SANUWAVE Health, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. The unaudited statements cover the company and its subsidiaries. SANUWAVE develops acoustic shock-wave technology; its lead product, dermaPACE, received FDA marketing authorization for diabetic foot ulcers in December 2017 and began U.S. commercialization in 2018.
Financial performance and liquidity
- Revenue: Q3 revenue was $595,789, up 269% from $161,585 a year earlier. Nine-month revenue was $1.393 million, up 230% from $422,199. Growth reflected product sales and licensing fees, principally internationally; Q3 licensing revenue included the FKS distribution arrangement.
- Gross margin: Q3 gross margin was 69%, versus 62% in Q3 2017; the nine-month margin was 63%, versus 66%. Management attributed the Q3 improvement to licensing revenue with no associated cost, and the year-to-date decline to a larger proportion of lower-margin device sales.
- Operating results: Q3 operating loss was $2.670 million, compared with $648,000 a year earlier. Q3 net loss was $825,142, versus $851,325, or $0.01 per share in both periods; a $2.241 million warrant-valuation gain substantially offset higher operating costs and interest expense. Nine-month operating loss was $5.913 million and net loss was $9.570 million, versus $2.578 million and $2.761 million, respectively, in 2017. Nine-month loss per share was $0.06, versus $0.02.
- Costs: Nine-month R&D expense rose 43% to $1.380 million; general and administrative expense rose 187% to $5.392 million. Management cited increased staffing, stock-based compensation, bonuses, travel, professional services and commercialization costs. Stock-based compensation was $2.474 million for the nine months.
- Cash flow: Operating activities used $2.272 million in the first nine months, compared with $945,000 in 2017. Investing activities used $32,171; financing provided $1.663 million. Cash fell $657,873 from year-end to $72,311 at September 30.
- Debt and liquidity: Total liabilities were $14.191 million against total assets of $723,604; stockholders’ deficit was $13.468 million. Current liabilities were $14.165 million versus current assets of $634,470. Major obligations included $5.335 million of related-party notes, $2.548 million of convertible notes, $1.005 million of accrued related-party interest, $524,869 under a related-party line of credit, and $1.561 million of accounts payable. The filing reports substantial doubt about the company’s ability to continue as a going concern and says additional capital is required.
Material changes and financing
- Convertible notes issued during the nine months included $1.596 million in principal. The notes carry a 10% stated rate and convert at $0.11 per share; multiple note tranches were in default and accruing interest at 18%. The company reported $2.548 million outstanding at September 30, net of applicable discounts and costs.
- Related-party notes were in continuing default for missed interest payments and accruing at 10%; principal and accrued interest were stated to be due December 31, 2018. A related-party line of credit is callable on demand. These obligations heighten near-term liquidity risk.
- Common shares issued and outstanding rose from 139.3 million at December 31, 2017 to 155.1 million at September 30, 2018. Conversions, warrant exercises and compensation-related awards contributed to dilution; the filing also reports 102.9 million warrants outstanding at period-end.
- After quarter-end, the related-party credit line was increased to $1.0 million. The company disclosed further short-term borrowing, including a $100,000 note from its president. It also described an expected additional $500,000 FKS distribution-rights fee; receipt was not assured.
Outlook, risks and unusual items
- Management said the company needed additional capital in Q4 2018 and Q1 2019 through strategic partners, licensing, warrant-related transactions, equity or debt. Financing could cause significant dilution or impose restrictive terms. Management warned that failure to obtain funding could force a U.S. Bankruptcy Code filing. No quantified revenue or earnings guidance was provided.
- The MundiMed Brazil arrangement became disputed after missed payments and was terminated effective October 8, 2018. Management said it was discussing a possible replacement partner. FKS paid $500,000 for Taiwan distribution rights; a 50/50 joint venture was incorporated in Singapore in November to serve multiple Southeast Asian markets.
- A government-facility distribution agreement is with entities owned by a director and shareholder. The filing reports $141,231 revenue from this related party through September 30, along with related contract liabilities and accrued expenses.
- The company disclosed possible securities-law exposure related to certain warrant exercises. Eligible holders could seek rescission and repayment of cash exercise amounts; the company said fewer than ten holders may be affected, but a claim could materially harm its financial condition. It also described ordinary-course litigation and said it did not expect pending claims to have a material adverse effect.
- Disclosure controls were not effective at September 30 because three material weaknesses remained, involving complex instruments and derivatives, equity components of service agreements, and completeness and accuracy of GAAP disclosures. Management planned an updated remediation plan.
- Clinical results cited by the company showed the primary 12-week wound-closure endpoint was not statistically significant; later analyses showed statistical significance at 20 and 24 weeks. Commercial adoption, reimbursement, regulatory and clinical uncertainties remain relevant.
Most important facts for investors to verify
- Near-term cash availability, the timing and terms of additional financing, and whether the going-concern warning has been resolved.
- Current status, default terms and maturity or acceleration risk for convertible notes, related-party notes, accrued interest and callable credit facilities.
- Whether the expected FKS fee was received, and the economics, funding obligations and performance of the Singapore joint venture and replacement Brazil distribution plans.
- Potential dilution from outstanding warrants, convertible securities and equity awards, and the status of required registration statements.
- The scope and remediation progress of the material weaknesses, and the potential exposure from the disclosed warrant-related securities-law issue.
- The filing contains inconsistent descriptions of November 2018 short-term borrowing amounts: one section reports $306,000, while MD&A reports $160,667. Confirm the correct amount in subsequent filings.