AxoGen, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. The September 30 merger of LecTec Corporation and AxoGen Corporation resulted in LecTec changing its name to AxoGen, Inc. For accounting, AxoGen Corporation was the acquirer; historical comparative results are primarily AxoGen Corporation’s, so the periods are not fully comparable to the post-merger company. The quarter’s results include LecTec only after the merger closing.
Business context and financial performance
- AxoGen develops and sells products for peripheral nerve repair and regeneration, including Avance Nerve Graft and AxoGuard products. Management attributed sales growth mainly to deeper penetration of key accounts through direct sales and independent distributors.
- Q3 revenue: $1.141 million, up 42.5% from $0.801 million in Q3 2010. Nine-month revenue: $3.488 million, up 58.8% from $2.196 million.
- Gross profit: $10,000 in Q3 2011 versus $640,000 in Q3 2010; gross margin was approximately 0.9% versus 79.9%. For the first nine months, gross profit was $1.594 million versus $1.660 million, with margin of approximately 45.7% versus 75.6%.
- Q3 included a $614,000 write-off of expiring inventory and a $214,000 raw-material obsolescence write-off. Management also cited product mix and higher processing, testing, travel, and temporary labor costs after restarting Avance manufacturing in January 2011.
- Operating loss: $2.626 million in Q3, compared with $879,000 in Q3 2010; $4.980 million for the nine months, compared with $3.033 million. Net loss: $3.113 million in Q3 and $7.082 million for the nine months, versus $943,000 and $2.643 million, respectively. Q3 loss per common share was $2.60; nine-month loss per share was $6.49.
- Q3 operating expenses were $2.637 million, up 73.6%; nine-month expenses were $6.574 million, up 40.1%. Increases reflected sales-force and marketing expansion, hiring, merger-related professional costs, and funding-related expenses. Interest and deferred-financing-cost expense also increased.
Cash, liquidity, and debt
- Cash and cash equivalents were $10.526 million at September 30, 2011, versus $1.799 million at December 31, 2010. The merger brought in $7.202 million of cash.
- For the first nine months, operating activities used $4.891 million of cash; investing activities provided $7.148 million, principally from cash acquired in the merger; financing activities provided $6.469 million. Cash increased by $8.726 million. The filing gives nine-month, not standalone quarterly, cash-flow figures.
- Working capital was $11.413 million and the current ratio was 7.89 at September 30, compared with a $4.120 million working-capital deficit and 0.56 current ratio at year-end 2010. The change was primarily merger-related.
- At September 30, long-term debt was $5.0 million principal, shown net of $173,736 unamortized discount as $4.826 million. The new MidCap facility bears 9.9% annual interest, has a 42-month term, and requires interest-only payments for 12 months followed by principal and interest payments. It is secured by company assets and includes minimum net-invoiced-revenue requirements and other covenants. The former $7.5 million loan was paid off at merger closing; convertible debt was converted or retired in connection with the merger.
- The company issued 423,709 common shares at $2.36 per share, raising approximately $1.0 million for working capital. Management said it believed available cash would meet liquidity requirements for the next 12 months.
Material changes, outlook, and risks
- The merger materially changed the balance sheet, capital structure, and reporting entity. Former AxoGen Corporation shareholders held approximately 56.8% of shares after closing; LecTec shareholders held 39.4%. The company reported 10,949,812 common shares outstanding as of November 14, 2011.
- Management planned to broaden sales and marketing efforts, increase production efficiency, and continue growing sales. It expected salaries and related costs to rise as it expanded its sales force and other staffing. No quantified revenue or earnings guidance was provided.
- License agreements carry product royalties of 1%–3%, subject to a 3.75% royalty cap in certain cases. One agreement includes potential maintenance fees beginning in 2012 if regulatory milestones are not met, and a potential $64,000 fee tied to specified partnering activity or a term sheet. These conditions and milestones merit monitoring.
- The filing says investment in the company remains high-risk and incorporates previously disclosed business, regulatory, and intellectual-property risks. The secured loan’s revenue covenants, operating cash use, inventory expiry and obsolescence, and the ability to sustain growth and improve gross margins are important exposures.
- The 2010 comparative nine-month results were restated: a $1.119 million gain from terminating a distribution agreement was moved from 2009 into Q1 2010 because the release was not executed until February 2010. No legal proceedings were reported. Management concluded disclosure controls were effective as of September 30, 2011.
- The debt disclosures contain an inconsistency: the debt note states the repaid former loan bore 18% annual interest, while MD&A says 18% “per month.” The loan had been paid in full by September 30; investors should verify the stated historical rate against the underlying agreement.
Important facts for investors to verify
- Whether the exceptional Q3 inventory write-offs are nonrecurring and whether manufacturing costs and gross margins recover.
- Whether revenue growth from key accounts translates into improving unit economics and sustainable operating performance.
- Cash runway under continued operating cash use, and compliance with MidCap’s minimum revenue and other covenants.
- The merger’s accounting, post-merger share count and dilution, and the effect of the acquired company on future comparisons.
- Potential license maintenance or partnering fees, royalty obligations, and progress toward applicable regulatory and commercial milestones.
- The former loan’s interest-rate disclosure inconsistency and the complete terms of the current secured facility and its prepayment provisions.