Greetings and welcome to the AxoGen Inc., First Quarter 2018 Second Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Brian Korb, Investor Relations. Thank you, sir. Please begin.

Thank you and good afternoon everyone. Thank you for joining us today for the AxoGen, Inc. conference call to discuss the financial results for the second quarter ended June 30, 2018. My name is Kaila Krum and I recently joined AxoGen as Vice President of Investor Relations and Corporate Development. I'm thrilled to have joined AxoGen at such an exciting time of growth and look forward to continuing to work with you as we expand our platform for nerve repair. 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'd like to remind you that during 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 the 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, or operating performance. And with that, I'd like to turn the call over to Karen Zaderej, President and Chief Executive Officer of AxoGen. Karen?

Thanks Kaila and good afternoon everyone. Welcome to our 2018 second quarter conference call. I know many of you know Kaila from her work in the analyst community and we couldn't be happier to have her joined our team. In addition, I'd like to welcome Lisa Colleran to the AxoGen Board of Directors. Lisa is the former CEO of LifeCell and brings a wealth of market development and commercialization experience in high growth companies. Also joining me today is AxoGen's Chief Financial Officer, Pete Mariani. I'd like to begin today's call with the review of our second quarter highlights, a brief company overview, and an update our key strategic initiatives. Pete will then provide a review of our second quarter financial results and review financial guidance, after which time, we'll open up the call to Q&A. We're pleased to report another quarter of strong growth for AxoGen. Second quarter revenue grew 36% to $20.6 million. We continue to invest in our commercial team and we've made significant organizational enhancements in recent quarters. We are realizing the benefit of those enhancements and in Q2, our direct sales channel continue to grow revenues above 40% and that channel now makes up approximately 80% of our total revenues up from 70% one year ago. We continue to have a hybrid commercial model with 19 independent sales agencies that account for approximately 20% of our revenue. In the quarter, we experienced challenges in a few of these territories. We are addressing these challenges and we believe sales agencies will continue to be an important aspect of our growth in selected territory. In our direct channel, we ended the quarter with 72 sales representatives, an increase if four in the quarter and 21 in the last year. As a reminder, in late 2017 and early…

Thanks Karen. Second quarter revenue grew 36% to $20.6 million. Revenue growth was primarily the result of increases in unit volume as well as the net impact of price increases and changes in product mix. As in prior quarters, most of our revenue growth was driven by growth in active accounts. The number of active accounts grew 24% to 634 in second quarter. We also continue to see growth in our pipeline of new accounts as surgeons become more familiar with our products and begin to develop their treatment algorithms. As Karen mentioned, we're pleased with the continued growth from our direct sales channel and including the improved productivity of our recent reps hires. Additionally, we continue to make investments in support of our independent sales agencies and believe that our hybrid commercial model will continue to support our growth plans through the rest of the year. Gross profit for the first quarter was $17.5 million, a 36% increase compared to Q2 of last year. Gross margin was 84.9% in Q2, relatively unchanged compared to the prior year. Total operating expenses in the second quarter was $22.3 million, up 56% over the prior year. The increase includes the additional investments in our expanding commercial capabilities, as well as increased investments in clinical, R&D, and general corporate expenses associated with our growth. Operating expenses also include non-cash stock compensation expense of $2 million in the second quarter compared to $724,000 of last year. Excluding the impact of non-cash stock compensation, total operating expenses for the second quarter increased 49% to $20.3 million or 98.4% of revenue compared to $13.6 million or 89% of revenue in the prior year. Sales and marketing expense in the second quarter was $14 million, up 49% over the prior year. As a percentage of revenue, sales…

In closing, our efforts to execute against our strategic initiatives focus 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. We have positioned AxoGen to lead and grow the peripheral nerve repair market. We are building awareness, developing additional clinical data, and expanding use of our products with innovator and early-adopter surgeons, and are excited to be moving towards developing the much larger middle-adopter segment of the peripheral nerve repair market. We're pleased to see expanded use of the AxoGen product portfolio across our core markets and increased adoption in new categories of our business. We are introducing our platform for nerve repair to fellows, allowing us to train the next generation of nerve repair surgeons. We are building a world-class commercial team that will continue to scale and enable us to drive growth in current and expanded applications where we believe we can bring meaningful solutions to current clinical challenges. We will continue to expand our platform and develop new nerve repair applications, challenging the norms of historical repair options, and positioning our algorithm as a new standard-of-care in the peripheral nerve repair, a market that currently represents more than $2.2 billion in existing applications and we expect will continue to grow. Before taking questions, I want to welcome our new investors and I want to thank the AxoGen team for their commitment to our mission and our values. And at this point, I'd like to open up the line for questions. Operator?

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question is from Richard Newitter with Leerink Partners. Please proceed.

Hi, thanks for taking the questions.

Hey Richard.

Hey, how are you doing Pete? Karen, I wanted to start with a comment that you made earlier in your prepared remarks about distributor challenges and if you could just elaborate on that a little bit? This was a first quarter in a while where your growth is below 40%. So, -- and I appreciate you reiterating your guidance of greater than 40%. So, clearly you're expecting a reacceleration into 3Q and 4Q to get there. But I'd love to just kind of hear what was kind of one-time in nature or what perhaps cause you to kind of come in below that that 40% threshold this quarter? And where did that stack-up relative to your plan?

Well, there's a couple of things to add here. As you know we had built out our direct team in the first quarter -- end of last year first quarter of this year and some of those reps are still ramping. So, that was part of our projected plan to see in second quarter. Again, we don't give quarterly guidance, but second quarter was still a growth quarter for us with looking at how it typically and historically have play out, expecting stronger performance in the last half of the year. And that is our expectation and in fact, I would say those direct reps are running ahead and more productive than what our historical numbers have been. So, we feel confident in that piece. I think the disruption for us is that in some of our independent agencies in selected territories, not all of the channel, but in some selected territories, we had some distractions that caused their performance to be below our expectations. And so we're addressing those and addressing those -- things including adding some resources to help support them. In some cases, its training and support for that -- the independent agencies. And in other cases, it was dividing out the territories and allowing them to focus perhaps in a small regional area where they have strength, but putting in a direct rep where they -- and splitting that territory where they were not as strong or it was an important area for us to provide ongoing growth.

Okay. So, is it safe to say that there's a little bit of lingering impact from some other kind of the salesforce changes they implemented last quarter, lingering into this quarter that maybe understated where your true growth trajectory is and that's why you're calling out the direct reps being greater than 40%?

Actually -- I guess I don't see lingering issues. When you make a change in a bunch of sales territories, there is some disruption factor and we definitely saw that in January and February. We saw just that for a lot of the focus that you get when you have a lot of new people and new reporting structures in an organization. That's passed us. I don't see any event now. But what we do still have going on is that 50% of our direct sales teams that are new with us are going through a learning curve and the conversion curve. And if I put a little color on that, historically, when we brought reps -- a new rep into a territory, we brought them into it a territory, if you go back a few years and often we have very little base business, and we've talked about how they would expect to breakeven within a year. And what happened was that rep would come into that territory across the first couple of months of training, so there's not a lot of productivity in the first couple of months. Then they start to hit the ground running. They would have grown their revenue in those first few months and then historically, what we saw was they hit the valley of death where all their surgeons went into their wait period and they didn't have any business. And so in a later period, they would drop and then they would start to come up towards the end of the year. Today, we see an improvement in our productivity because they're handed a base of business already because we're splitting territories, or some base and a conversion from a distributor. And so they have a base. They are both maintaining that base and continuing to add incremental revenue that more than pays for their -- the cost of adding that rep in that first year. In addition we don't see them hitting that valley of death. So, we don't have a sort of low point where they're worried if they can make house payments and we're worried that their actual quarter-to-quarter growth. We are seeing that they continue to grow and it's particularly backend loaded. And so that's a big part of why we're confident that we're on-track to do what we plan to do in the last half of the year.

Okay, that's helpful. Maybe just one more if I can squeeze one in for Pete. Pete, you mentioned the pipeline of new accounts was robust; maybe can you quantify that in any way for us? And also just with respect to kind of the cadence between 3Q and 4Q, should we be thinking about the -- really more 4Q-weighted verse 3Q. Any color there would be helpful. Thank you.

Well, when you say new accounts, I mean there's -- were you saying new active accounts, right? Is that what you mean?

I think, yes, your active. I think you had said active accounts, you added 24% and you said you had a fairly robust pipeline -- or the pipeline grew or something?

Yes. So, what we say is that the active accounts continue to grow. And again, the delta between the percentage of growth that we have in the active accounts and the revenue growth is a good indicator. That 36% to 24% gap is a good indicator of the fact that we are -- that our average revenue per active account is continuing to increase and the penetration of our active accounts is continuing to increase. So, we'll continue to see that delta. Again as Karen mentioned, as all these new sales reps continues to get through their first three, six, and nine months, new sales reps are always developing new accounts. So, we have lots of optimism that we'll continue to see growth in active accounts as a catalyst and part of what's going to drive our confidence in the back half of the revenue growth. And then we also do talk about there is a robust pipeline of accounts that haven't hit the active account list yet that are in some stage of evaluation. And we're seeing that continue to grow nicely and should continue to funnel more accounts into that active account list over the next six, 12, and 18 months.

Thanks.

Our next question is from Raj Denhoy with Jefferies. Please proceed with your question.

Hi, how are you guys doing?

Good Raj.

I wonder if I could maybe drill into this issue with the distributors a little bit more. You mentioned that that there was distractions, and I'm sure you got question as to what exactly that was that caused underperformance in that segment of your salesforce? So, was anything more you can give us just to give a little comfort that this is temporary and that you've put it behind you?

I don't think there was one cause. I think it's the things that are going to happen in a sales organization, especially with independent agencies and that they can get focused on other price. We're not the primary thing in really any of their bags. And so they're providing our product as a service to the people that they -- and surgeons that they already know. So, it was only a targeted few of them that had the distractions, but -- and it wasn't all one thing. So, it really is just digging in and solving that problem. And as I said in some cases, it was something that we felt that the independent agency still has a strong value to us and is committed to the line and we're providing additional resources to get them through that. In that case with some people in their team, so we wanted to make sure that we could provide them training and help them come up the learning curve. In other cases, we dug in a little bit and decided that they had enough focus in other products that we weren't going to get the attention that we needed. And we traded them out and put in a direct rep in either all or part of their part of their territory.

Okay. But I guess as you've probably going to gather -- you might have already gathered, I mean the results in the quarter of 36% was below the -- at least 40% guidance which you've reiterated several times this year. And I guess just try to again gauge this level of that that we can get back this distraction in the distributor side of your salesforce has been rectified and as you look into the third and fourth quarter, how do we get comfort as people on the outside that you can actually return to that level of growth? And the follow-on to that is given that this has now happened in this segment of our salesforce, how do you -- how does this not happen again? In a sense, how do you get these people perhaps more engaged or does this take you then having to perhaps go direct in more segments as opposed to relying on distributors?

Well, first off, I'll focus on the 80% of our revenue, which is really the direct channel. So, that's a portion of the business that we have clean and direct control over. And that's an increasing part of our business. Doesn't mean that we are going to be a hybrid model. The reason we think we want to be a hybrid model over the long-term is because their trauma is by design geographically spread out. And there are some selected trauma centers that are very good trauma centers, but they're geographically difficult to reach and maybe not concentrated enough. Examples are Alaska, Hawaii, Puerto Rico, parts of South Dakota. There are trauma centers in each of those locations, but no one of those in our current call pattern is probably large enough to put in a direct rep, at least at this point. And so what we're really doing is right-sizing what we consider to be some of our independent territories to say we definitely want strong partners in those locations. But in other areas where we may not be getting the focus, we're going to continue to divide out some of the territories and transition to direct reps. And you've seen us do that over time while the number of independent agencies has stayed about the same actually over the last year. The amount of trauma centers that they cover has actually gone down because we've been dividing out their territory and that's where some of the base has come for many of the direct reps that we've added. And that continues to be our strategy. You can see that we're planning to add some more reps over the rest of the year that will come from dividing either distributor or independent agencies territories or are direct territories. We still also plan to continue to split territories when they approach $2 million revenue number on any unrealized basis. We think that is where you might start to see some dampening of growth and that's obviously our goal is to continue to drive significant growth. And so we don't want to have that, so we set the expectation with our direct team and do execute such that we split territories when they are somewhere between a $1.5 million and $2.5 million. So, with all those things combined, I think we're in a good spot having addressed these. We won't eliminate all of our independent distributors, but we will be less reliant on that portion of the channel as we continue to grow.

Okay. And sorry just last one. As we look at the model in the back half of the year and get back above 40%, you have to grow north of 40% because you're a little below that in the first half. Is some of those going to linger now into the third quarter and then you'll have a particularly strong quarter, how should we really think about the back half?

Yes. Look, we just think the back half is going to be -- is going to continue to be stronger. I think -- again, we don't give quarterly guidance, but I think if you just look at where you -- where we would need to be, it certainly suggests that we're going to get back over 40% in both quarters and moving north in that range as well.

Okay, that's helpful. Thank you.

Our next question is from the Dave Turkaly with JMP Securities. Please proceed with your question.

Thanks. Just quickly back, I want to follow-up on the agencies, the 19. Can you give us a broad estimate of how many people are working at those places today? And then it sounds like I know that number has been fairly consistent, so this wasn't anything that came up with sort of new early ones that were more recently added, but maybe it sounds like the splitting of the territory is the same thing that caused disruption -- in the direct might have caused some disruption there, is that the right way to think about it?

So, in the last question, no, the distraction actually I think was external to us. Our solution was to split the territories. When you -- all of these, I think -- what do I see, all of these agencies have multiple people in them that carry our products, but they range in size quite a bit. Some of them are small and with only two sales associates and they can be as high as more than 10 to 12 associates carrying our product. They also have quite a bit of variation in geography. Some of them are -- really a few cities and others have multiple states. And so what our plan is to continue to look at these and will they perform and do a great job and continue to drive the kind of growth that a direct rep does. I'm very happy to work with them. Where they don't hit their quota and they underperform or get distracted with other aspects of their business or are worth hiring new people and get distracted, then our drive is to say that they may not be able to carry our products. And we are very upfront with them about that. It says it's all about hitting the number. And I think they understand that's their job. And they have a relationship. And we have an good enough communications channel that we can continue to talk to them to say well if you see something coming, then we'll go ahead and trade it out. I mean that's what our goal is to end these things in a smooth transition for the people that are their customers as well as our customers. Remember they are calling these customers for other products as well and they don't want to leave them high and dry. So, we have a good win-win to try and do an effective transition in that case.

Got you. And then sorry, I didn’t get the technical here, but just over 40% of the direct salesforce leaves a lot of room for what the actual number was. I was wondering if you might want to -- if you could kind of quantify we're talking 45, 50. Any color around how well the direct channel grew to give people comfort that 40% is the right number for the year.

Well, look I answered, we're continuing to grow low to mid 40s on the on the direct channel. And they're doing very, very well and what we're really encouraged with is the fact that these new reps as Karen had talked about are coming in with a good base of business and they're growing from that. And so we're seeing really strong initial productivity from our newer reps that we brought on and as they get through their third, six and nine months with the company. It gives us a lot of optimism as we look at the back half of the year.

The greater than 40%, by that we mean that that's their organic growth because it also -- it's bigger number than that if you do the math it's because we're adding in some of the distributor territories that we traded over. But their organic growth even with the newer associates is greater than 40%.

It's good to hear and I appreciate the color. Last one just quickly, obviously, this new facility. Next year people obviously having exceeding sort of $100 million in revenues and I guess I just love to get color on sort of what kind of capacity you think you'll have with this new facility. Do see the ability to kind of cover what people might expect for the next five years, 10 years, just any color on how much you could process both Avance and Avive with this facility up to speed? Thanks.

Yes. No, it’s a great question. We're really excited about this building; it's 70,000 square feet as it is with plenty of capacity within the current four walls of it to meet our needs over the next many years. And then one of the reasons why really like this place is because it's got a room where you can essentially double that 70,000 capacity down the road if you ever felt you needed. So, we've got a good opportunity to make a long-term decision here that will certainly handle our capacity needs for the long-term.

Thank you.

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the call back to management for closing remarks.

Thank you. And I want to thank everyone for joining us on today's call. And we look forward to talking with many of you at one of our upcoming investor events. Thank you.

Thank you. This concludes today's conference. You may disconnect your lines at this time and thank you for your participation.