Bioventus Inc.: Form 10-Q for the period ended Jul 2, 2022

The following discussion and analysis of Bioventus Inc.’s (sometimes referred to as “we,” “us,” “our” or “Bioventus”) financial condition and results of operations should be read in conjunction with the “Special Note Regarding Forward-Looking Statements” and our unaudited consolidated condensed financial statements and related notes thereto appearing elsewhere in this Form 10-Q, as well as our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the Securities and Exchange Commission (SEC) on March 11, 2022 (2021 10-K).

Executive Summary

We are a global medical device company focused on developing and commercializing clinically differentiated, cost efficient and minimally invasive treatments that engage and enhance the body’s natural healing process. We operate our business through two reportable segments, U.S. and International, and our portfolio of products is grouped into three verticals:

• Pain Treatments is comprised of non-surgical joint pain injection therapies as well as peripheral nerve stimulation (PNS) products to help the patient get back to their normal activities.
• Surgical Solutions is comprised of bone graft substitutes (BGS) to fuse and grow bones, improve results following spinal and other orthopedic surgeries as well as minimally invasive ultrasonic medical devices used for precise bone sculpting, removing tumors and tissue debridement, in various surgeries.
• Restorative Therapies is comprised of a bone healing system, skin allografts and products used to support healing of wounds as well as devices designed to help patients regain leg or hand function due to stroke, multiple sclerosis or other central nervous system disorders.

The following table sets forth total net sales, net (loss) income and Adjusted EBITDA for the periods presented:

(1) See below under results of operations-Adjusted EBITDA for a reconciliation of net (loss) income to Adjusted EBITDA.

Strategic transactions

CartiHeal

On July 15, 2020, we entered into an Option and Equity Purchase Agreement (Option Agreement) with CartiHeal (2009) Ltd. (CartiHeal), a privately-held company headquartered in Israel and the developer of the proprietary Agili-C™ implant for the treatment of joint surface lesions in traumatic and osteoarthritic joint, and its shareholders. The agreement provided us with an exclusive option to acquire 100% of CartiHeal’s shares under certain conditions (Call Option), and provided CartiHeal with a put option that would require us to purchase 100% of CartiHeal’s shares under certain conditions (Put Option).

We exercised the Call Option in April 2022 for the acquisition of all the remaining shares of CartiHeal, excluding shares we already owned, for approximately $315.0 million, with an additional $135.0 million payable upon the achievement of certain milestones. The Company’s decision to exercise the Call Option follows the U.S. Food and Drug Administration’s (FDA) March 29, 2022 premarket approval of CartiHeal’s Agili-C implant. In August, 2021, CartiHeal provided us with the required evidence of the Agili-CTM device clinical trial’s success demonstrating the superiority of the Agili-C implant over the surgical standard of care, including microfracture and debridement, for the treatment of cartilage or osteochondral defects, in both osteoarthritic knees and knees without degenerative changes. As a result, we deposited $50.0 million into escrow toward the potential purchase price of CartiHeal, which was subsequently transferred to a payment agent on June 16, 2022.

On June 17, 2022, we entered into an amendment to the Option Agreement with CartiHeal (CartiHeal Amendment) and Elron Ventures Limited, in its capacity as the CartiHeal shareholder representative. Pursuant to the CartiHeal Amendment, we secured the right to defer $215.0 million of upfront consideration (Deferred Amount) otherwise payable to CartiHeal stockholders at the closing of the acquisition (CartiHeal Acquisition). The Deferred Amount will be paid to CartiHeal stockholders upon the earlier of the achievement of certain milestones and the occurrence of certain installment payment dates. The Deferred Amount will be paid in five tranches commencing in 2023 and ending no later than 2027.

Pursuant to the CartiHeal Amendment, we will pay interest on each tranche of the Deferred Amount at a rate of 8.0% annually, until such tranche becomes due and payable and is paid (subject to an interest penalty of 10% per annum in the event of default). The additional $135.0 million payable would be payable upon achievement of $75.0 million in trailing twelve month sales pursuant to the CartiHeal Amendment. The acquisition of CartiHeal closed on July 12, 2022. We paid at closing to CartiHeal stockholders an aggregate up-front payment of $100.0 million (inclusive of the previously discussed escrow deposit). We also paid approximately $8.0 million of CartiHeal’s transaction related fees and expenses.

On July 11, 2022 we amended our credit agreement (as amended, the Amended 2019 Credit Agreement) in conjunction with the CartiHeal Acquisition. Pursuant to the Amended 2019 Credit Agreement, an $80.0 million term loan facility (Term Loan Facility) was extended to us for: (i) the financing of the CartiHeal Acquisition; (ii) the payment of related fees and expenses; and (iii) working capital needs and general corporate purposes of the Company, including without limitation for permitted acquisitions. The Term Loan Facility will mature on October 29, 2026. Refer to the Liquidity and Capital Resources—Credit Facilities for further information.

On July 12, 2022, we closed the CartiHeal Acquisition thereby acquiring all of its remaining shares for an aggregate purchase price of $315.0 million and an additional $135.0 million becoming payable after closing upon achievement of the sales milestones previously discussed. We paid $100.0 million of the aggregate purchase price at the closing consisting of the $50.0 million escrow deposit and the $50.0 million from the Term Loan Facility. We also paid approximately $8.0 million for the previously discussed transaction related fees and expenses of CartiHeal.

B.O.N.E.S. Trial

We submitted a premarket approval (PMA) supplement to the FDA in December 2020 seeking approval of an expanded indication for EXOGEN, specifically, for the adjunctive treatment of acute and delayed metatarsal fractures to reduce the risk of non-union. This PMA supplement was based on and supported by clinical data in metatarsal fractures from the ongoing B.O.N.E.S. study. In April 2021, we received a letter from the FDA identifying certain deficiencies in the PMA supplement that must be addressed before the FDA can complete its review of the PMA supplement. The deficiencies include concerns about the data and endpoints from the B.O.N.E.S. study, and requests for re-analyses of certain data and provision of other information to support the findings. We are in the process of performing ancillary analysis on the data as requested by the FDA and remain engaged in discussions with the FDA to address the agency’s concerns. In addition, in December 2021, we completed the follow-up of all patients in the scaphoid B.O.N.E.S. study. We plan on submitting a PMA supplement for this indication in the fourth quarter of 2022. We can give no assurance that we will be able to resolve the deficiencies identified by the FDA in a timely manner, or at all. Consequently, the FDA’s decision on the PMA supplements may be delayed beyond the time originally anticipated. Moreover, if our responses do not satisfy the FDA’s concerns, the FDA might not approve our PMA supplements seeking to expand the indications for use of EXOGEN in metatarsal and scaphoid fractures as proposed.

MOTYS Update

During the second quarter of 2022, prior to obtaining the results from our Phase 2 trial, we elected to discontinue the development of MOTYS, to focus our resources on other priorities, including the integration of our recent acquisitions and our expanded R&D and product development portfolio we inherited with these acquisitions. We expect to incur approximately $4.0 to $6.0 million in required costs over the next year exclusively to fulfill our remaining regulatory obligations related to our Phase 2 trial (MOTYS Costs) with the majority in the second half of 2022. We may assess further strategic options at a future date.

Consolidated Appropriations Act - 2021

In July 2022, in connection with the Consolidated Appropriations Act, 2021 (CAA), the Centers for Medicare and Medicaid Services (CMS) began utilizing new pricing information the Company reported to it pursuant to the newly adopted reporting obligations to adjust the Medicare payment to healthcare providers using our Durolane and Gelsyn-3 products.

COVID-19 pandemic impact

Our business, results of operations and financial condition have been and may continue to be, materially impacted by fluctuations in patient visits and elective procedures and any future temporary cessations of elective procedures as a result of the COVID-19 pandemic and could be further impacted by delays in payments from customers, supply chain interruptions, “shelter-in-place” orders or advisories, facility closures or other reasons related to the pandemic. As of the date of this Quarterly Report on Form 10-Q, the extent to which COVID-19 could materially impact our financial conditions, liquidity or results of operations is uncertain.

To the extent COVID-19 disruptions continue to adversely impact our business, results of operations and financial condition, it might also have the effect of heightening risks relating to our ability to successfully commercialize newly developed or acquired products or therapies, consolidation in the healthcare industry, intensified pricing pressure as a result of changes in the purchasing behavior of hospitals and maintenance of our numerous contractual relationships.

Results of Operations

For a description of the components of our results of operations, refer to Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2021 10-K.

The following table sets forth components of our condensed consolidated statements of operations as a percentage of net sales for the periods presented:

The following table presents a reconciliation of net (loss) income to Adjusted EBITDA for the periods presented:

(in thousands)

25

(a) Includes for the three months ended July 2, 2022 and July 3, 2021 and the six months ended July 2, 2022 and July 3, 2021, respectively, depreciation and amortization of $9,684, $5,618, $18,902 and $10,854 in cost of sales and $2,700, $1,861, $5,961 and $3,809 in operating expenses presented in the consolidated statements of operations and comprehensive (loss) income.

(b) Includes acquisition and integration costs related to completed acquisitions, amortization of inventory step-up associated with acquired entities, and changes in fair value of contingent consideration.

(c) Costs incurred during the three and six months ended July 2, 2022 were the result of adopting acquisition related restructuring plans to reduce headcount, reorganize management structure and to consolidate certain facilities. Costs incurred during the corresponding periods in 2021 were primarily related to executive transitions.

(d) The three and six months ended July 2, 2022 and the three months ended July 3, 2021 include compensation expense resulting from awards granted under the Company’s equity-based compensation plans in effect after its initial public offering (IPO). The six months ended July 3, 2021 also includes the expense and the change in fair value of the liability-classified awards granted under the compensation plans in effect prior to the Company’s IPO.

(e) Represents CartiHeal equity investment losses.

(f) Includes realized and unrealized gains and losses from fluctuations in foreign currency.

(g) Represents the loss on impairment of Harbor Medtech Inc.’s (Harbor) long-lived assets and the Company’s investment in Harbor.

(h) Other items primarily includes charges associated with strategic transactions, such as potential acquisitions; public company preparation costs, which primarily includes accounting and legal fees; and MOTYS Costs (as defined below). During the second quarter of 2022, prior to obtaining the results from our Phase 2 trial, we elected to discontinue the development of MOTYS, to focus our resources on other priorities, including the integration of our recent acquisitions and our expanded R&D and product development portfolio we inherited with these acquisitions. In the second quarter of 2022, we incurred $0.8 million, and we expect to incur approximately $4.0 to $6.0 million in required costs over the next twelve months with the majority in the second half of 2022, exclusively to fulfill our remaining regulatory obligations related to our Phase 2 trial (MOTYS Costs).

We present Adjusted EBITDA, a non-GAAP financial measure, because we believe it is a useful indicator that management uses as a measure of operating performance as well as for planning purposes, including the preparation of our annual operating budget and financial projections. We believe that Adjusted EBITDA is useful to our investors because it is frequently used by securities analysts, investors and other interested parties in their evaluation of the operating performance of companies in industries similar to ours. We define Adjusted EBITDA as net (loss) income before depreciation and amortization, provision of income taxes and interest expense (income), net, adjusted for the impact of certain cash, non-cash and other items that we do not consider in our evaluation of ongoing operating performance. These items include acquisition and related costs, restructuring and succession charges, equity compensation, equity loss in unconsolidated investments, foreign currency impact, and other items. Adjusted EBITDA by segment is comprised of net sales and costs directly attributable to a segment, as well as an allocation of corporate overhead costs primarily based on a ratio of net sales by segment to total consolidated net sales.

Non-GAAP financial measures have limitations as an analytical tool and should not be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with U.S. GAAP. These measures might exclude certain normal recurring expenses. Therefore, these measures might not provide a complete understanding of the Company's performance and should be reviewed in conjunction with the U.S. GAAP financial measures. Additionally, other companies might define their non-GAAP financial measures differently than we do. Investors are encouraged to review the reconciliation of the non-GAAP measure provided in this report, including in the table above, to its most directly comparable U.S. GAAP measure.

Net sales

(in thousands, except for percentage)

U.S.

Net sales increased $27.6 million, or 28.0%, of which acquisitions contributed $18.1 million. Revenue also increased due to volume growth. Total increases by vertical were: (i) Pain Treatments—$6.9 million; (ii) Restorative Therapies—$8.2 million; and (iii) Surgical Solutions—$12.5 million.

Net sales increased $2.9 million, or 25.9%, of which acquisitions contributed $3.5 million, partially offset by a decline in sales volume within our Restorative Therapies vertical.

(in thousands, except for percentage)

U.S.

Net sales increased $57.2 million, or 33.0%, of which acquisitions contributed $41.2 million. Revenue also increased due to volume growth. Total increases by vertical were: (i) Pain Treatments—$17.0 million; (ii) Restorative Therapies—$18.5 million; and (iii) Surgical Solutions—$21.6 million.

International

Net sales increased $8.9 million, or 48.2%, due to acquisitions. Revenue also slightly increased due to sales volume growth as revenue during the first quarter of 2021 was negatively affected by the economic impact of the COVID-19 pandemic. This growth was partially offset by a decline in sales volume within our Restorative Therapies vertical during the second quarter of 2022.

Gross profit and gross margin

(in thousands, except for percentage)

U.S.

Gross profit increased $18.5 million, or 26.9%, primarily due to the increase in net sales. Gross margin decreased due to product mix including products introduced as a result of acquisitions, partially offset by less inventory step-up amortization of acquisition related assets in 2022 compared with the prior year.

Gross profit increased $1.8 million, or 24.3%, primarily due to the increase in net sales. Gross margin decreased due to product mix including products introduced as a result of acquisitions.

(in thousands, except for percentage)

27

U.S.

Gross profit increased $31.5 million, or 25.5%, primarily due to the increase in net sales. Gross margin decreased due to product mix including products introduced as a result of acquisitions. Gross margin was also negatively impacted by 1.5% from inventory step-up amortization of acquisition related assets in 2022 compared with the prior year.

Gross profit increased $5.0 million, or 39.9%, primarily due to the increase in net sales. Gross margin decreased due to product mix including products introduced as a result of acquisitions.

Selling, general and administrative expense

(in thousands, except for percentage)

Selling, general and administrative expenses increased $20.6 million, or 29.8%, primarily due to: (i) an increase in compensation related expenses of $12.3 million, primarily resulting from acquisitions; (ii) an increase in consulting and travel related expenses of $4.4 million; and (iii) an increase in bad debt expenses of $1.9 million.

(in thousands, except for percentage)

Selling, general and administrative expenses increased $72.0 million, or 69.4%, primarily due to: (i) an increase in compensation related expenses of $29.1 million, primarily resulting from acquisitions; (ii) an increase in equity-based compensation of $24.0 million, which includes a $23.4 million decrease in fair market value during 2021 of accrued equity-based compensation resulting from the difference between the pricing from the pending IPO and the actual offering price; (iii) an increase in consulting and travel related expenses of $8.8 million; (iv) an increase of $2.9 million in bad debt expenses; and (v) an increase of $1.9 million in corporate and employee health insurance primarily resulting from acquisitions.

Research and development expenses

(in thousands, except for percentage)

Research and development expense increased by $1.5 million, or 31.6%, due to: (i) an increase of $0.9 million in consulting costs; and (ii) an increase of $0.8 million in compensation related expenses partially driven by acquisitions.

(in thousands, except for percentage)

Research and development expense increased by $7.5 million, or 129.9%, primarily due to: (i) an increase of $2.7 million in consulting costs; (ii) an increase of $2.3 million in compensation related expenses partially driven by acquisitions; and (iii) an increase in equity-based compensation of $2.0 million, which includes a $1.8 million decrease in fair market value during 2021 of accrued equity-based compensation resulting from the difference between the pricing from the pending IPO and the actual offering price.

Restructuring costs

Restructuring costs of $1.0 million and $1.6 million for the three and six months ended July 2, 2022, respectively, were incurred as a result of restructuring plans for recently acquired businesses to reduce headcount, to reorganize management structure and to consolidate certain facilities.

Change in fair value of contingent consideration

(in thousands, except for percentage)

28

(in thousands, except for percentage)

The changes in fair value of contingent consideration during the three and six months ended July 2, 2022 compared with the prior year comparable periods resulted from not meeting the $15,000 FDA approval milestone related to the Bioness Acquisition, thereby decreasing the amount of contingent consideration owed. Fair value changes involving contingent consideration represent changes in the present value of discounted cash flows due to the passage of time.

Depreciation and amortization

(in thousands, except for percentage)

(in thousands, except for percentage)

Depreciation and amortization increased during three and six months ended July 2, 2022 compared with the prior year comparable periods primarily due to acquisitions, partially offset by lower amortization expense in the current year as certain assets became fully amortized.

Impairment of variable interest entity assets

We terminated its Collaboration Agreement with Harbor on June 8, 2021 resulting in a $5.7 million impairment on Harbor’s long-lived asset balances, of which $5.2 million was recorded in loss attributable to noncontrolling interest. Refer to Note 3. Business combination and investments in the Notes to the unaudited condensed consolidated financial statements Part I, Item 1. Financial Statements of this Form 10-Q for further details concerning the impairment and deconsolidation of Harbor.

Other expense

(in thousands, except for percentage)

Interest expense, net increased $0.9 million due to an increase of $1.3 million in interest expense as a result of our October 2021 debt refinancing, partially offset by $0.5 million of interest income from the change in the fair value of our interest rate swap.

Other expense decreased $0.8 million primarily due to the impairment of our Harbor investment of $1.4 million in the prior year, partially offset by a $0.6 million foreign currency impact.

(in thousands, except for percentage)

Interest expense (income), net changed $2.2 million due to: (i) the settlement of our equity participation right (EPR) liability in 2021 resulting in interest income of $2.8 million; and (ii) an increase of $2.1 million in interest expense as a result of our October 2021 debt refinancing. These changes were partially offset by a $2.9 million increase in interest income resulting from the change in the fair value of our interest rate swap.

Other expense decreased $1.1 million primarily due to the impairment of our Harbor investment of $1.4 million in the prior year, partially offset by a $0.6 million foreign currency impact.

Income tax (benefit) expense

(in thousands, except for percentage)

Income tax expense for the three months ended July 2, 2022 and July 3, 2021 was primarily due to a change in our forecasted effective tax rate.

(in thousands, except for percentage)

(NM = Not Meaningful)

Income tax benefit for the six months ended July 2, 2022 and July 3, 2021 was primarily due to net losses experienced during the first six months of 2022. The income tax expense for the six months ended July 3, 2021 was primarily due to capitalized expenses resulting from our IPO.

Noncontrolling interest

(in thousands, except for percentage)

(in thousands, except for percentage)

Subsequent to the IPO and related transactions, we are the sole managing member of BV LLC in which we own 79.6%. We have a majority economic interest, the sole voting interest in, and control the management of BV LLC. As a result, we consolidate the financial results of BV LLC and report a non-controlling interest representing the 20.4% that is owned by the Continuing LLC Owner.

The decline in losses associated with other noncontrolling interest resulted from our deconsolidation of Harbor upon the termination of the Collaboration Agreement during the second quarter of 2021 in which we incurred a $5.7 million impairment charge. We ceased being the primary beneficiary upon termination as we no longer had the power to direct Harbor’s significant activities.

Segment Adjusted EBITDA

Adjusted EBITDA for each of our reportable segments is as follows:

(in thousands, except for percentage)

U.S.

Adjusted EBITDA increased $2.0 million, or 11.9%, primarily due to higher gross profit, partially offset with an increase in compensation related charges, consulting and travel related expenses as well as higher public company costs.

Adjusted EBITDA increased $1.0 million, or 36.4%, primarily due to an increase in gross profit resulting from the increase in sales. This increase was partially offset by consulting, travel related expenses and the negative impact of foreign currency.

(in thousands, except for percentage)

U.S.

Adjusted EBITDA decreased $3.2 million, or 11.9%, primarily due to an increase in compensation related charges of previously discussed as well as higher public company costs, partially offset by an increase in gross profit.

Adjusted EBITDA increased $2.3 million, or 60.6%, primarily due to an increase in gross profit resulting from the increase in sales. This increase was partially offset by the increase in consulting, travel related expenses, compensation and the negative impact of foreign currency.

Liquidity and Capital Resources

Sources of liquidity

Our principal liquidity needs have historically been for acquisitions, working capital, research and development, clinical trials, and capital expenditures. We expect these needs to continue as we develop and commercialize new products and further our expansion into international markets. As discussed below under CartiHeal, additional capital was provided to consummate the CartiHeal Acquisition through the Term Loan Facility, extended to us through the Amended 2019 Credit Agreement, and additional capital will be required to fund the Deferred Amount under the CartiHeal Amendment. We believe that our existing cash and cash equivalents, borrowing capacity under our revolving credit facility and cash flow from operations will be enough to meet our anticipated cash requirements for at least the next twelve months. However, additional capital may be required to fund the Deferred Amount under the CartiHeal Amendment.

We anticipate that to the extent that we require additional liquidity, we will obtain funding through the incurrence of other indebtedness, additional equity financings or a combination of these potential sources of liquidity. In addition, we may raise additional funds to finance future cash needs through receivables or royalty financings or corporate collaboration and licensing arrangements. If we raise additional funds by issuing equity securities or convertible debt, our stockholders will experience dilution. Debt financing, if available, would result in increased payment obligations and may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, or making capital expenditures. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish valuable rights to our products, future revenue streams or product candidates, or to grant licenses on terms that might not be favorable to us. The covenants under the Amended 2019 Credit Agreement limit our ability to obtain additional debt financing. We cannot be certain that additional funding will be available on acceptable terms, or at all. Any failure to raise capital in the future could have a negative impact on our financial condition and our ability to pursue our business strategies.

Initial public offering

On February 16, 2021, in connection with our IPO, we issued and sold 9,200,000 shares of our Class A common stock at a price to the public of $13.00 per share, resulting in gross proceeds to us of approximately $119.6 million, before deducting the underwriting discount, commissions and estimated offering expenses payable by us. Bioventus Inc. is a holding company and has no material assets other than the ownership of LLC Interests and has no independent means of generating revenue. Deterioration in the financial condition, earnings, or cash flow of BV LLC and its subsidiaries for any reason could limit or impair their ability to pay such distributions. In addition, the terms of our financing arrangements, including the Amended 2019 Credit Agreement, contain covenants that may restrict BV LLC and its subsidiaries from paying such distributions, subject to certain exceptions. Further, BV LLC is generally prohibited under Delaware law from making a distribution to a member to the extent that, at the time of the distribution, after giving effect to the distribution, liabilities of BV LLC (with certain exceptions), as applicable, exceed the fair value of its assets. Subsidiaries of BV LLC are generally subject to similar legal limitations on their ability to make distributions to BV LLC. Bioventus Inc., as the managing member, causes BV LLC to make cash distributions to the owners of LLC Interests in an amount sufficient to (i) fund tax obligations in respect of allocations of taxable income from BV LLC; and (ii) cover Bioventus Inc. operating expenses, including payments under the Tax Receivable Agreement (TRA).

Cash requirements

Except as provided below and the previously discussed capital requirements for the acquisition of CartiHeal, there have been no material changes to our future cash requirements as disclosed in Part II, Item 7 of our 2021 10-K.

We enter into contracts in the normal course of business with various third parties for development, collaboration and other services for operating purposes. These contracts provide for termination upon notice. Payments due upon cancellation generally consist only of payments for services provided or expenses incurred, including non-cancellable obligations of our service providers, up to the date of cancellation. Certain agreements include contingent events that upon occurrence would require payment. For information regarding Commitments and Contingencies, refer to Note 11. Commitment and contingencies in Part 1, Item 8. Financial Statements and Supplementary Data in this Quarterly Report on Form 10-Q for further information regarding other matters.

Tax Receivable Agreement

The BV LLC Agreement provides for the payment of certain distributions to the Continuing LLC Owner in amounts sufficient to cover the income taxes imposed with respect to the allocation of taxable income from BV LLC as well as obligations under the Tax Receivable Agreement (TRA). Under the TRA, we are required to make cash payments to the Continuing LLC Owner equal to 85% of the tax benefits, if any, that we actually realize (or in certain circumstances are deemed to realize), as a result of (1) increases in the tax basis of assets of BV LLC resulting from (a) any future redemptions or exchanges of LLC Interests, and (b) certain distributions (or deemed distributions) by BV LLC and (2) certain other tax benefits arising from payments under the TRA. We expect the amount of the cash payments required to be made under the TRA will be significant. The actual amount and timing of any payments under the TRA will vary depending upon a number of factors, including the timing of redemptions or exchanges by the Continuing LLC Owner, the amount of gain recognized by the Continuing LLC Owner, the amount and timing of the taxable income we generate in the future, and the federal tax rates then applicable. Any payments made by us to the Continuing LLC Owner under the TRA will generally reduce the amount of overall cash flow that might have otherwise been available to us. To the extent that we are unable to make payments under the TRA for any reason, such payments generally will be deferred and will accrue interest until paid; provided, however, that nonpayment for a specified period may constitute a material breach of a material obligation under the TRA and therefore accelerate payments due under the TRA.

CartiHeal

As disclosed under Strategic Transactions—CartiHeal, we exercised the Call Option in April 2022 for the acquisition of all the remaining shares of CartiHeal, excluding shares we already own, for approximately $315.0 million. An additional $135.0 million is payable contingent upon the achievement of $75.0 million in trailing twelve month sales. Pursuant to the CartiHeal Amendment, we deferred $215.0 million of the aggregate purchase price otherwise due at closing until the earlier of the achievement of certain milestones and the occurrence of certain installment payment dates. The first two milestones, each of which are $50.0 million, will be paid no later than the end of the third quarter of 2023. The next two milestones, each of which are $25.0 million, will be paid by the end of 2024 and 2025, respectively. The final milestone of $65.0 million is to be paid by 2027. We are currently exploring financing options in order to fund Deferred Amount payable in connection with the CartiHeal Acquisition. For additional information, see Part II, Item 1A. Risk Factors.

Credit Facilities

On July 11, 2022 we amended the 2019 Credit Agreement (as amended, the Amended 2019 Credit Agreement) in conjunction with the CartiHeal Acquisition. Through the Amended 2019 Credit Agreement, an $80.0 million Term Loan Facility was extended to us for (i) the financing of the CartiHeal Acquisition; (ii) the payment of related fees and expenses; and (iii) working capital needs and general corporate purposes of the Company. The Term Loan Facility will mature on October 26, 2026. We may elect either the secured overnight financial rate (SOFR) or base interest rate options for all borrowings as of July 12, 2022, which includes any outstanding balances under the Term Loan, Term Loan Facility and revolving credit facility. Initial SOFR loans and base rate loans had a margin of 3.25% and 2.25%, respectively, subsequent to July 12, 2022. The Amended 2019 Credit Agreement includes customary affirmative and negative covenants including financial maintenance covenants.

We were in compliance with all required financial covenants under the 2019 Credit Agreement as of July 2, 2022.

Other

For information regarding Commitments and Contingencies, refer to Note 11. Commitments and contingencies and Note 3. Acquisitions and investments to the Notes to the Unaudited condensed consolidated financial statements of Part 1, Item 1. Financial Statements of this Form 10-Q.

Information regarding cash flows

Cash, cash equivalents and restricted cash as of July 2, 2022 totaled $41.0 million, compared to $99.2 million as of December 31, 2021. The decrease in cash was primarily due to the following:

(in thousands, except for percentage)

NM = Not Meaningful

Operating Activities

Net cash used in operating activities increased $17.4 million, primarily due to completed acquisitions and the resulting integration costs, higher employee compensation and increased operating expenses. These outflows were partially offset by increased collections from higher sales.

Investing Activities

Cash flows used in investing activities increased $7.4 million, primarily due to the $50.0 million held in trust for the acquisition of CartiHeal and an increase of $2.3 million in capital expenditures, partially offset by the $45.8 million acquisition of Bioness in 2021.

Financing Activities

Cash flows provided by financing activities decreased $84.5 million, primarily due to the $107.8 million in net proceeds from the issuance of Class A common stock sold during our 2021 IPO. This was partially offset by a $25.0 million draw on our revolving credit facility in 2022.

Off-balance Sheet Arrangements

We do not have any off-balance sheet arrangements.

Contractual Obligations

Except as discussed above, there have been no material changes to our contractual obligations as disclosed in our 2021 10-K.

Critical Accounting Estimates

Our discussion of operating results is based upon the unaudited condensed consolidated financial statements and accompanying notes. The preparation of these statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Our critical accounting estimates are detailed in Item 7 of our 2021 10-K and we have no material changes from such disclosures.

Recently Issued Accounting Pronouncements

Refer to Note 1. Organization, in the Notes to the unaudited condensed consolidated financial statements of Part 1, Item 1. Financial Statements of this Form 10-Q for detailed information regarding the status of recently issued accounting pronouncements.

Limitations on Effectiveness of Controls and Procedures

In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of July 2, 2022.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarterly period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the risk factors and other cautionary statements described in Part I, Item 1A., Risk Factors included in our 2021 10-K, which could materially affect our businesses, financial condition, or future results. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, or future results. There have been no material updates to our Risk Factors presented in our 2021 10-K except for the following:

If we are unable to fund the remainder of the deferred consideration for the CartiHeal Acquisition as it becomes due, we will be subject to penalty interest payment and might lose the assets acquired in the acquisition.

On April 4, 2022, we exercised our Call Option to acquire CartiHeal., excluding the ownership interest already owned by us, for approximately $315.0 million with an additional approximately $135.0 million payable contingent upon the achievement of $75.0 million in trailing twelve-month sales. Pursuant to the CartiHeal Amendment entered into on June 17, 2022, we deferred $215.0 million of upfront consideration otherwise payable to CartiHeal stockholders at the closing of the CartiHeal Acquisition. We closed the acquisition on July 12, 2022 with an upfront payment of $100.0 million, funded through the $50.0 million previously deposited in escrow and an extension of an $80.0 million Term Loan Facility under the Amended 2019 Credit Agreement. We are required to pay the Deferred Amount in five tranches commencing in 2023 and ending no later than 2027, upon the earlier of the achievement of certain milestones and the occurrence of such installment payment dates. Interest on each tranche of the Deferred Amount is accrued at a rate of 8.0% annually until such tranche becomes due and payable and is paid, subject to a penalty interest at a rate of 10.0% per annum if we are unable to pay the amount when due and payable. Our obligation to pay the Deferred Amount also is secured by a first ranking fixed pledge of all of the share capital and intellectual property of CartiHeal and a first ranking floating pledge of all of the assets acquired in the CartiHeal Acquisition.

We expect to fund the Deferred Amount with cash on hand, in combination with the borrowing availability under our credit facility and our expected cash from operations. However, in the event our expected cash from operations together with the borrowing availability under our credit facility are not sufficient, we might require additional capital. If we were to seek additional funds from public and private stock offerings, borrowings under our existing or new credit facilities or other sources in order to fund the Deferred Amount under the CartiHeal Amendment and other future initiatives related to the expansion of our business, such financing might not be available on acceptable or commercially reasonable terms, if at all. Further, such alternative sources of borrowing might be subject to the approval of the requisite lenders under our credit facilities, which we might not be able to secure under reasonable terms.

Furthermore, if we issue equity or debt securities to raise additional capital, our existing stockholders might experience dilution, and the new equity or debt securities might have rights, preferences and privileges senior to those of our existing stockholders. In addition, if we raise additional capital through collaboration, licensing or other similar arrangements, it might be necessary to relinquish valuable rights to our products, potential products or proprietary technologies, or grant licenses on terms that are not favorable to us.

If we cannot fund any tranche of the Deferred Amount as such tranche becomes due, such unfunded amount will thereafter bear interest at a penalty rate of 10.0% per annum (as opposed to 8.0%) until paid, and CartiHeal’s former security holders will be entitled to enforce the pledge agreements securing our obligation to pay such Deferred Amounts when due and payable pursuant to the CartiHeal Amendment. If such events were to occur, it could adversely affect our results of operations, financial condition and business.

If we are unable to achieve and maintain adequate levels of coverage and/or reimbursement for our products, the procedures using our products, such as our HA viscosupplements, or any products or future products we may seek to commercialize, such as our recently acquired Agili-C product, the commercial success of these and other products we seek to commercialize may be adversely affected.

Our products are purchased by healthcare providers and customers who typically bill third-party payers or private insurance plans and healthcare networks, to cover all or a portion of the costs and fees associated with our products. These third-party payers and insurers may deny reimbursement if they determine that a device or product provided to a patient or used in a procedure does not meet applicable payment criteria or if the policyholder’s healthcare insurance benefits are limited. Further, limits put on reimbursement by third-party payers, whether foreign or domestic, governmental or commercial, could make it more difficult to buy our products and substantially reduce, or possibly eliminate, patient access to our products. The healthcare industry in the United States has experienced a trend toward cost containment as government and private insurers seek to control rising healthcare costs by imposing lower payment rates and negotiating reduced contract rates with providers and suppliers.

Private payers may adopt coverage decisions and payment amounts determined by the Centers for Medicare and Medicaid Services (CMS), the federal agency that administers the Medicare program in the United States, as guidelines in setting their coverage and reimbursement policies. In addition, CMS periodically reviews medical study literature to determine how the literature addresses certain procedures and therapies in the Medicare population. For some governmental programs, such as Medicaid, coverage and reimbursement differs from state to state. Medicaid payments to physicians, facilities and other providers are often lower than payments by other third-party payers and some state Medicaid programs may not pay an adequate amount for the procedures performed with our products, if any payment is made at all. If CMS, other government agencies or private payers lower their reimbursement rates or establish additional limitations on coverage of our products, or if any of the proposed drug pricing executive orders or legislative reforms are enacted, the commercial success of our products may be adversely affected.

At present, there is no established reimbursement for Agili-C products. As a result, we may also be required to conduct expensive clinical studies of Agili-C to justify reimbursement coverage by Medicare and private payers at the level of reimbursement equal to or greater than existing therapies. Moreover, since there is no uniform policy of coverage and reimbursement for our products or procedures using our products among third-party payers in the United States, even if such studies are successful, coverage and reimbursement for our products and procedures using our products can differ significantly from payer to payer. Further, these payers regularly review new and existing technologies for possible coverage and can, without notice, deny or reverse coverage for new or existing products and treatments. Third-party payers may not consider our products to be medically necessary or cost-effective for certain indications or off-label uses or for all uses, and as a result, might not provide coverage for the products. As a result, securing or maintaining third-party reimbursement for our Agili-C product or other products might be time consuming and expensive and the commercial success of our products may be adversely affected if we are not successful in our efforts to obtain and maintain adequate third-party reimbursement for our products.

Further, legislative or other regulatory reforms that have been adopted or may be adopted in the future may result in additional reductions in Medicare and other healthcare funding, more rigorous coverage criteria, new payment methodologies or other downward pressure on the pricing or reimbursement we or our customers receive for our products. For example, the Consolidated Appropriations Act, 2021 (CAA), was signed into law on December 27, 2020, and, pursuant to implementing regulations promulgated by CMS, expanded price reporting obligations for manufacturers of certain products reimbursed under Medicare Part B beginning January 1, 2022, including all of our HA viscosupplements. In July 2022, CMS began utilizing the new pricing information we reported to it pursuant to these newly adopted reporting obligations to adjust the Medicare payment to healthcare providers using our Durolane and Gelsyn-3 products. As a result, the rates currently available for those products have been reduced from those previously available and will be subject to future reporting and adjustment, which may affect the demand for those products or our ability to sell them profitably. We cannot predict the extent to which this law, or other reimbursement reform proposals or other healthcare cost containment measures that might be enacted in the future, may impact the demand or commercial success of our HA viscosupplements and other products we sell or plan to commercialize in the future.