Alphatec Holdings, Inc. (ATEC) Q1 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Alphatec Holdings First Quarter 2017 Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will be conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]. As a reminder, today's program is being recorded. I would now like to introduce your host for today's program. Nick Laudico with The Ruth Group. Please go ahead.

Thank you. Good afternoon, and welcome to the Alphatec Holdings first quarter 2017 conference call. Joining us on the call today will be Alphatec's CEO, Terry Rich and CFO, Jeff Black. We'd like to remind everyone that participants on the call make forward-looking statements. These statements are based on current expectations and are subject to uncertainties that could cause actual results to differ materially. These uncertainties are detailed in documents filed regularly with the SEC. During this call, you may hear the company refer to reported amounts, which are in accordance with U.S. GAAP as well as non-GAAP or pro forma measures. Reconciliations of non-GAAP measures to U.S. GAAP can be found in the supplemental financial tables included in the press release, which identify and quantify all excluded items and provide managements view of why this information is useful to investors. During the third quarter of 2016, we announced that we completed the sale of our international business to Globus Medical. Accordingly, the operating results, assets and liabilities of our international operations have been moved into discontinued operations and results presented on today's call are based on continuing operations. The company now reports revenue from its U.S. commercial operations separately from its non-U. S. revenue, which is attributed to sales to Globus under the agreement to supply its products for the international market. With that, we'll turn the call over to Terry Rich, Alphatec's CEO.

Thank you, Nick, and thanks everyone, for joining our call today. I'm pleased to be speaking to investors on behalf of our new Alphatec team. We have a comprehensive plan that we'll outline for you today which we believe will evolve Alphatec into an innovative share-taking leader in the U.S. spine market with a high performance culture, motivated employee base and highly-focused sales and marketing organizations. As Nick mentioned, joining me on the call today is Jeff Black, our CFO. I will give a summary of our financials, share my views on the Alphatec opportunity, review our sales and distribution strategy and provide some details on our recent organizational changes as well as our operating plan. I will then turn to Jeff for a detailed financial review, and will return to make closing comments before we take your questions. So here are the financial and operating highlights for our first quarter. Total revenue was $28 million, up slightly from about $27 million in the fourth quarter of last year. Our U.S. commercial business delivered $23.4 million in revenue, and our U.S. gross margin improved to 68% compared to 62% in the fourth quarter. We have received outstanding feedback regarding our recent limited user product releases, which speaks to the power of our development platform. On the cash management front, we raised nearly $19 million in gross proceeds from a private placement at the end of March, which positions us to execute on our growth strategy. Excluding restructuring charges, our operating expenses in the first quarter decreased by more than $2 million sequentially over the fourth quarter. Before I outline the strategy for the new Alphatec, let me take a moment to provide an overview of the key attributes that make Alphatec unique among U.S. spine companies of its size and provide a basis for the reason that I and the rest of the new senior leadership team decided to join the company over the last few months. The company has a broad portfolio, an accomplished product development team, robust IP protection and is releasing new, differentiated products. In fact, about 30% of our U.S. commercial revenue in the first quarter was derived from products that had been released in the market over the past 3 years. We have strong GPO and IBN access and broad hospital coverage. As the market continues to consolidate and smaller vendors are squeezed out, we are well positioned to provide continuous access for our sales channel. We have developed a strategic plan to build a dedicated distribution channel and rebrand the business based on high performance, high integrity culture. This has already provided us the opportunity to attract experienced successful leaders, many of whom have worked together before. We are here because we view Alphatec as the most attractive opportunity in orthopedics. So much so that we wrote in with our checkbooks in our March financing, with the entire senior leadership team investing our personal assets as a demonstration of our belief in the opportunity and our commitment to our collective success. Our new strategy for the company centers on significantly repositioning the Alphatec brand to customers, investors, employees and business partners. Specifically, we are focused on a vital few initiatives to revolutionize the Alphatec business. First, we are committed to strengthen our distribution channel by partnering with a consolidated network of current and new dedicated distribution partners. It is encumbered on us to develop those relationships and gain greater mind share. Second, we plan to drive new product innovation to advance our focus on improving outcomes. We are seeing some of this development prowess already began to play out in the limited user releases of our Arsenal Deformity System and our Squadron Lateral Retractor. And most important, we are focused on returning to being a growth organization. This focus underpins everything we discuss and do at Alphatec. Now I'll provide some more detail on our first key initiative. Converting our current distribution channel, consisting of nonexclusive distributors and a handful of direct representatives, into a team of established, high quality direct reps and distribution partners dedicated to selling Alphatec's spine products. For the first quarter of 2017, less than 15% of our revenue was generated from dedicated sales reps and distributors. So we have a lot of work to do. But we think that timing is optimal from an industry perspective, given that recent consolidation has left many high-quality distributors, sales reps and sales leaders available for new opportunities. We anticipate the process of evolving the entire distribution network will take up to 36 months to complete, so we expect to make significant progress in several high-priority geographies through the remainder of this year and over the next 12 months. We intend to work through the process at a measured pace so as to minimize impact on short-term revenue. Through this process, we need to ensure we are providing the proper training and resources for current and new distribution partners, so we can best support our surgeon customers. To execute on our distribution strategy, we have quickly rebuilt the Alphatec leadership team with experienced executives who have track records rivaling those of leaders in any of the global spine organizations. I've personally worked directly with many of these leaders over my 25-year career. I am most excited about leveraging our collective experience transitioning sales channels to the similar opportunity here at Alphatec. I'd like to briefly introduce some of the new Alphatec executives who will help us deliver on our strategy. John Allen, our Head of Commercial Operations, has 27 years of experience in orthopedics and spine, including leadership roles at Wright Medical, Tornier and DePuy. Brian Snider, our Head of Strategic Marketing and Product Development, spent the last nine years at NuVasive, focused on these functions. Dr. Amy Ables, our Head of Corporate Education and Performance, previously served in similar roles as an Executive with Wright Medical and Tornier. Jeff Black, our CFO, brings 25 years experience in Financial and Operations Management, including CFO and senior-level finance roles for six publicly traded companies. Over the past six weeks, we have added three new Area Vice Presidents of Sales, affecting a complete change in Alphatec's field sales leadership for the first time in more than a decade. Chris Ryan brings more than 20 years of spine and orthopedic experience, including sales leadership roles at Zimmer Spine and Medtronic. Greg Rhinehart has over 20 years experience in spine and orthopedics sales was recently at Medicrea, and before that Globus, DePuy and Medtronic. And Jim Duffy has spent 25 years in spine sales, including leadership roles at Zimmer Spine, Synthes Spine and Medtronic. Each of these Area VPs brings decades of experience, including proven history of building strong distributor relationships and dedicated distributor channels at industry-leading organizations. We look forward to leveraging our strong relationships with spine surgeons, distributors and industry talent. These AVPs are complemented by additional marketing and training talent that we believe will be critical to our success. We also recently enhanced our board with the addition of Dave Mowry. Dave is a key mentor of mine, and brings a wealth of business and leadership experience in med tech and orthopedics from his time at Wright Medical, Tornier, Covidien, ev3 and Zimmer Spine. As noted in our proxy, the board is also recommending the nomination of Jeff Rydin to replace Les Cross, who has served on the board since 2011. Les's time with the company includes over five years of Chairman and serving as interim CEO. We'd like to thank Les for his many contributions to Alphatec. Jeff, who's been serving as special adviser to the board, was previously President of Global Sales at NuVasive, where he helped build the company to the number three player in the spine market. He will continue to work in a consulting capacity in addition to his new duties as a board member. In a few months our new team has been together, we have taken many important steps to provide a solid foundation on which to execute our plans. In particular, we raised $19 million to support our new product launches and business transitions. We have implemented HPMS, a proven High Performance Management System that has created focus at many familiar successful companies such as ev3, Tornier and Wright Medical. We made the intentional decision to exit our stocking distributor business, knowing it would mean a short-term hit to the top line, but is a critical step in turning around the brand and doing the right thing. We engaged in responsible cost-cutting measures, reducing headcount from 195 in September of 2016 to approximately 140 today, while consolidating the company into a single building. We initiated 2 limited user releases, leading to new market opportunities, and the early feedback has been overwhelmingly positive. We'll provide a bit more of an overview on these new Alphatec products that are just beginning to launch. The Arsenal Deformity Adolescent Idiopathic Scoliosis System, the Battalion Lateral System and the relaunch of our biologics products. Arsenal Deformity builds on our established Arsenal platform with a comprehensive system capable of handling the most complex deformity pathologies from T1 to the pelvis. This system features uniquely designed instrumentation that facilitates surgical efficiency combined with differentiated implants and patented screws that offer significant advantages for both the surgeon and patient. We are exciting that the system was released ahead of this summer, which is the primary season for complex scoliosis procedures, as children are out of school. The Arsenal Deformity System targets an estimated $650 million U.S. deformity spine market. The Battalion Lateral System offers what we believe to be a best-in-class retractor, providing surgeons with a next-generation lateral system with innovative, unique functionality designed to improve clinical outcomes. It opens up a new estimated $500 million market opportunity in one of the fastest-growing segments in spine. And we are relaunching our biologics platform, which has been a significant revenue-generating business for us. We are looking to build that business back as a complement to our current suite of hardware products. In addition to these products, we are really excited about the depth and innovation in our development pipeline, which we will move forward quickly but diligently to deliver better outcomes in spine surgery. Finally, before turning the call over to Jeff for the financial review, I'd like to discuss one of the most important pieces of the change we are driving with the new Alphatec. A culture built on talent, ethics, integrity, teamwork, passion and high performance. This all starts with our HPMS process, which was a vigorous exercise involving 30 of the top leaders in the company who debated, came to consensus about and then aligned around our new vision, mission and values. Our vision, looking at a 3-year horizon is to become, the most respected, fastest-growing U.S. spine company. This is critically important, given the operational and reputational challenges the company has faced over the years. We have aligned around a mission of improving lives by providing innovative spine surgery solutions through our relentless pursuit of superior outcomes. These superior outcomes are the core of our focus. We are bringing a new focus on accountability and a sense of urgency with which people have already begun to identify. During this transition, I have been so impressed with the engagement and strong motivation from the existing Alphatec team. There is a hunger for success within this company. We are all eager to continue to deliver this message of positive change to top U.S. spine surgeons and we have already had success in doing so. With that, I'll turn the call to Jeff for a deeper dive into our financial results for the first quarter.

Thank you, Terry, and good afternoon, everybody. As Terry mentioned earlier, our U.S. commercial revenue for the first quarter of 2017 was $23.4 million. This compares to $29.2 million reported for the first quarter of last year. The two biggest drivers of this 19.9% decrease in year-over-year revenue were, first, the threats that Alphatec faced in 2016, which culminated in the sale of the company's International business in order to sustain operations, and this led to a dramatic reduction in volume from several distributors and surgeons. The second driver has been the intentional decision from new leadership to exit the stock and distributor business and to terminate distributor relationships that are not representative of our long-term business and rebranding strategy. On a sequential basis, our U.S. commercial revenue was down about $1 million or 4% as compared to the fourth quarter of last year, when our U.S. commercial revenue was $24.5 million. This decrease was primarily the result of our planned exit from the stocking business and the termination of other distributor relationships. Our U.S. gross margin in the first quarter of 2017 was just above 60% compared to just under 81% for the first quarter of last year. Our margins declined due primarily to increased supply costs from reduced sourcing and manufacturing volumes as well as an increase in inventory kit write-offs due to distributor turnover. But on a sequential basis, our U.S. gross margin increased from just about 62% in the fourth quarter of last year, and this increase resulted from a reduction in charges related to obsolescence for product portfolio management that we incurred in the fourth quarter and in addition, we're starting to see the impact of cost decreases in labor and overhead as a result of consolidating our facilities in the first quarter of 2017. Our operating expenses for the first quarter of 2017 were $20.2 million and this was a 28% improvement over the first quarter of last year. On a non-GAAP basis, which excludes restructuring charges, our total operating expenses in the first quarter of this year decreased 32% compared to the first quarter of last year. Most notably, we saw G&A expenses decrease by $2.8 million over the first quarter of last year. On a sequential basis, total operating expenses in the first quarter of this year were down $1.5 million or 7% compared to the fourth quarter of 2016, and on a non-GAAP basis, excluding restructuring charges, our total operating expenses in the first quarter of this year decreased about 10% compared to the fourth quarter of last year. While we expect to see G&A expenses remain relatively stable in the short term, we may see sales and marketing expenses tick up as we continue to make investments in our distribution channel to support our growing revenue base. And we'll also consider strategic investments in R&D to support opportunities to expand or enhance our pipeline. We ended the first quarter with $25.5 million in cash compared to $19.6 million at the end of the fourth quarter. In March, as Terry mentioned, we completed a private placement with gross proceeds of $18.9 million, generating $17.5 million of net proceeds in the quarter. And once all operating costs have been paid, we expect net proceeds from this transaction of between $17.1 million and $17.3 million. Excluding a onetime working capital adjustment of $3.7 million in the first quarter, which related to the sale of our International business, our cash use in the first quarter was about $7.8 million, and this compares to cash use of $11.1 million in the fourth quarter of last year. With respect to our financial outlook for the remainder of the year, we're optimistic that the first steps of our long-term strategic plan that we've initiated over the past quarter will result in significant process. Transitioning the sales organization in 2017 will allow us to exit the year with strong momentum. However, given the early stage in these initiatives and the very recent hiring of our management team and our AVPs who've been with us a little more than a month, we feel it would be inappropriate to provide financial guidance at this time. And with that, I'll turn the call back to Terry for closing comments.

Thank you, Jeff. We are extremely excited about the opportunity we have in front of us to turn Alphatec back into a growth organization and create value for our stakeholders. We are pleased with our progress to date. Given the short time the senior leadership team has been in place, we have already made tremendous headway in positioning Alphatec for growth. While we expect the Alphatec turnaround to take time, we are confident about our direction in 2017 and expect to exit the year with significant momentum. With an experienced team now in place, a broad and strong product portfolio and a significant revenue base, we feel we are extremely well positioned to execute on our core strategy to strengthen distribution channel, drive forward on product innovation to advance superior outcomes and return to a growth organization. We look forward to providing you with updates on our progress. Stay tuned. And with that, I would like to turn the call back over to the operator, and we'll take your questions.

Thank you, operator. That'll conclude.