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AXGN > SEC Filings for AXGN > Form 10-Q on 30-Oct-2013All Recent SEC Filings

Show all filings for AXOGEN, INC.

Form 10-Q for AXOGEN, INC.


30-Oct-2013

Quarterly Report


ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Unless the context otherwise requires, all references in this report to "AxoGen," "the Company," "we," "us" and "our" refer to AxoGen, Inc. and its wholly owned subsidiary AxoGen Corporation ("AC") after the Merger (as defined below), and AC before the Merger.

OVERVIEW

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 muscle function and feeling. AxoGen's innovative approach to regenerative medicine has resulted in first-in-class products that it believes will define their product categories. AxoGen's products offer a full suite of surgical nerve repair solutions including AvanceŽ Nerve Graft, the only off-the-shelf commercially available processed nerve allograft, human nerve tissue obtained from a donor, for bridging severed nerves without the comorbidities of an autograft second surgical site, such as loss of feeling where the nerve was removed and potential pain at the donor site. The Company's AxoGuardŽ line of products are derived from pig tissue and are natural scaffolds of the body called an ExtraCellular Matrix, or ECM. AxoGuardŽ Nerve Connector is used to facilitate the tensionless repair of severed nerves, and AxoGuardŽ Nerve Protector is used to wrap and protect injured peripheral nerves and reinforce the nerve reconstruction 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 third quarter of 2013 compared to the third quarter of 2012 primarily as a result of sales to new accounts and increased product usage by existing accounts. 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. In the near term revenue growth lags behind the expense increases for market development such as hiring and training of new sales representatives and surgeon education programs.

The Company anticipates to lease two new facilities to accommodate its growth and to allow for same-day shipment of orders from regions in western U.S. time zones. The Company anticipates moving to a new lease facility in Alachua, Florida in December of 2013 that will provide an additional 6,929 square feet. The cost of such move is anticipated to be approximately $225,000. The Company also anticipates moving into lease space in Burleson, Texas in November or December of 2013 that will minimize time zone difference and allow same-day shipping to regions in western U.S. time zones. The Company also expects to move raw material storage from the facility of its current contractor to the Burleson Facility. The cost of such move is anticipated to be approximately $500,000, with certain anticipated economic incentives from the City of Burleson offsetting a portion of such costs. The Burleson facility will allow the Company to eliminate the use of certain space in Alachua it currently uses to conduct such activity and monthly storage costs for raw material and certain record storage.

Results of Operations

Comparison of the Three and Nine Months Ended September 30, 2013 and 2012

Revenues

Revenues for the three months ended September 30, 2013 increased 49.3% to approximately $2,957,000 as compared to approximately $1,981,000 for the three months ended September 30, 2012. Additionally, revenues for the nine months ended September 30, 2013 increased 41.0% to approximately $7,963,000 as compared to approximately $5,647,000 for the six months ended September 30, 2012. This increase was primarily a result of sales to new accounts and increased product usage by existing accounts. Each new customer in a defined


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period has the potential to become an established customer with repeat orders and increased account penetration. As such, revenue growth occurs from both new customers who purchase for the first time in a period and increased purchasing from established customers. Each new period of measurement is thus benefited from the additional new customers added in the prior period.

Gross Profit

Gross profit for the three months ended September 30, 2013 increased 60.3% to approximately $2,307,000 as compared to approximately $1,439,000 for the three months ended September 30, 2012. This increase is primarily attributable to the increased revenues in the third quarter of 2013, manufacturing efficiencies and a product price increase instituted in March 2013, partially offset by an increase in the inventory reserve. As a result, gross margin also improved to 78.0% for the three months ended September 30, 2013 as compared to 72.6% for the same period in 2012.

Gross profit for the nine months ended September 30, 2013 increased 47.0% to approximately $6,119,000 as compared to approximately $4,163,000 for the nine months ended September 30, 2012, primarily attributable to the increased revenues, manufacturing efficiencies and a product price increase instituted in March 2013, partially offset by an increase in the inventory reserve. As a result, gross margin also improved to 76.9% for the nine months ended September 30, 2013 as compared to 73.7% for the same period in 2012. Product sales mix also has an effect on gross profit changes between periods.

Costs and Expenses

Total cost and expenses increased 31.6% to approximately $4,584,000 for the three months ended September 30, 2013 as compared to approximately $3,482,000 for the three months ended September 30, 2012. These increases were primarily due to increasing sales and marketing activities, which includes increased commissions as a result of increased sales. To a lesser extent, these increases were also attributable to expenses associated with being a public company and research and development costs associated with the Company's clinical efforts. As a percentage of revenues, total operating expenses were 155.0% for the three months ended September 30, 2013 as compared to 175.8% for the three months ended September 30, 2012. This decrease in total costs and expenses as a percentage of revenue were primarily a result of the Company's revenue increase outpacing costs and expenses increase.

Total cost and expenses increased 32.7% to approximately $12,914,000 for the nine months ended September 30, 2013 as compared to approximately $9,734,000 for the nine months ended September 30, 2012. These increases were primarily due to increasing sales and marketing activities, which includes increased commissions as a result of increased sales. To a lesser extent, these increases were also attributable to expenses associated with being a public company and research and development costs associated with the Company's clinical efforts. As a percentage of revenues, total operating expenses were 162.2% for the nine months ended September 30, 2013 as compared to 172.4% for the nine months ended September 30, 2012. Such lower total costs and expenses as a percentage of revenue were primarily a result of the Company's revenue increase outpacing costs and expenses increase.

Sales and marketing expenses increased 62.5% to approximately $2,757,000 for the three months ended September 30, 2013 as compared to approximately $1,697,000 for the three months ended September 30, 2012. This increase was primarily due to increased commissions attributable to higher sales and the expansion of the Company's direct sales force and marketing efforts. Increased marketing efforts included expansion of surgeon education, including training events and materials, and public relations. As a percentage of revenues, sales and marketing expenses were 93.2% for the three months ended September 30, 2013 compared to 85.7% for the three months ended September 30, 2012. Such higher sales and marketing expenses as a percentage of revenue were a result of the costs and expenses increase outpacing the revenue increase, primarily due to the fact that the direct sales force personnel require time to become effective in their territory and provide a positive financial contribution.


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Sales and marketing expenses increased 46.2% to approximately $7,177,000 for the nine months ended September 30, 2013 as compared to approximately $4,908,000 for the nine months ended September 30, 2012. This increase was primarily due to increased commissions attributable to higher sales and the expansion of the Company's direct sales force and marketing efforts. Increased marketing efforts included expansion of surgeon education, including training events and product materials, and public relations. As a percentage of revenues, sales and marketing expenses were 90.1% for the nine months ended September 30, 2013 compared to 86.9% for the nine months ended September 30, 2012. Such higher sales and marketing expenses as a percentage of revenue were a result of the costs and expenses increase outpacing the revenue increase, primarily due to the fact that the direct sales force personnel require time to become effective in their territory and provide a positive financial contribution.

General and administrative expenses decreased 11.5% to approximately $1,233,000 for the three months ended September 30, 2013 as compared to approximately $1,394,000 for the three months ended September 30, 2012. The decrease was primarily the result of a non-recurring expense related to a license agreement, which expense was incurred in the third quarter of 2012, reduced depreciation and amortization expenses and lower professional fees based upon the timing of such services. Such decreases were offset by increases in expenses associated with being a public company and those related to travel. As a percentage of revenues, general and administrative expenses were 41.7% for the three months ended September 30, 2013 as compared to 70.4% for the three months ended September 30, 2012. Such lower general and administrative expenses as a percentage of revenue were a result of the Company being able to limit increases in such expenses while sales continue to increase.

General and administrative expenses increased 12.3% to approximately $4,238,000 for the nine months ended September 30, 2013 as compared to approximately $3,773,000 for the nine months ended September 30, 2012. Such increase was the result of increased expenses related to being a public company and travel, offset by a non-recurring expense related to a license agreement, which expense was incurred in the third quarter of 2012, and reduced depreciation and amortization expenses. As a percentage of revenues, general and administrative expenses were 53.2% for the nine months ended September 30, 2013 as compared to 66.8% the nine months ended September 30, 2012. This decrease in total costs and expenses as a percentage of revenue were primarily a result of the Company's revenue increase outpacing costs and expenses increase.

Research and development expenses increased approximately 52.3% to approximately $594,000 in the three months ended September 30, 2013 as compared to approximately $390,000 for the three months ended September 30, 2012. Research and development expenses increased 42.2% to approximately $1,499,000 in the nine months ended September 30, 2013 as compared to approximately $1,054,000 for the nine months ended September 30, 2012. 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. Research and development includes AxoGen's clinical efforts and substantially all of the increase in research and development expenses from 2012 to 2013 related to expenditures for such clinical activity, including increase in personnel and associated expenses.

Other Income and Expenses

Interest expense increased 737.9% to approximately $1,215,000 for the three months ended September 30, 2013 as compared to approximately $145,000 for the three months ended September 30, 2012. Interest expense increased 785.4% to approximately $3,506,000 for the nine months ended September 30, 2013 compared to approximately $396,000 for the nine months ended September 30, 2012. This increase was primarily due to the interest accrued related to PDL. As a result of the accounting treatment for the PDL transaction, interest expense for the three months ended September 30, 2013 included approximately $923,000 of non-cash expense and for the nine months ended September 30, 2013 included approximately $2,756,000 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 $923,000 and $2,756,000 of non-cash expense was derived from taking the total amount of imputed interest for the three months and nine months ended September 30, 2013, respectively, on the PDL agreement less the actual cash payment made to PDL in the quarter. Other than the $923,000 and $2,756,000 non-cash expense, the remaining $292,000 and $750,000 in interest expense for the three months and nine months ended September 30, 2013, respectively, is related to cash paid for interest on the note payable. The $396,000 interest expense for the nine months ended September 30, 2012 was cash paid for interest on previous debt.


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Interest expense-deferred financing costs increased 1.7% to approximately $61,000 for the three months ended September 30, 2013 as compared to approximately $60,000 for the three months ended September 30, 2012. Interest expense-deferred financing costs decreased 5.2% to approximately $147,000 for the nine months ended September 30, 2013 as compared to approximately $155,000 for the nine months ended September 30, 2012. This decrease is primarily due to lower deferred financing cost amortization associated with the PDL agreement when compared to the previous bank debt.

Income Taxes

The Company had no income tax expenses or income tax benefit for the three months and nine months ended September 30, 2013 due to incurrence of net operating loss in each of these periods.

However, the Company did have an income tax benefit of approximately $736,000 for the nine months ended September 30, 2012 which was the result of the Company's ability to utilize net operating losses and franchise tax adjustments which resulted in tax refunds. The entire amount of the tax refund has been received. The Company does not believe there are any additional tax refund opportunities currently available.

Effect of Inflation

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

Liquidity and Capital Resources

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 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, the Company's transfer of revenue interest or substantially all of its interest in the products or 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


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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.

The Company had no material commitments for capital expenditures at September 30, 2013. 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. 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

AxoGen had working capital of approximately $26.66 million and a current ratio of 21.24 at September 30, 2013, compared to working capital of $16.82 million and a current ratio of 12.36 at December 31, 2012. The increase in working capital and the current ratio at September 30, 2013 as compared to December 31, 2012 was primarily due to the Company on August 14, 2013 completing an underwritten offering of 6,000,000 shares of its common stock at a price to the public of $3.00 per share. The Company granted the underwriters a 30-day option to purchase up to an aggregate of 900,000 additional shares of Company common stock at the public offering price, less the underwriting discount, to cover over-allotments, if any. On September 11, 2013, the underwriters exercised their option to purchase an additional 184,332 shares. The Company received net proceeds of approximately $16.7 million, after deducting approximately $1.8 million in underwriting discounts and commissions and offering expenses payable by the Company, and including the underwriters' over-allotment option. The Company intends to use the net proceeds from the offering to continue product commercialization and marketing efforts for its portfolio of peripheral nerve repair products; to further develop its product pipeline; and for general working capital purposes. The Company believes it has sufficient cash resources to meet its liquidity requirements for at least the next 12 months.

AxoGen's future capital requirements depend on a number of factors, including, without limitation, revenue increases consistent with its business plan, and the corresponding royalty payments of approximately $1.3 to $2.5 million per quarter due to PDL and pursuant to AxoGen's licensing agreements in connection with AvanceŽNerve Graft, cost of products and acquisition and/or development of new products. In particular, if revenue does not increase by fourth quarter 2014 to a level whereby the 9.95% royalty owed to PDL on AxoGen's gross revenues exceeds the PDL minimum royalty payments at such time of approximately $1.3 million, and such differential continues, or grows larger as the PDL minimum royalty payments increase, AxoGen would face increasing capital needs. Such capital needs could be substantial depending on the extent to which AxoGen is unable to increase revenue.

If AxoGen needs additional capital in the future, it 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 AxoGen will be able to secure funding on terms acceptable to it, or at all. The increasing need for capital as the PDL transaction matures could also make it more difficult to obtain funding through either equity or debt. Should additional capital not become available to AxoGen as needed, AxoGen may be required to take certain action, such as, slowing sales and marketing expansion, delaying regulatory approvals or reducing headcount. During the nine months ended September 30, 2013, the


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Company had a net increase in cash and cash equivalents of approximately $8,679,000 as compared to a net decrease of cash and cash equivalents of approximately $3,746,000 in the nine months ended September 30, 2012. The Company's principal sources and uses of funds are explained below:

Cash used in operating activities

The Company used approximately $8,061,000 of cash for operating activities in the nine months ended September 30, 2013, as compared to using approximately $5,288,000 of cash for operating activities in the nine months ended September 30, 2012. This increase in cash used in operating activities is primarily attributed to the net loss generated in the nine months ended September 30, 2013, net of significant non-cash interest added to the note payable, along with an increase in our accounts receivable and inventory.

Cash used for investing activities

Investing activities for the nine months ended September 30, 2013 used approximately $117,000 of cash as compared to using approximately $120,000 of cash in the nine months ended September 30, 2012. This use is principally attributable to the purchase of certain fixed and intangible assets.

Cash provided by financing activities

Financing activities through the sale of Company Common Stock in the nine months ended September 30, 2013 provided approximately $16,857,000 of cash as compared to providing approximately $1,662,000 of cash in the nine months ended September 30, 2012. The Company did not incur any debt issuance costs in 2013.

Anticipated Cash usage for facilities

The Company anticipates to lease two new facilities to accommodate its growth and to allow for same-day shipment of orders from regions in western U.S. time zones. The Company anticipates moving to a new lease facility in Alachua, Florida in December of 2013 that will provide an additional 6,929 square feet. The cost of such move is anticipated to be approximately $225,000. The Company also anticipates moving into lease space in Burleson, Texas in November or December of 2013 that will minimize time zone difference and allow same-day shipping to regions in western U.S. time zones. The Company also expects to move raw material storage from the facility of its current contractor to the Burleson Facility. The cost of such move is anticipated to be approximately $500,000, with certain anticipated economic incentives from the City of Burleson offsetting a portion of such costs. The Burleson facility will allow the Company to eliminate the use of certain space in Alachua it currently uses to conduct such activity and monthly storage costs for raw material and certain record storage.

Off-Balance Sheet Arrangements

AxoGen does not have any off-balance sheet arrangements.

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