form10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended June 30, 2012

OR
 
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _____________________to______________________

Commission file number 0-52491

MIMEDX GROUP, INC.
(Exact name of registrant as specified in its charter)

Florida
 
26-2792552
(State or other jurisdiction of incorporation)
 
(I.R.S. Employer Identification Number)

60 Chastain Center Blvd., Suite 60
   
Kennesaw, GA
 
30144
(Address of principal executive offices)
 
(Zip Code)

(678) 384-6720
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes T No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes T     No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Smaller reporting company T
   
(Do not check if a smaller reporting company)
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No T

As of July 31, 2012, there were 83,063,139 shares outstanding of the registrant’s common stock.
 


 
 

 
 
MIMEDX GROUP, INC.
 
Table of Contents
 
Part I      FINANCIAL INFORMATION  
     
Item 1
Condensed Consolidated Financial Statements
 
     
Condensed Consolidated Balance Sheets (unaudited) June 30, 2012 and December 31, 2011
3
4
5
6
8
     
Item 2
23
     
Item 3
31
     
Item 4
31
     
Part II     OTHER INFORMATION  
     
Item 1
31
     
   Item 1A
31
     
Item 2
32
     
Item 3
32
     
Item 4
32
     
Item 5
32
     
Item 6
32
     
33
 
 
1

 
Forward-Looking Statements
 
This Form 10-Q and certain information incorporated herein by reference contain forward-looking statements and information within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. This information includes assumptions made by, and information currently available to management, including statements regarding future economic performance and financial condition, liquidity and capital resources, acceptance of the Company’s products by the market, and management’s plans and objectives. In addition, certain statements included in this and our future filings with the Securities and Exchange Commission (“SEC”), in press releases, and in oral and written statements made by us or with our approval, which are not statements of historical fact, are forward-looking statements. Words such as “may,” “could,” “should,” “would,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “seeks,” “plan,” “project,” “continue,” “predict,” “will,” “should,” and other words or expressions of similar meaning are intended by us to identify forward-looking statements, although not all forward-looking statements contain these identifying words. These forward-looking statements are found at various places throughout this report and in the documents incorporated herein by reference. These statements are based on our current expectations about future events or results and information that is currently available to us, involve assumptions, risks, and uncertainties, and speak only as of the date on which such statements are made.
 
All forward-looking statements are subject to the risks and uncertainties inherent in predicting the future.  Our actual results may differ materially from those projected, stated or implied in these forward-looking statements as a result of many factors, including our critical accounting policies and risks and uncertainties related to, but not limited to, overall industry environment, delay in the introduction of products, regulatory delays, negative clinical results, and our financial condition.   These and other risks and uncertainties are described in more detail in our most recent Annual Report on Form 10-K, as amended, as well as other reports that we file with the SEC.
 
Forward-looking statements speak only as of the date they are made and should not be relied upon as representing our views as of any subsequent date.  We undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur, except as required by applicable laws, and you are urged to review and consider disclosures that we make in this and other reports that we file with the SEC that discuss factors germane to our business.

 
Part I - FINANCIAL INFORMATION

MIMEDX GROUP, INC. AND SUBSIDIARIES

ASSETS

   
June 30,
       
   
2012
   
December 31,
 
   
(unaudited)
   
2011
 
Current assets:
           
Cash and cash equivalents
  $ 2,654,694     $ 4,112,326  
Accounts receivable, net
    3,946,333       1,891,919  
Inventory, net
    961,939       712,602  
Prepaid expenses and other current assets
    292,223       164,664  
                 
Total current assets
    7,855,189       6,881,511  
                 
Property and equipment, net of accumulated depreciation of $2,045,964 and $1,814,473, respectively
    948,720       869,411  
Goodwill
    4,040,443       4,040,443  
Intangible assets, net of accumulated amortization of $4,136,469 and $3,468,515, respectively
    14,422,531       15,090,485  
Deposits and other long term assets
    204,803       214,342  
                 
Total assets
  $ 27,471,686     $ 27,096,192  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
Current liabilities:
               
Accounts payable and accrued expenses
  $ 1,902,349     $ 2,300,638  
Other current liabilities
    69,981       6,620  
Convertible line of credit with related party, net of unamortized discount of $398,899 and $46,746, respectively, plus accrued interest of $75,137 and $42,726, respectively
    976,238       1,295,980  
Convertible debt related to acquisition, net of unamortized discount of $3,821 and $170,509, respectively, plus accrued interest of $69,808 and $49,315, respectively
    1,065,987       1,128,806  
Current portion of earn-out liability payable In MiMedx common stock
    4,225,280       3,185,223  
Total current liabilities
    8,239,835       7,917,267  
                 
Earn-out liability payable in MiMedx common stock, net of current portion
    -       4,225,280  
Convertible Senior Secured Promissory Notes, net of unamortized discount of $1,818,446 and $2,263,145, respectively, plus accrued interest of $61,933 and $7,732, respectively
    3,243,487       2,744,587  
Other liabilities
    320,055       312,493  
Total liabilities
    11,803,377       15,199,627  
                 
Commitments and contingencies (Note 12)
    -       -  
                 
Stockholders' equity:
               
                 
Preferred stock; $.001 par value; 5,000,000shares authorized and 0 shares issued and outstanding
    -       -  
Common stock; $.001  par value; 110,000,000 shares authorized; 81,052,359 issued and 81,002,359 outstanding for 2012 and 74,306,895 issued and 74,256,895 outstanding for 2011
    81,052       74,307  
Additional paid-in capital
    79,471,324       73,868,604  
Treasury stock (50,000 shares at cost)
    (25,000 )     (25,000 )
Accumulated deficit
    (63,859,067 )     (62,021,346 )
                 
Total stockholders' equity
    15,668,309       11,896,565  
                 
Total liabilities and stockholders' equity
  $ 27,471,686     $ 27,096,192  
 
See notes to condensed consolidated financial statements.

 
MIMEDX GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
 
   
Three Months Ended June 30,
    Six Months Ended June 30,  
                         
   
2012
   
2011
   
2012
   
2011
 
                         
REVENUES:
                       
Net sales
  $ 4,884,256     $ 1,929,399     $ 8,590,064     $ 2,972,886  
                                 
OPERATING COSTS AND EXPENSES:
                               
Cost of products sold
    1,114,926       844,941       2,073,781       1,555,058  
Research and development expenses
    503,086       791,952       910,158       1,754,176  
Selling, general and administrative expenses
    3,383,760       2,708,941       6,355,006       5,336,435  
                                 
LOSS FROM OPERATIONS
    (117,516 )     (2,416,435 )     (748,881 )     (5,672,783 )
                                 
OTHER INCOME (EXPENSE), net
                               
Financing expense associated with the debt discount recognized in connection with the senior secured promissory notes
    (472,749 )     (60,599 )     (783,226 )     (133,517 )
Interest expense, net
    (153,804 )     (26,471 )     (305,614 )     (44,767 )
                                 
LOSS BEFORE INCOME TAXES
    (744,069 )     (2,503,505 )     (1,837,721 )     (5,851,067 )
Income taxes
    -       -       -       -  
                                 
NET LOSS
  $ (744,069 )   $ (2,503,505 )   $ (1,837,721 )   $ (5,851,067 )
                                 
Net loss per common share
                               
Basic and diluted
  $ (0.01 )   $ (0.03 )   $ (0.02 )   $ (0.08 )
                                 
Shares used in computing net loss per common share
                               
Basic and diluted
    79,952,542       71,819,017       77,416,073       71,098,976  
 
See notes to condensed consolidated financial statements.


MIMEDX GROUP, INC. AND SUBSIDIARIES
(unaudited)
 
   
Convertible
                                     
   
Preferred Stock
               
Additional
                   
   
Series A
   
Common Stock
   
Paid-in
   
Treasury
   
Accumulated
       
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Stock
   
Deficit
   
Total
 
                                                 
Balances, December 31, 2011
    -     $ -       74,306,895     $ 74,307     $ 73,868,604     $ (25,000 )   $ (62,021,346 )   $ 11,896,565  
                                                                 
Employee share-based compensation expense
    -       -       -       -       878,491       -       -       878,491  
                                                                 
Other share-based compensation expense
    -       -       -       -       207,709       -       -       207,709  
                                                                 
Exercise of stock options
    -       -       324,750       325       314,970       -       -       315,295  
                                                                 
Exercise of warrants
    -       -       3,453,869       3,453       320,185       -       -       323,638  
                                                                 
Cashless exercise of warrants
    -       -       167,183       167       (167 )     -       -       -  
                                                                 
Common stock issued for accrued Director fees
    -       -       167,086       167       184,486       -       -       184,653  
                                                                 
Common stock issued for Earn-out liability
    -       -       2,632,576       2,633       3,182,590       -       -       3,185,223  
                                                                 
Discount on benefical conversion feature recognized on line of credit with related party
    -       -       -       -       514,456       -       -       514,456  
                                                                 
Net loss for the peiod
    -       -       -       -       -       -       (1,837,721 )     (1,837,721 )
                                                                 
Balances, June 30, 2012
    -     $ -       81,052,359     $ 81,052     $ 79,471,324     $ (25,000 )   $ (63,859,067 )   $ 15,668,309  
 
See notes to condensed consolidated financial statements.

 
MIMEDX GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
 
   
Six Months Ended June 30,
 
   
2012
   
2011
 
Cash flows from operating activities:
           
Net loss
  $ (1,837,721 )   $ (5,851,067 )
Adjustments to reconcile net loss to net cash flows from operating activities:
               
Depreciation
    231,491       231,862  
Amortization of intangible assets
    667,954       667,954  
Amortization of debt discount and deferred financing costs
    783,226       133,517  
Employee share-based compensation expense
    878,491       809,469  
Other share-based compensation expense
    207,709       222,208  
Increase (decrease) in cash resulting from changes in (net of effects of acquisition):
               
Accounts receivable
    (2,054,414 )     (559,044 )
Inventory
    (249,337 )     (103,257 )
Prepaid expenses and other current assets
    (127,559 )     (140,508 )
Accounts payable and accrued expenses
    (338,636 )     574,521  
Accrued interest
    232,107       37,698  
Other liabilities
    7,878       57,127  
Net cash flows from operating activities
    (1,598,811 )     (3,919,520 )
                 
Cash flows from investing activities:
               
Purchases of equipment
    (238,498 )     (143,427 )
Cash paid for acquisition, net of cash aquired of $33,583
    -       (466,417 )
Net cash flows from investing activities
    (238,498 )     (609,844 )
                 
Cash flows from financing activities:
               
Proceeds from exercise of warrants
    323,638       -  
Proceeds from exercise of stock options
    315,295       3  
Repayment of Convertible Debt related to acquisition
    (250,000 )     -  
Repayment of Equipment Lease
    (9,256 )     -  
Proceeds from Line of Credit with related party
    -       1,300,000  
Repayment of Line of Credit
    -       (99,000 )
Repayment of Note Payable
    -       (30,932 )
Proceeds from sale of common stock and warrants and common stock with registration rights, net
    -       3,632,721  
Net cash flows from financing activities
    379,677       4,802,792  
                 
Net change in cash
    (1,457,632 )     273,428  
                 
Cash, beginning of period
    4,112,326       1,340,922  
                 
Cash, end of period
  $ 2,654,694     $ 1,614,350  
                 
Supplemental disclosure of cash flow information:
               
Cash paid for interest
  $ 5,435     $ 2,833  
Cash paid for income taxes
  $ -     $ -  
 
See notes to condensed consolidated financial statements.

 
Supplemental disclosure of non-cash financing and investing activities:

During the six months ended June 30, 2012:
 
*
the Company issued 167,086 shares of stock valued at $184,653 for accrued Director's fees

 
*
the Company issued 167,183 shares of stock for cashless exercise of warrants

 
*
the Company recognized $9,537 in deferred financing costs related to placement agent warrants issued in conjunction with the convertible Senior Promissory Notes
 
 
*
the Company recognized a beneficial conversion feature valued at $514,456 related to the vested contingent warrants on the line of credit with related party
 
 
*
the Company issued 2,632,576 shares of stock valued at $3,185,223 for payment of the 2011 Earn-out liability related to its acquisition of Surgical Biologics
 
 
*
the Company acquired equipment under a captial lease in the amount of $72,302

During the six months ended June 30, 2011:
 
*
the Company converted its outstanding convertible debt and accrued interest to equity by issuing 406,664 shares of common stock
 
 
*
the Company issued 5,250,000 shares of stock valued at $7,087,500 in conjunction with its acquisition of Surgical Biologics, LLC
 
 
*
the Company recognized a beneficial conversion feature valued at $437,500 related to the convertible debt of $1,250,000 issued with regard to its acquisition of Surgical Biologics
 
 
*
the Company recognized a beneficial conversion feature valued at $80,000 related to the convertible Line of Credit with a related party
 
See notes to condensed consolidated financial statements.

 
MIMEDX GROUP, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011
 
1.
Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulations S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  Changes to GAAP are established by the Financial Accounting Standards Board (“FASB”) in the form of accounting standards updates (“ASU’s”) to the FASB’s Accounting Standards Codification (“ASC”).  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the results of operations for the periods presented have been included.  Operating results for the three and six months ended June 30, 2012 and 2011, are not necessarily indicative of the results that may be expected for the fiscal year.  The balance sheet at December 31, 2011, has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements.
 
You should read these condensed consolidated financial statements together with the historical consolidated financial statements of the Company for the year ended December 31, 2011 included in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the Securities and Exchange Commission (“SEC”) on March 30, 2012, as amended by Amendment No. 1 filed on April 27, 2012, and by Amendment No. 2 filed on June 21, 2012.
 
The Company operates in one business segment, Biomaterials, which includes the design, manufacture, and marketing of products and amnion tissue processing for a variety of surgical applications using the Company’s proprietary biomaterials—CollaFix™, HydroFix®, EpiFix® and AmnioFix®.
 
2. 
Significant accounting policies
 
Please see Note 2 to our Consolidated Financial Statements included in the Company’s Form 10-K for the fiscal year ended December 31, 2011, for a description of all significant accounting policies.
 
Reclassifications
 
Certain amounts in the prior year financial statements have been reclassified to conform to the current year financial statement presentation.
 
Use of estimates
 
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
 
Accounts Receivable
 
Accounts receivable represent amounts due from customers for which revenue has been recognized. Generally, the Company does not require collateral or any other security to support its receivables.
 
The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing receivables. The Company determines the allowance based on factors such as historical collection experience, customer’s current creditworthiness, customer concentration, age of accounts receivable balance and general economic conditions that may affect the customer’s ability to pay.  The Company has $53,000 and $20,000 in the allowance for doubtful accounts as of June 30, 2012 and December 31, 2011, respectively.  Actual customer collections could differ from estimates.  The approximate provision during the six months ended June 30, 2012 was $51,000, and there were approximately $18,000 of write-offs during the same period.
 
 
Inventories
 
Inventories are valued at the lower of actual cost or market, using the first-in, first-out (“FIFO”) method.  Work in process is calculated by estimating the number of units that will be successfully converted to finished goods, based upon a build-up in the stage of completion using estimated labor inputs for each stage and historical yields reduced by estimated usage for quality control testing.  Idle facility expense, excessive spoilage, extra freight, and handling costs are expensed, as necessary, in cost of products sold and are not capitalized into inventories.  Allocation of fixed production overheads is based on the normal capacity of production facilities.
 
Goodwill and intangible assets
 
Goodwill is tested at least annually for impairment, or more frequently if events or changes in circumstances indicate that the asset might be impaired.  Intangible assets with finite useful lives are amortized into Selling, General and Administrative Expenses in the condensed consolidated statements of operations using the straight-line method over various periods depending upon the specific asset.
 
Debt Instruments with Detachable Warrants and Beneficial Conversion Features
 
According to ASC-470 Debt Instruments with Detachable Warrants, proceeds from the sale of debt instruments with stock purchase warrants (detachable call options) shall be allocated to the two elements based upon the relative fair values of the debt instrument without the warrants and of the warrants themselves at the time of issuance. The portion of the proceeds so allocated to the warrants shall be accounted for as paid-in capital. The remainder of the proceeds shall be allocated to the debt instrument portion of the transaction. Also, the embedded beneficial conversion feature present in the convertible instrument shall be recognized separately at issuance by allocating a portion of the proceeds equal to the intrinsic value of that feature to additional paid-in capital.
 
Revenue Recognition
 
The Company sells its products primarily through a combination of independent stocking distributors and representatives in the U.S. and independent distributors in international markets. The Company recognizes revenue when title to the goods and risk of loss transfers to customers, provided there are no material remaining performance obligations required of the Company or any matters of customer acceptance. In cases where the Company utilized distributors or ships product directly to the end user, it recognizes revenue upon shipment provided all revenue recognition criteria have been met. A portion of the Company’s revenue is generated from inventory maintained at hospitals or with field representatives. For these products, revenue is recognized at the time the product has been used or implanted. The Company records estimated sales returns, discounts and allowances as a reduction of net sales in the same period revenue is recognized.  The Company recorded approximately $107,000 and $94,000 for net sales returns provisions for the three months ended June 30, 2012 and 2011, respectively, and there were approximately $26,000 and $9,000 of charges against the provision during the three months ended June 30, 2012 and 2011, respectively.  The Company recorded approximately $146,000 and $137,000 for net sales returns provisions for the six months ended June 30, 2012 and 2011, respectively, and there were approximately $26,000 and $102,000 of charges against the provision during the six months ended June 30, 2012 and 2011, respectively.
 
Fair value of financial instruments
 
The carrying value of accounts payable and accrued expenses approximate their fair value due to the short-term nature of these liabilities. The fair value of our short term and long term convertible debt approximates $5,286,000 which represents the face value less the unamortized discount of any beneficial conversion feature plus accrued but unpaid interest at June 30, 2012.  The fair value of warrants issued in conjunction with placement fees was approximately $11,000 which represents the face value less the unamortized discount of any beneficial conversion feature at June 30, 2012.
 
 
Net loss per share
 
Basic net loss per common share is computed using the weighted-average number of common shares outstanding during the period.  Diluted net loss per common share is computed using the weighted-average number of common and dilutive common equivalent shares from stock options, warrants and convertible debt using the treasury stock method.  For all periods presented, diluted net loss per share is the same as basic net loss per share, as the inclusion of equivalent shares from outstanding common stock options, warrants and convertible debt would be anti-dilutive.
 
The following table sets forth the computation of basic and diluted net loss per share:
 
   
Three months ended June 30,
   
Six months ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
Net loss
  $ (744,069 )   $ (2,503,505 )   $ (1,837,721 )   $ (5,851,067 )
Denominator for basic earnings per share - weighted average shares
    79,952,542       71,819,017       77,416,073       71,098,976  
Effect of dilutive securities: Stock options and warrants outstanding and convertible debt (a)
                       
                                 
Denominator for diluted earnings per share - weighted average shares adjusted for dilutive securities
    79,952,542       71,819,017       77,416,073       71,098,976  
                                 
Loss per common share - basic and diluted
  $ (0.01 )   $ (0.03 )   $ (0.02 )   $ (0.08 )
 
 
(a)
Securities outstanding that were excluded from the computation, because they would have been anti-dilutive are as follows:
 
   
June 30, 2012
   
June 30, 2011
 
Outstanding Stock Options
    12,794,250       10,434,667  
Outstanding Warrants
    7,763,817       8,023,917  
Convertible Debt, promissory notes
    5,186,933        
Convertible Line of Credit with Related Party
    1,375,137       1,300,000  
Convertible Debt, Acquisition
    1,069,808       1,250,000  
      28,189,945       21,008,584  
 
The table above excludes all securities with contingencies including the earnout liability and contingent warrants.
 
Recent Accounting Pronouncements
 
The Company considers the applicability and impact of all ASU’s. ASU’s not listed below were assessed and determined to be either not applicable or are expected to have minimal impact on our consolidated financial position or results of operations.
 
Goodwill
 
The FASB issued updated authoritative guidance in September 2011 to amend previous guidance on the annual and interim testing of goodwill for impairment; the guidance became effective for MiMedx at the beginning of its 2012 fiscal year.  The guidance provides entities with the option of first assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If it is determined, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, the two-step impairment test would still be required.  Annual impairment tests are performed by the Company in the fourth quarter of each year.  The adoption of this updated authoritative guidance did not have a significant impact on the Company’s condensed consolidated financial statements.
 
 
Fair Value Measurements
 
The FASB issued updated authoritative guidance in May 2011 to amend fair value measurements and related disclosures; the guidance became effective for MiMedx at the beginning of its 2012 fiscal year.  This guidance relates to a major convergence project of the FASB and the International Accounting Standards Board to improve International Financial Reporting Standards (“IFRS”) and GAAP.  This guidance results in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between IFRS and GAAP.  The guidance also changes some fair value measurement principles and enhances disclosure requirements related to activities in Level 3 of the fair value hierarchy.  The adoption of this updated authoritative guidance had no impact on the Company’s condensed consolidated financial statements.
 
Intangibles – Goodwill and Other
 
In July 2012, the FASB issued an accounting standards update that gives an entity the option to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired.  If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action.  This guidance will be effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, which will be the Company’s fiscal year 2013, with early adoption permitted.  The Company does not expect the adoption of the guidance will have a material impact on the Company’s consolidated financial statements.
 
Recently issued accounting pronouncements not yet adopted:
 
In December 2011, the FASB issued new accounting guidance that will require entities to disclose information about instruments (including derivatives) and transactions eligible for offset in the statement of financial position or subject to an agreement similar to a master netting arrangement.  These new provisions are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods, and should be applied retrospectively for all comparative periods presented.  We do not expect this accounting standard to have an impact on our condensed consolidated financial statements.
 
3.
Liquidity and management’s plans
 
As of June 30, 2012, the Company had approximately $2,655,000 of cash and cash equivalents.  The Company reported total current assets of approximately $7,855,000 and current liabilities payable in cash of approximately $4,015,000 after adjusting for the short term earn-out liability payable in MiMedx common stock in the second quarter of 2013.  The Company believes that its anticipated cash from operating and financing activities and existing cash and cash equivalents will enable the Company to meet its operational liquidity needs, fund its planned investing activities and pay its debt when due for the next twelve months.
 
4. 
Acquisition of Surgical Biologics, LLC
 
On December 21, 2010, we entered into an Agreement and Plan of Merger (“the Merger Agreement”) with Membrane Products Holdings, LLC and OnRamp Capital Investments, LLC, the owners of Surgical Biologics, LLC (“Surgical Biologics”), a privately held company headquartered in Kennesaw, Georgia.  This transaction closed on January 5, 2011 and as a result we acquired all of the outstanding shares of Surgical Biologics in exchange for $500,000 cash, a total of $1,250,000 in 4% Convertible Secured Promissory Notes, and $7,087,500 in stock, represented by 5,250,000 shares of our common stock (525,000 of which were held in escrow for the purpose of securing the indemnification obligations outlined in the Merger Agreement).  Contingent consideration may be payable in a formula determined by sales and certain expenses for the years 2011 and 2012.  The contingent consideration was initially valued at $7,404,700 and is shown in the schedule below as fair value of earn-out.  We completed the acquisition of Surgical Biologics in an effort to extend our biomaterials product lines.  As of December 31, 2011, the Company evaluated the contingent liability based on operating results for the year, and adjusted the earn-out liability to $7,410,503.  On April 30, 2012, the Company issued 2,632,576 shares of its Common Stock valued at $3,185,223 in payment of the 2011 earn-out.  No additional adjustment was required as of June 30, 2012.
 
 
In total, the 4% Convertible Promissory Notes are convertible into up to 1,250,000 shares of the Company’s common stock at $1.00 per share (a) at any time upon the election of the holder of the Convertible Notes; or (b) at the election of the Company, at any such time as the closing price per share of the Company’s common stock (as reported by the OTCBB or on any national securities exchange on which the Company’s shares may be listed, as the case may be) closes at no less than $1.75 per share for not less than 20 consecutive trading days in any period prior to the maturity date. If converted, the Common Stock will be available to be sold following satisfaction of the applicable conditions as set forth in Rule 144. The 4% Convertible Promissory Notes mature in eighteen (18) months and earn interest at 4% per annum on the outstanding principal amount payable in cash on the maturity date or convertible into shares of common stock of the Company as provided for above. The 4% Convertible Promissory Notes are secured by a security interest in the Intellectual Property, including the Patents and know-how and trade secrets related thereto, owned by, or exclusively licensed to, Surgical Biologics, LLC.
 
The Company has evaluated the 4% Convertible Promissory Notes for accounting purposes under GAAP and has determined that the conversion feature meets the conventional-convertible exemption and, accordingly, bifurcation and fair-value measurement of the conversion feature is not required. We are required to re-evaluate this conclusion upon each financial statement closing date while the 4% Convertible Promissory Notes are outstanding. Notwithstanding, the 4% Convertible Promissory Notes were issued with a beneficial conversion feature having an intrinsic value of $437,500. The intrinsic value of the beneficial conversion feature was determined by comparing the contracted conversion price to the fair value of the common on the date the respective 4% Convertible Promissory Notes were issued. A beneficial conversion feature only exists when the embedded conversion feature is “in-the-money” at the commitment date.
 
As a result of the beneficial conversion feature, the 4% Convertible Promissory Notes were recorded net of a discount of $437,500 related to the beneficial conversion feature, the offset of which is recorded in paid-in capital, and the discount will be amortized through periodic charges to interest expense over the tem of the 4% Convertible Notes using the effective interest method.
 
The contingent consideration which was initially valued at $7,404,700 was classified as a liability. The Company has evaluated the contingent consideration for accounting purposes under GAAP and has determined that the contingent consideration is within the scope of ASC 480 Distinguishing Liabilities from Equity whereby a financial instrument other than an outstanding share, that embodies a conditional obligation that the issuer may settle by issuing a variable number of its equity shares, shall be classified as a liability if, at inception, the monetary value of the obligation is based solely or predominantly on variations in something other than the fair value of the issuer’s equity shares.
 
 
The actual purchase price was based on cash paid, the fair value of our stock on the date of the Surgical Biologics acquisition, and direct costs associated with the combination. The actual purchase price was allocated as follows:

Value of 5,250,000 shares issued at $1.35 per share
  $ 7,087,500  
Cash paid at closing
    350,000  
Cash retained for working capital
    150,000  
Assumed Debt
    182,777  
Convertible Secured Promissory Note
    1,250,000  
Fair value of earn-out
    7,404,700  
Total fair value of purchase price
  $ 16,424,977  
         
Assets purchased:
       
Tangible assets:
       
Debt-free working capital
  $ 671,880  
Other assets, net
    385  
Property, plant and equipment
    72,866  
      745,131  
Intangible assets:
       
Customer relationships
    3,520,000  
Supplier relationships
    241,000  
Patents and know-how
    5,530,000  
Trade names and trademarks
    1,008,000  
In-process research and development – liquid
    2,160,000  
In-process research and development – other
    25,000  
Licenses and permits
    13,000  
      12,497,000  
         
Goodwill
    3,182,846  
Total Assets Purchased
  $ 16,424,977  

 
Working capital and other assets were composed of the following:
 
Working capital:
     
Cash
  $ 33,583  
Prepaid Expenses
    2,738  
Accounts Receivable
    181,087  
License Receivable
    340,000  
Inventory
    347,106  
Accounts payable and accrued expenses
    (196,101 )
Deferred rent and customer deposits
    (36,533 )
Debt-free working capital
    671,880  
         
Current portion of debt
    (62,590 )
Long-term debt
    (21,187 )
Line of credit
    (99,000 )
Net working capital
  $ 489,103  
         
Deposits
  $ 16,582  
Deferred rent (non-current)
    (16,197 )
    $ 385  
 
The combination was accounted for as a purchase business combination as defined by ASC Topic 805 – Business Combinations.  The allocation of the purchase price to the assets acquired and liabilities assumed was based on an independent valuation report obtained by us.
 
The values assigned to intangible assets are subject to amortization.  The intangible assets were assigned the following lives for amortization purposes:
 
   
Estimated useful
 
Intangible asset:
 
life (in years)
 
Customer relationships
  14  
Supplier relationships
  14  
Patents and know-how
  14  
Trade names and trademarks
 
indefinite
 
In-process research and development – liquid
 
indefinite
 
In-process research and development – other
 
indefinite
 
Licenses and permits
  3  
 
Goodwill consists of the excess of the purchase price paid over the identifiable net assets and liabilities acquired at fair value.  Goodwill was determined using the residual method based on an independent appraisal of the assets and liabilities acquired in the transaction.  Goodwill is tested for impairment as defined by ASC Topic 350 – Intangibles – Goodwill and Other.
 
5. 
Inventories
          
Inventories consisted of the following items as of June 30, 2012 and December 31, 2011:
 
   
June 30, 2012
   
December 31, 2011
 
Raw materials
  $ 186,707     $ 95,288  
Work in process
    492,017       308,763  
Finished goods
    338,070       361,007  
    $ 1,016,794     $ 765,058  
Reserve for obsolescence
    (54,855 )     (52,456 )
Inventory, net
  $ 961,939     $ 712,602  

 
6. 
Property and equipment
 
Property and equipment consist of the following as of June 30, 2012 and December 31, 2011:

   
June 30, 2012
   
December 31, 2011
 
Leasehold improvements
  $ 978,550     $ 925,086  
Lab and clean room equipment (a)
    1,660,399       1,463,144  
Furniture and office equipment (a)
    355,735       295,654  
      2,994,684       2,683,884  
Less accumulated depreciation
    (2,045,964 )     (1,814,473 )
    $ 948,720     $ 869,411  
 
 
(a)
The table above includes reclassifications of production equipment previously included in the furniture and office equipment category.
 
7. 
Intangible assets and royalty agreement
 
Intangible assets activity is summarized as follows:
 
     
June 30, 2012
   
December 31, 2011
 
 
Weighted
                                   
 
Average
 
Gross
         
Net
   
Gross
         
Net
 
 
Amortization
 
Carrying
   
Accumulated
   
Carrying
   
Carrying
   
Accumulated
   
Carrying
 
 
Lives
 
Value
   
Amortization
   
Value
   
Value
   
Amortization
   
Value
 
Intangible assets subject to amortization:
                                     
License-Shriners Hsp for Children & USF Research (a)
10 years
  $ 996,000     $ (537,833 )   $ 458,167     $ 996,000     $ (488,033 )   $ 507,967  
License - SaluMedica LLC Spine Repair (b)
10 years
    2,399,000       (1,461,581 )     937,419       2,399,000       (1,313,573 )     1,085,427  
License - Polyvinyl Alcohol Cryogel (c)
10 years
    2,667,000       (1,135,091 )     1,531,909       2,667,000       (998,932 )     1,668,068  
Customer Relationships (d)
14 years
    3,520,000       (377,143 )     3,142,857       3,520,000       (251,429 )     3,268,571  
Supplier Relationships (d)
14 years
    241,000       (25,821 )     215,179       241,000       (17,215 )     223,785  
Patents & Know-How (d)
14 years
    5,530,000       (592,500 )     4,937,500       5,530,000       (395,000 )     5,135,000  
Licenses/Permits (d)
3 years
    13,000       (6,500 )     6,500       13,000       (4,333 )     8,667  
        15,366,000       (4,136,469 )     11,229,531       15,366,000       (3,468,515 )     11,897,485  
Intangible assets not subject to amortization:
                                                 
Trade Names/Trademarks (d)
indefinite
    1,008,000             1,008,000       1,008,000             1,008,000  
In-process Research & Development-Liquid (d)
indefinite
    2,160,000             2,160,000       2,160,000             2,160,000  
In-process Research & Development-Other (d)
indefinite
    25,000             25,000       25,000             25,000  
      $ 18,559,000     $ (4,136,469 )   $ 14,422,531     $ 18,559,000     $ (3,468,515 )   $ 15,090,485  
 
 
(a)
On January 29, 2007, the Company acquired a license from Shriners Hospitals for Children and University of South Florida Research Foundation, Inc.  The acquisition price of this license was a one-time fee of $100,000 and 1,120,000 shares of common stock valued at $896,000 (based upon the estimated fair value of the common stock on the transaction date).  Within 30 days after the receipt by the Company of approval by the FDA allowing the sale of the first licensed product, the Company is required to pay an additional $200,000 to the licensor.  Due to its contingent nature, this amount is not recorded as a liability. The Company will also be required to pay a royalty of 3% on all commercial sales revenue from the licensed products.

 
(b)
License from SaluMedica, LLC (SaluMedica) for the use of certain developed technologies related to spine repair.  This license was acquired through the acquisition of SpineMedica Corp.

 
(c)
On March 31, 2008, the Company entered into a license agreement for the use of certain developed technologies related to surgical sheets made of polyvinyl alcohol cryogel.  The acquisition price of the asset was 400,000 shares of common stock valued at $2,596,000 (based upon the closing price of the common stock on the transaction date).  The agreement also provides for the issuance of an additional 600,000 shares upon the Company meeting certain milestones related to future sales.  On December 31, 2009, the Company completed the sale of its first commercial product and met its first milestone under this agreement.  As a result, the Company issued an additional 100,000 shares of common stock to the licensor valued at $71,000.  At June 30, 2012 and 2011, there are no additional amounts accrued for this obligation due to its contingent nature.
 
 
 
(d)
On January 5, 2011, the Company acquired Surgical Biologics, LLC.  As a result, the Company recorded intangible assets for customer and supplier relationships, patents and know-how, licenses/permits, trade names and trademarks and in-process research and development.
 
Estimated future amortization expense related to the June 30, 2012 net carrying amount of $11,229,531 for intangible assets subject to amortization is as follows:
 
Year ending  December 31,
 
Estimated
Amortization
Expense
 
2012 (a)
  $ 667,955  
2013
    1,335,909  
2014
    1,331,575  
2015
    1,225,337  
2016
    1,024,843  
Thereafter
    5,643,912  
    $ 11,229,531  
 
 
(a)
Estimated amortization expense for the year ending December 31, 2012 includes only amortization to be recorded after June 30, 2012.
 
8.
Debt
             
The following disclosures reflect a summary of our outstanding convertible securities, as well as activity related to financing transactions.  The table below summarizes the Company’s financing, and further details regarding each transaction are provided following the table:
 
   
Convertible Line
of Credit with
Related Party
   
Convertible
Senior Secured
Promissory Note
   
Total
 
Face Value of Note
  $ 1,300,000     $ 5,000,000     $ 6,300,000  
Due date
 
(a)
12/31/2012
   
(b)
12/31/2013
         
Annual Interest rate
    5 %     5 %        
                         
Contingent warrants issued at inception (c):
                       
First Contingent Warrants
 
(d)
325,000    
(e)
1,250,000       1,575,000  
Second Contingent Warrants
 
(f)
325,000    
(f)
1,250,000       1,575,000  
Total Contingent Warrants
    650,000       2,500,000       3,150,000  
                         
Vested Warrants as of June 30, 2012:
                       
First Contingent Warrants
 
(d)
(325,000 )  
(e)
(1,250,000 )     (1,575,000 )
Second Contingent Warrants
                 
                         
Contingent Warrants Outstanding as of June 30, 2012 (g)
                       
First Contingent Warrants
                 
Second Contingent Warrants
    325,000       1,250,000       1,575,000  
Total Contingent Warrants Outstanding as of June 30, 2012
  $ 325,000     $ 1,250,000     $ 1,575,000  
Weighted average exercise price of warrants
  $ 0.01     $ 0.01          
 
 
(a)
The initial termination date of the Credit Agreement is December 31, 2012 and the Company may elect to extend the termination date until December 31, 2013 upon payment of an extension fee of 5% of the outstanding principle balance or $65,000.

 
(b)
Unless the Company has repaid the applicable lender’s Notes in full prior to December 31, 2012, the Company must pay to each lender an additional interest payment in the amount of five percent (5%) of the aggregate outstanding principal amount of such lender’s Notes as of December 31, 2012.
 
 
 
(c)
The Contingent Warrants have a term of five years from the date of issuance; however each is subject to automatic terminations as defined in the First Contingent Warrant and Second Contingent Warrant terms. The shares of Common Stock issuable upon exercise of the Contingent Warrants do not carry registration rights and may be exercised on a “cashless” basis. In the event of a change in control transaction on or prior to the First Measurement Date, then the Contingent Warrants shall be exercisable immediately prior to the closing of such change in control transaction. In the event (i) of a change in control transaction after the First Measurement Date and on or prior to the Second Measurement Date and (ii) the per share value of the consideration received by the holders of Common Stock in such change in control transaction is at least $1.75, the Second Contingent Warrant shall be null and void. If the value of the per share consideration received by the holders of Common Stock in such transaction is less than $1.75, the Second Contingent Warrant shall be exercisable immediately prior to the closing of such change in control transaction.

 
(d)
The First Contingent Warrant, (the “First Contingent Warrant”) is issued to each investor to purchase 25% of the number of shares of Stock purchased, at an exercise price of $0.01 per share, provided that the First Contingent Warrant shall only be exercisable if the Company’s Gross Revenue as reported in the Company’s Audited Financial Statements for the year ended December 31, 2011, do not equal or exceed $11,500,000 and further provided that such Warrant shall be null and void in the event that prior to issuance of such Audited Financial Statements (the “First Measurement Date”) the closing trading price of the Stock is at least $1.50 per share for ten or more consecutive trading days.  As of March 31, 2012, the First Contingent Warrants vested due to the Company’s Gross Revenue not exceeding $11,500,000 for the year ended December 31, 2011, and due to the closing trading price of the stock not equaling or exceeding $1.50 per share for ten or more consecutive trading days.

 
(e)
The First Contingent Warrant, (the “First Contingent Warrant”) is issued to each investor to purchase 25% of the number of shares of Stock purchased, at an exercise price of $0.01 per share, provided that the First Contingent Warrant shall only be exercisable if the Company’s Gross Revenue as reported in the Company’s Audited Financial Statements for the year ended December 31, 2011, do not equal or exceed $11,500,000.  As of December 31, 2011, the First Contingent warrants vested due to the Company’s Gross Revenue not exceeding $11,500,000 for the year ended December 31, 2011.

 
(f)
The Second Contingent Warrant, (the “Second Contingent Warrant”) is issued to each investor to purchase 25% of the number of shares of Stock purchased, at an exercise price of $0.01 per share, provided that the Second Contingent Warrant shall only be exercisable if the Company’s Gross Revenue as reported in the Company’s Audited Financial Statements for the year ended December 31, 2012, do not equal or exceed $31,150,000 and further provided that such Warrant shall be null and void in the event that prior to issuance of such Audited Financial Statements (the “Second Measurement Date”) the closing trading price of the Stock is at least $1.75 per share for ten or more consecutive trading days.

 
(g)
The contingent warrants have not been included in our earnings per share calculation per the guidance in ASC 260-10-45-13 Earnings per share: Treatment of Contingently Issuable Shares in Weighted-Average Shares Outstanding which states that shares issuable for little or no cash consideration upon the satisfaction of certain conditions (contingently issuable shares) shall be considered outstanding common shares and included in the computation of basic EPS as of the date that all necessary conditions have been satisfied (in essence, when issuance of the shares is no longer contingent).
 
Convertible Line of Credit with related party
 
On March 31, 2011, the Company and its Chairman of the Board and CEO (“the Lender”) entered into a Subscription Agreement for a 5% Convertible Senior Secured Promissory Note (“Subscription Agreement”) and, in connection therewith, agreed to issue a 5% Convertible Senior Secured Promissory Note (“Note”) in the amount borrowed by the Company, and a First Contingent Warrant (“First Contingent Warrant”) and a Second Contingent Warrant (“Second Contingent Warrant”) to Purchase Common Stock.
 
The Lender agreed to issue a Revolving Secured Line of Credit Agreement (“Credit Agreement”) to the Company of $1,300,000, after reductions for funds raised through other financing activities, to fund its working capital needs.  The first borrowing in the amount of $800,000 was on March 31, 2011, resulting in the issuance of 400,000 contingent warrants to purchase shares of common stock at an exercise price of $0.01 per warrant.  Additional borrowings in the amount of $500,000 were drawn during the three months ended June 30, 2011, resulting in the issuance of 250,000 contingent warrants at an exercise price of $0.01 per warrant.
 
The Company may repay and reborrow, provided there is no event of default, as needed. Collateral for the Credit Agreement includes (i) all of the Company’s intellectual property with the exception of intellectual property owned by Surgical Biologics, LLC, and (ii) all accessions to, substitutions for and replacements, products and proceeds thereof, as more particularly set forth in the Security and Intercreditor Agreement.
 
At the option of the Lender, the Note is convertible into the number of shares of common stock of the Company equal to the quotient of the outstanding principal amount and accrued interest of the Note as of the date of such election divided by $1.00 per share.
 
 
On February 28, 2012, 325,000 First Contingent Warrants vested to the Lender at an exercise price of $0.01 per share. The vesting of the shares resulted in an additional beneficial conversion feature which requires recognition. According to GAAP, proceeds from the sale of debt instruments with stock purchase warrants (detachable call options) shall be allocated to the two elements based upon the relative fair values of the debt instrument without the warrants and of the warrants themselves at the time of issuance. The portion of the proceeds so allocated to the warrants shall be accounted for as paid-in capital. The remainder of the proceeds shall be allocated to the debt instrument portion of the transaction. Also, the embedded beneficial conversion feature present in the convertible instrument shall be recognized separately at issuance by allocating a portion of the proceeds equal to the intrinsic value of that feature to additional paid-in capital. The amount of the warrants and beneficial conversion feature totaled approximately $550,000 net of previously recognized interest expense which has been recorded as a debt discount that will be charged to interest expense over the life of the convertible note.
 
The issuance of the aforementioned securities was not registered in reliance on Section 4(2) of the Securities Act of 1933, as amended.
 
Senior Secured Promissory Notes
 
From December 27 to December 31, 2011, the Company sold 5% Convertible Senior Secured Promissory Notes (the “Notes”) to individual accredited investors for aggregate proceeds of $5,000,000 and issued a First Contingent Warrant (“First Contingent Warrant”) and a Second Contingent Warrant (“Second Contingent Warrant”) to Purchase Common Stock.
 
The aggregate proceeds included $500,000 of Notes sold to the Company’s Chairman of the Board and CEO, who  had committed to lend the Company up to $1,500,000, to the extent other lenders did not subscribe to the Company’s debt offering.  The terms of those advances were subject to amendment as authorized by the Company’s Board of Directors to be consistent with the final terms of the Company’s debt offering.
 
In total, the principal of the Notes is convertible into up to 5,000,000 shares of common stock of the Company (“Common Stock”) at $1.00 per share at any time upon the election of the holder of the note. The Notes mature on December 31, 2013, and bear interest at 5% per annum on the outstanding principal amount payable in cash on a quarterly basis, with all unpaid interest being due and payable on maturity.  Unless the Company has repaid the applicable lender’s Notes in full prior to December 31, 2012, the Company must pay to each lender an additional interest payment in the amount of five percent (5%) of the aggregate outstanding principal amount of such lender’s Notes as of December 31, 2012.  The additional interest is being accrued on a monthly basis.  At the election of the holder, unpaid interest is convertible into shares of Common Stock at $1.00 per share.  Common Stock issued upon conversion of the Notes is available to be sold following satisfaction of the applicable conditions set forth in Rule 144.
 
The Notes are secured by a first priority lien in all of the patents and other intellectual property owned by the Company and its subsidiaries, provided that until the Convertible Secured Promissory Notes in the principal sum of $1,250,000 issued January 5, 2011, in connection with the acquisition of Surgical Biologics, LLC, are paid in full, (i) the patents and other intellectual property owned by Surgical Biologics, LLC, and (ii) all accessions to, substitutions for and replacements, products and proceeds thereof, are excluded from the collateral.  The maturity of the Notes may be accelerated upon the occurrence of certain Events of Default as set forth in the Notes. The lien is at an equal rate for all note holders in payment and lien priority with the notes outstanding under the Company’s Line of Credit with Related Party Agreement dated March 31, 2011, (the “Prior Notes”), all of which are held by the Company’s Chairman & CEO.  In order to effectuate that, to conform the description of the collateral and Events of Default in the Prior Notes to the description of the collateral and Events of Default in the Notes, and to clarify certain adjustments that would be applicable in the event of a stock split, stock dividend or similar event,  the Amended and Restated Security and Intercreditor Agreement executed  by the Company’s Chairman & CEO in connection with the Notes on December 27, 2011,  superseded  the Security and Intercreditor Agreement that was originally executed in connection with the Prior Notes and, on January 3, 2012, the parties also executed an amendment to certain of the other documents executed in connection with the Prior Notes.
 
Under the terms of the sale of the Convertible Senior Secured Promissory notes, each lender received a warrant (the “Conversion Warrant”) to purchase that number of shares of Common Stock equal to the number of shares of Common Stock that would be issuable upon conversion of the principal of such lender’s Note, at an exercise price of $1.00 per share, provided that such Conversion Warrant shall only be exercisable for the number of shares of Common Stock that would have been issued upon conversion of any portion of the principal of the lender’s Note that is, in fact, prepaid prior to maturity of the Notes. The maximum number of shares of Common Stock issuable upon exercise of the Conversion Warrants is 5,000,000 shares. The Conversion Warrant expires on December 31, 2013. The shares of Common Stock issuable upon exercise of the Conversion Warrant do not carry registration rights.  The Conversion Warrant must be exercised for cash.
 
 
According to GAAP, proceeds from the sale of debt instruments with stock purchase warrants (detachable call options) shall be allocated to the two elements based upon the relative fair values of the debt instrument without the warrants and of the warrants themselves at the time of issuance. The portion of the proceeds so allocated to the warrants shall be accounted for as paid-in capital. The remainder of the proceeds shall be allocated to the debt instrument portion of the transaction. Also, the embedded beneficial conversion feature present in the convertible instrument shall be recognized separately at issuance by allocating a portion of the proceeds equal to the intrinsic value of that feature to additional paid-in capital.  The amount of the warrants (i.e. the exercisable First Contingent Warrants) and beneficial conversion feature totaled $2,278,052 which has been recorded as a debt discount that will be charged to interest expense using the effective interest rate over the life of the convertible note.
 
In conjunction with the sale of the Convertible Senior Secured Promissory notes, the Company incurred a placement fee of $32,800 and issued 42,400 common stock warrants to the placement agents at an exercise price of $1.09 per share.  The warrants expire in five years.  The fair value of the warrants was determined to be approximately $15,000 using the Black-Scholes-Merton valuation technique.  The total direct costs of approximately $47,800 are recorded as deferred financing costs and are being amortized over the term of the Senior Notes using the effective interest method. Further, the placement agent warrants are classified in stockholders’ equity because they achieved all of the requisite conditions for equity classification in accordance with GAAP.
 
9. 
Common Stock Placements
 
October 2010 Private Placement
 
In October 2010, the Company commenced a private placement to sell common stock and warrants. From October 30, 2010, through December 31, 2010, the Company sold 2,405,000 shares of common stock at a price of $1.00 per share and received proceeds of $2,337,020 net of $67,980 in offering costs.  For the nine months ended September 30, 2011, the Company sold an additional 3,778,321 shares of Common Stock and issued an additional 1,889,161 warrants and received net cash proceeds of $3,730,587 net of $47,733 in offering costs.  Under the terms of the offering, for each share purchased, the investor received one 5-year warrant to purchase the common stock of the Company at an exercise price of $1.50 per share. The terms of the warrant, (the “Callable Warrant”) are that for every two shares of common stock purchased, the holder is issued a 5-year warrant to purchase one share of the Company’s Common Stock at an exercise price of $1.50 per share. The Callable Warrant does not carry registration rights and is callable by the Company at any time after the issuance if the closing sale price of the Stock exceeds $1.75 for fifteen (15) or more consecutive trading days. Upon written notice, the Company may redeem the Callable Warrant at a price of $0.01 per share.  Additionally, the Company issued a First Contingent Warrant (“First Contingent Warrant”) and a Second Contingent Warrant (“Second Contingent Warrant”) to Purchase Common Stock.
 
The First Contingent Warrant, (the “First Contingent Warrant”) vested during the three months ended March 31, 2012, resulting in the issuance of 1,672,742 warrants at an exercise price of $0.01 per share.
 
The Second Contingent Warrant, (the “Second Contingent Warrant”) is issued to each investor to purchase 25% of the number of shares of Stock purchased, at an exercise price of $0.01 per share, provided that the Second Contingent Warrant shall only be exercisable if the Company’s Gross Revenue as reported in the Company’s Audited Financial Statements for the year ended December 31, 2012, do not equal or exceed $31,150,000 and further provided that such Warrant shall be null and void in the event that prior to issuance of such Audited Financial Statements (the “Second Measurement Date”) the closing trading price of the Stock is at least $1.75 per share for ten or more consecutive trading days.
 
The contingent warrants have not been included in our earnings per share calculation per the guidance in ASC 260-10-45-13 Earnings per share: Treatment of Contingently Issuable Shares in Weighted-Average Shares Outstanding which states that shares issuable for little or no cash consideration upon the satisfaction of certain conditions (contingently issuable shares) shall be considered outstanding common shares and included in the computation of basic EPS as of the date that all necessary conditions have been satisfied (in essence, when issuance of the shares is no longer contingent).
 
 
The warrants met all the requirements for equity classification under GAAP and are recorded in stockholders’ equity.
 
The Company’s Chairman and CEO invested $1,006,664 in the October 2010 Private Placement including the investment of principal and accrued interest from the October 2010 Bridge note converted under the same terms as the Private Placement, receiving 503,332 warrants with an exercise price of $1.50, 251,666 First Contingent warrants at an exercise price of $0.01 and 251,666 Second Contingent warrants at an exercise price of $0.01 as per the aforementioned terms of the offering.
 
In connection with the October 2010 Private Placement, the Company entered into a registration rights agreement that provides “Piggy-Back” registration rights to each investor.
 
10. 
Equity
         
Stock Incentive Plans
 
The Company has three share-based compensation plans: the MiMedx Group, Inc. Assumed 2006 Stock Incentive Plan (the “2006 Plan”), the MiMedx Inc. 2007 Assumed Stock Plan (the “Assumed 2007 Plan”) and the MiMedx Group Inc. Amended and Restated Assumed 2005 Stock Plan (the “Assumed 2005 Plan”) which provide for the granting of qualified incentive and non-qualified stock options, stock appreciation awards and restricted stock awards to employees, directors, consultants and advisors. The awards are subject to a vesting schedule as set forth in each individual agreement. The Company intends to use only the 2006 Plan to make future grants. The number of assumed options under the Assumed 2005 Plan and Assumed 2007 Plan outstanding at June 30, 2012 totaled 375,000.  On May 10, 2012, the Board of Directors approved 4,000,000 additional shares to be made available under the 2006 Plan, bringing the maximum number of shares of common stock which can be issued under the 2006 Plan to 16,500,000 at June 30, 2012.
 
Activity with respect to the stock options is summarized as follows:
 
   
Number of
Shares
   
Weighted-
Average
Exercise
Price
   
Weighted-
Average
Remaining
Contractual
Term
(in years)
   
Aggregate
Intrinsic
Value
 
Outstanding at January 1, 2012
    10,333,583     $ 1.17              
Granted
    2,948,000     $ 1.26              
Exercised
    (324,750 )   $ 0.98              
Forfeited or cancelled/expired
    (162,583 )   $ 1.11              
Outstanding at June 30, 2012
    12,794,250     $ 1.20       7.3     $ 11,728,020  
                                 
Vested or expected to vest at June 30, 2012
    7,106,810     $ 1.17       5.9     $ 6,763,936  

 
The intrinsic value of the options exercised during the three months ended June 30, 2012, was approximately $83,000.
 
Following is a summary of stock options outstanding and exercisable at June 30, 2012:

     
Options Outstanding
   
Options Exercisable
 
Range of Exercise Prices
   
Number
outstanding
   
Weighted-
Average
Remaining
Contractual
Term
(in years)
   
Weighted-
Average
Exercise Price
   
Number
Exercisable
   
Weighted-
Average
Exercise Price
 
$ 0.50       566,250       2.4     $ 0.50       554,223     $ 0.50  
$ 0.65 - $1.00       2,717,500       5.6     $ 0.78       2,624,179     $ 0.78  
$ 1.04 - $1.80       8,960,500       8.7     $ 1.29       3,378,408     $ 1.39  
$ 2.40       550,000       0.2     $ 2.40       550,000     $ 2.40  
          12,794,250       7.3     $ 1.20       7,106,810     $ 1.17  
 
A summary of the status of the Company’s unvested stock options follows:
 
   
Number of
Shares
   
Weighted-
Average
Grant Date Fair Value
 
Unvested at January 1, 2012
    4,333,086     $ 0.72  
Granted
    2,948,000     $ 0.67  
Cancelled/expired
    (162,583 )   $ 0.68  
Vested
    (1,431,063 )   $ 0.74  
Unvested at June 30, 2012
    5,687,440     $ 0.69  
 
Total unrecognized compensation expense related to granted stock options at June 30, 2012, was approximately $4,120,000 and will be charged to expense through July 2015.
 
The fair value of options granted by the Company is estimated on the date of grant using the Black-Scholes-Merton option-pricing model that uses assumptions for expected volatility, expected dividends, expected term, and the risk-free interest rate.  Expected volatilities are based on historical volatility of peer companies and other factors estimated over the expected term of the options.  The term of employee options granted is derived using the “simplified method” which computes expected term as the average of the sum of the vesting term plus the contract term.  The term for non-employee options is generally based upon the contractual term of the option.  The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the period of the expected term or contractual term as described.
 
The assumptions used in calculating the fair value of options using the Black-Scholes-Merton option-pricing model are set forth in the following table:

   
Six months ended June 30,
 
   
2012
   
2011
 
Expected volatility
    58.31 - 59.04 %     57.3 - 57.6 %
Expected life (in years)
    6       6  
Expected dividend yield
           
Risk-free interest rate
    0.62% - 1.22 %     1.48% - 2.24 %
 
The weighted-average grant date fair value for options granted during the six months ended June 30, 2012 was approximately $0.67.
 
Warrants
 
The Company grants common stock warrants in connection with equity share purchases by investors as an additional incentive for providing long term equity capital to the Company and as additional compensation to consultants and advisors.  The warrants are granted at negotiated prices in connection with the equity share purchases and at the market price of the common stock in other instances.  The warrants have been issued for terms of five years.
 
 
Following is a summary of warrants outstanding at June 30, 2012:

   
Number of
Warrants
   
Weighted-
Average
Exercise
 Price per
Warrant
   
Number of
Contingent
Warrants
   
Weighted-
Average
Exercise
Price per
Contingent
Warrant
 
Warrants outstanding at January 1, 2012
    9,388,817     $ 1.00       5,245,484     $ 0.01  
Issued in connection with private placement of common stock
    1,672,743     $ 0.01       (1,672,743 )   $ 0.01  
Issued in connection with line of credit with related party
    325,000     $ 0.01       (325,000 )   $ 0.01  
Warrants exercised
    (3,621,052 )   $ 0.09              
Warrants redeemed for cashless exercises
    (1,691 )   $ 0.09              
Warrants outstanding at June 30, 2012
    7,763,817     $ 1.17       3,247,741     $ 0.01  
 
Warrants may be exercised in whole or in part by:
 
 
·
notice given by the holder accompanied by payment of an amount equal to the warrant exercise price multiplied by the number of warrant shares being purchased; or
 
 
·
election by the holder to exchange the warrant (or portion thereof) for that number of shares equal to the product of (a) the number of shares issuable upon exercise of the warrant (or portion) and (b) a fraction, (x) the numerator of which is the market price of the shares at the time of exercise minus the warrant exercise price per share at the time of exercise and (y) the denominator of which is the market price per share at the time of exercise.
 
These warrants are not mandatorily redeemable, do not obligate the Company to repurchase its equity shares by transferring assets or issue a variable number of shares.
 
The warrants require that the Company deliver shares as part of a physical settlement or a net-share settlement, at the option of the holder, and do not provide for a net-cash settlement.
 
All of our warrants are classified as equity as of June 30, 2012 and December 31, 2011.
 
11. 
Income taxes
         
The Company has incurred net losses since its inception and, therefore, no current income tax liabilities have been incurred for the periods presented.  Due to the Company’s losses, management has established a valuation allowance equal to the amount of net deferred tax assets since management cannot determine that realization of these benefits is more likely than not.
 
 
12. 
Contractual Commitments
 
The Company has entered into operating lease agreements for facility space and equipment, and employment agreements with some key employees acquired with Surgical Biologics.  In addition, the Company has minimum royalty payments due in conjunction with one of its licenses.  The estimated annual lease, royalty, and employment agreement expense are as follows:

12-month period ended June 30,
     
2013
  $ 730,000  
2014
    212,000  
Thereafter
    102,000  
    $ 1,044,000  
 
13.
Subsequent Events
 
On July 5, 2012, the Company paid approximately $177,000 and issued 437,877 shares of common stock valued at approximately $893,000 for the Convertible Secured Promissory Notes related to the acquisition of Surgical Biologics.

As of the close of the stock market on July 3, 2012, the closing trading price of MiMedx common stock had traded at or above $1.75 for a total of ten (10) consecutive trading days, which rendered null and void all Second Contingent Warrants issued by the Company.

In July 2012, the Company decided to exercise its right to call approximately 3,345,000 warrants issued to investors in conjunction with the October 2010 Private Placement.  As a result of calling the warrants, the Company raised approximately $4,900,000 and issued 3,288,733 shares of MiMedx common stock as of August 3, 2012. The balance of 56,750 warrants were repurchased at $.01 per share.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
    
Overview
 
MiMedx Group, Inc. ("MiMedx Group") is an integrated developer, manufacturer and marketer of patent-protected regenerative biomaterials and bioimplants processed from human amniotic membrane.
 
"Innovations in Regenerative Biomaterials" is the framework behind our mission to give physicians products and tissues to help the body heal itself. Our biomaterial platform technologies include the device technologies HydroFix® and CollaFix™, and our tissue technologies, AmnioFix® and EpiFix®. Our tissue technologies, processed from the human amniotic membrane, utilize our proprietary Purion® process that was developed by our wholly-owned subsidiary, Surgical Biologics, to produce a safe, effective and minimally manipulated implant.
 
Recent Events
 
On January 5, 2011, the Company acquired all of the outstanding equity interests in Surgical Biologics, LLC, for an aggregate of $16.4 million in cash, stock and assumed debt.  Certain additional considerations are contingent pending certain earn-out provisions.  This strategic acquisition brings together market leading know-how in amnion tissue processing technology with a global distribution network uniquely positioned to rapidly exploit significant market opportunities across multiple surgical indications.
 
Surgical Biologics, (“SB”), is located in Kennesaw, Georgia. Surgical Biologics develops bioimplants processed from human amniotic membrane that can be used for a wide range of surgical indications including ocular surface repair, gum repair, wound care, burns, and many other types of surgery that require the repair of a patient's integumental (native) tissue.  SB is focused on developing technologically innovative bioimplants that offer the surgeon a variety of clinical options; allowing for greater flexibility in treatment, as well as improved surgical results.
 
 
Surgical Biologics currently distributes tissue in several different membrane subsegments, such as ocular, dental, spine and wound care.  The wound care and tissue management market in the U.S. is currently valued at approximately $7.4B, in which our products could play a strong role. The regenerative dental market is estimated at approximately $232M. The Millennium Research Group has projected the anti‐adhesion market to reach an estimated $500M in 2012, and the ocular market is valued at approximately $100M.  Each market’s sub‐segment has unique competitors, products and distribution methods. Amniotic membrane, as processed by SB, has unique “bio‐active” properties that offer benefits that most competitive products cannot offer. SB’s tissues provide anti-inflammatory, anti-angiogenesis, anti-scarring and barrier properties as well as enhanced healing at the surgical site.
 
Surgical Biologics has developed a specialized method for the processing of amniotic membrane. This patent pending process, named Purion®, consists of unique methods which maximize yield, while minimizing manufacturing costs.  The Purion® process was engineered to create an implant that is optimized for ease of use while providing the patient with the maximum assurance of safety.  Surgical Biologics currently has nine patents pending that have been filed with the United States Patent Office and five patents pending that have been filed internationally. The patent filings consist of the intellectual property used to process tissues and/or apply the tissues in a unique manner in surgery.
 
The Company received the CE Mark for CollaFix® Surgical Mesh CD during the first quarter of 2012.  CollaFix® Surgical Mesh CD is intended for use in general surgical procedures for reinforcement of soft tissue where weakness exists.  This is the first product in the CollaFix® technology platform to receive the CE mark.
 
Results of Operations comparison for the Three Months Ended June 30, 2012 to the Three Months Ended June 30, 2011

Revenue
 
Total revenue increased approximately $2,955,000 to $4,884,000 for the three months ended June 30, 2012, as compared to $1,929,000 for the three months ended June 30, 2011.  The increase in revenue as compared to the prior year is due primarily to increased sales of our amniotic membrane tissue products, EpiFix® and AmnioFix®.  The Company experienced strong demand in the Spine, Wound Care, Ophthalmology, and Orthopedics markets for these products.
 
Tissue Processing Costs and Cost of Products Sold
 
Cost of products as a percentage of revenue improved to 22.8% from 43.8% as compared to prior year.  The improvement was due primarily to the increase in revenue.  Beginning in 2012, the Company decided to allocate both depreciation expense and share-based compensation to each functional area. These expenses were reclassified in the prior year to maintain comparability. The amount of depreciation expense in cost of products sold was approximately $38,000 and $26,000, and the amount of share-based compensation in cost of products sold was $29,000 and $30,000 for the three months ended June 30, 2012 and 2011, respectively.
 
Personnel costs represent approximately $542,000 or 48.6% of total manufacturing, quality assurance and regulatory spending for the three months ended June 30, 2012.
 
Research and Development Expenses
 
Our research and development expenses (“R&D expenses”) decreased approximately $289,000 or 36.5% to $503,000 during the three months ended June 30, 2012, compared to approximately $792,000 in the prior year.  The decrease is primarily related to the closure of our Tampa research facility in mid-2011, along with decreased spending on animal studies for our CollaFix™ and HydroFix® products.  Approximately $197,000, or 39.1%, of R&D expenses for the three months ended June 30, 2012 were attributable to personnel costs, compared to approximately $374,000 or 47.2% for the three months ended June 30, 2011.  Development and testing costs were approximately $23,000 and $161,000 for the three months ended June 30, 2012 and 2011, respectively.  This decrease of approximately $138,000 is a result of lower costs in animal studies related to our CollaFix™ and HydroFix® products.  Additionally, as described above in Cost of Products Sold, beginning in 2012, we decided to allocate both depreciation expense and share-based compensation expense to other functional areas, and have reclassified prior year amounts to maintain comparability.  During the three months ended June 30, 2012 and 2011, we recorded approximately $30,000 and $31,000 for depreciation expense and approximately $76,000 and $98,000 for share-based compensation expense, respectively, to research and development.
 
 
Our research and development expenses consist primarily of internal personnel costs, fees paid to external consultants, and supplies and instruments used in our laboratories.  During the quarter, the Company was granted 2 US patents for the hydrogel technology and 1 US patent for the collagen technology.
 
Selling, General and Administrative Expenses
 
Selling, General and Administrative expenses for the three months ended June 30, 2012, increased approximately $675,000 to $3,384,000 compared to $2,709,000 for the three months ended June 30, 2011.  Selling expense increases were driven by costs associated with our regional account management organization as we continue to build our distribution network for our amniotic tissue platform as well as increased commissions due to higher sales volume. Increased spending on support costs related to medical reimbursement including our 24-hour reimbursement hotline and scientific and clinical studies in support of both reimbursement and ongoing marketing activities were somewhat offset by reduced expense in legal and professional expenses incurred in 2011 related to the acquisition of Surgical Biologics and the aforementioned allocation of depreciation and share-based compensation expense to other functional areas. Selling, general and administrative expenses consist of personnel costs, professional fees, sales commissions, sales training costs, industry trade show fees and expenses, product promotions and product literature costs, facilities costs and other sales, marketing and administrative costs, depreciation and amortization, and share-based compensation.  Personnel costs represent approximately $1,181,000 or 34.9% of total Selling, General and Administrative expenses in the second quarter of 2012.

Historically, the Company has reported depreciation and share-based compensation expense as part of selling, general and administrative expense. The Company decided to report these expenses in each functional area in order to more accurately present all of the costs attributable to each functional area. During the three months ended June 30, 2012 and 2011, we recorded a total of approximately $121,000 and $115,000 in depreciation expense allocated to each functional area per the table below.  The overall $6,000 increase in depreciation was attributable to purchases of production equipment to support the revenue growth.  We depreciate our assets on a straight-line basis, principally over five to seven years.
 
The following table shows the allocation of depreciation for the three months ended June 30, 2012 and 2011, to operating departments:
 
   
Three Months Ended June 30,
 
   
2012
   
2011
 
Cost of products sold
  $ 38,000     $ 26,000  
Research and development
    30,000       31,000  
Selling, general and administrative
    53,000       58,000  
    $ 121,000     $ 115,000  
 
Share-based compensation for the three months ended June 30, 2012 and 2011, was approximately $585,000 and   $544,000, respectively, an increase of approximately $41,000 or 7.5%.  Increased employee stock option grants reflecting management’s philosophy of aligning employee compensation with investor objectives was the primary reason for the increase in expense.  The following table shows the allocation of share-based compensation for the three and six months ended June 30, 2012 and 2011, to operating departments:

   
Three Months Ended June 30,
 
   
2012
   
2011
 
Cost of products sold
  $ 29,000     $ 30,000  
Research and development
    76,000       98,000  
Selling, General and administrative
    480,000       416,000  
    $ 585,000     $ 544,000  
 
We recorded approximately $334,000 in amortization expense related to intangible assets in each of the three months ending June 30, 2012 and 2011.  We amortize our intangible assets over a period of three to fourteen years, which we believe represents the remaining useful lives of the patents underlying the licensing rights and intellectual property.  We do not amortize goodwill but we test at least annually our goodwill for impairment and periodically evaluate other intangibles for impairment based on events or changes in circumstances as they occur.
 
 
25

 
Net Interest Expense
 
We recorded financing and net interest expense of approximately $627,000 during the three months ended June 30, 2012, compared with approximately $87,000 of financing and net interest expense during the three months ended June 30, 2011.  The increase of approximately $540,000 is primarily due to interest related to our Convertible Senior Secured Promissory Notes, which were issued during the last quarter of 2011.  The following table summarizes the interest charges for the three months ended June 30, 2012 and 2011:
 
   
Three Months Ended June 30,
 
   
2012
   
2011
 
   
Debt
Discount
   
Accrued
Interest
   
Interest
Expense,
net
   
Total
   
Debt
Discount
   
Accrued
Interest
   
Interest
Expense,
net
   
Total
 
Convertible Line of Credit with Related Party
  $ 151,000     $ 16,000     $     $ 167,000     $ 11,000     $ 10,000     $     $ 21,000  
Convertible Debt related to acquisition
    86,000       10,000             96,000       50,000       12,000             62,000  
Convertible Senior Secured
                                                               
Promissory Notes
    231,000       125,000             356,000                          
Deferred financing related to Senior Secured Promissory Notes
    5,000                   5,000                          
Other
                3,000       3,000                   4,000       4,000  
    $ 473,000     $ 151,000     $ 3,000     $ 627,000     $ 61,000     $ 22,000     $ 4,000     $ 87,000  

Results of Operations comparison for the Six Months Ended June 30, 2012 to the Six Months Ended June 30, 2011

Revenue
 
Total revenue increased approximately $5,617,000 to $8,590,000 for the six months ended June 30, 2012, as compared to $2,973,000 for the six months ended June 30, 2011.  The increase in revenue as compared to the prior year is due primarily to increased sales of our amniotic membrane tissue products, EpiFix® and AmnioFix®.  The Company experienced strong demand in the Spine, Wound Care, Ophthalmology, and Orthopedics markets for these products.
 
Tissue Processing Costs and Cost of Products Sold
 
Cost of products as a percentage of revenue improved to 24.1% from 52.3% as compared to prior year.  The improvement was due primarily to the increase in revenue and product mix.  Beginning in 2012, the Company decided to allocate both depreciation expense and share-based compensation to each functional area. These expenses were reclassified in the prior year to maintain comparability. The amount of depreciation expense in cost of products sold was approximately $73,000 and $53,000, and the amount of share-based compensation in cost of products sold was $53,000 and $54,000 for the six months ended June 30, 2012 and 2011, respectively.
 
Personnel costs represent approximately $1,011,000 or 48.7% of total manufacturing, quality assurance and regulatory spending for the six months ended June 30, 2012.
 
 
26

 
Research and Development Expenses
 
Our research and development expenses (“R&D expenses”) decreased approximately $844,000 or 48.1% to $910,000 during the six months ended June 30, 2012, compared to approximately $1,754,000 in the prior year.  The decrease is primarily related to the closure of our Tampa research facility in mid-2011, along with decreased spending on animal studies for our CollaFix™ and HydroFix® products.  Approximately $333,000, or 36.5%, of R&D expenses for the six months ended June 30, 2012 were attributable to personnel costs, compared to approximately $731,000 or 41.7% for the six months ended June 30, 2011.  Development and testing costs were approximately $62,000 and $385,000 for the six months ended June 30, 2012 and 2011, respectively.  This decrease of approximately $323,000 is a result of lower costs in animal studies related to our CollaFix™ and HydroFix® products.  Additionally, as described above in Cost of Products Sold, beginning in 2012, we decided to allocate both depreciation expense and share-based compensation expense to other functional areas, and have reclassified prior year amounts to maintain comparability.  During the six months ended June 30, 2012 and 2011, we recorded approximately $60,000 and $59,000 for depreciation expense, respectively, and approximately $147,000 and $185,000 for share-based compensation expense, respectively, to research and development.
 
Our research and development expenses consist primarily of internal personnel costs, fees paid to external consultants, and supplies and instruments used in our laboratories.  During the current year, the Company filed 3 international patent applications for the amniotic tissue technology and 1 international patent application for the collagen technology.  Additionally, during the current year the Company was granted 2 US patents for the Hydrogel technology and 1 US patent for the Collagen technology.
 
Selling, General and Administrative Expenses
 
Selling, General and Administrative expenses for the six months ended June 30, 2012, increased approximately $1,019,000 or 19.1% to $6,355,000 compared to $5,336,000 for the six months ended June 30, 2011.  Selling expense increases were driven by costs associated with our regional account management organization as we continue to build our distribution network for our amniotic tissue platform as well as increased commissions due to higher sales volume. Increased spending on support costs related to medical reimbursement including our 24-hour reimbursement hotline and scientific and clinical studies in support of both reimbursement and ongoing marketing activities were somewhat offset by reduced expense in legal and professional expenses incurred in 2011 related to the acquisition of Surgical Biologics and the aforementioned allocation of depreciation and share-based compensation expense to other functional areas. General and administrative expenses consist of personnel costs, professional fees, sales commissions, sales training costs, industry trade show fees and expenses, product promotions and product literature costs, facilities costs and other sales, marketing and administrative costs, depreciation and amortization, and share-based compensation.  Personnel costs represent approximately $2,223,000 or 35.0% of total Selling, General and Administrative expenses in the six months ended June 30, 2012, compared to approximately $1,583,000 or 29.7% in the six months ended June 30, 2011.

Historically, the Company has reported depreciation and share-based compensation expense as part of selling, general and administrative expense. The Company decided to report these expenses in each functional area in order to more accurately present all of the costs attributable to each functional area. During the six months ended June 30, 2012 and 2011, we recorded a total of approximately $231,000 and $232,000 in depreciation expense allocated to each functional area per the table below.  The overall $1,000 decrease in depreciation was attributable to the retirement of leasehold improvements for the Marietta facility when the lease was terminated in August 2011.  We depreciate our assets on a straight-line basis, principally over five to seven years.

The following table shows the allocation of depreciation for the six months ended June 30, 2012 and 2011, to operating departments:
 
   
Six Months Ended June 30,
 
   
2012
   
2011
 
Cost of products sold
  $ 73,000     $ 53,000  
Research and development
    60,000       59,000  
Selling, general and administrative
    98,000       120,000  
    $ 231,000     $ 232,000  

 
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Share-based compensation for the six months ended June 30, 2012 and 2011, was approximately $1,086,000 and   $1,032,000, respectively, an increase of approximately $54,000 or 5.2%.  Increased employee stock option grants reflecting management’s philosophy of aligning employee compensation with investor objectives was the primary reason for the increase in expense.  The following table shows the allocation of share-based compensation for the six months ended June 30, 2012 and 2011, to operating departments:

   
Six Months Ended June 30,
 
   
2012
   
2011
 
Cost of products sold
  $ 53,000     $ 54,000  
Research and development
    147,000       185,000  
Selling, General and administrative
    886,000       793,000  
    $ 1,086,000     $ 1,032,000  

We recorded approximately $668,000 in amortization expense related to intangible assets in each of the six months ending June 30, 2012 and 2011.  We amortize our intangible assets over a period of three to fourteen years, which we believe represents the remaining useful lives of the patents underlying the licensing rights and intellectual property.  We do not amortize goodwill but we test at least annually our goodwill for impairment and periodically evaluate other intangibles for impairment based on events or changes in circumstances as they occur.
 
Net Interest Expense
 
We recorded financing and net interest expense of approximately $1,089,000 during the six months ended June 30, 2012, compared with approximately $178,000 of financing and net interest expense during the six months ended June 30, 2011.  The increase of approximately $911,000 is primarily due to interest related to our Convertible Senior Secured Promissory Notes, which were issued during the last quarter of 2011.  The following table summarizes the interest charges for each of the six months ended June 30, 2012 and 2012:
 
   
Six Months Ended June 30,
 
   
2012
   
2011
 
   
Debt
Discount
   
Accrued
Interest
   
Interest
Expense,
net
   
Total
   
Debt
Discount
   
Accrued
Interest
   
Interest
Expense,
net
   
Total
 
Convertible Line of Credit with Related Party
  $ 162,000     $ 32,000     $     $ 194,000     $ 11,000     $ 10,000     $     $ 21,000  
Convertible Debt related to acquisition
    167,000       20,000             187,000       123,000       24,000             147,000  
Convertible Senior Secured Promissory Notes
    445,000       248,000             693,000                          
Deferred financing related to Senior Secured Promissory Notes
    10,000                   10,000                          
Other
                5,000       5,000                   10,000       10,000  
    $ 784,000     $ 300,000     $ 5,000     $ 1,089,000     $ 134,000     $ 34,000     $ 10,000     $ 178,000  
 
Liquidity and Capital Resources

Revenue continues to increase quarter over quarter while management maintains tight controls over spending.  As of June 30, 2012, the Company had approximately $2,655,000 of cash and cash equivalents.  The Company reported total current assets of approximately $7,855,000 at June 30, 2012 and total current liabilities payable in cash of approximately $4,015,000 at June 30, 2012, after adjusting for the short term earn-out liability payable in MiMedx common stock in the second quarter of 2012.  Additionally, the current liabilities include a convertible line of credit of approximately $976,000 which is due to be paid in December 2012 but can be extended for an additional 12 months with a one-time payment of 5% of the principal balance due, or $65,000, in December 2012. Therefore the current liabilities after adjustment for the earnout and the convertible line of credit are approximately $3,103,000 which results in a current ratio of 2.54. The Company believes that its anticipated cash from operating and financing activities and existing cash and cash equivalents will enable the Company to meet its operational liquidity needs, fund its planned investing activities and pay its debt when due for the next twelve months.
 
 
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Contractual Obligations
 
Contractual obligations associated with our ongoing business activities are expected to result in cash payments in future periods.  The table below summarizes the amounts and estimated timing of these future cash payments as of June 30, 2012:
 
   
Payments due by period
 
Contractual Obligations
 
TOTAL
   
Less than 1 year
   
1-3 years
   
3-5 years
   
More than 5 years
 
Convertible senior secured promissory notes
  $ 5,000,000           $ 5,000,000              
Convertible debt, line of credit with related party
    1,300,000       1,300,000                    
Convertible debt, note related to acquisition of SB
    1,000,000       1,000,000                    
Employment agreements
    211,466       211,466                    
Operating lease obligations
    737,000       423,000       314,000              
Royalty payments
    95,000       95,000                    
    $ 8,343,466     $ 3,029,466     $ 5,314,000              
 
Discussion of cash flows
 
Net cash used in operations during the six months ended June 30, 2012, decreased approximately $2,321,000 to $1,599,000 compared to $3,920,000 used in operating activities for the six month period ended June 30, 2011, primarily attributable to our increased sales activity, improved gross margins and reduced spending in research and development.
 
Net cash used in investing activities during the six months ended June 30, 2012, decreased approximately $371,000 to $238,000 compared to $609,000 used in investing activities for the six month period ended June 30, 2011.  The decrease was due to the acquisition of Surgical Biologics in 2011 and no acquisition in 2012.
 
Net cash flows from financing activities during the six months ended June 30, 2012 decreased approximately $4,423,000 to $380,000 compared to $4,803,000 during the three months ended June 30, 2011.  Cash flows from financing activities during the current year include approximately $324,000 received from the exercise of warrants, $315,000 received from the exercise of stock options, $250,000 in payments related to the acquisition of Surgical Biologics, and $9,000 in payments on an equipment lease.
 
Due to the material amount of non-cash related items included in the Company results of operations, the Company has developed an Adjusted EBITDA metric which provides management with a clearer view of operational use of cash (see the table below).  The Adjusted EBITDA for the second quarter of 2012 was approximately $923,000 which is an improvement of approximately $2,346,000 as compared to the prior year quarter.  This improvement was the result of increased revenue, improved gross margins and reduced spending in research and development.
 
 
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We use various numerical measures in investor conference calls, investor meetings and other forums which are or may be considered “Non-GAAP financial measures” under Regulation G.  We have provided below for your reference, supplemental financial disclosure for these measures, including the most directly comparable GAAP measure and an associated reconciliation.  The following table provides reconciliation of reported Net Loss on a GAAP basis to Adjusted EBITDA defined as Earnings before Interest, Taxes, Depreciation, Amortization and Share-Based Compensation:
 
   
Three Months Ended June 30,