Alphatec Holdings, Inc. Q3 FY2024 Earnings Call

Good afternoon, everyone. And welcome to the webcast of ATEC’s Third Quarter Financial Results. We would like to remind everyone that participants on the call will make forward-looking statements. These statements are based on current expectations and are subject to uncertainties that could cause actual results to differ materially. These uncertainties are detailed in documents filed regularly with the SEC. During this call, you may hear the company refer to non-GAAP or adjusted measures. Reconciliations of non-GAAP measures to US GAAP can be found in the supplemental financial tables included in today’s press release, which identify and quantify all excluded items and provide management’s view of why this information is useful to investors. Leading today’s call will be ATEC’s Chairman and CEO, Pat Miles; and CFO, Todd Koning. And now, I will turn the call over to Pat Miles.

Thank you, Kathleen. We had a fantastic Q3 and I'm very excited about our progress. We have once again outpaced all competitors in the spine sector by at least double. I anticipate continued growth. Our main goal is to sustain profitable growth. In Q3, we achieved $151 million in total revenue, reflecting a 27% increase. Surgical revenue grew by 30%, indicating significant volume with a 20% increase in surgical volume, and a 9% rise in revenue per procedure, alongside a 19% increase in new surgeon users, which is encouraging. We conducted over 200 surgeon training engagements, launched EOS Insight, and reached a record number of orders for the year. Profitability remains strong with adjusted EBITDA of $7.4 million and a more than 50% reduction in cash burn sequentially. We are on track to generate cash by Q4 ‘24 and have increased our term loan capacity by $50 million, which is beneficial. Our focus is on creating value and generating cash. As a company centered on spine, our intention to create value is clear, achieved through various approaches. We have consistently been leaders in revenue generation for five consecutive years, demonstrating our ability to drive this forward. We've seen three years of organic growth exceeding $100 million, and our procedural strategy is proving effective with high average selling prices, a 20% increase in surgical volume, and strong growth in new surgeons. Our sales team continues to expand rapidly, laying the groundwork for future growth. I'm excited about our guidance of 25% growth for ‘24, following a 27% growth in Q3 and 26% year-to-date. We're very confident in our leadership in ongoing revenue growth over the past five years. Increasing profitability is critical, and we've achieved three consecutive quarters of stable operating expenses, with adjusted EBITDA exceeding expectations for the second consecutive quarter and an implied adjusted EBITDA margin of 10% for Q4 '24. Improving asset and inventory efficiency will significantly impact profitability in this people-driven business. We are strategically focused on investing in our people. If you work in sales or product development, we see you as valuable to our team. We are streamlining our organizational structure to be efficient. We are closer to our end users than ever before. All these factors will positively impact cash flow. We have the infrastructure to scale our business effectively. We possess adequate sets and inventory for growth. Our adjusted EBITDA in Q4 ‘24 will keep contributing, and we expect a sustained shift to positive cash flow starting in Q2 ‘25. We appreciate the flexibility provided by the $50 million increase in our term loan and are pleased with our partnerships. We remain committed to reaching our long-term financial goals. We aim to achieve $1 billion in revenue by ‘27, with an adjusted EBITDA of $180 million, an 18% margin, and free cash flow of $65 million. Our commitment to fulfilling our long-range plan remains unchanged. Now, I’ll turn it over to Todd for more financial details.

Thank you, Pat. And good afternoon, everyone. We appreciate you joining us today. I'll begin with revenue. Third quarter total revenue was $151 million, up 27% compared to the prior year and up 4% sequentially. The $151 million in revenue was comprised of $135 million in surgical revenue and $15 million of EOS revenue. Third quarter surgical revenue of $135 million increased $32 million, 30% growth over the prior year. Procedural volume growth was 20%, a reflection of strong surgeon adoption and utilization. We saw strong contributions across the portfolio, particularly in our lateral and expandable implant technologies, which contributed to the 9% growth in average revenue per procedure. Third quarter results grew $5 million sequentially as we benefited from the increased product availability and new territory additions. EOS revenue in the third quarter was $15 million, up 7% compared to last year. Notably, our year-to-date EOS order volume has been the strongest we've ever seen, which is encouraging for Q4 and 2025. Next, I'll turn to results for the remainder of the P&L. Third quarter non-GAAP gross margin was 69%, down 60 basis points compared to the prior year due to the impact of product mix. Third quarter non-GAAP R&D was $13 million and approximately 9% of sales compared to $13 million and 11% of sales in the prior year. We continue to invest in innovation and future growth of the business while top line growth drove 250 basis points of leverage. Non-GAAP SG&A was $100 million and approximately 67% of sales in Q3 compared to $80 million and 68% of sales in the prior year, an improvement of 150 basis points. Now included in this period's SG&A is a step in depreciation related to the purchase of instrument sets. As a percent of sales, depreciation increased about 180 basis points year-over-year. So excluding that impact, SG&A improved 330 basis points, driven primarily by infrastructure leverage. Total non-GAAP operating expense amounted to $114 million and approximately 75% of sales in the third quarter compared to $94 million and 79% of sales in the prior year period, demonstrating 390 basis points of operating leverage year-over-year. And in the third quarter, we achieved our second consecutive quarter of positive adjusted EBITDA, which was $7.4 million, a 5% margin. That compares to a loss of $400,000 and 0% of sales in the prior year, a 530 basis point improvement. Drop through of the year-over-year growth in revenue dollars to adjusted EBITDA was 24%. Adjusted EBITDA improvement was driven by 330 basis points of SG&A leverage and 250 basis points of R&D leverage, slightly offset by 60 basis points of gross margin impact. The chart on the next slide depicts the deliberate substantial profitability execution that we have demonstrated since the beginning of 2022. Adjusted EBITDA has increased from a loss of $13 million and 18% of sales to a contribution of $7 million and 5% of sales here in the Q3 of 2024, a 2,300 basis points improvement. The drivers of that progress have contributed as we expected with the improvement driven by variable selling rate followed by SG&A infrastructure leverage and R&D leverage. In fact, our non-GAAP operating expenses have been flat sequentially for the last three quarters, resulting in adjusted EBITDA growth and guidance that implies Q4 adjusted EBITDA of $17 million or 10% of sales. The considerable margin expansion that the business has produced gives us great confidence in our ability to deliver on our financial commitments and translate revenue growth into cash generation. Turning to the balance sheet. We ended the third quarter with $81 million in cash and the carrying value was $538 million. As we begin to move past the phase of intense growth investment, we reduced free cash use in the third quarter by over 50% sequentially to $21 million. That was net of approximately $30 million in cash that was directed toward inventory and instruments to support distribution expansion and new product launches. The chart at the bottom of this slide depicts the linear progression towards cash generation as we exit 2024 with the improving cash use trend from Q1 leading to an inflection in cash generation in the fourth quarter. The improvement from the third quarter to the fourth quarter is primarily driven by reduced instrument and inventory spend and an increase in adjusted EBITDA, partially offset by working capital. We continue to expect cash used to range between $125 million and $135 million for the full year of 2024. In conjunction with the financial results released today, we announced an increase in our term loan of $50 million, bringing the total term loan to $200 million. Through this transaction, we have added another strong lending partner in Pharmakon. The key terms of the loan are the same as the original facility bearing an interest rate of SOFR plus 5.75% and interest-only payments until its maturity in 2028. With this incremental capital, our pro forma cash at close is $128 million. Upon close of the transaction, we used proceeds to pay down our revolver balance. Exiting the year, we expect to have access to cash and liquidity of $145 million, which we believe provides us with ample liquidity going into 2025 where we expect to be cash flow breakeven. I'd also like to share our thoughts for the $316 million convertible notes that mature in August 2026. While we won't rule out doing a convert if the equity is at the right price, we expect the material improvement in EBITDA over the next few years to allow us to refinance without dilution. As we progress towards our 2027 long-range plan financial targets when we expect a $1 billion in revenue with 18% adjusted EBITDA margins and cash flowing, the company will have a different level of access to financing alternatives. Turning to our increased outlook for the full year 2024. The strong surgeon adoption and large volume of surgeon training are great indicators of durable revenue growth and are a testament to the ATEC clinical distinction. We expect total revenue growth of 25% to approximately $605 million. That includes surgical revenue growth of 28% to approximately $540 million and EOS revenue of approximately $65 million. That implies surgical volume grows at a high teens rate and revenue per surgeon growth at a high single-digit rate for the full year. Sales growth is powering leverage, and with the third quarter adjusted EBITDA outperformance, we are raising full year adjusted EBITDA guidance to approximately $27 million, which equates to 640 basis points of margin expansion. That implies a 30% drop through of the year-over-year growth in revenue dollars, a material acceleration compared to 22% drop through in 2023. We continue to expect cash used to range between $125 million and $135 million for the full year 2024. Our expectations for cash flow breakeven in 2025 remain unchanged. We expect the cadence next year to include seasonal cash used in the first quarter, followed by positive free cash flow in quarters two through four. I'll close today with reinforcing how well we are positioned for growth in 2025 and why that translates to cash flow breakeven. When you look at this year, our adjusted EBITDA is expected to be $27 million. We will have invested $140 million in CapEx and inventory and $17 million in interest and other working capital. In 2025, our expectation is that we will have $70 million of adjusted EBITDA consistent with our long-range plan assumption. Because we come into the year with an asset base from the 2024 investment that will support 2025 revenue growth, the required investment effect in inventory in 2025 is $50 million. We will also expect to see a step up in interest and other working capital to $25 million. That all adds up to a cash flow breakeven year. We recognize that execution on cash generation is crucial to rebuilding shareholder value. As such, we are focused on growing revenue and expanding profitability to generate cash, which has informed how we are attracting investments and the realignment of internal resources. Those efforts are complete and strengthen our position as we progress towards cash generation. Our organization has a lot of work to do and a lot to be excited about. As we seek to rebuild shareholder value know that this leadership team is confidently aligned. We know what needs to be prioritized and the work is underway. With that, I'll turn the call back over to Pat.

Thanks, Todd. Our best days are ahead of us. We are focused on long-term value creation and improving this environment to establish clinical distinction. This means setting ATEC apart through our procedures and informatics. I believe we are making good progress on that front. We are also working on compelling surgeon adoption and enhancing surgeries to attract more surgeon users. There is ample opportunity in the spine business, and we are excited about the engagement required to make it happen. Additionally, we aim to expand and elevate our sales force by strengthening teams and improving our operations. We have insights that others might not, which is reflected in our recent experience at the North American Spine Society meeting. Five years ago, Dr. Clemente presented our prone transpsoas approach to a sparse audience, but this year, the room was packed for his PTP demonstration. We have conducted thousands of surgeries and continue to learn from them. We are still in the beginning stages of our lateral reconstructive spine surgery journey, with plenty of future opportunities. This image serves as a reminder of our historical performance and our following in lateral probe surgery. There is a lot of work ahead, but this reflects who we are and how we differentiate ATEC in this space. We further distinguish ourselves by investing in our approach, integrating informatics to enhance precision and minimize neural complications, as seen with SafeOp, while also increasing predictability through EOS. We are attracting new users with our informatic platform, leading to more opportunities for application and utility. This translates into increased complexity with procedures like corpectomy and multilevel deformity, signaling a wealth of activities in the lateral sector. We are confident in our ongoing growth prospects, as this is the fastest-growing segment within thoracolumbar spine. Similar to NASS, the SRS meeting was also crowded, highlighting enthusiasm for our AI-informed EOS Insight's potential impact on spine deformity treatment. ATEC possesses the only AI-informed automated tool that aids clinical decision-making, which plays a crucial role in mitigating variability. This tool enhances decision-making that is reflected in our implants. The launch of EOS Insight converts invaluable imaging into actionable information. Early adopters are very positive about this technology, as it offers crucial insights for improved surgical outcomes. From pre-op auto-alignment in real-time to 3D surgical planning and patient-specific implants, along with intraoperative alignment and objective post-op data, this tool excites us, as it represents future growth. EOS Insight streamlines our workflow and improves our outcome tracking—automation is key, as past inconsistencies in capturing outcomes were due to a lack of automation. We are thrilled about the progress. We are also seeing a 19% increase in surgeon users, with training for over 200 surgeons, indicating a strong desire to join our company. Our focus on yield means that as more surgeons come in, we generate more users, which enhances our business impact. We remain committed to driving clinical predictability through improved training, which is a key growth indicator. Education and training are cornerstones of our approach to prepare surgeons for applying our clinical distinctions, fueling our growth leadership. Moving on to the sales force, we have strong confidence in our growth leadership, based on both current and incoming personnel. In examining our sales demographics, lateral business accounts for 30% of our top 10 agencies, a mix that we believe is well-protected by our technology suite, compared to 13% of our U.S. lateral share. This shows a significant advantage for our top performers. We have achieved a 25% growth rate in established territories, indicating strong momentum among our current team. In benchmark markets, our market share is 25%, significantly higher than the 5% seen in most areas, which is a robust indicator of potential growth we have consistently demonstrated for five years. Confidence is bolstered by strong growth in established territories and our expansion strategy into new U.S. territories. We are investing in inventory for 2024, ensuring that our resources are utilized effectively. Our recent agent meeting indicated exceptional alignment in our efforts moving forward. We are excited about attracting new talent to expand our U.S. footprint. The undeniable truth is that spine surgery needs ATEC. When looking at the revision rates in our field, it becomes clear that new entrants lack impact. We are taking an aggressive approach to improve the state of spine surgery and expect to increase our market share from 5% to low double digits in the coming years. We are extremely optimistic about what we are building. With that, I will turn it over for questions.

And your first question comes from Brooks O'Neil of Lake Street Capital Markets.

Thank you very much, and congratulations on a terrific quarter, guys. I have one question for you and that is, appreciate your enthusiasm, appreciate your track record, but investors still seem to believe you're going to outspend your resources. How can you convince us that that is not going to happen?

Let me start and then I'll let Todd jump in. And so the one thing that I will tell you is we are committed to building a monstrosity. And to build a monstrosity, you have to be self-funding. And when we start to demonstrate consecutive quarters of flat operating expenses, when we start to talk about adjusted EBITDA above expectations, when we start to talk about breakeven next year. And I got to tell you, we're taking kind of the internal, not kind of, we're taking the internal moves necessary to make sure that we're streamlining the organization. If people and sets and inventory are the spend profile of these companies, we're narrowing the spend profile associated with people. We've done that internally. We've made challenging moves. We're getting closer to the business. But also as it relates to the efficient utility of the assets, we've made a ton of progress in that realm. And so when I start to think about leverage, those are the areas that I think about and I see this stuff happen in real time and it provides me significant content.

Brooks, I'd like to add that this is fundamentally a growth-focused business. This growth is producing additional profitability measured through adjusted EBITDA. As we reflect on our recent efforts to streamline the organization, we've conducted a thorough review of our operations to eliminate unnecessary spending and significantly reduce overall expenditure in that area. We're being very strategic and careful about how we allocate our resources while also decreasing our resource consumption. Looking ahead to next year, this approach gives us confidence in our ability to continue expanding our profit margins. This is one reason I outlined the trajectory of adjusted EBITDA we've observed over the past two to two and a half years—it's been a systematic journey of increasing EBITDA margins. This has occurred due to the way we've structured the company and assures us that we can keep expanding those profit margins into 2025 and beyond. Regarding our investments, a significant portion will be directed towards sets and inventory. As mentioned in the call, we've invested substantially in these areas for 2024, and the existing inventory and sets will support growth in 2025. Consequently, we anticipate needing around $50 million for sets and inventory in 2025. When considering cash flow, we project $75 million in adjusted EBITDA, with about $50 million allocated to sets and inventory, alongside an increase of approximately $25 million in working capital and interest expenses. This positioning will help us reach breakeven, which is a source of our confidence. Looking into next year, we'll have a strengthened balance sheet that enhances our assurance in executing our outlined strategy.

Your next question comes from the line of Mathew Blackman of Stifel.

Maybe Todd, if I could start with you, just a couple of housekeeping questions. And we're asking this to everybody this quarter, so not saving it specifically for you. But anything notable in terms of hurricane exposure? And you've also been hearing some anecdotes of institutions delaying elective procedures due to the IV solution shortages. So just I appreciate any impact from both would be transient, but are you or what are you hearing from the field, if anything? And is there anything baked into the implied 4Q guidance as a headwind? And then I've got one follow-up.

As it relates to hurricanes, really no impact in the third quarter. And while we did see a little bit in the first half of the month, we're seeing that recover now. So really our guidance assumes that we're going to catch up all of that, and we feel very good about that as a base case. And so I think that's from a hurricane standpoint. And really no impact we're seeing on the IV side. And maybe Pat, you can give your perspective on elective surgeries and spine surgery and how that's probably less elective than maybe people think.

Yes, no impact.

I also think the deductible for now also works in everybody's favor here…

Could you elaborate on the current productivity of new representatives and distributors? You've provided a lot of useful information in the slides, but could you provide some context about how they are progressing? Additionally, can you confirm that the new team members are fully equipped in terms of accessing both sets and a wide range of implants?

Let me share some insights, and Todd can provide the objective details. It's interesting that we have inventory available. We often find ourselves transitioning from a group that wasn't effective to a new one. This shift means we leave behind unproductive business and start fresh, but it doesn't all happen immediately. We're building the sales force we envision, which I still find to be very capable, though effective in certain areas. Some geographies are more established and reflect the company's growth, while others are just beginning. What keeps me optimistic is that same store sales are increasing as we expected, and we haven't even factored in the new areas that are starting to pick up. This ramp-up can be uneven, as we lose revenue from the previous distributor or group and gain access to new opportunities. I've mentioned before that this business typically operates over a 12 to 24 month timeframe, so the investments made in new personnel won’t show results for some time. However, we are seeing consistent same store performance and an increasing engagement from the new team members.

And Mat, I would add to that. We've been adding coverage continuously for the last six years, however, long we've been doing this. And so we're seeing the investments we've made over the last 12 to 18 months begin to contribute. I think one good example of that is just the $5 million sequential step up Q2 to Q3. Clearly, some of that was product contribution but also some of that was the reflection of those investments beginning to ramp in an easier way. And so I think that's a good proof point for the effectiveness of the investment in those territories.

And just to add something to that. I just think it is relevant is, somebody will come on and they will have a non-compete, either they will sit out or will do something whereby they operate in a different territory. So it's everything from somebody coming on, having a non-compete, serving a non-compete, entering into a different geography that first 12 months and then coming off a non-compete. And we only see a little bit of a boost after that. And so it's one of these things where there's so many puts and takes to these things, like it's tough to provide you the exact because, again, there's a lot of different ins and outs as we continue to evolve the business.

But I guess the point is is that we're ramping up that productivity curve and we still have a ways to go…

We still have a long way to go. Yes, we are a small player in this business with a 5% market share and 95% still to capture. However, we are clearly growing rapidly. I have to say, we are the center of attention. If you look at our procedures with the lateral technology and what we are doing with EOS, it's clear to the industry that we are making significant strides in evolving care, and many want to be part of it.

Your next question comes from the line of Matt Miksic from Barclays.

Nice to see you kind of turning the corner here in terms of cash use and continued growth. One question that I wanted to ask, Pat, is one that I get sometimes often. I think it's sort of part of the Alphatec story as folks look at what's happening with robots, look at where your robot is in the pipeline and ask the question, why isn't competing with a robot today more of a challenge. Maybe if you could talk about your growth drivers today and how the robot and imaging kind of dovetails with that as you get into the 12, 18, 24 month period? And then I have one follow-up.

I appreciate this question because our goal is to significantly impact spine care. If we were to prioritize the challenges and factors affecting spine care, placing screws would not be at the forefront. Currently, the robot assists in placing screws, which I believe is excellent and worth our investment of $50 million in such a tool. What I find extremely valuable is the ability to provide information indicating that the highest likelihood for a patient to improve from this intervention relates to specific pathologies. This allows for informed decision-making and behavior modification by surgeons. I believe this is paramount, and that was the reasoning behind our EOS initiative. It serves as the foundation for an ecosystem that enhances decision-making. In terms of interventions, there is an opportunity to refine the processes within them, which is where robots and navigation come into play. Our focus has been on designing a procedure that follows a step-by-step approach, providing intraoperative information that leads to predictable outcomes—that is our strategy. When you integrate these technologies and build an ecosystem, it's crucial to appreciate the foundation of that ecosystem, which is the EOS image, the most treasured in spine care. Translating that image across the entire experience—from the surgical plan to the actual operation—is essential. Our excitement stems from a significant evolution in spine care because it is necessary for widespread adoption. We are passionate about robotics and navigation and are currently integrating these tools, performing surgeries today with our robotic system. However, the solution lies in the combination of multiple tools rather than relying on a single one. That would sum up my thoughts, and I may not have directly addressed your original question.

And I have one follow-up. Maybe on the way that you're guiding, the way you're thinking about the EBITDA and cash deployment comments that you've made in terms of titrating or the level of deployment and capital and some of the inefficiencies that you had earlier in the year. I guess, how you feel about that and how you feel about where in the bell curve you're sort of guiding us? And what maybe you're doing a little differently in the way you're communicating and planning for Q4, Q1 and going forward?

When you look at how we described our inventory challenges in the second quarter call, we really had a mix challenge more or less. And so the way that works its way out is and if you remember, it was really one of timing where we had stuff we needed at that point, or we did have stuff in the end and we had stuff we didn't necessarily need. And so ultimately, when you grow into a level of revenue that ultimately is supported by the inventory that we have today. So my point being is the inventory that we had in the second quarter and we have today that is less sufficient than it needs to be, that ultimately supports a revenue growth number next year, meaning you don't have to buy a certain amount of sets and inventory to support some portion of next year's growth. And so I think you look at what our expected growth rate is internally for next year. You understand what asset base you have, what asset base or what revenue base that that asset base will support. And you ultimately do the math and you come to the conclusion that about $50 million of investment in sets and inventory is what you need. And so I think our level of resolution and confidence in that is reasonably high given where we are in the planning cycle, knowing what investments we've made and subsequently what assets we have today and where we expect the revenue to come over the next 18 months. And so that's I think the level of confidence that we go into next year with on the asset front. And more specifically to Q4 and maybe the question is, you came in at $21 million of cash use, which was favorable to what you expected in the third quarter. Your cash flow expectation is 125 to 135. Ultimately, we saw some improvement in DSOs in the Q3, which helped us. And as we think about landing the plane in Q4 as it relates to cash flow, ultimately, we're giving ourselves a little bit of room for DSOs to creep back up to maybe in that 50 range, which is still pretty good. And also, we have some incremental cash expense associated with some of the actions we've taken from an operating expense standpoint here in the third quarter or in the fourth quarter. And so that will also play itself out in the fourth quarter. So when you take all of those things into context, our view was, let's stick with the $125 million to $135 million cash used on the full year and all the things that we're doing should give us confidence that we can hit that in a good way.

Your next question comes from the line of Matthew O'Brien from Piper Sandler.

It's a long one, but it is one question, I think we're supposed to be sticking with. So maybe this question is for Todd. Todd, as I look at your CapEx spending the last couple of years and again, it's a long question, so bear with me. But you spent about $80 million in '23 on CapEx. You're going to grow the top line this year about $100 million and $20 million-ish. So call it a 1.6 productivity of that capital, and I know it takes time to get up the curve and all that stuff. But you're adding $130 million this year and you're able to get some level of productivity that's similar to what you see here in '24. Why wouldn't your top line in '25 be something that's greater than $130 million of incremental revenue just based on all the investments that you've made this year? Because as I look at The Street, only modeling things up about $120 million year-over-year, it seems like just based on all these investments, it should be much higher than that.

Matt, if you examine our investments throughout 2022 and 2023, which we discussed in our long-range plan, historically, the rate has been $0.75 for every dollar of growth. The investment in inventory and sets, when combined, requires approximately $0.75 to generate a dollar of growth. This year, in 2024, we're looking at an investment level of around $140 million, which we made in anticipation of a potential revenue increase. Given our current significant growth rates, when we consider our investments throughout 2024 and what we plan for 2025, that totals $140 million plus $50 million. Assuming a growth rate of 7.25, which seems to align with the market, that equates to about $0.80 for every gross dollar. Therefore, our asset base indeed supports a level of revenue growth that exceeds what's currently projected. We will reassess our situation and discuss our guidance for 2025. Your point is well taken that our investments have provided us the asset base necessary to sustain meaningful growth, and we have consistently grown by over $100 million each year for the past three years. Clearly, we possess the assets to maintain that strong growth rate.

Your next question comes from the line of Josh Jennings of TD Cowen.

This is Eric on for Josh. Really strong momentum in the surgeon training front with 200 plus. Just curious about what the conversion rate is on those surgeon trainings. Should we be assuming that the vast majority of those surgeons are going to be added to the ATEC base once they're at your training center and have exposure to your technology? And then secondly, is there anything that you think can be done to possibly improve that conversion rate?

Every one of them is going to be a customer, I'm kidding. It's a great question and I got to tell you, it's one that we ask every day. And I think that when you look at the greater than 200, it's reflective of the perpetuation of the interest in what we're doing. And I think people are at different places in their kind of evolution of surgery and evolution, I think, especially the lateral. Lateral really is kind of the place that people clearly find that that, hey, how do I learn lateral and can I learn it from the guy who created it, Luiz Pimenta. And so what they want to do is they want to come in here, and we have such an unbelievable group of surgeons. So the peer-to-peer experience here is unbelievable. And so we see a high level of engagement as surgeons come. Everybody has a different algorithm in terms of what makes them comfortable to engage in the technique. And so some guys will come in here, they won't do anything. Then we'll do a peer-to-peer at a facility. They'll go to that facility, they'll either watch a surgeon or they'll watch it online. We have some online tools. But every surgeon has a different algorithm of things that they require to ultimately be comfortable on applying the technique to a patient. And so oftentimes it's different for each surgeon. So not to evade the question, but I'm not going to disclose the specific rate. But on the other side, it's one of those things where everyone is different and what we're doing is tailoring each of the different experiences. Part of the effort there is aligning interest. And I think it's making sure that are the right people being invited to come in and are they people that are serious about engaging in the technique. Do we have the sales structure in place in that geography, do we have access to the hospital, do we have the things aligned such that we can ultimately count on someone applying the technique if the comfort level is there. And so those are the ways that you ultimately continue to elevate the yield associated with people coming in. But it's something that I've dealt with over the last 20 some odd years in this business or 25 years in the business. And I wish that there is a predictable algorithm associated with exactly who's going to use and who's not. There just isn't.

Your next question comes from the line of Caitlin Cronin of Cannacord.

I just want to turn to EOS, you noted some record orders. Are these new EOS users or are they upgrades to the newer EOS system in order for those legacy users to use the Insight software specifically? And also just why keep EOS guys the same given the strength in order volumes? Is there a lead time for these volumes that isn't really translating to the Q4?

Todd mentioned that he will take two and I will take one, jokingly suggesting I should take both. There is significant enthusiasm around EOS Insight, and it seems that people grasp the technology's value. The order book for Q3 is impressive and features prominent names in the industry. What excites me the most is how this small ATEC company, which struggled to secure meetings five years ago, is now being recognized by major players in spine surgery purchasing EOS. This highlights our growing access to these institutions, allowing us to expand our presence with our implants. I eagerly anticipate the day we become a well-known player in this space while improving patient care through data from these tools. The vision is clear, and it's reassuring to witness the enthusiasm and engagement surrounding this tool. Comparatively, EOS has a significantly greater impact on spine care than SafeOp, which I also believe is crucial as the entry point to lateral surgery. The use of automated neurophysiology, especially automated SSCPs and MEPs, is essential for advancing lateral surgery. However, the potential of EOS to influence deformity treatment is far more substantial. This is what drives the excitement. We recognize that this is a gradual process. We will maintain a cautious approach in placing new units, as these are installations in new locations rather than upgrades. We are still upgrading existing units, which is encouraging. For revenue recognition, Todd could further explain why this process unfolds step by step.

Ye, it is. And I think, Caitlin, the point is that we've been about $15 million of revenue in EOS for the last probably six or seven quarters or so. And so this Q4 actually, the implied Q4 EOS revenue in our guidance is an $18 million number. And so it is a step-up going from Q3 to Q4. And so I think our comfort with that number is backed up by the level of interest we're seeing in the order book.

Your next question comes from the line of David Saxon of Needham.

I'll just ask one quick one on Valence. I know that's in kind of a friends and family stage launch at this point. So maybe just talk about kind of early feedback you've been getting and how we should think about the cadence from going from a friends and family into a broader launch in 2025?

This is one of my favorite topics. I appreciate that we don't need to maneuver a large vehicle to the operating room to bring in a tool that ultimately helps with screws. With Valence, we have a significantly smaller footprint in the operating room. As I mentioned, we're currently conducting procedures and aim to continually refine it in a way that integrates seamlessly into the surgical workflow. That's where we're focusing our efforts. Looking at the timeline, I'm excited about continuing this refinement until the middle of next year, and then we’ll assess if we're ready to launch around that time. From a footprint, technology, and software perspective, we have a talented team with extensive experience working on this project. Many skilled software professionals in our team, both here and in Colorado, bring substantial expertise to the table. This gives me confidence as I witness daily improvements and recognize the opportunities it presents. Importantly, it has a relatively low cost of goods and doesn't occupy much space, which gives us flexibility in how we implement it in hospitals. This may not directly answer your question, but it reflects where we are currently.

Your next question comes from the line of Sean Lee of H.C. Wainwright.

My question is a broad one. Looking back to the start of last year, it's clear that you have consistently exceeded your prior guidance. The latest revenues are now over 10% higher than your initial expectations for the year. I'm curious if this has been driven by a particular positive factor and whether these unexpected gains indicate a trend that we can anticipate continuing into next year.

Well, Sean, I think when you look at the guidance we put out at the beginning of the year and that was $595 million. Ultimately, that was where we're looking at today in terms of our guidance and the improvement and the increase in it, it's really all come from surgical revenue. So our EOS guidance has been consistent throughout the year. So you ask yourself why has the surgical revenue done better than what we anticipated early on? And it's really come through our volume assumptions. And so ultimately, I think this is a reflection of the interest, the adoption of our technology and our procedures by surgeons and aided and advanced through the addition of sales coverage and sales reps. And so it's not just one thing and I hate to be super simple about it. But ultimately, this has been a greater volume experience than we guided to at the outset of the year. And so I think that gives you confidence that we're on to something.

Your next question comes from the line of Drew Ranieri from Morgan Stanley.

Just I'll sneak in two, this should be pretty quick. But Pat, maybe on EOS, I think in your part of the slide deck, you're talking about it laying the foundation for future implant growth. And maybe just put a little bit more context there, especially against what that means for the record EOS orders that you're seeing with Insights. Are you embedding volume-based commitments with kind of like every new order from EOS, whether it's an upgrade or replacement? So maybe just talk to us a little bit about that. And then, Todd, just on the gross margin for the quarter. It came in a little bit weaker than we were expecting. And I know you highlighted product mix, but we saw lateral kind of continue to take more share. So just talk to us a little bit more about why it was a little bit softer versus maybe our expectations and what you're kind of thinking about for the fourth quarter?

I'll start by addressing your question, Drew. I'm concerned that I might not fully convey how we are integrating our implants into the overall experience. The advantage of automating these measures is that we gather a significant number of radiographs and numerous chances to create plans informed by our implants. This process extends all the way through the surgical intervention and into the post-operative assessment. Understanding how spine care impacts adjacent levels and recognizing changes in spine alignment proves to be extremely valuable, as it serves as an indicator of potential future issues. The surgical planning is ultimately informed by our implants. For instance, we identify the specific type of rod needed for the patient, and we customize that rod to match our implant. Early collaboration with the surgeon regarding their radiographic findings allows us to strategically plan and integrate our implants, ensuring they meet necessary requirements. This connection of implants to the planning process is impressive, and we possess an integrated tool that we can use during surgery to align with that plan, all of which is proprietary. When we consider selling these units and gaining access to hospitals, our ability to leverage the utility of this preoperative plan, driven by AI that supports alignment measures, is exceptional. Integrating our implants into this process is crucial. To provide some perspective on the volume of data, automation plays a significant role in gathering information and generating predictive measures. We have collected over 100,000 images from the 10 sites involved in our alpha evaluation. The vast amount of information we acquire through the use of these tools ultimately contributes to predictable outcomes in spine surgery, which is impressive. That's what generates all the enthusiasm. I apologize if I'm going on too long, but this capability truly sets our tool apart from others.

Our EOS margins were slightly lower, primarily due to geographic mix, as many international sales involve distributors which have lower margins. This caused a slight margin drag in the quarter. Additionally, we observed strong revenue performance from our biologic portfolio, although it also had a lower margin profile. These factors contributed to the headwind we experienced in the quarter. For the fourth quarter, we anticipate a non-GAAP gross margin in the range of 69.5% and expect to close the year with a gross margin of around 70%.

And EOS is international.

That concludes our Q&A session. I will now turn the conference back over to Pat Miles for closing remarks.

I just want to thank everybody for their attention. And I hope you share your enthusiasm about what we're building. So thanks very much.

Thank you everyone for joining. You may now disconnect.