Surgalign Holdings, Inc.
Q1 2021 Earnings Call Transcript

Published: 10 May 2021

[Operator:]

Good afternoon, ladies and gentlemen, and welcome to the Surgalign Holdings' First Quarter 2021 Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Jon Singer. Please go ahead.

[Jon Singer:]

Thank you, operator. Good afternoon and thank you for joining the Surgalign Holdings Inc.’s first quarter conference call. Joining me today on the call is Terry Rich, our President and Chief Executive Officer.

[Terry Rich:]

On today's call, I'll begin by providing an overview of our first quarter performance. Then turn the call over to Jon to provide a financial overview, after which I'll provide an update on the progress we have made thus far in 2021, before opening the line for questions. Total revenue for the first quarter was $23.3 million, down from $27.1 million during the first quarter of 2020, primarily driven by the negative impact of COVID-19 on elective procedures both in the U.S. and internationally. While our primary focus is the development of Holo and achieving key milestones during 2021, we continue to successfully deliver innovation within our product portfolio. During the first quarter, we launched a number of new products, including Fortilink in Europe and an expansion of coflex in the United States. In addition, we recently acquired the assets of a fully capable medical device machine shop in San Diego, which will enable us to support the acceleration of our innovation agenda by providing our research and development team was state of the art prototyping and manufacturing capabilities.

[Jon Singer:]

Thanks, Terry. Global spine revenue for the quarter ended March 31, 2021 was 23.3 million compared to 27.1 million for the prior year period. The declining revenue was primarily due to the impact of the COVID-19 pandemic on global elective procedure volumes. Domestic revenue was 19.8 million, a $2.4 million decline from the first quarter of 2020 and international revenue was 3.5 million or 1.3 million decline from the first quarter of 2020. Gross profit for the quarter was 17.1 million or 73% of revenue compared to 17.9 million or 66% of revenue in the prior year first quarter. The improvement in gross margin rate is due to the elimination of certain manufacturer related costs as we move from an integrated manufacturer to a fixed price purchase when we sold the OEM business. Marketing, general and administrative expenses decreased 11.4 million or 31% to 25.9 million for the three months ended March 31, 2021 compared to 37.2 million for the three months ended March 31, 2020. The decrease in marketing, general and administrative costs was driven by a reduction in spending as a result of the decline in revenue and the simplification of the distribution and marketing infrastructure and a reduction in spending due to the sale of the OEM business. Research and development expenses decreased 1.4 million or 33% to 2.9 million from 4.3 million for the three months ended March 31, 2021. The decline in research and development expense is a result of a reduction in spending as the company has begun to build out its internal R&D organization after the sale of the OEM business. Adjusted EBITDA for the first quarter of 2021 was a loss of 9.8 million compared with a loss of 20.2 million in the prior year period. The improvement in adjusted EBITDA is predominantly driven by the reduction in operating expenses --

[Operator:]

Ladies and gentlemen, please be patient. We are experiencing technical difficulties at this time. And your conference will resume shortly. Thank you.

[Jon Singer:]

I would start turning to guidance.

[Operator:]

And you are back in, sir.

[Jon Singer:]

Sorry about that. I believe we are back. We were at guidance. The COVID-19 global pandemic continued to impact demand for our products during the beginning of 2021, with a particularly strong impact on our international markets. We're beginning to see a slow recovery in our domestic markets and as a result expect total revenue for the second quarter of 2021 to grow by 5% to 7% sequentially over the first quarter of 2021. We continue to anticipate full year revenue growth in the range of 5% to 10% compared to full year revenue of 102 million in 2020. Our guidance assumes the global procedure volume continue to progress and begin normalizing towards the end of this quarter with a slow returns at historical levels for coflex and limited contribution from Cervalign ACP, which was withdrawn from the market due to a recall by our manufacturing partner in January. In addition, we assumed certain biologic products will be impacted by a delay in 510(k) clearance of the products as the FDA has upped classified the regulatory requirements. Based upon this revenue, we continue to anticipate full year adjusted EBITDA will be in the range of a loss of $35 million to $40 million. I would like to now turn the call back to Terry.

[Terry Rich:]

Thanks, Jon. Our primary focus this year is on the ongoing progression of our digital strategy, which includes the build out of the organization and the continued development of the whole surgical platform, and to re-imagine our product portfolio to accelerate the pace of new product introductions that will integrate seamlessly with the whole surgical digital platform to deliver better patient outcomes. Starting with some of the recent developments with our product portfolio, we continue to work to align our long-term product development roadmap to support Holo Surgical and the promise of digital surgery. In addition to focusing on identifying new development initiatives, we are undergoing a critical assessment of our existing portfolio to identify any individual products, or product segments that we don't believe will be supportive of our digital strategy going forward. In the near term, we've accelerated our innovation agenda and are building out our portfolio of products that can be integrated into the whole surgical platform.

[Operator:]

. Your first question comes from the line of Matthew O’Brien with Piper Sandler.

[Matthew O’Brien:]

Good afternoon. Thanks for taking the questions. I guess, Jon, just real quick, and I don't want to overstate this too much but reiteration of guidance of 5 to 10 in your press release from mid March was 7 to 10. So are you really kind of steering towards more of that 5% kind of range for the full year?

[Jon Singer:]

Well, I think the press release -- our commentary in the last quarter was 5 to 10. So it's consistent with what we had in the script. I would say based upon the first quarter and what we're guiding in the second quarter, we're trending towards the lower end of that guidance.

[Matthew O’Brien:]

Okay, makes total sense. And then just a couple more for me. And I think, Terry, you were kind of getting to it, but this 20 IRB/clinical site group that you're going to be targeting right away, what should we expect in terms of just kind of them getting the system, paying for a system, volume commitments? And then do you need to get and really kind of compile a lot of usage data, before you roll it out more broadly to clinicians and centers in '22, or is it the expectation that you're going to still be -- you're going to be pushing to sell systems fairly quickly in the first half of next year?

[Terry Rich:]

Yes. So, Matt, the goal is to get these systems out here, gain experience and publish on them and show what we believe to be true, which is that we have a highly differentiated and in fact revolutionary system that can help differentiate on patient outcomes. But to do that, we need data and we need experience with it in surgeon's hands. The other component of that, as I mentioned, this is the first submission, right, and we'll focus on the lumbar spine. We will continue to expand the application of the systems over time. Still expect to have full release of the system next year. And again, we'll continue to use the models that exist out there today until we have fully demonstrated that we drive a difference in patient reported outcomes.

[Matthew O’Brien:]

Got it. So we should be expecting a pretty measured rollout of the system late this year into next year. That's fair?

[Terry Rich:]

That’s fair.

[Matthew O’Brien:]

Okay. And then last one for me is it was interesting to hear you guys acquired that new machining company out West. You've got this massive R&D group as well now. So I'd say Holo is important, but you're also going to try to augment it with new products. Can you talk about what we should anticipate in terms of new product flow over the next couple of years? And then, I guess more importantly, on top of that, are you going to have the step capacity to support that new product flow?

[Terry Rich:]

Yes. So, look, Matt, the key is, is we stated everything we're doing is going to be compatible with Holo. And so we need to have best-in-class hardware and differentiated hardware, and we'll look to use Holo to help us differentiate as we continue to move the platform forward. And currently, without having those machine shop capabilities, your development process can get dragged out for forever waiting to get prototypes in, running testing on them, making changes, more prototypes. This substantially increases our speed to market. So, currently, again, we're focused on some of the key areas that we'll be able to support Holo next year, but sets should not be an issue for us.

[Matthew O’Brien:]

Got it. Thank you.

[Terry Rich:]

Thanks, Matt.

[Operator:]

You next question comes from the line of Ryan Zimmerman with BTIG.

[Ryan Zimmerman:]

Hi. Thanks for taking the question. So, Terry, you mentioned a dynamic and I think you're looking at some of your hardware, some of your product, in terms of what you may or may not keep. Could you just maybe put a little finer point on that kind of have you sized it up, help us understand kind of what you may not be continuing with, and at what point in time?

[Terry Rich:]

I’m sorry, you were cutting out a little bit there, but I think I got the gist of it. We've got almost 90 brands over, I forget how many countries and that is a lot to maintain. And so we need to be smarter about the products that we're going to continue to invest in. And so what we're looking to do is to effectively rationalize the portfolio in smart ways, because the products that we want to continue to come out with are going to be the products that support the Holo platform, and help us to drive outcomes. So not going to get into specifics on 80-some brands here today, but that's the gist.

[Ryan Zimmerman:]

Okay. And then just directionally maybe for Jon as a follow up to that, will this have a dilutive, an accretive impact on margins? I would assume it will help boost margins, but maybe if you could just provide your thoughts on it, Jon?

[Jon Singer:]

Look, I think we've given guidance that we're targeting 70%, 75% margins. And this rationalization of products is contemplated in that guidance. So I don't see it as something that's different than what we've guided at this point in time. And as Terry indicated, we're going to intelligently migrate out of these products in a way that will hopefully be transparent as we bring on -- as we consolidate brands and bring on new product families, we'll be able to transition surgeons in a way that doesn't create a significant change from an operational perspective.

[Ryan Zimmerman:]

Okay. Thank you for taking the questions.

[Operator:]

The next question comes from the line of Matt Hewitt with Craig-Hallum.

[Matt Hewitt:]

Good afternoon. Just a couple of questions. I guess following up on the gross margins there, obviously, another nice little uptick in Q1 here. Should we anticipate that continuing to trend higher over the course of the year as procedure volumes pick up, or are there other factors at play that it's going to bounce around a little bit?

[Terry Rich:]

No. We don't get -- because we were buying all our products, Matt, there's no manufacturing leverage. So the margins should be in the ranges in which you've seen it. It's predominantly a function of mix at this point in time than anything else.

[Matt Hewitt:]

Okay, fair enough. And then during your prepared remarks, you commented on some potential delays with some new product launches regarding the up classing of certain biologics. Will that only impact existing products in the pipeline or will it have an impact on some of the existing products, and how should we be thinking about that?

[Terry Rich:]

Yes, they're in particular, there's a DBM, a legacy DBM that we're getting from Florida that as they went through the process, they got pushback from the FDA. And so it's specific to an existing product that we're potentially going to have a gap in sales. We've identified an alternative and we're working with a partner, a new partner in order to fill that gap. But I think during the quarter, we could -- this quarter in particular, we could have a temporary disruption.

[Matt Hewitt:]

And how big of an impact is that? A couple percent headwind or any way to help us with sizing that up?

[Terry Rich:]

Yes, I think it's contemplated in the guidance I gave you on the projection for the quarter, so it's already embedded in the numbers.

[Matt Hewitt:]

Okay, fair enough. All right, that helps. Thank you very much.

[Operator:]

The next question comes from the line of Brooks O’Neil with Lake Street Capital.

[Brooks O’Neil:]

Good afternoon, guys. I cut out a little bit during the call, so if I ask something that you've already talked about, I apologize. I'm curious if you would be willing to talk a little bit about how quickly you anticipate being able to integrate and align the Holo capabilities with your existing product line, at least to the extent as you anticipate the product line being configured going forward?

[Terry Rich:]

Yes. Thanks, Brooks. And I think we cut out for a while during the call as well. So day one, we will immediately upon clearance. In fact, the submission is for clearance with our existing systems. So day one.

[Brooks O’Neil:]

Great. Fantastic. Second question, obviously, you made tremendous progress realigning the organization and whatnot. A, do you feel like you're in a pretty good spot with regard to your organization today? And b, can you speak to kind of the cultural integration and how that's all going across what is essentially today a global organization?

[Terry Rich:]

Yes, absolutely. So, Brooks, as I've mentioned in the past, the organization is the thing I'm proudest of. We are very clearly a rebuild, and the talent that we're bringing into this organization is literally unparalleled and again, in every department highlighting our most recent executive hire, Marc Mackey, but literally through every level of the organization. And everybody here understands what we have to do and there's full alignment. And I would suggest the culture continues to grow and get better literally every week. I couldn't be more excited about what we're building.

[Brooks O’Neil:]

That's fantastic. Let me just ask you one more. We're pretty excited about the opportunity internationally. Obviously, the COVID has been in the news internationally. I'm just curious if you can a, give us a sense for what you're seeing outside the United States? B, what the regulatory pathway looks like for Holo? And maybe when you think you might be in a place to start doing surgeries with doctors outside the United States as well? Thanks a lot and congratulations on all you've accomplished.

[Terry Rich:]

Yes, thanks a lot, Brooks. And yes, what we've encountered is that things have been very difficult in the international markets. We had a call this morning where they talked about a sales meeting in Germany they were trying to have live, but because of the lockdown had to move it back to virtual. A number of surgeries have been canceled. And it's been difficult times in a number of the countries over there. And so we're thankful that our team is in good health and great spirits, and look forward to things hopefully continuing to open up as they get the vaccines out. As it relates to our strategy for Holo, we're still working through what our regulatory strategy is going to be to get Holo cleared in the international markets. As you may know, the change from MDD to MDR has some significantly more clinical components of it. And so we're in process of understanding that pathway now.

[Brooks O’Neil:]

Perfect, makes sense. Thanks a lot for all the color.

[Terry Rich:]

Thanks, Brooks.

[Operator:]

. The next question comes from the line of Jim Sidoti with Sidoti.

[Jim Sidoti:]

Hi. Good afternoon. Two quick ones for me. It sounds like most doctors now, most surgeons are used to using a 2D system. How long do you think it will take for them to make the transition from a 2D to a 3D? How many cases or how many -- just in general, how long will it take for them to adopt this newer technology?

[Terry Rich:]

Yes. Hi, Jim. Thanks a lot. It will happen in their training, right. We're going to be required to train before they use the system, and it will happen there. It is literally going to be something that is far more familiar to them than what they've used before as well as a feature set that makes surgery easier that they've never had before either. Again, we had a design meeting on a number of other products, a bunch of surgeons here in town, and we showed it to them. And I could not have been more excited about the accolades the system received. We had surgeons requesting units right there, understanding they have to wait for clearance obviously, but wanting to be part of the alphas and IRBs.

[Jim Sidoti:]

Okay. And second one for me, Jon, I don't know if you said this or not. But after the raise in the first quarter, what should we be using for diluted share count going forward?

[Jon Singer:]

Yes. So we've got just right around 110 million, 111 million shares outstanding right now, Jim. So that's probably -- when you look at the weighted average for the year, that's probably directional.

[Jim Sidoti:]

Okay. Thank you.

[Operator:]

We have no further questions at this time. And now I will turn the call back over to Mr. Terry Rich for any closing remarks.

[Terry Rich:]

Excellent. Thanks everybody again for joining us here today. Look forward to updating our progress in the next quarter as we couldn't be more excited about what we're building here at Surgalign. Thanks.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation and you may now disconnect.