AxoGen, Inc. (AXGN) Q3 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to the AxoGen Third Quarter 2015 Results Conference Call. At this time, all 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 your host Doug Sherk. Thank you, you may begin.

Thank you, Diego. Good afternoon, everyone. Thank you for joining us today for the AxoGen conference call to discuss the financial results for the third quarter ended September 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 the live call, a replay will be available on the company’s website at www.axogeninc.com, under Investors tab. 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.

Thank you, Doug, and good afternoon everyone. Welcome to our third quarter 2015 conference call. Joining me on the call today is Greg Freitag, our Chief Financial Officer, General Counsel and Senior VP of Business Development. AxoGen has had an exciting an eventful quarter. I would like to start with an overview of the results from the quarter and then provide an update on the continued execution of our strategic growth plan. We achieved record quarterly revenue of $8.15 million representing a 74.5% increase over the year ago third quarter. Sequentially this represents a 27% increase compared to the 2015 second quarter which further demonstrates a significant progress we are making. In addition to the record revenue, our gross margins remain strong at more than 82%. The strategies we are executing are resulting in shifts in surgeon treatment algorithms. We continue to implement our plan and deliver improved sales performance. This successful execution has enabled us to increase our revenue guidance for 2015 to exceed $26.5 million. As you recall, our initial guidance this year was that revenue to exceed 24 million. There are several factors driving our growth. We continue to add new accounts and drive penetration and repeat usage of our products in our existing accounts. We are working to expand the treatment algorithm of the surgeon starting to use our products to include all three of our products and in various types of nerve injuries. We now have more than 300 active accounts and the number of accounts using two or more of our brands increased substantially over the third quarter in 2014. We have demonstrated that accounts ordering all three of our products generate approximately five times more revenue than an account ordering just one product. Our surgeon education events, we enforced this changing algorithm and support ourselves focused to increase penetration and repeat usage in our existing accounts. Our team is executing well, and this is yielding an impressive results. Peripheral nerve repair is a large and untapped market opportunity, but it’s estimated to be greater than 1.6 billion. I believe we are uniquely positioned to provide the best solutions to this market. We address an issue for surgeons of how to provide treatment options for patients in a safe and cost effective manner without the potential complications of a second surgery. Our unique products, comprehensive product portfolio and regulatory strategies provide a competitive barrier to entry as we develop this market. AxoGen’s portfolio of nerve repair products including Avance Nerve Graft, AxoGuard Nerve Connector, AxoGuard Nerve Protector provide surgeons with the off-the-shelf options to restore quality of life to patients suffering from peripheral nerve injury. Our products eliminates the need for a second surgery and offer new options to treat more than 900,000 nerve injuries that will be surgically repaired this year in the U S. I would like to take a moment to quickly review our market development and sales approach, which our team continues to successfully execute. We had previously referred to this as our four pillar growth strategy. First, building market awareness continues to be a strategic focus for us and we continue to execute to this pillar. To make surgeons aware of AxoGen’s treatment options, we are interacting with them at hospitals, clinical conferences, promotional events and the surgeon education courses we sponsor. Our second pillar of growth is focused on surgeon education and the development of surgeon advocates. Our professional educational programs supplement our local educational efforts and our peer-to-peer educational opportunities where we review the latest science and best practices in surgical nerve repair. We have held nine of these events in the past twelve months. These are highly successful events from both the surgeon and the company perspective and we continue to generate on average a greater than 80% increase in revenue from the surgeons who attend the events. The third pillar we focus on is growing our body of clinical data. We continue to make progress building data to assist surgeons in the decision making process. This past quarter surgeons presented data on AxoGen’s Avance Nerve Graft during several podium presentations including data from the RANGER registry at the 70th Annual Meeting of the American Society for Surgery of the Hand. The RANGER registry, a multicenter, observational clinical registry in peripheral nerve repair is aiding surgeons in making better informed clinical decisions. Through the third quarter this critical study has expanded to include more than 750 nerve repairs with Avance Nerve Graft enrolled in the study. In additional we have begun enrollment in the recon study, a multicenter, prospective, randomized, controlled, blinded study comparing Avance Nerve Graft to manufacture collagen tube in digital nerve repair. The fourth pillar is our solid sales execution. We’ve continued to grow our sales force to strategically focus on expansion in key markets, while simultaneously increasing the frequency of usage in existing accounts. As of today our sales force consists of 38 direct reps and 23 independent agencies in the field representing our products. Our goal is to add new accounts and drive penetration deeper into existing accounts. Our team now has a solid understanding of the science of nerve repair and the ability to deliver a clear and compelling message about all three of our products. Our focus remains on helping surgeons improve nerve repair algorithms and outcomes. As part of that mission, today we are announcing a fifth pillar to our growth strategy, through the expansion of our product portfolio and the expansion into new markets for our product portfolio. The first component of this fifth pillar is the latest addition to our product portfolio AcroVal Neurosensory & Motor Testing System. We believe that an important step for improving patient outcomes is to support the standardized evaluation and measurement of nerve function. Today there is little consistency of measurement protocols. With the AcroVal, we believe our examiners will be able to have less subjective results for their patients with injuries like certain peripheral neuropathies, nerve compression injuries and transected nerves. Ultimately, standardization of assessment techniques will facilitate comparison and interpretation of clinical function leading to better understanding and care for patients with peripheral nerve injuries. The AcroVal is a continuation of AxoGen’s commitment to the promotion and education of best practices in peripheral nerve repair. On a standalone basis, AcroVal’s direct contribution to AxoGen’s revenue growth is expected to be relatively minor. However, we believe that by working towards the standardization of assessment techniques the AcroVal will continue to establish AxoGen as the peripheral nerve repair solution provider and broaden our presence with our target customers. The AcroVal is based up on a device invented by Dr. Lee Dellon of the Dellon Institute for Peripheral Nerve repair. Dr. Dellon is one of the world’s renowned leaders [ph] in the field of peripheral nerve repair. AxoGen has entered into coloration with Dr. Dellon, to develop the AcroVal which is anticipated to be launched in the first quarter of next year. With the commercialization of AcroVal, AxoGen is expanding a role as the solution provider to the peripheral nerve repair market. We believe that there are more opportunities to improve peripheral nerve repair. In addition to our current focus and the efforts [indiscernible] in oral and maxillofacial, we have identified opportunities in head and neck surgery, urology, breast reconstruction and lower extremity. We are working to access these market opportunities and have other programs in our product pipeline. We anticipate to release of a second new product in late 2016. Finally, in August we entered into a transaction with Essex Woodlands, a leading investment firm focused on growth-oriented healthcare companies. The Essex Woodlands investment resulted in net proceeds of approximately $17.2 million to AxoGen. With the strengthening of our balance sheet we have the resources in place to execute our business plan as well as consider additional growth and revenue opportunities like the AcroVal we have announced today. We also believe that our current capital will be sufficient for us to reach profitability. In addition to increasing our capital position we gain access to the experience and relationships of Essex Woodlands organization including the addition of Guido Neels to the AxoGen Board of Directors, we welcome Guido to the board and believe he will be an outstanding advisor as we continue to execute our global growth plans. I’ll now turn the call over to Greg who’ll provide you some additional details about third quarter results. Greg?

Thanks, Karen and good afternoon everyone. Given that Karen has provided details about our revenue performance, I will begin my prepared remarks on our gross margin, other components of our P&L and balance sheet. Gross profit for the third quarter increased 78.3% to $6.74 million compared to $3.78 million for the prior year’s third quarter. Gross margin was 82.7% compared to 80.8% in the year ago third quarter. The year-over-year expansion reflects processing efficiencies and a favorable product mix. Preparation for the move of our advanced manufacturing to CTS in Dayton, Ohio is going smoothly and we expect it to be operational on schedule by the end of the first quarter of 2015. In the third quarter the implementation of this transition had little impact to gross margin. 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 of our products in our market and to expand our sales footprint. Sales and marketing expenses increased to 5.51 million compared to last year’s third quarter of 3.25 million. Factors impacting this increase are primarily due to the expansion of the direct sales force, increased support for the direct sales force and independent distributors, surgeon education and development of new products to markets. We ended the quarter with 38 direct reps, up from 27 at the end of the 2014 third quarter. For the third quarter of 2015 general and administrative expenses increased to $2.2million compared to 1.64 million in the third quarter of 2014. This increase was primarily a result of increased expenses related to employee compensation of which $335,000 was non-cash and related to employee stock options. In addition we had higher professional service fees during the quarter. As a percentage of revenue, general and administrative expenses for the three months and the nine months ended September 30, 2015 dropped 8.1% and 12.4% respectively as compared to the comparable period in 2014. R&D spending increased 37.4% to roughly $936,000 as compared to the $681,000 in the year ago third quarter. It is expected that R&D cost will further increase in 2016 as we invest in our fifth pillar of growth, which Karen touched upon earlier and as we continue enrollment of our recon clinical trial. The third quarter interest expense was approximately $1 million compared to approximately 1.4 million in the third quarter of 2014. The decrease was due to the difference in the interest expense related to the Three Peaks facility compared to the interest expense related to our former financing. We ended the third quarter with $29.9 million in cash. Our cash burn for the third quarter was approximately 3.16 million or 1.05 million per month. This burn included extraordinary payments aggregating approximately $454,000 for expenses related to our first and third quarter financings, expansion in our Burleson distribution facility, and the transition of our manufacturing facility. This represents approximately 15% of our third quarter burn. This afternoon we have also filed an S-3 shelf registration with the SEC, Securities and Exchange Commission. While we do not have any plans to access this shelf, this filing provides the company with maximum flexibility as we consider strategic options going forward. As we have grown the top line significantly, we have also continued to reduce our net loss. For the nine months ended September 30, 2015, we decreased the net loss over 1.47 million compared to the nine months ended September 30, 2014. Finally with our strong third quarter we have increased our 2015 revenue guidance to exceed $26.5 million and reaffirm our gross margin guidance in the high 70% range. With that, I will hand the call back over to Karen for closing remarks.

Thanks, Greg. In summary, strong operating momentum carried through the third quarter, where we set another record for revenue. Our year-to-date results reflect the successful execution of our strategy. With the strengthening of our balance sheet and cash position, we can look ahead implementing our fifth pillar of growth. Before taking questions, I want to thank our investors for their continued support and all of the members of the AxoGen team for their commitment in helping patients with nerve injuries. We’re having an outstanding year as we continue to penetrate the peripheral repair market. At this point I would like to open up the line for question.

Thank you. [Operator Instructions] Our first question comes from Dave Turkaly with JMP securities. Please state your question.

Thanks a lot, just to be clear, was there anything one time in major in the quarter any stocking orders or anything like that or is that actual strength just in the business.

Pure strength and growth, there is nothing in there that is all the ordinary on the revenue side.

And if I look at that, the performance I mean, you mentioned 300 active accounts, would you say that your sales force is more productive there is more accounts, I am sure with the combination but the strength kind of surprised us a bit, if you wanted to point to one factor, is there one that you could point to that was very strong in the quarter or is kind of a combination of those factors.

It’s the combination of the factors. Both the number of accounts have gone up and the penetration into those accounts have gone up, so both are driving the revenue.

And I guess just if we look at the guidance obviously happy to see a raise, implicit in it the new range would be that the fourth quarter would be maybe down a little bit, is that conservative or should we actually expect sort of the trends that we are seeing now in the third quarter to continue and then I guess the some as we head into 2016, sequentially should we see a build here.

Sure, we have seen some of the strong growth through the year which is why we raised our annual consensus. In fourth quarter, remember that’s a holiday period, so well, we think that the daily sales continue to see some moment, the impact - you won’t see the same momentum in the fourth quarter in total.

Great thanks a lot.

Thank you. Our next question comes from Bruce Jackson with Lake Street Capital Markets. Please state your question.

Hi, a nice quarter.

Hi, Bruce, thank you

Thanks Bruce.

Okay so obviously the surgeon education events has been an important component in terms of generating some market uptick, what do you have on plan in terms of upcoming events and meetings for the rest of the year.

Well, we have completed seven year-to-date, we have got two more yet to go in this quarter and will get those completed and yes, they are a strong contributor to our revenue growth

And then getting back to the sales strength in the quarter was it attributable to any particular practice area or surgeon specialty

No the majority of our sales of course remain in upper extremity, that’s the majority of our revenue and the growth of course a lot of it came from that, but we see it across the board, it’s not one surgeon, it’s not one territory and it’s not one class or type of surgeons, what we are really seeing is this momentum of surgeons starting to change what they are doing and they are talking to each other about changing what they do.

Okay, that’s great. In terms of the sales force, the target at least for this year was 35 to 39 any changes to that particular target?

A small amount, we may accelerate some that we would have hired in the beginning of next year into this year’s, so at this point I would see us ending somewhere above 40 because just accelerating hires that we had planned to do next year.

Okay, moving over to the new products, so you have got the AcroVal coming in Q1 2016. First, will there be any additional cost associated with that product?

No, right now, what you are seeing is part of the R&D increase has already baked into what we have been doing from the development side of that, some marketing costs have absorbed into the overall larger budget of the other products. That product will be through our normal sales distribution rule, so it’s not that we’re adding - having to add headcount that goes into what is already our sales model which is one of the benefits of it going into the portfolio, so it’s not something on the expense side that you will see any significant change on.

Okay and then in terms of the way that the product works and its measurement, is this consistent with the systems that the physicians are currently using to assess their patients, is it a - can you tell us what the - is there any advantage to using this particular device compared to what they are doing now aside from the standardization?

Yeah, there is, there are multiple ways that you can measure sensory function and Dr. Dellon again is a leader in identifying that. Certain types of sensory function act as an early indicator for a loss of nerve function and so this is a more sensitive test and the test they typically use in two point discrimination and will give an earlier indicator when there is nerve damage. This isn’t as much for obviously a transected nerve that’s damage, so it doesn’t work at all but in compression injuries or in neuropathies you don’t always know if there is a progression and this is an earlier more sensitive indicator. By the same token, as nerve is recovering after repair is a more sensitive indicator telling you when you are starting to get functional recovery and it measures sensory function and then there’s also grip and pen strength for hand function and motor function.

Okay. Then you mentioned one other new product for 2016, this can be implantable product by any chance?

Yes.

And beyond that would you be looking to provide any additional color on what it is going to be?

Not yet, stay tuned.

Okay, thank you very much.

Thank you.

Thank you. [Operators Instruction] Our next question comes from Steve Salamon with Rosalind. Please state your question.

Hello, everyone and congratulations on an amazing quarter frankly.

Thank you.

Thanks Steve

Yeah, this wasn’t my model, but maybe I can ask a little bit about your thoughts on overall market potential and sort of where you think you are in terms of reaching full market potential for AxoGen and I guess how we should think about that I mean, my guess is, there is a portion at the market that doesn’t really exist yet, that’s kind of - that’s using graft that is going to move over to using your products, but there is a portion that exists. Can you help us kind understand where you are in that kind of growth trajectory both from a market share perspective and in terms of growing the market and maybe it’s a topic for old investor day, but if you can try to summaries.

Sure, well the 1.6 break down in to three basic areas, so first of all it is based on traumatic upper extremity injuries, and the oral and maxillofacial market and then compression injuries. So that’s what makes up that markets, when I talk about expansion markets, that is all outside to the 1.6 billion from there we break it into thinking about transacted nerves that are relatively short, so five millimeters and less in gap between the two nerve ends, and those that are traditionally repaired actually mostly with sutures. So we are showing an alternative algorithm as compared to doing micro-sutures and that’s what our AxoGaurd Connector is targeted for. Then there is where there is a gap, so when the nerve ends, something has caused a loss of segment between the two nerve ends, that’s actually fairly common in trauma because of the event of the trauma itself either takes some of the nerve out or the nerve ends are scared and they need to turn back to healthy tissue which then creates a gap and that’s targeted to our Avance Nerve Graft and then finally would be the compression market. And the compression market we sized it really only looking at recurrent carpal tunnel, so these are procedures in the wrist where a surgeon has gone in to relieve the pressure that is on the nerve that causes the pain in carpal tunnel and they cut a ligament to free that up, but then following that about 20% of this patients reoccur in six months and that’s now due to tissue infiltration back into the small channel that’s putting compression on the nerve or tethering of the nerve and our AxoGuard Protector both create a sleeve around the nerve to stop it from being tethered and sort of separates the surrounding tissue from putting pressure on the nerve and helps to relieve the concerns about a compression injury reoccurring and so resize that looking at the carpal tunnel revision market frankly that can happen anywhere in the body, so there are upside opportunities in other parts of the body as well, but we’ve really focused on matt component. That’s what makes up the $1.6 billion so in terms of our progression in getting there, we are at the very beginning stages. We see that we are taking some share and as we see over the products that we are selling were taking some share away from those direct repairs where they would have used sutures. We’re seeing that we are getting accounts that are replacing their conduits where they would have been using those instead of Avance and then or autograph and using Avance instead. And so all of those are dynamics that we see happening as the market place changes and it’s really around continue to build confidence that built algorithms are the right thing to do for their patient.

And I guess - I guess what - I am trying to get my head around is, what part of the market exists today as a product market, what exists today in terms of procedures obviously you are estimating of procedures that exists, but maybe are more labor intensive in the surgery, but don’t reflect product sales and what’s kind of like a complete change in mindset that will cause incremental surgeries. Yes, the question is what’s your share in any of the product market or the market for nerve repair products at the moment versus the opportunity that AxoGen is building?

We actually don’t measure ourselves against the tubes directly because we consider that as a minor part of the market and so honestly I don’t know because that’s not how we look at things, we look at things in terms of the bigger potential. Now there are products that are sold. The hollow tubes and some collagen wraps that are sold and that market traditionally has been in the $50 million - $55 million range but again it’s such a niche portion of the overall market that we don’t really have our eye focused on that.

Given the margin - what’s important is the market in that - best is [ph] looking at repairs in the zero to 2.5 centimeter range, a lot of that is done up in the hand, but there really never has been this market for product in peripheral nerve because there hasn’t been products available in order to address the procedures we are talking about that create that overall market. So without a doubt if you look at our sales and our growth that is coming from those areas of replacing the procedures of drug suturing and the autograph with some of that coming from what are currently some product sales, but without a doubt as we eye this out where the growth comes from or the continued growth from where the market is, is the change that the two gold standard of drug suturing and autograph.

Right, so that makes sense. So the acceleration in growth that we are seeing in this quarter, I guess it’s fair to say is reflecting a kind of paradigm shift or the beginning of a paradigm shift. Is that correct?

Actually that’s a very good point, if we were to tell you that we saw most of our growth was into some product market in peripheral nerve repair that would not be good because there haven’t been a product there in fact, it is about change in that paradigm and that goes back to the points we have made with the four pillars and especially education and that’s been so successful is that it is not a matter of - I was trying to outsell another product , it is about us showing what the value of the products can be to those gold standards, how much better that can be for patients and that’s what’s working.

Okay, thank you for trying to guide me on that, I guess again we are trying to bridge that gap between the current revenue and the revenue potential and understand the path to that one?

We are happy answering the question because this is one, it is a little bit complicated one, arms around if it was the other way and there was a big market, generally your questions would be asking us about our competition. So the beauty of this is we get to answer the market opportunity but we don’t have to worry about answering the questions about the four other competitors because they are not there.

Right got it. Okay thank you. I will let you answer more questions.

Thank you. Our next question comes from Jack Fred [ph]. Please state your question.

Great quarter, Karen and Greg, question on the marketing side, the sales reps in-house versus the sales reps outside, they serve different targets as far as revenue for the reps versus the revenue for the outside?

Well, we set a target for sales for each territory because in addition to the variable of whether they are direct rep or an independent agency, also the factor of how long they have been with us and where they are and the development of that territory and so each territory has a quota that we set up, that’s based on our estimation of looking at the positional of that territory and where they are in the development pathway and so like and then the sales manager will process people who exceed their quota we’re happy with and reward and are delighted that they are part of the team and people who miss their quota, we evaluate what to do next whether it’s an independent rep or its somebody inside the team. We work hard to make sure we can get the most of the curve but execution and results are important.

Besides the salary and commissions is there stock options for the sales people that meet or exceed their quota?

We have sales award that provide some stock options to the people who yeah meet to well more than meet, exceed their quotas. So the top reps get stock option as a bond.

I guess just one last question and I am done. What kind of a sales person are you looking for, what kind of a background or age or experience I guess is what I am trying to get at?

Well, we obviously can’t hire reps to have some experience in nerve repair given that we’re really the pioneering company developing the market, so we don’t worry about that and we assume we’re going to be training on it. But what we do look for is somebody who has solid sales experience in a previous medical product sold into the OR, so that you’ve got somebody that you know as a good hunter and resilient and drives results, we are looking for somebody who has experience and conceptual sell and so by that I mean nerve repair something that well everybody feels like they know what it is, you can’t see it, so you got be able to explain it and so there are other products that are like that, but it is different than working with products, for example on the orthopedics market, we are looking at how parts stick together and it is very visual. So we are looking for people who have solid sales experience in a conceptual selling. And then finally we are looking for somebody who has been in a pipe of implant model like this, where you really work to convert surgeons but it’s not a service component. So some sales model are as much of more serviced as they are teaching new algorithms and by that then selling and we find that those reps kind of struggle because they spend time servicing surgeons that are already converted versus working with their partners or new people or expanding their algorithm. At least really what our interview process is built around, I think we have got a good profile built on the reps that we are hiring and Shawn McCarrey has done an outstanding job in leading the team and framing that up, so that we can get people hitting ground, go through our sales school which is also spend some significant time on to make sure that they hit the ground running and know again they’ve to tech on nerve, so teach them the nerve information and they can start to be productive and contribute.

How long is the training, to train a sales person?

When we bring somebody in they have two weeks of home study and then they have a one week sales school and they do also field drive with sales trainers that add up to about another week and then honestly if there is still what we consider a rep who is learning and establishing their territory for the first twelve months. So they have added attention during that time frame.

Okay, thank you for answering the question

Thank you

Thanks Jack.

Thank you. [Operator Instructions] Our next question comes from Clint Hessler [ph]. Please state your question.

Hi guys, just wanted to say nice quarter again, appreciate the hard work.

Thank you

My first question is, how many territories are you running right now? What’s your future expansion of territories do you think is available within the United States? I know there’s other countries [indiscernible] what do you think your expansion is for future territories?

So that’s a fabulous question and I am going to give you the answer that I have given before, but tell you what we are also relooking at it, as we have gotten more data. So typically we said, we think that there are about 50 to 55 territories in the United States that we need to make sure that we have covered but we’ve also started looking at the depth that a rep can get into a territory and frankly some of those territories end up kind of big with large spaces and that’s not productive time driving to some space. So we may be able to scale some territories again with independent distributors that cover - the trauma centers in South Dakota which are great trauma centers, but are kind a far apart places like that.

Right, do [indiscernible] model and what you have running right now?

I am sorry you broke up there and I can’t hear the question.

It’s been 55 model what you are going to try to get to and how many are you operating in right now?

Well today we have 38 reps and again by the end of the year will be above 40. We still have independent distributors again covering some spaces and we have not finalized what we will do for next year.

Okay, so the each rep is running one territories, how you are doing it right now?

No, we do have some territories that are tandem territories again where there are larger and it’s been a decision that we have made to say some territories will be more efficient if we go ahead and put two people working in tandem, some territories are solo direct rep. So it’s been an individual territory by territory decision.

Okay, thanks you all did a great job by the way thank you.

Thank you

Thanks Jack.

Ladies and gentlemen, there are no further questions at this time. I’d like to turn the conference back over to management for closing remarks. Thank you.

We just like to thank everybody for joining us in our third quarter update. Thank you.

Thank you.

All party disconnect, have a good day.