| Item 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and the related notes appearing elsewhere in this report, and together with our audited consolidated financial statements, related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as of and for the year ended December 31, 2020 included in our Annual Report on Form 10-K, filed with the SEC on October 21, 2021 (the “2020 Annual Report”).
Overview
We are a shock wave technology company using a patented system of noninvasive, high-energy, acoustic shock waves for regenerative medicine and other applications. Our initial focus is regenerative medicine utilizing noninvasive, acoustic shock waves to produce a biological response resulting in the body healing itself through the repair and regeneration of tissue, musculoskeletal, and vascular structures.
Our lead regenerative product in the United States is the dermaPACE® device, used for treating diabetic foot ulcers (“DFU”), which was subject to two double-blinded, randomized Phase III clinical studies. On December 28, 2017, the U.S. Food and Drug Administration (“FDA”) granted the Company’s request to classify the dermaPACE® System as a Class II device via the de novo process. As a result of this decision, the Company was able to immediately market the product for the treatment of DFU as described in the de novo request, subject to the general control provisions of the Food, Drug and Cosmetic Act and the special controls identified in this order.
On August 6, 2020, we entered into an asset purchase agreement (the “Asset Purchase Agreement” or “Acquisition”) with Celularity Inc. (“Celularity”) pursuant to which we acquired Celularity’s UltraMIST assets (“UltraMIST” or the “Assets”). The UltraMIST® System provides through a fluid mist a low-frequency, non-contact, and pain free ultrasound energy deep inside the wound bed that promotes healing from within. The ultrasound acoustic waves promote healing by reducing inflammation and bacteria in the wound bed, while also increasing the growth of new blood vessels to the area. The UltraMIST® System treatment must be administered by a healthcare professional. This proprietary technology has been cleared by the FDA for the promotion of wound healing through wound cleansing and maintenance debridement combined with ultrasound energy deposited inside the wound that stimulated tissue regeneration.
In connection with the Asset Purchase Agreement, on August 6, 2020, we entered into a license and marketing agreement with Celularity pursuant to which Celularity granted to the Company a license to the Celularity wound care biologic products, Biovance® and Interfyl® (the “License Agreement”). The License Agreement provides the Company with an exclusive license to use, market, distribute and sell Biovance® in the “Field” and “Territory” (each as defined in the License Agreement), and a non-exclusive license to use, market, distribute and sell Interfyl® in the Field and in the Territory. The License Agreement has an initial five-year term, after which it automatically renews for additional one-year periods, unless either party gives written notice at least 180 days prior to the expiration of the current term. In May 2021, the Company received notification alleging that it is not in compliance the License Agreement with Celularity. See further discussion in Note 15 - Contingencies in the accompanying Condensed Consolidated Financial Statements.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our Condensed Consolidated Financial Statements, which have been prepared in accordance with U.S. GAAP. The preparation of our Condensed Consolidated Financial Statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses.
On an ongoing basis, we evaluate our estimates and judgments, including those related to the recording of the allowances for doubtful accounts, net realizable value of inventory, useful lives of long-lived assets, fair value of goodwill and other intangible assets, the determination of the valuation allowance for deferred taxes, the estimated fair value of the warrants, and the estimated fair value of stock-based compensation. We base our estimates on authoritative literature and pronouncements, historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates under different assumptions or conditions. The results of our operations for any historical period are not necessarily indicative of the results of our operations for any future period.
Our significant accounting policies are more fully described in Note 3 to our Consolidated Financial Statements filed with our 2020 Annual Report. For a description of recent accounting policies and the impact on our financial statements, refer to Note 3 in the accompanying Condensed Consolidated Financial Statements.
Financial Overview
Since inception in 2005, our operations have primarily been funded from the sale of capital stock, notes payable, and convertible debt securities. We have devoted and expect to continue to devote substantial resources for the commercialization of the dermaPACE® System and intend to continue to research and develop the non-medical uses of the PACE technology, both of which will require additional capital resources. We also expect to require additional working capital as sales of our UltraMIST product continue to grow.
We incurred net losses of $30.9 million and $10.4 million for the years ended December 31, 2020 and 2019, respectively, and additional losses of approximately $13.6 million in the first six months of 2021. These factors and the events of default on the promissory notes discussed above create substantial doubt about the Company’s ability to continue as a going concern for a period of at least twelve months from the financial statement issuance date. See Note 17 – Subsequent Events to the accompanying Condensed Consolidated Financial Statements for a discussion of the various events of default.
Our operating losses create substantial doubt about our ability to continue as a going concern. Although no assurances can be given, we believe that potential additional issuances of equity, debt or other potential financing may provide the necessary funding for us to continue as a going concern for the 12 months. See “Liquidity and Capital Resources” for further information regarding our financial condition.
The continuation of our business is dependent upon raising additional capital to fund operations. Management’s plans are to obtain additional capital in 2022 through investments by strategic partners for market opportunities, which may include strategic partnerships or licensing arrangements, or raise capital through the conversion of outstanding warrants, the issuance of common or preferred stock, securities convertible into common stock, or secured or unsecured debt. These possibilities, to the extent available, may be on terms that result in significant dilution to our existing shareholders. In addition, there can be no assurances that our plans to obtain additional capital will be successful on the terms or timeline we expect, or at all. Although no assurances can be given, management believes that potential additional issuances of equity or other potential financing transactions as discussed above should provide the necessary funding for us for the next 12 months. If these efforts are unsuccessful, we may be required to significantly curtail or discontinue operations or, if available, obtain funds through financing transactions with unfavorable terms.
The accompanying Condensed Consolidated Financial Statements have been prepared in conformity with U.S. GAAP, which contemplate continuation of the Company as a going concern and the realization of assets and satisfaction of liabilities in the normal course of business. The carrying amounts of assets and liabilities presented in the financial statements do not necessarily purport to represent realizable or settlement values. The Condensed Consolidated Financial Statements do not include any adjustment that might result from the outcome of this uncertainty. Our Condensed Consolidated Financial Statements do not include any adjustments relating to the recoverability of assets and classification of assets and liabilities that might be necessary should we be unable to continue as a going concern.
Since our inception, we have incurred losses from operations each year. As of December 31, 2020, we had an accumulated deficit of $156.7 million. Although the size and timing of our future operating losses are subject to significant uncertainty, we anticipate that our operating losses will continue over the next few years as we continue to incur expenses related to commercialization of our dermaPACE® system for the treatment of DFU in the United States. If we are able to successfully commercialize, market and distribute the dermaPACE® system, then we believe we may be able to partially or completely offset these losses in the future with revenues from sales of our UltraMist systems and applicators. Although no assurances can be given, we believe that potential additional issuances of equity, debt or other potential financing, as discussed above, may provide the necessary funding for us to continue as a going concern for the next 12 months. We cannot reasonably estimate the nature, timing and costs of the efforts necessary to complete the development and approval of, or the period in which material net cash flows are expected to be generated from, any of our products, due to the numerous risks and uncertainties associated with developing and marketing products, including the uncertainty of:
• the scope, rate of progress and cost of our clinical trials;
• future clinical trial results;
• the cost and timing of regulatory approvals;
• supplier and customer disputes;
• the establishment of successful marketing, sales and distribution channels and partnerships, including our efforts to expand our marketing, sales and distribution reach through joint ventures and other contractual arrangements;
• the cost and timing associated with establishing reimbursement for our products;
• the effects of competing technologies and market developments; and
• the industry demand and patient wellness behavior.
Any failure to complete the development of our product candidates in a timely manner, or any failure to successfully market and commercialize our product candidates, would have a material adverse effect on our operations, financial position and liquidity. A discussion of the risks and uncertainties associated with us and our business are set forth under the section entitled “Risk Factors – Risks Related to Our Business” in our 2020 Annual Report.
The worldwide spread of the COVID-19 virus has resulted and is expected to continue to result in a global slowdown of economic activity which is likely to continue to decrease demand for a broad variety of products, including from our customers, while also disrupting supply channels and marketing activities for an unknown period of time. Also, the pandemic may cause continued or additional actions by hospitals and clinics such as limiting elective procedures and treatments and limiting clinical trial activities and data monitoring. We expect all of these factors to continue to have a negative impact on our sales and our results of operations, the size and duration of which we are currently unable to predict.
Results of Operations
Revenues and Gross Margin
Revenues for the three months ended June 30, 2021 were $2.9 million compared to $83 thousand for the same period in 2020, an increase of $2.8 million. For the first two quarters of 2021, revenues were $5.0 million compared with $232 thousand for the comparable period of 2020. The increases were primarily driven by 2021 sales of UltraMIST devices and single-use accessories. The Company’s UltraMIST business began with the August 6, 2020 Acquisition. Please see Note 14 - Contingencies in the accompanying Condensed Consolidated Financial Statements for a description of a supplier dispute relating to UltraMIST.
Gross margin as a percentage of revenue increased to 64% from 5% during the second quarter of 2021 as compared with the second quarter of the prior year. For the first six months of 2021 gross margin increased to 58% compared with 10% for the first six months of 2020. The increase in gross margin percentages for the both the quarter and year-to-date periods were driven by sales of UltraMIST products and accessories, which have higher gross margin percentages than do DuraPACE products and accessories.
Research and Development Expenses
Research and development expenses increased 3% to $272 thousand from $265 thousand during the second quarter of 2021 compared with the second quarter of 2020. For the first six months of 2021, research and development expenses increased 14% to $626 thousand from $551 thousand for the same period of 2020. Increases for both the quarter and six-month periods were driven by higher employee compensation and benefits costs incurred by the larger, post-Acquisition organization, though these costs were partially offset by lower amounts paid to external parties for clinical studies and other research and development.
Selling and Marketing Expenses
Selling and marketing expenses increased $2.1 million or 482% and $3.3 million or 313% for the three and six-month periods ended June 30, 2021, respectively, versus the same periods of 2020. The expense increases were primarily driven by higher employee compensation, commissions, benefits, travel and marketing costs incurred by the larger, post-Acquisition organization as well as higher levels of revenues.
General and Administrative Expenses
General and administrative expenses increased $536 thousand or 21% and $1.9 million or 43% for the three and six-month periods ended June 30, 2021, respectively, compared with the same periods of 2020. The primary drivers of these increases for the quarter and year-to-date periods, respectively, consist of approximately, $528 thousand and $1.3 million of expenses related to Registration Statement penalty accruals as well as approximately $176 thousand and $352 thousand of the increases for amortization of intangible assets related to the Acquisition on August 6, 2020. Additionally, both the quarter and year-to-date periods reflect increases in bad debt, insurance and public company expenses as well as offsetting decreases in legal and other professional fees.
Liquidity and Capital Resources
We expect to devote substantial resources for the commercialization of the dermaPACE® System and intend continue to research and develop the next generation of our technology as well as the non-medical uses of the PACE technology, both of which will require additional capital resources. We incurred a net loss of $30.9 million and $10.4 million for the years ended December 31, 2020 and 2019, respectively, and incurred additional net losses in the six months of 2021 of approximately $13.6 million. These factors and the events of default on the notes payable create substantial doubt about the Company’s ability to continue as a going concern for a period of at least twelve months from the financial issuance date. Historically, our operations have primarily been funded from the sale of capital stock, notes payable, and convertible debt securities. The continuation of our business is dependent upon raising additional capital to fund operations; we may not be able to do so, and/or the terms of any financings may not be advantageous to us.
During the six months ended June 30, 2021, cash used by operating activities totaled approximately $5.2 million, which was driven largely by the net loss for the same period and was partially offset by increases in accounts payable and accrued expenses as well as decreases in accounts receivable and inventory. Cash used by investing activities during the first six months of 2021 consisted of purchases of property and equipment of $277 thousand. Cash provided by financing activities for the period consisted primarily of $1.3 million of proceeds from convertible note issuances, $1.0 million in proceeds from a factoring accounts receivable, $1.0 million of proceeds from SBA Loan #2 as well as $125 thousand in proceeds from deposits from related parties and were offset by $94 thousand of principal payments on financing leases.
Cash used in operations averaged $1.1 million per month for the first quarter of 2021 and approximately $700 thousand for the second quarter. Management anticipates cash usage for operations to be approximately $250 thousand to $500 thousand per month for the second half of 2021 as resources are devoted to the commercialization of the dermaPACE and UltraMIST products including hiring of new employees, expansion of our international business and continued research and development of the next generation of our technology as well as non-medical uses of our technology. Management’s plans are to obtain additional capital in 2022 through investments by strategic partners for market opportunities, which may include strategic partnerships or licensing arrangements, or raise capital through the conversion of outstanding warrants, issuance of common or preferred stock, securities convertible into common stock, or secured or unsecured debt. These possibilities, to the extent available, may be on terms that result in significant dilution to our existing shareholders. Although no assurances can be given, management believes that potential additional issuances of equity or other potential financing transactions as discussed above should provide the necessary funding for us for the next 12 months. If these efforts are unsuccessful, we may be required to significantly curtail or discontinue operations or, if available, obtain funds through financing transactions with unfavorable terms.
Segment and Geographic Information
We have determined that we have one operating segment. Our revenues are generated from sales in United States, Europe, Canada, Middle East, Central America, South America, Asia and Asia/Pacific. All significant expenses are generated in the United States and all significant assets are located in the United States.
Contractual Obligations
Our major outstanding contractual obligations relate to our financing leases for rental equipment, operating leases for our facilities and office equipment, purchase and supplier obligations for product component materials and equipment, and our outstanding debt. Please see our 2020 Annual Report for additional discussions of these obligations.
Off-Balance Sheet Arrangements
Since inception, we have not engaged in any off-balance sheet activities, including the use of structured finance, special purpose entities or variable interest entities.
Effects of Inflation
Due to the fact that our assets are, to an extent, liquid in nature, they are not significantly affected by inflation. However, the rate of inflation, which has been increasing, affects expenses such as employee compensation, office space leasing costs and research and development charges, which may not be readily recoverable during the period of time that we are bringing the product candidates to market. To the extent inflation results in rising interest rates and has other adverse effects on the market, it may adversely affect our consolidated financial condition and results of operations.
| Item 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Not required under Regulation S-K for “smaller reporting companies.”
| Item 4. | CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
We carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer and accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures as of October 11, 2021. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not operating effectively as of June 30, 2021. Our disclosure controls and procedures were not effective because of the “material weakness” described below under “Management’s Annual Report on Internal Control over Financial Reporting.”
Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) for the Company. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance of achieving their control objectives.
Management, with the participation of the Chief Executive Officer (principal executive officer) and the Chief Financial Officer (principal financial and accounting officer), evaluated the effectiveness of the Company’s internal control over financial reporting as of October 11, 2021. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control — Integrated Framework (2013).
We previously reported three material weaknesses in our internal control over financial reporting process resulting from a lack of internal expertise and resources to analyze and properly apply U.S. GAAP to complex and non-routine transactions such as complex financial instruments and derivatives and complex sales distribution agreements, a lack of internal resources to analyze and properly apply U.S. GAAP to accounting for equity components of service agreements with select vendors and cybersecurity breaches from email spoofing in 2019. The Company remedied the cybersecurity breaches and email spoofing in 2020.
As of June 30, 2021 the Company has still identified the following material weaknesses:
| • | The Company lacks expertise and resources to analyze and properly apply U.S. GAAP to complex and non-routine transactions such as complex financial instruments and derivatives and complex sales distribution agreements. |
| • | The Company lacks internal resources to analyze and properly apply U.S. GAAP to accounting for financial instruments included in service agreements with select vendors. |
| • | The Company has failed to design and implement controls around all of its accounting and IT processes and procedures and, as such, it believes that all of its accounting and IT processes and procedures need to re-designed and tested for operating effectiveness. |
As a result, management concluded that its internal control over reporting was not effective as of June 30, 2021.
During 2021, we engaged external consultants with appropriate experience applying GAAP technical accounting guidance, and we have hired additional accounting personnel both internal and external. We engaged external consultants to review revenue recognition for new products, lease agreements, internal controls and related procedures and review of documentation of internal controls in addition to new equity and debt financing arrangements. Accounting memos were produced for all technical issues and reviewed with management. The Company will continue to implement and review new controls to address these issues.
We have also implemented cybersecurity training for all employees and redesign of procedures that cyber security breaches may impact and worked with our third-party IT vendor to develop a training plan for all existing and new employees related to cyber and implemented related controls around information technology infrastructure. In addition, an additional employee was hired to assist with the management of IT controls and enhance internal IT resources. Going forward, this employee will monitor our third-party IT vendor’s testing and monitoring efforts and where necessary implement new controls as the Company grows. These internal controls have been documented and procedures implemented.
There is no assurance that the measures described above will be sufficient to remediate the previously identified material weaknesses.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2021 that materially affect, or are reasonably likely to materially affect, our internal control over financial reporting, except as disclosed in “Remediation Plan” above.
PART II — OTHER INFORMATION
| Item 1. | LEGAL PROCEEDINGS. |
From time to time, the Company is subject to various legal actions, claims and proceedings arising in the ordinary course of business, including claims related to breach of contracts and intellectual property matters resulting from our business activities. As with most actions such as these, an estimation of any possible and/or ultimate liability cannot always be determined. The Company believes that all pending claims, if adversely decided, would not have a material adverse effect on our business, financial position or results of operations.
As a “smaller reporting company” as defined by Item 10 of Regulation S-K, we are not required to provide the information required under this item. A discussion of the risks and uncertainties associated with us and our business are set forth under the section entitled “Risk Factors – Risks Related to Our Business” in our 2020 Annual Report.
| Item 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. |
Not applicable.
| Item 3. | DEFAULTS UPON SENIOR SECURITIES. |
Not applicable.
| Item 4. | MINE SAFETY DISCLOSURES. |
Not applicable.
| Item 5. | OTHER INFORMATION. |
Not applicable.
| Exhibit No. | Description |
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| Rule 13a-14(a)/15d-14(a) Certification of the Principal Executive Officer. |
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| Rule 13a-14(a)/15d-14(a) Certification of the Chief Financial Officer. |
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| Section 1350 Certification of the Principal Executive Officer. |
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| Section 1350 Certification of the Chief Financial Officer. |
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101.INS*† | XBRL Instance. |
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101.SCH*† | XBRL Taxonomy Extension Schema. |
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101.CAL*† | XBRL Taxonomy Extension Calculation. |
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101.DEF*† | XBRL Taxonomy Extension Definition. |
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101.LAB*† | XBRL Taxonomy Extension Labels. |
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101.PRE*† | XBRL Taxonomy Extension Presentation. |
* Filed herewith.
** Furnished herewith.
† XBRL-related documents are not deemed filed for purposes of section 11 of the Securities Act of 1933, as amended, section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject the liabilities of these sections, and are not part of any registration statement to which they relate.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | SANUWAVE HEALTH, INC. |
| | |
Dated: January 14, 2022
| By: /s/ Kevin A. Richardson, II |
| | Name: Kevin A. Richardson, II |
| | Title: Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
| Signatures | | Capacity | | Date |
| | | | | |
By: /s/ Kevin A. Richardson, II Name: Kevin A. Richardson, II | | Chief Executive Officer and Chairman of the Board of Directors (principal executive officer) | | January 14, 2022 |
| | | | | |
By: /s/ Lisa E. Sundstrom Name: Lisa E. Sundstrom | | Chief Financial Officer (principal financial and accounting officer) | | January 14, 2022
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