Apyx Medical Corp 10-K

ITEM 7 . Management’s Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes contained elsewhere in this report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors discussed in this report and those discussed in other documents we file with the SEC. In light of these risks, uncertainties and assumptions, readers are cautioned not to place undue reliance on such forward-looking statements. These forward-looking statements represent beliefs and assumptions as of the date of this report. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change. Past performance does not guarantee future results. Executive Level Overview We are an advanced energy technology company with a passion for elevating people’s lives through innovative products in the cosmetic and surgical markets. Known for our innovative Helium Plasma Technology, Apyx is solely focused on bringing transformative solutions to physicians and their patients. Our Helium Plasma Technology is marketed and sold as Renuvion® in the cosmetic surgery market and J-Plasma® in the hospital surgical market. Renuvion® offers plastic surgeons, fascial plastic surgeons and cosmetic physicians a unique ability to provide controlled heat to tissue to achieve their desired results. We also leverage our deep expertise and decades of experience in unique waveforms through OEM agreements with other medical device manufacturers. On March 14, 2022, the FDA posted a Communication that warns consumers and health care providers against the use of our Advanced Energy products outside of their FDA-cleared indications for general use in cutting, coagulation, and ablation of soft tissue during open and laparoscopic surgical procedures. We continue to work with the FDA towards securing 510(k) clearance for additional indications. We are in the process of evaluating what effects, if any, the Communication will have on our results of operations, cash flows and financial position. Impact of COVID-19, Supply Chain Disruptions and Other Matters As discussed in our Annual Report on Form 10-K for the year ended December 31, 2020 ("2020 Form 10-K"), an outbreak of a novel strain of the coronavirus, COVID-19, was identified in China and subsequently recognized as a pandemic by the World Health Organization. The impact of the COVID-19 outbreak has subsided substantially in the U.S. but continues to result in reduced activity levels outside of the U.S., such as continued restrictions on travel and business operations and advising or requiring individuals to limit or forego their time outside of their homes or places of business. Throughout 2021, while our revenues were affected by the continued impacts of the COVID-19 pandemic and its related variants, we saw increased utilization of our Renuvion® handpieces from existing customers in both the U.S. and outside of the U.S., along with improved demand for capital equipment domestically. International demand trends for generator adoption are improving but remain in the earlier stages of recovery. Although the timing of a return to a fully normalized environment remains uncertain, we are cautiously optimistic with respect to the continued recovery of the global cosmetic and plastic surgery markets. In response to the global supply chain instability and inflationary cost increases, we continue to take action to minimize, as much as possible, any potential adverse impacts by working closely with our suppliers to closely monitor the availability of raw material components (i.e., semiconductors and plastics), lead times, and freight carrier availability. We expect global supply chain instability will continue to have an impact on our business, but to date that has not been material to our financial performance. The consequences of the pandemic, global supply chain instability and inflationary cost increases and their adverse impact to the global economy, continue to evolve. Accordingly, the significance of the future impact to our business and financial statements remains subject to significant uncertainty. Since the onset of the COVID-19 pandemic, we have taken action in these key areas: • Protecting the Health and Safety of our Employees: To reduce the risk to our employees and their families to potential exposure to COVID-19, we required that all non-essential employees work remotely until further notice. We also split the shifts of our manufacturing personnel to allow for adequate social distancing, and require all personnel to utilize 23 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued personal protective equipment while on site at our facilities. We also significantly reduced business travel and outside access to our facilities. • Maintaining Engagement of Our Sales Team and Customers: In addition to engaging with existing customers via virtual methods, our reps also continued to target and reach out to prospective customers, and outside the U.S., we continued to monitor the activities of our distributor partners and helped them navigate the challenges they faced as a result of the slower demand they have seen in their respective countries. • Operating Expenses: We continued to manage spending, including reducing some discretionary spending, and re-prioritizing certain R&D projects and clinical research studies. • Governmental Policy: On March 27, 2020, the U.S. government enacted the CARES Act to provide relief from COVID-19. We have taken advantage of certain provisions of the CARES Act which are applicable to us, including utilizing net operating loss (NOL) carryback provisions. We expect that utilizing these provisions will significantly help mitigate the working capital impact COVID-19 has had on our sales and operations. During 2021, we hosted over 15 Physician Mentor Programs, or “PMPs,” and our efforts to expand our presence and educational programming at industry conferences and trade shows proceeded as expected. In April 2021 we hosted our first virtual Users’ Meeting and had over 300 people in attendance. This program consisted of presentations from key Renuvion® users around the world on various applications for the product. All of the content was recorded and made available on our website portal for reference by all of our users around the world. Our virtual educational events have also included case studies to illustrate how our leading clinician customers have adopted Renuvion®, their strategies for marketing and selling to new patients, and their thoughts on pricing and return on investment. We also engaged with clinician customers outside the U.S. including hosting multiple continuing education training sessions on Renuvion® with our current international distributors and conducting multiple calls with groups of international prospects interested in learning about our Renuvion® technology. During 2021, we continued to drive sales in our Advanced Energy business by increasing the adoption and utilization of our handpieces in the U.S. cosmetic surgery market and fulfilling demand from distributors in our international markets. Management estimates that our products have been sold in more than 60 countries. As of December 31, 2021, we had a direct sales force of 31 field-based selling professionals and utilized 2 independent sales agencies. We also had 5 sales managers. This selling organization is focused on the use of Renuvion® in the cosmetic surgery market, supported by our global medical affairs team. This global team of clinical support specialists focuses on supporting our users to ensure optimal outcomes for their patients. In addition, we have invested in training programs and marketing-related activities to support accelerated adoption of Renuvion® into physicians' practices. We believe that our continued investment and focus on the following strategic initiatives in 2021 and beyond will position the Company for long-term growth in the cosmetic surgery market: • To formalize our regulatory strategy to pursue specific clinical indications that will enable us to sell our Renuvion® products for targeted procedures • To secure new clinical evidence demonstrating the safety and efficacy of our Helium Plasma Technology • To provide enhanced physician and practice support for our cosmetic surgery customers • To improve our manufacturing capabilities and efficiencies In regards to our operating segments, our results are aggregated into reportable segments only if they exhibit similar economic characteristics. In addition to similar economic characteristics, we also consider the following factors in determining the reportable segments: the nature of business activities, the management structure directly accountable to our chief operating decision maker for operating and administrative activities, availability of discrete financial information, and information presented to the Board of Directors and investors. Asset information is not reviewed by the chief operating decision maker by segment and is not available by segment and, accordingly, we have not presented a measure of assets by reportable segment. Our reportable segments are disclosed as principally organized and managed as two operating segments: Advanced Energy and OEM. "Corporate & Other" includes certain unallocated corporate and administrative costs which are not specifically attributed to any reportable segment. The OEM segment is primarily development and manufacturing contract and product driven, and all related expenses are recorded as cost of sales, therefore no segment specific operating expenses are incurred. 24 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued We strongly encourage investors to visit our website: www.apyxmedical.com to view the most current news and to review our filings with the Securities and Exchange Commission. Results of Operations Sales Year Ended December 31, (In thousands) 2021 2020 Change Sales by Reportable Segment Advanced Energy $ 42,985 $ 22,214 93.5 % OEM 5,532 5,497 0.6 % Total $ 48,517 $ 27,711 75.1 % Sales by Domestic and International Domestic $ 32,980 $ 18,812 75.3 % International 15,537 8,899 74.6 % Total $ 48,517 $ 27,711 75.1 % Total revenue increased by 75.1% or approximately $20.8 million for the year ended December 31, 2021 when compared with 2020. Advanced Energy segment sales increased 93.5% or approximately $20.8 million for the year ended December 31, 2021 when compared with 2020. During 2021, we experienced increased global utilization based demand for our handpieces and adoption of our generator technology despite the continued headwinds of the COVID-19 pandemic in certain geographic regions outside of the U.S., while overall 2020 demand was more severely impacted on a global basis. The OEM product line consists of proprietary products designed specifically for third party equipment manufacturers. Revenue for this product line increased 0.6% when compared to 2020. International sales represented approximately 32.0% and 32.1% of total revenues for the years ended December 31, 2021 and 2020, respectively. Management estimates our products have been sold in more than 60 countries through local dealers coordinated by sales and marketing personnel through our facilities in Clearwater, Florida and Sofia, Bulgaria. Gross Profit Year Ended December 31, (In thousands) 2021 2020 Change Cost of sales $ 14,916 $ 10,207 46.1 % Percentage of sales 30.7 % 36.8 % Gross profit $ 33,601 $ 17,504 92.0 % Percentage of sales 69.3 % 63.2 % Our gross profit margin as a percentage of sales increased by 6.1% during the year ended December 31, 2021 compared with 2020. The increase in gross profit margin from the prior year is primarily attributable to sales mix between our two segments, with our Advanced Energy segment comprising a higher percentage of total sales, as well as product mix within our Advanced Energy segment. Our continued manufacturing efficiency initiatives and the introduction of newer product models have continued to result in improved margins as we obtain registration, allowing these products to be introduced into the markets we serve. Additionally, the strong sales during the year resulted in reduced product costs as our fixed costs were spread across higher production volumes. This manufacturing efficiency was partially offset by higher inbound shipping costs, as we needed to expedite the sourcing of key component raw material inventories and experienced higher market rates for these services. 25 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued The prior year margins were also hindered as we reassessed our forecasted product mix due to COVID-19, increased availability of our newer handpiece designs, and earlier than expected completion of product registrations in certain international markets. As a result, certain products were reduced to a lower carrying value, and some components were also written off as it was determined to cease further production on these models. This resulted in a decrease in gross profit of approximately $0.3 million during the prior year. Other Costs and Expenses Research and development Year Ended December 31, (In thousands) 2021 2020 Change Research and development $ 4,321 $ 3,920 10.2 % Percentage of sales 8.9 % 14.1 % Our expenditures for research and development related activities increased by 10.2% or approximately $0.4 million for the year ended December 31, 2021, compared with 2020. This increase was primarily due to increases in payroll and related benefits of R&D personnel ($0.2 million) and continued spending on our two investigational device exemption (IDE) clinical studies and other research and development projects ($0.2 million). Professional services Year Ended December 31, (In thousands) 2021 2020 Change Professional services $ 7,589 $ 7,350 3.3 % Percentage of sales 15.6 % 26.5 % Professional services expenses increased 3.3% for the year ended December 31, 2021, compared with 2020. This increase was primarily due to increases in physician consulting expense associated with the increased sales activity in 2021 ($0.3 million), professional services for continued consulting expense associated with our implementation of SAP ($0.2 million), employee acquisition fees as the labor market has been highly competitive ($0.2 million) and Board of Directors option expense ($0.1 million). The increases were partially offset by a decrease in accounting and auditing fees ($0.6 million). In the prior year, we incurred significant fees related to our change in independent auditors and the associated reaudit of the 2019 financial statements. Salaries and related costs Year Ended December 31, (In thousands) 2021 2020 Change Salaries and related costs $ 17,522 $ 14,630 19.8 % Percentage of sales 36.1 % 52.8 % During 2021, salaries and related expenses increased 19.8% or approximately $2.9 million compared to 2020. The increase was primarily driven by increases in bonus expense ($1.2 million), higher headcount ($0.6 million), higher compensation and benefits ($0.5 million), stock compensation expense ($0.4 million) and temporary labor ($0.2 million) as compared to 2020. 26 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Selling, general and administrative expenses Year Ended December 31, (In thousands) 2021 2020 Change Selling, general and administrative $ 18,617 $ 11,687 59.3 % Percentage of sales 38.4 % 42.2 % Selling, general and administrative expense increased by 59.3% or approximately $6.9 million for the year ended December 31, 2021, compared with 2020. The change is primarily related to higher commissions on Advanced Energy sales ($4.0 million), travel and entertainment expense ($0.8 million), advertising expense, including trade show fees and related costs ($0.5 million), insurance expense associated with higher premiums and increased claims activity ($0.6 million), higher credit card processing fees ($0.3 million), OEM product recall costs ($0.2 million), higher employee training and meeting expenses ($0.2 million), increased Board of Directors compensation including compensation to an additional member ($0.1 million), higher computer supplies and related technology expenses ($0.1 million) and increased office supplies ($0.1 million). These increases were partially offset by lower bad debt expenses ($0.1 million). Interest Income Year Ended December 31, (In thousands) 2021 2020 Change Interest income $ 11 $ 241 (95.4) % Percentage of sales — % 0.9 % Interest income decreased 95.4% for the year ended December 31, 2021 as compared with the prior year. This decrease is due to a lower yield, as well as a lower average balance, on our investments in money market funds and U.S. Treasury securities included in cash and cash equivalents. Other (Loss) Income, net Year Ended December 31, (In thousands) 2021 2020 Change Other (losses) income, net $ (373) $ 479 (177.9) % Percentage of sales (0.8) % 1.7 % Other (losses) income, net decreased 177.9% for the year ended December 31, 2021 as compared with the prior year. This decrease is primarily due to the receipt of refunds in the first quarter 2020 on tariffs paid in 2019 ($0.3 million), severance expense for employees of the former Core business segment ($0.2 million), anticipated Core business segment inventory losses at the conclusion of our supply agreement with Symmetry Surgical ($0.2 million), and reduced volume under the supply agreement to cover other business expenses associated with the Core business segment ($0.1 million). 27 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Income Taxes The income tax expense was approximately $0.4 million, with an effective tax rate of (2.6)%, for the year ended December 31, 2021 as compared to an income tax benefit of approximately $7.5 million, with an effective tax rate of 38.7%, for the year ended December 31, 2020. For the year ended December 31, 2021, the effective tax rate differs from the statutory rate primarily due to the valuation allowance on our Federal and State net operating losses (NOLs) for 2021. For the year ended December 31, 2020, the effective tax rate differs from the statutory rate primarily due to the release of the valuation allowance on our Federal NOL from 2019 as a result of the CARES Act, partially offset by a valuation allowance on our State NOL for 2020. On March 27, 2020, the U.S. government enacted the CARES Act to provide relief from COVID-19. The CARES Act includes a provision that allows companies to carryback NOLs generated in the period 2018 through 2020 to prior years. As a result, we released the full valuation allowance of approximately $3.7 million on our Federal NOL carryforward from 2019 during the first quarter of 2020. In 2020, our income tax benefit is composed primarily of a benefit of $3.7 million associated with the current year net loss and $3.7 million associated with the release of the valuation allowance on the net operating loss from 2019 from the CARES Act. Liquidity and Capital Resources At December 31, 2021, we had approximately $30.9 million in cash and cash equivalents as compared to approximately $41.9 in cash and cash equivalents at December 31, 2020. Our working capital at December 31, 2021 was approximately $47.5 million compared with $56.9 million at December 31, 2020. The decrease in working capital at December 31, 2021 was primarily due to the net loss incurred by the Company in 2021, excluding non-cash activity, comprised primarily of stock-based compensation expense. For the year ended December 31, 2021, net cash used in operating activities was approximately $10.4 million, which principally funded our loss from operations of $14.4 million, compared with net cash used in operating activities of approximately $16.1 million in 2020. We believe that we have adequate cash to support our operations for the next twelve to eighteen months. Net cash used in investing activities for the years ended December 31, 2021 and 2020, were $0.7 million and $0.6 million, respectively, related to purchases of property and equipment. At December 31, 2021, we had purchase commitments for inventories totaling approximately $4.9 million, all of which is expected to be purchased by the end of 2022. Critical Accounting Estimates In preparing the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), we have adopted various accounting policies. Our most significant accounting policies are disclosed in Note 2 to the consolidated financial statements. The preparation of the consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Our estimates and assumptions, including those related to inventories, legal proceedings, research and development, warranty obligations, product liability, sales returns and discounts, stock-based compensation and income taxes are updated as appropriate, which in most cases is at least quarterly. We base our estimates on historical experience, or various assumptions that are believed to be reasonable under the circumstances and the results form the basis for making judgments about the reported values of assets, liabilities, revenues and expenses. Actual results may materially differ from these estimates. Estimates are considered to be critical if they meet both of the following criteria: (1) the estimate requires assumptions about material matters that are uncertain at the time the accounting estimates are made and (2) other materially different estimates could have been reasonably made or material changes in the estimates are reasonably likely to occur from period to period. Our critical accounting estimates include the following: 28 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Stock-Based Compensation Under our stock option plans, options to purchase common shares of the Company may be granted to employees, officers and directors of the Company by the Board of Directors. We account for stock options in accordance with FASB ASC Topic 718-10, Compensation-Stock Compensation , with compensation expense recognized over the vesting period. Options are valued using the Black-Scholes model, which includes a number of estimates that affect the amount of our expense. We have determined that the most critical of these estimates are the estimates of expected life and volatility used in the calculations. Expected life For employee stock-based compensation awards, we estimate the expected life of awards utilizing the SEC's simplified method. We utilize this method, as we have not historically granted stock-based compensation awards to employees in sufficient volumes to determine a reasonable estimate of the life of awards. For awards granted to non-employees, we calculate expected life using a combination of past exercise behavior, the contractual term and expected remaining exercise behavior. Volatility We determine the volatility by utilizing the historical volatility of our stock over the period of the awards expected life. The SEC allows us to include periods in excess of the useful life if we determine that they provide a more reasonable basis for the volatility of our stock. Additionally, ASC 718-10 allows us to exclude periods from the volatility if they pertain to events or circumstances that in our judgment are specific to us and if the event or transaction is not reasonably expected to occur again during the expected term of the awards. We have not included any additional periods, nor disregarded any periods, in calculating our volatility. Accounts Receivable Allowance We maintain a reserve for uncollectible accounts receivable. When evaluating the adequacy of the allowance for doubtful accounts, we analyze specific unremitted customer balances for known collectability issues, review historical bad debt experience, customer credit worthiness and economic trends, and we make estimates in connection with establishing the allowance for doubtful accounts, including the future impacts of current trends. Changes in estimates are reflected in the period they are made. If the financial condition of our customers deteriorates, resulting in an inability to make payments, additional allowances may be required. Inventory Obsolescence Allowance We maintain a reserve for excess and obsolete inventory resulting from the potential inability to sell our products at prices in excess of current carrying costs. The markets in which we operate are highly competitive, with new products and surgical procedures introduced on an ongoing basis. Such marketplace changes may cause our products to become obsolete. We make estimates regarding the future recoverability of the costs of these products and record a provision for excess and obsolete inventories based on historical experience and expected future trends. If actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, additional inventory write-downs may be required, which would unfavorably affect future operating results. Litigation Contingencies In accordance with authoritative guidance, we record a liability in our consolidated financial statements for these actions when a loss is known or considered probable and the amount can be reasonably estimated. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate than any other, the minimum amount of the range is accrued. If a loss is reasonably possible, but not known or probable, and can be reasonably estimated, the estimated loss or range of loss is disclosed in the notes to the consolidated financial statements. In most cases, significant judgment is required to estimate the amount and timing of a loss to be recorded; actual results may differ from these estimates. Income Taxes The provision for income taxes includes federal, foreign, state and local income taxes currently payable and those deferred because of temporary differences between the financial statement and tax bases of assets and liabilities. Deferred tax assets or 29 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using enacted marginal tax rates. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period. As a result of historical losses and our expectation to continue to generate losses in the near future, we recorded a valuation allowance on our net deferred tax assets. Exclusive of the carryback provisions of the CARES Act and the associated income tax benefit recognized in 2020, we do not anticipate recording an income tax benefit related to our deferred tax assets. We will reassess the realization of deferred tax assets each reporting period and will be able to reduce the valuation allowance to the extent our results of operations improve, and it becomes more likely than not that the deferred tax assets will be realized. As Management has not fully determined the timing of when it will generate taxable income in the U.S., we continued to record a valuation allowance on the net deferred tax assets balance as of December 31, 2021. We assess the financial statement impact of an uncertain tax position taken or expected to be taken on an income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized in the financial statements unless it is more likely than not of being sustained. Inflation The consequences of the pandemic, global supply chain instability and inflationary cost increases and their adverse impact to the global economy, continue to evolve. Accordingly, the significance of the future impact to our business and financial statements remains subject to significant uncertainty. Inflation has not, to date, materially impacted our operations or financial performance. However, as these trends continue for raw materials, freight, and labor costs, our future financial performance could be adversely impacted. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements at this time. Recent Accounting Pronouncements See Note 3 of the Notes to Consolidated Financial Statements. ITEM 7A . Quantitative and Qualitative Disclosures about Market Risk Not required. 30 Table of Contents APYX MEDICAL CORPORATION