Greetings. Welcome to the AxoGen’s Fourth Quarter and Full-Year 2019 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to our host, Pete Mariani, Chief Financial Officer. Thank you. You may begin.

Thank you, Diego, and good afternoon, everyone. Joining me on today's call is Karen Zaderej, AxoGen's Chairman, Chief Executive Officer and President. Karen will begin our call with an overview of our operational highlights for the quarter and then I will provide a detailed analysis of our fourth quarter and full-year financial performance later in the call. Today's call is being broadcast live via webcast, which is available on the Investors section of the AxoGen website. Within an hour following the end of the live call, a replay will be available in the Investors section at www.axogeninc.com. Before I 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 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, the regulatory environment, sales and marketing strategies, capital resources or operating performance. And with that, I'd like to turn the call over to Karen. Karen?

Thanks, Pete, and good afternoon, everyone. We delivered solid revenue growth in both the fourth quarter and the full-year. Total revenue in the fourth quarter grew 20.2% to $28.1 million, driven by the strength in our core trauma business. For the full-year, revenue grew 27.1% to $106.7 million. At AxoGen, our mission is to restore nerve function and quality of life to patients with peripheral nerve injuries. We are advancing this mission through the pursuit of our five pillars of growth, which are building market awareness, educating surgeons and developing advocates, growing the body of clinical evidence, sales execution, and introducing new products and expanded applications in nerve repair. Turning first to sales execution. As we discussed on last quarter's earnings call, we have rebalanced and refocused our commercial efforts towards extremity trauma, our largest market opportunity and most efficient path to sustainable long-term growth. Specifically, we have increased our sales representatives focus on going deeper within our current surgeon customers to support achievement of optimal clinical outcomes for all their nerve injury patients. This deeper use is anchored by our flagship, Avance Nerve Graft, and supported by the expanded use of our full nerve repair algorithm. We believe this increased sales rep focus will result in deeper penetration and improved development of active accounts. We are pleased with our progress executing this refocused approach, while also recognizing that new market development requires persistence at both the account and surgeon level. Developing surgeons should consistently use our nerve repair portfolio requires us to raise awareness of the clinical data that supports the use of our products and to provide peer-to-peer education programs and interactions that teach and endorse optimal nerve repair algorithms and techniques. We work closely with each surgeon as they build their own nerve repair experience and positive…

Thanks, Karen. Fourth quarter revenue grew 20.2% to $28.1 million, while full-year revenue grew 27.1% to $106.7 million. Revenue growth for the quarter and the year was primarily the result of increases in unit volume as well as the net impact of price increases and changes in product mix. Our revenue growth was largely driven by increased revenue and active accounts as well as the addition of new active accounts. We have 797 active accounts, which represents an increase of 12% over the prior year. We also continue to see growth in our pipeline of new accounts as surgeons become more familiar with our products and begin to incorporate them into their treatment algorithms. Gross profit for the fourth quarter was $23.3 million, a 17.7% increase compared to Q4 of 2018. Gross margin was 82.7% for Q4 compared to 84.5% in the prior year fourth quarter. Gross margins in the quarter were negatively impacted by increased processing costs as well as approximately $280,000 or 100 basis points from additional inventory reserves required in the quarter, which are not expected to repeat in future quarters. Total operating expense in the quarter was $30.7 million, up 19.7% compared to the prior year. The increase includes investments in our expanded 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 $2.9 million in the fourth quarter compared to $1.6 million in the prior year. Our spending growth has continued to moderate over the past three quarters and is now in line with our revenue growth. Sales and marketing expense in the fourth quarter was $18.8 million, an increase of 21.6% over the prior year. The increased spending includes the expansion of our sales footprint and continued…

Thanks, Pete. AxoGen remains a leading company solely dedicated to improving quality of life for patients suffering from peripheral nerve damage. We believe that we are building a foundation based in science and clinical outcomes that will allow us to address these important unmet clinical challenges. We are confident that the underlying fundamentals driving our business are strong and we believe that the continued execution of our strategic initiatives will deliver long-term sustainable growth. I want to thank our investors for their ongoing support and the AxoGen team for their commitment to our values and mission to revolutionize the science of nerve repair. Before taking questions, I'd like to end our prepared remarks with a story about how a surgeon using the AxoGen algorithm, helped his patient, David, recover from a terrible nerve injury. David suffered a gunshot wound to his upper right leg when he and his wife unknowingly interrupted a home invasion. David's immediate wound was treated in the ER, and he was sent home to recuperate. However, the gunshot has severed David's sciatic nerve, which impacted his ability to walk and left him with debilitating pain. He described the pain as constant lightning bolt in his leg. He was unable to sit, stand or walk comfortably. He struggled with everyday activities and was unable to return to work. He consulted several specialists. Unfortunately, one referred him to a nerve surgeon for evaluation. The surgeon was able to surgically remove significant scar tissue that it becomes wrapped around the injured nerve and cut out a large painful neuroma that had developed, which resolved the pain. The resulting nerve gap was then repaired with Avance Nerve Graft and Axoguard Nerve Protector. Following surgery, David was immediately pain-free and began working to rehabilitate his leg. He continues to regain sensation and motor function to his injured leg. He recently returned to work driving a forklift and he is back to roughhousing with his grandchildren. AxoGen is grateful for the role we were able to play partnering with the surgeon on Avance nerve repair techniques that provided David with the possibility of recovery following such a terrible trauma. At this point, I'd like to open up the line for questions. Diego?

Thank you. Ladies and gentlemen, at this time, we will conduct our question-and-answer session. [Operator Instructions] Our first question comes from Raj Denhoy with Jefferies. Please state your question.

Hi, good afternoon. Maybe I could just start with the cadence of the sales rep hires. In the last couple of years, you've almost doubled the sales force, and the expectation is to grow again here by about 20 reps or so in 2020. And I guess the question is really around where do you see it ultimately heading? I mean, will there be a period of time at which you think the sales force is at the right size? Or where the additional reps or the addition of reps maybe slows a little bit?

Well, I think we are slowing the rate of addition of reps starting this year. And I think that the size of the ultimate sales team will depend on as we scale and improve the productivity of the reps with the size of a territory that they can maintain growth and continue to build their business. So as we've talked about before, at this point, we see about a $2 million threshold where we need to split a territory to maintain the growth of a territory. We are exploring other selling models that may allow us to offload some of the more service components of a territory to allow that number to reach a higher threshold. But it's too early for me to tell you that I think that that's doable. So at this point, I would say, we continue to see that we will add reps as we need to split territories over time. It will be at a more reduced rate because we've done some of the strategic foundational things that we needed to do in 2019 that caused us to accelerate some of the rep hires like splitting and entering some key geographic territories, as well as converting some of the independent agencies. So those pieces are complete.

Okay. Well, maybe I can put a finer point on it, because I think one of the things that becomes difficult to parse out from the numbers when you're adding sales reps is that the pace that you are is to see any change in the productivity of those sales reps depending on how you calculate the average number of reps, the productivity has been relatively flat. Again, I imagine it's being masked by the sheer number of new sales reps coming in. But as you look now into 2020, do you expect that we'll start to see that rep productivity start to shine through a bit such that it can be appreciated by investors?

So what we've assumed in our guidance in 2020 is relatively flat productivity and not jumping ahead of that. I think, again, we're piloting some things that would have the potential to improve that. But until we see it, we're not baking it in. So at this point, the assumption is relatively flat productivity per rep. Longer-term, yes, I do think that that's very possible both with the maturing of our sales team as well as some of these productivity measures.

Okay. Maybe just one last one, just on the mix of revenue. Is there anything you can give us in terms of Avance versus the other products, the Axoguard family of products? Where are you seeing most of the growth at this point? Or is it relatively well balanced?

It's relatively well balanced, Avance remains a little over half of our revenue. That's been very consistent over the years. So we see growth across the Board. But again, Avance is a significant contributor with over half of the revenue and growth.

Okay, great. Thank you.

Thanks, Raj.

Thank you. Our next question comes from Richard Newitter with SVB Leerink. Please state your question.

Hi. Thanks for taking the questions. Maybe just one on guidance and then two follow-ups. I appreciate that the guidance reflects an attempt or you're refocusing a little bit more heavily on your core trauma and some of the sales – some sales force realignment that have been in the works here to do that and optimize the selling organization. I'm just curious though, can you talk about what contribution, if any, is contemplated from some of the newer areas that you're penetrating or looking to go into in nerve and breast? And I understand that OMF maybe is a little bit deemphasized. But what contribution if any is considered from those new areas?

Yes. We don't breakout each of the segments. I think both breast and OMF have a small – a relatively small base, but have a good opportunity for continued growth. And we've seen continued growth from both of those segments, when we look at their overall year-over-year performance. So we anticipate that both of those will continue to have growth. I'd be a little more cautious in pain. I think we're at the very early stages of pain, and just like all parts of nerve repair, the long-term conversion process just takes time to build. And so I would put that as a negligible impact this year with more of an eye towards outer years of seeing that start to take hold.

Got it. And Karen, just as you kind of look at and reevaluate, the things that are happening in your market versus the things that you feel like need to be reshuffled internally, and you had new sales leadership, which maybe gave you a fresh look or an opportunity to take a fresh look at some things and that maybe facilitated some of these changes. But I'm just curious, at what point or what gives you confidence that nothing necessarily structurally is changing in your end markets ultimately or the market opportunity. And what can you kind of say to give us confidence that as you reevaluate that that you're confident that it's all about the things that you're doing and under your control and just a way that you're accessing this market. Thanks.

Yes. We obviously look very closely at the potential and opportunity we see at the account and at the territory level for all of our reps and one piece that we've added into the disclosure. So we've put here that we've started reporting in the last couple of quarters is that 10% of our active accounts delivered 35% of our revenue. And those are good accounts, but they're not unique. It’s roughly 80 accounts. It's not the – there's nothing unique about those 80 accounts that we can't duplicate it more centers. And so what we do is see that there's significant potential to expand our existing active accounts of like sizes to be like that 10% where we've already developed that penetration. In addition, in the top – that top 10%, we still see continued growth, and when you look at them, it’s a small number of surgeons, usually early-adopter surgeons even in those best accounts. So we have room to expand those even further and keep raising the bar of what that top level performer is. So that's why we look at it and say, we're still at the early stages here. We don't see things that give us concern that there's a market limitation. It really is that we need to continue to be able to execute and move through the conversion process, stay focused in trauma, not get distracted with some of these other exciting areas like breast neurotization and OMF, but to stay focused in the trauma to put the hard work and effort into really getting these surgeons to convert what they're doing. And we believe that's the best approach to continue to realize the value out of these accounts.

Got it. One more, is there a price increase assumed in your outlook for 2020 and how much? Thanks.

Yes, we take a price increase or have taken a price historically in the first quarter. We are doing that again this year. We've assumed, however, that that price increase will be low-single digits. Just with anticipating that as we get into larger and larger accounts that there will be more price pressure for some discounting and so we've assumed a low single-digit pricing.

Thank you.

Thank you. Our next question comes from David Turkaly with JMP Securities. Please state your question.

Hi. This is actually Dan on for Dave. Thanks for taking the questions.

Hi, Dan.

So just first off, you mentioned operating margin should see some improvement in 2020, so we were just wondering if you could give us any color on where you expect to see this benefit on the P&L and how much of an impact this can make to the net income line? Thanks.

Well, I don't think I'll quantify it, but I'll certainly indicate that we're going to continue to make investments across the organization, but we've been moderating that spending growth. You'll see leverage in G&A, certainly in sales and marketing across the year. You've seen us continue to grow the R&D line. The R&D as a percentage of revenue is higher than it was a year-ago. It's going to continue to be at this higher rate because we've got some additional clinical work that we are initiating and we will continue to do an additional work in product development. So you'll see the leverage across sales and marketing and G&A. And we're not quantifying that, but you'll certainly see improvements in operating margin across the year.

Okay, great. That's helpful. And then just to follow-up, touching back on the splitting of territories, long-term this should drive productivity improvements, but could you just give us an idea of the amount of time it takes to transition a region through a split as well as how long it takes to see productivity ramp back up in these areas? Thanks for questions.

Yes. When we talk about bringing in a new rep, we still see that we assume nine to 12 months before they really start to get effective and start to see that ramping. So the rep who has been with us for a while and is keeping a portion of the territory, there will be a short-term disruption as they split things and work their work patterns. But the real impact is on the new person coming in and picking up the second half and it will be about a 12-month disruption in that split portion of the territory.

Great. Thank you.

Thank you. Our next question comes from Ryan Zimmerman with BTIG. Please state your question.

Hi, thanks. This is Sam on for Ryan. Just to start out with, I know it's early, but first quarter with updated CMS reimbursement for nerve repair, can you kind of characterize any change in usage patterns you're seeing based off of this?

Yes. It's still too early to see anything. Remember, Medicare is a very small amount of traumatic injuries, – trauma happens to be a young person injury, more often than it is anybody who's in the Medicare ranks. So we don't see a tremendous impact at this point. It's more around the commercial payers start to adjust and follow the structure that we think we'll see a bigger impact.

Okay. And then on the gross margin lines, some year-over-year decline there. How should we think about this going into FY2020? And can that contribute to that operating margin expansion? Or should we expect to see pressure there?

Yes. No, we said in our prepared remarks, we do have some increased processing costs. As we get larger, we've got additional costs in our current production facility. And in addition to that, we had a one-time event in the quarter where we ended up having to take some additional reserves on inventory primarily on some preprocessed donor tissue inventory. Not a significant issue, but it was, obviously, as notable in the quarter. But that's not something we would expect to go into the future. But we do see and have seen some increasing costs in the organization as we continue to build out the organization and prepare for growth.

Great. Thanks.

[Operator Instructions] Our next question comes from Kyle Rose with Canaccord Genuity. Please state your question.

Great. Thank you very much for taking the question. So I just wanted to follow-up just a little bit on some of the commentary around the 10% of accounts or the 80 accounts that represent the 35% of revenues. Just maybe if you could give us some historical context there as far as how long it takes some of those accounts to get to some of those high-performing levels? And then also maybe your success at driving accounts towards those levels. Was it – last year, was it 60 accounts that were driving that same type of revenue mix and you're able to drive 20 accounts higher? I guess, just trying to understand truly what's happening on an account basis to make somebody contribute that much relative to some of the other accounts, the other 700 accounts that you're hoping to walk up that type of productivity curve as well?

Yes. We noticed that this measure of the top 10% of our accounts yielding 35% of our revenue has been in place for a number of quarters, so that's not something that just popped in, in fourth quarter. Pretty much through the last year and then to the year before we saw the same sorts of trends, which does mean that we've added additional high-value accounts and these accounts have continued to grow. In terms of how long they take, I would say, it varies. It is interesting and obviously we look at that because we would like to see more accounts grow quickly, like we see with some of the accounts in that top 10%. It really looks at the speed at which a surgeon can go through their treatment algorithm and expand their usage to become a confident champion of AxoGen products. And so for us, it's around continuing to go back and getting them to add in that next step in the algorithm. And so the work for the rep is to make sure that they keep going back and identifying gaps in their usage and have them try that, follow their results and add that into their treatment. So for example, most surgeons will start with digital nerve injuries. We want to get the outcomes from those digital nerve injuries, but then continue to work our way up the arm with more and more complex injuries and that's the work that the rep does. So we want to make sure that the rep is doing that as rapidly as possible and the surgeon hopefully engages to pull in patients to do that as quickly as possible. It's still not months. Again, nerves heal slowly. So this pipeline is generally years, but you can go faster than – in some cases than others with that constant push with the rep to work with the surgeon to move through the algorithm.

Great. That's very helpful. And then I just wanted to circle back on one of the previous questions regarding sales force productivity and just kind of what's assumed with respect to the guidance this year? Maybe just also can you provide a little color on – you've made some significant increases in the sales force over the course of the last two years. Help us understand here, what's gone right in those productivity ramps of those cohorts, the last 12 and 24 months? And maybe how that's informed to the hiring when you think about 2020, whether it's the different training programs or the different types of reps you're trying to go target. How has that changed – how has the last 24 months changed? How you think about the rep hiring in the productivity?

Yes. I think we've done some very good things to give the new reps that we're hiring a solid foundation in nerve repair. And so we've increased both our clinical training as well as our sales direction on how to sell in nerve repair. We're a very technical sell, but we still need to be able to approach surgeons and understand what their issues are and help them to solve their issues. That's really what our job is in working with the surgeons. So I think we've really improved our sales training to approach it as a partner to the surgeon in trying to solve their patient issues. I think we've also done a very nice job of clarifying and standardizing what we're looking for in new people that we're hiring to make sure that we are consistent in the type of talent that we're recruiting. And I think that shown in the sales associates that we continue to bring in. Even in this more competitive job market, we have not seen challenges in hiring people and we've been able to hire to the profile that we've identified that we think create somebody who wants to really make change happen and focus on changing their territory. And so I think we've got a profile of a rep that works so that they can meet that need.

Great. Thank you for taking the questions.

Thank you. Ladies and gentlemen, there are no further questions at this time. I'll turn it back to management for closing remarks. Thank you.

Thank you, Diego. I want to thank everyone for joining us on today's call and we look forward to seeing many of you at Investor conferences in the weeks ahead. We'll be in attendance at the SVB Leerink Global Healthcare Conference in New York City later this week, followed by the Barclays Global Healthcare Conference in Miami on March 10, and the BTIG Medical Technology Conference in Snowbird, Utah on March 19. Thank you very much.

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