Amedica
Corporation
Condensed
Consolidated Statements of Operations - Unaudited
(in
thousands, except share and per share data)
|
|
Three
Months Ended March 31,
|
|
|
2017
|
|
|
2016
|
|
Product
revenue
|
|
$
|
2,629
|
|
|
$
|
4,173
|
|
Costs
of revenue
|
|
|
661
|
|
|
|
893
|
|
Gross
profit
|
|
|
1,968
|
|
|
|
3,280
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
Research
and development
|
|
|
1,016
|
|
|
|
1,608
|
|
General
and administrative
|
|
|
1,112
|
|
|
|
1,562
|
|
Sales
and marketing
|
|
|
1,642
|
|
|
|
2,594
|
|
Total
operating expenses
|
|
|
3,770
|
|
|
|
5,764
|
|
Loss
from operations
|
|
|
(
1,802
|
)
|
|
|
(2,484
|
)
|
Other
income (expenses):
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
(360
|
)
|
|
|
(900
|
)
|
Change
in fair value of derivative liabilities
|
|
|
11
|
|
|
|
(11
|
)
|
Other
income
|
|
|
1
|
|
|
|
7
|
|
Total
other expense, net
|
|
|
(348
|
)
|
|
|
(904
|
)
|
Net
loss before income taxes
|
|
|
(
2,150
|
)
|
|
|
(3,388
|
)
|
Provision
for income taxes
|
|
|
-
|
|
|
|
-
|
|
Net
loss
|
|
$
|
(2,150
|
)
|
|
$
|
(3,388
|
)
|
Net
loss per share
|
|
|
|
|
|
|
|
|
Basic
and diluted
|
|
$
|
(0.06
|
)
|
|
$
|
(0.30
|
)
|
Weighted
average common shares outstanding:
|
|
|
|
|
|
|
|
|
Basic
and diluted
|
|
|
33,917,628
|
|
|
|
11,193,250
|
|
The
condensed consolidated balance sheet as of December 31, 2016, has been prepared using information from the audited consolidated
balance sheet as of that date.
The
accompanying notes are an integral part of these condensed consolidated financial statements.
Amedica
Corporation
Condensed
Consolidated Statements of Cash Flows - Unaudited
(in
thousands)
|
|
Three
Months Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
Cash
flow from operating activities
|
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(2,150
|
)
|
|
$
|
(3,388
|
)
|
Adjustments
to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
Depreciation
expense
|
|
|
162
|
|
|
|
389
|
|
Amortization
of intangible assets
|
|
|
134
|
|
|
|
125
|
|
Amortization
of lease incentive for tenant improvements
|
|
|
5
|
|
|
|
5
|
|
Non-cash
interest expense
|
|
|
224
|
|
|
|
405
|
|
Stock
based compensation
|
|
|
60
|
|
|
|
88
|
|
Change
in fair value of derivative liabilities
|
|
|
(11
|
)
|
|
|
6
|
|
Gain
on disposal of equipment
|
|
|
-
|
|
|
|
(4
|
)
|
Provision
for inventory reserve
|
|
|
150
|
|
|
|
373
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Trade
accounts receivable
|
|
|
(82
|
)
|
|
|
813
|
|
Prepaid
expenses and other current assets
|
|
|
47
|
|
|
|
(476
|
)
|
Inventories
|
|
|
90
|
|
|
|
263
|
|
Accounts
payable and accrued liabilities
|
|
|
(462
|
)
|
|
|
(64
|
)
|
Net
cash used in operating activities
|
|
|
(1,833
|
)
|
|
|
(1,465
|
)
|
Cash
flows from investing activities
|
|
|
|
|
|
|
|
|
Purchase
of property and equipment
|
|
|
(292
|
)
|
|
|
(259
|
)
|
Proceeds
from sale of property and equipment
|
|
|
-
|
|
|
|
16
|
|
Net
cash used in investing activities
|
|
|
(292
|
)
|
|
|
(243
|
)
|
Cash
flows from financing activities
|
|
|
|
|
|
|
|
|
Proceeds
from issuance of common stock, net of issuance costs
|
|
|
3,807
|
|
|
|
-
|
|
Payments
on Debt
|
|
|
(1,653
|
)
|
|
|
(1,834
|
)
|
Net
cash provided by (used in) financing activities
|
|
|
2,154
|
|
|
|
(1,834
|
)
|
Net
increase (decrease) in cash and cash equivalents
|
|
|
29
|
|
|
|
(3,542
|
)
|
Cash
and cash equivalents at beginning of period
|
|
|
6,915
|
|
|
|
11,485
|
|
Cash
and cash equivalents at end of period
|
|
$
|
6,944
|
|
|
$
|
7,943
|
|
|
|
|
|
|
|
|
|
|
Supplemental
cash flow information
|
|
|
|
|
|
|
|
|
Cash
paid for interest
|
|
$
|
136
|
|
|
$
|
507
|
|
The
condensed consolidated balance sheet as of December 31, 2016, has been prepared using information from the audited consolidated
balance sheet as of that date.
The
accompanying notes are an integral part of these condensed consolidated financial statements.
AMEDICA
CORPORATION
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.
Organization and Summary of Significant Accounting Policies
Organization
Amedica
Corporation was incorporated in the state of Delaware on December 10, 1996. Amedica Corporation is a materials company focused
on developing, manufacturing and selling silicon nitride ceramics that are used in medical implants and in a variety of industrial
devices. At present, Amedica Corporation commercializes silicon nitride in the spine implant market and believes that its silicon
nitride manufacturing expertise positions it favorably to introduce new and innovative devices in the medical and non-medical
fields. Amedica Corporation also believes that it is the first and only company to commercialize silicon nitride medical implants.
Amedica Corporation acquired US Spine, Inc. (“US Spine”), a Delaware spinal products corporation with operations in
Florida, on September 20, 2010. Amedica Corporation and US Spine are collectively referred to as “Amedica” or “the
Company” in these condensed consolidated financial statements. The Company’s products are sold primarily in
the United States.
Basis
of Presentation
These
unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the United
States Securities and Exchange Commission (“SEC”), and include all assets and liabilities of the Company and its
wholly-owned subsidiary, US Spine. All material intercompany transactions and balances have been eliminated in consolidation.
SEC rules and regulations allow the omission of certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted in the United States, so long as the statements
are not misleading. In the opinion of management, these financial statements and accompanying notes contain all adjustments (consisting
of normal recurring adjustments) necessary to present fairly the financial position and results of operations for the periods
presented herein. These condensed consolidated financial statements should be read in conjunction with the consolidated audited
financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December
31, 2016, filed with the SEC on September 20, 2017. The results of operations for the three months ended March 31, 2017 are not
necessarily indicative of the results to be expected for the year ending December 31, 2017. The Company’s significant accounting
policies are set forth in Note 1 to the consolidated financial statements in its Annual Report on Form 10-K for the year ended
December 31, 2016.
Use
of Estimates
The
preparation of financial statements in conformity with accounting principles generally accepted in the United States (“U.S.
GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts
of revenue and expenses during the periods then ended. Actual results could differ from those estimates. The most
significant estimates relate to inventory, stock-based compensation, long-lived and intangible assets and the liability for preferred
stock and common stock warrants.
Liquidity
and Capital Resources
The
condensed consolidated financial statements have been prepared assuming the Company will continue to operate as a going concern,
which contemplates the realization of assets and settlement of liabilities in the normal course of business, and does not include
any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications
of liabilities that may result from uncertainty related to its ability to continue as a going concern within one year from the
date of issuance of these condensed consolidated financial statements.
For
the three months ended March 31, 2017 and 2016, the Company incurred net losses of $2.2 million and $3.4 million, respectively,
and used cash in operations of $1.8 million and $1.5 million, respectively. The Company had an accumulated deficit of $215 million
and $213 million as of March 31, 2017 and December 31, 2016, respectively. To date, the Company’s operations have been principally
financed by proceeds received from the issuance of preferred and common stock, convertible debt and bank debt and, to a lesser
extent, cash generated from product sales. It is anticipated that the Company will continue to generate operating losses and use
cash in operating activities. The Company’s continuation as a going concern is dependent upon its ability to increase sales,
implement cost saving measures, maintain compliance with debt covenants and/or raise additional funds through the capital markets.
Whether and when the Company can attain profitability and positive cash flows from operating activities or obtain additional financing
is uncertain.
In
2016, the Company implemented certain cost saving measures, including workforce and office space reductions, and will continue
to evaluate additional cost savings alternatives during 2017. These additional cost savings measures may include additional workforce
and research and development reductions, as well as cuts to certain other operating expenses. In addition to these cost saving
measures, an experienced and highly successful leader for the Sales and Marketing team was recruited and hired. This individual
has subsequently hired additional experienced personnel in Sales and Marketing. The Company is actively generating additional
scientific and clinical data to have it published in leading industry publications. The unique features of the Company’s
silicon nitride material are not well known, and publication of such data would help sales efforts as the Company approaches
new prospects. The Company is also making additional changes to the sales strategy, including a focus on revenue growth of silicon
nitride lateral lumbar implants and the newly developed pedicle screw system (known as Taurus).
As
discussed further in Note 7, in June 2014 the Company entered into a term loan with Hercules Technology Growth Capital, Inc. (“Hercules
Technology”), as administrative and collateral agent for the lenders thereunder and as lender, and Hercules Technology III,
LP, (“HT III” and, together with Hercules Technology, “Hercules”) as lender (the “Hercules Term
Loan”). The Hercules Term Loan has a liquidity covenant that requires the Company to maintain a cash balance of not less
than $2.5 million as of March 31, 2017. As of March 31, 2017, the Company’s cash balance was approximately $6.9 million.
The Company believes it will be in position to maintain compliance with the liquidity covenant related to the Hercules Term Loan
at least through October 2017, as once the Hercules Term Loan principal balance is reduced below $2.5 million the Company is only
required to maintain a cash balance equal to the outstanding balance of the Hercules Term Loan from that point forward. The Company
has common stock that is publicly traded and has been able to successfully raise capital when needed since the date of the Company’s
initial public offering. The Company is engaged in discussions with investment and banking firms to examine financing alternatives,
including options to encourage the exercise of outstanding warrants and other lending alternatives. On July 28, 2017, the Company
entered into a $2.5 million term loan that will assist the Company in its cash needs through November 2017 (see Note 11).
If
the Company is unable to access additional funds prior to becoming non-compliant with the financial and liquidity covenants related
to the Hercules Term Loan, the outstanding balance of the Hercules Term Loan would become immediately due and payable
at the option of the lender. Although the Company is seeking to obtain additional equity and/or debt financing, such funding is
not assured and may not be available to the Company on favorable or acceptable terms, and may involve significant restrictive
covenants. Any additional equity financing is also not assured and, if available to the Company, will most likely be dilutive
to its current stockholders. If the Company is not able to obtain additional debt or equity financing on a timely basis, the impact
on the Company will be material and adverse.
Significant
Accounting Policies
There
have been no significant changes to the Company’s significant accounting policies as described in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2016.
New
Accounting Pronouncement, Not Yet Adopted
In
January 2017, the FASB issued ASU 2017-04
Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill
Impairment
. The amendments in this guidance eliminate the requirement to calculate the implied fair value of goodwill used
to measure goodwill impairment charge (Step 2). As a result, an impairment charge will equal the amount by which a reporting unit’s
carrying amount exceeds its fair value, not to exceed the amount of goodwill allocated to the reporting unit. An entity still
has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is
necessary. The amendment should be applied on a prospective basis. The guidance is effective for goodwill impairment tests in
fiscal years beginning after December 15, 2021. Early adoption is permitted for goodwill impairment tests performed after January
1, 2017. The impact of this guidance for the Company will depend on the outcomes of future goodwill impairment tests.
In
August 2016, the Financial Accounting Standards Board (“FASB”) updated accounting guidance on the following eight
specific cash flow classification issues: (1) debt prepayment or debt extinguishment costs; (2) settlement of zero-coupon debt
instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest
rate of the borrowing; (3) contingent consideration payments made after a business combination; (4) proceeds from the settlement
of insurance claims; (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance
policies; (6) distributions received from equity method investees; (7) beneficial interests in securitization transactions; and
(8) separately identifiable cash flows and application of the predominance principle. Under existing U.S. GAAP,
there is no specific guidance on the eight cash flow classification issues aforementioned. These updates are effective for the
Company for its annual period beginning January 1, 2019, and interim periods therein, with early adoption permitted. The guidance
in this standard is not expected to have a material impact on the financial statements of the Company.
In
March 2016, the FASB updated the accounting guidance related to stock compensation. This update simplifies the accounting for
employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding
requirements, as the well as classification in the statement of cash flows. The standard is effective for the Company for its
annual period beginning January 1, 2018. The guidance in this standard is not expected to have a material impact on the financial
statements of the Company.
In
February 2016, the FASB updated the accounting guidance related to leases as part of a joint project with the International Accounting
Standards Board (“IASB”) to increase transparency and comparability among organizations by recognizing lease assets
and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. Under the new guidance,
a lessee will be required to recognize assets and liabilities for capital and operating leases with lease terms of more than 12
months. Additionally, this update will require disclosures to help investors and other financial statement users better understand
the amount, timing, and uncertainty of cash flows arising from leases, including qualitative and quantitative requirements. The
standard is effective for the Company for its annual period beginning January 1, 2020, and interim periods therein, with early
adoption permitted. The Company is currently evaluating the potential impact this new standard may have on its financial statements,
but believes the most significant change will relate to building leases.
In
May 2014, in addition to several amendments issued during 2016, the FASB updated the accounting guidance related to revenue from
contracts with customers, which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle
is that a company should recognize revenue when promised goods or services are transferred to customers in an amount that reflects
the consideration to which an entity expects to be entitled for those goods or services. The standard defines a five-step
process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition
process than are required under existing U.S. GAAP. The standard is effective for the Company for its annual period beginning
January 1, 2019, and interim periods therein, and shall be applied either retrospectively to each period presented or as a cumulative-effect
adjustment as of the date of adoption. The Company is in the preliminary stages of evaluating the impact that the new standard
will have on its financial statements.
The
Company has reviewed all other recently issued, but not yet adopted, accounting standards, in order to determine their effects,
if any, on its results of operations, financial position or cash flows. Based on that review, the Company believes that no other
pronouncements will have a significant effect on its financial statements.
2.
Basic and Diluted Net Loss per Common Share
Basic
net loss per share is calculated by dividing the net loss by the weighted-average number of common shares outstanding for the
period, without consideration for common stock equivalents. Diluted net loss per share is calculated by dividing the net loss
by the weighted-average number of common share equivalents outstanding for the period determined using the treasury-stock method.
Dilutive common stock equivalents are primarily comprised of warrants for the purchase of common stock and stock options.
For all periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding
because their effect would have been anti-dilutive due to the Company reporting a net loss. The Company had potentially dilutive
securities, shares of common stock, totaling approximately 17.9 million and 800,000 as of March 31, 2017 and 2016,
respectively.
3.
Inventories, net
Inventories
consisted of the following
(in thousands):
|
|
March
31, 2017
|
|
|
December
31, 2016
|
|
Raw
materials
|
|
$
|
685
|
|
|
$
|
761
|
|
WIP
|
|
|
185
|
|
|
|
75
|
|
Finished
goods
|
|
|
6,103
|
|
|
|
6,377
|
|
|
|
$
|
6,973
|
|
|
$
|
7,213
|
|
Finished
goods included consigned inventory totaling approximately $3.0 million and $5.6 million as of March 31, 2017 and December 31,
2016, respectively. As of March 31, 2017, inventories totaling $1,425 and $5,548 were classified as current and long-term,
respectively. Inventories classified as current represent the carrying value of inventories as of March 31, 2017 that management
estimates will be sold by March 31, 2018. As of December 31, 2016, all inventories were classified as current.
4.
Intangible Assets
Intangible
assets consisted of the following (in thousands):
|
|
March
31, 2017
|
|
|
December
31, 2016
|
|
Developed
technology
|
|
$
|
4,685
|
|
|
$
|
4,685
|
|
Customer
relationships
|
|
|
3,990
|
|
|
|
3,990
|
|
Other
patents and patent applications
|
|
|
562
|
|
|
|
562
|
|
Trademarks
|
|
|
350
|
|
|
|
350
|
|
|
|
|
9,587
|
|
|
|
9,587
|
|
Less:
accumulated amortization
|
|
|
(6,534
|
)
|
|
|
(6,400
|
)
|
|
|
$
|
3,053
|
|
|
$
|
3,187
|
|
Amortization
expense is expected to approximate $400,000 for the remainder of 2017, $536,000 per year through 2021, $369,000 in 2022 and total
$140,000 thereafter, until fully amortized.
5.
Fair Value Measurements
Financial
Instruments Measured and Recorded at Fair Value on a Recurring Basis
The
Company has issued certain warrants to purchase shares of common stock, which are considered mark-to-market liabilities and are
re-measured to fair value at each reporting period in accordance with accounting guidance. Fair value is based on the price that
would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants
at the measurement date, under a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as
follows:
|
Level
1 -
|
quoted
market prices for identical assets or liabilities in active markets.
|
|
|
|
|
Level
2 -
|
observable
prices that are based on inputs not quoted on active markets, but corroborated by market data.
|
|
|
|
|
Level
3 -
|
unobservable
inputs reflecting management’s assumptions, consistent with reasonably available assumptions made by other market participants.
These valuations require significant judgment.
|
The
Company classifies assets and liabilities measured at fair value in their entirety based on the lowest level of input that is
significant to their fair value measurement. No financial assets were measured on a recurring basis as of March 31, 2017
and December 31, 2016. The following tables set forth the financial liabilities measured at fair value on a recurring basis by
level within the fair value hierarchy as of March 31, 2017 and December 31, 2016:
|
|
Fair
Value Measurements as of March 31, 2017
|
|
Description
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Derivative
liability
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
stock warrants
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
517
|
|
|
$
|
517
|
|
|
|
Fair
Value Measurements as of December 31, 2016
|
|
Description
|
|
Level
1
|
|
|
Level
2
|
|
|
Level
3
|
|
|
Total
|
|
Derivative
liability
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
stock warrants
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
528
|
|
|
$
|
528
|
|
The
Company did not have any transfers of assets and liabilities between Level 1 and Level 2 of the fair value measurement hierarchy
during the three months ended March 31, 2017 and 2016.
The
assumptions used in estimating the common stock warrant liability as of March 31, 2017 and December 31, 2016 were as follows:
|
|
March
31, 2017
|
|
|
December
31, 2016
|
|
Weighted-average
risk free interest rate
|
|
|
1.64
|
%
|
|
|
0.92
|
%
|
Weighted-average
expected life (in years)
|
|
|
2.0
|
|
|
|
2.5
|
|
Expected
dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
Weighted-average
expected volatility
|
|
|
125
|
%
|
|
|
136
|
%
|
Other
Financial Instruments
The
Company’s recorded values of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate
their fair values based on their short-term nature. The recorded value of notes payable approximates the fair value as
the interest rates are reflective of market interest rates.
6.
Accrued Liabilities
Accrued
liabilities consisted of the following (in thousands):
|
|
March
31, 2017
|
|
|
December 31, 2016
|
|
Commissions
|
|
$
|
379
|
|
|
$
|
466
|
|
Payroll
and related expenses
|
|
|
229
|
|
|
|
461
|
|
Royalties
|
|
|
259
|
|
|
|
416
|
|
Interest
payable
|
|
|
112
|
|
|
|
76
|
|
Final
loan payment fees
|
|
|
1,433
|
|
|
|
1,333
|
|
Other
|
|
|
424
|
|
|
|
431
|
|
|
|
$
|
2,836
|
|
|
$
|
3,183
|
|
7.
Debt
Hercules
Term Loan
On
June 30, 2014, the Company entered into a Loan and Security Agreement with Hercules which provided the Company with a $20 million
term loan. The Hercules Term Loan matures on January 1, 2018. The Hercules Term Loan included a $200,000 closing fee, which was
paid to Hercules on the closing date of the loan. The closing fee was recorded as a debt discount and is being amortized to interest
expense over the life of the loan. The Hercules Term Loan also includes a non-refundable final payment fee of $1.7 million. The
final payment fee is being accrued and recorded to interest expense over the life of the loan. The Hercules Term Loan bears interest
at the rate of the greater of either (i) the prime rate plus 9.2%, and (ii) 12.5%, and was 12.7% as of March 31, 2017. Interest
accrues from the closing date of the loan and interest payments are due monthly. Principal payments commenced August 1, 2015 and
are currently being made in equal monthly installments totaling approximately $500,000, with the remainder due at maturity. The
Hercules Term Loan is secured by a first priority security interest in substantially all of its assets, including intellectual
property, of the Company and contains covenants restricting payments to certain Company affiliates and certain
financial reporting requirements.
On
September 8, 2015, the Company entered into a Consent and First Amendment to Loan and Security Agreement (the “Amendment”)
with Hercules. The Amendment modified the liquidity covenant to reduce the required minimum cash and cash equivalents balance
by $500,000 for every $1.0 million in principal paid, up to a minimum of $2.5 million. Once the Hercules Term Loan principal balance
is below $2.5 million the Company is only required to maintain a cash and cash equivalents balance equal to the outstanding
principal balance on the Hercules Term loan. The minimum cash and cash equivalents balance required to maintain compliance
with the minimum liquidity covenant as of March 31, 2017, was $2.5 million. The Company believes it will maintain compliance with
the liquidity covenant related to the Hercules Term Loan at least through October 2017. To maintain compliance beyond that date,
the Company will likely require additional cash (see Note 11).
See
discussion below with respect to the assignment of $3.0 million of the principal balance of the Hercules Term Loan to Riverside
Merchant Partners, LLC (“Riverside”) and the subsequent agreement between the Company and Riverside to exchange the
$3.0 million of the Hercules Term Loan held by Riverside for subordinated convertible promissory notes in the aggregate principal
amount of $3.0 million.
Hercules
and Riverside Debt Exchange
On
April 4, 2016, the Company entered into an Assignment and Second Amendment to Loan and Security Agreement (the “Assignment
Agreement”) with Riverside and Hercules, pursuant to which Hercules sold $1.0 million of the principal amount outstanding
under the Hercules Term Loan to Riverside. In addition, pursuant to the terms of the Assignment Agreement, Riverside acquired
an option to purchase an additional $2.0 million of the principal amount outstanding under the Hercules Term Loan from Hercules.
On April 18, 2016, Riverside exercised and purchased an additional $1.0 million of the principal amount of the Hercules Term Loan
and on April 27, 2016, Riverside exercised the remainder of its option and purchased an additional $1.0 million of the principal
amount of the Hercules Term Loan from Hercules.
Riverside
Debt
On
April 4, 2016, the Company entered into an exchange agreement (the “Exchange Agreement”) with Riverside, pursuant
to which the Company agreed to exchange $1.0 million of the principal amount outstanding under the Hercules Term Loan held by
Riverside for a subordinated convertible promissory note in the principal amount of $1.0 million (the “First Exchange Note”)
and a warrant to purchase 100,000 shares of common stock of the Company at a fixed exercise price of $1.62 per share (the “First
Exchange Warrant”) (the “Exchange”). All principal accrued under the Exchange Notes was convertible into shares
of common stock at the election of the Holder at any time at a fixed conversion price of $1.43 per share (the “Conversion
Price”). The closing stock price on April 4, 2016, was $1.63 and a beneficial conversion feature of $245,000 was recorded
to equity and as a debt discount. The warrant value of $106,000 was recorded to equity and as a debt discount.
In
addition, pursuant to the terms and conditions of the Exchange Agreement, the Company and Riverside had the option to exchange
an additional $2.0 million of the principal amount of the Hercules Term Loan for an additional subordinated convertible promissory
note in the principal amount of up to $2.0 million and an additional warrant to purchase 100,000 shares of common stock (the “Second
Exchange Warrant”). The Exchange Agreement also provided that if the volume-weighted average price of the Company’s
common stock was less than the Conversion Price, the Company would issue up to an additional 150,000 shares of common stock (the
“True-Up Shares”) to Riverside, which was subsequently reduced to 140,000 shares of common stock.
On
April 18, 2016, the Company and Riverside exercised their option to exchange an additional $1.0 million of the principal amount
of the Hercules Term Loan for an additional subordinated convertible promissory note in the principal amount of $1.0 million (the
“Second Exchange Note”). The closing stock price on April 18, 2016, was $2.02 and a beneficial conversion feature
of $412,000 was recorded to equity and as a debt discount. Additionally, on April 27, 2016, the Company and Riverside exercised
their option to exchange an additional $1.0 million of the principal amount of the Term Loan for an additional subordinated convertible
promissory note in the principal amount of $1.0 million (the “Third Exchange Note”) and an additional warrant to purchase
100,000 shares of the Company’s common stock at a fixed exercise price of $1.66 per share. The warrant value of $107,000
was recorded to equity and as a debt discount. The closing stock price on April 27, 2016, was $1.66 and a beneficial conversion
feature of $268,000 was recorded to equity and as a debt discount. Financing costs were $267,000 and were recorded to interest
expense. The unamortized deferred financing costs and debt discount of the Hercules Term Loan exchanged were $244,000 at the time
of the exchange and were recorded as a loss on extinguishment of debt related to the debt exchange. The First Exchange Note, the
Second Exchange Note and the Third Exchange Note are collectively referred to herein as the “Exchange Notes.”
Pursuant
to the terms of the Exchange Notes, since the volume-weighted average price of the Company’s common stock was less than
the Conversion Price on May 6, 2016, the Company issued an additional 140,000 shares of common stock to Riverside and recorded
the value of the True-Up Shares of $199,000 to interest expense and equity.
All principal outstanding under each of the
Exchange Notes was to be due on April 3, 2018 (the “Maturity Date”). Each of the Exchange Notes bore interest at a
rate of 6% per annum, with the interest that would accrue on the initial principal amount of the Exchange Notes during the first
12 months being guaranteed and deemed earned as of the date of issuance. Prior to the Maturity Date, all interest accrued under
the Exchange Notes was payable in cash or, if certain conditions were met, payable in shares of common stock at the Company’s
option, at a conversion price of $1.34 per share. During 2016, the entire principal amount of the First and Second Exchange
Notes, $300,000 of the Third Exchange Note, and the interest related to the First, Second, and Third Exchange Notes was converted
into 1,742,718 shares of common stock. In July 2016, the Company paid Riverside $840,000 to redeem in full the remaining principal
balance of the Third Exchange Note. The debt discounts associated with the converted debt was recorded to interest expense.
Long-term
debt consisted of the following (in thousands):
|
|
March
31, 2017
|
|
|
December
31, 2016
|
|
|
|
|
|
|
Unamortized
|
|
|
|
|
|
|
|
|
Unamortized
|
|
|
|
|
|
|
Outstanding
|
|
|
Discount and Debt
|
|
|
Net Carrying
|
|
|
Outstanding
|
|
|
Discount and Debt
|
|
|
Net Carrying
|
|
|
|
Principal
|
|
|
Issuance
Costs
|
|
|
Amount
|
|
|
Principal
|
|
|
Issuance
Costs
|
|
|
Amount
|
|
Hercules
Term Loan
|
|
$
|
5,767
|
|
|
$
|
(285
|
)
|
|
$
|
5,482
|
|
|
$
|
7,421
|
|
|
$
|
(409
|
)
|
|
$
|
7,012
|
|
Less:
Current portion
|
|
|
(5,767
|
)
|
|
|
285
|
|
|
|
(5,482
|
)
|
|
|
(7,421
|
)
|
|
|
409
|
|
|
|
(7,012
|
)
|
Long-term
debt
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Based
on contractual principal payment obligations on the Hercules term loan as of March 31, 2017, before considering acceleration
of maturity payments due to potential non-compliance with loan covenants, the entire principal balance is due January 1,
2018, and therefore current.
8.
Equity
During
the three months ended March 31, 2017, the Company completed a secondary offering in which the Company sold 8,900,000 shares of
common stock and warrants to purchase 4,005,000 shares of common stock for $0.51 per unit (each unit consisting of one share of
common stock and 0.45 warrants). The Company received approximately $3.8 million in proceeds from the offering, which was net
of approximately $732,000 in total underwriting expenses, commission and other offering expenses. The warrants became exercisable
on the closing date, expire on the five-year anniversary of the closing date, and have an initial exercise price per share
equal to $0.55 per share, subject to adjustments for events of recapitalization, stock dividends, stock splits, stock combinations,
reclassifications, reorganizations or similar events affecting the Company’s common stock.
On
February 24, 2017, the underwriter in the 2017 secondary offering exercised its option to purchase additional warrants
for 360,000 shares of the Company’s common stock.
9.
Stock-Based Compensation
A
summary of the Company’s outstanding stock option activity for the three months ended March 31, 2017 is as
follows:
|
|
|
|
|
|
|
|
Weighted-Average
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining
|
|
|
|
|
|
|
|
|
|
Weighted-Average
|
|
|
Contractual
Life
|
|
|
Intrinsic
|
|
|
|
Options
|
|
|
Exercise
Price
|
|
|
(Years)
|
|
|
Value
|
|
As
of
December 31, 2016
|
|
|
137,347
|
|
|
$
|
30.59
|
|
|
|
8.2
|
|
|
$
|
-
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Expired
|
|
|
(169
|
)
|
|
|
386.55
|
|
|
|
|
|
|
|
|
|
As
of March
31, 2017
|
|
|
137,178
|
|
|
|
30.16
|
|
|
|
8.0
|
|
|
|
-
|
|
Exercisable
as of
March 31, 2017
|
|
|
116,131
|
|
|
|
40.06
|
|
|
|
7.7
|
|
|
|
-
|
|
Expected
to vest as of
March
31, 2017
|
|
|
137,178
|
|
|
|
30.16
|
|
|
|
7.9
|
|
|
|
-
|
|
The
Company estimates the fair value of each stock option on the grant date using the Black-Scholes-Merton valuation model, which
requires several estimates including an estimate of the fair value of the underlying common stock on grant date. The expected
volatility was based on an average of the historical volatility of a peer group of similar companies. The expected term was calculated
utilizing the simplified method. The risk-free interest rate was based on the U.S. Treasury yield curve in effect at the time
of grant for the expected term of the option. The following weighted average assumptions were used in the calculation to estimate
the fair value of options granted to employees during the three months ended March 31, 2016 (no options were granted for
the three months ended March 31, 2017):
|
|
Three
Months Ended
|
|
|
|
March
31, 2016
|
|
Weighted-average
risk-free interest rate
|
|
|
1.86
|
%
|
Weighted-average
expected life (in years)
|
|
|
6.30
|
|
Expected
dividend yield
|
|
|
0.00
|
%
|
Weighted-average
expected volatility
|
|
|
65.00
|
%
|
Summary
of Stock-Based Compensation Expense
Total
stock-based compensation expense included in the condensed consolidated statements of operations is allocated as follows
(in thousands):
|
|
Three
Months Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
Cost
of revenue
|
|
$
|
5
|
|
|
$
|
4
|
|
Research
and development
|
|
|
26
|
|
|
|
29
|
|
General
and administrative
|
|
|
23
|
|
|
|
38
|
|
Selling
and marketing
|
|
|
6
|
|
|
|
15
|
|
Capitalized
into inventory
|
|
|
-
|
|
|
|
2
|
|
|
|
$
|
60
|
|
|
$
|
88
|
|
Unrecognized
stock-based compensation as of March 31, 2017 is as follows (in thousands):
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
Unrecognized
|
|
|
Remaining
Period
|
|
|
|
Stock-Based
|
|
|
of
Recognition
|
|
|
|
Compensation
|
|
|
(in
years)
|
|
Stock
options
|
|
$
|
198
|
|
|
|
0.95
|
|
10.
Commitments and Contingencies
From
time to time, the Company is subject to various claims and legal proceedings covering matters that arise in the ordinary course
of its business activities. Management believes any liability that may ultimately result from the resolution of these matters
will not have a material adverse effect on the Company’s consolidated financial position, operating results or cash flows.
11.
Subsequent Events
On
July 28, 2017, the Company entered into a $2.5 million term loan (the “Loan”) with North Stadium Investments, LLC
(North Stadium), a company owned and controlled by the Company’s Chief Executive Officer and Chairman of the Board. The
Loan bears interest at 10% per annum and requires the Company to make monthly interest only payments from September 5, 2017 through
September 5, 2018. All principal and unpaid interest (if any) under the Loan is due and payable on July 28, 2018. The Loan
is secured by substantially all of the assets of the Company but is junior to security interest in assets encumbered by the Hercules
Term Loan. In connection with the Loan the Company also issued North Stadium a warrant to purchase up to 660,000 shares of the
Company’s common stock at a purchase price of $0.42 per share, subject to a 5-year term.
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You
should read the following discussion and analysis of our financial condition and results of operations in conjunction with our
consolidated financial statements for the year ended December 31, 2016 and the notes thereto, along with Management’s Discussion
and Analysis of Financial Condition and Results of Operations, included in our Annual Report on Form 10-K for the year ended December
31, 2016, filed separately with the U.S. Securities and Exchange Commission. This discussion and analysis contains forward-looking
statements based upon current beliefs, plans, expectations, intentions and projections that involve risks, uncertainties and assumptions,
such as statements regarding our plans, objectives, expectations, intentions and projections. Our actual results and the timing
of selected events could differ materially from those anticipated in these forward-looking statements as a result of several factors,
including those set forth under the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December
31, 2016, and any updates to those risk factors filed from time to time in our Quarterly Reports on Form 10-Q.
Overview
We
are a materials company focused on developing, manufacturing and selling silicon nitride ceramics that are used in medical implants
and in a variety of industrial devices. At present, we commercialize silicon nitride in the spine implant market. We believe that
our silicon nitride manufacturing expertise positions us favorably to introduce new and innovative devices in the medical and
non- medical fields. We also believe that we are the first and only company to commercialize silicon nitride medical implants.
We
have received 510(k) regulatory clearance in the United States, a CE mark in Europe, and ANVISA approval in Brazil for a number
of our devices that are designed for spinal fusion surgery. To date, more than 28,000 of our silicon nitride devices have been
implanted into patients, with an 8-year successful track record. We intend to file an FDA 510(k) submission for clearance in the
United States of a novel composite spinal fusion device that combines porous and solid silicon nitride. The FDA sent us questions
about our upcoming submission and we are currently in the process of submitting a response.
We
believe that silicon nitride has a superb combination of properties that make it ideally suited for human implantation. Other
biomaterials are based on bone grafts, metal alloys, and polymers; all of which have practical limitations. In contrast, silicon
nitride has a legacy of success in the most demanding and extreme industrial environments. As a human implant material, silicon
nitride offers bone ingrowth, resistance to bacterial infection, resistance to corrosion, superior strength and fracture resistance,
and ease of diagnostic imaging, among other advantages.
We
market and sell our Valeo brand of silicon nitride implants to surgeons and hospitals in the United States and to selected markets
in Europe and South America through more than 50 independent sales distributors who are supported by an in-house sales and marketing
management team. These implants are designed for use in cervical (neck) and thoracolumbar (lower back) spine surgery. We are also
working with other partners in Japan to obtain regulatory approval for silicon nitride in that country.
In
addition to our silicon nitride-based spinal fusion products, we market a line of non-silicon nitride spinal fixation products
which allows us to provide surgeons and hospitals with a broader range of products. These additional products are complementary
to our fusion products and are designed for the treatment of deformity and degenerative spinal procedures. Although our non-silicon
nitride products have accounted for approximately 45% and 46% of our product revenues for the three months ended March 31, 2017
and 2016, respectively, we believe the continued promotion and potential for adoption of our silicon nitride products and product
candidates, if approved, provides us the greatest opportunity to grow our business in new and existing markets and achieve our
goal to become a leading biomaterial company.
In
addition to direct sales, we have targeted original equipment manufacturer (“OEM”) and private label partnerships
in order to accelerate adoption of silicon nitride, both in the spinal space, and also in future markets such as hip and knee
replacements, dental, extremities, trauma, and sports medicine. Existing biomaterials, based on plastics, metals, and bone grafts
have well-recognized limitations that we believe are addressed by silicon nitride, and we are uniquely positioned to convert existing,
successful implant designs made by other companies into silicon nitride. We believe OEM and private label partnerships will allow
us to work with a variety of partners, accelerate the adoption of silicon nitride, and realize incremental revenue at improved
operating margins, when compared to the cost-intensive direct sales model.
We
believe that silicon nitride addresses many of the biomaterial-related limitations in fields such as hip and knee replacements,
dental implants, sports medicine, extremities, and trauma surgery. We further believe that the inherent material properties of
silicon nitride, and the ability to formulate the material in a variety of compositions, combined with precise control of the
surface properties of the material, opens up a number of commercial opportunities across orthopedic surgery, neurological surgery,
maxillofacial surgery, and other medical disciplines.
We
operate a 30,000 square foot manufacturing facility at our corporate headquarters in Salt Lake City, Utah, and we believe we are
the only vertically integrated silicon nitride medical device manufacturer in the world.
Components
of our Results of Operations
We
manage our business within one reportable segment, which is consistent with how our management reviews our business, makes investment
and resource allocation decisions and assesses operating performance.
Product
Revenue
We
derive our product revenue primarily from the sale of spinal fusion and fixation devices and related products used in the treatment
of spine disorders. Our product revenue is generated from sales to three types of customers: (1) surgeons and hospitals; (2) stocking
distributors; and (3) private label customers. Most of our products are sold on a consignment basis through a network of independent
sales distributors; however, we also sell our products to independent stocking distributors and private label customers. Product
revenue is recognized when all four of the following criteria are met: (1) persuasive evidence that an arrangement exists; (2)
delivery of the products has occurred; (3) the selling price of the product is fixed or determinable; and (4) collectability is
reasonably assured. We generate the majority of our revenue from the sale of inventory that is consigned to independent sales
distributors that sell our products to surgeons and hospitals. For these products, we recognize revenue at the time we are notified
the product has been used or implanted and all other revenue recognition criteria have been met. For all other transactions, we
recognize revenue when title and risk of loss transfer to the stocking distributor or private label customers, and all other revenue
recognition criteria have been met. We generally recognize revenue from sales to stocking distributors and private label customers
at the time the product is shipped to the distributor. Stocking distributors and private label customers, who sell the products
to their customers, take title to the products and assume all risks of ownership at time of shipment. Our stocking distributors
and private label customers are obligated to pay within specified terms regardless of when, if ever, they sell the products. Our
policy is to classify shipping and handling costs billed to customers as an offset to total shipping expense in the statement
of operations, primarily within sales and marketing. In general, our customers do not have any rights of return or exchange.
We
believe our product revenue will increase due to our sales and marketing efforts and as we continue to introduce new products
into the market. We expect that our product revenue will continue to be primarily attributable to sales of our products in the
United States.
Cost
of Revenue
The
expenses that are included in cost of revenue include all direct product costs if we obtained the product from third-party manufacturers
and our in-house manufacturing costs for the products we manufacture. We obtain our non-silicon nitride products, including our
metal products, from third-party manufacturers, while we currently manufacture our silicon-nitride products in-house.
Specific
provisions for excess or obsolete inventory are also included in cost of revenue. In addition, we pay royalties attributable to
the sale of specific products to some of our surgeon advisors that assisted us in the design, regulatory clearance or commercialization
of a particular product. These payments are recorded as cost of revenue.
Gross
Profit
Our
gross profit measures our product revenue relative to our cost of revenue. We expect our gross profit to decrease as we expand
the penetration of our silicon nitride technology platform through OEM and private label partnerships.
Research
and Development Expenses
Our
research and development costs are expensed as incurred. Research and development costs consist of engineering, product development,
clinical trials, test-part manufacturing, testing, developing and validating the manufacturing process, manufacturing, facility
and regulatory-related costs. Research and development expenses also include employee compensation, employee and non-employee
stock-based compensation, supplies and materials, consultant services, and travel and facilities expenses related to research
activities. To the extent that certain research and development expenses are directly related to our manufactured products, such
expenses and related overhead costs are allocated to inventory.
We
expect to incur additional research and development costs as we continue to develop new spinal fusion products, our product candidates
for total joint replacements, such as our total hip replacement product candidate, and dental applications which, may increase
our total research and development expenses.
Sales
and Marketing Expenses
Sales
and marketing expenses consist of salaries, benefits and other related costs, including stock-based compensation, for personnel
employed in sales, marketing, medical education and training. In addition, our sales and marketing expenses include commissions
and bonuses, generally based on a percentage of sales, to our sales managers and independent sales distributors. We provide our
products in kits or banks that consist of a range of device sizes and separate instruments sets necessary to perform the surgical
procedure. We generally consign our instruments to our distributors or our hospital customers that purchase the device used in
spinal fusion surgery. Our sales and marketing expenses include depreciation of the surgical instruments.
We
expect our commissions to increase in absolute terms over time but remain approximately the same or decrease as a percentage of
product revenue.
General
and Administrative Expenses
General
and administrative expenses consist primarily of salaries, benefits and other related costs, including stock-based compensation
for certain members of our executive team and other personnel employed in finance, legal, compliance, administrative, information
technology, customer service, executive and human resource departments. General and administrative expenses also include other
expenses not part of the other cost categories mentioned above, including facility expenses and professional fees for accounting
and legal services.
We
expect our general and administrative expenses to remain stable or slightly decline as we continue to manage costs closely and
look for opportunities to make improvements.
RESULTS
OF OPERATIONS - UNAUDITED
The
following is a tabular presentation of our condensed consolidated operating results for the three months ended March 31, 2017
and 2016 (
in thousands
):
|
|
Three
Months Ended March 31,
|
|
|
|
|
|
|
|
|
|
2017
|
|
|
2016
|
|
|
$
Change
|
|
|
%
Change
|
|
Product
revenue
|
|
$
|
2,629
|
|
|
$
|
4,173
|
|
|
$
|
(1,544
|
)
|
|
|
-37
|
%
|
Cost
of revenue
|
|
|
661
|
|
|
|
893
|
|
|
|
(232
|
)
|
|
|
-26
|
%
|
Gross
profit
|
|
|
1,968
|
|
|
|
3,280
|
|
|
|
(1,312
|
)
|
|
|
-40
|
%
|
Gross
profit %
|
|
|
75
|
%
|
|
|
79
|
%
|
|
|
-4
|
%
|
|
|
-5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development
|
|
|
1,016
|
|
|
|
1,608
|
|
|
|
(592
|
)
|
|
|
-37
|
%
|
General
and administrative
|
|
|
1,112
|
|
|
|
1,562
|
|
|
|
(450
|
)
|
|
|
-29
|
%
|
Sales
and marketing
|
|
|
1,642
|
|
|
|
2,594
|
|
|
|
(952
|
)
|
|
|
-37
|
%
|
Total
operating expenses
|
|
|
3,770
|
|
|
|
5,764
|
|
|
|
(1,994
|
)
|
|
|
-35
|
%
|
Loss
from operations
|
|
|
(1,802
|
)
|
|
|
(2,484
|
)
|
|
|
682
|
|
|
|
27
|
%
|
Other
expense, net
|
|
|
(348
|
)
|
|
|
(904
|
)
|
|
|
556
|
|
|
|
62
|
%
|
Net
loss before taxes
|
|
|
(2,150
|
)
|
|
|
(3,388
|
)
|
|
|
1,238
|
|
|
|
37
|
%
|
Provision
for income taxes
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Net
loss
|
|
$
|
(2,150
|
)
|
|
$
|
(3,388
|
)
|
|
$
|
1,238
|
|
|
|
37
|
%
|
Product
Revenue - Unaudited
The
following table sets forth our product revenue from sales of the indicated product category for the three months ended March 31,
2017 and 2016 (in thousands):
|
|
Three
Months Ended March 31,
|
|
|
|
|
|
|
|
|
|
2017
|
|
|
2016
|
|
|
$
Change
|
|
|
%
Change
|
|
Silicon
Nitride
|
|
$
|
1,459
|
|
|
$
|
2,238
|
|
|
$
|
(779
|
)
|
|
|
-35
|
%
|
Non-Silicon
Nitride
|
|
|
1,170
|
|
|
|
1,935
|
|
|
|
(765
|
)
|
|
|
-40
|
%
|
Total
product revenue
|
|
$
|
2,629
|
|
|
$
|
4,173
|
|
|
$
|
(1,544
|
)
|
|
|
-37
|
%
|
For
the three months ended March 31, 2017, total product revenue was $2.6 million as compared to $4.2 million in the same period 2016,
a decrease of $1.6 million, or 37%. This decrease was due to the loss of surgeons and the consequences from our restructuring,
both of which occurred the latter part of 2016.
The
following table sets forth, for the periods indicated, our product revenue by geographic area (in thousands):
|
|
Three
Months Ended March 31,
|
|
|
|
|
|
|
|
|
|
2017
|
|
|
2016
|
|
|
$
Change
|
|
|
%
Change
|
|
Domestic
|
|
$
|
2,591
|
|
|
$
|
4,009
|
|
|
$
|
(1,418
|
)
|
|
|
-35
|
%
|
International
|
|
|
38
|
|
|
|
164
|
|
|
|
(126
|
)
|
|
|
-77
|
%
|
Total
product revenue
|
|
$
|
2,629
|
|
|
$
|
4,173
|
|
|
$
|
(1,544
|
)
|
|
|
-37
|
%
|
For
the three months ended March 31, 2017, domestic revenue decreased by $1.4 million, or 35%. This is attributable to the loss of
surgeons and the consequences from our restructuring, both of which occurred the latter part of 2016. International revenue
decreased $0.1 million, or 77% as compared to the same period in 2016. This is due to our Brazilian distributor making purchases
of instrumentation equipment and inventory in the first quarter of 2016 that was not repeated in 2017.
Cost
of Revenue and Gross Profit
For the three months ended March 31, 2017,
our cost of revenue decreased $0.2 million, or 26%, as compared to the same period in 2016. The decrease was primarily
due to a decline in sales. Gross profit decreased $1.3 million, and gross margin percentage decreased by 4%. The 4% decrease in
gross margin percentage was primarily due to a change in both product mix and reimbursement rates during the three months ended
March 31, 2017, as compared to the same period in 2016.
Research
and Development Expenses
For
the three months ended March 31, 2017, research and development expenses decreased $0.6 million, or 37%, as compared to the same
period in 2016. This decrease was primarily attributable to a $0.44 million decrease in personnel related expenses due to a reduction
in force in October 2016, a $0.06 million decrease in product validation expenses due to no new products being produced in 2017,
a $0.03 million decrease in production and lab supplies, a $0.02 million decrease in post marketing studies, a $0.02 million decrease
in equipment maintenance expenses, a $0.02 million decrease in machining and tooling expenses and the Company’s efforts
to reduce costs.
General
and Administrative Expenses
For
the three months ended March 31, 2017, general and administrative expenses decreased $0.45 million, or 29%, as compared to the
same period in 2016. This decrease was primarily attributable to a $0.26 million decrease in personnel related expenses due to
a reduction in force, a $0.1 million decrease in legal and patent expenses and a $0.08 million decrease in investor relation expense.
Sales
and Marketing Expenses
For
the three months ended March 31, 2017, sales and marketing expenses decreased $0.95 million, or 32%, as compared to the same period
in 2016. This decrease was primarily attributable to a $0.6 million decrease in commissions due to lower revenues, a $0.23 million
decrease in depreciation expense, a $0.09 million decrease in personnel expenses due to the October 2016 reduction in force, a
$0.04 million decrease in shipping expense, and a $0.04 million decrease in travel expenses. These improvements were offset by
a $0.05 million increase in consulting and other expenses.
Other
Expense, Net
For
the three months ended March 31, 2017, other expense decreased $0.6 million, or 68%, as compared to the same period in 2016. This
decrease was primarily due to a $0.5 million decrease in interest expense.
Liquidity
and Capital Resources
The
condensed consolidated financial statements have been prepared assuming the Company will continue to operate as a going concern,
which contemplates the realization of assets and settlement of liabilities in the normal course of business, and does not include
any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications
of liabilities that may result from uncertainty related to its ability to continue as a going concern within one year from the
date of issuance of these condensed consolidated financial statements.
F
or
the three months ended March 31, 2017 and 2016, the Company incurred net losses of $2.2 million and $3.4 million, respectively,
and used cash in operations of $1.8 million and $1.5 million, respectively. The Company had an accumulated deficit of $215 million
and $213 million at March 31, 2017 and December 31, 2016, respectively. To date, the Company’s operations have been principally
financed by proceeds received from the issuance of preferred and common stock, convertible debt and bank debt and, to a lesser
extent, cash generated from product sales. It is anticipated that the Company will continue to generate operating losses and use
cash in operating activities. The Company’s continuation as a going concern is dependent upon its ability to increase sales,
implement cost saving measures, maintain compliance with debt covenants and/or raise additional funds through the capital markets.
Whether and when the Company can attain profitability and positive cash flows from operating activities or obtain additional financing
is uncertain.
In
2016, the Company implemented certain cost saving measures, including workforce and office space reductions, and will continue
to evaluate additional cost savings alternatives during 2017. These additional cost savings measures may include additional workforce
and research and development reductions, as well as cuts to certain other operating expenses. In addition to these cost saving
measures an experienced and highly successful leader for the Sales and Marketing team was recruited and hired. This individual
has subsequently hired additional experienced personnel in Sales and Marketing. The Company is actively generating additional
scientific and clinical data to have it published in leading industry publications. The unique features of the Company’s
silicon nitride material are not well known, and publication of such data would help sales efforts as the Company approaches new
prospects. The Company is also making additional changes to the sales strategy, including a focus on revenue growth of silicon
nitride lateral lumbar implants and the newly developed pedicle screw system (known as Taurus).
As
discussed further in Note 7, in June 2014 the Company entered into a term loan with Hercules Technology Growth Capital, Inc. (“Hercules
Technology”), as administrative and collateral agent for the lenders thereunder and as lender, and Hercules Technology III,
LP, (“HT III” and, together with Hercules Technology, “Hercules”) as lender (the “Hercules Term
Loan”). The Hercules Term Loan has a liquidity covenant that requires the Company to maintain a cash balance of not less
than $2.5 million as of March 31, 2017. As of March 31, 2017, the Company’s cash balance was approximately $6.9 million.
The Company believes it will be in position to maintain compliance with the liquidity covenant related to the Hercules Term Loan
at least through October 2017, as once the Hercules Term Loan principal balance is reduced below $2.5 million the Company
is only required to maintain a cash balance equal to the outstanding balance of the Hercules Term Loan from that point
forward. The Company has common stock that is publicly traded and has been able to successfully raise capital when needed
since the date of the Company’s initial public offering. The Company is engaged in discussions with investment and
banking firms to examine financing alternatives, including options to encourage the exercise of outstanding warrants and
other lending alternatives. On July 28, 2017, the Company entered into a $2.5 million term loan that will assist the
Company in its cash needs through November 2017 (see Note 11).
If
the Company is unable to access additional funds prior to becoming non-compliant with the financial and liquidity covenants related
to the Hercules Term Loan, the outstanding balance of the Hercules Term Loan would become immediately due and payable
at the option of the lender. Although the Company is seeking to obtain additional equity and/or debt financing, such funding is
not assured and may not be available to the Company on favorable or acceptable terms, and may involve significant restrictive
covenants. Any additional equity financing is also not assured and, if available to the Company, will most likely be dilutive
to its current stockholders. If the Company is not able to obtain additional debt or equity financing on a timely basis, the impact
on the Company will be material and adverse.
Cash
Flows
The
following table summarizes, for the periods indicated, cash flows from operating, investing and financing activities (in thousands)
– unaudited:
|
|
Three
Months Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
Net
cash used in operating activities
|
|
$
|
(1,833
|
)
|
|
$
|
(1,465
|
)
|
Net
cash used in investing activities
|
|
|
(292
|
)
|
|
|
(243
|
)
|
Net
cash provided by financing activities
|
|
|
2,154
|
|
|
|
(1,834
|
)
|
Net
cash used
|
|
$
|
29
|
|
|
$
|
(3,542
|
)
|
Net
Cash Used in Operating Activities
Net
cash used in operating activities increased $0.3 million to $1.8 million during the three months ended March 31, 2017, as compared
to $1.5 million for the same period in 2016. Offset by the decrease in the net loss and related non-cash add backs to the net
loss, the increase in cash used in operating activities during 2017 was primarily due to changes in the movement of working capital
items during the three months ended March 31, 2017 as compared to the same period in 2016 as follows: a $0.9 million change in
trade accounts receivable, a $0.5 million change in prepaid and other current assets, a $0.4 change in the provision for obsolete
inventory reserve and a $0.4 million change in accounts payable and accrued expenses.
Net
Cash Used in Investing Activities
Net
cash used in investing activities increased $0.05 million to $0.3 million during the three months ended March 31, 2017, compared
to $0.25 million for the same period in 2016. The increase in cash used in investing
activities
during 2017 was due to a net increase of $0.05 million in purchases of property and equipment.
Net
Cash Used in Financing Activities
Net
cash from financing activities was $2.2 million during the three months ended March 31, 2017, compared to a negative $1.8
million during the same period in 2016. The $4.0 million increase in 2017 was primarily attributable to the $3.8 million in net
proceeds received from a common stock offering, and a $0.2 million decrease in principal payments on long-term debt.
Indebtedness
Hercules
Term Loan
On
June 30, 2014, the Company entered into a Loan and Security Agreement with Hercules which provided the Company with a $20 million
term loan. The Hercules Term Loan matures on January 1, 2018. The Hercules Term Loan included a $200,000 closing fee, which was
paid to Hercules on the closing date of the loan. The closing fee was recorded as a debt discount and is being amortized to interest
expense over the life of the loan. The Hercules Term Loan also includes a non-refundable final payment fee of $1.7 million. The
final payment fee is being accrued and recorded to interest expense over the life of the loan. The Hercules Term Loan bears interest
at the rate of the greater of either (i) the prime rate plus 9.2%, and (ii) 12.5%, and was 12.7% as of March 31, 2017. Interest
accrues from the closing date of the loan and interest payments are due monthly. Principal payments commenced August 1, 2015 and
are currently being made in equal monthly installments totaling approximately $500,000, with the remainder due at maturity. The
Company’s obligations to the Hercules Term Loan are secured by a first priority security interest in substantially
all of its assets, including intellectual property. The Hercules Term Loan contains covenants related to restrictions
on payments to certain Company affiliates and financial reporting requirements.
On
September 8, 2015, the Company entered into a Consent and First Amendment to Loan and Security Agreement (the “Amendment”)
with Hercules. The Amendment modified the liquidity covenant to reduce the required minimum cash and cash equivalent balance by
$500,000 for every $1.0 million in principal paid, up to a minimum of $2.5 million. Once the Hercules Term Loan principal balance
is below $2.5 million, the Company is only required to maintain a cash and cash equivalents balance equal to the outstanding
principal balance on the Hercules Term loan. The minimum cash and cash equivalents balance required to maintain compliance with
the minimum liquidity covenant as of March 31, 2017, was $2.5 million. The Company believes it will maintain compliance with the
liquidity covenant related to the Hercules Term Loan at least through October 2017. To maintain compliance beyond that date, the
Company will likely require additional cash (see Note 11).
See
discussion below with respect to the assignment of $3.0 million of the principal balance of the Hercules Term Loan to Riverside
and the subsequent agreement between the Company and Riverside to exchange the $3.0 million of the Hercules Term Loan held by
Riverside for subordinated convertible promissory notes in the aggregate principal amount of $3.0 million.
Hercules
and Riverside Debt Assignment
In
April 2016, we entered into an Assignment Agreement with Riverside, and Hercules, pursuant to which Hercules sold $3.0 million
of the principal amount outstanding under the Hercules Term Loan to Riverside. For a more detailed description of the Assignment
Agreement refer to Note 7 in the condensed consolidated financial statements of this Report.
Riverside
Debt
On
April 4, 2016, the Company entered into an exchange agreement (the “Exchange Agreement”) with Riverside, pursuant
to which the Company agreed to exchange $1.0 million of the principal amount outstanding under the Hercules Term Loan held by
Riverside for a subordinated convertible promissory note in the principal amount of $1.0 million (the “First Exchange Note”)
and a warrant to purchase 100,000 shares of our common stock at a fixed exercise price of $1.63 per share (the “First Exchange
Warrant”) (the “Exchange”). All principal under the Exchange Notes is convertible into shares of common stock
at the election of the Holder at any time at a fixed conversion price of $1.43 per share (the “Conversion Price”).
In
addition, pursuant to the terms and conditions of the Exchange Agreement, the Company and Riverside had the option to exchange
an additional $2.0 million of the principal amount of the Hercules Term Loan for an additional subordinated convertible promissory
note in the principal amount of up to $2.0 million and an additional warrant to purchase 100,000 shares of common stock (the “Second
Exchange Warrant”). The Exchange Agreement also provided that if the volume-weighted average price of our common stock was
less than the Conversion Price, the Company would issue up to an additional 150,000 shares of common stock (the “True-Up
Shares”) to Riverside, which was subsequently reduced to 140,000 shares of common stock.
On
April 18, 2016, the Company and Riverside exercised their option to exchange an additional $1.0 million of the principal amount
of the Hercules Term Loan for an additional subordinated convertible promissory note in the principal amount of $1.0 million (the
“Second Exchange Note”). Additionally, on April 28, 2016, the Company and Riverside exercised their option to exchange
an additional $1.0 million of the principal amount of the Term Loan for an additional subordinated convertible promissory note
in the principal amount of $1.0 million (the “Third Exchange Note”) and an additional warrant to purchase 100,000
shares of the Company’s common stock at a fixed exercise price of $1.66 per share. The First Exchange Note, the Second Exchange
Note and the Third Exchange Note are collectively referred to herein as the “Exchange Notes.”
Pursuant
to the terms of the Exchange Notes, since the volume-weighted average price of our common stock was less than the Conversion Price
on May 6, 2016, the Company issued an additional 140,000 shares of common stock to Riverside.
All
principal outstanding under each of the Exchange Notes was to be due on April 3, 2018 (the “Maturity Date”). Each
of the Exchange Notes bears interest at a rate of 6% per annum, with the interest that would accrue on the initial principal amount
of the Exchange Notes during the first 12 months being guaranteed and deemed earned as of the date of issuance. Prior to the Maturity
Date, all interest accrued under the Exchange Notes is payable in cash or, if certain conditions are met, payable in shares of
common stock at the Company’s option, at a conversion price of $1.34 per share. As of June 30, 2016, the entire principal
amount of the First and Second Exchange Notes, $300,000 of the Third Exchange Note, and the interest related to the First, Second,
and Third Exchange Notes has been converted into 1,742,718 shares of common stock. In July 2016, the Company paid Riverside $840,000
to redeem in full the remaining principal balance of the Third Exchange Note.
The
Company classifies all future debt obligations as current due to uncertainties in their ability to comply with debt covenant requirements.
Off-Balance
Sheet Arrangements
The
Company does not have any off-balance sheet arrangements, as defined in Item 303(a)(4) of Regulation S-K.
Critical
Accounting Policies and Estimates
A
summary of our significant accounting policies and estimates is discussed in Management’s Discussion and Analysis of Financial
Condition and Results of Operations and in Note 1 to our consolidated financial statements included in our Annual Report on Form
10-K for the year ended December 31, 2016. There have been no material changes to those policies during the three months ended
March 31, 2016. The preparation of the financial statements in accordance with U.S. generally accepted accounting principles requires
us to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities.
Significant areas of uncertainty that require judgments, estimates and assumptions include the accounting for income taxes and
other contingencies as well as valuation of derivative liabilities, asset impairment and collectability of accounts receivable.
We use historical and other information that we consider to be relevant to make these judgments and estimates. However, actual
results may differ from those estimates and assumptions that are used to prepare our financial statements.
New
Accounting Pronouncements
See
discussion under Note 1,
Organization and Summary of Significant Accounting Policies,
to the Condensed Consolidated Financial
Statements included in Item 1 of Part I of this Quarterly Report on Form 10-Q, for information on new accounting pronouncements.