Anika Therapeutics, Inc. - Quarter Report: 2021 June (Form 10-Q)

ANIKA THERAPEUTICS, INC.

TABLE OF CONTENTS

References in this Quarterly Report on Form 10-Q to “we,” “us,” “our” and “our company,” and other similar references refer to Anika Therapeutics, Inc. and its subsidiaries unless the context otherwise indicates.

Anika, Arthrosurface, Anika Therapeutics, Cingal, Hyaff, Monovisc, Orthovisc, Parcus Medical, Tactoset, Hyvisc and WristMotion are our registered trademarks that appear in this Quarterly Report on Form 10-Q. For convenience, these trademarks appear in this Quarterly Report on Form 10-Q without ® and ™ symbols, but that practice does not mean that we will not assert, to the fullest extent under applicable law, our rights to the trademarks. This Quarterly Report on Form 10-Q also contains trademarks and trade names that are the property of other companies and licensed to us. 

Anika Therapeutics, Inc. and Subsidiaries
Consolidated Balance Sheets
(in thousands, except per share data)
(unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements. 

Anika Therapeutics, Inc. and Subsidiaries

Consolidated Statements of Operations and Comprehensive Income

(in thousands, except per share data)

(unaudited) 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

Anika Therapeutics, Inc. and Subsidiaries

Consolidated Statements of Stockholders' Equity

(in thousands)

(unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

Anika Therapeutics, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

ANIKA THERAPEUTICS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(amounts in thousands, except share and per share amounts or as otherwise noted)

(unaudited)

Anika Therapeutics, Inc. (“the Company”) is a global joint preservation company that creates and delivers meaningful advancements in early intervention orthopedic care, including in the areas of osteoarthritis (“OA”) pain management, regenerative solutions, soft tissue repair and bone preserving joint technologies.

In early 2020, the Company expanded its overall technology platform through its strategic acquisitions of Parcus Medical, LLC (“Parcus Medical”), a sports medicine implant and instrumentation solutions provider focused on sports medicine and soft tissue repair, and Arthrosurface, Inc. (“Arthrosurface”), a company specializing in less invasive, bone preserving partial and total joint replacement solutions. These acquisitions broadened the Company’s product portfolio, developed over its nearly 30 years of expertise in hyaluronic acid technology, into joint preservation and restoration, added high-growth revenue streams, increased its commercial capabilities, diversified its revenue base, and expanded its product pipeline and research and development expertise.

The Company is subject to risks common to companies in the biotechnology and medical device industries including, but not limited to, development by the Company or its competitors of new technological innovations, dependence on key personnel, protection of proprietary technology, commercialization of existing and new products, and compliance with U.S. Food and Drug Administration (“FDA”) and foreign regulations and approval requirements, as well as the ability to grow the Company’s business through appropriate commercial strategies.

There continue to be uncertainties regarding the pandemic of the novel coronavirus (“COVID-19”), and the Company is closely monitoring the impact of COVID-19 on all aspects of its business, including how it will impact its customers, employees, suppliers, vendors, and business partners. The Company is unable to predict the specific impact that COVID-19 may have on its financial position and operations moving forward due to the numerous uncertainties. Any estimates made herein may change as new events occur and additional information is obtained, and actual results could differ materially from any estimates made herein under different assumptions or conditions. The Company will continue to assess the evolving impact of COVID-19.

The accompanying unaudited consolidated financial statements and related notes have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and in accordance with accounting principles generally accepted in the United States (“US GAAP”). The financial statements include the accounts of Anika Therapeutics, Inc. and its subsidiaries. Inter-company transactions and balances have been eliminated. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with US GAAP have been condensed or omitted from this report pursuant to SEC rules and regulations relating to interim financial statements. The December 31, 2020 balances reported herein are derived from the audited consolidated financial statements. In the opinion of management, these unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to fairly state the consolidated financial statements.

The accompanying unaudited consolidated financial statements and related notes should be read in conjunction with the Company’s annual financial statements filed with its Annual Report on Form 10-K for the year ended December 31, 2020. The results of operations for the three- and six-month periods ended June 30, 2021 are not indicative of the results to be expected for the year ending December 31, 2021.

Segment Information

Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is its President and Chief Executive Officer as of June 30, 2021. Based on the criteria established by Accounting Standards Codification (“ASC”) 280, Segment Reporting, the Company has one operating and reportable segment.

Recent Accounting Adoptions

In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2019-12, Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes, to simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify US GAAP for other areas of Topic 740 by clarifying and amending existing guidance. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020 and interim periods within those fiscal years. The Company adopted ASU 2019-12 as of January 1, 2021. The adoption of this standard did not have a significant impact on the Company’s consolidated financial statements and related disclosures.  

Parcus Medical, LLC

On January 24, 2020, the Company completed the acquisition of Parcus Medical pursuant to the terms of the Agreement and Plan of Merger, dated as of January 4, 2020 (the “Parcus Medical Merger Agreement”), by and among the Company, Parcus Medical, the Unitholder Representative, and Sunshine Merger Sub LLC, a Wisconsin limited liability company and a wholly-owned subsidiary of the Company. At the closing date, Parcus Medical became a wholly-owned subsidiary of the Company. Parcus Medical is a sports medicine implant and instrumentation solutions provider focused on surgical repair and reconstruction of soft tissue.

The acquisition of Parcus Medical has been accounted for as a business combination under ASC 805. Under ASC 805, Business Combinations, the assets acquired and liabilities assumed in a business combination must be recorded at their fair value as of the acquisition date. The Company’s consolidated financial statements include results of operations for Parcus Medical from the January 24, 2020 acquisition date.

Consideration Transferred

Pursuant to the Parcus Medical Merger Agreement, the Company acquired all outstanding equity of Parcus Medical for estimated total purchase consideration of $75.1 million, as of January 24, 2020, which consisted of:

Contingent consideration represents additional payments that the Company may be required to make in the future, which could total up to $60.0 million depending on the level of net sales of Parcus Medical products generated in 2020 through 2022. The fair value of contingent consideration related to net sales as of January 24, 2020 was determined based on a Monte Carlo simulation model in an option pricing framework at the acquisition date, whereby a range of possible scenarios were simulated. There was deferred consideration related to certain purchase price holdbacks, which was resolved within one year of the acquisition date in accordance with the Parcus Merger Agreement and was recorded in accounts payable as of December 31, 2020. The liability for contingent and deferred consideration is included in current and long-term liabilities on the consolidated balance sheets and will be remeasured at each reporting period until the contingency is resolved. See Note 4, Fair Value Measurements, for additional discussion of contingent consideration as of June 30, 2021 and December 31, 2020.

Acquisition-related costs are not included as a component of consideration transferred but are expensed in the periods in which the costs are incurred. The Company incurred approximately $1.9 million in transaction costs related to the Parcus Medical acquisition during the three-month period ending March 31, 2020. The transaction costs subsequent to March 31, 2020 were immaterial. The transaction costs have been included in selling, general and administrative expenses in the consolidated statements of operations.

Fair Value of Net Assets Acquired

The estimate of fair value as of the acquisition date required the use of significant assumptions and estimates. Critical estimates included, but were not limited to, future expected cash flows, including projected revenues and expenses, and the applicable discount rates. These estimates were based on assumptions that the Company believes to be reasonable, however, actual results may differ from these estimates.

The allocation of purchase price to the identifiable assets acquired and liabilities assumed was based on estimates of fair value as of January 24, 2020, and is as follows:

Subsequent to the acquisition date, during the three-month period ended September 30, 2020, the Company completed the identification and confirmation of Parcus Medical inventory in the possession of its direct and distributor sales force, which resulted in an increase to the fair value of inventory of $1.9 million as of the January 24, 2020 acquisition date. As a result, the Company recorded this addition to inventory with a corresponding reduction to goodwill as a measurement period adjustment which was reflected to the goodwill amount included in the table above. The impact to the consolidated statement of operations related to this adjustment was not material.

The acquired intangible assets based on estimates of fair value as of January 24, 2020 are as follows:

The fair value of the developed technology intangible assets has been estimated using the multi-period excess earnings method, which is based on the principle that the value of an intangible asset is equal to the present value of the incremental after-tax cash flow attributable to the asset, after charges for other assets employed by the business. The fair value of the customer relationships has been estimated using the avoided costs/lost profits method, which is based on the principle that the value of an intangible asset is based on consideration of the total costs that would be avoided by having this asset in place. The fair value of the trade name has been estimated using the relief from royalty method of the income approach, which is based on the principle that the value of an intangible asset is equal to the present value of the after-tax royalty savings attributable to owning the intangible asset. Key estimates and assumptions used in these models are projected revenues and expenses related to the asset, estimated contributory asset charges, estimated costs to recreate the asset, and a risk-adjusted discount rate used to calculate the present value of the future expected cash inflows or cash outflows avoided from the asset.

The fair value of developed technology will be amortized over a useful life of 15 years, the fair value of customer relationships over 10 years, and the fair value of the trade name over 5 years.

The excess of the purchase price over the fair value of the net assets acquired was recorded as goodwill and assigned to the newly established reporting unit for Parcus Medical and Arthrosurface. The goodwill is attributable to the workforce of the business and the value of future technologies expected to arise after the acquisition. Goodwill will not be amortized and is expected to be deductible for income tax purposes as the acquisition of the limited liability company is an asset purchase for tax purposes. See Note 7, Goodwill, for further discussion.

Arthrosurface, Inc.

On February 3, 2020, the Company completed the acquisition of Arthrosurface, pursuant to the terms of the Agreement and Plan of Merger, dated as of January 4, 2020 (the “Arthrosurface Merger Agreement”), by and among the Company, Arthrosurface, the Stockholder Representative, and Button Merger Sub, a Delaware corporation and a wholly-owned subsidiary of the Company. At the closing date, Arthrosurface became a wholly-owned subsidiary of the Company. Arthrosurface is a joint preservation technology company specializing in less invasive, bone-preserving partial and total joint replacement solutions.

The acquisition of Arthrosurface has been accounted for as a business combination under ASC 805. Under ASC 805, assets acquired and liabilities assumed in a business combination must be recorded at their fair values as of the acquisition date. The Company’s consolidated financial statements include results of operations for Arthrosurface from the February 3, 2020 acquisition date. 

Consideration Transferred

Pursuant to the Arthrosurface Merger Agreement, the Company acquired all outstanding equity of Arthrosurface for estimated total purchase consideration of $90.3 million, as of February 3, 2020, which consisted of:

Pursuant to the Arthrosurface Merger Agreement, the Company could be required to make future payments up to $40.0 million depending on the achievement of regulatory milestones and the level of net sales of Arthrosurface products in 2020 through 2021. The fair value of contingent consideration related to regulatory milestones as of February 3, 2020 was determined through a scenario-based discounted cash flow analysis using scenario probabilities and regulatory milestone dates. The fair value of contingent consideration related to net sales achievement as of February 3, 2020 was determined based upon a Monte Carlo simulation approach at acquisition date, whereby a range of possible scenarios were simulated. In October 2020 and July 2021, based upon the achievement of two distinct regulatory milestones, the Company paid $5.0 million and $10.0 million, respectively. The liability for contingent consideration is included in current and long-term liabilities on the consolidated balance sheets and will be remeasured at each reporting period until the contingency is resolved. See Note 4, Fair Value Measurements, for additional discussion of contingent consideration as of June 30, 2021 and December 31, 2020.

Acquisition-related costs are not included as a component of consideration transferred but are expensed in the periods in which the costs are incurred. The Company incurred approximately $2.2 million in transaction costs related to the Arthrosurface acquisition during the three-month period ending March 31, 2020. The transaction costs subsequent to March 31, 2020 were immaterial. The transaction costs have been included in selling, general and administrative expenses in the consolidated statements of operations.

Fair Value of Net Assets Acquired

The estimate of fair value required the use of significant assumptions and estimates. Critical estimates included, but were not limited to, future expected cash flows, including projected revenues and expenses, and the applicable discount rates. These estimates were based on assumptions that the Company believes to be reasonable. However, actual results may differ from these estimates.

The allocation of purchase price to the identifiable assets acquired and liabilities assumed was based on estimates of fair value as of February 3, 2020, as follows:

The fair value of the developed technology intangible assets has been estimated using the multi-period excess earnings method, which is based on the principle that the value of an intangible asset is equal to the present value of the incremental after-tax cash flow attributable to the asset, after charges for other assets employed by the business. The fair value of the customer relationships has been estimated using the avoided costs/lost profits method, which is based on the principle that the value of an intangible asset is based on consideration of the total costs that would be avoided by having this asset in place. The fair value of the trade name has been estimated using the relief from royalty method of the income approach, which is based on the principle that the value of an intangible asset is equal to the present value of the after-tax royalty savings attributable to owning the intangible asset. Key estimates and assumptions used in these models are projected revenues and expenses related to the asset, estimated contributory asset charges, estimated costs to recreate the asset, and a risk-adjusted discount rate used to calculate the present value of the future expected cash inflows or cash outflows avoided from the asset.

The fair value of developed technology will be amortized over an estimated useful life of 15 years, the fair value of customer relationships over 10 years, and the fair value of the trade name over 5 years. A total of $0.6 million represents the fair value of IPR&D with an indefinite useful life that will be evaluated for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired.

The excess of the purchase price over the fair value of the net assets acquired was recorded as goodwill and assigned to the newly established reporting unit for Parcus Medical and Arthrosurface. The goodwill is attributable to the workforce of the business and the value of future technologies expected to arise after the acquisition. Goodwill will not be amortized and is not expected to be deductible for income tax purposes as the acquisition of the corporation is a stock purchase for tax purposes See Note 7, Goodwill, for further discussion.

Pro forma Information

The Parcus Medical and Arthrosurface acquisitions were both completed in the first quarter of 2020. Both acquired companies have similar businesses with all of their products in the Joint Preservation and Restoration product family, serving orthopedic surgeons, ambulatory surgical centers and hospitals. The Company has combined legacy Anika, Parcus Medical and Arthrosurface pro forma supplemental information as follows.

The unaudited pro forma information for the three- and six-month periods ended June 30, 2021 and 2020 was calculated after applying the Company’s accounting policies and the impact of acquisition date fair value adjustments. The pro forma financial information presents the combined results of operations of Anika, Parcus Medical and Arthrosurface as if the acquisitions had occurred on January 1, 2019 after giving effect to certain pro forma adjustments. The pro forma adjustments reflected herein include only those adjustments that are factually supportable and directly attributable to the acquisitions.

These pro forma adjustments include: (i) a net increase in amortization expense to record amortization expense for the aforementioned acquired identifiable intangible assets, (ii) an adjustment to cost of revenue based on the preliminary inventory step-up and the anticipated inventory turnover, (iii) a net decrease in interest expense as a result of eliminating interest expense and interest income related to borrowings that were settled in accordance with the respective Parcus Medical Merger Agreement and Arthrosurface Merger Agreement, (iv) an adjustment to record the acquisition-related transaction costs in the period required, and (v) the tax effect of the pro forma adjustments using the anticipated effective tax rate. The effective tax rate of the combined company could be materially different from the effective rate presented in this unaudited pro forma combined financial information. As a result of the transaction, the combined company may be subject to annual limitations on its ability to utilize pre-acquisition net operating loss carryforwards to offset future taxable income. The amount of the annual limitation is determined based on the value of Anika immediately prior to the acquisition. As further information becomes available, any such adjustment described above could be material to the amounts presented in the unaudited pro forma combined financial statements. The pro forma information does not purport to be indicative of the results of operations that actually would have resulted had the combination occurred at the beginning of each period presented, or of future results of the consolidated entities.

The following table presents unaudited supplemental pro forma information:

The Company held investments in U.S. treasury bills of $2.5 million as available-for-sale securities at December 31, 2020. Unrealized losses and the associated tax impact on the Company’s available-for-sale securities were insignificant at December 31, 2020. There were no available-for-sale securities as of June 30, 2021.

The Company’s investments are all classified within Level 1 of the fair value hierarchy and are valued based on quoted prices in active markets. For cash, current receivables, accounts payable, and interest accrual, the carrying amounts approximate fair value, because of the short maturity of these instruments, and therefore fair value information is not included in the table below. Contingent consideration related to the previously described business combinations are classified within Level 3 of the fair value hierarchy as the determination of fair value uses considerable judgement and represents the Company’s best estimate of an amount that could be realized in a market exchange for the asset or liability.

The classification of the Company’s cash equivalents and investments within the fair value hierarchy is as follows:

Contingent Consideration

The following table provides a rollforward of the contingent consideration related to business acquisitions discussed in Note 3, Business Combinations.

Under the Parcus Medical Merger Agreement and Arthrosurface Merger Agreement, there are earn-out milestones totaling $100 million payable from 2020 to 2022. Parcus Medical has net sales earn-out milestones annually from 2020 to 2022, while Arthrosurface has both regulatory and net sales earn-out milestones annually in 2020 and 2021. Projected contingent payment amounts are discounted back to the current period using a discounted cash flow model or a Monte Carlo simulation approach. The unobservable inputs used in the fair value measurement of the Company’s contingent consideration are the probabilities of successful achievement, the net sales estimates, the weighted average cost of capital used for the Monte Carlo simulation, discount rate and the periods in which the milestones are expected to be achieved. The discount rates used for the net sales milestones ranged from 2.2% - 2.3%, and for the regulatory earn-out milestones the discount rate was 2.7%. The weighted average cost of capital for Arthrosurface and Parcus increased from 11.4% as of December 31, 2020 to 11.8% as of June 30, 2021. Increases or decreases in the discount rate would result in a lower or higher fair value measurement, respectively. As of December 31, 2020, the probability of successful achievement of the regulatory earn-out milestones was determined to be in a range of 60%-75%. As of June 30, 2021, the probability of successful achievement of one of the regulatory earn-out milestones was determined to be 100% as the Company achieved a regulatory milestone prior to June 30, 2021. The probability of successful achievement of the remaining regulatory milestone was determined to be 0% as of June 30, 2021.

The overall fair value of the contingent consideration decreased by $13.7 million and $18.5 million during the three- and six-month periods ended June 30, 2021, respectively, to $16.9 million, due primarily to the decrease in the likelihood that certain contingent milestones would be achieved and result in payment. The fair value of remaining contingent consideration is assessed on a quarterly basis.

In October 2020, the Company made a regulatory-based milestone payment of $5.0 million pursuant to the terms of the Arthrosurface Merger Agreement as a result of regulatory clearance for the WristMotion Total Arthroplasty System. In June 2021, the Company received regulatory clearance for a reverse shoulder implant system, which triggered a $10.0 million regulatory milestone payment per the terms of the Arthrosurface Merger Agreement. This amount is included as contingent consideration in current liabilities in the Company’s consolidated balance sheet as of June 30, 2021 and was paid in July 2021.

Inventories consist of the following:

The Company recorded an inventory reserve of $2.5 million during the three-month period ended June 30, 2021, of which $0.4 million was associated with the acquisition related inventory step-up, as a result of the Company's product rationalization efforts.

Intangible assets as of June 30, 2021 and December 31, 2020 consisted of the following:

The aggregate amortization expense related to intangible assets was $2.0 million and $2.2 million for the three-month periods ended June 30, 2021 and 2020, respectively, and $3.9 million and $3.5 million for the six-month periods ended June 30, 2021 and 2020, respectively. 

The Company assesses goodwill for impairment annually, or, under certain circumstances, more frequently, such as when events or changes in circumstances indicate there may be impairment.

Changes in the carrying value of goodwill for the six months ended June 30, 2021 were as follows:

Accrued expenses and other liabilities consist of the following:

In certain of its contracts, the Company warrants to its customers that the products it manufactures conform to the product specifications as in effect at the time of delivery of the specific product. The Company may also warrant that the products it manufactures do not infringe, violate, or breach any U.S. or international patent or intellectual property right, trade secret, or other proprietary information of any third party. On occasion, the Company contractually indemnifies its customers against any and all losses arising out of, or in any way connected with, any claim or claims of breach of its warranties or any actual or alleged defect in any product caused by the negligent acts or omissions of the Company. The Company maintains a products liability insurance policy that limits its exposure to these risks. Based on the Company’s historical activity, in combination with its liability insurance coverage, the Company believes the estimated fair value of these indemnification agreements is immaterial. The Company had no accrued warranties as of June 30, 2021 and December 31, 2020 and has no history of claims paid.

The Company is also involved from time-to-time in various legal proceedings arising in the normal course of business. Although the outcomes of these legal proceedings are inherently difficult to predict, the Company does not expect the resolution of these occasional legal proceedings to have a material adverse effect on its financial position, results of operations, or cash flows.

Revenue by product family was as follows: 

Revenue from the Company’s sole significant customer, DePuy Synthes Mitek Sports Medicine (“Mitek”), part of the Johnson & Johnson Medical Companies, as a percentage of the Company’s total revenue was 46% and 54% for the three months ended June 30, 2021 and 2020, respectively, and 44% and 54% for the six months ended June 30, 2021 and 2020, respectively

We receive payments from our customers based on billing schedules established in each contract. Up-front payments are recorded as deferred revenue upon receipt or when due and may require deferral of revenue recognition to a future period until we perform our obligations under these arrangements. Amounts are recorded as accounts receivable when our right to consideration is unconditional. Deferred revenue was $0.9 million and $0.2 million as of June 30, 2021 and December 31, 2020, respectively.

Total revenue by geographic location was as follows:

On June 16, 2021, the Company’s stockholders approved an amendment to the 2017 Plan. The amendment increased the number of shares of common stock reserved under the 2017 Plan by 1.1 million shares from 3.5 million shares to 4.6 million shares.

The Company presents the expenses related to stock-based compensation awards in the same expense line items as cash compensation paid to each of its employees as follows:

The Company recorded an income tax provision of $2.6 million and $1.0 million for the three- and six-month periods ended June 30, 2021, resulting in effective tax rates of 28.5% and 9.4%, respectively. The benefit from income taxes was $2.0 million and $0.4 million for the three- and six-month periods ended June 30, 2020, based on effective tax rates of 20.6% and 17.9%, respectively. The net increase in the effective tax rate for the three-month period ended June 30, 2021, as compared to the same period in 2020, was primarily due to $0.7 million recorded as tax expense for the change in the fair value of the contingent consideration, recognized as a discrete charge in the second quarter of 2021. The year to date net tax benefit on the change in the fair value of the contingent consideration, in the amount of $1.1 million, resulted in a net decrease in the effective tax rate for the six-month period ended June 30, 2021, as compared to the same period in 2020.

The Company files income tax returns in the United States on a federal basis, in certain U.S. states, and in certain foreign jurisdictions. The associated tax filings remain subject to examination by applicable tax authorities for a certain length of time following the tax year to which those filings relate.

In connection with the preparation of the financial statements, the Company assessed whether it is more likely than not that it will be able to utilize, in future periods, the deferred income taxes to offset future taxable income. The Company has concluded that it is more likely than not that the majority of its deferred tax assets will be realized through consideration of both the positive and negative evidence.  

Basic EPS is calculated by dividing net income by the weighted average number of shares outstanding during the period. Unvested restricted shares, although legally issued and outstanding, are not considered outstanding for purposes of calculating basic EPS. Diluted EPS is calculated by dividing net income by the weighted average number of shares outstanding plus the dilutive effect, if any, of outstanding share-based awards using the treasury stock method.

The following table provides share information used in the calculation of the Company's basic and diluted EPS (in thousands):

Stock options of 1.0 million shares were outstanding for each of the three-month periods ended June 30, 2021 and 2020 and were not included in the computation of diluted EPS because the awards’ impact on EPS would have been anti-dilutive. Stock options of 1.1 million and 0.9 million shares were outstanding for the six-month periods ended June 30, 2021 and 2020 and were not included in the computation of diluted EPS because the awards’ impact on EPS would have been anti-dilutive. 

You should read the following discussion in conjunction with our financial statements and related notes appearing elsewhere in this report and our audited consolidated financial statements and related notes contained in our Annual Report on Form 10-K for the year ended December 31, 2020, or our 2020 Form 10-K. In addition to historical information, 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 concerning our business, consolidated financial condition, and results of operations. The Securities and Exchange Commission, or the SEC, encourages companies to disclose forward-looking statements so that investors can better understand a company’s prospects and make informed investment decisions. Forward-looking statements are subject to risks and uncertainties, many of which are outside our control, which could cause actual results to differ materially from these statements. Therefore, you should not rely on any of these forward-looking statements. Forward-looking statements can be identified by such words as "will," "likely," "may," "believe," "expect," "anticipate," "intend," "seek," "designed," "develop," "would," "future," "can," "could," “estimate,” “potential,” and other expressions that are predictions of or indicate future events and trends and that do not relate to historical matters. All statements other than statements of historical facts included in this report regarding our strategies, prospects, financial condition, operations, costs, plans, and objectives are forward-looking statements. Examples of forward-looking statements include, among others, statements regarding the effect of COVID-19 and related impacts on our business, operations, and financial results, expected future operating results, expectations regarding the timing and receipt of regulatory results, anticipated levels of capital expenditures, and expectations of the effect on our financial condition of claims, litigation, and governmental and regulatory proceedings.

Please also refer to those factors described in “Part I, Item 1A. Risk Factors” of our 2020 Form 10-K and in Part II, Item 1A “Risk Factors” of this report for important factors that we believe could cause actual results to differ materially from those in our forward-looking statements. Any forward-looking statement made by us in this report is based only on information currently available to us and speaks only as of the date on which it is made. We undertake no obligation to publicly update any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future developments or otherwise.

Management Overview

We are a global joint preservation company that creates and delivers meaningful advancements in early intervention orthopedic care. Based on our collaborations with clinicians to understand what they need most to treat their patients, we develop minimally invasive products that restore active living for people around the world. We are committed to leading in high opportunity spaces within orthopedics, including osteoarthritis, or OA, pain management, regenerative solutions, soft tissue repair and bone preserving joint technologies.

We have nearly thirty years of global expertise developing, manufacturing and commercializing products based on our hyaluronic acid, or HA, technology platform. HA is a naturally occurring polymer found throughout the body that is vital for proper joint health and tissue function. Our proprietary technologies for modifying the HA molecule allow product properties to be tailored specifically to multiple uses, including enabling longer residence time to support OA pain management and creating a solid form of HA called HYAFF, which is the platform for our regenerative solutions portfolio.

In early 2020, we expanded our overall technology platform and significantly enhanced our commercial infrastructure, especially in the United States, through our strategic acquisitions of Parcus Medical, LLC, or Parcus Medical, a sports medicine implant and instrumentation solutions provider focused on sports medicine and soft tissue repair, and Arthrosurface, Inc., or Arthrosurface, a company specializing in bone preserving partial and total joint replacement solutions. Through these acquisitions, we have transformed our company. We expanded our addressable market from the over $1 billion global OA pain management market to the over $8 billion joint preservation market (which includes the faster growing sports medicine and extremities segments), improved our commercial capabilities, and expanded our product pipeline and research and development expertise in our target markets.

As we look towards the future, our business is positioned to capture value within our target market of joint preservation. We believe our success will be driven by our:

COVID-19 Pandemic

In March 2020, the World Health Organization declared the spread of the COVID-19 virus a global pandemic. This pandemic has caused an economic downturn on a global scale, as well as significant volatility in the financial markets. There has been significant volatility in our results on a quarterly basis due to the worldwide cancellation or delay of elective procedures, as well as the impact on timelines associated with certain clinical studies. While elective procedure volume had a limited recovery after the initial pandemic impacts seen in the early parts of second quarter of 2020 due to the easing of COVID-19 related restrictions in certain jurisdictions, areas of the United States and other countries have recently seen, and continue to see, fluctuating infection rates increasing as the result of emerging variants of COVID-19. These fluctuations make future results difficult to predict despite recent advances in the vaccination rates of certain parts of the population. In this time of uncertainty as a result of the COVID-19 pandemic, we have taken many precautions to provide a safe work environment for our employees and customers, including the establishment and implementation of a work from home policy, where possible. While increasing vaccination rates and the loosening of restrictions, especially in the United States, have resulted in a return to a more normalized business environment, the pandemic continues to have an impact on our business in certain jurisdictions and a resurgence of COVID-19 as a result of emerging variants or other factors, as is currently occurring in certain jurisdictions, could result in additional government lockdowns, quarantine requirements, or other restrictions that could impact our business and operations. We may also have to take further actions that we determine are in the best interests of our employees or as required by federal, state, or local authorities. To date, we do not anticipate disruption to our ability to supply products to our customers. Our commercial day-to-day operations have been impacted due to the worldwide cancellation or delay of elective procedures, and timelines associated with certain clinical studies and research and development programs have been delayed. While the impact has been limited to these items to date, we caution that there continues to be a possibility for potential future implementation of certain additional restrictions in certain jurisdictions. The impact of these restrictions on our operations, if implemented, is currently unknown, but could be significant. 

Products

Joint Pain Management

Our Joint Pain Management product family consists of:

Joint Preservation and Restoration

Our Joint Preservation and Restoration product family consists of: 

Other

Our Other product family consists of legacy HA-based products that do not fit into one of our other primary product categories. These products include Hyalobarrier, an anti-adhesion barrier indicated for use after abdomino-pelvic surgeries, and Hyalomatrix, which is used for the treatment of complex wounds such as burns and ulcers, products used in connection with the treatment of ears, nose and throat disorders, and ophthalmic products, including injectable, high molecular weight HA products used as viscoelastic agents in ophthalmic surgical procedures such as cataract extraction and intraocular lens implantation.

Results of Operations

Three and Six Months Ended June 30, 2021 Compared to Three and Six Months Ended June 30, 2020

Revenue

Revenue for the three-month period ended June 30, 2021 was $38.2 million, an increase of $7.5 million as compared to $30.7 million for the three-month period ended June 30, 2020. Revenue for the six-month period ended June 30, 2021 was $72.4 million, an increase of $6.4 million as compared to $66.1 million for the six-month period ended June 30, 2020. For the three- and six-month periods ended June 30, 2021, the increases in revenue were primarily driven by recovery from the initial impact of COVID on prior year sales volumes. The increase for the six-month period ended June 30, 2021, was also in part due to inclusion of full first quarter results of Parcus Medical and Arthrosurface, which we acquired on January 24, 2020 and February 3, 2020, respectively. 

The following tables present product revenue by product family:

Revenue from our Joint Pain Management product family increased 9% for the three-month period ended June 30, 2021 as compared to the same period in 2020 due primarily to recovery from the initial impact of the COVID-19 pandemic on sales volumes. For the six-month period ended June 30, 2021, revenue decreased 9% as compared to the same period in 2020 primarily due to the overall unfavorable impact of the COVID-19 pandemic in the same period of 2020. 

Revenue from our Joint Preservation and Restoration product family increased 79% and 66% for the three- and six-month periods ended June 30, 2021, respectively, as compared to the same periods in 2020 primarily due to organic growth as the impact of the COVID-19 pandemic on elective procedures begins to lift in various worldwide jurisdictions, especially in the United States, and for the six-month period, due also to the inclusion of full quarter results from Parcus Medical and Arthrosurface in the first quarter.

Revenue from our Other product family increased 7% for the three-month period ended June 30, 2021, as compared to the same period in 2020 primarily due to timing of distributor sales. For the six-month period ended June 30, 2021 revenue increased 23% as compared to the same period in 2020 primarily due to the sell through of legacy wound care products.

Gross Profit and Margin

Gross profit for the three- and six-month periods ended June 30, 2021 increased $7.1 million and $6.9 million to $20.8 million and $41.8 million, respectively, representing 55% and 58% of revenue. Gross profit for the three- and six-month periods ended June 30, 2020 was $13.7 million and $34.9 million, respectively, or 45% and 53% of revenue for the periods, respectively. These increases in gross profit for the three- and six-month periods ended June 30, 2021, primarily resulted from increased revenue, partially offset by product rationalization charges in the second quarter of 2021. We recorded an inventory reserve of $2.5 million during the three-month period ended June 30, 2021, of which $0.4 million was associated with the acquisition related inventory step-up, as a result of our product rationalization efforts. Gross margins include the impact of inventory step-up associated with the Arthrosurface and Parcus Medical acquisitions, as well as acquisition-related amortization expenses. These expenses together increased cost of revenue by $3.8 million, or 10 points of gross margin and $8.0 million, or 11 points of gross margin, for the three- and six-month periods ended June 30, 2021, respectively, as compared to increased cost of revenue of $3.8 million, or 13 points of gross margin, and $6.8 million, or 10 points of gross margin, respectively, for the same periods in 2020.

Research and Development

Research and development expenses for the three- and six-month periods ended June 30, 2021 were $7.3 million and $13.7 million, representing an increase of $2.8 million and $3.1 million, respectively, as compared to the same periods in 2020. The increase in research and development expense for the three- and six-month periods ended June 30, 2021 was primarily due to product development activities associated with the development of new product candidates in our research and development pipeline, preparation activities for the CINGAL Pilot study and certain European post-market clinical studies. Research and development activities were curtailed in the three- and six-months ended June 30, 2020 due to cost optimization in the light of the early stages of the COVID-19 pandemic.

Selling, General and Administrative

Selling, general and administrative, or SG&A expenses for the three- and six-month periods ended June 30, 2021 were $18.0 and $36.2 million, an increase of $3.4 million and $7.2 million, respectively, as compared to the same periods in 2020. The increase in SG&A expenses for the three-month period ended June 30, 2021 was primarily related to increased spending to support our commercial capability through the expansion of our commercial team in the United States, partially offset by the absence of transaction costs incurred in 2020 related to the acquisitions of Parcus Medical and Arthrosurface. 

The increase in SG&A expenses for the six-month period ended June 30, 2021 was primarily related to full period expenses from Parcus Medical and Arthrosurface, increased spending to support our commercial capability in the United States and a non-cash impairment charge related to fixed assets, partially offset by the absence of transaction costs incurred in 2020 related to acquisitions of Parcus and Arthrosurface. Certain activities were curtailed in the three- and six-months ended June 30, 2020 due to cost optimization in light of the early stages of the COVID-19 pandemic.

Goodwill Impairment Charge

We assess goodwill for impairment annually, as of end of November, or, under certain circumstances, more frequently, such as when events or changes in circumstances indicate there may be impairment. U.S. and other country government policy responses to the COVID-19 pandemic and the resulting changes in healthcare guidelines caused a temporary suspension of domestic elective surgical procedures. As a result of these events, during the three-month period ended March 31, 2020, we performed a quantitative assessment of goodwill impairment related to the Parcus and Arthrosurface reporting unit as of March 31, 2020. The results of these interim impairment tests indicated that the estimated fair value of this reporting unit was less than its carrying value. Consequently, a non-cash goodwill impairment charge of $18.1 million was recorded in the three-month period ended June 30, 2020. The decline in fair value was primarily due to a decrease in immediate term revenue and related cash flows as a result of the temporary suspension of domestic elective procedures, which directly impacted the Parcus and Arthrosurface reporting units. There were no goodwill impairment charges during the three- and six-month period ended June 30, 2021. 

Contingent Consideration Fair Value Change

We recorded a $13.7 million and $18.5 million net benefit related to changes in the fair value of contingent consideration for the three- and six-month periods ended June 30, 2021, respectively. We recorded a $4.2 million net expense and $20.3 million net benefit related to changes in the fair value of contingent consideration for the three- and six-month periods ended June 30, 2020, respectively. The increase in net benefit in the three-month period ended June 30, 2021 compared to the same period in 2020 is due primarily to the decrease in the likelihood that certain contingent milestones would be achieved and result in payment. The decrease in net benefit in the six-month period ended June 30, 2021 compared to the same period in 2020, is due primarily to the achievement of a regulatory milestone in June 2021, which partially offset the decrease in the likelihood that certain other contingent milestones would be achieved and result in payment.

Income Taxes

The provision for income taxes was $2.6 million and $1.0 million for the three- and six-month periods ended June 30, 2021, based on effective tax rates of 28.5% and 9.4%, respectively. The benefit from income taxes was $2.0 million and $0.4 million for the three- and six-month periods ended June 30, 2020, based on effective tax rates of 20.6% and 17.9%, respectively. The net increase in the effective tax rate for the three-month period ended June 30, 2021, as compared to the same period in 2020, was primarily due to the $0.7 million tax expense on the change in the fair value of the contingent consideration, recognized as a discrete charge in the second quarter of 2021. The net tax benefit for the six-month period ended June 30, 2021 on the decrease in the fair value of the contingent consideration, in the amount of $1.1 million, resulted in a net decrease in the effective tax rate for the six-month period ended June 30, 2021, as compared to the same period in 2020.

Non-GAAP Financial Measures

We present certain information with respect to adjusted gross profit and adjusted gross margin, adjusted Earnings Before Interest, Tax, Depreciation and Amortization (“EBITDA”), adjusted net income, adjusted diluted earnings per share or adjusted EPS, which are financial measures not based on any standardized methodology prescribed by accounting principles generally accepted in the United States, or GAAP, and is not necessarily comparable to similarly titled measures presented by other companies.

We have presented adjusted gross profit and adjusted gross margin, adjusted EBITDA, adjusted net income, adjusted EPS, because they are key measures used by our management and board of directors to understand and evaluate our operating performance and to develop operational goals for managing our business. We believe these financial measures help identify underlying trends in our business that could otherwise be masked by the effect of the expenses that we exclude. In particular, we believe that the exclusion of these items in calculating these measures can provide a useful tool for period-to-period comparisons of our core operating performance. Accordingly, we believe that these measures provide useful information to investors and others in understanding and evaluating our operating results, enhancing the overall understanding of our past performance and future prospects, and allowing for greater transparency with respect to key financial metrics used by our management in its financial and operational decision-making.

Adjusted Gross Profit and Adjusted Gross Margin

We define adjusted gross profit as our gross profit excluding amortization of certain acquired assets, the impact of inventory fair-value step up associated with our recent acquisitions and product rationalization charges. The amortized assets contribute to revenue generation, and the amortization of such assets will recur in future periods until such assets are fully amortized. These assets include fair value of certain identified assets acquired in acquisitions, including developed technology and acquired tradenames. We define adjusted gross margin as adjusted gross profit divided by total revenue.

The following is a reconciliation of adjusted gross profit to gross profit for the three- and six-month periods ended June 30, 2021 and 2020, respectively:

Adjusted gross profit for the three- and six-month periods ended June 30, 2021 increased $7.2 million and $8.1 million to $26.7 million and $51.8 million, respectively, representing 70% and 71% of revenue. Adjusted gross profit for the three- and six-month periods ended June 30, 2020 was $19.5 million and $43.7 million, respectively, or 64% and 66% of revenue for the periods, respectively. This increase in gross profit for the three- and six-month periods ended June 30, 2021, primarily resulted from higher revenue due to the inclusion of full period results from Parcus Medical and Arthrosurface in 2021 as we acquired these businesses in early 2020 and organic growth in existing legacy business as COVID-19 pandemic related restrictions started lifting in various worldwide jurisdictions, especially in the United States.  

Adjusted EBITDA

We present information below with respect to adjusted EBITDA, which we define as our net income (loss) excluding interest and other income, net, income tax benefit (expense), depreciation and amortization, stock-based compensation, product rationalization, and acquisition related expenses. In light of the COVID-19 pandemic, we have also excluded the impacts of goodwill impairment charges and changes in the fair value of contingent consideration associated with our acquisition transactions in early 2020.

Adjusted EBITDA is not prepared in accordance with US GAAP, and should not be considered in isolation of, or as an alternative to, measures prepared in accordance with US GAAP. There are a number of limitations related to the use of adjusted EBITDA rather than net income (loss), which is the nearest US GAAP equivalent. Some of these limitations are:

The following is a reconciliation of net income (loss) to adjusted EBITDA for the three- and six-month periods ended June 30, 2021 and 2020, respectively: