Surgalign Holdings, Inc.
Q3 2022 Earnings Call Transcript

Published: 2 Nov 2022

[Operator:]

Greetings, and welcome to the Surgalign Holdings 2022 Third Quarter Earnings Call. It is now my pleasure to introduce your host, David Lyle. Please sir, you may begin.

[David Lyle:]

Thank you, and good afternoon. I'll start today with our customary forward-looking statement disclaimer and then turn the call over to Terry Rich, our CEO, who will provide updates on our business operations and key milestones. I will then review our third quarter financial results and outlook followed by closing remarks from Terry. We will then open the call for questions. Additionally, Chris Thunander, our Chief Accounting Officer is with us today and will be available during the Q&A portion of our call. I'd like to remind everyone that on today's call and webcast, management will be making forward-looking statements about future events, Surgalign's business strategy and future financial and operating performance. Actual results could differ materially from those stated or implied by these forward-looking statements due to risks and uncertainties associated with the company's business. These forward-looking statements are qualified by the cautionary statements contained in today's earnings release and Surgalign's SEC filings. This conference call contains time-sensitive information that is accurate only as of the date of this live broadcast, November 2, 2022. Surgalign undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this conference call. In addition, this conference call may include a discussion of non-GAAP financial measures. Please see today's earnings release for further details, including a reconciliation of the GAAP to non-GAAP results. With that said, I'll now turn the call over to Terry.

[Terry Rich:]

Thank you, Dave, and good afternoon, everyone. During my remarks today, I'll focus on three areas

[David Lyle:]

Thanks, Terry. Similar to the past quarter, I'm going to provide sequential comparisons Q3 versus Q2. We can find our year-over-year comparisons for the third quarter and year-to-date and our 10-Q as in today's earnings press release. We reported Q3 revenue of $20.2 million as compared to $20.6 million in Q2. U.S. sales were in line with Q2 despite some product availability issues and continued procedural volume pressure. International is where we experienced the most softness as a result of current macroeconomic issues and market conditions, resulting in fewer procedures and lower sales volumes. Within the U.S., we saw a sequential improvements within our biomaterial product lines with the biggest sequential increase in ViBone, which was one of our late 2021 new innovations. Product sales for CervAlign, our anterior cervical plate for anterior cervical discectomy infusions were up modestly on a sequential basis following its relaunch, and we expect better contributions in the quarters ahead. Sales of Cortera products, our new pedicle screw system, which was just launched, went very well, and we believe will contribute to sequential growth in Q4 and beyond. I covered these products in particular as they are the new innovations from Surgalign and a sign that we have the opportunity to grow from here. Non-GAAP gross margin in Q3 was 74.9% as compared to 73.5% in the second quarter, an improvement of 140 basis points and primarily related to a favorable product mix shift and a decrease in excess and obsolete expense incurred. GAAP gross margin for the third quarter was 72.8% as compared to 68.9%, an improvement of 390 basis points sequentially. Excluded from Q3 non-GAAP gross profit was a $431,000 inventory purchase price accounting adjustment. Moving on to operating expense. Q3 non-GAAP operating expense was $26.5 million as compared to $27.5 million in Q2, a $1 million improvement. On a non-GAAP basis, excluded from Q3 operating expense was a gain of approximately $6.7 million for accounting adjustments to the fair value of milestones, asset impairment, and abandonment in expense of $2.3 million, $1.2 million of noncash stock-based compensation expense and transaction and integration expense of $214,000. Adjusted EBITDA in Q3 was a loss of $11.2 million as compared to an adjusted EBITDA loss of $11.7 million in Q2, a $500,000 improvement primarily due to higher non-GAAP gross margin and lower operating expense. To put this in perspective, our Q3 financial results were roughly in line with Q2 with slightly lower revenue, offset by higher gross margins and lower operating expense on a non-GAAP basis, impacting our ability to grow in Q3 was product availability, hospital staffing shortages, lower procedural volumes and contract delays, but most impactful with the macro environmental issues in Europe. We expect sequential revenue growth in Q4 with U.S. hardware implant revenue stabilizing and growth expected from new products just launched but more muted growth than previously expected as procedural volumes still remain at lower levels. Internationally, we anticipate some minor growth over Q3. For HOLO, we expect to grow sequentially in Q4, but at less than previously expected, given longer lead times to close contracts. These factors are leading to our revised 2022 revenue outlook in the range of $82 million to $84 million. We expect non-GAAP gross margin in Q4 to remain in the low 70% range as we grow higher gross margin HOLO Portal revenue, corporate gross margins could trend higher longer-term. U.S. gross margins tend to be higher than international gross margins. And if weakness continues and international declines as percent of revenue, there is some upside for improvement as well. We remain laser-focused on lowering our capital outlays, both expenses and nonrevenue-generating CapEx to both conserve capital and free up resources to support commercialization and product development. Looking at our G&A expenses, we have lowered our quarterly expenses in each period of this year and through a series of organizational efficiency enhancements, coupled with more stringent expense policies, we expect to lower our Q4 expenses further and be in a position to operate on a lower cost basis moving into 2023. We have now developed additional optimization plans to streamline operations, improve efficiencies and lower expenses further with the majority of programs anticipated to begin in Q1 of 2023, depending on our financial position at that time. I will note that R&D expense fluctuations have been minimal throughout the year, and we are continuing to invest in product innovation and our engineering and design capabilities, which brings me to the balance sheet and the status of our financing initiatives. First, the balance sheet. We ended the third quarter with $13.8 million in cash and cash equivalents compared to $29.3 million as of June 30, 2022, or a decline of $15.5 million. Key cash outflows were $11.9 million in cash used from operations, $2.2 million in capital expenditures, $1.4 million for changes in working capital and $600,000 in other net cash inflows. We've stated throughout the year that additional financing would be required by around year-end, given our cash runway gets us into early Q1. We have been seeking the least dilutive path to financing, looking at debt instruments, debt and equity combinations as well as straight equity alternatives. We are working on multiple parallel paths with our board and advisers evaluating all options available to us. Over the past few weeks, we have received indicative terms for a proposed transaction. But to date, we haven't been able to progress to definitive documents. The greatest challenge has been market headwinds and volatility and the process has taken longer, removing a number of potential players as a result. In the interim, we remain laser-focused on reducing our cash spend and finding a path that leads to shareholder returns. On this front, and as I mentioned earlier, we have instituted a number of cash savings initiatives and have plans to do more. Now I'll turn the call back over to Terry.

[Terry Rich:]

Thanks, Dave. And I'll build off that last comment. We've accomplished a lot over the past two years and the value provided to our customers have been significant. Many of our new products have been developed with their support, we have strong distribution, growth opportunities both domestically and abroad, and then there is HOLO both the HOLO Portal and our HOLO AI platform, both of which hold great promise, not just for Surgalign, but for the medical community at large and patients they serve. Our challenge right now is securing the resources we need to turn this vision into reality and realize the value we believe is in front of us. We know it's been a tough few years for shareholders ourselves included and greatly appreciate the support we've received. We're asking for more. We need time to explore all options as there is value in our assets and greater value to be realized. Operator, we're now ready to open the call for questions.

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Matt Hewitt with Craig-Hallum Capital Group. Please go ahead.

[Matthew Hewitt:]

Good afternoon. Thank you for the update and for taking the questions. Maybe the first one, and I apologize if I missed this, but do you have a number of HOLO procedures that were completed during the quarter or how that's trending?

[Terry Rich:]

Hey Matt, yes, no, we have not reported on HOLO procedures at this point, just units. But we're making great progress and are incredibly encouraged by the results and the surgeon excitement about the unit, both those surgeons having done cases as well as the reception we received at mass having had it in the booth for the first time, it was unbelievable.

[Matthew Hewitt:]

That's great. Regarding Cortera, has that been used in utilizing HOLO yet or when do you anticipate that could occur?

[Terry Rich:]

Yes. We have not done that in conjunction with HOLO yet. We're just doing the Alpha cases with Cortera. So as we get through the Alpha launch, then we'll look to integrate with HOLO, I don't think it should take an incredibly long time suggest in conjunction potentially with the full commercial release next year.

[Matthew Hewitt:]

Got it. And then I know originally with HOLO, that the plan was to do a measured rollout. You've kind of set those targets on a number of sites that you expected to have up now it sounds like Q1. But I'm just curious, given the environment that we're in, is there anything that you can do maybe to expedite the rollout a little bit, whether it'd be working with some of the existing foresights to maybe ramp up so that you can get the publications to drive incremental awareness and utilization? Or I'm just trying to think of ways that you could maybe ramp up a little bit quicker. And I get it, it's a very challenging environment with all the reasons you mentioned, and we're hearing that elsewhere. But I'm just trying to think of things that -- what are the levers to drive a little bit faster growth, whether it's here in Q4 or as we look at FY '23? Thank you.

[Terry Rich:]

Yes, of course. Thanks, Matt. And look, the engagement around HOLO has been huge. And in fact, a number of the sites we're bringing on additional surgeons now, which is very exciting. The feedback has been huge. We believe that with the increased funnel that we're seeing as a result of having put it in a number of these trade shows that we will be able to look to accelerate the placements through the back half of this year and into next. Again, assuming we've got the ability to get through these hospital contracting processes. That's been the number one issue delaying things. It absolutely has not been surgeon interest. We've got more there than we have units. So it's just about getting through these contracting processes and we're engaged in a bunch of them. So thank you.

[Matthew Hewitt:]

Got it. All right. Thank you.

[Operator:]

Ladies and gentlemen, as there are no further questions. This concludes today's call. Thank you.