AxoGen Struggling Through A Protracted Restructuring (NASDAQ:AXGN)

Small-cap med-tech AxoGen (AXGN) already had plenty of long-running challenges to deal with before the pandemic, and the decline in elective pressures has only added to the challenges and pressures. While AxoGen’s core product offers what I believe to be meaningful advantages over autografts and synthetic conduits, the company’s sales effort became too aggressive and too unfocused too early, and the company has had to retrench around its core opportunities in trauma – a process that was already wearing out investors’ patience before COVID-19 came onto the scene.

AxoGen is a good case-in-point regarding the risks and challenges of a small company trying to disrupt established surgical practices. I don’t want to push the similarities too hard, but investors can look at AtriCure (ATRC) as an example of how long it can take for these stories to work. I do believe AxoGen’s products are superior, though, and I believe that clinical data will eventually win over more surgeons. These shares look undervalued today on both discounted free cash flow and EV/revenue, but AxoGen is going to need time to win back investor confidence.

Improving Procedure Counts Drive A Significant Boost To Guidance

As the primary market for AxoGen’s nerve repair products (the Avance allograft, mainly) is in trauma, and trauma procedures are by no means elective, AxoGen has been hurt less than many med-tech companies by the COVID-19 shutdowns and elective procedure deferrals. Where many companies have seen 25% to 40% (and sometimes greater) declines in revenue on procedure cancellations and deferrals, AxoGen saw a 4% decline in the first quarter followed by a 17% decline in the second quarter.

While AxoGen isn’t as driven by elective/scheduled procedures, that isn’t to say it has no impact. Likewise, with people out and about again, trauma cases are starting to normalize. With those improving procedure counts, AxoGen recently (September 15) raised guidance for the third quarter, expecting “at least $30 million” revenue versus the prior guidance for “below year-ago” revenue for the quarter (< $29 million) and a sell-side average estimate of $23 million. Interestingly, it doesn’t appear that the sell-side average estimate has moved since the update, so investors may want to prepare themselves for a somewhat muted market reaction to what would otherwise look like a big beat to published estimates.

With this updated guidance, Axogen is close to returning to the pace of performance initially expected before COVID-19 came onto the scene. Management had originally guided for 16% to 20% growth in 2020, a range with a midpoint of $126 million, or about $31.5 million per quarter. While active accounts have declined during the pandemic, I believe we’ll start seeing a strong rebound toward the end of 2020.

Waiting For RECON, While RANGER Continues To Support The Basic Thesis

Earlier this summer, management announced that it had completed enrollment in its 220-patient RECON study that compares the Avance graft to nerve cuffs in nerve gap repair. The point of this study is to demonstrate non-inferiority in return of sensation, with secondary endpoints including quality of life measurements. Management expects to have preliminary data available in Q2’22 and file a BLA with the FDA in 2023.

RECON is significant not only for the potential to add to quality of efficacy data for Avance, but also for competitive moat-building reasons. As the potential reference product under the BLA process, AxoGen would enjoy 12 years of market exclusivity and could potentially receive stand-alone reimbursement; biologics have historically been able to get cost-plus-6% standalone reimbursement, but the reimbursement world is always in flux, so I believe the primary advantages will be data quality (a randomized, evaluator-blinded study) and the potential window of exclusivity.

In the meantime, the RANGER registry continues to accumulate data on the performance of Avance, showing meaningful clinical utility. In a wide range of patients, some with gaps of 70mm, Avance has shown an overall meaningful recovery rate of 82%, with a roughly 6% improvement over autografts and a 17% improvement over conduits.

It is worth remembering that Avance isn’t necessarily meant to be significantly superior to autografts; the main advantage versus autografts (taking pieces of a nerve from the patient) is eliminating the need for a second surgery (and the concomitant pain, infection risk, and cost) and eliminating the loss of sensation or pain from the graft harvest site. While conduits also eliminate the need for that harvesting procedure, AxoGen has thus far shown meaningful superiority to that option.

Trying To Rebuild The Base

I believe AxoGen management got a little too carried away with the potential of its nerve repair products a few years back, spreading the company’s resources too thin when the core trauma market was still significantly under-penetrated. While AxoGen has a strong core of surgeons who use the products frequently (10% of the active base drives 35% of revenue), getting new surgeons to use the product and getting “casual” users to them more has been challenging. This isn’t rare for a company in AxoGen’s position – surgeons will often do their own “mini-clinical trials” and will wait to see the long-term outcome of initial procedures before expanding their use.

The company has since retrenched around that core trauma opportunity ($1.6 billion to $1.9 billion in the U.S.), while also opportunistically looking to grow the breast recon (neurotization) and oral/maxillofacial market. The Sensation-NOW registry study for breast recon should help that market grow over time, but for the next couple of years, management needs to demonstrate to the Street that it can not only add active accounts in trauma, but drive meaningful utilization growth beyond that small core user base.

This process has been going on in earnest for over a year now, and COVID-19 has clearly created delays and complications, and I believe a lot of institutional investors have lost patience with the story and left for greener pastures. Although success is by no means guaranteed, I’ve been covering med-tech for over 20 years now, and good data usually (but not always) wins in the end.

The Outlook

AxoGen should regain some momentum in the second half of 2020, but for all intents and purposes, this is a lost year and I believe revenue and cash flow will likely approximate the year-ago numbers. I do believe growth can reaccelerate in 2021, though, and beyond that we will see if AxoGen’s refocused sales efforts, and the growing body of positive clinical data, will finally drive the expected improvements in utilization.

I’m expecting roughly 20% annualized revenue growth from 2020 to 2024 and high-teens growth (17% to 18%) for 2020 to 2030. I model cash flow break-even around $200M in revenue, double-digit FCF margins at around $300M, and 20% margins at over $500M.

The Bottom Line

AxoGen has not worked out the way I expected, with the shares down about 70% since my first positive article, and down significantly since my last update (underperforming the space by about 50%). Although the clinical data remain compelling to me, the sales force execution and market development simply haven’t been up to snuff. Between both discounted free cash flow and growth-based EV/revenue, AxoGen still looks undervalued, but the execution risk is extremely high.

The shares currently trade at around 3x forward revenue, well below the 6x or so that its expected growth would normally get, not to mention the 7-10x multiple that popular growth med-techs can get. That amply reflects the significant skepticism around AxoGen’s commercialization plan, but it also represents a significant opportunity if the restructured sales effort can produce results in 2021 and beyond.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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