UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 

 

FORM 8-K/A

 

CURRENT REPORT

PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

Date of Report (Date of earliest event reported): February 3, 2020

 

Anika Therapeutics, Inc.

(Exact name of registrant as specified in its charter)

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Delaware  000-21326  04-3145961
(State or other jurisdiction of  Commission file number  (I.R.S. Employer
incorporation or organization)     Identification No.)

 

32 Wiggins Avenue, Bedford, MA 01730

(Address of principal executive offices) (Zip code)

 

(781)-457-9000

Registrant’s telephone number, including area code:

 

 

Not applicable

(Former name or former address, if changed since last report)

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Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:

 

[_] Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

 

[_] Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

 

[_] Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

 

[_] Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

 

Title of each class   Trading Symbol(s)   Name of each exchange on which registered
Common Stock, par value $0.01 per share   ANIK   NASDAQ Global Select Market

 

Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 (17 CFR §230.405) or Rule 12b-2 of the Securities Exchange Act of 1934 (17 CFR §240.12b-2).

Emerging growth company [_]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [_]

 

EXPLANATORY NOTE

 

On February 3, 2020, Anika Therapeutics, Inc. (the “Company”) filed a Current Report on Form 8-K (the “Original Form 8-K”) reporting the completion of its acquisition (the “Arthrosurface Merger”) of Arthrosurface Incorporated (“Arthrosurface”), pursuant to the Agreement and Plan of Merger, dated January 4, 2020 (the “Arthrosurface Merger Agreement”), by and among the Company, Arthrosurface, Button Merger Sub, Inc. (“Arthrosurface Merger Sub”) and Boston Millennia Partners Button Shareholder Representation, Inc., solely in its capacity as the representative, agent and attorney-in-fact of the Equityholders (as defined in the Arthrosurface Merger Agreement). This Current Report on Form 8-K/A amends and supplements Item 9.01(a) and 9.01(b) of the Original Form 8-K to provide financial statements and pro forma financial information required by such items, respectively.

 

Item 9.01.Financial Statements and Exhibits.

 

(a) Financial Statements of Businesses Acquired.

 

The audited financial statements of Arthrosurface as of December 31, 2018 and for the years ended December 31, 2018 and 2017, and the notes related thereto, are filed as Exhibit 99.1 hereto and are incorporated by reference herein. The unaudited financial statements of Arthrosurface as of September 30, 2019 and the for the nine-months ended September 30, 2019 and 2018 are filed as Exhibit 99.2 and are incorporated by reference. The consent of BDO USA, LLP, Arthrosurface’s independent registered public accounting firm, is filed as Exhibit 23.1.

 

(b) Pro Forma Financial Information.

 

The unaudited pro forma condensed combined balance sheet as of September 30, 2019, giving effect to the Arthrosurface Merger as if it occurred on September 30, 2019, and the unaudited pro forma condensed combined statement of operations for the nine months ended September 30, 2019 and the year ended December 31, 2018, in each case giving effect to the Arthrosurface Merger as if it occurred on January 1, 2018, are filed as Exhibit 99.3 hereto and incorporated herein by reference.

 

(d) Exhibits.

       
Exhibit 
Number
  Description  
23.1   Consent of Independent Registered Public Accounting Firm  
99.1   Audited financial statements of Arthrosurface Incorporated as of December 31, 2018 and for the years ended December 31, 2018 and 2017, and the notes related thereto.  
99.2   Unaudited financial statements of Arthrosurface Incorporated as of September 30, 2019 and for the nine months ended September 30, 2019 and 2018.  
99.3   Unaudited pro forma condensed combined balance sheet as of September 30, 2019, giving effect to the Arthrosurface Merger as if it occurred on September 30, 2019, and the unaudited pro forma condensed combined statement of operations for the nine months ended September 30, 2019 and the year ended December 31, 2018 in each case giving effect to the Arthrosurface Merger as if it occurred on January 1, 2018.  

 

 

 

SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

   Anika Therapeutics, Inc.
       
Date: March 13, 2020  By:  /s/ Sylvia Cheung
      Chief Financial Officer

 

 

 

 

 

 

 

 

 

 

 

Exhibit 23.1

 

 

Consent of Independent Registered Public Accounting Firm

 

 

Anika Therapeutics, Inc.

Bedford, Massachusetts

 

We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-110326, 333-160102, 333-176103, 333-190597, 333-219190 and 333-232254) of Anika Therapeutics, Inc. of our report dated April 22, 2019, relating to the financial statements of Arthrosurface, Inc., which appear in this Form 8-K/A.

 

/s/ BDO USA, LLP

 

Boston, Massachusetts

 

March 12, 2020

 

 

 

 

 

 

Exhibit 99.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Arthrosurface, Inc.
   
  Financial Statements
  Years Ended December 31, 2018 and 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Arthrosurface, Inc.

 

Financial Statements

Years Ended December 31, 2018 and 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Arthrosurface, Inc.

 

Contents

 

 

Independent Auditor’s Report 3-4
   
   
Financial Statements  
   
Balance Sheets 6-7
   
Statements of Operations 8
   
Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity 9
   
Statements of Cash Flows 10
   
Notes to Financial Statements 11-22

 

 

 

 

 

 

 

 

 

 

 2 

 

 

 

 

 

Tel: 617-422-0700

Fax: 617-422-0909

www.bdo.com

One International Place
Boston, MA 02110-1742

 

 

 

 

Independent Auditor’s Report

 

 

Board of Directors

Arthrosurface, Inc.

Franklin, Massachusetts

 

We have audited the accompanying financial statements of Arthrosurface, Inc., which comprise the balance sheets as of December 31, 2018 and 2017, and the related statements of operations, redeemable convertible preferred stock and stockholders’ equity, and cash flows for the years then ended, and the related notes to the financial statements.

 

Management’s Responsibility for the Financial Statements

 

Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

 

Auditor’s Responsibility

 

Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

 

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

 

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

 

 

 

BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.

 

BDO is the brand name for the BDO network and for each of the BDO Member Firms.

 

 3 

 

 

Opinion

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Arthrosurface, Inc. as of December 31, 2018 and 2017, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.

 

 

 

April 22, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 4 

 

 

 

 

 

 

 

 

 

 

 

Financial Statements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 5 

 

 

Arthrosurface, Inc.

 

Balance Sheets

     

 

December 31,   2018    2017 
           
Assets          
           
Current Assets:          
Cash and cash equivalents  $109,945   $685,901 
Accounts receivable, net of reserves of $833,471 and $832,134 in 2018 and 2017, respectively       5,538,254         6,194,631  
Inventory, net of reserve of $494,802 and $606,414 in 2018 and 2017, respectively       9,813,841         9,402,056  
Prepaid expenses and other current assets   795,092    433,157 
           
Total Current Assets   16,257,132    16,715,745 
           
Property and Equipment:          
Medical instruments   18,031,426    16,863,117 
Computer equipment and software   963,386    952,482 
Dies and molds   864,424    810,924 
Furniture and fixtures   622,645    617,395 
Leasehold improvements   87,703    87,703 
Machinery and equipment   46,033    46,033 
    20,615,617    19,377,654 
Less accumulated depreciation and amortization   19,191,795    18,244,445 
           
Total Property and Equipment   1,423,822    1,133,209 
           
Other Assets:          
Deferred Taxes   1,127,318    2,599,712 
           
Total Assets  $18,808,272   $20,448,666 

 

See accompanying notes to the financial statements.

 

 

 6 

 

 

Arthrosurface, Inc.

 

Balance Sheets

     

December 31,   2018    2017 
           
Liabilities, Redeemable Convertible Preferred Stock and Stockholders’ Equity          
           
Current Liabilities:          
Notes payable, line of credit  $1,142,601   $ 
Accounts payable   395,887    491,882 
Accounts payable - related party   431,782    431,794 
Accrued expenses   2,115,534    1,778,435 
           
Total Current Liabilities   4,085,804    2,702,111 
           
Commitments (Notes 11 and 12)          
           
Redeemable Convertible Preferred Stock:          
Series B redeemable convertible preferred stock, $0.001 par  value; 2,000,000 shares designated, issued and outstanding (liquidation preference of $2,000,000)   9,500,000    9,500,000 
           
Stockholders' Equity:          
Series A convertible preferred stock, $0.001 par value;  3,311,557 shares designated, issued and outstanding (liquidation preference of $3,311,557)   3,097,680    3,097,680 
Series C convertible preferred stock, $0.001 par value;  4,000,000 shares designated; 2,448,500 shares issued and  outstanding (liquidation preference of $6,121,250)   5,760,374    5,760,374 
Series D convertible preferred stock, $0.001 par value;  3,057,724 shares designated, issued and outstanding (liquidation preference of $10,702,034)   10,622,252    10,622,252 
Series E convertible preferred stock, $0.001 par value; 1,131,112 shares designated; 1,111,112 shares issued and  outstanding (liquidation preference of $5,000,004)   4,969,845    4,969,845 
Series F convertible preferred stock, $0.001 par value; 1,052,632 shares designated; 884,608 shares issued  and outstanding (liquidation preference of $4,201,888)   4,167,632    4,167,632 
Common stock, $0.001 par value; 22,000,000 shares authorized; 6,570,944 shares issued and outstanding   6,573    6,573 
Additional paid-in capital   1,025,650    974,999 
Accumulated deficit   (24,427,538)   (21,352,800)
           
Total Stockholders' Equity   5,222,468    8,246,555 
           
Total Redeemable Convertible Preferred Stock and  Stockholders’ Equity   14,722,468    17,746,555 
           
Total Liabilities, Redeemable Convertible Preferred Stock and Stockholders’ Equity  $18,808,272   $20,448,666 

 

See accompanying notes to the financial statements.

 

 7 

 

 

Arthrosurface, Inc.

 

Statements of Operations

     

 

Years ended December 31,   2018    2017 
           
Net Revenues  $27,168,764   $25,876,568 
           
Cost of Goods Sold   6,416,924    5,454,714 
           
Gross Profit   20,751,840    20,421,854 
           
Operating Expenses:          
Selling and marketing   16,247,991    14,771,820 
Research and development   3,210,921    3,050,456 
General and administrative   2,846,651    2,939,370 
           
Total Operating Expenses   22,305,563    20,761,646 
           
Loss from Operations   (1,553,723)   (339,792)
           
Other Income (Expense):          
Interest income       741 
Interest expense   (7,558)    
Other income   564    21,690 
           
Loss before Income Taxes   (1,560,717)   (317,361)
           
Income Tax Expense   1,514,021    263,113 
           
Net Loss  $(3,074,738)  $(580,474)

 

See accompanying notes to the financial statements.

 

 8 

 

 

Arthrosurface, Inc.

 

 Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity

                         

    Series B                                                      Total Redeemable 
    Redeemable     Series A    Series C    Series D    Series E    Series F              Additional         Total    Convertible Preferred 
    Convertible     Convertible     Convertible     Convertible     Convertible     Convertible     Common Stock    Paid-in    Accumulated    Stockholders'    Stock and 
    Preferred Stock    Preferred Stock    Preferred Stock    Preferred Stock    Preferred Stock    Preferred Stock    Shares    Par Value    Capital    Deficit    Equity    Stockholders' Equity 
                                                             
Balance at December 31, 2016  $9,500,000   $3,097,680   $5,760,374   $10,622,252   $4,969,845   $4,167,632    6,460,265   $6,462   $699,226   $(20,772,326)  $8,551,145   $18,051,145 
                              `                                
Exercise of common stock options                           110,679    111    164,801        164,912    164,912 
                                                             
Stock-based compensation expense                                   110,972        110,972    110,972 
                                                             
Net income                                       (580,474)   (580,474)   (580,474)
                                                             
Balance at December 31, 2017   9,500,000    3,097,680    5,760,374    10,622,252    4,969,845    4,167,632    6,570,944    6,573    974,999    (21,352,800)   8,246,555    17,746,555 
                                                             
Stock-based compensation expense                                   50,651        50,651    50,651 
                                                             
Net income                                       (3,074,738)   (3,074,738)   (3,074,738)
                                                             
Balance at December 31, 2018  $9,500,000   $3,097,680   $5,760,374   $10,622,252   $4,969,845   $4,167,632    6,570,944   $6,573   $1,025,650   $(24,427,538)  $5,222,468   $14,722,468 

 

                        See accompanying notes to financial statements.

 

 9 

 

 

Arthrosurface, Inc.

 

Statements of Cash Flows

     

Years ended December 31,   2018    2017 
           
Cash Flows from Operating Activities:          
Net loss  $(3,074,738)  $(580,474)
Adjustments to reconcile net loss to net cash used in operating activities:          
Depreciation and amortization   947,350    1,098,382 
Change in reserves   (110,275)   (57,820)
Deferred taxes   1,472,394    247,618 
Stock-based compensation   50,651    110,972 
Increase (decrease) in cash resulting from a change in:          
Accounts receivable   655,040    (761,076)
Inventory   (300,173)   (238,922)
Prepaid expenses and other current assets   (361,935)   (98,197)
Accounts payable   (95,995)   100,542 
Accounts payable - related party   (12)   152,976 
Accrued expenses   337,099    (216,252)
           
Net Cash Used in Operating Activities   (480,594)   (242,251)
           
Cash Flows from Investing Activity:          
Purchases of property and equipment   (1,237,963)   (412,720)
           
Net Cash Used in Investing Activity   (1,237,963)   (412,720)
           
Cash Flows from Financing Activities:          
Proceeds from note payable, line of credit   1,142,601     
Proceeds from exercise of stock options       164,912 
           
Net Cash Provided by Financing Activities   1,142,601    164,912 
           
Net Decrease in Cash and Cash Equivalents   (575,956)   (490,059)
           
Cash and Cash Equivalents, beginning of year   685,901    1,175,960 
           
Cash and Cash Equivalents, end of year  $109,945   $685,901 
           
Supplemental Disclosures of Cash Flow Information          
           
Cash paid during the year for:          
           
Income Taxes  $41,627   $15,495 
           
Interest  $7,558   $ 

 

See accompanying notes to financial statements.

 

 10 

 

Arthrosurface, Inc.
 
Notes to Financial Statements

 

1. Business Operations

 

Arthrosurface, Inc. (the “Company”) was incorporated in Delaware in August 2001. The Company was formed to design, develop, manufacture, and market new surgical alternatives for the treatment of orthopedic joint disease. The Company is located primarily in Massachusetts and serves customers throughout the world.

 

The Company is subject to a number of risks associated with emerging, technology-oriented companies. Principal among these are the risks associated with dependence on key individuals, rapid technology change, competition from larger, more financially independent competitors, and the need for successful development and marketing of services and products.

 

2. Significant Accounting Policies

 

A summary of the significant accounting policies followed by the Company in the presentation of the accompanying financial statements is set forth below:

 

Basis of Presentation

 

The accompanying financial statements are prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents.

 

Allowance for Doubtful Accounts

 

The Company provides an allowance for doubtful accounts equal to estimated bad debt losses. The estimated losses are based on historical collection experience together with a review of the current status of existing receivables. The Company’s allowance for doubtful accounts was $310,900 and $416,194 at December 31, 2018 and 2017, respectively, and was netted with accounts receivable in the accompanying balance sheets, along with the sales return reserve.

 

Inventory

 

Inventory is stated at the lower of cost or market. Cost is determined on a first-in, first-out (“FIFO”) basis. Inventory consists principally of purchased components, the majority of which are considered finished goods. The Company provides a reserve for obsolescence equal to estimated losses resulting from obsolete inventory. The estimated losses are based upon historical product useful lives and a review of the current status of the existing inventory.

 

 11 

 

Arthrosurface, Inc.
 
Notes to Financial Statements

 

Property and Equipment

 

Property and equipment are stated at cost. Major renewals, additions, and betterments are charged to the property accounts, while replacements, maintenance, and repairs, which do not improve or extend the lives of the respective assets, are expensed in the year incurred.

 

Depreciation and Amortization

 

Depreciation and amortization are computed using the straight line method over the estimated useful lives of the related assets as follows:

 

Assets   Life in Years  
       
Medical instruments   3  
Computer equipment and software   3  
Dies and molds   3  
Furniture and fixtures   7  
Leasehold improvements   Life of lease  
Machinery and equipment   5  

 

Impairment of Long-lived Assets

 

The Company periodically evaluates its long-lived assets for events and circumstances that indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. The Company believes the future cash flows to be generated from the long-lived assets will exceed the assets’ carrying value, and accordingly, the Company has not recognized any impairment losses through December 31, 2018.

 

Redeemable Convertible Preferred Stock

 

The carrying value of the Series B redeemable convertible preferred stock is increased or decreased by periodic accretion so that the carrying amount will equal the redemption amount at the redemption date. The accretion is recorded as a decrease in additional paid-in capital until the balance becomes zero, with the remainder being recorded against the accumulated deficit.

 

 12 

 

Arthrosurface, Inc.
 
Notes to Financial Statements

 

Fair Value of Financial Instruments

 

Certain assets and liabilities are carried at fair value under U.S. GAAP. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. Financial assets and liabilities carried at fair value are to be classified and disclosed in one of the following three levels of the fair value hierarchy, of which the first two are considered observable and the last is considered unobservable:

 

·Level 1 — Quoted prices in active markets for identical assets or liabilities.
·Level 2 — Observable inputs (other than Level 1 quoted prices), such as quoted prices in active markets for similar assets or liabilities, quoted prices in markets that are not active for identical or similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data.
·Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to determining the fair value of the assets or liabilities, including pricing models, discounted cash flow methodologies and similar techniques.

 

The carrying values of the Company’s cash and cash equivalents, accounts receivable, accounts payable, and accounts payable – related party, approximate fair value due to the immediate or short-term maturity of these financial instruments.

 

Revenue Recognition

 

The Company’s revenue consists of sales of products directly to hospitals and distributors. The Company recognizes revenue when persuasive evidence of an arrangement exists, the price is fixed and determinable, the risk of loss has transferred to the customer, the Company’s performance obligations are complete, delivery has occurred, and collection is reasonably assured. Revenue from sales to distributors is reported net of sales returns, including an estimate of future returns based on historical return rates, with a corresponding reduction to cost of goods sold. The Company’s sales return reserve was $522,571 and $415,940 at December 31, 2018 and 2017, respectively, and was netted with accounts receivable in the accompanying balance sheets.

 

Research and Development Costs

 

The Company accounts for its research and development costs in accordance with Accounting Standards Codification (“ASC”) 730, “Research and Development.” Accordingly, research and development costs are charged to expense as incurred.

 

Advertising Costs

 

Advertising costs are charged to operations as incurred. The advertising costs incurred were $150,894 and $111,853 for the years ended December 31, 2018 and 2017, respectively.

 

Stock-Based Compensation

 

The Company accounts for its stock-based compensation based on the fair value recognition provisions of ASC 718, “Compensation: Stock Compensation.” The Company is required to include an estimate of the number of awards that will be forfeited in calculating compensation costs, which is recognized over the requisite service period of the awards on a straight-line basis.

 

There were no options granted in 2018 or 2017.

 

 13 

 

Arthrosurface, Inc.
 
Notes to Financial Statements

 

Stock-based awards issued to non-employees are accounted for at their fair market value. The compensation expense that will ultimately be recognized for these options will be measured at the vesting dates of the underlying options. There were 26,295 outstanding non-employee options as of December 31, 2018 and 2017. As these options vest, the Company will be required to re-measure the fair value of these options at each reporting period prior to vesting and finally at the vesting date of the option. Changes in the estimated fair value of these non-employee options will be recognized as compensation expense or a reduction in compensation expense in the period of the change.

 

Total stock-based compensation expense related to employee stock options was $50,651 and $110,972 for the years ended December 31, 2018 and 2017, respectively. As of December 31, 2018, there are no unrecognized compensation costs related to all non-vested stock options.

 

Income Taxes

 

Provisions for income taxes are based on taxes payable or refundable for the current year and deferred taxes on temporary differences between the amount of taxable income and pretax financial income and between the tax basis of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The Company evaluates the realizability of its deferred tax assets and assesses the need for a valuation allowance on an ongoing basis. In evaluating the deferred tax assets, the Company considers whether it is more likely than not that the deferred income tax assets will be realized. The ultimate realization of the deferred tax assets depends upon generating sufficient future taxable income during the periods in which the Company’s temporary differences either become deductible or expire. This assessment requires significant judgement. Any future changes in the valuation allowance could result in additional income tax expense or benefit and could decrease or increase stockholders’ equity, and such changes could have significant impact upon future earnings.

 

The Company may recognize tax benefits only in the event that a position is more likely than not to be sustained upon examination by the applicable taxing authority. There are no federal or state income tax audits in progress as of December 31, 2018, and the Company does not believe it has any uncertain tax positions.

 

Medical Device Tax

 

The Consolidated Appropriations Act of 2016, which was signed into law on December 18, 2015, temporarily repealed the medical device tax to which the Company is subject for sales of listed medical devices sold within the United States of America. The repeal was effective for the period beginning January 1, 2016, through December 31, 2017. During 2018, H.R. 195 (the “Continuing Resolution”) was signed into law which extended the temporary repeal of the medical device tax through December 31, 2019.

 

Recent Accounting Pronouncements Affecting the Company

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued converged guidance on recognizing revenue in contracts with customers, Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers. The intent of the new standard is to improve financial reporting and comparability of revenue globally. The core principle of the standard is for a company to recognize revenue in a manner that depicts the transfer of goods or services to customers in an amount that reflects the consideration which the company expects to receive in exchange for those goods or services. The guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. Other major provisions include capitalization of certain contract costs, consideration of the time value of money in the transaction price, and in certain circumstances, allowing estimates of variable consideration to be recognized before contingencies are resolved. The guidance also requires enhanced disclosures regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. The standard is effective for nonpublic business entities for annual reporting periods beginning after December 15, 2018. The Company is currently evaluating the provisions of this standard to determine the impact on the Company’s financial statements.

 

 14 

 

Arthrosurface, Inc.
 
Notes to Financial Statements

 

In February 2016, the FASB issued ASU 2016-02, which amends the ASC and creates Topic 842, Leases. Topic 842 will require lessees to recognize lease assets and lease liabilities for those leases classified as operating leases under previous U.S. GAAP on the balance sheet. This guidance is effective for nonpublic business entities for fiscal years beginning after December 15, 2019, and early adoption is permitted. The Company is in the initial stages of evaluating the effect of the standard on its financial statements and will continue to evaluate. While not yet in a position to assess the full impact of the application of the new standard, the Company expects that the impact of recording the lease liabilities and the corresponding right-to-use assets will have a minimal impact on its total assets and liabilities with a minimal impact on equity.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, that changes the impairment model for most financial assets and certain other instruments. For receivables, loans, and other instruments, entities will be required to use a new forward-looking current expected credit loss model that generally will result in the earlier recognition of allowance for losses. For available-for-sale debt securities with unrealized losses, entities will measure credit losses in a manner similar to current practice, except the losses will be recognized as allowances instead of reductions in the amortized cost of the securities. In addition, an entity will have to disclose significantly more information about allowances, credit quality indicators, and past due securities. The new provisions will be applied as a cumulative-effect adjustment to retained earnings. The Company will adopt the new standard on January 1, 2023. The Company is evaluating the impact that the new standard will have on its financial statements.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which provides guidance related to cash flows presentation and is effective for annual reporting periods beginning after December 15, 2018. The guidance in ASU 2016-15 is generally consistent with the Company’s current cash flow classifications, and adoption of this standard is not expected to have a material impact on its financial statements.

 

Subsequent Events

 

The Company has evaluated subsequent events through April 22, 2019, which is the date the financial statements were available for issuance.

 

3. Related-Party Transactions

 

The Company purchases a majority of its products from Primo Medical Group, Inc. (“PMG”), a related entity through common ownership. During the years ended December 31, 2018 and 2017, the Company purchased goods totaling $7,390,588 and $5,179,001 from PMG, respectively. At December 31, 2018 and 2017, the Company had amounts owed to PMG of $431,782 and $431,794, respectively.

 

 15 

 

Arthrosurface, Inc.
 
Notes to Financial Statements

 

4. Line of Credit

 

The Company has a revolving line of credit agreement with a bank with a maximum borrowing limit of $4,000,000. The line of credit is secured by all corporate assets, with the exception of intellectual property, and is subject to reporting covenants. The line of credit accrues interest at the bank’s prime rate (5.5% as of December 31, 2018) plus 0.25%; however, in no event shall the interest rate be less than 3.75%. At December 31, 2018 and 2017, the outstanding balance was $1,142,601 and $-0-, respectively.

 

5. Accrued Expenses

 

Accrued expenses consist of the following at:

 

December 31,   2018    2017 
           
Commissions  $725,387   $875,223 
Payroll, bonus and employee benefits   715,406    519,233 
Royalties   176,040    144,830 
Sales tax   24,985    15,588 
Other liabilities   473,716    223,561 
           
Total Accrued Expenses  $2,115,534   $1,778,435 

 

6. Detachable Series E Preferred Stock Warrants

 

In August 2007, in connection with entering into a prior credit facility with a bank, the Company issued an initial 13,333 warrants for the right to purchase Series E Preferred Stock. Additional warrants were issued when the Company borrowed $3,000,000 against the facility in July 2008 at a rate of 1% multiplied by the funds borrowed divided by the warrant price at the time of each funding. As such, the Company issued the additional 6,667 warrants related to the borrowings of the facility. The exercise price per share is equal to the most recent Series E Preferred Stock share price, which at the time of borrowing was $4.50 per share. The warrants expire 10 years from issuance. The Company has expensed the fair value of the entire 20,000 warrants over the full-term of the facility. During 2017, the warrant expiration date was extended to August 2019.

 

The fair value of the warrants was estimated using the Black-Scholes-Merton formula with the following assumptions: no dividend yield, risk free interest rate of 4.63%, a weighted average expected life of 10 years, and an estimated volatility of 46%. The discount was netted against the note payable, and the remaining costs were expensed monthly through July 2011.

 

7. Redeemable Convertible and Convertible Preferred Stock

 

At December 31, 2018, the Company had authorized 15,311,557 shares of preferred stock, of which 2,000,000 were designated Series B redeemable convertible preferred stock (“Series B Preferred Stock”), 3,311,557 were designated Series A convertible preferred stock (“Series A Preferred Stock”), 4,000,000 were designated Series C convertible preferred stock (“Series C Preferred Stock”), 3,057,724 were designated Series D convertible preferred stock (“Series D Preferred Stock”), 1,131,112 were designated Series E convertible preferred stock (“Series E Preferred Stock”), and 1,052,632 were designated Series F convertible preferred stock (“Series F Preferred Stock”).

 

 16 

 

Arthrosurface, Inc.
 
Notes to Financial Statements

 

The Series B, Series A, Series C, Series D, Series E, and Series F Preferred Stock (collectively known as “Preferred Stock”) have the following characteristics:

 

Voting

 

In general, the holders of the Preferred Stock are entitled to vote together with all other classes and series of stock of the Company as a single class on all actions to be taken by the stockholders of the Company. Each holder of the Preferred Stock is entitled to the number of votes equal to the number of shares of common stock into which each share of preferred stock is convertible at the time of such vote. The holders of the Series B Preferred Stock and common stock shall be entitled to elect one and four directors of the Company, respectively.

 

Dividends

 

Upon the declaration by the Company of dividends payable to the holders of the Company’s common stock, the holders of the Preferred Stock are entitled to dividends equal to the amount of dividends payable to the holders of the common stock on an as-if converted basis. No dividends shall be paid on the Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock, and Series F Preferred Stock until any and all dividends declared on the Series B Preferred Stock are paid in full. Through December 31, 2018, no dividends have been declared or paid by the Company.

 

Liquidation Preference

 

In the event of any voluntary or involuntary sale, liquidation, dissolution, or winding-up of the Company, the holders of the shares of Series B Preferred Stock shall be paid an amount equal to $1.00 per share, plus, in the case of each share, an amount equal to any declared but unpaid dividends.

 

If, upon liquidation, dissolution, or winding-up of the Company, the assets of the Company are not sufficient to permit payment of the full liquidation preference of the Series B Preferred Stock, the assets will be distributed to the Series B Preferred Stock stockholders pro rata. In addition, in no event shall the amount to be distributed to the holders of the Series B Preferred Stock be less than the $2.00 per share of common stock which would be issuable upon the conversion of the Series B Preferred Stock.

 

Immediately after payment in full of the liquidation payment to the holders of the Series B Preferred Stock listed above, the holders of the Series A Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock, and Series F Preferred Stock shall be paid an amount equal to $1.00 per share, $2.50 per share, $3.50 per share, $4.50 per share, and $4.75 per share, respectively, plus, in the case of each share, an amount equal to any declared but unpaid dividends. If, upon liquidation, dissolution, or winding-up of the Company, the assets of the Company are not sufficient to permit payment of the full liquidation preference of the Series A Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock, and Series F Preferred Stock, the assets will be distributed to the holders of such stock pro rata. After payment of the above mentioned amounts to the holders of the Preferred Stock, the remaining net assets of the Company shall be distributed to the holders of the Series B Preferred Stock and the holders of the common stock equally on an as-if converted basis.

 

 17 

 

Arthrosurface, Inc.
 
Notes to Financial Statements

 

Conversion

 

The holders of the Preferred Stock have the right, at their option at any time, to convert any such shares of Preferred Stock into fully paid and non-assessable shares of common stock on a one-for-one basis. The conversion rate is subject to anti-dilution adjustments and adjustments in the event of stock dividends, stock splits, and similar recapitalizations. If the holders of at least a majority interest in a particular series of Preferred Stock elect to convert such stock into common stock, then all of the outstanding shares in that series of preferred stock shall automatically convert into common stock. In addition, if the holders of at least a majority interest in the Series B Preferred Stock elect to convert such stock into common stock, then all of the outstanding shares of Preferred Stock automatically convert into common stock. Furthermore, all outstanding shares of Preferred Stock automatically convert into common stock, at the then-applicable conversion rate, upon consummation of a firm commitment for an underwritten public offering of the common stock yielding a per share price of at least $4.00 and gross proceeds of at least $20,000,000.

 

Redemption

 

The holders of at least a majority of the outstanding Series B Preferred Stock may, by written request, require the Company to redeem all of the outstanding Series B Preferred Stock by paying in cash a sum equal to the greater of the then fair value per share of the Series B Preferred Stock or the original purchase price of $1.00 per share plus all dividends declared and unpaid on each share. The required redemption amount of the Series B Preferred Stock outstanding as of December 31, 2018, calculated using an estimated fair value of $4.75 per share, would be $9,500,000. The fair value of $4.75 was estimated by management by referencing the last round of preferred stock financing; actual fair value may be significantly different upon an actual redemption.

 

8. Common Stock

 

As of December 31, 2018, the Company had authorized 22,000,000 shares of common stock, $0.001 par value per share. Each share of common stock entitles the holder to one vote on all matters submitted to a vote of the Company’s stockholders. Common stockholders are entitled to receive dividends, if any, as may be declared by the Board of Directors, subject to the prior rights of holders of the Preferred Stock outstanding. Upon the dissolution or liquidation of the Company, the holders of the common stock will be entitled to receive assets of the corporation available for distribution to its stockholders, subject to the preferential rights of the Preferred Stock.

 

The Company periodically issues shares of common stock, primarily to certain employees and other consultants who assist the Company, to promote the interests of the Company by providing long-term incentives through equity sharing (“restricted stock”). The stockholders of the restricted stock may not sell, assign, transfer, or pledge any of their shares without giving written notice to the Company. In the event that these stockholders cease to be employed by the Company, or otherwise cease to be affiliated with the Company, the Company has the right to repurchase some or all of the unvested shares at a price of $0.001 per share. Shares subject to the repurchase rights generally vest over a four-year period. As of December 31, 2018 and 2017, the Company had 3,056,815 shares that were outstanding and vested.

 

 18 

 

Arthrosurface, Inc.
 
Notes to Financial Statements

 

9. Stock Option Plan

 

In 2003, the Company adopted the 2002 Stock Plan (the “2002 Plan”). During 2012, the Company’s Board of Directors amended the 2002 Plan to increase the shares of the Company’s common stock reserved for issuance to employees, directors, and consultants to 3,600,000. During 2013, the Company’s Board of Directors created the 2013 Stock Incentive Plan (the “Plan”) to amend and replace the 2002 Plan. Options granted under the Plan may be incentive or non-statutory stock options. Stock purchase rights may also be granted under the Plan. Incentive stock options may only be granted to employees. The Board of Directors determines the period over which options become exercisable. Generally, stock options issued under the Plan vest over a period of four years and have contractual lives of 10 years. As of December 31, 2018 and 2017, there were 410,935 shares left for issuance under the Plan.

 

The following table summarizes the stock options activity of the Plan for the years ended December 31, 2018 and 2017:

 

    

Options

Outstanding

    

Weighted

Average

Exercise

Price

 
           
Options Outstanding at December 31, 2016   516,474   $2.87 
           
Exercised    (110,679)   1.49 
Cancelled   (121,000)   2.79 
           
Options Outstanding at December 31, 2017   284,795    3.44 
           
No activity        
           
Options Outstanding at December 31, 2018   284,795   $3.44 

 

The following table summarizes information about stock options outstanding and exercisable under the Plan at December 31, 2018:

 

   Options Outstanding  Options Exercisable
           Weighted              Weighted      
           Average    Weighted         Average    Weighted 
           Remaining    Average         Remaining    Average 
 Exercise    Number    Contractual    Exercise    Number of    Contractual    Exercise 
 Prices    Outstanding    Life    Price    Shares    Life    Price 
                                 
$3.00    104,000    3.78 years   $3.00    104,000    3.78 years   $3.00 
 3.69    180,795    5.64 years    3.69    145,141    5.64 years    3.69 
                                 
      284,795    4.93 years    3.44    249,141    4.95 years    3.44 

 

 19 

 

Arthrosurface, Inc.
 
Notes to Financial Statements

 

10. Income Taxes

 

The provision for income taxes shown in the accompanying statements of operations consisted of the following amounts:

 

Years ended December 31,   2018    2017 
           
Current Income Tax:          
Federal  $   $ 
State   41,627    15,495 
           
Total Current Income Tax   41,627    15,495 
           
Deferred Income Tax:          
Federal   (261,000)   1,723,000 
State   (9,000)   (74,000)
Increase in (release of) valuation allowance   1,742,394    (1,401,382)
           
Total Deferred Income Tax Expense   1,472,394    247,618 
           
Total Income Tax Expense  $1,514,021   $263,113 

 

Components of the Company’s deferred tax assets were as follows:

 

December 31,   2018    2017 
           
Deferred Tax Assets:          
Net operating loss carryforwards  $2,617,000   $2,554,000 
Research and development credits   1,774,000    1,724,000 
Other   487,000    330,000 
    4,878,000    4,608,000 
Valuation Allowance   (3,750,682)   (2,008,288)
           
Net Deferred Tax Assets  $1,127,318   $2,599,712 

 

The enactment of the Tax Cuts and Jobs Act (“Tax Reform Act”) on December 22, 2017, changes U.S. tax law by lowering corporate income tax rates. The Tax Reform Act permanently reduces the U.S. corporate income tax rate from a maximum of 35% to a flat 21% rate, effective January 1, 2018. As a result of the reduction in the U.S. corporate income tax rate, the Company revalued its ending net deferred tax assets at December 31, 2017, and recognized a provisional $1,640,000 tax expense in the Company’s statement of operations for the year ended December 31, 2017.

 

The Company recorded a tax provision in the amount of $1,514,021 and $263,113 for the years ended December 31, 2018 and 2017, respectively, resulting in an effective tax rate that significantly deviates from the Company’s statutory tax rate of 25.5% and 38.9%, respectively. This deviation from the statutory tax rate is the result of the valuation allowance released from or placed on all deferred taxes in these periods. The valuation allowance reflects the Company’s evaluation of the positive and negative evidence concerning the Company’s future profitability within the relevant tax jurisdictions.

 

 20 

 

Arthrosurface, Inc.
 
Notes to Financial Statements

 

At December 31, 2018, the Company had federal net operating loss carryforwards of approximately $12,426,000. The federal net operating loss carryforwards will begin to expire in 2025, unless utilized. At December 31, 2018, the Company also had federal and state research and development credit carryforwards of approximately $1,423,000 and $1,373,000, respectively. The federal and state research and development credit carryforwards will begin to expire in 2024 and 2018, respectively.

 

During the Company’s 2018 and 2017 assessments of the need for a valuation allowance against the carrying value of the deferred tax assets, management determined, based upon recent and future expected profitability, that it is more likely than not that the Company would generate sufficient pre-tax income in future periods to utilize $1,127,318 and $2,599,712 of the deferred taxes, respectively.

 

Realization of the future tax benefits is dependent on many factors, including the Company’s ability to generate taxable income within the net operating loss and research and development credit carryforward periods. Under the provisions of the Internal Revenue Code, certain substantial changes in the Company’s ownership, including a sale of the Company or significant changes in ownership due to the sale of capital stock, may have limited, or may limit in the future, the amount of net operating loss carryforwards which could be used annually to offset future taxable income.

 

11. Retirement Plan

 

The Company sponsors a 401(k) plan that covers substantially all employees of the Company. The employer matches contributions on behalf of contributing participants in an amount equal to 50% of the first 6% of such participants’ annual deferrals. The Company made contributions of $157,961 and $146,952 for the years ended December 31, 2018 and 2017, respectively.

 

12. Commitments

 

The Company has entered into agreements to lease its office space and certain office equipment under non-cancelable operating leases expiring at various dates through March 2020. The Company makes monthly payments relating to these leases in amounts ranging from $315 to $9,615. Rent expense under these operating leases for the years ended December 31, 2018 and 2017, was $119,154 and $117,182, respectively. The future minimum lease payments under all operating leases at December 31, 2018, is $148,943. Subsequent to year-end, the Company extended the lease of its office space through March 2020, with monthly payments due of $9,615.

 

13. Royalty Agreements

 

The Company has entered into various royalty agreements with physicians who have provided consultation and product development services pertaining to the Shoulder, Uni-Knee, Patello-Femoral, Toe, and Allograft products. The Company has royalty agreements with several physicians with limited time durations, based on percentages of sales.

 

Royalty payment obligations are based upon various percentages of net sales pertinent to the products covered by the respective royalty arrangements. Accrued royalty expenses as of December 31, 2018 and 2017, were $176,040 and $144,830, respectively.

 

 21 

 

Arthrosurface, Inc.
 
Notes to Financial Statements

 

14. Concentrations

 

The Company had one major vendor accounting for approximately 34% and 28% of the Company’s purchases for the years ended December 31, 2018 and 2017, respectively.

 

The Company had one major customer accounting for approximately 13% and 11% of accounts receivable at December 31, 2018 and 2017, respectively.

 

The Company has a potential concentration of credit risk in that it sometimes maintains deposits with financial institutions in excess of amounts insured by the Federal Deposit Insurance Corporation (“FDIC”). The maximum deposit insurance amount is $250,000, which is applied per depositor, per insured bank for each account ownership category. As of December 31, 2018, the Company had no cash in excess of FDIC limits.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

22

 

Exhibit 99.2

 

 

 

 

 

 

 

    Arthrosurface, Inc.
     
    Condensed Interim Financial Statements
    Nine Months Ended September 30, 2019 and 2018
     

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Arthrosurface, Inc.

 

Condensed Interim Financial Statements

Nine Months Ended September 30, 2019 and 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

Arthrosurface, Inc.

 

Contents

 

 

 

Financial Statements

 

Condensed Balance Sheets   4-5 
      
Condensed Statements of Operations   6 
      
Condensed Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity   7 
      
Condensed Statements of Cash Flows   8 
      
Notes to Condensed Financial Statements   9-20 
      

 

 

 

 

2

 

 

 

 

 

 

 

 

Condensed Interim Financial Statements

 

 

 

 

 

 

 

 

3

 

Arthrosurface, Inc.

 

Condensed Balance Sheets

 

    (Unaudited)      
    September 30,    December 31, 
    2019    2018 
           
Assets          
           
Current Assets:          
Cash and cash equivalents  $110,066   $109,945 
Accounts receivable, net of reserves of $837,257 and $833,471 at September 30, 2019 and December 31, 2018, respectively   3,505,181    5,538,254 
Inventory, net of reserve of $419,958 and $494,802 at September 30, 2019 and December 31, 2018, respectively   11,531,145    9,813,841 
Prepaid expenses and other current assets   367,166    795,092 
           
Total Current Assets   15,513,558    16,257,132 
           
Property and Equipment:          
Medical instruments   18,972,144    18,031,426 
Dies and molds   979,354    864,424 
Computer equipment and software   972,780    963,386 
Furniture and fixtures   681,365    622,645 
Leasehold improvements   87,703    87,703 
Machinery and equipment   46,033    46,033 
    21,739,379    20,615,617 
Less accumulated depreciation and amortization   19,875,013    19,191,795 
           
Total Property and Equipment   1,864,366    1,423,822 
           
Other Assets:          
Deferred Taxes   4,329,632    1,127,318 
           
Total Assets  $21,707,556   $18,808,272 

 

See accompanying notes to unaudited condensed interim financial statements.

 

4

 

Arthrosurface, Inc.

 

Condensed Balance Sheets

 

    (Unaudited)      
    September 30,    December 31, 
    2019    2018 
           
Liabilities, Redeemable Convertible Preferred Stock and Stockholders’ Equity
           
Current Liabilities:          
Notes payable, line of credit  $1,926,798   $1,142,601 
Accounts payable   935,793    395,887 
Accounts payable - related party   1,288,138    431,782 
Accrued expenses   1,647,837    2,115,534 
           
Total Current Liabilities   5,798,566    4,085,804 
           
Commitments (Notes 11 and 12)          
           
Redeemable Convertible Preferred Stock:          
Series B redeemable convertible preferred stock, $0.001 par value; 2,000,000 shares designated, issued and outstanding (liquidation preference of $2,000,000)   9,500,000    9,500,000 
           
Stockholders' Equity:          
Series A convertible preferred stock, $0.001 par value; 3,311,557 shares designated, issued and outstanding (liquidation preference of $3,311,557)   3,097,680    3,097,680 
Series C convertible preferred stock, $0.001 par value; 4,000,000 shares designated; 2,448,500 shares issued and outstanding (liquidation preference of $6,121,250)   5,760,374    5,760,374 
Series D convertible preferred stock, $0.001 par value; 3,057,724 shares designated, issued and outstanding (liquidation preference of $10,702,034)   10,622,252    10,622,252 
Series E convertible preferred stock, $0.001 par value; 1,131,112 shares designated; 1,111,112 shares issued and  outstanding (liquidation preference of $5,000,004)   4,969,845    4,969,845 
Series F convertible preferred stock, $0.001 par value; 1,052,632 shares designated; 884,608 shares issued and outstanding (liquidation preference of $4,201,888)   4,167,632    4,167,632 
Common stock, $0.001 par value; 22,000,000 shares authorized; 6,570,944 shares issued and outstanding   6,573    6,573 
Additional paid-in capital   1,025,650    1,025,650 
Accumulated deficit   (23,241,016)   (24,427,538)
           
Total Stockholders' Equity   6,408,990    5,222,468 
           
Total Redeemable Convertible Preferred Stock and Stockholders’ Equity   15,908,990    14,722,468 
           
Total Liabilities, Redeemable Convertible Preferred Stock and Stockholders’ Equity  $21,707,556   $18,808,272 

 

See accompanying notes to unaudited condensed interim financial statements.

5

 

Arthrosurface, Inc.

 

Condensed Statements of Operations

 

    September 30,    September 30, 
For the nine months ended (unaudited)   2019    2018 
           
Net Revenues  $20,606,252   $19,146,317 
           
Cost of Goods Sold   5,407,620    4,292,074 
           
Gross Profit   15,198,632    14,854,243 
           
Operating Expenses:          
Selling and marketing   12,798,701    11,847,872 
General and administrative   2,204,609    2,183,936 
Research and development   2,134,829    2,214,678 
           
Total Operating Expenses   17,138,139    16,246,486 
          
Loss from Operations   (1,939,507)   (1,392,243)
           
Other Income (Expense):          
Interest expense   (48,905)   (2,652)
Other income   -    564 
           
Loss before Income Taxes   (1,988,412)   (1,394,331)
           
Income Tax (Benefit) Expense   (3,174,934)   1,449,263 
           
Net Income (Loss)  $1,186,522   $(2,843,594)

 

See accompanying notes to unaudited condensed interim financial statements.

 

6

 

Arthrosurface, Inc.

 

Condensed Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity (Unaudited)

 

                                              

Total

Redeemable

    

Series B

Redeemable 

   Series A   Series C   Series D   Series E   Series F                    

Convertible

Preferred

    Convertible    Convertible    Convertible    Convertible    Convertible    Convertible    Common Stock    Additional      Total   Stock and
    

Preferred

Stock

   

Preferred

Stock

   

Preferred

Stock

   

Preferred

Stock

   

Preferred

Stock

   

Preferred

Stock

   

Shares

   

Par Value

   

Paid-in

Capital

   

Accumulated

Deficit

   

Stockholders'

 Equity

  

Stockholders'

Equity

                                                 
Balance at December 31, 2018  $9,500,000  $3,097,680  $5,760,374  $10,622,252  $4,969,845  $4,167,632   6,570,944  $6,573  $1,025,650  $(24,427,538) $5,222,468   $14,722,468
                         `                         
Net income   -   -   -   -   -   -   -   -   -   1,186,522   1,186,522   1,186,522
                                                 
Balance at September 30, 2019  $9,500,000  $3,097,680  $5,760,374  $10,622,252  $4,969,845  $4,167,632   6,570,944  $6,573  $1,025,650  $(23,241,016) $6,408,990   $15,908,990

 

 

 

See accompanying notes to unaudited condensed interim financial statements.

 

 

 

 

 

 

 

 

7

 

Arthrosurface, Inc.

 

Condensed Statements of Cash Flows

 

    September 30,    September 30, 
For the nine months ended (unaudited)   2019    2018 
           
Cash Flows from Operating Activities:          
Net income (loss)  $1,186,522   $(2,843,594)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:          
Depreciation and amortization   683,218    710,514 
Change in reserves   (71,058)   (111,681)
Deferred taxes   (3,202,314)   1,418,984 
Stock-based compensation   -    37,988 
Increase (decrease) in cash resulting from a change in:          
Accounts receivable   2,029,287    2,329,499 
Inventory   (1,642,460)   (1,346,593)
Prepaid expenses and other current assets   427,926    (286,968)
Accounts payable   539,906    (3,045)
Accounts payable - related party   856,356    128,733 
Accrued expenses   (467,697)   (370,875)
           
Net Cash Provided by (Used in) Operating Activities   339,686    (337,038)
           
Cash Flows from Investing Activity:          
Purchases of property and equipment   (1,123,762)   (1,007,565)
           
Net Cash Used in Investing Activity   (1,123,762)   (1,007,565)
           
Cash Flows from Financing Activities:          
Proceeds from note payable, line of credit   784,197    767,995 
           
Net Cash Provided by Financing Activities   784,197    767,995 
           
Net Increase (Decrease) in Cash and Cash Equivalents   121    (576,608)
           
Cash and Cash Equivalents, beginning of period   109,945    685,901 
           
Cash and Cash Equivalents, end of period  $110,066   $109,293 
           
Supplemental Disclosures of Cash Flow Information          
           
Cash paid during the period for:          
           
Income Taxes  $27,380   $30,279 
           
Interest  $48,905   $2,652 

 

See accompanying notes to unaudited condensed interim financial statements.

 

8

 

Arthrosurface, Inc.

 

Notes to Condensed Interim Financial Statements (Unaudited)

 

1. Business Operations

 

Arthrosurface, Inc. (the “Company”) was incorporated in Delaware in August 2001. The Company was formed to design, develop, manufacture, and market new surgical alternatives for the treatment of orthopedic joint disease. The Company is located primarily in Massachusetts and serves customers throughout the world.

 

The Company is subject to a number of risks associated with emerging, technology-oriented companies. Principal among these are the risks associated with dependence on key individuals, rapid technology change, competition from larger, more financially independent competitors, and the need for successful development and marketing of services and products.

 

2. Significant Accounting Policies

 

A summary of the significant accounting policies followed by the Company in the presentation of the accompanying financial statements is set forth below:

 

Basis of Presentation

 

The accompanying financial statements are prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). The presentation of information as of December 31, 2018, is derived from audited financial statements.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents.

 

Allowance for Doubtful Accounts

 

The Company provides an allowance for doubtful accounts equal to estimated bad debt losses. The estimated losses are based on historical collection experience together with a review of the current status of existing receivables. The Company’s allowance for doubtful accounts was $314,686 and $310,900 at September 30, 2019 and December 31, 2018, respectively, and was netted with accounts receivable in the accompanying balance sheets, along with the sales return reserve.

 

9

 

Arthrosurface, Inc.

 

Notes to Condensed Interim Financial Statements (Unaudited)

 

Inventory

 

Inventory is stated at the lower of cost or market. Cost is determined on a first-in, first-out (“FIFO”) basis. Inventory consists principally of purchased components, the majority of which are considered finished goods. The Company provides a reserve for obsolescence equal to estimated losses resulting from obsolete inventory. The estimated losses are based upon historical product useful lives and a review of the current status of the existing inventory.

 

Property and Equipment

 

Property and equipment are stated at cost. Major renewals, additions, and betterments are charged to the property accounts, while replacements, maintenance, and repairs, which do not improve or extend the lives of the respective assets, are expensed in the year incurred.

 

Depreciation and Amortization

 

Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets as follows:

 

Assets Life in Years  
     
Medical instruments 3  
Dies and molds 3  
Computer equipment and software 3  
Furniture and fixtures 7  
Leasehold improvements Life of lease  
Machinery and equipment 5  

 

Impairment of Long-lived Assets

 

The Company periodically evaluates its long-lived assets for events and circumstances that indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. The Company believes the future cash flows to be generated from the long-lived assets will exceed the assets’ carrying value, and accordingly, the Company has not recognized any impairment losses through September 30, 2019.

 

Redeemable Convertible Preferred Stock

 

The carrying value of the Series B redeemable convertible preferred stock is increased or decreased by periodic accretion so that the carrying amount will equal the redemption amount at the redemption date. The accretion is recorded as a decrease in additional paid-in capital until the balance becomes zero, with the remainder being recorded against the accumulated deficit.

 

10

 

Arthrosurface, Inc.

 

Notes to Condensed Interim Financial Statements (Unaudited)

 

Fair Value of Financial Instruments

 

Certain assets and liabilities are carried at fair value under U.S. GAAP. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. Financial assets and liabilities carried at fair value are to be classified and disclosed in one of the following three levels of the fair value hierarchy, of which the first two are considered observable and the last is considered unobservable:

 

·Level 1 — Quoted prices in active markets for identical assets or liabilities.
·Level 2 — Observable inputs (other than Level 1 quoted prices), such as quoted prices in active markets for similar assets or liabilities, quoted prices in markets that are not active for identical or similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data.
·Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to determining the fair value of the assets or liabilities, including pricing models, discounted cash flow methodologies and similar techniques.

 

The carrying values of the Company’s cash and cash equivalents, accounts receivable, accounts payable, and accounts payable – related party, approximate fair value due to the immediate or short-term maturity of these financial instruments.

 

Revenue Recognition

 

The Company’s revenue consists of sales of products directly to hospitals and distributors. The Company recognizes revenue when persuasive evidence of an arrangement exists, the price is fixed and determinable, the risk of loss has transferred to the customer, the Company’s performance obligations are complete, delivery has occurred, and collection is reasonably assured. Revenue from sales to distributors is reported net of sales returns, including an estimate of future returns based on historical return rates, with a corresponding reduction to cost of goods sold. The Company’s sales return reserve was $522,571 at September 30, 2019 and December 31, 2018, and was netted with accounts receivable in the accompanying balance sheets.

 

Research and Development Costs

 

The Company accounts for its research and development costs in accordance with Accounting Standards Codification (“ASC”) 730, “Research and Development.” Accordingly, research and development costs are charged to expense as incurred.

 

Advertising Costs

 

Advertising costs are charged to operations as incurred. The advertising costs incurred were $182,046 and $121,290 for the nine months ended September 30, 2019 and 2018, respectively.

 

Stock-Based Compensation

 

The Company accounts for its stock-based compensation based on the fair value recognition provisions of ASC 718, “Compensation: Stock Compensation.” The Company is required to include an estimate of the number of awards that will be forfeited in calculating compensation costs, which is recognized over the requisite service period of the awards on a straight-line basis.

 

There were no options granted during the nine months ended September 30, 2019 or 2018.

 

11

 

Arthrosurface, Inc.

 

Notes to Condensed Interim Financial Statements (Unaudited)

 

Stock-based awards issued to non-employees are accounted for at their fair market value. The compensation expense that will ultimately be recognized for these options will be measured at the vesting dates of the underlying options. There were 26,295 outstanding non-employee options as of September 30, 2019 and December 31, 2018. As these options vest, the Company will be required to re-measure the fair value of these options at each reporting period prior to vesting and finally at the vesting date of the option. Changes in the estimated fair value of these non-employee options will be recognized as compensation expense or a reduction in compensation expense in the period of the change.

 

Total stock-based compensation expense related to employee stock options was $-0- and $37,988 for the nine months ended September 30, 2019 and 2018, respectively. As of September 30, 2019, all stock options outstanding were fully vested.

 

Income Taxes

 

Provisions for income taxes are based on taxes payable or refundable for the current year and deferred taxes on temporary differences between the amount of taxable income and pretax financial income and between the tax basis of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The Company evaluates the realizability of its deferred tax assets and assesses the need for a valuation allowance on an ongoing basis. In evaluating the deferred tax assets, the Company considers whether it is more likely than not that the deferred income tax assets will be realized. The ultimate realization of the deferred tax assets depends upon generating sufficient future taxable income during the periods in which the Company’s temporary differences either become deductible or expire. This assessment requires significant judgement. Any future changes in the valuation allowance could result in additional income tax expense or benefit and could decrease or increase stockholders’ equity, and such changes could have significant impact upon future earnings.

 

The Company may recognize tax benefits only in the event that a position is more likely than not to be sustained upon examination by the applicable taxing authority. There are no federal or state income tax audits in progress as of September 30, 2019, and the Company does not believe it has any uncertain tax positions. Tax years through 2016 remain open for audit by various jurisdictions.

 

Medical Device Tax

 

The Consolidated Appropriations Act of 2016, which was signed into law on December 18, 2015, temporarily repealed the medical device tax to which the Company is subject for sales of listed medical devices sold within the United States of America. The repeal was effective for the period beginning January 1, 2016, through December 31, 2017. During 2018, H.R. 195 (the “Continuing Resolution”) was signed into law which extended the temporary repeal of the medical device tax through December 31, 2019. During 2019, H.R. 1865 was signed into law which permanently repealed the medical device tax.

 

12

 

Arthrosurface, Inc.

 

Notes to Condensed Interim Financial Statements (Unaudited)

 

Recent Accounting Pronouncements Affecting the Company

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued converged guidance on recognizing revenue in contracts with customers, Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers. The intent of the new standard is to improve financial reporting and comparability of revenue globally. The core principle of the standard is for a company to recognize revenue in a manner that depicts the transfer of goods or services to customers in an amount that reflects the consideration which the company expects to receive in exchange for those goods or services. The guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. Other major provisions include capitalization of certain contract costs, consideration of the time value of money in the transaction price, and in certain circumstances, allowing estimates of variable consideration to be recognized before contingencies are resolved. The guidance also requires enhanced disclosures regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. The standard is effective for nonpublic business entities for annual reporting periods beginning after December 15, 2018. The Company is currently evaluating the provisions of this standard to determine the impact on the Company’s financial statements.

 

In February 2016, the FASB issued ASU 2016-02, which amends the ASC and creates Topic 842, Leases. Topic 842 will require lessees to recognize lease assets and lease liabilities for those leases classified as operating leases under previous U.S. GAAP on the balance sheet. This guidance is effective for nonpublic business entities for fiscal years beginning after December 15, 2019, and early adoption is permitted. The Company is in the initial stages of evaluating the effect of the standard on its financial statements and will continue to evaluate. While not yet in a position to assess the full impact of the application of the new standard, the Company expects that the impact of recording the lease liabilities and the corresponding right-to-use assets will have a minimal impact on its total assets and liabilities with a minimal impact on equity.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, that changes the impairment model for most financial assets and certain other instruments. For receivables, loans, and other instruments, entities will be required to use a new forward-looking current expected credit loss model that generally will result in the earlier recognition of allowance for losses. For available-for-sale debt securities with unrealized losses, entities will measure credit losses in a manner similar to current practice, except the losses will be recognized as allowances instead of reductions in the amortized cost of the securities. In addition, an entity will have to disclose significantly more information about allowances, credit quality indicators, and past due securities. The new provisions will be applied as a cumulative-effect adjustment to retained earnings. The Company will adopt the new standard on January 1, 2023. The Company is evaluating the impact that the new standard will have on its financial statements.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which provides guidance related to cash flows presentation and is effective for annual reporting periods beginning after December 15, 2018. The guidance in ASU 2016-15 is generally consistent with the Company’s current cash flow classifications, and adoption of this standard is not expected to have a material impact on its financial statements.

 

13

 

Arthrosurface, Inc.

 

Notes to Condensed Interim Financial Statements (Unaudited)

 

Subsequent Events

 

The Company has evaluated subsequent events through January 31, 2020, which is the date the financial statements were available for issuance.

 

3. Related-Party Transactions

 

The Company purchases a majority of its products from Primo Medical Group, Inc. (“PMG”), a related entity through common ownership. During the nine months ended September 30, 2019 and 2018, the Company purchased goods totaling $6,398,057 and $6,277,939 from PMG, respectively. At September 30, 2019 and December 31, 2018, the Company had amounts owed to PMG of $1,288,138 and $431,782, respectively.

 

4. Line of Credit

 

The Company has a revolving line of credit agreement with a bank with a maximum borrowing limit of $4,000,000. The line of credit is secured by all corporate assets, with the exception of intellectual property, and is subject to reporting covenants. The line of credit accrues interest at the bank’s prime rate (5.0% and 5.5% as of September 30, 2019 and December 31, 2018, respectively) plus 0.25%; however, in no event shall the interest rate be less than 3.75%. At September 30, 2019 and December 31, 2018, the outstanding balance was $1,926,798 and $1,142,601, respectively. The line of credit has a maturity date of March 2, 2020.

 

5. Accrued Expenses

 

Accrued expenses consist of the following at:

 

    

September 30,

2019

    

December 31,

2018

 
           
Payroll, bonus and employee benefits  $621,573   $715,406 
Commissions   613,898    725,387 
Royalties   134,721    176,040 
Sales tax   23,672    24,985 
Other liabilities   253,973    473,716 
           
Total Accrued Expenses  $1,647,837   $2,115,534 

 

6. Detachable Series E Preferred Stock Warrants

 

In August 2007, in connection with entering into a prior credit facility with a bank, the Company issued an initial 13,333 warrants for the right to purchase Series E Preferred Stock. Additional warrants were issued when the Company borrowed $3,000,000 against the facility in July 2008 at a rate of 1% multiplied by the funds borrowed divided by the warrant price at the time of each funding. As such, the Company issued the additional 6,667 warrants related to the borrowings of the facility. The exercise price per share is equal to the most recent Series E Preferred Stock share price, which at the time of borrowing was $4.50 per share. The warrants expire 10 years from issuance. The Company has expensed the fair value of the entire 20,000 warrants over the full-term of the facility. During 2017, the warrant expiration date was extended to August 2019, and during 2019 the warrant expiration date was extended to August 2020. The impact of the extension of the warrant expiration date is immaterial to the financial statements.

 

14

 

Arthrosurface, Inc.

 

Notes to Condensed Interim Financial Statements (Unaudited)

 

The fair value of the warrants was estimated using the Black-Scholes-Merton formula with the following assumptions: no dividend yield, risk free interest rate of 4.63%, a weighted average expected life of 10 years, and an estimated volatility of 46%. The discount was netted against the note payable, and the remaining costs were expensed monthly through July 2011.

 

7. Redeemable Convertible and Convertible Preferred Stock

 

At September 30, 2019, the Company had authorized 15,311,557 shares of preferred stock, of which 2,000,000 were designated Series B redeemable convertible preferred stock (“Series B Preferred Stock”), 3,311,557 were designated Series A convertible preferred stock (“Series A Preferred Stock”), 4,000,000 were designated Series C convertible preferred stock (“Series C Preferred Stock”), 3,057,724 were designated Series D convertible preferred stock (“Series D Preferred Stock”), 1,131,112 were designated Series E convertible preferred stock (“Series E Preferred Stock”), and 1,052,632 were designated Series F convertible preferred stock (“Series F Preferred Stock”).

 

The Series B, Series A, Series C, Series D, Series E, and Series F Preferred Stock (collectively known as “Preferred Stock”) have the following characteristics:

 

Voting

 

In general, the holders of the Preferred Stock are entitled to vote together with all other classes and series of stock of the Company as a single class on all actions to be taken by the stockholders of the Company. Each holder of the Preferred Stock is entitled to the number of votes equal to the number of shares of common stock into which each share of preferred stock is convertible at the time of such vote. The holders of the Series B Preferred Stock and common stock shall be entitled to elect one and four directors of the Company, respectively.

 

Dividends

 

Upon the declaration by the Company of dividends payable to the holders of the Company’s common stock, the holders of the Preferred Stock are entitled to dividends equal to the amount of dividends payable to the holders of the common stock on an as-if converted basis. No dividends shall be paid on the Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock, and Series F Preferred Stock until any and all dividends declared on the Series B Preferred Stock are paid in full. Through September 30, 2019, no dividends have been declared or paid by the Company.

 

Liquidation Preference

 

In the event of any voluntary or involuntary sale, liquidation, dissolution, or winding-up of the Company, the holders of the shares of Series B Preferred Stock shall be paid an amount equal to $1.00 per share, plus, in the case of each share, an amount equal to any declared but unpaid dividends.

 

If, upon liquidation, dissolution, or winding-up of the Company, the assets of the Company are not sufficient to permit payment of the full liquidation preference of the Series B Preferred Stock, the assets will be distributed to the Series B Preferred Stock stockholders pro rata. In addition, in no event shall the amount to be distributed to the holders of the Series B Preferred Stock be less than the $2.00 per share of common stock which would be issuable upon the conversion of the Series B Preferred Stock.

 

15

 

Arthrosurface, Inc.

 

Notes to Condensed Interim Financial Statements (Unaudited)

 

Immediately after payment in full of the liquidation payment to the holders of the Series B Preferred Stock listed above, the holders of the Series A Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock, and Series F Preferred Stock shall be paid an amount equal to $1.00 per share, $2.50 per share, $3.50 per share, $4.50 per share, and $4.75 per share, respectively, plus, in the case of each share, an amount equal to any declared but unpaid dividends. If, upon liquidation, dissolution, or winding-up of the Company, the assets of the Company are not sufficient to permit payment of the full liquidation preference of the Series A Preferred Stock, Series C Preferred Stock, Series D Preferred Stock, Series E Preferred Stock, and Series F Preferred Stock, the assets will be distributed to the holders of such stock pro rata. After payment of the above-mentioned amounts to the holders of the Preferred Stock, the remaining net assets of the Company shall be distributed to the holders of the Series B Preferred Stock and the holders of the common stock equally on an as-if converted basis.

 

Conversion

 

The holders of the Preferred Stock have the right, at their option at any time, to convert any such shares of Preferred Stock into fully paid and non-assessable shares of common stock on a one-for-one basis. The conversion rate is subject to anti-dilution adjustments and adjustments in the event of stock dividends, stock splits, and similar recapitalizations. If the holders of at least a majority interest in a particular series of Preferred Stock elect to convert such stock into common stock, then all of the outstanding shares in that series of preferred stock shall automatically convert into common stock. In addition, if the holders of at least a majority interest in the Series B Preferred Stock elect to convert such stock into common stock, then all of the outstanding shares of Preferred Stock automatically convert into common stock. Furthermore, all outstanding shares of Preferred Stock automatically convert into common stock, at the then-applicable conversion rate, upon consummation of a firm commitment for an underwritten public offering of the common stock yielding a per share price of at least $4.00 and gross proceeds of at least $20,000,000.

 

Redemption

 

The holders of at least a majority of the outstanding Series B Preferred Stock may, by written request, require the Company to redeem all of the outstanding Series B Preferred Stock by paying in cash a sum equal to the greater of the then fair value per share of the Series B Preferred Stock or the original purchase price of $1.00 per share plus all dividends declared and unpaid on each share. The required redemption amount of the Series B Preferred Stock outstanding as of September 30, 2019, calculated using an estimated fair value of $4.75 per share, would be $9,500,000. The fair value of $4.75 was estimated by management by referencing the last round of preferred stock financing; actual fair value may be significantly different upon an actual redemption.

 

8. Common Stock

 

As of September 30, 2019, the Company had authorized 22,000,000 shares of common stock, $0.001 par value per share. Each share of common stock entitles the holder to one vote on all matters submitted to a vote of the Company’s stockholders. Common stockholders are entitled to receive dividends, if any, as may be declared by the Board of Directors, subject to the prior rights of holders of the Preferred Stock outstanding. Upon the dissolution or liquidation of the Company, the holders of the common stock will be entitled to receive assets of the corporation available for distribution to its stockholders, subject to the preferential rights of the Preferred Stock.

 

16

 

Arthrosurface, Inc.

 

Notes to Condensed Interim Financial Statements (Unaudited)

 

The Company periodically issues shares of common stock, primarily to certain employees and other consultants who assist the Company, to promote the interests of the Company by providing long-term incentives through equity sharing (“restricted stock”). The stockholders of the restricted stock may not sell, assign, transfer, or pledge any of their shares without giving written notice to the Company. In the event that these stockholders cease to be employed by the Company, or otherwise cease to be affiliated with the Company, the Company has the right to repurchase some or all of the unvested shares at a price of $0.001 per share. Shares subject to the repurchase rights generally vest over a four-year period. As of September 30, 2019 and December 31, 2018, the Company had 3,056,815 shares that were outstanding and vested.

 

9. Stock Option Plan

 

In 2003, the Company adopted the 2002 Stock Plan (the “2002 Plan”). During 2012, the Company’s Board of Directors amended the 2002 Plan to increase the shares of the Company’s common stock reserved for issuance to employees, directors, and consultants to 3,600,000. During 2013, the Company’s Board of Directors created the 2013 Stock Incentive Plan (the “Plan”) to amend and replace the 2002 Plan. Options granted under the Plan may be incentive or non-statutory stock options. Stock purchase rights may also be granted under the Plan. Incentive stock options may only be granted to employees. The Board of Directors determines the period over which options become exercisable. Generally, stock options issued under the Plan vest over a period of four years and have contractual lives of 10 years. As of September 30, 2019 and December 31, 2018, there were 415,435 and 410,935 shares, respectively, left for issuance under the Plan.

 

The following table summarizes the stock options activity for the nine months ended September 30, 2019:

 

    

Options

Outstanding

    

Weighted

Average

Exercise

Price

 
           
Options Outstanding at December 31, 2018   284,795   $3.44 
           
Cancelled   (4,500)  $3.23 
           
Options Outstanding at September 30, 2019   280,295   $3.44 

 

17

 

Arthrosurface, Inc.

 

Notes to Condensed Interim Financial Statements (Unaudited)

 

The following table summarizes information about stock options outstanding and exercisable under the Plan at September 30, 2019:

 

      Options Outstanding    Options Exercisable 
           Weighted              Weighted      
           Average    Weighted         Average    Weighted 
           Remaining    Average         Remaining    Average 
 Exercise    Number    Contractual    Exercise    Number of    Contractual    Exercise 
 Prices    Outstanding    Life    Price    Shares    Life    Price 
                                 
$3.00    101,000    2.77 years   $3.00    101,000    2.77 years   $3.00 
$3.69    179,295    4.65 years   $3.69    179,295    4.65 years   $3.69 
                                 
      280,295    3.97 years   $3.44    280,295    3.97 years   $3.44 

 

10. Income Taxes

 

The provision for income taxes shown in the accompanying statements of income consisted of the following amounts:

 

Nine months ended September 30,   2019    2018 
           
Current Income Tax:          
Federal  $-   $- 
State   27,380    30,279 
           
Total Current Income Tax   27,380    30,279 
           
Deferred Income Tax:          
Federal   (286,000)   (293,000)
State   30,000    6,000 
(Release of) increase in valuation allowance   (2,946,314)   1,705,984 
           
Total Deferred Income Tax (Benefit) Expense   (3,202,314)   1,418,984 
           
Total Income Tax (Benefit) Expense  $(3,174,934)  $1,449,263 

 

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18

 

Arthrosurface, Inc.

 

Notes to Condensed Interim Financial Statements (Unaudited)

 

Components of the Company’s deferred tax assets were as follows:

 

    

September 30,

2019

    

December 31,

2018

 
           
Deferred Tax Assets:          
Net operating loss carryforwards  $2,961,000   $2,617,000 
Research and development credits   1,810,000    1,774,000 
Other   363,000    487,000 
    5,134,000    4,878,000 
Valuation Allowance   (804,368)   (3,750,682)
           
Net Deferred Tax Assets  $4,329,632   $1,127,318 

 

The Company recorded a tax provision in the amount of $(3,174,934) and $1,449,263 for the nine months ended September 30, 2019 and 2018, respectively, resulting in an effective tax rate that significantly deviates from the Company’s statutory tax rate of 25.5%. This deviation from the statutory tax rate is the result of the valuation allowance released from or placed on all deferred taxes in these periods. The valuation allowance reflects the Company’s evaluation of the positive and negative evidence concerning the Company’s future profitability within the relevant tax jurisdictions. During the nine months ended September 30, 2019, the valuation allowance against the deferred tax assets was lowered as a result of the permanent repeal of the medical device tax.

 

At September 30, 2019, the Company had federal and state net operating loss carryforwards of approximately $14,200,000. The federal net operating loss carryforwards will begin to expire in 2025, unless utilized. State net operating loss carryforwards will begin to expire in 2034. At September 30, 2019, the Company also had federal and state research and development credit carryforwards of approximately $1,459,000 and $444,000, respectively. The federal and state research and development credit carryforwards will begin to expire in 2024 and 2019, respectively.

 

Realization of the future tax benefits is dependent on many factors, including the Company’s ability to generate taxable income within the net operating loss and research and development credit carryforward periods. Under the provisions of the Internal Revenue Code, certain substantial changes in the Company’s ownership, including a sale of the Company or significant changes in ownership due to the sale of capital stock, may have limited, or may limit in the future, the amount of net operating loss carryforwards which could be used annually to offset future taxable income.

 

11. Retirement Plan

 

The Company sponsors a 401(k) plan that covers substantially all employees of the Company. The employer matches contributions on behalf of contributing participants in an amount equal to 50% of the first 6% of such participants’ annual deferrals. The Company made contributions of $139,212 and $117,075 for the nine months ended September 30, 2019 and 2018, respectively.

 

19

 

Arthrosurface, Inc.

 

Notes to Condensed Interim Financial Statements (Unaudited)

 

12. Commitments

 

The Company has entered into agreements to lease its office space and certain office equipment under non-cancelable operating leases expiring at various dates through March 2020. The Company makes monthly payments relating to these leases in amounts ranging from $315 to $9,615. Rent expense under these operating leases for the nine months ended September 30, 2019 and 2018, was $89,066 and $90,044, respectively. The future minimum lease payments under all operating leases at September 30, 2019, is $59,577.

 

13. Royalty Agreements

 

The Company has entered into various royalty agreements with physicians who have provided consultation and product development services pertaining to the Shoulder, Uni-Knee, Patello-Femoral, Toe, and Allograft products. The Company has royalty agreements with several physicians with limited time durations, based on percentages of sales.

 

Royalty payment obligations are based upon various percentages of net sales pertinent to the products covered by the respective royalty arrangements. Accrued royalty expenses as of September 30, 2019 and December 31, 2018, were $134,721 and $176,040, respectively.

 

14. Concentrations

 

The Company had one major vendor accounting for approximately 49% and 47% of the Company’s purchases for the nine months ended September 30, 2019 and 2018, respectively.

 

The Company had one major customer accounting for approximately 14% and 13% of accounts receivable at September 30, 2019 and December 31, 2018, respectively.

 

The Company has a potential concentration of credit risk in that it sometimes maintains deposits with financial institutions in excess of amounts insured by the Federal Deposit Insurance Corporation (“FDIC”). The maximum deposit insurance amount is $250,000, which is applied per depositor, per insured bank for each account ownership category. As of September 30, 2019, the Company had no cash in excess of FDIC limits.

 

15. Subsequent Event

 

On January 4, 2020, the Company entered into a share purchase agreement with Anika Therapeutics, Inc. to purchase 100% of the stock of the Company for a total consideration of $100,000,000, subject to achievement of certain predetermined sales and regulatory milestones. The transaction is subject to standard closing conditions and is anticipated to close in the first quarter of 2020.

 

 

 

 

20

 

Exhibit 99.3

 

UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION

 

On February 3, 2020, (the “Closing Date”), Anika Therapeutics, Inc. (the “Company” or “Anika”) completed the acquisition of Arthrosurface Incorporated, a Delaware corporation (“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, Button Merger Sub, a Delaware corporation and a wholly-owned subsidiary of the Company (“Merger Sub”) and Boston Millenia Partners Button Shareholder Representation, Inc., a Delaware corporation, solely in its capacity as the representative, agent and attorney-in-fact of the equityholders of Arthrosurface. At the closing of the merger of Merger Sub with and into Arthrosurface, Arthrosurface continued as the surviving company and became a wholly-owned subsidiary of the Company (the “Transaction”).

 

The unaudited pro forma condensed combined financial statements are based on Anika’s historical financial statements as adjusted to give effect to the Transaction. The unaudited pro forma condensed combined balance sheet as of September 30, 2019 assumes the Transaction took place on September 30, 2019. The unaudited pro forma condensed combined statements of operations for the nine months ended September 30, 2019 and for the year ended December 31, 2018 that combine the historical consolidated statements of operations of Anika and Arthrosurface assume the Transaction occurred on January 1, 2018.

 

The pro forma adjustments are based upon currently available information and certain assumptions that Anika’s management believes are reasonable. The unaudited pro forma condensed combined financial information is presented for informational purposes only and is not intended to present or be indicative of what the results of operations or financial position would have been had the events actually occurred on the dates indicated, nor is it meant to be indicative of future results of operations or financial position for any future period or as of any future date. The unaudited pro forma condensed combined financial information does not give effect to the potential impact of current financial conditions, or any anticipated revenue enhancements, cost savings or operating synergies that may result from the Transaction.

 

The historical consolidated financial information has been adjusted in the accompanying unaudited pro forma condensed combined financial statements to give pro forma effect to events that are (1) directly attributable to the Transaction, (2) factually supportable, and (3) with respect to the unaudited pro forma condensed combined statements of operations, expected to have a continuing impact on the combined results. Assumptions underlying the pro forma adjustments are described in the accompanying notes, which should be read in conjunction with the unaudited pro forma condensed combined financial information.

 

The unaudited pro forma condensed combined financial information was based on and should be read in conjunction with Anika’s and Arthrosurface’s historical financial statements referenced below:

 

the historical unaudited condensed consolidated financial statements of Anika as of and for the nine months ended September 30, 2019, contained in its Quarterly Report on Form 10-Q for that period;

 

the historical audited consolidated financial statements of Anika as of and for the year ended December 31, 2018 contained in its Annual Report on Form 10-K;

 

the historical unaudited financial statements of Arthrosurface for the nine months ended September 30, 2019, which are included in this Form 8-K/A dated March 13, 2020; and

 

the historical audited financial statements of Arthrosurface as of and for the year ended December 31, 2018, which are included in this Form 8-K/A dated March 13, 2020.

 

In the accompanying unaudited pro forma condensed combined financial statements, the Transaction has been accounted for as a business combination using the acquisition method of accounting under the provisions of Accounting Standards Codification 805 (“ASC 805”). Under ASC 805, Anika, as the accounting acquirer, records assets acquired and liabilities assumed in a business combination at their fair values as of the Closing Date. The final valuation of assets acquired and liabilities assumed related to the Transaction is expected to be completed as soon as practicable, but no later than one year after the consummation of the Transaction. The allocation of purchase consideration reflected in the unaudited pro forma condensed combined financial statements is preliminary and will be adjusted based on Anika’s final valuations of the fair value of the assets acquired and liabilities assumed of Arthrosurface as of the date of the Transaction, which requires use of critical accounting estimates and significant management judgment. Although Anika believes the fair values preliminarily assigned to the assets to be acquired and liabilities to be assumed to be reflected in the unaudited pro forma condensed combined financial statements are based on reasonable estimates and assumptions using currently available data, the results of the final allocation could be materially different from the preliminary allocations.

 

Page 1 of 10

 

ANIKA THERAPEUTICS, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
AS OF SEPTEMBER 30, 2019
(In thousands)
 

 

 

   Historical         
   Anika
Therapeutics
  Arthrosurface After
Reclassifications
(Note 4)
  Pro Forma
Adjustments
  Notes  Pro Forma
Condensed
Combined
ASSETS                       
Current assets:                       
Cash and cash equivalents  $103,381   $110   $(62,177)  (6a), (6e)  $41,314 
Investments   69,825               69,825 
Accounts receivable, net   23,889    3,505           27,394 
Inventories, net   25,243    11,532    4,390   (6b)   41,165 
Prepaid expenses and other current assets   1,479    367           1,846 
Total current assets   223,817    15,514    (57,787)      181,544 
Property and equipment, net   51,750    1,864           53,614 
Operating lease right-of-use assets   23,082               23,082 
Other long-term assets   5,761        7,678   (6b)   13,439 
Intangible assets, net   7,680        52,300   (6d)   59,980 
Goodwill   7,489        23,512   (6c)   31,001 
Total assets  $319,579   $17,378   $25,703      $362,660 
LIABILITIES AND STOCKHOLDERS’ EQUITY                       
Current liabilities:                       
Accounts payable  $2,702   $2,224   $      $4,926 
Accrued expenses and other current liabilities   8,493    3,575    672   (6g)   12,740 
Total current liabilities   11,195    5,799    672       17,666 
Other long-term liabilities   372               372 
Deferred tax liability   4,727    (4,330)   16,092   (6f)   16,489 
Operating lease liabilities   21,603               21,603 
Contingent consideration           28,376   (6a)   28,376 
Total liabilities   37,897    1,469    45,140       84,506 
Stockholders’ equity:                       
Preferred stock       38,118    (38,118)  (6h)    
Common stock   143    7    (7)  (6h)   143 
Additional paid-in-capital   46,482    1,025    (1,025)  (6h)   46,482 
Accumulated other comprehensive loss   (6,318)              (6,318)
Retained earnings (accumulated loss)   241,375    (23,241)   19,713   (6e), (6h)   237,847 
Total stockholders' equity (deficit)   281,682    15,909    (19,437)      278,154 
Total liabilities and stockholders’ equity  $319,579   $17,378   $25,703      $362,660 

 

See accompanying notes to the unaudited pro forma condensed combined financial statements.

 

Page 2 of 10

ANIKA THERAPEUTICS, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2019
(In thousands, except per share data)
 

 

   Historical         
   Anika
Therapeutics
  Arthrosurface After
Reclassifications
(Note 4)
  Pro Forma
Adjustments
  Notes  Pro Forma
Condensed
Combined
Product revenue  $84,745   $20,606   $      $105,351 
Licensing, milestone and contract revenue   93               93 
Total revenue   84,838    20,606           105,444 
Operating expenses:                       
Cost of product revenue   20,098    5,407    6,541   (7a), (7b)   32,046 
Research & development   12,581    2,135           14,716 
Selling, general & administrative   22,713    15,004            37,717 
Total operating expenses   55,392    22,546    6,541       84,479 
Income (loss) from operations   29,446    (1,940)   (6,541)      20,965 
Interest and other income, net   1,513    (48)   48   (7c)   1,513 
Income (loss) before income taxes   30,959    (1,988)   (6,493)      22,478 
Provision for (benefit from) income taxes   7,817    (3,175)   (1,624)  (7d)   3,018 
Net income (loss)  $23,142   $1,187   $(4,869)     $19,460 
                        
Basic net income per share:                       
Net income  $1.65             (7e)  $1.38 
Basic weighted average common shares outstanding   14,065                 14,065 
Diluted net income per share:                       
Net income  $1.62             (7e)  $1.36 
Diluted weighted average common shares outstanding   14,266                 14,266 

 

 

 

See accompanying notes to the unaudited pro forma condensed combined financial statements.

Page 3 of 10

 

 

ANIKA THERAPEUTICS, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2018

(In thousands, except per share data)

 

 

   Historical      
   Anika
Therapeutics
  Arthrosurface After
Reclassifications
(Note 4)
  Pro Forma
Adjustments
  Notes  Pro Forma
Condensed
Combined
Product revenue  $105,531   $27,169   $      $132,700 
Licensing, milestone and contract revenue   24               24 
Total revenue   105,555    27,169           132,724 
Operating expenses:                       
Cost of product revenue   31,280    6,417    11,629   (7a), (7b)   49,326 
Research & development   18,190    3,211           21,401 
Selling, general & administrative   34,336    19,095            53,431 
Total operating expenses   83,806    28,723    11,629       124,158 
Income from operations   21,749    (1,554)   (11,629)      8,566 
Interest and other income, net   1,458    (7)   8   (7c)   1,459 
Income (loss) before income taxes   23,207    (1,561)   (11,621)      10,025 
Provision for (benefit from) income taxes   4,485    1,514    (2,905)  (7d)   3,094 
Net income (loss)  $18,722   $(3,075)  $(8,716)     $6,931 
                        
Basic net income per share:                       
Net income  $1.30             (7e)  $0.48 
Basic weighted average common shares outstanding   14,442                 14,442 
Diluted net income per share:                       
Net income  $1.27             (7e)  $0.47 
Diluted weighted average common shares outstanding   14,689                 14,689 
                        
                        

 

See accompanying notes to the unaudited pro forma condensed combined financial statements.

 

Page 4 of 10

NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION

 

Note 1     – Description of the Transaction

 

On January 4, 2020, Anika entered into the Arthrosurface Merger Agreement to acquire all outstanding equity of Arthrosurface. On February 3, 2020, the acquisition was completed and Arthrosurface became a wholly-owned subsidiary of the Company. Pursuant to the terms of the Arthrosurface Merger Agreement, the Company acquired all outstanding equity of Arthrosurface for an estimated total purchase consideration of $89.6 million, which consists of $61.2 million of cash paid at closing and $28.4 million for the acquisition-date estimated fair valued future cash payment of contingent consideration.

 

Note 2     – Basis of presentation

 

The accompanying unaudited pro forma condensed combined financial information was prepared in accordance with Article 11 of SEC Regulation S-X. The historical financial statements of Anika and Arthrosurface have only been adjusted to show pro forma effects that are (i) directly attributable to the Transaction, (ii) factually supportable, and (iii) with respect to the unaudited pro forma condensed combined statements of operations, expected to have a continuing impact on the combined results.

 

The unaudited pro forma condensed combined balance sheet as of September 30, 2019 was prepared using the historical balance sheets of Anika and Arthrosurface as of September 30, 2019 and gives effect to the Transaction as if it occurred on September 30, 2019. The unaudited pro forma condensed combined statements of operations for the nine months ended September 30, 2019 and the year ended December 31, 2018 give effect to the Transaction as if it occurred on January 1, 2018 and were prepared using:

 

the historical unaudited condensed consolidated financial statements of Anika as of and for the nine months ended September 30, 2019;

 

the historical audited consolidated financial statements of Anika as of and for the year ended December 31, 2018;

 

the historical unaudited financial statements of Arthrosurface as of and for the nine months ended September 30, 2019; and

 

the historical audited financial statements of Arthrosurface as of and for the year ended December 31, 2018.

 

The unaudited pro forma condensed combined financial information does not include the impacts of any revenue, cost or other operating synergies that may result from the Transaction or any related restructuring costs that may be contemplated.

 

Note 3     – Conforming accounting policies

 

The unaudited pro forma condensed combined financial statements do not assume any differences in accounting policies, except as described below, as the Company is not aware of any differences that would have a material impact on the unaudited pro forma condensed combined financial statements. Further review of Arthrosurface’s detailed accounting policies following the completion of the Transaction may result in the identification of additional differences between the accounting policies of the two companies that, when conformed, could have a material impact on the financial statements of the combined company. Certain reclassifications have been made to the historical financial statements of Arthrosurface to conform to the Company’s presentation, which are discussed in more detail in “Note 4 – Historical Arthrosurface.”

 

Page 5 of 10

Note 4     – Historical Arthrosurface

 

Certain reclassification adjustments have been made to conform Arthrosurface’s financial statement presentation to that of the Anika’s as indicated in the tables below.

 

a)The reclassification adjustments to conform Arthrosurface’s balance sheet presentation to that of Anika’s have no impact on net assets and are summarized below:

 

Item   Amount
(in $ thousands) 
  Presentation in Arthrosurface
Financial Statements 
  Presentation in Unaudited
Pro Forma Condensed
Combined Balance Sheet
Deferred tax assets   4,330   Deferred taxes   Deferred tax liability
Accounts payable, related party   1,288   Accounts payable, related party   Accounts payable  
Notes payable, line of credit   1,927   Notes payable, line of credit   Accrued expenses and other current liabilities 

 

b)The reclassification adjustments to conform Arthrosurface’s statement of operations presentation to that of Anika’s have no impact on net income and are summarized below:

 

Unaudited pro forma condensed combined statement of operations for the nine months ended September 30, 2019

 

Item   Amount
(in $ thousands)
  Presentations in
Arthrosurface Financial
Statements
  Presentation in Unaudited
Pro Forma Condensed
Combined Statement of Operations
Net revenues   20,606   Net revenues   Product revenue
Selling, general & administrative   15,004   Selling and marketing & general and administrative   Selling, general & administrative
Interest expense and other income, net   (48)   Interest income, interest expense, other income, net   Interest and other income, net
Income tax expense   (3,175)   Income tax expense   Provision for (benefit from) income taxes

 

Unaudited pro forma condensed combined statement of operations for the year ended December 31, 2018

 

Item  

Amount

(in $ thousands)

  Presentations in
Arthrosurface Financial
Statements
  Presentation in Unaudited
Pro Forma Condensed
Combined Statement of Operations
Net revenues   27,169   Net revenues   Product revenue
Selling, general & administrative   19,095   Selling and marketing & general and administrative   Selling, general & administrative
Interest income, interest expense, other income, net    (7)   Interest income, interest expense, other income, net   Interest and other income, net
Income tax expense   1,514   Income tax expense   Provision for income taxes

 

Note 5     – Preliminary purchase price allocation

 

The estimated total purchase consideration for the Transaction is approximately $89.6 million, which consists of $61.2 million of cash paid at closing and $28.4 million for the acquisition-date estimated fair value of future cash payment of contingent consideration. The contingent consideration is related to the earn-out amounts pursuant to the Arthrosurface Merger Agreement and represents the estimated fair value of potential future payments based on the estimated probability of achieving contingent regulatory approval milestones and certain net sales levels from 2020 through 2022. The following is a preliminary estimate of fair valued assets acquired and liabilities assumed of Arthrosurface at September 30, 2019, reconciled to estimated total purchase consideration (in thousands):

 

Page 6 of 10

 

Cash and cash equivalents  $110 
Accounts receivable   3,505 
Inventories   15,922 
Prepaid expenses and other current assets   367 
Property and equipment   1,864 
Other long-term assets   7,678 
Intangible assets   52,300 
Accounts payable   (2,224)
Accrued expenses and other liabilities   (1,648)
Deferred tax liability   (11,762)
Goodwill   23,512 
Total purchase consideration  $89,624 

 

This preliminary purchase price allocation has been used to prepare pro forma adjustments in the unaudited pro forma condensed combined balance sheet and condensed combined statement of operations. The final purchase price allocation will be determined when the Company has completed the detailed valuations and necessary calculations. The final allocation could differ materially from the preliminary allocation used in the pro forma adjustments.

 

Note 6     – Pro forma adjustments to the unaudited pro forma condensed combined balance sheet as of September 30, 2019

 

a)Estimated purchase consideration

 

Reflects $61.2 million of cash paid at closing and the acquisition-date estimated fair value of contingent consideration of $28.4 million. The estimated total purchase consideration includes payments of $1.1 million for Arthrosurface costs related to the Transaction and bonus payments to certain Arthrosurface employees of $1.0 million. The cash payment is reflected as reduction to cash in the unaudited pro forma condensed combined balance sheet. The estimated fair value of contingent consideration is recorded as an increase to the transferred consideration.

 

The following is a summary of consideration transferred to affect the Transaction (in thousands):

 

Cash paid at closing  $61,248 
Estimated fair value of contingent consideration   28,376 
Estimated total purchase consideration  $89,624 

 

b)Inventory

 

Reflects the adjustment to record inventories at their preliminary estimated fair value of $23.6 million and to eliminate the book value of historical inventory of $11.5 million. The estimated fair value consists of $15.9 million of short term inventory which is recorded in inventory and $7.7 million of long term inventory which is recorded in other long-term assets. The fair value estimate of inventory is preliminary and is determined based on the estimated selling price less the sum of (i) costs of disposal, and (ii) a profit allowance for the completion and selling effort of the buyer. The final fair value determination of inventory may differ from this preliminary determination, and such differences could be material.

Page 7 of 10

 

c)Goodwill

 

Reflects the adjustment to goodwill arising from the Transaction of $23.5 million. Goodwill is calculated as the difference between the estimated total purchase consideration and the estimated fair values assigned to the assets acquired and liabilities assumed.

 

Estimated total purchase consideration  $89,624 
Less: Estimated fair value of net assets acquired   66,112 
Total estimated goodwill  $23,512 

 

The goodwill is attributable to the workforce of the business and the value of future technologies expected to arise after the merger. Goodwill will not be amortized and is not expected to be deductible for income tax purposes. The fair value estimate for goodwill is preliminary. The final fair value determination of goodwill may differ from this preliminary determination once Anika’s valuation of the fair value of tangible and intangible assets acquired and liabilities assumed has been completed, and such differences could be material.

 

d)Intangible assets

 

Reflects adjustment to record intangible assets at the estimated fair value of $52.3 million. The estimated fair value of identifiable intangible assets includes $40.9 million of developed technology, $8.0 million of customer relationships, and $3.4 million of trade names. The preliminary estimated useful life of these intangible assets is 15 years.

 

The estimated fair value of the acquired intangible assets is based on a preliminary valuation and is determined using the multi-period excess earnings method, which is a variation of the income approach, which is a valuation technique that provides an estimate of the fair value of an asset based on the principle that the value of an intangible asset is equal to the present value of the incremental after-tax cash flows attributable to the asset, after taking charges for the use of other assets employed by the business. Key estimates and assumptions used in this model are projected revenues and expenses related to the asset, estimated contributory asset charges, and a risk-adjusted discount rate used to calculate the present value of the future expected cash inflows from the asset. The fair value estimate for identified intangible assets is preliminary. The final fair value determination of the identified intangible assets may differ from this preliminary determination, and such differences could be material.

 

e)Transaction costs

 

Reflects the adjustment to record $3.5 million Anika costs related to the Transaction that were not previously recorded in the historical financial statements as of September 30, 2019. Of these costs, $0.9 million were paid and $2.6 million were accrued at closing. These costs are recorded as a reduction in retained earnings in the unaudited pro forma condensed combined balance sheet. Additionally, since there is no continuing impact, these costs are not included in the unaudited pro forma condensed combined statement of operations.

 

f)Deferred taxes

 

Reflects the preliminary estimate of deferred income taxes resulting from the fair value adjustments for identifiable intangible assets and inventory. This estimate was determined based on the fair value adjustments at Anika’s estimated blended U.S. federal and state tax rate of 25%.

 

g)Debt

 

Reflects the adjustment to settle Arthrosurface’s debt of $1.9 million at September 30, 2019 in accordance with the Arthrosurface Merger Agreement. The adjustment is reflected as a decrease in accrued expenses and other current liabilities in the unaudited pro forma condensed combined balance sheet.

 

Page 8 of 10

h)Stockholders’ equity

 

Reflects the elimination of Arthrosurface’s historical preferred stock, common stock, additional paid-in-capital and retained earnings which was eliminated upon completion of the Transaction.

 

Note 7     – Pro forma adjustments to the unaudited pro forma condensed combined statements of operations

 

a)Amortization expense

 

Reflects the adjustment to record amortization expense based on the straight-line method of $2.6 million and $3.5 million for the nine months ended September 30, 2019 and for the year ended December 31, 2018, respectively. The amortization expense is related to the fair value of the acquired intangible assets with a preliminary estimated useful life of 15 years.

 

b)Recognition of inventory step-up

 

Reflect the adjustment to cost of product revenue of $3.9 million and $8.1 million for the nine months ended September 30, 2019 and for the year ended December 31, 2018, respectively, based on the preliminary fair value inventory adjustment and the anticipated inventory turnover.

 

c)Elimination of interest expense and interest income

 

Reflects the adjustment for the elimination of historical Arthrosurface’s interest expense of $48 thousand for the nine months ended September 30, 2019 and $8 thousand for the year ended December 31, 2018 as the related borrowings were settled as part of the Transaction in accordance with the Arthrosurface Merger Agreement.

 

d)Income tax expense (benefit)

 

Reflects the tax effect of the pro forma adjustments using Anika’s blended U.S. federal and state tax rate of 25% for the nine months ended September 30, 2019 and the year ended December 31, 2018. The effective tax rate of the combined company could be materially different from the rate presented in this unaudited pro forma condensed combined financial information.

 

e)Earnings per share

 

The unaudited pro forma condensed combined basic and diluted earnings per share calculations are based on the unaudited pro forma condensed combined net income of the combined company and the weighted average outstanding shares of Anika for the nine months ended September 30, 2019 and for the year ended December 31, 2018.

 

Note 8 – Items not included in the unaudited pro forma condensed combined financial statements

 

The unaudited pro forma condensed combined statements of operations do not include the impacts of any revenue, cost or other operating synergies that may result from the Transaction or any related restructuring costs that may be contemplated.

 

Anika adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Codification, Leases, (ASC 842) effective January 1, 2019. The impact of ASC 842 on Arthrosurface is not presented as the impact was immaterial to the unaudited pro forma condensed combined financial information.

 

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The unaudited pro forma condensed combined statements of operations do not include any non-recurring transaction costs incurred by Anika or Arthrosurface after September 30, 2019 as those costs are not expected to have a continuing impact on the operations of the combined business.

 

The unaudited pro forma condensed combined financial statements do not reflect possible limitations to the combined company’s net operating loss carryforwards (“NOLs”) as a result of an “ownership change” under Section 382 of the Internal Revenue Code of 1986. As a result of the Transaction, the combined company may be subject to annual limitations on its ability to utilize pre-change NOLs to offset future taxable income. The amount of the annual limitation is determined based on the value of Anika immediately prior to the ownership change.

 

 

 

 

 

 

 

 

 

 

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