SeaSpine Holdings Corporation
Q1 2017 Earnings Call Transcript

Published: 7 May 2017

[Operator:]

Welcome to the SeaSpine 2017 First Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we'll hold a Q&A session. [Operator Instructions] As a reminder, this conference call is being recorded today, May 4, 2017. I would now like to turn the conference call over to Carrie Mendivil, Investor Relations. Please go ahead.

[Carrie Mendivil:]

Thank you, Emily, and thank you for participating in today's call. Joining me from SeaSpine is CEO, Keith Valentine; and CFO, John Bostjancic. Earlier today, SeaSpine released financial results for the quarter ended March 31, 2017. During this conference call, we will make forward-looking statements within the meaning of federal securities laws in regard to our business strategy, expectations and plans, our objectives for the future operations and our future financial condition. All statements other than statements of historical fact are forward-looking statements. Such statements may include words such as believe, could, would, will, plan, intend and similar expressions. You are cautioned not to place undue reliance on forward-looking statements, which are only predictions and reflect our beliefs based on current information and speaks only as of today, May 4, 2017. For a description of risks and uncertainties that could cause material differences between our actual results and those stated or implied by the forward-looking statements, please see our annual report on Form 10-K filed with the Securities and Exchange Commission on March 3, 2017, which is available on our corporate website www.seaspine.com. I will now turn the call over to Keith Valentine. Keith?

[Keith Valentine:]

Thank you, Kerry. Good afternoon and thank you all for joining us. 2017 is off to a solid start, with early traction from our recently launched products and our strengthening distributor base. We continued to make progress throughout the first quarter through a foundation to support sustainable growth. And we remain on track for accelerating momentum throughout the year. With this, we are reiterating our expectations for revenue in the range of $129 million to $133 million for 2017. Total revenues from the first quarter was $31.9 million, up 1.6% year over year, consisting of orthobiologics sales of $17.1 million and hardware sales of $14.8 million. Geographically, U.S. revenues was up slightly to $28.6 million, while international revenue was up 15% to $3.3 million. In the first quarter of 2017, the global revenue growth generated from spine hardware products that have been launched since the spin, outpaced declines in our legacy products. We expect this trend to continue and to accelerate going forward, driven by our initiatives around product innovation and strengthening our distributor base. Last year, we launched more than 10 new products, primarily in the spinal hardware portfolio. And we further enhanced our commercial process by adding talented resources to our marketing and product development teams. We also fully engaged our marketing team to ensure more robust and predictable launch schedule. As a result of these initiatives, we have a dramatically improved launch process that allows for greater efficiency and speed to market. In 2017, we look forward to building on our momentum and expect to launch 8 to 10 new or next-generation products and product line extensions throughout the year, including 2 to 3 products in the orthobiologics portfolio. To that end, I would like to outline our expectations for some of our key product launches scheduled for 2017. As we have discussed previously, we are wrapping up our limited launch alpha evaluations of two key systems

[John Bostjancic:]

Thanks, Keith, and good afternoon, everyone. As Keith noted earlier, total revenue for first quarter of 2017 was $31.9 million, a 1.6% increase compared to the same period of the prior year. Revenue from orthobiologics products totaled $17.1 million, a 2.8% year-over-year increase, while revenue from spinal hardware totaled $14.8 million, an increase of 0.2%. U.S. orthobiologics revenue totaled $15.1 million, a 1.2% year-over-year increase, while revenue from U.S. spinal hardware totaled $13.5 million, a decrease of 0.8%. Gross margin for the first quarter of 2017 was 58.7%, compared to 54.5% in the same period 2016. The increase in gross margin was mainly driven by a $1.7 million provision for excess orthobiologics raw material inventory recorded in the first quarter of 2016. This was somewhat offset by a $240,000 increase in the current quarter in amortization of technology intangible assets from the NLT acquisition and by lower gross margins associated with international sales, which were slightly higher as a percentage of total revenue in the first quarter of 2017 compared to the same period of the prior year. Operating expenses for the first quarter of 2017 totaled $27.8 million, a decline of $1.6 million compared to the same period of prior year. The decrease was driven by lower SG&A and amortization expenses. R&D expense increased by approximately $300,000 to $3 million for the first quarter of 2017 or 9.6% of revenue, and is in line with our expectations. Selling, general and administrative expenses decreased $1.4 million to $24 million for the first quarter of 2017. The decrease was mainly driven by a $700,000 decrease in stock compensation expense and $800,000 increase in consulting services, as a result of the completion of various information system related projects in late 2016, and a $400,000 decrease in facility cost due to the closure of our facilities located in Vista, California in late 2016. These decreases were somewhat offset by a $500,000 increase in distributor commissions and a $300,000 noncash charge related to an increase in the fair value of contingent consideration liabilities from the NLT acquisition. While we expect total SG&A expense in 2017 to decrease as a percentage of revenue compared to 2016, components within SG&A, specifically distributor commissions are expected to increase relative to 2016 both in absolute terms and as a percentage of revenue. Net loss for the first quarter of 2017 was $9.1 million compared to a net loss of $12 million for the first quarter of 2016. Cash and cash equivalents at March 31, 2017 totaled $12.7 million and we had $3.9 million of outstanding debt against our $30 million credit facility. We are very pleased with the reliability and scalability of the infrastructure investments that we made in 2016 and are leveraging the efficiencies gained by those successes to invest even more aggressively in 2017 in the areas that will drive sustainable, long-term revenue growth namely product development, sales and marketing, and in the inventory and sets needed to support the 8 to 10 product launches expected in 2017. We also remain on track with our commitment to reduce our net cash spend by $9 million compared to the 2016 spend. Turning to our financial outlook for 2017, we continue to expect 2017 revenue to be in the range of $129 million to $133 million, reflecting flat to 3% growth for the year. While we are not providing quarterly guidance, we anticipate that revenue growth in the second half of the year will outpace the first half, with stability in our top line revenue in the first half of the year, followed by acceleration to mid-single-digit growth in the second half, as our new products and distributors further take hold. Moving down the P&L, we anticipate gross margins for 2017 in the range of 57% to 60%, which includes the impact of $900,000 more in annual non-cash intangible asset amortization, compared to 2016, because of the NLT technology acquisition. R&D to approximate 8% to 10% of revenue, and SG&A, excluding non-cash stock compensation, expense and any non-cash expense related to changes in the fair value of the NLT contingent consideration liabilities to approximate 67% to 71% of revenue. Looking ahead two to three years beyond 2017, as we build scale for the business and achieve anticipated longer-term, double-digit revenue growth and leverage the existing infrastructure in which we invested so heavily in 2016, we expect to generate gross margins in the mid to upper 60% range, to invest 7% to 8% of revenue in R&D and to reduce SG&A, excluding stock compensation expense, to between 60% and 64% of revenue. We plan to end 2017 with two years of liquidity as measured by cash on hand and availability under our credit facility. At this point, I'd like to turn the call back over to Keith for closing comments. Keith?

[Keith Valentine:]

Thank you, John. In closing, we are starting the year with positive momentum across both product portfolios, and our strategy to reposition SeaSpine for growth is on track. Progress in 2017 will be marked by consistent investment in new products and market development efforts, which we believe will further fuel this positive momentum throughout the year. I would like to acknowledge the accomplishments and commitment of our team here at SeaSpine and thank them for their continued efforts. We look forward to updating you on our progress on future calls. With that, we will now open it up to questions. Operator?

[Operator:]

[Operator Instructions] Your first question comes from the line of Matthew O'Brien with Piper Jaffray. Your line is open. Please go ahead.

[Matthew O'Brien:]

Thank you and thanks, guys, for taking the questions, several for you here. John, for starters on the guidance side of things, you just put up a nice Q1 results, talking about the second half growing faster than the first half. Do you feel more comfortable towards the higher end of the range, just based on that commentary?

[Keith Valentine:]

Yes, real quick, I'll let John answer as well. I just want to make one comment that, obviously, there's two very large launches coming up. We feel really good about what's going on in alpha, but we just want to be sure that the launches go smoothly. We have a lot of product to get in, we have a lot of sets to deploy. And so, I think the reality is we want to get through the second quarter before we would give that kind of comment of confidence, Matt.

[Matthew O'Brien:]

Sure, that's fair. So Keith, to the points you made early on as far as new products that you mentioned is recently growing faster than the de-sale [ph] in older products. Can you just give us a sense for how that's been trending maybe from a - on a month-to-month basis? Are you exiting Q1 with that delta starting to really widen? Or is it still fairly close? Or just anything along those lines, because I thought that comment was pretty interesting.

[John Bostjancic:]

Yes, Matt, it's accelerating every month, but it's a slow, steady progression, which is kind of in line with what our expectations were, right. We knew it was going to take some time for the new products to have traction, particularly coupled with brand-new distributors, because a lot of those distributors have access to the newer products. But it's definitely trending in the right direction and ramping up throughout the quarter, because we saw momentum building throughout the quarter, and that's what gives us the confidence heading into the second quarter, that we're well on track for hitting our guidance for the year.

[Matthew O'Brien:]

Okay, got that. So you just mentioned the reorder - sorry, you just mentioned the new products, John or Keith, for this. But I know it's early days, but can you just talk about the reorder rates you're seeing from some of the early adopters of the technology?

[Keith Valentine:]

Yes, a couple of things going on. I think one of the great things with the system and how we approach the system and its modularity is it gives great flexibility. And so what we're seeing is more and more individuals getting involved with trialing and using it, but expanding its usage, meaning over greater levels, right. And so especially when you talk about pedicle screw systems, it's great when you start having a versatile system that is really good at single and two level, but can also be good at much longer multilevel constructs as well. And so that's been a great feature of the modularity of the Mariner system. And then the other nice part, as you get into Shoreline, and what surgeons are excited about is it can be a standalone system and it also can have a plate attachment. And so that gives a great deal of versatility and decision-making inter-operatively, which is always the best place for it to be, where that surgeon knows going into the procedure they have options. And as they see the anatomy understand the nature of the pathology, they can then make decisions and have everything necessary on the back table to do it. And so that's why we're seeing some of this multiple used by clinicians.

[Matthew O'Brien:]

Got it. Okay. So switching over to the distributor commentary. First of all, was there any - you've been adding quite a few of those. Any material stock in either in the U.S. or O-US [ph]?

[Keith Valentine:]

Any material what?

[Matthew O'Brien:]

Stocking at your distributors.

[Keith Valentine:]

Stocking, no. I mean, you're talking about our distributors' stocking and sales, I mean, obviously our international distributors are stocking distributors. But U.S.-wide, no.

[Matthew O'Brien:]

Okay. I guess, just given the strength of this internationally, Keith, I know it's smaller numbers, but was there anything to call out there? It sounds like the answer is no.

[Keith Valentine:]

Yes. Well, there is expansion there. And so we do have expansion in Latin America that those distributors that were coming aboard, yes, those are bringing aboard new instrumentation, bringing aboard new implants. So those aren't fully getting cleared - are getting done into surgery in the field yet. So I guess in that case, yes, but they're still socking up and getting ready for broader and broader launches.

[Matthew O'Brien:]

Okay. Can you give us just a sense for what that revenue contribution - that incremental might have been?

[John Bostjancic:]

From the new distributors added internationally, Matt?

[Matthew O'Brien:]

Yes, please.

[John Bostjancic:]

Yes. Order of magnitude, less than $0.5 million. But again, because you said it's small numbers, it certainly moves the needle in a meaningful way.

[Matthew O'Brien:]

Got it. Okay. And then flipping over to the orthobiologics strength. It was pretty nice to see in the quarter. Can you just talk a little bit more about that? And then, Keith, as far as the NASS recommendations on allografts, and DBM specifically for you guys, go, can you just give us a sense for, I guess, what the association's after there and then any potential impact to your business?

[Keith Valentine:]

Yes. Our preliminary read on what's been published is that we still think it's going to continue to be a robust opportunity for DBMs. I mean, a great thing - as we've talked about previously is it's got such a longstanding, multi-decade track record of success. It has a very receptive audience with the insurance providers as well, so that encourages all of the larger buying groups especially to have contract opportunities in this space. So I really don't think much is going to change there at all. If anything, it's been kind of a reaffirmation of what's been going on for quite a long time, as I already mentioned, over a couple of decades. Now on the strength side, I think we're seeing a couple of things. We're getting some really nice momentum from our newer distribution and that more exclusive distribution, both the ones that handle spine and orthobiologics, and even some of the ones that are exclusive orthobiologics. And so, in addition, I think we've done some strong effort and good effort on making sure we're having the right conversations with the larger buying groups. And we have a team here that's very engaged on that. And I think that's an important part of kind of the sophistication of making sure you have the right individuals that keep the conversation with those buying groups active so it's not a surprise when new contracts are being renewed and you're coming up for contracts. So all of that is played nicely as we kick off 2017.

[Matthew O'Brien:]

Got it. So just a few more from me. Keith, at your previous company, you went through this change on the distributor side, from nonexclusive to exclusivity, and then eventually to direct sales representation. So we'd love to hear you kind of compare and contrast those two situations, from nonexclusive to exclusive distributors, and how that move - I guess, what kind of exclusivity, you're getting at this point at SeaSpine, and then how many more of your distributors you have to go along or go down that half with that could really contribute over the next several quarters and years?

[Keith Valentine:]

Sure. So a little bit different. I think in former years, when we were part of the same transition, it was all exclusive, so it was demanded contractually to be 100% exclusive. What we talk about now is majority exclusivity. So what we're seeing is 70% to 80% exclusivity, and I think that's a very reasonable request in light of what our portfolio is and where we're advancing it. I think it's also - the more meaningful commentary is, are you really developing true partnerships with your distribution team? And that's our ultimate goal. I think there's always areas of the country - I mean, interestingly enough, there are many - or a couple of organizations, one specifically out in the field now that has been long-time exclusive, and they are doing nonexclusive deals now in areas where they don't have as much penetration as they do in others. So I think that you have to have flexibility in your distribution channel to accommodate the different areas of the country. But overall, we still view that we have great opportunity and great progression for lift as we continue to focus on underpenetrated areas and looking for individuals that really want to partner and become exclusive. So we view it as, this will continue for a couple of years. And I don't think it's a matter of having to shift to direct. I think it's more a matter of making sure you're picking the best kind of partnerships in the areas you're going. And if you can't find the right partnership, then I think it is appropriate to strategically look at whether it makes sense to do something direct.

[Matthew O'Brien:]

Got it. And then lastly on the product side, just the commentary about the new pediatric deformity product, different market, I know some clinicians will do some pediatric - do some deformity cases, and they're higher revenue opportunities, but again, different market, pretty competitive. Just how should we think about the contribution of that platform, back half of the year into 2018?

[Keith Valentine:]

Well, I think that for deformity specifically, as you saw last year, there was a nice deformity participation that we had in the second quarter, so we anticipate it to be the same. I think you're right, it is a very close philosophical and relationship business. I think, we do have a great opportunity with our new system in the second quarter, because it is scoliosis season. And we're going to continue to advance both of our systems to make sure that we have the ability to participate even more meaningfully throughout the years, specifically into next year's scoliosis season as we do even more advancements. So I would still view it as our product line is early on in some regards, but it's one area of focus and opportunity that we think is ahead of us as we go through the next 18 months.

[Matthew O'Brien:]

Okay. And last one from me, I promise. For John, just the cash burn in the quarter was pretty low. And I understand, you were pretty affected at managing your working capital. But how should we think about that metric spending throughout the course of the year?

[John Bostjancic:]

Yes. Because of the set launches, we've got Shoreline and Mariner in particular being full launches, almost 50 sets each, and the alpha launch of the Skipjack, Q2 and Q3, depending upon the timing of everything, we expect a bubble in the middle of the year where that cash burn will accelerate. But as you know, we kept our guidance for the year, but Q1 is not indicative of probably the next two quarters, because of the heavy investments we make in sets and implants for those sets to support those big product launches. And then we expect it to trend back down in Q4 to something closer to Q1. But, certainly a bubble in the middle of the year, which was part of our original expectations, when we laid out the plan for 2017, because of the expected timing, those launches being around midyear.

[Matthew O'Brien:]

Okay. Thanks for taking all the questions.

[Keith Valentine:]

No problem.

[Operator:]

Your next question comes from the line of Swayampakula Ramakanth from H.C. Wainwright. Your line is open. Please go ahead.

[Swayampakula Ramakanth:]

Thank you. Thank you, Keith and John for taking my questions.

[Keith Valentine:]

You bet.

[Swayampakula Ramakanth:]

A lot of my questions have been answered. But I just want to understand a little bit about the dynamics of the numbers. So if we look at the two main divisions, orthobiologics and the hardware divisions, and look at the trajectory of revenues for the last three quarters, the orthobiologics seems to kind of reached to some level going from $14.6 million during the third quarter to $15.1 million now. But on the other side, the hardware seem - there seems to be some ups and downs. And I'm just trying to understand, because it was $13.9 million in the third quarter, $14.7 million in the fourth quarter, and now down to $13.5 million, what's driving these numbers? And how should we think about this in the - at least for the rest of the year?

[John Bostjancic:]

Yes. I think for orthobiologics, that's the portfolio particularly in the U.S., where we had much stronger, longer-tenured relationships with the distributors. So that's kind of what I view as a slow and steady growth, because of the strength of the relationships we've historically had there. That being said, with the two new products - two to three new products that Keith talked about launching orthobiologics this year that gives us the upside potential to create the acceleration we see in orthobiologics off of a fairly stable platform because of the strength of the relationships and the technology that we already have in the market. So the upside comes from those - launching those two new products in the back half of the year. On the spine hardware side, yes, it has been lumpy in the U.S., and that is a combination of a couple of factors. We've spoken to you in previous quarters that you had - as we brought new distributors onboard, some of the legacy distributors have moved their attention elsewhere because we haven't had that exclusivity Keith spoke to that we're bringing in with the new distributors, right, much more loyal and more exclusive type of relationships with the new distributors. As we bring those distributors on board, some of the legacy distributors, where we haven't had that type of loyalty, do shift their mindshare to other products they carry in their bag. And that was the dynamic we spoke about in the back-half of 2016, that coming off of a good Q2 last year, we saw some deceleration in Q2 and - Q3 and Q4 of 2016 as the hardware revenue decelerated, because the impact of those legacy distributors was outpacing the new revenue added from the new distribution, we brought on board and new products, because, as we said on past calls, it takes nine to 12 months for those new distributors to really get through the learning curve and start to move the needle in a meaningful way for revenue. So at the time, we were facing disruptions from the legacy distributors that were moving their mindshare, we were still having those new distributors come off the learning curve. And we didn't have - quite have the critical mass of the new products in the hardware side to really support the growth either. I think now, heading into 2017 - or in the second quarter, many of those distributors have been on board for six to nine months, so they're getting to the top of the learning curve. We're right on the cusp of launching the two big systems, the full launch for Mariner and Shoreline, and there's excitement around the Skipjack expandable device. And that's what creates the upside trajectory and growth opportunity in the back half of the year to take some of the lumpiness away from the hardware, because, while that legacy distributor disruption is still out there, it's being outpaced by the strength of the new distributors and the breadth of new products we've launched in the past year that should help stabilize, and generate the accelerating growth in the back half of the year.

[Swayampakula Ramakanth:]

Okay. Thank you. So just as a follow-up to what you just said. So should we - should I understand that whatever turnover you and the management wanted to make in terms of the legacy distributors, has that completed in your mind? Or is there some more legacy distributors that you need to flush out and it may be another additional one or two quarters before you get to that whatever that critical mass is of the new relationships that you wanted to generate?

[Keith Valentine:]

I think that majority of the larger disruptions, we'll see play out in 2017. But I think there's always a risk of some level of disruption depending on the kind of changes we have to make if we're not getting the right focus and partnership and growth, right. So - but I do think a lot of what we've done in the past year or so, that disruption filters out - most of that filters out in 2017. And that's why it comes at - we keep talking about this, this is a good time for it to happen, just because we have strength on new distribution coming up to speed. We have new products getting launched midyear in full instead of alpha and beta going to full. And so that really helps us eliminate the effect of that disruption, because now we're going to get a new stream.

[Swayampakula Ramakanth:]

Thank you. Perfect. Thank you very much for taking my questions.

[Keith Valentine:]

You bet. Thank you.

[John Bostjancic:]

Thank you.

[Operator:]

I'm showing no further questions at this time. I would like to turn the conference back over to your host, Robert [ph] Valentine.

[Keith Valentine:]

Thank you very much for joining us on the call today, and I wish everyone a great evening. Take care.

[Operator:]

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. Have a wonderful day. You may all disconnect.