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, including our Helium Plasma Technology products marketed and sold as Renuvion® in the cosmetic surgery market and J-Plasma® in the hospital surgical market. Renuvion® and J-Plasma® offer surgeons a unique ability to provide controlled heat to tissue to achieve their desired results. We also leverage our deep expertise and decades of experience in unique waveforms through OEM agreements with other medical device manufacturers. On March 14, 2022, the U.S. Food and Drug Administration (“FDA”) posted a Safety Communication that warns consumers and health care providers against the use of our Advanced Energy products outside of their FDA-cleared indications for general use in cutting, coagulation, and ablation of soft tissue during open and laparoscopic surgical procedures. Following the Safety Communication, we experienced slowed demand for the adoption of our Helium Plasma Technology. On May 26, 2022, we announced that we received 510(k) clearance from the FDA for the use of the Renuvion Dermal Handpiece for specific dermal resurfacing procedures. On July 18, 2022, we announced that we received 510(k) clearance from the FDA for the use of the Renuvion® APR Handpiece for certain skin contraction procedures. On June 2, 2022, and July 21, 2022, the FDA updated the Medical Device Safety Communication to recognize the new 510(k) clearances for the Renuvion® Dermal handpiece, and the expanded indications for the Renuvion® APR handpieces. The 510(k) clearance for the Renuvion® Dermal handpiece allows surgeons to perform dermal resurfacing procedures for the treatment of moderate to severe wrinkles and rhytides, limited to patients with Fitzpatrick Skin Types I, II or III. The 510(k) clearance for the Renuvion® APR handpieces now addresses improving the appearance of lax (loose) skin in the neck and submental region. On February 1, 2023, we announced we had submitted a 510(k) premarket notification (“510(k) submission”) for the Renuvion APR Handpiece to the FDA, supported by a clinical study and real-world evidence. The 510(k) submission is intended to expand Renuvion’s indications for use to include a specific indication for the use of the Renuvion APR Handpiece for the coagulation of subcutaneous soft tissues where needed, following liposuction. On February 27, 2023, we announced that we received 510(k) clearance from the FDA for the use of the Renuvion APR Handpiece for the delivery of radiofrequency energy and/or helium plasma where coagulation/contraction of soft tissue is needed. Soft tissue includes subcutaneous tissue. While we expected that receiving these clearances would materially mitigate the financial effects of the Safety Communication in future periods, we continue to experience reduced demand for the adoption and utilization of our technology and we believe that this may have an adverse effect in future periods. As part of our plan to accelerate and fully fund the development of our advanced energy business, with a focus in the cosmetic surgery market, we sold our Core business in 2018 for gross proceeds of $97 million. These proceeds were used to launch broad marketing and sales initiatives which resulted in rapid sales growth through December 31, 2021 and into the first quarter of 2022. This planned growth in the business was accompanied by scaled operations, including procurement of components, expanded manufacturing capacity to turn those materials into saleable inventory, additional discretionary expenditures, including increased global participation at trade shows, additional employee trainings, user meetings, increased travel and entertainment expenses, more expansive research and development projects, and additional headcount to support those activities. Additionally, we had and still have, some significant non-recurring discretionary expenditures associated with completing our multi-year marketing initiatives related to our dermal resurfacing and skin laxity clearances. While sales were continuing to grow into the first quarter of 2022 prior to the FDA Safety Communication, over the last few 26 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued years, exclusive of our sale of the Core business segment to Symmetry Surgical during 2018, we have incurred recurring net losses and cash outflows from operations and we anticipate that losses will continue in the near term. For the year ended December 31, 2022, we incurred an operating loss of $23.6 million and used $20.3 million of cash in operations. As of December 31, 2022, we had cash and cash equivalents of $10.2 million. These conditions raise substantial doubt about the Company’s ability to continue as a going concern for a period of at least one year from the date of issuance of these consolidated financial statements. In an effort to alleviate these conditions, we pursued various funding solutions in order to improve liquidity. On November 22, 2022, the we filed a shelf registration statement providing us the ability to register securities in the aggregate amount up to $100 million. The shelf registration included an embedded ATM facility for up to $40 million. To date we have not utilized this facility. On February 17, 2023, we entered into a Credit, Security and Guaranty Agreement (the “Credit Agreement”) with MidCap Funding IV Trust (as agent), and MidCap Financial Trust (as term loan servicer), and the lenders party thereto from time to time. The Credit Agreement provides for an up to $35 million facility, consisting of senior secured term loans and a secured revolving facility. The Credit Agreement provides for senior secured term loans of up to $25 million, comprised of (i) an initial tranche of $10 million, (ii) a second tranche of $5 million, and (iii) a third tranche of $10 million. The secured revolving facility provides for loans in an aggregate principal amount of up to $10 million, subject to a borrowing base equal to certain percentages of the Company’s eligible accounts receivable and inventory, as determined in accordance with the terms of the Credit Agreement. For a more in depth description of the terms of the Credit Agreement see Note 20 in Item 8 of this report on Form 10-K. On February 27, 2023, our Board of Directors approved a plan to sell and leaseback the our real property located in Clearwater, FL. On March 14, 2023, we entered into a Purchase and Sale Agreement (the “Purchase Agreement”) with VK Acquisitions VI, LLC (the “Purchaser”), for the sale of our facility located at 5115 Ulmerton Road, Clearwater, Florida, as more fully described in the Purchase Agreement (collectively, the “Property”) for a purchase price of $7,650,000. The Purchase Agreement is subject to the satisfactory completion of due diligence by the Purchaser. Upon the closing of the sale of the Property, we will enter into a lease agreement with the Purchaser, pursuant to which the Property will be leased back to us. For a more in depth description of the terms of the Purchase Agreement see Note 20 in Item 8 of this report on Form 10-K. During January 2023, we were notified that the IRS examination process of our 2018, 2019 and 2020 tax returns was complete and that the Company's tax refunds were approved for substantially the amount recorded in the Company's Consolidated Balance Sheet at December 31, 2022. As of the date of this report, we are awaiting receipt of the tax refunds. We also continue to re-assess our operating expenditures and cost structure to be commensurate with our expected levels of revenue and we have the ability to reduce or delay expenditures to enhance and preserve liquidity. We have already reduced some operating expenditures, including a reduction-in-force on January 9, 2023, that reduced our U.S. headcount by 14%. We believe that the actions already taken, and additional actions that we intend to take to manage operating expenditures, will enable us to meet our obligations for a period of at least one year from the date of issuance of our audited consolidated financial statements. As a result, we believe our plans alleviate substantial doubt about our ability to continue as a going concern. Our audited financial statements do not include any adjustments relating to the carrying amounts and classification of assets and liabilities that may be necessary should we be unable to continue as a going concern. Impact of COVID-19, Supply Chain Disruptions and Other Matters 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. 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 27 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued 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 global supply chain instability, inflationary cost increases aand the pandemic, 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. During 2022, we hosted over 30 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 2022, we hosted our first in-person Users’ Meeting and had over 200 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 continued 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 2022, 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, 2022, we had a direct sales force of 35 field-based selling professionals and utilized 3 independent sales agencies. We also had 4 sales managers. This selling organization is focused on the use of Renuvion® and J-Plasma® in the cosmetic and hospital surgical markets, supported by our global medical affairs team. This global team of clinical support specialists focuses on supporting our users to ensure optimal outcomes for their patients. In addition, we have invested in training programs and marketing-related activities to support accelerated adoption of Renuvion® into surgeons' practices. We believe that our continued investment and focus on the following strategic initiatives in 2022 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. 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. 28 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Results of Operations Sales Year Ended December 31, (In thousands) 2022 2021 Change Sales by Reportable Segment Advanced Energy $ 36,803 $ 42,985 (14.4) % OEM 7,707 5,532 39.3 % Total $ 44,510 $ 48,517 (8.3) % Sales by Domestic and International Domestic $ 31,208 $ 32,980 (5.4) % International 13,302 15,537 (14.4) % Total $ 44,510 $ 48,517 (8.3) % Total revenue decreased by 8.3% or approximately $4.0 million for the year ended December 31, 2022 when compared with 2021. Advanced Energy segment sales decreased 14.4% or approximately $6.2 million for the year ended December 31, 2022 when compared with 2021. The Advanced Energy sales decrease is due to global decreases in utilization based demand for our handpieces and the adoption of our generator technology following the FDA Safety Communication on March 14, 2022. The Advanced Energy sales decrease was partially offset by an increase in global utilization based demand for our handpieces and adoption of our generator technology in international markets for most of the first quarter before the FDA Safety Communication. The OEM product line consists of proprietary products designed specifically for third party equipment manufacturers. Revenue for this product line increased 39.3%, or approximately $2.2 million, when compared to 2021. The increase in OEM sales was due to increases in sales volume to existing customers, including Symmetry Surgical, under our 10-year generator manufacturing and supply agreement, as well as incremental new sales upon the commencement of the supply arrangement related to the completion of the development portion of some of our OEM development agreements. International sales represented approximately 29.9% and 32.0% of total revenues for the years ended December 31, 2022 and 2021, 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) 2022 2021 Change Cost of sales $ 15,379 $ 14,916 3.1 % Percentage of sales 34.6 % 30.7 % Gross profit $ 29,131 $ 33,601 (13.3) % Percentage of sales 65.4 % 69.3 % Our gross profit margin as a percentage of sales decreased by 3.8% during the year ended December 31, 2022 compared with 2021. The de crease in gross profit margins for the year ended December 31, 2022 from the prior year is primarily attributable to changes in the sales mix between our two segments, with our OEM segment comprising a higher percentage of total sales, product mix within our Advanced Energy Segment and higher material and inbound shipping costs to manufacture our inventory. These decreases were partially offset by geographic mix within our Advanced Energy segment, with domestic sales comprising a higher percentage of total sales and the mix of newer product models as we obtain registrations, allowing these products to be introduced into the markets we serve. 29 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Other Costs and Expenses Research and development Year Ended December 31, (In thousands) 2022 2021 Change Research and development $ 4,544 $ 4,321 5.2 % Percentage of sales 10.2 % 8.9 % Our expenditures for research and development related activities increased by 5.2% or approximately $0.2 million for the year ended December 31, 2022, compared with 2021. This increase was primarily due to increases in payroll and related benefits of R&D personnel ($0.3 million) partially offset by lower spending on ou r two investigational device exemption (IDE) clinical studies and other product development initiatives ($0.1 million). Professional services Year Ended December 31, (In thousands) 2022 2021 Change Professional services $ 9,044 $ 7,589 19.2 % Percentage of sales 20.3 % 15.6 % Professional services expenses increased 19.2%, or approximately $1.5 million for the year ended December 31, 2022, compared with 2021. This increase was primarily attributable to increases in legal expenses ($0.4 million), primarily associated with the estimated loss recorded for the class action lawsuit, Board of Directors option expense ($0.4 million), marketing consulting expense ($0.3 million), accounting and auditing fees ($0.2 million), physician consulting fees ($0.2 million), and employee recruitment expense ($0.2 million). These increases were partially offset by a decrease in stock compensation expense for our partner physicians ($0.2 million). Salaries and related costs Year Ended December 31, (In thousands) 2022 2021 Change Salaries and related costs $ 18,621 $ 17,522 6.3 % Percentage of sales 41.8 % 36.1 % Salaries and related expenses increased 6.3% or approximately $1.1 million for the year ended December 31, 2022, compared to 2021. The increase was primarily driven by higher compensation and benefits ($1.7 million) and stock compensation expense ($1.2 million) as compared to the same period in the prior year. These increases are partially offset by a decrease in bonus expense ($1.8 million) as we determined we did not meet our 2022 bonus objectives, and accordingly, we have recorded no annual bonus expense in 2022. 30 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) 2022 2021 Change Selling, general and administrative $ 20,484 $ 18,617 10.0 % Percentage of sales 46.0 % 38.4 % Selling, general and administrative expense increased by 10.0% or approximately $1.9 million for the year ended December 31, 2022, compared with 2021. The change is p rimarily driven by higher insurance expense, including product liability claims on our policies ($1.9 million), travel and entertainment expense ($1.1 million), advertising expense, including trade show fees and related costs ($1.0 million), employee training and other meeting expenses ($0.7 million), bad debt expense ($0.2 million), and other public company related costs ($0.1 million). These increases were partially offset by decreases in commissions on Advanced Energy sales ($2.5 million), OEM product recall costs ($0.2 million) as we experienced no product recalls in 2022, lower technology costs ($0.2 million) and lower regulatory registration expenses ($0.2 million). Interest Income Year Ended December 31, (In thousands) 2022 2021 Interest income $ 157 $ 11 Percentage of sales 0.4 % — % Interest income increased approximately $0.1 million for the year ended December 31, 2022, compared with 2021. This increase is due to higher yields on our investments in money market funds and U.S. Treasury securities included in cash and cash equivalents. Other (Loss) Income, net Year Ended December 31, (In thousands) 2022 2021 Other income (losses), net $ 509 $ (373) Percentage of sales 1.1 % (0.8) % Other income (losses), net increased 236.5% for the year ended December 31, 2022, compared with 2021. This increase was primarily attributable to the release of a portion of our joint and several payroll liability due to the lapse of the statute of limitations on a portion of the liability ($0.6 million) and the wind down of the supply arrangement with Symmetry in the Core business segment ($0.3 million). 31 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Income Taxes Twelve Months Ended December 31, (In thousands) 2022 2021 Change Income tax expense (benefit) $ 367 $ 380 (3.4) % Effective tax rate (1.6) % (2.6) % Income tax expense was approximately $0.4 million, with effective tax rates of (1.6)% and (2.6)%, respectively, for the years ended December 31, 2022 and 2021. For each of the years ended December 31, 2022 and 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) combined with interest and penalties on our uncertain tax positions. Liquidity and Capital Resources At December 31, 2022, we had approximately $10.2 million in cash and cash equivalents as compared to approximately $30.9 million in cash and cash equivalents at December 31, 2021. Our working capital at December 31, 2022 was approximately $31.1 million compared with $47.5 million at December 31, 2021. The decrease in working capital at December 31, 2022 was primarily due to the net loss incurred by the Company in 2022 following the Safety Communication on March 14, 2022, excluding non-cash activity, comprised primarily of stock-based compensation expense. Following the Safety Communication we had cash outflows of $5.6 million related to growth in inventory due to existing non-cancellable purchase orders when the Safety Communication was issued and management's decision to continue to build inventory with these materials through the uncertainty. The lower sales as a result of the Safety Communication also resulted in operating cash inflows of $1.9 million related to lower accounts receivable balances on the lower sales. For the year ended December 31, 2022, net cash used in operating activities was approximately $20.3 million , which principally funded our los s from operations of $23.6 million, compared with net cash used in operating activities of approximately $10.4 million in 2021. As discussed in the Executive Level Overview, our operating loss, cash used in operations and current cash and cash equivalents balance of $10.2 million raise substantial doubt about our ability to continue as a going concern for a period of at least one year from the date of issuance of our consolidated financial statements. In an effort to alleviate these conditions, we pursued various funding solutions in order to improve liquidity. On November 22, 2022, the we filed a shelf registration statement providing us the ability to register securities in the aggregate amount up to $100 million. The shelf registration included an embedded ATM facility for up to $40 million. To date we have not utilized this facility. On February 17, 2023, we entered into a Credit, Security and Guaranty Agreement (the “Credit Agreement”) with MidCap Funding IV Trust (as agent), and MidCap Financial Trust (as term loan servicer), and the lenders party thereto from time to time. The Credit Agreement provides for an up to $35 million facility, consisting of senior secured term loans and a secured revolving facility. The Credit Agreement provides for senior secured term loans of up to $25 million, comprised of (i) an initial tranche of $10 million, (ii) a second tranche of $5 million, and (iii) a third tranche of $10 million. The secured revolving facility provides for loans in an aggregate principal amount of up to $10 million, subject to a borrowing base equal to certain percentages of the Company’s eligible accounts receivable and inventory, as determined in accordance with the terms of the Credit Agreement. For a more in depth description of the terms of the Credit agreement see Note 20 in Item 8 of this report on Form 10-K. For a more in depth description of the terms of the Credit Agreement see Note 20 in Item 8 of this report on Form 10-K. On February 27, 2023, our Board of Directors approved a plan to sell and leaseback the our real property located in Clearwater, FL. On March 14, 2023, we entered into a Purchase and Sale Agreement (the “Purchase Agreement”) with VK Acquisitions VI, 32 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued LLC (the “Purchaser”), for the sale of our facility located at 5115 Ulmerton Road, Clearwater, Florida, as more fully described in the Purchase Agreement (collectively, the “Property”) for a purchase price of $7,650,000. The Purchase Agreement is subject to the satisfactory completion of due diligence by the Purchaser. Upon the closing of the sale of the Property, we will enter into a lease agreement with the Purchaser, pursuant to which the Property will be leased back to us. For a more in depth description of the terms of the Purchase Agreement see Note 20 in Item 8 of this report on Form 10-K. During January 2023, we were notified that the IRS examination process of our 2018, 2019 and 2020 tax returns was complete and that the Company's tax refunds were approved for substantially the amount recorded in the Company's Consolidated Balance Sheet at December 31, 2022. As of the date of this report, we are awaiting receipt of the tax refunds. We also continue to re-assess our operating expenditures and cost structure to be commensurate with our expected levels of revenue and we have the ability to reduce or delay expenditures to enhance and preserve liquidity. We have already reduced some operating expenditures, including a reduction-in-force on January 9, 2023, that reduced our U.S. headcount by 14%. We believe that the actions already taken, and additional actions that we intend to take to manage operating expenditures, will enable us to meet our obligations for a period of at least one year from the date of issuance of our audited consolidated financial statements. As a result, we believe our plans alleviate substantial doubt about our ability to continue as a going concern. Our audited financial statements do not include any adjustments relating to the carrying amounts and classification of assets and liabilities that may be necessary should we be unable to continue as a going concern. Net cash used in investing activities for the years ended December 31, 2022 and 2021, were $1.0 million and $0.7 million , respectively, related to purchases of property and equipment. At December 31, 2022, we had purchase commitments for inventories totaling approximately $4.1 million , all of which is expected to be purchased by the end of 2023. 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: 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 33 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued For employee stock-based compensation awards, we estimate the expected life of awards utilizing the SEC's simplified method. We utilize this method, as we have not historically granted stock-based compensation awards to employees in sufficient volumes to determine a reasonable estimate of the life of awards. For awards granted to non-employees, we calculate expected life using a combination of past exercise behavior, the contractual term and expected remaining exercise behavior. Volatility We determine the volatility by utilizing the historical volatility of our stock over the period of the awards expected life. The SEC allows us to include periods in excess of the useful life if we determine that they provide a more reasonable basis for the volatility of our stock. Additionally, ASC 718-10 allows us to exclude periods from the volatility if they pertain to events or circumstances that in our judgment are specific to us and if the event or transaction is not reasonably expected to occur again during the expected term of the awards. We have not included any additional periods, nor disregarded any periods, in calculating our volatility. Accounts Receivable Allowance We maintain a reserve for uncollectible accounts receivable. When evaluating the adequacy of the allowance for doubtful accounts, we analyze specific unremitted customer balances for known collectability issues, review historical bad debt experience, customer credit worthiness and economic trends, and we make estimates in connection with establishing the allowance for doubtful accounts, including the future impacts of current trends. Changes in estimates are reflected in the period they are made. If the financial condition of our customers deteriorates, resulting in an inability to make payments, additional allowances may be required. Inventory Obsolescence Allowance We maintain a reserve for excess and obsolete inventory resulting from the potential inability to sell our products at prices in excess of current carrying costs. The markets in which we operate are highly competitive, with new products and surgical procedures introduced on an ongoing basis. Such marketplace changes may cause our products to become obsolete. We make estimates regarding the future recoverability of the costs of these products and record a provision for excess and obsolete inventories based on historical experience and expected future trends. If actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, additional inventory write-downs may be required, which would unfavorably affect future operating results. Litigation Contingencies In accordance with authoritative guidance, we record a liability in our consolidated financial statements for these actions when a loss is known or considered probable and the amount can be reasonably estimated. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate than any other, the minimum amount of the range is accrued. If a loss is reasonably possible, but not known or probable, and can be reasonably estimated, the estimated loss or range of loss is disclosed in the notes to the consolidated financial statements. In most cases, significant judgment is required to estimate the amount and timing of a loss to be recorded; actual results may differ from these estimates. Income Taxes The provision for income taxes includes federal, foreign, state and local income taxes currently payable and those deferred because of temporary differences between the financial statement and tax bases of assets and liabilities. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using enacted marginal tax rates. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period. As a result of historical losses and our expectation to continue to generate losses in the near future, we recorded a valuation allowance on our net deferred tax assets. Exclusive of the carryback provisions of the CARES Act and the associated income tax benefit recognized in 2020, we do not anticipate recording an income tax benefit related to our deferred tax assets. We will reassess the realization of deferred tax assets each reporting period and will be able to reduce the valuation allowance to the extent our results of operations improve, and it becomes more likely than not that the deferred tax assets will be realized. As 34 Table of Contents APYX MEDICAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued 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, 2022. We assess the financial statement impact of an uncertain tax position taken or expected to be taken on an income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized in the financial statements unless it is more likely than not of being sustained based on the technical merit of the position. 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 in Part II, Item 8 of this Form 10-K. ITEM 7A . Quantitative and Qualitative Disclosures about Market Risk Not required. 35 Table of Contents APYX MEDICAL CORPORATION