SEAE HLDG The terms "we," "us," "our," "SeaSpine" or the "Company" refer collectively toSeaSpine Holdings Corporation and its wholly-owned subsidiaries, unless otherwise stated. All information in this report is based on our fiscal year. Unless otherwise stated, references to particular years, quarters, months or periods refer to our fiscal years endingDecember 31 and the associated quarters, months and periods of those fiscal years. This Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). The matters discussed in these forward-looking statements are subject to risk and uncertainties that could cause actual results to differ materially from those made, projected or implied in the forward-looking statements. Such risks and uncertainties may also give rise to future claims and increase exposure to contingent liabilities. Please see the "Risk Factors" section in our Annual Report on Form 10-K for the year endedDecember 31, 2021 (the 2021 10-K) for a discussion of the uncertainties, risks and assumptions associated with these statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
You can identify these forward-looking statements by forward-looking words such as "believe," "may," "could," "will," "estimate," "continue," "anticipate," "intend," "seek," "plan," "expect," "should," "would" and similar expressions.
These risks and uncertainties arise from (among other factors):
•the proposed merger with Orthofix, including whether the required regulatory and stockholder approvals will be obtained and the other conditions to closing will be satisfied, potential challenges to the proposed merger, the contractual restrictions on the operation of our business during the pendency of the merger, business operational uncertainties and potential loss of key employees; •if the proposed merger with Orthofix is not consummated, we may need to raise additional capital to continue our operations, execute our business strategy and remain a going concern;
•our expectations and estimates concerning future financial performance, financing plans and the impact of competition;
•our ability to successfully develop new and next-generation products and the costs associated with designing and developing those new and next-generation products, including risks inherent in collaborations, such as with restor3d, Inc. or use of nascent manufacturing techniques, such as additive processing/3D printing; •physicians' willingness to adopt our recently launched and planned products, customers' continued willingness to pay for our products and third-party payors' willingness to provide or continue coverage and appropriate reimbursement for any of our products and our ability to secure regulatory clearance and/or approval for products in development; •our ability to attract and retain new, high-quality distributors and direct sales representatives, whether as a result of perceived deficiencies, or gaps, in our existing product portfolio, inability to reach agreement on financial or other contractual terms or otherwise, as well as disruption associated with restrictive covenants to, which distributors or direct sales representatives may be subject and potential litigation and expense associate therewith; •the full extent to which the COVID-19 pandemic will, directly or indirectly, impact our business, results of operations and financial condition, including our sales, expenses, supply chain integrity, manufacturing capability, research and development activities, including arising from or relating to deferrals of procedures using our products, disruptions or restrictions on the ability of many of our employees and of third parties on which we rely to work effectively, and temporary closures of our facilities and of the facilities of our customers and suppliers; •the full extent to which the ongoing conflict inUkraine will, directly or indirectly, impact our business, results of operations and financial condition, including our sales, expenses, supply chain integrity, manufacturing capability, and research and development activities;
•our ability to continue to invest in medical education and training, product development, and/or sales and commercial marketing initiatives at levels sufficient to drive future revenue growth;
•anticipated trends in our business, including consolidation among hospital systems, healthcare reform inthe United States , increased pricing pressure from our competitors or hospitals, exclusion from major healthcare systems, whether as a result of unwillingness to provide required pricing or otherwise, and changes in third-party payment systems; 26 --------------------------------------------------------------------------------
•the risk of supply shortages, and the associated potentially long-term
disruption to product sales, including as a result of the pandemic, the ongoing
conflict in
•unexpected expenses and delay and our ability to manage timelines and costs related to manufacturing our products including as a result of litigation or developing and supporting the full commercial launch of new products or relating to the pandemic;
•our ability to obtain additional debt and equity financing to fund capital expenditures and working capital requirements and acquisitions;
•our ability to complete acquisitions, integrate operations post-acquisition and maintain relationships with customers of acquired entities;
•our ability to support the safety and efficacy of our products with long-term clinical data;
•existing and future regulations affecting our business, both in
•our ability to protect our intellectual property, including unpatented trade secrets, and to operate without infringing or misappropriating the proprietary rights of others;
•general economic and business conditions, in both domestic and international markets; and
•other risk factors described in the section entitled "Risk Factors" of the 2021 10-K.
These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements included in this report.
Overview
We are a global medical technology company focused on the design, development, and commercialization of surgical solutions for the treatment of patients suffering from spinal disorders. We offer procedural solutions that feature our FLASH™ Navigation, a system designed to improve accuracy of screw placement and provide a cost-effective, rapid, radiation-free solution to surgical navigation, and a comprehensive portfolio of spinal implants and orthobiologics to meet the varying combinations of products that neurosurgeons and orthopedic spine surgeons need to facilitate spinal fusion in degenerative, minimally invasive surgery (MIS), and complex spinal deformity procedures on the lumbar, thoracic and cervical spine. We believe our offerings are essential to meet the "complete solution" requirements of these surgeons. We report revenue in two product categories: (i) orthobiologics and (ii) spinal implants and enabling technologies. Our orthobiologics products consist of a broad range of advanced and traditional bone graft substitutes designed to improve bone fusion rates following a wide range of orthopedic surgeries, including spine, hip, and extremities procedures. Our spinal implants and enabling technologies portfolio consists of an extensive line of products and image-guided surgical solutions to facilitate spinal fusion in degenerative, minimally invasive surgery (MIS), and complex spinal deformity procedures. OurU.S. spinal implants and orthobiologics sales organization consists primarily of regional and territory managers who oversee a broad network of independent sales agents. We pay these sales agents commissions based on the sales of our products. Our enabling technologies sales organization consists of a direct sales force that works together with our independent sales agents to generate either a capital sale or to place systems and components in an account in a capital efficient manner in return for a longer-term revenue commitment for our spinal implant systems and/or orthobiologics products. Our international sales organization consists of a sales management team that oversees a network of independent stocking distributors that purchase products directly from us and independently sell them. For the three months endedSeptember 30, 2022 and 2021, international sales accounted for approximately 24% and 11% of our revenue, respectively, and 16% and 11% for the nine months endedSeptember 30, 2022 and 2021, respectively. Our policy is not to sell our products through or to participate in physician-owned distributorships.
Proposed Business Combination
OnOctober 10, 2022 ,SeaSpine entered into an Agreement and Plan of Merger (the "Merger Agreement") with Orthofix Medical Inc., aDelaware corporation ("OrthoFix"), andOrca Merger Sub Inc. , aDelaware corporation and a wholly-owned subsidiary of Orthofix ("Merger Sub"), pursuant to which, upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub will merge with and intoSeaSpine (the "Merger"), withSeaSpine continuing as the surviving company and a wholly-owned subsidiary of Orthofix. 27 -------------------------------------------------------------------------------- Under the terms of the Merger Agreement,SeaSpine stockholders will receive 0.4163 shares of Orthofix common stock for each share ofSeaSpine common stock owned immediately prior to the effective time of the Merger. Immediately following the closing of the Merger, Orthofix stockholders will own approximately 56.5 percent of the combined company, andSeaSpine stockholders will own approximately 43.5 percent of the combined company, on a fully diluted basis. The consummation of the Merger is subject to customary conditions, including the approval by Orthofix stockholders of the issuance of shares of Orthofix common stock in connection with the Merger; (ii) the adoption of the Merger Agreement bySeaSpine stockholders holding a majority of the outstanding shares ofSeaSpine's common stock, and all applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 having expired or been terminated and all mandatory waiting periods or required consents under any other applicable antitrust or competition laws having expired or been obtained. Each party also agreed not to (i) take certain actions to solicit proposals relating to alternative business combination transactions or (ii) subject to certain exceptions, including the receipt of a Superior Proposal (as such term is defined in the Merger Agreement), enter into discussions or an agreement concerning or provide confidential information in connection with any proposals for alternative business combination transactions. The Merger Agreement also contains certain termination rights, including, among others, the right of either party to terminate if the Merger shall not have become effective by the date that is five months following the date of the Merger Agreement, which date may be extended by either party to the date that is eight months following the date of the Merger Agreement if all conditions to consummate the Merger have been satisfied other than the condition requiring antitrust approvals. The Merger Agreement also provides for the payment of termination fees by both parties under specified circumstances. The amount payable by Orthofix toSeaSpine is$13.7 million plus expenses not to exceed$2 million , and the amount payable bySeaSpine to Orthofix is$10.6 million plus expenses not to exceed$2 million .
The Merger is expected to close in the first quarter of 2023, subject to the satisfaction of applicable conditions.
The foregoing description of the Merger Agreement does not purport to be
complete and is qualified in its entirety by reference to the full text of the
Merger Agreement, which is filed as Exhibit 2.1 to the registrant's current
report on Form 8-K filed on
European Spinal Implant Sales and Marketing
During the third quarter of 2021, we ceased in-person sales and marketing operations inFrance to reduce operating expenses and to centralize the management of our European sales and marketing operations in our headquarters located inCarlsbad, California . As a result, we closed our office located inLyon, France , and eliminated all employment positions at that location. During the fourth quarter of 2021, we notified our European distributors that we will discontinue all sales and marketing activities for our spinal implant portfolio in the European market effective inSeptember 2022 due to the significantly higher upfront and recurring annual costs required to comply with European medical device regulations. We will continue to market and sell our orthobiologics and enabling technologies products in the European market.
Acquisition
InMay 2021 , we acquired 7DSurgical, Inc. , a pioneer in the image-guided surgery market, that developed and commercialized advanced machine-vision-based registration algorithms to improve surgical workflow and patient care, currently with applications in spine and cranial surgeries. Its flagship system, founded on its machine-vision, image-guided surgery platform, reduces radiation exposure in open spine surgery by eliminating intra-operative CT (computed tomography) and fluoroscopy for purposes of registration, both of which commonly are used for patient registration with traditional navigational systems. 28 --------------------------------------------------------------------------------
Components of Our Results of Operations
Revenue
Our net revenue is derived primarily from the sale of orthobiologics, spinal implants and enabling technology products inNorth America ,Europe ,Asia Pacific andLatin America . Sales are reported net of returns, rebates, group purchasing organization fees and other customer allowances. Inthe United States , we generate most of our revenue by consigning our orthobiologics products and by consigning or loaning our spinal implant sets to hospitals and independent sales agents, who in turn either deliver them to hospitals for a single surgical procedure, after which they are returned to us, or leave them with hospitals that are high volume users for multiple procedures. The spinal implant sets typically contain the instruments, disposables, and spinal implants required to complete a surgery. We ship replacement inventory to independent sales agents to replace the consigned inventory used in surgeries. We maintain and replenish loaned sets at our kitting and distribution centers and return replenished sets to a hospital or independent sales agent for the next procedure. We recognize revenue on these consigned or loaned products when they have been used or implanted in a surgical procedure. Enabling technologies revenue related to the sale of capital equipment, tools and software is typically recognized upon acceptance by the customer. Revenue from training and installation is recognized upon completion of the training and installation process. Revenue from service contracts is recognized over the term of the contract. Under certain contracts, the transfer of capital equipment occurs over time as the customer's purchase commitments on other spinal implant and orthobiologics products are met. We allocate the transaction price to the multiple performance obligations under these contracts related to the sale of the products (recognized either upon the shipment or delivery of goods), the lease of capital equipment (recognized over the contract period), and the sale of capital equipment (recognized once the purchase commitments are met). For all other sales transactions, including sales to international stocking distributors and private label partners, we generally recognize revenue when the products are shipped and the customer or stocking distributor obtains control of the products. There is generally no customer acceptance or other condition that prevents us from recognizing revenue in accordance with the delivery terms for these sales transactions. Cost of Goods Sold Cost of goods sold primarily consists of the costs of finished goods purchased directly from third parties and raw materials used in the manufacturing of our products, plant and equipment overhead, labor costs and packaging costs. The majority of our orthobiologics products are designed and manufactured internally. The cost of human tissue and fixed manufacturing overhead costs are significant drivers of the cost of goods sold, and consequently our orthobiologics products, at current production volumes, generate lower gross margin than our spinal implant products. We rely on third-party suppliers to manufacture our spinal implants and enabling technology products, and we assemble the spinal implants into surgical sets at our kitting and distribution centers. The cost to inspect incoming finished goods is included in the cost of goods sold. Other costs included in cost of goods sold include amortization of product technology intangible assets, royalties, scrap and consignment losses, and charges for expired, excess and obsolete inventory.
Selling and Marketing Expense
Our selling and marketing expenses consist primarily of sales commissions, payroll and other headcount related expenses, marketing expenses, shipping, third-party logistics expenses, depreciation of spinal implant instrument sets, instrument replacement expense, and cost of tradeshows and events and medical education and training.
General and Administrative Expense
Our general and administrative expenses consist primarily of payroll and other
headcount related expenses, and expenses for information technology, legal,
human resources, insurance, finance, and management. We also record gains or
losses associated with changes in the fair value of contingent consideration
liabilities in general and administrative expenses.
29
--------------------------------------------------------------------------------Research and Development Expense
Our research and development (R&D) expenses primarily consist of expenses related to the headcount for engineering, product development, clinical affairs and regulatory functions, as well as consulting services, third-party prototyping services, outside research and clinical studies activities, and materials, production and other costs associated with development of our products. We expense R&D costs as they are incurred.
Intangible Amortization
Our intangible amortization, including the amounts reported in cost of goods sold, consists of acquisition-related amortization. We expect total annual amortization expense (including amounts reported in cost of goods sold) to be approximately$7.3 million in 2022,$6.6 million in 2023,$4.6 million in 2024,$3.3 million in 2025 and$3.3 million in 2026.
COVID-19 Pandemic - Impact on our Business
The COVID-19 pandemic has presented a substantial public health and economic challenge around the world and has materially and adversely affected our business. From lateMarch 2020 tomid-May 2020 , among other impacts on our business related to the pandemic, surgeons and their patients deferred surgical procedures in which our products otherwise could have been used. This decrease in demand for our products temporarily recovered to varying degrees beginning in the latter half ofMay 2020 as conditions improved in certain geographies, allowing patients to resume receiving their treatments. However, from lateNovember 2020 tomid-February 2021 , a significant and sustained increase in COVID-19 cases and hospitalization rates once again caused the deferral of surgical procedures in which our products otherwise could have been used. Additionally, in the third quarter of 2021, hospitalization rates in many geographies increased as a result of the spread of the Delta variant. This, along with hospital support staffing shortages in certain geographies, adversely impacted the number of elective surgical procedures and slowed the partial recovery we had been experiencing. There is a risk that we will see continued volatility in the demand for our products in 2022 and thereafter as geographies respond to local conditions. We will continue to closely monitor developments related to the pandemic and our decisions will continue to be driven by the health and well-being of our employees, our distributor and surgeon customers, and their patients while maintaining operations to support our customers and their patients in the near-term. At this time, the full extent of the impact of the pandemic on our business, financial condition and results of operations is uncertain and cannot be predicted with reasonable accuracy and will depend on future developments that are also uncertain and cannot be predicted with reasonable accuracy.
The effect of the pandemic will not be fully reflected in our results of operations and overall financial performance until future periods. For additional information on the various risks posed by the pandemic on our business, financial condition and results of operations, please see "Item 1A. Risk Factors" in Part II of this report.
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RESULTS OF OPERATIONS
Three Months Ended September 30, 2022 vs. 2021 Nine Months Ended September 30, 2022 vs. 2021
(In thousands, except
percentages) 2022 2021 % Change 2022 2021 % Change
Total revenue, net $ 67,147 $ 46,445 45 % $ 174,158 $ 135,862 28 %
Cost of goods sold 26,637 18,289 46 % 66,140 51,137 29 %
Gross profit 40,510 28,156 44 % 108,018 84,725 27 %
Gross margin 60.3 % 60.6 % 62.0 % 62.4 %
Operating expenses:
Selling and marketing 32,983 27,578 20 % 95,518 76,413 25 %
General and administrative 14,767 11,642 27 % 37,898 32,055 18 %
Research and development 6,596 6,262 5 % 18,095 15,618 16 %
Intangible amortization 856 942 (9) % 2,568 2,577 - %
Total operating expenses 55,202 46,424 19 % 154,079 126,663 22 %
Operating loss (14,692) (18,268) (20) % (46,061) (41,938) 10 %
Other (expense) income, net (419) (231) 81 % (976) 5,689 (117) %
Loss before income taxes (15,111) (18,499) (18) % (47,037) (36,249) 30 %
Provision (benefit) for income
taxes 389 (872) (145) % (986) (689) 43 %
Net loss $ (15,500) $ (17,627) (12) % $ (46,051) $ (35,560) 30 %
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Three Months Ended
Revenue
Total revenue, net for the three months ended
Three Months Ended September 30, 2022 vs. 2021
2022 2021 % Change
(In thousands)
Orthobiologics $ 25,671 $ 22,228 15 %
United States 23,754 20,145 18 %
International 1,917 2,083 (8) %
Spinal Implants and Enabling Technologies $ 41,476 $ 24,217 71 %
United States 27,381 21,082 30 %
International 14,095 3,135 350 %
Total revenue, net $ 67,147 $ 46,445 45 %
Three Months Ended September 30, 2022 vs. 2021
2022 2021 % Change
(In thousands)
United States $ 51,135 $ 41,227 24 %
International 16,012 5,218 207 %
Total revenue, net $ 67,147 $ 46,445 45 %
Revenue from orthobiologics sales totaled $25.7 million for the three months
ended September 30, 2022 , an increase of $3.4 million or 15%, from the same
period in 2021. Revenue from orthobiologics sales in the United States increased
$3.6 million to $23.8 million for the three months ended September 30, 2022
compared to the same period in 2021. The increase was primarily driven by higher
sales of recently launched products. During the three months ended September 30,
2022 , sales of products launched within the past five years increased to 48% of
U.S. orthobiologics revenue compared to 43% for the same period in 2021. Revenue
from orthobiologics sales internationally, which can be volatile from quarter to
quarter because of irregular ordering patterns from our stocking distributors,
decreased $0.2 million for the three months ended September 30, 2022 compared to
the same period in 2021.
Revenue from spinal implants and enabling technology sales was $41.5 million for
the three months ended September 30, 2022 , an increase of $17.3 million or 71%,
from the same period in 2021. Revenue from spinal implants and enabling
technology sales in the United States increased $6.3 million to $27.4 million
for the three months ended September 30, 2022 compared to the same period in
2021. The revenue growth in the current year period was driven by recently
launched products, predominantly those products that were alpha or fully
launched since 2020, and which have been important catalysts to our ability to
take market share in the U.S. spinal implants market. Revenue from spinal
implants and enabling technology sales internationally increased $11.0 million
for the three months ended September 30, 2022 as compared to the same period in
2021. The spinal implants and enabling technology revenue growth for
international was primarily driven by final spinal implant stocking orders to
European distributors prior to the Company's exit from that market in September
2022 .
Cost of Goods Sold and Gross Margin
Cost of goods sold increased$8.3 million , to$26.6 million for the three months endedSeptember 30, 2022 , compared to the same period in 2021. Gross margin remained relatively consistent at 60.3% for the three months endedSeptember 30, 2022 and 60.6% for the same period in 2021. Cost of goods sold included$1.0 million and$1.3 million of amortization for product technology intangible assets for the three months endedSeptember 30, 2022 and 2021, respectively. 32 --------------------------------------------------------------------------------
Selling and Marketing
Selling and marketing expenses increased$5.4 million to$33.0 million for the three months endedSeptember 30, 2022 compared to the same period in 2021. The increase was driven primarily by higher distributor commissions, higher tradeshow and travel costs, as well as higher selling, customer service, and supply chain headcount and related expenses.
General and Administrative
General and administrative expenses increased$3.1 million to$14.8 million for the three months endedSeptember 30, 2022 , primarily due to transaction costs related to the proposed merger with Orthofix, higher travel and headcount related expenses.
Research and Development
Research and development expenses increased$0.3 million to$6.6 million , or 10% of revenue, for the three months endedSeptember 30, 2022 compared to the same period in 2021 due to research and development headcount and related project expenses. Intangible Amortization Intangible amortization expense, excluding the amounts reported in cost of goods sold for product technology intangible assets was$0.9 million for each of the three months endedSeptember 30, 2022 and 2021, respectively. Income Taxes Three Months Ended September 30, 2022 2021 (In thousands) Loss before income taxes$ (15,111) $ (18,499) Provision (benefit) for income taxes 389 (872) Effective tax rate (2.6) % 4.7 % We recorded an income tax provision for the three months endedSeptember 30, 2022 primarily related to the change in deferred tax assets and liabilities in foreign jurisdictions, the change in US indefinite lived deferred tax liabilities, and current foreign and state income taxes. We recorded an income tax benefit for the three months endedSeptember 30, 2021 primarily related to the change in deferred tax assets and liabilities in foreign jurisdictions, offset by current activity in state and foreign operations as well as the change in US indefinite lived deferred tax liabilities. In addition, for any pretax losses incurred by the consolidatedU.S. tax group, we recorded no corresponding tax benefit because we have concluded that it is not more-likely-than-not that the full value of any resulting deferred tax assets will be realized. We will continue to assess our position in future periods to determine if it is appropriate to reduce a portion of our valuation allowance. The acquisition of 7D Surgical was treated as an asset purchase for US tax purposes and a stock purchase for Canadian tax purposes in 2021. As such, we recorded deferred tax assets and liabilities on its Canadian tax attributes. We continue to use our deferred tax liabilities as a source of income against a portion of our deferred tax assets. A valuation allowance was recorded for the portion of the deferred tax assets that are not more-likely-than-not to be realized. For the three months endedSeptember 30, 2022 , a net tax expense of$0.3 million was recorded as a result of the 7D Surgical current year losses. This was offset by expenses recorded for indefinite lived intangibles, current foreign and state taxes and prior year foreign tax true-ups. As part of the Tax Cuts and Jobs Act of 2017 (TCJA), beginning with our 2022 tax year, we are required to capitalize research and development expenses, as defined under Internal Revenue Code section 174. For expenses that are incurred for research and development in theU.S. , the amounts will be amortized over 5 years, and expenses that are incurred for research and experimentation outside theU.S. will be amortized over 15 years. This provision is not expected to have a significant impact to the consolidated financial statements. 33 --------------------------------------------------------------------------------
Nine Months Ended
Revenue
Total revenue, net for the nine months ended
Nine Months Ended September 30, 2022 vs. 2021
2022 2021 % Change
(In thousands)
Orthobiologics $ 76,176 $ 67,287 13 %
United States 69,595 60,389 15 %
International 6,581 6,898 (5) %
Spinal Implants and Enabling Technologies $ 97,982 $ 68,575 43 %
United States 76,533 60,877 26 %
International 21,449 7,698 179 %
Total revenue, net $ 174,158 $ 135,862 28 %
Nine Months Ended September 30, 2022 vs. 2021
2022 2021 % Change
(In thousands)
United States $ 146,128 $ 121,266 21 %
International 28,030 14,596 92 %
Total revenue, net $ 174,158 $ 135,862 28 %
Revenue from orthobiologics sales totaled $76.2 million for the nine months
ended September 30, 2022 , an increase of $8.9 million , from the same period in
2021. Revenue from orthobiologics sales in the United States increased $9.2
million for the nine months ended September 30, 2022 compared to the same period
in 2021. The increase was primarily driven by higher sales of recently launched
products. During the nine months ended September 30, 2022 , sales of products
launched within the past five years increased to 44% of U.S. orthobiologics
revenue compared to 41% for the same period in 2021. Revenue from orthobiologics
sales internationally, which can be volatile from quarter to quarter because of
irregular ordering patterns from our stocking distributors, decreased $0.3
million for the three months ended September 30, 2022 compared to the same
period in 2021.
Revenue from spinal implants and enabling technology sales totaled $98.0 million
for the nine months ended September 30, 2022 , an increase of $29.4 million , from
the same period in 2021. Revenue from spinal implants and enabling technology
sales in the United States increased $15.7 million for the nine months ended
September 30, 2022 compared to the same period in 2021. The revenue growth in
the current year period was driven by recently launched products, predominantly
those products that were alpha or fully launched since 2020, and which have been
important catalysts to our ability to take market share in the U.S. spinal
implants market, and from higher capital sales of enabling technology products
from 7D Surgical, which we acquired in May 2021 . Revenue from spinal implants
and enabling technology sales internationally increased $13.8 million for the
nine months ended September 30, 2022 compared to the same period in 2021. The
spinal implants and enabling technology revenue growth for international was
primarily driven by final spinal implant stocking orders to European
distributors and from higher capital sales of enabling technology products.
Cost of Goods Sold and Gross Margin
Cost of goods sold increased$15.0 million to$66.1 million for the nine months endedSeptember 30, 2022 , compared to the same period in 2021. Gross margin was 62.0% for the nine months endedSeptember 30, 2022 , compared to 62.4% for the same period in 2021. The decrease in gross margin was due to increased technology-related intangible asset amortization and inventory purchase accounting fair market value adjustments associated with the 7D Surgical acquisition. Cost of goods sold included$3.0 million and$2.2 million of amortization for product technology intangible assets, for the nine months endedSeptember 30, 2022 and 2021, respectively. 34 --------------------------------------------------------------------------------
Selling and Marketing
Selling and marketing expenses increased$19.1 million to$95.5 million for the nine months endedSeptember 30, 2022 compared to the same period in 2021. The increase was driven by higher commissions due to the revenue increase, 7D Surgical sales and marketing costs, higher sales, marketing, customer service and logistics headcount and related expenses, additional spinal instrument set depreciation and instrument replacement expense due to product launches, and higher freight and third-party logistics expenses.
General and Administrative
General and administrative expenses increased$5.8 million to$37.9 million for the nine months endedSeptember 30, 2022 compared to the same period in 2021, mostly due to transaction costs related to the proposed merger with Orthofix, the addition of general and administrative expenses attributable to 7D Surgical operations, and higher travel and headcount related expenses, which were partially offset by the legal, accounting and other due diligence costs incurred in the prior year quarter related to the 7D Surgical acquisition.
Research and Development
Research and development expenses increased$2.5 million to$18.1 million , or 10% of revenue, for the nine months endedSeptember 30, 2022 compared to the same period in 2021. The increase was due primarily to research and development headcount and related project expenses attributable to 7D Surgical operations.
Intangible Amortization
Intangible amortization expense, excluding the amounts reported in cost of goods sold for product technology intangible assets, was$2.6 million for each of the nine months endedSeptember 30, 2022 and 2021. Income Taxes Nine Months Ended September 30, 2022 2021 (In thousands) Loss before income taxes$ (47,037) $ (36,249) Benefit for income taxes (986) (689) Effective tax rate 2.1 % 1.9 %
We recorded an income tax benefit for the nine months ended
In addition, for any pretax losses incurred by the consolidatedU.S. tax group, we recorded no corresponding tax benefit because we have concluded that it is not more-likely-than-not that the full value of any resulting deferred tax assets will be realized. We will continue to assess our position in future periods to determine if it is appropriate to reduce a portion of our valuation allowance.
See "-Three Months Ended
Other Income
Other income for the nine months endedSeptember 30, 2021 primarily consisted of the gain on the forgiveness of debt related to the loan we obtained under the Paycheck Protection Program (PPP) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). 35
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Business Factors Affecting the Results of Operations
Special Charges and Gains
We define special charges and gains as expenses or non-operating gains and losses for which the amount or timing can vary significantly from period to period, and for which the amounts are non-cash in nature, or the amounts are not expected to recur at a similar frequency and magnitude in the future.
We believe that identification of these special charges and gains provides important supplemental information to investors regarding financial and business trends relating to our financial condition and results of operations. Investors may find this information useful in assessing comparability of our operating performance from period to period, against the business model objectives that management has established, and against other companies in our industry. We provide this information to investors so that they can analyze our operating and financial results in the same way that management does and use this information in their assessment of our core business and valuation.
Loss before income taxes includes the following special charges and gains for
the three and nine months ended
Three Months Ended September
30, Nine Months Ended September 30,
2022 2021 2022 2021
Special Charges and (Gains): (In thousands)
Severance and other costs associated with $ 152 $ 1,665 $ 558 $ 1,665
European sales and marketing reorganization
Purchase accounting inventory fair market value - 417 208 417
and adjustments
Acquisition and integration-related charges for 16 200 378 1,995 7D Surgical Business combination charges related to Orthofix 1,412 - 1,412 - Litigation special charges 544 - 544 - Gain on forgiveness of PPP Loan - - - (6,173) Total Special Charges and (Gains), net$ 2,124 $
2,282
The items reported above are reflected in the consolidated statements of
operations as follows:
Three Months Ended September
30, Nine Months Ended September 30,
2022 2021 2022 2021
(In thousands)
Cost of goods sold $ - $ 417 $ 208 $ 417
General and administrative 2,124 1,865 2,892 3,660
Other expense (income), net - - - (6,173)
Total Special Charges and (Gains), net $ 2,124 $
2,282
36
--------------------------------------------------------------------------------Other Matters
Critical Accounting Policies and the Use of Estimates
Our discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States of America . Preparing these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities, and the reported amounts of revenues and expenses. Significant estimates affecting amounts reported or disclosed in the consolidated financial statements include revenue recognition, allowances for doubtful accounts receivable and sales return and other credits, net realizable value of inventories, amortization periods for acquired intangible assets, estimates of projected cash flows and discount rates used to value intangible assets and test them for impairment, estimates of projected cash flows and assumptions related to the timing and probability of the product launch dates, discount rates matched to the timing of payments, and probability of success rates used to value contingent consideration liabilities from business combinations, estimates of projected cash flows and depreciation and amortization periods for long-lived assets, valuation of stock-based compensation, computation of taxes and valuation allowances recorded against deferred tax assets, and loss contingencies. These estimates are based on historical experience and on various other assumptions believed to be reasonable under the current circumstances. Actual results could differ from these estimates. The full extent to which the COVID-19 pandemic or the ongoing conflict inUkraine will directly or indirectly impact our business, results of operations and financial condition, including sales, expenses, manufacturing, research and development costs and employee-related compensation, will depend on future developments that are highly uncertain, with respect to COVID-19, including as a result of genetic variations of, or other information that may emerge concerning, COVID-19 and the actions taken to contain it or treat COVID-19, and with respect to the ongoing conflict inUkraine , the impact thereof on the supply chain for titanium, which is used in certain of our products, as well as the broader macroeconomic impact arising from both COVID-19 and the conflict on local, regional, national and international customers and markets. We have made estimates of the impact of COVID-19 within our financial statements and there may be changes to those estimates in future periods. Actual results may differ from these estimates. Note 2, "Summary of Significant Accounting Policies" to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this report and included in Part II, Item 8 of the 2021 10-K describe the significant accounting policies and estimates used in the preparation of our condensed consolidated financial statements.
Recently Issued Accounting Pronouncements
Information regarding new accounting pronouncements is included in Note 2, "Summary of Significant Accounting Policies," to the Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this report.
Liquidity and Capital Resources
Overview
As ofSeptember 30, 2022 , we had cash and cash equivalents totaling approximately$46.8 million and$0.6 million of borrowing capacity available under our credit facility. We incurred net losses in each year since inception. Our net losses were$46.1 million and$35.6 million for the nine months endedSeptember 30, 2022 and 2021, respectively. As ofSeptember 30, 2022 , we had an accumulated deficit of$319.7 million . We anticipate that our expenses will increase as we continue to invest in the expansion of our business, primarily in sales, marketing and research and development, and invest in inventory, spinal implant set builds and instrument capital expenditures. In addition, we are subject to a number of risks similar to other medical device companies, including, but not limited to, risks related to maintaining high levels of inventory, raising additional capital, and the successful discovery, development, and commercialization of products. These circumstances raise substantial doubt about our ability to continue as a going concern and, based on our operating plans and current liquidity resources, we do not believe that we have sufficient resources to fund operations and meet our contractual obligations for the 12 months following the issuance date of the accompanying consolidated financial statements. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty and assumes that we will continue as a going concern through the realization of assets and satisfaction of liabilities and commitments in the ordinary course of business. 37 -------------------------------------------------------------------------------- Subsequent to the quarter end, we entered into the Merger Agreement with Orthofix, which contemplates a merger of equals in an all stock transaction. See "-Proposed Business Combination," above. There is no assurance that the proposed Merger will be consummated. If the Merger is not consummated, we could be forced to raise funds through an equity or debt offering, delay, reduce or eliminate some or all of our projected inventory and capital expenditures spend, research and development programs or commercialization activities, which could materially adversely affect our business prospects and our ability to continue operations. See "Part II. Other Information-Item 1A. Risk Factors," below.
Capital Resources
In addition to cash from operations, our existing credit facility is our primary source of capital. However, we have raised funds in the capital markets in the past and may continue to do so from time-to-time.
Credit Facility
We have a$30.0 million credit facility withWells Fargo Bank, National Association which matures inJuly 2025 and which, under certain circumstances, could be increased by$10.0 million to$40.0 million . AtSeptember 30, 2022 , we had$25.8 million of outstanding borrowings under the credit facility. The borrowing capacity under the credit facility is determined monthly and is based on the amount of our eligible accounts receivable and inventory balances and qualified cash (as defined in the credit facility). Depending on the extent to which our eligible accounts receivable and inventory balances increase, our borrowing capacity could increase or decrease in the future. The credit facility contains various customary affirmative and negative covenants, including prohibiting us from incurring indebtedness without the lender's consent. Under the terms of the credit facility, if our Total Liquidity (as defined in the credit facility) is less than$5.0 million , we are required to maintain a minimum fixed charge coverage ratio of 1.10 to 1.00 for the applicable measurement period. Our Total Liquidity was$41.9 million atSeptember 30, 2022 , and therefore that financial covenant was not applicable at that time.
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