NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND BASIS OF PRESENTATION
Business
SeaSpine Holdings Corporation was incorporated in Delaware on February 12, 2015 in connection with the spin-off of the orthobiologics and spinal instrumentation business of Integra LifeSciences Holdings Corporation, a diversified medical technology company. The spin-off occurred on July 1, 2015. Unless the context indicates otherwise, (i) references to "SeaSpine" or the "Company" refer to SeaSpine Holdings Corporation and its wholly-owned subsidiaries, and (ii) references to "Integra" refer to Integra LifeSciences Holdings Corporation and its subsidiaries other than SeaSpine.
Basis of Presentation and Principles of Consolidation
The Company prepared the unaudited interim condensed consolidated financial statements included in this report in accordance with accounting principles generally accepted in the U.S. (GAAP) for interim financial information and the rules and regulations of the Securities and Exchange Commission (SEC) related to quarterly reports on Form 10-Q.
The Company’s financial statements are presented on a consolidated basis. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. The unaudited interim condensed consolidated financial statements do not include all information and disclosures required by GAAP for annual audited financial statements and should be read in conjunction with the Company’s consolidated financial statements and notes thereto for the year ended December 31, 2016 included in the Company’s Annual Report on Form 10-K filed with the SEC. In the opinion of management, the unaudited interim condensed consolidated financial statements included in this report have been prepared on the same basis as the Company's audited consolidated financial statements and include all adjustments (consisting only of normal recurring adjustments) necessary for a fair statement of the financial position, results of operations, cash flows, and statement of equity for periods presented. The results for the three and
six
months ended
June 30, 2017
are not necessarily indicative of the results expected for the full year. The condensed consolidated balance sheet as of December 31, 2016 was derived from the audited consolidated financial statements for the year ended December 31, 2016.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities, and the reported amounts of revenues and expenses. Significant estimates affecting amounts reported or disclosed in the consolidated financial statements include allowances for doubtful accounts receivable and sales returns and other credits, net realizable value of inventories, discount rates and estimated projected cash flows used to value and test impairments of identifiable intangible and long-lived assets, assumptions related to the timing and probability of the product launch dates, discount rates matched to the estimated timing of payments, and probability of success rates and discount adjustments on the related cash flows for contingent considerations in business combinations, depreciation and amortization periods for identifiable intangible and long-lived assets, computation of taxes, valuation allowances recorded against deferred tax assets, the valuation of stock-based compensation and loss contingencies. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the current circumstances. Actual results could differ from these estimates.
Recent Accounting Standards Not Yet Adopted
The Company qualifies as an “emerging growth company” (EGC) pursuant to the provisions of the Jumpstart Our Business Startups (JOBS) Act and elected to take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended, which permits EGCs to defer compliance with new or revised accounting standards (the EGC extension) until non-issuers are required to comply with such standards. Accordingly, so long as the Company continues to qualify as an EGC, the Company will not have to adopt or comply with new or revised accounting standards until non-issuers are required to adopt or comply with such standards.
In May 2014, the Financial Accounting Standards Board (FASB) issued Update No. 2014-09,
Revenue from Contracts with
SEASPINE HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Customers (Topic 606)
. The new standard provides a five-step approach to be applied to all contracts with customers. The new standard also requires expanded disclosures about revenue recognition. The new standard as amended by ASU 2015-14 will be effective for the Company beginning on January 1, 2019, and for interim periods within annual periods beginning on January 1, 2020. The Company performed a preliminary assessment of the impact of this new standard on its consolidated financial statements. In assessing the impact, the Company has outlined all revenue streams, and considered the five steps outlined in the standard for product sales, from which substantially all the Company's revenue is generated. The Company will continue to evaluate the future impact of the new standard throughout 2017. Overall, the Company does not currently expect the adoption of the new guidance to have a material impact on the amounts reported in its consolidated financial statements, but will impact certain disclosures regarding revenue recognition.
In February 2016, the FASB issued Update No. 2016-02,
Leases (Topic 842)
. The new standard requires lessees to recognize lease liabilities and corresponding right-of-use assets for all leases with lease terms of greater than twelve months. It also changes the definition of a lease and expands the disclosure requirements of lease arrangements. The new standard must be adopted using the modified retrospective approach. The standard will be effective for the Company beginning on January 1, 2020, and interim periods within annual periods beginning on January 1, 2021, with early adoption permitted. The Company does not plan to early adopt and expects to apply the transition practical expedients allowed by the standard.
Note 11
to the Condensed Consolidated Financial Statements provides details on the Company’s current lease arrangements. While the Company continues to evaluate the impact of this new standard on its consolidated financial statements, the Company expects the primary impact will be to record right-of-use assets and lease liabilities for existing operating leases in the consolidated balance sheets. The Company does not expect the adoption of this new standard to have a material impact on its consolidated results of operations or cash flows.
In August 2016, the FASB issued Update No. 2016-15,
Statement of Cash Flows (Topic 230): Classification of Certain Cash
Receipts and Cash Payments.
This new standard addresses eight specific cash flow issues related to cash receipts and cash payments with the objective of reducing the existing diversity of presentation and classification in the statement of cash flows. The new standard will be effective for the Company beginning on January 1, 2019, and interim periods within annual periods beginning on January 1, 2020. Early adoption is permitted and should be applied using a retrospective transition method to each period presented. The Company is in the process of evaluating the impact of this standard on its consolidated financial statements.
In May 2017, the FASB issued Update No. 2017-09,
Compensation- Stock Compensation (Topic 718): Scope of Modification Accounting.
The new standard provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The new standard will be effective for the Company beginning on January 1, 2018, and interim periods within those annual periods, beginning on January 1, 2018. The new standard should be applied prospectively to an award modified on or after the adoption date. The Company is in the process of evaluating the impact of this standard on its consolidated financial statements.
Recently Adopted Accounting Standards
In August 2014, the FASB issued Update No. 2014-15,
Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern
. The amendment requires management to evaluate, for each annual and interim reporting period, whether there are conditions and events, considered in the aggregate, that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date the financial statements are issued or are available to be issued. If substantial doubt is raised, additional disclosures around management’s plan to alleviate these doubts are required. This update became effective for all annual periods and interim reporting periods ending after December 15, 2016. The implementation of the amended guidance in 2016 did not have an impact on current disclosures in the Company's consolidated financial statements.
In March 2016, the FASB issued Update No. 2016-09,
Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accountin
g. Under current accounting guidance an entity is required to report excess tax benefits and tax deficiencies to the extent of previous windfalls in equity when the tax benefit is realized. Excess settlements are currently reported as cash inflows from financing activities. The amendment requires that an entity present all excess tax benefits and all tax deficiencies as income tax expense or benefit in the statement of operations to be applied using a prospective transition method. Related tax settlements are to be presented as cash inflows from operating activities using either a prospective or retrospective transition method. The amendment removes the requirement to delay recognition of an excess tax benefit until the tax benefit is realized, which should be applied using a modified retrospective transition method.
The Company elected to early adopt ASU 2016-09 as of January 1, 2016, the beginning of the annual period that includes the interim period of adoption. Amendments related to accounting for excess tax benefits (deficiencies) have been adopted
SEASPINE HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
prospectively, and recognition of excess tax benefits (deficiencies) against income tax expenses was immaterial for the year ended December 31, 2016. The Company elected to apply the change in classification for excess tax benefits in the statement of cash flows on a prospective basis, and elected to continue estimating stock-based compensation award forfeitures in determining the amount of compensation cost to be recognized each period.
In January 2017, the FASB issued Update No. 2017-01,
Business Combinations (Topic 805)
:
Clarifying the Definition of a Business
. The amendments in this update provide a screen to determine when a set of transferred assets and activities is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. If the screen is not met, the amendments in this update (1) require that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output and (2) remove the evaluation of whether a market participant could replace missing elements. The Company elected to early adopt this guidance as of December 31, 2016 and will apply the guidance on a prospective basis.
In July 2015, the FASB issued Update No. 2015-11,
Simplifying the Measurement of Inventory (Topic 330)
. The new guidance
requires an entity to measure inventory within the scope of the amendment at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The guidance was effective for the Company beginning on January 1, 2017, and interim periods within annual periods beginning on January 1, 2018. Adoption of this new guidance has had no impact on the Company’s consolidated financial statements.
Net Loss Per Share
Basic and diluted net loss per share was calculated using the weighted-average number of shares of common stock outstanding
during the period. The weighted average number of shares used to compute diluted net loss per share excludes any assumed exercise of stock options, and any assumed issuance of common stock under restricted stock awards and units as the effect would be antidilutive. Common stock equivalents of
3.4
million and
2.8 million
shares for the three and six months ended
June 30, 2017
and 2016, respectively, were excluded from the calculation because of their antidilutive effect.
3. DEBT AND INTEREST
Credit Agreement
On December 24, 2015, the Company entered into a
three
-year credit facility (the Credit Facility), with Wells Fargo Bank, National Association. The Credit Facility provides an asset-backed revolving line of credit of up to
$30.0 million
in borrowing capacity with a maturity date of December 24, 2018, which maturity date is subject to a one-time,
one
-year extension at the Company's election. In connection with the Credit Facility, the Company was required to become a guarantor and to provide a security interest in substantially all its assets for the benefit of the counterparty.
Borrowings under the Credit Facility accrue interest at the rate then applicable to base rate loans (as customarily defined), unless and until converted into LIBOR rate loans (as customarily defined) in accordance with the terms of the Credit Facility. Borrowings bear interest at a floating annual rate equal to (a) during any month for which the Company's average excess availability (as customarily defined) is greater than
$20.0 million
, base rate plus (i)
1.25
percentage points for base rate loans and (ii) LIBOR rate plus
2.25
percentage points for LIBOR rate loans, (b) during any month for which the Company's average excess availability is greater than
$10.0 million
but less than or equal to
$20.0 million
, (i) base rate plus
1.50
percentage points for base rate loans and (ii) LIBOR rate plus
2.50
percentage points for LIBOR rate loans and (c) during any month for which the Company's average excess availability is less than or equal to
$10.0 million
, (i) base rate plus
1.75
percentage points for base rate loans and (ii) LIBOR rate plus
2.75
percentage points for LIBOR rate loans. The Company will also pay an unused line fee in an amount equal to
0.375%
per annum of the unused Credit Facility amount. The unused line fee is due and payable on the first day of each month.
In September 2016, the Company borrowed
$3.3 million
from the revolving line of credit. The Company elected to have the LIBOR rate apply to the amount borrowed with an interest period of six months commencing on September 28, 2016, which was further extended for another interest period of six months commencing on March 28, 2017. At
June 30, 2017
, there was
$4.0 million
outstanding in total debt and
$15.8 million
borrowing capacity under the Credit Facility. Debt issuance costs and legal fees related to the Credit Facility totaling
$0.4 million
were recorded as a deferred asset and are being amortized ratably over the term of the arrangement.
The Credit Facility contains various customary affirmative and negative covenants, including prohibiting the Company from incurring indebtedness without the lender’s consent. The Credit Facility also includes a financial covenant that requires the Company
SEASPINE HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
to maintain a minimum fixed charge coverage ratio of
1.10
to
1.00
for the applicable measurement period, if the Company's Total Liquidity (as defined in the Credit Facility) is less than
$5.0 million
. The Company was in compliance with all applicable covenants at
June 30, 2017
.
The Credit Facility also includes customary events of default, including events of default relating to non-payment of amounts due under the Credit Facility, material inaccuracy of representations and warranties, violation of covenants, bankruptcy and insolvency, failure to comply with health care laws, violation of certain of the Company’s existing agreements, and the occurrence of a change of control. Under the Credit Facility, if an event of default occurs, Wells Fargo Bank, National Association will have the right to terminate the commitments and accelerate the maturity of any loans outstanding.
Insurance Premium Finance Agreements
In July 2016, the Company entered into two insurance premium finance agreements (the Finance Agreements) with First Insurance Funding Corporation and AFCO Acceptance Corporation (the Lenders), under which the Lenders agreed to pay premiums, taxes and fees to insurance companies on the Company's behalf for various insurance policies. The Company financed an aggregate of
$1.2 million
under the Finance Agreements with annual interest rates between
2%
and
4%
. The Company recorded the total amounts due to the Lenders as short-term debt on the balance sheet. At
June 30, 2017
, the financed amount plus interest was paid off and no amounts were outstanding under the Finance Agreements.
4. TRANSACTIONS WITH INTEGRA
Prior to the spin-off, and pursuant to certain supply agreements subsequent to the spin-off, SeaSpine purchased a portion of raw materials and finished goods from Integra for SeaSpine's Mozaik family of products, and SeaSpine contract manufactured certain finished goods for Integra. The Company's purchases of raw materials and Mozaik product finished goods from Integra totaled
$0.3 million
and
$0.5 million
for the three months ended
June 30, 2017
and 2016, respectively, and
$0.3 million
and
$1.0 million
for the six months ended
June 30, 2017
and 2016, respectively. The Company's sale of finished goods sold to Integra under its contract manufacturing arrangement totaled
$0.2 million
and
$0.4 million
for the three and six months ended
June 30, 2017
, respectively, and
$0.2 million
for both the three and
six
months ended
June 30, 2016
.
Pursuant to a transition services agreement, Integra and SeaSpine provided certain services to one another following the spin-off, and Integra and SeaSpine will indemnify each other against certain liabilities arising from their respective businesses. Under this agreement, Integra provided the Company with certain support functions, including information technology, accounting and other financial functions, regulatory affairs and quality assurance, human resources and other administrative support. The Company incurred no costs under the agreement for the three and
six
months ended
June 30, 2017
and approximately
$0.1 million
and
$0.3 million
of costs under the agreement for the three and
six
months ended
June 30, 2016
, respectively. Subsequent to the spin-off, Integra also collected trade receivables from customers on behalf of the Company. The outstanding amount owed by Integra to the Company was immaterial as of
June 30, 2017
and December 31, 2016.
5. INVENTORIES
Inventories consisted of the following:
|
|
|
|
|
|
|
|
|
|
June 30, 2017
|
|
December 31, 2016
|
|
(In thousands)
|
Finished goods
|
$
|
30,965
|
|
|
$
|
30,922
|
|
Work in process
|
8,345
|
|
|
10,554
|
|
Raw materials
|
3,205
|
|
|
3,823
|
|
|
$
|
42,515
|
|
|
$
|
45,299
|
|
6. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at historical cost less accumulated depreciation and any impairment charges. The Company provides for depreciation using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the lesser of the lease term or the useful life. The cost of major additions and improvements is capitalized, while maintenance and repair costs that do not improve or extend the lives of the respective assets are charged to operations as incurred. The cost of computer software obtained for internal use is accounted for in accordance with the Accounting Standards Codification (ASC) 350-40,
Internal-Use Software.
The cost of purchased spinal instruments which the Company consigns to hospitals and independent sales agents to support surgeries is initially capitalized as construction in progress. The amount is then reclassified to spinal instrument sets and
SEASPINE HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
depreciation is initiated when instruments are put together in a newly built set with spinal implants, or directly expensed for the instruments that are used to replace damaged instruments in an existing set. The depreciation expense and direct expense for replacement instruments are recorded in selling, general and administrative expense.
Property, plant and equipment balances and corresponding useful lives were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2017
|
|
December 31, 2016
|
|
Useful Lives
|
|
(In thousands)
|
|
|
Leasehold improvement
|
$
|
5,222
|
|
|
$
|
5,003
|
|
|
Lease Term
|
Machinery and production equipment
|
7,016
|
|
|
6,826
|
|
|
3-10 years
|
Spinal instrument sets
|
22,544
|
|
|
26,618
|
|
|
5 years
|
Information systems and hardware
|
7,283
|
|
|
6,918
|
|
|
3-7 years
|
Furniture and fixtures
|
1,072
|
|
|
1,058
|
|
|
3-5 years
|
Construction in progress
|
8,627
|
|
|
7,828
|
|
|
|
Total
|
51,764
|
|
|
54,251
|
|
|
|
Less accumulated depreciation and amortization
|
(28,778
|
)
|
|
(32,388
|
)
|
|
|
Property, plant and equipment, net
|
$
|
22,986
|
|
|
$
|
21,863
|
|
|
|
Depreciation and amortization expenses totaled
$1.0 million
and
$1.1 million
for the three months ended
June 30, 2017
and 2016, respectively, and
$2.0 million
and
$2.3 million
for the
six
months ended
June 30, 2017
and 2016, respectively. The cost of purchased instruments used to replace damaged instruments in existing sets and recorded directly to the instrument replacement expense totaled
$0.2 million
for each of the three months ended
June 30, 2017
and 2016, and
$0.7 million
and
$0.8 million
for the
six
months ended
June 30, 2017
and 2016, respectively.
For the three and six months ended June 30, 2016, the Company recorded impairment charges totaling
$0.6 million
and
$0.7 million
, respectively, against spinal instruments that are no longer expected to place into service. No impairment charges against spinal instruments were recorded for the three or six months ended June 30, 2017.
7. IDENTIFIABLE INTANGIBLE ASSETS
Identifiable intangible assets are initially recorded at fair value at the time of acquisition, generally using an income or cost approach. The Company capitalizes costs incurred to renew or extend the term of recognized intangible assets and amortizes those costs over their expected useful lives.
The components of the Company’s identifiable intangible assets were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2017
|
|
Weighted
Average
Life
|
|
Cost
|
|
Accumulated
Amortization
|
|
Net
|
|
(Dollars in thousands)
|
Product technology
|
12 years
|
|
$
|
40,769
|
|
|
$
|
(24,051
|
)
|
|
$
|
16,718
|
|
Customer relationships
|
12 years
|
|
56,830
|
|
|
(34,980
|
)
|
|
21,850
|
|
Trademarks/brand names
|
—
|
|
300
|
|
|
(300
|
)
|
|
—
|
|
|
|
|
$
|
97,899
|
|
|
$
|
(59,331
|
)
|
|
$
|
38,568
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
Weighted
Average
Life
|
|
Cost
|
|
Accumulated
Amortization
|
|
Net
|
|
(Dollars in thousands)
|
Product technology
|
12 years
|
|
$
|
40,569
|
|
|
$
|
(22,218
|
)
|
|
$
|
18,351
|
|
Customer relationships
|
12 years
|
|
56,830
|
|
|
(33,396
|
)
|
|
23,434
|
|
Trademarks/brand names
|
—
|
|
300
|
|
|
(300
|
)
|
|
—
|
|
|
|
|
$
|
97,699
|
|
|
$
|
(55,914
|
)
|
|
$
|
41,785
|
|
SEASPINE HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Annual amortization expense (including amounts reported in cost of goods sold) is expected to be approximately
$6.8 million
in
2017
,
$6.5 million
in
2018
,
$5.8 million
in
2019
,
$4.9 million
in
2020
and
$4.9 million
in
2021
. Amortization expense totaled
$1.7 million
and
$1.9 million
for the three months ended
June 30, 2017
and 2016, respectively, and included
$0.9 million
and
$0.6 million
, respectively, of amortization of product technology intangible assets that is presented within cost of goods sold. Amortization expense totaled
$3.4 million
and
$3.9 million
for the
six
months ended
June 30, 2017
and 2016, respectively, and included
$1.8 million
and
$1.3 million
, respectively, of amortization of product technology intangible assets that is presented within cost of goods sold.
8. BUSINESS COMBINATIONS
In August 2016, the Company entered into an asset purchase agreement with N.L.T Spine Ltd. (NLT), and NLT Spine, Inc., a wholly owned subsidiary of NLT, pursuant to which the Company agreed to purchase certain of the assets of NLT’s medical device business, including substantially all of NLT’s medical device intellectual property related to the ownership, design, development, manufacture, marketing and commercial exploitation of certain expandable interbody devices. The acquisition was undertaken to increase the Company's product offering in expandable interbody devices.
Upon the terms and subject to the conditions of the acquisition agreement, at the initial closing (as defined in the agreement), the Company entered into (i) an exclusive license agreement with NLT, pursuant to which the Company received an exclusive, worldwide license to make, use, import, offer for sale, sell and otherwise commercially exploit NLT’s expandable interbody device products , (ii) a transition services agreement with NLT, pursuant to which NLT agreed to provide certain services with respect to the continued development of the acquired intellectual property and (iii) a non-competition and non-solicitation agreement with NLT, pursuant to which NLT and its affiliates agreed not to compete with the Company with respect to the acquired intellectual property, subject to certain exceptions.
The purchase price consisted of an initial cash payment to NLT of
$1.0 million
, which was paid on September 26, 2016 upon the initial closing, and the issuance of
350,000
shares of the Company’s common stock with the total fair value of
$2.5 million
at issuance in January 2017 as contingent closing consideration upon the satisfaction of certain conditions, including FDA 510(K) clearance of one of the acquired product technologies. In accordance with the terms of the asset purchase agreement, the number of shares issued was determined based on the volume weighted average closing price (VWAP) of the common stock during the 20 trading day period ending one trading day prior to the issuance date, subject to a minimum and maximum VWAP of
$10.00
and $
17.00
, respectively. The VWAP over such
20
-trading day period was
$7.58
and therefore
$10.00
was used.
The Company is also obligated to pay up to a maximum of
$5.0 million
in milestone payments, payable at the Company's election in cash or in shares of its common stock, which are contingent on the Company's achievement of four independent events related to the commercialization of the acquired product technologies. Additionally, the Company is required to pay royalty payments, in cash, to NLT equal to declining (over time) percentages of the Company’s future net sales of certain of the acquired product technologies not to exceed
$43.0 million
in the aggregate. The Company has the option to terminate any future obligation to make royalty payments by making a one-time cash payment to NLT of
$18.0 million
.
The Company accounted for this transaction as a business combination in accordance with ASC 805
Business Combinations
, and as such, the assets acquired have been recorded at their respective fair values. There were no liabilities assumed. The determination of fair value for the identifiable intangible assets acquired requires extensive use of estimates and judgments. Significant estimates include, measurements estimating cash flows and determining the appropriate discount rate, which are considered Level 3 inputs, as defined using the fair value concepts defined in ASC 820. Intangible assets acquired were valued at
$9.3 million
as of the initial closing date and recorded as product technology intangible assets, which are being amortized ratably over a useful life of
10
years from the initial closing. Acquisition costs of
$0.5 million
incurred were recorded as selling, marketing and administrative expenses.
The following table summarizes the estimated fair value of total consideration to be paid to NLT as of September 26, 2016, the date of the initial closing. The Company estimated the fair value of the contingent consideration, including contingent milestone payments and contingent royalty payments, using a probability weighted approach that considers the possible outcomes based on assumptions related to the timing and probability of the product launch dates, discount rates matched to the timing of payments, and probability of success rates and discount adjustments on the related cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liabilities will be remeasured at current fair value with changes to be recorded in the consolidated statements of operations. The total purchase price was allocated entirely to product technology intangible asset.
SEASPINE HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
|
|
|
|
|
(In thousands)
|
|
Cash paid for purchase
|
$
|
1,000
|
|
Contingent closing consideration
|
2,930
|
|
Contingent milestone payments
|
2,310
|
|
Contingent royalty payments
|
3,010
|
|
Total purchase price
|
$
|
9,250
|
|
The unaudited pro forma financial information set forth below assumes that the NLT purchased assets had been acquired on January 1, 2016. The unaudited pro forma financial information includes the effect of estimated amortization charges for acquired intangible assets of
$0.2 million
and
$0.4 million
for the three and six months ended
June 30, 2016
, respectively, and the estimated research and development expenses for the purchased assets of
$0.3 million
and
$0.6 million
for the three and six months ended
June 30, 2016
, respectively. There was no adjustment to the total revenues. The unaudited pro forma information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of the periods presented.
The actual amortization charges for acquired intangible assets and research and development expenses for the purchased assets are included in the consolidated statement of operations for the three and six months ended June 30, 2017, and therefore no adjustment was made to such statement.
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
(In thousands, except per share data)
|
2016
|
|
2016
|
Operating loss
|
$
|
(12,685
|
)
|
|
$
|
(25,483
|
)
|
Net loss
|
(12,488
|
)
|
|
(25,001
|
)
|
Net loss per share, basic and diluted
|
$
|
(1.12
|
)
|
|
$
|
(2.24
|
)
|
Weighted average shares used to compute basic and diluted net loss per share
|
11,179
|
|
|
11,173
|
|
9. FAIR VALUE MEASUREMENTS
The fair values of the Company’s assets and liabilities, including contingent consideration liabilities, are measured at fair value on a recurring basis, and are determined under the fair value categories as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
Quoted Price in Active Market (Level 1)
|
|
Significant Other Observable Inputs (Level 2)
|
|
Significant Unobservable Inputs (Level 3)
|
June 30, 2017:
|
|
|
|
|
|
|
|
|
Contingent consideration liabilities- current
|
|
$
|
1,860
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,860
|
|
Contingent consideration liabilities- non-current
|
|
3,917
|
|
|
—
|
|
|
—
|
|
|
3,917
|
|
Total contingent consideration
|
|
$
|
5,777
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
5,777
|
|
Contingent consideration liabilities are classified within Level 3 of the fair value hierarchy because they use significant unobservable inputs. For those liabilities, fair value is determined using a probability-weighted discounted cash flow model, and the significant inputs which are not observable in the market. The significant inputs include assumptions related to the timing and probability of the product launch dates, discount rates matched to the timing of payments, and probability of success rates.
The following table sets forth the changes in the estimated fair value of the Company’s liabilities measured on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2017. The gain from change in fair value of contingent closing consideration is the difference between the fair value of shares expected to be issued to NLT based on assumptions as of December 31, 2016, including the forecasted issuance date and stock price and the fair value of the shares actually issued to NLT on January 31, 2017. The loss from change in fair value of contingent milestone and royalty payments resulted from the passage of time, updated discount rates matched to the estimated timing of payments, actual net sales of certain products for the three and six months ended June 30, 2017, and updated estimated net sales for the remaining of 2017.
SEASPINE HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
|
|
|
|
|
|
Three months ended June 30, 2017
|
|
(in thousands)
|
|
Balance as of March 31, 2017
|
|
5,617
|
|
Loss from change in fair value of contingent milestone and royalty payments recorded in selling, general and administrative expenses
|
|
160
|
|
Fair value at June 30, 2017
|
|
$
|
5,777
|
|
|
|
|
|
|
|
Six months ended June 30, 2017
|
|
(in thousands)
|
|
Balance as of January 1, 2017
|
|
$
|
7,980
|
|
Contingent consideration liabilities settled
|
|
(2,548
|
)
|
Gain from change in fair value of contingent closing consideration recorded in other income
|
|
(112
|
)
|
Loss from change in fair value of contingent milestone and royalty payments recorded in selling, general and administrative expenses
|
|
457
|
|
Fair value at June 30, 2017
|
|
$
|
5,777
|
|
SEASPINE HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
10. EQUITY AND STOCK-BASED COMPENSATION
Common Stock
On January 31, 2017, the Company issued
350,000
shares of common stock to NLT as the settlement of contingent closing consideration pursuant to the terms of the asset purchase agreement entered into with NLT in August 2016. The total fair value of such shares was
$2.5 million
at issuance. See
Note 8, "Business Combinations"
above.
In August 2016, the Company entered into an equity distribution agreement (Distribution Agreement) with Piper Jaffray & Co. (Piper Jaffray), pursuant to which the Company may offer and sell shares of its common stock in “at the market” (ATM) offerings (as defined in Rule 415 of the Securities Act of 1933, as amended) having an aggregate offering price up to
$25.0 million
in gross proceeds from time to time through Piper Jaffray acting as sales agent. The shares offered and sold under the Distribution Agreement are covered by a registration statement on Form S-3 that was declared effective on August 24, 2016. Under the Distribution Agreement, during the three months ended June 30, 2017, the Company sold
477,478
shares of common stock at an average price per share of
$10.03
and received net proceeds of approximately
$4.6 million
, net of offering costs. The Company intends to use the net proceeds for general corporate purposes, including sales and marketing expenditures aimed at growing its business, and research and development expenditures focused on product development. The Company has the capacity to issue up to approximately
$20.2 million
of additional shares of common stock under the Distribution Agreement as of June 30, 2017. Future sales, if any, will depend on a variety of factors including, but not limited to, market conditions, the trading price of the Company’s common stock and the Company’s capital needs.
Subsequent to June 30, 2017, the Company sold an additional
522,522
shares of common stock at an average price per share of
$12.18
and received net proceeds of approximately
$6.0 million
, net of offering costs.
Equity Award Plans
As of June 30, 2015, Integra had stock options, restricted stock awards, performance stock awards, contract stock awards and restricted stock units outstanding under three plans, the 2000 Equity Incentive Plan, the 2001 Equity Incentive Plan, and the 2003 Equity Incentive Plan. In connection with the spin-off, Integra equity awards granted to individuals who became employees of SeaSpine were converted to equity awards denominated in SeaSpine common stock. In general, each post-conversion award is subject to the same terms and conditions as were applicable to the pre-conversion award.
In May 2015, the Company adopted the 2015 Incentive Award Plan (the 2015 Plan), under which the Company can grant its employees and non-employee directors incentive stock options and non-qualified stock options, restricted stock, performance stock, dividend equivalent rights, stock appreciation rights, stock payment awards and other incentive awards. The Company may issue up to
2,000,000
shares of its common stock under the 2015 Plan. On January 27, 2016, the Company's board of directors approved an amendment and restatement of the 2015 Plan, pursuant to which the share reserve was increased by
300,000
shares over the original share reserve under the 2015 Plan, and on March 30, 2016, the board of directors approved a second amendment and restatement of the 2015 Plan, pursuant to which the share reserve was increased by an additional
1,209,500
shares of common stock. The Company's stockholders approved such amendments and restatements on June 7, 2016. An aggregate of
3,509,500
shares are reserved for issuance under the second amended and restated 2015 Plan. As of
June 30, 2017
, there were
307,634
shares available to grant under the second amended and restated 2015 Plan.
In 2016, the Company established the 2016 Employment Inducement Incentive Award Plan (the 2016 Plan). The plan is a broad-based incentive plan which allows for the issuance of stock-based awards, including non-qualified stock options, restricted stock awards, performance awards, restricted stock unit awards and stock appreciation rights, to any prospective officer or other employee who has not previously been an employee or director of SeaSpine or an affiliate or who is commencing employment with SeaSpine or an affiliate following a bona-fide period of non-employment by SeaSpine or an affiliate. An aggregate of
1,000,000
shares are reserved for issuance under the 2016 Plan. The Company has not awarded any shares under the 2016 Plan as of
June 30, 2017
.
Restricted Stock Awards and Restricted Stock Units
The Company expenses the fair value of restricted stock awards and restricted stock units on an accelerated basis over the vesting period or requisite service period, whichever is shorter. Stock-based compensation expense related to restricted stock awards, and restricted stock units includes an estimate for forfeitures. The expected forfeiture rate of all equity-based compensation is based on historical experience of pre-vesting forfeitures on awards by each homogenous group of shareowners and is estimated to be
12%
annually for all non-executive employees for the
six
months ended
June 30, 2017
and
10%
annually
SEASPINE HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
for the
six
months ended
June 30, 2016
. There is no forfeiture rate applied for non-employee directors and executive employees as their pre-vesting forfeitures are anticipated to be highly unlikely. As individual grant awards become fully vested, stock-based compensation expense is adjusted to recognize actual forfeitures.
During the three and
six
months ended
June 30, 2017
, the Company granted
116,628
and
120,610
shares of restricted stock awards to non-employee directors, respectively, and
13,153
and
743,955
shares of restricted stock units to employees, respectively. Of the total restricted stock units granted to employees,
131,523
shares were issued for bonuses earned under the annual incentive program for corporate and individual performance in 2016. During the three and six months ended June 30, 2016, the Company granted
75,075
shares of restricted stock awards to non-employee directors. There were no restricted stock units granted during the three or six months ended June 30, 2016. As of
June 30, 2017
, there was approximately
$4.2 million
of total unrecognized compensation expense related to the unvested portions of restricted stock awards and units. This cost is expected to be recognized over a weighted-average period of approximately
1.3 years
.
Stock Options
Stock option grants to employees generally have requisite service periods of four years, and stock option grants to non-employee directors generally have a requisite service period of one year. Both are subject to graded vesting. The Company records stock-based compensation expense associated with stock options on an accelerated basis over the various vesting periods within each grant and based on their fair value at the date of grant using the Black-Scholes-Merton option pricing model. There were
zero
and
156,492
stock options granted during the three months ended June 30, 2017 and 2016, respectively, and
21,500
and
857,024
stock options granted during the six months ended June 30, 2017 and 2016, respectively. The following weighted-average assumptions were used in the calculation of fair value for options grants for the three and
six
months ended June 30, 2017 and 2016, respectively.
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2016
|
|
2017
|
|
2016
|
Expected dividend yield
|
0
|
%
|
|
0
|
%
|
|
0
|
%
|
Risk-free interest rate
|
1.2
|
%
|
|
2.0
|
%
|
|
1.3
|
%
|
Expected volatility
|
38.2
|
%
|
|
35.7
|
%
|
|
38.3
|
%
|
Expected term (in years)
|
4.8
|
|
|
5.1
|
|
|
4.9
|
|
The Company considered that it has never paid cash dividends and does not currently intend to pay cash dividends. The risk-free interest rates are derived from the U.S. Treasury yield curve in effect on the date of grant for instruments with a remaining term similar to the expected term of the options. Due to the Company’s limited historical data, the expected volatility is calculated based upon the historical volatility of comparable companies in the medical device industry whose share prices are publicly available for a sufficient period of time. The expected term of "plain vanilla" options is calculated using the simplified method as prescribed by accounting guidance for stock-based compensation. A "plain vanilla" option is an option with the following characteristics: (1) the option is granted at-the-money; (2) exercisability is conditional only on satisfaction of a service condition through the vesting date; (3) employees who terminate their service prior to vesting forfeit the options; (4) employees who terminate their service after vesting are granted limited time to exercise their stock options; and (5) the options are nontransferable and non-hedgeable. The expected term of any other option is based on disclosures from similar companies with similar grants. In addition, the Company applies an expected forfeiture rate when amortizing stock-based compensation expense. The expected forfeiture rate of stock options is based on historical experience of pre-vesting forfeitures on awards by each homogenous group of shareowners and is estimated to be
12%
annually for all non-executive employees for the six months ended
June 30, 2017
, and
10%
annually for the six months ended
June 30, 2016
. There is no forfeiture rate applied for non-employee directors and executive employees as their pre-vesting forfeitures are anticipated to be highly unlikely. As individual grant awards become fully vested, stock-based compensation expense is adjusted to recognize actual forfeitures.
As of
June 30, 2017
, there was approximately
$1.6 million
of total unrecognized compensation expense related to unvested stock options. This cost is expected to be recognized over a weighted-average period of approximately
1.2
years.
Employee Stock Purchase Plan
In May 2015, the Company adopted a 2015 Employee Stock Purchase Plan, which was amended in December 2015 (as amended, the ESPP). Under the ESPP, eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to
15%
of eligible compensation during an offering period. Generally, each offering will be for a period of twenty-four months as determined by the Company's board of directors. There are four six-month purchase periods in each offering period for contributions to be made and to be converted into shares at the end of the purchase period. In no event
SEASPINE HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
may an employee purchase more than
2,500
shares per purchase period based on the closing price on the first trading date of an offering period or more than
$25,000
worth of stock during each calendar year. The purchase price for shares to be purchased under the ESPP is
85%
of the lesser of the market price of the Company's common stock on the first trading date of an offering period or any purchase date during an offering period (June 30 or December 31).
The ESPP authorizes the issuance of up to
400,000
shares of common stock pursuant to purchase rights granted to employees. The ESPP is intended to qualify as an “employee stock purchase plan” within the meaning of Section 423 of the Internal Revenue Code of 1986, as amended (the IRC). The first offering period under the ESPP commenced on January 1, 2016 and will end on December 31, 2017. However, the ESPP contains a restart feature, such that if the market price of the stock at the end of any six-month purchase period is lower than the stock price at the original grant date of an offering period, that offering period will terminate after that purchase date, and a new two-year offering period will commence on the January 1 or July 1 immediately following the date the original offering period terminated. This restart feature was first triggered on the purchase date that occurred on June 30, 2016, such that the offering period that commenced on January 1, 2016 was terminated, and a new two-year offering period commenced on July 1, 2016. This restart feature was triggered again on the purchase date that occurred on December 31, 2016, such that the offering period that commenced on July 1, 2016 was terminated, and a new two-year offering period commenced on January 1, 2017 and will end on December 31, 2018. The Company applied share-based payment modification accounting to the awards that were initially valued at the grant date to determine the amount of any incremental fair value associated with the modified awards. The impact to stock-based compensation expense for modifications during the three and six months ended
June 30, 2017
was immaterial.
During the
six
months ended
June 30, 2017
and 2016, there were
70,537
and
39,955
shares of common stock, respectively, purchased under the ESPP.
The Company estimates the fair value of shares issued to employees under the ESPP using the Black-Scholes-Merton option-pricing model. The following weighted average assumptions were used in the calculation of fair value of shares under the ESPP at the grant date for the three and
six
months ended
June 30, 2017
and 2016, respectively:
|
|
|
|
|
|
|
|
Three and Six Months Ended June 30,
|
|
2017
|
|
2016
|
Expected dividend yield
|
0
|
%
|
|
0
|
%
|
Risk-free interest rate
|
1.0
|
%
|
|
0.7
|
%
|
Expected volatility
|
28.5
|
%
|
|
32.4
|
%
|
Expected term (in years)
|
1.3
|
|
|
1.3
|
|
11. LEASES
The Company leases administrative, manufacturing, research, and distribution facilities and various manufacturing, office and transportation equipment through operating lease agreements. During the
six
months ended
June 30, 2017
, the Company entered into two lease agreements: one for an office located in Wayne, Pennsylvania, where the Company designs spinal implants and which facilitates the Company's interactions with customers on the East Coast, and another for an office located in Lyon, France, which serves as the Company's international sales and marketing office. The terms of these two new lease agreements are through July 2022 and February 2026, respectively, and both have an average annual cost of less than
$0.1 million
.
Future minimum lease payments under the Company's operating leases at
June 30, 2017
are as follows:
|
|
|
|
|
|
Payments Due by Calendar Year
|
|
|
(In thousands)
|
|
2017
|
$
|
954
|
|
2018
|
2,052
|
|
2019
|
2,100
|
|
2020
|
2,156
|
|
2021
|
2,212
|
|
Thereafter
|
8,474
|
|
Total minimum lease payments
|
$
|
17,948
|
|
SEASPINE HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Total rental expense for the three months ended
June 30, 2017
and 2016 was
$0.6 million
and
$0.8 million
, respectively, and
$1.1 million
and
$1.6 million
for the
six
months ended
June 30, 2017
and 2016, respectively.
12. INCOME TAXES
The following table provides a summary of the Company’s effective tax rate for the
three and six
months ended
June 30, 2017
and
2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
|
|
|
|
|
|
|
|
Reported tax rate
|
(0.6
|
)%
|
|
3.5
|
%
|
|
(0.3
|
)%
|
|
1.9
|
%
|
The Company reported an income tax expense for the three and six months ended June 30, 2017 primarily related to foreign and state operations.
The Company reported an income tax benefit for the three and six months ended June 30, 2016 which was primarily the result of a refund of tax initially paid toward the income tax return for our U.S. subsidiary which was not part of the U.S consolidated tax group for the tax period January 1, 2015 through August 31, 2015.
In addition, for all periods presented, the pretax losses incurred by the consolidated U.S. tax group received no corresponding tax benefit because the Company has concluded that it is more likely than not that the Company will be unable to realize the value of any resulting deferred tax assets. The Company will continue to assess its position in future periods to determine if it is appropriate to reduce a portion of its valuation allowance in the future.
13. COMMITMENTS AND CONTINGENCIES
In consideration for certain technology, manufacturing, distribution, and selling rights and licenses granted to the Company, the Company has agreed to pay royalties on sales of certain products sold by the Company. The royalty payments that the Company made under these agreements were included in the consolidated statements of operations as a component of cost of goods sold.
The Company is subject to various claims, lawsuits and proceedings in the ordinary course of its business with respect to its products, its current or former employees, and involving commercial disputes, some of which have been settled by the Company. In the opinion of management, such claims are either adequately covered by insurance or otherwise indemnified, or are not expected, individually or in the aggregate, to result in a material adverse effect on the Company's financial condition. However, it is possible that the Company's results of operations, financial position and cash flows in a particular period could be materially affected by these contingencies.
The Company accrues for loss contingencies when it is deemed probable that a loss has been incurred and that loss is estimable. The amounts accrued are based on the full amount of the estimated loss before considering insurance proceeds, and do not include an estimate for legal fees expected to be incurred in connection with the loss contingency. The Company does not believe there are any pending legal proceedings that would have a material impact on the Company’s financial position, cash flows or results of operations.
SEASPINE HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
14. SEGMENT AND GEOGRAPHIC INFORMATION
Management assessed its segment reporting based on how it internally manages and reports the results of its business to its chief operating decision maker. The Company’s management reviews financial results, manages the business and allocates resources on an aggregate basis. Therefore, financial results are reported in a single operating segment: the development, manufacture and marketing of orthobiologics and spinal instrumentation. The Company reports revenue in
two
product categories: orthobiologics and spinal instrumentation. Orthobiologics products consist of a broad range of advanced and traditional bone graft substitutes that are designed to improve bone fusion rates following surgery. The spinal instrumentation portfolio consists of an extensive line of products for minimally invasive surgery, complex spine, deformity and degenerative procedures.
Revenue, net consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Orthobiologics
|
$
|
17,615
|
|
|
$
|
16,805
|
|
|
$
|
34,740
|
|
|
$
|
33,463
|
|
Spinal instrumentation
|
16,581
|
|
|
16,396
|
|
|
31,350
|
|
|
31,137
|
|
Total revenue, net
|
$
|
34,196
|
|
|
$
|
33,201
|
|
|
$
|
66,090
|
|
|
$
|
64,600
|
|
The Company attributes revenues to geographic areas based on the location of the customer. Total revenue by major geographic area consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
Six Months Ended June 30,
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
United States
|
$
|
30,353
|
|
|
$
|
30,012
|
|
|
$
|
58,964
|
|
|
$
|
58,556
|
|
International
|
3,843
|
|
|
3,189
|
|
|
7,126
|
|
|
6,044
|
|
Total revenue, net
|
$
|
34,196
|
|
|
$
|
33,201
|
|
|
$
|
66,090
|
|
|
$
|
64,600
|
|