Inspire Medical Systems, Inc. — Q3 2018 Form 10-Q
Business context and reporting period. This unaudited quarterly filing covers the three and nine months ended September 30, 2018, compared with the same periods in 2017. Inspire develops and sells its FDA-approved Inspire neurostimulation system for moderate-to-severe obstructive sleep apnea (OSA). Revenue is primarily from system sales to U.S. and European hospitals and ambulatory surgery centers.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $13.1 million | $7.3 million | $34.0 million | $18.6 million |
| Gross margin | 81.1% | 78.5% | 79.8% | 77.8% |
| Operating loss | $(4.6) million | $(3.6) million | $(15.5) million | $(12.2) million |
| Net loss | $(4.7) million | $(4.0) million | $(17.1) million | $(13.3) million |
| Net loss per share, basic and diluted | $(0.22) | $(3.42) | $(1.40) | $(11.45) |
- Q3 revenue grew 79.5%; nine-month revenue grew 82.9%. U.S. sales were $11.3 million in Q3 and $29.6 million year to date; Europe contributed $1.7 million and $4.5 million, respectively.
- Gross margin improved year over year. Management attributed the comparative-period margin improvement primarily to 2017 excess-inventory charges related to the fourth-generation system ($0.2 million in Q3 and $0.5 million for the nine-month period).
- Operating expenses rose 62.9% in Q3 and 60.2% for the nine-month period. Selling and marketing was the largest category, at $11.3 million in Q3 and $31.9 million year to date. Management cited commercial-team expansion, direct-to-patient marketing, public-company costs, and higher personnel expenses.
- Cash used in operating activities was $16.1 million for the nine months, versus $12.5 million in 2017. Cash used in investing activities was $87.0 million, primarily reflecting purchases of short-term investments; financing provided $120.5 million, mainly from the IPO and additional borrowing.
- At September 30, cash and cash equivalents were $26.3 million and short-term investments were $94.1 million, totaling $120.4 million. Total current liabilities were $7.6 million. Notes payable were $24.8 million on the balance sheet; the credit facility principal was $24.5 million.
Material changes and developments
- The May 2018 IPO issued 7,762,500 common shares at $16 per share and generated approximately $112.0 million in net proceeds. Preferred shares converted into 12,111,706 common shares at the IPO closing.
- Japan approved Inspire therapy in June 2018; the company said it would seek reimbursement coverage there. Aetna began covering Inspire therapy in July, bringing the company’s stated total of U.S. commercial payors with positive coverage policies to nine. Management also reported reimbursement through prior authorization for approximately 300 commercial payors.
- The sales, marketing, and reimbursement organization grew from 70 employees at September 30, 2017 to 117 at September 30, 2018; total company headcount rose from 93 to 150.
- The company met the revenue condition to extend the credit facility’s interest-only period to March 1, 2020. Thereafter, scheduled principal and interest payments are due; the facility matures in February 2022. The debt bears interest at the greater of 7.95% or LIBOR plus 6.9% and is secured by substantially all assets other than intellectual property.
Outlook, risks, and other items
- No numerical revenue or earnings guidance is provided. Management expects continued net losses for the next several years and expects to make further investments in commercial expansion, product development, clinical studies, and new markets. Management believed available cash, cash equivalents, investments, and revenue would fund operations for at least 12 months; additional financing may be needed if assumptions or requirements change.
- Management cited historical first- and fourth-quarter seasonality: U.S. demand may be stronger in Q4 after insurance deductibles are met, while European demand may weaken in Q1 as coverage status and hospital budgets are determined.
- Key risks include dependence on one principal product, uneven third-party reimbursement and prior authorization, continued losses, competition, reliance on single-source suppliers and contract manufacturers, inventory obsolescence, regulatory and clinical requirements, and the ability to scale sales and operations. Longer-term safety and efficacy beyond five years were not yet known, according to the filing.
- Supplier inventory purchase commitments were $16.2 million at September 30, 2018; future operating lease payments were $2.043 million. The company reported no material legal proceedings and no material off-balance-sheet arrangements. It was in compliance with credit-facility covenants. Disclosure controls were assessed as effective, and no material changes in internal control over financial reporting were reported for the quarter.
- Potentially notable accounting and tax items include a $0.6 million year-to-date fair-value expense on preferred-stock warrants before their IPO-related reclassification to equity, no income-tax provision because deferred tax assets were fully valuation-allowed, and an incomplete assessment of certain Tax Cuts and Jobs Act effects at quarter-end.
Important facts for investors to verify
- Whether strong revenue growth and improved gross margin persist as the company expands its sales force and marketing spend, given that operating losses and operating cash use increased.
- Progress in broader commercial-payor coverage, prior-authorization approvals, Medicare reimbursement, and Japanese reimbursement access—and the effects of any changes in coverage policies.
- Cash burn and financing needs against management’s stated at-least-12-month liquidity assessment, including the timing and cost of debt repayment after the extended interest-only period.
- Supplier capacity and concentration, inventory reserves and commitments, and exposure to product-quality, clinical, regulatory, and competitive developments.
- Seasonality and the impact of the IPO-related increase in shares outstanding when comparing per-share results across periods.