Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
MIMEDX is a transformational placental biologics company, developing and distributing placental tissue allografts with patent-protected, proprietary processes for multiple sectors of healthcare. As a pioneer in placental biologics, we are focused on addressing unmet clinical needs in areas of advanced wound care, surgical recovery applications and musculoskeletal conditions. We derive our products from human placental tissues and process these tissues using our proprietary methods, including the PURION® process. We apply CGTP, CGMP, and terminal sterilization to produce our allografts. MIMEDX provides products primarily in the wound care, burn, and surgical recovery sectors of healthcare. All of our products are regulated by the FDA.
MIMEDX is a leading supplier of human placental allografts, which are human tissues that are derived from one person (the donor) and used to produce products that treat another person (the recipient). MIMEDX has supplied over two million allografts, through both direct and consignment shipments. Our platform technologies include tissue allografts derived from the amnion and chorion layers of the human placental membrane (EPIFIX and AMNIOFIX) and tissue allografts derived from human umbilical cord (EPICORD and AMNIOCORD).
EPIFIX and EPICORD products are marketed for external use, such as in advanced wound care applications, while our AMNIOFIX and AMNIOCORD products are positioned for use in surgical recovery applications, including lower extremity repair, plastic surgery, vascular surgery and multiple orthopedic repairs and reconstructions.
AMNIOFIX Injectable, or mdHACM is a micronized configuration of AMNIOFIX and is not currently marketed in the United States. mdHACM is our lead product candidate for our late-stage pipeline targeted at achieving FDA approval for specific clinical indications, including degenerative musculoskeletal conditions.
We have two classes of products: (1) Advanced Wound Care products, or Section 361 products, consisting of our tissue and cord sheet allograft products, and (2) Section 351 products, consisting of our micronized and particulate products, which, prior to May 31, 2021, the date of the FDA’s period of enforcement discretion ended, were used to treat a variety of clinical conditions, including both advanced wound care and musculoskeletal applications. Our Advanced Wound Care business includes two product categories, Tissue/Other and Cord products. We sell product through two distribution channels: (1) direct to customers (healthcare professionals and/or facilities); and (2) sales through distributors.
In November 2017, the FDA published a series of guidances that established an updated framework for the regulation of cellular and tissue-based products. These guidances clarified the FDA’s views about the criteria that differentiate those products subject to regulation under Section 361 of the Public Health Service Act from those considered to be drugs, devices, and/or biological products subject to licensure under Section 351 of the Public Health Service Act and related regulations. The FDA exercised enforcement discretion under limited conditions with respect to IND applications and pre-market approval requirements through May 31, 2021. The enforcement discretion period ended on May 31, 2021. We are not currently marketing our micronized and particulate products affected by the guidance in the United States.
This discussion, which presents our results for the fiscal years ended December 31, 2021 and December 31, 2020, should be read in conjunction with our Consolidated Financial Statements and the accompanying notes. Also please refer to Item 1 — Business and Item 1A — Risk Factors, which include detailed discussions of various items impacting our business, results of operations and financial condition. We intend for this discussion to provide the reader with information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from period to period and the primary factors that accounted for those changes. We also discuss certain performance metrics that management uses to assess the Company's performance. Further information on the factors that can affect our operating results can be found in Part I under the caption “Explanatory Note and Important Cautionary Statement Regarding Forward-Looking Statements.”
Our Annual Report for the year ended December 31, 2020 includes a discussion and analysis of our financial condition and results of operations for the year ended December 31, 2019 in Part II, Item 7, “ Management’s Discussion and Analysis of Financial Condition and Results of Operations .”
Trends in Our Business
Analysis of our Phase 2B Knee Osteoarthritis clinical trial has identified a probable root cause of the failure for this study to meet its primary endpoints. We intend to use these findings to inform planned future clinical trials
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In September 2021, we reported top-line data from the results of two late-stage musculoskeletal clinical trials of the Company’s mdHACM product, including a Phase 2B clinical trial for the treatment of Knee Osteoarthritis. Results from a topline analysis of the six-month efficacy data for the Phase 2B clinical trial for Knee Osteoarthritis revealed that the study did not meet its primary endpoints, but did reveal varied efficacy signals between patient cohorts evaluated pre- and post-blinded interim analysis performed in mid-2019.
A root-cause analysis of the Knee Osteoarthritis study indicated that the varied efficacy signals between the pre-interim analysis and post-interim analysis cohorts was the result of faded potency of the investigational product over time. We intend to incorporate these findings into the design of our Phase 3 program, which we plan to initiate in 2022.
We are expanding beyond advanced wound care and into areas of surgical recovery
Surgical recovery applications focus on the use of tissue products to augment tissue, serve as a barrier membrane, or aid in incisional closure with the goal of preventing or reducing procedural complications. Following a thorough review of surgical procedures and potential clinical applications across several specialties, we have identified those areas where we believe our tissue products could be incorporated. We are targeting certain procedures for use of our products based on unmet clinical need, potential procedural complication rate, clinical relevance, economic factors and overall business priorities. As in advanced wound care, we believe this market is expanding as a result of demographic trends, including an aging population, increasing incidence of obesity and diabetes and the associated higher susceptibility to non-healing chronic wounds.
We are actively pursuing growth strategies by expanding our geographic reach
We are actively pursuing international expansion, with an initial focus in Japan. We received regulatory approval by the Japanese Ministry of Health, Labor and Welfare in June 2021 to market EPIFIX in Japan. We expect to secure reimbursement approval in mid-2022, and are putting in place the necessary structure, medical education programs, and market development initiatives that will operationalize our commercial strategy. We are evaluating opportunities for geographic expansion in the United Kingdom, certain other areas of Europe and also the Middle East.
Impact of COVID-19 Pandemic
While the impact of the COVID-19 pandemic is still ongoing, the effects on our operations, such as access restrictions to hospitals and difficulties obtaining donor materials that we observed during the year ended December 31, 2020 did not materially affect our operations during the year ended December 31, 2021. We are continuously monitoring developments with respect to novel variants of the virus and government and societal responses to mitigate the continued spread of COVID-19, which could impact our operations.
We continue to exercise an abundance of caution with respect to the health and well being of our employees. We are providing employees with Personal Protective Equipment as needed, and advising all employees to receive a COVID-19 vaccine or booster as soon as reasonably possible. None of these efforts have materially affected the Company’s operations for the year ended December 31, 2021.
Components of and Key Factors Influencing Our Results of Operations
In assessing the performance of our business, we consider a variety of performance and financial measures. We believe the items discussed below provide insight into the factors that affect these key measures.
Net sales
Net sales is recognized based on the consideration we expect to receive from the sale. This consists of the gross selling price of the product, less any discounts, rebates, fees paid to GPOs, and returns.
We derive the majority of our revenue from selling our tissue and cord products in the United States. We are actively working to broaden our product portfolio in a number of clinical applications, while also seeking regulatory approval with the appropriate regulators to expand our geographic footprint.
We have two classes of products: (1) Advanced Wound Care products, or Section 361 products, consisting of our tissue and cord sheet allograft products, and (2) Section 351 products, consisting of our micronized and particulate products, which, prior to May 31, 2021, the date the FDA’s period of enforcement discretion ended, were used to treat a variety of patient needs, including both advanced wound care and musculoskeletal applications. Our Advanced Wound Care business includes two product categories, Tissue/Other and Cord products.
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We have two distribution channels: (1) direct to customers and (2) sales through distributors.
Several factors affect our reported revenue in any period, including product, payer and geographic sales mix, operational effectiveness, pricing realization, marketing and promotional efforts, timing of orders and shipments, regulatory actions including healthcare reimbursement scenarios, competition, and business acquisitions that involve our customers or competitors.
Cost of goods sold and gross profit
Cost of goods sold includes product testing costs, quality assurance costs, personnel costs, manufacturing costs, raw materials and product costs, depreciation and facility costs associated with our manufacturing and warehouse facilities. Fluctuations in our cost of goods sold correspond with the fluctuations in these costs as well as in sales units driven by the changes in our sales force and sales territories, product portfolio offerings and the number of facilities that offer our products.
Gross profit is calculated as net sales less cost of goods sold. Our gross profit is affected by product and geographic sales mix, realized pricing of our products, the efficiency of our manufacturing operations and the costs of materials used to make our products. Regulatory actions, including with respect to reimbursement for our products, may require costly expenditures or result in pricing pressure, and may decrease our gross profit and gross margin.
Selling, general and administrative expense
Selling, general and administrative expense includes personnel costs, commissions, incentive compensation, customer support, administrative and labor costs, insurance, professional fees, depreciation and bad debt expense. We expect our selling, general and administrative expense to fluctuate based on revenue fluctuations, geographic changes, and any changes to the size of our headcount, particularly that of our sales and marketing forces.
Research and development expense
Research and development expense relates to our investments in clinical trials to expand our product pipeline and platforms, as well as investments in improvements to our manufacturing process and the enhancement of existing products. Our research and development costs also include expenses such as salaries and benefits related to our research department, consulting costs and advisory costs, and regulatory costs.
We expense research and development costs as incurred. Fluctuations in research and development expenses are potentially driven by the timing and cadence of our clinical trials.
Investigation, restatement and related expense
Investigation, restatement and related expense primarily relates to legal fees advanced to certain former officers and directors of the Company under certain indemnification agreements and the Company’s liability from legal proceedings taken against us, which arose from the findings of the Audit Committee Investigation. The timing and extent of these expenses depend on the stage and status of legal proceedings. Other activity includes amounts received from certain director and officer insurance providers.
Interest expense
We incur interest expense primarily through stated interest on our outstanding term loan. The interest on our term loan is tied to the three-month London Interbank Offered Rate (“ LIBOR ”), subject to a floor of 1.5%. Increases in LIBOR could cause our interest expense to increase. Other activity influencing interest expense relates to the amortization of deferred financing costs and original issue discount associated with credit facilities outstanding.
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Results of Operations for 2021 Compared to 2020
Year Ended December 31,
(in thousands)
2021 2020 $ Change % Change
Net sales $ 258,615 $ 248,234 $ 10,381 4.2 %
Gross profit 215,332 208,904 6,428 3.1 %
Selling, general and administrative 198,359 181,022 17,337 9.6 %
Research and development 17,344 11,715 5,629 48.0 %
Investigation, restatement and related 3,791 59,465 (55,674) (93.6) %
Amortization of intangible assets 820 1,073 (253) (23.6) %
Impairment of intangible assets 53 1,027 (974) (94.8) %
Loss on extinguishment of debt — (8,201) 8,201 —
Interest expense, net (4,980) (7,941) 2,961 (37.3) %
Other expense, net (23) (3) (20) —
Income tax provision (expense) benefit (247) 12,259 (12,506) —
Net loss $ (10,285) $ (49,284) $ 38,999 (79.1) %
Net Sales
We recorded net sales for the year ended December 31, 2021 of $258.6 million, an increase of $10.4 million or 4.2% over 2020 net sales of $248.2 million. Net sales for 2021 and 2020 include collections on the Remaining Contracts of $1.0 million and $7.8 million, respectively. Refer to Item 8, Note 2, “ Significant Accounting Policies ,” of the consolidated financial statements for additional details regarding the Remaining Contracts.
Adjusted Net Sales, which excludes cash collected on the Remaining Contracts, were $257.6 million in 2021, an increase of $17.1 million or 7.1%, compared to $240.5 million in 2020. Adjusted Net Sales in these periods included net sales of Section 351 products of $17.6 million and $31.8 million in 2021 and 2020, respectively. Adjusted Net Sales is a Non-GAAP measure intended to remove cash collections from the Remaining Contracts, which are not a reflection of recurring revenue. We expect that collections on the Remaining Contracts will be negligible in 2022 and beyond. Refer to the section “ Non-GAAP Financial Measures ” below for more information.
Sales of our Advanced Wound Care products, which excludes the Section 351 Products, increased $31.4 million or 15.0%, year-over-year. This increase was primarily the result of an increase in sales volume due to lessening of restrictions implemented at the onset of the COVID-19 pandemic, including access to hospitals and travel restrictions. The increase also reflects the initial results of our commercial focus on areas of surgical recovery. We also saw growth in our EPIFIX sheet portfolio and the positive impact of sales of our EPICORD Expandable product launched in September 2020.
Refer to Item 8, Note 15, “ Revenue ”, for a disaggregation of our sales by product.
Gross Margin
Gross margin in 2021 was 83.3%, compared to 84.2% in 2020. The decrease in gross margin was driven primarily by write-downs of discontinued product recorded during 2021. The write-downs related to our Section 351 Products, which we no longer market in the United States after May 31, 2021, the date the FDA’s period of enforcement discretion ended, and certain Advanced Wound Care product lines which we no longer intend to market. We do not currently anticipate significant write-downs of our inventory to recur in 2022.
Selling, General and Administrative Expense
Selling, general and administrative (“ SG&A ”) expense increased $17.3 million, or 9.6%, to $198.4 million for 2021, compared to $181.0 million for 2020.
The increase in SG&A expense was driven by:
• the restoration of full-salary levels, which were restricted for a portion of 2020 as part of our response to the COVID-19 pandemic, and merit increases;
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• incremental costs associated with the expansion of our sales force;
• higher travel costs during 2021 compared to 2020, as travel was restricted at the onset of the COVID-19 pandemic in 2020;
• a proxy contest during the second quarter of 2021, totaling $3.9 million of expenses; and
• increases in sales commissions, resulting from higher sales volumes.
Research and Development Expense
Our research and development expense increased $5.6 million, or 48.0%, to $17.3 million in 2021, compared to $11.7 million in the prior year.
The increase was driven by higher personnel costs due to headcount increases to support investments in our clinical trials and the restoration of full salary levels and merit increases, which were restricted for a portion of 2020. We also incurred higher consulting fees in 2021, primarily to assist in the evaluation of the results of our clinical trials.
Investigation, Restatement and Related Expense
Investigation, restatement, and related expenses decreased $55.7 million, or 93.6% to $3.8 million for 2021 compared to $59.5 million for 2020. The decrease was the result of:
• lower fees advanced under indemnification agreements with certain former members of management during 2021 compared to 2020;
• recoveries from certain director and officer insurance policies relating to previously-recognized legal expenses in 2021;
• negotiated reductions in previously-recognized legal expenses in 2021; and
• year-over-year reductions in costs related to the restatement of our prior period financial information.
The funds received from insurance providers and reductions in legal expenses were reflected as reductions to expense in the periods in which those transactions occurred.
The restatement of our prior period financial information concluded in 2020 and we will not incur any expenses related to the restatement moving forward.
We remain subject to indemnification agreements with certain former officers and directors of the Company (other than our former Chief Executive Officer and our former Chief Operating Officer) for whom legal proceedings are still ongoing.
Amortization of Intangible Assets
Amortization expense related to intangible assets decreased $0.3 million to $0.8 million in 2021, compared to $1.1 million in 2020. The decrease was the result of intangible assets impaired in 2020.
Impairment of Intangible Assets
Impairment of intangible assets of $0.1 million was recorded in 2021 related to the impairment of a supplier relationship acquired as part of the acquisition of Surgical Biologics, LLC (“ SB ”) in 2011.
Impairment of intangible assets of $1.0 million was recorded in 2020 related to the impairment of customer relationships acquired as part of the SB acquisition.
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Loss on Extinguishment of Debt
Loss on extinguishment of debt of $8.2 million was recorded in 2020 resulting from the repayment and termination of a previous term loan agreement.
Interest Expense, Net
Interest expense, net decreased by $2.9 million to $5.0 million during 2021 from $7.9 million during 2020. The decrease was the result of less principal outstanding, a lower stated interest rate, and lower amortization of deferred financing costs and original issue discount under the Hayfin Loan Agreement, as defined and described in the Liquidity and Capital Resources section below, compared to our previous term loan agreement which was outstanding for the first half of 2020.
Other Expense, Net
Other expense was negligible in both periods.
Income Tax Provision (Expense) Benefit
The effective tax rate for 2021 was (2.5)% on pre-tax book loss of $10.0 million, primarily reflecting a current tax expense associated with state income taxes and adjustment to federal income tax refund receivable.
Liquidity and Capital Resources
We require capital for our operating activities, including costs associated with the sale of product through direct and indirect sales channels, the conduct of clinical trials and other research and development activities, compliance costs, costs to sell and market our products, regulatory fees, and legal and consulting fees in connection with ongoing litigation and other matters. We generally fund our operating capital requirements through our operating activities and cash reserves. We expect to use capital in the near and medium term to commence late-stage clinical trials for certain of our products, invest in the international expansion of our business and the broadening of our product portfolio, and invest in certain capital projects.
As of December 31, 2021, we had $87.1 million of cash and cash equivalents.
Our net working capital at December 31, 2021 was $106.2 million, an increase of $4.7 million from $101.5 million at December 31, 2020. Our current ratio (current assets divided by current liabilities) was 3.5 to 1 as of December 31, 2021 and 2.7 to 1 as of December 31, 2020.
The Company is currently paying its obligations in the ordinary course of business. We believe that our anticipated cash from operating activities and existing cash and cash equivalents will enable us to meet our operational liquidity needs for the twelve months following the filing date of this Annual Report.
We expect to incur additional costs in connection with the commencement of two late-stage clinical trials. This includes development of protocols, site selection, patient recruitment, start-up costs, ongoing monitoring, and the costs advanced to sites for carrying out such trials. These efforts also require human capital, expertise and resources.
Contractual Obligations
Contractual obligations associated with ongoing business activities are expected to result in cash payments in future periods. The table below summarizes the amounts and estimated timing of these future cash payments as of December 31, 2021 (in thousands):
Less than
Contractual Obligations Total 1 year 1-3 years 3-5 years Thereafter
Hayfin Term Loan Principal $ 50,000 $ — $ — $ 50,000 $ —
Hayfin Term Loan Interest 14,632 4,182 8,376 2,074 —
Operating lease obligations 5,886 1,566 3,174 779 367
Finance lease obligations 170 55 110 5 —
Meeting space commitments 701 383 318 — —
Total $ 71,389 $ 6,186 $ 11,978 $ 52,858 $ 367
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We have not declared or paid any cash dividends on our Series B Convertible Preferred Stock since their issuance. Dividends in arrears as of December 31, 2021 were $7.2 million. These were convertible into 27,850,916 shares as of December 31, 2021. Assuming we do not declare or pay a cash dividend, the holders do not exercise their option to convert, and the other conversion or redemption features are not triggered, we would accrue $6.6 million of dividends in 2022, $14.4 million in aggregate in 1-3 years, and $16.3 million in aggregate in 3-5 years. Refer to Item 8, Note 11, “ Equity ” for more detailed discussion regarding the rights and preferences of our Series B Convertible Preferred Stock.
Term Loan
The Hayfin Loan Agreement was funded on July 2, 2020 and provided us with a senior secured term loan in an aggregate amount of $50 million (the “ Term Loan ”). The Term Loan matures on June 30, 2025 (the “ Maturity Date ”). On February 28, 2022 (the “ Amendment Date ”), we executed an Amendment to the Hayfin Loan Agreement (the “ Amendment ”).
No principal payments are due on the Term Loan until the Maturity Date.
Interest is payable on the Term Loan for principal outstanding quarterly through the Maturity Date. The interest rate applicable to any borrowings under the Term Loan is equal to LIBOR (subject to a floor of 1.5%) plus a margin of 6.75%. If LIBOR is unavailable, the loan will carry interest at the greatest of the Prime Rate, the Federal Funds Rate plus 0.5% per annum, and 2.5% plus the Margin.
An additional 3.0% margin would be applied to the interest rate upon the occurrence of an Event of Default as defined in the Hayfin Loan Agreement. At issuance, and as of December 31, 2021, the Term Loan carried an interest rate of 8.3%.
Prior to the Amendment Date, the Hayfin Loan Agreement contained financial covenants requiring the Company, on a consolidated basis, to maintain the following:
• Maximum Total Net Leverage Ratio, required to be calculated on a quarterly basis, of 4.0x; and
• Minimum Liquidity, as defined in the Hayfin Term Loan Agreement, of $10 million, an at-all-times financial coven ant, tested monthly.
We were in compliance with all debt covenants as of December 31, 2021.
The Amendment changed these financial covenants and requires the Company, on a consolidated basis, to maintain the following beginning on the Amendment Date and continuing through the Maturity Date:
• Minimum Consolidated Total Net Sales (as defined in the Amendment) of varying amounts, required to be calculated on a quarterly basis,
• Minimum Liquidity of $20 million, an at-all-times financial covenant, tested monthly.
The Hayfin Loan Agreement, as amended, also specifies that any prepayment of the loan, voluntary or mandatory, as defined in the Hayfin Loan Agreement, will subject us to a prepayment premium applicable as of the date of the prepayment calculated as follows:
• On or before July 2, 2023: 2% of the principal balance repaid.
• After July 2, 2023, but on or before July 2, 2024: 1% of the principal balance repaid.
• After July 2, 2024: no premium.
The Hayfin Loan Agreement also includes certain negative covenants and events of default customary for facilities of this type, and upon the occurrence of such events of default, subject to customary cure rights, all outstanding loans under the Hayfin Loan Agreement may be accelerated or the lender’s commitments terminated. The mandatory prepayments are also required in the event of a change in control, incurring other indebtedness, certain proceeds from disposal of assets and insured casualty event.
From January 1, 2021, we are required to prepay the outstanding loans based on a percentage of Excess Cash Flow, as defined in the Hayfin Loan Agreement, if Excess Cash Flow is generated, with the percentage determined based on the Total Net Leverage thresholds. To date, we have not been required to make any such prepayments.
A breach of a financial covenant in the Hayfin Loan Agreement, if uncured or unable to be cured, would likely result in an event of default that could trigger the lender’s remedies, including acceleration of the entire principal balance of the loan as well
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as any applicable prepayment premiums. Future compliance with the financial covenants, as amended, requires continuing growth in net sales consistent with the Company’s business strategy and plans. Our business is subject to inherent uncertainties that could impact the Company’s net sales growth, including, but not limited to, the regulatory pathway of our cord-derived product.
While we currently have sufficient cash to repay all such amounts in an event of default, we may require alternative financing to cover other obligations. Even if alternative financing were available in an event of default under the Hayfin Loan Agreement, it might be on unfavorable terms, and the interest rate charged on any new borrowings may be substantially higher than the interest rate under the Hayfin Loan Agreement, thus adversely affecting our future cash flows, liquidity, and results of operations.
Series B Preferred Stock
The Company has 100,000 shares of Series B Preferred Stock outstanding as of December 31, 2021.
The Series B Preferred Stock paid a 4.0% cumulative dividend per annum prior to June 30, 2021, and pays a 6.0% cumulative dividend per annum thereafter. Dividends are declared at the sole discretion of our board of directors. Dividends, if declared, are paid in cash at the end of each quarter based on dividend amounts that accumulate beginning on the last payment date through the day prior to the end of each quarter. In lieu of paying a dividend in cash, we may elect to accrue the dividend owed to shareholders. Dividend balances accumulate at the prevailing dividend rate for each dividend period for which they are outstanding.
Each share of Series B Preferred Stock, including any accrued and unpaid dividends, is convertible into our common stock at any time at the option of the holder at a conversion price of $3.85 per common share, or 259.74 common shares for each Series B Preferred Share prior to any accrued and unpaid dividends. The Series B Preferred Stock, including any accrued and unpaid dividends, automatically converts into common stock at any time after July 2, 2023, provided that the common stock has traded at $7.70 or higher (i) for 20 out of 30 consecutive trading days and (ii) on such date of conversion.
If we undergo a change of control, we will have the option to repurchase some or all of the then-outstanding shares of Series B Preferred Stock for cash in an amount equal to the liquidation preference and any accumulated and unpaid dividends, subject to the rights of the holders of the Series B Preferred Stock in connection with such change in control. If we do not exercise such repurchase right, holders of the Series B Preferred Stock will have the option to (1) require us to repurchase any or all of our then-outstanding shares of Series B Preferred Stock for cash in an amount equal to the liquidation preference or (2) convert the Series B Preferred Stock, including accrued and unpaid dividends into common stock and receive its pro rata consideration thereunder.
Liquidity Considerations
Our net sales increased 4% in 2021 compared to 2020. This increase was due primarily to increases in sales volume due to lessening of access restrictions imposed by hospitals and travel restrictions implemented at the onset of the COVID-19 pandemic. However, our sales were negatively impacted by our inability to market our Section 351 products in the United States after May 31, 2021. Sales of our Section 351 products were $17.6 million and $31.8 million in 2021 and 2020, respectively. In addition, there is a possibility that the FDA may rule that our cord-derived products do not meet the requirements to be regulated solely under the authority of Section 361 of the Public Health Service Act, in which case we might need to cease marketing such products in the United States until FDA approval or clearance is secured. Sales of our cord products were $23.6 million and $16.1 million in 2021 and 2020, respectively.
See Item 1A - Risk Factors - “ Certain of our products no longer qualify for regulation as human cells, tissues and cellular and tissue-based products solely under Section 361 of the Public Health Service Act (“Section 361”), which has resulted in removal of the applicable products from the market, made the introduction of some new tissue products more expensive, significantly delayed the expansion of our tissue product offerings and subjected us to additional post-market regulatory requirements. Additional regulatory requirements may be imposed in the future. ”
Further, our liquidity will be impacted by expected and unexpected costs, investments in clinical trials to support BLAs, and contingent liabilities:
• Advancement of our clinical trials and BLA pipeline will involve substantial cost. Products subject to the FDA’s BLA requirements must comply with a range of pre- and post-market provisions. Pre-market compliance includes the conduct of clinical trials in support of BLA approval, the development and submission of a BLA, and the production of product for use in the clinical trials that meets the FDA’s quality expectations. See Item 1A - Risk Factors - “Obtaining and maintaining the necessary regulatory approvals for certain of our products will be expensive and time
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consuming and may impede our ability to fully exploit our technologies,” and “If any of the BLAs are approved, the Company would be subject to additional regulation which will increase costs and could result in adverse sanctions for non-compliance.”
• The international expansion of our business will require investment through the costs to achieve necessary regulatory approvals and reimbursement schemes, establishing a physical presence through office and warehouse space, identifying and hiring employees, and other costs to establish ongoing operations. Whether we pursue such opportunities will depend on a myriad of factors and the amount and timing of these costs are uncertain at this time.
• We are exposed to potential liabilities and reputational risk associated with litigation, regulatory proceedings, and government enforcement actions. The amounts, if any, for which we may be liable resulting from such proceedings are highly uncertain. See Item 3, “ Legal Proceedings ” and Item 8, Note 14, “Commitments and Contingencies ” and Item 1A, “ Risk Factors ” - “We are currently, and may in the future be, subject to substantial litigation and ongoing investigations that could cause us to incur significant legal expenses and result in harm to our business.
• The application of CGMP requires investment in our manufacturing establishments for production for our micronized products. The transition process includes development and enhancement of production processes, procedures, test and assays, and it requires extensive validation work. It can also involve the procurement and installation of new production or lab equipment. These efforts require human capital, expertise and resources. See Item 1A. – “ Risk Factors ” under the heading “ Certain of our products no longer qualify for regulation as human cells, tissues and cellular and tissue-based products solely under Section 361 of the Public Health Service Act (“Section 361”), which has resulted in removal of the applicable products from the market, made the introduction of some new tissue products more expensive, significantly delayed the expansion of our tissue product offerings and subjected us to additional post-market regulatory requirements. Additional regulatory requirements may be imposed in the future.”
Moreover, the COVID-19 pandemic may affect our operations in 2022 and beyond. More specifically:
• Our results of operations may be adversely affected if our customers restrict access to hospitals and our ability to access other healthcare providers, particularly for elective procedures.
• Our manufacturing operations, sales and demand for our products, and clinical trials may be adversely affected if our leadership, employees, sales agents, suppliers, medical professionals, or users of our products are impacted by illness or through actions taken to stop or slow the spread of the COVID-19 pandemic.
• Our results of operations may be adversely affected if we experience shortages of donated placentas because donors or our recovery specialists are excluded from hospitals, or because additional testing protocols are implemented for donated tissues based on guidance issued by the AATB, FDA, or other standards and are screened as ineligible.
• Because our sales are not evenly spread across the United States, to the extent that areas most impacted by COVID- are those where we have more of our sales, the pandemic will have a greater adverse impact on our results from operations.
• While vaccines have been approved by the FDA, the continued efficacy of the vaccine against current and future variants, as well as the general willingness to accept the vaccine and any recommended “boosters”, could influence the magnitude of the impact of the COVID-19 pandemic and any of the factors noted above.
The ultimate impact of the COVID-19 pandemic is highly uncertain. The duration and magnitude of these impacts on our business is uncertain.
Expectations for 2022 Operating Results
We expect net sales of our Advanced Wound Care products, which were $240 million in 2021, to grow 11% to 14% in 2022. We expect gross margin for 2022 to be slightly lower than 2021. We anticipate beginning the Phase 3 Knee Osteoarthritis clinical trial program in 2022, and expect the cost to be approximately $30 million, representing $15 million per trial for two trials incurred over the next three years. We expect research and development expense to increase over 2021 as we plan and begin to execute new clinical trials and execute other product development initiatives. However, the amount and timing of these expenses are dependent on many factors.
Discussion of Cash Flows
Operating Activities
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During the year ended December 31, 2021, net cash used in operating activities decreased $28.3 million to $2.0 million compared to $30.3 million for the year ended December 31, 2020. The decrease in cash used was primarily attributable to year-over-year reductions in amounts paid related to the Audit Committee Investigation, the Restatement, and related expenses, particularly those incurred with respect to the Restatement and the indemnification of certain former officers and directors of the Company. In addition, we received $9.2 million in income tax refunds during 2021. These effects were offset by year-over-year increases in SG&A and research and development expense.
Investing Activities
During the year ended December 31, 2021, net cash used in investing activities was $3.4 million, a decrease of $1.2 million, compared to $4.6 million for the year ended December 31, 2020. The primary reason for the decrease was a $1.0 million decrease in capital expenditures, year-over-year. The remaining variance was the result of a year-over-year decrease in paid for patent application costs as well as collections on a note receivable in 2021.
Financing Activities
During the year ended December 31, 2021, net cash used in financing activities was approximately $3.4 million compared to cash provided from financing activities of $61.6 million for the year ended December 31, 2020. Activity in 2020 was driven by the issuance of our Series B Convertible Preferred Stock, for which we received proceeds of $92.5 million, net of stock issuance costs. In addition, we received net proceeds on the borrowing of our Term Loan of $46.3 million, net of deferred financing costs and original issue discount. These proceeds were used to repay the outstanding principal and prepayment premium on a previous term loan of $73.4 million. We did not have a similar financing transaction in 2021.
The remaining variance was driven by year-over-year increases in the cash paid for shares repurchased for tax withholding ($2.4 million), offset by increases in proceeds from option exercises ($1.0 million).
Non-GAAP Financial Measures
In addition to our GAAP results, we provide the following Non-GAAP measures: Adjusted Net Sales, Earnings Before Interest, Taxes, Depreciation and Amortization (“ EBITDA ”), and Adjusted EBITDA. We believe that the presentation of these measures provides important supplemental information to management and investors regarding our performance. These measurements are not, and should not be used as, a substitute for GAAP measures. Company management uses these Non-GAAP measures as aids in monitoring our on-going financial performance from quarter-to-quarter and year-to-year on a regular basis and for benchmarking against comparable companies.
Adjusted Net Sales
We provide Adjusted Net Sales to provide a normalized view of revenue by removing effects related to our Transition Adjustment in revenue recognition practices. Specifically, we recognized a one-time Transition Adjustment in 2019 to reflect the change in our pattern of revenue recognition from a “cash receipts” to an “as-shipped” basis. Since the third quarter of 2019, we have recognized revenue from cash collections related to the Remaining Contracts, or transactions which occurred prior to the Transition but for which we had not previously recognized revenue. Refer to Item 8, Note 2, “ Significant Accounting Policies, ” of the consolidated financial statements for additional details regarding the Transition Adjustment and the Remaining Contracts.
Adjusted Net Sales provides comparative assessments of our revenue and assists in evaluating our sales performance. Adjusted Net Sales consists of GAAP net sales less the effects of the Transition. For 2019, this includes the Transition Adjustment and cash received from the Remaining Contracts. For 2020 and 2021, this reflects cash received from the Remaining Contracts. A reconciliation of GAAP net sales to Adjusted Net Sales is provided in the table below (in thousands):
Year Ended December 31,
2021 2020 2019
Net sales $ 258,615 $ 248,234 $ 299,255
Effect of change in revenue recognition (1,038) (7,767) (29,604)
Adjusted net sales $ 257,577 $ 240,467 $ 269,651
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EBITDA and Adjusted EBITDA
We provide EBITDA and Adjusted EBITDA to facilitate comparisons to results of other companies. We use EBITDA as a measure of our operating performance, planning, and budgeting purposes as it eliminates the effects of financing and investing activities. EBITDA is widely used by investors and analysts to measure operating performance and evaluate enterprise value.
EBITDA consists of GAAP net loss excluding: (i) depreciation, (ii) amortization of intangibles, (iii) interest expense, net, (iv) loss on extinguishment of debt, and (v) income tax provision.
Adjusted EBITDA is intended to provide an enduring, normalized view of EBITDA and our broader business operations that we expect to experience on an ongoing basis by removing from EBITDA certain items which may be irregular, non-recurring, or non-cash items not excluded when calculating EBITDA. This enables us to identify underlying trends in our business that could otherwise be masked by such items.
Adjusted EBITDA consists of GAAP net loss excluding: (i) depreciation, (ii) amortization of intangibles, (iii) interest expense, net, (iv) loss on extinguishment of debt, (v) income tax provision, (vi) costs incurred in connection with Audit Committee Investigation and Restatement, (vii) the effect of the change in revenue recognition on net income, (viii) share-based compensation, and (ix) impairment of intangible assets.
A reconciliation of GAAP net loss to EBITDA and Adjusted EBITDA appears in the table below (in thousands):
Year Ended December 31,
2021 2020 2019
Net loss $ (10,285) $ (49,284) $ (25,580)
Non-GAAP Adjustments:
Depreciation expense 4,363 5,782 6,546
Amortization of intangible assets 820 1,073 1,039
Interest expense, net 4,980 7,941 4,708
Loss on extinguishment of debt — 8,201 —
Income tax provision expense (benefit) 247 (12,259) (5)
EBITDA $ 125 $ (38,546) $ (13,292)
Additional Non-GAAP Adjustments:
Costs incurred in connection with Audit Committee Investigation and Restatement 3,791 59,465 66,504
Effect of change in revenue recognition (864) (6,680) (24,450)
Share-based compensation 14,757 15,357 12,064
Impairment of intangible assets 53 1,027 1,258
Adjusted EBITDA $ 17,862 $ 30,623 $ 42,084
Critical Accounting Estimates
This Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“ GAAP ”). The preparation of these financial statements requires that we make judgments and estimates which may affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We derive these judgments and estimates on historical experience and other relevant factors which we believe to be reasonable. Actual results may differ from these estimates.
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Net Sales
Description
We record estimates for returns and allowances as a reduction to net sales based on our expectation for such returns.
Judgments and Uncertainties
We sell our products to individual customer and independent distributors (collectively referred to as “ customers ”). Customers obtain and use products either through ship and bill sales or consignment arrangements. We recognize revenue as performance obligations are fulfilled, which generally occurs upon the shipment of product to customers for ship and bill sales or upon implantation for consignment sales. We recognize revenue based on consideration we expect to receive from the sale. This consists of the gross selling price of the product, less any discounts, rebates, fees paid to GPOs, and an expectation for sales returns.
We maintain a return policy that allows our customers to return product for any reason within 30 days of sale, and to return product that is damaged or non-conforming, ordered in error, or due to recall at any time.
We derive an expectation for product returns based on historical return patterns and other factors, including shifts in our regulatory environment and product recalls. Determinations involving other factors are based on our estimates for product at customer sites that are eligible for return.
Additions or reversals to our return allowance, as determined necessary, are accounted for prospectively and recorded as a decrease or increase to net sales, respectively. Actual returns are recorded against the recorded accrual.
Sensitivity of Estimate to Change
We have accrued $0.8 million for sales returns as of December 31, 2021. Changes in return patterns or unforeseen changes in regulations or identified product recalls could cause returns significantly in excess of this estimate.
Contingencies
Description
We record contingent liabilities related to legal and other proceedings at such point in time when loss is probable and reasonably estimable.
Judgments and Uncertainties
We evaluate the probability of loss and the range of potential losses based on salient details about a case. These evaluations consider evidence derived from discussions with counsel and include the merits and jurisdiction of the proceeding, the nature and the number of other similar current and past proceedings, damages sought by the counterparty, settlement offers we have extended to the counterparty and other factors. From this information, we make a judgmental determination of whether loss from a case is probable and whether a reasonable estimate of loss can be derived. In situations where a reasonable estimate is a range of estimates, we record the most likely amount in the range or, if no single amount is more likely than any of the others, we record the minimum amount of the range.
Sensitivity of Estimate to Change
We have accrued $1.0 million as of December 31, 2021 for potential losses relating to legal proceedings discussed in Item 8, Note 14, “Commitments and Contingencies.” The outcome of court judgments could lead to a change in our evaluation of probability of loss or our estimate for such loss. In addition, court judgments may result from matters for which we had previously assessed loss as being not probable or which result in losses which materially depart from our estimate, both favorably or unfavorably.
We believe that our estimates applied are based on reasonable assumptions, but are inherently uncertain. Actual results may differ from the assumptions and judgments used to derive our accrual.
Income Taxes
Description
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We record a valuation allowance to offset our net deferred tax asset to the extent that realization is not likely.
Judgments and Uncertainties
Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. Transactions which result in lower taxable income in the future give rise to deferred tax assets.
We evaluate our ability to recover deferred tax assets based on projected future taxable income, scheduled reversals of deferred tax liabilities, tax planning strategies, and our recent operating results. Judgment is required to determine whether the totality of this evidence suggests that we can recover our deferred tax assets in the future.
Sensitivity of Estimate to Change
As of December 31, 2021, we had valuation allowances recorded of $41.1 million, fully offsetting our net deferred tax asset. This determination may change due to changes in tax law, a revision to our expectation regarding taxable income in the future, taxable income generated in a period in which we had not previously anticipated taxable income, a change in scheduled reversals of deferred tax liabilities, and other changes.
Historically, exclusive of changes in tax law such as that enacted under the Coronavirus Aid, Relief and Economic Security Act, we have not reversed our valuation allowance.
If the weight of available evidence suggests that some or all of this amount is more likely than not to be realized, we will derecognize the valuation allowance as an income tax benefit to the extent that the underlying deferred tax asset is more likely than not to be realized.
Recently Adopted Accounting Pronouncements
See Note 2, “ Significant Accounting Policies ,” in the Consolidated Financial Statements for recently adopted accounting pronouncements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Based on our lack of market risk sensitive instruments outstanding at December 31, 2021, we have determined that we had no material market risk exposure as of such date.
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