Alphatec Holdings, Inc.
Q2 2019 Earnings Call Transcript

Published: 25 Jul 2019

[Operator:]

Good afternoon, everyone and welcome to Alphatec's Second Quarter 2019 Conference Call. We would like to remind everyone that participants on the call will make forward-looking statements. These statements are based on current expectations and are subject to uncertainties that could cause actual results to differ materially. These uncertainties are detailed in documents filed regularly with the SEC.During this call, you may hear the Company refer to reported amounts, which are in accordance with U.S. GAAP as well as non-GAAP or pro forma measures. Reconciliations of non-GAAP measures to U.S. GAAP can be found in the supplemental financial tables included in the press release, which identify and quantify all excluded items and provide management's views of why this information is useful to investors.Joining us on the call today will be ATEC's Chairman and CEO, Pat Miles; and CFO, Jeff Black.Now I will turn the call over to Pat Miles.

[Patrick Miles:]

Thank you very much Sydney and welcome everybody to the Q2 conference call. When we pivoted this company we knew that there are several things we have to do to make this a growth company. Really the first thing was to create a new team. And so just to refresh everybody's memory, we turned over a 100% of the executive team, 90% of the Board and 75% of the company. This truly is a new organization.We also knew that if we're going to create this growth company what we have to do is distinguish ourselves clinically and hence created a -- an organic innovation machine. And we realized that in the entire process that our focus have to be in the operating. And so when you look back and say, gosh, do we do those things? I think yes, I look forward now and say, at 2019, how do we do? And how are we with regard to those commitments that we’ve made.And so the commitments we made for 2019 included

[Jeffrey Black:]

Great. Thank you, Pat. Good afternoon, everybody. I will spend just a few minutes reviewing again the revenue results. Talk a little bit about gross margin, the P&L and then wrap up with the balance sheet.On revenue, U.S revenue growth from our strategic distribution channel, as Pat mentioned, was ahead of plan for the second quarter and for the first half of the year. We are seeing this growth on the strength of new product introductions, continued surgeon adoption, increase in revenue per case. And while slower than anticipated, we did see a continued wind down of our legacy distribution revenue as part of our planned transition of that channel. This headwind will continue in 2019. We still have about 12% of our U.S revenue contribution coming from what we consider a highly unpredictable channel.Revenue from our international supply agreement continue to decline consistent with our expectations as our supply relationship with Globus winds down in the next one to two years. Overall, Q2 revenue results above expectations. We are continuing to be encouraged by the performance of our strategic distribution channel.We will continue to see some lumpiness and unpredictability at our legacy distribution channel. But our revenue guidance updated $100 million to $104 million in U.S revenue, represents up to 24% year-over-year growth from -- in product revenue and up to a 39% or 39%, 40% decrease of -- I’m sorry 39% increase in our -- from our strategic distribution channel. So encouraged by performance and encouraged by the outlook for the second half of the year.On margin, U.S gross margin or gross profit of $18.8 million in absolute dollars was our highest level of gross profit since 2016. Year-over-year on a GAAP basis, our gross margin percentage decreased by about 360 basis points to about 72% compared to Q1 of 2018. However, on a non-GAAP basis, excluding non-cash obsolescence charges, our year-over-year gross margin improved by 310 basis points to nearly 81%, and this is on the strength of new product introductions.As we reported in Q4 and in Q1, we saw margin pressure much like we did in Q2 from non-cash obsolescence related to our legacy products. We expect to see continued margin pressure over the midterm as we introduced new products and obsolete these legacy products. So we think a non-GAAP view of gross margin is a valuable metric to track through this transition. At scale, we continue to believe that our gross margin will be in line with our peers in the mid 70% range.On the P&L, a couple of highlights on operating expenses. Our operating expenses here we present on a non-GAAP basis to reflect what we consider normalized R&D and SG&A and that excludes stock-based compensation, litigation expenses, restructuring and other nonrecurring or one-time charges or gains. As we continue to talk about, we continue to invest in our product pipeline, reflected in an increase in R&D expense in both absolute dollars and as a percentage of revenue in the second quarter compared to last year.And we do expect the continued investment to support new product launches and longer-term product development, as well our SG&A increase in absolute dollars and as a percent in the first quarter as compared to last year. Most of this increase is driven by variable sales compensation, which is tied directly to revenue increase.We’ve also made strategic investments in product marketing and the broader sales channel. In fact our core G&A expenses, which is including SG&A have actually remained relatively flat over the past six quarters. Still well below where we exited 2016 when we initiated the company's transformation. So we will continue to invest in the sales channel where we should start to see SG&A expense leverage in 2020 as we see continued revenue wrap from our 2019 product launches.So now that we’re several quarters in the transformation of ATEC, we thought it would be helpful to look back and where we began and where we are today. This historical look is a bid of an eye chart, but a few relevant points to highlight. First, is our commitment to drive revenue growth. It's coming to fruition now. In the first Quarter 2019, we delivered our largest U.S revenue quarters since the first quarter of 2017.Second, we are delivering our commitment to transition the sales channel to scalable committed strategic distribution partners. Revenue growth from this channel was now far outpacing declines from the nonstrategic channel. We’ve walked away from legacy unpredictable nonstrategic kind of relationships, which is clearly then a revenue headwind. That we exited the first quarter 2017 with an annualized run rate, about $44 million from this channel, representing more than half of our U.S revenue. And we exited Q1 of 2019 with about $12 million and annualized run rate, which represents less than 15% of our U.S revenue. So the transition is coming -- has come to fruition.It's been lumpy and at times painful. But it's a decision that set us up to -- for growth from the right strategic long-term partners. And finally, we’ve invested for growth. Our view is grown from 5% of revenue in 2017 to about 12% today, and our SGA -- SG&A growth is primarily been strategic investments in sales, in product marketing. All of these investments have enabled the growth trajectory we are seeing today.And finally on the balance sheet before I turn the call over to Pat. We ended the quarter with just $18.5 million in cash. Our operating burn decreased from $9.2 million in the first quarter to $8.5 million in the second quarter. We continue to hold the line on operating cash use, but we also continue to expect 2019 to be an investment year as we support new product launches with CapEx, for new instrument and implant sets and expand our sales channel.During the second quarter, we made a $10 million draw in our credit facility with Squadron and we’ve $20 million remaining on that line, and what we’ve realized, we have some work to do on the balance sheet. We are well-positioned now to execute on the business and approach financing solution the more strategically and opportunistically.And with that, I would like to turn the call back over to Pat.

[Patrick Miles:]

Thanks much, Jeff. I think as much as anything, I think you’re seeing the resolution of the level of predictability that we're trying to bring to this company. And to step back for a second and look at the marketplace, I think so often people see the spine market, which is a big mistake of being commoditized. We believe that they are misreading in this marketplace. And certain items may appear within the context of spine devices as being commoditized but spine surgery is far from predictable which creates an unbelievable opportunity for us to innovate. And that is why the spine market needs a new ATEC.So, Q2 would suggest that we're making solid progress on our priorities, I think the innovation -- the organic innovation machine continues to reflect success in all three of our core priorities for the organization, which is creating clinical distinction, compelling surgeon adoption and revitalizing the sales channel. And so we deem ourselves. The most experienced students in spine and on our way to building a very formidable organization.And so, with that, that concludes the presentation; and would welcome questions.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from the line of Brooks O'Neil with Lake Street Capital. Your line is open.

[Brooks O'Neil:]

Good afternoon, guys and congratulations on the terrific progress you’re making.

[Patrick Miles:]

Thank you.

[Brooks O'Neil:]

I have a couple questions. Obviously, we’re in the seventh month of 2019 and you, I think, introduced or launched formally seven new products. Would you expect sort of the pace of additional new product introductions to get to 12 to kind of go along with that sort of one per month kind of pacing? And do you think there's any remaining products that might be particularly significant to Alphatec going forward?

[Patrick Miles:]

Yes. Thanks, Brooks and I will tell you that there's not an insignificant product to ATEC. And so, I think the one that’s going to most standout is going to be the SafeOp platform and really start to integrate information into surgery. And so we're so reliant upon building spine approaches and so the ability to start to apply technology that integrates with each other such that we're architecting the approach, which will be reflected in convoyed sales. And so, I would say, that’s a big one. There's another one that is part of the InVictus system and it's called single step and that's about a month away. And that's another one that enables a technique within the confines of less invasive fixation that will really be a unique contributor to ATEC. And so when you start to integrate all of these things, what we are doing is we are making surgery better. And when you start to look at companies that I think that have grown over the past several years, it's the ones who have been profoundly focused on what's going on in the operating. And that’s who we are as a company and that's what you will see reflected throughout the year.

[Brooks O'Neil:]

Great. So then, I’m curious, you didn’t talk about it and I know it's sort of forward looking. But given that you prepared for and you’re on track to launch 12 new products in 2019, can you say generally, or with any degree of specificity what the outlook might be for 2020? Should we expect continued organic innovation from ATEC next year?

[Patrick Miles:]

I think as far as the eye can see our commitment is 8 to 10 products a year. And so when you start to think about what that does to the priorities, what happens is those salespeople who are profoundly interested in providing innovative solutions to their surgeons start to come our way. And so, with all of these feed one another and so as far as the eye can see we will do 8 to 10 new products per year. And that's why you start to see and it's fun to see the reflection of that in the financial metrics that Jeff presented is you start to see an increase in the R&D spend and then now what we are going to do is, we are going to appreciate the requisite for it.

[Brooks O'Neil:]

Yes, that’s good. And then just the last question, I had was, obviously, and I understand the importance of SafeOp and I’ve some sense that is not going to be a tremendous revenue generator. So can you talk just a little bit about SafeOp specifically in terms of revenue and contribution then how you see SafeOp driving revenue growth from other products that you’re producing today or innovating in the future to drive faster growth from ATEC going forward.

[Jeffrey Black:]

Yes. Thanks, Brooks. There's a bit of a interesting situation in Spine and that implants are the currency items, and they are the ones that generate most of the currency. The challenge is that currency that's been defined and what the surgeon requires to do predictable surgery are not one and the same. And so what happens is, a lot of companies won't create the requirements of surgery because financially they don't appear as viable. But I think as you look at things with regard to a procedure and the integration of the tools being used to fulfill a specific surgical need, what you see is you see the expanse of the currency items based upon the ability to deliver clear, objective, actionable information. And so, the opportunity there's that you will see a vast minority in the contribution from the SafeOp platform, but it will be responsible for the revenue gained, if you will.

[Brooks O'Neil:]

Yes. Okay, great. I've got it. Congratulations. Keep up all the good work.

[Patrick Miles:]

Thanks a lot.

[Jeffrey Black:]

Thank you, Brooks.

[Operator:]

Thank you. And our following question comes from the line of Swayampakula Ramakanth with H.C. Wainwright. Your line is open.

[Swayampakula Ramakanth:]

Thank you. Congratulations, Pat and Jeff. A couple of quick questions. So, obviously this quarter, the growth is quite interesting. Not only that, you also updated your outlook, financial outlook for the year-end coming out with $104 million to $109 million, obviously, higher than what it was in the previous guidance. But when you look at the 6-month revenue run it is basically kind of annualizing where you are at this point, at least on the bottom end of the range that you're giving us. So what are the pushes and pulls for that number to be north of that range, if it can -- what needs to get done, so that we can see that kind of a year-end number? So I’m talking more like a $110 million or $112 million kind of a number, what needs to happen? And also what could be potential challenges even to get to $104 million and if need to kind of think through that.

[Patrick Miles:]

Yes, RK, I’m going to let Jeff speak to some of the numbers directly, but one of the interesting dynamics is this company has been historically one that I would suggest it's not been as predictable as we would wanted to be. And so what we are trying to do is be exceedingly thoughtful with all of the -- trying to weigh the -- all of the headwinds and all of the tailwinds. And so, we feel like growing at 20% to 24% in the U.S marketplace is meaningful growth. And so as we start to look at what's transpired in the first half of the year and where we are, we felt like that was reasonably aggressive. The other thing is we still suffer from some of the uncertainty associated with the non-strategic legacy distribution. And so where it's probably done a little bit more than we expected in the front half of the year. Candidly, that's the part that creates some unpredictability forward. And so our desire is to be thoughtful stewards of our growth. And since we're going to be at this for a long time, we just want to be methodical. Jeff, you want to add?

[Jeffrey Black:]

Yes, RK, look, I think when you think about first half last year versus this year, so admittedly last year, we bottomed out on revenue, right? And a lot of it, we were just really beginning the transition from shedding the legacy distribution and ramping up strategic distribution. So, I think, the baseline or the denominator in the first half was much -- a little easier than it would be in the second half. I think, when you look at the second half on our guidance, we are still projecting on the dedicated or the strategic distribution 30% growth year-over-year. So we will continue to see headwinds, but we still believe that there's a real opportunity to continue to ramp the strategic distribution. But at the same time, we're aware that there will be continue to be headwinds.

[Swayampakula Ramakanth:]

Okay. Thank you for that. So the other -- the longer outlook that we have been talking about is the 2022 outlook that we are talking about. So, at this current growth rate of about, let's say, 17% or the middle of the range that you provided us today, obviously it has to be a little bit north of that just to get to that number. So for that to happen, what is -- how are you placing Alphatec in the marketplace such that you gain market share across the various product categories so that you can either maintain the 17% or actually go north of that 17% and what are the long-term strategies that you as a management have started and are trying to work through it so that we can kind of keep -- I was also looking at it as metrics going forward.

[Patrick Miles:]

Yes, I think the key thing in what we're trying to really be clear about is the contribution by new products. And what will happen to this company is, we will continue to do new product development and add products that are relevant to specific approaches that address specific pathology. And so what you will see is you will see a turn in from a new product company to an approach company. And what that will mean, reflectively will be you will start to see more and more products used within the context of a specific surgery. And so we believe that we will compel people and so we will need the right sales force and we will need to compel the surgeons. But what we will see is through this new technology, we will expand the opportunity not only from a number of products used, but also the number of cases done based upon the unique innovation that’s created within the context of those assembled products.

[Swayampakula Ramakanth:]

And also, are there any cost cutting strategies being put forward or because, as you said, if you have to get to a certain growth rate, you also have to spend in terms of getting the right sales force in place and also get the right message out there. But at the same time, you don't want to lose your sight on the bottom line. So is there anything that you are doing towards that end as well or would bundling some of these products help in improving the operating margins?

[Jeffrey Black:]

Yes. Okay. This is Jeff. I will answer that. So I think just from a cost structure perspective, when you look at the G&A load on the company, that's remained been pretty stable for the past, really seven or eight quarters. In fact, it's lower today than it was when we started this transformation. So, I would say, we've got G&A pretty dialed in. I would also say that keep in mind that a significant portion of our OpEx is variable selling, right? And so, we are going to continue to make investment in the sales channel and product marketing. We have to continue to make investments in R&D to keep the pipeline where it needs to be. And it really -- to us it's about ensuring that we are growing the top line and that we are controlling the fixed portion of costs that don't directly contribute to revenue.

[Swayampakula Ramakanth:]

Okay. Thank you. Thanks for taking all my questions.

[Jeffrey Black:]

Thanks, RK.

[Operator:]

Thank you. [Operator Instructions] And there are no further questions at this time. I would now like to turn the call back to Pat Miles for any further remarks.

[Patrick Miles:]

I just wanted to say thanks to the level of interest out there on the ATEC. Clearly there's an undercurrent enthusiasm about the company and I just want to thank everybody for their time. Take care.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.