13. Commitments and Contingencies

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Leases

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We lease office space, medical lab and research space, a distribution center, a tissue processing center and equipment. Leases with an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.

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Certain of our leases include options for the Company to extend the lease term. None of the options were reasonably certain of exercise and therefore are not included in the measure of our lease obligations and right-to-use assets.

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Certain of our lease agreements include provisions for the Company to reimburse the lessor for common area maintenance, real estate taxes, and insurance, which the Company accounts for as variable lease costs. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.

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The components of total lease expense for the three and nine months ended September 30, 2019 were as follows:

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The short-term lease cost shown above reasonably reflects the Company’s ongoing short-term lease commitment.

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Supplemental balance sheet information related to leases as of September 30, 2019 was as follows:

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Other information related to leases was as follows:

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The weighted-average discount rate for the majority of the Company’s leases is based on the Company’s estimated incremental borrowing rate since the rates implicit in the leases were not determinable. The Company’s incremental borrowing rate is based on Management’s estimate of the rate of interest the Company would have to pay to borrow on a fully collateralized basis over a similar term an amount equal to the lease payments.

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Future minimum lease payments under non-cancellable leases as of September 30, 2019 were as follows:

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The lease for office space in Tampa, Florida with Heights Union, LLC, a Florida limited liability company, has not commenced and is therefore not included in the measurement of right-to-use assets and lease liabilities.

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As previously disclosed in our 2018 Annual Report on Form 10-K, which followed the lease accounting guidance prior to our adoption of ASC 842, future commitments relating to noncancelable operating and capital leases as of December 31, 2018 were as follows:

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Rent expense for the three and nine months ended September 30, 2018 was $141 and $358, respectively.

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Service Agreements

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On August 6, 2015, the Company entered into a License and Services Agreement (the “CTS Agreement”) with Community Blood Center (d/b/a Community Tissue Services) (“CTS”), Dayton, Ohio, an FDA registered tissue establishment. Processing of the Avance Nerve Graft pursuant to the CTS Agreement began in February 2016. The CTS Agreement initially had a five-year term ending August 31, 2020. On February 22, 2019, the agreement was amended to extend the term through December 31, 2021. The amendment also gives the Company the right to terminate the agreement on or after March 1, 2021 with six-months advance notice. Under the CTS Agreement, the Company pays CTS a facility fee for use of clean room/manufacturing, storage and office space, which the Company accounts for as an embedded lease in accordance with ASC 842, “Leases”. The Company also pays CTS for services in support of its manufacturing process such as for routine sterilization of daily supplies, providing disposable supplies, microbial services and office support. During the three months ended September 30, 2019 and 2018, the Company paid fees to CTS of approximately $566 and $553, respectively, and during the nine months ended September 30, 2019 and 2018, approximately $1,624 and $1,426, respectively, and are included in cost of goods sold on the accompanying condensed consolidated statements of operations.

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In August 2008, the Company entered into an agreement with Cook Biotech to distribute the Axoguard products worldwide in the field of peripheral nerve repair, and the parties subsequently amended the agreement on February 26, 2018. Pursuant to the February 2018 amendment, the agreement expires on June 30, 2027. The Cook Biotech agreement requires certain minimum purchases, although, through mutual agreement, the parties have not established such minimums; and, to date, have not enforced such provision, and establishes a formula for the transfer cost of the Axoguard products. Under the agreement, Axogen provides purchase orders to Cook Biotech, and Cook Biotech fulfills the purchase orders.

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In December 2011, the Company also entered into a Master Services Agreement for Clinical Research and Related Services. The Company was required to pay $151 upon execution of this agreement and the remainder monthly based on activities associated with the execution of Axogen’s phase 3 pivotal clinical trial to support a biologics license application (“BLA”) for Avance Nerve Graft. In September 2019, the Company entered into an amendment to this agreement. The amendment extends the end of the study timeline from December 2019 to December 2021. It also increases the total number of subjects enrolled and the number of sites used in the studies. Payments made under this agreement were $196 and $212 for the three months ended September 30, 2019 and 2018, respectively. Payments made under this agreement were $337 and $372 for the nine months ended September 30, 2019 and 2018, respectively.  

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Certain executive officers of the Company are parties to employment contracts. Such contracts have severance payments for certain conditions including change of control.

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Concentrations

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Vendor

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Substantially all of Axogen’s revenue is currently derived from four products, Avance Nerve Graft, Axoguard Nerve Protector, Axoguard Nerve Connector and Avive Soft Tissue Membrane. Axogen has an exclusive distribution agreement with Cook Biotech for the purchase of Axoguard which expires June 30, 2027. The agreement with Cook Biotech requires certain minimum purchases by Axogen, although, through mutual agreement, the parties have not established such minimums and to date have not enforced such provision and establishes a formula for the transfer cost of the Axoguard products.

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The agreement allows for termination provisions for both parties. Although there are products that Axogen believes it could develop or obtain that would replace the Axoguard products, the loss of the ability to sell the Axoguard products could have a material adverse effect on Axogen’s business until other replacement products would be available.

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Processor

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Axogen is highly dependent on the continued availability of its processing facilities at CTS in Dayton Ohio and could be harmed if the physical infrastructure of this facility is unavailable for any prolonged period of time. In addition, disruptions could lead to significant costs and reductions in revenues, as well as a potential harm to Axogen’s business reputation and financial results. In the event of disruption, Axogen believes it can find and make operational a new leased facility in less than six months, but the regulatory process for approval of facilities is time-consuming and unpredictable. Axogen’s ability to rebuild or find acceptable lease facilities could take a considerable amount of time and expense and could cause a significant disruption in service to its customers. Although Axogen has business interruption insurance, which would cover certain costs, it may not cover all costs nor help to regain Axogen’s standing in the market.

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In July 2018, Axogen purchased a facility (the “APC”) in Vandalia, Ohio, located near the CTS processing facility where Avance Nerve Graft and Avive Soft Tissue Membrane are currently processed. The APC, when and if operational, will be the new processing facility for Avance Nerve Graft and Avive Soft Tissue Membrane to provide

continued capacity for growth and to support the transition of Avance Nerve Graft from a 361 HCT/P tissue product to a biologic product. The APC is comprised of a 70,000 square foot building on approximately 8.6 acres of land. The Company paid $731 for the land and is recorded as Land within our property and equipment account on our balance sheet. The Company paid $4,300 for the building and this is recorded as projects in process as part of the property and equipment on the balance sheet.

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On July 9, 2019, Axogen entered into a Standard Form of Agreement Between Owner and Design-Builder (the “Design-Build Agreement”) with CRB Builders, L.L.C., a Missouri limited liability company (“CRB”), pursuant to which CRB will renovate and retrofit the APC.  The Design-Build Agreement contains several design phase milestones that began in July 2019 and sets the date for Substantial Completion (as defined in the Design-Build Agreement) in the third quarter of 2020, subject to adjustment in accordance with the terms of the Design-Build Agreement. The estimated cost pursuant to the Design-Build Agreement is $29,000.  Additional costs associated with the renovation, purchasing of furniture and equipment, validation and certification of the APC are estimated to be $13,000.  These capital expenditure costs will be incurred as they arise until the anticipated full transition of material processing to the APC by early 2022. As of September 30, 2019, the Company has recorded $2,632 related to renovations and design build. These items are recorded as projects in process as part of the property and equipment on the balance sheet.

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Axogen expects to receive certain economic development grants from state and local authorities totaling up to $2,685 including $1,250 of cash grants to offset costs to acquire and develop the APC.  The economic development grants are subject to certain job creation milestones by 2023 and related contingencies. 

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As previously disclosed the Company previously entered into an agreement with Heights Union, LLC, a Florida limited liability company (“Heights Union”), for the lease of seventy-five thousand square feet of office space.  Pursuant to the Heights Union lease, the Company will use the Heights Union Premises for general office, medical laboratory, training and meeting purposes.  The Company anticipates occupying the premises by the second quarter of 2020.  Associated with the lease, the Company anticipates spending up to $10,240 for leasehold improvements, equipment and furniture and fixtures.  As of September 30, 2019, the Company has recorded $292 of leasehold improvements to the new facility.

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Litigation

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On January 9, 2019, Plaintiff Neil Einhorn, on behalf of himself and others similarly situated, filed a putative class action complaint in the United Stated District Court for the Middle District of Florida alleging violations of the federal securities laws against Axogen, Inc., certain of its directors and officers (“Individual Defendants”), and Axogen’s 2017 Offering Underwriters and 2018 Offering Underwriters (collectively, with the Individual Defendants, the “Defendants”), captioned Einhorn v. Axogen, Inc., et al., No. 8:19-cv-00069 (M.D. Fla.).  Plaintiff asserts that Defendants made false or misleading statements in connection with the Company’s November 2017 registration statement issued regarding its secondary public offering in November 2017 and May 2018 registration statement issued regarding its secondary public offering in May 2018, and during a class period of August 7, 2017 to December 18, 2018.   In particular, Plaintiff asserts that Defendants issued false and misleading statements and failed to disclose to investors: (1) that the Company aggressively increased prices to mask lower sales; (2) that the Company’s pricing alienated customers and threatened the Company’s future growth; (3) that ambulatory surgery centers form a significant part of the market for the Company’s products; (4) that such centers were especially sensitive to price increases; (5) that the Company was dependent on a small number of surgeons whom the Company paid to generate sales; (6) that the Company’s consignment model for inventory was reasonably likely to lead to channel stuffing; (7) that the Company offered purchase incentives to sales representatives to encourage channel stuffing; (8) that the Company’s sales representatives were encouraged to backdate revenue to artificially inflate metrics; (9) that the Company lacked adequate internal controls to prevent such channel stuffing and backdating of revenue; (10) that the Company’s key operating metrics, such as number of active accounts, were overstated; and (11) that, as a result of the foregoing, Defendants’ positive statements about the Company’s business, operations, and prospects, were materially misleading and/or lacked a reasonable basis.  Plaintiff seeks an order (a) declaring the action a proper class action pursuant to Rule 23 of the Federal Rules of Civil Procedures; (b) awarding Police and Fire Retirement System of the City of Detroit (“Lead Plaintiff”) and the prospective class compensatory damages against all Defendants in an amount to be proven at trial; (c) awarding Lead

Plaintiff and the prospective class extraordinary equitable and/or injunctive relief as permitted by the law (including but not limited to rescission); (d) awarding Lead Plaintiff and the prospective class their costs and expenses incurred in the action, including reasonable attorneys’ fees and expert fees; (e) all such other relief that may be just and proper. Axogen was served on January 15, 2019.  On February 4, 2019, the court granted the parties’ stipulated motion which provided that Axogen is not required to file a response to the complaint until thirty days after Plaintiff files a consolidated amended complaint. On June 19, 2019, Plaintiff filed an Amended Class Action Complaint, and on July 22, 2019, Defendants filed a motion to dismiss. Plaintiff filed opposing papers on August 12, 2019. The Court held a status hearing on September 11, 2019 and stayed all deadlines regarding the parties’ obligations to file a case management report. The Court scheduled oral argument for the motion to dismiss for December 4, 2019. The Company and Individual Defendants dispute the allegations and intend to vigorously defend against the complaint.

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On February 4, 2019, a complaint in Jerry Espinoza, Jr., et al. v. Megan M. Hess, et al. (2019-cv-30016) was filed in the District Court, Montrose County, Colorado. Plaintiffs, who are relatives of decedents, allege that Axogen purchased specimens from a vendor who failed to obtain consent before procuring the specimen from four decedents. Against Axogen, Plaintiffs allege claims of: (1) outrageous conduct; (2) unjust enrichment; (3) negligence; (4) negligence per se; (5) aiding and abetting; (6) civil conspiracy; and (7) violation of the Colorado Organized Crime Control Act. Plaintiffs seek compensatory damages for emotional distress and anxiety. Axogen was served with the complaint on February 13, 2019. A motion to dismiss has been filed and awaits the Court’s ruling. The Court has scheduled a conference on December 17, 2019, at 10:30 a.m. to discuss the pending motions to dismiss in this case and Wabel, a nearly identical case filed by the same Plaintiffs’ attorneys in June 2019. The Company intends to vigorously defend this matter. This amount of loss, if any, cannot be reasonably estimated at this time.

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On June 30, 2019, the law firm representing Plaintiffs in the Jerry Espinoza, Jr. matter filed a nearly identical complaint on behalf of additional Plaintiffs in the same Montrose County, Colorado District Court.  That action is captioned, Lisa Wabel, et al. v. Megan M. Hess, et al. (2019-cv-30071).  The claims alleged against Axogen in the Wabel complaint are nearly identical to the claims alleged in the Espinoza matter.  Plaintiffs seek compensatory damages for emotional distress and anxiety. Plaintiffs also seek compensation to the extent Axogen was unjustly enriched, and attorneys’ fees and costs. Axogen was served with the complaint effective on July 17, 2019.  A motion to dismiss has been filed, but the Court has granted Plaintiffs a stay on filing their opposition to this motion until the December conference. As discussed above, this case, in addition to Espinoza, will be discussed at the court conference set for December 17, 2019. The Company disputes the allegations and intends to vigorously defend against the complaint. This amount of loss, if any, cannot be reasonably estimated at this time.

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On August 12, 2019, Plaintiff Harvey Jackson, derivatively on behalf of Axogen, filed a verified shareholder derivative complaint in the United Stated District Court for the Middle District of Florida for violations of securities laws, breach of fiduciary duty, waste of corporate assets and unjust enrichment against Quentin S. Blackford, Gregory G. Freitag, Mark Gold, Jamie M. Grooms, Alan M. Levine, Peter J. Mariani, Guido Neels, Robert J. Rudelius, Amy Wendell, and Karen Zaderej (the “Individual Defendants”) and Nominal Defendant Axogen, Inc. (“Axogen”) (collectively, “Defendants”). Plaintiff asserts that the Individual Defendants, who are current or former Axogen officers or directors, issued a false proxy statement for the election of directors in violation of Section 14(a) of the Securities Exchange Act of 1934, breached their fiduciary duties, wasted corporate assets and were unjustly enriched by allowing Axogen to make false public statements to investors based on the same claims in the report issued December 18, 2018 by Seligman Investments (the same allegations that form the basis for the Einhorn matter and the Bussey shareholder demand). Plaintiff demands judgment in the Company’s favor against all Individual Defendants as follows: (A) declaring that Plaintiff may maintain this action on behalf of Axogen and that Plaintiff is an adequate representative of Company; (B) declaring that the Individual Defendants have breached and/or aided and abetted the breach of their fiduciary duties to Axogen; (C) determining and awarding to Axogen the damages sustained by it because of the violations set forth above from each of the Individual Defendants, jointly and severally, together with pre- and post-judgment interest thereon; (D) directing Axogen and the Individual Defendants to take all necessary actions to reform and improve its corporate governance and internal procedures to comply with applicable laws and protect Axogen and its shareholders from a repeat of the damaging events described therein, including but not limited to putting forward for shareholder vote the following resolutions for amendments to the Company’s Bylaws or Articles of Incorporation and the following actions as may be necessary to ensure proper corporate governance policies: (i) a proposal to strengthen the Board’s supervision of operations and develop and implement procedures for greater shareholder input into the policies

and guidelines of the Board; (ii) a provision to permit the shareholders of Axogen to nominate at least six candidates for election to the Board and (iii) a proposal to ensure the establishment of effective oversight of compliance with applicable laws, rules, and regulations; (E) awarding Axogen restitution form Individual Defendants, and each of them; (F) awarding Plaintiff the costs and disbursements of this actions, including reasonable attorneys’ and expert fees, costs, and expenses; and (G) granting such other and further relief as the Court may deem just and proper. The Defendants filed a motion to dismiss on October 22, 2019. Plaintiff’s opposition to the motion to dismiss was due on November 5, 2019. On November 5, 2019, Plaintiff filed an unopposed motion to voluntarily dismiss the complaint without prejudice to his right to make a demand upon the board of directors of Axogen, Inc. concerning the subject matter of his complaint. On November 5, 2019, the Court granted the unopposed motion, thereby dismissing the complaint without prejudice. We have taken the position with our insurer that since this claim arises out of the same allegations as in the Einhorn matter, the claim and any expenses with respect thereto should be subject to the same coverage policy and self-insured retention as in Einhorn, and we await the insurer’s formal reply.