Axogen, Inc. (AXGN) FY 2023 MD&A

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

The following information should be read in conjunction with our consolidated financial statements and the notes thereto contained in Item 8 of Part II in this Form 10-K, “Forward-Looking Statements” contained in Part 1 of this Form 10-K, “Risk Factors” contained in Item 1A of this Form 10-K, and the other information appearing elsewhere in, or incorporated by reference into, this Form 10-K. Dollar amounts referenced in this Item 7 are in thousands, except per share amounts.

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

Overview

We are the leading company focused specifically on the science, development, and commercialization of technologies for peripheral nerve regeneration and repair. We are passionate about providing the opportunity to restore nerve function and quality of life for patients with peripheral nerve injuries. We provide innovative, clinically proven, and economically effective repair solutions for surgeons and healthcare providers. Peripheral nerves provide the pathways for both motor and sensory signals throughout the body. Every day, people suffer traumatic injuries or undergo surgical procedures that impact the function of their peripheral nerves. Physical damage to a peripheral nerve or the inability to properly reconnect peripheral nerves can result in the loss of muscle or organ function, the loss of sensory feeling, or the initiation of pain.

Product Portfolio

•Avance® Nerve Graft, a biologically active off-the-shelf processed human nerve allograft for bridging severed peripheral nerves without the comorbidities associated with a second surgical site;

•Axoguard Nerve Connector®, a porcine (pig) submucosa extracellular matrix ("ECM") coaptation aid for tensionless repair of severed peripheral nerves;

•Axoguard Nerve Protector®, a porcine submucosa ECM product used to wrap and protect damaged peripheral nerves and reinforce the nerve reconstruction while preventing soft tissue attachments;

•Axoguard HA+ Nerve Protector™, is comprised of a processed porcine submucosa ECM base layer with a hyaluronate-alginate gel coating designed to provide short- and long-term protection for peripheral nerve injuries. The gel layer facilitates enhanced nerve gliding to aid in minimizing soft tissue attachments, while the base layer is remodeled into a long-term protective tissue layer.

•Axoguard Nerve Cap®, a porcine submucosa ECM product used to protect a peripheral nerve end and separate the nerve from the surrounding environment to reduce the development of symptomatic or painful neuroma;

•Axotouch® Two-Point Discriminator, used to measure the innervation density of any surface area of the skin.

Our portfolio of products is currently available in the United States "(U.S."), Canada, Germany, United Kingdom, Spain and several other European, Asian and Latin American countries.

Revenue from the distribution of our nerve repair products, Avance® Nerve Graft, Axoguard Nerve Connector®, Axoguard Nerve Protector®, Axoguard HA+ Nerve Protector™, and Axoguard Nerve Cap®, in the U.S. is the main contributor to our total reported sales and have been the key component of our growth to date.

As previously announced, we suspended the market availability of Avive® Soft Tissue Membrane ("Avive") on June 1, 2021, to have discussions with the U.S. Food and Drug Administration ("FDA") about the appropriate regulatory classification and requirements for Avive. The reported safety or product performance issues or concerns with Avive. Based on preliminary feedback from FDA on the product classification and regulatory pathway, we have decided not to continue discussions with FDA and will not pursue regulatory approval for Avive. Therefore, we will not seek to return Avive to the market. We are working on developing a replacement product called Avive + that we believe would not require a BLA and would fall under the criteria set forth in 21 CFR 1271.10(a) for regulation solely under Section 361 of the Public Health Service Act and the regulations in 21 CFR Part 1271. We seek to launch Avive+ in the second quarter of 2024.

We have observed that surgeons initially are cautious adopters for peripheral nerve repair products. Surgeons typically start with a few cases and then wait and review the results of these initial cases. Active accounts are usually past this wait period and

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have developed some level of product reorder. These active accounts have typically gone through the Value Analysis Committee approval process, have at least one surgeon who has converted a portion of his or her treatment algorithms of peripheral nerve repair to our portfolio and have ordered our products at least six times in the last twelve months. As of December 31, 2023, we had 1,006 active accounts, an increase of 3.9% from 968 one year ago. Active accounts are approximately 87% of our revenue. The top 10% of these active accounts continue to represent approximately 40% of our revenue.

Core accounts are defined as accounts that have purchased at least $100 in the past twelve months. As of December 31, 2023, we had 376 core accounts, an increase of 13.3% from 332 one year ago. These core accounts represented approximately 65% our revenue in 2023, which increased approximately 60% over the past two years.

Our business was originally anchored in emergent trauma and over the past several years we have introduced a number of new nerve repair applications that utilize our Avance and Axoguard product lines. These new applications share common characteristics that now lead us to think about our business along two primary categories, scheduled non-trauma (“Scheduled”) procedures, and emergent trauma (“Emergent”) procedures.

Scheduled procedures are generally characterized as procedures where a patient is seeking relief of a condition caused by a nerve defect or surgical procedure. These include breast reconstruction following a mastectomy, nerve reconstruction following the surgical removal of painful neuromas, oral and maxillofacial procedures, and nerve decompression.

The nature of Scheduled procedures affords patients the opportunity to actively search for treatment options and advocate for solutions that may improve quality of life following the procedure. For example, in breast reconstruction, this may include prioritizing neurotization as a part of their treatment plan. These procedures lend themselves to standardization of surgical techniques and more consistent nerve repair algorithms. In addition, these patients are likely to engage in extended follow-up evaluations with their physicians.

Emergent procedures generally result from injuries that initially present in an emergency room. These procedures are typically referred to and completed by a specialist either immediately or within a few days following the initial injury. Given the emergent and diverse nature of traumatic injuries, the required repair algorithm and procedure scheduling can be highly variable, and follow-up evaluations are generally inconsistent.

While the various applications can have unique surgeon customers, the procedures are often performed in the same accounts and use the same family of Axogen products. Scheduled procedures typically have a higher value of Axogen products used per procedure as compared to routine trauma; and, given the planned nature of these procedures, there is a higher level of predictability and are generally additive to our sales rep productivity.

Reporting by application has historically been challenging. However, we have recently developed improved analytical tools that we believe allow us to better monitor product utilization data within accounts and generate improved estimates of our revenue by application. We estimate revenue by application using the information received from hospitals and sales representatives based on assumptions regarding specific surgeon practice and account information. Accordingly, the accuracy of our estimates is subject to the limited data we receive and the accuracy of those assumptions.

We estimate that revenues from emergent trauma procedures represented approximately half of total revenues during the year ended December 31, 2023 and grew mid-single digits versus the year ended December 31, 2022.

Summary of Operational and Business Highlights

•Net revenue was $159,012 for the year ended December 31, 2023, an increase of $20,428 or 14.7% compared to the year ended December 31, 2022.

•Gross profit was $127,874 for the year ended December 31, 2023, an increase of $13,437 or 11.7% compared to the year ended December 31, 2022.

•In August 2023, we began processing tissue in the new, state-of-the-art APC facility, which provides for up to 3x the previous capacity and was designed for long-term growth and expansion.

•During 2023, we surpassed 100,000 Avance Nerve Graft implants since launch.

•We are continuing to expand our offering in the nerve protection market with the national launch of Axoguard HA+ Nerve Protector™ during 2023 and expect to launch Avive+ Soft Tissue Matrix™ second quarter of 2024.

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•We completed a Pre-BLA meeting with the FDA during the first quarter of 2024 where we aligned with the FDA on a rolling submission process and the content of the modules for the BLA submission for Avance® Nerve Graft. We anticipate completing the submission in the third quarter of 2024. Subject to ongoing engagement with the FDA, we believe this submission timetable will allow for a potential BLA approval in the middle of 2025.

•We have exceeded our initial goal of training 25 additional surgical teams on techniques in implant-based Resensation® and have more than 39 teams trained during the year ended December 31, 2023.

•Ended the year with 245 peer-reviewed clinical publications featuring Axogen’s nerve repair product portfolio.

•Ended the year with 116 direct sales representatives as compared to 115 for the year ended 2022.

Results of Operations

Comparison of the Years Ended December 31, 2023, and 2022

The following table sets forth, for the periods indicated, our results of operations expressed as dollar amounts and as percentages of total revenue:

Revenues

Revenues for the year ended December 31, 2023, increased, $20,428 or 14.7%, to $159,012 as compared to $138,584 for the year ended December 31, 2022. Revenue growth was driven by an increase in unit volume of approximately 8.6%, as well as the net impact of changes in price and product mix of approximately 3.7% and 2.5%, respectively. The unit volume increase was attributed to growth in our core and active accounts. As of December 31, 2023, we had 1,006 active accounts, an increase of 3.9% from 968 from the prior year and 376 core accounts, an increase of 13.3% from 332 at December 31, 2022.

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Gross Profit

Gross profit for the year ended December 31, 2023, increased $13,437 or 11.7% to $127,874 as compared to $114,437 for the year ended December 31, 2022. Gross margin as a percentage of revenue decreased to 80.4% for the year ended December 31, 2023, as compared to 82.6% for the year ended December 31, 2022.

Costs and Expenses

Total costs and expenses increased, $5,192 or 3.6%, to $149,336 for the year ended December 31, 2023, as compared to $144,144 for the year ended December 31, 2022. The increase in total operating costs was primarily attributable to the following (i) $5,083 in compensation costs; (ii) $1,277 in professional services; (iii) $1,243 in marketing programs costs; (iv) $852 in travel; (v) $185 in occupancy related costs partially offset by decreases of (i) $1,190 in research and development projects; (ii) $2,257 of other general business costs including insurance expenses of $1,033, bad debt recovery of $883, merchant fees of $727, other items administrative in nature of $355 offset by increased packaging, shipping and handling expenses of $741.

Sales and marketing expenses increased $5,833, or 7.3%, to $86,060 for the year ended December 31, 2023, as compared to $80,228 for the year ended December 31, 2022. The increase in sales and marketing was due to the following: (i) compensation costs of $1,969; (ii) $1,243 in marketing programs;(iii) $831 in travel costs; (iv) $745 in professional services, and (v) $1,034 of other costs which included packing, shipping and handling costs of $741 and other items administrative in nature of $293.

Research and development expenses increased $1,175, or 4.3%, to $28,333 for the year ended December 31, 2023, as compared to $27,158 for the year ended December 31, 2022. The increase was primarily due to product development and clinical expenses. Product development costs include spending for a number of specific programs including the non-clinical expenses related to the BLA for Avance Nerve Graft. Product development expenses represented approximately 60% and 52% of total research and development expense for the years ended December 31, 2023, and 2022, respectively. Clinical trial expenses represented approximately 40% and 48% of total research and development expense for the years ended December 31, 2023, and 2022, respectively. The increase in research and development included increases in compensation costs of $1,635; $331 in professional fees; $287 in occupancy costs; and $98 in travel costs to support these clinical and non-clinical expenses.

General and administrative expenses decreased $1,816, or 4.9%, to $34,943 for the year ended December 31, 2023, as compared to $36,758 for the year ended December 31, 2022. The decrease was primarily due to $1,033 in insurance costs, $833 in bad debt recovery, $727 in merchant fees, $330 in other services, and $205 in licenses and fees partially offset by an increase in compensation costs of $1,479.

Other Income and Expense

Total other (expense) income decreased $1,013, or 133.5% to expense of $254 for the year ended December 31, 2023, as compared to income of $759 for the year ended December 31, 2022. The change was primarily due to the increase in interest expense of $2,211 and other expenses of $208, partially offset by the increase in investment income of $918 and the fair value of the derivative liability of $488. In connection with the Credit Facility, we recognized total interest charges of $8,083 and $6,721 for the years ended December 31, 2023, and 2022, respectively, and of this interest we capitalized to the construction of the APC Facility, interest charges of $5,285 and $6,155 for the years ended December 31, 2023, and 2022, respectively. The increase in investment income was primarily related to the Federal Reserve raising interest rates 100 basis points throughout 2023.

Income Taxes

We had no federal income tax expense or benefit for the years ended December 31, 2023, and 2022, due to the incurrence of net operating losses in both years, the benefits of which have been fully reserved. We do not believe that there are any additional tax expenses or benefits currently available.

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Liquidity and Capital Resources

As of December 31, 2023, our principal sources of liquidity were our cash and cash equivalents totaling $31,024. Our cash equivalents are comprised of a money market mutual fund and during the year ended December 31, 2022, we had investments comprised of short-term commercial paper and U.S. Treasuries. Our cash and cash equivalents and investments decreased $17,766 from $48,790 at December 31, 2022, primarily as a result of the renovations of our APC Facility, and general operating activities. On December 31, 2023,and 2022, our current assets exceeded our current assets liabilities by $57,574 and $74,322, respectively. Based on current estimates, we believe that our existing cash and cash equivalents and investments, as well as cash provided by sales of our products will allow us to fund our operations through at least through the next 12 months from the issuance of these financial statements.

Cash Flow Information

The following table presents a summary of our cash flows from operating, investing and financing activities:

Net Cash Used in Operating Activities

Net cash used in operating activities was $5,716 and $16,066 during the years ended December 31, 2023, and 2022, respectively. The favorable change in net cash used in operating activities of $10,350 or 64.4% was due to the following: (i) the net favorable change of $5,172 in working capital accounts and (ii) the decrease in net loss of $7,232.

A discussion of net cash used in operating activities during the year ended December 31, 2021, can be found in Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, filed on March 14, 2023.

Net Cash Provided by Investing Activities

Net cash provided by investing activities was $19,253 as compared to cash used in investing activities of $3,200 for the years ended December 31, 2023, and 2022, respectively, an increase of $22,453 or 702%. The change in net cash used in investing activities was due to the increase in the net purchase and proceeds of the sale of investments totaling $16,118 and net decrease in the capital expenditures, primarily related to the renovation of the APC Facility, of $6,206.

A discussion of net cash provided by investing activities during the year ended December 31, 2021, can be found in Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, filed on March 14, 2023.

Net Cash Provided by Financing Activities

Net cash provided by financing activities was $1,954 as compared to $1,794 for the years ended December 31, 2023, and 2022, respectively, an increase of $161 or 9%. The change in net cash provided by financing activities was primarily due to an increase of $159 in proceeds from the exercise of stock options and ESPP purchases year-over-year.

A discussion of net cash provided by financing activities during the year ended December 31, 2021, can be found in Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, filed on March 14, 2023.

Liquidity and Capital Resources

Our expected future capital requirements may depend on many factors including expanding our customer base and sales force and timing and extent of spending in obtaining regulatory approval and introduction of new products. Additional sources of liquidity available to us include issuance of additional equity securities through public or private equity offerings, debt financings or from other sources. The sale of additional equity may result in dilution to our shareholders. There is no assurance that we will be able to secure funding on terms acceptable to us, or at all. The increasing need for capital could also make it more difficult to obtain funding through either equity or debt. Should additional capital not become available to us as needed,

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we may be required to take certain actions, such as slowing sales and marketing expansion, delaying regulatory approvals, or reducing headcount.

Credit Facilities

As of December 31, 2023, we had $50,000 outstanding in indebtedness under a credit facility; $35,000 maturing on June 30, 2027, and 15,000 maturing on June 30, 2028. Quarterly interest only and revenue participation payments are due through each of the maturity dates. Interest is calculated as 7.5% plus the greater of the Adjusted SOFR or 2.0% (12.99% as of December 31, 2023). Revenue participation payments are calculated as a percentage of our net revenues, up to $70,000 in any given year, adding approximately 1.5% per year of additional interest payments on the outstanding indebtedness. Upon each maturity date or upon such date earlier repayment occurs, we will repay the principal balance and provide a make-whole payment calculated to generate an internal rate of return to the lender equal to 11.5%, less the total of all quarterly interest and revenue participation payments previously paid. See Note 9 - Long-Term Debt, Net of Debt Discount and Financing Fees and Note 14 - Commitments and Contingencies in the Notes to the Consolidated Financial Statements Part II, Item 8 of this Form 10-K.

Contractual Obligations and Commitments

(1) See Note 9. Long-term Debt and Note 14. Commitments and Contingencies in Part II, Item 8 of this Form 10-K.

(2) Calculated at 13.0%; the interest rate as of December 31, 2023.

(3) See Note 8. Leases in Part II, Item 8 of this Form 10-K.

(4) Includes CEO's 2023 bonus to be paid in March 2024, 2024 Salary, 2024 bonus to paid in March of 2025, accrued PTO through January 4, 2025, nine months of senior advisory fees, and eighteen months of COBRA payments. Actual timing of payments are subject to the determination of the end of CEO Term per the Transition and Separation Agreement. See Note 14 - Commitments and Contingencies in Part II, Item 8 of this Form 10-K.

See Note 8 - Leases and Note 14 - Commitments and Contingencies in the Notes to the Consolidated Financial Statements Part II, Item 8 of this Form 10-K, for further information.

Critical Accounting Estimates

In preparing our financial statements in accordance with generally accepted accounting principles, there are certain accounting policies, which may require substantial judgment or estimation in their application. We believe these accounting policies and the others set forth in Note 2 - Summary of Significant Accounting Policies in the Notes to the Consolidated Financial Statements Part II Item 8 of this Form 10-K are critical to understanding our results of operations and financial condition. Actual results could differ from our estimates and assumptions, and any such differences could be material to our results of operations and financial condition.

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Inventories

Description

Inventories consist of purchased materials, direct labor and manufacturing overhead, are stated at the lower of cost or net realizable value, as determined by the first-in, first-out method.

Judgments and Uncertainties

We maintain reserves for excess and obsolete inventory resulting from the potential inability to sell certain products in excess of current carrying cost. We make estimates regarding the future recoverability of the costs of these products and record provisions based on historical experience, expiration dates and expected future trends.

Sensitivity of Estimate to Change

As of December 31, 2023, we have reserved $1,342 for potential losses relating to inventory. If our actual product life cycles, product demand or acceptance of new product introductions are less favorable than projected by management, additional inventory write downs may be required, which could unfavorably affect future operating results.

Derivative Instruments

Description

We review debt instruments to determine whether there are embedded derivative instruments, which are required to be bifurcated and accounted for separately as a derivative financial instrument. Embedded derivatives that are not clearly and closely related to the debt host are bifurcated and are recognized at fair value on the consolidated balance sheet with changes in fair value recognized as either a gain or loss on the consolidated statement of operations each reporting period.

Judgements and Uncertainties

The fair value of embedded derivatives are measured based on equity markets and interest rates, as well as an estimate of our nonperformance risk adjustment. This estimate includes an option adjusted spread and an estimate of our discount rate.

Sensitivity of Estimate to Change

As of December 31, 2023, we recorded a derivative liability of $2,987. However, if the discount rate were to change by 1%, it would have a less than $50 effect on our derivative liability.

Share-Based Compensation

Description

Share-based compensation is in the form of stock options, restricted stock units ("RSU") and performance stock units ("PSU"). The estimated grant date fair value of stock options held by employees is determined using a multiple-point Black-Scholes option valuation method. The fair value of RSUs and PSUs is determined based on the fair value of our common stock on the date of grant. The estimated fair value of the options related to the Employee Stock Purchase Plan are based on the Black-Scholes option pricing model.

Judgments and Uncertainties

We estimate the grant date fair value of each stock option award on the date of grant using a multiple-point Black-Scholes option-pricing model. In addition, we measure stock options granted to employees at a premium price based on market conditions, such as the trading price of our common stock, using a Monte Carlo Simulation option-pricing model in estimating the fair value at the grant date. Key assumptions in determining fair value include volatility, risk-free interest rate, dividend yield and expected term. As a result, if factors change and different assumptions are used, the stock-based compensation expense could be materially different in the future.

The fair value of the PSU grants is based on our closing stock price on the grant date. The number of PSU's that will ultimately be earned is based upon our performance as measured against specified targets over the measurement period. Expectations related to the achievement of performance goals associated with PSU grants is assessed at each reporting period and is used to determine whether PSU grants are expected to vest. If performance-based milestones related to PSU grants are not met or not expected to be met, any compensation expense recognized associated with such grants will be reversed.

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We recognize compensation expense related to the Employee Stock Purchase Plan (“ESPP”) based on the estimated fair value of the options on the date of grant. We estimate the grant date fair value, and the resulting stock-based compensation expense, using the Black-Scholes option pricing model for each purchase period. The grant date fair value is expensed on a straight-line basis over the offering period.

Sensitivity of Estimate of Change

As of December 31, 2023, stock-based compensation expense for PSU's was $3,273, however, if we determined that the PSUs outstanding were 100% achievable, our stock-based compensation would have been $8,652.

Recent Accounting Pronouncements

See Note 2 - Summary of Significant Accounting Policies in the Notes to the Consolidated Financial Statements, Part II Item 8 of this Form 10-K for further information.