UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

 

 

For the transition period from              to                                

 

Commission file number: 001-36709

SIENTRA, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

 

(805) 562-3500

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  ☒   No  ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  ☒   No  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐   No ☒

 

As of November 4, 2016, the number of outstanding shares of the registrant’s common stock, par value $0.01 per share, was 18,594,257.

 

 

 

SIENTRA, INC.

 

FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2016

 

TABLE OF CONTENTS

 

 

 

 

 

 

PART I — FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

SIENTRA, INC.

Condensed Balance Sheets

(In thousands, except per share and share amounts)

(Unaudited)

 

 

See accompanying notes to condensed financial statements.

 

 

SIENTRA, INC.

Condensed Statements of Operations

(In thousands, except per share and share amounts)

(Unaudited)

 

 

See accompanying notes to condensed financial statements.

SIENTRA, INC.

Condensed Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

See accompanying notes to condensed financial statements.

 

 

 

SIENTRA, INC.

Notes to the Condensed Financial Statements

(Unaudited)

 

1. Formation and Business of the Company

 

a.Formation

 

Sientra, Inc., or the Company, was incorporated in the State of Delaware on August 29, 2003 under the name Juliet Medical, Inc. and subsequently changed its name to Sientra, Inc. in April 2007. The Company acquired substantially all the assets of Silimed, Inc. on April 4, 2007. The purpose of the acquisition was to acquire the rights to the silicone breast implant clinical trials, related product specifications and premarket approval, or PMA, assets. Following this acquisition, the Company focused on completing the clinical trials to gain Food and Drug Administration, or FDA, approval to offer its silicone gel breast implants in the United States. 

In March 2012, Sientra announced it had received approval from the FDA for its portfolio of silicone gel breast implants, and in the second quarter of 2012 the Company began commercialization efforts to sell its products in the United States. The Company, based in Santa Barbara, California, is a medical aesthetics company that focuses on serving board-certified plastic surgeons and offers a portfolio of silicone shaped and round breast implants, scar management, tissue expanders, and body contouring products.

In November 2014, the Company completed an initial public offering, or IPO, and its common stock is listed on the Nasdaq Stock Exchange under the symbol “SIEN.”

b.    Follow-On Offering

 

On September 23, 2015, the Company closed a follow-on public offering, whereby it sold 3,000,000 shares of its common stock, at a price to the public of $22.00 per share. The Company received net proceeds from the follow-on offering of approximately $61.4 million after deducting underwriting discounts and commissions of $4.0 million and offering expenses of approximately $0.6 million.

 

c.    Regulatory Inquiries Regarding Products Manufactured by Silimed

 

There have been recent regulatory inquiries related to medical devices manufactured by Silimed Industria de Implantes Ltda. (formerly, Silimed-Silicone e Instrumental Medico-Cirugio e Hospitalar Ltda.), or Silimed, the Company’s sole source contract manufacturer for its silicone gel breast implants and certain other products.

On September 23, 2015, the Medicines and Healthcare Products Regulatory Agency, or MHRA, an executive agency of the United Kingdom, or U.K., issued a press release announcing the suspension of sales and implanting in the U.K. of all medical devices manufactured by Silimed following the suspension of the CE certificate of these products issued by TUV SUD, Silimed’s notified body under European Union, or EU, regulation. The suspension of Silimed’s CE certificate by TUV SUD followed TUV SUD’s inspection at Silimed’s manufacturing facilities in Brazil, relating to surface particles on Silimed breast products. Breast implants have stringent standards for manufacturing and robust quality systems, but there is no specific or defined standard for surface particles on breast implants. MHRA noted that no risks to patient health have been identified in connection with implanting Silimed products, and, accordingly, there is no need to adopt any procedure or action for those patients who have received them.

On October 2, 2015, the Brazilian regulatory agency ANVISA and the Department of the Secretary of State of the State of Rio de Janeiro announced that as a precautionary measure, they temporarily suspended the manufacturing and shipment of all medical devices made by Silimed, including products manufactured for Sientra, while they continue to review the technical compliance related to Good Manufacturing Practices, or GMP, of Silimed’s manufacturing facility. ANVISA reiterated that no risks to patient health have been identified in connection with implanting Silimed products, and, accordingly, there is no need to adopt any procedure or action for those patients who have received them. Furthermore,

ANVISA also indicated that, based on its contact to date with foreign regulatory authorities, there have been no reports of adverse events related to this issue.

On October 9, 2015, the Company voluntarily placed a hold on the sale of all Sientra devices manufactured by Silimed and recommended that plastic surgeons discontinue implanting the devices until further notice.  The Company had ongoing discussions with the FDA regarding European and Brazilian regulatory inquiries into Silimed products, and the Company conducted its own review of the matter with the assistance of independent experts in quality management systems, GMP and data-based risk assessment.  The FDA also reiterated that no reports of adverse events and no risks to patient health had been identified in connection with implanting Silimed products.

On January 27, 2016, after completing an analysis and risk assessment, ANVISA announced its authorization of Silimed to resume the commercialization and use of its previously manufactured products.  ANVISA concluded there was no evidence to prove that the presence of surface particles on the silicone implants represented risks which are additional to the ones inherent in the product.  However, Silimed would continue to be suspended from manufacturing and commercializing new batches of implants until an inspection was performed to reassess the fulfillment of its GMP compliance.

On March 1, 2016, after the completion of extensive independent, third-party testing and analyses of its devices manufactured by Silimed, the Company lifted the temporary hold on the sale of such devices.  The Company also sent a letter to plastic surgeons informing them of the Company’s controlled market re-entry plans designed to optimize the Company’s inventory supply. The results of the Company’s testing indicate no anticipated significant safety concerns with the use of its products, including its breast implants, consistent with their approval status since 2012.

On July 11, 2016, after completing an inspection of Silimed’s facility, ANVISA announced the reinstatement of Silimed’s GMP certificate and their ability to manufacture commercial products. The Brazilian GMP certificate is effective as of July 8, 2016 and is valid for two years. The Silimed facility that has been approved for manufacturing is an alternate facility to where Sientra products were previously manufactured, which was damaged by a fire on October 22, 2015, and it remains unclear as to whether the alternate facility is fully equipped to manufacture Sientra’s silicone gel breast implants. Moreover, even if the alternate facility was equipped to manufacture Sientra’s silicone gel breast implants, such products cannot be sold in the U.S. until a PMA supplement for that facility is submitted, Silimed’s operations have been fully validated to U.S. FDA standards and they have successfully passed an FDA inspection, the timing of which remains uncertain. Additionally, the suspension of Silimed’s CE certificate by TUV SUD remains in place and continues to limit Silimed’s ability to sell to countries requiring a CE mark. The Company’s existing manufacturing contract with Silimed expires on its terms in April 2017.

 

For more information on the status of the Company’s relationship with Silimed, see Note 12—Subsequent Events—Silimed Litigation.  

 

2. Summary of Significant Accounting Policies

 

a.Basis of Presentation

 

The accompanying unaudited condensed financial statements in this Quarterly Report on Form 10-Q have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, and the rules and regulations of the U.S. Securities and Exchange Commission, or SEC.  Accordingly, they do not include certain footnotes and financial presentations normally required under accounting principles generally accepted in the United States of America for complete financial reporting. The interim financial information is unaudited, but reflects all normal adjustments and accruals which are, in the opinion of management, considered necessary to provide a fair presentation for the interim periods presented. The accompanying condensed 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, 2015 filed with the SEC on March 10, 2016, or the Annual Report. The results for the three and nine months ended September 30, 2016 are not necessarily indicative of results to be expected for the year ending December 31, 2016, any other interim periods, or any future year or period.

 

b.Going Concern 

 

The accompanying financial statements have been prepared on a going concern basis, which implies the Company will continue to realize its assets and discharge its liabilities in the normal course of business. As of September 30, 2016, Silimed is the Company’s sole source manufacturer of silicone gel breast implants and certain other products, but has not been able to resume manufacturing products for the Company. Accordingly, the Company continues to evaluate the availability of alternative manufacturing sources, including with Vesta Intermediate Funding, Inc., or Vesta, a Lubrizol Lifesciences company, which is establishing manufacturing capacity for the Company and is working with the Company to finalize a long-term supply arrangement for the Company’s PMA-approved breast implants. The continuation of the Company as a going concern is dependent upon many factors including Silimed’s ability to resume the manufacturing of the Company’s medical devices, resolution of any outstanding disputes with Silimed (see Note 12—Subsequent Events – Silimed Litigation), the availability of alternative manufacturing sources, including the entry into a long-term supply arrangement with Vesta or other manufacturers, and continued sale of the Company’s products. Since inception, the Company has incurred net losses. At September 30, 2016, the Company had cash and cash equivalents of $79.3 million. The Company’s ability to continue to meet its obligations and to achieve its business objectives is dependent upon, amongst other things, generating sufficient revenues. The Company believes that it has the ability to continue as a going concern for at least 12 months. These financial statements do not include any adjustments to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

 

c.Use of Estimates

 

The preparation of the condensed financial statements, in conformity with 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 revenues and expenses during the reporting periods. Actual results could differ from those estimates.

 

d.Significant Accounting Policies

 

There have been no significant changes to the accounting policies during the three and nine months ended September 30, 2016, as compared to the significant accounting policies described in the “Notes to Financial Statements” in the Annual Report.

 

e.Recent Accounting Pronouncements

 

Recently Adopted Accounting Standards

 

In November 2015, the Financial Accounting Standards Board, or FASB, issued accounting standard update, or ASU, 2015-17, Balance Sheet Classification of Deferred Taxes, which simplifies the presentation of deferred income taxes. The standard requires that deferred tax assets and liabilities be classified as noncurrent on the balance sheet rather than being separated into current and noncurrent. ASU 2015-17 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is permitted and the standard may be applied either retrospectively or on a prospective basis to all deferred tax assets and liabilities. The Company early adopted ASU 2015-17 during the third quarter of 2016 on a prospective basis. The adoption of this ASU did not have a significant impact on the Company’s financial statements.

 

Recently Issued Accounting Standards

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers.  The standard was issued to provide a single framework that replaces existing industry and transaction specific GAAP with a five step analysis of transactions to determine when and how revenue is recognized. The accounting standard update will replace most existing revenue recognition guidance in GAAP when it becomes effective. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, to defer the effective date of ASU 2014-09 by one year.  Therefore, ASU 2014-09 will become effective for the Company beginning in fiscal year 2018.

Early adoption would be permitted for the Company beginning in fiscal year 2017. The standard permits the use of either the retrospective or cumulative transition method. The Company is currently evaluating the accounting, transition and disclosure requirements of the standard and cannot currently estimate the financial statement impact of adoption.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) which supersedes FASB Accounting Standard Codification Leases (Topic 840). The standard is intended to increase the transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This accounting standard update will be effective for the Company beginning in fiscal year 2019. The Company is currently evaluating the impact that adoption of the standard will have on the financial statements and related disclosures.

 

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718). The standard identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. This accounting standard update will be effective for the Company beginning in fiscal year 2017. The Company is currently evaluating the impact that adoption of the standard will have on the financial statements and related disclosures.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows – Classifications of Certain Cash Receipts and Cash Payments (Topic 230). The standard update addresses eight specific cash flow issues not currently addressed by GAAP, with the objective of reducing the existing diversity in practice of how these cash receipts and payments are presented and classified in the statement of cash flows. This accounting standard update will be effective for the Company beginning in fiscal year 2018. The Company is currently evaluating the impact that adoption of the standard will have on the financial statements and related disclosures.

 

f.Reclassifications

 

Certain reclassifications have been made to prior year amounts to conform to the current year presentation.

 

 

3.Acquisition of bioCorneum®

 

On March 9, 2016, the Company entered into an assets purchase agreement with Enaltus LLC, or Enaltus, to acquire exclusive U.S. rights to bioCorneum®, an advanced silicone scar treatment marketed exclusively to physicians. The acquisition of bioCorneum® aligns with the Company’s business development objectives and adds a complementary product that serves the needs of its customers. In connection with the acquisition, the Company recorded $2,000 and $0.2 million of professional fees for the three and nine months ended September 30, 2016, respectively, which are included in general and administrative expense. The aggregate preliminary acquisition date fair value of the consideration transferred was estimated at $7.4 million, which consisted of the following (in thousands):

 

 

The deferred consideration and contingent consideration consist of future royalty payments to be paid on a quarterly basis to Enaltus on future bioCorneum® sales for the 4.5 years beginning January 1, 2024. The Company has determined the fair value of the deferred consideration and contingent consideration at the acquisition date using a Monte Carlo simulation model. The fair value of the deferred consideration is based on the future minimum royalty payments using the risk-free U.S. Treasury yield curve discount rate. The minimum estimated future payments due under the deferred consideration are $0.5 million. The fair value of the contingent consideration is based on projected future bioCorneum® sales and a risk adjusted discount rate. The terms of the agreement do not provide for a limitation on the maximum potential future payments. The inputs are significant inputs not observable in the market, which are referred to as Level 3 inputs and are

further discussed in Note 5. The deferred consideration and contingent consideration components are classified as an other long-term liability and are subject to the recognition of subsequent changes in fair value through the results of operations.

 

The Company allocated the total consideration transferred to the tangible and identifiable intangible assets acquired based on their respective fair values on the acquisition date, with the remaining unallocated amount recorded as goodwill. The goodwill arising from the transaction is primarily attributable to expected operational synergies, and all of goodwill will be deductible for income tax purposes. The condensed financial statements for the three and nine months ended September 30, 2016 include the results of operations of bioCorneum® from the date of acquisition.

 

The following table summarizes the allocation of the fair value of the consideration transferred by major class for the business combination completed on March 9, 2016 (in thousands):

 

 

A summary of the intangible assets acquired, estimated useful lives and amortization method is as follows (in thousands):

 

 

The Company retained an independent third-party appraiser to assist management in its valuation; however, the purchase price allocation has not been finalized. This could result in adjustments to the carrying value of the assets acquired and liabilities assumed, the useful lives of intangible assets and residual amount allocated to goodwill. The preliminary allocation of the purchase price is based on the best estimates of management and is subject to revision based on the final valuations and estimates of useful lives.

 

Pro forma results of operations have not been presented because the effect of the acquisition was not material to the Company's condensed results of operations.

 

4.Fair Value of Financial Instruments

 

The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, and customer deposits are reasonable estimates of their fair value because of the short maturity of these items. The fair value of the common stock warrant liability, deferred consideration and contingent consideration is discussed in Note 5. As of September 30, 2016, the Company had no outstanding long-term debt.

 

5.Fair Value Measurements

 

Certain assets and liabilities are carried at fair value under GAAP. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must 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 levels of the fair value hierarchy, of which the first two are considered observable and the last is considered unobservable:

 

 

 

 

The Company’s common stock warrant liabilities are carried at fair value determined according to the fair value hierarchy described above. The Company has utilized an option pricing valuation model to determine the fair value of its outstanding common stock warrant liabilities. The inputs to the model include fair value of the common stock related to the warrant, exercise price of the warrant, expected term, expected volatility, risk-free interest rate and dividend yield.  The warrants are valued using the fair value of common stock as of the measurement date. The Company historically has been a private company and lacks company-specific historical and implied volatility information of its stock. Therefore, it estimates its expected stock volatility based on the historical volatility of publicly traded peer companies for a term equal to the remaining contractual term of the warrants. The risk-free interest rate is determined by reference to the U.S. Treasury yield curve for time periods approximately equal to the remaining contractual term of the warrants. The Company has estimated a 0% dividend yield based on the expected dividend yield and the fact that the Company has never paid or declared dividends. As several significant inputs are not observable, the overall fair value measurement of the warrants is classified as Level 3.

 

The Company assessed the fair value of the deferred consideration and contingent consideration for future royalty payments related to the acquisition of bioCorneum® using the Monte Carlo simulation model. Significant assumptions used in the measurement include future net sales for a defined term and the risk adjusted discount rate associated with the business. As the inputs are not observable, the overall, fair value measurement of the deferred consideration and contingent consideration is classified as Level 3.

 

The following tables present information about the Company’s liabilities that are measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015 and indicate the level of the fair value hierarchy utilized to determine such fair value (in thousands):

 

 

 

The liability for common stock warrants is included in “accrued and other current liabilities” and the liability for the deferred consideration and contingent consideration is included in the “warranty reserve and other long-term liabilities” in the balance sheet. The following table provides a rollforward of the aggregate fair values of the Company’s common stock warrants, deferred and contingent consideration for which fair value is determined by Level 3 inputs (in thousands):

 

 

The Company recognizes changes in the fair value of the warrants, deferred consideration and contingent consideration in “other income (expense), net” in the statement of operations.

 

 

6.Product Warranties

 

The Company offers a limited warranty and a lifetime product replacement program for the Company’s silicone gel breast implants. Under the limited warranty, the Company will reimburse patients for certain out-of-pocket costs related to revision surgeries performed within ten years from the date of implantation in a covered event. Under the lifetime product replacement program, the Company provides no-charge replacement breast implants if a patient experiences a covered event. The programs are available to all patients implanted with the Company’s silicone breast implants after April 1, 2012 and are subject to the terms, conditions, claim procedures, limitations and exclusions. Timely completion of a device

tracking and warranty enrollment form by the patient’s Plastic Surgeon is required to activate the programs and for the patient to be able to receive benefits under either program.

 

The following table provides a rollforward of the accrued warranties (in thousands):

 

 

 

 

7.Net Loss Per Share

 

Basic net loss per share attributable to common stockholders is computed by dividing net loss by the weighted average number of common shares outstanding during each period. Diluted net loss per common share is computed by dividing net loss available to common stockholders by the weighted average number of common shares and dilutive potential common share equivalents then outstanding, to the extent they are dilutive. Potential common shares consist of shares issuable upon the exercise of stock options and warrants (using the treasury stock method). Dilutive net loss per share is the same as basic net loss per share for all periods presented because the effects of potentially dilutive items were anti-dilutive.

 

 

The Company excluded the following potentially dilutive securities, outstanding as of September 30, 2016 and 2015, from the computation of diluted net loss per share attributable to common stockholders for the three and nine months ended September 30, 2016 and 2015 because they had an anti-dilutive impact due to the net loss attributable to common stockholders incurred for the periods.

 

 

 

 

8.Balance Sheet Components

 

a.Allowance for Sales Returns and Doubtful Accounts

 

The Company has established an allowance for sales returns of $3.5 million and $0.7 million as of September 30, 2016 and December 31, 2015, respectively, recorded net against accounts receivable in the balance sheet.

 

The Company has established an allowance for doubtful accounts of $0.4 million and $0.5 million as of September 30, 2016 and December 31, 2015, respectively, recorded net against accounts receivable in the balance sheet.

 

b.Property and Equipment

 

Property and equipment, net consist of the following (in thousands):

 

 

 

Depreciation expense for the three months ended September 30, 2016 and 2015 was $0.1 million and $0.1 million, respectively. Depreciation expense for the nine months ended September 30, 2016 and 2015 was $0.2 million and $0.2 million, respectively.

 

c.Goodwill and Other Intangible Assets, net

 

Goodwill represents the excess of the purchase price over the fair value of net assets of purchased businesses. Goodwill is not amortized, but instead subject to impairment tests on at least an annual basis and whenever circumstances suggest that goodwill may be impaired.  The Company’s annual test for impairment is performed as of October 1 of each fiscal year. The Company makes a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If the Company concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it is not required to perform the two-step impairment test for that reporting unit.

 

Under the first step of the test, the Company is required to compare the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered impaired and the second step of the test is not performed. If the results of the first step of the impairment test indicate that the fair value of a reporting unit does not exceed its carrying amount, then the second step of the test is required. The second step of the test compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. The impairment loss is measured by the excess of the carrying amount of the reporting unit goodwill over the implied fair value of that goodwill.

 

The changes in the carrying amount of goodwill during the nine months ended September 30, 2016 were as follows (in thousands):

 

 

 

The components of the Company’s other intangible assets consist of the following (in thousands):

 

 

Amortization expense for the three months ended September 30, 2016 and 2015 was $0.2 million and $15,000, respectively. Amortization expense for the nine months ended September 30, 2016 and 2015 was $0.5 million and $46,000, respectively. The following table summarizes the estimated amortization expense relating to the Company's intangible assets as of September 30, 2016 (in thousands):

 

 

d.Accrued and Other Current Liabilities

 

Accrued and other current liabilities consist of the following (in thousands):

 

 

 

 

9.Stockholders’ Equity

 

a.Authorized Stock

 

The Company’s Amended and Restated Certificate of Incorporation authorizes the Company to issue 210,000,000 shares of common and preferred stock, consisting of 200,000,000 shares of common stock with $0.01 par value and 10,000,000 shares of preferred stock with $0.01 par value. As of September 30, 2016 and December 31, 2015, the Company had no preferred stock issued or outstanding.

 

b.Common Stock Warrants

 

On January 17, 2013, the Company entered into a Loan and Security Agreement, or the Original Term Loan Agreement, with Oxford Finance, LLC, or Oxford. On June 30, 2014, the Company entered into the Amended and Restated Loan and Security Agreement, or the Amended Term Loan Agreement, with Oxford. In connection with the Original Term Loan Agreement and the Amended Term Loan Agreement, the Company issued to Oxford (i) seven-year warrants in January 2013 to purchase shares of the Company’s common stock with a value equal to 3.0% of the tranche A, B and C term loans amounts and (ii) seven-year warrants in June 2014 to purchase shares of the Company’s common stock with a value equal to 2.5% of the tranche D term loan amount.  The warrants have an exercise price per share of $14.671. As of September 30, 2016, there were warrants to purchase an aggregate of 47,710 shares of common stock outstanding.

 

c.Stock Option Plans

 

In April 2007, the Company adopted the 2007 Equity Incentive Plan, or the 2007 Plan. The 2007 Plan provides for the granting of stock options to employees, directors and consultants of the Company. Options granted under the 2007 Plan may either be incentive stock options or nonstatutory stock options. Incentive stock options, or ISOs, may be granted only to Company employees. Nonstatutory stock options, or NSOs, may be granted to all eligible recipients. A total of 1,690,448 shares of the Company’s common stock were reserved for issuance under the 2007 Plan.

 

The Company’s board of directors adopted the 2014 Equity Incentive Plan, or 2014 Plan, in July 2014, and the stockholders approved the 2014 Plan in October 2014. The 2014 Plan became effective upon completion of the IPO on November 3, 2014, at which time the Company ceased granting awards under the 2007 Plan. Under the 2014 Plan, the Company may issue ISOs, NSOs, stock appreciation rights, restricted stock awards, restricted stock unit awards and other forms of stock awards, or collectively, stock awards, all of which may be granted to employees, including officers, non-employee directors and consultants of the Company and their affiliates. ISOs may be granted only to employees.  A total of 1,027,500 shares of common stock were initially reserved for issuance under the 2014 Plan, subject to certain annual increases.  As of September 30, 2016, a total of 2,045,495 shares of the Company’s common stock were reserved for issuance under the 2014 Plan.

 

Pursuant to a board-approved Inducement Plan, the Company may issue NSOs and restricted stock unit awards, or collectively, stock awards, all of which may only be granted to new employees of the Company and their affiliates in accordance with NASDAQ Stock Market Rule 5635(c)(4) as an inducement material to such individuals entering into employment with the Company.  As of September 30, 2016, inducement grants for 30,000 shares have been awarded, and 150,000 shares were reserved for future issuance under the Inducement Plan.

 

Options under the 2007 Plan and the 2014 Plan may be granted for periods of up to ten years as determined by the Company’s board of directors, provided, however, that (i) the exercise price of an ISO shall not be less than 100% of the estimated fair value of the shares on the date of grant, and (ii) the exercise price of an ISO granted to a more than 10% shareholder shall not be less than 110% of the estimated fair value of the shares on the date of grant. An NSO has no such exercise price limitations. NSOs under the Inducement Plan may be granted for periods of up to ten years as determined by the board of directors, provided, the exercise price will be not less than 100% of the estimated fair value of the shares on the date of grant.  Options generally vest with 25% of the grant vesting on the first anniversary and the balance vesting monthly on a straight-lined basis over the requisite service period of three additional years for the award. Additionally, options have been granted to certain key executives which vest upon achievement of performance conditions based on performance targets as defined by the board of directors, which have included net sales targets and defined corporate objectives over the performance period with possible payout ranging from 0% to 100% of the target award.  Compensation expense is recognized on a straight-lined basis over the vesting term of one year based upon the probable performance target that will be met. The vesting provisions of individual options may vary but provide for vesting of at least 25% per year.

 

The following summarizes all option activity under the 2007 Plan, 2014 Plan and Inducement Plan:

 

 

For stock-based awards the Company recognizes compensation expense based on the grant date fair value using the Black-Scholes option valuation model.  Stock-based compensation expense was $0.4 million and $0.6 million for the three months ended September 30, 2016 and 2015, respectively. Stock-based compensation expense was $1.2 million and $1.4 million for the nine months ended September 30, 2016 and 2015, respectively. As of September 30, 2016, there was $3.5 million of unrecognized compensation costs related to stock options. The expense is recorded within the operating expense components in the statement of operations based on the recipients receiving the awards. These costs are expected to be recognized over a weighted average period of 2.57 years.

 

d.Restricted Stock Units

 

The Company has issued restricted stock unit awards, or RSUs, under the 2014 Plan. The RSUs issued vest on a straight-line basis, either quarterly over a 4-year requisite service period or annually over a 3-year requisite service period.

 

Activity related to RSUs is set forth below:

 

Stock-based compensation expense for RSUs for the three months ended September 30, 2016 and 2015 was $0.5 million and $0, respectively. Stock-based compensation expense for RSUs for the nine months ended September 30, 2016 and 2015 was $1.1 million and $0, respectively. As of September 30, 2016, there was $3.5 million of total unrecognized compensation cost related to non-vested RSU awards. The cost is expected to be recognized over a weighted average period of 2.11 years.

e.Employee Stock Purchase Plan

 

The Company’s board of directors adopted the 2014 Employee Stock Purchase Plan, or ESPP, in July 2014, and the stockholders approved the ESPP in October 2014. The ESPP allows eligible employees to purchase shares of the Company’s common stock at a discount through payroll deductions of up to 15% of their eligible compensation, subject to any plan limitations. The ESPP provides offering periods not to exceed 27 months, and each offering period will include purchase periods, which will be the approximately six-month period commencing with one exercise date and ending with the next exercise date, except that the first offering period commenced on the first trading day following the effective date of the Company’s registration statement.  Employees are able to purchase shares at 85% of the lower of the fair market value of the Company’s common stock on the first trading day of the offering period or on the exercise date.  A total of 255,500 shares of common stock were initially reserved for issuance under the ESPP, subject to certain annual increases. 

As of September 30, 2016, the number of shares of common stock reserved for issuance under the ESPP was 584,563.  During the nine months ended September 30, 2016, employees purchased 122,667 shares of common stock at a weighted

average price of $6.14 per share.  As of September 30, 2016, the number of shares of common stock available for future issuance was 417,646.

The Company estimated the fair value of employee stock purchase rights using the Black-Scholes model. Stock-based compensation expense related to the ESPP was $0.1 million and $0.1 million for the three months ended September 30, 2016 and 2015, respectively. Stock-based compensation expense related to the ESPP was $0.3 million and $0.3 million for the nine months ended September 30, 2016 and 2015, respectively.

 

10.Income Taxes

 

The Company operates in several tax jurisdictions and is subject to taxes in each jurisdiction in which it conducts business. To date, the Company has incurred cumulative net losses and maintains a full valuation allowance on its net deferred tax assets due to the uncertainty surrounding realization of such assets. However, the Company has deferred tax liabilities associated with indefinite lived intangible assets that cannot be considered sources of income to support the realization of the deferred tax assets, and has provided for tax expense and a corresponding deferred tax liability associated with these indefinite lived intangible assets. Tax expense was $48,000 and $0 for the three and nine months ended September 30, 2016 and 2015, respectively.

 

11.Commitments and Contingencies

 

a.Operating Leases

 

The Company’s lease for its general office facility in Santa Barbara, California expires in February 2020. The Company also leases additional industrial space for warehouse, research and development and additional general office use.  Rent expense was $0.1 million and $0.1 million for the three months ended September 30, 2016 and 2015, respectively. Rent expense was $0.4 million and $0.4 million for the nine months ended September 30, 2016 and 2015, respectively. The Company recognizes rent expense on a straight-line basis over the lease term.

 

b.Contingencies

 

The Company is subject to claims and assessment from time to time in the ordinary course of business. The Company accrues a liability for such matters when it is probable that future expenditures will be made and such expenditures can be reasonably estimated.

 

On September 25, 2015, a lawsuit styled as a class action of the Company’s stockholders was filed in the United States District Court for the Central District of California. The lawsuit names the Company and certain of its officers as defendants, or Sientra Defendants, and alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, in connection with allegedly false and misleading statements concerning the Company’s business, operations, and prospects.  The plaintiff seeks damages and an award of reasonable costs and expenses, including attorneys’ fees. On November 24, 2015, three stockholders (or groups of stockholders) filed motions to appoint lead plaintiff(s) and to approve their selection on lead counsel.  On December 10, 2015, the court entered an order appointing lead plaintiffs and approving their selection of lead counsel.  On February 19, 2016, lead plaintiffs filed their consolidated amended complaint, which added a claim under Section 11 of the Securities Act and named as defendants the underwriters associated with the Company’s follow-on public offering that closed on September 23, 2015, or the Underwriter Defendants. On March 21, 2016, the Sientra Defendants and the Underwriter Defendants each filed a motion to dismiss, or the Motions to Dismiss, the consolidated amended complaints. On April 20, 2016, lead plaintiffs filed their opposition to the Motions to Dismiss, and the Sientra Defendants and Underwriter Defendants filed separate replies on May 5, 2016. On June 9, 2016, the court granted in part and denied in part the Motions to Dismiss.  On July 14, 2016, the Sientra Defendants moved the court to reconsider its June 9, 2016 order and grant the Motions to Dismiss in full. On August 4, 2016, lead plaintiffs filed an opposition to the motion for reconsideration. On August 12, 2016, the court denied the motion for reconsideration, and the Sientra Defendants and the Underwriter Defendants each filed an answer to the consolidated amended complaint.

On October 28, November 5, and November 19, 2015, three lawsuits styled as class actions of the Company’s stockholders were filed in the Superior Court of California for the County of San Mateo. The lawsuits name the Company, certain of its officers and directors, and the underwriters associated with the Company’s follow-on public offering that closed on September 23, 2015 as defendants. The lawsuits allege violations of Sections 11, 12(a)(2), and 15 of the Securities Act in connection with allegedly false and misleading statements in the Company’s offering documents associated with the follow-on offering concerning its business, operations, and prospects. The plaintiffs seek damages and an award of reasonable costs and expenses, including attorneys’ fees. On December 4, 2015, defendants removed all three lawsuits to the United States District Court for the Northern District of California.  On December 15 and December 16, 2015, plaintiffs filed motions to remand the lawsuits back to San Mateo Superior Court, or the Motions to Remand.  On January 19, 2016, defendants filed their opposition to the Motions to Remand, and plaintiffs filed their reply in support of the Motions to Remand on January 26, 2016. 

On May 20, 2016, the United States District Court for the Northern District of California granted plaintiffs’ Motions to Remand, and the San Mateo Superior Court received the remanded cases on May 27, 2016.  On July 19, 2016, the San Mateo Superior Court consolidated the three lawsuits.  On August 2, 2016, plaintiffs filed their consolidated complaint. On August 5, 2016, defendants filed a motion to stay all proceedings in favor of the class action filed in the United States District Court for the Central District of California.

On September 13, 2016, the parties to the actions pending in the San Mateo Superior Court and the United States District Court for the Central District of California signed a memorandum of understanding that sets forth the material deal points of a settlement that covers both actions and includes class-wide relief. On September 13, 2016 and September 20, 2016, respectively, the parties filed notices of settlement in both courts. On September 22, 2016, the United States District Court for the Central District of California stayed that action pending the court’s approval of a settlement. On September 23, 2016, the San Mateo Superior Court stayed that action as well pending the court’s approval of a settlement.

As a result of these developments, the Company has determined a probable loss has been incurred and has recognized a net charge to earnings of approximately $1.6 million within general and administrative expense which is comprised of the loss contingency of approximately $10.9 million, net of expected insurance proceeds of approximately $9.3 million. The Company has classified the loss contingency as “legal settlement payable” and the expected insurance proceeds as “insurance recovery receivable” on the accompanying condensed balance sheets. While it is possible that the Company may incur a loss greater than the amounts recognized in the accompanying interim financial statements, the Company is unable to determine a range of possible losses greater than the amount recognized.

It is possible that additional suits will be filed, or allegations made by stockholders, with respect to these same or other matters and also naming the Company and/or its officers and directors as defendants. The Company believes it has meritorious defenses and intends to defend these lawsuits vigorously. 

12.Subsequent Events

 

On November 2, 2016, pursuant to an Asset Purchase Agreement, or Purchase Agreement, by and among the Company and Specialty Surgical Products, Inc., or SSP, the Company acquired certain assets, consisting of the Dermaspan™, Softspan™, Allox® and Allox2® tissue expanders, from SSP for the purchase price of $5.0 million in cash, along with contingent cash payments of up to an additional $2.0 million if certain future revenue targets are met.  The assets acquired consist of accounts receivable, inventory, consigned inventory, tooling, intellectual property and regulatory approvals, specified contracts and the associated assumed liabilities. The acquisition of these products aligns with the Company’s business development objectives and adds complementary products that serve the needs of its customers.

The Company expects to account for the transaction as a business combination and is in the process of determining the allocation of the purchase price to acquired assets and assumed liabilities. A determination of the acquisition-date fair values of the assets acquired and the liabilities assumed is pending the completion of an independent appraisal and other evaluations and therefore further disclosures have not been made.

Pro forma results of operations have not been presented because the effect of the business combination was not material to the Company's condensed results of operations.

 

 

On October 26, 2016, Matthew Pigeon resigned from his position as Chief Financial Officer, Senior Vice President and Treasurer of the Company. The Company entered into a Separation Agreement, or the Separation Agreement, with Mr. Pigeon on November 7, 2016, pursuant to which, Mr. Pigeon is entitled to receive: (i) twelve (12) months of his base salary as in effect on the separation date paid in equal installments plus a payment of $78,750 for the remaining 2016 bonus earned by Mr. Pigeon in connection with the completion of the fiscal year prior to the separation date, consisting of (a) $52,500 payable upon separation and (b) $26,250 to be paid on January 30, 2017, and (ii) up to twelve (12) months of company-paid health insurance premiums to continue his coverage. The benefits provided for in the Separation Agreement are consistent with the benefits that Mr. Pigeon would have been entitled to receive under his Amended and Restated Employment Agreement had Mr. Pigeon been terminated without cause. 

 

 

On October 26, 2016, the Company appointed Patrick F. Williams as its Chief Financial Officer, Senior Vice President and Treasurer. In connection with the appointment, the Company entered into an Employment Agreement, or the Employment Agreement, with Mr. Williams on October 26, 2016, pursuant to which: (i) Mr. William’s annual base salary will be three hundred fifty thousand dollars, (ii) Mr. Williams shall be eligible to earn an annual discretionary performance-based bonus of up to 50% of his base salary, and (iii) for the partial 2016 calendar year, Mr. Williams shall also be eligible for a discretionary performance-based bonus paid on a pro-rata basis to the extent that it is determined by the compensation committee of the board of directors. Additionally, on October 26, 2016, the compensation committee granted to Mr. Williams a nonqualified stock option under the Inducement Plan to purchase 300,000 shares of the Company’s common stock at a per share exercise price equal to the closing price of the Company’s common stock on the grant date. The stock options shall vest as follows: (i) 200,000 option shares shall vest and be exercisable as to 50,000 option shares on the one-year anniversary of the grant date, and as to 150,000 option shares, in thirty-six equal consecutive monthly installments commencing on the thirteenth month anniversary of the grant date, and (ii) 100,000 option shares shall vest and be exercisable in accordance with performance criteria established by the compensation committee.  Mr. Williams is also entitled to participate in all employee benefit programs for which he is eligible.

 

 

On October 26, 2016, the board of directors approved an increase to the share reserve under the Inducement Plan from 180,000 shares to 400,000 shares in order to cover in part the 300,000 share inducement grant awarded to Mr. Williams in connection with his appointment as the Company’s new Chief Financial Officer, Senior Vice President and Treasurer.  As of October 26, 2016, 70,000 shares remain available for future awards under the Inducement Plan.

 

 

On November 6, 2016, Silimed filed a lawsuit in the U.S. District Court for the Southern District of New York naming the Company as the defendant and alleging breach of contract of the Amended and Restated Exclusivity Agreement executed by the Company and Silimed in April 2007, or the 2007 Agreement, unfair competition, unjust enrichment, and misappropriation of trade secrets against the Company. In its complaint, Silimed alleges that the Company’s theft, misuse, and improper disclosure of Silimed’s confidential, proprietary, and trade secret manufacturing information was done in order for the Company to develop its own manufacturing capability that the Company intends to use to manufacture its PMA-approved products.  Silimed is seeking a declaration that the Company is in material breach of the 2007 Agreement, a preliminary and permanent injunction to prevent the Company’s allegedly wrongful use and disclosure of Silimed’s confidential and proprietary information, as well as unquantified compensatory and punitive damages.

 

The Company believes Silimed’s claims are legally and factually unsupported and intends to defend this lawsuit vigorously. 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed financial statements and related notes included in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto as of and for the year ended December 31, 2015 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the Securities and Exchange Commission on March 10, 2016, or the Annual Report. Unless the context requires otherwise, references in this Quarterly Report on Form 10-Q to “Sientra,” “the Company,” “we,” “us” and “our” refer to Sientra, Inc.

 

Forward-Looking Statements

 

The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks set forth in Part II, Item 1A, “Risk Factors” in this Quarterly Report on Form 10-Q and in our other filings with the SEC. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements.

 

Overview

 

We are a medical aesthetics company committed to making a difference in patients’ lives by enhancing their body image, growing their self‑esteem and restoring their confidence. We were founded to provide greater choices to board‑certified plastic surgeons and patients in need of medical aesthetics products. We have developed a broad portfolio of products with technologically differentiated characteristics, supported by independent laboratory testing and strong clinical trial outcomes. We sell our breast implants and breast tissue expanders, or Breast Products, exclusively to board‑certified and board‑admissible plastic surgeons and tailor our customer service offerings to their specific needs, which we believe helps secure their loyalty and confidence. We began selling bioCorneum®, an advanced silicone scar treatment, or Scar Management Products, directly to physicians after we acquired bioCorneum® from Enaltus on March 9, 2016. 

Our primary products are silicone gel breast implants for use in breast augmentation and breast reconstruction procedures, which we offer in over 195 variations of shapes, sizes, fill volumes and textures. Our breast implants are primarily used in elective procedures which are generally performed on a cash‑pay basis. Many of our breast implants incorporate one or more differentiated technologies, including a proprietary high‑strength, cohesive silicone gel and proprietary texturing branded TRUE Texture®. Our breast implants offer a desired balance between strength, shape retention and softness due to the high‑strength, cohesive silicone gel used in our manufacturing process. TRUE Texture® provides texturing on the implant shell that is designed to reduce the incidence of malposition, rotation and capsular contracture. We also offer breast tissue expanders and a range of other aesthetic and specialty products. We do not have any patents or patent applications, but rely on trade secrets, proprietary know‑how and regulatory barriers to protect our products and technologies.

Our breast implants were approved by the U.S. Food and Drug Administration, or FDA, in 2012, based on data we collected from our ongoing, long‑term clinical trial, or the Study, of our breast implants in 1,788 women across 36 investigational sites in the United States, which included 3,506 implants (approximately 53% of which were smooth and 47% of which were textured). Our clinical trial is the largest prospective, long‑term safety and effectiveness pivotal study of breast implants in the United States and includes the largest magnetic resonance imaging, or MRI, cohort with 571 patients. The

MRI cohort is a subset of study patients that underwent regular MRI screenings in addition to the other aspects of the clinical trial protocol prior to FDA approval. Post-approval, all patients in the Study are subject to serial MRI screenings as part of the clinical protocol. The clinical data we collected over a nine‑year follow‑up period demonstrated rupture rates, capsular contracture rates and reoperation rates that were comparable to or better than those of our competitors, at similar time points. In addition to our pivotal study, our clinical data is supported by our Continued Access Study of 2,497 women in the United States. We have also commissioned a number of bench studies run by independent laboratories that we believe further demonstrate the advantages of our breast implants over those of our competitors.

We sell our Breast Products exclusively to board‑certified and board‑admissible plastic surgeons, as determined by the American Board of Plastic Surgery, who we refer to as Plastic Surgeons. These surgeons have completed the extensive multi‑year plastic surgery residency training required by the American Board of Plastic Surgery. While aesthetic procedures are performed by a wide range of medical professionals, including dermatologists, otolaryngologists, obstetricians, gynecologists, dentists and other specialists, the majority of aesthetic surgical procedures are performed by Plastic Surgeons. Plastic Surgeons are thought leaders in the medical aesthetics industry. According to the American Board of Plastic Surgery, there are approximately 6,500 board‑certified plastic surgeons in the United States. We seek to provide Plastic Surgeons with differentiated services, including enhanced customer service offerings, a ten‑year limited warranty that we believe is the best in the industry based on: providing patients with the largest cash reimbursement for certain out‑of‑pocket costs related to revision surgeries in a covered event; a lifetime no‑charge implant replacement program for covered ruptures; and our industry‑first CapCon Care Program, or C3 Program, through which we offer no‑charge replacement implants to breast augmentation patients who experience capsular contracture within the first five years after implantation with our smooth or textured breast implants.

Between October 9, 2015 and March 1, 2016, we voluntarily suspended the sale of all Sientra devices manufactured by our sole manufacturer and supplier, Silimed, due to the suspension of Silimed’s CE certificate by TUV SUD, Silimed’s notified body under EU regulations, followed by Brazilian regulatory inquiries and a temporary suspension by the Brazilian regulatory agency ANVISA and the Department of the Secretary of State of Rio de Janeiro of the manufacturing and shipment of all medical devices made by Silimed, and recommended that plastic surgeons discontinue implanting the devices until further notice. See Note 1c to our Condensed Financial Statements for more information on the history of these developments with Silimed.  

After ongoing discussions with the FDA and our own review of the matter with the assistance of independent experts in quality management systems, Good Manufacturing Practices, or GMP, and data-based risk assessment, on March 1, 2016, we lifted the temporary hold on sales and also sent a letter to our Plastic Surgeons informing them of our market re-entry plans. We have limited inventory of our Breast Products manufactured by Silimed due to (i) the fire on October 22, 2015 at the manufacturing building where Silimed primarily manufactured our breast implants, and (ii) Silimed’s inability to manufacture products (only recently reinstated by ANVISA on July 11, 2016) for commercial sale in the U.S. at their alternate facility, which will require Sientra to submit a PMA supplement for the alternate facility and require the manufacturing operations to receive a validation of U.S. FDA standards and a successful FDA inspection, the timing of which is uncertain.  Accordingly, we developed and communicated to our Plastic Surgeons a controlled market re-entry plan designed to optimize our inventory supply.

 

There are several uncertainties regarding the events involving Silimed that may continue to have a material unfavorable impact on our net sales of Breast Products manufactured by Silimed, including the impact on inventory levels and inventory adjustments, and uncertainty of our customers’ responsiveness to our market re-entry plans after we had imposed our voluntary hold on the sale and implanting of all Sientra devices manufactured by Silimed between October 9, 2015 and March 1, 2016.  See “Risk Factors — Risks Relating to Our Business and Our Industry” for further detail.

 

Our existing manufacturing contract with Silimed expires on its terms on April 1, 2017. We cannot provide assurance that Silimed will be able to qualify its alternate facility and manufacture and ship new products to us. Moreover, on November 6, 2016, Silimed filed a lawsuit against us alleging, among other things, a material breach of the existing manufacturing contract.  Accordingly, we have increasingly focused our efforts on identifying and qualifying an alternate manufacturing supplier.

 

On August 9, 2016, we announced our collaboration with Vesta Intermediate Funding, Inc., or Vesta, pursuant to which we are working with Vesta towards establishing a dedicated contract manufacturing facility for our Breast Products.  Vesta is a Lubrizol LifeSciences Company and leading medical device contract manufacturer of silicone products and other medical devices headquartered in Wisconsin.    

 

We sell our products in the United States through a direct sales organization consisting of 45 employees, including 38 sales representatives and 7 sales managers, as of September 30, 2016.

 

Recent Developments

 

The following is a summary of significant developments affecting our business that have occurred since the filing of our Quarterly Report on Form 10-Q for the period ended June 30, 2016. For additional developments see the Annual Report and our Quarterly Reports on Form 10-Q for the period ended March 31, 2016 and June 30, 2016.

 

 

 

Components of Operating Results

 

Net Sales

 

We recognize revenue, net of sales discounts and estimated returns, as the customer has a standard six-month window to return purchased Breast Products. We commenced sales of our Breast Products in the United States in the second quarter of 2012 and our Breast Products have historically accounted for substantially all of our net sales. However, sales of our Breast Products accounted for 77% and 97% of our net sales for the three months ended September 30, 2016 and 2015, respectively, and 78% and 98% of our net sales for the nine months ended September 30, 2016 and 2015, respectively. The percentage decrease in sales of Breast Products for the 2016 periods reflects the combined effect of the temporary

hold on sales and implanting of Breast Products until March 1, 2016, our controlled re-entry to market designed to optimize our supply of Breast Products inventory and the commercial introduction of our Scar Management Products as a result of the acquisition of bioCorneum® on March 9, 2016. Sales of Scar Management Products are included in the results of operations from the date of acquisition and accounted for 20% of our net sales for the three months ended September 30, 2016 and 19% of our net sales for the nine months ended September 30, 2016.

 

We expect that, in the future, assuming a favorable outcome of the aforementioned recent events with Silimed or the successful establishment and transition of our manufacturing process to Vesta, that our net sales will fluctuate on a quarterly basis due to a variety of factors, including seasonality of breast augmentation procedures.  We believe that breast implant sales are subject to seasonal fluctuation due to breast augmentation patients’ planning their surgery leading up to the summer season and in the period around the winter holiday season.

Cost of Goods Sold and Gross Margin

 

Cost of goods sold consists primarily of costs of finished products purchased from our third‑party manufacturers, reserve for product warranties and warehouse and other related costs.

Our Breast Products and certain other products are currently manufactured in Brazil by Silimed. Under our contract with Silimed, each particular style of implant has a fixed unit cost. Our bioCorneum® Scar Management Products are manufactured in the U.S. by Formulated Solutions, LLC, or Formulated Solutions. Under our contract with Formulated Solutions, each particular product has a fixed unit cost.

In addition to product costs, we provide a commercial warranty on our silicone gel-filled breast implants. The warranty covers device ruptures in certain circumstances. Estimated warranty costs are recorded at the time of sale. Our warehouse and other related costs include labor, rent, product shipments from our third-party manufacturer and other related costs.

We expect our overall gross margin, which is calculated as net sales less cost of goods sold for a given period divided by net sales, to fluctuate in future periods primarily as a result of quantity of units sold, manufacturing price increases, the changing mix of products sold with different gross margins, overhead costs and targeted pricing programs.

Sales and Marketing Expenses

 

Our sales and marketing expenses primarily consist of salaries, bonuses, benefits, incentive compensation and travel for our sales, marketing and customer support personnel. Our sales and marketing expenses also include expenses for trade shows, our no‑charge customer shipping program and no-charge product evaluation units, as well as educational, promotional and marketing activities, including direct and online marketing. We expect our sales and marketing expenses to fluctuate in future periods as a result of headcount and timing of our marketing programs.  However, we generally expect these costs will increase in absolute dollars.

Research and Development Expenses

 

Our research and development, or R&D, expenses primarily consist of clinical expenses, product development costs, regulatory expenses, consulting services, outside research activities, quality control and other costs associated with the development of our products and compliance with Good Clinical Practices, or cGCP, requirements. R&D expenses also include related personnel and consultant compensation and stock‑based compensation expense. We expense R&D costs as they are incurred.

We expect our R&D expenses to vary as different development projects are initiated, including improvements to our existing products, expansions of our existing product lines, new product acquisitions and our FDA‑required PMA post‑approval studies of our breast implants. However, we generally expect these costs will increase in absolute terms over time as we continue to expand our product portfolio and add related personnel.

General and Administrative Expenses

 

Our general and administrative, or G&A, expenses primarily consist of salaries, bonuses, benefits and stock-based compensation for our executive, financial, legal, business development and administrative functions.  Other G&A expenses include outside legal counsel and litigation expenses, independent auditors and other outside consultants, corporate insurance, employee benefits, facilities and information technologies expenses. In 2015, G&A expenses also include the federal excise tax on the sale of our medical devices in the United States.

 

We expect future G&A expenses to increase as we continue to build our finance, legal, information technology, human resources and other general administration resources to continue to advance the commercialization of our products.  In addition, we expect to continue to incur G&A expenses in connection with operating as 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, or the JOBS Act.

 

Other Income (Expense), net

 

Other income (expense), net primarily consists of interest income and changes in the fair value of common stock warrants.

 

Income Taxes

 

Income tax expense consists of an estimate for income taxes based on the projected income tax expense for the period ending December 31, 2016. We operate in several tax jurisdictions and are subject to taxes in each jurisdiction in which we conduct business. To date, we have incurred cumulative net losses and maintain a full valuation allowance on our net deferred tax assets due to the uncertainty surrounding realization of such assets. However, we have deferred tax liabilities associated with indefinite lived intangible assets that cannot be considered sources of income to support the realization of the deferred tax assets, and have provided for tax expense and a corresponding deferred tax liability associated with these indefinite lived intangible assets.

 

Critical Accounting Policies and Significant Judgments and Estimates

 

The preparation of our unaudited condensed financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the revenues and expenses incurred during the reported periods. We base our estimates on 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 apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We discussed accounting policies and assumptions that involve a higher degree of judgment and complexity in Note 2 of the “Notes to Financial Statements” in our audited financial statements included in the Annual Report. There have been no material changes to our critical accounting policies and estimates from those disclosed in the Annual Report.

 

Recent Accounting Pronouncements

 

Please refer to Note 2 - Summary of Significant Accounting Policies in the notes to the unaudited condensed financial statements included in this Form 10-Q for information on recent accounting pronouncements and the expected impact on our financial statements.

 

Results of Operations

 

Comparison of the Three Months Ended September 30, 2016 and 2015

 

The following table sets forth our results of operations for the three months ended September 30, 2016 and 2015:

 

 

Net Sales

 

Net sales decreased $3.4 million, or 34.2%, to $6.5 million for the three months ended September 30, 2016, as compared to $9.9 million for the three months ended September 30, 2015.  Net sales of our Breast Products decreased $4.6 million to $5.0 million for the three months ended September 30, 2016, as compared to $9.6 million for the three months ended September 30, 2015, as a result of our controlled re-entry to market designed to optimize our supply of Breast Product inventory. The decrease in Breast Product net sales was offset by $1.3 million of Scar Management Product net sales for the three months ended September 30, 2016.

 

As of September 30, 2016, our sales organization included 38 sales representatives as compared to 45 sales representatives as of September 30, 2015.  

 

Cost of Goods Sold and Gross Margin

 

Cost of goods sold decreased $1.1 million, or 38.2%, to $1.8 million for the three months ended September 30, 2016, as compared to $2.9 million for the three months ended September 30, 2015.  This decrease was primarily due to a decrease in sales volume driven by our controlled re-entry into the marketplace.

 

The gross margins for the three months ended September 30, 2016 and 2015 were 72.2% and 70.5%, respectively. This increase was primarily due to a decrease in inventory write-offs of 1.1 percentage points and a decrease in warranty costs of 0.6 percentage points.  The decrease in inventory write-offs resulted from the timing and recognition of products anticipated to expire prior to being sold. The decrease in warranty costs resulted from improved rupture rates as indicated by our ongoing clinical studies.