Item 2.
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations
|
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q as well as our audited 2017 financial statements and related notes included in our Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission (“SEC”) on March 20, 2018. In addition to historical information, the discussion and analysis here and throughout this Quarterly Report contains forward-looking statements that are based upon current beliefs, plans and expectations and involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited, to those set forth under “Risk Factors” in Part II, Item 1A of this Quarterly Report. We undertake no obligations to update these forward-looking statements to reflect events or circumstances after the date of this Quarterly Report or to reflect actual outcomes.
Second Sight was founded in 1998 with a mission to develop, manufacture, and market prosthetic devices that are intended to create an artificial form of useful vision for blind individuals. Our principal offices are located in Los Angeles, California. We also have an office in Lausanne, Switzerland that manages our commercial operations and supports clinical activities in Europe, the Middle East, and Asia-Pacific.
Our current product, the Argus
®
II system (“Argus II”), treats outer retinal degenerations, such as retinitis pigmentosa, also referred to as RP. RP is a hereditary disease, affecting an estimated 1.5 million people worldwide including about 100,000 people in the United States, that causes a progressive degeneration of the light-sensitive cells of the retina, leading to significant visual impairment and ultimately blindness. The Argus II is the only retinal prosthesis approved in the United States by the Food and Drug Administration (“FDA”), and was the first approved retinal prosthesis in the world. By creating an artificial form of useful vision in patients who otherwise have total sight loss, the Argus II can provide benefits that include:
|
●
|
restoring independence through a renewed ability to navigate independently in unfamiliar environments;
|
|
●
|
improving patients’ orientation and mobility, such as locating doors and windows, avoiding obstacles, and following the lines of a crosswalk;
|
|
●
|
allowing patients to feel more connected with people in their surroundings, such as seeing when someone is approaching or moving away;
|
|
●
|
providing patients with enjoyment from being “visual” again, such as locating the moon, tracking groups of players as they move around a field, and watching the moving streams of lights from fireworks;
|
|
●
|
enabling some patients to re-enter the workforce through multiple vocations that become possible because of Argus II; and
|
|
●
|
improving patients’ well-being and ability to perform activities of daily living.
|
The Argus II system provides an artificial form of vision that differs from the vision of people with normal sight. It does not restore normal vision and there is no clear evidence that it can slow or reverse the progression of RP. The majority of patients receive a significant benefit from the Argus II, however results can vary and some patients report receiving little or no benefit.
We are currently developing the Orion
®
Visual Cortical Prosthesis System (“Orion”), an implanted cortical stimulation device intended to provide useful artificial vision to individuals who are blind due to a wide range of causes, including glaucoma, diabetic retinopathy, optic nerve injury or disease, or forms of cancer and trauma. The Orion System leverages hardware from the Argus II and is intended to convert images captured by a miniature video camera mounted on glasses into a series of small electrical pulses. The device is designed to bypass diseased or injured eye anatomy and to transmit these electrical pulses wirelessly to an array of electrodes implanted on the surface of the brain’s visual cortex, where it is intended to provide the perception of patterns of light. A six-patient feasibility study of the Orion I device is currently underway at UCLA and Baylor. No published in-human data is available yet for the Orion system. Depending on the results of this first in-human testing of the Orion cortical stimulation device, we anticipate initiation of the next study in 2019.
Our major corporate, clinical and regulatory milestones include:
|
●
|
In 1998, Second Sight was founded.
|
|
●
|
In 2002, we commenced clinical trials in the U.S. for our prototype product, the Argus I retinal prosthesis.
|
|
●
|
In 2007, we commenced clinical trials in the U.S. for the Argus II, which later became our first commercial product.
|
|
●
|
In 2011, we received marketing approval in Europe (CE Mark) for the Argus II.
|
|
●
|
In 2013, we received marketing approval from the FDA in the U.S. for the Argus II.
|
|
●
|
In 2014, we launched the Argus II in the U.S., completed our initial public offering (“IPO”), and began trading on NASDAQ under the symbol “EYES.”
|
|
●
|
In January 2016, we successfully implanted and activated a wireless cortical visual prosthesis in a human.
|
|
●
|
In November 2017, the FDA granted Expedited Access Pathway Designation for the Orion.
|
|
●
|
In the first quarter of 2018, first-in-human Orion was successfully implanted, activated and tested at UCLA.
|
|
●
|
In September 2018, we were awarded a $1.6 million grant from National Institutes of Health to support Orion clinical development (with the intent to fund $6.3 million over five years subject to annual review and approval.
|
Currently, we have approximately 120 employees involved in the development (research, engineering and clinical), manufacture, and commercialization of the Argus II, Orion and future products.
Financing
From inception, our operations have been funded primarily through the sales of our common stock and warrants, as well as from the issuance of convertible debt, research and clinical grants, and limited product revenue generated by the sale of our Argus II System. From 2016, we have funded our business primarily through:
|
●
|
Issuance of common stock in our rights offering in June 2016, which provided net cash proceeds of $19.5 million.
|
|
●
|
Issuance of common stock and warrants in our rights offering in March 2017, which provided net cash proceeds of $19.7 million.
|
|
●
|
Issuance of common stock through our At Market Issuance Sales Agreement during the fourth quarter of 2017 and first quarter of 2018, which has provided $5.1 million of net cash proceeds.
|
|
●
|
Issuance of common stock in a securities purchase agreement in May 2018, which provided net proceeds of $10.0 million.
|
|
●
|
Issuance of common stock in a securities purchase agreement in August 2018, which provided net proceeds of $5.0 million.
|
|
●
|
Issuance of common stock in a securities purchase agreement in October 2018, which provided net proceeds of $4.0 million.
|
|
●
|
Revenue of $5.1 million in the first nine months of 2018, and $8.0 million and $4.0 million, for the years ended December 31, 2017 and 2016, respectively, generated by sales of our Argus II product.
|
We entered into stock purchase agreements on October 18, 2018, August 14, 2018 and May 3, 2018 with entities beneficially owned by Gregg Williams for the purchase of 2,467,727, 3,225,807 and 6,756,757 shares, respectively of common stock priced at $1.62, $1.55 and $1.48 per share, respectively, the last reported sale price of the common stock on each purchase date. Gregg Williams is the Chairman of our Board of Directors. These placements of common stock provided net proceeds of $4.0 million, $5.0 million and $10.0 million, respectively.
No warrants or discounts were provided and no placement agent or investment banking fees were incurred in connection with these transactions. The shares issuable to the purchasers under the Securities Purchase Agreements were also issued pursuant to the exemption from registration under Rule 506 of Regulation D. We relied on this exemption from registration based in part on representations made by the purchasers.
In November 2017, we entered into an At Market Issuance Sales Agreement (the “Sales Agreement”) with B. Riley FBR Inc. and H.C. Wainwright & Co., LLC, as agents (“Agents”) pursuant to which we may offer and sell, from time to time through either of the Agents, shares of our common stock having an aggregate offering price as set forth in the Sales Agreement and a related prospectus supplement filed with the SEC. We agreed to pay the Agents a cash commission of 3.0% of the aggregate gross proceeds from each sale of shares under the Sales Agreement. During January and February 2018, we sold 2.2 million shares of common stock for additional net proceeds of $4.0 million under the Sales Agreement. No shares have been sold since February 2018 under the Sales Agreement. We are utilizing these proceeds to further develop and enhance our products, support operations and for general corporate purposes.
Going concern
Our financial statements have been presented on the basis that our business is a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We are subject to the risks and uncertainties associated with a business with one product line and limited commercial product revenues, including limitations on our operating capital resources and uncertain demand for our products. We have incurred recurring operating losses and negative operating cash flows since inception, and we expect to continue to incur operating losses and negative operating cash flows for the foreseeable future. Management has concluded that there is substantial doubt about our ability to continue as a going concern, and our independent registered public accounting firm, in its report on our 2017 consolidated financial statements, has raised substantial doubt about our ability to continue as a going concern.
We believe our current cash and cash equivalents will fund our operations into January 2019. We do not have sufficient funds to support our operations for the next 12 months from the date of issuance of these financial statements. Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially. Conducting clinical trials is a time-consuming, expensive and uncertain process that takes many years to complete and we may never generate the necessary data or results required to obtain marketing approval. We expect our expenses to increase in connection with our ongoing activities, particularly as we continue clinical trials of Orion, initiate new research and development projects and seek marketing approval for any product candidates that we successfully develop. In addition, if we obtain marketing approval for Orion, we expect to incur significant additional expenses related to sales, marketing, distribution and other commercial infrastructure to commercialize such product. In addition, our product candidates, if approved, may not achieve commercial success. We incur significant costs associated with operating as a public company in a regulated industry. Furthermore, we continue to generate significant operating losses related to our Argus II product.
Until such time, if ever, as we can generate substantial product revenues, we anticipate that we will seek to fund our operations through public or private equity or debt financings, grants, collaborations, strategic partnerships or other sources. However, we may be unable to raise additional capital or enter into such other arrangements when needed on favorable terms or at all. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interests of our common stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our common stockholders. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise funds through additional collaborations, strategic alliances or licensing arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates or to grant licenses on terms that may not be favorable to us.
If we are unable to obtain funding on a timely basis, we may be required to significantly curtail, delay or discontinue one or more of our research or development programs or the commercialization of Argus II or of any other approved product candidates, or we may be unable to expand our operations, maintain our current organization and employee base or otherwise capitalize on our business opportunities, as desired, which could materially affect our business, financial condition and results of operations.
Insurance Reimbursement
Obtaining reimbursement from governmental and private insurance companies is critical to our commercial success. Due to the price of the Argus II system, our sales would be limited without the availability of third party reimbursement. In the U.S., coding, coverage, and payment are necessary for the surgical procedure and Argus II system to be reimbursed by payers. Coding has been established for the device and the surgical procedure. Coverage and payment vary by payer. The majority of Argus II patients are eligible for Medicare, and coverage is primarily provided through traditional Medicare, sometimes referred to as Medicare Fee-for-Service (“FFS”) or Medicare Advantage. A small percentage of patients are covered by commercial insurers.
|
●
|
Medicare FFS patients
– Coverage is determined by Medicare Administrative Contractors (“MACs”) that administer various geographic regions of the U.S. The Argus II is authorized for coverage, when medically necessary in eight of 12 MAC jurisdictions (comprising 31 states). Effective January 1, 2018, the Centers for Medicare and Medicaid Services (“CMS”) established a 2018 national average payment rate of $122,500 for both the procedure and the Argus II retinal prosthesis system when furnished in a hospital outpatient department. On November 2, 2018 CMS posted the final rule and related rates for the calendar year (“CY”) 2019 for the Medicare Hospital Outpatient Prospective Payment Systems (“OPPS”) and the CY 2019 Ambulatory Surgical Center (“ASC”) payment system. In these postings, CMS established a national average Medicare hospital outpatient rate for CY 2019 of $155,500 for Argus II and the associated surgical implantation procedure, and a national average ASC rate of approximately $134,051 for the Argus II and related implantation procedure.
|
|
●
|
Medicare Advantage patients
– Medicare Advantage plans are required to cover the same benefits as those covered by the MAC in that jurisdiction. For example, if a MAC in a jurisdiction has favorable coverage for the Argus II, then all Medicare Advantage plans in that MAC jurisdiction are required to offer the same coverage for the Argus II. Individual hospitals and ASCs may negotiate contracts specific to that individual facility, which may include additional separate payment for the Argus II implant system. In addition, procedural payment is variable and can be based on a percentage of billed charges, payment groupings or other individually negotiated payment methodologies. Medicare Advantage plans may allow providers to confirm coverage and payment for the Argus II procedure in advance of implantation. Since 2015 a large majority of all Medicare Advantage pre-authorization requests for Argus II procedures were granted.
|
|
●
|
Commercial insurer patients
– Commercial insurance plans make coverage and payment rate decisions independent of Medicare, and contracts are individually negotiated with facility and physician providers.
|
We retain employees and utilize consultants with insurance reimbursement expertise dedicated to expand and enhance coverage decisions. Currently, eight of 12 Medicare jurisdictions authorize coverage of the Argus II in 31 states, two territories and the District of Columbia when medically necessary, including:
● CGS (J15 -- Ohio and Kentucky),
● Palmetto GBA (JM -- Virginia, (excluding Part B for Arlington and Fairfax counties), West Virginia, North Carolina and South Carolina),
● Palmetto GBA (JJ – Alabama, Georgia and Tennessee),
● NGS (J6 -- Minnesota, Illinois and Wisconsin),
● NGS (JK -- Connecticut, New York, Maine, Massachusetts, New Hampshire, Rhode Island and Vermont),
● FCSO (JN -- Florida, Puerto Rico and the U.S. Virgin Islands),
● Novitas (JH-- Arkansas, Colorado, Louisiana, Mississippi, New Mexico, Oklahoma, and Texas) and
● Novitas (JL -- Delaware, District of Columbia, Maryland, New Jersey and Pennsylvania)
We are actively engaged with the remaining MACs and are committed to supporting their requests for additional information and clinical evidence. We expect that additional positive coverage decisions will be issued over time but cannot predict timing or ultimate success with each MAC.
Within Europe, we have obtained reimbursement approval or funding in Germany, France, one region of Italy, and a Commissioning through Evaluation (“CtE”) program in England.
We are seeking additional reimbursement approvals in other countries in Europe and international markets.
In France, we were selected to receive the first “Forfait Innovation” (Innovation Bundle) from the Ministry of Health, which is a special funding program for breakthrough procedures to be introduced into clinical practice. As part of this program, we are conducting a post-market study in France which has enrolled a total of 18 subjects who are being followed for two years. The French program also funds implantation of up to 18 additional patients that are not part of the post-market study. After review of the study’s results, we expect Argus II therapy to be covered and funded through the standard payment system in France. However, we can provide no assurance that the French government will continue to fund the Argus II after the first 36 implants.
In December 2016, NHS England announced it would cover 10 Argus II implantations as part of their CtE program. The CtE program is especially designed for treatments that show significant promise for the future, while new clinical and patient experience data are collected within a formal evaluation program. This program is similar to the Forfait Innovation program in France. NHS England is known to be under significant financial pressure and also highly selective in adopting innovative technologies which must demonstrate sufficient value for the cost expended. This program is progressing slower than expected and we now believe implants under this program will not begin until late 2018 or early 2019.
To date, our marketing activities have focused on raising awareness of the Argus II with potential patients, implanting physicians, and referring physicians. Our marketing activities include exhibiting, sponsoring symposia, and securing podium presence at professional and trade shows, securing journalist coverage in popular and trade media, attending patient meetings focused on educating patients about existing and future treatments, and sponsoring information sessions for the Argus II. In the United States, our efforts will focus on media advertisements dedicated to RP patients and their families. These advertisements will be placed in geographic areas where we have Centers of Excellence committed to Argus II.
Currently, we are in process of evaluating potential reimbursement pathways for Orion. Compared to Argus II, which is largely catering to Medicare patient population, Orion is expected to address patient population with diverse and more balanced payer mix due to our potential indications profile and expected younger average patient population. As Orion is approved for FDA’s Breakthrough Devices program, we are closely evaluating a variety of fast track reimbursement programs catering to promising breakthrough treatments, including the Coverage with Evidence Development pathway with CMS. We also plan to approach some of the key payers early next year and get their feedback to ensure our pivotal clinical trial design will be able to cater to their key coverage requirements.
Product and Clinical Development Plans
Argus II.
The Argus II is currently approved for RP patients with bare or no light perception in the US, and in Europe for severe to profound vision loss due to outer retinal degeneration, such as from RP, choroideremia, and other similar conditions. The number of people who are legally blind due to RP is estimated to be about 25,000 in the US, 42,000 in Europe, and about 375,000 total worldwide. A subset of these patients would be eligible for the Argus II since the approved baseline vision for the Argus II is worse than legally blind (20/200). We commissioned 3
rd
party market research for the size of the RP market that resulted in an estimate of approximately 1,500 patients in the U.S. with advanced RP that could be treated with the Argus II given the eligibility criteria of our label.
We believe an opportunity exists to expand the use of our Argus II technology to better sighted individuals with RP who are currently not being treated. To achieve this market expansion, we have taken steps to request US label expansion with FDA and endeavor to improve the technology’s performance, including:
|
●
|
Development of advanced retina stimulation techniques that we believe can improve the quality or usefulness of the vision provided by Argus II;
|
|
●
|
Redesigns of the externals (glasses, camera, and video processing unit) that will provide a next-generation platform capable of supporting the commercial implementation of improved image processing capabilities and advanced retina stimulation techniques in late 2018 or 2019.
|
Given the limited addressable market of Argus II, we made the decision to maximize capital efficiency with our Argus commercial and clinical activities and increase our investment of resources with our Orion clinical and R&D programs. As a result, we evaluate the short-term financial payback to enter new Argus markets or expand geographically; have increased focus on our strongest markets and the top centers of excellence in those markets allowing for more efficient deployment of field resources; and continue our efforts to expand the U.S. label to include better-vision RP patients without conducting a potentially costly U.S. Investigational Device Exemption (“IDE”) trial.
In October 2018, we announced a restructuring of our international commercial activities and personnel. We will maintain a team that will continue support of existing Argus II patients and Centers of Excellence in our international markets. We anticipate that the annual savings from the restructuring will amount to approximately $3.0 million per year and we plan to reallocate savings to the Orion program and other related projects. We expect to recognize approximately $0.6 million of pre-tax restructuring charges in the fourth quarter of fiscal year 2018 in connection with this restructuring, consisting of severance and other employee termination benefits, substantially all of which are expected to be settled in cash during the fourth quarter of 2018.
Orion.
We believe that we can further expand our market to include nearly all profoundly blind individuals, other than those who are blind due to preventable diseases or due to brain damage, by developing a visual cortical prosthesis. We refer to this product as the Orion
®
Visual Cortical Prosthesis System. We estimate that there are approximately 5.8 million people worldwide who are legally blind due to causes other than preventable conditions, RP or age-related macular degeneration. We commissioned 3
rd
party market research for the potential market for Orion that resulted in initial estimates of over 500,000 individuals in the U.S. who are legally blind due to glaucoma, diabetic retinopathy, optic nerve disease and eye trauma and a potential U.S. addressable market of more than 70,000 individuals from this population with vision defined as bare light or no light perception. Our marketing approvals by the FDA and other regulatory agencies will ultimately determine the subset of these patients who are eligible for the Orion.
Our objective in designing and developing Orion is to bypass the optic nerve and directly stimulate the part of the brain responsible for vision. In 2017, we submitted and received FDA approval for an IDE application to begin a human feasibility study of Orion. Enrollment began for this study in January 2018, and to date, the five planned subjects have been implanted and had their devices activated; four at UCLA and one at Baylor. In addition, during the second quarter of 2018, we submitted and received approval from the FDA to enroll a sixth subject; we are screening for the sixth subject at Baylor. This study is intended to confirm initial findings in our human pilot study we announced in the fourth quarter of 2016, and provide the first human data of a fully functional wireless visual cortical stimulator system including the external video camera system. This initial study in a small number of subjects, if successful, should also form the basis for an expansion to our next clinical trial in 2019.
In November 2017, the FDA granted Expedited Access Pathway designation for the Orion. This designation is given to a few select medical devices in order to provide more effective treatment of life-threatening or irreversibly debilitating diseases or conditions. This program is intended to help patients have more timely access to these medical devices by expediting their development, assessment, and review. The FDA has also released a draft guidance document for a Breakthrough Devices Program, which, when finalized, will supersede the Expedited Access Pathway. The FDA has indicated that all devices which have Expedited Access Pathway designation will gain Breakthrough Device designation when the guidance document is finalized. With this designation, we believe the Orion will have the following advantages during the FDA review process:
|
●
|
Greater interactive review both for the Investigational Device Exemption and Premarket Approval application;
|
|
●
|
Greater reliance on post-market vs. pre-market data collection and greater acceptance of uncertainty in the benefit-risk profile at the time of approval;
|
|
●
|
Priority review (i.e., review of the submission is placed at the top of the review queue and receives additional review resources); and,
|
|
●
|
Senior FDA management involvement and assignment of a cross-disciplinary case manager.
|
It is our expectation that inclusion in the Expedited Access Pathway Program (soon-to-be Breakthrough Devices Program) will shorten the timeline required to bring the Orion to market as a commercial product. We are currently evaluating our pivotal trial design for Orion and expect to reach consensus with the FDA on design specifics during early 2019. Major elements of our clinical trial design include the number of patients, study duration, and the endpoints suitable for assessing visual function, functional vision, and quality of life. While negotiations with the FDA are ongoing, we believe the study design will require a minimum sample population of 30 subjects with at least 6 months of follow-up data for each patient prior to submittal of a premarket approval (PMA) application.
Critical Accounting Policies
The preparation of our condensed consolidated financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”) and the requirements of the United States Securities and Exchange Commission requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the notes to the financial statements. Some of those judgments can be subjective and complex, and therefore, actual results could differ materially from those estimates under different assumptions or conditions. A summary of our critical accounting policies is presented in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2017.
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09,
Revenue from Contracts with Customers (Topic 606).
This ASU is a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services.
We adopted this ASU on January 1, 2018 retrospectively, and the cumulative effect of the initial application on our accumulated deficit on that date was immaterial.
We generate our revenue from the sale of the Argus II which includes the implant and external components. Our product sales generally consist of the implant and related surgical supplies and may include a performance obligation related to post-surgical support.
We sell our products through two main sales channels: 1) directly to customers who use our products (the “Direct Channel”) and 2) to distribution partners who resell our products (the “Indirect Channel”).
Under the Direct Channel, we sell our systems to, and we receive payment directly from, customers who implant our products. Under our Indirect Channel, we have entered into distribution agreements that allow the distributors to sell our systems and fulfill performance obligations for surgical support and post-surgical support.
We determine revenue recognition through the following steps:
|
●
|
Identification of the contract, or contracts, with a customer
|
|
|
|
|
●
|
Identification of the performance obligations in the contract
|
|
|
|
|
●
|
Determination of the transaction price
|
|
|
|
|
●
|
Allocation of the transaction price to the performance obligations in the contract
|
|
|
|
|
●
|
Recognition of revenue when, or as, we satisfy a performance obligation
|
Revenue is generally recognized upon surgical implant, unless we have a significant performance obligation for post-surgical support. We recognize revenue when a material reversal is no longer probable. Conditions that preclude us from recognizing revenue generally involve new customers with no reimbursement or reimbursement history, and depends on third-party behavior beyond our control, uncertain payment cycles over an extended period of time, and our limited historical experience with these arrangements.
There have been no other material changes to our critical accounting policies during the nine months ended September 30, 2018.
Results of Operations
Net sales.
Our net sales are derived primarily from the sale of our Argus II product. We began selling the Argus II in Europe at the end of 2011, Saudi Arabia in 2012, the United States and Canada in 2014, Turkey in 2015, Iran, Taiwan, South Korea and Russia in 2017, and Singapore in 2018. Our objective is to increase our product revenue over the next several years as we pursue commercialization of our product, as our product becomes more well-known and accepted in the market, and as insurance coverage becomes more widespread.
Cost of sales.
Cost of sales includes the salaries, benefits, material, overhead, third party costs, warranty, charges for excess and obsolete inventory, and other costs required to make our Argus II system at our Los Angeles, California facility. Our product involves technologically complex materials and processes. While we are currently experiencing low yields on our manufacturing process, we expect that over the next few years we will be able to refine our processes and improve our manufacturing yields. We are also producing at less than our capacity which results in unabsorbed overhead costs. In future years, we expect to produce in greater quantities and improve our manufacturing yields, and we expect that we will more consistently generate positive gross margins. We record cost of sales when products are implanted, which may differ from the period we are able to record revenue. Such timing differences may cause our reported results of operations to be difficult to compare from period to period.
Operating Expenses.
We generally recognize our operating expenses as incurred in four general operational categories: research and development, clinical and regulatory, sales and marketing, and general and administrative. Our operating expenses also include a non-cash component related to the amortization of stock-based compensation for research and development, clinical and regulatory, sales and marketing, and general and administrative personnel. From time to time we have received grants from institutions or agencies, such as the National Institutes of Health, to help fund the some of the cost of our development efforts. We have recorded these grants as reductions to operating expenses.
|
●
|
Research and development expenses consist primarily of employee compensation and consulting costs related to the design, development, and enhancements of our current and potential future products, offset by grant revenue received in support of specific research projects. We expense our research and development costs as they are incurred. We expect research and development expenses to increase in the future as we pursue further enhancements of our existing product and develop technology for our potential future products, such as Orion. We also expect to receive additional grants in the future that will be offset primarily against research and development costs.
|
|
●
|
Clinical and regulatory expenses consist primarily of salaries, travel and related expenses for personnel engaged in clinical and regulatory functions, as well as internal and external costs associated with conducting clinical trials and maintaining relationships with regulatory agencies. We expect clinical and regulatory expenses to increase as we assess the safety and efficacy of enhancements to our current Argus II, seek to expand the indications for the Argus II, and conduct clinical studies of potential future products such as Orion.
|
|
●
|
Sales and marketing expenses consist primarily of salaries, commissions, travel and related expenses for personnel engaged in sales, marketing and business development functions, as well as costs associated with promotional and other marketing activities including the cost of units consumed as demos or samples. We expect sales and marketing expenses to increase as we hire additional sales personnel, initiate additional marketing programs, develop relationships with new distributors, and expand the number of doctors and medical centers that buy and implant our Argus II product and any future products.
|
|
●
|
General and administrative expenses consist primarily of salaries and related expenses for executive, legal, finance, human resources, information technology and administrative personnel, as well as recruiting and professional fees, patent filing and annuity costs, insurance costs and other general corporate expenses, including rent. We expect general and administrative expenses to increase as we add personnel and incur additional costs related to the growth of our business and operate as a public company.
|
Compariso
n of the Three Months Ended September
30, 2018 and 2017
We implanted a total of 20 Argus II products during the third quarter of 2018 and 12 in the third quarter of 2017. Of these, 11 implants were in Europe, the Middle East and Asia (collectively, “EMEA”) in the third quarter of 2018 and five implants were in EMEA in the third quarter of 2017.
In North America, there were nine implants in the third quarter of 2018 while there were seven implants in the third quarter of the prior year. Of these, there were seven implants in the U.S. in the third quarter of 2018 and 2017 and two implants in Canada in the third quarter of 2018.
Net Sales
. Net sales were $2.2 million in the third quarter of 2018 as compared to $1.6 million in the same period in 2017, an increase of $0.6 million or 38%. Revenue was recognized for 22 units in the current period while revenue from 12 units was recognized in the prior year quarter. Revenue recognized per implant was approximately $102,000 in the third quarter of 2018 and was $133,000 in same period of 2017. We expect our average revenue recognized per implant unit sold for the remainder of 2018 to be in a range of $100,000 to $120,000, depending on the geographic mix of implants.
Cost of sales.
Cost of sales increased by approximately $0.8 million, or 80%, from $1.0 million in the third quarter 2017 to $1.8 million in the third quarter of 2018. Cost of sales in the third quarter of 2018 consists primarily of the cost of products implanted and unabsorbed production costs in the quarter of $1.7 million and an increase in the reserve for excess inventory of $0.1 million. In the third quarter of 2017, the cost of sales included approximately $1.3 million for the cost of products implanted and unabsorbed production costs less an adjustment of $0.3 million for a reduction in the reserve for excess inventory. We expect cost of goods on a per-unit basis to stabilize, particularly related to overhead absorption and excess inventory reserve, as we produce more units.
Research and development expense.
Research and development expense, net of funding received from grants, increased by $0.9 million, or 50%, from $1.8 million in the third quarter of 2017 to $2.7 million in the third quarter of 2018. The increase from the prior year was primarily due to verification and validation activities related to Argus 2s and consists of increased headcount, outside services, and costs for internally produced prototypes. In both the third quarter of 2018 and 2017, we utilized $0.1 million of grant funds to offset costs.
Clinical and regulatory expense.
Clinical and regulatory expense increased $0.4 million, or 67%, from $0.6 million in the third quarter of 2017 to $1.0 million in the third quarter of 2018. This increase is primarily attributable to increased costs associated with the Orion feasibility study. We expect clinical and regulatory costs to increase in the future as we conduct additional clinical trials to assess new products such as Orion and enhancements to our existing product and enroll more patients in post market clinical studies for Argus II.
Selling and marketing expense.
Selling and marketing expense increased $0.6 million, or 25%, from $2.4 million in the third quarter of 2017 to $3.0 million in the third quarter of 2018. This increase in costs was primarily the result of increased market development activities, including headcount and related compensation expenses. We expect selling and marketing expense to decrease over time when expressed as a percentage of product revenue.
General and administrative expense.
General and administrative expense decreased $0.2 million, or 8%, from $2.5 million in the third quarter of 2017 to $2.3 million in the same period of 2018. This decrease is primarily attributable to $0.2 million in lower non-cash stock compensation costs primarily due to cancelled stock option grants.
Comparison of the Nine Months Ended September
30, 2018 and 2017
We implanted a total of 53 Argus II products during the first nine months of 2018 and 45 in the comparable period of 2017. Of these, 25 implants were in EMEA in the first nine months of 2018 as compared to 21 in the first nine months of 2017.
In North America, there were 28 implants in the first nine months of 2018 compared to 24 implants in the first nine months of the prior year. Of these, there were 19 implants in the U.S. and five implants in Canada in the first nine months of 2017 compared to 25 in the U.S. and three in Canada in the first nine months of 2018.
Net Sales
. Net sales were $5.1 million in the first nine months of 2018 as compared to $4.9 million in 2017, an increase of $0.2 million or 4%. Revenue was recognized for 48 units in the first nine months of 2018 as compared to 41 units in the first nine months of 2017. Revenue recognized per implant was approximately $107,000 in the first nine months of 2018 as compared to approximately $117,000 in the first nine months of 2017. We expect our average revenue recognized per implant unit sold for the remainder of 2018 to be in a range of $100,000 to $120,000, depending on the geographic mix of implants.
Cost of sales.
Cost of sales were $3.3 million in the first nine months 2017 and 2018. Cost of sales in the first nine months of 2018 consists primarily of the cost of products implanted and unabsorbed production costs in the period of $3.1 million and an increase in the reserve for excess inventory of $0.2 million. In the first nine months of 2017, the cost of sales included approximately $5.0 million for the cost of products implanted and unabsorbed production costs less an adjustment of $1.7 million for a reduction in the reserve for excess inventory. We expect cost of goods on a per-unit basis to stabilize, particularly related to overhead absorption and excess inventory reserve, as we produce more units.
Research and development expense.
Research and development expense, net of funding received from grants, increased by $2.0 million, or 36%, from $5.6 million in the first nine months of 2017 to $7.6 million in the first nine months of 2018. The increase from the prior year was primarily due to verification and validation activities related to Argus 2s and consists of increased headcount, outside services, costs for internally produced prototypes. In the first nine months of 2018 and 2017, we utilized $0.2 million of grant funds to offset costs.
Clinical and regulatory expense.
Clinical and regulatory expense increased $1.5 million, or 79%, from $1.9 million in the first nine months of 2017 to $3.4 million in the first nine months of 2018. This increase is primarily attributable to increased costs associated with the Orion feasibility study. We expect clinical and regulatory costs to increase in the future as we (i) increase our implant run rate and enroll more patients in post market clinical studies for regulatory authorities, and (ii) conduct additional clinical trials to assess new products such as the Orion I and enhancements to our existing product.
Selling and marketing expense.
Selling and marketing expense increased $1.8 million, or 25%, from $7.1 million in the first nine months of 2017 to $8.9 million in the first nine months of 2018. This increase in costs was primarily the result of a $0.6 million increase for market development activities, increased headcount and related $0.8 million increase in compensation expense, and a $0.4 million increase in costs related to additional travel costs. While we expect these costs to increase in the future as we increase our selling and marketing resources to accelerate the commercialization of our product, we expect selling and marketing expense to decrease over time when expressed as a percentage of product revenue.
General and administrative expense.
General and administrative expense remained constant at $8.2 million, in the first nine months of 2017 and 2018.
Liquidity and Capital Resources
Our consolidated financial statements have been presented on the basis that it is a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. We have experienced recurring operating losses and negative operating cash flows since inception, and have financed our working capital requirements through the recurring sale of our equity securities in both public and private offerings. As a result, our independent registered public accounting firm, in its report on our 2017 consolidated financial statements, has raised substantial doubt about our ability to continue as a going concern (see “Going Concern” above).
In March 2017, we successfully completed a rights offering to existing shareholders, raising proceeds of approximately $19.7 million net of offering costs, through the sale of 13,652,341 units at $1.47 per unit. Each unit consisted of a share of common stock and a five-year warrant with an exercise price of $1.47 per share.
During the first three months of 2018, we issued 2,224,000 shares of common stock for net proceeds of approximately $4.0 million as part of our At Market Issuance Sales Agreement with two separate investment banks.
We entered into stock purchase agreements on October 18, 2018, August 14, 2018 and May 3, 2018 with entities beneficially owned by Gregg Williams for the purchase of 2,467,727, 3,225,807 and 6,756,757 shares respectively of common stock priced at $1.62, $1.55 and $1.48 per share respectively, the last reported sale price of the common stock on each purchase date. Gregg Williams is the Chairman of our Board of Directors. These placements of common stock provided net proceeds of $4.0 million, $5.0 million and $10.0 million respectively.
No warrants or discounts were provided and no placement agent or investment banking fees were incurred in connection with these transactions. The shares issuable to the purchasers under the Securities Purchase Agreements were also issued pursuant to the exemption from registration under Rule 506 of Regulation D. We relied on this exemption from registration based in part on representations made by the purchasers
We believe our current cash and cash equivalents will fund our operations into January 2019. We do not have sufficient funds to support our operations for the next 12 months from the date of issuance of these financial statements. Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially. Conducting clinical trials is a time-consuming, expensive and uncertain process that takes many years to complete and we may never generate the necessary data or results required to obtain marketing approval. We expect our expenses to increase in connection with our ongoing activities, particularly as we continue clinical trials of Orion, initiate new research and development projects and seek marketing approval for any product candidates that we successfully develop. In addition, if we obtain marketing approval for Orion, we expect to incur significant additional expenses related to sales, marketing, distribution and other commercial infrastructure to commercialize such product. In addition, our product candidates, if approved, may not achieve commercial success. We incur significant costs associated with operating as a public company in a regulated industry. Furthermore, we continue to generate significant operating losses related to our Argus II product.
Until such time, if ever, as we can generate substantial product revenues, we anticipate that we will seek to fund our operations through public or private equity or debt financings, grants, collaborations, strategic partnerships or other sources. However, we may be unable to raise additional capital or enter into such other arrangements when needed on favorable terms or at all. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interests of our common stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our common stockholders. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise funds through additional collaborations, strategic alliances or licensing arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates, or to grant licenses on terms that may not be favorable to us.
Cash and cash equivalents decreased by $2.8 million, or 36%, from $7.8 million as of December 31, 2017 to $5.0 million as of September 30, 2018. Working capital was $2.8 million as of September 30, 2018, as compared to $6.6 million as of December 31, 2017, a decrease of $3.8 million, or 58%. We use our cash and cash equivalents and working capital to fund our operating activities.
Cash Flows from Operating Activities
During the first nine months of 2018, we used $22.1 million of cash in operating activities, consisting primarily of a net loss of $26.2 million, offset by non-cash charges which provided cash of $3.4 million for depreciation and amortization of property and equipment, stock-based compensation, bad debt recovery, excess inventory reserve and common stock issuable and by a net change in operating assets and liabilities which provided cash of $0.7 million. During the first nine months of 2017, we used $17.2 million of cash in operating activities, consisting primarily of a net loss of $21.1 million, offset by non-cash charges which provided cash of $1.5 million for depreciation and amortization of property and equipment, stock-based compensation, excess inventory reserve, bad debt recovery and common stock issuable and by a net change in operating assets and liabilities which provided cash of $2.4 million.
Cash Flows from Investing Activities
Cash used for investing activities in the first nine months of 2018 was $0.1 million and was $0.2 million in the first nine months of 2017 primarily for the purchase of property and equipment.
Cash Flows from Financing Activities
Financing activities provided $19.4 million of cash in the first nine months of 2018 consisting of $18.9 million from proceeds of common stock sold during the period and the remainder from the proceeds from exercise of warrants, options and employee stock plan purchases. Financing activities provided $19.9 million of cash in the first nine months of 2017 consisting of $19.7 million from the rights offering and the remainder from employee stock plan purchases.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.