CUE HEALTH INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-K)
You should read the following discussion and analysis of our financial condition and results of operations together with the financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. This discussion and other parts of this Annual Report on Form 10-K contain forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions, that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Our actual results could differ materially from those discussed in or implied by these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section of this Annual Report on Form 10-K titled "Risk Factors." For a discussion related to the results of operations for 2020 compared to 2019, refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2021 S-1 filed with the
Securities and Exchange Commissionon September 23, 2021.
We are a health technology company, and our mission is to enable personalized, proactive and informed healthcare that empowers people to live their healthiest lives. Our proprietary platform, the Cue Integrated Care Platform, which is comprised of our Cue Health Monitoring System, Cue Data and Innovation Layer, Cue Virtual Care Delivery Apps, and Cue Ecosystem Integrations and Apps, enables lab-quality diagnostics-led care at home, at work or at the point of care. Our platform is designed to empower stakeholders across the healthcare ecosystem, including consumers, providers, enterprises and payors with paradigm-shifting access to diagnostic and health data to inform care decisions. We are helping pioneer a new continuous care model that we believe has the potential to significantly improve the user experience, provide measurable and actionable clinical insights, and increase efficiency within the healthcare ecosystem. We believe this model, powered by our platform, will allow users to actively manage their health, which we believe will lead to improved health outcomes and a more resilient, connected, and efficient healthcare ecosystem for all stakeholders. The Cue Integrated Care Platform consists of the following hardware and software components: (1) our revolutionary Cue Health Monitoring System, made up of a portable, durable and reusable reader, or Cue Reader, a single-use test cartridge, or Cue Cartridge, and a sample collection wand, or Cue Wand, (2) our Cue Data and Innovation Layer, with cloud-based data and analytics capability, (3) our Cue Virtual Care Delivery Apps, including our consumer-friendly App and our Cue Enterprise Dashboard, and (4) our Cue Ecosystem Integrations and Apps, which allow for integrations with third party applications and sensors. Our Cue Health Monitoring System is designed to deliver a broad menu of tests through one system, enabling two major testing modalities, NAAT, and immunoassays, in one device. Our system is designed to handle different sample types, including saliva, blood, urine and swabs, and can detect nucleic acids, small molecules, proteins and cells. We believe this will enable us to address many of the diagnostic tests conducted in clinical laboratories, such as tests addressing indications in respiratory health, sexual health, cardiac and metabolic health, women's health, men's health, and chronic disease management.
Initial public offering
The Company's registration statement related to its initial public offering ("IPO") was declared effective on
September 23, 2021, and the Company's common stock began trading on the Nasdaq Global Select Market ("Nasdaq") on September 24, 2021. On September 28, 2021, the Company completed its IPO of 14,375,000 shares of the Company common stock at an offering price of $16.00per share, including 1,875,000 shares purchased by the IPO underwriters. The Company received aggregate net proceeds of approximately $206.0 millionafter deducting underwriting commissions and legal, accounting, and consulting fees related to the IPO. Upon completion of the IPO, Convertible Notes outstanding in the principal amount of $235.5 millionand accrued interest of $2.8 millionwere automatically converted into 18,611,914 shares of common stock. All outstanding shares of the Company's redeemable convertible preferred stock were converted into 83,605,947 shares of common stock. Immediately prior to the IPO, all of the Company's outstanding warrants to purchase redeemable convertible preferred stock were converted into the redeemable convertible preferred stock and the related warrant liabilities were reclassified to additional paid-in capital.
Impact of COVID-19
88 -------------------------------------------------------------------------------- Table of Contents While the ongoing global COVID-19 pandemic has adversely impacted global commercial activity, it served as a catalyst to accelerate our product pipeline and commercialization of our platform. We began selling and recording total revenue for our COVID-19 test in
August 2020after obtaining our first FDA EUA in June 2020. Currently, all of our revenue is related to sales of our Cue COVID-19 test. In December 2020, the FDA issued EUA for two COVID-19 vaccines and in February 2021, the FDA issued a third EUA for a COVID-19 vaccine. The widely-administered use of an efficacious vaccine or the availability of therapeutic treatments for COVID-19 may reduce the demand for our COVID-19 test and could cause the COVID-19 diagnostic testing market to fail to grow or to decline. However, we believe the need for ongoing detection and monitoring will continue to be high even after effective vaccines have been widely distributed and administered. We also believe COVID-19 will remain endemic for the foreseeable future and people suspected of having COVID-19 will want to obtain a fast and accurate COVID-19 test to confirm a diagnosis in order to receive timely and appropriate treatment. Even while vaccine efforts are underway, public health measures, like testing, will likely need to stay in effect to protect against COVID-19. However, given the unpredictable nature of the COVID-19 pandemic, the development and potential size of the COVID-19 diagnostic testing market is highly uncertain.
Certain key factors affecting our performance
We manufacture all of our Cue Cartridges in our vertically integrated facilities in
San Diego, California. We also produce all of our biochemistry in-house, including critical enzymes, antibodies and primers for our Cue Cartridges. Production of our Cue Readers is performed for us by third-party contract manufacturers and production of our Cue Wands is performed by both us and by third-party contract manufacturers. We continue to optimize our manufacturing capabilities, including our fully automated production pods. A production pod is a free standing, modular environmentally controlled structure containing an automated cartridge production line.
Investments in our growth
We expect to make continued significant investments in our business to drive growth, and therefore we expect our expenses to increase going forward. We expect to invest significant resources in sales and marketing to drive demand for our products and services as well as research and development to enhance our platform and bring additional tests to market. We also intend to continue investing in our supply chain and logistics operations. As we continue to scale our business, we expect to hire additional personnel and incur additional expenses, including those expenses in connection with our becoming a public company.
Expand our customer base
Following the completion of our obligations under the
U.S.DoD Agreement, the future commercial success of our diagnostic products is dependent on our ability to broaden our customer base beyond the U.S.government and public sector to include enterprise employers, healthcare providers and direct-to-consumer. As a result, our long term growth depends on our ability to renew and acquire new customers. Current key strategic relationships include BARDA, Google LLC, or Google, the Mayo Clinic, the National Basketball Association, and Henry Schein, Inc. We intend to leverage our success with our COVID-19 test and the expansion of our manufacturing capabilities to enable broad distribution of our Cue Readers and awareness of our platform across different groups of customers and to enhance pull-through of our future tests. For the year ended December 31, 2021, we sold over 155,000 readers and have sold over 160,000 readers since our first FDA EUA in June 2020.
Improve and expand our menu of testing and software capabilities
Currently, our only commercially available test is our molecular COVID-19 test. A key part of our growth strategy is to expand our menu of tests to include other diseases, ailments and general health markers, which we expect will support our growth and continue to contribute to the utility of our platform, including the Cue Health Monitoring System. We are currently developing tests in the fields of respiratory health, sexual health, cardiac and metabolic health, women's health, men's health, and chronic disease management. As we continue to develop and expand our menu of tests, we have made, and will continue to make, significant investments in our business, particularly in research and development, sales and marketing and the hiring of additional personnel. Investing in research and development will allow us to develop new tests as well as enhance our current product offerings and our Cue Integrated Care Platform. To build out our menu of tests and bring additional products to market, we will need to hire additional personnel, such as engineers and researchers, as well as develop robust sales and marketing and customer support teams to be able to sell our products.
Regulatory clearance of our diagnostic products
Our commercial success will depend upon a number of factors, some of which are beyond our control, including the receipt of regulatory clearances, approvals or authorizations for existing or new product offerings by us, product enhancements, or additions to our proprietary intellectual property portfolio. While we have received two EUAs for our COVID-19 test, a CE mark in the
European Union, an Interim Order authorization from Health Canada, and regulatory approval from CDSCO, our COVID-19 test has not been FDA cleared or approved and is only authorized for emergency use during the declaration that circumstances exist justifying the authorization of emergency use, and this declaration could be terminated, or our authorization could be revoked in the future. We will need to seek additional regulatory approval for our COVID-19 test if the EUA declaration or Interim Order is terminated or otherwise revised or revoked, and we will need to seek regulatory authorization, clearance or approval for our other diagnostic products in development. In addition, we will not be able to commercialize any other tests for our platform unless we obtain required regulatory clearances or other necessary approvals or authorizations. As such, our ability to navigate, obtain and maintain the required regulatory clearances, approvals or authorizations, as well as comply with other regulatory requirements, for our products will in part drive our results of operations and impact our business.
Reimbursement and insurance coverage
We have been granted two EUAs by the FDA for our COVID-19 test for point-of-care and at-home and over-the-counter indications. The commercial success of our COVID-19 test, and any of our subsequently developed tests, is dependent on a customer's ability to be able to pay for or otherwise be reimbursed for the purchase of a test, whether out-of-pocket, by insurance or from a governmental or other third-party payor. We believe payment for our products, including our Cue COVID-19 Test Kits, will be billable by a physician, reimbursable by government payors or insurance companies, paid for by a self-insured employer, or eligible under FSA and HSA guidelines. For example, most of our contemplated future tests that are currently offered by others through central labs are reimbursable by health plans and governmental payors if properly ordered by a physician. These third-party payors decide which products will be covered and establish reimbursement levels for those products. Coverage criteria and reimbursement rates for clinical laboratory tests are subject to adjustment by payors, and current reimbursement rates could be reduced, or coverage criteria restricted in the future. If the Cue Health Monitoring System, including any of our current or future tests, are not reimbursable or covered by insurance, our business may be materially and adversely impacted.
We anticipate that fluctuations in customer and user demand for our COVID-19 test may be similar to those related to influenza, which typically increases during the fall and winter seasons. Although our products will be available throughout the year, we anticipate that we may experience higher sales during the fall and winter seasons, relative to the spring and summer seasons. However, as our portfolio of diagnostic offerings increases beyond our COVID-19 test, we expect the impact of this seasonality on our results to decrease.
Summary of the 2021 financial year (for comparative purposes)
Selected GAAP financial results for the year ended
•Revenues increased to
$618.1 millionfrom $23.0 million; •Product gross margin was 55% compared to 3%; •Net income increased to $86.4 millionfrom $47.4 millionnet loss and; •Earnings per diluted share increased to $0.59from a $2.90loss per diluted share.
Key Non-GAAP Financial Results for the Year Ended
•Non-GAAP adjusted net income increased to
$164.5 millionfrom $47.4net loss; and •Non-GAAP adjusted earnings per diluted share increased to $1.21from a $2.90loss per diluted share.
Please see a description in the Non-GAAP Financial Measures section below.
Components of our operating results
Our product revenue currently primarily relates to sales of our COVID-19 test, which began in
August 2020after we obtained our initial EUA in June 2020. With respect to the U.S.DoD Agreement, the transaction price was fixed and did 90 -------------------------------------------------------------------------------- Table of Contents not include variable consideration. The U.S.DoD Advance of $184.6 millionwas recorded as deferred revenue and will be recognized upon satisfaction of performance obligations, such as the delivery of Cue Cartridges, Cue Readers, Cue Wands and Cue Control Swab Packs to the U.S.government. Significant judgment is applied in determining how deferred revenue will be recognized, including estimating future quantities, delivery schedules, pricing and contract duration from the U.S.government, which can have a significant impact on revenue recognition. Deferred revenue related to the U.S.DoD Advance as of December 31, 2021is $92.4 million. Of this amount, $82.2 millionwas classified as current as of December 31, 2021, based on amounts expected to be realized within the next twelve months. Deferred revenue related to the U.S.DoD Advance as of December 31, 2020, was $182.3 million. Of this amount, $114.9 millionwas classified as current at December 31, 2020, based on amounts expected to be realized during 2021. The remaining $92.4 millionof contract value under the U.S.DoD Agreement, that had not been recognized by us as of December 31, 2021, is expected to be recognized by us as revenue upon satisfaction of performance obligations by reference to the total products expected to be provided under the U.S.DoD Agreement, including an estimate of future performance obligations under expected contract renewals, and the corresponding expected consideration. Commercial customers outside of the U.S.government accounted for approximately 37.7% of our total revenue for the year ended December 31, 2021. Grant and Other Revenue. Our grant and other revenue primarily relate to our cost reimbursement research and development agreement with BARDA, which, as amended, is effective through January 2023. The objective of the contract is to accelerate the development, validation and FDA clearance of our influenza and COVID-19 diagnostic products. We have received $36.3 millionin contracts and awards, $21.8 millionfor phase one and $14.5 millionfor phase two, from BARDA from June 2018to December 31, 2021. Income derived from reimbursement of direct out-of-pocket expenses, overhead allocations and fringe benefits for research costs associated with U.S.government contracts are recorded as grant revenue. We recognize revenue from our contracts and awards with BARDA at the gross amount of the reimbursement in the period during which the related costs are incurred, provided that the conditions under which the grants and contracts were provided have been met and only perfunctory performance obligations are outstanding. Grant and other revenue in 2019 also included $0.4 millionrelated to our collaboration agreement with Janssen Pharmaceuticals, Inc, or the Janssen Contract. We did not recognize any revenue related to the Janssen Contract in 2020 or 2021. The direct costs associated with both contracts are reflected as a component of research and development expense in our statements of operations. BARDA revenue recognized for the year ended December 31, 2021was $2.2 million.
Operating costs and expenses
Cost of Product Revenue. Our cost of product revenue includes the cost of materials, direct labor, and manufacturing overhead costs used in the manufacture of our Cue Cartridges as well as contract manufacturing costs associated with production of our Cue Readers, Cue Wands and Cue Control Swab Packs. Prior to
August 2020, we had not commenced sales of our diagnostic products and as such, did not record any cost of product revenue. We expect our costs as a percentage of revenue to vary from period to period depending on the number of units produced to satisfy demand. Sales and Marketing Expense. Our sales and marketing expense consists primarily of salaries, commissions, and other related costs for personnel in sales and marketing, customer support and business development functions as well as advertising and marketing costs. We expect that our sales and marketing expense will increase on an absolute dollar basis and vary from period to period as a percentage of revenue for the foreseeable future as we focus on building out our customer facing organization and expand our brand.
Research and development costs. Research and development expenses include external and internal costs associated with our research and development activities, including costs associated with the development of our platform, the individual tests we offer on our platform, and clinical and regulatory costs associated with the development of our platform. obtaining regulatory approval for these tests.
Our internal resources, employees and infrastructure are not directly tied to any one program or test and there is often significant overlap in research and development efforts between different programs and tests and we are often able to leverage the research and development of one test or program to help advance one or more other programs or tests. As such, we do not track internal costs on a test-by-test basis. The following table summarizes our external and internal costs for the periods presented: 91
Table of Contents Year Ended December 31, (dollars in thousands) 2021 2020 2019 External costs
$ 3,612 $ 4,441 $ 1,534Internal costs Salaries and benefits 19,766 7,607 8,366 Facilities and supplies 19,451 16,430 11,505 Total internal costs 39,217 24,037 19,871
Total research and development costs
We expect that our research and development expense will increase significantly on an absolute dollar basis and vary from period to period as a percentage of revenue for the foreseeable future as we continue to invest in development activities related to our technology platform and our current and future test menus and continuing to expand our portfolio of diagnostic testing offerings. General and Administrative Expense. Our general and administrative expense consists primarily of salaries and other related costs, including stock-based compensation, for personnel in our executive, finance, corporate development and administrative functions. General and administrative expense also includes professional fees for legal, patent, accounting, information technology, auditing, tax and consulting services, travel expenses and facility-related expenses, which include direct depreciation costs and allocated expenses for rent and maintenance of facilities and other operating costs. We expect that our general and administrative expense will increase on an absolute dollar basis and vary from period to period as a percentage of revenue for the foreseeable future as we focus on processes, systems and controls to enable our internal support functions to scale with the growth of our business. We expect to incur increased expenses associated with being a public company, including costs of accounting, audit, legal, regulatory and tax compliance services, costs related to compliance with the rules and regulations of the
Securities and Exchange Commissionand exchange listing standards, higher director and officer insurance costs, and investor and public relations costs. Interest Expense. Our interest expense prior to February 2021primarily consists of expense related to our prior loan and security agreement with Comerica Bank. In February 2021, we entered into a new loan and security agreement with East West Bankand the other lenders party thereto. In May 2021, we repaid $63.2 millionoutstanding under the Revolving Credit Agreement with a portion of the net proceeds from the issuance and sale of the Convertible Notes. In June 2021, we terminated the Revolving Credit Agreement. Upon agreement with East West Bankand the other lenders to the Revolving Credit Agreement, we are keeping in place our outstanding letter of credit in the amount of $12.0 million, which will be cash collateralized. All other obligations under the Revolving Credit Agreement have otherwise been terminated. See "Liquidity and Capital Resources" below. Change in Fair Value of Redeemable Convertible Preferred Stock Warrants. Change in fair value of redeemable convertible preferred stock warrants relates to our liability-classified redeemable convertible preferred stock warrants which are recorded on the balance sheets at their fair values on the date of issuance and are revalued on each subsequent balance sheet date, with fair value changes recognized as increases or reductions in the statements of operations. Change in Fair Value of Convertible Notes. Change in fair value of convertible notes relates to our liability-classified convertible notes which are recorded on the balance sheets at their fair values on the date of issuance and are revalued on each subsequent balance sheet date, with fair value changes recognized as increases or reductions in the statements of operations. 92
Comparison of the years ended
The following table provides a summary of our results of operations for the years ended
2021 2020 $ Change % Change (dollars in thousands) Revenue: Product revenue $ 615,796 $ 15,391 $ 600,405 3,901% Grant and other revenue 2,311 7,562 (5,251) (69%) Total revenue 618,107 22,953 595,154 2,593% Operating costs and expenses: Cost of product revenue(1)(2) 276,542 14,951 261,591 1,750% Sales and marketing(1) 28,729 714 28,015 3,924% Research and development(1) 42,829 28,478 14,351 50% General and administrative(1) 79,788 23,936 55,852 233% Total operating costs and expenses 427,888 68,079 359,809 529% Income (loss) from operations 190,219 (45,126) 235,345 (522%) Interest expense (9,809) (374) (9,435) 2,523% Change in fair value of redeemable convertible preferred stock warrants 53 (1,289) 1,342 (104%) Change in fair value of convertible notes (59,560) - (59,560) n.m Loss on extinguishment of debt (1,998) (610) (1,388) 228% Other income (expense), net 272 47 225 479% Net income (loss) before income taxes 119,177 (47,352) 166,529 (352%) Income tax expense 32,759 - 32,759 n.m Net income (loss) $ 86,418 $ (47,352) $ 133,770 (283%) Net income (loss) per share attributable to common stockholders - diluted $ 0.59 $ (2.90) $ 3.49 (120%) n.m. = not meaningful
(1)Includes stock-based compensation expense as follows:
Year Ended December 31, 2021 2020 (dollars in thousands) Cost of product revenue
$ 1,979$ - Sales and marketing 2,634 1 Research and development 6,889 98 General and administrative 31,477 3,064 Total stock-based compensation expense $ 42,979$
Revenue increased to
$618.1 millionfor the year ended December 31, 2021, from $23.0 millionfor the year ended December 31, 2020. The increase was primarily due to the commencement of product sales in August 2020and continued expansion of our customer base. Revenue during the year ended December 31, 2021was driven by sales to public sector clients, primarily from our U.S.DoD Agreement, where we recognized $383.0 millionof revenue along with sales to private sector customers of $232.8 million. 93
Cost of Product Revenue increased to
$276.5 millionfor the year ended December 31, 2021, from $15.0 millionfor the year ended December 31, 2020. This increase was primarily due to the fact that we did not incur cost of product revenue until we began to generate product revenue in August 2020after receiving our first FDA EUA in June 2020. Our product gross profit margin, or product gross profit as a percentage of product revenue was approximately 55% in the year ended December 31, 2021compared to approximately 3%, in the year ended December 31, 2020. The increase in gross profit margin was driven by scaling up production and related efficiencies that resulted in more favorable absorption of fixed costs on a per unit basis in 2021. Sales and Marketing Expense increased to $28.7 millionfor the year ended December 31, 2021from $0.7 millionfor the year ended December 31, 2020. This increase was due to the launch of our COVID-19 test in August 2020and increased sales and marketing personnel costs to support the expected growth and demand for our products, higher expenses related to digital marketing services and increased headcount to support the growth of our business. Research and Development Expense increased to $42.8 millionfor the year ended December 31, 2021, from $28.5 millionfor the year ended December 31, 2020. This increase was primarily driven by higher research and development spend associated new product development and early costs related to upcoming clinical studies for 510(k) approval of our COVID-19 and influenza tests. Our research and development expenses primarily consist of engineering and research expenses related to our continuous COVID-19 and influenza technology, clinical trials, regulatory expenses, quality assurance programs, materials and products for clinical trials. We also incur significant expenses to operate our clinical trials including clinical site reimbursement, clinical trial product and associated travel expenses. General and Administrative Expense increased to $79.8 millionfor the year ended December 31, 2021from $23.9 millionfor the year ended December 31, 2020. This increase was primarily related to an increase in stock-based compensation expenses, legal, banking, headcount growth to build out central team, accounting and other consulting-related costs to support our growing business and prepare us to operate as a public company after our IPO in September 2021. Interest Expense increased to $9.8 millionfor the year ended December 31, 2021from $0.4 millionfor the year ended December 31, 2020. The increase was primarily driven by $6.0 millionof issuance costs related to our Convertible Notes in May 2021and subsequent write-off of additional issuance costs of $0.7 millionupon conversion of the Convertible Notes at the time of the IPO in September 2021. Additionally, we incurred $2.8 millionof interest expense during the period the Convertible Notes were outstanding. The termination of our revolving credit agreement required us to pay a fee of $1.3 million. Change in Fair Value of Convertible Notes was $59.6 millionand $0for the years ended December 31, 2021and 2020, respectively, reflecting fair value adjustments associated with the Convertible Notes issued by us in May 2021. We did not incur any gains or losses associated with changes in fair value of the Convertible Notes during the year ended December 31, 2020as the Convertible Notes were not outstanding during that period. Income Tax Expense increased to $32.8 millionfor the year ended December 31, 2021from $0for the year ended December 31, 2020, and our effective tax rate was 27.5% in the year ended December 31, 2021, compared to 0% for the year ended December 31, 2020. The increase in our provision and effective tax rate was primarily due to the current tax liability arising from an increase in income from operations which exceeded available net operating loss carryforwards. The California Competes Tax Credit will be reflected as a benefit when certified annually which did not occur during the year ended December 31, 2021. Substantially all of our deferred tax assets continue to maintain a valuation allowance. Non-GAAP Financial Measures We supplement the reporting of our financial information determined under accounting principles generally accepted in the United States, or GAAP, with certain non-GAAP financial measures, adjusted net income and adjusted net income per diluted share, or adjusted diluted EPS. We believe these non-GAAP financial measures provide meaningful information to assist investors and shareholders in understanding our financial results and assessing our prospects for future performance. Management believes the adjusted measures described above are important indicators of our operations because they exclude items that may not be indicative of or are unrelated to our core operating results and provide a baseline for analyzing trends in our underlying businesses. Management uses these non-GAAP financial measures for reviewing the operating results and analyzing potential future business trends in connection with our budget process on these non-GAAP financial measures. To measure earnings performance on a consistent and comparable basis, we exclude certain items that affect the comparability of operating results and the trend of earnings. These adjustments are irregular in timing and may not be indicative of our past and future performance. 94
For the years ended
Because non-GAAP financial measures are not standardized, it may not be possible to compare these financial measures with other companies' non-GAAP financial measures having the same or similar names. These adjusted financial measures should not be considered in isolation or as a substitute for reported net income and net income per diluted share, the most directly comparable GAAP financial measures. Our non-GAAP financial measures are an additional way of viewing aspects of our operations when viewed with our GAAP results and the reconciliations to corresponding GAAP financial measures below. Banking and finance-related items consist of (i) banking and finance fees associated with the issuance of Convertible Notes; (ii) early extinguishment of debt costs; and (iii) fees associated with our termination of our Revolving Credit Agreement. Since such fees and costs can be material, are irregular and often mask underlying operating performance, we excluded such amounts for purposes of calculating adjusted net income and adjusted diluted EPS for the year ended
December 31, 2021, as they may not be indicative of our past and future performance and we believe excluding such amounts may assist investors in their evaluation of our current operating performance. The Convertible Notes issued by us in May 2021were recorded at fair value. We excluded the impact of fair value changes to arrive at adjusted net income (loss) as it is valued based on probability weighted assumptions regarding potential future financing scenarios that may not be indicative of our past and future performance and to assist in the evaluation of our current operating performance.
The reconciliations of net income (loss) (GAAP) and diluted EPS to adjusted net income (loss) (non-GAAP) and adjusted diluted EPS were calculated as follows for the years ended
December 31, 2021and 2020: Year Ended December 31, 2021 2020 Per Diluted Per Diluted Dollar Amount Share Dollar Amount Share Net income (loss)/diluted EPS $ 86,4180.59 $ (47,352)(2.90) Fair value adjustments of convertible notes 59,560 0.47 - - Banking and financing-related items 7,998 0.07 - - Forgiveness of promissory notes(1) 12,880 0.10 - - Tax effects(2) (2,315) (0.02) - -
Adjusted net income (loss)/adjusted diluted EPS
(1)Represents stock-based compensation expense related to the forgiveness of promissory notes subject to restricted stock purchase agreements with certain executives. The forgiveness of the promissory notes resulted in the modification of the stock option accounting applied to the shares underlying these agreements. See Note 12, Stock-Based Compensation, to our audited financial statements included elsewhere in this annual report. (2)Represents the tax impact with respect to the adjustments noted above. We applied the effective tax rate of 27.5% to amounts deductible for tax purposes to quantify the tax effects. The charges related to the convertible notes and the portion of the forgiveness of promissory notes limited by Internal Revenue Code Section 162(m) were not deductible for income tax purposes and were excluded from the tax effects above. Also includes additional tax effects related to banking and financing-related items that became deductible upon the IPO during the year ended
December 31, 2021.
Cash and capital resources
December 31, 2021, we held $409.9 millionof cash and cash equivalents as a result of our IPO proceeds and other financing activities. Our primary cash needs are for the funding of day-to-day operations, financing capital investments and to address our working capital needs. Our largest source of operating cash generation is from sales to our customers. Our primary uses of cash from operating activities are for personnel-related expenses, material and supply costs 95 -------------------------------------------------------------------------------- Table of Contents for manufacturing, direct costs to deliver our products, and sales and marketing expenses and research and development initiatives. Based on our current business plan, we believe our anticipated operating cash flows, together with our existing cash and cash equivalents, will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months. We expect that our near and longer-term liquidity requirements will consist of working capital and general corporate expenses associated with the growth of our business, including, without limitation, expenses associated with scaling up our operations and continuing to increase our manufacturing capacity, sales and marketing expense associated with rollout of our over-the-counter, at home COVID-19 test to commercial customers, including directly to consumers, increasing market awareness of our platform and brand generally to individual consumers, enterprises and other target customers, additional research and development expenses associated with expanding our care offerings, expenses associated with continuing to build out our corporate infrastructure and expenses associated with being a public company. Our short-term capital expenditure needs relate primarily to the expansion of our research and development capabilities, expanding production capacity and optimization of existing business processes.
Revolving line of credit
February 2021, we entered into the Revolving Credit Agreement. In connection with our entering into the Revolving Credit Agreement, we repaid outstanding amounts of $5.4 millionand terminated our prior loan and security agreement with Comerica Bank, or the 2015 Credit Agreement, that we initially entered into in May 2015. The 2015 Credit Agreement, as amended, provided for a revolving line with a credit extension of up to $4.0 millionand a Growth Capital A Line with a credit extension of up to $6.0 million. The Revolving Credit Agreement provided for a revolving credit facility with an aggregate maximum principal amount of $130.0 millionand a letter of credit subfacility of $20.0 million. In June 2021, we terminated the Revolving Credit Agreement and we were required to pay a fee equal to 1.00% of the amount of the outstanding revolving commitment. Upon agreement with East West Bankand the other lenders to the Revolving Credit Agreement, we are keeping in place our outstanding letter of credit in the amount of $12.0 million, which will be cash collateralized. In November 2021, East West Bankincreased the letter of credit by $0.5 million. All other obligations under the Revolving Credit Agreement have otherwise been terminated.
The following table summarizes our cash flows for the periods indicated:
December 31, 20212020
(in thousands of dollars) Net cash, cash equivalents and restricted (used in) provided by operating activities
Net cash, cash equivalents and restricted cash used in investing activities
Net cash, cash equivalents and restricted cash provided by financing activities
Net increase in cash, cash equivalents and restricted cash
Cash flows used in operating activities
Net cash, cash equivalents and restricted cash used in operating activities was
$9.4 millionfor the year ended December 31, 2021, primarily due to increases in accounts receivable and inventory of $100.4 million, and $51.5 millionrespectively. Non-cash deferred revenue of $90.6 millionwas recognized during the period. The timing of our revenue, timing of our collections, and an increase in private sector customers increased our accounts receivable. The expected increase in demand for our products drove the increase in inventory. These outflows were offset by non-cash cost adjustments, primarily driven by the change in fair value of the Convertible Notes of $59.6 million, depreciation and amortization expenses of $32.5 millionand stock-based compensation expense of $43.0 million. Net cash, cash equivalents and restricted cash provided by operating activities was $92.7 millionfor the year ended December 31, 2020, primarily due to an increase in government funding of $183.1 million. The increase was primarily offset by the use of cash in inventory and prepaid expenses and other current assets of $36.8 million, and $31.0 million, respectively, related to the commencement of product manufacturing and expansion of production facilities and manufacturing capacity. 96
Cash flows used in investing activities
Net cash, cash equivalents and restricted cash used in investing activities was
$115.7 millionfor the year ended December 31, 2021, reflecting purchases of property and equipment of $108.8 million. The purchases of property and equipment were used to expand our production capabilities of our Cue COVID-19 Test Kits in relation to the U.S.DoD Agreement and our commercial customers. We also invested $6.9 millionin the development of software related to COVID-19 Testing apps for commercial customers. Net cash, cash equivalents and restricted cash used in investing activities was $78.1 millionfor the year ended December 31, 2020, reflecting purchases of property and equipment of $76.0 millionto expand our production capabilities of Cue COVID-19 Test Kits in relation to the U.S. DoDagreement. We also invested $2.1 millionin the development of internal-use software related to COVID-19 Testing apps for commercial customers.
Cash flows generated by financing activities
Net cash provided by financing activities for the year ended
December 31, 2021of $419.6 millionwas primarily driven by $206.0 millionin net proceeds from our IPO and $235.5 millionin gross proceeds from the issuance and sale of Convertible Notes. Net cash, cash equivalents and restricted cash provided by financing activities was $100.2 millionfor the year ended December 31, 2020, primarily reflecting proceeds received from our issuance of Series C redeemable convertible preferred stock in June 2020. Commitments and Contingencies See Note 15, Commitments and Contingencies, to our audited financial statements included elsewhere in this annual report for a summary of our commitments as of December 31, 2021. Our material cash commitments at December 31, 2021related to finance leases of manufacturing equipment totaling $6.0 million, real estate leases under non-cancelable operating lease agreements in the amount of $68.8 million, that expire at various dates through 2031 and a legal settlement of a contract dispute totaling $9.0 million, of which $4.5 millionhas not been paid. We expect to fund these commitments using our existing cash on hand. As of December 31, 2020, the Company was party to certain letters of credit, primarily related to a letter of credit with Comerica Bankas collateral required by one of the Company's vendors. During the year ended December 31, 2021, the Company entered into a Revolving Credit Agreement with a capacity of $130.0 millionand all but one of the letters of credit were no longer required by the counterparties. The one letter of credit, totaling $6.0 million, has been re-issued under the Revolving Credit Agreement. In May 2021, the Company repaid the debt outstanding under the Revolving Credit Agreement and terminated the agreement in June 2021. Upon agreement with East West Bankand the other lenders to the Revolving Credit Agreement, the Company kept in place its outstanding letter of credit in the amount of $6.0 million. The letter of credit was increased to $12.0 millionin July 2021. In November 2021 East West Bankincreased the letter of credit by $0.5 million. All other obligations under the Revolving Credit Agreement have otherwise been terminated. In November 2021, $0.8 millionof cash was restricted in relation to a customs surety on international imports. The Company also has outstanding, letters of credit with Comerica Bankrelated to its real estate leases totaling $0.5 millionas of December 31, 2021. All letters of credit are collateralized.
Significant Accounting Policies and Estimates
Our management's discussion and analysis of our financial condition and results of operations is based on our financial statements included elsewhere in this Form 10-K that have been prepared in accordance with
U.S.GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported income generated and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions and any such differences may be material. While our significant accounting policies are more fully described in Note 2 to our audited financial statements, included elsewhere in this Form 10-K, we believe that the accounting policies discussed below are critical to 97
understand our historical and future performance, as these policies relate to the most significant areas involving management’s judgments and estimates.
Recognition of deferred revenue
We recorded the
U.S.DoD Advance as deferred revenue and recognize this liability upon satisfaction of our performance obligations to the U.S. DoDby reference to estimated future performance obligations of a follow-on agreement with the U.S. DoDand the related expected contract consideration. Estimates of a future contract include future pricing, quantities and the timing and duration of future contracts. Estimates for standalone selling price are done at contract inception and are not subsequently updated. Changes in estimates are done on a prospective adjustment approach and the Company reassess its estimate on a quarterly basis. Changes in the assumptions used in our estimate of the future contract with the U.S. DoD, may have a material impact on the timing of recognition of deferred revenue. A 10% increase or decrease in our projection of quantities purchased by the U.S. DoDunder a follow-on agreement, holding all other assumptions constant, would increase or decrease the deferred revenue we recognized in the quarter ended December 31, 2021by less than $2.5 million. A 10% increase or decrease in our projection of future pricing under a follow-on agreement, holding all other assumptions constant, would increase or decrease the deferred revenue we recognized in the quarter ended December 31, 2021by less than $4.2 million.
Deferred tax assets (and related valuation allowance)
We recognize net deferred tax assets to the extent that we believe these assets are more likely than not to be realized. In making such a determination, management considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If we determine that deferred tax assets may be able to be recognized in the future in excess of their net recorded amount, the deferred tax asset valuation allowance would be adjusted, which would reduce the provision for income taxes. We record uncertain tax positions on the basis of a two-step process whereby (i) management determines whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (ii) for those tax positions that meet the more-likely-than-not recognition threshold, management recognizes the largest amount of tax benefit that is more than 50% likely to be realized upon ultimate settlement with the related tax authority. This requires management to make judgments and estimates regarding: (i) the timing and amount of the reversal of taxable temporary differences; (ii) expected future taxable income; and (iii) the impact of tax planning strategies. Future changes to tax rates would also impact the amounts of deferred tax assets and liabilities and could adversely affect our financial statements. All of our deferred tax assets as of
December 31, 2020, were fully offset by a valuation allowance. As of December 31, 2021, we continue to maintain a valuation allowance against our U.S.federal and state deferred tax assets. The valuation allowance will be reduced at such time as management believes it is more-likely-than-not that the deferred tax assets will be realized. The exact timing and amount of a valuation allowance release are subject to change on the basis of the future level of profitability and changes in tax law. Release of the valuation allowance would result in the recognition of certain deferred tax assets and a decrease to income tax expense for the period the release is recorded.
Product Warranty Reserve
We provide our customers with the right to receive a replacement of defective or nonconforming Cue Readers for a period of up to twelve months from the date of shipment. Although no explicit warranty is provided for Cue Cartridges, we may replace Cue Cartridges that result in invalid test results. Provisions for estimated expenses related to product warranty are made at the time products are sold. These estimates are determined using historical information that include testing failure rates, the frequency and probability of replacement units being requested, and the overall cost of replacement units. We evaluate the reserve quarterly and make adjustments when appropriate. Changes to testing failure rates, the overall cost of replacement units and replacement rates could have a material impact on our estimated liability. At
December 31, 2021and 2020, the product warranty reserve was $4.9 millionand $0, respectively. A 10% increase or decrease in our failure rate estimate during 2021, holding all other assumptions constant, would increase or decrease the product warranty reserve by approximately $0.6 million. A 10% increase or decrease in our replacement rate estimate during 2021, holding all other assumptions constant, would increase or decrease the product warranty reserve by approximately $0.5 million. 98
Recently Adopted and Issued Accounting Pronouncements
Recently issued and adopted accounting pronouncements are described in Note 2 to our financial statements included elsewhere in this document.
Emerging Growth Company Status
We are an "emerging growth company" (as defined in the JOBS Act). Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (that is, those that have not had a Securities Act registration statement declared effective or do not have a class of securities registered under the Exchange Act) are required to comply with the new or revised financial accounting standards. The JOBS Act provides that an emerging growth company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such election to opt out is irrevocable. We have elected to use this extended transition period under the JOBS Act until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our financial statements may not be comparable to companies who have adopted new or revised accounting pronouncements. 99
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