Item 1. Financial Statements
ENTELLUS MEDICAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(in thousands, except per share data)
|
September 30,
|
|
December 31,
|
|
|
2017
|
|
2016
|
|
ASSETS
|
|
|
|
|
|
|
CURRENT ASSETS
|
|
|
|
|
|
|
Cash and cash equivalents
|
$
|
51,452
|
|
$
|
21,417
|
|
Short-term investments
|
|
—
|
|
|
10,845
|
|
Accounts receivable, net of allowance for doubtful accounts and sales returns of $649 and $308, respectively
|
|
18,320
|
|
|
13,556
|
|
Inventories
|
|
8,618
|
|
|
7,226
|
|
Prepaid expenses and other current assets
|
|
2,300
|
|
|
1,862
|
|
Total current assets
|
|
80,690
|
|
|
54,906
|
|
Property and equipment, net
|
|
8,317
|
|
|
6,487
|
|
Intangible assets, net
|
|
89,630
|
|
|
9,840
|
|
Goodwill
|
|
62,772
|
|
|
477
|
|
Other non-current assets
|
|
427
|
|
|
379
|
|
Total assets
|
$
|
241,836
|
|
$
|
72,089
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
CURRENT LIABILITIES
|
|
|
|
|
|
|
Accounts payable
|
$
|
3,821
|
|
$
|
2,796
|
|
Accrued expenses
|
|
12,929
|
|
|
13,005
|
|
Current portion of contingent consideration
|
|
17,426
|
|
|
—
|
|
Revolving credit facility
|
|
7,943
|
|
|
—
|
|
Current portion of long-term debt
|
|
—
|
|
|
9,118
|
|
Total current liabilities
|
|
42,119
|
|
|
24,919
|
|
LONG-TERM LIABILITIES
|
|
|
|
|
|
|
Long-term debt, less current portion, net of debt issuance costs of $329 and $116, respectively
|
|
39,671
|
|
|
10,766
|
|
Contingent consideration, less current portion
|
|
35,493
|
|
|
—
|
|
Other non-current liabilities
|
|
273
|
|
|
959
|
|
Total liabilities
|
|
117,556
|
|
|
36,644
|
|
COMMITMENTS AND CONTINGENCIES (See Note N)
|
|
|
|
|
|
|
STOCKHOLDERS' EQUITY (see Note J)
|
|
|
|
|
|
|
Preferred stock, $0.001 par value per share:
|
|
|
|
|
|
|
Authorized shares: 10,000 at September 30, 2017 and December 31, 2016 Issued and outstanding shares: none
|
|
—
|
|
|
—
|
|
Common stock, $0.001 par value per share:
|
|
|
|
|
|
|
Authorized shares: 200,000 at September 30, 2017 and December 31, 2016; Issued and outstanding shares: 25,448 and 18,908 at September 30, 2017 and
December 31, 2016, respectively
|
|
25
|
|
|
19
|
|
Additional paid-in capital
|
|
294,740
|
|
|
186,370
|
|
Accumulated other comprehensive loss
|
|
(76
|
)
|
|
(156
|
)
|
Accumulated deficit
|
|
(170,409
|
)
|
|
(150,788
|
)
|
Total stockholders' equity
|
|
124,280
|
|
|
35,445
|
|
Total liabilities and stockholders' equity
|
$
|
241,836
|
|
$
|
72,089
|
|
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
5
ENTELLUS MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (Unaudited)
(in thousands, except per share data)
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
September 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
$
|
23,329
|
|
$
|
17,880
|
|
$
|
64,575
|
|
$
|
53,512
|
|
Cost of goods sold
|
|
6,555
|
|
|
4,648
|
|
|
17,287
|
|
|
13,107
|
|
Gross profit
|
|
16,774
|
|
|
13,232
|
|
|
47,288
|
|
|
40,405
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing
|
|
18,457
|
|
|
15,364
|
|
|
49,743
|
|
|
41,857
|
|
Research and development
|
|
4,653
|
|
|
2,047
|
|
|
8,881
|
|
|
5,832
|
|
General and administrative
|
|
5,043
|
|
|
4,698
|
|
|
13,964
|
|
|
12,183
|
|
Amortization of intangible assets
|
|
1,957
|
|
|
109
|
|
|
2,313
|
|
|
111
|
|
Acquisition-related expenses
|
|
3,865
|
|
|
—
|
|
|
5,059
|
|
|
300
|
|
Total operating expenses
|
|
33,975
|
|
|
22,218
|
|
|
79,960
|
|
|
60,283
|
|
Loss from operations
|
|
(17,201
|
)
|
|
(8,986
|
)
|
|
(32,672
|
)
|
|
(19,878
|
)
|
Other income (expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
117
|
|
|
75
|
|
|
286
|
|
|
228
|
|
Interest expense
|
|
(1,018
|
)
|
|
(562
|
)
|
|
(2,029
|
)
|
|
(1,686
|
)
|
Other non-operating expense
|
|
(20
|
)
|
|
(12
|
)
|
|
(82
|
)
|
|
(42
|
)
|
Loss before income tax expense
|
|
(18,122
|
)
|
|
(9,485
|
)
|
|
(34,497
|
)
|
|
(21,378
|
)
|
Income tax benefit (expense)
|
|
14,882
|
|
|
(34
|
)
|
|
14,876
|
|
|
(34
|
)
|
Net loss
|
$
|
(3,240
|
)
|
$
|
(9,519
|
)
|
$
|
(19,621
|
)
|
$
|
(21,412
|
)
|
Other comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized (loss) gain on short-term investments, net of tax
|
|
—
|
|
|
(39
|
)
|
|
(1
|
)
|
|
26
|
|
Foreign currency translation gain (loss)
|
|
34
|
|
|
(28
|
)
|
|
81
|
|
|
(123
|
)
|
Comprehensive loss
|
$
|
(3,206
|
)
|
$
|
(9,586
|
)
|
$
|
(19,541
|
)
|
$
|
(21,509
|
)
|
Net loss per share, basic and diluted
|
$
|
(0.13
|
)
|
$
|
(0.50
|
)
|
$
|
(0.87
|
)
|
$
|
(1.14
|
)
|
Weighted average common shares outstanding, basic and diluted
|
|
24,944
|
|
|
18,855
|
|
|
22,595
|
|
|
18,827
|
|
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
6
ENTELLUS MEDICAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
|
Nine Months Ended
|
|
|
September 30,
|
|
|
2017
|
|
2016
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
Net loss
|
$
|
(19,621
|
)
|
$
|
(21,412
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
Depreciation
|
|
1,800
|
|
|
1,201
|
|
Amortization of intangible assets
|
|
2,313
|
|
|
111
|
|
Amortization, other
|
|
88
|
|
|
158
|
|
Fair value adjustment to contingent consideration
|
|
2,329
|
|
|
—
|
|
Deferred taxes, net
|
|
(14,876
|
)
|
|
34
|
|
Acquired inventory fair value adjustment recognized
|
|
326
|
|
|
53
|
|
Stock-based compensation
|
|
5,892
|
|
|
4,060
|
|
Other
|
|
601
|
|
|
423
|
|
Changes in operating assets and liabilities, net of acquired assets and liabilities:
|
|
|
|
|
|
|
Accounts receivables
|
|
(3,448
|
)
|
|
(1,454
|
)
|
Inventories
|
|
(924
|
)
|
|
(2,057
|
)
|
Prepaid expenses and other current assets
|
|
493
|
|
|
656
|
|
Other non-current assets
|
|
297
|
|
|
(283
|
)
|
Accounts payable
|
|
(235
|
)
|
|
1,834
|
|
Accrued expenses
|
|
(1,936
|
)
|
|
3,393
|
|
Net cash used in operating activities
|
|
(26,901
|
)
|
|
(13,283
|
)
|
Cash flows from investing activities:
|
|
|
|
|
|
|
Purchase of property and equipment
|
|
(2,603
|
)
|
|
(3,469
|
)
|
Spirox acquisition
|
|
(24,778
|
)
|
|
—
|
|
XeroGel acquisition
|
|
—
|
|
|
(11,000
|
)
|
Purchase of investments
|
|
—
|
|
|
(32,182
|
)
|
Proceeds from maturities of short-term investments
|
|
10,837
|
|
|
46,339
|
|
Net cash used in investing activities
|
|
(16,544
|
)
|
|
(312
|
)
|
Cash flows from financing activities:
|
|
|
|
|
|
|
Proceeds from revolving credit facility
|
|
48,145
|
|
|
—
|
|
Payments on revolving credit facility
|
|
(40,202
|
)
|
|
—
|
|
Proceeds from long-term debt
|
|
40,000
|
|
|
—
|
|
Payments of term debt
|
|
(20,000
|
)
|
|
—
|
|
Payment of debt fees
|
|
(1,206
|
)
|
|
—
|
|
Payment of debt issuance costs
|
|
(132
|
)
|
|
—
|
|
Proceeds from stock plans
|
|
1,622
|
|
|
372
|
|
Proceeds from public offering, net of issuance costs
|
|
45,361
|
|
|
—
|
|
Net cash provided by financing activities
|
|
73,588
|
|
|
372
|
|
Effect of exchange rate changes on cash and cash equivalents
|
|
(108
|
)
|
|
(89
|
)
|
Net increase (decrease) in cash and cash equivalents
|
|
30,035
|
|
|
(13,312
|
)
|
Cash and cash equivalents - beginning of period
|
|
21,417
|
|
|
28,548
|
|
Cash and cash equivalents - end of period
|
$
|
51,452
|
|
$
|
15,236
|
|
Supplemental cash flow information:
|
|
|
|
|
|
|
Cash paid for interest
|
$
|
1,549
|
|
$
|
1,410
|
|
Non-cash transactions related to investing and financing activities:
|
|
|
|
|
|
|
Issuance of stock related to acquisition
|
$
|
55,502
|
|
$
|
—
|
|
Contingent consideration for acquisition
|
$
|
50,590
|
|
$
|
—
|
|
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
7
ENTELLUS MEDICAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE A.
|
BASIS OF PRESENTATION
|
Financial Statement Preparation
The financial statements of Entellus Medical, Inc. and its subsidiaries (collectively, the “Company” or “Entellus”) have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).
The interim financial data as of September 30, 2017 is unaudited and is not necessarily indicative of the results for a full year. In the opinion of the Company’s management, the interim data includes only normal and recurring adjustments necessary for a fair statement of the Company’s financial results for the three and nine months ended September 30, 2017 and 2016. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to SEC rules and regulations relating to interim financial statements. Certain amounts reported in the condensed consolidated financial statements for the previous reporting periods have been reclassified to conform to the current period presentation.
The accompanying condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 that has been filed with the SEC.
Spirox Acquisition
On July 13, 2017, the Company completed its previously announced acquisition of Spirox, Inc (“Spirox”). Spirox was a privately held medical device company that develops, manufactures and markets the Latera Absorbable Nasal Implant which is a minimally invasive option to treat nasal airway obstruction. Pursuant to the terms of the Agreement and Plan of Merger (the “Merger Agreement”), dated as of July 6, 2017, Stinger Merger Sub Inc., an indirect wholly-owned subsidiary of the Company (“Merger Sub”), merged with and into Spirox, with Spirox continuing as the surviving entity and an indirect wholly-owned subsidiary of the Company (the “Spirox Acquisition”).
In the transaction, the Company paid $24.8 million in cash and issued approximately 3.4 million in shares of its common stock with an approximate combined fair value of $80.3 million, subject to certain adjustments and as calculated pursuant to the calculation methodology set forth in the Merger Agreement. The Company common stock issued in connection with the Spirox Acquisition is subject to a lock-up agreement for a period of (i) three months from the date of closing of the Spirox Acquisition in the case of 25% of the shares, (ii) six months from the date of closing of the Spirox Acquisition in the case of an additional 25% of the shares and (iii) 12 months in the case of the remaining shares. Of the $24.8 million cash consideration, $7.5 million was deposited with an escrow agent to fund payment obligations with respect to the working capital adjustment and post-closing indemnification obligations of Spirox’s former equity holders. Under the terms of the Merger Agreement, the Company has agreed to pay additional contingent consideration to Spirox’s former equity holders based on the Company’s annual revenue growth from sales of Spirox’s Latera device and related products during the four-year period following the Spirox Acquisition. Related products include subsequent versions of the Latera device and any other device that treats nasal valve collapse or nasal lateral wall insufficiency by increasing the mechanical strength of the nasal lateral wall using a synthetic graft.
The Company has the discretion to pay the contingent consideration in shares of its common stock or cash, subject to compliance with applicable law and the Listing Rules of the NASDAQ Stock Market. A portion of the contingent consideration will be subject to certain rights of set-off for any post-closing indemnification obligations of Spirox’s equity holders. Because the contingent consideration arrangement (a) embodies a conditional obligation and is not an outstanding share, (b) may be settled by delivering a variable number of common shares, and (c) has a monetary value, at inception, that is based on variations in something other than the Company’s stock price, the obligation is classified as a liability under the classification guidance in Accounting Standards Codification (“ASC”) 480,
Distinguishing Liabilities from Equity
. Any subsequent changes to the contingent consideration will be reflected in the Company’s consolidated statements of operations. Although there is no cap on the amount of contingent consideration earn-out that could be paid, the Company does not expect the cumulative undiscounted payments to exceed $80.0 million over the four-year period.
All options and warrants to acquire shares of Spirox stock were terminated in connection with the Spirox Acquisition and the holders thereof have been entitled to receive the merger consideration that would have been payable to such holders had they exercised their vested options and warrants in full immediately prior to the effective time of the Spirox Acquisition, less the applicable exercise price of such vested options and warrants. See Note C. Business Acquisition.
Valuation adjustments to future contingent consideration due to the former equity holders of Spirox along with transaction and integration costs related to the Company’s 2017 acquisition of Spirox and 2016 acquisition of XeroGel are presented as “Acquisition-related expenses” on the condensed consolidated statements of operations.
8
Following the Spirox Acquisition, Company management evaluated the combined operations in light of the guidance provided by ASC 280
Segment Reporting
, and determined it will continue to report its financial information in one reportable segment. Spirox’s products represent an extension of the Company’s legacy business, and the Company is integrating Spirox’s sales force and operation
s into its existing operating segment. Going forward, discrete financial information concerning Spirox’s operating income and cash flows will no longer be available. The chief operating decision maker, who is the Company’s Chief Executive Officer, will reg
ularly review consolidated financial information in deciding how to allocate resources and assess performance.
Public Offering
In February 2017, the Company completed a public offering of shares of its common stock, issuing a total of 2.9 million shares of common stock (including 0.5 million shares issued after exercise by the underwriters of their option to purchase additional shares) at an offering price of $17.00 per share. Certain existing stockholders of the Company also sold approximately 1.2 million shares of common stock in the offering. The Company received net proceeds of approximately $45.4 million, after deducting underwriting discounts and commissions of $2.9 million and offering expenses of $0.7 million payable by the Company. The Company did not receive any proceeds from the sale of shares by the selling stockholders.
Use of Estimates
The preparation of financial statements in conformity with 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 at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. Actual results could differ from those estimates.
Significant Accounting Policies
There have been no changes in the Company’s significant accounting policies for the three and nine months ended September 30, 2017, as compared to the significant accounting policies described in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016. In addition to those policies, the following significant accounting policy was adopted in connection with the Spirox Acquisition:
Valuation of Business Combinations
The fair value of consideration, including contingent consideration, transferred in acquisitions accounted for as business combinations is first allocated to the identifiable tangible and intangible assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. Any excess purchase consideration is allocated to goodwill. Further, for those arrangements that involve liability classified contingent consideration, the Company records a liability equal to the fair value of the estimated additional consideration we may be obligated to make in the future on the date of acquisition. Liability classified contingent consideration is adjusted to its fair value each reporting period through earnings. Acquisition transaction costs are expensed as incurred.
The fair value of identifiable intangible assets requires management estimates and judgments based on market participant assumptions. Using alternative valuation assumptions, including estimated revenue projections, growth rates, cash flows, discount rates, estimated useful lives, and probabilities surrounding the achievement of milestones could result in different fair value estimates of our net tangible and intangible assets and related amortization expense in current and future periods.
Contingent consideration is remeasured to fair value each reporting period using projected revenues, discount rates, and projected payment dates. Projected contingent payment amounts are discounted back to the current period using a discounted cash flow model. Increases or decreases in the fair value of the contingent consideration can result from changes in the timing and amount of revenue estimates as well as changes in discount periods and rates. Because the fair value of contingent consideration is based on management assumptions and not observable market inputs, it is considered a Level 3 measurement. Contingent consideration valuation adjustments are recorded as operating expenses or income in the period in which the change is determined.
The Company’s accounting policy is to utilize deferred tax liabilities created through purchase accounting to first offset acquired deferred tax assets. The Company then utilizes any residual net deferred tax liability as a source of taxable income that can be used to support an equivalent amount of the Company’s existing deferred tax assets.
NOTE B.
|
RECENT ACCOUNTING PRONOUNCEMENTS
|
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09,
Revenue from Contracts with Customers
. This standard will eliminate the transaction and industry specific revenue recognition guidance under current U.S. GAAP and replace it with a principles-based approach for determining revenue recognition. In December 2016, the FASB issued ASU 2016-20,
Technical Corrections and Improvements to Topic 606 – Revenue from Contracts with Customers
, to clarify the Codification or to correct unintended application of guidance. The new guidance is effective for annual and interim periods beginning after December 15, 2018. ASU 2014-09 allows for full retrospective adoption applied to all periods presented or modified retrospective adoption with the cumulative effect of initially applying the standard recognized at the date of
9
initial application.
In March 2016, the
FASB issued ASU 2016-08,
Principal versus Agent Considerations – Reporting Revenue Gross versus Net
. This ASU clarifies the revenue recognition implementation guidance for preparers on certain aspects of principal versus agent consideration. The amendments
in this ASU are effective for private companies and emerging growth companies beginning after December 15, 2018.
The adoption of ASU 2016-08 will be concurrently adopted with the adoption of ASU 2014-09. The Company plans to adopt the new guidance beginni
ng January 1, 2019.
The Company has performed a review of the requirements of the new guidance and has identified which of its revenue streams will be within the scope of ASU 2014-09. The Company is working through an adoption plan which includes a review of customer contracts, applying the five-step model of the new standard to each revenue stream and comparing the results to its current accounting; an evaluation of the method of adoption; and assessing changes that might be necessary to information technology systems, processes, and internal controls to capture new data and address changes in financial reporting. Because of the nature of the work that remains, at this time the Company is unable to reasonably estimate the impact of adoption of ASU 2016-08 and ASU 2014-09 on its consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01,
Recognition and Measurement of Financial Assets and Financial Liabilities
, which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.
The updated guidance in this ASU is effective for private companies and emerging growth companies beginning after December 15, 2018.
The Company does not expect that adoption of ASU 2016-01 will have a significant impact on its consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02,
Leases
, which requires that lease arrangements longer than twelve months result in an entity recognizing an asset and liability. The updated guidance in this ASU are effective for private companies and emerging growth companies beginning after December 15, 2019. The Company is currently assessing the impact of ASU 2016-02 on its consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13,
Financial Instruments – Credit Losses
to require the measurement of expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable forecasts. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. This ASU is effective for private companies and emerging growth companies beginning after December 15, 2020; the ASU allows for early adoption as of the beginning of an interim or annual reporting period beginning after December 15, 2018. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15,
Statements of Cash Flows – Classifications of Certain Cash Receipts and Cash Payments
to clarify how companies present and classify certain cash receipts and cash payments in the statement of cash flows. This ASU is effective for private companies and emerging growth companies beginning after December 15, 2018; the ASU allows for early adoption. The Company is currently assessing the impact that ASU 2016-15 will have on its consolidated financial statements.
In January 2017, the FASB
issued ASU 2017-01,
Business Combinations – Clarifying the Definition of a Business
, to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or dispositions) of assets or businesses. This ASU is effective for private companies and emerging growth companies beginning after December 15, 2018; the ASU allows for early adoption. The Company does not believe that adoption of ASU 2017-01 will have a significant impact on its consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04,
Simplifying the Test for Goodwill Impairment
. This guidance eliminates the requirement to determine the implied fair value of goodwill to measure an impairment of goodwill. Rather, goodwill impairment charges will be calculated as the amount by which a reporting unit's carrying amount exceeds its fair value.
This ASU is effective for private companies and emerging growth companies beginning after December 15, 2020; the ASU allows for early adoption. The Company does not believe that adoption of ASU 2017-04 will have a significant impact on its consolidated financial statements.
In May 2017, the FASB issued ASU 2017-09,
Scope of Modification Accounting
. This guidance
will reduce diversity in practice and result in fewer changes to the terms of an award being accounted for as modifications. Under
ASU 2017-09, an
entity will not apply modification accounting to a share-based payment award if the award’s fair value, vesting conditions and classification as an equity or liability instrument are the same immediately before and after the change
.
This ASU is effective for private companies and emerging growth companies beginning after December 15, 2017; the ASU allows for early adoption. The Company does not believe that adoption of ASU 2017-09 will have a significant impact on its consolidated financial statements.
NOTE C.
|
BUSINESS ACQUISITION
|
On July 13, 2017, Entellus completed the Spirox Acquisition. See Note A. Basis of Presentation -
Spirox Acquisition
, for details of the transaction.
The Spirox Acquisition has been accounted for as a business combination, and assets acquired and liabilities assumed were recorded at their estimated fair values as of July 13, 2017, the date of the acquisition. Goodwill as of the acquisition date is measured
10
as the excess of consideration transferred, which is also generally measured at fa
ir value or the net acquisition date fair values of the assets acquired and the liabilities assumed. Total consideration transferred was $130.9 million and consisted of the preliminary purchase price of $80.3 million, consisting of $24.8 million cash and a
pproximately 3.4 million shares of Entellus common stock (at a closing stock price on July 13, 2017 of $17.69 subject to certain discounts for the lock-up period resulting in an implied price of $16.27), and $50.6 million related to the fair value of poten
tial additional earn-out payments based on Entellus’s net revenue from sales of Spirox’s Latera™ device, subsequent versions thereof and any other device that treats nasal valve collapse or nasal lateral wall insufficiency by increasing the mechanical stre
ngth of the nasal lateral wall through the use of a synthetic graft, evaluated annually during the four-year period following the Spirox Acquisition.
The acquisition has been accounted for in accordance with ASC 805,
Business Combinations,
with identifiable assets acquired and liabilities assumed recorded at their estimated fair values on the acquisition date. A valuation of the assets and liabilities from the business acquisition was performed utilizing costs, income and market approaches resulting in $68.6 million allocated to identifiable net assets. The allocation of the purchase price is preliminary pending the finalization of the fair value of the acquired assets and liabilities assumed, including acquired deferred income tax assets and liabilities and assumed income and non-income based tax liabilities. As of the acquisition date, the purchase price assigned to the acquired assets and assumed liabilities is summarized as follows:
(in thousands)
|
Purchase Price Allocation
|
|
Accounts and other receivables
|
$
|
1,440
|
|
Prepaid expenses and other current assets
|
|
925
|
|
Inventory
|
|
647
|
|
Property and equipment
|
|
1,257
|
|
Intangible assets
|
|
82,103
|
|
Other non-current assets
|
|
219
|
|
Total assets acquired
|
|
86,591
|
|
Accounts payable
|
|
1,297
|
|
Accrued expenses and other current liabilities
|
|
1,835
|
|
Deferred tax liabilities
|
|
14,884
|
|
Total liabilities assumed
|
|
18,016
|
|
Identifiable net assets acquired
|
|
68,575
|
|
Goodwill
|
|
62,295
|
|
Net assets acquired and purchase price consideration
|
$
|
130,870
|
|
As a result of recording the assets and liabilities at fair market value for GAAP purposes, but receiving primarily carryover basis for tax purposes in the acquisition, the Company recorded a deferred tax liability of $14.9 million.
The goodwill of $62.3 million resulting from the acquisition is the excess of the purchase price over the fair value of the net assets acquired. The goodwill recorded as part of the acquisition primarily reflects the value of strengthening the Company’s strategy of offering less invasive treatment options to ENT physicians while driving procedure volumes to more cost-effective sites of care, thus meaningfully enhancing the Company’s market opportunity and growth potential. Goodwill also reflects the value of the assembled workforce as well as the value to be realized through cost synergies and integration of product lines. None of the goodwill recognized is deductible for income tax purposes as it was a stock acquisition, and as such, no deferred taxes have been recorded related to goodwill.
Revenue of $3.1 million and a net operating loss of $6.1 million attributable to the acquisition is included in the Company’s consolidated statement of operations for the three and nine months ended September 30, 2017. Included in the operating loss for the three and nine months ended September 30, 2017 is amortization expenses of $1.8 million related to identifiable intangible assets acquired in the transaction and the full recognition of the $0.3 million of fair value adjustment of acquired inventory.
The following summarizes the intangible assets acquired, excluding goodwill. Intangible assets are amortized using methods that approximate the pattern of economic benefit provided by the utilization of the assets.
|
Gross Carrying Value
|
|
Amortization Term
|
|
|
(in thousands)
|
|
(in years)
|
|
Developed technology
|
$
|
73,930
|
|
|
10.4
|
|
Trade names and trademarks
|
|
4,630
|
|
|
10.4
|
|
Customer relationships
|
|
3,500
|
|
|
12.0
|
|
Non-competition arrangements
|
|
43
|
|
|
3.0
|
|
Total
|
$
|
82,103
|
|
|
|
|
11
Contingent consideration is a Level 3 fair value measurement, remeasured to fair value each reporting period using projected revenues, discount rates, and projected payment dates.
The Company recorded a $2.3
million valuation adjustment to the contingent consideration liability for the three and nine months ended September 30, 2017 due to the passage of time (i.e., accretion) as shown on the following Level 3 rollforward:
(in thousands)
|
Contingent Consideration
|
|
Fair value on July 13, 2017 (acquisition date)
|
|
50,590
|
|
Valuation adjustment
|
|
2,329
|
|
Fair value on September 30, 2017
|
$
|
52,919
|
|
The following supplemental pro forma information presents the financial results of the Company for the three and nine months ended September 30, 2017 and 2016, as if the acquisition of Spirox had occurred on January 1, 2016. This supplemental pro forma information has been prepared for comparative purposes and does not purport to be indicative of what would have occurred had the acquisition been made on January 1, 2016, nor are they indicative of any future results. The fiscal 2016 three and nine month pro forma financial information includes adjustments for additional amortization expense on intangible assets of $2.0 million and $6.1 million and additional interest expense on debt used to finance the transaction of $0.7 million and $2.0 million, respectively. The fiscal 2017 three and nine month pro forma information includes adjustments for the removal of transaction costs of $11.4 million and $12.6 million and net severance and other compensation costs of $1.3 million and $2.0 million, partially offset by additional amortization expense on intangible assets of $1.7 million and $6.0 million and additional interest expense of $0.1 million and $1.4 million, respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
(in millions except per share data)
|
2017
|
|
2016
|
|
|
2017
|
|
2016
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
Revenue
|
$
|
23.7
|
|
$
|
18.6
|
|
|
$
|
69.8
|
|
$
|
54.3
|
|
Net loss
|
|
(3.9
|
)
|
|
(15.7
|
)
|
|
|
(33.4
|
)
|
|
(39.5
|
)
|
Net loss per share, basic and diluted
|
$
|
(0.15
|
)
|
$
|
(0.71
|
)
|
|
$
|
(1.34
|
)
|
$
|
(1.78
|
)
|
Total acquisition-related expenses associated with the Spirox Acquisition aggregated $3.9 million and $5.1 million for the three and nine months ended September 30, 2017, respectively.
NOTE D.
|
COMPOSITION OF CERTAIN FINANCIAL STATEMENT ITEMS
|
Inventories
|
September 30,
|
|
December 31,
|
|
(in thousands)
|
2017
|
|
2016
|
|
Finished goods
|
$
|
4,256
|
|
$
|
3,562
|
|
Work-in-process
|
|
1,260
|
|
|
536
|
|
Raw materials
|
|
3,102
|
|
|
3,128
|
|
Total
|
$
|
8,618
|
|
$
|
7,226
|
|
Property and Equipment
|
September 30,
|
|
December 31,
|
|
(in thousands)
|
2017
|
|
2016
|
|
Furniture and office equipment
|
$
|
992
|
|
$
|
873
|
|
Computer hardware and software
|
|
3,717
|
|
|
2,831
|
|
Laboratory equipment
|
|
6,348
|
|
|
4,336
|
|
Tooling and molds
|
|
1,525
|
|
|
1,512
|
|
Leasehold improvements
|
|
2,488
|
|
|
2,006
|
|
|
$
|
15,070
|
|
$
|
11,558
|
|
Less accumulated depreciation
|
|
(7,122
|
)
|
|
(5,465
|
)
|
Property and equipment in progress
|
|
369
|
|
|
394
|
|
Total
|
$
|
8,317
|
|
$
|
6,487
|
|
12
Depreciation expense on property and equipment was $0.8 million and $0.5 million during the three months ended September 30, 2017 and 2016, respectively, and $1.8 million and $1.2 million during the nine months ended September 30, 2017 and 2016, respectively.
Accrued Expenses
|
September 30,
|
|
December 31,
|
|
(in thousands)
|
2017
|
|
2016
|
|
Compensation and commissions payable
|
$
|
8,214
|
|
$
|
8,674
|
|
Royalty payable
|
|
1,795
|
|
|
1,851
|
|
Other accrued expenses
|
|
2,920
|
|
|
2,480
|
|
Total
|
$
|
12,929
|
|
$
|
13,005
|
|
NOTE E.
LIQUIDITY AND BUSINESS RISKS
As of September 30, 2017, the Company had cash and cash equivalents of $51.5 million and an accumulated deficit of $170.4 million. In the first quarter of 2017, the Company completed a public offering of shares of its common stock, issuing a total of 2.9 million shares of common stock (including 0.5 million shares issued after exercise by the underwriters of their option to purchase additional shares) at an offering price of $17.00 per share. Certain existing stockholders of the Company also sold approximately 1.2 million shares of common stock in the offering. The Company received net proceeds of $45.4 million, after deducting underwriting discounts and commissions of $2.9 million and offering expenses of $0.7 million payable by the Company. The Company did not receive any proceeds from the sale of shares by the selling stockholders.
On March 31, 2017, the Company entered into a loan and security agreement with Oxford Financial, LLC providing for a new credit facility. Under this credit facility,
the Company may borrow up to $40.0 million in term loans in three tranches
and up to $10.0 million under a revolving line of credit
, subject to a borrowing base requirement. The Company immediately borrowed $13.5 million under the first term loan and
$8.0 million under the revolving line of credit to repay
approximately $20.0 million in pre-existing outstanding indebtedness.
On July 13, 2017, in connection with the closing of the Spirox Acquisition, the Company borrowed an additional $26.5 million in term loans under the loan and security agreement. As of September 30, 2017, the Company had $7.9 million outstanding under the revolving line of credit and can borrow up to an additional $2.1 million if the borrowing base requirement continues to be met. See Note I. Debt.
Prior to its February 2015 initial public offering (“IPO”), the Company financed its operations with a combination of revenue, private placements of convertible preferred securities and amounts borrowed under its credit facility.
Although it is difficult to predict its future liquidity requirements, the Company expects that its existing cash and cash equivalents, anticipated revenue and remaining amounts available under its line of credit will be sufficient to meet its anticipated capital requirements, and fund its operations beyond 2018. Further capital requirements may be necessary to fund any contingent consideration due to the former Spirox equity holders. See Note C. Business Acquisitions.
NOTE F.
|
SHORT-TERM INVESTMENTS
|
The Company determines the appropriate classification of its investments at the time of purchase and revaluates such determinations at each balance sheet date. Marketable securities are classified as held-to-maturity when the Company has the intent and ability to hold the securities to maturity.
Marketable securities for which the Company does not have the intent or ability to hold to maturity are classified as available-for-sale. Marketable securities classified as available-for-sale are carried at fair market value, with the unrealized gains and losses included in the determination of comprehensive income and reported in stockholders’ equity.
13
The following is a summary of the available-for-sale investments by type of instrument, which are included in short-term investments in the consolidated balance sheet as of December 31, 2016. There were no available-for
-sale investments as of September 30, 2017.
|
|
|
|
Unrealized
|
|
Unrealized
|
|
|
|
|
|
|
|
|
Gain in
|
|
Losses in
|
|
|
|
|
|
|
|
|
Accumulated
|
|
Accumulated
|
|
|
|
|
|
|
|
|
Other
|
|
Other
|
|
|
|
|
|
Amortized
|
|
Comprehensive
|
|
Comprehensive
|
|
Estimated
|
|
December 31, 2016
(in thousands)
|
Cost
|
|
Income (Loss)
|
|
Income
(Loss)
|
|
Fair Value
|
|
Commercial paper
|
$
|
2,495
|
|
$
|
2
|
|
$
|
—
|
|
$
|
2,497
|
|
Corporate bonds
|
|
4,099
|
|
|
—
|
|
|
(2
|
)
|
|
4,097
|
|
Foreign assets
|
|
4,250
|
|
|
1
|
|
|
—
|
|
|
4,251
|
|
Total available-for-sale securities
|
$
|
10,844
|
|
$
|
3
|
|
$
|
(2
|
)
|
$
|
10,845
|
|
Based on an evaluation of securities that have been in a loss position, the Company did not recognize any other-than-temporary impairment charges during the nine months ended September 30, 2017. The Company considered various factors, including a credit and liquidity assessment of the underlying securities and the Company’s intent and ability to hold the underlying securities until the estimated date of recovery of its amortized cost. As of December 31, 2016, available-for-sale maturities as noted in the table above mature in one year or less.
NOTE G.
|
FAIR VALUE MEASUREMENTS
|
As of September 30, 2017 and December 31, 2016, the carrying amounts of cash and cash equivalents, receivables, accounts payable and accrued expenses approximated their estimated fair values because of the short-term nature of these financial instruments. Goodwill and intangible assets acquired are stated at fair value based upon the acquisition valuation.
Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. Financial assets and liabilities carried at fair value are to be classified and disclosed in one of the following three categories:
|
•
|
Level 1: Quoted market prices in active markets for identical assets or liabilities.
|
|
•
|
Level 2: Includes other than Level 1 inputs that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs for which all significant inputs are observable or can be corroborated by observable market data for substantially the full term of the asset or liabilities.
|
|
•
|
Level 3: Unobservable inputs that are supported by little or no market activities, which would require the Company to develop its own assumptions.
|
Short-term Investments
The following is a summary of available-for-sale investments by type of instrument measured at fair value on a recurring basis at December 31, 2016. There were no available-for-sale investments as of September 30, 2017.
|
December 31, 2016
|
|
(in thousands)
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Commercial paper
|
$
|
—
|
|
$
|
2,497
|
|
$
|
—
|
|
$
|
2,497
|
|
Corporate bonds
|
|
—
|
|
|
4,097
|
|
|
—
|
|
|
4,097
|
|
Foreign assets
|
|
—
|
|
|
4,251
|
|
|
—
|
|
|
4,251
|
|
Total
|
$
|
—
|
|
$
|
10,845
|
|
$
|
—
|
|
$
|
10,845
|
|
Liabilities
The following is a summary of liabilities measured at fair value on a recurring basis at September 30, 2017. There were no such liabilities as of December 31, 2016.
|
September 30, 2017
|
|
(in thousands)
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Contingent consideration
|
$
|
—
|
|
$
|
—
|
|
$
|
52,919
|
|
$
|
52,919
|
|
14
The
contingent consideration was determined based on discounted cash flow analyses that included projected net revenue assumptions and a discount rate as of September 30, 2017, which are considered significant unobservable inputs. These inputs were used in an
option pricing approach in a risk-neutralized framework, using a risk-adjusted discount rate of 12% and a volatility factor of 35% based on the Company’s historical volatility. Projected net revenues developed for each contingent payment period, multiplie
d by their respective earnout multiples, were discounted to the valuation date using a discount rate of 8% based on the Company’s cost of debt. To the extent these assumptions were to change, the fair value of the contingent consideration could change sign
ificantly. Included in acquisition-related expenses in the condensed consolidated statements of operations for both the three and nine months ended September 30, 2017 is $2.3 million of contingent consideration valuation accretion due to the passage of tim
e.
There were no transfers in or out of Level 1, Level 2 or Level 3 fair value measurement categories during the three and nine months ended September 30, 2017. The Company has not experienced any significant realized gains or losses on its investments in the periods presented in the consolidated statements of operations and comprehensive loss.
NOTE H.
|
GOODWILL AND INTANGIBLE ASSETS
|
The change in the carrying amount of goodwill is as follows:
(in thousands)
|
Carrying Value
|
|
December 31, 2016
|
$
|
477
|
|
Spirox Acquisition, at acquisition date
|
|
62,295
|
|
September 30, 2017
|
$
|
62,772
|
|
Other intangible assets are as follows:
|
September 30, 2017
|
|
December 31, 2016
|
|
(in thousands)
|
Gross Carrying Amount
|
|
Accumulated Amortization
|
|
Gross Carrying Amount
|
|
Accumulated Amortization
|
|
Developed technology
|
$
|
83,630
|
|
$
|
(2,402
|
)
|
$
|
9,700
|
|
$
|
(342
|
)
|
Trade name
|
|
5,130
|
|
|
(141
|
)
|
|
500
|
|
|
(18
|
)
|
Customer relationships
|
|
3,500
|
|
|
(127
|
)
|
|
—
|
|
|
—
|
|
Noncompetition arrangements
|
|
43
|
|
|
(3
|
)
|
|
—
|
|
|
—
|
|
|
$
|
92,303
|
|
$
|
(2,673
|
)
|
$
|
10,200
|
|
$
|
(360
|
)
|
The weighted average useful lives of each class of intangible assets are as follows:
|
Useful Life (Years)
|
|
Developed technology
|
|
10.9
|
|
Trade name
|
|
10.8
|
|
Customer relationships
|
|
12.0
|
|
Noncompetition arrangements
|
|
3.0
|
|
Amortization expense on intangible assets was $2.0 million and $0.1 million during the three months ended September 30, 2017 and 2016, respectively, and $2.3 million and $0.1 million during the nine months ended September 30, 2017 and 2016, respectively.
Estimated aggregate amortization expense for the next five fiscal years based on the current carrying value of definite-lived intangible assets at September 30, 2017, is as follows:
(in thousands)
|
|
|
|
Remaining 2017
|
$
|
2,216
|
|
2018
|
|
8,818
|
|
2019
|
|
8,728
|
|
2020
|
|
8,647
|
|
2021
|
|
8,577
|
|
2022
|
|
8,525
|
|
In December 2013, the Company entered into an amended and restated credit facility with Oxford Finance LLC (“Oxford”) under which the Company borrowed $20.0 million at a fixed rate of 9.40%. The facility was scheduled to mature and all amounts borrowed thereunder were due on December 1, 2018. In February 2017, the Company entered into an amendment to the amended and restated loan and security agreement to allow principal payments due on February 1, 2017 and March 1, 2017 to be deferred until
15
March 15, 2017.
In March 2017, the principal payments were deferred again during renegotiations with Oxford.
In March 2017, the Company entered into a loan and security ag
reement (the “Loan Agreement”) with Oxford providing for a new credit facility.
The key terms of the new credit facility are summarized in the table below:
Origination date:
|
March 31, 2017
|
Maturity date:
|
March 1, 2022
|
Funding tranches:
|
|
First term loan
|
$13.5 million
|
Second term loan
(1)
|
$10.0 million
|
Third term loan
(1)
|
$16.5 million
|
Revolving line of credit:
(2)
|
$10.0 million
|
Outstanding as of September 30, 2017:
|
|
Term loans
|
$40.0 million
|
Revolving line of credit
|
$7.9 million
|
Term loan interest rate:
|
Floating per annum rate equal to the greater of (1) 7.95% and (2) the sum of (i) the greater of (A) the 30-day U.S. LIBOR rate reported in
The Wall Street Journal
on the last business day of the month that immediately precedes the month in which the interest will accrue and (B) 0.77%,
plus
(ii) 7.18%. The per annum rate was 8.39% as of September 30, 2017.
|
Revolving line of credit interest rate:
|
Floating per annum rate of interest is equal to the greater of (1) 4.95% and (2) the sum of (i) the greater of (A) 30-day U.S. LIBOR rate reported in
The Wall Street Journal
on the last business day of the month that immediately precedes the month in which the interest will accrue and (B) 0.77%,
plus
(ii) 4.18%. The per annum rate was 5.39% as of September 30, 2017.
|
Final payment fee as a percentage of term loans outstanding:
|
4.95%
|
Prepayment fees:
|
1.00% to 3.00% of the principal amount of such Term Loan prepaid, depending upon the timing of the prepayment.
|
Other fees:
|
Customary commitment fees and unused fees and certain other customary fees related to the Oxford’s administration of the credit facility.
|
Security interest:
|
A first priority security interest in substantially all of the Company’s assets, other than its intellectual property and, under certain circumstances more than 65% of its shares in any foreign subsidiary. The Company has agreed not to pledge or otherwise encumber its intellectual property assets, except for permitted liens, as such terms are defined in the Loan Agreement and except as otherwise provided for in the Loan Agreement.
|
_____________________
|
(1)
|
Became available and was borrowed to fund the July 13, 2017 Spirox Acquisition
|
|
(2)
|
Subject to a borrowing base requirement
|
The first term loan of $13.5 million and $8.0 million of the revolving line of credit were borrowed immediately and used to repay approximately $20.0 million of then outstanding indebtedness, which constituted all amounts outstanding related to the prior credit facility, together with the final payment fee of $1.2 million. The
new
credit facility was accounted for as a modification of debt under applicable accounting guidance. The borrowings under the revolving line of credit are classified as short-term obligations as the Loan Agreement contains a subjective acceleration clause and requires the Company to maintain a lockbox arrangement with Oxford.
The Loan Agreement contains affirmative and negative covenants applicable to the Company and any subsidiaries and events of default, in each case subject to grace periods, thresholds and materiality qualifiers, as more fully described in the Loan Agreement. The affirmative covenants include, among others, covenants requiring the Company to maintain its legal existence and material governmental approvals, deliver certain financial reports and maintain insurance coverage. The negative covenants include, among others, restrictions on the Company incurring additional indebtedness, engaging in mergers, consolidations or acquisitions, paying dividends or making other distributions, making investments, creating liens, selling assets, and suffering a change in control. The events of default include, among other things, the Company’s failure to pay any amounts due under the credit facility, a breach of covenants under the Loan Agreement, the Company’s insolvency, a material adverse change, the occurrence of a default under certain other indebtedness and the entry of final judgments against the Company in excess of a specified amount. If an event of default occurs, Oxford is entitled to take various actions, including the acceleration of amounts due under the
credit facility
,
16
termination of the commitments under the
credit facility
and certain other actions available to secured creditors.
The Company was in compliance with all required covenants as of September 30, 2017 and December 31, 2016.
As of September 30, 2017
and
December 31, 2016,
the carrying amount of debt approximated fair value because the interest rate approximates current market rates of interest available in the market. The fair value of the Company’s debt is considered a Level 3 measurement.
Assuming a 60-month amortization period as stated in the
Loan Agreement
, the Company’s principal payments on outstanding term loans are as follows:
Fiscal Year
|
Principal Payments
(in thousands)
|
|
2017
|
$
|
—
|
|
2018
|
|
—
|
|
2019
|
|
10,000
|
|
2020
|
|
13,333
|
|
2021
|
|
13,333
|
|
2022
|
|
3,334
|
|
Total
|
$
|
40,000
|
|
NOTE J.
|
STOCKHOLDERS’ EQUITY
|
Common Stock
The Company’s amended and restated certificate of incorporation authorizes 200.0 million shares of common stock. As of September 30, 2017, 25.4 million shares of common stock were outstanding.
On July 13, 2017, the Company issued approximately 3.4 million shares of common stock in connection with the Spirox Acquisition. See Note C. Business Acquisitions.
2015 Incentive Award Plan
In December 2014, the Company’s Board of Directors adopted, and in January 2015 the Company’s stockholders approved, the Entellus Medical, Inc. 2015 Incentive Award Plan (the “2015 Plan”). The 2015 Plan became effective in connection with the IPO, at which time the Company ceased making awards under the Entellus Medical, Inc. 2006 Stock Incentive Plan (the “2006 Plan”). Under the 2015 Plan, the Company may grant stock options, stock appreciation rights, restricted stock, restricted stock units and certain other awards to individuals who are employees, officers, directors or consultants of the Company. A total of 1,345,570 shares of common stock were initially reserved for issuance under the 2015 Plan. In addition, the number of shares available for issuance under the 2015 Plan is annually increased by an amount equal to the lesser of (A) 875,000 shares, (B) 4% of the outstanding shares of the Company’s common stock as of the last day of the Company’s immediately preceding fiscal year or an amount determined by the Company’s Board of Directors. Furthermore, any shares subject to awards granted under the 2006 Plan which terminate, expire or lapse without the delivery of shares to the holder thereof become available under the 2015 Plan. In the first quarter of 2017 and 2016, in accordance with this “evergreen” provision, the number of shares available under the 2015 Plan was increased in the amount of 756,339 shares and 751,750 shares, respectively. As of September 30, 2017, 320,865 shares of common stock were available for issuance under the 2015 Plan.
2017 Employee Inducement Incentive Award Plan
In connection with the Spirox Acquisition, the Board of Directors of the Company adopted the Entellus Medical, Inc. 2017 Employment Inducement Incentive Award Plan (the “Inducement Plan”), which is a non-stockholder approved plan, to facilitate the granting of equity awards as an inducement to new employees joining the Company. Under the Inducement Plan, the Company may grant stock options, stock appreciation rights, restricted stock, restricted stock units and certain other awards to new employees of the Company. A total of 450,000 shares of common stock were initially reserved for issuance under the Inducement Plan.
Stock Options and RSUs Granted in Connection with the Spirox Acquisition
The Compensation Committee of the Board of Directors granted the following stock options and restricted stock units (“RSUs”) under the Inducement Plan and the 2015 Plan in connection with the Spirox Acquisition:
(shares in thousands)
|
Employee Options
|
|
Employee RSUs
|
|
Director & Non-employee Options
|
|
Director & Non-employee RSUs
|
|
Inducement Plan
|
|
323
|
|
|
-
|
|
|
-
|
|
|
-
|
|
2015 Plan
|
|
93
|
|
|
90
|
|
|
23
|
|
|
11
|
|
Total
|
|
416
|
|
|
90
|
|
|
23
|
|
|
11
|
|
17
The employee stock options and RSUs were effective as of August 4, 2017. The stock options have a ten-year term, a per share exercise price equal to the closing price of the Company’s common stock on August 4, 2017, and will vest as to one-fourth of the underlying shares on the one-year anniversary of the Spirox Acquisition closing date, and monthly thereafter over the subsequent three years, subject to the recipient’s continued service. The RSU awards will vest annually over a four-year period.
The director stock options and RSUs were effective as of July 14, 2017 and non-employee stock options and RSUs were effective as of August 4, 2017. The stock options have a ten-year term and a per share exercise price equal to the closing price of the Company’s common stock on their respective effective dates. The stock options vest quarterly over a three-year period and the RSUs vest annually over a three-year period.
Stock Options
A summary of the Company’s stock option activity and related information is as follows:
|
September 30, 2017
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
Aggregate
|
|
|
|
|
|
Weighted
|
|
Remaining
|
|
Intrinsic
|
|
|
Options
|
|
Average
|
|
Contractual
|
|
Value
|
|
|
(in thousands)
|
|
Exercise Price
|
|
Term
|
|
(in thousands)
|
|
Outstanding, beginning of period
|
|
3,349
|
|
$
|
13.06
|
|
7.6 years
|
|
$
|
21,863
|
|
Granted
|
|
1,479
|
|
|
15.30
|
|
|
—
|
|
|
—
|
|
Exercised
|
|
(213
|
)
|
|
5.68
|
|
|
—
|
|
|
—
|
|
Cancelled
|
|
—
|
|
|
-
|
|
|
—
|
|
|
—
|
|
Forfeited
|
|
(407
|
)
|
|
16.68
|
|
|
—
|
|
|
—
|
|
Outstanding, end of period
|
|
4,208
|
|
$
|
13.87
|
|
8.1 years
|
|
$
|
21,369
|
|
Exercisable, end of period
|
|
1,850
|
|
$
|
11.92
|
|
7.0 years
|
|
|
13,279
|
|
The aggregate pre-tax intrinsic value of options exercised was $2.4 million and $0.8 million for the nine months ended September 30, 2017 and 2016, respectively. The aggregate pre-tax intrinsic value was calculated as the difference between the exercise prices of the underlying options and the estimated fair value of the common stock on the date of exercise on September 30, 2017 and 2016, as applicable. During the nine months ended September 30, 2017 and 2016, the fair value of shares vested was $5.7 million and $3.4 million, respectively. The total cash received by the Company upon the exercise of options was $1.2 million and $0.1 million during the nine months ended September 30, 2017 and 2016, respectively.
Restricted Stock Units
The Company grants time-based RSUs to directors, executive officers and certain other employees. Employee RSUs generally vest over a four-year period and director RSUs vest over a three-year period. In addition, certain key management members typically receive RSUs upon commencement of employment and may receive them annually in conjunction with their performance review.
The grant date fair value of the RSU awards is determined using the closing sale price of the Company’s common stock on the date of the grant.
The Company recognizes compensation expense for time-based RSUs on a straight-line basis over the vesting period.
Restricted stock unit activity during the nine months ended September 30, 2017 is summarized below:
|
September 30, 2017
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Average
|
|
|
RSUs
|
|
Grant Date
|
|
|
(in thousands)
|
|
Fair Value
|
|
Outstanding, beginning of period
|
|
12
|
|
$
|
16.99
|
|
Granted
|
|
282
|
|
|
—
|
|
Released
|
|
(3
|
)
|
|
—
|
|
Forfeited/expired
|
|
(28
|
)
|
|
—
|
|
Outstanding, end of period
|
|
263
|
|
$
|
16.90
|
|
Employee Stock Purchase Plan
In December 2014, the Company’s Board of Directors adopted, and in January 2015 the Company’s stockholders approved, the Entellus Medical, Inc. 2015 Employee Stock Purchase Plan (“ESPP”). Under the ESPP, the Company has set two six-month offering periods during each calendar year, one beginning January 1 and ending on June 30, and the other beginning July 1 and ending on December 31, during which employees can choose to have up to 20% of their eligible compensation withheld to purchase less than
18
2,000
share
s of the Company’s common stock during each offering period. The purchase price of the shares is 85% of the market price on the first or last trading day of the offering period, whichever is lower.
A total of 200,000 shares of common stock were initially r
eserved for issuance under the ESPP.
In addition, the number of shares of common stock available for issuance under the ESPP will be annually increased on the first day of each fiscal year during the term of the ESPP, beginning with the 2016 fiscal year, b
y an amount equal to the lesser of (A)
1% of the shares of the Company’s common stock outstanding on the date of the adoption of the plan or (B) a lesser amount determined by the Company’s Board of Directors. In accordance with the “evergreen” provision, t
he number of shares available for grant in the first quarter of 2017 and 2016 increased by 16,488 shares each year, resulting in a total of 232,976 shares reserved for issuance under the ESPP as of March 31, 2017. As of September 30, 2017, 166,523 shares o
f common stock remained available for issuance under the ESPP.
NOTE K.
|
STOCK-BASED COMPENSATION EXPENSE
|
The following table presents the components and classification of stock-based compensation expense for stock options, RSUs and employee stock purchase plan shares recognized for the
three and nine months ended September 30, 2017 and 2016:
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
September 30,
|
|
(in thousands)
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
Cost of goods sold
|
$
|
70
|
|
$
|
30
|
|
$
|
143
|
|
$
|
77
|
|
Selling and marketing
|
|
826
|
|
|
536
|
|
|
2,148
|
|
|
1,470
|
|
Research and development
|
|
375
|
|
|
149
|
|
|
839
|
|
|
413
|
|
General and administrative
|
|
900
|
|
|
821
|
|
|
2,762
|
|
|
2,100
|
|
Total
|
$
|
2,171
|
|
$
|
1,536
|
|
$
|
5,892
|
|
$
|
4,060
|
|
At September 30, 2017, there was approximately $17.8 million and $3.8 million of unrecognized stock-based compensation expense related to unvested stock options and RSUs, respectively, which the Company expects to recognize over the remaining weighted-average vesting period of approximately 2.8 years and 3.3 years, respectively. If there are any modifications or cancellations of the underlying unvested securities, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that the Company grants additional stock-based awards.
The Company estimates the fair value of stock-based compensation on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes model determines the fair value of stock-based payment awards based on the fair market value of the Company’s common stock on the date of grant and is affected by assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the fair market value of the Company’s common stock, volatility over the expected term of the awards and actual and projected employee stock option exercise behaviors. The Company has opted to use the “simplified method” for estimating the expected term of options, whereby the expected term equals the arithmetic average of the vesting term and the original contractual term of the option.
Due to the Company’s limited operating history and company-specific historical and implied volatility data, the Company has based its estimate of expected volatility on the blended historical volatility of a group of similar companies that are publicly traded and their historical volatility.
The historical volatility data was computed using the daily closing prices for the selected companies’ shares during the equivalent period of the calculated expected term of the stock-based payments. The Company will continue to analyze the historical stock price volatility and expected term assumptions as more historical data for the Company’s common stock becomes available. The risk-free rate assumption is based on the U.S. Treasury instruments with maturities similar to the expected term of the Company’s stock options. The expected dividend assumption is based on the Company’s history of not paying dividends and its expectation that it will not declare dividends for the foreseeable future.
The fair value of the options granted to employees or directors during the nine months ended September 30, 2017 and 2016 was estimated as of the grant date using the Black-Scholes model assuming the weighted average assumptions listed in the following table:
|
Nine Months Ended
|
|
|
September 30,
|
|
|
2017
|
|
2016
|
|
Expected life in years
|
|
6.2
|
|
|
6.0
|
|
Risk-free interest rate
|
|
2.1
|
%
|
|
1.6
|
%
|
Expected dividend yield
|
|
0
|
%
|
|
0
|
%
|
Expected volatility
|
|
52
|
%
|
|
51
|
%
|
Weighted average fair value
|
$
|
7.90
|
|
$
|
7.93
|
|
19
The fair value of the ESPP options granted to employees during the nine months ended September 30, 2017 and 2016 was estimated as of the grant date using the Black-Scholes model assuming the weighted average assumptions listed in the following table:
|
Nine Months Ended
|
|
|
September 30,
|
|
|
2017
|
|
2016
|
|
Expected life in years
|
|
0.5
|
|
|
0.5
|
|
Risk-free interest rate
|
|
0.8
|
%
|
|
0.4
|
%
|
Expected dividend yield
|
|
0
|
%
|
|
0
|
%
|
Expected volatility
|
|
49
|
%
|
|
49
|
%
|
Weighted average fair value
|
$
|
5.13
|
|
$
|
5.30
|
|
The Company did not record a federal, state or foreign income tax benefit in any prior periods due to its conclusion that a full valuation allowance is required against its net deferred tax assets, excluding the deferred tax liability related to its tax deductible goodwill acquired in connection with the XeroGel acquisition. In the current period ending September 30, 2017, the Company established a $14.9 million deferred tax liability through purchase accounting related to the acquisition of Spirox. The deferred tax liability is considered a source of taxable income that can be used to support an equivalent amount of the Company’s existing deferred tax assets. Accordingly, the Company recognized a one-time $14.9 million income tax benefit in the current period as a result of reducing the valuation allowance against its deferred tax assets.
NOTE M.
EARNINGS PER SHARE
Basic net loss per share is computed by dividing the net loss by the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by dividing the net loss by the weighted average number of shares of common stock and dilutive potential shares of common stock outstanding during the period. In periods in which Company has reported a net loss, diluted net loss per share is the same as basic net loss per share as all potentially dilutive shares consisting of RSUs, stock options and warrants were antidilutive.
The following table sets forth the computation of the Company’s net loss per share:
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
September 30,
|
|
September 30,
|
|
(in thousands)
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
Net loss
|
$
|
(3,240
|
)
|
$
|
(9,519
|
)
|
$
|
(19,621
|
)
|
$
|
(21,412
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common stock outstanding
|
|
24,944
|
|
|
18,855
|
|
|
22,595
|
|
|
18,827
|
|
Net loss per share, basic and diluted
|
$
|
(0.13
|
)
|
$
|
(0.50
|
)
|
$
|
(0.87
|
)
|
$
|
(1.14
|
)
|
The following potentially dilutive securities outstanding have been excluded from the computations of diluted earnings per share because such securities have an antidilutive impact due to losses reported:
|
September 30,
|
|
(in thousands)
|
2017
|
|
2016
|
|
Common stock warrants
|
|
38
|
|
|
38
|
|
Common stock options
|
|
4,208
|
|
|
3,375
|
|
Restricted stock units
|
|
263
|
|
|
12
|
|
Common stock ESPP
|
|
167
|
|
|
20
|
|
Total
|
|
4,676
|
|
|
3,445
|
|
20
NOTE N.
|
COMMITMENTS AND CONTINGENCIES
|
Operating Leases
As of September 30, 2017, the Company had three leased facilities under operating lease agreements. The Company entered into a 41-month lease in February 2012, effective April 1, 2012, for its corporate headquarters. The Company entered into a 50-month lease on June 30, 2014, effective July 1, 2014, for additional distribution space in a second facility. On February 26, 2015, the Company exercised its right to extend the lease term of its manufacturing and corporate facility for an additional three years through August 2018. On June 30, 2015, the Company entered into amendments to each of these two lease agreements, among other things, to expand the space occupied by the Company at the property at which the Company’s corporate headquarters are located, and to extend the term of each lease agreement through June 2021, with an option to extend for an additional term through June 2024. In connection with the Spirox Acquisition, the Company assumed a lease for a facility which expires in October 2021, in Redwood City, California. Rental payments on operating leases are charged to expense on a straight-line basis over the period of the lease. These lease agreements require the Company to pay executory costs such as real estate taxes, insurance and repairs, and include renewal and escalation clauses.
Total lease expense was approximately $0.2 million for each of the three months ended September 30, 2017 and 2016 and $0.7 million and $0.5 million for the nine months ended September 30, 2017 and 2016, respectively.
Other Commitment
In June 2016, the Company entered into an Amended and Restated Fiagon NA Distribution Agreement (the “Distribution Agreement”) with Fiagon NA Corporation in which the Company was granted exclusive distribution rights in the United States and Canada for Fiagon Image Guidance Systems (“IGS”) and certain components, parts and related ancillary products i) to hospitals, ii) to ENT physicians in the office, clinic, and surgery centers, and iii) under ENT healthcare system contracts. The terms of the Distribution Agreement require the Company to purchase minimum quantities of Fiagon IGS units and certain other disposable products through August 9, 2020 for the Company to retain exclusive distribution rights
.
21
Item 2. Management’s Discussion and Analysis of
Financial C
ondition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and accompanying notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Some of the numbers included herein have been rounded for the convenience of presentation. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under “Cautionary Note Regarding Forward-Looking Statements” and elsewhere in this Quarterly Report on Form 10-Q.
Business Overview
We are
a medical technology company
focused on delivering superior patient and physician experiences through products designed for the minimally invasive treatment of chronic and recurrent sinusitis, nasal airway obstruction and persistent Eustachian tube dysfunction. Our platform of products provides effective and easy-to-use solutions designed to simplify everything from diagnosis and patient selection, to complex case revisions and post-operative care. Our three core product lines, XprESS Multi-Sinus Dilation Systems, MiniFESS™ Surgical Instruments, and FocESS™ Imaging & Navigation, are designed to enable ear, nose and throat, or ENT, physicians to conveniently and comfortably perform a broad range of procedures in the ENT physician office and simplify operating room based treatment.
When used as a stand-alone therapy in the physician’s office, our balloon sinus dilation products are the only devices proven in a sufficiently powered prospective, multicenter, randomized, controlled trial to be as effective as functional endoscopic sinus surgery, or FESS, the primary surgical treatment for chronic and recurrent sinusitis. Patients treated with our products in this trial in the ENT physician office also experienced faster recovery, less bleeding at discharge, less use of prescription pain medication and fewer post-procedure debridements than patients receiving FESS
.
We believe our minimally invasive balloon sinus dilation devices, along with the additional sinus surgery products we have sold, have facilitated a shift towards office-based treatment of chronic and recurrent sinusitis patients who are candidates for sinus surgery in the operating room. We believe this shift has been facilitated by our technology and clinical data, as well as procedure economics that are favorable to the healthcare system, patient and provider. Our XprESS family of products is used to treat patients with inflammation of the frontal, ethmoid, sphenoid and maxillary sinuses and is specifically designed for ease-of-use in the ENT physician office setting. Our XprESS family of products includes our XprESS Pro device, our XprESS LoProfile device and our XprESS Ultra device. We derive a significant portion of our revenue from our XprESS family of products
.
Our research and development efforts are focused primarily on enhancing our XprESS family of products and broadening their indications for use, as well as developing new related products.
We consider new products to be any non-balloon products released within the last 24 months. As of September 30, 2017, new products included our Fiagon Image Guidance Systems and accessories, MiniFESS Tools, FocESS Scopes and accessories, Cyclone Sinonasal Suction and Irrigation System, Entellus Medical Shaver System and FocESS HD Wireless Camera System.
In July 2017, we completed our previously announced acquisition of Spirox, Inc. Spirox is a privately held medical device company that develops, manufactures and markets the Latera Absorbable Nasal Implant which is a minimally invasive option to treat nasal airway obstruction.
In April 2017, we received 510(k) clearance from the United States Food and Drug Administration, or FDA, for use of our XprESS ENT Dilation System for treating persistent Eustachian tube dysfunction. We also received 510(k) clearance from the FDA for our Reinforced Anesthesia Needle for use in injecting local anesthetics into a patient to provide regional anesthesia. Also in April 2017, as previously disclosed, we received a warning letter from the FDA related to two observed non-conformities relating to our prospective, multicenter study of children with chronic rhinosinusitis treated with the XprESS device. We responded fully to the FDA’s requests and recently received an acceptance letter from the FDA in October 2017, indicating our corrective actions are adequate.
In June 2016, we entered into an
amended and restated agreement with Fiagon NA Corporation that, subject to certain limited exceptions for third parties that were then distributing Fiagon products, grants us exclusive distribution rights for
Fiagon Image Guidance Systems, or Fiagon IGS, and certain components, parts and related ancillary products to ENT physicians in hospitals, p
hysician offices and ambulatory surgery centers, or ASCs, in the United States, certain U.S. territories
and Canada.
In June 2016, we
acquired and entered into an exclusive license for the XeroGel™ assets with CogENT Therapeutics, LLC for $11.0 million in cash. We refer to this transaction as the XeroGel acquisition. Under the terms of the agreements, we became the manufacturer and continue to sell XeroGel nasal packing material to hospitals, offices and ASCs. Prior to the transaction, we were the exclusive distributor of XeroGel in the United States. The distribution agreement between the two parties was terminated in connection with the transaction. As a result of the XeroGel nasal packing material acquisition, we began recognizing all XeroGel revenue on a gross basis effective June 29, 2016, the date of the acquisition.
22
In December 2016, the National Institute for Health and Care Excellence, or NICE, provided positive guidance for use of our XprESS
Multi-Sinus
Dilation System, recommending it for use in patients with uncomplicated c
hronic sinusitis who do not have severe nasal polyposis. In these patients, NICE has asserted that, in comparison with FESS, our XprESS
Multi-Sinus
Dilation System works as well, is associated with faster recovery times and can more often be performed unde
r local anesthesia. The NICE guidance indicates that our XprESS
Multi-Sinus
Dilation System is cost saving compared to FESS based on device cost, length of FESS procedure and assuming the treatments are performed under local anesthetic, in an outpatient se
tting. NICE estimates that, by adopting our technology, the National Health Service in England may save up to £7.4 million per year by 2020. The NICE guidance is specific to the XprESS
Multi-Sinus
Dilation System and does not extend to any other balloon si
nus dilation technology.
In 2015, we established a subsidiary in the United Kingdom. We sell our products in certain European countries using a combination of direct sales representatives and a network of independent distributors with experience in selling products into ENT markets in those regions. We intend to continue to increase our presence outside the United States through expansion of our U.K. sales force and as well as the addition of distributors.
We invest substantial resources to educate ENT physicians and patients on the proven clinical advantages of stand-alone balloon sinus dilation and our other products.
We have a diverse customer base of ENT physicians, hospitals and ASCs, with no single customer accounting for more than 5% of our revenue during the nine months ended September 30, 2017. Our customers are reimbursed by governmental and private health insurers for procedures using our products pursuant to reimbursement codes specific to the setting of the procedure.
Our revenues are dependent upon the future market acceptance and adoption of our existing and new products, appropriate pricing and adequate level of coverage or reimbursement for procedures using such products.
When used as a stand-alone balloon sinus dilation procedure in the physician office setting, the practice expense component of the physician’s fee is intended to cover all or a portion of the cost of our balloon dilation products. When used in an operating room in an ASC or hospital, our balloon dilation products are typically utilized as tools used during FESS and are not separately reimbursed by third-party payors
.
Medicare issued a final rule on the Hospital Outpatient Prospective Payment System, or HOPPS, for 2017 which includes a reduction of payments for certain outpatient procedures performed in the hospital when FESS is performed on more than two sinuses. The result is to bundle payments for multi-sinus surgery regardless of the number of sinuses being treated. On average we expect most hospitals will experience a reduction in Centers for Medicare and Medicaid Services, or CMS, reimbursement depending on the number of sinuses being treated.
The products we sell are either manufactured by us or by contracted manufacturers. We manufacture and assemble the majority of our proprietary products at our facility in Plymouth, Minnesota with components supplied by external suppliers.
As of September 30, 2017, our manufacturing organization included 32 people. We expect the capacity of our current facility to be able to meet expected demand through at least the end of 2020. Certain products are produced for us by qualified contract manufacturers.
During 2017, we intend to focus on the following key initiatives: (1) enhanced productivity of our sales force; (2) account development activities; (3) global expansion; (4) new products and indications; and (5) integration of the Spirox sales force and operations. In furtherance of these initiatives, we plan to, among other actions, continue to convert sales associates to full quota-carrying sales representatives during the remainder of 2017.
Financial Overview
|
•
|
We generated revenue of $23.3 million for the three months ended September 30, 2017, compared to revenue of $17.9 million for the three months ended September 30, 2016, an increase of 30%. During the nine months ended September 30, 2017 and 2016, we generated revenue of $64.6 million and $53.5 million, respectively, an increase of 21%. The growth in revenue was primarily attributable to sales of new products including sales of Latera, an increase in sales of our XprESS family of products, through broader account penetration, and to a lesser extent, sales in international markets. F
oreign currency exchange rates negatively impacted revenue for the
three and nine months ended September 30, 2017
by approximately $0.0 million and $0.1 million, respectively
. We operate in one segment.
|
|
•
|
For the third quarter of 2017, our full quota-carrying representatives sold at an annualized rate of approximately $813,000 compared to $739,000 for the third quarter of 2016.
|
|
•
|
Revenue per procedure, excluding Latera,
was approximately $1,500 in the third quarter of 2017. We calculate revenue per procedure by dividing our revenue from disposable products, which includes our balloon sinus dilation products, Fiagon disposable products, XeroGel
nasal packing material
, disposable shaver blades, Cyclone,
Reinforced Anesthesia Needle,
light fibers and surgical procedure packs, by the number of balloon sinus dilation devices sold during the quarter. We believe the number of balloon sinus dilation devices sold during a quarter is a reasonable proxy for the number of balloon procedures performed in the quarter because a balloon sinus dilation procedure often results in revenue from the sale of not just balloon devices, but also ancillary disposable products used in a balloon procedure. For this reason, in making this calculation, we include revenue from the ancillary disposable products noted above in addition to balloon devices,
which is then divided by an estimated number of procedures based on the number of balloon sinus dilation devices sold.
|
|
•
|
We had a net loss of $3.2 million for the three months ended September 30, 2017 compared to a net loss of $9.5 million for the three months ended September 30, 2016. During the nine months ended September 30, 2017, we had a net loss of
|
23
|
|
$19.6 million compared to a net loss of $21.4 million during the nine months ended September 30, 2016. These decreases were
primarily due to a $14.9 million tax benefit realized as a result o
f the Spirox acquisition, partially offset by amortization of acquired intangible assets, a valuation adjustment of the contingent consideration, added costs of the acquired Spirox organization, transaction and integration costs associated with the Spirox
acquisition, and increased compensation and other employee-related expenses resulting from expansion of our sales and corporate staff,
costs for training following the FDA’s clearance of the XprESS family of products for treating patients with persistent E
ustachian tube
.
As of September 30, 2017, we had an accumulated deficit of $170.4 million.
|
|
•
|
On July 13, 2017, we acquired Spirox in exchange for $24.8 million in cash and 3.4 million in shares of our common stock, subject to certain adjustments, and future contingent consideration based on our net revenue annual growth from sales of Spirox’s Latera device evaluated annually during the four-year period following the transaction.
The common stock issued in connection with the transaction is subject to a lock-up agreement for a period of (i) three months from the closing date in the case of 25% of the shares, (ii) six months from the closing date in the case of an additional 25% of the shares and (iii) 12 months in the case of the remaining shares. Of the $24.8 million cash consideration, $7.5 million was deposited with an escrow agent to fund payment obligations with respect to the working capital adjustment and post-closing indemnification obligations of Spirox’s former equity holders.
|
|
•
|
In the first quarter of 2017, we completed a public offering of shares of our common stock resulting in net proceeds of approximately $45.4 million, after deducting underwriting discounts and commissions and offering expenses payable by us, and we refinanced our credit facility
with Oxford Finance LLC. Under the new credit facility, we borrowed $40.0 million in term loans in three tranches and established a $10.0 million revolving line of credit.
The $40.0 million of term loans and $8.0 million of the $10.0 million revolving line
of credit were used to retire existing indebtedness and fund the Spirox Acquisition. As of September 30, 2017, we had cash and cash equivalents of $51.5 million and $2.1 million available under the revolving line of credit,
subject to a borrowing base requirement.
|
Revenue
We derive a significant portion of our revenue from the sale of our XprESS family of products to ENT physicians, hospitals and ASCs.
We also derive revenue from the sale of certain capital equipment, including Fiagon IGS products for which we are the exclusive distributor in the United States and Canada, our Entellus Medical Shaver System and FocESS Wireless HD Camera System, additional sinus diagnostic and surgery products, including our MiniFESS and FocESS product lines, and our XeroGel product
. As a result of the Spirox acquisition, we derive revenue from the sale of the Latera device.
Our historical revenue growth has been driven by, and we expect our revenue to continue to increase in the future as a result of, the introduction of new products, continued international expansion, increased physician awareness of our products, the clinical efficacy of stand-alone balloon sinus dilation and our other products and increased insurance coverage for balloon sinus dilation procedures. Any reversal in these trends could have a negative impact on our future revenue. In addition, we have expanded our sales and marketing infrastructure to help us drive and support revenue growth and we intend to continue this expansion.
Our revenue has fluctuated, and we expect our revenue to continue to fluctuate, from quarter to quarter, as well as within each quarter, due to a variety of factors, including the demand for and pricing of our products, seasonality, the timing of new product introductions including associated physician evaluations, the level of competition including competitor product introductions and competitor pricing changes, changes in our sales organization including the number of sales representatives and associates, the timing and structure of sales incentive programs, the timing and extent of promotional pricing or volume discounts, changes in average selling prices, the timing of capital equipment purchases, the timing of stocking order purchases, acquisitions, and fluctuations in foreign currency exchange rates
.
Seasonality
Our business is typically affected by seasonality. In the first quarter, our results can be impacted by adverse weather and by the resetting of annual patient healthcare insurance plan deductibles, both of which may cause patients to delay elective procedures in which our products are used. In the second quarter, demand may be increased by the seasonal nature of allergies and the resultant onset of sinus-related symptoms. In the third quarter, the number of balloon sinus dilation and FESS procedures nationwide is historically lower than other quarters throughout the year, which we believe is attributable to the summer vacations of ENT physicians and their patients. In the fourth quarter, demand may be increased by the onset of the cold and flu season and related symptoms, as well as the desire of patients to spend the remaining balances in their flexible-spending accounts or because of lower out-of-pocket costs to patients who have met their annual deductibles under their health insurance plans.
Cost of Goods Sold and Gross Margin
Cost of goods sold for products we manufacture and assemble consists primarily of material costs, manufacturing overhead costs and direct labor. A significant portion of our cost of goods sold consists of manufacturing overhead costs. These overhead costs include the cost of quality assurance, material procurement, inventory control, facilities, equipment and operations supervision and management. Cost of goods sold for products we manufacture and assemble also includes depreciation expense for production
24
equipment, shipping costs, and royalty expense related to our licensing agreement with Acclarent, Inc. that is payable in connection with sales of certain of our manufactured products. For those p
roducts we sell as a distributor, our cost of goods sold consists primarily of transfer price. We expect cost of goods sold to increase in absolute dollars primarily as, and to the extent, our revenue grows.
We calculate gross margin as gross profit divided by revenue. Our gross margin has been and we expect will continue to be affected by a variety of factors, including product sales mix, geographic mix and prices, launch of new products, sales through distributor relationships at generally lower gross margins, production volumes, manufacturing costs and product yields, and to a lesser extent, the implementation of cost-reduction strategies. We believe our gross margins are likely to be moderately lower in future periods compared to prior year periods due to relatively faster growth in our international business and capital product lines.
Selling and Marketing Expenses
Selling and marketing expenses consist primarily of compensation for personnel, including base salaries and variable compensation associated with sales results, spending related to marketing, reimbursement and customer service functions, and stock-based compensation. Other selling and marketing expenses include training, travel expenses, promotional activities, conferences, trade shows and consulting services. If our revenue from sales of new or existing products increases, we expect our selling and marketing expenses to increase primarily as a result of increased compensation expenses for existing and new sales personnel, including stock-based compensation.
Research and Development Expenses
Research and development, or R&D, expenses consist primarily of engineering, product development, clinical studies to develop and support our products, regulatory expenses, consulting services, materials, depreciation, and other costs associated with new products and technologies in development and next generation versions of current devices. These expenses include employee and non-employee compensation, including base salaries and bonus compensation, stock-based compensation, supplies, materials, quality assurance expenses allocated to R&D programs, consulting expenses, related travel expenses and facilities expenses, in each case related to R&D programs. Clinical expenses include clinical trial management and monitoring, payments to clinical investigators, data management and travel expenses and the cost of manufacturing products for clinical trials. We expect R&D expenses to increase modestly, as increases in expenses related to developing, enhancing and commercializing new products and technologies will be only partially offset by the timing and extent of expenses relating to clinical studies. We expect R&D expenses as a percentage of revenue to vary over time depending on the level and timing of initiating new product development efforts as well as our clinical development activities.
General and Administrative Expenses
General and administrative expenses consist primarily of compensation for personnel, including base salaries and bonus compensation, spending related to finance, information technology, human resource functions and stock-based compensation. Other general and administrative expenses include consulting expenses, travel expenses, credit card processing fees, professional services fees, audit fees, insurance costs and general corporate expenses, including allocated facilities-related expenses. As we expand our commercial infrastructure to both drive and support our planned growth in revenue, we expect our general and administrative expenses will continue to increase. We also expect to continue to incur legal, accounting, insurance and other professional service fees associated with being a public company, which may increase further when we are no longer able to rely on the “emerging growth company” exemption we are afforded under the Jumpstart Our Business Startups Act of 2012, or JOBS Act.
Amortization of Intangible Assets
As part the Spirox acquisition, we acquired certain intangible assets that are being amortized over a period of three to 12 years.
Acquisition-related Expenses
Acquisition-related expenses include transaction and integration costs related to our acquisition of Spirox and our 2016 acquisition of XeroGel, as well as valuation adjustments to future contingent consideration due to the former equity holders of Spirox. Contingent consideration is remeasured to fair value each reporting period using projected revenues, discount rates, and projected payment dates. Increases or decreases in the fair value of the contingent consideration can result from changes in the timing and amount of revenue estimates as well as changes in discount periods and rates. Projected contingent payment amounts are discounted back to the current period using a discounted cash flow model. We expect to incur in future periods fair value adjustments for future contingent consideration as a result of changes in projects, discounts rates, and the passage of time.
Other Expense, Net
Other expense, net primarily consists of interest expense payable under our credit facility, interest income, and realized foreign currency gains and losses.
We expect our interest expense to increase in future periods compared to prior year periods a result of our increased term loan borrowings.
25
Recent Accounting Pronouncements
See Note B. Recent Accounting Pronouncements in the Notes to Condensed Consolidated Financial Statements in Part I of this Quarterly Report on Form 10-Q.
Results of Operations
|
Three Months Ended
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
|
|
|
|
|
(in thousands)
|
2017
|
|
2016
|
|
$ Change
|
|
% Change
|
|
|
2017
|
|
2016
|
|
$ Change
|
|
% Change
|
|
Revenue
|
$
|
23,329
|
|
$
|
17,880
|
|
$
|
5,449
|
|
|
30
|
%
|
|
$
|
64,575
|
|
$
|
53,512
|
|
$
|
11,063
|
|
|
21
|
%
|
Cost of goods sold
|
|
6,555
|
|
|
4,648
|
|
|
1,907
|
|
|
41
|
%
|
|
|
17,287
|
|
|
13,107
|
|
|
4,180
|
|
|
32
|
%
|
Gross profit
|
|
16,774
|
|
|
13,232
|
|
|
3,542
|
|
|
27
|
%
|
|
|
47,288
|
|
|
40,405
|
|
|
6,883
|
|
|
17
|
%
|
Gross margin
|
|
72
|
%
|
|
74
|
%
|
|
|
|
|
|
|
|
|
73
|
%
|
|
76
|
%
|
|
|
|
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing
|
|
18,457
|
|
|
15,364
|
|
|
3,093
|
|
|
20
|
%
|
|
|
49,743
|
|
|
41,857
|
|
|
7,886
|
|
|
19
|
%
|
Research and development
|
|
4,653
|
|
|
2,047
|
|
|
2,606
|
|
|
127
|
%
|
|
|
8,881
|
|
|
5,832
|
|
|
3,049
|
|
|
52
|
%
|
General and administrative
|
|
5,043
|
|
|
4,698
|
|
|
345
|
|
|
7
|
%
|
|
|
13,964
|
|
|
12,183
|
|
|
1,781
|
|
|
15
|
%
|
Amortization of intangible assets
|
|
1,957
|
|
|
109
|
|
|
1,848
|
|
|
1,695
|
%
|
|
|
2,313
|
|
|
111
|
|
|
2,202
|
|
|
1,984
|
%
|
Acquisition-related expenses
|
|
3,865
|
|
|
—
|
|
|
3,865
|
|
|
—
|
%
|
|
|
5,059
|
|
|
300
|
|
|
4,759
|
|
|
1,586
|
%
|
Total operating expenses
|
|
33,975
|
|
|
22,218
|
|
|
11,757
|
|
|
53
|
%
|
|
|
79,960
|
|
|
60,283
|
|
|
19,677
|
|
|
33
|
%
|
Loss from operations
|
|
(17,201
|
)
|
|
(8,986
|
)
|
|
(8,215
|
)
|
|
91
|
%
|
|
|
(32,672
|
)
|
|
(19,878
|
)
|
|
(12,794
|
)
|
|
64
|
%
|
Other expense, net
|
|
(921
|
)
|
|
(499
|
)
|
|
(422
|
)
|
|
85
|
%
|
|
|
(1,825
|
)
|
|
(1,500
|
)
|
|
(325
|
)
|
|
22
|
%
|
Loss before income tax expense
|
|
(18,122
|
)
|
|
(9,485
|
)
|
|
(8,637
|
)
|
|
91
|
%
|
|
|
(34,497
|
)
|
|
(21,378
|
)
|
|
(13,119
|
)
|
|
61
|
%
|
Income tax expense
|
|
14,882
|
|
|
(34
|
)
|
|
14,916
|
|
|
(43,871
|
)%
|
|
|
14,876
|
|
|
(34
|
)
|
|
14,910
|
|
|
(43,853
|
)%
|
Net loss
|
$
|
(3,240
|
)
|
$
|
(9,519
|
)
|
$
|
6,279
|
|
|
(66
|
)%
|
|
$
|
(19,621
|
)
|
$
|
(21,412
|
)
|
$
|
1,791
|
|
|
(8
|
)%
|
Comparison of the Three and Nine Months Ended September 30, 2017 and 2016
Revenue
Revenue increased $5.4 million, or 30%, to $23.3 million during the three months ended September 30, 2017, compared to $17.9 million during the three months ended September 30, 2016. Revenue increased $11.1 million, or 21%, to $64.6 million during the nine months ended September 30, 2017, compared to $53.5 million during the nine months ended September 30, 2016. The growth in revenue was primarily attributable to sales of new products including Latera, an increase in sales of our XprESS family of products through broader account penetration, and to a lesser extent, sales in international markets. F
oreign currency exchange rates negatively impacted revenue for the
three and nine months ended September 30, 2017
by approximately
$0.0
million and $0.1 million, respectively
.
Cost of Goods Sold and Gross Margin
Cost of goods sold increased $1.9 million, or 41%, to $6.6 million during the three months ended September 30, 2017, compared to $4.7 million during the three months ended September 30, 2016. Cost of goods sold increased $4.2 million, or 32%, to $17.3 million during the nine months ended September 30, 2017, compared to $13.1 million during the nine months ended September 30, 2016. These increases in cost of goods sold were primarily attributable to the increased sales of new products and growth in sales of our XprESS family of products and recognition of the fair value adjustment associated with inventory acquired in the Spirox acquisition, which is now fully recognized.
Gross margin decreased during the three and nine months ended September 30, 2017 compared to gross margin for the three and nine months ended September 30, 2016 due primarily to the recognition of the fair value adjustment associated with inventory acquired in the Spirox acquisition and changes in product sales mix, including increases in sales of capital equipment, as we added new product lines, and geographic mix as we expanded our international sales.
Selling and Marketing Expenses
Selling and marketing expenses increased $3.0 million, or 20%, to $18.4 million during the three months ended September 30, 2017, compared to $15.4 million during the three months ended September 30, 2016. Selling and marketing expenses increased $7.8 million, or 19%, to $49.7 million during the nine months ended September 30, 2017, compared to $41.9 million during the nine months ended September 30, 2016. These increases were primarily attributable to $3.1 million of incremental expenses related to the Spirox acquisition. In addition, for the nine months ended September 30, 2017, there was an increase in salaries, benefits, stock-based compensation, travel expenses and other employee-related expenses as a result of increased headcount in our sales and marketing organization as well as increased marketing expenses compared to the prior year period.
26
Research and Development Expenses
R&D expenses increased $2.6 million, or 127%, to $4.7 million during the three months ended September 30, 2017, compared to $2.1 million during the three months ended September 30, 2016. R&D expenses increased $3.1 million, or 52%, to $8.9 million during the nine months ended September 30, 2017, compared to $5.8 million during the nine months ended September 30, 2016. These increases were primarily due to $2.4 million of incremental expenses related to the Spirox acquisition and an increase in compensation and other employee-related expenses, partially offset by reduced engineering prototypes expense.
General and Administrative Expenses
General and administrative expenses increased $0.3 million, or 7%, to $5.0 million during the three months ended September 30, 2017, compared to $4.7 million during the three months ended September 30, 2016. The increase was primarily due to $0.8 million of incremental expenses related to the Spirox acquisition, increases of $0.2 million in salaries, stock-based compensation, benefits and other employee-related expenses and $0.2 million in consulting fees, partially offset by a $0.9 million reduction of professional fees.
General and administrative expenses increased $1.8 million, or 15%, to $14.0 million during the nine months ended September 30, 2017, compared to $12.2 million during the nine months ended September 30, 2016. The increase was primarily due to an increase of $1.1 million in salaries, stock-based compensation, benefits and other employee-related expenses and $0.8 million of incremental expenses related to the Spirox acquisition.
Amortization of Intangible Assets
As part the Spirox acquisition, we acquired certain intangible assets that are being amortized over a period of three to 12 years. In addition, for comparative purposes, we have reclassified amortization expense of $0.1 million from the third quarter and first nine months of fiscal 2016 to the amortization expense line that was originally reported in general and administrative expense. The amortization that was reclassified related to the XeroGel acquisition. We recorded $1.8 million of amortization expense related to the intangible assets acquired in the Spirox acquisition in the three and nine months ended September 30, 2017.
Acquisition-related Expenses
Acquisition-related expenses related to the Spirox acquisition for the three months ended September 30, 2017 of $3.9 million consisted of a $2.3 million valuation adjustment to the contingent consideration liability primarily due to the passage of time (i.e., accretion), $0.9 million of transaction costs and $0.7 million of integration costs.
Acquisition-related expenses related to the Spirox acquisition for the nine months ended September 30, 2017 of $5.1 million consisted of a $2.3 million valuation adjustment to the contingent consideration liability due to the former equity holders of Spirox, $2.1 million of transaction costs and $0.7 million of integration costs.
Other Expense, Net
Other expense, net, increased 85% during the three months ended September 30, 2017, compared to the three months ended September 30, 2016 and 22% during the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016. These increases were primarily due to higher interest expense as a result of borrowings under our credit facility. We expect our interest expense to increase in future periods compared to prior year periods a result of our increased term loan borrowings.
Liquidity and Capital Resources
Overview
As of September 30, 2017, we had cash and cash equivalents of $51.5 million and an accumulated deficit of $170.4 million, compared to cash and cash equivalents of $21.4 million, short-term investments of $10.8 million and an accumulated deficit of $150.8 million as of December 31, 2016. Our primary sources of capital have been from product sales, net proceeds from our IPO, our first quarter 2017 public offering, private placements of our convertible preferred securities before our IPO, and amounts borrowed under credit facilities. As of September 30, 2017, we had $40.0 million of term loans outstanding and $7.9 million outstanding under a revolving line of credit under our credit facility.
In the first quarter of 2017, we completed a public offering of shares of our common stock, issuing a total of 2.9 million shares of common stock (including 0.5 million shares issued after exercise by the underwriters of their option to purchase additional shares) at an offering price of $17.00 per share. Certain of our existing stockholders also sold approximately 1.2 million shares of common stock in the offering. We received net proceeds of approximately $45.4 million, after deducting underwriting discounts and commissions and offering expenses payable by us. We did not receive any proceeds from the sale of shares by the selling stockholders.
27
In March 2017, we entered into a new credit facility with Oxford Fina
nce LLC. Under this credit facility, we borrowed $40.0 million in term loans in three tranches and established a $10.0 million revolving line of credit. The $40.0 million term loans and $8.0 million of the $10.0 million revolving line of credit were used t
o retire existing indebtedness and fund the Spirox acquisition.
On July 13, 2017, we acquired Spirox in exchange for $24.8 million in cash and 3.4 million in shares of our common stock, subject to certain adjustments, and future contingent consideration based on our net revenue from sales of Spirox’s Latera device evaluated annually during the four-year period following the transaction. The common stock issued in connection with the transaction is subject to a lock-up agreement for a period of (i) three months from the closing date in the case of 25% of the shares, (ii) six months from the closing date in the case of an additional 25% of the shares and (iii) 12 months in the case of the remaining shares.
We have the discretion to pay the contingent consideration in shares of our common stock or cash, subject to compliance with applicable law and the Listing Rules of the NASDAQ Stock Market. A portion of the contingent consideration will be subject to certain rights of set-off for any post-closing indemnification obligations of Spirox’s former equity holders. Although there is no cap on the amount of contingent consideration earn-out that could be paid, we do not expect the cumulative undiscounted payments to exceed $80.0 million over the four-year period. We initially recorded a $50.6 million contingent consideration on the balance sheet, which was our fair value assessment of the present value of the contingent consideration at the acquisition date. The fair value assessment of this liability was $52.9 million as of September 30, 2017.
As of September 30, 2017, we had cash and cash equivalents of $51.5 million and $2.1 million available under the revolving line of credit, subject to a borrowing base requirement. Although it is difficult to predict our future liquidity requirements, we believe that our existing cash and cash equivalents, anticipated revenue and remaining amounts available under our line of credit will be sufficient to meet our anticipated capital requirements, and fund our operations beyond 2018. Further capital requirements may be necessary to fund any contingent consideration. However, we have based these estimates on assumptions that may prove to be incorrect, and we could spend our available financial resources faster than we anticipated. If our current capital sources are insufficient to satisfy our liquidity requirements, or if we choose to take advantage of new product and market opportunities to expand our business and increase our revenues, we may sell additional equity or debt securities, or refinance, restructure, or enter into a new credit facility. If we raise additional funds by issuing equity securities, our stockholders would experience dilution. Debt financing, if available, may involve additional covenants restricting our operations or our ability to incur additional debt. Any additional debt financing or equity financing may contain terms that are not favorable to us or our stockholders. Additional financing may not be available at all, or in amounts or on terms acceptable to us. If we are unable to obtain additional financing, we may be required to delay the development, commercialization and marketing of our products.
As of September 30, 2017, cash held by our foreign subsidiary that was not available to fund domestic operations unless repatriated was $0.4 million. We do not intend to repatriate this cash; however, if circumstances changed and these funds were needed for our U.S. operations, we would be required to
accrue and pay U.S. taxes to repatriate these funds.
Cash Flows
Net Cash Used in Operating Activities
|
Nine Months Ended
|
|
|
September 30,
|
|
(in thousands)
|
2017
|
|
2016
|
|
Net cash (used in) provided by:
|
|
|
|
|
|
|
Operating activities
|
$
|
(26,901
|
)
|
$
|
(13,283
|
)
|
Investing activities
|
|
(16,544
|
)
|
|
(312
|
)
|
Financing activities
|
|
73,588
|
|
|
372
|
|
Effect of exchange rate change on cash and cash equivalents
|
|
(108
|
)
|
|
(89
|
)
|
Net increase (decrease) in cash and cash equivalents
|
$
|
30,035
|
|
$
|
(13,312
|
)
|
During the nine months ended September 30, 2017, net cash used in operating activities was $26.9 million, consisting primarily of a net loss of $19.6 million, a non-cash release of a $14.9 million deferred tax asset valuation and an increase in net operating assets of $5.8 million, offset partially by $5.9 million of stock-based compensation expense, $2.3 million of contingent consideration valuation adjustments, and $5.1 million of depreciation, amortization and other non-cash items. The increase in net operating assets was primarily due to increases in accounts receivable and decreases in accrued liabilities.
During the nine months ended September 30, 2016, net cash used in operating activities was $13.3 million, consisting primarily of a net loss of $21.4 million, offset partially by $4.1 million of stock-based compensation expense, a decrease in net operating assets of $2.1 million and non-cash charges of $5.50 million. Non-cash charges consisted primarily of stock-based compensation, depreciation and amortization, the amortization of premium on investments, and the accretion of the final payment fee on our credit facility.
28
Net Cash Used in Investing Activities
During the nine months ended September 30, 2017, net cash used in investing activities was $16.5 million, consisting of $24.8 million used for the Spirox acquisition and purchases of property and equipment of $2.6 million partially offset by proceeds from short-term investment maturities of $10.8 million.
During the nine months ended September 30, 2016, net cash used in investing activities was $0.3 million, consisting of $11.0 million for consideration for the XeroGel acquisition, purchases of short-term investments of $32.2 million and the purchase of property and equipment of $3.5 million, partially offset by proceeds from short-term investment maturities of $46.3 million.
Net Cash Provided by Financing Activities
During the nine months ended September 30, 2017, net cash provided by financing activities was $73.6 million, consisting of $45.4 million in proceeds from the first quarter 2017 public offering, proceeds of $40.0 million of term loans under our new credit facility, net proceeds of $7.9 million from the revolving line of credit under our new credit facility, $1.6 million of proceeds from the exercise of stock options and common stock purchases under our employee stock purchase plan, partially offset by principal payments of $20.0 million on our prior credit facility and a final payment fee of $1.2 million under our prior credit facility.
During the nine months ended September 30, 2016, net cash provided by financing activities was $0.4 million consisting of proceeds from common stock purchases under our employee stock purchase plan and the exercise of stock options.
Credit Facility
In December 2013, we entered into an amended and restated loan and security agreement with Oxford Finance LLC. Under this credit facility, we borrowed $20.0 million at a fixed rate of 9.40%. This credit facility was scheduled to mature and all amounts borrowed thereunder were due on December 1, 2018. In February 2017, we entered into an amendment to the amended and restated loan and security agreement to allow principal payments due on February 1, 2017 and March 1, 2017 to be deferred until March 15, 2017. In March 2017, the principal payments were deferred again during renegotiations with Oxford.
In March 2017, we entered into a loan and security agreement, or Loan Agreement, with Oxford providing for a new credit facility. Under the terms of the new credit facility,
we were able to borrow up to a total of $40.0 million in term loans in three tranches
and up to $10.0 million under a revolving line of credit
, subject to a borrowing base requirement. The first term loan of $13.5 million and $8.0 million under the revolving line of credit was borrowed immediately, which was used to repay then outstanding indebtedness of approximately $20.0 million under our prior credit facility and the final payment fee totaling $1.2 million.
As of September 30, 2017, we had borrowed under the credit facility and had outstanding $40.0 million of term loan debt and $7.9 million of the available $10.0 million under the revolving line of credit.
The term loans mature and all amounts borrowed under the Loan Agreement, including the revolving line of credit, become due and payable on March 1, 2022. Each term loan bears interest at a floating per annum rate equal to the greater of (1) 7.95% and (2) the sum of (i) the greater of (A) the 30-day U.S. LIBOR rate reported in
The Wall Street Journal
on the last business day of the month that immediately precedes the month in which the interest will accrue and (B) 0.77%,
plus
(ii) 7.18%. With respect to the revolving line of credit, the floating per annum rate of interest is equal to the greater of (1) 4.95% and (2) the sum of (i) the greater of (A) 30-day U.S. LIBOR rate reported in
The Wall Street Journal
on the last business day of the month that immediately precedes the month in which the interest will accrue and (B) 0.77%,
plus
(ii) 4.18%. We are required to make monthly interest-only payments following the funding of each term loan through April 1, 2019 or, under certain circumstances, through April 1, 2020. All outstanding term loans will begin amortizing at the end of the applicable interest-only period, with monthly payments of principal and interest being made by us to the lender in consecutive monthly installments following such interest-only period.
In addition to principal and interest payments, we are required under the new
credit facility
to make a final payment fee of 4.95% on the principal amount of any term loans outstanding, which will be accrued over the term of the new credit facility and will be due at the earlier of maturity, acceleration of the revolving line of credit or term loans or prepayment of a term loan. If we repay the amounts borrowed under any term loan prior to maturity, we will be required to make a prepayment fee equal to 1.00% to 3.00% of the principal amount of such term loan prepaid, depending upon the timing of the prepayment. In addition, we are required to pay customary commitment fees and unused fees and certain other customary fees related to the lender’s administration of the new credit facility.
Our obligations under the new
credit facility
are secured by a first priority security interest in substantially all of our assets, other than our intellectual property, and under certain circumstances more than 65% of shares in any foreign subsidiary. We have agreed not to pledge or otherwise encumber our intellectual property assets, except for permitted liens, as such terms are defined in the
Loan Agreement
and except as otherwise provided for in the
Loan Agreement
.
The Loan Agreement contains affirmative and negative covenants applicable to us and any subsidiaries and events of default, in each case subject to grace periods, thresholds and materiality qualifiers, as more fully described in the Loan Agreement. The affirmative covenants include, among others, covenants requiring us to maintain our legal existence and material governmental approvals, deliver certain financial reports and maintain insurance coverage. The negative covenants include, among others,
29
restrictions on us incurring additional indebtedness, engaging in mergers, consolidations or acquis
itions, paying dividends or making other distributions, making investments, creating liens, selling assets, and suffering a change in control. The events of default include, among other things, our failure to pay any amounts due under the new credit facili
ty, a breach of covenants under the Loan Agreement, our insolvency, a material adverse change, the occurrence of a default under certain other indebtedness and the entry of final judgments against us in excess of a specified amount. If an event of default
occurs, the lender is entitled to take various actions, including the acceleration of amounts due under the
credit facility
, termination of the commitments under the
credit facility
and certain other actions available to secured creditors.
We were in compl
iance with all required covenants as of September 30, 2017.
In connection with the Spirox acquisition, we entered into a First Amendment to Loan and Security Agreement with Oxford, pursuant to which the parties thereto amended the Loan Agreement to add Spirox and Entellus Intermediate Sub, Inc., a wholly-owned subsidiary of the Company, as borrowers under the Loan Agreement (collectively, the “New Borrowers”). In addition, under the terms of such amendment, (i) the New Borrowers granted the lender a first priority security interest in substantially all of their assets, other than their intellectual property and, under certain circumstances, more than 65% of their shares in any foreign subsidiary; (ii) the trailing revenue covenant contained in the Loan Agreement and the revenue requirement for the extension of the interest-only period were increased, in each case to account for the acquisition of Spirox; (iii) the securities of the New Borrowers were pledged to the lender; (iv) deposit account control agreements were delivered with respect to the deposit accounts of the New Borrowers; and (v) we agreed to deliver certain consent and waiver documents pertaining to the assets of the New Borrowers within 30 days following the execution of the amendment.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions for the reported amounts of assets, liabilities, revenue, expenses and related disclosures. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions and any such differences may be material.
There have been no changes in our significant accounting policies for the nine months ended September 30, 2017 as compared to the significant accounting policies described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 other than the addition of the valuation of business combinations as noted below.
Valuation of Business Combinations
. The fair value of consideration, including contingent consideration, transferred in acquisitions accounted for as business combinations is first allocated to the identifiable tangible and intangible assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. Any excess purchase consideration is allocated to goodwill. Further, for those arrangements that involve liability classified contingent consideration, we record on the date of acquisition a liability equal to the fair value of the estimated additional consideration we may be obligated to make in the future. Liability classified contingent consideration is adjusted to its fair value each reporting period through earnings. Acquisition transaction costs are expensed as incurred.
The fair value of identifiable intangible assets requires management estimates and judgments based on market participant assumptions. Using alternative valuation assumptions, including estimated revenue projections, growth rates, cash flows, discount rates, estimated useful lives, and probabilities surrounding the achievement of milestones could result in different fair value estimates of our net tangible and intangible assets and related amortization expense in current and future periods.
Contingent consideration is remeasured to fair value each reporting period using projected revenues, discount rates, and projected payment dates. Projected contingent payment amounts are discounted back to the current period using a discounted cash flow model. Increases or decreases in the fair value of the contingent consideration can result from changes in the timing and amount of revenue estimates and changes in discount periods and rates. Because the fair value of contingent consideration is based on management assumptions and not observable market inputs, it is considered a Level 3 measurement. Contingent consideration valuation adjustments are recorded as operating expenses or income.
The Company’s accounting policy is to utilize deferred tax liabilities created through purchase accounting to first offset acquired deferred tax assets. The Company then utilizes any residual net deferred tax liability as a source of taxable income that can be used to support an equivalent amount of the Company’s existing deferred tax
For a detailed description of our other critical accounting policies, see the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016.
Off-Balance Sheet Arrangements
We do not maintain any off-balance sheet partnerships, arrangements or other relationships with unconsolidated entities or others, often referred to as structured finance or special-purpose entities that are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
30
Contractual Obligations
The following table sets out, as of September 30, 2017, our contractual obligations due by period:
|
Payments Due by Period
|
|
(in thousands)
|
Less than
1 Year
|
|
1-3
Years
|
|
3-5
Years
|
|
More than
5 Years
|
|
Total
|
|
Contingent consideration (1)
|
$
|
17,426
|
|
$
|
35,493
|
|
$
|
—
|
|
$
|
—
|
|
$
|
52,919
|
|
Debt obligations (2)
|
|
7,943
|
|
|
33,333
|
|
|
8,647
|
|
|
—
|
|
|
49,923
|
|
Operating lease obligations (3)
|
|
1,042
|
|
|
2,039
|
|
|
981
|
|
|
—
|
|
|
4,062
|
|
Total
|
$
|
26,411
|
|
$
|
70,865
|
|
$
|
9,628
|
|
$
|
—
|
|
$
|
106,904
|
|
_____________________
|
(1)
|
The fair value of future contingent consideration due to Spirox’s former equity holders in connection with the Spirox acquisition, based on our net revenue from sales of Spirox’s Latera device evaluated annually during the four-year period following the transaction.
|
|
(2)
|
The total amount outstanding consists of principal amount of $40.0 million under a term loan and $7.9 million under a revolving line of credit under our new credit facility. The term loan assumes a 36-month amortization period for repayment of the debt. The term loan debt amount reflected in the table is inclusive of the final payment fee of 4.95% due with the final payment. As of September 30, 2017, we accrued $0.2 million related to this obligation.
|
|
(3)
|
We currently lease our headquarters and manufacturing facilities in Plymouth, Minnesota under leases that expire in June 2021 and office facilities in Redwood City, California under a lease that expires in October 2021.
|
In June 2016, we entered into an Amended and Restated Fiagon NA Distribution Agreement, or the Distribution Agreement, with Fiagon NA Corporation in which we were granted exclusive distribution rights in the United States and Canada for Fiagon Image Guidance Systems, or Fiagon IGS, and certain components, parts and related ancillary products i) to hospitals, ii) to ENT physicians in the office, clinic, and surgery centers, and iii) under ENT healthcare system contracts. The terms of the Distribution Agreement require us to purchase minimum quantities of Fiagon IGS and certain other disposable products through August 9, 2020 in order for us to retain exclusive distribution rights.