Surgalign Holdings, Inc.
Q4 2020 Earnings Call Transcript

Published: 16 Mar 2021

[Operator:]

Good afternoon, ladies and gentlemen and welcome to the Surgalign Holdings' Fourth Quarter and Full Year 2020 Results Conference Call. At this time, all participants are in a listen-only mode. Later we'll conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. I'd now like to turn the conference over to your host Jon Singer. Please go ahead.

[Jon Singer:]

Good afternoon and thank you for joining the Surgalign Holdings Inc. fourth quarter and full year conference call. Joining me today on the call is Terry Rich, our President and Chief Executive Officer.

[Terry Rich:]

Thanks John. Good afternoon, everyone. On today's call I'll provide an overview of our fourth quarter performance, an update on events that occurred during 2020 and then turn the call over to Jon to provide financial overview, after which I'll provide our thought on 2021. Total revenue for the fourth quarter was $26.2 million down from $31.6 million during the fourth quarter of 2019, primarily driven by the negative impact of COVID-19 on elective procedures both in the US and internationally. Taking a step back, 2020 was a transformational year for the company. Amidst all the uncertainty associated with COVID, we pursued an organizational overhaul in July, which included the separation of two businesses to create a standalone pure play spine company now known as Surgalign. Just a few months later in September, we acquired Holo Surgical, immediately shifting our priority to becoming a leader in the digital surgery space with an initial focus on spine. At the time we want Surgalign, we laid out our growth strategy for the business, which was made up of three components build, innovate and acquire. We've made tremendous progress towards each of these during the remaining five months of the year.

[Jon Singer:]

Thank you, Terry. Global spine revenue for the quarter ended December 31, 2020 was $26.2 million compared to $31.6 million for the prior-year period. The decline in revenue was primarily due to the impact of the COVID-19 pandemic and global electric procedural volumes. Domestic revenue was $22.7 million, a $4.5 million decline from the fourth quarter of 2019 and international revenue was $3.5 million, a $0.9 million decline from the fourth quarter of 2019. We believe that demand for our core implants and biologics, both domestically and internationally will return to historical levels globally in line with the return of global elective procedures. However, we anticipate complex product family will return to historical levels at a slower pace than the rest of our portfolio. Gross profit for the fourth quarter of 2020 was $12.8 million, inclusive of $6.9 million incremental inventory charges, predominantly related to the recall of the Surgalign ACP System and purchase accounting related mark-ups to inventory. Adjusted for the impact of the charges, gross profit was $19.7 million or 75% of revenue compared to $23.6 million or 75% of revenue in the fourth quarter of 2019. Marketing, general and administrative expenses for the fourth quarter of 2020 was $27.3 million compared to $39.9 million in the prior-year period. The decline in marketing, general and administrative expenses is predominantly driven by the decline in sales-related costs due to the decline in revenue and a reduction in the administrative infrastructure, as a result of the OEM sale.

[Terry Rich:]

Thanks, Jon. Before shifting to our 2021 outlook, I wanted to discuss our long-term vision for Surgalign and how we are approaching our transformation from a spinal implants company to a digital surgery technology company. The whole of platform is a revolutionary foundational technology and we believe it will impact how surgery is performed and ultimately how care is provided to patients. The initial application of the Holo platform is enabling digital spine surgery. The platform addresses limitations that exist in today's computer-assisted surgery and robotic platforms by introducing smart applications, enhanced visualization, real-time guidance, warnings, and alerts thus, enhancing surgical performance. We will leverage the autonomous anatomy segmentation and identification software to develop smart instruments to improve surgical workflows makes spine surgery safer, which we believe will lead to better patient outcomes. We intend to expand the applicability of the platform outside of the EOR as we believe it has the potential to provide benefits throughout the surgical landscape from diagnostic and predictive analytics capabilities to autonomous pre-op planning and intelligent post-op analysis functionality. While the spine market is a significant opportunity, we view it as a stepping stone application for the platform. Once the model has been proven, we intend to expand into other surgical specialties beyond spine. We are in the early innings of our journey through this transformation, but we are excited about the potential of this innovative technology. As part of this transformation, we intend to move away from the traditional model of selling screws, implants, and access as a package for procedural pull through instead moving towards delivering better outcomes by re-imagining what is possible through integrated intelligent technology. This shift will not happen immediately, but everything we are doing from this point onward will be done with the intention of moving towards personalized medicine through the application of the digital platform and supporting technologies. Before opening the call up to Q&A, I'd like to discuss our key priorities for 2021. At a high level 2021 will be a year of transition and investment building the foundation for growth in 2022 and beyond. Our priorities for the year are first continue to build out the organization in support of our digital strategy. Second, continue the development of our Holo platform with the goal of performing first cases in the U.S., by the end of the year. And third, reimagine our product portfolio to accelerate the pace of new product introductions.

[Operator:]

We have our first question coming from the line of Matthew O'Brien with Piper Sandler. Your line is open.

[Matthew O'Brien:]

Afternoon, and thanks for taking my questions. Terry or Jon, can you just talk a little bit more about that, the way that you saw on Holo maybe just quantify a bit how long the delay was and specifically what it was on was it software, was it hardware was it something else? Just any more color there would be helpful.

[Terry Rich:]

Yes, thanks, Matt. So yes, the software is perfect, which is the great news as we had to go through some third-party testing prior that was required for the submission. We ran into a couple of minor issues relating to some hardware and electrical systems that – the fix was quickly identified and are in process of finishing up that testing now. So it's really a nominal delay.

[Matthew O'Brien:]

Okay. We're talking a couple of weeks, basically?

[Terry Rich:]

Yes.

[Terry Rich:]

Yes, that's exactly right.

[Matthew O'Brien:]

Got it, okay. And then, on the new product side, I guess the first thing. It sounds like you feel pretty comfortable with the approval timelines. I don't know how much you're kind of factoring in some of the slowdown at FDA that we're seeing just COVID-related, but I'd love to hear just confidence again in that timeline that you're talking about that. Then secondly, on the new product side, I guess what happens, if the Holo does get delayed, can you still roll out those new technologies and then how differentiated can you really make those products can you get pricing premiums on et cetera?

[Terry Rich:]

Yes, sure. So again, we don't have any insight to the FDA and how COVID is back them up. We've had good conversations with them and it put together an outstanding submission. And so we feel very confident about that and certainly are contemplating what you mentioned into the timeframes. The other products – that you referred to look our sales forces has been starving for products for a number of years now. So we believe they just getting them into the field will continue to drive revenue growth, it will increase our products per distributor, per surgeon and drive all of those metrics up. As for premium pricing, there isn't a lot of it anymore with IDNs and GPOs really driving pricing at the product level. But we will certainly look to maximize the opportunity, the best we can.

[Matthew O'Brien:]

Okay and last one for Jon, just on the EBITDA loss for the year? How do we think about that ramp over the course of the year as we getting closer to the Holo approval and rollout – that we're going to see a big loss in Q4? And then that carries into next year, how do we think about the cadence there? Thank you.

[Jon Singer:]

Yes no, we don't anticipate we're going to build the competency through the course of the year. So as you kind of, we were at 7-7 in the fourth quarter. And I think it's just, it's pretty the cost will build a bit between now in the end of the year, but we're talking less than 10 resources incrementally to support the IRB. And then, really based on the output of that we'll get an assessment of what we need for the full commercial alpha launch. And so yes, I think that it will look, I don't anticipate that it's going to grow significantly in the fourth quarter, it's going to be more in line with the overall revenue cadence.

[Matthew O'Brien:]

Understood. Thank you.

[Operator:]

We have our next question coming from the line of Ryan Zimmerman with BTIG. Your line is open.

[Ryan Zimmerman:]

Hey, Terry, hey Jon, thanks for taking the questions. Just a follow-up on Matt's question on array and Holo real quick? So if we think about first case is kind of at the end of the year, how are you thinking about that launch in 2022 in terms of the size and scale? Is that, should we think of that is kind of a gradual launch – kind of beta testing going on, maybe in the first half of 2022? Just some color in terms of, once we get that product out to market, you know what that could look like, initially?

[Terry Rich:]

Yes, sure. Look, we plan on getting a number of these systems out as quickly as we get clearance and we'll be prepared to do so that we can begin to gain experience. Based on the success of the initial experience, we should be ready to begin to launch multiple units throughout the course of 2022, especially through the back half, and the key is that we want to do it responsibly as we scale up and build the field competency to ensure that these units are deployed in the way that delivers the best possible outcomes for physicians and patients.

[Ryan Zimmerman:]

Understood. And then, with the launch of products that are coming. Just for Jon kind of how to think about the capital expenditures that you're anticipating particularly with set investments and things with that? What are you thinking you may need this year as you start – as you launch some of those other products?

[Jon Singer:]

Yes so, I think overall when you look at our CapEx budget for the year between Holo and set, there is probably somewhere between $4 million and $7 million of capital and then there is. The other piece of capital that comes into play is, as we've talked about previously, we're working through an ERP implementation as part of the separation from RTI, that's probably another $3 million of capital. And then, there's probably another $2 million to $4 million related to a variety of activities its – we’re beginning to prepare for movement into a new space in San Diego. We just signed a lease, last week, and you'll see an 8-K on that – it's going to take about a year to build it out. But as we work through the build out, we're going to be building surgical suites that highlight the digital technology and they will begin to be some capital for that this year.

[Ryan Zimmerman:]

Got it. Thanks for taking the questions, guys.

[Operator:]

We have our next question coming from the line of Matt Hewitt with Craig-Hallum. Your line is open.

[Matt Hewitt:]

Thank you for taking the questions. First off, with the step back or the step down a little bit here in Q1 versus Q4, how much of that is COVID versus the winter storms that you saw in the southern part of the country. If not for those storms, is it – has the market somewhat stabilized from a COVID perspective?

[Jon Singer:]

Look there's probably a handful surgeries that were impacted by the winter storms, but it's really hard to tease that out from the COVID impact. I would say the vast majority of the shortfall was COVID-related. And we're beginning and its global, right and I think the important thing to keep in mind is that yield 20% of our revenue is international in the impact of COVID. They were much more draconian in the way they shutdown elective procedures. And so, the impact was felt more significantly is that portion of the business. I would say, as we've gone through the end of Q1, everybody is watching the statistics. And so, you're starting to see the return of elective procedures. I don't think we're going to – what we're seeing is that many patients are waiting to get vaccinated. At this stage in order to return to procedures. So yes, I'm not sure we'll see a full return to the levels we saw in Q3, but we think we should see kind of steady return to normalized levels in the second half of the year.

[Matt Hewitt:]

Got it, all right. And then, as far as gross margins are concerned, I think you said your adjusted gross margin in Q4 was 75%, is that how we should be thinking maybe a little bit lower for Q1, but then kind of getting back up and maybe above that level as the year progresses or how should be thinking about gross margins?

[Terry Rich:]

Yes, that's probably a reasonable way to think about it.

[Matt Hewitt:]

Fantastic all right, that's it from me. Thank you.

[Operator:]

We have our next question coming from the line of Frank Takkinen with Lake Street Capital Markets. Your line is open.

[Frank Takkinen:]

Thanks for taking my question. Just two today, I know it's been brought up in the past, but just curious if you could elaborate a little bit further on some of the potential models that Holo could use once it's commercially approved. And then speaking to some of the different packages software packages that you develop over time? Are those going to be additional add-on services or is there potentially going to be some sort of a subscription model pay-per-click? Just trying to get a little bit of understanding of the potential models on the Holo platform?

[Terry Rich:]

Yes, sure. So look, I think we’ll follow as we've said before, in the short-term to prove out the technology and the ability to validate better patient outcomes. The existing models which depending on a variety of factors, some hospitals like the capital purchase programs others like the lease programs. There certainly, the need for some software licenses, but the key portion of the revenue for the next couple of years. Anyhow, will be the pull-through of the hardware implants.

[Frank Takkinen:]

Got it, okay. And then maybe one for Jon, just to finish it off, any comments on assumptions of international growth within the fiscal year 2021 guidance you're comfortable sharing with us?

[Jon Singer:]

Yes, I think international will grow slightly faster than the overall business, they've got a number of new product introductions we talked about HPS 2.0, which is a dynamic coupler which is approved in Europe, but nice PMA pathway in the United States. So, we're not introducing this year and then a number the Fortilink family has gotten CE Mark, so there'll be launching that. So, we anticipate the international market will grow slightly faster than the domestic market. But overall it's, we're not going to see a significant deviation from kind of 20% of the overall revenue.

[Frank Takkinen:]

Perfect, all right. Thanks for taking my questions.

[Operator:]

We have our next question coming from the line of Brandon Folkes with Cantor Fitzgerald. Your line is open.

[Brandon Folkes:]

Hi, thanks for taking my questions, and congratulations on the quarter. And sorry, if I missed this as I was hopping between two calls here, but I saw the spine revenue guidance? Do you contemplate any potential Holo revenue in 2021 and yes Terry, your comments on installs in 2022, but just wondering sort of how early, you could get an impact from Holo? And then maybe secondly…?

[Terry Rich:]

Brad, sorry I interrupted finish your questions.

[Brandon Folkes:]

Sorry and then maybe secondly, can you just talk about either lost days the expansion of the partnership into the impacts you’ve see there and your willingness to continue to do these sort of partnerships as you launch Holo into the field. Thank you.

[Jon Singer:]

So yes Terry referenced in the previous question, in the short term the majority of the revenue that we anticipate seeing from Holo is going to be through products. There is a small disposable portion that goes along with the procedure and so -- and that revenue you would be recognized in conjunction with IRB and so we do anticipate what I would call some pretty moderate revenue driven as we start placing the products for purposes of the study, but again it's going to be predominantly seen through implants. And we anticipated that that will accelerate obviously as we transition from the IRB and the output to the field for commercial launch, but that's going to take both to work for us. From a standpoint its early days in the relationship and we're seeing a subset of users like the handling characteristics of that product but it's surplus at this point in time the progression of that. It's a nice product but early I guess would be the best way to characterize it. And then from a standpoint of similar relationship, yes I think we're very open to partnering, licensing, acquiring for purposes of accelerating the transformation of the product portfolio and so there's certain competencies that we had no intention to develop internally. So Biologics is an example, there is a lot of categories within the Biologics space that we're not currently competing in. Those we work to either upgrade or expand our Biologics operating. We anticipate there will be number of additional distributions or licensing relationship and then as we look at the new product development pathway, we're going to constantly do a make or buy decision on the product portfolio in order to determine what's best economic use of cash. I think that we've got aggressive cohorts for the investment in R&D of the organization to re-imagine the portfolio and exploit the Holo technology, but there are some gap pillars that I can will be very valuable to our customers that probably make more sense to partner on that to develop internally.

[Operator:]

We have our last question coming from the line of Jim Sidoti with Sidoti & Co. Your line is open.

[Jim Sidoti:]

So Terry your company has changed quite a bit considering their much super model now and you made some pretty significant changes to the distribution and the sales teams. Now that you're going in the direction of becoming more of a digital story, do you think that you have the right people in place, the distribution or do you think there will be more changes on that front going forward?

[Terry Rich:]

Yeah Jim it's a great question and it's an evolution. So we will begin to add those competencies to support the sales teams, but as we continue to build out and become more of a digital player, it's going to come down to those partners and whether they're willing to go through the various trainings and protocols that we have if they want access to the technology. So my thought is that we'll have broad internal organization to support them and we'll move to both in a direct and distributors that are committed to following the same path.

[Jim Sidoti:]

And then my second question for Jon, can you just give us an update on where you think the share count will end up for 2021 and what you think the cash burn for the year will be?

[Jon Singer:]

The share count will be 110 million, which is representative the shares we issued for the Holo acquisition as well as the impact of the offering that we did in the first quarter here. So that's what I would use for modeling purposes at this stage and then we anticipate EBITDA guidance, we don't anticipate a significant investment in the working capital as we move through the year. I think there's some opportunity to improve in certain of those categories. So I think if you just look at EBITDA guidance plus the direction that we gave around CapEx is to give you a sense of the cash burn for the purpose of the year.

[Operator:]

There are no further questions at this time. I will now turn the call back over to Terry Rich for closing remarks.

[Terry Rich:]

Thanks again for joining us today everyone. We look forward to updating you on our progress on our next quarterly call.

[Operator:]

This concludes today's conference call. You may now disconnect.