ITEM 2.
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (amounts in thousands, except per share amounts or as otherwise noted)
|
You should read the
following discussion in conjunction with our financial statements and related notes appearing elsewhere in this report. In addition
to historical information, this report contains "forward-looking statements" within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 concerning our business, consolidated financial
condition, and results of operations. The Securities and Exchange Commission ("SEC") encourages companies to disclose
forward-looking statements so that investors can better understand a company’s prospects and make informed investment decisions.
Forward-looking statements are subject to risks and uncertainties, many of which are outside our control, which could cause actual
results to differ materially from these statements. Therefore, you should not rely on any of these forward-looking statements.
Forward-looking statements can be identified by such words as "will," "likely," "may," "believe,"
"expect," "anticipate," "intend," "seek," "designed," "develop," "would,"
"future," "can," "could," “estimate,” “potential,” and other expressions
that are predictions of or indicate future events and trends and that do not relate to historical matters. All statements other
than statements of historical facts included in this report regarding our strategies, prospects, financial condition, operations,
costs, plans, and objectives are forward-looking statements. Examples of forward-looking statements include, among others, statements
regarding the effect of COVID-19 and related impacts on our business, operations, and financial results, expected future operating
results, expectations regarding the timing and receipt of regulatory results, anticipated levels of capital expenditures, and expectations
of the effect on our financial condition of claims, litigation, and governmental and regulatory proceedings.
Please also refer to
those factors described in “Part I, Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December
31, 2019 and in Part II, Item 1A “Risk Factors” of this report for important factors that we believe could cause actual
results to differ materially from those in our forward-looking statements. Any forward-looking statement made by us in this report
is based only on information currently available to us and speaks only as of the date on which it is made. We undertake no obligation
to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result
of new information, future developments or otherwise.
Management Overview
We are a global,
integrated joint preservation and regenerative therapies company based in Bedford, Massachusetts. Our mission is to be the global
leader in orthopedic joint therapies and sports medicine with innovative technologies that exceed our customers’ expectations.
We are committed to delivering solutions to improve the lives of patients across a continuum of care from joint pain management
and regenerative therapies to sports medicine and orthopedic joint preservation and restoration. We have nearly thirty years of
global expertise commercializing more than twenty products based on our hyaluronic acid, or HA, technology platform, and we are
focused on adding innovative and differentiated offerings to our consolidated portfolio. Our proprietary technologies for modifying
the HA molecule allow product properties to be tailored specifically to multiple therapeutic uses. Certain of our technology chemically
modifies HA to allow for longer residence time in the body. We have two forms of cross-linked HA gel technologies, and a solid
form of HA technology – HYAFF which is our platform for regenerative medicine. These proprietary technologies are protected
by an extensive portfolio of owned and licensed patents.
As we look towards
the future, our business is uniquely positioned to capture value within the sports and regenerative medicine market. Our success
is driven by our focus on our talent and culture, investment in innovative research and development programs to feed our product
pipeline, expanding our commercial footprint domestically and internationally, and pursuing strategic inorganic growth opportunities.
We intend to continue to accelerate our commercial capabilities as we transform into a customer-centric company dedicated to advancing
the joint preservation and restoration continuum of care. We believe that this commitment, along with our financial resources and
operating history, have positioned us well to deliver sustained value to our shareholders,
In early 2020, we expanded
our overall technology platform through our strategic acquisitions of Parcus Medical, LLC, or Parcus Medical, a sports medicine
implant and instrumentation solutions provider focused on surgical repair and reconstruction of ligaments and tendons, and Arthrosurface,
Incorporated, or Arthrosurface, a joint preservation technology company specializing in less invasive, bone preserving partial
and total joint replacement solutions. We expect the Parcus Medical and Arthrosurface acquisitions to drive growth by:
•
|
|
Broadening our product portfolio further
into the sports medicine joint preservation and restoration space;
|
•
|
|
Adding high-growth potential revenue
streams;
|
•
|
|
Expanding our commercial capabilities;
|
•
|
|
Diversifying our revenue base; and
|
•
|
|
Expanding our product pipeline and research and development expertise.
|
In addition, we believe
that our historical HA and regenerative medicine expertise will be highly complementary to the sports medicine implants and instrumentation
expertise of Parcus Medical and the partial and total joint replacement expertise of Arthrosurface. We believe that the combination
of these three businesses positions us to provide innovative solutions along the orthopedic continuum of care and build significant
value for patients, physicians, and key healthcare system stakeholders.
Since our inception
in 1992 through mid-2019, we utilized a commercial partnership model for the distribution of our products to end-users. Our strong,
worldwide network of distributors has historically provided, and continues to provide, a solid foundation for our revenue growth
and territorial expansion. In 2019, we implemented a hybrid commercial approach that comprises a small direct model with a network
of distributor partners in the U.S. market, and we utilized this hybrid approach for the launch of TACTOSET in the second half
of 2019. The acquisitions of Arthrosurface and Parcus Medical each added to our commercial infrastructure, especially in the United
States. Arthrosurface has approximately 35 sales representatives and 100 distributors in the U.S., while Parcus Medical employs
a similar, though more mature, model as us and has over 50 U.S. distributors in place.
For products in our
Orthopedic Joint Preservation and Restoration family, including those currently in research and development or those not yet developed,
we intend to leverage the expanded hybrid-direct sales infrastructure of the consolidated entity. This framework pairs an internal
direct sales team with external sales agent partners to maximize territorial coverage and sales generation. Generally, products
within this family are sold into surgical environments, such as hospitals or ambulatory surgery centers, and we believe that we
have a strong infrastructure now in place to service these customers. We intend to cross-train the sales staffs to create a consolidated
sales structure selling all of the products within our portfolio. We also intend to assess each selling territory to maximize our
coverage and reach as many customers and patients as possible.
For longer-term future
products in the U.S. market within our Joint Pain Management or Other families, we intend to evaluate our commercial model and
possible alternatives or augmentations in each instance on a case-by-case basis, based on market dynamics and other factors. These
models could include direct sales, distribution partnerships, or a hybrid of those forms. For current products in the U.S. market,
we intend to retain our current distribution relationships, including with DePuy Synthes Mitek Sports Medicine, a division of DePuy
Orthopaedics, or Mitek, as they continue to provide meaningful revenue and growth opportunities.
Please see the section
captioned “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Management
Overview” in our Annual Report on Form 10-K for the year ended December 31, 2019, for a description of each of the above
therapeutic areas, including the individual products.
Key Developments during the Quarter
Ended March 31, 2020
•
|
|
We completed the acquisitions of Parcus Medical, a sports medicine implant and instrumentation solutions provider focused on surgical repair and reconstruction of ligaments and tendons, and Arthrosurface, a joint preservation technology company specializing in less invasive partial joint replacement solutions. After closing the transactions, we began to execute our integration plans and started to see benefits to commercial operations and our product pipeline.
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•
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|
Our Board of Directors appointed Dr. Cheryl Blanchard as the Company’s Interim Chief Executive Officer effective February 12, 2020 to succeed Mr. Joseph Darling, our former CEO who passed unexpectedly in late January. Dr. Blanchard was formally named President and Chief Executive Officer on April 26, 2020.
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•
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We expanded our experienced executive team with the addition of David Colleran as Executive Vice President, General Counsel and Corporate Secretary.
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•
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We completed our $30.0 million accelerated share repurchase program in January 2020, under which we repurchased approximately 600,000 shares of our outstanding common stock.
|
COVID-19 Pandemic
In March 2020, the
World Health Organization declared the spread of the COVID-19 virus a pandemic. This pandemic has caused an economic downturn on
a global scale, as well as significant volatility in the financial markets. The Company cannot at this time predict the impact
that the COVID-19 pandemic will have on its full year financial condition and operations, although we are continuing to monitor
our operations for COVID-19 pandemic related changes. In this time of uncertainty as a result of the COVID-19 pandemic, we are
focused on serving our customers while taking every precaution to provide a safe work environment for our employees and customers.
We have established and implemented a work from home provision where possible. We may have to take further actions that we determine
are in the best interests of our employees or as required by federal, state, or local authorities. To date, we do not anticipate
disruption to our ability to supply products to our customers. Our commercial day-to-day operations have been impacted due to the
worldwide cancellation or delay of elective procedures, and timelines associated with certain clinical studies and research and
development programs have been delayed. While the impact has been limited to these items to date, we caution that there continues
to be a possibility for potential future implementation of certain additional restrictions. The impact of these restrictions on
our operations, if implemented, is currently unknown but could be significant.
Research and Development
Our research and development efforts primarily consist of the development of new medical
applications for our technology platform, the development of intellectual property with respect to our technology platform, the
management of clinical trials for certain product candidates, the preparation and processing of applications for regulatory approvals,
and process development and scale-up manufacturing activities for our existing and new products. Our development focus is orthopedic
and regenerative medicine and includes products for tissue protection, repair, and regeneration, and we believe that our HA and
surgical platform technologies provide broad pipeline versatility and expansion opportunities within this targeted space. We routinely
interact with key external stakeholders to leverage customer and patient insights in our development process to ensure that we
bring needed therapies to the market. We anticipate that we will continue to commit significant resources in the near future to
research and development activities, including in relation to preclinical activities and clinical trials. These activities are
aimed at the delivery of a steady cascade of new product development and launches over the next several years. The COVID-19 pandemic,
however, has resulted in a significant decline in elective procedures worldwide. This decline has impacted our ability to enroll
patients in our clinical trials. Given the uncertainty around the scale and duration of the COVID-19 pandemic, it is difficult
to predict the precise impact on our clinical activities.
Our third generation, single-injection osteoarthritis
product under development in the United States, CINGAL, is a joint pain management therapy composed of our proprietary cross-linked
HA material combined with an approved steroid, is designed to provide both short- and long-term pain relief to patients, and is
a main pipeline product and a component of our growth strategy. In pursuing a U.S. regulatory pathway for CINGAL, we have conducted
two Phase III clinical trials and two follow-up studies, and the United States Food and Drug Administration, or FDA, has indicated
an additional Phase III trial is necessary to support U.S. approval. We are currently working to initiate a pilot study to confirm
our trial design, increase our probability of success in a Phase III trial and generate data that ultimately will be needed to
support FDA approval. As a result of the COVID-19 pandemic, we no longer expect to commence the CINGAL pilot study in the first
half of 2020. Given the evolving environment, we will update product development and clinical trial timelines after we have more
visibility with respect to the length and regional impacts of the COVID-19 pandemic.
We have several research
and development programs underway for new products, including for HYALOFAST (in the United States), an innovative product for cartilage
tissue repair, and other early stage regenerative medicine development programs. We commenced patient enrollment in a Phase III
clinical trial in December 2015 and advanced site initiations and patient enrollment activities. Given the changing medical landscape
with respect to the randomization arm for this trial, the microfracture procedure, we are also actively pursuing other alternative
strategies to accelerate patient enrollment. We also have several other research and development programs underway focused on expanding
the joint preservation and regenerative medicine product portfolio.
Results of Operations
Three Months Ended March 31, 2020 Compared to Three Months
Ended March 31, 2019
|
|
Three Months Ended March 31,
|
|
|
2020
|
|
2019
|
|
$ Inc/(Dec)
|
|
% Inc/(Dec)
|
|
|
(in thousands, except percentages)
|
|
|
Product revenue
|
|
$
|
35,397
|
|
|
$
|
24,717
|
|
|
$
|
10,680
|
|
|
|
43
|
%
|
Licensing, milestone and contract revenue
|
|
|
-
|
|
|
|
6
|
|
|
|
(6
|
)
|
|
|
(100
|
%)
|
Total revenue
|
|
|
35,397
|
|
|
|
24,723
|
|
|
|
10,674
|
|
|
|
43
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product revenue
|
|
|
14,200
|
|
|
|
7,311
|
|
|
|
6,889
|
|
|
|
94
|
%
|
Research & development
|
|
|
6,050
|
|
|
|
4,258
|
|
|
|
1,792
|
|
|
|
42
|
%
|
Selling, general & administrative
|
|
|
14,431
|
|
|
|
7,672
|
|
|
|
6,759
|
|
|
|
88
|
%
|
Goodwill impairment
|
|
|
18,144
|
|
|
|
-
|
|
|
|
18,144
|
|
|
|
-
|
|
Change in fair value of contingent consideration
|
|
|
(24,522
|
)
|
|
|
-
|
|
|
|
(24,522
|
)
|
|
|
-
|
|
Total operating expenses
|
|
|
28,303
|
|
|
|
19,241
|
|
|
|
9,062
|
|
|
|
47
|
%
|
Income from operations
|
|
|
7,094
|
|
|
|
5,482
|
|
|
|
1,612
|
|
|
|
29
|
%
|
Interest and other income, net
|
|
|
279
|
|
|
|
498
|
|
|
|
(219
|
)
|
|
|
(44
|
%)
|
Income before income taxes
|
|
|
7,373
|
|
|
|
5,980
|
|
|
|
1,393
|
|
|
|
23
|
%
|
Provision for income taxes
|
|
|
1,580
|
|
|
|
1,473
|
|
|
|
107
|
|
|
|
7
|
%
|
Net income
|
|
$
|
5,793
|
|
|
$
|
4,507
|
|
|
$
|
1,286
|
|
|
|
29
|
%
|
Product gross profit
|
|
$
|
21,197
|
|
|
$
|
17,406
|
|
|
$
|
3,791
|
|
|
|
22
|
%
|
Product gross margin
|
|
|
60
|
%
|
|
|
70
|
%
|
|
|
|
|
|
|
|
|
Product Revenue
Product revenue for
the three-month period ended March 31, 2020 was $35.4 million, an increase of $10.7 million as compared to $24.7 million for the
three-month period ended March 31, 2019. For the three-month period ended March 31, 2020, the increase in product revenue was primarily
driven by growth across our product portfolio, especially in our orthopedic joint preservation and restoration product family,
as a result of the acquisitions of Parcus Medical and Arthrosurface, as well as the global growth of the joint pain management
business.
Historically,
we categorized our product offerings into four product families: Orthobiologics, Dermal, Surgical, and Other, which included
our ophthalmic and veterinary products. As a result of the Company’s acquisitions of Parcus Medical and Arthrosurface during
the period ended March 31, 2020, we now divide our product portfolio into three product families: Joint Pain Management,
Orthopedic Joint Preservation and Restoration, and Other.
The following tables
present product revenue by product group:
|
|
Three Months Ended March 31,
|
|
|
2020
|
|
2019
|
|
$ Inc/(Dec)
|
|
% Inc/(Dec)
|
|
|
|
|
|
|
|
|
|
Joint Pain Management
|
|
$
|
25,483
|
|
|
$
|
22,850
|
|
|
$
|
2,633
|
|
|
|
12
|
%
|
Orthopedic Joint Preservation and Restoration
|
|
|
7,896
|
|
|
|
163
|
|
|
|
7,733
|
|
|
|
4,744
|
%
|
Other
|
|
|
2,018
|
|
|
|
1,704
|
|
|
|
314
|
|
|
|
18
|
%
|
|
|
$
|
35,397
|
|
|
$
|
24,717
|
|
|
$
|
10,680
|
|
|
|
43
|
%
|
Joint Pain Management
Our Joint Pain
Management product family consists of injectable viscosupplement products that provide pain relief from osteoarthritis, or
OA, conditions. These products include MONOVISC, ORTHOVISC, and CINGAL, all widely-used, HA-based viscosupplements utilized
to treat OA pain in humans, as well as HYVISC, an HA-based treatment for equine osteoarthritis pain. Overall, revenue from
joint pain management therapies increased 12% for the three-month period ended March 31, 2020, as compared to the same period
in 2019. The increase was primarily driven by increased revenue from CINGAL and MONOVISC.
Orthopedic Joint Preservation and Restoration
Our Orthopedic Joint
Preservation and Restoration product family consists of the following key products:
|
·
|
Arthrosurface’s catalogue of over 150 partial and total joint
surface implants and preservation solutions for the knee, shoulder, hip, ankle, wrist and toe that are designed to treat upper
and lower extremity orthopedic conditions caused by trauma, injury and arthritic disease. These products are designed to be less
invasive and more bone preserving than conventional joint replacements. These products are available in the United States and over
25 international markets.
|
|
·
|
Parcus Medical’s line of surgical implant and instrumentation
solutions are used by surgeons to repair and reconstruct damaged ligaments and tendons due to sports injuries, trauma and
disease. These solutions include screws, sutures, anchors, and other surgical systems that facilitate surgical procedures on the
shoulder, knee, hip, distal extremities, and soft tissue. They are typically utilized by surgeons in ambulatory surgical center,
or ASC, and hospital environments. These products are commercialized in the United States and over 60 international markets.
|
|
·
|
HYALOFAST, a biodegradable, HYAFF-based support for human bone marrow
mesenchymal stem cells used for cartilage regeneration and as an adjunct for microfracture surgery. This product is currently available
in Europe, South America, Asia, and certain other international markets.
|
|
·
|
TACTOSET, an HA-enhanced bone repair therapy designed to treat insufficiency
fractures. TACTOSET is available in the United States, and we expect to leverage the commercial infrastructure of our recent acquisitions
to increase market access to sell TACTOSET.
|
For the three-month
period ended March 31, 2020, Orthopedic Joint Preservation and Restoration product revenue increased by $7.7 million to $7.9 million
as compared to the same period in 2019 resulting primarily from the additions of the Arthrosurface and Parcus Medical product portfolios.
Other
Our Other product family
consists of legacy HA-based products that do not fit into one of our other primary product categories. These products include:
|
·
|
Advanced wound care products based on our HYAFF technology which
are used to treat skin wounds, ranging from burns to diabetic ulcers. The products cover a variety of wound treatment solutions,
including debridement agents, advanced therapies to aid healing, and scaffolds used as skin substitutes. Leading products include
HYALOMATRIX and HYALOFILL, which are used for the treatment of complex wounds such as burns and ulcers.
|
|
·
|
Products used in connection with the treatment of ENT (ears, nose
and throat) disorders. The lead product is MEROGEL, a HYAFF-based woven fleece nasal packing. We have partnered with Medtronic
XoMed, Inc., or Medtronic, for worldwide distribution of these ENT products.
|
|
·
|
Ophthalmic products, including injectable, high molecular weight
HA products used as viscoelastic agents in ophthalmic surgical procedures such as cataract extraction and intraocular lens implantation.
|
Other product revenue increased for the three-month
period ended March 31, 2020 by $0.3 million or 18%, as compared to the corresponding period in 2019.
Product Gross Profit and Margin
Product gross profit for the three-month period
ended March 31, 2020 increased $3.8 million to $21.2 million, representing a 60% product gross margin, for the period. The decrease
in product gross margin for the three-month period ended March 31, 2020, as compared to the same period in 2019, was primarily
due to fair valuation of inventory purchased associated with the two newly acquired companies. The inventory fair-value markup
and amortization of acquired intangible assets resulted in an increase of cost of goods sold by approximately $3.0 million.
Research and Development
Research and development expenses for the three-month
period ended March 31, 2020 were $6.1 million, an increase of $1.8 million as compared to the same period in 2019. The increases
in research and development expense were primarily due to preparation activities for the Cingal Pilot study, certain European post-market
clinical studies, and product development activities associated with the development of product candidates in our research and
development pipeline at the legacy Anika business as well as at the recently acquired Parcus Medical and Arthrosurface business.
Selling, General and Administrative
Selling, general and
administrative (“SG&A”) expenses for the three-month period ended March 31, 2020 were $14.4 million, an increase
of $6.8 million, as compared to the same period in 2019. The increase in SG&A expenses for the three-month period ended March
31, 2020 was related to the Company’s newly acquired sales infrastructure and expenses related to the acquisitions of Parcus
Medical and Arthrosurface during the first quarter of 2020, partially offset by a decrease in stock compensation expense in the
three-month period ended March 31, 2020 due to the forfeiture of unvested awards.
Goodwill Impairment Charge
We assess goodwill
for impairment annually, or, under certain circumstances, more frequently, such as when events or changes in circumstances indicate
there may be impairment. U.S. government policy responses to the COVID-19 pandemic and the resulting changes in healthcare guidelines
caused a temporary suspension of domestic elective surgical procedures. As a result of these events during the quarter, we performed
a quantitative assessment of goodwill impairment related to the Parcus and Arthrosurface reporting unit as of March 31, 2020.
The results of these interim impairment tests indicated that the estimated fair value of
this reporting unit was less than its carrying value. Consequently, a non-cash goodwill impairment charge of $18 million was recorded
in the quarter ended March 31, 2020. The decline in fair value was primarily due to decreases in immediate term revenue
and related cash flows as a result of the temporary suspension of domestic elective procedures which directly impact the Parcus
and Arthrosurface reporting unit.
Contingent Consideration Fair Value
Change
In the quarter ended March 31, 2020, we recorded a
net benefit of $24.5 million related to the change in fair value of our contingent consideration liabilities incurred as a result
of the acquisition of Parcus Medical and Arthrosurface in January and February of 2020. The liability for contingent consideration
is remeasured at each reporting period until the contingency is resolved. The decrease in fair value of the contingent consideration
as of March 31, 2020 is a result of result of a decrease in the near term projections of revenue due to the COVID-19 pandemic.
Income Taxes
The provision for income taxes was $1.6 million
for the three-month period ended March 31, 2020, based on an effective tax rate of 21.4%. The provision for income taxes
was $1.5 million for the three-month periods ended March 31, 2019, based on effective tax rates of 24.6%. The net decrease in
the effective tax rate for the three-month period ended March 31, 2020, as compared to the same period in 2019, was primarily
due to the $1.9 million tax expense on the impairment of non-tax deductible goodwill offset by the $2.0 million tax benefit on
the decrease in the fair value of the contingent consideration, both recognized in the first quarter of 2020. In addition,
we recorded a $0.4 million tax windfall for the three-month period ended March 31, 2020 related to exercises of employee equity
awards.
Non-GAAP Financial Measures
Adjusted EBITDA
We present information
below with respect to adjusted EBITDA, which we define as our net income excluding interest and other income, net, income tax
benefit (expense), depreciation and amortization, stock-based compensation, and acquisition related expenses. In light of the
COVID-19 pandemic, we have also excluded the impacts of goodwill impairment charges and changes in the fair value of contingent
consideration associated with our recent acquisition transactions. This financial measure is not based on any standardized methodology
prescribed by accounting principles generally accepted in the United States (“GAAP”) and are not necessarily comparable
to similarly titled measures presented by other companies.
We have presented adjusted
EBITDA because it is a key measure used by our management and board of directors to understand and evaluate our operating performance
and to develop operational goals for managing our business. We believe this financial measure helps identify underlying trends
in our business that could otherwise be masked by the effect of the expenses that we exclude. In particular, we believe that the
exclusion of the expenses eliminated in calculating adjusted EBITDA can provide a useful measure for period-to-period comparisons
of our core operating performance. Accordingly, we believe that adjusted EBITDA provides useful information to investors and others
in understanding and evaluating our operating results, enhancing the overall understanding of our past performance and future prospects,
and allowing for greater transparency with respect to key financial metrics used by our management in its financial and operational
decision-making.
Adjusted EBITDA is
not prepared in accordance with GAAP, and should not be considered in isolation of, or as an alternative to, measures prepared
in accordance with GAAP. There are a number of limitations related to the use of adjusted EBITDA rather than net income (loss),
which is the nearest GAAP equivalent. Some of these limitations are:
|
·
|
adjusted EBITDA excludes depreciation and amortization, and, although these are non-cash expenses, the assets being depreciated or amortized may have to be replaced in the future, the cash requirements for which are not reflected in adjusted EBITDA;
|
|
·
|
we exclude stock-based compensation
expense from adjusted EBITDA although (a) it has been, and will continue to be for the foreseeable future, a significant recurring
expense for our business and an important part of our compensation strategy and (b) if we did not pay out a portion of our compensation
in the form of stock-based compensation, the cash salary expense included in operating expenses would be higher, which would affect
our cash position;
|
|
·
|
we exclude acquisition related
expenses, including impacts of purchase price accounting, such as the impact of inventory fair-value step up on cost of goods
sold, amortization and depreciation of acquired assets, transactions
costs, and other related expenses;
|
|
·
|
we exclude goodwill impairment charges and changes in the fair value of contingent consideration as a result of the COVID-19 pandemic;
|
|
·
|
the expenses and other items that we exclude in our calculation of adjusted EBITDA may differ from the expenses and other items, if any, that other companies may exclude from adjusted EBITDA when they report their operating results;
|
|
·
|
adjusted EBITDA does not reflect changes in, or cash requirements for, working capital needs;
|
|
·
|
adjusted EBITDA does not reflect provision for (benefit from) income taxes or the cash requirements to pay taxes; and
|
|
·
|
adjusted EBITDA does not reflect historical cash expenditures or future requirements for capital expenditures or contractual commitments.
|
The following is a reconciliation
of net income to adjusted EBITDA for the three-month periods ended March 31, 2020 and 2019, respectively:
|
|
Three Months Ended March 31,
|
|
|
2020
|
|
2019
|
Net income
|
|
$
|
5,793
|
|
|
$
|
4,507
|
|
Interest and other income, net
|
|
|
(279
|
)
|
|
|
(498
|
)
|
Provision for income taxes
|
|
|
1,580
|
|
|
|
1,473
|
|
Depreciation and amortization
|
|
|
1,673
|
|
|
|
1,477
|
|
Stock-based compensation
|
|
|
(207
|
)
|
|
|
1,386
|
|
Acquisition related expenses
|
|
|
7,326
|
|
|
|
-
|
|
Goodwill impairment
|
|
|
18,144
|
|
|
|
-
|
|
Change in fair value of contingent consideration
|
|
|
(24,522
|
)
|
|
|
-
|
|
Adjusted EBITDA
|
|
$
|
9,508
|
|
|
$
|
8,345
|
|
Adjusted EBITDA in the three-month period
ended March 31, 2020, increased $1.2 million as compared with the comparable period in 2019. The increase in adjusted EBITDA for
the period was primarily due to an increase in total revenue, partially offset by increases in cost of product revenue and selling
and marketing expenses.
Adjusted Net Income and Adjusted EPS
We present information
below with respect to adjusted net income and adjusted diluted earnings per share (“adjusted EPS”), which we define
as our net income excluding acquisition related expenses and the impacts of goodwill impairment charges and changes in the fair
value of contingent consideration, each on a tax effected basis. Acquisition related expenses are those that we would not have
incurred except as a direct result of acquisition transactions. Acquisition related expenses consist of investment banking, legal,
accounting, and other professional and related expenses and the impact of purchase accounting, associated with acquisition transactions.
In the context of adjusted net income, the impact of purchase accounting includes the amortization of inventory step up and the
amortization of intangible assets recorded as part of purchase accounting for acquisition transactions. The amortized assets contribute
to revenue generation, and the amortization of such assets will recur in future periods until such assets are fully amortized.
These assets include the estimated fair value of certain identified assets acquired in acquisitions, including in-process research
and development, developed technology, customer relationships and acquired trade name. We define adjusted EPS as GAAP diluted earnings
per share excluding acquisition related costs on a tax-adjusted per share basis. As a result of COVID-19, we also exclude the impacts
of goodwill impairment charges and changes in the fair value in contingent consideration associated with the acquisition transactions,
each on a tax effected basis if applicable. This financial measure is not based on any standardized methodology prescribed by GAAP
and is not necessarily comparable to similarly titled measures presented by other companies.
We have presented adjusted
net income and adjusted EPS because they are key measures used by our management and board of directors to understand and evaluate
our operating performance and to develop operational goals for managing our business. We believe these financial measures help
identify underlying trends in our business that could otherwise be masked by the effect of the expenses that we exclude. In particular,
we believe that the exclusion of the expenses eliminated in calculating adjusted net income and adjusted EPS can provide useful
measures for period-to-period comparisons of our core operating performance. Accordingly, we believe that adjusted net income and
adjusted EPS provide useful information to investors and others in understanding and evaluating our operating results, enhancing
the overall understanding of our past performance and future prospects, and allowing for greater transparency with respect to key
financial metrics used by our management in its financial and operational decision-making.
The following is a
reconciliation of adjusted net income to net income for the three-month periods ended March 31, 2020 and 2019, respectively:
|
|
Three Months Ended March 31,
|
|
|
2020
|
|
2019
|
Net income
|
|
$
|
5,793
|
|
|
$
|
4,507
|
|
Acquisition related expenses, tax effected
|
|
|
5,593
|
|
|
|
-
|
|
Goodwill impairment, tax effected
|
|
|
15,773
|
|
|
|
-
|
|
Change in fair value contingent consideration, tax effected
|
|
|
(20,682
|
)
|
|
|
-
|
|
Adjusted net income
|
|
$
|
6,477
|
|
|
$
|
4,507
|
|
The following
is a reconciliation of adjusted diluted EPS to diluted EPS for the three-month periods ended March 31, 2020 and 2019, respectively:
(in thousands, expect per share data):
|
|
Three Months Ended March 31,
|
|
|
2020
|
|
2019
|
Diluted earnings per share (EPS)
|
|
$
|
0.40
|
|
|
$
|
0.31
|
|
Acquisition related expenses per share, tax effected
|
|
|
0.39
|
|
|
|
-
|
|
Goodwill impairment per share, tax effected
|
|
|
1.10
|
|
|
|
-
|
|
Change in fair value contingent consideration per share, tax effected
|
|
|
(1.44
|
)
|
|
|
-
|
|
Adjusted diluted EPS
|
|
|
0.45
|
|
|
|
0.31
|
|
Adjusted net income
and adjusted diluted EPS in the three-month period ended March 31, 2020 increased $2.0 million and $0.14 as compared with the comparable
period in 2019. The increase for the period was primarily due to an increase in total revenue, partially offset by increases in
cost of product revenue and selling and marketing expenses.
Liquidity and Capital Resources
We require cash to
fund our operating expenses and to make capital expenditures. We expect that our requirements for cash to fund these uses will
increase as our operations expand. Historically we have generated positive cash flow from operations, which, together with our
available cash, investments, and debt, have met our cash requirements. Cash, cash equivalents, and investments aggregated $92.3
million and $184.9 million, and working capital totaled $134.9 million and $218.0 million as of March 31, 2020 and December 31,
2019, respectively. We are closely monitoring our liquidity and capital resources for any potential impact that the COVID-19
pandemic may have on our operations. As a precautionary measure, we executed a drawdown of $50.0 million from our existing credit
facility with Bank of America on April 8, 2020. The Company’s credit facility has an additional $50.0 million accordion
feature that it could potentially access in the future. In addition, we are exploring other sources of funding aimed at further
supporting our liquidity profile, as well as maintaining business and organizational continuity through the pandemic. In parallel,
we have implemented a number of internal short-term expense controls and are prioritizing business initiatives to conserve cash
flow.
Cash provided by operating
activities was $1.0 million for the three-month period ended March 31, 2020, as compared to cash provided by operating activities
of $8.5 million for the same period in 2019. The decrease was primarily attributable to the decrease in accrued
operating expenses and the increase in inventory for the three-month period ended March 31, 2020.
Cash used in investing
activities was $92.5 million for the three-month period ended March 31, 2020, as compared to cash used in investing activities
of $1.9 million for the same period in 2019. The change was primarily due to the consideration paid for the acquisitions of
Parcus Medical and Arthrosurface in the three-month period ended Marth 31, 2020.
Cash used by financing
activities was $0.1 million for the three-month period ended March 31, 2020, as compared to cash used by financing activities of
$0.1 million for the same period in 2019. In both periods, the cash used in financing activities was attributable to utilization
of cash for employee tax withholding in exchange for shares surrendered by equity award holders.
Critical Accounting Policies and
Estimates
There were no other
significant changes in our critical accounting policies or estimates during the three months ended March 31, 2020 to augment the
critical accounting estimates disclosed under the heading “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, other than
those described below.
Business Combinations and Contingent
Consideration
Amounts
paid for acquisitions are allocated to the intangible and tangible assets acquired and liabilities assumed, if any, based on their
fair values at the dates of acquisition. This purchase price allocation process requires management to make significant estimates
and assumptions with respect to intangible assets and deferred revenue obligations. Critical estimates include, but are not limited
to, future expected cash flows, including projected revenues and expenses, and the applicable discount rates. The fair value of
identifiable intangible assets is based on detailed valuations that use information and assumptions determined by management.
Any excess of purchase price over the fair value of the net tangible and intangible assets acquired is allocated to goodwill.
While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition
date as well as any contingent consideration, where applicable, our estimates are inherently uncertain and subject to refinement.
As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the
assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon conclusion of the measurement period or
final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments
are recorded to our consolidated statements of comprehensive income. The fair value of contingent consideration includes estimates
and judgments made by management regarding the probability that future contingent payments will be made.
We use the income
approach to determine the fair value of certain identifiable intangible assets including developed technology and IPR&D. This
approach determines fair value by estimating after-tax cash flows attributable to these assets over their respective
useful lives and then discounting these after-tax cash flows back to a present value. The estimated economic lives were
determined using a variety of indicators including historical usage, evolutionary changes and other observable market data. We
base our assumptions on estimates of future cash flows, expected growth rates, expected trends in technology, etc. We base the
discount rate used to arrive at the present value used in this method as of the date of acquisition on the time value of money
and certain industry-specific risk factors. We use the relief from royalty method of the income approach to determine the fair
value of trade names. This approach determines fair value by estimating the after-tax royalty savings attributable to owning the
intangible asset and then discounting these after-tax royalty savings back to a present value. We base our assumptions
on the estimated revenue attributable to the trade name, the estimated royalty rate attributable to the trade name, etc. We use
the avoided costs/lost profits method to determine the fair of customer relationships. This approach determines fair value by
estimating the projected revenues related to the asset and estimated costs to recreate the intangible asset. We believe the estimated
purchased customer relationships, developed technologies, trade name, and in process research and development amounts so determined
represent the fair value at the date of acquisition and do not exceed the amount a third party would pay for the assets.
We
use the comparative sales method to determine the fair value of work-in-process and finished goods inventory acquired and ultimately
the inventory step-up required. The fair value of WIP inventory was estimated as the selling price less the sum of (a) costs to
complete, (b) costs of disposal, and (c) a reasonable profit allowance for the selling effort of the acquiring entity based on
profit for similar products. The fair value of finished goods inventory was estimated as the selling price less the sum of
(a) costs of disposal and (b) a reasonable profit allowance for the selling effort of the acquiring entity based on profit for
similar products.
For contingent consideration,
management updates these estimates and the related fair value of contingent consideration at each reporting period based on the
estimated probability of achieving the earnout targets and applying a discount rate that captures the risk associated with the
expected contingent payments. Under the Parcus Medical and Arthrosurface merger agreements, there
are earn-out milestones totaling $100 million payable from 2020 to 2022. Parcus Medical and Arthrosurface each have net sales earn-out
milestones annually from 2020 to 2022, while Arthrosurface has regulatory earn-out milestones in 2020 and 2021. Projected contingent
payment amounts are discounted back to the current period using a discounted cash flow model or a Monte Carlo simulation approach.
To the extent our estimates change in the future regarding the likelihood of achieving these targets we may need to record
material adjustments to our accrued contingent consideration. Changes in the fair value of contingent consideration are recorded
in our consolidated statements of comprehensive income.
Goodwill
We
assess goodwill for impairment on November 30th of each year, or, under certain circumstances, more frequently, such
as when events or changes in circumstances indicate there may be impairment. In evaluating goodwill for impairment, we have the
option to first assess qualitative factors to determine whether further impairment testing is necessary, such as macroeconomic
conditions, changes in our industry and the markets in which we operate, and our market capitalization, and our reporting units'
historical and expected future financial performance. If we conclude that it is more likely than not that a reporting unit's fair
value is less than it’s carrying value or we bypass the optional qualitative assessment, recoverability is assessed by comparing
the fair value of the reporting unit with its carrying amount. If a reporting unit's carrying value exceeds its fair value, we
will measure any goodwill impairment losses as the amount by which the carrying amount of a reporting unit exceeds its fair value,
not to exceed the total amount of goodwill allocated to that reporting unit.
For quantitative tests,
we estimate the fair value of the reporting units using an income approach. Under the income approach, the fair value of the reporting
unit is estimated based on the discounted present value of the its projected future cash flows. Rates used to discount cash flows
are dependent upon interest rates and the cost of capital based on our industry and capital structure, adjusted for equity and
size risk premiums based on market capitalization, as well as other financial inputs from a selection of comparable publicly-traded
companies with product offerings similar to those of the reporting unit. Estimates of future cash flows are dependent on our knowledge
and experience about past and current events, and as well as significant judgments and assumptions about conditions we expect to
exist, including revenue growth rates, margins, and the discount rate. Our estimates of cash flows are also based on historical
and future operating performance, economic conditions and actions we expect to take. These assumptions are based on a number of
factors, including future operating performance, economic conditions, actions we expect to take, and present value techniques.
There are inherent uncertainties related to these factors and management’s judgment in applying them to the analysis of goodwill
impairment. It is possible that assumptions underlying the impairment analysis will change in a manner that impairment in value
may occur in the future.
U.S. government policy responses to the COVID-19
pandemic and the resulting changes in healthcare guidelines caused a temporary suspension of domestic elective surgical procedures.
As a result of these events during the first quarter, we assessed goodwill for each of our reporting units. As of March 31, 2020,
there was $7.5 million of goodwill on the balance sheet related to the legacy Anika reporting unit. We assessed that our legacy
reporting unit’s fair value was greater than its carrying value using the qualitative assessment. Upon their acquisition,
we recorded $44.4 million of goodwill on the balance sheet related to the combined Parcus Medical and Arthrosurface reporting
unit. We performed a quantitative assessment of goodwill impairment related to the Parcus Medical and Arthrosurface reporting
unit. The temporary suspension of domestic elective procedures directly impacted the Parcus and Arthrosurface reporting unit,
resulting in an immediate term revenue decline. We further applied an increase in discount rate due to the increased overall uncertainty.
These key changes, together with estimates on operating expenses, capital requirements, tax benefits, and other cash flow projections
indicated that the estimated fair value of this reporting unit was less than its carrying value. Consequently, a goodwill impairment
charge of $18.1 million was recorded in the quarter ended March 31, 2020.
In the event the financial performance of the Company’s reporting units do not meet
our expectations in the future, we experience future prolonged market downturns, negative trends from the COVID-19 pandemic continue,
or there are other negative revisions to key assumptions, we may be required to perform additional impairment analyses and could
be required to recognize a goodwill impairment charge.
Recent Accounting Pronouncements
A discussion of Recent
Accounting Pronouncements is included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 and is updated
in the Notes to the condensed consolidated financial statements included in this report.
Contractual Obligations and Other
Commercial Commitments
Our
contractual obligations and other commercial commitments are summarized in the section captioned “Part II, Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Contractual
Obligations and Other Commercial Commitments” in our Annual Report on Form 10-K for the year ended December 31, 2019.
Material contractual obligations incurred in the quarter include those described
in Note 3, “Business Combinations”, Note 4, “Fair Value Measurements”, Note 8, “Leases.” There
were no material changes to our contractual obligations reported in our 2019 Annual Report on Form 10-K during the three months
ended March 31, 2020. For additional discussion, see Note 10 to the condensed consolidated financial statements included in this
report.
To the extent that
funds generated from our operations, together with our existing capital resources, are insufficient to meet future requirements,
we will be required to obtain additional funds through equity or debt financings, strategic alliances with corporate partners and
others, or through other sources. No assurance can be given that any additional financing will be made available to us or will
be available on acceptable terms should such a need arise.
Off-balance Sheet Arrangements
We do not use special
purpose entities or other off-balance sheet financing techniques that we believe have, or are reasonably likely to have, a current
or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations,
liquidity, or capital resources.