Alphatec Holdings, Inc.
Q4 2008 Earnings Call Transcript

Published: 3 Mar 2009

[Operator:]

Good day and welcome to the Alphatec Spine Incorporated fourth quarter fiscal 2008 financial results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to the Mr. Peter Wulff, Chief Financial Officer. Please go ahead, sir.

[Peter Wulff:]

Okay. Thank you and good afternoon everyone. Welcome to Alphatec Spine's conference call to discuss our fourth quarter and fiscal year ended December 31, 2008 financial and operating results. With me today are Dirk Kuyper, President and Chief Executive Officer and Ebun Garner, General Counsel. By now you should have seen the copy of today’s press release announce our fourth quarter and fiscal year 2008 financial and operating results. If you do not have a copy of today's press release, you can find it in the Investor Relations section on our website at www.alphatecspine.com. Before we start, there are a couple of items we would like to cover. I would like to remind you that this call is being webcast live and recorded. A replay of the event will be available later today, on our website and will remain available for at least 30 days following the call. We would like to remind you that our discussions today include forward-looking statements. These statements are based on certain assumptions made by us based on historical trends, current conditions, expected future developments, including business prospects, product development objectives, future financial performance and other factors we believe to be appropriate in the circumstances. Risks and uncertainties may cause our actual results to differ materially from these projected and these forward-looking statements. You can find a discussion of these factors and more information about us in our filings with the SEC, including the risk factor section on our annual report on Form 10-K and subsequently, quarterly reports on Form 10-Q and periodic filings on Form 8-K. These forward-looking statements are made as of the date of this call and we assume no obligation to update these statements publicly, even if new information becomes available in the future. This broadcast is covered by US copyright laws and any use or rebroadcast of all or any portion of this conference call may only be done with our expressed written permission. I will now hand the call over to Dirk Kuyper, Alphatec Spine's President and CEO.

[Dirk Kuyper:]

Thank you, Peter. Good afternoon and thank you for joining us today. As most of you know, we previously preannounced our fourth quarter 2008 revenue performance on Tuesday, January 13th of 2009. At that time, we announced continued record revenue growth, preliminary 2009 revenue and EBITDA guidance, announced the launch of the OsseoFix spinal fracture reduction system in Europe as well as gave update on improvement to our US sale distribution. This afternoon, we will provide additional highlights of our operating performance form the fourth quarter of 2008 as well as an overview of new product introductions and accomplishments that we achieved. Our focus my remarks on updating you on the four primary drivers and growth in Alphatec

[Peter Wulff:]

Okay. Thank you, Dirk. The following remarks are about our reported operating performance for the fourth quarter and fiscal year ended December 31, 2008. Consolidated revenues for the fourth quarter 2008 were $28.4 million, an increase of 33.3% from the $21.3 million reported for the fourth quarter 2007. US revenues for the fourth quarter 2008 were $22 million, an increase of 28.8% from the $17.1 million reported for the fourth quarter of 2007. Asian revenues for the fourth quarter 2008 were $4.8 million, an increase of 12.9% from the $4.3 million reported for the fourth quarter 2007. European revenues for the fourth quarter 2008 were $1.6 million versus no revenues reported in 2007. Consolidated revenues for the full year 2008 were $101.3 million, an increase of 26.6% from the $80 million reported for the year end 2007. US revenues for the full year 2008 were $81.5 million, an increase of 22.1%. Asian revenues for the full year 2008 were $17.7 million, an increase of 33.2%, and European revenues for the full year 2008 were $2.1 million versus no revenue reported in 2007. Gross profit for the fourth quarter 2008 was $16.9 million, an increase of $4.2 million over fourth quarter 2007 of $12.6 million. Fourth quarter 2008 gross margin of 59.2% was relatively consistent versus fourth quarter 2007 gross margin of 59.1%. Product costs did decline year-over-year of a partially offset by an increase of product royalties in the amortization of intangible assets. Gross profit for the year end 2008 was $64.7 million, an increase of $14.5 million over the year end 2007 of $50.2 million. Full year 2008 gross margin of 63.9% represents a 120 basis point increase over our 2007 gross margin of 62.7%. Total operating expenses for the fourth quarter 2008 were $21 million, a decrease of $2.8 million compared to the fourth quarter 2007 operating expenses of $23.8 million. The decrease was primarily related to 2007 in-process research and development expenses of $6.8 million, offset partially by increases in research and development and sales and marketing expenses. Total operating expenses for year end 2008 were $92.5 million, an increase of 22.6% over year end 2007 of $69.9 million. The increase of 2008 operating expenses was primarily attributable to DePuy spine patent litigation settlement expense of $11 million as well as increases in both research and development and sales and marketing expenses. Research and development expenses for the fourth quarter 2008 were $3 million, an increase of $0.8 million compared to the fourth quarter 2007 of $2.2 million. Research and development expenses for the year end 2008 were $13 million, an increase of $6.6 million over year end 2007 of $6.4 million. The increase in 2008 research and development expenses was primarily due to development activities relating to the development of the OsseoFix, the OsseoScrew and additional product development. Sales and marketing expenses for the fourth quarter 2008 were $11.5 million, an increase of $2.8 million compared to the fourth quarter 2007 of $8.7 million. Sales and marketing expenses for the year end 2008 were $42.4 million, an increase of $8.9 million over year end 2007 of $33.5 million. The increase was primarily due to the increase, sales commission expenses related to the increase sales volume increase sales management as well as marketing activities to support the new product introductions. General and administrative expenses for the fourth quarter 2008 were $6.3 million, an increase of $500,000 compared to the fourth quarter 2007 of $5.8 million. General and administrative expenses for the year end 2008 were $23.4 million, an increase of $2.8 million over year end 2007 of $20.6 million. The increase in 2008 expenses was primarily attributable to stock-based compensation expenses, and increased administration costs in Asia. The net loss for the fourth quarter 2008 was $5.1 million or negative $0.11 per share, per basic and diluted compared with a net loss of $11.2 million or negative $0.24 per share, basic and diluted for the fourth quarter of 2007. Net loss for the year end 2008 was $29.3 million or $0.63 per share, basic and diluted compared with a net loss of $20.2 million or $0.54 per share, basic and diluted for the year end 2007. On a non-GAAP basis for the fourth quarter 2008, we reported EBITDA adjusted for stock-based compensation and in-process research and development expenses of negative $533,000. This includes two non-recurring costs which totaled $590,000. First, we recorded US severance expenses of $425,000 as we have seen line R&D manufacturing and marketing functions, and secondly, we have reported $165,000 year end accounting adjustments in Japan. Excluding these items, adjusted EBITDA for the fourth quarter would have been a positive $57,000. As of December 31, 2008, cash and cash equivalents totaled $18.3 million. During the fourth quarter, we raised net proceeds of $12 million through our credit facility after paying down prior debts of approximately $14 million. Our cash burn for the fourth quarter was approximately $4.5 million and we expect our burn rate to decrease as we move through 2009. Given our expectations for revenue growth through the year, coupled with reaching profitability in the third quarter of 2009 we believe that our current cash position and available debt is sufficient to fund the business through 2009, after which point we expect to be generating cash. Now at this point, I would like to turn the call back over to Dirk. Thank you.

[Dirk Kuyper:]

Thank you, Peter. A driver of our continued year-over-year revenue increase is the continued increase in the adaption of our products by the surgeon community. As of the end of 2008, we had more than 400 surgeon customers that are consistently utilizing our spine products in their medical practice. This represents a 30% increase since the end of 2007 and provides us with a solid platform for products launched throughout December 2008 and as we release new products in 2009. Of note, we pushed several products through the development pipeline in 2008 and as such had multiple products in various stages of discussion with the FDA. Overall, we are pleased with our success. In many cases, we exceeded our expectations in product launch and development timing and in some cases, we fell short either due to lengthened discussions with the FDA or longer than expected development cycles. As such, going forward, we will take a conservative stance on our timing expectations for upcoming product offerings and revenue contribution from key new initiatives, and we will provide periodic visibility on product rollouts through initial beta launch and full commercial release. We expect to launch 15 new products in 2009, 11 addressing our core spine product portfolio and additional four, which address the aging spine market. While our core product launches expand the breadth of offerings, I am going to take a moment to talk about our new minimally invasive GLIF system which we believe addresses a 225 million market in the US. Seemingly, I will take a minute to provide an update on OsseoFix and OsseoScrew as well as provide an overview of Helifuse and Helifix products that we recently licensed. The GLIF which stands for Guided Lumbar Interbody Fusion is our breakthrough access system that provides a far lateral approach to the spine with the patient in a natural face down position. The GLIF is designed to allow surgeons to perform a 360 degree minimally invasive procedure without the need for repositioning the patient. We believe that this design may reduce the length of the surgical procedure, reduce the trauma to the patient and reduce the postoperative recovery period. We recently accelerated development of GLIF and anticipate releasing the product to market in the second quarter of 2009. As we announced previously, we recently launched the OsseoFix system in Europe. In conjunction with the launch of OsseoFix in Europe, we also planned to launch OsseoFix Plus cement and the complementary vertebroplasty system which already has a CE Mark of both in Europe and the US. The OsseoFix Plus system has improved capacity for visualization under imaging, a self contained mixing chamber for fume reduction and a superior delivery system for cement introduction. In the US following discussions with the FDA, they have asked us to conduct the clinical study of the OsseoFix system to support our 510K application. We had our most recent meeting with the FDA in the current quarter and while final parameters and timing of the study are presently being discussed, we are optimistic that we have reached a conclusion shortly and anticipate our US 510K clinical study to begin in the second quarter of 2009. The OsseoScrew system is our unique pedicle screw solution for treating patients with poor bone quality. We believe that has significantly increased pullout and holding strength as well as improve purchase in osteopenic bone. It can be used with or without bone cement leading room for revisions if necessary down the road, and lastly, it can be used both open or minimally invasively and works as part of our current Zodiac instrumentation. As many of you may recall, we had originally expected to submit the 510K for the OsseoScrew to the FDA by the end of March. Although, we are extremely comfortable with the FDA requirements, we decided to add an additional layer of testing in osteopenic bone to ensure product outperformance. We still expect to submit the 510K early in the second quarter and continue to anticipate US market launch in late 2009. As many of you may have seen, we announced last week that we have entered into a license agreement with Helix Point, LLC that provides Alphatec Spine with the rights to develop and commercialize both the Helifix and Helifuse proprietary concepts for two interspinous devices to treat lumbar spinal stenosis, also known LSS. Helifix is a non-fusion interspinous device designed to provide relief from the symptoms of spinal stenosis by providing flexion in the posterior elements. Helifuse is similar in design to Helifix that will be a fusion device that maybe combined with percutaneous spinal fixation. We expect to submit Helifuse to the FDA for 510K clearance in the fourth quarter of 2009. Helifix is a non-fusion device will likely require an IDE/PMA approval before it can be sold in the US and we expect to launch the products initially in Europe under CE Mark in the first quarter of 2010 and subsequently submit a clinical trial protocol to the FDA thereafter. Lumbar spinal stenosis arises from age related changes to the facets and the intravertebral disk. They can eventually lead to a reduction in the patient’s quality of life. In 2008 in the US, more than two million people age 65 and older were diagnosed with spinal stenosis and more than 145,000 laminectomies were performed as treatment options. Recently, less invasive potentially reversible procedures have been adopted by many physicians especially for the aging spine patient. We expect that in 2009, the US market for interspinous devices will reach over $300 million. The Helifix device will be unique and that can be inserted and removed percutaneously. It is self-destructing and can be made from a variety of materials including titanium [pick] or bone. The Helifix can be inserted by spine surgeons and/or interventional radiologists and the procedure can be performed on an inpatient or outpatient basis. In addition to product launches throughout 2009, we expect ongoing improvements and selective upgrades to our US sales force as well as continued international expansion. While our goal is to end 2008 with 65% of our distributors exclusive we exceeded that target and as previously announced we ended the year with 70% exclusivity among our distributors. We expect continued progress to this end and our goal for 2009 is to achieve 85% exclusivity among our distributors and to grow from 240 to 280 individual representatives. In Europe, we are in the late stage discussions to add exclusive distributors in the Benelux, Denmark, Germany, and Italy and expect to announce that at least one of these regions have signed by mid 2009. Across Asia, we are also looking to add exclusive distributors in key markets. Now I will provide the financial guidance that we have previously released, which is to achieve four-year revenue of 123 to 125 million in 2009, of these 12 to 14 million in annual adjusted EBITDA and positive GAAP based EPS will occur in the third quarter of 2009. We expect gross margin expansion over the next two years as driven by manufacturing efficiencies as we scale up the business from product mix and new product launches or redesign that are intended to reduce royalty commitments. For 2009, we anticipate gross margin improvement throughout the year and anticipate a range of 65% to 67% for the full year, which compares favorably to the 63.9% for 2008. In summary, we are extremely pleased to have exceeded our goal of obtaining at least the 20% growth rate for 2008 and are confident that we can sustain this growth rate going forward while leveraging our platform to drive earnings. One last comment before opening up the call to questions, it is significant to note that our industry currently faces many challenges, both relative to increased scrutiny on surgeon, and company relationships as well as on the broader economic uncertainty and the potential impact of procedure volumes. We are pleased that our culture at Alphatec [39.44] and distributors to a high standard and that our selling practices are ethical and we believe we would withstand any level of scrutiny. As it relates to the broader economy, we are fortunate that our business continues to see substantial growth and to date, we have not seen a slow down in procedure volume, product utilization or desire for innovation. We have and will continue to monitor our surgeon costumers to determine that there is a shift in practice. Our mission is to be the leading independent full line spine company with a focus on providing solutions for the aging spine and our ultimately goal is to improve the aging patient’s quality of life. We expect surgeons to increasingly shift their focus to the elder population and as such have invested heavily in proprietary products that will outperform in poor bone quality and which position the company for a market leadership position in what we believe represents the fastest growing segment of the spine market. Thank you and we will now open it up for questions.

[Operator:]

(Operator Instruction) And our first question today comes from Glenn Navarro with RBC Capital Markets.

[Glenn Novarro:]

Good afternoon guys, two questions. One and I asked this question on an earlier conference call. I just wanted to clarify your comments about the overall market. Are you saying that the end markets in which you play are not slowing. In other words, the economy and perhaps the elective nature of spinal procedure is not slowing because of the economy or are you saying that Alphatec is gaining more each year and because you are smaller player within the market your business is not being impacted by the broader market dynamics? That is the question one, and then two, I am wondering if you can give us any more info on OsseoFix, perhaps, similar in the ballpark of how many patients you think you may have to enroll. Is there a follow up time and maybe a range of when you can actually send in an FDA filing?

[Dirk Kuyper:]

Okay. Hi Glenn, this is Dirk, in relation to your first question. We are obviously in constant contact with a number of our surgeons and we have not seen a substantial change in their practices. In fact, some of them seemed to be as busy as ever but you know that does not mean that sort of in the general economy, there is no slow down. We would not know about that as early as this point but we are obviously grabbing market share. We are growing at three times in the market and so I do not see that necessarily having a significant impact on us this year. I think we can continue to grab market share and continue to hit our targets in relation to that. Regarding OsseoFix, we just had our meeting with the FDA; we are still in negotiation in regards to the questions that you asked. So, it is hard to give you a firm answer. I think we can provide an update once we have finalized the protocol that we believe it is not a substantial change from what companies had been asked to do before, which is somewhere around 100 patients and the follow up is still in negotiation. So, it ranges from nine months at the low end to twelve months at the high end.

[Glenn Novarro:]

Okay. That is a great info. One last question, just because we look at the spine as a $7billion plus market but within the $7billion dollar market, there is various segments from fusion to non-fusion to biologic. I am wondering is it possible for you to quantify some of your end market and how you see them growing in 2009. That is my final question. Thanks.

[Dirk Kuyper:]

Well, We are, in our updated presentation, which... Are you telling about the market or our growth rate versus the market?

[Glenn Novarro:]

The markets in general.

[Dirk Kuyper:]

Okay. We see the overall market continuing to grow in around 10%, which is a little bit of a slow down from a couple of years ago, but it continues to grow, we think, most certainly the VCF for vertebral compression market continues to grow very nicely. The biologic’s market I think has a lot of growth in it as well the fusion market is probably a little bit less than 10% somewhere depending on the area but within that MIS, continues to pick up share.

[Glenn Novarro:]

That is very helpful. Thank you very much.

[Operator:]

We will take our next question from Bill Plovanic with Cannacord Adams.

[William Plovanic:]

Great. Thank you. Good evening A couple of questions here, first from the operating cost standpoint. Your gross margins were a little lower than we are expecting and your operating expenses were a little higher and it seems like, first of all with gross margin, couple of years in the row now, I think, you have gone down to a low point in the fourth quarter. Is that something that we should model in going forward?

[Peter Wulff:]

Good afternoon Bill. Hi, this is Peter. Not necessarily. I think there is one adjustment that we had at the end of this year relating to the termination of the design fixed licensing agreement. We took a $357,000 expense in the fourth quarter. They are for the final termination of that agreement, which affected our overall margins about 125 basis points.

[William Plovanic:]

Okay but you are running in the mid 60s all year and then that would only get you to the low 60s. Will it [Inaudible] is attributable?

[Peter Wulff:]

The other part of it is attributable to the sales mix between our US business, Asia business, and our European business. As you know the European business is really to stocking distributors so the margins there are slightly different.

[William Plovanic:]

Okay and then that rolls down to my next question, which is in the sales and marketing expenses were up almost 800,000 sequentially your domestic sales were only up about 400,000 international is more stocking distributors outside, that one time charge, you called out. Was there anything else in the incremental in the fourth quarter?

[Peter Wulff:]

You are speaking about operating expenses bill or gross margin?

[William Plovanic:]

Sales and marketing.

[Peter Wulff:]

Sales and marketing. Well, I think, one thing everybody needs to be careful on is if you look at the historical reporting we had the Japanese sales and marketing expenses accounted for under G&A. We classified those starting in the third quarter back to sales and marketing where is appropriately classified. We have in our 10-K and 10-Q filings properly consistently classified back up to sales and marketing but if you look at the historical reports; you would see that is as a switch. I would say that overall, for example for G&A, we are holding our expenses relatively constant year over year on that.

[William Plovanic:]

Should I use this quarter in sales and marketing as the jumping off point in going forward? Were there any incremental commissions you are paying for to the reps that you brought on in the floor?

[Peter Wulff:]

No. No. There were no… I would agree with that comment. There were no incremental. Now, one thing I would state that, as I mentioned to you on the EBITDA, there was $425,000 that we incurred in the fourth quarter in operating expenses for severance expense. So about a majority of that was actually expense to sales and marketing.

[William Plovanic:]

Okay. Then, if you went through the quarter in Japan, what percentage of those sales was actually ‘spine’ for the quarter and for the year?

[Peter Wulff:]

For the year, there are approximately 20% and we continued to expand on that. I think for the quarter, may be in the 25% range.

[Dirk Kuyper:]

Bill this is Dirk, it is still sort of the minority, if you will, but it grew at about more than 70% rate and we plan on continuing that actually. Our goal for 2009 is to try to get that mixed to 50 – 50. So, we are not focused as much on pure growth at the top line in Japan as we are sort of growth in the mix of spine versus non-spine.

[William Plovanic:]

For the deferred revenue line, it came down about a million dollars, just about &1.6 now. Has your agreement with your distributor changed at all where you might capture the balance of all that in one quarter or will it continue the roll forward?

[Peter Wulff:]

Well, on the balance sheet the amount there is about a $1.9 on the third revenue recorded there. Our position is that that will roll forward as we get collections or payments from these distributors.

[William Plovanic:]

Last question, I think you mentioned the $12 million in long term debts that you have spoken down either from [SVB] or from Oxford, I do not know if it is a combination of both thereof and then what term is [50.47].

[Peter Wulff:]

Okay. to summarize, we have a new credit facility completed jointly with Silicon Valley Bank and Oxford Finance Corporation for $30 million in total. In the fourth quarter, we drew down about $26.5 million of that $30m. Proceeds of that was approximately $14 million to use, to pay off the prior existing debts with GE Capital Corporation. That amount added to our coffers was approximately $12 million dollars. The terms of the debt, it is broken down into two pieces. There is $115 million which is a term loan due April of 2012. It is a fixed interest rate term debt that has an interest cost of about 11.25% and then the other part of it is the working capital line of credit of $15 million. It is based on the Silicon Valley Bank’s prime rate in 250 basis points, and again that is due as well on April of 2012.

[William Plovanic:]

What is the interest rate on that right now?

[Peter Wulff:]

That is about 6.25%.

[Operator:]

(Operator Instructions) Unidentified Analyst.

[Unidentified Analyst:]

Yeah. Hi, I got it. Thanks for taking the question. So, first I just wanted to just stick with the margin questioning specifically maybe on the pricing of implants. Have you seen any negative pressure on implant pricing and is that part of the reason why the margin is kind of depressed in the border?

[Dirk Kuyper:]

Hi, Seth. This is Dirk. In regards to the implant pricing, we do track that very closely obviously and we have not seen a decrease in sort of our average selling price. Actually, over the whole year it held up relatively well. Obviously, within quarter to quarter, there is a mix change but that it is not due to any pricing pressure.

[Peter Wulff:]

If I would add in terms of the margin effect on it, I think everybody will recall that we added onto the settlement agreement with DePuy in the second quarter of 2008. So, when you look at prior years, we did not have the royalty obligation at that point in time and so we are seeing the effect of that rolling through into our margin into the second half of 2008 and I think one of these things as Dirk mentioned earlier on his prepared remarks that we are actively looking within our product development group to look at other product designs that will help mitigate essential future royalty commitments as well to manage that.

[Unidentified Analyst:]

Can you give the basis point impact from the royalty payment to DePuy?

[Peter Wulff:]

Well, in terms of expenses that have increased quarterly approximately a million dollars in expenses.

[Unidentified Analyst:]

That is great and one last question just on the [54.18] requirements for consultant’s disclosures. I know lot of the larger players have been pretty pro active in taking the stance and saying that they are going to file through the disclosure this year. Do you have any position on that or do you plan on addressing that? Thanks.

[Peter Wulff:]

Well, we have not made a decision yet. We have been obviously seen what they are doing and we are viewing that right now. Obviously, we believe that we are very much on sort of the far end of that and probably a benefit to us to disclose earlier rather than later but we have not made an ultimate decision on that yet.

[Operator:]

We have no more questions at this time.

[Dirk Kuyper:]

Okay. Again, thank you all for participating. We feel very good about our performance in 2008. We believe that we have set the stage for 2009 and the future and we have established sort of our four quarter growth drivers for the Company being the core product portfolio, the aging spine portfolio, continued expansion of the US distribution that work and the international expansion and we see those being key drivers in terms of helping us to reach our numbers and driving towards earnings and profitability this year. So, we look forward to continued future success and thank you very much. I wish everyone have a pleasant rest of the day.

[Operator:]

We thank you for your participation on today’s call and have a wonderful day.

[Dirk Kuyper:]

Thank you.