Note 4 - Fair Value Measurements

9 Months Ended

Sep. 30, 2020

Notes to Financial Statements

Fair Value Disclosures [Text Block]

4. Fair Value Measurements

The Company held U.S. treasury bills of $15.0 million and certificates of deposit of $5.5 million at September 30, 2020. The Company held U.S. treasury bills of $27.5 million at December 31, 2019. Unrealized losses and the associated tax impact on the Company’s available-for-sale securities were insignificant as of September 30, 2020 and December 31, 2019, respectively.

The Company’s investments are all classified within Levels 1 and 2 of the fair value hierarchy. The Company’s investments classified within Level 1 of the fair value hierarchy are valued based on quoted prices in active markets. Level 2 investments are based on matrix pricing compiled by third party pricing vendors, using observable market inputs such as interest rates, yield curves, and credit risk. For cash, current receivables, accounts payable, long-term debt and interest accrual, the carrying amounts approximate fair value, because of the short maturity of these instruments, and therefore fair value information is not included in the table below. Contingent consideration related to the previously described business combinations are classified within Level 3 of the fair value hierarchy as the determination of fair value uses considerable judgement and represents the Company’s best estimate of an amount that could be realized in a market exchange for the asset or liability.

The fair value hierarchy of the Company's cash equivalents, investments and liabilities at fair value was as follows:

			Fair Value Measurements at Reporting Date Using
			Quoted Prices in
			Active Markets		Significant Other		Significant
			for Identical Assets		Observable Inputs		Unobservable Inputs
	September 30, 2020		(Level 1)		(Level 2)		(Level 3)		Amortized Cost
Cash equivalents:
Money Market Funds	$	56,431	$	56,431	$	-	$	-	$	56,431
Investments:
Bank Certificates of Deposit	$	5,503	$	-	$	5,503	$	-	$	5,516
U.S. Treasury Bills		15,039		15,039		-		-		15,130
Total Investments	$	20,542	$	15,039	$	5,503	$	-	$	20,646
Other current and long-term liabilities:
Contingent Consideration - Short Term	$	11,855	$	-	$	-	$	11,855	$	-
Contingent Consideration - Long Term		41,045		-		-		41,045		-
Total Other current and long-term liabilities	$	52,900	$	-	$	-	$	52,900	$	-

			Fair Value Measurements at Reporting Date Using
			Quoted Prices in
			Active Markets		Significant Other		Significant
			for Identical Assets		Observable Inputs		Unobservable Inputs
	December 31, 2019		(Level 1)		(Level 2)		(Level 3)		Amortized Cost
Cash equivalents:
Money Market Funds	$	48,971	$	48,971	$	-	$	-	$	48,971
Investments:
U.S. Treasury Bills	$	27,480	$	27,480	$	-	$	-	$	27,479

There were no transfers between fair value levels during the nine-month period ended September 30, 2020 or in 2019.

Contingent Consideration

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

	Nine Months Ended
	September 30, 2020
Balance, beginning January 1, 2020	$	-
Additions		69,076
Payments		-
Change in fair value		(16,176	)
Balance, ending September 30, 2020	$	52,900

Under the Parcus Medical Merger Agreement and Arthrosurface Merger Agreement, there are earn-out milestones totaling $100 million payable from 2020 to 2022. Parcus Medical has net sales earn-out milestones annually from 2020 to 2022, while Arthrosurface has both regulatory and net sales earn-out milestones in 2020 and 2021. Projected contingent payment amounts are discounted back to the current period using a discounted cash flow model or a Monte Carlo simulation approach. The unobservable inputs used in the fair value measurement of the Company’s contingent consideration are the probabilities of successful achievement, the weighted average cost of capital used for the Monte Carlo simulation, discount rate and the periods in which the milestones are expected to be achieved. The discount rates used for the net sales and regulatory earn-out milestones ranged from 2.0% - 2.5%. The probability of successful achievement of the regulatory earn-out milestones range from 60%-90% for Arthrosurface, which remained unchanged from the acquisition date to September 30, 2020. The key variables that led to a decrease in contingent consideration versus the acquisition date are the decrease in near term revenues due to the COVID-19 pandemic and an increase in the weighted average cost of capital from 11.5% to 13.0% for Arthrosurface and 14.5% to 15.0% for Parcus Medical. Increases or decreases in any of the probabilities of success in which milestones are expected to be achieved would result in a higher or lower fair value measurement, respectively. Increases or decreases in the discount rate would result in a lower or higher fair value measurement, respectively.

The fair value of contingent consideration is assessed on a quarterly basis. The fair value of contingent consideration increased by $4.2 million for the three- month period ended September 30, 2020 due primarily to the passage of time, higher than forecasted revenues during the third quarter, and a reduction in market-based borrowing rates. The fair value of the contingent consideration increased by $16.2 million for the nine-month period ended September 30, 2020 due to a decrease in the revenue due to the COVID-19 pandemic. On October 15, 2020, the Company received regulatory clearance for its WRISTMOTION Total Arthroplasty System, triggering a $5 million regulatory-based milestone payment pursuant to the terms of the Arthrosurface Merger Agreement.