12.  Commitments and Contingencies

 

Leases

 

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.

 

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.

 

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.

 

The components of total lease expense for the three months ended March 31, 2019 were as follows:

 

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

 

Supplemental balance sheet information related to leases as of March 31, 2019 was as follows:

 

 

Other information related to leases was as follows:

 

 

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.

 

Future minimum lease payments under non-cancellable leases as of March 31, 2019 were as follows:

 

 

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.

 

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:

 

 

Rent expense for the three months ended March 31, 2018 was $115.  

 

 

Service Agreements

 

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 March 31, 2019 and 2018,  the Company paid fees to CTS of approximately $488 and $419, respectively, which are included in cost of goods sold on the accompanying condensed consolidated statements of operations.

 

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 September 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.

 

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. 

 

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

 

Concentrations

 

Vendor

 

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 September 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.

 

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.

 

Processor

 

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.

 

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 is comprised of a 70,000 square foot building on approximately 8.6 acres of land.  It is expected that renovations to the APC will be completed by the third quarter of 2020 so that the APC can be included in the Company’s BLA for the Avance Nerve Graft.  The capacity of the APC once operational, along with the ability for expansion, is expected to provide processing capabilities that will meet the Company’s intended sales growth objectives.

 

Litigation

 

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.  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, which will not occur until thirty days after the court appoints a lead plaintiff and lead counsel. On April 30, 2019, the Court granted Police and Fire Retirement System of the City of Detroit (“Detroit”)’s Motion for Appointment as Lead Counsel and approved of its Lead Counsel Saxena White P.A. and Grant & Eisenhofer P.A., and set the following schedule: on or before May 30, 2019, Detroit must file a consolidated amended complaint; on or before July 1, 2019, Defendants must file an answer or move to dismiss the consolidated amended complaint; on or before July 29, 2019, the parties shall meet and confer and prepare to file a Case Management Report, which must be filed by August 12, 2019; and, on or before 30 days after either the filing of an answer or the Court’s ruling on a motion to dismiss, Detroit must file a motion for class certification and Defendants must file an opposition 30 days later.  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 dispute the allegations and intend to vigorously defend against the Complaint.

 

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. The Company disputes the allegations and intends to vigorously defend against the Complaint.