ITEM 1. BUSINESS
Overview
GI Dynamics® is a medical device company focused on the development and commercialization of EndoBarrier, a medical device indicated for treatment of patients with type 2 diabetes and obesity.
Diabetes mellitus type 2 (also known as type 2 diabetes) is a long-term progressive metabolic disorder characterized by high blood sugar, insulin resistance, and reduced insulin production. People with type 2 diabetes represent 90% of the worldwide diabetes population, whereas 10% of this population is diagnosed with type 1 diabetes (a form of diabetes mellitus in which not enough insulin is produced).
Being overweight is a condition where the patient’s body mass index (BMI) is greater than 25 (kg/m2); obesity is a condition where the patient’s BMI is greater than 30. Obesity and its comorbidities contribute to the progression of type 2 diabetes. Many experts believe obesity contributes to higher levels of insulin resistance, which creates a feedback loop that increases the severity of type 2 diabetes.
When considering treatment for type 2 diabetes, it is optimal to address obesity concurrently with diabetes.
EndoBarrier® is the only medical device approved for the treatment of both type 2 diabetes and obesity.
The current treatment paradigm for type 2 diabetes is pharmacological, whereby treating clinicians prescribe a treatment regimen of one to four concurrent medications that could include insulin for patients with higher levels of blood sugar. Insulin carries a significant risk of increased mortality and directly contributes to weight gain, which in turn leads to higher levels of insulin resistance and diabetes. In other words, the primary drug used to treat severe type 2 diabetes raises risk significantly and increases the downstream progression of the disease by increasing obesity. Fewer than 50% of patients treated pharmacologically for type 2 diabetes are adequately managed, meaning that medication does not halt the progressive nature of diabetes.
The current pharmacological treatment algorithms for type 2 diabetes fall short of ideal, creating a large and unfilled treatment gap.
Our vision is to make EndoBarrier the essential nonpharmacological and non anatomy-altering treatment for patients with type 2 diabetes and obesity. We intend to achieve this vision by providing a safe and effective device, focusing on optimal patient care, supporting treating clinicians, adding to the extensive body of clinical evidence around EndoBarrier, gaining appropriate regulatory approvals, continuing to improve our products and systems, operating the company in a lean fashion, and maximizing shareholder value.
EndoBarrier is the only proven, incision-free, non-anatomy-altering medical device designed to specifically mimic the mechanism of action of duodenal-jejunal exclusion created by gastric bypass surgery. EndoBarrier has three label indications outside the United States:
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Type 2 diabetes with BMI ³ 30 kg/m2
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Obese patients with BMI ³ 30 kg/m2 with ³ 1 co-morbidities
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Obese patients with BMI > 35 kg/m2
The EndoBarrier system consists of three primary components:
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EndoBarrier - The EndoBarrier gastrointestinal liner is a 60-cm-long implant consisting of a thin, flexible, impermeable fluoropolymer sleeve coupled to a proprietary nitinol anchor assembly. A gastroenterologist (GI clinician) or bariatric or metabolic surgeon implants EndoBarrier into the patient’s duodenum in a minimally invasive manner using the EndoBarrier Delivery System. EndoBarrier is placed via endoscopy (through the mouth and esophagus and into the stomach without cutting tissue) during a procedure that typically takes less than twenty minutes. Once properly positioned in the patient’s upper intestine just below the stomach, the EndoBarrier Delivery System is removed and EndoBarrier remains, held in place by a proprietary anchoring mechanism. EndoBarrier remains in the body for a maximum intended duration of twelve months until removal, again via a minimally invasive endoscopic procedure using the EndoBarrier Removal System. The effect of EndoBarrier begins promptly after device placement.
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EndoBarrier Delivery System - EndoBarrier is delivered using our proprietary single-use delivery system. This includes a sterile custom-made catheter 300 cm in length that is sufficiently flexible to be passed through the patient’s mouth, through the stomach, and into the intestine. EndoBarrier is provided prepacked in the EndoBarrier Delivery System inside a capsule at the distal end of the delivery catheter. EndoBarrier is deployed by the clinician using the delivery system controls at the proximal end of the system. The delivery procedure is brief, typically taking less than twenty minutes, during which the patient is either anaesthetized or semisedated.
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EndoBarrier Removal System - EndoBarrier is removed at the end of the treatment period via a minimally invasive endoscopic procedure using our proprietary grasper which passes through a standard gastroscope. The grasper is used to pull one of two drawstrings that connect to the EndoBarrier anchor assembly to collapse the anchor inward. As the drawstring is pulled, EndoBarrier collapses inward and the anchor system disengages from the wall of the duodenum. The retrieval hood, placed on the end of a gastroscope, allows the EndoBarrier anchor assembly to be pulled and collapsed into the hood and positioned to cover the anchor. The implant is then safely removed through the patient’s stomach, esophagus, and mouth. The EndoBarrier device is usually retrieved in a brief procedure typically taking less than twenty minutes, during which the patient is either anaesthetized or semisedated.
EndoBarrier has been shown in multiple company-sponsored and independent clinical studies to lower blood sugar levels (hemoglobin A1c or HbA1c), reduce excess body weight, and positively affect other health metrics and comorbidities.
EndoBarrier is approved and commercially available in multiple countries outside the United States, including in Europe, the Middle East, and South America.
In the United States, we must seek agreement from the FDA to conduct a clinical study under an investigational device exemption (IDE). To gain regulatory approval to commercialize EndoBarrier in the United States, we must submit a pre-market authorization (PMA) application for review and approval by the FDA.
Operations
We began selling EndoBarrier in Europe and South America in 2010 and in Australia in 2011. To date, we have distributed over 3,500 EndoBarriers and generated a total of $7.8 million in revenue. We have incurred net losses in each year since our inception.
We were incorporated in Delaware in 2003. We have raised net proceeds of approximately $232.6 million through sales of our equity. We generated $75.7 million in proceeds, net of expenses, through the sale of convertible preferred stock to a number of US venture capital firms, two global medical device manufacturers, and individuals prior to going public. In June 2011, we issued convertible term promissory notes to several of our shareholders totaling $6.0 million, which were repaid concurrently with the closing of our IPO in September 2011 with the associated gross proceeds. In September 2011, we raised approximately $72.5 million, net of expenses, and repaid $6.0 million of convertible term promissory notes in our IPO in Australia and simultaneous private placement of Chess Depository Interests (CDIs) to accredited investors in the United States. In connection with the IPO, all our existing shares of preferred stock were converted into common stock.
In July and August 2013, we raised approximately $52.5 million, net of expenses, in an offering of our CDIs to sophisticated, professional, and accredited investors in Australia, the United States, and certain other jurisdictions. In May 2014, we raised approximately $30.8 million, net of expenses, in an offering of our CDIs to sophisticated, professional, and accredited investors in Australia, Hong Kong, the United Kingdom, and certain other jurisdictions.
In December 2016, we raised approximately $1.0 million, net of expenses, in an offering of our CDIs to sophisticated and professional investors in Australia and certain other jurisdictions. In January 2017, we raised approximately $0.2 million, net of expenses, in an offering of our CDIs to eligible shareholders under a Security Purchase Plan (SPP) available to security holders with registered addresses in Australia or New Zealand.
We will continue to seek additional capital to fund the company’s operations as the situation dictates. Future financing may take the form of a number of different options as the management team seeks the best solutions for our corporate needs, clinical support of EndoBarrier, and our shareholders.
We are headquartered in Boston, Massachusetts, where the majority of the company’s employees work. We have employees and subsidiaries in the Netherlands, Germany, and Australia.
We are in the process of validating a contract manufacturer who will manufacture EndoBarrier. This is a result of eighteen months of joint effort with a world-class contract manufacturer in Mansfield, Massachusetts.
The rights of our shareholders are governed by Delaware general corporation law. We have five subsidiaries: GI Dynamics Securities Corporation, a Massachusetts-incorporated nontrading entity; GID Europe Holding B.V., a Netherlands-incorporated nontrading holding company; GID Europe B.V., a Netherlands-incorporated company that conducts certain of our European business operations; GID Germany GmbH, a German-incorporated company that conducts certain of our European business operations; and GI Dynamics Australia Pty Ltd, an Australia-incorporated company that conducts our Australian business operations.
We will need to raise additional capital in 2017.
For the year ended December 31, 2016, we had revenue of approximately $0.5 million, and our net loss was approximately $13.1 million. Our accumulated deficit as of December 31, 2016, was approximately $248.2 million. As of December 31, 2016, we had approximately $8.3 million of cash and cash equivalents. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” for further information regarding our funding requirements.
Market Opportunity
Unmet Clinical Needs in the Treatment of Type 2 Diabetes and Obesity
The International Diabetes Federation (2015) estimates there are 415 million adults with diabetes worldwide, with ~90% diagnosed with type 2 diabetes. Diabetes is the leading cause of cardiovascular disease, kidney failure, blindness, and lower-limb amputation in almost all high-income countries.
Three years after initial diagnosis, over half of patients with type 2 diabetes require multiple drug therapies; studies show that less than 50% of the type 2 diabetes population is adequately managed pharmacologically. At ten years postdiagnosis, most patients, despite insulin use in many, struggle to reach their hemoglobin A1c (HbA1c) treatment goals. HbA1c is a glycosylated hemoglobin molecule found in the bloodstream that is formed when red blood cells are exposed to blood glucose. HbA1c has become the generally accepted gold standard biomarker for measuring levels of diabetes control in clinical practice and in human trials.
Many patients and health care systems struggle to meet the financial burden imposed by the numerous concurrent medications required to attempt to control the progressive nature of type 2 diabetes.
According to the World Health Organization (2014), more than 1.9 billion adults 18 and older were overweight. Of these, 600 million people worldwide were considered obese (BMI ³ 30 kg/m 2), a condition often leading to serious health consequences such as cardiovascular disease, diabetes, musculoskeletal disorders, and some cancers.
Those suffering from both type 2 diabetes and obesity total more than 169 million worldwide, representing one of the largest health care market issues and opportunities in the world. We believe that the unchecked worldwide rate of growth of the type 2 diabetes and obesity patient population presents one of the greatest unmanaged health risks in all of health care.
We believe EndoBarrier is the only new treatment with a proven clinical profile that can treat patients with type 2 diabetes and obesity in a safe, effective, nonpharmacological, and nonpermanent procedural manner.
The Treatment Gap
Our intent in developing, seeking regulatory approval, and marketing EndoBarrier is to help clinicians deliver a unique treatment option in a disease state that sorely lacks innovative new treatment options: the type 2 diabetes and obesity clinical space.
We and our scientific advisors feel there must be a seismic shift in how the medical establishment currently treats patients suffering from type 2 diabetes and obesity. We believe current treatment options fall well short of treating the disease. The number of patients progressing to later stages of type 2 diabetes and obesity continues to grow at an alarming rate. Yet less than half of all type 2 diabetes patients are adequately managed by pharmacotherapy, and insulin carries serious risks and contributes to further progression of obesity. At the extreme end of the treatment spectrum, the treatment options are limited to different types of bariatric or metabolic surgery, which are highly invasive procedures. Less than 2% of patients who are eligible for bariatric or metabolic surgery opt to undergo the procedure.
The graphic above illustrates the multiple treatment options along the course of progression of type 2 diabetes:
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Risk associated with treatment increases from left to right.
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Progression of diabetes and obesity increases on a vertical axis from left to right.
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Lifestyle, diet, and exercise are the first line of defense against the progression of type 2 diabetes and obesity.
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Pharmacotherapy
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Oral monotherapy is next, often with metformin as the first line of treatment.
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Multiple combinations may then be administered, as recommended by the American Diabetes Association.
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Ultimately, as disease progression continues, injected insulin may be prescribed.
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Bariatric or metabolic gastric bypass surgery represents the final option.
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A significant and rapidly growing patient population falls into the treatment gap, where the patient is inadequately managed by medication yet unwilling to undergo gastric bypass.
The type 2 diabetes and obesity treatment gap is widening at an alarming rate.
We believe that neither pharmacotherapy nor gastric bypass surgery adequately treat the disease.
More alarming is that for many patients who elect to undergo bariatric or metabolic surgery, the clinical gains are not permanent, but the exposure to risk associated with the procedure is. The fastest growing area of bariatric and metabolic surgery is revisional bariatric/metabolic intervention (RBMI) surgery, which carries an even higher rate of complications and risk.
We believe a solution is desperately needed to fill this treatment gap.
EndoBarrier Value Proposition
Our intent in developing EndoBarrier is to offer an alternative to pharmacotherapy, especially insulin, and an alternative to bariatric or metabolic surgery.
Obesity exacerbates insulin resistance and worsens type 2 diabetes. In situations where lifestyle modification and pharmacotherapy have failed and surgery is not an option or is considered a therapy of last resort, EndoBarrier is a proven solution intended to break the pathogenic relationship between type 2 diabetes and obesity. In clinical trials in both the United States and outside of the United States (OUS), EndoBarrier has been shown to:
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Significantly improve glucose levels
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Significantly lower body weight
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Lower cardiovascular-related risks
EndoBarrier accomplishes this by affecting key hormones involved in insulin sensitivity, glucose metabolism, satiety, and food intake. (See section “The EndoBarrier Mechanism of Action.”)
Our intent in positioning EndoBarrier to fill the treatment gap is to help patients and clinicians avoid the initiation of insulin therapy by helping patients maintain lower HbA1c levels and slowing the progression of type 2 diabetes. Furthermore, for those patients whose type 2 diabetes has progressed to the point where insulin therapy is necessary, we hope EndoBarrier will reduce HbA1c levels to the point where insulin is no longer needed. Finally, if the progression of type 2 diabetes is severe enough to warrant gastric bypass surgery, we hope that EndoBarrier may serve as an opportunity to control type 2 diabetes so that surgery may not be needed, or at least better prepare the patient for bariatric surgery by lowering weight and helping control other comorbidities prior to surgery.
Our goal:
EndoBarrier Value Proposition:
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One solution - With EndoBarrier, patients with type 2 diabetes and obesity may control their glucose levels and weight with one procedure.
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Incision-free procedure, does not alter anatomy - Brief, minimally invasive implantation and removal procedures that do not involve the cutting of any tissue or permanent anatomical alterations are far less invasive than bariatric or metabolic procedures and therefore may be more acceptable to patients.
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Reduces and helps control HbA1c - Multiple studies have shown that EndoBarrier reduces HbA1c in a clinically meaningful manner.
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Reduces and helps control body weight - Multiple studies have shown that EndoBarrier reduces weight in a clinically meaningful manner.
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Simple procedure - The procedure is minimally invasive and fully reversible, usually takes less than twenty minutes, and may be conducted under general anesthesia or conscious sedation.
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EndoBarrier is safe - EndoBarrier is currently the only treatment for type 2 diabetes without an established mortality rate.
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Economically viable - An EndoBarrier procedure may significantly reduce costs associated with pharmacotherapy and costs of treating comorbidities. EndoBarrier is significantly less expensive than a single gastric bypass procedure, which becomes more expensive considering the revision rate and cost associated with RBMIs.
We and our scientific advisory board (SAB) are dedicated to furthering the scientific and clinical understanding of EndoBarrier, associated mechanisms of action, and the target disease states.
How EndoBarrier Works: EndoBarrier Mechanism of Action
EndoBarrier’s mechanism of action is widely accepted based on its functional similarities to Roux-en-Y gastric bypass surgery (RYGB). Clinical data suggest that once the EndoBarrier is implanted into the duodenum and proximal jejunum, ingested food passing through the EndoBarrier during the normal digestive process is prevented from interacting with the epithelium, microbiota, mucosal layer, or biliopancreatic secretions within the duodenum and proximal jejunum. The EndoBarrier acts as a physical barrier that prevents the interaction of food with pancreatic enzymes and bile. Pancreatic enzymes and bile pass outside EndoBarrier and mix with the food at the distal end of the liner, where absorption ultimately takes place in the intestine. Thus, EndoBarrier creates a functional but reversible bypass of the upper intestine. Unlike Roux-en-Y gastric bypass surgery,
EndoBarrier does not require an invasive and permanent surgical procedure or permanent physical modification of the stomach and exclusion of the distal stomach from the alimentary flow.
Our scientific team and advisors have postulated the following EndoBarrier mechanisms of action:
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Decreased caloric intake - Studies have demonstrated that patients with EndoBarrier, aided by increased satiety from GLP-1, eat less and feel full longer, leading to a decrease in caloric intake.
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Exclusion of the duodenum - This may offset an abnormality of gastrointestinal physiology responsible for insulin resistance and type 2 diabetes.
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Increased nutrient delivery to the distal small bowel - Additional findings suggest that the exclusion of the proximal intestine (foregut theory) and increase in nutrient delivery to the distal small bowel (hindgut theory) created by EndoBarrier likely induce neuro-hormonal changes and nutrient sensing that affect energy balance and glucose homeostasis.
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Secretion of GLP-1 - Partially digested nutrients reach the distal ileum, which stimulates the secretion of GLP-1 by L-cells located in this area. GLP-1 is known to regulate insulin secretion and action.
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Increase in gut hormones - This contributes to the restoration of energy and glucose homeostasis.
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Elevated GLP-1 and PYY levels - Both levels are elevated as quickly as one week post-implantation. Both hormones may play a role in satiety and body weight control.
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Increased levels of bile acids - This stimulates thermogenesis and gut hormone secretions.
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Improved islet function - Data suggest that pancreatic islet function is improved, affecting both insulin and glucagon secretion, positively affecting blood glucose levels. This shift to more favorable pancreatic islet function may be explained in part by the increase in the incretin hormone GLP-1 (as noted above) because this beneficial effect is well documented (i.e., a fundamental mechanism of both DPP4 inhibitor and GLP-1 receptor agonist pharmacologies).
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Intestinal flora - EndoBarrier may positively alter intestinal flora.
There is no known evidence of significant malabsorption of ingested calories with the EndoBarrier device. EndoBarrier covers only 60 cm of duodenal and proximal jejunal mucosa, which represents less than 15% of the length of the small intestine and leaves almost the entire jejunum and ileum for digestion and absorption.
2016 in Review
For us, 2016 was a year focused on stabilizing the Company and rebooting operations by significantly reducing cash burn, making wholesale changes to management and the employee base, addressing difficult legacy issues across multiple areas, supporting OUS commercial goals, and re-engaging with the FDA.
The company appointed three new executives to help stabilize and rebuild. The new team consists of a chief executive officer, chief financial officer, and chief compliance officer who have significant experience in corporate turnarounds and revitalizing distressed assets. They in turn have recruited highly experienced professionals who have been engaged since of the second quarter of 2016 with the sole purpose of rebuilding GI Dynamics and continuing to support EndoBarrier as a critical treatment option for clinicians and patients in the markets we serve.
The new team has conducted a thorough review of all available EndoBarrier safety and efficacy data as a first priority to ensure the device is safe and effective. This included hiring an independent consulting team with significant risk management, biostatistical, and quality management system experience to evaluate all major risks of EndoBarrier as well as the EndoBarrier efficacy profile. In addition, multiple new analyses of EndoBarrier were conducted, including a process optimization effort aimed at documenting the best practices from the most successful high-volume clinicians around the world and DNA analysis of explanted EndoBarriers.
We have retained numerous experienced clinicians who have served as clinical experts to provide feedback with regard to any instructions for use (IFU) or label changes to EndoBarrier, including modifications to recommended medication, patient selection, and patient monitoring.
Given this comprehensive review, the team has concluded that EndoBarrier is a safe and effective device. We will continue to analyze and work to more fully understand the benefit: risk profile of EndoBarrier and how best to optimally utilize the device.
We believe EndoBarrier to be a safe and effective device that fills a growing treatment gap in a unique manner.
The new leadership team undertook a comprehensive restructuring of every expense and major contract with the goal of reducing burn as rapidly as possible. The company restructured or replaced contracts with all major service providers and closed out all activities related to the pivotal trial in the United States, the ENDO clinical trial. The company ended its lease and moved out of its Lexington, Massachusetts, facility to a new facility in Boston, Massachusetts, which is significantly less expensive and offers a greater opportunity to attract new hires.
The changes to the leadership, employee base, and systems of the company are evidence of a comprehensive cultural change at GI Dynamics that will continue to evolve through 2017 and beyond. The company is operating with a high level of focus on accountability. When the new leadership team joined GI Dynamics at the end of Q1 2016, the following areas of focus were communicated. The results of the new team’s focus on these areas are captured here.
Corporate priorities for 2016, communicated on Q1 2016 shareholder call on 12 May 2016 (AEST):
1. Modify cost structure.
2. Rebuild team.
3. Develop clinical data and core science.
4. Focus revenue efforts.
5. Improve regulatory relationships.
By the end of 2016, the following results were achieved:
1. Modify cost structure.
Decreased cash used in operations from 2015 by over 60%.
Reduced quarterly burn from approximately $4.8 million in Q4 of 2015 to approximately $2.5 million in Q4 of 2016.
Analyze every line item of spending on a monthly basis. Replaced every large vendor with a less expensive and more appropriate service provider.
2. Rebuild team.
New leadership team.
Completely reworked team; hired new experienced professionals. Retained core team where appropriate.
3. Develop clinical data and core science.
Multiple clinical studies announced data in 2016.
Conducted thorough analysis of clinical data and risk and safety data.
4. Focus revenue efforts.
Redoubled efforts supporting reimbursement in the United Kingdom and Germany.
Retained key accounts during reduction in commercial expense.
5. Improve regulatory relationships.
Re-engaged with FDA.
Improved relationships with the regulatory bodies we work with.
Was unable to solve historical compliance issue within allotted time in Australia, which resulted in Therapeutic Goods Administration (TGA) cancellation.
Although we were able to achieve most of the objectives first communicated by the new leadership team in 2016, we were not able to achieve all our stated objectives.
Most notably, we were not able to solve historical compliance issues with the TGA dating back to early 2015. The result was the delisting of EndoBarrier from the Australian Register of Therapeutic Goods (ARTG). Despite this, all patients with an implanted EndoBarrier in Australia will be allowed to proceed to their scheduled therapy duration and removal at the time of the treating clinician’s choosing; there was no recall associated with this regulatory decision. In addition, an investigator-initiated and -led clinical trial focused on nonalcoholic fatty liver disease (NAFLD) and type 2 diabetes continues to enroll participants in Australia.
We and our new quality and regulatory teams have built significantly stronger relationships with regulatory agencies in multiple countries and have enhanced surveillance, complaint handling, and reporting systems. This has resulted in a significantly improved dialogue between the company and the regulatory agencies governing EndoBarrier use in Europe and the Middle East.
In addition, we achieved the following notable items:
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Presented ENDO preliminary clinical data trial at ADA
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Appointed Dan Moore as non-executive chairman of the board
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Presented ABCD REVISE clinical study data at ADA
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Presented NAFLD data at ADA
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Presented “The Effect of 1-Year’s Endoscopic Proximal Intestinal Exclusion Using EndoBarrier on 10-Year Cardiovascular Risk in Type 2 Diabetes” at ADA
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German hospitals won reimbursement arbitration court cases supporting EndoBarrier reimbursement under NUB-1
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Released German registry data on over 235 patients at EASD
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Closed financing of 15% shelf registration, raising ~USD $1.1 million
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Association of British Clinical Diabetologists initiated Worldwide EndoBarrier Registry
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FDA Accepted ENDO clinical study report
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U.S. Patent Office and the European Patent Office granted 8 patent allowances
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Closed Lexington Massachusetts office, terminated lease, moved into new facility in Boston Innovation District
EndoBarrier remains ahead of known competition; we have not lost our first-mover advantage. In fact, given that the unmet clinical need continues to grow every day, coupled with the fact that significant new data emerge regularly from clinicians who independently continue to reinforce the unique safety and efficacy profile of EndoBarrier, the future for EndoBarrier is bright.
Our team and many clinicians around the world firmly believe EndoBarrier represents a vital treatment option that fills a significant gap in current options in the type 2 diabetes and obesity disease state. We are universally committed to making EndoBarrier safe, effective, and available to clinicians around the world.
The new team has rapidly learned from the past, understands the issues, and is focused on delivering on the clinical promise of EndoBarrier and the strategic promise of GI Dynamics in 2017 and beyond.
Strategic Focus in 2017: The Path Forward
We are focused on the following initiatives in 2017, which are described in greater detail below:
1. Continue to rebuild GI Dynamics from the ground up.
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Build the new team and evolve the culture
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Complete systems overhaul
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Update risk management
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Continue implementing lean operating environment and spending controls
2. Focus on commercial outcomes in targeted geographies.
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Continue to focus efforts on reimbursement in the United Kingdom and Germany.
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Focus on commercial activity, primarily in the United Kingdom and Germany, with additional focus on other European countries and the Middle East.
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Revitalize and revamp corporate and product branding.
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Retain core commercial team.
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Optimize commercial model and sales force effectiveness.
3. Continue to develop additional clinical data regarding EndoBarrier’s safety and efficacy.
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Remain focused on additional clinical data being generated around the world.
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Build and leverage a world-class scientific advisory board.
4. Move toward US IDE plan and clinical study.
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Seek agreement with FDA to commence IDE trial to gain U.S. regulatory approval for EndoBarrier.
5. Adequately capitalize the company and continue to operate in a lean fashion.
1. Continue to rebuild GI Dynamics from the ground up:
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Build the new team and evolve the culture
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Complete systems overhaul
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Update risk management
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Continue implementing lean operating environment and spending controls
Building the new team and evolve the culture
The new management team continues to evolve our operations and attract talented new employees. We have added and will continue to add full-time employees and key consultants with significant domain expertise to provide work product at a high level.
The new culture at GI Dynamics is focused on accountability, teamwork, and open communications, and has a strong focus on patient safety and supporting EndoBarrier patients, clinicians, and provider organizations.
Complete systems overhaul
Our quality management system (QMS) has undergone a comprehensive review, undergone multiple SOP revisions and process improvement resulting in a measurable improvement to quality metrics. In addition, the company is close to validating its external contract manufacturer, a milestone that is the result of eighteen months of concerted effort.
Given the historical compliance issues at GI Dynamics, there remains risk of regulatory compliance issues moving forward. We are working to reduce that risk.
Update risk management
Each clinical risk associated with EndoBarrier has been reviewed by an external team of risk management experts and clinicians.
Continue implementing lean operating environment and spend controls
On a cost-management basis, we have cut our costs significantly from $4.8 million cash used in operations in Q4 2015 to $2.5 million cash used in operations in Q4 2016 by renegotiating with or replacing every one of our largest or most expensive service providers. In addition, we moved our headquarters from Lexington, Massachusetts, to Boston, Massachusetts, and ended the lease for the larger Lexington facility in favor of a significantly smaller and less expensive Boston facility. The growth of the company from this point forward will be carried out only in a highly accountable and lean fashion.
2. Focus on commercial outcomes in targeted geographies:
We have continued to focus on building the foundation upon which revenue can be maximized in the following ways:
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Continue to focus efforts on reimbursement in the United Kingdom and Germany.
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Focus on commercial activity, primarily in the United Kingdom and Germany, with additional focus on the Middle East and additional EU geographies.
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Revitalize and revamp corporate and product branding.
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Retain core commercial team.
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Optimize commercial model and sales force effectiveness.
Continue to focus efforts on reimbursement in the United Kingdom and Germany
We have dedicated significant time and effort towards gaining reimbursement in the United Kingdom and Germany. Management anticipates this focus will start to show results in 2017 and 2018. We expect early signs of these successes in 2017; we look forward to releasing information as it becomes available. Attaining reimbursement for new technologies is often a lengthy but necessary effort on the way to full commercialization.
German reimbursement
The German system of reimbursement is defined by a diagnostic related group (DRG) system similar to the DRG system in the United States. To proceed to an ideal level of full reimbursement, the German system provides for new technology payments within the Neue Untersuchungs- und Behandlungsmethoden (NUB system). NUB-1 is the highest level of new technology payment support in the system, and is designed to require payments that cover the gap between the full cost of a procedure including all supplies (including EndoBarrier) and the existing DRG. EndoBarrier was renewed at NUB-1 level in early 2017.
We have been working to support the increase of the base DRG to more appropriate levels by supporting EndoBarrier procedures within calculation hospitals. If, at the end of any calendar year, an adequate number of procedures have been conducted in calculation hospitals and supported by NUB-1 payments, a process may be initiated by the Institute for the Hospital Remuneration System (InEK) that may recalculate a new and higher DRG payment. This process occurs independently of involvement by us other than support by us for each procedure. The financial information from those procedures has been submitted independently of us to the German InEK to support a calculation for a potentially increased DRG that could take effect in either Q1 2018 or Q1 2019.
UK reimbursement
In the United Kingdom, we are following a two-pronged approach focused on a technical review process with the National Institute for Health and Care Excellence (NICE) and reimbursement support of individual clinical commissioning groups (CCGs).
We are continuing the engagement with NICE that was started in 2012 by refining the materials submitted and adding additional relevant clinical data to further support the NICE new technology evaluation process.
We support clinicians and hospital executives in their independent efforts to gain reimbursement from their local CCGs. There are 209 CCGs in the United Kingdom covering an average of 250,000 patient lives each. The executive leadership of each CCG is charged with optimizing the health of all patients within their CCG territory within their budget. We provide clinical and economic data to clinicians and hospital executives with the intent of assisting them in their work with their local CCG.
Although this activity is out of our direct control, we expect that the numerous clinicians who are aware of the growing untreated patient population, and the ability of EndoBarrier to help them treat said population, will follow the example of CCGs that have implemented an EndoBarrier payment plan and follow suit.
We are pursuing numerous awareness and advocacy activities to increase the awareness of EndoBarrier and its treatment effects.
Revitalize and revamp corporate and product branding
We are creating a new approach to messaging with a highly patient-centric message. This approach will manifest itself in refined messaging, updated and upgraded graphics, a new corporate website (www.gidynamics.com), and upgraded sales support tools.
Retention of core commercial team
We have focused on retaining our most experienced executives, sales professionals, clinical engineers, and distributors. We will continue to focus on attracting, training, and retaining the most effective sales professionals.
Optimize commercial model and sales force effectiveness
We employ a number of different sales force deployment strategies that range from 100% direct to 100% distributor, along with hybrid approaches combining both. These sales force deployment models will be evaluated for effectiveness and optimized on a real-time basis as the situation dictates. We are also focused on constantly improving the sales force effectiveness of our field teams through sales process optimization, individual and team development, and advanced analytical and sales operations support. Our management and sales leadership teams have significant experience in sales force deployment and optimization.
3. Continue to develop additional EndoBarrier safety and efficacy clinical data:
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Remain focused on additional clinical data being generated around the world.
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Build a world-class scientific advisory board.
Investigator-initiated clinical trials
EndoBarrier is the subject of multiple investigator-initiated trials and two independent registries. We and the independent investigators have maintained arms-length relationships with limited or no financial support to ensure the financial independence of these trials and to maintain the scientific credibility of the clinicians and the study results.
Two independent registries are currently enrolling.
German registry
The German registry is lead by: Professor Seufert, MD, from Freiburg University and Dr. Aberle, MD, from UKE Hamburg University. The German registry released clinical data on 234 patients at the European Association for the Study of Diabetes (EASD) in Munich in September 2016. This registry now has over 300 patients enrolled.
ABCD global registry
ABCD registry is a global registry run by the ABCD and financially supported by the UK National Health Service. More than 60 patients have been entered into the ABCD global registry.
Build and leverage a world-class SAB
As disclosed in the third quarter of 2016, a focus area of ours going forward will be to recruit a formal scientific advisory board. The SAB will be composed of a multidisciplinary and highly selective group of clinicians who share the belief that EndoBarrier is a critical part of their current treatment plans and are dedicated to helping us build on the scientific understanding and safety and efficacy profile of EndoBarrier.
The SAB will focus on expanding clinical support for both the safety and efficacy of EndoBarrier through analysis of current clinical data as well as helping to guide future clinical study plans. In addition, the SAB will lead efforts to understand and communicate mechanisms of action associated with different disease states, EndoBarrier function, and mechanisms associated with potential areas of risk for EndoBarrier. The SAB will also play a critical role in evaluating modifications to the labeling of EndoBarrier, optimizing the recommended medication protocol for treatment, and optimizing the comprehensive patient care plan supporting EndoBarrier among other material contributions.
4. Move toward US regulatory clearance:
Seek approval from FDA to gain US regulatory approval for EndoBarrier
GI Dynamics is working toward an IDE trial design that will be acceptable to the FDA. The purpose of this new trial is to prove the safety and efficacy of EndoBarrier in patients suffering from unmanaged type 2 diabetes and obesity. Management hopes to share further information with regards to the IDE study design in 2017.
5. Adequately capitalize the company and continue to operate in a lean fashion:
We will require additional capital to fund our operations, expand commercial efforts, primarily in the United Kingdom and Germany, continue to support revenue-generating operations in the Middle East, South America, and other select European countries, and fund an EndoBarrier clinical trial in the United States.
We will constantly evaluate multiple financing options with a focus on continuing to deliver a safe and effective treatment in EndoBarrier, continuing operations in a lean fashion, achieving the most impactful milestones, and maximizing shareholder value.
We will need to secure financing no later than the third quarter of 2017 to continue operations.
Finally, we have implemented numerous financial and operating systems and increased management oversight to ensure that as the company grows in the future, it will do so in a highly lean fashion.
Intellectual Property
We rely on a combination of patents, together with nondisclosure and confidentiality agreements, to establish and protect the proprietary rights to our technologies. Seedling Enterprises, LLC, initially conceived and developed our technology. In 2003, Seedling Enterprises, LLC, incorporated as GI Dynamics, Inc., and transferred all of its intellectual property relating to EndoBarrier to us with no further claims or royalties in exchange for shares of our common stock, par value $0.01 per share, or common stock.
On December 31, 2016, our current patent portfolio was composed of 155 issued and pending US and non-US patents. We have been issued 43 US patents and maintain 17 pending US patent applications. We have also sought intellectual property protection outside the US and have been issued 72 patents across Australia, Canada, China, the European Patent Convention region (including Austria, Belgium, France, Germany, Ireland, Italy, the Netherlands, Spain, Sweden, Switzerland, Turkey, and the United Kingdom), Hong Kong, and Japan, and we have 2 pending PCT applications and 21 pending foreign patent applications. We believe our patents and patent applications cover, but are not limited to, the following areas:
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The gastrointestinal liner and anchor;
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Delivery and removal systems;
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Placement of the device;
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Treatment alternatives; and
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The restrictor device.
Our current issued patents expire between 2023 and 2031. We also actively monitor our intellectual property by regularly reviewing new developments to identify extensions to our patent portfolio.
We entered into a patent license agreement with Crabb Co., LLC, or Crabb, in 2003, which was amended in 2005, for the in-license of certain intellectual property related to the anchoring of an intestinal liner, which is anchored in the pylorus. This license was obtained early in our history, and though we are not currently using this intellectual property, it may be useful in future implant designs. The royalty obligation begins with US commercial sales of products covered by the Crabb intellectual property. The royalty percentage may vary on products covered by the license, but, in any case, the royalties are not considered significant. We will cease paying royalties, if any, when the patent covered by the license expires in 2017.
We employ external patent attorneys to assist us in managing our intellectual property portfolio.
In 2013, we settled litigation with the supplier of the liner material used to manufacture EndoBarrier, W. L. Gore & Associates, Inc., or Gore. Under the settlement, we retain exclusive ownership and control of our patent portfolio, and we and Gore have dismissed all claims against each other. We also granted Gore a nonexclusive, royalty-free license to use our patents, restricted to the vascular system. Gore is not licensed to use our patents for any applications in the gastrointestinal tract. Neither we nor Gore are required to make any cash payments to the other, nor will any royalties be due.
Item 1A.
Item 1A. RISK FACTORS
Our business faces many risks. We believe the risks described below are the material risks that we face. However, the risks described below may not be the only risks that we face. Additional unknown risks or risks that we currently consider immaterial, may also impair our business operations. If any of the events or circumstances described below actually occur, our business, financial condition or results of operations could suffer, and the trading price of our CDIs could decline significantly. You should consider the specific risk factors discussed below together with the cautionary statements under the caption “Forward-Looking Statements” and the other information and documents that we file from time to time with the Securities and Exchange Commission, or SEC.
Risks Related to Our Business
We will need substantial additional funding and may be unable to raise capital when needed, which could force us to delay, reduce, or eliminate planned activities or result in our inability to operate as a going concern.
As we have limited commercialization of our products, we are generating a small amount of revenue and are not cash flow positive or profitable. Our net revenue from product sales was approximately $0.5 million for the year ended December 31, 2016 and, as of December 31, 2016, we had cash and cash equivalents of approximately $8.3 million. Our existing capital is insufficient to meet our requirements (including the costs of commercializing our products, conducting clinical trials, obtaining regulatory approvals and partnering with third-party manufacturers) and cover any losses, so we will need to raise additional funds through financings or borrowings prior to September 30, 2017. Failure to raise additional funds could delay, reduce, or halt our commercialization and clinical trial efforts and would impact our ability to continue as a going concern.
We have no committed sources of capital funding and there is no assurance that additional funding will be available to us in the future or be secured on acceptable terms. These factors raise substantial doubt about our ability to continue as a going concern. If adequate funding is not available, we may no longer be a going concern and may be forced to curtail operations, including our commercial activities and research and development programs, or cease operations altogether, file for bankruptcy, or undertake any combination of the foregoing. In such event, our stockholders may lose their entire investment in our company.
In addition, if we do not meet our payment obligations to third parties as they become due, we may be subject to litigation claims and our credit worthiness would be adversely affected. Even if we are successful in defending against these claims, litigation could result in substantial costs and would be a distraction to management, and may have other unfavorable results that could further adversely impact our financial condition.
We have a history of net losses and we may never achieve or maintain profitability.
We are a medical device company with a limited history of operations and have limited commercial experience with our product. We have incurred net losses since our inception, including net losses of approximately $48.2 million, $35.2 million and $13.1 million for the fiscal years ended December 31, 2014, 2015 and 2016, respectively. As of December 31, 2016, our accumulated deficit was approximately $248.2 million. Although we have started to generate revenues from sales in select markets outside the U.S., we expect to continue to incur significant operating losses for the foreseeable future as we incur costs, including those associated with commercializing our products, conducting clinical trials to test our products, attempting to secure regulatory approvals for our products (in the U.S. and other countries) and increased costs associated with being a public company in the U.S. with equity securities listed on the Australian Securities Exchange, or ASX.
We cannot predict the extent of our future operating losses and accumulated deficit and we may never generate sufficient revenues to achieve or sustain profitability.
In order to commercialize our products in the U.S. and certain other countries, we will need to obtain regulatory and other approvals. If we are unable to achieve or are delayed in achieving such approvals, this could have a significant effect on the time it takes to commercialize our technology in the U.S. and certain other countries.
At present, our only product that is approved for marketing and sale is EndoBarrier, which has received CE Mark approval in the E.U. In October 2016, we received final cancellation notification from the Australian Therapeutic Goods Administration, or TGA, for the listing of EndoBarrier on the Australian Register of Therapeutic Goods, or ARTG. As a result, we are not permitted to supply the EndoBarrier device in Australia for use outside of approved trials. There is no guarantee that we will maintain the CE Mark, be reapproved for inclusion on the ARTG, or obtain additional approvals from regulatory bodies, including the FDA in the U.S., to commercialize EndoBarrier or any of our other products. In the U.S., we stopped our pivotal trial of EndoBarrier. Accordingly, we will not be able to obtain FDA approval to commercialize EndoBarrier in the U.S. without a new clinical trial which may be lengthy and expensive. The regulatory authorities in other countries may also require additional clinical trials. Necessary regulatory approvals could also be delayed, which could significantly impact our ability to commercialize our technology in the U.S. and other countries.
We depend heavily on the success of our product, EndoBarrier, which is commercialized in select markets outside the U.S.
Assuming that we can obtain the required regulatory approvals in the U.S. and certain other countries, we expect to derive substantially all of our revenue from sales of our product, EndoBarrier, which is currently commercialized in the E.U. and the Middle East. Accordingly, our ability to generate revenues in the future relies on our ability to market and sell this product.
The degree of market acceptance for EndoBarrier will depend on a number of factors, including:
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the efficacy, ease of use and perceived advantages and disadvantages of EndoBarrier over other available treatments and technologies for managing type 2 diabetes and obesity;
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the prevalence and severity of any adverse events or side effects of EndoBarrier;
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the extent to which physicians adopt EndoBarrier (which may be influenced by our ability to provide additional clinical data regarding the potential long-term benefits provided by EndoBarrier and the strength of our sales and marketing initiatives); and
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the price of EndoBarrier and the third-party coverage and reimbursement for procedures using EndoBarrier.
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the extent to which reimbursement may be secured for each country in which EndoBarrier is commercialized.
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our ability to attract and retain professional sales personnel to drive EndoBarrier revenue
We cannot predict the outcome and timing of our current and future human clinical trials of EndoBarrier products.
The results of current and future human clinical trials, whether investigator initiated or Company sponsored, cannot be predicted. If EndoBarrier or new products that we develop and test in the future cause serious adverse events in future human clinical trials, these trials may need to be delayed or stopped. In addition, these clinical trials may not produce positive safety or efficacy results, or may produce results that are not as favorable as those seen in previous clinical trials.
Negative safety or efficacy results of our U.S. pivotal trial or any other current or future human clinical trials could require that we attempt to modify the EndoBarrier device or the treatment guidelines to address these issues and there is no guarantee that any potential modifications would be successfully developed.
If current or future human clinical trials of EndoBarrier products do not meet the required clinical specifications or cause serious adverse or unexpected events, such as those experienced in our U.S. pivotal trial, then these results could also materially impact product sales and reimbursement where we are currently selling our product and could affect regulatory approvals and adoption in countries where our product is being or has been introduced or regulatory approvals to seek to expand the use of EndoBarrier. If we are not able to adequately address any adverse or unexpected events through training, education, changes in product design or product claims, this may significantly impair the commercial prospects for EndoBarrier.
Doctors may not accept EndoBarrier as a treatment option.
The commercial success of EndoBarrier will require acceptance by physicians, who may be slow to adopt our product for the following reasons (among others):
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lack of long-term clinical data supporting patient benefits or cost savings over existing alternative treatments;
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lack of experience with EndoBarrier and training time required before it can be used driving preferences for other products or procedures;
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lack of adequate payment to the physician for implanting the device or caring for the patient (driven by availability of adequate coverage and reimbursement for hospitals and implanting physicians); and
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perceived strength of products, procedures or pharmacotherapies as alternatives to EndoBarrier
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perceived liability risks associated generally with the use of new products and procedures.
Although we have developed relationships with physicians who are key opinion leaders in certain countries, it cannot be assured that these existing relationships and arrangements can be maintained or that new relationships will be established in support of our products. If physicians do not consider our products to be adequate for the treatment of type 2 diabetes and obesity or if a sufficient number of physicians recommend and use competing products or pharmacotherapies, it could harm our business and future revenues.
We have limited sales, marketing and distribution experience.
There can be no guarantee that we will be able to effectively commercialize our products. Developing direct sales, distribution and marketing capabilities will require the devotion of significant resources and require us to ensure compliance with all legal and regulatory requirements for sales, marketing and distribution. Failure to develop these capabilities and meet these requirements could jeopardize our ability to market our products or could subject us to substantial liability. In addition, for those countries where we commercialize our products through distributors or other third parties, we will rely heavily on the ability of our partners to effectively market and sell our products to physicians and other end users in those countries.
We compete against companies that have longer operating histories, more established or approved products, and greater resources than we do, which may prevent us from achieving market penetration with our products.
Competition in the medical device industry is intense and EndoBarrier will compete in part against more established procedures and products for the treatment of type 2 diabetes and obesity. Bariatric surgery, including
gastric bypass surgery and the gastric band, have been used for many years with extensive publication histories on clinical effectiveness. Large multinational medical device companies sell supplies for these procedures and are formidable competitors to us. In addition, certain drugs have been approved, and are used, for the treatment of type 2 diabetes and obesity. Pharmaceutical companies with significantly greater resources than us market these drugs, and we may be unable to compete effectively against these companies.
Many of our competitors have significantly greater sales, marketing, financial and manufacturing capabilities than us and have established reputations and/or significantly greater name recognition. Accordingly, there is no assurance that we will be able to win market share from these competitors or that these competitors will not succeed in developing products that are more effective or economic.
Additionally, we are likely to compete with companies offering new technologies in the future. We may also face competition from other medical therapies, which may focus on our target market as well as competition from manufacturers of pharmaceutical and other devices that have not yet been developed. Competition from these companies could adversely affect our business.
We do not have data regarding the long-term benefits of EndoBarrier.
An important factor that may be relevant to market acceptance of EndoBarrier is whether it improves or maintains glycemic control and maintains weight loss over extended periods of time after removal of the device. While we have tested and evaluated our technology in several clinical trials with hundreds of patients which in aggregate have shown that EndoBarrier is an effective treatment for type 2 diabetes and obesity, we do not yet have sufficient data to demonstrate any longer-term benefits of our product in the treatment of type 2 diabetes and obesity following removal of the device from the patient.
We are continuing to monitor some patients who were implanted in our clinical trials after device removal to determine the ongoing effects and longevity of results, however, we do not currently have long-term data that supports the safety and efficacy of EndoBarrier. Accordingly, we cannot provide assurance that the long-term data, once obtained, will prove lower HbA1c levels compared to alternative treatment options for type 2 diabetes. If the results obtained from our clinical trials indicate that EndoBarrier is not as safe or effective as other treatment options or as effective as our current short-term data would suggest, EndoBarrier may not be approved, or its adoption may suffer and our business would be harmed.
If we fail to obtain and maintain adequate levels of reimbursement for our products by health insurers and other third-party payers, there may be no commercially viable markets for our products or the markets may be much smaller than expected.
Health care providers, including hospitals and physicians that purchase our products, generally rely on third-party payers, particularly government-sponsored health care and private health insurance providers, to pay for all or a portion of the costs of the procedures, including the cost of the products used in such procedures. Reimbursement and health care payment systems vary significantly by country. Third-party payers may attempt to limit coverage and the level of reimbursement of new therapeutic products.
If we fail to obtain and maintain adequate levels of reimbursement for our products by health insurers and other third-party payers, there may be few commercially viable markets for our products or the markets may be much smaller than expected. Third-party payers may demand additional clinical data requiring new clinical trials or economic models showing the cost savings of using our product, each of which would consume resources and may delay the decision on reimbursement. If the results of such studies are not satisfactory to third-party payers, then reimbursement may not be received in an acceptable amount or at all. In addition, the efficacy, safety, performance and cost-effectiveness of our products in comparison to any competing products or therapies may determine the availability and level of reimbursement.
We believe that future reimbursement may be subject to increased restrictions both in the U.S. and in international markets. Future legislation, regulation or reimbursement policies of health insurers or third-party payers may adversely affect the demand for our current and future products or limit our ability to sell these products on a profitable basis.
Our products are subject to extensive, dynamic and ongoing regulation in the E.U. and the other areas and countries where we sell EndoBarrier, which may impede or hinder the approval or sale of our products and, in some cases, may ultimately result in our inability to obtain approval of certain products or may result in the recall or seizure of previously approved products.
The medical device industry is regulated extensively by governmental authorities, principally the FDA and corresponding state and foreign regulatory agencies and authorities, such as the E.U., legislative bodies and the European Economic Area, or EEA, Member State Competent Authorities. Before we can market our products in the E.U., and in many other parts of the world, we must obtain and maintain CE Mark certification, which indicates that a product meets the essential requirements of applicable E.U. Directives and has been subject to the appropriate conformity assessment route. This conformity assessment procedure is often done through a self-certification, but depending on the type of product, may also require verification by an independent certification body, called a “Notified Body.” Notified Bodies will also periodically audit us to ensure that we remain in compliance with the applicable requirements. The CE Mark allows free movement of products in the E.U., the EEA and Switzerland although any of the member countries may require medical devices to be registered and also impose requirements relating to the language of the device information. Many non-European countries also recognize and accept the CE Mark. If we cannot support our performance claims and demonstrate continued compliance with the applicable E.U. requirements, we could lose our right to affix the CE Mark to our products, which would prevent us from selling our products within the territory and in other countries that recognize the CE Mark.
In addition, even after we receive regulatory approval of our products in existing markets, we are subject to ongoing regulatory requirements relating to our existing products in those markets. These include the requirement to timely file various reports with regulatory authorities in the countries in which we market our products, including reports of adverse events such as those experienced in our U.S. pivotal trial, including events that may have caused or contributed to a death or serious injury and malfunctions that would likely cause or contribute to a death or serious injury if the malfunction were to recur. If these reports are not timely filed, regulators may impose sanctions, including temporarily suspending our market authorizations or CE Mark, and sales of EndoBarrier may suffer. In that case, we may be subject to product liability or regulatory enforcement actions, all of which could harm our business. Our failure to comply with EEA or other foreign regulations applicable in the countries where we operate could lead to the issuance of warning letters or untitled letters, the imposition of injunctions, suspensions or loss of regulatory clearance or approvals, product recalls, termination of distribution, product seizures or civil penalties. In the most extreme cases, criminal sanctions or closure of our manufacturing facilities are possible.
In addition, numerous new regulatory changes in the E.U. came into effect in 2016. The company may not be able to comply with the new regulations and standards, despite compliance with prior regulations and standards
In addition, the company has evidenced a historical issue with compliance, leading to quality system issues that led to a 2014 shipping hold for E.U., multiple observations by the TGA in Australia regarding the company’s failure to comply with Essential Principals of the TGA and compliance issues which led to the TGA’s cancellation of the EndoBarrier’s listing on the ARTG. Given the history of non-compliance on a quality system basis, a substantial risk exists of future compliance issues, until such time as the company has had adequate time and resources to address the historical issues.
In some countries, we rely on our foreign distributors and agents to assist us in complying with foreign regulatory requirements, and we cannot be sure that they will always do so. If we or any of our suppliers, third-party manufacturers, distributors, agents or customers fail to comply with applicable requirements, we may face:
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adverse publicity;
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investigations by governmental authorities;
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fines and prosecutions;
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inability to raise capital;
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inability to attract and retain sales professionals;
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inability to attract and agree to terms with business partners;
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increased difficulty in obtaining required approvals;
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losses of approvals already granted;
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delays in purchasing decisions by customers or cancellation of existing orders; and
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the inability to sell our products in or to import our products into such countries.
Regulatory requirements affecting the development, manufacture and sale of medical devices are evolving and subject to future change. We cannot predict what impact, if any, those changes might have on our business. Failure to comply with regulatory requirements could have a material adverse effect on our business, financial condition and results of operations. Later discovery of previously unknown problems with a product or manufacturer could result in fines, delays or suspensions of regulatory approvals. The failure to receive product approval on a timely basis, or the withdrawal of product approval by regulatory agencies, such as the TGA’s cancellation of the EndoBarrier’s listing on the ARTG, could have a material adverse effect on our business, financial condition or results of operations.
Claims that our current or future products infringe or misappropriate the proprietary rights of others could adversely affect our ability to sell those products and cause us to incur additional costs.
If any third-party intellectual property claim against us is successful, we could be prevented from commercializing EndoBarrier or our other products.
There are numerous issued patents and pending patent applications in the U.S. and internationally that are owned by third parties and that contain patent claims in areas that are the focus of our product development efforts. We are aware of patents owned by third parties, to which we do not have licenses, that relate to, among other things, liner materials and anchoring. We have also employed individuals who were previously employed at other medical device companies, including competitors or potential competitors which may result in claims from third parties that we have inadvertently or otherwise used or disclosed alleged trade secrets or other proprietary information of former employers of our employees.
In addition, because patent applications can take many years to issue, there may be currently-pending applications, unknown to us, which may later result in issued patents that pose a material risk to us.
We expect that we could be subject to third-party infringement claims if our product sales increase, the number of competitors grows and the functionality of products and technology in different industry segments overlap. Third parties may currently have, or may eventually be issued, patents on which our current or future technologies may infringe.
If we are unable to obtain, maintain and enforce intellectual property protection covering our products, others may be able to make, use, or sell products substantially the same as ours, which could adversely affect our ability to compete in the market.
Our commercial success is dependent in part on obtaining, maintaining and enforcing intellectual property rights, including patents, covering EndoBarrier and our future products. If we are unable to obtain, maintain and enforce intellectual property protection covering our products, others may be able to make, use or sell products that are substantially the same as ours without incurring the sizeable development costs that we have incurred, which would adversely affect our ability to compete in the market.
Even if our patents are determined by a court to be valid and enforceable, they may not be sufficiently broad or enforceable to prevent others from marketing products similar to ours or designing around our patents, despite our patent rights. Our products may also nor may also not have freedom to operate unimpeded by the patent rights of others.
In addition to patented technology, we rely on a combination of non-patented proprietary technology, trade secrets, processes, procedures, technical knowledge and know-how accumulated or acquired since inception. Any of our intellectual property rights could be challenged, invalidated, circumvented or misappropriated. In order to preserve and enforce our patent and other intellectual property rights, we may need to make claims or file lawsuits against third parties. This can entail significant costs and divert management’s attention from developing and commercializing EndoBarrier.
We rely on suppliers for certain key components in the manufacture of the EndoBarrier system.
We rely on suppliers for several key components of EndoBarrier, in particular the material used to manufacture the sleeve used in EndoBarrier. We do not presently have active supply agreements with any of these suppliers. Our reliance on third-party suppliers subjects us to risks that could harm our business, particularly with respect to the supply of key components or processes. Although we believe that alternative suppliers are available, the process of identifying and qualifying new suppliers who can produce the components to our specifications could cause delays in the commercialization of our products.
In addition, we are in the process of validating a contract manufacturer for our product. We do not have experience with the manufacturer, and the manufacturer may fail to manufacture our products in a validated manner or to acceptable levels of quality.
The use, misuse or off-label use of our products by physicians may harm our image in the marketplace or result in injuries that lead to product liability.
We cannot prevent a physician from using EndoBarrier for purposes outside of its approved and intended use, which is known as off-label use. If physicians attempt to use our products off-label, there may be an increased risk of adverse events. Further, the use of our products for uses other than those uses for which our products have been approved may not effectively treat such conditions, which could harm our reputation in the marketplace among physicians and patients.
Physicians may also misuse our products or use improper techniques if they are not adequately trained, potentially leading to injury and an increased risk of product liability for us. Physicians may also treat patients from other countries where the product is not approved and the physician is then unable to properly monitor the patient’s progress. If we are deemed to have engaged in the promotion of any of our products for off-label use, we could be subject to action by regulatory authorities and the imposition of sanctions, which could also affect our reputation and position within the industry.
Patients may not follow instructions from their physicians. Patients who ignore training and ignore their clinician’s request to remove EndoBarrier at the end of the 12 month indication for treatment may be exposed to greater clinical risk.
Product liability claims could damage our reputation or adversely affect our business or financial position.
We may be exposed to the risk of product liability claims, which are inherent in the design, manufacturing, marketing and use of medical devices and, in particular, implantable medical devices. We hold product liability insurance; however, adequate product liability insurance may not continue to be available on commercially-acceptable terms. Product liability claims may damage our reputation and, if our insurance coverage proves inadequate, may harm or destroy our business. Defending a suit, regardless of its merits, could be costly and could divert our management’s attention from our core business activities.
We rely on a third-party manufacturer for our products and this manufacturer is required to comply with regulatory requirements.
Completion of our current and future clinical trials and commercialization of our products require access to manufacturing facilities that meet applicable regulatory standards to manufacture a sufficient supply of our products. We will rely on a third-party manufacturer to meet the applicable regulatory requirements. To date, we have been working to complete the transfer of our technology and manufacturing processes to a designated third-party manufacturer. That process is not complete and we have not executed a separate manufacturing supply agreement. We anticipate completing such an agreement in the near term. Any disruption to manufacturing by this third-party manufacturer would adversely affect our business.
Suppliers of components and products used to manufacture our products and our third-party manufacturer must also comply with applicable regulatory requirements. These often require significant time, resources, record-keeping and quality assurance efforts and subject us, our suppliers and third-party manufacturer to potential regulatory inspections and stoppages. Compliance with applicable regulatory requirements is subject to continual review and is rigorously monitored by regulatory authorities. Failure by us, our third-party manufacturer or suppliers to comply with regulatory requirements or failure to take satisfactory corrective action in response to an adverse inspection could result in enforcement actions that could disrupt manufacturing or sales of EndoBarrier.
In order to manufacture EndoBarrier in the quantities that we anticipate will be required to meet our clinical trial needs and market demand, we will need to increase production capacity and efficiency over current levels, and our third-party manufacturer must therefore be able to provide us with sufficient quantities of our product in compliance with regulatory requirements, in accordance with agreed upon specifications, at acceptable cost and on a timely basis. Our potential future growth could strain the ability of our third-party manufacturer to deliver our product and obtain materials and components in sufficient quantities. Third-party manufacturers often experience difficulties in scaling up production, including problems with production yields and quality control and assurance. If we are unable to obtain a sufficient or consistent supply of EndoBarrier or any other product we are developing, or if we cannot do so efficiently, our revenue, business and financial prospects would be adversely affected.
Following our reduction of headcount in August 2015 and the second and third quarters of 2016, we may be unable to retain our remaining employees and therefore we may not be able to sustain our business.
Since we began our efforts to restructure our business and expenses (the “Restructuring”) in August 2015, our workforce has been reduced by 40 people, leaving 15 employees as of February 28, 2017.
As a result of the Restructuring, we are heavily dependent upon our ability to retain our remaining employees. The loss of the service of any of our remaining employees may have an adverse effect on our business. Given the magnitude of our reduction in force since August 2015, the morale of our remaining employees may be lower, employees may be distracted and any one of our remaining employees could terminate his or her employment with us at any time. A departing employee’s expertise would be difficult to replace and the failure to do so on a timely basis could have a material adverse effect on our ability to achieve our business
goals. There can be no assurance that we will have the financial resources or otherwise to be successful in retaining our remaining personnel and our failure to do so could have a material adverse effect on our business, financial condition and results of operations. In addition, the Restructuring may prove to be more disruptive to our operations than we anticipated. For example, cost savings measures may distract management from our core business, harm our reputation, yield unanticipated consequences, such as attrition beyond the planned Restructuring, increased reliance on consultants, or increased difficulties in our day-to-day operations.
If we are unable to retain or hire key personnel, we may not be able to sustain or grow our business.
Our ability to operate successfully and manage our potential future growth depends significantly upon our ability to attract, retain and motivate highly-skilled and qualified research, technical, clinical, regulatory, sales, marketing, managerial and financial personnel. The competition for qualified employees in the medical device industry is intense and there are a limited number of persons with the necessary skills and experience.
Our performance is substantially dependent on our senior management and key technical staff to continue to develop and manage our operations. The loss or the inability to recruit and retain high-caliber staff could have a material adverse effect on us. We also rely on the technical and management abilities of certain key directors, key members of our executive team and employees, consultants and scientific advisers. The loss of any of these directors, members of the executive team, employees, consultants or scientific advisers could have an adverse effect on our business. In March 2016, our prior chief executive officer left the Company.
We may be unable to effectively manage our anticipated growth.
To manage our anticipated growth and to commercialize our products, we will need to expand our operations (research and development, product development, quality, regulatory, manufacturing, sales, marketing and administrative). This expansion will place a significant strain on our management, infrastructure and operational and financial resources, particularly in light of the Restructuring. Specifically, we will need to manage relationships with various persons and entities participating in our clinical trials, quality systems, manufacturers, suppliers and other organizations, including various regulatory bodies in the U.S. and other jurisdictions. We may not be able to implement the required improvements in an efficient and timely manner and may discover deficiencies in existing systems and controls. The failure to accomplish any of these tasks could materially harm our business and our ability to commercialize EndoBarrier. As a result, our revenue, business and financial prospects would be adversely affected.
We incur increased costs as a result of being a public company in the U.S. whose equity securities are listed on the Australian Securities Exchange.
As of December 31, 2013, we became subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Although the existing listing of our Chess Depositary Interests, or CDIs, on the ASX requires us to file financial information and make certain other filings with the ASX, our status as a reporting company under the Exchange Act causes us to incur additional legal, accounting and other expenses, including costs related to compliance with the requirements of the Sarbanes-Oxley Act of 2002, insurance costs related to being an exchange act reporting company and other administrative costs. We also expect all of these rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our Board or as executive officers. We cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.
Our shares of our Common Stock are publicly traded on the ASX in the form of CDIs. As a result, we must comply with the ASX Listing Rules. We have policies and procedures that we believe are designed to provide reasonable assurance of our compliance with the ASX Listing Rules. If, however, we do not follow those
procedures and policies, or they are not sufficient to prevent non-compliance, we could be subject to liability, fines and lawsuits. These laws, regulations and standards are subject to varying interpretations and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If, notwithstanding our efforts to comply with new laws, regulations and standards, we fail to comply, regulatory authorities may initiate legal proceedings against us and our business may be harmed.
Investors could lose confidence in our financial reports, and the value of our CDIs and Common Stock may be adversely affected, if our internal controls over financial reporting are found not to be effective by management or by an independent registered public accounting firm or if we make disclosure of existing or potential significant deficiencies or material weaknesses in those controls.
As a public company in the U.S., we are required, pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting as of the end of the fiscal year. Our first report on compliance with Section 404 was furnished in connection with our financial statements for the year ended December 31, 2014. Additionally, our independent registered public accounting firm will be required to issue a report on management’s assessment of our internal control over financial reporting and a report on their evaluation of the operating effectiveness of our internal control over financial reporting. Our auditor’s first report on our compliance with Section 404 is expected to be in connection with our annual report on Form 10-K following the date on which we are no longer an emerging growth company. The controls and other procedures are designed to ensure that information required to be disclosed by us in the reports that we file with the SEC, is disclosed accurately and is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. We continue to update, document and evaluate our internal control over financial reporting to the requirements of Section 404. Despite our efforts, there is a risk that we will not be able to conclude, from time to time, that our internal control over financial reporting is effective as required by Section 404.
We continue to evaluate our existing internal controls over financial reporting against the standards adopted by the Public Company Accounting Oversight Board. During the course of our ongoing evaluation of the internal controls, we may identify areas requiring improvement, and may have to design enhanced processes and controls to address issues identified through this review. Remediating any deficiencies, significant deficiencies or material weaknesses that we or our independent registered public accounting firm may identify may require us to incur significant costs and expend significant time and management resources. We cannot assure you that any of the measures we implement to remedy any such deficiencies will effectively mitigate or remedy such deficiencies. The existence of one or more material weaknesses could affect the accuracy and timing of our financial reporting. Investors could lose confidence in our financial reports, and the value of our CDIs and Common Stock may be adversely affected, if our internal controls over financial reporting are found not to be effective by management or by an independent registered public accounting firm or if we make disclosure of existing or potential significant deficiencies or material weaknesses in those controls.
Fluctuations in foreign currency exchange rates could adversely affect our financial results.
As our activities produce revenues and incur expenses in a variety of different currencies, we are exposed to exchange rate risk which may affect our financial performance and position. Furthermore, some of our funds may be held in euros, Australian dollars or other currencies, while our functional currency is U.S. dollars. We are not currently hedging against exchange rate fluctuations, and consequently we will be at the risk of any adverse movement in the U.S. dollar exchange rate if we exchange funds held in one currency into another currency.
Our shares of Common Stock, in the form of CDIs, are listed on the ASX and priced in Australian dollars. However, our reporting currency is U.S. dollars. As a result, movements in foreign exchange rates may
cause the price of our securities to fluctuate for reasons unrelated to our financial condition or performance and may result in a discrepancy between our actual results of operations and investors’ expectations of returns on our securities expressed in Australian dollars.
Risks Related to Our Industry
The medical device industry is subject to rapid technology change, which may result in obsolescence of our products.
The medical device industry is subject to rapid technology change. In order for us to remain competitive and to retain and build market share, we must continually develop new products as well as improve our existing ones. Accordingly, we must devote substantial resources to research, development and commercialization activities.
There can be no assurance that we will be successful in developing competitive new products and/or improving existing products so that such products remain competitive and avoid obsolescence. There can also be no assurance that any or all of our research and development projects for new products will demonstrate safety and efficacy and result in commercial products, or that if such products are successfully designed and launched, they will be profitable.
Health care reform legislation could adversely affect our future revenue and financial condition.
In recent years, there have been numerous initiatives by governments throughout the world for comprehensive reforms affecting the delivery of and payment for health care. We cannot predict the changes that will be made and the effect such changes will have on the use of EndoBarrier. Decisions to increase or decrease reimbursement or coverage for treatments for type 2 diabetes and/or obesity could have a material impact on our business and results of operations.
New legislation in the U.S. has also been enacted that imposes additional reporting requirements, penalties and taxes on the medical device industry. While we have adopted comprehensive compliance programs to attempt to comply with these regulations, it is possible that some of our business activities could be subject to challenge under one or more of such laws. If our past or present operations, or those of our independent sales agents and distributors, are found to be in violation of any of such laws or any other applicable governmental regulations, we may be subject to penalties, including civil and criminal penalties, damages, fines or exclusion from health care reimbursement.
Pricing pressures in the health care industry could lead to further demands for price concessions, which could have an adverse effect on our business, financial condition or results of operations.
Due to the significant rise in health care costs over the past decade, numerous initiatives and reforms initiated by governments and third-party payers to curb these costs have resulted in difficulties in maintaining or raising the number and price of procedures. The increase in pricing pressure is driven by the competitive environment in the medical device industry as many larger companies cut prices as they struggle to retain market share.
The type 2 diabetes and obesity market has seen increasing resistance from payers with regard to local and national reimbursement coverage. We expect that market demand, government regulation, third-party reimbursement policies and societal pressures will continue to exert downward pressure on the prices of our products and may adversely impact our business, financial condition or results of operations.
International operations subject us to certain operating risks, which could adversely impact our net revenues, results of operations and financial condition.
While our products are manufactured in the U.S., sales of our products are currently only made in select markets outside the U.S. As we seek to expand into the U.S. and additional foreign markets, we will be subject to
new business risks, including failure to fulfill regulatory requirements on a timely basis, or at all, to market EndoBarrier or other future products; difficulties in managing foreign relationships and operations, including relationships we establish with foreign partners, distributors, or sales or marketing agents; adapting to the differing laws and regulations, business and clinical practices, and patient preferences in various countries; difficulty in collecting accounts receivable and longer collection periods; costs of enforcing contractual obligations in foreign jurisdictions; recessions in relevant foreign countries; political instability and unexpected changes in diplomatic and trade relationships, currency exchange fluctuations and potentially adverse tax consequences.
The sale and shipment of our products across international borders, as well as the purchase of components and products from international sources, could subject us to extensive U.S. and other governmental trade, import and export, and custom regulations and laws. Compliance with these regulations is costly and exposes us to penalties for non-compliance.
Other laws and regulations that can significantly impact us include various anti-bribery laws, including the U.S. Foreign Corrupt Practices Act, anti-boycott, anti-kickback, false claims and fraud laws, as well as laws protecting the confidentiality of patient health information. Any failure to comply with applicable legal and regulatory obligations could impact us in a variety of ways, including, but not limited to, civil and administrative penalties, denial of export privileges, seizure of shipments and restrictions on certain business activities.
Manufacturing facilities for medical devices must comply with applicable regulatory requirements.
Completion of our current and future clinical trials and commercialization of our products requires access to manufacturing facilities that meet applicable regulatory standards to manufacture a sufficient supply of our products. The third-party manufacturer and suppliers of components and parts that we intend to use to manufacture our products must also comply with applicable regulatory requirements, which often require significant time, money, resources and record-keeping and quality assurance efforts and subject us, our third-party manufacturer and our suppliers to potential regulatory inspections and stoppages.
Compliance with applicable regulatory requirements is subject to continual review and is rigorously monitored through periodic inspections by regulatory authorities. Failure by us, our third-party manufacturer or our suppliers to comply with regulatory requirements or failure to take satisfactory corrective action in response to an adverse inspection could result in enforcement actions, including a public warning letter, a shutdown of, or restrictions on, our ability to obtain sufficient quantities of our products, delays in approving or clearing a product, refusal to permit the import or export of our products or other enforcement action.
Risks Related to Our CDIs and Our Common Stock
There is no current trading market for our Common Stock in the U.S. and no such market may develop.
Although our CDIs are currently listed on the ASX in Australia, there is not any current trading market for our CDIs or the underlying shares of Common Stock in the U.S. As a result, no trading market for our Common Stock may develop in the U.S. and you may not be able to transfer or resell your CDIs at their fair value, or at all.
We are eligible to be treated as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our Common Stock and CDIs less attractive to investors.
We are an “emerging growth company”, as defined in the JOBS Act. For as long as we continue to be an emerging growth company, we may take advantage of exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including (1) not being required to
comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, (2) reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and (3) exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We could be an emerging growth company until the last day of the fiscal year following the fifth anniversary of the date of the first sale of our common equity securities pursuant to an effective Securities Act registration statement, although circumstances could cause us to lose that status earlier, including if the market value of our Common Stock and CDIs held by non-affiliates exceeds $700.0 million as of any June 30 before that time or if we have total annual gross revenue of $1.0 billion or more during any fiscal year before that time, in which cases we would no longer be an emerging growth company as of the following December 31 or, if we issue more than $1.0 billion in non-convertible debt during any three-year period before that time, we would cease to be an emerging growth company immediately. We cannot predict if investors will find our Common Stock or CDIs less attractive because we may rely on these exemptions. If some investors find our Common Stock or CDIs less attractive as a result, there may be a less active trading market for our Common Stock or CDIs and our stock price may be more volatile.
Under the JOBS Act, emerging growth companies can also delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.
Changes in economic conditions may adversely affect our business.
Changes in the general economic climate in which we operate may adversely affect our financial performance and the value of our assets. Factors that contribute to that general economic climate include:
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contractions in the world economy or increases in the rate of inflation;
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international currency fluctuations;
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changes in interest rates;
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new or increased government taxes or duties or changes in taxation laws; or
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changes in government regulatory policy.
Stock market fluctuations may adversely affect the price of our CDIs and Common Stock.
There are a number of risks associated with any stock market investment. Our CDIs have been traded on the ASX since September 7, 2011. The price of our CDIs has been, and is likely to continue to be, volatile, which means that it could decline substantially within a short period of time. The value of the CDIs will be determined by the stock market and will be subject to a range of factors beyond our control. These factors include movements in local and international stock exchanges, local interest rates and exchange rates, domestic and international economic and political conditions, government taxation, market supply, competition and demand and other legal, regulatory or policy changes.
The trading volume of our CDIs is relatively low, which may result in reduced liquidity for our shareholders.
Our CDIs are only listed on the ASX and are not listed for trading on any other securities exchanges in Australia, the U.S. or elsewhere. As such, there can be no guarantee that an active market in the CDIs will develop or continue, or that the market price of the CDIs will increase. If a market does not develop or is not sustained, it may be difficult for investors to sell their CDIs. Furthermore, the market price for the CDIs may fall or be made more volatile because of the relatively low volume of trading in our securities. When trading volume is low, significant price movement can be caused by trading in a relatively small number of shares.
Sales of a substantial number of CDIs, or the perception that these sales may occur, could cause the market price of our CDIs to decline. Sales by our current shareholders of a substantial number of CDIs, or the expectation that such sales may occur, could significantly reduce the market price of our CDIs. We may also offer additional CDIs in subsequent offerings, which may adversely affect the market price for the CDIs.
Some of our current shareholders can exert control over us and may not make decisions that are in the best interests of all shareholders.
As of March 15, 2017, 4 shareholders and their affiliated entities owned approximately 57.7% of our outstanding shares of Common Stock, or CDIs representing Common Stock, in the aggregate. As a result, these shareholders, if they act together, would be able to exert a significant degree of influence over our management and affairs and over matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may harm the market price of the CDIs by delaying or preventing a change in control, even if a change is in the best interests of our other shareholders.
Provisions of our Certificate of Incorporation, our Bylaws and Delaware law could make an acquisition of us more difficult.
Certain provisions of our Certificate of Incorporation and Bylaws could discourage, delay or prevent a merger, acquisition or other change of control that our shareholders may consider favorable, including transactions in which our shareholders might otherwise receive a premium for their CDIs. These provisions could also limit the price that investors might be willing to pay in the future for the CDIs, thereby depressing the market price of the CDIs. Shareholders who wish to participate in these transactions may not have the opportunity to do so. A summary of these provisions is set out in our Registration Statement on Form 10, filed with the SEC on April 30, 2014. In addition, we are incorporated in the State of Delaware and, as such, are governed by the provisions of Section 203 of the Delaware General Corporation Law, which may, unless certain criteria are met, prohibit large shareholders, in particular those owning 15% or more of the voting rights on our Common Stock, from merging or combining with us for a prescribed period of time.
We do not intend to pay cash dividends on our Common Stock in the foreseeable future.
We have never declared or paid any cash dividends on our shares, and we currently do not anticipate paying any cash dividends in the foreseeable future. We intend to retain any earnings to finance the development and expansion of our products and business. Accordingly, our shareholders will not realize a return on their investment unless the trading price of our CDIs appreciates.
We may be subject to arbitrage risks.
Investors may seek to profit by exploiting the difference, if any, in the price of our CDIs on the ASX and the price of our Common Stock available for sale in the U.S., whether such sales would take place on a U.S. securities exchange or in the over-the-counter market or otherwise. Such arbitrage activities could cause our share price in the market with the higher value to decrease to the price set by the market with the lower value.
Our ability to use our net operating loss carryforwards and certain other tax attributes may be limited.
Our ability to utilize our federal net operating losses and federal tax credits may be limited under Sections 382 and 383 of the Internal Revenue Code. The limitations apply if an ownership change, as defined by Section 382, occurs. Generally, an ownership change occurs when certain shareholders increase their aggregated ownership by more than 50 percentage points over their lowest ownership percentage in a testing period (typically three years). We may already be subject to Section 382 limitations due to previous ownership changes. In addition, future changes in stock ownership may also trigger an ownership change and, consequently, a Section 382 limitation. Due to the significant complexity and cost associated with a change in control study, and
the expectation of continuing to incur losses whereby the net operating losses and federal tax credits are not anticipated to be used in the foreseeable future, we have not assessed whether there have been changes in control since our formation. If we have experienced changes in control at any time since our formation, utilization of our net operating losses or research and development credit carryforwards would be subject to annual limitations under Section 382. Any limitation may result in expiration of a portion of the net operating loss or research and development credit carryforwards before utilization, which would reduce our gross deferred tax assets and corresponding valuation allowance. As a result, if we earn net taxable income, our ability to use our pre-change net operating loss carryforwards to offset U.S. federal taxable income may be subject to limitations, which could potentially result in increased future tax liability to us.
Other general risks.
Our future viability and profitability is also dependent on a number of other factors that affect the performance of all industries and not just the medical device industry, including (but not limited to) the following:
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financial failure or default by a party to any contract to which we are, or may become, a party;
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insolvency or other managerial failure by any of the contractors that we use;
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industrial disputes;
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litigation;
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natural disasters; and
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acts of terrorism or an outbreak of international hostilities.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
On May 23, 2013, we entered into a Sublease Agreement with Cambridge Technology, Inc., as sub-landlord for the sublease of the premises located at 25 Hartwell Avenue, Lexington, Massachusetts. The subleased premises were approximately 33,339 square feet. The sublease expired on December 31, 2016.
In June 2016, we entered into a non-cancelable agreement to lease approximately 4,200 square feet of office and laboratory space in Boston, Massachusetts. The lease commenced in June 2016 and expires in April 2018. There are no extension options. In the event that the lease is terminated early, and provided there is sufficient notice, we believe we could find suitable alternative premises with no interruption in operations. If the lease is terminated without notice or the premises are severely damaged, there could be an impact on our operations while we relocate to new premises. We believe that these premises are suitable and adequate for our needs now and for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not Applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our CDIs, each representing one-fiftieth of one share of our Common Stock after giving effect to our April 9, 2015 1:10 reverse stock split, have been listed on the ASX under the trading symbol “GID” since September 7, 2011. Prior to such time there was no public market for our securities. Our high and low sales prices on the ASX for the respective periods are shown below, both in Australian dollars per CDI and in U.S. dollars per share of Common Stock. All currency conversions are based on the prevailing Australian dollar to U.S. dollar exchange rate applicable on the relevant date as reported by the Reserve Bank of Australia.
On December 31, 2016, the last reported sale price of our CDIs was A$0.02 per CDI, or $0.83 per share of Common Stock.
As of December 31, 2016, 1,180,604 of our shares were subject to outstanding options, restricted stock units and warrants to purchase shares of Common Stock.
Holders
As of March 15, 2017, we had 11,157,489 shares of Common Stock issued and outstanding with approximately 20 holders of record. The holders included CHESS Depositary Nominees Pty Limited, or CDN, which held 11,059,680 shares of our Common Stock in the form of CDIs on behalf of the CDI holders; there were approximately 1,056 registered owners of our CDIs on March 15, 2017.
Dividends
We have never declared or paid any dividends on our share capital and do not currently anticipate declaring or paying dividends in the foreseeable future. We currently intend to retain all of our future earnings, if any, to finance the operation and expansion of our business. Any future determination relating to our dividend policy will be made at the discretion of the Board of Directors, the Board, and will depend on a number of factors, including future earnings, capital requirements, financial conditions, future prospects, contractual restrictions and covenants and other factors that the Board may deem relevant.
Equity Compensation Plan Information
The information required to be disclosed by Item 201(d) of Regulation S-K, “Securities Authorized for Issuance Under Equity Compensation Plans” is referenced under Item 12 of Part III of this Annual Report on Form 10-K.
Corporate Performance Graph
The following performance graph and related information shall not be deemed to be “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that we specifically incorporate it by reference into such filing.
The following performance graph compares the performance of our Common Stock from December 31, 2011 through December 31, 2016, after giving effect to the fifty-for-one CDI-to-Common Stock exchange ratio and after converting to U.S. dollars using the closing exchange rate applicable on the relevant date as reported by the Reserve Bank of Australia, to the performance of the NASDAQ Composite Index and the NASDAQ Medical Equipment Index from December 31, 2011 through December 31, 2016. The comparison assumes $100 was invested in our Common Stock after the market closed on December 31, 2011. Pursuant to applicable SEC rules, all values assume reinvestment of the full amount of all dividends, however no dividends have been declared on our Common Stock to date. The stockholder return shown on the performance graph below is not necessarily indicative of future performance, and we do not make or endorse any predictions as to future stockholder returns.
COMPARISON OF CUMULATIVE TOTAL RETURN*
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
You should read the following selected financial data together with our consolidated financial statements and the related notes appearing elsewhere in this Annual Report on Form 10-K. We have derived the consolidated statements of comprehensive loss data for the years ended December 31, 2016, 2015 and 2014 and the consolidated balance sheet data as of December 31, 2016, and 2015 from our audited financial statements included elsewhere in this Annual Report on Form 10-K. We have derived the consolidated statements of comprehensive loss data for the years ended December 31, 2013 and 2012 and the consolidated balance sheet data as of December 31, 2014, 2013 and 2012 from our audited financial statements not included in this Annual Report on Form 10-K. Our historical results for any prior period are not necessarily indicative of results to be expected in any future period.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes to those financial statements appearing elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. You should review the “Risk Factors” section of this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements described in the following discussion and analysis.
Overview
We are a medical device company headquartered in Boston, Massachusetts, which is dedicated to restoring health and improving quality of life through the design and application of device and disease management solutions for treatment of metabolic disease. Our vision is to make our product, EndoBarrier, a vital treatment option for patients with type 2 diabetes and obesity by restoring healthier blood sugar levels and reducing body weight. EndoBarrier is the first endoscopically-delivered device approved for the treatment of obese type 2 diabetes. EndoBarrier is the only proven, incision-free, non-anatomy altering solution designed to specifically mimic the clinical benefit of the duodenal-jejunal exclusion created by gastric bypass surgery. We have commercially launched EndoBarrier, which is approved and commercially available in multiple countries outside the U.S.
In the U.S., we commenced enrollment of patients in our pivotal trial of EndoBarrier Therapy, the ENDO Trial, in 2013. In the third quarter of 2015, we announced our decision to stop the ENDO Trial. On August 21, 2015, we announced that we were reducing headcount by approximately 46% as part of our efforts to restructure our business and expenses in response to stopping the ENDO Trial and to ensure sufficient cash remained available for us to establish new priorities, continue market development and research, and to evaluate strategic options.
As part of our reorganization efforts in the third quarter of 2015, we decided to focus sales activity on a limited number of countries while disengaging from others. As a result, we are focused on the commercialization of EndoBarrier in selected countries in Europe and the Middle East. In certain geographies where reimbursement is necessary for clinical acceptance and commercial uptake such as in Europe, we are receiving partial reimbursement in certain markets at a local level, but we have not yet achieved full or national reimbursement in any market.
On May 10, 2016, we announced that we were further reducing headcount by approximately 30% as part of our previously announced efforts to restructure our expenses in order to extend our cash runway.
On September 14, 2016, we announced that we received formal notification from the TGA of the cancellation of the EndoBarrier device’s inclusion on the ARTG, taking effect on October 12, 2016. As a result, with effect from October 12, 2016, we are not permitted to supply the EndoBarrier device in Australia, outside of approved trials.
For financial reporting purposes, we have one reportable segment which designs, manufactures and markets a medical device for the treatment of type 2 diabetes and obesity.
To date, we have devoted substantially all of our efforts to research and development, business planning, clinical research, clinical study management, reimbursement development, product commercialization, acquiring operating assets and raising capital. We have incurred significant operating losses since our inception in 2003. As of December 31, 2016, we had an accumulated deficit of approximately $248.2 million. We expect to incur net losses for the next several years while we continue to evaluate which markets are appropriate to continue pursuing reimbursement, market awareness and general market development efforts, and continue to restructure our business and costs, establish new priorities, continue limited research, and evaluate strategic options.
We have raised net proceeds of approximately $232.6 million through sales of our equity. We generated $75.7 million in proceeds, net of expenses, through the sale of convertible preferred stock to a number of U.S. venture capital firms, two global medical device manufacturers and individuals, prior to going public. In June 2011, we issued Convertible Term Promissory Notes to several of our shareholders totaling $6.0 million, which were repaid concurrent with the closing of our IPO in September 2011 with the associated gross proceeds. In September 2011, we raised approximately $72.5 million, net of expenses and repayment of $6.0 million of Convertible Term Promissory Notes, in our IPO in Australia and simultaneous private placement of CDIs to accredited investors in the U.S. In connection with the IPO, all of our existing shares of preferred stock were converted into Common Stock.
In July and August 2013, we raised approximately $52.5 million, net of expenses, in an offering of our CDIs to sophisticated, professional and accredited investors in Australia, the U.S. and certain other jurisdictions. In May 2014, we raised approximately $30.8 million, net of expenses, in an offering of our CDIs to sophisticated, professional and accredited investors in Australia, Hong Kong, the United Kingdom and certain other jurisdictions.
In December 2016, we raised approximately $1.0 million, net of expenses, in an offering of our CDIs to sophisticated and professional investors in Australia and certain other jurisdictions. In January 2017, we raised approximately $0.2 million, net of expenses, in an offering of our CDIs to eligible shareholders under a Special Purchase Plan available to security holders with a registered address in Australia or New Zealand.
Our corporate headquarters are located in Boston, Massachusetts.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements prepared in accordance with generally accepted accounting principles in the U.S. The preparation of these financial statements requires us to make certain estimates and assumptions that may affect the reported amounts of assets and liabilities, and the reported amounts of revenues and expenses during the reported periods and related disclosures. These estimates and assumptions, including those related to revenue recognition, inventory valuation including reserves for excess and obsolete inventory, impairment of long-lived assets, valuation of warrant liabilities income taxes including the valuation allowance for deferred tax assets, research and development expenses, estimates used in assessing our ability to continue as a going concern, contingencies and stock-based compensation are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on our historical experience and various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from our estimates under different assumptions or conditions.
We believe that our application of the following accounting policies, each of which require significant judgments and estimates on the part of management, are the most critical to aid in fully understanding and evaluating our reported financial results. Our significant accounting policies are more fully described in Note 2, “Summary of Significant Accounting Policies and Basis of Presentation”, to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K.
Revenue Recognition
We generate all of our revenue from sales of EndoBarrier to health care providers and third-party distributors who resell the product to health care providers.
We consider revenue to be realized or realizable and earned when all of the following criteria are met: persuasive evidence of a sales arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collectability is reasonably assured. Revenue is recognized upon passage of title and risk of loss to customers, unless a consignment arrangement exists, and provided an estimate can be made for sales returns.
With respect to these criteria:
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The evidence of an arrangement generally consists of a health care provider or distributor purchase order with the necessary approvals and acceptance by us.
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Transfer of title and risk and rewards of ownership are passed to the health care provider or third-party distributor upon delivery of the products.
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The selling prices for all sales are fixed and agreed with the health care provider or third-party distributor. Provisions for discounts and rebates to customers are established as a reduction to revenue in the same period the related sales are recorded.
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When doubt exists about collectability from specific customers, we defer revenue from sales of products to those customers until payment is received.
In certain circumstances, we allow customers to return defective or nonconforming products for credit or replacement products. Defective or nonconforming products typically include those products that resulted in an unsuccessful implant procedure. We consider these transactions to be product returns and base our estimate for sales returns upon historical trends and record the amount as a reduction to revenue upon the initial sale of the product. In the event we are unable to reasonably estimate future returns, we recognize revenue when the right of return lapses. Prior to the fourth quarter of 2013, we did not have sufficient historical experience on which to base an estimate of returns, and therefore recognized revenue when the right of return lapsed. We determined this point to be when the product was implanted or otherwise consumed and payment was received from the customer, which indicated that we had no further obligations to the customer and that the sale was complete. As a result, starting in the fourth quarter of 2013, we began to recognize revenue at the time of delivery net of these return estimates. Prospectively, we will continue to evaluate whether we have sufficient data to determine return estimates as we enter new markets.
We had certain relationships in which title to delivered product passed to a buyer, but the substance of the transaction was that of a consignment arrangement. In these cases, we recognized revenue when the product was implanted or otherwise consumed and payment was received from the customer, which indicated that we had no further obligations to the customer and that the sale was complete. For these transactions, revenue recognition was deferred until the sale was complete.
In addition, we have entered into consignment arrangements in which we deliver the product to the customer but retain title to the product until it is implanted or otherwise consumed. In these arrangements, we recognize revenue once we receive proof of third party purchase, usually in the form of a customer purchase order.
Inventory
We state inventory at the lower of first-in, first-out cost or market. We record a provision for excess, expired, and obsolete inventory based primarily on estimates of forecasted revenues. A significant change in the timing or level of demand for products as compared to forecasted amounts may result in recording additional provisions for excess, expired, and obsolete inventory in the future. When capitalizing inventory, we consider factors such as status of regulatory approval, alternative use of inventory, and anticipated commercial use of the product.
The valuation of inventory also requires us to estimate obsolete or excess inventory. We maintain reserves for excess and obsolete inventory based on forecasted product sales, new product introductions by us or our competitors, product expirations and historical experience. The inventory reserves we recognize are based on our estimates of how these factors are expected to impact the amount and value of inventory we expect to sell. The markets in which we operate are highly competitive and characterized by rapid product development and technological change, putting our products at risk of losing market share and/or becoming obsolete. Forecasting demand for EndoBarrier in a market in which there are few, if any, comparable approved devices and for which reimbursement from third-party payers is limited has been difficult. We monitor our inventory reserves on an ongoing basis, and although we consider our inventory reserves to be adequate, we may be required to recognize additional inventory reserves if future demand or market conditions are less favorable than we have estimated.
Research and Development Costs
Research and development costs are expensed when incurred. Research and development costs include costs of all basic research activities as well as other research, engineering, and technical effort required to develop a new product or service or make significant improvement to an existing product or manufacturing process. Research and development costs also include preapproval regulatory and clinical trial expenses.
Stock-Based Compensation
We account for stock-based compensation in accordance with the Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, 718, Stock Compensation, or ASC 718, which requires that stock-based compensation be measured and recognized as an expense in the financial statements and that such expense be measured at the grant date fair value.
For awards that vest based on service conditions, we use the straight-line method to allocate compensation expense to reporting periods. The grant date fair value of options granted is calculated using the Black-Scholes option pricing model, which requires the use of subjective assumptions including volatility, expected term and the fair value of the underlying Common Stock, among others.
The assumptions used in determining the fair value of stock-based awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change, and we use different assumptions, our stock-based compensation could be materially different in the future. The risk-free interest rate used for each grant is based on a zero-coupon U.S. Treasury instrument with a remaining term similar to the expected term of the stock-based award. Because we do not have a sufficient history to estimate the expected term, we use the simplified method for estimating the expected term. The simplified method is based on the average of the vesting tranches and the contractual life of each grant. Because there was no public market for our Common Stock prior to our IPO, we lacked company-specific historical and implied volatility information. We do have approximately 5 years of historical price volatility since our IPO in September 2011. Therefore, we estimate our expected stock volatility based on a combination of our to-date historical price volatility and that of publicly-traded peer companies. For purposes of identifying publicly-traded peer companies, we selected publicly-traded companies that develop, manufacture, and market medical devices, have operating businesses in the design and development of products that focus in the treatment
of diabetes, and have sufficient trading history to derive a historic volatility rate. We expect to rely more heavily on our own price volatility in the future. We have not paid and do not anticipate paying cash dividends on our shares of Common Stock; therefore, the expected dividend yield is assumed to be zero. We also recognize compensation expense for only the portion of options that are expected to vest. Accordingly, we have estimated expected forfeitures of stock options based on our historical forfeiture rate, adjusted for known trends, and used these rates in developing a future forfeiture rate. Our forfeiture rates were 15% as of December 31, 2016, 15% as of December 31, 2015 and 5.0% as of December 31, 2014. If our actual forfeiture rate varies from our historical rates and estimates, additional adjustments to compensation expense may be required in future periods.
We periodically issue performance-based awards. For these awards, vesting will occur upon the achievement of certain milestones. When achievement of the milestone is deemed probable, we expense the compensation of the respective stock award over the implicit service period.
Stock awards to non-employees are accounted for in accordance with ASC 505-50, Equity Based Payments to Non-Employees, or ASC 505-50. The measurement date for non-employee awards is generally the date performance of services required from the non-employee is complete. For non-employee awards that vest based on service conditions, we expense the value of the awards over the related service period, provided we expect the service condition to be met. We record the expense of services rendered by non-employees based on the estimated fair value of the stock option using the Black-Scholes option pricing model over the contractual term of the non-employee. The fair value of unvested non-employee awards are remeasured at each reporting period and expensed over the vesting term of the underlying stock options on a straight-line basis.
Impairment of Long-Lived Assets
We regularly review the carrying amount of our long-lived assets to determine whether indicators of impairment may exist that warrant adjustments to carrying values or estimated useful lives. If indications of impairment exist, projected future undiscounted cash flows associated with the asset are compared to the carrying amount to determine whether the asset’s value is recoverable. If the carrying value of the asset exceeds such projected undiscounted cash flows, the asset will be written down to its estimated fair value.
Foreign Currency Translation
The functional currency of GID Europe Holding B.V., GID Europe B.V., GID Germany GmbH and GI Dynamics Australia Pty Ltd is the U.S. dollar. Balance sheet accounts of our subsidiaries are translated into U.S. dollars using the exchange rate in effect at the balance sheet date while expenses are translated using the average exchange rate in effect during the period. Gains and losses arising from translation of our wholly owned subsidiaries’ financial statements are included in the determination of net loss.
Emerging Growth Company Status
The JOBS Act permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We have choosen to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.
Results of Operations
The following is a description of significant components of our operations, including significant trends and uncertainties that we believe are important to an understanding of our business and results of operations.
Year Ended December 31, 2016 Compared to Year Ended December 31, 2015
Revenue. The decrease in revenue of approximately $0.8 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 was primarily due to decreased unit volume in the Europe, South America and Asia Pacific markets with an increase in the Middle East market. Revenue decreased approximately 69.4%, 100.0% and 32.3% in Europe, South America and Asia Pacific, respectively. Revenue increased in the Middle East market by approximately 5.6%. In addition, the cancellation of the TGA’s inclusion of EndoBarrier on the ARTG in October 2016 partially impacted 2016 revenue. Revenue generated in Australia represented ~15% of total revenue.
We believe the following factors adversely affected our commercial activities for the year ended December 31, 2016:
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stopping of the ENDO Trial;
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continued lack of reimbursement support for EndoBarrier;
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regulatory-related questions arising out of our decision to stop the ENDO Trial; and
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our decision, as part of our reorganization efforts, to reduce the number of sales related employees and focus sales activity on a limited number of markets while disengaging from others.
In the near-term, we intend to focus commercialization efforts on strategic centers while continuing to support efforts in collecting additional clinical evidence via the numerous ongoing investigator-initiated studies around the world, many of which are randomized controlled trials. We will also continue to work to secure reimbursement in our target markets. We believe that the collection of additional data via patient registries is important to help support the attainment of reimbursement, but will likely adversely affect our commercial operations in the near term as it may limit commercial expansion.
Cost of Revenue. Cost of revenue decreased approximately $4.4 million for the year ended December 31, 2016 compared to the year ended December 31, 2015. The decrease in cost of revenue resulted from an approximately $0.7 million decrease in product cost, approximately $0.6 million decrease in personnel and related expenses, approximately $0.2 million decrease in asset impairment expense and a decrease of approximately $3.0 million in excess, expired and obsolete inventory expense. Other Manufacturing cost and absorption of $0.1 million offset the decreases from above.
Our gross loss decreased by approximately $3.7 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 for the reasons discussed above. We expect that our gross margin will vary, and may vary significantly, quarter to quarter and year to year due to our current stage of commercial development and future plans. Specifically, factors such as our intention to focus on strategic centers and securing reimbursement in our target markets, our transition of production to a third-party manufacturer, changes in volume of inventory production, and overall economies of scale may result in variability in our gross margin.
Operating Expenses
Research and Development Expense. The decrease in research and development expense of approximately $12.7 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 was primarily due to a decrease of approximately $7.7 million in clinical trial and other clinical study related expenses associated primarily with the ENDO trial and a decrease of approximately $3.7 million in employee and related expenses.
Though we expect to implement a more efficient cost structure in order to extend our cash runway, it may be partially offset by the costs associated with rebuilding the research and development management team,
improving our quality and regulatory systems and relationships and finalizing the protocol for our U.S. investigational device exemption trial in anticipation of initiating and beginning enrollment of the trial in 2017.
Sales and Marketing Expense. The decrease in sales and marketing expense of approximately $2.9 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 was primarily the result of a decrease of approximately $1.5 million in compensation and employee related expenses, related to our decision to reduce headcount, as well as a decrease of approximately $1.1 million in marketing related activities.
As we look forward and continue our focus on key strategic markets in Europe and the Middle East, we may add additional headcount for sales and marketing activities, which will increase our sales and marketing costs.
General and Administrative Expense. The decrease in general and administrative expense of approximately $2.1 million for the year ended December 31, 2016 compared to the year ended December 31, 2015 was primarily a result of decreased employee and related expenses of approximately $2.0 million primarily as a result of headcount reductions, including approximately $1.7 million lower stock-based compensation, as well as an approximately $0.1 million decrease in consulting, professional services and expenses related to being a public company.
We continue to look for ways to streamline our general and administrative expenses. In so doing, we recognize that some costs, particularly those associated with being a public company with multiple reporting jurisdictions are unavoidable. We will continue to provide general and administrative support for scope and size of the entire company.
Other Income (Expense), Net
Interest income. The decrease in interest income of approximately $26,000 for the year ended December 31, 2016 compared to the year ended December 31, 2015 was due to lower average cash and cash equivalents balances in 2016.
Interest expense. Interest expense was approximately the same for year ended December 31, 2016 compared to the year ended December 31, 2015.
Foreign Exchange gain (loss). The change from a foreign exchange loss of approximately $0.6 million for the year ended December 31, 2015 to a gain of approximately $10,000 for the year ended December 31, 2016 is primarily due to significantly lower average foreign currency balances in the year ended December 31, 2016 compared to the year ended December 31, 2015.
Re-measurement of Warrant Liability. The change in the re-measurement of warrant liability of approximately $25,000 for the year ended December 31, 2016 compared to the year ended December 31, 2015 was the result of a decrease in the fair value of the warrants issued in connection with our IPO, which expired in
September 2016 partially offset by the issuance of the new consulting warrant and re-measurement of expense in the third and fourth quarters of 2016. The consultant warrant increased in value by approximately $5,000 in the year ended December 31, 2016 after recognition of the initial expense in May 2016.
Year Ended December 31, 2015 Compared to Year Ended December 31, 2014
Revenue. The decrease in revenue of approximately $1.5 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 was primarily due to decreased revenue across all markets. Revenue decreased approximately 91%, 72%, 41%, and 40% in South America, Asia Pacific region, the Middle East and Europe, respectively, primarily as a result of lower unit volume.
We believe the following factors adversely affected our commercial activities for the year ended December 31, 2015:
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the Notified Body request to stop shipment of CE Mark product in late 2014;
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the ENDO Trial enrollment hold and subsequent stopping of the ENDO Trial;
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the regulatory-related questions arising out of our decision to stop the ENDO Trial; and
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our decision, as part of our reorganization efforts, to focus sales activity on a limited number of markets while disengaging from others.
Cost of Revenue. Cost of revenue increased approximately $1.6 million for the year ended December 31, 2015 compared to the year ended December 31, 2014. The increase in cost of revenue was primarily related to an increase in the charge for inventory reserves of approximately $1.7 million, an approximately $1.2 million increase in expense due to manufacturing inefficiencies resulting from lower production volume and an approximately $0.3 million charge for impaired fixed assets. The increase in expense was partially offset by a decrease of approximately $0.9 million in cost of revenue resulting from lower sales volume and a decrease of approximately $0.6 million of personnel related expenses. The increase in inventory reserves was primarily related to a charge for additional inventory reserves needed to write-down the net realizable value of our existing inventory which was in excess of our currently anticipated commercial requirements for future sales of EndoBarrier. Factors contributing to the inventory write-down included: the effect the uncertainty around the timing and success of the ENDO Trial, as well as the effect our ultimate decision to stop the ENDO Trial had on commercial activity and our inventory levels, the expected timing of third-party payer reimbursement in our commercial markets, our conclusion that certain inventory will not be used for sales inside or outside the U.S. and the historical accuracy of our demand forecasts.
Gross loss increased by approximately $3.1 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 for the reasons discussed above.
Operating Expenses
Research and Development Expense. The decrease in research and development expense of approximately $10.0 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 was primarily due to a decrease of approximately $6.7 million in clinical trial and other clinical study related expenses, primarily third-party expenses related to the ENDO Trial, and a decrease of approximately $3.1 million in compensation and employee related expenses, including approximately $0.7 million in lower stock-based compensation expense, due to decreases in headcount.
Sales and Marketing Expense. The decrease in sales and marketing expense of approximately $4.9 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 was primarily the result of a decrease of approximately $2.9 million in compensation and employee related expenses, including approximately $0.9 million in lower stock-based compensation expense, due to decreases in headcount, as well as a decrease of approximately $1.3 million in marketing activities to support our commercialization efforts and a decrease of approximately $0.7 million of consulting and professional fees.
General and Administrative Expense. The decrease in general and administrative expense of approximately $1.9 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 was primarily a result of decreased compensation and employee related expenses of approximately $1.3 million primarily as a result of our CEO transition and departure of our CFO in 2014 and an approximately $0.3 million decrease in consulting and professional services and expenses related to being a public company.
Other Income (Expense), Net
Interest Income. The decrease in interest income of approximately $0.2 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 was due to lower average interest rates and lower average cash and cash equivalents balances.
Interest Expense. Interest expense was the same for the years ended December 31, 2015 and 2014 as we incurred the same amount of interest expense on our capital lease in 2015 as we did on our debt in 2014.
Foreign Exchange Loss. The increase in the foreign exchange loss of approximately $0.1 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 was primarily the result of the depreciation of the Australian dollar versus the U.S. dollar during the year ended December 31, 2015.
Re-measurement of Warrant Liability. The change in the re-measurement of warrant liability of approximately $0.3 million for the year ended December 31, 2015 compared to the year ended December 31, 2014 was the result of a smaller decrease in the fair value of the warrants issued in connection with our IPO for the year ended December 31, 2015 compared to the decrease in the fair value of the warrants for the year ended December 31, 2014.
Liquidity and Capital Resources
We have incurred losses since our inception in March 2003 and, as of December 31, 2016, we had an accumulated deficit of approximately $248.2 million. We have financed our operations from a combination of sales of equity securities and issuances of convertible term notes. In June 2011, we generated approximately $6.0 million in net proceeds from the issuance of our Convertible Term Promissory Notes. In September 2011, we generated approximately $72.5 million in proceeds, net of expenses and repayment of $6.0 million of Convertible Term Promissory Notes, from our IPO in Australia and simultaneous private placement in the U.S. In July and August 2013, we generated approximately $52.5 million in proceeds, net of expenses, from a private placement and share purchase plan of our CDIs. In May 2014, we generated approximately $30.8 million in proceeds, net of expenses, from a private placement of our CDIs. In December 2016, we generated approximately $1.0 million in proceeds, net of expenses, from a private placement of our CDIs. As of December 31, 2016, we had approximately $8.3 million of cash and cash equivalents. In addition, we had restricted cash of $30,000 as of December 31, 2016 to cover exposure on Company supported credit cards. In January 2017, we raised approximately $0.2 million, net of expenses, in an offering of our CDIs to eligible shareholders with a registered address in Australia or New Zealand.
During the year ended December 31, 2016, our cash and cash equivalents balance decreased by approximately $11.3 million as a result of the funds utilized to support our operations. We made payments related to, among other things, research and development, sales and marketing, and general and administrative expenses as we continued to commercialize EndoBarrier and close out our ENDO Trial.
The following table sets forth the major sources and uses of cash for each of the periods set forth below:
Cash Flows used in Operating Activities
Net cash used in operating activities totaled approximately $12.4 million for the year ended December 31, 2016. The primary uses of cash were:
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to fund our net loss of approximately $13.1 million;
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a net negative adjustment to cash flow from changes in working capital of approximately $0.2 million resulting primarily from decreases in accrued expenses and other current liabilities, partially offset by a decrease in inventory and prepaid expenses; and
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a net positive adjustment to cash flow from non-cash items of approximately $1.0 million, primarily from stock-based compensation expense of approximately $0.7 million and depreciation, amortization and impairment of property and equipment of approximately $0.3 million.
Our fiscal 2016 results contain non-recurring charges totaling approximately $1.1M, including $0.4 million related to restructuring charges in our second quarter, $0.6 million related to employee departures in both our second and third quarters and $0.1 million related to abandonment of our former headquarters in Lexington, MA. Through our repositioning efforts during fiscal 2016, we were able to reduce our cash used in operations on a quarterly basis over the last two quarters. We continue to look for opportunities to reduce costs as we work to complete our strategies to continue the development of EndoBarrier.
Net cash used in operating activities totaled approximately $31.4 million for the year ended December 31, 2015. The primary uses of cash were:
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to fund our net loss of approximately $35.2 million;
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a net negative adjustment to cash flow from changes in working capital of approximately $3.4 million resulting primarily from decreases in accrued expenses, accounts payable and deferred revenue, partially offset by decreases in inventory, accounts receivable and prepaid and other current assets; and
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a net positive adjustment to cash flow from non-cash items of approximately $7.2 million, primarily from stock-based compensation of approximately $3.2 million and increases in inventory reserves resulting from a charge of approximately $3.2 million for inventory in excess of our commercial requirements.
Due to the nature and timing of the cash flows related to our ENDO Trial, we believe that stopping the ENDO Trial had a significant effect on our cash flows from operations for the year ended December 31, 2015 as our clinical trial accrual decreased by approximately $2.1 million. Additionally, our August 2015 restructuring had a significant effect on our cash flows from operations for the year ended December 31, 2015 as our accrual for payroll and related liabilities decreased by approximately $2.1 million.
Net cash used in operating activities totaled approximately $38.5 million for the year ended December 31, 2014. The primary uses of cash were:
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to fund our net loss of approximately $48.2 million;
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a net positive adjustment to cash flow from changes in working capital of approximately $3.2 million resulting primarily from an increase in accrued expenses related to restructuring charges and clinical trial accruals; and
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a net positive adjustment to cash flow from non-cash items of approximately $6.5 million, primarily from stock-based compensation expense and increases in inventory reserves resulting from a charge of approximately $1.6 million for inventory in excess of our commercial requirements.
The temporary suspension of our commercial shipments had an adverse effect on our cash flow from operating activities as a result of lower anticipated revenue in the fourth quarter of 2014.
Cash Flows used in Investing Activities
Cash used in investing activities for the year ended December 31, 2016 totaled approximately $0.1 million and primarily resulted from the purchase of office equipment.
Cash used in investing activities for the year ended December 31, 2015 totaled approximately $0.2 million and resulted from the purchase of property and equipment.
Cash used in investing activities for the year ended December 31, 2014 totaled approximately $0.3 million and resulted primarily from the purchase of property and equipment, principally manufacturing equipment and software.
Cash Flows provided by Financing Activities
Cash provided by financing activities for the year ended December 31, 2016 totaled approximately $1.2 million and resulted primarily from the net proceeds from our private placement of CDIs and from a short-term financing for insurance policies offset by payments on our short-term financing.
Cash from financing activities for the year ended December 31, 2015 consisted of proceeds from the exercise of stock options offset by payments on capital leases.
Cash provided by financing activities for the year ended December 31, 2014 totaled approximately $31.4 million and resulted primarily from the net proceeds from our sale of CDIs in a private placement in May 2014, as well as from cash provided by stock option exercises.
Funding Requirements
As of December 31, 2016, our primary source of liquidity was our cash and cash equivalents of approximately $8.3 million. In January 2017, we closed a Security Purchase Plan, or SPP, in which we sold to eligible shareholders with a registered address in Australia or New Zealand approximately 12.5 million CDIs (approximately 250,000 shares) at an issue price of A$0.022 per CDI, for total proceeds of approximately $0.2 million.
Based on our decision to stop the ENDO Trial, we continue to evaluate which markets are appropriate to continue pursuing reimbursement, market awareness and general market development efforts, and continue to restructure our business and costs, establish new priorities, continue limited research, and evaluate strategic options. As a result, we expect to incur significant operating losses for the next several years. We do not expect our current cash balances will be sufficient to enable us to conduct an additional clinical trial in the U.S. for the purpose of seeking regulatory approval from the FDA. We continue to restructure our costs and believe that our current cash and cash equivalents, together with the proceeds from the financing that occurred in Q4 2016 and Q1 2017, are sufficient to fund our operations into the third quarter of 2017. We will need to raise additional funds in 2017 in order to fund our operations, focused sales efforts, and U.S. clinical development plans in which we anticipate initiating and beginning enrollment of a U.S. trial. These factors raise substantial doubt about our ability to continue as a going concern. We may seek to raise additional funds through any combination of collaborative arrangements, strategic alliances, and additional equity and debt financings or from other sources. There can be no assurance that any such financing opportunities will be available on acceptable terms, if at all. If we are unable to raise capital when needed, we could be forced to significantly delay or discontinue research and development activities and further commercialization of EndoBarrier, which could have a material adverse effect on our business, financial condition and results of operations. In addition, we could be required to cease operations if we are unable to raise capital when needed.
Our forecast of the period of time through which our financial resources will be adequate to support our operations are forward-looking statements and involve risks and uncertainties, and actual results could vary materially and negatively as a result of a number of factors, including the factors discussed in the “Risk Factors” section of this Annual Report on Form 10-K. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect.
Due to the numerous risks and uncertainties associated with the development and commercialization of EndoBarrier, at this time we are unable to estimate precisely the amounts of capital outlays and operating expenditures necessary to complete the development of, and to obtain regulatory approval for, EndoBarrier (other than in select markets in Europe, South America and the Middle East) for the U.S. and other markets for which we believe EndoBarrier is suited. Our funding requirements will depend on many factors, including, but not limited to, the following:
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the rate of progress and cost of our commercialization activities;
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the expenses we incur in marketing and selling EndoBarrier;
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the timing and decisions of payer organizations related to reimbursement;
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the revenue generated by sales of EndoBarrier;
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the product performance from a safety and efficacy standpoint in addressing diabetes and obesity;
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the success of our investment in our manufacturing and supply chain infrastructure;
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the time and costs involved in obtaining regulatory approvals for EndoBarrier in new markets;
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the success of our research and development efforts;
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the costs associated with stopping the ENDO Trial;
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the costs associated with any additional clinical trial(s) required in the U.S.;
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the ability to ship CE marked products;
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the emergence of competing or complementary developments; and
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the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights.
We will continue to manage our capital structure and to consider all financing opportunities, whenever they may occur, that could strengthen our long-term liquidity profile. Any such capital transactions may or may not be similar to transactions in which we have engaged in the past and the ownership interests of our existing stockholders may be materially diluted. There can be no assurance that any such financing opportunities will be available on acceptable terms, if at all. If we are unable to raise capital when needed, we could be forced to significantly delay or discontinue research and development activities and further commercialization of EndoBarrier.
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements (as that term is defined in Item 303(a)(4)(ii) of Regulation S-K) or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in those types of relationships. We enter into guarantees in the ordinary course of business related to the guarantee of our own performance and the performance of our subsidiaries.
Contractual Obligations and Commitments
Our commitments for operating leases relate to our lease of office and laboratory space in Boston, Massachusetts.
The following table summarizes our outstanding contractual obligations as of December 31, 2016:
Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements please refer to Note 2, “Summary of Significant Accounting Policies and Basis of Presentation”, to our consolidated financial statements included in this Annual Report on Form 10-K.
In May 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update (“ASU”) No. 2014-09, or ASU 2014-09, Revenue from Contracts with Customers, which supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and most industry-specific guidance. The new standard requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In July 2015, the FASB approved a one year deferral of the effective date of this standard to annual reporting periods, and interim reporting periods within those years, beginning after December 15, 2017. Early adoption is permitted to the original effective date of December 15, 2016, including interim reporting periods within those years. We are currently evaluating the potential impact that ASU 2014-09 may have on our consolidated financial statements.
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). This new standard gives a company’s management the final responsibilities to decide whether there is substantial doubt about the company’s ability to continue as a going concern and to provide related footnote disclosures. The standard provides guidance to management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that companies commonly provide in their footnotes. Under the new standard, management must decide whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the company’s ability to continue as a going concern within one year after the date that the financial statements are issued, or within one year after the date that the financial statements are available to be issued when applicable. This updated pronouncement was adopted for the annual reporting period ended December 31, 2016 and had no material impact on the Company’s financial statements.
In April 2015, the FASB issued ASU No. 2015-05, Intangibles - Goodwill and Other - Internal-Use Software (“ASU 2015-05”). This new standard provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. ASU 2015-05 will be effective for the Company for reporting periods beginning after December 15, 2015. Early adoption is permitted and a company can elect to adopt ASU 2015-05 either (1) prospectively to all arrangements entered into or materially modified after the effective date or (2) retrospectively. Accordingly, the standard is effective for the Company on January 1, 2016. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory (“ASU 2015- 11”). ASU 2015-11, which simplifies the measurement of inventories valued under most methods, including the Company’s inventories valued under FIFO - the first-in, first-out cost method. Inventories valued under LIFO - the last-in, first-out method - are excluded. Under this new guidance, inventories valued under these methods would be valued at the lower of cost and net realizable value, with net realizable value defined as the estimated selling price less reasonable costs to sell the inventory. This guidance is effective for annual reporting beginning after December 15, 2016, including interim periods within the year of adoption, with early application permitted. The adoption of this guidance is not expected to have a significant impact on the Company’s consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17, Income Taxes - Balance Sheet Reclassification of Deferred Taxes (Topic 740) (“ASU 2015-17”). ASU 2015-17 requires that deferred tax liabilities and assets, and any related valuation allowances, be classified as noncurrent in a classified statement of financial position. The classification change for all deferred taxes as noncurrent simplifies entities’ processes as it eliminates the need to separately identify the net current and net noncurrent deferred tax asset or liability in each jurisdiction and allocate valuation allowances. ASU 2015-17 is effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted and the amendments may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company early adopted ASU 2015-17 in the fourth quarter of 2015 on a prospective basis and reclassified the current portion of deferred tax assets to the non-current portion of deferred tax assets within its consolidated balance sheets resulting in a reduction of other long-term assets and other current liabilities of approximately $97,000 as of December 31, 2015. The prior period balances were not retrospectively adjusted.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), or ASU 2016-02. ASU 2016-02 requires that lessees recognize in the statement of financial position for all leases (with the exception of short-term leases) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis, and a right-of-use asset, which is an asset representing the lessee’s right to use
the underlying asset for the lease term. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. Lessees must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees may not apply a full retrospective transition approach. The adoption of this guidance is not expected to have a significant impact on our consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, or ASU 2016-09. ASU 2016-09 will simplify the income tax consequences, accounting for forfeitures and classification on the statements of consolidated cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods, with early adoption permitted. We are currently evaluating the potential impact that ASU 2016-09 may have on our consolidated financial statements.
In August, 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force), or ASU 2016-15. The amendments in ASU 2016-15 address eight specific cash flow issues and apply to all entities that are required to present a statement of cash flows under FASB Accounting Standards Codification 230, Statement of Cash Flows. The amendments in ASU 2016-15 are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption during an interim period. We are currently evaluating the impact that ASU No. 2016-15 may have on our consolidated financial statements.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issue Task Force), or ASU 2016-18. This new standard addresses the diversity that exists in the classification and presentation of changes in restricted cash on the statement of cash flows. The amendments in ASU 2016-18 require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within the year of adoption, with early adoption permitted. We do not expect that the adoption of ASU 20116-18 will have a material impact on our consolidated financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop, manufacture and sell EndoBarrier globally and our earnings and cash flows are exposed to market risk from changes in currency exchange rates and interest rates.
Interest Rate Sensitivity
Our cash and cash equivalents of $8.3 million at December 31, 2016 consisted of cash and money market funds, all of which will be used for working capital purposes. We do not enter into investments for trading or speculative purposes. The goals of our investment policy are preservation of capital, fulfillment of liquidity needs and fiduciary control of cash and investments. We also seek to maximize income from our investments without assuming significant risk. Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of interest rates in the U.S. and Australia. Because of the short-term nature of our cash and cash equivalents, we do not believe that we have any material exposure to changes in their fair values as a result of changes in interest rates. The continuation of historically low interest rates in the U.S. will limit our earnings on investments held in U.S. dollars.
Our capital lease bears interest at a fixed rate and therefore has minimal exposure to changes in interest rates.
Foreign Currency Risk
We conduct business in foreign countries. For U.S. reporting purposes, we translate all assets and liabilities of our non-U.S. entities at the period-end exchange rate and revenue and expenses at the average exchange rates in effect during the periods. The net effect of these translation adjustments is shown in the accompanying consolidated financial statements as a component of net loss.
We generate a significant portion of our revenue and collect receivables in foreign currencies. Fluctuations in the exchange rate of the U.S. dollar against major foreign currencies, including the euro, British Pound and Australian dollar, can result in foreign currency exchange gains and losses that may significantly impact our financial results. These foreign currency transaction and translation gains and losses are presented as a separate line item on our consolidated statements of operations and comprehensive loss. Continued fluctuation of these exchange rates could result in financial results that are not comparable from quarter to quarter. We do not currently utilize foreign currency contracts to mitigate the gains and losses generated by the re-measurement of non-functional currency assets and liabilities but do hold cash reserves in currencies in which those reserves are anticipated to be expended.
All of the proceeds from our 2011, 2013, 2014 and 2016 offerings were denominated in Australian dollars and as of December 31, 2016 we held the equivalent of approximately U.S. $51,000 denominated in Australian dollars and approximately U.S. $0.2 million denominated in euros. Accordingly, we have had and will continue to have exposure to foreign currency exchange rate fluctuations. A change of 10% or more in foreign currency exchange rates of the Australian dollar or the euro would not have a material impact on our financial position and results of operations.
Effects of Inflation
We do not believe that inflation and changing prices over the years ended December 31, 2016, 2015 and 2014 had a significant impact on our results of operations.
ITEM 8.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements, together with the independent registered public accounting firm report thereon, appear at pages through, of this Annual Report on Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, or the Exchange Act, our management, including our principal executive officer and our principal financial officer, conducted an evaluation as of the end of the period covered by this Annual Report on Form 10-K of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective at the reasonable assurance level in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over our financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act as the process designed by, or under the supervision of, our chief executive officer and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that:
(1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets;
(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with the authorizations of management and directors; and
(3) provide reasonable assurance regarding the prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on our financial statements.
Under the supervision and with the participation of our management, including our Chief Executive Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework provided in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2016.
Changes in Internal Control
As required by Rule 13a-15(d) of the Exchange Act, our management, including our principal executive officer and our principal financial officer, conducted an evaluation of the internal control over financial reporting to determine whether any changes occurred during the quarter ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, our principal executive officer and principal financial officer concluded no such changes during the quarter ended December 31, 2016 materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Controls and Procedures
Our management, including our principal executive officer and principal financial officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered 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 and instances of fraud, if any, have been detected. Thus, misstatements due to error or fraud may occur and not be detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of controls.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The other information required by this Item 10 related to our directors is incorporated by reference to the applicable information in our proxy statement for our 2017 Annual Meeting of Stockholders to be filed with the SEC.
Information regarding our executive officers required by this Item 10 is incorporated by reference to the applicable information in our proxy statement for our 2017 Annual Meeting of Stockholders to be filed with the SEC.
Code of Business Conduct and Ethics
We have adopted a code of business conduct and ethics applicable to our directors, executive officers and all other employees. A copy of that code is available on our corporate website at http://www.gidynamics.com. Any amendments to the code of business conduct and ethics, and any waivers thereto involving our executive officers, also will be available on our corporate website. A printed copy of these documents will be made available upon request. The content on our website is not incorporated by reference into this Annual Report on Form 10-K.
Directors of the Registrant
The following table sets forth the name, age and position of each of our directors as of March 15, 2017:
1. Member of the audit committee.
2. Member of compensation committee.
3. Member of nominating and corporate governance committee.
Daniel J. Moore has served as a director of the Company since 2014, as our vice-chairman from March 2015 to April 2016 and our chairman since May 2016. Mr. Moore’s extensive experience in domestic and international sales, operations and executive management in global medical device manufacturers and years of service on other boards makes him qualified to serve on our board of directors.
Mr. Moore has served as president, chief executive officer and director of Cyberonics, Inc., a medical technology company with core expertise in neuromodulation, from 2007 to October 2015. From 1989 to 2007, Mr. Moore held positions in sales, marketing, and senior management in the U.S. and in Europe at Boston Scientific Corporation, a diverse maker of minimally invasive medical products. His last position at Boston Scientific was President, International Distributor Management. Prior to that role, he held the position of President, Inter-Continental, the fourth largest business unit of Boston Scientific, with more than 1,000 global employees and revenues exceeding $700 million. Mr. Moore previously held senior management positions at several Boston Scientific U.S. and international divisions.
Mr. Moore currently serves as the chairman of LivaNova PLC (the company resulting from the merger of Sorin S.p.A. and Cyberonics, Inc.), a member of the board of directors for the Epilepsy Foundation of
America, and as a member of the boards or advisory boards for BioHouston, Inc. and the Weldon School of Biomedical Engineering at Purdue University. He currently serves on the board of privately-held BrainScope Company, Inc., a medical technology company focused on traumatic brain injury, where he serves as Chairman. Past board positions include Smiling Kids, Inc., the Epilepsy Foundation of Texas (past-Chair), the Epilepsy Foundation of Texas - Houston (past-President), the Medical Device Manufacturers Association (past-Chair), Topera, Inc. (acquired by Abbott) and TriVascular Technologies, Inc. (acquired by Endologix).
Mr. Moore holds a B.A. from Harvard University and earned an MBA from Boston University.
Timothy J. Barberich has been a director of the Company since June 2011. Mr. Barberich has nearly 40 years’ experience in pharmaceutical and medical device companies, in technical, sales, marketing and management positions, including as chief executive officer and chairman of the board. Mr. Barberich is the founder and former president, chief executive officer and chairman of Sepracor, Inc., a NASDAQ-listed-pharmaceutical company based in Massachusetts, which was acquired by Dainippon Sumitomo Pharma Co., Ltd. in 2009. Mr. Barberich founded Sepracor in 1984 and served as its chief executive officer from 1984 to 2007 and chairman of the board from 1990 to 2007. From 2007 to 2008, Mr. Barberich served as executive chairman of Sepracor and then chairman of the board from 2008 to 2009. Mr. Barberich led Sepracor through its early-stage research and development, product approvals, commercialization, private financings and initial public offering, partnerships with major companies, several successful spin-outs and achievement of revenues in excess of $1 billion. Through his work at Sepracor, Mr. Barberich brings to our board invaluable knowledge and experience of leading a company in the health care industry through every stage of its life cycle. Prior to founding Sepracor, Mr. Barberich spent 10 years as a senior executive at Millipore Corporation, a company that provides separations products to the life science research, pharmaceutical, biotechnology and electronic markets. Mr. Barberich brings to our board the knowledge and experience of leading a company in the health care industry through every stage of its life cycle. We believe this experience and familiarity with the types of risks we may face, together with his broad medical device and pharmaceutical industry experience, makes Mr. Barberich uniquely suited to serve on our board.
Mr. Barberich is currently chairman and CEO of BioNevia Pharmaceuticals, Inc. and is a director of Verastem, Inc., a NASDAQ-listed biotechnology company, and Inotek Pharmaceuticals, Inc., a NASDAQ-listed biopharmaceutical company. Mr. Barberich also serves on the board of several private companies including Neurovance, Inc. and Frequency Therapeutics. Mr. Barberich was formerly a director of HeartWare International, Inc., a NASDAQ-listed medical device company, Tokai Pharmaceuticals, Inc., a NASDAQ-listed biopharmaceutical company, MirImmune Inc., which was acquired in 2016, BioSphere Medical, Inc., a NASDAQ-listed biotechnology company and Gemin X Biotechnologies, Inc. and Resolvyx Pharmaceuticals, which were acquired in 2011 and 2010, respectively.
Mr. Barberich holds a Bachelor of Science degree in Chemistry from Kings College in Pennsylvania and has taken graduate courses from the School of Chemistry at Rutgers University.
Graham J. Bradley has served as a director of the Company since June 2011. Mr. Bradley has had an extensive career spanning a range of industries across the Australian economy including banking and finance, residential and commercial property, insurance, telecommunications, mining services, minerals and energy, medical research and the arts. From 1995 to 2003, Mr. Bradley was managing director of leading listed investment management and financial services group Perpetual Limited and during his eight-year tenure, Perpetual became one of Australia’s leading listed funds management and financial services groups. Mr. Bradley’s strong financial background provides financial expertise to our board, including an understanding of financial statements, corporate finance, accounting and capital markets.
Mr. Bradley is currently chairman of HSBC Bank Australia Limited and Virgin Australia International Holdings Limited, a council member of the European Australian Business Council; the chairman and director of Energy Australia Holdings Limited, the chairman of Infrastructure New South Wales and is a director and chairman-elect of GrainCorp Limited. From 2009 to 2011, Mr. Bradley served as the president of the Business Council of Australia, the preeminent business leadership organization in Australia representing some 120 of the largest businesses and employers. Mr. Bradley was a director of the Garvan Institute for Medical Research, a
leading Australian medical research organization, which includes a leading diabetes research group, for 10 years from 1999 to 2009 and also chaired the Garvan Foundation during this time. Mr. Bradley has held former roles including as chairman of Stockland Corporation Limited, Po Valley Energy Limited, Boart Longyear Limited and Proteome Systems Limited; as chairman of the advisory board for Anglo American Australian Limited and as a director of Singapore Telecommunications Limited, Queensland Investment Corporation and MBF Australia Limited. Prior to his role at Perpetual, Mr. Bradley was managing partner of the law firm Blake Dawson Waldron and a partner of McKinsey & Company.
Mr. Bradley holds a Bachelor of Arts and a Bachelor of Law with first class honours from the University of Sydney and a Masters of Law from Harvard University. Mr. Bradley is also a Fellow of the Australian Institute of Company Directors and was recognized as a Member of the Order of Australia in July 2009 for his services to business, the arts and medical research.
Michael A. Carusi has served as a director of the Company since 2003. Mr. Carusi has over 20 years’ experience in the life sciences and health care industry in business development, management consulting and venture capital roles. As a result of this experience, Mr. Carusi provides us financial and management experience. Since 2012, Mr. Carusi has been a general partner of Lightstone Ventures which is a venture capital firm focused on investments in the life sciences industry. Since October 1998, Mr. Carusi has been a general partner of Advanced Technology Ventures, or ATV, which is a venture capital firm focused on investments in the life sciences and technology sectors. In 2003, Mr. Carusi led the ATV investment in the Company.
Mr. Carusi is a director of private medical companies in which ATV and Lightstone has invested, including EndoGastric Solutions, Inc., PowerVision, Inc., Holaira, Inc., Second Genome, Inc., and Gynesonics, Inc. He is also a former director of ATV investee companies where he was responsible for investments and successful exits, including Altura Medical, Inc., which was acquired by Lombard Medical, Inc., Ardian, Inc., which was acquired by Medtronic, Inc., Plexxikon, Inc., which was acquired by Daiichi Sankyo Co, Ltd, and MicroVention, which was acquired by Terumo Medical Corporation, and TranS1 (BAXS) which went public on NASDAQ in 2007.
Prior to joining ATV, Mr. Carusi served as the director of business development for Inhale Therapeutic Systems, Inc., a pulmonary drug delivery company that listed on NASDAQ in 1994, where he led partnering activities in the US, Europe and Japan. Mr. Carusi was formerly a principal at The Wilkerson Group, a management consulting firm focused exclusively on health care. Mr. Carusi also serves as a lecturer at the Amos Tuck School of Business Administration at Dartmouth College where he also sits on the Tuck MBA Advisory Board. In addition, Mike is a Director on the National Venture Capital Association (NVCA) Board of Directors where he is active in helping to shape policy affecting both innovation and healthcare. Lastly, Mike has been heavily involved with several programs at Stanford University including the Stanford Biodesign Program and, more recently, the Stanford Center for Clinical and Translational Research and Education (Spectrum) where he currently serves as a Member of the Oversight Committee.
Mr. Carusi holds a Masters of Business Administration from the Amos Tuck School of Business Administration at Dartmouth College and a Bachelor of Science in mechanical engineering from Lehigh University.
Anne J. Keating has served as a director of the Company since June 2011. Ms. Keating has had an extensive career in management and as a director of Australian companies, divisions of US companies and not-for-profit organizations. Her extensive business and governance experience makes her qualified to serve on our board of directors.
Ms. Keating is currently a director of a number of ASX-listed companies in a range of different industries, including REVA Medical, Inc., a US-based medical device company developing and commercializing bioresorbable stents for the treatment of coronary artery disease, and Goodman Group Limited, a global property development and management company. Ms. Keating is Chairman of Houlihan Lokey Australia, an investment bank.
Ms. Keating is also a director of the Garvan Institute of Medical Research (a leading research institute which studies diabetes and obesity among other diseases) and an Inaugural Governor for the Cerebral Palsy Alliance Research Foundation. From 1993 to 2001, Ms. Keating held the position of general manager, Australia
for United Airlines and from 1993 to 1998 she was also a governor for the American Chamber of Commerce. She was also a delegate to the Australian/American Leadership Dialogue for 14 years. Ms. Keating was an inaugural board member of the Victor Chang Cardiac Research Institute for 10 years and also served on the board of NRMA Pty Ltd, Insurance Australia Group (IAG) for 9 years and STW Ltd for 16 years. She has also held former directorships with Ardent Leisure Management Limited, Spencer Street Station Redevelopment Holdings Limited, Easy FM China Pty Ltd, Radio 2CH Pty Ltd and Workcover Authority of New South Wales.
Oern R. Stuge, M.D. has served as a director of the Company since his appointment in January 2017. Dr. Stuge’s extensive experience in domestic and international sales, management and operations in a global medical device manufacturer makes him qualified to serve on our board of directors.
Dr. Stuge has served as an executive in various medical device, health care and life sciences companies over the last thirty years. Since January 2011, Dr. Stuge has been Chairman of Orsco Lifesciences AG, a management firm that specializes in medical technology through which he supports several companies. Prior to that, Dr. Stuge served in various positions, including as Senior Vice-President, at Medtronic Inc., from May 1998 to December 2009. Dr. Stuge is currently Chairman of Mainstay Medical Limited, a Euronext Paris-listed and Irish Stock Exchange-listed medical devices company and Luminas Limited, formerly a NASDAQ-listed medical company. Dr. Stuge also serves on the board of several private companies including Balt Extrusion SAS, Vision Ophthalmology Group Gmbh, Pulmonx International SA, Phagenesis Limited and Aleva Neurotherapeutics SA. Furthermore, until December 2016, Dr. Stuge served on the board of Bonesupport AB, a private medical technology company.
Dr. Stuge received an M.D. from the University of Oslo, Norway, an M.B.A. from IMD and an INSEAD Certification in Corporate Governance.
Australian Disclosure Requirements
Because we are listed on the Australian Securities Exchange, or ASX, we are required to comply with various disclosure requirements as set out in the ASX Listing Rules. The following information is provided to comply with the ASX Listing Rules and is not intended to fulfill SEC information required by Part III of this Annual Report on Form 10-K.
Overview
Our securities are listed for quotation in the form of CHESS Depositary Interests, or CDIs, on the ASX and trade under the symbol “GID.” Each share of our Common Stock is equivalent to fifty CDIs. The shareholder information below was applicable as at March 15, 2017.
Our share capital was as follows:
1. As at March 15, 2017, an additional 1,157,915 shares of Common Stock were available for grant under our 2011 Employee, Director and Consultant Equity Incentive Plan.
Substantial Holders
The number of CDIs held by our substantial shareholders (being shareholders who, together with their associates, have a relevant interest in at least 5% of our voting shares) assuming the conversion of Common
Stock held by those shareholders into CDIs and based on the information in the substantial holder notices we received as of March 15, 2017, was as follows:
Distribution of Equity Security Holders
There were a total of 11,157,489 shares of Common Stock on issue, 11,059,680 of which were held as CDIs (being 552,983,980 CDIs in total). The table below presents the number of shares of Common Stock and the number of CDIs on issue, as well as the number of options, restricted stock units and warrants on issue by size of holding as of March 15, 2017.
Unmarketable Parcels
As of March 15, 2017, the number of shareholders holding less than a marketable parcel (for the purposes of the ASX Listing Rules) was 547, based on the closing market price as at March 15, 2017.
Top 20 Holders
Holders of CDIs Only
The table below provides a list of the top 20 holders of our CDIs. Related but separate legal entities are not aggregated.
Holders of CDIs and Common Stock Combined
The table below provides a list of the top 20 holders of our securities taking into account securities held in the form of both Common Stock and CDIs. Information presented below is prepared on the assumption that all shares of Common Stock on issue are held as CDIs. Related but separate legal entities are not aggregated.
Shares of Common Stock (not listed on ASX)
Options (not listed on ASX)
There were 1,071,390 options on issue to purchase shares of Common Stock under the 2011 Employee, Director and Consultant Equity Incentive Plan and the 2003 Omnibus Stock Plan with varying exercise prices. These options are held by 29 individuals.
Restricted Stock Units (not listed on ASX)
There were 403,501 restricted stock units on issue for 403,501 shares of Common Stock under the 2011 Employee, Director and Consultant Equity Incentive Plan. These restricted stock units are held by 3 individuals.
Warrants (not listed on ASX)
There was one warrant on issue to subscribe for in aggregate 28,532 shares of Common Stock at an exercise price of $0.64 per share.
Restricted Securities
There were no restricted securities on issue.
Voting Rights
Our bylaws provide that each shareholder has one vote for every share of Common Stock entitled to vote held of record by such shareholder and a proportionate vote for each fractional share of Common Stock entitled to vote so held, unless otherwise provided by Delaware General Corporation Law or in the certificate of incorporation.
Holders of CDIs have one vote for every fifty CDIs held of record by such shareholder. If holders of CDIs wish to attend our general meetings, they will be able to do so. Under the ASX Listing Rules, the Company, as an issuer of CDIs, must allow CDI holders to attend any meeting of the holders of the underlying securities unless relevant U.S. law at the time of the meeting prevents CDI holders from attending those meetings.
In order to vote at such meetings, CDI holders have the following options:
a) Instructing CDN, as the legal owner, to vote the shares of Common Stock underlying their CDIs in a particular manner. The instruction form must be completed and returned to our share registry prior to the meeting;
b) Informing us that they wish to nominate themselves or another person to be appointed as CDN’s proxy for the purposes of attending and voting at the general meeting; and
c) Converting their CDIs into a holding of shares of Common Stock and voting these at the meeting (however, if thereafter the former CDI holder wishes to sell their investment on the ASX, it would be necessary to convert the shares of Common Stock back to CDIs). This must be done prior to the record date for the meeting.
As holders of CDIs will not appear on our share register as the legal holders of shares of Common Stock, they will not be entitled to vote at our shareholder meetings unless one of the above steps is undertaken.
Proxy forms and details of these alternatives will be included in each notice of meeting we send to CDI holders.
Holders of restricted stock units, issued but unexercised options and warrants are not entitled to vote.
Required Statements
GI Dynamics, Inc. makes the following disclosures:
a) There is no current on-market buy-back of our securities.
b) GI Dynamics, Inc. is incorporated in the state of Delaware in the United States of America.
c) GI Dynamics, Inc. is not subject to Chapters 6, 6A, 6B or 6C of the Corporations Act 2001 (Cth), or Corporations Act, dealing with the acquisitions of shares (including substantial shareholdings and takeovers).
d) Under the Delaware General Corporation Law, shares are generally freely transferable subject to restrictions imposed by U.S. federal or state securities laws, by our certificate of incorporation or bylaws, or by an agreement signed with the holders of the shares at issue. Our amended and restated certificate of incorporation and bylaws do not impose any specific restrictions on transfer. Section 203 of the Delaware General Corporation Law prohibits a publicly-held Delaware corporation from engaging in a “business combination” with an “interested shareholder” for a period of three years following the time the person became an interested shareholder, unless the business combination or
acquisition of shares that resulted in a shareholder becoming an interested shareholder is approved in a prescribed manner. A “business combination” can include a merger, asset or share sale, or other transaction resulting in a financial benefit to an interested shareholder. Generally, an interested shareholder is a person who, together with its affiliates and associates, owns (or within three years prior to the determination of interested shareholder status did own) 15% or more of a corporation’s voting shares. The existence of this provision would be expected to have an anti-takeover effect with respect to transactions not approved in advance by the board of directors, including discouraging attempts that might result in a premium over the market price for the shares of Common Stock held by shareholders. As a general matter, Section 203 applies solely to corporations with a class of voting stock listed on a national securities exchange in the U.S. or held of record by 2,000 or more stockholders, neither of which currently apply to us, but may at any time in the future.
e) We have used the cash (and assets in a form readily convertible to cash) that we had at the time of admission to the ASX in a manner consistent with our stated business objectives (as described in the Australian prospectus lodged with the Australian Securities and Investments Commission with respect to our IPO) from the time of our admission to the ASX through to December 31, 2016.
f) The securities of GI Dynamics, Inc. are not quoted on any exchange other than the ASX.
g) The name of our Secretary is James Murphy.
h) The address and telephone number of our principal registered office in Australia is:
KPMG
Tower Three
International Towers Sydney
300 Barangaroo Avenue
Sydney NSW 2000 Australia
Telephone: +61 2 9335 8054
i) Registers of securities are held as follows:
1. for CDIs in Australia at:
Link Market Services Limited
Level 12, 680 George Street
Sydney NSW 2000
Telephone: +61 1300 554 474
2. for Common Stock in the United States at:
American Stock Transfer & Trust Company, LLC
6201 15th Avenue
Brooklyn New York 11219
Telephone: +1 718 921 8124
Australian Corporate Governance Statement
The Company’s board of directors, or Board, and employees are committed to developing, promoting and maintaining a strong culture of good corporate governance and ethical conduct.
The Board is pleased to confirm that the Company’s corporate governance framework is generally consistent with the ASX Corporate Governance Council’s “Corporate Governance Principles and Recommendations 3rd Edition” (“ASX Governance Recommendations”), other than as set out below. To this end, the Company provides below a review of its corporate governance framework using the same numbering as adopted for the principles as set out in the ASX Governance Recommendations.
This corporate governance statement relates to the financial year ended December 31, 2016, and has been approved by the Board.
Copies of the Company’s codes and policies may be downloaded from the corporate governance section of the Company’s website at www.gidynamics.com .
Principle 1 - Lay solid foundations for management and oversight
Recommendation 1.1 - A listed entity should disclose:
a) the respective roles and responsibilities of its board and management; and
b) those matters expressly reserved to the board and those delegated to management.
The Board’s responsibilities are recognized and documented by the charter of the Board (“Board Charter”), a copy of which is available on the Company’s website at www.gidynamics.com, and there is a clear delineation between the Board’s responsibility for the Company’s strategy and activities, and the day-to-day management of operations conferred upon the Company’s officers.
The Board Charter provides that the role of the Board, as the body ultimately responsible for the corporate governance of the Company, includes the following major functions:
•
providing input into and final approval of management’s development of corporate strategy and performance objectives;
•
reviewing, ratifying and monitoring systems of risk management and internal control, codes of conduct, and legal compliance;
•
ensuring appropriate resources are available to senior executives;
•
approving and monitoring the progress of major capital expenditure, capital management and acquisitions and divestments;
•
approving and monitoring financial and other reporting;
•
evaluating the overall effectiveness of the Board and its committees; and
•
evaluating, selecting and recommending an appropriate slate of candidates for election as directors.
Management is responsible for implementing the strategic objectives set by the Board, carrying out the day-to-day operations of the Company, and making accurate, timely, and clear reports to the Board.
Recommendation 1.2 - A listed entity should:
a) undertake the appropriate checks before appointing a person, or putting forward to security holders a candidate for election, as a director; and
b) provide security holders with all material information in its possession relevant to a decision on whether or not to elect or re-elect a director.
The nominating and corporate governance committee of the Company is responsible for reviewing, with the Board from time to time, the appropriate skills and characteristics required of Board members in the context of the current make-up of the Board and the Company’s business needs. When considering Board appointments, the committee ensures that appropriate checks are undertaken on the candidate’s character, education, qualifications, criminal record and bankruptcy history and that sufficient information is provided to security holders when a candidate is standing for election or re-election as a director to enable them to make an informed decision on whether or not to elect or re-elect the candidate. Information regarding the directors who were re-appointed at the Company’s 2016 annual general meeting was provided in the notice of meeting disclosed to the ASX and shareholders on May 2, 2016.
Recommendation 1.3 - A listed entity should have a written agreement with each director and senior executive setting out the terms of their appointment.
The terms of Board membership are set forth in the Company’s Board Charter and the remuneration paid to Board members is provided in accordance with shareholder approval (where required) following the
compensation committee’s recommendation. While the Company does not have a separate written agreement with each of its Board members, it believes these guidelines are adequate to provide a clear understanding of the roles and responsibilities of Board members. In the case of senior executives, the Company has provided a letter or contract of employment to each executive detailing the terms of employment and has developed job descriptions setting forth the position, duties, and reporting structure. Where there are any agreed entitlements upon termination, such agreed items are set forth in the employment letters or contracts. In January 2017, the Company amended the employment agreements with Scott Schorer, President and Chief Executive Officer and Brian Callahan, Chief Compliance Officer. The amendments concerned provisions of the agreement upon the termination of these two executives under certain circumstances - See Form 8K filed with the Securities and Exchange Commission January 30, 2017.
Recommendation 1.4 The company secretary of a listed entity should be accountable directly to the board, through the chair, on all matters to do with the proper functioning of the board:
The role and responsibilities of the Company’s secretary are set forth in the Company’s bylaws. The Board is responsible for electing or appointing the secretary and for prescribing the duties and powers of the secretary. Each director is able to communicate freely and directly with the secretary and vice versa. The secretary is accountable to the Board, through the chairman of the Board, for all matters to do with the proper functioning of the Board, including:
•
monitoring the Company’s compliance in respect of all corporate governance matters;
•
drafting and circulating the minutes of meetings of the Board and all committees for approval at the next meeting; and
•
monitoring the Company’s compliance with all disclosure obligations and regularly reviewing Company policies and procedures relating to compliance with such disclosure obligations.
Recommendation 1.5 - A listed entity should:
a) have a diversity policy which includes requirements for the board or a relevant committee of the board to set measurable objectives for achieving gender diversity and to assess annually both the objectives and the entity’s progress in achieving them;
b) disclose that policy or a summary of it; and
c) disclose as at the end of each reporting period the measurable objectives for achieving gender diversity set by the board or a relevant committee of the board in accordance with the entity’s diversity policy and its progress towards achieving them, and either:
i. the respective proportions of men and women on the board, in senior executive positions and across the whole organization (including how the entity has defined ‘senior executive’ for these purposes); or
ii. if the entity is a “relevant employer” under the Workplace Gender Equality Act, the entity’s most recent “Gender Equality Indicators”, as defined in and published under that Act.
The Company has adopted a Diversity Policy, a copy of which is available on the corporate governance section of the Company’s website. The Company’s Diversity Policy includes requirements for the Board to establish measurable objectives to assist the Company in achieving diversity.
The Board continued to evaluate the gender diversity of the Company’s employees, its senior executives, and the Board during 2016. During 2016, the Board, in considering measurable objectives to set for achieving gender diversity, concluded that, because of the current stage of the Company’s development and the ongoing restructuring efforts, the Company should continue to recruit employees from a diverse pool of talented candidates without regard to gender while continuing to focus on the necessary skills and experience required to achieve the Company’s performance objectives. As a result, the Company did not set measurable objectives for
achieving gender diversity in 2016 but used 2015 data as a baseline to measure gender diversity among its employees, senior executives and Board for 2016.
At December 31, 2016, the proportion of women in the Company as a percentage of its total employees decreased from 44% (16 out of 36 in 2015) to 40% (6 out of 15 in 2016) based on data maintained by the Company’s human resources organization. In senior executive positions (vice president and above), the proportion of women remained the same at 0% (none out of 4 in 2016 and 2015). The proportion of women on the Board increased from 14% (1 out of 7 in 2015) to 17% (1 out of 6 in 2016).
Recommendation 1.6 - A listed entity should:
a) have and disclose a process for periodically evaluating the performance of the board, its committees and individual directors; and
b) disclose, in relation to each reporting period, whether a performance evaluation was undertaken in the reporting period in accordance with that process.
In accordance with the Company’s agreed evaluation process, during the reporting period ended December 31, 2016, the Board and each committee performed a self-evaluation. Each director provided their assessments of the effectiveness of the Board and the committees on which they serve to the nominating and corporate governance committee. The individual assessments were summarized by the nominating and corporate governance committee and reported for discussion to the full Board and the committees. The nominating and corporate governance committee completed its assessment of the Board’s compliance with the principles set forth in the Board Charter and did not identify any areas in which the Board or committees needed to improve performance and has reviewed and approved disclosures relating to any departures from the ASX Governance Recommendations. During the reporting period ended December 31, 2016, the nominating and corporate governance committee also evaluated individual directors in accordance with the criteria set by the nominating and corporate governance committee and the Board from time to time. Based on such assessments, the nominating and corporate governance committee has determined that the Board, its committees and each director were effective.
Recommendation 1.7 - A listed entity should:
a) have and disclose a process for periodically evaluating the performance of its senior executives; and
b) disclose, in relation to each reporting period, whether a performance evaluation was undertaken in the reporting period in accordance with that process.
Under the Board Charter, the directors of the Company are ultimately responsible for monitoring the performance of the senior management team and the compensation committee, in accordance with its charter, reviews and approves corporate and personal performance goals and objectives relevant to the compensation of all executive officers. At the end of each calendar year, the chief executive officer presents to the compensation committee his assessment of the performance during the year of each executive officer (other than himself) against pre-established performance objectives. The compensation committee considers this assessment and determines each executive officer’s (including the chief executive officer’s) compensation, including but not limited to salary, bonus, incentive compensation and equity awards based on such an evaluation. In addition, the compensation committee is responsible for regularly reviewing the Company’s compensation, recruitment, retention and termination policies for senior executives.
In January 2016, a performance evaluation of the Company’s executive officers for the year ended December 31, 2015 was undertaken. In January 2017, a performance evaluation of the Company’s executive officers for the year ended December 31, 2016 was undertaken. Following each performance evaluation, the Company’s compensation committee reviewed and approved changes to the compensation of the Company’s executive officers based on the individual levels of achievement against pre-established performance objectives.
Further information regarding executive compensation for the year ended December 31, 2016, as required by Item 11
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated by reference to the applicable information in our proxy statement for our 2017 Annual Meeting of Stockholders to be filed with the SEC and ASX.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information relating to security ownership of certain beneficial owners of our Common Stock and information relating to the security ownership of our management required by this Item 12 is incorporated by reference to the applicable information in our proxy statement for our 2017 Annual Meeting of Stockholders to be filed with the SEC and ASX.
The table below sets forth information with regard to shares authorized for issuance under our equity compensation plans as of December 31, 2016. As of December 31, 2016, we had two active equity compensation plans, each of which was approved by our stockholders:
•
Our 2003 Omnibus Stock Plan; and
•
Our 2011 Employee, Director and Consultant Equity Incentive Plan.
1) Our 2011 Employee, Director and Consultant Equity Incentive Plan allows for an annual increase in the number of shares available for issue commencing on the first day of each fiscal year during the period beginning in fiscal year 2012 and ending in fiscal year 2020. The annual increase in the number of shares shall be equal to the lowest of: (i) 500,000 shares; (ii) 4% of the number of common shares outstanding as of such date; and (iii) an amount determined by our board of directors or our compensation committee.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item 13 is incorporated by reference to the applicable information in our proxy statement for our 2017 Annual Meeting of Stockholders to be filed with the SEC and ASX.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item 14 is incorporated by reference to the applicable information in our proxy statement for our 2017 Annual Meeting of Stockholders to be filed with the SEC and ASX.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) List of documents filed as part of this Annual Report on Form 10-K
(1) Consolidated Financial Statements listed under Part II, Item 8 and included herein by reference.
(2) Consolidated Financial Statement Schedules
No schedules are submitted because they are not applicable, not required or because the information is included in the Consolidated Financial Statements or Notes to Consolidated Financial Statements.
(3) Exhibits
The exhibits listed in the accompanying Exhibit Index are filed or incorporated by reference as part of this Annual Report on Form 10-K.
ITEM 16. FORM 10-K SUMMARY
Not applicable.
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, hereunto duly authorized.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.
EXHIBIT INDEX
* Filed herewith.
 Furnished herewith.
 Management contract or compensatory plan or arrangement.
GI Dynamics, Inc. and Subsidiaries
Index to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of
GI Dynamics, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of GI Dynamics, Inc. and Subsidiaries (the Company) as of December 31, 2016, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of GI Dynamics, Inc. and Subsidiaries as of December 31, 2016, and the consolidated results of their operations and their consolidated cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1 to the consolidated financial statements, the Company has experienced recurring losses, and negative cash flows from operations since inception and has an accumulated deficit as of December 31, 2016. These factors raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Moody, Famiglietti & Andronico, LLP
Tewksbury, Massachusetts
March 30, 2017
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
GI Dynamics, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of GI Dynamics, Inc. and Subsidiaries (the Company) as of December 31, 2015, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2015. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of GI Dynamics, Inc. and Subsidiaries as of December 31, 2015, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles.
/s/ Ernst & Young LLP
Boston, MA
March 30, 2016
GI Dynamics, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except share and per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
GI Dynamics, Inc. and Subsidiaries
Consolidated Statements of Operations and Comprehensive Loss
(In thousands, except share and per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
GI Dynamics, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
(In thousands, except share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
GI Dynamics, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. Nature of Business
GI Dynamics, Inc. (the “Company”) was incorporated on March 24, 2003, as a Delaware corporation, with operations based in Boston, Massachusetts. The Company is dedicated to restoring health and improving quality of life through the design and application of device and disease management solutions for treatment of metabolic disease. The Company’s near-term goal is to establish EndoBarrier Therapy as a vital treatment option for patients suffering from type 2 diabetes and obesity by restoring more manageable blood sugar levels and reducing body weight. The Company is the developer of EndoBarrier®, the first endoscopically-delivered device therapy approved for the treatment of obese type 2 diabetic patients. EndoBarrier is the only proven, incision-free, non-anatomy altering solution designed to specifically mimic the duodenal-jejunal exclusion created by gastric bypass surgery, without the permanent safety issues associated with gastric bypass. Since incorporation, the Company has devoted substantially all of its efforts to product commercialization, research and development, business planning, recruiting management and technical staff, acquiring operating assets, and raising capital. The Company currently operates in one reportable business segment which designs, manufactures and markets medical devices.
In 2011, the Company began commercial sales of its product, the EndoBarrier, which is approved and commercially available in multiple countries outside the U.S.
In the U.S., the Company received approval from the Food and Drug Administration (“FDA”), to commence its pivotal trial of EndoBarrier Therapy (the “ENDO Trial”), which the Company began in 2013. The multi- center, randomized, double-blinded study planned to enroll 500 patients with uncontrolled type 2 diabetes and obesity at 25 sites in the U.S. The primary endpoint was improvement in diabetes control as measured by HbA1c levels. In the second half of fiscal 2015, the Company announced its decision to stop the ENDO Trial.
On August 21, 2015, the Company announced that it was reducing headcount by approximately 46% as part of its efforts to restructure its business and expenses in response to stopping the ENDO Trial and to ensure sufficient cash remained available for it to establish new priorities, continue limited market development and research, and to evaluate strategic options.
In the second and third quarters of fiscal 2016, the Company took additional actions that it thought necessary to allow the opportunity to evolve its strategic options. These actions resulted in non-recurring charges totaling approximately $1.1 million, including $0.4 million related to restructuring charges in our second quarter, $0.6 million related to employee departures in both our second and third quarters and $0.1 million related to abandonment of our former headquarters in Lexington, MA.
In October 2016 we received final cancellation notification from the Therapeutic Goods Administration (TGA) for the listing of EndoBarrier on the Australian Register of Therapeutic Goods (ARTG). The TGA stated that the Company failed to provide adequate evidence of compliance with certain provisions of the TGA Essential Principles within the required number of working days.
Currently, the Company is focused on commercialization efforts within select European Union and Middle East countries and is re-engaging with the FDA to explore regulatory approval for EndoBarrier.
The Company has incurred operating losses since inception and at December 31, 2016, had an accumulated deficit of approximately $248.2 million. GI Dynamics expects to incur significant operating losses for the next several years. At December 31, 2016, the Company had approximately $8.3 million in cash and cash equivalents and restricted cash. The Company does not expect its current cash balances will be sufficient to enable it to conduct an additional clinical trial for the purpose of seeking regulatory approval from the FDA and complete development of an improved EndoBarrier for its current use and potential new indications. The Company will
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. Nature of Business (continued)
need to raise additional funding prior to September 30, 2017 in order to continue to pursue its current business objectives as planned and to continue to fund its operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The Company may seek to raise additional funds through any combination of collaborative arrangements, strategic alliances, and additional equity and debt financings or from other sources. There can be no assurance that any such financing opportunities will be available on acceptable terms, if at all. If the Company is unable to raise capital when needed, it could be forced to significantly delay or discontinue research and development activities and further commercialization of EndoBarrier, which could have a material adverse effect on its business, financial condition and results of operations. In addition, the Company could be required to cease operations if it is unable to raise capital when needed.
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates the realization of assets and liabilities and commitments in the normal course of business. The consolidated financial statements for the year ended December 31, 2016 do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from uncertainty related to the Company’s ability to continue as a going concern.
In September 2011, the Company completed its initial public offering (“IPO”) of common stock in the form of CHESS Depositary Interests (“CDIs”) in Australia. As a result of the IPO and simultaneous private placement in the U.S., the Company raised a total of approximately $72.5 million in proceeds, net of expenses and repayment of $6.0 million of the Company’s Convertible Term Promissory Notes. Additionally, in July and August 2013, the Company sold CDIs on the Australian Securities Exchange (“ASX”) through a private placement and Share Purchase Plan (“SPP”), which raised a total of approximately $52.5 million, net of expenses. In May 2014, the Company raised an additional approximately $30.8 million, net of expenses, when it sold CDIs on the ASX through a private placement. On December 20, 2016 the company completed a private placement sale of 69,865,000 CDI’s (1,397,300 shares) for approximately $1.0 million, net of expenses.
2. Summary of Significant Accounting Policies and Basis of Presentation
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of GI Dynamics, Inc. and its wholly owned subsidiaries. All intercompany transactions and balances are eliminated in consolidation.
The functional currency of GID Europe Holding B.V., GID Europe B.V., GID Germany GmbH and GI Dynamics Australia Pty Ltd is the U.S. dollar. Consolidated balance sheet accounts of the Company’s subsidiaries are translated into U.S. dollars using the exchange rate in effect at the consolidated balance sheet date while expenses are translated using the average exchange rate in effect during the period. Gains and losses arising from translation of the wholly owned subsidiaries’ financial statements are included in the determination of net loss.
Use of Estimates
The preparation of consolidated financial statements in accordance with generally accepted accounting principles in the U.S. requires the Company’s management to make estimates and judgments that may affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. On an ongoing basis, the Company’s management evaluates its estimates, including those related to revenue recognition, allowance for doubtful accounts, inventory valuation including reserves for excess and obsolete inventory, impairment of long-lived assets, income taxes including the valuation allowance for deferred
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies and Basis of Presentation (continued)
tax assets, research and development, contingencies, valuation of warrant liabilities, estimates used to assess its ability to continue as a going concern and stock-based compensation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. Changes in estimates are reflected in reported results in the period in which they become known.
Cash and Cash Equivalents
The Company considers all highly liquid investment instruments with an original maturity when purchased of three months or less to be cash equivalents. Investments qualifying as cash equivalents primarily consist of money market funds and have a carrying amount that approximates fair value. The amount of cash equivalents included in cash and cash equivalents was approximately $6.3 million and $17.2 million at December 31, 2016 and 2015, respectively.
At December 31, 2016 and 2015, the Company had approximately $0.1 million and $0.2 million, respectively, of cash and cash equivalents denominated in Australian dollars that is subject to foreign currency gain and loss. At December 31, 2016 and 2015, the Company had approximately $0.2 million and $0.5 million, respectively, of cash and cash equivalents denominated in euros that is subject to foreign currency gain and loss.
Property and Equipment
Property and equipment, including leasehold improvements, are recorded at cost and are depreciated when placed in service using the straight-line method based on their estimated useful lives as follows:
Included in property and equipment are certain costs of software obtained for internal use. Costs incurred during the preliminary project stage are expensed as incurred, while costs incurred during the application development stage are capitalized and amortized over the estimated useful life of the software. The Company also capitalizes costs related to specific upgrades and enhancements when it is probable the expenditures will result in additional functionality. Maintenance and training costs related to software obtained for internal use are expensed as incurred.
Leasehold improvements are amortized over the shorter of the estimated useful life of the asset or the remaining lease term. Costs for capital assets not yet placed into service have been capitalized as construction in progress and will be depreciated in accordance with the above guidelines once placed into service. Maintenance and repair costs are expensed as incurred.
Revenue Recognition
The Company generates all of its revenue from sales of its EndoBarrier to health care providers and third- party distributors who resell the product to health care providers.
The Company considers revenue to be realized or realizable and earned when all of the following criteria are met: persuasive evidence of a sales arrangement exists, delivery has occurred or services have been rendered, the
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies and Basis of Presentation (continued)
price is fixed or determinable, and collectability is reasonably assured. Revenue is recognized upon passage of title and risk of loss to customers, unless a consignment arrangement exists and provided an estimate can be made for sales returns.
With respect to these criteria:
•
The evidence of an arrangement generally consists of a health care provider or distributor purchase order with the necessary approvals and acceptance by the Company.
•
Transfer of title and risk and rewards of ownership are passed to the health care provider or third-party distributor upon delivery of the products.
•
The selling prices for all sales are fixed and agreed with the health care provider or third-party distributor. Provisions for discounts and rebates to customers are established as a reduction to revenue in the same period the related sales are recorded.
When doubt exists about collectability from specific customers, the Company defers revenue from sales of products to those customers until payment is received. GI Dynamics, Inc. and Subsidiaries
In certain circumstances the Company allows customers to return defective or nonconforming products for credit or replacement products. Defective or nonconforming products typically include those products that resulted in an unsuccessful implant procedure. The Company considers these transactions to be product returns and bases its estimate for sales returns upon historical trends and records the amount as a reduction to revenue upon the initial sale of the product. In the event the Company is unable to reasonably estimate future returns, it recognizes revenue when the right of return lapses. Prior to the fourth quarter of 2013, the Company did not have sufficient historical experience on which to base an estimate of returns, and therefore recognized revenue when the right of return lapsed. The Company determined this point to be when the product was implanted or otherwise consumed and payment was received from the customer, which indicated that the Company had no further obligations to the customer and that the sale was complete. As a result, starting in the fourth quarter of 2013, the Company began to recognize revenue at the time of delivery net of these return estimates. Prospectively, the Company will continue to evaluate whether it has sufficient data to determine return estimates as it enters new markets.
The Company has certain relationships in which title to delivered product passes to a buyer, but the substance of the transaction is that of a consignment arrangement. In these cases, the Company recognizes revenue when the product is implanted or otherwise consumed and payment is received from the customer, which indicates that the Company has no further obligations to the customer and that the sale is complete. For these transactions, revenue recognition is deferred until the sale is complete.
At December 31, 2016 and 2015, the Company had deferred revenue of approximately $11,000.
In addition, the Company has entered into consignment arrangements in which the Company delivers the product to the customer but retains title to the product until it is implanted or otherwise consumed. In these arrangements, the Company recognizes revenue once it receives proof of third party purchase, usually in the form of a customer purchase order.
Shipping and Handling Costs
Shipping and handling costs are included in costs of revenue.
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies and Basis of Presentation (continued)
Research and Development Costs
Research and development costs are expensed when incurred. Research and development costs include costs of all basic research activities as well as other research, engineering, and technical effort required to develop a new product or service or make significant improvement to an existing product or manufacturing process.
Research and development costs also include pre-approval regulatory and clinical trial expenses.
Patent Costs
The Company expenses as incurred all costs, including legal expenses, associated with obtaining patents until the patented technology becomes feasible. All costs incurred after the patented technology is feasible will be capitalized as an intangible asset. As of December 31, 2016, no such costs had been capitalized since inception of the Company. The Company has expensed approximately $0.4 million, $0.5 million and $0.5 million of patent costs within general and administrative expenses in the consolidated statements of operations and comprehensive loss for the years ended December 31, 2016, 2015 and 2014, respectively.
Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 718, Stock Compensation (“ASC 718”), which requires that stock-based compensation be measured and recognized as an expense in the financial statements and that such expense be measured at the grant date fair value.
For awards that vest based on service conditions, the Company uses the straight-line method to allocate compensation expense to reporting periods. The grant date fair value of options granted is calculated using the Black-Scholes option pricing model, which requires the use of subjective assumptions including volatility, expected term and the fair value of the underlying common stock, among others.
The Company periodically issues performance-based awards. For these awards, vesting will occur upon the achievement of certain milestones. When achievement of the milestone is deemed probable, the Company expenses the compensation of the respective stock award over the implicit service period.
Stock awards to non-employees are accounted for in accordance with ASC 505-50, Equity-Based Payments to Non-Employees (“ASC 505-50”). The measurement date for non-employee awards is generally the date performance of services required from the non-employee is complete. For non-employee awards that vest based on service conditions, the Company expenses the value of the awards over the related service period, provided they expect the service condition to be met. The Company records the expense of services rendered by non- employees based on the estimated fair value of the stock option using the Black-Scholes option pricing model over the contractual term of the non-employee. The fair value of unvested non-employee awards are remeasured at each reporting period and expensed over the vesting term of the underlying stock options on a straight-line basis.
The stock-based compensation plans provide that grantees may have the right to exercise an option prior to vesting. Shares purchased upon the exercise of unvested options will be subject to the same vesting schedule as the underlying options, and are subject to repurchase at the original exercise price by the Company should the grantee discontinue providing services to the Company for any reason, prior to becoming fully vested in such shares.
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies and Basis of Presentation (continued)
Impairment of Long-Lived Assets
The Company regularly reviews the carrying amount of its long-lived assets to determine whether indicators of impairment may exist that warrant adjustments to carrying values or estimated useful lives. If indications of impairment exist, projected future undiscounted cash flows associated with the asset are compared to the carrying amount to determine whether the asset’s value is recoverable. If the carrying value of the asset exceeds such projected undiscounted cash flows, the asset will be written down to its estimated fair value.
Comprehensive Loss
Comprehensive loss is the change in equity of a company during a period from transactions and other events and circumstances, excluding transactions resulting from investments by owners and distributions to owners. The Company currently does not have any changes in equity from non-owner sources. As a result, comprehensive loss was equal to the net loss for all periods reported.
Loss Contingencies
In accordance with ASC 450, Contingencies, the Company accrues anticipated costs of settlement, damages, and losses for loss contingencies based on historical experience or to the extent specific losses are probable and estimable. Otherwise, the Company expenses these costs as incurred. If the estimate of a probable loss is a range, and no amount within the range is more likely, the Company accrues the minimum amount of the range.
Income Taxes
The Company provides for income taxes under the liability method. The Company records deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the Company’s financial reporting and the tax bases of assets and liabilities measured using the enacted tax rates expected to be in effect in the years in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to reflect the uncertainty associated with their ultimate realization.
The Company accounts for uncertain tax positions recognized in the consolidated financial statements by applying a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.
Guarantees
The Company has identified the guarantees described below as disclosable, in accordance with ASC 460, Guarantees.
As permitted under Delaware law, the Company indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was, serving at the Company’s request in such capacity. The maximum potential amount of future payments the Company could be required to make is unlimited; however, the Company has directors’ and officers’ insurance coverage that should limit its exposure and enable it to recover a portion of any future amounts paid.
The Company is a party to a number of agreements entered into in the ordinary course of business that contain typical provisions that obligate the Company to indemnify the other parties to such agreements upon the occurrence of certain events. Such indemnification obligations are usually in effect from the date of execution of the applicable agreement for a period equal to the applicable statute of limitations. The aggregate maximum potential future liability of the Company under such indemnification provisions is uncertain.
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies and Basis of Presentation (continued)
As of December 31, 2016 and 2015, the Company had not experienced any material losses related to these indemnification obligations, and no material claims with respect thereto were outstanding. The Company does not expect significant claims related to these indemnification obligations and, consequently, concluded that the fair value of these obligations is negligible. As a result, no related reserves have been established.
Reverse Stock Split
In November 2014, the Company’s stockholders approved a one-for-ten reverse stock split of the Company’s common stock that was effective April 9, 2015. All share and per share amounts in the consolidated financial statements and notes thereto have been retroactively adjusted, where necessary, to reflect this reverse stock split. Because the par value of the Company’s shares of common stock remain unchanged after the date of the split, the total stated par value and additional paid-in capital changed by offsetting amounts. The stated par value was reduced to one-tenth of the amount before the split and the additional paid-in capital was increased the same amount.
Subsequent Events
The Company evaluates events occurring after the date of its consolidated balance sheet for potential recognition or disclosure in its consolidated financial statements. There have been no subsequent events that have occurred through the date the Company issued its consolidated financial statements that require disclosure in or adjustment to its consolidated financial statements.
New Accounting Pronouncements
From time to time, new accounting pronouncements are issued by the FASB or other standard setting bodies that are adopted by the Company as of the specified effective date. Unless otherwise discussed, the Company believes that the effect of recently issued standards that are not yet effective will not have a material effect on its consolidated financial position or results of operations upon adoption.
In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09 (“ASU 2014-09”), Revenue from Contracts with Customers, which supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and most industry-specific guidance. The new standard requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In July 2015, the FASB approved a one year deferral of the effective date of this standard to annual reporting periods, and interim reporting periods within those years, beginning after December 15, 2017. Early adoption is permitted to the original effective date of December 15, 2016, including interim reporting periods within those years. The Company is currently evaluating the potential impact that ASU 2014-09 may have on its consolidated financial statements.
In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). This new standard gives a company’s management the final responsibilities to decide whether there is substantial doubt about the company’s ability to continue as a going concern and to provide related footnote disclosures. The standard provides guidance to management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that companies commonly provide in their footnotes. Under the new standard, management must decide whether there are conditions or events, considered in the aggregate, that raise
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies and Basis of Presentation (continued)
substantial doubt about the company’s ability to continue as a going concern within one year after the date that the financial statements are issued, or within one year after the date that the financial statements are available to be issued when applicable. This updated pronouncement was adopted for the annual reporting period ended December 31, 2016 and had no material impact on the Company’s financial statements.
In April 2015, the FASB issued ASU No. 2015-05, Intangibles - Goodwill and Other - Internal-Use Software (“ASU 2015-05”). This new standard provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. ASU 2015-05 will be effective for the Company for reporting periods beginning after December 15, 2015. Early adoption is permitted and a company can elect to adopt ASU 2015-05 either (1) prospectively to all arrangements entered into or materially modified after the effective date or (2) retrospectively. Accordingly, the standard is effective for the Company on January 1, 2016. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory (“ASU 2015- 11”). ASU 2015-11, which simplifies the measurement of inventories valued under most methods, including the Company’s inventories valued under FIFO - the first-in, first-out cost method. Inventories valued under LIFO - the last-in, first-out method - are excluded. Under this new guidance, inventories valued under these methods would be valued at the lower of cost and net realizable value, with net realizable value defined as the estimated selling price less reasonable costs to sell the inventory. This guidance is effective for annual reporting beginning after December 15, 2016, including interim periods within the year of adoption, with early application permitted. The adoption of this guidance is not expected to have a significant impact on the Company’s consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17, Income Taxes - Balance Sheet Reclassification of Deferred Taxes (Topic 740) (“ASU 2015-17”). ASU 2015-17 requires that deferred tax liabilities and assets, and any related valuation allowances, be classified as noncurrent in a classified statement of financial position. The classification change for all deferred taxes as noncurrent simplifies entities’ processes as it eliminates the need to separately identify the net current and net noncurrent deferred tax asset or liability in each jurisdiction and allocate valuation allowances. ASU 2015-17 is effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted and the amendments may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company early adopted ASU 2015-17 in the fourth quarter of 2015 on a prospective basis and reclassified the current portion of deferred tax assets to the non-current portion of deferred tax assets within its consolidated balance sheets resulting in a reduction of other long-term assets and other current liabilities of approximately $97,000 as of December 31, 2015. The prior period balances were not retrospectively adjusted.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), or ASU 2016-02. ASU 2016-02 requires that lessees recognize in the statement of financial position for all leases (with the exception of short-term leases) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis, and a right-of-use asset, which is an asset representing the lessee’s right to use the underlying asset for the lease term. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. Lessees must apply a
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. Summary of Significant Accounting Policies and Basis of Presentation (continued)
modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees may not apply a full retrospective transition approach. The adoption of this guidance is not expected to have a significant impact on our consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, or ASU 2016-09. ASU 2016-09 will simplify the income tax consequences, accounting for forfeitures and classification on the statements of consolidated cash flows. ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods, with early adoption permitted. We are currently evaluating the potential impact that ASU 2016-09 may have on our consolidated financial statements.
In August, 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force), or ASU 2016-15. The amendments in ASU 2016-15 address eight specific cash flow issues and apply to all entities that are required to present a statement of cash flows under FASB Accounting Standards Codification 230, Statement of Cash Flows. The amendments in ASU 2016-15 are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption during an interim period. We are currently evaluating the impact that ASU No. 2016-15 may have on our consolidated financial statements.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issue Task Force), or ASU 2016-18. This new standard addresses the diversity that exists in the classification and presentation of changes in restricted cash on the statement of cash flows. The amendments in ASU 2016-18 require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within the year of adoption, with early adoption permitted. We do not expect that the adoption of ASU 20116-18 will have a material impact on our consolidated financial statements.
3. Net Loss per Common Share
Basic net loss per common share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Potential common stock equivalents are determined using the treasury stock method. For diluted net loss per share purposes, the Company excludes stock options and other stock-based awards, including shares issued as a result of option exercises but which are subject to repurchase by the Company, whose effect would be anti-dilutive from the calculation. During each of the years ended December 31, 2016, 2015 and 2014, common stock equivalents were excluded from the calculation of diluted net loss per common share, as their effect was anti-dilutive due to the net loss incurred. Therefore, basic and diluted net loss per share was the same in all periods presented.
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. Net Loss per Common Share (continued)
The following potentially dilutive securities have been excluded from the computation of diluted weighted- average shares outstanding as of December 31, 2016, 2015 and 2014, as they would be anti-dilutive:
4. Common Stock Warrants
In connection with the Company’s IPO in September 2011, the Company issued warrants in an aggregate amount of 50,000 shares of common stock at an exercise price of A$55.00 per share to the lead manager of the IPO and certain other investors. The warrants expired on the fifth anniversary of their date of grant.
On May 4, 2016, the Company entered into a consulting agreement pursuant to which the consulting firm will provide strategic advisory, finance, accounting, human resources and administrative functions, including chief financial officer services, to the Company. In connection with the consulting agreement, the Company granted the consulting firm a warrant (“Consultant Warrant,” together with the IPO Warrants, the “Warrants”) to purchase up to 28,532 shares of the Company’s common stock at an exercise price per share equal to $0.64. The Consultant Warrant vests on a monthly basis over two years and has a term of five years. The Company has reserved 28,532 shares of common stock related to the Consultant Warrant. As of December 31, 2016, no Consultant Warrants had been exercised.
The Company accounts for the warrants under ASC 815, Derivatives and Hedging (“ASC 815”). In accordance with the guidance included in ASC 815, because the Company’s functional currency is the U.S. dollar and the exercise price of the warrants is in Australian dollars, the Company is exposed to currency exchange risk related to the warrants. As a result, the warrants are not considered indexed to the Company’s own stock, and therefore, the warrants are classified as a liability and the fair value of the warrants must be remeasured at each reporting period. At the time the warrants were issued, the Company estimated the fair value of the warrants using the Black-Scholes option pricing model. The Company remeasured the fair value of the warrants at each reporting period using current assumptions and current foreign exchange rates, with changes in value recorded as other income or expense (Note 5).
5. Fair Value of Financial Instruments
The tables below present information about the Company’s assets and liabilities that are measured at fair value on a recurring basis as of December 31, 2016 and 2015, and indicates the fair value hierarchy of the valuation techniques the Company used to determine such fair value. In general, fair values determined by Level 1 inputs utilize observable inputs such as quoted prices in active markets for identical assets or liabilities. Fair values determined by Level 2 inputs utilize data points that are either directly or indirectly observable, such as quoted prices, interest rates and yield curves. Fair values determined by Level 3 inputs utilize unobservable data points in which there is little or no market data, requiring the Company to develop its own assumptions for the asset or liability.
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. Fair Value of Financial Instruments (continued)
The following tables present the assets and liabilities the Company has measured at fair value on a recurring basis (in thousands):
The assumptions used in the Black-Scholes option pricing model to determine the fair value of the common stock warrants at December 31, 2016, 2015 and 2014 were as follows:
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Notes to Consolidated Financial Statements (continued)
5. Fair Value of Financial Instruments (continued)
The following table rolls forward the fair value of the warrants, where fair value is determined by Level 3 inputs (in thousands):
Cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable, accrued expenses and other current liabilities at December 31, 2016 and 2015 are carried at amounts that approximate fair value due to their short-term maturities and highly liquid nature of these instruments.
6. Concentrations of Credit Risk, Accounts Receivable and Related Valuation Account
Financial instruments that subject the Company to credit risk primarily consist of cash and cash equivalents and accounts receivable. The Company maintains its cash and cash equivalent balances with high quality financial institutions, and consequently, the Company believes that such funds are subject to minimal credit risk. The Company’s short-term investments potentially subject the Company to concentrations of credit risk. The Company has adopted an investment policy that limits the amounts the Company may invest in any one type of investment and requires all investments held by the Company to hold at least an A rating from a recognized credit rating agency, thereby reducing credit risk concentration.
Accounts receivable primarily consist of amounts due from customers, including distributors and health care providers in different countries. In light of the current economic state of many foreign countries, the Company continues to monitor the creditworthiness of its customers.
At December 31, 2016 one health care provider accounted for approximately 43% of the Company’s accounts receivable and another health care provider accounted for approximately 22% of the Company’s accounts receivable.
At December 31, 2015, one health care provider accounted for approximately 15% of the Company’s accounts receivable and two health care providers accounted for approximately 11% each and a fourth health care provider accounted for approximately 10%. No other customer accounted for greater than 10% of the Company’s accounts receivable at December 31, 2016 and 2015.
The Company grants credit to customers in the normal course of business but generally does not require collateral or any other security to support its receivables. The Company makes judgments as to its ability to collect outstanding receivables and provides an allowance for receivables when collection becomes doubtful. Provisions are made based upon a specific review of all significant outstanding invoices and the overall quality and age of those invoices not individually reviewed. Amounts determined to be uncollectible are written off against this reserve. The Company recorded write-offs of uncollectible accounts receivable of approximately $48,000 in the year ended December 31, 2016 and approximately $31,000 in 2015 and none in 2014. As of December 31, 2016, the Company believes its allowance for doubtful accounts of approximately $16,000 is adequate based on its review.
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. Concentrations of Credit Risk, Accounts Receivable and Related Valuation Account (continued)
In certain circumstances the Company allows customers to return defective or nonconforming products for credit or replacement products. Defective or nonconforming products typically include those products that resulted in an unsuccessful implant procedure. The Company records an estimate for product returns based upon historical trends. The associated reserve for product returns is recorded as a reduction of the Company’s accounts receivable.
The following table shows the components of the Company’s accounts receivable at December 31, 2016 and 2015 (in thousands):
The following is a roll forward of the Company’s allowance for doubtful accounts (in thousands):
7. Inventory
The Company states inventory at the lower of first-in, first-out cost or market. The Company records a provision for excess, expired, and obsolete inventory based primarily on estimates of forecasted revenues. A significant change in the timing or level of demand for products as compared to forecasted amounts may result in recording additional provisions for excess, expired, and obsolete inventory in the future. When capitalizing inventory, the Company considers factors such as status of regulatory approval, alternative use of inventory, and anticipated commercial use of the product.
The determination of obsolete or excess inventory requires the Company to estimate the future demand for its products within appropriate time horizons. The estimated future demand is compared to inventory levels to determine the amount, if any, of obsolete and excess inventory. The demand forecast includes the Company’s estimates of market growth and various internal estimates, and is based on assumptions that are consistent with the plans and estimates the Company is using to manage its underlying business and short-term manufacturing plans. Forecasting demand for EndoBarrier in a market in which there are few, if any, comparable approved devices and for which reimbursement from third-party payers is limited has been difficult. To the extent the Company’s demand forecast is less than its inventory on-hand, the Company could be required to record additional reserves for excess, expired or obsolete inventory in the future.
In 2015, the Company performed an analysis of its inventory on hand and due to current evidence that the utility of certain amounts of its inventory as it was expected to be used will be less than its cost recorded an
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. Inventory (continued)
approximately $3.2 million charge for excess, expired and obsolete inventory. Factors contributing to the inventory write-down included: the effect that the ENDO Trial enrollment hold and subsequent termination had on commercial activity and the Company’s inventory levels, the expected timing of third-party payer reimbursement in its commercial markets, its conclusion that certain inventory will not be used for sales inside or outside the U.S. and the historical accuracy of its demand forecasts. As of December 31, 2016 and 2015, the Company has a reserve totaling approximately $5.0 million of which approximately $3.3 million was for its inventory of sleeve material. The Company continues to review any evidence that may indicate that the utility of additional amounts of inventory, as it was expected to be used, will be less than cost.
In 2014, the Company determined that its raw material sleeve inventory was in excess of its anticipated commercial demand for future sales. Accordingly, for the year ended December 31, 2014, the Company recorded a provision for excess inventory of approximately $1.6 million to reduce the carrying value of the raw material sleeve inventory.
Inventory, net of reserves, at December 31, 2016 and 2015 was as follows (in thousands):
The Company has entered into consignment arrangements in which the Company delivers product to the customer but retains title to the product until it is implanted or otherwise consumed. At December 31, 2016 and 2015, approximately 5% and 2% of the finished goods inventory was at customer locations pursuant to these arrangements.
8. Property and Equipment
Property and equipment consisted of the following (in thousands):
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Notes to Consolidated Financial Statements (continued)
8. Property and Equipment (continued)
As part of the Company’s restructuring in 2015 and then in 2016 in connection with the abandonment of its Company headquarters in Lexington, Massachusetts, the Company recognized a charge for impaired fixed assets as follows (in thousands):
In January 2015, the Company entered into a capital lease for certain office equipment. The company disposed of the certain office equipment during the 4th quarter in 2016. At December 31, 2016, the Company had no assets under capital lease.
Depreciation and amortization expense of property and equipment, including equipment recorded under capital leases, totaled approximately $0.2 million, $0.5 million and $0.7 million for the years ended December 31, 2016, 2015, and 2014, respectively.
9. Accrued Expenses
Accrued expenses consisted of the following (in thousands):
In both 2016 and 2015, the Company recorded approximately $0.6 million of separation related expenses of which approximately none and $0.1 million is included in payroll and related liabilities at December 31, 2016 and 2015, respectively.
10. Short-Term Notes Payable
GI Dynamics, Inc. entered into a short-term loan agreement with First Insurance Funding Corp to borrow $306,380 to be used to purchase insurance. The agreement calls for ten monthly payments of $30,638 which includes principal and interest. The annual interest rate on the borrowing is 1.95%. The outstanding balance at December 31, 2016 was $214,466 and has been included in other current liabilities in the accompanying balance sheet.
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
11. Commitments and Contingencies
Lease Commitments
In June 2016, the Company entered into a non-cancelable agreement to lease approximately 4,200 square feet of office and laboratory space in Boston, Massachusetts. The lease commenced in June 2016 and expires in April 2018. Rent during the term is $11,900 per month.
Future minimum lease payments under all non-cancelable lease arrangements at December 31, 2016, are as follows (in thousands):
Rent expense on non-cancelable operating leases was approximately $0.5 million, $0.5 million and $0.5 million for the years ended December 31, 2016, 2015 and 2014, respectively.
License Agreement
In 2003, the Company entered into a license agreement (“License Agreement”) for certain intellectual property. The License Agreement required the Company to pay $75,000 at execution, make payments of $12,500 in 2004, and $25,000 each year thereafter, until the date of first commercial sale of the product, as defined in the License Agreement. In 2011, the Company began commercial sales of the product as defined in the License Agreement and as a result ceased making the yearly payments. The royalty obligation begins with U.S. commercial sales of products as defined in the License Agreement, if any. The royalty percentage may vary on products covered by the License Agreement, but in any case, the royalties are not considered significant. The Company will cease paying royalties, if any, at the time the patent covered by the License Agreement expires in 2017.
12. Stockholders’ Equity
On April 9, 2015, the Company amended its certificate of incorporation to reflect the one-for-ten reverse stock split approved by its shareholders. After giving effect to the reverse stock split, the authorized capital stock of the Company now consists of 14,500,000 shares, of which 13,000,000 shares are designated as common stock, 1,000,000 shares are designated as Class B common stock, and 500,000 shares are designated as preferred stock.
The Company has raised net proceeds of approximately $232.6 million through sales of its equity from inception.
Common Stock
The Company authorized Class B common stock in order to meet the Listing Rules of the ASX so far as they apply to escrowed securities. In the event that holders of common stock, who were subject to ASX-imposed escrow, breached the terms of their escrow agreement or the Listing Rules as they apply to escrowed securities, their common stock would have been automatically converted into Class B common stock until the earlier to occur of the expiration of the escrow period or the breach being rectified. The Class B common stock is identical to and ranks equally with the common stock except that Class B common stock has no voting rights and is not entitled to any dividends. No shares of common stock are currently subject to such an escrow.
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
12. Stockholders’ Equity (continued)
In December 2016, GI Dynamics raised approximately $1.0 million, net of expenses, in an offering of 1,397,300 shares of common stock (69,865,000 CDIs) to sophisticated and professional investors in Australia and certain other jurisdictions.
13. Stock Plans
The Company has two stock-based compensation plans. The Board of Directors adopted the 2003 Omnibus Stock Plan (the “2003 Plan”), which provides for the grant of qualified incentive stock options and nonqualified stock options or other awards to the Company’s employees, officers, directors, advisors, and outside consultants to purchase up to an aggregate of 922,086 shares of the Company’s common stock.
In August 2011, the Board of Directors adopted the 2011 Employee, Director and Consultant Equity Incentive Plan (the “2011 Plan”, together with the 2003 Plan, the “Plans”) as the successor to the 2003 Plan. Under the 2011 Plan, the Company may grant incentive stock options, nonqualified stock options, restricted and unrestricted stock awards and other stock-based awards. The Company had initially reserved 450,000 shares of its common stock for issue under the 2011 Plan. Awards that are returned to the Company’s 2003 Plan as a result of their forfeiture, expiration or cancellation without delivery of common stock shares or that result in the forfeiture of shares back to the Company on or after August 1, 2011, the date the 2011 Plan became effective, are automatically made available for issuance under the 2011 Plan. At August 1, 2011, 80,235 shares available for grant under the 2003 Plan were transferred to the 2011 Plan. At December 31, 2016, 1,060,920 shares were available for grant under the 2011 Plan.
In addition, the 2011 Plan allows for an annual increase in the number of shares available for issue under the 2011 Plan commencing on the first day of each fiscal year during the period beginning in fiscal year 2012 and ending in fiscal year 2020. The annual increase in the number of shares shall be equal to the lowest of:
•
500,000 shares;
•
4% of the number of common shares outstanding as of such date; and
•
an amount determined by the Board of Directors or the Company’s compensation committee. Accordingly, during 2016, 380,222 shares were added to the 2011 Plan.
Stock-Based Compensation
Stock-based compensation is reflected in the consolidated statements of operations and comprehensive loss as follows for the years ended December 31, 2016, 2015 and 2014 (in thousands):
The stock options granted under the Plans generally vest over a four-year period and expire ten years from the date of grant. From time to time, the Company grants stock options to purchase common stock subject to
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
13. Stock Plans (continued)
performance-based milestones. The vesting of these stock options will occur upon the achievement of certain milestones. When achievement of the milestone is deemed probable, the Company expenses the compensation of the respective stock option over the implicit service period.
At December 31, 2014, the Company had options for the purchase of 20,000 shares of common stock subject to performance-based milestone vesting. During the years ended December 31, 2016, 2015 and 2014, the Company did not recognize any expense associated with options subject to performance-based milestones as the vesting of the underlying awards was not deemed probable. At December 31, 2015, there were no options subject to performance-based milestone vesting outstanding.
During the year ended December 31, 2015, the Company modified the post-employment exercise period of stock awards previously granted to the Company’s former chief financial officer in relation to his separation from the Company. The modification extended the exercise period to December 8, 2015. The modification resulted in an approximately $19,000 increase in stock-based compensation in 2015. The Company accounted for the modification of these stock awards in accordance with the provisions of ASC 718.
In calculating stock-based compensation costs, the Company estimates the fair value of stock options using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model was developed for use in estimating the fair value of short-lived, exchange-traded options that have no vesting restrictions and are fully transferable. The Company estimates the number of awards that will be forfeited in calculating compensation costs. Such costs are then recognized over the requisite service period of the awards on a straight-line basis.
Determining the fair value of stock-based awards using the Black-Scholes option-pricing model requires the use of highly subjective assumptions, including the expected term of the award and expected stock price volatility. The weighted-average assumptions used to estimate the fair value of employee stock options using the Black-Scholes option-pricing model were as follows for the years ended December 31, 2016, 2015 and 2014:
Expected Volatility
Volatility measures the amount that a stock price has fluctuated or is expected to fluctuate during a period. As the Company was not publicly traded prior to September 2011 and therefore had no trading history, stock price volatility was estimated based on an analysis of historical and implied volatility of comparable public companies.
Expected Term
The Company has limited historical information to develop reasonable expectations about future exercise patterns and post-vesting employment termination behavior for its stock option grants. As a result, for stock option grants made during the years ended December 31, 2016, 2015 and 2014, the expected term was estimated
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Notes to Consolidated Financial Statements (continued)
13. Stock Plans (continued)
using the “simplified method.” The simplified method is based on the average of the contractual term of the option and the weighted-average vesting period of the option. For options granted to non-employees, the Company used the remaining contractual life to estimate the expected term of non-employee awards for the years ended December 31, 2016, 2015 and 2014.
Risk-Free Interest Rate
The risk-free interest rate used for each grant is based on a zero-coupon U.S. Treasury instrument with a remaining term similar to the expected term of the stock-based award.
Expected Dividend Yield
The Company has not paid and does not anticipate paying cash dividends on its shares of common stock in the foreseeable future; therefore, the expected dividend yield is assumed to be zero.
Forfeitures
Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from the Company’s estimates. Subsequent changes in estimated forfeitures are recognized through a cumulative adjustment in the period of change and will also impact the amount of stock-based compensation expense in future periods. The Company uses historical data to estimate forfeiture rates. The Company’s estimated forfeiture rates were 15.0%, 15.0% and 5.0% as of December 31, 2016, 2015 and 2014, respectively.
Stock Options
The following table summarizes share-based activity under the Company’s stock option plans:
As of December 31, 2016, there was approximately $0.4 million of unrecognized stock-based compensation, net of estimated forfeitures, related to unvested stock option grants having service-based vesting under the Plans which is expected to be recognized over a weighted-average period of 2.67 years. The total unrecognized stock- based compensation cost will be adjusted for future changes in estimated forfeitures.
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
13. Stock Plans (continued)
The weighted-average grant date fair value of options granted during the years ended December 31, 2016, 2015 and 2014 was $1.00, $2.91 and $15.22, respectively. The total intrinsic value of options exercised during the years ended December 31, 2016, 2015 and 2014 was approximately none, $10,000 and $4.4 million, respectively. The intrinsic value represents the difference between the fair value of the Company’s common stock on the date of exercise and the exercise price of the stock option. Cash received from option exercises during the years ended December 31, 2016, 2015 and 2014 was approximately none, $1,500 and $0.6 million respectively. No tax benefits were realized from options and other stock-based payment arrangements during these periods.
The stock-based compensation plans provide that grantees may have the right to exercise an option prior to vesting. Shares purchased upon the exercise of unvested options will be subject to the same vesting schedule as the underlying options, and are subject to repurchase at the original exercise price by the Company should the grantee discontinue providing services to the Company for any reason, prior to becoming fully vested in such shares. At December 31, 2016 and 2015, there were none and 168 shares of common stock, respectively, issued pursuant to the exercise of unvested options that remain unvested and subject to repurchase by the Company. The exercise of these shares is not substantive and as a result, the cash paid for the exercise price is considered a deposit or prepayment of the exercise price and is recorded as a liability. The liability related to these shares was approximately none and $4,000, respectively, at December 31, 2016 and 2015. Additionally, while the shares of common stock subject to repurchase are included in the legally issued shares, they are excluded from the calculation of outstanding shares.
Restricted Stock Units
Each restricted stock unit (“RSU”) represents a contingent right to receive one share of the Company’s common stock. There is no consideration payable on the vesting of RSUs issued under the Plans. Upon vesting, the RSUs are exercised automatically and settled in shares of the Company’s common stock. During the years ended December 31, 2016 and 2015, the Company awarded a total of 392,659 and 143,506 RSUs to employees and directors of the Company, respectively.
The following table summarizes information related to the RSUs and activity during the year ended December 31, 2016:
The aggregate intrinsic value at December 31, 2016 and 2015 noted in the table above represents the closing price of the Company’s common stock multiplied by the number of RSUs outstanding.
The fair value of each RSU award equals the closing price of the Company’s common stock on the date of grant. The weighted average grant date fair value per share of RSUs granted in the years ended December 31, 2016 and 2015 was $0.75 and $5.39, respectively.
GI Dynamics, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
13. Stock Plans (continued)
At December 31, 2016, 403,501 of the RSUs outstanding are subject to performance-based vesting criteria. For these awards, the vesting will occur upon the achievement of certain product revenue, regulatory and reimbursement milestones. When achievement of the milestone is deemed probable, the Company expenses the compensation of the respective stock award over the implicit service period.
During the year ended December 31, 2015, the Company determined that a milestone previously deemed probable was now not probable of being achieved prior to the expiration of the award. This change in estimate was recognized through a cumulative adjustment in 2015, resulting in a reduction of stock-based compensation of approximately $0.3 million, all of which was previously recognized in the year ended December 31, 2014.
During the years ended December 31, 2016 and 2015, the Company recognized stock-based compensation related to RSUs having service-based vesting of approximately $(0.1) million and $0.5 million, respectively.
As of December 31, 2016, there was approximately $0.1 million of unrecognized stock-based compensation expense, net of estimated forfeitures, related to non-vested RSU awards that have service-based vesting.
Non-employee awards
The Company accounts for non-employee awards in accordance with ASC 505-50. Stock-based compensation expense related to stock options granted to non-employees is recognized as services are rendered, generally on a straight-line basis. The Company believes that the fair value of the stock options is more reliably measurable than the fair value of the services rendered. The fair value of the stock options granted is remeasured at each reporting date using the Black-Scholes option pricing model as prescribed by ASC 718. During the year ended December 31, 2013, the Company granted options to purchase 30,000 shares of common stock to non- employees with an aggregate fair value of approximately $0.6 million. In 2016 the Company granted 50,000 stock options to purchase 50,000 shares of common stock to non-employees. During the year ended December 31, 2015 the Company did not grant any options for shares of common stock to non-employees.
During the years ended December 31, 2014 and 2013, the Company modified the terms of stock awards previously granted to certain employees upon their change in status from employee to non-employee. The modifications included an extension of the exercise period after the status change with respect to certain of the awards and the extension of the vesting of certain options through the end of the respective expected service to the Company. These modifications resulted in increases in stock-based compensation of an immaterial amount in the year ended December 31, 2014. The Company accounted for the modifications of stock awards in accordance with the provisions of ASC 718. Stock awards that are modified and continue to vest when an employee has a change in employment status are subject to periodic revaluation over their vesting terms.
The Company has recorded non-employee stock-based compensation expense in accordance with ASC
505-50 of approximately $0.5 million, $6,000 and $0.2 million during the years ended December 31, 2016, 2015 and 2014, respectively, which is included in the total stock-based compensation expense.
14. Segment Reporting
Operating segments are components of an enterprise for which separate financial information is available and is evaluated regularly by the Company’s chief operating decision-maker in deciding how to allocate
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Notes to Consolidated Financial Statements (continued)
14. Segment Reporting (continued)
resources and in assessing performance. The Company has one reportable segment which designs, develops, manufactures and markets medical devices for non-surgical approaches to treating type 2 diabetes and obesity.
Geographic Reporting
All the Company’s revenue is attributable to customers outside the U.S. The Company is dependent on favorable economic and regulatory environments for its products. Products are sold to customers located in Europe, the Middle East, the Asia Pacific region and South America and sales are attributed to a country or region based on the location of the customer to whom the products are sold.
At December 31, 2016, long-lived assets, comprised of property and equipment, of approximately $0.1 million are all held in the U.S.
Product sales by geographic location for the years ended December 31, 2016, 2015 and 2014 are listed in the table below (in thousands).
Germany is a significant component of revenue in Europe for the year ended December 31, 2016. Germany and the United Kingdom comprised a significant component of revenue in Europe for the year ended December 31, 2015. Germany, Chile and Australia comprised a significant component of revenue in their respective regions for the year ended December 31, 2014.
Major Customers
For the year ended December 31, 2016, one distributor accounted for approximately 24% of the Company’s revenue. For the year ended December 31, 2015, one distributor accounted for approximately 15% of the Company’s revenue. For the year ended December 31, 2014, one distributor accounted for approximately 16% of the Company’s revenue. No other customer accounted for greater than 10% of the Company’s revenue during the years ended December 31, 2016, 2015 and 2014.
15. Retirement Plans
The Company has a 401(k) retirement and savings plan (“401(k) Plan”) covering all qualified U.S. employees. The 401(k) Plan is a defined contribution plan and allows each participant to contribute up to 100% of the participant’s base wages up to an amount not to exceed an annual statutory maximum. The Company has made discretionary contributions to the 401(k) Plan and recorded expenses of approximately $0.1 million, $0.2 million and $0.3 million for the years ended December 31, 2016, 2015 and 2014, respectively.
The Company maintains a defined contribution plan for certain international employees. The Company contributes 100% of the cost of the defined contribution. The Company recorded expenses of approximately
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Notes to Consolidated Financial Statements (continued)
15. Retirement Plans (continued)
$7,000, $21,000 and $30,000 for the years ended December 31, 2016, 2015 and 2014, respectively, under this plan.
16. Income Taxes
Loss before provision for income taxes consisted of the following (in thousands):
The provision for income taxes in the accompanying consolidated statements of operations and comprehensive loss consisted of the following (in thousands):
A reconciliation of income taxes from operations computed using the U.S. federal statutory rate of 34% to that reflected in operations follows (in thousands):
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Notes to Consolidated Financial Statements (continued)
16. Income Taxes (continued)
Components of the Company’s deferred tax assets and liabilities are as follows (in thousands):
In accordance with ASU No. 2015-17, at December 31, 2015, the Company reclassified its net current deferred tax asset to the net non-current deferred tax asset in our consolidated balance sheet. No prior periods were retrospectively adjusted.
Management of the Company has evaluated the positive and negative evidence bearing upon the realizability of the Company’s deferred tax assets and determined that it is more likely than not that the Company will not recognize the benefits of the deferred tax assets related to the U.S. As a result, a valuation allowance of approximately $92.4 million and $91.1 million was established at December 31, 2016 and 2015, respectively. The valuation allowance increased by approximately $1.3 million during the year ended December 31, 2016, primarily due to the increase in the Company’s net operating loss carryforwards.
At December 31, 2016, the Company had federal and state net operating loss carryforwards (excluding ASC 718 additional paid-in capital net operating losses) of approximately $208.5 million and $198.9 million, respectively. These operating loss carryforwards will expire at various times beginning in 2024 through 2036 for federal purposes and begin to expire in 2030 and will continue to expire through 2036 for state purposes. The Company has also recorded approximately $1.5 million as a reduction to net operating losses carryforward that is attributable to excess stock option deductions as of December 31, 2016.
In addition, at December 31, 2016, the Company also has federal and state research and development tax credit carryforwards (excluding ASC 740, Income Taxes (“ASC 740”), reserve) of approximately $2.7 million and $1.0 million, respectively, to offset future income taxes. These tax credit carryforwards will expire at various times beginning in 2023 through 2036 for federal purposes and will expire at various times beginning in 2018 through 2031 for state purposes.
Utilization of net operating loss carryforwards and research and development credit carryforwards may be subject to a substantial annual limitation due to ownership change limitations that have occurred previously or that could occur in the future in accordance with Section 382 of the Internal Revenue Code of 1986 (“IRC Section 382”) and with Section 383 of the Internal Revenue Code of 1986, as well as similar state provisions. These ownership changes may limit the amount of net operating loss carryforwards and research and development credit carryforwards that can be utilized annually to offset future taxable income and taxes, respectively. In general, an ownership change, as defined by IRC Section 382, results from transactions
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Notes to Consolidated Financial Statements (continued)
16. Income Taxes (continued)
increasing the ownership of certain stockholders or public groups in the stock of a corporation by more than 50 percentage points over a three-year period. The Company has completed several financings since its inception, which may have resulted in a change in control as defined by IRC Section 382 or could result in a change in control in the future. As of December 31, 2016, the Company has not, as yet, conducted an IRC Section 382 study, which could impact its ability to utilize net operating loss and tax credit carryforwards annually in the future to offset the Company’s taxable income, if any.
The Company applies ASC 740-10, which provides guidance on the accounting for uncertainty in income taxes recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained by the taxing authority. When uncertain tax positions exist, the Company recognizes the tax benefit of tax positions to the extent that the benefit will more likely than not be realized. The determination as to whether the tax benefit will more likely than not be realized is based upon the technical merits of the tax position as well as consideration of the available facts and circumstances. At December 31, 2016 and 2015, the Company had unrecognized tax liabilities of approximately $1.4 million.
The following is a roll forward of the Company’s unrecognized tax benefits (in thousands):
The Company will recognize interest and penalties related to uncertain tax positions, should they be assessed, in income tax expense. As of December 31, 2016 and 2015, the Company had no accrued interest or penalties related to uncertain tax positions, and no amounts have been recognized in the Company’s consolidated statements of comprehensive loss.
The statute of limitations for assessment by the Internal Revenue Service (“IRS”) and state tax authorities is open for tax years ended December 31, 2012 through December 31, 2016, although carryforward attributes that were generated prior to tax year 2012 may still be adjusted upon examination by the IRS or state tax authorities if they either have been or will be used in a future period. The statute of limitations for assessment by foreign tax authorities is open for tax years ended December 31, 2012 through December 31, 2016. There are currently no federal or state audits in progress.
The Company has not, as yet, completed a study of its research and development credit carryforwards. Once completed, this study may result in an adjustment to the Company’s research and development credit carryforwards. A full valuation allowance has been provided against the Company’s research and development credits, and if an adjustment is required at the time the study is completed, this adjustment would be offset by an adjustment to the deferred tax asset established for the research and development credit carryforward and the valuation allowance.
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Notes to Consolidated Financial Statements (continued)
17. Selected Quarterly Financial Information - (Unaudited)
* In the second quarter of 2016 the Company recorded a reduction of cost of revenue of approximately $0.2 million and in the fourth quarter of 2016 the Company recorded a change of approximately $0.1 million to cost of revenue for excess, expired and obsolete inventory. In the second and fourth quarter of 2015, the Company recorded a charge to cost of revenue of approximately $1.7 million and $1.5 million, respectively, for excess, expired and obsolete inventory.
18. Subsequent Events
In January 2017, the Company completed the sale of 249,632 shares (12,481,600 CDI’s) to eligible investors under a Security Purchase Plan for approximately $0.83 per share resulting in net proceeds after expenses of approximately $0.2 million.