CHF Solutions
Sunshine Heart, Inc. (Form: 10-K, Received: 03/08/2017 16:51:30)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 


 

x       ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Fiscal Year Ended: December 31, 2016

 

o          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Transition Period from              to            

 

Commission file number 001-35312

 

SUNSHINE HEART, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

68-0533453

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

12988 Valley View Road

Eden Prairie, Minnesota 55344

(Address of principal executive offices including zip code)

 

(952) 345-4200

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, par value $0.0001 per share

 

The Nasdaq Stock Market LLC

 

 

(Nasdaq Capital Market)

 

Securities registered pursuant to Section 12(g) of the Act:  None.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o   No  x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes  o   No  x

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x   No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K  o

 

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

 

Large accelerated filer  o

 

Accelerated filer  o

 

 

 

Non-accelerated filer  o

 

Smaller reporting company  x

(Do not check if a smaller reporting company)

 

 

 

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

 

As of June 30, 2016, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of shares of the registrant’s common stock held by non-affiliates of the registrant (based upon the June 30, 2016 closing sale price of $13.8 per share) was approximately $8.5 million.

 

The number of shares of the registrant’s common stock, par value $0.0001 per share, outstanding as of March 1, 2017 was 1,741,745 shares.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

N/A

 

 

 



Table of Contents

 

SUNSHINE HEART, INC.

ANNUAL REPORT ON FORM 10-K

Table of Contents

 

PART I

 

1

 

 

 

Item 1.

Business

1

Item 1A.

Risk Factors

9

Item 1B.

Unresolved Staff Comments

24

Item 2.

Properties

24

Item 3.

Legal Proceedings

24

Item 4.

Mine Safety Disclosures

24

 

 

 

PART II

 

25

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

25

Item 6.

Selected Financial Data

25

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

25

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

33

Item 8.

Financial Statements and Supplementary Data

33

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

53

Item 9A.

Controls and Procedures

53

Item 9B.

Other Information

54

 

 

 

PART III

 

54

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

54

Item 11.

Executive Compensation

57

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

64

Item 13.

Certain Relationships and Related Transactions, and Director Independence

65

Item 14.

Principal Accounting Fees and Services

66

 

 

 

PART IV

 

67

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

67

 

 

 

SIGNATURES

68

 



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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended (the “Securities Act” ), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act” ).  These forward-looking statements relate to us, our business prospects and our results of operations and are subject to certain risks and uncertainties posed by many factors and events that could cause our actual business, prospects and results of operations to differ materially from those anticipated by such forward-looking statements.  Factors that could cause or contribute to such differences include, but are not limited to, those described under the heading “Risk Factors” included in this Annual Report on Form 10-K.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report.  In some cases, you can identify forward-looking statements by the following words: “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “ongoing,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words.  We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that might subsequently arise.  Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the U.S. Securities and Exchange Commission (the “SEC” ) that advise interested parties of the risks and factors that may affect our business.

 

PART I

 

Item 1.                    Business

 

Overview

 

We are an early-stage medical device company focused on commercializing the Aquadex FlexFlow® System.  Our commercial product, the Aquadex FlexFlow® System is indicated for temporary (up to eight hours) ultrafiltration treatment of patients with fluid overload who have failed diuretic therapy, and extended (longer than 8 hours) ultrafiltration treatment of patients with fluid overload who have failed diuretic therapy and require hospitalization.

 

Company History

 

Prior to July 2016, we were focused on developing the C-Pulse® Heart Assist System for treatment of Class III and ambulatory Class IV heart failure. The C-Pulse System utilized the known concept of counterpulsation applied to the aorta.  In March 2016, we announced that we were no longer enrolling patients into our two clinical studies for the C-Pulse System and that we planned to pursue a new strategic direction. In July 2016, we announced that we were moving forward with a therapeutic strategy utilizing neuromodulation rather than counterpulsation.

 

In August 2016, we acquired the Aquadex Business from Baxter, a global leader in the hospital products and dialysis markets.

 

On September 29, 2016, we announced a strategic refocus of our near-term strategy that includes halting clinical evaluations of our neuromodulation technology to fully focus our resources on our recently acquired Aquadex Business, taking actions to reduce our cash burn in connection with such strategic refocus, and reviewing potential strategic alliances and financing alternatives.

 

The Aquadex FlexFlow System

 

The Aquadex FlexFlow is designed to simply, safely, and precisely remove excess fluid (primarily excess salt and water) from patients suffering from fluid overload who have failed diuretic therapy. With the Aquadex FlexFlow, medical practitioners can specify and control the amount of fluid to be extracted at a safe, predictable, and effective rate. The Aquadex FlexFlow has been shown to have no clinically significant impact on electrolyte balance, blood pressure or heart rate. (1)

 

The Aquadex FlexFlow is indicated for temporary (up to 8 hours) ultrafiltration treatment of patients with fluid overload who have failed diuretic therapy; and extended (longer than 8 hours) ultrafiltration treatment of patients with fluid overload who have failed diuretic therapy and require hospitalization. All treatments must be administered by a healthcare provider, under physician prescription, both of whom have received training in extracorporeal therapies.

 

Benefits of the Aquadex FlexFlow

 

The Aquadex FlexFlow ultrafiltration system offers a safe approach to treating fluid overload and:

 


(1)  SAFE Trial: Jaski BE, et al. J Card Fail. 2003 Jun; 9(3): 227-231; RAPID Trial: Bart BA, et al. J Am Coll Cardiol. 2005 Dec 6; 46(11): 2043-2046.

 

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·                   Provides complete control over rate and total volume of fluid removed by allowing a medical practitioner to specify the amount of fluid to be removed from each individual patient

·                   Aquapheresis therapy can be performed via peripheral or central venous access

·                   Removes isotonic fluid (extracts sodium while sparing potassium and magnesium)(2)

·                   Following ultrafiltration, neurohormonal activation is reset toward a more physiological condition and diuretic efficacy is restored (3)

·                   Provides highly automated operation with only one setting required to begin

·                   Utilizes a single-use, disposable auto-loading blood filter circuit that facilitates easy set-up

·                   The console guides medical practitioner through the setup and operational process

·                   Decreased hospital length of stay and readmissions (4)

 

The Aquadex FlexFlow system consists of:

 

·                   A console, a piece of capital equipment containing electromechanical pumps and an LCD screen

·                   A one-time disposable blood set (the “Aquadex Blood Set” ), an integrated collection of tubing, filter, sensors, and connectors that contain and deliver the blood from and back to the patient, and

·                   A disposable catheter (the “Aquadex Catheter” ), a small, dual-lumen catheter designed to access the peripheral venous system of the patient and to simultaneously withdraw blood and return filtered blood to the patient.  The Aquadex Blood Set is proprietary and the Aquadex FlexFlow can only be used with the Aquadex Blood Set. The Aquadex Catheter is often used in conjunction with the Aquadex FlexFlow, although it is one of many potential catheter options available to the provider.

 

Our Market Opportunity

 

Heart failure is one of the leading causes of death in the United States and other developed countries. The American Heart Association estimates that 5.7 million people in the United States age 20 and over are affected by heart failure, with an estimated 870,000 new cases diagnosed each year and 670,000 emergency department visits. Congestive heart failure is the highest U.S. chronic health care expense category. (5)

 

Heart failure is a progressive disease caused by impairment of the left heart’s ability to pump blood to the various organs of the body. Patients with heart failure commonly experience shortness of breath, fatigue, difficulty exercising and swelling of the legs. The heart becomes weak or stiff and enlarges over time, making it harder for the left heart to pump the blood needed for the body to function properly. The severity of heart failure depends on how well a person’s heart is able to pump blood throughout the body.

 

Heart failure is the leading cause of fluid overload, a condition where patients become decompensated resulting in lengthy and costly hospitalizations.  In fact, 90% of heart failure patients present symptoms of fluid overload. (6)  Our system is indicated for temporary (up to eight hours) ultrafiltration treatment of patients with fluid overload who have failed diuretic therapy, and extended (longer than 8 hours) ultrafiltration treatment of patients with fluid overload who have failed diuretic therapy and require hospitalization.

 

According to a nationwide study of over 140,000 patients suffering from acute decompensated heart failure, over 38% of patients discharged were still symptomatic and about half of the patients were discharged with less than five pounds lost. (7) This clinical evidence from the ADHERE Registry clearly shows patients are discharged too early while still showing evidence of fluid overload. By not truly addressing the fluid overload problem, patients are being readmitted to the hospital too frequently with 30 day readmissions of 22% and 6-month readmissions of 44%, with 78% of patients admitted directly to the Emergency Department as the first point of care. (8) (9)

 

The Affordable Care Act includes a Hospital Readmission Reduction program and is designed to reduce payments to hospitals with excess heart failure readmissions, among other conditions. The penalty to hospitals can be significant, as much as 3% of total

 


(2)  Ali SS, et al. Congest Heart Fail. 2009; 15(1):1-4.

(3)  Marenzi G, et al. J Am Coll Cardiol. 2001 Oct; 38(4): 963-968.

(4)  Costanzo MR, et al. J Am Coll Cardiol. 2005 Dec 6; 46(11): 2047-2051.

(5)  Mozzafarian D, Benjamin EJ, Go AS, et al. on behalf of the American Heart Association Statistics Committee and Stroke Statistics Subcommittee. Heart disease and stroke statistics—2016 update: a report from the American Heart Association. Circulation. 2016;133:e38-e360.

(6)  Costanzo MR, et al. J Am Coll Cardiol . 2007 Feb 13; 49(6): 675-683.

(7)  ADHERE Scientific Advisory Committee. ADHERE Final Cumulative National Benchmark Report. Mountain View, CA: Scios Inc.; 2006

(8)  Centers for Medicare & Medicaid Services. Hospital Compare datasets. National Rate (READM_30_HF); 3Q2011 — 2Q2014.

(9)  Krumholtz HM et. al. Arch Intern Med. 1997 Jan 13;157(1): 99-104 — Ross JS, et al. Circ Heart Fail. 2010 Jan; 3(1): 97-103.

 

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Medicare reimbursement. The Aquadex FlexFlow is positioned to assist hospitals with the Affordable Care Act and may offer hospitals an economic benefit for using the device on a regular basis for in-patient or out-patient usage.

 

There are two market segments for treating fluid overload with the Aquadex FlexFlow:

 

1)              Inpatient Care — Given to a patient admitted to a hospital, extended care facility, nursing home or other facility. Long term care is the range of services typically provided at skilled nursing, intermediate-care, personal care or eldercare facilities.

 

2)              Outpatient Care — Any health care service provided to a patient who is not admitted to a facility. Outpatient care can be provided in a doctor’s office, clinic, or hospital outpatient department.

 

Our target customers for the Aquadex FlexFlow include large academic hospitals specializing in advanced treatment of chronic heart failure, other large hospitals with heart failure related admissions and clinical practices with transplant or LVAD programs.

 

Our Strategy

 

Our goal is to become a leader in the treatment of moderate to severe heart failure and related conditions. We believe that our technology will provide us with a competitive advantage in the market for treating specific segments of heart failure patients.

 

On September 29, 2016, we announced a strategic refocus of our near term strategy that includes halting clinical evaluations of our neuromodulation technology to fully focus our resources on our recently acquired Aquadex Business, taking actions to reduce our cash burn in connection with such strategic refocus and reviewing potential strategic alliances and financing alternatives.

 

There is currently a large installed base of over 500 Aquadex FlexFlow consoles in U.S. hospitals that, once reactivated and reengaged, should enable increased utilization of the already installed console with ongoing purchases of the Aquadex Blood Sets.  In order to grow our Aquadex Business, we intend to focus our efforts in providing superior service to our customers through our direct field organization, our in-house customer service team, our technical service team, and our clinical education efforts. We are actively focused on strengthening our capabilities in all of these areas.

 

We are executing on our growth strategy in deliberate stages by:

 

·                   Initially focusing on the top 55 hospital accounts that generated eighty percent of the revenue for the Aquadex Business in 2015 through customer support and therapy development and by diagnosing each hospital’s use of the Aquadex FlexFlow to gain additional opportunity for increased utilization.

·                   Expanding our efforts to re-engage the additional 110 hospital accounts that also purchased Aquadex Blood Sets in 2015.

·                   Re-educating customers to help increase the utilization of the Aquadex FlexFlow owned by an additional 200 hospital accounts prior to 2015.

 

Aquadex FlexFlow Growth Drivers

 

The Aquadex Business will benefit from re-engaging clients, targeting new customers and markets as well as positive industry dynamics favoring technologies that reduce hospital readmission rates.  We plan to reach these customers and markets by:

 

·                   Established Customer Base — Continuing to service the top 55 accounts producing 80% of the business with customer support and therapy development and diagnosing each hospital’s use of Aquadex FlexFlow to gain additional opportunity for increased utilization.

·                   Enhancing the Outpatient Market — Continue supporting outpatient usage and expanding to include a registry and possible collaboration with payer/providers to allow greater opportunity in the future.

·                   International Opportunity — Currently, there is limited activity in Europe. Investigate use of distributors to expand usage of the Aquadex FlexFlow outside the United States.

·                   Differentiated Technology & Product Development — Work to enhance the current product to provide exceptional performance for our customers and patients.

·                   Alignment with Market Dynamics — Utilize existing and new data to demonstrate to hospital administrators that Aquadex FlexFlow can be a solution for 30-day readmissions and challenges with length of stay. Therefore, every Aquadex FlexFlow usage is economically advantageous driving increased demand.

·                   Reimbursement Opportunity — Work to build acceptance through clinical evidence and a registry to gain reimbursement coding for Aquapheresis therapy.

 

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Sales and Marketing

 

As of March 1, 2017, we had 8 full-time employees in sales and marketing. During 2016, we trained our existing field personnel and hired additional sales personnel with prior experience with the Aquadex Business. Our sales force includes therapy development managers as well as field clinical engineers who provide training, technical and other support services to our customers. Since the acquisition of the Aquadex Business from Baxter in August 2016, our direct sales force has focused on reengaging hospital accounts that ordered Aquadex Blood Sets in prior years, re-educating customers on the therapy and diagnosing each hospital’s use of the Aquadex FlexFlow to gain additional opportunity for increased utilization. We plan to grow the sales and marketing organization as necessary to support future growth.

 

Our sales representatives implement consumer marketing programs and provide physicians and nurses with educational patient materials. We also market to potential referral source clinicians in order to build awareness.

 

Clinical Experience

 

Several large-scale, multi-center, randomized, controlled trials have evaluated the use of ultrafiltration using the Aquadex FlexFlow in patients with acute decompensated heart failure compared to standard-of-care treatment with intravenous diuretics. These trials followed early-stage studies which primarily focused on safety of ultrafiltration treatment with Aquadex FlexFlow.

 

The UNLOAD trial enrolled 200 patients and showed that average weight and fluid loss were greater in the ultrafiltration group 48 hours following randomization. No differences were noted in symptoms of dyspnea between the groups. In addition, through 90 days of follow-up, the ultrafiltration group experienced fewer re-hospitalizations for heart failure, while renal function assessed by serum creatinine level was not significantly different between the groups.

 

The CARESS trial studied 188 randomized acute decompensated heart failure patients over the course of 96 hours and found no difference in weight loss and an increase in creatinine level relative to the control group treated with intravenous diuretics. The creatinine increase was interpreted as a sign of potential worsening renal function in the ultrafiltration group. Results of CARESS have been criticized on several grounds, particularly that trial results were impacted by centers unfamiliar with the use of ultrafiltration therapy and that the diuretic regimen employed was not representative of standard-of-care. In addition, a recent analysis of the DOSE trial to explore the putative link between short-term changes in creatinine level and outcome in acute decompensated heart failure has found that the intragroup difference observed in CARESS does not fall into a range associated with adverse long-term outcomes including death, re-hospitalization or visits to the emergency department. Such events were examined in CARESS over 60 days and no differences were detected between the groups.

 

Disparate results between UNLOAD and CARESS led to initiation of the AVOID trial. AVOID was designed to prospectively address the question of patient outcomes when treated with ultrafiltration versus intravenous diuretics for acute decompensated heart failure. Trial design assumptions indicated that 810 patients would need to be randomized to achieve adequate statistical power. However, the study was terminated at 224 patients for business reasons by Baxter. Despite being underpowered, the results of AVOID indicated distinct trends toward reduced composite heart-failure events in the ultrafiltration group over 90 days. In addition, pre-specified secondary endpoints demonstrated significant reductions in heart failure re-hospitalization at 30 days. No significant differences were observed in creatinine level between the groups, although a trend toward increase may have been present at 48 hours. In totality, AVOID recapitulated the results of both UNLOAD and CARESS while providing evidence that had AVOID been followed to completion it would likely have met its primary endpoint of improved outcome in acute decompensated heart failure patients.

 

Other uses of ultrafiltration with the Aquadex FlexFlow have not been studied extensively. Case studies and case series demonstrating the use of ultrafiltration in the maintenance of outpatient chronic heart failure have been published but there has been no prospective, systematic evaluation of ultrafiltration versus standard-of-care for this population. Other potential uses also largely remain to be formally evaluated.

 

Research and Development

 

Research and development costs include activities related to research, development, design, testing and manufacturing of prototypes of the Aquadex FlexFlow. The Aquadex FlexFlow software will require periodic modifications for feature additions and performance improvements.  We will make such design changes as needed based on pro-active and reactive mechanisms.

 

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Manufacturers and Suppliers

 

We are party to a commercial manufacturing and supply agreement with Baxter which requires Baxter to manufacture Aquadex Blood Sets and Aquadex Catheters for a period of 18 months following our acquisition of the Aquadex Business.  There is no such agreement relating to the manufacturing of Consoles.  As an initial focus, we plan to transfer Console manufacturing to Sunshine Heart or a qualified contract manufacturer by mid-year 2017.  We plan to transfer the Aquadex Blood Set and Aquadex Catheter manufacturing activities from Baxter to Sunshine Heart or a qualified contract manufacturer by the end of 2017.

 

Intellectual Property

 

We have established an intellectual property portfolio through which we seek to protect our system and technology. As of December 31. 2017, our portfolio consisted of over 35 patents issued and 13 patents pending in the United States and abroad for our counterpulsation, technology. In addition, our portfolio includes over 50 exclusively and non-exclusively licensed patents with respect to ultrafiltration and the Aquadex system.  Finally, Sunshine Heart has two patents pending in the neuromodulation space. Our patents and patent applications cover various aspects of both the methodology as well as the design of our discontinued C-Pulse System device and related components, our discontinued neuromodulation technology, and the Aquadex FlexFlow.

 

We have developed technical knowledge that, although non-patentable, we consider to be significant in enabling us to compete. It is our policy to enter into confidentiality agreements with each of our employees and consultants prohibiting the disclosure of any confidential information or trade secrets. In addition, these agreements provide that any inventions or discoveries by employees and consultants relating to our business will be assigned to us and become our sole property.

 

Despite our patent rights and policies with regard to confidential information, trade secrets and inventions, we may be subject to challenges to the validity of our patents, claims that our system infringes the patent rights of others and the disclosure of our confidential information or trade secrets. These and other risks are described more fully under the heading “Risk Factors—Risks Relating to our Intellectual Property”.

 

At this time we are not a party to any material legal proceedings that relate to patents or proprietary rights.

 

Competition

 

Competition from medical device companies and medical device divisions of health care companies, pharmaceutical companies and gene- and cell-based therapies is intense and expected to increase. The vast majority of heart failure patients with fluid overload receive pharmacological treatment (diuretics) as a standard of care. There are no direct competitors in the U.S. other than diuretics. Other ultrafiltration systems, such as Baxter’s Prismaflex, a filter-based device approved for continuous renal replacement therapy for patients weighing 20kg or more with acute renal failure and/or fluid overload, represent indirect competitors.

 

Our ability to compete effectively depends upon our ability to distinguish Aquadex FlexFlow from our competitors and their products. Factors affecting our competitive position include:

 

·                   Financial resources;

·                   Product performance and design;

·                   Risk management;

·                   Product safety;

·                   Acceptance of our system in the marketplace;

·                   Sales, marketing and distribution capabilities;

·                   Manufacturing and assembly costs;

·                   Pricing of our system and of our competitors’ products;

·                   The availability of reimbursement from government and private health insurers;

·                   Success and timing of new product development and introductions;

·                   Regulatory approvals; and

·                   Intellectual property protection.

 

Third-Party Reimbursement

 

In the United States, the Aquadex FlexFlow is purchased primarily by customers, such as hospitals or other health care providers. Customers bill various third-party payers for covered Aquadex FlexFlow services provided to patients. These payers, which include federal health care programs (e.g., Medicare and Medicaid), state health care programs, private health insurance companies and

 

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managed care organizations, would then reimburse our customers based on established payment formulas that take into account part or all of the cost associated with these devices and the related procedures performed.

 

While the agency responsible for administering the Medicare program, the Centers for Medicare and Medicaid Services has not issued a favorable national coverage for ultrafiltration using the Aquadex FlexFlow, a number of private insurers have approved reimbursement for Aquadex FlexFlow for specific indications and points of service. In addition, patients and providers may see insurance coverage on a case-by-case basis.

 

We are exploring the ability to increase the range of coverage for uses of Aquadex FlexFlow, such as use in the outpatient setting and use for decompensated heart failure and other indicated uses under its approved labeling.

 

Legislative proposals can substantially change the way health care is financed by both governmental and private insurers and may negatively impact payment rates for our system. Also, from time to time there are a number of legislative, regulatory and other proposals both at the federal and state levels; it remains uncertain whether there will be any future changes that will be proposed or finalized and what effect, if any, such legislation or regulations would have on our business. However, in the United States and international markets, we expect that both government and third-party payers will continue to attempt to contain or reduce the costs of health care by challenging the prices charged, or deny coverage, for health care products and services.

 

Government Regulations

 

Regulation by governmental authorities in the United States and foreign countries is a significant factor in the manufacture and marketing of our current system and any future products and in our ongoing research and development activities.  In particular, medical devices are subject to rigorous pre-clinical testing as a condition of approval by the FDA and by similar authorities in foreign countries.  Any proposed products will require regulatory approval prior to commercialization.

 

United States

 

The FDC Act and the FDA’s implementing regulations govern medical device design and development, preclinical and clinical testing, premarket clearance or approval, registration and listing, manufacturing, labeling, storage, advertising and promotion, sales and distribution, export and import, and post market surveillance. Medical devices and their manufacturers are also subject to inspection by the FDA. The FDC Act, supplemented by other federal and state laws, also provides civil and criminal penalties for violations of its provisions. We manufacture and market medical devices that are regulated by the FDA, comparable state agencies and regulatory bodies in other countries.

 

Unless an exemption applies, each medical device we wish to commercially distribute in the U.S. will require marketing authorization from the FDA prior to distribution. The two primary types of FDA marketing authorization are premarket notification (also called 510(k) clearance) and premarket approval (PMA). The type of marketing authorization applicable to a device - 510(k) clearance or PMA - is generally linked to classification of the device. The FDA classifies medical devices into one of three classes (Class I, II or III) based on the degree of risk the FDA determines to be associated with a device and the extent of control deemed necessary to ensure the device’s safety and effectiveness. Devices requiring fewer controls because they are deemed to pose lower risk are placed in Class I or II. Class I devices are deemed to pose the least risk and are subject only to general controls applicable to all devices, such as requirements for device labeling, premarket notification, and adherence to the FDA’s current good manufacturing practice requirements, as reflected in its Quality System Regulation ( “QSR” ). Class II devices are intermediate risk devices that are subject to general controls and may also be subject to special controls such as performance standards, product-specific guidance documents, special labeling requirements, patient registries or post market surveillance. Class III devices are those for which insufficient information exists to assure safety and effectiveness solely through general or special controls, and include life-sustaining, life-supporting or implantable devices, and devices not “substantially equivalent” to a device that is already legally marketed.

 

Most Class I devices and some Class II devices are exempted by regulation from the 510(k) clearance requirement and can be marketed without prior authorization from FDA. Class I and Class II devices that have not been exempted are eligible for marketing through the 510(k) clearance pathway. By contrast, devices placed in Class III generally require PMA prior to commercial marketing. The PMA process is generally more stringent, time-consuming and expensive than the 510(k) clearance process.

 

510(k) Clearance.   To obtain 510(k) clearance for a medical device, an applicant must submit a premarket notification to the FDA demonstrating that the device is “substantially equivalent” to a predicate device legally marketed in the United States. A device is substantially equivalent if, with respect to the predicate device, it has the same intended use and has either (i) the same technological characteristics or (ii) different technological characteristics and the information submitted demonstrates that the device is as safe and effective as a legally marketed device and does not raise different questions of safety or effectiveness. A showing of substantial

 

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equivalence sometimes, but not always, requires clinical data. Generally, the 510(k) clearance process can exceed 90 days and may extend to a year or more.

 

After a device has received 510(k) clearance for a specific intended use, any modification that could significantly affect its safety or effectiveness, such as a significant change in the design, materials, method of manufacture or intended use, will require a new 510(k) clearance or PMA (if the device as modified is not substantially equivalent to a legally marketed predicate device). The determination as to whether new authorization is needed is initially left to the manufacturer; however, the FDA may review this determination to evaluate the regulatory status of the modified product at any time and may require the manufacturer to cease marketing the modified device until 510(k) clearance or PMA is obtained. The manufacturer may also be subject to significant regulatory fines or penalties.

 

The Aquadex FlexFlow was granted FDA 510(k) clearance for commercial use on June 3, 2002.  Additional 510(k) clearances have been received for the Aquadex FlexFlow in subsequent years.

 

Clinical Trials.   To obtain FDA approval to market the C-Pulse System, clinical trials are required to support a PMA application. These trials generally require submission of an application for an IDE to the FDA. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. The IDE application must be approved in advance by the FDA for a specified number of patients, unless the product is deemed a non-significant risk device and eligible for more abbreviated IDE requirements. Generally, clinical trials for a significant risk device may begin once the IDE application is approved by the FDA and the study protocol and informed consent are approved by appropriate institutional review boards at the clinical trial sites.

 

FDA approval of an IDE allows clinical testing to go forward but does not bind the FDA to accept the results of the trial as sufficient to prove the product’s safety and efficacy, even if the trial meets its intended success criteria. With certain exceptions, changes made to an investigational plan after an IDE is approved must be submitted in an IDE supplement and approved by FDA (and by governing institutional review boards when appropriate) prior to implementation.

 

All clinical trials must be conducted in accordance with regulations and requirements collectively known as Good Clinical Practice. Good clinical practices include the FDA’s IDE regulations, which describe the conduct of clinical trials with medical devices, including the recordkeeping, reporting and monitoring responsibilities of sponsors and investigators, and labeling of investigational devices. They also prohibit promotion, test marketing or commercialization of an investigational device and any representation that such a device is safe or effective for the purposes being investigated. Good Clinical Practices also include the FDA’s regulations for institutional review board approval and for protection of human subjects (such as informed consent), as well as disclosure of financial interests by clinical investigators.

 

Required records and reports are subject to inspection by the FDA. The results of clinical testing may be unfavorable or, even if the intended safety and efficacy success criteria are achieved, may not be considered sufficient for the FDA to grant approval or clearance of a product. The commencement or completion of any clinical trials may be delayed or halted, or be inadequate to support approval of a PMA application or clearance of a premarket notification for numerous reasons, including, but not limited to, the following:

 

·                   the FDA or other regulatory authorities do not approve a clinical trial protocol or a clinical trial (or a change to a previously approved protocol or trial that requires approval), or place a clinical trial on hold;

·                   patients do not enroll in clinical trials or follow up at the rate expected;

·                   patients do not comply with trial protocols or experience greater than expected adverse side effects;

·                   institutional review boards and third-party clinical investigators may delay or reject the trial protocol or changes to the trial protocol;

·                   third-party clinical investigators decline to participate in a trial or do not perform a trial on the anticipated schedule or consistent with the clinical trial protocol, investigator agreements, good clinical practices or other FDA requirements;

·                   third-party organizations do not perform data collection and analysis in a timely or accurate manner;

·                   regulatory inspections of the clinical trials or manufacturing facilities, which may, among other things, require corrective action or suspension or termination of the clinical trials;

·                   changes in governmental regulations or administrative actions;

·                   the interim or final results of the clinical trial are inconclusive or unfavorable as to safety or efficacy; or

·                   the FDA concludes that the trial design is inadequate to demonstrate safety and efficacy.

 

Continuing Regulation.     After a device is cleared or approved for use and placed in commercial distribution, numerous regulatory requirements continue to apply. These include:

 

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·                   establishment registration and device listing upon the commencement of manufacturing;

·                   the QSR, which requires manufacturers, including third-party manufacturers, to follow design, testing, control, documentation and other quality assurance procedures during medical device design and manufacturing processes;

·                   labeling regulations, which prohibit the promotion of products for unapproved or “off-label” uses and impose other restrictions on labeling and promotional activities;

·                   medical device reporting regulations, which require that manufacturers report to the FDA if a device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if malfunctions were to recur;

·                   corrections and removal reporting regulations, which require that manufacturers report to the FDA field corrections; and

·                   product recalls or removals if undertaken to reduce a risk to health posed by the device or to remedy a violation of the FDC Act caused by the device that may present a risk to health.

 

In addition, the FDA may require a company to conduct post market surveillance studies or order it to establish and maintain a system for tracking its products through the chain of distribution to the patient level.

 

Failure to comply with applicable regulatory requirements, including those applicable to the conduct of clinical trials, can result in enforcement action by the FDA, which may lead to any of the following sanctions:

 

·                   warning letters or untitled letters;

·                   fines, injunctions and civil penalties;

·                   product recall or seizure;

·                   unanticipated expenditures;

·                   delays in clearing or approving or refusal to clear or approve products;

·                   withdrawal or suspension of FDA approval;

·                   orders for physician notification or device repair, replacement or refund;

·                   operating restrictions, partial suspension or total shutdown of production or clinical trials; or

·                   criminal prosecution.

 

We and our contract manufacturers and suppliers are also required to manufacture our products in compliance with Current Good Manufacturing Practice requirements set forth in the QSR.

 

The QSR requires a quality system for the design, manufacture, packaging, labeling, storage, installation and servicing of marketed devices, and includes extensive requirements with respect to quality management and organization, device design, buildings, equipment, purchase and handling of components, production and process controls, packaging and labeling controls, device evaluation, distribution, installation, complaint handling, servicing and record keeping. The FDA enforces the QSR through periodic announced and unannounced inspections that may include the manufacturing facilities of subcontractors. If the FDA believes that we or any of our contract manufacturers or regulated suppliers is not in compliance with these requirements, it can shut down our manufacturing operations, require recall of our products, refuse to clear or approve new marketing applications, institute legal proceedings to detain or seize products, enjoin future violations or assess civil and criminal penalties against us or our officers or other employees. Any such action by the FDA would have a material adverse effect on our business.

 

Employees

 

As of March 1, 2017, we had 29 full-time employees and no part-time employees. None of our employees are covered by a collective bargaining agreement. We consider relations with our employees to be good.

 

Corporate Information

 

Sunshine Heart, Inc. was incorporated in Delaware on August 22, 2002. We began operating our business in November 1999 through Sunshine Heart Company Pty Limited, which currently is a wholly owned Australian subsidiary of Sunshine Heart, Inc. In September of 2004, Chess Depositary Instruments or CDIs representing beneficial ownership of our common stock began trading on the Australian Securities Exchange or ASX under the symbol “SHC.” Initially, each CDI represented one share of our common stock. In connection with the 1-for-200 reverse stock split we affected on January 27, 2012, we changed this ratio so that each CDI represented 1/200th of a share of our common stock. Our common stock began trading on the Nasdaq Capital Market on February 16, 2012.  We delisted from the ASX at the close of trading on May 6, 2013.

 

Our principal executive offices are located at 12988 Valley View Road, Eden Prairie, Minnesota 55344, and our telephone number is (952) 345-4200. Our website address is www.sunshineheart.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-

 

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Q and, going forward, Current Reports on Form 8-K and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Exchange Act will be made available free of charge on our website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information on, or that may be accessed through, our website is not incorporated by reference into and should not be considered a part of this Annual Report on Form 10-K

 

Until December 31, 2017, we qualify as an “emerging growth company” as defined in the Jumpstart our Business Startups Act of 2012 or the JOBS Act. Furthermore, we are and will remain a “smaller reporting company” as long as our public float remains less than $75 million as of the last business day of our most recently-completed second fiscal quarter. An emerging growth company or smaller reporting company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to U.S. public companies. These provisions include an exemption from the attestation requirement in the assessment of our internal control over financial reporting by our independent auditors pursuant to section 404 (b) of the Sarbanes-Oxley Act of 2002 (“SOX”) but do not preclude us from the requirement to make our own internal assessment of the effectiveness of our internal controls over financial reporting. Furthermore, as an emerging growth company, we can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act, for complying with new or revised accounting standards.  Until such date as we no longer qualify as an emerging growth company, our financial statements may not be comparable to those of companies that comply with new or revised accounting standards for U.S. public companies.

 

We have elected to take advantage of the benefits of this extended transition period, which will end on December 31, 2017. Until such date, and as a result of this election, our financial statements may not be comparable to those of companies that comply with new or revised accounting standards for U.S. public companies.

 

On September 21, 2016, we received notice from the Listing Qualifications Staff (the “Staff”) of The Nasdaq Stock Market LLC (“ Nasdaq ”) indicating that the Staff had determined to delist our securities from The Nasdaq Capital Market due to our then continued non-compliance with the minimum bid price requirement.  We requested a hearing before the Nasdaq Hearings Panel (the “Panel” ), which occurred on November 10, 2016.  On November 11, 2016, we received notice from the Staff that we no longer satisfied Nasdaq Listing Rule 5550(b) insofar as we did not expect to report stockholders’ equity of at least $2.5 million upon the filing of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2016 and that the deficiency could serve as an additional basis for the delisting of the Company’s common stock from The Nasdaq Capital Market.  On November 21, 2016, Nasdaq informed us that the Panel had granted us continued listing on The Nasdaq Capital Market while we implement our plan to regain compliance with the minimum bid price and minimum stockholders’ equity requirements.  The Panel granted us until January 30, 2017 to evidence a closing bid price of $1.00 or more for a minimum of ten prior consecutive trading days. At a special meeting of our stockholders on January 9, 2017, our stockholders approved, among other things, a reverse stock split, and following such special meeting, our Board of Directors approved a 1-for-30 reverse split of our issued and outstanding shares of common stock.  The reverse stock split was effective as of 5:00 p.m. Eastern Time on January 12, 2017, and our common stock began trading on a split-adjusted basis on The Nasdaq Capital Market on January 13, 2017.  The reverse stock split did not change the par value of our stock or the authorized number of common or preferred shares.  All share and per share amounts in this Annual Report on Form 10-K for the year ended December 31, 2016, including the financial statements and notes thereto included in Item 8 hereof, have been retroactively adjusted to reflect the reverse stock split for all periods presented.

 

After implementing the reverse stock split, we received confirmation from Nasdaq on February 9, 2017 that we have regained compliance with the minimum bid price rule.  The Panel granted us until March 20, 2017 to evidence compliance with the $2.5 million stockholder’s equity requirement. If it appears to the Nasdaq staff that we will not be able to meet the minimum stockholders’ equity or any other listing standard, our common stock may be subject to delisting.

 

Item 1A.                                                 Risk Factors.

 

Our business faces many risks. We believe the risks described below are the material risks we face. However, the risks described below may not be the only risks 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 occurs, our business, financial condition or results of operations could suffer, and the trading price of our shares of common stock could decline significantly. Investors should consider the specific risk factors discussed below, together with the “Cautionary Note Regarding Forward-Looking Statements” and the other information contained in this Annual Report on Form 10-K and the other documents that we will file from time to time with the SEC.

 

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Risks Related to Our Business

 

We have limited history of operations and limited experience in sales and marketing, and we might be unsuccessful in increasing our sales and cannot assure you that we will ever generate substantial revenue or be profitable.

 

Prior to our acquisition of the Aquadex FlexFlow in August 2016, we did not have a product approved for commercial sale and focused our resources on developing, manufacturing and commercializing our C-Pulse System.  On September 29, 2016, we announced a strategic refocus of our near-term strategy that includes halting all clinical evaluations to fully focus our resources on our recently acquired Aquadex FlexFlow, taking actions to reduce our cash burn in connection with such strategic refocus and reviewing potential strategic alliances and financing alternatives.  Our business strategy depends in part on our ability to grow our Aquadex Business by establishing a sales force, selling our products to hospitals and other healthcare facilities and controlling costs all of which we may be unable to do. We have no prior experience with respect to manufacturing, sales and marketing. If we are unsuccessful at manufacturing, marketing and selling our Aquadex FlexFlow, our operations and potential revenues will be materially adversely affected.

 

We have incurred operating losses since our inception and anticipate that we will continue to incur operating losses in the near-term. The report of our independent registered public accounting firm issued in connection with its audit of our financial statements for the fiscal year ended December 31, 2016 expresses substantial doubt about our ability to continue as a going concern. We will need additional funding to continue operations, which may not be available to us on favorable terms or at all.

 

We are an early-stage company with a history of incurring net losses. We have incurred net losses since our inception, including net losses of $15.8 million and $26.6 million for the years ended December 31, 2016, and 2015, respectively. As of December 31, 2016, our accumulated deficit was $169.0 million.

 

The report of our independent registered public accounting firm issued in connection with its audit of our financial statements for the fiscal year ended December 31, 2016 expresses substantial doubt about our ability to continue as a going concern. Prior to August 2016, we did not have any products approved for commercialization, generated only limited revenue from our clinical studies and had significant operating losses as we incurred costs associated with the conduct of clinical studies and our research and development programs for our C-Pulse System.  We became a revenue generating company only a few months ago after acquiring the Aquadex Business in August 2016.  We expect to incur additional losses in the near-term as we grow the Aquadex Business, including investments in expanding our sales and marketing capabilities, purchasing inventory, manufacturing components, and complying with the requirements related to being a U.S. public company listed on NASDAQ.  To become and remain profitable, we must succeed in expanding the adoption and market acceptance of the Aquadex FlexFlow. This will require us to succeed in a range of challenging activities, including training personnel at hospitals and effectively and efficiently manufacturing, marketing and distributing the Aquadex FlexFlow and related components. There can be no assurance that we will succeed in these activities, and we may never generate revenues sufficient to achieve profitability. If we do achieve profitability, we may not be able to sustain it.

 

We expect to require additional funding to grow our Aquadex Business, which may not be available on terms favorable to us, or at all. In addition, the risk that we may not be able to continue as a going concern may make it more difficult to obtain necessary additional funding on terms favorable to us, or at all.  We expect to seek additional financing during 2017.  If we raise additional funding through the issuance of equity securities, our stockholders may suffer dilution and our ability to use our net operating losses to offset future income may be limited. If we raise additional funding through debt financing, we may be required to accept terms that restrict our ability to incur additional indebtedness, require us to use our cash to make payments under such indebtedness, force us to maintain specified liquidity or other ratios or restrict our ability to pay dividends or make acquisitions. If we are unable to secure additional funding, our development programs and our commercialization efforts would be delayed, reduced or eliminated, our relationships with our suppliers and manufacturers may be harmed, and we may not be able to continue our operations.

 

Failure to integrate our recently-acquired business into our operations successfully could adversely affect our business.

 

Our integration of the operations of the Aquadex Business requires significant efforts and we may need to allocate more resources to integration and product development activities than originally anticipated. These efforts will result in additional expenses and involve significant amounts of management’s time. Our failure to manage and coordinate the growth of the company could also have an adverse impact on our business. Investments in medical technology are inherently risky, and we cannot guarantee that the Aquadex Business will be profitable or successful or will not have a material unfavorable impact on us. Acquisitions can cause decrease in customer loyalty and product orders in connection with the change of ownership and management.  Customers may be unwilling to continue doing business with us after our acquisition of the Aquadex Business from Baxter and some customers may not consent to the assignment of their contracts with Baxter or agree to enter into a new contract with us. Inconsistencies in standards, controls, procedures and policies may adversely affect our ability to achieve the anticipated benefits of the acquisition. We also could experience negative effects on our results of operations, cash flows, and financial condition from acquisition-related charges, amortization of intangible assets and asset impairment charges. These effects, individually or in the aggregate, could harm our business.

 

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Our near-term prospects are highly dependent on the development of a single product, the Aquadex FlexFlow.

 

We face significant challenges in expanding market acceptance of the Aquadex FlexFlow , which could adversely affect our potential sales and revenues.

 

Our near-term prospects are highly dependent on the development of a single product, the Aquadex FlexFlow, and we have no other commercial products or products in active development at this time. The established market or customer base for our Aquadex FlexFlow is limited and our success depends on our ability to increase adoption of the Aquadex FlexFlow. Acceptance of our product in the marketplace by health care providers is uncertain, and our failure to achieve sufficient market acceptance will significantly limit our ability to generate revenue and be profitable. Market acceptance will require substantial marketing efforts and the expenditure of significant funds by us to inform health care providers of the benefits of using the Aquadex FlexFlow and to provide further training on its use. We may not be able to build key relationships with health care providers to drive further sales in the United States or sell the Aquadex FlexFlow outside the United States. Product orders may be cancelled, patients or customers currently using our products may cease to do so and patients or customers expected to begin using our products may not. Our ability to achieve acceptance of our Aquadex FlexFlow depends on our ability to demonstrate the safety, efficacy, ease-of-use and cost-effectiveness of the system.  We may not be able to expand the adoption and market acceptance of the Aquadex FlexFlow to both the inpatient and outpatient markets and our potential sales and revenues could be harmed.

 

We will need to raise additional capital in the future.  If additional capital is not available, we will have to delay, reduce or cease operations.

 

We expect to seek additional financing during 2017.  Changing circumstances may cause us to consume capital significantly faster than we currently anticipate and could adversely affect our ability to raise additional capital.  Additional financing may not be available when we need it or may not be available on terms that are favorable to us. If adequate funds are not available to us on a timely basis or at all, we would likely be required to significantly reduce our operations.

 

We have no commercial manufacturing experience and could experience difficulty in producing the Aquadex FlexFlow and related components or may need to depend on third parties for manufacturing.

 

We have no experience in commercial manufacturing and no experience in commercially manufacturing the Aquadex FlexFlow and related components.  As a result, we may not be able to develop and implement efficient, low-cost manufacturing capabilities and processes that will enable us to manufacture the Aquadex FlexFlow or related components in significant volumes, while meeting the legal, regulatory, quality, price, durability, engineering, design and production standards required to market our products successfully. In addition, we depend upon third parties to manufacture and supply components for the Aquadex FlexFlow.  We are party to a commercial manufacturing and supply agreement with Baxter which requires Baxter to manufacture Aquadex Blood Sets and Aquadex Catheters for a period of 18 months following our acquisition of the Aquadex Business.  There is no such agreement relating to the manufacturing of Consoles.  We plan to transfer Console manufacturing to us or a qualified contract manufacturer by mid-year 2017 and Aquadex Blood Set and Catheter manufacturing activities from Baxter to us or a qualified contract manufacturer by the end of 2017, but we may experience difficulties in doing so.  Furthermore, we may not be able to contract for such manufacturing on terms favorable to us or at all.  If we experience difficulties in transitioning manufacturing operations, we may experience delays in providing products and services to our customers, and our business could be harmed.

 

We depend upon third-party suppliers, including single source suppliers to us and our customers, making us vulnerable to supply problems and price fluctuations.

 

We will rely on third-party suppliers, including single source suppliers, to provide us with certain components of the Aquadex FlexFlow and to provide key components or supplies for use with our products. We depend on our suppliers to provide us and our customers with materials in a timely manner that meet our and their quality, quantity and cost requirements. The forecasts of demand we use to determine order quantities and lead times for components purchased from outside suppliers may be incorrect. Our failure to obtain required components or subassemblies when needed and at a reasonable cost would adversely affect our business. These suppliers may encounter problems during manufacturing for a variety of reasons, any of which could delay or impede their ability to meet our demand.  Any difficulties in locating and hiring third-party manufacturers, or in the ability of third-party manufacturers to supply quantities of our products at the times and in the quantities we need, could have a material adverse effect on our business.

 

If we cannot develop adequate distribution, customer service and technical support networks, then we may not be able to market and distribute the Aquadex system effectively and our sales and revenues will suffer.

 

Our strategy requires us to provide a significant amount of customer service and maintenance and other technical service to our customers. To provide these services, we have begun, and will need to continue, to develop a network of distribution and a staff of employees and independent contractors in each of the areas in which we intend to operate. We cannot assure that we will be able to organize and manage this network on a cost-effective basis. If we cannot effectively organize and manage this network, then it may be

 

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difficult for us to distribute our products and to provide competitive service and support to our customers, in which case customers may be unable, or decide not, to order our products and our sales and revenues will suffer.

 

We compete against many companies, some of which have longer operating histories, more established products and greater resources than we do, which may prevent us from achieving further market penetration or improving operating results.

 

Competition from medical device companies and medical device divisions of health care companies, as well as pharmaceutical companies is intense and is expected to increase. Our Aquadex FlexFlow mainly competes against pharmacological therapies, diuretics, as well as a range of other specialized medical device companies with devices at varying stages of development. Some of these competitors have significantly greater financial and human resources than we do and have established reputations, as well as worldwide distribution channels and sales and marketing capabilities that are significantly larger and more established than ours. Additional competitors may enter the market, and we are likely to compete with new companies in the future. We 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 harm our business. In addition, because our system has been implanted in a limited number of patients to date, all of the material risks and potential competitive disadvantages of our system are not necessarily known at this time.

 

Our ability to compete effectively depends upon our ability to distinguish our Company and our system from our competitors and their products. Factors affecting our competitive position include:

 

·                   financial resources;

·                   product performance and design;

·                   product safety;

·                   acceptance of our system in the marketplace;

·                   sales, marketing and distribution capabilities;

·                   manufacturing and assembly costs;

·                   pricing of our system and of our competitors’ products;

·                   the availability of reimbursement from government and private health insurers;

·                   success and timing of new product development and introductions;

·                   regulatory approvals in the United States; and

·                   intellectual property protection.

 

The competition for qualified personnel is particularly intense in our industry. 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. We face intense competition for such personnel, and we may not be able to attract, retain and motivate these individuals. We compete for talent with numerous companies, as well as universities and nonprofit research organizations. Our future success also depends on the personal efforts and abilities of the principal members of our senior management and scientific staff to provide strategic direction, manage our operations and maintain a cohesive and stable environment. We do not maintain life insurance on the lives of any of the members of our senior management. The loss of key personnel for any reason or our inability to hire, retain and motivate additional qualified personnel in the future could prevent us from sustaining or growing our business.

 

Significant additional governmental regulation could subject us to unanticipated delays which would adversely affect our sales and revenues.

 

Our business strategy depends in part on our ability to expand the use of the Aquadex FlexFlow in the market as quickly as possible. Health care laws in the United States and other countries are subject to ongoing changes, including changes to the amount of reimbursement for hospital services. Additional laws and regulations, or changes to existing laws and regulations that are applicable to our business may be enacted or promulgated, and the interpretation, application or enforcement of the existing laws and regulations may change. Legislative proposals can substantially change the way health care is financed by both governmental and private insurers and may negatively impact payment rates for our system. We cannot predict the nature of any future laws, regulations, interpretations, applications or enforcements or the specific effects any of these might have on our business. However, in the United States and international markets, we expect that both government and third-party payers will continue to attempt to contain or reduce the costs of health care by challenging the prices charged, or deny coverage, for health care products and services. Any future laws, regulations, interpretations, applications or enforcements could delay or prevent regulatory approval or clearance of our Aquadex FlexFlow and our ability to market our Aquadex FlexFlow. Moreover, changes that result in our failure to comply with the requirements of

 

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applicable laws and regulations could result in the types of enforcement actions by the U.S. Food and Drug Administration (the “FDA”) and/or other agencies as described above, all of which could impair our ability to have manufactured and to sell the affected products.

 

In the United States, the Aquadex FlexFlow is purchased primarily by customers, such as hospitals or other health care providers. Customers bill various third-party payers for covered Aquadex FlexFlow services provided to patients. These payers, which include federal health care programs (e.g., Medicare and Medicaid), state health care programs, private health insurance companies and managed care organizations, would then reimburse our customers based on established payment formulas that take into account part or all of the cost associated with these devices and the related procedures performed.

 

While the agency responsible for administering the Medicare program, the Centers for Medicare and Medicaid Services, has not issued a favorable national coverage determination under its Investigational Device Exception Studies Program for ultrafiltration using the Aquadex FlexFlow, a number of private insurers have approved reimbursement for Aquadex FlexFlow for specific indications and points of service. In addition, patients and providers may see insurance coverage on a case-by-case basis.  We are exploring the ability to increase the range of coverage for uses of Aquadex FlexFlow, such as use in the outpatient setting and use for decompensated heart failure and other indicated uses under its approved labeling, although we may not be successful in doing so.

 

The Patient Protection and Affordable Care Act of 2010, as modified by the Health Care and Education Reconciliation Act of 2010 (collectively, the “Health Reform Laws”), provides those states that expand their Medicaid coverage to otherwise eligible state residents with incomes at or below 138% of the federal poverty level with an increased federal medical assistance percentage, effective January 1, 2014, when certain conditions are met. On June 28, 2012, the United States Supreme Court upheld the individual mandate of the Health Reform Laws but partially invalidated the expansion of Medicaid. The ruling on Medicaid expansion allows states to elect not to participate in the expansion-and to forego funding for the Medicaid expansion-without losing their existing Medicaid funding.  States will be expected to pay for part of costs of Medicaid expansion beginning in 2017. In light of the current political environmental and the possibility that proposed legislation may significantly impact Medicaid funding to states, it is unclear how states will pay their share of these additional Medicaid costs and providers would be able to continue to receive reimbursement for services to all patients receiving treatment using the Aquadex FlexFlow who are currently enrolled in Medicaid.

 

We enrolled patients in studies for the C-Pulse System through February 2016 and continue to have reporting obligations related to two open studies for the C-Pulse.

 

Conducting clinical studies is a complex and uncertain process.  Clinical trials are subject to extensive recordkeeping and reporting requirements. Any clinical trials must be conducted under the oversight of an institutional review board for the relevant clinical trial sites and must comply with FDA regulations, including, but not limited to, those relating to current good clinical practices. Each trial must obtain the written informed consent of patients in form and substance that complies with both FDA requirements and state and federal privacy and human subject protection regulations. The testing company, the FDA or the IRB may suspend a clinical trial at any time for various reasons, including a belief that the risks to study subjects outweigh the anticipated benefits. Similarly, in Europe, the clinical study must be approved by a local ethics committee and, in some cases, including studies with high-risk devices, by the ministry of health in the applicable country. Patients may experience serious adverse events or side effects during the study, which, whether or not related to our system, could cause the FDA or other regulatory authorities to investigate and potentially assess regulatory penalties.  Any regulatory penalties assessed for failure to comply with the foregoing requirements could harm our business, results of operations, financial condition and prospects and cause us to seek additional funding.

 

Product defects, including lawsuits for product liability, could harm our business, results of operations and financial condition.

 

The design, manufacture and marketing of medical devices involve certain inherent risks. Manufacturing or design defects, unanticipated use of a product or inadequate disclosure of risks relating to the use of the product can lead to injury or other adverse events. These events could lead to recalls or safety alerts relating to a product (either voluntary or required by the FDA or similar governmental authorities in other countries), and could result, in certain cases, in the removal of a product from the market. Any recall of our Aquadex FlexFlow or any related components could result in significant costs, as well as negative publicity and damage to our reputation that could reduce demand for our products. Additionally, the C-Pulse system treats Class III and ambulatory Class IV heart failure for patients who typically have serious medical issues. As a result, our exposure to product liability claims may be heightened because the people who use this system have a high risk of suffering adverse outcomes, regardless of the safety or efficacy of our system. In addition, because this system was implanted in a limited number of patients, we cannot assure you that we are currently aware of all material risks related to use of our system or that could lead to product liability claims against us.  Personal injuries relating to the use of our products could also result in product liability claims being brought against us. In some circumstances, such adverse events could also cause delays in new product approvals.

 

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We may be held liable if any product we develop or commercialize causes injury or is found otherwise unsuitable during product testing, manufacturing, marketing, sale or consumer use. The safety studies we must perform and the regulatory approvals required to commercialize our products will not protect us from any such liability. We carry product liability insurance with a $5 million aggregate limit. However, if there are product liability claims against us, our insurance may be insufficient to cover the expense of defending against such claims, or may be insufficient to pay or settle such claims. Furthermore, we may be unable to obtain adequate product liability insurance coverage for commercial sales of any approved product. If such insurance is insufficient to protect us, our business, results of operations and financial condition will be harmed. If any product liability claim is made against us, our reputation and future sales will be damaged, even if we have adequate insurance coverage. Even if a product liability claim against us is without merit or if we are not found liable for any damages, a product liability claim could result in decreased interest in our registry studies, decreased demand for our system, if approved for commercialization, injury to our reputation, diversion of management’s attention from operating our business, withdrawal of study participants, significant costs of related litigation, loss of revenue or the inability to commercialize our products.

 

We may face significant risks associated with international operations, which could have a material adverse effect on our business, financial condition and results of operations.

 

We expect to manufacture and to market our products globally. Our international operations are subject to a number of risks, including the following: fluctuations in exchange rates of the United States dollar could adversely affect our results of operations, we may face difficulties in enforcing and collecting accounts receivable under some countries’ legal systems, local regulations may restrict our ability to sell our products, have our products manufactured or conduct other operations, political instability could disrupt our operations, some governments and customers may have longer payment cycles, with resulting adverse effects on our cash flow, and some countries could impose additional taxes or restrict the import of our products.  Any one or more of these factors could increase our costs, reduce our revenues, or disrupt our operations, which could have a material adverse effect on our business, financial condition and results of operations.

 

If we are not able to maintain sufficient quality controls, then the approval or clearance of our products by the European Union, the FDA or other relevant authorities could be withdrawn, delayed or denied and our sales and revenues will suffer.

 

Approval or clearance of our products could be withdrawn, delayed or denied by the European Union, the FDA and the relevant authorities of other countries if our manufacturing facilities do not comply with their respective manufacturing requirements. The European Union imposes requirements on quality control systems of manufacturers, which are inspected and certified on a periodic basis and may be subject to additional unannounced inspections. Failure by our manufacturers to comply with these requirements could prevent us from marketing our products in the European Community. The FDA also imposes requirements through quality system requirements, or QSR, regulations, which include requirements for good manufacturing practices, or GMP. Failure by our manufacturers to comply with these requirements could prevent us from obtaining FDA approval of our products and from marketing such products in the United States. Although the manufacturing facilities and processes that we use to manufacture our products have been inspected and certified by a worldwide testing and certification agency (also referred to as a notified body) that performs conformity assessments to European Union requirements for medical devices, they have not been inspected by the FDA. A “notified body” is a group accredited and monitored by governmental agencies that inspects manufacturing facilities and quality control systems at regular intervals and is authorized to carry out unannounced inspections. We cannot be sure that any of the facilities or processes we use will comply or continue to comply with their respective requirements on a timely basis or at all, which could delay or prevent our obtaining the approvals we need to market our products in the European Community and the United States.

 

To market our products in the European Community, the United States and other countries, where approved, manufacturers of such products must continue to comply or ensure compliance with the relevant manufacturing requirements. Although we cannot control the manufacturers of our products, if we choose to subcontract manufacturing to a contract manufacturer, we may need to expend time, resources and effort in product manufacturing and quality control to assist with their continued compliance with these requirements. If violations of applicable requirements are noted during periodic inspections of the manufacturing facilities of our manufacturers or we fail to address issues raised by the FDA in these inspections, then we may not be able to continue to market the products manufactured in such facilities and our revenues may be materially adversely affected.

 

If we violate any provisions of the Federal Food, Drug, and Cosmetic Act (“FDC Act”) or any other statutes or regulations, then we could be subject to enforcement actions by the FDA or other governmental agencies.

 

We face a significant compliance burden under the FDC Act and other applicable statutes and regulations which govern the testing, labeling, storage, record keeping, distribution, sale, marketing, advertising and promotion of our medically approved products.

 

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If we violate the FDC Act or other regulatory requirements at any time during or after the product development and/or approval process, we could be subject to enforcement actions by the FDA or other agencies, including: fines, injunctions, civil penalties, recalls or seizures of products, total or partial suspension of the production of our products, withdrawal of any existing approvals or pre-market clearances of our products, refusal to approve or clear new applications or notices relating to our products, recommendations that we not be allowed to enter into government contracts and criminal prosecution. Any of the above could have a material adverse effect on our business, financial condition and results of operations.

 

We cannot assure you that our products will be safe or that there will not be serious injuries or product malfunctions. Further, we are required under applicable law to report any circumstances relating to our medically approved products that could result in deaths or serious injuries. These circumstances could trigger recalls, class action lawsuits and other events that could cause us to incur expenses and may also limit our ability to generate revenues from such products.

 

We cannot assure you that our products will prove to be safe or that there will not be serious injuries or product malfunctions, which could trigger recalls, class action lawsuits and other events that could cause us to incur significant expenses, limit our ability to market our products and generate revenues from such products or cause us reputational harm.

 

Under the FDC Act, we are required to submit medical device reports, or MDRs, to the FDA to report device-related deaths, serious injuries and malfunctions of medically approved products that could result in death or serious injury if they were to recur. Depending on their significance, MDRs could trigger events that could cause us to incur expenses and may also limit our ability to generate revenues from such products, such as the following: information contained in the MDRs could trigger FDA regulatory actions such as inspections, recalls and patient/physician notifications, because the reports are publicly available, MDRs could become the basis for private lawsuits, including class actions, and if we fail to submit a required MDR to the FDA, the FDA could take enforcement action against us.

 

If any of these events occur, then we could incur significant expenses and it could become more difficult for us to market and sell our products and to generate revenues from sales. Other countries may impose analogous reporting requirements that could cause us to incur expenses and may also limit our ability to generate revenues from sales of our products.

 

We face significant uncertainty in the industry due to government healthcare reform.

 

The Patient Protection and Affordable Care Act, as amended, (the “Affordable Care Act”) as well as other healthcare reform, including possible repeal of the Affordable Care Act, may have a significant impact on our business. The impact of the Affordable Care Act on the health care industry is extensive and includes, among other things, the federal government assuming a larger role in the health care system, expanding healthcare coverage of United States citizens and mandating basic healthcare benefits. The Affordable Care Act contains many provisions designed to generate the revenues necessary to fund the coverage expansions and to reduce costs of Medicare and Medicaid, including imposing a 2.3% excise tax on domestic sales of many medical devices by manufacturers that began in 2013. Although a moratorium was placed on the medical device excise tax in 2016 and 2017, if it is reinstated, it may adversely affect our sales and the cost of goods sold.

 

The Affordable Care Act includes a Hospital Readmission Reduction program and is designed to reduce payments to hospitals with excess heart failure readmissions, among other conditions. The penalty to hospitals can be significant, as much as 3% of total Medicare reimbursement. We believe the Aquadex FlexFlow may offer hospitals an economic benefit for using the device on a regular basis for in-patient or out-patient usage; however, if the Hospital Readmission Reduction program is repealed, hospitals may not be as inclined to take measures to reduce readmissions.

 

In addition, any healthcare reforms enacted in the future may, like the Affordable Care Act, be phased in over a number of years but, if enacted, could reduce our revenue, increase our costs, or require us to revise the ways in which we conduct business or put us at risk for loss of business. In addition, our results of operations, financial position and cash flows could be materially adversely affected by changes under the Affordable Care Act and changes under any federal or state legislation adopted in the future.

 

Moreover, the Physician Payment Sunshine Act (the Sunshine Act), which was enacted by Congress as part of the Patient Protection and Affordable Care Act on March 23, 2010, requires medical device companies to track and publicly report, with limited exceptions, all payments and transfers of value to physicians and teaching hospitals in the U.S. Implementing regulations for these tracking and reporting obligations were finalized in 2013, and companies are now required to track payments made since August 1, 2013. If we fail to comply with the data collection and reporting obligations imposed by the Sunshine Act, we may be subject to substantial civil monetary penalties.

 

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We are subject, directly or indirectly, to United States federal and state healthcare fraud and abuse and false claims laws and regulations. Prosecutions under such laws have increased in recent years and we may become subject to such litigation. If we are unable to, or have not fully complied with such laws, we could face substantial penalties.

 

Our operations are directly, or indirectly through customers, subject to various state and federal fraud and abuse laws, including, without limitation, the federal Anti-Kickback Statute, the Stark Law and federal False Claims Act. These laws may impact, among other things, our sales, marketing and education programs.

 

The federal Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing or arranging for a good or service, for which payment may be made under a federal healthcare program such as the Medicare and Medicaid programs. Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal healthcare covered business, the statute has been violated. The Anti-Kickback Statute is broad and, despite a series of narrow safe harbors, prohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. Penalties for violations of the federal Anti-Kickback Statute include criminal penalties and civil sanctions such as fines, imprisonment and possible exclusion from Medicare, Medicaid and other federal healthcare programs. Many states have also adopted laws similar to the federal Anti-Kickback Statute, some of which apply to the referral of patients for healthcare items or services reimbursed by any source, not only the Medicare and Medicaid programs.

 

The physician self-referral laws, commonly referred to as the Stark law is a strict liability statute that generally prohibits physicians from referring Medicare patients to providers of “designated health services,” with whom the physician or the physician’s immediate family member has an ownership interest or compensation arrangement, unless an applicable exception applies. Moreover, many states have adopted or are considering adopting similar laws, some of which extend beyond the scope of the Stark law to prohibit the payment or receipt of remuneration for the prohibited referral of patients for designated healthcare services and physician self-referrals, regardless of the source of the payment for the patient’s care. If it is determined that any of the relationships we may have with physicians violate the Stark law or similar statutes, we could become subject to civil and criminal penalties. The imposition of any such penalties could harm our business.

 

The federal False Claims Act prohibits persons from knowingly filing, or causing to be filed, a false claim to, or the knowing use of false statements to obtain payment from the federal government. Suits filed under the False Claims Act, known as “qui tam” actions, can be brought by any individual on behalf of the government and such individuals, commonly known as “whistleblowers,” may share in any amounts paid by the entity to the government in fines or settlement. The frequency of filing qui tam actions has increased significantly in recent years, causing greater numbers of medical device, pharmaceutical and healthcare companies to have to defend a False Claim Act action. When an entity is determined to have violated the federal False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties for each separate false claim. Various states have also enacted laws modeled after the federal False Claims Act.

 

We are unable to predict whether we could be subject to actions under any of these laws, or the impact of such actions. If we are found to be in violation of any of the laws described above or other applicable state and federal fraud and abuse laws, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion from government healthcare reimbursement programs and the curtailment or restructuring of our operations.

 

If we acquire other businesses, products or technologies, we will be subject to risks that could hurt our business.

 

We may pursue acquisitions to obtain complementary businesses, products or technologies. Any such acquisition may not produce the revenues, earnings or business synergies that we anticipate and an acquired business, product or technology might not perform as we expect. Our management could spend a significant amount of time, effort and money in identifying, pursuing and completing the acquisition. If we complete an acquisition, we may encounter significant difficulties and incur substantial expenses in integrating the operations and personnel of the acquired businesses, products or technologies into our operations. In particular, we may lose the services of key employees and we may make changes in management that impair the acquired business’s relationships with employees, vendors and customers. Additionally, we may acquire development-stage companies that are not yet profitable and which require continued investment, which could decrease our future earnings or increase our futures losses.

 

Any of these outcomes could prevent us from realizing the anticipated benefits of an acquisition. To pay for an acquisition, we might use stock or cash. Alternatively, we might borrow money from a bank or other lender. If we use stock, our stockholders would experience dilution of their ownership interests. If we use cash or debt financing, our financial liquidity would be reduced. As a result of our annual impairment testing, we may be required to capitalize a significant amount of intangibles, including goodwill, which may lead to significant amortization or write-off charges. These amortization charges and write-offs could decrease our future earnings or increase our future losses.

 

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Risks Related to Our Intellectual Property

 

We may not be able to protect our intellectual property rights effectively, which could have an adverse effect on our business, financial condition or results of operations.

 

Our success depends in part on our ability to obtain and maintain protection in the United States and other countries of the intellectual property relating to or incorporated into our Aquadex FlexFlow and related components. As of December 31, 2016, we owned over 35 issued patents and 13 pending patent applications in the United States and in foreign jurisdictions related to our C-Pulse System and had 2 pending applications for neuromodulation. We estimate that most of our currently issued U.S. patents will expire between approximately 2021 and 2027.  Given the strategic refocus away from C-Pulse and towards Aquadex FlexFlow, we have chosen to limit the maintenance of issued C-Pulse related patents to those innovations that are of the highest value.  Further, we have elected to emphasize a few of the most critical jurisdictions rather than maintain the earlier approach that involved multiple countries.

 

On August 5, 2016, upon closing of our acquisition of the Aquadex Business, we entered into a patent license agreement with Baxter, pursuant to which we obtained, for no additional consideration, a world-wide license to 49 exclusively licensed and 9 non-exclusively licensed patents used in connection with the Aquadex FlexFlow to make, have made, use, sell, offer for sale and import, the Aquadex FlexFlow in the “field of use.”  The “field of use” is defined as system and apparatus only capable of performing isolated ultrafiltration for treatment of congestive heart failure, and methods to the extent used therein (excluding system, apparatus, or methods performing any kind of renal therapy or dialysis and/or any system capable of providing substitution fluid).  The license is exclusive, with respect to some patents, and non-exclusive, with respect to other patents.  Under the patent license agreement, Baxter has agreed to use commercially reasonable efforts to continue maintenance of seven “required maintenance patents,” and we have agreed to reimburse Baxter for all fees, costs, and expenses (internal or external) incurred by Baxter in connection with such continued maintenance. The rights granted to us under the patent license agreement will automatically revert to Baxter in the event we cease operation of the Aquadex Business or we file for, or have filed against us, or otherwise undertake any bankruptcy, reorganization, insolvency, moratorium, or other similar proceeding.  In addition, for two years following the closing, the patent license agreement is not assignable by us (including in connection with a change of control) without Baxter’s prior written consent. We estimate that the patents licensed from Baxter will expire between approximately 2020 and 2025.

 

Our pending and future patent applications may not issue as patents or, if issued, may not issue in a form that will provide us any competitive advantage. Even if issued, existing or future patents may be challenged, narrowed, invalidated or circumvented, which could limit our ability to stop competitors from marketing similar products or limit the length of terms of patent protection we may have for our system. Changes in patent laws or their interpretation in the United States and other countries could also diminish the value of our intellectual property or narrow the scope of our patent protection. In addition, the legal systems of certain countries do not favor the aggressive enforcement of patents, and the laws of foreign countries may not protect our rights to the same extent as the laws of the United States. As a result, our patent portfolio may not provide us with sufficient rights to exclude others from commercializing products similar or identical to ours. 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 to us and divert our management’s attention from our business.

 

Intellectual property litigation could be costly and disruptive to us.

 

In recent years, there has been significant litigation involving intellectual property rights. From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies used in our business. Any claims, with or without merit, could be time-consuming, result in costly litigation, divert the efforts of our technical and management personnel or require us to pay substantial damages. If we are unsuccessful in defending ourselves against these types of claims, we may be required to do one or more of the following:

 

·                                          halt use of our Aquadex Business;

·                                          attempt to obtain a license to sell or use the relevant technology or substitute technology, which license may not be available on reasonable terms or at all; or

·                                          redesign our system.

 

In the event a claim against us were successful and we could not obtain a license to the relevant technology on acceptable terms or license a substitute technology or redesign our system to avoid infringement, our business, results of operations and financial condition would be significantly harmed.

 

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If we were unable to protect the confidentiality of our proprietary information and know-how, the value of our technology and system could be adversely affected.

 

In addition to patented technology, we rely on our unpatented proprietary technology, trade secrets, processes and know-how. We generally seek to protect this information by confidentiality agreements with our employees, consultants, scientific advisors and third parties. These agreements may be breached, and we may not have adequate remedies for any such breach. In addition, our trade secrets may otherwise become known or be independently developed by competitors. To the extent that our employees, consultants or contractors use intellectual property owned by others in their work for us, disputes may arise as to the rights in related or resulting know-how and inventions.

 

Our products could infringe patent rights of others, which may require costly litigation and, if we are not successful, could cause us to pay substantial damages or limit our ability to commercialize our products.

 

Our commercial success depends on our ability to increase adoption of the Aquadex Business without infringing the patents and other proprietary rights of third parties. As our industry expands and more patents are issued, the risk increases that there may be patents issued to third parties that relate to our system and technologies of which we are not aware or that we must challenge to continue our operations as currently contemplated. Our system may infringe or may be alleged to infringe these patents.

 

In addition, some patent applications in the United States may be maintained in secrecy until the patents are issued because patent applications in the United States and many foreign jurisdictions are typically not published until 18 months after filing, and because publications in the scientific literature often lag behind actual discoveries, we cannot be certain that others have not filed patent applications for technology covered by our issued patents or our pending applications or that we were the first to invent the technology. Another party may have filed, and may in the future file, patent applications covering our system or technology similar to ours. Any such patent application may have priority over our patent applications or patents, which could further require us to obtain rights to issued patents covering such technologies. If another party has filed a U.S. patent application on inventions similar to ours, we may have to participate in an interference or deviation proceeding declared by the U.S. Patent and Trademark Office to determine priority of invention in the United States. The costs of these proceedings could be substantial, and it is possible that such efforts would be unsuccessful if the other party had independently arrived at the same or similar invention prior to our own invention, resulting in a loss of our U.S. patent position with respect to such inventions.

 

We may be subject to claims that our employees have wrongfully used or disclosed alleged trade secrets of their former employers.

 

As is common in our industry, we employ individuals who were previously employed at other medical device companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees, or we, have used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management.

 

Security breaches, loss of data and other disruptions could compromise sensitive information related to our business or prevent us from accessing critical information and expose us to liability, which could adversely affect our business and our reputation.

 

In the ordinary course of our business, we collect and store sensitive data, including legally protected health information, personally identifiable information, intellectual property and proprietary business information owned or controlled by ourselves or others. At times we may have access to limited amounts of protected health information as part of other healthcare providers’ provision of treatment to patients with our medical devices.  We manage and maintain our applications and data utilizing on-site systems. These applications and data encompass a wide variety of business-critical information including research and development information, commercial information, and business and financial information. We face four primary risks relative to protecting this critical information, including: loss of access risk; inappropriate disclosure risk; inappropriate modification risk; and the risk of our being unable to adequately monitor our controls over the first three risks.

 

The secure processing, storage, maintenance, and transmission of this critical information is vital to our operations and business strategy. Although we take measures to protect sensitive information from unauthorized access or disclosure, our information technology and infrastructure may be vulnerable to attacks by hackers or viruses or breached due to employee error, malfeasance, or other disruptions.  Any such breach or interruption could compromise our networks and the information stored there could be accessed by unauthorized parties, publicly disclosed, lost, or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws and regulations that protect the privacy of personal information and regulatory penalties. To the extent that we may engage in activities regulated by the Health Insurance Portability and Accountability Act (HIPAA) and the Health Information Technology for Clinical and Economic Health Act (HITECH) we may have additional regulatory and reporting obligations.  Although we believe we have implemented adequate security measures, there is no guarantee we can continue to protect our systems and data from unauthorized access, loss or dissemination that could also disrupt our operations,

 

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including our ability to conduct our analyses conduct research and development activities, collect, process, and prepare company financial information, provide information about our products and other patient and physician education and outreach efforts through our website, manage the administrative aspects of our business, and damage our reputation, any of which could adversely affect our business.

 

In addition, the interpretation and application of consumer, health-related, and data protection laws in the United States, Europe and elsewhere are often uncertain, contradictory, and in flux. It is possible that these laws may be interpreted and applied in a manner that is inconsistent with our practices. If so, this could result in government-imposed fines or orders requiring that we change our practices, which could adversely affect our business. In addition, these privacy regulations may differ from country to country, and may vary based on whether testing is performed in the United States or in the local country. Complying with these various laws could cause us to incur substantial costs or require us to change our business practices and compliance procedures in a manner adverse to our business.

 

Risks Related to Our Common Stock

 

Nasdaq may delist our common stock from its exchange which could limit your ability to make transactions in our securities and subject us to additional trading restrictions.

 

On September 21, 2016, we received notice from the Staff of Nasdaq indicating that the Staff had determined to delist our securities from The Nasdaq Capital Market due to our then continued non-compliance with the minimum bid price requirement.  We timely requested a hearing before the Panel, which occurred on November 10, 2016.  On November 11, 2016, we received notice from the Staff that we no longer satisfied Nasdaq Listing Rule 5550(b) insofar as we did not expect to report stockholders’ equity of at least $2.5 million upon the filing of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2016 and that the deficiency could serve as an additional basis for the delisting of the Company’s common stock from The Nasdaq Capital Market.  On November 21, 2016, Nasdaq informed us that the Panel had granted us continued listing on The Nasdaq Capital Market while we implement our plan to regain compliance with the minimum bid price and minimum stockholders’ equity requirements.  The Panel granted us until January 30, 2017 to evidence a closing bid price of $1.00 or more for a minimum of ten prior consecutive trading days and until March 20, 2017 to evidence compliance with the $2.5 million stockholder’s equity requirement. On December 9, 2016, we provided notice of our intention to call a special meeting of our stockholders on January 9, 2017 to, among other things, obtain stockholder approval for a reverse stock split. At a special meeting of our stockholders on January 9, 2017, our stockholders approved, among other things, a reverse stock split, and following such special meeting, our Board of Directors approved a 1-for-30 reverse split of the Company’s issued and outstanding shares of common stock.  The reverse stock split became effective as of 5:00 p.m. Eastern Time on January 12, 2017, and the Company’s common stock began trading on a split-adjusted basis on The Nasdaq Capital Market on January 13, 2017.  We received confirmation from Nasdaq on February 9, 2017 that we have regained compliance with the minimum bid price rule.

 

Despite our efforts, we cannot assure you that we will be able to meet the minimum stockholders’ equity or other listing requirements. If it appears to the Nasdaq staff that we will not meet the minimum stockholders’ equity or any other listing standard, our common stock may be subject to delisting.  If our common stock is delisted, our common stock would likely trade only in the over-the-counter market. If our common stock were to trade on the over-the-counter market, selling our common stock could be more difficult because smaller quantities of shares would likely be bought and sold and transactions could be delayed, and we could face significant material adverse consequences, including:

 

·                   a limited availability of market quotations for our securities;

·                   reduced liquidity with respect to our securities;

·                   a determination that our shares are a “penny stock,” which will require brokers trading in our securities to adhere to more stringent rules, possibly resulting in a reduced level of trading activity in the secondary trading market for our securities;

·                   a reduced amount of news and analyst coverage for our Company; and

·                   a decreased ability to issue additional securities or obtain additional financing in the future.

 

These factors could result in lower prices and larger spreads in the bid and ask prices for our common stock and would substantially impair our ability to raise additional funds and could result in a loss of institutional investor interest and fewer development opportunities for us.

 

In addition to the foregoing, if our common stock is delisted from NASDAQ and it trades on the over-the-counter market, the application of the “penny stock” rules could adversely affect the market price of our common stock and increase the transaction costs to sell those shares. The SEC has adopted regulations which generally define a “penny stock” as an equity security that has a market price of less than $5.00 per share, subject to specific exemptions. The closing price of our common stock on March 1, 2017 was $4.33.

 

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If our common stock is delisted from NASDAQ and it trades on the over-the-counter market at a price of less than $5.00 per share, our common stock would be considered a penny stock. The SEC’s penny stock rules require a broker-dealer, before a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document that provides information about penny stocks and the risks in the penny stock market. The broker-dealer must also provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and the salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer’s account. In addition, the penny stock rules generally require that before a transaction in a penny stock occurs, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s agreement to the transaction. If applicable in the future, these rules may restrict the ability of brokers-dealers to sell our common stock and may affect the ability of investors to sell their shares, until our common stock no longer is considered a penny stock.

 

The reverse split of our common stock could decrease our total market capitalization and increase the volatility of our stock price.

 

We effected 1-for-30 reverse split of our issued and outstanding shares of common stock as of 5:00 p.m. Eastern Time on January 12, 2017, and our common stock began trading on a split-adjusted basis on The Nasdaq Capital Market on January 13, 2017. There can be no assurance that the total market capitalization of our common stock after the reverse stock split will be equal to or greater than the total market capitalization before the reverse stock split or that the per share market price of our common stock following the reverse stock split will increase in proportion to the reduction in the number of shares of common stock outstanding before the reverse stock split. Furthermore, a decline in the market price of our common stock after the reverse stock split may result in a greater percentage decline than would occur in the absence of a reverse stock split, and the liquidity of our common stock could be adversely affected following such a reverse stock split.

 

The number of shares of common stock underlying our outstanding preferred stock and outstanding warrants is significant in relation to our currently outstanding common stock and could cause downward pressure on the market price for our common stock and conversion of such outstanding convertible securities will cause dilution to holders of our common stock.

 

The number of shares of common stock issuable upon conversion of our outstanding preferred stock and exercise of outstanding warrants is significant in relation to the number of shares of our common stock currently outstanding. If any security holder, including the Selling Stockholders, determines to sell a substantial number of shares into the market at any given time, there may not be sufficient demand in the market to purchase the shares without a decline in the market price for our common stock. Moreover, continuous sales into the market of a number of shares in excess of the typical trading volume for our common stock, or even the availability of such a large number of shares, could depress the trading market for our common stock over an extended period of time. Through March 1, 2017, shares of our Series C Convertible Preferred Stock have been converted into 501,000 shares of our common stock. As of March 1, 2017, 344.9 shares of our Series C Convertible Preferred Stock remain outstanding and are currently convertible into 67,627 shares of our common stock, and 900 shares of our Series D Convertible Preferred Stock remain outstanding and are convertible into 200,759 shares of our common stock.  If the effective price per share in a future offering is lower than the then price of conversion of the Series C Convertible Preferred Stock or the Series D Convertible Preferred Stock, then the price of conversion of such preferred stock shall be reduced to equal to such lower price and such preferred stock shall be issuable for additional shares of common stock in connection with such conversion price reduction.  Furthermore, each holder of our Series C Convertible Preferred Stock has the right to exchange all or some of the Series C Preferred Stock for securities issued in a future offering on a $1.00 for $1.00 basis based on the outstanding stated value of the Series C Convertible Preferred Stock, along with any accrued but unpaid liquidated damages and other amounts owing thereon, and the effective price in the offering.  With respect to our Series D Convertible Preferred Stock, on or after May 3, 2017, the conversion price on our Series D Convertible Preferred Stock shall become an adjustable rate equal to 80% of the average of the daily volume weighted average price of our common stock for the ten trading days immediately prior to the conversion date, but shall not be reduced below $1.26. To the extent the outstanding shares of Series C Convertible Preferred Stock or Series D Convertible Preferred Stock become exercisable for additional shares of common stock, holders of our common stock will experience further dilution.

 

As of March 1, 2017, we have warrants to purchase 926,884 shares of common stock outstanding.  Pursuant to a letter agreement dated February 15, 2017 with the holders of our Series C Convertible Preferred Stock and Series D Convertible Preferred Stock (the “Holders”) , who also hold certain outstanding warrants (the “Warrants” ), we agreed in consideration for the Holders exercising Warrants during the period beginning on February 15, 2017 to and including March 31, 2017 (the “ Exercise Period” ), that we would issue, promptly upon receipt of the cash exercise price, a common stock purchase warrant to the Holders (the “New Warrants” ) pursuant to Section 4(a)(2) of the Securities Act, to purchase up to a number of shares of our common stock equal to 100% of the number of shares issued pursuant to such Holder’s exercise of Warrants under the letter agreement, which New Warrants shall have a term of five years from the date of issuance and an exercise price equal to consolidated closing bid price of our common stock as quoted on The Nasdaq Capital Market on the date each New Warrant is issued. The letter agreement also (i) amends the definition of “Beneficial Ownership Limitation” in the Warrants to mean, solely for purposes of any exercises of such Warrants that occurs during the Exercise Period, “9.99%” and (ii) amends the initial exercise date of the Warrants issued on November 3, 2016 and January 11,

 

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2017 so that such Warrants are exercisable on or after the receipt of stockholder approval of such Warrants.  Since such stockholder approval was received on January 9, 2017, such Warrants became immediately exercisable on the date of the letter agreement. On February 15, 2017, following the execution of the letter agreement, the Holders exercised Warrants to purchase shares of our common stock so that, after such exercise, such holders owned, in the aggregate, 9.9% of our common stock.  We received gross proceeds of $563,863 in connection with such exercise and issued the Holders New Warrants to purchase an aggregate of 104,419 shares of our common stock with a per share exercise price of $4.99.  To the extent additional Warrants are exercised during the Exercise Period and we issue additional New Warrants, holders of our common stock will be further diluted and sales of any shares of common stock underlying such Warrants or the New Warrants could cause downward pressure on the market price for our common stock.

 

The rights of holders of our capital stock will be subject to, and could be adversely affected by, the rights of holders of our outstanding preferred stock any stock that may be issued in the future.

 

Our board of directors has authority, without further stockholder approval, to issue additional shares of preferred stock with such rights, preferences and privileges as our board may determine.  These rights, preferences and privileges may include dividend rights, conversion rights, voting rights and liquidation rights that may be greater than the rights of our common stock.

 

Our board of directors has approved, pursuant to this authority, the issuance of preferred stock, and we have 344.9 shares of Series C Convertible Preferred Stock and 900 shares of Series D Convertible Preferred Stock outstanding as of March 1, 2017.  The rights, preferences and privileges of our Series C Convertible Preferred Stock and Series D Convertible Preferred Stock are described in our Current Report on Form 8-K filed with the SEC on October 31, 2016.  As described therein, upon liquidation, dissolution or winding-up of the Company, holders of our Series C Convertible Preferred Stock and Series D Convertible Preferred Stock have the right to receive, out of the assets, whether capital or surplus, of the Company, (i) for the Series C Convertible Preferred Stock, an amount equal to the par value, plus any accrued and unpaid dividends thereon, and (ii) for the Series D Convertible Preferred Stock, an amount equal to the stated value, plus any accrued and unpaid dividends thereon and any other fees or liquidated damages then due and owing thereon, in each case, for each such share of preferred stock held by such holder before any distribution or payment shall be made to the holders of our common stock, and, following such payment, such holders are entitled to receive the same amount that a holder of common stock would receive if such preferred stock was fully converted, pari passu with all the holders of common stock. Our board of directors may issue additional series of preferred stock in the future pursuant to this authority.  As a result, the rights of holders of our capital stock will be subject to, and could be adversely affected by, the rights of holders of any stock that may be issued in the future.

 

We have a large number of authorized but unissued shares of stock, which could negatively impact a potential investor if they purchased our common stock.

 

We effected 1-for-30 reverse split of our issued and outstanding shares of common stock as of 5:00 p.m. Eastern Time on January 12, 2017, and our common stock began trading on a split-adjusted basis on The Nasdaq Capital Market on January 13, 2017.

 

Because the number of authorized shares of our common stock was not reduced proportionately, the reverse stock split increased our board of directors’ ability to issue authorized and unissued shares without further stockholder action.  As of March 1, 2017, our certificate of incorporation provides for 100,000,000 shares of authorized common stock and 40,000,000 shares of authorized preferred stock.  As of March 1, 2017, we had 1,741,745 shares of common stock outstanding and 90,651 shares of common stock reserved pursuant to outstanding convertible preferred stock, warrants, options or restricted stock units or under the Company’s equity incentive plans.

 

With respect to authorized but unissued and unreserved shares, we could also use such shares to oppose a hostile takeover attempt or delay or prevent changes in control or changes in or removal of management. The issuance of additional shares of common stock or securities convertible into common stock may have a dilutive effect on earnings per share and relative voting power and may cause a decline in the trading price of our common stock.  We could use the shares that are available for future issuance in dilutive equity financing transactions, or to oppose a hostile takeover attempt or delay or prevent changes in control or changes in or removal of management, including transactions that are favored by a majority of the stockholders or in which the stockholders might otherwise receive a premium for their shares over then-current market prices or benefit in some other manner.

 

The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell the common stock you want or at prices you find attractive.

 

The price of our common stock constantly changes. The price of our common stock could fluctuate significantly for many reasons, including the following:

 

·                   future announcements concerning us, including our clinical and product development strategy, or our competitors;

·                   regulatory developments, disclosure regarding completed, ongoing or future clinical studies and enforcement actions bearing on advertising, marketing or sales;

 

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·                   reports and recommendations of analysts and whether or not we meet the milestones and metrics set forth in such reports;

·                   introduction of new products;

·                   acquisition or loss of significant manufacturers, distributors or suppliers or an inability to obtain sufficient quantities of materials needed to manufacture our system;

·                   quarterly variations in operating results, which we have experienced in the past and expect to experience in the future;

·                   business acquisitions or divestitures;

·                   changes in governmental or third-party reimbursement practices;

·                   fluctuations of investor interest in the medical device sector; and

·                   fluctuations in the economy, world political events or general market conditions.

 

In addition, stock markets in general, and the market for shares of health care stocks in particular, have experienced extreme price and volume fluctuations in recent years, fluctuations that frequently have been unrelated to the operating performance of the affected companies. These broad market fluctuations may adversely affect the market price of our common stock. The market price of our common stock could decline below its current price and the market price of our shares may fluctuate significantly in the future. These fluctuations may be unrelated to our performance.  We expect that the market price of our common stock will continue to fluctuate.

 

Our ability to use U.S. net operating loss carryforwards or Australian tax losses might be limited.

 

As of December 31, 2016, we had U.S. net operating loss (“NOL”) carryforwards of approximately $110.6 million for U.S. income tax purposes, which expire from 2024 through 2034. To the extent these NOL carryforwards are available, we intend to use them to reduce any corporate income tax liability associated with our operations that we might have in the future. Section 382 of the U.S. Internal Revenue Code of 1986, as amended, generally imposes an annual limitation on the amount of NOL carryforwards that might be used to offset taxable income when a corporation has undergone significant changes in stock ownership. As a result, prior or future changes in ownership, including due to this offering, could put limitations on the availability of our NOL carryforwards. In addition, our ability to utilize the current NOL carryforwards might be further limited by future issuances of our common stock.

 

As of December 31, 2016, we had tax losses in the Commonwealth of Australia of approximately AU$49.0 million. Continuing utilization of carryforward tax losses in Australia may also be affected by the issuance of our common stock. This is because one test for carrying forward tax losses in Australia from year to year requires continuity of ultimate ownership (subject to the relevant tests in Australian tax law) of more than 50% between the loss year and the income year in which the loss is claimed.

 

To the extent use of our NOL carryforwards or tax losses is limited, our income could be subject to corporate income tax earlier than it would if we were able to use NOL carryforwards and tax losses, which could result in lower profits.

 

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 common stock, 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 stockholders will not realize a return on their investments unless the trading price of our common stock appreciates.

 

We will continue to incur increased costs as a result of being a U.S. reporting company.

 

In connection with the effectiveness of our registration statement on Form 10, as of February 14, 2012, we became subject to the periodic reporting requirements of the Exchange Act. Although we were previously listed on the Australian Securities Exchange and had been required to file financial information and make certain other filings with the Australian Securities Exchange, our status as a U.S. reporting company under the Exchange Act has caused us, and will continue to cause us, to incur additional legal, accounting and other expenses that we did not previously incur, including costs related to compliance with the requirements of SOX and the listing requirements of The Nasdaq Capital Market. We expect these rules and regulations will continue to increase our legal and financial compliance costs and make some activities more time-consuming and costly, and these activities may increase general and administrative expenses and divert management’s time and attention away from revenue-generating activities. Furthermore, now that we are a revenue-generating company following the acquisition of the Aquadex Business in August 2016, our costs to comply with regulations applicable to U.S. reporting companies may further increase.  We also expect 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 of directors or as executive officers.

 

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Investors could lose confidence in our financial reports, and the value of our 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 material weaknesses in those controls.

 

In connection with becoming a company required to file reports with the SEC, we are required to comply with the internal control evaluation and certification requirements of Section 404 of SOX. Our independent registered public accounting firm will not be required to formally attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of SOX until the date we are no longer an “emerging growth company” as defined in the JOBS Act or a “smaller reporting company” as defined by applicable SEC rules.  We will no longer qualify as an “emerging growth company” on or before December 31, 2017, although we will remain a “smaller reporting company” as long as our public float remains less than $75 million as of the last business day of our most recently-completed second fiscal quarter.

 

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. It may be more difficult for us to manage our internal control over financial reporting following our acquisition of the Aquadex Business now that we are a revenue generating company. Investors could lose confidence in our financial reports, and the value of our common stock may be harmed, 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 material weaknesses in those controls.

 

Our certificate of incorporation designates the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain litigation that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with the Company.

 

Our certificate of incorporation provides that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers or other employees to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, as amended (the “DGCL”), or (iv) any other action asserting a claim governed by the internal affairs doctrine. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock shall be deemed to have notice of and to have consented to the provisions described above. This forum selection provision may limit our stockholders’ ability to obtain a judicial forum that they find favorable for disputes with us or our directors, officers or other employees.

 

Our certificate of incorporation and bylaws, as well as certain provisions of the DGCL, may delay or deter a change in control transaction.

 

Certain provisions of our certificate of incorporation and bylaws may have the effect of deterring takeovers, such as those provisions authorizing our board of directors to issue, from time to time, any series of preferred stock and fix the designation, powers, preferences and rights of the shares of such series of preferred stock; prohibiting stockholders from acting by written consent in lieu of a meeting; requiring advance notice of stockholder intention to put forth director nominees or bring up other business at a stockholders’ meeting; prohibiting stockholders from calling a special meeting of stockholders; requiring a 66 2/3% majority stockholder approval in order for stockholders to amend certain provisions of our certificate of incorporation or bylaws or adopt new bylaws; providing that, subject to the rights of preferred shares, the directors will be divided into three classes and the number of directors is to be fixed exclusively by our board of directors; and providing that none of our directors may be removed without cause. Section 203 of the DGCL, from which we did not elect to opt out, provides that if a holder acquires 15% or more of our stock without prior approval of our board of directors, that holder will be subject to certain restrictions on its ability to acquire us within three years. These provisions may delay or deter a change in control of us, and could limit the price that investors might be willing to pay in the future for shares of our common stock.

 

We are an “emerging growth company” under federal securities laws and we cannot be certain if the reduced reporting requirements applicable to emerging growth companies will make our common stock 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 not being required to comply with the external auditor attestation requirements of Section 404

 

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of SOX, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a non-binding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. The JOBS Act also permits emerging growth companies to take advantage of an extended transition period to comply with new or revised accounting standards applicable to U.S. public companies. We will be an emerging growth company until December 31, 2017. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may decline or be more volatile.

 

As explained above, Section 102(b)(1) of the JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act, for complying with new or revised accounting standards. An emerging growth company can delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards would otherwise apply to private companies. We have elected to take advantage of the benefits of this extended transition period, and as a result of this election, our financial statements may not be comparable to those of companies that comply with public company effective dates for new or revised accounting standards for U.S. public companies. We will be an emerging growth company until December 31, 2017 and after such date can no longer take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act.

 

Item 1B.                                                 Unresolved Staff Comments.

 

Not applicable.

 

Item 2.                                                          Properties.

 

We lease a 23,000 square foot facility located in Eden Prairie, Minnesota. The lease period commenced December 1, 2011 and extends through March 31, 2019. This facility serves as our corporate headquarters and houses substantially all of our functional areas. Monthly rent and common area maintenance charges for our headquarters total approximately $23,000.  The lease contains provisions for annual inflationary adjustments.

 

We believe that our current facilities are suitable and adequate to meet our current needs, and that suitable additional or substitute space will be available as needed to accommodate expansion of our operations.

 

Item 3.                                                          Legal Proceedings.

 

We are not currently subject to any material pending legal proceedings.

 

Item 4.                                                          Mine Safety Disclosures.

 

Not applicable.

 

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PART II

 

Item 5.                                                          Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Market Information.   Commencing February 16, 2012, our shares of common stock began trading on NASDAQ under the symbol “SSH.”  See “Risk Factors—Risks Related to Our Common Stock—Nasdaq may delist our common stock from its exchange which could limit your ability to make transactions in our securities and subject us to additional trading restrictions” under Part I, Item 1A of this Annual Report on Form 10-K.

 

The following table sets forth, for the periods indicated, the high and low closing prices for our common stock as reported on NASDAQ in U.S. Dollars. Effective January 13, 2017, we effected a 1-for-30 reverse split of our issued and outstanding shares of common stock.  All share and per share amounts presented below have been retroactively adjusted to reflect the reverse stock split for all periods presented.

 

 

 

High

 

Low

 

2015

 

 

 

 

 

First Quarter

 

$

207.0207

 

$

114.0114

 

Second Quarter

 

$

148.8149

 

$

96.6097

 

Third Quarter

 

$

107.0777

 

$

59.706

 

Fourth Quarter

 

$

81.9082

 

$

31.8032

 

2016

 

 

 

 

 

First Quarter

 

$

41.4041

 

$

16.8017

 

Second Quarter

 

$

29.2139

 

$

12.0012

 

Third Quarter

 

$

48.6049

 

$

13.2013

 

Fourth Quarter

 

$

28.8029

 

$

4.5005

 

2017

 

 

 

 

 

First Quarter (through March 1, 2017

 

$

12.0012

 

$

4.25

 

 

Stockholders of Record.   As of March 1, 2017, we had 1,741,745 shares of common stock issued and outstanding, and there were 226 holders of record of our common stock.

 

Dividends.   We have not historically paid cash dividends on our capital stock.  We intend to retain our future earnings, if any, to finance the expansion and growth of our business, and we do not expect to pay cash dividends on our common stock in the foreseeable future.  Payment of future cash dividends, if any, will be at the sole discretion of our board of directors after taking into account various factors, including our financial condition, earnings, capital requirements of our operating subsidiaries, covenants associated with any debt obligations, legal requirements, regulatory constraints and other factors deemed relevant by our board of directors. Moreover, if we determine to pay any dividends in the future, there can be no assurance that we will continue to pay such dividends.

 

Item 6.                                                          Selected Financial Data.

 

Not applicable.

 

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 together with our audited financial statements and related notes which are included elsewhere in this Annual Report on Form 10-K. Our actual results could differ materially from those anticipated in the forward-looking statements included in this discussion as a result of certain factors, including, but not limited to, those discussed in “Risk Factors” included elsewhere in this Annual Report on Form 10-K.

 

Overview

 

We are an early-stage medical device company focused on commercializing the Aquadex FlexFlow® System.  Our commercial product, the Aquadex FlexFlow® System is indicated for temporary (up to eight hours) ultrafiltration treatment of patients with fluid overload who have failed diuretic therapy, and extended (longer than 8 hours) ultrafiltration treatment of patients with fluid overload who have failed diuretic therapy and require hospitalization.

 

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Prior to July 2016, we were focused on developing the C-Pulse® Heart Assist System for treatment of Class III and ambulatory Class IV heart failure. The C-Pulse System utilized the known concept of counterpulsation applied to the aorta.  In March 2016, we announced that we were no longer enrolling patients into our two clinical studies for the C-Pulse System and that we planned to pursue a new strategic direction. In July 2016, we announced that we were moving forward with a therapeutic strategy utilizing neuromodulation rather than counterpulsation.

 

In August 2016, we acquired the Aquadex Business from a subsidiary of Baxter International, Inc. ( “Baxter” ), a global leader in the hospital products and dialysis markets.

 

On September 29, 2016, we announced a strategic refocus of our near-term strategy that includes halting clinical evaluations of our neuromodulation technology to fully focus our resources on our recently acquired Aquadex Business, taking actions to reduce our cash burn in connection with such strategic refocus, and reviewing potential strategic alliances and financing alternatives.

 

Recent Developments

 

Nasdaq Compliance

 

On September 21, 2016, we received notice from the Listing Qualifications Staff (the “Staff”) of The Nasdaq Stock Market LLC (“Nasdaq”) indicating that the Staff had determined to delist our securities from The Nasdaq Capital Market due to our then continued non-compliance with the minimum bid price requirement.  We timely requested a hearing before the Nasdaq Hearings Panel (the “Panel”), which occurred on November 10, 2016.  On November 11, 2016, we received notice from the Staff that we no longer satisfied Nasdaq Listing Rule 5550(b) insofar as we did not expect to report stockholders’ equity of at least $2.5 million upon the filing of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2016 and that the deficiency could serve as an additional basis for the delisting of the Company’s common stock from The Nasdaq Capital Market.  On November 21, 2016, Nasdaq informed us that the Panel had granted us continued listing on The Nasdaq Capital Market while we implement our plan to regain compliance with the minimum bid price and minimum stockholders’ equity requirements.  The Panel granted us until January 30, 2017 to evidence a closing bid price of $1.00 or more for a minimum of ten prior consecutive trading days. After implementing the reverse stock split described below, we received confirmation from Nasdaq on February 9, 2017 that we have regained compliance with the minimum bid price rule.  The Panel granted us until March 20, 2017 to evidence compliance with the $2.5 million stockholder’s equity requirement. If it appears to the Nasdaq staff that we will not be able to meet the minimum stockholders’ equity or any other listing standard, our common stock may be subject to delisting.

 

Reverse Stock Split

 

At a special meeting of our stockholders on January 9, 2017, our stockholders approved, among other things, a reverse stock split, and following such special meeting, our Board of Directors approved a 1-for-30 reverse split of our issued and outstanding shares of common stock.  The reverse stock split was effective as of 5:00 p.m. Eastern Time on January 12, 2017, and our common stock began trading on a split-adjusted basis on The Nasdaq Capital Market on January 13, 2017.  The reverse stock split did not change the par value of our stock or the authorized number of common or preferred shares.  All share and per share amounts in this Annual Report on Form 10-K for the year ended December 31, 2016, including the financial statements and notes thereto included in Item 8 hereof, have been retroactively adjusted to reflect the reverse stock split for all periods presented.

 

Warrant Exercise Agreement

 

On February 15, 2017, we entered into a letter agreement with the institutional investors (“the Investors”) that hold the majority of our outstanding warrants, to incent the cash exercise of these warrants on or before March 31, 2017 (the “Exercise Period”). These warrants, if exercised in full, would yield gross proceeds of approximately $4.65 million to the Company.  In exchange for any such exercise, we agreed to provide the Investors a replacement warrant (the “Replacement Warrants”) to purchase the same number of shares of common stock as were issued upon exercise of the exercised warrants, with an exercise price equal to the consolidated closing bid price of our common stock on the date of issuance. The agreement also (i) amends the definition of “Beneficial Ownership Limitation” in the existing warrants to mean, solely for purposes of any exercises of warrants that occur during the Exercise Period, “9.99%” and (ii) amends the Initial Exercise Date of the existing warrants issued on November 3, 2016 and January 11, 2017 so that such warrants are exercisable on or after the receipt of stockholder approval.  Since such stockholder approval was received on January 9, 2017, such warrants were immediately exercisable as of the date of the agreement. The Replacement Warrants will be in the same form as the exercised warrants except the exercise price will not be subject to reduction for subsequent equity and (ii) the Replacement Warrants will not allow the Investor to demand that we purchase the Replacement Warrants in the event of a fundamental transaction involving the Company. Concurrent with the signing of the agreement, the Investors exercised warrants to purchase 104,419 shares of common stock for cash proceeds of approximately $564,000, and we issued such Investors Replacement Warrants to purchase 104,419 shares of common stock.

 

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Critical Accounting Policies and Estimates

 

We have adopted various accounting policies to prepare the condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States. (U.S. GAAP).   The preparation of the condensed consolidated financial statements, in conformity with U.S. GAAP, requires us to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Our estimates and assumptions, including those related to stock-based compensation, valuation of equity and debt securities, and income tax reserves are updated as appropriate, which in most cases is quarterly. We base our estimates on historical experience, valuations, or various assumptions that are believed to be reasonable under the circumstances.

 

Revenue Recognition

 

We recognize revenue from product sales when earned. Specifically, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectability is reasonably assured. Revenue is not recognized until title and risk of loss have transferred to the customer. The shipping terms for our revenue arrangements are FOB shipping point.

 

Accounts Receivable

 

Our accounts receivable have terms that require payment in 30 days.  We did not establish an allowance for doubtful accounts at December 31, 2016 as we have not experienced any write offs or a deterioration in the aging of our receivables to date and do not expect to experience in the future.

 

Inventories

 

Inventories represent primarily finished goods purchased from our supplier and are recorded as the lower of cost or market using the first-in-first out method.

 

Intangible assets

 

Our intangible assets as of December 31, 2016 consist of $3.1 million for customer relationships, $1.1 million for developed technology, and $0.4 million for trademarks and tradenames. All intangible assets are estimated to have a useful life of 5-7 years.  We review our definite-lived intangible assets for impairment when impairment indicators exist.  When impairment indicators exist, we determine if the carrying value of the intangible assets exceeds the related undiscounted cash flows.  In cases where the carrying value exceeds the undiscounted cash flows, the carrying value is written down to its fair value, generally using a discounted cash flow analysis.  No impairments have been identified or recorded in the periods presented.

 

Goodwill

 

Goodwill is the cost of an acquisition in excess of the fair value of acquired assets and liabilities and is recorded as an asset on our balance sheet. Goodwill is not subject to amortization but must be tested for impairment at least annually. This test requires us to assign goodwill to an appropriate reporting unit and to determine if the implied fair value of the reporting unit’s goodwill is less than its carrying amount.

 

We evaluate goodwill for impairment annually on November 1 st  of each calendar year, or to the extent events or conditions indicate a risk of possible impairment during the interim periods prior to our annual impairment test. Generally, the evaluation of goodwill for impairment involves a two-step test, although under certain circumstance an initial qualitative evaluation may be sufficient to conclude that goodwill is not impaired without conducting the quantitative test.

 

Step 1 involves comparing the estimated fair value of each respective reporting unit to its carrying value, including goodwill. If the estimated fair value exceeds the carrying value, the reporting unit’s goodwill is not considered impaired. If the carrying value exceeds the estimated fair value, step 2 must be performed to determine whether goodwill is impaired and, if so, the amount of the impairment. Step 2 involves calculating an implied fair value of goodwill by performing a hypothetical allocation of the estimated fair value of the reporting unit determined in step 1 to the respective tangible and intangible net assets of the reporting unit. The remaining implied goodwill is then compared to the actual carrying amount of the goodwill for the reporting unit. To the extent the carrying amount of goodwill exceeds the implied goodwill, the difference is the amount of the goodwill impairment.  No impairments have been identified or recorded in the periods presented.

 

Contingent consideration

 

In connection with our purchase of the Aquadex Business, we have an obligation to pay additional consideration that is contingent upon the occurrence of certain future events.  Contingent consideration is recognized at the acquisition date at the estimated fair value of the contingent milestone payments.  The fair value of the contingent consideration is remeasured to its estimated fair value at the end of each reporting period, with changes recorded to earnings.

 

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Common stock warrant liability

 

We record common stock warrant liability at fair value at the date of issuance using primarily a Monte Carlo valuation model.  The fair value is remeasured to its estimated fair value at the end of each reporting period with changes recorded to earnings.

 

Stock-Based Compensation

 

We recognize all share-based payments to employees and directors, including grants of stock options, restricted stock units (RSUs), warrants and common stock awards in the income statement as an operating expense based on their fair values over the requisite service period.

 

We compute the estimated fair values of stock options and warrants using the Black-Scholes option pricing model. Market price at the date of grant is used to calculate the fair value of restricted stock units and common stock awards.

 

Stock-based compensation expense is based on awards ultimately expected to vest and is reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

 

Equity instruments issued to non-employees include RSUs, warrants or options to purchase shares of our common stock. These RSUs, warrants or options are either fully-vested and exercisable at the date of grant or vest over a certain period during which services are provided. We expense the fair market value of fully vested awards at the time of grant, and of unvested awards over the period in which the related services are received. Unvested awards are remeasured to fair value until they vest.

 

Earnings per share

 

We compute basic earnings per share based on the net loss allocable to common stockholders for each period divided by the weighted average number of common shares outstanding. The net loss allocable to common stockholders reflects an increase for net deemed dividends of $1.9 million to preferred shareholders provided in connection with the 2016 Series B and B-1 convertible preferred stock offering.  Diluted earnings per share is computed based on the net loss allocable to common stockholders for each period divided by the weighted average number of common shares outstanding, increased by the number of additional shares that would have been outstanding had the potentially dilutive common shares been issued, and reduced by the number of shares the Company could have repurchased from the proceeds from issuance of the potentially dilutive shares. Potentially dilutive shares of common stock include warrants, stock options and other stock-based awards granted under stock-based compensation plans. These potentially dilutive shares were excluded from the computation of loss per share as their effect was antidilutive due to our net loss in each of those periods.

 

Going Concern

 

Our financial statements have been prepared and presented on a basis assuming we continue as a going concern. During the years ended December 31, 2016 and 2015, we incurred losses from operations and net cash outflows from operating activities as disclosed in the consolidated statements of operations and cash flows, respectively.

 

We became a revenue generating company only a few months ago after acquiring the Aquadex Business in August 2016.  We expect to incur additional losses in the near-term as we grow the Aquadex Business, including investments in expanding our sales and marketing capabilities, purchasing inventory, manufacturing components, and complying with the requirements related to being a U.S. public company.  To become and remain profitable, we must succeed in expanding the adoption and market acceptance of the Aquadex FlexFlow. This will require us to succeed in training personnel at hospitals and effectively and efficiently manufacturing, marketing and distributing the Aquadex FlexFlow and related components. There can be no assurance that we will succeed in these activities, and we may never generate revenues sufficient to achieve profitability.

 

We expect to require additional funding to grow our Aquadex Business in 2017, which may not be available on terms favorable to us, or at all. In addition, the risk that we may not be able to continue as a going concern may make it more difficult to obtain necessary additional funding on terms favorable to us, or at all. Our directors, after due consideration, believe that we will be able to raise new capital as required to fund our business plan. Should future capital raising be unsuccessful, we may not be able to continue as a going concern. Furthermore, our ability to continue as a going concern is subject to our ability to develop and successfully commercialize the product being developed. If we are unable to obtain such funding of an amount and timing necessary to meet our future operational plans, or to successfully commercialize our intellectual property, we may be unable to continue as a going concern. No adjustments have been made relating to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should we not continue as a going concern.

 

Accounting Standards Applicable to Emerging Growth Companies

 

We qualify as an “emerging growth company” pursuant to the provisions of the JOBS Act, enacted on April 5, 2012. Section 102(b)(1) of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. An emerging growth company can delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards would otherwise apply to private companies. We have elected to take advantage of the benefits of this extended

 

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transition period, and as a result of this election, our financial statements may not be comparable to those of companies that comply with public company effective dates for new or revised accounting standards for U.S. public companies.

 

Internal Controls and Procedures

 

Our independent registered public accounting firm is not yet required to formally attest to the effectiveness of our internal control over financial reporting, and will not be required to do so for as long as we are an “emerging growth company” pursuant to the provisions of the JOBS Act.  However, management is subject to Section 404(a) of the Sarbanes-Oxley Act of 2002 and is required to report annually on effectiveness of our internal control over financial reporting.

 

Recent Accounting Pronouncements

 

In April 2015, the Financial Accounting Standards Board (FASB) issued amended guidance concerning debt issuance costs in relation to a recognized debt liability to require it be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This guidance was effective for the Company’s interim and annual reporting periods beginning January 1, 2016.  In connection with the adoption of this standard, we reclassified $120,000 of debt issuance costs that were previously reported as current assets and other assets on the December 31, 2015 balance sheet, to an offset to current and long-term debt.

 

In May 2014, August 2015, March 2016, April 2016 and May 2016, the FASB issued amended revenue recognition guidance to clarify the principles for recognizing revenue from contracts with customers. The guidance requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. The guidance also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract.   The standard allows the Company to transition to the new model using either a full or modified retrospective approach, and early adoption is not permitted. This guidance will be effective for the Company’s interim and annual periods beginning January 1, 2018. We are currently evaluating the impact that this standard will have on our business practices, financial condition, results of operations and disclosures.

 

In August 2014, the FASB amended guidance relating to the presentation and disclosure of the uncertainties of an entity’s ability to continue as a going concern.  This guidance explicitly requires management of a company to evaluate whether there is substantial doubt about a company’s ability to continue as a going concern and to provide related footnote disclosure in certain circumstances. This guidance was effective for our annual reporting period ending on December 31, 2016, and annual and interim periods thereafter. The adoption of this standard did not have a material impact on our going concern evaluations or disclosures.

 

In November 2015, the FASB issued amended guidance concerning the classification of deferred taxes on the balance sheet to require that deferred tax assets and deferred tax liabilities be presented as noncurrent in a classified balance sheet. The amendment is effective for our annual and interim reporting periods beginning January 1, 2017, with early adoption permitted. The adoption of this standard will not have an impact on our consolidated financial statements as all deferred tax assets are fully reserved.

 

In February 2016, the FASB issued updated guidance to improve financial reporting about leasing transactions. This guidance will require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. This guidance is effective for the Company’s annual reporting period beginning January 1, 2020, and for interim periods beginning January 1, 2021.  We are evaluating the impact that the adoption of this standard will have, if any, on our financial statements and disclosures.

 

Financial Overview

 

Until August 2016, our activities had consisted principally of raising capital, performing research and development and conducting pre-clinical and clinical studies. In August 2016, we acquired our commercial product line, the Aquadex FlexFlow, and transitioned our activities to commercializing the Aquadex FlexFlow. At December 31, 2016, we had an accumulated deficit of $169.0 million and we expect to incur losses for the near future while we continue to ramp up sales of the Aquadex Business. To date, we have been funded primarily by various equity and debt financings. Although we believe that we will be able to successfully fund our operations, there can be no assurance that we will be able to do so or that we will ever operate profitably.

 

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Results of Operations

 

Net Sales

(dollars in thousands)

 

Year Ended
December 31, 2016

 

Year Ended
December 31, 2015

 

Increase (Decrease)

 

% Change

 

$

1,289

 

$

59

 

$

1,230

 

N/A

%

 

On August 5, 2016, we completed the acquisition of the Aquadex Business from Baxter. The Aquadex Business generated revenues of $1.23 million from the date of acquisition through December 31, 2016.  Revenue is generated mainly from the sale of disposable blood filters and catheters used in conjunction with our Aquadex consoles. We estimate that there are over 500 installed Aquadex consoles around the United States. We had no commercial sales prior to the acquisition of the Aquadex Business.

 

On March 3, 2016, we announced that we were no longer enrolling patients in our two clinical studies for our now discontinued C-Pulse System. Prior to this announcement, all of our revenue was generated by sales of the C-Pulse System to hospitals and clinics in conjunction with our U.S. clinical study.  The C-Pulse System was not approved for commercial sale, however, the FDA had assigned the C-Pulse System to a Category B designation, making it eligible for reimbursement at certain U.S. sites when implanted in connection with our clinical studies.  During the year ended December 31, 2016, we received reimbursement and recognized revenue of $59,000 for one implant that was performed before the announcement that we were no longer enrolling patients in the study. Since we terminated enrollment in these clinical studies, we do not expect to generate revenue from our clinical studies in the foreseeable future.

 

On September 29, 2016, we announced a strategic refocus of our near term strategy to fully focus the Company’s resources on our recently acquired Aquadex Business. As such, we expect our Aquadex revenue to grow in the upcoming quarters as we drive increased utilization of disposable sales within our installed base.

 

Costs and Expenses

 

Our costs and expenses were as follows:

 

(dollars in thousands)

 

Year Ended
December 31, 2016

 

Year Ended
December 31, 2015

 

Increase (Decrease)

 

% Change

 

Cost of goods sold

 

$

713

 

$

 

$

713

 

N/A

 

Selling, general and administrative

 

$

8,129

 

$

8,345

 

$

(216

)

(2.6

)%

Research and development

 

$

8,109

 

$

17,672

 

$

(9,563

)

(54.1

)%

 

Cost of Goods Sold

 

In connection with the acquisition of the Aquadex Business, we entered into a manufacturing and supply agreement with Baxter. Cost of sales reflects the agreed-upon price paid to Baxter for the manufacturing of the disposables and consoles. This acquisition closed on August 5, 2016. Prior to that date, we did not have commercial sales or related product costs.

 

Selling, General and Administrative

 

The changes in selling, general and administrative expense reflect primarily the impact of our transition from a research and development stage company to a commercially focused organization. As a result, we incurred $1.1 million of incremental expenses related to the commercialization of the Aquadex FlexFlow, which we acquired from Baxter in August of 2016. In addition, during the year, we incurred $0.9 million in transaction fees (accounting, audit, valuation and legal fees) in connection with the acquisition of the Aquadex Business. These increases were offset by efficiencies achieved as a result of ongoing consolidation and streamlining activities in our administrative functions, and by lower stock-based compensation costs.

 

As we continue to ramp up our sales organization we expect that our commercial expenses will continue to increase in future quarters, and that general and administrative expenses will continue to decrease.

 

Research and Development

 

The decrease in research and development expense resulted primarily from our decision to stop enrollment in our two clinical studies for our now discontinued C-Pulse System, which was announced on March 3, 2016.  In July 2016, we announced that we were moving forward with a therapeutic strategy utilizing neuromodulation rather than counterpulsation.  Further, on September 29, 2016, we announced a strategic refocus of our near term strategy that includes halting clinical evaluations of the neuromodulation technology to fully focus the Company’s resources on our recently acquired Aquadex system. As a result, we expect that our research and development expenditures will continue to decrease in future quarters.

 

Other Income (Expense)

 

The following is a summary of other income (expense)

 

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(dollars in thousands)

 

Year Ended
December 31, 2016

 

Year Ended
December 31, 2015

 

Increase (Decrease)

 

% Change

 

Interest expense

 

$

(504

)

$

(743

)

$

(239

)

(32.2

)%

Loss on early retirement of long term debt

 

(500

)

 

500

 

N/A

 

Change in fair value of warrant liability

 

818

 

 

646

 

N/A

 

 

Interest Expense

 

We incurred interest expense in connection with our prior debt facility with Silicon Valley Bank.  On August 4, 2016, we repaid all amounts outstanding under this loan facility, totaling $5.5 million.

 

Loss on early retirement of debt

 

On August 4, 2016, we repaid all amounts outstanding under our prior term loan with Silicon Valley Bank, totaling $5.5 million. In connection with the repayment of this debt, we incurred a $0.5 million loss, including the accelerated write-off of unamortized warrants and debt issuance costs.

 

Change in fair value of warrant liability

 

In connection with financings completed on July 26, 2016 and November 3, 2016, we issued warrants that are classified as liabilities on our balance sheet as of December 31, 2016.  These warrants must be marked to market at each reporting period, with the changes in fair value recorded on our statement of operations. As of December 31, 2016 these warrants had experienced a net decrease in value of $818,000 since their issuance in July and November of 2016. There were no warrants outstanding that were classified as liabilities and required to be measured at fair value during the year ended December 31, 2015.

 

Income tax benefit, net

 

(dollars in thousands)

 

Year Ended
December 31, 2016

 

Year Ended
December 31, 2015

 

Increase (Decrease)

 

% Change

 

Income tax benefit, net

 

$

54

 

$

124

 

$

(70

)

(56.5

)%

 

Our income tax benefit for the year ended December 31, 2016 and 2015 resulted mainly from research and development tax credits in Australia.  We have substantially reduced research and development expenditures in Australia, so future research and development tax credits refunds, if any, are expected to decrease. We have not recognized any income tax benefit in our statement of operations related to our U.S. operating losses, as all tax benefits are fully reserved.

 

We generate minimal amounts of income tax expense in connection with activities incurred by our Irish subsidiary.

 

Liquidity and Capital Resources

 

Sources of Liquidity

 

We have funded our operations primarily through cash on hand and a series of equity and debt issuances.

 

On July 26, 2016, pursuant to a Securities Purchase Agreement dated July 20, 2016, we completed an equity financing with an institutional investor of shares of Series B Convertible Preferred Stock and warrants for gross cash proceeds of approximately $3.5 million in a registered direct offering and simultaneous private placement. Also, on October 30, 2016, we entered into securities purchase agreement with an institutional investor for shares of Series C Convertible Preferred Stock, Series D Convertible Preferred Stock and warrants with an aggregate purchase price of $3.8 million in a registered direct offering and simultaneous private placement. The first closing occurred on November 3, 2016, whereby we received $3.6 million in gross proceeds and issued and sold shares of Series C Convertible Preferred Stock, shares of Series D Convertible Preferred Stock and warrants. At the second closing, which was subject to receipt of shareholder approval of the transactions, we received $0.2 million in gross proceeds and issued and sold shares of Series D Convertible Preferred Stock and warrants.  Also on October 30, 2017, we entered into a securities exchange agreement with the holders of our Series B Convertible Preferred Stock pursuant to which we agreed to issue such holders shares of our Series B-1 Convertible Preferred Stock in exchange for the cancellation of all shares of Series B Convertible Preferred Stock held by such holders in reliance on an exemption from registration provided by Section 3(a)(9) of the Securities Act.

 

Subsequent to year-end, in February 2017, we entered into an agreement with the holder of the majority of our outstanding warrants to incent their exercise of warrants for cash on or before March 31, 2017 (the “Exercise Period”) . If all such warrants are exercised for cash, we will receive approximately $4.65 million in proceeds from the exercise.  In exchange for any such exercise, we agreed to provide the Investors a replacement warrant (the “Replacement Warrants”) to purchase the same number of shares of common stock as were issued upon exercise of the exercised warrants, with an exercise price equal to the consolidated closing bid price of our

 

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common stock on the date of issuance. The Replacement Warrants will be in the same form as the exercised warrants except the exercise price will not be subject to reduction for subsequent equity and (ii) the Replacement Warrants will not allow the Investor to demand that we purchase the Replacement Warrants in the event of a fundamental transaction involving the Company. Concurrent with the signing of the agreement, the Investors exercised warrants to purchase 104,419 shares of common stock for cash proceeds of approximately $564,000, and we issued such Investors Replacement Warrants to purchase 104,419 shares of common stock

 

During 2015, we entered into a loan agreement with Silicon Valley Bank for proceeds of up to $10.0 million. On August 4, 2016, we repaid all amounts outstanding under this loan facility, totaling $5.5 million, and entered into a new loan agreement with Silicon Valley Bank for proceeds of up to $5.0 million, including a $1.0 million revolving line of credit and a $4.0 million term loan. The term loan expired unused on November 30, 2016. The revolving line of credit expires on March 31, 2021. We had no borrowings outstanding under the Silicon Valley Bank facility as of December 31, 2016.

 

In 2014, we entered into a sales agreement with Cowen and Company, LLC ( “Cowen” ) , allowing Cowen to sell from time to time, shares of our common stock having an aggregate offering price of up to $40.0 million, through an “at the market” equity offering program (the “Sales Agreement” ). We pay Cowen a commission of up to 3.0% of the gross proceeds from the sale of any shares pursuant to the Sales Agreement.  In 2015, we sold 41,879 shares of common stock for net proceeds of $7.1 million after stock issuance costs of $0.2 million. There were no issuances of common stock under this facility during 2016. As of March 01, 2017, we had a total of $32.6 million available for future sales under the Sales Agreement.

 

As of December 31, 2016 and 2015, cash and cash equivalents were $1.3 million and $23.1 million, respectively. Prior to our acquisition of the Aquadex FlexFlow in August 2016, we did not have a product approved for commercial sale and focused our resources on developing, manufacturing and commercializing our C-Pulse System.  In September 2016, we announced a strategic refocus of our near-term strategy that includes halting all clinical evaluations to fully focus our resources on our recently acquired Aquadex Business, taking actions to reduce our cash burn in connection with such strategic refocus and reviewing potential strategic alliances and financing alternatives.  Our business strategy and ability to fund our operations in the future depends in part on our ability to grow our Aquadex Business by establishing a sales force, selling our products to hospitals and other healthcare facilities and controlling costs. We believe that our cash on hand and proceeds from the warrant exercises will fund our operations until mid-2017, and expect to seek additional financing during 2017.

 

The sale of additional equity, debt, or convertible debt securities and the conversion or exercise of our outstanding convertible securities may result in dilution to our stockholders.  If we raise additional funds through the issuance of debt, convertible debt or enter into credit facilities, these securities and debt holders could have rights senior to those of our common stock, and this debt could contain covenants that would restrict our operations and would require us to use cash for debt service rather than our operations.  We may require additional capital beyond our currently forecasted amounts.  Although we have successfully financed our operations through equity and debt financings to date, any such required additional capital may not be available to us on acceptable terms, or at all.

 

Cash Flows from Operating Activities

 

Net cash used in operating activities was $16.3 million and $23.0 million in 2016 and 2015, respectively. The net cash used in each of these periods primarily reflects the net loss for those periods, offset in part by stock-based compensation, depreciation and amortization expense, amortization of debt discount and financing fees, loss on retirement of long-term debt, and the effects of changes in operating assets and liabilities.

 

Cash Flows from Investing Activities

 

Net cash used in investing activities was $4.1 million and $0.2 million in 2016 and 2015, respectively. In 2016, we paid $4.0 million for the acquisition of the Aquadex Business. Other uses of cash relate to the purchase of laboratory and office equipment.

 

Cash Flows from Financing Activities

 

Net cash (used in) provided by financing activities was $(1.4) million and $15.1 million in 2016 and 2015, respectively. Net cash used during 2016 is attributable to repayments of the principal amounts outstanding on our debt facility with Silicon Valley Bank, offset by net proceeds from the issuance of preferred stock in July and November of 2016. Net cash provided by financing activities in 2015 was attributable to debt borrowings and proceeds from sales of our common stock.

 

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Contractual Obligations and Commitments

 

The following table summarizes our contractual obligations as of December 31, 2016, which represent material expected or contractually committed future obligations:

 

 

 

Payments Due by Period

 

(Dollars in thousands)

 

Less than 1 year

 

1-3 years

 

3-5 years

 

More than 5 years

 

Total

 

Operating Leases

 

$

207,689

 

$

253,415

 

$

 

$

 

$

461,104

 

Total

 

$

207,689

 

$

253,415

 

$

 

$

 

$

461,104

 

 

We lease a 23,000 square foot facility located in Eden Prairie, Minnesota. The lease period commenced December 1, 2011 and extends through March 31, 2019. This facility serves as our corporate headquarters and houses substantially all of our functional areas. Monthly rent and common area maintenance charges for our headquarters total approximately $23,000.  The lease contains provisions for annual inflationary adjustments.  Rent expense is being recorded on a straight line basis over the term of the lease.

 

We lease office equipment under non-cancelable operating leases that expire at various times through February 2019.

 

Capital Resource Requirements

 

As of December 31, 2015, we did not have any material commitments for capital expenditures.

 

Off-Balance Sheet Arrangements

 

In April 2015, we amended our lease agreement for our office space leased in Eden Prairie, Minnesota, to extend it for an additional thirty-six months beyond its original expiration date. This amended lease agreement expires March 31, 2019.

 

On August 5, 2016, we entered into an asset purchase agreement for the Aquadex Business with Baxter, whereby we agreed that if we dispose of any of the acquired assets for a price that exceeds $4.0 million within three years of the closing, we will pay Baxter 40% of the amount of such excess; and if shares of our common stock cease to be publicly traded on the Nasdaq Capital Market, Baxter has the option to require us to repurchase, in cash, all or any part of the common shares held by Baxter at a price equal to their fair market value, as determined by a third-party appraiser.

 

In connection with the acquisition of the Aquadex Business, we entered into a manufacturing and supply agreement with Baxter that will expire within a period not to exceed 18 months from the close of the transaction. Upon termination of this agreement, we have an obligation to purchase from Baxter the remaining Aquadex inventory. We estimate that this inventory will consist mainly of raw materials priced at cost, and that this amount will not exceed $2.5 million.

 

Except as disclosed above, w e have no off-balance sheet transactions, arrangements, obligations (including contingent obligations), or other relationships with unconsolidated entities or other persons that have, or may have, a material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources

 

Item 7A.                                                 Quantitative and Qualitative Disclosures About Market Risk.

 

Not Applicable

 

Item 8.                                                          Financial Statements and Supplementary Data.

 

Report of Independent Registered Public Accounting Firm

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Shareholders

Sunshine Heart, Inc. and Subsidiaries

 

We have audited the accompanying consolidated balance sheets of Sunshine Heart, Inc. and Subsidiaries (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of operations and comprehensive loss, shareholders’ equity, and cash flows for the years then ended. 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 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 Sunshine Heart, Inc. and Subsidiaries at December 31, 2016 and 2015, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

 

The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern.  As discussed in Note 1 of the consolidated financial statements, the Company has recurring losses from operations and an accumulated deficit that 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 contain any adjustments that might result from the outcome of this uncertainty.

 

/s/ Ernst & Young LLP

Minneapolis, Minnesota

March 8, 2017

 

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Table of Contents

 

SUNSHINE HEART, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

 

(In thousands, except share and per share amounts)

 

December 31,
2016

 

December 31,
2015

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and cash equivalents

 

$

1,323

 

$

23,113

 

Accounts receivable

 

282

 

 

Inventory

 

677

 

 

Other current assets

 

137

 

479

 

Total current assets

 

2,419

 

23,592

 

Property, plant and equipment, net

 

540

 

535

 

Intangible assets, net

 

4,302

 

 

Goodwill

 

189

 

 

Other assets

 

21

 

323

 

TOTAL ASSETS

 

$

7,471

 

$

24,450

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities

 

 

 

 

 

Current portion of long-term debt

 

$

 

$

3,798

 

Accounts payable and accrued expenses

 

2,351

 

2,832

 

Accrued compensation

 

909

 

1,368

 

Total current liabilities

 

3,260

 

7,998

 

Long-term debt, net of discount and financing fees

 

 

3,881

 

Common stock warrant liability

 

1,843

 

 

Other liabilities

 

126

 

400

 

Total liabilities

 

5,229

 

12,279

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

Temporary Stockholders’ Equity

 

 

 

 

 

Series D convertible preferred stock as of December 31, 2016 and December 31, 2015, par value $0.0001 per share; authorized 900 and 0 shares, respectively, issued and outstanding 700 and 0, respectively

 

485

 

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

Series A junior participating preferred stock as of December 31, 2016 and December 31, 2015, par value $0.0001 per share; authorized 30,000 shares, none outstanding

 

 

 

Series B-1 convertible preferred stock as of December 31, 2016 and December 31, 2015, par value $0.0001 per share; authorized 1,824.4 and 0 shares, respectively, issued and outstanding 1,824.4 and 0, respectively

 

 

 

Series C convertible preferred stock as of December 31, 2016 and December 31, 2015, par value $0.0001 per share; authorized 2,900 and 0 shares, respectively, issued and outstanding 2,900 and 0, respectively

 

 

 

Preferred stock as of December 31, 2016 and December 31, 2015, par value $0.0001 per share; authorized 39,964,375.6 and 39,970,000 shares, respectively, none outstanding

 

 

 

Common stock as of December 31, 2016 and December 31, 2015, par value $0.0001 per share; authorized 100,000,000 shares, issued and outstanding 777,238 and 611,483, respectively

 

 

 

Additional paid-in capital

 

169,496

 

164,107

 

Accumulated other comprehensive income:

 

 

 

 

 

Foreign currency translation adjustment

 

1,235

 

1,246

 

Accumulated deficit

 

(168,974

)

(153,182

)

Total stockholders’ equity

 

1,757

 

12,171

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

7,471

 

$

24,450

 

 

See notes to the consolidated financial statements

 

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SUNSHINE HEART, INC. AND SUBSIDIARIES

 

Consolidated Statements of Operations and Comprehensive Loss

(In thousands, except per share amounts)

 

 

 

Year Ended
December 31,

 

 

 

2016

 

2015

 

Net sales

 

$

1,289

 

$

59

 

Costs and Expenses:

 

 

 

 

 

Cost of goods sold

 

713

 

 

Selling, general and administrative

 

8,129

 

8,345

 

Research and development

 

8,109

 

17,672

 

Total costs and expenses

 

16,951

 

26,017

 

Loss from operations

 

(15,662

)

(25,958

)

Other income (expense):

 

 

 

 

 

Interest expense

 

(504

)

(743

)

Loss on early retirement of long-term debt

 

(500

)

 

Other income (expense), net

 

2

 

(6

)

Change in fair value of warrant liability

 

818

 

 

Total other income (expense)

 

(184

)

(749

)

Loss before income taxes

 

(15,846

)

(26,707

)

Income tax benefit, net

 

54

 

124

 

Net loss

 

$

(15,792

)

$

(26,583

)

 

 

 

 

 

 

Basic and diluted loss per share

 

$

(27.06

)

$

(44.01

)

 

 

 

 

 

 

Weighted average shares outstanding — basic and diluted

 

654

 

604

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

Foreign currency translation adjustments

 

$

(11

)

$

(26

)

Total comprehensive loss

 

$

(15,803

)

$

(26,609

)

 

See notes to the consolidated financial statements

 

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SUNSHINE HEART, INC. AND SUBSIDIARIES

 

Consolidated Statements of Stockholders’ Equity

(In thousands, except share amounts)

 

In thousands

 

Outstanding
Shares

 

Common
Stock

 

Additional
Paid in
Capital

 

Accumulated
Other
Comprehensive
Income

 

Accumulated
Deficit

 

Stockholders’
Equity

 

Balance December 31, 2014

 

566,088

 

$

 

$

154,542

 

$

1,272

 

$

(126,599

)

$

29,215

 

Net loss

 

 

 

 

 

(26,583

)

(26,583

)

Foreign currency translation adjustment

 

 

 

 

(26

)

 

(26

)

Stock based compensation, net

 

3,516

 

 

2,510

 

 

 

2,510

 

Issuance of common stock, net

 

41,879

 

 

7,055

 

 

 

7,055

 

Balance December 31, 2015

 

611,483

 

$

 

$

164,107

 

$

1,246

 

$

(153,182

)

$

12,171

 

Net loss

 

 

 

 

 

(15,792

)

(15,792

)

Foreign currency translation adjustment

 

 

 

 

(11

)

 

(11

)

Stock based compensation, net

 

9,448

 

 

949

 

 

 

949

 

Issuance of preferred stock, net

 

 

 

4,440

 

 

 

4,440

 

Issuance of common stock for acquisition

 

33,334

 

 

 

 

 

 

Conversion of preferred stock into common stock

 

122,973

 

 

 

 

 

 

Balance December 31, 2016

 

777,238

 

$

 

$

169, 496

 

$

1,235

 

$

(168,974

)

$

1,757

 

 

See notes to the consolidated financial statements

 

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SUNSHINE HEART, INC. AND SUBSIDIARIES

 

Consolidated Statements of Cash Flow s

(In thousands)

 

 

 

For the years ended December 31,

 

In thousands

 

2016

 

2015

 

Operating Activities

 

 

 

 

 

Net loss

 

$

(15,792

)

$

(26,583

)

Adjustments to reconcile net loss to cash flows from operating activities:

 

 

 

 

 

Depreciation and amortization

 

697

 

325

 

Stock based compensation expense, net

 

949

 

2,154

 

Amortization of debt discount and financing fees

 

187

 

263

 

Loss on retirement of long-term debt

 

500

 

 

Change in fair value of warrant liability

 

(818

)

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(282

)

59

 

Inventory

 

(677

)

 

Other current assets

 

342

 

(181

)

Other assets and liabilities

 

(464

)

(92

)

Accounts payable and accrued expenses

 

(934

)

1,066

 

Net cash used in operations

 

(16,292

)

(22,989

)

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

Purchase of property and equipment

 

(117

)

(199

)

Purchase of Aquadex product line

 

(4,000

)

 

Net cash used in investing activities

 

(4,117

)

(199

)

 

 

 

 

 

 

Financing activities:

 

 

 

 

 

Net proceeds from the sale of preferred stock, common stock and warrants

 

6,636

 

7,055

 

Proceeds from borrowings on long-term debt

 

 

8,000

 

Repayments of long-term debt

 

(8,000

)

 

Net cash provided by (used in) financing activities

 

(1,364

)

15,055

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(17

)

(47

)

Net decrease in cash and cash equivalents

 

(21,790

)

(8,180

)

Cash and cash equivalents—beginning of period

 

23,113

 

31,293

 

Cash and cash equivalents—end of period

 

$

1,323

 

$

23,113

 

 

 

 

 

 

 

Supplemental schedule of non-cash activities

 

 

 

 

 

Warrants issued in connection with debt financing

 

$

 

$

355

 

Financing fees on debt

 

$

 

$

400

 

Common stock issued for business acquisition

 

$

950

 

$

 

 

 

 

 

 

 

Supplemental cash flow information

 

 

 

 

 

Interest paid on debt borrowings

 

$

840

 

$

388

 

Cash paid for income taxes

 

$

47

 

$

 

 

See notes to the consolidated financial statements

 

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SUNSHINE HEART, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

Note 1—Nature of Business and Significant Accounting Policies

 

Nature of Business

 

Sunshine Heart, Inc. (the “Company”) is an early-stage medical device company focused commercializing the Aquadex FlexFlow® System.  The Company’s commercial product, the Aquadex FlexFlow System (Aquadex) is indicated for temporary (up to eight hours) ultrafiltration treatment of patients with fluid overload who have failed diuretic therapy, and extended (longer than 8 hours) ultrafiltration treatment of patients with fluid overload who have failed diuretic therapy and require hospitalization. Sunshine Heart is a Delaware corporation headquartered in Minneapolis with wholly owned subsidiaries in Australia. Ireland and Delaware. The Company has been listed on the NASDAQ Capital Market since February 2012.

 

Prior to July 2016, the Company was focused on developing the C-Pulse® Heart Assist System for treatment of Class III and ambulatory Class IV heart failure. The C-Pulse System utilized the known concept of counterpulsation applied to the aorta.  In March 2016, the Company announced that it was no longer enrolling patients into its two clinical studies for the C-Pulse System and that it planned to pursue a new strategic direction. In July 2016, the Company announced that it was moving forward with a therapeutic strategy utilizing neuromodulation rather than counterpulsation.  In August 2016, the Company acquired the Aquadex business from a subsidiary of Baxter International, Inc. (“Baxter”), a global leader in the hospital products and dialysis markets. On September 29, 2016, the Company announced a strategic refocus of its near-term strategy that included halting clinical evaluations of its neuromodulation technology to fully focus its resources on its recently acquired Aquadex business, taking actions to reduce its cash burn in connection with such strategic refocus, and reviewing potential strategic alliances and financing alternatives.

 

The Company’s board of directors and stockholders approved a 1-for-30 reverse split of the Company’s outstanding common stock that became effective after trading on January 12, 2017. The reverse stock split did not change the par value of the Company’s stock or the number of common or preferred shares authorized by the Company’s Fourth Amended and Restated Certificate of Incorporation, as amended. All share and per share amounts have been retroactively adjusted to reflect the split for all periods presented.

 

Going Concern

 

The Company’s financial statements have been prepared and presented on a basis assuming it continues as a going concern. During the years ended December 31, 2016 and 2015, the Company incurred losses from operations and net cash outflows from operating activities as disclosed in the consolidated statements of operations and cash flows, respectively. At December 31, 2016, the Company had an accumulated deficit of $169.0 million and it expects to incur losses for the foreseeable future. To date, the Company has been funded by debt and equity financings, and although the Company believes that it will be able to successfully fund its operations, there can be no assurance that it will be able to do so or that it will ever operate profitably.

 

The Company became a revenue generating company after acquiring the Aquadex Business in August 2016.  The Company expects to incur additional losses in the near-term as it grows the Aquadex Business, including investments in expanding its sales and marketing capabilities, purchasing inventory, manufacturing components, and complying with the requirements related to being a U.S. public company.  To become and remain profitable, the Company must succeed in expanding the adoption and market acceptance of the Aquadex FlexFlow. This will require the Company to succeed in training personnel at hospitals and effectively and efficiently manufacturing, marketing and distributing the Aquadex FlexFlow and related components. There can be no assurance that the Company will succeed in these activities, and it may never generate revenues sufficient to achieve profitability.

 

The Company expects to require additional funding to grow its Aquadex Business in 2017, which may not be available on terms favorable to the Company, or at all. The Company’s ability to continue as a going concern is dependent on the Company’s ability to raise additional capital based on the achievement of commercial milestones. Should future capital raising be unsuccessful, the Company may not be able to continue as a going concern. Furthermore, the ability of the Company to continue as a going concern is subject to the ability of the Company to successfully commercialize its Aquadex products. If the Company is unable to obtain such funding of an amount and timing necessary to meet its future operational plans, or to successfully commercialize its products, the Company may be unable to continue as a going concern. No adjustments have been made relating to the recoverability and classification of recorded asset amounts and classification of liabilities that might be necessary should the Company not continue as a going concern.

 

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Basis of Presentation

 

The accompanying consolidated financial statements include the accounts of Sunshine Heart, Inc. and its wholly owned subsidiaries, Sunshine Heart Company Pty Limited and Sunshine Heart Ireland Limited. All inter-company accounts and transactions between consolidated entities have been eliminated.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

 

Cash and Cash Equivalents

 

Cash and cash equivalents consist of cash and term deposits with original maturities of three months or less. The carrying value of these instruments approximate fair value. The balances, at times, may exceed federally insured limits. The Company has not experienced any losses on its cash and cash equivalents.

 

Accounts Receivable

 

Accounts receivable are unsecured, are recorded at net realizable value, and do not bear interest. The Company makes judgments as to its ability to collect outstanding receivables based upon significant patterns of uncollectability, historical experience, and managements’ evaluation of specific accounts and will provide an allowance for credit losses when collection becomes doubtful. The Company performs credit evaluations of its customers’ financial condition on an as-needed basis. Payment is generally due 30 days from the invoice date and accounts past 30 days are individually analyzed for collectability. When all collection efforts have been exhausted, the account is written off against the related allowance. To date the Company has not experienced any write-offs or significant deterioration of its accounts receivable aging, and therefore, no allowance for doubtful accounts was considered necessary as of December 31, 2016 or 2015.

 

Inventories

 

Inventories primarily represent finished goods purchased from the Company’s supplier and are recorded as the lower of cost or market using the first-in-first out method.

 

Other Current Assets

 

Other current assets represent prepayments and deposits made by the Company.

 

Property, Plant and Equipment

 

Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed based upon the estimated useful lives of the respective assets. Leasehold improvements and capital lease assets are amortized using the straight-line method over the shorter of the lease term or the estimated useful life of the assets. Repairs and maintenance costs are expensed as incurred. The cost and accumulated depreciation of property, plant and equipment retired, or otherwise disposed of are removed from the related accounts, and any residual values are charged to expense. Depreciation expense has been calculated using the following estimated useful lives:

 

Office furniture and equipment

 

5-15 years

 

Computer software and equipment

 

3-4 years

 

Laboratory and research equipment

 

3-15 years

 

Production equipment

 

3-7 years

 

Leasehold improvements and capital lease asset

 

3-5 years

 

 

Depreciation expense and amortization of the capital lease asset was $419,000, and $325,000 for the years ended December 31, 2016, and 2015, respectively.

 

Property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. If the impairment tests indicate that the carrying value of the asset, or asset group is greater than the expected undiscounted cash flows to be generated by such asset or asset group further analysis is performed to determine the fair value of the asset or asset group. To the extent the fair value of the asset or asset group is less than its carrying

 

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value, an impairment loss is recognized equal to the amount the fair value of the asset or asset group exceeds its carrying amount. The Company generally measures fair value by considering sale prices for similar assets or asset groups, or by discounting estimated future cash flows from such assets or asset groups using an appropriate discount rate. Assets to be disposed of are carried at the lower of their carrying value or fair value less costs to sell. Considerable management judgment is necessary to estimate the fair value of assets or asset groups, and accordingly, actual results could vary significantly from such estimates. There have been no impairment losses recognized for the years ended December 31, 2016 or 2015.

 

Other Assets

 

Other assets consisted primarily of deferred financing fees, net of amortization, recorded in connection with the term loan with Silicon Valley Bank. Upon repayment of the term loans, the Company was required to make a final payment to Silicon Valley Bank equal to 5.0% of the original principal amount. As further described in Note 4, this final payment fee was paid to the bank in August 2016 in connection with the repayment of all outstanding borrowings.

 

Intangible assets

 

The Company’s intangible assets consist of customer relationships, developed technology, and trademarks and tradenames. All intangible assets recognized by the Company result from the acquisition of the Aquadex business. All intangible assets are estimated to have a useful life of 5-7 years.  The Company reviews its definite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through the estimated undiscounted future cash flows derived from such assets.  In cases where the carrying value exceeds the undiscounted cash flows, the carrying value is written down to its fair value, using a discounted cash flow analysis.  No impairments have been identified or recorded in 2016.

 

Amortization expense was $278,000 and $0 for the years ended December 31, 2016 and 2015, respectively.

 

Goodwill

 

Goodwill is the cost of an acquisition in excess of the fair value of acquired assets and liabilities and is recorded as an asset on the balance sheet. Goodwill is not subject to amortization but must be tested for impairment at least annually. This test requires the Company to determine if the implied fair value of the goodwill is less than its carrying amount.

 

The Company evaluates goodwill for impairment annually on November 1 st  of each calendar year, or to the extent events or conditions indicate a risk of possible impairment during the interim periods prior to its annual impairment test. Generally, the evaluation of goodwill for impairment involves a two-step test, although under certain circumstance an initial qualitative evaluation may be sufficient to conclude that goodwill is not impaired without conducting the quantitative test.

 

Step 1 involves comparing the estimated fair value of each respective reporting unit to its carrying value, including goodwill. The Company has one reporting unit. If the estimated fair value exceeds the carrying value, the reporting unit’s goodwill is not considered impaired. If the carrying value exceeds the estimated fair value, step 2 must be performed to determine whether goodwill is impaired and, if so, the amount of the impairment. Step 2 involves calculating an implied fair value of goodwill by performing a hypothetical allocation of the estimated fair value of the reporting unit determined in step 1 to the respective tangible and intangible net assets of the reporting unit. The remaining implied goodwill is then compared to the actual carrying amount of the goodwill for the reporting unit. To the extent the carrying amount of goodwill exceeds the implied goodwill, the difference is the amount of the goodwill impairment.  No impairments have been identified or recorded in 2016.

 

Contingent consideration

 

In connection with the Company’s purchase of the Aquadex Business, the Company has an obligation to pay additional consideration that is contingent upon the occurrence of certain future events.  Contingent consideration is recognized at the acquisition date at the estimated fair value of the contingent milestone payments.  The fair value of the contingent consideration is remeasured to its estimated fair value at the end of each reporting period, with changes recorded to earnings.

 

Common stock warrant liability

 

The Company records its common stock warrant liability at fair value at the date of issuance using primarily a Monte Carlo valuation model.  The fair value is remeasured to its estimated fair value at the end of each reporting period with changes recorded to earnings.

 

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Revenue Recognition

 

The Company recognizes revenues from product sales when earned. Specifically, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, and collectability is reasonably assured. Revenue is not recognized until title and risk of loss have transferred to the customer. The shipping terms for the Company’s revenue arrangements are FOB shipping point.

 

Foreign Currency Translation

 

Sales and expenses denominated in foreign currencies are translated at average exchange rates in effect throughout the year. Assets and liabilities of foreign operations are translated at period-end exchange rates with the impacts of foreign currency translation recognized to cumulative translation adjustment, a component of accumulated other comprehensive income . Foreign currency transactions gains and losses are included in other expense, net in the consolidated statements of operations and other comprehensive loss.

 

Stock-Based Compensation

 

The Company recognizes all share-based payments to employees and directors, including grants of stock options, restricted stock units (RSUs) and common stock awards in the income statement as an operating expense, based on their fair value.  The Company’s stock awards use a graded vesting schedule.  The Company recognizes the option expense over the requisite service period, which is generally the vesting period.

 

The Company computes the estimated fair values of stock options and certain of its warrants using the Black-Scholes option pricing model. The closing market price of the Company’s common stock at the date of grant is used to calculate the fair value of restricted stock units and common stock awards.

 

Stock-based compensation expense is based on awards ultimately expected to vest and is reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

 

Equity instruments issued to non-employees include RSUs, warrants or options to purchase shares of the Company’s common stock. These RSUs, warrants or options are either fully-vested and exercisable at the date of grant or vest over a certain period during which services are provided. The Company expenses the fair market value of fully vested awards at the time of grant, and of unvested awards over the period in which the related services are received. Unvested awards are remeasured to fair value until they vest.

 

See Note 6 for further information regarding the assumptions used to calculate the fair value of share-based compensation.

 

Income Taxes

 

Deferred income taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards. Deferred tax liabilities are recognized for taxable temporary differences, which are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

 

Earnings per share

 

Basic earnings per share is computed based on the net loss allocable to common stockholders for each period divided by the weighted average number of common shares outstanding. The net loss allocable to common stockholders for 2016 reflects a $1.9 million increase for the net deemed dividend to preferred shareholders provided in connection with the 2016 Series B and B-1 offering (see Note 5).  Diluted earnings per share is computed based on the net loss allocable to common stockholders for each period divided by the weighted average number of common shares outstanding, increased by the number of additional shares that would have been outstanding had the potentially dilutive common shares been issued, and reduced by the number of shares the Company could have repurchased from the proceeds from issuance of the potentially dilutive shares. Potentially dilutive shares of common stock include warrants, stock options and other stock-based awards granted under stock-based compensation plans.

 

The following table sets forth the potential shares of common stock that are not included in the calculation of diluted net loss per share because to do so would be anti-dilutive as of the end of each period presented:

 

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December 31,

 

 

 

2016

 

2015

 

Stock options

 

87,870

 

66,435

 

Restricted stock units

 

10,356

 

378

 

Warrants to purchase common stock

 

885,601

 

9,930

 

Series B, C and D convertible preferred stock

 

1,063,615

 

 

Total

 

2,047,442

 

76,743

 

 

Research and Development

 

Research and development expenses consist primarily of development personnel and non-employee contractor costs incurred in connection with the discontinued C-Pulse System clinical studies, and of enhancement of existing products and services, quality assurance and testing incurred in connection with the recently acquired Aquadex Business.

 

Recent Accounting Pronouncements

 

In April 2015, the Financial Accounting Standards Board (FASB) issued amended guidance concerning debt issuance costs in relation to a recognized debt liability to require it be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This guidance is effective for the Company’s interim and annual reporting periods beginning January 1, 2016.  In connection with the adoption of this standard, the Company reclassified $120,000 of debt issuance costs that were previously reported as current assets and other assets on the December 31, 2015 balance sheet, to an offset to current and long-term debt.

 

In May 2014, August 2015, March 2016, April 2016 and May 2016, the FASB issued amended revenue recognition guidance to clarify the principles for recognizing revenue from contracts with customers. The guidance requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. The guidance also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract.   The standard allows the Company to transition to the new model using either a full or modified retrospective approach, and early adoption is not permitted. This guidance will be effective for the Company’s interim and annual periods beginning January 1, 2018. The Company is currently evaluating the impact that this standard will have on its business practices, financial condition, results of operations and disclosures.

 

In August 2014, the FASB amended guidance relating to the presentation and disclosure of the uncertainties of an entity’s ability to continue as a going concern.  This guidance explicitly requires management of a company to evaluate whether there is substantial doubt about a company’s ability to continue as a going concern and to provide related footnote disclosure in certain circumstances. This guidance was effective for the Company’s annual reporting period ending on December 31, 2016, and annual and interim periods thereafter. The adoption of this standard did not have a material impact on the Company’s going concern evaluations or disclosures.

 

In November 2015, the FASB issued amended guidance concerning the classification of deferred taxes on the balance sheet to require that deferred tax assets and deferred tax liabilities be presented as noncurrent in a classified balance sheet. The amendment is effective for our annual and interim reporting periods beginning January 1, 2017, with early adoption permitted. The adoption of this standard will not have an impact on the Company’s consolidated financial statements as all deferred tax assets are fully reserved.

 

In February 2016, the FASB issued updated guidance to improve financial reporting about leasing transactions. This guidance will require organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. This guidance is effective for the Company’s annual reporting period ending December 31, 2020, and for annual and interim periods thereafter.  The Company is evaluating the impact that the adoption of this standard will have, if any, on its financial statements and disclosures.

 

The Company evaluates events through the date the financial statements are filed for events requiring adjustment to or disclosure in the financial statements.

 

Note 2 — Aquadex Acquisition

 

On August 5, 2016, the Company completed the acquisition of certain assets used in the production and sale of the Aquadex product line from Baxter. The acquisition of these assets meets the criteria for the purchase of a business, and has been accounted for in

 

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accordance with Accounting Standards Codification (ASC) 805, Business Combinations , with identifiable assets acquired and liabilities assumed recorded at their estimated fair values on the acquisition date. A valuation of the assets and liabilities from the business acquisition was performed utilizing cost, income and market approaches resulting in $5.1 million allocated to identifiable net assets.

 

In connection with the acquisition of the Aquadex Business, the Company entered into a manufacturing and supply agreement with Baxter whereby Baxter will manufacture and supply all of the Company’s finished goods for a period of up to 18 months from the close of the transaction. During the year ended December 31, 2016, the Company recorded $1.2 million of revenue from the sale of Aquadex products. The Company completed the acquisition in order to strengthen its presence in the heart failure market.

 

Purchase Consideration: Total purchase consideration for the Aquadex business is as follows:

 

(in thousands)

 

 

 

Cash consideration

 

$

4,000

 

Common stock consideration

 

950

 

Fair value of contingent consideration

 

126

 

Total purchase consideration

 

$

5,076

 

 

·                   Common Stock Consideration: The common stock consideration consisted of 33,334 shares of the Company’s common stock, worth $0.95 million based on the closing market value of $0.95 per share on August 5, 2016.

 

·                   Contingent Consideration: In connection with the acquisition of the Aquadex product line, the Company agreed to pay the Seller 40% of any proceeds in excess of $4.0 million related to the sale or disposal of the Aquadex assets within three years of the close of the transaction. The fair value of this contingent consideration was calculated based on the estimated likelihood of occurrence of this event in the timeframe provided by the agreement.

 

Purchase price consideration does not include expenses of $0.9 million for accounting, audit, legal, and valuation services that were incurred as part of the transaction and were expensed as incurred as general and administrative expense in the accompanying statement of operations.

 

The acquisition was recorded by recognizing the assets acquired at their estimated fair value at the acquisition date. The excess of the cost of the acquisition over the fair value of the assets acquired was recorded as goodwill. The fair values were based on management’s analysis, including work performed by third-party valuation specialists.  The following presents the amounts recognized for the assets acquired on August 5, 2016 (in thousands):

 

Capital lease asset

 

$

307

 

Intangible assets

 

4,580

 

Total identifiable assets acquired

 

4,887

 

Goodwill

 

189

 

Total purchase consideration

 

$

5,076

 

 

The goodwill is primarily attributable to new and/or future customer relationships that were not acquired in the transaction. All recorded goodwill is expected to be deductible for tax purposes. The fair value of the capital lease asset utilized a combination of the cost and market approaches, depending on the characteristics of the asset classification.

 

Pro Forma Condensed Combined Financial Information (Unaudited)

 

The following unaudited pro forma combined financial information summarizes the results of operations for the periods indicated as if the acquisition of Aquadex had been completed on of January 1, 2015. Pro forma information reflects adjustments that are expected to have a continuing impact on our results of operations and are directly attributable to the acquisition. The unaudited pro forma results include adjustments to reflect, among other things, direct transaction costs relating to the acquisition, the difference in intangible asset amortization to be incurred based on the preliminary values of each identifiable intangible asset, and the difference in depreciation expense to be incurred based on preliminary value of the capital lease asset. The pro forma amounts do not purport to be indicative of the results that would have actually been obtained if the acquisition had occurred as of January 1, 2015 or that may be obtained in the future, and do not reflect future synergies, integration costs, or other such costs or savings.

 

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Twelve Months Ended

 

 

 

December 31,

 

$ in thousands, except per share amounts

 

2016

 

2015

 

Pro forma net sales

 

$

3,160

 

$

4,225

 

Pro forma net loss from operations

 

(15,340

)

(39,836

)

Pro forma basic and diluted net loss per share

 

$

(23.93

)

$

(65.95

)

 

Note 3—Property, Plant and Equipment

 

Property, plant and equipment were as follows:

 

(Dollars in thousands)

 

December 31, 2016

 

December 31, 2015

 

Office Furniture & Fixtures

 

$

280

 

$

269

 

Leasehold Improvements

 

145

 

145

 

Software

 

124

 

121

 

Production Equipment

 

968

 

837

 

Computer Equipment

 

245

 

273

 

Capital Lease Asset

 

307

 

 

Total

 

2,069

 

1,645

 

Accumulated Depreciation

 

(1,529

)

(1,110

)

 

 

$

540

 

$

535

 

 

Note 4—Intangible Assets

 

Intangible assets were as follows:

 

(Dollars in thousands)

 

December 31, 2016

 

December 31, 2015

 

Customer Relationships

 

$

3,090

 

$

 

Developed Technology

 

1,050

 

 

Trade Names and Trademarks

 

440

 

 

Total

 

4,580

 

 

Accumulated Depreciation

 

(278

)

 

 

 

$

4,302

 

$

 

 

Future amortization expense for intangible assets is as follows:

 

(Dollars in thousands)

 

 

 

 

 

 

Year 1

 

$

654

 

 

 

 

Year 2

 

654

 

 

 

 

Year 3

 

654

 

 

 

 

Year 4

 

654

 

 

 

 

Year 5

 

654

 

 

 

 

Thereafter

 

1,032

 

 

 

 

 

 

$

4,302

 

 

 

 

 

Note 5—Debt

 

Prior Loan Agreement : On February 18, 2015, the Company entered into a loan and security agreement with Silicon Valley Bank (the Bank) for proceeds of up to $10.0 million at an annual interest rate of 7.0%. Under this agreement, a $6.0 million term loan was funded at closing and an additional term loan in the amount of $2.0 million was funded on June 26, 2015. The proceeds from the term loans were used for general corporate and working capital purposes. Commencing on January 1, 2016, the Company began repaying the advances made in twenty-four consecutive equal monthly installments.

 

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On August 4, 2016, the Company repaid all amounts outstanding under its existing debt facility of $5.5 million, and incurred a $0.5 million loss on early extinguishment of debt, including the accelerated write-off of unamortized warrants and debt issuance costs. Total borrowings outstanding under this agreement totaled $8.0 million as of December 31, 2015. There were no borrowings outstanding under this facility as of December 31, 2016.

 

Warrants: In connection with funding of the first term loan for $6.0 million, the Company issued 2,300 warrants at an exercise price of $156.6 per share to the Bank and one of its affiliates. The Company valued these warrants at $115.8 per share utilizing the Black Scholes valuation model and the following assumptions: an expected dividend yield of 0%, an expected stock price volatility of 88.07%, a risk-free interest rate of 1.86%, and an expected life of 6.25 years.

 

In connection with the funding of the second term loan for $2.0 million, the Company issued 1,087 warrants at an exercise price of $110.40 per share to Silicon Valley Bank and one of its affiliates. The Company valued these warrants at $81.30 per share utilizing the Black Scholes valuation model and the following assumptions: an expected dividend yield of 0%, an expected stock price volatility of 87.04%, a risk-free interest rate of 2.20%, and an expected life of 6.25 years.

 

All warrants have a life of ten years and were fully vested at the date of grant. The value of these warrants were recorded as debt discount in the accompanying balance sheet and were amortized to interest expense over the term of the debt agreement using the effective interest rate method.  As of December 31, 2015, $201,000 of unamortized debt discount was netted against long-term debt in the accompanying condensed consolidated balance sheet. In connection with the repayment of the debt on August 4, 2016, the Company wrote off the remaining unamortized value of the warrants totaling $113,000.

 

New Loan Agreement: On August 5, 2016, the Company entered into a new loan and security agreement with the Bank (the “New Loan Agreement”).  Under the New Loan Agreement, the Bank agreed to provide the Company with up to $5.0 million in debt financing, consisting of a term loan in an aggregate original principal amount not to exceed $4.0 million (the “Term Loan”) and a revolving line of credit in an aggregate principal amount not to exceed $1.0 million outstanding at any time (the “Revolving Line”; together with the Term Loan, the “Loans”).  Proceeds from the Loans were to be used for general corporate and working capital purposes.  Advances under the Term Loan were available to the Company until November 30, 2016 and were subject to the Company’s compliance with liquidity covenants. The Term Loan expired unused on November 30, 2016. Advances under the Revolving Line are available to the Company until March 31, 2020 and accrue interest at a floating annual rate equal to 1.75% or 1.0% above the prime rate, depending on liquidity factors. Outstanding borrowings, if any, are collateralized by all of the Company’s assets, excluding intellectual property which is subject to a negative pledge. There were no borrowings outstanding under this facility as of December 31, 2016.

 

Note 6—Shareholder’s Equity

 

Series B/B-1 Convertible Preferred Stock : On July 20, 2016, the Company entered into a securities purchase agreement with an institutional investor for an offering of shares of convertible preferred stock and warrants with gross proceeds of approximately $3.5 million in a registered direct offering. The transaction closed on July 26, 2016, and the Company issued 3,468 shares of Series B Convertible Preferred Stock. The Series B Convertible Preferred Stock is non-voting and was convertible into a total of 122,979 shares of common stock at the holder’s election at any time at a conversion price of $28.2 per share. Approximately $1.6 million of the proceeds were allocated to the preferred stock, representing the residual proceeds after the warrants (described below) were recorded at fair value.

 

On October 30, 2016, the Company entered into an exchange agreement with the holders of its Series B Convertible Preferred Stock and agreed to issue such holders 2,227.2 shares of the Company’s Series B-1 Convertible Preferred Stock in exchange for the cancellation of all shares of Series B Convertible Preferred Stock held by such holders. The Series B-1 Convertible Preferred Stock has similar terms as the Series B Convertible Preferred Stock, except that the initial conversion price of the Series B-1 Convertible Preferred Stock is $5.10 per share. Prior to the October 30, 2016 exchange, 1,240.8 of the Series B Convertible Preferred Stock had been converted into 44,000 shares of common stock. As of December 31, 2016, 402.8 shares of the Series B-1 Convertible Preferred Stock had been converted into 78,973 shares of common stock, and 1,824.4 shares of Series B-1 remained outstanding.

 

The Series B and B-1 convertible preferred stock include a net deemed dividend in the amount of $1.9 million, representing the intrinsic value of the shares at the time of issuance, which is reflected as an increase to the loss per share allocable to common shareholders.

 

Series C and D Convertible Preferred Stock : Also, on October 30, 2016, the Company entered into securities purchase agreements with an institutional investor for shares of convertible preferred stock and warrants with an aggregate purchase price of $3.8 million in a registered direct offering and simultaneous private placement. The first closing of the transaction occurred on November 3, 2016, whereby the Company received $3.6 million in gross proceeds and issued and sold 2,900 shares of Series C Convertible

 

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Preferred Stock, and 700 shares of Series D Convertible Preferred Stock, both at $5.10 per share. At the second closing, which was subject to the Company receiving shareholder approval of the transactions, the Company expected to issue and sell 200 shares of Series D Convertible Preferred Stock convertible into 39,216 shares of common stock at $5.10 per share and warrants to purchase an additional 39,216 shares of common stock at $5.40 per share for a gross purchase price of $0.2 million. The Series C and D convertible preferred stock includes a contingent beneficial conversion amount of $1.3 million and $0.3 million, respectively, representing the intrinsic value of the shares at the time of issuance. This amount will be reflected as an increase to the loss per share allocable to common shareholders in the first quarter of 2017 when the contingency for the conversion was resolved with the shareholder approval allowing for the conversion of the preferred stock into common stock.   As of December 31, 2016, no shares of the Series C or D convertible preferred stock had been converted into common stock, and all remained outstanding.

 

The Series D Convertible Preferred Stock with a carrying value of $0.5 million is classified as temporary equity in the consolidated balance sheet because the Company cannot control that it will settle its redemption in common stock, but it is not remeasured to fair value each period through earnings because the events that could trigger its redemption are not probable of occurrence.

 

In connection with these transactions, the Company paid the placement agent an aggregate cash placement fee equal to 6% of the aggregate gross proceeds raised in the offering and issued the warrants described below.

 

Investor Warrants : In connection with the issuance of the Series B Convertible Preferred Stock in July 2016, the Company issued the investor warrants to purchase 122,979 shares of common stock at an exercise price of $ 28.2 per share at no additional cost.  The warrants are exercisable for 36 months commencing six months from the closing date and are subject to a reduction of the exercise price if the Company subsequently issues common stock or equivalents at an effective price less than the current exercise price of such warrants.

 

Concurrently with the closing of the Series C and D Convertible Preferred Stock and warrant financing on November 3, 2016, the exercise price for these warrants was adjusted to $5.10 per share.

 

In connection with the issuance of the Series C and D Convertible Preferred Stock in November 2016, the Company issued the investor warrants to purchase 705,884 shares of common stock at an exercise price of $5.40 per share at no additional cost.  The warrants are exercisable for 60 months commencing on the day that is the later of the receipt of approval of the Company’s stockholders of a proposal to approve the issuance of the shares of common stock underlying the warrants or the six-month anniversary of the date of issuance. The warrants are subject to a reduction of the exercise price if the Company subsequently issues common stock or equivalents at an effective price less than the current exercise price of such warrants.

 

Placement Agent Warrant: In connection with the issuance of the Series B Convertible Preferred Stock, the Company issued 7,379 warrants to the placement agent to purchase shares of common at an exercise price of $40.50 per share. In connection with the issuance of the Series C and D Convertible Preferred Stock, the Company issued 42,353 warrants to the placement agent to purchase shares of common stock at an exercise price of $6.38 per share. These warrants were issued at no additional cost, were exercisable immediately and expire five years from the closing of the offerings. These warrants do not contain repricing provisions.

 

Both the investor and placement agent warrants are accounted for as liabilities and were recorded at fair value on the date of issuance. These warrants must be measured and recorded at fair value for each subsequent reporting period that the warrants remain outstanding, and any changes in fair value must be recognized in the statement of operations. The change in fair value of these warrants since their issuance was $0.8 million and was reflected as an unrealized gain in the accompanying statement of operations.

 

Transaction Costs: The Company incurred approximately $0.9 million of cash and non-cash transaction costs which were allocated to the preferred stock and investor warrants on a relative fair value basis.  The $0.6 million allocated to the preferred stock was recorded as a reduction of additional paid-in-capital, while the $0.3 million allocated to the investor warrants was expensed as incurred.

 

ATM Sales: In March 2014, the Company entered into a sales agreement with Cowen and Company LLC to sell from time to time, in “at the market” offerings, shares of its common stock having an aggregate offering price of up to $40.0 million.  There were no issuances of common stock under this facility in the twelve months ended December 31, 2016. During the twelve months ended December 31, 2015, the Company sold 41,879 shares of common stock for net proceeds of $7.1 million after stock issuance costs of $0.2 million. As of December 31, 2016, the Company had a total of $32.6 million available for future sales under the sales agreement.

 

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Table of Contents

 

Note 7— Stock-Based Compensation

 

Stock Options and Restricted Stock Awards

 

The Company has various share-based compensation plans, including the Amended and Restated 2002 Stock Plan, the Second Amended and Restated 2011 Equity Incentive Plan, the 2013 Non-Employee Directors’ Equity Incentive Plan and the New-Hire Equity Incentive Plan (collectively, the “Plans” ).  The Plans are designed to assist in attracting, motivating and retaining employees and directors and to recognize the importance of employees to the long-term performance and success of the Company. The Company has also granted stock options to certain non-employees outside of the Plans.

 

The Company recognized share-based compensation expense related to grants of stock options, RSUs and common stock awards to employees, directors and consultants of $1.0 million, and $2.4 million during the years ended December 31, 2016 and 2015, respectively. The following table summarizes the stock-based compensation expense which was recognized in the consolidated statements of operations for the years ended December 31,

 

(Dollars in thousands)

 

2016

 

2015

 

Selling, general and administrative

 

$

630

 

$

1,612

 

Research and development

 

385

 

825

 

Total

 

$

1,015

 

$

2,437

 

 

The majority of the RSUs and options to purchase common stock vest on the anniversary of the date of grant, which ranges from one to four years.  Share-based compensation expense related to these awards is recognized on a straight-line basis over the related vesting term in most cases, which generally is the service period. It is the Company’s policy to issue new shares upon the exercise of options.

 

Stock Options : The following is a summary of the Plans’ stock option activity during the years ended December 31:

 

 

 

2016

 

2015

 

 

 

Options
Outstanding

 

Weighted
Average
Exercise
Price

 

Options
Outstanding

 

Weighted
Average
Exercise
Price

 

Beginning Balance

 

66,382

 

$

184.45

 

72,273

 

$

194.36

 

Granted

 

45,413

 

27.17

 

9,176

 

117.05

 

Exercised

 

 

 

 

 

Forfeited/expired

 

(23,925

)

139.18

 

(15,067

)

192.21

 

Outstanding at December 31

 

87,870

 

$

115.41

 

66,382

 

$

184.45

 

Vested at December 31

 

43,280

 

$

189.74

 

41,505

 

$

202.54

 

 

For options outstanding and vested at December 31, 2016, the weighted average remaining contractual life was 7.58 years and 7.38 years, respectively. There were no option exercises in 2016 or 2015.

 

The total fair value of options that vested in 2016 and 2015 was $1.1 million, and $1.9 million, respectively, at the fair value of the options as of the date of grant.

 

Valuation Assumptions : The fair value of each stock option is estimated at the grant date using the Black-Scholes option pricing model. The fair value of stock options under the Black-Scholes model requires management to make assumptions regarding projected employee stock option exercise behaviors, risk-free interest rates, volatility of the Company’s stock price, and expected dividends.

 

The Company has not historically paid cash dividends to its stockholders, and currently does not anticipate paying any cash dividends in the foreseeable future. As a result, the Company has assumed a dividend yield of 0%. The risk free interest rate is based upon the rates of U.S. Treasury bills with a term that approximates the expected life of the option. Since the Company has limited historical exercise data to reasonably estimate the expected life of its option awards, the expected life is calculated using a simplified method. Expected volatility is based on historical volatility of the Company’s stock.

 

The following table provides the assumptions used in the Black-Scholes model for the years ended December 31:

 

 

 

2016

 

2015

 

Expected dividend yield

 

0

%

0

%

Risk-free interest rate

 

1.71

%

1.89

%

Expected volatility

 

86

%

88

%

Expected life (in years)

 

6.25

 

6.25

 

 

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The weighted-average fair value of stock options granted in 2016 and 2015 was $27.17 and $117.05, respectively. As of December 31, 2016, the total compensation cost related to all non-vested stock option awards not yet recognized was $1.2 million and is expected to be recognized over the remaining weighted-average period of 2.5 years.

 

Restricted Stock Awards : The following table summarizes restricted stock award activity during 2016 and 2015:

 

 

 

2016

 

2015

 

 

 

RSUs

 

Weighted
Average
Grant
Price

 

RSUs

 

Weighted
Average
Grant
Price

 

Nonvested, beginning balance

 

376

 

$

128.70

 

5,210

 

$

151.80

 

Granted

 

23,366

 

27.67

 

906

 

128.70

 

Vested

 

(12,771

)

22.73

 

(5,704

)

131.00

 

Forfeited

 

(639

)

21.30

 

(36

)

96.00

 

Nonvested at December 31

 

10,332

 

$

27.17

 

376

 

$

128.70

 

 

During 2016, and 2015, employees tendered restricted stock units totaling 3,333, and 2,190, respectively, to cover related payroll tax withholdings.

 

Warrants

 

Warrants to purchase 885,601, and 9,930 shares of common stock were outstanding at December 31, 2016 and 2015, respectively.  As of December 31, 2016, warrants outstanding were exercisable at prices ranging from $5.10 to $210.00 per share, and are exercisable over a period ranging from eight months to 8.5 years.

 

Note 8 - Fair Value of Financial Instruments

 

The Company’s financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, warrants, contingent consideration and debt.

 

Pursuant to the requirements of ASC Topic 820 “Fair Value Measurement,” the Company’s financial assets and liabilities measured at fair value on a recurring basis are classified and disclosed in one of the following three categories:

 

·                   Level 1 - Financial instruments with unadjusted quoted prices listed on active market exchanges.

 

·                   Level 2 - Financial instruments lacking unadjusted, quoted prices from active market exchanges, including over the counter traded financial instruments. The prices for the financial instruments are determined using prices for recently traded financial instruments with similar underlying terms as well as directly or indirectly observable inputs, such as interest rates and yield curves that are observable at commonly quoted intervals.

 

·                   Level 3 - Financial instruments that are not actively traded on a market exchange. This category includes situations where there is little, if any, market activity for the financial instrument. The prices are determined using significant unobservable inputs or valuation techniques.

 

The fair value of the Company’s common stock warrant liability related to the investor warrants is calculated using a Monte Carlo valuation model and is classified as Level 3 in the fair value hierarchy. The common stock warrants issued July 26, 2016 had a fair value of $1.8 million on the date of issuance and $0.2 million on December 31, 2016. The common stock warrants issued November 3, 2016 had a fair value of $0.8 million on the date of issuance and $1.5 million on December 31, 2016.

 

The fair value of the Company’s common stock warrant liability related to the placement agent warrants is calculated using a Black Scholes valuation model and is classified as Level 3 in the fair value hierarchy.

 

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Fair values were calculated using the following assumptions:

 

 

 

July 26, 2016

 

Nov. 3, 2016

 

Dec. 31, 2016

 

Risk-free interest rates, adjusted for continuous compounding

 

0.94

%

1.33

%

1.47%/1.96

%

Term (years)

 

3.5

 

5.5

 

3.1/5.3

 

Expected volatility

 

78

%

41.4

%

55.3%/49.8

%

Dates and probability of future equity raises

 

various

 

various

 

various

 

 

A significant change in the inputs used for the Monte Carlo and Black Scholes valuation models such as the expected volatility, bond yield of equivalent securities, or probability of future equity financings, in isolation, would result in significantly higher or lower fair value measurements. In combination, changes in these inputs could result in a significantly higher or lower fair value measurement if the input changes were to be aligned, or could result in a minimally higher or lower fair value measurement if the input changes were of a compensating nature.

 

During the twelve months ended December 31, 2016, the Company recognized unrealized gains of $0.8 million in the condensed consolidated statements of operations from changes in fair value of the warrant liability.

 

The fair value of the Company’s contingent consideration, as described in Note 2, was initially measured based on the consideration expected to be transferred (probability-weighted), discounted back to present value, and it is considered a Level 3 instrument. The discount rate used was determined at the time of measurement in accordance with accepted valuation methods. The Company measures the liability on a recurring basis using Level 3 inputs including probabilities of payment and projected payment dates. Changes to any of the inputs may result in significantly higher or lower fair value measurements. There were no changes in the fair value of the contingent consideration subsequent to the initial measurement.

 

All cash equivalents are considered Level 1 measurements for all periods presented. The Company does not have any financial instruments classified as Level 2 or any other classified as Level 3 and there were no movements between these categories during the periods ended December 31, 2016 and 2015. The Company believes that the carrying amounts of all remaining financial instruments approximate their fair value due to their relatively short maturities.

 

Note 9—Income Taxes

 

Domestic and foreign loss before income taxes, consists of the following for the years ended December 31:

 

(Dollars in thousands)

 

2016

 

2015

 

Domestic

 

$

(15,877

)

$

(26,665

)

Foreign

 

31

 

(42

)

Loss before income taxes

 

$

(15,846

)

$

(26,707

)

 

The components of income tax benefit consist of the following for the years ended December 31:

 

(Dollars in thousands)

 

2016

 

2015

 

Current:

 

 

 

 

 

United States and state

 

$

 

$

 

Foreign, net

 

54

 

124

 

Deferred:

 

 

 

 

 

United States and state

 

 

 

Foreign

 

 

 

Total income tax benefit

 

$

54

 

$

124

 

 

Actual income tax benefit differs from statutory federal income tax benefit as follows for the years ended December 31:

 

(Dollars in thousands)

 

2016

 

2015

 

Statutory federal income tax benefit

 

$

5,388

 

$

9,066

 

State tax benefit, net of federal taxes

 

2

 

4

 

Foreign tax

 

3

 

3

 

R&D tax credit

 

80

 

135

 

Nondeductible/nontaxable items

 

(86

)

(186

)

Other

 

(257

)

(164

)

Valuation allowance increase

 

(5,076

)

(8,734

)

Total income tax benefit

 

$

54

 

$

124

 

 

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Deferred taxes consist of the following as of December 31:

 

(Dollars in thousands)

 

2016

 

2015

 

Deferred tax assets:

 

 

 

 

 

Current:

 

 

 

 

 

Accrued leave

 

$

43

 

$

71

 

Other accrued expenses

 

97

 

163

 

Total current deferred tax asset

 

140

 

234

 

Noncurrent:

 

 

 

 

 

Stock based compensation

 

1,477

 

1,539

 

Net operating loss carryforward

 

49,720

 

44,462

 

Deferred rent

 

17

 

21

 

Other

 

777

 

52

 

R&D credit carryforward

 

531

 

531

 

Total noncurrent deferred tax assets

 

52,522

 

46,605

 

Total deferred tax assets

 

$

52,662

 

$

46,839

 

Deferred tax liabilities:

 

 

 

 

 

Current:

 

$

 

$

 

Noncurrent:

 

 

 

 

 

Fixed assets

 

 

 

Total deferred tax liabilities

 

$

 

$

 

Net deferred tax asset

 

52,662

 

46,839

 

Less: valuation allowance

 

(52,662

)

(46,839

)

Total

 

$

 

$

 

 

As of December 31, 2016, the Company had net operating loss (“NOLs”) carryforwards of approximately $110.0 million for U.S. federal income tax purposes, which expire between 2024 and 2034, and NOLs in the Commonwealth of Australia of approximately AU$49.0 million which the Company can carry forward indefinitely. U.S. NOLs cannot be used to offset taxable income in foreign jurisdictions. In addition, future utilization of NOL carryforwards in the U.S. may be subject to certain limitations under Section 382 of the Internal Revenue Code.

 

The Company received $80,000 and $135,000 fully refundable research and development tax credits in 2016 and 2015, respectively, related to qualified research and development expenditures of its Australian subsidiary for its tax years ended June 30, 2015 and 2014, respectively, and recorded the benefit in the year that the refund was received. The Company has not completed its Australian tax return for its Australian subsidiaries tax year ended June 30, 2016. As the Company cannot be reasonably assured of the amount or eligibility of the refundable research and development credit resulting from its 2016 Australian research and development activities, the Company has not reflected the related estimated benefit.

 

The Company provides for a valuation allowance when it is more likely than not that it will not realize a portion of the deferred tax assets. The Company has established a valuation allowance for U.S. and foreign deferred tax assets due to the uncertainty that enough taxable income will be generated in those taxing jurisdictions to utilize the assets. Therefore, the Company has not reflected any benefit of such deferred tax assets in the accompanying financial statements. For the years ended December 31, 2016 and 2015, the valuation allowance increased by $5.8 million and $7.5 million, respectively.