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AXGN > SEC Filings for AXGN > Form 10-K on 6-Mar-2014All Recent SEC Filings

Show all filings for AXOGEN, INC.

Form 10-K for AXOGEN, INC.


6-Mar-2014

Annual Report


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

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

Overview

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

Revenue from the distribution of these products is the main contributor to AxoGen's total reported sales and has been the key component of its growth to date. AxoGen revenues increased in 2013 compared to 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.

Results of Operations

Critical Accounting Policies and Estimates

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

We have identified the following policies as critical to our business operations and the understanding of our consolidated results of operations:

Accounts Receivable and Concentration of Credit Risk - Doubtful Accounts

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The carrying amount of accounts receivable is reduced by an allowance for doubtful accounts which reflects management's best estimate of the amounts that are uncollectable. In establishing the required allowance, management considers customers' financial condition, credit history and current economic conditions. In 2013, we established a reserve for doubtful accounts as we did have some accounts deemed uncollectible. Such accounts, however, have been immaterial both in number and dollar amount. Account balances are charged off after all means of collection have been exhausted and the potential for recovery is considered remote. Our internal financial operations have primary responsibility for billing and collecting our accounts receivable. We utilize various processes and procedures in our collection efforts; these efforts include monthly statements, written collection notices and telephonic follow-ups. In the event the current conditions as to doubtful accounts negatively changes, management will consider increasing the reserve for doubtful accounts. Management judgment as to identifying negative trends is important in its assumption of exposure to uncollectable receivables requiring a reserve and if revenues expand as expected accounts receivable will rise potentially causing management to reevaluate its underlying assumptions.


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Goodwill

Goodwill represents the excess of the purchase price over the net tangible and intangible assets acquired in business combinations. The Company is required to perform a review for impairment of goodwill in accordance with FASB ASC 350, Intangibles - Goodwill and Other. Goodwill is considered to be impaired if it is determined that the carrying value of goodwill exceeds its fair value. The Company conducted an impairment test during the year ended December 31, 2012 and determined the goodwill was impaired. The full amount of goodwill was written off in 2012.

Effective Interest Rate on Note Payable

The PDL Royalty Contract is accounted for as long-term debt. AxoGen records interest using its best estimate of the effective interest rate. This estimate takes into account both the internal rate of return (IRR) of the PDL agreement and the rate of return as the result of exercise of the Put option. The IRR of the PDL Royalty Contract is based on the actual payments to date, projected future revenues and required minimum payments, and is calculated at 20.535%. The PDL Royalty Contract Put option provides PDL a 20% return, if exercised. As a result of the return of the Put option being higher than the IRR of the PDL agreement, management believes the best estimate of the effective interest rate on this instrument would be the Put rate. As a result, AxoGen is accruing interest using the specified internal rate of return for the Put which is 20%. We currently have no knowledge of PDL's intent to exercise the Put, but will monitor this on an ongoing basis. From time to time, AxoGen will reevaluate the expected cash flows and may adjust the effective interest rate. Determining the effective interest rate requires judgment and is based on significant assumptions related to estimates of the amounts and timing of future revenue streams and PDL's ultimate decision to exercise the Put. Determination of these assumptions is highly subjective and different assumptions could lead to materially different outcomes.

Income Taxes

Deferred income taxes reflect the impact of temporary differences between the reported amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. A valuation allowance is provided for deferred tax assets when management concludes it is more-likely-than-not that some portion of the deferred tax assets will not be recognized. We have a full valuation allowance established on the deferred tax asset upon management's best estimate of final outcomes based upon estimated future revenue and changes in business capitalization. Factors used to establish the valuation allowance are complicated and could cause variability in application over time.

Comparison of the Years Ended December 31, 2013 and 2012

Revenues

Revenues for the year ended December 31, 2013 increased 42.3% to approximately $10,947,000 as compared to approximately $7,692,000 for the year ended December 31, 2012. This increase was primarily a result of sales to new accounts, increased product usage by existing accounts and grant revenue received of approximately $67,000. Each new customer in a defined 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 and growth, if any, realized from established customers.

Gross Profit

Gross profit for the year ended December 31, 2013 increased 48.5% to approximately $8,508,000 as compared to approximately $5,730,000 for the year ended December 31, 2012. This increase is primarily attributable to the increased revenues in 2013, manufacturing efficiencies and a product price increase instituted in March 2013. As a result, gross margin also improved to 77.7% in 2013 as compared to 74.5% for 2012. Product sales mix has an effect on gross profit changes between periods.

Costs and Expenses

Total cost and expenses increased 33.8% to approximately $18,100,000 for the year ended December 31, 2013 as compared to approximately $13,532,000 for the year ended December 31, 2012. These increases were primarily due to increasing sales and marketing activities, which includes salaries and increased commissions as a result of increased sales, increases in research and development in preparation for AxoGen's Investigational New Drug (IND) Application with the FDA and the subsequent start of its phase 3 trial, expenses associated with being a public company and increases in salaries as AxoGen hires to meet growth needs, offset by a non-recurring expense incurred in the third quarter of 2012 related to a license agreement and reduced depreciation and amortization expenses. As a percentage of revenues, total operating expenses were 165.3% for the year ended December 31, 2013 compared to 175.9% for the year ended December 31, 2012. Such lower total costs and expenses as a percentage of revenue were primarily a result of AxoGen's revenue increase outpacing costs and expenses increase.


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Sales and marketing expenses increased 49.0% to approximately $10,259,000 for the year ended December 31, 2013 as compared to approximately $6,884,000 for the year ended December 31, 2012. This increase was primarily due to increased commissions attributable to higher sales and the expansion of AxoGen's direct sales force and marketing efforts. Increased marketing efforts included expansion of surgeon education, including training events and materials, public relations and additional materials, and increased resources for the expanding sales force and independent distributors. As a percentage of revenues, sales and marketing expenses were 93.7% for the year ended December 31, 2013 compared to 89.5% for the year ended December 31, 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 increased 9.5% to approximately $5,715,000 for the year ended December 31, 2013 as compared to approximately $5,221,000 for the year ended December 31, 2012. As a percentage of revenues, general and administrative expenses were 52.2% for the year ended December 31, 2013 compared to 67.9% the year ended December 31, 2012. The increase in aggregate dollars spent were a result of hiring and costs related to being a public company, offset by a savings in finance costs, a non-recurring expense incurred in the third quarter of 2012 related to a license agreement and reduced depreciation and amortization expenses. As a percentage of revenue, general and administrative expenses decreased as a result of AxoGen being able to limit increases in such expenses while sales continue to increase.

Research and development expenses increased 48.9% to approximately $2,125,000 in the year ended December 31, 2013 as compared to approximately $1,427,000 for the year ended December 31, 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 246.4% to approximately $4,820,000 in 2013 as compared to approximately $1,391,000 for the year ended December 31, 2012. This increase was primarily due to the interest accrued related to PDL for the full year in 2013. As a result of the accounting treatment for the PDL transaction, interest expense for 2013 included approximately $3,783,000 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 $3,783,000 of non-cash expense was derived from taking the total amount of imputed interest for 2013 on the PDL agreement less the actual cash payment made to PDL for the year. Other than the $3,783,000 non-cash expense, the remaining $1,030,000 in interest expense for 2013 is related to cash paid for interest on the note payable.

Interest expense- deferred financing costs decreased 81.9% to approximately $179,000 for 2013 as compared to approximately $987,000 in 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

AxoGen had no income tax expenses or income tax benefit for 2013 due to incurrence of net operating loss for the year. However, AxoGen did have an income tax benefit of approximately $738,000 for 2012 which was the result of AxoGen's ability to utilize net operating losses and franchise tax adjustments which resulted in tax refunds. The entire amount of the tax refund was received in 2012. AxoGen does not believe there are any additional tax refund opportunities currently available.

Effect of Inflation

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


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Liquidity and Capital Resources

Long-Term Debt / Note Payable

On October 5, 2012, AxoGen entered into the Royalty Contract with PDL. Proceeds from the PDL transaction were used to fully repay the MidCap Loan, as defined below, and extinguish AxoGen's long-term debt obligations thereunder. The Royalty Contract has a term of eight years. Under the Royalty Contract, PDL is to receive royalty payments currently paid weekly based on a 9.95% royalty rate of certain of AxoGen'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 AxoGen's products AvanceŽ Nerve Graft, AxoGuardŽ Nerve Protector and AxoGuardŽ Nerve Connector (the "Acquired Revenues"), which at this time represents all of AxoGen'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, AxoGen'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 AxoGen was $20,800,000 (the "Funded Amount"), including $19,050,000 PDL paid to AxoGen on October 5, 2012, and $1,750,000 PDL paid to AxoGen 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.

Under the Royalty Contract, AxoGen 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 AxoGen's Net Revenues, subject to certain agreed upon minimum payments of approximately $1.3 to $2.5 million per quarter starting in October 2014, was provided the Put and receives certain payments in the event of a Change of Control. The total consideration PDL paid to AxoGen was $20,800,000, including $19,050,000 PDL paid to AxoGen on October 5, 2012, and $1,750,000 PDL paid to AxoGen 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 AxoGen 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 AxoGen 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.

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

The MidCap Loan contained customary affirmative and negative covenants, including, without limitation, (i) covenants requiring AxoGen to comply with applicable laws, provide to MidCap copies of AxoGen's financial statements, maintain appropriate levels of insurance and protect, defend and maintain the validity and enforceability of AxoGen's material intellectual property,
(ii) covenants restricting AxoGen's ability to dispose of all or any part of its assets (subject to certain


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exceptions), engage in other lines of business, changes in its senior management, enter into merger or consolidation transactions, incur or assume additional indebtedness, or incur liens on its assets, and (iii) covenants requiring AxoGen to meet certain minimum Net Invoiced Revenue, as defined in the agreement, or maintain a cash balance of 80% of the loan principal amount.

The MidCap Loan was secured by all of AxoGen's assets. The Lenders also received a ten-year warrant to purchase 89,686 shares of AxoGen's common shares at $2.23 per share. Proceeds from the PDL transaction were used to fully repay the MidCap Loan, along with a $172,581 prepayment penalty, and extinguish AxoGen's obligations thereunder.

The Company had no material commitments for capital expenditures at December 31, 2013 or 2012.

Cash Flow Information

AxoGen had working capital of approximately $23.56 million and a current ratio of 12.23 at December 31, 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 at December 31, 2013 as compared to December 31, 2012 was primarily due to AxoGen 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. AxoGen 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. AxoGen received net proceeds of approximately $16.7 million, after deducting approximately $1.8 million in underwriting discounts and commissions and offering expenses payable by AxoGen, and including the underwriters' over-allotment option. AxoGen believes it has sufficient cash resources to meet its liquidity requirements for 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, starting in October 2014, due to PDL and pursuant to AxoGen's licensing agreements in connection with AvanceŽ Nerve 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 year ended December 31, 2013, AxoGen had a net increase in cash and cash equivalents of approximately $6,162,000 as compared to a net increase of cash and cash equivalents of approximately $5,717,000 in the year ended December 31, 2012. AxoGen's principal sources and uses of funds are explained below:

Net Cash used in operating activities

AxoGen used approximately $10,445,000 of cash for operating activities in 2013, as compared to using approximately $8,662,000 of cash for operating activities in 2012. This increase in cash used in operating activities is primarily attributed to the net loss generated in 2013, net of significant non-cash interest added to the note payable, an increase in the stock based compensation along with an increase in our accounts payable offset by increases in accounts receivable and inventory.

Net Cash used in investing activities

Investing activities for 2013 used approximately $244,000 of cash as compared to 2012 which used approximately $127,000. This increase in cash used is attributable to the purchase of property and equipment related to the new facility in Burleson, Texas.

Net Cash provided by financing activities

Financing activities in 2013 provided approximately $16,851,000 of cash as compared to approximately $14,506,000 of cash in 2012. This increase in cash provided is primarily attributed to approximately $16,778,000 of cash provided in 2013 as a result of the sale of Common Stock compared to the issuance of $20,800,000 of additional debt, partially offset by the repayment of approximately $5,000,000 of debt (of which approximately $4.8 million is non-cash proceeds and payments) during 2012 and fees associated therewith.


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Off-Balance Sheet Arrangements

AxoGen does not have any off-balance sheet arrangements.

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