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AXGN > SEC Filings for AXGN > Form 10-K/A on 7-Aug-2013All Recent SEC Filings

Show all filings for AXOGEN, INC.

Form 10-K/A for AXOGEN, INC.


7-Aug-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following information should be read in conjunction with "Selected Financial Data" contained in Item 6 of this Report, our consolidated financial statements and the notes thereto contained in Item 8 of this Report, the "Cautionary Notice Regarding Forward-Looking Statements" contained in Part 1 of this Report, "Risk Factors" contained in Item 1A of this Report, and the other information appearing elsewhere in, or incorporated by reference into, in this Report.

Overview

On September 30, 2011, LecTec completed its business combination with AC in accordance with the terms of the Merger Agreement. Pursuant to the Merger Agreement, Merger Sub merged with and into AC, with AC continuing after the Merger as the surviving corporation and a wholly owned subsidiary of LecTec. Immediately following the Merger, LecTec changed its name to AxoGen, Inc. In October 2011, AxoGen, Inc. moved its corporate headquarter facilities (principal executive office) from Texarkana, Texas to 13859 Progress Blvd., Suite 100, Alachua, Florida 32615.

For accounting purposes, AC was identified as the acquiring entity and LecTec as the acquired entity. The Merger was accounted for using the purchase method of accounting for financial reporting purposes. The purchase method requires the identification of the acquiring entity, based on the criteria of Accounting Standards Codification 805-10-55-12, Accounting for Business Combinations. Under purchase accounting, the assets and liabilities of an acquired company (LecTec) as of the effective date of the acquisition were recorded at their respective estimated fair values and added to those of the acquiring company. Accordingly, the consolidated financial statements and related footnote disclosures presented for periods prior to the Merger are those of AC alone. The consolidated Statement of Operations for the year ended December 31, 2011 and 2010 include the operations and cash flows of AC through September 30, 2011 and the combined operations and cash flows of the Company subsequent to the Merger. The common stock of AC has been retrospectively adjusted to reflect the exchange ratio of one share of AC common stock for 0.03727336 share of the Company's common shares as established in the Merger Agreement. Historical results for LecTec prior to the Merger are not included in the Company's consolidated financial statements.

AxoGen is a leading regenerative medicine company dedicated to advancing the science and commercialization of peripheral nerve repair solutions. Peripheral nerves provide the pathways for both motor and sensory signals throughout the body and their damage can result in the loss of function and feeling. In order to improve surgical reconstruction and regeneration of peripheral nerves, AxoGen has developed and licensed patented and patent pending technologies. AxoGen's innovative approach to regenerative medicine has resulted in first-in-class products that will define their product categories. AxoGen's products offer a full suite of surgical nerve reconstruction solutions including AvanceŽ Nerve Graft, the only commercially available processed nerve allograft for bridging severed nerves without the comorbidities associated with a second surgical site, AxoGuardŽ Nerve Connector, a porcine submucosa ExtraCellular Matrix ("ECM") coaptation aid for tensionless repair of severed nerves, and AxoGuardŽNerve Protector, a porcine submucosa ECM product used to wrap and protect injured peripheral nerves and reinforce coaptation sites while preventing soft tissue attachments.

Revenue from the distribution of these products is the main contributor to AxoGen's total reported sales and has been the key component of its growth to date. AxoGen revenues increased in the fourth quarter and the twelve months of 2012 compared to the fourth quarter and the twelve months of 2011, respectively, as a result of increased usage in the number of accounts utilizing our products. AxoGen has continued to broaden its sales and marketing focus which is expected to have a positive contribution to its revenue growth in the long term, even though in the near term revenue growth may lag behind expense increase.

From May 2009 to December 2010, AxoGen temporarily stopped the manufacturing of AvanceŽ Nerve Graft due to adequate inventory. In December 2010, AxoGen resumed the manufacturing of AvanceŽ Nerve Graft, and as a result incurred higher processing and testing fees, travel costs and temporary labor costs in 2011


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compared to 2012. In 2011 AxoGen reviewed inventory expiration and wrote off inventory for products manufactured in early 2009. Additionally AxoGen reviewed and adjusted inventories and established reserves to adequately reflect inventory value in 2011. AxoGen believes that such actions will not be required in the future and that it has the necessary inventories, inventory reserves and manufacturing capabilities for its anticipated sales growth.

Results of Operations

Critical Accounting Policies and Estimates

The discussion and analysis of the Company's financial condition and results of operations is based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and reported amount of expenses during the period reported. Management bases its estimates and judgments on historical experience, observance of trends in the industry, information provided by outside sources and on various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 3 to the consolidated financial statements contained in Item 8 of this Report. The most significant estimates include allowance for doubtful accounts, valuation of goodwill, effective interest rate on the note payable, and the provision for income taxes.

Effective Interest Rate on Note Payable

The PDL Royalty Contract is accounted for as long-term debt. The Company records interest using its best estimate of the effective interest rate. This estimate takes into account both the internal rate of return (IRR) of the PDL agreement and the rate of return as the result of exercise of the Put option. The IRR of the PDL Royalty Contract is based on the actual payments to date, projected future revenues and required minimum payments, and is calculated at 19.81%. The PDL Royalty Contract Put option provides PDL a 20% return, if exercised. As a result of the return of the Put option being higher than the IRR of the PDL agreement, management believes the best estimate of the effective interest rate on this instrument would be the Put rate. As a result, the Company is accruing interest using the specified internal rate of return for the Put which is 20%. We currently have no knowledge of PDL's intent to exercise the Put, but will monitor this on an ongoing basis. From time to time, the Company will reevaluate the expected cash flows and may adjust the effective interest rate. Since inception of the Royalty Contract, if the interest rate utilized were to change by 1% the effect on interest expense through December 31, 2012 would increase or decrease by approximately $51,000. Determining the effective interest rate requires judgment and is based on significant assumptions related to estimates of the amounts and timing of future revenue streams and PDL's ultimate decision to exercise the Put. Determination of these assumptions is highly subjective and different assumptions could lead to materially different outcomes.

Comparison of the Years Ended December 31, 2012 and 2011

Revenues

Revenues for the year ended December 31, 2012 increased 59% to approximately $7,692,000 as compared to approximately $4,849,000 for the year ended December 31, 2011 principally due to a greater number of customers utilizing AxoGen products.

Gross Profit

Gross profit for the year ended December 31, 2012 increased 136% to approximately $5,730,000 as compared to approximately $2,423,000 for the year ended December 31, 2011. This increase was primarily attributable to the increased revenues and gross margin in 2012 and not incurring inventory write-offs such as that of $614,000 for expiring inventory and $214,000 for raw material obsolescence in 2011 or higher processing and testing fees, travel costs and temporary labor costs due to the resumption of the manufacturing of AvanceŽ Nerve Graft in 2011.

Costs and Expenses

Total cost and expenses increased 44% to approximately $13,532,000 for the year ended December 31, 2012 as compared to approximately $9,392,000 for the year ended December 31, 2011. These increases were primarily due to increasing sales and marketing activities, increases in research and development in preparation for the Company's Investigational New Drug (IND) Application with the FDA and subsequent start of its phase 3 trial and increases in salaries as AxoGen hires to meet growth needs, offset by decreases in certain professional services and financing costs.

As a percentage of revenues, total operating expenses were 175.9% for the year ended December 31, 2012 compared to 193.7% for the year ended December 31, 2011. Such lower total costs and expenses as a percentage of revenue were a result of increased expenses in 2012 being absorbed by increased revenues.


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Sales and marketing expenses increased 57.2% to approximately $6,884,000 for the year ended December 31, 2012 as compared to approximately $4,379,000 for the year ended December 31, 2011. This increase was primarily due to an increase in sales and marketing activity as the Company expands support for both its direct sales force and independent distributors and increasing the number of its direct sales representatives. As a percentage of revenues, sales and marketing expenses were 89.4% for the year ended December 31, 2012 compared to 90.3% for the year ended December 31, 2011. Sales and marketing expenses as a percentage of revenue remaining flat between periods was primarily a result of 2012 revenue increases being offset by increased costs associated with new sales representatives and marketing and educational resources in 2012.

General and administrative expenses increased 21.0% to approximately $5,221,000 for the year ended December 31, 2012 as compared to approximately $4,316,000 for the year ended December 31, 2011. As a percentage of revenues, general and administrative expenses were 67.9% for the year ended December 31, 2012 compared to 89.0% the year ended December 31, 2011. The increase in aggregate dollars spent were a result of hiring and costs related to being a public company, offset by a savings in certain professional fees and finance costs. As a percentage of revenue, general and administrative expenses decreased as the increase in aggregate dollars spent were absorbed by the increase in revenues.

Research and development expenses increased 104.7% to approximately $1,427,000 in the year ended December 31, 2012 as compared to approximately $697,000 for the year ended December 31, 2011. Development includes AxoGen's clinical efforts and a large portion of the increase in research and development expenses from 2011 to 2012 related to expenditures for such clinical activity. Because AxoGen's products are developed for sale in their current use, it conducts limited direct research and product development, but intends to pursue new products and new applications for existing products in the future that may result in increased spending.

Other Income and Expenses

Interest expense increased 27% to approximately $1,391,000 for the year ended December 31, 2012 as compared to approximately $1,095,000 for the year ended December 31, 2011. This increase was a result of the interest expense related to the PDL transaction. As a result of the accounting treatment for the PDL transaction, interest expense included approximately $780,000 of non-cash expense that is expected to be paid in the future based upon the terms of the PDL transaction and increases in AxoGen revenues. The $780,000 of non cash expense was derived from taking the total amount of imputed interest for the year ended December 31, 2012 on the PDL agreement less the actual cash payment made to PDL for that period. Excluding this non-cash component, cash paid for interest decreased in 2012 by approximately $381,000 compared to 2011 as a result of accrued interest on convertible debt and an increased interest rate on borrowed money in 2011 not recurring in 2012.

Interest expense - deferred financing costs decreased 19.3% to approximately $987,000 for the year ended December 31, 2012 as compared to approximately $1,223,000 for the year ended December 31, 2011. This decrease is primarily due to certain deferred financing costs associated with warrants issued as consideration for several amendments executed during 2010 related to the Loan and Security agreement originally entered into in April 2008 becoming fully amortized by March 31, 2011.

Change in fair value of warrant liability decreased 100% to $0 in the year ended December 31, 2012 as compared to approximately $62,000 for the year ended December 31, 2011.

Income Taxes

Income tax benefit of approximately $738,000 for 2012 was the result of the Company's ability to utilize net operating losses and franchise tax adjustments which resulted in tax refunds. The company had no income tax expense or income tax benefit for 2011 due to incurrence of net operating losses. The Company does not believe there are any additional tax refund opportunities currently available.


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Effect of Inflation

Inflation has not had a significant impact on the Company's operations or cash flows.

Liquidity and Capital Resources

Long-Term Debt / Note Payable

On October 5, 2012, AxoGen entered into the Royalty Contract with PDL. Proceeds from the PDL transaction were used to fully repay the MidCap Loan, as defined below, and extinguish AxoGen's long-term debt obligations thereunder. The Royalty Contract has a term of eight years. Under the Royalty Contract, PDL is to receive royalty payments currently paid weekly based on a 9.95% royalty rate of certain of the Company's Net Revenues (the "Assigned Interests"), subject to certain guaranteed quarterly payment amounts of approximately $1.3 to $2.5 million per quarter that commence in the quarter ending December 31, 2014. The minimum annual payment amounts are as follows: 2014 - $1,250,805, 2015 - $6,781,440, 2016 - $9,232,642, 2017 and 2018 - $9,000,000, 2019 - $9,063,000 and 2020 - $6,939,000. The royalty payment is based on only that portion of Company Net Revenue that is generated by the sale, distribution or other use of the Company's products AvanceŽ Nerve Graft, AxoGuardŽ Nerve Protector and AxoGuardŽNerve Connector (the "Acquired Revenues"), which at this time represents all of the Company's Net Revenue with the exception of shipping and handling fees which represent less than 2.3% of total revenues. Future revenue, if any, from other products or services will not be subject to the PDL royalty payment. Further, on October 5, 2016, or in the event of the occurrence of a material adverse event, our transfer of revenue interest or substantially all of our interest in the products or AxoGen's bankruptcy or material breach of the Royalty Contract, PDL may require AxoGen to repurchase the Assigned Interests at the Put Price. The Put Price is equal to the sum of (i) an amount that, when paid to PDL, would generate a 20% internal rate of return to PDL on the Funded Amount, taking into consideration payments made to PDL by AxoGen, and (ii) any Delinquent Assigned Interests Payment AxoGen owed to PDL. Although we have no knowledge of PDL's intent to exercise the Put, based on actual payments to date, projected future revenues and the required minimum payments, we currently believe the Put Rate is the best estimate of the effective interest rate of the Royalty Contract. Finally, in the event of a Change of Control, AxoGen must repurchase the Assigned Interests from PDL for a repurchase price equal to the Change of Control Price on or prior to the third business day after the occurrence of the Change of Control. The Change of Control Price is the sum of
(i) an amount that, when paid to PDL, would generate an internal rate of return to PDL of thirty-two and one half percent (32.5%) on all payments made by PDL pursuant to the Royalty Contract as of the date of the Change of Control Payment, taking into account the amount and timing of all payments made by AxoGen to PDL (and retained by PDL) prior to and as of the date of payment of the Change of Control Payment, plus (ii) any Delinquent Assigned Interests Payment owed. The total consideration PDL paid to the Company was $20,800,000 (the "Funded Amount"), including $19,050,000 PDL paid to the Company on October 5, 2012, and $1,750,000 PDL paid to the Company on August 14, 2012 pursuant to the Interim Royalty Contract. Upon the closing of PDL's purchase of the specified royalties described above, which was concurrent with the execution of the Royalty Contract, the Interim Royalty Contract was terminated. There are no financial covenants or other restrictions on the use of capital by AxoGen as a result of the Royalty Contract, however, PDL has a first perfected security interest in the Assigned Interests.

On September 30, 2011, the Company, entered into the Loan and Security Agreement with MidCap Financial SBIC, LP ("MidCap"), as administrative agent, and the Lenders listed on Schedule 1 thereto (the "MidCap Loan"). The MidCap Loan had a principal amount of $5.0 million and a term of 42 months, and was subject to prepayment penalties. Under this agreement, AxoGen was required to make interest only payments for the first 12 months, and payments of both interest and straight line amortization of principal for the remaining 30 months. The interest rate was 9.9% per annum, and interest was computed on the basis of a 360-day year and the actual number of days elapsed during which such interest accrues.

The MidCap Loan contained customary affirmative and negative covenants, including, without limitation, (i) covenants requiring AxoGen to comply with applicable laws, provide to MidCap copies of AxoGen's financial statements, maintain appropriate levels of insurance and protect, defend and maintain the validity and enforceability of AxoGen's material intellectual property,
(ii) covenants restricting AxoGen's ability to dispose of all or any part of its assets (subject to certain exceptions), engage in other lines of business, changes in its senior management, enter into merger or consolidation transactions, incur or assume additional indebtedness, or incur liens on its assets, and (iii) covenants requiring the Company to meet certain minimum Net Invoiced Revenue, as defined in the agreement, or maintain a cash balance of 80% of the loan principal amount.

The MidCap Loan was secured by all of AxoGen's assets. The Lenders also received a ten-year warrant to purchase 89,686 shares of AxoGen's common stock at $2.23 per share. Proceeds from the PDL transaction were used to fully repay the MidCap Loan and extinguish AxoGen's obligations thereunder.

On April 21, 2008, AxoGen entered into a Loan and Security Agreement with Oxford Finance Corporation and ATEL Ventures, Inc., as subsequently amended (the "2008 Loan and Security Agreement"), which provided for a loan with an aggregate principal amount of $7.5 million. The loan's maturity date was October 1, 2011. The loan boar interest at a rate of 18% per month and was secured by all of AxoGen's assets. On September 30, 2011, AxoGen paid in full the entire outstanding balance of the 2008 Loan and Security Agreement, using the proceeds from the MidCap Loan.

On June 11, 2010, AxoGen entered into Convertible Debt Agreements for an aggregate principal amount of $3.7 million with 8% interest and principal and interest payable in full on June 30, 2013, as amended. The Convertible Debt Agreements were collateralized by a third lien on certain property and were subordinated to the


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2008 Loan and Security Agreement. Immediately prior to the closing of the Merger, the Convertible Debt Agreements pursuant to their terms automatically converted into AC common stock which was then exchanged for Company common stock pursuant to the terms of the Merger Agreement.

On May 3, 2011, AxoGen issued an 8% Convertible Note Payable to LecTec Corporation for $500,000. On May 31, 2011, AxoGen issued additional convertible notes payable under the same terms of which $2,000,000 was issued to LecTec and $500,000 was issued to certain AC shareholders. On August 29, 2011, AxoGen issued an additional subordinated secured convertible promissory note in the principal amount of $2,000,000 to LecTec and $500,000 to certain AC shareholders. These notes were collateralized by all of AxoGen's assets and subordinated to the 2008 Loan and Security Agreement. Immediately prior to the closing of the Merger, the notes held by investors other than LecTec automatically converted into AC's common stock which was then exchanged for LecTec common stock pursuant to the terms of the Merger Agreement. Immediately after to the closing of the Merger, the notes held by LecTec were retired.

The Company had no material commitments for capital expenditures at December 31, 2012 or 2011. Under the Royalty Contract, the Company sold to PDL the Acquired Revenues and PDL is to receive for eight years the Assigned Interests, i.e., a royalty payment based on a 9.95% royalty rate of the Company's Net Revenues, subject to certain agreed upon minimum payments of approximately $1.3 to $2.5 million per quarter, and was provided the Put and receives certain payments in the event of a Change of Control. The total consideration PDL paid to the Company was $20,800,000, including $19,050,000 PDL paid to the Company on October 5, 2012, and $1,750,000 PDL paid to the Company on August 14, 2012, pursuant to the Interim Royalty Contract. Upon the closing of PDL's purchase of the specified royalties under the Royalty contract, which was concurrent with its execution, the Interim Royalty Contract was terminated. Proceeds from the PDL Royalty Contract transaction where used to fully repay the MidCap Loan and extinguish AxoGen's obligations thereunder. There are no financial covenants or other restrictions on the use of capital by AxoGen as a result of the Royalty Contract, however, PDL has a first perfected security interest in the Assigned Interests. In the event that the Company is unable to generate revenue in excess of its PDL Assigned Interests payments and other expenses, or PDL were to exercise the Put at a time when the Company did not have sufficient capital to pay the Put Price, AxoGen would need to raise additional capital. There is no assurance that if AxoGen is required to secure funding it can do so on terms acceptable to it, or at all, and its liquidity would be severely compromised.

Cash Flow Information

On October 5, 2012, AxoGen entered into the Royalty Contract with PDL. Proceeds from the PDL transaction were used to fully repay the MidCap Loan, and extinguish AxoGen's long-term debt obligations thereunder. The Royalty Contract has a term of eight years. Under the Royalty Contract, PDL is to receive royalty payments currently paid weekly based on a 9.95% royalty rate of certain of the Company's Net Revenues (the "Assigned Interests"), subject to certain guaranteed quarterly payment amounts of approximately $1.3 to $2.5 million per quarter that commence in the quarter ending December 31, 2014. The minimum annual payment amounts are as follows: 2014 - $1,250,805, 2015 - $6,781,440, 2016 - $9,232,642, 2017 and 2018 - $9,000,000, 2019 - $9,063,000 and 2020 - $6,939,000. The royalty payment is based on only that portion of Company Net Revenue that is generated by the sale, distribution or other use of the Company's products AvanceŽNerve Graft, AxoGuardŽ Nerve Protector and AxoGuardŽ Nerve Connector (the "Acquired Revenues"), which at this time represents all of the Company's Net Revenue with the exception of shipping and handling fees which represent less than 2.3% of total revenues. Future revenue, if any, from other products or services will not be subject to the PDL royalty payment. Further, on October 5, 2016, or in the event of the occurrence of a material adverse event, our transfer of revenue interest or substantially all of our interest in the products or AxoGen's bankruptcy or material breach of the Royalty Contract, PDL may require AxoGen to repurchase the Assigned Interests at the Put Price. The Put Price is equal to the sum of (i) an amount that, when paid to PDL, would generate a 20% internal rate of return to PDL on the Funded Amount, taking into consideration payments made to PDL by AxoGen, and (ii) any Delinquent Assigned Interests Payment AxoGen owed to PDL. Although we have no knowledge of PDL's intent to exercise the Put, based on actual payments to date, projected future revenues and the required minimum payments, we currently believe the Put Rate is the best estimate of the effective interest rate of the Royalty Contract. Finally, in the event of a Change of Control, AxoGen must repurchase the Assigned Interests from PDL for a repurchase price equal to the Change of Control Price on or prior to the third business day after the occurrence of the Change of Control. The Change of Control Price is the sum of (i) an amount that, when paid to PDL, would generate an internal rate of return to PDL of thirty-two and one half percent (32.5%) on all payments made by PDL pursuant to the Royalty Contract as of the date of the Change of Control Payment, taking into account the amount and timing of all payments made by AxoGen to PDL (and retained by PDL) prior to and as of the date of payment of the Change of Control Payment, plus (ii) any Delinquent Assigned Interests Payment owed. The total consideration PDL paid to the Company was $20,800,000 (the "Funded Amount"), including $19,050,000 PDL paid to the Company on October 5, 2012, and $1,750,000 PDL paid to the Company on August 14, 2012 pursuant to the Interim Royalty Contract. Upon the closing of PDL's purchase of the specified royalties described above, which was concurrent with the execution of the Royalty Contract, the Interim Royalty Contract was terminated. There are no financial covenants or other restrictions on the use of capital by AxoGen as a result of the Royalty Contract, however, PDL has a first perfected security interest in the Assigned Interests.


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The Company currently has sufficient capital to maintain its operations for more than 12 months. If future capital is necessary, the Company may raise additional funds through public or private equity offerings, debt financings or from other sources. The sale of additional equity may result in dilution to AxoGen's shareholders. There is no assurance that, if necessary, AxoGen will be able to secure additional funding on terms acceptable to it, or at all. Should additional capital not become available to AxoGen, if needed, AxoGen may be required to take certain action, such as, slowing sales and marketing expansion, delaying certain regulatory activities or reducing headcount.

AxoGen had working capital of approximately $16.8 million and a current ratio of 12.4 at December 31, 2012, compared to a working capital of $8.8 and a current . . .

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