AxoGen, Inc. (AXGN) Q2 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to the AxoGen Second Quarter 2015 Results Conference Call. At this time, the participants are in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Mr. Michael Polyviou, Investor Relations. Please go ahead, sir.

Thanks, Jerry, and good afternoon, everyone. Thank you for joining us today for the AxoGen, Inc. conference call to discuss the financial results for the second quarter ended June 30, 2015. Today’s call is being broadcast live via webcast, which is available on the AxoGen website. Within an hour following the end of today’s live call, a replay will be available on the company’s website at www.axogeninc.com, under Investors. Before we get started, I’d like to remind you that during the course of this conference call, the company will make projections and forward-looking statements regarding future events. We encourage you to review the company’s past and future filings with the SEC, including, without limitation, on the company’s Forms 10-K and 10-Q, which identify the specific factors that may cause actual results or events to differ materially from those described in these forward-looking statements. These factors may include, without limitation, statements regarding product development, product potential, regulatory environment, sales and marketing strategies, capital resources or operating performance. And with that, I’d like to turn the call over to Karen Zaderej, President and CEO of AxoGen. Karen?

Thank you, Michael, and good afternoon, everyone, and welcome to AxoGen’s second quarter 2015 conference call. Joining me on the call today is Greg Freitag, who many of you know as our General Counsel and Senior Vice President of Business Development. Greg is also a Director of the company and, until April of 2014, served as our Chief Financial Officer. Effective today, Bob Johnston was terminated as CFO and Greg has reassumed the Chief Financial Officer’s responsibilities at AxoGen. We are very pleased that Greg provides a seamless transition and he’ll be joining me next week as we meet with investors at the Wedbush Conference in New York City. Today, he’ll review the financial highlights of the quarter. Our record performance in the second quarter of 2015 demonstrates AxoGen’s growing momentum. Our strategy which is aimed at elevating the levels of awareness and usage of our portfolio of nerve repair products is succeeding. Our professional education forums and sales team performance are driving increased customer interest for our peripheral nerve injury solutions. Our execution enabled us to generate record revenue of $6.4 million, an increase of 52% from the prior year quarter. In addition to reporting record revenue, our gross margin also reached a record level of 83.8%. The peripheral nerve repair market in the US is large. And in the clinical areas in which we operate, it is estimated to be more than $1.6 billion. Our off-the-shelf products address all of the surgeon’s nerve repair and protection needs and avoid unnecessary complications and costs derived from an additional surgery to harvest autograph tissue. The first of these products is Avance Nerve Graft. It is donated human nerve tissue processed through our proprietary cleansing and deceleration methods and intended for the surgical repair of peripheral nerve gaps. Next is AxoGuard Nerve Connector, the only extracellular matrix coaptation aid for the tensionless repair of severed peripheral nerves. And finally AxoGuard Nerve Protector, the only extracellular matrix surgical implant used to protect injured nerves and to reinforce the nerve reconstruction while preventing soft tissue attachments. More than 900,000 nerve injuries will be surgically repaired this year in the United States alone. AxoGen’s portfolio of products provides surgeons with an off-the-shelf solution for the repair of a vast range of peripheral nerve injuries. AxoGen products offer a less invasive option to patients by eliminating the need for additional surgeries associated with the harvest of autograph tissue, which may cause a loss of function in the impacted area. Eliminating the need for an additional surgery also provides healthcare economic value by reducing risk and cost of these procedures. These new repair pathways for nerve injuries provide a win-win-win for the patients, surgeons, and hospitals. The harvest of the autograph is not separately reimbursed and there is no financial driver for a hospital to perform this procedure. Elimination of the procedure to harvest the patient’s own nerve tissue will save 30 to 90 minutes in total procedure time. That, in turn, reduces the cost of both OR time and anesthesia. Using a national average for OR cost, this time savings equals between $3,200 and $9,500 in cost savings for the hospital. In fact, not only does the reduction in time save OR and anesthesia cost, it presents a typical large hospital with the opportunity to gain the equivalent of as much as six to nine days of additional OR time to perform more surgical procedures in a year. In addition, eliminating the need to harvest a patient’s own tissue by use of an off-the-shelf AxoGen nerve repair product may allow for the use of local or regional anesthesia instead of general anesthesia, which further reduces cost. AxoGen’s off-the-shelf nerve repair products may also help reduce costs associated with complications that may arise from nerve autograph harvest procedures, particularly surgical site infections, one of the most common complications of any surgical procedure. The treatment of a surgical site infection cost an average of over $20,000 and can exceed over $100,000. Hospitals are increasingly being held accountable for readmissions, avoidable complications, and serious reportable events that occur during a patient’s time in the hospital. By eliminating the need for an additional surgery, AxoGen’s products reduce the chance of a hospital acquired infection. Now, let’s turn to our execution strategy and highlight how the team is successfully executing our plan, what I like to refer to as our four pillars of growth. First, we continue to generate higher levels of market awareness for AxoGen’s branded products. By engaging with surgeons at hospitals, clinical conferences, promotional events, and surgeon education courses, we are introducing more and more surgeons to the benefits of our new nerve repair options. Also, in a recent series of radio interviews, we engaged with our key constituents to highlight how our products have helped military personnel with nerve injuries, the promising ability of nerve repair to restore erectile function after non-nerve sparing radical prostatectomy, and the opportunity to repair the nerves responsible for sensation in the mouth following complications during wisdom tooth removal. The cumulative effect of these efforts is shifting the conversations with surgeons. They are no longer focused on just the basic science of our products, rather more the practical aspects of using our products. Our second pillar of growth is focused on surgeon education and the development of surgeon advocates on best practices and nerve repair to help drive awareness of surgical techniques that lead to positive outcomes. So far in the first half of 2015, we’ve conducted four best practices and nerve repair educational events with a total attendance of over 100 surgeons. We also hosted our first international event in Milan, Italy just prior to the 20th Congress of the Federation of European Societies for Surgery of the Hand, or FESSH. This program, titled Advances and Best Practices in Upper Extremity Nerve Repair, was led by a faculty of internationally known surgeons from both the US and Europe and attendance exceeded 60 international surgeons. These professional education forums are highly successful and the return on investment is significant as we’ve seen an increase in revenue of approximately 60% from surgeons who attended our two day courses. For example, the revenue generated from the first four upper extremity events held in late 2013 and early 2014 have demonstrated over $0.5 million increase in the 12 months following each course. The third pillar of our growth strategy is to grow the body of clinical evidence to support the use and benefits of our products. We enrolled the first subject in the recon study to support an investigational new drug application for Avance Nerve Graft. This phase three clinical trial compares AxoGen’s Avance Nerve Graft to synthetic nerve tubes for bridging gaps in peripheral nerve tissue and will support the biologic’s license application, or BLA, that we are pursuing. Pursuant to an enforcement discretion granted by the FDA, we continue to market Avance Nerve Graft while it is transitioned to this biologic product. We believe that it is a competitive differentiator and a further barrier to entry. As we anticipated, it would take someone starting today at least eight years to get a product commercially available through the BLA pathway. In addition, at the FESSH conference, there were three clinical presentations on the use of Avance Nerve Graft. The first presentation focused on the use of Avance Nerve Graft to repair long gaps in nerve tissue in the upper extremity and hand. The second presentation compared outcomes from nerve repairs in the upper extremity using Avance Nerve Graft, synthetic tube conduits, and autograph nerve tissue. The third presentation focused on outcomes of digital nerve repairs made with the Avance Nerve Graft. Finally, we’re pleased that the first peer review clinical paper was published in the Journal of Hand Surgery on the use of AxoGuard Nerve Protector and the repair of recurrent cubital tunnel repair. In this study, nerve decompression, combined with AxoGuard Nerve Protector, showed a reduction in post-operative pain and improved grip and pinch strength with an average of 41 months of follow up. Our fourth and final growth pillar is sales execution. Our strategy has been centered on simultaneously increasing the frequency of usage in existing accounts while at the same time, expanding our sales footprint by adding new accounts. In Q2, an account that ordered all three of our brands generated five times more revenue than an account ordering just one brand. So we continue to drive usage of the full portfolio to realize this increased penetration. To achieve our desired goal, we ended the second quarter with 32 direct reps and as of today we have 34 direct reps, with a goal to end the year with 35 to 39. At the end of June, more than half of our direct reps in the US had been with us for more than 12 months. In addition to our direct sales team, we had 23 territories managed by our independent distributors and our full team is now far more knowledgeable on the best practices of nerve repair and that is continuing to fuel our growth. I also want to provide an update on processing as we continue to accommodate our growth. We have entered into a license and services agreement with Community Tissue Center, an accredited member of the American Association of Tissue Banks and one of the largest non-profit tissue banks in the United States. Last year, CTS distributed more than 355,000 tissue grafts to over 5,000 hospitals, physicians, and surgeons. As a result, we will be moving processing of Avance Nerve Graft from our current location to CTS’ facility in Dayton, Ohio. We will continue to process and package Avance Nerve Graft using our employees and our equipment located at CTS. CTS’s infrastructure will provide a cost effective, quality-controlled, and licensed facility for our processing. We anticipated that all processing will be transferred to the CTS facility by the end of 2016 first quarter. We’re off to a solid start through the first six months of the year. With this progress and continued momentum, we’re raising our revenue guidance and now expect 2015 full year revenue to exceed $25 million. And we expect to maintain our annual gross margins in the mid to high 70% range. With that, Greg will provide you with some additional details on our financial results. Greg?

Thanks, Karen. I’ll focus my comments on the financial highlights during our second quarter. Our revenue increased 52% $6.4 million compared to last year’s second quarter of $4.2 million. The growth was primarily due to increased product usage by existing accounts and the addition of new customers catalyzed by the additions to our sales force. Gross profit for the second quarter increased 62% to $5.38 million compared to $3.33 million for the prior year second quarter. Gross margin was 83.8% compared to 78.9% in the year ago second quarter. The year over year expansion reflects processing efficiencies and a favorable product mix. We continue to enjoy favorable gross margin that could vary throughout the year due to product mix and other processing factors, including our move to our new facility at CTS. Now, let me turn to expenses. As we have discussed in prior calls, we continue to invest in the sales and marketing to raise our awareness and to expand our sales footprint. Sales and marketing expenses increased approximately 43.4% to $4.8 million compared to last year’s second quarter of $3.4 million, due to the expansion of the direct sales force, increased support for both the direct sales force and independent distributors, and surgeon education. We ended the quarter, as Karen said, with 32 direct reps, up from 23 at the end of the 2014 second quarter. We also held two surgeon education forums in this year’s second quarter compared to just one in last year’s comparable period. However, with a 52% quarterly revenue increase, sales and marketing expenses as a percentage of revenue declined to 75% for the second quarter of 2015 compared to approximately 79.6% for the same quarter in 2014. For the second quarter of 2015, general and administrative expenses increased 15.7% to $1.98 million compared to $1.71 million in the second quarter of 2014. As a percentage of revenue, general and administrative expenses continue to decrease on a quarter by quarter basis due to the significant revenue growth. R&D spending increased 32.4% to roughly $736,000 compared to the year ago second quarter. Research and development includes AxoGen’s product development and clinical efforts substantially focused on SBLA for the Avance Nerve Graft. This activity varies from quarter to quarter due to the timing of certain projects. A substantial portion of the research and development expenses in 2014 and thus far in 2015 relate to expenditures for such clinical activity, including preparation for and the start of the pivotal clinical trial for the BLA and hiring additional personnel to support both clinical and product development activities. It is expected that costs associated with the BLA will continue to increase as more patients enrolled in the trial over approximately the next two years. As a percentage of sales, R&D expenses continued to decline as we have continued to show a top line growth. The second quarter interest expense was approximately $1 million compared to approximately $1.4 million in the second quarter of 2014. The decrease was due to the difference in interest expense related to the Three Peaks facility compared to the interest expense related to the former PDL royalty contract. We ended the second quarter with $15.6 million in cash. Our monthly cash burn for the second quarter was approximately $1.2 million. However, this included extraordinary payments for expenses related to our first quarter financing and equipment purchases for expansion in our Burleson distribution facility, representing approximately $160,000 per month of that burn. As we have grown the top line significantly, we have also continued to reduce our net loss. For the six months ended June 30, 2015, we decreased the net loss over $1.2 million compared to the six months ended June 30, 2014. With that, I will hand the call back over to Karen for closing remarks. Karen?

Thanks, Greg. With the increasing acceptance and adoption of our product portfolio and the successful execution of our four pillar growth strategy, we’re exploring additional revenue opportunities, which include new geographies and new market applications for our existing products, which can begin to contribute to our growth during 2016. Our international business represents less than 6% of revenue today, but we see significant growth opportunities in certain EU and Asia Pacific countries with the number of nerve injuries that’s comparable to the US market. We’ve been focused on building awareness and engaging the international key opinion leaders as we seek to build champions for our products in these markets. At the same time, we’re pursuing regulatory approvals and partnerships with leading distributors in these international markets. With a solid business plan, proven track record, an increasing body of clinical data supporting the benefits of our products, we expect our international business to be a bigger revenue contributor in 2016. I also want to highlight nerves severed during prostate cancer surgery. The cavernous nerves that control erectile function, incontinence line on the side of the prostate and are sometimes removed when cancer has spread beyond the prostate. In this situation, high rates of impotence and incontinence are reported and there is a need to evaluate options to repair the nerve at the time of surgery. During the second quarter, we completed a pilot clinical study assessing cavernous nerve reconstruction with the Avance Nerve Graft following radical prostatectomy. The results of the study demonstrated the technical feasibility and promising ability of this technique to restore erectile function and reduce incontinence. We are currently examining the market potential and preliminary strategies for this application for our processed nerve allograft. Before taking questions, I want to thank our investors for their continued support and all the members of the AxoGen team for their commitment in helping patients with nerve injuries. We’re off to a solid start for the second half of 2015. Operator, we’re ready now to take some questions.

[Operator Instructions] The first question is from Tao Levy, Wedbush Securities.

In the quarter itself, I was just wondering if maybe you could give us some of the typical breakdowns that you provided in the past, Avance versus AxoGuard metrics.

From a product mix standpoint, we continue to see what we see in the market between the two product lines in Avance and AxoGuard. We don’t do a specific breakdown of the AxoGuard product line, but it’s starting to get a little bit closer to 50-50 breakdown, somewhere around the quarter to the six months, you’re at 52% to 55% range with Avance. And so over the last couple of years, that’s collapsed at about 5%. We used to be about 60-40 and it’s solidly 55-45, in that range.

And you said roughly...

It’s about 52% to 54% Avance right now. And the reason I say, depending if you’re looking at the three months or the quarter or the six months.

If you think about that move down in the percent of revenues, is that surprising? Do you expect it to continue moving down as surgeons get more comfortable with using AxoGuard and just numbers wise there might be more procedures that they’re accustomed to using tissue products in?

First, just to be clear, all of our products are increasing in revenue and units. But in terms of mix, the mix has shifted to be actually closer to what we think the market potential is. We were heavier before in Avance and frankly we’re not getting the usage of some of the AxoGuard products in applications where they had good applications. And so we are now, through our work in driving penetration, picking up that additional revenue in cases.

And so now revenues are hitting record type levels, can you provide maybe sort of number of customers that you have or surgeons who have done a few cases, trying to see if eventually we can start thinking of a same store sales kind of productivity type number.

We don’t have any guidance that we’ve given on number of customers and numbers of surgeons. So I don’t have anything I can give you good color commentary at this point.

And then just last one, obviously termination of the CFO, was that person now kind of issue, obviously it can’t be discussed or any insights there would be helpful.

So, as we said, I’ve assumed the CFO position. The termination did not relate in any way to any of our financial reporting. I’m happy...

That’s enough. Yeah, that’s all I needed.

And just to remind everybody that Greg also was our CFO earlier. So it’s an easy seamless transition for us.

Next question is from Bruce Jackson, Lake Street Capital Markets.

So in terms of the surgeon events, they’ve been extremely effective in generating new demand for the product. How many of these events do you have scheduled for the second half? And do you have any indications as to the potential attendance?

So we have completed four year to date or through the first six months. And we have five scheduled in the second half of the year. Attendance ranges from 25 to 30 is what we generally target and we’ve had no problems in filling the events. The events, in fact, very often get wait listed just because there is a good demand for them.

And so I was just curious to know if your next event, is it overbooked yet, I want to know what’s the demand for the next one coming up.

Our next one actually does not happen to be overbooked because we’re doing it in the summer, during vacation season. We’re still getting in our target range, but that one doesn’t happen to be overbooked. But many of the previous events have been.

And then in terms of the CTS transition, are you going to have to build up any extra inventory to carry you through?

So one of the things with the CTS, which is just a great situation for us again, as we move that from [indiscernible] one of the things we will do is we’ll do some inventory build in front of that just to make sure in that transition if we’re all off by a little bit in some of our movements we have inventory, so we don’t have any glitches. And we’re dealing with that within our cash flow, but that inventory, whatever we build with the way that we’re ramping right now, quite frankly, just gets resold out next year. So there will be a little bit of a shifting and a little bolas in there of the inventory while we do this move defensively just to make sure, but as that move occurs, we are ahead of our time frames in doing that. And so we’re very excited to have that signed, be with good partners, and to be in a position where we’re all ready putting the things in place to have that transition be very good.

And then with the Avance sales, were they between 52% to 54% for the quarter or for the first six months?

So what we were is for the quarter, we were looking more around the 52% range. And for the six months, it was running, more of like about a 54% to 55% range. And so that’s what I’m saying, there’s been that shift. Although, as Karen said, as we look at it, that has been stepping its way over the years. If one were to go back to the calls in that question, it’s always moved a little bit each quarter, but it really is a function of what we see as the effort, as Karen said, of the AxoGuard promotion because our unit volume in the Avance product has been wonderful. And it’s just we’ve been able to speed up what was a little bit of a lag in the AxoGuard side of the equation.

Then last question, I didn’t quite catch the distributor number. Was it 34?

It’s 23 independent distributors. And at the end of the quarter, it was 32 direct reps, but we’ve now added a couple people just in the last couple of weeks. So we’re actually at 34 direct reps today.

[Operator Instructions] At this time, there are no further questions. I’d like to turn the conference – we just had somebody come in with a question, a private investor, [Mr. Kipling Thacker].

And I was wondering if you could tell us anything about the gross margins as you make the transition to community tissue? Do you expect those to continue to improve? Do you expect them to go down? Can you give us some insight into that? And then secondly, do you have much validation work that has to be done in making that transition from one location to another?

With regards to the margin, yes, we would expect that will find a little bit margin pressure as we change those facilities, just we’ll have some change in some personnel. And so we expect that. That’s one of the reasons, if you notice our guidance and we’ve been doing extremely well in what our margins are, but we’re not expecting that to be huge amounts of margin hit. But we are preparing for some in that transition then being able to get back to full efficiency. So, yes, but we plan for the numbers.

Again our guidance will still remain in the mid to high 70%s and we’re comfortable with that. In terms of the validation, yeah, there’s validation, any time you move equipment, or you move to a new manufacturing facility, there are a number of validations you need to do on both the equipment and the environment. We manufacture, obviously, in very tightly controlled clean rooms. It’s pretty straightforward, so we’ve got protocols all written. We know exactly what we need to do. But, yes, we will need to do that and that’s part of the time lag; why it’s more than just moving equipment, and why we expect to be up and running by the end of first quarter, versus in the next couple of weeks.

[Operator Instructions] We have a question from [Clint Hessler], he is a private investor.

Wondering how you intend to handle your burn rate with the cash on hand versus the expenditures.

We continue to have the cash that we think we need in order to continue with our plan. One of the things in trying to point out is that there’s the cash burn obviously, but also the reduction net loss and we continue to reduce the net loss, which is important. There’s some timing things between quarters and some extraordinary items with regard to the cash that pop up here and there. But at this point, as we reported, at the end of the quarter, we had a strong cash position, continuing on, $15.6 million in cash as of June 30.

At that rate, though, it looks like just over a year and a half, basically, if you increase sales and stuff like that.

We don’t give guidance as to what those numbers are, but that’s a little bit of trying to point out the cash burn versus the extraordinary items versus the continued reduction in the net loss and as we try to keep moving to now a situation where the reduction in net loss starts being a reflection of what we’re trying to do because ultimately that’s what we have to get as that turned around to a net income, but the cash as compared to previously the amount of money that we have and the burn rates we have, as we said at the end of the year, that will just be the direct calculation, but we keep driving sales.

It does look good, by the way. It does look good what you’re doing.

We’re excited as to how things are coming along with regards to the overall P&L of the company.

We have a question from Dave Turkaly, JMP Group, LLC.

I apologize. I’ve been juggling back and forth a bit and you may have hit this. But I just wanted to clarify you mentioned some of the European efforts. Did you guys talk at all about other geographies you might go to and how soon that could happen?

We have started to move into some other countries, and in fact, we’re showing about 6% of our revenue, of our product sales is today from international markets. While that’s still small, we see it as a good footprint and starting to grow. And our area of focus has been predominately in Europe and Canada, although we are moving into some Asia Pac countries as well.

One of the things I think that’s important to note is that when you look at the regulatory landscape of country to country, which is what we have to do, we’ve been working very hard for the last two years to do two things, three things, actually. To get countries to the regulatory approval for all of our product portfolio; to get distributors in place who are distributors who match our own thought process as to educational needs of the sale of the product; and then as the FESSH conference showed in order to get both our key speakers and the information out into those markets, so that we start creating those markets with the same information we’ve had in the US. So what we’re very excited about as we come through the rest of 2015 is to have gotten the core of our regulatory pulled together, to have gotten our distributors in place, and to also have gotten that information that we need in 2016, we are moving forward with all of that put together, while basically starting our OUS sales, we’ve been able to have revenue while we’ve been putting that in place. So we’re very excited about what 2016 brings for us from an international basis because we’re getting – we’ve got it pulled together. We’re ready to roll.

In terms of just color ASP wise in some of those international markets, could they be similar to they are here, given what your product is, the biologic nature, I’m just curious if you have any color on how the ASP looks Europe or any of the other territories versus what it looks like there.

It is actually similar to the US. It lags a little bit in just the timing of price increases, but otherwise, yes, it’s similar.

There are no further questions. I’d like to turn the conference back over to Ms. Karen Zaderej for closing remarks. Please go ahead, ma’am.

Thank you all for joining our call today. We’re proud of this record quarter and we’re off to a solid start to the second half of the year. Have a good night.

Ladies and gentlemen, the conference is now ended. You may disconnect your telephones. Thank you for calling.