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or +manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China and Canada +among other places. We also have registrations or pending trademark applications for the marks Jibbitz, Jibbitz Logo, YOU by Crocs, YOU by Crocs Logo, Ocean Minded, Tail Logo, Bite, Bite Logo, +Crocband, Crocs Tone and Crocs Littles, "Croslite" and the Croslite logo, as well as other marks in various countries around the world. +In +the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks registered within and outside of the U.S. +are generally valid as long +11 +Table of Contents +as +they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks are crucial to the successful marketing and sale of our +products. We intend to continue to strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the future. We will also +continue to aggressively police our patents, trademarks and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We +consider the formulations of the materials covered by our trademark Croslite and used to produce our shoes to be a valuable trade secret. Croslite material is manufactured through a +process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the +formula by using exclusive supply agreements for key components, confidentiality agreements with our third party processors and by requiring our employees to execute confidentiality agreements +concerning the protection of our confidential information. Other than our third party processors, we are unaware of any third party using our formula in the production of shoes. We believe the comfort +and utility of our +products depend on the properties achieved from the compounding of Croslite material and constitute a key competitive advantage for us, and we intend to continue to vigorously protect this trade +secret. +We +also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors and retailers, as well as outside +investigators and attorneys, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and +distributors are also educated on our patents, pending patents, trademarks and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of +certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for +our intellectual property in certain jurisdictions. +Seasonality +Due to the seasonal nature of our footwear which is more heavily focused on styles suitable for warm weather, revenues generated during +our first and fourth quarters are typically less than revenues generated during our second and third quarters, when the northern hemisphere is experiencing warmer weather. We continue to expand our +product line to include more winter oriented styles to mitigate some of the seasonality of our revenues. Our quarterly results of operations may also fluctuate significantly as a result of a variety +of other factors, including the timing of new model introductions or general economic or consumer conditions. Accordingly, results of operations and cash flows for any one quarter are not necessarily +indicative of results to be expected for any other quarter or year. +Backlog +We receive a significant portion of orders from our wholesale customers and distributors that remain unfilled as of any date and, at +that point, represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog. While all orders in our backlog are subject to cancellation by customers, we expect +that the majority of such orders will be filled within one year. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing schedule and the timing of +product shipments. Further, the mix of future and immediate delivery orders can vary significantly period over period. Backlog only relates to wholesale and distributor orders for the next season and +current season fill-in orders and excludes potential sales in our retail and internet channels. Backlog also is affected by the timing of customers' orders and product availability. Due to these +factors and since the unfulfilled orders can be canceled at any time prior to shipment by our customers, we believe that backlog may be an imprecise indicator of future revenues that may be achieved +in a fiscal period and comparisons of backlog from period to period may be misleading. In +12 +Table of Contents +addition, +our historical cancellation experience may not be indicative of future cancellation rates. The following table summarizes backlog by reportable segment as of December 31, 2013 and +2012: +December 31, +($ thousands) +2013 +2012 +Americas +$ +113,972 +$ +122,376 +Asia Pacific +141,446 +121,767 +Japan +47,651 +53,732 +Europe +76,203 +56,456 +Total backlog +$ +379,272 +$ +354,331 +Competition +The global casual, athletic and fashion footwear markets are highly competitive. Although we believe that we do not compete directly +with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale business compete with companies such as, but not limited to, Deckers Outdoor Corp., +Skechers USA Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations also compete with footwear retailers such as +Genesco, Inc., Macy's, Dillard's, Dick's Sporting Goods Inc., The Finish Line Inc. and Footlocker, Inc. +The +principal elements of competition in these markets include brand awareness, product functionality, design, quality, pricing, customer service, marketing and distribution. We believe +that our unique footwear designs, the Croslite material, our prices, expanded product line and our distribution network continue to position us well in the marketplace. However, some companies in the +casual footwear and apparel industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating +histories, greater distribution capabilities, stronger brand recognition and greater marketing resources than we have. Furthermore, we face competition from new players who have been attracted to the +market with imitation products similar to ours as the result of the unique design and success of our footwear products. +Employees +As of December 31, 2013, we had approximately 5,000 full-time, part-time and seasonal employees, none of which were represented +by a union. +Available Information +We were organized in 1999 as a limited liability company. In January 2005, we converted to a Colorado corporation and subsequently +re-incorporated as a Delaware corporation in June 2005. In February 2006, we completed our initial public offering and trading of our common stock on NASDAQ commenced. +Our +internet address is www.crocs.com on which we post the following filings, free of charge, as soon as reasonably practicable after they are electronically filed with or furnished to +the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports +filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Copies of any of these documents will be provided in print to any +stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. +13 +Table of Contents +ITEM 1A. Risk Factors +Described +below are certain risks that our management believes are applicable to our business and the industry in which we operate. These risks have the potential to materially adversely +affect our business, results of operations, financial condition, liquidity or access to sources of financing. The risks included here are not exhaustive and there may be additional risks that are not +presently material or known. You should carefully consider each of the following risks described below in conjunction with all other information presented in this report. Since we operate in a very +competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such +risk factors on our business. +Uncertainty about current global economic conditions may adversely affect consumer spending and the financial health of our customers and others with whom we do business +which may adversely affect our financial condition, results of operations and cash resources. +Uncertainty about current and future global economic conditions may cause consumers and retailers to defer purchases or cancel purchase +orders for our products in response to tighter credit, decreased cash availability and weakened consumer confidence. Our financial success is sensitive to changes in general economic conditions, both +globally and nationally, that may adversely affect the demand for our products including recessionary economic cycles, higher interest borrowing rates, higher fuel and other energy costs, inflation, +increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws or other economic factors. For example, we experienced +volatility in sales and operating performance in our Americas and Japan segments in 2013 due to adverse macroeconomic conditions in those regions and overall weakness in consumer confidence. In +addition, sales and operating performance in our Europe segment in 2012 were adversely affected by the macroeconomic conditions surrounding the European sovereign debt crisis. If global economic and +financial market conditions deteriorate or remain weak for an extended period of time, the following factors could have a material adverse effect on our business, operating results and financial +condition: +• Slower consumer spending may result in our inability to maintain or increase our sales to new and existing customers, +reduced orders or order cancellations from wholesale accounts that are directly impacted by fluctuations in the broader economy, increased difficulty regarding inventory management, higher discounting +efforts and lower gross margins. +• We may be unable to open and operate new retail stores, or continue to operate existing stores, due to the high fixed cost +nature of the retail segment. +• We conduct operations in several different countries and therefore, are exposed to fluctuations in foreign currency +exchange rates relative to the U.S. Dollar. Transactional and translational foreign currency risk exposure could have a material impact on our reported financial results and condition. +• Any decrease in available credit caused by a weakened global economy may result in financial difficulties for our +wholesale and retail customers, product suppliers and other service providers, as well as the financial institutions that are counterparties to our credit facility and derivative transactions. If +credit pressures or other financial difficulties result in insolvency for these parties, it could adversely impact our estimated reserves, our ability to obtain future financing and our financial +results. +• If our customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer +order cancellations and/or the need to extend customer payment +14 +Table of Contents +terms +which could lead to higher accounts receivable balances, reduced cash flows, greater expense associated with collection efforts and increased bad debt expense. +• If our manufacturers or other parties in our supply chain experience diminished liquidity, they may not meet their +obligations to us, and we may experience the inability to meet customer product demands in a timely manner. +We face significant competition. +The footwear industry is highly competitive. Continued growth in the market for casual footwear has encouraged the entry of new +competitors into the marketplace and has increased competition from established companies. Our competitors include most major athletic and footwear companies, branded apparel companies and retailers +with their own private label footwear products. A number of our competitors have significantly greater financial resources than us, more comprehensive product lines, a broader market presence, longer +standing relationships with wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition and spend substantially more than we do on product marketing. Our +competitors' greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and production and more +quickly develop new products. Additionally, +some of our competitors are offering products that are substantially similar, in design and materials, to Crocs branded footwear. In addition, access to offshore manufacturing is also making it easier +for new companies to enter the markets in which we compete. If we fail to compete successfully in the future, our sales and profits may decline, we may lose market share, our financial condition may +deteriorate and the market price of our common stock is likely to fall. +We may be unable to successfully execute our long-term growth strategy, maintain our current revenue levels or accurately forecast geographic demand and supply for our +products. +Our ability to maintain our revenue levels or to grow in the future depends on, among other things, the continued success of our +efforts to maintain our brand image, our ability to bring compelling and revenue enhancing footwear offerings to market, and our ability to expand within our current distribution channels and increase +sales of our products into new locations internationally. Successfully executing our long-term growth and profitability strategy will depend on many factors, +including: +• the global strengthening of the Crocs brand into a leading casual lifestyle footwear provider; +• focusing on relevant product innovation and profitable new growth platforms while maintaining demand for our current +offerings; +• our ability to balance disciplined global retail store growth and existing store renovation while meeting operational and +financial targets at the retail store level; +• accurately forecasting the global demand for our products and the timely execution of supply chain strategies to deliver +product around the globe efficiently based on that demand; +• our ability to use and protect the Crocs brand and our other intellectual property in new markets and territories; +• achieving and maintaining a strong competitive position in new and existing markets; +• our ability to attract and retain qualified distributors or agents or to continue to develop direct sales channels; +• our ability to consolidate our network to leverage resources and simplify our fulfillment process; and +15 +Table of Contents +• executing a multi-channel advertising and marketing campaign to effectively communicate our message directly to our +consumers and employees. +If +we are unable to successfully implement any of the above mentioned strategies and many other factors mentioned throughout this section, our business may fail to grow, our brand may +suffer and our results of operations may be adversely impacted. +Our success depends substantially on the value of our brands and failure to strengthen and preserve their value, either through our actions or those of our business +partners, could have a negative impact on our financial results. +We believe much of our success has been attributable to the strengthening of the Crocs global brand. To be successful in the future, +particularly outside of the U.S., where the Crocs brand is less well-known and perceived differently, we believe we must timely and appropriately respond to changing consumer demand and leverage the +value of our brands across all sales channels. We may have difficulty managing our brand image across markets and international borders as certain consumers may perceive our brand image to be outdated +and one-dimensional prior to purchasing our products. Brand value is based in part on consumer perceptions on a variety of subjective qualities. In +the past, several footwear companies including ours have experienced periods of rapid growth in revenues and earnings followed by periods of declining sales and losses. Our business has been and may +be similarly affected in the future. Business incidents, such as perceived product safety issues, whether isolated or recurring, that erode consumer trust, particularly if the incidents receive +considerable publicity or result in litigation, can significantly reduce brand value and have a negative impact on our financial results. Consumer demand for our products and our brand equity could +diminish significantly if we fail to preserve the quality of our products, are perceived to act in an unethical or socially irresponsible manner, fail to comply with laws and regulations or fail to +deliver a consistently positive consumer experience in each of our markets. Additionally, counterfeit reproductions of our products or other infringement of our intellectual property rights, including +from unauthorized uses of our trademarks by third parties could harm our brand and adversely impact our business. +Opening and operating additional retail stores, which require substantial financial commitments and fixed costs, are subject to numerous risks, and declines in revenue of +such retail stores could adversely affect our profitability. +In recent years, we have significantly expanded and intend to continue the expansion of our retail sales channel. Our ability to open +new stores successfully depends on our ability to identify suitable store locations, negotiate acceptable lease terms, hire, train and retain store personnel and satisfy the fashion preferences in new +geographic areas. Many of our retail stores are located in shopping malls where we depend on obtaining prominent locations and the overall success of the malls to generate customer traffic. We cannot +control the success of individual malls and an increase in store closures by other retailers may lead to mall vacancies and reduced foot traffic. Reduced customer traffic could reduce sales of +existing retail stores or hinder our ability to open retail stores in new markets, which could negatively affect our operating results. +Opening +retail stores globally involves substantial investment, including the construction of leasehold improvements, furniture and fixtures, equipment, information systems, inventory +and personnel. Operating global retail stores incurs fixed costs; if we have insufficient sales, we may be unable to reduce such fixed costs and avoid losses or negative cash flows. The testing of our +retail stores' long-lived assets for impairment requires us to make significant estimates about our future performance and cash flows that are inherently uncertain. These estimates can be affected by +numerous factors, including changes in economic conditions, our results of operations, and competitive conditions in the industry. Due to the high fixed cost structure associated with our retail +operations, negative cash flows or the closure of a store could result in write downs of inventory, impairment of leasehold +16 +Table of Contents +improvements, +impairment losses on other long-lived assets, severance costs, significant lease termination costs or the loss of working capital, which could adversely impact our financial position, +results of operations or cash flows. For example, during 2013, we recorded impairments relating to retail stores of $10.6 million, and these impairment charges may increase as we expand our +retail operations. +Our business relies significantly on the use of information technology, and any material disruption to operational technology or failure to protect the integrity and +security of customer and employee information could harm our reputation and/or our ability to effectively operate our business. +We rely heavily on the use of information technology systems and networks in our operations and supporting departments such as +marketing, accounting, finance, and human resources. The future success and growth of our business depend on streamlined processes made available through information systems, global communications, +internet activity and other network processes. Despite our current security measures, our systems, and those of our third-party service providers, may be vulnerable to information security breaches, +acts of vandalism, computer viruses and interruption or loss of valuable business data. Any disruption to these systems or networks could result in product fulfillment delays, key personnel being +unable to perform duties or communicate throughout the organization, loss of retail and internet sales, significant costs for data restoration and other adverse impacts on our business. +Over +the last several years, we have implemented numerous information systems designed to support various areas of our business, including warehouse management, order management, retail +point-of-sale and internet point-of-sale as well as various interfaces between these systems and supporting back office systems. In addition, we are currently in the process of implementing a +customized and fully-integrated global accounting, operations and finance ERP system, which is expected to launch in late 2014. Delays or issues in introducing the new ERP system to our current +operations, failure of these systems to operate effectively, problems with transitioning to upgraded or replacement systems, or a breach in security of these systems could cause delays in product +fulfillment and reduced efficiency of our operations, could require significant additional capital investments, including to remediate problems, and may have an adverse effect on our results of +operations and financial condition. +We +routinely possess sensitive customer and employee information and, while we believe we have taken reasonable and appropriate steps to protect that information, if our security +procedures and controls were compromised, it could harm our business, reputation, results of operations and financial condition and may increase the costs we incur to protect against such information +security breaches, such as increased investment in technology, the costs of compliance with consumer protection laws and costs resulting from consumer fraud. +We depend on key personnel across the globe, the loss of whom would harm our business. +We rely on executives and senior management to drive the financial and operational performance of our business. Turnover of executives +and senior management can adversely impact our stock price, our results of operations and our client relationships and may make recruiting for future management positions more difficult. Changes in +other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. In recent years, we have experienced +management turnover. Our future success depends on our ability to identify, attract and retain qualified personnel on a timely basis. In addition, we must successfully integrate any newly hired +management personnel within our organization in order to achieve our operating objectives. In late 2013, our President and CEO, John McCarvel, announced his resignation from the Company effective the +earlier of April 30, 2014 or the board of director's appointment of his successor. If we are unable to appoint a qualified successor prior to his resignation +17 +Table of Contents +or +the appointed successor does not perform up to expectations, we may experience declines in our financial performance and/or delays in our long-term growth strategy. In some cases, we may be +required to pay significant amounts of severance to terminated management employees. For example, we agreed to pay Mr. McCarvel approximately $2.1 million in separation payments in +connection with his resignation. +As +a global company, we also rely on a limited number of key international personnel to perform their functions at a high level in many of our geographic regions. In certain instances, +one or two personnel may be the primary knowledge base for business operations in a geographic region. The loss of key international personnel can adversely impact our operations and our client +relationships. +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers' orders, either of which could +adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid +changes in consumer preferences, the effects of weather, general economic conditions and other factors affecting demand and possibly impairing our brand image. In addition, sales to our wholesale +customers are generally subject to rights of cancellation and rescheduling by the customer. These factors make it difficult to forecast consumer +demand. If we overestimate demand for our products, we may be forced to liquidate excess inventories at discounted prices resulting in lower gross margins. Conversely, if we underestimate consumer +demand, we could have inventory shortages which can result in lower sales, delays in shipments to customers, strains on our relationships with customers and diminished brand loyalty. A decline in +demand for our products, or any failure on our part to satisfy increased demand for our products, could adversely affect our business and results of operations. In addition, an inability to accurately +forecast consumer demand could cause our revenue and earnings guidance to differ materially from our financial results. +Expanding our footwear product line may be difficult and expensive. If we are unable to successfully continue such expansion, our brand may be adversely affected and we may +not be able to maintain or grow our current revenue and profit levels. +To successfully expand our footwear product line, we must anticipate, understand and react to the rapidly changing tastes of consumers +and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with consumers or our brand may fall out of favor with consumers. If we are unable to +anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decrease, our brand image may suffer, our operating performance may decline and we may not be able to +execute our growth plans. +In +producing new footwear models, we may encounter difficulties that we did not anticipate during the product development stage. Our development schedules for new products are difficult +to predict and are subject to change in response to consumer preferences and competing products. If we are not able to efficiently manufacture new products in quantities sufficient to support retail +and wholesale distribution, we may not be able to recover our investment in the development of new styles and product lines and we would continue to be subject to the risks inherent to having a +limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new style may depend on our pricing. We have a limited history +of introducing new products in certain target markets; as such, we may set the prices of new styles too high for the market to bear or we may not provide the appropriate level of marketing in order to +educate the market and potential consumers about our new products. Achieving market acceptance will require us to exert substantial product development and marketing efforts, which could result in a +material increase in our selling, general and administrative expenses and there can be no assurance that we will have the resources necessary to undertake such efforts effectively or that such efforts +will be successful. Failure to gain market acceptance for new products could impede our ability to maintain or grow +18 +Table of Contents +current +revenue levels, reduce profits, adversely affect the image of our brands, erode our competitive position and result in long-term harm to our business. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of factors, including seasonal variations, which could increase the +volatility of the price of our common stock. +Sales of our products are subject to seasonal variations and are sensitive to weather conditions. As a significant portion of our +revenues are attributable to footwear styles that are more suitable for fair weather and are derived from sales in the northern hemisphere, we typically experience our highest sales activity during +the second and third quarters of the calendar year, when there is fair weather in the northern hemisphere. While we continue to create new footwear styles that are more suitable for cold weather, the +effects of favorable or unfavorable weather on sales can be significant enough to affect our quarterly results which could adversely affect our common stock price. Quarterly results may also fluctuate +as a result of other factors, including new style introductions, general economic conditions or changes in consumer preferences. Results for any one quarter are not necessarily indicative of results +to be expected for any other quarter or for any year and revenues for any particular period may fluctuate. This could lead to results outside of analyst and investor expectations, which could increase +volatility of our stock price. +We depend heavily on third party manufacturers located outside the U.S. +Third party manufacturers located in China and Vietnam produced 81.3% of our footwear products in 2013. We depend on the ability of +these manufacturers to finance the production of goods ordered, maintain adequate manufacturing capacity and meet our quality standards. We compete with other companies for the production capacity of +our third party manufacturers, and we do not exert direct control over the manufacturers' operations. As such, we have experienced at times, delays or inabilities to fulfill customer demand and +orders, particularly in China. We cannot guarantee that any third party manufacturer will have sufficient production capacity, meet our production deadlines or meet our quality standards. +In +addition, we do not have supply contracts with these third party manufacturers and any of them may unilaterally terminate their relationship with us at any time or seek to increase +the prices they charge us. As a result, we are not assured of an uninterrupted supply of products of an acceptable quality and price from our third party manufacturers. Foreign manufacturing is +subject to additional risks, including transportation delays and interruptions, work stoppages, political instability, expropriation, nationalization, foreign currency fluctuations, changing economic +conditions, changes in governmental policies and the imposition of tariffs, import and export controls and other non-tariff barriers. We may not be able to offset any interruption or decrease in +supply of our products by increasing production in our internal manufacturing facilities due to capacity constraints, and we may not be able to substitute suitable alternative third party +manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third party manufacturers may harm our business and could result in a loss of sales and an +increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or unexpected demand for our products may require us to use faster, more +expensive transportation methods, such as aircraft, which could adversely +affect our profit margins. The cost of fuel is a significant component in transportation costs. Increases in the price of petroleum products can adversely affect our profit margins. +In +addition, because a large portion of our footwear products is manufactured in China and Vietnam, the possibility of adverse changes in trade or political relations between the U.S. +and these countries, political instability in China, increases in labor costs, or adverse weather conditions could significantly interfere with the production and shipment of our products, which would +have a material adverse effect on our operations and financial results. +19 +Table of Contents +We manufacture a portion of our products which causes us to incur greater fixed costs. Any difficulties or disruptions in our manufacturing operations could adversely affect +our sales and results of operations. +We produce a portion of our footwear products at our internal manufacturing facilities in Mexico and Italy. Ownership of these +facilities adds fixed costs to our cost structure which are not as easily scalable as variable costs. In addition, the manufacture of our products from the Croslite material requires the use of a +complex process and we may experience difficulty in producing footwear that meets our high quality control standards. We will be required to absorb the costs of manufacturing and disposing of products +that do not meet our quality standards. Any increases in our manufacturing costs could adversely impact our profit margins. Furthermore, our manufacturing capabilities are subject to many of the same +risks and challenges faced by our third party manufacturers, including our ability to scale our production capabilities to meet the needs of our customers. Our manufacturing may also be disrupted for +reasons beyond our control, including work stoppages, fires, earthquakes, floods or other natural disasters. Any disruption to our manufacturing operations will hinder our ability to deliver products +to our customers in a timely manner and could have a material and adverse effect on our business and results of operations. +We conduct significant business activity outside the U.S. which exposes us to risks of international commerce. +A significant portion of our revenues is from foreign sales. Our ability to maintain the current level of operations in our existing +international markets is subject to risks associated with international sales operations as well as the difficulties associated with promoting products in unfamiliar cultures. In addition to foreign +manufacturing, we operate retail stores and sell our products to retailers outside of the U.S. Foreign manufacturing and sales activities are subject to +numerous risks, including tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas and local content rules; delays associated with the manufacture, +transportation and delivery of products; increased transportation costs due to distance, energy prices, or other factors; delays in the transportation and delivery of goods due to increased security +concerns; restrictions on the transfer of funds; restrictions, due to privacy laws, on the handling and transfer of consumer and other personal information; changes in governmental policies and +regulations; political unrest, changes in law, terrorism, or war, any of which can interrupt commerce; potential violations of U.S. and foreign anti-corruption and anti-bribery laws by our employees, +business partners or agents, despite our policies and procedures relating to compliance with these laws; expropriation and nationalization; difficulties in managing foreign operations effectively and +efficiently from the U.S.; and difficulties in understanding and complying with local laws, regulations and customs in foreign jurisdictions. In addition, we are subject to customs laws and +regulations with respect to our export and import activity which are complex and vary within legal jurisdictions in which we operate. We cannot assure that there will be no control failure around +customs enforcement despite the precautions we take. We are currently subject to audits by various customs authorities including the U.S. and Mexico. Any failure to comply with customs laws and +regulations could be discovered during a U.S. or foreign government customs audit, or customs authorities may disagree with our tariff treatments, and such actions could result in substantial fines +and penalties, which could have an adverse effect on our financial position and results of operations. +Our third party manufacturing operations must comply with labor, trade and other laws; failure to do so may adversely affect us. +We require our third party manufacturers to meet our quality control standards and footwear industry standards for working conditions +and other matters, including compliance with applicable labor, environmental and other laws; however, we do not control our third party manufacturers or their respective labor practices. A failure by +any of our third party manufacturers to adhere to quality standards or labor, environmental and other laws could cause us to incur additional costs for our +20 +Table of Contents +products, +generate negative publicity, damage our reputation and the value of our brand and discourage customers from buying our products. We also require our third party manufacturers to meet certain +product safety standards. A failure by any of our third party manufacturers to adhere to such product safety standards could lead to a product recall which could result in critical media coverage and +harm our business and reputation and could cause us to incur additional costs. +In +addition, if we or our third party manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and +the forfeiture of the products we are attempting to import or the loss of our import privileges. Possible violations of U.S. or +foreign laws or regulations could include inadequate record keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our +imported products, fraudulent visas or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact +on our operating results. We cannot predict whether additional U.S. or foreign customs quotas, duties, taxes or other changes or restrictions will be imposed upon the importation of foreign produced +products in the future or what effect such actions could have on our business, financial condition or results of operations. +Our revolving credit facility contains financial covenants that require us to maintain certain financial metrics and ratios and restrictive covenants that limit our +flexibility. A breach of those covenants may cause us to be in default under the facility, and our lenders could foreclose on our assets. +The credit agreement for our revolving credit facility requires us to maintain a certain leverage ratio, a certain level of +unrestricted cash at all times, and a minimum fixed charge coverage ratio on a quarterly basis. A failure to maintain current revenue levels or an inability to control costs or capital expenditures +could negatively impact our ability to meet these financial covenants. If we breach such covenants or any of the restrictive covenants described below, the lenders could either refuse to lend funds to +us or accelerate the repayment of any outstanding borrowings under the revolving credit facility. We may not have sufficient assets to repay such indebtedness upon a default. If we are unable to repay +the indebtedness, the lenders could initiate a bankruptcy proceeding or collection proceedings with respect to our assets, all of which secure our indebtedness under the revolving credit facility. +The +credit agreement also contains certain restrictive covenants that limit and in some circumstances prohibit, our ability to, among other things incur additional debt, sell, lease or +transfer our assets, pay dividends on our common stock, make capital expenditures and investments, guarantee debt or obligations, create liens, repurchase our common stock, enter into transactions +with our affiliates and enter into certain merger, consolidation or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, make acquisitions or +needed capital expenditures, withstand the current or future downturns in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may +arise, any of which could place us at a competitive disadvantage relative to our competitors. +Foreign currency fluctuations could have a material adverse effect on our results of operations and financial condition. +As a global company, we have significant revenues, costs, assets, liabilities and intercompany balances denominated in currencies other +than the U.S. Dollar. We pay the majority of expenses attributable to our foreign operations in the functional currency of the country in which such operations are conducted and pay the majority of +our overseas third-party manufacturers in U.S. Dollars. Our ability to sell our products in foreign markets and the U.S. Dollar value of the sales made +in foreign currencies can be significantly influenced by foreign currency fluctuations. A decrease in the value of foreign currencies relative to the U.S. Dollar could result in lower revenues, +product price pressures and increased losses from currency exchange rates. Price increases caused by currency +21 +Table of Contents +exchange +rate fluctuations could make our products less competitive or have an adverse effect on our profitability as most of our purchases from third party suppliers are denominated in U.S. Dollars. +Currency exchange rate fluctuations could also disrupt the business of the third party manufacturers that produce our products by making their purchases of raw materials more expensive and more +difficult to finance. +In +addition to the operational effects of foreign currency fluctuations, any amounts recorded in foreign currencies and translated into U.S. Dollars for consolidated financial reporting +are affected by foreign currency fluctuations. For example, in 2013, we experienced a decrease of $30.2 million in revenue in our Japan segment related to foreign currency translation losses as +a result of decreases in the value of the Japanese Yen compared to the U.S. Dollar. +While +we enter into foreign currency exchange forward contracts as economic cash flow hedges to reduce our exposure to changes in exchange rates, the volatility of foreign currency +exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy and our forward contracts may not prove effective in reducing our exposures. +Our financial success may be limited to the strength of our relationships with our wholesale customers and to the success of such wholesale customers. +Our financial success is related to the willingness of our current and prospective wholesale customers to carry our products. We do not +have long term contracts with any of our wholesale customers. Sales to our wholesale customers are generally on an order-by-order basis and are subject to rights of cancellation and rescheduling by +the customer. If we cannot fill our customers' orders in a timely manner, the sales of our products and our relationships with those customers may suffer. Alternatively, if our customers experience +diminished liquidity or other financial issues, we may experience a reduction in product orders, an increase in customer order cancellations and/or the need to extend customer payment terms which +could lead to higher accounts receivable balances, reduced cash flows, greater expense associated with collection efforts and increased bad debt expense. This could have a material adverse effect on +our product sales and ability to grow our product lines. +Additionally, +many of our wholesale customers compete with each other. If they perceive that we are offering their competitors better pricing and support, they may reduce purchases of +our products. Moreover, we compete directly with our wholesale customers by selling our products directly to consumers over the internet and through our company-operated retail locations. If our +wholesale customers believe that our direct sales to consumers divert sales from their stores, our relationships with such customers may weaken and cause them to reduce purchases of our products. As +we continue to grow our consumer direct channels (company-operated retail stores and internet webstores) this issue could be exacerbated. +We depend on a limited number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and +increase product costs. +We depend on a limited number of sources for the primary materials used to make our footwear. We source the elastomer resins that +constitute the primary raw materials used in compounding our Croslite products, which we use to produce our various footwear products, from multiple suppliers. If the suppliers we rely on for +elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production cycle. We are also subject to +market issues related to supply and demand for our raw materials. We may have to pay substantially higher prices in the future for the elastomer resins or any substitute materials we use, which would +increase our production costs and could have a significantly adverse impact on our profit margins and results of operations. If we are unable to obtain suitable elastomer resins or if we are unable to +procure sufficient quantities of the Croslite material, we may not be able to meet our +22 +Table of Contents +production +requirements in a timely manner or may need to modify our product characteristics resulting in less favorable market acceptance which could result in lost potential sales, delays in +shipments to customers, strained relationships with customers and diminished brand loyalty. +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our brand image and adversely +affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents and trade dress and designs on nearly all of +our products. We believe that having distinctive marks that are readily identifiable is important to our brand, our success and our +competitive position. The laws of some countries, for example, China, do not protect intellectual property rights to the same extent as do U.S. laws. We frequently discover products that are +counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party's products on the basis of trademark or +design or utility patent infringement, particularly in some foreign countries, or if we are required to change our name or use a different logo, continued sales of such competing products by third +parties could harm our brand and adversely impact our business, financial condition, revenues and results of operations by resulting in the shift of consumer preference away from our products. If our +brands are associated with inferior counterfeit reproductions, the integrity and reputation of our brands could be adversely affected. Furthermore, our efforts to enforce our intellectual property +rights are typically met with defenses and counterclaims attacking the validity and enforceability of our intellectual property rights. We may face significant expenses and liability in connection +with the protection of our intellectual property, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition +could be adversely affected. +We +also rely on trade secrets, confidential information and other unpatented proprietary rights and information related to, among other things, the Croslite material and product +development, particularly where we do not believe patent protection is appropriate or obtainable. Using third party manufacturers and compounding facilities may increase the risk of misappropriation +of our trade secrets, confidential information and other unpatented proprietary information. The agreements we use in an effort to protect our intellectual property, confidential information and other +unpatented proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the +agreement and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information and other unpatented proprietary rights and information may become known to +others, including our competitors. Furthermore, our competitors or others may independently develop or discover such trade secrets and information, which would render them less valuable to us. +We have substantial cash requirements in the U.S.; however, a majority of our cash is generated and held outside of the U.S. The consequential risks of holding cash abroad +could adversely affect our financial condition and results of operations. +We have substantial cash requirements in the U.S., but the majority of our cash is generated and held abroad. We generally consider +unremitted earnings of subsidiaries operating outside of the U.S. to be indefinitely reinvested and it is not our current intent to change this position. Cash held outside of the U.S. is primarily +used for the ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., but under current law, would be +subject to U.S. federal and state income taxes, less applicable foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax +consequences if we were to move the cash to another country. Certain countries, including China, may have monetary laws which may limit our ability to utilize cash resources in those countries for +operations in other countries. These limitations may affect our ability to fully utilize our cash resources +23 +Table of Contents +for +needs in the U.S. or other countries and may adversely affect our liquidity. Since repatriation of such cash is subject to limitations and may be subject to significant taxation, we cannot be +certain that we will be able to repatriate such cash on favorable terms or in a timely manner. If we incur operating losses on a continued basis and require cash that is held in international accounts +for use in our U.S. operations, a failure to repatriate such cash in a timely and cost-effective manner could adversely affect our business, financial condition and results of operations. +We are subject to periodic litigation, which could result in unexpected expense of time and resources. +From time to time, we are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties +of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. We are currently involved in several, potentially adverse legal proceedings. For a detailed discussion of our +current legal proceedings, see Item 3 Legal Proceedings in Part I of this Form 10-K. An unfavorable outcome in any of these +proceedings could have an adverse impact on our business, financial condition and results of operations. In addition, any significant litigation in the future, regardless of its merits, could divert +management's attention from our operations and result in substantial legal fees. In the past, securities class action litigation has been brought against us. If our stock price is volatile, we may +become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management's attention and resources that are needed to successfully run +our business. +We may fail to meet analyst expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly and various securities analysts follow our financial results and frequently issue reports on us +which include information about our historical financial results as well as their estimates of our future performance. These estimates are based on their own opinions and are often different from +management's estimates or expectations of our business. If our operating results are below the estimates or expectations of public market analysts and investors, our stock price could decline. +Changes in tax laws and unanticipated tax liabilities and the results of tax audits or litigation could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the United States and numerous foreign jurisdictions. Our effective income tax rate in the future +could be adversely affected by a number of factors, including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and +liabilities, changes in tax laws, the outcome of income tax audits in various jurisdictions around the world and any repatriation of non-U.S. earnings for which we have not previously provided for +U.S. taxes. We regularly assess all of these matters to determine the adequacy of our tax provision, which is subject to significant discretion and we could face significant adverse impact if our +assumptions are incorrect and/or face significant cost to defend our practices from international and U.S. tax authorities. We are regularly subject to, and are currently undergoing, audits by tax +authorities in the United States and foreign jurisdictions for prior tax years. Please refer to Item 3 Legal Proceedings in Part I of this +Form 10-K as well as Note 13—Commitments and Contingencies in the accompanying notes to the consolidated financial statements for additional details regarding current tax +audits. Although we believe our tax estimates are reasonable and we intend to defend our positions through litigation if necessary, the final outcome of tax audits and related litigation is inherently +uncertain and could be materially different than that reflected in our historical income tax provisions and accruals. Moreover, we could be subject to assessments of substantial additional taxes +and/or fines or penalties relating to ongoing or future audits. The adverse resolution of any audits or litigation could have an adverse effect on our financial position and results of operations. +24 +Table of Contents +We are required to pay regular dividends on the Series A Convertible Preferred Stock, par value $0.001 per share ("Series A Preferred Stock") issued to +Blackstone Capital Partners VI L.P. ("Blackstone") in 2014, which ranks senior to our common stock, and we may be required under certain circumstances to repurchase the outstanding shares of +Series A Preferred Stock; such obligations could adversely affect our liquidity and financial condition. +The Series A Preferred Stock ranks senior to our common stock with respect to dividend rights, and holders of Series A +Preferred Stock are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum of the stated value of $1,000 per share. These regular cash dividends on our Series A +Preferred Stock are payable quarterly in arrears on January 1, April 1, July 1 and October 1 of each year, commencing on April 1, 2014. If the Company fails to make +timely dividend payments, the dividend rate will increase to 8% per annum until such time as all accrued but unpaid dividends have been paid in full. In addition, the holders of our Series A +Preferred Stock have certain redemption rights, including upon certain change in control events involving us, which, if exercised, could require us to repurchase all of the outstanding shares of +Series A Preferred Stock at 100% or more of the stated value of the shares, plus all accrued but unpaid dividends. Our +obligations to pay regular dividends to the holders of our Series A Preferred Stock or any required repurchase of the outstanding shares of Series A Preferred Stock could impact our +liquidity and reduce the amount of cash flows available for working capital, capital expenditures, growth opportunities, acquisitions, and other general corporate purposes. Our obligations to the +holders of Series A Preferred Stock could also limit our ability to obtain additional financing or increase our borrowing costs, which could have an adverse effect on our financial condition. +Our financial results may be adversely affected if substantial investments in businesses and operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, acquisitions of new businesses and expansion of existing businesses, such +as our retail operations, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability; however, +significant investments are subject to typical risks and uncertainties inherent in acquiring or expanding a business. The failure of any significant investment to provide the returns or profitability +we expect or the failure to integrate newly acquired businesses could have a material adverse effect on our financial results and divert management attention from more profitable business operations. +Natural disasters could negatively impact our operating results and financial condition. +Natural disasters such as earthquakes, hurricanes, tsunamis or other adverse weather and climate conditions, whether occurring in the +U.S. or abroad, and the consequences and effects thereof, including energy shortages and public health issues, could disrupt our operations or the operations of our vendors and other suppliers, or +result in economic instability that may negatively impact our operating results and financial condition. For example, the 2011 tsunami in Japan negatively impacted consumer demand for our products in +Japan in the months following the disaster. +The issuance of 200,000 shares of our Series A Preferred Stock to Blackstone in 2014 and certain of its permitted transferees reduces the relative voting power of +holders of our common stock, may dilute the ownership of such holders, and may adversely affect the market price of our common stock. +On January 27, 2014, we issued 200,000 shares of Series A Preferred Stock to Blackstone and certain of its permitted +transferees (collectively, the "Blackstone Purchasers") pursuant to an Investment Agreement between us and Blackstone, dated December 28, 2013 (as amended, the "Investment Agreement"). The +Blackstone Purchasers currently own all of the outstanding shares of Series A Preferred Stock, and based on the number of shares of our common stock outstanding as of +25 +Table of Contents +January 31, +2014, the Blackstone Purchasers collectively own Series A Preferred Stock convertible into approximately 13.5% of our common stock. As holders of our Series A +Preferred Stock are entitled to vote, on an as-converted basis, together with holders of our common stock as a single class on all matters submitted to a vote of our common stock holders, the issuance +of the Series A Preferred Stock to the Blackstone Purchasers has effectively reduced the relative voting power of the holders of our common stock. +In +addition, conversion of the Series A Preferred Stock to common stock will dilute the ownership interest of existing holders of our common stock, and any sales in the public +market of the common stock issuable upon conversion of the Series A Preferred Stock could adversely affect prevailing market prices of our common stock. We have granted the Blackstone +Purchasers registration rights in respect of the shares of Series A Preferred Stock and any shares of common stock issued upon conversion of the Series A Preferred Stock. These +registration rights would facilitate the resale of such securities into the public market, and any such resale would increase the number of shares of our common stock available for public trading. +Sales by the Blackstone Purchasers of a substantial number of shares of our common stock in the public market, or the perception that such sales might occur, could have a material adverse effect on +the price of our common stock. +Blackstone may exercise significant influence over us, including through its ability to elect up to two members of our Board of Directors. +As of January 31, 2014, the shares of Series A Preferred Stock owned by the Blackstone Purchasers represent approximately +13.5% of the voting rights of our common stock, on an as-converted basis, so the Blackstone Purchasers will have the ability to significantly influence the outcome of any matter submitted for the vote +of our stockholders. In addition, the Certificate of Designations of the Series A Preferred Stock grants certain consent rights to the holders of Series A Preferred Stock in respect of +certain actions by the Company, including the issuance of pari passu or senior equity securities of the Company, certain amendments to our certificate +of incorporation or bylaws, any increase in the size of our Board above eight members, the payment of certain distributions to our stockholders, and the incurrence or refinancing of a certain level of +indebtedness. The Blackstone Purchasers may have interests that diverge from, or even conflict with, those of our other stockholders. For example, Blackstone and its affiliates may have an interest in +directly or indirectly pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their other equity investments, even though such transactions might +involve risks to us. Blackstone and its affiliates are in the business of making or advising on investments in companies, including businesses that may directly or indirectly compete with certain +portions of our business. They may also pursue acquisition opportunities that may be complementary to our business, and, as a result, those acquisition opportunities may not be available to us. +In +addition, the Investment Agreement grants Blackstone certain rights to designate directors to serve on our Board. For so long as Blackstone and its permitted transferees +(i) beneficially own at least 95% of the Series A Preferred Stock or the as-converted common stock purchased pursuant to the Investment Agreement or (ii) maintain beneficial +ownership of at least 12.5% of our outstanding common stock (the "Two-Director Threshold"), Blackstone will have the right to designate for nomination two directors to our Board. For so long as +Blackstone and its permitted transferees beneficially own shares of Series A Preferred Stock or the as-converted common stock purchased pursuant to the Investment Agreement that represent less +than the Two-Director Threshold but more than 25% of the number of shares of the as-converted common stock purchased pursuant to the Investment Agreement, Blackstone will have the right to designate +for nomination one director to our Board. The directors designated by Blackstone are entitled to serve on Board committees, subject to applicable law and stock exchange rules, and one of such +directors has been appointed to the newly- +26 +Table of Contents +formed +committee tasked with identifying a new chief executive officer to fill the vacancy resulting from Mr. McCarvel's resignation. +Our restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could discourage a third party from acquiring us and +consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could +delay, defer, or prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and +take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General +Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be +favorable could cause the market price of our common stock to decline. +ITEM 1B. Unresolved Staff Comments +None. +27 +Table of Contents +ITEM 2. Properties +Our principal executive and administrative offices are located at 7477 East Dry Creek Parkway, Niwot, Colorado. We lease, rather than +own, all of our domestic and international facilities. We currently enter into short-term and long-term leases for kiosk, manufacturing, office, outlet, retail, and warehouse space. The terms of our +leases include fixed monthly rents and/or contingent rents based on percentage of revenues for certain of our retail locations, and expire at various dates through the year 2033. The general location, +use and approximate size of our principal properties are given below. +Location +Reportable Operating Segment(s) +that Use this Property +Use +Approximate +Square Feet +Ontario, California +Americas +Warehouse +399,000 +Leon, Mexico +Americas, Asia Pacific, Japan, Europe +Manufacturing/warehouse/offices +392,000 +Rotterdam, the Netherlands +Europe +Warehouse +174,000 +Niwot, Colorado +Americas +Corporate headquarters and regional offices +160,000 +Narita, Japan +Asia Pacific, Japan +Warehouse +156,000 +Tampere, Finland(1) +Europe +Warehouse/offices +78,000 +Padova, Italy +Americas, Asia Pacific, Japan, Europe +Manufacturing/warehouse/offices +45,000 +Hoopddorf, the Netherlands +Europe +Regional offices +31,000 +Shenzen, China +Asia Pacific +Regional offices +28,000 +Gordon's Bay, South Africa +Asia Pacific +Warehouse/offices +28,000 +Singapore +Asia Pacific +Regional offices +23,000 +Shanghai, China +Asia Pacific +Regional offices +19,000 +Tokyo, Japan +Japan +Regional offices +13,000 +Moscow, Russia +Europe +Warehouse/offices +11,000 +(1) The +warehouse facilities in this location are fully or partially subleased. +In +addition to the principal properties listed above, we maintain small branch sales offices in the United States, Canada, South America, Taiwan, Hong Kong, Australia, Korea, China, the +United Emirates, India and Europe. We also lease more than 600 retail, outlet and kiosk/store in store locations worldwide. See Item 1 of this Form 10-K for further discussion regarding +global company-operated stores. +ITEM 3. Legal Proceedings +We and certain current and former officers and directors have been named as defendants in complaints filed by investors in the United +States District Court for the District of Colorado. The first complaint was filed in November 2007 and several other complaints were filed shortly thereafter. These actions were consolidated and, in +September 2008, the district court appointed a lead plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purports to state claims under +Section 10(b), 20(a), and 20A of the Exchange Act on behalf of a class of all persons who purchased our common stock between April 2, 2007 and April 14, 2008 (the "Class Period"). +The amended complaint also added our independent auditor as a defendant. The amended complaint alleges that, during the Class Period, the defendants made false and misleading public statements about +us and our business and prospects and, as a result, the market price of our common stock was artificially inflated. The amended complaint also claims that certain current and former officers and +directors traded in our common stock on the basis of material non-public information. The amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified amount, +including interest, and also added attorneys' fees and costs of litigation. On February 28, 2011, +28 +Table of Contents +the +District Court granted motions to dismiss filed by the defendants and dismissed all claims. A final judgment was thereafter entered. Plaintiffs subsequently appealed to the United States Court of +Appeals for the Tenth Circuit. We and those current and former officers and directors named as defendants have entered into a Stipulation of Settlement with the plaintiffs that would, if approved by +the United States District Court for the District of Colorado, resolve all claims asserted against us by the plaintiffs on behalf of the putative class, and plaintiffs' appeal would be dismissed. Our +independent auditor is not a party to the Stipulation of Settlement. The Stipulation of Settlement received preliminary approval from the District Court on August 28, 2013. It remains subject +to customary conditions, including final court approval following notice to stockholders. On February 13, 2014 a final settlement hearing took place and the parties are awaiting a ruling in +conjunction with the same. If the settlement becomes final, all amounts required by the settlement will be paid by our insurers. There can be no assurance that the settlement will be finally approved +by the District Court, or that approval by the District Court will, if challenged, be upheld by the Tenth Circuit. +On +October 27, 2010, Spectrum Agencies ("Spectrum") filed suit against our subsidiary, Crocs Europe B.V. ("Crocs Europe"), in the High Court of Justice, Queen's Bench +Division, Royal Courts of Justice in London, United Kingdom ("UK"). Spectrum acted as an agent for Crocs products in the UK from 2005 until Crocs Europe terminated the relationship on July 3, +2008 due to Spectrum's breach of its duty to act in good faith toward Crocs Europe. Spectrum alleges that Crocs Europe unlawfully terminated the agency relationship and failed to pay certain sales +commissions. A trial on the liability, not quantum (compensation and damages), was held at the High Court in London from November 30, +2011 to December 5, 2011. On December 16, 2011, the High Court of Justice issued a judgment that found that although Spectrum's actions were a breach of its duty to act in good faith +toward Crocs Europe the breach was not sufficiently severe to justify termination. We believe that the trial judge erred in his findings and subsequently appealed the judgment. On October 30, +2012, the Court of Appeal handed down its judgment confirming the trial judge's findings. We submitted a request to the Supreme Court seeking permission to appeal. On April 24, 2013 the Supreme +Court declined to grant permission to appeal. Given that to date the legal proceedings in this case have only addressed liability, there have been no findings in relation to the amount of compensation +or damages other than with respect to legal fees. Under English law, the prevailing party is entitled to reimbursement of reasonable legal fees incurred in the proceedings. The trial of liability and +quantum were split by the Court in the interests of case management. The alleged quantum of damages has not been fully pleaded out and will be assessed as part of the forthcoming damages phase. A +trial and judgment on damages is expected in approximately 12 months. +We +are currently subject to an audit by U.S. Customs & Border Protection ("CBP") in respect of the period from 2006 to 2010. In the course of the audit, we identified certain +valuation errors and tendered approximately $1.4 million in additional duties. Subsequently, we identified additional value errors which will require the payment of additional duties totaling +approximately $718,000. The exact amount of this additional tender is subject to verification by CBP. In October 2013, CBP issued an audit report to which we filed comments and objections. CBP has +projected unpaid duties totaling approximately $12.4 million in connection with various classification errors during the period under review. We have responded that these projections are +erroneous and provided arguments that demonstrate the amount due in connection with this matter is considerably less than the amount projected. CBP is currently reviewing this response. It is not +possible at this time to predict whether our arguments will be successful in eliminating or reducing the amount in dispute. At this time, it is not possible to determine when a formal notice of claim +will be received from CBP. Likewise, it is not possible to predict whether CBP may seek to assert a claim for penalties in addition to any unpaid duties. +Mexico's +Federal Tax Authority ("SAT") audited the period from January 2006 to July 2011. There were two phases to the audit, the first for capital equipment and finished goods and the +second for raw +29 +Table of Contents +materials. +The first phase was completed and no major discrepancies were noted by the SAT. On January 9, 2013, Crocs received a notice for the second phase in which the SAT issued a tax +assessment (taxes and penalties) of roughly 280.0 million pesos (approximately $22.0 million) based on the value of all of Crocs' imported raw materials during the audit period. We +believe that the proposed penalty amount is unfounded and without merit. With the help of local counsel we filed an appeal by the deadline of March 15, 2013. We have argued that the amount due +in connection with the matter, if any, is substantially less than that proposed by the SAT. In connection with the appeal, the SAT required us to post an appeal surety bond in the amount of roughly +321.0 million pesos (approximately $26.0 million), which amount reflects estimated additional penalties and interest if we are not successful on our appeal. This amount will be adjusted +on an annual basis. We are currently awaiting a ruling +from the Mexican courts. It is not possible at this time to predict the outcome of this matter or reasonably estimate any potential loss. +Although +we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, we are not +party to any other pending legal proceedings that we believe will have a material adverse impact on our business, financial position, results of operations or cash flows. +ITEM 4. Mine Safety Disclosures +None. +30 +Table of Contents +PART II +ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock, par value $0.001, is listed on the NASDAQ Global Select Market and trades under the stock symbol "CROX". The +following table shows the high and low sales prices of our common stock for the periods indicated. +Fiscal Year 2013 Three Months Ended +High +Low +March 31, 2013 +$ +16.36 +$ +14.13 +June 30, 2013 +17.95 +14.19 +September 30, 2013 +17.62 +12.65 +December 31, 2013 +$ +16.27 +$ +11.96 +Fiscal Year 2012 Three Months Ended +High +Low +March 31, 2012 +$ +22.40 +$ +15.06 +June 30, 2012 +22.59 +15.24 +September 30, 2012 +18.60 +13.80 +December 31, 2012 +$ +16.79 +$ +12.00 +Performance Graph +The following performance graph illustrates a five-year comparison of cumulative total return of our common stock, the NASDAQ Composite +Index and the Dow Jones U.S. Footwear Index from December 31, 2008 through December 31, 2013. The graph assumes an investment of $100 on December 31, 2008 and assumes the +reinvestment of all dividends and other distributions and reflects our stock prices post-stock split. +31 +Table of Contents +Comparison of Cumulative Total Return on Investment +12/31/2008 +12/31/2009 +12/31/2010 +12/31/2011 +12/31/2012 +12/31/2013 +Crocs, Inc. +$ +100.00 +$ +463.71 +$ +1,380.65 +$ +1,191.13 +$ +1,160.48 +$ +1,283.87 +Dow Jones US Footwear Index +100.00 +127.86 +167.41 +187.27 +196.23 +300.80 +Nasdaq Composite Index +$ +100.00 +$ +143.89 +$ +168.22 +$ +165.19 +$ +191.47 +$ +264.84 +The +Dow Jones U.S. Footwear Index is a sector index and includes companies in the major line of business in which we compete. This index does not encompass all of our competitors or all +of our product categories and lines of business. The Dow Jones U.S. Footwear Index consists of Crocs, Inc., NIKE, Inc., Deckers Outdoor Corp., Iconix Brand Group, Inc., Skechers +U.S.A., Inc. Steven Madden Ltd. and Wolverine World Wide, Inc., among other companies. As Crocs, Inc. is part of the Dow Jones U.S. Footwear Index, the price and returns of +our stock have an effect on this index. The Nasdaq Composite Index is a market capitalization-weighted index and consists of more than 3,000 common equities, including Crocs, Inc. +The +stock performance shown on the performance graph above is not necessarily indicative of future performance. We do not make or endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 154 as of January 31, 2014. Because many of the shares +of our common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial owners represented by these stockholders of record. +Dividends +We have never declared or paid cash dividends on our common stock, and we do not anticipate paying any cash dividends on our common +stock in the foreseeable future. Our financing arrangements contain certain restrictions on our ability to pay cash dividends on our common stock. In addition, the Certificate of Designations +governing the Series A Convertible Preferred Stock that we issued in January 2014 restricts us from declaring and paying certain dividends on our common stock if we fail to pay all accumulated +and unpaid regular dividends and/or declared and unpaid participating dividends to +32 +Table of Contents +which +the preferred holders are entitled. Any future determination to declare cash dividends on our common stock will be made at the discretion of our board of directors, subject to compliance with +covenants under any then-existing financing agreements and the terms of the Certificate of Designations. +Purchases of Equity Securities by the Issuer +Period +Total Number +of Shares +(or Units) +Purchased +Average +Price Paid +per Share +(or Unit) +Total Number of +Shares (or Units) +Purchased as Part of +Publicly Announced +Plans or Programs +Maximum Number +of Shares that +May Yet Be +Purchased Under the +Plans Programs(1) +Approximate Dollar +Value of Shares that +May Yet Be +Purchased Under the +Plan Programs +(in thousands)(2) +October 1, 2013—October 31, 2013 +— +$ +— +— +17,758,776 +$ +— +November 1, 2013—November 30, 2013 +— +— +— +17,758,776 +— +December 1, 2013—December 31, 2013 +— +— +— +— +350,000 +Total +— +$ +— +— +— +$ +350,000 +(1) On +November 1, 2007 and April 14, 2008, the Company's board of directors (the "Board") approved an authorization to repurchase up to +1.0 million shares and 5.0 million shares, respectively, of our common stock. On October 29, 2013, the Board authorized the repurchase of up to an additional 15.0 million +shares of Company common stock under the Company's previously announced stock repurchase authorization. This brought the total shares available for repurchase by the Company under existing board +authorizations up to approximately 17.8 million shares as of December 25, 2013. +(2) On +December 26, 2013, the Board approved the repurchase of up to $350.0 million of our common stock, which was announced on +December 30, 2013. This authorization effectively replaced our previous stock repurchase authorizations. The number, price, structure and timing of the repurchases, if any, will be at the +Company's sole discretion and future repurchases will be evaluated by the Company depending on market conditions, liquidity needs and other factors. Share repurchases may be made in the open market or +in privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, +modify or terminate the repurchase program at any time without prior notice. +33 +Table of Contents +ITEM 6. Selected Financial Data +The following table presents selected historical financial data for each of our last five fiscal years. The information in this table +should be read in conjunction with the consolidated financial statements and accompanying notes and with Management's Discussion and Analysis of Financial Conditions and Results of Operations included +in Item 7 of this Form 10-K. +Financial History +($ thousands, except share and per share data) +2013 +2012 +2011 +2010 +2009 +Year Ended December 31, +Revenues +$ +1,192,680 +$ +1,123,301 +$ +1,000,903 +$ +789,695 +$ +645,767 +Cost of sales +569,482 +515,324 +464,493 +364,631 +337,720 +Restructuring charges +— +— +— +1,300 +7,086 +Gross profit +623,198 +607,977 +536,410 +423,764 +300,961 +Gross margin % +52.3 +% +54.1 +% +53.6 +% +53.7 +% +46.6 +% +Selling, general and administrative expenses +549,154 +460,393 +404,803 +342,961 +319,102 +Selling, general and administrative expenses as a % of revenues +46.0 +% +41.0 +% +40.4 +% +43.4 +% +49.4 +% +Restructuring charges +— +— +— +2,539 +7,623 +Asset impairment charges +10,949 +1,410 +528 +141 +26,085 +Income (loss) from operations +63,095 +146,174 +131,079 +78,123 +(51,849 +) +Income (loss) before income taxes +59,959 +145,548 +136,690 +80,792 +(48,621 +) +Income tax (benefit) expense +49,539 +14,205 +23,902 +13,066 +(6,543 +) +Net income (loss) +$ +10,420 +$ +131,343 +$ +112,788 +$ +67,726 +$ +(42,078 +) +Income (loss) per common share: +Basic +$ +0.12 +$ +1.46 +$ +1.27 +$ +0.78 +$ +(0.49 +) +Diluted +$ +0.12 +$ +1.44 +$ +1.24 +$ +0.76 +$ +(0.49 +) +Weighted average common shares: +Basic +87,988,798 +89,571,105 +88,317,898 +85,482,055 +85,112,461 +Diluted +89,089,473 +90,588,416 +89,981,382 +87,595,618 +85,112,461 +Cash provided by operating activities +$ +83,464 +$ +128,356 +$ +142,376 +$ +104,274 +$ +61,109 +Cash used in investing activities +(69,758 +) +(65,943 +) +(41,664 +) +(42,078 +) +(25,731 +) +Cash provided by (used in) financing activities +$ +(1,161 +) +$ +(16,625 +) +$ +8,917 +$ +5,245 +$ +(22,191 +) +Financial History +($ thousands) +2013 +2012 +2011 +2010 +2009 +As of December 31, +Cash and cash equivalents +$ +317,144 +$ +294,348 +$ +257,587 +$ +145,583 +$ +77,343 +Inventories +162,341 +164,804 +129,627 +121,155 +93,329 +Working capital +453,149 +455,177 +370,040 +243,252 +180,598 +Total assets +875,159 +829,638 +695,453 +549,481 +409,738 +Long term obligations +63,487 +54,300 +48,370 +35,613 +35,462 +Total stockholders' equity +$ +624,744 +$ +617,400 +$ +491,780 +$ +376,106 +$ +287,620 +34 +Table of Contents +ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations +Business Overview +We are a designer, developer, manufacturer, worldwide marketer and distributor of casual lifestyle footwear, apparel and accessories +for men, women and children. We strive to be the global leader in the sale of molded footwear featuring fun, comfort, color and functionality. Our products include footwear and accessories that +utilize our proprietary closed cell-resin, called Croslite. Our products include footwear and accessories that utilize our proprietary closed-cell resin, called Croslite. The use of this unique +material enables us to produce innovative, lightweight, non-marking, and odor-resistant footwear. We currently sell our products in more than 90 countries +through domestic and international retailers and distributors and directly to end-user consumers through our company-operated retail stores, outlets, kiosks and webstores. +Since +the initial introduction and popularity of the Beach and Crocs Classic designs, we have expanded our Croslite products to include a variety of new styles and products and have +further extended our product reach through the acquisition of brand platforms such as Jibbitz and Ocean Minded. We intend to continue to expand the breadth of our footwear product lines, bringing a +unique and original perspective to the consumer in styles that may be unexpected from Crocs. We believe this will help us to continue to build a stable year-round business as we move toward becoming a +four-season brand. +The +broad appeal of our footwear has allowed us to market our products to a wide range of distribution channels, including department stores and traditional footwear retailers as well as +a variety of specialty and independent retail channels. Our marketing efforts surround specific product launches and employ a fully integrated approach utilizing a variety of media outlets, including +print and websites. Our marketing efforts drive business to both our wholesale partners and our company-operated retail and internet stores, ensuring that our presentation and story are first class +and drive purchasing at the point of sale. +As +a global company, we have significant revenues and costs denominated in currencies other than the U. S. Dollar. Sales in international markets in foreign currencies are expected to +continue to represent a substantial portion of our revenues. Likewise, we expect our subsidiaries with functional currencies other than the U.S. Dollar will continue to represent a substantial portion +of our overall gross margin and related expenses. Accordingly, changes in foreign currency exchange rates could materially affect revenues and costs or the comparability of revenues and costs from +period to period as a result of translating our financial statements into our reporting currency. +Recent Events +On January 27, 2014, we issued to Blackstone Capital Partners VI L.P. ("Blackstone") and certain of its permitted +transferees (together with Blackstone, the "Blackstone Purchasers"), 200,000 shares of our Series A Preferred Stock for an aggregate purchase price of $198.0 million, or $990 per share, +pursuant to an Investment Agreement between us and Blackstone, dated December 28, 2013 (as amended, the "Investment Agreement"). In connection with the issuance of the Series A Preferred +Stock (the "Closing") and pursuant to the Investment Agreement, we paid Blackstone a closing fee of $2.0 million and reimbursed Blackstone's transaction fees and expenses of approximately +$4.0 million. We intend to use the net proceeds of the transactions, as well as cash on hand, to fund the previously announced $350.0 million stock repurchase authorization approved by +the board of directors. The Blackstone investment represented approximately 13.5% ownership of the Company as of January 31, 2014. We believe this investment provides an opportunity to drive +shareholder value and refine the strategic direction of the business. +35 +Table of Contents +The +Series A Preferred Stock ranks senior to our common stock with respect to dividend rights and rights on liquidation, winding-up and dissolution. Holders of Series A +Preferred Stock are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum as well as any dividends declared or paid on common stock and are entitled to vote together +with the holders of common stock on an as-converted basis. Pursuant to the Investment Agreement, the Series A Preferred Stock is subject to several different conversion features as well as +redemption rights, which are at the option of the holder, the Company or contingent events. The conversion rate is subject to customary anti-dilution and other adjustments subject to certain share +caps and other restrictions. +As +a condition of the Investment Agreement, Blackstone received rights to designate two out of eight members of the board of directors. As a result, Stephen Cannon and Jeffrey Margolis +have resigned from the Company's board and Blackstone's two nominees, Prakash Melwani and Gregg Ribatt, have been added to the board of directors. The board of directors will remain at eight members. +Mr. Melwani is currently a Senior Managing Director at Blackstone and Chief Investment Officer of the firm's Private Equity Group; Mr. Ribatt most recently served as the President and +Chief Executive Officer of Collective Brands Performance + Lifestyle Group. +In +addition, on December 27, 2013, John McCarvel resigned from his position as President, Chief Executive Officer and director of the Company effective upon the earlier to occur +of (i) April 30, 2014 or (ii) the board of director's appointment of his successor as CEO. In connection with his resignation, we entered into a separation agreement that will pay +Mr. McCarvel $2.1 million within one year of the effectiveness of his resignation. Mr. McCarvel has agreed to continue in a consulting capacity with the Company through +April 30, 2014 if his successor is appointed prior to such date. The separation payments are conditioned upon the effectiveness of Mr. McCarvel's release of claims in favor of the +Company and his compliance with the non-competition, non-solicitation and confidentiality covenants contained in the separation agreement. +Pursuant +to the terms of the Investment Agreement, as amended, the board of directors formed a special committee on January 24, 2014 and has granted to such committee the sole +power and authority to identify, consider, assess, evaluate, research, and recommend individual nominees for the position of CEO of the Company to replace Mr. McCarvel. Any recommendation from +the Search Committee with respect to a Chief Executive Officer nominee requires the unanimous consent of the members of the special committee, and the board of directors may not appoint a new CEO +without the recommendation of the committee. The board of directors has appointed Thomas Smach, Ronald Frasch, Peter Jacobi and Prakash Melwani as members of the committee. +2013 Financial Highlights +Our results for fiscal year 2013 demonstrated our overall focus on becoming the leading brand in casual lifestyle footwear and +delivering shareholder value through the balanced global expansion of our direct-to-consumer markets and wholesale partners, innovative product development and strategic financial decisions. We are +committed to delivering fun, colorful and comfortable products to the global marketplace through efficient distribution channels with an emphasis on customer service. Despite ongoing macroeconomic +challenges around the globe, we delivered record revenues and footwear unit sales. Our revenues increased 6.2% to $1.2 billion and footwear unit sales increased 8.8% to 54.3 million +pairs sold. +We +specifically experienced exceptional growth and exceeded expectations in our Asia Pacific segment and saw marked improvement in our Europe segment partially due to slow signs of +macroeconomic recovery from prior years. Our Asia Pacific segment remains a key component of the business and a fundamental driver of our growth strategy as all revenue channels experienced +double-digit growth within the region. Our Europe segment experienced drastic improvement in 2013 compared to the prior year as we achieved growth in all three revenue channels. In addition to our +36 +Table of Contents +positive +results, we faced several challenges in the current year relating to our Americas and Japan segments. Specific challenges in our Americas segment include wholesale accounts remaining lean on +inventory and weak consumer confidence in the region as lingering effects of recessionary traffic and spending continue to impact retail markets. On a constant-currency basis, our Japan segment +performed on-par with the prior year; however, limited ability for growth due to macroeconomic turmoil presented a major challenge for us in 2013 as we saw the Japanese Yen decline approximately 18.0% +on a year-to-date average basis compared to 2012. Based solely on currency factors, our year-over-year revenues in our Japan segment decreased $30.2 million. +Globally, +we continued to focus on and expand our direct-to-consumer channel. On a constant-currency basis, our direct-to-consumer channel sales grew 10.8% primarily through the addition +of 82 global retail locations (net of store closures) partially offset by a decrease in global comparable store sales of 2.7% due to lingering recessionary effects and weak consumer confidence in +select markets. The expansion of our retail footprint has led to increased gross margins in the U.S. and other markets around the globe. Our wholesale business performed well on a year-over-year basis +as we expanded through existing wholesale accounts and global distributors in emerging markets. Despite conservative at-once ordering and inventory levels from our wholesale partners, we experienced a +7.3% increase in wholesale sales on a constant-currency basis, which demonstrates the depth of our wholesale relationships and ability to deliver product. +Overall, +the current year presented us with many growth opportunities as well as challenges. Despite these challenges, we exceeded expectations in several areas of the globe and have +identified key areas of focus for the business going forward. The Company goes into 2014 with a renewed sense of focus which is aided by our recent relationship with Blackstone. We believe the +investment by Blackstone conveys a strong financial commitment in our brand and, coupled with our strong balance sheet, will enhance our long-term growth strategy. +The +following are the more significant developments in our businesses during the year ended December 31, 2013: +• Revenues increased $69.4 million, or 6.2%, to $1.2 billion compared to 2012. Revenue growth was +predominately driven by sales volume though balanced wholesale and retail expansion combined with new and classic product expansion as we continue to transform into an all-season footwear brand. +• Gross profit increased $15.2 million, or 2.5%, to $623.2 million compared to 2012; however, gross margin +percentage decreased 180 basis points, or 3.3%, to 52.3%. The decline in gross margin percentage is primarily driven by the evolution of our product assortment and is consistent with our product +strategy. As we expand our product lines, product mix shifts into styles that may utilize more expensive materials such as textile fabric and leather compared to the traditional clog. Product cost +inflation also contributed to the decline in gross margin percentage, but was mostly offset by internal cost saving initiatives. +• Selling, general and administrative expenses increased $88.8 million, or 19.3%, to $549.2 million compared +to 2012. Selling, general and administrative expenses continued to rise as we increased our global retail presence. In addition, we experienced several increases due to non-recurring charges such as +the resolution of a statutory tax audit in Brazil during the second quarter of 2013, operating expenses related to our ERP implementation and additional charges related to on-going litigation. +• We recorded $10.6 million in retail asset impairment charges related to 60 underperforming stores in 2013 compared +to $1.4 million in retail asset impairment charges related to four underperforming stores in 2012. The $10.6 million in asset impairment charges consists of +37 +Table of Contents +$6.6 million +related to 35 stores in Europe, $3.9 million related to 23 stores in the Americas and $0.2 million related to two stores in Asia Pacific. +• Net income decreased $120.9 million, or 92.1%, to $10.4 million compared to 2012 driving our diluted +earnings per share from $1.44 to $0.12. +• We continued to expand our retail channel through the net addition of 82 stores in 2013 in order to further increase brand +recognition and create opportunities to present new and classic product lines. In January 2014, we opened our much anticipated three-story flagship location with approximately 4,500 square feet of +selling space in a 13,600 square foot building located on 34 th Street in New York. +• We continue to fund the implementation of our customized and fully integrated operations, accounting, and finance ERP +system, which is expected to launch globally in late 2014. The introduction of the new ERP system to our current environment will allow for seamless and high-quality data across the Company. As of +December 31, 2013, total costs to date related to the ERP implementation were $41.4 million, of which $34.6 million was capitalized and $6.8 million was expensed. As of +December 31, 2013, we had $16.8 million in outstanding borrowings related to the ERP system under a Master Installment Payment Agreement ("Master IPA") with PNC Equipment +Finance, LLC ("PNC Equipment"). +• We repurchased approximately 0.8 million shares at an average price of $14.99 per share for a total value of +$12.5 million, excluding related commission charges. +Future Outlook +Given the recent events including the investment from Blackstone and the resignation of our CEO, we expect to undergo some strategic +transitioning during the next fiscal year to refine our short-term and long-term growth strategies, which will include prioritizing earnings growth, and our focus on becoming the leading brand in +casual lifestyle footwear. The investment by Blackstone is a vote of confidence in our company and our brand, and we anticipate both will benefit from Blackstone's financial, consumer, retail and +brand experience. Due to these recent events and additional changes expected in 2014, we expect an environment that is more challenging to predict the impact on our business, financial position and +results of operations. +We +head into 2014 with a renewed sense of focus and an emphasis on delivering shareholder value. We intend to use the proceeds from the Blackstone investment as well as internal cash to +repurchase approximately $350.0 million of our common stock. We intend to be patient, methodical and opportunistic in the execution of this expanded buyback plan. In addition, we are excited +about our new product launches for spring/summer, including the Stretch Sole and Busy Day, as well as carryover products such as the Huarache and A-Leigh wedge, which are proving more successful in +their second seasons. Entering the year, our backlog was up approximately $24.6 million to $378.9 million, which shows the strength of our wholesale relationships. +We +have implemented several investment strategies that we believe will drive revenue growth while improving the operational and technological efficiency of the business. As part of our +overall retail expansion strategy, we ended the year with 619 global retail locations. In 2014, as we intend to increasingly focus on profitable growth and retail excellence, we may moderate the pace +of our investments in new retail stores as well as consolidate some existing locations. We remain in the testing and development phase of our ERP system implementation. This implementation represents +the beginning of a transformational change intended to improve our operational efficiency as we adapt as a global company. We expect to launch our new ERP system globally in late 2014. +Overall, +the organization is focused on delivering shareholder value through our focus on casual lifestyle footwear sales and balancing long-term global growth between company-operated +retail locations, partner store and multiband independent wholesale accounts and internet sites in local languages. +38 +Table of Contents +Results of Operations +Comparison of the Years Ended December 31, 2013 and 2012 +Year Ended December 31, +Change +($ thousands, except per share data +and average footwear selling price) +2013 +2012 +$ +% +Revenues +$ +1,192,680 +$ +1,123,301 +$ +69,379 +6.2 +% +Cost of sales +569,482 +515,324 +54,158 +10.5 +Gross profit +623,198 +607,977 +15,221 +2.5 +Selling, general and administrative expenses +549,154 +460,393 +88,761 +19.3 +Asset impairment charges +10,949 +1,410 +9,539 +676.5 +Income from operations +63,095 +146,174 +(83,079 +) +(56.8 +) +Foreign currency transaction losses, net +4,678 +2,500 +2,178 +87.1 +Interest income +(2,432 +) +(1,697 +) +(735 +) +43.3 +Interest expense +1,016 +837 +179 +21.4 +Other income, net +(126 +) +(1,014 +) +888 +(87.6 +) +Income before income taxes +59,959 +145,548 +(85,589 +) +(58.8 +) +Income tax expense +49,539 +14,205 +35,334 +248.7 +Net income +$ +10,420 +$ +131,343 +$ +(120,923 +) +(92.1 +)% +Net income per common share: +Basic +$ +0.12 +$ +1.46 +$ +(1.34 +) +(91.9 +)% +Diluted +$ +0.12 +$ +1.44 +$ +(1.32 +) +(91.9 +)% +Gross margin +52.3 +% +54.1 +% +(180 +)bps +(3.3 +)% +Operating margin +5.3 +% +13.0 +% +(770 +)bps +(59.2 +)% +Footwear unit sales +54,326 +49,947 +4,379 +8.8 +% +Average footwear selling price +$ +21.27 +$ +21.55 +$ +(0.28 +) +(1.3 +)% +Revenues. During the year ended December 31, 2013, revenues increased $69.4 million, or 6.2%, compared to the same +period in 2012, +primarily due to an increase of 4.4 million, or 8.8%, in global footwear unit sales. This increase was partially offset by a decrease of $0.28 per unit, or 1.3%, in average footwear selling +price. +For +the year ended December 31, 2013, revenues from our wholesale channel increased $27.9 million, or 4.3%, compared to 2012, which was primarily driven by increased +wholesale demand in our Asia Pacific, Europe and Americas segments partially offset by decreased wholesale sales in our Japan segment. These increases were driven by strong commitments from current +wholesale customers and global distributors in emerging markets specifically in our Asia Pacific and Europe regions. We faced challenges in our Americas segment due to lower than anticipated at-once +sales as a result of accounts remaining lean on inventory and in our Japan segment due to continued macroeconomic pressure on consumer spending and unfavorable exchange rates between the Japanese Yen +and U.S. Dollar. +For +the year ended December 31, 2013, revenues from our retail channel increased $43.2 million, or 11.5%, compared to 2012, primarily driven by the disciplined expansion of +our global retail presence, which included the opening of 82 company-operated stores (net of store closures) during the year. This increase was driven by a global balance as we realized retail revenue +growth in all four segments on a constant currency basis. Partially offsetting this increase was a global decrease in comparable store sales of 2.7% on a constant currency basis which is primarily the +result of global weakness in consumer confidence, particularly in the Americas and Japan, as lingering effects of recessionary traffic and spending continued to impact retail markets. Despite these +macroeconomic challenges, we continued to +39 +Table of Contents +expand +our global retail footprint in a disciplined manner. Consistent with our retail growth strategy for 2013, we continue to close certain kiosks as branded stores allow us to better merchandise +the full breadth and depth of our product line. +For +the year ended December 31, 2013, revenues from our internet channel decreased $1.7 million, or 1.7%, compared to 2012, which was primarily driven by decreased internet +sales in Americas and Japan partially offset by increased internet sales in Europe and Asia Pacific. Our internet sales totaled approximately 8.5% and 9.1% of our consolidated net sales in 2013 and +2012, respectively. We continue to increase our online presence by adding new webstores worldwide enabling us to have increased access to our customers in a low cost, attractive manner and providing +an opportunity to educate them about our products and brand. +Impact on Revenues due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to +translate revenues from our +functional currencies to our reporting currency during the year ended December 31, 2013 decreased our revenues by $29.1 million compared to 2012. The majority of this decrease was +related to the decrease in value of the Japanese Yen compared to the U.S. Dollar due to the political and macroeconomic environment in Japan. +The +following table summarizes our total revenue by channel for the years ended December 31, 2013 and 2012: +Year Ended December 31, +Change +Constant +Currency +Change(1) +($ thousands) +2013 +2012 +$ +% +$ +% +Channel revenues: +Wholesale: +Americas +$ +239,104 +$ +235,988 +$ +3,116 +1.3 +% +$ +5,589 +2.4 +% +Asia Pacific +212,761 +180,970 +31,791 +17.6 +31,199 +17.2 +Japan +90,426 +117,380 +(26,954 +) +(23.0 +) +(6,940 +) +(5.9 +) +Europe +131,215 +110,947 +20,268 +18.3 +17,585 +15.8 +Other businesses +254 +574 +(320 +) +(55.7 +) +(325 +) +(56.6 +) +Total Wholesale +673,760 +645,859 +27,901 +4.3 +47,108 +7.3 +Consumer-direct: +Retail: +Americas +202,925 +196,711 +6,214 +3.2 +7,303 +3.7 +Asia Pacific +120,020 +104,632 +15,388 +14.7 +15,380 +14.7 +Japan +36,566 +38,430 +(1,864 +) +(4.9 +) +6,526 +17.0 +Europe +58,507 +35,052 +23,455 +66.9 +22,728 +64.8 +Total Retail +418,018 +374,825 +43,193 +11.5 +51,937 +13.9 +Internet: +Americas +56,523 +63,153 +(6,630 +) +(10.5 +) +(6,404 +) +(10.1 +) +Asia Pacific +9,971 +7,244 +2,727 +37.6 +2,749 +37.9 +Japan +7,871 +8,755 +(884 +) +(10.1 +) +867 +9.9 +Europe +26,537 +23,465 +3,072 +13.1 +2,231 +9.5 +Total Internet +100,902 +102,617 +(1,715 +) +(1.7 +) +(557 +) +(0.5 +) +Total revenues: +$ +1,192,680 +$ +1,123,301 +$ +69,379 +6.2 +% +$ +98,488 +8.8 +% +(1) Reflects +year-over-year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Non-GAAP Financial +Measures" below for more information. +40 +Table of Contents +The +table below illustrates the overall growth in the number of our company-operated retail locations by type of store and reportable operating segment as of December 31, 2013 and +2012: +Company-operated retail locations: +December 31, +2012 +Opened +Closed +December 31, +2013 +Type: +Kiosk/Store in Store +121 +23 +(22 +) +122 +Retail Stores +287 +66 +(26 +) +327 +Outlet Stores +129 +43 +(2 +) +170 +Total +537 +132 +(50 +) +619 +Operating segment: +Americas +199 +34 +(17 +) +216 +Asia Pacific +201 +61 +(26 +) +236 +Japan +40 +11 +(2 +) +49 +Europe +97 +26 +(5 +) +118 +Total +537 +132 +(50 +) +619 +The +table below sets forth our comparable store sales by reportable operating segment for the year ended December 31, 2013 as compared to 2012: +Comparable store sales(1) +Constant Currency +Year Ended +December 31, 2013(2) +Constant Currency +Year Ended +December 31, 2012(2) +Americas +(5.8 +)% +2.6 +% +Asia Pacific +6.9 +3.3 +Japan +(15.0 +) +(13.0 +) +Europe +2.4 +5.4 +Global +(2.7 +)% +1.5 +% +(1) Comparable +store sales is determined on a monthly basis. Comparable store sales begin in the thirteenth month of a store's operation. Stores in which +selling square footage has changed more than 15% as a result of a remodel, expansion or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily +closed stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. +Comparable store sales growth is calculated on a currency neutral basis using historical annual average currency rates. +(2) Reflects +year-over-year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Non-GAAP Financial +Measures" below for more information. +Gross profit. During the year ended December 31, 2013, gross profit increased $15.2 million, or 2.5%, compared to 2012, +which was +primarily attributable to the 6.2% increase in revenues as a result of higher footwear unit sales partially offset by lower footwear selling prices and a $54.2 million, or 10.5%, increase in +cost of sales. Gross margin percentage decreased 180 basis points compared to 2012. The decline in gross margin percentage is primarily driven by the evolution of our product assortment and is +consistent with our product strategy. As we expand our product lines, product mix shifts into styles that may utilize more expensive materials such as textile fabric and leather compared to the +traditional clog. Product cost inflation also contributed to the decline in gross margin percentage, but was mostly offset by internal cost savings initiatives. +41 +Table of Contents +Impact on Gross Profit due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency +exchange rates used to translate revenues and costs of sales from our functional currencies to our reporting currency during the year ended December 31, 2013 decreased our gross profit by +$15.9 million compared to 2012. The majority of this decrease was related to the decrease in value of the Japanese Yen compared to the U.S. Dollar due to the political and macroeconomic +environment in Japan. +Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $88.8 million, or +19.3%, during the year +ended December 31, 2013 compared to 2012. We continue to focus our operating expense increases around the long-term growth of the Company and are currently undergoing several long-term +strategic projects including global retail expansion and the implementation of our ERP system, which resulted in selling, general and administrative charges as well as capitalized expenditures. The +increase in selling, general and administrative expenses is primarily due to: +(i) an +increase of $39.6 million, or 19.3%, related to the global expansion of our retail channel, in which we opened 82 company-operated stores (net of +store closures) during the year. This increase includes $23.5 million of additional building expenses such as rent and maintenance fees, $11.4 million in additional labor expenses and +$3.2 million in depreciation and amortization; +(ii) an +increase of $14.9 million, or 13.9%, related to non-retail labor charges including variable and stock compensation as well as the normalization +of 2012 headcount increases; +(iii) an +increase of $9.9 million, or 44.8%, related to other non-retail expenses which includes a $6.1 million non-recurring expense related to +the resolution of a statutory tax audit in Brazil during the second quarter of 2013; +(iv) an +increase of $9.8 million, or 25.3%, related to non-retail professional expenses related to various litigation services, consulting fees, contract +labor and other outside services. This increase includes $3.5 million of additional non-recurring charges related to on-going litigation and $1.1 million of additional non-recurring fees +related to our recent investment agreement with Blackstone, which includes professional service fees associated with the transaction and our cash repatriation activities; +(v) an +increase of $7.1 million in non-retail marketing expenses, which was part of a company-wide initiative to increase advertising and agency services +in order to help drive demand; and +(i) an +increase of $5.0 million in operating expenses related to the implementation of our ERP system. +As +a percentage of revenue, selling, general and administrative expenses increased 12.2%, or 500 basis points, to 46.0% during the year ended December 31, 2013 compared to 2012 as +we continue to increase our global retail presence, utilize state-of-the-art marketing techniques to expand our global brand and update our information technology for a streamlined business approach. +Impact on Selling, General, and Administrative Expenses due to Foreign Exchange Rate Fluctuations. Changes in average foreign +currency exchange rates +used to translate expenses from our functional currencies to our reporting currency during the year ended December 31, 2013, decreased selling, general and administrative expenses by +approximately $8.6 million compared to 2012. The majority of this decrease was related to the decrease in value of the Japanese Yen compared to the U.S. Dollar due to the political and +macroeconomic environment in Japan. +42 +Table of Contents +Asset Impairments. We periodically evaluate all of our long-lived assets for impairment when events or circumstances would +indicate the carrying +value of a long-lived asset may not be fully recoverable. In addition, we assess goodwill for impairment annually on the last day of the fourth quarter, or more frequently if events and circumstances +indicate impairment may have occurred. Asset impairments increased $9.5 million during the year ended December 31, 2013 compared to 2012 primarily due to $10.6 million of +long-lived asset impairment charges during the year ended December 31, 2013 related to 60 underperforming retail locations in the Americas, Asia Pacific and Europe segments that we concluded +were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores' assets over their remaining economic life. In addition, we recorded $0.3 million of goodwill +impairment during the year ended December 31, 2013 related to our Crocs Benelux B.V. business, which we purchased in July 2012. +Foreign Currency Transaction Losses. The line item entitled 'Foreign currency transaction losses, net' is comprised of foreign +currency gains and +losses from the re-measurement and settlement of monetary assets and liabilities denominated in non-functional currencies and the impact of certain foreign currency derivative instruments. During the +year ended December 31, 2013, losses on foreign currency transactions increased $2.2 million, or 87.1%, compared to 2012. This increase is primarily related to an $8.0 million +increase in net losses associated with exposure from day-to-day business transactions in various foreign currencies compared to 2012. This difference was partially offset by a $5.8 million +increase in net gains associated with our derivative instruments and our ability to hedge foreign currency fluctuations through undesignated forward instruments compared to 2012. +Income tax expense. During the year ended December 31, 2013, income tax expense increased $35.3 million resulting in a +72.9% increase +in effective tax rate compared to 2012, which was primarily the result of valuation allowances being recorded on net deferred tax assets in tax jurisdictions where we believe it is not more likely +than not that those benefits will be realized and tax associated with our cash repatriation activities. Our effective tax rate of 82.6% for the year ended December 31, 2013 differs from the +federal U.S. statutory rate primarily because the result of valuation allowances being recorded on net deferred tax assets in tax jurisdictions where we believe it is not more likely than not that +those benefits will be realized and tax associated with our cash repatriation activities. +43 +Table of Contents +Comparison of the Years Ended December 31, 2012 and 2011 +Year Ended December 31, +Change +($ thousands, except per share data +and average footwear selling price) +2012 +2011 +$ +% +Revenues +$ +1,123,301 +$ +1,000,903 +$ +122,398 +12.2 +% +Cost of sales +515,324 +464,493 +50,831 +10.9 +Gross profit +607,977 +536,410 +71,567 +13.3 +Selling, general and administrative expenses +460,393 +404,803 +55,590 +13.7 +Asset impairment charges +1,410 +528 +882 +167.0 +Income from operations +146,174 +131,079 +15,095 +11.5 +Foreign currency transaction (gains) losses, net +2,500 +(4,886 +) +7,386 +(151.2 +) +Interest income +(1,697 +) +(957 +) +(740 +) +77.3 +Interest expense +837 +853 +(16 +) +(1.9 +) +Other income, net +(1,014 +) +(621 +) +(393 +) +63.3 +Income before income taxes +145,548 +136,690 +8,858 +6.5 +Income tax expense +14,205 +23,902 +(9,697 +) +(40.6 +) +Net income +$ +131,343 +$ +112,788 +$ +18,555 +16.5 +% +Net income per common share: +Basic +$ +1.46 +$ +1.27 +$ +0.19 +15.0 +% +Diluted +$ +1.44 +$ +1.24 +$ +0.20 +16.1 +% +Gross margin +54.1 +% +53.6 +% +50 +bps +0.9 +% +Operating margin +13.0 +% +13.1 +% +(10 +)bps +(0.8 +)% +Footwear unit sales +49,947 +47,736 +2,211 +4.6 +% +Average footwear selling price +$ +21.55 +$ +20.04 +$ +1.51 +7.5 +% +Revenues. During the year ended December 31, 2012, revenues increased $122.4 million, or 12.2%, compared to 2011, +primarily due to an +increase of 2.2 million, or 4.6%, in global footwear unit sales and an increase of $1.51, or 7.5%, in footwear average selling price. For the year ended December 31, 2012, revenues from +our wholesale channel increased $47.5 million, or 7.9%, which was primarily driven by increased wholesale sales in Americas and Asia. Revenues from our retail channel increased +$68.2 million, or 22.2%, primarily driven by strong demand in all three reportable segments as well as the continued growth of our retail presence by opening 107 company-operated stores (net of +store closures) during the year. We closed certain kiosks as branded stores allowed us to better merchandise the full breadth and depth of our product line. Revenues from our internet channel +increased $6.7 million, or 7.0%, compared to 2011 primarily driven by increased brand awareness in the Americas and Asia operating segments and focus on improving our regional webstore +presence. +Impact on Revenues due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to +translate revenues from our +functional currencies to our reporting currency during the year ended December 31, 2012 decreased our revenues by $18.0 million compared to 2011. The majority of this decrease was +related to the decrease in value of the Euro and the Brazilian Real compared to the U.S. Dollar due to the political and macroeconomic environments in Europe and Brazil. +44 +Table of Contents +The following table summarizes our total revenue by channel for the years ended December 31, 2012 and 2011: +Year Ended December 31, +Change +Constant Currency Change(1) +($ thousands) +2012 +2011 +$ +% +$ +% +Channel revenues: +Wholesale: +Americas +$ +235,988 +$ +214,062 +$ +21,926 +10.2 +% +$ +25,920 +12.1 +% +Asia Pacific +180,970 +144,483 +36,487 +25.3 +35,932 +24.9 +Japan +117,380 +114,621 +2,759 +2.4 +3,052 +2.7 +Europe +110,947 +124,995 +(14,048 +) +(11.2 +) +(5,168 +) +(4.1 +) +Other businesses +574 +191 +383 +200.5 +406 +212.6 +Total Wholesale +645,859 +598,352 +47,507 +7.9 +60,142 +10.1 +Consumer-direct: +Retail: +Americas +196,711 +174,840 +21,871 +12.5 +22,691 +13.0 +Asia Pacific +104,632 +78,864 +25,768 +32.7 +26,827 +34.0 +Japan +38,430 +32,786 +5,644 +17.2 +5,716 +17.4 +Europe +35,052 +20,167 +14,885 +73.8 +16,093 +79.8 +Total Retail +374,825 +306,657 +68,168 +22.2 +71,327 +23.3 +Internet: +Americas +63,153 +59,175 +3,978 +6.7 +4,069 +6.9 +Asia Pacific +7,244 +3,614 +3,630 +100.4 +3,693 +102.2 +Japan +8,755 +7,398 +1,357 +18.3 +1,356 +18.3 +Europe +23,465 +25,707 +(2,242 +) +(8.7 +) +(163 +) +(0.6 +) +Total Internet +102,617 +95,894 +6,723 +7.0 +8,955 +9.3 +Total revenues: +$ +1,123,301 +$ +1,000,903 +$ +122,398 +12.2 +% +$ +140,424 +14.0 +% +(1) Reflects +year-over-year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Non-GAAP Financial +Measures" below for more information. +The +table below illustrates the overall growth in the number of our company-operated retail locations by type of store and reportable operating segment as of December 31, 2012 and +2011: +Company-operated retail locations: +December 31, +2011 +Opened +Closed +December 31, +2012 +Type: +Kiosk/Store in Store +158 +39 +(76 +) +121 +Retail Stores +180 +120 +(13 +) +287 +Outlet Stores +92 +42 +(5 +) +129 +Total +430 +201 +(94 +) +537 +Operating segment: +Americas +197 +44 +(42 +) +199 +Asia Pacific +174 +78 +(51 +) +201 +Japan +24 +16 +— +40 +Europe +35 +63 +(1 +) +97 +Total +430 +201 +(94 +) +537 +45 +Table of Contents +The +table below sets forth our comparable store sales growth by reportable operating segment for the year ended December 31, 2012 as compared to 2011: +Comparable store sales(1) +Constant Currency +Year Ended +December 31, 2012(2) +Constant Currency +Year Ended +December 31, 2011(2) +Americas +2.6 +% +1.7 +% +Asia Pacific +3.3 +11.9 +Japan +(13.0 +) +(11.3 +) +Europe +5.4 +(5.7 +) +Global +1.5 +% +2.3 +% +(1) Comparable +store sales is determined on a monthly basis. Comparable store sales begin in the thirteenth month of a store's operation. Stores in which +selling square footage has changed more than 15% as a result of a remodel, expansion or reduction are excluded until the thirteenth month in which they have comparable prior year sales. Temporarily +closed stores are excluded from the comparable store sales calculation during the month of closure. Location closures in excess of three months are excluded until the thirteenth month post re-opening. +Comparable store sales growth is calculated on a currency neutral basis using historical annual average currency rates. +(2) Reflects +year-over-year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Non-GAAP Financial +Measures" below for more information. +Gross profit. During the year ended December 31, 2012, gross profit increased $71.6 million, or 13.3%, compared to 2011, +which was +primarily attributable to the 4.6% increase in sales volume and a 7.5% increase in footwear average selling price. Higher prices and sales volume are the result of the continued growth and expansion +of our retail and internet channels as the growth in combined sales from these channels began to outpace our wholesale channel. These drivers were offset by higher costs primarily from the expansion +of our product offerings in 2012 which utilized traditional materials, such as textile fabric and leather, and increased offerings of discounted products and promotional items through our wholesale +and direct-to-consumer channels. +Impact on Gross Profit due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to +translate revenues and +costs of sales from our functional currencies to our reporting currency during the year ended December 31, 2012 decreased our gross profit by $7.8 million compared to 2011. +Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $55.6 million, or 13.7%, +during the year +ended December 31, 2012 compared to 2011 primarily due to: +(i) an +increase of $23.7 million in rent and building related costs, both of which resulted from continued growth in the number of company operated +retail stores; +(ii) an +increase of $14.4 million in salaries and related costs, including variable compensation, resulting from higher global headcount including those +needed for new retail store openings and increased stock compensation; +(iii) an +increase of $9.7 million in other expenses primarily from increases in depreciation and amortization expenses related to additional retail store +locations, and capitalized software as well as bad debt and sales tax expense increases; +(iv) an +increase of $9.8 million in professional service expenses resulting from increased use of outside accounting and finance services, consulting for +our new ERP implementation which +46 +Table of Contents +began +in October 2012, certain legal contingency accruals, increased outside IT costs related to the implementation of new networking devices in our corporate headquarters, and increased costs +associated with contracted customer service, sales support, and performance improvement; and +(v) the +remaining difference was primarily a result of $2.1 million of net decreases in selling, general, and administrative expenses including travel, +as we became conscious of operating expenses throughout the company. +As +a percentage of revenues, selling, general and administrative expenses increased 1.5%, or 60 basis points, to 41.0% in 2012 from 40.4% in 2011. +Impact on Selling, General, and Administrative Expenses due to Foreign Exchange Rate Fluctuations. Changes in average foreign +currency exchange rates +used to translate expenses from our functional currencies to our reporting currency during the year ended December 31, 2012, decreased selling, general and administrative expenses by +approximately $4.8 million as compared to 2011. +Asset Impairments. Asset impairments increased $0.9 million during the year ended December 31, 2012 compared to 2011 +primarily due to +the impairment of $1.4 million of long-lived assets related to retail stores in the United States and Canada. During 2012, we recorded impairments related to four retail locations as our +projected discounted future cash flows of these locations was determined to be insufficient to cover our fixed asset investments for these stores. +Foreign Currency Transaction (Gains)/Losses. The line item entitled "Foreign currency transaction (gains)/losses, net" is +comprised of foreign +currency gains and losses from the re-measurement and settlement of monetary assets and liabilities denominated in non-functional currencies and the impact of certain foreign currency derivative +instruments. In 2012, we recognized a loss of $2.5 million related to foreign currency transactions, compared to a $4.9 million gain in 2011, primarily due to a $4.3 million loss +in the first quarter of 2012 as a result of large currency fluctuations and an increase in international business. We implemented a foreign currency hedging strategy in the second quarter of 2012. As +a result of this strategy, we were able to reduce the impacts of foreign currency fluctuations on our financial statements. +Income tax (benefit) expense. During the year ended December 31, 2012, income tax expense decreased $9.7 million +resulting in a 7.7% +decrease in effective tax rate compared to the same period in 2011, which was primarily due to a reversal of certain tax provisions and the release of certain valuation allowances associated with +deferred tax assets. Our effective tax rate of 9.8% for the year ended December 31, 2012 differed from the federal U.S. statutory rate primarily because of the above mentioned releases as well +as differences between income tax rates between U.S. and foreign jurisdictions. +Presentation of Reportable Segments +During the first quarter of 2013, we adjusted our operating segment structure for internal reports reviewed by the chief operating +decision maker ("CODM") by presenting Japan separate from the Asia Pacific segment. This change was made due to recurring amounts of substantial business activity as well as the macroeconomic +environment within Japan, which resulted in the need for a regular review of Japan operating results by management and the CODM in order to better evaluate performance and allocate resources for the +consolidated business. Segment information for all periods presented has been reclassified to conform to the fiscal 2013 presentation. +As +a result of the changes discussed above, we have four reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, Japan and Europe. We also +have an "Other businesses" category which aggregates insignificant operating segments that do not meet the +47 +Table of Contents +reportable +segment threshold and represent manufacturing operations located in Mexico, Italy and Asia. The composition of our reportable operating segments is consistent with that used by our CODM to +evaluate performance and allocate resources. +Each +of our reportable operating segments derives its revenues from the sale of footwear, apparel and accessories to external customers as well as intersegment sales. Revenues of the +"Other businesses" category are primarily made up of intersegment sales. The remaining revenues for the "Other businesses" represent non-footwear product sales to external customers. Intersegment +sales are not included in the measurement of segment operating income or regularly reviewed by the CODM and are eliminated when deriving total consolidated revenues. +The +primary financial measure utilized by the CODM to evaluate performance and allocate resources is segment operating income. Segment performance evaluation is based primarily on +segment results without allocating corporate expenses, or indirect general, administrative and other expenses. Segment profits or losses of our reportable operating segments include adjustments to +eliminate intersegment profit or losses on intersegment sales. As such, reconciling items for segment operating income represent unallocated corporate and other expenses as well as intersegment +eliminations. Segment assets consist of cash and cash equivalents, accounts receivable and inventory as these balances are regularly reviewed by the CODM. +48 +Table of Contents +Comparison of the Years Ended December 31, 2013 and 2012 by Segment +The following tables set forth information related to our reportable operating business segments for the years ended +December 31, 2013 and 2012: +Year Ended December 31, +Change +Constant Currency Change(4) +($ thousands) +2013 +2012 +$ +% +$ +% +Revenues: +Americas +$ +498,552 +$ +495,852 +$ +2,700 +0.5 +% +$ +6,488 +1.3 +% +Asia Pacific +342,752 +292,846 +49,906 +17.0 +49,328 +16.8 +Japan +134,863 +164,565 +(29,702 +) +(18.0 +) +453 +0.3 +Europe +216,259 +169,464 +46,795 +27.6 +42,544 +25.1 +Total segment revenues +1,192,426 +1,122,727 +69,699 +6.2 +98,813 +8.8 +Other businesses +254 +574 +(320 +) +(55.7 +) +(325 +) +(56.6 +) +Total consolidated revenues +$ +1,192,680 +$ +1,123,301 +$ +69,379 +6.2 +% +$ +98,488 +8.8 +% +Operating income (loss): +Americas +$ +61,894 +$ +85,538 +$ +(23,644 +) +(27.6 +)% +$ +(24,364 +) +(28.5 +)% +Asia Pacific +80,693 +74,535 +6,158 +8.3 +5,419 +7.3 +Japan +37,560 +66,293 +(28,733 +) +(43.3 +) +(20,324 +) +(30.7 +) +Europe +16,192 +21,678 +(5,486 +) +(25.3 +) +(5,359 +) +(24.7 +) +Total segment operating income +196,339 +248,044 +(51,705 +) +(20.8 +) +(44,628 +) +(18.0 +) +Other businesses(1) +(20,811 +) +(10,805 +) +(10,006 +) +92.6 +(9,756 +) +90.3 +Intersegment eliminations +61 +60 +1 +1.7 +1 +0.9 +Unallocated corporate and other(2) +(112,494 +) +(91,125 +) +(21,369 +) +23.5 +(21,242 +) +23.3 +Total consolidated operating income(3) +$ +63,095 +$ +146,174 +$ +(83,079 +) +(56.8 +)% +$ +(75,625 +) +(51.7 +)% +Foreign currency transaction losses, net +4,678 +2,500 +2,178 +87.1 +Interest income +(2,432 +) +(1,697 +) +(735 +) +43.3 +Interest expense +1,016 +837 +179 +21.4 +Other income, net +(126 +) +(1,014 +) +888 +(87.6 +) +Income before income taxes +$ +59,959 +$ +145,548 +$ +(85,589 +) +(58.8 +)% +(1) During +the year ended December 31, 2013, operating losses of Other businesses increased $10.0 million compared to 2012, primarily due to a +$9.7 million decrease in gross margin as a result of increased cost of sales and a $0.3 million increase in selling, general and administrative expenses. +(2) Includes +a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand marketing, legal, depreciation on corporate and other assets not allocated to operating segments and costs of the same nature of certain corporate holding companies. +For the year ended December 31, 2013, operating losses of Unallocated corporate and other expenses increased $21.4 million compared to 2012, primarily due to a $23.0 million +increase in selling, general and administrative costs as a result of increased labor charges including variable and stock compensation as well as the normalization of 2012 headcount increases and +increased professional services expenses related to the implementation of our ERP system. This increase of selling, general and administrative expenses was partially offset by a $1.6 million +decrease in cost of sales primarily related to decreases in variable overhead and freight expenses. +49 +Table of Contents +(3) Please +refer to our Results of Operations to reconcile total consolidated operating income to net income as segment information does not have an effect on +values below total consolidated operating income. +(4) Reflects +year-over-year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Non-GAAP Financial +Measures" below for more information. +Americas Operating Segment. During the year ended December 31, 2013, revenues from our Americas segment increased +$2.7 million, or +0.5%, compared to 2012 primarily due to a 5.0% increase in average footwear selling price. This increase was partially offset by a 2.6% decrease in footwear units sold and $3.8 million +unfavorable impact from foreign currency fluctuations driven by weakening of the Brazilian Real against the U.S. Dollar. During the year ended December 31, 2013, revenue growth for the region +was realized primarily in the retail channel which increased $6.2 million, or 3.2%, and in the wholesale channel which increased $3.1 million, or 1.3% compared to 2012. The increase in +retail channel revenue is predominately driven by the disciplined expansion of our retail presence, which included the opening of 17 company-operated stores (net of closures) during the year. Despite +the advancement of our retail presence in the Americas segment and increased retail channel revenues, we experienced a decrease in comparable store sales of 5.8% on a constant currency basis. This +decrease was primarily the result of weakness in consumer confidence in the region as lingering effects of recessionary traffic and spending continue to impact retail markets. Despite the slight +increase in wholesale channel revenues on a year-over-year basis, we continue to face challenges in the region due to lower than anticipated at-once sales as a result of wholesale accounts remaining +lean on inventory. In addition, we were impacted by economic and market conditions in Latin America as our revenue was constrained due to import restrictions and lower market demand. These increases +in retail and wholesale channel revenues during the year ended December 31, 2013 were partially offset by our internet channel which decreased $6.6 million, or 10.5%, compared to 2012. +This decrease was attributable to decreased internet traffic and conversion rates throughout the year. During the year ended December 31, 2013, segment operating income decreased +$23.6 million, or 27.6%, compared to 2012 driven predominately by: +(i) a +$18.4 million, or 11.3%, increase in selling, general and administrative expenses as a result of the continued expansion of our retail channel, +increased marketing efforts and a non-recurring net expense of $6.1 million related to the resolution of a statutory tax audit in Brazil; +(ii) retail +asset impairment charges of $3.9 million related to certain underperforming locations; +(iii) a +non-recurring write-off of $3.4 million related to obsolete inventory including raw materials, footwear and other accessories; and +(iv) a +decrease in segment gross margins of 1.6%, or 80 basis points. +Partially +offsetting this decrease were the revenue increases noted above and a $0.7 million favorable impact from foreign currency fluctuations. +Asia Pacific Operating Segment. During the year ended December 31, 2013, revenues from our Asia Pacific segment increased +$49.9 million, or 17.0%, compared to 2012 primarily due to a 14.1% increase in footwear units sold, a 3.0% increase in average footwear selling price and a $0.6 million favorable impact +from foreign currency fluctuations. Although our leading footwear model in terms of sales in the Asia Pacific region continues to be our traditional clog, the increase in footwear units sold and +average footwear selling price was driven mainly through other footwear styles such as our mary-jane, flip-flop and loafer. During the year ended December 31, 2013, we realized revenue growth +for the region in all three channels compared to 2012. Our wholesale channel revenue increased $31.8 million, or 17.6%, primarily due to the expansion of our wholesale doors and the continued +50 +Table of Contents +support +from existing customers. Our direct-to-consumer channel revenues increased $18.1 million, or 16.2%, primarily due to our continued focus on and the disciplined expansion of our retail +channel as we opened 35 company-operated stores (net of store closures) during the year combined with an increase in comparable store sales of 6.9% on a constant currency basis. During the year ended +December 31, 2013, segment operating income increased $6.2 million, or 8.3%, compared to 2012 driven predominately by the revenue increases noted above and a $0.7 million +favorable impact from foreign currency fluctuations. Partially offsetting this increase were the following: +(i) a +$21.2 million, or 20.5%, increase in selling, general and administrative expenses as a result of the continued expansion of our retail channel, +increased salaries and wages as we added approximately 40 full-time employees to our growing Asia Pacific business and increased marketing efforts; +(ii) retail +asset impairment charges of $0.2 million related to certain underperforming locations; and +(iii) a +decrease in segment gross margins of 1.3%, or 80 basis points. +Japan Operating Segment. During the year ended December 31, 2013, revenues from our Japan segment decreased +$29.7 million, or 18.0%, +compared to 2012 primarily due to $30.2 million unfavorable impact from foreign currency fluctuations as a result of recent decreases in the value of the Japanese Yen to the U.S. Dollar +stemming from political and macroeconomic challenges in the region, which led to a 21.0% decrease in footwear selling price. This decrease was partially offset by a 4.8% increase in footwear units +sold. During the year ended December 31, 2013, revenue underperformance was realized primarily in the wholesale channel which decreased $27.0 million, or 23.0%, compared to 2012. This +decrease was mainly due to a soft wholesale market and slow sell-through of inventory as a result of macroeconomic declines. Our direct-to-consumer channel revenues decreased $2.7 million, or +5.8%, primarily due to a decrease in comparable store sales growth of 15.0% on a constant currency basis. Despite current macroeconomic conditions in Japan, we continue to expand our retail channel in +the region as we opened nine company-operated stores (net of store closures) during the year in anticipation of an economic recovery. During the year ended December 31, 2013, segment operating +income decreased $28.7 million, or 43.3%, compared to 2012 driven predominately by a the revenue decreases noted above, a $8.4 million unfavorable impact from foreign currency +fluctuations and a decrease in segment gross margins of 12.6%, or 800 basis points. Partially offsetting this decrease was a $0.9 million, or 2.3%, decrease in selling, general and +administrative expenses. +Europe Operating Segment. During the year ended December 31, 2013, revenues from our Europe segment increased +$46.8 million, or 27.6%, +compared to 2012 primarily due to a 41.9% increase in footwear units sold and a $4.3 million favorable impact from foreign currency fluctuations driven by strengthening of the Euro against the +U.S. Dollar. This increase was partially offset by a 9.9% decrease in average footwear selling price. Our traditional clog continues to generate the majority of our footwear sales in Europe, making up +approximately 70.3% of total footwear unit sales during the year; however, we did experience marked improvement in the sales of other footwear models during the year including boots and flip-flops. +During the year ended December 31, 2013, we realized revenue growth for the region in all three channels compared to 2012 as we experienced noticeable improvement in the macroeconomic +environment in Europe. Our retail channel revenue increased $23.5 million, or 66.9%, primarily due to our continued focus on and the disciplined expansion of our retail channel as we opened 21 +company-operated stores (net of store closures) during the year combined with an increase in comparable store sales growth of 2.4% on a constant currency basis. Our wholesale channel revenue increased +$20.3 million, or 18.3%, primarily due to the expansion in our number of wholesale doors leading to improved backlog sales and at-once orders. Our internet channel revenue increased +$3.1 million, or 13.1%, primarily due to increased internet traffic and our promotional focus. During +51 +Table of Contents +the +year ended December 31, 2013, segment operating income decreased $5.5 million, or 25.3%, compared to 2012 driven predominately by: +(i) a +$26.8 million, or 41.5%, increase in selling, general and administrative expenses as a result of the continued expansion of our retail channel and +a non-recurring legal contingency accrual of $5.7 million related to on-going litigation; +(ii) retail +asset impairment charges of $6.9 million related to certain underperforming locations; +(iii) a +goodwill impairment charge of $0.3 million related to our acquisition of Benelux in 2012; and +(iv) a +$0.1 million unfavorable impact from foreign currency fluctuations. +Partially +offsetting this decrease were the revenue increases noted above and an increase in segment gross margins of 3.9%, or 200 basis points. +52 +Table of Contents +Comparison of the Years Ended December 31, 2012 and 2011 by Segment +The following tables set forth information related to our reportable operating business segments for the years ended +December 31, 2012 and 2011: +Year Ended December 31, +Change +Constant +Currency +Change(4) +($ thousands) +2012 +2011 +$ +% +$ +% +Revenues: +Americas +$ +495,852 +$ +448,077 +$ +47,775 +10.7 +% +$ +52,680 +11.8 +% +Asia Pacific +292,846 +226,961 +65,885 +29.0 +66,452 +29.3 +Japan +164,565 +154,805 +9,760 +6.3 +10,124 +6.5 +Europe +169,464 +170,869 +(1,405 +) +(0.8 +) +10,762 +6.3 +Total segment revenues +1,122,727 +1,000,712 +122,015 +12.2 +140,018 +14.0 +Other businesses +574 +191 +383 +200.5 +406 +212.6 +Total consolidated revenues +$ +1,123,301 +$ +1,000,903 +$ +122,398 +12.2 +% +$ +140,424 +14.0 +% +Operating income (loss): +Americas +$ +85,538 +$ +70,532 +$ +15,006 +21.3 +% +$ +14,962 +21.2 +% +Asia Pacific +74,535 +52,872 +21,663 +41.0 +21,412 +40.5 +Japan +66,293 +71,046 +(4,753 +) +(6.7 +) +(4,711 +) +(6.6 +) +Europe +21,678 +37,106 +(15,428 +) +(41.6 +) +(12,137 +) +(32.7 +) +Total segment operating income +248,044 +231,556 +16,488 +7.1 +19,526 +8.4 +Other businesses(1) +(10,805 +) +(14,128 +) +3,323 +(23.5 +) +3,235 +(22.9 +) +Intersegment eliminations +60 +66 +(6 +) +(9.1 +) +(16 +) +(23.6 +) +Unallocated corporate and other(2) +(91,125 +) +(86,415 +) +(4,709 +) +5.5 +(4,785 +) +5.5 +Total consolidated operating income(3) +$ +146,174 +$ +131,079 +$ +15,095 +11.5 +% +$ +17,960 +13.7 +% +Foreign currency transaction (gains) losses, net +2,500 +(4,886 +) +7,386 +(151.2 +) +Interest income +(1,697 +) +(957 +) +(740 +) +77.3 +Interest expense +837 +853 +(16 +) +(1.9 +) +Other income, net +(1,014 +) +(621 +) +(393 +) +63.3 +Income before income taxes +$ +145,548 +$ +136,690 +$ +8,858 +6.5 +% +(1) During +the year ended December 31, 2012, operating losses of Other businesses decreased $3.3 million compared to 2011 primarily due to a +$2.5 million increase in gross margin and a $0.8 million decrease in selling, general and administrative expenses. +(2) Includes +a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand marketing, legal, depreciation on corporate and other assets not allocated to operating segments and costs of the same nature of certain corporate holding companies. +For the year ended December 31, 2012, Unallocated corporate and other expenses increased $4.7 million compared to 2011, primarily due to a $3.3 million increase in cost of sales +and a $2.0 million increase in selling, general, and administrative costs due to higher corporate headcount partially offset by a decrease of $0.5 million in asset impairments and a +decrease of $0.1 million in charitable contributions.. +53 +Table of Contents +(3) Please +refer to our Results of Operations to reconcile total consolidated operating income to net income as segment information does not have an effect on +values below total consolidated operating income. +(4) Reflects +year-over-year change as if the current period results were in "constant currency," which is a non-GAAP financial measure. See "Non-GAAP Financial +Measures" below for more information. +Americas Operating Segment. During the year ended December 31, 2012, revenues from our Americas segment increased +$47.8 million, or +10.7%, compared to 2011 primarily due to a 4.3% increase in footwear units sold and a 5.8% increase in average footwear selling price partially offset by a $4.9 million unfavorable impact from +foreign currency fluctuations. Revenue growth for the region was realized primarily in our retail channel which increased $21.9 million, or 12.5%, and in our wholesale channel which increased +$21.9 million, or 10.2%. We continued to focus on the disciplined expansion of our retail channel by opening 22 full price stores (net of store closures) and 15 outlet stores (net of +store closures) in 2012, offset by the closing of 35 underperforming kiosk locations (net of store closures). Segment operating income increased by $15.0 million, or 21.3%, compared to 2011 +driven mainly by the revenue increase and a slight increase in segment gross margin of approximately 2.2%, or 110 basis points, which was largely offset by a $12.5 million, or 8.3%, increase in +selling, general and administrative expenses resulting from the continued expansion of the retail channel. +Asia Pacific Operating Segment. During the year ended December 31, 2012, revenues from our Asia Pacific segment increased +$65.9 million, or 29.0%, compared to 2011 primarily due to a 17.5% increase in footwear units sold and a 10.0% increase in average footwear selling price partially offset by a +$0.6 million unfavorable impact from foreign currency fluctuations. During the year ended December 31, 2012, revenue growth for the region was realized in all three channels compared to +the same period in 2012 as we retained strong support from our wholesale channel customers, continued to focus on disciplined expansion of our retail channel and continued to implement new, +consumer-friendly webstores in various countries in our internet channel. Wholesale channel revenue increased $36.5 million, or 25.3%, retail channel revenue increased $25.8 million, or +32.7%, and internet channel revenue increased $3.6 million, or 100.4%. During the year ended December 31, 2012, we opened 27 company-operated stores (net of store closures) in our Asia +Pacific region compared to 2011. Segment operating income increased $21.7 million, or 41.0%, compared to 2011 primarily due to the increase in revenues, a slight increase in segment gross +margin of approximately 1.7%, or 100 basis points, and a $0.3 million favorable net impact from foreign currency fluctuations on operating income. This increase was partially offset by a +$20.7 million, or 25.1%, increase in selling, general and administrative expenses resulting from the continued expansion of the retail channel. +Japan Operating Segment. During the year ended December 31, 2012, revenues from our Japan segment increased +$9.8 million, or 6.3%, +compared to 2011 primarily due to a 9.4% increase in footwear units sold. This increase was partially offset by a 2.0% decrease in average footwear selling price and a $0.4 million unfavorable +impact from foreign currency fluctuations due to recent decreases in value of the Japanese Yen to the U.S. Dollar. During the year ended December 31, 2012, revenue growth for the region was +realized in all three channels compared to the same period in 2011. Retail channel revenue increased $5.6 million, 17.2%, wholesale channel revenue increased $2.8 million, or 2.4%, and +internet channel revenue increased $1.4 million, or 18.4%. During the year ended December 31, 2012, we opened 16 company-operated stores in our Japan region compared to the same period +in 2011. Segment operating income decreased $4.8 million, or 6.7%, compared to 2011 primarily due to a $6.9 million, or 22.1%, increase in selling, general and administrative expenses +resulting from the continued expansion of the retail channel and a decrease in segment gross margin of approximately 3.9%, or 260 basis points. This decrease was partially offset by the increase in +revenues mentioned above. +54 +Table of Contents +Europe Operating Segment. During the year ended December 31, 2012, revenues from the Europe segment decreased +$1.4 million, or 0.8%, +compared to 2011 primarily due to an 11.3% decrease in footwear units sold and a $12.2 million unfavorable impact from foreign currency fluctuations partially offset by a 13.4% increase in +average footwear selling price. A decrease of $14.0 million, or 11.2%, in wholesale channel revenue and a decrease of $2.2 million, or 8.7%, in internet channel revenue drove the decline +in total segment revenues which was primarily due to the decrease in footwear units sold and unfavorable impact of foreign currency fluctuations as a result of challenging macroeconomic conditions in +Europe. The wholesale and internet channel revenue decreases were partially offset by a revenue increase of $14.9 million, or 73.8%, in the retail channel as we opened 62 stores (net of store +closures) in 2012 including 44 full price stores (net of store closures), 14 outlet stores (net of store closures) and 4 kiosk locations (net of store closures). Segment operating income decreased by +$15.4 million, or 41.6%, compared to 2011 driven mainly by decreased revenues, an increase of $14.3 million, or 28.4%, in selling, general, and administrative expenses resulting from the +continued expansion of the retail channel, a $3.3 million unfavorable net impact from foreign currency fluctuations on operating income, and a slight decrease in segment gross margin of +approximately 0.4%, or 20 basis points. +Non-GAAP Financial Measures +In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America +("U.S. GAAP"), we present current period results below in 'adjusted results of operations', which is a non-GAAP financial measure. Adjusted results of operations exclude the impact of items +that management believes are non-recurring, unusual and infrequent charges that affected our consolidated statements of operations in the periods presented. +We +also present certain information related to our current period results of operations in this Item 2 through "constant currency", which is a non-GAAP financial measure and +should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been +restated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rate +fluctuations. +Management +uses adjusted results of operations and constant currency figures to assist in comparing business trends from period to period on a consistent basis without regard to the +impact of non-recurring, unusual and infrequent items and foreign exchange rate fluctuations and in communications with the board of directors, stockholders, analysts and investors concerning our +financial performance. We believe that these non-GAAP measures are used by, and are useful to, investors and other users of our financial statements in evaluating operating performance by providing +better comparability between reporting periods because they provide an additional tool to evaluate our performance without regard to foreign currency fluctuations and non-recurring items that may not +be indicative of overall business trends. They also provide a better baseline for analyzing trends in our +operations. We do not suggest that investors should consider these non-GAAP measures in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. +55 +Table of Contents +The following table is a reconciliation of our results of operations, the most directly comparable U.S. GAAP measures, to non-GAAP adjusted results of +operations: +Year Ended December 31, +2013 +2012 +Non-Recurring, +Unusual and +Infrequent +Charges +Non-Recurring, +Unusual and +Infrequent +Charges +($ thousands, except per share data) +GAAP +Cash +Non-Cash +Non-GAAP +GAAP +Cash +Non-Cash +Non-GAAP +Revenues +$ +1,192,680 +$ +$ +$ +1,192,680 +$ +1,123,301 +$ +$ +$ +1,123,301 +Cost of sales +569,482 +515,324 +Inventory write-down(1) +— +(3,419 +) +(3,419 +) +— +— +— +Contingency accruals(2) +— +— +— +— +(3,704 +) +(3,704 +) +Cost of sales +— +(3,419 +) +566,063 +— +(3,704 +) +511,620 +Gross profit +623,198 +626,617 +607,977 +611,681 +Gross margin +52.3 +% +52.5 +% +54.1 +% +54.5 +% +Selling, general and administrative expenses ("SG&A") +549,154 +460,393 +Brazil tax credits(3) +(6,094 +) +— +(6,094 +) +— +— +— +New ERP implementation(4) +(5,902 +) +— +(5,902 +) +(870 +) +— +(870 +) +Contingency accruals(2) +— +(5,714 +) +(5,714 +) +— +(2,200 +) +(2,200 +) +Depreciation and amortization(5) +— +(2,991 +) +(2,991 +) +— +(903 +) +(903 +) +Blackstone deal and cash repatriation(6) +(1,091 +) +— +(1,091 +) +— +— +— +Management turnover benefit(7) +— +625 +625 +— +— +— +SG&A +(13,087 +) +(8,080 +) +527,987 +(870 +) +(3,103 +) +456,420 +SG&A as a percentage of revenues +46.0 +% +44.3 +% +41.0 +% +40.6 +% +Asset impairment charges +10,949 +1,410 +Retail asset impairment charges(8) +— +(10,610 +) +(10,610 +) +— +(1,410 +) +(1,410 +) +Goodwill impairment charges(9) +— +(339 +) +(339 +) +— +— +— +Asset impairment charges +— +(10,949 +) +— +— +(1,410 +) +— +Income from operations +63,095 +98,630 +146,174 +155,261 +Foreign currency transaction losses, net +4,678 +— +— +4,678 +2,500 +— +— +2,500 +Interest income +(2,432 +) +— +— +(2,432 +) +(1,697 +) +— +— +(1,697 +) +Interest expense +1,016 +— +— +1,016 +837 +— +— +837 +Other income, net +(126 +) +— +— +(126 +) +(1,014 +) +— +— +(1,014 +) +Income before income taxes +59,959 +— +— +95,494 +145,548 +— +— +154,635 +Income tax expense(10) +49,539 +(1,000 +) +(25,831 +) +22,708 +14,205 +— +11,368 +25,573 +Net income +$ +10,420 +$ +(14,087 +) +$ +(48,279 +) +$ +72,786 +$ +131,343 +$ +(870 +) +$ +3,151 +$ +129,062 +Net income per common share: +Basic +$ +0.12 +$ +1.46 +Diluted +$ +0.12 +$ +0.82 +$ +1.44 +$ +1.42 +(1) This +relates to a write-off of obsolete inventory including raw materials, footwear and accessories. +(2) This +represents legal and customs contingency accruals during the year ended December 31, 2013 and 2012 of which $5.7 million and +$2.2 million, respectively, was recorded in selling, general and administrative expenses and $0.0 million and $3.7 million, respectively, was recorded in cost of sales. +(3) This +represents a net expense related to the resolution of a statutory tax audit in Brazil. +(4) This +represents operating expenses related to the implementation of our new ERP system. +(5) This +represents the add-back of accelerated depreciation and amortization on tangible and intangible items related to our current ERP system and supporting +platforms that will no longer be utilized once the implementation of a new ERP is complete. +(6) This +is related to our recent investment agreement with Blackstone, which includes professional service fees associated with the transaction and our cash +repatriation activities. +(7) This +is related to benefits recognized by the Company due to the cancellation of stock awards associated with the resignation of our Chief Executive +Officer. +56 +Table of Contents +(8) This +represents retail asset impairment charges for certain underperforming locations in our Americas, Asia Pacific and Europe segments. +(9) This +is related to a portion of our Crocs Benelux B.V. business purchased by our Crocs Stores B.V. subsidiary in July 2012. +(10) These +represent the add-back of certain income tax expenses (benefits). The three months and year-ended December 31, 2013 includes a non-recurring +tax expense related to our cash repatriation strategy as well as a valuation allowance adjustment. The year-ended December 31, 2012 includes a non-recurring tax benefit of $11.4 million +related to the reversal of reserves for specific uncertain tax positions and the release of certain valuation allowances associated with deferred tax assets. +Liquidity and Capital Resources +Cash Flows +Cash and cash equivalents at December 31, 2013 increased 7.7% to $317.1 million compared to $294.3 million at +December 31, 2012. The cash and cash equivalents balance has fluctuated throughout the year due in part to typical seasonal changes in working capital requirements. Cash outflows consist of +strategic reinvestments of excess cash into the business, including $68.8 million in net capital spending primarily related to our ERP system implementation and global retail expansion and a +$12.5 million repurchase of stock associated with board authorized repurchases (further discussed below). Cash inflows were primarily sourced from operating income and net proceeds from bank +borrowings related to the implementation of our ERP system. +We +anticipate that cash flows from operations will be sufficient to meet the ongoing needs of our business for the next twelve months. In order to provide additional liquidity in the +future and to help support our strategic goals, we issued Series A Convertible Preferred Stock ("Series A Preferred Stock") to Blackstone Capital Partners VI L.P. ("Blackstone") +on January 27, 2014 for net proceeds of approximately $182.2 million (see Sale of Preferred Stock below), we have a revolving credit +facility with a syndicate of lenders, including PNC Bank, National Association ("PNC"), which currently provides us with up to $100.0 million in borrowing capacity and matures in December 2017 +(see Revolving Credit Facility below) and we have the ability to finance portions of our ERP system implementation through PNC Equipment +Finance, LLC ("PNC Equipment") (see Long Term Bank Borrowings below). Additional future financing may be necessary and there can be no assurance +that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. +Sale of Preferred Stock +On December 28, 2013, we entered into, and on January 27, 2014, we closed on an investment agreement with Blackstone, +which resulted in approximately $182.2 million of proceeds, which is net of related expenses, in exchange for 200,000 shares of the Company's Series A Preferred Stock, par value $0.001 +per share, with an aggregate stated value of $200.0 million, or $1000 per share, and an aggregate purchase price of $198.0 million, or $990 per share. +The +Series A Preferred Stock ranks senior to our common stock with respect to dividend rights and rights on liquidation, winding-up and dissolution. Holders of Series A +Preferred Stock are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum as well as any dividends declared or paid on common stock and are entitled to vote together +with the holders of common stock on an as-converted basis. Pursuant to the Investment Agreement, the Series A Preferred Stock is subject to several different conversion features as well as +redemption rights, which are at the option of the holder, the Company or contingent events. The conversion rate is subject to customary anti-dilution and other adjustments subject to certain share +caps and other restrictions. +We +intend to use the net proceeds of the transactions, as well as excess cash, to fund the previously announced $350.0 million stock repurchase authorization approved by the board +of directors. The Blackstone investment represented approximately 13.5% ownership of the Company as of +57 +Table of Contents +January 31, +2014. The Company believes this investment provides an opportunity to drive shareholder value and refine the strategic direction of the business. +Stock Repurchase Plan Authorizations +We continue to evaluate options to maximize the returns on our cash and maintain an appropriate capital structure, including, among +other alternatives, repurchases of our common stock. +On +December 26, 2013, the Board approved the repurchase of up to $350.0 million of our common stock. This replaced any of the Company's existing stock repurchase +authorizations. The number, price, structure and timing of the repurchases, if any, will be at the Company's sole discretion and future repurchases will be evaluated by the Company depending on market +conditions, liquidity needs and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have an expiration date +and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, modify or terminate the repurchase program at any time without prior notice. +During +the three months ended December 31, 2013, we did not repurchase any shares. During the year ended December 31, 2013, we repurchased approximately 0.8 million +shares at an average price of $14.99 for an aggregate price of approximately $12.5 million excluding related commission charges, under a publicly-announced repurchase plan. +As +of December 31, 2013, subject to certain restrictions on repurchases under our revolving credit facility, we had $350.0 million of our common shares available for +repurchase under previously announced repurchase authorizations. +Revolving Credit Facility +On September 25, 2009, we entered into a Revolving Credit and Security Agreement, as amended, with the lenders named therein and +PNC Bank, National Association ("PNC"), as a lender and administrative agent for the lenders. On December 16, 2011 and June 12, 2013, we entered into our first and second amendments, +respectively, to the Revolving Credit and Security Agreement (collectively, the "Amended and Restated Credit Agreement"). +On +December 27, 2013, we entered into the Third Amendment to Amended and Restated Credit Agreement (the "Third Amendment"), pursuant to which certain terms of the Amended and +Restated Credit Agreement were amended. The Third Amendment, among other things, (i) allows for the payment of dividends on the Series A Preferred Stock, (ii) permits the Company +to have greater flexibility to repurchase its Common Stock, (iii) decreases the maximum leverage ratio from 3.50 to 1.00 to 3.25 to 1.00, and (iv) amends certain definitions of the +financial covenants to become more favorable to the Company. +The +Credit Agreement enables us to borrow up to $100.0 million, with the ability to increase commitments to up to $125 million subject to certain conditions, and is +currently set to mature on December 16, 2017. The Credit Agreement is available for working capital, capital expenditures, permitted acquisitions, reimbursement of drawings under letters of +credit, and permitted dividends, distributions, purchases, redemptions and retirements of equity interests. Borrowings under the Credit Agreement are secured by all of our assets including all +receivables, equipment, general intangibles, +inventory, investment property, subsidiary stock and intellectual property. Borrowings under the Credit Agreement bear interest at a variable rate. For domestic rate loans, the interest rate is equal +to the highest of (i) the daily federal funds open rate as quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC's prime rate and (iii) a daily LIBOR rate plus 1.0%, in +each case there is an additional margin ranging from 0.25% to 1.00% based on certain conditions. For LIBOR rate loans, the interest rate is equal to a LIBOR rate plus a margin ranging from 1.25% to +2.00% based on certain conditions. +58 +Table of Contents +The +Credit Agreement requires monthly interest payments with respect to domestic rate loans and at the end of each interest period with respect to LIBOR rate loans. The Credit Agreement further +provides for a limit on the issuance of letters of credit to a maximum of $20.0 million. The Credit Agreement contains provisions requiring us to maintain compliance with certain restrictive +and financial covenants. +As +of December 31, 2013 and 2012, we had no outstanding borrowings under the Credit Agreement. As of each of December 31, 2013 and 2012, we had issued and outstanding +letters of credit of $7.2 million, which were reserved against the borrowing base under the terms of the Credit Agreement. During the years ended December 31, 2013, 2012 and 2011, we +capitalized $0.1 million, $0.5 million and $0.4 million, respectively, in fees and third party costs which were incurred in connection with the Credit Agreement, as deferred +financing costs. As of December 31, 2013, we were in compliance with all restrictive financial and other covenants under the Credit Agreement. +Long-term Bank Borrowings +On December 10, 2012, we entered into a Master Installment Payment Agreement ("Master IPA") with PNC Bank National Association +("PNC") in which PNC will finance the Company's purchase of software and services, which may include but are not limited to third party costs to design, install and implement software systems, and +associated hardware described in the schedules defined within the Master IPA. This agreement was entered into to finance the recent implementation of a new enterprise resource planning ("ERP") system +which began in October 2012 and is estimated to continue through late 2014. The terms of the agreement consist of variable interest rates and payment terms based on amounts borrowed and timing of +activity throughout the implementation of the ERP system. +As +of December 31, 2013 and 2012, we had $16.8 million and $6.6 million, respectively, of long-term debt outstanding under five and one separate notes payable, +respectively, of which $5.1 million and $2.0 million, respectively, represent current installments. As of December 31, 2013, the notes bear +interest rates ranging from 2.45% to 2.79% and maturities ranging from September 2016 to September 2017. As this debt arrangement relates solely to the construction and implementation of an ERP system +for use by the entity, all interest expense incurred under the arrangement has been capitalized to the consolidated balance sheets until the assets are ready for intended use and will be amortized +over the useful life of the software upon that date. During the year ended December 31, 2013, we capitalized $0.3 million in interest expense related to this debt arrangement to the +consolidated balance sheets. Interest rates and payment terms are subject to changes as further financing occurs under the Master IPA. +Working Capital +As of December 31, 2013, accounts receivable increased $12.1 million, or 13.1%, to $104.4 million when compared to +December 31, 2012, which is primarily the result of higher sales year-over-year. This increase was partially offset by increased efficiency in our accounts receivable and collections +departments. Inventories decreased $2.5 million, or 1.5%, to $162.3 million as of December 31, 2013 when compared to December 31, 2012, as we conservatively managed unit +inventory and the flow product towards the end of the year. +Capital Assets +During the year ended December 31, 2013, net capital expenditures acquired, inclusive of intangible assets, increased to +$72.7 million compared to $59.5 million during the same period in 2012 primarily due to increased capitalization of our ERP implementation costs and further leasehold improvements +related to our retail store expansion. +59 +Table of Contents +We +have entered into various operating leases that require cash payments on a specified schedule. Over the next five years we are committed to make payments of approximately +$275.8 million related to our operating leases. We plan to continue to enter into operating leases related to our retail stores; however, we plan to reduce our overall retail expansion in 2014. +We also continue to evaluate cost reduction opportunities. Our evaluation of cost reduction opportunities will include an evaluation of contracts for sponsorships, operating lease contracts and other +contracts that require future minimum payments resulting in fixed operating costs. Any changes to these contracts may require early termination fees or other charges that could result in significant +cash expenditures. +Repatriation of Cash +As we are a global business, we have cash balances which are located in various countries and are denominated in various currencies. +Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in foreign currencies may have a material impact on our cash flows and capital +resources. Cash balances held in foreign countries have additional restrictions and covenants associated with them which adds increased strains on our liquidity and ability to timely access and +transfer cash balances between entities. +We +generally consider unremitted earnings of subsidiaries operating outside of the U.S. to be indefinitely reinvested; however, our board of directors recently approved a foreign cash +repatriation strategy which is intended to, along with net cash proceeds received from the recent Blackstone investment, substantially fund our previously announced $350.0 million stock +repurchase authorization. As part of this strategy, we intend to repatriate approximately $165.0 million of foreign cash by the end of 2014, of which $65.0 million was repatriated during +the three months ended December 31, 2013 and we expect the remaining $100.0 million will be repatriated by the end of 2014. Not including amounts previously accrued, we anticipate the +aggregate tax impact of our repatriation strategy to be approximately $11.7 million, which was charged against the consolidated statement of operations at December 31, 2013. +Most +of the cash balances held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal and state income taxes less applicable +foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. +Certain countries, including China, have monetary laws which may limit our ability to utilize cash resources in those countries for operations in other countries. These limitations may affect our +ability to fully utilize our cash resources for needs in the U.S. or other countries and could adversely affect our liquidity. As of December 31, 2013, we held $252.3 million of our +total $317.1 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the +$252.3 million, $15.3 million could potentially be restricted, as described above. If the remaining $237.0 million were to be immediately repatriated to the U.S., we would be +required to incur approximately $36.3 million in taxes that were not previously provided for in our consolidated statement of operations. +Contractual Obligations +In February 2011, we renewed and amended our supply agreement with Finproject S.r.l. which provides us the exclusive right to +purchase certain raw materials used to +manufacture our products. The agreement also provides that we meet minimum purchase requirements to maintain exclusivity throughout the term of the agreement, which expires December 31, 2014. +Historically, the minimum purchase requirements have not been onerous and we do not expect them to become onerous in the future. Depending on the material purchased, pricing is either based on +contracted price or is subject to quarterly reviews and fluctuates based on order volume, currency fluctuations and raw material prices. Pursuant to the agreement, we guarantee the payment for certain +third-party manufacturer +60 +Table of Contents +purchases +of these raw materials up to a maximum potential amount of €3.5 million (approximately $4.8 million as of December 31, 2013), through a letter of credit +that was issued to Finproject S.r.l. +The +following table summarizes aggregate information about our significant contractual cash obligations as of December 31, 2013: +Payments due by period +($ thousands) +Total +Less than +1 year +1 - 3 years +3 - 5 years +More than +5 years +Operating lease obligations(1) +$ +412,434 +$ +83,831 +$ +119,661 +$ +72,311 +$ +136,631 +Inventory purchase obligations with third party manufacturers(2) +172,311 +172,311 +— +— +— +Other contracts(3) +37,303 +11,775 +17,002 +8,526 +— +Estimated liability for uncertain tax positions(4) +6,376 +— +6,376 +— +— +Debt obligations(5)(8) +17,559 +5,525 +10,405 +1,629 +— +Minimum licensing royalties(6) +7,789 +3,754 +2,135 +1,900 +— +Capital lease obligations(7)(8) +101 +67 +33 +1 +— +Total +$ +653,873 +$ +277,263 +$ +155,612 +$ +84,367 +$ +136,631 +(1) Our +operating lease obligations consist of leases for retail stores, offices, warehouses, vehicles, and equipment expiring at various dates through 2033. +This balance represents the minimum cash commitment under contract to various third-parties for operating lease obligations including the effect of rent escalation clauses and deferred rent. This +balance does not include certain contingent rent clauses that may require additional rental amounts based on sales volume, inventories, etc. as these amounts are not determinable for future periods. +(2) Our +inventory purchase obligations with third party manufacturers consist of open purchase orders for footwear products. All purchase obligations with third +party manufacturers are expected to be paid within one year. +(3) Other +contracts consist of various agreements with third-party providers primarily for IT renovation and maintenance in our Niwot, CO facility and global +accounting services. +(4) Our +estimated liability for uncertain tax positions are unrecognized tax benefits taken in our income tax return that would reduce our effective tax rate, +if recognized. As of December 31, 2013, we had gross unrecognized tax benefits recorded in non-current liabilities of $31.6 million and an additional $5.0 million in gross +interest and penalties. Of the $31.6 million, we expect approximately $6.4 million to be paid within one to three years. Of the remaining $25.2 million uncertain tax liabilities, +we are unable to make a reasonable estimate of the timing of payments in individual years and therefore, such amounts are not included in the contractual cash obligations table above. +(5) We +have entered into an agreement with PNC to finance the purchase of software and services related to the implementation of our new ERP system, which began +in October 2012 and is expected to continue into late 2014. Our current debt obligations consist of five separate notes issued under the agreement, which bear interest rates ranging from 2.45% to +2.79% and maturities ranging from September 2016 to September 2017. We will continue to finance the ERP implementation on an as needed basis through this agreement. Interest rates and payment terms +are subject to change as further financing occurs. +(6) Our +minimum licensing royalties consist of usage-based payments for the right to use various licenses, trademarks and copyrights in the production of our +footwear, apparel and accessories. +61 +Table of Contents +Royalty +obligations are based on minimum guarantees under contract; however, may include additional royalty obligations based on sales volume that are not determinable for future periods. +(7) Our +capital lease obligations consist of leases for office equipment expiring at various dates through 2016. This balance represents the minimum cash +commitment under contract to various third-parties for capital lease obligations. +(8) Amounts +include anticipated interest payments. +Off-Balance Sheet Arrangements +We had no material off balance sheet arrangements as of December 31, 2013. +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of operations, outside of discussions regarding constant currency and +non-GAAP financial measures, is based on the consolidated financial statements which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make +estimates and judgments that affect the reported amounts of assets, liabilities and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during +the reporting periods. We evaluate our assumptions and estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable +under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results +may differ from these estimates under different assumptions or conditions. The following discussion pertains to accounting policies management believes are most critical to the portrayal of our +financial condition and results of operations that require management's most difficult, subjective or complex judgments. +Reserves for Uncollectible Accounts Receivable. We make ongoing estimates related to the collectability of +our accounts receivable and maintain a reserve for estimated losses resulting from the inability of our customers to make required payments. Our estimates are based on a variety of factors, including +the length of time receivables are past due, economic trends and conditions affecting our customer base, significant non-recurring events and historical write-off experience. Specific provisions are +recorded for individual receivables when we become aware of a customer's inability to meet its financial obligations. Because we cannot predict future changes in the financial stability of our +customers, actual future losses from uncollectible accounts may differ from our estimates and we may experience changes in the amount of reserves we recognize for accounts receivable that we deem +uncollectible. If the financial condition of some of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the event we determine +that a smaller or larger reserve is appropriate, we would record a credit or a charge to selling, general and administrative expenses in the period in which we made such a determination. +Sales Returns, Allowances and Discounts. We record reductions to revenue for estimated customer returns, allowances and +discounts. Our estimated +sales returns and allowances are based on customer return history and actual outstanding returns yet to be received. Provisions for customer specific discounts based on contractual obligations with +certain major customers are recorded as reductions to net sales. We may accept returns from our wholesale and distributor customers on an exception basis at the sole discretion of management for the +purpose of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, at the sole discretion of management, we may provide markdown allowances to key +wholesale and distributor customers to facilitate the "in-channel" markdown of products where we have experienced less than anticipated sell-through. We +62 +Table of Contents +also +record reductions to revenue for estimated customer credits as a result of price mark-downs in certain markets. Fluctuations in our estimates for sales returns, allowances and discounts may be +caused by many factors, including, but not limited to, fluctuations in our sales revenue and changes in demand for our products. Our judgment in determining these estimates is impacted by various +factors including customer acceptance of our new styles, customer inventory levels, shipping delays or errors, known or suspected product defects, the seasonal nature of our products and macroeconomic +factors affecting our customers. Because we cannot predict or control certain of these factors, the actual amounts of customer returns and allowances may differ from our estimates. +Inventory Valuation. Inventories are valued at the lower of cost or market. Inventory cost is determined using the moving +average cost method. At +least annually, or more frequently if events and circumstances indicate fair value is less than carrying value, we evaluate our inventory for possible impairment using standard categories to classify +inventory based on the degree to which we believe that the products may need to be discounted below cost to sell within a reasonable period. We base inventory fair value on several subjective and +unobservable assumptions including estimated future +demand and market conditions and other observable factors such as current sell-through of our products, recent changes in demand for our product, shifting demand between the products we offer, global +and regional economic conditions, historical experience selling through liquidation and "off-price" channels and the amount of inventory on hand. If the estimated inventory fair value is less than its +carrying value, the carrying value is adjusted to market value and the resulting impairment charge is recorded in cost of sales on the consolidated statements of operations. The ultimate results +achieved in selling excess and discontinued products in future periods may differ significantly from management's fair value estimates. See Note 2—Inventories in the accompanying +notes to the consolidated financial statements for additional information regarding inventory. +Impairment of Long-Lived Assets. We test long-lived assets to be held and used for impairment when events or circumstances +indicate the carrying +value of a long-lived asset may not be fully recoverable. Events that may indicate the impairment of a long-lived asset (or asset group, as defined below) include: (i) a significant decrease in +its market price, (ii) a significant adverse change in the extent or manner in which it is being used or in its physical condition, (iii) a significant adverse change in legal factors or +business climate that could affect its value, including an adverse action or assessment by a regulator, (iv) an accumulation of costs significantly in excess of the amount originally expected +for its acquisition or construction, (v) its current period operating or cash flow losses combined with historical operating or cash flow losses or a forecast of its cash flows demonstrate +continuing losses associated with its use, and (vi) a current expectation that, more likely than not, it will be sold or otherwise disposed of significantly before the end of its previously +estimated useful life. If such facts indicate a potential impairment of a long-lived asset (or asset group), we assess the recoverability by determining if its carrying value exceeds the sum of its +projected undiscounted cash flows expected from its use and eventual disposition over its remaining economic life. If the asset is not supported on an undiscounted cash flow basis, the amount of +impairment is measured as the difference between its carrying value and its fair value. Assets held for sale are reported at the lower of the carrying amount or fair value less costs to sell. Fair +value is determined by independent third party appraisals, the net present value of expected cash flows, or other valuation techniques as appropriate. Assets to be abandoned or from which no further +benefit is expected are written down to zero at the time that the determination is made and the assets are removed entirely from service. +An +asset group is the lowest level of assets and liabilities for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. For assets +involved in our retail business, our asset group is at the retail store level. Our estimates of future cash flows over the remaining useful life of the asset group are based on management's operating +budgets and forecasts. These budgets and forecasts take into consideration inputs from our regional management related to growth rates, pricing, new markets and other factors expected to affect the +business, as well as +63 +Table of Contents +management's +forecasts for inventory, receivables, capital spending, and other cash needs. These considerations and expectations are inherently uncertain, and estimates included in our operating +forecasts beyond a three to six month future period are extremely subjective. Accordingly, actual cash flows may differ significantly from our estimated future cash flows. +Impairment +charges are driven by, among other things, changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product and +other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets and result in impairment charges in future periods. Significant +impairment charges recognized during a reporting period could have an adverse effect on our reported financial results. +Impairment of Goodwill & Intangible Assets. Intangible assets with indefinite lives (i.e. goodwill) are evaluated +for impairment when +events or changes in circumstances indicate that the carrying value may not be fully recoverable and, at least, annually. Intangible assets that are determined to have definite lives, such as customer +relationships, core technology, capitalized software, patents and non-compete agreements are amortized over their useful lives and are evaluated for impairment only when events or circumstances +indicate a carrying value may not be fully recoverable. Recoverability is based on the estimated future discounted cash flows of an asset. If the asset is not supported on a discounted cash flow +basis, the amount of impairment is measured as the difference between its carrying value and its fair value. Determination of the fair value of indefinite lived intangible assets involves a number of +management assumptions including the expected future operating performance of our reporting units which may change in future periods due to technological changes, economic conditions, changes to our +business operations, or the inability to meet business plans, among other things. The valuation is sensitive to the actual results of any of these uncertain factors which could be negatively affected +and may result in additional impairment charges should the actual results differ from management's estimates. See Note 4—Goodwill & Intangible Assets, in the accompanying +notes to the consolidated financial statements for additional information regarding our intangible assets. +Share-based Compensation. We estimate the fair value of our stock option awards using a Black Scholes valuation model, the inputs +of which require +various assumptions including the expected volatility of our stock price and the expected life of the option. The expected volatility assumptions are derived using our historical stock price +volatility and the historical volatilities of competitors whose shares are traded in the public markets. These assumptions reflect our best estimates, however; they involve inherent uncertainties +based on market conditions generally outside of our control. If factors change and we use a different methodology for deriving the Black Scholes assumptions, our share- based compensation expense may +differ materially in the future from that recorded in the current period. Additionally, we make certain estimates about the number of awards which will be made under performance based incentive plans. +As a result, if other assumptions or estimates had been used, share-based compensation expense could have been materially impacted. Furthermore, if we use different assumptions in future periods, +share-based compensation expense could be materially impacted in future periods. See Note 9—Equity in the accompanying notes to the consolidated financial statements for additional +information regarding our share-based compensation. +Income Taxes. We account for income taxes using the asset and liability method which requires the recognition of deferred tax +assets and liabilities +for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future +enacted tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures +regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not of being sustained upon examination by the relevant taxing authority must be +recognized at the largest amount that is more +64 +Table of Contents +likely +than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. Interest expense is recognized on the +full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the +application of the law is complex and often ambiguous. +Our +annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is +required in determining our annual tax expense and in evaluating our tax positions. Tax laws require items to be included in our tax returns at different times than when these items are reflected in +the consolidated financial statements. As a result, the annual tax rate reflected in our consolidated financial statements is different than that reported in our tax return (our cash tax rate). Some +of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create +deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax basis of assets and liabilities. The tax +rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year in which the differences are expected to reverse. Based on the evaluation of all available +information, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. +We +evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating +results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to +be established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. Undistributed earnings of a subsidiary +are accounted for as a temporary difference, except that deferred tax liabilities are not recorded for undistributed earnings of a foreign subsidiary that are deemed to be indefinitely reinvested in +the foreign jurisdiction. We have operated under a specific plan for reinvestment of undistributed earnings of our foreign subsidiaries which demonstrates that such earnings will be indefinitely +reinvested in the applicable tax jurisdictions. +Should we change our plans, we would be required to record a significant amount of deferred tax liabilities. We recognize interest and penalties related to unrecognized tax benefits within the "Income +tax expense" line in the accompanying consolidated statement of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheets. See +Note 11—Income Taxes in the accompanying notes to the consolidated financial statements for additional information regarding our income taxes. +Recent Accounting Pronouncements. See Note 1—Organization and Summary of Significant Accounting Policies in the +accompanying notes +to the consolidated financial statements for recently adopted and issued accounting pronouncements. +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall +financing strategies. Our exposure to market risk includes interest rate fluctuations in connection with our revolving credit facility and certain financial instruments. In addition to the revolving +credit facility, we have incurred short- and long-term indebtedness related to the implementation of our ERP system. Borrowings under these debt instruments bear fixed interest rates and therefore, do +not have the potential for market risk. +65 +Table of Contents +Borrowings +under the revolving credit facility bear interest at a variable rate. For domestic rate loans, the interest rate is equal to the highest of (i) the daily federal funds +open rate as quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC's prime rate and (iii) a daily LIBOR rate plus 1.0%, in each case there is an additional margin ranging from +0.25% to 1.00% based on certain conditions. For +LIBOR rate loans, the interest rate is equal to a LIBOR rate plus a margin ranging from 1.25% to 2.00% based on certain conditions. Borrowings under the revolving credit facility are therefore subject +to risk based upon prevailing market interest rates. Interest rates fluctuate as a result of many factors, including governmental monetary and tax policies, domestic and international economic and +political considerations and other factors that are beyond our control. During the year ended December 31, 2013, the maximum daily amount borrowed under the revolving credit facility was +$5.0 million and the average daily amount of borrowings outstanding was $0.1 million. As of December 31, 2013, there were no borrowings outstanding under the revolving credit +facility. If the prevailing market interest rates relative to these borrowings increased by 10% during the year ended December 31, 2013, our interest expense would not have increased +materially. +We +additionally hold cash equivalents including certificate of deposits, time deposits and money market funds. Interest income generated from these cash equivalents will fluctuate with +the general level of interest rates. As of December, 2013, we held $37.9 million in cash equivalents subject to variable interest rates. If the prevailing market interest rates relative to +these investments increased 10% during the year ended December 31, 2013, interest income would have increased by approximately $0.2 million. +Foreign Currency Exchange Risk +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. We pay the majority +of expenses attributable to our foreign operations in the functional currency of the country in which such operations are conducted and pay the majority of our overseas third-party manufacturers in +U.S. Dollars. Our ability to sell our products in foreign markets and the U.S. Dollar value of the sales made in foreign currencies can be significantly influenced by foreign currency fluctuations. +Fluctuations in the value of foreign currencies relative to the U.S. Dollar could result in downward price pressure for our products and increase losses from currency exchange rates. An increase of 1% +in value of the U.S. Dollar relative to foreign currencies would have decreased income before taxes during the year ended December 31, 2013 by approximately $1.4 million. The volatility +of the applicable exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. In the event our foreign sales and purchases increase and are denominated in currencies +other than the U.S. Dollar, our operating results may be affected by fluctuations in the exchange rate of currencies we receive for such sales. See Item 7, "Management's Discussion and Analysis +of Financial Condition and Results of Operations," for a discussion of the impact of foreign exchange rate variances experienced during the years ended December 31, 2013 and 2012. +We +transact business in various foreign countries and are therefore exposed to foreign currency exchange rate risk inherent in revenues, costs, and monetary assets and liabilities +denominated in non-functional currencies. We have entered into foreign currency exchange forward contracts and currency swap derivative instruments to selectively protect against volatility in the +value of non-functional currency denominated monetary assets and liabilities, and of future cash flows caused by changes in foreign currency exchange rates. +The +following table summarizes the notional amounts of the outstanding foreign currency exchange contracts at December 31, 2013 and 2012. The notional amounts of the derivative +financial instruments shown below are denominated in their U.S. dollar equivalents and represent the amount of all contracts of the foreign currency specified. These notional values do not necessarily +represent amounts +66 +Table of Contents +exchanged +by the parties and, therefore, are not a direct measure of our exposure to the foreign currency exchange risks. +December 31, +($ thousands) +2013 +2012 +Foreign currency exchange forward contracts by currency: +Japanese Yen +$ 68,707 +$112,500 +Euro +38,577 +5,159 +Singapore Dollar +28,225 +— +Mexican Peso +18,350 +11,400 +Russian Ruble +17,588 +— +Pound Sterling +15,487 +8,742 +South Korean Won +12,100 +— +Australian Dollar +4,941 +4,178 +New Taiwan Dollar +3,463 +— +Canadian Dollar +3,428 +— +South African Rand +3,076 +— +Indian Rupee +2,150 +— +Hong Kong Dollar +1,844 +— +Swedish Krona +1,615 +— +New Zealand Dollar +943 +1,137 +Total notional value, net +$220,494 +$143,116 +Latest maturity date +December 2015 +December 2015 +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the index to consolidated financial statements on +page F-1. +ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial +Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange +Act, as of December 31, 2013 (the "Evaluation Date"). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the Evaluation Date, our disclosure +controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission ("SEC") +reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, +including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. +67 +Table of Contents +Management's Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange +Act Rules 13a-15(f) and 15d-15(f). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2013, using the criteria set forth in the Internal +Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on +this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2013. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued a report on our internal control over financial reporting, which is included herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially +affected, or is reasonably likely to materially affect, our internal control over financial reporting. +68 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the Company) as of December 31, 2013, based on criteria established in Internal Control—Integrated Framework +(1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's +management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the +accompanying "Management's Annual Report on +Internal Control Over Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control +over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or +persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting +and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those +policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material +misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to +future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In +our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control—Integrated Framework +(1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year +ended December 31, 2013 of the Company and our report dated February 25, 2014 expressed an unqualified opinion on those financial statements. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +February 25, 2014 +69 +Table of Contents +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2014 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2013. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer, principal +financial officer, principal accounting officer and controller. A copy of our business code of conduct and ethics policy is available on our website: www.crocs.com. We are required to disclose certain +changes to, or waivers from, our code of ethics for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our business code of conduct +and ethics policy as permitted by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2014 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2013. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2014 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2013, with the exception of those items listed below. +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, we reserved 4.1 million shares of common stock for future issuance on exercise of outstanding +options and rights under equity compensation plans as of December 31, 2013. +Plan Category +Number of +Securities to be Issued +on Exercise of +Outstanding +Options and Rights +Weighted Average +Exercise Price of +Outstanding +Options(2) +Number of Securities +Remaining Available +for Future +Issuance Under +Plans, Excluding +Securities Available +in First Column +Equity compensation plans approved by stockholders(1) +4,070,819 +$ +13.34 +4,421,428 +Equity compensation plans not approved by stockholders +— +— +— +Total +4,070,819 +$ +13.34 +4,421,428 +(1) On +July 9, 2007, at the annual stockholders' meeting, our stockholders approved the 2007 Equity Incentive Plan (the "2007 Plan"), which previously +had been approved by our board of directors and which became effective as of July 19, 2007. On June 28, 2011, our stockholders approved an amendment to the 2007 Plan to increase the +number of shares of our common stock available for issuance from 9.0 million shares to 15.3 million shares, subject to adjustment for future stock splits, stock dividends and similar +changes in our capitalization. On April 27, 2005, our board of directors +70 +Table of Contents +adopted +the 2005 Equity Incentive Plan (the "2005 Plan"). On January 10, 2006, our board of directors amended the 2005 Plan to increase the number of shares of our common stock available for +issuance under the 2005 Plan from 11.7 million shares to 14.0 million shares. Following the adoption of the 2007 Plan, no additional grants were made under the 2005 Plan. +(2) The +weighted average exercise price of outstanding options pertains only to 2.1 million shares issuable on the exercise of outstanding options and +rights. +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2014 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2013. +ITEM 14. Principal Accountant Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2014 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2013. +71 +Table of Contents +PART IV +ITEM 15. Exhibits and Financial Statement Schedules +(1) Financial Statements +The +financial statements filed as part of this report are listed on the index to the consolidated financial statements on page F-1. +(2) Financial Statement Schedules +All +financial statement schedules have been omitted because they are not required, are not applicable or the information is included in the Financial Statements or Notes thereto. +72 +Table of Contents +(3) Exhibit list +Exhibit +Number +Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File +No. 333-132312)). +3.1 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 12, +2007). +3.2 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File +No. 333-132312)). +3.3 +Certificate of Designations of Series A Convertible Preferred Stock of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on +January 27, 2014). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +10.1 +* +Form of Indemnification Agreement between Crocs, Inc. and each of its directors and executive officers (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.2 +* +Crocs, Inc. 2005 Equity Incentive Plan (the "2005 Plan") (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.3 +* +Amendment No. 1 to the 2005 Plan (incorporated herein by reference to Exhibit 10.2.2 to Crocs, Inc.'s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +10.4 +* +Form of Notice of Grant of Stock Option under the 2005 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.5 +* +Form of Notice of Grant of Stock Option for Non-Exempt Employees under the 2005 Plan (incorporated herein by reference to Exhibit 10.4 to Crocs, Inc.'s Registration Statement on Form S-1, filed on +August 15, 2005 (File No. 333-127526)). +10.6 +* +Form of Stock Purchase Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.5 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.7 +* +Form of Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.6 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.8 +* +Form of Restricted Stock Award Grant Notice under the 2005 Plan (incorporated herein by reference to Exhibit 10.7 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +73 +Table of Contents +Exhibit +Number +Description +10.9 +* +Form of Restricted Stock Award Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.8 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.10 +* +Form of Non Statutory Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.9 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 +(File No. 333-127526)). +10.11 +* +Crocs, Inc. 2011 Board of Directors Compensation Plan. +10.12 +* +Crocs, Inc. Amended and Restated 2007 Senior Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.15 to Crocs, Inc.'s Annual Report on Form 10-K, filed on +March 17, 2009). +10.14 +* +2008 Cash Incentive Plan (As Amended and Restated Effective June 4, 2012) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on June 7, +2012). +10.15 +* +Crocs, Inc. 2007 Equity Incentive Plan (As Amended and Restated) (the "2007 Plan") (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on +July 1, 2011). +10.16 +* +Form of Incentive Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, +2007). +10.17 +* +Form of Non-Statutory Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, +2007). +10.18 +* +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on +November 14, 2007). +10.19 +* +Form of Restricted Stock Unit Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 1, 2011). +10.20 +* +Employment Agreement, dated February 9, 2009, between Crocs, Inc. and John McCarvel (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on +February 13, 2009). +10.21 +* +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on August 5, +2010). +10.22 +Amended and Restated Credit Agreement, dated December 16, 2011, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and PNC Bank, +National Association, as a lender and administrative agent for the lenders (the "Amended and Restated Credit Agreement") (incorporated herein by reference to Crocs, Inc.'s Current Report on Form 8-K, filed on December 19, +2011). +74 +Table of Contents +Exhibit +Number +Description +10.23 +First Amendment to the Amended and Restated Credit Agreement, dated December 10, 2012, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named +therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Crocs, Inc.'s Current Report on Form 8-K, filed on December 11, 2012). +10.24 +Second Amendment to Amended and Restated Credit Agreement, dated June 12, 2013, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named +therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on July 30, 2013). +10.25 +Third Amendment to Amended and Restated Credit Agreement, dated December 27, 2013, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named +therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on December 30, 2013). +10.26 +Master Installment Payment Agreement, dated December 10, 2012, among Crocs, Inc. the lender named therein and PNC Bank National Association, as a lender and administrative agent (incorporated herein by +reference to Exhibit 10.24 to Crocs, Inc.'s Annual Report on Form 10-K, filed on February 25, 2013). +10.27 +* +Crocs, Inc. 2013 Change in Control Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on June 18, 2013). +10.28 +Investment Agreement, dated December 28, 2013, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on +Form 8-K, filed on December 30, 2013). +10.29 +First Amendment to Investment Agreement, dated January 27, 2014, between Crocs, Inc. and Blackstone Capital Partners VI L.P. (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s +Current Report on Form 8-K, filed on January 27, 2014). +10.29 +* +Separation Agreement, dated December 27, 2013, between Crocs, Inc. and John P. McCarvel (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Current Report on Form 8-K, filed on +December 30, 2013). +10.30 +* +Form Severance Agreement (incorporated herein by reference to Exhibit 10.4 to Crocs, Inc.'s Current Report on Form 8-K, filed on December 30, 2013). +10.31 +Registration Rights Agreement, dated January 27. 2014 (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on January 27, 2014). +21 +† +Subsidiaries of the registrant. +23.1 +† +Consent of Deloitte & Touche LLP. +31.1 +† +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2 +† +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes- Oxley +Act. +75 +Table of Contents +Exhibit +Number +Description +32 +† +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +101.INS +† +XBRL Instance Document +101.SCH +† +XBRL Taxonomy Extension Schema Document +101.CAL +† +XBRL Taxonomy Extension Calculation Linkbase Document +101.DEF +† +XBRL Taxonomy Extension Definition Linkbase Document +101.LAB +† +XBRL Taxonomy Extension Label Linkbase Document +101.PRE +† +XBRL Taxonomy Extension Presentation Linkbase Document +* Compensatory +plan or arrangement +† Filed +herewith. +76 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) 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, as of February 25, 2014. +CROCS, INC. +a Delaware Corporation +By: +/s/ JOHN P. MCCARVEL +Name: +John P. McCarvel +Title: +President and Chief Executive Officer +Pursuant +to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on +the dates indicated. +Signature +Title +Date +/s/ JOHN P. MCCARVEL +John P. McCarvel +President, Chief Executive Officer and Director +February 25, 2014 +/s/ JEFFREY J. LASHER +Jeffrey J. Lasher +Senior Vice President—Finance, Chief Financial Officer +February 25, 2014 +/s/ RAYMOND D. CROGHAN +Raymond D. Croghan +Director +February 25, 2014 +/s/ RONALD L. FRASCH +Ronald L. Frasch +Director +February 25, 2014 +/s/ PETER A. JACOBI +Peter A. Jacobi +Director +February 25, 2014 +/s/ PRAKASH A. MELWANI +Prakash A. Melwani +Director +February 25, 2014 +/s/ GREGG S. RIBATT +Gregg S. Ribatt +Director +February 25, 2014 +77 +Table of Contents +Signature +Title +Date +/s/ THOMAS J. SMACH +Thomas J. Smach +Chairman of the Board +February 25, 2014 +/s/ DOREEN A. WRIGHT +Doreen A. Wright +Director +February 25, 2014 +78 +Table of Contents +INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm +F-2 +Consolidated Statements of Operations for the Years Ended December 31, 2013, 2012 and 2011 +F-3 +Consolidated Statements of Comprehensive Income as of December 31, 2013, 2012 and 2011 +F-4 +Consolidated Balance Sheets as of December 31, 2013 and 2012 +F-5 +Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2013, 2012 and 2011 +F-6 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2013, 2012 and 2011 +F-7 +Notes to Consolidated Financial Statements +F-8 +F-1 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2013 and 2012 and the related consolidated +statements of operations, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2013. These financial statements are the +responsibility of the Company's +management. Our responsibility is to express an opinion on the financial statements based on our audits. +We +conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in +the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement +presentation. We believe that our audits provide a reasonable basis for our opinion. +In +our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Crocs, Inc. and subsidiaries as of December 31, +2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally +accepted in the United States of America. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of +December 31, 2013, based on the criteria established in Internal Control—Integrated Framework (1992) issued by the Committee of +Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2014 expressed an unqualified opinion on the Company's internal control over financial reporting. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +February 25, 2014 +F-2 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +Year Ended December 31, +($ thousands, except per share data) +2013 +2012 +2011 +Revenues +$ +1,192,680 +$ +1,123,301 +$ +1,000,903 +Cost of sales +569,482 +515,324 +464,493 +Gross profit +623,198 +607,977 +536,410 +Selling, general and administrative expenses +549,154 +460,393 +404,803 +Asset impairment charges +10,949 +1,410 +528 +Income from operations +63,095 +146,174 +131,079 +Foreign currency transaction (gains) losses, net +4,678 +2,500 +(4,886 +) +Interest income +(2,432 +) +(1,697 +) +(957 +) +Interest expense +1,016 +837 +853 +Other income, net +(126 +) +(1,014 +) +(621 +) +Income before income taxes +59,959 +145,548 +136,690 +Income tax expense +49,539 +14,205 +23,902 +Net income +$ +10,420 +$ +131,343 +$ +112,788 +Net income per common share (Note 12): +Basic +$ +0.12 +$ +1.46 +$ +1.27 +Diluted +$ +0.12 +$ +1.44 +$ +1.24 +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +December 31, +($ thousands) +2013 +2012 +2011 +Net income +$ +10,420 +$ +131,343 +$ +112,788 +Other comprehensive income (loss): +Foreign currency translation +(5,335 +) +5,525 +(16,031 +) +Reclassification of cumulative foreign exchange translation adjustments to net income, net of tax of $(3), $7 and $0, respectively +299 +(658 +) +— +Total comprehensive income +$ +5,384 +$ +136,210 +$ +96,757 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +($ thousands, except number of shares) +2013 +2012 +ASSETS +Current assets: +Cash and cash equivalents +$ +317,144 +$ +294,348 +Accounts receivable, net of allowances of $10,513 and $13,315, respectively +104,405 +92,278 +Inventories +162,341 +164,804 +Deferred tax assets, net +4,440 +6,284 +Income tax receivable +10,630 +5,613 +Other receivables +11,942 +24,821 +Prepaid expenses and other current assets +29,175 +24,967 +Total current assets +640,077 +613,115 +Property and equipment, net +86,971 +82,241 +Intangible assets, net +74,822 +59,931 +Deferred tax assets, net +19,628 +34,112 +Other assets +53,661 +40,239 +Total assets +$ +875,159 +$ +829,638 +LIABILITIES AND STOCKHOLDERS' EQUITY +Current liabilities: +Accounts payable +$ +57,450 +$ +63,976 +Accrued expenses and other current liabilities +97,111 +81,371 +Deferred tax liabilities, net +11,199 +2,405 +Income taxes payable +15,992 +8,147 +Current portion of long-term borrowings and capital lease obligations +5,176 +2,039 +Total current liabilities +186,928 +157,938 +Long term income tax payable +36,616 +36,343 +Long-term borrowings and capital lease obligations +11,670 +4,596 +Other liabilities +15,201 +13,361 +Total liabilities +250,415 +212,238 +Commitments and contingencies (Note 13) +Stockholders' equity: +Preferred shares, par value $0.001 per share, 5,000,000 shares authorized, none outstanding +— +— +Common shares, par value $0.001 per share, 250,000,000 shares authorized, 91,662,656 and 88,450,203 shares issued and outstanding, respectively, at +December 31, 2013 and 91,047,297 and 88,662,845 shares issued and outstanding, respectively, at December 31, 2012 +92 +91 +Treasury stock, at cost, 3,212,453 and 2,384,452 shares, respectively +(55,964 +) +(44,214 +) +Additional paid-in capital +321,532 +307,823 +Retained earnings +344,432 +334,012 +Accumulated other comprehensive income +14,652 +19,688 +Total stockholders' equity +624,744 +617,400 +Total liabilities and stockholders' equity +$ +875,159 +$ +829,638 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY +Common Stock +Treasury Stock +Accumulated +Other +Comprehensive +Income +Total +Stock +Holders' +Equity +Additional +Paid in +Capital +Retained +Earnings +($ thousands) +Shares +Amount +Shares +Amount +BALANCE—January 1, 2011 +88,066 +$ +88 +535 +$ +(22,008 +) +$ +277,293 +$ +89,881 +$ +30,852 +$ +376,106 +Amortization of stock compensation +— +— +— +— +8,928 +— +— +8,928 +Forfeitures +(149 +) +— +— +— +(435 +) +— +— +(435 +) +Exercises of stock options and issuance of restricted stock awards +1,912 +2 +(58 +) +2,739 +8,173 +— +— +10,914 +Repurchase of common stock for tax withholding +(22 +) +— +22 +(490 +) +— +— +— +(490 +) +Net income +— +— +— +— +— +112,788 +— +112,788 +Foreign currency translation +— +— +— +— +— +— +(16,031 +) +(16,031 +) +BALANCE—December 31, 2011 +89,807 +$ +90 +499 +$ +(19,759 +) +$ +293,959 +$ +202,669 +$ +14,821 +$ +491,780 +Amortization of stock compensation +— +— +— +— +11,764 +— +— +11,764 +Forfeitures +(43 +) +— +— +— +(493 +) +— +— +(493 +) +Exercises of stock options and issuance of restricted stock awards +783 +1 +(29 +) +1,112 +2,593 +— +— +3,706 +Repurchase of common stock for tax withholding +— +— +30 +(493 +) +— +— +— +(493 +) +Purchase of treasury stock +(1,884 +) +— +1,884 +(25,074 +) +— +— +— +(25,074 +) +Net income +— +— +— +— +— +131,343 +— +131,343 +Foreign currency translation +— +— +— +— +— +— +5,525 +5,525 +Reclassification of cumulative foreign exchange translation adjustments to net income +— +— +— +— +— +— +(658 +) +(658 +) +BALANCE—December 31, 2012 +88,663 +$ +91 +2,384 +$ +(44,214 +) +$ +307,823 +$ +334,012 +$ +19,688 +$ +617,400 +Amortization of stock compensation +— +— +— +— +14,483 +— +— +14,483 +Forfeitures +(78 +) +— +— +— +(2,014 +) +— +— +(2,014 +) +Exercises of stock options and issuance of restricted stock awards +715 +1 +(22 +) +1,039 +1,240 +— +— +2,280 +Repurchase of common stock for tax withholding +(16 +) +— +16 +(256 +) +— +— +— +(256 +) +Purchase of treasury stock +(834 +) +— +834 +(12,533 +) +— +— +— +(12,533 +) +Net income +— +— +— +— +— +10,420 +— +10,420 +Foreign currency translation +— +— +— +— +— +— +(5,335 +) +(5,335 +) +Reclassification of cumulative foreign exchange translation adjustments to net income +— +— +— +— +— +— +299 +299 +BALANCE—December 31, 2013 +88,450 +$ +92 +3,212 +$ +(55,964 +) +$ +321,532 +$ +344,432 +$ +14,652 +$ +624,744 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +($ thousands) +2013 +2012 +2011 +Cash flows from operating activities: +Net income +$ +10,420 +$ +131,343 +112,788 +Adjustments to reconcile net income to net cash provided by operating activities: +Depreciation and amortization +41,506 +36,694 +37,263 +Unrealized (gain) loss on foreign exchange, net +(6,420 +) +13,928 +(11,892 +) +Deferred income taxes +23,536 +(2,981 +) +(819 +) +Asset impairment charges +10,949 +1,410 +528 +Provision for (recovery of) doubtful accounts, net +1,930 +2,166 +(383 +) +Share-based compensation +11,871 +11,321 +8,550 +Inventory write-down charges +3,419 +— +— +Other non-cash items +1,193 +1,725 +1,845 +Changes in operating assets and liabilities: +Accounts receivable +(17,166 +) +(9,475 +) +(23,278 +) +Inventories +(5,274 +) +(35,493 +) +(13,328 +) +Prepaid expenses and other assets +(4,225 +) +(25,490 +) +(17,598 +) +Accounts payable +(5,740 +) +99 +30,314 +Accrued expenses and other liabilities +14,256 +8,016 +19,922 +Accrued restructuring +— +— +(439 +) +Income taxes +3,209 +(4,907 +) +(1,097 +) +Cash provided by operating activities +83,464 +128,356 +142,376 +Cash flows from investing activities: +Cash paid for purchases of property and equipment +(40,424 +) +(39,762 +) +(27,718 +) +Proceeds from disposal of property and equipment +250 +2,216 +319 +Cash paid for intangible assets +(28,404 +) +(21,074 +) +(13,922 +) +Business acquisitions, net of cash +— +(5,169 +) +— +Restricted cash +(1,180 +) +(2,154 +) +(343 +) +Cash used in investing activities +(69,758 +) +(65,943 +) +(41,664 +) +Cash flows from financing activities: +Proceeds from bank borrowings +23,375 +96,086 +316,595 +Repayment of bank borrowings and capital lease obligations +(13,160 +) +(90,625 +) +(317,704 +) +Deferred debt issuance costs +(100 +) +(225 +) +(398 +) +Deferred offering costs +(767 +) +— +— +Issuances of common stock +2,280 +3,706 +10,914 +Purchase of treasury stock +(12,533 +) +(25,074 +) +— +Repurchase of common stock for tax withholding +(256 +) +(493 +) +(490 +) +Cash provided by (used in) financing activities +(1,161 +) +(16,625 +) +8,917 +Effect of exchange rate changes on cash +10,251 +(9,027 +) +2,375 +Net increase in cash and cash equivalents +22,796 +36,761 +112,004 +Cash and cash equivalents—beginning of period +294,348 +257,587 +145,583 +Cash and cash equivalents—end of period +$ +317,144 +$ +294,348 +$ +257,587 +Supplemental disclosure of cash flow information—cash paid during the period for: +Interest +$ +693 +$ +619 +843 +Income taxes +$ +20,274 +$ +29,385 +26,632 +Supplemental disclosure of non-cash, investing, and financing activities: +Assets acquired under capitalized leases +$ +61 +$ +34 +— +Accrued purchases of property and equipment +$ +2,165 +$ +2,368 +4,022 +Accrued purchases of intangibles +$ +4,742 +$ +768 +223 +The accompanying notes are an integral part of these consolidated financial statements. +F-7 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Organization —Crocs, Inc. and its subsidiaries (collectively the "Company," "we," "our" or "us") are engaged in the design, development, +manufacturing, marketing and distribution of footwear, apparel and accessories for men, women and children. +Basis of Consolidation —The consolidated financial statements and accompanying notes have been prepared in accordance with accounting principles +generally accepted in the United States of America ("U.S. GAAP"). The consolidated financial statements include the accounts of our wholly-owned subsidiaries as well as variable interest +entities ("VIE") for which we are the primary beneficiary after the elimination of intercompany accounts and transactions. The primary beneficiary of a VIE is the entity that has (i) the power +to direct the activities of the VIE that most significantly impact the VIE's economic performance and (ii) the obligation to absorb losses of the VIE that could potentially be significant to +the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. +In +2007, we established a relationship with Shanghai Shengyiguan Trade, Ltd Co ("ST") for the purpose of serving as a distributor of our products in the People's Republic of +China. We had previously +determined that ST was a VIE for which we were the primary beneficiary and consequently it was consolidated as if a wholly-owned subsidiary. On March 15, 2012, we exercised an Equity Option +Agreement that we had in place with ST and became the sole owner of ST. +In +April 2011, we and an unrelated third party formed Crocs Gulf, LLC ("Crocs Gulf") for the purpose of selling our products in the United Arab Emirates. We have determined that +Crocs Gulf is a VIE for which we are the primary beneficiary due to our variable interest in Crocs Gulf's equity and because we currently control all of the VIE's business activities and will absorb +all of its expected residual returns and expected losses. All voting and dividend rights have been assigned to us. As of December 31, 2013 and 2012, the consolidated financial statements +included $2.4 million and $2.5 million in total assets of Crocs Gulf, respectively, which primarily consisted of cash and cash equivalents, inventory, property and equipment. The total +assets as of each of December 31, 2013 and 2012 were partially offset by $0.2 million in total liabilities, which primarily consisted of accounts payable and accrued expenses, excluding +liabilities related to the support provided by us. +Noncontrolling Interests —As of December 31, 2013, all of our subsidiaries were, in substance, wholly owned. +Concentrations of Risk —We are exposed to concentrations of risks in the following categories: +Cash and cash equivalents— Our cash and cash equivalents are maintained in several different financial institutions in amounts that typically exceed +U.S. federally insured +limits or in financial institutions in international jurisdictions where insurance is not provided and restrictions may exist. +As +we are a global business, we have cash and cash equivalent balances which are located in various countries and are denominated in various currencies. Most of the cash balances held +outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal and state income taxes less applicable foreign tax credits. In some countries, +repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. Certain countries, including China, have +monetary laws which may limit our ability to utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully utilize our cash and +F-8 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +cash +equivalent resources for needs in the U.S. or other countries and could adversely affect our liquidity. As of December 31, 2013, we held $252.3 million of our total +$317.1 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the +$252.3 million held in international locations, $15.3 million could potentially be restricted, as described above. +On +January 27, 2014, we issued to Blackstone Capital Partners VI L.P. ("Blackstone"), and certain of its permitted transferees (together with Blackstone, the "Blackstone +Purchasers"), 200,000 shares of our Series A Preferred Stock. In return, we received approximately $182.2 million in cash proceeds (net of related expenses) all of which is held in the +U.S. See Note 17—Subsequent Events for further detail regarding the investment agreement. +Accounts receivable— We have not experienced any significant losses in such accounts and believe we are not exposed to significant credit risk. We +consider any +concentration of credit risk related to accounts receivable to be mitigated by our credit policy, the insignificance of outstanding balances owed by each individual customer at any point in time and +the geographic dispersion of our customers. +Manufacturing sources— We rely on a limited source of internal and external manufacturers. Establishing a replacement source could require significant +additional time and +expense. +Suppliers of certain raw materials— We source the elastomer resins that constitute the primary raw materials used in compounding Croslite, which we use +to produce our footwear products, +from multiple suppliers. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid +interruption of our production cycle, if at all. We may also have to pay materially higher prices in the future for the elastomer resins or any substitute materials we use, which would increase our +production costs and could have a materially adverse impact on our margins and results of operations. +Reclassifications —Certain prior period amounts presented in the consolidated financial statements have been reclassified to conform to current +period +presentation as follows. +Management Estimates —The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates, judgments +and +assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Management +believes that the estimates, judgments and assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, sales returns, impairment +assessments and charges, recoverability of assets (including deferred tax assets), uncertain tax positions, share-based compensation expense, the assessment of lower of cost or market on inventory, +useful lives assigned to long-lived assets, depreciation and provisions for contingencies are reasonable based on information available at the time they are made. Management also makes estimates in +the assessments of potential losses in relation to tax and customs matters and threatened or pending legal proceedings (see Note 13—Commitments & Contingencies and +Note 15—Legal Proceedings). Actual results could materially differ from these estimates. For matters not related to income taxes, if a loss is considered probable and the amount can +be reasonably estimated, we recognize an expense for the estimated loss. If there is the potential to recover a portion +F-9 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +of +the estimated loss from a third party, we make a separate assessment of recoverability and reduce the estimated loss if recovery is deemed probable. +Accumulated Other Comprehensive Income —Activity within our accumulated other comprehensive income ("AOCI") balance consists solely of gains and +losses +resulting from the translation of foreign subsidiary financial statements to our reporting currency. Foreign currency translation resulting in changes to other comprehensive income and related +reclassification adjustments are presented net of tax effects on the consolidated statements of other comprehensive income. Foreign currency reclassification adjustments are included within the line +item entitled 'Foreign currency transaction gains (losses), net' on the consolidated statements of operations. +Fair Value —Fair value is the price that would be received from the sale of an asset or transfer of a liability in an orderly transaction between +market participants at the measurement date. +When determining the fair value measurements for assets and liabilities which are required to be recorded at fair value, we consider the principal or most advantageous market in which a hypothetical +sale or transfer would take place and consider assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of +non-performance. +The +fair value hierarchy is made up of three levels of inputs which may be used to measure fair value: +Level 1—observable +inputs such as quoted prices for identical instruments in active markets; +Level 2—observable +inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not +active and model derived valuations in which all significant inputs are observable in active markets; and +Level 3—unobservable +inputs for which there is little or no market data and which require us to develop our own assumptions. We categorize fair value measurements +within the fair value hierarchy based upon the lowest level of the most significant inputs used to determine such fair value measurement. +Cash +equivalents primarily include time deposits and certificates of deposit with original maturities of three months or less. Time deposits and certificates of deposit included in cash +equivalents are valued at amortized cost, which approximates fair value. These investments have been classified as a Level 1 measurement. +Derivative +financial instruments are required to be recorded at their fair value, on a recurring basis. The fair values of our derivative instruments are determined using a discounted +cash flow valuation model. The significant inputs used in the model are readily available in public markets or can be derived from observable market transactions, and therefore, have been classified +as Level 2. These inputs include the applicable exchange rates and forward rates, and discount rates based on the prevailing LIBOR deposit rates. +Our +other financial instruments are not required to be carried at fair value on a recurring basis. The carrying value of these financial instruments, including cash equivalents, accounts +receivable, accounts payable and accrued liabilities, approximates fair value due to their short maturities. Based on borrowing rates currently available to us, with similar terms, the carrying values +of capital lease obligations and the line of credit approximate their fair values. +F-10 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Inventories +and long-lived assets such as property and equipment and intangible assets are also not required to be carried at fair value on a recurring basis. For a discussion of +inventory estimated fair value see "Inventory Valuation" below. However, when determining impairment losses, the fair values of property and equipment and intangibles must be determined. For such +determination, we generally use either an income approach with inputs that are mainly unobservable, such as expected future cash flows, or a market approach using observable inputs such as replacement +cost or third party appraisals, as appropriate. Estimated future cash flows are based on management's operating budgets and forecasts which take into consideration both observable and unobservable +inputs including growth rates, pricing, new markets and other factors expected to affect the business, as well as management's forecasts for inventory, receivables, capital spending, and other cash +needs. We consider this type of estimate to be classified as a Level 3 measurement. See Note 6—Fair Value Measurements for further discussion related to fair value +measurements. +Cash and Cash Equivalents —Cash and cash equivalents represent cash and short-term, highly liquid investments with maturities of three months or +less +at the date of purchase. We consider receivables from credit card companies to be cash equivalents, if expected to be received within five days. +Accounts Receivable —Accounts receivable represent amounts due from customers. Accounts receivable are recorded at invoiced amounts, net of +reserves +and allowances, are not collateralized and do not bear interest. We use our best estimate to determine the required allowance for doubtful accounts based on a variety of factors, including the length +of time receivables are past due, economic trends and conditions affecting our customer base, significant non-recurring events and historical non-collection experience. Specific provisions are +recorded for individual receivables when we become aware of a customer's inability to meet its financial obligations. See Note 10—Allowances for further discussion related to +provisions for doubtful accounts and sale returns and allowances. +Inventory Valuation —Inventories are valued at the lower of cost or market. Inventory cost is determined using the moving average cost method. At +least +annually, or more frequently if events and circumstances indicate fair value is less than carrying value, we evaluate our inventory for possible impairment using standard categories to classify +inventory based on the degree to which we believe that the products may need to be discounted below cost to sell within a reasonable period. We base inventory fair value on several subjective +assumptions including estimated future demand and market +conditions, as well as other observable factors such as current sell-through of our products, recent changes in demand for our products, global and regional economic conditions, historical experience +selling through liquidation and price discounted channels and the amount of inventory on hand. If the estimated inventory fair value is less than its carrying value, the carrying value is adjusted to +market value and the resulting impairment charge is recorded in 'Cost of sales' on the consolidated statements of operations. See Note 2—Inventories for further discussion related +to inventories. +Property and Equipment —Property, equipment, furniture and fixtures are stated at cost and depreciation is computed using the straight-line method +based on the estimated useful lives ranging from two to five years. Leasehold improvements are stated at cost and amortized on the straight-line basis over their estimated economic useful lives or the +lease term, whichever is shorter. Depreciation of manufacturing assets is included in cost of sales on the consolidated statements of operations. Depreciation related to corporate, non-product and +non-manufacturing assets is included in 'Selling, general and administrative expenses' on the consolidated statements of operations. +F-11 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Impairment of Long-Lived Assets —Long-lived assets to be held and used are evaluated for impairment when events or circumstances indicate the +carrying +value of a long-lived asset may not be fully recoverable. Events that may indicate the impairment of a long-lived asset (or asset group, as defined below) include (i) a significant decrease in +its market price, (ii) a significant adverse change in the extent or manner in which it is being used or in its physical condition, (iii) a significant adverse change in legal factors or +business climate that could affect its value, including an adverse action or assessment by a regulator, (iv) an accumulation of costs significantly in excess of the amount originally expected +for its acquisition or construction, (v) its current period operating or cash flow losses combined with historical operating or cash flow losses or a forecast of its cash flows demonstrate +continuing losses associated with its use, and (vi) a current expectation that, more likely than not, it will be sold or otherwise disposed of significantly before the end of its previously +estimated useful life. If such facts indicate a potential impairment of a long-lived asset (or asset group), we assess the recoverability by determining if its carrying value exceeds the sum of its +projected undiscounted cash flows from its use and eventual disposition over its remaining economic life. If the asset is not supported on an undiscounted cash flow basis, the amount of impairment is +measured as the difference between its carrying value and its estimated fair value. Assets held for sale are reported at the lower of the carrying amount or fair value less costs to sell. Assets to be +abandoned or from which no further benefit is expected are written down to zero at the time that the determination is made and the assets are removed entirely from service. +An +asset group is the lowest level of assets and liabilities for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. For assets +involved in our retail business, +our asset group is at the retail store level. See Note 3—Property and Equipment for a discussion of impairment losses recorded during the periods presented. +Intangible Assets —Intangible assets that are determined to have finite lives are amortized over their useful lives on a straight-line basis. +Customer +relationships are amortized on a straight-line basis or an accelerated basis. Indefinite lived intangible assets, such as trade names, are not amortized and are evaluated for impairment at least +annually and when circumstances imply possible impairment. +Amortization +of manufacturing intangible assets is included in cost of sales on the consolidated statements of operations. Amortization related to corporate, non-product and +non-manufacturing assets such as our global information systems is included in selling, general and administrative expenses on the consolidated statements of operations. The following table sets forth +our definite lived intangible assets and the periods over which they are amortized. +Intangible Asset Class +Weighted Average Amortization Period +Patents +10 years +Customer relationships +Estimated customer life +Core technology +5 years +Non-competition agreement +Contractual term +Capitalized software +Shorter of 7 years or useful life +Capitalized Software— We capitalize certain internal and external software acquisition and development costs, including the costs of employees and +contractors devoting +time to the software +F-12 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +development +projects and external direct costs for materials and services. Initial costs associated with internally-developed-and-used software are expensed until it is determined that the project has +reached the application development stage. Once in its development stage, subsequent additions, modifications or upgrades to an internal-use software project are capitalized to the extent that they +add functionality. Software maintenance and training costs are expensed in the period in which they are incurred. Capitalized software primarily consists of our enterprise resource system software, +warehouse management software and point of sale software. At least annually, we consider the potential impairment of capitalized software by assessing the substantive service potential of the +software, changes, if any, in the extent or manner in which the software is used or is expected to be used, and the actual cost of software development or modification compared to expected cost. See +Note 4—Goodwill and Intangible Assets for further discussion. +Impairment of Intangible Assets— Intangible assets with indefinite lives are evaluated for impairment when events or changes in circumstances indicate +that the carrying value may not +be fully recoverable and at least annually. Intangible assets that are determined to have definite lives are amortized over their useful lives and are evaluated for impairment only when events or +circumstances indicate a carrying value may not be fully recoverable. Recoverability is based on the estimated future undiscounted cash flows of the asset. If the asset is not supported on an +undiscounted cash flow basis, the amount of impairment is measured as the difference between its carrying value and its estimated fair value. +Goodwill —Goodwill represents the excess purchase price paid over the fair value of assets acquired and liabilities assumed in acquisitions. +Goodwill +is considered an indefinite lived asset and therefore is not amortized. The Company assesses goodwill for impairment annually on the last day of the fourth quarter, or more frequently if events and +circumstances indicate impairment may have occurred. If the carrying value of goodwill exceeds its implied fair value, the Company records an impairment loss equal to the difference. See +Note 4—Goodwill and Intangible Assets for discussion of goodwill balances and discussion of impairment losses recorded during the periods presented. +Earnings per Share —Basic and diluted earnings per common share ("EPS") is presented using the two-class method, which is an earnings allocation +formula that determines earnings per share for common stock and any participating securities according to dividend rights and participation rights in undistributed earnings. Under the two-class +method, EPS is computed by dividing the sum of distributed and undistributed earnings attributable to common stockholders by the weighted average number of shares of common stock outstanding during +the period. A participating security is an unvested share-based payment award containing non-forfeitable rights to dividends and must be included in the computation of earnings per share pursuant to +the two-class method. Shares of the Company's non-vested restricted stock awards are considered participating securities. Diluted EPS reflects the potential dilution from securities that could share +in the earnings of the Company. Anti-dilutive securities are excluded from diluted EPS. See Note 12—Earnings per Share for further discussion. +Recognition of Revenues —Revenues are recognized when the customer takes title and assumes risk of loss, collection of related receivables is +probable, +persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer +F-13 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +depending +on the country in which the sale occurs and the agreement terms with the customer. Allowances for estimated returns and discounts are recognized when the related revenue is earned. +Shipping and Handling Costs and Fees —Shipping and handling costs are expensed as incurred and included in cost of sales. Shipping and handling fees +billed to customers are included in revenues. +Share-based Compensation —We have share-based compensation plans in which certain officers, employees and members of the board of directors are +participants and may be granted stock options, restricted stock and stock performance awards. Awards granted under these plans are fair valued and amortized, net of estimated forfeitures, over the +vesting period using the straight-line method. The fair value of stock options is calculated by using the Black Scholes option pricing model that requires estimates for expected volatility, expected +dividends, the risk-free interest rate and the term of the option. If any of the assumptions used in the Black Scholes model or the anticipated number of shares to be awarded change significantly, +share-based compensation expense may differ materially in the future from that recorded in the current period. Share-based compensation expense associated with our manufacturing and retail employees +is included in 'Cost of sales' in the consolidated statements of operations. Share-based compensation expense associated with selling, marketing and administrative employees is included 'Selling, +general and administrative expenses' on the consolidated statements of operations. Share-based compensation directly associated with the construction or implementation of certain long-term projects +for internal use are capitalized to the consolidated balance sheets until assets are ready for intended use and will be amortized over the useful life of the assets upon that date. See +Note 9—Equity for additional information related to share-based compensation. +Defined contribution plans —We have a 401(k) plan known as the Crocs, Inc. 401(k) Plan (the "Plan"). The Plan is available to employees on our +U.S. payroll and provides employees with tax deferred salary deductions and alternative investment options. The Plan does not provide employees with the option to invest in our common stock. Employees +may contribute up to 75.0% of their salary, subject to certain limitations. We match employees' contributions to the Plan up to a maximum of 4.0% of eligible compensation. We expensed +$6.8 million, $5.8 million and $4.6 million in the years ended December 31, 2013, 2012 and 2011, respectively, for our employee match contributions to the Plan. +Advertising —Advertising costs are expensed as incurred and production costs are generally expensed when the advertising is first run. Total +advertising, marketing and promotional costs reflected in 'Selling, general, and administrative expenses' on the consolidated statement of operations were $47.6 million, $39.8 million +and $39.8 million for the years ended December 31, 2013, 2012 and 2011, respectively. +Research and Development —Research and development costs are expensed as incurred. Research and development expenses amounted to $15.4 million, +$12.0 million and $10.8 million for the years ended December 31, 2013, 2012 and 2011, respectively, and are included in 'Selling, general, and administrative expenses' in the +consolidated statement of operations. +Foreign Currency Translation and Foreign Currency Transactions —Our reporting currency is the U.S. dollar. Assets and liabilities of foreign +operations +denominated in local currencies are translated at the rate of exchange at the balance sheet date. Revenues and expenses are translated at the weighted average rate of exchange during the applicable +period. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are included in the foreign currency +F-14 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +translation +adjustment, a component of accumulated other comprehensive income in stockholders' equity. +Gains +and losses generated by transactions denominated in currencies other than the local functional currencies are reflected in the consolidated statement of operations in the period in +which they occur and are primarily associated with payables and receivables arising from intercompany transactions. +Derivative Foreign Currency Contracts —We are directly and indirectly affected by fluctuations in foreign currency rates which may adversely impact +our +financial performance. To mitigate the potential impact of foreign currency exchange rate risk, we may employ derivative financial instruments including forward contracts and option contracts. Forward +contracts are agreements to buy or sell a quantity of a currency at a predetermined future date and at a predetermined rate. An option contract is an agreement that conveys the purchaser the right, +but not the obligation, to buy or sell a quantity of a currency at a predetermined rate during a period or at a time in the future. These +derivative financial instruments are viewed as risk management tools and are not used for trading or speculative purposes. We recognize derivative financial instruments as either assets or liabilities +in the consolidated balance sheets and measure those instruments at fair value. Changes in the fair value of derivatives not designated or effective as hedges are recorded in 'Foreign currency +transaction (gains)/losses, net" in the consolidated statements of operations. We had no derivative instruments that qualified for hedge accounting during any of the periods presented. See +Note 7—Fair Value Measurements and Financial Instruments for further discussion. +Income Taxes —Income taxes are accounted for using the asset and liability method which requires the recognition of deferred tax assets and +liabilities +for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. We provide for income taxes at the current and future +enacted tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures +regarding uncertainties in income tax positions. We recognize interest and penalties related to income tax matters in income tax expense in the consolidated statement of operations. See +Note 11—Income Taxes for further discussion. +Taxes Assessed by Governmental Authorities —Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, +including +value added tax, are recorded on a net basis and are therefore excluded from sales. +Application of Recent Accounting Pronouncements +Recently Adopted Accounting Pronouncements +In December 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-11 Balance Sheet (Topic 210) Disclosures +about Offsetting Assets and Liabilities ("ASU No. 2011-11"). This pronouncement was issued to enhance +disclosure requirements surrounding the nature of an entity's right to offset and related arrangements associated with its financial instruments and derivative instruments. This new guidance requires +companies to disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to master +netting +arrangements. ASU No. 2011-11 was effective for us on January 1, 2013. The adoption of this pronouncement did not have +F-15 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +a +material impact to the Company's consolidated financial position or results of operations. ASU No. 2011-11 was subsequently amended by ASU No. 2013-01. +In +January 2013, the FASB issued ASU No. 2013-01 Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and +Liabilities ("ASU No. 2013-01"). This pronouncement clarifies the scope of the offsetting disclosure requirements in ASU No. 2011-11. Under ASU +No. 2013-01, the disclosure would apply to derivative instruments accounted for in accordance with ASC 815. ASU No. 2013-01 was effective for us January 1, 2013. The adoption of +this pronouncement did not have a material impact to the Company's consolidated financial position or results of operations. +In +February 2013, the FASB issued ASU No. 2013-02 Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other +Comprehensive Income ("ASU No. 2013-02"). This pronouncement required entities to disclose the following additional information about items reclassified out of +AOCI: +1) Changes +in AOCI balances by component, with separate presentation of reclassification adjustments and current period other comprehensive income ("OCI"). Both +before-tax and net-of-tax presentations of the information are acceptable as long as an entity presents the income tax benefit or expense attributed to each component of OCI and reclassification +adjustments in either the financial statements or the notes to the financial statements. +2) Significant +items reclassified out of AOCI by component either on the face of the consolidated statements of operations or as a separate footnote to the +financial statements. +This +pronouncement does not change the current U.S. GAAP requirements for interim financial statement reporting of comprehensive income. However, public entities also need to +include information about (1) changes in AOCI balances by component and (2) significant items reclassified out of AOCI in interim reporting periods. This pronouncement was effective for +us on January 1, 2013. The adoption of this pronouncement did not have a material impact to the Company's consolidated financial position or results of operations. +In +March 2013, the FASB issued ASU No. 2013-05 Foreign Currency Matters (Topic 830): Parent's Accounting for the Cumulative Translation Adjustment upon +Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity ("ASU No. 2013-05"). This pronouncement +indicates that the entire amount of a cumulative translation adjustment (CTA) related to an entity's investment in a foreign entity should be released when there has been a: +1) Sale +of a subsidiary or group of net assets within a foreign entity and the sale represents the substantially complete liquidation of the investment in the +foreign entity. +2) Loss +of a controlling financial interest in an investment in a foreign entity (i.e. deconsolidation) +3) Step +acquisition for a foreign entity (i.e. when an entity has changed from applying the equity method for an investment in a foreign entity to +consolidating the foreign entity). +This +ASU does not change the requirement to release a pro rata portion of the CTA of the foreign entity into earnings for a partial sale of an equity method investment in a foreign +entity. For all public entities, this pronouncement is effective for fiscal years beginning on or after December 15, 2013. As early adoption is permitted, the Company adopted this pronouncement +on January 1, 2013. +F-16 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +The +adoption of this pronouncement did not have a material impact to the Company's consolidated financial position or results of operations. +Recently Issued Accounting Pronouncements +In July 2013, the FASB issued ASU No. 2013-11 Income Taxes (Topic 740): Presentation of an Unrecognized +Tax Benefit when a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU No. 2013-11"). This pronouncement provides guidance on +financial statement presentation of an unrecognized tax benefit ("UTB") when a net operating loss ("NOL") carryforward, a similar tax loss or a tax credit carryforward exists. Under the +pronouncement, an entity must present a UTB, or a portion of the UTB, in the financial statements as a reduction to a deferred tax asset ("DTA") for an NOL carryforward, a similar tax loss or a tax +credit carryforward except when: +1) An +NOL carryforward, a similar tax loss or a tax credit carryforward is not available as of the reporting date under the governing tax law to settle that +would result from the disallowance of the tax position. +2) The +entity does not intend to use the DTA for this purpose (provided that the tax law permits a choice). +If +either of these conditions exists, an entity should present a UTB in the financial statements as a liability and should not net the UTB with a DTA. This amendment does not affect the +amounts disclosed in the tabular reconciliation of the total amounts of UTBs because the tabular reconciliation presents gross amounts of UTBs. This pronouncement is effective for fiscal years and +interim periods within those fiscal years beginning after December 15, 2013. The Company will adopt the provisions of ASU No. 2013-11 on January 1, 2014. We do not anticipate the +provisions of ASU No. 2013-11 will have a material impact on to the Company's consolidated financial position or results of operations. +2. INVENTORIES +The following table summarizes inventories by major classification as of December 31, 2013 and 2012: +December 31, +($ thousands) +2013 +2012 +Finished goods +$ +154,272 +$ +155,833 +Work-in-progress +685 +911 +Raw materials +7,384 +8,060 +Inventories +$ +162,341 +$ +164,804 +Inventory Write-down +During the year ended December 31, 2013, we recorded approximately $3.4 million of inventory write-down charges related +to obsolete inventory with a market value lower than cost. These charges were related to certain obsolete raw materials, footwear and accessories in the Americas segment and are reported in 'Cost of +sales' in the consolidated statement of operations for the year ended +F-17 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. INVENTORIES (Continued) +December 31, +2013. We recorded no inventory write-down charges for the years ended December 31, 2012 and 2011. +Charitable Contributions +During the years ended December 31, 2013, 2012 and 2011, we donated certain inventory items to charitable organizations +consisting primarily of end of life units. The contributions made were expensed at their fair value of $0.6 million, $1.7 million and $2.0 million, respectively. Also during the +years ended December 31, 2013, 2012 and 2011, we recognized a gain of $0.1 million, $0.6 million and $0.7 million, respectively, and a net reduction of inventory of +$0.5 million, $1.1 million and $1.3 million, respectively, as the fair value of the inventory contributed exceeded its carrying amount. +3. PROPERTY AND EQUIPMENT +The following table summarizes property and equipment by major classification as of December 31, 2013 and 2012: +December 31, +($ thousands) +2013 +2012 +Machinery and equipment +$ +52,003 +$ +68,713 +Leasehold improvements +93,235 +88,653 +Furniture, fixtures and other +23,653 +20,827 +Construction-in-progress +16,231 +8,766 +Property and equipment, gross(1) +185,122 +186,959 +Less: Accumulated depreciation(2) +(98,151 +) +(104,718 +) +Property and equipment, net +$ +86,971 +$ +82,241 +(1) Includes +$0.1 million of certain equipment held under capital leases and classified as equipment as of each of December 31, 2013 and 2012. +(2) Includes +$0.1 million of accumulated depreciation related to certain equipment held under capital leases, as of each of December 31, 2013 and +2012, which are depreciated using the straight-line method over the lease term. +During +the years ended December 31, 2013, 2012 and 2011, we recorded $24.3 million, $23.1 million and $27.5 million, respectively, in depreciation expense of +which $2.9 million, $4.6 million and $11.5 million, respectively, was recorded in 'Cost of sales', with the remaining amounts recorded in 'Selling, general and administrative +expenses' on the consolidated statements of operations. +During +the year ended December 31, 2013, we retired $19.5 million of fully depreciated shoe molds related to styles that we no longer intend on manufacturing. As such, we +did not record a gain or loss associated with the disposal and the cost and accumulated depreciation previously classified as machinery and equipment were removed from the consolidated balance sheets. +We did not retire a material amount of fully depreciated, long-lived assets during the year ended December 31, 2012. +We +periodically evaluate all of our long-lived assets for impairment when events or circumstances would indicate the carrying value of a long-lived asset may not be fully recoverable. +During the years +F-18 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +3. PROPERTY AND EQUIPMENT (Continued) +ended +December 31, 2013 and 2012, we recorded $10.6 million and $1.4 million, respectively, in impairment charges related to underperforming retail locations, respectively, that +were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores' assets over their remaining economic life. In addition, during the year ended December 31, +2011, we recorded $0.5 million in impairment charges in our 'Other business' category, which primarily related to obsolete molds previously depreciated in 'Cost of sales'. The following table +summarizes asset impairment charges by reportable operating segment for the years ended December 31, 2013, 2012 and 2011: +December 31, +2013 +2012 +2011 +($ thousands, except store count data) +Impairment +charge +Number of +stores +Impairment +charge +Number of +stores +Impairment +charge +Number of +stores +Americas +$ +3,861 +23 +$ +1,410 +4 +$ +— +— +Asia Pacific +185 +2 +— +— +— +— +Japan +— +— +— +— +— +— +Europe +6,565 +35 +— +— +— +— +Asset impairment charges +$ +10,611 +60 +$ +1,410 +4 +$ +— +— +4. GOODWILL & INTANGIBLE ASSETS +The following table summarizes the goodwill and identifiable intangible assets as of December 31, 2013 and 2012: +December 31, 2013 +December 31, 2012 +($ thousands) +Gross Carrying +Amount +Accumulated +Amortization +Net Carrying +Amount +Gross Carrying +Amount +Accumulated +Amortization +Net Carrying +Amount +Capitalized software +$ +118,940 +(1) +$ +(49,665 +)(2) +$ +69,275 +$ +87,426 +(1) +$ +(33,933 +)(2) +$ +53,493 +Customer relationships +6,878 +(6,439 +) +439 +7,145 +(6,222 +) +923 +Patents, copyrights, and trademarks +6,501 +(4,272 +) +2,229 +6,161 +(3,522 +) +2,639 +Core technology +4,548 +(4,548 +) +— +4,856 +(4,856 +) +— +Other +983 +(709 +) +274 +670 +(636 +) +34 +Total finite lived intangible assets +137,850 +(65,633 +) +72,217 +106,258 +(49,169 +) +57,089 +Indefinite lived intangible assets +97 +— +97 +113 +— +113 +Goodwill +2,508 +— +2,508 +2,729 +— +2,729 +Intangible assets +$ +140,455 +$ +(65,633 +) +$ +74,822 +$ +109,100 +$ +(49,169 +) +$ +59,931 +(1) Includes +$4.1 million of software held under a capital lease classified as capitalized software as of each of December 31, 2013 and 2012. +F-19 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +4. GOODWILL & INTANGIBLE ASSETS (Continued) +(2) Includes +$1.9 million and $1.3 million of accumulated amortization of software held under a capital lease as of December 31, 2013 and +2012, respectively, which is amortized using the straight-line method over the useful life. +During +the years ended December 31, 2013, 2012 and 2011, amortization expense recorded for intangible assets with finite lives was $17.2 million, $13.6 million and +$9.8 million, respectively, of which $6.0 million, $4.3 million and $2.9 million, respectively, was recorded in 'Cost of sales', with the remaining amounts recorded in +'Selling, general and administrative expenses' on the consolidated statements of operations. +The +following table summarizes estimated future annual amortization of intangible assets as of December 31, 2013: +Fiscal years ending December 31, +Amortization +($ thousands) +2014 +$ +16,721 +2015 +13,729 +2016 +13,935 +2017 +14,706 +2018 +7,198 +Thereafter +5,928 +Total +$ +72,217 +Goodwill Impairment +We assess goodwill for impairment on an annual basis on the last day of the fourth quarter, or more frequently if events and +circumstances indicate impairment may have occurred, at the reporting unit level. If the carrying value of the goodwill exceeds its implied fair value, we record an impairment loss equal to the +difference. During the year ended December 31, 2013, we recorded $0.3 million of goodwill impairment related to the retail channel of our Crocs Benelux B.V. business purchased by +our Crocs Stores B.V. subsidiary in July 2012. Goodwill and associated impairments are part of our Europe operating segment. During the years ended December 31, 2012 and 2011, we did not +record any impairments related to goodwill. +F-20 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES +The following table summarizes accrued expenses and other current liabilities as of December 31, 2013 and 2012: +December 31, +($ thousands) +2013 +2012 +Accrued compensation and benefits +$ +26,903 +$ +19,714 +Professional services +14,128 +10,342 +Fulfillment, freight and duties +12,565 +8,621 +Accrued rent and occupancy +12,198 +10,226 +Sales/use and VAT tax payable +9,142 +12,444 +Accrued legal +8,722 +3,246 +Customer deposits +6,940 +2,593 +Entrusted loan payable(1) +— +7,943 +Other(2) +6,513 +6,242 +Total accrued expenses and other current liabilities +$ +97,111 +$ +81,371 +(1) A +corresponding entrusted loan receivable of $7.9 million is recorded in 'Other receivables' as of December 31, 2012 as amounts are related to +our subsidiaries in China. The entrusted loan was paid in full during the second quarter of 2013 and as such, the entrusted loan payable, and corresponding receivable, were removed from the +consolidated balance sheets as of December 31, 2013. +(2) The +amounts in Other consist of various accrued expenses and no individual item accounted for more than 5% of the total balance at December 31, 2013 +or December 31, 2012. +Asset Retirement Obligations +We record a liability equal to the fair value of the estimated future cost to retire an asset, if the liability's fair value can be +reasonably estimated. Our asset retirement obligation ("ARO") liabilities are primarily associated with the disposal of property and equipment which we are contractually obligated to remove at the end +of certain retail and office leases in order to restore the facilities back original condition as specified in the related lease agreements. We estimate the fair value of these liabilities based on +current store closing costs and discount the costs back as if they were to be performed at the inception of the lease. At the inception of such leases, we record the ARO as a liability and also record +a related asset in an amount equal to the estimated fair value of the obligation. The capitalized asset is then depreciated on a straight-line basis over the useful life of the asset. Upon retirement +of the ARO liability, any difference between the actual retirement costs incurred and the previously recorded estimated ARO liability is recognized as a gain or loss in the consolidated statements of +operations. Our ARO liability as of December 31, 2013 and 2012 was $2.0 million and $2.4 million, respectively. +F-21 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +6. FAIR VALUE MEASUREMENTS +Recurring Fair Value Measurements +The following tables summarize the financial instruments required to be measured at fair value on a recurring basis as of +December 31, 2013 and 2012. See Note 1—Organization & Summary of Significant Accounting Policies for additional detail regarding our fair value measurement +determinations. +Fair Value as of December 31, 2013 +($ thousands) +Quoted prices in +active markets +for identical +assets or liabilities +(Level 1) +Significant +other +observable +inputs +(Level 2) +Significant +unobservable +inputs +(Level 3) +Total +Balance Sheet Classification +Cash equivalents +$ +37,870 +$ +— +$ +— +$ +37,870 +Cash and cash equivalents and other current assets +Derivative assets: +Foreign currency contracts +— +13,501 +— +13,501 +Prepaid expenses and other current assets and other assets +Derivative liabilities: +Foreign currency contracts +$ +— +$ +984 +$ +— +$ +984 +Accrued expense and other current liabilities +Fair Value as of December 31, 2012 +($ thousands) +Quoted prices in +active markets +for identical +assets or liabilities +(Level 1) +Significant +other +observable +inputs +(Level 2) +Significant +unobservable +inputs +(Level 3) +Total +Balance Sheet Classification +Cash equivalents +$ +14,800 +$ +— +$ +— +$ +14,800 +Cash and cash equivalents +Derivative assets: +Foreign currency contracts +— +5,548 +— +5,548 +Prepaid expenses and other current assets and other assets +Derivative liabilities: +Foreign currency contracts +$ +— +$ +295 +$ +— +$ +295 +Accrued expense and other current liabilities +F-22 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +6. FAIR VALUE MEASUREMENTS (Continued) +Non-Recurring Fair Value Measurements +The majority of our non-financial instruments, which include inventories, property and equipment and intangible assets, are not +required to be carried at fair value on a recurring basis. However, if certain triggering events occur such that a non-financial instrument is required to be evaluated for impairment and the carrying +value is not recoverable, the carrying value would be adjusted to the lower of its cost or fair value and an impairment charge would be recorded. See Note 2—Inventories, +Note 3—Property and Equipment and Note 4—Goodwill & Intangible Assets for discussions on impairment charges recorded during the periods presented. +7. DERIVATIVE FINANCIAL INSTRUMENTS +We transact business in various foreign countries and are therefore exposed to foreign currency exchange rate risk inherent in revenues, costs, and monetary assets and liabilities +denominated in non-functional currencies. We have entered into foreign currency exchange forward contract and currency swap derivative instruments to selectively protect against volatility in the +value of non-functional currency denominated monetary assets and liabilities, and of future cash flows caused by changes in foreign currency exchange rates. We do not designate these derivative +instruments as hedging instruments under the accounting standards for derivatives and hedging. Accordingly, these instruments are recorded at fair value as a derivative asset or liability on the +balance sheet with their corresponding change in fair value recognized in 'Foreign currency transaction (gains) losses, net' in our consolidated statements of operations. For purposes of the cash flow +statement, we classify the cash flows at settlement from undesignated instruments in the same category as the cash flows from the related hedged items, generally within 'Cash provided by operating +activities'. See Note 6—Fair Value Measurements for further details regarding the fair values of the corresponding derivative assets and liabilities. +The +following table summarizes the notional amounts of the outstanding foreign currency exchange contracts at December 31, 2013 and 2012. The notional amounts of the derivative +financial instruments shown below are denominated in their U.S. dollar equivalents and represent the amount of all contracts of the foreign currency specified. These notional values do not necessarily +represent amounts +F-23 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +7. DERIVATIVE FINANCIAL INSTRUMENTS (Continued) +exchanged +by the parties and, therefore, are not a direct measure of our exposure to the foreign currency exchange risks. +December 31, +($ thousands) +2013 +2012 +Foreign currency exchange forward contracts by currency: +Japanese Yen +$ +68,707 +$ +112,500 +Euro +38,577 +5,159 +Singapore Dollar +28,225 +— +Mexican Peso +18,350 +11,400 +Russian Ruble +17,588 +— +Pound Sterling +15,487 +8,742 +South Korean Won +12,100 +— +Australian Dollar +4,941 +4,178 +New Taiwan Dollar +3,463 +— +Canadian Dollar +3,428 +— +South African Rand +3,076 +— +Indian Rupee +2,150 +— +Hong Kong Dollar +1,844 +— +Swedish Krona +1,615 +— +New Zealand Dollar +943 +1,137 +Total notional value, net +$ +220,494 +$ +143,116 +Latest maturity date +December 2015 +December 2015 +The +following table presents the amounts affecting the consolidated statements of operations from derivative instruments for the years ended December 31, 2013, 2012 and 2011: +Year Ended December 31, +Location of Gain (Loss) Recognized in Income on Derivatives +($ thousands) +2013 +2012 +2011 +Derivatives not designated as hedging instruments: +Foreign currency exchange forwards +$ +(13,002 +) +$ +(7,200 +) +$ +540 +Foreign currency transaction (gains) losses, net +The +account 'Foreign currency transaction gains (losses), net' on the consolidated statements of operations includes both realized and unrealized gains/losses from underlying foreign +currency activity and derivative contracts. These gains and losses are reported on a net basis. For the year ended December 31, 2013, the net loss recognized of $4.7 million recorded on +the consolidated statements of operations is comprised of a $17.7 million net loss associated with exposure from day-to-day business transactions in various foreign currencies partially offset +by a $13.0 million net gain associated with our derivative instruments. For the year ended December 31, 2012, the net loss recognized of $2.5 million recorded on the consolidated +statements of operations is comprised of a $9.7 million net loss associated with exposure from day-to-day business transactions in various foreign currencies partially offset by a +F-24 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +7. DERIVATIVE FINANCIAL INSTRUMENTS (Continued) +$7.2 million +net gain associated with our derivative instruments. For the year ended December 31, 2011, the net gain recognized of $4.9 million recorded on the consolidated +statements of operations is +comprised of a $5.4 million net gain associated with exposure from day-to-day business transactions in various foreign currencies partially offset by a $0.5 million net loss associated +with our derivative instruments. +8. REVOLVING CREDIT FACILITY & BANK BORROWINGS +Revolving Credit Facility +On September 25, 2009, we entered into a Revolving Credit and Security Agreement, as amended, with the lenders named therein and +PNC Bank, National Association ("PNC"), as a lender and administrative agent for the lenders. On December 16, 2011, we entered into our first amendment to the Revolving Credit and Security +Agreement (the "Amended and Restated Credit Agreement"). +On +December 27, 2013, we entered into the Third Amendment to Amended and Restated Credit Agreement (the "Third Amendment"), pursuant to which certain terms of the Amended and +Restated Credit Agreement were amended. The Third Amendment, among other things, (i) allows for the payment of dividends on the Series A Convertible Preferred Stock ("Series A +Preferred Stock"), (ii) permits the Company to have greater flexibility to repurchase its Common Stock, (iii) decreases the maximum leverage ratio from 3.50 to 1.00 to 3.25 to 1.00, and +(iv) amends certain definitions of the financial covenants to become more favorable to the Company. See Note 17—Subsequent Events for further details regarding the payment of +dividends on the Series A Preferred Stock. +The +Credit Agreement enables us to borrow up to $100.0 million, with the ability to increase commitments to up to $125.0 million subject to certain conditions, and is +currently set to mature on +December 16, 2017. The Credit Agreement is available for working capital, capital expenditures, permitted acquisitions, reimbursement of drawings under letters of credit, and permitted +dividends, distributions, purchases, redemptions and retirements of equity interests. Borrowings under the Credit Agreement are secured by all of our assets including all receivables, equipment, +general intangibles, inventory, investment property, subsidiary stock and intellectual property. Borrowings under the Credit Agreement bear interest at a variable rate. For domestic rate loans, the +interest rate is equal to the highest of (i) the daily federal funds open rate as quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC's prime rate and (iii) a daily +LIBOR rate plus 1.0%, in each case there is an additional margin ranging from 0.25% to 1.00% based on certain conditions. For LIBOR rate loans, the interest rate is equal to a LIBOR rate plus a margin +ranging from 1.25% to 2.00% based on certain conditions. The Credit Agreement requires monthly interest payments with respect to domestic rate loans and at the end of each interest period with respect +to LIBOR rate loans. The Credit Agreement further provides for a limit on the issuance of letters of credit to a maximum of $20.0 million. The Credit Agreement contains provisions requiring us +to maintain compliance with certain restrictive and financial covenants. +As +of December 31, 2013 and 2012, we had no outstanding borrowings under the Credit Agreement. As of each of December 31, 2013 and 2012, we had had issued and outstanding +letters of credit of $7.2 million, which were reserved against the borrowing base under the terms of the Credit Agreement. During the years ended December 31, 2013, 2012 and 2011, we +capitalized $0.1 million, $0.5 million and $0.4 million, respectively, in fees and third party costs which were incurred in +F-25 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +8. REVOLVING CREDIT FACILITY & BANK BORROWINGS (Continued) +connection +with the Credit Agreement, as deferred financing costs. As of December 31, 2013, we were in compliance with all restrictive financial and other covenants under the Credit Agreement. +Long-term Bank Borrowings +On December 10, 2012, we entered into a Master Installment Payment Agreement ("Master IPA") with PNC in which PNC finances the +Company's purchase of software and services, which may include but are not limited to third party costs to design, install and implement software systems, and associated hardware described in the +schedules defined within the Master IPA. This agreement was entered into to finance our implementation of a new enterprise resource planning ("ERP") system which began in October 2012 and is estimated +to continue through late 2014. The terms of the agreement consist of variable interest rates and payment terms based on amounts borrowed and timing of activity throughout the implementation of the ERP +system. +As +of December 31, 2013 and 2012, we had $16.8 million and $6.6 million, respectively, of long-term debt outstanding under five and one separate notes payable, +respectively, of which $5.1 million and $2.0 million, respectively, represent current installments. As of December 31, 2013, the notes bear interest rates ranging from 2.45% to +2.79% and maturities ranging from September 2016 to September 2017. As this debt arrangement relates solely to the construction and implementation of an ERP system for use by the entity, all interest +expense incurred under the arrangement has been capitalized to the consolidated balance sheets until the assets are ready for intended use and will be amortized over the useful life of the software +upon that date. During the year ended December 31, 2013, we capitalized $0.3 million in interest expense related to this debt arrangement to the consolidated balance sheets. During the +year ended December 31, 2012, we recorded no capitalized interest related to this debt arrangement to the consolidated balance sheets. Interest rates and payment terms are subject to changes as +further financing occurs under the Master IPA. +The +aggregate maturities of long-term bank borrowings at December 31, 2013 are as follows (in thousands): +Fiscal years ending December 31, +2014 +$ +5,135 +2015 +5,271 +2016 +4,765 +2017 +1,607 +2018 +— +Thereafter +— +Total principal debt maturities +$ +16,778 +9. EQUITY +Equity Incentive Plans +On August 15, 2005, we adopted the 2005 Equity Incentive Plan (the "2005 Plan"), which permitted the issuance of up to +14.0 million common shares in connection with the grant of non-qualified stock options, incentive stock options, and restricted stock to eligible employees, consultants and members of our board +of directors. As of December 31, 2013 and 2012, 0.7 million and +F-26 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. EQUITY (Continued) +0.9 million +stock options, respectively, were outstanding under the 2005 Plan. Following the adoption of the 2007 Equity Incentive Plan (the "2007 Plan"), described below, no additional grants +were made under the 2005 Plan. +On +July 9, 2007, we adopted and on June 28, 2011 we amended the 2007 Plan which increased the allowable number of shares of our common stock reserved for issuance under the +2007 Plan from 9.0 million to 15.3 million (subject to adjustment for future stock splits, stock dividends and similar changes in our capitalization) in connection with the grant of +non-qualified stock options, incentive stock options, restricted stock, restricted stock units, stock appreciation rights, performance units, common stock or any other share-based award to eligible +employees, consultants and members of our board of directors. As of December 31, 2013 and 2012, 3.6 million and 3.5 million shares of common +stock, respectively, were issuable under the 2007 Plan pursuant to outstanding stock options and RSUs. As of December 31, 2013, 4.4 million shares were available for future issuance +under the 2007 Plan. +Restricted +stock awards and units generally vest annually on a straight-line basis over three or four years depending on the terms of the award agreement. +Stock Option Activity +The following table summarizes stock option activity for the years ended December 31, 2013, 2012 and 2011: +Shares +Weighted +Average +Exercise +Price +Weighted +Average +Remaining +Contractual +Life +(Years) +Aggregate +Intrinsic +Value +($ thousands) +Outstanding at December 31, 2010 +5,007,337 +$ +9.10 +6.36 +$ +47,009 +Granted +468,000 +19.81 +Exercised +(1,738,741 +) +6.28 +Forfeited or expired +(405,565 +) +10.46 +Outstanding at December 31, 2011 +3,331,031 +11.91 +6.35 +18,468 +Granted +208,400 +16.84 +Exercised +(613,691 +) +6.04 +Forfeited or expired +(304,054 +) +17.55 +Outstanding at December 31, 2012 +2,621,686 +13.03 +5.55 +11,373 +Granted +177,000 +15.62 +Exercised +(333,395 +) +6.84 +Forfeited or expired +(360,139 +) +18.18 +Outstanding at December 31, 2013 +2,105,152 +$ +13.34 +4.86 +$ +10,790 +Exercisable at December 31, 2013 +1,732,398 +$ +12.56 +4.21 +$ +10,621 +Vested and expected to vest at December 31, 2013 +2,019,478 +$ +13.22 +4.72 +$ +10,745 +F-27 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. EQUITY (Continued) +During +the years ended December 31, 2013, 2012 and 2011, options issued were valued using the Black Scholes option pricing model using the following assumptions: +Year Ended December 31, +2013 +2012 +2011 +Expected volatility +50 - 64 +% +50 - 70 +% +50 - 60 +% +Dividend yield +— +— +— +Risk-free interest rate +0.81% - 1.62 +% +0.62% - 1.20 +% +0.87% - 2.31 +% +Expected life (in years) +4.00 +4.00 - 4.27 +4.35 - 4.89 +The +weighted average fair value of options granted during the years ended December 31, 2013, 2012 and 2011 was approximately $7.33, $7.76 and $9.19, respectively. The aggregate +intrinsic value of options exercised during the years ended December 31, 2013, 2012 and 2011 was $2.8 million, $6.9 million and $27.3 million, respectively. During the +years ended December 31, 2013 and 2012, we received $2.3 million and $3.7 million in cash in connection with the exercise of stock options with no income tax benefit due to our +use of Accounting Standard Codification 740—'Income Taxes' (with-and-without approach) ("ASC 740") ordering for purposes of determining when excess benefits have been realized (see +Note 11—Income Taxes). The total grant date fair value of stock options vested during the years ended December 31, 2013, 2012 and 2011 was $1.2 million, +$2.8 million and $2.7 million, respectively. +As +of December 31, 2013, we had $2.6 million of total unrecognized share-based compensation expense related to unvested options, net of expected forfeitures, which is +expected to be amortized over the remaining weighted average period of 2.3 years. +Stock +options under both the 2005 Plan and the 2007 Plan generally vest ratably over four years with the first year vesting on a "cliff" basis followed by monthly vesting for the +remaining three years. +Restricted Stock Awards and Units +From time to time, we grant restricted stock awards (RSAs) and restricted stock units (RSUs) to our employees. Unvested RSAs have the +same rights as those of common shares including voting rights and non-forfeitable dividend rights. However, ownership of unvested RSAs cannot be transferred until they are vested. An unvested RSU is a +contractual right to receive a share of common stock only upon its vesting. RSUs have dividend equivalent rights which accrue over the term of the award and are paid if and when the RSUs vest, but +they have no voting rights. +We +typically grant time-based RSUs and performance-based RSUs. Time-based RSUs are typically granted on an annual basis to certain non-executive employees and vest in three annual +installments on a straight-line basis beginning one year after the grant date. During the years ended December 31, 2013, 2012 and 2011, the board of directors approved grants of +0.4 million, 0.4 million and 0.2 million of RSUs to certain non-executives. Performance-based RSUs are typically granted on an annual basis to certain executive employees and +consist of a time-based and performance-based component. The +F-28 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. EQUITY (Continued) +following +represents the vesting schedule of performance-based RSUs granted during the years ended December 31, 2013, 2012 and 2011: +Time Vested RSUs +(50% of Award) +Performance Vested RSUs (50% of Award) +Vest in 3 annual installments beginning one year after the date of grant +Performance Goal +Potential Award +Further Time Vesting +Achievement of at least 70% of a two-year cumulative earnings per share performance goal +Executive may earn from 50% to 200% of the target number of RSUs based on the level of achievement of the performance goal +Earned RSUs vest 50% upon satisfaction of performance goal and 50% one year later +During +the years ended December 31, 2013, 2012 and 2011, the board of directors approved the grant of 0.9 million, 0.4 million and 0.4 million, respectively, +of RSUs or RSAs to certain executives as part of a performance incentive program. +The +following table summarizes RSA and RSU activity during the years ended December 31, 2013, 2012 and 2011: +Restricted Stock Awards +Restricted Stock Units +Shares +Weighted +Average +Grant Date +Fair Value +Units +Weighted +Average +Grant Date +Fair Value +Unvested at December 31, 2010 +953,423 +$ +8.54 +116,400 +$ +— +Granted +118,520 +19.10 +651,791 +24.89 +Vested +(352,150 +)(1) +6.19 +(21,150 +)(1) +17.25 +Forfeited +(148,618 +) +9.67 +(35,061 +) +15.41 +Unvested at December 31, 2011 +571,175 +11.87 +711,980 +23.43 +Granted +18,813 +16.48 +1,010,559 +18.92 +Vested +(191,779 +)(1) +9.22 +(133,555 +)(1) +23.25 +Forfeited +(42,700 +) +13.25 +(174,323 +) +20.64 +Unvested at December 31, 2012 +355,509 +13.37 +1,414,661 +20.61 +Granted +21,590 +16.56 +1,637,114 +14.96 +Vested +(89,006 +)(1) +14.81 +(329,542 +)(1) +21.52 +Forfeited +(77,603 +) +12.46 +(756,566 +) +14.71 +Unvested at December 31, 2013 +210,490 +$ +13.43 +1,965,667 +$ +16.50 +(1) The +RSAs vested during the years ended December 31, 2013, 2012 and 2011 consisted entirely of time-based awards. The RSUs vested during the years +ended December 31, 2013 consisted of 52,288 performance-based awards and 277,254 time-based awards. The RSUs vested during the years ended December 31, 2012 and 2011 consisted entirely +of time-based awards. +F-29 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. EQUITY (Continued) +The +total grant date fair value of RSAs vested during the years ended December 31, 2013, 2012 and 2011 was $1.3 million, $1.8 million and $2.2 million, +respectively. At December 31, 2013, we had $1.0 million of total unrecognized share-based compensation expense related to non-vested restricted stock awards, net of expected forfeitures, +of which $0.5 million is related to performance-based awards and $0.5 million is time-based awards. The unvested RSAs are expected to be amortized over the remaining weighted average +period of 0.52 years, which consists of a remaining weighted average period of 0.45 years related to performance-based awards and a remaining weighted average period of 0.64 years +related to time-based awards. +The +total grant date fair value of RSUs vested during the years ended December 31, 2013, 2012 and 2011 was $7.1 million, $3.1 million, and $0.4 million, +respectively. At December 31, 2013, we had $15.6 million of total unrecognized share-based compensation expense related to unvested restricted stock units, net of expected forfeitures, +of which $5.8 million is related to performance-based awards and $9.8 million is time-based awards. The unvested RSUs are expected to be amortized over the remaining weighted average +period of 1.75 years, which consists of a remaining weighted average period of 1.77 years related to performance-based awards and a remaining weighted average period of 1.73 years +related to time-based awards. +Share-based Compensation +During the years ended December 31, 2013, 2012 and 2011, we recorded $12.5 million, $11.3 million +$8.6 million, respectively, of pre-tax share-based compensation expense of which $0.7 million, $0.0 million, and $0.0 million, respectively, related solely to the +construction and implementation of our ERP system for use by the entity was capitalized to the consolidated balance sheets until assets are ready for intended use and will be amortized over the useful +life of the software upon that date. +Separation Agreements +On December 27, 2013, John McCarvel resigned from his position as President, Chief Executive Officer (CEO) and director of the +Company effective upon the earlier to occur of (i) April 30, 2014 or (ii) the Board's appointment of his successor as CEO. Also on December 27, 2013, the Company and +Mr. McCarvel entered into a separation agreement providing that the Company will pay Mr. McCarvel (i) a $1.1 million separation payment on the first regularly scheduled +payroll date after the effectiveness of his resignation and (ii) a $1.0 million separation payment on the first anniversary of the effectiveness of his resignation. In accordance with ASC 420—Exit or Disposal +Cost Obligations , the Company will recognize first and second installment payments of $1.1 million and +$1.0 million ratably from December 27, 2013 through April 30, 2014. If the separation date occurs prior to April 30, 2014 due to the appointment of a new CEO by the board +of directors, the Company will consider the entire $2.1 million incurred and will expense the remaining portion on that date. Mr. McCarvel will also be entitled to receive any amount +earned pursuant to the Company's 2013 annual incentive program, in such form and at such time as is provided under the terms of such program. +Mr. McCarvel +also agreed to continue in a consulting capacity with the Company at his regular salary through April 30, 2014 if his successor is appointed prior to such +date. Subject to continued service, Mr. McCarvel will be entitled to continued vesting through April 30, 2014 of the unvested portion of his existing restricted stock and restricted +stock unit awards. Pursuant to the separation +F-30 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. EQUITY (Continued) +agreement, +unvested share awards that are expected to vest through April 30, 2014 amounted to 58,840 shares. Additionally, pursuant to the terms of the separation agreement, Mr. McCarvel +forfeited 388,745 share awards not expected to vest through April 30, 2014. The separation payments are conditioned +upon the effectiveness of Mr. McCarvel's release of claims in favor of the Company and his compliance with the non-competition, non-solicitation and confidentiality covenants contained in the +separation agreement. +10. ALLOWANCES +The changes in the allowance for doubtful accounts and reserve for sales returns and allowances for the years ended December 31, 2013, 2012 and 2011, are as follows: +($ thousands) +Balance at +Beginning of Year +Charged to costs +and expenses +Reversals and +Write-offs +Balance at End of +Year +Year ended December 31, 2011: +Allowance for doubtful accounts +$ +4,642 +$ +(383 +) +$ +(579 +) +$ +3,680 +Reserve for sales returns and allowances +5,607 +9,965 +(3,744 +) +11,828 +Year ended December 31, 2012: +Allowance for doubtful accounts +3,680 +2,166 +(2,405 +) +3,441 +Reserve for sales returns and allowances +11,828 +5,111 +(7,065 +) +9,874 +Year ended December 31, 2013: +Allowance for doubtful accounts +$ +3,441 +$ +1,930 +$ +(1,715 +) +$ +3,656 +Reserve for sales returns and allowances +9,874 +13,888 +(16,905 +) +6,857 +F-31 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. INCOME TAXES +The following table sets forth income before taxes and the expense for income taxes for the years ended December 31, 2013, 2012 and 2011: +December 31, +($ thousands) +2013 +2012 +2011 +Income (loss) before taxes: +U.S. +$ +(7,818 +) +$ +12,060 +$ +(12,057 +) +Foreign +67,777 +133,488 +148,747 +Total income before taxes +59,959 +145,548 +136,690 +Income tax expense: +Current income taxes +U.S. federal +3,311 +(6,364 +) +4,798 +U.S. state +355 +597 +165 +Foreign +22,337 +22,953 +19,758 +Total current income taxes +26,003 +17,186 +24,721 +Deferred income taxes: +U.S. federal +14,968 +(3,981 +) +(2,338 +) +U.S. state +3,639 +(4,016 +) +— +Foreign +4,929 +5,016 +1,519 +Total deferred income taxes +23,536 +(2,981 +) +(819 +) +Total income tax expense +$ +49,539 +$ +14,205 +$ +23,902 +The +following table sets forth income reconciliations of the statutory federal income tax rate to our actual rates based on income or loss before income taxes as of December 31, +2013, 2012 and 2011: +December 31, +($ thousands) +2013 +2012 +2011 +Federal income tax rate +35.0 +% +35.0 +% +35.0 +% +State income tax rate, net of federal benefit +(0.6 +) +(2.7 +) +0.3 +Foreign income tax rate differential +(47.9 +) +(25.0 +) +(30.3 +) +Non-deductible / Non-taxable items +3.4 +4.6 +3.2 +Change in valuation allowance +35.6 +(8.4 +) +3.6 +U.S. tax on foreign earnings +38.2 +2.0 +— +Uncertain tax positions +6.8 +3.5 +8.7 +Audit settlements +5.1 +— +— +Non-deductible write-off of intercompany debt +1.9 +— +— +Non-deductible impairment +3.5 +— +— +Other +1.6 +0.8 +(3.0 +) +Effective income tax rate +82.6 +% +9.8 +% +17.5 +% +F-32 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. INCOME TAXES (Continued) +The +following table sets forth deferred income tax assets and liabilities as of December 31, 2013 and 2012: +December 31, +($ thousands) +2013 +2012 +Current deferred tax assets: +Accrued expenses +$ +13,108 +$ +12,934 +Unrealized loss on foreign currency +10 +2,026 +Other +1,364 +8 +Valuation allowance +(5,139 +) +(3,492 +) +Total current deferred tax assets +$ +9,343 +$ +11,476 +Current deferred tax liabilities: +Unremitted earnings of foreign subsidiary +$ +(16,102 +) +$ +(7,596 +) +Total current deferred tax liabilities. +$ +(16,102 +) +$ +(7,596 +) +Non-current deferred tax assets: +Stock compensation expense +$ +9,652 +$ +8,865 +Long-term accrued expenses +3,811 +3,067 +Net operating loss and charitable contribution carryovers +24,517 +23,255 +Intangible assets +895 +— +Property and equipment +8,527 +8,994 +Future uncertain tax position offset +1,804 +3,780 +Unrealized loss on foreign currency +639 +921 +Foreign tax credit +8,524 +5,392 +Other +1,755 +1,767 +Valuation allowance +(41,745 +) +(22,406 +) +Total non-current deferred tax assets +$ +18,379 +$ +33,635 +Non-current deferred tax liabilities: +Intangible assets +$ +— +$ +(779 +) +Total non-current deferred tax liabilities +$ +— +$ +(779 +) +We +do not provide for deferred taxes on the excess of the financial reporting basis over the tax basis in our investments in foreign subsidiaries that are essentially permanent in +duration. In general, it is our practice and intention to reinvest the earnings of our foreign subsidiaries in those operations. Generally, the earnings of our foreign subsidiaries become subject to +U.S. taxation upon the remittance of dividends and under certain other circumstances. Exceptions may be made on a year-by-year basis to repatriate current year earnings of certain foreign subsidiaries +based on cash needs in the U.S. As of December 31, 2013, we have provided for deferred U.S. income tax of $16.1 million on $76.6 million of foreign subsidiary earnings. No +withholding tax is due with respect to the repatriation of these earnings to the U.S. and none has been provided for. +At +December 31, 2013, U.S. income and foreign withholding taxes have not been provided on for approximately $474.2 million of unremitted earnings of subsidiaries operating +outside of the U.S. These earnings are estimated to represent the excess of the financial reporting over the tax basis in our +F-33 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. INCOME TAXES (Continued) +investments +in those subsidiaries. These earnings, which are considered to be indefinitely reinvested, would become subject to U.S. income tax if they were remitted to the U.S. The amount of +unrecognized deferred U.S. income tax liability on the unremitted earnings has not been determined because the hypothetical calculation is not practicable. +We +have deferred tax assets related to certain deductible temporary differences in various tax jurisdictions for which we have recorded a valuation allowance of $46.9 million +against these deferred tax assets because we do not believe that it is more likely than not that we will be able to realize these deferred tax assets. The significant components of the deferred tax +assets for which a valuation allowance has been applied consist of net operating losses in certain tax jurisdictions for which management believes there is not sufficient positive evidence that such +net operating losses will be realized against future income and book expenses not deductible for tax purposes in the current year such as inventory impairment reserves, equity compensation and +unrealized foreign exchange loss that would increase such net operating losses in the same jurisdictions. These temporary differences are amounts which arose in jurisdictions where (i) current +losses exist, (ii) such losses are in excess of any loss carryback potential, (iii) any tax planning strategies exist with which to overcome such losses are cost prohibitive and +(iv) no profits are projected for the following year. For these reasons it is determined that it is more likely than not that these deferred tax assets will not be realized and a valuation +allowance has been provided with respect to these deferred tax assets. +At +December 31, 2013, we had U.S. federal net operating loss carryforwards of $1.0 million, state net operating loss carryforwards of $96.5 million, charitable +contribution carryforwards of $20.4 million and foreign tax credits of $4.0 million which will expire at various dates between 2014 and 2034. We do not believe that it is more likely +than not that the benefit from certain federal and state net operating losses, and charitable contribution carryforwards will be realized. Consequently, we have a valuation allowance of +$12.1 million on the deferred tax assets relating to these tax attributes. +At +December 31, 2013, we have a foreign deferred tax asset of $16.0 million reflecting the benefit of $50.4 million in foreign net operating loss carryforwards, some +of which have an indefinite life. We do not believe it is more likely than not that the benefit from certain foreign net operating loss carryforwards will be realized. Consequently, we have provided a +valuation allowance of $14.5 million on the deferred tax assets relating to these foreign net operating loss carryforwards. +We +had approximately $11.6 million in net deferred tax assets at December 31, 2013. Approximately $7.6 million of the net deferred tax assets were located in foreign +jurisdictions for which a sufficient history and expected future profits indicated that it is more likely than not that such deferred tax assets will be realized. Pre-tax profit of approximately +$40.3 million is required to realize the net deferred tax assets. +At +December 31, 2013, approximately $1.8 million of net deferred tax assets consists of deferred tax assets related to estimated liabilities for uncertain tax positions +that would be realized if such liabilities are actually incurred. The deferred tax assets represent primarily the reduction in tax expense that would occur upon an increase of intercompany royalty +expense by various taxing authorities. Approximately $6.4 million of taxable income would have to be recognized to realize these deferred tax assets. +As +a result of certain accounting realization requirements, the table of deferred tax assets and liabilities shown above does not include certain deferred tax assets at +December 31, 2013 that arose +F-34 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. INCOME TAXES (Continued) +directly +from tax deductions related to equity compensation in excess of compensation recognized for financial reporting. Equity will be increased by $11.5 million if and when such deferred tax +assets are ultimately realized. We use ASC 740 with-and-without ordering for purposes of determining when excess tax benefits have been realized. +The +following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits during the years ended December 31, 2013, 2012 and 2011: +($ thousands) +2013 +2012 +2011 +Unrecognized tax benefit—January 1 +$ +31,900 +$ +44,537 +$ +33,042 +Gross increases—tax positions in prior period +572 +— +8,332 +Gross decreases—tax positions in prior period +(2,086 +) +(425 +) +— +Gross increases—tax positions in current period +3,743 +4,310 +4,689 +Settlements +(2,291 +) +(16,260 +) +(427 +) +Lapse of statute of limitations +(222 +) +(262 +) +(1,099 +) +Unrecognized tax benefit—December 31 +$ +31,616 +$ +31,900 +$ +44,537 +Unrecognized +tax benefits of $31.6 million, $31.9 million, and $44.5 million at December 31, 2013, 2012 and 2011, respectively, if recognized, would reduce +our annual effective tax rate offset by deferred tax assets recorded for uncertain tax positions. +Interest +and penalties related to income tax liabilities are included in income tax expense in the consolidated statement of operations. As of December 31, 2013, 2012 and 2011, we +recorded approximately $0.6 million, $0.6 million, and $1.0 million, respectively, of penalties and interest which resulted in a cumulative accrued balance of penalties and +interest of $5.0 million, $4.4 million, and $3.9 million at December 31, 2013, 2012 and 2011, respectively. +Unrecognized +tax benefits consist primarily of tax positions related to intercompany transfer pricing in multiple international jurisdictions. The gross increase for tax positions in +current and prior periods in 2013 of $4.3 million primarily includes specific transfer pricing exposures in various jurisdictions. We +believe that it is reasonably possible that a decrease of approximately $11.3 million in unrecognized tax benefits will occur in the next twelve months. Only a portion of this amount will be +recognized in our consolidated statements of operations due to balance sheet offsets. We do not believe we can reasonably estimate the effect of unrecognized tax benefits on our consolidated +statements of operations. +The +following table sets forth the remaining tax years subject to examination for the major jurisdictions where we conduct business as of December 31, 2013: +Netherlands +2007 to 2013 +Canada +2007 to 2013 +Japan +2007 to 2013 +China +2007 to 2013 +Singapore +2009 to 2013 +United States +2010 to 2013 +F-35 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. INCOME TAXES (Continued) +State +income tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains +subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. +12. EARNINGS PER SHARE +The following table illustrates the basic and diluted earnings per share ("EPS") computations for the years ended December 31, 2013, 2012 and 2011. See +Note 1—Organization & Summary of Significant Accounting Policies for additional detail regarding our EPS calculations. +Year Ended December 31, +($ thousands, except share and per share data) +2013 +2012 +2011 +Numerator +Net income attributable to common stockholders +$ +10,420 +$ +131,343 +$ +112,788 +Less: income allocated to participating securities +(36 +) +(645 +) +(1,014 +) +Net income attributable to common stockholders—basic and diluted +$ +10,384 +$ +130,698 +$ +111,774 +Denominator +Weighted average common shares outstanding—basic +87,988,798 +89,571,105 +88,317,898 +Plus: dilutive effect of stock options and unvested restricted stock units +1,100,675 +1,017,311 +1,663,484 +Weighted average common shares outstanding—diluted +89,089,473 +90,588,416 +89,981,382 +Net income attributable per common share: +Basic +$ +0.12 +$ +1.46 +$ +1.27 +Diluted +$ +0.12 +$ +1.44 +$ +1.24 +For +the years ended December 31, 2013, 2012 and 2011, 1.0 million, 1.4 million, and 1.1 million options and RSUs, respectively, were not included in the +calculation of diluted EPS as their effect would have been anti-dilutive. +Stock Repurchase Plan Authorizations +We continue to evaluate options to maximize the returns on our cash and maintain an appropriate capital structure, including, among +other alternatives, repurchases of our common stock. +On +December 26, 2013, the Board approved the repurchase of up to $350.0 million of our common stock. This authorization effectively replaced the Company's previous stock +repurchase authorizations. The number, price, structure and timing of the repurchases, if any, will be at the Company's sole discretion and future repurchases will be evaluated by the Company +depending on market conditions, liquidity needs and other factors. Share repurchases may be made in the open market or in privately negotiated transactions. The repurchase authorization does not have +an expiration date and does not oblige us to acquire any particular amount of our common stock. The Board may suspend, modify or terminate the repurchase program at any time without prior notice. +F-36 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. EARNINGS PER SHARE (Continued) +During +the three months ended December 31, 2013, we did not repurchase any shares associated with a publicly-announced repurchase plan. During the year ended December 31, +2013, we repurchased approximately 0.8 million shares at an average price of $14.99 for an aggregate price of approximately $12.5 million excluding related commission charges, under a +publicly-announced repurchase plan. +As +of December 31, 2013, subject to certain restrictions on repurchases under our revolving credit facility, we had $350.0 million of our common shares available for +repurchase under previously announced repurchase authorizations. +13. COMMITMENTS AND CONTINGENCIES +Rental Commitments and Contingencies +We rent space for our retail stores, offices, warehouses, vehicles, and equipment under operating leases expiring at various dates +through 2033. Certain leases contain rent escalation clauses (step rents) that require additional rental amounts in the later years of the term. Rent expense for leases with step rents or rent +holidays is recognized on a straight-line basis over the lease term beginning on the lease inception date. Deferred rent is included in the consolidated balance sheets in 'Accrued expenses and other +current liabilities.' +Future +minimum annual rental commitments under non-cancelable operating leases for each of the five succeeding years as of December 31, 2013, are as follows (in thousands): +Fiscal years ending December 31, +2014 +$ +83,831 +2015 +67,722 +2016 +51,939 +2017 +40,090 +2018 +32,222 +Thereafter +136,630 +Total minimum lease payments(1) +$ +412,434 +(1) Minimum +lease payments have not been reduced by minimum sublease rentals of $0.4 million due in the future under non-cancelable subleases. They also +do not include contingent rentals which may be paid under certain retail leases on a basis of percentage of sales in excess of stipulated amounts. +F-37 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. COMMITMENTS AND CONTINGENCIES (Continued) +The +following table summarizes the composition of rent expense under operating leases for the years ended December 31, 2013, 2012 and 2011 (in thousands): +Fiscal years ending December 31, +2013 +2012 +2011 +Minimum rentals(1) +$ +101,721 +$ +84,671 +$ +68,675 +Contingent rentals +18,178 +16,519 +13,639 +Less: Sublease rentals +(646 +) +(619 +) +(573 +) +Total rent expense +$ +119,253 +$ +100,571 +$ +81,741 +(1) Minimum +rentals include all lease payments as well as fixed and variable common area maintenance ("CAM"), parking and storage fees, which were approximately +$9.7 million, $8.5 million and $8.6 million during the years ended December 31, 2013, 2012 and 2011, respectively. +Purchase Commitments +As of December 31, 2013, we had purchase commitments with certain third party manufacturers for $172.3 million. As of +December 31, 2012, we had purchase commitments with certain third party manufacturers for $152.8 million, of which $5.9 million was for yet-to-be-received finished product where +title passes to us upon receipt. +In +February 2011, we renewed and amended our supply agreement with Finproject S.r.l. which provides us the exclusive right to purchase certain raw materials used to manufacture +our products. The agreement also provides that we meet minimum purchase requirements to maintain exclusivity throughout the term of the agreement, which expires December 31, 2014. Historically, +the minimum purchase requirements have not been onerous and we do not expect them to become onerous in the future. Depending on the material purchased, pricing is either based on contracted price or +is subject to quarterly reviews and fluctuates based on order volume, currency fluctuations and raw material prices. Pursuant to the agreement, we guarantee the payment for certain third party +manufacturer purchases of these raw materials up to a maximum potential amount of €3.5 million (approximately $4.8 million as of December 31, 2013), through a +letter of credit that was issued to Finproject S.r.l. +Government Tax Audits +We are regularly subject to, and are currently undergoing, audits by tax authorities in the United States and several foreign +jurisdictions for prior tax years. +In +April 2013, the State of Sao Paulo, Brazil government ("Brazil") assessed sales taxes, interest and penalties for the period April 2009 to May 2011. We had previously tendered these +taxes using Brazil obligations purchased at a discount from third parties. On May 22, 2013, we applied for amnesty in order to receive a significant reduction in penalties and interest, agreed +to amend our 2009 through 2012 tax returns to remove the Brazil obligations, and agreed to settle the assessment in cash to Brazil. In June 2013, cash payment was made to Brazil, in full satisfaction +of the Brazil assessment. Brazil is making court-ordered payments to holders of the Brazil obligations along with accrued interest. The Company anticipates that the Brazil obligations (plus accrued +interest) will be paid by Brazil in +F-38 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. COMMITMENTS AND CONTINGENCIES (Continued) +accordance +with the court-orders. The Company is carrying the Brazil obligations at the original discounted cost to the Company and intends to hold the Brazil obligations until paid by Brazil. The net +impact of the above is a $6.1 million charge to operating income recorded during the year ended December 31, 2013, and the carrying balance of the Brazil obligations as of +December 31, 2013 is $3.5 million, which is recorded in 'Other assets' on the consolidated balance sheets. +The +Company is currently undergoing a tax audit in Canada. We recently received a notice of proposed adjustment on certain transfer pricing items from the Canadian tax authorities, which +includes penalties and interest. The proposed adjustment, along with penalties and interest, is currently being reviewed by the Canada Transfer Pricing Review Committee with a decision expected by the +end of the first quarter in 2014. We intend to defend our position through litigation if necessary; however, the final outcome of tax audits and related litigation, including the assessment of +potentially significant penalties and interest, is inherently uncertain and could be materially different than that reflected in our historical income tax provisions and accruals and could have a +material adverse impact on our financial position, results of operations or cash flows. +See +Note 15—Legal Proceedings for further details regarding potential loss contingencies related to government tax audits and other current legal proceedings. +14. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +During the first quarter of 2013, we adjusted our operating segment structure for internal reports reviewed by the chief operating decision maker ("CODM") by presenting Japan separate +from the Asia Pacific segment. This change was made due to recurring amounts of substantial business activity as well as the macroeconomic environment within Japan, which resulted in the need for a +regular review of Japan operating results by management and the CODM in order to better evaluate performance and allocate resources for the consolidated business. Segment information for all periods +presented has been reclassified to conform to the fiscal 2013 presentation. +As +a result of the changes discussed above, we have four reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, Japan and Europe. We also +have an "Other businesses" category which aggregates insignificant operating segments that do not meet the reportable segment threshold and represent manufacturing operations located in Mexico, Italy +and Asia. The composition of our reportable operating segments is consistent with that used by our CODM to evaluate performance and allocate resources. +Each +of our reportable operating segments derives its revenues from the sale of footwear, apparel and accessories to external customers as well as intersegment sales. Revenues of the +"Other businesses" category are primarily made up of intersegment sales. The remaining revenues for the "Other businesses" represent non-footwear product sales to external customers. Intersegment +sales are not included in the measurement of segment operating income or regularly reviewed by the CODM and are eliminated when deriving total consolidated revenues. +The +primary financial measure utilized by the CODM to evaluate performance and allocate resources is segment operating income. Segment performance evaluation is based primarily on +segment results without allocating corporate expenses, or indirect general, administrative and other expenses. Segment profits or losses of our reportable operating segments include adjustments to +eliminate intersegment profit or losses on intersegment sales. As such, reconciling items for segment operating income represent unallocated corporate and other expenses as well as intersegment +eliminations. Segment +assets consist of cash and cash equivalents, accounts receivable and inventory as these balances are regularly reviewed by the CODM. +F-39 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +The +following tables set forth information related to our reportable operating business segments as of and for the years ended December 31, 2013, 2012 and 2011 +Year Ended December 31, +($ thousands) +2013 +2012 +2011 +Revenues: +Americas +$ +498,552 +$ +495,852 +$ +448,077 +Asia Pacific +342,752 +292,846 +226,961 +Japan +134,863 +164,565 +154,805 +Europe +216,259 +169,464 +170,869 +Total segment revenues +1,192,426 +1,122,727 +1,000,712 +Other businesses +254 +574 +191 +Total consolidated revenues +$ +1,192,680 +$ +1,123,301 +$ +1,000,903 +Operating income: +Americas +$ +61,894 +(1) +$ +85,538 +(1) +$ +70,532 +Asia Pacific +80,693 +(2) +74,535 +52,872 +Japan +37,560 +(3) +66,293 +71,046 +Europe +16,192 +21,678 +37,106 +Total segment operating income +196,339 +248,044 +231,556 +Reconciliation of total segment operating income to income before income taxes: +Other businesses +(20,811 +) +(10,805 +) +(14,128 +) +Intersegment eliminations +61 +60 +66 +Unallocated corporate and other(4) +(112,494 +) +(91,125 +) +(86,415 +) +Total consolidated operating income +63,095 +146,174 +131,079 +Foreign currency transaction (gains) losses, net +4,678 +2,500 +(4,886 +) +Interest income +(2,432 +) +(1,697 +) +(957 +) +Interest expense +1,016 +837 +853 +Other income, net +(126 +) +(1,014 +) +(621 +) +Income before income taxes +$ +59,959 +$ +145,548 +$ +136,690 +Depreciation and amortization: +Americas +$ +10,384 +$ +9,849 +$ +9,203 +Asia Pacific +5,032 +4,869 +3,764 +Japan +1,454 +2,053 +2,320 +Europe +5,108 +3,116 +2,584 +Total segment depreciation and amortization +21,978 +19,887 +17,871 +Other businesses +8,002 +7,003 +11,657 +Unallocated corporate and other(4) +11,526 +9,804 +7,735 +Total consolidated depreciation and amortization +$ +41,506 +$ +36,694 +$ +37,263 +(1) Includes +$3.9 million and $1.4 million for the years ended December 31, 2013 and 2012, respectively, of asset impairment charges +related to 23 and four underperforming retail locations, respectively. +(2) Includes +$0.2 million for the year ended December 31, 2013 of asset impairment charges related to two underperforming retail locations. +F-40 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +(3) Includes +$6.6 million for the year ended December 31, 2013 of asset impairment charges related to 35 underperforming retail locations. +(4) Includes +a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand marketing, legal, depreciation and amortization of corporate and other assets not allocated to operating segments and costs of the same nature related to certain +corporate holding companies. +The +following table sets forth asset information related to our reportable operating business segments as of December 31, 2013 and December 31, 2012: +($ thousands) +December 31, 2013 +December 31, 2012 +Assets: +Americas +$ +139,855 +$ +143,236 +Asia Pacific +177,343 +170,426 +Japan +51,155 +111,785 +Europe +137,701 +85,756 +Total segment current assets +506,054 +511,203 +Other businesses +14,093 +14,489 +Unallocated corporate and other(1) +63,743 +25,738 +Deferred tax assets, net +4,440 +6,284 +Income tax receivable +10,630 +5,613 +Other receivables +11,942 +24,821 +Prepaid expenses and other current assets +29,175 +24,967 +Total current assets +640,077 +613,115 +Property and equipment, net +86,971 +82,241 +Intangible assets, net +74,822 +59,931 +Deferred tax assets, net +19,628 +34,112 +Other assets +53,661 +40,239 +Total consolidated assets +$ +875,159 +$ +829,638 +(1) Corporate +assets primarily consist of cash and equivalents. +F-41 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +There +were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2013, 2012 and 2011. The following table sets forth certain +geographical and other information regarding our revenues during the years ended December 31, 2013, 2012 and 2011: +Year Ended December 31, +($ thousands) +2013 +2012 +2011 +Product: +Footwear +$ +1,155,377 +$ +1,076,210 +$ +956,816 +Other +37,303 +47,091 +44,087 +Total revenues +$ +1,192,680 +$ +1,123,301 +$ +1,000,903 +Location: +United States +$ +401,948 +$ +396,121 +$ +355,560 +International +790,732 +727,180 +645,343 +Total revenues +$ +1,192,680 +$ +1,123,301 +$ +1,000,903 +Foreign country revenues in excess of 10% of total revenues: +Japan +$ +134,863 +$ +164,565 +$ +154,805 +The +following table sets forth geographical information regarding our property and equipment assets as of December 31, 2013 and 2012: +December 31, +($ thousands) +2013 +2012 +Location: +United States +$ +56,262 +$ +47,587 +International +30,709 +34,654 +Total long-lived assets(1) +$ +86,971 +$ +82,241 +(1) Not +more than 10% of our long-lived assets resided in any individual foreign country in 2013 or 2012. +15. LEGAL PROCEEDINGS +We and certain current and former officers and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of Colorado. +The first complaint was filed in November 2007 and several other complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the district court appointed a lead +plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purports to state claims under Section 10(b), 20(a), and 20A of the Exchange Act on +behalf of a class of all persons who purchased our common stock between April 2, 2007 and April 14, 2008 (the "Class Period"). The amended complaint also added our independent auditor as +a defendant. The amended complaint alleges that, during the Class Period, the defendants made false and misleading public statements about us and our business and prospects and, as a result, the +market price of our common +F-42 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. LEGAL PROCEEDINGS (Continued) +stock +was artificially inflated. The amended complaint also claims that certain current and former officers and directors traded in our common stock on the basis of material non-public information. +The amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified amount, including interest, and also added attorneys' fees and costs of litigation. On +February 28, 2011, the District Court granted motions to dismiss filed by the defendants and dismissed all claims. A final judgment was thereafter entered. Plaintiffs subsequently appealed to +the United States Court of Appeals for the Tenth Circuit. We and those current and former officers and directors named as defendants have entered into a Stipulation of Settlement with the plaintiffs +that would, if approved by the United States District Court for the District of Colorado, resolve all claims asserted against us by the plaintiffs on behalf of the putative class, and plaintiffs' +appeal would be dismissed. Our independent auditor is not a party to the Stipulation of Settlement. The Stipulation of Settlement received preliminary approval from the District Court on +August 28, 2013. It remains subject to customary conditions, including final court approval following notice to stockholders. On February 13, 2014 a final settlement hearing took place +and the parties are awaiting a ruling in conjunction with the same. If the settlement becomes final, all amounts required by the settlement will be paid by our insurers. There can be no assurance that +the settlement will be finally approved by the District Court, or that approval by the District Court will, if challenged, be upheld by the Tenth Circuit. +On +October 27, 2010, Spectrum Agencies ("Spectrum") filed suit against our subsidiary, Crocs Europe B.V. ("Crocs Europe"), in the High Court of Justice, Queen's Bench +Division, Royal Courts of Justice in London, United Kingdom ("UK"). Spectrum acted as an agent for Crocs products in the UK from 2005 until Crocs Europe terminated the relationship on July 3, +2008 due to Spectrum's breach of its duty to act in good faith towards Crocs Europe. Spectrum alleges that Crocs Europe unlawfully terminated the agency relationship and failed to pay certain sales +commissions. A trial on the liability, not quantum (compensation and damages), was held at the High Court in London from November 30, 2011 to December 5, 2011. On December 16, +2011, the High Court of Justice issued a judgment that found that although Spectrum's actions were a breach of its duty to act in good faith towards Crocs Europe the breach was not sufficiently severe +to justify termination. We believe that the trial judge erred in his findings and subsequently appealed the judgment. On October 30, 2012, the Court of Appeal handed down its judgment +confirming the trial judge's findings. We submitted a request to the Supreme Court seeking permission to appeal. On April 24, 2013 the Supreme Court declined to grant permission to appeal. +Given that to date the legal proceedings in this case have only addressed liability, there have been no findings in relation to the amount of compensation or damages other than with respect to legal +fees. Under English law, the prevailing party is entitled to reimbursement of reasonable legal fees incurred in the proceedings. The trial of liability and quantum were split by the Court in the +interests of case management. The alleged quantum of damages has not been fully pleaded out and will be assessed as part of the forthcoming damages phase. A trial and judgment on damages is expected +in approximately 12 months. +We +are currently subject to an audit by U.S. Customs & Border Protection ("CBP") in respect of the period from 2006 to 2010. In the course of the audit, we identified certain +valuation errors and tendered approximately $1.4 million in additional duties. Subsequently, we identified additional value errors which will require the payment of additional duties totaling +approximately $0.7 million. The exact amount of this additional tender is subject to verification by CBP. In October 2013, CBP issued an +audit report to which we filed comments and objections. CBP has projected unpaid duties totaling approximately $12.4 million in connection with various classification errors during the period +under +F-43 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. LEGAL PROCEEDINGS (Continued) +review. +We have responded that these projections are erroneous and provided arguments that demonstrate the amount due in connection with this matter is considerably less than the amount projected. CBP +is currently reviewing this response. It is not possible at this time to predict whether our arguments will be successful in eliminating or reducing the amount in dispute. At this time, it is not +possible to determine when a formal notice of claim will be received from CBP. Likewise, it is not possible to predict whether CBP may seek to assert a claim for penalties in addition to any unpaid +duties. +Mexico's +Federal Tax Authority ("SAT") audited the period from January 2006 to July 2011. There were two phases to the audit, the first for capital equipment and finished goods and the +second for raw materials. The first phase was completed and no major discrepancies were noted by the SAT. On January 9, 2013, Crocs received a notice for the second phase in which the SAT +issued a tax assessment (taxes and penalties) of roughly 280.0 million pesos (approximately $22.0 million) based on the value of all of Crocs' imported raw materials during the audit +period. We believe that the proposed penalty amount is unfounded and without merit. With the help of local counsel we filed an appeal by the deadline of March 15, 2013. We have argued that the +amount due in connection with the matter, if any, is substantially less than that proposed by the SAT. In connection with the appeal, the SAT required us to post an appeal surety bond in the amount of +roughly 321.0 million pesos (approximately $26.0 million), which amount reflects estimated additional penalties and interest if we are not successful on our appeal. This amount will be +adjusted on an annual basis. We are currently awaiting a ruling from the Mexican courts. It is not possible at this time to predict the outcome of this matter or reasonably estimate any potential +loss. +As +of December 31, 2013, we have accrued a total of $11.8 million relating to these litigation matters and other disputes. We estimate that the ultimate resolution of these +litigation matters and other disputes could result in a loss that is reasonably possible between $0 and $10.6 million in the aggregate, in excess of the amount accrued. +Although +we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, we are not +party to any other pending legal proceedings that we believe will have a material adverse impact on our business, financial position, results of operations or cash flows. +16. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +2013 +($ thousands, except per share data) +Quarter Ended +March 31 +Quarter Ended +June 30 +Quarter Ended +September 30 +Quarter Ended +December 31 +Revenues +$ +311,656 +$ +363,827 +$ +288,524 +$ +228,673 +Gross profit +165,849 +200,867 +153,581 +102,901 +Asset impairment charges +— +202 +— +10,747 +Income (loss) from operations +37,650 +50,419 +17,907 +(42,881 +) +Net income (loss) +$ +28,961 +$ +35,356 +$ +13,036 +$ +(66,933 +) +Basic income (loss) per common share +$ +0.33 +$ +0.40 +$ +0.15 +$ +(0.76 +) +Diluted income (loss) per common share +$ +0.33 +$ +0.40 +$ +0.15 +$ +(0.76 +) +F-44 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (Continued) +2012 +($ thousands, except per share data) +Quarter Ended +March 31 +Quarter Ended +June 30 +Quarter Ended +September 30 +Quarter Ended +December 31 +Revenues +$ +271,798 +$ +330,942 +$ +295,569 +$ +224,992 +Gross profit +144,799 +196,085 +160,743 +106,350 +Asset impairment charges +713 +106 +— +591 +Income (loss) from operations +39,796 +71,261 +40,014 +(4,897 +) +Net income (loss) +$ +28,346 +$ +61,524 +$ +45,080 +$ +(3,607 +) +Basic income (loss) per common share +$ +0.32 +$ +0.68 +$ +0.50 +$ +(0.04 +) +Diluted income (loss) per common share +$ +0.31 +$ +0.68 +$ +0.49 +$ +(0.04 +) +During +the three months ended December 31, 2013, we recorded the following charges that affect the comparability of information between +periods: +• Tax expenses of $26.8 million related to our cash repatriation activities as well as a valuation allowance +adjustment. See Note 11—Income Taxes for further discussions regarding these charges. +• Retail asset impairment charges of $10.4 million for certain underperforming locations in our Americas, Asia +Pacific and Europe segments as well as $0.3 million in goodwill impairment charges. See Note 3—Property & Equipment and Note 4—Goodwill & +Intangible Assets for further discussions regarding these charges. +• Legal contingency accruals of $5.7 million recorded in selling, general and administrative expenses. See +Note 15—Legal Proceedings for further discussions regarding these charges. +• Inventory write-down charges of $3.4 million related to obsolete inventory including raw materials, footwear and +accessories. See Note 2—Inventories for further discussions regarding these charges. +• Professional services fees of $1.1 million associated with our recent investment agreement with Blackstone and cash +repatriation activities. See Note 17—Subsequent Events for further discussions regarding these charges. +17. SUBSEQUENT EVENTS +Accounting Standards Update No. 2010-09 to ASC Topic 855, Subsequent Events , requires the Company to disclose the date through +which subsequent events have been evaluated. The Company has evaluated subsequent events through the date the financial statements were issued, and has determined there are no other subsequent events +to be reported, other than as follows: +Issuance of Series A Convertible Preferred Stock to Blackstone +On January 27, 2014, we issued to Blackstone, and certain of its permitted transferees, 200,000 shares of our Series A +Preferred Stock for an aggregate purchase price of $198.0 million, or $990 per share, pursuant to an Investment Agreement between us and Blackstone, dated December 28, 2013 (as amended, +the "Investment Agreement"). In connection with the issuance of the Series A Preferred Stock (the "Closing") and pursuant to the Investment Agreement, we paid Blackstone a closing fee of +$2.0 million and reimbursed Blackstone's transaction fees and expenses of approximately $4.0 million. +F-45 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +17. SUBSEQUENT EVENTS (Continued) +Prior +to the Closing, we filed with the Secretary of State of the State of Delaware a Certificate of Designations of Series A Convertible Preferred Stock (the "Certificate of +Designations") creating the Series A Preferred Stock and establishing the designations, preferences, and other rights of the Series A Preferred Stock. The Certificate of Designations +became effective upon filing. The Series A Preferred Stock ranks senior to our common stock with respect to dividend rights and rights on liquidation, winding-up and dissolution. The +Series A Preferred Stock has a stated value of $1,000 per share, and holders of Series A Preferred Stock are entitled to cumulative dividends payable quarterly in cash at a rate of 6% +per annum. If we fail to make timely dividend payments, the dividend rate will increase to 8% per annum until such time as all accrued but unpaid dividends have been paid in full. Holders of +Series A Preferred Stock are entitled to receive dividends declared or paid on our common stock and are entitled to vote together with the holders of our common stock as a single class, in each +case, on an as-converted basis. Holders of Series A Preferred Stock have certain limited special approval rights, including with respect to the issuance of pari +passu or senior equity securities of the Company. +The +Series A Preferred Stock is convertible at the option of the holders at any time after the Closing into shares of common stock at an implied conversion price of $14.50 per +share, subject to adjustment. At our election, all or a portion of the Series A Preferred Stock will be convertible into the relevant number of shares of common stock on or after the third +anniversary of the Closing, if the closing price of the common stock equals or exceeds $29.00 for 20 consecutive trading days. The conversion rate is subject to customary anti-dilution and other +adjustments subject to certain share caps and other restrictions. +At +any time after the eighth anniversary of the Closing, we will have the right to redeem and the holders of the Series A Preferred Stock will have the right to require us to +repurchase, all or any portion of the Series A Preferred Stock at 100% of the stated value thereof plus all accrued but unpaid dividends. Upon certain change of control events involving us, the +holders can require us to repurchase the Series A Preferred Stock at 101% of the stated value thereof plus all accrued but unpaid dividends. +The +Investment Agreement grants Blackstone certain rights to designate directors to serve on our Board. For so long as Blackstone and its permitted transferees (i) beneficially +own at least 95% of the Series A Preferred Stock or the as-converted common stock purchased pursuant to the Investment Agreement or (ii) maintain beneficial ownership of at least 12.5% +of the our outstanding common stock (the "Two-Director Threshold"), Blackstone will have the right to designate for nomination two directors to our Board. For so long as Blackstone and its permitted +transferees beneficially own shares of Series A Preferred Stock or the as-converted common stock purchased pursuant to the Investment Agreement that represent less than the Two-Director +Threshold but more than 25% of the number of shares of the as-converted common stock purchased pursuant to the Investment Agreement, Blackstone will have the right to designate for nomination one +director to our Board. The directors designated by Blackstone are entitled to serve on Board committees, subject to applicable law and stock exchange +rules, and one of such directors must be appointed to the newly-formed committee tasked with identifying a new chief executive officer to fill the vacancy resulting from Mr. McCarvel's +resignation. +Pursuant +to the Investment Agreement, Blackstone is subject to certain standstill restrictions which restrict Blackstone from acquiring more than 25% of our outstanding common stock +until the date on which Blackstone is no longer entitled to designate any directors to the Board. In addition, subject to certain customary exceptions, Blackstone is restricted from transferring the +Series A Preferred Stock +F-46 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +17. SUBSEQUENT EVENTS (Continued) +until +the second anniversary of the Closing and, for so long as any Series A Preferred Stock is outstanding, may not transfer the Series A Preferred Stock to certain of our competitors +(as defined in the Investment Agreement) or holders of 25% or more of our common stock. Blackstone also has certain preemptive rights and information rights under the Investment Agreement, which are +subject to certain conditions. +Registration Rights Agreement +On January 27, 2014, we and the Blackstone Purchasers entered into a Registration Rights Agreement (the "Registration Rights +Agreement"), pursuant to which we have agreed to provide to the Blackstone Purchasers certain customary demand and piggyback registration rights in respect of the shares of Series A Preferred +Stock and any shares of common stock issued upon conversion of the Series A Preferred Stock. The Registration Rights Agreement contains customary terms and conditions, including certain +customary indemnification obligations. +Director Resignations and Appointments of New Directors +On January 24, 2014, Stephen Cannon and Jeffrey Margolis resigned from the Board, effective upon the Closing. Neither +Mr. Cannon's nor Mr. Margolis's decision to resign was the result of any disagreement with us on any matter relating to our operations, policies or practices. +Effective +upon the Closing, the Board appointed Prakash Melwani to serve as a Class III director and Gregg Ribatt to serve as a Class I director to fill the vacancies on +the Board resulting from the resignations of Messrs. Cannon and Margolis. Messrs. Melwani and Ribatt were designated by Blackstone for election to the Board in accordance with the terms +of the Investment Agreement. +F-47 \ No newline at end of file diff --git a/raw/filings/0001334036/2013/0001047469-14-001323/filing_metadata.csv b/raw/filings/0001334036/2013/0001047469-14-001323/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..c391478f11b22bee8fce306aba453d2ba4cd7bd9 --- /dev/null +++ b/raw/filings/0001334036/2013/0001047469-14-001323/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2014-02-25,2013-12-31,2014-02-25T22:17:35.000Z,0001047469-14-001323,a2218528z10-k.htm,10-K,17259162,1,0,https://www.sec.gov/Archives/edgar/data/1334036/000104746914001323/a2218528z10-k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000104746914001323/,2013,2013,1 diff --git a/raw/filings/0001334036/2013/0001047469-14-001323/item1.txt b/raw/filings/0001334036/2013/0001047469-14-001323/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..ce91722b4950ee10882a45b9d7f3048f985d06b5 --- /dev/null +++ b/raw/filings/0001334036/2013/0001047469-14-001323/item1.txt @@ -0,0 +1,558 @@ +ITEM 1. Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the "Company," "we," "our" or "us") are engaged in the design, +development, manufacturing, worldwide marketing and distribution of casual lifestyle footwear, apparel and accessories for men, women and children. We strive to be the global leader in the sale of +molded footwear featuring fun, comfort, color and functionality. Our products include footwear and accessories that utilize our proprietary closed-cell resin, called Croslite. The use of this unique +material enables us to produce innovative, lightweight, non-marking, and odor-resistant footwear. We currently sell our products in more than 90 countries through domestic and international retailers +and distributors and directly to end-user consumers through our company-operated retail stores, outlets, kiosks and webstores. +In +2002, we launched the marketing and distribution of our original clog style footwear in the United States. The unique characteristics of Croslite enabled us to offer consumers a shoe +unlike any other footwear model then available. Since the initial introduction and popularity of the Beach and Crocs Classic designs, we have expanded our Croslite products to include a variety of new +styles and products and have further extended our product reach through the acquisition of brand platforms such as Jibbitz, LLC ("Jibbitz") and Ocean Minded, Inc. ("Ocean Minded"). We +intend to continue to expand the breadth of our footwear product lines, bringing a unique and original perspective to the consumer in styles that may be unexpected from Crocs. We believe this will +help us to continue to build a stable year-round business as we move toward becoming a four-season brand. +The +broad appeal of our footwear has allowed us to market our products to a wide range of distribution channels, including department stores and traditional footwear retailers as well as +a variety of specialty and independent retail channels. Our marketing efforts surround specific product launches and employ a fully integrated approach utilizing a variety of media outlets, including +print and websites. Our marketing efforts drive business to both our wholesale partners and our company-operated retail and internet stores, ensuring that our presentation and story are first class +and drive purchasing at the point of sale. +As +a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. Sales in international markets in foreign currencies are expected to +continue to represent a substantial portion of our revenues. Likewise, we expect our subsidiaries with functional currencies other than the U.S. dollar will continue to represent a substantial portion +of our overall gross margin and related expenses. Accordingly, changes in foreign currency exchange rates could materially affect revenues and costs or the comparability of revenues and costs from +period to period as a result of translating our financial statements into our reporting currency. +Products +Footwear +Our footwear product offerings have grown significantly since we first introduced the single-style clog in six colors, in 2002. We +currently offer a wide variety of footwear products, some of which includes boots, sandals, sneakers, mules and flats, which are made of materials like leather and textile fabrics as well as Croslite. +Footwear sales made up 96.9%, 95.8% and 95.6% of total revenues for the years ended December 31, 2013, 2012 and 2011, respectively. During the years ended December 31, 2013, 2012 and +2011, approximately 71.1%, 75.3% and 73.1%, respectively, of unit sales consisted of products geared toward adults compared to 28.9%, 24.7% and 26.9%, respectively, of unit sales of products geared +towards children. +2 +Table of Contents +A +key differentiating feature of our footwear products is the Croslite material, which is uniquely suited for comfort and functionality. Croslite is carefully formulated to be of a +density that creates extremely lightweight, comfortable and non-marking footwear which conforms to the shape of the foot and increases comfort. Croslite is a closed-cell resin material which is water +resistant, virtually odor free and allows many of our footwear styles to be cleaned simply with water. As we have expanded our product offering, we have incorporated traditional materials such as +textile fabric and leather into many new styles; however, we continue to utilize the Croslite material for the foot bed, sole and other key structural components for many of these styles. +We +strive to provide our global consumer with a year-round product assortment featuring comfort, fun, color and innovation. Our collections are designed to meet the needs of the family +by focusing on their key wearing occasions. Our goal is to deliver world-class product assortments for the family with all of the comfort features and benefits Crocs is known for. Our products are +divided into three product offerings: Core, Style and Active. +Core Products +At the heart of our brand resides the Classic, our first and most iconic style for adults and kids that embodies our innovation in +molding and design, delivers all-day comfort, and has established a new category in the footwear marketplace. The unique look and feel of the Classic can be experienced throughout our entire product +line due to the design and application of our proprietary material Croslite. Dual density technology, warm lined styles, seasonal flips and slides drive additional business to our core molded product +line introduced in 2002. Licensed style partnerships from Disney, Sanrio, Nickelodeon and Warner Bros. provide popularity to our kids core line along with our kids-only product innovations including +color-change materials, lights and interactive elements. In addition, we have extended our licensing partnerships to sports leagues such as Major League Baseball and the NCAA and artists such as Van +Gogh, Mondo Guerra and Jon Burgerman. Our core molded products are available to all channels of distribution and span both stylish and active wearing occasions for the entire family. +Style Products +Our Style Category showcases collections designed for the family around casual and stylish wearing occasions with a relaxed and fun +point of view. This category is primarily designed for our consumers shopping in footwear, department stores, specialty/independent and our own direct-to-consumer channel. +Stretch +Sole +Launched +in Spring 2014, Stretch Sole featuring Fit2U technology represents the ultimate of 360 degree fit-to-you comfort and molding innovation. Our new proprietary platform is intended +to raise the bar of combined comfort and style. Launched exclusively in our direct-to-consumer channel and premium wholesale accounts, Stretch Sole is the latest addition to our collection of +comfort-enhancing technologies and designs. +Translucents +The +beauty of molding is best expressed in our Translucents collection, first introduced in 2011 with the goal of providing our female consumer with new and innovative styles. +Translucents, a beautiful and opaquely colorful collection of flats, sandals, flips and clogs, have become a summer staple for women and girls looking for the ultimate combination of comfort and style +for the spring and summer months. +3 +Table of Contents +A'Leigh +This +day-to-night collection showcases traditionally stylish and natural materials including leather, canvas, cork and wood combined with our proprietary Croslite material in a variety +of simple, fashionable wedge silhouettes. This combination of comfort and style has proven to be compelling for our female consumers looking to expand their wearing occasions with our brand. +Canvas +Collection +A +staple for the family, our collection of casual canvas loafers including Walu, Santa Cruz and the Cabo provide industry-leading comfort cushioning via our Croslite footbeds and +outsoles combined with simple, easy to wear, casually stylish uppers suitable for a day at the office and a night at the movies. +Active Products +Our Active Category showcases collections designed with an active-casual point of view, catering to on-the-go families with busy +lifestyles. These collections are primarily found in sport, footwear, specialty/independent retailers and our own direct-to-consumer channel. +Busy +Day +Designed +with the busy mom in mind, the Busy Day collection drives a casually active design through a wide variety of silhouettes including flats, Mary Janes, sneakers and slip-ons. This +collection is instantly recognizable from its simple sleek styling, easy on-and-off designs, Croslite outsole and drop-in Croslite footbed designed for maximum comfort and cushioning for all-day wear. +The collection will expand in 2014 to include Busy Day styles designed for active boys and girls. +Outdoor/Active +Sandals and Boots +Season +after season, our Outdoor/Active Sandals and Boot Collections provide opportunities for wearing occasions for the family celebrating the outdoors and the change of seasons from +sun to rain to snow. Our collections around Yukon Sport, Real Tree™, Swiftwater Sandals, Handle It and Jaunt Rain Boots and Crocband and Gust Winter Boots offer a variety of fun and +comfortable seasonal options for every member of the family. +Crocs +Golf +Introduced +in 2012, our Crocs Golf Collection won the Best New Product at the 2012 PGA Show and Editor's Pick at the 2013 PGA Show. Combining the best of casual golf styles and +outstanding underfoot comfort via our proprietary Croslite material, the Crocs Golf line provides a number of outstanding styles for casual golfers. +Crocs +Professional Footwear Division (PFD) +Providing +solutions to our consumers in Healthcare, Food and Beverage and Light Industrial, we combine the comfort of Croslite with purpose-built benefits including slip-resistance, +seamless uppers and electrical hazard safety in our Professional Footwear Division product collection. +As +a global leader in casual footwear, we recognize the responsibility we have to our employees and the global communities we serve. We strive to maintain a spirit of "giving back" as a +part of the Crocs culture and worldwide reputation. With the help of our donation partners, we are able to provide shoes to millions of individuals. We have donated over three million pairs of shoes +to individuals in need both domestically and internationally in more than 40 countries including Democratic Republic of +4 +Table of Contents +The +Congo, Haiti, Iraq, and Malawi. These donations and other social responsibility initiatives, form the Crocs Cares program. Crocs is dedicated to providing robust programs, donations, and community +work opportunities designed to make a difference in the lives of our employees as well as both local and global communities. +Accessories +In addition to our footwear brands, we own the Jibbitz brand, a unique accessory product-line with colorful snap-on charms specifically +suited for Crocs shoes. We acquired Jibbitz in December 2006 and have expanded the product line to include a wide variety of charms in varying shapes and sizes, with designs such as flowers, sports +gear, seasonal and holiday designs, animals, symbols, letters and rhinestones. Crocs licensing agreements also extend to Jibbitz, which allows Jibbitz to create designs bearing logos and emblems of +Disney, Nickelodeon and the Crocs collegiate line, among others. Jibbitz designs allow Crocs consumers to personalize their footwear to creatively express their individuality. More than 3,000 unique +Jibbitz charm designs have been sold to consumers for personalizing their Crocs footwear. Sales from Jibbitz designs made up 2.8%, 3.5% and 3.7% of total revenues for the years ended +December 31, 2013, 2012 and 2011, respectively. +Sales and Marketing +Each season, we focus on presenting a compelling "brand story and experience" for our new product collections and our broader casual +lifestyle assortment. Our marketing efforts center on multi-level story-telling across diverse wearing occasions and product silhouettes. +As +we are a global brand, our marketing model is based on global relevance while still allowing for regional flexibility in execution and message. At the regional or market level, +campaigns are initiated using a mix of digital, social, and traditional media outlets that align with local marketplaces and target consumer dynamics. This strategy allows for relevant cross-channel +input coordinated through our global brand objectives to drive an aligned global marketing and brand strategy. +We +utilize an in-house creative team to execute our marketing efforts. Local marketing teams focus on localizing campaigns by establishing and executing marketing programs to effectively +engage target customers in a meaningful manner. We utilize a proprietary Brand Performance System to help prioritize demand generation initiatives and optimize local marketing activities. The Brand +Performance System integrates multiple research and consumer database platforms across key markets to provide guidance on highest yielding customer growth opportunities and market performance +analysis. +We +have three primary sales channels: wholesale, retail and internet (discussed at a more detailed level below). Our marketing efforts are aimed toward driving business to both our +wholesale partners and our company-operated retail and internet stores. Our marketing efforts in the wholesale and retail channels are focused on visual product merchandising with alignment on key +stories, activation materials and creative materials. Retail stores provide a unique opportunity to engage with customers in a three-dimensional manner. Strong emphasis is placed on making the store +experience a meaningful and memorable showcase of our larger assortment of casual lifestyle footwear and key new product launches. Our marketing, merchandising, and visual merchandising departments +work closely together to ensure the store environment and merchandise are aligned to support key seasonal product stories while promoting the larger product lines and iconic product collections. +We +have an in-house digital marketing team that oversees digital marketing programs and platforms that include paid-and-organic search, display, re-targeting, email and affiliate +marketing to drive new customers to the brand and retain existing customers. Under our universal seasonal brand campaign, the team helps to adapt key brand story content and produces additional +web-specific content for our internet channel. +5 +Table of Contents +Wholesale Channel +During the years ended December 31, 2013, 2012 and 2011, approximately 56.5%, 57.5% and 59.8% of net revenues, respectively, +were derived from sales through the wholesale channel which consists of sales to distributors and third party retailers. Wholesale customers include +national and regional retail chains, department stores, sporting goods stores, independent footwear retailers and family footwear retailers, such as Academy, Rack Room Shoes, Famous Footwear, Kohl's, +DSW, Shoe Carnival, Dick's Sporting Goods, Nordstrom, Xebio and Murasaki Sports, as well as on-line retailers such as Amazon and Zappos. No single customer accounted for 10% or more of our revenues +for any of the years ended December 31, 2013, 2012 and 2011. +We +use third party distributors in select markets where we believe such arrangements are preferable to direct sales. These third party distributors purchase products pursuant to a price +list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to four years, are +generally terminable on 30 days prior notice and have minimum sales requirements. Many of our agreements allow us to accept returns from wholesale customers at our discretion for defective +products, quality issues and shipment errors on an exception basis or, for certain wholesale customers, extend pricing discounts in lieu of defective product returns. We also may accept returns from +our wholesale customers, on an exception basis, for the purpose of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, we may provide markdown +allowances to key wholesale customers to facilitate in-channel product markdowns where sell-through is less than anticipated. +Consumer Direct Channels +Consumer direct sales channels include retail and internet channels and serve as an important and effective means to enhance our +product and brand awareness as they provide direct access to our consumers and an opportunity to showcase our entire line of footwear and accessory offerings. Consequently, we view the consumer direct +channels to be complementary to our wholesale channel. +Retail Channel +During the years ended December 31, 2013, 2012 and 2011, approximately 35.0%, 33.4% and 30.6%, respectively, of our net revenues +were derived from sales through our retail channel. We operate our retail channel through three integrated platforms: full retail locations, outlet locations, and kiosk/store-in-store locations. Our +three types of store platforms enable us to organically promote the breadth of our product in high-traffic, highly visible locations. Our strategy for expanding our global retail business is to +increase our market share in a disciplined manner, by selectively opening additional stores in new and existing markets, as well as increasing sales in existing stores, to support our long-term +strategic growth objective to further build Crocs into the leading casual lifestyle footwear brand in the world. As store growth will vary in new and existing markets due to many factors, including +maturity of the market and brand recognition, we periodically evaluate the fixed assets and leasehold improvements related to our retail locations for impairment. +• Full Retail Locations +Our +company-operated retail locations allow us to effectively showcase the full extent of our new and existing products to customers at retail pricing. In addition, our full retail locations enable us +to interact with our customers on a personal level in order to guarantee a satisfying shopping experience as well as to obtain key retail metrics to better fulfill customer demands. On average, the +optimal space for our retail locations is between approximately 1,500 and 1,800 square feet, depending on the geographical vicinity of the property, and typically located in high-traffic shopping +malls or districts. In early 2014, we opened a three-story flagship location with approximately 4,500 square feet of selling space in a 13,600 square foot building located on +6 +Table of Contents +34 th Street +in New York. As of December 31, 2013, 2012, and 2011, we operated 327, 287 and 180 global full retail stores, respectively. +• Outlet Locations +Our +company-operated outlet locations allow us to sell discontinued and overstock merchandise directly to consumers at discounted prices. We additionally sell full priced products in certain of our +outlet stores. Outlet locations follow a similar size model as our full retail stores; however, they are generally located within outlet shopping locations. As of December 31, 2013, 2012 and +2011, we operated 170, 129 and 92 global outlet stores, respectively. +• Kiosk/Store-in-Store Locations +Our +company-operated kiosks and store-in-store locations allow us to market specific product lines with the further flexibility to tailor products to consumer preferences in shopping malls and other +high foot traffic areas. With bright and colorful displays, efficient use of retail space, and limited initial capital investment, we believe that kiosks can be an effective outlet for marketing our +products. As part of our overall retail strategy, we continue to close certain kiosks/store-in-store locations, as we believe our full retail and outlet locations allow us to better merchandise the +full extent and depth of our product line. As of December 31, 2013, 2012 and 2011, we operated 122, 121 and 158 global kiosks and store-in-stores, respectively. +7 +Table of Contents +The +following table illustrates the net growth in 2013 with respect to the number of our company-operated retail locations by reportable operating segment and country: +Company-operated retail locations: +December 31, +2012 +Opened +Closed +December 31, +2013 +Americas +U.S. +170 +30 +(14 +) +186 +Canada +12 +2 +(1 +) +13 +Brazil +8 +1 +(1 +) +8 +Puerto Rico +7 +— +— +7 +Argentina +1 +1 +— +2 +Chile +1 +— +(1 +) +— +Total Americas +199 +34 +(17 +) +216 +Asia Pacific +Korea +63 +17 +(4 +) +76 +Taiwan +39 +27 +(8 +) +58 +China +43 +2 +(7 +) +38 +Hong Kong +17 +8 +(4 +) +21 +Singapore +14 +2 +(1 +) +15 +Australia +11 +1 +(1 +) +11 +United Arab Emirates (UAE) +8 +2 +(1 +) +9 +South Africa +6 +2 +— +8 +Total Asia Pacific +201 +61 +(26 +) +236 +Japan +40 +11 +(2 +) +49 +Europe +Russia +29 +7 +— +36 +Germany +18 +6 +(4 +) +20 +Great Britain +16 +2 +(1 +) +17 +France +7 +7 +— +14 +Netherlands +8 +1 +— +9 +Finland +6 +1 +— +7 +Spain +6 +— +— +6 +Belgium +3 +— +— +3 +Italy +— +2 +— +2 +Sweden +2 +— +— +2 +Ireland +1 +— +— +1 +Portugal +1 +— +— +1 +Total Europe +97 +26 +(5 +) +118 +Total company-operated retail locations +537 +132 +(50 +) +619 +Internet Channel +As of December 31, 2013, we offered our products through 43 company-operated internet webstores worldwide. During the years +ended December 31, 2013, 2012 and 2011, approximately 8.5%, 9.1% and 9.6%, respectively, of our net revenues were derived from sales through our internet channel. Our internet presence enables +us to have increased access to our customers and provides us with an opportunity to educate them about our products and brand. We continue to expand our web-based marketing efforts to increase +consumer awareness of our full product range and have begun expanding the implementation of locally executed internet web stores at the regional level. +8 +Table of Contents +Business Segments and Geographic Information +During the first quarter of 2013, we adjusted our operating segment structure for internal reports reviewed by the chief operating +decision maker ("CODM") by presenting Japan separate from the Asia Pacific segment. This change was made due to recurring amounts of substantial business activity as well as the macroeconomic +environment within Japan, which resulted in the need for a regular review of Japan operating results by management and the CODM in order to better evaluate performance and allocate resources for the +consolidated business. See Note 14—Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements for additional financial +information regarding our operating segments. Segment information for all periods presented has been reclassified to conform to the fiscal 2013 presentation. +As +a result of the changes discussed above, we have four reportable operating segments based on the geographic nature of our operations: Americas, Asia Pacific, Japan and Europe. We also +have an "Other businesses" category which aggregates insignificant operating segments that do not meet the reportable segment threshold and represents manufacturing operations located in Mexico, Italy +and Asia. The composition of our reportable operating segments is consistent with that used by our CODM to evaluate performance and allocate resources. +Each +of our reportable operating segments derives its revenues from the sale of footwear, apparel and accessories to external customers as well as intersegment sales. Revenues of the +"Other businesses" category are primarily made up of intersegment sales. The remaining revenues for the "Other businesses" represent non-footwear product sales to external customers. Intersegment +sales are not included in the measurement of segment operating income or regularly reviewed by the CODM and are eliminated when deriving total consolidated revenues. +The +primary financial measure utilized by the CODM to evaluate performance and allocate resources is segment operating income. Segment performance evaluation is based primarily on +segment results without allocating corporate expenses, or indirect general, administrative and other expenses. Segment profits or losses of our reportable operating segments include adjustments to +eliminate intersegment profit or losses on intersegment sales. As such, reconciling items for segment operating income represent unallocated corporate and other expenses as well as intersegment +eliminations. Segment assets consist of cash and cash equivalents, accounts receivable and inventory as these balances are regularly reviewed by the CODM. +Americas +The Americas segment consists of revenues and expenses related primarily to product sales in the North and South America geographic +regions. Regional wholesale channel customers consist of a broad range of sporting goods and department stores as well as specialty retailers and distributors. The regional retail channel sells +directly to the consumer through 216 company-operated store locations as well as through webstores. During the years ended December 31, 2013, 2012 and 2011, revenues from the Americas segment +constituted approximately 41.9%, 44.1% and 44.7% of our consolidated revenues, respectively. +Asia Pacific +The Asia Pacific segment consists of revenues and expenses related primarily to product sales throughout Asia (excluding Japan), +Australia, New Zealand, the Middle East and South Africa. The Asia Pacific wholesale channel consists of sales to a broad range of retailers similar to the wholesale channel we have established in the +Americas segment. We also sell products directly to the consumer through 236 company-operated stores as well as through our webstores. During the years ended December 31, 2013, 2012 and 2011, +revenues from the Asia segment constituted 28.7%, 26.1% and 22.7% of our consolidated revenues, respectively. +9 +Table of Contents +Japan +The Japan segment consists of revenues and expenses related to product sales in Japan. The Japan wholesale channel consists of sales to +a broad range of retailers similar to the wholesale channel we have established in the Americas segment. The regional retail channel sells directly to the consumer through 49 company-operated store +locations as well as through webstores. During the years ended December 31, 2013, 2012 and 2011, revenues from the Japan segment constituted approximately 11.3%, 14.7% and 15.5% of our +consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related primarily to product sales throughout Europe and Russia. The Europe +segment wholesale channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas segment. We also sell our products directly to the +consumer through 118 company-operated stores as well as through our webstores. During the years ended December 31, 2013, 2012 and 2011, revenues from the Europe segment constituted 18.1%, 15.1% +and 17.1% of our consolidated revenues, respectively. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network so as to further streamline our supply chain, increase +our speed to market and lower operating costs. During the year ended December 31, 2013, we stored our raw material and finished goods inventories in company-operated warehouse and distribution +facilities located in the United States, Mexico, the Netherlands, Japan, Finland, South Africa, Russia and Italy. We also utilize distribution centers which are operated by third parties located in +the United States, China, Japan, Hong Kong, Australia, Korea, Singapore, India, Taiwan, the United Arab Emirates, Russia, Brazil, Argentina, Chile, Puerto Rico and Italy. Throughout 2013, we continued +to engage in efforts to consolidate our global warehouse and distribution facilities to maintain a lean cost structure. As of December 31, 2013, our company-operated warehouse and distribution +facilities provided us with approximately 1.0 million square feet and our third party operated distribution facilities provided us with approximately 0.4 million square feet. We also +ship a portion of our products directly to our customers from our internal and third party manufacturers. We are actively pursuing initiatives aimed at shipping more of our product directly to our +customers in an effort to lower future cost of sales. +Raw Materials +"Croslite", our branded proprietary closed-cell resin, is the primary raw material used in the majority of our footwear and some of our +accessories. Croslite is soft and durable and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and development in order to refine our +materials to enhance these properties and to target the development of new properties for specific applications. +Croslite +material is produced by compounding elastomer resins, that we or one of our third party processors purchase from major chemical manufacturers, together with certain other +production inputs such as color dyes. At this time, we have identified multiple suppliers that produce the elastomer resins used in the Croslite material. We may, however, in the future identify and +utilize materials produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use to +produce the Croslite products are readily available for purchase from multiple suppliers. +Since +our inception, we have substantially increased the number of footwear products that we offer. Many of our new products are constructed using leather, textile fabrics or other +non-Croslite materials. We, or our third party manufacturers, obtain these materials from a number of third party +10 +Table of Contents +sources +and we believe these materials are broadly available. We also outsource the compounding of the Croslite material and continue to purchase a portion of our compounded raw materials from a third +party in Europe. +Design and Development +We continue to dedicate significant resources to product design and development as we develop footwear styles based on opportunities we +identify in the marketplace. Our design and development process is highly collaborative, as members of the regional design teams, including our EXO Italia ("EXO") location, which specializes in EVA +(Ethylene Vinyl Acetate) based finish products for the footwear industry, frequently meet with sales and marketing staff, production and supply managers and certain of our retail customers to further +refine our products to meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs while +maintaining product quality. We spent $15.4 million, $12.0 million and $10.8 million in research, design and development activities for the years ended December 31, 2013, +2012 and 2011, respectively. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have company-operated +production facilities in Mexico and Italy. We also contract with third party manufacturers to produce certain of our footwear styles or provide support to our internal production processes. We believe +that our internal manufacturing capabilities enable us to rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high demand models and colors +throughout the year, while outsourcing allows us to capitalize on the efficiencies and cost benefits of using contracted manufacturing services. We believe this strategy will continue to minimize our +production costs, increase overall operating efficiencies and shorten production and development times. +In +the years ended December 31, 2013, 2012 and 2011, we manufactured approximately 15.1%, 21.1% and 20.6%, respectively, of our footwear products internally. We sourced the +remaining footwear production from multiple third party manufacturers primarily in China, Vietnam, Eastern Europe and South America. During the years ended December 31, 2013, 2012 and 2011, our +largest third-party manufacturer in China produced approximately 28.0%, 31.7% and 33.1%, respectively, of our footwear +unit volume. We do not have written supply agreements with our primary third party manufacturers in Asia. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress and patent protection to establish, protect and enforce our +intellectual property rights in our product designs, brand, materials and research and development efforts, although no such methods can afford complete protection. We own or license the material +trademarks used in connection with the marketing, distribution and sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or +manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China and Canada +among other places. We also have registrations or pending trademark applications for the marks Jibbitz, Jibbitz Logo, YOU by Crocs, YOU by Crocs Logo, Ocean Minded, Tail Logo, Bite, Bite Logo, +Crocband, Crocs Tone and Crocs Littles, "Croslite" and the Croslite logo, as well as other marks in various countries around the world. +In +the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks registered within and outside of the U.S. +are generally valid as long +11 +Table of Contents +as +they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks are crucial to the successful marketing and sale of our +products. We intend to continue to strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the future. We will also +continue to aggressively police our patents, trademarks and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We +consider the formulations of the materials covered by our trademark Croslite and used to produce our shoes to be a valuable trade secret. Croslite material is manufactured through a +process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the +formula by using exclusive supply agreements for key components, confidentiality agreements with our third party processors and by requiring our employees to execute confidentiality agreements +concerning the protection of our confidential information. Other than our third party processors, we are unaware of any third party using our formula in the production of shoes. We believe the comfort +and utility of our +products depend on the properties achieved from the compounding of Croslite material and constitute a key competitive advantage for us, and we intend to continue to vigorously protect this trade +secret. +We +also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors and retailers, as well as outside +investigators and attorneys, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and +distributors are also educated on our patents, pending patents, trademarks and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of +certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for +our intellectual property in certain jurisdictions. +Seasonality +Due to the seasonal nature of our footwear which is more heavily focused on styles suitable for warm weather, revenues generated during +our first and fourth quarters are typically less than revenues generated during our second and third quarters, when the northern hemisphere is experiencing warmer weather. We continue to expand our +product line to include more winter oriented styles to mitigate some of the seasonality of our revenues. Our quarterly results of operations may also fluctuate significantly as a result of a variety +of other factors, including the timing of new model introductions or general economic or consumer conditions. Accordingly, results of operations and cash flows for any one quarter are not necessarily +indicative of results to be expected for any other quarter or year. +Backlog +We receive a significant portion of orders from our wholesale customers and distributors that remain unfilled as of any date and, at +that point, represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog. While all orders in our backlog are subject to cancellation by customers, we expect +that the majority of such orders will be filled within one year. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing schedule and the timing of +product shipments. Further, the mix of future and immediate delivery orders can vary significantly period over period. Backlog only relates to wholesale and distributor orders for the next season and +current season fill-in orders and excludes potential sales in our retail and internet channels. Backlog also is affected by the timing of customers' orders and product availability. Due to these +factors and since the unfulfilled orders can be canceled at any time prior to shipment by our customers, we believe that backlog may be an imprecise indicator of future revenues that may be achieved +in a fiscal period and comparisons of backlog from period to period may be misleading. In +12 +Table of Contents +addition, +our historical cancellation experience may not be indicative of future cancellation rates. The following table summarizes backlog by reportable segment as of December 31, 2013 and +2012: +December 31, +($ thousands) +2013 +2012 +Americas +$ +113,972 +$ +122,376 +Asia Pacific +141,446 +121,767 +Japan +47,651 +53,732 +Europe +76,203 +56,456 +Total backlog +$ +379,272 +$ +354,331 +Competition +The global casual, athletic and fashion footwear markets are highly competitive. Although we believe that we do not compete directly +with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale business compete with companies such as, but not limited to, Deckers Outdoor Corp., +Skechers USA Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations also compete with footwear retailers such as +Genesco, Inc., Macy's, Dillard's, Dick's Sporting Goods Inc., The Finish Line Inc. and Footlocker, Inc. +The +principal elements of competition in these markets include brand awareness, product functionality, design, quality, pricing, customer service, marketing and distribution. We believe +that our unique footwear designs, the Croslite material, our prices, expanded product line and our distribution network continue to position us well in the marketplace. However, some companies in the +casual footwear and apparel industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating +histories, greater distribution capabilities, stronger brand recognition and greater marketing resources than we have. Furthermore, we face competition from new players who have been attracted to the +market with imitation products similar to ours as the result of the unique design and success of our footwear products. +Employees +As of December 31, 2013, we had approximately 5,000 full-time, part-time and seasonal employees, none of which were represented +by a union. +Available Information +We were organized in 1999 as a limited liability company. In January 2005, we converted to a Colorado corporation and subsequently +re-incorporated as a Delaware corporation in June 2005. In February 2006, we completed our initial public offering and trading of our common stock on NASDAQ commenced. +Our +internet address is www.crocs.com on which we post the following filings, free of charge, as soon as reasonably practicable after they are electronically filed with or furnished to +the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports +filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Copies of any of these documents will be provided in print to any +stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. +13 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2013/0001047469-14-001323/item13.txt b/raw/filings/0001334036/2013/0001047469-14-001323/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..5fed0a1a9d0a08ffee89f4c3497eab2c59f19a3f --- /dev/null +++ b/raw/filings/0001334036/2013/0001047469-14-001323/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. Certain Relationships and Related Transactions and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2014 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2013. \ No newline at end of file diff --git a/raw/filings/0001334036/2013/0001047469-14-001323/item9a.txt b/raw/filings/0001334036/2013/0001047469-14-001323/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..04c5be54e63b844cc58e0f77c87b3b5b2aaaf96b --- /dev/null +++ b/raw/filings/0001334036/2013/0001047469-14-001323/item9a.txt @@ -0,0 +1,64 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial +Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange +Act, as of December 31, 2013 (the "Evaluation Date"). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the Evaluation Date, our disclosure +controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission ("SEC") +reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, +including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. +67 +Table of Contents +Management's Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange +Act Rules 13a-15(f) and 15d-15(f). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2013, using the criteria set forth in the Internal +Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on +this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2013. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued a report on our internal control over financial reporting, which is included herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially +affected, or is reasonably likely to materially affect, our internal control over financial reporting. +68 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the Company) as of December 31, 2013, based on criteria established in Internal Control—Integrated Framework +(1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's +management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the +accompanying "Management's Annual Report on +Internal Control Over Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control +over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or +persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting +and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those +policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material +misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to +future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In +our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control—Integrated Framework +(1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year +ended December 31, 2013 of the Company and our report dated February 25, 2014 expressed an unqualified opinion on those financial statements. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +February 25, 2014 +69 +Table of Contents +PART III \ No newline at end of file diff --git a/raw/filings/0001334036/2013/0001047469-14-001323/rp_note.txt b/raw/filings/0001334036/2013/0001047469-14-001323/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2013/0001047469-14-001323/rpt_disclosure.txt b/raw/filings/0001334036/2013/0001047469-14-001323/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..5f5c31357256d1a7a2687650e2d2ffe40dcfe691 --- /dev/null +++ b/raw/filings/0001334036/2013/0001047469-14-001323/rpt_disclosure.txt @@ -0,0 +1,67 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +Investment Agreement with Blackstone +On January 27, 2014, we issued to Blackstone and certain of its permitted transferees (together with Blackstone, the "Blackstone Purchasers"), +200,000 shares of our Series A Convertible Preferred Stock for an aggregate purchase price of $198 million, or $990 per share, pursuant to the Investment Agreement. In connection with +the issuance of the convertible preferred stock (the "Closing") and pursuant to the Investment Agreement, we paid Blackstone a closing fee of $2 million and reimbursed Blackstone's transaction +fees and expenses of approximately $4 million. As of March 31, 2015, the Blackstone Purchasers collectively owned all of our outstanding shares of convertible preferred stock and, on an +as-converted basis, approximately 15.2% of our outstanding common stock. Mr. Ribatt was a permitted transferee of Blackstone and purchased 1,000 shares of our Series A Convertible +Preferred Stock. +As +discussed above under "Proposal 1—Election of Directors," the Investment Agreement grants Blackstone certain rights to designate directors to serve on our Board. For so long as +the Blackstone Purchasers (i) beneficially own at least 95% of our convertible preferred stock or the as-converted common stock purchased pursuant to the Investment Agreement or +(ii) maintain beneficial ownership of at least 12.5% of the our outstanding common stock (the "Two-Director Threshold"), Blackstone will have the right to designate for nomination two directors +to our Board. For so long as the Blackstone Purchasers beneficially own shares of our convertible preferred stock or the as-converted common stock purchased pursuant to the Investment Agreement that +represent less than the Two-Director Threshold but more than 25% of the number of shares of the as-converted common stock purchased pursuant to the Investment Agreement, Blackstone will have the right +to designate for nomination one director to our Board. The directors designated by Blackstone are entitled to serve on Board committees, subject to applicable law and stock exchange rules. Blackstone +designated Messrs. Melwani and Giordano for nomination to our Board and had previously nominated Mr. Ribatt. +19 +Table of Contents +Pursuant to the Investment Agreement, Blackstone is subject to certain standstill restrictions which restrict Blackstone from acquiring more than 25% of our outstanding common +stock until the date on which Blackstone is no longer entitled to designate any directors to our Board. In addition, subject to certain customary exceptions, Blackstone is restricted from transferring +any shares of the convertible preferred stock until the second anniversary of the Closing and, for so long as any convertible preferred stock is outstanding, may not transfer any shares of convertible +preferred stock to certain of our competitors (as defined in the Investment Agreement) or holders of 25% or more of our common stock. Blackstone also has certain preemptive rights and information +rights under the Investment Agreement, which are subject to certain conditions. +Certificate of Designations +Pursuant to the Certificate of Designations of Series A Convertible Preferred Stock filed with the Delaware Secretary of State on +January 24, 2014, which establishes the +designations, preferences, and other rights of the convertible preferred stock: +• The convertible preferred stock ranks senior to our common stock with respect to dividend rights and rights on liquidation, winding-up +and dissolution; +• The Blackstone Purchasers are entitled to cumulative dividends payable quarterly in cash at a rate of 6% per annum of the stated value +of $1,000 per share; +• If we fail to make timely dividend payments to the holders of our convertible preferred stock, the dividend rate will increase to 8% +per annum until such time as all accrued but unpaid dividends have been paid in full; +• The Blackstone Purchasers are entitled to receive any dividends declared or paid on our common stock and are entitled to vote together +with the holders of our common stock as a single class, in each case, on an as-converted basis; +• The Blackstone Purchasers have certain limited special approval rights, including with respect to the issuance by us of pari passu or senior equity securities; +• The Blackstone Purchasers may, at any time, require us to convert their shares of convertible preferred stock into shares of common +stock at an implied conversion price of $14.50 per share, subject to certain adjustments; +• At our election, all or a portion of the convertible preferred stock will be convertible into the relevant number of shares of common +stock on or after the third anniversary of the Closing, if the closing price of the common stock equals or exceeds $29.00 for 20 consecutive trading days; +• The conversion rate is subject to customary anti-dilution and other adjustments subject to certain share caps and other restrictions; +• At any time after the eighth anniversary of the Closing, we will have the right to redeem, and the Blackstone Purchasers will have the +right to require us to repurchase, all or any portion of the convertible preferred stock at 100% of the stated value, plus all accrued but unpaid dividends; and +• Upon certain change in control events involving us, the Blackstone Purchasers can require us to repurchase their shares of convertible +preferred stock at 101% of the stated value plus all accrued but unpaid dividends. +Registration Rights Agreement +In connection with the Closing, we and the Blackstone Purchasers entered into a Registration Rights Agreement (the "Registration Rights Agreement"), +pursuant to which we have agreed to provide to the Blackstone Purchasers certain customary demand and piggyback registration rights in respect of the shares of convertible preferred stock and any +shares of common stock issued upon conversion of the +20 +Table of Contents +convertible +preferred stock. The Registration Rights Agreement contains customary terms and conditions, including certain customary indemnification obligations. +Policy on Transactions with Related Persons +Our Code of Business Conduct and Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive +officers, or greater than five percent stockholders, or one of the aforementioned's immediate family members (each, a "related person"), have a material interest be approved or ratified by the Audit +Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course +of business transactions in which directors have an interest as part of the Board's annual director independence review, and our Code of Business Conduct and Ethics permits the full Board to waive any +conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems +appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. The full Board approved each of the transactions disclosed above. +Director and Officer Indemnification +We have entered into agreements to indemnify certain directors and executive officers in addition to the indemnification provided for in our +certificate of incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys' fees), +judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person's services as a director or +executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We believe that these provisions and agreements are necessary +to attract and retain qualified persons as directors and executive officers. \ No newline at end of file