The accompanying notes are an integral part
of these condensed consolidated financial statements.
The accompanying notes are an integral part
of these condensed consolidated financial statements
The accompanying notes are an integral part
of these condensed consolidated financial statements
The accompanying notes are integral part of
these condensed consolidated financial statements.
Notes to Condensed Consolidated Financial
Statements (unaudited)
Three Months and Nine Months Ended September
30, 2016 and 2015
1. Organization and Business Operations
Second Sight Medical Products,
Inc. (“Second Sight” or “the Company”), was founded in 1998 as a limited liability
company and was subsequently incorporated in the State of California in 2003. Second Sight develops, manufactures and markets implantable
prosthetic devices that can restore some functional vision to patients blinded by outer retinal degenerations, such as Retinitis
Pigmentosa.
In 2007, Second Sight
formed Second Sight (Switzerland) Sarl, initially to manage clinical trials for its products in Europe, and later to manage sales
and marketing in Europe and the Middle East. As the laws of Switzerland require at least two corporate stockholders, Second Sight
(Switzerland) Sarl is 99.5% owned directly by the Company and 0.5% owned by an executive of Second Sight, who is acting as a nominee
of the Company. Accordingly, Second Sight (Switzerland) Sarl is considered 100% owned for financial statement purposes and is consolidated
with Second Sight for all periods presented.
Since its inception, the
Company has generated limited revenues from the sale of products and has financed its operations primarily through the issuance
of common stock, convertible debt (which has been converted into common stock), and grants primarily from government agencies.
The Company’s financial
statements have been presented on the basis that its business is a going concern, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business. The Company is subject to the risks and uncertainties associated
with a business with one product line and limited commercial product revenues, including limitations on the Company’s operating
capital resources and uncertain demand for its products. The Company has incurred recurring operating losses and negative operating
cash flows since inception, and it expects to continue to incur operating losses and negative operating cash flows for at least
the next few years. The Company’s independent registered public accounting firm, in its report on the Company’s 2015
consolidated financial statements, raised substantial doubt about the Company’s ability to continue as a going concern.
In June 2016,
the Company successfully completed a Rights Offering to existing stockholders, raising proceeds of $19.5 million net of
cash offering costs, and selling 5,978,465 shares of common stock at $3.315 per share, representing 85% of the
Company’s stock price at the close of the rights offering. The Company believes that it has sufficient funds to last
through the end of the second quarter of 2017. In order to continue business operations past that
point, the Company currently anticipates that it will need to raise additional debt and/or equity capital during the next
several months. However, there can be no assurances that the Company will be able to secure any such additional financing on
acceptable terms and conditions, or at all. If cash resources become insufficient to satisfy the Company’s ongoing cash
requirements, the Company would be required to scale back or discontinue its technology and product development programs
and/or clinical trials, or obtain funds, if available (although there can be no certainty), through strategic alliances that
may require the Company to relinquish rights to its products, or to discontinue its operations entirely.
2. Basis of Presentation, Significant
Accounting Policies and Recent Accounting Pronouncements
Basis of Presentation
The accompanying unaudited
condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and
Exchange Commission for Form 10-Q. Accordingly, certain information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and
regulations. The condensed consolidated balance sheet at December 31, 2015 has been derived from the Company’s audited consolidated
financial statements.
In the opinion of management,
these financial statements reflect all normal recurring and other adjustments necessary for a fair presentation. These consolidated
financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s
Annual Report on Form 10-K for the year ended December 31, 2015. Operating results for interim periods are not necessarily indicative
of operating results for an entire fiscal year or any other future periods.
Significant Accounting
Policies
The Company’s significant
accounting policies are set forth in Note 2 of the financial statements in its Annual Report on Form 10-K for the year ended December
31, 2015.
Recent Accounting Pronouncements
In August 2016, the FASB
issued ASU 2016-15,
Statement of Cash Flows (Topic 230)
, which updates the guidance as to how certain cash receipts and
cash payments should be presented and classified. The update is intended to reduce the existing diversity in practice. The amended
guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, with early adoption
permitted, including adoption in an interim period. The Company is currently evaluating the impact of the adoption of this standard
on its consolidated financial statements.
In June 2016, the
FASB issued ASU 2016-13,
Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial
Instruments
, which requires measurement and recognition of expected versus incurred credit losses for financial assets
held. ASU 2016-13 is effective for the Company in the first quarter of fiscal 2020 with early adoption permitted beginning in
the first quarter of fiscal 2019. The Company is currently evaluating the impact the adoption of this standard will have on
its consolidated financial statements.
In March 2016, the FASB
issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (Topic 718), a new standard that changes the accounting
for certain aspects of share-based payments to employees. The new guidance requires excess tax benefits and tax deficiencies to
be recorded in the income statement when the awards vest or are settled. In addition, cash flows related to excess tax benefits
will no longer be separately classified as a financing activity apart from other income tax cash flows. The standard also allows
the Company to repurchase more of an employee’s shares for tax withholding purposes without triggering liability accounting,
clarifies that all cash payments made on an employee’s behalf for withheld shares should be presented as a financing activity
on the cash flow statement, and provides an accounting policy election to account for forfeitures as they occur. The new standard
is effective for the annual periods beginning after December 15, 2016, and interim periods within those annual periods with early
adoption permitted. The Company is currently evaluating the impact of the standard on the Company’s financial statements.
Management does not believe
that any recently issued, but not yet effective, accounting standards, if adopted, will have a material effect on the financial
statements.
3. Concentration of Risk
Credit Risk
Financial instruments
that subject the Company to concentrations of credit risk consist primarily of cash, money market funds, and trade accounts receivable.
The Company maintains cash and money market funds with financial institutions that management deems reputable, and at times, cash
balances may be in excess of Federal Deposit Insurance Corporation and Securities Investor Protection Corporation insurance limits.
The Company extends differing levels of credit to customers, and typically does not require collateral.
The Company also maintains
a cash balance at a bank in Switzerland, which is insured up to an amount specified by the deposit insurance agency of Switzerland.
Customer Concentration
During the three and nine
months ended September 30, 2016 and 2015 (unaudited), the following customers comprised more than 10% of revenues
:
|
|
Three Months
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30, 2016
|
|
|
September 30, 2015
|
|
|
September 30, 2016
|
|
|
September 30, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer 1
|
|
|
21
|
%
|
|
|
0
|
%
|
|
|
8
|
%
|
|
|
1
|
%
|
Customer 2
|
|
|
12
|
%
|
|
|
6
|
%
|
|
|
3
|
%
|
|
|
2
|
%
|
Customer 3
|
|
|
11
|
%
|
|
|
12
|
%
|
|
|
16
|
%
|
|
|
15
|
%
|
Customer 4
|
|
|
7
|
%
|
|
|
13
|
%
|
|
|
5
|
%
|
|
|
8
|
%
|
Customer 5
|
|
|
0
|
%
|
|
|
13
|
%
|
|
|
3
|
%
|
|
|
10
|
%
|
Customer 6
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
10
|
%
|
|
|
1
|
%
|
As of September 30, 2016
and December 31, 2015, the following customers comprised more than 10% of accounts receivable:
|
|
September 30,
|
|
|
December31,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(unaudited)
|
|
|
|
|
Customer 1
|
|
|
37
|
%
|
|
|
0
|
%
|
Customer 2
|
|
|
29
|
%
|
|
|
17
|
%
|
Customer 3
|
|
|
21
|
%
|
|
|
0
|
%
|
Customer 4
|
|
|
15
|
%
|
|
|
3
|
%
|
Customer 5
|
|
|
0
|
%
|
|
|
19
|
%
|
Customer 6
|
|
|
0
|
%
|
|
|
10
|
%
|
Customer 7
|
|
|
0
|
%
|
|
|
10
|
%
|
Customer 8
|
|
|
0
|
%
|
|
|
10
|
%
|
Geographic Concentration
During the three and
nine months ended September 30, 2016 and 2015 (unaudited), regional revenue, based on customer location, consisted of the
following:
|
|
Three Months
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30, 2016
|
|
|
September 30, 2015
|
|
|
September 30, 2016
|
|
|
September 30, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
|
47
|
%
|
|
|
56
|
%
|
|
|
47
|
%
|
|
|
46
|
%
|
Germany
|
|
|
35
|
%
|
|
|
4
|
%
|
|
|
15
|
%
|
|
|
5
|
%
|
Italy
|
|
|
11
|
%
|
|
|
12
|
%
|
|
|
21
|
%
|
|
|
20
|
%
|
France
|
|
|
7
|
%
|
|
|
11
|
%
|
|
|
8
|
%
|
|
|
18
|
%
|
Canada
|
|
|
0
|
%
|
|
|
13
|
%
|
|
|
3
|
%
|
|
|
6
|
%
|
Turkey
|
|
|
0
|
%
|
|
|
4
|
%
|
|
|
5
|
%
|
|
|
3
|
%
|
Sources of Supply
Several of the components,
materials and services used in the Company’s current Argus II product are available from only one supplier, and substitutes
for these items cannot be obtained easily or would require substantial design or manufacturing modifications. Any significant problem
experienced by one of the Company’s sole source suppliers could result in a delay or interruption in the supply of components
to the Company until that supplier cures the problem or an alternative source of the component is located and qualified. Even where
the Company could qualify alternative suppliers, the substitution of suppliers may be at a higher cost and create time delays that
impede the commercial production of the Argus II and impact the Company’s abilities to deliver its products as may be timely
required to meet demand.
Foreign Operations
The accompanying condensed
consolidated financial statements as of September 30, 2016 (unaudited) and December 31, 2015 include assets amounting to $2,228,000
and $3,041,000, respectively, relating to operations of the Company’s subsidiary based in Switzerland. It is possible that
unanticipated events in foreign countries could disrupt the Company’s operations.
4. Money Market Funds
The authoritative guidance
with respect to fair value establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure
fair value into three levels, and requires that assets and liabilities carried at fair value be classified and disclosed in one
of three categories, as presented below. Disclosure as to transfers in and out of Levels 1 and 2, and activity in Level 3 fair
value measurements, is also required.
Level 1. Observable inputs
such as quoted prices in active markets for an identical asset or liability that the Company has the ability to access as of the
measurement date. Financial assets and liabilities utilizing Level 1 inputs include active-exchange traded securities and exchange-based
derivatives.
Level 2. Inputs, other
than quoted prices included within Level 1, which are directly observable for the asset or liability or indirectly observable through
corroboration with observable market data. Financial assets and liabilities utilizing Level 2 inputs include fixed income securities,
non-exchange based derivatives, mutual funds, and fair-value hedges.
Level 3. Unobservable
inputs in which there is little or no market data for the asset or liability which requires the reporting entity to develop its
own assumptions. Financial assets and liabilities utilizing Level 3 inputs include infrequently-traded non-exchange-based derivatives
and commingled investment funds, and are measured using present value pricing models.
Money market funds are
the only financial instrument measured and recorded at fair value on the Company’s balance sheet, and they are considered
Level 1 valuation securities. The following table presents money market funds at their level within the fair value hierarchy at
September 30, 2016 and December 31, 2015 (in thousands):
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2016 (unaudited):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds
|
|
$
|
17,546
|
|
|
$
|
17,546
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds
|
|
$
|
15,721
|
|
|
$
|
15,721
|
|
|
$
|
—
|
|
|
$
|
—
|
|
5. Selected Balance Sheet Detail
Inventories, net
Inventories consisted
of the following at (in thousands):
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(unaudited)
|
|
|
|
|
Raw materials
|
|
$
|
470
|
|
|
$
|
575
|
|
Work in process
|
|
|
4,920
|
|
|
|
5,028
|
|
Finished goods
|
|
|
3,499
|
|
|
|
3,156
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,889
|
|
|
|
8,759
|
|
|
|
|
|
|
|
|
|
|
Allowance for excess and obsolescence
|
|
|
(3,079
|
)
|
|
|
(550
|
)
|
Inventories, net
|
|
$
|
5,810
|
|
|
$
|
8,209
|
|
Property and equipment, net of accumulated
depreciation and amortization
Property and equipment
consisted of the following at (in thousands):
|
|
September 30,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(unaudited)
|
|
|
|
|
Laboratory equipment
|
|
$
|
3,594
|
|
|
$
|
3,369
|
|
Computer hardware and software
|
|
|
2,117
|
|
|
|
1,960
|
|
Leasehold improvements
|
|
|
533
|
|
|
|
508
|
|
Furniture, fixtures and equipment
|
|
|
135
|
|
|
|
135
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,379
|
|
|
|
5,972
|
|
Accumulated depreciation and amortization
|
|
|
(4,852
|
)
|
|
|
(4,540
|
)
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
$
|
1,527
|
|
|
$
|
1,432
|
|
6. Long Term Investor Right
Investors who purchased
shares in the Company’s IPO, and who complied with certain terms and conditions, such as holding their IPO shares in their
name during the twenty-four month period following the closing of the IPO, are entitled under certain conditions to receive up
to one additional share for each share they purchased in the IPO. For a more complete discussion of the Long Term Investor Right,
see Note 2 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
As of September 30, 2016,
the Company identified investors who had perfected and maintained Long Term Investor Rights in 1,181,927 shares of common stock
that were acquired as part of the Company’s IPO. The highest average closing price for the Company’s common stock on
NASDAQ during any consecutive 90 day period ended on or before September 30, 2016 was $13.96. Based on this average closing stock
price, an investor who purchased shares as part of the IPO, and who has perfected its Long Term Investor Right, would be entitled
to 0.2894 shares for each share purchased in the IPO, rounded up to the next whole share, which represents an aggregate maximum
of 342,089 shares that are potentially issuable by the Company pursuant to the Long Term Investor Right at that date. The actual
number of common shares issuable pursuant to the Long Term Investor Right is dependent on the future stock price of the Company
over the two year period subsequent to the November 24, 2014 closing date of the IPO, and could be as high as 342,089 shares and
as low as zero shares.
The Long Term Investor
Right is an equity instrument that will be accounted for as a component of the actual price per common share paid by the investor
in the IPO. For basic earnings per share, the common shares associated with the Long Term Investor Right are treated as contingently
issuable shares and are not being included in basic earnings per share until the actual number of shares can be calculated and
the shares have been issued.
7. Equity Securities
Common Stock Issuable
Beginning with services
rendered in 2014, and with payments in June 2015 and 2016, non-employee members of the Board of Directors are paid for their services
in common stock on June 1 of each year based on the average closing prices for the immediately preceding twenty trading days. As
of September 30, 2016, the Company accrued $87,000 for these services, which equates to 26,274 shares. These shares have not yet
been issued and are excluded from the calculation of weighted average common shares outstanding for EPS purposes.
Potentially Dilutive
Common Stock Equivalents
At September 30, 2016
and 2015 (unaudited), the Company excluded the outstanding securities summarized below, which entitle the holders thereof to ultimately
acquire shares of common stock, from its calculations of earnings per share and weighted average shares outstanding, as their effect
would have been anti-dilutive (in thousands).
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
Long Term Investor Rights
|
|
|
342
|
|
|
|
412
|
|
Underwriter’s warrants
|
|
|
802
|
|
|
|
802
|
|
Warrants associated with convertible debt
|
|
|
1,038
|
|
|
|
1,038
|
|
Common stock options
|
|
|
3,669
|
|
|
|
3,505
|
|
Restricted stock units
|
|
|
142
|
|
|
|
190
|
|
Employee stock purchase plan
|
|
|
109
|
|
|
|
75
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
6,102
|
|
|
|
6,022
|
|
Rights
Offering
In June 2016, the
Company completed a Rights Offering to existing stockholders by selling 5,978,465 shares of common stock. The Company evaluated
the financial impact of FASB ASC 260, "Earnings per Share," which states, among other things, that if a rights issue
is offered to all existing stockholders at an exercise price that is less than the fair value of the stock, then the weighted
average shares outstanding and basic and diluted earnings per share shall be adjusted retroactively to reflect the bonus element
of the rights offering for all periods presented. The Company determined that the application of this specific provision of ASC
260 was immaterial to previously issued financial statements and, therefore, did not retroactively adjust previously reported
weighted average shares outstanding and basic and diluted earnings per share.
8. Warrants
A summary of warrant activity for the nine
months ended September 30, 2016 (unaudited) is presented below (in thousands, except per share and contractual life data).
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
|
|
|
Weighted
|
|
|
Remaining
|
|
|
|
Number of
|
|
|
Average
|
|
|
Contractual
|
|
|
|
Shares
|
|
|
Exercise Price
|
|
|
Life (in Years)
|
|
Warrants outstanding at December 31, 2015
|
|
|
1,840
|
|
|
$
|
7.72
|
|
|
|
2.80
|
|
Granted
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
—
|
|
|
|
|
|
|
|
|
|
Forfeited or expired
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants outstanding at September 30, 2016
|
|
|
1,840
|
|
|
$
|
7.72
|
|
|
|
2.06
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants exercisable at September 30, 2016
|
|
|
1,840
|
|
|
$
|
7.72
|
|
|
|
2.06
|
|
The intrinsic value of
warrants outstanding at September 30, 2016 was $0. During the nine months ended September 30, 2016, no warrants were exercised.
9. Stock-Based Compensation
On May 10, 2016, the stockholders
approved amendments to the Company’s 2011 Equity Incentive Plan that (i) increase the maximum number of shares of common
stock that may be issued under the Plan from 6.0 million shares to 7.5 million shares, (ii) allow issuance of Restricted Stock
Units, and (iii) permit repricing and exchanges of options at the discretion of the Board of Directors.
Under the 2003 Plan, as
restated in June 2011, the Company was authorized to issue options covering up to 3,500,000 common stock shares. Effective June
1, 2011, the Company adopted the 2011 Equity Incentive Plan (the “2011 Plan”). The maximum number of shares with respect
to which options may be granted under the 2011 Plan is 7,500,000 shares, which is offset and reduced by options previously granted
under the 2003 Plan. The option price is determined by the Board of Directors but cannot be less than the fair value of the shares
at the grant date. Generally, the options vest ratably over either four or five years and expire ten years from the grant date.
Both plans provide for accelerated vesting if there is a change of control, as defined in the plans.
A summary of stock option
activity for the nine months ended September 30, 2016 (unaudited) is presented below (in thousands, except per share and contractual
life data).
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
|
|
|
Weighted
|
|
|
Remaining
|
|
|
|
Number of
|
|
|
Average
|
|
|
Contractual
|
|
|
|
Shares
|
|
|
Exercise Price
|
|
|
Life (in Years)
|
|
Options outstanding at December 31, 2015
|
|
|
3,472
|
|
|
$
|
8.01
|
|
|
|
6.39
|
|
Granted
|
|
|
690
|
|
|
$
|
4.33
|
|
|
|
|
|
Exercised
|
|
|
(96
|
)
|
|
$
|
5.00
|
|
|
|
|
|
Forfeited or expired
|
|
|
(397
|
)
|
|
$
|
9.03
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding at September 30, 2016
|
|
|
3,669
|
|
|
$
|
7.28
|
|
|
|
6.45
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at September 30, 2016
|
|
|
1,934
|
|
|
$
|
6.54
|
|
|
|
4.40
|
|
The estimated aggregate
intrinsic value of stock options exercisable at September 30, 2016 was $0. As of September 30, 2016, there was $6.9 million of
total unrecognized compensation cost related to outstanding stock options that will be recognized over a weighted average period
of 2.84 years.
On January 1, 2015, the
Company’s current Chairman, who at the time was the Chief Executive Officer, exercised stock options on a cashless basis
to purchase 59,063 shares of common stock at an exercise price of $4.75 per share. Based on the closing market price of the Company’s
common stock of $10.26 on December 31, 2014, the Chief Executive Officer tendered 27,344 shares of common stock that he owned to
satisfy the aggregate exercise price and surrendered 12,055 shares of common stock to satisfy the related $123,684 income and payroll
tax withholding amounts related to the transaction.
During the nine months
ended September 30, 2016, the Company granted stock options to purchase 659,973 shares of common stock to certain employees and
contractors. The options are exercisable for a period of ten years from the date of grant at prices ranging from $3.44 to $5.16
per share, which was the fair value of the Company’s common stock on the respective grant dates. The options vest over a
period of four years. The fair value of these options, as calculated pursuant to the Black-Scholes option-pricing model, was determined
to be $1,350,000 ($1.64 to $2.47 per share). Assumptions used in the model were an expected term of 6.25 years, volatility of 48.2%,
a risk-free interest rate of 1.40% to 1.87%, and an expected dividend rate of 0%. During the nine months ended September
30, 2016, the Company issued 95,493 shares of common stock through exercises of stock options that resulted in net proceeds of $479,000.
During the nine months
ended September 30, 2016, the Company granted stock options to purchase 30,000 shares of common stock to an outside attorney in
connection with his services relating to the Company’s rights offering to stockholders. The options have fully vested and
are exercisable for a period of four years from the date of grant at a price of $5.23 per share, which was 125% of the fair value
of the Company’s common stock on the grant date of January 14, 2016. The fair value of these options, as calculated pursuant
to the Black-Scholes option-pricing model, was determined to be $53,000 ($1.77 per share). Assumptions used in the model were an
expected term of 6.25 years, volatility of 48.2%, a risk-free interest rate of 1.87%, and an expected dividend rate of 0%. The
cost of these shares was treated as an issuance cost of the offering and was deducted from the gross proceeds from the offering.
During the first quarter
of 2016, the Company recorded a charge of $55,000 to extend the exercise period of 98,681 vested options for one employee who resigned
and became a consultant for the Company. All unvested options for this employee were terminated when this employee ceased full-time
employment with the Company.
The following table summarizes
Restricted Stock Unit (RSU) activity for the nine months ended September 30, 2016 (in thousands, except per share data):
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average Grant
|
|
|
|
Number
|
|
|
Date Fair Value
|
|
|
|
of Awards
|
|
|
Per Share
|
|
|
|
|
|
|
|
|
Outstanding as of December 31, 2015
|
|
|
190
|
|
|
$
|
12.43
|
|
Awarded
|
|
|
-
|
|
|
|
-
|
|
Vested
|
|
|
(48
|
)
|
|
|
-
|
|
Forfeited/canceled
|
|
|
-
|
|
|
|
-
|
|
Outstanding as of September 30, 2016
|
|
|
142
|
|
|
$
|
12.43
|
|
As of September 30, 2016,
there was $1,699,000 of total unrecognized compensation cost related to the outstanding RSUs that will be recognized over a weighted
average period of 2.88 years.
On August 18, 2016, of
the 190,000 RSUs held by the Company’s Chief Executive Officer, 47,500 RSUs vested at a market price of $3.76 per share.
The Company adopted an
employee stock purchase plan (“ESPP”) starting in June 2015 for all eligible employees. Under the ESPP, shares of the
Company's common stock may be purchased at six-month intervals at 85% of the lower of the closing fair market value of the common
stock (i) on the first trading day of the offering period or (ii) on the last trading day of the purchase period. An employee may
purchase in any one calendar year shares of common stock having an aggregate fair market value of up to $25,000 determined as of
the first trading day of the offering period. Additionally, a participating employee may not purchase more than 100,000 shares
of common stock in any one offering period. At September 30, 2016, 154,225 shares had been issued under the plan. Proceeds from
the purchase of stock under the plan totaled $337,000 for the nine months ended September 30, 2016.
The total stock-based
compensation recognized for stock-based awards granted under the 2003 Plan and the 2011 Plan in the condensed consolidated statements
of operations for the three and nine months ended September 30, 2016 and 2015 (unaudited) is as follows (in thousands):
|
|
Three Months
|
|
|
Three Months
|
|
|
Nine Months
|
|
|
Nine Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September 30, 2016
|
|
|
September 30, 2015
|
|
|
September 30, 2016
|
|
|
September 30, 2015
|
|
Cost of sales
|
|
$
|
80
|
|
|
$
|
103
|
|
|
$
|
245
|
|
|
$
|
265
|
|
Research and development
|
|
|
77
|
|
|
|
99
|
|
|
|
238
|
|
|
|
217
|
|
Clinical and regulatory
|
|
|
43
|
|
|
|
84
|
|
|
|
136
|
|
|
|
206
|
|
Selling and marketing
|
|
|
74
|
|
|
|
127
|
|
|
|
59
|
|
|
|
312
|
|
General and administrative
|
|
|
624
|
|
|
|
443
|
|
|
|
1,903
|
|
|
|
918
|
|
Total
|
|
$
|
898
|
|
|
$
|
856
|
|
|
$
|
2,581
|
|
|
$
|
1,918
|
|
10. Litigation, Claims
and Assessments
Fifteen
oppositions have been filed by a third-party in the European Patent Office, each challenging the validity of a European
patent owned or exclusively licensed by the Company. The outcome of the challenges is not certain, however, if successful,
they may affect the Company's ability to block competitors from utilizing some of its patented technology in Europe.
Management of the Company does not believe any successful challenges will have a material effect on the Company’s ability to
manufacture and sell its products, or otherwise have a material effect on its operations.
The Company is party to
litigation arising in the ordinary course of business. It is management's opinion that the outcome of such matters will not have
a material effect on the Company's financial statements.
|
Item 2.
|
Management’s Discussion and Analysis of Financial
Condition and Results of Operations
|
The following discussion
and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed financial
statements and related notes included elsewhere in this Quarterly Report on Form 10-Q as well as our audited 2015 financial statements
and related notes included in our Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March
11, 2016 and as amended in a filing with the Commission on August 8, 2016. In addition to historical information, the discussion
and analysis here and throughout this Form 10-Q contains forward-looking statements that involve risks, uncertainties and assumptions.
Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors,
including, but not limited, to those set forth under “Risk Factors” in Part II, Item 1A of this report.
Second Sight was founded
in 1998 with a mission to develop, manufacture, and market prosthetic devices that restore some useful vision to blind individuals.
Our principal offices are located in Sylmar, California, approximately 25 miles northwest of downtown Los Angeles. We also have
an office in Lausanne, Switzerland, that manages our commercial and clinical operations in Europe and the Middle East.
Our current product,
the Argus
®
II System, treats outer retinal degenerations, such as retinitis pigmentosa, which we refer to as
RP. RP is a hereditary disease, affecting an estimated 1.5 million people worldwide including about 100,000 people in the
United States, that causes a progressive degeneration of the light-sensitive cells of the retina, leading to significant
visual impairment and ultimately to blindness. The Argus II System is the only retinal prosthesis approved in the United
States by the Food and Drug Administration (FDA), and was the first approved retinal prosthesis in the world. By restoring
some useful vision in patients who otherwise have total sight loss, the Argus II System can provide benefits which
include:
|
·
|
improving patients’ orientation and mobility, such as locating doors and windows, avoiding
obstacles, and following the lines of a crosswalk,
|
|
·
|
allowing patients to feel more connected with people in their surroundings, such as seeing when
someone is approaching or moving away,
|
|
·
|
providing patients with enjoyment from being “visual” again, such as locating
the moon, tracking groups of players as they move around a field, and watching the moving streams of lights from fireworks, and
|
|
·
|
improving patients’ well-being and ability to perform activities of daily living.
|
The Argus II System provides
an artificial form of vision that differs from the vision of people with normal sight. It does not restore normal vision and it
does not slow or reverse the progression of the disease. Results vary among patients and while the majority of patients receive
a significant benefit from the Argus II, some patients report receiving little or no benefit.
Our major corporate, clinical
and regulatory milestones include:
|
·
|
In 1998, Second Sight was founded.
|
|
·
|
In 2002, we commenced clinical trials in the US for our prototype product, the Argus I retinal
prosthesis.
|
|
·
|
In 2007, we commenced clinical trials in the US for the Argus II System, which later became our
first commercial product.
|
|
·
|
In 2011, we received marketing approval in Europe (CE Mark) for the Argus II System.
|
|
·
|
In 2013, we received marketing approval in the United States (FDA) for the Argus II System.
|
|
·
|
In 2014, we launched the Argus II in the US, completed our initial public offering (“IPO”),
and began trading on NASDAQ under the symbol “EYES.”
|
|
·
|
In 2015, we commenced a clinical trial in the UK for an expanded indication for the Argus II System
in individuals with dry AMD.
|
We began selling the
Argus II System in Europe at the end of 2011, Saudi Arabia in 2012, the United States and Canada in 2014, and Turkey in 2015.
We have full regulatory approval to sell in these regions. We sell primarily through our direct sales force, but use
distributors in Saudi Arabia, Spain and Turkey. We recently signed distribution agreements in Argentina, Iran and Taiwan. We
are at various stages of discussions with a number of other distributors for other countries outside of the U.S.
Going Concern
From inception, our operations
have been funded primarily through the sales of our common stock, as well as from the issuance of convertible debt, research and
clinical grants, and product revenue generated by the sale of our Argus II System. During the years ended December 31, 2015 and
2014 and the nine months ended September 30, 2016, we funded our business primarily through:
|
·
|
Revenue of $3.3 million in the first nine months of 2016, and $8.9 million and $3.4 million in
2015 and 2014, respectively, generated by sales of our Argus II System,
|
|
·
|
A $4.1 million grant under Joint Research and Development Agreement with The Johns Hopkins University
Applied Physics Laboratory in 2014,
|
|
·
|
Issuance of common stock in private placements aggregating $9.1 million in 2014,
|
|
·
|
Issuance of common stock in our initial public offering in November 2014, which generated net proceeds
of $34.2 million of cash after offering expenses, and
|
|
·
|
Issuance of common stock in our Rights Offering in June 2016, which generated net proceeds of $19.5
million of cash after offering expenses.
|
Our financial statements
have been presented on the basis that our business is a going concern, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. We are subject to the risks and uncertainties associated with a business with
one product line and limited commercial product revenues, including limitations on our operating capital resources and uncertain
demand for our products. We have incurred operating losses and negative operating cash flows since inception, and we expect to
continue to incur operating losses and negative operating cash flows for at least the next few years. The Company’s independent
registered public accounting firm, in its report on the Company’s 2015 consolidated financial statements, raised substantial
doubt about the Company’s ability to continue as a going concern.
In June 2016, the
Company successfully completed a Rights Offering to existing stockholders, raising proceeds of $19.5 million net of cash
offering costs, and selling 5,978,465 shares of common stock at $3.315 per share, representing 85% of the Company’s
stock price at the close of the rights offering. The Company believes that it has sufficient funds to last through the end of
the second quarter of 2017. In order to continue business operations past that point, the Company currently anticipates that
it will need to raise additional debt and/or equity capital during the next several months. However, there can be no
assurances that the Company will be able to secure any such additional financing on acceptable terms and conditions, or at
all. If cash resources become insufficient to satisfy the Company’s ongoing cash requirements, the Company would be
required to scale back or discontinue its technology and product development programs and/or clinical trials, or obtain
funds, if available (although there can be no certainty), through strategic alliances that may require the Company to
relinquish rights to its products, or to discontinue its operations entirely.
Insurance Reimbursement
Obtaining reimbursement
from governmental and private insurance companies is critical to our future commercial success. Due to the cost of the Argus II
System, our sales would be limited without the availability of third party reimbursement.
In the U.S., coding, coverage,
and payment are necessary for the surgical procedure and Argus II system to be reimbursed by payers. Coding has been established
for the device and the surgical procedure. Coverage and payment vary by payer. Argus II patients are eligible for Medicare, and
coverage is primarily provided through traditional Medicare Fee-for-Service (FFS) or Medicare Advantage. A small percentage of
U.S. patients are covered by commercial insurers.
|
·
|
Medicare FFS patients
– Coverage is determined by Medicare Administrative
Contractors (MACs) that administer various geographic regions of the US. As of September 30, 2016, five of 12 MACs (who
collectively cover 17 states, Puerto Rico and U.S. Virgin Islands) have made positive coverage decisions for the Argus II.
For calendar
2016, the Centers for Medicare & Medicaid Services (CMS) established a hospital outpatient payment rate of
$95,000 for both the procedure and the Argus II Retinal Prosthesis System.
On November 1, 2016, CMS finalized the calendar 2017 Medicare hospital outpatient payment rate of $150,000 for the Argus
II and the associated surgical implantation procedure. Prior to
2016, the
Argus II
was
classified as
having
pass-through
payment
status and
the device
was
paid
separately from
the
procedure.
|
|
·
|
Medicare Advantage patients
– Medicare Advantage plans are required to cover the same
benefits as those covered by the MAC in that jurisdiction. For example, if a MAC in a jurisdiction has favorable coverage for the
Argus II, then all Medicare Advantage plans in that MAC jurisdiction are required to offer the same coverage for the Argus II.
Individual hospitals and Ambulatory Surgery Centers (ASCs) may negotiate Medicare Advantage contracts specific to that individual
facility, which may include additional separate payment for the Argus II implant system. In addition, procedural payment is variable
and can be based on a percentage of billed charges, payment groupings or other individually negotiated payment methodologies. Medicare
Advantage plans also allow providers to confirm coverage and payment for the Argus II procedure in advance of implantation.
|
|
·
|
Commercially insured patients
– Commercial insurance plans make coverage and payment
rate decisions independent of Medicare decisions and contracts are individually negotiated with facility and physician providers.
|
For the third quarter
of 2016, four individuals in the US received and were implanted with the Argus II technology, all of whom were Medicare FFS patients.
The Agency for Healthcare
Research and Quality, or AHRQ, which is an agency of the Department of Health and Human Services, is conducting a Technology Assessment
that will provide an overview of retinal prosthesis systems (RPSs). On May 18, 2016, AHRQ published a draft of its assessment
entitled, Retinal Prostheses in the Medicare Population. This assessment evaluated all retinal prosthesis systems and examined
the availability of evidence for each. The draft concluded that the strength of the evidence was insufficient to estimate the
proportion of patients who will benefit from an RPS. It is important to note that the literature review combined all retinal prosthesis
systems, whether in concept phase or in development, and came to a single conclusion about the strength of the evidence as noted
in this draft assessment. Comments have been submitted by various stakeholders, including Second Sight, and it is anticipated
that the AHRQ technology assessment final report will be published in the next few months. A description of the draft Health Technology
Assessment can be found at http://www.ahrq.gov/sites/default/files/wysiwyg/research/findings/ta/retinalprostheses/eye1215-retinal-prosthesis-draft-report.pdf.
No assurance can be given as to what impact, if any, this report may have on us.
Based on a review of
three-year clinical data, in June 2016 the Ontario Health Technology Committee (OHTAC) recommended that Health Quality Ontario
(HQO) should not publicly fund the Argus II. HQO is the agency mandated to advise government and health care providers on evidence
to support healthcare solutions in Ontario, Canada. OHTAC recommended that HQO review the evidence for retinal prosthesis systems
in one year to re-evaluate the clinical effectiveness. To date, all Argus II implants in Canada have been privately funded.
Within Europe, we have
obtained reimbursement approval in Germany, France and parts of Italy. We also are seeking reimbursement approval in other countries
including the United Kingdom, Belgium, Switzerland and Turkey.
In
France, Second Sight was selected to receive the first "Forfait Innovation" (Innovation Bundle) from the Ministry of
Health, which is a special funding program for breakthrough procedures to be introduced into clinical practice. As part of this
program, Second Sight is conducting a post-market study in France which will enroll a total of 18 subjects and follow them for
two years. The French program will fund implantation of up to 18 additional
patients
that will not be part of the post-market study. After review of the study’s results, we expect Argus II therapy to be covered
and funded through the standard payment system in France, however, we can provide no assurance that the French government will
continue to fund the Argus II after the first 36 implants.
To date, we have not faced
traditional sales challenges in any of our markets, largely due to the currently unmet clinical need and the lack of any other
commercially available device or competitive treatment for RP-caused profound blindness. However, we believe that recently we may
have lost commercial implant opportunities in France and Germany due to patients electing to wait or to participate in clinical
trials for new products from other manufacturers that are seeking regulatory approval or reimbursement. We have faced what we believe
are unfair and illegal marketing practices by our competitors and certain European courts have granted us six preliminary injunctions
against two European companies. As these competitive implant technologies expand their clinical trials, or gain regulatory approval,
gain national reimbursement and gain market acceptance, they may have or cause an adverse impact on our business in several European
countries. Currently, we are not aware of any existing clinical trials by possible competitors in the U.S. market.
Our marketing activities
continue to focus on raising awareness of the Argus II System with potential patients, implanting physicians, and referring physicians.
We believe we are differentiating our product by highlighting the Argus II’s unmatched durability in long term trials, the
large number of centers performing implants, the relative availability of reimbursement, and the fact that over 200 Argus II units
have been implanted, making it by far the most performed solution among those available. Our marketing activities include exhibiting,
sponsoring symposia, and securing podium presence at professional and trade shows, securing journalist coverage in popular and
trade media, attending patient meetings focused on educating patients about existing and future treatments, and sponsoring information
sessions for the Argus II System. In the US, our efforts in 2016 include media ads dedicated to RP patients and their families.
These ads are being placed in geographic areas where we have proven implanting centers and established reimbursement. As a result
of the above efforts, as of September 30, 2016, the Company had a patient interest list in the U.S. with over 150 conditionally
qualified individuals.
Product and Clinical Development Plans
In the first half
of 2016, we introduced new clinical software that is used for programming the Argus II that we believe helps clinicians with
the initial programming and follow-up training of patients. In 2017, subject to FDA approval, we plan to introduce
new eyewear (including camera) and a more powerful VPU that will allow us to implement various software enhancements and
an improved user interface. We believe that new, more sophisticated software enhancements may improve the quality and
usefulness of the vision provided by Argus II. Commercial rollouts of the software enhancements are dependent on outcomes of
testing and additional regulatory approvals.
Currently, our Argus
II System is approved for persons suffering from RP. We believe we may be able to expand the market for the Argus II System
beyond RP to patients with severe to profound vision loss due to dry age-related macular degeneration, or AMD. We have
enrolled and implanted five patients in a pilot study to evaluate the safety and benefit of the Argus II System for use in
persons suffering from AMD. We plan to expand the number of patients implanted and will submit a revised protocol to the U.K.
authorities. Based on the results of this expanded study, we may decide to begin a larger scale efficacy trial. The size and
timing of the pivotal study are dependent on multiple factors including the actual subset of AMD patients we target and
whether we decide to modify the Argus II system prior to commencing a pivotal study. The subset of patients will influence
the regulatory and reimbursement pathways, the size of the study and the length of time required to enroll the study. The
Company is also evaluating the potential benefits of system changes optimized for AMD. No assurance can be given that we will
be successful in any of these endeavors. If the Argus II System is successfully developed and approved for sale to treat AMD,
as to which there can be no assurances, we believe that the potential addressable market opportunity for that device will
significantly exceed our existing RP markets for the Argus II System.
We are also conducting
preclinical development, including animal studies, of a product for cortical stimulation that we refer to as the Orion I visual
cortical prosthesis (or “Orion I”), which we expect will be able to provide some vision restoration to individuals
with almost all unpreventable forms of blindness. Our objective in designing and developing the Orion I is to bypass the retina
and optic nerve and to directly stimulate the visual cortex region of the brain. In October 2016, we announced the first successful
implantation and activation of a wireless visual cortical stimulator in a human subject. While this device was not the Company’s
Orion I, the study provides the initial human proof of concept for the ongoing development of the Orion I. Human clinical
testing of the Orion I is likely to take the form of a feasibility study followed by a premarket approval pivotal trial. The details
of these trials will be determined collaboratively with the FDA at that time. We cannot accurately estimate the timing or exact
cost of these trials at this time although we do plan to apply to the FDA to begin a feasibility study by early 2017. If the Orion
I is successfully developed and approved for sale, as to which there can be no assurances, we believe that the potential addressable
market opportunity for that device will greatly exceed our existing RP market for the Argus II System.
Critical Accounting Policies
The preparation of our
condensed consolidated financial statements in conformity with generally accepted accounting principles in the United States, or
GAAP, requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the
notes to the financial statements. Some of those judgments can be subjective and complex, and therefore, actual results could differ
materially from those estimates under different assumptions or conditions. A summary of our critical accounting policies is presented
in Item 7 of our Annual Report on Form 10-K, as amended, for the year ended December 31, 2015. There have been no
material changes to our critical accounting policies during the nine months ended September 30, 2016.
Results of Operations
Net
sales.
Our net sales are derived substantially from the sale of our Argus II System. We began selling our products
in Europe in 2011, Saudi Arabia in 2012, the United States and Canada in 2014, and Turkey in 2015. Our objective is to
increase our product revenue over the next several years as we pursue commercialization of our product, as our product
becomes more well-known and accepted in the market, and as insurance coverage becomes more widespread.
Cost of
sales.
Cost of sales includes the salaries, benefits, material, overhead, third party costs, warranty, charges for
excess inventory, and other costs required to make our Argus II System at our Sylmar, California facility. Historically, our
cost of sales has been greater than our revenues, which has resulted in gross losses. However, beginning in the second half
of fiscal 2014 and continuing through the first quarter of 2016, due to higher revenues and increased manufacturing output
and efficiencies, we began generating positive gross margins for the first time in our operating history. In each of
the second and third quarters of 2016, due to lower revenues, lower production activity and a reserve for excess inventory,
we once again recorded a gross loss. Our ability to generate a gross profit in the future will be dependent on our ability
to (1) generate higher revenues and (2) to produce our product in sufficient amounts that will allow us to absorb all
production costs in a given period by spreading our costs over a larger production base, which will lower our cost per
unit.
Operating Expenses.
We
generally recognize our operating expenses as we incur them in four general operational categories: research and development, clinical
and regulatory, sales and marketing, and general and administrative. Our operating expenses also include a non-cash component related
to the amortization of deferred stock-based compensation allocated to research and development, clinical and regulatory, sales
and marketing and general and administrative personnel. From time to time we have received grants from institutions or agencies,
such as the National Institutes of Health, to help fund some of the cost of our development efforts. We have recorded these grants
as offsets to the costs as they are incurred to complete the related work.
|
·
|
Research and development expenses consist primarily of employee compensation and consulting costs
related to the design, development, and enhancements of our current and potential future products, offset by grant revenue received
in support of specific research projects. We expense our research and development costs as they are incurred. We expect research
and development expenses to increase in the future as we pursue further enhancements of our existing product and develop technology
for our potential future products, such as the Orion I visual cortical prosthesis. We also expect to receive additional grants
in the future that will be offset primarily against research and development costs.
|
|
·
|
Clinical and regulatory expenses consist primarily of salaries, travel and related expenses for
personnel engaged in clinical and regulatory functions, as well as internal and external costs associated with conducting clinical
trials and maintaining relationships with regulatory agencies. We expect clinical and regulatory expenses to increase as we assess
the safety and efficacy of enhancements to our current Argus II System, seek to expand the indications for the Argus II System,
such as AMD, and prepare to initiate clinical studies of potential future products, such as the Orion I visual cortical prosthesis.
|
|
·
|
Sales and marketing expenses consist primarily of salaries, commissions, travel and related expenses
for personnel engaged in sales, marketing and business development functions, as well as costs associated with promotional and
other marketing activities. We expect sales and marketing expenses to increase as we hire additional sales personnel, initiate
additional marketing programs, develop relationships with new distributors, and expand the number of doctors and medical centers
that buy and implant our Argus II System and any future products.
|
|
·
|
General and administrative expenses consist primarily of salaries and related expenses for executive,
legal, finance, human resources, information technology and administrative personnel, as well as recruiting and professional fees,
patent filing costs, insurance costs and other general corporate expenses, including rent. We expect general and administrative
expenses to increase as we add personnel and incur additional costs related to the growth of our business and operate as a public
company.
|
Comparison of the Three Months Ended September
30, 2016 and 2015
Net Sales.
Net
sales decreased by $1,047,000, or 47%, from $2,227,000 in the third quarter of 2015 to $1,180,000 in same period in 2016,
primarily due to lower revenue per implant in the third quarter of 2016 compared
to the same period in 2015. Revenue recognized
per implant was $84,000 in the third quarter of 2016 compared to $148,000 in the same period of the prior year. The lower
revenue per implant reflects the reduced CMS reimbursement rate for 2016, the timing of revenue recognition due to certain
deal terms and certain incentives provided to customers. For the balance of 2016, due to our temporary discounting strategy
in the U.S. we expect the overall revenue per implant will be approximately $80,000 to $90,000. For 2017, given the
CMS hospital outpatient payment rate of $150,000 for U.S. Medicare patients, we would expect our average
revenue per implant to increase to $100,000 to $120,000, depending on the geographic mix of implants.
There were 14 Argus II
Systems implanted in the third quarter of 2016, compared to 15 in the same period of the prior year. Of this total, there were
10 implants in Europe and the Middle East (EMEA) in the third quarter of 2016 compared to seven in the third quarter of 2015. The
increase in EMEA in the current year quarter compared to the prior year is primarily due to an increase of four units implanted
in Germany.
In North
America, there were four implants in the third quarter of 2016 compared to eight implants in the same period of 2015, with
all implants in both periods occurring in the U.S. The decline in U.S. implants was due, in part, to the 2016 Medicare
reimbursement level being reduced to $95,000, which in Q1 was approximately $50,000 below our U.S. list price. We made the
decision in late February 2016 to implement temporary discounts in the U.S., lasting through December 2016, to
alleviate concerns of our customers that they would lose money on Argus II patient cases due to the difference between the
device cost and the reimbursement amount. With this U.S. pricing issue addressed, and with the hiring of a new commercial
vice president for the U.S. and Canada in March 2016, we expect that implant volumes in North America will rebound from
current levels, and potentially grow, over the next few quarters.
Cost of sales.
Cost
of sales increased by approximately $1,858,000, or 145%, from $757,000 in the third quarter of 2015 to $2,615,000 in
the third quarter of 2016, and consists of approximately $900,000 for cost of goods shipped in the quarter, approximately
$700,000 for unabsorbed manufacturing overhead and approximately $1.0 million of additional reserves for excess inventory.
Our gross margin was a negative 122% in the third quarter of 2016 compared to a positive 66% in the third quarter of 2015. We
made the decision during the second quarter of 2016 to reduce our production levels and lay off certain direct manufacturing
personnel and reassign certain other indirect personnel to where the Company could better utilize their skills. As a result
of the reduced production output, we are spreading our production costs over a lower number of units, which resulted in
unabsorbed production variances that we recognize in the period incurred. In addition, we are utilizing certain manufacturing
resources to support our research and development efforts to build prototypes for our Orion I cortical product. We will
continue to monitor our inventory levels, sales volume, and sales projections. In future quarters, if implant volumes and
projections are lower than we now expect them to be, we may book additional reserves for slow-moving inventory. Conversely,
if implant volumes and projections remain constant or improve from current levels, we may increase production of Argus II
units and components. Until then, we intend to utilize a significant portion of our manufacturing resources to support our
research and development efforts.
Research and
development expense.
Research and development expense, net of grant revenue, increased by $995,000, or 168%, to
$1,588,000 in the third quarter of 2016 compared to $593,000 in the third quarter of 2015. The increase from the prior year
was due to higher costs in the current year for compensation costs, supplies and outside services, as well as higher labor
and material costs for internally produced prototypes for new and next generation products. In the third quarter of 2016, we
utilized $713,000 of grant funds to offset costs compared to $778,000 in the prior year period. Excluding the effect of
grants, research and development expense increased by $930,000 in the current year quarter, primarily due to an increase in
expenditures related to next generation products. We expect that the amount of grant funding utilized to offset research and
development costs will decrease in 2017, resulting in a higher level of recognized expense.
Clinical and regulatory
expense.
Clinical and regulatory expense decreased $375,000, or 38%, from $984,000 in the third quarter of 2015 to $609,000
in the third quarter of 2016. This decrease is primarily attributable to lower new enrollment in post-market studies being conducted
in the U.S. and Europe due to the lower level of implants in the current year compared to 2015. We expect clinical and regulatory
costs to increase in the future as we conduct clinical trials to assess new products, further enhancements to our existing product,
and continue to assess the safety and efficacy of our current product for treating blindness due to age related macular degeneration.
Selling and marketing
expense.
Selling and marketing expense increased $130,000, or 6%, from $2,132,000 in the third quarter of 2015 to $2,262,000
in the third quarter of 2016. This increase in costs was primarily the net of $232,000 less in people related costs, including
lower salaries, stock based compensation, travel and commissions, offset by $325,000 in higher costs for consultants related to
items such as customer outreach programs and insurance reimbursement for our products in the U.S. and foreign markets. While we
expect these costs to increase in the future as we increase our selling and marketing resources to accelerate the commercialization
of our product, we expect selling and marketing expense to decrease over time when expressed as a percentage of product revenue.
General
and administrative expense.
General and administrative expense increased $182,000, or 8%, from $2,423,000 in the
third quarter of 2015 to $2,605,000 in the same period of 2016. This increase is primarily attributable to $315,000 in
higher compensation costs, including higher stock-based compensation charges, and $57,000 related to higher business
insurance expense in the current year offset, in part, by $161,000 in lower costs for outside services. In the third quarter
of 2016 as compared to the third quarter of the prior year, stock-based compensation (which includes the value of fees
earned by directors and paid in stock) increased by $161,000 primarily to new-hire grants made in August 2015 to the
Company’s Chief Executive Officer.
Comparison of the Nine Months Ended September
30, 2016 and 2015
Net Sales.
Our
net sales decreased from $6,588,000 in the first nine months of 2015 to $3,270,000 in same period in 2016, a decrease of $3,318,000,
or 50%. This decrease in net sales was due to a lower number of implants in 2016, and at a lower average amount of recognized revenue
per implant than in the same period of the prior year.
35 Argus II
Systems were implanted in the first nine months of 2016 compared to 54 in the first nine months of 2015. Of these, there were
25 implants in EMEA in the first nine months of 2016 compared to 32 in the first nine months of 2015. The decrease in EMEA
between the 2015 and 2016 periods is primarily attributable to a decrease of 10 implants in France due, in part, to two
potential competitors recruiting RP patients for a clinical trial in France.
In North America,
there were 10 implants in the first nine months of 2016 compared to 22 implants in the same period of the prior year. The
decline in U.S. implants was due, in part, to the 2016 Medicare reimbursement level being reduced to $95,000, which in early
Q1 was approximately $50,000 below our U.S. list price. We made the decision in late February 2016 to implement
temporary discounts in the U.S., lasting through December 2016, to alleviate concerns of our customers that they would lose
money on Argus II patient cases due to the difference between the device cost and the reimbursement amount. With this U.S.
pricing issue addressed for fiscal year 2016, and with the hiring of a new commercial vice president for the U.S. and Canada
in March 2016, we expect that implant volumes in North America will rebound from current levels, and potentially grow, over
the next few quarters.
In the first nine months
of 2016, revenue recognized per implant was approximately $93,000 compared to approximately $122,000 in the same period of 2015.
Average revenue per implant was lower in the first nine months of 2016 compared to the first nine months of 2015 primarily due
to the lower Medicare reimbursement rate in the United States in 2016. For the balance of 2016, due to our temporary discounting
strategy in the U.S., we expect our overall revenue per implant will be approximately $80,000 to $90,000. For 2017, with the CMS reimbursement rate of $150,000 discussed above for U.S. Medicare patients, we would expect to have our average revenue per
implant to increase to approximately $100,000 to $120,000, depending on the geographic mix of implants.
Cost of sales.
Cost
of sales increased from $3,622,000 in the first nine months of 2015 to $6,768,000 in the first nine months of 2016, an
increase of $3,146,000 or 87%. This increase of the cost of goods sold in the first nine months of 2016 represents a lower
cost of goods associated with the lower volume of implants in the first nine months of 2016 offset by charges in the first
nine months of 2016 for excess inventory of $2.6 million and unabsorbed overhead costs of $2.1 million. Our gross margin was
a negative 107% in the first nine months of 2016 compared to a positive 45% in the first nine months of 2015. We made the
decision during the second quarter of 2016 to reduce our production levels and lay off certain direct manufacturing personnel
and reassign certain other indirect personnel to where the Company could better utilize their skills. As a result of the
reduced production output, we are spreading our production costs over a lower number of units, which resulted in
unabsorbed production variances that we recognize in the period incurred. In addition, we are utilizing certain manufacturing
resources to support our research and development efforts to build prototypes for our Orion cortical product. We will
continue to monitor our inventory levels, sales volume, and sales projections. In future quarters, if implant volumes and
projections are lower than we now expect them to be, we may book additional reserves for slow-moving inventory. Conversely,
if implant volumes and projections remain constant or improve from current levels, we may increase production of Argus II
units and components. Until then, we will utilize a significant portion of our manufacturing resources to support our
research and development efforts.
Research and development
expense.
Research and development expense, net of grant revenue, increased by $776,000, or 31%, from $2,490,000 in the first
nine months of 2015 to $3,266,000 in the first nine months of 2016. In the first nine months of 2016, we utilized $1,985,000 of
grant funds to offset costs versus $1,308,000 of grant funds utilized in the same period of 2015. Excluding this grant offset,
there was an increase in research and development costs of $1,453,000 or 38%, primarily as a result of increased expenditures for
compensation costs, outside consulting services and higher labor and material costs for internally produced prototypes for next
generation products. We expect that the amount of grant funding utilized to offset research and development costs will decrease
in 2017, resulting in a higher level of recognized expense.
Clinical and regulatory
expense.
Clinical and regulatory expense decreased by $588,000, or 23%, from $2,543,000 in the first nine months of 2015 to
$1,955,000 in the same period of 2016. This decrease is primarily attributable to a lower level of clinical and regulatory activity
reflecting decreased new enrollment in post-market studies being conducted in the US and Europe. We expect clinical and regulatory
costs to increase in the future as we conduct clinical trials to assess new products, further enhancements to our existing product,
and continue to assess the safety and efficacy of our current product for treating blindness due to age related macular degeneration.
Selling and marketing
expense.
Selling and marketing expense increased by $48,000, or 1%, from $6,425,000 in the first nine months of 2015 to $6,473,000
in the same period of 2016. This increase in costs was primarily the net of $657,000 less in people related costs, including lower
salaries, stock based compensation, travel and commissions, offset by $731,000 in higher costs for consultants related to items
such as customer outreach programs and insurance reimbursement for our products in the U.S. and foreign markets. While we expect
these costs to increase in the future as we increase our selling and marketing resources to accelerate the commercialization of
our product, we expect selling and marketing expense to decrease over time when expressed as a percentage of product revenue.
General and
administrative expense.
General and administrative expense increased by $1,556,000, or 26%, from $6,079,000 in the first
nine months of 2015 to $7,635,000 in the same period of 2016. This increase is primarily attributable to $1.4 million of
higher people related costs in the current year, including $365,000 for higher salaries and $958,000 for higher-stock based
compensation charges (which includes the value of fees earned by directors and paid in stock). These higher salary and
stock-based compensation expenses relate primarily to the Company’s chief executive officer who was hired August 2015.
While we expect general and administrative costs to increase in the future, we expect these expenses to grow at a slower rate
than in the past 12 months.
Liquidity and Capital Resources
Our consolidated
financial statements have been presented on the basis of our being a going concern, which contemplates the realization of
assets and satisfaction of liabilities in the normal course of business. We have experienced recurring operating losses and
negative operating cash flows since inception, and have financed our working capital requirements through the recurring sale
of our equity securities in both public and private offerings. As a result, our independent registered public accounting
firm, in its report on our 2015 consolidated financial statements, raised substantial doubt about our ability to continue as
a going concern (see “Going Concern” above). In June 2016, the Company successfully completed a Rights
Offering to existing shareholders, raising proceeds of $19.5 million net of cash offering costs, and selling 5,978,465 shares
of common stock at $3.315 per share. Based upon this funding, management believes that it has sufficient funds to last
through the end of the second quarter of 2017. In order to continue business operations past that point, we currently
anticipate that we will need to raise additional debt and/or equity capital during the next several months.
Cash and money market
funds increased by $1,863,000, or 12%, from $15,960,000 at December 31, 2015 to $17,823,000 at September 30, 2016. Working capital
was $19,017,000 at September 30, 2016, as compared to $18,782,000 at December 31, 2015, an increase of $235,000, or 1%. We use
our cash, money market funds and working capital to fund our operating activities.
Cash Flows from Operating Activities
During the first nine
months of 2016, we used $18,054,000 of cash in operating activities, consisting primarily of a net loss of $22,809,000, offset
by non-cash charges of $5,900,000 for depreciation and amortization of property and equipment, stock-based compensation, excess
inventory reserve, bad debt expense and common stock issuable and increased by a net change in operating assets and liabilities
of $1,145,000. This compares to the first nine months of 2015, we used $14,652,000 of cash in operating activities, consisting primarily
of a net loss of $14,545,000, offset by non-cash charges of $2,382,000 for depreciation and amortization of property and equipment,
stock-based compensation and common stock issuable, and increased by a net change in operating assets and liabilities of $2,489,000.
Cash Flows from Investing Activities
Investing activities in
the first nine months of 2016 used $2,226,000 of cash, reflecting $1,820,000 used by the purchase of money market investments and
$406,000 used for the purchase of equipment. This compares to the first nine months of 2015 when investing activities provided
$12,021,000, reflecting $12,599,000 in proceeds from the sales of money market investments, offset by $578,000 for the purchase
of equipment.
Cash Flows from Financing Activities
Financing activities
provided $20,299,000 of cash in the first nine months of 2016, $19,483,000 of net proceeds from the Rights Offering
and $479,000 from the exercise of stock options and $337,000 from the proceeds from sale of stock for the ESPP plan.
Financing activities provided $2,352,000 of cash in first nine months of 2015, $2,476,000 from the exercise of stock options
and warrants offset by $124,000 of cash used to satisfy the related income and payroll tax withholding amounts related to
stock option exercises for our current chairman, who at the time was our chief executive officer.
Off-Balance Sheet Arrangements
We do not have any off-balance
sheet arrangements.