AxoGen Inc. (AXGN, $13.08): “Nerve
Damage from Productivity Losses”
By: Alexander
Warstler, AIM Student at Marquette University
Disclosure: The AIM Equity Fund currently holds this position. This
article was written by myself, and it expresses my own opinions. I am not
receiving compensation for it and I have no business relationship with any
company whose stock is mentioned in this article.
Summary
• AxoGen, Inc. (NASDAQ:AXGN) is a leading nerve repair company, which
develops and commercializes healthcare solutions for patients with peripheral
nerve damage. AXGN’s revenue is currently derived from four products which
consist of the Axoguard Nerve Connector, Axoguard Nerve Protector, Avive Soft
Tissue Membrane, and Avance Nerve Graft.
Of these four products, the Avance Nerve Graft represents approximately half
of the company’s total revenue. The company was founded in 2002 and is
headquartered in Alachua, Florida.
• AXGN’s shares have experienced
near term negative volatility from a short report against the company in
December of 2018 and management slightly trimming FY 2019 guidance in Q2 2019.
• For the second quarter ended
August 6, 2019, revenue increased 30% compared to the second quarter in 2018
($26.7 million vs 20.6 million). Active
accounts increased 20% to 762 from 634 a year ago.
• New sales rep productivity is
ramping slower than expected while tenured reps are performing better than
expected.
• Management is continuing to
make progress towards BLA approval for the Avance Nerve Graft.
Key points:
On December 18, 2018, Seligman
Investments reported allegations against AXGN relating to channel shuffling,
backdating of revenue, and possible overstatement of active accounts. Following this report, AXGN’s share price
declined 31% over a three-day period. Analysts have appeared to shrug off the
short report and continue to post buy recommendations. At first glance, I would have recommended a
buy as well, however after digging deeper into the company, there are some
major concerns that need to be addressed.
AXGN’s Axoguard Nerve Connector
and Axoguard Nerve Protector represent approximately 50% of total revenue and
AXGN is merely a third party distributor of these products for Cook
Biotech. AxoGen rebranded Cook Biotech’s
products into their own, as AxoGen knew the development process for creating their
own products was too long. Cook Biotech could terminate the agreement at
anytime if AXGN fails to generate reasonable sales. Furthermore, AXGN’s Avance Nerve Graft, which
represents the other 50% of revenue, was first introduced into the market in
2007. Upon initial release, AXGN classified the Avance Nerve Grafts as a human
cell and tissue based product regulated solely under section 361 of the PHS
Act. This designation did not require FDA approval. In 2010, the FDA determined
the Avance Nerve Graft was ultimately a biologic product that must undergo
clinical trials and be regulated by the FDA.
Currently, AXGN has 180 patients
enrolled in the RECON study with a goal of generating clinical evidence for the
use of the Avance Nerve Graft over synthetic conduits. AXGN expects to have 220
patients enrolled in the study by August of 2020, complete the study at the
beginning of 2021, submit the results for approval in early 2022, and obtain
FDA approval or disapproval in 2023. In the meantime, AXGN can distribute
Avance Nerve Grafts as long as AXGN adheres to a transition plan with the FDA. If AXGN does not adhere to current FDA
requests, the FDA can at any point in time revoke AXGN’s permission to sell Avance
Nerve Grafts. It is also important to note that AXGN has patent protection on
the Avance Nerve Graft until September 2023.
On a more positive note, AXGN
continues to generate strong YoY growth figures. For the second quarter ended August
6, 2019, revenue increased 30% compared to the second quarter in 2018 and
active accounts increased 20% to 762 from 634 a year ago. The strong revenue
growth seems to be backed by a 40% increase in direct sales reps since Q2 2018
and management remains focused on converting independent agency territories to
direct. Direct sales reps now represent 87% of total revenue versus
approximately 80% one year ago. Management did however lower FY 2019 guidance
from $109M - $114M to $108M - $110M citing delays in new sales rep productivity.
What has the stock done lately?
After reporting earnings on
August 6th, the stock fell 29% due to a FY 2019 guidance cut signaling
a slightly lower growth rate heading into 2H 2019 (26.5% vs 29% previously) and
disappointing commentary on new sales rep productivity. Since Q2 earnings, AXGN
has remained highly volatile and continues to trade around 5.5x sales.
Past Year Performance:
On July 23, 2018 AXGN hit an all
time high at $55.90. Strong YoY growth numbers and a potential massive $2.7
billion TAM opportunity attracted investor interest. Shortly after achieving an
all time high, the stock took a nose dive and has never looked back since. Over
the past year, AXGN has significantly underperformed the Russel 2000. AXGN is down
33% compared to a 18.5% gain from the Russel 2000 index.
1 Year Stock Chart vs.
Benchmark
Source: FactSet
My Takeaway:
AXGN has a compelling peripheral
growth story and the stock might react positively on third quarter earnings if sales
rep productivity increases, but ultimately AxoGen should not be held in the AIM
portfolio. AXGN originated from a
reverse merger with LecTec and continues to milk the balance sheet with cash
and cash equivalents by issuing stock. Shares outstanding have spiked from
11.1M in 2011 to 38.7M in Q2 2019 and cash flow from operations is becoming
increasingly more negative each year. In addition, I believe the 30% growth
rate is attributable to the rapid growth in sales reps and improper accounting instead
of organic growth. A “portion” of AXGN’s revenue is generated from consigned
inventory maintained at hospitals, independent sales agencies, and inventory
physically held by field sales representatives. Furthermore, 50% of AXGN’s
revenue could be terminated at any point from Cook Biotech and the other 50% of
revenue could be terminated at any point by the FDA. It is also important to
note that AXGN has a weak IP portfolio with a majority of their 15 patents
expiring in the next 3-4 years. Based off of my research, I foresee AxoGen
encountering fraud charges, further delays enrolling patients in the RECON
study, and continued shareholder dilution.
1 Month Stock Chart
Source: FactSet
