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 and in Part II, Item 1A “Risk Factors” of this report 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 joint preservation
and regenerative therapies company based in Bedford, Massachusetts. We are committed to delivering innovative therapies to improve
the lives of patients across a continuum of care from osteoarthritis pain management to joint preservation and restoration. We
have over two decades of global expertise commercializing more than 20 products based on our proprietary hyaluronic acid (“HA”)
technology. Our therapeutic portfolio includes ORTHOVISC, MONOVISC, and CINGAL, viscosupplements which alleviate osteoarthritis
pain and restore joint function by replenishing depleted HA, TACTOSET, a surgically-delivered therapy for bone repair procedures,
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. In the
third quarter of 2019, we completed the implementation of a U.S.-based hybrid commercial model through which we launched TACTOSET,
our surgically-delivered bone repair therapy. By utilizing a network of regional and local distributors in conjunction with our
own small internal sales team, our hybrid model grants us a direct line of sight to our customers, enhanced commercial control
over all aspects of sales, marketing, and market access, and the ability to scale our operations where and when appropriate. We
intend to employ our hybrid commercial strategy for additional opportunities in the U.S. market, especially with respect to surgical
products utilized in an operating room environment. For longer-term future products in the U.S. market, especially those that are
not utilized in an operating room environment, 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 September 30, 2019
•
|
|
We deployed our hybrid commercial model in the U.S.
by onboarding four regional sales directors and engaging our first U.S. distribution agent.
|
•
|
|
We completed the soft commercial launch and the first
sale of TACTOSET, our first surgically-delivered regenerative therapy in the U.S. for bone repair procedures.
|
•
|
|
We expanded our experienced executive team with the
addition of James Loerop as Executive Vice President of Business Development and Strategic Planning, and completed the recruitment
efforts of the Vice President of Regulatory, Quality and Clinical Affairs, filled by Mira Leiwant.
|
•
|
|
We held an Analyst and Investor Day highlighting key facets of our 5-year strategic plan and providing updates on our transformation into a global commercial company.
|
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 joint tissue preservation and restoration, and we believe
that our HA platform technology provides broad pipeline versatility and expansion opportunities within this targeted space. We
routinely interact with key external stakeholders to leverage customer and patient insights in our development process to ensure
that we bring needed therapies to the market. 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 TACTOSET, a surgically-delivered therapy for bone repair
procedure 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 made 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 in late 2020 or early 2021, with a potential commercial launch to occur in late 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 during the fourth quarter of 2014
and an associated retreatment study in the first half of 2015. The results of the 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, and a formal meeting with the FDA’s
Office of Combination Products (“OCP”), we submitted a formal request for designation with OCP in October 2015. In
its response, 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 subsequently commenced work on a second Phase III clinical trial (“CINGAL
16-02 Study”) in the first quarter of 2017 and completed the associated 6-month 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 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 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 have undertaken, we previously 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. This agreement was
mutually terminated in August 2019 after discussions between the parties.
Results of Operations
Three and Nine Months Ended September 30, 2019 Compared
to Three and Nine Months Ended September 30, 2018
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2019
|
|
2018
|
|
$ Inc/(Dec)
|
|
% Inc/(Dec)
|
|
2019
|
|
2018
|
|
$ Inc/(Dec)
|
|
% Inc/(Dec)
|
|
|
(in thousands, except percentages)
|
|
(in thousands, except percentages)
|
Product revenue
|
|
$
|
29,615
|
|
|
$
|
26,781
|
|
|
$
|
2,834
|
|
|
|
11
|
%
|
|
$
|
84,745
|
|
|
$
|
78,581
|
|
|
$
|
6,164
|
|
|
|
8
|
%
|
Licensing, milestone and contract revenue
|
|
|
82
|
|
|
|
6
|
|
|
|
76
|
|
|
|
1,267
|
%
|
|
|
93
|
|
|
|
18
|
|
|
|
75
|
|
|
|
417
|
%
|
Total revenue
|
|
|
29,697
|
|
|
|
26,787
|
|
|
|
2,910
|
|
|
|
11
|
%
|
|
|
84,838
|
|
|
|
78,599
|
|
|
|
6,239
|
|
|
|
8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product revenue
|
|
|
5,951
|
|
|
|
8,282
|
|
|
|
(2,331
|
)
|
|
|
(28
|
%)
|
|
|
20,098
|
|
|
|
24,279
|
|
|
|
(4,181
|
)
|
|
|
(17
|
%)
|
Research & development
|
|
|
4,158
|
|
|
|
4,232
|
|
|
|
(74
|
)
|
|
|
(2
|
%)
|
|
|
12,581
|
|
|
|
14,126
|
|
|
|
(1,545
|
)
|
|
|
(11
|
%)
|
Selling, general &
administrative
|
|
|
7,539
|
|
|
|
5,700
|
|
|
|
1,839
|
|
|
|
32
|
%
|
|
|
22,713
|
|
|
|
28,207
|
|
|
|
(5,494
|
)
|
|
|
(19
|
%)
|
Total operating expenses
|
|
|
17,648
|
|
|
|
18,214
|
|
|
|
(566
|
)
|
|
|
(3
|
%)
|
|
|
55,392
|
|
|
|
66,612
|
|
|
|
(11,220
|
)
|
|
|
(17
|
%)
|
Income from operations
|
|
|
12,049
|
|
|
|
8,573
|
|
|
|
3,476
|
|
|
|
41
|
%
|
|
|
29,446
|
|
|
|
11,987
|
|
|
|
17,459
|
|
|
|
146
|
%
|
Interest and other income, net
|
|
|
482
|
|
|
|
522
|
|
|
|
(40
|
)
|
|
|
(8
|
%)
|
|
|
1,513
|
|
|
|
907
|
|
|
|
606
|
|
|
|
67
|
%
|
Income before income taxes
|
|
|
12,531
|
|
|
|
9,095
|
|
|
|
3,436
|
|
|
|
38
|
%
|
|
|
30,959
|
|
|
|
12,894
|
|
|
|
18,065
|
|
|
|
140
|
%
|
Provision for (benefit from) income taxes
|
|
|
3,331
|
|
|
|
1,496
|
|
|
|
1,835
|
|
|
|
123
|
%
|
|
|
7,817
|
|
|
|
1,890
|
|
|
|
5,927
|
|
|
|
314
|
%
|
Net income
|
|
$
|
9,200
|
|
|
$
|
7,599
|
|
|
$
|
1,601
|
|
|
|
21
|
%
|
|
$
|
23,142
|
|
|
$
|
11,004
|
|
|
$
|
12,138
|
|
|
|
110
|
%
|
Product gross profit
|
|
$
|
23,664
|
|
|
$
|
18,499
|
|
|
$
|
5,165
|
|
|
|
28
|
%
|
|
$
|
64,647
|
|
|
$
|
54,302
|
|
|
$
|
10,345
|
|
|
|
19
|
%
|
Product gross margin
|
|
|
79.9
|
%
|
|
|
69.1
|
%
|
|
|
|
|
|
|
|
|
|
|
76.3
|
%
|
|
|
69.1
|
%
|
|
|
|
|
|
|
|
|
Product Revenue
Product revenue for
the three-month period ended September 30, 2019 was $29.6 million, an increase of $2.8 million as compared to $26.8 million for
the three-month period ended September 30, 2018. Product revenue for the nine-month period ended September 30, 2019 was $84.7
million, an increase of 8%, or $6.2 million, as compared to $78.6 million for the nine-month period ended September 30, 2018.
For the three-month period ended September 30, 2019, the increase in product revenue was driven by growth in our orthobiologics,
dermal and other franchises. For the nine-month period ended September 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 September 30,
|
|
|
2019
|
|
2018
|
|
$ Inc/(Dec)
|
|
% Inc/(Dec)
|
|
|
(in thousands, except percentages)
|
Orthobiologics
|
|
$
|
26,765
|
|
|
$
|
24,097
|
|
|
$
|
2,668
|
|
|
|
11
|
%
|
Surgical
|
|
|
578
|
|
|
|
1,191
|
|
|
|
(613
|
)
|
|
|
(51
|
%)
|
Dermal
|
|
|
417
|
|
|
|
80
|
|
|
|
337
|
|
|
|
421
|
%
|
Other
|
|
|
1,855
|
|
|
|
1,413
|
|
|
|
442
|
|
|
|
31
|
%
|
Total
|
|
$
|
29,615
|
|
|
$
|
26,781
|
|
|
$
|
2,834
|
|
|
|
11
|
%
|
|
|
Nine Months Ended September 30,
|
|
|
2019
|
|
2018
|
|
$ Inc/(Dec)
|
|
% Inc/(Dec)
|
|
|
(in thousands, except percentages)
|
Orthobiologics
|
|
$
|
74,975
|
|
|
$
|
69,778
|
|
|
$
|
5,197
|
|
|
|
7
|
%
|
Surgical
|
|
|
4,071
|
|
|
|
3,700
|
|
|
|
371
|
|
|
|
10
|
%
|
Dermal
|
|
|
990
|
|
|
|
163
|
|
|
|
827
|
|
|
|
507
|
%
|
Other
|
|
|
4,709
|
|
|
|
4,940
|
|
|
|
(231
|
)
|
|
|
(5
|
%)
|
Total
|
|
$
|
84,745
|
|
|
$
|
78,581
|
|
|
$
|
6,164
|
|
|
|
8
|
%
|
Orthobiologics
Our orthobiologics franchise consists of orthopedic pain management and regenerative therapies. Overall, sales
increased 11% and 7% for the three- and nine-month periods ended September 30, 2019, respectively, as compared to the same periods
in 2018. For the three-month period ended September 30, 2019, the increase was primarily driven by increased sales of MONOVISC
domestically, supplemented by an increase in sales of our international viscosupplement products, led by CINGAL. The increase in
revenue for the nine-month period ended September 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 global MONOVISC revenue
and the U.S. commercial launch of TACTOSET 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. For the
three-month period ended September 30, 2019, surgical product sales decreased by $0.6 million as compared to the same period in
2018 resulting primarily from order timing. For the nine-month period ended September 30, 2019, sales increased $0.4 million as
compared to the same period in 2018. The increase in surgical product revenue for the nine-month period 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 remain flat in 2019 as compared to 2018.
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. Sales of our dermal products
increased $0.3 million and $0.8 million for the three- and nine-month periods ended September 30, 2019, to $0.4 million and $1.0
million, respectively, as compared to the same periods in 2018. For the three- and nine-month periods ended September 30,
2019, the increases were 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
increased for the three-month period ended September 30, 2019 by $0.4 million or 31%, and decreased by $0.2 million or 5%, for
the nine-month period ended September 30, 2019, each as compared to the corresponding period in 2018. We expect other product revenue
to remain flat in 2019 as compared to 2018.
Product Gross Profit and Margin
Product
gross profit for the three- and nine-month periods ended September 30, 2019 increased $5.2 million and
$10.3 million to $23.7 and $64.7 million, respectively, representing 79.9% and 76.3% of product revenue. Product gross profit for
the three- and nine-month periods ended September 30, 2018 was $18.5 million and $54.3 million, respectively, or 69.1% of product
revenue for each of the periods. The increase in product gross margin for the three- and nine-month periods ended September 30,
2019, as compared to the same periods in 2018, was in part due to more favorable changes in revenue mix, including an increase
in domestic royalty revenue from the viscosupplement business. In addition, the product gross margin for the nine-month period
ended September 30, 2018 was also adversely impacted by the previously-described voluntary
product recall.
Research and Development
Research and development
expenses for the three- and nine-month periods ended September 30, 2019 were $4.2 million and $12.6 million, representing 14% and
15% of total revenue for the respective periods, a decrease of $0.1 million and $1.5 million, respectively, as compared to the
same periods in 2018. The decreases in research and development expense were primarily due to lower clinical trial expenses related
to CINGAL for the three- and nine-month periods ended September 30, 2019, as compared to the same periods in 2018, partially offset
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. 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 related to the
European Union Medical Device Regulation.
Selling, General and Administrative
Selling, general and administrative (“SG&A”)
expenses for the three- and nine-month periods ended September 30, 2019 were $7.5 million and $22.7 million, representing 25%
and 27% of total revenue for the period, an increase of $1.8 million and decrease of $5.5 million, respectively, as compared to
the same periods in 2018. The increase in SG&A expenses for the three-month period ended September 30, 2019 was primarily
due to the establishment of our U.S. hybrid commercial model and the soft launch of TACTOSET, including increased personnel-related
costs and external professional fees. The decrease for the nine-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 $3.3 million and $7.8 million for the three- and nine-month periods ended
September 30, 2019, based on effective tax rates of 26.6% and 25.3%, respectively. The provision for income taxes was $1.5
million and $1.9 million for the three- and nine-month periods ended September 30, 2018, based on effective tax rates of 16.4%
and 14.7%, respectively. The net increase in the effective tax rate for the three- and nine- month periods ended September 30,
2019, as compared to the same periods in 2018, was primarily due to the windfall tax benefit we realized in June 2018 related to
exercises of employee equity awards offset by 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, we recorded a $0.3 million
and $0.4 million tax shortfall for the three- and nine-month periods ended September 30, 2019 related to exercises of employee
equity awards.
Non-GAAP Financial Measures
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;
|
|
•
|
adjusted EBITDA does not reflect provision for (benefit from) income taxes or the cash requirements to pay taxes; and
|
|
•
|
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 nine-month periods ended September 30, 2019 and 2018, respectively:
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2019
|
|
2018
|
|
2019
|
|
2018
|
Net income
|
|
$
|
9,200
|
|
|
$
|
7,599
|
|
|
$
|
23,142
|
|
|
$
|
11,004
|
|
Interest and other income, net
|
|
|
(482
|
)
|
|
|
(522
|
)
|
|
|
(1,513
|
)
|
|
|
(907
|
)
|
Provision for income taxes
|
|
|
3,331
|
|
|
|
1,496
|
|
|
|
7,817
|
|
|
|
1,890
|
|
Depreciation and amortization
|
|
|
1,516
|
|
|
|
1,513
|
|
|
|
4,459
|
|
|
|
4,433
|
|
Stock-based compensation
|
|
|
1,311
|
|
|
|
1,177
|
|
|
|
4,140
|
|
|
|
10,064
|
|
Adjusted EBITDA
|
|
$
|
14,876
|
|
|
$
|
11,263
|
|
|
$
|
38,045
|
|
|
$
|
26,484
|
|
Adjusted EBITDA in the three- and nine-month periods ended September 30, 2019, increased $3.6 million and $11.6
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 total revenue, product gross profit and operating income as a result of a more favorable revenue mix. In
addition, the product gross margin for the nine-month period ended September 30, 2018 was also adversely impacted by the previously-described
voluntary product recall.
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 $173.2 million and $159.0 million, and working
capital totaled $212.6 million and $191.7 million as of September 30, 2019 and December 31, 2018, respectively. In addition,
as of September 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 September 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 $24.0 million for the nine-month period ended September 30, 2019, as compared to cash provided by operating activities
of $24.9 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.
Cash used in investing activities was $1.3 million
for the nine-month period ended September 30, 2019, as compared to cash provided by investing activities of $47.7 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 $8.4 million for the nine-month period ended September 30, 2019, as compared to cash used by financing activities
of $28.9 million for the same period in 2018. In each period, we executed a $30.0 million accelerated share repurchase agreement.
The decrease in cash used in financing activities for the nine-month period ended September 30, 2019, was primarily attributable
to a $18.9 million increase 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 September 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 nine months ended September 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.