NATUS MEDICAL INCORPORATED

(NTUS)
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Delayed Nasdaq  -  04:00 2022-06-24 pm EDT
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05/06NATUS MEDICAL INC Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)
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NATUS MEDICAL INC Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

05/06/2022 | 04:11pm EDT

Overview

The following Management Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") supplements the MD&A in our Annual Report on Form 10-K for the year ended December 31, 2021. MD&A should be read in conjunction with our condensed consolidated financial statements and accompanying footnotes, the risk factors referred to in Part II, Item 1A of this report, our Annual Report filed on Form 10-K for the year ended December 31, 2021 and the cautionary information regarding forward-looking statements at the end of this section.

Our Business

We are recognized by healthcare providers as a leading source for solutions to screen, diagnose, and treat disorders of the brain, neural pathways, and sensory nervous systems. Our service and education complement hardware, advanced software and algorithms, and consumables that provide stimulus, acquire and monitor physiological signals and capture how the body responds, enabling clinicians worldwide to improve patient outcomes and quality of life.

End Markets

We provide innovative healthcare solutions in four product portfolios: Brain, Neural Pathways, Sensory Nervous System and Other.

•Brain - This product portfolio includes solutions focused on diagnosing, monitoring and treating disorders specific to the brain, which include areas of neurodiagnostics and neurocritical care. Key neurodiagnostic product lines in this portfolio include electroencephalography (EEG) used in epilepsy monitoring and polysomnography (PSG) used to diagnose sleep disorders. Key neurocritical care product lines provide access through the cranium to the brain, monitor intracranial pressure and temperature, and provide therapeutic drainage of cerebrospinal fluid in cases of traumatic brain injury, hemorrhagic stroke, and hydrocephalus. This portfolio is comprised of well-known brands in the industry, including Nicolet®, Xltek®, Olympic®, Embla®, Grass®, Natus Quantum®, Trex™ and Camino®.

•Neural Pathways - Focused on nerve and muscle disorders, the Neural Pathways portfolio uses electromyography (EMG) and nerve conduction studies (NCS) testing. These product lines help diagnose neuromuscular diseases, such as myasthenia gravis, movement disorders, such as dystonia and Parkinson's disease, and peripheral neuropathies, carpal tunnel syndrome and pinched nerves. Our portfolio is comprised of well-known brands in the industry, including Nicolet®, Dantec®, UltraPro™ and Natus Elite™.

•Sensory Nervous System - This product portfolio focuses on hearing and balance disorders and pediatric eye imaging. Multiple clinical needs across hearing screening and diagnosis are addressed by this portfolio, including newborn hearing screening, hearing assessment and diagnostics and hearing aid fitting. A

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comprehensive list of balance tests helps in the diagnosis of vestibular disorders, such as dizziness and vertigo. Eye imaging is used to diagnose and monitor retinopathy of prematurity to help prevent blindness in premature babies. Natus products are sold under trusted brand names, including ALGO®, RetCam®, Aurical®, Bio-logic®, Madsen® and Otoscan®.

•Other - The products in this portfolio do not directly fit within the Brain, Neural Pathways or Sensory Nervous System portfolio. These solutions span eight product lines, including phototherapy for jaundice management, video streaming of newborns in the NICU, data management for newborn care and a full range of shunts and valves for neurosurgical applications, among others. This portfolio includes several well-known brands, such as neoBLUE®, NICVIEW®, Vac-Pac® and Neometrics®.

Segment and Geographic Information

We operate as one operating segment and one reportable segment, which provides healthcare products, and services focused on solutions to screen, diagnose, and treat disorders affecting the brain, neural pathways, and eight sensory nervous systems. Financial information is reviewed on a consolidated basis for purposes of making operating decisions and assessing financial performance. Consolidated financial information is accompanied by disaggregated information about revenues by end market and geographic region. We do not assess the performance of our end markets or geographic regions on measures of profit or loss, or asset-based metrics. We have disclosed the revenues for each of our end markets and geographic regions to provide the reader of the financial statements transparency into our operations.

Information regarding our revenues and long-lived assets in the U.S. and in countries outside the U.S. is contained in Note 14 - Segment, Customer and Geographic Information of our condensed consolidated financial statements included in this report and is incorporated in this section by reference.

Revenue by Product Category

We generate our revenue from sales of Devices and Systems, which are generally non-recurring, and from related Supplies and Services, which are generally recurring. The products that are attributable to these categories are described in our Annual Report on Form 10-K for the year ended December 31, 2021. Revenue from Devices and Systems, Supplies, and Services, as a percent of total revenue for the three months ended March 31, 2022 and 2021, is as follows:

                                               Three Months Ended
                                                   March 31,
                                                2022             2021
                   Devices and Systems                 63  %      65  %
                   Supplies                            23  %      22  %
                   Services                            14  %      13  %
                   Total                              100  %     100  %


2022 First Quarter Overview

Our business and operating results are driven in part by worldwide economic conditions. Our revenue is significantly dependent on both capital spending by hospitals in the United States and healthcare spending by ministries of health outside the United States. While we have no direct exposure to Russia and Ukraine, we are monitoring any broader economic impact from the current crisis, especially on commodities.

We experienced an increase in demand in the United States and Europe, during the first quarter compared to the same period in the prior year. Our consolidated revenue for the first quarter ended March 31, 2022 was $119.8 million compared to $114.9 million in the first quarter of the previous year, an increase of $4.9 million.

Our net income was $1.9 million or $0.06 per diluted share in the three months ended March 31, 2022, compared with net income of $2.4 million or $0.07 per diluted share in the same period in 2021. The decrease in net


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income is due to lower gross margin and higher tax provision due to enactment of IRC Section 174, partly offset by increased revenue and lower operating expenses.

COVID-19 Update

Healthcare providers and patients continue to depend on our products and services every day. Our team members and partners are continuing to maintain our supply chain, manufacturing and delivery of our products and services. The health and welfare of our employees, our customers and our partners remain our top priority as we continue our business operations.

We have implemented safeguards in our facilities to protect team members, including social distancing practices, work from home and other measures consistent with specific regulatory requirements and guidance from health authorities. As an essential supplier of healthcare products and services, all of our manufacturing, engineering and customer support functions remain fully operational and will continue to support customers with vital supplies, service and equipment. Supply chain delays and constraints, as well as cost increases for semiconductors, have impacted our ability to ship products in the last few quarters. We are working with our suppliers to reduce constraints by providing forecasts further into the future and closely monitoring and communicating changes in the forecast, however we remain uncertain of when the supply chain will stabilize.

Impact to our supply chain

Many of our materials are single source and require lengthy qualification periods. Disruptions in our supply chain could negatively impact our ability to produce and supply our finished products. We continue to experience some extended lead times and delays in receiving supplies and finished goods which impacted revenue this period. We are working closely with our suppliers to manage orders and proactively resolve delays in the materials we require to meet our demand.

Application of Critical Accounting Estimates

We prepare our financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP"). In so doing, we must often make estimates and use assumptions that can be subjective and, consequently, our actual results could differ from those estimates. For any given individual estimate or assumption we make, there may also be other estimates or assumptions that are reasonable. Our estimates are based on our historical experience and a variety of other assumptions that we believe to be reasonable under the circumstances. We evaluate our estimates, assumptions, and judgements on a regular basis.

We believe that the following critical accounting estimates require the use of significant assumptions and judgments to have a full understanding of our financial statements:

•Inventory valuation

By their nature, these estimates and judgements are subject to an inherent degree of uncertainty. The use of different estimates, assumptions, and judgments could have a material effect on the reported amounts of assets, liabilities, revenue, expenses, and related disclosures as of the date of the financial statements and during the reporting period. These critical accounting estimates are described in more detail in our Annual Report on Form 10-


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Table of Contents K for the year ended December 31, 2021, under Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.

Recent Developments

On April 17, 2022, we entered into an Agreement Plan of Merger (the "Merger Agreement") with Prince Parent Inc., a Delaware corporation ("Parent"), and Prince Mergerco Inc., a Delaware corporation and wholly owned subsidiary of Parent ("Merger Sub"), providing for, among other things, the merger of Merger Sub with and into Natus (the "Merger"), with Natus surviving the Merger as a wholly owned subsidiary of Parent. Under the terms of the Merger Agreement, the Company's stockholders will receive $33.50 in cash for each share of common stock they hold on the closing date of the Merger. The transaction is expected to close in the third quarter of 2022, subject to customary closing conditions, including, but not limited to, the: (i) adoption of the Merger Agreement by the holders of a majority of the outstanding shares of Company Common Stock, (ii) expiration or termination of any waiting periods applicable to the consummation of the Merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and certain other applicable foreign antitrust laws and foreign direct investment laws of certain other jurisdictions; and (iii) absence of any law or order restraining, enjoining or otherwise prohibiting the Merger. The Merger is not subject to any financing condition. There can be no assurance that the proposed Merger will be consummated.

Results of Operations

The following table sets forth selected consolidated statement of operations data as a percentage of total revenue for the periods indicated:

                                                         Three Months Ended
                                                             March 31,
                                                         2022              2021
         Revenue                                             100.0  %     100.0  %
         Cost of revenue                                      44.1  %      40.6  %
         Intangibles amortization                              1.3  %       1.5  %
         Gross profit                                         54.6  %      57.9  %
         Operating expenses:
         Marketing and selling                                24.7  %      25.2  %
         Research and development                             11.0  %      12.2  %
         General and administrative                           10.7  %      12.9  %
         Intangibles amortization                              3.0  %       3.4  %
         Restructuring                                         1.7  %       0.2  %
         Total operating expenses                             51.1  %      53.9  %
         Income from operations                                3.5  %       4.0  %
         Other expense, net                                   (0.7) %      (1.4) %
         Income before provision for income tax                2.8  %       2.6  %
         Provision for income taxes                            1.2  %       0.4  %
         Net income                                            1.6  %       2.2  %


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Revenues

The following table shows revenue by products during the three months ended March 31, 2022 and March 31, 2021 (in thousands):

                                                           Three Months Ended
                                                               March 31,
                                                    2022           2021         Change
         Brain Products:
         Devices and Systems                     $  37,807      $  37,293          1  %
         Supplies                                    6,291          5,486         15  %
         Services                                    7,290          5,705         28  %
         Total Brain Revenue                        51,388         48,484          6  %
         Neural Pathway Products:
         Devices and Systems                         9,657          8,832          9  %
         Supplies                                    9,531          8,751          9  %
         Services                                      204            257        (21) %
         Total Neural Pathways Revenue              19,392         17,840          9  %
         Sensory Nervous Systems Products:
         Devices and Systems                        23,342         21,292         10  %
         Supplies                                    8,473          8,143          4  %
         Services                                    5,858          6,097         (4) %
         Total Sensory Nervous Systems Revenue      37,673         35,532          6  %
         Other Products:
         Devices and Systems                         5,025          7,067        (29) %
         Supplies                                    2,781          2,898         (4) %
         Services                                    3,534          3,106         14  %
         Total Other Revenue                        11,340         13,071        (13) %
         Total Revenue                           $ 119,793      $ 114,927          4  %

For the three months ended March 31, 2022, Brain revenue increased by 6% compared to the same period last year driven by higher sales of devices and supplies, particularly in EEG.

For the three months ended March 31, 2022, Neural Pathways revenue increased by 9% compared to the same period last year due to an increase in both device and supplies revenue.

For the three months ended March 31, 2022, Sensory Nervous Systems revenue increased by 6% compared to the same period last year due to increased demand for our devices and supplies, particularly in our Digital Eye Imaging & Hearing Fitting products.

For the three months ended March 31, 2022, Other revenue decreased by 13% compared to the same period last year mostly due to a large one-time order in the first quarter of 2021 for our NicView products that did not repeat in the first quarter of 2022.

Revenue from domestic sales increased to $70.0 million for the three months ended March 31, 2022 compared to $67.8 million in the three months ended March 31, 2021. The increase was driven by improved demand for our Brain, Neural Pathways and Sensory Nervous Systems products.

Revenue from international sales increased to $49.8 million for the three months ended March 31, 2022 compared to $47.2 million for the three months ended March 31, 2021. The increase was driven by improved demand by our Brain, Neural Pathways and Sensory Nervous Systems products.


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Cost of Revenue and Gross Profit

Cost of revenue and gross profit consists of (in thousands):

                                                  Three Months Ended
                                                      March 31,
                                                 2022            2021
                  Revenue                    $ 119,793       $ 114,927
                  Cost of revenue               52,781          46,688
                  Intangibles amortization       1,600           1,751
                  Gross profit                  65,412          66,488
                  Gross profit percentage         54.6  %         57.9  %

For the three months ended March 31, 2022, gross profit as a percentage of revenue decreased 3.3% compared to the same period in the prior year. The decrease was mainly driven by higher supply chain costs in procuring semiconductors for our products and the costs of freight, and we expect this trend will continue throughout the year.

Operating Costs

Operating costs consist of (in thousands):

                                                   Three Months Ended
                                                       March 31,
                                                  2022           2021
                  Marketing and selling        $ 29,551       $ 28,971
                  Percentage of revenue            24.7  %        25.2  %
                  Research and development     $ 13,224       $ 14,040
                  Percentage of revenue            11.0  %        12.2  %
                  General and administrative   $ 12,807       $ 14,855
                  Percentage of revenue            10.7  %        12.9  %
                  Intangibles amortization     $  3,598       $  3,897
                  Percentage of revenue             3.0  %         3.4  %
                  Restructuring                $  2,051       $    205
                  Percentage of revenue             1.7  %         0.2  %


Marketing and Selling

Marketing and selling expenses increased for the three months ended March 31, 2022. The increase was primarily driven by higher travel expenses resulting from increased commercial activity compared to the same periods last year.

Research and Development

Research and development expenses decreased slightly during the three months ended March 31, 2022 compared to the same periods in 2021. The decrease is the result of lower project spend due to timing.

General and Administrative

General and administrative expense during the three months ended March 31, 2022 decreased when compared to the same periods in the prior year. This decrease was due to lower stock compensation and lower outside services spending.

Intangibles Amortization

Intangibles amortization remained relatively flat during the three months ended March 31, 2022 as compared to the same periods in 2021 due to currency exchange fluctuations.


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Restructuring

Restructuring expenses increased during the three months ended March 31, 2022 compared to the same periods in 2021. The increase was primarily driven by higher severance costs incurred.

Other Expense, net

Other expense, net consists of investment income, interest expense, net currency exchange gains and losses, and other miscellaneous income and expense. For the three months ended March 31, 2022 we reported $0.8 million of other expense compared to $1.7 million of other expense for the same period in 2021. The decrease during the three months was due to less interest expense and currency exchange fluctuations.

Provision for Income Tax

Our tax provision for interim periods is determined using an estimated annual effective tax rate, adjusted for discrete events arising in each respective quarter. During each interim period, we update the estimated annual effective tax rate which is subject to significant volatility due to several factors, including our ability to accurately predict the income before provision for income taxes in multiple jurisdictions, the effects of acquisitions, the integration of those acquisitions, and changes in tax law. In circumstances where we are unable to predict income in multiple jurisdictions, the actual year to date effective tax rate may be the best estimate of the annual effective tax rate for purposes of determining the interim provision for income tax.

We recorded income tax expense of $1.5 million and $0.5 million for the three months ended March 31, 2022 and March 31, 2021, respectively. The effective tax rate was 43.6% and 16.4% for the three months ended March 31, 2022 and March 31, 2021, respectively. The increase in the effective tax rate for the three months ended March 31, 2022 compared with the three months ended March 31, 2021, is primarily attributable to a tax law change in effect from January 1, 2022 that requires the capitalization of research and experimental costs under IRC Section 174 and directly increased the Company's Subpart F inclusion. The approximate impact of the change in the estimated tax rate due to all impacts from IRC Section 174 resulted in a $0.01 reduction in the GAAP earnings per share. Other significant factors impacting the current period effective tax rate included the benefit of Federal and California research and development credits, offset by global intangible low taxed income inclusions ("GILTI") that was also impacted by IRC Section 174, and non-deductible executive compensation expenses. Factors impacting the effective rate for the three months ended March 31, 2021, include the benefit of Federal and California research and development credits, favorable discrete items for the carryback of losses, partially offset by non-deductible executive compensation expenses, and other discrete events.

Under the Tax Cut and Jobs Act (the "Act") enacted on December 22, 2017, research and experimental ("R&E") expenditures under IRC Section 174 incurred for tax years beginning after December 31, 2021 must be capitalized and amortized ratably over five or fifteen years for tax purposes, depending on where the research activities are conducted, U.S. or foreign respectively. Although there is proposed legislation that would defer the capitalization requirement to later years, we have no assurance that IRC Section 174 will be repealed or otherwise modified.

We recorded no change related to unrecognized tax benefits for the three months ended March 31, 2022. Within the next twelve months, it is possible that the uncertain tax positions may change with a range of approximately zero to $0.8 million. Our tax returns remain open to examination as follows: U.S Federal, 2018 through 2021, U.S. states, 2017 through 2021, and significant foreign jurisdictions, generally 2017 through 2021.


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Liquidity and Capital Resources

Liquidity and capital resources consist of (in thousands):

                               March 31, 2022       December 31, 2021
Cash and cash equivalents     $        84,285      $           75,595

Working capital                       173,913                 162,690


                                                          Three Months Ended
                                                              March 31,
                                                          2022           2021
Net cash provided by operating activities             $    8,897      $ 24,703
Net cash used in investing activities                     (1,634)         (731)

Net cash provided by (used in) financing activities 2,516 (21,275)

We believe that our current cash and cash equivalents and any cash generated from operations will be sufficient to meet our ongoing operating requirements for the foreseeable future.

As of March 31, 2022, we had cash and cash equivalents outside the U.S. in certain of our international subsidiaries of $56.1 million, primarily in Canada and Ireland. We intend to permanently reinvest the cash held by our international subsidiaries except for Excel Tech Corporation and Natus Manufacturing Limited, which we intend to repatriate. A net deferred tax liability has been recorded for the potential future repatriation. If, however, a portion of permanently reinvested funds were needed for and distributed to our operations in the United States, we would be subject to additional U.S. income taxes and foreign withholding taxes depending on facts and circumstances at the time of distribution. The amount of taxes due would depend on the amount and manner of repatriation, as well as the country from which the funds were repatriated.

We have a Credit Agreement with JP Morgan, Citibank, and Wells Fargo. During the third quarter of 2020 we amended the terms of the Credit Agreement to extend the maturity of the original agreement, reduce the aggregate value of the revolving credit facility, and amend certain covenants. The amended Credit Agreement provides for an aggregate $150.0 million of secured revolving credit facility. The Credit Agreement contains covenants, including covenants relating to maintenance of books and records, financial reporting and notification, compliance with laws, maintenance of properties and insurance, and limitations on guaranties, investments, issuance of debt, lease obligations and capital expenditures, and is secured by virtually all of our assets. The Credit Agreement provides for events of default, including failure to pay any principal or interest when due, failure to perform or observe covenants, bankruptcy or insolvency events and the occurrence of the event has a material adverse effect. The Credit Agreement matures on September 25, 2023, at which time all principal amounts outstanding under the Credit Agreement will be due and payable. We have no other significant credit facilities. As of March 31, 2022, no amounts were outstanding under the Credit Agreement.

During the three months ended March 31, 2022 cash provided by operating activities of $8.9 million was the result of $1.9 million of net income, non-cash adjustments to net income of $11.0 million which was primarily driven by an adjustment for depreciation and amortization of $6.7 million, and net cash outflows of $4.0 million from changes in operating assets and liabilities primarily resulting from reductions in accounts receivable and increases in inventory. Cash used in investing activities during the period was $1.6 million consisting of $1.1 million to acquire other property and equipment, $0.6 million for purchase of equity method investments. Cash provided by financing activities during the three months ended March 31, 2022 was $2.5 million and consisted of $4.2 million stock option exercises offset by $1.2 million for taxes paid related to net share settlement of equity awards and $0.4 million for principal payments of financing lease liability.

During the three months ended March 31, 2021 cash provided by operating activities of $24.7 million was the result of $2.4 million of net income, non-cash adjustments to net income of $11.0 million which was primarily driven by an adjustment for depreciation and amortization of $7.3 million, and net cash inflows of $11.3 million from changes in operating assets and liabilities primarily driven by reductions in accounts receivable and inventory. Cash used in investing activities during the period was $0.7 million to acquire other property and equipment. Cash


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used in financing activities during the three months ended March 31, 2021 was $21.3 million and consisted of repayment on borrowing of $20.0 million, $1.2 million for taxes paid related to net share settlement of equity awards, and $0.1 million for principal payments of financing lease liability.

Our future liquidity and capital requirements will depend on numerous factors, including the:

•Extent to which we make acquisitions;

•Amount and timing of revenue;

•Extent to which our existing and new products gain market acceptance;

•Cost and timing of product development efforts and the success of these development efforts;

•Cost and timing of marketing and selling activities; and

•Availability of borrowings under line of credit arrangements and the availability of other means of financing.

Contractual Obligations

In the normal course of business, we enter into obligations and commitments that require future contractual payments. The commitments result primarily from purchase orders placed with contract vendors that manufacture some of the components used in our medical devices and related disposable supply products, purchase orders placed for employee benefits and outside services, as well as commitments for leased office space, leased equipment, and bank debt.

As of March 31, 2022, we have unconditional purchase obligations of $120.7 million that payments are due within the next year and $84.9 million due within one to three years. Purchase obligations are defined as agreements to purchase goods or services that are enforceable and legally binding. Included in the purchase obligations are obligations related to purchase orders for inventory purchases under our standard terms and conditions and under negotiated agreements with vendors. We expect to receive consideration (products or services) for these purchase obligations. The purchase obligation amount does not represent all anticipated purchases in the future, but represent only those items for which we are contractually obligated. This does not include obligations under employment agreements for services rendered in the ordinary course of business.

As of March 31, 2022, we have estimated interest payments of $1.0 million due less than one year and $0.6 million due within one to three years. These interest payments are an estimate of expected interest payments but could vary materially based on the timing of future loan draws and payments. See Note 13 of our Consolidated Financial Statements for further discussion on debt and credit arrangements.

As of March 31, 2022, we have $5.7 million of tax obligation relating to repatriation tax. The repatriation tax is a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017 due to the enactment in December 2017 of the Tax Act.

We are not able to reasonably estimate the timing of any potential payments for uncertain tax positions under Accounting Standards Codification ("ASC") 740, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement 109, therefore contractual obligations exclude any potential tax payments related to our ASC 740 liability for uncertain positions. See Note 12 of our Consolidated Financial Statements for further discussion on income taxes.

Recently Issued Accounting Pronouncements

None.

Cautionary Information Regarding Forward Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 about Natus Medical Incorporated. Forward-looking


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statements can be identified by the words "expects," "anticipates," "believes," "intends," "estimates," "plans," "will," "outlook" and other similar expressions. Forward-looking statements are based on management's current plans, estimates, assumptions and projections, and speak only as of the date they are made. These forward-looking statements within Item 2 include, without limitation, statements regarding our ability to consummate the proposed Merger, and the timing, costs and any benefits of such transaction, the impact of COVID-19 pandemic on our business, the sufficiency of our current cash, cash equivalents and short-term investment balances, any cash generated from operations to meet our ongoing operating and capital requirements for the foreseeable future, outcomes of new product development, improved operations performance and profitability as the result of restructuring activities, and our intent to acquire additional technologies, products or businesses.

Forward-looking statements are not guarantees of future performance and are subject to substantial risks and uncertainties that could cause the actual results predicted in the forward-looking statements as well as our future financial condition and results of operations to differ materially from our historical results or currently anticipated results. Investors should carefully review the information contained under the caption "Risk Factors" referred to in Part II, Item 1A of this report for a description of risks and uncertainties. All forward-looking statements are based on information available to us on the date hereof, and we assume no obligation to update forward-looking statements.

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