ORTHOPEDIATRICS 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 of our financial condition and results of operations together with our consolidated financial statements and the related notes thereto and other financial information included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should review the ‘‘Risk Factors’’ section of this Annual Report on Form 10-K for a discussion of important factors that could cause our actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Overview We are the only global medical device company focused exclusively on providing a comprehensive trauma and deformity correction, scoliosis and sports medicine product offering to the pediatric orthopedic market in order to improve the lives of children with orthopedic conditions. We design, develop and commercialize innovative orthopedic implants, instruments and specialized braces to meet the needs of pediatric surgeons or orthotists and their patients, who we believe have been largely neglected by the orthopedic industry. We currently serve three of the largest categories in this market. We estimate that the portion of this market that we currently serve represents a $3.9 billion opportunity globally, including over $1.7 billion in the United States. We sell implants, instruments and specialized braces to our customers for use by pediatric orthopedic surgeons, orthotists or physical therapists to treat orthopedic conditions in children. We provide our implants in sets that consist of a range of implant sizes and include the instruments necessary to perform the surgical procedure. In the United States and a few selected international markets, our customers typically expect us to have full sets of implants and instruments on site at each hospital but do not purchase the implants until they are used in surgery. Accordingly, we must make an up-front investment in inventory of consigned implants and instruments before we can generate revenue from a particular hospital and we maintain substantial levels of inventory at any given time. In the international markets where we sell to stocking distributors or in the case of our braces, we transfer control of our products to the distributor or customer when title passes upon shipment. We currently market 46 surgical and specialized bracing systems that serve three of the largest categories within the pediatric orthopedic market: (i) trauma and deformity correction, (ii) scoliosis and (iii) sports medicine. We rely on a broad network of third parties to manufacture the components of our products, which we then inspect and package. We believe our innovative products promote improved surgical accuracy, increase consistency of outcomes and enhance surgeon confidence in achieving high standards of care. In the future, we expect to expand our product offering within these categories, as well as to address additional categories of the pediatric orthopedic market. The majority of our revenue from implants, instruments and specialized braces has been generated in the United States. We sell our implants and instruments through a network of 41 independent sales agencies employing 197 sales representatives specifically focused on pediatrics. These independent sales agents are trained by us, distribute our products and are compensated through sales-based commissions and performance bonuses. We do not sell our products through or participate in physician-owned distributorships, or PODs. The revenue generated in the United States from our bracing products is sold directly to orthopedic surgeons, orthotists, physical therapists or, at certain times, directly to the end customer. We market and sell our products internationally in over 70 countries through independent stocking distributors and sales agencies. Our independent stocking distributors manage the billing relationship with each hospital in their respective territories and are responsible for servicing the product needs of their surgeon customers. In 2017, we began to supplement our international stocking distributors with sales agencies using direct sales programs in the United Kingdom, Ireland, Australia and New Zealand where we sell directly to the hospitals. We began selling direct to Canada in September 2018, Belgium and the Netherlands in January 2019, Italy in March 2020 and Germany, Switzerland and Austria in January 2021. In order to further enhance our operations in Europe, we established operating companies in the Netherlands and Germany in March 2019 and April 2022, respectively. In these markets, we work through sales agencies that are paid a commission, similar to our U.S. sales model. These arrangements have generated an increase in revenue and gross margin. For the years ended 72 December 31, 2022, 2021 and 2020, international sales accounted for approximately 24%, 21% and 11% of our revenue, respectively. We believe there are significant opportunities for us to strengthen our position in U.S. and international markets by increasing investments in consigned implant and instrument sets, strengthening our global sales and distribution infrastructure and expanding our product offering. Environmental, Social and Governance ("ESG") Activities OrthoPediatrics was founded on the cause of impacting the lives of children with orthopedic conditions. Since inception we have impacted the lives of over 630,000 children, when including those served by our acquired companies. We believe we should continue to expand our social efforts while minimizing our impact to the environment and ensuring corporate governance. In 2021, we created an internal ESG team, which reports directly to our Board’s Governance Committee, to identify ESG topics for disclosure by assessing both the impact on our business and the importance to our stakeholders. We encourage you to review our ESG page under the "About" section of our corporate website for more detailed information regarding our ESG efforts and current initiatives. On our website, among other information, are the following highlights: • OrthoPediatrics cares about our environmental impact while working in a highly regulated industry and we are certified according to ISO 13485. • The Company and its associates regularly participate in philanthropic causes important to our local communities. We also partner with charitable organizations that provide pediatric orthopedic care around the world. In 2020 we were named as "Corporate Partner of the Year" by the World Pediatric Project - with whom we work to provide access to medical care for children in developing countries. • We are committed to fostering an environment that is respectful, compassionate, and inclusive of everyone in our community. • The Company and its Board of Directors understand the value of diversity. In 2022, the Company added one additional diverse Director and our Board is targeting the addition of another diverse candidate in 2023. We believe effectively managing our priorities, as well as increasing our transparency related to ESG programs, will help create long-term value for our stakeholders. We expect to increase our disclosures and communicate our ESG efforts in future SEC filings. Nothing on our website shall be deemed part of or incorporated by reference into this Annual Report on Form 10-K. Trends and Uncertainties From time to time we acquire, make investments in or license other technologies, products and business that may enhance our capabilities, complement our current products or expand the breadth of our markets or customer base. As a result of these transactions, we may record certain intangible assets, including goodwill and trademarks, which are subject to annual impairment testing. Fair value is based on our current assessment of the expected future cash flows based on recent results and other specific market factors. During 2022, we determined that a triggering event had occurred indicating it was more likely than not the fair value of the ApiFix trademark was less than the associated carrying value. Subsequently, the company completed a quantitative analysis and concluded that the fair value was in fact less than the carrying value and an impairment loss of $3.6 million was recorded in the period. We believe that the expected future cash flows in the most recent calculations represent management’s best estimate; however, if actual results differ materially from these estimates, we could record an additional impairment charge which could be material to our consolidated financial statements and have an adverse impact on our results of operations. In 2022, there was a significant and unprecedented increase in cases of respiratory syncytial virus, or RSV, and other respiratory illnesses. RSV is a common respiratory virus that follows a seasonal pattern. The typical season 73 shows an increase in mid-September, peaks in late December and drops around mid-April; however, in 2022 the United States experienced a significant increase during the summer months. The volume of elective procedures utilizing our products were negatively impacted as a significant percent of hospital capacity was absorbed to cover the increase in RSV-related hospitalizations. This had a negative impact on our sales volume in 2022 and may continue to do so into the future. We are unable to accurately determine exactly how this will impact us in the future, but we will continue to monitor this dynamic as we get closer to the traditional peak of RSV season. As a result of the COVID-19 pandemic, we have experienced significant business disruption throughout the last few years. Elective procedures are delayed in some cases as hospitals continue to struggle with adequate staffing levels. As a majority of our products are utilized in elective surgeries or procedures, the deferrals of such surgeries and procedures have had, and may continue to have, a significant negative impact on our business and results of operations. Throughout the pandemic, we have taken a variety of steps to address the impact. We continue to monitor the impact of the pandemic on our employees and customers and the markets in which we operate and will take further actions that are considered prudent to address the pandemic. We cannot accurately predict with certainty the full extent to which the pandemic will impact demand for our products in the future. We encourage the readers of this document to read our risk factors in its entirety contained in Item 1A “Risk Factors” where there is additional information regarding epidemics, pandemics or other illnesses such as RSV and COVID-19. Components of our Results of Operations Revenue Revenue in the United States is generated primarily from the sale of our implants, specialized braces and, to a much lesser extent, from the sale of our instruments. Sales of our implants and instruments in the United States are primarily to hospital accounts through independent sales agencies. We recognize revenue when our performance obligations under the terms of a contract with our customer are satisfied. This typically occurs when we transfer control of our products to the customer, generally upon implantation or when title passes upon shipment. The products are generally consigned to our independent sales agencies, and revenue is recognized when the products are used by or shipped to the hospital for surgeries on a case by case basis. On rare occasions, hospitals purchase products for their own inventory, and revenue is recognized when the hospital obtains control of the product, typically either upon shipment or delivery of the product dependent on the terms of the contract. We consider our performance obligation of our braces to be settled upon shipment, and revenue is therefore recognized at that time. Outside of the United States, we sell our products directly to hospitals through independent sales agencies or to independent stocking distributors. Generally, the distributors are allowed to return products, and some are thinly capitalized. Based on a history of reliable collections, we have concluded that a contract exists and revenue should be recognized when we transfer control of our products to the customer, generally when title passes upon shipment. Additionally, based on our history of immaterial returns from international customers, we have historically estimated no reserve for returns. Cost of Revenue and Gross Profit Our cost of revenue consists primarily of products purchased from third-party suppliers, inbound freight, excess and obsolete inventory adjustments and royalties. Our implants and instruments are manufactured to our specifications by third-party suppliers. We purchase the raw materials to make our specialized bracing products in our own facility in Iowa. The majority of our implants and instruments are produced in the United States. We recognize cost of revenue for consigned implants at the time the implant is used in surgery and the related revenue is recognized. Prior to their use in surgery, the cost of consigned implants is recorded as inventory in our balance sheet. The costs of instruments are typically capitalized and not included in cost of revenue unless sold as a set to our international stocking distributors or directly to hospitals. We expect our cost of revenue to increase in absolute dollars due primarily to increased sales volume and changes in the geographic mix of our sales as our international operations tend to have a higher cost of revenue as a percentage of sales. Our gross profit is calculated by subtracting our cost of revenue from revenue and is expected to increase in absolute dollars due primarily to increased sales volume and sales mix to customers based in the United States. Our gross profit as a percentage of total revenue, or gross margin, was similar across all periods presented. Our gross margin is impacted by the mix of revenue between the United States, where we earn a higher gross 74 margin that is required to pay sales commissions, and international stocking distributors, where we earn a lower gross margin because the distributor is responsible for paying sales commissions. Sales and Marketing Expenses Our sales and marketing expenses primarily consist of commissions to our domestic and international independent sales agencies, as well as compensation, commissions, benefits and other related personnel costs. Commissions and bonuses are generally based on a percentage of sales. Our international independent stocking distributors purchase implant and instrument sets and replenishment stock for resale, and we do not pay commissions or any other sales-related costs for these international sales. We expect our sales and marketing expenses to continue to increase in absolute dollars with the commercialization of our current and pipeline products and continued investment in our global sales organization to reach new customers. General and Administrative Expenses Our general and administrative expenses primarily consist of compensation, benefits and other related costs for personnel employed in our executive management, administration, finance, legal, quality and regulatory, product management, warehousing, information technology and human resources departments, including stock-based compensation for all personnel, as well as facility costs. We include insurance expenses in general and administrative expenses, as well as costs related to the maintenance and protection of our intellectual property portfolio. Our general and administrative expenses also include the depreciation of our capitalized instrument sets, which represented $6.2 million, $5.6 million and $3.8 million for the years ended December 31, 2022, 2021 and 2020, respectively. We expect our general and administrative expenses to continue to increase in absolute dollars as we hire additional personnel to support the growth of our business as well as increased set deployment. We expect the growth rate of our general and administrative expenses will be lower than the growth rate of our revenue. Legal Settlement Expenses The Company is involved in various legal proceedings from time-to-time. Liabilities for estimated losses are accrued if the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated. For the year ended December 31, 2020, the Company accrued $6.3 million as a result of legal settlement negotiations ongoing at that time. During 2021, there were no material adjustments to the accrual and we paid the settlement amounts, resolving the related legal proceedings. No accrual or adjustments were made during the year ended December 31, 2022. Research and Development Expenses Our research and development expenses primarily consist of costs associated with engineering, product development, consulting services, outside prototyping services, outside research activities, materials and development of our intellectual property portfolio. We also include related personnel and consultants’ compensation expense. We expect research and development expenses to continue to increase both in absolute dollars and as a percentage of revenue as we continue to develop new products to expand our product offering, broaden our intellectual property portfolio and add research and development personnel. Other Expenses Our other expenses primarily consist of fair value adjustments of contingent consideration, accreted interest expense related to the acquisition installment payables and borrowing costs and expenses related to long-term debt. 75 Results of Operations Comparison of the Years Ended December 31, 2022 and 2021 The following table sets forth our results of operations for the years ended December 31, 2022 and 2021: (in thousands, except percentages) 2022 2021 Increase (Decrease) % Increase (Decrease) Net revenue $ 122,289 $ 98,049 $ 24,240 25 % Cost of revenue 31,629 24,646 6,983 28 % Sales and marketing expenses 45,053 39,673 5,380 14 % General and administrative expenses 59,383 46,061 13,322 29 % Trademark impairment 3,609 — 3,609 100 % Legal settlement expenses — 150 (150) (100) % Research and development expenses 8,014 5,543 2,471 45 % Other expenses (income) (21,710) (636) (21,074) 3314 % Provision for income taxes (benefit) (4,947) (1,128) (3,819) 339 % Net income (loss) $ 1,258 $ (16,260) $ 17,518 (108) % Revenue The following tables set forth our revenue by geography and product category for the years ended December 31, 2022 and 2021: Revenue by Geography Year Ended December 31, (in thousands, except percentages) 2022 % of revenue 2021 % of revenue U.S. $ 92,419 76% $ 77,781 79% International 29,870 24% 20,268 21% Total $ 122,289 100% $ 98,049 100% Revenue by Product Category Year Ended December 31, (in thousands, except percentages) 2022 % of revenue 2021 % of revenue Trauma and deformity $ 85,055 70% $ 65,829 67% Scoliosis 33,428 27% 28,046 29% Sports medicine/other 3,806 3% 4,174 4% Total $ 122,289 100% $ 98,049 100% Net revenue increased $24.2 million, or 25%, from $98.0 million for the year ended December 31, 2021 to $122.3 million for the year ended December 31, 2022. The increase was primarily driven by the COVID-19 recovery in both domestic and global markets as well as $11.2 million of growth as a result of the MDO and Pega acquisitions. This was offset by a reduction in the number of procedures caused by an unusually high volume of respiratory illnesses in the United States, as well as a negative impact from the foreign currency conversion of our international revenue. Revenue from current year acquisitions is included in our trauma and deformity channel. Trauma and deformity revenue, which includes the impact from current year acquisitions, increased $19.2 million, or 29%, primarily driven by increased sales in our PNP Femur, Cannulated Screws, Orthex systems and $11.2 million of sales generated from acquired businesses. Scoliosis revenue increased $5.4 million, or 19%, primarily driven by increased sales of our 4.5/5.0 and 5.5/6.0 RESPONSE systems, BandLoc and ApiFix as well as the sale and pull through of 7D. Sports medicine / other decreased $0.4 million, or 9%, due to lower external revenue from Telos. Nearly all the change in each category was due to a change in the unit volume sold and not a result of price changes. 76 Cost of Revenue and Gross Margin Cost of revenue was $31.6 million and $24.6 million for the years ended December 31, 2022 and 2021, respectively. Gross margin was 74% for the year ended December 31, 2022 and 75% for the year ended December 31, 2021. The increase in cost of revenue was primarily driven by volume of units sold which included approximately $3.5 million from the result of acquisitions. The slight decrease in gross margin was driven primarily by higher set sales, sold at cost, to our international stocking distributors, as well as by payment of a minimum performance obligation fee on the Firefly licensing agreement, which resulted from the unfavorable impacts of COVID and respiratory illnesses in the first and fourth quarters of 2022, respectively. See note 15 - Commitments and Contingencies in Item 8 for additional details of our purchase commitments and performance obligations. Sales and Marketing Expenses Sales and marketing expenses increased $5.4 million, or 13.6%, from $39.7 million for the year ended December 31, 2021 to $45.1 million for the year ended December 31, 2022. The increase was due primarily to increased sales commission expenses and an overall increase in volume of units sold. Sales and marketing expenses also increased by approximately $1.5 million as a result of the acquisitions. Sales and marketing expenses for the year ended December 31, 2022 were approximately 37% of revenue compared to 40% for 2021. The lower rate was driven by MD Ortho e-Commerce sales, which is sold without sales commissions, and lower commissions on other newly acquired products. General and Administrative Expenses General and administrative expenses increased $13.3 million, or 29%, from $46.1 million for the year ended December 31, 2021 to $59.4 million for the year ended December 31, 2022. The increase was due primarily to the addition of personnel and resources to support the continued expansion of our business and approximately $4.6 million in increased general and administrative expenses as a result of the acquisitions of MD Ortho and Pega. Depreciation and amortization expenses increased $2.4 million, or 22%, from $10.7 million for the year ended December 31, 2021 to $13.1 million for the year ended December 31, 2022. The increase was primarily due to the amortization on intangible assets acquired through the MD Ortho and Pega acquisitions and a full year of amortization associated with the purchase of the Band-Lok intellectual property and the purchases of licensing agreements, including the 7D Surgical FLASH TM Navigation platform, FIREFLY, and the 2021 scoliosis derotation license. Research and Development Expenses Research and development expenses increased $2.5 million, or 45%, from $5.5 million for the year ended December 31, 2021 to $8.0 million for the year ended December 31, 2022. The increase was primarily due to incremental product development including the addition of personnel and the support of future growth of our business as well as the research and development associated from the newly acquired businesses. Total Other Income Total other income increased $21.1 million from $0.6 million for the year ended December 31, 2021 to $21.7 million for the year ended December 31, 2022. The change is driven primarily by the decrease in fair value of the contingent consideration related to the ApiFix acquisition. For the year ended December 31, 2022, the change in fair value resulted in income of $25.9 million, compared to income of $1.8 million for the year ended December 31, 2021. This was offset partially by the realized losses of investments of approximately $1.6 million and increased interest expense while the Company had borrowings under its Loan Agreement for the Pega acquisition. Interest expense for the year ended December 31, 2022 was $0.7 million compared to $0.1 million for the year ended December 31, 2021. Liquidity and Capital Resources We have incurred operating losses since inception, excluding the fiscal year ended December 31, 2022, and negative cash flows from operating activities of $21.8 million, $13.1 million and $18.5 million for the years ended December 31, 2022, 2021 and 2020, respectively. As of December 31, 2022, we had an accumulated deficit of $176.8 million. We anticipate that our losses will continue in the near term as we continue to expand our product portfolio and invest in additional consigned implant and instrument sets to support our expansion into existing and new markets. Since inception, we have funded our operations primarily with proceeds from the sales of our 77 common and preferred stock, convertible securities and debt, as well as through sales of our products. As of December 31, 2022, we had cash, cash equivalents and restricted cash of $10.5 million and short-term investments of $109.3 million. We believe our existing cash and cash equivalents, amounts available under the Loan Agreement, cash receipts from sales of our products and net proceeds from our August 2022 public securities offering will be sufficient to meet our anticipated cash requirements for at least the next 12 months. Nonetheless, from time to time, we may seek additional financing sources to meet our working capital requirements, make continued research and development investments and make capital expenditures needed for us to maintain and grow our business. We may not be able to obtain additional financing on terms favorable to us, if at all. It is also possible that we may allocate significant amounts of capital toward products or technologies for which market demand is lower than anticipated and, as a result, abandon such efforts. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, or if we expend capital on products or technologies that are unsuccessful, our ability to continue to support our business growth and to respond to business challenges could be significantly limited, or we may have to scale back our operations. If we raise additional funds through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock. Cash Flows The following table sets forth our cash flows from operating, investing and financing activities for the periods indicated: Year Ended December 31, (in thousands) 2022 2021 2020 Net cash used in operating activities $ (21,766) $ (13,063) $ (18,530) Net cash used in investing activities (113,371) (7,411) (69,693) Net cash provided by financing activities 135,974 6 46,732 Effect of exchange rate changes on cash 619 (658) (404) Net increase (decrease) in cash and restricted cash $ 1,456 $ (21,126) $ (41,895) Cash Used in Operating Activities Net cash used in operating activities was $21.8 million, $13.1 million and $18.5 million for the years ended December 31, 2022, 2021 and 2020, respectively. The primary use of this cash was to fund our operations related to the development and commercialization of our products in each of these years. Net cash used for working capital was $17.8 million, $12.6 million and $5.0 million for the years ended December 31, 2022, 2021 and 2020, respectively. During 2022, the primary uses of cash included an increase in inventory of $16.9 million as we deployed additional inventory, and an increase in accounts receivable of $3.9 million. These uses of cash were partially offset by cash inflows from other accrued expenses of $3.3 million, related primarily to accrued compensation. During 2021, we increased inventory by $5.1 million as we deployed additional inventory, including $1.6 million and accounts receivable increased by $0.5 million. These uses of cash for working capital were offset by our legal settlement accrual of $6.3 and $1.1 million of other accrued expenses. During 2020, we increased inventory by $12.1 million as we deployed additional inventory, including $1.6 million due to the repurchase of inventory from a stocking distributor in Germany, Austria and Switzerland that we converted to a sales agency, and accounts receivable increased by $0.5 million. These uses of cash for working capital were offset by our legal settlement accrual of $6.3 million and an increase in accounts payable of $3.1 million. We had net income of $1.3 million and net losses of $16.3 million and $32.9 million for the years ended December 31, 2022, 2021 and 2020, respectively. Cash Used in Investing Activities Net cash used in investing activities was $113.4 million, $7.4 million and $69.7 million for the years ended December 31, 2022, 2021 and 2020, respectively. Net cash used in investing activities in 2022 was primarily related to the cash portions paid in the acquisitions of MDO and Pega in the aggregate amount of $40.1 million and purchases of short term investments of $110.1 million, both of which were offset by sales of short term securities of $46.9 million. We also invested an additional $10.0 million in property, plant and equipment, primarily instrument sets which were consigned in the United States and select international markets. Net cash used in 78 2021 consisted primarily of the purchases of licenses of $7.9 million and the purchases of property plant and equipment, which were primarily instrument sets which were consigned in the United States and select international markets, of $8.1 million. This was partially offset by the sale of short term investments which was a $9.3 million source of cash. Net cash used in investing activities in 2020 consisted primarily of the purchase of short-term investments of $55.0 million, the acquisition of Telos of $1.7 million, net of cash received, the acquisition of ApiFix of $1.7 million, net of cash received, the acquisition of the Band-Lok intellectual property of $0.8 million and the purchases of property plant and equipment, primarily instrument sets, of $10.5 million. Cash Provided By Financing Activities Net cash provided by financing activities was $136.0 million, $6 thousand and $46.7 million for the years ended December 31, 2022, 2021 and 2020, respectively. Net cash provided by financing activities for 2022 consisted primarily of the proceeds from the issuance of common stock and pre-funded warrants of $139.3 million, net of issuance costs. This was offset by the cash paid for the first acquisition installment to ApiFix. The Company also utilized $31.0 million of its revolving credit facility with Squadron to fund the Pega acquisition. This was subsequently paid off in 2022. Net cash provided by financing activities in 2021 were immaterial to the results of our operations. Net cash provided by financing activities in 2020 consisted primarily of the proceeds from the issuance of common stock of $70.2 million, net of issuance costs and $1.6 million from the exercise of stock options, offset by the payment of $25.0 million of the revolving credit facility and term loan with Squadron. Indebtedness Loan Agreement The Company is party to a Fourth Amended and Restated Loan and Security Agreement with Squadron, as amended from time to time (as amended, the “Loan Agreement”), which provides the Company with a $50.0 million revolving credit facility. As of December 31, 2022, there was no outstanding indebtedness under the Loan Agreement. Borrowings under the revolving facility accrue interest at an annual rate equal to the greater of (a) six month SOFR plus 8.69% and (b) 10.0%, and the Company is permitted to make interest only payments on amounts outstanding. Prior to December 31, 2021, the interest rate on the facility had been equal to the greater of (a) three month LIBOR plus 8.61% and (b) 10.0%. The Company pays Squadron an unused commitment fee in an amount equal to the per annum rate of 0.50% (computed on the basis of a year of 360 days and the actual number of days elapsed) times the daily unused portion of the revolving credit commitment. The unused commitment fee is payable quarterly in arrears. Borrowings under the revolving credit facility are made under a Second Amended and Restated Revolving Note, dated June 13, 2022 (the “Amended Revolving Note”), payable, jointly and severally, by the Company and each of its subsidiaries party thereto. The Amended Revolving Note matures at the earlier of: (i) the date on which any person or persons acquire (x) capital stock of the Company possessing the voting power to elect a majority of the Company’s Board of Directors (whether by merger, consolidation, reorganization, combination, sale or transfer), or (y) all or substantially all of the Company’s assets, determined on a consolidated basis; and (ii) January 1, 2024. Borrowings under the Loan Agreement are secured by substantially all of the Company's assets and are unconditionally guaranteed by each of its subsidiaries with the exception of Vilex. There are no traditional financial covenants associated with the Loan Agreement. However, there are negative covenants that prohibit us from, among other things, transferring any of our material assets, merging with or acquiring another entity, entering into a transaction that would result in a change of control, incurring additional indebtedness, creating any lien on our property, making investments in third parties and redeeming stock or paying dividends, in each case subject to certain exceptions as further detailed in the Loan Agreement. The Loan Agreement includes events of default, the occurrence and continuation of any of which provides Squadron with the right to exercise remedies against us and the collateral securing the loans, including cash. These events of default include, among other things, the failure to pay amounts due under the credit facilities, insolvency, the occurrence of a material adverse event, which includes a material adverse change in our business, operations or properties (financial or otherwise) or a material impairment of the prospect of repayment of any portion of the obligations, the occurrence of any default under certain other indebtedness and a final 79 judgment against us in an amount greater than $250 thousand. The occurrence of a material adverse change could result in the acceleration of payment of the debt. Mortgage Note In August 2013, pursuant to the purchase of our office and warehouse space, we entered into a mortgage note payable to Tawani Enterprises Inc., the owner of which is a member of Squadron’s management committee. Pursuant to the terms of the mortgage note, we pay Tawani Enterprises Inc. monthly principal and interest installments of $15,543, with interest compounded at 5% until maturity in August 2028, at which time a final payment of remaining principal and interest will become due. The mortgage is secured by the related real estate and building. The mortgage balance was $0.9 million and $1.0 million as of December 31, 2022 and 2021, respectively. Contractual Obligations and Commitments The Company's cash requirements within the next twelve months include accounts payable, accrued compensation and benefits, current maturities of long-term debt, current portion of acquisition installment payable and other current liabilities. The acquisition installment payable is related to the acquisition of ApiFix - See Note 3. Business Combinations in Item 8 for further detail of the acquisition and the acquisition installment payables. Our long-term cash requirements under various contractual obligations and commitments include: • Debt obligations and interest payments - See Note 8. Debt and Credit Arrangements in Item 8 for further detail regarding our debt and the timing of expected future principal and interest payments. • Acquisition installment payables, net of current portion and contingent consideration - See Note 3. Business Combinations in Item 8 for further detail regarding our obligations and timing of expected future payments. • Minimum purchase obligations - Purchase obligations include agreements for purchases of product in the normal course of business, including minimum quantities required pursuant to our license agreements. See Note 15. Commitments and Contingencies in Item 8 for further detail regarding these requirements. • Lease Obligations - See Note 15. Commitments and Contingencies in Item 8 for further detail regarding our lease obligations. • Royalties - See Note 15. Commitments and Contingencies in Item 8 for further detail regarding minimum royalty obligations. Pediatric Orthopedic Business Seasonality Our revenue is typically higher in the summer months and holiday periods, driven by higher sales of our trauma and deformity and scoliosis products, which is influenced by the higher incidence of pediatric surgeries during these periods due to recovery time provided by breaks in the school year. Additionally, our scoliosis patients tend to have additional health challenges that make scheduling their procedures variable in nature. Critical Accounting Policies and Significant Judgments and Estimates This management’s discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue and expenses during the reporting periods. We monitor and analyze these items for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ materially from these estimates under different assumptions or conditions. 80 While our significant accounting policies are more fully described in the notes to our consolidated financial statements appearing elsewhere in this annual report, we believe the following accounting policies are most critical to understanding and evaluating our reported financial results and require significant or complex judgment and estimates on the part of management. Revenue Recognition In the United States and in fourteen international markets, we primarily sell our implants, and to a much lesser extent our instruments, through third-party independent sales agencies to medical facilities and hospitals. For such sales, revenue and associated cost of revenue is recognized when a product is used in a procedure. In a few cases, hospitals purchase our products for their own inventory, and such revenue and associated cost of revenue is recognized when a product is shipped or delivered and the title and risk of loss passes to the customer. Sales of our bracing products are sold to stocking distributors, hospitals, orthotist and other medical professionals or directly to end customers. Revenue is recognized for braces generally when title passes upon shipment. Outside of the United States, we sell our products directly to hospitals through independent sales agencies or to independent stocking distributors. Generally, the distributors are allowed to return products, and some are thinly capitalized. Based on a history of reliable collections, we have concluded that a contract exists and revenue should be recognized when we transfer control of our products to the customer, generally when title passes upon shipment. Additionally, based on our history of immaterial returns from international customers, we have historically estimated no reserve for returns. Inventory Valuation Inventory is stated at the lower of cost or net realizable value, with cost determined using the first-in-first-out method. Inventory, which consists of implants and instruments included in deployed sets in the field or held in our warehouse, is considered finished goods and is purchased from third parties. We evaluate the carrying value of our inventory in relation to the estimated forecast of product demand, which takes into consideration the life cycle of the products. A significant decrease in demand could result in an increase in the amount of excess inventory on hand, which could lead to additional charges for excess and obsolete inventory. The need to maintain substantial levels of inventory impacts our estimates for excess and obsolete inventory. Each of our systems are designed to include implantable products that come in different sizes and shapes to accommodate the surgeon’s needs. Typically, a small number of the set components are used in each surgical procedure. Certain components within each set may become obsolete before other components based on the usage patterns. We adjust inventory values to reflect these usage patterns and life cycle. In addition, we continue to introduce new products, which we believe will increase our revenue. As a result, we may be required to take additional charges for excess and obsolete inventory in the future. Goodwill and Other Intangible Assets Our goodwill represents the excess of the cost over the fair value of net assets acquired. The determination of the value of goodwill and intangible assets arising from acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of net tangible and intangible assets acquired. Goodwill is not amortized and is assessed for impairment using fair value measurement techniques on an annual basis or more frequently if facts and circumstances warrant such a review. The goodwill is considered to be impaired if we determine that the carrying value of either of our reporting units exceeds its respective fair value. We have indefinite lived trademark assets that are reviewed for impairment by performing a quantitative analysis, which occurs annually in the fourth quarter or whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Recoverability is measured by a comparison of the carrying amount to future net discounted cash flows expected to be generated by the associated asset. Calculating net discounted cash flows requires us to make significant estimates and assumptions related to forecasts of future revenues and discount rates. Changes in these assumptions could have a significant impact on the fair value of of trademarks. If such assets are determined to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair market value of the assets. The calculation of the fair value 81 of the trademark assets involves Level 3 fair value measurements. To estimate the fair value of the trademark asset and associated impairment, we utilized an income approach, or discounted cash flow model. This approach requires us to make significant estimates and assumptions including preparation of forecasted revenue, selection of a royalty rate and discount rate and estimate of the terminal year revenue growth rate. During 2022, management determined that a triggering event occurred, indicating that it was more likely than not the fair value of the ApiFix trademark asset was less than the carrying value. As such, the company completed a quantitative analysis whereby we determined the fair value of the ApiFix trademark asset associated was below the carrying value. The primary reason for the impairment is the lower forecasted revenue of our ApiFix product than previously expected. We recorded a $3,609 impairment charge for the year ended December 31, 2022 to reduce the carrying amount of the intangible asset to its estimated fair value. Following the impairment, the newly calculated fair value becomes the new accounting basis and carrying value of the trademark. Net Operating Losses As of December 31, 2022, we had federal, state and foreign tax net operating loss carryforwards, or NOLs, of approximately $117.1 million, $74.8 million and $24.4 million, respectively, which begin to expire in 2028 unless utilized. The deferred tax assets, except for those recorded in Canada and Israel, were fully offset by a valuation allowance as of December 31, 2022 and 2021 and no income tax benefit has been recognized in continuing operations related to the NOLs which have valuation allowances. Pursuant to Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, annual use of our pre-change NOLs may be limited in the post-change period in the event that an ‘‘ownership change’’ occurs, which is generally defined as a cumulative change in equity ownership by ‘‘5% shareholders’’ that exceeds 50 percentage points over a rolling three-year period. We determined that an ownership change occurred on May 30, 2014, resulting in a limitation of approximately $1.1 million per year being imposed on the use of our pre-change NOLs of approximately $45.2 million. An additional Section 382 ownership change was deemed to have occurred following our follow-on offering in December 2018 resulting in a limitation of approximately $9.7 million per year.