Tenon Medical, Inc.: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis is intended as a review of significant factors affecting our financial condition and results of operations for the periods indicated. The discussion should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q and the audited financial statements and the other information set forth in the Registration Statement. In addition to historical information, the following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in these forward-looking statements as a result of certain factors discussed herein and any other periodic reports filed and to be filed with the SEC.

Overview

Tenon Medical, Inc., a medical device company formed in 2012, has developed a proprietary, U.S. Food and Drug Administration (“FDA”) approved surgical implant-system, which we call The Catamaran™ SI Joint Fusion System (“The Catamaran System”). The Catamaran System offers a novel, less invasive inferior-posterior approach to the sacroiliac joint (“SI Joint”) using a single, robust titanium implant to treat SI Joint dysfunction that often causes severe lower back pain. The system features the Catamaran™ Fixation Device which passes through both the axial and sagittal planes of the ilium and sacrum, transfixing the SI Joint along its longitudinal axis. Published clinical studies have shown that 15% to 30% of all chronic lower back pain is associated with the SI Joint.

With an entry similar to the SI Joint injection, the surgical approach is direct to the joint. The angle and trajectory of the inferior-posterior approach is designed to point away from critical neural and vascular structures and into the strongest cortical bone. Joined by a patented osteotome bridge, the implant design consists of two hollow fenestrated pontoons with an open framework to facilitate bony in-growth through the SI Joint. One pontoon fixates into the ilium and the other into the sacrum. The osteotome is designed to disrupt the articular portion of the joint to help facilitate a fusion response.

Our initial clinical results indicate that The Catamaran System implant is promoting fusion across the joint as evidenced by computerized tomography (CT) scans which is the gold standard widely accepted by the clinical community. We had our national launch of The Catamaran System in October 2022 and are building a sales and marketing infrastructure to market our product and address the greatly underserved market opportunity that exists.

We believe that the implant design and procedure we have developed, along with the 2D and 3D protocols for proper implantation will be received well by the clinician community who have been looking for a next generation device.

We have incurred net losses since our inception in 2012. As of September 30, 2023, we had an accumulated deficit of approximately $51.9 million. To date, we have financed our operations primarily through an initial public offering, private placements of equity securities, certain debt-related financing arrangements, and sales of our product. We have devoted substantially all of our resources to research and development, regulatory matters and sales and marketing of our product.

Components of Results of Operations

Revenue

We derive substantially all our revenue from sales of The Catamaran System to a limited number of clinicians. Revenue from sales of The Catamaran System fluctuates based on volume of cases (procedures performed), discounts, and the number of implants used for a particular patient. Similar to other orthopedic companies, our revenue can also fluctuate from quarter to quarter due to a variety of factors, including reimbursement, changes in independent sales representatives and physician activities.

Cost of Goods Sold, Gross Profit, and Gross Margin

We utilize contract manufacturers for production of The Catamaran System implants and Catamaran Tray Sets. Cost of goods sold consists primarily of costs of the components of The Catamaran System implants and instruments, quality inspection, packaging, scrap and inventory obsolescence, as well as distribution-related expenses such as logistics and shipping costs. We anticipate that our cost of goods sold will increase in absolute dollars as case levels increase.

Our gross margins have been and will continue to be affected by a variety of factors, including the cost to have our product manufactured for us, pricing pressure from increasing competition, and the factors described above impacting our revenue.

Operating Expenses

Our operating expenses consist of sales and marketing, research and development, and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist of consulting expenses, salaries, sales commissions and other cash and stock-based compensation related expenses. We expect operating expenses to increase in absolute dollars as we continue to invest and grow our business.

Sales and Marketing Expenses

Sales and marketing expenses primarily consist of independent sales representative training and commissions in addition to salaries and stock-based compensation expense. Starting in May 2021, commissions to our national distributor have been based on a percentage of sales and we anticipate that these commissions will make up a significant portion of our sales and marketing expenses. We expect our sales and marketing expenses to increase in absolute dollars with the commercial launch of The Catamaran System resulting in higher commissions and salaries, increased clinician and sales representative training, and the start of clinical studies to gain wider clinician adoption of The Catamaran System. Our sales and marketing expenses may fluctuate from period to period due to timing of sales and marketing activities related to the commercial launch of our product.

Research and Development Expenses

Our research and development expenses primarily consist of engineering, product development, regulatory expenses, and consulting services, outside prototyping services, outside research activities, materials, and other costs associated with development of our product. Research and development expenses also include related personnel and consultants’ compensation and stock-based compensation expense. We expense research and development costs as they are incurred. We expect research and development expense to increase in absolute dollars as we improve The Catamaran System, develop new products, add research and development personnel, and undergo clinical activities that may be required for regulatory clearances of future products.

General and Administrative Expenses

General and administrative expenses primarily consist of salaries, consultants’ compensation, stock-based compensation expense, and other costs for finance, accounting, legal, compliance, and administrative matters. We expect our general and administrative expenses to increase in absolute dollars as we add personnel and information technology infrastructure to support the growth of our business. We also expect to incur additional general and administrative expenses as a result of operating as a public company, including but not limited to: expenses related to compliance with the rules and regulations of the SEC and those of The Nasdaq Stock Market LLC on which our securities are traded; additional insurance expenses; investor relations activities; and other administrative and professional services. While we expect the general and administrative expenses to increase in absolute dollars, we anticipate that it will decrease as a percentage of revenue over time.

Gain (Loss) on Investments, Interest Expense and Other Income (Expense), Net

Gain (loss) on investments consists of interest income and realized gains and losses from the sale of our investments in money market and corporate debt securities. Interest expense is related to borrowings and includes deemed interest derived from the beneficial conversion prices of notes payable. Other income and expenses have not been significant to date.

Results of Operations

The following table sets forth our results of operations for the periods presented (in thousands):

The following table sets forth our results of operations as a percentage of revenue:

Comparison of the Three and Nine Months Ended September 30, 2023 and 2022 (in thousands, except percentages)

Revenue, Cost of Goods Sold, Gross Profit, and Gross Margin

17

Revenue. The increase in revenue for the three and nine months ended September 30, 2023 as compared to the same periods in 2022 was primarily due to increases of 329% and 404%, respectively, in the number of surgical procedures in which The Catamaran System was used.

Cost of Goods Sold, Gross Profit, and Gross Margin. The increase in cost of goods sold for the three and nine months ended September 30, 2023 as compared to the same periods in 2022 was due to increases of 329% and 404%, respectively, in the number of surgical procedures performed. Gross loss and gross margin percentage improved due to higher revenue associated with the increase in the number of surgical procedures.

Operating Expenses

Research and Development Expenses. Research and development expenses for the three months ended September 30, 2023 decreased as compared to the same period in 2022 primarily due to decreased professional fees ($64), partially offset by increased payroll expenses ($15).

Research and development expenses for the nine months ended September 30, 2023 increased as compared to the same period in 2022 primarily due to increased stock-based compensation ($549) and payroll expenses ($101), partially offset by decreased professional fees ($36).

Sales and Marketing Expenses. Sales and marketing expenses for the three months ended September 30, 2023 increased as compared to the same period in 2022 primarily due to increased payroll expenses ($641), SpineSource transition expenses ($203), sales commissions ($75), and stock-based compensation ($18), partially offset by decreased consulting and professional fees ($54). The increase in payroll and payroll related expenses is primarily due to the increased number of sales and marketing employees as we build out our sales function.

Sales and marketing expenses for the nine months ended September 30, 2023 increased as compared to the same period in 2022 primarily due to increased payroll expenses ($1,965), SpineSource transition expenses ($893), sales commissions ($684) and stock-based compensation ($110), partially offset by decreased consulting and professional fees ($1,198). The increase in payroll and payroll related expenses is primarily due to the increased number of sales and marketing employees as we build out our sales function.

General and Administrative Expenses. General and administrative expenses for the three months ended September 30, 2023 decreased as compared to the same period in 2022 primarily due to decreased professional service fees ($91) and payroll expenses ($22) partially offset by increased stock-based compensation ($12).

General and administrative expenses for the nine months ended September 30, 2023 decreased as compared to the same period in 2022 primarily due to a legal settlement accrual in 2022 ($574) and decreased professional service fees ($603), partially offset by increased stock-based compensation ($738) and payroll expenses ($223).

Gain (Loss) on Investments, Interest Expense and Other Income (Expense), Net

Gain on investments for the three months ended September 30, 2023 decreased $22 as compared to the three months ended September 30, 2022. Gain on investments for the nine months ended September 30, 2023 increased $35 as compared to the nine months ended September 30, 2022 due to interest on our investments in money market and corporate debt securities. We had no significant interest expense for the three and nine months ended September 30, 2023 and interest expense for the nine months ended September 30, 2022 of $362 related to our convertible debt.

Liquidity and Capital Resources; Going Concern

As of September 30, 2023, we had cash and cash equivalents and short-term investments of approximately $3.4 million. Since inception, we have financed our operations through private placements of preferred stock, debt financing arrangements, our initial public offering, a subsequent public offering, issuance of stock under our Equity Distribution Agreement and the sale of our products. As of September 30, 2023, we had no outstanding debt.

As of September 30, 2023, we had an accumulated deficit of approximately $51.9 million and expect to incur additional losses in the future. We have not achieved positive cash flow from operations to date and don’t expect to in the near future. Based upon our current operating plan, our existing cash and cash equivalents will not be sufficient to fund our operating expenses and working capital requirements through at least the next 12 months from the date these consolidated financial statements were available to be released. We plan to raise the necessary additional capital through one or a combination of public or private equity offerings, debt financings, and collaborations. We continue to face challenges and uncertainties and, as a result, our available capital resources may be consumed more rapidly than currently expected due to (a) the uncertainty of future revenues from The Catamaran System; (b) changes we may make to the business that affect ongoing operating expenses; (c) changes we may make in our business strategy; (d) regulatory developments affecting our existing products; (e) changes we may make in our research and development spending plans; and (f) other items affecting our forecasted level of expenditures and use of cash resources.

As we attempt to raise additional capital to fund our operations, funding may not be available to us on acceptable terms, or at all. If we are unable to obtain adequate financing when needed, we may have to delay, reduce the scope of or suspend one or more of our sales and marketing efforts, research and development activities, or other operations. We may seek to raise any necessary additional capital through a combination of public or private equity offerings, debt financings, and collaborations. If we do raise additional capital through public or private equity offerings, the ownership interest of our existing stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our stockholders’ rights. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures, or declaring dividends. If we are unable to raise capital, we will need to delay, reduce, or terminate planned activities to reduce costs. Doing so will likely harm our ability to execute our business plans. Due to the uncertainty in our ability to raise capital, management believes that there is substantial doubt in our ability to continue as a going concern for the next twelve months from the issuance of these consolidated financial statements.

We plan to use our cash within the twelve months from September 30, 2023 and beyond for working capital and research and development.

Contractual Obligations

The following table summarizes our contractual obligations as of September 30, 2023:

Obligations under Terminated Sales Representative Agreement: On October 6, 2022, we entered into the Terminating Amended and Restated Exclusive Sales Representative Agreement (the “Termination Agreement”). In accordance with the Termination Agreement, (i) we paid the Representative $1,000 in cash; and (ii) we agreed to pay the Representative (a) $85 per month during the six months after the date of the Termination Agreement in return for efforts by the Representative to transition operations to us, (b) 20% of net sales of the Product sold in the United States and Puerto Rico until December 31, 2023 and (c) after December 31, 2023, 10% of net sales until such time as the aggregate amount paid to the Representative under this clause (c) and clause (b) above equal $3,600. In the event of an acquisition, we will pay the Representative $3,600 less previous amounts paid pursuant to clause (b) and clause (c) above. The timing of the payments under clause (b) and (c) is variable depending on the timing of our sales.

Cash Flows (in thousands, except percentages)

The following table sets forth the primary sources and uses of cash for each of the periods presented below:

The increase in net cash used in operating activities for the nine months ended September 30, 2023 as compared to the nine months ended September 30, 2022 was primarily attributable to our increased net loss of $1.8 million, adjusted for increases in non-cash stock-based compensation expenses ($1,409) and a decrease in common stock issued for services (1,561), in addition to increases in accounts receivable ($477) and prepaid expenses ($157).

Cash provided by investing activities for the nine months ended September 30, 2023 consisted primarily of the net sales of short-term investments of approximately $6.5 million to use to fund our operations, partially offset by purchases of property and equipment of $0.3 million. Cash used in investing activities for the nine months ended September 30, 2022 consisted primarily of the net purchases of short-term investments of $5.0 million and purchases of property and equipment of $0.2 million.

Cash provided by financing activities for the nine months ended September 30, 2023 consisted primarily of the $5.3 million, net of relevant expenses, received from our offerings of stock in 2023. Cash provided by financing activities for the nine months ended September 30, 2022 consisted of the $14.1 million cash received from our initial public offering in April 2022, net of relevant expenses.

Critical Accounting Policies, Significant Judgments, and Use of Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported results of operations during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from three other sources. Actual results could differ from these estimates under different assumptions or conditions. For the nine months ended September 30, 2023, there were no significant changes to our existing critical accounting policies from those disclosed on our Annual Report on Form 10-K.

Off-Balance Sheet Arrangements

As of September 30, 2023, and December 31, 2022, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms promulgated by the Securities and Exchange Commission, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Because of the inherent limitations to the effectiveness of any system of disclosure controls and procedures, no evaluation of disclosure controls and procedures can provide absolute assurance that all control issues and instances of fraud, if any, with a company have been prevented or detected on a timely basis. Even disclosure controls and procedures determined to be effective can only provide reasonable assurance that their objectives are achieved.

As of September 30, 2023, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) pursuant to Rule 13a-15 of the Exchange Act. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are not effective at the reasonable assurance level.

Our size has prevented us from being able to employ sufficient resources to enable us to have an adequate level of supervision and segregation of duties. Therefore, it is difficult to effectively segregate accounting duties which comprises a material weakness in internal controls. This lack of segregation of duties leads management to conclude that the Company’s disclosure controls and procedures are not effective to give reasonable assurance that the information required to be disclosed in reports that the Company files under the Exchange Act is recorded, processed, summarized and reported as and when required.

To the extent reasonably possible given our limited resources, we intend to take measures to cure the aforementioned weaknesses, including, but not limited to, increasing the capacity of our qualified financial personnel to ensure that accounting policies and procedures are consistent across the organization and that we have adequate control over our Exchange Act reporting disclosures.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control procedures over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the nine months ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

As a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934, as amended, and in item 10(f)(1) of Regulation S-K, we are electing scaled disclosure reporting obligations and therefore are not required to provide the information requested by this item. In any event, there have been no material changes in our risk factors as previously disclosed in our Annual Report on Form 10-K filed with the U.S. Securities and Securities Exchange Commission (“SEC”) on March 10, 2023.