Establishment Labs Holdings Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; unaudited, consolidated financial statements. Amounts below are in U.S. dollars.
Business context
The company manufactures and sells medical devices, principally Motiva silicone breast implants, through distributors and direct sales in international markets. It had not received U.S. commercial approval. The FDA approved an investigational device exemption in March 2018 for its U.S. clinical trial; enrollment was expected to be completed in early 2019.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $16.3 million | $7.3 million | $44.8 million | $22.9 million |
| Gross profit / margin | $10.1 million / 62.1% | $3.6 million / 49.2% | $26.2 million / 58.6% | $11.1 million / 48.7% |
| Operating expenses | $16.2 million | $9.6 million | $41.5 million | $26.5 million |
| Operating loss | $(6.0) million | $(6.0) million | $(15.2) million | $(15.4) million |
| Net income (loss) | $1.3 million | $(10.7) million | $(10.6) million | $(27.8) million |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $(25.4) million | $(23.8) million |
At September 30, cash was $65.6 million, current assets were $104.8 million, and current liabilities were $14.9 million. Working capital was approximately $89.9 million. Madryn debt had $40.0 million principal outstanding, recorded at a net carrying value of $21.5 million after discounts and issuance costs; its weighted-average interest rate was approximately 13.3%. Principal payments were not due until 2021. The company reported $76.987 million of shareholders’ equity and an accumulated deficit of $78.5 million.
Changes versus the prior comparable period
- Q3 revenue rose 122.4%; nine-month revenue rose 95.9%, primarily from higher Motiva implant sales, market penetration, and new geographies, including Brazil.
- Gross margin improved in both periods, which management attributed to higher production volumes spreading fixed manufacturing costs and a greater contribution from direct markets with higher average selling prices.
- Operating expenses increased: nine-month SG&A rose 46.8% to $32.5 million and R&D more than doubled to $9.0 million, reflecting staffing, public-company costs, and U.S. clinical-trial activity.
- Q3 net income was driven by an $11.4 million non-cash gain from the change in fair value of derivative instruments, despite a $6.0 million operating loss. The nine-month derivative gain was $15.9 million, compared with a $2.1 million loss in 2017; these gains should not be read as operating profitability.
- The July 2018 IPO raised approximately $70.1 million net. The company also repaid $5.1 million of related-party notes in August.
Outlook, risks and unusual items
- Management expects continued losses in the near and intermediate term as it expands sales, R&D, clinical trials, and public-company infrastructure. It said available cash, operating cash, and IPO proceeds should meet liquidity needs for at least 12 months, while noting that additional capital may be needed.
- Management estimated U.S. PMA clinical-trial costs of $30 million to $40 million over ten years. Motiva implants were not approved for commercial sale in the United States.
- Madryn covenant issues caused technical defaults in early 2018; a June amendment removed the relevant restrictive covenants. The company reported compliance with all debt covenants at September 30.
- Foreign-currency transaction losses were $3.2 million for the first nine months, principally associated with Brazilian real remeasurement. The company had no foreign-currency hedging program.
- NuSil was the sole supplier of medical-grade silicone; purchases from it were $10.6 million, or 64.9% of total purchases, in the first nine months. The filing also describes a supplier dispute involving insertion sleeves.
- Disclosure controls were not effective at quarter-end because of material weaknesses involving review of debt accounting and standard-to-actual inventory costing, and insufficient accounting staff and expertise at the Brazilian subsidiary. Remediation was ongoing.
- The company sued Keller Medical and Allergan over a distribution agreement; Keller filed a counterclaim alleging unpaid product invoices. The company disputed the counterclaim and made no prediction about litigation outcomes.
- After quarter-end, the company agreed to acquire distribution-related assets in Spain and Germany. The Spain agreement included an approximately $1.9 million cash payment; the Germany agreement provided for up to approximately $2.2 million in milestone-based cash payments.
Important facts for investors to verify
- Whether revenue growth and gross-margin gains persist as geographic and direct-sales mix changes, and whether operating expenses can grow more slowly than revenue.
- The timing, enrollment, cost, and results of the U.S. clinical trial, and the regulatory and post-approval requirements for U.S. commercialization.
- Cash burn, future financing needs, Madryn’s effective debt cost and covenants, and the company’s ability to maintain liquidity while servicing debt.
- Progress in remediating the disclosed material weaknesses and whether subsequent filings report effective controls.
- Exposure to single-source suppliers, foreign-exchange movements, product-safety developments, and the outcome or financial impact of the Keller/Allergan dispute.
- The assumptions behind derivative fair-value gains and contingent consideration; Q3 reported net income depended materially on non-operating fair-value movements.