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MDXG > SEC Filings for MDXG > Form 10-K on 4-Mar-2014All Recent SEC Filings

Show all filings for MIMEDX GROUP, INC.

Form 10-K for MIMEDX GROUP, INC.


4-Mar-2014

Annual Report


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

The following discussion and analysis should be read in conjunction with the consolidated financial statements and the corresponding notes included elsewhere in this Form 10-K. Certain percentages presented in this discussion and analysis are calculated from the underlying whole dollar amounts and therefore may not recalculate from the rounded numbers used for disclosure purposes. Some of the information contained in this discussion and analysis or set forth elsewhere in this report includes forward-looking statements that involve risks and uncertainties. You should read the "Risk Factors" section of this report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

The discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires making estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue, and expenses during the reporting periods. On an ongoing basis, we evaluate such estimates and judgments, including those described in greater detail below. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Overview

MiMedx® is an integrated developer, manufacturer and marketer of patent protected regenerative biomaterial products and bioimplants processed from human amniotic membrane. "Innovations in Regenerative Biomaterials" is the framework behind our mission to give physicians products and tissues to help the body heal itself. Our biomaterial platform technologies include AmnioFix® and EpiFix®, our tissue technologies processed from human amniotic membrane that is derived from donated placentas. Through our donor program, mothers delivering full-term Caesarean section births can elect in advance of delivery to donate the placenta in lieu of having it discarded as medical waste. We process the human amniotic membrane utilizing our proprietary Purion® Process, to produce a safe and effective implant. MiMedx® is the leading supplier of amniotic tissue, having supplied over 200,000 allografts to date for application in the Wound Care, Surgical, Sports Medicine, Ophthalmic and Dental sectors of healthcare. These tissue-based products represented approximately 96% of our revenues in 2011 and 99% of our revenues in 2012 and 2013.
Our EpiFix® allografts are configured for external use. We offer EpiFix® in a sheet form as well as a micronized powder form. Currently, EpiFix® and EpiFix® Micronized are being used to treat chronic wounds, including diabetic foot ulcers, venous stasis ulcers, arterial ulcers and pressure ulcers, burns and surgical wounds (such as wounds following plastic surgery).
Our AmnioFix® allografts consist of three configurations, all configured for internal use:

•            AmnioFix® is provided in a sheet form. It is being used currently in
             spine, general and urology surgeries to reduce inflammation, enhance
             non-structural soft tissue healing and to minimize scar tissue.


•            AmnioFix® Wrap also is supplied in a sheet form and is configured
             for the same purposes as AmnioFix®, but is optimized for use as a
             "wrap" for nerves, tendons or ligaments.


•            AmnioFix® Injectable is supplied in micronized powder form used for
             injection into soft tissue areas to treat conditions such as:
             tendonitis, including plantar fasciitis, lateral epicondylitis, and
             medial epicondylitis; bursitis; strains and sprains.

We also process allografts for ophthalmic surgery and dental and oral maxilla facial applications, which are sold on an OEM basis.
Our assets also include licenses to two medical device technology platforms- HydroFix® and CollaFix™. Although we had commercialized some products based on the HydroFix® technology, due to the relatively small size of the addressable market for those products, we decided to discontinue that product line in the fourth quarter of 2013. We have yet to commercialize any products using our CollaFix™ technology and continue to assess how best to exploit that technology.

Our distribution model is comprised of direct sales, third party sales agents and stocking distributors that market MiMedx-branded products. We also have several OEM relationships targeting the spine market, as well as the ophthalmic and dental


markets. Our current focus is in the U.S. market, though a small portion of our revenues (less than 1%) are from sales outside the U.S. to a handful of stocking distributors.
Recent Events
Centers for Medicare and Medicaid Services Releases New Methodology for Reimbursement for Skin Substitutes

In 2013, 56% of our products were purchased for government accounts, which do not depend on reimbursement from third parties. With the exception of government accounts, most users of our products are doctors, hospitals or ambulatory surgery centers that rely on reimbursement by third-party payers. Accordingly, our revenues and growth substantially depend on adequate levels of third-party reimbursement from these payers.
Our AmnioFix® surgical products generally are bundled as part of a hospital's bill for a diagnosis-related group(DRG). There currently is no third party reimbursement for our injectable products. Most skin substitutes, such as our EpiFix® sheet products, on the other hand, historically have been separately reimbursed by third party payers.
By far, the largest third party payer in the United States is the Medicare program, which is a federally funded program that provides healthcare coverage for senior citizens and the disabled. In addition, while other third party payers have their own process and standards for determining whether to cover and reimburse a procedure for our products, private payers often follow the lead of governmental payers in making coverage and reimbursement determinations. The Medicare program is administered by the Centers for Medicare and Medicaid Services (CMS). CMS has appointed eight Medicare Administrative Contractors (MACs), which are private insurance companies that serve as agents of CMS in the administration of the Medicare program, including the payment of claims and making coverage decisions for the Medicare-assigned jurisdiction for which they are responsible. In 2012, we did not have any confirmed MAC coverage or reimbursement for our EpiFix® sheet products. At the end of 2013, six of the eight MACs provided reimbursement for our EpiFix® sheet allografts. One additional MAC has agreed to cover those products effective March 1, 2014. Also, for 2014, CMS has changed its methodology for reimbursing skin substitutes used in the hospital outpatient and ambulatory surgery center settings in a way that will make the use of allografts such as EpiFix®, which come in many sizes appropriate to the size of the wound being treated, in those settings more cost effective than many competitive products. FDA Untitled Letter and Subsequent Developments Initially, we processed our tissue allografts in only one form, which was a sheet form. In 2011, we introduced a micronized form of our sheet allografts. The FDA has specific regulations governing human cells, tissues and cellular and tissue-based products, or HCT/Ps. An HCT/P is a product containing or consisting of human cells or tissue intended for transplantation into a human patient. If an HCT/P meets the criteria for regulation solely under Section 361 of the Public Health Service Act (so-called "361 HCT/Ps"), no FDA review for safety and effectiveness under a drug, device, or biological product marketing application is required.
We believe that all of our tissue products qualify as 361 HCT/Ps. On August 28, 2013, however, the FDA issued an Untitled Letter alleging that our micronized allografts do not meet the criteria for regulation solely under Section 361 of the Public Health Service Act and that, as a result, we would need a biologics license to lawfully market the micronized products.
After a series of correspondence and conference calls and a meeting with FDA representatives, in December 2013, the FDA clarified the basis for its position regarding the micronized products. Specifically, the FDA explained its belief that "[c]ryo-milling cut, dehydrated amniotic/chorionic membrane results in a micron-sized powder and the loss of the tensile strength and elasticity that are essential characteristics of the original amniotic/chorionic tissue relating to its utility to function as a 'physical membrane' (i.e. covering, barrier)." For this reason, the FDA continues to believe that the micronized products are more than minimally manipulated and the products therefore are not eligible for marketing solely under Section 361 of the Public Health Service Act. We responded to the FDA that while we do not agree with the agency's position, we understand the agency's interest in further regulating this emerging technology. Accordingly, we have proposed to the FDA that we will pursue the Investigational New Drug ("IND") and Biologics License Application ("BLA") process for certain micronized products, and, in parallel, also proposed to enter into negotiations with the FDA on a plan to transition the micronized products to licensed biological products and continue to market the micronized products under specific conditions. We also have informed the FDA that we are ready to commence discussions regarding this transition plan. There is no guarantee that the FDA will agree to a transition plan or allow us to continue to market our micronized products while we pursue one or more BLAs. If they do allow us to continue to market our micronized products, they may impose conditions, such as labeling restrictions and


compliance with Current Good Manufacturing Practices ("cGMP"). It is also possible that we will be required to recall our micronized products. Revenues from micronized product make up about 15% of projected 2014 revenues. Following the publication of the Untitled Letter from the FDA regarding our micronized products, in September 2013, the trading price of our stock dropped sharply and several purported class action lawsuits were filed against us and certain of our executive officers asserting violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 with respect to various statements and alleged omissions related to our belief that FDA approval was not required to market its products, including our micronized products. These cases have now all been removed to, and consolidated in, the United States District Court for the Northern District of Georgia. By order dated December 9, 2013, the Court approved the appointment of a lead plaintiff and a lead counsel. A Consolidated Amended Class Action Complaint, containing substantially the same causes of action and claims for relief as the initial complaints, was filed on January 27, 2014. On February 26, 2014, we filed a Motion to Dismiss on various grounds. The plaintiffs' response to our Motion to Dismiss is due March 28, 2014. We currently believe that the outcome of this litigation will not have a material adverse impact on our financial position or results of operations. Public Offering of Common Stock
In December of 2013, we completed a public offering (the "Offering") of 5,750,000 shares of our common stock at $6.80 per share. Proceeds from the Offering, net of underwriting expenses were $36,704,000. In addition, we incurred approximately $194,000 in various legal fees for services related to the Offering.
We intend to use the net proceeds from the Offering for general corporate purposes, including, but not limited to, research, development and further commercialization of our products, obtaining regulatory approvals, funding of our clinical trials, capital expenditures, working capital and future acquisitions of complementary businesses, technology or products, although we currently have no agreements or commitments with respect to any such investment or acquisition.
Critical Accounting Policies
We believe that of our significant accounting policies, which are described in Note 2 to our financial statements appearing elsewhere in this report, the following accounting policies involve a greater degree of judgment and complexity.
Goodwill and Impairment of Long-Lived Assets Goodwill is the excess of the purchase price over the fair value of net assets of acquired businesses. Goodwill is tested for impairment annually or whenever an event occurs or circumstances change that would indicate that the carrying amount may be impaired. The test for impairment requires us to make several estimates about fair value, most of which are based on projected future cash flows. Our estimates associated with the goodwill impairment test are considered critical due to the amount of goodwill recorded on our consolidated balance sheets and the judgment required in determining fair value, including projected future cash flows. No goodwill impairment has been recognized during 2013, 2012 or 2011.
Other intangible assets include patents, trademarks, and purchased technology. Intangible assets with a definite life are amortized on a straight-line or accelerated basis, as appropriate, with estimated useful lives ranging from ten to fourteen years, and are tested for impairment whenever events or changes in circumstances indicate that the carrying amount of an intangible asset may not be recoverable. Indefinite-lived intangible assets are tested for impairment annually or whenever events or changes in circumstances indicate that the carrying amount of an intangible asset may not be recoverable. Refer to Note 6 to the consolidated financial statements in "Item 8. Financial Statements and Supplementary Data" in this Annual Report on Form 10-K for additional information. Our impairment reviews are based on an estimated future cash flow approach that requires significant judgment with respect to future revenue and expense growth rates, selection of appropriate discount rate, asset groupings, and other assumptions and estimates. We use estimates that are consistent with our business plans and a market participant view of the assets being evaluated. Actual results may differ from our estimates. In 2012, because our impairment test indicated that the carrying value of the intangible assets related to HydroFix® exceeded its fair value, an impairment loss of approximately $1,798,000 was recognized and the intangible asset carrying amount was adjusted to its new basis. During the fourth quarter of 2013 we chose to discontinue the HydroFix® product line. This action resulted in an impairment charge of approximately $368,000. This item is included in our Statement of Operations for the year ended December 31, 2013.


Fair Value Measurements
We record certain financial instruments at fair value, including: cash equivalents and contingent consideration. We may make an irrevocable election to measure other financial instruments at fair value on an instrument-by-instrument basis; although as of December 31, 2013 we have not chosen to make any such elections. Fair value financial instruments are recorded in accordance with the fair value measurement framework.
We also measure certain non-financial assets at fair value on a non-recurring basis. These non-recurring valuations include evaluating assets such as long-lived assets, and non-amortizing intangible assets for impairment; allocating value to assets in an acquired asset group; and applying accounting for business combinations. We use the fair value measurement framework to value these assets and reports these fair values in the periods in which they are recorded or written down.
The fair value measurement framework includes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair values in their broad levels. These levels from highest to lowest priority are as follows:

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


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


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

The determination of fair value and the assessment of a measurement's placement within the hierarchy requires judgment. Level 3 valuations often involve a higher degree of judgment and complexity. Level 3 valuations may require the use of various cost, market, or income valuation methodologies applied to unobservable management estimates and assumptions. Management's assumptions could vary depending on the asset or liability valued and the valuation method used. Such assumptions could include: estimates of prices, earnings, costs, actions of market participants, market factors, or the weighting of various valuation methods. We may also engage external advisors to assist us in determining fair value, as appropriate.
Although we believe that the recorded fair value of our financial instruments is appropriate, these fair values may not be indicative of net realizable value or reflective of future fair values.
Share-based Compensation
We follow the provisions of FASB Accounting Standards Codification ("ASC") 718, "Compensation - Stock Compensation" (ASC 718), previously referred to as Statement of Financial Accounting Standards No. 123R - Share-based Payments which requires the measurement and recognition of compensation expense for all share-based payment awards either modified or granted to employees and directors based upon estimated fair values. The Black-Scholes-Merton option-pricing model, consistent with the provisions of ASC 718, was used to determine the fair value of each option granted. Option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. We use projected volatility rates, which are based upon historical volatility rates, trended into future years. Because tour stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our options.
Debt Instruments with Detachable Warrants and Beneficial Conversion Features According to ASC470-20 "Debt With Conversion and Other Options", proceeds from the sale of convertible debt instruments with stock purchase warrants (detachable call options) shall be allocated to the two elements based upon the relative fair values of the debt instrument without the warrants and of the warrants themselves at the time of issuance. The Black-Scholes-Merton pricing model, consistent with the provisions of ASC 470, was used to determine the fair value of each warrant granted. The portion of the proceeds so allocated to the warrants is accounted for as paid-in capital. The remainder of the proceeds is allocated to the debt instrument portion of the transaction. Also, the embedded beneficial conversion feature present in the convertible instrument is recognized separately at issuance by allocating a portion of the proceeds equal to the intrinsic value of that feature to additional paid-in capital.


Contingent Consideration
The Agreement and Plan of Merger between us and the former owners of Surgical Biologics (the "Merger") dated January 5, 2011, involved the potential for the payment of future contingent consideration in our common stock. The contingent consideration was originally recorded at the estimated fair value of the contingent milestone payment on the acquisition date. The initial payment of contingent consideration was equal to 60% of the excess of the amniotic tissue-based adjusted Gross Revenues in calendar year 2011 over the amniotic tissue-based Gross Revenues in calendar year 2010, minus any FDA approval costs. The adjustments to Gross Revenues were established in the Agreement and Plan of Merger. The payment was made in an aggregate number of shares of our common stock computed per a specified formula in the Agreement and Plan of Merger. At December 31, 2011, the fair value of the contingent consideration tied to 2011 revenue was calculated to be approximately $3,185,000 and resulted in the issuance of approximately 2,632,576 shares of our common stock in April 2012. In addition we were required to deliver to the former owners of Surgical Biologics an aggregate number of shares of our common stock valued at 30% of the difference between amniotic tissue-based Gross Revenues in calendar year 2012 and amniotic tissue-based Gross Revenues in calendar year 2011, minus any FDA approval costs. The fair value of the contingent milestone consideration was remeasured at the estimated fair value as of December 31, 2012, with the change in fair value recognized as income or expense within Other Income (Expense) in the consolidated statements of earnings. At December 31, 2012, the fair value of the contingent consideration tied to 2012 revenue was calculated to be approximately $5,792,000 and the liability was adjusted and recorded as a non-current liability in the consolidated balance sheet. This debt was satisfied by the issuance of approximately 1,175,000 shares of our common stock in the first quarter of 2013.
Recently Adopted Accounting Pronouncements We consider the applicability and impact of all Accounting Standards Updates ("ASUs"). For the year ended December 31, 2013, and through the date of this report, all ASUs issued, effective and not yet effective, were assessed and determined to be either not applicable or expected to have minimal impact on our financial position or results of operations.
Results of Operations for the year ended December 31, 2013, compared to the year ended December 31, 2012
Revenue
Total revenue increased $32.1 million, or 119%, from approximately $27.1 million in 2012 to $59.2 million in 2013. The increase in revenue as compared to the prior year is due primarily to increased sales of our amniotic membrane tissue products, EpiFix® and AmnioFix®.
Wound Care market revenue increased by approximately $21.7 million, or 190%, to $33.1 million as compared to $11.4 million in the prior year. Growth was driven by increased revenue in both government and commercial accounts. In the first half of 2012, we sold our products through distributors. In the second half of 2012, we made the strategic decision to hire a direct sales force initially focused on government accounts. While the sales personnel maintain a direct relationship with the physician, the product is sold to government accounts through a distributor that handles all contracting matters, including invoicing and collection. This distributor is a service-disabled veteran owned small business. In January 2013, the Medicare Q code for Epifix® became effective and during the year we received positive coverage decisions from six of eight MACs that process medical claims for Medicare on a regional basis. We added direct sales personnel targeting commercial accounts in those territories where there was MAC coverage. The sales executives hired generally have extensive wound care experience and bring with them existing relationships with physicians. Surgical and Sports Medicine revenue increased approximately $10.2 million, or 79%, to $23.2 million as compared to $13.0 million in the prior year. The growth was driven by increased use of our AmnioFix ® products in both government and commercial accounts in various sports medicine and surgical applications. The Other markets category, which includes our Ophthalmic and Dental tissue-based products sold on an OEM basis as well as our HydroFix® medical device product sold through distributors, increased approximately $0.2 million, or 9%, as compared to the prior year.
Tissue Processing Costs and Cost of Products Sold Cost of products sold as a percentage of revenue improved to 15.8% from 19.2% as compared to the prior year. The improvement was due primarily to the increase in direct sales revenue, favorable product mix and higher production rates that absorb a greater percentage of fixed manufacturing costs.


Research and Development Expenses
Our research and development expenses ("R&D expenses") increased approximately $2.0 million, or 68%, to $4.8 million in 2013, compared to approximately $2.9 million in the prior year. The increase is primarily related to increased investments in clinical trials, personnel costs, lab supplies, and testing costs. Our research and development expenses consist primarily of internal personnel costs, clinical trials, fees paid to external consultants, and supplies and instruments used in our laboratories. Additionally, during 2013, we were granted eight U.S. patents for the amnion technology, two US patents and one Chinese patent for the hydrogel technology, two U.S. patents for the collagen technology, and two Australian patents for the collagen technology. To date, we have received an additional two U.S. patents for amnion technology in 2014.
Selling, General and Administrative Expenses Selling, General and Administrative expenses for 2013 increased approximately $26.6 million, or 136%, to $46.2 million compared to $19.6 million for 2012. Selling expense increases were driven by costs associated with building our direct sales organization for government and commercial accounts, where headcount grew by 39 during the year, as well as increased commissions due to higher sales volume.
Additional spending increases included spending on support costs related to medical reimbursement, including our reimbursement hotline; our information technology infrastructure to help manage the growth of the business; and increased share-based compensation expense and a provision for anticipated costs associated with the management incentive program.
Selling, General and Administrative expenses consist of personnel costs, professional fees, sales commissions, sales training costs, industry trade show fees and expenses, product promotions and product literature costs, facilities costs and other sales, marketing and administrative costs, depreciation and amortization, and share-based compensation. Share-based compensation for the years ended December 31, 2013 and 2012, was approximately $6.0 million and $2.5 million, respectively, an increase of approximately $3.5 million or 140%. Increased employee stock option grants reflecting management's philosophy of aligning employee compensation with investor objectives and the increase in the market price of our common stock were the primary reasons for the increase in expense.
We recorded approximately $1.1 million and $1.4 million in amortization expense related to intangible assets in the years ended December 31, 2013 and 2012, respectively. The decrease of approximately $.3 million is attributable to the impairment related to our HydroFix® product line which we elected to discontinue . . .

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