Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report, as well as the audited financial statements and the related notes thereto, and the discussion under Part II, Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report. This discussion contains forward-looking statements reflecting our current expectations, estimates, plans and assumptions concerning events and financial trends that involve risks and may affect our future operating results and financial position. Actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed in the sections entitled “Forward-Looking Statements” and Part II, Item 1A. “Risk Factors” of this Quarterly Report and in the section entitled “Risk Factor Summary” and in Part I, Item IA. “Risk Factors” of our Annual Report.
Overview
We are a commercial-stage regenerative medicine company focused on creating the next generation of differentiated products and improving outcomes in patients undergoing surgery, concentrating on patients receiving implantable medical devices. From our proprietary tissue processing platforms, we have developed a portfolio of advanced regenerative medical products that are designed to be very similar to natural biological material. Our proprietary products, which we refer to as our Core Products, are designed to address the implantable electronic device/cardiovascular, orthopedic/spinal repair and soft tissue reconstruction markets, which represented a combined $3 billion market opportunity in the United States in 2020. To expand our commercial reach, we have commercial relationships with major medical device companies, such as Boston Scientific and Biotronik, to promote and sell some of our Core Products. We believe our focus on our unique regenerative medicine platforms and our Core Products will ultimately maximize our probability of continued clinical and commercial success and will create a long-term competitive advantage for us.
We estimate that, over the past two years, approximately two million patients per year in the United States are implanted with either medical devices, such as pacemakers, defibrillators, neuro-stimulators, spinal fusion and trauma fracture hardware or tissue expanders for breast reconstruction. This number is driven by advances in medical device technologies and an aging population with a growing incidence of comorbidities, including diabetes, obesity and cardiovascular and peripheral vascular diseases. These comorbidities can exacerbate various immune responses and other complications that can be triggered by a device implant.
Our Core Products are targeted to address unmet clinical needs with the goal of promoting healthy tissue formation and avoiding complications associated with medical device implants, such as scar-tissue formation, capsular contraction, erosion, migration, non-union of implants and implant rejection. We believe that we have developed the only biomaterial envelope, which is covered by a number of patents that forms a natural, systemically vascularized pocket for holding implanted electronic devices. We have a proprietary processing technology for manufacturing bone regenerative products for use in orthopedic/spinal repair that preserves a cell’s ability to regenerate bone and decelerates cell apoptosis or programmed cell death. We have a patented cell removal technology that produces undamaged extracellular matrices for use in soft tissue reconstruction.
Our Non-Core Products are those fulfilled through tissue processing contracts at our Richmond, California facility. These contracts serve to utilize as much as possible of the starting human biological material from which we produce our orthopedic/spinal repair and soft tissue reconstruction products, leverage our existing overhead and improve our cash flow. The resulting processed materials, including particulate bone, precision milled bone, cellular bone matrix, acellular dermis and other soft tissue products, are sold to medical/surgical companies as finished products and as a subcomponent of their products. Additionally, we process amniotic membrane as finished product for selected customers.
We process all of our products at our two manufacturing facilities in Roswell, Georgia and Richmond, California, and stock inventory of raw materials, components and finished goods at those locations. We rely on a single or limited number of suppliers for certain raw materials and components. Except for the porcine tissue supplier of our raw materials for our CanGaroo and cardiovascular products, which is Cook Biotech, we generally have no long-term supply agreements with our suppliers, as we obtain supplies on a purchase order basis. Specifically, we acquire donated human tissue directly
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through tissue procurement firms engaged by us. We primarily ship our Core Products from our facilities directly to hospital customers.
Since inception, we have financed our operations primarily through private placements of our convertible preferred stock, amounts borrowed under our credit facilities, sales of our products and, more recently, with proceeds from our initial public offering (“IPO”) and a private placement of our common stock. We have devoted the majority of our resources to acquisitions and integration, manufacturing and administrative costs, general and administrative, research and development, clinical activity, purchase of property and equipment used in the production activities of our Richmond, California facility and investing in our commercial infrastructure through our direct sales force and our commercial partners in order to expand our presence and to promote awareness and adoption of our products. As of September 30, 2022, we had 166 employees, of which 26 were direct sales representatives.
For the nine months ended September 30, 2022, we incurred a net loss of $27.5 million, and as of September 30, 2022, we had an accumulated deficit of $132.5 million. In addition, during the nine months ended September 30, 2022, we used $16.2 million and $5.7 million of cash in operating and financing activities, respectively. We expect to continue to incur significant expenses and operating losses for the foreseeable future as we expand our product development and clinical and research activities and to the extent we grow our sales organization to coincide with product launches. Because of the numerous risks and uncertainties associated with our commercialization and development efforts, we are unable to predict when we will become profitable, and we may never become profitable. Our inability to achieve and then maintain profitability would negatively affect our business, financial condition, results of operations and cash flows.
Our ability to achieve profitability will depend on our ability to generate sales from existing or new products sufficient to exceed our ongoing operating expenses and capital requirements. Because of the numerous risks and uncertainties affecting product sales and our ongoing commercialization and product development efforts, we are unable to predict with any certainty whether we will be able to increase sales of our products or the timing or amount of ongoing expenditures we will be required to incur. Accordingly, even if we are able to increase sales of our products, we may not become profitable.
In order to mitigate the current and potential future liquidity issues caused by the matters noted above, we may seek to raise capital through the issuance of common stock, restructure our Revenue Interest Obligation, or pursue asset sale or licensing transactions. However, such transactions may not be successful and we may not be able to raise additional equity, refinance or restructure our debt instruments, or sell assets on acceptable terms, or at all. As such, based on our current operating plans, we believe there is uncertainty as to whether our future cash flows along with our existing cash, potential availability under our SWK Loan Facility (described below under “– Liquidity and Capital Resources – Credit Facilities”), issuances of additional equity and cash generated from expected future sales will be sufficient to meet our anticipated operating needs through twelve months from the financial statement issuance date. Due to these factors, there is substantial doubt about our ability to continue as a going concern within one year after the issuance of the financial statements.
Impact of COVID-19
We continue to closely monitor the impact of the COVID-19 pandemic and its variants on our business. In March 2020, the World Health Organization declared COVID-19 a global pandemic and recommended various containment and mitigation measures worldwide. Since that time, the number of procedures performed using our products has intermittently decreased, as governmental authorities in the United States have recommended, and in certain cases required, that elective, specialty and other non-emergency procedures and appointments be suspended or canceled in order to avoid patient exposure to medical environments and the risk of potential infection with COVID-19, and to focus limited resources and personnel capacity on the treatment of COVID-19 patients. As a result, beginning in March 2020, a significant number of procedures using our products have intermittently been postponed or cancelled, which has negatively impacted sales of our products. These measures and challenges will likely continue for the duration of the pandemic, which is uncertain, and may reduce our net sales in the future and negatively impact our business, financial condition and results of operations while the pandemic continues.
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In addition, numerous state and local jurisdictions, including those where our facilities are located, imposed, and others in the future may impose or re-impose, “shelter-in-place” orders, quarantines, executive orders and similar government orders and restrictions for their residents to control the spread of COVID-19. Such orders or restrictions resulted in reduced operations at our manufacturing facilities and service providers, travel restrictions and cancellation of events, and have restricted the ability of our sales representatives and those of our commercial partners and independent sales agents to attend procedures in which our products are used, among other effects, thereby negatively impacting our operations.
While access to procedures for our sales representatives and independent sales agents have improved, the extent to which the COVID-19 pandemic impacts our future financial condition and results of operations will depend on future events and developments, which are highly uncertain and cannot be predicted, including the severity and spread of the disease and the effectiveness of actions to contain the disease or treat its impact, among others. As new information regarding COVID-19 continues to emerge, and, as variants of COVID-19 emerge, it is difficult to predict the degree to which this disease will ultimately affect our business.
FiberCel Recall
In June 2021, we issued a voluntary recall pertaining to a single donor lot of our FiberCel, a bone repair product formerly distributed by Medtronic, after learning of postsurgical infections reported in several patients treated with the product, including some patients that tested positive for tuberculosis. For information about the FiberCel Litigation in which we are involved, the impact of such proceedings on our financial statements included in this Quarterly Report, and the possible future financial implications, see Note 8 to the condensed consolidated financial statements included elsewhere in this Quarterly Report. The impact of FiberCel Litigation on our results of operations for the periods covered by this Quarterly Report are discussed below under “ – Results of Operations.”
Strategic Transactions
We operate four distinct business units – Device Protection, Cardiovascular, Women’s Health, and Orthobiologics. We have received interest and are actively considering material strategic transactions in each of these business units. The types of transactions under consideration include exclusive supply agreements, co-promotion arrangements, exclusive distribution partnerships, and whole business unit divestitures. The most advanced of these potential transactions are based on written statements of interest with detailed terms that include cash offers for acquisition of the unit, and partnership opportunities with significant upfront payments and purchase commitments.
Each business unit has at least one contemplated transaction with the potential, we believe, to be consummated, add non-dilutive capital, and enhance shareholder value. However, we intend to be selective and only execute agreements that we believe are in the best long-term interest of shareholders. As a result, it is possible that we do not execute any of the aforementioned. Moreover, if we do execute one or more of these transactions, there can be no assurance that the terms of any such transaction would be favorably received by the market.
CanGaroo RM Status
A 510(k) submission for pre-market clearance of the CanGaroo RM Antibacterial Envelope, the only biomaterial envelope designed to mitigate complications in implantable electronic device procedures, is currently under review by the U.S. FDA. We recently held a positive meeting with the FDA that clarified certain information requirements related to our 510(k) submission. We will be able to complete our responses to outstanding questions from FDA in time for an anticipated CanGaroo RM marketing clearance in the first quarter of 2023.
Impact of Inflation
Inflationary factors, such as increases in our cost of goods sold or other operating expenses, may adversely affect our operating results. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we do not believe inflation had a material effect on our financial condition or results of operations during the nine months ended September 30, 2022 and 2021. We cannot assure you, however, that we will be able to
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increase the selling prices of our products or reduce our operating expenses in an amount sufficient to offset the effects future inflationary pressures may have on our gross margin. Accordingly, we cannot assure you that our financial condition and results of operations will not be materially impacted by inflation in the future.
Components of Our Results of Operations
Net Sales
We recognize revenue on the sale of our Core Products and our Non-Core Products. With respect to our Core Products, CanGaroo and our cardiovascular products are sold to hospitals and other healthcare facilities primarily through our direct sales force, commercial partners or independent sales agents. Our orthopedic/spinal repair products are sold through commercial partners. Our soft tissue reconstruction product SimpliDerm is sold directly to hospitals and other healthcare facilities through independent sales agents. Our contract manufacturing products are sold directly to corporate customers. Gross to net sales adjustments include sales returns and prompt payment and volume discounts.
Expenses
In recent years, we have incurred significant costs in the operation of our business. We expect that our recurring operating costs will largely stabilize, or increase at modest rates, in the near future through the identification of efficiencies as we grow. We may, however, still experience more significant expense increases as we expand our product development and clinical and research activities and to the extent we grow our sales organization to coincide with product launches. As a result, we will need to generate significant net sales in order to achieve profitability. Below is a breakdown of our main expense categories and the related expenses incurred in each category:
Cost of Goods Sold
Our cost of goods sold relate to purchased raw materials and the processing and conversion costs of such raw materials consisting primarily of salaries and benefits, supplies, quality control testing and the manufacturing overhead incurred at our processing facilities in Richmond, California and Roswell, Georgia. Both facilities have additional capacity, which if utilized, would further leverage our fixed overhead. Cost of goods sold also includes the amortization of intangibles generated from the CorMatrix Acquisition in 2017.
Sales and Marketing Expenses
Sales and marketing expenses are primarily related to our direct sales force, consisting of salaries, commission compensation, fringe benefits, meals and other expenses. Auto and travel costs have also historically contributed to sales and marketing expenses, albeit to a lesser extent due to the COVID-19 pandemic. Outside of our direct sales force, we incur significant expenses relating to commissions to our CanGaroo commercial partners and independent sales agents. Additionally, this expense category includes distribution costs as well as market research, trade show attendance, advertising and public relations related to our products, and customer service expenses.
General and Administrative Expenses
General and administrative (“G&A”) expenses consist primarily of compensation, consulting, legal, human resources, information technology, accounting, insurance and general business expenses. Our G&A expenses have increased as a result of operating as a public company, especially as a result of hiring additional personnel and incurring greater director and officer insurance premiums, greater investor relations costs, and additional costs associated with accounting, legal, tax-related and other services associated with maintaining compliance with exchange listing and SEC requirements.
Research and Development Expenses
Research and development (“R&D”) expenses consist primarily of salaries and fringe benefits, laboratory supplies, clinical trials and outside service costs. Our product development efforts primarily relate to new offerings in
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support of the orthopedic/spinal repair market and activities associated with the development of a CanGaroo Envelope with antibiotics. We also conduct clinical trials to validate the performance characteristics of our products and to capture patient data necessary to support our commercial efforts.
FiberCel Litigation Costs
FiberCel litigation costs consist primarily of legal fees and the estimated costs to resolve the outstanding FiberCel litigation cases offset by the estimated amounts recoverable under insurance, indemnity and contribution agreements for such costs.
Results of Operations
Comparison of the Three Months Ended September 30, 2022 and 2021
Three Months Ended September 30,
2022
2021
Change 2021 / 2022
% of Net
% of Net
(in thousands, except percentages)
Amount
Sales
Amount
Sales
$
%
Net sales
$
12,389
100.0
%
$
11,485
100.0
%
$
904
7.9
%
Cost of goods sold
7,340
59.2
%
7,796
67.9
%
(456)
(5.8)
%
Gross profit
5,049
40.8
%
3,689
32.1
%
1,360
36.9
%
Sales and marketing
4,915
39.7
%
4,783
41.6
%
132
2.8
%
General and administrative
4,487
36.2
%
3,516
30.6
%
971
27.6
%
Research and development
1,966
15.9
%
2,289
19.9
%
(323)
(14.1)
%
FiberCel litigation costs
1,474
11.9
%
77
0.7
%
1,397
NM
Total operating expenses
12,842
103.7
%
10,665
92.9
%
2,177
20.4
%
Loss from operations
(7,793)
(62.9)
%
(6,976)
(60.7)
%
(817)
11.7
%
Interest expense
1,302
10.5
%
1,328
11.6
%
(26)
(2.0)
%
Other (income) expense, net
803
6.5
%
—
—
%
803
NM
Loss before provision of income taxes
(9,898)
(79.9)
%
(8,304)
(72.3)
%
(1,594)
19.2
%
Income tax expense
12
0.1
%
12
0.1
%
—
—
%
Net loss
$
(9,910)
(80.0)
%
$
(8,316)
(72.4)
%
$
(1,594)
19.2
%
Net Sales
Net sales increased $0.9 million, or 7.9%, to $12.4 million in the three months ended September 30, 2022 compared to $11.5 million in the three months ended September 30, 2021. The improvement in net sales was due to growth in net sales of our Core Products of $0.4 million and Non-Core Products of $0.5 million.
Net sales information for our Core Products and Non-Core Products is summarized as follows:
Three Months Ended September 30,
2022
2021
% of Net
% of Net
Change 2021 / 2022
(in thousands, except percentages)
Amount
Sales
Amount
Sales
$
%
Products:
Core Products
$
8,949
72.2
%
$
8,588
74.8
%
$
361
4.2
%
Non-Core Products
3,440
27.8
%
2,897
25.2
%
543
18.7
%
Total Net Sales
$
12,389
100.0
%
$
11,485
100.0
%
$
904
7.9
%
Net sales generated by our Core Products increased $0.4 million, or 4.2%, to $8.9 million in the three months ended September 30, 2022 compared to $8.6 million in the three months ended September 30, 2021. The Core Products net sales growth can be attributed to sales volume increases in our CanGaroo and SimpliDerm products.
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Net sales generated by our Non-Core Products increased $0.5 million, or 18.7%, to $3.4 million in the three months ended September 30, 2022 compared to $2.9 million in the three months ended September 30, 2021. The increase was primarily driven by a growth in the revenue from several contract manufacturing customers .
Cost of Goods Sold
Cost of goods sold decreased $0.5 million, or 5.8%, to $7.3 million in the three months ended September 30, 2022 compared to $7.8 million in the three months ended September 30, 2021, and included, in each case, $0.8 million of intangible asset amortization expenses. Gross margin in the three months ended September 30, 2022 was 40.8%, an increase from 32.1% in the corresponding prior year period. Gross margin, excluding intangible asset amortization, in the three months ended September 30, 2022 was 47.6%, an increase from 39.5% in the corresponding prior year period. Gross margin, excluding intangible asset amortization, is a non-GAAP financial measure. See "Non-GAAP Financial Measures” for a discussion regarding our use of gross margin, excluding intangible asset amortization, including its limitations and a reconciliation to the most directly comparable GAAP financial measure. The increase in gross margin and decrease in cost of goods sold was primarily due to recent production efficiencies and improved inventory management in the three months ended September 30, 2022.
Operating Expenses
Sales and Marketing
Sales and marketing expenses increased $0.1 million, or 2.8%, to $4.9 million in the three months ended September 30, 2022 compared to $4.8 million in the three months ended September 30, 2021. As a percentage of sales, sales and marketing expenses declined to 39.7% in the three months ended September 30, 2022 from 41.6% in the three months ended September 30, 2021. The decrease as a percentage of sales was the result of the growth during the three months ended September 30, 2022 of revenues from sales to contract manufacturing customers as such revenues have lower selling costs than our sales directly to end users.
General and Administrative
G&A expenses increased $1.0 million, or 27.6%, to $4.5 million in the three months ended September 30, 2022 compared to $3.5 million in the three months ended September 30, 2021. As a percentage of net sales, G&A expenses increased to 36.2% in the three months ended September 30, 2022 from 30.6% in the three months ended September 30, 2021. The increase in expense was primarily due to certain non-recurring charges associated with legal fees on various corporate matters and the Chief Executive Officer transition described in Note 4 to the condensed consolidated financial statements.
Research and Development
R&D expenses decreased to $2.0 million in the three months ended September 30, 2022 compared to $2.3 million in the three months ended September 30, 2021. We continue to focus our R&D efforts on the development of our pipeline products and the decline in R&D expenses in the three months ended September 30, 2022 was largely attributable to the lessening of work needed to finalize the development and testing of our CanGaroo with antibiotics.
FiberCel Litigation Costs
FiberCel litigation costs increased to $1.5 million in the three months ended September 30, 2022 compared to $0.1 million in the three months ended September 30, 2021. The increase in expense was primarily due to the settlements reached in a significant number of FiberCel Litigation cases in the three months ended September 30, 2022 as well as the estimation of contingent liabilities for the unsettled cases. The total of such settlement and estimated settlement values was recorded (net of estimated insurance, indemnity and contribution agreement recoveries) in the three months ended September 30, 2022. See further discussion in Note 8 to condensed consolidated financial statements included elsewhere in this Quarterly Report.
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Interest Expense
Interest expense was approximately $1.3 million in both the three months ended September 30, 2022 and 2021. See “- Liquidity and Capital Resources - Credit Facilities” below for a discussion of our borrowings related to these interest expenses and Note 7 to the condensed consolidated financial statements included elsewhere in this Quarterly Report for a description of our Revenue Interest Obligation and the interest expense related thereto.
Other (Income) Expense, net
Other (income) expense, net was approximately $0.8 million of expense in the three months ended September 30, 2022. Such other expense relates to our debt refinancing in August 2022 and the associated prepayment fees, payment of unaccrued exit fees and write-off of unamortized deferred financing costs which collectively resulted in a loss of $1.2 million. Such loss was offset by other income of $0.4 million related to the forgiveness of interest accrued on the promissory note to a tissue supplier upon repayment of such note in August 2022. See Note 6 to the accompanying condensed consolidated statements of operations for the three and nine months ended September 30, 2022 for further discussion of these transactions.
Comparison of the Nine Months Ended September 30, 2022 and 2021
Nine Months Ended September 30,
2022
2021
Change 2021 / 2022
% of Net
% of Net
(in thousands, except percentages)
Amount
Sales
Amount
Sales
$
%
Net sales
$
36,522
100.0
%
$
36,529
100.0
%
$
(7)
(0.0)
%
Cost of goods sold
22,294
61.0
%
20,897
57.2
%
1,397
6.7
%
Gross profit
14,228
39.0
%
15,632
42.8
%
(1,404)
(9.0)
%
Sales and marketing
15,139
41.5
%
14,285
39.1
%
854
6.0
%
General and administrative
13,223
36.2
%
10,501
28.7
%
2,722
25.9
%
Research and development
6,855
18.8
%
5,890
16.1
%
965
16.4
%
FiberCel litigation costs
1,908
5.2
%
226
0.6
%
1,682
NM
Total operating expenses
37,125
101.7
%
30,902
84.6
%
6,223
20.1
%
Loss from operations
(22,897)
(62.7)
%
(15,270)
(41.8)
%
(7,627)
49.9
%
Interest expense
3,721
10.2
%
4,034
11.0
%
(313)
(7.8)
%
Other (income) expense, net
803
2.2
%
(3,579)
(9.8)
%
4,382
NM
Loss before provision of income taxes
(27,421)
(75.1)
%
(15,725)
(43.0)
%
(11,696)
74.4
%
Income tax expense
36
0.1
%
43
0.1
%
(7)
(16.3)
%
Net loss
$
(27,457)
(75.2)
%
$
(15,768)
(43.2)
%
$
(11,689)
74.1
%
Net Sales
Net sales were $36.5 million in both the nine months ended September 30, 2022 and 2021. Net sales information for our Core Products and Non-Core Products is summarized as follows:
Nine Months Ended September 30,
2022
2021
% of Net
% of Net
Change 2021 / 2022
(in thousands, except percentages)
Amount
Sales
Amount
Sales
$
%
Products:
Core Products
$
26,141
71.6
%
$
29,230
80.0
%
$
(3,089)
(10.6)
%
Non-Core Products
10,381
28.4
%
7,299
20.0
%
3,082
42.2
%
Total Net Sales
$
36,522
100.0
%
$
36,529
100.0
%
$
(7)
(0.0)
%
Net sales generated by our Core Products declined $3.1 million, or 10.6%, to $26.1 million in the nine months ended September 30, 2022 compared to $29.2 million in the nine months ended September 30, 2021. The decrease in Core Products net sales can be attributed to the cessation of purchases by Medtronic of FiberCel following our recall of a single
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lot of FiberCel in June 2021 partially offset by sales volume increases in our CanGaroo and SimpliDerm products. Sales of FiberCel to Medtronic were $4.9 million in the nine months ended September 30, 2021.
Net sales generated by our Non-Core Products increased $3.1 million, or 42.2%, to $10.4 million in the nine months ended September 30, 2022 compared to $7.3 million in the nine months ended September 30, 2021. The increase was primarily driven by a growth in the revenue from several contract manufacturing customers.
Cost of Goods Sold
Cost of goods sold increased $1.4 million, or 6.7%, to $22.3 million in the nine months ended September 30, 2022 compared to $20.9 million in the nine months ended September 30, 2021, and included, in each case, $2.5 million of intangible asset amortization expenses. Gross margin in the nine months ended September 30, 2022 was 39.0%, a decrease from 42.8% in the corresponding prior year period. Gross margin, excluding intangible asset amortization, in the nine months ended September 30, 2022 was 45.9%, a decline from 49.8% in the corresponding prior year period. Gross margin, excluding intangible asset amortization, is a non-GAAP financial measure. See "Non-GAAP Financial Measures” for a discussion regarding our use of gross margin, excluding intangible asset amortization, including its limitations and a reconciliation to the most directly comparable GAAP financial measure. The decrease in gross margin and increase to cost of goods sold was primarily due to product mix (higher Non-Core revenues in 2022 with lower gross margins).
Operating Expenses
Sales and Marketing
Sales and marketing expenses increased $0.8 million, or 6.0%, to $15.1 million in the nine months ended September 30, 2022 compared to $14.3 million in the nine months ended September 30, 2021. As a percentage of sales, sales and marketing expenses grew to 41.5% in the nine months ended September 30, 2022 from 39.1% in the nine months ended September 30, 2021. The increase as a percentage of sales was the result of higher stock-based compensation and travel costs related to our sales force.
General and Administrative
G&A expenses increased $2.7 million, or 25.9%, to $13.2 million in the nine months ended September 30, 2022 compared to $10.5 million in the nine months ended September 30, 2021. As a percentage of net sales, G&A expenses increased to 36.2% in the nine months ended September 30, 2022 from 28.7% in the nine months ended September 30, 2021. The increase in expense was primarily due to higher stock-based compensation as well as non-recurring charges totaling $1.7 million associated with legal fees on various corporate matters and the Chief Executive Officer transition described in Note 4 to the condensed consolidated financial statements.
Research and Development
R&D expenses increased to $6.9 million in the nine months ended September 30, 2022 compared to $5.9 million in the nine months ended September 30, 2021. We continue to focus our R&D efforts on the development of our pipeline products and the growth in R&D expenses in the nine months ended September 30, 2022 was largely attributable to the work performed on the final development and testing of our CanGaroo with antibiotics.
FiberCel Litigation Costs
FiberCel litigation costs increased to $1.9 million in the nine months ended September 30, 2022 compared to $0.2 million in the nine months ended September 30, 2021. The increase in expense was primarily due to the settlements reached in a significant number of FiberCel Litigation cases in the nine months ended September 30, 2022 as well as the estimation of contingent liabilities for the unsettled cases. The total of such settlement and estimated settlement values was recorded (net of estimated insurance, indemnity and contribution agreement recoveries) in the nine months ended September 30, 2022. See further discussion in Note 8 to condensed consolidated financial statements included elsewhere in this Quarterly Report.
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Interest Expense
Interest expense was approximately $3.7 million in the nine months ended September 30, 2022 compared to $4.0 million in the nine months ended September 30, 2021. The decrease was due to lower draws on our formerly outstanding MidCap Credit Facility (as defined, and further described, in Note 6 to the condensed consolidated financial statements included elsewhere in this Quarterly Report) and lower outstanding principal on our formerly outstanding MidCap Loan Facility (as defined, and further described, in Note 6 to the condensed consolidated financial statements included elsewhere in this Quarterly Report) due to the commencement of principal payments in August 2021. See “ - Liquidity and Capital Resources - Credit Facilities” below for a further discussion of these debt agreements and Note 6 to the condensed consolidated financial statements included elsewhere in this Quarterly Report.
Other (Income) Expense, net
Other (income) expense, net was approximately $0.8 million of expense in the nine months ended September 30, 2022. Such other expense relates to our debt refinancing in August 2022 and the associated prepayment fees, payment of unaccrued exit fees and the write-off of unamortized deferred financing costs, which collectively resulted in a loss of $1.2 million. Such loss was offset by other income of $0.4 million related to the forgiveness of interest accrued on the promissory note to a tissue supplier upon repayment of such note in August 2022. See Note 6 to the accompanying condensed consolidated statements of operations for the three and nine months ended September 30, 2022 for further discussion of these transactions.
Other (income) expense, net was approximately $3.6 million of income in the nine months ended September 30, 2021. Such other income relates to the forgiveness of our PPP Loan totaling approximately $3.0 million and the Company’s receipt of $550,000 in satisfaction of a 2018 settlement with Keralink. For further discussion on these items, see Notes 6 and 10 to the condensed consolidated financial statements shown elsewhere in this Quarterly Report.
Non-GAAP Financial Measures
This Quarterly Report presents our gross margin, excluding intangible asset amortization, for the three and nine months ended September 30, 2022 and 2021. We calculate gross margin, excluding intangible asset amortization, as gross profit, excluding amortization expense relating to intangible assets we acquired in the CorMatrix Acquisition, divided by net sales. Gross margin, excluding intangible asset amortization, is a supplemental measure of our performance, is not defined by or presented in accordance with U.S. generally accepted accounting principles (“GAAP”), has limitations as an analytical tool and should not be considered in isolation or as an alternative to our GAAP gross margin, gross profit or any other financial performance measure presented in accordance with GAAP. We present gross margin, excluding intangible asset amortization, because we believe that it provides meaningful supplemental information regarding our operating performance by removing the impact of amortization expense, which is not indicative of our overall operating performance. We believe this provides our management and investors with useful information to facilitate period-to-period comparisons of our operating results. Our management uses this metric in assessing the health of our business and our operating performance, and we believe investors’ understanding of our operating performance is similarly enhanced by our presentation of this metric. In addition, other companies, including companies in our industry, may use other measures to evaluate their performance, which could reduce the usefulness of this non-GAAP financial measure as a tool for comparison.
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The following table presents a reconciliation of our gross margin, excluding intangible asset amortization, for the three and nine months ended September 30, 2022 and 2021 to the most directly comparable GAAP financial measure, which is our GAAP gross margin (in thousands).
Three Months Ended
Nine Months Ended
September 30,
September 30,
2022
2021
2022
2021
Net sales
$
12,389
$
11,485
$
36,522
$
36,529
Cost of goods sold
7,340
7,796
22,294
20,897
Gross profit
5,049
3,689
14,228
15,632
Intangible asset amortization expense
849
849
2,548
2,548
Gross profit, excluding intangible asset amortization
$
5,898
$
4,538
$
16,776
$
18,180
Gross margin
40.8
%
32.1
%
39.0
%
42.8
%
Gross margin, excluding intangible asset amortization
47.6
%
39.5
%
45.9
%
49.8
%
Seasonality
Historically, we have experienced seasonality, with lower sales in our first and second quarters and higher sales in our fourth quarter, and we expect this trend to continue. We have experienced and may in the future experience, higher sales in the fourth quarter as a result of hospitals in the United States increasing their purchases of our products to coincide with the end of their budget cycles. Satisfaction of patient deductibles throughout the course of the year also results in increased sales later in the year, once patients have paid their annual insurance deductibles in full, which reduces their out-of-pocket costs. Conversely, our first quarter generally has lower sales than the preceding fourth quarter as patient deductibles are re-established with the new year, which increases their out-of-pocket costs.
Liquidity and Capital Resources
As of September 30, 2022, we had cash of approximately $8.1 million. In August 2022, we refinanced our debt as described below under “— Credit Facilities.” Since inception, we have financed our operations primarily through private placements of our convertible preferred stock, amounts borrowed under our credit facilities, sales of our products and more recently, proceeds from our IPO and a private placement of our common stock. Our historical cash outflows have primarily been associated with acquisitions and integration, manufacturing and administrative costs, general and marketing, research and development, clinical activity, purchase of property and equipment used in the production activities of our Richmond, California facility and investing in our commercial infrastructure through our direct sales force and our commercial partners in order to expand our presence and to promote awareness and adoption of our products. As of September 30, 2022, our accumulated deficit was $132.5 million.
On December 8, 2021, we closed on a private investment in public equity (PIPE) financing, thereby receiving net proceeds of approximately $13.8 million, after deducting offering costs. The PIPE investors purchased an aggregate of 2,122,637 shares of the Company’s Class A common stock and an aggregate of 1,179,244 shares of the Company’s Class B common stock (which are convertible on a one-for-one basis into shares of Class A common stock), in each case, at a price of $4.24 per share.
We expect our losses to continue for the foreseeable future and these losses will continue to have an adverse effect on our financial position. Because of the numerous risks and uncertainties associated with our commercialization and development efforts, we are unable to predict when we will become profitable, and we may never become profitable. Our inability to achieve and then maintain profitability would negatively affect our business, financial condition, results of operations and cash flows.
In order to mitigate the current and potential future liquidity issues caused by the matters noted above, we may seek to raise capital through the issuance of common stock, restructure our Revenue Interest Obligation, or pursue asset sale or licensing transactions. However, such transactions may not be successful and we may not be able to raise additional equity, refinance our debt instruments, or sell assets on acceptable terms, or at all. As such, based on our current operating plans, we believe there is uncertainty as to whether our future cash flows along with our existing cash, availability under
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the SWK Loan Facility (described below under “—Credit Facilities”), issuances of additional equity and cash generated from expected future sales will be sufficient to meet our anticipated operating needs through twelve months from the financial statement issuance date. Due to these factors, there is substantial doubt about our ability to continue as going concern within one year after the issuance of the financial statements.
Cash Flows for the Nine Months Ended September 30, 2022 and 2021
Nine Months Ended September 30,
2022
2021
(in thousands)
Net cash used in:
Operating activities
$
(16,189)
$
(9,059)
Investing activities
(406)
(344)
Financing activities
(5,732)
(7,503)
Net decrease in cash
$
(22,327)
$
(16,906)
Net Cash Used in Operating Activities
Net cash used in operating activities for the nine months ended September 30, 2022 was $16.2 million compared to $9.1 million for the nine months ended September 30, 2021. The year-over-year increase was primarily due to a gain on extinguishment of debt in the three months ended September 30, 2021 versus a loss experienced in the three months ended September 30, 2022. Additionally, due to timing, accounts payable increases in the current period increased cash and offset a portion of the cash used in operating cash activities when compared to the prior period.
Net Cash Used in Investing Activities
Net cash used in investing activities for the nine months ended September 30, 2022 was $0.4 million compared to $0.3 million for the nine months ended September 30, 2021. In both periods, the use of cash related to the purchase of property and equipment, the majority of which were used in the production activities of our Richmond, California facility.
Net Cash Used in Financing Activities
Net cash used in financing activities for the nine months ended September 30, 2022 was $5.7 million compared to $7.5 million for the nine months ended September 30, 2021. The year-over-year net decrease was caused primarily by the net cash infusion from the proceeds of the August 2022 debt refinancing, less all debt repayments and refinancing costs incurred during the nine months ended September 30, 2022. See “Credit Facilities” below for further discussion.
Credit Facilities
General
O n August 10, 2022 (the “Closing Date”), we entered into a senior secured term loan facility with SWK Funding LLC, as agent, and other lenders party thereto (the “SWK Loan Facility”) for an aggregate principal amount of $25 million, with $21 million drawn on the Closing Date (the “Initial Term Loan”) and $4 million that becomes available, subject to the achievement of specified operational and financial metrics by September 30, 2023 (the “Additional Term Loan”). The SWK Loan Facility also allows for the establishment of a separate, new asset-based revolving loan facility of up to $8 million, which had not been entered into as of September 30, 2022. We used $16 million of the proceeds of the SWK Loan Facility to pay all outstanding obligations on the formerly outstanding MidCap Loan Facility and MidCap Credit Facility. Such payment included (i) $12.8 million to repay all outstanding principal and accrued interest on the MidCap Loan Facility, (ii) $1.7 million to pay the prepayment and exit fees on the MidCap Loan Facility and (iii) $1.5 million to repay the outstanding balance, accrued interest and exit fees on the MidCap Credit Facility.
As of September 30, 2022, we had $20.0 million of indebtedness outstanding under our SWK Loan Facility (net of $1.0 million of unamortized discount and deferred financing costs).
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Interest Rates
All of the SWK Loan Facility borrowings take the form of Secured Overnight Financing Rate (“SOFR”) loans and will bear interest at a rate per annum equal to the sum of an applicable margin of (i) 8.75% and the “Term SOFR Rate” (based upon an interest period of 3 months), or (ii) if we have elected the PIK Interest option (as defined below), 4.75% and the “Term SOFR Rate.” We may elect a portion of the interest due, to be paid in-kind at a rate per annum of 4.5% (“PIK Interest”), and such election may be made (x) until November 15, 2024 if the conditions to draw the Additional Term Loan have not been met, or (y) if such conditions to draw the Additional Term Loan have been satisfied, until November 17, 2025. The “Term SOFR Rate” is subject to a floor of 2.75%.
Mandatory Prepayments
The SWK Loan Facility Agreement requires certain mandatory prepayments, subject to certain exceptions, with: (1) 100% of any net casualty proceeds in excess of $250,000 and (2) for non-ordinary course asset sales, an amount equal to the difference between (x) the proportion of divested gross profit (as defined in the SWK Loan Facility Agreement) to the Company’s total gross profit (as defined in the SWK Loan Facility Agreement) multiplied by the outstanding loans under the SWK Loan Facility, and (y) the difference between $1,000,000 and the aggregate sale proceeds of any assets previously sold during the fiscal year. No such mandatory prepayments were required during the three and nine months ended September 30, 2022.
Optional Prepayment
The SWK Loan Facility Agreement also includes an exit fee equal to: (i) if such prepayment occurs prior to the first anniversary of the Closing Date, 2% of the aggregate principal amount funded prior to the termination plus remaining unpaid interest payments scheduled to be paid during the first year of the loan or (ii) if such prepayment occurs after the first anniversary of the Closing Date but prior to the second anniversary of the Closing Date, 2% of the aggregate principal amount funded prior to termination.
Amortization and Final Maturity
The SWK Loan Facility matures on August 10, 2027 and accrues interest, payable quarterly in arrears. Principal amortization of the SWK Loan Facility starts on November 15, 2024, which amortization may be extended to November 17, 2025 if conditions to draw the Additional Term Loan have been satisfied. Principal payments during the amortization period will be limited based on revenue-based caps. As of September 30, 2022, quarterly principal payments are scheduled to begin on November 15, 2024, in an amount equal to 5% of the Initial Term Loan with the balance paid at maturity.
Security
All obligations under the SWK Loan Facility are, and any future guarantees of those obligations will be, secured by, among other things, and in each case subject to certain exceptions, a first priority lien on and security interest in, upon, and to all of our assets, whether now owned or hereafter acquired, wherever located.
Covenants and Other Matters
The SWK Loan Facility Agreement that governs the SWK Loan Facility contains a number of covenants that, among other things and subject to certain exceptions, restrict our ability to:
● incur additional indebtedness;
● incur certain liens;
● pay dividends or make other distributions on equity interests;
● redeem, repurchase or refinance subordinated indebtedness;
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● consolidate, merge or sell or otherwise dispose of their assets;
● make investments, loans, advances, guarantees and acquisitions;
● enter into transactions with affiliates;
● amend or modify their governing documents;
● amend or modify certain material agreements; and
● alter the business conducted by them and their subsidiaries.
In addition, the SWK Loan Facility Agreement contains two financial covenants. The first covenant, which is measured quarterly, requires us to achieve a specified Minimum Aggregate Revenue (as defined in the SWK Loan Facility Agreement) for the preceding 12-month period. The second covenant requires us to maintain a minimum liquidity (as defined in the SWK Loan Facility Agreement) of $5.0 million until November 21, 2022 (as amended from the previous compliance date of November 10, 2022, which had been previously amended from the compliance date of October 10, 2022) and thereafter, the greater of (a) $5.0 million and (b) the sum of the operating cash burn (as defined in the SWK Loan Facility Agreement) for the two prior consecutive fiscal quarters then ended (the “Liquidity Covenant”).
The SWK Loan Facility Agreement contains events of default, including, most significantly, a failure to timely pay interest or principal, insolvency, or an action by the FDA or such other material adverse event impacting the operations of Aziyo. As of September 30, 2022, we were in compliance with the financial covenant and all other covenants.
Funding Requirements
We expect to continue to incur significant expenses and operating losses for the foreseeable future as we expand our product development and clinical and research activities and to the extent we grow our sales organization to coincide with product launches. In addition, we expect to continue to incur significant costs and expenses associated with operating as a public company.
As of September 30, 2022, we had $20.0 million of indebtedness outstanding, consisting of $21.0 million outstanding under our SWK Loan Facility (net of $1.0 million of unamortized discount and deferred financing costs). In addition, as further described in Note 7 to the condensed consolidated financial statements included elsewhere in this Quarterly Report, we are party to a royalty agreement with Ligand Pharmaceuticals Incorporated (“Ligand”) pursuant to which we assumed a restructured, long-term obligation to Ligand (the “Revenue Interest Obligation”), that requires us to pay Ligand 5.0% of future sales of the products we acquired from CorMatrix (as well as products substantially similar to those products), subject to annual minimum payments of $2.75 million. Furthermore, a $5.0 million payment will be due to Ligand if cumulative sales of these products exceed $100 million and a second $5.0 million will be due if cumulative sales exceed $300 million during the ten-year term of the agreement which expires on May 31, 2027. We are currently forecasting that the initial $5.0 million milestone payment will become payable in mid-2023.
If our available cash balances and cash flow from operations, if any, are insufficient to satisfy our liquidity requirements, we may seek to raise additional capital through equity offerings, debt financings, or asset sale or licensing transactions. However, such transactions may not be successful and we may not be able to raise additional equity or debt, or sell or license assets on acceptable terms, or at all. We may also consider raising additional capital in the future to expand our business, pursue strategic investments or take advantage of financing opportunities. Our present and future funding requirements will depend on many factors, including, among other things:
● continued patient, physician and market acceptance of our products;
● the scope, rate of progress and cost of our current and future pre-clinical and clinical studies;
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● the cost of our research and development activities and the cost and timing of commercializing new products or technologies;
● the cost and timing of expanding our sales and marketing capabilities;
● the cost of filing and prosecuting patent applications and maintaining, defending and enforcing our patent or other intellectual property rights;
● the cost of defending, in litigation or otherwise, any claims that we infringe, misappropriate or otherwise violate third-party patents or other intellectual property rights;
● the costs of defending against or the damages payable in connection with the FiberCel Litigation and any future litigation that we may be subject to (to the extent above the applicable insurance coverage);
● the cost and timing of additional regulatory approvals;
● costs associated with any product recall that may occur;
● the effect of competing technological and market developments;
● the expenses we incur in manufacturing and selling our products;
● the extent to which we acquire or invest in products, technologies and businesses, although we currently have no commitments or agreements relating to any of these types of transactions;
● the costs of operating as a public company;
● unanticipated general, legal and administrative expenses; and
● the effects on any of the above of the current COVID-19 pandemic or any other pandemic, epidemic or outbreak of infectious disease.
In addition, our operating plans may change as a result of any number of factors, including those set forth above and other factors currently unknown to us, and we may need additional funds sooner than anticipated. To the extent that we raise additional capital through the sale of equity or convertible debt securities, your ownership interest may be materially diluted, and the terms of such securities could include liquidation or other preferences that adversely affect your rights as a common stockholder. Debt financing and preferred equity financing, if available, may involve agreements that include restrictive covenants that limit our ability to take specific actions, such as incurring additional debt, making capital expenditures, creating liens, redeeming shares of our common stock and/or declaring dividends. If we raise funds through collaborations, licensing agreements or other strategic alliances, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates, or grant licenses on terms that may not be favorable to us. If we are unable to raise additional funds through equity or debt financings or other arrangements when needed, we may be required to delay the development or commercialization of our products, license to third parties the rights to commercialize products or technologies that we would otherwise seek to commercialize and reduce marketing, customer support or other resources devoted to our products or cease operations. See our Annual Report, Part I, Item 1A. “Risk Factors — Risks Related to Our Business — Our future capital needs are uncertain and we may need to raise funds in the future, and such funds may not be available on acceptable terms or at all.”
Based on our current operating plans, we believe there is uncertainty as to whether our future cash flows along with our existing cash, availability under the SWK Loan Facility, issuances of additional equity and cash generated from expected future sales will be sufficient to meet our anticipated operating needs through twelve months from the financial statement issuance date. Due to these factors, there is substantial doubt about our ability to continue as going concern within one year after the issuance of the financial statements.
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Critical Accounting Policies and Estimates
The preparation of our unaudited condensed consolidated financial statements in accordance with GAAP requires us to make estimates and assumptions that affect reported amounts and related disclosures. We have discussed the policies and estimates that we believe are critical and require the use of complex judgment in their application in our Annual Report, and, during the nine months ended September 30, 2022, there were no material changes to those previously disclosed, except as noted below. Refer to Note 2, “Summary of Significant Accounting Policies,” to our condensed consolidated financial statements included elsewhere in this Quarterly Report for information regarding our critical accounting estimates and policies.
Contingent Liability for FiberCel Litigation
We believe the determination of our Contingent Liability for FiberCel Litigation is a critical accounting policy. We review every lawsuit and claim and are in contact with outside counsel on an ongoing basis. An accrual is established for each lawsuit and claim, when appropriate, based on the nature of each such lawsuit or claim. The provision for FiberCel Litigation claims are based upon many factors, which vary for each case. These factors include (i) the extent of the injuries incurred, (ii) recent experience on settled claims, (iii) settlement offers made to the other parties to the litigation and (iv) any other factors that may have a material effect on the estimated liability. While we believe our estimated liability to be reasonable, the actual loss amounts are highly variable and turn on a case-by-case analysis of the relevant facts. As such, actual settlement amounts may differ from our estimates and such differences may be material.
Recent Accounting Pronouncements
Refer to Note 3, “Recently Issued Accounting Standards,” to our condensed consolidated financial statements included elsewhere in this Quarterly Report for information regarding recently issued accounting pronouncements.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.