Welcome to the Xtant Medical Holdings, Inc. Second Quarter 2024 Conference Call. [Operator Instructions] I would now like to turn the call over to your host, Brett Maas, IR. You may begin, sir.

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 that 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 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 1, 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 to 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 who may be listening to the replay of this call, this call was held and recorded on August 9 at approximately 9 a.m. Eastern Time. The company declines any obligation to update its forward-looking statements, except as required by applicable law. now I'd like to turn the call over to Sean Browne. Sean, the floor is yours.

Thank you, Brett, and good morning, everyone. I'm pleased to announce another strong quarter for the Xtant team. With 48% growth over prior year, we are solidly on pace to achieve our full year revenue guidance of $116 million to $120 million, which we are reaffirming today. This range represents total annual revenue growth of approximately 27% to 31% compared to the full year 2023. From an organic growth perspective, which we define as revenue growth, excluding contributions from products acquired during the previous 365 days for which there were no comparable sales, second quarter revenue was flat compared to the prior year, mostly due to the planned Surgalign cannibalization of our X-spine hardware and significant OEM sales during Q2 2023. as our supply chain challenges abate and we introduce new products to the market, we continue to expect our organic growth to accelerate during the second half of 2024 and reach double digits. From a profitability perspective, adjusted EBITDA for the second quarter was $0.5 million and marking our fifth consecutive quarter of positive adjusted EBITDA. In the second quarter, we expanded our gross margin by 50 basis points compared to the prior year period and reduced our operating expenses as a percentage of revenue compared to Q1 2024. Our production is becoming more efficient and we continue to scale. We anticipate further improvements in adjusted EBITDA in Q3 2024, and beyond. As I have discussed in previous calls, we expect the first -- we expected the first half of this year to be challenging due to numerous supply chain issues so we are pleased to have such a strong second quarter. We have worked through most of these issues that have impacted some of our fastest-growing products. Additionally, we are closer to producing our own stem cells, which…

Thank you, Sean, and good morning to everyone on the call. Total revenue for the second quarter of 2024 was $29.9 million, compared to $20.2 million for the same period in 2023. The 48% increase is attributed primarily to product sales from the recently acquired Surgalign hardware and biologics business. Gross margin for the second quarter of 2024 was 62.1%, compared to 61.6% for the same period in 2023. The increase was primarily attributable to greater scale and improved production efficiency, which was partially offset by increased charges for excess and obsolete inventory, non-absorbed costs and sales mix. Second quarter 2024 operating expenses were $21.5 million, compared to $13.9 million in the same period a year ago. As a percentage of total revenue, operating expenses were 71.9%, compared to 68.5% in the same period a year ago. These increases were primarily attributable to additional commission expense resulting from revenue growth, additional compensation expense related to additional headcount and additional stock-based compensation. Sequentially, operating expenses declined 260 basis points from Q1 of 2024. General and administrative expenses were $7.7 million for the 3 months ended June 30, 2024, compared to $5 million for the same period in 2023. This increase is primarily attributable to increases in compensation expense, stock-based compensation, professional service fees and hardware and software expenses. Sales and marketing expenses were $13.2 million for the 3 months ending June 30, 2024, compared to $8.7 million for the same period in 2023. This increase is primarily due to higher commission expenses related to increased sales and additional compensation expenses associated with additional headcount. Research and development expenses were $0.6 million for the 3 months ending June 30, 2024, an increase from $0.2 million for the same period in 2023. The increase is primarily due to increased headcount related to our additional focus on new product introduction. Net loss in the second quarter of 2024 was $3.9 million or $0.03 per share, compared to a net loss of $2.2 million or $0.02 per share in the comparable 2023 period. Net loss in the second quarter of 2024 was a sequential improvement of $0.5 million from $4.4 million in Q1 of 2024. Adjusted EBITDA for the second quarter of 2024 was $0.5 million, compared to $0.1 million for the same period in 2023. As of June 30, 2024, we had $5.4 million of cash, cash equivalents and restricted cash. Net accounts receivable was $21.2 million, inventory of $40.5 million and $5.1 million was available under our revolving credit facility. In addition, on August 7, 2024, we entered into an agreement for a $5 million pipe with an existing institutional investor to provide additional working capital as we transition towards positive operating cash flows. Operator, you may now open the line for questions.

[Operator Instructions] And our first question comes from Ryan Zimmerman of BTIG.

Can you hear me okay?

Yes, I can hear you great?

Congrats on all the progress this quarter. Maybe to start, Sean, with just a little color around kind of the mix of the revenue this quarter kind of between orthobiologics and spinal implants. And how you see that playing out over the balance of the year? It seems like a lot of the Surgalign hardware helped in the quarter. But just appreciate any color there, and then I have a follow-up on guidance.

Okay. Yes, sure. So when I think about it, I'll take it from a high-level perspective, and Scott, I don't know if you want to add any color with the specifics of the percentages of each. But from a high-level perspective, yes, the Surgalign hardware has been a real nice helper. And it is -- as I mentioned, this is something that we're really -- to take over some of our older X-spine hardware. The Surgalign product line, which is a very good product line, and so it's one that's helping us replace. So that whole cannibalization was something that we wanted to build in. And so as we think about what's going to happen in the second half of this year, you're going to see two things that will take place. You're going to see an increase of our own self-produced things like I said, are amnio, some of our stem cell stuff that will be coming out in the second half of this year. All of that will help drive more of our Biologic sales. But concurrently, we have a nice Cortera product line that's going to be really rolled out in full, the MIS portion of this. We have the open already with us today, but the MIS portion will be rolled out during NASS. And so we feel that in the fourth quarter, we'll really start to see a nice uptick when it comes to the hardware side of things. So overall, I think we got a nice balance of growth. But I think, yes, just over the course of time, I just also think that our biologics business based on the strength of where that is, will start to become even more prominent.

Okay, that's very helpful. And then with the guidance, you beat by a little bit but obviously, not flowing that through to the guidance, very much reiterating guidance. And just help us take through the pacing for the balance of the year, kind of how to think about third quarter versus fourth quarter. It seems like traditionally, you'll get a nice seasonal step up in the fourth quarter. I just want to make sure we're clear on that.

Sure. So we will see an uptick in the third quarter from certainly the second quarter, which is something that typically you wouldn't see, but we do feel good about what's happening within the business overall, especially the ramp-up that's starting to take place with our stem cell business, where we really just -- about early second quarter, we finally got fully stocked in that. We haven't been fully stocked in probably 2 years. And so that has taken this -- a little longer than we expected but we are starting to see it really start to take off here in the third, and we expect also in the fourth quarter. So we do think that as we think about the pacing, third quarter should be improved, fourth quarter should be strong.

Okay. Just want to be clear that third quarter higher than second quarter and maybe not as much of a step-up in fourth quarter relative to third but still kind of continuing sequentially to grow.

Yes.

Okay, very helpful. And then just last one for me. Maybe for Scott, just looking at the gross margins, they've held steady this first half of the year. Talk to me about kind of where you think those margins will go, particularly as you bring those stem cells back in-house. You add the amniotics, I would assume both carry pretty good margin. So just talk to me about kind of where you see that transitioning?

Sure. Going back to Q1, I think what we sort of laid out is -- e progression on that was an expectation that those would remain relatively constant in Q2 and Q3 with an uptick -- a fairly significant uptick occurring in Q4 as we started really leaning into internally-produced stem cell. I think the one change I would come back on this go around would be that a look back at our inventory in our stem cell in terms of sourced stem cells, and I think we'll continue selling through that for the remainder of Q4. So I don't think we'll see as dramatic of an uptick in gross margins in Q4, although I do expect to see some but I think we'll fully realize that in Q1 of 2025. But I think it will be more consistent in Q3 and Q4 as we round out the year.

Our next question comes from Chase Knickerbocker of Craig-Hallum Capital.

Congrats on the good progress here. Maybe just starting, Sean, on the amniotic side, can you give us an update as you've kind of launched that product now, how you see the bigger opportunity for Xtant to being your direct distribution or those OEM agreements, particularly maybe in wound care, it's a dynamic market. But I'd love to get your -- just get your updated thoughts there on kind of what the largest opportunity is for Xtant?

Yes. No question about the largest opportunity for us will be what we do on the OEM side. And quite frankly, with the agreements that we already have in place, we can't make enough of it, quite frankly. So the biggest issue we have is sourcing the amniotic tissue itself. So that's job one, so getting more in. So -- because there is quite a bit of OEM opportunity. And then we do see that this product line for us already is like $1 million product line. And what's interesting about it, it's only 4 different doctors who use this. And so it's really used as a protective barrier. And so as we have gotten it further out to our own sales force, we're finding more and more of our distribution network that sells a little bit here, a little bit there. And here, we have a really great product, and we can afford much, much better margins than we have in the past or at least I should say, much better commissions than we have in the past. And so this may be a product line that will surprise us and we'll see what it is. But we know right away as a $1 million product line, where we are making, say, 50% margins, we're now making close to 90% margins on that same product line. So it has a nice drop-through. And on the OEM side, it's a terrific contribution margin drop through. So maybe not so much on the gross margin side but definitely on the contribution side.

Got it. And kind of maybe talk about what you're doing on the supply side to source more placentas. I know it takes a while to build those relationships. Maybe just speak to how you're trying to up production there.

Well, the good news is that our relatively new COO, Mark Schallenberger, had come from that side. He had worked with a competitor a couple of years back that had grown very, very fast in this amnio world. And so Mark certainly has relationships. It's now just getting more of those agreements signed, and so we get more coming through. But it's -- one of the other things too about Mark, Mark has just an impeccable reputation within that world. And that matters because there are some guys out there that aren't necessarily to have such terrific reputations. And so I think through that, we will be able to get more and more of those placenta donors in. And so yes, that's literally right now is our most limiting factor.

Got it. And then Scott kind of answered this partially in his last answer. But on the stem cell side, kind of how should we think about supply that you guys will have available soon after the launch of that product? It sounds like it's going to be a phaseout of the sourced product. But maybe just talk to how quick you think you can get inventory there to meet all of the VBM demand that you have today and then potentially unlock demand that you're supply constrained from addressing today?

I'll jump in, and Scott, if you want to add some color to this, that would be great. So two things, yes, we will absolutely be able to manage our own demand, which, again, is terrific as now we're selling a product that again in the high 80s, low 90% margin product versus the 60% margin product that we source today. So that is absolutely fantastic. Now where we see also some really terrific opportunities that's what's taking place on the OEM side. And so we're very, very -- because we were in this position. We don't want to necessarily bring on anybody that we can't be fully -- to be able to meet all of their needs. And so today, we have 3 groups that are signed up as we speak, that are patiently waiting as we roll out our new product line here. But we're -- we -- the volumes that they're projecting for us right now are ones that we can manage. And they're ones that's on top of, first and foremost, we have to feed ourselves and then we're going to take care of the OEM opportunities, but we're not going to overstretch our capabilities. But there is, quite frankly, quite a bit of opportunity that's out there. So as we get better at this and we are able to become more efficient with our production, we will be looking to expand that OEM opportunity too.

Got it. And is it going to take a little bit of time to ramp up that production? Or again, just how soon after the launch of the product, would you expect to be able to fulfill your demand and then start to chip away at this OEM opportunity? Is it fairly short? Is it a couple of quarters, et cetera?

Yes. Great question. And as Scott had mentioned, we have -- happily, we now have as much stem cells as we could sell throughout the year, which is both a good and a bad thing. So for our own product line, we're going to be good. So right now, our initial focus will be to start fulfilling those OEM opportunities. And so we think that by doing that, -- and just, again, the ramp up of any kind of production over the course of literally the next 3 or 4 months, we'll be in really terrific shape come really Q1 of 2025 when we're actually producing our own products as well. So this year, what you're going to see from us, and this is a little bit of why Scott was saying that our margins may not be as high because we won't be selling -- our gross margins won't be as high because we won't be selling as much of our own stem cell products but we will be selling a hell of a lot of stem cell products to OEM guys. And so that, again, the contribution margin is really nice because there's not a commission tied to that. And so that's something, at least from our side, where we don't get it on the growth side, we will get it on the overall profit side.

Yes. Okay, that makes a lot more sense. And then Ryan touched on it briefly. I just wanted to put another finer point on it. I hear you on the organic growth number but looking at the hardware number here, it seems pretty clear that, that cannibalization that you're talking about is hiding some pretty good growth that would otherwise probably be organic. So can you maybe just talk to what kind of in the hardware bucket is really working and you're really encouraged by?

Yes. So when you look at -- here's a great example. So when you were to look at any of our competitors who sell spine fixation, most of them have -- their pedicle screw systems will sell anywhere from 40% to as much as 50% of their overall revenue. The old X-spine business was less than 13%. So it was a really, really, really dated line. So the pedicle screw systems that we've brought over from Surgalign right away has helped us considerably because that is a -- it can be a very impactful product line. And then when you throw in Cortera on top of that and the kind of growth that we're starting to see from that, this past quarter, we had more users, the month of June was our highest amount of revenue that we've had in that particular product line, and it only continues to climb. And so then as we add the MIS part to this in September or late September, we really feel that the Spine Fixation business is going to profitably contribute to our business and to our growth in a nice way.

Got it. And then just last one for Scott. Great to hear on the expectation for positive operating cash flows in Q4. Maybe just speak to expectations from there, is that sustainable cash flow breakeven? How are you thinking about that as we exit the year?

I would say that I don't expect that to be the case in Q1 simply because there is a comp payout in Q1, but I would suspect that thereafter that, that would sort of be the expectation as we look at cash flows from operations.

[Operator Instructions] I am seeing no further questions, I'll throw the call back over to our hosts.

Great. Thank you, operator. We made great progress in the second quarter and first half of 2024. As we progress through the remainder of the year, we believe there are 3 key drivers for Xtant to become a self-sustaining company. One, build our own biologics. This is a big quarter for our internal development team. The more we produce of our own highly profitable biologics, the less we'll rely on other manufacturers' supply chains. We believe this one step alone will help us get to positive operating cash flow in Q4. Second thing, optimize the integration of the businesses we bought last year. We see great growth opportunities and more opportunities to leverage costs. And then three, continue to drive the 4 pillars of growth. This formula has worked for Xtant, and we plan to continue to drive growth through these pillars. In closing, I want to reiterate our mission of honoring the gift of donation by allowing our patients to live as full and complete a life as possible. I appreciate the dedication of our valuable employees, without them, our success and achievements would not be possible. Thank you for joining us today and for your continued support.

That concludes today's conference call. Thank you for attending.