DELAWARE		33-0909022
(State or other jurisdiction of		(I.R.S. employer
incorporation or organization)		identification no.)
110 Horizon Drive, Suite 230, Raleigh, NC		27615
(Address of principal executive office)		(Zip code)

Title of Each Class:		Name of Each Exchange on which Registered:
Common Stock, par value $0.0001 per share		The NASDAQ Stock Market LLC

Large accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer ¨	Smaller reporting company þ

Cautionary Note Regarding Forward-Looking Statements		3
PART I		4
Item 1.	Business	4
Item 1A.	Risk Factors	24
Item 1B.	Unresolved Staff Comments	42
Item 2.	Properties	42
Item 3.	Legal Proceedings	42
Item 4.	Mine Safety Disclosures	42
PART II		43
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	43
Item 6.	Selected Financial Data	44
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	45
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	58
Item 8.	Financial Statements and Supplementary Data	58
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	58
Item 9A.	Controls and Procedures	58
Item 9B.	Other Information	59
PART III		60
Item 10.	Directors, Executive Officers and Corporate Governance	60
Item 11.	Executive Compensation	60
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	60
Item 13.	Certain Relationships and Related Transactions, and Director Independence	60
Item 14.	Principal Accounting Fees and Services	60
PART IV		61
Item 15.	Exhibits, Financial Statement Schedules	61
Signatures		62
Index to Consolidated Financial Statements		63
Exhibit Index		91

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Item 1.

Business

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Limited Reach.  Traditional rigid instruments used in decompression surgery are generally limited in their ability to reach lumbar stenosis in all three regions of the spine (central canal, lateral recess, and neural foramen) and the surgeon frequently must cut through and remove healthy parts of the spine in order to access hard to reach areas where overgrown bone and tissue are compressing the nerves. Failure to remove all stenosis during decompression is often recognized as a leading cause of poor surgical outcomes, including continued symptoms and reoperation. In addition, removing anatomy important for spinal stability, such as the facet joints and posterior midline structures, in an attempt to access all three regions of stenosis may lead to a complication called instability and the possible need for a spinal fusion procedure to help re-stabilize the spine.

·

Disruption to Soft Tissue and Support Structures.  Traditional lumbar fusion procedures require the creation of a pathway from the skin to the degenerative disc that is large enough to allow direct visualization and work by the surgeon. It is common to cut through healthy muscle or move critical organs, arteries, nerves and soft tissue, which can lead to bleeding, scarring, nerve damage and bowel disruption.

·

Significant Blood Loss.  As a result of undergoing current lumbar fusion procedures, patients typically experience significant blood loss of between 100 and 1,400 cubic centimeters of blood. As a result, it is common for patients to use the hospital’s blood supply or donate units of their own blood before a lumbar fusion procedure to replenish any significant blood loss.

·

Lengthy Operative Procedure Times.  It is common for current lumbar fusion procedures to take between 90 minutes and four hours to complete. With some procedures, a second surgeon may be required. Long procedure times increase the risk of complications and blood loss. Also, hospital and physician resources are consumed for lengthy periods of time, which reduces productivity and increases costs.

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Lengthy Patient Hospital Stays.  Patients remain in the hospital for an average of three days following a lumbar fusion procedure.

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Significant Patient Recovery Time.  Patients typically require three to six months to recover and rehabilitate after undergoing a lumbar fusion procedure before resuming normal activities.

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Unresolved Patient Pain.  Patients may continue to experience symptoms after undergoing lumbar fusion procedures even though x-rays show successful fusion has been achieved through the growth of new bone.

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Less Invasive Approach Minimizes Complications.  Our AxiaLIF products are delivered using the proprietary pre-sacral approach, which we believe is a less invasive solution for delivering fusion products to the L4/L5/S1 region. Procedures performed utilizing the pre-sacral approach have been documented to have favorable clinical safety profiles with low complication rates.

·

Spinal Stability.  The pre-sacral interbody fusion approach does not violate or cut through the muscles, ligaments or bones that control the stability of the spine. Thus, the axial approach to the spine does not affect inherent spinal stability, a benefit that cannot be achieved with other approaches to interbody fusion. Moreover, in another recent peer-reviewed retrospective clinical series, the fusion rate associated with procedures utilizing the pre-sacral interbody fusion approach was demonstrated to be 93%. We believe this compares favorably with the fusion rates of 90-95% associated with other fusion procedures. See additional information under the heading “Clinical Experience” below.

·

Cost Effectiveness.  Increased focus on health care quality and value has brought greater scrutiny than ever on the clinical and economic impact that technologies have on different stakeholders including patient, provider and payor. Various government and commercial programs, including payment bundling, accountable care organizations and value-based purchasing, new incentivize providers to deliver quality care in a cost-effective manner. We believe that pre-sacral interbody fusion employing our AxiaLIF device is well positioned in the current health economic climate based on its evidence of good clinical outcomes combined with a favorable economic profile. In addition to low morbidity, there are procedural efficiencies associated with pre-sacral interbody fusion that can potentially reduce costs borne by the provider and/or payor. Traditionally, surgeon-decision makers weighted a technology's clinical profile more heavily than hospital economic considerations; however, with the rapid growth in surgeons seeking employment by hospitals, we believe the hospital economics will be a more important driver of medical technology adoption going forward. We believe that this will provide an opportunity for us to differentiate the pre-sacral interbody fusion approach and our AxiaLIF devices from the traditional approaches to lumbar interbody fusion based on quality outcomes combined with positive impact on payor and provider economics.

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Targets Stenosis and Thorough Decompression. The iO-Flex instruments offer improved access to thoroughly target  areas where lumbar stenosis occurs: the lateral recess and foramen.

·

Economic Benefits. Less invasive decompression instruments may result in shorter operating times and hospital stays, lower complications, and improved recovery times compared to traditional instrumentation methods.

·

Preserving Healthy Bone and Tissue. Flexible instruments can allow surgeons to preserve healthy bone, ligaments, and muscle to help maintain spinal stability and in some cases avoid a more invasive fusion procedure.

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Versatility. The iO-Flex instruments have utility in lumbar decompression procedures with and without spinal fusion and are able to treat up to two levels of stenotic foraminal openings on each side of the spine through one laminotomy.

·

Capitalize on the Baxano Acquisition and Focus Our Sales And Marketing Infrastructure To Penetrate the Market. We intend to continue expending significant resources targeting spine surgeons through our sales and marketing efforts in the United States and internationally in order to drive the adoption of our products. Our marketing will promote the differentiated features of our product’s technology to further penetrate the large global spine fusion market. Our new sales leadership and management team is confident in our product offering and our ability to leverage our growing customer base to cross-sell our differentiated technologies. Along with the sales team expansion in the United States, we intend to expand our presence in new and existing international markets through ongoing investment in our international infrastructure and use of independent sales agents and distributors.

·

Drive Private Payor Reimbursement for AxiaLIF. We anticipate that increasing private payor reimbursement coverage and the improved AxiaLIF implant and instruments will allow us to rebuild our surgeon base and increase procedure volume over time. The greatest risk to the growth of AxiaLIF continues to be driven by a lack of broad private payor reimbursement for the Category I code that was established on January 1, 2013 (discussed below under “Third-Party Reimbursement”). We are employing a multi-pronged strategy to continue to expand the coverage. First, we are leveraging surgeon demand along with existing clinical data to have procedures pre-authorized on a case-by-case basis. Secondly, we continue to have further data published, which will increase the body of evidence we are sharing with medical directors and help overturn investigational or experimental policies that exist at some private payors. Third, we are making progress in gaining broader spine society support, which we feel is an important step towards gaining broader private payor reimbursement.

·

Expand Our Presence In The Direct Lateral Interbody Fusion Market. We intend to promote the differentiated features of our VEO lateral system which allows surgeons improved visualization as they perform a VEO lateral procedure, to help us further penetrate the direct lateral interbody fusion market. Our recently issued VEO United States patent further illustrates the differentiation with its unique approach through the psoas muscle.

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Generate Published, Peer Reviewed Clinical Literature that Demonstrates the Clinical and Economic Benefits of Our Products in Order to Help Support Adoption by All Stakeholders. We had one new clinical paper submitted for peer review and seven papers accepted for publication in the fourth quarter of 2013. With regard to VEO, we now have two papers published and have collected retrospective data for a third paper with 30 patients measuring short term safety outcomes that was submitted for peer review at the end of 2013.

·

AxiaLIF Pre-sacral Access and Interbody Fusion System.  Our AxiaLIF products include surgical instruments designed to create a safe and reproducible access route to the L4/L5/S1 vertebral bodies, fusion implants and supplemental stabilization products. We believe our AxiaLIF implants and instruments, combined with facet screws and/or pedicle screws, provide surgeons with the tools necessary to perform a lumbar fusion in a less invasive manner. We sell these products to our customers in procedure kits that include all the instruments and implants needed to complete a lumbar fusion.

·

VEO Lateral Access and Interbody Fusion System.  Our VEO lateral access and interbody fusion system is a minimally invasive direct lateral system featuring a two-stage retraction method that focuses on nerve visualization followed by muscle retraction. The VEO lateral system is designed for direct visualization of the psoas muscles and adjacent nerves prior to muscle dissection, and features a full range of PEEK (polyetheretherketone) lateral interbody implants and a variety of ergonomic instruments.

 

	11

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iO-Flex Minimally Invasive Decompression Instruments. Our iO-Flex minimally invasive set of flexible instruments allow surgeons to target lumbar stenosis  of the spine with minimal disruption to the patient’s healthy anatomy critical for maintaining spinal stability. Our iO-Flex instruments were designed to do a thorough decompression while sparing the facet joints and posterior midline structures. The device is a single use disposable set of instruments that can be used at multiple levels during the same spinal procedure. The instruments include the following components:

o

iO-Flex Probe delivers the iO-Flex Wire for access to the areas of stenosis in the spine.

o

iO-Flex Wire is the guide wire over which the other tools will be introduced to the area of stenosis.

o

iO-Flex Neuro Check® device helps confirm the location of the nerve to be decompressed when direct visualization of the neural structures is compromised.

o

iO-Flex MicroBlade Shaver® instrument is designed to allow surgeons to precisely shave away the targeted bone and tissue that is compressing the nerve.

o

iO-Flex Distal Handle attaches to and is used to manipulate the microblade shaver device.

·

iO-Tome Minimally Invasive Rapid Facetectomy Instruments. Our iO-Tome instrument received FDA clearance in July 2012 and was launched in 2013. It is a novel disposable facetectomy instrument that allows surgeons to perform rapid facetectomies while working above the exiting nerves. Our iO-Tome instrument utilizes our iO-Flex instrument platform to rapidly and precisely remove the facet joint, which is commonly performed in TLIF spinal fusions.

·

Vectre Facet Screw System.  Our Vectre facet screw system was commercially launched in 2010 and offers a cannulated facet screw inserted over a guidewire to provide stability. The Vectre system features are designed to offer a minimally invasive posterior fixation option in select patients.

·

Bi-Ostetic Bone Void Filler.  In February 2010, we began selling Bi-Ostetic, a synthetic, osteoconductive material intended to be used to fill voids and gaps that are not intrinsic to the stability of bone structure. These gaps or voids may be located in the extremities, spine, or pelvis. In spine surgery, it can be used to fill a void in the sacrum or as a substitute or adjunct to autograft or allograft during posterolateral fusion. Bi-ostetic is not indicated for use in the interbody space during interbody fusion procedures or in load bearing applications.

·

Iliac Crest Bone Graft Harvesting System. Our disposable iliac crest bone graft harvesting system was developed to aid surgeons in harvesting iliac crest autograft via a minimally invasive approach. Fusion success is dependent on a proper disc preparation technique, including a thorough discectomy with removal of the cartilaginous endplate and nuclear material. Use of autograft, which is osteogenic, osteoinductive and osteoconductive, further improves the chances of fusion success. Because it is harvested from the patient, it eliminates risk of disease transmission. It provides living cells as well as scaffolding for new bone growth.

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·

improved outcomes for medical conditions affecting the lumbar spine;

·

acceptance by spine surgeons;

·

ease of use and reliability;

·

product price and qualification for reimbursement;

·

technical leadership and superiority;

·

effective marketing and distribution; and speed to market.

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·

In August 2013, an article was published in Medical Devices: Evidence and Research (“Axial lumbar interbody fusion: a 6-year single-center experience,” by Zeilstra et al.) that discusses a single surgeon’s experience using the AxiaLIF device. This is the largest series of patient data to date by one surgeon. In this study of 131 patients with degenerative disc disease, there were no intraoperative complications, including vascular, neural, urologic, or bowel injuries reported. Clinical outcomes demonstrated a decrease in back and leg pain severity by 51% and 42%, respectively. Overall back function scores improved by 50% compared to baseline. Clinical success (defined as improvement ≥ 30%) was 67% for back pain severity, 65% for leg pain severity, and 71% for back function. The employment rate increased from 47% before surgery to 64% at final follow-up. Lastly, patient satisfaction with AxiaLIF was 83% and the fusion rate was 87.8% at final follow-up.

 

·

In September 2013, an article was published in Medical Devices: Evidence and Research (“Clinical and radiographic outcomes with L4–S1 axial lumbar interbody fusion (AxiaLIF) and posterior instrumentation: a multicenter study,” by Tobler et al.) that discusses the outcome of a retrospective study of 52 patients on the two-level AxiaLIF device conducted at four clinical sites. The results demonstrated a 56% improvement in patient back pain two years after surgery compared to immediately prior to the procedure. In addition, there was a 42% improvement in the Oswestry Disability Index (“ODI”) a commonly used measure for levels of disability in daily living activities. Back pain clinical success and ODI clinical success (defined as ≥ 30% improvement from baseline) was 75% and 50%, respectively. At final follow-up, 87% were rated as good or excellent according to Odom’s criteria. The article also reports that the procedures utilizing our pre-sacral approach demonstrated a 93% fusion rate. The article further concludes that, for the evaluated population, our pre-sacral approach did not result in any vascular or neural injury. In addition, while we have received reports of bowel injury associated with our pre-sacral approach, no bowel injuries were reported in this article. Not all patients have the same experience when treated with AxiaLIF.

 

·

In October 2013, an article was accepted for publication in Spine (“Biomechanical effect of TLIF and Axial Interbody Threaded Rod on Range of Motion and S1 Screw Loading in a Destabilized L5-S1 Spondylolisthesis Model,” by Fleischer et al.) that compared the reduction in pedicle screw strain and spinal range of motion between AxiaLIF and TLIF in a cadaveric model. The findings demonstrated AxiaLIF significantly reduced screw strain in extension compared to TLIF and AxiaLIF reduced range of motion in flexion-extension, lateral bending and in torsion. The authors concluded that AxiaLIF decreases the range of motion of the spine which provides the necessary stabilization needed to allow fusion to occur. Concurrently, AxiaLIF also decreases the amount of strain seen on the S1 screw, decreasing the chances of screw failure and maintains the necessary stabilization of the spine, ultimately allowing fusion to occur.

 

·

In December 2013, in The Journal of Spinal Disorders and Techniques featured two clinical studies focused on the AxiaLIF Plus pre-sacral access and interbody fusion system and our iO-Flex decompression instrument.

 

	15

“Comparison of Axial and Anterior Interbody Fusions of the L5-S1 Segment: A Retrospective Cohort Analysis,” (Whang et al.) describes a head-to-head study by two independent spine surgeons comparing AxiaLIF Plus to ALIF in 96 total patients. AxiaLIF Plus 1-Level (L5-S1) with pedicular fixation was compared to ALIF (L5-S1) with pedicular fixation. All patients had two year or greater follow up with thin slice CT scans. In the surgeons' combined review, AxiaLIF Plus demonstrated higher fusion rates than ALIF, although the difference was not statistically significant. Further, the AxiaLIF cohort experienced no serious adverse events, compared with the ALIF cohort, in which one serious adverse event was reported. 

 

“Facet-sparing Decompression With a Minimally Invasive Flexible Microblade Shaver: A Prospective Operative Analysis,” (Dickinson et al) describes data from a prospective, observational study on 59 subjects who underwent a facet-sparing decompression using the iO-Flex minimally invasive decompression instrument for lumbar spinal stenosis. Operative technique, operative data and surgical adverse events were evaluated. There were no device-related operative complications with the iO-Flex instrument. A subset of patients were evaluated radiographically using CT scans and showed that access to the lateral recess and foramen was achieved with removal of less than 6% of the superior facet cross-sectional area.

·

In May 2013, an article was published in Medical Devices: Evidence and Research (“TranS1 VEO System: a novel psoas-sparing device for transpsoas lumbar Interbody fusion,” by Hardenbrook et al.) that describes the clinical uses, procedural details, and indications for use of the VEO system. In this paper, the author reports his clinical findings on 65 subjects. Using validated outcome tools, Visual Analog Scale (VAS) and the Oswestry Disability Index, Hardenbrook demonstrated back pain improvement of 48% and back function improvement of 34% over pre-operative scores. There were also no nerve, vascular, or intra-abdominal injuries. The author feels that the direct visualization to the psoas and surrounding nerves potentially reduces iatrogenic injury and the risk of postoperative thigh symptoms.

·

In December 2013, an article was published in Neurosurgery (“Genitofemoral Nerve Protection During the Lateral Retroperitoneal Transpsoas Approach,” by Tender et al.) that discusses the early clinical results of 13 subjects from a single surgeon and compares the results to a historical matched cohort using a different lateral system. The findings for operative time and estimated blood loss were similar but the hospital length of stay was shorter in the VEO cohort and was found to be a statistically significant difference. In this study, the genitofemoral nerve (GFN) was identified in 7/13 patients compared to the historical cohort (0/13), which does not use direct visualization. Thigh pain at two weeks post-op was reported in one patient compared to five patients in the control arm. There were no reports of thigh pain at three months post-op in this study but three patients still reported thigh pain in the control arm. Historically, the lateral approach has been marked with having a relatively high incidence of complications, most of them are transient in nature, and some surgeons consider these complications to be a natural part of surgery.

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our method for performing pretrans-sacral procedures in the spine, including diagnostic or therapeutic procedures, and trans-sacral introduction of instrumentation or implants;

·

apparatus for conducting these procedures including access, disc preparation and implantation including the current AxiaLIF instruments individually and in kit form;

·

implants for fusion and motion preservation in the spine;

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a direct lateral access and interbody fusion system;

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posterior fixation systems; and

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instrumentation individually and in kit form for accessing target spinal tissue, confirming the location of neural tissue, and modifying target tissue to achieve decompression.

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product design and development;

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establishment registration and device listing;

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product testing (preclinical and clinical);

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product manufacturing;

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product labeling;

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product storage;

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premarket clearance or approval;

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advertising and promotion;

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product marketing, sales and distribution; and

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post-market surveillance, including reporting deaths or serious injuries related to products and certain product malfunctions.

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quality system regulation, which requires manufacturers, including third-party contract manufacturers, to follow stringent design, testing, control, documentation, and other quality assurance controls, during all aspects of the manufacturing process;

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establishment registration and listing;

·

labeling regulations, and FDA prohibitions against the promotion of products for uncleared or unapproved “off-label” uses;

·

medical device reporting obligations, which require that manufacturers submit reports to the FDA if information reasonably suggests that their device (i) may have caused or contributed to a death or serious injury, or (ii) malfunctioned and the device or a similar company device would likely cause or contribute to a death or serious injury if the malfunction were to recur; and

·

other post-market surveillance requirements, which apply when necessary to protect the public health or to provide additional safety and effectiveness data for the device.

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Item 1A.

Risk Factors

·

it may limit our ability to obtain additional debt or equity financing for working capital, capital expenditures, product development, debt service requirements, acquisitions or general corporate or other purposes;

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a portion of our cash flows from operations will be dedicated to the payment of principal and interest on our indebtedness and will not be available for other purposes, including our operations, capital expenditures and other business opportunities;

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if we seek to refinance our debt or require additional refinancing in the future, we may be unable to do so on attractive terms or at all;

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it may limit our flexibility in planning for, or our ability to adjust to, changes in our business or the industry in which we operate and place us at a competitive disadvantage compared to our competitors that have less debt; and

·

we may be vulnerable to a downturn in general economic conditions or in our business, or we may be unable to carry out capital spending that is important to our growth.

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lack of long-term clinical data supporting additional patient benefits;

·

lack of experience with our products;

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lack of evidence supporting the cost savings, clinical efficacy or safety of our products and procedure over competitive products and medical technologies;

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perceived liability risks generally associated with the use of new products and procedures;

·

training time required to use a new product or procedure; and

·

availability of adequate coverage and reimbursement for hospitals and surgeons.

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·

greater financial and human resources for product development, sales and marketing and patent litigation;

·

significantly greater name recognition;

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established relationships with spine surgeons, customers and third-party payors;

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additional lines of products, and the ability to offer rebates or bundle products to offer greater discounts or incentives to gain a competitive advantage;

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established sales and marketing, and distribution networks; and

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greater experience in developing new products, conducting clinical trials, preparing regulatory submissions and obtaining regulatory clearance or approval for products and marketing approved products.

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the imposition of additional U.S. and foreign governmental controls or regulations;

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the imposition of complicated and costly import or export controls or requirements;

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the imposition of U.S. or international sanctions against a country, company, person or entity with whom we do business that would restrict or prohibit continued business with the sanctioned country, company, person or entity;

·

economic weakness or uncertainty, including the sovereign debt crises affecting several countries in the European Union;

·

political instability;

·

changes in third-party reimbursement policies that may require some of the patients who receive our products to directly absorb medical costs or that may necessitate the reduction of the selling prices of our products;

·

changes in duties and tariffs, license obligations and other non-tariff barriers to trade;

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the imposition of new trade restrictions;

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the imposition of restrictions on the activities of foreign agents, representatives and distributors;

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difficulties in maintaining consistency with our internal guidelines;

·

complications arising from longer accounts receivable payment cycles and enforcing agreements and collecting receivables through certain foreign legal systems; and

·

uncertainties surrounding the enforcement or defense of our intellectual property rights.

·

inadequate capacity of the manufacturer’s facilities;

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financial difficulties experienced by manufacturers due to the current economic weakness and uncertainty;

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interruptions in access to certain process technologies; and

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reduced control over product availability, quality, delivery schedules, manufacturing yields and costs.

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market acceptance of our products and the revenues we are able to generate as a result;

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the availability of adequate coverage and reimbursement for hospitals and surgeons;

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the scope, rate of progress and cost of our clinical trials;

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the cost of our research and development activities;

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the cost of defending, in litigation or otherwise, any claims that we infringe third-party patent or other intellectual property rights;

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the cost and timing of additional regulatory clearances or approvals; and

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the cost and timing of establishing additional sales, marketing and distribution capabilities.

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properly identify and anticipate spine surgeon and patient needs;

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develop and introduce new products or product enhancements in a timely manner;

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avoid infringing upon the intellectual property rights of third parties;

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demonstrate the safety and efficacy of new products with data from preclinical studies and clinical trials;

·

obtain the necessary regulatory clearances or approvals for new products or product enhancements;

·

be fully FDA-compliant with marketing of new devices or modified products;

·

provide adequate training to potential users of our products;

·

receive adequate coverage and reimbursement for procedures performed with our products; and

·

develop an effective and FDA-compliant, dedicated marketing and distribution network.

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the federal Anti-kickback Statute, which prohibits, among other things, persons or entities from soliciting, receiving, offering or providing remuneration, directly or indirectly, in return for or to induce either the referral of an individual for, or the purchase order or recommendation of, any item or services for which payment may be made under a federal healthcare program such as the Medicare and Medicaid programs;

·

HIPAA, which established federal crimes for knowingly and willfully executing a scheme to defraud any healthcare benefit program or making false statements in connection with the delivery of or payment for healthcare benefits, items or services;

·

federal false claims laws, which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false or fraudulent, and which may apply to entities like us to the extent that our interactions with customers may affect their billing or coding practices; and

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state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws, which may apply to items or services reimbursed by any third-party payor, including commercial insurers.

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Future sales of common stock to new investors to continue to provide us operating capital may cause significant dilution to existing stockholders 

 

We will continue to require additional working capital through

the sale of common or preferred stock or through additional debt instruments until we have cash flow break-even.  All of these financing options may also include additional incentives to new investors in the form of warrants to acquire additional shares of our common stock.  Related to our current debt facility, we issued a warrant to our lender which enables them to obtain common shares for a term of five years from the warrant issue date if the holder pays the stated exercise price. As a result of these future financing transactions as well as any exercise of the outstanding warrant, dilution to the interests of other holders of our common stock may occur.

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a classified board so that only one of the three classes of directors on our Board of Directors is elected each year;

·

procedures for advance notification of stockholder director nominations and proposals;

·

a prohibition on stockholders being able to call a special meeting of stockholders;

·

the ability of our Board of Directors to amend our bylaws without stockholder approval;

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a supermajority stockholder vote requirement for amending certain provisions of our amended and restated certificate of incorporation and our amended and restated bylaws; and

·

the ability of our Board of Directors to issue up to 5,000,000 shares of preferred stock without stockholder approval upon the terms and conditions and with the rights, privileges and preferences as our Board of Directors may determine.

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Item 1B.

Unresolved Staff Comments.

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Item 5.

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The closing price for our common stock as reported by the NASDAQ Global Market on March 7, 2014 was $1.49 per share. As of March 7, 2014, we had approximately 93 stockholders of record.

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Item 6.

Selected Financial Data.

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

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The Credit Facility has a term of 39 months or 42 months if the specified revenue targets are achieved. Each advance accrues interest at a rate equal to the prime rate plus 7.75% (with the prime rate subject to a floor of 4.75%), calculated on an actual/360 basis and payable monthly in arrears. Amounts outstanding during an event of default accrue interest at a rate of 3% in excess of the above rate, and past due amounts are subject to a 5% late charge. Outstanding principal will amortize in the 30-month period preceding maturity, payable in equal installments of principal and interest (subject to recalculation upon a change in prime rates). Any advance may be prepaid in whole or in part at any time, subject to a prepayment fee of 1-2% if prepaid more than one year after closing. In addition, a fee equal to 3.50% of all advances made under the Credit Facility will be payable upon the repayment or prepayment in full of the advances. The Credit Facility is secured by a lien on substantially all of our assets.

 

The Loan Agreement contains customary covenants and representations, including a financial reporting covenant and limitations on dividends, distributions, debt, contingent obligations, liens, loans, investments, mergers, acquisitions, divestitures, subsidiaries, and changes in control. There are no financial covenants. Prior to the maturity of the Credit Facility, Hercules will also have the right to participate on the same terms as other participants in certain types of our broadly marketed equity financings. The events of default under the Loan Agreement include, without limitation, (1) a material adverse change in our ability to perform our obligations under the Loan Agreement, or in the value of our collateral and (2) an event of default under any other of our indebtedness in excess of $150,000. If an event of default occurs, Hercules is entitled to take enforcement action, including acceleration of amounts due under the Loan Agreement. The Loan Agreement also contains other customary provisions, such as expense reimbursement and confidentiality. Hercules has indemnification rights and the right to assign the Credit Facility.

 

On December 3, 2013, we utilized a portion of the initial advance under the Credit Facility, together with other available cash, to prepay all obligations owing under, and to terminate the Term Loan. We recognized $341,245 as a loss on extinguishment of debt.

  

In connection with the Credit Facility, we issued to Hercules a warrant to purchase shares of our common stock (the “Warrant”). The Warrant consists of two tranches, the first tranche issued at closing and the second tranche to be issued if and when Hercules makes a second advance under the Loan Agreement. The first tranche is exercisable for a number of shares of our common stock equal to $900,000 divided by the exercise price. The second tranche is exercisable for a number of shares of our common stock equal to $300,000 divided by the exercise price. The exercise price is $1.02 initially, but is subject to downward adjustment upon our consummation of a financing at a lower effective price per share during the one-year period following the Credit Facility Closing Date. The aggregate number of shares issuable upon exercise is limited to 1,176,471. The Warrant is exercisable until the fifth anniversary of the Credit Facility Closing Date and will be exercised automatically on a net issuance basis if not exercised prior to the expiration date.

 

The Warrant is considered a mark-to-market liability which is re-measured to fair value at each reporting period due to a provision whereby the exercise price of the Warrants could be decreased if the Company had a subsequent issue of equity instruments at a price less than $1.02 per share. We will be required to mark-to-market the fair value of the warrant liability each reporting period over the warrant term. At December 3, 2013, we recorded as a liability the initial Warrants tranche for 882,353 shares of our common stock at an estimated fair value of approximately $0.7 million with an offset to debt discount.

 

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If the financial conditions of our customers were to deteriorate, resulting in an impairment of their ability to make payments or our ability to collect, an increase to the allowance may be required. Also, should actual collections of accounts receivable be different than our estimates included in determining the allowance, the allowance would be adjusted through charges or credits to SG&A in our consolidated income statement in the period in which such changes in collection become known. If conditions change in future periods, additional allowances or reversals may be required. Such allowances or reversals could be significant. 

·

Revenue.  Our revenue reflects product revenue primarily consisting of our AxiaLIF and VEO fusion systems as well as our iO-Flex and iO-Tome instruments utilized in lower lumbar spinal surgeries. The product revenue may also include revenue for other disposable surgical products also used in those surgeries including bone void filler and bone graph harvester.

	50

·

Cost of Revenue.  Cost of revenue consists primarily of material, direct labor and overhead costs related to our products, including reusable kit depreciation, product royalties and medical device taxes. Overhead costs primarily include facilities-related costs, such as rent and utilities, and indirect labor costs.

·

Research and Development. Research and development expenses consist primarily of personnel costs within our product development, regulatory and clinical functions and the costs of clinical studies, product development projects and technology licensing costs. In future periods, we expect research and development expenses to grow as we continue to invest in basic research, clinical trials, product development and intellectual property. Research and development expenses are expensed as incurred.

·

Sales and Marketing.  Sales and marketing expenses consist primarily of personnel costs, sales commissions paid to our direct sales representatives, independent sales agents and independent distributors and costs associated with physician training programs, promotional activities and participation in medical and trade conferences. In future periods, we expect sales and marketing expenses to increase as we expand our sales and marketing efforts.

·

General and Administrative.  General and administrative expenses consist of personnel costs related to the executive, finance and human resource functions, as well as professional service fees, legal fees, accounting fees, insurance costs, bad debt expense and general corporate expenses.

·

Charges Related to U.S. Government Settlement.  Charges related to U.S. Government settlement consist of settlement costs and legal fees related to the subpoena issued by the OIG in October 2011 and the June 2013 settlement with the U.S. Department of Justice.

·

Merger and Integration Expenses.  Merger expenses consist primarily of legal, accounting, consulting and other professional fees related to the Merger. Integration expenses consist of costs incurred in planning for and integrating our operations.

·

Non-Operating Items, Net.  Non-operating items, net is primarily composed of interest expense on the long-term debt and U.S. Government settlement, interest earned on our cash and cash equivalents, gain or loss on disposal of fixed assets, loss on extinguishment of debt and increase/decrease in the estimated fair value of the Warrant liability.

	51

	52

 

	53

	54

	55

	56

(1)

In June 2013, we entered into a settlement agreement with the OIG. The $6.0 million settlement, plus accrued interest of 2%, is to be paid in nine quarterly installments starting in July 2013.

(2)

Long-term debt in the table consists of outstanding amounts for our $7.5 million advance and related final payment of $0.3 million under our Credit Facility.

As of December 31, 2013, we did not have any off-balance sheet arrangements.

	57

	58

 

	59

	60

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	Baxano Surgical, Inc.
Date:  March 10, 2014	By:	/s/ Ken Reali
		Ken Reali
		President and Chief Executive Officer
		(Principal Executive Officer)

                Pursuant to the requirements of the Securities Exchange Act of 1934, this annual report on Form 10-K has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.  

Signature		Title		Date
/s/ Ken Reali		President, Chief Executive Officer and Director
Ken Reali		(Principal Executive Officer)		March 10, 2014
/s/ Timothy M. Shannon		Interim Chief Financial Officer
Timothy M. Shannon		(Principal Financial and Accounting Officer)		March 10, 2014
/s/ Paul LaViolette		Chairman of the Board
Paul LaViolette				March 10, 2014
/s/ Jeffrey Fischgrund		Director
Jeffrey Fischgrund				March 10, 2014
/s/ Russell Hirsch		Director
Russell Hirsch				March 10, 2014
/s/ James Shapiro		Director
James Shapiro				March 10, 2014
/s/ David Simpson		Director
David Simpson				March 10, 2014
/s/ Mark Stautberg		Director
Mark Stautberg				March 10, 2014
/s/ Roderick Young		Director
Roderick Young				March 10, 2014

	62

		Page
Report of Independent Registered Public Accounting Firm		64
Consolidated Balance Sheets		65
Consolidated Statements of Operations and Comprehensive Loss		66
Consolidated Statements of Stockholders’ Equity		67
Consolidated Statements of Cash Flows		68
Notes to Consolidated Financial Statements		69
Schedule II—Valuation and Qualifying Accounts		90

	63

/s/ PricewaterhouseCoopers LLP
Raleigh, North Carolina March 10, 2014

 

	65

 

	66

	67

	68

1.

Organization

2.

Summary of Significant Accounting Policies

We lease various property and equipment. Leased property and equipment that meet certain criterion are capitalized and the present values of the related lease payments are recorded as liabilities. Capital lease payments are allocated between a reduction of the lease obligation and interest expense using the interest rate implicit in the lease. All other leases are accounted for as operating leases and the related payments are expensed ratably over the rental period. Amortization of assets under capital leases is computed using the straight-line method over the shorter of the lease term or the estimated useful life.

 

	71

3.

Merger and Financing Transaction

	77

 

We allocated approximately  $15.8 million of the purchase price to identifiable intangible assets that met the separability and contractual legal criterion of ASC 805. The following summarizes the intangible assets that were acquired and the period over which we will recognize amortization cost using the straight-line method (in thousands):

4.

Goodwill and Intangible Assets

5.

Long Term Debt and Credit Facilities

The following table presents the components of long-term debt at December 31, 2013 (in thousands):

 
       

7.

Stockholders’ Equity

	82

  

8.

Stock Incentive Plans and Stock-Based Compensation

 

9.

Income Taxes

10.

Other Consolidated Balance Sheet Information

	87

 

Accrued expenses

11.

Cash Flow Supplemental Disclosures

12.

Quarterly Data (Unaudited)

 

13.

Subsequent Events

Restricted Stock Unit Retention Program

 

On January 2, 2014, our Compensation Committee of the Board of Directors approved the terms of the 2014 Restricted Stock Unit Retention Program (the “RSU Program”) and the grant of restricted stock units (“RSUs”) to all our executives and management pursuant to the RSU Program and our 2007 Stock Incentive Plan, as amended. Each award amount equals a number of stock-settled RSUs reflecting one times the employee’s current salary at a target value of $3.00 per share of Common Stock. A portion of the RSU awards is subject to time-based vesting and a portion of the RSU awards is subject to performance-based vesting based on the achievement of certain comparative Company revenue performance criteria. On January 2, 2014, 3,055,997 shares were granted under the RSU Program.

 

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Exhibit
No.		Description
2.1		Agreement and Plan of Merger, among TranS1 Inc., RacerX Acquisition Corp., Baxano, Inc., and Sumeet Jain and David Schulte as Securityholder Representatives, dated March 3, 2013 (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed with the SEC on March 5, 2013).
2.2		List of Schedules Omitted from Agreement and Plan of Merger included as Exhibit 2.1 above (incorporated by reference to Exhibit 2.2 to our Current Report on Form 8-K filed with the SEC on March 5, 2013).
2.3		First Amendment to Agreement and Plan of Merger, dated April 10, 2013, among TranS1 Inc., RacerX Acquisition Corp., Baxano, Inc., and Sumeet Jain and David Schulte as Securityholder Representatives (including Form of Bridge Note in Attachment A) (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K filed with the SEC on April 10, 2013).
3.1		Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.2 to the Registration Statement on Form S-1, as amended (File No. 333-144802), and as declared effective on October 16, 2007).
3.2		Certificate of Ownership and Merger, effective May 31, 2013 (incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K filed with the SEC on June 3, 2013).
3.3		Amended and Restated Bylaws (incorporated by reference to Exhibit 3.4 to the Registration Statement on Form S-1, as amended (File No. 333-144802), and as declared effective on October 16, 2007).
4.1		Specimen Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-3 (File No. 333-189617), as declared effective on July 11, 2013).
10.1		Amended and Restated 2000 Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to the Registration Statement on Form S-1, as amended (File No. 333-144802), and as declared effective on October 16, 2007).*
10.2		Form of Stock Option Agreement under Amended and Restated 2000 Stock Incentive Plan (incorporated by reference to Exhibit 10.2 to the Registration Statement on Form S-1, as amended (File No. 333-144802), and as declared effective on October 16, 2007).*
10.3		2007 Stock Incentive Plan, as amended (incorporated by reference to Exhibit 99.1 to the Registration Statement on Form S-8 (File No. 333-191260) filed with the SEC on September 19, 2013).*
10.4		Form of Stock Option Agreement under 2007 Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013).*
10.5		2007 Employee Stock Purchase Plan, as amended (incorporated by reference to Exhibit 10.5 to our Annual Report on Form 10-K for the year ended December 31, 2010).*
10.6		Lease, dated July 30, 2009, between TranS1 Inc. and Market Place Group, LLC (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on March 11, 2010).
10.7		Form of Indemnification Agreement (incorporated by reference to Exhibit 10.7 to the Registration Statement on Form S-1, as amended (File No. 333-144802), and as declared effective on October 16, 2007).
10.7.1		Schedule of Parties to Indemnification Agreement.+
10.8		Offer Letter, dated December 11, 2009, between TranS1 Inc. and Kenneth Reali (incorporated by reference to Exhibit 10.1 to  our Current Report on Form 8-K filed with the SEC on January 12, 2010).*

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10.9		Offer Letter, dated February 22, 2010, between TranS1 Inc. and Dwayne Montgomery (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on March 18, 2010).*
10.10		Offer Letter, dated April 13, 2010, between TranS1 Inc. and Joseph Slattery (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on April 21, 2010). *
10.11		Offer Letter, dated July 30, 2010, between TranS1 Inc. and Rick Feiler (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on August 4, 2010).*
10.12		Offer Letter, dated September 28, 2010, between TranS1 Inc. and Steve Ainsworth (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on October 4, 2010).*
10.13		Form of Employment Severance Agreement (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on November 9, 2011).*
10.13.1		Schedule of Parties to Employment Severance Agreement.+
10.14		Summary of Non-Employee Director Compensation (incorporated by reference to Exhibit 10.14 to our Annual Report on Form 10-K for the year ended December 31, 2012).*
10.15		Summary of Retention Bonus Plan (incorporated by reference to Exhibit 10.15 to our Annual Report on Form 10-K for the year ended December 31, 2012).* +
10.16		Summary of 2012 Cash Incentive Plan (incorporated by reference to Exhibit 10.16 to our Annual Report on Form 10-K for the year ended December 31, 2012).*
10.17		Summary of 2013 Incentive Bonus Plan (incorporated by reference to Exhibit 10.2 to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013).*
10.18		Lease Agreement, dated October 28, 2011, between TranS1 Inc. and Six Forks Capital, LLC (incorporated by reference to Exhibit 10.17 to our Annual Report on Form 10-K for the year ended December 31, 2012).
10.19		Lease Modification Agreement No. 1, dated January 27, 2012, between TranS1 Inc. and Six Forks Capital, LLC (incorporated by reference to Exhibit 10.18 to our Annual Report on Form 10-K for the year ended December 31, 2012).
10.20		Office Lease, dated October 24, 2012, between TranS1 Inc. and Sun Life Assurance Company of Canada (incorporated by reference to Exhibit 10.19 to our Annual Report on Form 10-K for the year ended December 31, 2012).
10.21		Exclusive License Agreement, dated as of January 24, 2011, between TranS1 Inc., Mitchell A. Hardenbrook, M.D., and MH Brook, Inc. (incorporated by reference to Exhibit 10.20 to our Annual Report on Form 10-K for the year ended December 31, 2012).**
10.22		Distribution Agreement, dated as of October 9, 2012, by and between TranS1 Inc. and Jiade Sunshine (incorporated by reference to Exhibit 10.1 to our Amendment No. 1 to Current Report on Form 8-K/A filed with the SEC on February 1, 2013).**
10.23		Form of Securities Purchase Agreement, between TranS1 Inc. and the investors identified on the signature pages thereto, dated March 3, 2013 (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on March 5, 2013).
10.24		Amended and Restated Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.3 to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013).
10.25		Employment Agreement, effective as of May 31, 2013, between TranS1 Inc. and Greg Welsh (incorporated by reference to Exhibit 10.3 to our Current Report on Form 8-K filed with the SEC on June 3, 2013).*
10.26		General Release and Severance Agreement, dated May 1, 2013, between TranS1 Inc. and Dwayne Montgomery (incorporated by reference to Exhibit 10.4 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013).*

	92

10.27		First Amendment to Lease, dated June 30, 2013, between Baxano Surgical, Inc. and Sun Life Assurance Company of Canada (incorporated by reference to Exhibit 10.5 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013).
10.28		Loan and Security Agreement, dated as of March 15, 2012, among Baxano, Inc., Oxford Finance LLC, and Silicon Valley Bank (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on June 3, 2013).
10.29		First Amendment to Loan and Security Agreement, dated May 31, 2013, among Baxano Surgical, Inc., Oxford Finance LLC, Oxford Finance Funding I, LLC, and Silicon Valley Bank (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on June 3, 2013).
10.30		Settlement Agreement, entered into on June 28, 2013, among the United States of America, acting through the United States Department of Justice and on behalf of the Office of Inspector General of the Department of Health and Human Services, the TRICARE Management Activity, the Office of Personnel Management, the United States Department of Veteran Affairs, Baxano Surgical, Inc. and relator Kevin J. Ryan (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on July 3, 2013).
10.32		Corporate Integrity Agreement, entered into on June 24, 2013, among the Office of Inspector General of the Department of Health and Human Services and Baxano Surgical, Inc. (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on July 3, 2013).
10.33		Offer Letter, dated September 17, 2013, between Baxano Surgical, Inc. and Greg Slusser (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on September 20, 2013).*
10.33		Purchase Agreement, dated as of December 3, 2013, between Baxano Surgical, Inc. and Lincoln Park Capital Fund, LLC (incorporated by reference to Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on December 3, 2013).
10.34		Loan and Security Agreement, dated December 3, 2013, between Baxano Surgical, Inc. and Hercules Technology Growth Capital, Inc. (incorporated by reference to Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on December 3, 2013).
10.35		Warrant Agreement, dated December 3, 2013, between Baxano Surgical, Inc. and Hercules Technology Growth Capital, Inc. (incorporated by reference to Exhibit 10.3 to our Current Report on Form 8-K filed with the SEC on December 3, 2013).
10.36		Terms of 2014 Restricted Stock Unit Retention Program (incorporated by reference to Exhibit 10.1 to our Current Report on From 8-K filed with the SEC on January 8, 2014).*
10.37		Form of Restricted Stock Unit Award Agreement under 2007 Stock Incentive Plan (incorporated by reference to Exhibit 10.2 to our Current Report on From 8-K filed with the SEC on January 8, 2014).*
23.1		Consent of Independent Registered Public Accounting Firm.+
31.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) / 15d-14(a) of the Securities Exchange Act of 1934.+
31.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) / 15d-14(a) of the Securities Exchange Act of 1934.+
32.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(b) / 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.++
32.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(b) / 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.++
101.INS		XBRL Instance Document.+

	93

101.SCH		XBRL Schema Document.+
101.CAL		XBRL Calculation Linkbase Document.+
101.DEF		XBRL Definition Linkbase Document.+
101.LAB		XBRL Label Linkbase Document.+
101.PRE		XBRL Presentation Linkbase Document.+

*	These exhibits are identified as management contracts or compensatory plans or arrangements of the Registrant pursuant to Item 15 of Form 10-K.
**	Portions of this exhibit have been omitted and filed separately with the SEC as part of an application for confidential treatment pursuant to the Securities Exchange Act of 1934, as amended.
+	Filed herewith.
++	Furnished herewith.

	94