Xtant Medical Holdings, Inc. (NYSE:XTNT) Q3 2021 Earnings Conference Call November 12, 2021 9:00 AM ET

Company Participants

David Carey – Lazar FINN Partners
Sean Browne – President and Chief Executive Officer
Greg Jensen – Vice President-Finance and Chief Financial Officer

Conference Call Participants

Operator

Greetings and welcome to the Xtant Third Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host David Carey at FINN Partners. Thank you. You may begin.

David Carey

Thank you, operator, and welcome to Xtant Medical’s third quarter 2021 financial results call. Joining me today is Sean Browne, President and Chief Executive Officer; and Greg Jensen, Vice President, Finance and 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 by such words as expect, plan, will, may, anticipate, believe, should, intends, and other words with similar meaning.

Such forward-looking statements are not guarantees of future performance and involve risk and uncertainties including those noted in the Risk Factor section of the company’s annual report on Form 10-K filed with the SEC on February 24, 2021 and 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 to GAAP reconciliations, which appear in the tables of 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 the replay, this call was held and recorded on Friday, November 12th at approximately 9:00 A.M. Eastern Standard Time. The company declines any obligation to update its forward-looking statements, except as required by applicable law.

Now, I’ll like to turn the call over to Sean Browne.

Sean Browne

Thank you, David. And good morning to everyone listening. In my comments this morning, I’m going to address the following. One, the impact of the COVID Delta variant on our business this past quarter, which was similar to its impact in other companies in the spine industry. Two, our Q3 revenue results, which on a relative basis were better than most of the market leaders in the spine industry. Three, our key growth initiatives and progress made on those initiatives. And then four, changes in our gross margin.

Although I had hoped to never again, bring up COVID in the context of the company’s financial performance on a macro level, as we have seen with other medical technology companies that have recently reported the COVID Delta wave has had a negative impact on financial results across the board.

Following our solid second quarter, the rapidly expanding Delta variant began to severely impact elective spinal procedures in some of our core markets. While July results were good overall, we’d actually met all of our internal financial goals. The months of August and September proved to be challenging. Despite those challenges, I am pleased with our top-line results.

When comparing our top-line results against the leading players in the spine market on a relative basis, we outperformed or fared as well as the biggest names in our industry, which we feel can be attributed to our focus on key growth initiatives that have helped diversify our revenue stream.

In the third quarter, we continue to make great progress against those key growth initiatives. Our focus on new product introductions, distribution network expansion, and penetration into adjacent markets, which will continue to diversify our revenue stream, have us poised to leverage our platform for growth and position the company for long-term success. In many respects, our focus on diversifying our revenue stream has also become a strategic advantage. It was that diversity that helped stabilize our third quarter revenues as we began to see significant increases in our original equipment manufacturer or OEM channel sales at the same time that we began to see softness in our independent agent or IA channel sales due to the COVID Delta variant.

Although OEM channel sales typically carry lower gross margins, they generally have a slightly better operating margins compared to our traditional IA channel sales. OEM channel sales also provide an opportunity to serve adjacent markets, including the foot and ankle, cranial/maxillofacial, oncology, joint reconstruction, and trauma markets. These adjacent market opportunities allow the company to further participate in the $625 million plus U.S. bone graft market without having to develop new products, which is why we see them as a significant growth opportunity for the company.

As we previously stated, we’ve established a regular cadence of new product releases, which began earlier this year. During the third quarter, we continued to execute on this promise with the September launch of OsteoFactor, a uniquely processed allograft containing retained growth factors found within the endosteum layer of allograft bone. This marrow derived growth factor product is very safe, highly effective, easy to use, and customizable.

More importantly, OsteoFactor adds to our broad biologics product portfolio and enables us to penetrate the $670 million plus growth factor market. OsteoFactor is our third new product introduced this year with our fourth product, a bone marrow aspirate concentrate set to be introduced during the fourth quarter. Another critical part of our growth strategy is targeted expanding our distribution network, both in penetrating existing agents and bringing on new agents. At the start of the year, we set up to add 10 new agents per quarter.

I’m pleased to report that through the third quarter, we have brought on 41 new agents. We are also diversifying the territories where our agents are selling, given and our strong market presence in large states, such as Texas, California, Arizona, Georgia, and Pennsylvania, our expansion strategy targets regions, where we historically have not had a robust presence such as in the Midwest, the Mid-Atlantic and New England. With the Delta variant impacting our largest revenue contributing states in the third quarter, we believe expanding and diversifying geographically will mitigate risk to our distribution network and ultimately to our revenues moving forward.

Our final key growth initiative focuses on pursuing strategic acquisitions, designed to enhance and complement our product portfolio. Needless to say those endeavors take time, however, we continue to explore opportunities that align with our growth platform, provide scale, fill product or technology gaps, expanding new adjacent markets or broaden our access to customers.

Now, the final topic I would like to discuss is the decline in our gross margins during the third quarter, which was due in part to the COVID, Delta variant into a more significant degree to the strategic and intentional decisions we made as a management team. The impact of the strategic and intentional decisions on our gross margins can be summarized by the following. One, about a third of our gross margins softness was related to Xtant’s revenue mix, which showed a greater combination of lower gross margin OEM channel sales versus our higher gross margin independent agent channel sales.

As mentioned above, even though OEM channel sales have a lower gross margin, they provide a slightly better operating margin than the IA channel sales. So, we plan on continuing to pursue these opportunities. Two, about two-thirds of our gross margin softness was intentional and more importantly, it’s expected to be temporary as it was a result of our team’s efforts to lower our finished goods inventory and optimize the production of our donors. As our team has taken steps to improve efficiencies, through capital investment and optimization of the production of our donors. We determined that there was no need to produce [indiscernible] products during the third quarter. This reduced our finished goods inventory by over $2 million. However, it also temporarily reduced the overhead absorption rate for the third quarter.

Greg, will provide greater detail in the gross margins when he reviews the financials. But the good news is that we expect to see gross margins improved as the demand for elective procedures return to pre-COVID levels. The improvement will be driven by an increase in the IA channel sales combined with an increase in the overhead absorption rate from higher production levels. That said, given the current state gross margins will likely remain soft during the fourth quarter and into the first half of 2022.

Now, looking to the fourth quarter and beyond, we intend to focus primarily and executing our four key growth initiatives. We realize that the pandemic has caused adverse effects on general commercial activity and the global economy that could linger into 2022. However, we believe steps, we are taking to grow our distribution network, expand into adjacent markets, improve our operational efficiency and increase capacity will help us improve our growth potential. In addition, by operating with a healthy balance sheet, we are a well position to invest and leverage our growth platform for future value creation.

Now, I’d like to turn the call over to our CFO, Greg Jensen, to discuss our third quarter 2021 financial results.

Greg Jensen

Thank you, Sean, and good morning, everyone. Total revenue for the third quarter of 2021 was $13.8 million compared to $14 million in the same quarter of the prior year. As Sean mentioned earlier, the revenue decrease was attributed to significantly lower sales from the distributor sales channel because elective procedures across our key markets were significantly impacted by COVID-19.

However, on a positive note, we saw a significant increase in our OEM revenue during Q3, which we believe is an indication that our initiatives to expand into other vertical markets are showing early signs of success. We remain focused on future growth opportunities by expanding into a other adjacent markets.

Gross margin for the third quarter of 2021 was 52.2% compared to 66% for the same period in 2020. The decrease in gross margin was attributed to three key factors, which include the shift in the sales channel mix, lower absorption of labor and overhead expenses. And finally, an increase in the excess in obsolete inventory expense.

The shift in the sales channel mix was evidenced by the significant increase in OEM and private label sales combined with a corresponding decrease in the distributor sales channel. Since OEM and private label sales carry lower gross margins. The impact on gross margin was $500,000 or 3.4% of the total gross margin percentage decline.

The lower absorption of labor and overhead expenses totaled $800,000 or 5.6% of the total gross margin percentage decline. The success of our inventory reduction efforts have decreased our finished goods inventory by $2 million. In addition, because we have reduced our production lead times from eight weeks to three weeks, it has enabled us to improve our working capital and equally as important has reduced our time to ship OEM customer orders from 90 days to 45 days.

Finally, we saw an increase in excess and obsolete inventory expense totaling $300,000 or 2.2% of the gross margin decline. Operating expenses in the third quarter of 2021 were $8.6 million and compared to $8.5 million for the third quarter of 2020. As a percentage of total revenue, operating expenses were 62.9% in the third quarter of 2021, compared to 60.6% in the third quarter of 2020.

General and administrative expenses were $3.1 million for the third quarter of 2021 compared to $3 million for the same period in 2020. The increase was primarily due to additional salary expenses and the write-down of product registration fees for the South American market partially offset by reduced employee performance based compensation expense.

Sales and marketing expenses were $5.3 million for the three months ended September 30, 2021, relatively flat compared to the same period of 2020. The three month comparison included, reduced commission’s expense resulting from a greater mix of original equipment manufacturer sales, partially offset by increased salary expenses, marketing expenses, and finally travel expenses.

Net loss in the third quarter of 2021 totaled $1.8 million or $0.02 per share compared to a net loss of $1.4 million or $0.10 per share in the comparable 2020 period. Adjusted EBITDA for the third quarter of 2021 was $500,000 loss compared to a $1.6 million gain for the same period in 2020. As of September 30, 2021, we had $18.2 million of cash and cash equivalents, $6.3 million of net accounts receivable, $19.7 million of inventory and $5 million available under our credit facility.

Now, I’ll turn a call back to Sean for closing remarks.

Sean Browne

Thank you, Greg. To summarize, we are pleased that our dedicated team continues their strong execution, against the persistent backdrop of the ongoing pandemic. Despite the broader market challenges, we plan to stay the course with our strategy, because we believe the pandemic related headwinds are temporary, and we are confident in the opportunities and benefits of our leading spine brand.

With positive momentum from our actions earlier this year to increase our manufacturing capabilities and invest in our key growth initiatives, we believe we are putting the company in a position to grow top-line revenues over the long run. On a parallel track, we continue to optimize our manufacturing capabilities, which will allow us to meet additional demand while optimizing inventory levels.

As we look beyond COVID and elective procedures begin to normalize, we feel Xtant is poised to benefit from the combination of the increased market access, newly introduced, differentiated products and ability to achieve scale.

And finally, I’d like to end on a positive note, with a story that reinforces our mission. As we announce last month, we honored Samuel Lee Becker, a donor hero as part of our sponsorship of the 2022 Donate Life Float at the Rose Bowl Parade in Pasadena on New Year’s Day. Sam was a person who gave freely and frequently and had every intention of making the world a better place for everyone. Sam gave his time, money, smile, humor, compassion, empathy, and ultimately himself.

Since his passing through bone and tissue donation, a part of Sam lives on and the patient recipients whose lives are greatly improved. Thanks to Sam’s gift. We are proud to celebrate the life of Sam Becker, whose extraordinary gift enables others to have a full life. Our support of Sam Donate Life and encouraged to hope, which is the title, the 2022 Donate Life Rose Bowl Parade float closely aligned with our mission of honoring the gift of donation by allowing our patients to live as full and complete a life as possible. Our thoughts, prayers, and appreciation are with the Sam and the Becker family.

That concludes our call. Thank you for joining us today and for your continued support.

Operator

Thank you. This concludes today’s conference. Thank you for your participation. You may now disconnect your lines.

Question-and-Answer Session

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