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BAXS > SEC Filings for BAXS > Form 10-Q on 14-Aug-2013All Recent SEC Filings

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Form 10-Q for BAXANO SURGICAL, INC.


14-Aug-2013

Quarterly Report


Item 2. 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 to our consolidated financial statements included in this report. In addition to historical financial information, this report contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, that concern matters that involve risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. These forward-looking statements are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact contained in this report, including statements regarding future events, our future financial performance, our future business strategy and the plans and objectives of management for future operations, are forward-looking statements. We have attempted to identify forward-looking statements by terminology including "anticipates," "believes," "can," "continue," "could," "estimates," "expects," "intends," "may," "plans," "potential," "predicts," "should" or "will" or the negative of these terms or other comparable terminology. Although we do not make forward-looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Readers are urged to carefully review and consider the various disclosures made by us, which attempt to advise interested parties of the risks, uncertainties, and other factors that affect our business, operating results, financial condition and stock price, including without limitation the disclosures made under the captions "Management's Discussion and Analysis of Financial Condition and Results of Operations", "Risk Factors", "Financial Statements" and "Notes to Consolidated Financial Statements" in this report, as well as the disclosures made under the captions "Management's Discussion and Analysis of Financial Condition and Results of Operations", "Risk Factors", "Consolidated Financial Statements" and "Notes to Consolidated Financial Statements" included in our Annual Report on Form 10-K for the year ended December 31, 2012, and in other filings we make with the Securities and Exchange Commission, or the SEC. Furthermore, such forward-looking statements speak only as of the date of this report. We expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations except as required by applicable law or the rules of The NASDAQ Stock Market LLC. References in this report to "Baxano Surgical", "we", "our", "us", or the "Company" refer to Baxano Surgical, Inc.

Overview

We are a medical device company focused on marketing, designing and developing minimally invasive products to treat degenerative conditions of the spine affecting the lumbar region. We are committed to delivering minimally invasive surgical technologies that enhance patient clinical care while providing sustained value for our customers. We currently market the AxiaLIF® family of products for single and two level lower lumbar fusion, the VEOTM lateral access and interbody fusion system and the iO-Flex® system, a proprietary set of flexible instruments used by surgeons during spinal decompression procedures. Our AxiaLIF products use our pre-sacral approach, through which a surgeon can access discs in the lumbar region of the spine through an incision adjacent to the tailbone and perform an interbody fusion procedure through instrumentation that provides direct access to the intervertebral space. We developed our pre-sacral approach to allow spine surgeons to access and treat intervertebral spaces without compromising important surrounding soft tissue, nerves and bone structures. Our VEO lateral access and interbody fusion system provides for direct visualization of the psoas muscle and unrestricted lateral fluoroscopic views, which we believe has allowed us to increase our market share in the highly competitive lateral fusion segment. We believe that direct visualization allows a surgeon to have improved visibility of the psoas and the nerves running through this muscle that, when used in conjunction with neuromonitoring, can potentially reduce complications. We also market other products that complement these primary offerings, including pedicle screws, facet screws, bowel retractors, discectomy tools, bone void filler and a bone graft harvesting system that can be used to extract bone graft. Our philosophy of continuous improvement is driven by ongoing research and development investment in our core technologies. We support this investment by diligently expanding, maintaining, and protecting our significant patent portfolio.

On May 31, 2013, we changed our name from TranS1 Inc. to Baxano Surgical, Inc. and completed the acquisition of Baxano, Inc. ("Baxano"), a medical device company headquartered in San Jose, California.

From our incorporation in 2000 through 2004, we devoted substantially all of our resources to research and development and start-up activities, consisting primarily of product design and development, clinical trials, manufacturing, recruiting qualified personnel and raising capital. We received 510(k) clearance from the U.S. Food and Drug Administration, or FDA, for our AxiaLIF Legacy product in the fourth quarter of 2004, and commercially introduced our AxiaLIF Legacy product in the United States in the first quarter of 2005. We received a CE mark to market our AxiaLIF Legacy product in the European market in the first quarter of 2005 and began commercialization in the first quarter of 2006. We received a CE mark for our AxiaLIF 2L product in the third quarter of 2006 and began commercialization in the European market in the fourth quarter of 2006. We received FDA 510(k) clearance for our AxiaLIF 2L product and began marketing this product in the United States in the second quarter of 2008. The AxiaLIF 2L product was discontinued in 2010 after we launched our AxiaLIF Plus 2-Level™ product in July 2010, for which we had received FDA 510(k) clearance in January 2010. We commercially launched the Vectre™ facet screw system in April 2010. In the first quarter of 2010, we completed product and regulatory training and began marketing Bi-Ostetic™ bone void filler, a biologics product for specific indications outside the interbody space of the spine. We commercially launched our AxiaLIF Plus 1-Level product in September 2011, for which we had received FDA 510(k) clearance in March 2011. In 2010, we received 510(k) clearance for our VEO lateral access and interbody fusion system, which was commercially launched in November 2011, and in July 2012 we received a CE mark for our VEO lateral access and interbody fusion system and began commercialization in the European market. The iO-Flex System was commercialized in the United States in 2009 for decompression applications and received a CE Mark in February 2012. The iO-Tome product received FDA clearance in July 2012 and is currently in a limited market release. We currently sell our products through a direct sales force, independent sales agents and international distributors.

In March 2012, we announced that the Current Procedural Terminology ("CPT") Editorial Panel, or the Panel, voted to approve an application for a new Category I CPT code, 22586, for L5/S1 spinal fusion utilizing our AxiaLIF implant when performing a pre-sacral interbody fusion. In addition, the Panel voted to establish a new Category III CPT code, 0309T, as an add-on code to the new Category I code for use with 22586 when performing L4/5 spinal fusion. The new CPT codes were announced on the American Medical Association's website on March 2, 2012, and became effective on January 1, 2013. The Medicare final rule was released in November 2012, which stated a valuation of the Category I CPT code 22586 for pre-sacral interbody single level spinal fusion at L5-S1, and became effective January 1, 2013. This CPT code, which applies to our AxiaLIF Plus 1-Level device, is a bundled lumbar arthrodesis procedure that includes bone graft, posterior instrumentation and fixation. With the establishment of a Category I CPT code effective January 1, 2013, we believe that we are in a position to transition to a period of sustainable revenue growth.

We rely on third parties to manufacture virtually all of our AxiaLIF, VEO, Vectre and Bi-Ostetic products and their components. The majority of our iO-Flex and iO-Tome product manufacturing, including subassemblies, final assemblies, packaging, and product release, is performed at our San Jose facility. Our outsourcing partners are manufacturers that meet FDA, International Organization for Standardization or other internal quality standards, where applicable.

On May 31, 2013, we, through our wholly-owned subsidiary Racer X Acquisition Corp., or the Merger Sub, consummated our acquisition of Baxano pursuant to an Agreement and Plan of Merger, or the Merger Agreement. Under the terms of the Merger Agreement, Merger Sub merged with and into Baxano, with Baxano remaining as the surviving corporation and as a wholly-owned subsidiary of the Company, or the Merger. Immediately following the closing of the Merger on May 31, 2013, we changed our name to Baxano Surgical, Inc. in connection with the merger of this wholly-owned subsidiary with and into the Company.

Upon the closing of the Merger, and in accordance with the terms of the Merger Agreement, we issued an aggregate of 10,329,035 shares of our common stock as merger consideration. In connection with the closing of the Merger, 796,772 shares of our common stock (equal to approximately 7.5% of the total merger consideration) were deposited in a third-party escrow account to secure certain indemnification obligations of the Baxano securityholders and to fund any post-closing adjustment payable to us based on excess indebtedness or unpaid transaction expenses of Baxano, or to the extent Baxano's actual working capital at March 31, 2013 is less than target working capital of $2,121,000. Once the amount of any post-closing adjustment is determined and paid, remaining escrow shares, if any, in excess of 5% of the merger consideration will be distributed to the Baxano securityholders. The remainder of the escrow shares will be distributed to the Baxano securityholders promptly following the first anniversary of the closing date to the extent such escrow shares are not then subject to indemnification claims by us.

Concurrent with the closing of the Merger, and in accordance with the terms of a Securities Purchase Agreement, dated March 3, 2013, or the Securities Purchase Agreement, we issued and sold to certain investors 7,522,009 shares of our common stock, at a purchase price of $2.28 per share, resulting in gross proceeds to us of approximately $17.2 million.

As of June 30, 2013, we have incurred $2.1 million of merger related expenses and $0.8 million of integration expenses.

Since inception, we have been unprofitable. As of June 30, 2013 we had an accumulated deficit of $154.4 million.

We expect to continue to invest in sales and marketing infrastructure for our products in order to gain wider acceptance for them. We also expect to continue to invest in research and development and related clinical trials, and increase general and administrative expenses as we grow. As a result, we will need to generate significant revenue in order to achieve profitability.

Results of Operations



Our results of operations include the acquired Baxano operations from the Merger
date, May 31, 2013, forward.



                                 Three Months Ended June 30,                 Six Months Ended June 30,
                                                             %                                         %
                              2013           2012         change         2013          2012         change
                                            (in thousands, except gross margin percentage)
Revenue                    $    3,877      $   3,460          12.1 %   $   6,977     $   7,243          -3.7 %
Cost of revenue                 1,295            912          42.0 %       2,327         1,909          21.9 %
Gross margin %                   66.6 %         73.6 %        -9.5 %        66.6 %        73.6 %        -9.5 %
Total operating expenses       11,053          8,839          25.0 %      20,219        17,353          16.5 %
Net loss                       (8,531 )       (6,293 )       -35.6 %     (15,631 )     (12,051 )       -29.7 %

Revenue

Revenue is recognized based on the following criteria: (i) persuasive evidence that an arrangement exists with the customer; (ii) delivery of the products and/or services has occurred; (iii) the selling price has been fixed for the products or services delivered; and (iv) collection is reasonably assured. We generate revenue from the sales of our implants and disposable surgical instruments. We have two distinct sales methods. The first method is when implants and/or disposable surgical instruments are sold directly to hospitals or surgical centers for the purpose of conducting a scheduled surgery. Our sales representatives or independent sales agents hand deliver the products to the customer on or before the day of the surgery. The sales representative or independent agent is then responsible for reporting the delivery of the products and the date of the operation to the corporate office for proper revenue recognition. We recognize revenue upon the confirmation that the products have been used in a surgical procedure. The other sales method is for sales to distributors or hospitals. These transactions require the customer to send in a purchase order before shipment will be made and the customer only has the right of return for defective products. We primarily recognize revenue upon the shipment of the product to distributors outside the United States, when risk of loss and title has transferred to the distributor, provided we have no material performance obligations. We expect that a substantial portion of our revenues will continue to be generated in the United States in future periods.

Cost of Revenue

Cost of revenue consists primarily of material and overhead costs related to our products, including reusable kit depreciation, product royalties and medical device taxes. Overhead costs include facilities-related costs, such as rent and utilities.

Research and Development

Research and development expenses consist primarily of personnel costs within our product development, regulatory and clinical functions and the costs of clinical studies, product development projects and technology licensing costs. In future periods, we expect research and development expenses to grow as we continue to invest in basic research, clinical trials, product development and intellectual property. Research and development expenses are expensed as incurred.

Sales and Marketing

Sales and marketing expenses consist primarily of personnel costs, sales commissions paid to our direct sales representatives, independent sales agents and independent distributors and costs associated with physician training programs, promotional activities and participation in medical and trade conferences. In future periods, we expect sales and marketing expenses to increase as we expand our sales and marketing efforts.

General and Administrative

General and administrative expenses consist of personnel costs related to the executive, finance and human resource functions, as well as professional service fees, legal fees, accounting fees, insurance costs and general corporate expenses. In future periods, we expect general and administrative expenses to increase to support our sales, marketing, research and development efforts.

Charges Related to U.S. Government Settlement

Charges related to U.S. Government settlement consist of settlement costs and legal fees related to the subpoena issued by the Department of Health and Human Services, Office of Inspector General, or the OIG, in October 2011 and the June 2013 settlement with the U.S. Department of Justice.

Merger and Integration Expenses

Merger expenses consist primarily of legal, accounting, consulting and other professional fees related to the Merger. Integration expenses consist of costs incurred in planning for and integrating our operations with Baxano.

Other Expense

Other expense is primarily composed of interest expense on the long-term debt and U.S. Government settlement, interest earned on our cash and cash equivalents and the gain or loss on disposal of fixed assets.

Comparison of the Three Months Ended June 30, 2012 and 2013

Revenue Revenue increased from $3.5 million in the three months ended June 30, 2012 to $3.9 million in the three months ended June 30, 2013.

Revenue by product line was:

                          Three Months Ended
                               June 30,
                           2013          2012
                            (in thousands)
Domestic revenue:
AxiaLIF                 $    1,733      $ 2,254
iO-Flex                        798            -
VEO                            664          447
Other                          492          515
Total                        3,687        3,216
International revenue          190          244
Total Revenue           $    3,877      $ 3,460

Note: iO-Flex revenue is included from the Merger date, May 31, 2013.

The $0.4 million increase in revenue from 2012 to 2013 was primarily due to the addition of the iO-Flex family of products to our portfolio as of May 31, 2013, offset by a lower number of AxiaLIF cases performed by our current surgeon base. Domestically, sales of our AxiaLIF Plus 1-Level products decreased from $1.5 million in the three months ended June 30, 2012 to $1.3 million in the three months ended June 30, 2013, and sales of our AxiaLIF Plus 2-Level products decreased from $0.8 million in the three months ended June 30, 2012 to $0.4 million in the three months ended June 30, 2013. In the three months ended June 30, 2013, average revenue per AxiaLIF case increased, primarily as a result penetration into existing cases by our other products. In the three months ended June 30, 2012 and 2013, we recorded 193 and 153 domestic AxiaLIF cases, respectively, including 52 AxiaLIF Plus 2-Level cases in the three months ended June 30, 2012, and 31 AxiaLIF Plus 2-Level cases in the three months ended June 30, 2013. Sales of our iO-Flex products for the quarter were $0.8 million, which represented 204 cases. Sales of our VEO lateral access and interbody fusion system increased from $0.4 million in the three months ended June 30, 2012 to $0.7 million in the three months ended June 30, 2013, as the number of cases increased from 32 in the three months ended June 30, 2012, to 65 in the three months ended June 30, 2013. During both the three months ended June 30, 2012 and 2013, we generated $0.2 million in revenues from sales of our posterior fixation systems. Sales of our Bi-Ostetic bone void filler decreased from $0.2 million for the three months ended June 30, 2012 to $0.1 million in the three months ended June 30, 2013. Revenue generated outside the United States was $0.2 million in both the three months ended June 30, 2012 and 2013. There were $25,000 in initial stocking shipments to new distributors outside the United States in the three months ended June 30, 2012, but there were no initial stocking shipments to new distributors in the three months ended June 30, 2013. In the three months ended June 30, 2012, 93% of our revenues were generated in the United States compared to 95% in the three months ended June 30, 2013.

Cost of Revenue Cost of revenue increased from $0.9 million for the three months ended June 30, 2012 to $1.3 million for the three months ended June 30, 2013. Gross margin decreased from 73.6% in the three months ended June 30, 2012 to 66.6% in the three months ended June 30, 2013. The decrease in gross margin was primarily due to increased depreciation expense on reusable kits, primarily due to upgrading reusable kits as we launched our next generation of AxiaLIF and VEO products, increased royalty expenses and the medical device tax that became effective on January 1, 2013.

Research and Development Research and development expenses increased from $1.2 million in the three months ended June 30, 2012 to $1.5 million in the three months ended June 30, 2013. Personnel-related expenses increased by $0.2 million from the three months ended June 30, 2012 compared to three months ended June 30, 2013 as we increased the headcount in our regulatory and clinical functions, including an increase in headcount related to the Merger. In addition, R&D project spending increased by $0.2 million, partially offset by a decrease of $0.1 million clinical trial spending in the three months ended June 30, 2013 compared to the three months ended June 30, 2012.

Sales and Marketing Sales and marketing expenses increased from $5.4 million in the three months ended June 30, 2012 to $6.0 million in the three months ended June 30, 2013. The increase in expenses from 2012 to 2013 of $0.6 million was primarily due to higher personnel-related costs of $0.3 million as we increased our direct sales personnel, including headcount related to the Merger, higher commissions of $0.5 million related to the increased revenue, as well as integrating the commission plans, partially offset by a decrease in consulting expenses of $0.3 million as we reduced our external reimbursement consultants and moved more of the efforts in-house.

General and Administrative General and administrative expenses increased from $1.5 million in the three months ended June 30, 2012 to $1.9 million in the three months ended June 30, 2013. The increase in expenses of $0.3 million was primarily due to an increase in personnel-related expense of $0.2 million, including headcount increases related to the Merger, increased insurance expenses related to the changes in the business and higher recruiting expenses.

U.S. Government Settlement Charges In December 2012, we reached a tentative agreement in principle with the U.S. Department of Justice related to the subpoena issued in October 2011. Baxano Surgical and the staff of the Department of Justice agreed to settle its federal investigation for $6.0 million. The final agreement was executed in June 2013. The $6.0 million settlement, plus accrued interest of 2%, will be paid in nine quarterly installments beginning in July 2013. We also incurred legal fees related to the investigation of $0.5 million in the three months ended June 30, 2012 and $0.1 million in the three months ended June 30, 2013.

Merger and Integration ExpensesWe have incurred $1.6 million of merger and integration related expenses for the three months ended June 30, 2013 related to the Merger with Baxano. These expenses consist primarily of legal expenses related to the Merger and employee severance and retention costs as we integrate the businesses.

Other Expense, net Other expense increased from $2,000 in the three months ended June 30, 2012 to $60,000 in the three months ended June 30, 2013. The increase of $58,000 was primarily related to interest on the term debt assumed in the Merger, including amortization of the debt discount, and interest on the U.S. Government settlement.

Comparison of the Six Months Ended June 30, 2012 and 2013

Revenue Revenue decreased from $7.2 million in the six months ended June 30, 2012 to $7.0 million in the six months ended June 30, 2013.

Revenue by product line was:

                          Six Months Ended
                              June 30,
                          2013         2012
                           (in thousands)
Domestic revenue:
AxiaLIF Plus 1-Level    $   3,383     $ 4,902
iO-Flex                       798           -
VEO                         1,239         749
Other                         861       1,067
Total                       6,281       6,718
International revenue         696         525
Total Revenue           $   6,977     $ 7,243

Note: iO-Flex revenue is included from the Merger date, May 31, 2013.

The $0.2 million decrease in revenue from 2012 to 2013 was due primarily to the lower number of AxiaLIF cases performed by our current surgeon base, partially offset by the addition of the iO-Flex family of products to our portfolio as of May 31, 2013. Domestically, sales of our AxiaLIF Plus 1-Level products decreased from $3.0 million in the six months ended June 30, 2012 to $2.2 million in the six months ended June 30, 2013, and sales of our AxiaLIF Plus 2-Level products decreased from $1.9 million in the six months ended June 30, 2012 to $1.1 million in the six months ended June 30, 2013. In the six months ended June 30, 2013, average revenue per AxiaLIF case increased, primarily as a result of the release of new AxiaLIF products and penetration into existing cases by our other products. In the six months ended June 30, 2012 and 2013, we recorded 415 and 286 domestic AxiaLIF cases, respectively, including 128 AxiaLIF Plus 2-Level cases in the six months ended June 30, 2012, and 79 AxiaLIF Plus 2-Level cases in the six months ended June 30, 2013. Sales of our VEO lateral access and interbody fusion system increased from $0.7 million in the six months ended June 30, 2012 to $1.2 million in the six months ended June 30, 2013, as the number of cases increased from 61 in the six months ended June 30, 2012, to 113 in the six months ended June 30, 2013. Sales of our iO-Flex products for the six months ended June 30, 2013 were $0.8 million, which represented 204 cases. During the six months ended June 30, 2012 and 2013, we generated $0.4 million and $0.3 million, respectively, in revenues from sales of our posterior fixation systems. Sales of our Bi-Ostetic bone void filler decreased from $0.4 million for the six months ended June 30, 2012 to $0.3 million for the six months ended June 30, 2013. Revenue generated outside the United States increased from $0.5 million in the six months ended June 30, 2012 to $0.7 million in the six months ended June 30, 2013. There was $25,000 in initial stocking shipments to new distributors outside the United States in the six months ended June 30, 2012 compared to $0.3 million in initial stocking shipments to new distributors in the six months ended June 30, 2013. In the six months ended June 30, 2012, 93% of our revenues were generated in the United States compared to 90% in the six months ended June 30, 2013.

Cost of Revenue Cost of revenue increased from $1.9 million for the six months ended June 30, 2012 to $2.3 million for the six months ended June 30, 2013. Gross margin decreased from 73.6% in the six months ended June 30, 2012 to 66.6% in the six months ended June 30, 2013. The decrease in gross margin was primarily due to a higher percentage of international sales which carry a lower gross margin than domestic sales, increased depreciation expense on reusable kits, primarily due to upgrading reusable kits as we launched our next generation of AxiaLIF and VEO products, increased royalty expenses and the medical device tax that became effective on January 1, 2013.

Research and Development Research and development expenses increased from $2.6 million in the six months ended June 30, 2012 to $2.8 million in the six months ended June 30, 2013. Personnel-related expenses increased by $0.4 million from the six months ended June 30, 2012 compared to six months ended June 30, 2013 as we increased our headcount in our regulatory and clinical functions, including an increase in headcount related to the Merger, and R&D project spending . . .

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