UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 30, 2015

OR

For the transition period from              to             

Commission File Number: 001-36419

 

TRIVASCULAR TECHNOLOGIES, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

3910 Brickway Blvd.

Santa Rosa, CA 95403

(Address of principal executive offices)

(707) 573-8800

(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  x    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  x    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.

 

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

As of October 31, 2015, the registrant had 20,571,028 shares of common stock, $0.01 par value per share, outstanding.

 

 

 

 

 

 

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TABLE OF CONTENTS

 

 

 

 

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Part 1 Financial Information

 

Item 1.  CONSOLIDATED FINANCIAL STATEMENTS

TRIVASCULAR TECHNOLOGIES, INC.

Consolidated Balance Sheets

(unaudited)

(in thousands, except par value)

 

 

The accompanying notes are an integral part of these consolidated financial statements.

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TRIVASCULAR TECHNOLOGIES, INC.

Consolidated Statements of Comprehensive Loss

(unaudited)

(in thousands, except per share data)

 

 

The accompanying notes are an integral part of these consolidated financial statements.

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TRIVASCULAR TECHNOLOGIES, INC.

Consolidated Statements of Cash Flows

(unaudited)

(in thousands)

 

The accompanying notes are an integral part of these consolidated financial statements.

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TRIVASCULAR TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

TriVascular Technologies, Inc. (the “Company”) was incorporated in the state of Delaware in July 2007 and began operations on March 28, 2008. The Company is a medical device company developing and commercializing innovative technologies to significantly advance minimally invasive treatment of abdominal aortic aneurysms (“AAA”). The Ovation® System, the Company’s solution for the treatment of AAA through minimally invasive endovascular aortic repair (“EVAR”), is a new stent graft platform, providing an innovative and effective alternative to conventional devices. It is designed specifically to address many of the limitations associated with conventional EVAR devices and expand the pool of patients eligible for EVAR. The Company received CE Mark clearance in August 2010 and began commercial sales of its Ovation System in Europe in September 2010. In October 2012, the Company received approval from the U.S. Food and Drug Administration (“FDA”) for the Ovation System for the treatment of AAA and began commercial sales in the United States in November 2012.

As a medical device company with little commercial operating history, the Company is subject to all of the risks and expenses associated with a growing company. The Company must, among other things, respond to competitive developments, attract, retain and motivate qualified personnel, and support the expense of developing and marketing new products based on innovative technology. In the course of its development activities, the Company has sustained significant operating losses. Even if development and marketing efforts are successful, substantial time may pass before significant revenues will be realized, and during this period, the Company will require additional funds, the availability of which cannot be reasonably assured.

 

 

Basis of Presentation

The accompanying Consolidated Financial Statements in this Quarterly Report on Form 10-Q have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) and with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). These financial statements include the financial position, results of operations, and cash flows of the Company, including its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation.

The interim financial data as of September 30, 2015, is unaudited and is not necessarily indicative of the results for a full year or any interim period. In the opinion of the Company’s management, the interim data includes all normal and recurring adjustments necessary for a fair statement of the Company’s financial results for the three and nine months ended September 30, 2015. The December 31, 2014 consolidated balance sheet data was derived from audited financial statements. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to SEC rules and regulations relating to interim financial statements.

The accompanying Consolidated Financial Statements should be read in conjunction with the Company’s audited Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, filed with the SEC on March 9, 2015.

On April 22, 2014, the Company completed its initial public offering (“IPO”) of 7,475,000 shares of common stock, which included the exercise in full by the underwriters in the offering of their option to purchase 975,000 additional shares of common stock, at an offering price of $12.00 per share. The Company received net proceeds of approximately $81.1 million, after deducting underwriting discounts and commissions and offering expenses. In connection with the IPO, the Company’s outstanding shares of convertible preferred stock were automatically converted into 11,601,860 shares of common stock and warrants exercisable for convertible preferred stock were automatically converted into warrants exercisable for 192,472 shares of common stock, resulting in the reclassification of the related redeemable convertible preferred stock warrant liability of $0.6 million to additional paid-in capital.

Use of estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates and such differences could be material.

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Segment Information

The Company considers operating segments to be components of the Company in which separate financial information is available that is evaluated regularly by the Company’s chief operating decision maker in deciding how to allocate resources and in assessing performance. The chief operating decision maker for the Company is the Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis, accompanied by information about revenue by geographic region, for purposes of allocating resources and evaluating financial performance. The Company has one business activity and there are no segment managers who are held accountable for operations, operating results or plans for levels or components below the consolidated unit level. Accordingly, the Company has determined that it has a single reportable and operating segment structure. The Company and its Chief Executive Officer evaluate performance based primarily on revenue in the geographic locations in which the Company operates.

Revenues by geography are based on the billing address of the customer. The following table sets forth revenue by geographic area (in thousands):

 

 

The U.S. is the only country with revenues accounting for more than 10% of the Company’s total revenues. For the three months ended September 30, 2015 and 2014, revenues in the U.S. represented 68% for both periods, while in the nine months ended September 30, 2015 and 2014, revenues in the U.S. represented 70% and 67%, respectively.

Long-lived assets and operating income outside the U.S. are not material; therefore disclosures have been limited to revenue.

Cash and Cash Equivalents

Cash and cash equivalents consist of demand deposit accounts held in U.S. and foreign banks and U.S. money market funds. Cash equivalents consist of highly liquid investment securities with original maturities at the date of purchase of three months or less and can be exchanged for a known amount of cash.

Investments

At September 30, 2015, the Company’s investments consisted of investments with maturities of longer than 90 days from the date of purchase but less than a year based on expected maturity dates. They are classified as available for sale as the Company can liquidate its securities as needed, and changes in fair value between accounting periods are included in accumulated other comprehensive loss on the consolidated balance sheet until the securities are sold or mature. Discounts or premiums are amortized to interest income and other expense, net using the interest method.

Accounts Receivable

Trade accounts receivable are recorded at the invoice amount and do not include interest. The Company regularly reviews accounts for collectability and establishes an allowance for probable credit losses and writes off uncollectible accounts as necessary. The Company recorded an allowance of doubtful accounts of $137,000 and $72,000 at September 30, 2015 and December 31, 2014, respectively.

Inventories

The Company values inventory at the lower of cost to purchase or manufacture the inventory or the market value for such inventory. Cost is determined using the standard cost method which approximates the first-in first-out method. The Company regularly reviews inventory quantities in consideration of actual loss experiences, projected future demand, and remaining shelf life to record a provision for excess and obsolete inventory when appropriate.

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Property and Equipment

Property and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets.

The depreciation and amortization periods for the Company’s property and equipment are as follows:

 

 

Leasehold improvements are amortized over the lesser of their useful lives or the remaining life of the lease. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation and amortization are removed from the consolidated balance sheet and the resulting gain or loss is reflected in operations in the period realized. Cost of maintenance and repairs are charged to expense as incurred, and improvements and betterments are capitalized.

Goodwill and Indefinite Lived Intangible Assets

The Company has recorded goodwill and intangible assets on the consolidated balance sheets. The Company classifies intangible assets into three categories: (1) goodwill; (2) intangible assets with indefinite lives not subject to amortization; and (3) intangible assets with definite lives subject to amortization.

Goodwill and intangible assets with indefinite lives are not amortized. The Company assesses goodwill and intangible assets with indefinite lives for impairment on an annual basis in the fourth quarter of each year or more frequently if indicators of impairment exist. For the purpose of testing goodwill for impairment, the Company has determined that it has one reporting unit.

Convertible Preferred Stock Warrant Liability

Freestanding warrants related to convertible preferred stock shares that are contingently redeemable were classified as a liability on the Company’s consolidated balance sheet at December 31, 2013. The convertible preferred stock warrants were subject to re-measurement at each balance sheet date, and any change in fair value was recognized as a component of interest income and other expense, net. The Company continued to adjust the liability for changes in fair value until the completion of the IPO in April 2014, at which time all redeemable convertible preferred stock warrants were converted into warrants to purchase common stock and the liability was reclassified to additional paid-in capital.  See Note 5.

Revenue

The Company recognizes revenue when all of the following criteria are met:

For sales directly to hospitals or medical facilities, the Company recognizes revenue upon completion of a procedure, which is when the product is implanted in a patient, and a valid purchase order has been received. For distributor sales, the Company recognizes revenue at the time of shipment of product, as this represents the point that the customer has taken ownership and assumed risk of loss. The Company does not offer rights of return or price protection and has no post-delivery obligations. The Company offers rights of exchange in limited circumstances for products with a short shelf life at the time of shipment, and has established a $0.1 million reserve for such exchanges included in accrued liabilities and other on the consolidated balance sheets at September 30, 2015 and December 31, 2014.

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Income Taxes

The Company records income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s consolidated financial statements or income tax returns. In estimating future tax consequences, expected future events other than enactments or changes in the tax law or rates are considered. Valuation allowances are provided when necessary to reduce deferred tax assets to the amount expected to be realized.

The Company operates in various tax jurisdictions and is subject to audit by various tax authorities. The Company provides for tax contingencies whenever it is deemed probable that a tax asset has been impaired or a tax liability has been incurred for events such as tax claims or changes in tax laws. Tax contingencies are based upon their technical merits, relative tax law, and the specific facts and circumstances as of each reporting period. Changes in facts and circumstances could result in material changes to the amounts recorded for such tax contingencies.

The Company records uncertain tax positions on the basis of a two-step process whereby (1) a determination is made as to whether it is more likely than not that the tax positions will be sustained based on the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold the Company recognizes the largest amount of tax benefit that is greater than 50% likely to be realized upon ultimate settlement with the related tax authority.

Other Comprehensive Loss

Other comprehensive loss represents all changes in stockholders’ equity except those resulting from investments or contributions by stockholders. The Company’s other comprehensive loss consists of its net loss and changes in accumulated other comprehensive loss, which represents unrealized gains on investments and foreign currency translation adjustments.

Currency Translation

The Euro is the functional currency of the Company’s wholly-owned subsidiaries in Italy and Germany, the Swiss Franc is the functional currency of the Company’s wholly-owned subsidiary in Switzerland and the Canadian Dollar is the functional currency of the Company’s wholly-owned subsidiary in Canada. Accordingly, the assets and liabilities of these subsidiaries are translated into United States dollars using the current exchange rate in effect at the balance sheet date and equity accounts are translated into United States dollars using historical rates. Revenues and expenses are translated using the average exchanges rates in effect when the transactions occur. Foreign currency translation adjustments are recorded within accumulated other comprehensive loss, a separate component of stockholders’ equity, on the consolidated balance sheets. Foreign exchange transaction gains and losses have not been material to the Company’s consolidated financial statements for all periods presented.

Stock-Based Compensation

The Company’s determination of the fair value of stock options on the date of grant and shares to be issued to employees under the Employee Stock Purchase Plan (“ESPP”) utilizes the Black-Scholes option-pricing model, and is impacted by its common stock price as well as changes in assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, expected common stock price volatility, expected term, risk-free interest rates and expected dividends.  For restricted stock unit (“RSU”) awards, the fair value is determined based on the closing price on the NASDAQ Global Select Market on the date of the award.

The fair value is recognized over the period during which services are rendered, known as the requisite service period on a straight-line basis for awards that vest based on service conditions. Stock-based compensation expense recognized at fair value includes the impact of estimated forfeitures. The Company estimates future forfeitures at the date of grant and revises the estimates, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Equity instruments issued to non-employees are recorded at their fair value on the measurement date and are subject to periodic adjustments as the underlying equity instruments vest. The fair value of options granted to consultants is expensed when vested. The non-employee stock-based compensation expense was not material for all periods presented.

Cash flows resulting from the tax benefits for tax deductions resulting from the exercise of stock options in excess of the compensation expense recorded for those options (excess tax benefits) are classified as cash flows from financing activities in the consolidated statements of cash flows; however there were no cash flow impacts from excess tax benefits during the three and nine months ended September 30, 2015 or 2014.

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Estimating the fair value of equity-settled awards as of the grant date using valuation models, such as the Black-Scholes option pricing model, is affected by assumptions regarding a number of complex variables. Changes in the assumptions can materially affect the fair value and ultimately how much stock-based compensation expense is recognized. These inputs are subjective and generally require significant analysis and judgment to develop. For valuations of all equity awards utilizing the Black-Scholes option-pricing model to date, the Company estimated the expected term and the volatility data based on a study of publicly traded industry peer companies and the Company’s actual experience since the IPO. For purposes of identifying these peer companies, the Company considered the industry, stage of development, size and financial leverage of potential comparable companies. The risk-free interest rate is based on the yield available on U.S. Treasury zero-coupon issues similar in duration to the expected term of the equity-settled award.

Net Loss per Share

Basic net loss per share is calculated by dividing the net loss by the weighted average number of common shares that were outstanding for the period, without consideration for potential common shares. Prior to April 22, 2014, the Company had convertible preferred stock, all of which converted into common stock at the closing of the IPO.  Because the holders of the Company’s convertible preferred stock and its restricted common shares were entitled to participate in dividends and earnings of the Company when dividends are paid on common stock, the Company would have applied the two-class method in calculating its earnings per share for periods when the Company generates net income. The two-class method requires net income to be allocated between the common and preferred stockholders based on their respective rights to receive dividends, whether or not declared. Because the convertible preferred stock and restricted common stock were not contractually obligated to share in the Company’s losses, no such allocation was made for any period presented given the Company’s net losses. Diluted net loss per share is calculated by dividing the net loss by the sum of the weighted-average number of dilutive potential common shares outstanding for the period determined using the treasury-stock method or the as-converted method. Potentially dilutive shares are comprised of convertible preferred stock, convertible preferred stock and common stock warrants, shares purchased with nonrecourse loans and options outstanding under the Company’s equity incentive plans. Purchase rights granted pursuant to the Company’s ESPP are excluded from the basic net loss per share calculation because the employee’s participation in the ESPP is revocable, and such rights will not be included until the shares subject to the purchase rights are purchased by the employee.  For all periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding due to the Company’s net loss and potentially dilutive shares being anti-dilutive.

The following equity shares were excluded from the calculation of diluted net loss per share because their effect would have been anti-dilutive for the periods presented (shares for the convertible preferred stock and convertible preferred stock warrants were determined based on the applicable conversion ratios):

 

 

 

In May 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update (“ASU”) No. 2014-09.  ASU 2014-09 provided guidance related to revenue from contracts with customers. Under this guidance, revenue is recognized when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. The updated standard will replace most existing revenue recognition guidance under GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. In July 2015, the FASB deferred the effective date to the reporting periods beginning after December 15, 2017, for public companies. Early adoption prior to the original effective date of January 1, 2017, is not permitted. The updated standard will be effective for the Company in the first quarter of 2018.  The Company has not yet selected a transition method and is currently evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures.

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In August 2014, the FASB issued new guidance related to the disclosures around going concern. The new standard provides guidance around 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. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on our financial statements.

In April 2015, the FASB issued ASU No. 2015-03. ASU 2015-03 simplifies presentation of debt issuance costs, by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. The actual recognition and measurement guidance for debt issuance costs are not affected by this guidance.  The guidance is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on our financial statements.

In July 2015, the FASB issued guidance which requires entities to measure most inventory “at the lower of cost and net realizable value (“NRV”),” thereby simplifying the current guidance under which an entity must measure inventory at the lower of cost or market. Under the new guidance, inventory is “measured at the lower of cost and net realizable value,” which eliminates the need to determine replacement cost and evaluate whether it is above the ceiling (NRV) or below the floor (NRV less a normal profit margin). The guidance defines NRV as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.” The guidance is effective for annual periods beginning after December 15, 2016, and interim periods therein. Early application is permitted. The Company is evaluating the impact of adoption of this guidance on its financial position and results of operations.

 

 

The Company classifies stock-based compensation expense in the accompanying Consolidated Statements of Comprehensive Loss based on the department to which a recipient belongs. The following table sets forth stock-based compensation expense related to all stock-based compensation arrangements for the periods presented (in thousands):  

 

 

 

 

The carrying amount of certain financial instruments, including accounts receivable, accounts payable, and accrued liabilities, approximate fair value due to their relatively short maturities.

The Company discloses and recognizes the fair value of its assets and liabilities using a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to valuations based upon unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to valuations based upon unobservable inputs that are significant to the valuation (Level 3 measurements). The guidance establishes three levels of the fair value hierarchy as follows:

 

Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability.

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The following table sets forth the Company’s financial instruments that were measured at fair value on a recurring basis at September 30, 2015, by level within the fair value hierarchy (in thousands):

 

The following table sets forth the Company’s financial instruments that were measured at fair value on a recurring basis at December 31, 2014, by level within the fair value hierarchy (in thousands):

 

The fair value of the Company’s Series C and D convertible preferred stock warrant liabilities was based on Level 3 inputs. The Company valued the Series C convertible preferred stock warrant liabilities and the Series D convertible preferred stock warrant liabilities using the Black-Scholes model as well as the residual value approach until they converted to warrants to purchase common stock in connection with the IPO.

The table below presents the activity of Level 3 liabilities during the year ended December 31, 2014, (in thousands):

 

 

 

 

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Short-term Investments

Short-term investments consisted of the following estimated fair value at September 30, 2015 and December 31, 2014 (in thousands):

 

 

All investments have a maturity of less than one year.  Management reviewed the short-term investments as of the end of the periods presented and concluded that there are no securities with other than temporary impairments in its investment portfolio.  The Company will not likely be required to sell the investments before recovery of their amortized cost basis at the expected maturity.

Inventories

Inventories consisted of the following (in thousands):

 

 

Property and equipment

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

 

 

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The Company recognized depreciation and amortization expense on property and equipment during the periods indicated as follows (in thousands):

 

 

Goodwill and other intangible assets, net

The goodwill and the indefinite-lived intangible assets on the consolidated balance sheets was $8.3 million and $1.2 million, respectively, for all periods presented.

Accrued liabilities and other

Accrued liabilities and other consist of the following on the accompanying consolidated balance sheets (in thousands):

 

 

 

On January 1, 2014, the Company entered into a distribution agreement (the “Distribution Agreement”) with Century Medical, Inc. (“Century”) with respect to the anticipated distribution of the Company’s Ovation and Ovation Prime medical devices in Japan. Under the terms of a secured note purchase agreement, Century agreed to loan the Company an aggregate of up to $6.0 million, with principal due in January 2019, under the agreement, subject to certain conditions. Under this facility, the Company received $4.0 million on January 10, 2014 and received the remaining $2.0 million on March 18, 2014, as the Company had achieved trailing 12-month revenues of $20 million and no material adverse event had occurred. The notes bear 5% annual interest which is payable quarterly in arrears through January 9, 2019, the maturity date when the entire principal balance becomes due. In return for the loan commitment, the Company granted Century distribution rights to the Company’s planned Ovation and Ovation Prime product line in Japan, and a right of first negotiation for distribution rights in Japan to future products. Century will be responsible for securing regulatory approval from the Ministry of Health in Japan for the Ovation and Ovation Prime product lines.

Proceeds from the note and granting the distribution rights were allocated to the note based on its aggregate fair value of $3.0 million at the dates of receipt. This fair value was determined by discounting cash flows using a discount rate of 15%, which the Company estimated as market rate of borrowing that could be obtained by companies with credit risk similar to the Company’s. The remainder of the proceeds of $3.0 million was recognized as debt issuance discount and allocated to the value of the distribution rights granted to Century under the Distribution Agreement. It is included in deferred revenue in other long term liabilities on the consolidated balance sheets. The deferred revenue will be recognized on a straight-line basis over the term of the Distribution Agreement, beginning upon the first sale by Century of the Ovation and Ovation Prime products in Japan.

 

 

Operating Leases

The Company’s headquarters’ facility lease expires on February 28, 2018. The Company also has immaterial office leases in its subsidiary locations. Total lease expense for the periods indicated was as follows (in thousands):

 

 

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The Company recognizes lease expense on a straight-line basis over the life of the lease. In addition to the lease obligation, the Company pays for common area maintenance and insurance for the facility. The Company also has various office equipment leases for copiers and postage machines.

Contingencies

From time to time, the Company may have certain contingent liabilities that arise in the ordinary course of business activities. The Company accrues a liability for such matters when it is probable that a liability has been incurred and such amounts can be reasonably estimated. There were no contingent liabilities requiring accrual at September 30, 2015.

Employment Agreements

The Company enters into employment agreements with its executive officers. The contracts do not have a fixed term and are constructed on an at-will basis. Some of these contracts provide executives with the right to receive certain additional payments and benefits after a change in control, as defined in such agreements.

Indemnification

The Company enters into standard indemnification arrangements in the ordinary course of business. Pursuant to these arrangements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified parties for losses suffered or incurred by the indemnified party, in connection with any trade secret, copyright, patent or other intellectual property infringement claim by any third party with respect to the Company’s technology. The term of these indemnification agreements is generally perpetual. The maximum potential amount of future payments the Company could be required to make under these agreements is not determinable because it involves claims that may be made against the Company in the future, but have not yet been made.

The Company has entered into indemnification agreements with its directors and officers that may require the Company to indemnify its directors and officers against liabilities that may arise by reason of their status or service as directors or officers, other than liabilities arising from willful misconduct of the individual.

The Company has not incurred costs to defend lawsuits or settle claims related to these indemnification agreements. No liability associated with such indemnifications has been recorded to date.

 

 

Century Medical, Inc. Subordinated Loan

In connection with the Distribution Agreement with Century (see Note 7), the Company entered into a secured note purchase agreement and a related security agreement, pursuant to which Century agreed to loan to the Company up to an aggregate of $6.0 million, which amount was received in the first quarter ended March 31, 2014.  This note bears 5% annual interest which is payable quarterly in arrears on the last business day of March, June, September and December of each year through January 9, 2019, the maturity date when the total $6.0 million of principal becomes due. The debt issuance discount of approximately $3.0 million is reflected as a reduction in long-term debt and is being amortized as interest expense over the term of the note using the effective interest method. The loan contains various affirmative and negative covenants and customary events of default, including if a material adverse change occurs with respect to the Company’s business, operations or financial condition, and is subordinated to the Company’s term loan with Capital Royalty.

The Company made the following interest payments in the periods indicated as follows (in thousands):

 

On November 4, 2014, the Company entered into a First Amendment to Loan Agreement with Century primarily to conform certain terms of the existing term loan agreement between the Company and Century to those of the Amended and Restated Term Loan Agreement with Capital Royalty.   

As of September 30, 2015, the Company was in compliance with all its covenants.

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Capital Royalty Term Loan

On October 12, 2012, the Company executed a Term Loan Agreement with Capital Royalty Partners II L.P. and its affiliate Parallel Investment Opportunities Partners II L.P. (collectively “Capital Royalty”) for up to a $50 million term loan to be used to pay off the Company’s then existing senior notes held by a previous lender and to fund operations. The loan could be drawn in two tranches. The first tranche of $40 million was drawn in October 2012, and an additional amount up to $10 million could have been available upon achievement of a revenue-based milestone, if notice of that achievement was issued by May 31, 2014. While the Company timely achieved the revenue-based milestone, it elected not to draw down additional funds.  The loan bore interest at a rate of 14.0%, based upon a year of 360 days and actual days elapsed. Prior to September 30, 2017, the Company could, at its election pay the interest as follows: 11.5% per annum paid in cash and 2.5% per annum paid in-kind in the form of additional term loans, or PIK Loans. Payments under the loan were made on a quarterly basis with payment dates fixed at the end of each calendar quarter (“Payment Dates”). The notes were interest-only through the 14^th Payment Date (March 31, 2016) following funding. Following the interest-only period principal payments were to be made in equal installments at the end of the six subsequent calendar quarters. The notes matured on the 20^th Payment Date (September 30, 2017).  In connection with the loan, the Company paid a loan origination fee of 1% and issued warrants to purchase 167,611 shares of common stock at $0.41 per share. The initial fair value of the warrants was $496,000 and resulted in a discount to the notes payable, which is being accreted to interest income and other income (expense), net in the statements of comprehensive loss over the life of the loan.

On November 4, 2014, the Company entered into the Amended and Restated Term Loan Agreement (the “Existing Term Loan Agreement”) with Capital Royalty amending the original term loan. In connection with this amendment, the Company increased borrowings under the facility by drawing down $10 million upon closing of the transaction on November 21, 2014. Additionally, subject to the achievement of certain revenue milestones, the Company had an option to access up to an additional $15 million on or before December 31, 2015.  

The Existing Term Loan Agreement primarily amended the terms of the original term loan agreement to increase the borrowing amount, reduce the applicable interest rate from 14.0% to 12.5%, extend the interest only payment period through September 30, 2018 and extend the final maturity date to June 30, 2020. Interest is payable, at the Company’s option, (i) in cash at a rate of 12.5% per annum or (ii) 9.0% of the 12.5% per annum in cash and 3.5% of the 12.5% per annum being added to the principal of the loan and subject to accruing interest. Interest-only payments are due quarterly on March 31, June 30, September 30 and December 31 of each year of the interest-only payment period. Thereafter, in addition to interest accrued during the period, the quarterly payments shall include an amount equal to the outstanding principal at September 30, 2018 divided by the remaining number of quarters prior to the end of the term of the loan which is June 30, 2020. The Existing Term Loan Agreement provided for prepayment fees of 4% of the outstanding balance of the loan if the loan had been repaid prior to September 30, 2015. The prepayment fee is reduced by 1% per year for each subsequent year.

Certain affirmative and negative covenants were also amended to provide the Company with additional flexibility. The principal financial covenants required that the Company attained minimum annual revenues of $30.0 million in 2015, $45.0 million in 2016, $60.0 million in 2017, $75.0 million in 2018 and $90.0 million thereafter. The loan and security agreement provides that an event of default will occur if, among other triggers, (1) the Company defaults in the payment of any amount payable under the agreement when due, (2) there occurs any circumstance or circumstances that could reasonably be expected to result in a material adverse effect on the Company’s business, operations or condition, or on the Company’s ability to perform its obligations under the agreement, (3) the Company becomes insolvent, (4) the Company undergoes a change in control or (5) the Company breaches any negative covenants or certain affirmative covenants in the agreement or, subject to a cure period, otherwise neglects to perform or observe any material item in the agreement. The repayment of the term loan may be accelerated, at the option of Capital Royalty, following the occurrence of an event of default, which would require the Company to pay to Capital Royalty an amount equal to the sum of: (i) all outstanding principal plus accrued interest, (ii) the final payment, plus (iii) all other sums, that shall have become due and payable but have not been paid, including interest at the default rate with respect to any past due amounts plus the Prepayment Premium.

In August 2015, the Company entered into a Second Amended and Restated Term Loan Agreement (the “Restated Loan Agreement”) with Capital Royalty and its affiliate funds amending and restating the Existing Term Loan Agreement.  In connection with the amendment, the Company borrowed an additional $10 million under its facility upon the closing of this transaction on August 18, 2015.  The debt discount of approximately $1.3 million related to the conversion feature discussed below, is reflected as a reduction in long-term debt and an increase in additional paid-in capital and is being amortized as interest expense over the term of the note using the effective interest method.

The Restated Loan Agreement primarily amended the terms of the Existing Term Loan Agreement to increase the borrowing amount to up to $95.0 million, net of financing fees. The Company continues to have the option to access up to $15.0 million on or before December 31, 2015, subject to achievement of certain revenue milestones.  The newly available debt of $30.0 million was divided amongst two tranches.  The first new tranche, which was drawn in August 2015, consisted of $10.0 million in convertible

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notes with an interest rate of 8%.  The convertible notes are convertible into the Company’s common stock at a price of $8.00 per share at CRG’s option, or, if the Company’s common stock trades above $8.00 per share for twenty consecutive trading days, at the Company’s option. The second new tranche consists of $20.0 million of borrowings that may be available to draw upon the achievement of $12.5 million of net revenue in any consecutive 3-month period before December 31, 2016 and has the same interest, payment, and other material terms discussed above.

The term loan, as amended, continues to be collateralized by a first priority security interest on all of the Company’s assets excluding property not assignable without consent by a third party, trademarks that would be invalid by reason of including it in the collateral and 35% of the ownership interest in a foreign subsidiary.

The principal financial covenants were also amended to require that the Company attain minimum annual revenues of $30.0 million in 2015, $43.0 million in 2016, $55.0 million in 2017, $70.0 million in 2018 and $90.0 million thereafter.

As of September 30, 2015, the Company was in compliance with all of the covenants.

Boston Scientific Corporation Note Payable

In March 2008, in conjunction with the acquisition of Boston Scientific Santa Rosa, or BSSR, the Company issued a promissory note in the amount of approximately $3.5 million to the prior owners of BSSR as part of the purchase consideration. The note bore an interest rate of 5.25% per annum and would have matured on March 28, 2018 per the original terms. The note (along with unpaid accrued interest) was repayable upon the earlier of (a) the date upon which initial public offering is consummated, or (b) the sale of the Company, including liquidation, dissolution or winding up. The Company repaid the note in full, including all accrued interest and the unamortized debt discount, subsequent to the closing of the IPO in April 2014.  Warrants to purchase up to 223,487 shares of common stock expired unexercised upon the IPO in April 2014.

 

 

In February 2014, the Company’s board of directors and stockholders approved an amendment to the amended and restated certificate of incorporation effecting a reverse stock split within a specified range with the final ratio to be determined by a committee of the board of directors. In March 2014, the committee of the board of directors approved a 1-for-40.57 reverse stock split of the Company’s issued and outstanding shares of common stock and the corresponding adjustments to the conversion ratio of the convertible preferred stock. The reverse split was implemented on April 1, 2014. The par value of the common and convertible preferred stock was not adjusted as a result of the reverse stock split. All issued and outstanding share and per share amounts included in the accompanying consolidated financial statements have been adjusted to reflect this reverse stock split for all periods presented.

Each share of Series A, Series B, Series C, Series D and Series E convertible preferred stock were automatically converted into common stock immediately upon the completion of the Company’s initial public offering on April 22, 2014.

As of September 30, 2015, the Company has reserved sufficient shares of common stock for exercise of the warrants, stock options and other equity incentive awards, and issuance of shares under the ESPP.

Warrants

The Company had warrants to purchase 395,863 shares of its common stock outstanding as of September 30, 2015. The Company’s convertible preferred stock warrants all converted to warrants to purchase common stock in April 2014.

 

 

In April 2014, the Company adopted the ESPP. A total of 500,000 shares of common stock were initially reserved for issuance under the ESPP, subject to certain annual adjustments. After such annual increase on January 1, 2015, there were 621,601 shares of common stock reserved for issuance under the ESPP.  The initial offering under the ESPP commenced on the IPO date and has a duration of approximately 24 months, consisting of four approximately six-month purchase periods. The first purchase period ended on October 31, 2014, when 82,226 shares were purchased at a specified discount.  The second purchase period ended on April 30, 2015, when 109,649 shares were purchased at a specified discount.  The Company recorded amounts that had been withheld from employees for that purchase of $376,000 in accrued liabilities and other at September 30, 2015, for the next purchase period, which will end on October 31, 2015.  

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In April 2014, the Company adopted the 2014 Equity Incentive Plan (the “2014 Plan”).  A total of 2,750,000 shares of common stock were initially reserved for issuance under the 2014 Plan, subject to certain annual adjustments.   After such annual increase on January 1, 2015, there were 3,565,307 shares of common stock reserved for issuance under the 2014 Plan. The 2014 Plan provides for the granting of stock options, RSUs and other equity awards to employees, directors and consultants of the Company. Options granted under the 2014 Plan may be either incentive stock options (“ISOs”) or nonqualified stock options (“NSOs”). ISOs may be granted only to Company employees while NSOs may be granted to all eligible recipients. At September 30, 2015, there were 1,027,549 shares of common stock subject to outstanding options under the 2014 Plan.

In April 2008, the Company adopted the 2008 Equity Incentive Plan (the “2008 Plan”). The 2008 Plan provided for the granting of stock options to employees, directors and consultants of the Company. In connection with the IPO, the 2008 Plan terminated in April 2014, and no further grants may be made from the 2008 Plan, while previously granted options continue in accordance with their respective terms.  At September 30, 2015, there were 1,313,366 shares of common stock subject to remaining outstanding options under the 2008 Plan.

Options under the 2014 and 2008 Plans have terms of up to ten years. The exercise price of an ISO may not be less than 100% of the fair market value of the shares on the date of grant; the exercise price for an NSO may not be less than 100% of the fair market value of the shares on the date of grant and the exercise price of an ISO or an NSO granted to a more than 10% shareholder may not be less than 110% of the fair market value of the shares on the date of grant. Options become exercisable as determined by the compensation committee of the board of directors. Options expire as determined by the board of directors but not more than ten years after the date of grant.

Restricted Stock Units

Following its IPO, the Company began granting other equity incentive awards, such as RSUs, to its employees and service providers. RSUs are awards that cover a number of shares of the Company’s common stock that may be settled upon vesting by the issuance of the underlying shares. These awards are subject to forfeiture prior to settlement because of termination of employment, and may contain settlement deferral features. The Company expects that RSUs it will utilize for its executives and employees, generally, will vest as to 25% on a specified date within the calendar quarter nearest to the first anniversary of the vesting commencement date and as to additional 25% on the second, third and fourth such anniversaries. The Company expects that RSUs it will utilize for its U.S. sales force, generally, will vest as to 50% on a specified date within the calendar quarter nearest to the second anniversary of the vesting commencement date, as to 25% on the third such anniversary and as to the remaining 25% on the fourth such anniversary. As of September 30, 2015, there were 808,133 RSUs outstanding.  Of these, 38,503 RSUs were included in the basic EPS at September 30, 2015, in the Consolidated Statements of Comprehensive Loss as they were fully vested, but not considered issued and outstanding as they are subject to a settlement deferral feature upon termination of employment or a change in control.

 

 

The Company applied an estimated annual effective tax rate (“ETR”) approach for calculating a tax provision for interim periods, as required under U.S. GAAP. The Company recorded a provision for income taxes of the following amounts for the periods indicated (in thousands):

 

 

The Company’s ETR for the periods shown differs from the U.S. federal statutory tax rate of 35% primarily as a result of nondeductible expenses, state income taxes, foreign income taxes, and the impact of a full valuation allowance on its deferred tax assets.

The Company has evaluated the available evidence supporting the realization of its deferred tax assets, including the amount and timing of future taxable income, and has determined that it is more likely than not that its net deferred tax assets will not be realized in the U.S. and certain foreign jurisdictions. Due to uncertainties surrounding the realization of the deferred tax assets, the Company maintains a full valuation allowance against substantially all deferred tax assets. If/when the Company determines that it will be able to realize some portion or all of its deferred tax assets, an adjustment to its valuation allowance on its deferred tax assets would have the effect of increasing net income, or decreasing net loss, in the period that such determination is made.

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13. Subsequent Events

On October 26, 2015, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Endologix, Inc., a Delaware corporation (“Endologix” or “Parent”), and Parent’s wholly owned subsidiary, Teton Merger Sub Inc., a Delaware corporation (“Merger Sub”). Subject to the satisfaction or waiver of the conditions set forth in the Merger Agreement, Merger Sub will be merged with and into the Company (the “Merger”) with the Company surviving the Merger as a wholly-owned subsidiary of the Parent.

Under the terms and conditions of the Merger Agreement, at the effective time of the Merger, all outstanding shares of capital stock of the Company (other than shares for which appraisal rights under Delaware law are properly exercised and other than shares held in treasury by the Company or shares held by Endologix, any subsidiary of Endologix, the Company or any subsidiary of the Company) will be cancelled and converted into the right to receive per share merger consideration, consisting of:

 

 

Based on the closing price of Endologix’s common stock on October 23, 2015, the trading date before the date of the announcement of the Merger Agreement, the overall value of the transaction was equal to up to approximately $211 million, of which approximately $187 million represented stock consideration based on the Endologix’s closing price as of that date.  As described above, in accordance with the terms and conditions of the Merger Agreement, the overall value of the transaction, including the stock consideration and the cash consideration, will continue to fluctuate until the effective time of the Merger when final adjustments and calculations of the exact per share amounts of stock consideration and cash consideration payable at closing will be made.

In each case, the stock consideration and cash consideration do not reflect interest or any applicable withholding taxes. Additional cash may be issued in lieu of any fractional shares of Endologix common stock. The Company, Parent, and Merger Sub intend, for U.S. federal income tax purposes, that the Merger will qualify as a “reorganization” within the meaning of Section 368(a) of the Internal Revenue Code of 1986.

The Merger Agreement includes customary representations, warranties and covenants of the Company, Endologix and Merger Sub. The Company and Endologix have agreed to operate their respective businesses in the ordinary course until completion of the Merger. The Company has also agreed not to solicit or initiate discussions with third parties regarding other proposals to acquire it and to certain restrictions on its ability to respond to any such proposals. The Merger Agreement contains customary closing conditions, including the requisite consent to the adoption of the Merger Agreement by the Company’s stockholders and the expiration or termination of the waiting period (and any extension thereof) under the Hart-Scott-Rodino Antitrust Improvements Act of 1976. The consummation of the Merger is not subject to a financing condition.

The Merger Agreement also includes customary termination provisions for both the Company and Endologix, subject, in certain circumstances, to the payment by the Company or Endologix of a termination fee of 3.0% or 4.5%, respectively, of the aggregate purchase price. The Company must pay Endologix the 3.0% termination fee on the occurrence of certain events, including following a change of recommendation by the board of directors of the Company or if the Company terminates the Merger Agreement to enter into an agreement with respect to a proposal from a third party that the board of directors of the Company has determined in good faith in the exercise of its fiduciary duties is superior to Endologix’s, in each case, as is described in further detail in the Merger Agreement.

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Endologix must pay TriVascular the 4.5% termination fee if Endologix is unable to obtain antitrust approval of the Merger, as is described in further detail in the Merger Agreement.

Closing of the Merger is expected to occur in January 2016. In connection with the Merger Agreement, the Company entered into a letter agreement, dated October 23, 2015, with Capital Royalty clarifying the expected timing of the conversion or repayment of their debt in connection with the closing of the Merger.

 

 

 

 

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

The following discussion of our financial condition and results of operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include statements that may relate to our plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs and other information that is not historical information. Forward-looking statements can often be identified by the use of terminology such as “subject to,” “believe,” “anticipate,” “plan,” “expect,” “intend,” “estimate,” “project,” “may,” “will,” “should,” “would,” “could,” “can,” the negatives thereof, variations thereon and similar expressions, or by discussions of strategy. All forward-looking statements, including, without limitation, our examination of historical operating trends, are based upon our current expectations and various assumptions. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in our forward-looking statements. Such risks and uncertainties include, among others, those discussed in our Annual Report on Form 10-K, filed with the SEC on March 9, 2015.  We do not intend, and undertake no obligation, to update any of our forward-looking statements after the date of this report to reflect actual results or future events or circumstances. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. You should read the following Management’s Discussion and Analysis of Financial Condition and Results of Operations in conjunction with the unaudited consolidated financial statements and the related notes that appear elsewhere in this report, as well as our consolidated financial statements and related notes included in the above mentioned Form 10-K.

When we refer to “we,” “our,” “us” or ““TriVascular”” in this Quarterly Report on Form 10-Q, we mean TriVascular Technologies, Inc., as well as all of our consolidated subsidiaries, unless otherwise expressly stated or the context otherwise requires. References to the “Ovation System” refer to our “Ovation” and “Ovation Prime” Systems and their related components.

Overview

We are a medical device company developing and commercializing innovative technologies to significantly advance minimally invasive treatment of abdominal aortic aneurysms, or AAA. Our mission is to help physicians improve the lives of patients suffering from aortic disease through excellence in research, product development, manufacturing, sales and service. We developed our technology platform leveraging engineering principles utilized in many other industries and applied these concepts with the goal of designing an optimal solution for AAA therapy to address unmet clinical needs. The Ovation System, our solution for the treatment of AAA through minimally invasive endovascular aortic repair, or EVAR, is a new stent graft platform. It is designed to specifically address many of the limitations associated with conventional EVAR devices and expand the pool of patients eligible for EVAR by virtue of its low profile, flexible delivery system and novel sealing mechanism. The Ovation System consists of a main aortic body, injected with a conformable polymer, and typically two iliac limbs. These components allow the devices to be customized to a patient’s unique anatomy to effectively seal the aneurysm.

We received CE Mark clearance in August 2010 and began commercial sales of our Ovation System in Europe in September 2010. In October 2012, we received approval from the U.S. Food and Drug Administration, or FDA, for the Ovation System for the treatment of AAA and began commercial sales in the United States in November 2012. We sell our products through our direct U.S., Canadian and European sales forces and through third-party distributors in Europe and in other parts of the world.

We manufacture and package all of the components of our implantable products at our headquarters in Santa Rosa, California. We also engage third-party contractors and suppliers to perform sterilization and accessory component assembly.

In April 2014, we completed the IPO of our common stock, which resulted in the sale of 7,475,000 shares at a price of $12.00 per share. We received net proceeds from the IPO of approximately $81.1 million, after deducting underwriting discounts and commissions and offering expenses.

In May 2014, we initiated the launch of our CustomSeal™ short cure fill polymer in Europe, further enhancing the implant experience for physicians.  Subsequently, in October 2014, we received FDA approval of CustomSeal polymer for use in the U.S.

In October 2014, we initiated our LIFE Study, which we expect will illustrate the potential advantages of PEVAR with the Ovation System. In early 2015, we initiated the LUCY Study which will evaluate the clinical benefits associated with EVAR using the Ovation System in female patients.  We enrolled our first patient in the LUCY study in August 2015.

In June 2015, FDA approved our next generation Ovation iX ^TM Iliac Stent Graft for the Ovation System, and in July 2015, the FDA approved the Ovation iX^TM Abdominal Stent Graft System.  In September 2015, the first patients were treated with the Ovation

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iX Abdominal Stent Graft System in Europe, and in October 2015, we initiated the launch of our Ovation iX System in the United States.

On October 26, 2015, we entered into a definitive merger agreement with Endologix, Inc., or Endologix. Subject to the satisfaction or waiver of the conditions set forth in that merger agreement, TriVascular will be merged into a wholly-owned subsidiary of Endologix, with TriVascular surviving the merger and becoming a wholly-owned subsidiary of Endologix (the “Merger”). Closing of the Merger is expected to occur in January 2016. See Note 13, “Subsequent Events,” of our consolidated financial statements in this Form 10-Q for more information about the Merger.

In November, 2015, we announced our four-year follow-up data on primary safety and performance metrics from the Ovation Pivotal trial. The data showed 100% freedom from aneurysm rupture, 100% freedom from conversion to open surgical repair, 100% freedom from Type I and Type III endoleaks, and 100% freedom from device migration.  Subset analysis of the results of patients with aortic neck lengths less than 10 mm, as well as patients who presented with tortuous aortic neck anatomy, showed 100% freedom from:  Type I and Type III endoleaks; rupture; migration; and conversion to surgical repair.

Important Factors Affecting our Results of Operations

We believe there are several important factors that have impacted and that we expect to continue to impact our results of operations.

Our Ability to Recruit, Train and Retain our Sales Representatives and their Productivity

We only recently began building our sales organization in the United States and have made, and intend to continue to make, a significant investment in recruiting and training our sales representatives. This process is lengthy because it requires significant education and training for our sales representatives to achieve the level of clinical competency with our products that is expected by implanting physicians. Upon completion of the training, our sales representatives typically require lead time in the field to grow their network of accounts and achieve the productivity levels we expect them to reach. Successfully recruiting and training a sufficient number of productive sales representatives is required to achieve growth at the rate we expect. Employee retention may be particularly challenging during the pendency of the Merger as our employees may experience uncertainty about their future roles with the combined business.

Physician Awareness and Acceptance of our Ovation System

We continue to invest in programs to educate physicians who treat AAA disease about the advantages of our Ovation System. This requires significant commitment by our marketing team and sales organization, and can vary depending upon the physician’s practice specialization, personal preferences and geographic location. We are competing with well-established companies in our industry that have strong existing relationships with many of these physicians. Educating physicians about the advantages of our Ovation System, and influencing these physicians to use our Ovation System to treat AAA disease, is required to grow our revenue. Our physician relationships may be subject to disruption due to uncertainty associated with the Merger.

Access to Hospital Facilities

In order for physicians to use our Ovation System, most hospital facilities where these physicians treat patients typically require us to enter into purchasing contracts with them. This process can be lengthy and time-consuming and require extensive negotiations and management time. In some cases, contract bidding processes are only open at certain periods of time and we may not be successful in bidding. In many hospitals, we are not able to sell our products unless and until a purchasing contract has been executed. Our hospital relationships may be subject to disruption due to uncertainty associated with the Merger and, assuming the Merger is consummated, may require additional negotiations and amendments in order to be utilized by the combined company, if at all.

Leveraging our Manufacturing Capacity

With our current operating model and infrastructure, we have the capacity to significantly increase our manufacturing production. We intend to use our design, engineering and manufacturing capabilities to increase manufacturing efficiency and to continue to develop new products with lower manufacturing costs. In addition, if we grow our revenue and sell more units, our fixed manufacturing costs will be spread over more units, which we believe will further reduce our manufacturing costs on a per-unit basis. Improving our gross margin, which is dependent upon further increasing our manufacturing efficiency and growing our U.S. revenue, among other factors, is critical to our ability to reach profitability.

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Investment in Research and Clinical Trials

We are continuously investing in research and development of new products and product enhancements to improve outcomes and enhance the physician experience with our products, while reducing the invasiveness of AAA therapy and expanding the pool of patients eligible for EVAR. We believe that these efforts will continue to drive adoption of our Ovation platform and further validate the advantages of our innovative technology. While research and development and clinical testing are time consuming and costly, we believe that clinical data demonstrating efficacy, safety and cost effectiveness is critical to increasing the adoption of our Ovation System.

For additional information about the risks and uncertainties associated with our business, see the section entitled “Risk Factors” in our Annual Report on Form 10-K, filed with the SEC on March 9, 2015 and the additional risks and uncertainties set forth in Item 1A of this Quarterly Report, including the risks related to the Merger, the risks to our operations during the pendency of the Merger, and the risks faced by the combined business in integrating after the consummation of the Merger.

Components of Results of Operations

Revenue

Our Ovation System consists of an aortic body preloaded into a catheter, at least two iliac limbs preloaded into catheters, a fill polymer kit and an autoinjector. In some cases, extra iliac limbs or iliac extensions may be required. Most of our sales are on a per-component basis; however, a small minority of our direct customers have total system pricing.

We derive revenue from sales of our Ovation System and related components and accessories to two types of customers: hospitals and distributors. We recognize revenue from sales to hospitals when we are notified that the product has been used or implanted and we have received a valid purchase order. Product sales to hospitals are billed to and paid by the hospitals as part of their normal payment processes, with payment received by us in the form of an electronic transfer, check or credit card. We recognize revenue from our distributors at the time the product is shipped to the distributor. Product sales to distributors are billed to and paid by the distributors as part of their normal payment processes, with payment received by us in the form of an electronic transfer. Our average sales prices are significantly higher in the United States than they are internationally. Our revenue from international sales can also be, and has been, significantly impacted by fluctuations in foreign currency exchange rates.

We expect our revenue to increase as we expand our sales and marketing infrastructure and increase awareness of our products. We also expect our revenue to fluctuate significantly from quarter to quarter due to a variety of factors, including seasonality and the impact of the buying patterns and implant volumes of our distributors and hospitals.  We have historically experienced lower sales in the summer months and around the holidays.

Cost of Goods Sold, Gross Profit and Gross Margin

We manufacture the Ovation System at our manufacturing facility in Santa Rosa, California. Cost of goods sold includes the cost of raw materials, labor costs, manufacturing overhead expenses, reserves for expected scrap and inventory obsolescence as well as distribution-related expenses. Due to our relatively low production volumes compared to our current potential manufacturing capacity, a significant portion of our cost of goods sold consists of manufacturing overhead expenses. These expenses include the cost of quality assurance, material procurement, inventory control, facilities, equipment and operations supervision and management. Cost of goods sold also includes depreciation expense for production equipment, changes to our excess and obsolete inventory reserves, and certain direct costs such as shipping costs, net of costs charged to customers.

We calculate gross margin as revenue less cost of goods sold divided by revenue. Our gross margin has been and will continue to be affected by a variety of factors, primarily by our manufacturing costs and, to a lesser extent, the percentage of products we sell in the United States versus internationally and the percentage of products we sell to distributors versus directly to hospitals. Our gross margin is significantly higher on products we sell in the United States, as compared to products we sell internationally, due to significantly higher average selling prices in the United States. Our gross margin is typically higher on products we sell directly to hospitals as compared to products we sell through distributors.

We expect our gross margin to increase over the long term because we expect to increase our manufacturing efficiency and, as our production volume increases, we will spread our fixed manufacturing costs over a larger number of units, thereby significantly reducing our per-unit manufacturing costs. However, our gross margin may fluctuate from period to period depending on the interplay of all of these factors.

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Sales, General and Administrative

Sales, general and administrative, or SG&A, expenses primarily consist of compensation, including salary, employee benefits and stock-based compensation expenses for our sales and marketing personnel, and for administrative personnel that support our general operations such as information technology, executive management, financial accounting, customer service, and human resources personnel. SG&A expenses also includes costs attributable to marketing our products to our customers and prospective customers, patent and legal fees, financial audit fees, insurance costs, recruiting fees, fees for other consulting services, and allocated facilities-related expenses. We expect to incur additional SG&A expenses in connection with our becoming a public company, which may increase further when we are no longer able to rely on the “emerging growth company” exemption we are afforded under the JOBS Act of 2012.

We expect our SG&A expenses to continue to increase in absolute dollars for the foreseeable future as our business grows and we continue to invest in our sales, marketing, clinical education, training and general administration resources to build our direct sales, distribution and administrative infrastructure in the United States. However, we expect our SG&A expenses to decrease as a percentage of our revenue over the long term, although our SG&A expenses may fluctuate from period to period due to the seasonality of our revenue and the timing and extent of our SG&A expenses.

Research and Development

Our research and development, or R&D, activities primarily consist of engineering and research programs associated with our products under development, as well as R&D activities associated with our core technologies. Our R&D expenses primarily consist of compensation, including salary, employee benefits and stock-based compensation expenses for our R&D and clinical personnel. We also incur significant expenses for supplies, development prototypes, design and testing, clinical study costs and product regulatory expenses. We expect our R&D expenses to increase as we initiate and advance our development projects and conduct additional clinical studies.

We expect our R&D expenses to continue to increase in absolute dollars for the foreseeable future as we continue to advance our products under development, as well as initiate and prepare for additional clinical studies. However, we expect our R&D expenses to decrease as a percentage of our revenue over the long term, although our R&D expenses may fluctuate from period to period due to the seasonality of our revenue and the timing and extent of our R&D expenses.

Interest Expense

Our interest expense primarily consists of interest expense and amortization of debt discount associated with our term loan agreement with Capital Royalty. At September 30, 2015, there was $50.0 million outstanding principal under the term loan, accruing interest at a rate of 12.5% per annum, and $10.0 million outstanding principal accruing interest at a rate of 8.0% per annum.  There was also $6.0 million outstanding principal under our subordinated loan with Century which we drew in the first quarter of 2014, accruing interest at a rate of 5.0% per annum.

Interest Income and Other Expense, Net

Interest income and other expense, net primarily consisted of changes in the fair value of then outstanding convertible preferred stock warrants.  Prior to our IPO, the convertible preferred stock warrants were subject to re-measurement at each balance sheet date, and any change in fair value was recognized as a component of interest income and other expense, net.  We continued to adjust the liability for changes in fair value until the completion of the IPO in April 2014, at which time all convertible preferred stock warrants were converted into warrants to purchase common stock and a final valuation was performed.  We recognize interest and, if applicable, penalties related to income tax matters in income tax expense.  

Critical Accounting Policies and Estimates

Our consolidated financial statements included in this Form 10-Q have been prepared in accordance with generally accepted accounting principles in the United States, or U.S. GAAP. To prepare our financial statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities, sales, costs and expenses. We base our estimates on historical expenses and on various other assumptions that we believe to be reasonable under the circumstances. Changes in the accounting estimates are likely to occur from period to period. Actual results could be significantly different from these estimates. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgment and estimates.

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In May 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update (“ASU”) No. 2014-09.  ASU 2014-09 provided guidance related to revenue from contracts with customers. Under this guidance, revenue is recognized when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. The updated standard will replace most existing revenue recognition guidance under GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. In July 2015, the FASB deferred the effective date to the reporting periods beginning after December 15, 2017, for public companies.  Early adoption prior to the original effective date of January 1, 2017, is not permitted.  The updated standard will be effective for us in the first quarter of 2018.  We have not yet selected a transition method and are currently evaluating the effect that the updated standard will have on our consolidated financial statements and related disclosures.

In August 2014, the FASB issued new guidance related to the disclosures around going concern. The new standard provides guidance around 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. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on our financial statements.

In April 2015, the FASB issued ASU No. 2015-03. ASU 2015-03 simplifies presentation of debt issuance costs, by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. The actual recognition and measurement guidance for debt issuance costs are not affected by this guidance.  The guidance is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on our financial statements.

In July 2015, the FASB issued guidance which requires entities to measure most inventory “at the lower of cost and net realizable value (“NRV”),” thereby simplifying the current guidance under which an entity must measure inventory at the lower of cost or market. Under the new guidance, inventory is “measured at the lower of cost and net realizable value,” which eliminates the need to determine replacement cost and evaluate whether it is above the ceiling (NRV) or below the floor (NRV less a normal profit margin). The guidance defines NRV as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.” The guidance is effective for annual periods beginning after December 15, 2016, and interim periods therein. Early application is permitted. We are evaluating the impact of adoption of this guidance on our financial position and results of operations.

Our critical accounting policies and estimates are more fully described in Note 2, “Summary of Significant Accounting Policies,” of our consolidated financial statements in this Form 10-Q, and in our Annual Report on Form 10-K, filed with the SEC on March 9, 2015.

Revenue Recognition

Our revenue is generated from sales to two types of customers: hospitals and third-party distributors. Sales to hospitals represent the majority of our revenue. We utilize a network of direct sales representatives for sales in the United States and a combination of direct sales representatives, independent sales agencies and distributors for sales outside the United States. We recognize revenue when persuasive evidence of an arrangement exists, product delivery has occurred, pricing is fixed or determinable and collection is reasonably assured. In direct markets, we provide products for a specific implant procedure and recognize revenue at the time that we are notified that the product has been used or implanted and a valid purchase order has been received. For all other transactions, we recognize revenue when title to the goods and risk of loss transfer to customers, provided that there are no remaining performance obligations that will affect the customer’s final acceptance of the sale. We recognize revenue from sales to distributors at the time the product is shipped to the distributor. Distributors, who sell the products to their customers, take title to the products and assume all risks of ownership at time of shipment. Our distributors are obligated to pay within specified terms regardless of when or if they ever they sell the products. Our policy is to classify shipping and handling costs, net of costs charged to customers, as cost of goods sold. In general, we do not offer rights of return or price protection to our customers and have no post-delivery obligations. We offer rights of exchange in limited circumstances for products that have a short shelf life at the time of shipment. One of our distributor customers represented 13.6% of our net accounts receivable at and less than 3.1% of our sales for the three months ended September 30, 2015.

Excess and Obsolete Inventory

We state inventories at the lower of cost or market. We determine cost on a standard cost method, which approximates the first-in, first-out method. We evaluate the carrying value of our inventories in relation to our estimated forecast of product demand, which takes into consideration the estimated life cycle of our products. A significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand. When quantities on hand exceed estimated sales forecasts, we record a write-down for

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excess inventories, which results in a corresponding charge to cost of goods sold. Charges incurred for excess and obsolete inventory were nominal and $0.4 million for the three months ended September 30, 2015 and 2014, respectively and $0.3 million and $0.8 million for the nine months ended September 30, 2015 and 2014, respectively.

Our industry is characterized by ongoing product innovation that could result in an increase in the amount of obsolete inventory quantities on hand. For example, as we introduce new products or next generation products, we may be required to take charges for excess and obsolete inventory that could have a significant impact on the value of our inventory or our operating results.

For discussion of our other accounting policies, refer to Note 2, “Summary of Significant Accounting Policies,” of our consolidated financial statements included in this Form 10-Q.

Results of Operations

The following table presents our results of continuing operations and the related percentage of the period’s revenue (dollars in thousands):

 

 

Comparison of the Three Months Ended September 30, 2015 and 2014 (all dollars in thousands)

Revenue

 

 

Revenue. Revenue for the three months ended September 30, 2015 and 2014, was $9.5 million and $7.9 million, respectively, an increase of 20.0%. The increase in revenue was primarily related to the growth of our U.S. business. For the three months ended September 30, 2015 and 2014, our U.S. revenue was $6.5 million and $5.4 million, respectively, and represented 68.2% and 68.1%, respectively, of our revenue in the respective periods.   Since we initiated sales of our Ovation System in the U.S. in November 2012, our U.S. revenue has grown significantly as our U.S. sales force gains more experience and we are more effective in increasing adoption of our products.  For the three months ended September 30, 2015 and 2014, international revenue was $3.0 million and $2.5 million, respectively. For the three months ended September 30, 2015, our distributor revenue represented 20.0% of our revenue, compared to 21.6% during the three months ended September 30, 2014.

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Cost of Goods Sold, Gross Profit and Gross Margin

 

 

Cost of Goods Sold, Gross Profit and Gross Margin. Our cost of goods sold for the three months ended September 30, 2015, was $3.5 million, resulting in a gross profit of $6.0 million, compared to $3.4 million in cost of goods sold and gross profit of $4.5 million in the three months ended September 30, 2014. Our gross margin for the three months ended September 30, 2015, was 63.5%, compared to 57.2% for the three months ended September 30, 2014. The increase in gross margin was primarily due to a reduction in our per-unit manufacturing costs resulting from the absorption of fixed manufacturing costs over substantially more units.

Operating Expenses

 

 

Sales, General and Administrative. Our SG&A expenses for the three months ended September 30, 2015, were $13.2 million, compared to $12.6 million for the three months ended September 30, 2014, an increase of 5.4%. The increase in SG&A expenses was primarily associated with increases in compensation, public company and legal related spending. Employee-related compensation expenses for our SG&A functions increased by $0.8 million for the three months ended September 30, 2015, compared to the same period in 2014 driven by increased headcount and severance related expenses. Public company related expenses increased by $0.09 million and legal expenses increased by $0.3 million each as compared to the same period in 2014.

Research and Development. Our R&D expenses for the three months ended September 30, 2015 were $4.2 million, an increase of 3.1% as compared to the same period in 2014.  There was a $0.3 million increase in clinical study related spending with increased enrollments offset by a decrease in product development spending.

Interest Expense

 

 

Interest Expense. Our interest expense for the three months ended September 30, 2015, was $2.1 million, compared to $1.7 million for the three months ended September 30, 2014. The increase in interest expense was primarily attributable to additional debt incurred since September 30, 2014 including $20.0 million additional principal outstanding from Capital Royalty Group as well as $6.0 million additional principal outstanding from Century Medical Group.

Comparison of the Nine Months Ended September 30, 2015 and 2014 (all dollars in thousands)

Revenue

 

 

Revenue. Revenue for the nine months ended September 30, 2015 and 2014, was $27.2 million and $22.7 million, respectively, an increase of 19.8%.   For the nine months ended September 30, 2015 and 2014, U.S. revenue was $19.0 million and $15.1 million, respectively, and represented 69.9% and 66.7%, respectively, of our revenue in the respective periods. Since we initiated sales of our

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Ovation System in the U.S. in November 2012, our U.S. revenue has grown significantly as our U.S. sales force gains experience and we are increasing adoption of our products.  For the nine months ended September 30, 2015 and 2014, international revenue was $8.2 million and $7.6 million, respectively, and represented 30.1% and 33.3%, respectively, of our revenue in the respective periods. Our international revenue growth was driven primarily by sales to new geographies. For the nine months ended September 30, 2015, our distributor revenue represented 17.1% of our revenue, compared to 23.0% during the nine months ended September 30, 2014.

Cost of Goods Sold, Gross Profit and Gross Margin

 

 

Cost of Goods Sold, Gross Profit and Gross Margin. Our cost of goods sold for the nine months ended September 30, 2015, was $10.6 million resulting in a gross profit of $16.6 million compared to $10.5 million in cost of goods sold and gross profit of $12.2 million in the nine months ended September 30, 2014. Our gross margin for the nine months ended September 30, 2015, was 61.2%, compared to 53.8% for the nine months ended September 30, 2014. The increase in gross margin was primarily due to a reduction in our per-unit manufacturing costs resulting from the absorption of fixed manufacturing costs over substantially more units.

Operating Expenses

 

 

Sales, General and Administrative. Our SG&A expenses for the nine months ended September 30, 2015, were $42.1 million, compared to $37.8 million for the nine months ended September 30, 2014, an increase of 11.5%. The increase in SG&A expenses was primarily associated with and the continued expansion of our U.S. commercial operations. Employee-related compensation expenses for our SG&A functions increased by $2.6 million for the nine months ended September 30, 2015, compared to the same period in 2014, partially due to severance costs incurred in the nine months ended September 30, 2015.  SG&A expenses also increased by $1.0 million due to increased costs associated with becoming a public company in April 2014, inclusive of audit and consulting costs.  Legal expenses increased by $1.0 million.

Research and Development. Our R&D expenses for the nine months ended September 30, 2015, were $12.3 million compared to $11.9 million for the nine months ended September 30, 2014, an increase of 3.3%. The increase in R&D expenses for the nine months ended September 30, 2015, consisted primarily of salary expenses and product development costs including clinical study costs.

Interest Expense

 

 

Interest Expense. Our interest expense for each of the nine months ended September 30, 2015 and 2014 was $5.9 million.  There was no net change in interest expense, but there was higher interest expense in 2014 related to the repayment of principal and interest due on a note held by Boston Scientific Corporation (the “BSC Note) upon completion of our IPO in April 2014.  There was increased interest expense in 2015 due to interest on a higher principal balance of the Capital Royalty term loan as a result of both PIK notes and additional outstanding principal, as well as debt with Century.

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Liquidity and Capital Resources

Historically, our sources of cash have primarily included our IPO, private placements of equity securities and debt arrangements, and, to a much lesser extent, cash generated from operations, primarily from the collection of accounts receivable resulting from sales. Our historical cash outflows have primarily been associated with cash used for operating activities such as expansion of our sales and marketing infrastructure, investing in inventory, R&D activities and other working capital needs.  At September 30, 2015, we had $50.0 million in cash and cash equivalents and short-term investments.

Since our inception, we have generated significant losses and expect to continue to generate losses for the foreseeable future. In January 2014, we entered into a term loan agreement with Century for an aggregate amount of $6.0 million, $4.0 million of which we drew down in January 2014 and the remaining $2.0 million of which we drew down in March 2014. In April 2014, we completed our IPO of 7,475,000 shares of common stock, which included the exercise in full by the underwriters in the offering of their option to purchase 975,000 additional shares of common stock, at an offering price of $12.00 per share. We received net proceeds of approximately $81.1 million, after deducting underwriting discounts and commissions and offering expenses. In November 2014, we entered into the Amended and Restated Term Loan Agreement with Capital Royalty Partners II L.P. and its affiliate funds (collectively, “CRG” or “Capital Royalty”) amending the original term loan agreement under which we previously borrowed $40.0 million in October 2012 (the “Existing Term Loan Agreement”) and upon closing of the transaction, increased borrowings under the facility by $10.0 million. In August 2015, we entered into a Second Amended and Restated Term Loan Agreement with CRG (the “Restated Loan Agreement”). In additional to the $50.0 million of borrowings outstanding and the option to access up to an additional $15.0 million subject to achievement of certain revenue milestones under the Existing Term Loan Agreement, the Restated Loan Agreement also provides for two additional tranches of up to $30.0 million in the aggregate. The first new tranche consists of $10.0 million in convertible notes with an interest rate of 8%. The convertible notes are convertible into shares of our common stock at a price of $8.00 per share at CRG’s option, or if our common stock trades above $8.00 per share for twenty consecutive trading days, at our option. The remaining new tranche consists of $20.0 million in borrowings that may be available to us upon the achievement of $12.5 million of net revenue in any consecutive 3-month period before December 31, 2016. We would be required to amend our loan with Century to obtain its consent for subordination of additional borrowings before we could draw down the non-convertible tranches unless the convertible notes are converted in full, in which case access to up to the additional $15.0 million may be available without Century’s consent.

In May 2015, we entered into a Controlled Equity Offering^SM sales agreement, with Cantor Fitzgerald & Co., or Cantor, as agent, pursuant to which we may, from time to time, issue and sell shares of our common stock having an aggregate offering price of up to $25.0 million. Cantor may sell our common stock by methods deemed to be an “at-the-market” offering as defined in Rule 415 promulgated under the Securities Act. Sales made pursuant to the controlled equity offering program, if any, will be made under our shelf registration statement on Form S-3, which was declared effective by the SEC on June 17, 2015. As of September 30, 2015, Cantor had made no sales, and we have not issued any shares, under the controlled equity offering program.

We believe that our available cash will be sufficient to satisfy our liquidity requirements for at least the next 12 months. We have utilized, and may continue to utilize, debt arrangements with debt providers and financial institutions to finance our operations. Factors such as interest rates and available cash will impact our decision to continue to utilize debt arrangements as a source of cash.

The following presents a discussion of our cash flows for the nine months ended September 30, 2015 and 2014 (in thousands):

 

Operating activities. The slight increase in net cash used in operating activities during the nine months ended September 30, 2015, compared to the nine months ended September 30, 2014, was primarily related to an increase in our stock-based compensation, offset by other working capital needs.

Investing activities. The net cash provided by investing activities in the three months ended September 30, 2015, was primarily related to the maturities of short-term investments, offset by short-term investment purchases.  Net cash used in investing activities in the nine months ended September 30, 2014, was related only to the purchase of capital equipment.

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Financing activities. The net cash provided by financing activities in the nine months ended September 30, 2015, was primarily related to issuance of common stock, mostly from our ESPP purchase in April 2015 and the proceeds from the issuance of additional debt to Capital Royalty Group.  The net cash provided by financing activities in the nine months ended September 30, 2014, was primarily related to the execution and draw-down of our subordinated loan agreement with Century, proceeds from the issuance of common stock and the repayment of the BSC Note as part of the IPO.

Indebtedness

For discussion of our indebtedness, refer to Note 9, “Notes Payable” of our consolidated financial statements included in this Form 10-Q.

Future Capital Requirements

Our liquidity position and capital requirements are subject to a number of factors. For example, our cash inflow and outflow may be impacted by the following:

Our primary short-term capital needs, which are subject to change, include expenditures related to:

Additionally, as a public company, we incur significant audit, legal, and other expenses that we did not incur as a private company.

Although we believe the foregoing items reflect our most likely uses of cash in the short term, we cannot predict with certainty all of our particular short-term cash uses or the timing or amount of cash used. If cash generated from operations is insufficient to satisfy our working capital and capital expenditure requirements, we may be required to sell additional equity or debt securities or obtain additional credit facilities. This capital may not be available on satisfactory terms, if at all. Furthermore, any additional equity financing may be dilutive to our stockholders, and debt financing, if available, may include restrictive covenants. For a discussion of other factors that may impact our future liquidity and capital funding requirements, see “Risk Factors” in our Annual Report on Form 10-K, filed on March 9, 2015 and those set forth in Item 1A of this Quarterly Report.

Credit Risk

We had receivable balances from customers in Europe of $2.4 million and $2.8 million as of September 30, 2015 and December 31, 2014, respectively. Our accounts receivable outside of the United States are primarily due from third-party distributors, and to a lesser extent, public government-owned and private hospitals. Our accounts receivable in the United States are primarily due from for-profit and not-for-profit private hospitals. Our historical write-offs of accounts receivable have not been significant.

We monitor the financial performance and credit worthiness of our customers, so that we can properly assess and respond to changes in their credit profile. Our third-party distributors operate in certain countries, such as Greece, Italy, Spain and Turkey, where economic conditions continue to present challenges to their businesses, and thus, could place at risk the amounts due to us from them. These distributors are owed certain amounts from public hospitals that are funded by their governments. Adverse financial conditions in these countries may continue, thus negatively affecting the length of time that it will take us to collect associated accounts receivable, or impact the likelihood of ultimate collection.

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Off Balance Sheet Arrangements

We do not maintain any off balance sheet partnerships, arrangements, or other relationships with unconsolidated entities or others, often referred to as structured finance or special-purpose entities, which are established for the purpose of facilitating off balance sheet arrangements or other contractually narrow or limited purposes.

 

 

 

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Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We do not believe that we currently have material exposure to interest rate, foreign currency exchange rate or other relevant market risks.

Interest Rate Risk

We are exposed to market risks in the ordinary course of our business. Our cash and cash equivalents include cash in readily available checking and money market accounts. These securities are not dependent on interest rate fluctuations that may cause the principal amount of these assets to fluctuate. Additionally, the interest rate on our Capital Royalty and Century term loans are fixed and not subject to changes in market interest rates.

Foreign Currency Exchange Risk

A significant portion of our business is located outside the United States and, as a result, we generate revenue and incur expenses denominated in currencies other than the U.S. dollar, a majority of which is denominated in Euros. For the quarters ended September 30, 2015 and 2014, approximately 22.8% and 19.3%, respectively, of our sales were denominated in foreign currencies, and 31.8% and 31.9%, respectively, were generated in countries outside the U.S. As a result, our revenue can be, and has been, significantly impacted by fluctuations in foreign currency exchange rates. Our international selling, marketing and administrative costs related to these sales are largely denominated in the same foreign currencies, which mitigated our foreign currency exchange risk exposure. A hypothetical 10% favorable or unfavorable change in the weighted average foreign currency rates for the quarter ended September 30, 2015, would have affected foreign currency denominated revenue by $0.2 million for the quarter.

 

Item 4.  CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures.

Prior to our IPO, we were a private company with limited accounting personnel and other resources with which to address our controls and procedures. However, we are committed to maintaining disclosure controls and procedures designed to ensure that information required to be disclosed in our periodic reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Management necessarily applies its judgment in assessing the benefits of controls relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within our company have been detected. Based on the evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)) under the Exchange Act) required by Rules 13a-15(b) or 15d-15(b) under the Exchange Act, our Chief Executive Officer and our Chief Financial Officer have concluded that as of the end of the period covered by this report, our disclosure controls and procedures were effective at the reasonable assurance level.

(b) Changes in internal controls.

There were no changes in our internal control over financial reporting that occurred during the period covered by this report 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

 

Item 1.  LEGAL PROCEEDINGS

We may from time to time be involved in various claims and legal proceedings of a nature we believe are normal and incidental to a medical device business. These matters may include product liability, intellectual property, employment, and other general claims. We accrue for contingent liabilities when it is probable that a liability has been incurred and the amount can be reasonably estimated. Regardless of outcome, litigation can have an adverse impact on us because defense and settlement costs, diversion of management resources and other factors.

On May 17, 2013, Dr. Shaun L. W. Samuels filed a complaint in the United States District Court for the Northern District of California alleging infringement of U.S. Patent No. 6,007,575, or the ’575 Patent, by us in connection with the manufacture and sale of the Ovation Prime System and seeking damages in an amount no less than a reasonable royalty, together with additional damages to compensate for infringement of the patent and for attorney fees. We have denied all such claims and filed counterclaims against Dr. Samuels alleging, inter alia, non-infringement and invalidity of the ’575 Patent, breach of contract, and promissory estoppel.  The case is proceeding and no trial date has been set.  

 

Item 1A.  RISK FACTORS

There have been no material changes from the risk factors set forth in Part I, Item IA, “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2014, filed with the SEC on March 9, 2015, except as set forth below.

Risks Related to the Endologix Merger

There can be no assurance that the Endologix merger will be completed and, if the merger is not completed, we may be required to pay a material termination fee.

On October 26, 2015, we signed a definitive merger agreement to merge with Endologix, which we refer to as the Endologix merger. We currently expect the Endologix merger to close early in January 2016. The merger agreement is subject to a number of conditions that must be fulfilled in order to complete the Endologix merger. Those conditions include continued accuracy of the representations and warranties by both parties and the performance by both parties of their covenants and agreements, absence of orders prohibiting the completion of the merger, expiration or early termination of the applicable pre-merger waiting period (and extensions thereof) under the Hart-Scott-Rodino Act, the effectiveness of the Form S-4 registering the Endologix shares to be issued as merger consideration and adoption of the merger agreement by at least a majority of the issued and outstanding shares of our common stock. The closing of the Endologix merger is not subject to a financing contingency. In addition, the merger agreement also includes customary termination provisions for both Endologix and TriVascular, subject, in certain circumstances, to the payment by us or Endologix or us of a termination fee of 3.0% or 4.5%, respectively, of the aggregate purchase price. We must pay Endologix the 3.0% termination fee following a change of recommendation by our board of directors or if we terminate the merger agreement to enter into an agreement with respect to a proposal from a third party that our board of directors has determined in good faith in the exercise of its fiduciary duties is superior to Endologix’s, in each case, as is described in further detail in the merger agreement. Endologix must pay us the 4.5% termination fee if Endologix is unable to obtain antitrust approval of the merger. We cannot assure you that the Endologix merger will be completed. Delays in closing the Endologix merger or the failure to close the Endologix merger at all may result in our incurring significant additional costs in connection with such delay or termination of the merger agreement and/or failing to achieve the anticipated benefits of the Endologix merger. Any delay in closing or a failure to close the Endologix merger could have a negative impact on our business and the trading price of our common stock.

Our and Endologix’s business relationships, including customer relationships, may be subject to disruption due to uncertainty associated with the Endologix merger.

Parties with which we or Endologix do business may experience uncertainty associated with the Endologix merger, including with respect to current or future business relationships with us, Endologix or the combined business. These business relationships may be subject to disruption as customers and others attempt to negotiate changes in existing business relationships or consider entering into business relationships with parties other than us, Endologix or the combined business, including our competitors or those of Endologix. These disruptions could have a material adverse effect on our business, operating results and financial condition prior to the closing of the merger and of the combined business following the completion of the merger. The adverse effect of such disruptions could be exacerbated by a delay in the completion of the Endologix merger or termination of the merger agreement.

We may have difficulty attracting, motivating and retaining executives and other key employees in light of the merger.

Uncertainty about the effect of the Endologix merger on our employees may have an adverse effect on us and, consequently, the combined business resulting from the merger. This uncertainty may impair our ability to attract, retain and motivate key personnel until the merger is completed, or longer for the combined entity. Employee retention may be particularly challenging during the

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pendency of the merger as our employees may experience uncertainty about their future roles with the combined business. In addition, if key employees depart because of issues relating to the uncertainty and difficulty of integration, financial incentives or a desire not to become employees of the combined business, we may incur significant costs in identifying, hiring and retaining replacements for departing employees, which could substantially reduce or delay our ability to realize the anticipated benefits of the merger.

Actual results may differ from any guidance issued by us or Endologix concerning future revenue and revenue growth or the anticipated impact of the Endologix merger on the operating results of the combined company, and these differences could be material.

We and Endologix have made a number of forward-looking statements, including statements relating to the expected timing of the Endologix merger, the prospects for the combined company, the market opportunity for our and Endologix’s products, expectations for the development and introduction of new products and the future growth of our business. These statements are based upon management’s preliminary estimates based on forecasts prepared by our and Endologix’s management. Although we believe that we have a reasonable basis for such forward-looking statements, these statements are based on our projections of future events that are subject to known and unknown risks and uncertainties and other factors that may cause the combined company’s actual results, level of activity, performance or achievements, expressed or implied by these forward-looking statements, to differ in a material way. Risks and uncertainties that could cause actual results to differ materially from currently anticipated results include, but are not limited to, risks relating to:

The combined company’s actual financial condition and results of operations following the Endologix merger may not be consistent with, or evident from, the guidance we or Endologix provide. Other unknown or unpredictable factors also could harm the results. Consequently, actual results or developments anticipated by us or Endologix may not be realized or, even if substantially realized, may not have the expected consequences for, or effects on, us or Endologix.

Any failure by Endologix to successfully integrate our business and operations into Endologix’s or to fully realize potential synergies from the Endologix merger in the expected time frame would adversely affect our business, operating results and financial condition.

The success of the Endologix merger will depend, in part, on Endologix’s ability to successfully integrate our business and operations and fully realize the anticipated benefits and potential synergies from combining our business with Endologix’s business. If these objectives are not achieved following the Endologix merger, the anticipated benefits and potential synergies of the Endologix merger may not be realized fully or at all, or may take longer to realize than expected. Any failure to timely realize these anticipated benefits would have a material adverse effect on the combined company’s business, operating results and financial condition. Until the completion of the Endologix merger, we and Endologix will continue to operate independently. The integration process could result in a loss of key customers, decreases in revenue and increases in operating costs, as well as the disruption of each company’s ongoing businesses, any or all of which could limit our ability to achieve the anticipated benefits and synergies of the Endologix merger and have a material adverse effect on our business, operating results and financial condition.

 

We have made certain assumptions relating to the Endologix merger that may prove to be materially inaccurate.

We have made certain assumptions relating to the Endologix merger that may prove to be inaccurate, such as expected benefits of the Endologix merger, expected revenue growth rates, operating, transaction and integration costs, as well as general economic and business conditions that adversely affect the combined company following the Endologix merger. These assumptions relate to numerous matters, including:

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We will incur significant transaction expenses in connection with the Endologix merger.

We have incurred, and expect to continue to incur, significant transaction costs relating to the negotiation and completion of the Endologix merger. Except in limited circumstances, we will have to bear these costs whether or not the Endologix merger is completed. These transaction expenses could materially affect our results of operations in the period in which the charges are recorded, especially if the completion of the merger is delayed or does not occur.

If we do not complete the Endologix merger, we will have incurred substantial expenses without our stockholders realizing any potential benefits.

If we are unable to complete the Endologix merger, we will have incurred significant due diligence, legal, accounting and other transaction costs in connection with the merger without our stockholders realizing any potential benefits. We cannot assure you that we will complete the Endologix merger because it is subject to a variety of factors, including the satisfaction of customary closing conditions.

 

Item 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Unregistered Sales of Equity Securities

None.

 

Item 6.  EXHIBITS

The exhibits listed in the Exhibit Index to this Quarterly Report on Form 10-Q are incorporated herein by reference.

 

 

 

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SIGNATURES

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 in the city of Santa Rosa, State of California, on November 9, 2015.

 

 

 

 

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Exhibit Index

 

 

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