ELUT - NASDAQ

Good day, ladies and gentlemen. Welcome to the Aziyo Biologics' Second Quarter 2023 Financial Results Conference Call. [Operator Instructions] Please be advised that today's conference call is being recorded. I would now like to hand the conference over to Matt Steinberg of FINN Partners.

Thank you, operator, and thank you all for participating in today's call. Earlier today, Aziyo released financial results for the quarter ended June 30, 2023. A copy of the press release is available on the company's website. Before we begin, I'd like to remind you that management will make statements during this call that include forward-looking statements within the meaning of the federal securities laws, which are pursuant to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. Any statements contained in this call that do not relate to matters of historical facts or relate to expectations or predictions of future events, results or performance are forward-looking statements. All forward-looking statements, including, without limitation, those relating to our operating trends, future financial performance and expectations for our product development and sales are based upon our current estimates and various assumptions. These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by these forward-looking statements. Accordingly, you should not place undue reliance on these statements. For a list and description of the risks and uncertainties associated with our business, please refer to the Risk Factors section of our public filings with the SEC, including Aziyo's annual report on Form 10-Q for the quarter ended June 30, 2023, to be filed with the SEC, accessible on the SEC's website at www.sec.gov. Such factors may be updated from time to time in Aziyo's other filings with the SEC. The conference call contains time-sensitive information and is accurate only as of the live broadcast today, August 14, 2023. Aziyo disclaims any intention or obligation, except as required by law, to update or revise any financial projections or forward-looking statements, whether because of new information, future events or otherwise. And with that, I will turn the call over to Aziyo's CEO, Randy Mills.

Thank you, Matt. Today, I will discuss our second quarter results and the progress we continue to make on our strategy to transform Aziyo into a drug-eluting biomatrix company. Matt Ferguson, our CFO, will then discuss our financial results in more detail. After that, we'll open the line up for your questions. First and foremost, I would like to address the recent events surrounding our viable bone matrix products within our Orthopedics business. Patient safety is and always will be our priority. Patients are at the heart of our organization's mission and motivate us each and every day. Last month, we were contacted by the Centers for Disease Control regarding a patient who had developed symptoms consistent with mycobacterium tuberculosis or MTB infection, following the implantation of one of our viable bone matrix. We immediately initiated a voluntary withdrawal of these products and opened an investigation in cooperation with health and regulatory authorities. A review of the production records indicated that samples from the specific lot of bone matrix have been tested and found negative for MTB prior to release. This prerelease test is part of our standard operating procedures and exceeds guidelines set by both the AATB and FDA. It was also conducted by an independent laboratory using a nucleic acid assay specific for MTB. So far, additional testing of this same lot, both by independent laboratories as well as the CDC, have not detected the presence of MTB via either nucleic acid testing or culture methods optimized for TB. We continue to work closely with the FDA and the CDC to further investigate the circumstances surrounding this event. Now let me turn to our progress of transforming Aziyo into a high-growth drug-eluting biomatrix company. As previously communicated, we are focusing the company on what we believe to be our highest value-creating assets, namely CanGaroo and SimpliDerm. Here's what we are doing to make this vision a reality. First, we signed an exclusive distribution partnership with LeMaitre Vascular for our Cardiovascular product lines. And as you can see from our second quarter results, the partnership is off to a strong start. Second, we engaged an investment bank to help divest our Orthopedics business. We have received strong interest and are negotiating multiple LOIs at this time. We are working through the process to find the best home for this business, one where the acquiring entity appreciates the value of our stellar Orthopedics team. Our goal is to get this divesture wrapped up as quickly as possible. These moves enable us to focus on what we think will drive both short- and long-term value for the company, our drug-eluting biomatrix technology. This is our unique and proprietary platform that combines the benefits of biological matrices for soft tissue repair with powerful drug-eluting activity designed to target specific surgical needs. We are building this platform on 2 established biologic product lines: CanGaroo, our extracellular matrix product line for CIED placement; and SimpliDerm, our acellular dermis product line used in breast reconstruction. Both are safe, sterile and ready-to-use implants with years of clinical data to support their use. Our most advanced drug-eluting biomatrix product is CanGaroo RM, for which we hope to have cleared in the first quarter of 2024. CanGaroo RM should be the second entrant into the drug-eluting pouch market for pacemakers and implantable defibrillators. Currently, the only antibiotic-eluting pouch on the market is TYRX, a synthetic product marketed exclusively by Medtronic. Medtronic acquired the product line for approximately $200 million back when TYRX was early in its launch. Since the acquisition, Medtronic has done a nice job developing the market, and it's now estimated that worldwide TYRX does between $200 million and $300 million in revenue and currently addresses about 1/3 of the U.S. market. Because of these dynamics, we think that CanGaroo RM will become a highly valuable asset that can help capture, not just pouch, but CIED market share for a strategic partner. We also think that it is a product that physicians will prefer, given the benefits of a biologic envelope that turns into a patient's own healthy tissue instead of one made from a synthetic polymer. Therefore, we believe that the approval of CanGaroo RM should represent the creation of several hundred million dollars of value for Aziyo, making it our greatest near-term opportunity. And behind CanGaroo RM, we see a similar opportunity for our SimpliDerm product in breast reconstruction. Given that background, let me provide a more detailed update on our progress towards obtaining FDA clearance for CanGaroo RM. We had previously submitted a 510(k) for CanGaroo RM that resulted in the issuance of a Not Substantially Equivalent or NSE letter. The silver lining of that letter is that we were given the explicit list of outstanding items needed for us to demonstrate substantial equivalence and to gain market clearance. In total, there were 4 items listed. 2 were administrative in nature. The FDA requested that we provide them with information on a test method and requested a few specific document numbers. The other 2 items that were more substantive in nature related to our in-vitro elution method performed as a quality control step in the device manufacturing process. This test is used to show a consistent rate of drug release from batch to batch. FDA requested that we, one, develop an accelerated IVE method that can be completed within 48 hours or less; and two, establish lot release criteria of greater than 80% elution within that time frame. Now this is challenging for an extended release product such as CanGaroo RM, since the product is designed to elute the drug over days and weeks, not hours. So to better understand this request, we met with the FDA soon after receipt of the NSE letter. And FDA provided helpful clarification in their request and expressed to us that their interest was in the tool to assess lot-to-lot variability that ensured the label claim was represented accurately. Importantly, they did not have concerns about the actual in vivo performance of the product. FDA also clarified that certain conditions could be adjusted to facilitate the acceleration of the test and provided options, such as changes in pH, the addition of detergents and agitation that were acceptable to the agency. With this information, the teamwork could generate elution profiles under these accelerated conditions. For the sake of time, and because they represent new intellectual property, I'll spare you the details, but here's what matters. This graph represents a curve that we had under the original conditions. Notice that the curve plateaus in the 70% range with 48-hour results of only 75% drug release. Now here's a curve that we were able to create under the accelerated conditions. As you can see, drug release exceeds 80% -- exceeds the 80% threshold by the 24 hours and reaches 93% at 48 hours. We believe this new method to be fully responsive to FDA's request and are now in the process of completing the work necessary to put the new test into practice. We will be discussing this data with FDA prior to resubmission to make sure our filing is fully responsive to their needs. We expect to have all of this work completed, compiled and submitted for review by the end of the year. Since the review clock for the 510(k) is 90 days, and we are only updating the specific items in the NSE letter, we hope to gain clearance sometime in the first quarter of next year. We will, of course, provide you with updates along the way. And with that, I'll turn the call over to Matt Ferguson, our CFO, for the financial update.

Okay. Thanks, Randy. For the second quarter, we generated net sales of $10.3 million as compared to $12.6 million in the corresponding prior year period. The Q2 2023 result included a revenue reversal of $3 million in our Orthopedics business related to the viable bone matrix recall and market withdrawal. In our other 3 segments, growth was led by our SimpliDerm product line with a 32% increase compared to Q2 2022. Sales of our CanGaroo product line in our Device Protection segment were relatively consistent versus the prior year quarter, despite the significant reduction in sales headcount that we implemented earlier this year. Lastly, we completed the handoff of our Cardiovascular products to LeMaitre Vascular during the quarter. This resulted in a significant increase in volume, but largely a distributor transfer pricing rather than the previous end-user pricing. We're really pleased that the LeMaitre partnership is off to a good start. It's allowing us to focus on the higher growth parts of our business, and we believe it will also improve the bottom line contribution from this Cardiovascular segment. Gross profit for the second quarter of 2023 was $1 million and gross margin was 9.5%. The substantial decline in gross profit and gross margin was directly attributable to the viable bone matrix recall and market withdrawal, which decreased gross profit by $5 million and gross margin by 35 percentage points. Total operating expenses were $10.1 million for the second quarter of 2023 compared to $13.1 million in the corresponding prior year period. We realized nearly $4 million of expense reductions across sales and marketing, R&D and G&A, primarily as a result of organizational streamlining, enabled by our strategic partnerships with LeMaitre and Sientra as well as reduced spending on CanGaroo RM development as that project approaches completion. The decreases were offset by approximately $900,000 in increased FiberCel litigation expense, which, to date, has been covered by insurance and therefore has not resulted in cash outlays by the company. Factoring in all of the above, our net loss in the second quarter of 2023 was $10.6 million as compared to $9.4 million in the corresponding prior year period. As of June 30, 2023, our cash position was $9.3 million. This reflects cash usage of $2.5 million for Q2, down significantly from $5.2 million for the first quarter of 2023. With the loss of revenue from our viable bone matrix products, we do expect cash burn to increase somewhat in the current quarter, but we expect to moderate that impact through ongoing optimization efforts across the business and continued growth in our SimpliDerm and CanGaroo product lines. We look forward to sharing these results as we continue to execute on our growth strategy in coming quarters. And that concludes our prepared remarks. Operator, you may open the line for questions.

[Operator Instructions] We have a question coming from the line of Ross Osborn with Cantor Fitzgerald.

Congrats on the progress on the RM resubmission. So starting off on the product recall and regarding the $3 million in reversal of revenue related to VBM during the 2Q, does this reflect an entire quarter's worth of revenue and a good way to think about the loss revenue for the 3Q and 4Q, assuming the business is not divested?

Ross, that's exactly right. The recall reflected the outstanding viable bone matrix product for the quarter and sales associated with that, and that is just about the amount for the entire quarter. So in terms of ongoing reduction in that segment of the business, that is about the right assumption going forward.

Okay. Got it. And then turning to your partnerships. Where do you believe LeMaitre and Sientra's sales teams are in terms of productivity levels and selling your products?

Ross, this is Randy. So LeMaitre is further ahead, obviously, because they've started the transition process and are further along into it. And they're doing -- I think they're doing a beautiful job and either at or beyond where we had expected and hoped they would be. So we're really excited about the LeMaitre partnership. We're also super excited about the Sientra partnership, too. It's just much, much earlier on. That is a partnership that, as we said on previous calls, would really start launching the product in the second half of this year. And with that said, even more so in the fourth quarter than in the third quarter. We do love their coverage. And so they do represent a very significant increase in surgical coverage for us, actually about fivefold increase in surgical coverage for us as they get up and running. But I would be remiss if I didn't congratulate the existing team on what, again, was another blowout quarter, another 32% increase, and that was done by the existing team. So we're super excited about both of those partnerships. LeMaitre is well underway, and Sientra is getting up and running. And our existing commercial team, both for SimpliDerm as well as our team for CanGaroo are doing beautiful jobs as well.

Got it. And then last one for us. One of your goals for '23 is to strengthen your relationship with Boston Scientific regarding the synergies between their CRM products in your current CanGaroo offering. Do you have any update there on how that's going?

Yes. So we had a great meeting at the Heart Rhythm Society meeting in New Orleans where we were at. There was a lot of data that was presented around CanGaroo and the clinical benefits of CanGaroo in CIED placements. I think it got the attention of a number of clinicians, but it also got, I think, the attention of representatives at Boston Scientific. And I think there was a -- sort of a light went off and said, hey, this actually could be a pretty strong offensive tool. And so with that said, I mean, again, as we think about the use of CanGaroo. CanGaroo is a great product in and of its own right, but its -- tremendous value comes from its ability to help drive CIED business. And so we really like the leverage that it's able to bring. We think there's sort of a light went off said, we can actually use CanGaroo and then, to a much greater extent, CanGaroo RM, to really help guide cardiologists' preference around the actual placement of the pacemaker or defibrillator. So with that said, coming out of that meeting, it actually led to additional interaction between the leadership of Aziyo and Boston Scientific. And our Head of our CanGaroo business regularly participates with the commercial organization at Boston Scientific on their different strategy and tactic meetings. So very good partnership, very good relationship on our current CanGaroo business. And really, we look forward to the work -- to getting the work our R&D teams have now done to get the rest of the questions buttoned up on RM, so we can get that product in front of FDA and get a really, really great drug-eluting biologic on the market.

If I could just add one thing to that, Ross. I think it kind of combines your previous question about LeMaitre and Boston Scientific. The fact that this is now the first quarter, Q3 that is, it's the first quarter where the focus of our sales force is really 100% on CanGaroo as opposed to selling the cardiovascular patch products. We're already starting to see the benefit of that. So while we're really pleased with what LeMaitre is doing with the cardiovascular business, it's also having associated positive effects on the CanGaroo business as a result of the additional focus there.