TSON Baxano Surgical, Inc. (MM)

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes to our consolidated financial statements included in this report. In addition to historical financial information, t his report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, that concern matters that involve risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. These forward-looking statements are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact contained in this report, including statements regarding the expected timing, completion, and benefits of the Merger (as defined below) and Private Placement Transaction (as defined below), other future events, our future financial performance, our future business strategy and the plans and objectives of management for future operations, are forward-looking statements. We have attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” “can,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should” or “will” or the negative of these terms or other comparable terminology. Although we do not make forward-looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Readers are urged to carefully review and consider the various disclosures made by us, which attempt to advise interested parties of the risks, uncertainties, and other factors that affect our business, operating results, financial condition and stock price, including without limitation the disclosures made under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, “Risk Factors”, “Financial Statements” and “Notes to Consolidated Financial Statements” in this report, as well as the disclosures made under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, “Risk Factors”, “Consolidated Financial Statements” and “Notes to Consolidated Financial Statements” included in our Annual Report on Form 10-K for the year ended December 31, 2012, and in other filings we make with the Securities and Exchange Commission, or the SEC. Furthermore, such forward-looking statements speak only as of the date of this report. We expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations except as required by applicable law or the rules of The NASDAQ Stock Market LLC . References in this report to “TranS1”, “we”, “our”, “us”, or the “Company” refer to TranS1 Inc.

Overview

We are a medical device company focused on designing, developing and marketing products to treat degenerative conditions of the spine affecting the lumbar region. We are committed to delivering minimally invasive surgical technologies that enhance patient clinical care while providing sustained value for our customers. We currently market the AxiaLIF ^® family of products for single and two level lumbar fusion, the VEO ^TM lateral access and interbody fusion system, the Vectre ™ lumbar posterior fixation system and Bi-Ostetic ^TM bone void filler, a biologics product. Our AxiaLIF products use our pre-sacral approach, through which a surgeon can access discs in the lumbar region of the spine through an incision adjacent to the tailbone and perform an interbody fusion procedure through instrumentation that provides direct access to the intervertebral space. We developed our pre-sacral approach to allow spine surgeons to access and treat intervertebral spaces without compromising important surrounding soft tissue, nerves and bone structures . Our VEO lateral access and interbody fusion system provides for direct visualization of the psoas muscle and unrestricted lateral fluoroscopic views, which we believe has allowed us to increase our market share in the highly competitive lateral fusion segment. We believe that direct visualization allows a surgeon to have improved visibility of the psoas and the nerves running through this muscle that, when used in conjunction with neuromonitoring, can potentially reduce complications. We also market products that may be used with our AxiaLIF surgical approach, including bowel retractors and additional discectomy tools, as well as a bone graft harvesting system that can be used to extract bone graft in any procedure for which the use of bone graft is appropriate. Our philosophy of continuous improvement is driven by ongoing research and development investment in our core technologies. We support this investment by diligently expanding, maintaining, and protecting our significant patent portfolio.

From our incorporation in 2000 through 2004, we devoted substantially all of our resources to research and development and start-up activities, consisting primarily of product design and development, clinical trials, manufacturing, recruiting qualified personnel and raising capital. We received 510(k) clearance from the U.S. Food and Drug Administration, or FDA, for our AxiaLIF Legacy product in the fourth quarter of 2004, and commercially introduced our AxiaLIF Legacy product in the United States in the first quarter of 2005. We received a CE mark to market our AxiaLIF Legacy product in the European market in the first quarter of 2005 and began commercialization in the first quarter of 2006. We received a CE mark for our AxiaLIF 2L product in the third quarter of 2006 and began commercialization in the European market in the fourth quarter of 2006. We received FDA 510(k) clearance for our AxiaLIF 2L product and began marketing this product in the United States in the second quarter of 2008. T he AxiaLIF 2L product was discontinued in 2010 after we launched our AxiaLIF Plus 2-Level ™ product in July 2010, for which we had received FDA 510(k) clearance in January 2010. We commercially launched our next generation Vectre facet screw system in April 2010. In the first quarter of 2010, we completed product and regulatory training and began marketing Bi-Ostetic bone void filler, a biologics product for specific indications outside the interbody space of the spine. We commercially launched our AxiaLIF Plus 1-Level product in September 2011, for which we had received FDA 510(k) clearance in March 2011. In 2010, we received 510(k) clearance for our VEO lateral access and interbody fusion system, which was commercially launched in November 2011, and in July 2012 we received a CE mark for our VEO lateral access and interbody fusion system and began commercialization in the European market . We currently sell our products through a direct sales force, independent sales agents and international distributors.

In March 2012, we announced that the Current Procedural Terminology (“CPT”) Editorial Panel, or the Panel, voted to approve an application for a new Category I CPT code, 22586, for L5/S1 spinal fusion utilizing our AxiaLIF implant when performing a pre-sacral interbody fusion. In addition, the Panel voted to establish a new Category III CPT code, 0309T, as an add-on code to the new Category I code for use with 22586 when performing L4/5 spinal fusion. The new CPT codes were announced on the American Medical Association’s website on March 2, 2012, and became effective on January 1, 2013. The Medicare final rule was released in November 2012, which stated a valuation of the Category I CPT code 22586 for pre-sacral interbody single level spinal fusion at L5-S1, and became effective January 1, 2013. This CPT code, which applies to our AxiaLIF Plus 1-Level device, is a bundled lumbar arthrodesis procedure that includes bone graft, posterior instrumentation and fixation. With the establishment of a Category I CPT code effective January 1, 2013, we believe that we are in a position to transition to a period of sustainable revenue growth.

We rely on third parties to manufacture all of our products and their components, except for our nitinol nucleus cutter blades, which we manufacture at our facility in Wilmington, North Carolina. Our outsourcing partners are manufacturers that meet FDA, International Organization for Standardization or other internal quality standards, where applicable. We believe these manufacturing relationships allow us to work with suppliers who have the best specific competencies while we minimize our capital investment, control costs and shorten cycle times.

On March 3, 2013, we entered into an Agreement and Plan of Merger with RacerX Acquisition Corp., a wholly-owned subsidiary of the Company, or Merger Sub, Baxano, Inc., or Baxano, and Sumeet Jain and David Schulte solely as Securityholder Representatives, or the Securityholder Representatives, as amended on April 10, 2013 by the First Amendment to Agreement and Plan of Merger by and among the parties. We refer to this agreement, as amended, as the Merger Agreement. Under the terms of the Merger Agreement, we will acquire Baxano through a merger of Merger Sub with and into Baxano, or the Merger. At the effective time of the Merger, Merger Sub will cease to exist and Baxano will continue as the surviving corporation and as a wholly-owned subsidiary of the Company. The dollar value of the shares of our common stock to be issued in connection with the Merger is expected to be approximately $23.1 million, subject to fluctuations in the price of our common stock on the NASDAQ Global Market and certain adjustments.

As of March 31, 2013, we have incurred $1.2 million of merger related expenses and $0.1 million of integration expenses.

Baxano is a medical instrument company focused on designing, developing and marketing innovative tools that restore spine function, preserve healthy tissue, and enable a better quality of life for the patients it serves.  Baxano currently markets the patented iO-Flex® system, a proprietary minimally invasive set of flexible instruments allowing surgeons to target lumbar spinal stenosis in all three regions of the spine: central canal, lateral recess, and neural foramen, and has developed the patented iO-Tome ^TM instrument to rapidly and precisely remove bone, including the facet joints, which is commonly performed in spinal fusion procedures. Baxano was founded in 2005 and is headquartered in San Jose, California. The Merger is expected to close in the second quarter of 2013 and is subject to TranS1 stockholder approval and customary conditions to closing.

Concurrent with entering into the Merger Agreement, we entered into a Securities Purchase Agreement, or the Securities Purchase Agreement, dated March 3, 2013, with certain investors, or the Investors, pursuant to which we will sell to the Investors, and the Investors will purchase from us, an aggregate of 7,522,009 shares of our common stock, at a purchase price of $2.28 per share, resulting in gross proceeds to us of $17.2 million, or the Private Placement Transaction. Consummation of the Private Placement Transaction is subject to approval by our stockholders of the issuance of shares of our common stock in connection with the Merger Agreement and the Securities Purchase Agreement, the closing of the Merger, and other customary closing conditions set forth in the Securities Purchase Agreement.

Since inception, we have been unprofitable. As of March 31, 2013 we had an accumulated deficit of $145.9 million.

We expect to continue to invest in sales and marketing infrastructure for our products in order to gain wider acceptance for them. We also expect to continue to invest in research and development and related clinical trials, and increase general and administrative expenses as we grow. As a result, we will need to generate significant revenue in order to achieve profitability.

Revenue

Revenue is recognized based on the following criteria: (i) persuasive evidence that an arrangement exists with the customer; (ii) delivery of the products and/or services has occurred; (iii) the selling price has been fixed for the products or services delivered; and (iv) collection is reasonably assured. We generate revenue from the sales of our implants and disposable surgical instruments. We have two distinct sales methods. The first method is when implants and/or disposable surgical instruments are sold directly to hospitals or surgical centers for the purpose of conducting a scheduled surgery. Our sales representatives or independent sales agents hand deliver the products to the customer on or before the day of the surgery. The sales representative or independent agent is then responsible for reporting the delivery of the products and the date of the operation to the corporate office for proper revenue recognition. We recognize revenue upon the confirmation that the products have been used in a surgical procedure. The other sales method is for sales to distributors outside the United States. These transactions require the customer to send in a purchase order before shipment will be made and the customer only has the right of return for defective products. We primarily recognize revenue upon the shipment of the product to distributors outside the United States, when risk of loss and title has transferred to the distributor, provided we have no material performance obligations. We expect that a substantial portion of our revenues will continue to be generated in the United States in future periods.

Cost of Revenue

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

Research and Development

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

Sales and Marketing

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

General and Administrative

General and administrative expenses consist of personnel costs related to the executive, finance and human resource functions, as well as professional service fees, legal fees, accounting fees, insurance costs and general corporate expenses. In future periods, we expect general and administrative expenses to increase to support our sales, marketing, research and development efforts.

Charges Related to U.S. Government Settlement

Charges related to U.S. government settlement consist of legal fees related to a federal investigation by the U.S. Department of Justice related to their subpoena issued in October 2011. We expect to incur additional expenses until this investigation is settled.

Merger and Integration Expenses

Merger expenses consist primarily of legal, accounting, consulting and other professional fees related to the pending merger with Baxano. Integration expenses consist of costs incurred in planning for the integration of our operations with Baxano. We expect the merger costs to continue through the completion of the merger and the integration costs to continue through the remainder of 2013.

Other Expense

Other expense is primarily composed of interest earned on our cash, cash equivalents and available-for-sale securities and the gain or loss on disposal of fixed assets.

Comparison of the Three Months Ended March 31, 2012 and 2013

Revenue Revenue decreased from $3.8 million in the three months ended March 31, 2012 to $3.1 million in the three months ended March 31, 2013. The $0.7 million decrease in revenue from 2012 to 2013 was due primarily to the lower number of AxiaLIF cases performed by our current surgeon base. Domestically, sales of our AxiaLIF Plus 1-Level products decreased from $1.5 million in the three months ended March 31, 2012 to $1.0 million in the three months ended March 31, 2013, and sales of our AxiaLIF Plus 2-Level products decreased from $1.1 million in the three months ended March 31, 2012 to $0.7 million in the three months ended March 31, 2013. In the three months ended March 31, 2013, average revenue per AxiaLIF case increased, primarily as a result of a price increase effective April 1, 2012, the release of new AxiaLIF products and penetration into existing cases by our other products. In the three months ended March 31, 2012 and 2013, we recorded 222 and 133 domestic AxiaLIF cases, respectively, including 76 AxiaLIF Plus 2-Level cases in the three months ended March 31, 2012, and 48 AxiaLIF Plus 2-Level cases in the three months ended March 31, 2013. Sales of our VEO lateral access and interbody fusion system increased from $0.3 million in the three months ended March 31, 2012 to $0.6 million in the three months ended March 31, 2013. During the three months ended March 31, 2012 and 2013, we generated $0.2 million and $0.1 million, respectively, in revenues from sales of our posterior fixation systems. Sales of our Bi-Ostetic bone void filler remained the same at $0.2 million for both the three months ended March 31, 2012 and 2013. Revenue generated outside the United States increased from $0.3 million in the three months ended March 31, 2012 to $0.5 million in the three months ended March 31, 2013. There were no initial stocking shipments to new distributors outside the United States in the three months ended March 31, 2012 compared to $0.3 million in initial stocking shipments to new distributors in the three months ended March 31, 2013. In the three months ended March 31, 2012, 93% of our revenues were generated in the United States compared to 84% in the three months ended March 31, 2013.

Cost of Revenue Cost of revenue remained the same at $1.0 million for both the three months ended March 31, 2012 and March 31, 2013. Gross margin decreased from 73.6% in the three months ended March 31, 2012 to 66.7% in the three months ended March 31, 2013. The decrease in gross margin was primarily due to a higher percentage of international sales which carry a lower gross margin than domestic sales, increased depreciation expense on reusable kits, primarily due to upgrading reusable kits as we launched our next generation of AxiaLIF and VEO products, increased royalty expenses and the new medical device tax.

Research and Development Research and development expenses remained the same at $1.3 million in both the three months ended March 31, 2012 and March 31, 2013. Personnel-related expenses increased by $0.2 million from the three months ended March 31, 2012 compared to three months ended March 31, 2013 as we increased our headcount in our regulatory and clinical functions, offset by a decrease of $0.2 million in licensing agreements incurred in the three months ended March 31, 2012.

Sales and Marketing Sales and marketing expenses decreased from $5.3 million in the three months ended March 31, 2012 to $4.9 million in the three months ended March 31, 2013. The decrease in expenses from 2012 to 2013 of $0.4 million was primarily due to lower personnel-related costs of $0.3 million and lower promotional costs of $0.3 million, partially offset by an increase in training expenses of $0.2 million to train surgeons on our new products.

General and Administrative General and administrative expenses increased from $1.4 million in the three months ended March 31, 2012 to $1.6 million in the three months ended March 31, 2013. The increase in expenses of $0.2 million was primarily due to an increase in legal fees related to our intellectual property of $0.1 million and an increase in personnel-related expense of $0.1 million.

U.S. Government Settlement Charges. In December 2012, we reached a tentative agreement in principle with the U.S. Department of Justice related to the subpoena issued in October 2011. TranS1 and the staff of the Department of Justice tentatively agreed to settle its federal investigation for $6.0 million, subject to completion and approval of written settlement agreements with the Department of Justice and the OIG. We also incurred legal fees related to the investigation of $0.5 million in the three months ended March 31, 2012 and $0.1 million in the three months ended March 31, 2013.

Merger and Integration Expenses. We have incurred $1.2 million of merger related expenses and $0.1 million of integration expenses for the three months ended March 31, 2013 related to the Merger Agreement with Baxano.

Other Expense Other expense decreased from $30,000 in expense in the three months ended March 31, 2012 to $2,000 in expense in the three months ended March 31, 2013. The decrease of $28,000 was primarily related to a loss on the disposal of fixed assets in the three months ended March 31, 2012 from the disposal of obsolete components of certain reusable instrument kits.

Liquidity and Capital Resources

Sources of Liquidity

Since our inception in 2000, we have incurred significant losses and, as of March 31, 2013, we had an accumulated deficit of $145.9 million. We have not yet achieved profitability, and we cannot assure investors that we will achieve profitability with our existing capital resources. Our recurring losses raise substantial doubt about our ability to continue as a going concern. As a result, our independent registered public accounting firm included an explanatory paragraph in its report on our financial statements as of and for the year ended December 31, 2012 with respect to this uncertainty. We expect to continue to fund research and development, sales and marketing and general and administrative expenses at similar to current levels or higher and, as a result, we will need to generate significant revenues to achieve profitability. Prior to our October 2007 initial public offering, our operations were funded primarily with the gross proceeds from the sale of preferred stock of $40.5 million. The net proceeds from our October 2007 initial public offering of $86.7 million and the net proceeds of our September 2011 stock offering of $18.2 million have funded our operations since then.

In May 2011, we filed a “universal shelf” Registration Statement on Form S-3 (Filing No. 333-174255), or the Shelf Registration Statement, with the SEC, which became effective on August 1, 2011 and which we used for our September 2011 stock offering. Depending on our non-affiliated public equity float during the time period prior to consummating a financing transaction, the Shelf Registration Statement allows us to raise up to an additional $29.85 million through the sale of debt securities, common stock, preferred stock, or warrants, or any combination thereof. The timing and terms of any additional financing transactions pursuant to the Shelf Registration Statement, or otherwise, have not yet been determined. Any additional financing may not be available in amounts or on terms acceptable to us, if at all.

As of March 31, 2013, we did not have any outstanding debt financing arrangements, other than capital lease obligations, we had working capital of $12.2 million and our primary source of liquidity was $14.7 million in cash and cash equivalents. We currently invest our cash and cash equivalents primarily in money market treasury funds.

Cash and cash equivalents decreased from $21.5 million at December 31, 2012 to $14.7 million at March 31, 2013. The decrease of $6.8 million was primarily the result of net cash used in operating activities of $6.5 million and purchases of property and equipment of $0.4 million.

Cash Flows

Net Cash Used in Operating Activities. Net cash used in operating activities was $6.4 million in the three months ended March 31, 2013. This amount was attributable primarily to the net loss after adjustment for non-cash items, such as depreciation, stock-based compensation expense, inventory and bad debt reserves. There were no significant changes in working capital requirements in the three months ended March 31, 2013. The three months ended March 31, 2013 included a decrease in accrued legal expenses of $0.4 million related to the U.S. Government settlement.

Net Cash Used in Investing Activities. Net cash used in investing activities was $0.5 million in the three months ended March 31, 2013. This amount reflected purchases of property and equipment of $0.4 million, primarily for reusable instrument kits used in the field and up-fitting our new headquarters in Raleigh, North Carolina.

Net Cash Provided by Financing Activities. Net cash provided by financing activities in the three months ended March 31, 2013 was $9,000, which represented proceeds from the issuance of shares of common stock upon the exercise of stock options.

Operating Capital and Capital Expenditure Requirements

We believe that our existing cash and cash equivalents, together with cash received from sales of our products, will be insufficient to meet our anticipated cash needs through 2013. We intend to spend substantial amounts on sales and marketing initiatives to support the ongoing commercialization of our products and on research and development activities, including product development, regulatory and compliance, clinical studies in support of our currently marketed products and future product offerings, and the enhancement and protection of our intellectual property. We will need to obtain additional financing to pursue our business strategy, to respond to new competitive pressures or to take advantage of opportunities that may arise. To meet our capital needs, we are considering multiple alternatives, including, but not limited to, additional equity financings, debt financings and other funding transactions. There can be no assurance that we will be able to complete any such transaction on acceptable terms or otherwise. If we are unable to obtain the necessary capital, we will need to pursue a plan to license or sell our assets, cease operations and/or seek bankruptcy protection.

Under the Shelf Registration Statement, we have the ability to issue debt securities, common stock, preferred stock, or warrants, or any combination thereof. Depending on our non-affiliated public equity float during the time period prior to consummating another financing transaction, the Shelf Registration Statement will allow us to raise up to an additional $29.85 million. The timing and terms of any additional financing transactions, whether pursuant to the Shelf Registration Statement or otherwise, have not yet been determined. Any additional financing may not be available in amounts or on terms acceptable to us, if at all. If we are unable to obtain this additional financing, we may be required to reduce the scope of our planned product development and marketing efforts.

In October 2011, we received a subpoena issued by the Department of Health and Human Services, Office of Inspector General, or the OIG, under the authority of the federal healthcare fraud and false claims statutes. We have cooperated with the government’s request. On December 24, 2012 we reached a tentative agreement in principle with the U.S. Department of Justice related to the subpoena issued in October 2011. We tentatively agreed with the staff of the Department of Justice to settle its federal investigation for $6.0 million, subject to completion and approval of written settlement agreements with the Department of Justice and the OIG, which are expected to be finalized in the second quarter of 2013. We admit no wrongdoing as part of the settlement.

On January 24, 2012, we received notice that a putative class action lawsuit had been filed in the U.S. District Court Eastern District, North Carolina, on behalf of all persons, other than defendants, who purchased TranS1 securities between February 21, 2008 and October 17, 2011.   The complaint alleges violations of the Exchange Act, based upon purported omissions and/or false and misleading statements concerning our financial statements and reimbursement practices.  The complaint seeks damages sustained by the putative class, pre- and post-judgment interest, and attorneys’ fees and other costs.  On September 7, 2012, we filed a motion to dismiss the complaint for failure to meet the heightened pleading requirements of the Private Securities Litigation Reform Act of 1995, among other grounds; the motion is pending.  We are unable to predict what impact, if any, the outcome of this matter might have on our consolidated financial position, results of operations, or cash flows.

On March 3, 2013, we entered into the Merger Agreement with Merger Sub, Baxano and the Securityholder Representatives. Under the terms of the Merger Agreement, we will acquire Baxano through a merger of Merger Sub with and into Baxano. At the effective time of the Merger, or the Effective Time, Merger Sub will cease to exist and Baxano will continue as the surviving corporation and as a wholly-owned subsidiary of the Company.

Pursuant to the terms of the Merger Agreement, the merger consideration will consist of approximately 10.4 million shares of our common stock. The number of shares comprising the merger consideration will be reduced by a number of shares with a value equal to the following (using for the per share value an average closing price on the NASDAQ Global Market during the 10 days preceding the Effective Time): (1) Baxano’s indebtedness in excess of (a) amounts under promissory notes of Baxano that are convertible into capital stock of Baxano, each a Baxano Note, outstanding at the Effective Time, and (b) up to $3,000,000 of principal as well as interest outstanding under certain long-term indebtedness; (2) $300,000 in cash, which will be used to fund a compensation plan to be adopted by Baxano prior to the closing of the Merger providing for bonuses to Baxano’s employees and certain non-employee directors; and (3) $250,000 in cash, which we have agreed to deposit into an account specified for the purpose of funding the expenses of the Securityholder Representatives under the Merger Agreement.

The Merger Agreement contains customary representations, warranties, and covenants, including covenants related to obtaining the requisite stockholder approvals, appointing two Baxano designees to our Board of Directors, restricting the solicitation of competing acquisition proposals, the lock-up and registration of the shares of our common stock issued in connection with the Merger pursuant to the Securities Purchase Agreement described below, and the Company’s and Baxano’s conduct of their businesses between the date of signing the Merger Agreement and the closing of the Merger.

The Merger Agreement grants certain termination rights to us and Baxano. In addition, the Merger Agreement provides that we will be required to pay Baxano a termination fee equal to $2,000,000 and to reimburse Baxano for its expenses incurred relating to the transactions contemplated by the Merger Agreement, up to a cap of $750,000, if Baxano or we terminate the Merger Agreement under certain conditions. The Merger Agreement also provides that Baxano will be required to pay us a termination fee equal to $1,000,000 and to reimburse us for our expenses incurred relating to the transactions contemplated by the Merger Agreement, up to a cap of $750,000, if we terminate the Merger Agreement under certain conditions.

Concurrent with entering into the Merger Agreement, we entered into the Securities Purchase Agreement with the Investors, pursuant to which we will sell to the Investors, and the Investors will purchase from us, an aggregate of 7,522,009 shares of our common stock, at a purchase price of $2.28 per share, resulting in gross proceeds to us of $17.2 million.

Pursuant to the Securities Purchase Agreement, we agreed to register the resale of the shares of our common stock to be issued pursuant to the Merger Agreement and the Securities Purchase Agreement under a registration statement (the “Registration Statement”) on Form S-3 (or another appropriate form if Form S-3 is not then available to us). If the Registration Statement is not declared effective by the SEC by a certain date, we must pay each Investor and other holder of shares issued pursuant to the Merger Agreement liquidated damages equal to 1% of the value of their shares (calculated at the closing price of such shares) per month, up to a maximum of 12%.

The Securities Purchase Agreement contains customary representations and warranties of us and the Investors. Consummation of the Private Placement Transaction is subject to approval by our stockholders of the issuance of shares of our common stock in connection with the Merger Agreement and the Securities Purchase Agreement, the closing of the Merger, and other customary closing conditions set forth in the Securities Purchase Agreement.

Recent Developments

On April 16, 2013 and April 25, 2013, Baxano issued promissory notes, or the Bridge Notes, to us in the principal amount of $800,000 and $1.3 million, respectively, as contemplated by the Merger Agreement. The Bridge Notes bear interest at a rate of 6% per annum. The Bridge Notes are not secured by any collateral; are subordinated in right of payment to the loan evidenced by the Loan and Security Agreement dated as of March 15, 2012, among Oxford Finance LLC, Silicon Valley Bank and Baxano; and are senior in right of payment to the Baxano Notes.

The Bridge Notes will be cancelled immediately prior to the effective time of the Merger without consideration, repayment, or any other right of ours to be repaid or otherwise compensated. All outstanding principal and interest under the Bridge Notes will be due and payable on demand by us any time on or after September 7, 2013 if the Effective Time has not occurred by such date. Additionally, all principal and accrued interest under the Bridge Notes will be due and payable upon the consummation of any sale by Baxano of its equity securities to venture capital, institutional, or private investors, including at least one investor that is not an existing noteholder or stockholder of Baxano, resulting in aggregate cash proceeds to Baxano of at least $15,000,000 (excluding any amount invested by cancellation or conversion of the indebtedness represented by the Baxano Notes).

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenue and expenses, and disclosures of contingent assets and liabilities at the date of the financial statements. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, accounts receivable reserves, inventory reserves, accrued expenses, income tax valuations and stock-based compensation. We base our estimates on historical experience and various other assumptions that we believe to be reasonable, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not apparent from other sources. Actual results could differ from those estimates under different assumptions or conditions.

For a description of our critical accounting policies and estimates, please refer to the “Critical Accounting Policies and Estimates” section of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section contained in our Annual Report on Form 10-K for the year ended December 31, 2012. There have been no material changes in any of our accounting policies since December 31, 2012.

New Accounting Standards

In February 2013, the Financial Accounting Standards Board issued guidance (ASU No. 2013-02) finalizing the reporting of amounts reclassified out of accumulated other comprehensive income. The new standard requires either in a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified from each component of accumulated other comprehensive income based on its source and the income statement line items affected by the reclassification. The guidance is effective for annual reporting periods and interim periods within those years, beginning after December 15, 2012. In the first quarter of 2013, we adopted the guidance and determined that there were no amounts reclassified in the period that would require enhanced disclosure.