TREACE MEDICAL CONCEPTS, INC. (TMCI) FY 2021 MD&A

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

You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and related notes thereto included elsewhere in this Annual Report. This discussion and other parts of this Annual Report contain forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section titled “Risk Factors.” Please also see the section titled “Special Note Regarding Forward-Looking Statements.”

Overview

We are a medical technology company driving a paradigm shift in the surgical treatment of Hallux Valgus (commonly known as bunions). We have pioneered our proprietary Lapiplasty 3D Bunion Correction System—a combination of innovative instruments, implants and surgical methods designed to improve the inconsistent clinical outcomes of traditional approaches to bunion surgery. Although bunions are deformities typically caused by an unstable joint in the middle of the foot that leads to a three-dimensional ("3D") misalignment in the foot’s anatomical structure, the majority of traditional surgical approaches focus on correcting the deformity from a two-dimensional ("2D") perspective and therefore fail to address the root cause of the disorder. To effectively restore the normal anatomy of bunion patients and improve clinical outcomes, we believe addressing the root cause of the bunion is critical and have developed the Lapiplasty System to correct the deformity across all three anatomic dimensions. Our mission is to be the leader in the surgical treatment of bunions by establishing the Lapiplasty System as the standard of care. We recently expanded our offerings with the Adductoplasty™ Midfoot Correction System, designed for reproducible correction of the midfoot to provide further support to hallux valgus patients.

We were formed in 2013 and since receiving 510(k) clearance for the Lapiplasty System in March 2015, we have sold more than 42,000 Lapiplasty Procedure Kits in the United States. We market and sell our Lapiplasty Systems to physicians, surgeons, ambulatory surgery centers and hospitals. The Lapiplasty Procedure can be performed in either hospital outpatient or ambulatory surgery centers settings, and utilizes existing, well-established reimbursement codes. We currently market and sell the Lapiplasty System through a combination of a direct employee sales force and independent sales agencies across 118 territories in the United States. As of December 31, 2021, we had 81 direct sales representatives and 37 independent sales agencies. In 2021, employee sales representatives generated approximately 52% of revenues while approximately 48% of revenues came through independent sales agencies.

On April 27, 2021, we completed our initial public offering (“IPO”) of 12,937,500 shares of common stock, which included the exercise in full of the underwriters’ option to purchase additional shares. Before our IPO, our primary sources of capital have been private placements of common stock and convertible preferred stock, debt financing agreements and revenue from the sale of our products. As part of the IPO, we received net proceeds of approximately $107.6 million. Upon the completion of the IPO, all 6,687,475 shares of Series A convertible preferred stock then outstanding were converted into shares of common stock on a one-to-one basis plus 158,447 shares of common stock were issued to pay accrued cumulative dividends on Series A convertible preferred stock of $2.5 million. As of December 31, 2021, we had cash and cash equivalents of $105.8 million, an accumulated deficit of $41.9 million and $30.0 million of principal outstanding under our term loan agreement.

COVID-19 Impact

In March 2020, the World Health Organization declared the outbreak of a novel coronavirus (COVID-19) as a pandemic, and in response to COVID-19 at that time, certain states within the United States implemented shelter-in-place rules requiring certain businesses not deemed “essential” to close and requiring elective procedures to be delayed. These restrictions began to adversely affect our revenue growth and operating results during the three months ended March 31, 2020. While we are encouraged by our results since restrictions were eased at the end of the second quarter of 2020 and with the introduction of vaccines in early 2021, we are aware that the actual and perceived impact of COVID-19 is changing and cannot be predicted, particularly due to potentially more contagious and virulent variants of the virus becoming prevalent and vaccination rates in the United States slowing. For example, during the three months ended September 30, 2021, the volume of procedures utilizing our product were adversely impacted by elective surgery delays and cancellations, and hospital capacity constraints due to increased hospitalizations caused by the COVID-19 Delta variant, particularly in Florida, Georgia, Texas and other areas significantly impacted by COVID-19. In the 2021 fourth quarter and into the 2022 first quarter, we have continued to observe elective surgery delays and cancellations and hospital staffing and capacity constraints, primarily related to the surge of infections and hospitalizations from the Omicron variant of COVID-19. We cannot assure you that we will not experience additional negative impacts associated with COVID-19, which could be significant. The COVID-19 pandemic has negatively impacted our business, financial condition and results of operations by significantly decreasing and delaying the number of procedures performed using our products, and we expect the pandemic could continue to negatively impact our business, financial condition and results of operations.

58

Key Business Metrics

We regularly review a number of operating and financial metrics, including the number of Lapiplasty Procedure Kits sold, the number of active surgeons using the Lapiplasty System and utilization rate, to evaluate our business, measure our performance, identify trends affecting our business, formulate our business plans and make strategic decisions. The number of Lapiplasty Procedure Kits sold during the twelve months ended December 31, 2021 increased by 6,377 or 57.4% over the twelve months ended December 31, 2020, and the number of active surgeons as of December 31, 2021 was 1,783, an increase of 39.8% from the prior year. The utilization rate for the twelve months ended December 31, 2021 increased 12.6% over the twelve months ended December 31, 2020 to an average of 9.8 Lapiplasty Procedure Kits per active surgeon.

We believe that the number of Lapiplasty Procedure Kits sold, number of active surgeons using the Lapiplasty System and utilization rate are useful indicators of our ability to drive adoption of the Lapiplasty System and generate revenue and are helpful in tracking the progress of our business. While we believe these metrics are representative of our current business, we anticipate these metrics may be substituted for additional or different metrics as our business grows.

Factors Affecting Our Business

We believe that our financial performance has been and in the foreseeable future, will continue to depend on many factors, including COVID-19 as described above, those described below, those noted in the section titled “Special Note Regarding Forward-Looking Statements” and in the section titled “Risk Factors”.

Adoption of the Lapiplasty System

The growth of our business depends on our ability to gain broader acceptance of the Lapiplasty System by successfully marketing and distributing the Lapiplasty System and ancillary products. We currently have approval at over 1,500 facilities across the United States and plan to continue to increase access by convincing even more surgeons and facility administrators that our products are alternatives to traditional products used in bunion surgical procedures. While surgeon adoption of the Lapiplasty Procedure remains critical to driving procedure growth, hospital and ambulatory surgery center facility approvals are necessary for both existing and future surgeon customers to access our products. To facilitate greater access to our products and drive future sales growth, we intend to continue educating hospitals and facility administrators on the differentiated benefits associated with the Lapiplasty System, supported by our robust portfolio of clinical data. If we are unable to successfully commercialize our Lapiplasty System, we may not be able to generate sufficient revenue to achieve or sustain profitability. In the near term, we expect we will continue to operate at a loss, and we anticipate we will finance our operations principally through offerings of our capital stock and by incurring debt.

Investments in Innovation and Growth

We expect to continue to focus on long-term revenue growth through investments in our business. In sales and marketing, we are dedicating meaningful resources to expand our sales force and management team in the United States, as well as our patient focused outreach and education campaigns. We are hiring additional direct sales representatives and employee field sales management to strategically access more regions with high densities of prospective patients and by focusing the efforts of our independent sales channel on our products. In research and development, our team and our Surgeon Advisory Board are continually working on next-generation innovations of the Lapiplasty System and related products. In addition to expanding our Lapiplasty offerings with products like the Lapiplasty Mini-Incision System, we are continually exploring opportunities to advance our core Lapiplasty System instrumentation and implants to further improve surgical efficiency, enhance reproducibility of outcomes and speed surgical recovery for patients.

We are also pursuing the development and potential commercialization, if cleared, of new products to address ancillary surgical procedures performed routinely in connection with the Lapiplasty Procedure. For example, to help address midfoot deformities that can occur in up to 30% of bunion patients, we developed and, in September 2021, announced the commercial launch of the Adductoplasty™ System. The Adductoplasty™ System brings together our implants and instrumentation to provide a comprehensive system designed for reproducible realignment, stabilization, and fusion of the midfoot and thus, provides surgeons with a precision, instrumented approach to treat both the bunion and coexisting midfoot deformities.

Moreover, in our general and administrative functions, we expect to continue to hire personnel and expand our infrastructure to both drive and support our anticipated growth and operations as a public company. Accordingly, in the near term, we expect these activities to increase our net losses, but in the longer term we anticipate they will positively impact our business and results of operations.

59

Seasonality

We have experienced and expect to continue to experience seasonality in our business, with higher sales volumes in the fourth calendar quarter, historically accounting for approximately 40% of full year revenues, and lower sales volumes in the first calendar quarter. Our sales volumes in the fourth calendar quarter tend to be higher as many patients elect to have surgery after meeting their annual deductible and having time to recover over the winter holidays. Our sales volumes in the first calendar quarter also tend to be lower as a result of adverse weather and by resetting annual patient healthcare insurance plan deductibles, both of which may cause patients to delay elective procedures. The orthopaedic industry traditionally experiences lower sales volumes in the third quarter than throughout the rest of the year as elective procedures generally decline during the summer months. Although we follow orthopaedic industry trends generally, to date our third quarter sales volumes have not been lower than other quarters, but we may experience relatively lower sales volumes during third quarters in the future.

Coverage and Reimbursement

Hospitals, ambulatory surgery centers and surgeons that purchase or use our products generally rely on third-party payors to reimburse for all or part of the costs and fees associated with procedures using our products. As a result, sales of our products depend, in part, on the extent to which the procedures using our products are covered by third-party payors, including government programs such as Medicare and Medicaid, private insurance plans and managed care programs. Based on historical claims data from 2017, approximately 63% of Lapidus cases and 60% of all bunion surgical cases were paid by private payors.

Medicare payment rates to hospital outpatient departments are set under the Medicare hospital outpatient prospective payment system, which groups clinically similar hospital outpatient procedures and services with similar costs to ambulatory payment classifications ("APCs"). Each APC is assigned a single lump sum payment rate, which includes payment for the primary procedure as well as any integral, ancillary, and adjunctive services. The primary CPT codes for the Lapiplasty Procedure, CPT 28297 and CPT 28740, are grouped together under APC 5114. For Lapiplasty Procedures in which fusion is performed on multiple TMT joints, CPT 28730 applies and is classified under APC 5115.

Components of Our Results of Operations

Revenue

We currently derive nearly all of our revenue from the sale of our proprietary Lapiplasty System, and to a lesser extent from the Adductoplasty System, which we introduced in the third quarter of 2021, and ancillary products. The Lapiplasty and Adductoplasty Systems are comprised of single-use implant kits and reusable instrument trays. We sell the Lapiplasty and Adductoplasty Systems to physicians, surgeons, hospitals and ambulatory surgery centers in the United States through a network of independent agencies and employee sales representatives. Our primary product is the Lapiplasty System, which is an instrumented, reproducible approach to 3D bunion correction that helps patients rapidly return to weight-bearing in a post-operative boot. We also offer other advanced instrumentation and implants for use in the Lapiplasty and Adductoplasty Procedures or other ancillary procedures performed in high frequency with bunion surgery. No single customer accounted for 10% or more of our revenue during 2021. We expect our revenue to increase in absolute dollars in the foreseeable future as we expand our sales territories, new accounts and trained physician base and as existing physician customers perform more Lapiplasty Procedures, though it may fluctuate from quarter to quarter due to a variety of factors, including seasonality.

Cost of Goods Sold

Cost of goods sold consists primarily of manufacturing costs for the purchase of our Lapiplasty and Adductoplasty Systems and other products from third-party manufacturers. Direct costs from our third-party manufacturers includes costs for raw materials plus the markup for the assembly of the components. Cost of goods sold also includes royalties, allocated overhead for indirect labor, depreciation, certain direct costs such as those incurred for shipping our products and personnel costs. We expense all provisions for excess and obsolete inventories as cost of goods sold. We record adjustments to our inventory valuation for estimated excess, obsolete and non-sellable inventories based on assumptions about future demand, past usage, changes to manufacturing processes and overall market conditions. We expect our cost of goods sold to increase in absolute dollars in the foreseeable future to the extent more of our products are sold, though it may fluctuate from quarter to quarter.

Gross Profit and Gross Margin

We calculate gross profit as revenue less cost of goods sold, and gross margin as gross profit divided by revenue. Our gross margin has been and will continue to be affected by a variety of factors, primarily average selling prices, production and ordering volumes, change in mix of customers, third-party manufacturing costs and cost-reduction strategies. We expect our gross profit to increase in the foreseeable future as our revenue grows, though our gross margin may fluctuate from quarter to quarter due to changes in average selling prices as we introduce new products, and as we adopt new manufacturing processes and technologies.

60

Operating Expenses

Sales and Marketing

Sales and marketing expenses consist primarily of compensation for personnel, including salaries, bonuses, benefits, sales commissions and share-based compensation, related to selling and marketing functions, physician education programs, training, travel expenses, marketing initiatives including our direct-to-patient outreach program and advertising, market research and analysis and conferences and trade shows. We expect sales and marketing expenses to continue to increase in absolute dollars in the foreseeable future as we continue to invest in our direct sales force and expand our marketing efforts, and as we continue to expand our sales and marketing infrastructure to both drive and support anticipated sales growth, though it may fluctuate from quarter to quarter.

Research and Development

Research and development ("R&D") expenses consist primarily of engineering, product development, clinical studies to develop and support our products, regulatory expenses, and other costs associated with products and technologies that are in development. These expenses include compensation for personnel, including salaries, bonuses, benefits and share-based compensation, supplies, consulting, prototyping, testing, materials, travel expenses, depreciation and an allocation of facility overhead expenses. We expect R&D expenses to continue to increase in absolute dollars in the foreseeable future as we continue to hire personnel and invest in next-generation innovations of the Lapiplasty System and related products, though it may fluctuate from quarter to quarter due to a variety of factors, including the level and timing of our new product development efforts, as well as our clinical development, clinical trial and other related activities.

General and Administrative

General and administrative expenses consist primarily of compensation for personnel, including salaries, bonuses, benefits and share-based compensation, related to finance, information technology, legal and human resource functions, as well as professional services fees (including legal, audit and tax fees), insurance costs, general corporate expenses and allocated facilities-related expenses. We expect general and administrative expenses to continue to increase in absolute dollars in the foreseeable future as we hire personnel and expand our infrastructure to drive and support the anticipated growth in our organization. Moreover, we have incurred, and expect to continue to incur, additional general and administrative expenses associated with operating as a public company, including legal, accounting, insurance, compliance with the rules and regulations of the SEC and those of any stock exchange on which our securities are traded, investor relations, and other administrative and professional services expenses.

Interest and other income (expense), net

Interest income and other income (expense), net consists of interest received on our money market funds and a loss and penalties from the extinguishment of term loans under the SVB Credit Facility.

Interest Expense

Interest expense consists of interest incurred and amortization of debt discount related to outstanding borrowings during the reported periods.

61

Results of Operations

Comparison of the years ended December 31, 2021 and 2020

The following table summarizes our results of operations for the periods indicated ($ in thousands):

* Not meaningful

Revenue. Revenue increased by $37.1 million, or 64.6%, from the year ended December 31, 2021 as compared to 2020. The increase was primarily due to a 57.4% increase in the number of Lapiplasty Procedure Kits sold in 2021 compared to 2020 as the result of an expanded customer base and a slight increase in average sales prices. In addition, revenues in 2020 were adversely impacted by government-mandated restrictions on elective procedures in response to the COVID-19 pandemic that lasted from March 2020 through May 2020 when such restrictions began to ease. Although the restrictions were eased at the end of the second quarter of 2020 and vaccines were introduced in early 2021, the volume of procedures utilizing our product in 2021 were adversely impacted by elective surgery delays or cancellations and hospital staffing and capacity constraints, primarily related to the surge of infections and hospitalizations from the Delta and Omicron variants of COVID-19.

Cost of Goods Sold, Gross Profit and Gross Margin. Cost of goods sold increased by $5.4 million, or 43.0%, in the year ended December 31, 2021 as compared to 2020. The increase in cost of goods sold was primarily due to $4.0 million increase in direct costs of goods sold resulting from increased sales, $1.9 million increase in royalty expense resulting from our increased sales, and $0.5 million increase in overhead expenses resulting from expansion of our headquarters and headcount and the normalization of operations compared to the year ended December 31, 2020, which was adversely impacted by pandemic-related restrictions on elective surgeries. The increases were partially offset by a decrease in provision for inventory obsolescence of $0.9 million and $0.3 million decrease in depreciation expense of our surgical instruments due to a prospective adjustment that was made on January 1, 2021 to the useful life of our capitalized instruments to align with the expected life of the instruments. Gross profit and gross margin increased to $76.6 million and 81.1%, respectively, from the year ended December 31, 2021 as compared to 2020, primarily due to the decreased per unit direct costs of goods sold and depreciation expense of our surgical instruments, which were partially offset by an increase in royalty expense as a percent of sales.

Sales and Marketing Expenses. Sales and marketing expenses increased by $32.8 million, or 103.7%, from the year ended December 31, 2021 as compared to 2020. The increase in sales and marketing expenses was primarily due to growth in our overall business. Sales and marketing expenses increased as a result of an increase of $9.7 million in professional services primarily for higher commissions from increased sales by our independent sales agencies, an increase of $11.4 million in advertising and marketing-related expenses primarily due to higher advertising fees and a new television commercial campaign, an increase of $9.5 million in payroll and payroll-related expenses resulting from increased headcount of sales personnel, and $2.2 million in other marketing-related expenses resulting from increased sales efforts. Additionally, we experienced delayed expenditures for surgeon education events, patient outreach campaigns and other planned sales and marketing expenses in connection with the pandemic in 2020.

Research and Development Expenses. Research and development expenses increased by $4.4 million, or 74.5%, from the year ended December 31, 2021 as compared to 2020. The increase in research and development expenses was due to an increase of $3.1 million in payroll and payroll-related costs resulting from increased headcount of research and development personnel, an increase of $1.1 million in professional services from higher consulting fees, and an increase of $0.4 million due to increased purchases of prototypes.

62

General and Administrative Expenses. General and administrative expenses increased by $11.9 million, or 181.9%, from the year ended December 31, 2021 as compared to 2020. The increase in general and administrative expenses was primarily due to an increase of $5.8 million in payroll and payroll-related costs due to increased headcount in our business, an increase of $3.0 million in business-related expenses primarily resulting from increased insurance costs and fees, an increase of $2.6 million in professional services primarily related to legal and audit expenses, and an increase of $0.3 million in rent expense resulting from the expansion of our headquarters.

Interest and Other Income (Expense), Net. Interest and other income (expense), net increased by $1.8 million, or 101%, in 2021 as compared to 2020. The increase was primarily due to the recognition of a $0.6 million loss from the extinguishment of term loans under the SVB Credit Facility and $1.2 million prepayment penalty paid upon termination of the loans under the SVB Credit Facility in 2020.

Interest Expense. Interest expense increased by $1.3 million, or 46.2%, during 2021 as compared to 2020. The increase in interest expense was primarily due to higher interest due under our CRG loan of $30.0 million, which is outstanding from July 2020.

For the comparison of the results of operations for the years ended December 31, 2020 and 2019, refer to our Registration Statement on Form S-1 as filed with the U.S Securities and Exchange Commission on April 19, 2021.

Liquidity and Capital Resources

Overview

Before our IPO, our primary sources of capital were private placements of common stock and convertible preferred stock, debt financing agreements and revenue from the sale of our products. In April 2021, we received net proceeds of $107.6 million from our IPO. As of December 31, 2021, we had cash and cash equivalents of $105.8 million, an accumulated deficit of $41.9 million and $30.0 million of principal outstanding under our term loan agreement with CRG. We repaid $1.8 million in borrowings outstanding from the Paycheck Protection Program loan program (the “PPP Loan”) under the Coronavirus Aid Relief and Economic Recovery Act in 2021. We have an existing credit facility with SVB that provides a revolving line of credit of $10.0 million. We believe that our existing cash and cash equivalents, available debt borrowings and expected revenues will be sufficient to meet our capital requirements and fund our operations for at least twelve months from the issuance of our financial statements as of and for the year ended December 31, 2021. We may be required or decide to raise additional financing to support further growth of our operations.

Short-Term and Long-Term Obligations

Silicon Valley Bank Loan

On August 3, 2020, we entered into the Third Amendment to the Loan and Security Agreement (the “Third Amendment”), with SVB which terminated the third tranche term loan and increased the revolving line of credit to $10.0 million. The Loan and Security Agreement (“LSA”), as amended by the First Amendment, Second Amendment, and Third Amendment (collectively, the “SVB Credit Facility”) matures August 3, 2024. The SVB Credit Facility incurs interest at the greater of (i) 1.00% above the Prime Rate or (ii) 5.00% and is subject to a termination fee of 1.00%.

As of December 31, 2021, we had $10 million of availability to borrow under the revolving line of credit and no borrowings outstanding related to our revolving line of credit.

Under the terms of the SVB Credit Facility, we granted SVB first-priority liens and security interests in substantially all of our assets (excluding our intellectual property but including any proceeds and rights to payments associated with our intellectual property) as collateral. The SVB Credit Facility also contains certain representations and warranties, indemnification provisions in favor of SVB, affirmative and negative covenants (including, among other things, requirements that we maintain a minimum amount of liquidity and achieve minimum revenue targets, limitations on other indebtedness, liens, acquisitions, investments and dividends and requirements relating to financial reporting, sales and leasebacks, insurance and protection of our intellectual property rights) and events of default (including payment defaults, breaches of covenants following any applicable cure period, investor abandonment, a material impairment in the perfection or priority of the lender’s security interest or in the collateral), and events relating to bankruptcy or insolvency). As of December 31, 2021, we were in compliance with all covenants under the SVB Credit Facility.

CRG Term Loan Facility

On July 31, 2020, we entered into a non-revolving term loan facility with CRG (the “CRG Term Loan Facility”) to obtain up to $50.0 million in financing over three tranches to be advanced no later than December 31, 2021. Principal borrowings outstanding excluding discount and issuance costs as of December 31, 2021, totaled $30.0 million.

63

The CRG Term Loan Facility matures on June 30, 2025, and we can elect to make quarterly interest-only payments, to pay 7.50% interest in cash and 5.5% interest in-kind. We are not required to make any principal payments until the maturity of the CRG Term Loan Facility and all outstanding principal and accrued interest are due upon the maturity of the CRG Term Loan Facility. Interest under the CRG Term Loan Facility is applied to outstanding principal and accrued interest at a rate of 13.00% per annum. If an event of default occurs, interest under the CRG Term Loan Facility will increase by 4.00%. If we repay the CRG Term Loan Facility within one year of the applicable borrowing date, we are required to pay a premium of 20.00% of the aggregated outstanding principal amount of the loans that is repaid. If we repay the CRG Term Loan Facility between one and two years from the applicable borrowing date, we are required to pay a premium of 11.00% of the aggregated outstanding principal amount of the loans that is repaid. The CRG Term Loan Facility does not require a prepayment premium for loans being prepaid on the prepayment date that is after two years from the applicable borrowing date.

Under the terms of the CRG Term Loan Facility, we granted CRG first priority liens and security interests in substantially all of our assets as collateral (including our intellectual property), provided that the priority of such liens are subject to an intercreditor agreement between CRG and SVB. The CRG Term Loan Facility also contains certain representations and warranties, indemnification provisions in favor of CRG, affirmative and negative covenants (including, among other things, requirements that we maintain a minimum amount of liquidity and achieve minimum revenue targets, limitations on other indebtedness, liens, acquisitions, investments and dividends and requirements relating to financial reporting, sales and leasebacks, insurance and protection of our intellectual property rights) and events of default (including payment defaults, breaches of covenants following any applicable cure period, investor abandonment, a material impairment in the perfection or priority of the lender’s security interest or in the collateral, and events relating to bankruptcy or insolvency). As of December 31, 2021, we were in compliance with all covenants under the CRG Term Loan Facility.

Funding Requirements

We use our cash to fund our operations, which primarily include the costs of manufacturing our Lapiplasty and Adductoplasty Systems and ancillary products, as well as our sales and marketing and research and development expenses and related personnel costs. We expect our sales and marketing expenses to increase for the foreseeable future as we continue to invest in our direct sales force and expand our marketing efforts, and as we continue to expand our sales and marketing infrastructure to both drive and support anticipated sales growth. We also expect R&D expenses to increase for the foreseeable future as we continue to hire personnel and invest in next-generation innovations of the Lapiplasty System and related products. In addition, we expect our general and administrative expenses to increase for the foreseeable future as we hire personnel and expand our infrastructure to both drive and support the anticipated growth in our organization. We will also incur additional expenses as a result of operating as a public company and also expect to increase the size of our administrative function to support the growth of our business. From time to time, we may also consider additional investments in technologies, assets and businesses to expand or enhance our product offerings. The timing and amount of our operating expenditures will depend on many factors, including:

•
the scope and timing of our investment in our commercial infrastructure and sales force;

•
the costs of our ongoing commercialization activities including product sales, marketing, manufacturing and distribution;

•
the scope of our marketing efforts, including the degree to which we utilize direct to consumer campaigns;

•
the degree and rate of market acceptance of the Lapiplasty System;

•
the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights, including enforcing our intellectual property rights against infringing products or technologies;

•
our need to implement additional infrastructure and internal systems;

•
the research and development activities we intend to undertake in order to improve the Lapiplasty System and to develop or acquire additional products;

•
the investments we make in acquiring other technologies, assets or businesses to expand our product portfolio;

•
the success or emergence of new competing technologies or other adverse market developments;

•
any product liability or other lawsuits related to our products;

•
the expenses needed to attract and retain skilled personnel;

•
the costs associated with being a public company; and

•
the impact of the COVID-19 pandemic, hospital staffing shortages, and general economic conditions on our operations and business.

64

Based upon our current operating plan, we believe that our existing cash and cash equivalents, will enable us to fund our operating expenses and capital expenditure requirements for at least the next twelve months. We have based this estimate on assumptions that may prove to be wrong or that may change in the future, and we could utilize our available capital resources sooner than we expect. We may seek to raise any necessary additional capital through public or private equity offerings or debt financings, credit or loan facilities or a combination of one or more of these or other funding sources. Additional funds may not be available to us on acceptable terms or at all. If we fail to obtain necessary capital when needed on acceptable terms, or at all, we could be forced to delay, limit, reduce or terminate our product development programs, commercialization efforts, sales and marketing initiatives, or other operations. If we raise additional funds by issuing equity securities, our stockholders will suffer dilution and the terms of any financing may adversely affect the rights of our stockholders. In addition, as a condition to providing additional funds to us, future investors may demand, and may be granted, rights superior to those of existing stockholders. Debt financing, if available, is likely to involve restrictive covenants limiting our flexibility in conducting future business activities, and, in the event of insolvency, debt holders would be repaid before holders of our equity securities received any distribution of our corporate assets.

Cash Flows

The following table sets forth the primary sources and uses of cash and cash equivalents for the periods presented below (in thousands):

Net Cash Used in Operating Activities

Net cash used in operating activities for 2021 was $17.2 million, consisting primarily of a net loss of $20.6 million and an increase in net operating assets of $1.3 million, which were partially offset by non-cash charges of $4.6 million. The increase in net operating assets was primarily due to an increase in accounts receivable resulting from higher revenues in 2021, higher inventories resulting from higher purchases in anticipation of growing demand in 2022, and an increase in prepaid expenses and other assets due to timing of payments and growth of our operations, which were offset by increases in accounts payable and accrued liabilities due to timing of payments and growth of our operations. The non-cash charges primarily consisted of depreciation and amortization expense of $0.7 million, share-based compensation expense of $3.4 million, amortization of debt issuance costs of $0.2 million and the provision for inventory obsolescence of $0.3 million.

Net cash used in operating activities for 2020 was $4.5 million, consisting primarily of a net loss of $3.7 million and an increase in net operating assets of $5.3 million, which were partially offset by non-cash charges of $4.5 million. The increase in net operating assets was primarily due to an increase in accounts receivable resulting from higher revenues in 2020 and inventories resulting from higher purchases in anticipation of growing demand in 2021, which were offset by increases in accounts payable and accrued liabilities due to timing of payments and growth of our operations. The non-cash charges primarily consisted of depreciation and amortization expense of $1.2 million, provision for excess and obsolete inventories of $1.1 million, share-based compensation expense of $0.9 million, provision for allowance for doubtful accounts of $0.2 million, amortization of debt issuance costs of $0.2 million and impairment of surgical instruments of $0.1 million.

Net cash used in operating activities for 2019 was $7.7 million, consisting primarily of a net loss of $4.3 million and an increase in net operating assets of $5.3 million, partially offset by non-cash charges of $1.9 million. The increase in net operating assets was primarily due to an increase in accounts receivable resulting from higher revenues in 2019, inventories resulting from increased purchases in anticipation of growing demand in 2020 and prepaid expenses to support the growth of our operations, partially offset by increases in accrued liabilities and accounts payable, due to timing of payments and growth of our operations. The non-cash charges primarily consisted of depreciation and amortization expense of $0.8 million, stock-based compensation expense of $0.8 million, provision for doubtful accounts of $0.1 million and amortization of debt issuance costs and warrant discount of $0.1 million.

Net Cash Used in Investing Activities

Net cash used in investing activities was $2.7 million, $1.1 million and $1.2 million in 2021, 2020 and 2019, respectively, consisting of purchases of capitalized surgical instruments for our reusable instrument trays.

65

Net Cash Provided by Financing Activities

Net cash provided by financing activities in 2021 was $107.7 million, consisting primarily of net proceeds from our IPO of $107.6 million and $1.8 million proceeds from exercise of stock options, partially offset by repayment of our PPP Loan from the SBA of $1.8 million.

Net cash provided by financing activities in 2020 was $11.5 million, consisting primarily of additional borrowings under the CRG Term Loan Facility of $29.5 million, net of debt discount, partially offset by repayment of the term loans under the SVB Credit Facility of $20.0 million, borrowing under SBA Loan of $1.8 million and cash received of $0.3 million from the exercise of stock options, partially offset by debt issuance costs of $0.2 million.

Net cash provided by financing activities in 2019 was $19.7 million, consisting primarily of additional borrowings under the term loan agreement of $20.0 million and cash received of $0.1 million from the exercise of stock options, partially offset by debt issuance costs of $0.3 million.

Surgeon Advisory Board Royalty Agreements

We recognized royalties’ expense of $4.3 million and $2.4 million for the years ended December 31, 2021 and 2020, respectively. For the years ended December 31, 2021 and 2020, the aggregate royalty rate was 4.6% and 4.1%, respectively. Each of the SAB Royalty Agreements prohibits the payment of royalties on products sold to entities and/or individuals with whom any of the surgeon advisors is affiliated.

Operating Lease

We have commitments for future payments related to our office lease located in Ponte Vedra, Florida which expires in 2026. Lease payments comprise of the base rent stated in the lease plus operating costs which include taxes, insurance and common area maintenance. The remaining lease obligation was $2.3 million under this lease as of December 31, 2021.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions for the reported amounts of assets, liabilities, revenue, expenses and related disclosures. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions and any such differences may be material.

While our significant accounting policies are more fully described in Note 2 of our financial statements included in this Annual Report on Form 10-K, we believe the following discussion addresses our most critical accounting policies, which are those that are most important to our financial condition and results of operations and require our most difficult, subjective and complex judgments.

Stock-Based Compensation

We account for stock-based compensation arrangements with employees in accordance with ASC 718, Compensation—Stock Compensation, using a fair-value based method. We determine the fair value of stock options on the date of grant using the Black-Scholes option pricing model.

The fair value of time-based awards is recognized over the period during which an award holder is required to provide services in exchange for the award, known as the requisite service period, which is typically the vesting period using the straight-line method. Stock-based compensation expense is recorded net of estimated forfeitures in our statements of operations.

We estimate the fair value of our stock-based awards using the Black-Scholes option-pricing model, which requires the input of highly subjective assumptions regarding the expected volatility of our stock, the expected life of the stock award and our dividend ratio. We primarily use historical data to determine the assumptions to be used in the Black-Scholes model and have no reason to believe that future data is likely to differ materially from historical data. However, changes in the assumptions regarding future stock price volatility, future dividend payments and future stock award exercise could result in a change in the assumptions used to value awards in the future and may result in a material change to the fair value calculation of stock-based awards.

66

Fair Value of Common Stock

Prior to our IPO, the estimated fair value of the common stock underlying our stock options and stock awards was determined at each grant date by our board of directors, with assistance from management and external appraisers. All options to purchase shares of our common stock were intended to be exercisable at a price per share not less than the per-share fair value of our common stock underlying those options on the date of grant. The approach to estimate the fair value of our common stock was consistent with the methods outlined in the American Institute of Certified Public Accountants’ Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or Practice Aid. Subsequent to our IPO, the fair value of our common stock is determined based on its closing market price.

Recently Issued Accounting Pronouncements

Refer to Note 3, "Recent Accounting Pronouncements", to our audited financial statements included elsewhere in this Annual Report on Form 10-K for new accounting pronouncements as of the date of this Annual Report on Form 10-K.