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 II, Item 1A “Risk
Factors” of our Annual Report on Form 10-K for the year ended December 31, 2017 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 Quarterly Report on Form 10-Q 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, 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 opportunities in
the U.S. market, we are evaluating a potential hybrid commercial approach that would see us balance a small direct model with
an optimal form of strategic partnership. For longer-term future products in the U.S. market, we intend to evaluate the appropriate
commercial model for each on a case-by-case basis, based on market dynamics 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, 2017, 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 three-month period ended March 31, 2018 we recorded a revenue
reserve for this voluntary recall of $1.1 million of which $0.9 million was related to revenue recorded in prior periods. The
adjustments related to the initial revenue reserve during the three-month period ended September 30, 2018 were immaterial. As
a result of the voluntary recall, we had an inventory charge of $0.8 million for the related non-saleable inventory during
the nine-month period ended September 30, 2018. In addition, we incurred $0.6 million for future expenses associated with the
administration and remediation of the voluntary recall. As of September 30, 2018, a majority of the affected products had
been returned with no material change to the related reserves. Based on the facts currently known to us, we believe we can
resolve this matter and resume production and shipment of these products by the end of 2018.
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 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.
Our second 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 our lead pipeline product and a critical 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 Investigational New Drug Application (“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. Given the results
of the CINGAL 16-02 Study, we continue to evaluate multiple strategies to optimize the potential U.S. regulatory pathway for CINGAL.
After completing the analysis of the results from the three-month extended follow-up study, we intend to meet with FDA to discuss
the totality of our clinical data for CINGAL and to identify and execute an optimal approach towards a potential future regulatory
approval in the United States.
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 we are advancing 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. The voluntary recall described above does not impact the HYALOFAST clinical trial, as the product used in
the clinical trial is not sourced from the affected production lots. Given the changing medical landscape with respect to the
randomization arm for this trial, the microfracture procedure, we are actively pursuing alternative strategies to accelerate patient
enrollment.
We are 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 expect to begin work in a post-market
clinical study in relation to the CE Mark for this product before the end 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 and we expect will commence in 2019.
We also have other research and development programs underway focused on expanding the indications of our current products, including
one program being conducted and funded by our U.S. MONOVISC distribution partner, DePuy Synthes Mitek Sports Medicine, a division
of DePuy Orthopaedics Inc., seeking to expand MONOVISC’s indication to include treatment of pain associated with osteoarthritis
of the hip. In third quarter of 2017, we also submitted an application to the FDA for 510(k) clearance of an injectable HA-based
bone repair treatment, an injectable, self-setting, osteoconductive bone graft substitute that is reabsorbed by the body and replaced
by the growth of new bone during the healing process. The 510(k) clearance was received from the FDA in December 2017, and we expect
to make this product commercially available during 2019. In addition to other early stage research and development initiatives
we are currently undertaking, 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. This implant could be used to repair partial and full-thickness
rotator cuff tears, and we expect to have a fully-developed prototype by the end of the year.
In June 2015, we entered into an agreement with the Institute for Applied
Life Sciences at the University of Massachusetts Amherst to collaborate on research to develop a therapy for rheumatoid arthritis.
The purpose of this research was to develop a novel modality for the treatment of rheumatoid arthritis. The agreement with the
University of Massachusetts Amherst was extended in January 2018, and it was terminated in October 2018 after discussions between
the parties. In January 2018, we entered into an agreement with the University of Liverpool 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.
Results of Operations
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
$ Inc/(Dec)
|
|
|
% Inc/(Dec)
|
|
|
2018
|
|
|
2017
|
|
|
$ Inc/(Dec)
|
|
|
% Inc/(Dec)
|
|
|
|
(in thousands, except percentages)
|
|
|
(in thousands, except percentages)
|
|
Product revenue
|
|
$
|
26,781
|
|
|
$
|
27,178
|
|
|
$
|
(397
|
)
|
|
|
(1
|
%)
|
|
$
|
78,581
|
|
|
$
|
78,899
|
|
|
$
|
(318
|
)
|
|
|
(0
|
%)
|
Licensing, milestone and contract revenue
|
|
|
6
|
|
|
|
6
|
|
|
|
-
|
|
|
|
0
|
%
|
|
|
18
|
|
|
|
5,133
|
|
|
|
(5,115
|
)
|
|
|
*
|
|
Total revenue
|
|
|
26,787
|
|
|
|
27,184
|
|
|
|
(397
|
)
|
|
|
(1
|
%)
|
|
|
78,599
|
|
|
|
84,032
|
|
|
|
(5,433
|
)
|
|
|
(6
|
%)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product revenue
|
|
|
8,282
|
|
|
|
6,250
|
|
|
|
2,032
|
|
|
|
33
|
%
|
|
|
24,279
|
|
|
|
18,648
|
|
|
|
5,631
|
|
|
|
30
|
%
|
Research and development
|
|
|
4,232
|
|
|
|
5,842
|
|
|
|
(1,610
|
)
|
|
|
(28
|
%)
|
|
|
14,126
|
|
|
|
14,521
|
|
|
|
(395
|
)
|
|
|
(3
|
%)
|
Selling, general &
administrative
|
|
|
5,700
|
|
|
|
4,823
|
|
|
|
877
|
|
|
|
18
|
%
|
|
|
28,207
|
|
|
|
14,862
|
|
|
|
13,345
|
|
|
|
90
|
%
|
Total operating expenses
|
|
|
18,214
|
|
|
|
16,915
|
|
|
|
1,299
|
|
|
|
8
|
%
|
|
|
66,612
|
|
|
|
48,031
|
|
|
|
18,581
|
|
|
|
39
|
%
|
Income from operations
|
|
|
8,573
|
|
|
|
10,269
|
|
|
|
(1,696
|
)
|
|
|
(17
|
%)
|
|
|
11,987
|
|
|
|
36,001
|
|
|
|
(24,014
|
)
|
|
|
(67
|
%)
|
Interest and other income, net
|
|
|
522
|
|
|
|
261
|
|
|
|
261
|
|
|
|
100
|
%
|
|
|
907
|
|
|
|
335
|
|
|
|
572
|
|
|
|
171
|
%
|
Income before income taxes
|
|
|
9,095
|
|
|
|
10,530
|
|
|
|
(1,435
|
)
|
|
|
(14
|
%)
|
|
|
12,894
|
|
|
|
36,336
|
|
|
|
(23,442
|
)
|
|
|
(65
|
%)
|
Provision for income taxes
|
|
|
1,496
|
|
|
|
3,643
|
|
|
|
(2,147
|
)
|
|
|
(59
|
%)
|
|
|
1,890
|
|
|
|
12,587
|
|
|
|
(10,697
|
)
|
|
|
(85
|
%)
|
Net income
|
|
$
|
7,599
|
|
|
$
|
6,887
|
|
|
$
|
712
|
|
|
|
10
|
%
|
|
$
|
11,004
|
|
|
$
|
23,749
|
|
|
$
|
(12,745
|
)
|
|
|
(54
|
%)
|
Product gross profit
|
|
$
|
18,499
|
|
|
$
|
20,928
|
|
|
$
|
(2,429
|
)
|
|
|
(12
|
%)
|
|
$
|
54,302
|
|
|
$
|
60,251
|
|
|
$
|
(5,949
|
)
|
|
|
(10
|
%)
|
Product gross margin
|
|
|
69
|
%
|
|
|
77
|
%
|
|
|
|
|
|
|
|
|
|
|
69
|
%
|
|
|
76
|
%
|
|
|
|
|
|
|
|
|
* Percentage increase has been omitted due to magnitude.
Product Revenue
Product revenue for the three-month period ended September 30, 2018
was $26.8 million, a decrease of $0.4 million as compared to $27.2 million for the three-month period ended September 30, 2017.
Product revenue for the nine-month period ended September 30, 2018 was $78.6 million, a decrease of $0.3 million as compared to
$78.9 million for the nine-month period ended September 30, 2017. For the nine-month period ended September 30, 2018, the decrease
in product revenue was mainly driven by a decline in ORTHOVISC revenue and the effects of the previously-described voluntary recall
of certain production lots of our HYAFF-based products, partially offset by increases in MONOVSC and CINGAL revenue.
The following tables present product revenue by product group:
|
|
Three Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
$ Inc/(Dec)
|
|
|
% Inc/(Dec)
|
|
|
|
(in thousands, except percentages)
|
|
Orthobiologics
|
|
$
|
24,097
|
|
|
$
|
23,990
|
|
|
$
|
107
|
|
|
|
0
|
%
|
Surgical
|
|
|
1,191
|
|
|
|
1,765
|
|
|
|
(574
|
)
|
|
|
(33
|
%)
|
Dermal
|
|
|
80
|
|
|
|
358
|
|
|
|
(278
|
)
|
|
|
(78
|
%)
|
Other
|
|
|
1,413
|
|
|
|
1,065
|
|
|
|
348
|
|
|
|
33
|
%
|
Total
|
|
$
|
26,781
|
|
|
$
|
27,178
|
|
|
$
|
(397
|
)
|
|
|
(1
|
%)
|
|
|
Nine Months Ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
$ Inc/(Dec)
|
|
|
% Inc/(Dec)
|
|
|
|
(in thousands, except percentages)
|
|
Orthobiologics
|
|
$
|
69,778
|
|
|
$
|
68,686
|
|
|
$
|
1,092
|
|
|
|
2
|
%
|
Surgical
|
|
|
3,700
|
|
|
|
4,395
|
|
|
|
(695
|
)
|
|
|
(16
|
%)
|
Dermal
|
|
|
163
|
|
|
|
1,235
|
|
|
|
(1,072
|
)
|
|
|
(87
|
%)
|
Other
|
|
|
4,940
|
|
|
|
4,583
|
|
|
|
357
|
|
|
|
8
|
%
|
Total
|
|
$
|
78,581
|
|
|
$
|
78,899
|
|
|
$
|
(318
|
)
|
|
|
(0
|
%)
|
Orthobiologics
Our orthobiologics franchise consists of our orthopedic pain management and regenerative therapies. Overall,
sales were flat for the three-month period ended September 30, 2018, as compared to the same period in 2017, as a result of increased
unit demand offset by a decline in pricing in the U.S. For the nine-month period ended September 30, 2018, sales increased by $1.1
million as compared to the same period in 2017. The overall increase in the nine-month period ended September 30, 2018 was primarily
due to strong growth in domestic MONOVISC revenue and international CINGAL revenue offset in part by declines in worldwide ORTHOVISC
revenue. The growth of U.S. MONOVISC revenue remains strong. We expect orthobiologics product revenue in 2018 to increase as compared
to 2017, due to the growth of worldwide MONOVISC and international CINGAL revenue offset by declines in ORTHOVISC revenue, U.S.
viscosupplement product pricing declines, and the effects of the previously described voluntary recall of certain production lots
of our HYAFF-based products.
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 declined $0.6 million
and $0.7 million, respectively, for the three- and nine-month periods ended September 30, 2018 to $1.2 million and $3.7 million,
respectively, as compared to the same periods in 2017. The decrease in surgical product revenue for the three-month period was
primarily due to a decrease in sales to our worldwide ENT commercial partner and a decrease in sales of our surgical anti-adhesion
products. We expect surgical product revenue to decrease modestly in 2018 as compared to 2017 primarily due to decreased worldwide
sales of our ENT and surgical anti-adhesion products.
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- and nine-month periods ended
September 30, 2018, dermal product sales decreased $0.3 million and $1.1 million, respectively, as compared to the same periods
in 2017 due to the voluntary recall of certain production lots of our HYAFF-based products previously described. As a result, we
expect dermal revenue to decrease in 2018 as compared to 2017.
Other
Other product revenue includes revenues from our ophthalmic and veterinary
franchises. Other product revenue increased for the three-month period ended September 30, 2018 by $0.3 million and increased for
the nine-month period ended September 30, 2018 by $0.4 million or 8%, both as compared to the same periods in 2017. We expect other
revenue to increase in 2018 as compared to 2017, primarily driven by increases in ophthalmic revenue.
Licensing, Milestone and Contract Revenue
Licensing, milestone and contract revenue for the three- and nine-month
periods ended September 30, 2018 was $6 thousand and $18 thousand, as compared to $6 thousand and $5.1 million for the same periods
in 2017. Revenue for the nine-month period ended September 30, 2017 included a $5.0 million milestone payment associated with our
U.S. license agreement with Mitek for MONOVISC that was received and fully recognized as a result of U.S. MONOVISC 12-month end-user
sales exceeding $100.0 million.
Product Gross Profit and Margin
Product gross profit for the three-
and nine-month periods ended September 30, 2018 decreased $2.4 million and $5.9 million to $18.5 million and $54.3 million, respectively,
representing 69% of product revenue for each period. Product gross profit for the three- and nine-month periods ended September
30, 2017 was $20.9 million and $60.3 million, respectively, or 77% and 76%
of
product
revenue for the periods. The decrease in product gross margin for the three-month period ended September 30, 2018, as compared
to the same period in 2017, was due to higher production costs, revenue mix, including the impact of pricing declines for our
ORTHOVISC and MONOVISC products in the U.S., and certain period costs related to inventory reserve charges. The decrease in product
gross margin for the nine-month period ended September 30, 2018, as compared to the same period in 2017, was due to an increase
in inventory reserves related to certain raw materials, inventory write-offs associated with the previously described
voluntary
recall of certain production lots of our HYAFF-based products
, higher production costs,
revenue mix and pricing dynamics, and voluntary recall related charges. We began remediation and mitigation plans during the first
quarter of 2018 and currently expect to resolve the identified issues by the end of 2018. This current product gross margin may
not be indicative of the rest of the year, and we expect to see continued improvement in product gross margin as we progress through
2018.
Research and Development
Re
search and development expenses for
the three- and nine-month periods ended September 30, 2018 were $4.2 million and $14.1 million, representing 16% and 18% of total
revenue for the respective periods, a decrease of $1.6 million and $0.4 million, respectively, as compared to the same periods
in 2017. The decrease in research and development expenses was primarily due to the completion of our CINGAL 16-02 Study in the
second quarter of 2018. The decrease was partially offset by
increased pre-clinical product
development activities associated with certain product candidates in our research and development pipeline, including our new
rotator cuff product candidate.
Research and development spending is expected to increase in 2018 and thereafter, as compared
to 2017, as we further develop new products and line extensions and initiate new clinical trials based on our existing technology
assets, as well as increase research and development activities for other products in the pipeline.
Selling, General and Administrative
Selling, general and administrative (“SG&A”) expenses
for the three- and nine-month periods ended September 30, 2018 were $5.7 million and $28.2 million, representing 21% and 36% of
total revenue for the respective periods, an increase of $0.9 million and $13.3 million as compared to the same periods in 2017.
The increase in SG&A expenses for the three-month period ending September 30, 2018 was primarily related to increased personnel
costs and external professional fees. SG&A expenses increased for the nine-month period ending September 30, 2018, as compared
to prior period, primarily as a result of costs related to the retirement of our former Chief Executive Officer, certain accrued
expenses related to the previously described voluntary recall of certain production lots of our HYAFF-based products and increased
personnel costs, external professional fees, and marketing expenses.
Income Taxes
The provisions for income taxes were $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. Provisions
for income taxes were $3.6 million and $12.6 million for the three- and nine-month periods ended September 30, 2017, based on an
effective tax rate of 34.6%. The net decrease in the effective tax rate for the three- and nine-month periods ended September 30,
2018, as compared to the same periods in 2017, was primarily due to the reduction of Federal Corporate Income Tax rate as a result
of the Tax Cuts and Jobs Act of 2017 (“Tax Act”) tax reform legislation. This legislation makes significant changes
to the U.S. tax law, including a reduction in the corporate tax rate from 35% to 21% starting in 2018. In addition, the Company
realized a windfall tax benefit for the nine-month period ended September 30, 2018 related to exercises of employee equity awards
resulting in a discrete period income tax benefit of $1.6 million and a reduction in the effective tax rate of 12.1%. The Company
realized a $0.1 million windfall tax benefit for the three-month period ended September 30, 2018.
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 $149.0 million and $157.3 million, and working capital totaled $186.3 million and $193.3 million as of September 30,
2018 and December 31, 2017, respectively. In addition, as of September 30, 2018, 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, 2018, we were
in compliance with the terms of our credit agreement with Bank of America, N.A.
Cash provided by operating activities was $24.9 million for the nine-month
period ended September 30, 2018, as compared to cash provided by operating activities of
$33.8
million
for the same
period in 2017. The decrease in cash provided by operations
for the nine-month period ended September 30, 2018, as compared to the same period in 2017, was primarily related to our higher
operating expenses in manufacturing operations, sales and marketing, decrease in accounts payable, and an increase in inventory
on hand.
Cash used in investing activities
was $47.7 million for the nine-month period ended September 30, 2018, as compared to cash used in investing activities of $11.8
million for the same period in 2017. The increase was due to increased purchases of investments, partially offset by lower
capital expenditures as compared to 2017.
Cash used in financing activities was $28.8 million for the nine-month
period ended September 30, 2018, as compared to cash used in financing activities of $0.3 million for the same period in 2017.
The decrease in cash used in financing activities for the nine-month period ended September 30, 2018 was primarily attributable
to the utilization of $30.0 million cash to repurchase outstanding common stock under the previously-discussed Fixed Dollar
Accelerated Share Repurchase program and $1.7 million of vested RSAs that were withheld for individual taxes and retired. This
was partially offset by $2.9 million of proceeds received from the exercise of stock-based compensation awards.
Critical Accounting Policies and Estimates
There were no other significant changes in our critical accounting policies
during the nine months ended September 30, 2018 to augment the critical accounting policies disclosed in Management’s Discussion
and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2017 other than those described in the Notes to the condensed consolidated financial statements included in
this Quarterly Report on Form 10-Q, including the adoption of the FASB’s Accounting Standards Codification Revenue
from Contracts with Customers (ASC 606) effective January 1, 2018. As a result of our adoption of the new revenue recognition
standard, we re-assessed the estimates, assumptions, and judgments that are most critical in our recognition of revenue and have
revised our revenue recognition critical accounting policy. For information regarding the impact of recently adopted accounting
standards, refer to Note 3 to the condensed financial statements included in this Quarterly Report on Form 10-Q.
There were no other significant changes in our critical
accounting estimates during the nine months ended September 30, 2018 to augment the critical accounting estimates disclosed in
Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K
for the fiscal year ended December 31, 2017 other than those described in the Notes to the condensed consolidated financial statements
included in this Quarterly Report on Form 10-Q, including the estimated costs for the previously described voluntary recall of
certain production lots of our HYAFF-based products.
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, 2017 and is updated in the Notes to the condensed consolidated financial
statements included in this Quarterly Report on Form 10-Q.
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, 2017. Except for $2.0
million of retirement and post-retirement consulting benefits we accrued on March 9, 2018 related to the retirement of our former
Chief Executive Officer, we had no material changes outside the ordinary course to our contractual obligations reported in our
2017 Annual Report on Form 10-K during the nine months ended September 30, 2018. For additional discussion, see Note 12 to the
condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
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, except for operating leases, 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.