ORTHOFIX MEDICAL INC. The following discussion and analysis ofOrthofix Medical Inc.'s (sometimes referred to as "we," "us" or "our") financial condition and results of our operations should be read in conjunction with the "Forward-Looking Statements" and our condensed consolidated financial statements and related notes thereto appearing elsewhere in this Form 10-Q.
Executive Summary
We are a global medical device company focused on musculoskeletal products and therapies. Our mission is to improve patients' lives by providing superior reconstruction and regenerative musculoskeletal solutions to physicians worldwide. Headquartered inLewisville, Texas , our spine and orthopedic extremities products are distributed in more than 70 countries via our sales representatives and distributors.
Notable financial metrics and achievements in the second quarter of 2020 include the following:
• Net sales were
36.6% on a constant currency basis
• Record Motion Preservation sales quarter of
increase of 24% sequentially
• Net loss of
year period
• Decrease in earnings before interest, income taxes, depreciation, and
amortization ("EBITDA") of
net sales
COVID-19 Update and Outlook
The global COVID-19 pandemic is significantly affecting our patients, communities, employees and business operations. The pandemic has led to the temporary closure of businesses, restrictions on travel and the implementation of physical distancing measures around the world. SinceMarch 2020 , hospitals, ambulatory surgery centers and other medical facilities in our sales markets have cancelled or deferred elective surgery procedures and diverted resources to patients being treated for COVID-19. The pandemic has caused surgeons and patients to defer procedures in which our products otherwise would be used, and many facilities that specialize in the procedures in which our products otherwise would be used have temporarily closed or reduced operating hours. In addition, broad economic factors resulting from the pandemic, including increased unemployment rates and reduced consumer spending, are affecting our patients and partners. These circumstances have negatively affected the sales of our products, particularly during the period fromMarch 2020 throughMay 2020 when surgery center closures were most pronounced, though these effects remain ongoing. However, we remain focused on protecting the health and wellbeing of its employees, partners, patients, and the communities in which we operate while assuring the continuity of our business operations. At this time, the future trajectory of the COVID-19 pandemic remains very uncertain, both in theU.S. and in other markets. Within theU.S. , for example, new infection counts have significantly decreased in some regions, while other regions have seen increases in recent weeks. The exact reasons for varying case trajectories remains unclear, including the level of infection rates in different states and geographic areas. As a result, it is not yet clear whether the future trajectory of the pandemic is likely to include one or more future waves of cases, or whether case counts may slowly decline from this point forward. In addition, progress continues to be made on therapeutic treatments and vaccine candidates, though the efficacy and timing of various treatments and vaccines is uncertain. Given these various uncertainties, it is unclear the extent to which lingering slowdowns in elective procedures will affect our business during the second half of 2020 and beyond. We expect that the effects of COVID-19 on our business will depend on various factors including (i) the comfort level of patients in returning to clinics and hospitals, (ii) the extent to which localized elective surgery shutdowns occur, (iii) the unemployment rate's effect on potential patients lacking medical insurance coverage, and (iv) general hospital capacity constraints occurring because of the need to treat high volumes of COVID-19 patients. During the second quarter of 2020, we focused on making our facilities safe given updated COVID-19 public health guidelines, and we believe that our employee workforce has adapted to the new environment. In particular, we have been able to continue our manufacturing activities to keep pace with customer orders. However, given the potential for further shelter in place orders in our largest manufacturing and operational centers (particularly,Lewisville, Texas andVerona, Italy ), there remains a risk that a significant localized surge in the virus could cause disruption to our manufacturing, distribution, administrative and other business operations (including downtime at our manufacturing facilities and the interruption of the production of our products). In addition, while we have not seen such effects to date, risk remains that COVID-19 could have material negative effects on contractual counterparties, leading to supply chain disruptions or counterparty payment defaults and bankruptcies (including bankruptcies to hospital systems that significantly rely on revenue from elective surgeries). 21 -------------------------------------------------------------------------------- Our results of operations and liquidity have been materially impacted by the decrease in elective surgical procedures and could be further impacted by delays in payments from customers, supply chain interruptions, the potential of extended "shelter in place" and social distancing orders or advisories, facility closures, or other reasons related to the pandemic. Our results of operations and liquidity may also be affected by the rate at which and timing of when elective procedures resume at hospitals and other facilities, which may occur at a faster or slower pace than current expectations. As of the date of issuance of these condensed consolidated financial statements, the full extent to which COVID-19 could materially affect the Company's financial condition, liquidity, or results of operations is uncertain. As precautionary measures to increase our cash position and preserve financial flexibility in view of the current uncertainty resulting from the COVID-19 pandemic, we (i) completed a borrowing of$100.0 million under our secured revolving credit facility onApril 16, 2020 (of this amount,$50.0 million was subsequently repaid inJuly 2020 ), (ii) executed temporary salary reductions forU.S. employees and the Board of Directors, which were in effect for two months during the second quarter of 2020, (iii) suspended the our 401(k) match program through the remainder of fiscal year 2020, and (iv) initiated travel restrictions and a significant slow-down in hiring.
Results of Operations
The following table provides certain items in our condensed consolidated
statements of operations and comprehensive income (loss) as a percent of net
sales:
Three Months Ended Six Months Ended
June 30, June 30,
2020 2019 2020 2019
(%) (%) (%) (%)
Net sales 100.0 100.0 100.0 100.0
Cost of sales 31.7 22.3 26.2 22.0
Gross profit 68.3 77.7 73.8 78.0
Sales and marketing 59.5 49.1 55.0 49.1
General and administrative 20.6 18.9 18.5 18.9
Research and development 12.0 7.8 10.5 8.1
Acquisition-related amortization and
remeasurement 4.9 1.5 (2.3 ) 3.7
Operating income (loss) (28.7 ) 0.4 (7.9 ) (1.8 )
Net income (loss) (25.2 ) (0.5 ) 4.1 0.2
The following tables provide net sales by major product category by reporting
segment:
Three Months Ended
June 30, Percentage Change
(U.S. Dollars, in thousands) 2020 2019 Reported Constant Currency
Bone Growth Therapies $ 28,379 $ 50,109 -43.4 % -43.4 %
Spinal Implants 18,594 23,226 -19.9 % -19.7 %
Biologics 11,125 16,744 -33.6 % -33.6 %
Global Spine 58,098 90,079 -35.5 % -35.4 %
Global Extremities 15,037 25,771 -41.7 % -40.5 %
Net sales $ 73,135 $ 115,850 -36.9 % -36.6 %
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Six Months Ended
June 30, Percentage Change
(U.S. Dollars, in thousands) 2020 2019 Reported Constant Currency
Bone Growth Therapies $ 73,822 $ 97,392 -24.2 % -24.2 %
Spinal Implants 41,520 46,129 -10.0 % -9.7 %
Biologics 25,074 32,476 -22.8 % -22.8 %
Global Spine 140,416 175,997 -20.2 % -20.1 %
Global Extremities 37,542 48,965 -23.3 % -21.6 %
Net sales $ 177,958 $ 224,962 -20.9 % -20.5 %
Global Spine
Global Spine offers the following products categories:
- Bone Growth Therapies, which manufactures, distributes, sells, and provides
support services for market leading devices that enhance bone fusion. Bone
Growth Therapies uses distributors and sales representatives to sell itsdevices and provide associated services to hospitals, healthcare providers,
and patients.
- Spinal Implants, which designs, develops and markets a broad portfolio of
motion preservation and fixation implant products used in surgical
procedures of the spine. Spinal Implants distributes its products globally
through a network of distributors and sales representatives to sell spine
products to hospitals and healthcare providers.
- Biologics, which provides a portfolio of regenerative products and tissue
forms that allow physicians to successfully treat a variety of spinal and
orthopedic conditions. Biologics markets its tissues to hospitals and
healthcare providers, primarily in the
and independent sales representatives.
Three months ended
Net sales decreased
• Bone Growth Therapies net sales decreased
driven by the disruption caused by COVID-19, which has led to lower order
volumes and a longer revenue cycle for these products, particularly due to
many patients only being able to be fitted for devices in a virtual or
telehealth environment
• Spinal Implants net sales decreased
by the reduction in elective procedures in both the
due to COVID-19; however, Motion Preservation net sales increased
million in the
case volumes and active surgeons
• Biologics net sales decreased
lower procedure volumes as a result of the disruption caused by COVID-19
Six months ended
Net sales decreased
• Bone Growth Therapies net sales decreased
driven by the disruption caused by COVID-19, which has led to lower order
volumes and a longer revenue cycle for these products, particularly due to
many patients only being able to be fitted for devices in a virtual or
telehealth environment
• Spinal Implants net sales decreased
by the reduction in elective procedures in both the
due to COVID-19; however, Motion Preservation net sales increased
million in the
case volumes and active surgeons
• Biologics net sales decreased
lower procedure volumes as a result of the disruption caused by COVID-19
23
--------------------------------------------------------------------------------Global Extremities
Global Extremities offers products and solutions that allow physicians to successfully treat a variety of orthopedic conditions unrelated to the spine. Global Extremities distributes its products globally through a network of distributors and sales representatives to sell orthopedic products to hospitals and health providers.
Three months ended
Net sales decreased
• Decrease of
procedure volumes
• Decrease of
rates, which had a negative impact on net sales
Six months ended
Net sales decreased
• Decrease of
procedure volumes
• Decrease of
rates, which had a negative impact on net sales
Gross Profit
Three Months Ended June 30, Six Months Ended June 30,
(U.S. Dollars, in thousands) 2020 2019 % Change 2020 2019 % Change
Net sales $ 73,135 $ 115,850 (36.9 %) $ 177,958 $ 224,962 (20.9 %)
Cost of sales 23,166 25,812 (10.3 %) 46,575 49,520 (5.9 %)
Gross profit $ 49,969 $ 90,038 (44.5 %) $ 131,383 $ 175,442 (25.1 %)
Gross margin 68.3 % 77.7 % (9.4 %) 73.8 % 78.0 % -4.2 %
Three months ended
Gross profit decreased
• Decrease primarily due to the decline in net sales and lower fixed cost
absorption, primarily attributable to COVID-19 and its negative effect on
elective procedure volumes, as well as an increase in expense resulting from
non-cash inventory reserves
Six months ended
Gross profit decreased
• Decrease primarily due to the decline in net sales and lower fixed cost
absorption, primarily attributable to COVID-19 and its negative effect on
elective procedure volumes, as well as an increase in expense resulting from
non-cash inventory reserves
Sales and Marketing Expense
Three Months Ended June 30, Six Months Ended June 30,
(U.S. Dollars, in thousands) 2020 2019 % Change 2020 2019 % Change
Sales and marketing $ 43,479 $ 56,864 (23.5 %) $ 97,792 $ 110,558 (11.5 %)
As a percentage of net sales 59.5 % 49.1 % 10.4 % 55.0 % 49.1 % 5.9 %
Three months ended
Sales and marketing expense decreased
• Decrease largely attributable to reduced commissions as a result of the
decline in net sales, partially offset by commission support provided to our
direct sales representatives
• Decrease of
for salary reductions, travel, entertainment, and professional fees due to
the limited mobility of our sales force and the conversion of many sales
events from in-person events to virtual events
24
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Six months ended
Sales and marketing expense decreased
• Decrease largely attributable to reduced commissions as a result of the
decline in net sales, partially offset by commission support provided to our
direct sales representatives
• Decrease of
for travel, entertainment, and professional fees due to the limited mobility
of our sales force and the conversion of many sales events from in-person
events to virtual events
General and Administrative Expense
Three Months Ended June 30, Six Months Ended June 30,
(U.S. Dollars, in thousands) 2020 2019 % Change 2020 2019 % Change
General and administrative $ 15,047 $ 21,935 (31.4 %) $ 32,912 $ 42,407 (22.4 %)
As a percentage of net sales 20.6 % 18.9 % 1.7 % 18.5 % 18.9 % (0.4 %)
Three months ended
General and administrative expense decreased
• Decrease of
largely due to diligence and integration costs associated with strategic
initiatives
• Decrease of
including acceleration of certain share-based compensation expense, relating
to the retirement, transition, or termination of certain executive officers
and from targeted restructuring activities
• Decrease of
excluding amounts included within succession, transition, and restructuring
activities discussed above
• Decrease of
as salary reductions, travel and entertainment expenses and professional
fees, primarily related to our legal, finance, information technology, and
compliance functions
Six months ended
General and administrative expense decreased
• Decrease of
largely due to diligence and integration costs associated with strategic
initiatives
• Decrease of
including acceleration of certain share-based compensation expense, relating
to the retirement, transition, or termination of certain executive officers
and from targeted restructuring activities
• Decrease of
excluding amounts included within succession, transition, and restructuring
activities discussed above
• Decrease of
as salary reductions, travel and entertainment expenses and professional
fees, primarily related to our legal, finance, information technology, and
compliance functions
Research and Development Expense
Three Months Ended June 30, Six Months Ended June 30,
(U.S. Dollars, in thousands) 2020 2019 % Change 2020 2019 % Change
Research and development $ 8,765 $ 8,980 (2.4 %) $ 18,729 $ 18,209 2.9 %
As a percentage of net sales 12.0 % 7.8 % 4.2 % 10.5 % 8.1 % 2.4 %
Three months ended
Research and development expense decreased
• Decrease of
expenses
• Partially offset by an increase of
with recent medical device reporting regulations
• Further offset by
the FITBONE assets, inclusive of transitional services
25
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Six months ended
Research and development expense increased
• Increase of
device reporting regulations
• Increase of
regulatory improvements, largely related to increases in headcount
• Increase of
FITBONE assets, inclusive of transitional services
• Partially offset by a decrease of
for clinical costs and product development
Acquisition-related Amortization and Remeasurement
Three Months Ended June 30, Six Months Ended June 30,
(U.S. Dollars, in thousands) 2020 2019 % Change 2020 2019 % Change
Acquisition-related amortization
and remeasurement $ 3,678 $ 1,808 103.4 % $ (3,904 ) $ 8,265 (147.2 %)
As a percentage of net sales 4.9 % 1.5 % 3.4 % (2.3 %) 3.7 % (6.0 %)
Acquisition-related amortization and remeasurement consists of amortization related to intangible assets acquired through business combinations or asset acquisitions and the remeasurement of any related contingent consideration arrangement.
Three months ended
Acquisition-related amortization and remeasurement increased
• Increase of
revenue-based milestone payments associated with the Spinal Kinetics
acquisition that become due upon achievement of certain revenue targets
• Increase of
acquired through business combinations or asset acquisitions
Six months ended
Acquisition-related amortization and remeasurement decreased
• Decrease of
revenue-based milestone payments associated with the Spinal Kinetics
acquisition that become due upon achievement of certain revenue targets,
largely due to uncertainty attributable to COVID-19
• Decrease of
artificial cervical disc by the
the "FDA Milestone") during the first quarter of 2019
• Partially offset by an increase of
of intangible assets acquired through business combinations or asset
acquisitions
Non-operating Income and Expense
Three Months Ended June 30, Six Months Ended June 30,
(U.S. Dollars, in thousands) 2020 2019 % Change 2020 2019 % Change
Interest income (expense), net $ (901 ) $ 457 (297.2 %) $ (1,324 ) $ 200 (762.0 %)
Other income (expense), net 5,069 (236 ) (2247.9 %) 4,271 (640 ) (767.3 %)
Three months ended
Interest income (expense), net, decreased
• Decrease of
investment in eNeura in 2019
• Decrease of
outstanding indebtedness under our secured revolving credit facility
26
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Other income (expense), net, increased
• Increase of
included within the Coronavirus Aid, Relief, and Economic Security Act
("CARES Act")
• Increase of
exchange rates, as we recorded a non-cash remeasurement gain of
in the second quarter of 2020 compared to a gain of $0.3 million in the
second quarter of 2019
Six months ended
Interest income (expense), net, decreased
• Decrease of
investment in eNeura in 2019
• Decrease of
outstanding indebtedness under our secured revolving credit facility
Other income (expense), net, increased
• Increase of
included within the CARES Act
• Increase of
exchange rates, as we recorded a non-cash remeasurement loss of
in the for the six months ended June 30, 2020 compared to a loss of $0.6
million for the six months ended June 30, 2019
• Partially offset by a decrease of $0.2 million associated with the
impairment of our investment in Bone Biologics, Inc. Income Taxes
Three Months Ended June 30, Six Months Ended June 30,
(U.S. Dollars, in thousands) 2020 2019 % Change 2020 2019 % Change
Income tax expense (benefit) $ 1,592 $ 1,219 30.6 % $ (18,440 ) $ (4,787 ) 285.2 %
Effective tax rate (9.5 %) 181.4 % (190.9 %) 164.7 % 107.9 % 56.8 %
Three months ended
The decrease in the effective tax compared to the prior year period rate was primarily a result of the following factors:
• Changes in financial expenses not recognized for tax purposes, primarily
related to acquisition-related remeasurement
• Reversal of the anticipated benefit of
quarter of 2020 related to potential carryback under the CARES Act
• Reversal of tax benefits related to certain performance stock units that
were forfeited in the current period
The primary factors affecting our effective tax rate for the second quarter of 2020 are as follows:
• Financial expenses not recognized for tax purposes, primarily related to
acquisition-related remeasurement
• Reversal of the anticipated benefit of
quarter of 2020 related to potential carryback under the CARES Act
• Reversal of tax benefits related to certain performance stock units that
were forfeited in the current period
Six months ended
The increase in the effective tax compared to the prior year period rate was primarily a result of the following factors:
• Changes in financial expenses not recognized for tax purposes, primarily
related to acquisition-related remeasurement
• Reversal of tax benefits related certain performance stock units that were
forfeited in the current period
• Partially offset by, benefits related to statute expirations for previously
unrecognized tax benefits
• Further offset by decreases in non-deductible executive compensation
The primary factors affecting our effective tax rate for the six months ended
• Statute expirations related to previously unrecognized tax benefits
• Financial benefits not recognized for tax purposes, primarily related to
acquisition-related remeasurement
• Reversal of tax benefits related to certain performance stock units that
were forfeited in the current period
• Non-deductible executive compensation
27
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Segment Review
Our business is managed through two reporting segments: Global Spine and Global
Extremities. The primary metric used in managing the business by segment is
EBITDA (which is described further in Note 13 to the Notes to the Unaudited
Condensed Consolidated Financial Statements contained herein). The following
table presents EBITDA by segment and reconciles consolidated EBITDA to income
(loss) before income taxes:
Three Months Ended Six Months Ended
June 30 , June 30 ,
(
2019
Global Spine $ (3,707 ) $ 16,523 $ 18,710 $ 27,098
Global Extremities (3,359 ) 2,750 (5,253 ) 2,577
Corporate (1,923 ) (12,880 ) (10,063 ) (22,407 )
Total EBITDA $ (8,989 ) $ 6,393 $ 3,394 $ 7,268
Depreciation and amortization (6,942 ) (6,178 ) (13,269 ) (11,905 )
Interest income (expense), net (901 ) 457 (1,324 ) 200
Income (loss) before income taxes
Liquidity and Capital Resources
Cash, cash equivalents, and restricted cash atJune 30, 2020 , totaled$173.4 million compared to$70.4 million atDecember 31, 2019 . This increase was largely a result of our draw of$100.0 million under our secured revolving credit facility in 2020 and from proceeds received under the CARES Act totaling$18.5 million , partially offset by$18.0 million in cash paid to acquire assets associated with the FITBONE intramedullary lengthening system for limb lengthening of the femur and tibia bones. Six Months Ended June 30, (U.S. Dollars, in thousands) 2020 2019 Change
Net cash from operating activities
(28,572 ) (16,738 ) (11,834 )
Net cash from financing activities 101,918 (11,581 ) 113,499
Effect of exchange rate changes on cash (452 ) (71 ) (381 ) Net change in cash, cash equivalents and restricted cash$ 102,988 $ (20,046 ) $ 123,034 The following table presents free cash flow, a non-GAAP financial measure, which is calculated by subtracting capital expenditures from net cash from operating activities: Six Months Ended June 30, (U.S. Dollars, in thousands) 2020 2019 Change Net cash from operating activities$ 30,094 $ 8,344 $ 21,750 Capital expenditures (9,332 ) (10,338 ) 1,006 Free cash flow$ 20,762 $ (1,994 ) $ 22,756 Operating Activities
Cash flows from operating activities increased
• Increase in net income of
• Net decrease of
to changes in fair value of contingent consideration
• Net increase of
accounts, primarily attributable to changes in accounts receivable, a
million prepayment received under the Medicare & Medicaid Services ("CMS")
Accelerated and Advance Payment Program, and other current and long-term
assets and liabilities, which included the expiration of statute of
limitations related to certain unrecognized tax benefits in the first
quarter of 2020
Two of our primary working capital accounts are accounts receivable and
inventory. Days sales in receivables were 84 days at June 30, 2020 compared to
63 days at June 30, 2019 , with much of this increase attributable to the
significant decline in net sales as a result of COVID-19. Inventory turns
decreased to 1.2 times as of June 30, 2020 compared to 1.3 times as of June 30,
2019 .
28
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Investing Activities
Cash flows from investing activities decreased
• Decrease of
assets associated with the FITBONE intramedullary lengthening system for
limb lengthening of the femur and tibia bones
• Partially offset by a change of
transactions to acquire certain assets of former distributors
• Further offset by a decrease in capital expenditures of $1.0 million Financing Activities
Cash flows from financing activities increased
• Increase of
facility in 2020 (of which
• Increase of
FDA Milestone during the first quarter of 2019, which represented the
acquisition-date fair value attributable to the FDA Milestone liability
originally recognized
Credit Facilities
As of June 30, 2020 , we had $100.0 million of principal in borrowings
outstanding under the five year $300 million secured revolving credit facility.
In addition, we had no borrowings outstanding under on our €5.5 million ($6.2
million ) available lines of credit in Italy . We were in compliance with all
required financial covenants as of June 30, 2020 .
In July 2020 , we repaid $50.0 million of principal outstanding under the secured
revolving credit facility. Subsequent to this payment, we had $50.0 million of
principal outstanding under the secured revolving credit facility.
Other
For information regarding Contingencies, see Note 9 to the Notes to the Unaudited Condensed Consolidated Financial Statements contained herein.
Impact of COVID-19 and the CARES Act on Liquidity and Capital Resources
Our liquidity has been materially impacted over the last several months by the decrease in elective surgical procedures and could be further impacted by delays in payments from customers, the potential of extended "shelter in place" and social distancing orders or advisories, facility closures, or other reasons related to the COVID-19 pandemic. Our liquidity may also be affected by the rate at which and timing of when elective procedures fully resume at hospitals and other facilities, which may occur at a faster or slower pace than our expectations. As of the date of issuance of these condensed consolidated financial statements, the extent to which COVID-19 is likely to materially impact our liquidity in the future remains uncertain. As precautionary measures to increase our cash position and preserve financial flexibility in view of ongoing uncertainty resulting from the COVID-19 pandemic, we (i) completed a borrowing of$100.0 million under our secured revolving credit facility onApril 16, 2020 (of which, we have since repaid$50.0 million in principal), (ii) executed temporary salary reductions forU.S. employees and the Board of Directors, which were in effect for two months during the second quarter of 2020, (iii) suspended the 401(k) match program through the remainder of fiscal year 2020, and (iv) initiated organizational travel restrictions and a temporary reduction in new hiring.
On
InApril 2020 , we received$13.9 million in funds from the CMS Accelerated and Advance Payment Program to increase cash flow to providers of services and suppliers impacted by the COVID-19 pandemic. Repayment of this amount is required to begin 120 days after the issuance of the payment, or beginning inAugust 2020 . After the 120 day period, every claim we submit will be offset against the accelerated / advanced payment. Thus, instead of receiving payment for newly submitted claims, our outstanding accelerated / advance payment balance will be reduced by the claim payment amount. In addition, inApril 2020 , we automatically received, without request,$4.7 million in funds from theU.S. Department of Health and Human Services as part of theProvider Relief Fund . Upon review of the qualifying criteria required to retain the funding, which primarily relate to lost revenues or the incurrence of expenses attributable to COVID-19, it was determined that we met the criteria to permanently retain all of the proceeds received. 29 -------------------------------------------------------------------------------- Further, as part of the CARES Act, we are permitted to defer all employer social security payroll tax payments for the remainder of the 2020 calendar year, such that 50% of the taxes is deferred untilDecember 31, 2021 , with the remaining 50% deferred untilDecember 31, 2022 . As ofJune 30, 2020 , we have deferred$1.3 million associated with this program.
Spinal Kinetics Contingent Consideration
Under the terms of the acquisition agreement under which we acquired Spinal Kinetics, we agreed to make contingent milestone payments of up to$60.0 million in cash to Spinal Kinetics' former shareholders. One milestone payment, which was for$15.0 million , became due upon FDA approval of Spinal Kinetics' M6-C artificial cervical disc (the "FDA Milestone"). The FDA Milestone was achieved and paid in 2019. The remaining milestone payments are comprised of revenue-based milestone payments of up to$45.0 million in connection with future sales of the acquired artificial discs. The fair value of the contingent consideration arrangement as ofJune 30, 2020 was$35.8 million ; however, the actual amount ultimately paid could be higher or lower than the fair value of the contingent consideration. As ofJune 30, 2020 , we classified$14.5 million of the liability attributable to the revenue-based milestone within other current liabilities, as we expect to pay one of the revenue-based milestones in the next twelve months, and the remaining$21.3 million within other long-term liabilities. For additional discussion of this matter, see Note 8 of the Notes to the Unaudited Condensed Consolidated Financial Statements.
FITBONE Asset Acquisition
OnFebruary 3, 2020 , we entered into an Asset Purchase Agreement (the "Purchase Agreement") withWittenstein SE ("Wittenstein"), a privately-held German-based company, to acquire assets associated with the FITBONE intramedullary lengthening system for limb lengthening of the femur and tibia bones. Under the terms of the Purchase Agreement, as consideration for the acquired assets, we paid$18.0 million in cash consideration and entered into a Contract Manufacturing and Supply Agreement ("CMSA") with Wittenstein. The acquisition was completed onMarch 26, 2020 and was treated as a business combination. The CMSA with Wittenstein has an initial term of up to two years to manufacture the FITBONE product line. As consideration for the CMSA, we will pay$2.0 million to Wittenstein at the conclusion of the CMSA if certain conditions are met in relation to the prompt delivery of manufactured products.
Other Acquisitions
In
InSeptember 2019 , in relation to an ongoing legal dispute with a former Brazilian distributor, approximately$0.5 million (based upon foreign exchange rates as ofJune 30, 2020 ) of our cash inBrazil was frozen upon request to satisfy a judgment. Although we are appealing the judgment, this cash has been reclassified to restricted cash.
For additional discussion regarding these matters, see Note 9 of the Notes to the Unaudited Condensed Consolidated Financial Statements.
Off-balance Sheet Arrangements
As ofJune 30, 2020 , we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, cash flows, liquidity, capital expenditures or capital resources that are material to investors.
Contractual Obligations
There have been no material changes in any of our material contractual
obligations as disclosed in our Form 10-K for the year ended
Critical Accounting Estimates
Our discussion of operating results is based upon the condensed consolidated
financial statements and accompanying notes. The preparation of these statements
requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amount of
30
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revenues and expenses during the reporting period. Our critical accounting
estimates are detailed in Item 7 of our Annual Report on Form 10-K for the year
ended December 31, 2019 . There have been no significant changes to our critical
accounting estimates except for the following:
Allowance for Expected Credit Losses and Contractual Allowances
Subsequent to the adoption of ASU 2016-13, our allowance for expected credit losses represents the portion of the receivable's amortized cost basis that we do not expect to collect over the receivable's contractual life, considering past events, current conditions, and reasonable and supportable forecasts of future economic conditions. The process for estimating the ultimate collection of accounts receivable involves significant assumptions and judgments. The determination of the contractual life of accounts receivables, the aging of outstanding receivables, as well as the historical collections, write-offs, and payor reimbursement experience over the estimated contractual lives of such receivables, are integral parts of the estimation process related to reserves for expected credit losses and the establishment of contractual allowances. Accounts receivable are analyzed on a quarterly basis to assess the adequacy of both reserves for expected credit losses and contractual allowances. Revisions in allowances for expected credit loss estimates are recorded as an adjustment to bad debt expense within sales and marketing expenses. Revisions to contractual allowances are recorded as an adjustment to net sales. These estimates are periodically tested against actual collection experience. In addition, we analyze our receivables by geography and by customer type, where appropriate, in developing estimates for expected credit losses.
Recently Issued Accounting Pronouncements
See Note 2 of the Notes to the Unaudited Condensed Consolidated Financial Statements for detailed information regarding the status of recently issued accounting pronouncements.
Non-GAAP Financial Measures
We believe that providing non-GAAP financial measures that exclude certain items provides investors with greater transparency to the information used by senior management in its financial and operational decision-making. We believe it is important to provide investors with the same non-GAAP metrics used to supplement information regarding the performance and underlying trends of our business operations in order to facilitate comparisons to historical operating results and internally evaluate the effectiveness of our operating strategies. Disclosure of these non-GAAP financial measures also facilitates comparisons of our underlying operating performance with other companies in the industry that also supplement their GAAP results with non-GAAP financial measures. The non-GAAP financial measures used in this filing may have limitations as analytical tools, and should not be considered in isolation or as a replacement for GAAP financial measures. Some of the limitations associated with the use of these non-GAAP financial measures are that they exclude items that reflect an economic cost that can have a material effect on cash flows.
Constant Currency
Constant currency is calculated by using foreign currency rates from the comparable, prior-year period, to present net sales at comparable rates. Constant currency can be presented for numerous GAAP measures, but is most commonly used by management to analyze net sales without the impact of changes in foreign currency rates.
EBITDA
EBITDA is a non-GAAP metric defined as earnings before interest income (expense), income taxes, depreciation, and amortization. EBITDA is the primary metric used by our Chief Operating Decision Maker in managing the business.
Free Cash Flow
Free cash flow is calculated by subtracting capital expenditures from net cash from operating activities. Management uses free cash flow as an important indicator of how much cash is generated or used by our normal business operations, including capital expenditures. Management uses free cash flow as a measure of progress on its capital efficiency and cash flow initiatives.
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