Apyx Medical Corp: Form 10-Q for the period ended Sep 30, 2021

You should read the following discussion and analysis in conjunction with our financial statements and related notes contained elsewhere in this report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors discussed in this report and those discussed in other documents we file with the SEC. In light of these risks, uncertainties and assumptions, readers are cautioned not to place undue reliance on such forward-looking statements. These forward-looking statements represent beliefs and assumptions as of the date of this report. While we may elect to update forward-looking statements and at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change. Past performance does not guarantee future results.

Executive Level Overview

We are an advanced energy technology company with a passion for elevating people’s lives through innovative products in the cosmetic and surgical markets. Known for our innovative Helium Plasma Technology, Apyx is solely focused on bringing transformative solutions to the physicians and patients it serves. Our Helium Plasma Technology is marketed and sold as Renuvion® in the cosmetic surgery market and J-Plasma® in the hospital surgical market. Renuvion® offers plastic surgeons, fascial plastic surgeons and cosmetic physicians a unique ability to provide controlled heat to tissue to achieve their desired results. The J-Plasma® system allows surgeons to operate with a high level of precision, virtually eliminating unintended tissue trauma. We also leverage our deep expertise and decades of experience in unique waveforms through OEM agreements with other medical device manufacturers.

We continue to drive sales in our Advanced Energy business by increasing the adoption and utilization of our handpieces in the U.S. cosmetic surgery market and fulfilling demand from distributors in our international markets. Management estimates that our products have been sold in more than 60 countries. As of September 30, 2021, we had a direct sales force of 31 field-based selling professionals and utilized 2 independent sales agencies. We also had 5 sales managers. This selling organization is focused on the use of Renuvion® in the cosmetic surgery market. In addition, we have invested in both in-person and virtual training programs and marketing-related activities to support accelerated adoption of Renuvion® into physicians' practices.

In regards to our operating segments, our results are aggregated into reportable segments only if they exhibit similar economic characteristics. In addition to similar economic characteristics, we also consider the following factors in determining the reportable segments: the nature of business activities, the management structure directly accountable to our chief operating decision maker for operating and administrative activities, availability of discrete financial information, and information presented to the Board of Directors and investors. Asset information is not reviewed by the chief operating decision maker by segment and is not available by segment and, accordingly, we have not presented a measure of assets by reportable segment.

Our reportable segments are disclosed as principally organized and managed as two operating segments: Advanced Energy and OEM. "Corporate & Other" includes certain unallocated corporate and administrative costs which are not specifically attributed to any reportable segment. The OEM segment is primarily development and manufacturing contract and product driven, and all related expenses are recorded as cost of sales, therefore no segment specific operating expenses are incurred.

We strongly encourage investors to visit our website: www.apyxmedical.com (http://www.apyxmedical.com) to view the most current news and to review our filings with the Securities and Exchange Commission.

Impact of COVID-19

As discussed in our Annual Report on Form 10-K for the year ended December 31, 2020 ("2020 Form 10-K"), an outbreak of a novel strain of the coronavirus, COVID-19, was identified in China and subsequently recognized as a pandemic by the World Health Organization. While the situation shows signs of improvement in certain countries, the COVID-19 outbreak generally continues to severely restrict the level of economic activity around the world. In response to the COVID-19 outbreak the governments of many countries, states, cities and other geographic regions have taken preventative or protective actions, such as imposing restrictions on travel and business operations and advising or requiring individuals to limit or forego their time outside of their homes. Temporary closures of businesses in some jurisdictions were ordered, and numerous other businesses closed permanently. Many other businesses continue to be operated at reduced capacity.

As vaccines have become more available, the number of COVID-19 cases has declined in the United States and various other countries, and economic conditions have improved. However, uncertainty remains regarding the extent, timing, and duration of the pandemic, including the extent to which the availability and acceptance of these vaccines will positively impact public health conditions and whether new, potentially more contagious variants may pose additional public health risks. The pandemic continues to cause uncertainty and potential economic volatility, including with regard to the pandemic’s various and unpredictable impacts on our customers and our business.

Any future significant reductions in business-related activities could result in loss of sales and profits and other material adverse effects. The extent of the impact of COVID-19 on our business, financial results, liquidity and cash flows will depend largely on future developments, including new information that may emerge concerning actions taken to contain or prevent further spread of the virus, or its newly forming variants, within the U.S. and the related impact on consumer confidence and spending, all of which are highly uncertain and cannot be predicted.

While our revenues were affected by the continued impacts of the COVID-19 pandemic, starting in the latter half of 2020 we saw strong utilization of our Renuvion® handpieces from existing customers in the U.S., along with shipments to several new customers in our international markets, which helped to offset sluggish global demand for capital equipment. Throughout this event, we continued our efforts to support our customers during this challenging time.

We were pleased to see overall improvements in our Advanced Energy business trends starting in the latter half of 2020, and continued to see improvements through the first three quarters of 2021 in utilization based global demand for our handpieces and adoption of our generator technology. Demand trends, however, for generator adoption continue to remain in varying stages of recovery in the markets we serve. Although the timing of a return to a more normalized economic environment remains uncertain, we remain optimistic with respect to the continued recovery of the cosmetic and plastic surgery market, and the utilization and adoption of our products globally.

We source the components used in our products from a variety of suppliers and we have collaborative arrangements with four key foreign suppliers. At this time our suppliers have experienced no significant production disruptions as a result of COVID-19. However, we have started to experience longer lead times and increased delays in our deliveries from these suppliers as a result of the availability of shipping from third party freight carriers. While we continue to monitor these delays, they have not, to date, had a significant impact on our manufacturing operations, but have resulted in increased inbound shipping costs and the necessity to increase levels of our key raw material component inventories. We have also begun to see increasing costs and tightened availability of various components used in our products as a result of global supply chain disruptions; these costs to date have not had a material impact on our results of operations.

We continue to closely monitor developments related to COVID-19 that may impact our operations and financial performance, and continue our efforts to support our employees and customers in the following areas:

• Protecting the Health and Safety of our Employees: To reduce the risk to our employees and their families to potential exposure to COVID-19, we have required that all non-essential employees work remotely until further notice. We also split the shifts of our manufacturing personnel to allow for adequate social distancing, and require all personnel to utilize personal protective equipment while on site at our facilities. We also significantly reduced business travel and outside access to our facilities.
• Maintaining Engagement of or Sales Team and Our Customers: In addition to the initiatives we put in place to protect health and safety for all employees, we focused our direct sales team on remaining in close contact with their existing surgeon customers to do everything they can to provide them with support during this difficult time. With this goal in mind, we implemented additional training for our sales reps in order to sharpen their ability to engage with our customers virtually. In addition to engaging with existing customers via virtual methods, our sales representatives also continued to target and reach out to prospective customers, and outside the U.S., we continued to monitor the activities of our distributor partners and helped them navigate the challenges they faced as a result of the slower demand they have seen in their respective countries.
• Operating Expenses: Given the uncertainty surrounding the impacts that COVID-19 could have on our business, we took preemptive steps to curtail spending, including implementing hiring restrictions,reducing discretionary spending, reducing capital expenditures, and delaying certain R&D projects and clinical research studies. Taking into account the early signs of improving economic environment and conditions related to COVID-19, we have started to ease these measures in certain areas. However, we will continue to monitor any future developments related to the pandemic and may reinstate them if necessary.
• Governmental Policy: On March 27, 2020, the U.S. government enacted the CARES Act to provide relief from COVID-19. We have taken advantage of certain provisions of the CARES Act which are applicable to us, including utilizing net operating loss (NOL) carryback provisions. Utilizing these provisions significantly mitigated the working capital impact COVID-19 has had on our sales and operations.

Results of Operations

Sales

(In thousands)

Total revenue increased by 70.1% and 95.1%, or approximately $4.9 million and $15.4 million, for the three and nine months ended September 30, 2021 when compared with the three and nine months ended September 30, 2020. Advanced Energy segment sales increased 88.2% and 126.7%, or approximately $4.8 million and $15.6 million, for the three and nine months ended September 30, 2021 when compared with the three and nine months ended September 30, 2020. In the nine months ended September 30, 2021, we experienced increased global utilization based demand for our handpieces and adoption of our generator technology despite the continued headwinds of the COVID-19 pandemic in certain geographic regions, while the same period in 2020 was more severely impacted on a global basis.

International sales represented approximately 33.1% and 34.2% of total revenues for the three and nine months ended September 30, 2021, respectively, as compared with 25.0% and 24.8% of total revenues for the same prior year period. Management estimates our products have been sold in more than 60 countries through local dealers coordinated by sales and marketing personnel through our facilities in Clearwater, Florida and Sofia, Bulgaria.

Gross Profit

(In thousands)

Gross profit for the three months ended September 30, 2021, increased 70.5% to $8.1 million, compared to $4.7 million for the same period in the prior year. Gross margin for the three months ended September 30, 2021, was 68.1%, compared to 67.9% for the same period in 2020.

Gross profit for the nine months ended September 30, 2021, increased 118.8% to $21.5 million, compared to $9.8 million for the same period in the prior year. Gross margin for the nine months ended September 30, 2021, was 67.7%, compared to 60.3% for the same period in 2020.

The increase in gross profit margins for the three and nine months ended September 30, 2021 from the prior year periods is primarily attributable to sales mix between our two segments, with our Advanced Energy segment comprising a higher percentage of total sales, as well as product mix within our Advanced Energy segment. Our continued manufacturing efficiency initiatives and the introduction of newer product models have continued to result in improved margins as we obtain registration, allowing these products to be introduced into the markets we serve. Additionally, the strong sales during the three and nine months ended September 30, 2021, resulted in reduced product costs as our fixed costs were spread across higher production volumes. This manufacturing efficiency was partially offset by higher inbound shipping costs, as we expedited the sourcing of key component raw material inventories.

During the second quarter of 2020, we reassessed our forecasted product mix due to COVID-19, increased availability of our newer handpiece designs, and earlier than expected completion of product registrations in certain international markets. As a result, certain products were reduced to a lower carrying value, and some components were also written off as it was determined to cease further production on these models. This resulted in a decrease in gross profit of approximately $0.4 million during the nine months ended September 30, 2020.

Other Costs and Expenses

Research and development

(In thousands)

Research and development expenses increased 12.2% and 12.4% for the three and nine months ended September 30, 2021, primarily due to continued spending on our two investigational device exemption (IDE) clinical studies and product development initiatives.

Professional services

(In thousands)

Professional services expense increased 10.7% for the three months ended September 30, 2021, primarily attributable to an increase in physician consulting fees ($0.5 million). This increase was partially offset by a decrease in accounting and auditing fees ($0.3 million). In the prior year period, we incurred significant fees related to our change in independent accountants and the associated reaudit of the 2019 financial statements.

Professional services expense decreased 7.5% for the nine months ended September 30, 2021, primarily attributable to decreases in accounting and auditing fees ($0.7 million) related to 2019 financial statement restatements, remediation, and reaudit activities that occurred in 2020 and legal fees ($0.2 million). These decreases were partially offset by increases in in physician consulting fees ($0.3 million) and professional services for continued consulting expense associated with our implementation of SAP ($0.1 million).

Salaries and related costs

(In thousands)

During the three months ended September 30, 2021, salaries and related expenses increased 19.9%, primarily driven by increases in bonus expense in 2021 ($0.4 million), higher headcount ($0.2 million), and stock option expense ($0.1 million) as compared to the same period in the prior year.

During the nine months ended September 30, 2021, salaries and related expenses increased 24.7%, primarily driven by increases in bonus expense in 2021 ($1.3 million), higher headcount ($0.5 million), stock option expense ($0.2 million), and temporary labor ($0.2 million) as compared to the same period in the prior year.

Selling, general and administrative expenses

(In thousands)

During the three months ended September 30, 2021, selling, general and administrative expense increased 70.4%, primarily driven by higher commissions on Advanced Energy sales ($0.9 million), advertising expense, including trade show fees and related costs ($0.7 million), travel and entertainment expense ($0.3 million) and higher credit card processing fees ($0.1 million).

During the nine months ended September 30, 2021, selling, general and administrative expense increased 44.9%, primarily driven by higher commissions on Advanced Energy sales ($2.5 million), travel and entertainment expense ($0.4 million), advertising expense, including trade show fees and related costs ($0.4 million), insurance expense ($0.3 million), higher credit card processing fees ($0.3 million) and accrued OEM product recall costs ($0.2 million). These increases were partially offset by lower bad debt expenses ($0.4 million).

Other income (loss)

(In thousands)

Interest income decreased 96.1% for the nine months ended September 30, 2021 compared with the same period in the prior year. This decrease is due to a lower yield, as well as a lower average balance, on our investments in U.S. Treasury securities included in cash and cash equivalents.

Other loss, net increased 204.8% for the three months ended September 30, 2021, as compared with the same period in the prior year. This increase is primarily due to accrued severance expense for employees of the Core business segment ($0.1 million) and anticipated Core business segment inventory losses at the conclusion of our supply agreement with Symmetry ($0.1 million).

Other (loss) income, net decreased 153.9% for the nine months ended September 30, 2021, as compared with the same period in the prior year. This decrease is primarily due to the receipt of refunds in the first quarter 2020 on tariffs paid in 2019 ($0.3 million), accrued severance expense for employees of the Core business segment ($0.1 million) and anticipated Core business segment inventory losses at the conclusion of our supply agreement with Symmetry ($0.1 million).

Income Taxes

(In thousands)

Our income tax expense (benefit) was approximately $73,000 and $(715,000) with effective tax rates of (1.8)% and 16.1% for the three months ended September 30, 2021 and 2020, respectively. Our income tax expense (benefit) was approximately $246,000 and $(7,112,000) with effective tax rates of (1.9)% and 40.7% for the nine months ended September 30, 2021 and 2020, respectively. For the three and nine months ended September 30, 2021, the effective rates differ from statutory rates primarily due to the full valuation allowance recorded on our NOL generated during the periods, combined with interest and penalties on our uncertain tax positions. For the nine months ended September 30, 2020, the effective rate differs from the statutory rate primarily due to the release of the valuation allowance on our NOL carryforward from 2019.

Liquidity and Capital Resources

Our working capital at September 30, 2021 was approximately $48.2 million compared with $56.9 million at December 31, 2020. The decrease in working capital from December 31, 2020 was primarily due to the net loss incurred by the Company during the first three quarters of 2021, excluding non-cash activity, comprised primarily of stock-based compensation expense.

For the nine months ended September 30, 2021, net cash used in operating activities was approximately $10.7 million, which principally funded our loss from operations of $12.8 million, compared with net cash used in operating activities of approximately $15.0 million in the same period for 2020.

Net cash used in investing activities for the nine months ended September 30, 2021 and 2020, was $0.4 million and $0.2 million, respectively, related to investments in property and equipment.

At September 30, 2021, we had purchase commitments totaling approximately $5.2 million, substantially all of which is expected to be purchased within the next twelve months.

Critical Accounting Estimates

In preparing the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), we have adopted various accounting policies. Our most significant accounting policies are disclosed in Note 2 to the consolidated financial statements included in our 2020 Form 10-K, filed with the SEC on March 31, 2021.

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Our estimates and assumptions, including those related to inventories, intangible assets, property, plant and equipment, legal proceedings, research and development, warranty obligations, product liability, sales returns and discounts, stock-based compensation and income taxes are updated as appropriate, which in most cases is at least quarterly. We base our estimates on historical experience, or various assumptions that are believed to be reasonable under the circumstances and the results form the basis for making judgments about the reported values of assets, liabilities, revenues and expenses. Actual results may materially differ from these estimates.

Estimates are considered to be critical if they meet both of the following criteria: (1) the estimate requires assumptions about material matters that are uncertain at the time the accounting estimates are made and (2) other materially different estimates could have been reasonably made or material changes in the estimates are reasonably likely to occur from period to period. Our critical accounting estimates include the following:

Stock-based Compensation

Under our stock option plans, options to purchase common shares of the Company may be granted to employees, officers and directors of the Company by the Board of Directors. We account for stock options in accordance with FASB ASC Topic 718-10, Compensation-Stock Compensation, with compensation expense recognized over the vesting period. Options are valued using the Black-Scholes model, which includes a number of estimates that affect the amount of our expense. We have determined that the most critical of these estimates are the estimates of expected life and volatility used in the calculations.

Expected life

For employee stock-based compensation awards, we estimate the expected life of awards utilizing the SEC's simplified method. We utilize this method, as we have not historically granted stock-based compensation awards to employees in sufficient volumes to determine a reasonable estimate of the life of awards. For awards granted to non-employees, we calculate expected life using a combination of past exercise behavior, the contractual term and expected remaining exercise behavior.

Volatility

We determine the volatility by utilizing the historical volatility of our stock over the period of the awards expected life. The SEC allows us to include periods in excess of the useful life if we determine that they provide a more reasonable basis for the volatility of our stock. Additionally, ASC 718-10 allows us to exclude periods from the volatility if they pertain to events or circumstances that in our judgment are specific to us and if the event or transaction is not reasonably expected to occur again during the expected term of the awards. We have not included any additional periods, nor disregarded any periods, in calculating our volatility.

Accounts Receivable Allowance

We maintain a reserve for uncollectible accounts receivable. When evaluating the adequacy of the allowance for doubtful accounts, we analyze specific unremitted customer balances for known collectability issues, review historical bad debt experience, customer credit worthiness and economic trends, and we make estimates in connection with establishing the allowance for doubtful accounts, including the future impacts of current trends. Changes in estimates are reflected in the period they are made. If the financial condition of our customers deteriorates, resulting in an inability to make payments, additional allowances may be required.

Inventory Obsolescence Allowance

We maintain a reserve for excess and obsolete inventory resulting from the potential inability to sell our products at prices in excess of current carrying costs. The markets in which we operate are highly competitive, with new products and surgical procedures introduced on an ongoing basis. Such marketplace changes may cause our products to become obsolete. We make estimates regarding the future recoverability of the costs of these products and record a provision for excess and obsolete inventories based on historical experience and expected future trends. If actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, additional inventory write-downs may be required, which would unfavorably affect future operating results.

Litigation Contingencies

In accordance with authoritative guidance, we record a liability in our consolidated financial statements for these actions when a loss is known or considered probable and the amount can be reasonably estimated. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate than any other, the minimum amount of the range is accrued. If a loss is reasonably possible, but not known or probable, and can be reasonably estimated, the estimated loss or range of loss is disclosed in the notes to the consolidated financial statements. In most cases, significant judgment is required to estimate the amount and timing of a loss to be recorded; actual results may differ from these estimates.

Income Taxes

The provision for income taxes includes federal, foreign, state and local income taxes currently payable and those deferred because of temporary differences between the financial statement and tax bases of assets and liabilities. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using enacted marginal tax rates. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period.

As a result of historical losses, and our expectation to continue to generate losses in the near future, we recorded a valuation allowance on our net deferred tax assets. Exclusive of the carryback provisions of the CARES Act and the associated income tax benefit recognized in 2020, we do not anticipate recording an income tax benefit related to deferred tax assets. We will reassess the realization of deferred tax assets each reporting period and will be able to reduce the valuation allowance to the extent the financial results of continuing operations improve, and it becomes more likely than not that the deferred tax assets will be realizable. As management expects the Company to continue to generate losses in the foreseeable future after 2020, we will continue to record a valuation allowance on the net deferred tax assets balance as of September 30, 2021.

We assess the financial statement impact of an uncertain tax position taken or expected to be taken on an income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized in the financial statements unless it is more likely than not of being sustained.

Inflation

Inflation has not materially impacted the operations of our Company.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements at this time.

Recent Accounting Pronouncements

See Note 2 of the Notes to Condensed Consolidated Financial Statements.

Disclosure Controls and Procedures

Our management has established and maintains disclosure controls and procedures that are designed to ensure 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 Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Management carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of September 30, 2021, the Company's disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

We rely extensively on information systems to manage our business and summarize and report our financial condition, results of operations and cash flows. In 2020, we began the implementation of a new global enterprise resource planning (“ERP”) system, which replaced much of our existing core financial systems in the first quarter of 2021. The ERP system is designed to accurately maintain our financial records, enhance the flow of financial information, improve data management and provide timely information to our management team.

As a result of this implementation, certain internal controls over financial reporting have been automated, modified or implemented to address the new environment associated with this type of system. While we believe that this new system will strengthen our internal controls, there are inherent risks in implementing any new system, and we will continue to evaluate these control changes as part of our assessment of internal control over financial reporting throughout 2021.

There have been no material changes to the risk factors described under Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, except for the following:

Any disruption in our suppliers’ operations, or timely availability of shipments from our third party freight carriers, could disrupt our production schedule and our ability to provide product to our customers in a timely manner

Our operations and ability to maintain production is dependent upon our suppliers delivering sufficient quantities of components and raw materials on time to manufacture our products and meet our production schedules. The COVID-19 pandemic has adversely impacted worldwide supply chains and the ability to obtain sufficient amounts of component parts, while disruptions and delays in the ability of our third party freight carriers to transport these items to our manufacturing facilities also continues to be a challenge. If the situation worsens, these negative impacts on our supply chain could have a material adverse effect on our business.

Any shortage of components or raw materials could cause us to not be able to meet customer demand, to alter production schedules, to delay product launch schedules, or to suspend production entirely, which could cause a loss of revenues or increased costs, which could materially and adversely affect our results of operations and cash flows.