TREACE MEDICAL CONCEPTS, INC. – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis of our financial condition and results of operations together with our condensed financial statements and related notes thereto included in this Quarterly Report and our audited financial statements and related notes thereto for the year endedDecember 31, 2020 , included in our prospectus datedApril 22, 2021 filed with theU.S. Securities and Exchange Commission , pursuant to Rule 424(b)(4) under the Securities Act (the "Prospectus"). This discussion and other parts of this Quarterly Report contain forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in our Prospectus in the section titled "Risk Factors." Please also see the section titled "Special Note Regarding Forward-Looking Statements."
Overview
We are a commercial-stage orthopaedic medical device company with the goal of advancing the standard of care for the surgical management of bunion deformities. Bunions are complex three-dimensional (3D) deformities that originate from an unstable joint in the middle of the foot. We have pioneered our proprietary Lapiplasty® 3D Bunion Correction™ System (the "Lapiplasty System") -a combination of instruments, implants and surgical methods (the "Lapiplasty Procedure") designed to correct all three planes of the bunion deformity and secure the unstable joint, addressing the root cause of the bunion and helping patients get back to their active lifestyles. Our mission is to be the leader in the surgical treatment of bunions by establishing the Lapiplasty System as the standard of care. We were formed in 2013 and since receiving 510(k) clearance for the Lapiplasty System inMarch 2015 , we have sold more than 35,000 Lapiplasty Procedure Kits inthe United States . The Lapiplasty System is comprised of single-use implant kits ("Lapiplasty Procedure Kits") and reusable instrument trays. We market and sell our Lapiplasty System to physicians, surgeons, ambulatory surgery centers and hospitals. The Lapiplasty Procedure can be performed in either hospital outpatient or ambulatory surgery centers settings, and utilizes existing, well-established reimbursement codes. We currently market and sell the Lapiplasty System through a combination of a direct employee sales force and independent sales agents across 98 territories inthe United States . As ofSeptember 30, 2021 , we had 59 direct sales representatives, 43 independent sales agents, and ten regional sales vice presidentswho are responsible for managing the sales representatives and independent sales agents. For the three months endedSeptember 30, 2021 , employee sales representatives generated approximately 53% of revenues while approximately 47% of revenues came through independent sales agents. For the nine months endedSeptember 30, 2021 , employee sales representatives generated approximately 50% of revenues while approximately 50% of revenues came through independent sales agents. For the three months endedSeptember 30, 2021 , we generated revenue of$21.6 million , with a gross margin of 80.4% and net loss of$6.4 million , compared to revenue of$14.3 million , with a gross margin of 79.6% and net loss of$2.7 million for the three months endedSeptember 30, 2020 . OnApril 27, 2021 , we completed our initial public offering ("IPO") of 12,937,500 shares of common stock, which included the exercise in full of the underwriters' option to purchase additional shares. Before our IPO, our primary sources of capital have been private placements of common stock and convertible preferred stock, debt financing agreements and revenue from the sale of our products. As part of the IPO, 6,953,125 shares of common stock were issued and sold by us (inclusive of 703,125 shares pursuant to the exercise of the underwriters' option) and 5,984,375 shares of common stock were sold by the selling stockholders named in the Prospectus (inclusive of 984,375 shares pursuant to the exercise of the underwriters' option), at a price to the public of$17.00 per share. We received net proceeds of approximately$107.6 million , after deducting underwriting discounts and commissions of$8.3 million and offering expenses payable by us of$2.3 million . Upon the completion of the IPO, all 6,687,475 shares of Series A convertible preferred stock then outstanding were converted into shares of common stock on a one-to-one basis plus 158,447 shares of common stock were issued to pay accrued cumulative dividends on Series A convertible preferred stock of$2.5 million . As ofSeptember 30, 2021 , we had cash and cash equivalents of$109.5 million , an accumulated deficit of$35.3 million and$30.0 million of principal outstanding under our term loan agreement. InMarch 2020 , theWorld Health Organization declared the outbreak of a novel coronavirus (COVID-19) as a pandemic, and in response to COVID-19 at that time, certain states withinthe United States implemented shelter-in-place rules requiring certain businesses not deemed "essential" to close and requiring elective procedures to be delayed. These restrictions began to adversely affect our revenue growth and operating results during the three months endedMarch 31, 2020 . While we are encouraged by our results since restrictions were eased at the end of the second quarter of 2020 and with 21 -------------------------------------------------------------------------------- the introduction of vaccines in early 2021, we are aware that the actual and perceived impact of COVID-19 is changing and cannot be predicted, particularly due to potentially more contagious and virulent variants of the virus becoming prevalent and vaccination rates inthe United States slowing. For example, during the three months endedSeptember 30, 2021 , the volume of procedures utilizing our product were adversely impacted by elective surgery delays and cancellations, and hospital capacity constraints due to increased hospitalizations caused by theCOVID-19 Delta variant, particularly inFlorida ,Georgia ,Texas and other areas significantly impacted by COVID-19. In addition to constraints in hospital capacity, we continue to observe disruptions from deferral of elective procedures and hospital staffing shortages. We cannot assure you that we will not experience additional negative impacts associated with COVID-19, which could be significant. The COVID-19 pandemic has negatively impacted our business, financial condition and results of operations by significantly decreasing and delaying the number of procedures performed using our products, and we expect the pandemic could continue to negatively impact our business, financial condition and results of operations.
Key Business Metrics
We regularly review a number of operating and financial metrics, including the number of Lapiplasty Procedure Kits sold, the number of active surgeons using the Lapiplasty System and utilization rate, to evaluate our business, measure our performance, identify trends affecting our business, formulate our business plan and make strategic decisions. The number of Lapiplasty Procedure Kits sold during the three months endedSeptember 30, 2021 increased by 1,181 or 42.5% over the three months endedSeptember 30, 2020 , and the number of active surgeons1 as ofSeptember 30, 2021 was 1,592, an increase of 41% fromSeptember 30, 2020 . The utilization rate for the three months endedSeptember 30, 2021 increased 16.3% over the three months endedSeptember 30, 2020 to an average of 10.0 Lapiplasty Procedure Kits per active surgeon.2 We believe that the number of Lapiplasty Procedure Kits sold, number of active surgeons using the Lapiplasty System and utilization rate are useful indicators of our ability to drive adoption of the Lapiplasty System and generate revenue and are helpful in tracking the progress of our business. While we believe these metrics are representative of our current business, we anticipate these metrics may be substituted for additional or different metrics as our business grows.
Factors Affecting Our Business
We believe that our financial performance has been and in the foreseeable future, will continue to depend on many factors, including COVID-19 as described above, those described below, those noted in the section titled "Special Note Regarding Forward-Looking Statements" and in the section titled "Risk Factors" (incorporated from our Prospectus).
Adoption of the Lapiplasty System
The growth of our business depends on our ability to gain broader acceptance of the Lapiplasty System by successfully marketing and distributing the Lapiplasty System and ancillary products. We currently have approval at over 1,000 facilities acrossthe United States and plan to continue to increase access by convincing even more surgeons and facility administrators that our products are superior alternatives to traditional products used in bunion surgical procedures. While surgeon adoption of the Lapiplasty Procedure remains critical to driving procedure growth, hospital and ambulatory surgery center facility approvals are necessary for both existing and future surgeon customers to access our products. To facilitate greater access to our products and drive future sales growth, we intend to continue educating hospitals and facility administrators on the differentiated benefits associated with the Lapiplasty System, supported by our robust portfolio of clinical data. If we are unable to successfully commercialize our Lapiplasty System, we may not be able to generate sufficient revenue to achieve or sustain profitability. In the near term, we expect we will continue to operate at a loss and we anticipate we will finance our operations principally through offerings of our capital stock and by incurring debt.
Investments in Innovation and Growth
We expect to continue to focus on long-term revenue growth through investments in our business. In sales and marketing, we are dedicating meaningful resources to expand our sales force and management team inthe United States , as well as our patient focused marketing campaigns 1 We define the number of active surgeons as the number of surgeons that
performed at least one procedure using the Lapiplasty System in the trailing
twelve-month period.
2 We define utilization rate as the number of Lapiplasty Procedure Kits sold
divided by the number of active surgeons. 22
-------------------------------------------------------------------------------- . We are hiring additional direct sales representatives and employee field sales management to strategically access more regions with high densities of prospective patients and by focusing the efforts of our independent sales channel on our products. In research and development, our team and ourSurgeon Advisory Board are continually working on next-generation innovations of the Lapiplasty System and related products. In addition to expanding our Lapiplasty offerings with products like the Lapiplasty Mini-Incision System, we are continually exploring opportunities to advance our core Lapiplasty System instrumentation and implants to further improve surgical efficiency, enhance reproducibility of outcomes and speed surgical recovery for patients. We are also pursuing the development and potential commercialization, if cleared, of new products to address ancillary surgical procedures performed routinely in connection with the Lapiplasty Procedure. For example, to help address midfoot deformities that can occur in up to 30% of bunion patients, we developed and, inSeptember 2021 , announced the commercial launch of the Adductoplasty™ System. The Adductoplasty™ System brings together our implants and instrumentation to provide a comprehensive system designed for reproducible realignment, stabilization, and fusion of the midfoot and thus, provides surgeons with a precision, instrumented approach to treat both the bunion and coexisting midfoot deformities. Moreover, in general and administrative, we expect to continue to hire personnel and expand our infrastructure to both drive and support our anticipated growth and operations as a public company. Accordingly, in the near term, we expect these activities to increase our net losses, but in the longer term we anticipate they will positively impact our business and results of operations.
Seasonality
We have experienced and expect to continue to experience seasonality in our business, with higher sales volumes in the fourth calendar quarter, historically accounting for approximately 40% of full year revenues, and lower sales volumes in the first calendar quarter. Our sales volumes in the fourth calendar quarter tend to be higher as many patients elect to have surgery after meeting their annual deductible and having time to recover over the winter holidays. Our sales volumes in the first calendar quarter also tend to be lower as a result of adverse weather and by resetting annual patient healthcare insurance plan deductibles, both of which may cause patients to delay elective procedures. The orthopaedic industry traditionally experiences lower sales volumes in the third quarter than throughout the rest of the year as elective procedures generally decline during the summer months. Although we follow orthopaedic industry trends generally, to date our third quarter sales volumes have not been lower than other quarters, but we may experience relatively lower sales volumes during third quarters in the future.
Coverage and Reimbursement
Hospitals, ambulatory surgery centers and surgeons that purchase or use our products generally rely on third-party payors to reimburse for all or part of the costs and fees associated with procedures using our products. As a result, sales of our products depend, in part, on the extent to which the procedures using our products are covered by third-party payors, including government programs such as Medicare and Medicaid, private insurance plans and managed care programs. Based on historical claims data from 2017, approximately 63% of Lapidus cases and 60% of all bunion surgical cases were paid by private payors. Medicare payment rates to hospital outpatient departments are set under the Medicare hospital outpatient prospective payment system, which groups clinically similar hospital outpatient procedures and services with similar costs to ambulatory payment classifications (APCs). Each APC is assigned a single lump sum payment rate, which includes payment for the primary procedure as well as any integral, ancillary, and adjunctive services. The primary CPT codes for the Lapiplasty Procedure, CPT 28297 and CPT 28740, are grouped together under APC 5114. For Lapiplasty Procedures in which fusion is performed on multiple TMT joints, CPT 28730 applies and is classified under APC 5115.
Components of Our Results of Operations
Revenue
We currently derive nearly all of our revenue from the sale of our proprietary Lapiplasty System, and to a lesser extent from ancillary products. The Lapiplasty System is comprised of single-use implant kits and reusable instrument trays. We sell the Lapiplasty System to physicians, surgeons, hospitals and ambulatory surgery centers inthe United States through a network of independent agents and employee sales representatives. Our primary product is the Lapiplasty System, which is an instrumented, reproducible approach to 3D bunion correction that helps patients rapidly return to weight-bearing in a post-operative boot. We also offer other advanced instrumentation and implants for use in the Lapiplasty Procedure or other ancillary procedures performed in high frequency with bunion surgery. No single customer accounted for 10% or more of our revenue during the three and nine months endedSeptember 30, 2021 . We expect our revenue to increase in absolute dollars in the foreseeable future as we expand our sales territories, new accounts and trained physician base and as existing physician customers perform more Lapiplasty Procedures, though it may fluctuate from quarter to quarter due to a variety of factors, including seasonality. 23
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Cost of Goods Sold
Cost of goods sold consists primarily of costs related to manufacturing costs for the purchase of our Lapiplasty System products from third-party manufacturers. Direct costs from our third-party manufacturers includes costs for raw materials plus the markup for the assembly of the components. Cost of goods sold also includes royalties, allocated overhead for indirect labor, depreciation, rent and information technology, certain direct costs such as those incurred for shipping our products and personnel costs. We expense all inventory provisions for excess and obsolete inventories as cost of goods sold. We record adjustments to our inventory valuation for estimated excess, obsolete and non-sellable inventories based on assumptions about future demand, past usage, changes to manufacturing processes and overall market conditions. We expect our cost of goods sold to increase in absolute dollars in the foreseeable future to the extent more of our products are sold, though it may fluctuate from quarter to quarter. Gross Profit and Gross Margin We calculate gross profit as revenue less cost of goods sold, and gross margin as gross profit divided by revenue. Our gross margin has been and will continue to be affected by a variety of factors, primarily average selling prices, production and ordering volumes, change in mix of customers, third-party manufacturing costs and cost-reduction strategies. We expect our gross profit to increase in the foreseeable future as our revenue grows, though our gross margin may fluctuate from quarter to quarter due to changes in average selling prices as we introduce new products, and as we adopt new manufacturing processes and technologies. Operating Expenses Sales and Marketing Sales and marketing expenses consist primarily of compensation for personnel, including salaries, bonuses, benefits, sales commissions and share-based compensation, related to selling and marketing functions, physician education programs, training, travel expenses, marketing initiatives including our direct-to-patient outreach program and advertising, market research and analysis and conferences and trade shows. We expect sales and marketing expenses to continue to increase in absolute dollars in the foreseeable future as we continue to invest in our direct sales force and expand our marketing efforts, and as we continue to expand our sales and marketing infrastructure to both drive and support anticipated sales growth, though it may fluctuate from quarter to quarter. Research and Development Research and development (R&D) expenses consist primarily of engineering, product development, clinical studies to develop and support our products, regulatory expenses, patent costs, and other costs associated with products and technologies that are in development. These expenses include compensation for personnel, including salaries, bonuses, benefits and share-based compensation, supplies, consulting, prototyping, testing, materials, travel expenses, depreciation and an allocation of facility overhead expenses. Additionally, R&D expenses include costs associated with our clinical studies, including clinical trial design, clinical trial site initiation and study costs, data management, related travel expenses and the cost of products used for clinical trials, internal and external costs associated with our regulatory compliance and quality assurance functions and allocated overhead costs. We expect R&D expenses to continue to increase in absolute dollars in the foreseeable future as we continue to hire personnel and invest in next-generation innovations of the Lapiplasty System and related products, though it may fluctuate from quarter to quarter due to a variety of factors, including the level and timing of our new product development efforts, as well as our clinical development, clinical trial and other related activities. General and Administrative General and administrative expenses consist primarily of compensation for personnel, including salaries, bonuses, benefits and share-based compensation, related to finance, information technology, legal and human resource functions, as well as professional services fees (including legal, audit and tax fees), insurance costs, general corporate expenses and allocated facilities-related expenses. We expect general and administrative expenses to continue to increase in absolute dollars in the foreseeable future as we hire personnel and our expand infrastructure to both drive and support the anticipated growth in our organization and due to additional legal, accounting, insurance, compliance with the rules and regulations of theSEC and those of any stock exchange on which our securities are traded, investor relations, and other administrative and professional services expenses associated with operating as a public company, though it may fluctuate from quarter to quarter. 24
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Interest and other income, net
Interest income and other income, net consists of interest received on our money
market funds.
Interest Expense
Interest expense consists of interest incurred and amortization of debt discount
related to outstanding borrowings during the reported periods.
Results of Operations
For the three and nine months ended
The following table summarizes our results of operations for the periods
presented below ($ in thousands):
Three Months Nine Months Ended Ended September 30, Change September 30, Change 2021 2020 Amount % 2021 2020 Amount % Revenue$ 21,619 $ 14,266 $ 7,353 51.5 %$ 60,980 $ 33,260 $ 27,720 83.3 % Cost of goods sold 4,248 2,911 1,337 45.9 % 11,519 7,386 4,133 56.0 % Gross profit 17,371 11,355 6,016 53.0 % 49,461 25,874 23,587 91.2 % Operating expenses Sales and marketing 15,984 8,103 7,881
97.3 % 42,142 20,229 21,913 108.3 %
Research and development
2,537 1,511 1,026
67.9 % 6,827 3,925 2,902 73.9 %
General and administrative 4,310 1,804 2,506 138.9 % 11,405 4,500 6,905 153.4 %
Total operating expenses
22,831 11,418 11,413
100.0 % 60,374 28,654 31,720 110.7 %
Loss from operations
(5,460 ) (63 ) (5,397 ) (10,913 ) (2,780 ) (8,133 ) Interest and other income (expense), net 5 (1,784 ) 1,789 -100.3 % 12 (1,748 ) 1,760 (100.7 )% Interest expense (963 ) (808 ) (155 ) 19.2 % (3,032 ) (1,707 ) (1,325 ) 77.6 % Other expense, net (958 ) (2,592 ) 1,634 (63.0 )% (3,020 ) (3,455 ) 435 (12.6 )% Net loss and comprehensive loss (6,418 ) (2,655 ) (3,763 ) 141.7 % (13,933 ) (6,235 ) (7,698 ) 123.5 % 25
-------------------------------------------------------------------------------- The following shows the three months and nine months results of operations as a percentage of revenue. Three Months Ended Nine Months Ended September 30, September 30, 2021 2020 2021 2020 Revenue 100.0 % 100.0 % 100.0 % 100.0 % Cost of goods sold 19.6 % 20.4 % 18.9 % 22.2 % Gross profit 80.4 % 79.6 % 81.1 % 77.8 % Operating expenses Sales and marketing 73.9 % 56.8 % 69.1 % 60.8 % Research and development 11.7 % 10.6 % 11.2 % 11.8 % General and administrative 19.9 % 12.6 % 18.7 % 13.5 % Total operating expenses 105.6 % 80.0 % 99.0 % 86.2 % Loss from operations (25.2 )% (0.4 )% (17.9 )% (8.4 )% Interest and other income (expense), net 0.0 % (12.5 )% 0.0 % (5.3 )% Interest expense (4.5 )% (5.7 )% (5.0 )% (5.1 )% Other expense, net (4.5 )% (18.2 )% (5.0 )% (10.4 )% Net loss and comprehensive loss (29.7 )% (18.6 )% (22.9 )% (18.8 )%
Comparison of the three months ended
Revenue. Revenue increased$7.4 million , or 51.5%, from$14.3 million during the three months endedSeptember 30, 2020 , to$21.6 million during the three months endedSeptember 30, 2021 . The increase in revenue was primarily due to an increased number of Lapiplasty Procedure Kits sold as the result of an expanded customer base. Cost of Goods Sold, Gross Profit and Gross Margin. Cost of goods sold increased$1.3 million , or 45.9%, from$2.9 million during the three months endedSeptember 30, 2020 , to$4.2 million during the three months endedSeptember 30, 2021 . The increase in cost of goods sold was primarily due to$0.8 million increase in direct costs of goods sold resulting from increased sales,$0.5 million increase in royalty expense resulting from our increased sales, and$0.1 million increase in overhead expenses, which were offset by a reduction of$0.1 million in depreciation expense from our surgical instruments. Gross profit and gross margin increased from$11.4 million and 79.6%, respectively, during the three months endedSeptember 30, 2020 , to$17.4 million and 80.4%, respectively, during the three months endedSeptember 30, 2021 , primarily due to the decreased per unit direct costs of goods sold and depreciation expense of our surgical instruments, which were offset by an increase in royalties expense as a percent of sales. Sales and Marketing Expenses. Sales and marketing expenses increased$7.9 million , or 97.3%, from$8.1 million during the three months endedSeptember 30, 2020 , to$16.0 million during the three months endedSeptember 30, 2021 . The increase in sales and marketing expenses was primarily due to growth in our overall business and normalization of sales operations compared to the three months endedSeptember 30, 2020 , during which we delayed expenditures for surgeon education events, patient outreach campaigns and other planned sales and marketing expenses in connection with the pandemic. Sales and marketing expenses also increased as a result of an increase of$2.1 million in professional services primarily for higher commissions from increased sales, an increase of$2.3 million in advertising and marketing-related expenses primarily due to higher advertising fees and a new television commercial campaign, an increase of$1.7 million in payroll and payroll-related expenses resulting from increased headcount of sales personnel, and$0.5 million in other marketing-related expenses resulting from increased sales efforts. Research and Development Expenses. Research and development expenses increased$1.0 million , or 67.9%, from$1.5 million for the three months endedSeptember 30, 2020 , to$2.5 million during the three months endedSeptember 30, 2021 . The increase in research and development expenses was due to an increase of$0.5 million in payroll and payroll-related costs resulting from increased headcount of research personnel, an increase of$0.2 million in professional services from higher consulting and patent filing fees, and an increase of$0.1 million in clinical expenses resulting from increased purchases of materials used in our prototypes. General and Administrative Expenses. General and administrative expenses increased$2.5 million , or 138.9%, from$1.8 million during the three months endedSeptember 30, 2020 , to$4.3 million during the three months endedSeptember 30, 2021 . The increase in general and administrative expenses was primarily due to an increase of$0.7 million in payroll and payroll-related costs as we increased headcount in our business, an increase of$0.8 million in business-related expenses 26
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primarily resulting from increased insurance costs and fees, an increase of
expenses, and an increase of
expansion of our headquarters.
Interest and Other Income (Expense), Net. The increase in interest and other income (expense), net during the three months endedSeptember 30, 2021 , was primarily due to the recognition of loss of$0.6 million from the extinguishment of term loans under the SVB Credit Facility and$1.2 million paid as a prepayment penalty upon termination of the loans under the SVB Credit Facility. Interest Expense. Interest expense increased$0.2 million from$0.8 million during the three months endedSeptember 30, 2020 , to$1.0 million during the three months endedSeptember 30, 2021 . The increase in interest expense was primarily due to an increase of$10.0 million in balances outstanding on our CRG Term Loan Facility for all three months in the current quarter as compared to two months for the prior year quarter.
Comparison of the nine months ended
Revenue. Revenue increased$27.7 million , or 83.3%, from$33.3 million during the nine months endedSeptember 30, 2020 , to$61.0 million during the nine months endedSeptember 30, 2021 . The increase in revenue was primarily due to an increased number of Lapiplasty Procedure Kits sold as the result of an expanded customer base and normalization of sales compared to the nine months endedSeptember 30, 2020 , which was adversely impacted by government-mandated restrictions on elective procedures in response to the COVID-19 pandemic that lasted fromMarch 2020 throughMay 2020 when such restrictions were largely eased. Cost of Goods Sold, Gross Profit and Gross Margin. Cost of goods sold increased$4.1 million , or 56.0%, from$7.4 million during the nine months endedSeptember 30, 2020 , to$11.5 million during the nine months endedSeptember 30, 2021 . The increase in cost of goods sold was primarily due to$2.9 million increase in direct costs of goods sold resulting from increased sales,$1.3 million increase in royalty expense resulting from our increased sales, and$0.4 million increase in overhead expenses resulting from expansion of our headquarters and headcount and the normalization of operations compared to the nine months endedSeptember 30, 2020 , which was adversely impacted by pandemic-related restrictions on elective surgeries. The increases are offset by a decrease in provision for inventory obsolescence of$0.3 million resulting from a lower number of days in inventory and$0.6 million decrease in depreciation expense of our surgical instruments resulting from lower average net book value of surgical instruments. Gross profit and gross margin increased from$25.9 million and 77.8%, respectively, during the nine months endedSeptember 30, 2020 , to$49.5 million and 81.1%, respectively, during the nine months endedSeptember 30, 2021 , primarily due to the decreased per unit direct costs of goods sold, depreciation expense of our surgical instruments, and provision for inventory obsolescence. Sales and Marketing Expenses. Sales and marketing expenses increased$21.9 million , or 108.3% from$20.2 million during the nine months endedSeptember 30, 2020 , to$42.1 million during the nine months endedSeptember 30, 2021 . The increase in sales and marketing expenses was primarily due to growth in our overall business and normalization of sales operations compared to the nine months endedSeptember 30, 2020 , in which we delayed expenditures for surgeon education events, patient outreach campaigns and other planned sales and marketing expenses to respond to the pandemic. Sales and marketing expenses increased as a result of an increase of$7.1 million in professional services primarily for higher commissions from increased sales, an increase of$4.9 million in advertising and marketing-related expenses from higher advertising fees, a new television commercial campaign and, public relations expenses, an increase of$4.9 million in payroll and payroll-related expenses resulting from increased headcount of sales personnel,$1.0 million in travel and related expenses, and an increase$1.7 million in clinical-related expenses resulting from increased sales. Research and Development Expenses. Research and development expenses increased$2.9 million , or 73.9%, from$3.9 million for the nine months endedSeptember 30, 2020 , to$6.8 million during the nine months endedSeptember 30, 2021 . The increase in research and development expenses was primarily due to an increase of$1.6 million in payroll and payroll-related costs resulting from increased headcount of research personnel, an increase of$0.7 million in professional services from higher consulting and patent filing fees, and an increase of$0.3 million in clinical expenses resulting from higher purchases of materials used in our prototypes. General and Administrative Expenses. General and administrative expenses increased$6.9 million , or 153.4%, to$11.4 million during the nine months endedSeptember 30, 2021 , from$4.5 million during the nine months endedSeptember 30, 2020 , when we implemented salary reductions, headcount freeze, and other actions in response to the pandemic. The increase in general and administrative expenses was primarily due to an increase of$3.2 million in payroll and payroll-related 27 -------------------------------------------------------------------------------- costs as we increased headcount in our business, an increase of$1.3 million in business-related expenses primarily resulting from increased insurance costs and fees, an increase of$1.3 million in professional services primarily related to legal and audit expenses, and an increase of$0.3 million in rent expense resulting from the expansion of our headquarters. The increases are offset by a decrease of$0.3 million in bad debt expense. Interest and Other Income (Expense), Net. The decrease in interest and other income (expense), net during the three months endedSeptember 30, 2021 , was primarily due to the recognition of loss of$0.6 million from the extinguishment of term loans under the SVB Credit Facility and$1.2 million paid as a prepayment penalty upon termination of the loans under the SVB Credit Facility. Interest Expense. Interest expense increased$1.3 million from$1.7 million during the nine months endedSeptember 30, 2020 , to$3.0 million during the nine months endedSeptember 30, 2021 . The increase in interest expense was primarily due to an increase of$30.0 million in balances outstanding on our term loans and credit facility.
Liquidity and Capital Resources
Overview
Before our IPO, our primary sources of capital were private placements of common stock and convertible preferred stock, debt financing agreements and revenue from the sale of our products. As ofSeptember 30, 2021 , we had cash and cash equivalents of$109.4 million , an accumulated deficit of$35.3 million and$30.0 million of principal outstanding under our term loan agreement. We repaid$1.8 million in borrowings outstanding from the Paycheck Protection Program loan program (the "PPP Loan") under the Coronavirus Aid Relief and Economic Recovery Act inMarch 2021 . InJuly 2020 , we entered into the new term loan agreement withCRG Servicing LLC ("CRG") to obtain up to$50.0 million in financing over three tranches. We borrowed$30.0 million under the new facility with CRG and repaid prior existing outstanding debt under our credit facility withSilicon Valley Bank ("SVB"). We also amended our existing credit facility with SVB to increase the revolving line of credit from$5.0 million to$10.0 million . We received net proceeds of$107.6 million from our IPO. We believe that our existing cash and cash equivalents, available debt borrowings and expected revenues will be sufficient to meet our capital requirements and fund our operations for at least twelve months. We may be required or decide to raise additional financing to support further growth of our operations.
Short-Term and Long-Term Obligations
Silicon Valley
OnAugust 3, 2020 , we entered into the Third Amendment to the Loan and Security Agreement (the "Third Amendment"), with SVB which terminated the third tranche term loan and increased the revolving line of credit to$10.0 million . The Loan and Security Agreement ("LSA"), as amended by the First Amendment, Second Amendment, and Third Amendment (collectively, the "SVB Credit Facility") maturesAugust 3, 2024 . The SVB Credit Facility incurs interest at the greater of (i) 1.00% above the Prime Rate or (ii) 5.00%, and is subject to a termination fee of 1.00%.
As of
the revolving line of credit and no borrowings outstanding related to our
revolving line of credit.
Under the terms of the SVB Credit Facility, we granted SVB first priority liens and security interests in substantially all of our assets (excluding our intellectual property but including any proceeds and rights to payments associated with our intellectual property) as collateral. The SVB Credit Facility also contains certain representations and warranties, indemnification provisions in favor of SVB, affirmative and negative covenants (including, among other things, requirements that we maintain a minimum amount of liquidity and achieve minimum revenue targets, limitations on other indebtedness, liens, acquisitions, investments and dividends and requirements relating to financial reporting, sales and leasebacks, insurance and protection of our intellectual property rights) and events of default (including payment defaults, breaches of covenants following any applicable cure period, investor abandonment, a material impairment in the perfection or priority of the lender's security interest or in the collateral), and events relating to bankruptcy or insolvency). As ofSeptember 30, 2021 , we were in compliance with all covenants under the SVB Credit Facility. 28
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CRG Term Loan Facility
OnJuly 31, 2020 , we entered into a non-revolving term loan facility with CRG (the "CRG Term Loan Facility") to obtain up to$50.0 million in financing over three tranches to be advanced no later thanDecember 31, 2021 . Principal borrowings outstanding excluding discount and issuance costs as ofSeptember 30, 2021 , totaled$30 million . The CRG Term Loan Facility matures onJune 30, 2025 , and we can elect to make quarterly interest-only payments, to pay 7.50% interest in cash and 5.5% interest in-kind. We are not required to make any principal payments until the maturity of the CRG Term Loan Facility and all outstanding principal and accrued interest are due upon the maturity of the CRG Term Loan Facility. Interest under the CRG Term Loan Facility is applied to outstanding principal and accrued interest at a rate of 13.00% per annum. If an event of default occurs, interest under the CRG Term Loan Facility will increase by 4.00%. If we repay the CRG Term Loan Facility within one year of the applicable borrowing date, we are required to pay a premium of 20.00% of the aggregated outstanding principal amount of the loans that is repaid. If we repay the CRG Term Loan Facility between one and two years from the applicable borrowing date, we are required to pay a premium of 11.00% of the aggregated outstanding principal amount of the loans that is repaid. The CRG Term Loan Facility does not require a prepayment premium for loans being prepaid on the prepayment date that is after two years from the applicable borrowing date. Under the terms of the CRG Term Loan Facility, we granted CRG first priority liens and security interests in substantially all of our assets as collateral (including our intellectual property), provided that the priority of such liens are subject to an intercreditor agreement between CRG and SVB. The CRG Term Loan Facility also contains certain representations and warranties, indemnification provisions in favor of CRG, affirmative and negative covenants (including, among other things, requirements that we maintain a minimum amount of liquidity and achieve minimum revenue targets, limitations on other indebtedness, liens, acquisitions, investments and dividends and requirements relating to financial reporting, sales and leasebacks, insurance and protection of our intellectual property rights) and events of default (including payment defaults, breaches of covenants following any applicable cure period, investor abandonment, a material impairment in the perfection or priority of the lender's security interest or in the collateral, and events relating to bankruptcy or insolvency). As ofSeptember 30, 2021 , we were in compliance with all covenants under the CRG Term Loan Facility. Funding Requirements We use our cash to fund our operations, which primarily include the costs of manufacturing our Lapiplasty System and ancillary products, as well as our sales and marketing and research and development expenses and related personnel costs. We expect our sales and marketing expenses to increase for the foreseeable future as we continue to invest in our direct sales force and expand our marketing efforts, and as we continue to expand our sales and marketing infrastructure to both drive and support anticipated sales growth. We also expect R&D expenses to increase for the foreseeable future as we continue to hire personnel and invest in next-generation innovations of the Lapiplasty System and related products. In addition, we expect our general and administrative expenses to increase for the foreseeable future as we hire personnel and expand our infrastructure to both drive and support the anticipated growth in our organization. We will also incur additional expenses as a result of operating as a public company and also expect to increase the size of our administrative function to support the growth of our business. From time to time, we may also consider additional investments in technologies, assets and businesses to expand or enhance our product offerings. The timing and amount of our operating expenditures will depend on many factors, including:
• the scope and timing of our investment in our commercial infrastructure
and sales force;
• the costs of our ongoing commercialization activities including product
sales, marketing, manufacturing and distribution; • the scope of our marketing efforts, including the degree to which we utilize direct to consumer campaigns; • the degree and rate of market acceptance of the Lapiplasty System;
• the costs of filing, prosecuting, defending and enforcing any patent
claims and other intellectual property rights, including enforcing our
intellectual property rights against infringing products or technologies;
• our need to implement additional infrastructure and internal systems;
• the research and development activities we intend to undertake in order to
improve the Lapiplasty System and to develop or acquire additional products; • the investments we make in acquiring other technologies, assets or businesses to expand our product portfolio; • the success or emergence of new competing technologies or other adverse market developments; 29
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• any product liability or other lawsuits related to our products; • the expenses needed to attract and retain skilled personnel; • the costs associated with being a public company; and • the impact of the COVID-19 pandemic on our operations and business. Based upon our current operating plan, we believe that our existing cash and cash equivalents, will enable us to fund our operating expenses and capital expenditure requirements for at least the next twelve months. We have based this estimate on assumptions that may prove to be wrong or that may change in the future, and we could utilize our available capital resources sooner than we expect. We may seek to raise any necessary additional capital through public or private equity offerings or debt financings, credit or loan facilities or a combination of one or more of these or other funding sources. Additional funds may not be available to us on acceptable terms or at all. If we fail to obtain necessary capital when needed on acceptable terms, or at all, we could be forced to delay, limit, reduce or terminate our product development programs, commercialization efforts or other operations. If we raise additional funds by issuing equity securities, our stockholders will suffer dilution and the terms of any financing may adversely affect the rights of our stockholders. In addition, as a condition to providing additional funds to us, future investors may demand, and may be granted, rights superior to those of existing stockholders. Debt financing, if available, is likely to involve restrictive covenants limiting our flexibility in conducting future business activities, and, in the event of insolvency, debt holders would be repaid before holders of our equity securities received any distribution of our corporate assets.
Cash Flows
The following table sets forth the primary sources and uses of cash and cash
equivalents for the period presented below:
Nine Months Ended Change September 30, 2021 2020 Amount % (in thousands, other than percent change) Net cash (used in) provided by: Operating activities$ (13,441 ) $ (6,942 ) $ (6,499 ) 93.6 % Investing activities (1,805 ) (981 ) (824 ) 84.0 % Financing activities 106,626 11,180 95,446 853.7 % Net increase in cash and cash equivalents$ 91,380 $ 3,257 $ 88,123 2,705.5 %
Net cash used in operating activities for the nine months endedSeptember 30, 2021 , increased by$6.5 million from the nine months endedSeptember 30, 2020 , due to an increase in operating assets and liabilities of$1.6 million offset by an increase in net loss of$7.7 million and decrease in noncash charges of$0.4 million . The decrease in net operating assets was primarily due to reduced purchases of inventories of$1.7 million , reduced settlements of accrued liabilities of$1.0 million due to greater decrease in accrued commissions and accrued compensation for the nine months endedSeptember 30, 2020 , as compared to the nine months endedSeptember 30, 2021 . This decrease in net operating assets is offset by an increase in prepaid expenses and other assets of$3.0 million resulting from an increase in general prepaid expenses due to our overall growth.
Net cash used in investing activities during the nine months endedSeptember 30, 2021 , increased by$0.8 million from the nine months endedSeptember 30, 2020 . The increase was primarily due to increased level of purchases of capitalized surgical instruments for our reusable surgical kits during the nine months endedSeptember 30, 2021 , as compared to the nine months endedSeptember 30, 2020 . 30
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Net Cash Provided by Financing Activities
Net cash provided by financing activities during the nine months endedSeptember 30, 2021 , increased by$95.5 million from the nine months endedSeptember 30, 2020 . The increase cash provided by financing activities was due to an increase in proceeds from the exercise of stock options of$0.7 million and the receipt of net cash proceeds of$107.6 million from the issuance shares of common stock, net of$10.6 million in issuance costs, upon completion of our IPO onApril 27, 2021 . The increase is offset by the repayment of our PPP Loan from the SBA of$1.8 million inMarch 2021 . During the nine months endedSeptember 30, 2020 , we received$10.0 million in net proceeds from borrowings on interest bearing debt while during the nine months endedSeptember 30, 2021 , we did not have any proceeds from borrowings on interest bearing debt.
Surgeon Advisory Board Royalty Agreements
We recognized royalties' expense of$1.1 million and$0.6 million for the three months endedSeptember 30, 2021 and 2020, respectively, and$2.8 million and$1.4 million for the nine months endedSeptember 30, 2021 and 2020, respectively. For the three months endedSeptember 30, 2021 and 2020, the aggregate royalty rate was 5.3% and 4.2%, respectively. For the nine months endedSeptember 30, 2021 and 2020, the aggregate royalty rate was 4.5% and 4.3%, respectively. Each of the SAB Royalty Agreements prohibits the payment of royalties on products sold to entities and/or individuals with whom any of the surgeon advisors is affiliated.
Off-Balance Sheet Arrangements
We did not have during the period presented, and we currently have no
off-balance sheet arrangements, such as structured finance, special purpose
entities, or variable interest entities.
Critical Accounting Policies and Estimates
Management's discussion and analysis of our financial condition and results of operations is based on our condensed financial statements, which have been prepared in accordance withU.S. generally accepted accounting principles. The preparation of these condensed financial statements requires us to make estimates and assumptions for the reported amounts of assets, liabilities, revenue, expenses and related disclosures. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions and any such differences may be material. BeginningJanuary 1, 2021 , the Company adjusted the useful life of its capitalized instruments from 18 months to 36 months to align with the expected life of the instruments. The change in useful life is expected to reduce depreciation expense by$0.2 million per year. During the three and nine months endedSeptember 30, 2021 , there were no other material changes to our critical accounting policies or in the methodology used for estimates from those described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the Prospectus.
Recently Issued Accounting Pronouncements
See Note 3 to our condensed financial statements included elsewhere in this
Quarterly Report for new accounting pronouncements not yet adopted as of the
date of this Quarterly Report.
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