AxoGen, Inc.
Q4 2016 Earnings Call Transcript

Published: 23 Feb 2017

[Operator:]

Greetings and welcome to the AxoGen’s Fourth Quarter and 2016 Full Year Financial Results Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference will be recorded. I would now like to turn the conference over to your host, Mr. Brian Korb. Thank you, Mr. Korb. You may begin.

[Brian Korb:]

Thank you, operator, and good afternoon, everyone. Thank you for joining us today for the AxoGen conference call to discuss the financial results for the fourth quarter and full year ended December 31, 2016. 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. Before we get started, I would 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, 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 acquisition and/or development, product potential, regulatory environment, sales and marketing strategies, capital resources and operating performance. And with that, I would like to turn the call over to Karen Zaderej, President and Chief Executive Officer of AxoGen. Karen?

[Karen Zaderej:]

Thanks, Brian and good afternoon, everyone. Welcome to our fourth quarter and full year 2016 conference call. Joining me today is AxoGen’s Chief Financial Officer, Pete Mariani. I would like to begin today’s call with a review of our fourth quarter and full year highlights, a brief company overview and an update on our key strategic initiatives. Pete will then provide a review of our fourth quarter and full year results and 2017 financial guidance after which time we will open up the call to Q&A. We are pleased to report on a very busy and successful fourth quarter, which included several important strategic advancements across the company. These included the launch of our newest product, Avive Soft Tissue Membrane, the growth of our sales team and the launch of two new market development activities and breast reconstruction neurotization and the repair of lower limb iatrogenic nerve injuries, as well as increased efforts in surgeon education with four national education courses. And we closed the quarter with a record $11.4 million of revenue, which is an increase of 46% over last year. We believe that these efforts, combined with our recent equity raise and debt refinancing, demonstrate our ability to successfully execute our strategy and have positioned us to continue to drive awareness and growth in the emerging peripheral nerve repair market in 2017. We are building awareness of peripheral nerve repair and expanding usage of our products with innovator and early adopter surgeons and we are excited to be moving toward developing the middle adopter toward the majority segment of the nerve repair market. In fact, we continue to increase our surgeon training and conducted four national education courses in the quarter. Two of these events were fellows courses where we are training the next generation of neurosurgeons. This is meaningful, because these new surgeons are learning the benefits of the AxoGen product portfolio as a part of their initial training in nerve repair. Our revenue growth continues to be driven primarily by our active accounts with increased penetration and adoption of AxoGen’s portfolio of products for the repair of nerve injuries. We find surgeons are initially cautious adopters for nerve repair products. They typically start with a few cases and then wait and see their results. Active accounts are usually past this wait period and have developed some level of product reorder. These accounts have typically gone through the committee approval process, have at least one surgeon who has converted a portion of his or her treatment algorithms of nerve repair to the AxoGen portfolio and are ordering AxoGen products at least 6 times in the last 12 months. In the fourth quarter, the number of active accounts increased 41% to 452, up from 320 in the prior year. The growing number and penetration of active accounts is driven by increased adoption of our nerve repair products across the surgeons’ treatment algorithms. Accounts ordering all three of our surgical nerve repair implants continue to generate approximately 5 times more revenue than an account ordering just one product. With the addition of Avive, our objective is to continue expanding the treatment algorithms of surgeons to now include all 4 of our surgical implants across their full continuum of nerve repair. For those of you who are new to our story, AxoGen is a global leader in innovative surgical solutions for peripheral nerve injuries and the only company focused solely on this nerve repair market. We currently have 4 surgical implants in our portfolio. Avance Nerve Graft is the only commercially available processed nerve allograft used for bridging of nerve gaps of 5 millimeters to 70 millimeters. AxoGuard Nerve Connector is a minimally processed porcine extracellular matrix implants for connector-assisted coaptation of transected nerves with gaps of 5 millimeters or less. AxoGuard Nerve Protector is a minimally processed porcine extracellular matrix implant for wrapping and protecting injured peripheral nerves. Avive Soft Tissue Membrane is a minimally processed human umbilical cord membrane that maybe used as a resortable soft tissue covering to start with tissue layers and modulate inflammation in the surgical bed. Also with these core surgical products, we also offer the AcroVal Neurosensory & Motor Testing System. AcroVal and our AxoTouch Two-Point Discriminator are evaluation and measurement tools. Healthcare professionals use these tools in detecting changes in sensation, assessing a return of sensory grip and pinch function, evaluating effective treatment interventions and providing feedback to patients on nerve functions prior to and following nerve repair. All products are used primarily by plastic surgeons, hand surgeons and oral maxillofacial surgeons in a wide variety of nerve repair surgeries, including upper extremity trauma, iatrogenic injuries from dental procedures such third molar extraction as well as nerve compression surgeries including recurrent carpal tunnel syndrome. AxoGen is generating strong and consistent revenue growth in a nerve repair market that remains largely untapped. There are approximately 900,000 nerve repair surgeries annually in the U.S., pointing to a market opportunity of over $1.8 billion for AxoGen’s products. The vast majority of these procedures are being performed in approximately 5,100 centers. In the fourth quarter, 462 of these centers were active AxoGen accounts. Most of these active accounts are still in an early stage of penetration and provide additional opportunities for growth. As a result, we believe we are just scratching the surface of our available market potential. We continued to develop this market through the execution of our strategic initiatives, which we believe will allow us to build long-term sustainable growth. We refer to these strategic initiatives as our five pillars of growth

[Pete Mariani:]

Thanks, Karen. Fourth quarter revenue was $11.4 million, a 46% increase over the prior year. The growth in revenue was primarily the result of the increases in unit volume as well as the net impact of price increases and changes in product mix. As in prior quarters, the majority of our revenue growth is driven by growth in active accounts. Additionally, we continue to see growth in our pipeline of new accounts as surgeons become familiar with our products and begin to expand their treatment algorithms. Gross profit for the fourth quarter was $9.6 million, an increase of 50% compared to the prior year’s fourth quarter. Gross margin for the fourth quarter was 84% compared to 81.9% in the prior year. The year-over-year increase was driven by growth in unit volume, operational efficiencies and the net impact of price increases and changes in product mix. Total operating expenses in the fourth quarter were $12.3 million, up 36% over prior year. This increase was due to additional surgeon education programs, increased investment in market development and awareness activities, cost associated with the launch of Avive Soft Tissue Membrane, and expansion of our sales team and leadership structure. These investments are driving growth in the company’s operating expenses, but importantly at a lower rate than sales growth, demonstrating the continued operating leverage of our business model. Sales and marketing expenses in the fourth quarter were $8.3 million up 43% over prior year. As a percentage of revenue, sales and marketing expenses improved to 73% compared to 75% in the prior year fourth quarter. And as Karen mentioned, we ended the quarter with 51 direct sales reps, up from 41 at the end of 2015. However, 7 of the 10 net sales rep additions during the fourth quarter – occurred in the fourth quarter of ‘16. We also added to our sales leadership structure in the fourth quarter to accommodate both our current and anticipated growth. Additionally, we completed 13 national education courses in the calendar year, 4 of these events occurred in the fourth quarter. And we anticipate conducting 15 of these events in 2017. R&D spending in the fourth quarter was $1.2 million compared to $894,000 in the prior year’s fourth quarter. Research and development costs included product development, including final development cost of the Avive Soft Tissue Membrane as well as expenditures in our clinical efforts with the RANGER Registry, the RECON study and support of our biologic license application for the advanced nerve graft as well as support of additional clinical research activity. As a percentage of revenue, R&D expenses for Q4 of ‘16 were 10.3% compared to 11.4% in the prior year’s fourth quarter. In the fourth quarter, general and administrative expenses were $2.8 million, up 20% over the prior year. As a percentage of revenue, general and administrative expenses improved to 24% compared to 30% in the prior year’s fourth quarter. In total, SG&A expenses as a percentage of revenue improved to 97% in Q4 compared to a 105% in the prior year. EBITDA loss in the quarter was $2.6 million compared to an EBITDA loss of $2.6 million in the prior year’s fourth quarter. Net loss in the fourth quarter was $5.6 million or $0.17 per share and included $2.3 million or $0.07 per share related to the net charges associated with the refinancing of our debt. Excluding these charges, adjusted net loss improved to $3.4 million or $0.10 per share in the fourth quarter of ‘16 compared to a net loss of $3.6 million or $0.12 per share in the fourth quarter of ‘15. Cash increased $14 million in the quarter to $30 million compared to $60 million at the end of the third quarter. The net increase was due to $18.6 million of net proceeds received in the October equity raise partially offset by $2.9 million of prepayment and other fees paid in the quarter related to the October debt refinancing. After these items, the net operating use of cash in Q4 was $1.7 million. As we have previously disclosed, we closed on a new debt, a new lower cost debt facility with mid cap financial in October. We used the proceeds of this facility to repay and retire our previous $25 million debt facility. The new agreement provides for up to $31 million of debt comprised of a $21 million term loan and a revolving line of credit of up to $10 million. The revolver maybe increased at a later date to $15 million at our request and with the approval of mid capital. However, the amount available under our revolver subject to our borrowing base, which is tied to certain accounts receivable in inventory balances. At December 31, our borrowing base was $5.5 million and we have $4 million borrowed on the revolver. The facility carries a 54-month term with interest-only payments on the term loan for the first 24 months. In Q4, the interest rate our mid cap term loan was 8.5% and the interest rate on the revolving line of credit was 5%. Total bank debt outstanding at the end of 2016 inclusive of both the term loan and the revolver and excluding the impact of deferred financing fees was $25 million, which is flat with the balance of total bank debt at the end of the third quarter. Total interest and other expenses in Q4 amounted to $2.9 million and included net prepayment and related refinancing charges of approximately $2.3 million. This net charge was comprised of a prepayment fees bode on the exit of the previous facility of $2.3 million which was partially offset by approximately $750,000 of deferred interest charges on the previous facility, plus the write-off of deferred financing fees on the previous facility which also approximated to $750,000. Interest expense in the quarter excluding the impact of this net charge was approximately $600,000. Annual interest costs savings of this new facility will be at least $1.5 million compared to the previous debt facility. Additionally, fees and expenses associated with this agreement were approximately $800,000, which were capitalized as deferred financing fees, approximately $658,000 of these fees were paid in Q4. Today’s press release also notes that this is the first year that we are required to fully implement the internal control testing and audit provisions of Sarbanes Oxley section 404. Our assessment of internal control structure as of December 31, 2016 revealed material weaknesses related to the design and operation of key controls around the calculations of significant judgment and estimates as well as quarterly cycle count procedures associated with consigned inventories. Our assessment has not resulted in any changes of prior period financial results or statements. And subsequent to year end, we reviewed and modified the design of internal controls over these areas and we will continue to make additional modifications as necessary. The material weaknesses will not be considered re-mediated until the applicable remedial controls operate for a sufficient period of time and we have concluded through testing that these controls are operating effectively. Now as Karen mentioned we are pleased with the commercial clinical and strategic execution in 2016 from a financial perspective, we reported 2016 revenue of $41.1 million representing an increase of 50% over 2015. Our gross margin is expanded and continued to be above 80% and we demonstrated the continued leverage of our business model by improving our EBITDA loss to $7.7 million in 2016 from $9 million in 2015. And we have positioned ourselves to continue to drive this growth in 2017. Specifically in Q4, we made additional strategic investments in sales reps and leadership structure, surgeon education and new market development. We launched the Avive Soft Tissue Membrane and saw the reporting of additional positive clinical data from our MATCH study comparing our Avance Nerve Grafts to conduits and additional data around successful outcomes in our expanding OMF opportunity. We will continue to make investments to drive growth and we will do so in a manner that demonstrates the annual efficiency of our business model with improved margins and cash burn as revenue increases. Our equity raise and refinanced lower cost debt provides us with the strengthened balance sheet to support our growth in this emerging peripheral nerve repair market and achieve profitability. Finally, we are regenerating our 2017 full year guidance. We expect 2017 revenue will be at least 40% over 2016 revenues and gross margins will continue to be above 80%. And with that, I would like to hand the call back over to Karen.

[Karen Zaderej:]

Thanks Steve. Before we close, I would like to highlight a few investor events in the coming months that we will be participating in. The BTIG Annual Medical Technology, Diagnostics and Healthcare IT Conference in Snowbird, Utah, March 1 and 2, the 29th Annual ROTH Conference in Dana Point, California on March 13, the Canaccord Genuity Musculoskeletal Conference in San Diego, California on March 14 and the Oppenheimer 27th Annual Healthcare Conference in New York City on March 21. Information about these events will be available on the AxoGen website. In closing, our efforts to execute against our strategic initiatives focused on building market awareness, educating surgeons and developing advocates, growing the body of clinical evidence, executing on our sales plan and expanding new products and applications in nerve repair. And these have resulted in record revenues and have positioned AxoGen to continue to lead and grow the emerging peripheral nerve repair market. We are building awareness and expanding usage of our products with innovator and early adopter surgeons and are excited to be moving towards developing the middle adopter segment of the nerve repair market. We are introducing our products portfolio to fellows allowing us to train the next generation of nerve repair surgeons. And we will continue to expand our portfolio of products and develop new nerve repair applications where we believe we can bring meaningful solutions to current clinical challenges. Before taking questions, I want to welcome our new investors and thank all of the members of the accident team for their commitment to helping patients with nerve injuries. At this point I would like to open up the line for questions. Operator?

[Operator:]

At this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Dave Turkaly of JMP Securities. Please proceed with your question.

[Dave Turkaly:]

Thanks and just a firm one just a point of clarification, the guidance for ‘17, the 40% growth I was just curious, are you including any contribution from the new products. And as a quick follow-up on that if we are looking at sort of $16 million in incremental sales, I was wondering if you might provide any color on sort of the breakout between AxoGuard and Avance, the mix there and do we expect potentially AxoGuard continues to maybe become more of your mix to grow a little faster in 2017?

[Karen Zaderej:]

So first on the new products on – if you remember on AcroVal, we have said that AcroVal will always have modest revenue, it has no disposable component, it’s a capital project, it’s important part for our overall treatment algorithm and that it provides surgeons a way to measure their outcomes, but the revenue is not material, it is included in the guidance, but it’s not material. Avive, we believe is a great and important part of our overall portfolio, but we think surgeons will adopt in the same way they have adopted nerve repair products in the past which means that they will try a few products and then they will wait and see outcomes. And so we did not included in our thinking about the 40% growth, but we also believe it will be small this year. This year we are building a base that it really start to move into its rightful place next year. So well, it’s not included and it’s also not material in terms of the amount of revenue that it will provide in that first year. So we think it will continue obviously to grow. In terms of your question about mix, historically we have seen that our revenue for Avance has been a little more than a half of our revenue in total. We haven’t given any kind of breakdown in terms of forward booking projections, but that’s actually been consistent over the last several years. So historically you can see what our mix has been. [Technical Difficulty] And so Avive is really an ideal material to use in that type of application where the surgeon is wanting to separate tissue layers and again modulate inflammation.

[Dave Turkaly:]

Thanks a lot.

[Operator:]

Our next question comes from the line of Tao Levy of Wedbush Securities. Please proceed with your question.

[Tao Levy:]

Great. Thanks. Good afternoon.

[Karen Zaderej:]

Thank you.

[Pete Mariani:]

Hello.

[Tao Levy:]

I think you haven’t provided this type of guidance in the past, but given that you are breaking out your active accounts, should we assume that that number roughly increases by 40% next year as well kind of in line with your revenue growth?

[Karen Zaderej:]

So we believe that our revenue growth will continue be a combination of driving penetration in existing active accounts as well as adding new active accounts. Actually I think our primary driver will be driving penetration that’s the bigger piece. New active accounts come in a much smaller revenue dollar than obviously the opportunity exists to drive penetration. And so as we go forward in the next year, well, I think we would grow, certainly we will be adding new active accounts, it may not be at the same rate and I would not think that be detrimental to our revenue growth.

[Tao Levy:]

Got it. And just maybe for clarification and so when you look at your 452 number of active accounts and you mentioned is around 5,100 centers out there, so it’s a little less than 10%, that doesn’t obviously mean that you are 10% penetrated in your opportunity, right, I mean that’s you are significantly lower than that within each of your active accounts, is that the right way?

[Karen Zaderej:]

Actually, it’s true and in fact in our active accounts the level of penetration is usually very light. Our threshold for calling something an active account is just that they have got a very basic reorder patterns that are doing at least six orders in the last 12 months. And at that level, it’s a tinny single-digits penetrated in most cases. So we have got a lot of room for upside growth and that’s actually why I think that our biggest opportunity is driving penetration in the active accounts, because we are such an entry level penetration in the accounts that we are in.

[Tao Levy:]

Got it, okay. And just lastly maybe for Pete, should we expect higher G&A expenses this coming year related to the either having to fix the internals accounting controls or is that not a meaningful expense this year?

[Pete Mariani:]

Fixing the internal controls won’t drive additional significant G&A expense now. I think we have made some additions in the G&A line. We will continue to see some growth as necessary as we continue to grow, but not due to the controls this year.

[Tao Levy:]

Okay, great. Thank you very much.

[Karen Zaderej:]

Thank you.

[Operator:]

Our next question comes from the line Bruce Jackson of Lake Street Capital Markets. Please proceed with your question.

[Bruce Jackson:]

Hi, nice quarter. If I could challenge the remediation for the material deficiency, the way these things usually work [indiscernible] a year later when your auditors come in and then you get the final green light there everything is okay, so can you just tell us the process for fixing everything, you have made provisions to the procedures and then you are going to see how they are work and then should we just assume that the final audit takes place about a year from now, is that the way to think about it?

[Pete Mariani:]

Yes, that’s exactly right, Bruce. I mean, the Sarbanes Oxley test is an annual test with our auditors. We have certainly made modifications already. We will continue to – and we have modified controls and we have modified procedures and we will continue to maintain that and we will test those ourselves, manage them well on a regular quarterly basis. So we are going to have confidence in that a lot sooner than what will show up in a formal Sarbanes Oxley 404 certification.

[Bruce Jackson:]

Okay. And then just a quick question on the sales hiring plans for 2017, do you still plan to make a few adds to the sales force and do you have a target?

[Karen Zaderej:]

Yes. Absolutely, we still see room for expansion in adding territories as well as splitting territories as they start to get above theoretical a peak level which we have set as – at about $2 million or above number. So we still see room to add. This year, we think we will add five to ten additional direct sales associates. The majority of those will probably be in the later half of the year, but we will add reps.

[Bruce Jackson:]

Okay, great, that’s it for me. Thank you.

[Operator:]

There are no further questions at this time. I would now like to turn the call back over to the President and CEO, Ms. Karen Zaderej for closing remarks.

[Karen Zaderej:]

Thank you, Tim. And I want to thank everyone for joining us on today’s call. I look forward to seeing many of you in person at one of the upcoming investor events and we look forward to speaking with you during our Q1 conference call in May. Thank you.

[Operator:]

This concludes today’s conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful evening.