Surgalign Holdings, Inc.
Q3 2021 Earnings Call Transcript

Published: 9 Nov 2021

[Operator:]

Good day, ladies and gentlemen and welcome to your Surgalign Holdings, Inc. Third Quarter 2021 Results Call. All lines have been placed on a listen-only mode and the floor will be open for your questions and comments following the presentation. At this time, it is my pleasure to turn the floor over to Chris Thunander, Chief Accounting Officer. Sir, the floor is yours.

[Chris Thunander:]

Thank you, operator. Good afternoon and thank you for joining the Surgalign Holdings, Inc.'s third 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 disclosures. 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 line 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 the 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 noncash 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 Investors section of our website. On today's call, I'll begin providing an overview of our third quarter performance and an update to our guidance for the year. I'll then turn the call over to Terry to walk through the progress we made with our digital strategy and 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 September 30, 2021, was $20.5 million compared to $27.9 million for the prior year period. The decrease in revenue is primarily due to decreased demand as a result of COVID-19-related elective surgical procedure headwinds in the third quarter. Domestic revenue was $17.3 million compared to $23.7 million in the prior year quarter and international revenue was $3.2 million compared to $4.2 million in the prior year quarter. Gross profit for the quarter was $13.7 million or 66.8% of revenue compared to $16 million or 57.4% of revenue in the third quarter of 2020. Marketing, general and administrative expenses were $27.6 million for the three months ended September 30, 2021, compared to $27.7 million for the three months ended September 30, 2020. Research and development expenses in the third quarter of 2021 were $2.9 million compared to $2.2 million for the three months ended September 30, 2020. Adjusted EBITDA for the third quarter of 2021 was a loss of $13.6 million compared with a loss of $6.2 million in the prior year period. We ended the third quarter with $68.4 million in cash and cash equivalents which includes the net proceeds of the financing completed on June 14, 2021, as well as final settlements related to the sale of the OEM business for tax liabilities and the resolution of the working capital dispute. Turning to guidance. Based on the impact of COVID on our third quarter performance as well as our expectations for continued COVID headwinds during the fourth quarter, including pressures of -- on elective procedural demand, hospital staffing shortages and global supply chain-related headwinds, we now expect full year revenue in the range of $88 million to $92 million compared to prior guidance of $95 million to $100 million. We now expect full year adjusted EBITDA loss will be in the range of $44 million to $48 million. With that, I would like to turn the call over to Terry.

[Terry Rich:]

Thanks, Chris. Our main focus for driving long-term growth in the business continues to be the development of the Holo platform and the achievement of near-term milestones on the path to commercialization. Starting with a regulatory update. We continue to have a productive dialogue with the FDA as it relates to our initial 510(k) clearance. Recently, we were notified of an FDA automated system error regarding our application and as a result, our time line for clearance has shifted slightly. The error omitted AIs, or additional information requests, that require certain texting activities to validate the performance of the system. We are performing the required tests and will revert to the FDA as quickly as possible but this does pose a risk to clearance and first cases by the end of the year and could push us into early 2022. To be very clear, this is a nominal delay and this shift in timing due to document automation error does not impact our expectations for clearance or change our belief that the Holo system is now meeting or exceeding FDA clearance criteria. Additionally, this shift does not change our expectations related to our ability to initiate IRB and alpha sites through the first half of the year and more broadly launched the platform in the second half of 2022. We are branding the initial application of the Holo platform, our surgical guidance system, as Holo Portal. The Holo portal combines image-based guidance technology with augmented reality, automated spine segmentation and surgical planning utilizing proprietary artificial intelligence software that we believe will help surgeons perform better surgery more quickly and ultimately deliver on the promise of better outcomes and patient satisfaction. As we previously noted, the market opportunity for the Holo platform over the long term is tremendous as it encompasses a variety of uses outside of interoperative support, including diagnostic, surgical planning and postoperative solutions. When looking at Holo Portal's initial application within the lumbar spine procedures, we estimate the total addressable market to be approximately $5 billion which will expand exponentially as we move into new indications and integrate additional capabilities. As a reminder, this submission is the first of many as our R&D has already been working on expanding the applications into neuro, orthopedics in general and many other surgical specialties and applications across the continuum of care. Early interest in utilizing the system has been extremely strong and we are currently working directly with a number of U.S. surgeons and their institutions to install the platform. Because of this preliminary work, we expect to have multiple sites up and running in a relatively short order after clearance. Before turning to Q&A, I wanted to highlight a recent addition to our Board of Directors. In September, Sheryl Conley was appointed as Chairman of the Board following her appointment to the Board as part of our annual meeting. Sheryl brings over three decades of executive leadership experience in the orthopedic space including over 25 years spent at Zimmer. We are excited for her to now help guide the development of our company as we position ourselves to be leaders in the evolution of surgery through the application of artificial intelligence, data analytics and augmented reality. Let me reiterate. We're incredibly excited about the opportunity that lies ahead for Surgalign as it transforms into an AI technology-focused company with a broad selection of applications in addressable markets. Our impending 510(k) clearance will be a major achievement for everyone across the organization and represents the first major step towards Surgalign becoming the leader in digital health care. Subsequent to clearance, we'll shift our focus to taking the steps required to ensure a successful commercial rollout of the Holo Portal. In addition, we will continue to invest heavily in the technological development of the platform to take advantage of the massive market opportunity that exists for this revolutionary platform and ultimately deliver on the promise of qualitatively better outcomes and patient satisfaction. With that, I'd like to open the line for questions.

[Operator:]

We'll take our first question from Matthew O'Brien with Piper Sandler. Please go ahead.

[Simran Kaur:]

Hi guys, thanks for taking the questions. This is Simran on for Matt. I guess I just wanted to first start off with the automated documentation error in the FDA filing. It sounds like reprocessing of this submission is contingent upon completion of this testing requirement that was admitted from the initial processing. Am I understanding that correct?

[Terry Rich:]

Yes. There were two questions that were left off of the original group of AIs, or request for additional information, that we received. And so we're in process. The rest are complete. So we're in process of finalizing the testing to reply to those last two.

[Simran Kaur:]

Okay. So then what do you expect the turnaround to be in terms of getting that information back to the FDA. And thinking ahead with the FDA and you data right now, what makes you confident in those time lines for Holo only being pushed marginally?

[Terry Rich:]

Just based on our conversations with the FDA. And so when we get the questions in, it starts the 30-day clock with them again. So we're again pushing to get the testing done as efficiently as possible and we'll resubmit the last two components.

[Simran Kaur:]

Okay. And then a quick one on the balance sheet. It looks like you guys have a little over $68 million in cash. So how much cash runway does that provide you with given you guys are pushing ahead with Holo and we are expecting to see some new product launches next year? And then maybe from an OpEx standpoint, could you help us understand quantitatively or qualitatively the pace of spending in subsequent quarters both on the R&D and SG&A side?

[Chris Thunander:]

Yes. To answer your first question on the runway for cash, we have enough cash for the IRB size and get prepared for the broader launch of Holo, broader commercial launch of Holo. So that's how I would think of that. And similarly, on the OpEx side, our OpEx spend will be in line with the development and the IRBs of Holo, the alpha sites and the likes. And we'll continue to kind of support that legacy business and the R&D related to it.

[Simran Kaur:]

Okay, perfect. Thank you, guys.

[Chris Thunander:]

Thank you.

[Terry Rich:]

Thank you.

[Operator:]

We'll take our next question from Brooks O'Neil with Lake Street Capital Markets. Please go ahead.

[Brooks O'Neil:]

Good afternoon, all. Just following up there quickly, not that this is terribly significant but I'm curious, did the FDA forget to ask you two questions? Or did you guys just not see something they asked and missed responding?

[Terry Rich:]

Yes. No. Brooks, there's an automated system that sends over the PDF of the questions to us. And two questions were admitted. Apparently, this -- we weren't the only ones that had this error and just an automation error.

[Brooks O'Neil:]

Sure. Cool. That's helpful. Just thinking out loud before we talk more about Holo. Obviously, you've got -- you've provided sort of a revised outlook for the historic business, the traditional spine device business. I'm hoping you could just talk a little bit about how you see that fitting into your company over the next year or two, sort of should we kind of ignore that business? Is it significant? Are you going to sell it? How do you think about it?

[Krzysztof Siemionow:]

Yes. So Brooks, I guess is -- I think through this year and obviously, no one wants to lower guidance. We've just seen things that we haven't experienced before and I think largely related to the pandemic. If you look at the quarters, just the swings we have quarter-to-quarter, you're not picking up that much new business fast enough to have that kind of effect and you're not losing it fast enough to have that kind of effect. And we really thought the worst was behind us. And we were quite taken back by how dramatic the effect was on Q3. We've made great progress in the area. If you consider some of the quality issues we've referred to in the previous quarters, knock on wood, we have those behind us. We've made great progress and Surgalign is back out on the market. We're -- the navigation instruments are back out on the market. We've got a number of new interbodies coming out. We've started in Europe with them and we'll start here shortly after the first of the year. So I believe that we're headed down a really good path. And really, this is a testament to the R&D team that we've brought in to shore these up and now we look forward to moving forward in getting new products out the door.

[Brooks O'Neil:]

Yes. Okay, that's helpful. And then, just wonder if you or Chris could provide any color in your thinking about a $5 billion TAM. Obviously, that's a really juicy number, if you will. And I'm hoping you might be able to help us sort of put some context around how you're seeing the market and the opportunity you're going after with Holo.

[Krzysztof Siemionow:]

Yes. I'll start and then, Chris, why don't you jump in on the end? But look, I think that there are a number of reasons why whether it's robotics or navigation has seen low adoption rates. And I believe that Holo overcomes a number of those issues. I think the other thing, Brooks, is I'm getting as excited or potentially even more excited about the applications that we're going to have outside of the OR as I am for the applications that we're going to have within the OR. And that's for spine, brain, even orthopedics and general surgery. And so as we continue to advance and build out the team and see the progress they're making in these areas, it's incredibly exciting with what we see. And we'll begin to unveil some of this further after first of the year with a number of programs. So Chris, why don't you go ahead and comment?

[Chris Thunander:]

Yes. So Brooks, two things that some of we have shown already which is the intraoperative applications. But I think what's key to understand and this is something we've actually highlighted and we made a press release around the intellectual property, the granted patent normally, we wouldn't do a press release about some ordinary patent getting granted but this is very foundational to what we're doing on a number of fronts and one of them is outside of the operating room. So the technology that we have been showing to surgeons and people that have been coming through the office has multiple applications. And once again, the very graphic one is guiding a surgeon during a surgical procedure. However, the same core technology -- and you know what I'm talking about, so the same quarter.

[Brooks O'Neil:]

Yes. No. I tried it.

[Chris Thunander:]

Yes. You have. The same core technology behind the curtain we have been developing for a number of years to serve as an automated image reader. So imagine the CT scans, MRIs and X-rays that are done every day of the week at a hospital, right now, they're being read by radiologists, right? So the same technology that breaks that anatomy down that we have deployed in the operating room to guide the surgeon, we have also deployed to read MRI, CT scans and X-rays. So very soon, we will be doing some testing with surgeons and non-surgeons because the technology is applicable not only once again in the operating room and not only to surgeons but to practitioners, such as neurologists, for example, or primary care physicians that have no surgical experience but are faced daily with reading images. And they rely heavily on the radiologists to do that for them. And by no means are we saying, "Hey, we're getting rid of the radiologist here," but we're definitely introducing the software into the workflow to help us better understand what's going on with the patient. So that's something you will be hearing more from us about in the coming months as we start unveiling that a little bit.

[Brooks O'Neil:]

Yes. And you guys talked a little bit about surgical planning and some of those things. Do you think those are markets where you use sell systems that specifically help with surgical planning? Or do you think it's more a component of the system that enhances the value you think you could derive from sales of the system?

[Chris Thunander:]

Yes. I'm going to go, Terry. The answer to that is both actually, right? It depends on which angle you're hitting at that because there are certain device manufacturers in a space we're not in, such as orthopedics, that are relying on a lot of manual engineering and essentially marking images by hand to achieve a certain goal such as -- to make a robotic surgery procedure possible. So we see a lot of opportunities for our software to assist with that and, once again, speed up those workflows and reduce the amount of manual intervention which equals time, money and all those other things, that those teams and those companies have to do. So that's on the outside of the operating room. And then I do feel that this will be one of the key differentiators of our system that we utilize artificial intelligence to how formulate a plan. Of course, the doctor checks and validates it. That's what a doctor's job is. But I do think that they will save significant time and reduce errors for those patients in the operating room.

[Brooks O'Neil:]

Great. Appreciate all that color. I'm excited about seeing this continue to evolve.

[Terry Rich:]

Thanks, Brooks.

[Operator:]

We'll take our last question from Jim Sidoti with Sidoti & Company. Please go ahead.

[Jim Sidoti:]

Hi, good afternoon and thanks for taking the questions. You're not the first company at all to have issues with COVID in the quarter. It seems like it really ticked up. Are you seeing any relief towards the end of the quarter and into October? Or do you think this will be an issue through the first half of 2022?

[Terry Rich:]

Yes. Great question, Jim. And I wish I knew. Look, certainly, various points in the quarter, you get upticks and downticks and that's what's made this thing so difficult. I mean again, if you just look at our quarters throughout the course of the year, I mean Q2 is never bigger than Q1. And so we -- it has been something that we struggle to predict. We never thought we'd get back to the kind of level we hit in Q3 and we're certainly hopeful that things continue to progress in Q4 and we can get back on a more normal track. But as I say that, Europe is experiencing greater pressures from COVID again. And we have recently had some things closing down on us there. At the same time, Australia seems to be picking it back up again. So it's just -- it's a tough balancing act to be able to predict where these things are at right now.

[Jim Sidoti:]

Great. And then my follow-up, is there anything you can do now prior to the FDA approval to get feedback from doctors on Holo and kind of tweak the system, make sure that it's going to be what you think it's going to be when you go out and launch it in 2022?

[Terry Rich:]

Yes. So a lot of the testing that we've been doing with the system does require surgeons to come in and help us. And we've shown it to a number of folks and have taken in a lot of their feedback. But the things that you do with phantoms or cadavers are always different than how they work when you get them into the actual operating theater which is why we plan on starting with the alphas and IRBs to validate where we are prior to proceeding with a broader commercial launch.

[Jim Sidoti:]

Okay. And despite the issue you had with the FDA, you still think that's likely to happen in the first half of 2022. Is that correct?

[Terry Rich:]

Yes, yes.

[Jim Sidoti:]

All right, thank you.

[Terry Rich:]

We do. Thanks, Jim.

[Operator:]

We'll now turn the call back over to Mr. Terry Rich for closing remarks. Mr. Rich, the floor is yours.

[Terry Rich:]

Excellent. Thanks, everybody, for joining our call. Again, we continue to be extremely bullish on the transformation that we're making in this company and are exceptionally excited to get the Holo platform to market. I look forward to updating you on our progress on the next call. Thank you.

[Operator:]

This does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time and have a great day.