Surgalign Holdings, Inc.
Q2 2021 Earnings Call Transcript

Published: 6 Aug 2021

[Operator:]

Greetings, and welcome to the Surgalign Holdings' Inc Second Quarter 2021 Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. . As a reminder, this conference call is being recorded. It is now pleasure to introduce your host Mr. Jon Singer, Chief Financial and Operating Officer. Thank you sir. Please go ahead.

[Jon Singer:]

Thank you, operator. Good afternoon and thank you for joining the Surgalign Holdings Inc.’s second quarter conference call. Joining me today on the call are Terry Rich, our President and Chief Executive Officer and Dr. Kris Siemionow, our Chief Medical Officer. Before we start, let me make the following disclosure. The earnings and other matters we will be discussing on this conference call will involve statements that are forward-looking. These statements are based on our management's current expectations. They are subject to various risks and uncertainties associated with our lines of business and with the economic environment in general. Our actual results may vary from our statements concerning our expectations about future events that are made during this call. We make no guarantees as to the accuracy of these statements. Accordingly, we urge you to consider all information about the company and not to place undue reliance on these forward-looking statements. During the call, we will also present certain financial information on a non-GAAP basis. Management believes that non-GAAP financial measures taken in conjunction with U.S. GAAP financial measures provide useful information for both management and investors by excluding certain non-cash and other expenses that are not indicative of our core operating results. Management uses non-GAAP measures to compare our performance relative to forecast and strategic plans to benchmark our performance externally against competitors and for certain compensation decisions. Reconciliations between U.S. GAAP and non-GAAP results are presented in the tables accompanying our earnings release, which can be found in the Investor Relations section of our Web site. On today call, I'll begin by providing an overview of our second quarter performance, and then update on guidance for the year. I'll then turn the call over to Terry and Dr. Siemionow to walk through our ongoing progress with our digital strategy in the Holo platform. We will then open the line for questions. Starting with the review of the quarter. Global spine revenue for the quarter ended June 30th, 2021 was $24.8 million, a $4.3 million or 21% increase compared to $20.5 million for the prior year period. The increasing revenue is driven by the partial return of elective procedures in certain geographic regions partially offset by quality and regulatory issues impacting product availability from our global manufacturing partners. Domestic revenue was $20.7 million, a $3.8 million or 22% increase from the second quarter of 2020, and international revenue was $4.1 million, a $0.5 million or 15% increase from the prior year quarter. Gross profit for the quarter was $17.6 million or 71% of revenue compared to $11.1 million or 54% of revenue in the second quarter of 2020. The improvement in gross margin is due to the elimination of certain manufacturing related cost as we move from an integrated manufacturer to a fix purchase price when we sold the OEM business. Marketing, general and administrative expenses decreased $6.6 million or 21% to $25.5 million for the three months ended June 30, 2021 compared to $32.1 million for the three months ended June 30, 2020. The decrease in marketing, general and administrative costs was driven by the reduction in spending as a result of the simplification of the distribution, administrative infrastructure and a reduction in spending due to the sale of the OEM business. Research and development expenses in the second quarter of 2021 were $3.2 million compared to $3.3 million for the prior year period. Adjusted EBITDA for the second quarter of 2021 was a loss of $8.5 million compared with a loss of $21.4 million in the prior year period. The improvement in adjusted EBITDA is primarily driven by the increase in gross profit and the reduction in operating expenses outlined above. We ended the second quarter with approximately $69.3 million in cash and cash equivalents reflective of the net proceeds of the financing completed in June in payments for tax liabilities and finalization of the working capital dispute related to the sale of the OEM business. In addition, at the end of July, we entered into a binding term sheet to fully resolve the class-action securities litigation pending against the company. The term sheet provides for a $10.5 million settlement payment that is anticipated to be fully paid by the Company’s directors’ and officers, insurance providers under existing policies. Turning to guidance. We now expect full-year revenue in the range of $95 million to a $100 million compared to full-year revenue of $102 million in 2020. Looking our forecast for the rest of the year, we are essentially a quarter behind where we thought we'd be at the beginning of the year at the end of the first quarter. This set back is due to the continued quality issues in our global supply chain related to the separation of the business, as well as the ongoing impact of COVID generally on demand in both the U.S. and international market and specifically its impact on coflex procedural volumes. When looking at the cadence of revenue in the back half of the year, we expect the third quarter to be sequentially down from the second quarter due to typical seasonality, as well as the COVID headwinds. Starting with the first issue, quality issues in our global supply chain. The business separation during the height of COVID pandemic last year has presented a number of challenges that we are continuing to work through. We have had a number of issues in the supply chain, as well as recalls that have delayed the launch and relaunch of a number of our product lines. As we rebuild the organization including the addition of high quality personnel in our R&D, quality and supply chain groups, we have looked more closely at our products and processes. Under this scrutiny, we have been smarter around how we are remediating the quality issues. This is the right thing to do to ensure the highest quality product, but it has caused a shift in the cadence of new product launches. We are confident these actions will pay dividend over the long term. Secondly, we have seen a prolonged negative impact from COVID in our served markets. Early in the year, we believe that the impact would subside in the second half of 2021 and approach a more normalized level of end customer demand. However, we continue to see varying levels of shutdown across European regions with specific pressures in Asia, Australia and other regions where vaccines are lagging. Along these lines, COVID has had a continued impact on coflex domestically. With reduced access to elective procedures and periodic shutdowns, we have seen a slower than expected return to pre-COVID volumes. In addition to COVID, we have continued to experience reimbursement related headwinds which creates an economic disadvantage for surgeons to use coflex versus more complex procedural solutions. Both of these factors have resulted in a moderation of expectation for coflex for the remainder of the year. We are in a turnaround and are confident that we have built the right team, are putting the right fixes in place and will return to predictable performance and growth in the long run. We continue to expect full year adjusted EBITDA will be in the range of a loss of $35 million to $40 million. I would now like to turn the call over to Terry.

[Terry Rich:]

Thanks Jon. Our main focus for driving accelerated growth in the business continues to be the development of the Holo platform. With half the year already completed, I'm happy to report, we've made significant progress towards all of our Holo milestones for 2021 and remain on track with the development of the system. Starting with a regulatory update. Last quarter, we announced that we have filed our initial 510(k) submission to the FDA for Holo and continue to expect clearance in the second half of 2021. As a reminder, this submission is the first of many as we expand the applications into neuro, orthopedics. general and many other surgical specialties and applications across the continuum of care. We took our first steps towards the development of those additional applications during the quarter when we announced a strategic collaboration agreement with Inteneural Networks, a developer of innovative AI applications. Inteneural software enables autonomous neural structure segmentation and the rapid delivery of information. The algorithms used have been developed for intracranial applications in neurosurgery identifying tumor, aneurysm, stroke and neurovascular structures. The partnership allows Surgalign to access to Inteneural's unique technology. We'll be assessing its suitability for inclusion to our digital surgical portfolio. This collaboration lays the groundwork for us to expand the application beyond spine and will enable us to grow to be the powerhouse in the use of AI and machine learning to deliver better patient outcomes. We continue to expect first cases to be performed in the fourth quarter of 2021 after FDA clearance followed by a limited market release of the system, which will include both IRB sites to support the accumulation of clinical evidence and alpha sites or early adopters that will allow us to gain insights as we continue to refine the system and understand the demands of surgeons, hospitals and ASCs. We expect to have multiple sites up and running in a relatively short order following the clearance. The market opportunity for Holo over the long term is tremendous, as it encompasses diagnostics, surgical planning, interoperative support and post-operative solutions. We believe each installed system can initially generate anywhere from $1 million to $1.5 million in revenue on an annual basis. When looking at the initial application within lumbar spine procedures, we estimate the total addressable market to be approximately $5 billion. As we expand into new indications and integrate additional SaaS capabilities, we would expect that figure to expand exponentially. To provide a more in-depth look at Holo and its capabilities, we wanted to bring Dr. Kris Siemionow, our Chief Medical Officer and Co-founder of Holo Surgical.

[Kris Siemionow:]

Thanks, Terry. As we get closer to an FDA approval and our first procedures being performed using Holo, we wanted to provide an overview of the system, its capabilities, its differentiation in the market and how we envision its role in the healthcare ecosystem in the future. Holo is a surgical platform technology that combines artificial intelligence, data analytics and augmented reality with a goal of improving patient outcomes while reducing all our time and decreasing surgical complications. What is truly unique about our solution is that we taught the computer anatomy. And once you teach the computer anatomy, it enables an incredible amount of possibilities. A key feature of the platform is its autonomous segmentation. Because the computer knows anatomy, it can automatically differentiate between the different levels of the spine and other anatomical structures such as bone, nerve, blood vessels and more. The platform can then automatically segment and label these different pieces of the anatomy. All of this information is analyzed and delivered to the surgeon in real time. The next key feature of the platform will be our autonomous surgical planning capabilities, because the computer knows and understands the anatomy, we are able to deliver an autonomous surgical plan to the surgeon. The system can suggest the size, position and trajectory of the implants, which a surgeon can then approve. Currently, there's not another competitive platform that provides the autonomous anatomy identification or planning feature on the market. A third key feature of the platform is our real-time 3D guidance display that enables the execution of the surgery. All the functionality and information is delivered to the surgeon through the augmented reality display that is directly above the surgical field showing the surgeon a fully segmented color-coded overlay as if the patient had no skin, muscles or connective tissues in the way. We believe the 3D color-coded image and the associated guidance dramatically reduce a surgeon's cognitive load. So with all of that, how are we different than existing technologies and methods used by spine surgeons today? The two primary technologies leveraged by spine surgeons today to perform lumbar procedures or navigation and surgical robots. At the end of the day these are simply tools. And they offer limited visualization of the anatomy. They lack intelligence and they complicate surgical workflows. We are moving surgeons from navigation to intelligent guidance. Currently, navigation requires a doctor to take the role of interpreting the images presented on the screen, which are typically in two dimensions and not located in the surgical field, and makes surgical decisions based on his or her understanding of the patient's anatomy seen on that 2D screen. This dramatically increases the cognitive load on the surgeon. How the doctor interprets the image impacts how they perform the surgery. This is an outdated and antiquated way of approaching surgery given the evolution of machine learning and artificial intelligence. So, we have a different approach where the computer assists the doctor by autonomously identifying and segmenting the anatomy, analyzing each individual anatomical component and preparing the surgical plan and then guiding the doctor during the procedure. So Holo not only enhances visualization in a surgeon-friendly way, but brings intelligent capabilities with the goal of improving patient outcomes. We are often asked to compare Holo to robotics, which is a popular technology among surgeons because of its ability to enhance specific movements or surgical techniques during a procedure. However, we know robots to effectively be another instrument that is both dumb and blind. Since robots lack the ability to autonomously identify anatomical structures, they cannot deliver usable insights to a surgeon and let alone plan a procedure or provide intraoperative guidance. While the initial capabilities of the Holo system are an evolution in the way surgical procedures are performed, we have a much larger vision. Our strategic roadmap includes a variety of additional capabilities for the platform. In the near term, we are focused on advanced spine planning, which offers fully automated planning for implants such as screws and cages to improve surgical workflows while offering optimal alignment for the patient. Additional segmentation capabilities in other anatomical areas, which would expand into pre-op MRIs and X-rays among others. And smart instruments which would integrate with the platform to deliver execution of the autonomously developed surgical plan. In addition to these enhanced capabilities, we are working to expand the applications into neural, orthopedics and general surgery and many other surgical specialties. And into a larger portion of the care of continuum including diagnostic. In summary, Holo is a highly differentiated machine learning based technology platform that is delivering intelligent solutions to the surgeon allowing them to deliver superior care to their patients. I would now like to hand the call back over to Terry.

[Terry Rich:]

Thanks, Kris. We're very excited about the future of Surgalign since the beginning of the year we have invested heavily in the business and the team. As Dr. Siemionow mentioned, we are developing an incredible technology that will materially evolve the way surgery is performed, by bringing intelligence and advanced visualization to the OR , we can help surgeons perform better surgery more quickly and ultimately deliver on the promise of better outcomes and patient satisfaction. Surgeon feedback and demand to use this system upon clearance has been beyond our expectation and validates our belief that we have the most innovative solution to support our leadership in the future of digital surgery. Looking ahead to the rest of 2021, we are confident in achieving our near-term goals and are positioned to be the leader in digital surgery. With that, I'd like to open the line for questions.

[Operator:]

Thank you. The floor is now open for questions. . Our first question is coming from Matt Hewitt of Craig-Hallum Capital Group. Go ahead.

[Matt Hewitt:]

Good morning. Thank you for taking our questions. Maybe first up if we could dig in a little bit on the quality and regulatory issues. Are these new issues? Is this something that's just popped up since the divestiture of the OEM? Or is this something maybe that was kind of percolating and it wasn't recognized until the divestiture occurred?

[Jon Singer:]

Well, many of the products in which we're having the issues, Matt, have been on the market quite a while. So, they were stable and we really weren't seeing when you look at you kind of the history of the quality system at the level to which we've experienced. We were -- we talked about the Surgalign recall. Some of the issues related to delays in the launch of new products, which I think between COVID and the work being done on the separation just caused disconnect on timelines. And then, we're having issues internationally with our suppliers as well, which is combination of some bad raw material and then just their difficulty in driving timelines with COVID. So it's really a combination of factors.

[Terry Rich:]

Yes. Matt, the separation's been hard, right, like even harder than expected. The key is, we're transforming this organization in a really meaningful way and we're becoming the AI powerhouse in surgery. And that's the critical thing and what we need to be looking for. It's what we're measuring against.

[Matt Hewitt:]

Okay. And then, I guess, the next step is and I think one of the key elements to this transformation is going to be the pull-through that you expect with the base product portfolio. It sounds like you're making all these changes and enhancements to the quality and regulatory teams, so that once the platform is approved you're going to actually see that pull-through. Is that the expectation?

[Terry Rich:]

Yes. Look, the pull-through is certainly a key component. But we're going to monetize the system in a variety of ways. And like this thing is to quote, a well-renowned surgeon recently thought, we're going to revolutionize surgery, and not just spine surgery, but we've got to be laser focused on getting this thing out there, applying it in spine and then continuing to diversify into pre-op during the surgery and then post-op as well. This thing is going to make a meaningful difference in patient lives.

[Matt Hewitt:]

Okay, great. And then, I guess last question for me and then I'll hop back into queue. What feedback? What dialogue have you had with the FDA? I'm assuming there has been some back and forth at this point. But what dialogue have you had that gives you the confidence that you can get this approved and launched by the end of the year? Thank you.

[Terry Rich:]

Yes. Of course, look, I'm not going to comment directly on our dialogue with the FDA other than to suggest that we believe that we're on track and should have clearance in first surgeries in Q4, and we couldn't be more excited about the opportunity in front of us.

[Matt Hewitt:]

Okay, great. Thank you.

[Operator:]

Thank you. Our next question is coming from Matthew O’Brien of Piper Sandler. Please go ahead.

[Matthew O’Brien:]

Morning. Thanks for taking my questions. Just to kind of follow up a little bit on the last questions. Jon, does the manufacturing issues that you guys have run into on the implant side of things potentially bleed into anything that could impact your ability to start manufacturing Holo and getting that system out in the field?

[Jon Singer:]

No, absolutely not. I mean, Holo is essentially an assembly operation that's being handled separately and distinct from the legacy implants. And all of the disposables and related products are kind of what you would call a new supply chain and more comfortable that we're on track with what needs to be done in order to deliver in the timelines as Terry's outlet .

[Terry Rich:]

Matt, when I when I talked about transforming the organization, the key to understand is, we're a software company now, right? That's really what we're transforming into. And the software that we have in Holo is different than anything that has been introduced into the surgical environment prior. The first time the computer's been taught anatomy, like this is this is a major deal.

[Matthew O’Brien:]

Got it. Okay. Very helpful. That's understandable and certainly clear as well. Just curious, Terry, when you talk about getting to a $1 million per system, eventually, I mean, is that a two to three-year kind of timeframe to get up to that level of revenue per system? And then, how do you frame up thoughts on Holo going into 2022? I know you don't want to get too much on the guidance side of things. But how big of a revenue contributor could this be both from a system and an implant perspective?

[Terry Rich:]

Yes. So, we're not -- the $1 million per unit will occur almost instantaneously as soon as we start putting them out there. And it'll be a combination of certainly implant pull-through, but also whether it's lease software fees per case, the disposable components. It'll be made up of a variety of revenue streams. And we're certainly not providing guidance for next year, but we have expressed our goal to get 15 to 20 units up and running in relatively short orders, so that we can continue to learn and move the platform forward. So it'll be a variety of both alpha sites and even more importantly IRBs where we can collect clinical data, which will allow us to continue to evolve the system and add additional features and benefits.

[Matthew O’Brien:]

Go it. And just to be clear though. The system's not going to cost a million bucks, but just the system plus other features et cetera could be up to $1 million pretty quickly?

[Terry Rich:]

Yes. The system should cost a heck of a lot more than a million bucks. But no, what we're talking about is recurring revenue.

[Matthew O’Brien:]

Got it. And just the last one for me is, things are a little bit softer here versus maybe some of your peers in spine and in the near-term I know you guys are kind of reshaping the business. How are things going from a salesforce perspective? Is that group still pretty stable? And then just as they're waiting for Holo, just talk about how that group is kind of progressing I guess for lack of a better word?

[Terry Rich:]

Yes. So look, I think the group is incredibly stable. They're certainly looking forward to us delivering new products and Holo is at the forefront of that. But having something like Holo that is so incredibly differentiated is I believe a significant component in why these folks continue to be excited about Surgalign. And when we have meetings like the spine summit last week. And people get to see it. And they hear their surgeons comments, right? Like again, well-renowned surgeon, we're going revolutionize surgery. Like these are meaningful comments made by guys that are key influencers in spine. And they not only influence their peers, but they influence the distributors and the salesforce out there.

[Matthew O’Brien:]

Very helpful. Thank you.

[Operator:]

Thank you. Our next question is coming from Brooks O’Neil of Lake Street Capital Markets. Please go ahead.

[Brooks O’Neil:]

Yes. Good morning. I was hoping, Kris could talk just a little bit about how you anticipate the learning curve for doctors. I know it's early, but is this something that you think they can incorporate relatively quickly? Or is this something you think is going to take a number of years to both convince doctors to try and then get them to fully incorporate into their surgical practices?

[Terry Rich:]

Yes, Brooks. I'll let Kris talk. But the first thing I'd like to say is, there's no user manual for your iPhone. And this system is going to be just as intuitive. Kris please.

[Kris Siemionow:]

Right. Thanks Brooks. That's a great question. One that we get a lot. And I think that question is predominantly generated based on your experience and perhaps other people on the calls experience with systems that are currently on the market. And the robotics, the navigation systems, they're not simple to operate. And I can tell you with very high confidence that the learning curve here is very, very flat. To the point where we've done numerous tests with individuals of various capabilities anywhere from medical students all the way through experienced physicians, and they all perform very well in terms of their precision accuracy and ability to deliver the implant literally on the first try. Okay. And just to give you a little bit of an anecdote. We frequently have non-surgeons come through for the lab such as you can imagine we have a Board of Directors and our board members also demo the system. And for the record, we do not have any spine surgeons on our board. But every one of the board members that's tried the system was able to perfectly place the implant in the right spot on essentially the first time by using the intuitive guidance of the system. And the key word here is guidance. As you heard me on the on the call, I said that we're going away from navigation and towards guidance. And the key differentiator here for our system is that we literally guide you how to do this in an intuitive way, which we feel will decrease the cognitive load on the surgeon, which will result in increased adoption of the system, because for the simple fact. We make the surgeon's job easier. I hope that answers the question.

[Brooks O’Neil:]

Yes. It does. It's great. I really appreciate it. And then I just had one follow-up. Have you had any experience or kind of gotten feedback about what do you think it's going to take to get these systems into hospitals and surgery facilities? Is that going to be a cumbersome process in your opinion? Or do you think the acceptance will be quick and intuitive like you believe the doctors will gravitate to this stuff? Thank you.

[Terry Rich:]

Yes. So Brooks, look, getting anything into a hospital is a cumbersome process these days, right?

[Brooks O’Neil:]

Right.

[Terry Rich:]

Likely rightfully so. What I'm confident in is that orthopedic spine surgeons and neurospine surgeons still drive decision making especially around technologies like this that deliver better patient outcomes. And so, based on that and the team we've assembled I have all the confidence in the world that we will break down these barriers very effectively.

[Brooks O’Neil:]

Perfect. Thank you very much.

[Operator:]

Thank you. Our next question is coming from Jim Sidoti of Sidoti & Company. Please go ahead.

[Jim Sidoti:]

Hi. Good morning and thanks for taking the questions. Can you tell us what can you do now pre-approval with regards to Holo? Are you able to schedule training? Just what steps can you take now in anticipation of that approval?

[Terry Rich:]

Yes. So, we're not doing any formal trainings, Jim, now. There are a number of things that we're continuing to do for our continued FDA submission. So there's various testing. So we're doing labs and a variety of things that require surgeons. And so, based on those types of things to continue to provide information to the FDA, we are using surgeons for the testing of the system. But there is no training going on at this point in time. And prior to clearance there's not a lot we can do beyond the necessary testing.

[Jim Sidoti:]

Okay. So I'm just trying to get a sense of how quickly things can take up once the approval comes. So it sounds like maybe it takes a couple quarters to get all -- to get the process started. Is that reasonable?

[Terry Rich:]

Yes. Look, I don't think it's going to take a couple quarters. We're outlining the trainings now and believe that we'll be able to move forward relatively quickly post clearance. We've got -- beyond clearance, there's a variety of things that we need to do to get systems and disposables and all the necessary things on the shelf. But don't believe that training or anything else will be a barrier.

[Jim Sidoti:]

Okay. So I mean, there are some things that you can do now ahead of approval to get ready to accelerate the launch, it sounds like?

[Terry Rich:]

Yes, absolutely.

[Jim Sidoti:]

Yes. I'm not trying to get you in trouble with the FDA. I'm just trying to understand.

[Terry Rich:]

No. Look, I appreciate it. The relationship with the FDA has been a very good one. We respect the process and are following it appropriately.

[Jim Sidoti:]

Okay. All right. And then the quality issues you experienced. Do you think those are all resolved at the point that the Holo is ready to go. And even though they don't really affect how well they affect the other devices. Do you think you'll have all those devices available once Holo is approved?

[Terry Rich:]

Yes. Look, we're making tremendous progress with our suppliers. And again, like Jon stated, we're about a quarter behind where we thought we would be as a result of these things. But we continue to make good progress and expect to have them result in the coming quarters.

[Jim Sidoti:]

All right. And then, last one for me for Jon. Looks like you made a tax payment in the quarter. I assume that's on the sale from the OEM business. Is that the -- do you anticipate other tax payments this year?

[Jon Singer:]

No. As we indicated in the release, that's the settlement from the OEM sales you referenced Jim. And we believe at this point in time that were settled with the IRS and in fact, now that we're going through the year-end returned, we're optimistic that we're actually going to -- they're going to actually owe us money.

[Jim Sidoti:]

Okay. All right. I just want to make sure I was clear on that. Thank you.

[Operator:]

Thank you. Our next question is coming from Brandon Folkes of Cantor Fitzgerald. Please go ahead.

[Brandon Folkes:]

Hi. Thanks for taking my questions. Maybe just a broader question in terms of sort of the turnaround. Granted, you're not giving guidance yet for 2022. But how do you think about the time frame to get the business to where most of the turnaround is behind you. Is this maybe 2022 being sort of a normalized year for things Surgalign can control, right, granted, none of us can't control COVID. So that's always an overhang. But just any colors there would be helpful? And then maybe just on the 2021 guidance. It doesn't imply a massive bump in 4Q 2021. Is that driven a bit more by these disruptions? Or is this just caution around COVID thinking that maybe we won't get this bolus of patients taking advantage of deductibles at year-end? Thank you.

[Terry Rich:]

Yes. So, as we said in the guidance, we think we're about a quarter behind on some of the separation related activity. So to your question, we're still going to have initiatives around the separation and stabilization building out of the organization in 2022, but we do believe that 2022 should be more of a forward leaning year. That's the expectation. At that point in time, if you look at the number of new team members that we've brought into the organization, they'll be -- they'll at least have some tenure under their belt which will you know create stability in the organization going forward. So yes, 2022 should be less disruptive from factors that we've been dealing with this year. And then, from a guidance perspective, yes, there's just a fair amount of continued caution around both COVID and the supply chain. We have an expectation. As we said that we're quarter behind, but we came out of the first quarter with an expectation of what we were going to see coming out of this quarter and it hasn't come into fruition. So I think that we're just being cautious at this point in time given that this is such a turnaround year and just making sure that we are smart around the way in which we fix things and move forward. So that going back to your original portion of your question. So as we move into 2022, we're not dealing with these issues.

[Operator:]

Sir, did you have any other questions. Our next question is coming from Ryan Zimmerman of BTIG. Please go ahead.

[Ryan Zimmerman:]

Hey. Thanks for taking my questions. Just a couple follows for me. A lot's been asked already. But on Holo, Terry, I know you're agnostic to kind of whether you place it, lease it, however it may be sold. But how do we think about the margin expectations for the Holo system regardless and in terms of how you -- what you can make these for versus what you think that the ultimate ASP kind of shakes out at?

[Jon Singer:]

Yes, Ryan. I think -- I don't think -- when you look at our long-term margin guidance of 70% to 75%, I think in the short term Holo will not have any impact on it from a blend perspective. I think as we evolve the system and move more towards a SaaS model where you're getting per click charges on some of the functionality that Kris overviewed in development. It will obviously be pretty significant margin, because the incremental COGs so to say, will be non-existent. But in the short term, really 2022, 2023, the guidance we gave for long-term margins contemplate the cost of building out the systems relative to the economics of placement.

[Ryan Zimmerman:]

Okay. I appreciate that Jon. And then, a lot has been asked about these quality issues and it's really it’s a guidance. But one thing I'm just wondering if you put a little color around guard rails is we think about the third quarter commentary and it being down sequentially. I mean, if you have to think about it from the perspective, what's driving the impact to guidance? Is it more the quality issues? Is it more COVID caution? I don't know if you could frame up kind of the impact of the size of the two. But we'd love some color around kind of that interplay between those two components that are impacting the business? Thank you.

[Terry Rich:]

Yes. Look, at the end of the day there were three factors as we look in between now and the end of the year that we outlined. There's the quality issues. There is COVID and there's the COVID related impact on coflex. And overly simplified it's probably a third, a third, a third when we look at what we've pulled back. That's the simple answer. I mean, I can go deeper into it. But that's kind of the way -- best way to think about it.

[Ryan Zimmerman:]

Okay. That's helpful. Thanks.

[Jon Singer:]

Yes. The other factor to take into consideration is just -- between Q2 and Q3 there's just naturally a reduction in procedures because of the vacations and whatnot. So Q3 is normally down anyhow. And then what we are seeing with the resurgence of COVID is that there's a lot of regions in which we're seeing reduction in elective procedures. And so, what a lot of our customers are doing is they're just taking longer vacations than they anticipated. We've got a number of surgeons where we've gotten feedback that they're getting one or two slots a week right now. And so, that's also impacting it.

[Ryan Zimmerman:]

And the coflex is -- to be clear, the coflex dynamic is domestic. It's not international or it's both?

[Terry Rich:]

It's predominantly domestic.

[Ryan Zimmerman:]

Okay. Thank you.

[Operator:]

Thank you. At this time, I'd like to turn the floor back over to management for any additional or closing comments.

[Terry Rich:]

Yes. So, thanks everybody for joining the call. Again, we continue to be completely bullish on the transformation that we're making in this company. And are exceptionally excited to get the Holo platform to market. Thanks everybody for your time.

[Operator:]

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines or log off the webcast at this time and have a wonderful day.