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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to______________

Commission file number: 001-36046

Axogen, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Minnesota

41-1301878

(State or Other Jurisdiction of

(I.R.S. Employer

Incorporation or Organization)

Identification No.)

13631 Progress Blvd., Suite 400, Alachua, FL

32615

(Address of Principal Executive Offices)

(Zip Code)

386-462-6800

(Registrant’s Telephone Number, Including Area Code)

Not Applicable

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol

Name of each exchange on which registered

Common Stock, $0.01 par value

AXGN

The Nasdaq Stock Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES    NO 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). YES   NO  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES   NO 

As of October 27, 2020, the registrant had 40,126,253 shares of common stock outstanding.

Forward-Looking Statements

From time to time, in reports filed with the U.S. Securities and Exchange Commission (the “SEC”) (including this Form 10-Q), in press releases, and in other communications to shareholders or the investment community, Axogen, Inc. (including Axogen, Inc.’s wholly owned subsidiaries, Axogen Corporation, Axogen Processing Corporation and Axogen Europe GmbH, the “Company”, “Axogen”, “we” or “our”) may provide forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, concerning possible or anticipated future results of operations or business developments. These statements are based on management’s current expectations or predictions of future conditions, events or results based on various assumptions and management’s estimates of trends and economic factors in the markets in which we are active, as well as our business plans. Words such as "expects", "anticipates", "intends", "plans", "believes", "seeks", "estimates", "projects", "forecasts", "continue", "may", "should", "will", “goals”, variations of such words and similar expressions are intended to identify such forward-looking statements.  The forward-looking statements may include, without limitation, statements regarding our growth, product development, product potential, financial performance, sales growth, product adoption, market awareness of our products, data validation, our assessment of our internal controls over financial reporting, our visibility at and sponsorship of conferences and educational events.   The forward-looking statements are and will be subject to risks and uncertainties, which may cause actual results to differ materially from those expressed or implied in such forward-looking statements.  Such risks and uncertainties include, but are not limited to, risks and uncertainties caused by extraordinary events or circumstances, such as the COVID-19 pandemic, and their impact on our business and operations, the business and operations of our customers, suppliers and other business partners and economic conditions generally.  Forward-looking statements contained in this Form 10-Q should be evaluated together with the many uncertainties that affect the Company’s business and its market, particularly those discussed in the risk factors and cautionary statements set forth in the Company’s filings with the SEC  and other risk factors detailed from time to time as described in “Risk Factors” included in Item 1A of our Annual Filing on Form 10-K, as amended on Form 10-K/A. Forward-looking statements are not guarantees of future performance, and actual results may differ materially from those projected. The forward-looking statements are representative only as of the date they are made, and, except as required by applicable law, the Company assumes no responsibility to publicly update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or otherwise.

2

PART 1 — FINANCIAL INFORMATION

ITEM 1 —FINANCIAL STATEMENTS

Axogen, Inc.

Condensed Consolidated Balance Sheets

(unaudited)

(In Thousands, Except Share and Per Share Amounts)

    

    

    

September 30,

December 31,

2020

2019

Assets

Current assets:

Cash and cash equivalents

$

60,002

$

35,724

Restricted cash

7,607

6,000

Investments

39,126

60,786

Accounts receivable, net of allowance for doubtful accounts of $478 and $1,092, respectively

 

18,758

 

16,944

Inventory

 

11,929

 

13,861

Prepaid expenses and other

 

2,551

 

1,706

Total current assets

 

139,973

 

135,021

Property and equipment, net

 

36,110

 

14,887

Operating lease right-of-use assets

15,987

3,133

Finance lease right-of-use assets

70

87

Intangible assets

 

1,797

 

1,515

Total assets

$

193,937

$

154,643

Liabilities and Shareholders’ Equity

Current liabilities:

Accounts payable and accrued expenses

$

16,279

$

19,130

Current maturities of long-term lease obligations

2,499

1,736

Contract liabilities, current

 

14

 

14

Total current liabilities

 

18,792

 

20,880

Long-term Debt, net of financing fees

31,817

Debt derivative liability

2,450

Common stock derivative option liability

183

Long-term lease obligations

18,976

1,595

Long-term contract liabilities

 

6

 

15

Total liabilities

 

72,224

 

22,490

Commitments and Contingencies - see Note 13

Shareholders’ equity:

Common stock, $0.01 par value per share; 100,000,000 shares authorized; 40,123,841 and 39,589,755 shares issued and outstanding

 

401

 

396

Additional paid-in capital

 

318,949

 

311,618

Accumulated deficit

 

(197,637)

 

(179,861)

Total shareholders’ equity

 

121,713

 

132,153

Total liabilities and shareholders’ equity

$

193,937

$

154,643

See notes to condensed consolidated financial statements.

3

Axogen, Inc.

Condensed Consolidated Statements of Operations

(unaudited)

(In Thousands, Except Share and Per Share Amounts)

Three Months Ended

Nine Months Ended

September 30,

September 30,

September 30,

September 30,

    

2020

    

2019

    

2020

    

2019

    

Revenues

$

33,428

$

28,564

$

79,805

$

78,550

Cost of goods sold

 

5,697

 

4,510

 

16,118

12,468

Gross profit

 

27,731

 

24,054

 

63,687

66,082

Costs and expenses:

Sales and marketing

 

17,726

 

18,245

 

49,854

53,146

Research and development

 

4,230

 

4,181

 

12,915

12,602

General and administrative

 

6,820

 

7,740

 

18,726

24,321

Total costs and expenses

 

28,776

 

30,166

 

81,495

90,069

Loss from operations

 

(1,045)

 

(6,112)

 

(17,808)

(23,987)

Other income (expense):

Investment income

28

555

576

1,925

Interest expense

 

(397)

 

(7)

 

(459)

(32)

Change in fair value of derivatives

(71)

(71)

Other (expense)/income

 

6

 

(7)

 

(14)

(3)

Total other income (expense), net

 

(434)

 

541

 

32

1,890

Net Loss

$

(1,479)

$

(5,571)

$

(17,776)

$

(22,097)

Weighted average common shares outstanding — basic and diluted

 

40,093,588

 

39,340,492

 

39,873,167

39,151,218

Loss per common share — basic and diluted

$

(0.04)

$

(0.14)

$

(0.45)

$

(0.56)

See notes to condensed consolidated financial statements.

4

Axogen, Inc.

Condensed Consolidated Statements of Cash Flows

(unaudited)

(In Thousands)

Nine Months Ended

September 30,

September 30,

    

2020

    

2019

    

Cash flows from operating activities:

Net loss

$

(17,776)

$

(22,097)

Adjustments to reconcile net loss to net cash used in operating activities:

Depreciation

993

631

Amortization of right-of-use assets

1,282

1,352

Amortization of intangible assets

 

111

89

Amortization of deferred financing fees

22

Provision for bad debt

(115)

(150)

Provision for inventory write-down

2,108

(44)

Changes in fair value of derivatives

71

Changes in investment gains and losses

(29)

(957)

Share-based compensation

 

5,725

7,384

Change in operating assets and liabilities:

Accounts receivable

 

(1,700)

20

Inventory

 

(176)

(1,657)

Prepaid expenses and other

 

(844)

(1,099)

Accounts payable and accrued expenses

 

(911)

1,288

Operating lease obligations

(1,213)

(1,276)

Cash paid for interest portion of finance leases

(2)

(3)

Contract and other liabilities

 

(9)

(23)

Net cash used in operating activities

 

(12,463)

(16,542)

Cash flows from investing activities:

Purchase of property and equipment

 

(18,907)

(3,676)

Purchase of investments

(41,794)

(104,314)

Proceeds from sale of investments

63,483

122,071

Cash payments for intangible assets

 

(393)

(396)

Net cash provided by investing activities

 

2,389

13,685

Cash flows from financing activities:

Proceeds from the issuance of long-term debt

35,000

Proceeds from the paycheck protection program

7,820

Repayment of paycheck protection program

(7,820)

Payments for debt issuance costs

(642)

Payments of employee tax withholding in exchange of common stock awards

(665)

Cash paid for debt portion of finance leases

(10)

(24)

Proceeds from exercise of stock options

 

2,276

3,142

Net cash provided by financing activities

 

35,959

3,118

Net increase in cash, cash equivalents, and restricted cash

 

25,885

261

Cash, cash equivalents, and restricted cash, beginning of period

 

41,724

30,294

Cash, cash equivalents and restricted cash, end of period

$

67,609

$

30,555

Supplemental disclosures of cash flow activity:

Cash paid for interest

$

379

$

31

Supplemental disclosure of non-cash investing and financing activities:

Acquisition of fixed assets in accounts payable and accrued expenses

$

1,271

$

684

Obtaining a right-of-use asset in exchange for a lease liability

$

14,119

$

26

Embedded derivative associated with the long-term debt

$

2,562

$

See notes to condensed consolidated financial statements.

5

Axogen, Inc.

Condensed Consolidated Statements of Changes in Shareholders’ Equity

(unaudited)

(In Thousands, Except Share Amounts)

Common Stock

    

Paid-in

    

Accumulated

    

Shareholders'

Shares

Amount

    

Capital

    

Deficit

    

Equity/(Deficit)

Three Months Ended September 30, 2020

Balance at June 30, 2020

40,022,499

$

400

$

315,518

$

(196,158)

$

119,760

Net Loss

-

-

-

(1,479)

(1,479)

Stock-based compensation

-

-

2,947

-

2,947

Issuance of restricted and performance stock units

22,529

-

-

-

-

Shares surrendered by employees to pay tax withholdings

(1,230)

-

(8)

-

(8)

Exercise of stock options and employee stock purchase plan

80,043

1

492

-

493

Balance at September 30, 2020

40,123,841

$

401

$

318,949

$

(197,637)

$

121,713

Nine Months Ended September 30, 2020

Balance at December 31, 2019

39,589,755

$

396

$

311,618

$

(179,861)

$

132,153

Net Loss

-

-

-

(17,776)

(17,776)

Stock-based compensation

-

-

5,725

-

5,725

Issuance of restricted and performance stock units

168,311

2

(2)

-

-

Shares surrendered by employees to pay tax withholdings

(38,086)

(1)

(664)

-

(665)

Exercise of stock options and employee stock purchase plan

403,861

4

2,272

-

2,276

Balance at September 30, 2020

40,123,841

$

401

$

318,949

$

(197,637)

$

121,713

Three Months Ended September 30, 2019

Balance at June 30, 2019

39,252,294

$

393

$

304,819

$

(167,252)

$

137,960

Net Loss

-

-

-

(5,571)

(5,571)

Stock-based compensation

-

-

2,397

-

2,397

Issuance of restricted and performance stock units

3,312

-

-

-

-

Exercise of stock options and employee stock purchase plan

205,712

2

623

-

625

Balance at September 30, 2019

39,461,318

$

395

$

307,839

$

(172,823)

$

135,411

Nine Months Ended September 30, 2019

Balance at December 31, 2018

38,900,875

$

389

$

297,319

$

(150,726)

$

146,982

Net Loss

-

-

-

(22,097)

(22,097)

Stock-based compensation

-

-

7,384

-

7,384

Issuance of restricted and performance stock units

41,340

-

-

-

-

Exercise of stock options and employee stock purchase plan

519,103

6

3,136

-

3,142

Balance at September 30, 2019

39,461,318

$

395

$

307,839

$

(172,823)

$

135,411

See notes to condensed consolidated financial statements.

6

Axogen, Inc.

Notes to Condensed Consolidated Financial Statements

(unaudited)

(In Thousands, Except Per Share Amounts)

Unless the context otherwise requires, all references in these Notes to “Axogen,” “the Company,” “we,” “us” and “our” refer to Axogen, Inc. and its wholly owned subsidiaries Axogen Corporation (“AC”), Axogen Processing Corporation, and Axogen Europe GmbH.

1.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company as of September 30, 2020 and December 31, 2019 and for the three and nine-month periods ended September 30, 2020 and 2019.  The Company’s condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X, and therefore, do not include all information and footnotes necessary for a fair presentation of consolidated financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) and should be read in conjunction with the audited financial statements of the Company for the year ended December 31, 2019, which are included in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2019, as amended on Form 10-K/A.  The interim condensed consolidated financial statements are unaudited and in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of results for the periods presented.  Results for interim periods are not necessarily indicative of results for the full year. All intercompany accounts and transactions have been eliminated in consolidation.  

The results of operations for the three and nine-months ended September 30, 2020 are not necessarily indicative of the results to be expected for the full fiscal year due primarily to the impact of the continued uncertainty of general economic conditions that may impact our markets for the remainder of fiscal year 2020. Specifically, we are uncertain of the extent to which the Coronavirus Disease 2019 (“COVID-19”) pandemic will affect our sales channels, supply chain, manufacturing, distribution capabilities, clinical trials, employee availability and productivity and capital expenditures.  The Company’s access to healthcare facilities has improved each month, although restrictions remain and supporting customers remotely continues to be an important learned capability.  There can be no assurances that resurgences of COVID-19 will not affect our future results.

2.

Summary of Significant Accounting Policies

Credit Losses

On January 1, 2020, the Company adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (“CECL”) methodology.  The CECL model utilizes a lifetime expected credit loss measurement objective for the recognition of credit losses for loans and other receivables at the time the financial asset is originated or acquired. The expected credit losses are adjusted each period for changes in expected lifetime credit losses. This model replaces the multiple existing impairment models previously used under U.S. generally accepted accounting principles, which generally require that a loss be incurred before it is recognized. The new standard also applies to financial assets arising from revenue transactions such as contract assets and accounts receivables. The adoption did not have a material impact on our condensed consolidated financial statements.

Credit losses for trade receivables is determined based on historical information, current information and reasonable and supportable forecasts.  We have concluded that the adoption of the standard was not material as the composition of the trade receivables at the reporting date is consistent with that used in developing the historical credit-loss percentages.  Further, the risk characteristics of the Company’s customer and composition of the portfolio have not changed significantly over time.

7

Fair Value Measurements

On January 1, 2020, the Company adopted ASU 2018-13, Fair Value Measurements (Topic 820) Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 changes the fair value measurement disclosure requirements of ASC 820, “Fair Value Measurement” by adding, eliminating, and modifying certain disclosure requirements. The adoption of ASU 2018-13 did not have a material impact on the Company’s consolidated financial statements.

Cloud Based Arrangements

On January 1, 2020, the Company adopted ASU No. 2018-15, Guidance on Cloud Computing Arrangements.  ASU 2018-15 provides guidance on implementation costs incurred in a cloud computing arrangement (“CCA”) that is a service contract and aligns the accounting for such costs with the guidance on capitalizing costs associated with developing or obtaining internal-use software.   More specifically, the ASU 2018-15 provides guidance on accounting for implementation, set-up and other upfront costs incurred in a CCA hosted by a vendor.  As of January 1, 2020, this standard did not have a material impact on the Company’s consolidated financial statements.

Reference Rate Reform

On March 12, 2020, the FASB issued ASU 2020-04, Reference Rate Reform (ASC 848).  The ASU also establishes (1) a general contract modification principle that entities can apply in other areas that may be affected by reference rate reform and (2) certain elective hedge accounting expedients.  The elective contract modification guidance in the ASU applies to “contracts or other transactions that reference [LIBOR] or a reference rate that is expected to be discontinued as a result of reference rate reform” (an “affected rate”).  The optional amendments are effective for all entities as of March 12, 2020 through December 31, 2020.  As of September 30, 2020, this standard did not have a material impact on the Company’s consolidated financial statements.

Derivative Instruments

Company analyzes all financial instruments with features under ASC 480, “Distinguishing Liabilities from Equity” and ASC 815, “Derivatives and Hedging”.  The Company records liability classified equity contracts at fair value at the issuance and recorded as a liability.  The Company also reviews debt agreements for embedded features. If these features are not clearly and closely related to the debt host, they meet the definition of a derivative and require bifurcation from the host.   All derivative instruments are recorded on the balance sheet at their respective fair values.  The Company will adjust the carrying value of the derivative liability to fair value at each subsequent reporting date.  The changes in the value of the derivatives are recorded in the consolidated statement of operations in the period in which they occur.

Revenue Recognition

The Company enters into contracts to sell and distribute products and services to hospitals and surgical facilities for use in caring for patients with peripheral nerve damage or transection.  Revenue is recognized when the Company has met its performance obligations pursuant to its contracts with its customers in an amount that the Company expects to be entitled to in exchange for the transfer of control of the products and services to the Company’s customers.  

In the case of products or services sold to a customer under an international distribution or purchase agreement, the distributors are granted exclusive distribution rights to sell the products or services in an international territory defined by the contract. These international distributor agreements contain provisions that allow the Company to terminate the distribution agreement with the distributor, and upon termination, the right to repurchase inventory from the distributor at the distributor’s cost. The Company has determined that its contractual rights to repurchase international distributor inventory upon termination of such distributor agreement are not substantive and do not impact the timing of when control transfers; and, therefore, the Company has determined it is appropriate to recognize revenue when:  i) the product is shipped via common carrier; or ii) the product is delivered to the customer or distributor, depending on the terms of the agreement.  Determining the timing of revenue recognition for such contracts is subject to significant judgment, because an evaluation

8

must be made regarding the international distributor’s ability to direct the use of, and obtain substantially all of the remaining benefits from, the implants received from the Company.  Changes in these assessments could have a significant impact on the timing of revenue recognition from sales to distributors.  

A portion of the Company's product revenue is generated from consigned inventory maintained at hospitals and domestic independent sales agencies, and also from inventory physically held by field sales representatives. For these types of product sales, the Company retains control until the product has been used or implanted, at which time revenue is recognized.

The Company elected to account for shipping and handling activities as a fulfillment cost rather than a separate performance obligation. Amounts billed to customers for shipping and handling are included as part of the transaction price and recognized as revenue when control of the underlying products is transferred to the customer. The related shipping and freight charges incurred by the Company are included in the cost of sales.

The Company operates in a single reportable segment of peripheral nerve repair, offers similar products to its customers, and enters into consistently structured arrangements with similar types of customers. As such, the Company does not disaggregate revenue from contracts with customers as the nature, amount, timing and uncertainty of revenue and cash flows does not materially differ within and among the contracts with customers.

The contract with the customer states the final terms of the sale, including the description, quantity, and price of each implant distributed. The payment terms and conditions in the Company’s contracts vary; however, as a common business practice, payment terms are typically due in full within 30 to 60 days of delivery. Since the customer agrees to a stated price in the contract that does not vary over the contract term, the contracts do not contain any material types of variable consideration, and contractual rights of return are not material.  The Company has several contracts with distributors in international markets which include consideration paid to the customer in exchange for distinct marketing and other services. The Company records such consideration paid to the customer as a reduction to revenue from the contracts with those distributor customers.

In connection with the Acroval® Neurosensory and Motor Testing System, a product previously offered by the Company, the Company sold extended warranty and service packages to certain customers, and the prepayment of these extended warranties represent contract liabilities until the performance obligations are satisfied ratably over the term of the contract. The sale of the aforementioned extended warranty represents the only performance obligation the Company satisfies over time and creates the contract liability disclosed below.  

The opening and closing balances of the Company’s contract receivables and liabilities are as follows:

Contract Balances

Net Receivables

Contract Liabilities, Current

Contract Liabilities, Long-Term

Opening, January 1, 2019

$

15,321

$

18

$

42

Closing, September 30, 2019

15,451

14

22

Increase (decrease)

130

(4)

(20)

Opening, January 1, 2020

$

16,944

$

14

$

15

Closing, September 30, 2020

18,758

14

6

Increase (decrease)

1,814

-

(9)

Loss Per Share of Common Stock

Basic and diluted net loss per share is computed by dividing the net loss by the weighted average number of common shares outstanding during the period.  Since the Company has experienced net losses for all periods presented, options and

9

awards of 5,496,833 and 4,584,991 shares which were outstanding as of September 30, 2020 and 2019, respectively, were not included in the computation of diluted net loss per share because they are anti-dilutive.

3.

Recently Issued Standards to be Adopted

In October 2020, the FASB issued ASU 2020-08, Codification Improvements to Subtopic 310-20, Receivables-Nonrefundable Fees and Other Costs.  The guidance is effective for fiscal years beginning after December 15, 2020.  Early adoption is not permitted.  We are currently evaluating the impact the standard may have on our consolidated financial statements and related disclosures.

4.

Inventory

Inventories are comprised of unprocessed tissue, work-in-process, Avance® Nerve Graft, Axoguard® Nerve Connector, Axoguard® Nerve Protector, Axoguard® Nerve Cap, Avive® Soft Tissue Membrane, Acroval® Neurosensory and Motor Testing System, Axotouch® Two-Point Discriminator and supplies and are valued at the lower of cost (first-in, first-out) or net realizable value and consist of the following:

    

September 30,

    

December 31,

    

2020

2019

Finished goods

$

8,339

$

10,403

Work in process

 

798

 

730

Raw materials

2,792

 

2,728

Inventories

$

11,929

$

13,861

The Company monitors the shelf life of its products and historical expiration and spoilage trends and writes-down inventory based on the estimated amount of inventory that may not be distributed before expiration or spoilage.  For the nine months ended September 30, 2020 and 2019, the Company had adjustments to the provision for inventory write downs of $2,108 and ($44) respectively.    

5.

Fair Value Considerations

Fair value is defined as the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy defines a three-level valuation hierarchy for classification and disclosure of fair value measurements as follows:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company classifies cash equivalents and investments according to the hierarchy of techniques used to determine fair value based on the types of inputs.  The Company has elected the Fair Value Option for all investments in debt securities.  

On June 30, 2020, the Company entered into the Oberland Facility (see Note 10 Long Term Debt), concluding that the term debt instrument included certain embedded features that required separate accounting (the “Debt Derivative Liability”) and that the equity contract entered into concurrently was required to be classified as a liability and recorded at its fair value (the “Common Stock Derivative Option Liability”).  These instruments were determined to be financial liabilities requiring Level 3 fair value measurements.

10

Debt Derivative Liability

The debt derivative liability was measured using a ‘with and without’ valuation model to compare the fair value of the Oberland Facility including the identified embedded derivative features and the fair value of a plain vanilla note with the same terms. The fair value of the Oberland Facility including the embedded derivative features was determined using a probability-weighted expected return model (“PWERM”) based on four potential settlement scenarios for the Oberland Facility due to a mandatory prepayment event between January 1, 2024 and June 30, 2027; (a) the prepayment of the Oberland Facility at the Company’s option; and (b) the repayment of the Oberland Facility at its maturity in accordance with the terms of the debt agreement. The estimated settlement value of each scenario, which would include any required make-whole payment (see Note 10 Long Term Debt) is then discounted to present value using a discount rate that is derived based on the initial terms of the Oberland Facility at issuance and corroborated utilizing a synthetic credit rating analysis.

The significant inputs that are included in the valuation of the debt derivative liability include:

September 30, 2020

Input

Remaining term (years)

6.75 years

Maturity date

June 30, 2027

Coupon rate

9.50%

Revenue participation payments

Maximum each year

Discount rate

10.03%

(1)

Probability of mandatory prepayment before 2024

5.0%

(1)

Estimated timing of mandatory prepayment event before 2024

December 31, 2023

(1)

Probability of mandatory prepayment 2024 or after

15.0%

(1)

Estimated timing of mandatory prepayment event 2024 or after

March 31, 2026

(1)

Probability of optional prepayment event

5.0%

(1)

Estimated timing of optional prepayment event

December 31, 2025

(1)

(1) Represents a significant unobservable input

Common Stock Derivative Option Liability  

The common stock option liability was measured using a Monte Carlo simulation model to simulate the future changes in the Company’s common stock price from the issuance date of the option agreement through the termination date of the option agreement. The 45-day volume weighted average price (“VWAP”) (see Note 10 Long Term Debt) is calculated for each simulation trial to determine the effective exercise price and number of common shares to be issued. The model assumes the holder will only exercise the option if the common stock is in the money on the exercise date. The value of the option is then determined based on the number of shares to be issued and the stock price on the date that the option is exercised. This option value is then discounted back to present value. The calculated present value of the option is then estimated using the average of 100,000 trials of the simulation model.

The significant inputs that are included in the valuation of the common stock option liability include:

September 30, 2020

Input

Option term

6.75 years

Company stock price

$

11.63

Risk free rate

0.45%

Equity volatility

60%

(1)

Simulation trials

100,000

(1) Represents a significant unobservable input

11

The following table represents the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2020:

(Level 1)

(Level 2)

(Level 3)

Total

September 30, 2020

Assets:

Money market funds

$

39,112

$

$

$

39,112

U.S. government securities

4,520

4,520

Corporate bonds

6,441

6,441

Commercial paper

28,165

28,165

Asset-backed securities

Total assets

$

43,632

$

34,606

$

$

78,238

Liabilities

Debt derivative liability

$

$

$

2,450

$

2,450

Common stock derivative option liability

183

183

Total liabilities

$

$

$

2,633

$

2,633

(Level 1)

(Level 2)

(Level 3)

Total

December 31, 2019

Assets:

Money market funds

$

26,812

$

$

$

26,812

U.S. government securities

4,544

4,544

Corporate bonds

17,754

17,754

Commercial paper

24,679

24,679

Asset-backed securities

13,808

13,808

Total assets

$

31,356

$

56,241

$

$

87,597

There were no changes in the levels or methodology of the measurement of financial assets or liabilities during the three and nine months ended September 30, 2020.  The maturity date of the Company’s investments is less than one year.

The following represents the rollforward of the fair value of instruments classified as Level 3 measurements for the three and nine months ended September 30, 2020:

Quarter Ending September 30, 2020

Beginning Balance, July 1, 2020

$

2,562

Change in fair value of option derivative

11

Change in fair value of debt derivative

60

Ending Balance, September 30, 2020

$

2,633

Year Ending December 31, 2020

Beginning Balance

$

Option to purchase shares

183

Fair Value of Derivative Feature

2,450

Ending Balance, September 30, 2020

$

2,633

12

6.

Prepaid Expense and Other

Prepaid and other assets consist of the following:

    

September 30,

    

December 31,

    

2020

2019

Prepaid insurance

$

539

$

Stock option receivable

244

Litigation receivable

23

98

Prepaid events

493

110

Prepaid marketing

480

227

Prepaid software license

135

207

Prepaid professional fees

529

433

Other Prepaid items

352

387

Prepaid and Other Assets

$

2,551

$

1,706

Our policy year for our insurance runs on a calendar year and as such a significant portion of the policy payment is made at the beginning of the new year and amortized to expense throughout the remaining year.

7.

Property and Equipment

Property and equipment consist of the following:

    

September 30,

    

December 31,

    

2020

2019

Furniture and equipment

$

2,236

$

2,059

Leasehold improvements

 

12,223

 

2,203

Processing equipment

 

2,887

 

2,772

Land

731

731

Projects in process

22,790

10,886

Property and equipment, at cost

40,867

18,651

Less: accumulated depreciation and amortization

 

(4,757)

 

(3,764)

Property and equipment, net

$

36,110

$

14,887

Depreciation expense for the three months ended September 30, 2020 and 2019 was $374 and $192, respectively.  Depreciation expense for the nine months ended September 30, 2020 and 2019 was $993 and $631, respectively.  The significant increase in projects in process is related to our Axogen Processing Center (“APC”) facility (See Note 13 Commitments and Contingencies).

On September 20, 2018, the Company entered into an agreement (the “Heights Agreement”) with Heights Union, LLC, a Florida limited liability company (“Heights Union”), for the lease of seventy-five thousand square feet of office space (the “Heights Union Premises”) in Tampa, Florida (See Note 13 Commitments and Contingencies).  In May 2020, the Company entered into a construction escrow agreement (the “Escrow Agreement”) with Heights Union and Commonwealth Land Title Insurance Company (“Escrow Agent”) which provided for the establishment of a federally insured escrow bank account (the “Escrow Account”) to hold Company funds to be used for tenant improvements in excess of the tenant allowance as provided in the Heights Agreement. The Company deposited $6,289 into the Escrow Account for use in completing construction of the tenant improvements.  The Escrow Agent will disburse the funds upon joint written instructions from Heights Union and the Company.  During the three months and nine months ended September 30, 2020, $3,464 and $4,682, respectively, was disbursed from the Escrow Account and recorded in property and equipment account of the balance sheet.  The Company anticipates depleting the Escrow Account by November 2020.  As

13

of September 30, 2020, $1,607 remained in the Escrow Account and is recorded as restricted cash in the condensed consolidated balance sheet.

.

8.

Intangible Assets

The Company’s intangible assets consist of the following:

    

September 30, 2020

    

December 31, 2019

    

Gross Carrying Amount

Accumulated Amortization

Net Carrying Amount

Gross Carrying Amount

Accumulated Amortization

Net Carrying Amount

Amortized intangible assets

Patents

$

1,201

$

(122)

$

1,079

$

845

$

(84)

$

761

License agreements

1,089

(720)

369

1,067

(647)

420

Total amortizable intangible assets

$

2,290

$

(842)

$

1,448

$

1,912

$

(731)

$

1,181

Unamortized intangible assets

Trademarks

$

349

$

$

369

$

334

$

$

334

Total intangible asset, net

$

2,639

$

(842)

$

1,797

$

2,246

$

(731)

$

1,515

License agreements are being amortized over periods ranging from 17-20 years. Patent costs are being amortized over periods up to 20 years. Amortization expense was approximately $39 and $33 for the three months ended September 30, 2020 and 2019, respectively.  Amortization was approximately $111 and $89 for the nine months ended September 30, 2020 and 2019, respectively.  As of September 30, 2020, future amortization of license agreements and patents are as follows:

Year Ending December 31,

2020 (excluding nine months ended September 30, 2020)

$

40

2021

160

2022

160

2023

151

2024

67

Thereafter

870

TOTAL

$

1,448

License Agreements

The Company has entered into multiple license agreements (together, the “License Agreements”) with the University of Florida Research Foundation and the University of Texas at Austin. Under the terms of the License Agreements, the Company acquired exclusive worldwide licenses for underlying technology used in repairing and regenerating nerves. The licensed technologies include the rights to issued patents and patents pending in the United States and international markets. The effective term of the License Agreements extends through the term of the related patents and the agreements may be terminated by the Company with 60 days’ prior written notice. Additionally, in the event of default, licensors may terminate an agreement if the Company fails to cure a breach after written notice. The License Agreements contain the key terms listed below:

Axogen pays royalty fees ranging from 1% to 3% under the License Agreements based on net sales of licensed products. One of the agreements also contains a minimum royalty of $12.5 per quarter, which may include a credit in future quarters in the same calendar year for the amount the minimum royalty exceeds the royalty fees. Also, when Axogen pays royalties to more than one licensor for sales of the same product, a royalty stack cap applies, capping total royalties at 3.75%;

14

If Axogen sublicenses technologies covered by the License Agreements to third parties, Axogen would pay a percentage of sublicense fees received from the third party to the licensor. Currently, Axogen does not sublicense any technologies covered by License Agreements. The Company is not considered a sub-licensee under the License Agreements and does not owe any sub-licensee fees for its own use of the technologies;

Axogen reimburses the licensors for certain legal expenses incurred for patent prosecution and defense of the technologies covered by the License Agreements; and

Currently, under the University of Texas at Austin’s agreement, Axogen would owe a milestone fee of $15 upon receiving a Phase II Small Business Innovation Research or Phase II Small Business Technology Transfer grant involving the licensed technology. The Company has not received either grant and does not owe such a milestone fee.  A milestone fee to the University of Florida Research Foundation of $125 is due if Axogen receives FDA approval of its Avance Nerve Graft, a milestone fee of $25 is due upon the first commercial use of certain licensed technology to provide services to manufacture products for third parties and a milestone fee of $10 is due upon the first use to manufacture products that utilize certain technology that is not currently incorporated into Axogen products.

Royalty fees were approximately $701 and $577 during the three months ended September 30, 2020 and 2019, respectively, and approximately $1,635 and $1,573 during the nine months ended September 30, 2020 and 2019, respectively, and are included in sales and marketing expense on the accompanying condensed consolidated statements of operations.

9.

Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses consist of the following:

    

September 30,

    

December 31,

    

2020

2019

Accounts payable

$

3,507

$

8,262

Accrued expenses

3,091

3,237

Accrued compensation

9,681

 

7,631

Accounts Payable and Accrued Expenses

$

16,279

$

19,130

10. Long Term Debt

On June 30, 2020, the Company entered into a seven-year financing agreement with Oberland Capital (the “Oberland Facility”) and obtained the first tranche of $35,000 at closing.  The Oberland Facility provides for a total of $75,000 through two additional tranches that can be drawn by December 31, 2021 and requires interest-only payments for the duration of the term.  A second tranche of $15,000 may be drawn at the Company’s option upon achieving two consecutive quarters with revenue of at least $20,000. Such second tranche may also be put to the Company at any time by Oberland Capital. A third tranche of $25,000 may be drawn at the Company’s option upon achieving two consecutive quarters with revenue of $28,000.  The financing costs for this facility are approximately $642 and will be recorded as a contra liability to the debt facility.  As of September 30, 2020, the Company has paid all of the financing costs.

The Oberland Facility requires quarterly interest payments for seven years. Interest is calculated as 7.5% plus the greater of LIBOR or 2.0% (9.5% as of September 30, 2020). Each tranche of the Oberland Facility, if and when issued, will have a term of seven years from the date of issuance (with the first tranche issued on June 30, 2020 maturing on June 30, 2027).  In connection with the Oberland Facility, the Company entered into a revenue participation agreement with Oberland Capital, which provides that, among other things, an additional quarterly royalty payment as a percentage of the Company’s net revenues, up to $70 million in any given fiscal year, subject to certain limitations set forth therein, during the period commencing on the later of (i) April 1, 2021 and (ii) the date of funding of a tranche of the loan, and ending on the date upon which all amounts owed under the Oberland Facility have been paid in full (the “Revenue Participation Agreement”).  Payments will commence on September 30, 2021.  This royalty structure results in approximately 1.0% per year of additional interest payments on the outstanding loan amount.   For the three months ended September 30, 2020, the

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Company paid $858 of interest to Oberland for this debt facility.  The Company capitalized approximately $489 of the interest towards the costs to construct and retrofit its Axogen Processing Center in Vandalia, OH (See Note 13 Commitments and Contingency).  The capitalized interest is recorded as part of property and equipment in the consolidated balance sheet.

Additionally, Oberland Capital has the right to purchase up to $3,500 worth of Axogen common stock from Axogen in one transaction at any time after closing of the Oberland Facility until the later of (i) the date all amounts due under the Oberland Facility are repaid and (ii) June 30, 2027 (the “Oberland Option”). The purchase price of the common stock will be calculated based on the 45-day moving average of the closing stock price on the day prior to the purchase.  In the event that Oberland Capital exercises the Oberland Option and is issued common stock, Oberland Capital will receive certain protective rights (including protection from down-round stock issuances) for a period of one year subsequent to the issuance. The Company is also required to register the shares underlying the Oberland Option on a ‘best-efforts’ basis.

The amounts outstanding under the Oberland Facility may be accelerated upon certain events, including: (a) required mandatory prepayments upon an asset sale; (b) in the event Axogen is subject to (i) any litigation brought by a Governmental Authority (as defined in the Oberland Facility) including intervention after litigation is commenced by a Person (as defined in the Oberland Facility ), or (ii) any final administrative action by a Governmental Authority, in each case arising out of or in connection with any of the Company’s registry studies, payments made to doctors or training activities with respect to healthcare professionals (excluding certain final administrative action that have been fully and finally resolved by the parties pursuant to a settlement agreement) or (c) upon the occurrence of an event of default (either automatically or at the option of Oberland Capital depending on the nature of the event).  In addition, the Company has the right to prepay any amounts outstanding under the Oberland Facility. Upon maturity or upon such earlier repayment of the Oberland Facility, the Company will repay the principal balance and provide a make-whole payment calculated to generate an internal rate of return (“IRR”) to Oberland Capital of at least 11.5%, less the total of all quarterly interest and royalty payments previously paid to Oberland Capital.

Upon the occurrence of an event of default, the interest rate incurred on amounts outstanding under the Oberland Facility will be increased by 4%. The Oberland Facility includes a financial covenant requiring the Company to achieve revenue targets of $8,750 for the third and four quarters of 2020, $17,500 for the first and second quarter of 2021 and $20,000 for each quarter thereafter.  In the event of a failure to meet such covenant the Company may avoid a default by electing to be subject to a liquidity covenant and meeting all of the obligations required by such covenant.  Specifically, the liquidity covenant provides that the Company must maintain on deposit in a cash collateral account an amount not less than 1.1 times the aggregate outstanding principal balance of all outstanding loan amounts.  The borrowings under the Oberland Facility are secured by substantially all of the assets of the Company.  As of September 30, 2020, the Company was in compliance with the minimum revenue covenant.

Accounting Considerations

The Company assessed the accounting impact of the Oberland Facility and the related agreements entered into with Oberland Capital. The Company concluded that the Oberland Facility and the Revenue Participation Agreement should be assessed on a combined unit of account basis (with the Revenue Participation Agreement being considered as an embedded feature with the Oberland Facility), and that the Oberland Option should be considered as a separate freestanding instrument for analysis purposes.

In relation to the Oberland Facility and Revenue Participation Agreement, the Company assessed the identified embedded features to determine if they would require separate accounting. In performing this assessment, the Company concluded the following embedded features met the definition of a derivative and would not be considered clearly and closely related to the debt instrument, requiring separate accounting as bifurcated derivatives:

Mandatory prepayments upon an asset sale or litigation involving the government, including the make-whole payment (put rights)
Optional or automatic prepayment upon an event of default (put rights)
Payments under the Revenue Participation Agreement (contingent interest feature)
Additional interest upon events of default (contingent interest feature)

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The Company considered these separable embedded features on a combined basis as a single derivative feature. The Company estimated the fair value of these features as $2,387 as of the date of issuance of the Oberland Facility (see Note 5 Fair Value Considerations) and recorded this value as a deduction to the carrying value of the Oberland Facility.

In relation to the Oberland Option, the Company concluded that the equity contract met the definition of a derivative and did not qualify for an exception from derivative accounting. As such, the Company concluded that the Oberland Option should be classified as a liability. The Company estimated the fair value of the Oberland Option as $176 as of the date of issuance of the Oberland Facility (see Note 5 Fair Value Considerations) and recorded this value as a deduction to the carrying value of the Oberland Facility.  As of September 30, 2020, the carrying amount of the long-term debt reported in the consolidated balance sheet approximates fair value using Level 2 inputs in the fair value hierarchy.  Fair values are generally estimated based on quoted market prices for similar instruments.

The following represents the components of the net carrying value of the Oberland Facility at September 30, 2020:

September 30,

2020

Principal Balance

Debt Discount

Debt Issuance Costs, Net

Long-term Debt, Net

Oberland facility

$

35,000

$

(2,563)

(620)

31,817

Other Long-Term Debt

On April 23, 2020, the Company received a Small Business Administration (“SBA”) loan under the Paycheck Protection Program (“PPP”) in the amount of $7,820.  The loan was obtained pursuant to the original guidance of the SBA to preserve positions in the Company by providing necessary economic relief during this period of reduced surgical procedures because of the negative business effects of COVID-19.  The Company believed it correctly applied for the loan, met the initial intent of the PPP program to preserve jobs and believed it complied with the representations provided in the loan documents.  However, subsequent to obtaining the loan, the United States Treasury Department issued guidance, which the Company believes contradicts the original intent and language of the PPP, providing that public companies are unlikely to be able to meet the standards for receiving the PPP loan.  As a result of this change, the Company believed it was in its best business interests to repay the loan and did so on May 5, 2020.

11.

Stock Incentive Plan

At the 2019 Annual Meeting of Shareholders held on August 14, 2019, the shareholders approved the Axogen 2019 Long-Term Incentive Plan (the “New Axogen Plan”), which allows for issuance of incentive stock options, non-qualified stock options, performance stock units (“PSUs”) and restricted stock units (“RSUs”) to employees, directors and consultants at exercise prices not less than the fair market value at the date of grant.  The number of shares of common stock authorized for issuance under the New Axogen Plan is (A) 3,385,482 shares, comprised of (i) 3,000,000 new authorized shares and (ii) 385,482 unallocated shares of common stock available for issuance as of August 14, 2019 pursuant to the Company’s 2010 Stock Incentive Plan, as amended and restated (the “Prior Axogen Plan”), that were not then subject to outstanding awards; plus (B) shares under the Prior Axogen Plan and the New Axogen Plan that are cancelled, forfeited, expired, unearned or settled in cash, in any such case that does not result in the issuance of common stock.  Following shareholder approval of the New Axogen Plan, no future awards will be made under the Prior Axogen Plan. As of September 30, 2020, 1,807,299 shares of common stock were available for issuance under the New Axogen Plan.

The options granted to employees prior to July 1, 2017 typically vest 25% one year after the grant date and 12.5% every six months thereafter for the remaining three-year period until fully vested after four years. The options granted to employees after July 1, 2017 typically vest 50% two years after the grant date and 12.5% every six months thereafter for the remaining two-year period until fully vested after four years.  The options granted to directors and certain options

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granted from time to time to certain executive officers have vested ratably over three years, 25% per quarter over one year or had no vesting period. Options typically have terms ranging from seven to ten years.

Performance stock units generally have a requisite service period of three years and are subject to graded vesting conditions based on revenue goals of the Company. The Company expenses their fair value over the requisite service period. Restricted stock units have a requisite service period of four years.  The Company expenses the fair value of restricted stock awards on a straight-line basis over the requisite service period.

In February 2020, the Company issued PSUs relating to a 2017 grant with performance metrics tied to 2019 revenue.  The award was issued at 72.3% of achievement and therefore, 27.7% of the stock compensation, or $536 relating to this grant was forfeited or reversed in the first quarter 2020. In addition, as a result of COVID-19 and the expected decline in revenue for 2020, it was determined that the 2018 PSU grant with performance metrics tied to 2020 revenue would not be awarded and therefore stock compensation related to these grants of $1,161 was forfeited.  In June 2020, the Company concluded that the performance metrics relating to the 2020 PSU grant with performance metrics tied to 2021 revenue were no longer probable and therefore stock compensation related to these grants of $340 was also forfeited.

The New Axogen Plan allows an immediate share repurchase feature for tax withholding.  The Company has a statutory obligation to withhold taxes on the employee’s behalf and the tax withholding is limited to the maximum statutory tax rates in the employees’ applicable jurisdictions.  In the nine months ended September 30, 2020, employees surrendered 38,086 shares of RSU and PSU to the Company. As a result, the Company paid $665 of tax withholdings for the employees.

The Company also maintains the Axogen 2017 Employee Stock Purchase Plan (the “2017 ESPP”), which allows eligible employees to acquire shares of the Company’s common stock through payroll deductions at a discount to market price.  A total of 600,000 shares of the Company’s common stock are authorized for issuance under the 2017 ESPP, and, as of September 30, 2020, 373,066 shares remained available for issuance.  In June 2020, the employees purchased 77,239 shares at $7.85 through the 2017 ESPP plan.  

The Company recognized stock-based compensation expense, which consisted of compensation expense related to employee stock options, PSUs, RSUs and the 2017 ESPP based on the value of share-based payment awards that are ultimately expected to vest during the period, as well as the adjustment mention above, of approximately $2,947 and $2,395 for the three months ended September 30, 2020 and 2019, respectively and approximately $5,725 and $7,384 for the nine months ended September 30, 2020 and 2019, respectively.

The Company estimates the fair value of each option award issued under such plans on the date of grant using a Multiple Point Black-Scholes option-pricing model which uses a weighted average of historical volatility and peer company volatility. The Company determines the expected life of each award giving consideration to the contractual terms, vesting schedules and post-vesting forfeitures. The Company uses the risk-free interest rate on the implied yield currently available on U.S. Treasury issues with an equivalent remaining term approximately equal to the expected life of the award.

A summary of the stock option activity is as follows:

Options

Weighted Average Exercise Price

Weighted Average Remaining Contractual Life

Aggregate Intrinsic Value (in thousands)

Outstanding, December 31, 2019

3,420,181

$ 12.69

5.7

$ 26,074

Granted

647,090

$ 9.19

Exercised

(326,622)

$ 5.22

Cancelled

(103,586)

$ 20.18

Outstanding, September 30, 2020

3,637,063

$ 12.52

5.93

$ 10,901

Exercisable, September 30, 2020

2,127,093

$ 9.78

$ 9,125

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The Company used the following weighted-average assumptions for options granted during the periods indicated:

Nine months ended September 30,

    

2020

2019

    

Expected term (in years)

 

5.69

5.76

Expected volatility

 

59.25

%  

56.03

%  

Risk free rate

 

0.35

%  

1.54

%  

Expected dividends

 

%  

%  

A summary of the status of non-vested RSUs/PSUs as of September 30, 2020 and the changes during the nine months then ended are presented below:

Outstanding Stock Units

Stock Units

Weighted-Average Fair Value at Date of Grant per Share

Weighted Average Remaining Vesting Life

Aggregate Intrinsic Value (in thousands)

Unvested December 31, 2019

1,113,696

$ 21.62

2.26

$ 19,800

Granted

995,940

$ 9.52

Released

(168,311)

$ 18.80

Forfeited

(81,555)

$ 18.91

Unvested September 30, 2020

1,859,770

$ 15.51

2.45

$ 21,572

Vested and Expected to Vest

1,859,770

$ 15.51