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13.  Commitments and Contingencies

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Leases

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The Company determines whether or not a contract contains a lease at the inception date and determines the lease classification, recognition and measurement at commencement date.  The Company classifies a lease based on whether the arrangement is effectively a purchase of the underlying asset.  Leases that transfer the control of the underlying asset are classified as finance leases and all others are classified as an operating lease.  Interest and amortization expense are recognized for operating leases on a straight-lined basis. If a change to the lease term leads to a reassessment of the lease classification and remeasurement, assumptions such as the discount rate and variable rents based on a rate or index will be updated as of the remeasurement date.  If an arrangement is modified, the Company will reassess whether the arrangement contains a lease.  Any subsequent changes in lease payments are recognized when incurred, unless the change requires a remeasurement of the lease liability.

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The Company made an accounting policy election to not recognize right-to-use assets and lease liabilities that arise from short term leases, which are defined as leases with a lease term of 12 months or less at the lease commencement date.

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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 Company and Heights Union are parties to the Heights Agreement for the lease of seventy-five thousand square feet of office space in Tampa, Florida.  Pursuant to the Heights Agreement, the Company will use the leased premises for general office, medical laboratory, training and meeting purposes.  In September 2020, the Company began occupying the space.  The lease includes a $5,250 lessor allowance to be used towards the hard and soft costs of the tenant improvements. The Company will bear the cost of any tenant improvement in excess of this allowance. Total costs of the tenant improvements were approximately $11,450.  The Company concluded that it is the accounting owner of the tenant improvements.  The lessor’s allowance of $5,250 for the construction of tenant improvements will be treated as an incentive.  Because the Company is the accounting owner of the improvements, the lease incentive is accounted for as a reduction of the right-of-use asset and the total cost of the improvements of $11,539 is recognized on the balance sheet separate from the right-of-use asset as leasehold improvements.  The improvements will be amortized over the life of the lease, which was determined to be the shorter of the useful life of the improvements or the lease term.  The Company determined the commencement date of the lease was August 28, 2020 and valued the lease using a 10.6% incremental borrowing rate.  The Company recorded a right-of-use asset of $13,323 and lease liability of $18,573 for the new office lease as of the commencement date.

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The components of total lease expense for the three and nine months ended September 30, 2020 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, 2020 and December 31, 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, 2020 were as follows:

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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 and then on April 22, 2020 was further amended to extend the term through December 31, 2022 and provides the Company the right to terminate the agreement after February 28, 2022, with six-months advance written 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, 2020 and 2019, the Company paid fees to CTS of approximately $454 and $566, respectively, and during the nine months ended September 30, 2020 and 2019, approximately $1,193 and $1,624, respectively, and are included 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 $208 and $196 for the three months ended September 30, 2020 and 2019, respectively.  Payments made under this agreement were $699 and $337 for the nine months ended September 30, 2020 and 2019, respectively.

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In June 2017, the Company entered into the Nerve End Cap Supply Agreement with Cook Biotech whereby Cook Biotech is the exclusive contract manufacturer of the Axoguard Nerve Cap and both parties have provided the other party the necessarily licenses to their technologies for operation of the Supply Agreement. The Supply Agreement has a term through August 27, 2027, provided, however, that after June 27, 2022, either party may terminate the Supply Agreement

upon 90 days written notice. Under the Supply Agreement the Company provides purchase orders to Cook Biotech and Cook Biotech fulfills the purchase orders.

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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 in 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.  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 this 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 $29,300.  Additional costs associated with the renovation, purchasing of furniture and equipment, validation and certification of the APC are estimated to be $13,600.  The Company temporarily deferred the construction as part of the cost containment initiatives implemented in the second quarter, and has subsequently determined to resume construction in early 2021.  As of September 30, 2020, the Company has recorded $9,062 in the current year and $15,127 to date related to renovations and design build in construction in progress. These items are recorded as projects in process as part of the property and equipment in its condensed consolidated balance sheet.

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Litigation

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The Company is subject to various claims, lawsuits and proceedings in the ordinary course of the Company's business, some of which have been dismissed by the Company. In the opinion of management, such claims are either adequately covered by insurance or otherwise indemnified, or are not expected, individually or in the aggregate, to result in a material, adverse effect on the Company's financial condition. However, it is possible that the Company's results of operations, financial position and cash flows in a particular period could be materially affected by these contingencies.

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Einhorn v. Axogen, Inc., et al., No. 8:19-cv-00069 (M.D. Fla.) (the “Einhorn Litigation”) (the “Court”).

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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, certain of its directors and officers (“Individual Defendants”), and (i) the several underwriters (the “2017 Offering Underwriters”) named in that certain Underwriting Agreement, dated November 16, 2017, by and between the Company and Leerink Partners LLC, as representative of the several underwriters named therein, and (ii) the several underwriters (the “2018 Offering Underwriters”) named in that certain Underwriting Agreement, dated May 8, 2018, by and between the Company and Jefferies LLC and Leerink Partners LLC, as representatives of the several underwriters named therein (the 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.  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. On December 4, 2019 the parties’ presented oral arguments.  On April 21, 2020, the Court dismissed the Complaint without prejudice, finding the Plaintiff failed to state a claim upon which relief could be granted.  The Plaintiff filed a Second Amended Class Action Complaint on June 22, 2020.  Axogen filed a motion to dismiss on August 6, 2020.  The Plaintiff filed an opposition to such dismissal on September 20, 2020.  Both parties have requested to present oral arguments and await the Court’s decision.  Plaintiff is seeking compensatory damages, reimbursement of expenses and costs, including counsel and expert fees and such other relief as the court deems just and proper. The Company and Individual Defendants continue to dispute the allegations and intend to vigorously defend against any amended Complaint, if filed.  The amount of loss, if any, cannot be reasonably estimated at this time.

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Michael Bach v. Karen Zaderej, Peter J. Mariani, Gregory G. Freitag, Jamie M. Grooms, Robert Rudelius et al, 27-CV-20-5997 (District Court, 4th Judicial District, Hennepin County, MN).

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On October 3, 2019, the Company received a shareholder demand sent on behalf of shareholder Michael Bach requesting that the Board of Directors take action to remedy alleged breaches of fiduciary duties related to the claims in the report issued December 18, 2018 by Seligman Investments (substantially the same allegations that form the basis for the Einhorn matters referenced above).  On February 14, 2020 the Company sent a written response stating that it did not

intend to take any further action.  On April 21, 2020, Bach filed a shareholder derivative complaint in Hennepin County, Minnesota, alleging breach of fiduciary duty, insider selling, corporate waste, and unjust enrichment.  The Board intends to vigorously defend itself in this matter.  The amount of loss, if any, cannot be reasonably estimated at this time.

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These matters are subject to various uncertainties and it is possible that one or more may be resolved unfavorably to the Company. However, while it is not possible to predict with certainty the outcome of a matter, the Company and the Individual Defendants dispute the allegations, intend to vigorously defend themselves and as provided above the Einhorn Litigation was dismissed without prejudice prior to an amended motion being filed by plaintiffs.