Apyx Medical Corp: Form 10-Q for the period ended Mar 31, 2022

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, including our Helium Plasma Technology products marketed and sold as Renuvion® and J-Plasma® in surgical markets. We are solely focused on bringing transformative solutions to physicians and their patients. Renuvion® and J-Plasma® offer surgeons a unique ability to provide controlled heat to tissue to achieve their desired results. We also leverage our deep expertise and decades of experience in unique waveforms through OEM agreements with other medical device manufacturers.

On March 14, 2022, the U.S. Food and Drug Administration ("FDA") posted a Safety Communication that warns consumers and health care providers against the use of our Advanced Energy products outside of their FDA-cleared indications for general use in cutting, coagulation, and ablation of soft tissue during open and laparoscopic surgical procedures. Following the Safety Communication, we began to experience some slowed demand for the adoption of our Helium Plasma Technology primarily in the U.S. We continue to evaluate the full effects the Safety Communication will have on the results of our operations, cash flows and financial position, and expects there will be some continued impact to the results of our operations and cash flows into the second fiscal quarter and possibly beyond.

We continue to work with the FDA towards securing 510(k) clearance for additional indications. On April 4, 2022, a 510(k) premarket notification was filed for the use of Renuvion® to improve the appearance of lax (loose) skin in the neck and submental region.

We continue to drive sales in our Advanced Energy business by increasing the adoption and utilization of our handpieces by surgeons in the U.S. and fulfilling demand from distributors in our international markets. Management estimates that our products have been sold in more than 60 countries. As of March 31, 2022, 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® and J-Plasma® in the surgical markets, supported by our global medical affairs team. This global team of clinical support specialists focuses on supporting our users to ensure optimal outcomes for their patients. In addition, we have invested in training programs and marketing-related activities to support accelerated adoption of Renuvion® into surgeons' 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.

In response to the global supply chain instability and inflationary cost increases, we continue to take action to minimize, as much as possible, any potential adverse impacts by working closely with our suppliers to closely monitor the availability of raw material components (i.e. semiconductors and plastics), lead times, and freight carrier availability. We expect global supply chain instability will continue to have an impact on our business, but to date that has not been material to our financial performance. The consequences of the pandemic, global supply chain instability and inflationary cost increases and their adverse impact to the global economy, continue to evolve. Accordingly, the significance of the future impact to our business and financial statements remains subject to significant uncertainty.

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.

Results of Operations

Sales

(In thousands)

Total revenue increased by 44.6%, or approximately $3.9 million, for the three months ended March 31, 2022 when compared with the three months ended March 31, 2021. Advanced Energy segment sales increased 41.2%, or approximately $3.2 million, for the three months ended March 31, 2022 when compared with the three months ended March 31, 2021. The Advanced Energy sales increase was driven by an increase in global utilization based demand for our handpieces and adoption of our generator technology in international markets. This increase was partially offset by a decrease in the adoption of our generator technology in the U.S. following the FDA Safety Communication on March 14, 2022.

OEM segment sales increased 71.7%, or approximately $0.7 million, for the three months ended March 31, 2022 when compared with the three months ended March 31, 2021. The increase in OEM sales was due to increases in sales volume to existing customers, including Symmetry Surgical under our 10-year generator manufacturing and supply agreement.

International sales represented approximately 39.6% of total revenues for the three months ended March 31, 2022, as compared with 35.6% 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 March 31, 2022, increased 40.3% to $8.2 million, compared to $5.9 million for the same period in the prior year. Gross margin for the three months ended March 31, 2022, was 65.8%, compared to 67.8% for the same period in 2021.

The decrease in gross profit margins for the three months ended March 31, 2022 from the prior year period is primarily attributable to sales mix between our two segments, with our OEM segment comprising a higher percentage of total sales, product and geographic mix within our Advanced Energy segment, and higher costs to manufacture our inventory as we continue to experience higher shipping costs. These decreases were partially offset by the mix of newer product models as we obtain registrations, allowing these products to be introduced into the markets we serve.

Other Costs and Expenses

Research and development

(In thousands)

Research and development expenses increased 3.9% for the three months ended March 31, 2022, primarily due to increased labor and benefit costs from the same period in the prior year ($0.1 million). These increased costs were partially offset by lower spending on our two investigational device exemption (IDE) clinical studies and other product development initiatives ($0.1 million).

Professional services

(In thousands)

Professional services expense increased 50.3% for the three months ended March 31, 2022 as compared to the same period in the prior year, primarily attributable to increases in legal expenses ($0.4 million), physician consulting fees ($0.3 million) and Board of Directors option expense ($0.1 million).

Salaries and related costs

(In thousands)

16

During the three months ended March 31, 2022, salaries and related expenses increased 22.0%, primarily driven by higher compensation and benefits ($0.5 million), stock compensation expense ($0.3 million) and bonus expense ($0.1 million) as compared to the same period in the prior year.

Selling, general and administrative expenses

(In thousands)

During the three months ended March 31, 2022, selling, general and administrative expense increased 46.8%, primarily driven by increased advertising expense, including trade show fees and related costs ($0.7 million), higher employee training and other meeting expenses ($0.5 million), travel and entertainment expense ($0.4 million), commissions on Advanced Energy sales ($0.2 million) and higher bad debt expenses ($0.1 million). These increases were partially offset by a decrease in OEM product recall costs ($0.2 million) as we experienced no product recalls in 2022.

Income Taxes

(In thousands)

Our income tax expense (benefit) was approximately $70,000 and $66,000 with effective tax rates of (1.2)% and (1.4)% for the three months ended March 31, 2022 and 2021, respectively. For the three and three months ended March 31, 2022 and 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.

Liquidity and Capital Resources

Our working capital at March 31, 2022 was approximately $43.2 million compared with $47.5 million at December 31, 2021. The decrease in working capital from December 31, 2021 was primarily due to the net loss incurred by the Company during the first quarter of 2022, excluding non-cash activity, comprised primarily of stock-based compensation expense.

For the three months ended March 31, 2022, net cash used in operating activities was approximately $4.5 million, which principally funded our loss from operations of $5.9 million, compared with net cash used in operating activities of approximately $2.1 million in the same period for 2021.

Net cash used in investing activities for the three months ended March 31, 2022 and 2021, was $0.3 million and $0.2 million, respectively, related to investments in property and equipment.

At March 31, 2022, we had purchase commitments totaling approximately $7.5 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 2021 Form 10-K, filed with the SEC on March 17, 2022.

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 our 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 our results of operations improve, and it becomes more likely than not that the deferred tax assets will be realized. As Management has not fully determined the timing of when it will generate taxable income in the U.S., we continued to record a valuation allowance on the net deferred tax assets balance as of March 31, 2022.

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

The consequences of the pandemic, global supply chain instability and inflationary cost increases and their adverse impact to the global economy, continue to evolve. Accordingly, the significance of the future impact to our business and financial statements remains subject to significant uncertainty. Inflation has not, to date, materially impacted our operations or financial performance. However, as these trends continue for raw materials, freight, and labor costs, our future financial performance could be adversely impacted.

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 March 31, 2022, the Company's disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended March 31, 2022, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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, 2021.