ITEM 2.
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (amounts in thousands, except per share amounts or as otherwise noted)
|
You should read the
following discussion in conjunction with our financial statements and related notes appearing elsewhere in this report. In addition
to historical information, this report contains "forward-looking statements" within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 concerning our business, consolidated financial
condition, and results of operations. The Securities and Exchange Commission ("SEC") encourages companies to disclose
forward-looking statements so that investors can better understand a company’s prospects and make informed investment decisions.
Forward-looking statements are subject to risks and uncertainties, many of which are outside our control, which could cause actual
results to differ materially from these statements. Therefore, you should not rely on any of these forward-looking statements.
Forward-looking statements can be identified by such words as "will," "likely," "may," "believe,"
"expect," "anticipate," "intend," "seek," "designed," "develop," "would,"
"future," "can," "could," and other expressions that are predictions of or indicate future events
and trends and that do not relate to historical matters. All statements other than statements of historical facts included in this
report regarding our strategies, prospects, financial condition, operations, costs, plans, and objectives are forward-looking statements.
Examples of forward-looking statements include, among others, statements regarding expected future operating results, expectations
regarding the timing and receipt of regulatory results, anticipated levels of capital expenditures, and expectations of the effect
on our financial condition of claims, litigation, and governmental and regulatory proceedings.
Please also refer to
those factors described in “Part I, Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December
31, 2018 for important factors that we believe could cause actual results to differ materially from those in our forward-looking
statements. Any forward-looking statement made by us in this report is based only on information currently available to us and
speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statement, whether
written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.
Management Overview
We are a global, integrated orthopedic and regenerative medicines company committed to improving the lives
of patients with degenerative orthopedic diseases and traumatic conditions with clinically meaningful therapies along the continuum
of care, from palliative pain management to regenerative tissue repair. We have over two decades of global expertise developing,
manufacturing, and commercializing our products based on our proprietary hyaluronic acid (“HA”) technology. Our orthopedic
medicine portfolio includes ORTHOVISC, MONOVISC, and CINGAL, viscosupplements which alleviate pain and restore joint function by
replenishing depleted HA, and HYALOFAST, a solid HA-based scaffold to aid cartilage repair and regeneration.
Our therapeutic offerings
consist of products in the following areas: Orthobiologics, Dermal, Surgical, and Other, which includes our ophthalmic and veterinary
products. All of our products are based on HA, a naturally occurring, biocompatible polymer found throughout the body. Due to its
unique biophysical and biochemical properties, HA plays an important role in a number of physiological functions such as the protection
and lubrication of soft tissues and joints, the maintenance of the structural integrity of tissues, and the transport of molecules
to and within cells.
Our proprietary technologies
for modifying the HA molecule allow product properties to be tailored specifically to therapeutic use. Our patented technology
chemically modifies HA to allow for longer residence time in the body. We also offer products made from HA based on two other technologies:
HYAFF, which is a solid form of HA, and ACP gel, an autocross-linked polymer of HA. Our technologies are protected by an extensive
portfolio of owned and licensed patents.
Since our inception in 1992, we have utilized a commercial partnership model for the distribution of our products
to end-users. Our strong, worldwide network of distributors has historically provided, and continues to provide, a solid foundation
for our revenue growth and territorial expansion. For near-term and long-term opportunities in the U.S. market, especially with
respect to surgical products utilized in an operating room environment, we are executing a hybrid commercial strategy in the U.S.
that balances a small direct model with an optimal form of strategic partnership. We are initially utilizing this model to commercialize
our injectable, HA-based, surgical bone repair product in the United States. For longer-term future products in the U.S. market,
we intend to evaluate the appropriate commercial model for each instance on a case-by-case basis, based on market dynamics, product
type and other factors. These models could include direct sales, distribution partnerships, or a hybrid of those forms. We believe
that the combination of the direct and distribution commercial models will maximize the revenue potential from our current and
future product portfolio.
Please see the section
captioned “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Management
Overview” in our Annual Report on Form 10-K for the year ended December 31, 2018, for a description of each of the above
therapeutic areas, including the individual products.
On May 2, 2018, we
publicly disclosed a voluntary recall of certain production lots of our HYAFF-based products, HYALOFAST, HYALOGRAFT C, and HYALOMATRIX.
We communicated with all affected distributors in advance of that announcement, and we are taking all required or otherwise appropriate
actions with respect to applicable regulatory bodies. We initiated the recall following internal quality testing, which indicated
that the products were at risk of not maintaining certain measures throughout their entire shelf life. While there was no indication
of any safety or efficacy issue related to the products, we are committed to the highest standards of quality and removed the products
from the field as a precautionary measure. During the fourth quarter of 2018, we resolved this matter and resumed shipment of these
products.
Key Developments during the Quarter
Ended June 30, 2019
·
|
|
We
made the decision to advance our U.S. CINGAL development program to achieve FDA approval, initially through the execution of a
pilot study.
|
·
|
|
We executed a $30.0 million accelerated share repurchase agreement with Morgan Stanley & Co. LLC to repurchase common
stock.
|
·
|
|
We continued to build our U.S. commercial infrastructure to execute our hybrid commercial strategy for the launch of our
injectable, HA-based, surgical bone repair product in the third quarter of 2019.
|
·
|
|
We generated total revenue of $30.4 million for the second quarter of 2019.
|
Research and Development
Our research and development
efforts primarily consist of the development of new medical applications for our HA-based technology, the management of clinical
trials for certain product candidates, the preparation and processing of applications for regulatory approvals or clearances at
all relevant stages of product development, and process development and scale-up manufacturing activities for our existing and
new products. Our development focus is orthopedic and regenerative medicine and includes products for tissue protection, repair,
and regeneration. We anticipate that we will continue to commit significant resources in the near future to research and development
activities, including in relation to preclinical activities and clinical trials. These activities are aimed at the delivery of
a steady cascade of new product development and launches over the next several years.
In the third quarter of 2017, we submitted an application to the FDA for 510(k) clearance of an injectable,
HA-based surgical bone repair product that is reabsorbed by the body and replaced by the growth of new bone during the healing
process. We received the 510(k) clearance from the FDA in December 2017, and we expect to make this bone repair product commercially
available in the United States during the third quarter of 2019 utilizing the previously-described hybrid commercial approach.
In addition, we are working to expand our regenerative medicine pipeline with a new product candidate in the form of an implant
for rotator cuff repair utilizing our proprietary solid HA, which could be used to repair partial and full-thickness rotator cuff
tears. We finalized development of an initial product prototype during the fourth quarter of 2018. We are currently working on
refining the prototype and performing preclinical testing of and developing the surgical instrumentation for the potential product.
We anticipate that we will seek 510(k) clearance for this product during 2020, with a potential commercial launch to occur in mid-2021.
Our third generation,
single-injection osteoarthritis product under development in the United States, CINGAL, which is composed of our proprietary cross-linked
HA material combined with an approved steroid and is designed to provide both short- and long-term pain relief to patients, is
a main pipeline product and a component of our growth strategy. We completed an initial CINGAL Phase III clinical trial, including
the associated statistical analysis for 368 enrolled patients, during the fourth quarter of 2014 with data indicating that the
product met all primary and secondary endpoints relative to placebo set forth for the trial. During the first half of 2015, we
completed a CINGAL retreatment study with 242 patients who had participated in the Phase III clinical trial and reported safety
data related to the retreatment study. This initial Phase III clinical trial and the associated retreatment study supported the
Health Canada and CE Mark approval of the product, and the commercial launch of the product in both Canada and the European Union
occurred in the second quarter of 2016. In the United States, after discussions with the U.S. Food and Drug Administration (“FDA”)
related to the regulatory pathway for CINGAL, we conducted a formal meeting with the FDA’s Office of Combination Products
(“OCP”) to present and discuss our data in September 2015, and we submitted a formal request for designation with OCP
a month later. In its response to our formal request for designation, OCP assigned the product to the FDA’s Center for Drug
Evaluation and Research (“CDER”) as the lead agency center for premarket review and regulation. We then held discussions
with CDER to understand the requirements for submitting a New Drug Application (“NDA”) for CINGAL. We held a meeting
with CDER in September 2016 to align on an approval framework and on submission requirements for this NDA for CINGAL, including
the execution of an additional Phase III clinical trial to supplement our existing CINGAL pivotal study data. We submitted an IND
in late 2016, and discussions with CDER indicated that they did not have objections to our clinical protocol design. As a result,
we commenced work on this second Phase III clinical trial (“CINGAL 16-02 Study”) in the first quarter of 2017, and
the first patient was treated in the second quarter of 2017. Enrollment of the 576 patients in this second Phase III clinical trial
was completed during October 2017, and we completed the six-month patient follow-up in April 2018. We received and analyzed the
data from the CINGAL 16-02 Study during the second quarter of 2018, and, while substantial pain reduction associated with CINGAL
was evident at each measurement point, we determined based on statistical analysis that it did not meet the primary study endpoint
of demonstrating a statistically significant difference in pain reduction between CINGAL and the approved steroid component of
CINGAL at the six-month time point. In the third quarter of 2017, we initiated an additional three-month extended follow-up study
in conjunction with the CINGAL 16-02 Study to investigate the efficacy of CINGAL over this longer period. The first patients were
enrolled in this follow-up study in the fourth quarter of 2017 and we completed the nine-month patient follow-up in the third quarter
of 2018. In the first quarter of 2019, we met with the FDA to discuss the potential approval pathway for CINGAL in the United States
moving forward in light of the work we have previously done. In the meeting, the FDA indicated that an additional Phase III clinical
trial would be necessary to support U.S. marketing approval for CINGAL, and we received feedback from the FDA on the parameters
and requirements for this additional clinical trial. After substantial internal review, we have decided to conduct a pilot study
to enable us to evaluate our full-scale Phase III clinical trial design, including patient and site selection criteria, and increase
the probability of success for the Phase III trial. We expect to begin enrolling patients in the pilot study in the first half
of 2020.
We have several research and development programs underway for new products, including for HYALOFAST (in
the United States), an innovative product for cartilage tissue repair, and other early stage regenerative medicine development
programs. HYALOFAST, which received CE Mark approval in September 2009, is commercially available in Europe and certain international
countries. During the first quarter of 2015, we submitted an Investigational Device Exemption (“IDE”) for HYALOFAST
to the FDA, which was approved in July 2015. We commenced patient enrollment in a clinical trial in December 2015 and advanced
site initiations and patient enrollment activities. In the second quarter of 2016, a supplement to the HYALOFAST IDE was approved
to expand the inclusion criteria for the clinical study, which was aimed at decreasing the time needed to complete the clinical
trial. An additional supplement to the HYALOFAST IDE was approved in June 2019, amending the clinical protocol to allow worldwide
trial site locations and to adjust inclusion criteria with the goal of accelerating trial enrollment and maximizing our probability
of a successful trial outcome. Given the changing medical landscape with respect to the randomization arm for this trial, the microfracture
procedure, we are also actively pursuing other alternative strategies to accelerate patient enrollment. The previously-described
voluntary recall of certain production lots of our HYAFF-based products did not impact the HYALOFAST clinical trial, as the product
used in the clinical trial is not sourced from the affected production lots.
We are also currently
proceeding with other research and development programs, one of which utilizes our proprietary HA technology to treat pain associated
with common repetitive overuse injuries, such as lateral epicondylitis, also known as tennis elbow. We submitted a CE Mark application
for this treatment during the first quarter of 2016 and received a CE Mark for the treatment of pain associated with tennis elbow
in December 2016. We began work towards a post-market clinical study in relation to the CE Mark for this product in the fourth
quarter of 2018. Outside of the United States, this product is marketed under the trade name ORTHOVISC-T. Additionally, in the
second quarter of 2016, we submitted an IDE to the FDA to conduct a Phase III clinical trial for this treatment, which was approved
by the FDA in June 2016. Notwithstanding that approval and in light of recent changes to the regulatory environment for HA-based
products, in the first quarter of 2019, the FDA requested that we submit this product to OCP for designation, which we did early
in the second quarter of 2019. We remain in discussions with the FDA with respect to the designation and approval pathway for this
product. We also have several other research and development programs underway focused on expanding the indications of our current
products, including MONOVISC. During 2019, we will also be performing post-market clinical work in relation to the CE Mark for
MONOVISC.
In addition to other
early stage research and development initiatives we are undertaking, we entered into an agreement with the University of Liverpool
in January 2018 to develop an injectable mesenchymal stem cell therapy for the treatment of age-related osteoarthritis with the
goal of bringing a therapeutics candidate through clinical trials to market to meet an unmet therapeutic need. We are currently
in the preclinical phase of this program and aim to finalize proof of concept during the second quarter of 2020.
Results of Operations
Three- and Six-Months Ended June 30, 2019 Compared to Three- and Six-Months Ended June 30, 2018
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
|
2019
|
|
2018
|
|
$ Inc/(Dec)
|
|
% Inc/(Dec)
|
|
2019
|
|
2018
|
|
$ Inc/(Dec)
|
|
% Inc/(Dec)
|
|
|
(in thousands, except percentages)
|
|
(in thousands, except percentages)
|
Product revenue
|
|
$
|
30,413
|
|
|
$
|
30,542
|
|
|
$
|
(129
|
)
|
|
|
(0
|
%)
|
|
$
|
55,130
|
|
|
$
|
51,800
|
|
|
$
|
3,330
|
|
|
|
6
|
%
|
Licensing, milestone and contract revenue
|
|
|
5
|
|
|
|
6
|
|
|
|
(1
|
)
|
|
|
(17
|
%)
|
|
|
11
|
|
|
|
12
|
|
|
|
(1
|
)
|
|
|
(8
|
%)
|
Total revenue
|
|
|
30,418
|
|
|
|
30,548
|
|
|
|
(130
|
)
|
|
|
(0
|
%)
|
|
|
55,141
|
|
|
|
51,812
|
|
|
|
3,329
|
|
|
|
6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product revenue
|
|
|
6,836
|
|
|
|
8,152
|
|
|
|
(1,316
|
)
|
|
|
(16
|
%)
|
|
|
14,147
|
|
|
|
15,996
|
|
|
|
(1,849
|
)
|
|
|
(12
|
%)
|
Research & development
|
|
|
4,165
|
|
|
|
4,733
|
|
|
|
(568
|
)
|
|
|
(12
|
%)
|
|
|
8,423
|
|
|
|
9,895
|
|
|
|
(1,472
|
)
|
|
|
(15
|
%)
|
Selling, general & administrative
|
|
|
7,502
|
|
|
|
6,417
|
|
|
|
1,085
|
|
|
|
17
|
%
|
|
|
15,174
|
|
|
|
22,507
|
|
|
|
(7,333
|
)
|
|
|
(33
|
%)
|
Total operating expenses
|
|
|
18,503
|
|
|
|
19,302
|
|
|
|
(799
|
)
|
|
|
(4
|
%)
|
|
|
37,744
|
|
|
|
48,398
|
|
|
|
(10,654
|
)
|
|
|
(22
|
%)
|
Income from operations
|
|
|
11,915
|
|
|
|
11,246
|
|
|
|
669
|
|
|
|
6
|
%
|
|
|
17,397
|
|
|
|
3,414
|
|
|
|
13,983
|
|
|
|
410
|
%
|
Interest and other income, net
|
|
|
533
|
|
|
|
290
|
|
|
|
243
|
|
|
|
84
|
%
|
|
|
1,031
|
|
|
|
385
|
|
|
|
646
|
|
|
|
168
|
%
|
Income before income taxes
|
|
|
12,448
|
|
|
|
11,536
|
|
|
|
912
|
|
|
|
8
|
%
|
|
|
18,428
|
|
|
|
3,799
|
|
|
|
14,629
|
|
|
|
385
|
%
|
Provision for (benefit from) income taxes
|
|
|
3,013
|
|
|
|
1,444
|
|
|
|
1,569
|
|
|
|
109
|
%
|
|
|
4,486
|
|
|
|
394
|
|
|
|
4,092
|
|
|
|
1,039
|
%
|
Net income
|
|
$
|
9,435
|
|
|
$
|
10,092
|
|
|
$
|
(657
|
)
|
|
|
(7
|
%)
|
|
$
|
13,942
|
|
|
$
|
3,405
|
|
|
$
|
10,537
|
|
|
|
309
|
%
|
Product gross profit
|
|
$
|
23,577
|
|
|
$
|
22,390
|
|
|
$
|
1,187
|
|
|
|
5
|
%
|
|
$
|
40,983
|
|
|
$
|
35,804
|
|
|
$
|
5,179
|
|
|
|
14
|
%
|
Product gross margin
|
|
|
77.5
|
%
|
|
|
73.3
|
%
|
|
|
|
|
|
|
|
|
|
|
74.3
|
%
|
|
|
69.1
|
%
|
|
|
|
|
|
|
|
|
Product Revenue
Product revenue for the three-month period ended June 30, 2019 was $30.4 million, a decrease of $0.1 million as
compared to $30.5 million for the three-month period ended June 30, 2018. Product revenue for the six-month period ended June 30,
2019 was $55.1 million, an increase of 6%, or $3.3 million, as compared to $51.8 million for the six-month period ended June 30,
2018. For the three-month period ended June 30, 2019, the decrease in product revenue was driven by growth in our orthobiologics
and surgical franchises, offset by decreases resulting from order timing in our dermal and other franchises. For the six-month
period ended June 30, 2019, the increase in product revenue was driven by growth in our orthobiologics, dermal and surgical franchises,
partially offset by a decrease resulting from order timing in our other franchise.
The following tables
present product revenue by product group:
|
|
Three Months Ended June 30,
|
|
|
2019
|
|
2018
|
|
$ Inc/(Dec)
|
|
% Inc/(Dec)
|
|
|
(in thousands, except percentages)
|
Orthobiologics
|
|
$
|
26,462
|
|
|
$
|
26,192
|
|
|
$
|
270
|
|
|
|
1
|
%
|
Surgical
|
|
|
2,101
|
|
|
|
1,263
|
|
|
|
838
|
|
|
|
66
|
%
|
Dermal
|
|
|
444
|
|
|
|
623
|
|
|
|
(179
|
)
|
|
|
(29
|
%)
|
Other
|
|
|
1,406
|
|
|
|
2,464
|
|
|
|
(1,058
|
)
|
|
|
(43
|
%)
|
Total
|
|
$
|
30,413
|
|
|
$
|
30,542
|
|
|
$
|
(129
|
)
|
|
|
(0
|
%)
|
|
|
Six Months Ended June 30,
|
|
|
2019
|
|
2018
|
|
$ Inc/(Dec)
|
|
% Inc/(Dec)
|
|
|
(in thousands, except percentages)
|
Orthobiologics
|
|
$
|
48,210
|
|
|
$
|
45,681
|
|
|
$
|
2,529
|
|
|
|
6
|
%
|
Surgical
|
|
|
3,493
|
|
|
|
2,509
|
|
|
|
984
|
|
|
|
39
|
%
|
Dermal
|
|
|
573
|
|
|
|
83
|
|
|
|
490
|
|
|
|
591
|
%
|
Other
|
|
|
2,854
|
|
|
|
3,527
|
|
|
|
(673
|
)
|
|
|
(19
|
%)
|
Total
|
|
$
|
55,130
|
|
|
$
|
51,800
|
|
|
$
|
3,330
|
|
|
|
6
|
%
|
Orthobiologics
Our orthobiologics franchise consists of orthopedic pain management and regenerative therapies. Overall, sales
increased 1% and 6% for the three- and six-month periods ended June 30, 2019, respectively, as compared to the same periods in
2018. For the three-month period ended June 30, 2019, there were increased sales of our international viscosupplement products,
led by strong CINGAL sales. This increase was partially offset by a decrease in U.S. viscosupplement revenue in the period. The
increase in revenue for the six-month period ended June 30, 2019 was primarily driven by increased revenue from MONOVISC domestically
and internationally, as well as increased revenue from CINGAL in international markets. We expect orthobiologics product revenue
in 2019 to continue to increase as compared to 2018, primarily due to the growth in international CINGAL and MONOVISC revenue and
the commercial launch of our injectable, HA-based surgical bone repair product in the U.S. via the previously-described hybrid
commercial approach.
Surgical
Our surgical franchise
consists of products used to prevent surgical adhesions and to treat ear, nose, and throat (“ENT”) disorders. Sales
of our surgical products increased 66% and 39% for the three- and six-month periods ended June 30, 2019, to $2.1 million and $3.5
million, respectively, as compared to the same periods in 2018. The increase in surgical product revenue for the three- and six-month
periods was due to increased sales to our worldwide ENT commercial partner and higher sales of surgical anti-adhesion products
to our international distributors. We expect surgical product revenue to increase in 2019 as compared to 2018 primarily due to
increased worldwide revenue associated with sales of our surgical anti-adhesion product and ENT sales.
Dermal
Our dermal franchise
consists
of advanced wound care products, which are
based on our HYAFF technology, and aesthetic dermal fillers. Our advanced wound
care products treat complex skin wounds ranging from burns to diabetic ulcers, with HYALOMATRIX and HYALOFILL as the lead products.
For the three-month period ended June 30, 2019, dermal product sales decreased by $0.2 million as compared to the same period
in 2018 resulting primarily from order timing. For the six-month period ended June 30, 2019, sales increased $0.5 million as compared
to the same period in 2018. This increase was due to recovery from the previously-described voluntary recall of certain production
lots of our HYAFF-based products in 2018. We expect dermal sales to increase in 2019 as a result of resuming HYALOMATRIX shipments
in late 2018 after the product was impacted by the voluntary recall in 2018.
Other
Other product revenue
includes revenues from our ophthalmic and veterinary franchises. Other product revenue decreased for the three-month period ended
June 30, 2019 by $1.1 million or 43%, and decreased by $0.7 million or 19%, for the six-month period ended June 30, 2019, each
as compared to the corresponding period in 2018. We expect other revenue to decrease modestly in 2019 as compared to 2018, primarily
as a result of decreased sales to one of our ophthalmic distributors offset in part by increased revenue from veterinary products.
Product Gross Profit and Margin
Product
gross profit for the three- and six-month periods ended June 30, 2019 increased $1.2 million and $5.2
million to $23.6 and $41.0 million, respectively, representing 77.5% and 74.3% of product revenue. Product gross profit for the
three- and six-month periods ended June 30, 2018 was $22.4 million and $35.8 million, respectively, or 73.3% and 69.1% of product
revenue for the periods, respectively. The increase in product gross margin for the three- and six-month periods ended June 30,
2019, as compared to the same periods in 2018, was primarily due to favorable changes in revenue mix and certain inventory charges
related to our solid HA product lines incurred during the 2018 periods.
Research and Development
Research and development
expenses for the three- and six-month periods ended June 30, 2019 were $4.2 million and $8.4 million, representing 14% and 15%
of total revenue for the respective periods, a decrease of $0.6 million and $1.5 million, respectively, as compared to the same
periods in 2018. The decrease in research and development expense was primarily due to lower clinical trial expenses related to
CINGAL for the three- and six-month periods ended June 30, 2019, as compared to the same periods in 2018, offset in part by higher
pre-clinical product development activities associated with the development of product candidates in our research and development
pipeline, including our rotator cuff therapy, and additional expenses associated with compliance activities related to the European
Union Medical Device Regulation. Research and development expenses may potentially increase in 2019 as compared to 2018 as we
further develop new products and clinical trial activities, including preparation for the CINGAL pilot study, perform required
post-market clinical follow-ups for our MONOVISC and ORTHOVISC-T products in the European Union, and as a result of current or
future changes to the regulatory environments in the jurisdictions in which we do business.
Selling, General and Administrative
Selling, general and
administrative (“SG&A”) expenses for the three- and six-month periods ended June 30, 2019 were $7.5 million and
$15.2 million, representing 25% and 28% of total revenue for the period, an increase of $1.1 million and decrease of $7.3 million,
respectively, as compared to the same periods in 2018. The increase in SG&A expenses for the three-month period ended June
30, 2019 was primarily the result of increased personnel-related costs and external professional fees. The decrease for the
six-month period was primarily due to the one-time, non-cash, stock-based compensation expense of approximately $8.0 million in
the three-month period ended March 31, 2018 related to the retirement of our former Chief Executive Officer. We expect SG&A
expenses for 2019 to decrease in comparison to 2018 due to the above mentioned one-time charge. The decrease will be partially
offset by investments in our global commercial capabilities and the implementation of improved business and financial technology
platforms required to grow our business.
Income Taxes
The provision for
income taxes was $3.0 million and $4.5 million for the three- and six-month periods ended June 30, 2019, based on effective
tax rates of 24.2% and 24.3%, respectively. The provision for income taxes was $1.4 million and $0.4 million for the
three- and six-month periods ended June 30, 2018, based on effective tax rates of 12.5% and 10.4%, respectively. The net
increase in the effective tax rate for the three- and six- month periods ended June 30, 2019, as compared to the same
periods in 2018, was primarily due to the limitation on the deductibility of executive compensation for accelerated stock
vesting upon the retirement of our former Chief Executive Officer on March 9, 2018 in addition to the windfall tax benefit we
realized in June 2018 related to exercises of employee equity awards. We realized an immaterial shortfall for the three- and
six-month periods ended June 30, 2019.
How We Evaluate Our Operations
We present information below with respect to adjusted EBITDA, which we define as our net income excluding
interest and other income, net, income tax benefit (expense), depreciation and amortization, and stock-based compensation. This
financial measure is not based on any standardized methodology prescribed by accounting principles generally accepted in the United
States (“GAAP”) and are not necessarily comparable to similarly titled measures presented by other companies.
We have presented adjusted
EBITDA because it is a key measure used by our management and board of directors to understand and evaluate our operating performance
and to develop operational goals for managing our business. We believe this financial measure helps identify underlying trends
in our business that could otherwise be masked by the effect of the expenses that we exclude. In particular, we believe that the
exclusion of the expenses eliminated in calculating adjusted EBITDA can provide a useful measure for period-to-period comparisons
of our core operating performance. Accordingly, we believe that adjusted EBITDA provides useful information to investors and others
in understanding and evaluating our operating results, enhancing the overall understanding of our past performance and future prospects,
and allowing for greater transparency with respect to key financial metrics used by our management in its financial and operational
decision-making.
Adjusted EBITDA is
not prepared in accordance with GAAP, and should not be considered in isolation of, or as an alternative to, measures prepared
in accordance with GAAP. There are a number of limitations related to the use of adjusted EBITDA rather than net income (loss),
which is the nearest GAAP equivalent. Some of these limitations are:
|
•
|
adjusted EBITDA excludes depreciation and amortization and, although these are non-cash expenses, the assets being depreciated or amortized may have to be replaced in the future, the cash requirements for which are not reflected in adjusted EBITDA;
|
|
•
|
we exclude stock-based compensation expense from adjusted EBITDA although (a) it has been, and will continue to be for the foreseeable future, a significant recurring expense for our business and an important part of our compensation strategy and (b) if we did not pay out a portion of our compensation in the form of stock-based compensation, the cash salary expense included in operating expenses would be higher, which would affect our cash position;
|
|
•
|
the expenses and other items that we exclude in our calculation of adjusted EBITDA may differ from the expenses and other items, if any, that other companies may exclude from adjusted EBITDA when they report their operating results;
|
|
•
|
adjusted EBITDA does not reflect changes in, or cash requirements for, working capital needs;
|
|
•
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adjusted EBITDA does not reflect provision for (benefit from) income taxes or the cash requirements to pay taxes; and
|
|
•
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adjusted EBITDA does not reflect historical cash expenditures or future requirements for capital expenditures or contractual commitments.
|
The following is a
reconciliation of net income to adjusted EBITDA for the three- and six-month periods ended June 30, 2019 and 2018, respectively:
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Net income
|
|
$
|
9,435
|
|
|
$
|
10,092
|
|
|
$
|
13,942
|
|
|
$
|
3,405
|
|
Interest and other income, net
|
|
|
(533
|
)
|
|
|
(290
|
)
|
|
|
(1,031
|
)
|
|
|
(385
|
)
|
Provision for income taxes
|
|
|
3,013
|
|
|
|
1,444
|
|
|
|
4,486
|
|
|
|
394
|
|
Depreciation and amortization
|
|
|
1,466
|
|
|
|
1,447
|
|
|
|
2,943
|
|
|
|
2,920
|
|
Stock-based compensation
|
|
|
1,443
|
|
|
|
1,322
|
|
|
|
2,829
|
|
|
|
8,887
|
|
Adjusted EBITDA
|
|
$
|
14,824
|
|
|
$
|
14,015
|
|
|
$
|
23,169
|
|
|
$
|
15,221
|
|
Adjusted EBITDA in
the three- and six-month periods ended June 30, 2019, increased $0.8 million and $7.9 million, respectively, as compared with
the comparable periods in 2018. The increase in adjusted EBITDA for the periods was primarily due to an increase in product gross
profit and operating income as a result of a reduction in inventory related charges and a more favorable revenue mix.
Liquidity and Capital Resources
We require cash to
fund our operating expenses and to make capital expenditures. We expect that our requirements for cash to fund these uses will
increase as our operations expand. Historically we have generated positive cash flow from operations, which, together with our
available cash, investments, and debt, have met our cash requirements. Cash, cash equivalents, and investments aggregated $141.5
million and $159.0 million, and working capital totaled $179.5 million and $191.7 million as of June 30, 2019 and December 31,
2018, respectively. In addition, as of June 30, 2019, we have $50.0 million of available credit under our senior revolving
credit facility with Bank of America, N.A. We believe that we have adequate financial resources to support our business for at
least the twelve months from the issuance date of our financial statements. As of June 30, 2019, we were in compliance with the
terms of our credit agreement with Bank of America, N.A.
Cash provided by operating activities was $13.9 million for the six-month period ended June 30, 2019, as compared
to cash provided by operating activities of $14.1 million for the same period in 2018. The decrease was primarily
related to a decrease in collections of our accounts receivable due to timing of receipts and a decrease in accrued expenses. These
factors were partially offset by a decrease in prepayments of income taxes and payments for inventory.
Cash used in investing
activities was $3.4 million for the six-month period ended June 30, 2019, as compared to cash provided by investing activities
of $7.5 million for the same period in 2018. The change was due to increased purchases of investments, partially offset by
lower capital expenditures as compared to the same period in 2018.
Cash used by financing activities was $30.1 million for the six-month period ended June 30, 2019, as compared
to cash used by financing activities of $28.8 million for the same period in 2018. In each period, we executed a $30 million
accelerated share repurchase agreement. The increase in cash used in financing activities for the six-month period ended June 30,
2019, was primarily attributable to a $2.9 million decrease in proceeds from the exercise of employee equity awards as compared
to the corresponding period in the prior year.
Critical Accounting Policies and
Estimates
There were no other
significant changes in our critical accounting policies or estimates during the three months ended June 30, 2019 to augment the
critical accounting estimates disclosed under the heading “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, other than
those described in the Notes to the condensed consolidated financial statements included in this report, including the adoption
of the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification,
Leases
,
(ASC 842) effective January 1, 2019. As a result of our adoption of the new lease standard, we re-assessed the estimates, assumptions,
and judgments that are most critical in our recognition of leases. For information regarding the impact of recently adopted
accounting standards, refer to Notes 2 and 12 to the condensed financial statements included in this report.
Recent Accounting Pronouncements
A discussion of Recent
Accounting Pronouncements is included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018 and is updated
in the Notes to the condensed consolidated financial statements included in this report.
Contractual Obligations and Other
Commercial Commitments
Our
contractual obligations and other commercial commitments are summarized in the section captioned “Part
II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital
Resources—Contractual Obligations and Other Commercial Commitments” in our Annual Report on Form 10-K for the year
ended December 31, 2018. We had no material changes outside the ordinary course to our contractual obligations reported in our
2018 Annual Report on Form 10-K during the six months ended June 30, 2019. For additional discussion, see Note 13 to the condensed
consolidated financial statements included in this report.
To the extent that
funds generated from our operations, together with our existing capital resources, are insufficient to meet future requirements,
we will be required to obtain additional funds through equity or debt financings, strategic alliances with corporate partners and
others, or through other sources. No assurance can be given that any additional financing will be made available to us or will
be available on acceptable terms should such a need arise.
Off-balance Sheet Arrangements
We do not use special
purpose entities or other off-balance sheet financing techniques that we believe have, or are reasonably likely to have, a current
or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations,
liquidity, or capital resources.