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Fair value measurements and investments | 12 Months Ended
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Dec. 31, 2020
Fair Value Measurements And Investment Disclosure [Abstract] |
Fair value measurements and investments |
1 2. | Fair value measurements and investments
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. Non-financial assets and liabilities of the Company measured at fair value include any long-lived assets that are impaired in a currently reported period or equity securities measured at observable prices in orderly transactions. The authoritative guidance also describes three levels of inputs that may be used to measure fair value:
Level 1: | quoted prices in active markets for identical assets and liabilities
Level 2: | observable inputs other than quoted prices in active markets for identical assets and liabilities
Level 3: | unobservable inputs in which there is little or no market data available, which require the reporting entity to develop its own assumptions
The Company’s financial instruments include cash equivalents, restricted cash, accounts receivable, accounts payable, long-term secured debt, available for sale debt securities, equity securities, contingent consideration, and deferred compensation plan liabilities. The carrying value of cash equivalents, restricted cash, accounts receivable, and accounts payable approximate fair value due to the short-term maturities of these instruments. The Company’s secured revolving credit facility carries a floating rate of interest, and therefore, the carrying value of long-term debt is considered to approximate the fair value. The Company’s available for sale debt securities, equity securities, contingent consideration, and deferred compensation plan liabilities are the only financial instruments recorded at fair value on a recurring basis as follows:
(U.S. Dollars, in thousands) |  | Balance December 31, 2020 |  |  | Level 1 |  |  | Level 2 |  |  | Level 3 |
Assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Neo Medical convertible loan agreement |  | $ | 7,160 |  |  | $ | — |  |  | $ | — |  |  | $ | 7,160 |
Neo Medical preferred equity securities |  |  | 5,000 |  |  |  | — |  |  |  | 5,000 |  |  |  | — |
Bone Biologics equity securities |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Total |  | $ | 12,160 |  |  | $ | — |  |  | $ | 5,000 |  |  | $ | 7,160 |
Liabilities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Spinal Kinetics contingent consideration |  | $ | (35,400 | ) |  | $ | — |  |  | $ | — |  |  | $ | (35,400 | )
Other contingent consideration |  |  | (375 | ) |  |  | — |  |  |  | — |  |  |  | (375 | )
Deferred compensation plan |  |  | (1,441 | ) |  |  | — |  |  |  | (1,441 | ) |  |  | — |
Total |  | $ | (37,216 | ) |  | $ | — |  |  | $ | (1,441 | ) |  | $ | (35,775 | )
(U.S. Dollars, in thousands) |  | Balance December 31, 2019 |  |  | Level 1 |  |  | Level 2 |  |  | Level 3 |
Assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Bone Biologics equity securities |  | $ | 219 |  |  | $ | — |  |  | $ | 219 |  |  | $ | — |
Total |  | $ | 219 |  |  | $ | - |  |  | $ | 219 |  |  | $ | - |
Liabilities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Spinal Kinetics contingent consideration |  | $ | (42,700 | ) |  | $ | — |  |  | $ | — |  |  | $ | (42,700 | )
Deferred compensation plan |  |  | (1,255 | ) |  |  | — |  |  |  | (1,255 | ) |  |  | — |
Total |  | $ | (43,955 | ) |  | $ | — |  |  | $ | (1,255 | ) |  | $ | (42,700 | )
The fair value of the Company’s equity securities and deferred compensation plan liabilities are determined based on inputs that are readily available in public markets or that can be derived from information available in publicly quoted markets; therefore, the Company has categorized these instruments as Level 2 financial instruments. Neo Medical Convertible Loan Agreement and Equity Investment On October 1, 2020, the Company purchased shares of Neo Medical’s preferred stock for consideration of $5.0 million and entered into a Convertible Loan Agreement pursuant to which Orthofix loaned Neo Medical CHF 4.6 million (the “Convertible Loan”). The loan bears interest at 8.0%, with interest due semi-annually. At each interest payment date, the borrower may elect to capitalize any interest due to the then outstanding principal balance of the loan. The Convertible Loan matures on October 1, 2024, provided that if a change in control of Neo Medical occurs prior to the maturity date, the Convertible Loan shall become immediately due upon such event. The Convertible Loan may be convertible by either party into shares of Neo Medical’s preferred stock. The Company may convert the loan at its own election at any time prior to the full repayment or settlement of the Convertible Loan. Neo Medical may elect to convert the loan only in the event of a qualified financing event, as defined within the agreement. The price per share at which the loan converts is dependent upon i) the party electing conversion and ii) Neo Medical’s price per share in its most recent fundraising activities at the time of conversion, as specified within the agreement. The equity securities are recorded in other long-term assets and are considered an investment that does not have a readily determinable fair value. As such, the Company measures this investment at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. As such, the carrying value of this investment as of December 31, 2020, was $5.0 million. The Convertible Loan is recorded in other long-term assets as an available for sale debt security at fair value, with applicable interest recorded in interest income. The fair value of the Convertible Loan, including accrued interest, is based upon significant unobservable inputs, including the use of Monte Carlo simulations, option-pricing models, and a probability-weighted discounted cash flows model, requiring the Company to develop its own assumptions. Therefore, the Company has categorized this asset as a Level 3 financial asset. Some of the more significant unobservable inputs used in the fair value measurement of the Convertible Loan include 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. Holding other inputs constant, changes in these assumptions could result in a significant change in the fair value of the Convertible Loan. If the amortized cost of the Convertible Loan exceeds its estimated fair value, security is deemed to be impaired, and must be evaluated for the recognition of credit losses. Impairment resulting from credit losses is recognized within the statement of income, while impairment resulting from other factors is recognized within other comprehensive income. As of December 31, 2020, the Company has no t recognized any credit losses related to the Convertible Loan. The following table provides a reconciliation of the beginning and ending balances of the Convertible Loan, measured at fair value using significant unobservable inputs (Level 3):
(U.S. Dollars, in thousands) |  | 2020 |  |  | 2019 |
Fair value of Neo Medical Convertible Loan at January 1 |  | $ | — |  |  | $ | — |
Issuance date |  |  | 5,000 |  |  |  | — |
Interest recognized in interest income, net |  |  | 103 |  |  |  | — |
Foreign currency remeasurement recognized in other income (expense), net |  |  | 176 |  |  |  | — |
Unrealized gain (loss) recognized in other comprehensive income (loss) |  |  | 1,881 |  |  |  | — |
Fair value of Neo Medical Convertible Loan at December 31 |  |  | 7,160 |  |  |  | — |
Amortized cost basis of Neo Medical Convertible Loan at December 31 |  |  | 5,279 |  |  |  | — |
The following table provides quantitative information related to certain key assumptions utilized within the valuation as of December 31, 2020:
(U.S. Dollars, in thousands) |  | Fair Value as of December 31, 2020 |  |  | Unobservable inputs |  | Estimate |
Neo Medical Convertible Loan |  | $ | 7,160 |  |  | Cost of equity discount rate |  |  | 21.1 | %
|  |  |  |  |  | Implied volatility |  |  | 108.1 | %
Bone Biologics Equity Securities The Company holds an investment in common stock of Bone Biologics Inc. (“Bone Biologics”), a privately-held developer of orthobiologic products. The equity securities are considered investments that do not have readily determinable fair values. As such, the Company measures these investments at cost, less any impairments, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. In 2018, Bone Biologics completed a series of equity financing activities, which provided a new observable price change in an orderly transaction. As a result, the Company determined its investment was impaired and recorded a charge of $4.4 million in other expense, net. An additional impairment of $0.2 million was recognized in 2020 as a result of concerns over Bone Biologics’ ability to continue as a going concern. The changes in valuation of these securities for the years ended December 31, 2020, 2019, and 2018 are shown below:
(U.S. Dollars, in thousands) |  | 2020 |  |  | 2019 |  |  | 2018 |
Bone Biologics equity securities at January 1 |  | $ | 219 |  |  | $ | 219 |  |  | $ | 2,768 |
Impact of adoption of ASU 2016-01 recognized in other income |  |  | — |  |  |  | — |  |  |  | 1,629 |
Purchase of additional common stock |  |  | — |  |  |  | — |  |  |  | 500 |
Fair value adjustments and impairments recognized in other expense |  |  | (219 | ) |  |  | — |  |  |  | (4,678 | )
Bone Biologics equity securities at December 31 |  | $ | — |  |  | $ | 219 |  |  | $ | 219 |
Contingent Consideration The Company recognized a contingent consideration obligation in connection with the acquisition of Spinal Kinetics in 2018. The Spinal Kinetics contingent consideration consists of potential future milestone payments of up to $60.0 million in cash. The milestone payments included (i) $15.0 million upon U.S. Food and Drug Administration (“FDA”) approval of the M6-C artificial cervical disc (the “FDA Milestone”) and (ii) revenue-based milestone payments of up to $45.0 million in connection with future sales of the acquired artificial discs. Milestones must be achieved within five years of April 30, 2018 to trigger applicable payments. In February 2019, the FDA Milestone was achieved and paid. The estimated fair value of the remaining Spinal Kinetics contingent consideration was $35.4 million as of December 31, 2020. The estimated fair value reflects assumptions made by management as of December 31, 2020, including the estimated impact of COVID-19 on significant unobservable assumptions, such as the expected timing and volume of elective procedures and the impact of these procedures on future revenues. However, the impact of COVID-19 on the Company’s business remains uncertain and difficult to predict. As information surrounding the pandemic is continuing to evolve, the actual amount ultimately paid could be higher or lower than the fair value of the remaining contingent consideration. As of December 31, 2020, the Company has classified $14.9 million of the remaining liability within other current liabilities, as the Company currently expects to pay one of the revenue-based milestones in the next twelve months, and the remaining $20.5 million within other long-term liabilities. Any changes in fair value are recorded as an operating expense within acquisition-related amortization and remeasurement. The following table provides a reconciliation of the beginning and ending balances for the contingent consideration measured at fair value using significant unobservable inputs (Level 3):
(U.S. Dollars, in thousands) |  | 2020 |  |  | 2019 |
Spinal Kinetics contingent consideration at January 1 |  | $ | 42,700 |  |  | $ | 28,560 |
Increase (decrease) in fair value recognized in acquisition-related amortization and remeasurement |  |  | (7,300 | ) |  |  | 29,140 |
Payment made |  |  | — |  |  |  | (15,000 | )
Spinal Kinetics contingent consideration at December 31 |  | $ | 35,400 |  |  | $ | 42,700 |
The Company estimated the fair value of the remaining potential future revenue-based milestone payments using a Monte Carlo simulation and a discounted cash flow model. This fair value measurement is based on significant inputs that are unobservable in the market and thus represents a Level 3 measurement. The key assumptions in applying the valuation model include the Company’s forecasted future revenues for Spinal Kinetics products, the expected timing of payment, applicable discount rates applied, and assumptions for potential volatility of the Company’s forecasted revenue. Significant changes in these assumptions could result in a significantly higher or lower fair value. The following table provides a range of key assumptions used within the valuation as of December 31, 2020:
(U.S. Dollars, in thousands) |  | Fair Value as of December 31, 2020 |  |  | Valuation Technique |  | Unobservable inputs |  | Range
Spinal Kinetics contingent consideration |  | $ | 35,400 |  |  | Discounted cash flow |  | Revenue discount rate |  | 8.09% - 8.12%
|  |  |  |  |  |  |  | Payment discount rate |  | 3.83% - 3.90%
|  |  |  |  |  |  |  | Projected year of payment |  | 2021 - 2022
Other contingent consideration is attributable to an agreement closed in the third quarter of 2020 to acquire certain assets of a medical device distributor as a portion of the consideration is based upon meeting certain revenue-based targets. This contingent liability is measured using a probability-weighted cash flow analysis. eNeura Debt Security Until October of 2019, the Company held a debt security of eNeura, Inc. (“eNeura”), a privately held medical technology company that was developing devices for the treatment of migraines. The principal amount of the debt security was $15.0 million and accrued interest at 8.0%, with payment due at maturity. The debt security was originally set to mature on March 4, 2019. On March 1, 2019, the Company entered into an Amended and Restated Senior Secured Promissory Note with eNeura (the “Restructured Debt Security”) to restructure the debt security, which extended the maturity date to the earlier of (i) March 4, 2022, (ii) the effective date of a change in control, or (iii) the effective date of an initial public offering by eNeura, and which also eliminated the conversion feature included within the original note. As consideration for the extension, eNeura issued to the Company a Warrant to Purchase Common Stock (the “Warrant”), exercisable at $0.01 per share over a ten year contractual term. Prior to the restructuring, the debt security was accounted for as an available for sale debt security at fair value and included within other long-term assets. The fair value was based upon significant unobservable inputs, including the use of a discounted cash flow model and assumptions regarding the expected payback period for the debt security, requiring the Company to develop its own assumptions; therefore, the Company had categorized this asset as a Level 3 financial asset. The Company evaluated any declines in fair value, if any, each quarter to determine if impairments are other-than-temporary. The debt security had an amortized cost basis of $9.0 million at the time of the restructuring and as of December 31, 2018. Subsequent to the restructuring, the debt security was no longer classified as an available for sale debt security, but rather as a held to maturity debt security. The debt security was reclassified from an available for sale debt security to a held to maturity debt security at its fair value on the date of the restructuring. As a result, the unrealized gains included in accumulated other comprehensive income (loss) related to the debt security were to be subsequently amortized to interest income over the remaining term of the Restructured Debt Security. In October 2019, the Company and eNeura settled the Restructured Debt Security for a $4.0 million cash payment and agreed to transfer the Warrant to eNeura. As such, the Company determined the Restructured Debt Security and Warrant were impaired and adjusted the carrying value of the Restructured Debt Security to $4.0 million, its settlement value, by recording a net other-than-temporary impairment of $6.5 million in other expense, net, which included a reclassification of the related unrealized gains included in accumulated other comprehensive income (loss) of $5.2 million. The following table provides a reconciliation of the beginning and ending balances for the eNeura debt security, when it was measured at fair value as an available for sale debt security (prior to its change in classification):
(U.S. Dollars, in thousands) |  | 2020 |  |  | 2019 |  |  | 2018 |
Balance at January 1 |  | $ | — |  |  | $ | 17,820 |  |  | $ | 16,050 |
Gains (losses) recorded for the period |  |  |  |  |  |  |  |  |  |  |  |
Recognized in other expense, net |  |  | — |  |  |  | — |  |  |  | — |
Recognized in other comprehensive income (loss) |  |  | — |  |  |  | (2,593 | ) |  |  | 1,770 |
Change in classification of debt security to held to maturity |  |  | — |  |  |  | (15,227 | ) |  |  | — |
Issuance of Warrant as consideration for extension |  |  | — |  |  |  | 491 |  |  |  | — |
Impairment of Warrant |  |  | — |  |  |  | (491 | ) |  |  | — |
Balance at December 31 |  | $ | — |  |  | $ | — |  |  | $ | 17,820 |

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