The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to promote an understanding of the financial condition and results of operations and should be read in conjunction with our consolidated financial statements and related notes appearing 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. As a result of many factors, including those factors set forth in the ''Risk Factors'' section of this Annual Report on Form 10-K, our actual results could differ materially from the results described, in or implied, by these forward-looking statements.
We are a medical technology company and innovator in the orthopedic industry since our founding in 2004. In particular, we believe that we are a leader in the development, manufacturing, and sales of patient-specific products and instrumentation that are individually sized and shaped to fit each patient's unique knee and hip anatomy. The worldwide market for total knee and hip replacement products is approximately
$17.1 billionannually. In the U.S.elective total joint procedures are shifting from the hospital to outpatient facilities and ambulatory surgery centers ("ASCs"). We believe that approximately 50% of all primary hip and knee procedures will be performed in ASCs within the next five years. A key driver in the outpatient shift of orthopedic procedures is the ongoing changes by the Centers for Medicare & Medicaid Services("CMS"). In recent years, CMS removed key musculoskeletal services from the inpatient-only list, including total knee arthroplasty in 2018 and total hip arthroplasty in 2020. CMS also continues to expand the ASCs covered procedure list, including total knee arthroplasty in 2020 and total hip arthroplasty in 2021. Additionally, the COVID-19 pandemic has fueled efforts to reduce risk and lengths of stay that further accelerated the shift of procedures to outpatient facilities. In addition, as healthcare costs rise, governments, including CMS, are looking to reduce their healthcare expenditures markedly through reimbursement reductions and cost-shifting to patients. As patients assume more of their overall healthcare costs, we believe that they are increasingly seeking treatment options that are tailored more closely to their individual needs. We have observed that this movement in healthcare consumerism appears to have accelerated and evolved during the COVID-19 pandemic. As one of the more important decisions individuals have to make, patients want more from the healthcare industry and are willing to pay out-of-pocket for premium products and services. With this healthcare consumerism on the rise, Conformisis evolving its portfolio and business model to address the changing market dynamics. On January 6, 2022, we announced the launch of our new Image-to-Implant® Platinum Services? Program, a premium service offering for the U.S. market. New to orthopedics, this program addresses the rapidly evolving demands of the healthcare marketplace where generic products are being commoditized and patients are increasingly willing to pay a premium for personalized treatment options. As of January 6, 2022, new U.S.customers are only able to purchase our fully personalized iTotal Identity knee system through participation in our Image-to-Implant Platinum Services? Program. We expect to transition all existing U.S.customers to the new program by September 1, 2022. Both Medicare and most commercial payors permit patients to pay out-of-pocket for non-covered, deluxe services. Through the Image-to-Implant® Platinum Services? Program, Conformisis bringing this approach to orthopedics by enabling participating medical facilities to establish and offer patients an out-of-pocket upgrade to obtain the Company's fully personalized iTotal Identity™ knee system. Combined with its standardized Identity Imprint™ knee system, Conformisnow addresses multiple market segments within knee arthroplasty:
The Identity Imprint™ knee system provides a data-informed high-quality knee implant system that provides a level of personalization through its patient-specific instruments (“PSI”) and proprietary algorithms for pre-
surgical planning, but is only available in pre-designed standard sizes, all at a price comparable to standard off-the-shelf options; and
•the Image-to-Implant® Platinum Services? Program gives patients in
the United Statesthe opportunity to upgrade to a fully-personalized iTotal Identity™ knee implant system by paying an incremental deluxe services fee. As of December 31, 2021, we had sold a total of more than 137,000 knee implants, including more than 111,000 total knee implants and 26,000 partial knee implants. In multiple clinical studies, iTotal CR, our cruciate-retaining total knee replacement implant, demonstrated superior clinical outcomes, including with respect to function, kinematics and objective functional measures, and greater patient satisfaction compared to those of standard, or off-the-shelf, implants that it was tested against. On August 16, 2021, the first procedure was performed using the Identity Imprint knee replacement system. Identity Imprint, available in both cruciate retaining ("CR") and posterior stabilized ("PS") implants, utilizes a proprietary algorithm to select the appropriate implant size from 12 standard sizes that most closely meets the geometric and anatomic requirements of the patient's knee based on the individual's CT scan. As with Conformis'personalized iTotal knee product line, Identity Imprint uses Conformis'sterile Surgery-in-a-Box delivery system, which we believe provides ASCs and hospitals with greater procedural efficiency and improved sterilization cost savings over comparable systems. With the growing interest in our Identity Imprint system from ASC customers, we have prioritized applying cementless technology to our Identity Imprint system. We anticipate a limited commercial launch of the Identity Imprint cementless option in late 2022. On November 11, 2019, we entered full commercial launch of the Conformiship system. In September 2020, we announced the Cordera hip system, and in December 2020, we commenced the U.S.commercial launch of the Cordera Match hip system, one of multiple planned product extensions featuring the Cordera hip system. We are planning for a limited commercial launch of a second hip stem within our hip portfolio by mid-2022. This will be a shorter stem conducive to the popular direct anterior approach and be offered in the most common standard sizes. All of our currently marketed knee and hip replacement products and related design software have been cleared by the U.S. Food and Drug Administration(the "FDA") under the premarket notification process of Section 510(k) of the federal Food, Drug, and Cosmetic Act (the "FDCA"). We have received CE Certificates of Conformity allowing us to affix the CE Mark. We market our products and services to orthopedic surgeons, hospitals, and other medical facilities, and patients. We use direct sales representatives, independent sales representatives and distributors to market and sell our products in the United States, Germany, the United Kingdom, Austria, Ireland, Switzerland, Spain, Portugal, the Netherlands, Belgium, the Dutch Antilles, Suriname, Australia, the United Arab Emirates, the Sultanate of Oman, Italy, Polandand other markets.
We were incorporated in
December 2019, a human infection originating in Chinawas traced to a novel strain of coronavirus. The virus subsequently spread to other parts of the world, including the United Statesand Europe, and caused unprecedented disruptions in the global economy as efforts to contain the spread of the virus intensified. In March 2020, the World Health Organizationdeclared this coronavirus outbreak ("COVID-19") to be a pandemic. The future progression of the pandemic, including the scope, severity and duration of the pandemic, potential resurgences, the speed and effectiveness of vaccine and treatment developments, and the direct and indirect economic effects of the pandemic and containment measures, and its effects on our business and operations remain uncertain. We have experienced significantly decreased demand for our products during the pandemic as healthcare providers and individuals have de-prioritized and deferred medical procedures deemed to be elective, such as joint replacement procedures, which has had and is expected to continue to have a significant negative effect on our revenue. Such negative effects were most pronounced during the second quarter of 2020, when a significant number of hospitals were either closed for elective procedures or otherwise operating at significantly reduced volumes. Generally, we saw an increase in procedure volumes during the summer of 2020, as many regions were able to reopen for elective procedures, with an existing patient backlog. 65 -------------------------------------------------------------------------------- However, in the United Statesand Germany, which are our major sales markets, estimated case counts increased in the fourth quarter of 2020 and peaked in January 2021. While worldwide case counts have declined after January, we saw a decline in elective procedures during the first quarter of 2021. In Germany, case counts declined after January 2021but then increased again in the second quarter. Germanycase counts began to decline mid-way through the second quarter but the Company saw a decline in Germanyelective procedures during the second quarter of 2021. In the United States, elective procedures improved sequentially in the second quarter of 2021 over first quarter of 2021 consistent with the market. However, in the third and fourth quarters of 2021, we experienced higher levels of deferred and rescheduled knee and hip procedures as a result of the surge in COVID-19 cases associated with the Delta and Omicron variants. We expect that these negative effects will continue in the near-term until infection rates decline further from their current level, and more of the population is vaccinated. However, the future progression of the pandemic remains uncertain. To the extent that individuals in these markets continue to de-prioritize or delay deferrable procedures as a result of the COVID-19 pandemic or otherwise, our business, cash flows, financial condition and results of operations could continue to be negatively affected. On March 20, 2020, we provided notice to our employees of a furlough of approximately 80 employees effective as of March 23, 2020to help address decreased demand for our products. The furlough resulted in reduced production capacity at our manufacturing facilities, but sufficient to meet demand. While we have not experienced and do not currently anticipate significant interruptions in our supply chain, extended or additional quarantines, travel restrictions and other measures may significantly impact the ability of employees of our third-party suppliers to get to their places of work to manufacture the key components and materials necessary for our products. We have experienced and may experience further shortages of mask and gown consumables used in our clean room processes, which may further limit our production capacity and further delay the joint replacement procedures in which our products are used. Any delay or shortage of such components or materials or delays in delivering our products may result in our inability to satisfy consumer demand for our products in a timely manner or at all, which could harm our reputation, future sales, profitability and financial condition. On April 17, 2020, we entered into an approximately $4.7 millionpromissory note (the "PPP Note"), with East West Bankunder the Paycheck Protection Program ("PPP") offered by the U.S. Small Business Administration(the "SBA"), to mitigate the negative financial and operational impacts of the pandemic. On April 23, 2020, we accelerated a plan to return to full-time employment the vast majority of those employees whowere furloughed on March 23, 2020. This plan was completed at the end of April 2020.
Components of our results of operations
The following is a description of factors that may influence our results of operations, including significant trends and challenges that we believe are important to an understanding of our business and results of operations.
Our product revenue is generated from sales to hospitals and other medical facilities that are served through a direct sales force, independent sales representatives and distributors in
the United States, Germany, the United Kingdom, Austria, Ireland, Switzerland, Spain, Portugal, the Netherlands, Belgium, the Dutch Antilles, Suriname, Australia, the United Arab Emirates, the Sultanate of Oman, Italy, Polandand other markets. In order for surgeons to use our products, the medical facilities where these surgeons treat patients typically require us to enter into pricing agreements. The process of negotiating a pricing agreement can be lengthy and time-consuming, requiring extensive management time and may not be successful. Revenue from sales of our products fluctuates principally based on the selling price of the joint replacement product, as the sales price of our products varies among hospitals and other medical facilities as well as health insurance coverage and reimbursement rates. In addition, our product revenue may fluctuate based on the product sales mix and mix of sales by geography. Our product revenue from international sales can be significantly impacted by fluctuations in foreign currency exchange rates, as our sales are typically denominated in the local currency in the countries in which we sell our products. We expect our product revenue to fluctuate from quarter-to-quarter due to a variety of factors, including seasonality, as we have historically experienced lower sales in the summer months, the timing of the introduction of our new products, if any, and the impact of the buying patterns and implant volumes of medical facilities. Royalty and licensing revenue for the year ended December 31, 2021, includes revenue of $15.0 milliongenerated from our settlement with Stryker Corporation ("Stryker"), Wright Medical Technology, Inc.("Wright Medical"), and Tornier, Inc.("Tornier" and, collectively with Stryker and Wright Medical, the "Stryker Parties"), $25.066 -------------------------------------------------------------------------------- million recognized under the Development and License Agreements with Stryker, and $1.0 milliongenerated from our license agreement (the "License Agreement") with Paragon 28. Royalty and licensing revenue for the year ended December 31, 2020includes revenue of $9.6 milliongenerated from our settlement and license agreement (the "Zimmer Settlement and License Agreement") with Zimmer Biomet, Zimmer US, Inc.and Biomet Manufacturing, LLC(collectively,"Zimmer Biomet"). Ongoing royalty revenue is generated from our license agreement (the " MicroPortLicense Agreement") with MicroPort Orthopedics Inc., a wholly owned subsidiary of MicroPort Scientific Corporation, or collectively, MicroPort. The MicroPortLicense Agreement will expire upon the expiration of the last to expire of our patents and patent applications licensed to MicroPort, which currently is expected to occur in 2031. We provide certain information regarding our financial results or projected financial results on a non-GAAP "constant currency basis." This information estimates the impact of changes in foreign currency rates on the translation of our current or projected future period financial results as compared to the applicable comparable period. This impact is derived by taking the adjusted current or projected local currency results and translating them into U.S.Dollars based upon the foreign currency exchange rates for the applicable comparable period. It does not include any other effect of changes in foreign currency rates on our results or business. Non-GAAP information is not a substitute for, and is not superior to, information presented on a GAAP basis. This non-GAAP financial measure may be different from non-GAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We consider the use of a period over period revenue comparison on a constant currency basis to be helpful to investors, as it provides a revenue growth measure free of positive or negative volatility due to currency fluctuations.
Cost of revenue
We produce our computer aided designs, or CAD, in-house and in
Indiaand use them to direct most of our product manufacturing efforts. We manufacture all of our PSI, or iJigs, tibial trays used in our total knee implants, and polyethylene tibia tray inserts for our iTotal CR and our iTotal PS product, in our facility in Wilmington, Massachusetts. We polish our femoral implants used in our total and partial knee products in our facility in Wallingford, Connecticut. Starting in 2019, we began to manufacture the lateral partial tibial tray components in our facility in Wilmington, Massachusetts. We outsource the production of the remainder of the partial knee tibial components, femoral castings, and other knee and hip components to third-party suppliers. Our suppliers make our personalized implant components using the CAD designs we supply. Cost of revenue consists primarily of costs of raw materials, manufacturing personnel, outsourced CAD labor, manufacturing supplies, inbound freight, manufacturing overhead, and depreciation expense. Also included in cost of revenue for the year ended December 31, 2020, are legal fees payable to external counsel in connection with our patent licensing and enforcement activities related to the Settlement and License Agreement with Zimmer Biomet. We calculate gross margin as revenue less cost of revenue divided by revenue. Our gross margin has been and will continue to be affected by a variety of factors, including primarily volume of units produced, manufacturing efficiencies, our average selling price, the geographic mix of sales, product sales mix, the number of cancelled sales orders resulting in wasted implants, and royalty revenue. We expect our gross margin from the sale of our products, which excludes royalty and licensing revenue, to expand over time to the extent we are successful in reducing our manufacturing costs per unit, increasing our manufacturing efficiency, and increasing sales volume through with launch of Identity Imprint™ and our Image-to-Implant® Platinum Services? Program. We believe that areas of opportunity to expand our gross margin in the future, if and as the volume of our product sales increases, include the following: •absorbing overhead costs across a larger volume of product sales; •obtaining more favorable pricing for the materials used in the manufacture of our products; •obtaining more favorable pricing of certain components of our products manufactured for us by third parties; •increasing the proportion of our CAD design activities that is performed in-house at our Indiafacility; and •developing new versions of our software used in the design of our joint replacement implants, which we believe will reduce costs associated with the design process.
We also continue to explore other opportunities to reduce our manufacturing costs. However, these and the above opportunities may not be realized. In addition, our gross margin may fluctuate from period to period.
Our operating expenses consist of sales and marketing, research and development and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, stock-based compensation and sales commissions.
Sales and marketing. Sales and marketing expense consists primarily of personnel costs, including salary, employee benefits and stock-based compensation for personnel employed in sales, marketing, customer service, medical education and training, as well as investments in surgeon training programs, industry events and other promotional activities. In addition, our sales and marketing expense includes sales commissions and bonuses, generally based on a percentage of sales, to our sales managers, direct sales representatives and independent sales representatives. Recruiting, training and retaining productive sales representatives and educating surgeons about the benefits of our products are required to generate and grow revenue. We expect sales and marketing expense to increase as we build up our sales and support personnel and expand our marketing efforts. Our sales and marketing expense may fluctuate from period to period due to the seasonality of our revenue and the timing and extent of our expenses. Research and development. Research and development expense consists primarily of personnel costs, including salary, employee benefits and stock-based compensation for personnel employed in research and development, regulatory and clinical areas. Research and development expense also includes costs associated with product design, product refinement and improvement efforts before and after receipt of regulatory clearance, development of prototypes, testing, clinical study programs and regulatory activities, contractors and consultants, and equipment and software to support our development. As our revenue increases, we will also incur additional expense for revenue share payments to our past and present scientific advisory board members, including one of our past directors. We expect research and development expense to increase in absolute dollars as we develop new products to expand our product pipeline, add research and development personnel and conduct clinical activities. General and administrative. General and administrative expense consists primarily of personnel costs, including salary, employee benefits and stock-based compensation for our administrative personnel that support our general operations, including executive management, general legal and intellectual property, finance and accounting, information technology and human resources personnel. General and administrative expense also includes outside legal costs associated with intellectual property and general legal matters, financial audit fees, insurance, fees for other consulting services, depreciation expense, long-lived asset impairment charges, freight, facilities expense, allocation of manufacturing training costs, and severance expense. We expect our general and administrative expense will increase in absolute dollars as we increase our headcount and expand our infrastructure to support growth in our business and our operations as a public company. As our revenue increases we also will incur additional expenses for freight. Our general and administrative expense may fluctuate from period to period due to the timing and extent of the expenses.
Total other income (expenses), net
Total other income (expenses), net consists primarily of interest expense and amortization of debt discount associated with our term loans outstanding during the year, gain on forgiveness of PPP loan, debt extinguishment loss, income related to the development agreement with Stryker, and gains (losses) from foreign currency transactions. The effect of exchange rates on our foreign currency-denominated asset and liability balances are recorded as foreign currency translation adjustments in the consolidated statements of comprehensive income (loss). Income tax provision Income tax provision consists primarily of a provision for income taxes in foreign jurisdictions in which we conduct business. We maintain a full valuation allowance for deferred tax assets including net operating loss carryforwards and research and development credits and other tax credits. 68 --------------------------------------------------------------------------------
Consolidated results of operations
Comparison of the years ended
The following table sets forth our results of operations expressed as dollar amounts, percentage of total revenue and year-over-year change (in thousands): 2021 2020 2021 vs 2020 As a% As a% of of Total Total $ % Years Ended December 31, Amount Revenue Amount Revenue Change Change Revenue Product revenue
$ 58,31858 % $ 58,54085 % $ (222)- % Royalty and licensing 41,542 42 10,221 15 31,321 306 Total revenue 99,860 100 68,761 100 31,099 45 Cost of revenue 34,179 34 35,046 51 (867) (2) Gross profit 65,681 66 33,715 49 31,966 95 Operating expenses: Sales and marketing 24,904 25 22,646 33 2,258 10 Research and development 14,791 15 11,939 17 2,852 24 General and administrative 28,994 29 24,244 35 4,750 20 Total operating expenses 68,689 69 58,829 86 9,860 17 Loss from operations (3,008) (3) (25,114) (37) 22,106 88 Total other income/(expenses), net 686 1 863 1 (177) (21) Loss before income taxes (2,322) (2) (24,251) (35) 21,929 90 Income tax provision 91 - 42 - 49 117 Net loss $ (2,413)(2) % $ (24,293)(35) % $ 21,88090 %
Product revenue. Product revenue was
The following table sets forth, for the periods indicated, our product revenue by geography expressed as
U.S.dollar amounts, percentage of product revenue and year-over-year change (in thousands): 2021 2020 2021 vs 2020 As a % of As a % of Product Product $ % Years Ended December 31, Amount Revenue Amount Revenue Change Change United States $ 50,99087 % $ 50,73687 % $ 2541 % Germany 5,422 9 6,526 11 (1,104) (17) Rest of world 1,906 4 1,278 2 628 49 Product revenue $ 58,318100 % $ 58,540100 % $ (222)- % Product revenue in the United Stateswas generated through our direct sales force and independent sales representatives. Product revenue outside the United Stateswas generated through our direct sales force and distributors. The percentage of product revenue generated in the United Stateswas 87% for each of the years ended December 31, 2021and 2020. United Statesproduct revenue increased $0.3 millionto $51.0 millionor 1% year over year. The increase in revenue inside the United Stateswas primarily due to growth in our hip products. Germanyproduct revenue decreased $1.1 millionto $5.4 million, or 17% year over year on a reported basis and 21% on a constant currency basis. The decline was primarily due to COVID-19 negatively impacting elective procedure volumes and 69 --------------------------------------------------------------------------------
reimbursement denials from MDK in
Royalty and licensing revenue. Royalty and licensing revenue was
$41.5 millionfor the year ended December 31, 2021compared to $10.2 millionfor the year ended December 31, 2020, an increase of $31.3 millionor 306%. The increase in royalty and licensing revenue was driven by $25.0 millionin revenue recognized in connection with receiving 510(k) clearance from the FDA, which was for the third of three milestones under the License Agreement with Stryker, $15.0 millionin revenue recognized under the Settlement and License Agreement with the Stryker Parties, and $1.0 millionin revenue recognized under the License Agreement with Paragon 28. Royalty and licensing revenue for the year ended December 31, 2020includes $9.6 millionin revenue recognized under the Zimmer Settlement and Licensing Agreement with Zimmer Biomet. Cost of revenue, gross profit and gross margin. Cost of revenue was $34.2 millionfor the year ended December 31, 2021compared to $35.0 millionfor the year ended December 31, 2020, a decrease of $0.9 millionor 2%. The decrease was due primarily to lower legal fees as 2020 included outside counsel expense in connection with our patent licensing and enforcement activities related to the Settlement and License Agreement with Zimmer Biomet. Gross profit was $65.7 millionfor the year ended December 31, 2021compared to $33.7 millionfor the year ended December 31, 2020, an increase of $32.0 millionor 95%. Gross margin was 66% for the year ended December 31, 2021compared to 49% for the year ended December 31, 2020, an increase of 1,680 basis points. The increase in gross margin was driven primarily by the Stryker licensing revenue under the Development and License Agreements and the Stryker Parties licensing revenue under the Settlement and License Agreement. Sales and marketing. Sales and marketing expense was $24.9 millionfor the year ended December 31, 2021compared to $22.6 millionfor the year ended December 31, 2020, an increase of $2.3 millionor 10%. The increase was due primarily to higher personnel costs of $0.4 million, commission expense of $0.7 million, tradeshow and surgeon training of $0.5 million, market research of $0.2 million, marketing collateral of $0.1 million, legal fees of $0.1 million, depreciation expense of $0.1 million, and travel and entertainment of $0.1 million. Sales and marketing expense decreased as a percentage of total revenue to 25% for the year ended December 31, 2021compared to 33% for the year ended December 31, 2020. Research and development. Research and development expense was $14.8 millionfor the year ended December 31, 2021compared to $11.9 millionfor the year ended December 31, 2020, an increase of $2.9 millionor 24%. The increase was due primarily to an increase in professional services of $0.6 million, revenue share expense of $0.4 million, project prototype costs of $0.5 million, personnel related costs of $0.5 million, and a reduction of $0.9 millionof cost allocated to the advance on research and development. Research and development expense decreased as a percentage of total revenue to 15% for the year ended December 31, 2021from 17% for the year ended December 31, 2020. General and administrative. General and administrative expense was $29.0 millionfor the year ended December 31, 2021compared to $24.2 millionfor the year ended December 31, 2020, an increase of $4.8 millionor 20%. The increase was primarily due to an increase in legal fees of $2.8 million, an increase in freight costs of $1.5 million, an increase in insurance of $0.2 million, an increase in office and facilities expenses of $0.1 million, and an increase in other various expenses of $0.2 million. General and administrative expense decreased as a percentage of total revenue to 29% for the years ended December 31, 2021from 35% for the year ended December 31, 2020. Total other income (expenses), net. Total other income (expenses), net was $0.7 millionof other income for the year ended December 31, 2021compared to other income of $0.9 millionfor the year ended December 31, 2020, a change of $0.2 million, or 21%. The change was primarily due to higher interest expense, net of $0.1 million, a decrease of $6.3 millionin foreign currency exchange transaction loss and a loss on the extinguishment of debt of $1.1 million. This was offset by the recognition of a gain on forgiveness of PPP loan of $4.8 million, and the recognition of $2.5 millionfor the unused portion of the advance on research and development under the Development Agreement with Stryker. Income taxes. Income tax provision was $91,000for the year ended December 31, 2021and $42,000for the year ended December 31, 2020. We continue to generate losses for U.S.federal and state tax purposes and have net operating loss carryforwards creating a deferred tax asset. We maintain a full valuation allowance for deferred tax assets.
Comparison of the years ended
70 -------------------------------------------------------------------------------- For a discussion of the comparison of our results of operations for the fiscal years ended
December 31, 2020and 2019, refer to the Management's Discussion and Analysis of Financial Condition and Results of Operations section in our previously filed Annual Report on Form 10-K for the fiscal year ended December 31, 2020.
Liquidity, capital resources and plan of operations
Sources of liquidity and funding requirements
From our inception in
June 2004through the year ended December 31, 2021, we have financed our operations primarily through private placements of preferred stock, our initial public offering in 2015, other equity financings, debt and convertible debt financings, equipment purchase loans, patent licensing, and product revenue beginning in 2007. We have not yet attained profitability and continue to incur operating losses and negative operating cash flows.
January 2017, we filed a shelf registration statement on Form S-3, which was declared effective by the SECon May 9, 2017(the "2017 Shelf Registration Statement"). The 2017 Shelf Registration Statement allows us to sell from time to time up to $200 millionof common stock, preferred stock, debt securities, warrants, or units comprised of any combination of these securities, for our own account in one or more offerings. On May 10, 2017, we filed with the SECa prospectus supplement, pursuant to which we could issue and sell up to $50 millionof our common stock and entered into an Equity Distribution Agreement ("Distribution Agreement") with Canaccord Genuity LLC(formerly, Canaccord Genuity Inc.) ("Canaccord"), pursuant to which Canaccord agreed to sell shares of our common stock from time to time, as our agent in an "at-the-market" ("ATM"), offering as defined in Rule 415 promulgated under the U.S. SecuritiesAct of 1933, as amended, or the Securities Act. We are not obligated to sell any number of shares under the Distribution Agreement. On August 4, 2020, we and Canaccord mutually agreed to terminate the Distribution Agreement, and as of that date, we had sold 2,663,000 shares under the Distribution Agreement resulting in net proceeds of $4.4 million. On March 23, 2020, we filed a new shelf registration statement on Form S-3 or the New Shelf Registration Statement, which was declared effective by the SECon August 5, 2020. Under the New Shelf Registration Statement, we will be permitted to sell from time to time up to $200 millionof common stock, preferred stock, debt securities, warrants, or units comprised of any combination of these securities, for its own account in one or more offerings. The New Shelf Registration Statement is intended to provide us flexibility to conduct sales of our registered securities, subject to market conditions and our future capital needs. On August 5, 2020, we filed with the SECa prospectus supplement, for the sale and issuance of up to $25 millionof its common stock and entered into an ATM issuance sales agreement (the "Sales Agreement"), with Cowen and Company, LLC("Cowen"), pursuant to which we may offer and sell shares of the our common stock to or through Cowen, acting as agent and/or principal, from time to time in an "at-the-market" offering as defined in Rule 415 promulgated under the Securities Act of 1933, as amended, including without limitation sales made by means of ordinary brokers' transactions on the Nasdaq Capital Market or otherwise at market prices prevailing at the time of sale, in block transactions, or as otherwise directed by us. Cowen will use commercially reasonable efforts to sell the Common Stock from time to time, based upon instructions from us (including any price, time or size limits or other customary parameters or conditions we may impose). We will pay Cowen a commission of up to 3.0% of the gross sales proceeds of any Common Stock sold through Cowen under the Sales Agreement, and we also provided Cowen with customary indemnification rights. The shares of Common Stock being offered pursuant to the Sales Agreement will be offered and sold pursuant to the New Shelf Registration Statement. We are not obligated to make any sales of Common Stock under the Sales Agreement. The offering of shares of Common Stock pursuant to the Sales Agreement will terminate upon the earlier of (i) the sale of all Common Stock subject to the Sales Agreement or (ii) termination of the Sales Agreement in accordance with its terms. As of December 31, 2021, we had not sold any shares under the Sales Agreement. On December 17, 2018, we entered into a stock purchase agreement (the "Stock Purchase Agreement") with Lincoln Park Capital("LPC"). Upon entering into the Stock Purchase Agreement, we sold 1,921,968 shares of common stock for $1.0 millionto LPC, representing a premium of 110% to the previous day's closing price. Additionally, as consideration for LPC's commitment to purchase shares of common stock under the LPC Agreement, we issued 354,430 shares to LPC. We have the right at our sole discretion to sell to LPC up to $20.0 millionworth of shares over a 36-month period subject to the terms of the Stock Purchase Agreement. We will 71 -------------------------------------------------------------------------------- control the timing of any sales to LPC and LPC will be obligated to make purchases of our common stock upon receipt of requests from us in accordance with the terms of the Stock Purchase Agreement. There are no upper limits to the price per share LPC may pay to purchase the up to $20.0 millionworth of common stock subject to the Stock Purchase Agreement, and the purchase price of the shares will be based on the then prevailing market prices of our shares at the time of each sale to LPC as described in the Stock Purchase Agreement, provided that LPC will not be obligated to make purchases of our common stock pursuant to receipt of a request from us on any business day on which the last closing trade price of our common stock on the Nasdaq Capital Market (or alternative national exchange in accordance with the Stock Purchase Agreement) is below a floor price of $0.25per share. No warrants, derivatives, financial or business covenants are associated with the Stock Purchase Agreement and LPC has agreed not to cause or engage in any manner whatsoever, any direct or indirect short selling or hedging of shares of our common stock. The Stock Purchase Agreement may be terminated by us at any time, at our sole discretion, without any cost or penalty. On August 5, 2020, we filed with the SECa prospectus supplement, for the sale and issuance of up to $17.6 millionof our common stock pursuant to the Stock Purchase Agreement dated December 17, 2018. As of December 31, 2021, we have sold 4,521,968 shares under the Stock Purchase Agreement resulting in proceeds of $3.4 million. On September 23, 2020, we and a healthcare-focused institutional investor entered into a subscription agreement the "Subscription Agreement," pursuant to which we sold (i) 8,512,088 shares of its common stock and accompanying warrants to purchase up to 8,512,088 shares of common stock and (ii) pre-funded warrants to purchase up to 9,492,953 shares of common stock and accompanying warrants to purchase up to 9,492,953 shares of common stock in a registered direct offering for gross proceeds of approximately $17.3 million. The common stock (or one pre-funded warrants in lieu thereof) and accompanying warrants were sold as units, each consisting of one share (or one pre-funded warrant to purchase one share of common stock in lieu thereof) and one warrant to purchase one share of common stock, at an offering price of $0.9581per unit. The net proceeds to us from the offering, after deducting the placement agent's fees and other estimated offering expenses payable by us, was approximately $15.9 million. The pre-funded warrants became exercisable immediately upon issuance, have an exercise price of $0.0001per share and were exercisable until all of the pre-funded warrants were exercised in full. As of March 31, 2021, all pre-funded warrants were exercised. The warrants became exercisable immediately upon issuance, have an exercise price of $0.8748per share, and will expire five years from the date of issuance. As of December 31, 2021, approximately 6.0 million of these warrants have been exercised. The pre-funded warrants and the warrants each prohibit the holder from exercising any portion thereof to the extent that the holder would own more than 9.99% of the number of shares of common stock outstanding immediately after exercise. The number of shares issuable upon exercise of the warrants and pre-funded warrants and the exercise price of the warrants and pre-funded warrants is adjustable in the event of stock splits, stock dividends, combinations of shares and similar recapitalization transactions. On June 25, 2019, we entered into a Loan and Security Agreement (the "2019 Secured Loan Agreement") with Innovatus Life Sciences Lending Fund I, LP("Innovatus"), as collateral agent and lender, East West Bankand the other lenders party thereto from time to time (the "Lenders"), pursuant to which the Lenders agreed to make term loans and to provide a revolving credit facility to us to repay existing indebtedness, for working capital and general business purposes, in a principal amount of up to $30 million. We used the proceeds from the 2019 Secured Loan Agreement to pay off the $15 millionterm loan from Oxford Finance LLC. In addition, Innovatuspurchased approximately $3 millionof our common stock at the previous day's closing price. During the first quarter of 2020, we reported that we may not be able to meet our second quarter revenue covenant and would work with Innovatuswith the goal of adjusting the revenue covenants under the 2019 Secured Loan Agreement. On July 1, 2020, we entered into a third amendment to the 2019 Secured Loan Agreement, which, among other things, waived the trailing six-month revenue covenant milestones that applied to the quarters ended June 30, September 30and December 31, 2020under the agreement, reduced the revenue covenant milestones that apply thereafter, and delays until June 25, 2021our option to prepay all, but not less than all, of the term loans advanced under the 2019 Secured Loan Agreement. On August 20, 2020, we entered into a fourth amendment to the 2019 Secured Loan Agreement, which, among other things, waived certain provisions of the agreement that apply to Conformis India LLP. On March 1, 2021, we entered into a fifth amendment to the 2019 Secured Loan Agreement, which, among other things, waives the trailing six-month revenue covenant milestones that apply to the quarters ending March 31, June 30, September 30and December 31, 2021and reduces the revenue covenant milestones that apply in 2022. 72 --------------------------------------------------------------------------------
The revenue covenant milestones remain unchanged for 2023 and 2024. The amendment increased our minimum cash covenant to
November 22, 2021, we entered into a Credit and Security Agreement (the "New Credit Agreement") with MidCap Financial Services, LLC(" MidCap Financial Services"), as servicer for MidCap Financial Trustto refinance the Company's existing senior secured indebtedness. The New Credit Agreement provides for a five-year, $21 millionsecured term loan facility (the "Term Facility"), and replaces our existing credit facility under the 2019 Secured Loan Agreement, with Innovatus, as collateral agent and lender, East West Bankand other lenders party thereto (collectively, the "Lenders"). We used the proceeds from the debt financings to pay off our existing credit facility under the 2019 Secured Loan Agreement with the Lenders. The New Credit Agreement contains customary affirmative and negative covenants, including limitations on our ability to incur additional debt, grant or permit additional liens, make investments and acquisitions, merge or consolidate with others, dispose of assets, pay dividends and distributions, pay subordinated indebtedness and enter into affiliate transactions. In addition, the New Credit Agreement contains a minimum liquidity covenant requiring the us to maintain unrestricted cash and cash equivalents in excess of $4.0 million. The New Credit Agreement also includes events of default customary for facilities of this type and upon the occurrence of such events of default, subject to customary cure rights, all outstanding loans under the Term Facility may be accelerated. As of December 31, 2021, we were not in breach of covenants under the New Credit Agreement. For further information regarding the 2019 Secured Loan Agreement and the Amendments, and the New Credit Agreement see "Note I-Debt and Notes Payable" in the financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. On September 30, 2019, we entered into an Asset Purchase Agreement with Howmedica Osteonics Corp., a subsidiary of Stryker Corporation also known as Stryker Orthopaedics, or Stryker. In connection with entering into the Asset Purchase Agreement, we also entered into a Development Agreement, a License Agreement, and other ancillary agreements contemplated by the Asset Purchase Agreement with Stryker. Under the terms of the agreements, we agreed to sell and license to Stryker certain assets relating to our patient-specific instrumentation technology, and to develop, manufacture, and supply patient-specific instrumentation for use in connection with Stryker's "off-the-shelf" non-personalized knee implant offerings. We received $14 millionupfront and became eligible to receive up to an additional $16 millionin milestone payments pursuant to the License Agreement and the Development Agreement. As of December 31, 2021, we had successfully completed the third of three milestones with Stryker and received $11.0 million, for a total aggregate received of $16.0 millionfor achievement of these milestones. Under the long-term Distribution Agreement, we began supplying patient-specific instrumentation to Stryker. The Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"), was enacted on March 27, 2020in the United States. On April 17, 2020, we entered into an approximately $4.7 millionpromissory note, or the PPP Note, with East West Bankas the lender under the PPP offered by the SBA, to mitigate the negative financial and operational impacts of the COVID-19 pandemic. The interest rate on the PPP Note is a fixed rate of 1% per annum. We are required to make one payment of all outstanding principal plus all accrued unpaid interest on April 9, 2022, or the Maturity Date. We were required to pay regular monthly payments in an amount equal to one month's accrued interest commencing on August 2, 2021, with all subsequent interest payments to be due on the same day of each month after that. All interest which accrues during the deferral period were to be payable on the Maturity Date. According to the terms of the PPP, all or a portion of the loan as well as any accrued interest may be fully forgiven if the funds are used for payroll costs (and at least 60% of the forgiven amount must have been used for payroll), interest on certain other outstanding debt, rent, and utilities. In accordance with the CARES Act, we used the proceeds of the loan primarily for payroll costs. We submitted the loan forgiveness application to the lender on December 11, 2020. We resubmitted the application on February 23, 2021with additional supporting documentation as requested by the lender. On March 4, 2021, our lender submitted our application to the SBA for their review and on June 30, 2021, we received notification through our lender that the SBA had rendered a final decision regarding its review of the PPP loan forgiveness application, fully approving the loan forgiveness application as of June 28, 2021. On May 22, 2020, we entered into the Zimmer Settlement and License Agreement with Zimmer Biomet, pursuant to which the parties agreed to terms for resolving then-existing patent disputes. Under the Settlement and License Agreement, we and Zimmer Biomet agreed to dismiss both outstanding patent infringement lawsuits between the parties; we granted to Zimmer Biomet a royalty-free, non-exclusive, worldwide license to certain of our patents for Zimmer Biomet's patient-specific instrumentation used with off-the-shelf knee, hip, and shoulder implants; and Zimmer Biomet granted us a fully paid-up, royalty-free, non-exclusive, worldwide license to certain Zimmer Biomet patents for our implants and PSI for the knee. Under the agreement, Zimmer Biomet was required to pay us a total of $9.6 millionin installments through January 15, 2021, and all such payments were made and received by such date. No payment was due from us to Zimmer Biomet. 73 -------------------------------------------------------------------------------- On February 17, 2021, we closed an offering of our common stock under the New Shelf Registration Statement and issued and sold 80,952,381 shares of our common stock at a public offering price of $1.05per share, for aggregate net proceeds of approximately $79.6 million. We intend to use the net proceeds of the offering of the shares for general corporate purposes, which may include research and development costs, sales and marketing costs, clinical studies, manufacturing development, the acquisition or licensing of other businesses or technologies, repayment and refinancing of debt, including our secured term loan facility, working capital and capital expenditures. On April 8, 2021, we entered into a License Agreement with Paragon 28, granting Paragon 28 a non-exclusive license under a subset of our U.S.patents for the use of PSI with off-the-shelf implants. In connection with this License Agreement, we recognized revenue of $1.0 millionduring the quarter ended June 30, 2021. On June 30, 2021we entered into the Settlement and License Agreement with the Stryker Parties, pursuant to which the parties have agreed to terms for resolving all of their existing patent disputes. Under the Settlement and License Agreement, we granted to the Stryker Parties a royalty-free, non-exclusive, worldwide license to certain of our patents for the Stryker Parties' patient-specific instrumentation used with off-the-shelf knee, hip, and shoulder implants. Under the agreement, the Stryker Parties are required to pay us a one-time payment of $15.0 millionno later than October 15, 2021. The payment was received in October 2021.
We expect to incur substantial expenditures in the forseeable future in connection with the following:
•expansion of our sales and marketing efforts;
•expansion of our manufacturing capacity;
•funding research, development and clinical activities related to our existing products and product platform, including iFit design software and product support;
•funding research, development and clinical activities related to new products that we may develop, including other joint replacement products;
•pursuing and maintaining appropriate regulatory clearances and approvals for our existing products and any new products that we may develop; and
•preparing, filing and prosecuting patent applications, and maintaining and enforcing our intellectual property rights and position.
We anticipate that our principal sources of funds in the future will be revenue generated from the sales of our products, available sales of shares under the Sales Agreement and the Stock Purchase Agreement, and revenues that we may generate in connection with licensing our intellectual property. Additionally, in order for us to meet our long-term operating plan, revenue growth, gross margin improvements and leveraging operating expenses will be necessary to reduce cash used in operations. We will need to generate significant additional revenue to achieve and maintain profitability, and even if we achieve profitability, we cannot be sure that we will remain profitable for any substantial period of time. 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 projects that are not successful, our ability to continue to support our business growth and to respond to business challenges could be significantly limited, and we may even have to scale back our operations. Our failure to become and remain profitable could impair our ability to raise capital, expand our business, maintain our research and development efforts or continue to fund our operations. We may need to engage in additional equity or debt financings to secure additional funds. We may not be able to obtain additional financing on terms favorable to us, or at all. To the extent that we raise additional capital through the future sales of equity or debt, the ownership interest of our stockholders will be diluted. The terms of these future or debt securities may include liquidation or other preferences that adversely affect the rights of our existing common stockholders or involve negative covenants that restrict our ability to take specific actions, such as incurring additional debt or making capital expenditures. At
December 31, 2021, we had cash and cash equivalents of $100.6 millionand $0.6 millionin restricted cash allocated to lease deposits. Based on our current operating plan, we expect to fund our operations, capital expenditure requirements and debt service with existing cash and cash equivalents as of December 31, 2021, 74 -------------------------------------------------------------------------------- anticipated revenue from operations, revenue that may be generated in connection with licensing intellectual property, available sales of shares under the Sales Agreement and the Stock Purchase Agreement and funds from potential exercises of our common stock warrants. We have based this expectation on assumptions that may prove to be wrong, such as the revenue that we expect to generate from the sale of our products, the gross profit we expect to generate from those revenues, and the fact that we could use our capital resources sooner than we expect. The COVID-19 pandemic has negatively impacted and will continue to impact our business, operations and financial condition. As part of our response to COVID-19, we took certain measures in preserving liquidity. In addition to the furlough implemented in March 2020, we have eliminated, reduced, or are deferring significant non-essential expense including sales, marketing, quality, clinical, regulatory and general and administrative expense. Non-essential programs have been eliminated or deferred where possible. In addition, we are working with suppliers to help match future revenue and expense.
The following table sets forth a summary of our cash flows for the periods indicated, as well as the year-over-year change (in thousands):
Years Ended December 31, 2021 2020 $ Change % Change Net cash (used in) provided by: Operating activities
$ (8,399) $ (18,310) $ 9,91154 % Investing activities (2,300) (3,249) 949 29 Financing activities 82,803 23,757 59,046 249 Effect of exchange rate on cash (121) 81 (202) (249) Total $ 71,983 $ 2,279 $ 69,7043,059 % Net cash used in operating activities. Net cash used in operating activities was $8.4 millionfor the year ended December 31, 2021and $18.3 millionfor the year ended December 31, 2020, a decrease of $9.9 million. The $9.9 milliondecrease in net cash used in operating activities was primarily affected by a decrease in net loss of $21.8 million, an increase in accounts payable, accrued expenses and other liabilities of $6.5 million, and a decrease in royalty and licensing receivable of $2.1 million, partially offset by an increase in accounts receivable of $3.1 million, an increase in inventory of $2.1 million, and a decrease in contract liability and advance on research and development under the Agreements with Stryker of $18.5 million. Non-cash reconciling items include an increase in unrealized foreign exchange gain/loss of $6.2 million, an increase on the loss on extinguishment of debt of $1.1 million, and a decrease due to the gain on forgiveness of PPP loan of $4.8 million. Net cash used in investing activities. Net cash used in investing activities was $2.3 millionfor the year ended December 31, 2021compared to $3.2 millioncash used in investing activities for the year ended December 31, 2020, a decrease of $0.9 million. The decrease is due to a decrease in costs related to the acquisition of property, plant, and equipment. Net cash provided by financing activities. Net cash provided by financing activities was $82.8 millionfor the year ended December 31, 2021and $23.8 millionfor the year ended December 31, 2020, an increase of $59.0 million. The increase is due to $79.6 millionof net proceeds from the issuance of common stock under the New Shelf Registration Statement, $5.3 millionof proceeds from the exercise of common stock warrants, and $2.1 millionof net costs related to the refinancing of the Innovatusdebt, compared to $15.9 millionof proceeds from the issuance of common stock and prefunded warrants under the registered direct offering, net proceeds of $3.1 millionfrom issuance of common stock and $4.7 millionof proceeds from the issuance of the PPP loan during the same period last year. Revenue share agreements We are party to revenue share agreements with certain past and present members of our scientific advisory boards under which these advisors agreed to participate on our scientific advisory board and to assist with the development of our personalized implant products and related intellectual property. These agreements provide that we will pay the advisor a specified percentage of our net revenue, ranging from 0.1% to 1.33%, with respect to our 75 -------------------------------------------------------------------------------- products on which the advisor made a technical contribution or, in some cases, which are covered by a claim of one of our patents on which the advisor is a named inventor. The specific percentage is determined by reference to product classifications set forth in the agreement and may be tiered based on the level of net revenue collected by us on such product sales. Our payment obligations under these agreements typically expire a fixed number of years after expiration or termination of the agreement, but in some cases expire on a product-by-product basis or expiration of the last to expire of our patents for which the advisor is a named inventor that has claims covering the applicable product. The aggregate revenue share percentage of net revenue from our currently marketed knee replacement products, including percentages under revenue share agreements with all of our scientific advisory board members, ranges, depending on the particular product, from 0.8% to 6.2%. We incurred aggregate revenue share expense, included in research and development, including all amounts payable under our scientific advisory board revenue share agreements of $2.2 millionduring the year ended December 31, 2021, and representing 3.7% of product revenue, $1.6 millionduring the year ended December 31, 2020, representing 2.7% of product revenue. For further information, see "Note H-Commitments and Contingencies-Revenue Share Agreements" in the financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K.
We have one primary business activity and operate as one reportable segment.
Off-balance sheet arrangements
December 31, 2021, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical accounting policies and estimates
We have prepared our consolidated financial statements in conformity with accounting principles generally accepted in
the United States. Our preparation of these financial statements and related disclosures requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting periods. We believe the critical accounting policies and estimates that require the use of significant estimates and judgments in the preparation of our consolidated financial statements include revenue recognition, inventory valuations, impairment assessments, and income tax reserves and related allowances. We evaluate our estimates and judgments on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates are more fully described in "Note B - Summary of Significant Accounting Policies" to the consolidated financial statements appearing in this Annual Report on Form 10-K. Revenue recognition Our product revenue is generated from sales to hospitals and other medical facilities that are served through a direct sales force, independent sales representatives and distributors in the United States, Germany, the United Kingdom, Austria, Ireland, Switzerland, Spain, Portugal, the Netherlands, Belgium, the Dutch Antilles, Suriname, Australia, the United Arab Emirates, the Sultanate of Oman, Italy, Polandand other markets. In order for surgeons to use our products, the medical facilities where these surgeons treat patients typically require us to enter into pricing agreements. 76 -------------------------------------------------------------------------------- Product revenue is recognized when, or as, obligations under the terms of a contract are satisfied, which occurs when control of the promised products or services is transferred to customers. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring products or services to a customer ("transaction price"). When determining the transaction price of a contract, an adjustment is made if payment from a customer occurs either significantly before or significantly after performance, resulting in a significant financing component. Applying the practical expedient in paragraph 606-10-32-18, the Company does not assess whether a significant financing component exists if the period between when the Company performs its obligations under the contract and when the customer pays is one year or less. None of the Company's contracts contained a significant financing component as of December 31, 2021. Payment is typically due between 30 - 60 days from invoice. To the extent that the transaction price includes variable consideration, such as prompt-pay discounts or rebates, the Company estimates the amount of variable consideration that should be included in the transaction price utilizing the expected value to which the Company expects to be entitled. Variable consideration is included in the transaction price if, in the Company's judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. Actual amounts of consideration ultimately received may differ from the Company's estimates. Estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of the Company's anticipated performance and all information (historical, current and forecasted) that is reasonably available. If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price based on the estimated relative standalone selling prices of the promised products or services underlying each performance obligation. The Company determines standalone selling prices based on observable prices or a cost-plus margin approach when one is not available. Revenue is recognized at the time the related performance obligation is satisfied by transferring control of a promised good or service to a customer. The Company's performance obligations are satisfied at the same time, typically upon surgery, therefore, product revenue is recognized at a point in time upon completion of the surgery. Since the Company does not have contracts that extend beyond a duration of one year, there is no transaction price related to performance obligations that have not been satisfied. Certain customer contracts include terms that allow the Company to bill for orders that are cancelled after the product is manufactured and could result in revenue recognition over time. However, the impact of applying over time revenue recognition was deemed immaterial. Under ASC 606, the individual rights to license certain of our patents are accounted for as a single performance obligation. The earnings process is complete and revenue is recognized upon the execution of the contract, when collectability is probable and all other revenue recognition criteria have been met. Ongoing royalty revenue is generated from our agreement with MicroPort Orthopedics Inc., a wholly owned subsidiary of MicroPort Scientific Corporation, or collectively, MicroPort. Under ASC 606, the license agreement with MicroPortindicates that the licenses are functional and thus revenue recognition is upon the license execution date.
Under the long-term Distribution Agreement with Stryker, we supply patient specific instrumentation and revenue is recognized at a point in time, that is, when Stryker obtains control of the products.
We determined that the Asset Purchase Agreement and the License Agreement is within the scope of ASC 606. Under the Asset Purchase and License Agreements, we are required to provide certain assets and the right to use the license for a specific purpose. The assets and the right to use the license are highly interdependent and is considered one performance obligation. The transaction price of
$25.0 millionwas determined using the residual approach under ASC 606 by deducting the other services (development) performed under the agreement noting the arrangement does not contain a significant financing component. We recognize a contract liability when there is an obligation to transfer goods or services and consideration has already been received from the customer. We concluded that Stryker meets the definition of a customer for a portion of the obligations under the Stryker Agreements. The contract liability balances as of January 1, 2021and 2020, were $14.0 millionand $12.0 million, respectively, which were related to consideration received from the customer under the Asset Purchase Agreement and Development Agreement. We concluded the license rights under the License Agreement were functional and would be recognized at the point in time when 510(k) clearance was received from the FDA as required under Milestone 3 in the License Agreement, or upon termination by Stryker and Stryker's election to purchase the license rights. On April 19, 2021, we achieved the third of three milestones 77 -------------------------------------------------------------------------------- under the License Agreement when it received 510(k) clearance from the FDA and received $11.0 millionfrom Stryker. In connection with the 510(k) clearance, we recognized as royalty and license revenue the $14.0 millionthat was previously deferred as contract liability, plus the $11.0 millionpayment received, for a total aggregate of $25.0 millionduring the quarter ended June 30, 2021. There are no amounts recorded as contract liability as of December 31, 2021. In addition, during the quarter ended June 30, 2021, we recorded $2.5 millionin other income for the remaining portion of the advance on research and development, that was not used to offset against research and development expenses.
Inventories consist of raw materials, work-in-process components and finished goods. Inventories are stated at the lower of cost, determined using the first-in first-out method, or net realizable value. We regularly review our inventory quantities on hand and related cost and record a provision for any excess or obsolete inventory based on its estimated forecast of product demand and existing product configurations. We also review our inventory value to determine if it reflects the lower of cost or net realizable value. Appropriate consideration is given to inventory items sold at negative gross margin, purchase commitments and other factors in evaluating net realizable value. During the years ended
December 31, 2021, and 2020, we recognized provisions of $2.6 million, and $2.7 million, respectively, to adjust our inventory value to the lower of cost or net realizable value for estimated unused product related to known and potential cancelled cases, which is included in cost of revenue.
We test impairment of long-lived assets when events or changes in circumstances indicate that the assets might be impaired. If changes in circumstances lead us to believe that any of our long-lived assets may be impaired, we will test the asset group for recoverability, by evaluating whether the estimated undiscounted cash flows, including estimated residual value, generated from the asset group are sufficient to support the carrying value of the assets. During the quarters ended
March 31, 2021, June 30, 2021and September 30, 2021, there were no changes in circumstances that led us to believe that our long-lived assets may be impaired. During the quarter ended December 31, 2021, we had experienced a significant decrease in our stock price and incurred current-period operating losses associated with our asset group, and as such, an assessment for recoverability was performed. We evaluated whether the estimated undiscounted cash flows, including estimated terminal value, generated from the asset group were sufficient to support the carrying value of the assets. If the cash flow estimates or the significant operating assumptions upon which they are based change in the future, we may be required to record impairment charges. During the years ended December 31, 2021and 2020, no such impairment charges were recognized. Income taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases, operating losses and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income in the period that includes the enactment date. In evaluating the need for a valuation allowance, we consider all reasonably available positive and negative evidence, including recent earnings, expectations of future taxable income and the character of that income. In estimating future taxable income, we rely upon assumptions and estimates of future activity including the reversal of temporary differences. Presently, we believe that a full valuation allowance is required to reduce deferred tax assets to the amount expected to be realized. The tax benefit from an uncertain tax position is only recognized if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from these positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. We review our tax positions on an annual basis and more frequently as facts surrounding tax positions change. Based on these future events, we may recognize uncertain tax positions or reverse current uncertain tax positions, the impact of which would affect the consolidated financial statements. 78 --------------------------------------------------------------------------------
We have operations in
March 27, 2020, the U.S.government enacted the CARES Act which included modifications to the limitation on business interest expense, net operating loss provisions, and other various U.S.tax law updates. We analyzed these aspects of the CARES Act and it had no material impact on our consolidated financial statements. On December 27, 2020, the U.Sgovernment enacted the Consolidated Appropriations Act, 2021 "the Act", which included various tax extenders, an update to meals and entertainment expensing, and the deductibility of expenses related to PPP loan proceeds. We applied the Act in regards to expenses related to the PPP loan proceeds, which previously would have been non-deductible. 79
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