Xtant Medical Holdings, Inc. (XTNT) Q3 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Xtant Medical Third Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Miss Laura Kendall, Interim CFO for Xtant Medical. Thank you. You may begin.

Thank you. Good morning. Thank you for joining Xtant Medical's Third Quarter 2017 Earnings Call. My name is Laura Kendall and I am serving Xtant Medical as Deputy Restructuring Officer. Joining me today for the conference call will be Carl O'Connell, Chief Executive Officer for Xtant. Yesterday afternoon, Xtant issued a press release announcing third quarter 2017 financial results. Today's call is being webcast and includes a slide presentation. The recording will be posted to the company's website for playback. We expect the duration of the call to be approximately 30 minutes. During the course of this call, management may make certain forward-looking statements regarding future events and the company's expected performance. These forward-looking statements reflect Xtant's current perspectives on existing trends and information and can be identified by such words as expect, plan, will, may, anticipate, believe, should, intends and other words of similar meaning. Any such forward-looking statements are not guarantees of future performance and involve risk and uncertainties, including those noted in the Risk Factors section of our most recent annual report on Form 10-K. In addition, any unaudited or pro forma financial information is preliminary and does not purport to project the future financial position or operating results of the company. Actual results may differ materially. For the benefit of those of you who may be listening to the replay, this call was held and recorded on Wednesday, November 22, 2017, at approximately 9 a.m. Eastern Time. Since then, the company may have made additional announcements related to the topics discussed herein. Please reference the company's most recent press releases and current filing with the SEC. The company declines any obligation to update these forward-looking statements, except as required by applicable law. With that, I would like to turn the call over to Carl.

Thank you, Laura. For today's call, I will review the ongoing accomplishments of the company that were achieved in the third quarter as we continue to make significant progress towards our goal of operational excellence. I'd also like to formally welcome Laura Kendall to the call for the review of the quarter financial performance of the organization. For legal advisement, we are not able to field questions following today's call, as we remain in negotiations with a senior lender to restructure the company's debt, and although we remain optimistic that these negotiations will be successful, there are no assurances they will be successful. This ongoing effort includes negotiation amendments to the indenture dated July 31, 2015 and to the additional convertible promissory notes held by Ross Acquisition Offshore LP and Orbimed Royalty Opportunities II, LP, to extend the date for the payment of such interest. We appreciate your ongoing support during this quiet period and look forward to addressing questions as soon as we can. With that, I'd like to review the current state of the organization on our third quarter of business performance. In May, we began working with Aurora Management Partners, having engaged David Baker and his team to initiate and execute restructuring endeavors for improved financial operations and the system processes to support a successful trajectory for profitability of the organization. Collaboration between the Xtant employees and the Aurora team continues to be excellent and are pleased to see the benefits from the relationship and the improved systems that were initiated throughout the first half of the year. I've stated our focus for the second half of this year will be maximizing the company's gross and operating profit while reducing our cost of selling. Last night, we issued a press release announcing $19.8 million in revenue for the third quarter, a decrease of 14% in comparison to the third quarter 2016. Part of the decline is attributed to there being 1 less selling day this quarter versus the comparable quarter of 2016. However, the prime reason for the revenue decline was a shift in management strategy to focus on more profitable sales activities, which includes the elimination of unprofitable sales channel arrangements and positioning the company for long-term sustainability. We've begun to move away from the reseller relationships that have significant price discounts and results in sales and yields very little operating profit. This helps us maintain ASP optimization while avoiding end user customer pricing conflict, increasing our EBITDA as a percentage of revenues. In the similar fashion, we're moving away from distributor partner relationships with above-market commission rates. These arrangements have historically resulted in significant reduced operation profit margins. Simultaneously, we've increased our marketing and development activities, and new relationships which will yield increased profits in the future. Lastly, we analyzed the economics surrounding resell program of the third-party pedicle screw system for a few select customers, and have decided to move away from this unprofitable activity. These are direct results of our sales optimization program introduced earlier this year in an ongoing effort to focus on positioning the company to achieve further profitable growth strategies. As a direct result of the above-mentioned restructuring activities and programs, our EBITDA performance for the third quarter 2017 has improved significantly. Consolidated EBITDA for the third quarter 2017 grew 111% to $1.4 million compared to $672,000 for the third quarter 2016. This improved operating performance largely due to decreased operating expenses as part of our cash conservation efforts which include decreased sales and marketing expenses as well as decreased G&A expenses. Laura will provide additional color regarding the company's EBITDA performance during the financial segment of the call. As a company, we have continued to identify and achieve merger synergies in areas that will maximize our operating efficiencies. As announced on October 6, we made the difficult decision to close our Dayton, Ohio Hardware Distribution Facility, and shift those operations to our Montana facility, consolidating our operations to a single location. After one-time expenses, we calculate this is -- after expenses, we calculate this decision will result in annualized cost savings of over $2 million. I'd like to take this opportunity to commend all of our Xtant Medical teams members located in Dayton, Ohio who are directly impacted by this decision. I'd like to thank them for their dedication and continued support to our company, our partners and our customers for their ongoing commitment to execute a successful transition. In addition, we've engaged an experienced consulting team, who have assisted other orthopedic organizations with managing transition teams following a merger or a facility closure. This team is being working closely with our restructuring team to help ensure this process is executed with minimal disruption for employees, partners, vendors and the customers. Our sales organization under the leadership of Chris Valois is continuing to define our strategic focus in the regenerative care space. A proprietary line of the mineralized allografts currently makes up 9% of the U.S. DBM market. Xtant saw continued growth of our 3Demin fiber product line with 16% year-over-year revenue growth. OsteoVive continues to grow rapidly with sequential quarterly double-digit revenue growth with 30% -- 37% increase with the 705% revenue increase over the third quarter of 2016 when the product line was first introduced. When looking at the third quarter 2017 performance of our combined portfolio based on revenue split, Biologics produced products represent 64% of our total Q3 2017 revenue and fixation products accounted for 36% of the total. For the third quarter of 2016, Biologics products accounted for 51% of the total revenue and fixation products accounted for 49%. We anticipate our future revenue to continue to trend in a similar pattern. The 510(k) clearances that were announced this quarter expanded indications for utilization of fixation products with allograft, providing Xtant with the ability to promote the implantation of OsteoSponge and 3Demin with Calix-C and Irix-A, further supporting Biologics' revenue growth. We also recently announced execution of our private label distribution agreement with curasan, which will add synthetic scaffolds to our product portfolio in 2018. This will help round out our Biologics portfolio allowing us to strengthen our national contract position with many integrated delivery networks and competing networks with pure-play scenarios or institutions looking to consolidate vendors. Additionally, we'd be better positioned for exclusive distribution agreements with distributor partners. While we had various countries that achieve growth in our international business, our overall revenue in this segment declined 16% in comparison to Q3 2016. The majority of the decline was due to changes in regulatory requirements in Germany, requiring for sterile individual packed implants beginning in 2018. As a result, our German partners have forced -- focused distribution efforts on other product opportunities. Additionally, our distribution partners in U.K. and Australia purchased additional fixation systems to expand their business during the third quarter 2016, achieved greater revenues during that quarter. However, we are excited about our progress in many other markets with strong year-over-year growth. Latin America grew 28% with revenue both fixation and Biologics. So Africa expanded their business into new service fixation lines increasing their revenue performance by over 300%, and Canada, with 55% growth which stemmed from increased users of the Silex SI fusion implant system. We've been expanding our focus on international market opportunities as we exit this year into 2018. Within the U.S. sales channel optimization program, we're in the process of expanding our hybrid distribution model. We initiated a direct sales force program in late Q3, which is being focused on recruiting and hiring experienced sales specialists to service areas on which we have strong contractual access to end user facilities and limited distribution representation. This would be a significant focus of the organization over the next few quarters. A long-term goal of this high-performing sales channel strategy is to drive market share in high-volume and currently underrepresented demographics. This will be accomplished through new products being released with the clear focus on customer value creation and engagement at a lower cost of sales. Further support the shift of the hybrid model, 18% of our distribution network is focused on distributing our hardware and Biologics lines and are responsible for generation of approximately 49% of our revenue this quarter, which is consistent with the performance of our distribution channel during the first half of the year. This further supports that our model has room to not only support the addition of direct sales specialists in key demographic areas, it is an opportunity to drive revenue growth and limited channel overlap. Our national accounts team, led by Amy Radtke, has had continued success in Q3, adding over 60 hospitals under contract for hardware and extending and expanding on many of our Biologics agreements. We're in the process of negotiation direct distribution agreements, with some health systems for majority spend commitment and are hopeful that these negotiations will come to fruition in the fourth quarter. As recorded in August, John Gandolfo resigned as Chief Financial Officer of the organization. I'd like to take this opportunity to you to introduce Laura Kendall with Aurora Management Partners. Laura has been working with Xtant Medical since May and is serving as the Deputy Restructuring Officer and Interim Chief Financial Officer until we recruit a permanent CFO. With that, please join me in welcoming Laura to the call to review our third quarter 2017 financial performance. Laura?

Thank you, Carl. As Carl indicated, consolidated total revenue for the 3 months ended September 30, 2017 was $19.8 million compared to $23.1 million of revenue for the same period of 2016, a decline of 14%. For the 9 months ended September 30, 2017, revenue was $63.3 million, a 3% decrease compared to $65.5 million reported for the first 9 months of 2016. As Carl has related, the decline in sales year-over-year as a result of transitioning to collaborative, profitable distributor relationships by reducing sales volume in unprofitable sales distribution channels with high commission structures and reducing -- also reducing channel conflict. There is also 1 less day sales in the 3 months ended September 30, 2017 than in the prior year. Consolidated gross profit for the third quarter of 2017 was $11.4 million or 57.5% of revenue compared to gross profit of $16 million or 69.2% of revenues for the third quarter of 2016. For the 9 months ended September 30, 2017, gross profit was $39.8 million or 62.9% of revenue compared to $44.8 million or 68.3% of revenue. As Carl previously mentioned, a change in sales mix toward Biologics, which carries a lower margin than fixation products, impacted the gross margins. In addition, increases in inventory and surgical instrument reserves in the quarter ended September 30, 2017 of $1.1 million based on current estimates of missing or damaged parts, primarily on consignment and a onetime charge of $900,000 in inventory and surgical instrument reserves related to litigation with the distributor, reduced gross margin for the quarter and 9 months ended September 30, 2017. Operating expenses for the quarter were $14.9 million, a decline of $3 million from the prior year. Operating expenses for the 9 months ended September 30, 2017 were $50.6 million compared to $51.2 million in 2016. When considering the core operating expenses of general and administrative sales and marketing and research and development, these expenses as a percentage of sales were 64.4% in the third quarter compared to 69% in the comparable quarter of the prior year. The reduction in the expenses is primarily attributable to lower commission expense as a direct result of the company moving away from unprofitable sales distributor arrangements with high commission rates. In addition, the company has continued to execute on its cost reduction initiatives in realizing merger synergies in its 2015 acquisition of X-spine, resulting in lower payroll and related expenses such as benefit and travel cost and lower overall operating expenses. Operating expenses would have been lower, excluding a one-time charge of $400,000 in reserves related to net receivables from a distributor with which the company is engaged in litigation. Separation-related expense in the third quarter was $0.8 million, representing the cost associated with headcount reductions in the quarter. Year-to-date, separation expense is $1.4 million. As previously noted, the reduction in personnel relates to restructuring the company for profitable operations, is a key factor in the reduction of operating expenses for the third quarter and year-to-date. In 2016, Xtant recognized acquisition and integration expense related to the July 2015 acquisition of X-spine in the amount of $517,000 in the 3 months and $1,270,000 for the 9 months ended September 30, 2016. Similar expenses were not incurred in 2017. The company defines EBITDA, as earnings before interest, taxes, depreciation and amortization, nonrecurring expenses and non-cash stock-based compensation. EBITDA for the third quarter of 2017 was $1.4 million compared to $672,000 for the same period during 2016. The improvement in the third quarter EBITDA is result of a change in the company's sales strategy towards profitable distributor relationships coupled with expense reductions in commission and payroll related expenses. For the 9 months ended September 30, 2017, EBITDA was a negative $784,000 compared to $700,000 last year, reflecting low margin performance, a higher commission cost structure earlier in the year and higher insurance professional fees and employee benefits in the first half of fiscal 2017. The company reported the third quarter 2017 loss from operations of $8.5 million compared to a loss from operations of $4.9 million in the comparable period last year. The 9-month year-to-date loss is $24 million compared to a loss of $15 million in the prior year. Of particular note, one-time reserves of $1.3 million were recorded against the company's net assets, due from or in the possession of a distributor in litigation with the company, which commenced in the third quarter. Xtant filed a motion to dismiss this case on September 15, 2017 and is awaiting the court's ruling. Interest expense of $3.8 million for the third quarter and $10.5 million in the 9 months ended September 30, 2017 increased $600,000 and $1.6 million over the comparable periods in the prior year. Other expense of $1.2 million for the third quarter and $2.8 million for the 9 months ended September 30, 2017, is comprised primarily of restructuring charges for legal and professional fees related to the company's turnaround strategy. On Monday, November 20, 2017, the company filed a Form 8-K that stated the company's unaudited financial statements for the quarter ended March 31, 2017 and June 30, 2017 should no longer be relied upon because of an error in the quarter ended March 31, 2017 first quarter, pertaining to accumulated depreciation on surgical instruments as of that date. Correcting the error requires a decrease in property and equipment net in the amount of $618,000 and the related increase in cost of goods sold. All such corrections have been properly accounted for in the third quarter 2017 press release and in the Form 10-Q filed yesterday. The company plans to restate the first and second quarter Form 10-Q reports as soon as possible. We refer you to the Form 8-K filing for further information. With respect to our liquidity position at September 30, 2017, we had $2.1 million of cash and cash equivalents, $14 million of net accounts receivable and $24.9 million of inventory. As of today, the company has approximately $2.1 million of funds available to draw down on its delayed draw term loan with Orbimed. Xtant has reduced its account payable from $10.5 million at the prior year-end to $7.4 million as of September 30, 2017. Accrued liabilities of $13.4 million at September 30 rose from $9 million at December 31, 2016, primarily due to the accumulation of accrued interest on Xtant's debt, the payment of which has been delayed as noted in recent amendments of the company's long-term debt agreements. Total liabilities include approximately $70.8 million of convertible debt and $65.6 million under its debt agreements. Our debt agreements include a revenue covenant requiring the company to achieve minimum revenue benchmarks on a calendar quarter basis. A waiver was obtained from the lenders for not achieving the minimum revenue covenant for the third quarter ended September 30, 2017. The minimum revenue covenant is $27.5 million for the fourth quarter ended December 31, 2017. The company does not anticipate achieving this minimum revenue covenant and that does not assure the lenders will provide a waiver of this anticipated covenant violation at this future date. We have classified this debt as a current liability in the September 30, 2017 balance sheet and are in discussions with the lenders to obtain a waiver of this covenant for the fourth quarter. Now I would like to turn the call back to Carl for summary comments.

Thank you, Laura. As outlined in this earnings call, we've made significant strides as an organization, executing aggressively on cost-saving programs, implementing restructuring and operating efficiencies and improving upon our financial processes, all around driving for a more profitable structure in 2018 onwards. We remain optimistic and focused on both the hardware and driving above-market growth for the Biologics business segment, creating market-leading customer value as we move forward with our sales optimization programs with our hybrid sales channel and future surgeon partnership programs. We'd like to thank our shareholders and stakeholders for your continued support and look forward to providing you with an update on our restructuring efforts once discussions with Orbimed are finalized. Thank you.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.