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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_____________________________________

FORM 10-Q

_____________________________________

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2019

 

Commission File Number 001-37525

 _____________________________________

Nuvectra Corporation

(Exact name of Registrant as specified in its charter)

 _____________________________________

 

Delaware		30-0513847
(State of Incorporation)		(I.R.S. Employer Identification No.)

 

5830 Granite Parkway, Suite 1100

Plano, Texas 75024

(Address of principal executive offices) (Zip code)

 

(214) 474-3103

(Registrant’s telephone number, including area code)

 

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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  ☒    No  ☐    

 

Indicate by checkmark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒     No  ☐

 

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

 

Large accelerated filer     ☐	Accelerated filer                     ☒
Non-accelerated filer       ☐	Smaller reporting company   ☒
	Emerging growth company   ☒

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☒

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange

Act).    Yes  ☐    No  ☒

 

As of April 23, 2019, shares outstanding of the Company’s common stock, $0.001 par value per share, totaled 17,800,235.

 

 

 

Nuvectra Corporation

Table of Contents for Form 10-Q

As of and for the Quarterly Period Ended March 31, 2019

 

 

		Page No.
PART I—FINANCIAL INFORMATION
ITEM 1.	Condensed Consolidated Financial Statements	3
	Condensed Consolidated Balance Sheets—Unaudited	3
	Condensed Consolidated Statements of Operations and Comprehensive Loss—Unaudited	4
	Condensed Consolidated Statements of Cash Flows—Unaudited	5
	Condensed Consolidated Statement of Stockholders' Equity—Unaudited	6
	Notes to Condensed Consolidated Financial Statements—Unaudited	7
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	34
ITEM 4.	Controls and Procedures	34
PART II—OTHER INFORMATION
ITEM 1.	Legal Proceedings	35
ITEM 1A.	Risk Factors	35
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	35
ITEM 3.	Defaults Upon Senior Securities	35
ITEM 4.	Mine Safety Disclosures	35
ITEM 5.	Other Information	35
ITEM 6.	Exhibits	36
SIGNATURES		37
EXHIBIT INDEX		38

 

 

 

		As of
		March 31, 2019				December 31, 2018
ASSETS
Current assets:
Cash and cash equivalents		$	81,310			$	99,240
Trade accounts receivable, net of allowance for doubtful accounts of $720 and $691 in 2019 and 2018, respectively			10,245				12,324
Inventories			8,087				6,627
Prepaid expenses and other current assets			1,093				1,117
Total current assets			100,735				119,308
Property, plant and equipment, net			5,305				5,213
Goodwill			33,491				33,491
Other long-term assets			1,285				—
Total assets		$	140,816			$	158,012
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	6,525			$	7,950
Accrued liabilities			5,831				5,736
Accrued compensation			2,903				6,858
Total current liabilities			15,259				20,544
Other long-term liabilities			1,629				490
Long-term debt, net			44,375				44,082
Total liabilities			61,263				65,116
Commitments and contingencies (Note 8)
Stockholders’ equity:
Common stock, $0.001 par value, 100,000,000 shares authorized; 17,792,244 and 17,689,928 shares issued and outstanding in 2019 and 2018, respectively			18				18
Additional paid-in capital			220,271				218,844
Accumulated other comprehensive gain			1				1
Accumulated deficit			(140,737	)			(125,967	)
Total stockholders’ equity			79,553				92,896
Total liabilities and stockholders’ equity		$	140,816			$	158,012

 

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		Three Months Ended
		March 31, 2019				March 31, 2018
Sales:
Product		$	11,043			$	9,081
Service			82				456
Total sales			11,125				9,537
Cost of sales:
Product			5,908				4,066
Service			129				354
Total cost of sales			6,037				4,420
Gross profit			5,088				5,117
Operating expenses:
Selling, general and administrative expenses			14,746				11,911
Research, development and engineering costs, net			4,227				2,861
Total operating expenses			18,973				14,772
Operating loss			(13,885	)			(9,655	)
Interest expense, net			851				850
Other (income) expense, net			(6	)			23
Loss from continuing operations before taxes			(14,730	)			(10,528	)
Provision for income taxes			40				10
Loss from continuing operations			(14,770	)			(10,538	)
Discontinued operations:
Income from operations of discontinued operations			—				8
Provision for income taxes			—				3
Income from discontinued operations			—				5
Net loss		$	(14,770	)		$	(10,533	)
Other comprehensive gain:
Unrealized holding gain on investments arising during period			—				1
Other comprehensive gain			—				1
Comprehensive loss		$	(14,770	)		$	(10,532	)
Basic and diluted net loss per share:
Loss from continuing operations		$	(0.83	)		$	(0.84	)
Income from discontinued operations			—				—
Basic and diluted net loss per share		$	(0.83	)		$	(0.84	)
Basic and diluted weighted average shares outstanding			17,739				12,509

 

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		Three Months Ended
		March 31, 2019				March 31, 2018
Cash flows from operating activities:
Net loss		$	(14,770	)		$	(10,533	)
Adjustments to reconcile net loss to net cash used in operating activities:
Provision for uncollectible accounts			170				—
Write-downs of excess and obsolete inventories			106				101
Depreciation and amortization			386				445
Debt related amortization included in interest expense			301				268
Stock-based compensation			1,126				551
Amortization of operating lease right-of-use assets			104				—
Changes in operating assets and liabilities:
Trade accounts receivable			1,909				1,795
Inventories			(1,566	)			399
Prepaid expenses and other current assets			469				94
Accounts payable and other current liabilities			(1,847	)			(1,350	)
Accrued compensation			(3,955	)			(1,594	)
Other long-term liabilities			(130	)			13
Net cash used in operating activities			(17,697	)			(9,811	)
Cash flows from investing activities:
Acquisition of property, plant and equipment			(526	)			(90	)
Net cash used in investing activities			(526	)			(90	)
Cash flows from financing activities:
Borrowings under credit facility, net			—				11,711
Proceeds from the sale of common stock			—				24,046
Payments of financing costs related to issuance of common stock			—				(246	)
Proceeds from the exercise of stock options			301				76
Payment of debt issuance costs and other financing activities			(8	)			—
Net cash provided by financing activities			293				35,587
Net (decrease) increase in cash and cash equivalents			(17,930	)			25,686
Cash and cash equivalents, beginning of period			99,240				28,165
Cash and cash equivalents, end of period		$	81,310			$	53,851
Supplemental Disclosure of Cash Flow Information:
Income taxes paid		$	—			$	—
Interest paid			1,076				622
Acquisition of property, plant and equipment accrued not paid			48				96

 

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										Additional								Accumulated Other				Total
		Common Stock								Paid-In				Accumulated				Comprehensive				Stockholders’
		Shares				Amount				Capital				Deficit				Gain				Equity
At December 31, 2018			17,690			$	18			$	218,844			$	(125,967	)		$	1			$	92,896
Option exercises			48				-				301				-				-				301
Restricted stock issued, net of stock forfeited			54				-				-				-				-				-
Stock-based compensation			-				-				1,126				-				-				1,126
Net loss			-				-				-				(14,770	)			-				(14,770	)
At March 31, 2019			17,792			$	18			$	220,271			$	(140,737	)		$	1			$	79,553

										Additional								Accumulated Other				Total
		Common Stock								Paid-In				Accumulated				Comprehensive				Stockholders’
		Shares				Amount				Capital				Deficit				Loss				Equity
At December 31, 2017			10,849			$	11			$	125,999			$	(77,836	)		$	(1	)		$	48,173
Issuance of common stock, net of issuance costs of $2,190			3,249				3				23,797				-				-				23,800
Issuance of common stock warrants			-				-				455				-				-				455
Option exercises			11				-				76				-				-				76
Restricted stock issued, net of stock forfeited			38				-				-				-				-				-
Stock-based compensation			-				-				551				-				-				551
Unrealized holding period gain			-				-				-				-				1				1
Net loss			-				-				-				(10,533	)			-				(10,533	)
At March 31, 2018			14,147			$	14			$	150,878			$	(88,369	)		$	-			$	62,523

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1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Nature of Operations – Nuvectra Corporation, together with its wholly-owned subsidiaries, Algostim, LLC (“Algostim”) and PelviStim LLC (“PelviStim”) (collectively “Nuvectra” or the “Company”), is a neurostimulation company committed to helping physicians improve the lives of people with chronic conditions. The Algovita® Spinal Cord Stimulation (“SCS”) System (“Algovita”) is the Company’s first commercial offering and is Conformité Européene (“CE”) marked and United States Food & Drug Administration (“FDA”) approved for the treatment of chronic pain of the trunk and/or limbs. Nuvectra’s innovative technology platform also has capabilities under development to support other neurological indications such as sacral neuromodulation (“SNM”) for the treatment of overactive bladder and deep brain stimulation (“DBS”) for the treatment of Parkinson’s disease.

 

In March 2016, the Company was formed as a separate public company as a result of a spin-off from Integer Holdings Corporation (“Integer”).

 

On January 2, 2019, the Company announced that it had completed the divestiture of its wholly owned subsidiary, NeuroNexus Technologies, Inc. (“NeuroNexus”), effective December 31, 2018. As a result, the results of operations of NeuroNexus have been classified as discontinued operations in the condensed consolidated statements of operations for all periods presented. The condensed consolidated cash flow statements include cash flows related to the discontinued operations due to Nuvectra’s (the parent company) centralized treasury and cash management processes, and accordingly cash flow amounts for discontinued operations are disclosed in Note 2 “Discontinued Operations.” All results and information in the condensed consolidated financial statements and related notes are presented as continuing operations and exclude NeuroNexus unless otherwise noted specifically as discontinued operations. Refer to Note 2 “Discontinued Operations” for additional information.

 

Basis of Presentation – The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information (Accounting Standards Codification (“ASC”) 270, Interim Reporting) and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a full presentation of financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America. Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole. In the opinion of management, the condensed consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of the results of Nuvectra for the periods presented.

 

Liquidity and Capital Resources – The Company has incurred significant net losses and negative cash flows from operations since inception and expects to incur additional net losses for the foreseeable future.

 

Based on its current plans and expectations, the Company estimates that its cash on hand, which includes proceeds from the Company’s follow-on common stock offerings completed in the first and third quarters of 2018, Credit Facility draw-downs, proceeds from the divestiture of NeuroNexus, and cash generated from sales, should meet its cash needs for at least the next twelve months.

 

The Company periodically evaluates its liquidity requirements, alternative uses of capital, capital needs and available resources. As a result of this process, the Company has in the past sought, and may in the future seek, to explore strategic alternatives to finance its business plan, including but not limited to, a public offering of its common stock, private equity or debt financings, sale of non-strategic assets, or other sources, such as strategic partnerships. The Company has elected and may continue to elect to make near-term decisions, including engaging in various capital generating initiatives, to provide additional liquidity. If the Company is unable to raise additional funds when needed, it may be required to delay, reduce, or terminate some or all of its development plans. The Company is also focusing on increasing the sales of its products to generate cash flow to fund its operations. However, there can be no assurance that the Company will be successful in its plans described above or in attracting alternative debt or equity financing. 

 

Use of Estimates – The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of sales and expenses during the reporting period. Actual results could differ materially from those estimates. Significant items subject to such estimates and assumptions include inventories, tangible and intangible asset valuations, revenue, stock-based compensation, warrants, certain accruals, and income tax accounts.

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

Concentration of Credit Risk – Financial instruments that potentially subject the Company to concentration of credit risk consist principally of trade accounts receivable owed to the Company by its customers. The Company performs on-going credit evaluations of its customers. No customer individually accounted for more than 10% of the Company’s consolidated revenues in three months ended March 31, 2019 or 2018. No customer individually accounted for more than 10% of the Company’s accounts receivable at March 31, 2019 or December 31, 2018. Additionally, the Company maintains cash deposits with major banks, which from time to time may exceed insured limits. The Company performs on-going credit evaluations of its banks. See Note 11 “Business Segment, Geographic and Concentration Risk Information” for additional information.

 

Inventories – The value of inventories, comprised solely of finished goods, are stated at the lesser of net realizable value or cost, determined using the first-in, first-out (“FIFO”) method. To value inventory, management must estimate excess or obsolete inventory, as well as inventory that is not of saleable quality. This valuation involves an inherent level of risk and uncertainty due to unpredictability of trends in the industry and customer demand for the Company’s products. In assessing the ultimate realization of inventories, management must make judgments as to future demand requirements and compare that with the current or committed inventory levels. Reserve requirements generally increase as demand decreases due to market conditions and technological and product life-cycle changes.

 

Write-downs of excess and obsolete inventories were $0.1 million in each of the first quarter of 2019 and 2018. Future events and variations in valuation methods or assumptions may cause significant fluctuations in this estimate and could have a material impact on the Company’s results.

 

Impairment of Long-Lived Assets – The Company assesses the impairment of definite-lived long-lived assets or asset groups when events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that are considered in deciding when to perform an impairment review include: a significant decrease in the market price of the asset or asset group; a significant change in the extent or manner in which a long-lived asset or asset group is being used or in its physical condition; a significant change in legal factors or in the business climate that could affect the value of a long-lived asset or asset group, including an action or assessment by a regulator; an accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction; a current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset or asset group; or a current expectation that, more likely than not, a long-lived asset or asset group will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The term more likely than not refers to a level of likelihood that is more than 50 percent.

 

Potential recoverability is measured by comparing the carrying amount of the asset or asset group to its related total future undiscounted cash flows. The projected cash flows for each asset or asset group considers multiple factors, including current revenue from existing customers, proceeds from the sale of the asset or asset group and expected profit margins giving consideration to historical and expected margins. If the carrying value is not recoverable, the asset or asset group is considered to be impaired. Impairment is measured by comparing the asset or asset group’s carrying amount to its fair value. When it is determined that useful lives of assets are shorter than originally estimated, and no impairment is present, the rate of depreciation is accelerated in order to fully depreciate the assets over their new shorter useful lives.

 

The Company did not identify any indicators of impairment for the Nuvectra asset group in the first three months of 2019 or 2018; however, as noted below, the Company performed an interim impairment test in the first quarter of 2018 for the NeuroNexus asset group, which was disposed of effective December 31, 2018, and determined the undiscounted cash flows exceeded the carrying amounts of long-lived assets.

 

Goodwill Valuation – The Company tests its goodwill balances for impairment as of December 31 of each year, or more frequently if certain indicators are present or changes in circumstances suggest that impairment may exist. When evaluating goodwill for impairment, the Company compares the fair value of a reporting unit with its carrying amount. The Company recognizes an impairment charge for the amount by which the carrying amount of a reporting unit, including goodwill, exceeds its fair value; however, the loss recognized would not exceed the total amount of goodwill allocated to the reporting unit. The Company first assesses qualitative factors to determine whether it is necessary to perform the quantitative goodwill impairment test. If determined to be necessary, the quantitative impairment test is used to identify goodwill impairment and measure the amount of the goodwill impairment to be recognized, if any.  In addition, the Company also performs impairment tests of its other long-lived assets in accordance with ASC 360-10, Impairment and Disposal of Long-Lived Assets, when indicators of impairment exist.  

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

The Company did not identify any indicators of impairment that required an impairment test in the first three months of 2019 for Nuvectra, its one remaining reporting unit following the divestiture of NeuroNexus. 

 

Previously, the Company completed its annual impairment assessment of goodwill for the Nuvectra reporting unit as of December 31, 2018, and the Company determined that it was more likely than not that the fair value of the reporting unit exceeded its carrying value as of such time. 

 

In the first quarter of 2018, the Company evaluated strategic alternatives with respect to its NeuroNexus reporting unit, which triggered an interim impairment test. Upon completing the goodwill impairment test for NeuroNexus, the Company determined that its fair value exceeded its carrying value.

 

Subsequently, on December 31, 2018, the Company determined that the fair value of NeuroNexus, based on the sale price in the divestiture, was less than the recorded carrying value of NeuroNexus. Consequently, the Company recorded an impairment charge pertaining to NeuroNexus of approximately $1.3 million and subsequently disposed of the remaining goodwill balance of approximately $3.4 million.

 

Warranty Reserve – The Company offers a warranty on certain of its products and maintains a warranty reserve, as a component of other current liabilities, for any potential claims. The Company estimates its warranty reserve based upon an analysis of all identified or expected claims and an estimate of the cost to resolve those claims. Factors that affect the Company’s warranty liability include the number of units sold, historical and anticipated rates of warranty claims, and differences between actual and expected warranty costs per claim. The Company periodically assesses the adequacy of its warranty liability and adjusts the amount as necessary.

 

Subsequent Events – The Company considers events or transactions that occur after the balance sheet date, but prior to the issuance of the financial statements, to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure.

 

On April 22, 2019, the Company entered into a Fifth Amendment to its Loan and Security Agreement, dated as of March 18, 2016, as amended, with Oxford Finance LLC and Silicon Valley Bank to revise certain financial covenants that require Nuvectra to achieve quarterly product revenues at specified levels.

 

2.	Discontinued Operations

 

Effective December 31, 2018, the Company completed the divestiture of its wholly owned subsidiary, NeuroNexus. The Company sold all of the stock of NeuroNexus to NEL Group, Inc. for $5.0 million in cash, NeuroNexus distributed all of its accounts receivable ($0.8 million, net) and other current assets to the Company, and the Company contributed $0.4 million in cash to NeuroNexus and assumed current liabilities ($0.5 million, net) of NeuroNexus. The Company also contributed certain trademarks to NeuroNexus and accelerated vesting of equity grants for all NeuroNexus employees. The Company recognized a loss of approximately $0.3 million on the disposal of NeuroNexus, which was included in other expense, net in the consolidated statements of operations and comprehensive loss for the year ended December 31, 2018.

 

For disposal transactions, the disposal of a component of an entity is reported in discontinued operations if the disposition represents a strategic shift that has (or will have) a major effect on the entity's operations and financial results. The Company evaluated the quantitative and qualitative factors related to the sale of NeuroNexus and concluded that it met the requirements for discontinued operations presentation as of December 31, 2018. Accordingly, the operating results of NeuroNexus have been classified as discontinued operations in the consolidated statements of operations for all periods presented. The discontinued operations of NeuroNexus were previously reported as the NeuroNexus segment.

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

Income (loss) from discontinued operations, net of income taxes, were as follows (in thousands):

 

 

 

 

 

3.	REVENUE FROM CONTRACTS WITH CUSTOMERS

 

The Company adopted ASC 606, Revenue From Contracts With Customers (“ASC 606”), on January 1, 2018 using the modified retrospective method for all contracts not completed as of the date of adoption. The adoption of ASC 606 did not have a material impact on the Company’s consolidated financial statements. The reported results for 2018 and thereafter reflect the application of ASC 606 guidance. The adoption of ASC 606 represents a change in accounting principle that will more closely align revenue recognition with the delivery of the Company's goods and services and will provide financial statement readers with enhanced disclosures. In accordance with ASC 606, revenue is recognized when a customer obtains control of promised goods or services. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these goods or services, and excludes any sales incentives or taxes collected from a customer which are subsequently remitted to government authorities. To achieve this core principle, the Company applies the following five steps:

 

1) Identify the contract(s) with a customer - A contract with a customer exists when (i) the Company enters into an enforceable contract with a customer that defines each party’s rights regarding the goods or services to be transferred and identifies the payment terms related to those goods or services, (ii) the contract has commercial substance and, (iii) the Company determines that collection of substantially all consideration for goods or services that are transferred is probable based on the customer’s intent and ability to pay the promised consideration.

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

2) Identify the performance obligations in the contract - Performance obligations promised in a contract are identified based on the goods or services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the good or service either on its own or together with other resources that are readily available from third parties or from the Company, and are distinct in the context of the contract, whereby the transfer of the goods or services is separately identifiable from other promises in the contract. To the extent a contract includes multiple promised goods or services, the Company must apply judgment to determine whether promised goods or services are capable of being distinct in the context of the contract. If these criteria are not met the promised goods or services are accounted for as a combined performance obligation.

 

3) Determine the transaction price - The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring goods or services to the customer. To the extent the transaction price includes variable consideration, the Company estimates the amount of variable consideration that should be included in the transaction price utilizing either the expected value method or the most likely amount method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. Determining the transaction price requires significant judgment, which is discussed by revenue category in further detail below.

 

4) Allocate the transaction price to the performance obligations in the contract - If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price (“SSP”) basis unless the transaction price is variable and meets the criteria to be allocated entirely to a performance obligation or to a distinct good or service that forms part of a single performance obligation. The Company determines SSP based on the price at which the performance obligation is sold separately. If the SSP is not observable through past transactions, the Company estimates the SSP taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations.

 

5) Recognize revenue when (or as) the Company satisfies a performance obligation - The Company satisfies performance obligations either over time or at a point in time as discussed in further detail below. Revenue is recognized at the time the related performance obligation is satisfied by transferring a promised good or service to a customer.

 

Disaggregated Revenue - Revenue Streams & Timing of Revenue Recognition

 

The Company’s revenue streams currently include product sales of Nuvectra’s Algovita system and development and engineering service revenue, and prior to 2019, also included product sales of NeuroNexus’s neural interface systems. Following is a description of the nature of the Company’s disaggregated revenue streams. Also see Note 11 “Business Segment, Geographic and Concentration Risk Information” and Note 2 “Discontinued Operations” for further disaggregation of revenue by reportable product line.

 

Product Sales

 

The contracts under which the Company realizes revenues from product sales may involve one or more systems or components, and each is determined to be a distinct performance obligation. Product revenue from continuing operations was $11.0 million for the three months ended March 31, 2019.

 

Algovita – Generally, Algovita product sales are made through the Company’s trained personnel when the Company has the obligation to perform the initial programming and stimulation, which occurs on the same day as the trial or permanent procedure. For these customers, the products and the programming and stimulation services are not determined to be distinct, but rather are treated as a combined performance obligation for which revenue is recognized upon completion of the procedure. In cases where the customer has a clinician programmer and has undergone the requisite training in order to perform the programming and stimulation services, the Company recognizes revenue upon shipment when control passes to the customer. Similarly, when the Company sells through distributors or ships product directly to the end user and has no additional obligations, revenue is recognized at the time of shipment when control passes to the customer. For the remaining sales that are sent from the Company’s distribution center directly to hospitals and medical facilities, where product is ordered in advance of an implantation procedure and a valid purchase order has been received, the Company defers revenue until all programming and stimulation obligations are fulfilled.

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

Revenue from discontinued operations of neural interface systems and components – Prior to the divestiture of NeuroNexus, each component was treated as a distinct performance obligation. The customer obtained control of the individual components upon shipment, and therefore revenue was recognized at that point in time.

 

Shipping and handling costs – Costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of sales.

 

Warranty – The Company provides a standard warranty against defects but does not provide a general right of return.

 

Significant judgments – The Company’s contracts with customers often include promises to transfer multiple products to a customer. Determining whether the promises are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Judgment is required to determine the SSP for each distinct performance obligation. The Company determines SSP based on the price at which the performance obligation is sold separately. If the SSP is not observable through past transactions, the Company estimates the SSP taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations.

 

Development and Engineering Service Revenue

 

The Company’s development services are typically provided on a fixed-fee basis. Service revenue is recognized over time as the services are performed using an input method, on a cost-to-cost basis. In 2019 and 2018, the Company had one contract that generated development and engineering services revenue, with Aleva Neurotherapeutics S.A. (“Aleva”). Under this contract, the Company is leveraging its neurostimulation technology platform in its performance of services in the development of a DBS system for Aleva to treat Parkinson’s disease. If successful, the Company will provide Aleva a royalty-bearing distribution license for commercialization by Aleva. The Company previously concluded that the licenses and the development services were not separately distinct given the proprietary nature of the Company’s technology. As such, the combined performance obligation will be recognized over time as costs are incurred. The transaction price includes a fixed fee, payable monthly based on the progress completion in satisfying the performance obligations in that month, royalties for intellectual property licenses on future sales of the licensed technology, and non-cash consideration for the customer commitment to issue the Company a common stock warrant upon CE Mark approval in Europe. When the Company receives consideration in the form of royalties, the Company will estimate the royalty revenue and recognize the royalty revenue when a sale by the customer occurs. The non-cash consideration is a form of variable consideration that must be estimated at contract inception and therefore requires significant judgment. See “Significant judgments” below for further discussion. Services revenue recognized over time was $0.1 million for the first three months of 2019. The Company is still performing services and the client has yet to receive CE Mark approval and therefore, the Company has not yet billed or recognized any royalty revenue to date.

 

Significant judgments – The Company’s contracts with customers often include promises to transfer multiple products to a customer. Determining whether the promises are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment, specifically for development and engineering service revenues. Once the performance obligations are identified, the Company determines the transaction price, which includes estimating the amount of variable consideration to be included in the transaction price, if any. The Company then allocates the transaction price to each performance obligation in the contract based on a relative stand-alone selling price method. The corresponding revenues are recognized as the related performance obligations are satisfied as discussed above. Judgment is required to determine the SSP for each distinct performance obligation. The Company determines SSP based on the price at which the performance obligation is sold separately. If the SSP is not observable through past transactions, the Company estimates the SSP taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations.

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

The Company’s service revenue is recognized over time using an input method based on costs incurred. As such, estimating the total costs to be incurred and progress to completion on the contract requires significant judgment. Management uses historical experience, project plans and an assessment of the risks and uncertainties inherent in the arrangements to establish these estimates. Various uncertainties may or may not be within the Company’s control.

 

Transaction Price Allocated to Future Performance Obligations 

 

ASC 606 requires disclosure of the aggregate amount of transaction price that is allocated to performance obligations that have not yet been satisfied or are partially satisfied as of the balance sheet date. The Company has elected to apply certain optional exemptions that limit this requirement to exclude contracts, which are expected to be satisfied within one year as well as the potential royalty license revenue. After considering these exemptions, the Company’s service revenue contract with Aleva is subject to this disclosure for the portion of the transaction price not subject to royalties. As of March 31, 2019, the estimated revenue expected to be recognized in the future related to this contract totals $0.6 million and is expected to be recognized over the following 3 to 9 months.

 

Contract Balances

 

Timing of revenue recognition may differ from the timing of invoicing to customers. The Company records a receivable when revenue is recognized prior to invoicing when it has an enforceable right to payment and a contract asset when the Company does not. If invoicing occurs prior to revenue recognition, the unearned revenue is presented on the consolidated balance sheet as a contract liability, referred to as deferred revenue. When invoicing occurs after revenue recognition, earned revenue is presented on the consolidated balance sheet as a contract asset, referred to as unbilled receivables. The Company’s standard payment terms are 30 days.

 

Revenue recognized during the first three months of 2019 from amounts included in deferred revenue at the beginning of the period was $0.1 million, which was related to product sales revenue. There was no revenue recognized during the first three months of 2019 from performance obligations satisfied or partially satisfied in previous periods. During the first three months of 2019, there were no contract assets reclassified to receivables as a result of the right to the transaction consideration becoming unconditional.

 

Costs to Obtain and Fulfill a Contract

 

The Company has elected to apply the practical expedient and recognize the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets that the Company otherwise would have recognized is one year or less, and therefore, the Company recognizes an asset for the incremental costs of obtaining a contract with a customer if the expected period of benefit of those costs is longer than one year. As of March 31, 2019 and December 31, 2018, all contract acquisition costs have been expensed as incurred as the period of benefit is less than one year.

 

Certain NeuroNexus contracts may have included pre-production activities, design work for custom products. The Company’s policy is to capitalize incremental costs incurred to fulfill its contracts that (i) relate directly to the contract (ii) are expected to generate resources that will be used to satisfy the Company’s performance obligation under the contract and (iii) are expected to be recovered through revenue generated under the contract. These costs have historically been immaterial. Accordingly, there were no capitalized fulfillment costs as of March 31, 2019 or December 31, 2018.

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

4.	Accrued Liabilities

 

Accrued liabilities consisted of the following (in thousands):

 

 

 

 

5.	EMPLOYEE BENEFIT PLANS

 

Nuvectra Corporation 2016 Equity Incentive Plan – The Nuvectra Corporation 2016 Equity Incentive Plan (the “2016 Equity Plan”) provides that the Compensation and Organization Committee of the Company’s board of directors (the “Compensation Committee”) may award eligible participants, as it may determine from time to time, the following types of awards: stock options, stock appreciation rights, restricted stock, restricted stock units and stock bonuses. Subject to adjustment provisions in the 2016 Equity Plan, the total number of shares of Nuvectra common stock reserved for issuance under the 2016 Equity Plan is 2,682,197 as of March 31, 2019.

 

During the three months ended March 31, 2019, the Compensation Committee granted equity awards aggregating 981,871 shares of common stock under the 2016 Equity Plan in the form of both restricted stock units and non-qualified stock options to its directors and certain officers and key employees. Compensation cost related to the 2016 Equity Plan for the three months ended March 31, 2019 was approximately $1.1 million.

 

During the three months ended March 31, 2018, the Compensation Committee granted equity awards aggregating 26,716 of common stock under the 2016 Equity Plan in the form of both restricted stock units and non-qualified stock options to its directors and certain officers and key employees. Compensation cost related to the 2016 Equity Plan for the three months ended March 31, 2018 was approximately $0.5 million.

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

The components and classification of stock-based compensation expense were as follows (in thousands):

 

 

 

The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model with weighted-average assumptions based on the grant date. The weighted average fair value and assumptions used to value options granted under the 2016 Equity Plan were as follows:

 

 

The following table summarizes the stock option activity during the first three months of 2019:

 

  

The Company received proceeds totaling approximately $0.3 million upon the exercise of 47,983 stock options during the first three months of 2019.

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

The following table summarizes the restricted stock and restricted stock unit activity during the first three months of 2019:

 

 

Nuvectra Bonus Plan – The terms of the Nuvectra Corporation Bonus Plan provide for both annual discretionary cash contribution-based bonuses and cash performance-based bonuses based upon Nuvectra’s company-wide performance measures and, for certain employees, individual performance measures that are set by Nuvectra’s executive management and, in some instances, members of the board of directors. Compensation cost related to the bonus plan for the three months ended March 31, 2019 and 2018 was approximately $0.2 million and $0.3 million, respectively

 

Defined Contribution Plans – The Company sponsors a defined contribution plan under Section 401(k) of the Internal Revenue Code of 1986, as amended (“Section 401(k)”), for its employees. The plan provides for the deferral of employee compensation under Section 401(k), and a discretionary match by the Company. For the three months ended March 31, 2019 and 2018 this match was 25% per dollar of participant deferral, up to 6% of the total compensation for each participant. Direct costs related to this defined contribution plan were $0.1 million for each of the three months ended March 31, 2019 and 2018.

 

6.

DEBT

 

Long-term debt is comprised of the following (in thousands):

 

Credit Facility – The Company has a credit facility, originally entered into and funded in March 2016 and subsequently amended in February 2017, February 2018, December 2018 and February 2019 (the “Credit Facility”). The Credit Facility consists of term loan facilities in an aggregate maximum principal amount of $45 million. The term loan facilities are comprised of (i) a $27.5 million Term Loan A commitment (“Term Loan A”), which was funded in full in February 2018 and replaced a $27.5 million term loan previously outstanding under the Credit Facility, (ii) a $12.5 million Term Loan B commitment (“Term Loan B”), which was funded in full in February 2018, and (iii) a $5 million Term Loan C commitment (“Term Loan C”), which was funded in full in September 2018.

 

In connection with the February 2018 amendment to the Credit Facility, Term Loan A and Term Loan B were funded for aggregate gross proceeds of $40 million, of which $27.5 million was applied to repay the outstanding principal balance of previously-outstanding term loans. The Company determined that it met the criteria to be accounted for as a modification in which any unamortized debt discount is amortized over the remaining term of the exchanged or modified debt. The Company also paid a fee of approximately $0.8 million in connection with the February 2018 amendment, which was recorded as a discount on long-term debt to be amortized over the term of Term Loan B. If any term loans are prepaid prior to their scheduled maturity, the Company must pay, in addition to a final payment due at maturity (as described below), a prepayment fee equal to $1.3 million plus 2% of the prepaid principal if paid prior to February 2020 and 1% of the prepaid principal if paid thereafter.

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

On December 31, 2018, in connection with the sale of NeuroNexus, the Company amended the Credit Facility to remove NeuroNexus as a borrower and release the security interests on the stock and assets of NeuroNexus. The Company paid a fee of $0.03 million in connection with the December 2018 amendment, which was recorded as a discount on long-term debt to be amortized over the term of the loan. Subsequent to the quarter ending March 31, 2019, on April 22, 2019, the Company entered into a Fifth Amendment to the Credit Agreement to revise certain financial covenants that require Nuvectra to achieve quarterly product revenues at specified levels.

 

The term loans bear interest at a floating rate equal to the prime rate plus 4.15%, with a floor of 8.65%. At March 31, 2019 the interest rate on borrowings under the term loans was 9.65%. The Company pays accrued interest monthly on the term loans through March 2020, and for 30 months thereafter the Company will pay accrued interest monthly plus equal payments of principal on the term loans. At the maturity of the term loans, on September 1, 2022, all principal on the term loans then outstanding, plus an additional 7.75% of the funded loan amounts, will be due and payable. This final payment has been treated as an in-substance discount and is being amortized using the straight-line method over the life of the term loans. 

 

The term loans are secured by a first priority lien on substantially all of the assets of the Company, including, without limitation, all cash, deposit accounts, accounts receivable, equipment, inventory, contract rights, the ownership interests of its subsidiaries and the Company’s real property located in Blaine, Minnesota, but excluding all intellectual property of the Company (other than accounts receivable and proceeds of intellectual property). The Company’s intellectual property is subject to a negative pledge. The Company must maintain its primary operating and investment accounts with SVB Financial Group, one of the Company’s lenders under the Credit Facility, which accounts are subject to customary control agreements.

  

The Credit Facility contains customary representations and warranties, reporting and other covenants for credit facilities of this kind including prohibitions on the payment of cash dividends on the Company’s capital stock and restrictions on mergers, sales of assets, investments, incurrence of liens, incurrence of indebtedness and transactions with affiliates. The Company is subject to a quarterly financial covenant requiring the Company to achieve specified minimum consolidated product revenues. As of March 31, 2019, the Company was in compliance with the financial covenant. The events of default in the Credit Facility are customary for credit facilities of this kind, and include failure to pay interest or principal, breaches of affirmative and negative covenants, a material adverse change occurring, and cross defaults to other material agreements of the Company.

  

Warrants – On March 18, 2016, as a condition to the lenders’ initial funding of the initial Term Loan A commitment in the amount of $15 million, the Company issued to each of its two lenders, Oxford Finance LLC and SVB Financial Group (successor by assignment to Silicon Valley Bank), a warrant to purchase 56,533 shares of Nuvectra common stock (a total of 113,066 shares) at an exercise price of $5.97 per share, which warrants are exercisable until March 18, 2026. Additionally, the Company incurred $1.5 million in fees and other direct costs of the debt transaction in connection with the initial funding. The fair value of the warrants on the date of grant totaled approximately $0.2 million and was recorded as a discount on long-term debt along with the cash issuance costs and as additional paid-in capital in the consolidated balance sheet, as the warrants met the criteria under the relevant accounting standard for treatment as an equity instrument. The related debt discount was being amortized over the term of the Term Loan A commitment.

 

On September 28, 2017, as a condition to the lenders’ funding the initial Term Loan B commitment in the amount of $12.5 million, the Company issued to each of its two lenders a warrant to purchase 22,844 shares of Nuvectra common stock (a total of 45,688 shares) at an exercise price of $12.31 per share, which warrants are exercisable until September 28, 2027. In connection with the February 2017 Credit Facility amendment, the Company paid fees of $0.04 million. The fair value of the warrants on the date of grant totaled approximately $0.4 million and was recorded as additional paid-in capital in the consolidated balance sheet, as the warrants met the criteria under the relevant accounting standard for treatment as an equity instrument. The related debt discount was being amortized over the term of the Term Loan B commitment.

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

As a condition to the lenders’ funding the new Term Loan B commitment under the February 2018 amendment to the Credit Facility, the Company issued to the each of its two lenders a warrant to purchase 30,245 shares of Nuvectra common stock (a total of 60,490 shares) at an exercise price of $9.30 per share, which warrants are exercisable until February 18, 2028. The fair value of the warrants on the date of grant totaled approximately $0.5 million and was recorded as additional paid-in capital in the consolidated balance sheet in the first quarter of 2018, as the warrants met the criteria under the relevant accounting standard for treatment as an equity instrument. The related debt discount is being amortized over the term of the Term Loan B commitment.

 

As a condition to the lenders’ funding the new Term Loan C commitment on September 28, 2018 in the amount of $5 million, the Company issued to the each of its two lenders a warrant to purchase 5,119 shares of Nuvectra common stock (a total of 10,238 shares) at an exercise price of $21.98 per share, which warrants are exercisable until September 28, 2028. The fair value of the warrants on the date of grant totaled approximately $0.2 million and was recorded as additional paid-in capital in the consolidated balance sheet in the third quarter of 2018, as the warrants met the criteria under the relevant accounting standard for treatment as an equity instrument. The related debt discount is being amortized over the term of the Term Loan C commitment.

 

Deferred Financing Fees – The change in deferred financing fees is as follows (in thousands):

 

 

In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2015-03, “Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs,” the Company has presented debt issuance costs as a direct deduction from Long-Term Debt in the condensed consolidated balance sheets.

 

7.	INCOME TAXES

 

The income tax provision for interim periods is determined using an estimate of the annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter, the estimate of the annual effective tax rate is updated, and if the estimated effective tax rate changes, a cumulative adjustment is made. There is a potential for volatility of the effective tax rate due to several factors, including changes in the mix of the pre-tax income and the jurisdictions to which it relates, changes in tax laws, business reorganizations and settlements with taxing authorities.

 

The Company records a valuation allowance when it is “more likely than not” that all or a portion of a deferred tax asset will not be realized. Management reviews all available positive and negative evidence, including the Company’s current and past performance, the market environment in which the Company operates, the utilization of past tax credits, length of carry back and carry forward periods, existing contracts or sales backlog that will result in future profits, as well as other factors. The Company maintains a full valuation allowance on all of the net deferred tax assets for the periods presented. Until an appropriate level of profitability is sustained, the Company expects to continue to record a full valuation allowance on future tax benefits.

 

8.	COMMITMENTS AND CONTINGENCIES

 

Litigation – Periodically the Company is a party to various legal actions, both threatened and filed, arising in the ordinary course of business. While the Company does not expect that the ultimate resolution of any ordinary course pending actions will have a material effect on its results of operations, financial position, or cash flows, litigation is subject to inherent uncertainties. As such, there can be no assurance that any pending or threatened ordinary course legal action, which the Company currently believes to be immaterial, does not become material in the future.

 

On September 19, 2017, Boston Scientific Corporation (“Boston Scientific”) filed a lawsuit in district court in Suffolk County, Massachusetts, against the Company and three former Boston Scientific employees hired by the Company, alleging tortious interference of contract on the part of the Company and breaches of contract related to non-solicitation and confidentiality by Boston Scientific’s former employees. The parties entered into a settlement agreement and release in February 2019, under which the Company paid consideration for the full release of all claims and Boston Scientific’s dismissal, with prejudice, of its suit against all parties. The settlement amount was immaterial to the Company.

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

Purchase Commitments – Contractual obligations for purchase of goods or services are defined as agreements that are enforceable and legally binding on the Company and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum, or variable price provisions; and the approximate timing of the transaction. The Company’s purchase orders are normally based on its current manufacturing or other operational needs. Inventory to be purchased by Nuvectra in 2019 under its supply agreements is subject to certain minimum order quantity requirements. As of March 31, 2019, the Company had no material commitments to purchase capital assets; however, planned capital expenditures for the remainder of 2019 are estimated at approximately $1.0 million and will primarily be financed by existing cash and cash equivalents. The Company also enters into contracts for outsourced services; however, the contracts generally contain provisions allowing for cancellation without significant penalty.

 

Leases – The Company is party to various operating lease agreements for office and laboratory facilities and dedicated information technology hardware. Please see Note 13 “Recently Issued Accounting Standards” for the Company’s updated policies related to leases.

 

The components of lease expense and supplemental cash flow information related to leases for the period are as follows (in thousands):

 

 

The supplemental balance sheet information related to leases for the period is as follows (in thousands):

 

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

Maturities of the Company’s lease liabilities are as follows (in thousands):

 

 

 

9.	EARNINGS (LOSS) PER SHARE

 

Basic net loss per share is calculated by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted net loss per share is equal to basic net loss per share, as the Company had no potentially dilutive securities outstanding for any of the periods presented. The following table illustrates the calculation of basic and diluted net loss per share (in thousands, except per share amounts):

 

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

10.	FAIR VALUE MEASUREMENTS

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e. the “exit price”) in an orderly transaction between market participants at the measurement date. ASC establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. The hierarchy is broken down into three levels based on the reliability of inputs as follows:

 

Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Level 1 valuations do not entail a significant degree of judgment.

 

Level 2 – Valuation is determined from quoted prices for similar assets or liabilities in active markets, quoted prices for identical instruments in markets that are not active or by model-based techniques in which all significant inputs are observable in the market.

 

Level 3 – Valuation is based on unobservable inputs that are significant to the overall fair value measurement. The degree of judgment in determining fair value is greatest for Level 3 valuations.

 

The carrying amounts of cash, accounts receivable, accounts payable, and accrued expenses approximate fair value because of the short-term nature of these items. As of March 31, 2019, the fair value of the Company’s variable rate long-term debt approximates its carrying value and is categorized in Level 2 of the fair value hierarchy.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

Fair value measurement standards apply to certain financial assets and liabilities that are measured at fair value on a recurring basis (each reporting period).

 

The Company categorizes its warrants measured at fair value on a recurring basis in Level 3 of the fair value hierarchy.

 

The Company’s investments in marketable securities primarily consist of investments in debt securities, which are classified as Cash and Cash Equivalents on the consolidated balance sheet because of their original maturities of three months or less. Unrealized gains or losses for the periods presented are included in other comprehensive gain or loss, as applicable.

 

The fair values of marketable securities were estimated using the market approach using prices and other relevant information generated by market transactions involving identical or comparable assets. The Company uses quoted market prices in active markets or quoted market prices in markets that are not active to measure fair value. When developing fair value estimates, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs. As of March 31, 2019, the fair value of marketable securities was approximately $72.8 million, all of which had original maturities of three months or less.

 

Marketable securities, measured at fair value, by level within the fair value hierarchy were as follows (in thousands):

 

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

Fair value standards also apply to certain assets and liabilities that are measured at fair value on a nonrecurring basis. A summary of the valuation methodologies for assets and liabilities measured on a nonrecurring basis is as follows:

 

Long-lived Assets – The Company reviews the carrying amount of its long-lived assets to be held and used, other than goodwill, for potential impairment whenever certain indicators are present as described in Note 1 “Summary of Significant Accounting Policies.” During the first three months of 2019 and 2018, no impairment charges were recorded related to the Company’s long-lived assets.

 

Goodwill – Goodwill recorded is not amortized but is periodically tested for impairment. The Company assesses goodwill for impairment on December 31, or more frequently if certain events occur as described in Note 1 “Summary of Significant Accounting Policies.”

 

During the first three months of 2019, no impairment charges were recorded related to the Company’s goodwill.

 

On December 31, 2018, the Company determined that the fair value of NeuroNexus, based on the sale price in the divestiture, was less than the recorded carrying value of NeuroNexus. Consequently, the Company recorded an impairment charge pertaining to NeuroNexus of approximately $1.3 million and subsequently disposed of the remaining goodwill balance of approximately $3.4 million.

 

Warrants – In order to determine the fair value of its warrants classified as equity awards, the Company used a Monte Carlo simulation model. The risk-free interest rate represents the 10-Year U.S. Treasury rate as of the issuance date. The expected volatility assumption is based on historical volatilities for publicly traded stock of comparable companies.

 

 

11.	BUSINESS SEGMENT, GEOGRAPHIC AND CONCENTRATION RISK INFORMATION

 

Effective December 31, 2018, the Company completed the divestiture of its wholly-owned subsidiary, NeuroNexus. As a result, as of December 31, 2018, the Company has one reportable segment and one reporting unit, Nuvectra.

 

Nuvectra is a neurostimulation company committed to helping physicians improve the lives of people with chronic conditions. Algovita is the Company’s first commercial offering and is approved for the treatment of chronic pain of the trunk and/or limbs. Nuvectra’s innovative technology platform also has capabilities under development to support other neurological indications such as SNM for the treatment of overactive bladder and DBS for the treatment of Parkinson’s disease. Revenue includes development and engineering service fees and sales from the release of Algovita in the United States and Europe. Future revenues of Nuvectra are expected to come primarily from sales of Algovita, particularly after expansion of its launch commercially in the United States, and, subject to FDA approval, Virtis, the second application of the Company’s neurostimulation technology platform and its first product for the SNM market.

 

Prior to its divestiture, NeuroNexus designed, manufactured and marketed neural-interface technologies for the neuroscience clinical research market. Revenues included sales of neural interface technology, components and systems to the neuroscience and clinical markets. Refer to Note 2 “Discontinued Operations” for additional information.

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

An analysis and reconciliation of the Company’s product lines to the respective information in the condensed consolidated financial statements follows (in thousands):

 

 

All of the Company’s long-lived tangible assets are located in the United States.

 

12.	related party transactions

 

On March 14, 2016, Integer completed the spin-off, at which time the Company became a separate public company. The Company entered into, or amended, various agreements with Integer to effect the spin-off and to provide a framework for the Company’s relationship with Integer after the spin-off including a supply agreement, license agreements, a separation and distribution agreement, a tax matters agreement, a transition services agreement and an employee matters agreement, which provided for the allocation between Nuvectra and Integer of assets, employees, liabilities and obligations (including PP&E, employee benefits, and tax-related assets and liabilities) attributable to the Company’s business for the period prior to, at, and after the spin-off. The tax matters agreement, the transition services agreement and the employee matters agreement have expired and are no longer in effect.

 

Supply Agreement – The Company has a supply agreement with Integer pursuant to which Integer manufactures Algovita and certain of its components. Total charges incurred under this supply agreement are included in cost of sales.

 

13.	RECENTLY ISSUED ACCOUNTING STANDARDS

 

In the normal course of business, management evaluates all new accounting pronouncements issued by the FASB to determine the potential impact they may have on the Company’s consolidated financial statements. Based upon this review, except as noted below, management does not expect any of the recently issued accounting pronouncements, which have not already been adopted, to have a material impact on the Company’s consolidated financial statements.

 

Recently Adopted in 2019

 

The Company adopted ASC Topic 842, Leases, as of January 1, 2019 and has applied its transition provisions at the beginning of the period of adoption (i.e. on the effective date), and so did not restate comparative periods. Under this transition provision, the Company has applied the legacy guidance under ASC Topic 840, Leases, including its disclosure requirements, in the comparative periods presented.

 

Under ASC Topic 842, a lease is a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment (i.e., an identified asset) for a period of time in exchange for consideration. The Company’s contracts determined to be or contain a lease include explicitly or implicitly identified assets where the Company has the right to substantially all of the economic benefits of the assets and has the ability to direct how and for what purpose the assets are used during the lease term. Leases are classified as either operating or financing. For operating leases, the Company has recognized a lease liability equal to the present value of the remaining lease payments, and a right of use asset equal to the lease liability, subject to certain adjustments, such as for prepaid rents. The Company used its incremental borrowing rate to determine the present value of the lease payments. The Company’s incremental borrowing rate is the rate of interest that it would have to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. The Company determined the incremental borrowing rates for its leases by applying its applicable borrowing rate, with adjustment as appropriate for lease currency and lease term.

 

Upon adoption, the Company recognized right-of-use assets and lease liabilities for operating leases in the amount of $1.8 million and $2.3 million, respectively.    

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

The Company enters into contracts to lease real estate and information technology equipment. The Company’s most significant lease liabilities relate to real estate leases that have initial contract lease terms ranging from 5 to 8 years. Certain leases include renewal, termination or purchase options that were not deemed reasonably assured of exercise under ASC 840. Under ASC Topic 842, the lease term at the lease commencement date is determined based on the non-cancellable period for which the Company has the right to use the underlying asset, together with any periods covered by an option to extend the lease if the Company is reasonably certain to exercise that option, periods covered by an option to terminate the lease if the Company is reasonably certain not to exercise that option, and periods covered by an option to extend (or not to terminate) the lease in which the exercise of the option is controlled by the lessor. The Company considered a number of factors when evaluating whether the options in its lease contracts were reasonably certain of exercise, such as length of time before option exercise, expected value of the leased asset at the end of the initial lease term, importance of the lease to overall operations, costs to negotiate a new lease, and any contractual or economic penalties.

 

Operating leases result in a straight-line lease expense, while finance leases result in a front-loaded expense pattern. The Company has no finance leases. The Company does not have any contracts where it is the lessor and does not sublease any of its leased assets to third parties. The lease for the Company’s Plano, Texas headquarters facility is with Integer. The Company’s lease agreements do not contain any residual value guarantees or restrictive covenants.

 

ASC Topic 842 includes practical expedient and policy election choices. The Company elected the package of practical expedients available in the standard and as a result, did not reassess the lease classification of existing contracts or leases or the initial direct costs associated with existing leases. The Company elected the hindsight practical expedient, and evaluated lease term for existing leases.

 

The Company has made an accounting policy election not to recognize right of use assets and lease liabilities for leases with a lease term of 12 months or less, including renewal options that are reasonably certain to be exercised, that also do not include an option to purchase the underlying asset that is reasonably certain of exercise. Instead, lease payments for these leases are recognized as lease cost on a straight-line basis over the lease term.

 

ASC Topic 842 includes a number of reassessment and re-measurement requirements for lessees based on certain triggering events or conditions, including whether a contract is or contains a lease, assessment of lease term and purchase options, measurement of lease payments, assessment of lease classification and assessment of the discount rate. The Company reviewed the reassessment and re-measurement requirements and did not identify any events or conditions during the quarter ended March 31, 2019 that required a reassessment or re-measurement. In addition, there were no impairment indicators identified during the quarter ended March 31, 2019 that required an impairment test for the Company’s right-of-use assets or other long-lived assets in accordance with ASC 360-10.

 

Certain of the Company’s leases include variable lease costs to reimburse the lessor for real estate tax and insurance expenses, and certain non-lease components that transfer a distinct service to the Company, such as common area maintenance services. The Company has elected to separate the accounting for lease components and non-lease components, for real estate leases.

 

Please see Note 8 “Commitments and Contingencies” for the Company’s updated disclosures related to leases.

 

Not Yet Adopted

 

In August 2018, the FASB issued ASU 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract. ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a cloud computing arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption of the ASU on its condensed consolidated financial statements.

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, which modifies the disclosure requirements on fair value measurements. ASU 2018-13 is effective in the first quarter of fiscal 2020, and earlier adoption is permitted. The Company is currently in the process of evaluating the impact of adoption of the ASU on its condensed consolidated financial statements.

 

 

Nuvectra Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – Unaudited

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The purpose of ASU 2016-13 is to replace the current incurred loss impairment methodology, for financial assets measured at amortized cost, with a methodology that reflects expected credit losses. It also requires consideration of a broader range of reasonable and supportable information, including forecasted information, to develop credit loss estimates. The ASU affects trade receivables, debt securities, net investment in leases, and most other financial assets that represent a right to receive cash. Additional disclosures about significant estimates and credit quality are also required. ASU 2016-13 is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption is permitted for annual periods beginning after December 15, 2018. The Company is currently in the process of evaluating the impact of adoption of the ASU on its condensed consolidated financial statements.

 

 

Nuvectra Corporation

 

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