Earnings Call Transcript - XTNT Q3 2024

Operator, Operator

Welcome to the Xtant Medical Holdings, Inc. Third Quarter 2024 Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. I would now like to turn the call over to your host, Brett Maas, Investor Relations. Please go ahead, sir.

Brett Maas, Investor Relations

Thank you, operator. Joining me today is Sean Browne, President and Chief Executive Officer, and Scott Neils, Chief Financial Officer. Today's call is being webcast and will be posted on the company's website for playback. During the course of this call, management may make certain forward-looking statements regarding future events and the company's expected future performance. These forward-looking statements reflect Xtant’s current perspective on existing trends and information and can be identified with such words as expect, plan, will, may, anticipate, believes, should, and intends, or other words with similar meanings. Such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, including those noted in the risk factors section of the company's annual report on Form 10-K filed with the SEC on April 1st, 2024, and in subsequent SEC reports and press releases. Actual results may differ materially. The company's financial results, press release, and today's discussion include certain non-GAAP financial measures. Please refer to the non-GAAP and GAAP reconciliations, which appear in our press release and are otherwise available on our website. Note that our Form 8-K filed with our financial results press release provides a detailed narrative that describes our use of such measures. For the benefit of those of you who may be listening to a replay, this call was held and recorded on November 12th at approximately 4:30 p.m. Eastern Time. The company declines any obligation to update its forward-looking statements except as required by law. Now I’d like to turn the call over to Sean Browne. Sean, the floor is yours.

Sean Browne, CEO

Thank you, Brett, and good afternoon, everyone. I am pleased to announce solid growth for the third quarter with 12% growth for the quarter and 36% growth year-to-date. We are on pace to achieve our full-year revenue guidance of $116 to $120 million, which we affirmed today. This range represents total annual revenue growth of approximately 27% to 31% compared to the full year of 2023. Despite solid year-over-year growth for the quarter, sales were softer than we expected due to slight delays in our launch of two new products. OsteoVive Plus, our new stem cell product, experienced validation delays, while our new pedicle screw system, Cortera, faced supplier issues. We have since overcome these challenges, and both product lines were released in late September and are well-received by our distributors and surgeons. We are bullish on these products and believe they will help us finish strong for fiscal year 2024. From a profitability perspective, our adjusted EBITDA results for Q3, which Scott will cover in a moment, reflect the effect of these product delays I just discussed. Year-to-date, we remain profitable on an adjusted EBITDA basis with $435,000. In addition, we anticipate being adjusted EBITDA positive in Q4 of 2024 as we continue to focus on profitability and self-sustainability. Our operating expenses were lower in the third quarter compared to the three immediate preceding quarters as we continue to rationalize expenses and become more efficient. Another important development in October, we signed a licensing agreement with a significant player in the advanced wound care market. The deal includes licensing one of our 3Q codes and the corresponding SimpliMax dual-layer amniotic membrane. We received a $1.5 million upfront payment for this in October, and the terms of this agreement provide for full licensing and royalty revenues, aggregating a minimum of $3.75 million in 2025. This incremental revenue will bear little to no incremental costs and will therefore carry high margins that will fall directly to our bottom line. As a historical backdrop, to put into context where our business has been and where we are going: remember that at the end of fiscal year 2022, we were only a $58 million revenue business. By the end of this year, we expect to have doubled in size with 2024 revenues between $116 million and $120 million. The acquisitions we made last year have greatly assisted us in achieving greater scale, which is extremely important for our continued growth in GPO and IDN agreements. Without access to hospitals, our business cannot grow. Secondarily, the Surgalign acquisition has revitalized our Extend hardware line. For instance, our Coflex interlaminar stabilization device is a one-of-a-kind motion preservation alternative that perfectly complements our ASC-focused offering. Our ASC offering includes our Silex SI Fusion device and Axle, our inner spinous process device. Extend's cervical offering includes a complete line of products, including our anterior Surgalign system, our posterior Streamline system, and a comprehensive line of inner body devices. With the release of Cortera, we now have a best-in-class pedicle screw system to complete our hardware offering. From a biologics perspective, our number one priority for fiscal year 2024 was to bring all manufacturing in-house. The strategic rationale for this was twofold. First, we've faced disruptions with some of our fastest-growing products. In the past three years, we believe this accounted for approximately $10 million to $15 million in lost revenue. By manufacturing our products in-house, we gain control over our supply chain, production, and the availability of our products for sale. Secondly, we are substantially more profitable when making and selling our Xtant-branded products. Our distributed stem cell, growth factor, MDO, and synthetic products exhibit gross margins ranging from mid-40s to 60%. In-house production elevates these margins significantly to the mid-80s to low 90s. Moreover, strategically, Xtant is now positioned to grow more profitably as an OEM supplier for companies in the spine market and other adjacent sectors. For instance, our new Amnio line, projected to generate about $1 million in sales this year, serves as a surgical barrier for spine procedures. Furthermore, we now have OEM customers in wound care, foot and ankle, and sports medicine who will contribute over $2 million in just OEM Amnio sales this year. Our new stem cell product line also creates a fantastic OEM opportunity in spine, trauma, and foot and ankle markets. The advantage of OEM deals is that they come with minimal sales and marketing expenses, yielding contribution margins of 60% to 70%. Regarding operational leverage, one important concern that shareholders have voiced is our operational leverage. I assure you that we are actively seeking ways to reduce our expense base as we complete the integration of the Surgalign businesses while focusing on profitability. Operating expenses have decreased for the last three quarters compared to the immediately preceding quarter, and we are consistently scouting for opportunities to cut costs and utilize our increased scale more effectively. Rounding out fiscal year 2024, the second half is expected to perform better than the first half as we implement improvements to our supply chain issues and enhance our control over product production. We've addressed most challenges impacting our fastest-growing products. In May, we raised our revenue guidance from $112 million to $116 million because it became clear that many issues affecting our Surgalign hardware line and our distributed non-manufactured stem cells were resolved. We remain on track to deliver the established revenue guidance of $116 million to $120 million and anticipate a breakout fourth quarter as our hard work pays off with increased revenues. Now, discussing our new product pipeline: like every robust organization, we continually innovate with a deep pipeline of new products. During our turnaround, we expanded our Biologics offering from two categories to five, enhancing our growth profile. We are among the few Orthobiologics companies that provide a comprehensive line, including allograft, demineralized bone matrix, synthetics, viable bone matrix (stem cells), and growth factor. Over the next two quarters, we will be the sole vertically integrated Orthobiologics company that manufactures and sells under our own brand. Along with our amnio products, we completed the production of our own viable bone matrix, better known as stem cells, which has been our fastest-growing product line. However, our growth was constrained by reliance on external vendors due to supply chain issues. With a superior product and an improved cost profile, we believe we can profitably expand our Xtant brand in the stem cell market significantly. Additionally, a supply shortage of stem cells presents an opportunity for Xtant to become a major OEM provider to other orthopedic companies. In fiscal year 2025, we anticipate our OsteoVive Plus viable bone matrix will be our largest product line. Lastly, regarding the Cortera Pedicle Screw System released during NASH, we received rave reviews from potential surgeons. This new system is a next-generation posterior system featuring innovative screw designs with a low profile and newly designed locking mechanisms. The rollout of Cortera is expected to drive substantial growth for Xtant in Q4 and beyond. In short, we have a fantastic product pipeline filled with winnable opportunities for clinically validated, commercially proven products that serve large and growing markets. These future products will capitalize on our existing operational and quality infrastructure and will not necessitate significant investments in new product development or large clinical evidence or regulatory clearances. Moving forward, we aim to become operationally self-sustaining by controlling our supply chain and reducing reliance on external production. We believe this self-reliance will enable us to be a larger and more diverse producer of biologics. Crucially, making our own products is expected to enhance our margin profile while expanding our product line and introducing transformative treatment options to a vast patient population. These actions will help us achieve positive adjusted EBITDA during the fourth quarter of 2024. Now, I’d like to turn the call over to Scott, who will discuss our third quarter 2024 financial results.

Scott Neils, CFO

Thank you, Sean, and good afternoon, everyone. Total revenue for the third quarter of 2024 was $27.9 million compared to $25 million for the same period in 2023. The 12% increase is attributed primarily to product sales from the recently acquired Surgalign hardware and biologics business, although a reduction in surgical procedures partially offset year-over-year growth. Gross margin for the third quarter of 2024 was 58.4% compared to 61.3% for the same period in 2023. The decrease was primarily attributable to reduced throughput resulting from the delayed launch of an internally produced stem cell product, which was partially offset by greater scale. Third quarter 2024 operating expenses were $20.1 million compared to $18.7 million in the same period a year ago. As a percentage of total revenue, operating expenses were 71.9% compared to 74.8% in the same period last year. Sequentially, operating expenses declined by $1.4 million and remained consistent as a percentage of revenue compared to Q2 2024. General and administrative expenses were $7.5 million for the three months ended September 30, 2024, compared to $7.1 million for the same period in 2023. This increase was primarily due to severance expenses, an increase in stock-based compensation, partially offset by reductions in various compensation plans. Sales and marketing expenses were $11.9 million for the three months ended September 30, 2024, compared to $11.1 million for the same quarter last year. This increase is primarily due to higher commission expenses related to increased sales. Research and development expenses were $701,000 for the three months ended September 30, 2024, an increase from $490,000 in the third quarter of 2023. This increase is primarily due to increased headcount focused on new product introduction. Net loss in the third quarter of 2024 was $5 million, or $0.04 per share, compared to net income of $9.2 million, or $0.07 per share, in the comparable 2023 period. I'll note that net income during the third quarter of 2023 included a $13.3 million gain on bargain purchase and tax benefit resulting from our acquisition of the Surgalign hardware and biologics business. Adjusted EBITDA for the third quarter of 2024 was a loss of $193,000, compared to adjusted EBITDA of $458,000 for the same period in 2023. As of September 30, 2024, we had $7.1 million in cash, cash equivalents, and restricted cash, along with net accounts receivable of $20.5 million, inventory of $41.9 million, and $3.8 million available under revolving credit facilities. Operator, you may now open the line for questions.

Operator, Operator

Thank you. We will now begin the question and answer session, and our first question will come from Ryan Zimmerman with BTIG.

Unidentified Analyst, Analyst

Hi, everyone. This is actually Izzy on for Ryan, so thanks for taking the question. I just wanted to start out about your commentary on some of the third-quarter results. I know you guys noted that some of the product delays impacted the top-line, but you also called out some softness in the procedure environment. So I was just wondering if you could provide some more color around that and what trends you've been seeing in the fourth quarter so far.

Sean Browne, CEO

And, Scott, I'll jump in, and then if you want to add any color. So, Izzy, first of all, thanks for the question. Second of all, what we saw was actually the summer months of July were soft. August was very soft. It was tied directly to our doctors going on vacation. It’s as simple as that. I hate to say it, but as we become more of a hardware company, there's more of that impact on hardware practitioners, which can be both beneficial and detrimental. The good news is we saw a bounce back in September, and in the fourth quarter, we're experiencing a return to normalcy. If I may add one other element to this: this is the first year since COVID where we, at Xtant, have experienced a summer slowdown that's customary across the industry, particularly in the world of spine. During COVID in 2020 and 2021, hospitals and systems across the country were shut down. In 2022 and 2023, doctors didn't fully take vacations as we saw in the past summers. This is the first summer we've seen that returned to normal prior to COVID. So, that’s how I would answer that. Scott, do you have anything more to add?

Scott Neils, CFO

No, I think that's a pretty comprehensive account of kind of a new development in what historically or of late has not existed in the way of seasonality.

Unidentified Analyst, Analyst

Got it. That's helpful. And then just shifting gears a little bit. Do you mind speaking to the revenue mix this quarter between orthobiologics and spinal implants? I was just curious if, as you transition to in-house manufacturing, you expect to see a change in this mix and kind of what a steady state may be going forward?

Sean Browne, CEO

Scott, I'll let you take that, then I'll add my color.

Scott Neils, CFO

Sure. I think during the course of 2024, we'd see it splitting out roughly 55% orthobiologics to 45% spinal implants. As we move into future years, we'll observe that orthobiologics will pull away and take on more of our overall revenue share.

Sean Browne, CEO

Yeah, nothing more to add to that, yeah.

Unidentified Analyst, Analyst

And then I know we're not going to get any guidance today, but I was just wondering if you have any early considerations for us as we start to think about 2025?

Sean Browne, CEO

Scott?

Scott Neils, CFO

Yeah, as it comes to 2025 guidance, we'll provide formal guidance when we release Q4 earnings in March. However, it's still early yet. Broadly speaking, we can anticipate revenue growth approaching double digits, perhaps three to four points in the way of gross margin improvement, and continued improvement in operating leverage in terms of operating expenses.

Unidentified Analyst, Analyst

All right, thanks, guys. Thank you for taking the questions.

Sean Browne, CEO

Thanks, Izzy. Appreciate it.

Operator, Operator

And we'll move next to Chase Knickerbocker with Craig Hallum.

Unidentified Analyst, Analyst

Hi, guys. It's Jake on for Chase. Thanks for taking the questions. I'm just wondering, if we think about Q4 in 2025, what sort of contribution do you think VBN can have, and is this contribution more on the white-label side or the distributor side? Could you please talk us through the mix?

Sean Browne, CEO

Scott, would you like to jump in on this? I'll add my comments afterward.

Scott Neils, CFO

Yeah, I think probably going back to Q3, what we described during Q4, we expect minimal impact on the distributor side. I think the pickup in Q4 will be primarily on the white-label side. As we transition into 2025, we anticipate a predominant shift towards private-label and white-label contributions, coupled with modest but significant pickup on the distributor side.

Sean Browne, CEO

A lot of that is tied to the fact that we're still working through the inventories of our distributed products. That's why we won't see it much, or at all from our own product in the fourth quarter. However, we will start to see it in the first quarter of 2025.

Unidentified Analyst, Analyst

Okay, thank you. That's helpful. And then one more for you guys. How are you thinking about profitability next year, and where should we be modeling leverage? Is it going to be largely on the gross margin side or more on the operating line?

Sean Browne, CEO

I'll jump in here, then, Scott, I'll let you provide additional insights. More broadly, it's going to be a combination of both: improved margins and enhanced leverage on our expenses, as well as a higher sales volume of products with better margins. Therefore, from a profitability standpoint, we believe that's an effective mix.

Scott Neils, CFO

I'll just add that if we sustain the trends we've observed throughout 2024 with sequential improvements in operating leverage, this will significantly benefit profitability. Within gross margin, we also anticipate similar progress, aiming for an increase of about three to four points during 2025.

Unidentified Analyst, Analyst

Thanks very much, guys.

Operator, Operator

And there are no further questions. I apologize, we do have an additional question that will come from Ankur Sagar. Please go ahead.

Unidentified Analyst, Analyst

Hey, good afternoon, Sean and Scott. Thank you for taking my questions. I have two. One, I think I caught a mention of some licensing agreement in the press release for the earnings release something regarding the Q codes that can actually provide a minimum of north of $5 million in royalty fees. I would appreciate it if you could elaborate on that. What opportunity is that? And when do you expect that?

Scott Neils, CFO

So upon signing, we received the first $1.5 million upfront. Additionally, there is a minimum of $3.75 million expected in fiscal year 2025. These figures are minimums that will depend on the developments within the wound care market and the LCDs that people are awaiting. The good news is that most of the $3.75 million is anticipated to be front-loaded in the first half of the year. However, we believe that this could yield significantly more revenue if the partner we are collaborating with performs as we expect.

Unidentified Analyst, Analyst

I see. And then, as of November, you've maintained the same guidance. Do you expect a ramp in Q4 in the top line, and there's still a delta between $116 and $120. What is your confidence level in achieving that guidance, particularly aiming for the high end? Is it reliant on the new products or the OEM portion?

Sean Browne, CEO

Yes, it's a combination of both. Even some orders from the third quarter that we couldn’t ship were moved into the fourth quarter, which is a portion of what happened. Furthermore, we will see a notable increase in our OEM business, alongside a strong pickup in our Cortera business. Cortera is particularly advantageous because, when it comes to pedicle screws, it translates well into other biologics as well. Overall, we feel optimistic about achieving $116 to $120 million in revenue. Unfortunately, I wish I could tighten that range, but for now, I’ll stick with what we provided.

Unidentified Analyst, Analyst

Okay, okay. And then just one more for Scott. In terms of Q4, you mentioned the prospects of positive cash flow. I think you noted Q1 for sales and commissions next year. Moreover, can you clarify what you said in Q2 regarding cash flow break-even or generating positive cash flow? Is this predicated on revenue growth and gross margin improvement, or can we achieve cash flow break-even even without that?

Scott Neils, CFO

Well, it reflects several factors, starting first with Q4. The timing of some Q3 revenue will influence cash flows from operations in Q4, as we initially expected that revenue to be on the balance sheet as receivables collected in Q4. However, more of it will remain in the accounts receivable for Q4. Looking ahead to 2025, achieving break-even cash flow is not only about revenue growth; it involves the nature of revenue as well. We expect more efficient revenue from working capital perspective, in line with shorter DSOs from OEM channels. Also, we are transitioning from consignment products to finished goods shipped, resulting in significantly lower working capital needs on our balance sheet. This should enhance our cash flows and improve efficiency from a working capital standpoint.

Unidentified Analyst, Analyst

Okay. All right, great. Thank you for taking my questions.

Operator, Operator

And there are no further questions at this time. I'd like to turn the conference back to management for closing remarks.

Sean Browne, CEO

Great. Thank you, Operator. We made great progress in the third quarter of 2024. As we close out 2024, we believe there are two key drivers for Xtant to become a self-sustaining, profitable company. First, building our own biologics. This quarter is pivotal for our internal development team. The more we produce of our highly profitable biologics, the less we rely on other manufacturers' supply chains. We believe this step alone will help us achieve positive adjusted EBITDA in Q4. Secondly, optimizing the integration of the businesses we acquired last year presents significant growth opportunities, some of which we haven’t capitalized on due to supply constraints. However, we feel we have addressed most of these challenges and there are additional cost leveraging opportunities as the businesses combine. In closing, I want to reiterate our mission to honor the gift of donation by allowing our patients to lead full and complete lives. I appreciate the dedication of our valued employees. Without them, our success and accomplishments would not be possible. Thank you for joining us today and for your continued support.

Operator, Operator

This concludes today's conference call. Thank you for attending. Goodbye.