# Organogenesis Holdings Inc. (ORGO) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Organogenesis Holdings Inc.'s 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1661181/000119312522061686/d283851d10k.htm
Accession: 0001193125-22-061686
Filing date: 2022-03-01
Report date: 2021-12-31
Extracted from a substantive MD&A body after the formal Item 7 span was a TOC or reference stub.
Confidence: high

Company profile: /company/ORGO/
All MD&A years: /company/ORGO/mda/
Next year: /company/ORGO/mda/fy2022/ (FY 2022)

Overview

Organogenesis is a leading regenerative medicine company focused on the development, manufacture, and commercialization of solutions for the Advanced Wound Care and Surgical & Sports Medicine markets. Our products have been shown through clinical and scientific studies to support and in some cases accelerate tissue healing and improve patient outcomes. We are advancing the standard of care in each phase of the healing process through multiple breakthroughs in tissue engineering and cell therapy. Our solutions address large and growing markets driven by aging demographics and increases in comorbidities such as diabetes, obesity, cardiovascular and peripheral vascular disease and smoking. We offer our differentiated products and
in-house
customer support to a wide range of health care customers including hospitals, wound care centers, government facilities, ambulatory service centers (“ASCs”) and physician offices. Our mission is to provide integrated healing solutions that substantially improve medical outcomes and the lives of patients while lowering the overall cost of care.

We offer a comprehensive portfolio of products in the markets we serve that address patient needs across the continuum of care. We have and intend to continue to generate data from clinical trials, real-world outcomes and health economics research that validate the clinical efficacy and value proposition offered by our products. Several of our existing and pipeline products in our portfolio have PMA approval, or 510(k) clearance from the FDA. Given the extensive time and cost required to conduct clinical trials and receive FDA approvals, we believe that our data and regulatory approvals provide us a strong competitive advantage. Our product development expertise and multiple technology platforms provide a robust product pipeline, which we believe will drive future growth.

In the Advanced Wound Care market, we focus on the development and commercialization of advanced wound care products for the treatment of chronic and acute wounds in various treatment settings. We have a comprehensive portfolio of regenerative medicine products, capable of supporting patients from early in the wound healing process through wound closure regardless of wound type. Our advanced wound care products include Apligraf for the treatment of venous leg ulcers (“VLUs”) and diabetic foot ulcers (“DFUs”); Dermagraft for the treatment of DFUs (manufacturing currently suspended pending transition to our Massachusetts based manufacturing facilities); PuraPly AM as an antimicrobial barrier for a broad variety of wound types; and the Affinity, Novachor and NuShield wound coverings to address a variety of wound sizes and types. We have a highly trained and specialized direct wound care sales force paired with comprehensive customer support services.

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In the Surgical & Sports Medicine market, we focus on products that support the healing of musculoskeletal injuries, including degenerative conditions such as OA and tendonitis. We are leveraging our regenerative medicine capabilities in this attractive, adjacent market. Our Sports Medicine products include NuShield for surgical application in targeted soft tissue repairs; and Affinity, Novachor and PuraPly AM for management of open wounds in the surgical setting. We currently sell these products through independent agencies and our growing direct sales force.

We generated net revenue of $468.1 million, $338.3 million, and $261.0 million for the years ended December 31, 2021, 2020, and 2019, respectively. We reported net income of $94.9 million (which includes a $48.3 million benefit from release of a tax valuation allowance) and $17.2 million for the years ended December 31, 2021 and 2020, respectively, and net loss of $38.7 million for the year ended December 31, 2019. While we reported net income for the most recent two years, we have incurred significant losses since inception and we may incur operating losses in the future as we expend resources as part of our efforts to grow our organization to support the planned expansion of our business. As of December 31, 2021, we had an accumulated deficit of $60.1 million. Our primary sources of capital to date have been from sales of our products, borrowings from related parties and institutional lenders and proceeds from the sale of our Class A common stock. We operate in one segment of regenerative medicine.

COVID-19 pandemic

The emergence of the
coronavirus (COVID-19) around
the world, and particularly in the United States, continues to present risks to the Company. While
the COVID-19 pandemic
has not materially adversely affected our financial results and business operations through December 31, 2021, we are unable to predict the impact
that COVID-19 will
have on our financial position and operating results because of the numerous uncertainties created by the unprecedented nature of the pandemic. We are closely monitoring the evolving impact of the pandemic on all aspects of our business. We have implemented a number of measures designed to protect the health and safety of our employees, support our customers and promote business continuity. We continue to evaluate the Company’s liquidity position, communicate with and monitor the actions of our customers and suppliers, and review our near-term financial performance as we manage the Company through this period of uncertainty.

CPN Acquisition

On September 17, 2020, we acquired certain assets and assumed certain liabilities of CPN Biosciences, LLC (“CPN”) pursuant to an asset purchase agreement dated July 24, 2020. This transaction was accounted for as a business combination using the acquisition method of accounting in accordance with ASC Topic 805,

 Business Combinations

. The aggregated consideration amounted to $19.0 million as of the acquisition date which consisted of $6.4 million in cash, 2,151,438 shares of our common stock with a fair value of $8.8 million, and a contingent consideration (the “Earnout”) with a fair value at such time of $3.8 million. At the closing, we paid $5.8 million in cash and issued 1,947,953 shares of our Class A common stock. The remaining consideration was held back and will be paid or issued, as applicable, eighteen months after the closing date, subject to any offsetting indemnification claims against CPN. The results of operations of CPN have been included in our consolidated financial statements beginning on the acquisition date.

Dermagraft

As previously disclosed, as part of our long-term plan to consolidate manufacturing operations in Massachusetts, manufacturing of Dermagraft was suspended in the fourth quarter of 2021 and sales of Dermagraft will be suspended in the second quarter of 2022. We currently plan to transition our Dermagraft manufacturing to our Massachusetts-based manufacturing facilities, which we expect will result in substantial long-term cost savings. In the period when Dermagraft is not available (possibly for a few years), we expect that customers will be willing to substitute Apligraf for Dermagraft and that the suspension of Dermagraft sales will

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not have a material impact on our net revenue. However, if we do not realize the expected substantial long-term cost savings or if customers are unwilling to substitute Apligraf for Dermagraft during the period in which Dermagraft is unavailable, it could have an adverse effect on net revenue and results of operations.

Management’s Use of
Non-GAAP
Measures

Our management uses financial measures that are not in accordance with generally accepted accounting principles in the United States, or GAAP, in addition to financial measures in accordance with GAAP to evaluate our operating results. These
non-GAAP
financial measures should be considered supplemental to, and not a substitute for, our reported financial results prepared in accordance with GAAP. Our management uses Adjusted EBITDA to evaluate our operating performance and trends and make planning decisions. Our management believes Adjusted EBITDA helps identify underlying trends in our business that could otherwise be masked by the effect of the items that we exclude. Accordingly, we believe that Adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating results, enhancing the overall understanding of our past performance and future prospects, and allowing for greater transparency with respect to key financial metrics used by our management in its financial and operational decision-making.

We define EBITDA as net income (loss) before depreciation and amortization, interest expense and income taxes. We define Adjusted EBITDA as EBITDA, further adjusted for the impact of certain items that we do not consider indicative of our core operating performance. These items include
non-cash
equity compensation, restructuring charges, loss on the extinguishment of debt, mark to market adjustments on our Earnout liability and warrant liability, transaction costs related to a warrant exchange transaction, and CPN acquisition, gain on settlement of deferred acquisition consideration, recovery of certain notes receivable from related parties,
write-off
of the capitalized costs related to certain unfinished construction work, and the cancellation fee for terminating certain agreements. We have presented Adjusted EBITDA in this Annual Report on Form
10-K
because it is a key measure used by our management and Board of Directors to understand and evaluate our operating performance, generate future operating plans and make strategic decisions regarding the allocation of capital. In particular, we believe that the exclusion of certain items in calculating Adjusted EBITDA can produce a useful measure for

period-to-period

comparisons of our business.

Our Adjusted EBITDA is not prepared in accordance with GAAP, and should not be considered in isolation of, or as an alternative to, measures prepared in accordance with GAAP. There are a number of limitations related to the use of Adjusted EBITDA rather than net income (loss), which is the most directly comparable financial measure calculated and presented in accordance with GAAP. Some of these limitations are:

[[GREPCENT_TABLE]]
[["","\u2022","","Adjusted EBITDA excludes stock-based compensation expense as it has been, and will continue to be for the foreseeable future, a significant recurring non-cash expense for our business and an important part of our compensation strategy;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","","Adjusted EBITDA excludes depreciation and amortization expense and, although these are non-cash expenses, the assets being depreciated may have to be replaced in the future;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","","Adjusted EBITDA excludes net interest expense, or the cash requirements necessary to service interest, which reduces cash available to us;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","","Adjusted EBITDA excludes the impact of the changes in the fair value of our Earnout liability and warrant liability;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","","Adjusted EBITDA excludes certain transactions expenses such as the Company\u2019s warrant exchange transaction and the CPN acquisition transaction;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","","Adjusted EBITDA excludes loss on the extinguishment of debt;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","","Adjusted EBITDA excludes charges related to restructuring activities;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","","Adjusted EBITDA excludes certain income associated with the settlement of deferred acquisition consideration and recovery of certain notes receivable from related parties;"]]
[[/GREPCENT_TABLE]]

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[[GREPCENT_TABLE]]
[["","\u2022","","Adjusted EBITDA excludes write-off of the capitalized costs related to certain unfinished construction work;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","","Adjusted EBITDA excludes the cancellation fee for terminating certain agreements;"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","","Adjusted EBITDA excludes income tax expense (benefit); and"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["","\u2022","","Other companies, including companies in our industry, may calculate Adjusted EBITDA differently, which reduces its usefulness as a comparative measure."]]
[[/GREPCENT_TABLE]]

Because of these limitations, we consider, and you should consider, Adjusted EBITDA together with other operating and financial performance measures presented in accordance with GAAP. A reconciliation of Adjusted EBITDA from net income (loss), the most directly comparable financial measure calculated in accordance with GAAP, has been included herein.

Components of Our Consolidated Results of Operations

In assessing the performance of our business, we consider a variety of performance and financial measures. We believe the items discussed below provide insight into the factors that affect these key measures.

Revenue

We derive our net revenue from our portfolio of Advanced Wound Care and Surgical & Sports Medicine products. We primarily sell our Advanced Wound Care products through direct sales representatives who manage and maintain the sales relationships with hospitals, wound care centers, government facilities, ASCs and physician offices. We primarily sell our Surgical & Sports Medicine products through third-party agencies.

We recognize revenue from sales of our Advanced Wound Care and Surgical & Sports Medicine products when the customer obtains control of our product, which occurs at a point in time and may be upon procedure date, shipment or delivery, based on the contractual terms of a contract. We record revenue net of a reserve for returns, discounts and GPO rebates, which represent a direct reduction to the revenue we recognize.

Several factors affect our reported revenue in any period, including product, payer and geographic sales mix, operational effectiveness, pricing realization, marketing and promotional efforts, the timing of orders and shipments, regulatory actions including healthcare reimbursement scenarios, competition and business acquisitions.

Cost of goods sold and gross profit

Cost of goods sold includes personnel costs, product testing costs, quality assurance costs, raw materials and product costs, manufacturing costs, and the costs associated with our manufacturing and warehouse facilities. The increases in our cost of goods sold correspond with the increases in sales units driven by the expansion of our sales force and sales territories, expansion of our product portfolio offerings, and the number of healthcare facilities that offer our products. We expect our cost of goods sold to increase due primarily to anticipated increased sales volumes.

Gross profit is calculated as net revenue less cost of goods sold and generally increases as revenue increases. Our gross profit are affected by product and geographic sales mix, realized pricing of our products, the efficiency of our manufacturing operations and the costs of materials used and fees charged by third-party manufacturers to produce our products. Regulatory actions, including healthcare reimbursement scenarios, which may require costly expenditures or result in pricing pressures, may decrease our gross profit.

Selling, general and administrative expenses

Selling, general and administrative expenses generally include personnel costs for sales, marketing, sales support, customer support, and general and administrative personnel, sales commissions, incentive compensation,

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insurance, professional fees, depreciation, amortization, bad debt expense, royalties, information systems costs and costs associated with our administrative facilities. We generally expect our selling, general and administrative expenses to continue to increase due to increased investments in market development and the geographic expansion of our sales forces as we drive for continued revenue growth.

Research and development expenses

Research and development expenses include personnel costs for our research and development personnel, expenses related to improvements in our manufacturing processes, enhancements to our currently available products, and additional investments in our product and platform development pipeline. Our research and development expenses also include expenses for clinical trials. We expense research and development costs as incurred. We generally expect that research and development expenses will increase as we continue to conduct clinical trials on new and existing products, move products through the regulatory pathway (e.g., seek BLA approval), add personnel to support product enhancements as well as to bring new products to market, and enhance our manufacturing process and procedures.

Other expense, net

Interest expense

—Interest expense consists of interest on our outstanding indebtedness, including amortization of debt discount and debt issuance costs, net of interest income recognized.

Loss on the extinguishment of debt

—In August 2021, upon entering into the 2021 Credit Agreement, we paid an aggregate amount of $70.6 million associated with the termination of the 2019 Credit Agreement, including unpaid principal, accrued interest, the Final Payment and a prepayment fee. We recognized $1.9 million as loss on the extinguishment of the loan for year ended December 31, 2021. In March 2019, upon entering into the 2019 Credit Agreement, we paid an aggregate amount of $17.6 million associated with the termination of the ML Agreement (as defined below), including unpaid principal, accrued interest and an early termination penalty. We recognized $1.9 million as loss on the extinguishment of the loan.

Change in fair value of warrant liability—

In connection with the Avista Merger, we issued 4.1 million private warrants to Avista Capital Partners IV, L.P. and Avista Capital Partners IV (Offshore), L.P. on December 10, 2018 (the “Private Warrants”). We classified the warrants as a liability on our consolidated balance sheets as the settlement provisions of the Private Warrants failed the

“fixed-for-fixed”

rules under

ASC815-40-15-7

. The warrant liability was initially recorded at fair value upon issuance and was subsequently remeasured to fair value at each reporting date until the warrants were settled in the warrant exchange transactions in the third quarter of 2019. See Note “13. Stockholders’ Equity”. Changes in the fair value of the warrant liability were recognized as a component of other expense, net in the consolidated statements of operations.

Gain on settlement of deferred acquisition consideration

—In February 2020, we settled a dispute on the $5.0 million deferred acquisition consideration with the sellers of NuTech Medical for $4.0 million and assumed from the sellers of NuTech Medical the responsibilities related to a legacy lawsuit of NuTech Medical which was settled in October 2020. In connection with the settlement of this dispute and the legacy lawsuit, we recorded a gain of $2.2 million for the year ended December 31, 2020.

Income taxes

We account for income taxes using an asset and liability approach. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Valuation allowances are provided when necessary to reduce net deferred tax assets to an amount that is more likely than not to be realized.

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In determining whether a valuation allowance for deferred tax assets is necessary, we analyze both positive and negative evidence related to the realization of deferred tax assets including projected future taxable income, recent financial results and estimates of future reversals of deferred tax assets and liabilities. In addition, we consider whether it is more likely than not that the tax position will be sustained on examination by taxing authorities based on the technical merits of the position. Based on a consideration of the factors discussed above, in the fourth quarter of fiscal year 2021, we determined it was more likely than not that our deferred tax assets would be realized in the future and released the valuation allowance on our net U.S. deferred tax assets as of December 31, 2021, resulting in a benefit of $48.3 million in income taxes.

Our U.S. provision for income taxes relates to current tax expense associated with taxable income that could not be offset by state net operating losses. We have utilized net operating losses to offset all of the 2021 federal taxable income but have exhausted net operating losses and are subject to limitations in the net operating loss utilization in certain states. We have also recorded a foreign provision for income taxes related to our wholly-owned subsidiary in Switzerland.

We account for uncertainty in income taxes recognized in the consolidated financial statements by applying
a two-step process
to determine the amount of tax benefit to be recognized. First, the tax position must be evaluated to determine the likelihood that it will be sustained upon external examination by the taxing authorities. If the tax position is
deemed more-likely-than-not to
be sustained, the tax position is then assessed to determine the amount of benefit to recognize in the consolidated financial statements. The amount of the benefit that may be recognized is the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement. The provision for income taxes includes the effects of any resulting tax reserves, or unrecognized tax benefits, that are considered appropriate as well as the related net interest and penalties.

Results of Operations

The following table sets forth, for the periods indicated, our results of operations:

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020","","","2019"],["Net revenue","","$","468,059","","","$","338,298","","","$","260,981"],["Cost of goods sold","","","114,199","","","","87,319","","","","75,948"],["Gross profit","","","353,860","","","","250,979","","","","185,033"],["Operating expenses:"],["Selling, general and administrative","","","250,200","","","","204,193","","","","200,088"],["Research and development","","","30,742","","","","20,086","","","","14,799"],["Total operating expenses","","","280,942","","","","224,279","","","","214,887"],["Income (loss) from operations","","","72,918","","","","26,700","","","","(29,854",")"],["Other expense, net:"],["Interest expense","","","(7,236",")","","","(11,279",")","","","(8,996",")"],["Gain on settlement of deferred acquisition consideration","","","\u2014","","","","2,246","","","","\u2014"],["Change in fair value of warrant liability","","","\u2014","","","","\u2014","","","","2,140"],["Loss on the extinguishment of debt","","","(1,883",")","","","\u2014","","","","(1,862",")"],["Other income (loss), net","","","(13",")","","","97","","","","13"],["Total other expense, net","","","(9,132",")","","","(8,936",")","","","(8,705",")"],["Net income (loss) before income taxes","","","63,786","","","","17,764","","","","(38,559",")"],["Income tax (expense) benefit","","","31,116","","","","(530",")","","","(150",")"],["Net income (loss)","","$","94,902","","","$","17,234","","","$","(38,709",")"]]
[[/GREPCENT_TABLE]]

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EBITDA and Adjusted EBITDA

The following table presents a reconciliation of GAAP net income (loss)
to non-GAAP EBITDA

and non-GAAP Adjusted
EBITDA, for each of the periods presented:

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020","","","2019"],["","","(in thousands)"],["Net income (loss)","","$","94,902","","","$","17,234","","","$","(38,709",")"],["Interest expense","","","7,236","","","","11,279","","","","8,996"],["Income tax expense (benefit)","","","(31,116",")","","","530","","","","150"],["Depreciation","","","5,781","","","","4,438","","","","3,783"],["Amortization","","","4,949","","","","3,745","","","","6,043"],["EBITDA","","","81,752","","","","37,226","","","","(19,737",")"],["Stock-based compensation expense","","","3,864","","","","1,661","","","","936"],["Restructuring charge (1)","","","4,704","","","","618","","","","\u2014"],["Gain on settlement of deferred acquisition consideration (2)","","","\u2014","","","","(2,246",")","","","\u2014"],["Recovery of certain notes receivable from related parties (3)","","","(179",")","","","(1,516",")","","","\u2014"],["Cancellation fee (4)","","","\u2014","","","","1,950","","","","\u2014"],["Write-off of a fixed asset (5)","","","1,104","","","","\u2014","","","","\u2014"],["Change in fair value of Earnout (6)","","","(3,985",")","","","203","","","","\u2014"],["Change in fair value of warrant liability (7)","","","\u2014","","","","\u2014","","","","(2,140",")"],["Loss on extinguishment of debt (8)","","","1,883","","","","\u2014","","","","1,862"],["Exchange offer transaction costs (9)","","","\u2014","","","","\u2014","","","","916"],["CPN transaction costs (10)","","","\u2014","","","","929","","","","\u2014"],["Adjusted EBITDA","","$","89,143","","","$","38,825","","","$","(18,163",")"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(1)","Amounts reflect employee retention and benefits as well as the facility-related cost associated with the Company\u2019s restructuring activities. See Note \u201c11. Restructuring\u201d."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(2)","Amount reflects the gain recognized related to the settlement of the deferred acquisition consideration dispute with the sellers of NuTech Medical in February 2020 as well as the settlement of the assumed legacy lawsuit from the sellers of NuTech Medical in October 2020. See Note \u201c18. Commitments and Contingencies\u201d."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(3)","Amounts reflect the collection of certain notes receivable from related parties previously reserved. See Note \u201c19. Related Party Transactions\u201d."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(4)","Amount reflects the cancellation fee for terminating certain product development and consulting agreements the Company inherited from NuTech Medical."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(5)","Amount reflects the write-off of certain design and consulting fees previously capitalized related to the unfinished construction work on the 275 Dan Road Building."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(6)","Amounts reflect the change in the fair value of the Earnout liability in connection with the CPN acquisition. See Note \u201c3. Acquisition\u201d."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(7)","In connection with the Avista Merger, we issued 4.1 million Private Warrants which were classified as a liability. The Private Warrants were settled in the warrant exchange transactions in the third quarter of 2019. Amount reflects the change in the fair value of the warrant liability."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(8)","Amounts reflect the loss recognized on the extinguishment of the 2019 Credit Agreement upon repayment in 2021 and the loss recognized on the extinguishment of the Master Lease Agreement upon repayment in 2019. See Note \u201c12. Long-Term Debt Obligations\u201d."]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(9)","Amount reflects legal, advisory and other professional fees incurred in the quarter ended September 30, 2019, related directly to the warrant exchange transactions. See Note \u201c13. Stockholders\u2019 Equity\u201d."]]
[[/GREPCENT_TABLE]]

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[[GREPCENT_TABLE]]
[["(10)","Amount reflects legal, advisory and other professional fees incurred in the nine months ended September 30, 2020, related directly to the CPN acquisition. See Note \u201c3. Acquisition\u201d."]]
[[/GREPCENT_TABLE]]

Comparison of the Year Ended December 31, 2021, 2020, and 2019

Revenue

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,","","","Change"],["","","2021","","","2020","","","2019","","","2021 to 2020","","","2020 to 2019"],["","","(in thousands, except for percentages)"],["Advanced Wound Care","","$","430,839","","","$","294,624","","","$","220,744","","","$","136,215","","","","46","%","","$","73,880","","","","33","%"],["Surgical & Sports Medicine","","","37,220","","","","43,674","","","","40,237","","","","(6,454",")","","","(15","%)","","","3,437","","","","9","%"],["Net revenue","","$","468,059","","","$","338,298","","","$","260,981","","","$","129,761","","","","38","%","","$","77,317","","","","30","%"]]
[[/GREPCENT_TABLE]]

For the year ended December 31, 2021, net revenue from our Advanced Wound Care products increased by $136.2 million, or 46%, as compared to the year ended December 31, 2020. The increase in Advanced Wound Care net revenue was primarily attributable to the expanded sales force, increased sales to existing and new customers, increased adoption of our placental-based product portfolio, including our Affinity product, as well as increased adoption of our PuraPly line extensions launched in the second half of 2020.

For the year ended December 31, 2021, net revenue from our Surgical & Sports Medicine products decreased by $6.5 million, or 15%, as compared to the year ended December 31, 2020. The decrease in Surgical & Sports Medicine net revenue was primarily attributable to ReNu and NuCel which we stopped marketing after May 31, 2021 due to the expiration of the FDA’s enforcement grace period for these products.

For the year ended December 31, 2020, net revenue from our Advanced Wound Care products increased by $73.9 million, or 33%, as compared to the year ended December 31, 2019. The increase in Advanced Wound Care net revenue was primarily attributable to the expanded sales force, increased sales to existing and new customers and increased adoption of our placental-based product portfolio, including our Affinity product.

For the year ended December 31, 2020, net revenue from our Surgical & Sports Medicine products increased by $3.4 million, or 9%, as compared to the year ended December 31, 2019. The increase in Surgical & Sports Medicine net revenue was primarily attributable to the expanded sales force and penetration of existing and new customer accounts, partially offset by postponement or cancellation of medical procedures as a
result of COVID-19.

Included within net revenue is PuraPly revenue of $198.4 million, $147.3 million, and $126.8 million for the years ended December 31, 2021, 2020 and 2019, respectively. PuraPly exited pass-through status on October 1, 2020. The continued increase in PuraPly revenue in the year ended December 31, 2021 was due to the expanded sales forces, increased adoption, by existing and new customers, of our PuraPly line extensions launched in the second half of 2020 as well as expanded sites of care.

Cost of Goods Sold and Gross Profit

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,","","","Change"],["","","2021","","","2020","","","2019","","","2021 to 2020","","","2020 to 2019"],["","","(in thousands, except for percentages)"],["Cost of goods sold","","$","114,199","","","$","87,319","","","$","75,948","","","$","26,880","","","","31","%","","$","11,371","","","","15","%"],["Gross profit","","$","353,860","","","$","250,979","","","$","185,033","","","$","102,881","","","","41","%","","$","65,946","","","","36","%"]]
[[/GREPCENT_TABLE]]

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For the year ended December 31, 2021, cost of goods sold increased by $26.9 million, or 31%, as compared to the year ended December 31, 2020. The increase in cost of goods sold was primarily due to increased unit volumes, and additional manufacturing and quality control headcount.

For the year ended December 31, 2021, gross profit increased by $102.9 million, or 41%, as compared to the year ended December 31, 2020. The increase in gross profit resulted primarily from increased sales volume due to the strength in our Advanced Wound Care products as well as a shift in product mix to our higher gross margin products.

For the year ended December 31, 2020, cost of goods sold increased by $11.4 million, or 15%, as compared to the year ended December 31, 2019. The increase in cost of goods sold was primarily due to increased unit volumes, additional manufacturing and quality control headcount.

For the year ended December 31, 2020, gross profit increased by $65.9 million, or 36%, as compared to the year ended December 31, 2019. The increase in gross profit resulted primarily from increased sales volume due to the strength in our Advanced Wound Care and Surgical & Sports Medicine products as well as a shift in product mix to our higher gross margin products.

Selling, General and Administrative Expenses

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,","","","Change"],["","","2021","","","2020","","","2019","","","2021 to 2020","","","2020 to 2019"],["","","(in thousands, except for percentages)"],["Selling, general and administrative","","$","250,200","","","$","204,193","","","$","200,088","","","$","46,007","","","","23","%","","$","4,105","","","","2","%"]]
[[/GREPCENT_TABLE]]

For the year ended December 31, 2021, selling, general and administrative expenses increased by $46.0 million, or 23%, as compared to the year ended December 31, 2020. The increase in selling, general and administrative expenses was primarily due to a $33.0 million increase related to additional headcount, primarily in our direct sales force and increased sales commissions due to increased sales, a $4.3 million increase related to increased travel and marketing programs amid the
relaxed COVID-19
travel restrictions, a $2.9 million increase in restructuring cost associated with closing the La Jolla office, a
$1.1 million write-off
of certain design and consulting fees previously capitalized related to the unfinished construction work on the 275 Dan Road Building, and a $10.9 million increase in various administrative costs resulting from increased revenue and increased in legal, consulting fees and other costs associated with the ongoing operations of our business. These increases were partially offset by a $4.2 million decrease resulting from the CPN Earnout fair value adjustment and a $2.0 million decrease in the cancellation fee incurred in the three months ended March 31, 2020 to cancel certain product development and consulting agreements.

For the year ended December 31, 2020, selling, general and administrative expenses increased by $4.1 million, or 2%, as compared to the year ended December 31, 2019. The increase in selling, general and administrative expenses was primarily due to a $15.6 million increase related to additional headcount, primarily in our direct sales force and increased sales commissions due to increased sales, a $2.0 million cancellation fee for certain product development and consulting agreements. These increases were partially offset by a $10.0 million decrease related to reduced travel and marketing programs amid travel restrictions in place due to
the COVID-19, a
$2.3 million decrease in various costs including legal, consulting fees and other costs associated with the ongoing operations of our business, and a $1.1 million collection of the previously reserved related party receivables.

Research and Development Expenses

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,","","","Change"],["","","2021","","","2020","","","2019","","","2021 to 2020","","","2020 to 2019"],["","","(in thousands, except for percentages)"],["Research and development","","$","30,742","","","$","20,086","","","$","14,799","","","$","10,656","","","","53","%","","$","5,287","","","","36","%"]]
[[/GREPCENT_TABLE]]

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For the year ended December 31, 2021, research and development expenses increased by $10.7 million, or 53%, as compared to the year ended December 31, 2020. The increase in research and development expenses was primarily due to increased headcount associated with our existing Advanced Wound Care and Surgical & Sports Medicine products, an increase in product costs associated with our pipeline products not yet commercialized and an increase in the clinical study and related costs necessary to seek regulatory approvals for certain of our products.

For the year ended December 31, 2020, research and development expenses increased by $5.3 million, or 36%, as compared to the year ended December 31, 2019. The increase in research and development expenses was primarily due to an increase in process development costs associated with a new contract manufacturer, increased headcount associated with our existing Advanced Wound Care and Surgical & Sports Medicine products, an increase in product costs associated with our pipeline products not yet commercialized and an increase in the clinical study and related costs necessary to seek regulatory approvals for certain of our products.

Other Expense, Net

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,","","","Change"],["","","2021","","","2020","","","2019","","","2021 to 2020","","","2020 to 2019"],["","","(in thousands, except for percentages)"],["Interest expense","","$","(7,236",")","","$","(11,279",")","","$","(8,996",")","","$","4,043","","","","(36","%)","","$","(2,283",")","","","25","%"],["Gain on settlement of deferred acquisition consideration","","","\u2014","","","","2,246","","","","\u2014","","","","(2,246",")","","","(100","%)","","","2,246","","","","**"],["Change in fair value of warrant liability","","","\u2014","","","","\u2014","","","","2,140","","","","\u2014","","","","**","","","","(2,140",")","","","(100","%)"],["Loss on the extinguishment of debt","","","(1,883",")","","","\u2014","","","","(1,862",")","","","(1,883",")","","","**","","","","1,862","","","","(100","%)"],["Other income (expense), net","","","(13",")","","","97","","","","13","","","","(110",")","","","(113","%)","","","84","","","","**"],["Total other expense, net","","$","(9,132",")","","$","(8,936",")","","$","(8,705",")","","$","(196",")","","","2","%","","$","(231",")","","","3","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["**","not meaningful"]]
[[/GREPCENT_TABLE]]

For the year ended December 31, 2021, total other expense, net, increased by $0.2 million or 2%, as compared to the year ended December 31, 2020. Interest expense decreased by $4.0 million or 36% primarily due to the reduced interest rate for borrowings under the 2021 Credit Agreement. Loss on extinguishment of debt of $1.9 million was related to loss recognized on the extinguishment of the 2019 Credit Agreement upon repayment in August 2021. The gain of $2.2 million on the settlement of deferred acquisition consideration was related to the settlement of the deferred acquisition consideration dispute with the sellers of NuTech Medical in February 2020 as well as the decrease in legal accruals related to the settlement in October 2020 of a legacy lawsuit which we assumed from the sellers of NuTech Medical as part of the resolution of the aforementioned dispute.

For the year ended December 31, 2020, other expense, net, increased by $0.2 million or 3%, as compared to the year ended December 31, 2019. Interest expense increased by $2.3 million or 25% primarily due to the increased borrowings under the 2019 Credit Agreement. Change in fair value of warrant liability of $2.1 million in 2019 reflected the decrease in the fair value of warrant liability when it was settled in the warrant exchange transaction in the third quarter of 2019. Loss on the extinguishment of debt of $1.9 million in 2019 reflected the
write-off
of unamortized debt discount upon repayment of the Master Lease Agreement as well as early payment penalties in March 2019. Gain of $2.2 million in 2020 was related to the settlement of the deferred acquisition consideration dispute with the sellers of NuTech Medical in February 2020 as well as the settlement in October 2020 of a legacy lawsuit which we assumed from the sellers of NuTech Medical as part of the resolution of the aforementioned dispute.

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Income Tax (Expense) Benefit

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,","","","Change"],["","","2021","","","2020","","","2019","","","2021 to 2020","","","2020 to 2019"],["","","(in thousands, except for percentages)"],["Income tax (expense) benefit","","$","31,116","","","$","(530",")","","$","(150",")","","$","31,646","","","","**","","","$","(380",")","","","**"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["**","not meaningful"]]
[[/GREPCENT_TABLE]]

For the year ended December 31, 2021, income tax (expense) benefit decreased by $31.6 million, as compared to the year ended December 31, 2020. The decrease is due to the deferred tax benefit of $32.0 million primarily resulting from the release of the valuation allowance previously recorded against the full amount of our net U.S. deferred tax assets as of December 31, 2021. See Note “15. Income Taxes”.

For the year ended December 31, 2020, income tax (expense) benefit increased by $0.4 million, as compared to the year ended December 31, 2019. The increase is primarily due to the cash tax expected in states where net operating loss utilization is limited.

Liquidity and Capital Resources

Since our inception, we have funded our operations and capital expenditures through cash flows from product sales, loans from affiliates and entities controlled by certain of our affiliates, third-party debt and proceeds from the sale of our capital stock. As of December 31, 2021, we had an accumulated deficit of $60.1 million and working capital of $145.0 million which includes $113.9 million in cash and cash equivalents. We also had $125.0 million available for future revolving borrowings under our Revolving Facility (see Note “12. Long-Term Debt Obligations”). For the year ended December 31, 2021, we have reported $94.9 million of net income and $62.0 million of cash flows from operating activities. We expect that our cash on hand and other components of working capital as of December 31, 2021, availability under the 2021 Credit Agreement, plus net cash flows from product sales, will be sufficient to fund our operating expenses, capital expenditure requirements and debt service payments for at least 12 months beyond the filing date of this annual report.

We continue to closely monitor ongoing developments in connection with
the COVID-19 pandemic,
which may negatively impact our commercial prospects, cash position and access to capital in fiscal 2022 or beyond. We will continue to assess our cash and other sources of liquidity and, if circumstances warrant, we will make appropriate adjustments to our operating plan. Please see “Item 1A. Risk Factors” in this Annual Report on
Form 10-K for
an additional discussion of risks.

Our primary uses of cash are working capital requirements, capital expenditure and debt service payments. Additionally, from time to time, we may use capital for acquisitions and other investing and financing activities. Working capital is used principally for our personnel as well as manufacturing costs related to the production of our products. Our working capital requirements vary from period to period depending on manufacturing volumes, the timing of shipments and the payment cycles of our customers and payers. Our capital expenditures consist primarily of building improvements, manufacturing equipment, computer hardware and software.

To the extent additional funds are necessary to meet our long-term liquidity needs as we continue to execute our business strategy, we anticipate that they will be obtained through additional equity or debt financings, other strategic transactions or a combination of these potential sources of funds. There can be no assurance that we will be able to obtain additional funds on terms acceptable to us, on a timely basis or at all.

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The following table presents our cash and outstanding debt as of the dates indicated:

[[GREPCENT_TABLE]]
[["","","December 31,"],["","","2021","","","2020","","","2019"],["","","(in thousands)"],["Cash and cash equivalents","","$","113,929","","","$","84,394","","","$","60,174"],["Line of credit","","$","\u2014","","","$","10,000","","","$","33,484"],["Term loan","","","73,425","","","","59,710","","","","49,634"],["Finance lease obligations","","","200","","","","15,061","","","","17,488"],["Total debt","","$","73,625","","","$","84,771","","","$","100,606"]]
[[/GREPCENT_TABLE]]

Under the line of credit or the Revolving Facility, we have up to $125,000 available for future revolving borrowings.

Cash Flows

The following table summarizes our cash flows for each of the periods presented:

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2021","","","2020","","","2019"],["","","(in thousands)"],["Net cash provided by (used in) operating activities","","$","61,978","","","$","5,466","","","$","(33,528",")"],["Net cash used in investing activities","","","(31,220",")","","","(23,498",")","","","(6,234",")"],["Net cash provided by (used in) financing activities","","","(1,036",")","","","42,468","","","","78,727"],["Net increase in cash and restricted cash","","$","29,722","","","$","24,436","","","$","38,965"]]
[[/GREPCENT_TABLE]]

Operating Activities

During the year ended December 31, 2021, net cash provided by operating activities was $62.0 million, resulting from our net income of $94.9 million,
non-cash charges
of $4.8 million, partially offset by net cash used in connection with changes in our operating assets and liabilities of $37.7 million. The
non-cash
charges of $4.8 million consisted of $36.8 million standard non-cash items primarily related to depreciation and amortization, stock-based compensation expense, and inventory reserve, partially offset by the deferred tax benefit of $32.0 million primarily resulting from the release of the valuation allowance previously recorded against the full amount of our net U.S. deferred tax assets as of December 31, 2021. Net cash used in changes in our operating assets and liabilities included an increase in accounts receivable of $28.7 million, an increase in inventory of $9.3 million, and a decrease in operating leases and other liabilities of $12.2 million, all of which were partially offset by an increase in accounts payable, accrued expenses and other current liabilities of $12.5 million.

During the year ended December 31, 2020, net cash provided by operating activities was $5.5 million, resulting from our net income of $17.2 million and
non-cash charges
of $15.9 million, partially offset by net cash used in connection with changes in our operating assets and liabilities of $27.8 million. Net cash used in changes in our operating assets and liabilities included an increase in accounts receivable of $17.6 million, an increase in inventory of $6.7 million, an increase in prepaid expenses and other current assets of $0.4 million, and a decrease in accounts payable and other liabilities of $4.6 million, all of which were partially offset by an increase in accrued expenses and other current liabilities of $1.4 million.

During the year ended December 31, 2019, net cash used in operating activities was $33.5 million, resulting from our net loss of $38.7 million and net cash used in connection with changes in our operating assets and

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liabilities of $9.7 million partially offset
by non-cash charges
of $14.8 million. Net cash used in connection with changes in our operating assets and liabilities includes an increase in inventory of $11.1 million, an increase in accounts receivable of $4.7 million, an increase in prepaid expenses and other current assets and a decrease in other liabilities of $1.6 million, all of which were partially offset by an increase in accounts payable of $4.7 million and an increase of accrued expenses and other current liabilities of $2.9 million.

Investing Activities

During the year ended December 31, 2021, we used $31.2 million of cash in investing activities solely consisting of capital expenditures.

During the year ended December 31, 2020, we used $23.5 million of cash in investing activities consisting of capital expenditures of $17.7 million and payment of $5.8 million related to the acquisition of CPN.

During the year ended December 31, 2019, we used $6.2 million of cash in investing activities consisting primarily of capital expenditures and an intangible asset purchase.

Financing Activities

During the year ended December 31, 2021, net cash used in financing activities was $1.0 million. This consisted primarily of the repayment of borrowings of $70.0 million under the 2019 Credit Agreement, the payment of $1.6 million to extinguish this debt facility, the payment of finance lease obligations of $2.6 million, the payment of $2.2 million related to other financing activities. The net cash used in financing activities was principally offset by $73.2 million in net proceeds from the 2021 Credit Agreement and $2.2 million in proceeds from the exercise of common stock options.

During the year ended December 31, 2020, net cash provided by financing activities was $42.5 million. This consisted primarily of $59.1 million in net proceeds from the issuance of Class A common stock and $2.8 million in proceeds from the exercise of options. The net cash provided by financing activities was partially offset by the payment of finance lease obligations of $2.4 million, the payment of $3.5 million related to the NuTech Medical deferred acquisition consideration and the net debt repayment of $13.5 million under our 2019 Credit Agreement.

During the year ended December 31, 2019, net cash provided by financing activities was $78.7 million that consisted primarily of $56.1 million in net proceeds from the 2019 Credit Agreement, $47.4 million in net proceeds from the issuance of Class A common stock and $0.9 million in proceeds from the exercise of warrants and options. The net cash provided by financing activities was partially offset by the payment of the put option on redeemable Class A common stock of $6.8 million, repayment of the ML Agreement of $17.6 million, and payment of finance lease obligations of $1.3 million.

Indebtedness

2021 Credit Agreement

In August 2021, we and our subsidiaries entered into a credit agreement with SVB and several other lenders, which we refer to as the 2021 Credit Agreement. The 2021 Credit Agreement provides for a term loan facility not to exceed $75,000 (the “Term Loan Facility”) and a revolving credit facility not to exceed $125,000 (the “Revolving Facility”).

Advances made under the 2021 Credit Agreement may be either Eurodollar Loans or ABR Loans, at our option. For Eurodollar Loans, the interest rate is a per annum interest rate equal to LIBOR plus an Applicable Margin based on the Total Net Leverage Ratio. For ABR Loans, the interest rate is equal to (1) the highest of (a) the Wall Street Journal Prime Rate, (b) the Federal Funds Rate plus 0.50% and (c) the LIBOR rate plus 1.0%,

 plus

 (2) an Applicable Margin based on the Total Net Leverage Ratio.

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The 2021 Credit Agreement requires us to make consecutive quarterly installment payments of principal in an amount equal to between 0.625% to 2.50% of the original principal amount of the Term Loans starting from September 30, 2021 through August 6, 2026 (the “Term Loan Maturity Date”). We may prepay the Term Loan Facility, provided that any Term Loans prepaid prior to August 6, 2022, must be accompanied by a prepayment premium equal to 1.00% of the aggregate amount of Term Loans prepaid. Once repaid, amounts borrowed under the Term Loan Facility may not
be re-borrowed.

We must pay a quarterly fee in arrears (the “Commitment Fee”), for the
Company’s non-use of
available funds through August 6, 2026 (the “Revolving Termination Date”). The Commitment Fee rate is based on the Total Net Leverage Ratio. We may elect to reduce or terminate the Revolving Facility in its entirety at any time by repaying all outstanding principal, unpaid accrued interest and, with respect to any such reduction or termination of the Revolving Commitments made prior to August 6, 2022, 1.00% of the aggregate amount of the Revolving Commitments so reduced or terminated.

Under the 2021 Credit Agreement, we are required to comply with certain financial covenants including the Consolidated Fixed Charge Coverage Ratio and Consolidated Total Net Leverage Ratio, tested quarterly. In addition, we are also required to make representations and warranties and comply with certain
non-financial
covenants that are customary in loan agreements of this type, including restrictions on the payment of dividends, repurchase of stock, incurrence of indebtedness, dispositions and acquisitions.

As of December 31, 2021, we were in compliance with the covenants under the 2021 Credit Agreement. We had outstanding borrowings under the Revolving Facility and Term Loan Facility of the 2021 Credit Agreement of $0.0 million and $74.1 million, respectively.

2019 Credit Agreement

In March 2019, we, our subsidiaries and SVB, and the several other lenders thereto entered into a credit agreement, as amended (the “2019 Credit Agreement”), providing for a term loan facility of $40,000 and a revolving credit facility of up to $60,000. Both facilities were set to mature in 2024. The interest rate for the term loan facility was a floating per annum interest rate equal to the greater of 3.75% above the Wall Street Journal Prime Rate and 9.25%. The interest rate for advances under the revolving facility was a floating per annum interest rate equal to the greater of the Wall Street Journal Prime Rate and 5.50%. If we elected to prepay the loan or terminate the facilities, we were required to pay a certain percentage of the outstanding principal as a prepayment fee. A final payment fee (the “Final Payment”) of 6.5% multiplied by the original aggregate principal amount of term loan facility was due upon the earlier to occur, the maturity date of the term loan or prepayment of all outstanding principal.

In August 2021, upon entering into the 2021 Credit Agreement, we paid an aggregate amount of $70.6 million due under the 2019 Credit Agreement, including unpaid principal, accrued interest, the Final Payment and a prepayment fee, with proceeds from the 2021 Credit Agreement, and the 2019 Credit Agreement was terminated. Upon termination of the 2019 Credit Agreement, the Company recognized $1.9 million as loss on the extinguishment of the loan for year ended December 31, 2021.

Master Lease Agreement

In April 2017, we entered into the Master Lease Agreement (the “ML Agreement”) with Eastward Fund Management LLC. In March 2019, upon entering into the 2019 Credit Agreement, we paid an aggregate amount of $17.6 million due under the ML Agreement with proceeds from the 2019 Credit Agreement, and the ML Agreement was terminated. Upon termination of the ML Agreement, we recognized $1.9 million as loss on the extinguishment of the loan.

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Critical Accounting Policies and Significant Judgments and Estimates

Our consolidated financial statements have been prepared in accordance with GAAP. The preparation of our consolidated financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, and the disclosure at the date of the financial statements, as well as revenue and expenses recorded during the reporting periods. Management bases its estimates, assumptions and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our consolidated financial statements, which, in turn, could materially change our results from those reported. Management evaluates its estimates, assumptions and judgments on an ongoing basis. Historically, our critical accounting estimates have not differed materially from actual results. However, if our assumptions change, we may need to revise our estimates or take other corrective actions, either of which may also have a material adverse effect on our consolidated statements of operations, liquidity and financial condition.

We believe the following critical accounting policies involve significant areas where management applies judgments and estimates in the preparation of our consolidated financial statements.

Revenue Recognition

We generate revenue through the sale of Advanced Wound Care and Surgical & Sports Medicine products. There is a single performance obligation in all of our contracts, which is our promise to transfer our product to customers based on specific payment and shipping terms in the arrangement. The entire transaction price is allocated to this single performance obligation. Product revenue is recognized when a customer obtains control of our product which occurs at a point in time and may be upon shipment, procedure date, or delivery, based on the terms of the contract. Revenue is recorded net of a reserve for returns, discounts and GPO rebates, which represent a direct reduction to the revenue we recognize. These reductions are accrued at the time revenue is recognized, based upon historical experience and specific circumstances.

Accounts Receivable, Net

Accounts receivables are stated at invoice value less estimated allowances for doubtful accounts. We continually monitor customer payments and maintain a reserve for estimated losses resulting from our customers’ inability to make required payments. We consider factors such as historical experience, credit quality, age of the accounts receivable balances, geography-related risks and economic conditions that may affect a customer’s ability to pay. In cases where there are circumstances that may impair a specific customer’s ability to meet its financial obligations, a specific allowance is recorded against amounts due, and thereby reduces the net recognized receivable to the amount reasonably believed to be collectible. Accounts receivables are written off when deemed uncollectible. Recoveries of accounts receivables previously written off are recorded when received.

Inventory

Inventory is stated at the lower of cost (determined under the
first-in

first-out
method) or net realizable value. Inventory includes raw materials, work in process and finished goods. It also includes cell banks and the cost of tests mandated by regulatory agencies, of the materials to qualify them for production.

We regularly review inventory quantities on hand and record a provision to write down excess and obsolete inventory to its estimated net realizable value based upon management’s assumptions of future material usage, yields and obsolescence, which are a result of future demand and market conditions and the effective life of certain inventory items. Our excess and obsolete inventory review process includes analysis of sales forecasts and historical sales as compared to inventory on hand and working with operations to maximize recovery of excess inventory. The estimate of excess quantities is subjective and primarily dependent on our estimate of

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future demand for a particular product. If the estimate of future demand is inaccurate based on actual sales, we may increase the write-down for excess inventory for that component.

Goodwill

Goodwill represents the excess of the purchase price of an acquired business over the fair value of the identifiable assets acquired and liabilities assumed. Goodwill is not amortized but is tested for impairment at least annually (as of December 31), or more frequently if events or circumstances indicate the carrying value may no longer be recoverable and that an impairment loss may have occurred. Circumstances that could trigger an impairment test include, but are not limited to, a significant adverse change in the business climate or legal factors, an adverse action or assessment by a regulator, or unanticipated competition. We operate as one segment, which is considered to be the sole reporting unit, and therefore goodwill is tested for impairment at the consolidated level.

In accordance with ASC Topic 350,

 Intangibles—Goodwill and Other

, we first assess qualitative factors to determine whether it is necessary to perform the quantitative goodwill impairment test. If after assessing the totality of events or circumstances, we determine that it is more likely than not (i.e. greater than 50% likelihood) that the fair value of the reporting unit is less than its carrying amount, then the quantitative test is required. Otherwise, no further testing is required. The quantitative goodwill impairment test requires us to estimate and compare the fair value of the reporting unit with its carrying value. If the fair value of the reporting unit exceeds the carrying value of the net assets, goodwill is not impaired. If the fair value of the reporting unit is less than the carrying value, the difference is recorded as an impairment loss up to the amount of goodwill.

Application of the goodwill impairment test requires judgments, including a qualitative assessment to determine whether there are any impairment indicators, and determining the fair value of the reporting unit which often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, asset lives and market multiples, among other items. There is no assurance that the actual future earnings or cash flows of the reporting unit will not decline significantly from the projections used in the impairment analysis. Goodwill impairment charges may be recognized in future periods to the extent changes in factors or circumstances occur, including deterioration in the macroeconomic environment and industry, deterioration in the Company’s performance or its future projections, or changes in plans for its reporting unit.

There were no impairment charges of goodwill recorded during 2021, 2020, and 2019.

Impairment of Long-Lived Assets

We review other long-lived assets (including identifiable definite lived intangible assets) for impairment whenever events or changes in circumstances indicate that the useful life is shorter than originally estimated or the carrying amount of an asset or asset group may not be recoverable. If such facts and circumstances exist, we assess the recoverability of the identified assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives to their respective carrying amounts. Impairments, if any, are based on the excess of the carrying amount over the fair value of those assets and occur in the period in which the impairment determination is made.

There were no impairments of long-lived assets recorded during 2021, 2020, and 2019.

Income Taxes

We account for income taxes using an asset and liability approach. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Valuation allowances are provided when necessary to reduce net deferred tax assets to an amount that is more likely than not to be realized.

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In determining whether a valuation allowance for deferred tax assets is necessary, we analyze both positive and negative evidence related to the realization of deferred tax assets including projected future taxable income, recent financial results and estimates of future reversals of deferred tax assets and liabilities. In addition, we consider whether it is more likely than not that the tax position will be sustained on examination by taxing authorities based on the technical merits of the position. In the fourth quarter of 2021, we determined it was more likely than not that our deferred tax assets would be realized in the future and released the valuation allowance on our net deferred tax assets as of December 31, 2021, resulting in a benefit of $48.3 million in income taxes.

We account for uncertainty in income taxes recognized in the consolidated financial statements by applying
a two-step process
to determine the amount of tax benefit to be recognized. First, the tax position must be evaluated to determine the likelihood that it will be sustained upon external examination by the taxing authorities. If the tax position is
deemed more-likely-than-not to
be sustained, the tax position is then assessed to determine the amount of benefit to recognize in the consolidated financial statements. The amount of the benefit that may be recognized is the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement. The provision for income taxes includes the effects of any resulting tax reserves, or unrecognized tax benefits, that are considered appropriate as well as the related net interest and penalties.

Valuation of Contingent Purchase Earnout

In connection with our acquisition of CPN Biosciences, LLC (“CPN”), we recognized a
non-current
liability, at the time of the acquisition in 2020, for the fair value of the contingent consideration (the “Earnout”). The Earnout liability is classified as a Level 3 measurement for which fair value is derived from inputs that are unobservable and significant to the overall fair value measurement. The fair value of such Earnout liability is estimated using a Monte Carlo simulation model that utilizes key assumptions including forecasted revenues and volatilities of the underlying financial metrics during the Earnout period. We assess the fair value of the Earnout liability at each reporting period. Any subsequent changes in the estimated fair value of the liability are reflected in selling, general and administrative expenses until the liability is settled.

Stock-Based Compensation

We measure stock-based awards granted based on the fair value of the awards on the date of grant and recognize compensation expense for those awards over the requisite service period, which is generally the vesting period of the respective award. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Generally, we issue stock-based awards with only service-based vesting conditions and record the expense for these awards using the straight-line method. We have not issued any stock-based awards with performance-based vesting conditions.

We recognize stock-based compensation expense within selling, general and administrative expenses in the consolidated statement of operations for all share-based payments based upon the estimated grant-date fair value for the awards expected to ultimately vest.

The fair value of each restricted stock unit is based on the fair market value of our Class A common stock on the date of grant. The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model. We have been a public company for a short period of time, have limited public float and lack company-specific historical and implied volatility information for our Class A common stock. Therefore, we estimate our expected stock price volatility based on the historical volatility of publicly traded peer companies and expect to continue to do so until such time as we have adequate historical data regarding the volatility of our own traded stock price. The expected term of our stock options has been determined utilizing the “simplified” method for awards that qualify as “plain-vanilla” options. The risk-free interest rate is determined by reference to the U.S. Treasury yield curve in effect at the time of grant of the award for time periods approximately equal to the expected term of the award. Expected dividend yield is based on the fact that we have never paid cash dividends on Class A common stock and do not expect to pay any cash dividends in the foreseeable future.

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Off-Balance
Sheet Arrangements

We did not have during the periods presented, and we do not currently have, any
off-balance
sheet arrangements, as defined in the rules and regulations of the SEC.

Recently Issued Accounting Pronouncements

For a description of recently issued accounting pronouncements, including the expected dates of adoption and the estimated effects, if any, on our consolidated financial statements, see Note “2. Significant Accounting Policies” to our consolidated financial statements appearing at the end of this Annual Report on Form
10-K.