# ARTIVION, INC. (AORT) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from ARTIVION, INC.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/784199/000078419923000040/aort-20221231.htm
Accession: 0000784199-23-000040
Filing date: 2023-02-23
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/AORT/
All MD&A years: /company/AORT/mda/
Previous year: /company/AORT/mda/fy2021/ (FY 2021)
Next year: /company/AORT/mda/fy2023/ (FY 2023)

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

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this filing. The discussion contains forward-looking statements that involve known and unknown risks and uncertainties, including those set forth under Part I, Item 1A."Risk Factors" of this Form 10-K. The following discussion and analysis do not include certain items related to the year ended December 31, 2020, including year-to-year comparisons between the year ended December 31, 2021 and the year ended December 31, 2020. For a comparison of our results of operations for the fiscal years ended December 31, 2021 and December 31, 2020, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on February 22, 2022.

Overview

Artivion, Inc. (“Artivion,” the “Company,” “we,” or “us”), is a leader in the manufacturing, processing, and distribution of medical devices and implantable human tissues used in cardiac and vascular surgical procedures for patients with aortic disease. We have four major product families: aortic stent grafts, surgical sealants, On-X® mechanical heart valves and related surgical products, and implantable cardiac and vascular human tissues. Aortic stent grafts include aortic arch stent grafts, abdominal stent grafts, and synthetic vascular grafts. Aortic arch stent grafts include our E-vita Open NEO, E-vita Open Plus, AMDS, NEXUS, and E-vita Thoracic 3G products. Abdominal stent grafts include our E-xtra Design Engineering, E-nside, E-tegra, E-ventus BX, and E-liac products. Surgical sealants include BioGlue® Surgical Adhesive (“BioGlue”) products. In addition to these four major product families, we sell or distribute PhotoFix® bovine surgical patches, CardioGenesis® cardiac laser therapy, and PerClot® hemostatic powder (prior to the sale to a subsidiary of Baxter International, Inc. (“Baxter”)).

For the year ended December 31, 2022 we reported annual revenues of $313.8 million, increasing 5% over the prior year. Excluding the effects of foreign exchange, revenues increased 9% over the prior year. The increase in revenues was due to increases in revenues from aortic stent grafts, On-X products, preservation services, and other products, partially offset by a decrease in revenues from surgical sealants. For the year ended December 31, 2022 we reported a net loss of $19.2 million. See the “Results of Operations” section below for additional analysis of the fourth quarter and full year 2022 results. See Part I, Item 1, “Business,” for further discussion of our business and activities during 2022.

Effects of COVID-19

The COVID-19 pandemic continued to impact global economic conditions during 2022 including having an impact on our operations. Our efforts to protect our supply chain and reduce the spread of COVID-19 among our employees, including our work-from-home arrangements, have been successful to date as we have continued to operate all manufacturing sites at full production. These efforts have not materially affected our ability to maintain our business operations, including the operation of financial reporting systems, internal control over financial reporting, or disclosure controls and procedures. Although we have scaled back most of our COVID-19 mitigation efforts, we continue to monitor the impact of the pandemic and the emergence of new variants on our business and recognize that COVID-19 and its effects could continue to negatively impact our business and results of operations during 2023 and beyond.

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The COVID-19 pandemic has also impacted certain aspects of the global supply chain and resulted in supply chain inflation. Although we have yet to experience any material effects on our supply chain or operations, we face an increasing risk that upstream disruptions may occur or worsen. As global economies continue to recover from the COVID-19 downturn, increased opportunities for remote work, and increasing compensation pressure have resulted in competition for talent and an unprecedented number of retirements or career changes. The resulting worker shortages at all levels have impacted supply chains, distribution channels, and employers’ and our own ability to adequately staff operations. These shortages to date, have impacted, and may impact our operations going forward. Hospitals and other healthcare providers have also experienced staffing shortages impacting our business including increased restrictions on elective and non-emergent procedures, restrictions on access to healthcare facilities, cancellation of elective procedures, and the re-allocation of scarce resources.

The extent to which our operations and financial performance will be impacted by the pandemic in 2023 and beyond will depend largely on future developments, including changes in hospital utilization rates and staffing, prevalence and severity of new variants, disruptions to workforce availability, and the impact on the global supply chain. Due to the significant uncertainty related to the pandemic and its impact on macroeconomic conditions, our operations, revenues, financial conditions, profitability, and cash flows may be materially impacted.

See the “Risk Factors” identified in Part I, Item 1A of this form 10-K for risks related to COVID-19.

Critical Accounting Policies

A summary of our significant accounting policies is included in Part II, Item 8, Note 1 of the “Notes to Consolidated Financial Statements.” We believe that the consistent application of these policies enables us to provide users of the financial statements with useful and reliable information about our operating results and financial condition. The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the US, which require us to make estimates and assumptions. The following are accounting policies that we believe are most important to the portrayal of our financial condition and results of operations and may involve a higher degree of judgment and complexity.

Deferred Preservation Costs, net

Deferred preservation costs include costs of cardiac and vascular tissues available for shipment, tissues currently in active processing, and tissues held in quarantine pending release to implantable status. By federal law, human tissues cannot be bought or sold; therefore, the tissues we preserve are not held as inventory. The costs we incur to procure and process cardiac and vascular tissues are instead accumulated and deferred. Deferred preservation costs are stated at the lower of cost or net realizable value on a first-in, first-out basis and are deferred until revenue is recognized. Upon shipment of tissue to an implanting facility, revenue is recognized, and the related deferred preservation costs are expensed as cost of preservation services. Cost of preservation services also includes, as applicable, lower of cost or net realizable value write-downs and impairments for tissues not deemed to be recoverable, and includes, as incurred, idle facility expense, excessive spoilage, extra freight, and re-handling costs.

The calculation of deferred preservation costs involves judgment and complexity and uses the same principles as inventory costing. Donated human tissue is procured from deceased human donors by organ and tissue procurement organizations (“OPOs”) and tissue banks that provide the tissue to us for processing, preservation, and distribution. Deferred preservation costs consist primarily of the procurement fees charged by the OPOs and tissue banks, direct labor and materials (including salary and fringe benefits, laboratory supplies and expenses, and freight-in charges), and indirect costs (including allocations of costs from support departments and facility allocations). Fixed production overhead costs are allocated based on actual tissue processing levels, to the extent that they are within the range of the facility’s normal capacity.

These costs are then allocated among the tissues processed during the period based on cost drivers, such as the number of donors or number of tissues processed. We apply a yield estimate to all tissues in process and in quarantine to estimate the portion of tissues that will ultimately become implantable. We estimate quarantine and in process yields based on our experience and reevaluate these estimates periodically. Actual yields could differ significantly from our estimates, which could result in a change in tissues available for shipment and could increase or decrease the balance of deferred preservation costs. These changes could result in additional cost of preservation services expense or could increase per tissue preservation costs, which would impact gross margins on tissue preservation services in future periods.

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We regularly evaluate our deferred preservation costs to determine if the costs are appropriately recorded at the lower of cost or net realizable value. We also evaluate our deferred preservation costs for costs not deemed to be recoverable, including tissues not expected to ship prior to the expiration date of their packaging. Lower of cost or net realizable value write-downs are recorded if the tissue processing costs incurred exceed the estimated market value of the tissue services, based on recent average service fees at the time of the evaluation. Impairment write-downs are recorded based on the book value of tissues deemed to be impaired. Actual results may differ from these estimates. Write-downs of deferred preservation costs are expensed as cost of preservation services, and these write-downs are permanent impairments that create a new cost basis, which cannot be restored to its previous levels if our estimates change.

Fair Value Measurements

We record certain financial instruments, including cash equivalents, at fair value on a recurring basis. We may make an irrevocable election to measure other financial instruments at fair value on an instrument-by-instrument basis. Fair value financial instruments are recorded in accordance with the fair value measurement framework.

We also measure certain assets and liabilities at fair value on a non-recurring basis. These non-recurring valuations include evaluating assets such as certain financial assets, long-lived assets, and indefinite lived intangible assets for impairment, allocating value to assets in an acquired asset group and applying accounting for business combinations and the initial recognition of liabilities such as contingent consideration. We use the fair value measurement framework to value these assets and liabilities and report these fair values in the periods in which they are recorded or written down.

The fair value measurement framework includes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair values in their broad levels. These levels from highest to lowest priority are as follows:

•Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical assets or liabilities;

•Level 2: Quoted prices in active markets for similar assets or liabilities or observable prices that are based on inputs not quoted in active markets, but corroborated by market data; and

•Level 3: Unobservable inputs or valuation techniques that are used when little or no market data is available.

The determination of fair value and the assessment of a measurement’s placement within the hierarchy requires judgment. Level 3 valuations often involve a higher degree of judgment and complexity. Level 3 valuations may require the use of various cost, market, or income valuation methodologies applied to our unobservable estimates and assumptions. Our assumptions could vary depending on the asset or liability valued and the valuation method used. Such assumptions could include: estimates of prices, earnings, costs, actions of market participants, market factors, or the weighting of various valuation methods. We may also engage external advisors to assist in determining fair value, as appropriate.

Although we believe that the recorded fair value of our financial instruments is appropriate, these fair values may not be indicative of net realizable value or reflective of future fair values.

Deferred Income Taxes

Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and tax return purposes. We assess the recoverability of our deferred tax assets and provide a valuation allowance against our deferred tax assets when, as a result of this analysis, we believe it is more likely than not that some portion or all of our deferred tax assets will not be realized.

Assessing the recoverability of deferred tax assets involves judgment and complexity, including the consideration of prudent and feasible tax planning. Estimates and judgments used in the determination of the need for a valuation allowance and in calculating the amount of a needed valuation allowance include, but are not limited to, the following:

•The ability to carry back deferred tax attributes to a prior tax year;

•Timing of the anticipated reversal of book/tax temporary differences;

•Projected future operating results;

•Anticipated future state tax apportionment;

•Timing and amounts of anticipated future taxable income;

•Evaluation of statutory limits regarding usage of certain tax assets; and

•Evaluation of the statutory periods over which certain tax assets can be utilized.

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Significant changes in the factors above, or other factors, could affect our ability to use our deferred tax assets. Such changes could have a material, adverse impact on our profitability, financial position, and cash flows. We will continue to assess the recoverability of our deferred tax assets, as necessary, when we experience changes that could materially affect our prior determination of the recoverability of our deferred tax assets.

Valuation of Acquired Assets or Businesses

As part of our corporate strategy, we are seeking to identify and capitalize upon acquisition opportunities of complementary product lines and companies. We evaluate and account for acquired patents, licenses, distribution rights, and other tangible or intangible assets as the purchase of an asset or asset group, or as a business combination, as appropriate. The determination of whether the purchase of a group of assets should be accounted for as an asset group or as a business combination requires judgment based on the weight of available evidence.

For the purchase of an asset group, we allocate the cost of the asset group, including transaction costs, to the individual assets purchased based on their relative estimated fair values. In-process research and development acquired as part of an asset group is expensed upon acquisition.

We account for business combinations using the acquisition method. Under this method, the allocation of the purchase price is based on the fair value of the tangible and identifiable intangible assets acquired and the liabilities assumed as of the date of the acquisition. The excess of the purchase price over the estimated fair value of the tangible net assets and identifiable intangible assets is recorded as goodwill. The identifiable intangible assets typically consist of developed technology, customer relationships, and in-process research and development costs. Transaction costs related to a business combination are expensed as incurred. In-process research and development acquired as part of a business combination is accounted for as an indefinite-lived intangible asset until the related research and development project gains regulatory approval or is discontinued.

We typically engage external advisors to assist us in determining the fair value of acquired asset groups or business combinations, using valuation methodologies such as: the excess earnings, the discounted cash flow, Monte Carlo, or the relief from royalty methods. The determination of fair value in accordance with the fair value measurement framework requires significant judgments and estimates, including, but not limited to: timing of product life cycles, estimates of future revenues, estimates of profitability for new or acquired products, cost estimates for new or changed manufacturing processes, estimates of the cost or timing of obtaining regulatory approvals, estimates of the success of competitive products, and discount rates and represent Level 3 measurements. We, in consultation with our advisors, make these estimates based on our prior experiences and industry knowledge. We believe that our estimates are reasonable, but actual results could differ significantly from our estimates. A significant change in our estimates used to value acquired asset groups or business combinations could result in future write-downs of tangible or intangible assets acquired by us and, therefore, could materially impact our financial position and profitability. If the value of the liabilities assumed by us, including contingent liabilities, is determined to be significantly different from the amounts previously recorded in purchase accounting, we may need to record additional expenses or write-downs in future periods, which could materially impact our financial position and profitability.

New Accounting Pronouncements

See Part II, Item 8, Note 1 of “Notes to Consolidated Financial Statements” for further discussion of new accounting standards that have been adopted or are being evaluated for future adoption.

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Results of Operations

Year Ended December 31, 2022 Compared to Year Ended December 31, 2021

(Tables in thousands)

Revenues

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Revenues increased 5% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. The increase in revenues for the twelve months ended December 31, 2022 was due to an increase in revenues from aortic stent grafts, On-X products, preservation services, and other products, partially offset by a decrease in revenues from surgical sealants. Excluding the effects of foreign exchange, revenues increased 9% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. Revenues for the twelve months ended December 31, 2022 and 2021 were negatively impacted in certain regions by delays or cancellations of some surgical procedures as a result of reduced hospital capacity and staffing and hospital restrictions due to the COVID-19 pandemic. The revenue impact from COVID-19 was smaller and varied regionally during the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021.

A detailed discussion of the changes in product revenues and preservation services revenues for the twelve months ended December 31, 2022 is presented below.

Products

Revenues from products increased 4% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. The increase was due to an increase in revenues from aortic stent grafts, On-X products, and other products, partially offset by a decrease in revenues from surgical sealants. A discussion of the changes in product revenues for aortic stent grafts, surgical sealants, On-X, and other product revenues is presented below.

Sales of certain products through our direct sales force and distributors across Europe and various other countries are denominated in a variety of currencies including Euros, British Pounds, Polish Zlotys, Swiss Francs, Brazilian Reals, and Canadian Dollars, with a concentration denominated in Euros. Each currency is subject to exchange rate fluctuations. For the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021, the US Dollar strengthened in comparison to major currencies, resulting in revenue decreases when these foreign currency denominated transactions were translated into US Dollars. Future changes in these exchange rates could have a material, adverse effect on our revenues denominated in these currencies. Additionally, our sales to many distributors around the world are denominated in US Dollars, and although these sales are not directly impacted by currency exchange rates, we believe that some of our distributors may delay or reduce purchases of products in US Dollars depending on the relative price of these goods in their local currencies.

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Aortic Stent Grafts

Aortic stent grafts include aortic arch stent grafts, abdominal stent grafts, synthetic vascular grafts, and original equipment manufacturing (“OEM”) aortic stent graft products. Aortic arch stent grafts include our E-vita Open NEO, E-vita Open Plus, AMDS, NEXUS, and E-vita Thoracic 3G products. Abdominal stent grafts include our E-xtra Design Engineering, E-nside, E-tegra, E-ventus BX, and E-liac products. Aortic stent grafts are used in endovascular and open vascular surgery for the treatment of complex aortic arch, thoracic, and abdominal aortic diseases. Our aortic stent grafts are primarily distributed in international markets.

Aortic stent grafts revenues increased 9% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021.

Aortic stent grafts revenues, excluding OEM, increased 10% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. This increase in revenue was primarily due to an increase in volume of units sold, which increased revenues by 20%, and an increase in average sales prices, which increased revenues by 1%, partially offset by the effect of foreign exchange rates, which decreased revenues by 11%.

On a constant currency basis, revenues for aortic stent grafts, excluding OEM, increased 22% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. The increase in revenues was partially due to improved conditions from the COVID-19 pandemic for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. Revenues for the twelve months ended December 31, 2022 increased primarily in Europe, the Middle East, and Africa (collectively, “EMEA”), Canada, Asia Pacific (“APAC”), and Latin America (“LATAM”). The revenue increase in EMEA for the twelve months ended December 31, 2022 was due to increases in sales direct (to hospitals) and indirect (through distributor) markets. The revenue increase in APAC for the twelve months ended December 31, 2022 was primarily due to an increase in sales of newly launched aortic stent grafts and distributor buying patterns in certain markets. The revenue increase in LATAM for the twelve months ended December 31, 2022 was primarily due to market penetration in certain regions. OEM sales of aortic stent grafts accounted for less than 1% of product revenues for the twelve months ended December 31, 2022 and 2021.

Surgical Sealants

Surgical sealants include BioGlue products used as an adjunct to standard methods of achieving hemostasis (such as sutures and staples) in adult patients in open surgical repair of large vessels (such as aorta, femoral, and carotid arteries).

Revenues from the sales of surgical sealants decreased 8% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. This decrease in revenues was primarily due to a decrease in the volume and a change in the mix of milliliters sold, which decreased revenues by 5%, and the effect of foreign exchange rates, which decreased revenues by 3%.

On a constant currency basis, revenues from the sales of surgical sealants decreased 5% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. The decrease in revenues was primarily due to decreases in revenues in North America and EMEA, partially offset by increases in revenues in APAC and LATAM.

During the twelve months ended December 31, 2021 revenues from the sales of surgical sealants in North America were larger than in the twelve months ended December 31, 2022, primarily due to inventory restocking orders placed during the first half of 2021 as hospitals experienced reduced impact from the COVID-19 pandemic and began resuming more normal operations. Revenues were negatively impacted during the first quarter of 2022 due to delays and cancellations of some surgical procedures due to hospital staffing challenges as a result of a new COVID-19 variant.

During the twelve months ended December 31, 2022 revenues from sales of surgical sealants in EMEA were adversely impacted primarily due to temporary commercialization restrictions resulting from the expiration of our BioGlue CE Mark during our transition to a new Notified Body. We received renewal of our BioGlue CE Mark and completed our Notified Body transition late in the fourth quarter of 2022.

Domestic revenues from surgical sealants accounted for 49% of total surgical sealant revenues for the twelve months ended December 31, 2022 and 51% of total surgical sealant revenues for the twelve months ended December 31, 2021.

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On-X

The On-X catalogue of products includes the On-X prosthetic aortic and mitral heart valves and the On-X ascending aortic prosthesis (“AAP”) for heart valve replacement. On-X product revenues also include revenues from the distribution of CarbonAid® CO2 diffusion catheters and from the sale of Chord-X® ePTFE sutures for mitral chordal replacement. On-X also generates revenue from pyrolytic carbon coating services for OEM customers.

On-X product revenues increased 11% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021.

On-X product revenues, excluding OEM, increased 11% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. This increase in revenues was primarily due to an increase in volume of units sold, which increased revenues by 10%, and an increase in average sales prices, which increased revenues by 3%, partially offset by the effect of foreign exchange rates, which decreased revenues by 2%.

On a constant currency basis, On-X revenues, excluding OEM, increased 13% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. The increase in revenues was primarily due to revenue increases in North America, EMEA, and LATAM. The revenue increases in these markets were partially due to improved conditions from the COVID-19 pandemic for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. The increase in revenues was also impacted by customer buying patterns in North America, an increase of shipments primarily in direct markets in EMEA, and market penetration in certain regions in LATAM. On-X OEM sales accounted for less than 1% of product revenues for the twelve months ended December 31, 2022 and 2021.

Domestic revenues from On-X accounted for 63% of total On-X revenues for the twelve months ended December 31, 2022, and 62% of On-X revenues for the twelve months ended December 31, 2021.

Other

Other revenues are comprised of PhotoFix, PerClot (prior to the Baxter Transaction, described below), and CardioGenesis cardiac laser therapy product revenues.

On July 28, 2021 we entered into an asset purchase agreement and other ancillary agreements related to the sale of PerClot, a polysaccharide hemostatic agent used in surgery, to Baxter, and an agreement to terminate all of our material agreements with Starch Medical, Inc. (“SMI”) related to PerClot (collectively the “Baxter Transaction”).

Other revenues increased 2% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021.

The increase in other revenues for the twelve months ended December 31, 2022 was primarily due to an increase in CardioGenesis cardiac laser therapy product services, partially offset by a decrease in PerClot product revenues. The increase in CardioGenesis cardiac therapy product revenues for the twelve months ended December 31, 2022 was primarily due to our ability to resume limited sales of handpieces during the fourth quarter of 2021, as further described below. The decrease in PerClot product revenues for the twelve months ended December 31, 2022 was due to the Baxter Transaction, described in more detail in Part II, Item 8, Note 2 of "Notes to Consolidated Financial Statements" of this form 10-K.

Revenues from our CardioGenesis cardiac laser therapy product line historically consisted primarily of sales of handpieces and, in certain periods, the sale of laser consoles. During the nine months ended September 30, 2021 we had minimal revenues from the CardioGenesis cardiac laser therapy product line as we did not have a supply of handpieces due to the FDA’s review of our supplier’s change in manufacturing location. After obtaining authorization to resume commercial distribution, our supplier resumed manufacturing a limited supply of handpieces allowing us to resume limited sales during the fourth quarter of 2021. In February 2023 our supplier of handpieces informed us that the sole-source manufacturer of tubing used in the handpiece assembly had gone out of business and, because a new supplier has yet to be identified and qualified, they are exiting the business and will no longer be supplying handpieces effective immediately. We are evaluating the impact of this disruption on our business and possible avenues for resumption of supply including the evaluation of alternate suppliers and handpiece manufacturers. We don’t expect revenues from the CardioGenesis cardiac laser therapy product line after the first quarter of 2023 until we qualify and obtain approval for a new hand piece manufacturing source.

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Preservation Services

Preservation services include service revenues from processing cardiac and vascular tissues. Our cardiac valves are primarily used in cardiac replacement and reconstruction surgeries, including the Ross procedure, for patients with endocarditis or congenital heart defects. Our cardiac tissues are primarily distributed in domestic markets. The majority of our vascular preservation services revenues are related to shipments of saphenous veins, which are mainly used in peripheral vascular reconstruction surgeries to avoid limb amputations. Competition with synthetic product alternatives and the availability of tissues for processing are key factors affecting revenue volume that can fluctuate from quarter to quarter. Our vascular tissues are primarily distributed in domestic markets.

We continue to evaluate modifications to our tissue processing procedures in an effort to improve tissue processing throughput, reduce costs, and maintain quality across our tissue processing business. Preservation services revenues, particularly revenues for certain high-demand cardiac tissues, can vary from quarter to quarter and year to year due to a variety of factors, including quantity and type of incoming tissues, yields of tissue through the preservation process, timing of receipt of donor information, timing of the release of tissues for implant, demand for certain tissue types due to the number and type of procedures being performed, and pressures from competing products or services.

In the fourth quarter of 2020 we became aware that a supplier shipped to us a saline solution lot that we use in our tissue processing that contained some contamination in a small number of bottles of the solution lot. The contamination was identified by our in-process quality controls. The contaminated solution was estimated to have impacted a small percentage of tissue processed with this solution lot, causing us to write-off approximately $826,000 of tissue in the fourth quarter of 2020. An additional $5.0 million of tissue was quarantined in process pending further testing. Upon completion and FDA acceptance of the testing, we began releasing tissue meeting our release criteria late in the second quarter of 2021. We believe that the written-off and quarantined tissue impacted the availability of tissue for distribution, which had a negative impact on revenue in the first quarter of 2021 and, to a lesser extent, the second quarter of 2021.

Revenues from tissue processing increased 8% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. The increase in revenues was primarily due to an increase of tissues shipped, which increased revenues by 5%, and an increase in average sales prices, which increased revenues by 3%.

The increase in revenues from tissue processing for the twelve months ended December 31, 2022 was primarily due to an increase in medical procedures that utilize our cardiac tissues.

Cost of Products and Preservation Services

Cost of Products

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[[/GREPCENT_TABLE]]

Cost of products increased 11% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. Cost of products for the twelve months ended December 31, 2022 and 2021 included costs related to aortic stent grafts, surgical sealants, On-X, and other products.

The increase in cost of products for the twelve months ended December 31, 2022 was primarily due to an increase in shipments of aortic stent grafts and On-X products as well as an increase in the cost of aortic stent grafts and BioGlue as compared to the twelve months ended December 31, 2021.

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Cost of Preservation Services

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[[/GREPCENT_TABLE]]

Cost of preservation services increased 8% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. Cost of preservation services included costs for cardiac and vascular tissue preservation services.

The increase in cost of preservation services for the twelve months ended December 31, 2022 was primarily due to an increase in shipments of cardiac tissue and an increase in the processing cost of cardiac and vascular tissues, partially offset by a decrease in shipments of vascular tissue, as compared to the twelve months ended December 31, 2021.

Gross Margin

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[[/GREPCENT_TABLE]]

Gross margin increased 3% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. The increase for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021 was primarily due to an increase in shipments of aortic stent grafts, On-X products, and preservation services, partially offset by the effect of foreign exchange rates and an increase in cost of certain products. Gross margin as a percentage of total revenues decreased for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021, primarily due to an increase in product costs of certain products sold resulting from inflationary pressures of materials and labor, and to a lesser extent, the mix of products shipped, partially offset by favorable pricing of certain products during the twelve months ended December 31, 2022.

Operating Expenses

General, Administrative, and Marketing Expenses

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[[/GREPCENT_TABLE]]

General, administrative, and marketing expenses decreased 7% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. The decrease in General, administrative, and marketing expenses for the twelve months ended December 31, 2022 was primarily due to a decrease in business development expenses partially offset by personnel-related expenses, travel, and marketing.

General, administrative, and marketing expenses included $7.7 million of business development income for the twelve months ended December 31, 2022, as compared to $16.1 million of business development expense for the twelve months ended December 31, 2021.

Business development income during the twelve months ended December 31, 2022 included a $9.0 million fair value reduction for the contingent consideration related to Ascyrus Acquisition (“Ascyrus contingent consideration”) further described in Part II, Item 8, Note 3 of “Ascyrus Acquisition” of this form 10-K. Business development expenses during the twelve months ended December 31, 2021 included a $4.9 million expense related to the impairment of the Endospan Option further described in Part II, Item 8, Note 4 of “Endospan Agreements” of this form 10-K and $9.7 million expense related to an increase in the fair value of the Ascyrus contingent consideration.

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Research and Development Expenses

[[GREPCENT_TABLE]]
[["","Twelve Months Ended December 31,"],["","2022","","2021"],["Research and development expenses","$","38,879","","","$","35,546"],["Research and development expenses as a percentage of total revenues","12","%","","12","%"]]
[[/GREPCENT_TABLE]]

Research and development expenses increased 9% for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021. Research and development spending for the twelve months ended December 31, 2022 and 2021 was primarily focused on clinical work to gain regulatory approvals for On-X, certain aortic stent grafts, and PerClot products.

On September 23, 2022 we stopped the PROACT Xa clinical trial as recommended by the trial's independent Data and Safety Monitoring Board. The PROACT Xa clinical trial was a prospective, randomized, trial designed to determine if patients with On-X mechanical aortic valves could be maintained safely and effectively on apixaban rather than on warfarin. As a result of PROACT Xa's early termination, we recorded $4.5 million of termination and wind-down expenses that are included in Research and development operating expenses on the Consolidated Statements of Operations and Comprehensive Loss for the twelve months ended December 31, 2022. The majority of these costs include administrative costs that we paid during the fourth quarter of 2022 and anticipate paying during the first quarter of 2023, as well as the estimated cost of clinical drugs purchased for patients participating in the study that are not expected to be recovered.

Research and development expenses for the twelve months ended December 31, 2022 also include $1.9 million related to PerClot pre-launch inventory manufactured as part of the Baxter transaction.

Gain from Sale of Non-Financial Assets

Gain from sale of non-financial assets for the twelve months ended December 31, 2021 consisted of the net $15.9 million gain from the sale of PerClot assets as part of the Baxter Transaction on July 28, 2021.

Interest Expense

Interest expense was $18.2 million and $16.9 million for the twelve months ended December 31, 2022 and 2021, respectively. Interest expense for the twelve months ended December 31, 2022 and 2021 relates to interest on debt and uncertain tax positions.

Other Expense, Net

Other expense, net was $3.1 million and $6.1 million for the twelve months ended December 31, 2022 and 2021, respectively. Other expense, net for the twelve months ended December 31, 2022 primarily includes the realized and unrealized effects of foreign currency gains and losses. Other expense, net for the twelve months ended December 31, 2021 primarily includes realized and unrealized effects of foreign currency gains and losses and fair value adjustments of financial instruments.

Earnings

(Table in thousands, except per share data)

[[GREPCENT_TABLE]]
[["","Twelve Months Ended December 31,"],["","2022","","2021"],["Loss before income taxes","$","(14,984)","","","$","(14,827)"],["Income tax expense","4,208","","","7"],["Net loss","$","(19,192)","","","$","(14,834)"],["Diluted loss per common share","$","(0.48)","","","$","(0.38)"],["Diluted weighted-average common shares outstanding","40,032","","","38,983"]]
[[/GREPCENT_TABLE]]

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We incurred a loss before income taxes for the twelve months ended December 31, 2022 and 2021. The loss before income taxes for the twelve months ended December 31, 2022 was negatively impacted by an increase in certain operating expenses to support revenue expansion, and an increase in investments in the research and development pipeline. The loss before income taxes was partially offset by the change in fair value of the Ascyrus contingent consideration for the twelve months ended December 31, 2022. The loss before income taxes for the twelve months ended December 31, 2021 was primarily due to business development expenses primarily related to the Ascyrus contingent consideration and investments in the research and development pipeline. Revenues for the twelve months ended December 31, 2022 and 2021 were also unfavorably impacted by delays or cancellations of some surgical procedures as a result of reduced hospital capacity and staffing and hospital restrictions due to the COVID-19 pandemic in certain regions. The revenue impact from COVID-19 was smaller and varied regionally during the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021.

Our effective income tax rate was an expense of 28% for the twelve months ended December 31, 2022, as compared to break-even for the twelve months ended December 31, 2021. The change in the tax rate for the twelve months ended December 31, 2022 was primarily due to a decrease in the excess tax benefit related to stock compensation, an increase in the estimated current year valuation allowance, an increase in unfavorable prior year tax return true-ups, and an increase in the benefit related to uncertain tax position statute expirations for the twelve months ended December 31, 2022, as compared to the twelve months ended December 31, 2021.

Our income tax rate for the twelve months ended December 31, 2022 was primarily affected by an increase in the valuation allowance on current year items, nondeductible executive compensation expenses, and uncertain tax position expenses. These tax expenses were partially offset by the research and development tax credit.

Our income tax rate for the twelve months ended December 31, 2021 was primarily affected by an increase in the valuation allowance on current year items, foreign expense items, non-deductible executive compensation expenses, and the recording of a tax reserve on prior year items. These tax expenses were partially offset by the reduction of a valuation allowance on prior year items, the research and development tax credit, and releases of uncertain tax position liabilities.

We experienced a net loss and diluted loss per common share for the twelve months ended December 31, 2022 and 2021. Net loss and diluted loss per common share for the twelve months ended December 31, 2022 was primarily due to an increase in loss before income taxes, as discussed above.

Seasonality

As a result of the uncertainty and other impacts of the COVID-19 pandemic and the resulting shifts of timing in some revenue, our historically observable seasonality of revenues has been impacted or obscured in 2021 and 2022 and potentially beyond.

Historically, we believe the demand for most of our aortic stent grafts is seasonal, with a decline in demand generally occurring in the third quarter due to the summer holiday season in Europe. We are uncertain whether the demand for AMDS and NEXUS products is seasonal, as these products have not fully penetrated many markets and, therefore, the nature of any seasonal trends may not yet be obvious.

Historically, we believe the demand for BioGlue and On-X products is seasonal, with a decline in demand generally occurring in the third quarter followed by stronger demand in the fourth quarter. We believe that this trend may be due to the summer holiday season in Europe and the US.

We do not believe the demand for our other products is seasonal.

Demand for our cardiac preservation services has traditionally been seasonal, with peak demand generally occurring in the third quarter. We believe this trend for cardiac preservation services is primarily due to the high number of surgeries scheduled during the summer months for school-aged patients. Based on experience in recent years, we believe that this trend is lessening as we are distributing a higher percentage of our tissues for use in adult populations.

Demand for our vascular preservation services has also traditionally been seasonal, with lowest demand generally occurring in the fourth quarter. We believe this trend for vascular preservation services is primarily due to fewer vascular surgeries being scheduled during the winter holiday months.

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Liquidity and Capital Resources

Net Working Capital

At December 31, 2022 net working capital (current assets of $247.3 million less current liabilities of $49.7 million) was $197.6 million, with a current ratio (current assets divided by current liabilities) of 5 to 1, as compared to net working capital of $202.7 million and a current ratio of 6 to 1 at December 31, 2021.

Overall Liquidity and Capital Resources

Our primary cash requirements for the twelve months ended December 31, 2022 were for general working capital needs, interest and principal payments under our Credit Agreement (defined below), interest payments under our Convertible Senior Notes (defined below), capital expenditures for facilities and equipment, and repurchases of stock to cover tax withholdings. We funded our cash requirements through our existing cash reserves, proceeds from stock option exercises, and the Baxter Transaction described above.

We believe our cash from operations and existing cash and cash equivalents will enable us to meet our current operational liquidity needs for at least the next twelve months. Our future cash requirements are expected to include interest and principal payments under our Credit Agreement and Convertible Senior Notes (described in “Significant Sources and Uses of Liquidity” section below), expenditures for clinical trials, research and development expenditures, general working capital needs, capital expenditures, and other corporate purposes and may include cash to fund business development activities including obligations in the Endospan and Ascyrus agreements. These items may have a significant effect on our future cash flows during the next twelve months. Subject to the terms of our Credit Agreement, we may seek additional borrowing capacity or financing, pursuant to our current or any future shelf registration statement, for general corporate purposes or to fund other future cash requirements. If we undertake any further significant business development activity, we may need to finance such activities by obtaining additional debt financing or using a registration statement to sell equity securities. There can be no assurance that we will be able to obtain any additional debt or equity financing at the time needed or that such financing will be available on terms that are favorable or acceptable to us.

Significant Sources and Uses of Liquidity

On December 1, 2017 we entered into a credit and guaranty agreement for a $255.0 million senior secured credit facility, consisting of a $225.0 million secured term loan facility (the “Term Loan Facility”) and a $30.0 million secured revolving credit facility (the "Revolving Credit Facility” and, together with the Term Loan Facility, the “Credit Agreement”). We and each of our existing domestic subsidiaries (subject to certain exceptions and exclusions) guarantee the obligations under the Credit Agreement (the “Guarantors”). The Credit Agreement is secured by a security interest in substantially all existing and after-acquired real and personal property (subject to certain exceptions and exclusions) of us and the Guarantors.

On June 2, 2021 we entered into an amendment to our Credit Agreement to extend the maturity dates of both the Company’s Term Loan and its Revolving Credit Facility. As part of the amendment, the maturity dates of both the Company’s Term Loan and its Revolving Credit Facility were each extended by two and one-half years, until June 1, 2027 and June 1, 2025, respectively, subject to earlier springing maturities if our 4.25% Convertible Senior Notes, described below, remain outstanding on April 1, 2025 and December 31, 2024, respectively. With respect to the Term Loan, if the Convertible Senior Notes remain outstanding on April 1, 2025, the Term Loan’s maturity date will be April 1, 2025, or, if the Convertible Senior Notes’ own maturity date has been extended, the earlier of (i) 91 days prior to the Convertible Senior Notes’ new maturity date and (ii) June 1, 2027. In the case of the Revolving Credit Facility, if the Convertible Senior Notes are still outstanding on December 31, 2024, the Revolving Credit Facility’s maturity date will be either December 31, 2024 or, if the Convertible Senior Notes’ own maturity date has been extended, the earlier of (i) 182 days prior to the Convertible Senior Notes’ new maturity date and (ii) June 1, 2025. Under the amendment, the Term Loan Facility bears interest, at our option, at a floating annual rate equal to either the base rate, plus a margin of 2.50%, or LIBOR, plus a margin of 3.50%. Prior to the amendment, the optional floating annual rate was equal to either the base rate plus a margin of 2.25%, or LIBOR, plus a margin of 3.25%.

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On December 19, 2022 in accordance with adopting ASU 2020-04 and 2021-01, we entered into an amendment to our Credit Agreement to replace the LIBOR based benchmark interest rate with the Secured Overnight Financing Rate (“SOFR”) based benchmark interest rate for our Term Loan Facility and our Revolving Credit Facility. Based on historical analysis of the differences between the benchmark rates, SOFR is adjusted to arrive at a Term SOFR rate that serves as the replacement base rate for LIBOR under our amended credit facilities. Under this amendment, at the maturity of our existing LIBOR-based loan on December 30, 2022, the interest rate at the repricing of our Term Loan Facility was calculated as Term SOFR plus a fixed percentage credit spread of 3.50%. The loan under the Revolving Credit Facility bears interest at Term SOFR plus a margin of between 4.00% and 4.25%, depending on our consolidated leverage ratio. As of December 31, 2022 the aggregate interest rate of the Credit Agreement was 8.34% per annum.

On June 18, 2020 we issued $100.0 million aggregate principal amount of 4.25% Convertible Senior Notes with a maturity date of July 1, 2025 (the “Convertible Senior Notes”). The net proceeds from this offering, after deducting initial purchasers’ discounts and costs directly related to this offering, were approximately $96.5 million. On January 1, 2021 we adopted ASU 2020-06 and adjusted the carrying balance of the Convertible Senior Notes to notional. The Convertible Senior Notes balance was $100.0 million recorded in Long-term debt on the Consolidated Balance Sheets as of December 31, 2021. The Convertible Senior Notes may be settled in cash, stock, or a combination thereof, solely at our discretion. The initial conversion rate of the Convertible Senior Notes is 42.6203 shares per $1,000 principal amount, which is equivalent to a conversion price of approximately $23.46 per share, subject to adjustments. We use the if-converted method for assumed conversion of the Convertible Senior Notes for the diluted earnings per share calculation. The fair value and the effective interest rate of the Convertible Senior Notes as of December 31, 2022 was approximately $87.6 million and 5.05%, respectively. The fair value was based on market prices observable for similar instruments and is considered Level 2 in the fair value hierarchy.

The interest expense recognized on the Convertible Senior Notes includes approximately $4.9 million for the aggregate of the contractual coupon interest and the amortization of the debt issuance during the twelve months ended December 31, 2022 and 2021. Interest on the Convertible Senior Notes began accruing upon issuance and is payable semi-annually.

Holders of the Convertible Senior Notes may convert their notes at their option at any time prior to January 1, 2025 but only under the following circumstances: (i) during any calendar quarter commencing after the calendar quarter ending on September 30, 2020 (and only during such calendar quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (ii) during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such trading day; (iii) we give a notice of redemption with respect to any or all of the notes, at any time prior to the close of business on the second scheduled trading day immediately preceding the redemption date; or (iv) upon the occurrence of specified corporate events. On or after January 1, 2025 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their notes at any time, regardless of the foregoing circumstances.

We cannot redeem the Convertible Senior Notes before July 5, 2023. We can redeem them on or after July 5, 2023, in whole or in part, at our option, if the last reported sale price per share of our common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which we provide notice of redemption. We may redeem for cash all or part of the Convertible Senior Notes at a redemption price equal to 100% of the principal amount of the redeemable Convertible Senior Notes, plus accrued and unpaid interest to, but excluding, the redemption date. No principal payments are due on the Convertible Senior Notes prior to maturity. Other than restrictions relating to certain fundamental changes and consolidations, mergers or asset sales and customary anti-dilution adjustments, the Convertible Senior Notes do not contain any financial covenants and do not restrict us from conducting significant restructuring transactions or issuing or repurchasing any of its other securities.

We have benefited from various aspects of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) including a decrease in the amount of interest expense limitation in 2020 and the deferment of a portion of the 2020 employer’s portion of social security tax into 2021 and 2022.

As of December 31, 2022 approximately 40% of our cash and cash equivalents were held in foreign jurisdictions.

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The following table summarizes cash flows from operating activities, investing activities and financing activities for the periods indicated (in thousands):

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2022","","2021"],["Cash flows (used in) provided by:"],["Operating activities","$","(5,153)","","","$","(2,585)"],["Investing activities","(10,715)","","","5,660"],["Financing activities","(1,639)","","","(12,223)"],["Effect of exchange rate changes on cash and cash equivalents","1,848","","","2,200"],["Decrease in cash and cash equivalents","$","(15,659)","","","$","(6,948)"]]
[[/GREPCENT_TABLE]]

Net Cash Flows from Operating Activities

Net cash used in operating activities was $5.2 million and $2.6 million for the twelve months ended December 31, 2022 and 2021, respectively.

We use the indirect method to prepare our cash flow statement, and accordingly, the operating cash flows are based on our net loss, which is then adjusted to remove non-cash items, items classified as investing and financing cash flows, and for changes in operating assets and liabilities from the prior year end. For the twelve months ended December 31, 2022 these non-cash items primarily included $22.4 million in depreciation and amortization expenses, $12.3 million in non-cash compensation, $9.0 million in fair value adjustments of financial instruments, $7.4 million in non-cash lease expense, and $1.7 million of deferred income tax changes.

Our working capital needs, or changes in operating assets and liabilities, also affected cash from operations. For the twelve months ended December 31, 2022 these changes included the unfavorable effect of $13.3 million due to the timing differences between recording receivables and the receipt of cash, $8.4 million due to an increase in inventory balances and deferred preservation costs, $2.2 million due to an increase in prepaid expenses and other assets, and $2.0 million due to the timing differences between the recording of accounts payable and other current liabilities.

Net Cash Flows from Investing Activities

Net cash used in investing activities was $10.7 million for the twelve months ended December 31, 2022, as compared to net cash provided by investing activities of $5.7 million for the twelve months ended December 31, 2021. During the twelve months ended December 31, 2022 cash flows used in investing activities primarily included $9.0 million of cash used for capital expenditures. During the twelve months ended December 31, 2021 cash flows provided by investing activities included $19.0 million of net proceeds from the sale of non-financial assets, partially offset by $13.1 million of cash used for capital expenditures.

Net Cash Flows from Financing Activities

Net cash used in financing activities was $1.6 million and $12.2 million for the twelve months ended December 31, 2022 and 2021, respectively. The current year cash used in financing activities was primarily due to $2.8 million repayment of debt and $1.8 million for repurchases of common stock to cover tax withholdings, partially offset by $3.4 million of proceeds from exercise of stock options and issuances of common stock.

Scheduled Contractual Obligations and Future Payments

Our long-term debt obligations and interest payments include $314.8 million of scheduled principal payments and $89.7 million in anticipated interest payments related to our Credit Agreement, Convertible Senior Notes, and other governmental loans.

We have contingent payment obligations that include up to $100.0 million to be paid to the former shareholders of Ascyrus, upon the achievement of certain milestones. We are obliged to make a $5.0 million third tranche payment under our loan agreement with Endospan upon receipt of certification that certain clinical trial milestones have been achieved. See “Overview” identified in Part II, Item 8, Note 3 of the “Notes to Consolidated Financial Statements” of this Form 10-K.

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As part of the Baxter Transaction, we may be required to pay up to $7.5 million to SMI if certain milestones are met. See “Overview” identified in Part II, Item 8, Note 2 of the “Notes to Consolidated Financial Statements” of this Form 10-K.

Our operating and finance lease obligations result from the lease of land and buildings that comprise our corporate headquarters and our various manufacturing facilities, leases related to additional manufacturing, office, and warehouse space, leases on company vehicles, and leases on a variety of office equipment and other equipment.

Capital Expenditures

Capital expenditures for the twelve months ended December 31, 2022 and 2021 were $9.0 million and $13.1 million, respectively. Capital expenditures in the twelve months ended December 31, 2022 were primarily related to computer software, routine purchases of manufacturing and tissue processing equipment, leasehold improvements needed to support our business, and computer equipment.