Orthofix Medical Inc. (OFIX) FY 2023 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and result of operations should be read in conjunction with “Forward-Looking Statements” and our consolidated financial statements and notes thereto appearing elsewhere in this Annual Report. The discussion and analysis below is focused on our 2023 and 2022 financial results, including comparisons of our year-over-year performance between these years. Discussion and analysis of our 2021 fiscal year specifically, as well as the year-over-year comparison of our 2022 financial performance to 2021, is located in Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, filed with the SEC on March 6, 2023, which is available on our website at www.orthofix.com and the SEC’s website at www.sec.gov.

Executive Summary

Orthofix is a leading global spine and orthopedics company with a comprehensive portfolio of biologics, innovative spinal hardware, bone growth therapies, specialized orthopedic solutions and a leading surgical navigation system. Its products are distributed in more than 60 countries worldwide.

We are headquartered in Lewisville, Texas, and have primary offices in Carlsbad, CA, with a focus on spine and biologics product innovation and surgeon education, and Verona, Italy, with an emphasis on product innovation, production, and medical education for orthopedics. Our global R&D, commercial and manufacturing footprint also includes facilities and offices in Irvine, CA, Toronto, Canada, Sunnyvale, CA, Wayne, PA, Olive Branch, MS, Maidenhead, UK, Munich, Germany, Paris, France, and São Paulo, Brazil.

The merger with SeaSpine was completed on January 5, 2023, with SeaSpine continuing as a wholly-owned subsidiary of Orthofix following the transaction. For additional discussion of the merger with SeaSpine, see Note 4 of the Notes to the Consolidated Financial Statements in Item 8 of this Annual Report. The shares of common stock of Orthofix, as the corporate parent entity in the combined company structure, continue to trade on NASDAQ under the symbol "OFIX".

Notable financial results in 2023 include the following:

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Net sales were $746.6 million, an increase of 62.1% on a reported basis and 61.6% on a constant currency basis

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Bone Growth Therapies growth of 13.5%, with of each the last four consecutive quarters exhibiting double-digit net sales growth

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U.S. Spinal Implants, Biologics, and Enabling Technologies growth of 7.6% on a pro forma basis over 2022

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Global Orthopedics net sales growth of 7.2% on a reported basis and 5.2% on a constant currency basis

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Adjusted EBITDA of $46.3 million compared to pro forma adjusted EBITDA in 2022 of $27.4 million

Results of Operations

The following table presents certain items in our consolidated statements of operations as a percent of net sales:

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Net Sales by Reporting Segment

The following table provides net sales by major product category by reporting segment:

Global Spine

Global Spine offers the following products categories:

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Bone Growth Therapies, which manufactures, distributes, sells, and provides support services for market-leading devices used adjunctively in high-risk spinal fusion procedures and to treat both nonunion and acute fractures in the orthopedic space. Bone Growth Therapies uses distributors and a direct sales channel to sell its devices and provide associated support services to hospitals, healthcare providers, and patients in the U.S.

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Spinal Implants, Biologics, and Enabling Technologies is comprised of a broad portfolio of spine fixation and motion preservation implant products used in surgical procedures of the spine, one of the most comprehensive biologics portfolios in both the demineralized bone matrix and cellular allograft market segments, and image-guided surgical solutions to facilitate degenerative, minimally invasive, and complex surgical procedures. Spinal Implants, Biologics, and Enabling Technologies products are sold through a network of distributors and sales representatives to hospitals and healthcare providers on a global basis for Spinal Implants and Enabling Technologies, primarily within the U.S. for Biologics.

2023 Compared to 2022

Net sales increased $278.1 million or 78.8%

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Bone Growth Therapies net sales increased $25.3 million or 13.5%, with above market performance in both the spine and fracture channels, largely driven by (i) an increase in complex spine procedures, which are typically paired within our CervicalStim and SpinalStim devices, (ii) increased reimbursement rates that Medicare approved for 2023, (iii) growth in our spine and fracture sales channels as a result of investments made in the commercial channel in the prior year, and (iv) the launch of AccelStim for the healing of fresh and nonunion fractures

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Spinal Implants, Biologics, and Enabling Technologies net sales increased $252.9 million or 152.4%, primarily due to the contribution of SeaSpine net sales and growth driven by the onboarding of new, high-volume distribution partners along with multiple recent product launches

Global Orthopedics

Global Orthopedics offers products and solutions that allow physicians to successfully treat a variety of orthopedic conditions specifically related to limb reconstruction and deformity correction unrelated to the spine. Global Orthopedics distributes its products world-wide through a network of distributors and sales representatives to sell orthopedic products to hospitals and healthcare providers.

2023 Compared to 2022

Net sales increased $7.8 million, or 7.2% on a reported basis and 5.2% on a constant currency basis

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U.S. growth of 11.1% largely due to investments made in recent product launches, commercial execution within our sales channel, and from our best in class surgeon education programs

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International growth of 3.3% on a constant currency basis, largely due to an increase in stocking distributor orders and as a result of recent product launches

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Increase of $2.2 million due to movement in foreign current exchange rates, which had a favorable impact on net sales in 2023

Gross Profit

2023 Compared to 2022

Gross profit increased $149.1 million, or 44.2%

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Gross profit largely increased due to the contribution of SeaSpine results in 2023, as SeaSpine contributed approximately $258.9 million in net sales

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Partially offset by $36.0 million in amortization of the inventory fair value step up at acquisition, which is being recognized over the expected sales cycles of the acquired inventory

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Further offset by approximately $6.0 million in charges due to inventory rationalization decisions related to the Merger

Sales and Marketing Expense

2023 Compared to 2022

Sales and marketing expense increased $156.9 million

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Increase largely due to the contribution of SeaSpine results in 2023 and the overall increase in net sales as compared to the prior year period, which resulted in increased variable expenses, such as commissions and bonus expenses associated with the achievement of certain sales objectives

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Included within sales and marketing expenses for 2023 are integration-related expenses of $4.5 million, which are mainly related to severance and retention costs

General and Administrative Expense

2023 Compared to 2022

General and administrative expense increased $64.7 million

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Increase largely due to the contribution of SeaSpine results in 2023 and resulting integration costs incurred as a result of the Merger, partially offset by a reduction in due diligence and transaction costs incurred prior to the closing of the Merger

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Included within general and administrative expenses for 2023 are merger and integration related expense of $22.7 million, which are mainly comprised of (i) professional fees totaling $11.5 million, inclusive of a $5.5 million payment to Orthofix's financial advisor for the Merger upon closing of the transaction, and (ii) severance and retention costs totaling $10.5 million

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Increase of $8.8 million in share-based compensation expense as a result of a larger employee base post-Merger and from accelerated vesting of certain equity-based awards as a result of the Merger, partially offset by a recognized benefit related to the forfeiture of outstanding equity grants due to executive leadership changes

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Increases of approximately $10.0 million in costs associated with the Board of Directors' independent investigation conducted by independent outside legal counsel, which resulted in the termination of three former executives, and other resulting activities

Research and Development Expense

2023 Compared to 2022

Research and development expense increased $31.2 million

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Increase largely due to the contribution of SeaSpine results in 2023 and resulting integration costs incurred as a result of the Merger

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Included within research and development expenses for 2023 are merger and integration-related expenses of $2.8 million, which are mainly comprised of severance and retention costs

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Increase of $0.8 million related to the attainment of a development milestone with MTF Biologics achieved in the first quarter of 2023

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Partially offset by a decrease of $1.5 million in costs to comply with the European Union Medical Device Regulations

Acquisition-related Amortization and Remeasurement

2023 Compared to 2022

Acquisition-related amortization and remeasurement increased $22.2 million

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Increase of $17.2 million related to a benefit recognized in 2022 from the remeasurement of potential revenue-based milestone payments associated with the Spinal Kinetics acquisition; we did not achieve the remaining milestone prior to April 30, 2023, the end of the measurement period for achieving such milestone

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Increase in amortization expense of $9.4 million during 2023 associated with intangible assets recognized as a result of the Merger

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Partially offset by a benefit of $2.7 million recognized in 2023 associated with the remeasurement of a contingent consideration obligation with Lattus Spine LLC assumed in the Merger

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Further offset by $1.6 million in costs recognized in 2022 associated with the acquisition of in-process research and development assets, recognized immediately upon acquisition

Non-operating Income (Expense)

Non-operating income and expense largely consists of interest income and expense, transaction gains and losses from changes in foreign currency exchange rates, changes in fair value related to our equity holdings in certain privately-held companies, and credit losses recognized on certain convertible debt investments. Foreign exchange gains and losses are primarily a result of several of our foreign subsidiaries holding trade and intercompany payables or receivables in currencies (most notably the U.S. Dollar) other than their functional currency.

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2023 Compared to 2022

Interest expense, net, increased $7.3 million

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Increase of $5.0 million attributable to an increase in outstanding indebtedness in 2023, either under our prior Credit Agreement or in relation to our new Financing Agreement, as no such balance was outstanding in the prior year

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Increase of $2.2 million associated with the amortization of capitalized debt issuance costs and lenders fees

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Increase of $0.6 million attributable to an early termination prepayment penalty associated with the payoff of the assumed indebtedness of SeaSpine as of the close of the Merger

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Partially offset by $0.6 million of interest income recognized on third-party notes receivable

Other expense, net, decreased $2.2 million

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Favorable change of $4.9 million associated with changes in foreign currency exchange rates, as we recorded a non-cash remeasurement gain of $1.6 million in 2023 compared to a loss of $3.3 million in 2022

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Partially offset by an increase in impairment losses on held-for-sale investment securities of $2.0 million as compared to the prior year

Income Tax Expense

2023 Compared to 2022

Income tax expense increased by $0.7 million

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Increase of $8.4 million associated with financial statement expenses not deductible for tax, including executive compensation and Merger-related deal costs

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Increase of $1.3 million associated with foreign income inclusion, largely driven by research and development expenses outside of the U.S.

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Decrease of $10.1 million associated with higher financial statement losses offset by valuation allowances

2022 Compared to 2021

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Decrease of $20.2 million related to changes in valuation allowances recorded in 2021 versus 2022

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Decrease of $2.7 million related to the change in fair value of contingent consideration

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Partially offset by $1.0 million U.S. tax expense on foreign income inclusion

A reconciliation of the effective tax rate for each year is reported in Note 20 to the Notes to the Consolidated Financial Statements contained in Item 8 of this Annual Report.

Segment Review

The Company has two reporting segments: Global Spine and Global Orthopedics. The primary metric used in managing the Company is adjusted earnings before interest, tax, depreciation, and amortization ("Adjusted EBITDA", a non-GAAP financial measure) (which is described further in Note 16 to the Notes to the Consolidated Financial Statements contained in Item 8 of this Annual Report).

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The following table presents adjusted EBITDA by segment and reconciles consolidated adjusted EBITDA to loss before income taxes:

Liquidity and Capital Resources

Cash, cash equivalents, and restricted cash at December 31, 2023, was $37.8 million compared to $50.7 million at December 31, 2022.

The following table presents free cash flow, a non-GAAP financial measure, which is calculated by subtracting capital expenditures from net cash from operating activities.

Operating Activities

Cash flows from operating activities decreased $34.2 million

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Unfavorable change in net loss of $24.4 million, excluding the impact of non-cash adjustments to net loss

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Unfavorable change of $9.8 million relating to changes in working capital accounts, primarily attributable to changes in inventory levels, partially offset by recoupment activities associated with the CMS Accelerated and Advance Payment Program in prior year and favorable changes in accounts payable and other current liabilities

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Two of our primary working capital accounts are accounts receivable and inventory. Day’s sales in receivables were 59 days at December 31, 2023, compared to 62 days at December 31, 2022 (calculated using fourth quarter net sales and ending accounts receivable). Inventory turns were consistent at 1.2 times as of December 31, 2023, and December 31, 2022, respectively.

Investing Activities

Cash flows from investing activities decreased $8.6 million

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Primarily driven by an increase of $38.9 million in capital expenditures, largely due to the inclusion of SeaSpine's financial results within the 2023 financial results

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Partially offset by an increase of $29.4 million attributable to cash acquired as a result of the Merger

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Further offset by a favorable change of $0.9 million associated with certain asset acquisitions and other investing activities

Financing Activities

Cash flows from financing activities increased $65.4 million

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Increase of $95.5 million in net borrowings associated with proceeds from our new Financing Agreement during 2023, borrowings made under our Prior Credit Agreement, and the repayment of our Prior Credit Agreement upon execution of the Financing Agreement

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Increase of $2.0 million related to the conclusion of the Fitbone Contract Manufacturing and Supple Agreement with Wittenstein in 2022, which was accounted for as a finance lease obligation

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Partially offset by a decrease of $26.9 million associated with the termination and repayment of SeaSpine's credit facility

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Further offset by a decrease of $2.7 million for tax withholdings obligations from shares traded and a decrease in other financing activities of $2.3 million

Credit Facilities

On November 6, 2023, we entered into a Financing Agreement (the "Financing Agreement") with Blue Torch Finance LLC and certain lenders party thereto, which provides for a $100.0 million senior secured term loan (the "Initial Term Loan"), a $25.0 million senior secured delayed draw term loan facility (the "Delayed Draw Term Loan") which, subject to certain conditions specified in the Financing Agreement, may be drawn on or prior to March 30, 2024, and a $25.0 million senior secured revolving credit facility (the "Revolving Credit Facility", and together with the Initial Term Loan and the Delayed Draw Term Loan, the "Credit Facilities"), each of which mature on November 6, 2027. In connection with entering into the Financing Agreement, we repaid in full amounts outstanding and terminated all commitments under the prior $175.0 million senior secured revolving credit facility evidenced by that certain Second Amended and Restated Credit Agreement (the "Prior Credit Agreement"), dated as of October 25, 2019.

Borrowings under the Financing Agreement were and may be used for, among other things, the repayment in full of the Prior Credit Agreement, working capital and other general corporate purposes of the Company.

As of December 31, 2023, we have $100.0 million outstanding borrowings under the Financing Agreement related to the Initial Term Loan. As of December 31, 2023, we have not made any borrowings under the Delayed Draw Term Loan or the Revolving Credit Facility. However, on January 10, 2024, we borrowed $15.0 million under the $25.0 million secured revolving credit facility for working capital purposes. In addition, we intend to utilize the Delayed Draw Term Loan following the completion of the audit of financial statements for the year ended December 31, 2023. For additional information regarding the credit facility, see Note 11 of the Notes to the Consolidated Financial Statements in Item 8 of this Annual Report.

We have no outstanding borrowings on our Italian line of credit of €5.5 million ($6.1 million) as of December 31, 2023. This unsecured line of credit provides us the option to borrow amounts in Italy at rates which are determined at the time of borrowing.

Other

For information regarding Contingencies, see Note 13 of the Notes to the Consolidated Financial Statements in Item 8 of this Annual Report.

Lattus Spine LLC ("Lattus") Contingent Consideration

In connection with the Merger, we assumed a contingent consideration obligation under a purchase agreement between SeaSpine and Lattus executed in December 2022. Under the terms of the agreement, we may be required to make installment payments at

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certain dates based on future net sales of certain products (the "Lateral Products"). The estimated fair value of the contingent consideration arrangement as of December 31, 2023, was $8.5 million; however, the actual amount ultimately paid could be higher or lower than the estimated fair value of the contingent consideration. As of December 31, 2023, we classified the remaining contingent consideration liability within other long-term liabilities. For additional discussion of this matter, see Note 12 of the Notes to the Consolidated Financial Statements in Item 8 of this Annual Report.

Legion Innovations, LLC Asset Acquisition

On December 29, 2022, we entered into a technology assignment and royalty agreement with Legion Innovations, LLC, a U.S.-based medical device technology company, whereby we acquired intellectual property rights to certain assets. As consideration, we paid $0.2 million in January 2023, with additional payments contingent upon reaching future commercialization and revenue-based milestones.

IGEA S.p.A Exclusive License and Distribution Agreement

In April 2021, we entered into an Exclusive License and Distribution Agreement (the “License Agreement”) with IGEA S.p.A (“IGEA”), an Italian manufacturer and distributor of bone and cartilage stimulation systems. Per the terms of the License Agreement, we have the exclusive right to sell IGEA products in the U.S. and Canada. As consideration for the License Agreement, we agreed to pay up to $4.0 million, of which $0.5 million was paid in 2021, with certain payments contingent upon achieving an FDA milestone.

In May 2022, we achieved FDA approval pertaining to the acquired technology, triggering a contingent consideration milestone obligation of $3.5 million. Of this amount, $1.5 million was paid in 2022, $1.0 million was paid in May 2023, and $1.0 million was accrued within other current liabilities as of December 31, 2023.

Unremitted Foreign Earnings

Unremitted foreign earnings were $33.6 million as of December 31, 2023. The Company’s investment in foreign subsidiaries continues to be indefinite in nature; however, the Company may periodically repatriate a portion of these earnings to the extent that it does not incur significant additional tax liability.

Contractual Obligations

As a result of our operations, we are subject to certain contractual obligations with material cash requirements. Our material contractual obligations include, but are not limited to (i) our contingent consideration arrangement under a purchase agreement between SeaSpine and Lattus assumed in the Merger, (ii) contingent consideration arrangements associated with certain asset acquisitions or business combinations, of which material obligations are described above, (iii) operating lease and finance lease obligations, and (iv) uncertain tax positions.

Refer to the Notes to the Consolidated Financial Statements in Item 8 of this Annual Report for a further description of our contingent consideration arrangements (Notes 12 and 17), lease obligations (Note 9), and uncertain tax positions (Note 20).

Off-balance Sheet Arrangements

As of December 31, 2023, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, cash flows, liquidity, capital expenditures, or capital resources that are material to investors. In addition, we do not consider the backlog of firm orders to be material.

Critical Accounting Estimates

Our discussion of operating results is based upon the consolidated financial statements and accompanying notes. The preparation of these statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amount of revenues and expenses during the reporting period. On an ongoing basis, we evaluate these estimates, which are based on historical experience and various other assumptions that management believe to be reasonable under the circumstances at that point in time. Actual results may differ, significantly at times, from these estimates.

We believe the estimates described below are the most critical in preparing our consolidated financial statements. We have reviewed these critical accounting estimates with the Audit Committee of the Board of Directors.

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Revenue Recognition

The process for recognizing revenue involves significant assumptions and judgments for certain of our revenue streams. Revenue recognition policies are “critical accounting estimates” because changes in the assumptions used to develop the estimates could materially affect key financial measures, including net sales, gross margin, operating income, adjusted EBITDA, and net income.

Bone Growth Therapies revenue is largely attributable to the U.S. and is comprised of third-party payor transactions and wholesale revenue.

For revenue derived from third-party payors, including commercial insurance carriers, health maintenance organizations, preferred provider organizations, and governmental payors, such as Medicare, in connection with the sale of our Bone Growth Therapies products, we recognize revenue when the stimulation product is fitted to and accepted by the patient and all applicable documents that are required by the third-party payor have been obtained. Amounts paid by these third-party payors are generally based on fixed or allowable reimbursement rates. These revenues are recorded at the expected or preauthorized reimbursement rates, net of any contractual allowances or adjustments. Certain billings are subject to review by the third-party payors and may be subject to adjustment.

Wholesale revenue is related to the sale of our Bone Growth Therapies products directly to physicians and other healthcare providers. Wholesale revenues are recognized upon shipment and receipt of a confirming purchase order, which is when the customer obtains control of the promised goods.

Biologics revenue is largely attributable to the U.S. and is mostly processed from within our Irvine facility. In addition, we have a long-standing collaborative arrangement with MTF that provides exclusive global marketing rights to MTF's Trinity and FiberFuse product families. We receive marketing fees from MTF based on sales of products covered under the collaborative arrangement. MTF is considered the principal in these arrangements; therefore, we recognize these marketing service fees on a net basis upon shipment of the product to the customer and receipt of a confirming purchase order.

Spinal Implants and Global Orthopedics products are distributed world-wide, with U.S. sales largely comprised of commercial revenue and international sales derived from commercial sales and through stocking distributor arrangements.

Commercial revenue is largely related to the sale of our Spinal Implants and Global Orthopedics products to hospital customers. Commercial revenues are recognized when these products have been utilized and a confirming purchase order has been received from the hospital.

Stocking distributors purchase our products and then re-sell them directly to customers, such as hospitals. Revenue derived from stocking distributor arrangements is recognized upon shipment and receipt of a confirming purchase order, which is when the distributor obtains control of the promised goods. The transaction price is estimated based upon our historical collection experience with the stocking distributor. This percentage, which is specific to each stocking distributor, is then used to calculate the transaction price. Cost of sales is also recorded upon transfer of control of the product to the customer, which is when our performance obligation has been satisfied.

Allowance for Expected Credit Losses and Contractual Allowances

The process for estimating the ultimate collection of accounts receivable involves significant assumptions and judgments. The determination of the contractual life of accounts receivable, the aging of outstanding receivables, as well as the historical collections, write-offs, and payor reimbursement experience over the estimated contractual lives of such receivables, are integral parts of the estimation process related to reserves for expected credit losses and the establishment of contractual allowances. Accounts receivable are analyzed on a quarterly basis to assess the adequacy of both reserves for expected credit losses and contractual allowances. Revisions in allowances for expected credit loss estimates are recorded as an adjustment to bad debt expense within sales and marketing expenses. Revisions to contractual allowances are recorded as an adjustment to net sales. These estimates are periodically tested against actual collection experience. In addition, we analyze our receivables by geography and by customer type, where appropriate, in developing estimates for expected credit losses.

We believe our allowance for credit losses is sufficient to cover customer credit risks; however, a 10% change in our allowance for credit losses as of December 31, 2023, would result in an increase or decrease to sales and marketing expense of $0.7 million. Additionally, we believe our estimate to establish contractual allowances is sufficient to cover customer credit risks; however, a 10% change in our reserve for contractual allowances as of December 31, 2023, would result in an increase or decrease to net sales of $0.4 million. Our allowance for credit losses and estimation of contractual allowances are “critical accounting estimates” because changes in the assumptions used to develop the estimates could materially affect key financial measures, including net sales, gross margin, operating income, adjusted EBITDA, net income, and accounts receivable.

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Inventory Allowances

Reserves for excess, slow moving, and obsolete inventory are calculated as the difference between the cost of inventory and market value, and are based on assumptions and judgments about new product launch periods, overall product life cycles, forecasted demand, and market conditions. In the event of a decrease in demand for our products, excess product production, or a higher incidence of inventory obsolescence, we could be required to increase our inventory reserves, which would increase cost of sales and decrease gross profit. We regularly evaluate our exposure for inventory write-downs. If conditions or assumptions used in determining the market value or forecasted demand change, additional inventory adjustments in the future may be necessary. Our inventory allowance is a “critical accounting estimate” because changes in the assumptions used to develop the estimate could materially affect key financial measures, including gross profit, operating income, adjusted EBITDA, net income, and inventory.

Valuation of Intangible Assets

Our intangible assets are comprised primarily of patents, acquired or developed technology, in-process research and development (“IPR&D”), customer relationships, trade names, trademarks, and licensing arrangements. We make significant judgments in relation to the valuation of intangible assets resulting from business combinations or asset acquisitions. Intangible assets acquired in a business combination that are used for IPR&D activities are considered to have indefinite lives until the completion or abandonment of the associated project. Upon reaching the end of the relevant project, we will either amortize the acquired IPR&D over its estimated useful life or expense the acquired IPR&D should the project be unsuccessful with no future alternative use.

Significant judgment is required related to the forecasting of future operating results within our discounted cash flow valuation models to determine the valuation of intangible assets. Key assumptions include the anticipated useful lives of acquired intangibles, the projected cash flows associated with each intangible asset, the estimated probability of success for acquired IPR&D projects, and projected growth rates and discount rates. It is possible that significant changes in plans or assumptions may affect the recoverability of these assets and could potentially result in impairment. Our valuation of intangible assets is a “critical accounting estimate” because changes in the assumptions used to develop these estimates could materially affect key financial measures, including operating income and net income.

Goodwill

Our goodwill represents the excess of cost over fair value of net assets acquired from business combinations. The determination of the value of goodwill and intangible assets arising from business combinations requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired.

We test goodwill at least annually for impairment, and between annual tests if indicators of potential impairment exist. These indicators include, among others, significant declines in sales, earnings, or cash flows, or the development of a material adverse change in the business climate. Assessing goodwill impairment involves a high degree of judgment due to the estimates and assumptions used. We believe the estimates and assumptions involved in the impairment assessment to be critical because significant changes in such estimates and assumptions could materially affect key financial measures, including operating income and net income.

In the fourth quarter of 2021, we performed a quantitative assessment for our annual goodwill impairment analysis. Upon estimating the fair value of each of reporting unit, we determined the Global Orthopedics reporting unit’s fair value was less than its carrying value of net assets. This resulted in recording a full impairment of the Global Orthopedics goodwill of $11.8 million, which was reflected within Acquisition-related amortization and remeasurement for the year ended December 31, 2021. The assessment concluded there were no indicators of impairment for the Global Spine goodwill.

In the fourth quarter of 2022, we performed a qualitative assessment for our annual goodwill impairment analysis, which did not result in an impairment charge. This qualitative analysis considered all relevant factors specific to the reporting units, including macroeconomic conditions, industry and market considerations, overall financial performance, and relevant entity-specific events.

In the third quarter of 2023, we announced the termination of the former President and Chief Executive Officer, former Chief Financial Officer, and former Chief Legal Officer, from their respective roles. Immediately following the announcement, our market capitalization decreased by approximately 30%, indicating that an impairment may exist. As a result, we performed an interim quantitative assessment of our goodwill as of September 30, 2023. Upon performing our assessment, we determined the Global Spine reporting unit's fair value exceeded its carrying value as of September 30, 2023.

In the fourth quarter of 2023, we performed a qualitative assessment for our goodwill impairment analysis, which did not result in an impairment charge. This quantitative analysis considered all relevant factors specific to the reporting units, including macroeconomic conditions, industry and market considerations, overall financial performance, and relevant entity-specific events.

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We estimate the fair value of each reporting unit using a weighted average of fair value derived from both an income approach and a market approach. The fair value measurements are based on significant inputs that are unobservable in the market, with key assumptions including, but not limited to, our forecasted future net sales and expenses, terminal growth rates, discount rates applied, and allocation of corporate-level expenses to each reporting unit. Significant changes in these assumptions could result in a significantly higher or lower fair value, which in turn can affect the ultimate conclusion regarding if goodwill is impaired.

Fair Value Measurements

Fair value is defined as the 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. The two most significant items that are or were recorded at fair value as of December 31, 2023, and 2022, include (i) contingent consideration attributable to Lattus and (ii) our convertible loan agreements with Neo Medical.

The contingent consideration obligation consists of future installment payments at certain dates based on future net sales of Lateral Products. The estimated fair value of the contingent consideration arrangement as of December 31, 2023, was $8.5 million; however, the actual amount ultimately paid could be higher or lower than the estimated fair value of the contingent consideration.

The estimated fair value of the Lattus contingent consideration is determined using a Monte Carlo simulation and a discounted cash flow model requiring significant inputs which are not observable in the market. The significant inputs include assumptions related to the timing and probability of certain product launch dates, estimated future sales of the products, revenue risk-adjusted discount rate, revenue volatility, and discount rates matched to the timing of payments.

We estimate the fair value of our convertible loan agreements with Neo Medical using option-pricing models and a probability-weighted discounted cash flow model. The fair value measurement is based on significant inputs that are unobservable in the market, with significant unobservable inputs including applicable discount rates, implied volatility, the likelihood and projected timing of repayment or conversion, and projected cash flows in support of the estimated enterprise value of Neo Medical. Significant changes in these assumptions could result in a significantly higher or lower fair value. Holding other inputs constant, an increase of the present value factor by 5% would have resulted in a decrease in the fair value of the convertible loan of $0.5 million, whereas a decrease of the present value factor by 5% would have resulted in an increase in the fair value of the convertible loan by $0.2 million.

Our fair value measurements are a "critical accounting estimate" because changes in the assumptions used to develop the estimate could materially affect key financial measures, including operating income and net income.

Other Fair Value Measurements Utilized in Purchase Accounting

Assets acquired and liabilities assumed in a business combination or asset acquisition are recorded at fair value as of the date of acquisition. Common adjustments to historical carrying values recognized for such assets or liabilities include (i) adjusting the basis of acquired inventory from net realizable value to fair value, (ii) adjusting acquired plant, property, and equipment, net of any historical accumulated depreciation, to the asset’s estimated fair value, and (iii) the remeasurement of right-of-use assets and assumed lease liabilities. The determination of the acquisition date fair value of the assets acquired and liabilities assumed requires management's judgment and involves the use of significant estimates and assumptions, especially with respect to future expected cash flows, useful lives, and discount rates.

As part of the Merger, we acquired SeaSpine's inventory, including raw materials, work-in-process ("WIP"), and finished goods. Raw materials had not been subjected to any manufacturing processes that would add additional value, therefore we determined book value is representative of fair value. We assessed the fair value of the WIP and finished goods inventory using the comparative sales method. The estimated step-up in fair value on acquired inventory recognized in connection with the Merger was $48.2 million. As of December 31, 2023, the unamortized step-up in fair value on acquired inventory remaining was $12.2 million.

We estimated the fair value of the various classes of property, plant, and equipment acquired using the income approach, sales comparison approach, and the cost approach. The estimated fair value of property, plant, and equipment acquired in connection with the Merger was $68.9 million.

Intangible assets primarily included customer relationships, developed technology, and in-process research and development. Determining the fair value of intangible assets acquired as part of purchase accounting requires us to make significant estimates. These estimates include the amount and timing of projected future cash flows, royalty savings, and the discount rate used to discount those cash flows to present value.

We estimated the fair value of acquired right-of-use assets and assumed lease liabilities acquired in connection with the Merger using the yield capitalization method of the income approach. Acquired right-of-use assets and assumed lease liabilities are measured based on the remaining lease payments over the remaining portion of the lease term. As our leases do not provide an

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implicit rate, our incremental borrowing rate is used as a discount rate, based on the information available as of the acquisition date, in determining the present value of lease payments.

These fair value measurements are a “critical accounting estimate” because changes in the assumptions used to develop the estimate could materially affect key financial measures, including operating income and net income.

Litigation and Contingent Liabilities

From time to time, we are parties to or targets of lawsuits, investigations, and proceedings, including product liability, personal injury, patent and intellectual property, health and safety, and employment and healthcare regulatory matters, which are handled and defended in the ordinary course of business. These lawsuits, investigations, or proceedings could involve a substantial number of claims and could also have an adverse impact on our reputation and customer base. Although we maintain various liability insurance programs for liabilities that could result from such lawsuits, investigations, or proceedings, we are self-insured for a significant portion of such liabilities.

We accrue for such claims when it is probable that a liability has been incurred and the amount can be reasonably estimated. The assessments of whether a loss is probable or a reasonable possibility, and whether the loss or range of loss is reasonably estimable, often involve a series of complex judgments about future events. Among the factors that we consider in this assessment are the nature of existing legal proceedings, investigations, and claims, the asserted or possible damages or loss contingency (if reasonably estimable), the progress of the matter, existing law and precedent, the opinions or views of legal counsel and other advisers, the involvement of the U.S. Government and its agencies in such proceedings, our experience in similar matters and the experience of other companies, the facts available to us at the time of assessment, and how we intend to respond, or have responded, to the proceeding, investigation or claim. Our assessment of these factors may change over time as individual proceedings, investigations or claims progress. For matters where we are not currently able to reasonably estimate the range of reasonably possible loss, the factors that have contributed to this determination include the following: (i) the damages sought are indeterminate, or an investigation has not manifested itself in a filed civil or criminal complaint, (ii) the matters are in the early stages, (iii) the matters involve novel or unsettled legal theories or a large or uncertain number of actual or potential cases or parties, and/or (iv) discussions with the government or other parties in matters that may be expected ultimately to be resolved through negotiation and settlement have not reached the point where we believe a reasonable estimate of loss, or range of loss, can be made. In such instances, we believe that there is considerable uncertainty regarding the timing or ultimate resolution of such matters, including a possible eventual loss, fine, penalty, or business impact, if any.

Changes in the facts and circumstances associated with a claim could have a material impact on our results of operations and cash flows in the period that reserve estimates are recorded or revised. We believe our insurance coverage and reserves are sufficient to cover currently estimated exposures, but we cannot give any assurance that we will not incur liabilities in excess of recorded reserves or our present insurance coverage. Litigation and contingent liabilities are “critical accounting estimates” because changes in the assumptions used to develop the estimates could materially affect key financial measures, including operating income, adjusted EBITDA, and net income.

Tax Matters

We and each of our subsidiaries are taxed at the rates applicable within each of their respective jurisdictions. Our income tax expense, effective tax rate, deferred tax assets, and deferred tax liabilities will vary according to the jurisdiction in which profits arise. Further, certain of our subsidiaries sell products directly to our other subsidiaries or provide administrative, marketing, and support services to our other subsidiaries. These intercompany sales and support services involve subsidiaries operating in jurisdictions with differing tax rates. The tax authorities in such jurisdictions may challenge our treatment under residency criteria, transfer pricing provisions, or other aspects of their respective tax laws, which could affect our composite tax rate and provisions.

We sometimes engage in transactions in which tax consequences may be subject to uncertainty. We account for these uncertain tax positions in accordance with applicable accounting guidance, which requires significant judgment in assessing the estimated tax consequences of a transaction. We evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of available evidence indicates that it is more likely than not that, on an evaluation of the technical merits, the tax position will be sustained on audit, including resolution of any related appeals or litigation processes. We measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. We re-evaluate our income tax positions periodically to consider factors such as changes in facts or circumstances, changes in or interpretations of tax law, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in recognition of a tax benefit or an additional charge to the tax provision, which could have a material impact to the financial statements.

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We establish a valuation allowance when measuring deferred tax assets if it is more likely than not that certain deferred tax assets will not be realized in the foreseeable future. This process requires significant judgment as we must project the current tax liability and estimate the deferred tax assets and liabilities into future periods, including net operating loss and tax credit carry forwards. In assessing the need for a valuation allowance, we consider recent operating results, availability of taxable income in carryback years, future reversals of taxable temporary differences, future taxable income projections (exclusive of reversing temporary differences), and all prudent and feasible tax planning strategies.

Tax matters are “critical accounting estimates” because changes in the assumptions used to develop the estimates could materially affect key financial measures, including net income.

Share-based compensation

We use the Black-Scholes valuation model to calculate the fair value of service-based stock options. The value is recognized as expense over the service period net of actual forfeitures. The expected term of options granted is estimated based on a number of factors, including the vesting and expiration terms of the award, historical employee exercise behavior for both options that are currently outstanding and options that have been exercised or are expired, the historical volatility of our common stock, and an employee’s average length of service. The risk-free interest rate is determined based upon a constant U.S. Treasury security rate with a contractual life that approximates the expected term of the option award. We estimate expected volatility based on the historical volatility of our stock.

We use the Monte Carlo valuation methodology to calculate the fair value of market-based restricted stock units, with any discounts for post-vesting restrictions estimated using the Chaffe Model. The value is recognized as expense over the requisite service period and adjusted for forfeitures as they occur. The Monte Carlo methodology that we use to estimate the fair value of the awards incorporates the possibility that the market condition may not be satisfied.

The fair value of performance-based restricted stock units is calculated based upon (i) the closing stock price at the date of grant and (ii) the number of stock units expected to vest at the conclusion of the performance period. The value is recognized as expense over the derived requisite service period beginning in the period in which the grants are deemed probable to vest. Vesting probability is assessed based upon forecasted financial results metrics or applicable milestones associated with the grant and requires significant judgment.

As part of the Merger, our Board of Directors determined to treat the transaction as a "Change in Control" under applicable agreements and equity plans. As a result, all outstanding and previously granted performance-based and market-based restricted stock units were converted to time-based restricted stock units. We used the Monte Carlo valuation methodology to calculate the fair value of the performance-based and market-based restricted stock units. The value is recognized as expense over the requisite service period and adjusted for forfeitures as they occur.

Determining the appropriate fair value model and calculating the fair value of employee stock awards requires estimates and judgments. Our share-based compensation is a “critical accounting estimate” because changes in the assumptions used to develop estimates of fair value or the requisite service period could materially affect key financial measures, including gross profit, operating income, and net income.

Non-GAAP Financial Measures

We believe that providing non-GAAP financial measures that exclude certain items provides investors with greater transparency to the information used by senior management in its financial and operational decision-making. We believe it is important to provide investors with the same non-GAAP metrics that senior management uses to supplement information regarding the performance and underlying trends of our business operations in order to facilitate comparisons to historical operating results and internally evaluate the effectiveness of our operating strategies. Disclosure of these non-GAAP financial measures also facilitates comparisons of our underlying operating performance with other companies in the industry that also supplement their GAAP results with non-GAAP financial measures.

The non-GAAP financial measures used in this Annual Report may have limitations as analytical tools and should not be considered in isolation or as a replacement for GAAP financial measures. Some of the limitations associated with the use of these non-GAAP financial measures are that they exclude items that reflect an economic cost that can have a material effect on cash flows. Similarly, certain non-cash expenses, such as equity compensation expense, do not directly impact cash flows, but are part of total compensation costs accounted for under GAAP.

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Constant Currency

Constant currency is a non-GAAP measure, which is calculated by using foreign currency rates from the comparable, prior-year period, to present net sales at comparable rates. Constant currency can be presented for numerous GAAP measures, but is most commonly used by management to analyze net sales without the impact of changes in foreign currency rates.

Adjusted EBITDA

Adjusted EBITDA represents earnings before interest income (expense), income taxes, depreciation, and amortization and excludes the impact of share-based compensation, gains and losses related to changes in foreign exchange rates, charges related to the SeaSpine merger and other strategic investments, acquisition-related fair value adjustments, interest and gains and losses on investments, litigation and investigation costs, charges related to initial compliance with regulations set forth by the European Union Medical Device Regulation, charges related to business interruption resulting from the COVID-19 pandemic, and succession charges. Adjusted EBITDA is the primary metric used by our Chief Operating Decision Maker in managing the business.

Free Cash Flow

Free cash flow is a non-GAAP financial measure, which is calculated by subtracting capital expenditures from net cash from operating activities. Free cash flow is an important indicator of how much cash is generated or used by our normal business operations, including capital expenditures. Management uses free cash flow as a measure of progress on its capital efficiency and cash flow initiatives.