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BAXS > SEC Filings for BAXS > Form 10-Q on 12-Nov-2013All Recent SEC Filings

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Form 10-Q for BAXANO SURGICAL, INC.


12-Nov-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, 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. These risks include, without limitation, the pace of adoption of the Company's product technology by spine surgeons, limited clinical data about the efficacy of these products, the outcome of coverage and reimbursement decisions by the government and third party payors, the success of continuing product development efforts, the effect on the business of existing and new regulatory requirements, cost pressures in the healthcare industry, competitive pressures from substitute products and larger companies, the historical lack of profitability, the dependence on key employees, regulatory approval and market acceptance for new products, compliance with complex and evolving healthcare laws and regulations, the Company's ability to raise additional capital, the ability to comply with the settlement agreement and Corporate Integrity Agreement (the "CIA") with certain entities of the U.S. government, the reliance on a limited number of suppliers to provide the Company's products and their components, changes in economic conditions, the ability to effectively manage a sales force to meet the Company's objectives and the ability to conduct successful clinical studies. 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 designing, developing and marketing 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 VEO® lateral access and interbody fusion system, the iO-Flex® system, a proprietary set of flexible instruments used by surgeons during spinal decompression procedures, and the iO-Tome® instrument, which rapidly and precisely removes bone, specifically the facet joints, which is commonly performed in spinal fusion 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.

We first commercially introduced our AxiaLIF branded products in 2005. Our VEO lateral access and interbody fusion system was commercially launched in November 2011, our iO-Flex System was commercially launched in 2009, and our iO-Tome instrument was commercially launched in the fourth quarter of 2013. 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 and certain other 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 U.S. Food and Drug Administration, 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 Merger Sub, consummated our acquisition of Baxano, Inc., or 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. Upon the determination that no post-closing adjustment was required, 265,584 escrow shares were 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.

For the nine months ended September 30, 2013, we have incurred $2.2 million of merger related expenses and $1.2 million of integration expenses.

Since inception, we have been unprofitable. As of September 30, 2013 we had an accumulated deficit of $162.4 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.


 18



                         Three Months Ended September 30,                   Nine Months Ended September 30,
                      2013              2012          % change          2013              2012          % change
                                                  (in millions, except percentages)
Revenue            $       5.7       $       3.2            76.7 %   $      12.6       $      10.4            20.9 %
Cost of revenue            1.5               0.8            79.7 %           3.8               2.7            39.5 %
Gross margin %            73.3 %            73.8 %          -0.7 %          69.7 %            73.7 %          -5.4 %
Total operating
expenses                  12.0               8.1            47.9 %          32.2              25.5            26.5 %
Net loss                 (8.0)             (5.9)           -35.7 %        (23.6)            (17.9)           -31.7 %

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. The Company, and we believe our industry, tends to experience some revenue seasonality during the summer months as certain elective procedures may be deferred beyond the summer months.

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, bad debt expense 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 September 30, 2012 and 2013 Revenue Revenue increased from $3.2 million in the three months ended September 30, 2012 to $5.7 million in the three months ended September 30, 2013.

Revenue by product line was:

                          Three Months Ended
                            September 30,
                           2013         2012
                            (in thousands)
Domestic revenue:
AxiaLIF                 $    1,617    $  1,916
iO-Flex                      2,654           -
VEO                            523         484
Other                          492         504
Total                        5,286       2,904
International revenue          364         294
Total Revenue           $    5,650    $  3,198

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

The $2.5 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 $1.2 million in the three months ended September 30, 2012 to $1.1 million in the three months ended September 30, 2013, and sales of our AxiaLIF Plus 2-Level products decreased from $0.7 million in the three months ended September 30, 2012 to $0.5 million in the three months ended September 30, 2013. In the three months ended September 30, 2013, average revenue per AxiaLIF case increased, primarily as a result of penetration into existing cases by our other products.
In the three months ended September 30, 2012 and 2013, we recorded 164 and 140 domestic AxiaLIF cases, respectively, including 46 AxiaLIF Plus 2-Level cases in the three months ended September 30, 2012, and 37 AxiaLIF Plus 2-Level cases in the three months ended September 30, 2013. Sales of our iO-Flex products for the quarter were $2.7 million, which represented 701 cases. Sales of our VEO lateral access and interbody fusion system were $0.5 million in the three months ended September 30, 2012 and September 30, 2013, and the number of cases increased from 44 in the three months ended September 30, 2012, to 51 in the three months ended September 30, 2013. Other domestic revenues primarily includes revenue from our posterior fixation systems and our Bi-Ostetic bone void filler products and did not change materially over the comparative three month periods presented. Revenue generated outside the United States increased from $0.3 million in the three months ended September 30, 2012 to $0.4 million in the three months ended September 30, 2013. There were $0.1 million in initial stocking shipments to new distributors outside the United States in the three months ended September 30, 2012, compared to $0.2 million in the three months ended September 30, 2013. In the three months ended September 30, 2012, 91% of our revenues were generated in the United States compared to 94% in the three months ended September 30, 2013. Our revenue generated outside the United States included sales of AxiaLIF, VEO and iO-Flex products in 2013 and sales of AxiaLIF and VEO products in 2012.

Cost of Revenue Cost of revenue increased from $0.8 million for the three months ended September 30, 2012 to $1.5 million for the three months ended September 30, 2013. Gross margin decreased from 73.8% in the three months ended September 30, 2012 to 73.3% in the three months ended September 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 $1.4 million in the three months ended September 30, 2012 to $1.9 million in the three months ended September 30, 2013. Personnel-related expenses increased by $0.4 million from the three months ended September 30, 2012 compared to three months ended September 30, 2013 as we increased the headcount in our regulatory and clinical functions, including an increase in headcount related to the Merger

Sales and Marketing Sales and marketing expenses increased from $4.5 million in the three months ended September 30, 2012 to $6.8 million in the three months ended September 30, 2013. The increase in expenses from 2012 to 2013 of $2.3 million was primarily due to higher personnel-related costs of $0.9 million as we increased our direct sales personnel, including headcount related to the Merger, higher commissions of $0.8 million related to the increased revenue, as well as integrating the commission plans, increased promotional expense of $0.3 million and increased travel expenses related to the personnel increase of $0.1 million.

General and Administrative General and administrative expenses increased from $1.7 million in the three months ended September 30, 2012 to $2.8 million in the three months ended September 30, 2013. The increase in expenses of $1.1 million was primarily due to an increase in personnel-related expense of $0.4 million, including headcount increases related to the Merger, increased bad debt expense of $0.6 million, and amortization of the intangible assets acquired in the merger.

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, with the first installment paid in July 2013. We also incurred legal fees related to the investigation of $0.6 million in the three months ended September 30, 2012 and $32,000 in the three months ended September 30, 2013.

Merger and Integration Expenses We have incurred $0.5 million of merger and integration related expenses for the three months ended September 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 decreased from $114,000 in the three months ended September 30, 2012 to $104,000 in the three months ended September 30, 2013. The expense in 2012 was primarily related to a loss on the disposal of fixed assets from the disposal of obsolete components of certain reusable instrument kits and the expense in 2013 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 Nine Months Ended September 30, 2012 and 2013 Revenue Revenue increased from $10.4 million in the nine months ended September 30, 2012 to $12.6 million in the nine months ended September 30, 2013.

Revenue by product line was:

                          Nine Months Ended
                            September 30,
                           2013        2012
                           (in thousands)
Domestic revenue:
AxiaLIF                 $    4,992   $  6,809
iO-Flex                      3,452          -
VEO                          1,750      1,232
Other                        1,373      1,581
Total                       11,567      9,622
International revenue        1,060        819
Total Revenue           $   12,627   $ 10,441

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

The $2.2 million increase in revenue from 2012 to 2013 was due primarily to the addition of the iO-Flex family of products to our portfolio as of May 31, 2013, partially offset by the lower number of AxiaLIF cases performed by our current surgeon base. Domestically, sales of our AxiaLIF Plus 1-Level products decreased from $4.3 million in the nine months ended September 30, 2012 to $3.4 million in the nine months ended September 30, 2013, and sales of our AxiaLIF Plus 2-Level products decreased from $2.6 million in the nine months ended September 30, 2012 to $1.6 million in the nine months ended September 30, 2013. In the nine months ended September 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 nine months ended September 30, 2012 and 2013, we recorded 579 and 426 domestic AxiaLIF cases, respectively, including 174 AxiaLIF Plus 2-Level cases in the nine months ended September 30, 2012, and 113 AxiaLIF Plus 2-Level cases in the nine months ended September 30, 2013. Sales of our iO-Flex products for the nine months ended September 30, 2013 were $3.4 million, which represented 922 cases. Sales of our VEO lateral access and interbody fusion system increased from $1.2 million in the nine months ended September 30, 2012 to $1.8 million in the nine months ended September 30, 2013, as the number of cases increased from 122 in the nine months ended September 30, 2012, to 174 in the nine months ended September 30, 2013. Other domestic revenue primarily includes revenues from our posterior fixation systems and our Bi-Ostetic bone void filler products and did not change materially over the comparative nine month periods presented. Revenue generated outside the United States increased from $0.8 million in the nine months ended September 30, 2012 to $1.1 million in the nine months ended September 30, 2013. There was $0.1 million in initial stocking shipments to new distributors outside the United States in the nine months ended September 30, 2012 compared to $0.5 million in initial stocking shipments to new distributors in the nine months ended September 30, 2013. In the nine months ended September 30, 2012 and 2013, 92% of our revenues were generated in the United States.

Cost of Revenue Cost of revenue increased from $2.7 million for the nine months ended September 30, 2012 to $3.8 million for the nine months ended September 30, 2013. Gross margin decreased from 73.7% in the nine months ended September 30, 2012 to 69.7% in the nine months ended September 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 $3.9 million in the nine months ended September 30, 2012 to $4.7 million in the nine months ended September 30, 2013. Personnel-related expenses increased by $0.7 million from the nine months ended September 30, 2012 compared to nine months ended September 30, 2013 as we increased our headcount in our regulatory and clinical functions, primarily related to the Merger and R&D project spending, partially offset by a decrease of clinical trial spending and licensing agreements in the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012.

Sales and Marketing Sales and marketing expenses increased from $15.1 million in the nine months ended September 30, 2012 to $17.7 million in the nine months ended September 30, 2013. The increase in expenses from 2012 to 2013 of $2.6 million was primarily due to higher commissions of $1.2 million related to integrating the commission plans, higher personnel-related costs of $1.1 million as we increased our direct sales personnel, including headcount related to the Merger, as well as increased training expense of $0.3 million as we educate our . . .

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