UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
| (Mark One) | ||
| ☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended September 30, 2016
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ________ to ________
Commission file number 001-32518
Nuo Therapeutics, Inc.
(Exact Name of Registrant as Specified in its Charter)
| Delaware | 23-3011702 |
| (State or Other Jurisdiction of Incorporation or Organization) |
(IRS Employer Identification No.) |
207A Perry Parkway, Suite 1
Gaithersburg, MD 20877
(Address of Principal Executive Offices) (Zip Code)
(240) 499-2680
(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.
| Large Accelerated Filer ☐ | Accelerated Filer ☐ |
| Non-accelerated Filer ☐ | Smaller Reporting Company ☒ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Indicate by check make whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☒ No ☐
APPLICABLE ONLY TO CORPORATE ISSUERS
The aggregate market value of voting common stock, $0.0001 par value (the “New Common Stock”) held by non-affiliates of the registrant as of June 30, 2016, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $3.6 million based on the $1.00 per share sales price of the shares of New Common Stock in a private placement of such stock completed in connection with the registrant’s emergence from bankruptcy on May 5, 2016. The registrant does not have any non-voting common stock outstanding. The New Common Stock is not currently trading on the OTC market.
As of November 7, 2016, the number of shares outstanding of the registrant’s New Common Stock, $0.0001 par value, was 9,927,112.
TABLE OF CONTENTS
NUO THERAPEUTICS, INC.
TABLE OF CONTENTS
2
Explanatory Note
As described in Notes 1 and 2 to the unaudited condensed consolidated financial statements of Nuo Therapeutics, Inc. (“we,” “us,” “Nuo Therapeutics,” “Nuo” and the “Company”) appearing in Part I of this Quarterly Report on Form 10-Q (this “Quarterly Report”), the Company emerged from bankruptcy protection effective May 5, 2016 (the “Effective Date”) in accordance with the Modified First Amended Plan of Reorganization of the Debtor under Chapter 11 of the Bankruptcy Code, as confirmed by the April 25, 2016 Order Granting Final Approval of Disclosure Statement and Confirming Debtor’s Plan of Reorganization (as so confirmed, the “Plan of Reorganization”).
This Quarterly Report contains the Company’s unaudited condensed consolidated financial statements as of September 30, 2016 and December 31, 2015, and for the periods between January 1, 2016 and May 4, 2016, and between May 5, 2016 and September 30, 2016, for the three month period ended September 30, 2016, and for the three and nine month periods ended September 30, 2015, and the accompanying footnotes (the “Q3 Financial Statements”), as well as a discussion comparing the Company’s results of operations for the periods ended September 30, 2016 and 2015 and related financial condition in the section titled “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” (the “Period-to-Period Comparison”). The historical financial and share-based information contained in the Q3 Financial Statements and the Period-to-Period Comparison as of and relating to periods ending on dates prior to the Effective Date reflects the Company’s financial condition and results of operations prior to its emergence from bankruptcy, and therefore is not indicative of the Company’s current financial condition or results of operations from and after May 5, 2016.
More specifically, following the consummation of the Plan of Reorganization, the Company’s financial condition and results of operations from and after May 5, 2016 are not comparable to the financial condition or results of operations reflected in the Company’s prior financial statements (including those as of and for periods ending on May 4, 2016 and September 30, 2015 included in this Quarterly Report) due to the Company’s application of fresh start accounting to time periods beginning on and after May 5, 2016. Fresh start accounting requires the Company to adjust its assets and liabilities contained in its financial statements immediately before its emergence from bankruptcy protection to their estimated fair values using the acquisition method of accounting. Those adjustments are material and affect the Company’s financial condition and results of operations from and after May 5, 2016. For that reason, it is difficult to assess our performance in periods beginning on or after May 5, 2016 in relation to prior periods.
3
PART I
FINANCIAL INFORMATION
NUO THERAPEUTICS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
| Successor | Predecessor | |||||||
| September 30, 2016 | December 31, 2015 | |||||||
| ASSETS | ||||||||
| Current assets | ||||||||
| Cash and cash equivalents | $ | 3,878,853 | $ | 922,317 | ||||
| Restricted cash | 53,489 | 53,449 | ||||||
| Accounts and other receivable, net | 906,650 | 1,014,245 | ||||||
| Inventory, net | 48,225 | 254,385 | ||||||
| Prepaid expenses and other current assets | 729,054 | 804,508 | ||||||
| Total current assets | 5,616,271 | 3,048,904 | ||||||
| Property and equipment, net | 691,082 | 1,115,214 | ||||||
| Deferred costs and other assets | 308,938 | 396,233 | ||||||
| Intangible assets, net | 8,053,425 | 2,513,394 | ||||||
| Goodwill | 2,079,284 | - | ||||||
| Total assets | $ | 16,749,000 | $ | 7,073,745 | ||||
| LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) | ||||||||
| Current liabilities | ||||||||
| Accounts payable | $ | 498,288 | $ | 1,066,766 | ||||
| Accrued expenses and liabilities | 1,212,382 | 2,453,255 | ||||||
| Accrued interest | - | 3,143,470 | ||||||
| Deferred revenue, current portion | - | 523,900 | ||||||
| Convertible debt subject to put rights | - | 35,000,000 | ||||||
| Total current liabilities | 1,710,670 | 42,187,391 | ||||||
| Deferred revenue | - | 637,097 | ||||||
| Other liabilities | 143,191 | 307,058 | ||||||
| Total liabilities | 1,853,861 | 43,131,546 | ||||||
| Commitments and contingencies (Note 10) | ||||||||
| Predecessor conditionally redeemable common stock, 909,091 issued and outstanding | - | 500,000 | ||||||
| Stockholders' equity (deficit) | ||||||||
| Successor common stock; $0.0001 par value, 31,500,000 shares authorized, 9,927,112 issued and outstanding | 993 | - | ||||||
| Successor preferred stock; $0.0001 par value, 1,000,000 shares authorized, 29,038 issued and outstanding; liquidation value $29,038,000 | 3 | - | ||||||
| Predecessor common stock; $.0001 par value, 425,000,000 shares authorized, 125,680,100 issued and outstanding | - | 12,477 | ||||||
| Predecessor common stock issuable | - | 392,950 | ||||||
| Additional paid-in capital | 18,105,659 | 125,956,728 | ||||||
| Accumulated deficit | (3,211,516 | ) | (162,919,956 | ) | ||||
| Total stockholders' equity (deficit) | 14,895,139 | (36,557,801 | ) | |||||
| Total liabilities and stockholders' equity (deficit) | $ | 16,749,000 | $ | 7,073,745 | ||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
4
NUO THERAPEUTICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
| Three Months ended September 30, 2016 | Three Months ended September 30, 2015 | |||||||
| Successor | Predecessor | |||||||
| Revenue | ||||||||
| Product sales | $ | 139,000 | $ | 1,633,464 | ||||
| License fees | - | 100,594 | ||||||
| Royalties | 37,773 | 435,146 | ||||||
| Total revenue | 176,773 | 2,169,204 | ||||||
| Costs of revenue | ||||||||
| Costs of sales | 277,603 | 1,557,420 | ||||||
| Costs of license fees | - | - | ||||||
| Costs of royalties | - | 42,653 | ||||||
| Total costs of revenue | 277,603 | 1,600,073 | ||||||
| Gross profit (loss) | (100,830 | ) | 569,131 | |||||
| Operating expenses | ||||||||
| Sales and marketing | 331,636 | 1,582,682 | ||||||
| Research and development | 323,455 | 515,163 | ||||||
| General and administrative | 1,099,915 | 1,989,212 | ||||||
| Impairment of intangible assets and goodwill | - | 23,740,963 | ||||||
| Total operating expenses | 1,755,006 | 27,828,020 | ||||||
| Loss from operations | (1,855,836 | ) | (27,258,889 | ) | ||||
| Other income (expense) | ||||||||
| Interest, net | (1,059 | ) | (967,013 | ) | ||||
| Change in fair value of derivative liabilities | - | 14,399,884 | ||||||
| Other | 55,371 | 1,952 | ||||||
| Reorganization items, net | (115,149 | ) | - | |||||
| Total other income (expense) | (60,837 | ) | 13,434,823 | |||||
| Income (loss) before provision for income taxes | (1,916,673 | ) | (13,824,066 | ) | ||||
| Provision for income taxes | - | 4,921 | ||||||
| Net loss | $ | (1,916,673 | ) | $ | (13,828,987 | ) | ||
| Basic and diluted loss per share | ||||||||
| Basic | $ | (0.19 | ) | $ | (0.11 | ) | ||
| Diluted | $ | (0.19 | ) | $ | (0.11 | ) | ||
| Weighted average shares outstanding | ||||||||
| Basic | 9,927,112 | 125,951,100 | ||||||
| Diluted | 9,927,112 | 125,951,100 | ||||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
5
NUO THERAPEUTICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
| Period from May 5, 2016 through September 30, 2016 | Period from January 1, 2016 through May 4, 2016 | Nine Months ended September 30, 2015 | ||||||||||
| Successor | Predecessor | Predecessor | ||||||||||
| Revenue | ||||||||||||
| Product sales | $ | 247,890 | $ | 922,608 | $ | 5,272,073 | ||||||
| License fees | - | 139,534 | 3,301,783 | |||||||||
| Royalties | 63,740 | 670,079 | 1,327,706 | |||||||||
| Total revenue | 311,630 | 1,732,221 | 9,901,562 | |||||||||
| Costs of revenue | ||||||||||||
| Costs of sales | 453,416 | 829,095 | 5,176,715 | |||||||||
| Costs of license fees | - | - | 1,500,000 | |||||||||
| Costs of royalties | - | 54,543 | 130,492 | |||||||||
| Total costs of revenue | 453,416 | 883,638 | 6,807,207 | |||||||||
| Gross profit (loss) | (141,786 | ) | 848,583 | 3,094,355 | ||||||||
| Operating expenses | ||||||||||||
| Sales and marketing | 568,950 | 833,943 | 5,187,911 | |||||||||
| Research and development | 547,824 | 554,586 | 1,847,497 | |||||||||
| General and administrative | 1,702,732 | 2,307,009 | 7,384,659 | |||||||||
| Impairment of intangible assets and goodwill | - | - | 23,740,963 | |||||||||
| Total operating expenses | 2,819,506 | 3,695,538 | 38,161,030 | |||||||||
| Loss from operations | (2,961,292 | ) | (2,846,955 | ) | (35,066,675 | ) | ||||||
| Other income (expense) | ||||||||||||
| Interest, net | (1,168 | ) | (252,956 | ) | (2,746,588 | ) | ||||||
| Change in fair value of derivative liabilities | - | - | 27,248,891 | |||||||||
| Other | 75,495 | 2,495 | (13,164 | ) | ||||||||
| Reorganization items, net | (324,551 | ) | 31,271,350 | - | ||||||||
| Total other income (expense) | (250,224 | ) | 31,020,889 | 24,489,139 | ||||||||
| Income (loss) before provision for income taxes | (3,211,516 | ) | 28,173,934 | (10,577,536 | ) | |||||||
| Provision for income taxes | - | - | 14,688 | |||||||||
| Net income (loss) | $ | (3,211,516 | ) | $ | 28,173,934 | $ | (10,592,224 | ) | ||||
| Basic and diluted earnings (loss) per share | ||||||||||||
| Basic | $ | (0.33 | ) | $ | 0.22 | $ | (0.08 | ) | ||||
| Diluted | $ | (0.33 | ) | $ | 0.15 | $ | (0.08 | ) | ||||
| Weighted average shares outstanding | ||||||||||||
| Basic | 9,876,605 | 125,951,100 | 125,951,100 | |||||||||
| Diluted | 9,876,605 | 193,258,792 | 125,951,100 | |||||||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
6
NUO THERAPEUTICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
| Period from May 5, 2016 through September 30, 2016 | Period from January 1, 2016 through May 4, 2016 | Nine Months ended September 30, 2015 | ||||||||||
| Successor | Predecessor | Predecessor | ||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||||||
| Net income (loss) | $ | (3,211,516 | ) | $ | 28,173,934 | $ | (10,592,224 | ) | ||||
| Adjustments to reconcile net income (loss) to net cash | ||||||||||||
| used in operating activities: | ||||||||||||
| Non-cash interest expense | - | - | 1,198,352 | |||||||||
| Non-cash gain on reorganization | - | (34,869,565 | ) | - | ||||||||
| Change in fair value of derivative liabilities | - | - | (27,248,891 | ) | ||||||||
| Impairment of intangible assets and goodwill | - | - | 23,740,963 | |||||||||
| Stock-based compensation | - | 55,081 | 657,318 | |||||||||
| Depreciation and amortization | 518,209 | 289,360 | 532,714 | |||||||||
| Non cash debtor-in-possession note payable debt issuance costs | 278,303 | - | ||||||||||
| Deferred income tax provision | - | - | 14,688 | |||||||||
| Increase in allowance for uncollectible accounts | 1,651 | - | 37,642 | |||||||||
| Increase in allowance for inventory obsolescence | 2,308 | - | 13,240 | |||||||||
| Change in operating assets and liabilities: | ||||||||||||
| Accounts and other receivable | 380,144 | (274,200 | ) | (373,695 | ) | |||||||
| Inventory | 5,815 | 106,108 | (60,427 | ) | ||||||||
| Prepaid expenses and other current assets | (133,514 | ) | 194,835 | 756,130 | ||||||||
| Other assets | 46,803 | (61,427 | ) | (43,803 | ) | |||||||
| Accounts payable | (2,378,882 | ) | 2,024,959 | 632,158 | ||||||||
| Accrued expenses and liabilities | (1,681,926 | ) | 1,159,737 | (2,274,239 | ) | |||||||
| Accrued interest | - | 172,651 | 1,567,751 | |||||||||
| Deferred revenue | - | (261,075 | ) | (119,489 | ) | |||||||
| Other liabilities | (28,422 | ) | (76,992 | ) | (89,560 | ) | ||||||
| Net cash used in operating activities | (6,479,330 | ) | (3,088,291 | ) | (11,651,372 | ) | ||||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||||||
| Changes in restricted cash | (26 | ) | (14 | ) | - | |||||||
| Property and equipment acquisitions | - | - | (270,817 | ) | ||||||||
| Proceeds from sale of equipment | - | - | 29,497 | |||||||||
| Net cash used in investing activities | (26 | ) | (14 | ) | (241,320 | ) | ||||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||||||
| Proceeds from issuance of common and preferred stock, net of issuance costs | - | 7,052,500 | - | |||||||||
| Proceeds from issuance of debtor-in-possession note payable, net of issuance costs | - | 5,471,697 | - | |||||||||
| Net cash provided by financing activities | - | 12,524,197 | - | |||||||||
| Net increase (decrease) in cash and cash equivalents | (6,479,356 | ) | 9,435,892 | (11,892,692 | ) | |||||||
| Cash and cash equivalents, beginning of period | 10,358,209 | 922,317 | 15,946,425 | |||||||||
| Cash and cash equivalents, end of period | $ | 3,878,853 | $ | 10,358,209 | $ | 4,053,733 | ||||||
| Supplemental cash flow information | ||||||||||||
| Interest expense paid in cash | $ | 1,241 | $ | 78,822 | $ | - | ||||||
| Cash flows related to reorganization items, net | $ | 1,507,863 | $ | 1,839,560 | $ | - | ||||||
| Non-cash financing and investing activities | ||||||||||||
| Issuance of common stock to settle outstanding accruals | $ | 217,936 | $ | - | $ | - | ||||||
| Issuance of preferred stock to settle debt | $ | 8,288,719 | $ | - | $ | - | ||||||
| Issuance of common stock to prior investors | $ | 226 | $ | - | $ | - | ||||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
7
NUO THERAPEUTICS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)
(unaudited)
| Common Stock | Preferred Stock | |||||||||||||||||||||||||||||||||||
| Redeemable common stock | Shares | Amount | Shares | Amount | Common Stock Issuable | Additional Paid-in Capital | Accumulated Deficit | Total Stockholders' Equity (Deficit) | ||||||||||||||||||||||||||||
| Balance, January 1, 2015 (Predecessor) | $ | 500,000 | 125,680,100 | $ | 12,477 | - | $ | - | $ | 392,950 | $ | 125,173,973 | $ | (110,111,848 | ) | $ | 15,467,552 | |||||||||||||||||||
| Stock-based compensation related to stock options and warrants issued for service rendered | - | - | - | - | - | - | 782,755 | - | 782,755 | |||||||||||||||||||||||||||
| Net loss | - | - | - | - | - | - | - | (52,808,108 | ) | (52,808,108 | ) | |||||||||||||||||||||||||
| Balance, December 31, 2015 (Predecessor) | 500,000 | 125,680,100 | 12,477 | - | - | 392,950 | 125,956,728 | (162,919,956 | ) | (36,557,801 | ) | |||||||||||||||||||||||||
| Stock-based compensation related to stock options and warrants issued for service rendered | - | - | - | - | - | - | 55,081 | - | 55,081 | |||||||||||||||||||||||||||
| Net income | - | - | - | - | - | - | - | 28,173,934 | 28,173,934 | |||||||||||||||||||||||||||
| Elimination of Predecessor Company equity | (500,000 | ) | (125,680,100 | ) | (12,477 | ) | - | - | (392,950 | ) | (126,011,809 | ) | 134,746,022 | 8,328,786 | ||||||||||||||||||||||
| Balance, May 4, 2016 (Predecessor) | - | - | - | - | - | - | - | - | - | |||||||||||||||||||||||||||
| Issuance of Successor Company preferred stock | - | - | - | 29,038 | 3 | - | 8,288,716 | - | 8,288,719 | |||||||||||||||||||||||||||
| Issuance of Successor Company common stock | - | 7,500,000 | 750 | - | - | - | 9,599,250 | - | 9,600,000 | |||||||||||||||||||||||||||
| Balance, May 5, 2016 (Successor) | - | 7,500,000 | 750 | 29,038 | 3 | - | 17,887,966 | - | 17,888,719 | |||||||||||||||||||||||||||
| Issuance of common stock to previous investors | - | 2,264,612 | 226 | - | - | - | (226 | ) | - | |||||||||||||||||||||||||||
| Issuance of common stock for services | - | 162,500 | 17 | - | - | - | 217,919 | - | 217,936 | |||||||||||||||||||||||||||
| Net loss | - | - | - | - | - | - | - | (3,211,516 | ) | (3,211,516 | ) | |||||||||||||||||||||||||
| Balance, September 30, 2016 (Successor) | $ | - | 9,927,112 | $ | 993 | 29,038 | $ | 3 | $ | - | $ | 18,105,659 | $ | (3,211,516 | ) | $ | 14,895,139 | |||||||||||||||||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
8
NUO THERAPEUTICS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 – Description of Business and Bankruptcy Proceedings
Description of Business
Nuo Therapeutics, Inc. (“Nuo Therapeutics,” the “Company,” “we,” “us,” or “our”) is a biomedical company marketing products primarily within the U.S. We commercialize innovative cell-based technologies that harness the regenerative capacity of the human body to trigger natural healing. The use of autologous (from self) biological therapies for tissue repair and regeneration is part of a transformative clinical strategy designed to improve long term recovery in complex chronic conditions with significant unmet medical needs. Growth drivers in the U.S. include the treatment of chronic wounds with Aurix in the Veterans Affairs healthcare system and other federal accounts settings and the Medicare population under a National Coverage Determination when registry data is collected under CMS’ Coverage with Evidence Development (CED) program.
As of September 30, 2016, our commercial offering consists solely of a point of care technology for the safe and efficient separation of autologous blood to produce a platelet based therapy for the chronic wound care market. Prior to the Effective Date (as defined below), we had two distinct platelet rich plasma (“PRP”) devices, the Aurix System for wound care and the Angel® concentrated Platelet Rich Plasma (“cPRP”) System for orthopedics markets. Prior to the Effective Date, Arthrex, Inc. (“Arthrex”) was our exclusive distributor for Angel. Pursuant to the Plan of Reorganization (as defined below), on May 5, 2016 the Company assigned its rights, title and interest in and to its existing license agreement with Arthrex to the Deerfield Lenders (as defined below), as well as rights to collect royalty payments thereunder.
Bankruptcy Proceedings
On January 26, 2016, the Company filed a voluntary petition in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) seeking relief under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”), which is administered under the caption “In re: Nuo Therapeutics, Inc.”, Case No. 16-10192 (MFW) (the “Chapter 11 Case”).
On April 25, 2016 (the “Confirmation Date”), the Bankruptcy Court entered an Order Granting Final Approval of Disclosure Statement and Confirming Debtor’s Plan of Reorganization (the “Confirmation Order”), which confirmed the Modified First Amended Plan of Reorganization of the Debtor under Chapter 11 of the Bankruptcy Code (as confirmed, the “Plan,” or “Plan of Reorganization”).
Scenario A contemplated by the Plan of Reorganization became effective on May 5, 2016 (the “Effective Date”). Pursuant to the Plan, as of the Effective Date (i) all equity interests of the Company, including but not limited to all shares of the Company’s common stock, $0.0001 par value per share (including its redeemable common stock)(the “Old Common Stock”), warrants and options, that were issuable or issued and outstanding immediately prior to the Effective Date, were cancelled, (ii) the Company’s certificate of incorporation in effect immediately prior to the Effective Date was amended and restated in its entirety, (iii) the Company’s by-laws in effect immediately prior to the Effective Date were amended and restated in their entirety, and (iv) the Company issued New Common Stock, Warrants and Series A Preferred Stock (all as defined below).
Upon emergence from bankruptcy on the Effective Date, the Company applied fresh start accounting, resulting in the Company becoming a new entity for financial reporting purposes (see Note 2 – Fresh Start Accounting). As a result of the application of fresh start accounting, the Company reflected the disposition of its pre-petition debt and changes in its equity structure effected under the Confirmation Order in its balance sheet as of the Effective Date. Accordingly, all financial statements prior to May 5, 2016 are referred to as those of the "Predecessor Company" as they reflect the periods prior to application of fresh start accounting. The balance sheet as of September 30, 2016 and the financial statements for periods subsequent to May 4, 2016, are referred to as those of the "Successor Company." Under fresh start accounting, the Company's assets and liabilities were adjusted to their fair values, and a reorganization value for the entity was determined by the Company based upon the estimated fair value of the enterprise before considering values allocated to debt to be settled in the reorganization. The fresh start adjustments are material and affect the Company’s results of operations from and after May 5, 2016. As a result of the application of fresh start accounting and the effects of the implementation of the Plan of Reorganization, the financial statements on or after May 5, 2016 are not comparable to the financial statements prior to that date.
9
Common Stock
Recapitalization
In accordance with the Plan of Reorganization, as of the Effective Date, the Company issued 7,500,000 shares (the “Recapitalization Shares”) of new common stock, par value $0.0001 per share (the “New Common Stock”) to certain accredited investors (the “Recapitalization Investors”) for gross cash proceeds of $7,300,000 and net cash to the Company of $7,052,500 (the “Recapitalization Financing”). 200,000 of the 7,500,000 shares of New Common Stock were issued in partial payment of an advisory fee. The net cash amount excludes the effect of $100,000 in offering expenses paid from the proceeds of the DIP Financing (as defined below in Note 7 - Debt), which was converted into Series A Preferred Stock as of the Effective Date as described below under “Series A Preferred Stock.” As part of the Recapitalization Financing, the Company also issued warrants to purchase 6,180,000 shares of New Common Stock to certain of the Recapitalization Investors (the “Warrants”). The Warrants terminate on May 5, 2021 and are exercisable at any time on or after November 5, 2016 at exercise prices ranging from $0.50 per share to $1.00 per share. The number of shares of New Common Stock underlying a Warrant and its exercise price are subject to customary adjustments upon subdivisions, combinations, payment of stock dividends, reclassifications, reorganizations and consolidations.
A significant majority of the Recapitalization Investors executed backstop commitments to purchase up to 12,800,000 additional shares of New Common Stock for an aggregate purchase price of up to $3,000,000 (collectively, the “Backstop Commitment). The Company cannot call the Backstop Commitment prior to June 30, 2017.
With respect to each Recapitalization Investor who executed a Backstop Commitment, the commitment terminates on the earlier of (i) the date on which the Company receives net proceeds (after deducting all costs, expenses and commissions) from the sale of New Common Stock in the aggregate amount of the Backstop Commitment, (ii) the date that all shares of Series A Preferred Stock (as defined below) have been redeemed by the Company or (iii) the date that all shares of Series A Preferred Stock are no longer owned by entities affiliated with Deerfield Mgmt, L.P., Deerfield Management Company, L.P., Deerfield Special Situations Fund, L.P., and Deerfield Private Design Fund II, L.P. (the “Deerfield Lenders” or “Deerfield”). We refer to this date as the “Termination Date.” Under the terms of the Backstop Commitment, the Company is obligated to pay to the committed Recapitalization Investors upon the Termination Date a commitment fee of $250,000 in the aggregate.
As of the Effective Date, the Company entered into a registration rights agreement (the “Registration Rights Agreement”) with the Recapitalization Investors. The Registration Rights Agreement provides certain resale registration rights to the Recapitalization Investors with respect to securities received in the Recapitalization Financing. Pursuant to the Registration Rights Agreement, the Company has agreed to use its best efforts to prepare and file with the U.S. Securities and Exchange Commission a “shelf” registration statement covering the resale of all shares of New Common Stock issued to the Recapitalization Investors on the Effective Date.
Issuance of New Common Stock to Holders of Old Common Stock
As of the Effective Date, the Company committed to the issuance of up to 3,000,000 shares of New Common Stock and subsequently issued 2,264,612 shares of New Common Stock (the “Exchange Shares”) to record holders of the Old Common Stock as of March 28, 2016 who executed and timely delivered the required release documents no later than July 5, 2016 in accordance with the Confirmation Order and the Plan. The holders of Old Common Stock who executed and timely delivered the required release documents are referred to as the “Releasing Holders.”
The 2,264,612 Exchange Shares were issued as of the Effective Date to Releasing Holders who asserted ownership of a number of shares of Old Common Stock that matched the Company’s records or could otherwise be confirmed, at a rate of one share of New Common Stock for every 41.8934 shares of Old Common Stock held by such holders as of March 28, 2016. In accordance with the Plan, if the calculation would otherwise have resulted in the issuance to any Releasing Holder of a number of shares of New Common Stock that is not a whole number, then the number of shares actually issued to such Releasing Holder was determined by rounding down to the nearest number.
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Issuance of Shares in Exchange for Administrative Claims
On June 20, 2016, the Company issued 162,500 shares of New Common Stock (the “Administrative Claim Shares”) pursuant to the Order Granting Application of the Ad Hoc Equity Committee Pursuant to 11 U.S.C. §§ 503(b)(3)(D) and 503(b)(4) for Allowance of Fees and Expenses Incurred in Making a Substantial Contribution, entered by the Bankruptcy Court on June 20, 2016. The Administrative Claim Shares were issued to holders of administrative claims under sections 503(b)(3)(D) and 503(b)(4) of the Bankruptcy Code. Of the 162,500 shares, 100,000 shares were issued to outside counsel to the Ad Hoc Equity Committee of the Company’s equity holders as compensation of all remaining allowed fees for legal services provided by such counsel, and 62,500 were issued to designees of the Ad Hoc Equity Committee who had granted loans in an aggregate amount of $62,500 to the Ad Hoc Equity Committee in December 2015 as repayment of such loans.
Series A Preferred Stock
On the Effective Date, the Company filed a Certificate of Designations of Series A Preferred Stock (the “Certificate of Designations”) with the Delaware Secretary of State, designating 29,038 shares of the Company’s undesignated preferred stock, par value $0.0001 per share, as Series A Preferred Stock (the “Series A Preferred Stock”). On the Effective Date, the Company issued 29,038 shares of Preferred Stock to Deerfield in accordance with the Plan pursuant to the exemption from the registration requirements of the Securities Act provided by Section 1145 of the Bankruptcy Code. The Deerfield Lenders did not receive any shares of New Common Stock or other equity interests in the Company.
The Series A Preferred Stock has no stated maturity date, is not convertible or redeemable and carries a liquidation preference of $29,038,000, which is required to be paid to holders of such Series A Preferred Stock before any payments are made with respect to shares of New Common Stock (and other capital stock that is not issued on parity or senior to the Series A Preferred Stock) upon a liquidation or change in control transaction. For so long as Series A Preferred Stock is outstanding, the holders of Series A Preferred Stock have the right to nominate and elect one member of the board of directors of the Company (the “Board of Directors”) and to have such director serve on a standing committee of the Board of Directors established to exercise powers of the Board of Directors in respect of decisions or actions relating to the Backstop Commitment. Lawrence Atinsky serves as the designee of the holders of Series A Preferred Stock. The Series A Preferred Stock have voting rights, voting with the New Common Stock as a single class, with each share of Series A Preferred Stock having the right to five votes, currently representing approximately one percent (1%) of the voting rights of the capital stock of the Company, and the holders of Series A Preferred Stock have the right to approve certain transactions and incurrences of debt. The Certificate of Designations limits the Company’s ability to pay dividends on or purchase shares of its capital stock.
Assignment and Assumption Agreement; Transition Services Agreement
Pursuant to the Plan, on May 5, 2016, the Company entered into an Assignment and Assumption Agreement with Deerfield SS, LLC (the “Assignee”), the designee of the Deerfield Lenders, to assign to the Assignee the Company’s rights, title and interest in and to its existing license agreement with Arthrex, and to transfer and assign to the Assignee associated intellectual property owned by the Company and licensed thereunder, as well as rights to collect royalty payments thereunder. The assignment and transfer was effected in exchange for a reduction of $15,000,000 in the amount of the allowed claim of the Deerfield Lenders pursuant to the Plan. As a result of the assignment and transfer, the Aurix System currently represents the Company’s only commercial product offering.
On the Effective Date, the Company and the Assignee entered into a Transition Services Agreement in which the Company agreed to continue to service its license agreement with Arthrex for a transition period. See Note 11 – Subsequent Events for a description of an agreement with Arthrex and Assignee extending such transition period, among other matters.
Termination of Deerfield Facility Agreement and DIP Credit Agreement
On the Effective Date, the obligations of the Company under the Deerfield Facility Agreement, and under the DIP Credit Agreement (as defined below in Note 7 - Debt), were cancelled in accordance with the Plan of Reorganization and the Company ceased to have any obligations thereunder.
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Note 2 – Fresh Start Accounting
Upon the Company’s emergence from Chapter 11 bankruptcy, the Company applied the provisions of fresh start accounting to its financial statements because (i) the holders of existing voting shares of the Predecessor Company received less than 50% of the voting shares of the emerging entity and (ii) the reorganization value of the Company’s assets immediately prior to confirmation was less than the sum of post-petition liabilities and allowed claims. The Company applied fresh start accounting as of May 4, 2016, with results of operations and cash flows in the period from January 1, 2016 through May 4, 2016 attributed to the Predecessor Company.
Upon the application of fresh start accounting, the Company allocated the reorganization value to its individual assets based on their estimated fair values. Reorganization value represents the fair value of the Successor Company’s assets before considering liabilities, and the excess of reorganization value over the fair value of identified tangible and intangible assets is reported separately on the consolidated balance sheet as goodwill.
The Company, with the assistance of external valuation specialists, estimated the enterprise value of the Company upon emergence from Chapter 11 bankruptcy to be approximately $17.9 million. Enterprise value is defined as the total invested capital which includes cash and cash equivalents. The estimate is based on a calculation of the present value of the projected future cash flows of the Company from May 5, 2016 through the year ending December 31, 2025, along with a terminal value. The Company estimated a terminal value using the Gordon Growth Model, applying a constant growth rate of 3.4% to the debt-free net cash flows subsequent to 2025.
The Company’s future cash flow projections included a variety of estimates and assumptions that had a significant effect on the determination of the Company’s enterprise value. While the Company considered such estimates and assumptions reasonable, they are inherently subject to significant business, economic and competitive uncertainties, many of which are beyond the Company’s control and, therefore, may not be realized. The assumptions used in the calculations for the discounted cash flow analysis included the following: forecasted revenue, costs and free cash flows through 2025, and a discount rate of 29% that considered various factors, including bonds yields, risk premiums, tax rates and the likelihood of various business outcomes to determine an appropriate discount rate. In applying fresh start accounting, the Company followed these principles:
| · | The reorganization value, estimated as approximately $24.0 million, which represents the sum of the enterprise value and estimated fair value of noninterest bearing liabilities, was allocated to the Successor Company's assets based on their estimated fair values. The reorganization value exceeded the sum of the fair value assigned to the assets, and the excess was recognized as goodwill of the Successor Company as of May 5, 2016. |
| · | Each liability existing as of May 5, 2016 has been stated at its estimated fair value. |
| · | Deferred tax assets and liabilities have been recognized for differences between the assigned values and the tax basis of the recognized assets and liabilities, and have been fully valued as of May 5, 2016 to reduce deferred tax assets to the amounts expected to be realized. |
Pursuant to fresh start accounting the Company allocated the determined reorganization value to the Successor Company’s assets as follows (in thousands):
| Enterprise Value | $ | 17,889 | ||
| Plus estimated fair value of liabilities | 6,161 | |||
| Reorganization Value | 24,050 | |||
| Less: | ||||
| Estimated fair value of tangible assets | (13,574 | ) | ||
| Estimated fair value of identifiable intangible assets | (8,397 | ) | ||
| Goodwill | $ | 2,079 |
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Upon the adoption of fresh start accounting, the Successor Company adopted the significant accounting policies of the Predecessor Company (see Note 3 – Liquidity and Summary of Significant Accounting Policies). The adjustments set forth in the following table at May 5, 2016 reflect the effect of the consummation of the transactions contemplated by the Plan of Reorganization (reflected in the column “Reorganization Adjustments”) as well as fair value adjustments as a result of the adoption of fresh start accounting (reflected in the column “Fresh Start Adjustments”).
| Predecessor Company | Reorganization Adjustments | Fresh Start Adjustments |
Successor Company | |||||||||||||
| ASSETS | ||||||||||||||||
| Current assets | ||||||||||||||||
| Cash and cash equivalents | $ | 3,305,709 | $ | 7,052,500 | (1) | $ | 10,358,209 | |||||||||
| Restricted cash | 53,463 | 53,463 | ||||||||||||||
| Accounts and other receivable, net | 1,288,445 | 1,288,445 | ||||||||||||||
| Inventory, net | 56,348 | 56,348 | ||||||||||||||
| Prepaid expenses and other current assets | 611,593 | $ | (16,053 | )(b) | 595,540 | |||||||||||
| - | ||||||||||||||||
| Total current assets | 5,315,558 | (16,053 | ) | 7,052,500 | 12,352,005 | |||||||||||
| Property and equipment, net | 865,716 | 865,716 | ||||||||||||||
| Deferred costs and other assets | 355,741 | 355,741 | ||||||||||||||
| Intangible assets, net | 2,406,457 | (2,406,457 | )(a) | 8,397,000 | (2) | 8,397,000 | ||||||||||
| Goodwill | - | 2,079,284 | (2) | 2,079,284 | ||||||||||||
| TOTAL ASSETS | $ | 8,943,472 | $ | (2,422,510 | ) | $ | 17,528,784 | $ | 24,049,746 | |||||||
| LIABILITIES AND EQUITY | ||||||||||||||||
| Current liabilities not subject to compromise | ||||||||||||||||
| Accounts payable | $ | 2,877,170 | $ | 2,877,170 | ||||||||||||
| Accrued expenses and liabilities | 3,112,244 | 3,112,244 | ||||||||||||||
| Accrued interest | - | - | ||||||||||||||
| Deferred revenue, current portion | 899,920 | $ | (899,920 | )(c) | - | |||||||||||
| Convertible debt subject to put rights | - | - | ||||||||||||||
| Short term debtor-in-possession note payable | 5,750,000 | (5,750,000 | )(d) | - | ||||||||||||
| Total current liabilities not subject to compromise | 12,639,334 | (6,649,920 | ) | - | 5,989,414 | |||||||||||
| Non-current liabilities not subject to compromise | ||||||||||||||||
| Deferred revenue | - | - | ||||||||||||||
| Other liabilities | 171,613 | 171,613 | ||||||||||||||
| Total non-current liabilities not subject to compromise | 171,613 | - | - | 171,613 | ||||||||||||
| Liabilities subject to compromise | ||||||||||||||||
| Accounts payable | 214,554 | (214,554 | )(e) | - | ||||||||||||
| Accrued expenses and liabilities | 559,202 | (559,202 | )(e) | - | ||||||||||||
| Accrued interest | 3,316,121 | (3,316,121 | )(d) | - | ||||||||||||
| Deferred revenue | - | - | ||||||||||||||
| Convertible debt subject to put rights | 35,000,000 | (35,000,000 | )(d) | - | ||||||||||||
| Derivative liabilities | - | - | ||||||||||||||
| Other liabilities | - | - | ||||||||||||||
| Total liabilities subject to compromise | 39,089,877 | (39,089,877 | ) | - | - | |||||||||||
| TOTAL LIABILITIES | 51,900,824 | (45,739,797 | ) | - | 6,161,027 | |||||||||||
| Conditionally redeemable common stock | 500,000 | (500,000 | )(f) | - | ||||||||||||
| Common stock outstanding, at par | 12,477 | (12,477 | )(f) | 750 | (1) | 750 | ||||||||||
| Common stock issuable | 392,950 | (392,950 | )(f) | - | ||||||||||||
| Preferred stock outstanding, at par | - | 3 | (3) | 3 | ||||||||||||
| Additional paid-in capital | 126,011,808 | (126,011,808 | )(f) | 17,887,966 | (4) | 17,887,966 | ||||||||||
| Retained earnings (deficit) | (169,874,587 | ) | 170,234,522 | (g) | (359,935 | )(5) | - | |||||||||
| TOTAL EQUITY | (43,457,352 | ) | 43,817,287 | 17,528,784 | 17,888,719 | |||||||||||
| TOTAL LIABILITIES AND EQUITY | $ | 8,943,472 | $ | (2,422,510 | ) | $ | 17,528,784 | $ | 24,049,746 | |||||||
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Reorganization Adjustments
| (a) | As a result of fresh start accounting, all intangible assets existing as of the Effective Date were established at fair value. This adjustment eliminates the carrying value of previously existing intangible assets as of the Effective Date as the underlying Angel assets were assigned to Deerfield pursuant to the Plan of Reorganization. |
| (b) | Pursuant to the Plan of Reorganization, the Company assigned to Deerfield the Company’s (i) rights, title and interest in and to its existing license agreement with Arthrex, (ii) the associated intellectual property owned by the Company and licensed under such agreement, and (iii) rights to collect royalty payments thereunder. As such, certain prepaid expenses related to the Angel business were eliminated. |
| (c) | Pursuant to the Plan of Reorganization, the Company assigned to Deerfield the Company’s (i) rights, title and interest in and to its existing license agreement with Arthrex, (ii) the associated intellectual property owned by the Company and licensed under such agreement, and (iii) rights to collect royalty payments thereunder. As such, all deferred revenue related to the existing license agreement with Arthrex as of the Effective Date was eliminated. |
| (d) | Pursuant to the Plan of Reorganization, the Company’s obligations under the Deerfield Facility Agreement including accrued interest were cancelled and the Company ceased to have any obligations thereunder. Additionally, pursuant to the Plan of Reorganization, the DIP Credit Agreement was terminated. |
| (e) | Represents claims not expected to be settled in cash. |
| (f) | Pursuant to the Plan of Reorganization, all equity interests of the Company, including but not limited to all shares of the Company’s common stock, $0.0001 par value per share (including its redeemable common stock) (the “Old Common Stock”), warrants and options, that were issuable or issued and outstanding immediately prior to the Effective Date, were cancelled. The elimination of the carrying value of the cancelled equity interests was reflected as direct charge to retained earnings (deficit). |
| (g) | Represents the cumulative impact of the reorganization adjustments: |
| Description | Adjustment | Amount | ||||
| Elimination of existing intangible assets | (a) | $ | (2,406,457 | ) | ||
| Elimination of prepaid Angel expenses | (b) | (16,053 | ) | |||
| Elimination of Angel deferred revenue | (c) | 899,920 | ||||
| Termination of debt agreements and accrued interest | (d) | 44,066,121 | ||||
| Elimination of various payables and accruals | (e) | 773,756 | ||||
| Cancellation of existing equity | (f) | 126,917,235 | ||||
| $ | 170,234,522 | |||||
Fresh Start Adjustments
| (1) | Pursuant to the Plan of Reorganization, as of the Effective Date, the Company issued 7,500,000 shares of new common stock, par value $0.0001 per share (the “New Common Stock”), to certain accredited investors for net cash to the Company of $7,052,500. The Company also issued warrants (the “Warrants”) to purchase 6,180,000 shares of New Common Stock to certain of the investors. The Warrants terminate on May 5, 2021 and are exercisable at any time on or after November 5, 2016 at exercise prices ranging from $0.50 per share to $1.00 per share. The number of shares of New Common Stock underlying a Warrant and its exercise price are subject to customary adjustments upon subdivisions, combinations, payment of stock dividends, reclassifications, reorganizations and consolidations. Certain investors also provided backstop commitments (collectively, the “Backstop Commitment”) to purchase up to 12,800,000 additional shares of New Common Stock for an aggregate purchase price of up to $3,000,000. The Company cannot call the Backstop Commitment prior to June 30, 2017. The New Common Stock, Warrants and Backstop Commitment are classified as equity. |
| (2) | Represents identifiable intangible assets of approximately $8.4 million and goodwill of approximately $2.1 million. Upon the application of fresh start accounting, the Company allocated the reorganization value to its individual assets based on their estimated fair values. Reorganization value represents the fair value of the Successor Company’s assets before considering liabilities, and the excess of reorganization value over the fair value of identified tangible and intangible assets is reported separately on the consolidated balance sheet as goodwill. |
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The Company, with the assistance of external valuation specialists, estimated the enterprise value of the Company upon emergence from Chapter 11 bankruptcy to be $17.9 million. Enterprise value is defined as the total invested capital, which includes cash and cash equivalents. The estimate is based on a calculation of the present value of the projected future cash flows of the Company from May 5, 2016 through the year ending December 31, 2025 along with a terminal value. The Company estimated a terminal value using the Gordon Growth Model.
In applying fresh start accounting, the Company followed these principles:
| · | The reorganization value, estimated as approximately $24.0 million, which represents the sum of the enterprise value and estimated fair value of noninterest bearing liabilities, was allocated to the Successor Company's assets based on their estimated fair values. The reorganization value exceeded the sum of the fair value assigned to the assets, and the excess was recognized as goodwill of the Successor Company as of May 5, 2016. |
| · | Each liability existing as of May 5, 2016 has been stated at its estimated fair value. |
| · | Deferred tax assets and liabilities have been recognized for differences between the assigned values and the tax basis of the recognized assets and liabilities, and have been fully valued as of May 5, 2016 to reduce deferred tax assets to the amounts expected to be realized. |
Pursuant to fresh start accounting the Company allocated the determined reorganization value to the Successor Company’s assets as follows (in thousands):
| Enterprise Value | $ | 17,889 | ||
| Plus estimated fair value of liabilities | 6,161 | |||
| Reorganization Value | 24,050 | |||
| Less: | ||||
| Estimated fair value of tangible assets | (13,574 | ) | ||
| Estimated fair value of identifiable intangible assets | (8,397 | ) | ||
| Goodwill | $ | 2,079 |
| (3) | Pursuant to the Plan of Reorganization, on the Effective Date, the Company issued 29,038 shares of Series A Preferred Stock to Deerfield. The Series A Preferred Stock has no stated maturity date, is not convertible or redeemable and carries a liquidation preference of $29,038,000, which is required to be paid to holders of such Series A Preferred Stock before any payments are made with respect to shares of New Common Stock (and other capital stock that is not issued on parity or senior to the Series A Preferred Stock) upon a liquidation or change in control transaction. The Series A Preferred Stock is carried at par value and is classified as equity. |
| (4) | Reflects the cumulative impact of the fresh start adjustments described above on additional paid in capital: |
| Description | Adjustment | Amount | ||||
| Cash proceeds from issuance of common stock | (1) | $ | 7,052,500 | |||
| Establishment of intangible assets | (2) | 10,476,284 | ||||
| Net assets of the predecessor | (5) | 359,935 | ||||
| Less par value of common and preferred stock | (3) | (753 | ) | |||
| $ | 17,887,966 | |||||
| (5) | Reflects the elimination of retained earnings upon the application of fresh start accounting. |
Reorganization Items, net
Costs directly attributable to the bankruptcy proceedings and implementation of the Plan are reported as reorganization items, net. A summary of reorganization items, net is presented in the following tables:
| Three Months ended September 30, 2016 | Period from May 5, 2016 through September 30, 2016 | Period from January 1, 2016 through May 4, 2016 | ||||||||||
| Successor | Successor | Predecessor | ||||||||||
| Professional fees | $ | 115,149 | $ | 324,551 | $ | 3,598,216 | ||||||
| Net gain on reorganization adjustments | - | - | (34,869,566 | ) | ||||||||
| Reorganization items, net | $ | 115,149 | $ | 324,551 | $ | (31,271,350 | ) | |||||
| Cash payments for reorganization items | $ | 406,157 | $ | 1,507,863 | $ | 1,839,560 | ||||||
Note 3 – Liquidity and Summary of Significant Accounting Principles
Liquidity
Our operations are subject to certain risks and uncertainties including, among others, current and potential competitors with greater resources, dependence on significant customers, lack of operating history and uncertainty of future profitability and possible fluctuations in financial results. Since our inception, we have financed our operations by raising debt, issuing equity and equity-linked instruments, executing licensing arrangements, and to a lesser extent by generating royalties and product revenues. We have incurred, and continue to incur, recurring losses and negative cash flows. On the Effective Date, the obligations of the Company under the Deerfield Facility Agreement and the DIP Credit Agreement were cancelled and the Company ceased to have any obligations thereunder. At September 30, 2016, we had cash and cash equivalents on hand of approximately $3.9 million, and had no outstanding debt.
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The accompanying condensed consolidated financial statements have been prepared assuming that we will continue as a going concern, which contemplates continuity of operations, realization of assets, and satisfaction of liabilities in the ordinary course of business. The propriety of using the going-concern basis is dependent upon, among other things, the achievement of future profitable operations, the ability to generate sufficient cash from operations, and potential other funding sources, including cash on hand, to meet our obligations as they become due. After our emergence from bankruptcy on May 5, 2015, we believe our current resources, expected revenue from sales of Aurix, including additional revenue expected to be generated from our collaboration with Restorix Health, limited royalty and license fee revenue from our license of certain aspects of the ALDH technology to StemCell Technologies for the Aldeflour product line, combined with the $3.0 million of backstop commitments, which is not available until June 30, 2017, will be adequate to maintain our operations through at least the end of 2017. However, if we are unable to increase our revenues as much as expected or control our costs as effectively as expected, then we may be required to curtail portions of our strategic plan or to cease operations. More specifically, if we are unable to increase revenues or control costs in this manner, we may be forced to delay the completion of, or significantly reduce the scope of, our current business plan; delay some of our development and clinical or marketing efforts; delay our plans to penetrate the market serving Medicare beneficiaries and fulfill the related data gathering requirements as stipulated by the Medicare CED coverage determination; delay the pursuit of commercial insurance reimbursement for our wound treatment technologies; or postpone the hiring of new personnel; or, under certain dire financial circumstances, cease our operations. Specific programs that may require additional funding include, without limitation, continued investment in the sales, marketing, distribution, and customer service areas, further expansion into the international markets, significant new product development or modifications, and pursuit of other opportunities. If adequate capital cannot be obtained on a timely basis and on satisfactory terms, the Company’s operations could be materially negatively impacted.
As noted in Note 2 – Fresh Start Accounting, as part of fresh start accounting, the Successor Company adopted the significant accounting policies of the Predecessor Company. As a result, the following summary of significant accounting policies applies to both the Predecessor Company and Successor Company.
Basis of Presentation
The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). In our opinion, the accompanying unaudited interim condensed consolidated financial statements include all adjustments, consisting of normal recurring adjustments, which are necessary to present fairly our financial position, results of operations and cash flows. The condensed consolidated balance sheet at December 31, 2015, has been derived from audited financial statements of the Predecessor Company as of that date. The interim unaudited condensed consolidated results of operations are not necessarily indicative of the results that may occur for the full fiscal year. More specifically, upon emergence from bankruptcy on the Effective Date, the Company applied fresh start accounting, resulting in the Company becoming a new entity for financial reporting purposes (see Note 2 – Fresh Start Accounting). As a result of the application of fresh start accounting and the effects of the implementation of the Plan of Reorganization, the financial statements on or after May 5, 2016 are not comparable to the financial statements prior to that date. Certain information and footnote disclosure normally included in financial statements prepared in accordance with U.S. GAAP have been omitted pursuant to instructions, rules and regulations prescribed by the United States Securities and Exchange Commission, or the SEC. We believe that the disclosures provided herein are adequate to make the information presented not misleading when these unaudited interim condensed consolidated financial statements are read in conjunction with the audited financial statements and notes previously included in the Predecessor Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
Principles of Consolidation
The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned and controlled subsidiary Aldagen, Inc. (“Aldagen”). All significant inter-company accounts and transactions are eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires us 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 amount of revenues and expenses during the reporting period. In the accompanying condensed consolidated financial statements, estimates are used for, but not limited to, stock-based compensation, allowance for inventory obsolescence, allowance for doubtful accounts, valuation of derivative liabilities, contingent liabilities, fair value and depreciable lives of long-lived assets (including property and equipment, intangible assets and goodwill), deferred taxes and associated valuation allowance and the classification of our long-term debt. Actual results could differ from those estimates.
Credit Concentration
We generate accounts receivable from the sale of our products. Specific customer receivables balances in excess of 10% of total receivables at September 30, 2016 and December 31, 2015 were as follows:
| Successor | Predecessor | |||||||
| September 30, 2016 | December 31, 2015 | |||||||
| BioProd / Pharmagena | 49 | % | 47 | % | ||||
| Arthrex | 34 | % | 21 | % | ||||
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Revenue from significant customers exceeding 10% of total revenues for the periods presented was as follows:
| Three Months ended September 30, 2016 | Three Months ended September 30, 2015 | |||||||||||
| Successor | Predecessor | |||||||||||
| St. Luke's Hospital System | $ | 42,000 | $ | - | ||||||||
| STEMCELL Technologies | 37,773 | - | ||||||||||
| Marion IL VA Hospital | 24,000 | - | ||||||||||
| Arthrex | - | 1,938,485 | ||||||||||
| Period from May 5, 2016 through September 30, 2016 | Period from January 1, 2016 through May 4, 2016 | Nine Months ended September 30, 2015 | ||||||||||
| Successor | Predecessor | Predecessor | ||||||||||
| STEMCELL Technologies | $ | 63,740 | $ | - | $ | - | ||||||
| St. Luke's Hospital System | 63,000 | - | - | |||||||||
| Vibra | 35,320 | - | - | |||||||||
| Arthrex | - | 1,342,480 | 6,316,296 | |||||||||
| Rohto Pharmaceutical, Co. | - | - | 3,000,000 | |||||||||
Historically, we used single suppliers for several components of the Aurix™ product line. We outsource the manufacturing of various products to contract manufacturers. While we believe these manufacturers demonstrate competency, reliability and stability, there is no assurance that one or more of them will not experience an interruption or inability to provide us with the products needed to satisfy customer demand. Additionally, while most of the components of Aurix™ are generally readily available on the open market, a reagent, bovine thrombin, is available exclusively through Pfizer, with whom we have an established vendor relationship.
Cash Equivalents
We consider all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents potentially subject us to a concentration of credit risk as approximately $3.6 million held in financial institutions was in excess of the FDIC insurance limit of $250,000 at September 30, 2016. We maintain our cash and cash equivalents in the form of money market and checking accounts with financial institutions that we believe are credit worthy.
Accounts Receivables
We generate accounts receivables from the sale of our products. We provide for an allowance against receivables for estimated losses that may result from a customer’s inability or unwillingness to pay. The allowance for doubtful accounts is estimated primarily based upon historical write-off percentages, known problem accounts, and current economic conditions. Accounts are written off against the allowance for doubtful accounts when we determine that amounts are not collectable. Recoveries of previously written-off accounts are recorded when collected. At September 30, 2016 and December 31, 2015, we maintained an allowance for doubtful accounts of approximately $2,000 and $97,000, respectively.
Inventory
Our inventory is produced by third party manufacturers and consists of raw materials and finished goods. Inventory cost is determined on a first-in, first-out basis and is stated at the lower of cost or net realizable value. We maintain an inventory of kits, reagents, and other disposables that have shelf-lives that generally range from 18 months to five years.
We provide for an allowance against inventory for estimated losses that may result in excess and obsolete inventory (i.e., from the expiration of products). Our allowance for expired inventory is estimated based upon the inventory’s remaining shelf-life and our anticipated ability to sell such inventory, which is estimated using historical usage and future forecasts, within its remaining shelf life. At September 30, 2016 and December 31, 2015, the Company maintained an allowance for expired and excess and obsolete inventory of approximately $3,000 and $58,000, respectively. Expired products are segregated and used for demonstration purposes only; the Company records the associated expense for this reserve to cost of sales in the condensed consolidated statements of operations.
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Property and Equipment
Property and equipment is stated at cost less accumulated depreciation and is depreciated, using the straight-line method, over its estimated useful life ranging from three to five years for all assets except for furniture, lab, and manufacturing equipment which is depreciated over seven and ten years, respectively. Leasehold improvements are stated at cost less accumulated depreciation and are amortized, using the straight-line method, over the lesser of the expected lease term or its estimated useful life ranging from three to six years. Amortization of leasehold improvements is included in depreciation expense. Maintenance and repairs are charged to operations as incurred. When assets are disposed of, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in other income (expense).
Centrifuges may be sold or placed at no charge with customers. Depreciation expense for centrifuges that are available for sale or placed at no charge with customers are charged to cost of sales. Depreciation expense for centrifuges used for sales and marketing and other internal purposes are charged to general and administrative expenses.
Property and equipment is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. Recoverability measurement and estimating of undiscounted cash flows is done at the lowest possible level for which we can identify assets. If such assets are considered to be impaired, impairment is recognized as the amount by which the carrying amount of assets exceeds the fair value of the assets.
Goodwill and Other Intangible Assets
Predecessor intangible assets and goodwill
In the Predecessor Company financial statements, intangible assets were acquired as part of our acquisition of the Angel business and Aldagen, and consisted of definite-lived and indefinite-lived intangible assets, including goodwill. During the quarter ended September 30, 2015, we determined that our in-process research and development (“IPR&D”) asset was impaired and recognized a non-cash IPR&D impairment charge of $22.6 million to write down our IPR&D asset to its estimated fair value. Also during the quarter ended September 30, 2015, we determined that goodwill was impaired, and recognized a non-cash impairment charge of $1.1 million to write down goodwill to its estimated fair value of zero. As of December 31, 2015, we had fully impaired our IPR&D asset and our goodwill.
In conjunction with the application of fresh start accounting, all remaining definite lived intangible assets were written off as of the Effective Date (See Note 2 – Fresh Start Accounting).
Successor intangible assets and goodwill
In the Successor Company financial statements, intangible assets were established as part of fresh start accounting and relate to trademarks, technology, clinician relationships and goodwill (see Note 2 – Fresh Start Accounting).
Our definite-lived intangible assets include trademarks, technology (including patents), and clinician relationships, and are amortized over their useful lives and reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If any indicators were present, we test for recoverability by comparing the carrying amount of the asset to the net undiscounted cash flows expected to be generated from the asset. If those net undiscounted cash flows do not exceed the carrying amount (i.e., the asset is not recoverable), we would perform the next step, which is to determine the fair value of the asset and record an impairment loss, if any. We periodically reevaluate the useful lives for these intangible assets to determine whether events and circumstances warrant a revision in their remaining useful lives.
Goodwill represents the excess of reorganization value over the fair value of tangible and identifiable intangible assets and the fair value of liabilities as of the Effective Date. Goodwill is not amortized, but is subject to periodic review for impairment. Goodwill is reviewed annually, as of October 1, and whenever events or changes in circumstances indicate that the carrying amount of the goodwill might not be recoverable. We perform our review of goodwill on our one reporting unit.
Before employing detailed impairment testing methodologies, we first evaluate the likelihood of impairment by considering qualitative factors relevant to our reporting unit. When performing the qualitative assessment, we evaluate events and circumstances that would affect the significant inputs used to determine the fair value of the goodwill. Events and circumstances evaluated include: macroeconomic conditions that could affect us, industry and market considerations for the medical device industry that could affect us, cost factors that could affect our performance, our financial performance (including share price), and consideration of any company specific events that could negatively affect us, our business, or the fair value of our business. If we determine that it is more likely than not that goodwill is impaired, we will then apply detailed testing methodologies. Otherwise, we will conclude that no impairment has occurred.
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Detailed impairment testing involves comparing the fair value of our one reporting unit to its carrying value, including goodwill. If the fair value exceeds carrying value, then it is concluded that no goodwill impairment has occurred. If the carrying value of the reporting unit exceeds its fair value, a second step is required to measure possible goodwill impairment loss. The second step includes hypothetically valuing the tangible and intangible assets and liabilities of our one reporting unit as if it had been acquired in a business combination. The implied fair value of our one reporting unit's goodwill then is compared to the carrying value of that goodwill. If the carrying value of our one reporting unit's goodwill exceeds the implied fair value of the goodwill, we recognize an impairment loss in an amount equal to the excess, not to exceed the carrying value.
Successor Company intangible assets and goodwill were not impaired as of September 30, 2016.
Conditionally Redeemable Common Stock
The Maryland Venture Fund (“MVF,” part of Maryland Department of Business and Economic Development) had an investment in the Predecessor Company’s common stock, and could have required us to repurchase the common stock, at MVF’s option, upon certain events outside of our control. MVF’s common stock was classified as “contingently redeemable common shares” in the Predecessor Company’s accompanying condensed consolidated balance sheets. The contingently redeemable common shares were cancelled as of the Effective Date.
Revenue Recognition – Successor Company
We recognize revenue when the four basic criteria for recognition are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) consideration is fixed or determinable; and (4) collectability is reasonably assured.
We provide for the sale of our products, including disposable processing sets and supplies to customers. Revenue from the sale of products is recognized upon shipment of products to the customers. We do not maintain a reserve for returned products as in the past those returns have not been material and are not expected to be material in the future. Percentage-based fees on licensee sales of covered products are generally recorded as products are sold by licensees and are reflected as royalties in the condensed consolidated statements of operations. Direct costs associated with product sales and royalty revenues are recorded at the time that revenue is recognized.
Revenue Recognition – Predecessor Company
The Predecessor Company provided for the sale of our products, including disposable processing sets and supplies to customers, and to Arthrex as distributor of the Angel product line. Revenue from the sale of products was recognized upon shipment.
Usage or leasing of blood separation equipment
As a result of the acquisition of the Angel business, we acquired various multiple element revenue arrangements that combined the (i) usage or leasing of blood separation processing equipment, (ii) maintenance of processing equipment, and (iii) purchase of disposable processing sets and supplies. We assigned these multiple element revenue arrangements to Arthrex in 2013 pursuant to a license agreement, and further assigned all of our rights, title and interest in and to such license agreement to the Deerfield Lenders as of the Effective Date; as such, the Successor Company no longer recognizes revenue under these arrangements.
Deferred revenue at December 31, 2015 consists of prepaid licensing revenue of approximately $1.0 million from the licensing of Angel centrifuges and $0.1 million from product sales billed and not yet shipped. Prepaid licensing revenue was being recognized on a straight-line basis over the term of the agreement prior to the Effective Date. Revenue of approximately $0.14 million related to the prepaid license was recognized during the period January 1, 2016 through May 4, 2016. Revenue of approximately $0.3 million, and $0.1 million related to the prepaid license was recognized for the nine and three month periods ended September 30, 2015, respectively. We assigned all of our rights under the Arthrex license agreement to Deerfield on the Effective Date and eliminated the remaining deferred revenue as of that date.
License Agreement with Rohto
The Company’s license agreement with Rohto (See Note 4 – Distribution, License and Collaboration Arrangements) contains multiple elements that include the delivered license and other ancillary performance obligations, such as maintaining its intellectual property and providing regulatory support and training to Rohto. The Company has determined that the ancillary performance obligations are perfunctory and incidental and are expected to be minimal and infrequent. Accordingly, the Company combined the ancillary performance obligations with the delivered license and recognized revenue as a single unit of accounting following revenue recognition guidance applicable to the license. Because the license is delivered, the Company recognized the entire $3.0 million license fee as revenue in the three months ended March 31, 2015. Other elements contained in the license agreement, such as fees and royalties related to the supply and future sale of the product, are contingent and will be recognized as revenue when earned.
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Segments and Geographic Information
Approximately 13%, 0% and 0% of our product sales were generated outside of the United States for the period from January 1, 2016 through May 4, 2016, May 5, 2016 through September 30, 2016 and for the three months ended September 30, 2016, respectively. Approximately 16% and 13% of our product sales were generated outside of the United States for the nine and three months period ended September 30, 2015, respectively. We operate in one business segment.
Exit Activities and Realignment
In May 2014, we announced preliminary efficacy and safety results of our RECOVER-Stroke Phase 2 clinical trial in patients with neurological damage arising from ischemic stroke and treated with ALD-401. Observed improvements in the primary endpoint (mean modified Rankin Score or mRS) of the trial were not clinically or statistically significant. In light of this outcome, we discontinued further funding of the ALD-401 development program, decided to close our facilities in Durham, NC, and terminated certain employees. An accrual of approximately $0.2 million for the loss on abandonment of the lease remains at September 30, 2016. The accrued loss on abandonment is being amortized over the life of the lease against future rental payments made and sublease income payments received. Loss on abandonment is classified in general and administrative expenses in the accompanying condensed consolidated statements of operations. The accrued loss on abandonment is included in accrued expenses and other liabilities in the accompanying condensed consolidated balance sheets.
On August 11, 2015, our Board of Directors approved our realignment plan with the goal of preserving and maximizing, for the benefit of our stockholders, the value of our existing assets. The plan eliminated approximately 30% of our workforce and was aimed at the preservation of cash and cash equivalents to finance our future operations and support our revised business objectives. On December 4, 2015, the Company eliminated approximately 22% of its workforce, or seven employees, and in January 2016, the Company eliminated four additional employees. As of September 30, 2016, there was no remaining severance accrual for these employees on the condensed consolidated balance sheets.
Stock-Based Compensation
Prior to the Effective Date, the Company, from time to time, issued stock options or stock awards to employees, directors, consultants, and other service providers under its 2002 Long-Term Incentive Plan (“LTIP”) or 2013 Equity Incentive Plan (“EIP”). In some cases, it had issued compensatory warrants to service providers outside the LTIP or EIP (See Note 8 – Equity and Stock-Based Compensation). In July 2016, the Board of Directors approved, and in August 2016 it amended, the Company’s 2016 Omnibus Incentive Compensation Plan (the “2016 Omnibus Plan”), which remains subject to approval by the Company’s stockholders. In July and August 2016, the Board of Directors granted options to purchase an aggregate of 1,362,500 shares of New Common Stock to certain of the Company’s management, employees and directors, subject to approval of the 2016 Omnibus Plan by the Company’s stockholders, of which 105,000 options have been forfeited since their grant date.
The fair value of employee stock options is measured at the date of grant. Expected volatilities are based on historical volatility of the Company’s stock. Company data was utilized to estimate option exercises and employee terminations within the valuation model. Expected years until exercise represents the period of time that options are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The Company estimated that the dividend rate on its common stock will be zero.
Stock-based compensation for awards granted to non-employees is periodically re-measured as the underlying awards vest. The Company recognizes an expense for such awards throughout the performance period as the services are provided by the non-employees, based on the fair value of these options and warrants at each reporting period. The fair value of stock options and compensatory warrants issued to service providers utilizes the same methodology with the exception of the expected term. For awards to non-employees, the Company estimates that the options or warrants will be held for the full term.
All outstanding stock options were cancelled as of the Effective Date.
Income Taxes
The Company accounts for income taxes using the asset and liability method. Under the asset and liability method, current income tax expense or benefit is the amount of income taxes expected to be payable or refundable for the current year. A deferred income tax asset or liability is recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carryforwards. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Tax rate changes are reflected in income during the period such changes are enacted.
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For the nine and three months ended September 30, 2015, the income tax provision relates exclusively to a deferred tax liability associated with the amortization for tax purposes of the Predecessor Company’s goodwill. The deferred tax liability was eliminated in the third quarter of 2015 with the impairment charge recognized for all our goodwill. The Successor Company’s goodwill is not tax deductible in any taxing jurisdiction.
The Company’s policy for recording interest and penalties associated with audits is to record such items as a component of income before taxes. There were no such items in 2016 and 2015.
Basic and Diluted Earnings (Loss) per Share
Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of shares of common stock outstanding (including contingently issuable shares when the contingencies have been resolved) during the period.
For periods of net loss, diluted loss per share is calculated similarly to basic loss per share because the impact of all dilutive potential common shares is anti-dilutive. For periods of net income, and when the effects are not anti-dilutive, diluted earnings per share is computed by dividing net income available to common shareholders by the weighted-average number of shares outstanding (including contingently issuable shares when the contingencies have been resolved) plus the impact of all potential dilutive common shares, consisting primarily of common stock options and stock purchase warrants using the treasury stock method, and convertible debt using the if-converted method.
All of the Company’s outstanding stock options and warrants were considered anti-dilutive for the periods from January 1, 2016 through May 4, 2016, May 5 through September 30, 2016 and for the three and nine months ended September 30, 2015. The Company’s convertible debt was dilutive during the period from January 1, 2016 through May 4, 2016. The total number of anti-dilutive shares underlying common stock options, warrants exercisable for common stock, and convertible debt, which have been excluded from the computation of diluted earnings (loss) per share for the periods presented, was as follows:
| Three Months ended September 30, 2016 | Three Months ended September 30, 2015 | |||||||||||
| Successor | Predecessor | |||||||||||
| Shares underlying: | ||||||||||||
| Common stock options | - | 12,738,931 | ||||||||||
| Stock purchase warrants | 6,180,000 | 116,134,682 | ||||||||||
| Convertible debt | - | 72,294,951 | ||||||||||
| Period from May 5, 2016 through September 30, 2016 | Period from January 1, 2016 through May 4, 2016 | Nine Months ended September 30, 2015 | ||||||||||
| Successor | Predecessor | Predecessor | ||||||||||
| Shares underlying: | ||||||||||||
| Common stock options | - | 9,173,119 | 12,738,931 | |||||||||
| Stock purchase warrants | 6,180,000 | 113,629,178 | 116,134,682 | |||||||||
| Convertible debt | - | - | 72,294,951 | |||||||||
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Earnings (loss) per share are calculated for basic and diluted earnings per share as follows:
| Three Months ended September 30, 2016 | Three Months ended September 30, 2015 | |||||||||||
| Successor | Predecessor | |||||||||||
| Numerator for basic and fully diluted income (loss) per share | $ | (1,916,673 | ) | $ | (13,828,987 | ) | ||||||
| Denominator for basic and fully diluted income (loss) per share weighted average outstanding common shares | 9,927,112 | 125,951,100 | ||||||||||
| Basic and diluted earnings (loss) per share | ||||||||||||
| Basic | $ | (0.19 | ) | $ | (0.11 | ) | ||||||
| Diluted | $ | (0.19 | ) | $ | (0.11 | ) | ||||||
| Period from May 5, 2016 through September 30, 2016 | Period from January 1, 2016 through May 4, 2016 | Nine Months ended September 30, 2015 | ||||||||||
| Successor | Predecessor | Predecessor | ||||||||||
| Numerator for basic income (loss) per share | $ | (3,211,516 | ) | $ | 28,173,934 | $ | (10,592,224 | ) | ||||
| Numerator adjustment for potential dilutive securities | - | 172,546 | - | |||||||||
| Numerator for diluted income (loss) per share | (3,211,516 | ) | 28,346,480 | (10,592,224 | ) | |||||||
| Denominator for basic income (loss) per share weighted average outstanding common shares | 9,876,605 | 125,951,100 | 125,951,100 | |||||||||
| Dilutive effect of convertible debt | - | 67,307,692 | - | |||||||||
| Denominator for diluted income (loss) per share weighted average outstanding common shares | 9,876,605 | 193,258,792 | 125,951,100 | |||||||||
| Basic and diluted earnings (loss) per share | ||||||||||||
| Basic | $ | (0.33 | ) | $ | 0.22 | $ | (0.08 | ) | ||||
| Diluted | $ | (0.33 | ) | $ | 0.15 | $ | (0.08 | ) | ||||
Recently Adopted Accounting Pronouncements
In April 2015, the Financial Accounting Standards Board (“FASB”) issued guidance as to whether a cloud computing arrangement (e.g., software as a service, platform as a service, infrastructure as a service, and other similar hosting arrangements) includes a software license and, based on that determination, how to account for such arrangements. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The amendment is effective for reporting periods beginning after December 15, 2015 and may be applied on either a prospective or retrospective basis. Early adoption is permitted. We adopted this pronouncement effective January 1, 2016; the adoption did not have a material impact to our consolidated financial statements.
In April 2015, the FASB issued guidance to simplify the balance sheet disclosure for debt issuance costs. Under the guidance, debt issuance costs related to a recognized debt liability will be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, in the same manner as debt discounts, rather than as an asset. The standard is effective for reporting periods beginning after December 15, 2015 and early adoption is permitted. We adopted this pronouncement effective January 1, 2016; the adoption did not have a material impact to our consolidated financial statements.
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In September 2015, the FASB issued accounting guidance to simplify the accounting for measurement period adjustments resulting from business combinations. Under the guidance, an acquirer will be required to recognize adjustments to provisional amounts identified during the measurement period in the reporting period in which the adjustments are determined. The guidance requires an entity to present separately on the face of the income statement or disclose in the notes to the financial statements the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment had been recognized as of the acquisition date. The standard is effective for reporting periods beginning after December 15, 2015. The amendments in this pronouncement should be applied prospectively, with earlier application permitted. We adopted this pronouncement effective January 1, 2016; the adoption did not have a material impact to our consolidated financial statements.
Unadopted Accounting Pronouncements
In May 2014, the FASB issued guidance for revenue recognition for contracts, superseding the previous revenue recognition requirements, along with most existing industry-specific guidance. The guidance requires an entity to review contracts in five steps: 1) identify the contract, 2) identify performance obligations, 3) determine the transaction price, 4) allocate the transaction price, and 5) recognize revenue. The new standard will result in enhanced disclosures regarding the nature, amount, timing, and uncertainty of revenue arising from contracts with customers. In August 2015, the FASB issued guidance approving a one-year deferral, making the standard effective for reporting periods beginning after December 15, 2017, with early adoption permitted only for reporting periods beginning after December 15, 2016. In March 2016, the FASB issued guidance to clarify the implementation guidance on principal versus agent considerations for reporting revenue gross rather than net, with the same deferred effective date. In April 2016, the FASB issued guidance to clarify the implementation guidance on identifying performance obligations and the accounting for licenses of intellectual property, with the same deferred effective date. In May 2016, the FASB issued guidance rescinding SEC paragraphs related to revenue recognition, pursuant to two SEC Staff Announcements at the March 3, 2016 Emerging Issues Task Force meeting. In May 2016, the FASB also issued guidance to clarify the implementation guidance on assessing collectability, presentation of sales tax, noncash consideration, and contracts and contract modifications at transition, with the same effective date. We are currently evaluating the impact, if any, that this guidance will have on our consolidated financial statements.
In August 2014, the FASB issued guidance for the disclosure of uncertainties about an entity’s ability to continue as a going concern. Under U.S. GAAP, continuation of a reporting entity as a going concern is presumed as the basis for preparing financial statements unless and until the entity’s liquidation becomes imminent. Preparation of financial statements under this presumption is commonly referred to as the going concern basis of accounting. Previously, there was no guidance in U.S. GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern or to provide related footnote disclosures. This was issued to provide guidance in U.S. GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. In doing so, the amendments should reduce diversity in the timing and content of footnote disclosures. The amendments in this update are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. We are currently evaluating the impact, if any, that the adoption will have on our consolidated financial statements.
In July 2015, the FASB issued guidance for the accounting for inventory. The main provisions are that an entity should measure inventory within the scope of this update at the lower of cost and net realizable value, except when inventory is measured using LIFO or the retail inventory method. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. In addition, the Board has amended some of the other guidance in Topic 330 to more clearly articulate the requirements for the measurement and disclosure of inventory. The amendments in this update for public business entities are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The amendments in this update should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. We are currently evaluating the impact, if any, that the adoption will have on our consolidated financial statements.
In November 2015, the FASB issued accounting guidance to simplify the presentation of deferred taxes. Previously, U.S. GAAP required an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts. Under this guidance, deferred tax liabilities and assets will be classified as noncurrent amounts. The standard is effective for reporting periods beginning after December 15, 2016. The Company is currently evaluating the impact, if any, that this new accounting pronouncement will have on its consolidated financial statements.
In February 2016, the FASB issued guidance for accounting for leases. The guidance requires lessees to recognize assets and liabilities related to long-term leases on the balance sheet and expands disclosure requirements regarding leasing arrangements. The guidance is effective for reporting periods beginning after December 15, 2018 and early adoption is permitted. The guidance must be adopted on a modified retrospective basis and provides for certain practical expedients. We are currently evaluating the impact that this guidance will have on our consolidated financial statements.
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In March 2016, the FASB issued guidance simplifying the accounting for and financial statement disclosure of stock-based compensation awards. Under the guidance, all excess tax benefits and tax deficiencies related to stock-based compensation awards are to be recognized as income tax expenses or benefits in the income statement and excess tax benefits should be classified along with other income tax cash flows in the operating activities section of the statement of cash flows. Under the guidance, companies can also elect to either estimate the number of awards that are expected to vest or account for forfeitures as they occur. In addition, the guidance amends some of the other stock-based compensation awards guidance to more clearly articulate the requirements and cash flow presentation for withholding shares for tax-withholding purposes. The guidance is effective for reporting periods beginning after December 15, 2016 and early adoption is permitted, though all amendments of the guidance must be adopted in the same period. The adoption of certain amendments of the guidance must be applied prospectively, and adoption of the remaining amendments must be applied either on a modified retrospective basis or retrospectively to all periods presented. We are currently evaluating the impact that this guidance will have on our consolidated financial statements.
In March 2016, the FASB issued guidance to clarify the requirements for assessing whether contingent call or put options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. The amendments of this guidance are effective for reporting periods beginning after December 15, 2016, and early adoption is permitted. Entities are required to apply the guidance to existing debt instruments using a modified retrospective transition method as of beginning of the fiscal year of adoption. We are currently evaluating the impact that this guidance will have on our consolidated financial statements.
In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. For trade and other receivables, loans, and other financial instruments, we will be required to use a forward-looking expected loss model rather than the incurred loss model for recognizing credit losses which reflects losses that are probable. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The new standard will be effective for us beginning July 1, 2020, with early adoption permitted beginning July 1, 2019. Application of the amendments is through a cumulative-effect adjustment to retained earnings as of the effective date. We are currently evaluating the impact that this guidance will have on our consolidated financial statements.
We have evaluated all other issued and unadopted Accounting Standards Updates and believe the adoption of these standards will not have a material impact on our results of operations, financial position, or cash flows.
Note 4 – Distribution, Licensing and Collaboration Arrangements
Distribution and License Agreement with Arthrex
In 2013, we entered into a Distributor and License Agreement (the “Original Arthrex Agreement”) with Arthrex. The term of the Original Arthrex Agreement was originally for five years, automatically renewable for an additional three-year period unless Arthrex gives the Company a termination notice at least one year in advance of the end of the initial five-year period. Under the terms of the Original Arthrex Agreement, Arthrex obtained the exclusive rights to sell, distribute, and service the Company’s Angel concentrated Platelet System and activAT (“Products”), throughout the world, for all uses other than chronic wound care. In connection with execution of the Original Arthrex Agreement, Arthrex paid the Company a nonrefundable upfront payment of $5.0 million. In addition, under the terms of the Original Arthrex Agreement, Arthrex paid royalties to the Company based upon volume of the Products sold. Arthrex’s rights to sell, distribute and service the Products were not exclusive in the non-surgical dermal and non-surgical aesthetics markets. On October 16, 2015, the Company entered into an Amended and Restated License Agreement (the "Amended Arthrex Agreement") with Arthrex, which amended and restated the Original Arthrex Agreement. Under the terms of the Amended Arthrex Agreement, among others, the Company licensed certain exclusive and non-exclusive rights to Arthrex in return for the right to receive royalties, and on a date to be determined by Arthrex, but not later than March 31, 2016, Arthrex was to assume all rights related to the manufacture and supply of the Angel product line. As part of the transaction, the Company transferred to Arthrex all of its rights and title to product registration rights and intellectual property (other than patents) related to Angel. In connection with the Agreement, the Deerfield Lenders irrevocably released their liens on the product registration rights and intellectual property (other than patents) assets transferred by the Company to Arthrex. The Amended Arthrex Agreement, as further supplemented in April 2016, is referred to collectively as the “Arthrex Agreement.”
Pursuant to the Plan, on May 5, 2016, the Company entered into an Assignment and Assumption Agreement with Deerfield SS, LLC (the “Assignee”), the designee of the Deerfield Lenders, to assign to the Assignee the Company’s rights, title and interest in and to the Arthrex Agreement, and to transfer and assign to the Assignee associated intellectual property owned by the Company and licensed thereunder, as well as rights to collect royalty payments thereunder. The assignment and transfer was effected in exchange for a reduction of $15,000,000 in the amount of the allowed claim of the Deerfield Lenders pursuant to the Plan. As a result of the assignment and transfer, the Aurix System currently represents the Company’s only commercial product offering.
On the Effective Date, the Company and the Assignee entered into a Transition Services Agreement in which the Company agreed to continue to service the Arthrex Agreement for a transition period. Transition services fees of $0.03 million and $0.05 million have been recorded as other income for the three months ended September 30, 2016 and for the period May 5, 2016 through September 30, 2016, respectively, on the condensed consolidated statements of operations. See Note 11 - Subsequent Events for a description of an agreement with Arthrex and Assignee extending such transition period, among other matters.
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Distribution and License Agreement with Rohto
In September 2009, we entered into a licensing and distribution agreement with Millennia Holdings, Inc. (“Millennia”) for the Company’s Aurix System in Japan.
In January 2015, we granted to Rohto Pharmaceutical Co., Ltd. (“Rohto”) a royalty bearing, nontransferable, exclusive license, with limited right to sublicense, to use certain of the Company’s intellectual property for the development, import, use, manufacturing, marketing, sale and distribution for all wound care and topical dermatology applications of the Aurix System and related intellectual property and know-how in human and veterinary medicine in Japan in exchange for an upfront payment from Rohto of $3.0 million. The agreement also contemplates additional royalty payments based on the net sales of Aurix in Japan and an additional future cash payment if and when the reimbursement price for the national health insurance system in Japan has been achieved after marketing authorization as described below. In connection with and effective as of the entering into the Rohto Agreement, we amended the licensing and distribution agreement with Millennia to terminate it and allow us to transfer the exclusivity rights from Millennia to Rohto. In connection with this amendment we paid a one-time, non-refundable fee of $1.5 million to Millennia upon our receipt of the $3.0 million upfront payment from Rohto, and we may be required to make certain future payments to Millennia if we receive the milestone payment from Rohto as well as future royalty payments based upon net sales in Japan. Rohto has assumed all responsibility for securing the marketing authorization in Japan, while we will provide relevant product information, as well as clinical and other data, to support Rohto’s efforts.
Collaboration Agreement with Restorix Health
On March 22, 2016, we entered into a Collaboration Agreement (the “Collaboration Agreement”) with Restorix Health (“Restorix”), pursuant to which we agreed to provide Restorix with certain limited geographic exclusivity benefits over a defined period of time for the usage of the Aurix System in up to 30 of the approximately 125 hospital outpatient wound care clinics with which Restorix has a management contract (the “RXH Partner Hospitals”), in exchange for Restorix making minimum commitments of patients enrolled in three prospective clinical research studies primarily consisting of patient data collection (the “Protocols”) necessary to maintain exclusivity under the Collaboration Agreement. The Collaboration Agreement will initially continue for a two-year period, subject to one or more extensions with the mutual consent of the parties.
Pursuant to the Collaboration Agreement, the Company agreed to provide: (i) clinical support services by its clinical staff as reasonably agreed between the Company and Restorix as necessary and appropriate, (ii) reasonable and necessary support regarding certain reimbursement activities, (iii) coverage of Institutional Review Board (“IRB”) fees and payment to Restorix for certain training costs subject to certain limitations and (iv) community-focused public relations materials for participating RXH Partner Hospitals to promote the use of Aurix and participation in the Protocols. Pursuant to the Collaboration Agreement, Restorix agreed to: (i) provide access and support as reasonably necessary and appropriate at up to 30 RXH Partner Hospitals to identify and enroll patients into the Protocols, including senior executive level support and leadership to the collaboration and its enrollment goals and (ii) reasonably assist the Company to correct through a query process, any patient data submitted having incomplete or inaccurate data fields.
Subject to the satisfaction of certain conditions, during the term of the Collaboration Agreement: (i) Restorix will have site specific geographic exclusivity for usage of Aurix in connection with treatment of patients in the Protocols within a 30 mile radius of each RXH Partner Hospital, and (ii) other than with respect to existing CED sites, the Company will not provide corporate exclusivity with any other wound management company operating in excess of 19 wound care facilities for any similar arrangement.
Under the Collaboration Agreement, the Company will pay Restorix or the RXH Partner Hospital, as the case may be, a per patient data collection (administrative) fee upon full completion and delivery of a patient data set. In addition, the Company is responsible to pay for any IRB fees necessary to conduct the Protocols and enroll patients, and to pay Restorix a training cost stipend per site. Each RXH Partner Hospital will pay the Company the then current product price ($700 in 2016, and no greater than $750 in the remainder of the initial term) as set forth in the Collaboration Agreement.
Boyalife Distribution Agreement
Effective as of May 5, 2016, the Company and Boyalife Hong Kong Ltd. (“Boyalife”), an entity affiliated with the Company’s significant shareholder, Boyalife Investment Fund I, Inc., entered into an Exclusive License and Distribution Agreement (the “Boyalife Distribution Agreement”) with an initial term of five years, unless the agreement is terminated earlier in accordance with its terms. Under this agreement, Boyalife received a non-transferable, exclusive license, with limited right to sublicense, to use certain of the Company’s intellectual property relating to its Aurix System for the purposes and in the territory specified below. Under the agreement, Boyalife is entitled to import, use for development, promote, market, sell and distribute the Aurix Products in greater China (China, Hong Kong, Taiwan and Macau) for all regenerative medicine applications, including but not limited to wound care and topical dermatology applications in human and veterinary medicine. “Aurix Products” are defined as the combination of devices to produce a wound dressing from the patient’s blood - as of May 5, 2016 consisting of centrifuge, wound dressing kit and reagent kit. Under the Boyalife Distribution Agreement, Boyalife is obligated to pay the Company (a) $500,000 within 90 days of approval of the Aurix Products by the China Food and Drug Administration (“CFDA”), but no earlier than December 31, 2018, and (b) a distribution fee per wound dressing kit and reagent kit of $40, payable quarterly, subject to an agreement by the parties to discuss in good faith the appropriate distribution fee if the pricing of such kits exceeds the current general pricing in greater China. Under the agreement, Boyalife is entitled, with the Company’s approval (not to be unreasonably withheld or delayed) to procure devices from a third party in order to assemble them with devices supplied by the Company to make the Aurix Products. Boyalife also has a right of first refusal with respect to the Aurix Products in specified countries in the Asia Pacific region excluding Japan and India, exercisable in exchange for a payment of no greater than $250,000 in the aggregate. If Boyalife files a new patent application for a new invention relating to wound dressings, the Aurix Products or the Company’s technology, Boyalife will grant the Company a free, non-exclusive license to use such patent application outside greater China during the term of the Boyalife Distribution Agreement.
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Note 5 – Receivables
Accounts and other receivable, net consisted of the following:
| Successor | Predecessor | |||||||
| September 30, | December 31, | |||||||
| 2016 | 2015 | |||||||
| Trade receivables | $ | 90,661 | $ | 460,763 | ||||
| Other receivables | 817,640 | 650,230 | ||||||
| 908,301 | 1,110,993 | |||||||
| Less allowance for doubtful accounts | (1,651 | ) | (96,748 | ) | ||||
| $ | 906,650 | $ | 1,014,245 | |||||
Other receivables at September 30, 2016 and December 31, 2015 consist primarily of a value added tax receivable, royalties due from Arthrex, and the receivable due from our contract manufacturer for the cost of raw materials required to manufacture the Angel products that were purchased by the Company and immediately resold, at cost, to the contract manufacturer. We assigned all of our rights under the Arthrex Agreement to Deerfield on the Effective Date.
Note 6 – Goodwill and Other Intangible Assets
Our definite-lived intangible assets as of September 30, 2016 and December 31, 2015 are as follows:
| Successor | Predecessor | |||||||
| September 30, | December 31, | |||||||
| 2016 | 2015 | |||||||
| Trademarks | $ | 917,000 | $ | 1,047,000 | ||||
| Technology | 6,576,000 | 2,355,000 | ||||||
| Customer and clinician relationships | 904,000 | 708,000 | ||||||
| 8,397,000 | 4,110,000 | |||||||
| Less accumulated amortization | (343,575 | ) | (1,596,606 | ) | ||||
| $ | 8,053,425 | $ | 2,513,394 | |||||
Goodwill
Predecessor Company
Goodwill represents the purchase price of acquisitions in excess of the fair value of amounts assigned to acquired tangible or intangible assets and assumed liabilities. As a result of our acquisition of Aldagen in February 2012, we recorded goodwill of approximately $0.4 million. Prior to the acquisition of Aldagen, we had goodwill of approximately $0.7 million as a result of the acquisition of the Angel business in April 2010. We determined that goodwill was impaired as of September 30, 2015 and recognized a noncash goodwill impairment charge of approximately $1.1 million to fully write down the goodwill to its estimated fair value of zero as of September 30, 2015.
Successor Company (see Note 2 – Fresh Start Accounting)
Goodwill represents the excess of reorganization value over the fair value of tangible and identifiable intangible assets and the fair value of liabilities as of the Effective Date.
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Changes in goodwill for the periods presented follows:
| Successor | Predecessor | |||||||
| Balance, at December 31, 2014 | $ | - | $ | 1,128,517 | ||||
| 2015 impairment | - | (1,128,517 | ) | |||||
| Balance, at December 31, 2015 | - | - | ||||||
| Fresh start accounting | 2,079,284 | |||||||
| Balance, at September 30, 2016 | $ | 2,079,284 | ||||||
Definite-lived intangible assets – trademarks, customer and clinician relationships and technology
The Predecessor Company’s definite-lived intangible assets include Angel-related trademarks, technology (including patents) and customer relationships, and were being amortized over their useful lives ranging from eight to twenty years. Amortization expense associated with our Angel related definite-lived intangible assets was approximately $0.1 million for the period from January 1, 2016 through May 4, 2016. The remaining Angel related definite lived intangible assets were eliminated as of May 4, 2016 as the underlying Angel assets were assigned to Deerfield pursuant to the Plan of Reorganization. Amortization expense associated with our Angel related definite-lived intangible assets was approximately $0.2 million and $0.1 million for the nine and three month periods ended September 30, 2015, respectively.
The Successor Company’s Aurix related definite-lived intangible assets include trademarks, technology (including patents) and clinician relationships, and are being amortized over their useful lives ranging from nine to fifteen years.
Amortization expense associated with our Aurix related definite-lived intangible assets was approximately $0.3 million and $0.2 million for the period from May 5, 2016 through September 30, 2016 and for the three months ended September 30, 2016, respectively. Annual amortization expense based on our existing intangible assets and their estimated useful lives is expected to be approximately:
| 2016 (October 1, 2016 – December 31, 2016) | $ | 213,000 | |
| 2017 | 852,000 | ||
| 2018 | 852,000 | ||
| 2019 | 852,000 | ||
| 2020 | 852,000 | ||
| 2021 | 852,000 | ||
| Thereafter | 3,580,000 |
Note 7 – Debt
Successor Company Debt
As of September 30, 2016, the Company had no debt outstanding due the cancellation of the Deerfield Credit Facility and the DIP Credit Agreement as of the Effective Date.
Predecessor Company Debt
Deerfield Facility
In 2014, we entered into the Deerfield Facility Agreement, a $35 million five-year senior secured convertible credit facility with Deerfield due March 31, 2019. Deerfield had the right to convert the principal amount of the related notes (the “Notes”) into shares of our common stock (“Conversion Shares”) at a per share price equal to $0.52. In addition, we granted to Deerfield the option to require the Company to redeem up to 33.33% of the total amount drawn under the facility, together with any accrued and unpaid interest thereon, on each of the second, third, and fourth anniversaries of the closing with the option right triggered upon the Company’s net revenues failing to be equal to or in excess of certain quarterly milestone amounts. We also granted Deerfield the option to require us to apply 35% of the proceeds received by us in equity-raising transaction(s) to redeem outstanding principal and interest of the Notes, provided that the first $10 million so raised by us would be exempt from this put option. We entered into a security agreement which provided, among other things, that our obligations under the Notes would be secured by a first priority security interest, subject to customary permitted liens, on all our assets.
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Under the terms of the facility, we also issued stock purchase warrants to purchase up to 97,614,999 shares of our common stock at an initial exercise price of $0.52 per share (subject to adjustments). We also entered into a registration rights agreement pursuant to which we filed a registration statement to register the resale of the Conversion Shares and the shares underlying the stock purchase warrants. As a result of certain non-standard anti-dilution provisions and cash settlement features, we classify the detachable stock purchase warrants and the conversion option embedded in the Notes as derivative liabilities. The derivative liabilities were recorded initially at their estimated fair value and as a result, we recognized a total debt discount on the convertible notes of $34.8 million. We re-measure the warrants and the conversion option to fair value at each balance sheet reporting date; the estimated fair value of the warrant liability was de minimis at March 31, 2016 and December 31, 2015. Certain debt issuance costs, in the form of warrants and fees, were recorded as deferred debt issuance costs. The issuance costs include a yield enhancement fee, for which we issued 2,709,677 shares of the Company’s common stock in 2014, with a fixed value of approximately $1.1 million. As a result of the default and our assessment that we would not be able to cure the causes of the default, as of December 31, 2015 we accelerated the amortization of the debt discount and deferred financing costs associated with the Deerfield credit facility (see discussion below).
Under the Deerfield Facility Agreement, we were required to maintain a compensating cash balance of $5,000,000 in deposit accounts subject to control agreements in favor of the lenders and we were required to pay to Deerfield accrued interest of approximately $2.6 million on October 1, 2015. We were unable to meet these requirements and on both December 4 and 18, 2015 we entered into consent letters with the Deerfield Lenders to modify the Deerfield Facility Agreement and waive the compliance violations for a limited period. Under the terms of the December 18, 2015 consent letter, (i) solely during the period between December 18, 2015 and January 7, 2016, the amount of cash that was required to be maintained in a deposit account subject to control agreements in favor of the Company’s senior lenders was reduced from $5,000,000 to $500,000 and (ii) the date for payment of the accrued interest amount originally payable on October 1, 2015 was extended to January 7, 2016. The continued effectiveness of the consent letter was conditioned upon the Company’s continued engagement of a Chief Restructuring Officer and providing the Deerfield Lenders with all relevant business contracts, agreements, and vendor relationships for the Aurix and Angel product lines by December 28, 2015; the Company’s failure to do either would result in an immediate default under the Deerfield Facility Agreement. The consent letter contained various customary representations and warranties.
As of January 26, 2016 (the date of our voluntary filing for bankruptcy protection), we were in default under the Deerfield Facility Agreement, and Deerfield had the right to demand repayment of the entire amount owed to them, including accrued interest. As a result of the default and our assessment that we would not be able to cure the causes of the default, as of December 31, 2015 we accelerated the amortization of the debt discount and deferred financing costs associated with the Deerfield credit facility and at December 31, 2015 we classified the entire Deerfield Facility Agreement as a current liability. The total amount owing under the Deerfield Facility Agreement including accrued interest was compromised by the Bankruptcy Court. This amount of approximately $38.3 million and the $5.75 million outstanding under the DIP Credit Agreement (as defined below) was settled as of the Effective Date through the issuance of 29,038 shares of our Series A Preferred Stock and the assignment to Deerfield of all rights, title, and interest under the Arthrex Agreement including the rights to receive royalty payments thereunder. Because the amounts owed to Deerfield pursuant to the Deerfield Facility Agreement were subject to compromise and, in fact, subsequently were compromised by the Court, we stopped accruing interest on the debt effective January 26, 2016.
Debtor-in-Possession Financing
On January 28, 2016, the Bankruptcy Court entered an interim order approving the Company's debtor-in-possession financing (“DIP Financing”) pursuant to terms set forth in a senior secured, super-priority debtor-in-possession credit agreement (the “DIP Credit Agreement”), dated as of January 28, 2016, by and among the Company, as borrower, each lender from time to time party to the DIP Credit Agreement, including, but not limited to Deerfield Private Design Fund II, L.P., Deerfield Private Design International II, L.P., and Deerfield Special Situations Fund, L.P. (collectively, the “Deerfield Lenders”) and Deerfield Mgmt, L.P., as administrative agent (the “DIP Agent”) for the Deerfield Lenders. The Deerfield Lenders comprised 100% of the lenders under the then-existing Deerfield Facility Agreement.
On March 9, 2016, the Bankruptcy Court approved on a final basis the Company's motion for approval of the DIP Credit Agreement and use of cash collateral, and approved a Waiver and First Amendment to the DIP Credit Agreement (the “Waiver and First Amendment”) with the Deerfield Lenders and DIP Agent, pursuant to which the DIP Credit Agreement was approved to include certain amendments, including to set forth the material terms of the proposed restructuring of the prepetition and post-petition secured debt, unsecured debt and equity interests of the Company, the terms of which were eventually effected pursuant to the Plan of Reorganization (as defined below). The Waiver and First Amendment provided for senior secured loans in the aggregate principal amount of up to $6,000,000 in post-petition financing (collectively, the “DIP Loans”).
We received $5.75 million in gross proceeds from the DIP Financing in the period from January 1, 2016 through May 4, 2016, and incurred approximately $0.3 million in issuance costs. In accordance with the Plan of Reorganization, as of the Effective Date, the DIP Credit Agreement was terminated.
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Note 8 – Equity and Stock-Based Compensation
Successor Company Common Stock
Under the Second Amended and Restated Certificate of Incorporation of the Successor Company, it has the authority to issue a total of 32,500,000 shares of capital stock, consisting of: (i) 31,500,000 shares of common stock, par value $0.0001 per share (the “New Common Stock”) and 1,000,000 shares of preferred stock, par value $0.0001 per share, which will have such rights, powers and preferences as the board of directors of the Company (the “Board of Directors”) shall determine.
In accordance with the Plan, as of the Effective Date, the Company issued 7,500,000 shares (the “Recapitalization Shares”) of New Common Stock to certain investors (the “Recapitalization Investors”) for gross cash proceeds of $7,300,000 and net cash to the Company of $7,052,500 (the “Recapitalization Financing”). The net cash amount excludes the effect of $100,000 in offering expenses paid from the proceeds of the DIP Financing, which was converted into Series A Preferred Stock as of the Effective Date.
A significant majority of the Recapitalization Investors executed backstop commitments to purchase up to 12,800,000 additional shares of New Common Stock for an aggregate purchase price of up to $3,000,000 (collectively, the “Backstop Commitment). The Company cannot call the Backstop Commitment prior to June 30, 2017.
With respect to each Recapitalization Investor who executed a Backstop Commitment, the commitment terminates on the earlier of (i) the date on which the Company receives net proceeds (after deducting all costs, expenses and commissions) from the sale of New Common Stock in the aggregate amount of the Backstop Commitment, (ii) the date that all shares of Series A Preferred Stock (as defined below) have been redeemed by the Company or (iii) the date that all shares of Series A Preferred Stock are no longer owned by entities affiliated with Deerfield (“Termination Date”). Under the terms of the Backstop Commitment, the Company is obligated to pay to the committed Recapitalization Investors upon the Termination Date a commitment fee of $250,000 in the aggregate.
Under the Plan of Reorganization, the Company committed to the issuance of up to 3,000,000 shares of New Common Stock and subsequently issued 2,264,612 shares of New Common Stock (the “Exchange Shares”) on the Effective Date to record holders of the Old Common Stock as of March 28, 2016 who executed and timely delivered the required release documents no later than July 5, 2016 in accordance with the Confirmation Order and the Plan. The holders of Old Common Stock who executed and timely delivered the required release documents are referred to as the “Releasing Holders.”
The 2,264,612 Exchange Shares were issued as of the Effective Date to Releasing Holders who asserted ownership of a number of shares of Old Common Stock that matched the Company’s records or could otherwise be confirmed, at a rate of one share of New Common Stock for every 41.8934 shares of Old Common Stock held by such holders as of March 28, 2016. In accordance with the Plan, if the calculation would otherwise have resulted in the issuance to any Releasing Holder of a number of shares of New Common Stock that is not a whole number, then the number of shares actually issued to such Releasing Holder was determined by rounding down to the nearest number.
On June 20, 2016, the Company issued 162,500 shares of New Common Stock (the “Administrative Claim Shares”) pursuant to the Order Granting Application of the Ad Hoc Equity Committee Pursuant to 11 U.S.C. §§ 503(b)(3)(D) and 503(b)(4) for Allowance of Fees and Expenses Incurred in Making a Substantial Contribution, entered by the Bankruptcy Court on June 20, 2016. The Administrative Claim Shares were issued to holders of administrative claims under sections 503(b)(3)(D) and 503(b)(4) of the Bankruptcy Code. Of the 162,500 shares, 100,000 shares were issued to outside counsel to the Ad Hoc Equity Committee of the Company’s equity holders as compensation of all remaining allowed fees for legal services provided by such counsel, and 62,500 were issued to designees of the Ad Hoc Equity Committee who had granted loans in an aggregate amount of $62,500 to the Ad Hoc Equity Committee in December 2015 as repayment of such loans.
Successor Company Stock Purchase Warrants
As part of the Recapitalization Financing, the Company also issued warrants to purchase 6,180,000 shares of New Common Stock to certain of the Recapitalization Investors (the “Warrants”). The Warrants terminate on May 5, 2021 and are exercisable at any time on or after November 5, 2016 at exercise prices ranging from $0.50 per share to $1.00 per share. The number of shares of New Common Stock underlying a Warrant and its exercise price are subject to customary adjustments upon subdivisions, combinations, payment of stock dividends, reclassifications, reorganizations and consolidations. The Warrants are classified in equity.
Successor Company Series A Preferred Stock
On the Effective Date, the Company filed a Certificate of Designations of Series A Preferred Stock (the “Certificate of Designations”) with the Delaware Secretary of State, designating 29,038 shares of the Company’s undesignated preferred stock, par value $0.0001 per share, as Series A Preferred Stock (the “Series A Preferred Stock”). On the Effective Date, the Company issued 29,038 shares of Preferred Stock to the Deerfield Lenders in accordance with the Plan pursuant to the exemption from the registration requirements of the Securities Act provided by Section 1145 of the Bankruptcy Code. The Deerfield Lenders did not receive any shares of New Common Stock or other equity interests in the Company.
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The Series A Preferred Stock has no stated maturity date, is not convertible or redeemable and carries a liquidation preference of $29,038,000, which is required to be paid to holders of such Series A Preferred Stock before any payments are made with respect to shares of New Common Stock (and other capital stock that is not issued on parity or senior to the Series A Preferred Stock) upon a liquidation or change in control transaction. For so long as Series A Preferred Stock is outstanding, the holders of Series A Preferred Stock have the right to nominate and elect one member of the board of directors of the Company (the “Board of Directors”) and to have such director serve on a standing committee of the Board of Directors established to exercise powers of the Board of Directors in respect of decisions or actions relating to the Backstop Commitment. The Series A Preferred Stock have voting rights, voting with the New Common Stock as a single class, with each share of Series A Preferred Stock having the right to five votes, currently representing approximately one percent (1%) of the voting rights of the capital stock of the Company, and the holders of Series A Preferred Stock have the right to approve certain transactions and incurrences of debt. Under the Certificate of Designations, for so long as the Backstop Commitment remains in effect, a majority of the members of the standing backstop committee of the Board of Directors may approve a drawdown under the Backstop Commitment. Among other restrictions, the Certificate of Designations for our Series A Preferred Stock limits the Company’s ability to (i) issue securities that are senior or pari passu with the Series A Preferred Stock, (ii) incur debt other than for working capital purposes not in excess of $3.0 million, (iii) issue securities that are junior to the Series A Preferred Stock and that provide certain consent rights to the holders of such junior securities in connection with a liquidation or contain certain liquidation preferences, (iv) pay dividends on or purchase shares of its capital stock, and (v) change the authorized number of members of its Board of Directors to a number other than five, in each case without the consent of holders representing at least two-thirds of the outstanding shares of Series A Preferred Stock. The Series A Preferred Stock is classified in equity.
Predecessor Company Common Stock
The Predecessor Company’s Certificate of Incorporation authorized 440,000,000 shares of capital stock, consisting of 425,000,000 authorized shares of Old Common Stock and 15,000,000 Series A, B, C, and D convertible preferred stock. Each share of Old Common Stock represented the right to one vote, and holders of the Old Common Stock were entitled to receive dividends as may be declared by the Board of Directors. No dividends were declared or paid on our Old Common Stock in 2016 or 2015. Pursuant to the Plan of Reorganization, as of the Effective Date all equity interests of the Company, including but not limited to all shares of the Old Common Stock (including its redeemable common stock), warrants and options, that were issuable or issued and outstanding immediately prior to the Effective Date, were cancelled.
2014 Private Placement
In March 2014, we raised $2.0 million from the private placement of 3,846,154 shares of common stock (at a price of $0.52 per share) and five-year stock purchase warrants to purchase 2,884,615 shares of common stock at $0.52 per share. As a result of certain non-standard anti-dilution provisions and cash settlement features contained in the warrants, we classified the detachable stock purchase warrants as derivative liabilities, initially at their estimated relative fair value of approximately $1.1 million. We re-measure the warrants to fair value at each balance sheet date; the estimated fair value of the warrant liabilities was de minimis at December 31, 2015. Issuance costs, in the form of warrants and fees, were valued at approximately $136,000 and were recorded to additional paid-in-capital.
Predecessor Stock Purchase Warrants
The Company had the following stock purchase warrants outstanding at May 4, 2016:
| Outstanding | Exercise Price | Expiration Date | Classification | |||
| 20,000 | $0.40 | June 2016 | Equity | |||
| 136,364 | $0.66 | February 2018 | Equity | |||
| 6,363,638 | $0.75 | February 2018 | Equity | |||
| 5,047,461 | $0.65 | December 2017 | Equity | |||
| 232,964 | $0.65 | December 2017 | Equity | |||
| 2,884,615 | $0.52 | March 2019 | Liability | |||
| 1,474,615 | $0.52 | March 2019 | Liability | |||
| 3,525,000 | $0.52 | June 2019 | Liability | |||
| 1,079,137 | $0.70 | February 2020 | Equity | |||
| 250,000 | $0.70 | February 2020 | Equity | |||
| 25,115,384 | $0.52 | March 2021 | Liability | |||
| 67,500,000 | $0.52 | June 2021 | Liability | |||
| 113,629,178 |
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All of such warrants were cancelled in their entirety as of the Effective Date.
Stock-Based Compensation
The Company’s 2002 Long Term Incentive Plan (“LTIP”) and 2013 Equity Incentive Plan (“EIP” and, together with the LTIP, the “Incentive Plans”) permitted the awards of stock options, stock appreciation rights, restricted stock, phantom stock, performance units, dividend equivalents and other stock-based awards to employees, directors and consultants. We were authorized to issue up to 10,500,000 shares of common stock under the LTIP and up to 18,000,000 shares under the EIP (as approved by our shareholders on June 9, 2014). All stock options granted under the LTIP and EIP were cancelled in their entirety as of the Effective Date.
As of May 4, 2016, the Company only issued stock options under the Incentive Plans. Stock option terms were determined by the Board of Directors for each option grant, and options generally vested immediately upon grant or over a period of time ranging up to four years, were exercisable in whole or installments, and expired no longer than ten years from the date of grant. There were no stock options granted or exercised for the period from January 1, 2016 through May 4, 2016. As of May 4, 2016, there was approximately $0.3 million of total unrecognized compensation cost related to non-vested stock options, and in the absence of our emergence from bankruptcy, that cost would have been recognized over a weighted-average period of 2.4 years. As a result of the cancellation of all outstanding stock options and the application of fresh start accounting as of the Effective Date, unrecognized compensation costs related to the stock options outstanding as of May 4, 2016 are not recognized after the Effective Date.
The Company recorded stock-based compensation expense in the periods presented as follows:
| Three Months ended September 30, 2016 | Three Months ended September 30, 2015 | |||||||||||
| Successor | Predecessor | |||||||||||
| Sales and marketing | $ | - | $ | (36,046 | ) | |||||||
| Research and development | - | 21,072 | ||||||||||
| General and administrative | - | 149,577 | ||||||||||
| $ | - | $ | 134,603 | |||||||||
| Period from May 5, 2016 through September 30, 2016 | Period from January 1, 2016 through May 4, 2016 | Nine Months ended September 30, 2015 | ||||||||||
| Successor | Predecessor | Predecessor | ||||||||||
| Sales and marketing | $ | - | $ | 18,504 | $ | 83,583 | ||||||
| Research and development | - | 6,858 | 64,542 | |||||||||
| General and administrative | - | 29,719 | 509,193 | |||||||||
| $ | - | $ | 55,081 | $ | 657,318 | |||||||
In July 2016, the Board of Directors approved, and in August 2016 it amended, the 2016 Omnibus Plan, which remains subject to approval by the Company’s stockholders. In July and August 2016, the Board of Directors granted options to purchase an aggregate of 1,362,500 shares of New Common Stock to certain of the Company’s management, employees and directors, subject to approval of the 2016 Omnibus Plan by the Company’s stockholders, of which 105,000 options have been forfeited since their grant date. Until such time as the 2016 Omnibus Plan is approved by the Company’s stockholders, the Company will not begin recognizing any stock-based compensation expense.
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Note 9 – Fair Value Measurements
Financial Instruments Carried at Cost
Short-term financial instruments in our condensed consolidated balance sheets, including accounts and other receivables and accounts payable, are carried at cost which approximates fair value, due to their short-term nature. The fair value of our long-term convertible debt was approximately $25.4 million at December 31, 2015; the convertible debt was cancelled as of the Effective Date.
In February 2014, we purchased a Certificate of Deposit (“CD”) from a commercial bank in the amount of $53,000. The CD bears interest at an annual rate of 0.10% and matured on February 24, 2016 and it was auto-renewed for an eight month period at the same rate. The next maturity date is June 24, 2017. The carrying value of the CD approximates its fair value. This CD collateralizes a letter of credit. See Note 10 – Commitments and Contingencies.
Fair Value Measurements
Our condensed consolidated balance sheets include certain financial instruments that are carried at fair value. Fair value is the price that would be received from the sale of an asset or paid to transfer a liability assuming an orderly transaction in the most advantageous market at the measurement date. U.S. GAAP establishes a hierarchical disclosure framework which prioritizes and ranks the level of observability of inputs used in measuring fair value. These tiers include:
| · | Level 1, defined as observable inputs such as quoted prices in active markets for identical assets; |
| · | Level 2, defined as observable inputs other than Level 1 prices such as quoted prices for similar assets; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and |
| · | Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. |
An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. At each reporting period, we perform a detailed analysis of our assets and liabilities that are measured at fair value. All assets and liabilities for which the fair value measurement is based on significant unobservable inputs or instruments which trade infrequently and therefore have little or no price transparency are classified as Level 3.
Successor Company Financial Assets and Liabilities Measured at Fair Value
The Successor Company has segregated its financial assets and liabilities that are measured at fair value on a recurring basis as of September 30, 2016 into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date in the table below. The inputs used in measuring the fair value of cash and short-term investments are considered to be Level 1 in accordance with the three-tier fair value hierarchy. The fair market values are based on period-end statements supplied by the various banks and brokers that held the majority of our funds.
| As of September 30, 2016 | ||||||||||||||||
| Description | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
| Assets - money market funds | $ | 2,501,211 | $ | - | $ | - | $ | 2,501,211 | ||||||||
The Successor Company had no other financial assets and liabilities measured at fair value on a recurring or non-recurring basis as of September 30, 2016.
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Successor Company Non-Financial Assets and Liabilities Measured at Fair Value
The Successor Company’s property and equipment and intangible assets are measured at fair value on a non-recurring basis, upon establishment pursuant to fresh start accounting, and upon impairment. The Successor Company determined the fair value of its intangibles assets as of the Effective Date as follows:
| Identifiable Intangible Asset | Valuation Method | Significant Unobservable Inputs | Estimated Fair Value | |||||
| Trademarks | Income approach - royalty savings method | Projected sales | $ | 917,000 | ||||
| Estimated royalty rates | ||||||||
| Discount rate | ||||||||
| Technology | Income approach - royalty savings method | Projected sales | $ | 6,576,000 | ||||
| Estimated royalty rates | ||||||||
| Discount rate | ||||||||
| Clinician Relationships | Income approach - excess earnings method | Projected sales | $ | 904,000 | ||||
| Estimated attrition | ||||||||
| Projected margins | ||||||||
| Discount rate | ||||||||
No impairments were identified during the Successor Company periods presented.
Predecessor Company Financial Assets and Liabilities Measured at Fair Value
The Predecessor Company segregated its financial assets and liabilities that are measured at fair value on a recurring basis into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date in the table below. The inputs used in measuring the fair value of cash and short-term investments are considered to be Level 1 in accordance with the three-tier fair value hierarchy. The fair market values are based on period-end statements supplied by the various banks and brokers that held the majority of our funds.
We account for our derivative financial instruments, consisting solely of certain stock purchase warrants that contain non-standard anti-dilutions provisions and/or cash settlement features, and certain conversion options embedded in our convertible instruments, at fair value using Level 3 inputs. We determine the fair value of these derivative liabilities using the Black-Scholes option pricing model when appropriate, and in certain circumstances using binomial lattice models or other accepted valuation practices.
| · | When determining the fair value of our financial assets and liabilities using the Black-Scholes option pricing model, we are required to use various estimates and unobservable inputs, including, among other things, contractual terms of the instruments, expected volatility of our stock price, expected dividends, and the risk-free interest rate. Changes in any of the assumptions related to the unobservable inputs identified above may change the fair value of the instrument. Increases in expected term, anticipated volatility and expected dividends generally result in increases in fair value, while decreases in the unobservable inputs generally result in decreases in fair value. |
| · | When determining the fair value of our financial assets and liabilities using binomial lattice models or other accepted valuation practices, we also are required to use various estimates and unobservable inputs, including in addition to those listed above, the probability of certain events. |
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As a result of our deteriorating financial condition (as further evidenced by our filing for bankruptcy protection in January 2016) and decreased stock price in 2015, the value of our derivative liabilities related to stock purchase warrants and embedded conversion option was de minimis as of May 4, 2016 and December 31, 2015. The derivative liabilities related to stock purchase warrants and embedded conversion option were compromised on the Effective Date and our obligations thereunder were cancelled. All gains and losses arising from changes in the fair value of derivative instruments are classified as the changes in the fair value of derivative instruments in the accompanying condensed consolidated statements of operations.
The following table represents the fair value hierarchy for our financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2015.
| As of December 31, 2015 | ||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | |||||||||||||
| Assets - money market funds | $ | 614,283 | $ | - | $ | - | $ | 614,283 | ||||||||
| Liabilities: | ||||||||||||||||
| Warrant liabilities | $ | - | $ | - | $ | - | $ | - | ||||||||
| Embedded conversion option | $ | - | $ | - | $ | - | $ | - | ||||||||
The Level 1 assets measured at fair value in the above table are classified as cash and cash equivalents in the accompanying condensed consolidated balance sheets.
We did not have any transfers between Level 1, Level 2, or Level 3 assets or liabilities in 2016 or 2015. The following tables set forth a summary of changes in the fair value of Level 3 liabilities measured at fair value on a recurring basis for the periods presented:
| Predecessor | ||||||||||||||||
| Balance at January 1, 2015 | Established in 2015 | Change in Fair Value | Balance at September 30, 2015 | |||||||||||||
| Description | ||||||||||||||||
| Liabilities: | ||||||||||||||||
| Embedded conversion option | $ | 4,362,225 | - | (3,965,990 | ) | $ | 396,235 | |||||||||
| Warrant liabilities | $ | 25,484,596 | - | (23,282,901 | ) | $ | 2,201,695 | |||||||||
| Predecessor | ||||||||||||||||
| Balance at July 1, 2015 | Established in 2015 | Change in Fair Value | Balance at September 30, 2015 | |||||||||||||
| Description | ||||||||||||||||
| Liabilities: | ||||||||||||||||
| Embedded conversion option | $ | 5,112,346 | - | (4,716,111 | ) | $ | 396,235 | |||||||||
| Warrant liabilities | $ | 11,885,468 | - | (9,683,773 | ) | $ | 2,201,695 | |||||||||
| Predecessor | ||||||||||||||||
| Balance at January 1, 2016 | Established in 2016 | Change in Fair Value | Balance at May 4, 2016 | |||||||||||||
| Description | ||||||||||||||||
| Liabilities: | ||||||||||||||||
| Embedded conversion option | $ | - | - | - | $ | - | ||||||||||
| Warrant liabilities | $ | - | - | - | $ | - | ||||||||||
The Predecessor Company had no other financial assets and liabilities measured at fair value on a nonrecurring basis.
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Predecessor Company Non-Financial Assets and Liabilities Measured at Fair Value
The Predecessor Company’s property and equipment and intangible assets were measured at fair value on a non-recurring basis, upon impairment. As of September 30, 2015, we determined that the estimated fair value of our IPR&D asset was less than its carrying value, and recognized an impairment charge of $22.6 million. Additionally, we determined that the estimated fair value of our goodwill was less than its carrying value, and recognized a noncash impairment charge of $1.1 million in the third quarter of 2015.
In determining the fair value of our intangibles assets, we assessed how our net tangible assets, goodwill and other intangible assets would be valued in a hypothetical sale of the Company, with the sales price being equal to our market capitalization as of September 30, 2015. After allocating the total fair value of our reporting unit to the estimated fair value of our net tangible assets, we then allocated the remaining fair value first to our definite-lived intangible assets and second to our indefinite-lived intangible asset. We determined the fair value of the goodwill as the excess of the total fair value of the reporting unit over the fair value of all other assets and liabilities. The Predecessor Company had no non-financial assets and liabilities measured at fair value on a recurring basis.
Note 10 – Commitments and Contingencies
Successor Company Commitments and Contingencies
As of the Effective Date, the Company entered into a registration rights agreement (the “Registration Rights Agreement”) with the Recapitalization Investors. The Registration Rights Agreement provides certain resale registration rights to the Investors with respect to securities received in the Recapitalization Financing. Pursuant to the Registration Rights Agreement, the Company has agreed to use its best efforts to prepare and file with the U.S. Securities and Exchange Commission a “shelf” registration statement covering the resale of all shares of New Common Stock issued to the Investors on the Effective Date.
Our primary office and warehouse facilities are located in Gaithersburg, Maryland, and comprise approximately 12,000 square feet. The facilities fall under two leases with monthly rent, including our share of certain annual operating costs and taxes, at approximately $14,000 and $4,000 per month, respectively, with each lease expiring in September 2019. In addition, we lease an approximately 2,100 square foot facility in Nashville, Tennessee, which is being utilized as a commercial operation. The lease is approximately $4,000 per month excluding our share of annual operating expenses and expires April 30, 2018. We also lease a 16,300 square foot facility located in Durham, North Carolina. This facility falls under one lease with monthly rent, including our share of certain annual operating costs and taxes, at approximately $21,000 per month with the lease expiring December 31, 2018. As a result of our discontinuance of the ALD-401 clinical trial, the Company ceased use of the facility in Durham, North Carolina on July 31, 2014 and sublet the facility beginning August 1, 2014. The sublease rent is approximately $14,000 per month and expires December 31, 2018.
In July 2009, in satisfaction of a Maryland law pertaining to Wholesale Distributor Permits, we established a Letter of Credit, in the amount of $50,000, naming the Maryland Board of Pharmacy as the beneficiary. This Letter of Credit serves as security for the performance by us of our obligations under applicable Maryland law and is collateralized by a Certificate of Deposit maintained at a commercial bank.
Note 11 – Subsequent Events
On October 20, 2016, the Company entered into a letter agreement (the “Three Party Letter Agreement”) with Arthrex and Deerfield SS, LLC (the “Assignee”), which extends the transition period under the Transition Services Agreement through January 15, 2017. Under the terms of the Three Party Letter Agreement, subject to Arthrex making a payment of $201,200 to the Company on October 28, 2016, (a) the Company has sold, conveyed, transferred and assigned to Arthrex its title and interest in the Company’s inventory of Angel products (including spare parts therefor) and production equipment, and (b) the Assignee is obligated to make three equal payments of $33,333.33 each to the Company as consideration for the extension of the transition period. Under the terms of the Three Party Letter Agreement, the Company will have no further obligations under the Transition Services Agreement or the Amended Arthrex Agreement after January 15, 2017. The agreement contains a full and irrevocable release of Arthrex by the Company with respect to any actions, claims or other liabilities for payments of Royalty (as defined in the Amended Arthrex Agreement) owed to the Company based on sales of Angel products occurring on or before June 30, 2016, and a full and irrevocable release of the Company and the Assignee by Arthrex with respect to any actions, claims or other liabilities arising under the Amended Arthrex Agreement as of the date of the Three Party Letter Agreement. Neither Arthrex nor the Assignee assumed any liabilities or obligations of the Company in connection with the Three Party Letter Agreement.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the financial statements and related notes appearing elsewhere in this Quarterly Report and our Annual Report on Form 10-K for the year ended December 31, 2015 (the “Annual Report”), filed with the U.S. Securities and Exchange Commission, or the Commission.
Important Note About Our Bankruptcy, Emergence from Bankruptcy and Fresh Start Accounting
Following the consummation of the Plan of Reorganization, the Company’s financial condition and results of operations from and after May 5, 2016 are not comparable to the financial condition or results of operations reflected in the Company’s prior financial statements (including those as of May 4, 2016 and December 31, 2015 and for the periods ended May 4, 2016 and September 30, 2015 contained in this Quarterly Report) due to the Company’s application of fresh start accounting to its financial statements from and after May 5, 2016. For that reason, it is difficult to assess our performance in periods beginning on or after May 5, 2016 in relation to prior periods. Please refer to “Note 2 - Fresh Start Accounting” in the notes to the unaudited condensed consolidated financial statements for additional details.
Special Note Regarding Forward Looking Statements
Some of the information in this Quarterly Report (including this section) contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance, or achievements, and may contain the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “the facts suggest,” “will,” “will be,” “will continue,” “will likely result,” “could,” “may” and words of similar import. These statements reflect the Company’s current view of future events and are subject to certain risks and uncertainties as noted in this Quarterly Report and in other reports filed by us with the Securities and Exchange Commission, including Forms 8-K, 10-Q, and 10-K. These risks and uncertainties include, among others, the following:
| · | our limited sources of working capital; |
| · | our need for substantial additional financing and our ability to obtain that financing, whether equity or debt, in the post-restructuring environment; |
| · | our history of losses and future expectations; |
| · | our short history and limited operating experience; |
| · | our and Restorix’ successful implementation of our Collaboration Agreement; |
| · | whether the Centers for Medicare & Medicaid Services (“CMS”) will continue to consider its treatment of the geometric mean cost of the services underlying Aurix to be comparable to the geometric mean cost of APC 5054 in the future; |
| · | our ability to maintain classification of Aurix as APC 5054; |
| · | whether CMS will continue to maintain a national average reimbursement rate of $1,411 per Aurix treatment, and, more generally, our ability to continue to be reimbursed at a profitable national average rate per application in the future; |
| · | uncertainties surrounding the timing of our ability to commence trading of our common stock on an OTC market, the price at which our common stock will commence and continue trading, and the trading volume or liquidity of our common stock; |
| · | our ability to meet our obligations under the Transition Services Agreement with the Deerfield Lenders, as supplemented by the Three Party Letter Agreement; |
| · | our reliance on several single source suppliers and our ability to source raw materials at affordable costs; |
| · | our ability to protect our intellectual property; |
| · | our compliance with governmental regulations; |
| · | the success of our clinical study protocols under our Coverage with Evidence Development program |
| · | our ability to contract with healthcare providers; |
| · | our ability to successfully sell and market the Aurix System; |
| · | the acceptance of our products by the medical community; |
| · | our ability to attract and retain key personnel; and |
| · | our ability to successfully pursue strategic collaborations to help develop, support or commercialize our products. |
Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results could differ materially from those anticipated in these forward-looking statements.
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In addition to the risks identified under the heading “Risk Factors” in our Annual Report and the other filings referenced above, other sections of this report may include additional factors which could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time, and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on our business, or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.
Finally, we can offer no assurances that we have correctly estimated the resources necessary to execute under our existing customer agreements and seek partners, co-developers or acquirers for our regenerative therapies post-reorganization. If a larger workforce or one with a different skillset is ultimately required to implement our post-reorganization strategy successfully, or if we inaccurately estimated the cash and cash equivalents necessary to finance our operations, or if we are unable to identify additional sources of capital if necessary to continue our operations, our business, results of operations, financial condition and cash flows may be materially and adversely affected.
The Company undertakes no obligation and does not intend to update, revise or otherwise publicly release any revisions to its forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of any unanticipated events.
Bankruptcy and Emergence from Bankruptcy
Filing of Petition
On January 26, 2016, the Company filed a voluntary petition in the United States Bankruptcy Court for the District of Delaware (the “Bankruptcy Court”) seeking relief under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”), which is administered under the caption “In re: Nuo Therapeutics, Inc.”, Case No. 16-10192 (MFW) (the “Chapter 11 Case”). During the pendency of the Chapter 11 Case, the Company continued to operate its business as a “debtor-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court.
In conjunction with the Company’s filing of the Chapter 11 Case, on January 29, 2016, the Bankruptcy Court granted the Company's motion and entered an interim order which required certain notices and restricted proposed transfers of the Company's equity securities by any person or entity that beneficially owned, or would have owned following a proposed transfer, at least 6,200,000 shares of the Company’s common stock, par value $0.0001 per share (the “Old Common Stock”), representing approximately 5.0% of the Company's issued and outstanding shares at the time.
Debtor-in-Possession Financing
In connection with the Chapter 11 Case, on January 28, 2016, the Bankruptcy Court entered an order approving the Company's interim debtor-in-possession financing (“DIP Financing”) pursuant to terms set forth in a senior secured, superpriority debtor-in-possession credit agreement (the “DIP Credit Agreement”), dated as of January 28, 2016, by and among the Company, as borrower, each lender from time to time party to the DIP Credit Agreement, including, but not limited to Deerfield Private Design Fund II, L.P., Deerfield Private Design International II, L.P., and Deerfield Special Situations Fund, L.P. (collectively, the “Deerfield Lenders”) and Deerfield Mgmt, L.P., as administrative agent (the “DIP Agent”) for the Deerfield Lenders. The Deerfield Lenders comprised 100% of the lenders under the then-existing facility agreement by and among the Company and the Deerfield Lenders, entered into as of March 31, 2014, as amended (the “Deerfield Facility Agreement”).
On March 9, 2016, the Bankruptcy Court approved on a final basis the Company's motion for approval of the DIP Credit Agreement and use of cash collateral, and approved a Waiver and First Amendment to the DIP Credit Agreement (the “Waiver and First Amendment”) with the Deerfield Lenders and DIP Agent, pursuant to which the DIP Credit Agreement was approved to include certain amendments, including the material terms of the proposed restructuring of the pre-petition and post-petition secured debt, unsecured debt and equity interests of the Company, the terms of which were eventually effected pursuant to the Plan of Reorganization (as defined below). The Waiver and First Amendment provided for senior secured loans in the aggregate principal amount of up to $6,000,000 in post-petition financing (collectively, the “DIP Loans”). In accordance with the Plan of Reorganization, as of the Effective Date, the DIP Credit Agreement was terminated.
Plan of Reorganization and Emergence from Bankruptcy
On April 25, 2016, the Bankruptcy Court entered an Order Granting Final Approval of Disclosure Statement and Confirming Debtor’s Plan of Reorganization (the “Confirmation Order”), which confirmed the Modified First Amended Plan of Reorganization of the Debtor under Chapter 11 of the Bankruptcy Code (as confirmed, the “Plan of Reorganization”).
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The Plan of Reorganization contemplated that, prior to the effective date of such plan (which would occur no later than May 5, 2016), the Company would seek to raise not less than $10,500,000 in funding (of which $3,000,000 could be in the form of backstop irrevocable capital call commitments from creditworthy obligors in the reasonable judgment of the Deerfield Lenders (collectively, the “Backstop Commitment”)) through a private placement of common stock of the reorganized Company (in such event, a “Successful Capital Raise”). If the Company were unable to achieve a Successful Capital Raise, then the Plan of Reorganization contemplated alternative treatment of certain claims and equity interests. The proposed treatment of claims and equity interests in the event of a Successful Capital Raise was defined under the Plan of Reorganization as “Scenario A.”
The Company having met the conditions contemplated for the Scenario A Successful Capital Raise, the Plan of Reorganization became effective on the Effective Date. Pursuant to the Plan of Reorganization, as of the Effective Date (i) all equity interests of the Company, including but not limited to all shares of the Company’s common stock, $0.0001 par value per share (including its redeemable common stock)(the “Old Common Stock”), warrants and options, that were issuable or issued and outstanding immediately prior to the Effective Date, were cancelled, (ii) the Company’s certificate of incorporation in effect immediately prior to the Effective Date was amended and restated in its entirety, as described in the Company’s Form 8-A filed on May 10, 2016 (such description is incorporated herein by reference), (iii) the Company’s by-laws in effect immediately prior to the Effective Date were amended and restated in their entirety as described in the Company’s Form 8-A filed on May 10, 2016 (such description is incorporated herein by reference), and (iv) the Company issued New Common Stock, Warrants and Series A Preferred Stock (all as defined below).
The Plan of Reorganization and the Confirmation Order were filed as Exhibits 2.1 and 99.1, respectively, to the Company’s Current Report on Form 8-K filed on April 28, 2016, and are incorporated herein by reference.
New Common Stock
Recapitalization
In accordance with the Plan of Reorganization, as of the Effective Date, the Company issued 7,500,000 shares (the “Recapitalization Shares”) of new common stock, par value $0.0001 per share (the “New Common Stock”) to certain accredited investors (the “Recapitalization Investors”) for gross cash proceeds of $7,300,000 and net cash to the Company of $7,052,500 (the “Recapitalization Financing”). 200,000 of the 7,500,000 shares of New Common Stock were issued in partial payment of an advisory fee. The net cash amount excludes the effect of $100,000 in offering expenses paid from the proceeds of the DIP Financing, which was converted into Series A Preferred Stock as of the Effective Date. As part of the Recapitalization Financing, the Company also issued warrants to purchase 6,180,000 shares of New Common Stock to certain of the Recapitalization Investors (the “Warrants”). The Warrants terminate on May 5, 2021 and are exercisable at any time on or after November 5, 2016 at exercise prices ranging from $0.50 per share to $1.00 per share. The number of shares of New Common Stock underlying a Warrant and its exercise price are subject to customary adjustments upon subdivisions, combinations, payment of stock dividends, reclassifications, reorganizations and consolidations. The Form of Warrant, which was filed as Exhibit 10.4 to the Company’s Current Report on Form 8-K dated May 5, 2016, is incorporated herein by reference.
The Recapitalization Shares and Warrants were issued to the Recapitalization Investors pursuant to an exemption from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”) provided by Section 4(a)(2) of the Securities Act and/or Rule 506 promulgated thereunder.
A significant majority of the Recapitalization Investors executed backstop commitments to purchase up to 12,800,000 additional shares of New Common Stock for an aggregate purchase price of up to $3,000,000 (collectively, the “Backstop Commitment”). The Company cannot call the Backstop Commitment prior to June 30, 2017.
With respect to each Recapitalization Investor who executed a Backstop Commitment, the commitment terminates on the earlier of (i) the date on which the Company receives net proceeds (after deducting all costs, expenses and commissions) from the sale of New Common Stock in the aggregate amount of the Backstop Commitment, (ii) the date that all shares of Series A Preferred Stock (as defined below) have been redeemed by the Company or (iii) the date that all shares of Series A Preferred Stock are no longer owned by entities affiliated with Deerfield (the “Termination Date”). Under the terms of the Backstop Commitment, the Company is obligated to pay to the committed Recapitalization Investors upon the Termination Date a commitment fee of $250,000 in the aggregate.
As of the Effective Date, the Company entered into a registration rights agreement (the “Registration Rights Agreement”) with the Recapitalization Investors. The Registration Rights Agreement provides certain resale registration rights to the Recapitalization Investors with respect to securities obtained in the Recapitalization Financing. Pursuant to the Registration Rights Agreement, the Company has agreed to use its best efforts to prepare and file with the U.S. Securities and Exchange Commission a “shelf” registration statement covering the resale of the shares of New Common Stock issued to the Recapitalization Investors on the Effective Date. The Registration Rights Agreement was filed as Exhibit 10.3 to the Company’s Current Report on Form 8-K dated May 5, 2016, and is incorporated herein by reference.
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Issuance of New Common Stock to Holders of Old Common Stock
As of the Effective Date, the Company issued 2,264,612 shares of New Common Stock (the “Exchange Shares”) to record holders of the Old Common Stock as of March 28, 2016 who executed and timely delivered the required release documents no later than July 5, 2016 in accordance with the Confirmation Order and the Plan of Reorganization. The holders of Old Common Stock who executed and timely delivered the required release documents are referred to as the “Releasing Holders.”
The 2,264,612 Exchange Shares were issued as of the Effective Date to Releasing Holders who asserted ownership of a number of shares of Old Common Stock that matched the Company’s records or could otherwise be confirmed, at a rate of one share of New Common Stock for every 41.8934 shares of Old Common Stock held by such holders as of March 28, 2016. In accordance with the Plan of Reorganization, if the calculation would otherwise have resulted in the issuance to any Releasing Holder of a number of shares of New Common Stock that is not a whole number, then the number of shares actually issued to such Releasing Holder was determined by rounding down to the nearest number.
In accordance with the Plan of Reorganization, the Exchange Shares were issued under the exemption from the registration requirements of the Securities Act provided by Section 1145 of the United States Bankruptcy Code.
Issuance of New Common Stock in Exchange for Administrative Claims
On June 20, 2016, the Company issued 162,500 shares of New Common Stock (the “Administrative Claim Shares”) pursuant to the Order Granting Application of the Ad Hoc Equity Committee Pursuant to 11 U.S.C. §§ 503(b)(3)(D) and 503(b)(4) for Allowance of Fees and Expenses Incurred in Making a Substantial Contribution, entered by the Bankruptcy Court on June 20, 2016. The Administrative Claim Shares were issued to holders of administrative claims under sections 503(b)(3)(D) and 503(b)(4) of the Bankruptcy Code. Of the 162,500 shares, 100,000 shares were issued to outside counsel to the Ad Hoc Equity Committee of the Company’s equity holders as payment of all remaining allowed fees for legal services provided by such counsel, and 62,500 were issued to designees of the Ad Hoc Equity Committee who had granted loans in an aggregate amount of $62,500 to the Ad Hoc Equity Committee in December 2015 as repayment of such loans.
The Administrative Claim Shares were issued under the exemption from the registration requirements of the Securities Act provided by Section 4(a)(2) of the Securities Act and/or Rule 506 thereunder.
Series A Preferred Stock
On the Effective Date, the Company filed a Certificate of Designations of Series A Preferred Stock (the “Certificate of Designations”) with the Delaware Secretary of State, designating 29,038 shares of the Company’s undesignated preferred stock, par value $0.0001 per share, as Series A Preferred Stock (the “Series A Preferred Stock”). A copy of the Certificate of Designations is attached as Exhibit 3.3 to the Company’s Current Report on Form 8-K dated May 5, 2016 and is incorporated herein by reference. On the Effective Date, the Company issued 29,038 shares of Series A Preferred Stock to the Deerfield Lenders in accordance with the Plan of Reorganization pursuant to the exemption from the registration requirements of the Securities Act provided by Section 1145 of the Bankruptcy Code. The Deerfield Lenders did not receive any shares of New Common Stock or other equity interests in the Company.
The Series A Preferred Stock has no stated maturity date, is not convertible or redeemable and carries a liquidation preference of $29,038,000, which is required to be paid to holders of such Series A Preferred Stock before any payments are made with respect to shares of New Common Stock (and other capital stock that is not issued on parity or senior to the Series A Preferred Stock) upon a liquidation or change in control transaction. For so long as Series A Preferred Stock is outstanding, the holders of Series A Preferred Stock have the right to nominate and elect one member of the board of directors of the Company (the “Board of Directors”) and to have such director serve on a standing committee of the Board of Directors established to exercise powers of the Board of Directors in respect of decisions or actions relating to the Backstop Commitment. Lawrence Atinsky serves as the designee of the holders of Series A Preferred Stock, which are all currently affiliates of Deerfield Management Company, L.P., of which Mr. Atinsky is a Partner. The Series A Preferred Stock have voting rights, voting with the New Common Stock as a single class, with each share of Series A Preferred Stock having the right to five votes, currently representing approximately one percent (1%) of the voting rights of the capital stock of the Company, and the holders of Series A Preferred Stock have the right to approve certain transactions. Under the Certificate of Designations, for so long as the Backstop Commitment remains in effect, a majority of the members of the standing backstop committee of the Board of Directors may approve a drawdown under the Backstop Commitment. Among other restrictions, the Certificate of Designations for our Series A Preferred Stock limits the Company’s ability to (i) issue securities that are senior or pari passu with the Series A Preferred Stock, (ii) incur debt other than for working capital purposes not in excess of $3.0 million, (iii) issue securities that are junior to the Series A Preferred Stock and that provide certain consent rights to the holders of such junior securities in connection with a liquidation or contain certain liquidation preferences, (iv) pay dividends on or purchase shares of its capital stock, and (v) change the authorized number of members of its Board of Directors to a number other than five, in each case without the consent of holders representing at least two-thirds of the outstanding shares Series A Preferred Stock.
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Assignment and Assumption Agreement; Transition Services Agreement
Pursuant to the Plan of Reorganization, on May 5, 2016 the Company entered into an Assignment and Assumption Agreement with Deerfield SS, LLC (the “Assignee”), the designee of the Deerfield Lenders, to assign to the Assignee the Company’s rights, title and interest in and to its existing license agreement with Arthrex, or the Arthrex Agreement, and to transfer and assign to the Assignee associated intellectual property owned by the Company and licensed thereunder, as well as rights to collect royalty payments thereunder. The assignment and transfer was effected in exchange for a reduction of $15,000,000 in the amount of the allowed claim of the Deerfield Lenders pursuant to the Plan of Reorganization. As a result of the assignment and transfer, the Aurix System currently represents the Company’s only commercial product offering.
Pursuant to the Plan of Reorganization, on May 5, 2016, the Company also entered into a Transition Services Agreement with the Assignee. The Transition Services Agreement generally contemplates that, during a transition period, we will continue to provide for the manufacture and supply to Arthrex of the Angel product line in accordance with the terms of the Arthrex Agreement, and to provide our full cooperation, as commercially reasonable, to assist Arthrex with the manufacture and supply of the Angel product line. Initially, our obligation to provide such transition services was not to extend beyond October 15, 2016 unless agreed between the Company and the Assignee. On October 20, 2016, the Company entered into a letter agreement (the “Three Party Letter Agreement”) with Arthrex and the Assignee, which extends the transition period under the Transition Services Agreement through January 15, 2017. The Assignment and Assumption Agreement and the Transition Services Agreement were filed as Exhibit 10.1 and Exhibit 10.2 to the Company’s Current Report on Form 8-K dated May 5, 2016, respectively, and are incorporated herein by reference. The Three Party Letter Agreement was filed as Exhibit 10.47 to our Annual Report and is incorporated herein by reference.
Termination of Deerfield Facility Agreement and DIP Credit Agreement
On the Effective Date, the obligations of the Company under the Deerfield Facility Agreement and the DIP Credit Agreement were cancelled in accordance with the Plan of Reorganization and the Company ceased to have any obligations thereunder.
Trading in the New Common Stock
The shares of New Common Stock are not currently eligible for trading on an OTC market. The Company is working with its advisors to obtain FINRA approval for trading, and to obtain eligibility through the Depository Trust Company for electronic distribution of shares to brokerage accounts. There can be no assurances that the Company will be successful in these endeavors.
Our Business
Nuo Therapeutics, Inc. (“we,” “us,” “Nuo Therapeutics,” “Nuo,” and the “Company”) is a regenerative therapies company developing and marketing products primarily within the U.S. We commercialize innovative cell-based technologies that harness the regenerative capacity of the human body to trigger natural healing. The use of autologous (from self) biological therapies for tissue repair and regeneration is part of a transformative clinical strategy designed to improve long term recovery in complex chronic conditions with significant unmet medical needs.
Our current commercial offering consists of a point of care technology for the safe and efficient separation of autologous blood to produce a platelet based therapy for the chronic wound care market. Prior to the Effective Date, we had two distinct Platelet Rich Plasma (“PRP”) devices, the Aurix System for chronic wound care, and the Angel concentrated PRP (“cPRP”) system for usage generally within the orthopedics market. Approximately 85% of our product sales during the year ended December 31, 2015 were in the United States, where we sold Aurix through direct sales representatives and Angel via our distribution agreements with Arthrex, Inc.
As described above under “Bankruptcy and Emergence from Bankruptcy,” on May 5, 2016 the Company entered into an Assignment and Assumption Agreement with Deerfield SS, LLC (the “Assignee”), the designee of the Deerfield Lenders, to assign to the Assignee the Company’s rights, title and interest in and to the Arthrex Agreement, and to transfer and assign to the Assignee associated intellectual property owned by the Company and licensed under the Arthrex Agreement, as well as rights to collect royalty payments thereunder. On May 5, 2016, the Company and the Assignee also entered into a Transition Services Agreement in which the Company agreed to continue to service the Arthrex Agreement for a transition period. As a result of the assignment and transfer, the Aurix System currently represents our only commercial product offering.
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Growth drivers in the United States include the treatment of chronic wounds with Aurix in (i) the Veterans Affairs (“VA”) healthcare system and other federal accounts settings and (ii) the Medicare population under a National Coverage Determination (“NCD”) when registry data is collected under the Coverage with Evidence Development (“CED”) program of the Centers for Medicare & Medicaid Services (“CMS”).
The Aurix TM System
In October 2014, we relaunched our AutoloGel chronic wound care system under the Aurix brand, as a part of our strategic plan for the commercialization of Aurix in the U.S. chronic wound care market.
The Aurix System is a point of care device for the rapid production of a platelet based bioactive wound treatment derived from a small sample of the patient’s own blood. Aurix is cleared by the FDA for use on exuding wounds and is currently marketed in the chronic wound market. The advanced wound care market, within which Aurix competes, is composed of advanced wound care dressings, wound care devices, and wound care biologics, and is estimated to be an approximate $12.5 billion global market according to the visiongain Advanced Wound Care Market Forecast 2015-2015, published in 2015. The most significant growth driver for Aurix is the 2012 National Coverage Decision from CMS, which reversed a twenty year old non-coverage decision for autologous blood derived products used in wound care. The Company’s recent collaboration with Restorix Health, Inc. (“Restorix”) (as described below) is strategically intended to drive patient enrollment in the data registry protocols being conducted under the CED program.
Using the patient’s own platelets as a therapeutic agent, Aurix harnesses the body’s natural healing processes to deliver growth factors, chemokines and cytokines known to promote angiogenesis and to regulate cell growth and the formation of new tissue. Once applied to the prepared wound bed, the biologically active platelet gel can restore the balance in the wound environment to transform a non-healing wound to a wound that heals naturally. There have been nine peer-reviewed scientific and clinical publications demonstrating the effectiveness of Aurix in the management of chronic wounds since the device and gel was cleared by the FDA in 2007.
CMS previously advised us that payment levels for reimbursement claims with respect to Aurix would be reviewed annually and subject to change. Any decision by CMS to decrease payment rates for reimbursement claims will negatively impact the Company's economic value proposition for Aurix in the market for advanced wound care therapies, and could have material adverse effects on the Company’s financial position and results of operations.
In July 2015, CMS released the proposed Hospital Outpatient Prospective Payment System (“HOPPS”) rule for calendar year 2016. In it, CMS proposed a national average reimbursement rate for calendar year 2016 of $305 per Aurix treatment. The Company worked with CMS to establish a higher rate in the CMS’ final rule for calendar year 2016 issued on October 30, 2015. The final national average reimbursement rate under HOPPS for calendar year 2016 was established at $1,411 per treatment effective January 1, 2016, with Aurix placed in Ambulatory Payment Classification (“APC”) 5054 (Level 4 Skin Procedures). In the text of the ruling, CMS commented they believed the geometric mean cost of the services underlying Aurix is comparable to the geometric mean cost of APC 5054. In July 2016, CMS released the proposed HOPPS rule for calendar year 2017. In it, CMS proposed the continuation of a national average payment of $1,411 per treatment. The final national reimbursement rate for 2017 has not yet been established and could be above or below the proposed rate.
The Company’s Aurix revenues in VA facilities are unaffected by CMS determined reimbursement rates, as the Company establishes an agreed price on the Federal Supply Schedule for use of Aurix in federal healthcare facilities.
In September 2009, we entered into an original license and distribution agreement with Millennia Holdings, Inc. (“Millennia”) for the Company’s Aurix System in Japan.
In January 2015, we granted to Rohto Pharmaceutical Co., Ltd. (“Rohto”) a royalty bearing, nontransferable, exclusive license, with limited right to sublicense, to use certain of the Company’s intellectual property for the development, import, use, manufacturing, marketing, sale and distribution for all wound care and topical dermatology applications of the Aurix System and related intellectual property and know-how in human and veterinary medicine in Japan in exchange for an upfront payment from Rohto of $3.0 million. The agreement also contemplates additional royalty payments based on the net sales of Aurix in Japan and an additional cash payment of $1.0 million if and when the reimbursement price for the national health insurance system in Japan has been achieved after marketing authorization as described below.
In conjunction with the Rohto license, we amended our licensing and distribution agreement with Millennia to terminate the agreement and to allow us to transfer the Japanese exclusivity rights from Millennia to Rohto. In connection with this amendment, we paid a one-time, non-refundable fee of $1.5 million to Millennia upon our receipt of the $3.0 million upfront payment from Rohto, are required to make a one-time, non-refundable payment of $0.5 million upon our receipt of the $1.0 million milestone payment from Rohto, and may be required to make future royalty payments to Millennia based upon net sales in Japan. Millennia has been instrumental in establishing the advanced wound care market in Japan, and will continue to work with Rohto to develop the market for Aurix in that market. Further, Rohto has assumed responsibility for securing the Marketing Authorization (“MA”) from Japan’s Ministry of Health, Labor and Welfare (“MHLW”), while we will provide relevant product information, as well as clinical and other data to support Rohto’s regulatory initiatives.
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The license agreement with Rohto and the amendment to our licensing and distribution agreement with Millennia were filed as Exhibits 10.32 and 10.33 to our Annual Report, respectively, and are incorporated herein by reference.
On March 22, 2016, we entered into a Collaboration Agreement (the “Collaboration Agreement”) with Restorix, pursuant to which we agreed to provide Restorix with certain limited geographic exclusivity benefits over a defined period of time for the usage of the Aurix System in up to 30 of the approximately 125 hospital outpatient wound care clinics with which Restorix has a management contract (the “RXH Partner Hospitals”), in exchange for Restorix making minimum commitments of patients enrolled in three prospective clinical research studies primarily consisting of patient data collection (the “Protocols”) necessary to maintain exclusivity under the Collaboration Agreement. The Collaboration Agreement will initially continue for a two-year period, subject to one or more extensions with the mutual consent of the parties.
Pursuant to the Collaboration Agreement, the Company agreed to provide: (i) clinical support services by its clinical staff as reasonably agreed between the Company and Restorix as necessary and appropriate, (ii) reasonable and necessary support regarding certain reimbursement activities, (iii) coverage of Institutional Review Board (“IRB”) fees and payment to Restorix for certain training costs subject to certain limitations and (iv) community-focused public relations materials for participating RXH Partner Hospitals to promote the use of Aurix and participation in the Protocols. Pursuant to the Collaboration Agreement, Restorix agreed to: (i) provide access and support as reasonably necessary and appropriate at up to 30 RXH Partner Hospitals to identify and enroll patients into the Protocols, including senior executive level support and leadership to the collaboration and its enrollment goals and (ii) reasonably assist the Company to correct through a query process, any patient data submitted having incomplete or inaccurate data fields.
Subject to the satisfaction of certain conditions, during the term of the Collaboration Agreement: (i) Restorix will have site specific geographic exclusivity for usage of Aurix in connection with treatment of patients in the Protocols within a 30 mile radius of each RXH Partner Hospital, and (ii) other than with respect to existing CED sites, the Company will not provide corporate exclusivity with any other wound management company operating in excess of 19 wound care facilities for any similar arrangement.
Under the Collaboration Agreement, the Company will pay Restorix or the RXH Partner Hospital, as the case may be, a per patient data collection (administrative) fee upon full completion and delivery of a patient data set. In addition, the Company is responsible to pay for any IRB fees necessary to conduct the Protocols and enroll patients, and to pay Restorix a training cost stipend per site. Each RXH Partner Hospital will pay the Company the then current product price ($700 in 2016, and no greater than $750 in the remainder of the initial term) as set forth in the Collaboration Agreement.
The Collaboration Agreement may be terminated by either party for a material breach, subject to a 60 day cure period. The Agreement is further subject to certain covenants regarding confidentiality, assignment, indemnification and limitations on liability, as well as certain representations and warranties of the parties. The Collaboration Agreement was filed as Exhibit 10.39 to our Annual Report and is incorporated herein by reference.
Effective as of May 5, 2016, the Company and Boyalife Hong Kong Ltd. (“Boyalife”), an entity affiliated with the Company’s significant shareholder, Boyalife Investment Fund I, Inc., entered into an Exclusive License and Distribution Agreement (the “Boyalife Distribution Agreement”) with an initial term of five years, unless the agreement is terminated earlier in accordance with its terms. Under this agreement, Boyalife received a non-transferable, exclusive license, with limited right to sublicense, to use certain of the Company’s intellectual property relating to its Aurix System for the purposes and in the territory specified below. Under the agreement, Boyalife is entitled to import, use for development, promote, market, sell and distribute the Aurix Products in greater China (China, Hong Kong, Taiwan and Macau) for all regenerative medicine applications, including but not limited to wound care and topical dermatology applications in human and veterinary medicine. “Aurix Products” are defined as the combination of devices to produce a wound dressing from the patient’s blood - as of May 5, 2016 consisting of centrifuge, wound dressing kit and reagent kit. Under the Boyalife Distribution Agreement, Boyalife is obligated to pay the Company (a) $500,000 within 90 days of approval of the Aurix Products by the China Food and Drug Administration (“CFDA”), but no earlier than December 31, 2018, and (b) a distribution fee per wound dressing kit and reagent kit of $40, payable quarterly, subject to an agreement by the parties to discuss in good faith the appropriate distribution fee if the pricing of such kits exceeds the current general pricing in greater China. Under the agreement, Boyalife is entitled, with the Company’s approval (not to be unreasonably withheld or delayed) to procure devices from a third party in order to assemble them with devices supplied by the Company to make the Aurix Products. Boyalife also has a right of first refusal with respect to the Aurix Products in specified countries in the Asia Pacific region excluding Japan and India, exercisable in exchange for a payment of no greater than $250,000 in the aggregate. If Boyalife files a new patent application for a new invention relating to wound dressings, the Aurix Products or the Company’s technology, Boyalife will grant the Company a free, non-exclusive license to use such patent application outside greater China during the term of the Boyalife Distribution Agreement.
The Boyalife Distribution Agreement was filed as Exhibit 10.41 to our Annual Report and is incorporated herein by reference.
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Angel Product Line
The Angel cPRP System, acquired from Sorin Group USA, Inc. in April 2010, is designed for single-patient use at the point of care, and provides a simple and flexible means for producing quality concentrated PRP and platelet poor plasma (“PPP”) from a small sample of whole blood or bone marrow. The Angel cPRP System is a multi-functional cell separation device which produces cPRP for use in the operating room and clinic and is generally used in a range of orthopedic indications.
In August 2013, we entered into a Distributor and License Agreement with Arthrex, Inc. (“Arthrex”). Under the terms of this agreement, Arthrex obtained the exclusive rights to sell, distribute, and service the Angel cPRP System and activAT throughout the world for all uses other than chronic wound care. We granted Arthrex a limited license to use our intellectual property as part of enabling Arthrex to sell these products. Pursuant to this license, Arthrex purchased these products from us at cost to distribute and service in exchange for payments based on a certain royalty rate depending on volume of the products sold. As described below, we have assigned the right to this royalty stream to Deerfield SS, LLC pursuant to the Plan of Reorganization.
On October 16, 2015, the Company entered into an Amended and Restated License Agreement (the “Amended Arthrex Agreement”) with Arthrex, which amended and restated the original agreement. Under the terms of the Amended Arthrex Agreement, the Company granted Arthrex an exclusive, irrevocable, worldwide, sub-licensable, transferable license to the Angel Patents (as defined in the following sentence) to research, develop, make, have made, use, sell, offer for sale, have sold, distribute and have distributed, import and have imported, the Angel® Concentrated Platelet System (“Angel”) product line (including, without limitation, the activeAT disposables and associated components) and certain new enhanced products within the Exclusive Field of Use (as defined in the following sentence) and (B) a non-exclusive, irrevocable, worldwide, sub-licensable, transferable license to the Angel Patents to research, develop, make, have made, use, sell, offer for sale, have sold, distribute and have distributed, import and have imported, Angel and certain new enhanced products within (a) nonsurgical aesthetics markets in the United Kingdom and Ireland subject to certain license rights granted to Biotherapy Services Ltd. and (b) any wound care applications (i) worldwide, outside the United States, its territories and possessions and (ii) in the United Kingdom and Ireland subject to certain license rights granted to Biotherapy Services Ltd. (the “Non-Exclusive Field of Use”). For purposes of the Amended Arthrex Agreement, the “Exclusive Field of Use” consists of uses in human and veterinary applications except those described in the Non-Exclusive Field of Use, and “Angel Patents” are those patents used in the technology required, or previously used by the Company, to make, use and sell the Angel product line. The Company also transferred to Arthrex all of its rights and title to product registration and intellectual property (other than patents) related to Angel. In connection with the Amended Arthrex Agreement, the Deerfield Lenders irrevocably released their liens on the product registration rights and intellectual property assets (other than patents) transferred by the Company to Arthrex. The Amended Arthrex Agreement provided that, on a date to be determined by Arthrex, but not later than March 31, 2016, Arthrex would assume all rights related to the manufacture and supply of the Angel product line. We refer to the Amended Arthrex Agreement, as supplemented in April 2016, collectively as the “Arthrex Agreement.”
Under the Arthrex Agreement, the Company had the right to receive certain royalties through 2024. However, pursuant to the Plan of Reorganization, on May 5, 2016, the Company entered into an Assignment and Assumption Agreement with Deerfield SS, LLC (“Assignee”), the designee of the Deerfield Lenders, to assign to the Assignee the Company’s rights, title and interest in and to the Arthrex Agreement, and to transfer and assign to the Assignee associated intellectual property and royalty and payment rights owned by the Company and licensed thereunder. Pursuant to the Plan of Reorganization, on May 5, 2016, the Company and the Assignee also entered into a Transition Services Agreement pursuant to which the Company agreed to continue to service the Arthrex Agreement for a transition period. The Transition Services Agreement generally contemplates that, during this transition period, we will continue to provide for the manufacture and supply to Arthrex of the Angel product line in accordance with the terms of Arthrex Agreement and to provide our full cooperation, as commercially reasonable, to assist Arthrex with the manufacture and supply of the Angel product line, notwithstanding the original March 31, 2016 assumption deadline for Arthrex described above. Initially, our obligation to provide such transition services was not to extend beyond October 15, 2016 unless agreed between the Company and the Assignee.
On October 20, 2016, the Company entered into the Three Party Letter Agreement with Arthrex and the Assignee, which extends the transition period under the Transition Services Agreement through January 15, 2017. Under the terms of the Three Party Letter Agreement, subject to Arthrex making a payment of $201,200 to the Company on October 28, 2016, (a) the Company has sold, conveyed, transferred and assigned to Arthrex its title and interest in the Company’s inventory of Angel products (including spare parts therefor) and production equipment, and (b) the Assignee is obligated to make three equal payments of $33,333.33 each to the Company as consideration for the extension of the transition period. Under the terms of the Three Party Letter Agreement, the Company will have no further obligations under the Transition Services Agreement or the Amended Arthrex Agreement after January 15, 2017. The agreement contains a full and irrevocable release of Arthrex by the Company with respect to any actions, claims or other liabilities for payments of Royalty (as defined in the Amended Arthrex Agreement) owed to the Company based on sales of Angel products occurring on or before June 30, 2016, and a full and irrevocable release of the Company and the Assignee by Arthrex with respect to any actions, claims or other liabilities arising under the Amended Arthrex Agreement as of the date of the Three Party Letter Agreement. Neither Arthrex nor the Assignee assumed any liabilities or obligations of the Company in connection with the Three Party Letter Agreement.
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ALDHbr, or Bright Cell, Technology and Clinical Development Pipeline
The Company acquired the ALDHbr “Bright Cell” technology as part of our acquisition of Aldagen in February 2012. The Bright Cell technology is a novel approach to cell-based regenerative medicine with potential clinical indications in large markets with significant unmet medical needs, such as peripheral arterial disease and ischemic stroke. The Bright Cell technology is unique in that it utilizes an intracellular enzyme marker to facilitate fractionation of essential regenerative cells from a patient’s bone marrow. This core technology was originally licensed by Aldagen from Duke University and Johns Hopkins University (JHU). The proprietary bone-marrow fractionation process identifies and isolates active stem and progenitor cells expressing high levels of the enzyme aldehyde dehydrogenase, or ALDH, which is a key enzyme involved in the regulation of gene activities associated with cell proliferation and differentiation. These select, autologous biologically instructive cells have the potential to promote the repair and regeneration of multiple types of cells and tissues, including the growth of new blood vessels, or angiogenesis, which is critical to the generation of healthy tissue.
Reorganization of Research and Development Operations related to the Bright Cell Technology
Following the January 2014 completion of the trial enrollment in the RECOVER-Stroke trial, in May 2014 we announced preliminary efficacy and safety results of this Phase 2 clinical trial in patients with neurological damage arising from ischemic stroke and treated with ALD-401. Observed improvements in the primary endpoint (mean modified Rankin Score) of the trial were not clinically or statistically significant. In light of this outcome, we discontinued further direct funding of the clinical development program, and in connection therewith, closed the Aldagen research and development facility in Durham, NC.
Continued Clinical Investigation and Development of Bright Cell Technology
Notwithstanding the discontinuation of further direct funding of clinical development, an ongoing Phase 2 clinical study (PACE) in intermittent claudication (a condition associated with peripheral arterial disease) has continued under the sole funding of the National Heart, Lung, and Blood Institute (“NHLBI”), a division of the National Institutes of Health (“NIH”) and in collaboration with the Cardiovascular Cell Therapy Research Network. This study enrolled 82 patients and trial enrollment concluded in January 2016. Clinical study results are expected to be publicly available in the fourth quarter of 2016 with presentation at a major medical meeting. The Bright Cell technology is also being investigated in a Phase 1 clinical trial in grade IV malignant glioma following surgery being conducted by Duke University and funded externally.
Results of Operations
Upon emergence from bankruptcy on the Effective Date, the Company applied fresh start accounting, resulting in the Company becoming a new entity for financial reporting purposes (see Note 2 – Fresh Start Accounting). As a result of the application of fresh start accounting, the Company reflected the disposition of its pre-petition debt and changes in its equity structure effected under the Confirmation Order in its balance sheet as of the Effective Date. Accordingly, all financial statements prior to May 5, 2016 are referred to as those of the "Predecessor Company" as they reflect the periods prior to application of fresh start accounting. The balance sheet as of September 30, 2016 and the financial statements for periods subsequent to May 4, 2016, are referred to as those of the "Successor Company." Under fresh start accounting, the Company's assets and liabilities were adjusted to their fair values, and a reorganization value for the entity was determined by the Company based upon the estimated fair value of the enterprise before considering values allocated to debt to be settled in the reorganization. The fresh start adjustments are material and affect the Company’s results of operations from and after May 5, 2016. As a result of the application of fresh start accounting and the effects of the implementation of the Plan of Reorganization, the financial statements on or after May 5, 2016 are not comparable to the financial statements prior to that date.
When evaluating results of operations below, management views the three and nine months ended September 30, 2016 as a single, whole measurement period instead of a pair of distinct periods which must be divided and reported separately according to GAAP. Consequently, the Company is presenting the operating results of the Predecessor and Successor on a combined basis for the three and nine months ended September 30, 2016. This combined presentation is a non-GAAP summation of the Predecessor’s pre-reorganization results of operations for the period from January 1, 2016 through May 4, 2016 and the Successor’s results of operations for the period from May 5, 2016 through September 30, 2016. Management believes that the combined presentation provides additional information that enables meaningful comparison of the Company’s financial performance during uniform periods.
Please refer to Note 2 – Fresh Start Accounting in the notes to the condensed consolidated financial statements for a detailed description of the effects of (i) the transactions contemplated by the Plan of Reorganization (reflected in the column “Reorganization Adjustments” in the second table of Note 2) and (ii) fair value adjustments as a result of the adoption of fresh start accounting (reflected in the column “Fresh Start Adjustments” in the second table of Note 2). Please refer to the section titled “Reorganization Items, net” in such note for a summary of the costs directly attributable to the implementation of the Plan of Reorganization. The disclosure provided in Note 2 – Fresh Start Accounting is incorporated herein by reference.
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Comparison of Quarters Ended September 30, 2016 and 2015
The amounts presented in this comparison section are rounded to the nearest thousand.
Revenue and Gross Profit
The following table presents the profitability of sales for the periods presented:
| Successor | Predecessor | |||||||
| Quarter ended September 30, 2016 | Quarter ended September 30, 2015 | |||||||
| Product sales | $ | 139,000 | $ | 1,633,000 | ||||
| License Fees | 101,000 | |||||||
| Royalties | 38,000 | 435,000 | ||||||
| Total revenues | 177,000 | 2,169,000 | ||||||
| Product cost of sales | 278,000 | 1,557,000 | ||||||
| License fees cost of sales | - | |||||||
| Royalties cost of sales | 43,000 | |||||||
| Total cost of sales | 278,000 | 1,600,000 | ||||||
| Gross profit | $ | (101,000 | ) | $ | 569,000 | |||
| Gross margin % | -57 | % | 26 | % | ||||
Revenues decreased $1,992,000 (92%) to $177,000 comparing the three months ended September 30, 2016 to the comparable period in 2015. This was primarily due to the absence of sales of Angel devices and disposables to Arthrex as Angel distributor and the absence of Angel-related royalties from Arthrex in the third quarter of 2016 as opposed to a full three months of Angel related revenues in the 2015 period.
Overall gross profit decreased $670,000 (118%) to ($101,000) while overall gross margin decreased to (57)% from 26%, comparing the three months ended September 30, 2016 to the comparable period in 2015. The negative gross profit resulted primarily from non-cash expenses relating to the amortization of intangible assets and prepaid royalty expense and depreciation expense on Aurix centrifuges of approximately $252,000 in 2016 resulting in a reduction in gross margin from what would have been 85% to (57)% for the period, as compared to a reduction in gross margin for the prior year quarter from what would have been 30% to 26% associated with approximately $91,000 of non-cash amortization expense relating to intangibles associated with Angel royalty revenue, product depreciation expense, and prepaid royalty expense. Quarterly amortization charges for the definite lived intangible assets resulting from the application of fresh start accounting as of the Effective Date and prepaid royalty expense is expected to be approximately $213,000.
Operating Expenses
Operating expenses decreased $26,073,000 (94%) to $1,755,000 comparing the three months ended September 30, 2016 to the three months ended September 30, 2015. The decrease was primarily due to the $23.7 million impairment of intangible assets and goodwill recognized in the prior year period. A discussion of the various other components of operating expenses follows below.
Sales and Marketing
Sales and marketing expenses decreased $1,251,000 (79%) to $332,000 comparing the three months ended September 30, 2016 to the prior year period. The decrease was due to lower compensation expense and a decrease in travel and entertainment expenses, professional service and marketing services, all due to the realignment initiated in the second half of 2015 and the commencement of the Company’s bankruptcy proceedings in January 2016.
Research and Development
Research and development expenses decreased $192,000 (37%) to $323,000 comparing the three months ended September 30, 2016 to the prior year period. The decrease was due to lower Aldagen related clinical trial costs as a result of the close out of the RECOVER-Stroke trial, and lower travel expenses which were partially offset by higher clinical costs associated with CED treatment sites.
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General and Administrative
General and administrative expenses decreased $889,000 (45%) to $1,100,000 comparing the three months ended September 30, 2016 to the prior year period. The decrease was primarily due to lower compensation expenses, decreased professional fees and lower services expense due to cost reduction initiatives.
Other Income (Expense)
Other income, net decreased $13,496,000 to $61,000 other expense, net comparing the three months ended September 30, 2016 to the prior year period. The change was primarily attributable to the absence of the approximately $14.4 million gain on change in fair value of derivative liabilities recognized in the third quarter of 2015, partially offset by the absence of the approximately $1.0 million of net interest expense also recognized in the prior year third quarter.
Comparison of the Nine Months Ended September 30, 2016 and 2015
The amounts presented in this comparison section are rounded to the nearest thousand.
Revenue and Gross Profit
The following table presents the profitability of sales for the periods presented:
| Successor | Predecessor | Combined | Predecessor | |||||||||||||
| Period from May 5, 2016 through September 30, 2016 | Period from January 1, 2016 through May 4, 2016 | Nine Months ended September 30, 2016 | Nine Months ended September 30, 2015 | |||||||||||||
| Product sales | $ | 248,000 | $ | 923,000 | $ | 1,171,000 | $ | 5,272,000 | ||||||||
| License Fees | - | 140,000 | 140,000 | 3,302,000 | ||||||||||||
| Royalties | 64,000 | 670,000 | 734,000 | 1,328,000 | ||||||||||||
| Total revenues | 312,000 | 1,733,000 | 2,045,000 | 9,902,000 | ||||||||||||
| Prodcut cost of sales | 453,000 | 829,000 | 1,282,000 | 5,177,000 | ||||||||||||
| License fees cost of sales | - | - | - | 1,500,000 | ||||||||||||
| Royalties cost of sales | - | 55,000 | 55,000 | 130,000 | ||||||||||||
| Total cost of sales | 453,000 | 884,000 | 1,337,000 | 6,807,000 | ||||||||||||
| Gross profit | $ | (141,000 | ) | $ | 849,000 | $ | 708,000 | $ | 3,095,000 | |||||||
| Gross margin % | -45 | % | 49 | % | 35 | % | 31 | % | ||||||||
Revenues decreased $7,857,000 (79%) to $2,045,000, comparing the nine months ended September 30, 2016 to the comparable period in 2015. This was primarily due to (1) the $3 million license revenue from Rohto recognized in the first nine months of 2015, (2) significantly decreased pass-through sales of Angel devices and disposables to Arthrex as Angel distributor for the period January 1, 2016 through May 5, 2016 (the date of the assignment of the Angel asset to Deerfield) and (3) royalties on Angel product sales from Arthrex for only four months during 2016 as opposed to a full nine months of royalties in the 2016 period.
Overall gross profit decreased $2,387,000 (77%) to $708,000 while overall gross margin increased to 35% from 31%, comparing the nine months ended September 30, 2016 to the comparable period in 2015. The increase in gross margin resulted primarily from a greater mix of royalty revenues as a share of total revenues in the first nine months of 2016 which have higher gross margins. The decline in gross profit was primarily attributable to the absence in 2016 of the $1.5 million gross profit resulting from the Rohto license agreement in the 2015 period plus an approximately $0.5 million decrease in royalty gross profits resulting from only four months of Angel royalties in the 2016 period. On a full year basis, the Aurix product line is expected to incur approximately $852,000 of non-cash amortization charges recorded as cost of sales due to the amortization of the intangible assets resulting from the application of fresh start accounting as of the Effective Date and prepaid royalty expense.
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Operating Expenses
Operating expenses decreased $31,646,000 (83%) to $6,515,000 comparing the nine months ended September 30, 2016 to the nine months ended September 30, 2015. The decrease was primarily due to the $23.7 million impairment of intangible assets and goodwill recognized in the prior year period. A discussion of the various other components of operating expenses follows below.
Sales and Marketing
Sales and marketing decreased $3,785,000 (73%) to $1,403,000 comparing the nine months ended September 30, 2016 to the prior year period. The decrease was due to lower compensation expense and a decrease in all associated sales and marketing expenses, all due to the realignment initiated in the second half of 2015 and the commencement of the Company’s bankruptcy proceedings in January 2016.
Research and Development
Research and development expenses decreased $745,000 (40%) to $1,102,000 comparing the nine months ended September 30, 2016 to the prior year period. The decrease was due to lower compensation expense related to the realignment of the Company started in the second half of 2015 and the absence of significant Aldagen related clinical trial costs in the current year period as a result of the close out of the trial in the summer of 2015.
General and Administrative
General and administrative expenses decreased $3,375,000 (46%) to $4,010,000 comparing the nine months ended September 30, 2016 to the prior year period. The decrease was primarily due to lower compensation expenses and a reduction in all general and administrative expenses due to the realignment initiated in the second half of 2015 and the bankruptcy reorganization beginning in January 2016.
Other Income (Expense)
Other income, net increased $6,282,000 (26%) to $30,771,000 comparing the nine months ended September 30, 2016 to the prior year period. The change was primarily attributable to the approximately $30.9 million gain on reorganization and a decrease of approximately $2.5 million in net interest expense partially offset by the absence in 2016 of the approximately $27.2 million gain on change in fair value of derivative liabilities recognized in the nine months ended September 30, 2015.
Liquidity and Capital Resources
We have a history of losses, are not currently profitable, and expect to incur losses and negative operating cash flows in the future. Our revenues have declined from approximately $9.9 million for the nine months ended September 30, 2015 to approximately $2.0 million for the nine months ended September 30, 2016. Our only current significant source of revenues is our Aurix product. We may never generate sufficient revenues to achieve and maintain profitability. For the period from January 1, 2016 through May 4, 2016, and for the period from May 5, 2016 through September 30, 2016, we incurred net losses from operations of approximately $2.8 million and $3.0 million, respectively. As a result of the application of fresh start accounting as of May 5, 2016, or the Effective Date, on such date our retained earnings (deficit) was zero and our total stockholders’ equity was approximately $17.9 million.
At September 30, 2016, we had cash and cash equivalents of approximately $3.9 million, total current assets of approximately $5.6 million and total current liabilities of approximately $1.7 million, compared to cash and cash equivalents of approximately $6.1 million, total current assets of approximately $8.1 million, and total current liabilities of approximately $2.6 million at June 30, 2016. Our operations are subject to certain risks and uncertainties including those described in “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015.
We estimate that our current resources, expected revenue from sales of Aurix, including additional revenue expected to be generated from our Restorix collaboration and limited royalty from our license of certain aspects of the ALDH technology to StemCell Technologies for the Aldeflour product line, combined with the $3.0 million Backstop Commitment (which is not available to us until June 30, 2017), will be adequate to maintain our operations through at least the end of 2017. However, if we are unable to increase our revenues as much as expected or control our costs as effectively as expected, then we may be required to curtail portions of our strategic plan or to cease operations. The Backstop Commitment is, by its terms, only available to us on or after June 30, 2017, and terminates upon the occurrence of certain events. Any issuances of shares under the Backstop Commitment will occur at an average share price of $0.2344, which will likely cause substantial dilution for our existing stockholders.
Historically, we have financed our operations through a combination of the sale of debt, equity and equity-linked securities, licensing, royalty, and product revenues. As disclosed in “- Comparison of the Nine Months Ended September 30, 2016 and 2015” and “- The Aurix System” above, in the first quarter 2015, we received from Rohto an upfront payment of $3.0 million as part of our licensing arrangement with Rohto, and we paid a one-time, non-refundable fee of $1.5 million to Millennia upon our receipt of the $3.0 million payment.
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On August 11, 2015, our Board of Directors approved a realignment plan with the goal of preserving and maximizing, for the benefit of our stockholders, the value of our existing assets. The plan eliminated approximately 30% of our workforce and was aimed at the preservation of cash and cash equivalents to finance our future operations and support our revised business objectives. In addition, on December 4, 2015, the Company eliminated an additional 22% of its workforce, or seven employees, and in January 2016, the Company eliminated four additional employees. We recognized and paid cumulative severance costs to executives and non-executives in connection with the realignment plan of approximately $1.1 million through September 30, 2016.
On January 26, 2016, we filed a voluntary petition in the United States Bankruptcy Court for the District of Delaware seeking relief under Chapter 11 the Bankruptcy Code. During the pendency of the Chapter 11 Case, we continued to operate our business with funding under the DIP Loans as a “debtor-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. On January 28, 2016, the Bankruptcy Court entered an order approving our interim DIP Financing pursuant to terms set forth in a senior secured, superpriority DIP Credit Agreement by and among the Company, as borrower, each lender from time to time party to the DIP Credit Agreement, including, but not limited to the Deerfield Lenders and the DIP Agent. The Deerfield Lenders comprised 100% of the lenders under the Deerfield Facility Agreement. The final DIP Credit Agreement provided for senior secured loans in the aggregate principal amount of up to $6 million in post-petition financing, of which $5.75 million was outstanding as of May 4, 2016.
In addition, at May 4, 2016 we had total debt outstanding under the Deerfield Facility Agreement of approximately $38.3 million, including accrued interest.
In accordance with the Plan of Reorganization, as of the Effective Date, the DIP Credit Agreement was terminated and the obligations of the Company under the Deerfield Facility Agreement were cancelled and the Company ceased to have any obligations thereunder. We had no outstanding debt as of September 30, 2016.
In accordance with the Plan of Reorganization, as of the Effective Date, the Company issued 7,500,000 shares of New Common Stock to certain accredited investors in the Recapitalization Financing for net cash proceeds to the Company of $7,052,500. The net cash amount excludes the effect of $100,000 in offering expenses paid from the proceeds of the DIP Financing, which was converted into Series A Preferred Stock as of the Effective Date. As part of the Recapitalization Financing, the Company also issued Warrants to purchase 6,180,000 shares of New Common Stock to certain of the Recapitalization Investors.
Under the Plan of Reorganization, the Company issued 29,038 shares of Series A Preferred Stock to the Deerfield Lenders. The Series A Preferred Stock has no stated maturity date, is not convertible or redeemable and carries a liquidation preference of $29,038,000, which is required to be paid to holders of such Series A Preferred Stock before any payments are made with respect to shares of New Common Stock (and other capital stock that is not issued on parity or senior to the Series A Preferred Stock) upon a liquidation or change in control transaction. For so long as Series A Preferred Stock is outstanding, the holders of Series A Preferred Stock have the right to nominate and elect one member of the Board of Directors and to have such director serve on a standing committee of the Board of Directors established to exercise powers of the Board of Directors in respect of decisions or actions relating to the Backstop Commitment. Lawrence Atinsky serves as the designee of the holders of Series A Preferred Stock, which are all currently affiliates of Deerfield Management Company, L.P., of which Mr. Atinsky is a Partner. The Series A Preferred Stock have voting rights, voting with the New Common Stock as a single class, representing approximately one percent (1%) of the voting rights of the capital stock of the Company, and the holders of Series A Preferred Stock have the right to approve certain transactions. For so long as the Backstop Commitment remains in effect, a majority of the members of the standing backstop committee of the Board of Directors may approve a drawdown under the Backstop Commitment. Among other restrictions, the Certificate of Designations for our Series A Preferred Stock limits the Company’s ability to (i) issue securities that are senior or pari passu with the Series A Preferred Stock, (ii) incur debt other than for working capital purposes not in excess of $3.0 million, (iii) issue securities that are junior to the Series A Preferred Stock and that provide certain consent rights to the holders of such junior securities in connection with a liquidation or contain certain liquidation preferences, (iv) pay dividends on or purchase shares of its capital stock, and (v) change the authorized number of members of its Board of Directors to a number other than five, in each case without the consent of holders representing at least two-thirds of the outstanding shares Series A Preferred Stock.
As a result of the assignment to Deerfield of our rights, title and interest in and to the Arthrex Agreement pursuant to the Plan of Reorganization, the related transfer and assignment of associated intellectual property previously owned by us and licensed under the Arthrex Agreement, as well as rights to collect royalty payments thereunder, we no longer receive royalties from the Angel product line for periods after May 5, 2016, but we continue to incur modest net expenses under the Transition Services Agreement with Deerfield.
If we are unable to generate sufficient revenues or raise additional funds, we may be forced to delay the completion of, or significantly reduce the scope of, our current business plan; delay some of our development and clinical or marketing efforts; delay our plans to penetrate the market serving Medicare beneficiaries and fulfill the related data gathering requirements as stipulated by the Medicare CED coverage determination; delay the pursuit of commercial insurance reimbursement for our wound treatment technologies; or postpone the hiring of new personnel; or, under certain dire financial circumstances, cease our operations. Specific programs that may require additional funding include, without limitation, continued investment in the sales, marketing, distribution, and customer service areas, expansion into the international markets, significant new product development or modifications, and pursuit of other opportunities.
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Any equity financings may cause substantial dilution to our shareholders and could involve the issuance of securities with rights senior to the New Common Stock. Any allowed debt financings may require us to comply with onerous financial covenants and restrict our business operations. Our ability to complete additional financings is dependent on, among other things, the state of the capital markets at the time of any proposed offering, market reception of the Company and the likelihood of the success of our business model, of the offering terms, etc. We may not be able to obtain any such additional capital as we need to finance our efforts, through asset sales, equity or debt financing, or any combination thereof, on satisfactory terms or at all. Additionally, any such financing, if at all obtained, may not be adequate to meet our capital needs and to support our operations. If adequate capital cannot be obtained on a timely basis and on satisfactory terms, our revenues and operations and the value of our New Common Stock and common stock equivalents would be materially negatively impacted and we may be forced to curtail or cease our operations.
The Company will continue to opportunistically pursue exploratory conversations with companies regarding their interest in our products and technologies. We will seek to leverage these relationships if and when they materialize to secure non-dilutive sources of funding if practicable. There is no assurance that we will be able to secure such relationships or, even if we do, that the terms will be favorable to us.
We cannot assure you that we have accurately estimated the cash and cash equivalents necessary to finance our operations. If revenues are less than we anticipate, if operating expenses exceed our expectations or cannot be adjusted accordingly, and/or we cannot obtain financing on acceptable terms or at all, then our business, results of operations, financial condition and cash flows will be materially and adversely affected.
Cash Flows
Net cash provided by (used in) operating, investing, and financing activities for the periods presented were as follows (in millions):
| Successor | Predecessor | Combined | Predecessor | |||||||||||||
| Period from May 5, 2016 through September 30, 2016 | Period from January 1, 2016 through May 4, 2016 | Nine Months ended September 30, 2016 | Nine Months ended September 30, 2015 | |||||||||||||
| Cash flows used in operating activities | $ | (6.5 | ) | $ | (3.1 | ) | $ | (9.6 | ) | $ | (11.7 | ) | ||||
| Cash flows used in investing activities | $ | - | $ | - | $ | - | $ | (0.2 | ) | |||||||
| Cash flow provided by financing activities | $ | - | $ | 12.5 | $ | 12.5 | $ | - | ||||||||
Operating Activities
Cash used in operating activities for the nine months ended September 30, 2016 of $9.6 million primarily reflects our net income of $25.0 million adjusted by the approximately $34.8 million non-cash gain on reorganization and a net decrease in operating assets and liabilities of approximately $0.8 million and partially offset by (i) approximately $0.8 million of depreciation and amortization expense and (ii) approximately $0.3 million of non-cash DIP Financing debt issuance costs.
Cash used in operating activities for the nine months ended September 30, 2015 of $11.7 million primarily reflects our net loss of $10.6 million adjusted by a (i) $27.2 million decrease for changes in derivative liabilities resulting from a change in their fair value, (ii) $23.7 increase for impairment charge for intangible assets and goodwill, (iii) $1.2 million increase for amortization of deferred costs and debt discount relating to debt issuances, (iv) $0.7 million increase for stock-based compensation, and (v) $0.5 million increase for depreciation and amortization.
Investing Activities
We did not have any investing activities for the nine months ended September 30, 2016.
Cash used in investing activities for the nine months ended September 30, 2015 primarily reflects software implementation costs for our CED protocols and the purchase of Angel centrifuge devices for research and development use.
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Financing Activities
Cash provided by financing activities for the nine months ended September 30, 2016 of approximately $12.5 million consisted of approximately $5.5 million, net of issuance costs, of DIP Financing provided by Deerfield and net cash of approximately $7.1 million from the Recapitalization Financing. The total amount outstanding under the DIP Credit Agreement as of May 4, 2016 was $5.75 million excluding approximately $0.3 million of debt issuance costs. The DIP Credit Agreement and Deerfield Facility Agreement were terminated and cancelled, respectively, as the Effective Date of May 5, 2016.
We did not have any financing activities for the nine months ended September 30, 2015.
Inflation
The Company believes that the rates of inflation in recent years have not had a significant impact on its operations.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements.
Critical Accounting Policies
A “critical accounting policy” is one that is both important to the portrayal of our financial condition and results of operations and that requires management’s most difficult, subjective or complex judgments. Such judgments are often the result of a need to make estimates about the effect of matters that are inherently uncertain. We have identified the following accounting policies as critical to the successor company.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires us 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 amount of revenues and expenses during the reporting period. In the accompanying condensed consolidated financial statements, estimates are used for, but not limited to, stock-based compensation, allowance for inventory obsolescence, allowance for doubtful accounts, valuation of derivative liabilities, contingent liabilities, fair value and depreciable lives of long-lived assets (including property and equipment, intangible assets and goodwill), deferred taxes and associated valuation allowance and the classification of our long-term debt. Actual results could differ from those estimates.
Successor Company Intangible Assets and Goodwill
Our definite-lived intangible assets include trademarks, technology (including patents), customer and clinician relationships, and are amortized over their useful lives and reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If any indicators were present, we test for recoverability by comparing the carrying amount of the asset to the net undiscounted cash flows expected to be generated from the asset. If those net undiscounted cash flows do not exceed the carrying amount (i.e., the asset is not recoverable), we would perform the next step, which is to determine the fair value of the asset and record an impairment loss, if any. We periodically reevaluate the useful lives for these intangible assets to determine whether events and circumstances warrant a revision in their remaining useful lives.
Goodwill represents the excess of reorganization value over the fair value of tangible and identifiable intangible assets and the fair value of liabilities as of the Effective Date. Goodwill is not amortized, but is subject to periodic review for impairment. Goodwill is reviewed annually, as of October 1, and whenever events or changes in circumstances indicate that the carrying amount of the goodwill might not be recoverable. We perform our review of goodwill on our one reporting unit.
Before employing detailed impairment testing methodologies, we first evaluate the likelihood of impairment by considering qualitative factors relevant to our reporting unit. When performing the qualitative assessment, we evaluate events and circumstances that would affect the significant inputs used to determine the fair value of the goodwill. Events and circumstances evaluated include: macroeconomic conditions that could affect us, industry and market considerations for the medical device industry that could affect us, cost factors that could affect our performance, our financial performance (including share price), and consideration of any company specific events that could negatively affect us, our business, or the fair value of our business. If we determine that it is more likely than not that goodwill is impaired, we will then apply detailed testing methodologies. Otherwise, we will conclude that no impairment has occurred.
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Detailed impairment testing involves comparing the fair value of our one reporting unit to its carrying value, including goodwill. If the fair value exceeds carrying value, then it is concluded that no goodwill impairment has occurred. If the carrying value of the reporting unit exceeds its fair value, a second step is required to measure possible goodwill impairment loss. The second step includes hypothetically valuing the tangible and intangible assets and liabilities of our one reporting unit as if it had been acquired in a business combination. The implied fair value of our one reporting unit's goodwill then is compared to the carrying value of that goodwill. If the carrying value of our one reporting unit's goodwill exceeds the implied fair value of the goodwill, we recognize an impairment loss in an amount equal to the excess, not to exceed the carrying value.
Successor Company Revenue Recognition
We recognize revenue when the four basic criteria for recognition are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) consideration is fixed or determinable; and (4) collectability is reasonably assured.
We provide for the sale of our products, including disposable processing sets and supplies to customers. Revenue from the sale of products is recognized upon shipment of products to the customers. We do not maintain a reserve for returned products as in the past those returns have not been material and are not expected to be material in the future.
Percentage-based fees on licensee sales of covered products are generally recorded as products are sold by licensees and are reflected as royalties in the condensed consolidated statements of operations. Direct costs associated with product sales and royalty revenues are recorded at the time that revenue is recognized.
Fair Value Measurements
Our condensed consolidated balance sheets include certain financial instruments that are carried at fair value. Fair value is the price that would be received from the sale of an asset or paid to transfer a liability assuming an orderly transaction in the most advantageous market at the measurement date. U.S. GAAP establishes a hierarchical disclosure framework which prioritizes and ranks the level of observability of inputs used in measuring fair value. These tiers include:
| · | Level 1, defined as observable inputs such as quoted prices in active markets for identical assets; |
| · | Level 2, defined as observable inputs other than Level 1 prices such as quoted prices for similar assets; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and |
| · | Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. |
An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. At each reporting period, we perform a detailed analysis of our assets and liabilities that are measured at fair value. All assets and liabilities for which the fair value measurement is based on significant unobservable inputs or instruments which trade infrequently and therefore have little or no price transparency are classified as Level 3.
The Successor Company’s property and equipment and intangible assets are measured at fair value on a non-recurring basis, upon establishment pursuant to fresh start accounting, and upon impairment. The Successor Company determined the fair value of its intangibles assets as of the Effective Date as follows:
| Identifiable Intangible Asset | Valuation Method | Significant Unobservable Inputs | Estimated Fair Value | |||||
| Trademarks | Income approach - royalty savings method | Projected sales | $ | 917,000 | ||||
| Estimated royalty rates | ||||||||
| Discount rate | ||||||||
| Technology | Income approach - royalty savings method | Projected sales | $ | 6,576,000 | ||||
| Estimated royalty rates | ||||||||
| Discount rate | ||||||||
| Clinician Relationships | Income approach - excess earnings method | Projected sales | $ | 904,000 | ||||
| Estimated attrition | ||||||||
| Projected margins | ||||||||
| Discount rate | ||||||||
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Unadopted Accounting Pronouncements
In May 2014, the FASB issued guidance for revenue recognition for contracts, superseding the previous revenue recognition requirements, along with most existing industry-specific guidance. The guidance requires an entity to review contracts in five steps: 1) identify the contract, 2) identify performance obligations, 3) determine the transaction price, 4) allocate the transaction price, and 5) recognize revenue. The new standard will result in enhanced disclosures regarding the nature, amount, timing, and uncertainty of revenue arising from contracts with customers. In August 2015, the FASB issued guidance approving a one-year deferral, making the standard effective for reporting periods beginning after December 15, 2017, with early adoption permitted only for reporting periods beginning after December 15, 2016. In March 2016, the FASB issued guidance to clarify the implementation guidance on principal versus agent considerations for reporting revenue gross rather than net, with the same deferred effective date. In April 2016, the FASB issued guidance to clarify the implementation guidance on identifying performance obligations and the accounting for licenses of intellectual property, with the same deferred effective date. In May 2016, the FASB issued guidance rescinding SEC paragraphs related to revenue recognition, pursuant to two SEC Staff Announcements at the March 3, 2016 Emerging Issues Task Force meeting. In May 2016, the FASB also issued guidance to clarify the implementation guidance on assessing collectability, presentation of sales tax, noncash consideration, and contracts and contract modifications at transition, with the same effective date. We are currently evaluating the impact, if any, that this guidance will have on our consolidated financial statements.
In August 2014, the FASB issued guidance for the disclosure of uncertainties about an entity’s ability to continue as a going concern. Under U.S. GAAP, continuation of a reporting entity as a going concern is presumed as the basis for preparing financial statements unless and until the entity’s liquidation becomes imminent. Preparation of financial statements under this presumption is commonly referred to as the going concern basis of accounting. Previously, there was no guidance in U.S. GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern or to provide related footnote disclosures. This was issued to provide guidance in U.S. GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. In doing so, the amendments should reduce diversity in the timing and content of footnote disclosures. The amendments in this update are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early application is permitted. We are currently evaluating the impact, if any, that the adoption will have on our consolidated financial statements.
In July 2015, the FASB issued guidance for the accounting for inventory. The main provisions are that an entity should measure inventory within the scope of this update at the lower of cost and net realizable value, except when inventory is measured using LIFO or the retail inventory method. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. In addition, the Board has amended some of the other guidance in Topic 330 to more clearly articulate the requirements for the measurement and disclosure of inventory. The amendments in this update for public business entities are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The amendments in this update should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. We are currently evaluating the impact, if any, that the adoption will have on our consolidated financial statements.
In November 2015, the FASB issued accounting guidance to simplify the presentation of deferred taxes. Previously, U.S. GAAP required an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts. Under this guidance, deferred tax liabilities and assets will be classified as noncurrent amounts. The standard is effective for reporting periods beginning after December 15, 2016. The Company is currently evaluating the impact, if any, that this new accounting pronouncement will have on its consolidated financial statements.
In February 2016, the FASB issued guidance for accounting for leases. The guidance requires lessees to recognize assets and liabilities related to long-term leases on the balance sheet and expands disclosure requirements regarding leasing arrangements. The guidance is effective for reporting periods beginning after December 15, 2018 and early adoption is permitted. The guidance must be adopted on a modified retrospective basis and provides for certain practical expedients. We are currently evaluating the impact that this guidance will have on our consolidated financial statements.
In March 2016, the FASB issued guidance simplifying the accounting for and financial statement disclosure of stock-based compensation awards. Under the guidance, all excess tax benefits and tax deficiencies related to stock-based compensation awards are to be recognized as income tax expenses or benefits in the income statement and excess tax benefits should be classified along with other income tax cash flows in the operating activities section of the statement of cash flows. Under the guidance, companies can also elect to either estimate the number of awards that are expected to vest or account for forfeitures as they occur. In addition, the guidance amends some of the other stock-based compensation awards guidance to more clearly articulate the requirements and cash flow presentation for withholding shares for tax-withholding purposes. The guidance is effective for reporting periods beginning after December 15, 2016 and early adoption is permitted, though all amendments of the guidance must be adopted in the same period. The adoption of certain amendments of the guidance must be applied prospectively, and adoption of the remaining amendments must be applied either on a modified retrospective basis or retrospectively to all periods presented. We are currently evaluating the impact that this guidance will have on our consolidated financial statements.
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In March 2016, the FASB issued guidance to clarify the requirements for assessing whether contingent call or put options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. The amendments of this guidance are effective for reporting periods beginning after December 15, 2016, and early adoption is permitted. Entities are required to apply the guidance to existing debt instruments using a modified retrospective transition method as of beginning of the fiscal year of adoption. We are currently evaluating the impact that this guidance will have on our consolidated financial statements.
In June 2016, the FASB issued a new standard to replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. For trade and other receivables, loans, and other financial instruments, we will be required to use a forward-looking expected loss model rather than the incurred loss model for recognizing credit losses which reflects losses that are probable. Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. The new standard will be effective for us beginning July 1, 2020, with early adoption permitted beginning July 1, 2019. Application of the amendments is through a cumulative-effect adjustment to retained earnings as of the effective date. We are currently evaluating the impact that this guidance will have on our consolidated financial statements.
We have evaluated all other issued and unadopted Accounting Standards Updates and believe the adoption of these standards will not have a material impact on our results of operations, financial position, or cash flows.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
During the pendency of its Chapter 11 case and following the date of the Company’s emergence from bankruptcy on May 5, 2016, in addition to their regular financial reporting duties, the Company’s management team and finance and accounting personnel were required to devote significant time and attention to matters relating to and on the preparation of materials required in connection with the Chapter 11 case and the Plan of Reorganization, including monthly reports which the Company filed under cover of Current Reports on Form 8-K. As a result, the Company was unable to file its Annual Report and its Quarterly Reports on Form 10-Q for the periods ended March 31, 2016 and June 30, 2016 within the prescribed time periods because of the limitations on staffing, the Company’s limited financial resources and the significant additional burdens that the Chapter 11 case imposed on the Company’s available human and financial resources. Such inability could not have been eliminated by the Company without unreasonable effort or expense. Following its emergence from bankruptcy on May 5, 2016, the Company commenced the process of preparing the above mentioned periodic reports.
As of the end of the period covered by this Quarterly Report, under the supervision and with the participation of management, including the Chief Executive Officer who is also our Chief Financial Officer (the “Certifying Officer”), the Company conducted an evaluation of its disclosure controls and procedures. As defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, the term “disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including the Certifying Officer, to allow timely decisions regarding required disclosure. Based on this evaluation, our Certifying Officer has concluded that, as of September 30, 2016, our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
There have not been any changes in our internal control over financial reporting during the quarter ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II
OTHER INFORMATION
The Company filed its Chapter 11 Case on January 26, 2016 and emerged from bankruptcy on May 5, 2016. Please see the description of the Company’s Chapter 11 Case contained in “Part I - Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Bankruptcy and Emergence from Bankruptcy”, which is incorporated herein by reference. Other than the Chapter 11 Case, the Company has not been party to, and its property has not been the subject of, any material legal proceedings required to be disclosed herein.
Not Applicable.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Not applicable.
The exhibits listed in the accompanying Exhibit Index are furnished as part of this Report.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| NUO THERAPEUTICS, INC. | |
| Date: November 14, 2016 | By: |
| /s/ David E. Jorden | |
|
David E. Jorden, Chief Executive Officer and Chief Financial Officer | |
| (Principal Executive Officer and Principal Financial Officer) |
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| Exhibit Number | Description | |
| 10.1 | 2016 Omnibus Incentive Compensation Plan, as amended and restated (subject to approval by the Company’s stockholders) (previously filed on October 24, 2016 as Exhibit 10.3 to the Annual Report on Form 10-K and incorporated by reference herein).* | |
| 10.2 | Form of Incentive Stock Option Grant Agreement under 2016 Omnibus Incentive Compensation Plan (Plan subject to approval by the Company’s stockholders).* | |
| 10.3 | Form of Non-Qualified Stock Option Grant Agreement under 2016 Omnibus Incentive Compensation Plan (Plan subject to approval by the Company’s stockholders).* | |
| 31 | Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
| 32 | Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 101 | The following materials from Nuo Therapeutics, Inc. Form 10-Q for the quarter ended September 30, 2016, formatted in Extensible Business Reporting Language (XBRL): (i) Condensed Consolidated Balance Sheets at September 30, 2016 and December 31, 2015, (ii) Condensed Consolidated Statements of Operations for the period from January 1, 2016 through May 4, 2016; from May 5, 2016 through September 30, 2016; the three months ended September 30, 2016; and for the nine and three month periods ended September 30, 2015, (iii) Condensed Consolidated Statements of Cash Flows for the period from January 1, 2016 through May 4, 2016, from May 5, 2016 through September 30, 2016 and for the nine months ended September 30, 2015, (iv) Condensed Consolidated Statements of Changes in Stockholders Equity (Deficit) for the period January 1, 2015 through September 30, 2016 and (v) Notes to the Unaudited Condensed Consolidated Financial Statements. |
| * | Indicates a management contract or compensatory plan or arrangement. |
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