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AxoGen, Inc. (NASDAQ:AXGN)

Q1 2014 Results Earnings Conference Call

April 30, 2014, 16:30 AM ET

Executives

Karen Zaderej - President and CEO

Greg Freitag - CFO

Analysts

Nathan Cali - Nobel Financial

John Gillings - JMP Securities

Jeffrey Cohen - Ladenburg Thalmann

Operator

Good day, ladies and gentlemen and welcome to the AxoGen Inc. First Quarter 2014 Results Conference Call. At this time, all participants will be in a listen-only mode. Later we will conduct a question and answer session and instructions will be given at that time. (Operator Instructions) And as a reminder, today’s conference is being recorded.

And now, I would like to turn it over to your host, Mr. [Doug Sherk] (ph). Mr. Sherk, you may begin.

Unidentified Company Representative

Thank you, Bridget and good afternoon everyone. Thank you for joining us today for the AxoGen conference call to discuss the financial results for the first quarter ended March 31, 2014, as well as recent corporate developments and management’s perspectives on 2014.

Following today's market close, AxoGen issued its results release, which is posted on the company’s website at www.axogen.com. In addition, the company’s 10-Q for 2014 first quarter was filed with the SEC this afternoon.

Today’s call is being broadcast live via webcast which is available in the AxoGen website. There will be a taped replay of this call, which will be available approximately one hour after the call’s conclusion and will remain available for seven days. The operator will provide the replay instructions at end of today’s call.

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 development, product potential, regulatory environment, sales and marketing strategies, capital resources or operating performance.

And with that out of the way, I would like to turn the call over to Karen Zaderej, President and Chief Executive Officer of AxoGen.

Karen Zaderej

Thanks, Doug and good afternoon everyone. Welcome to our first quarter 2014 conference call. Joining me on the call today is Greg Freitag, our CFO and General Counsel.

We generated year-over-year revenue of 46% and sequential revenue growth of 5% during the first quarter. I believe our strong start to the year clearly demonstrates that our efforts to pioneer the development of the peripheral nerve repair market are gaining market traction.

We are the only player focused on nerve repair and we are working to change decade's old paradigm. Our team's drive in focus led to all three of our brands; Avance Nerve Graft, AxoGuard Nerve Protector and AxoGuard Nerve Connector showing solid unit growth during the quarter.

Greg will provide more details on our financial performance, but I would like to focus my comment on the details of our growth strategies and our sales approach. Our revenue today reflects just a small fraction of the broader nerve repair market, estimated to be $1.6 billion.

We are driving the market to covert from surgical technique to commercially available product that provide surgeons new options to restore quality of life to patients suffering from peripheral nerve injury.

We are making steady progress in our goal to change the status quo, eliminate the need for second surgery and offer new options to the nearly 1 million nerve entries that will be repaired this year. Our value proposition is compelling and everyday we witnessed surgeons adapting our portfolio of regenerative nerve repair products.

Our suite of products provides them with the opportunity to repair the nerve with convenience and proprietary off the shelf, easy-to-use solution that bridge gap, protect nerve and offer tension free repair and provide optimal nerve size matching.

We have been successful, but we want to grow even faster. We refine our approach to the market and have implemented programs that directly correlate to accelerated adoption and increased sales revenue. Our strategy has four key components. Awareness, surgeon education on the science of nerve repair, clinical evidence and sales execution.

Let me begin with the awareness. During the first quarter, we build awareness of our products by engaging with surgeons at 30 events includes clinical conferences, surgeon discussion panels, and multiple peer led education forums. But perhaps even more important than the number is the quality of those events.

We continually monitor the impact of our participation in these events and have shifted our focus to those inhab or likely to generate the most meaningful revenue impact. For example, we found the peer led education forums deliver immediately increases on sales. As a result, we increased our involvement in this type of venue.

In terms of surgeon education, in late 2013, we launched the AxoGen special education program to provide peer-to-peer education opportunities on the latest science and best practices in surgical nerve repair.

These are two-day seminars taught by leading surgeons and focus entirely on the science of nerve repair, AxoGen products, case presentations and category grant for hands-on experience.

In addition to teaching best practices in nerve repair, these courses do an exceptional job of showcasing the benefits of AxoGen's full portfolio of product and support our sales initiative. We have two seminars in the fourth quarter of last year and we held one in the first quarter of this year at Buncke Clinic in San Francisco.

The response at all three of these events has been very positive. Following each course, we attract product usage of attendees and absorbed a 50% increasing utilization of all of our brands.

These results illustrate the importance and power of a well developed educational program to change a traditional paradigm in nerve surgery. Even the early sales result would increase the number of seminars that were hosting this year from three to four.

Turning to clinical data, we are the sponsor of what now is going to be the largest multi-center performance with their study. As you recall, the RANGER study is a multi-center observational registry of peripheral nerve injuries. The study now includes 436 nerve repairs.

Results from the RANGER study have already been published in two periodic journals and then presented at 24 clinical conferences. What continues to impress the surgical community is the clinical results for Avance nerve graft remain favorable compared to the results of past studies conducted on nerve repairs with both autograft and to hallow tube conduits.

The last pillar of our strategy is solid sales execution and accountability. At the end of the first quarter, we had 24 direct reps and 23 independent distributors covering most of the United States.

At this time, Shawn McCarrey, our Senior Vice President of Sales had his team in place and is executing a targeted strategy. We are acutely focused on those elements that drives sustainable business results what we call breadth, depth, and quality.

In late January at our annual sales meeting, we ensured that the team has a solid understanding of the science of nerve repair and the ability to deliver a clear compelling message about all three of our grants.

The team emerged in that meeting enthused, aligned in our objectives and well-positioned to take the company's revenues to the next level. The results we have reported in this first quarter of 2014 reflect the beginning of this momentum.

One of the example of how we refined our strategy is our focus on grant debt and by that I mean ensuring that we introduce all three of our brands into our target accounts. And accounts that orders all three of our brands generates five to seven times more revenue than an account ordering just one brand.

We focused on increasing brand penetration and we're seeing results. During the first quarter, the number of accounts that increased used from one of our brands to two or more increased 17% sequentially. By identifying drivers such as these and incorporating them into our sales direction we ensure that the field organization is fully aligned with our corporate sales growth goals.

Finally, I do want to recommend another important step we taken to ensure our customers have access to our products when they need them, especially for emergent cases early in the development cycle of an account.

Earlier this month, we opened a new worldwide distribution center in Dallas and Texas, a growing city that is part of the [Dallas Sport Work] (ph) metropolitan area. This location provides us with the centralized distribution point near two major airports allowing us mix day access to shipping services to all parts of the United States and other countries that we serve.

With that, I'd now like to turn the call over to Greg for a review of our financial highlights.

Greg Freitag

Thanks, Karen and good afternoon everyone. Given that we have filed our news release and 10-K this afternoon, I'll focus my comments on financial highlights during our first quarter, as well as provide our outlook for 2014.

As Karen stated, our sales increased 46.4% during the first quarter compared to a year ago which includes approximately 2% or $62,000 in grants revenues which is funding some of the exciting research and development work, Karen will review in a few moments.

First quarter gross margin expanded to 77.7% compared to 73.9% in the year ago first quarter reflecting manufacturing efficiencies, price increases in March 2014 and change in product mix.

Now let me turn to expenses. We continue to make investments in our organization as first quarter expenses increased 39% over last year's first quarter. However, as a percentage of revenue, total operating cost and expenses was approximately 9% lower than year ago.

Sales and marketing expenses increased approximately 43% due to the expansion of the sales team which is now 24 sales associates compared to 18 in the year ago first quarter.

Additional cost increases were due to sales training and surgeon education investments including the nerve repair professional education course at San Francisco as they were no comparable costs for this in the 2013 first quarter.

However, as a percentage of revenue, sales and marketing expenses were 86.7% slightly lower than in the first quarter of last year and sequentially down approximately 17%.

General and administrative expenses increased 18% with some of factors driving this including the move to our new corporate offices and Texas distribution facility. R&D spending increased to a total of $813,000. These are center portion of our R&D increases related to clinical work, which includes our FDA PoA as well as increased investments in our product development pipeline.

As we have said in the past quarter, we will mange our expand on research. And in this regard, we have been successful in securing grant funding recovery portion of our research expenses.

Interest expense was up 11.5% to approximately $1.19 million due to the increased interest related to the PDL royalty contract from higher revenue and interest accrued related to PDL.

As the result of the accounting treatment for the PDL transaction, interest expense included approximately $892,000 of non-cash expense that is expected to be paid in the future based upon the terms of the PDL transaction and increases in our revenue.

During the quarter, we used approximately $3.15 million in cash and ended the quarter with $15.8 million. Approximately $370,000 of the $3.15 million was related to one-time fixed asset acquisition for our facility's expansion would provide us with the infrastructure to support our growth.

We have no current need for additional operating capital in our executing to our business plan. At the same time, like most medical technology companies, today we filed a Form S-3 Registration Statement with the SEC that would allow us to sell up $35 million of our common stock.

It is important to note that we have no plans to raise capital under the shelf at this, but our Board wanted to provide our company with the maximum flexibility should future opportunities require additional capital.

Our first quarter revenue performance generated sequential growth each month and this trend appears to be continuing in April. This revenue performance and the initiatives underway to accelerate the adoption of our products, leads us to confirm our previous guidance that full year 2014 revenue of $16 million is achievable, while maintaining gross margins of 75%.

With that, I will now turn it back to Karen for her summary comments and then we will take questions.

Karen Zaderej

Thank you, Greg. While our current commercialization strategy is delivering positive results, we believe there is additional opportunity for growth for nerve repair and additional areas of the body. Our initial focus was upper extremities in nerve repair.

As we have announced previously, we have now also entered the oral and maxillofacial market in the middle of 2013 with the focus on repairing injured trigeminal. This is an exciting market, with strong clinical need and we will continue to develop this opportunity.

We're exploring additional markets such as prostate cancer surgery, while we're continuing our clinical investigation work on the potential for nerve grafting during the prostatectomy.

Enrollment in this pilot study is completed and a two-year follow-up is underway. And we anticipate data from this preliminary study by this time next year. Additionally, we are looking at the potential of expanding our products into other surgical areas, including surgical intervention for pain generated from nerve entrapment and the reconstructive breast market.

As Greg mentioned, we're also doing some limited pipeline development work. And then effort to manage cost in this area, we are participating in several Department of Defense grant that offset our investment in the pipeline. We have previously announced shared grants with major research institution such as Vanderbilt and Wake Forest.

In addition, while more details will be forthcoming, I'm able to share that we're participating in DOD funded research valued at more than $2 million with investigators from Brigham and Women’s Hospital for two grants related to nerve repair.

The first is related through the use of induce pluripotent cell with Avance Nerve Graft to augment nerve regeneration. The second grant explores the efficacy of branched and long segment, the process nerve allograft which could be useful in certain types of surgery such as facial reconstruction and complex trauma.

In summary, we are pleased with our results this quarter. It is a solid conformation that we're effectively penetrating the market and positions us well for the future growth that we believe this product portfolio can deliver.

We have the pieces in place to maintain this momentum and our confident that as we move through the year, we will continue to generate year-over-year and sequential revenue growth.

With that, Bridget, we're ready for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions)

Our first question is from Nathan Cali. Your line is open.

Nathan Cali - Nobel Financial

Thank you guys, thanks for taking the questions.

Karen Zaderej

Hi, Nathan.

Nathan Cali - Nobel Financial

Hi. So, you mentioned a grant from the Department of Defense and what was the other one?

Karen Zaderej

So, we have two grants with -- at Brigham and Women's, the look Department at Defense grants. They totaled to -- it's in combination with the investigators from Brigham and Women's, for little over $2 million worth, all focused in profits autograft enrollments.

Greg Freitag

So, it's two grants. They're both, with Brigham and Women for two different investigators and both are coming from DOD.

Nathan Cali - Nobel Financial

Okay. And what type of nerve repair is this?

Karen Zaderej

So, in particular one of them is focused on branched and longer segment. So, today we provide a straight segment of a nerve, but in the body of course they are times when nerves have a branch in them, or Y.

And that's particularly important in complex trauma and facial reconstruction. And so, the target on that we'll be looking at branched and longer than our seven centimeter length, focused on facial reconstruction.

Nathan Cali - Nobel Financial

Yeah. And then, for your independent reps, what are the products of those reps selling? What's in their bag? Besides, what they're selling for you guys?

Karen Zaderej

We, always make sure that they have a call pattern that matches our call patterns, so, they are in some way calling on the hand surgeon or the upper extremity surgeon, with our primary call point.

They don't care any competing products, as a requirement we don't want them to care anything that's competing. So, most of the time, they do handset, orthopedic implants, but some of them are more soft tissue. So, it does vary but they all call on the upper extremity surgeon.

Nathan Cali - Nobel Financial

And, then, your retention rate, you noted in your release that you had additional sales into existing accounts. What's been your retention rate on your product as far as we order?

Karen Zaderej

So, we do monitor the retention rate on our accounts. We look in fact in driving increased penetration into the accounts so that we get a stronger repeat order pattern, we call it stickiness.

So, our goal is to get an account that will get to a point that they order five out of six months, and actually share the specific statistics on that because obviously from competition standpoint, our competitors would like to know that but they don't but we do monitor that very closely with the push to drive a steady repeat order pattern.

Nathan Cali - Nobel Financial

Okay. All right. Thanks for taking the questions.

Karen Zaderej

Thank you.

Operator

Thank you. And our next question is from John Gillings of JMP Securities. Your line is open.

John Gillings - JMP Securities

Hi Karen, how're you doing?

Karen Zaderej

Good evening John. Rachel, I think we lost John.

Operator

Okay. For our next question…

John Gillings - JMP Securities

Hello, can you hear me okay.

Operator

Okay.

Greg Freitag

Here we go.

John Gillings - JMP Securities

Okay. Just one quick clarification to start. You mentioned some grant revenue, was that part of the $3.14 million in sales in the quarter?

Greg Freitag

Yes, outside there was $52,000 of that was part of the revenue.

John Gillings - JMP Securities

Okay. And then the next one, and, I appreciate the 5% sequential uptick in sales. But this is, probably the fourth quarter in the row that we've been kind of in the $3 million range and we can't see what's going on obviously from months to month within the quarter.

Was there anything in terms of - sort of the progression from the beginning of the first quarters through the end that help to give you some confidence to restate the $60 million guidance for the year? Can you give us a little color on that?

Greg Freitag

Yeah, John, so, as I have said in the script, what we have looked at is, we've had sequential growth monthly through the quarter and it would appear that in April we're sequentially up again.

The other flavor to that is, the January was a very difficult month. It had both a, our national sales meeting which came at the end of the month. It also had surgeon conference that was in Hawaii which pulled a lot of people out from the United States during January and also just coming into that season.

So, we -- January was not a great month, yet the quarters came up very well. And we're very excited because we have been putting down better months each month and that's what leading us to make the statement that we're so confirming that we believe $16 million is anticipated by us.

Karen Zaderej

I think, I'll add just more color standpoint. One of the things that we looked for in the marketplace anecdotally is that point where we see surgeons calling surgeons and telling them, hey, you need to be aware about this new technology and you should see some of the impressive results that they're getting in there own hand and telling each other that, without us being in the nick. And I think one other things I've seen most encouraging, is that, I see surgeons starting to do that independently.

And that really leads to a lot of the momentum that I think we're seeing today. So, just anecdotally, I think we're getting some very good momentum

Greg Freitag

And the other piece of that truth is we adjust that coming out of our year end earnings call, is that, this year we would continue to grow on the growth back and loaded. And so, in fact, first quarter is coming around and came inline with what we anticipated, both, as we looked at this year and the growth rate again as they climb round for itself.

This is inline in what we believe we can get back at the last earnings call as going according to our anticipation.

John Gillings - JMP Securities

Hey, that's great color. I appreciate that, that's helpful. Maybe next, just kind of looking at the productivity for reps, obviously that kicks up as they become more seasoned and you guys have brought in; - you've bringing in new reps for several quarters.

Can you give us maybe a little color around where the productivity for reps fits for the more seasoned ones versus the new ones and how the new ones are coming along?

Karen Zaderej

So, we've had some transitions and reps in the field. So, at this point, actually right about half of our sales teams still has less than 12 months. As we've gone through and - both right sized territories and realigns in territory.

And, so, that leads half of our sales team still in the new big category, throwing the reps that have been here longer, different duration, from territories to territory.

But we see some really strong progression in solitary territories and showing growth. And I think, again, when we talk about our confidence about building towards our year end number, is that we're looking at some of the territories that have not been disrupted and have that conductivity and see what the growth has happened in those territories and applying it across the rest of the country, obviously the delayed state.

John Gillings - JMP Securities

And then, one of the things we typically see was sort of doing unique products, that can be a challenge sometimes lead them through the committee process and hospital. I would assume that in some of those territories, even if you had some turnover that maybe, that was already underway.

Can you give us an update on kind of where things stand in giving through hospital committees that headwind or that's something that's kind of either starting to pickup that could, further along in the process than in the past?

Karen Zaderej

Yeah. Today committees are absolutely a barrier into every, into every trauma centre. And, so we continue to go through the committee process, it just takes time to get through it.

We do find that we have a bank of those that we're now well into, or pushing through the committee process. We also have a lot more to continue to add and that's really where our new accounts come from, as we pop out through the committee process and get through the initial trial period and get an account on Board, then we can start really working to do that breadth, depth and quality to really drive into that account, expand the brands and expand the number of surgeons who are using it.

Yes, that's absolutely a barrier to getting a product establishment account but now I feel like we're coming through the backside of that where we get a lot committees done that's how we're continuing to build that sales.

John Gillings - JMP Securities

All right. That's helpful. That's it for us. Thanks.

Operator

Thank you. And our next question is from Jeffrey Cohen from Ladenburg Thalmann. Your line is open.

Jeffrey Cohen - Ladenburg Thalmann

Hi, can you hear me okay?

Karen Zaderej

We can Jeff, good afternoon.

Jeffrey Cohen - Ladenburg Thalmann

Good afternoon. Thanks for taking my questions in advance. I just have - I will take my question offline. So firstly, could you comment it on, if there's any weather related effect upon the quarter, or have prophesied if there was a weather effect?

Karen Zaderej

Yeah.

Greg Freitag

Yeah. So, we, yeah, Karen and I are both jumping edge. Weather has been a factor for a lot of companies we believe that might have some effect but that’s not any sort of thing that we're putting out there they may have, but we stand solid quarter of what we did and then broke that with their, weather is weather.

Jeffrey Cohen - Ladenburg Thalmann

Got it. And was there any price increases on any of the product lines for the quarter?

Karen Zaderej

Yeah, we could take a price increase in March. So, it did have some impact in the quarter. So, it's going to be left - less than 2%, something in that range. It rolls through, so obviously as we now get a full quarter impact you'll start to see some impact in second quarter.

But as then we'll actually walk you through the rest of the year because some accounts had delayed price implementation plans. And so it to doesn't hit us on it one, it'll be staggered throughout the quarter, yes we did take a price increase and we saw frankly limited objections to that price increase.

I think that we still demonstrate that we have value at the prices that we're talking, that we're presenting as well as reimbursement that allows coverage of that price.

Jeffrey Cohen - Ladenburg Thalmann

Okay. Got it, and lastly I know you gave some account specific metrics as far as function habits on more than one product line. Could you give us any kind of indication on just the aggregate number of accounts out there, if that increases during the quarter and if so by how much or how many or what percent?

Karen Zaderej

We don't put out how many accounts are out there. It did increase - I will say that, we have shifted our focus on, in aggregate. So that when I talk to the sales team and when Shawn talks with the sales team, we're really emphasizing in those territories where we have a rep well established to go deep in the accounts that we're already in rather than focus on account acquisition.

Now, that's not a blanket statement because obviously we still have some territories that are brand new. And so we're having a new rep, their whole job is to get through committees and get into new accounts.

But in our more established territories we really got a good base of accounts, so we made it through the committee and our lowest hanging fruit is to get deeper penetration.

And so we saw a shift in this quarter where we're acquiring new accounts at slower level but it's a focus on getting that sticky accounts, the accounts that we're already in and getting deeper and with a regular reorder pattern.

Jeffrey Cohen - Ladenburg Thalmann

Okay. Got it. Thanks very much for taking the questions.

Greg Freitag

Thanks Jeff.

Operator

Thank you. (Operator Instructions)

I'm not showing any questions at this time. I'd like to turn it back over to management for any closing remarks.

Karen Zaderej

Thank you everybody. I appreciate you listening to the update.

Greg Freitag

We appreciate everybody on the phone. Everybody who was asking the questions, we look forward to continuing to drive the performance, that we shown in first quarter. Have a great rest of day.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.

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