Apyx Medical Corp: Form 10-Q for the period ended Jun 30, 2023

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® in the cosmetic surgery market and J-Plasma® in the hospital surgical market. 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.

As part of our plan to accelerate and fully fund the development of our advanced energy business, with a focus in the cosmetic surgery market, we sold our Core business in 2018 for gross proceeds of $97 million. These proceeds were used to launch broad marketing and sales initiatives which resulted in rapid sales growth through December 31, 2021 and into the first quarter of 2022. This planned growth in the business was accompanied by scaled operations, including procurement of components, expanded manufacturing capacity to turn those materials into saleable inventory, additional discretionary expenditures, including increased global participation at trade shows, additional employee trainings, user meetings, increased travel and entertainment expenses, more expansive research and development projects, and additional headcount to support those activities. Additionally, we had and still have, some significant non-recurring discretionary expenditures associated with completing our multi-year marketing initiatives related to our dermal resurfacing and skin laxity clearances.

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 experienced slowed demand for the adoption of our Helium Plasma Technology.

On May 26, 2022, we announced that we received 510(k) clearance from the FDA for the use of the Renuvion Dermal Handpiece for specific dermal resurfacing procedures. On July 18, 2022, we announced that we received 510(k) clearance from the FDA for the use of the Renuvion® APR Handpiece for certain skin contraction procedures.

On June 2, 2022, and July 21, 2022, FDA updated the Medical Device Safety Communication to recognize the new 510(k) clearances for the Renuvion® Dermal handpiece, and the expanded indications for the Renuvion® APR handpieces. The 510(k) clearance for the Renuvion® Dermal handpiece allows surgeons to perform dermal resurfacing procedures for the treatment of moderate to severe wrinkles and rhytides, limited to patients with Fitzpatrick Skin Types I, II or III. The 510(k) clearance for the Renuvion® APR handpieces now addresses improving the appearance of lax (loose) skin in the neck and submental region.

On July 18, 2022, we announced that we received 510(k) clearance from the FDA for the use of the Renuvion® APR Handpiece for use in subcutaneous dermatological and aesthetic procedures to improve the appearance of lax (loose) skin in the neck and submental (under the chin) region.

On July 21, 2022, the FDA updated the Safety Communication to inform consumers and healthcare providers about the clearance for the Renuvion® APR handpieces for use under the skin in certain procedures intended to improve the appearance of loose skin.

On February 27, 2023, we announced that we received 510(k) clearance from the FDA for the use of the Renuvion® APR Handpiece for the delivery of radiofrequency energy and/or helium plasma where coagulation/contraction of soft tissue is needed. Soft tissue includes subcutaneous tissue.

FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

On April 28, 2023, we announced that we received 510(k) clearance from the FDA for the use of the Renuvion® APR Handpiece for coagulation of subcutaneous soft tissues following liposuction for aesthetic body contouring.

On May 10, 2023, the FDA updated the Safety Communication to inform consumers and healthcare providers about the clearance for the Renuvion® APR handpiece for use under the skin in certain procedures intended to improve the appearance of the skin, including for coagulation of subcutaneous soft tissues following liposuction for aesthetic body contouring.

We believe that the May 10, 2023 FDA update to the Safety Communication addresses the issues set forth in the original Safety Communication from March 14, 2022. While no assurances can be provided, we believe that receiving these additional clearances and the corresponding updates to the Safety Communication since March 14, 2022 should assist in mitigating the financial effects of the Safety Communication in future periods.

While sales were continuing to grow into the first quarter of 2022 prior to the FDA Safety Communication, over the last few years, exclusive of our sale of the Core business segment to Symmetry Surgical during 2018, we have incurred recurring net losses and cash outflows from operations and we anticipate that losses will continue in the near term. During the six months ended June 30, 2023, we incurred an operating loss of $6.8 million and used $6.7 million of cash in operations. As of June 30, 2023, we had cash and cash equivalents of $18.5 million. These conditions raise substantial doubt about our ability to continue as a going concern for a period of at least one year from the date of issuance of these unaudited condensed consolidated financial statements.

In an effort to alleviate these conditions, we pursued various funding solutions in order to improve liquidity.

On November 22, 2022, the we filed a shelf registration statement providing us the ability to register securities in the aggregate amount up to $100 million. The shelf registration included an embedded ATM facility for up to $40 million. To date, we have not utilized this facility.

On February 17, 2023, we entered into a Credit, Security and Guaranty Agreement (the “Credit Agreement”) with MidCap Funding IV Trust (as agent), and MidCap Financial Trust (as term loan servicer), and the lenders party thereto from time to time.

The Credit Agreement provides for an up to $35 million facility, consisting of senior secured term loans and a secured revolving facility. The Credit Agreement provides for senior secured term loans of up to $25 million, comprised of (i) an initial tranche of $10 million, (ii) a second tranche of $5 million, and (iii) a third tranche of $10 million. The secured revolving facility provides for loans in an aggregate principal amount of up to $10 million, subject to a borrowing base equal to certain percentages of the Company’s eligible accounts receivable and inventory, as determined in accordance with the terms of the Credit Agreement.

For a more in depth description of the terms of the Credit Agreement, see Note 7 of Notes to Condensed Consolidated Financial Statements in Item 1 of this report on Form 10-Q.

On February 27, 2023, our Board of Directors approved a plan to sell and leaseback the our real property located in Clearwater, FL. On March 14, 2023, we entered into a Purchase and Sale Agreement (the “Purchase Agreement”) with VK Acquisitions VI, LLC (the “Purchaser”), for the sale of our facility located at 5115 Ulmerton Road, Clearwater, Florida, as more fully described in the Purchase Agreement (collectively, the “Property”) for a purchase price of $7,650,000. The Purchase Agreement is subject to the satisfactory completion of due diligence by the Purchaser. On May 8, 2023, we closed on the Purchase Agreement and concurrently executed a 10-year agreement to leaseback the underlying Property from the Purchaser.

For a more in depth description of the terms of the Purchase Agreement, see Notes 4 and 5 of Notes to Condensed Consolidated Financial Statements in Item 1 of this report on Form 10-Q.

During January 2023, we were notified that the IRS examination process of our 2018, 2019 and 2020 tax returns was complete and that the our tax refunds were approved for approximately $0.2 million more than the amount recorded in the Company’s Consolidated Balance Sheet at December 31, 2022. On August 10, 2023, we received $8.1 million from the IRS, which included approximately $0.4 million of interest on the $7.7 million income tax refunds.

FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

We also reassessed our operating expenditures and cost structure and made adjustments in light of expected levels of revenue. This included reducing some operating expenditures, including a reduction-in-force on January 9, 2023, that reduced the our U.S. headcount by 14%.

We believe that the actions already taken, and additional actions that we can take to manage operating expenditures, will enable us to meet our obligations and our debt covenants for a period of at least one year from the date of issuance of our audited consolidated financial statements. As a result, we believe our plans alleviate substantial doubt about our ability to continue as a going concern. Our audited financial statements do not include any adjustments relating to the carrying amounts and classification of assets and liabilities that may be necessary should we be unable to continue as a going concern.

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 June 30, 2023, we had a direct sales force of 36 field-based selling professionals and utilized 3 independent sales agencies. We also had 4 sales managers. This selling organization is focused on the use of Renuvion® in the cosmetic surgery market, 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 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.

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.

FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

Results of Operations

Sales

(In thousands)

Total revenue increased by 31.8%, or approximately $3.3 million, for the three months ended June 30, 2023 when compared with the three months ended June 30, 2022. Advanced Energy segment sales increased 40.1%, or approximately $3.4 million, for the three months ended June 30, 2023 when compared with the three months ended June 30, 2022. The Advanced Energy sales increase is driven by domestic customers who upgraded their generator to our new Apyx One Console, which we launched in January 2023, a higher average selling price on sales of new generators due to the introduction of the Apyx One Console, and increased sales of our handpieces to domestic customers. These domestic increases were accompanied by an increase in generator sales in international markets. OEM segment sales decreased 4.2%, or approximately $0.8 million, for the three months ended June 30, 2023 when compared with the three months ended June 30, 2022. The decrease in OEM sales was due to decreases in sales volume to existing customers.

Total revenue increased by 12.8%, or approximately $2.9 million, for the six months ended June 30, 2023 when compared with the six months ended June 30, 2022. Advanced Energy segment sales increased 11.6%, or approximately $2.2 million, for the six months ended June 30, 2023 when compared with the six months ended June 30, 2022. The Advanced Energy sales increase is driven by domestic customers who upgraded their generator to our new Apyx One Console, which we launched in January 2023 and a higher average selling price on sales of new generators due to the introduction of the Apyx One Console. These domestic increases were partially offset by decreases in new generator sales, and demand for our handpieces, in international markets following the FDA Safety Communication on March 14, 2022. OEM segment sales increased 19.2%, or approximately $0.7 million, for the six months ended June 30, 2023 when compared with the six months ended June 30, 2022. The increase in OEM sales was due to increases in sales volume to existing customers as well as incremental new sales upon the commencement of the supply arrangement related to the completion of the development portion of some of our OEM development agreements.

International sales represented approximately 25.3% and 26.1% of total revenues for the three and six months ended June 30, 2023, respectively, as compared with 22.8% and 32.0% of total revenues for the same period in the prior year. 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.

FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

Gross Profit

(In thousands)

Gross profit for the three months ended June 30, 2023, increased 34.2% to $9.3 million, compared to $6.9 million for the same period in the prior year. Gross margin for the three months ended June 30, 2023, was 68.4%, compared to 67.2% for the same period in 2022. The increase in gross profit margins for the three months ended June 30, 2023 from the prior year period is primarily attributable to changes in the sales mix between our two segments, with our Advanced Energy segment comprising a higher percentage of total sales. These increases were partially offset by geographic mix within our Advanced Energy segment, with international sales comprising a higher percentage of total sales and product mix within our Advanced Energy segment.

Gross profit for the six months ended June 30, 2023, increased 11.4% to $16.9 million, compared to $15.1 million for the same period in the prior year. Gross margin for the six months ended June 30, 2023, was 65.5%, compared to 66.4% for the same period in 2022. The decrease in gross profit margins for the six months ended June 30, 2023 from the prior year periods is primarily attributable to changes in the sales mix between our two segments, with our OEM segment comprising a higher percentage of total sales and product mix within our Advanced Energy Segment. These decreases were partially offset by geographic mix within our Advanced Energy segment, with domestic sales comprising a higher percentage of total sales.

Other Costs and Expenses

Research and development

(In thousands)

Research and development expenses increased 12.1% for the three months ended June 30, 2023, primarily due to higher spending on our product development initiatives and clinical studies ($0.1 million).

Research and development expenses increased 4.1% for the six months ended June 30, 2023, primarily due to increased labor and benefits costs from the same period prior year ($0.1 million).

Professional services

(In thousands)

Professional services expense decreased 33.3% for the three months ended June 30, 2023, primarily attributable to decreases in legal expenses ($0.7 million) associated with the estimated loss recorded in the prior year for the class action lawsuit and current year reversal of a legal loss contingency, and a decrease in recruiting expenses ($0.1 million).

FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

Professional services expense decreased 28.7% for the six months ended June 30, 2023, primarily attributable to decreases in legal expenses ($1.0 million) associated with the estimated loss recorded in the prior year for the class action lawsuit and current year reversal of a legal loss contingency, accounting and audit fees ($0.1 million), physician consulting fees ($0.1 million), and a decrease in recruiting expenses ($0.1 million).

Salaries and related costs

(In thousands)

During the three months ended June 30, 2023, salaries and related expenses increased 2.9%, primarily driven by increases in bonus expense ($0.2 million) and temporary labor expenses ($0.2 million). These increases were partially offset by lower stock based compensation expense ($0.3 million).

During the six months ended June 30, 2023, salaries and related expenses increased 0.3%, primarily driven by increases in bonus expense ($0.2 million) and temporary labor expenses ($0.3 million) as compared to the same period in the prior year. These increases are partially offset by lower stock based compensation expense ($0.5 million).

Selling, general and administrative expenses

(In thousands)

During the three months ended June 30, 2023, selling, general and administrative expense increased 18.5%, primarily driven by increases in commissions ($0.4 million), insurance expense, including product liability claims on our policies ($0.2 million), advertising expense, including trade show fees and related costs ($0.1 million) and bad debt expense ($0.1 million).

During the six months ended June 30, 2023, selling, general and administrative expense increased 6.3%, primarily driven by increases in insurance expense, including product liability claims on our policies ($0.4 million), commissions ($0.4 million), and travel expense ($0.4 million). These increases were partially offset by decreases in advertising expense, including trade show fees and related costs ($0.4 million) and bad debt expense ($0.2 million).

Gain on sale-leaseback

(In thousands)

During the three and six months ended June 30, 2023, gain on sale-leaseback was approximately $2.7 million as a result of the gain on the sale and leaseback of our Clearwater, FL facility in May 2023.

FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

Interest Income (Expense)

(In thousands)

Interest income increased approximately $0.2 million for both the three and six months ended June 30, 2023, compared with the same periods the prior year. This increase is due to higher yields on our investments in money market funds and U.S. Treasury securities included in cash and cash equivalents, partially offset by a lower average balance.

During the three months ended June 30, 2023, interest expense increased approximately $0.5 million compared with the same period in the prior year. During the six months ended June 30, 2023, interest expense increased approximately $0.7 million. These increases are due to cash and noncash interest expense on the Credit Agreement executed on February 17, 2023.

Income Taxes

(In thousands)

Our income tax expense was approximately $66,000 and $96,000 with effective tax rates of (6.9)% and (1.8)% for the three months ended June 30, 2023 and 2022, respectively. For the three months ended June 30, 2023 and 2022, the effective rates differ from the statutory rate primarily due to the full valuation allowance recorded on the net operating loss (“NOL”) generated during the period.

Our income tax expense was approximately $(2,201,000) and $166,000 with effective tax rates of 32.6% and (1.5)% for the six months ended June 30, 2023 and 2022, respectively. For the six months ended June 30, 2023, the effective rate differs from the statutory rate primarily due to the reversal of our liability for uncertain tax positions, including accrued interest and penalties of approximately $2.1 million which were sustained upon the completion in January 2023 of the IRS examination of our 2018 through 2020 income tax returns, partially offset by a valuation allowance on the NOL and net deferred tax assets generated during the period. For the six months ended June 30, 2022, the effective rate differs from the statutory rate primarily due to the full valuation allowance recorded on the NOL generated during the period, combined with interest and penalties on uncertain tax positions.

Liquidity and Capital Resources

At June 30, 2023, we had approximately $18.5 million in cash and cash equivalents as compared to approximately $10.2 million in cash and cash equivalents at December 31, 2022. Our working capital at June 30, 2023 was approximately $33.9 million compared with $31.1 million at December 31, 2022. The increase in working capital at June 30, 2023 was primarily due to the proceeds received upon the sale of our Clearwater, FL facility in May 2023 and the reversal of our liability for uncertain tax positions upon the completion in January 2023 of the IRS examination of our 2018, 2019 and 2020 income tax returns. This increase was partially offset by the net loss incurred by the Company in the first half of 2023, excluding non-cash activity, comprised primarily of stock-based compensation.

For the six months ended June 30, 2023, net cash used in operating activities was approximately $6.7 million, which principally funded our loss from operations of $6.8 million, compared with net cash used in operating activities of approximately $10.4 million in the same period for 2022. As discussed in the Executive Level Overview, our operating loss, cash used in operations and current cash and cash equivalents balance of $18.5 million, of which we must maintain $10.0 million under our Credit

FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

Agreement, raise substantial doubt about our ability to continue as a going concern for a period of at least one year from the date of issuance of our unaudited condensed consolidated financial statements.

In an effort to alleviate these conditions, we pursued various funding solutions in order to improve liquidity.

On November 22, 2022, the we filed a shelf registration statement providing us the ability to register securities in the aggregate amount up to $100 million. The shelf registration included an embedded ATM facility for up to $40 million. To date, we have not utilized this facility.

On February 17, 2023, we entered into a Credit, Security and Guaranty Agreement (the “Credit Agreement”) with MidCap Funding IV Trust (as agent), and MidCap Financial Trust (as term loan servicer), and the lenders party thereto from time to time.

The Credit Agreement provides for an up to $35 million facility, consisting of senior secured term loans and a secured revolving facility. The Credit Agreement provides for senior secured term loans of up to $25 million, comprised of (i) an initial tranche of $10 million, (ii) a second tranche of $5 million, and (iii) a third tranche of $10 million. The secured revolving facility provides for loans in an aggregate principal amount of up to $10 million, subject to a borrowing base equal to certain percentages of the Company’s eligible accounts receivable and inventory, as determined in accordance with the terms of the Credit Agreement.

For a more in depth description of the terms of the Credit Agreement, see Note 7 of Notes to Condensed Consolidated Financial Statements in Item 1 of this report on Form 10-Q.

On February 27, 2023, our Board of Directors approved a plan to sell and leaseback the our real property located in Clearwater, FL. On March 14, 2023, we entered into a Purchase and Sale Agreement (the “Purchase Agreement”) with VK Acquisitions VI, LLC (the “Purchaser”), for the sale of our facility located at 5115 Ulmerton Road, Clearwater, Florida, as more fully described in the Purchase Agreement (collectively, the “Property”) for a purchase price of $7,650,000. On May 8, 2023, we closed on the Purchase Agreement and concurrently executed a 10-year agreement to leaseback the underlying Property from the Purchaser.

For a more in depth description of the terms of the Purchase Agreement, see Notes 4 and 5 of Notes to Condensed Consolidated Financial Statements in Item 1 of this report on Form 10-Q.

During January 2023, we were notified that the IRS examination process of our 2018, 2019 and 2020 tax returns was complete and that the Company's tax refunds were approved for approximately $0.2 million more than the amount recorded in the Company's Consolidated Balance Sheet at December 31, 2022. On August 10, 2023, we received $8.1 million from the IRS, which included approximately $0.4 million of interest on the $7.7 million income tax refunds.

We also continue to re-assess our operating expenditures and cost structure to be commensurate with our expected levels of revenue and we have the ability to reduce or delay expenditures to enhance and preserve liquidity. We have already reduced some operating expenditures, including a reduction-in-force on January 9, 2023, that reduced our U.S. headcount by 14%.

We believe that the actions already taken, and additional actions that we intend to take to manage operating expenditures, will enable us to meet our obligations and our debt covenants for a period of at least one year from the date of issuance of our audited consolidated financial statements. As a result, we believe our plans alleviate substantial doubt about our ability to continue as a going concern. Our audited financial statements do not include any adjustments relating to the carrying amounts and classification of assets and liabilities that may be necessary should we be unable to continue as a going concern.

Net cash provided by investing activities for the six months ended June 30, 2023 was $7.0 million related to the sale of our Clearwater, FL facility ($7.3 million), partially offset by investments in property and equipment ($0.3 million). Net cash used in investing activities for the six months ended June 30, 2022 was $0.7 million related to investments in property and equipment.

Net cash provided by financing activities for the six months ended June 30, 2023 was $8.2 million, which primarily related to proceeds received upon the execution of the Credit Agreement ($9.9 million) less debt issuance costs incurred in the transaction ($1.8 million).

At June 30, 2023, our borrowing availability under the revolving facility was approximately $8.0 million.

FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

At June 30, 2023, we had purchase commitments totaling approximately $3.3 million, substantially all of which is expected to be purchased within the next twelve months.

FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

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 2022 Form 10-K, filed with the SEC on March 16, 2023.

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 historical bad debt experience, the composition of outstanding receivables by customer class, and the age of outstanding balances, and we make estimates in connection with establishing the allowance for doubtful accounts, including the expected impacts of changes in the operating environment and other 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.

FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued

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 June 30, 2023.

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 Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q.

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 June 30, 2023, the Company’s disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

In February 2023, we entered into a Credit, Security and Guaranty Agreement (“Credit Agreement”). We are in the process of developing new control activities around the accounting for the Credit Agreement, including the review and compliance with debt covenants. There were no other changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by the Quarterly Report on Form 10-Q that has materially affected, or is 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, 2022.