Alphatec Holdings, Inc. (ATEC) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Alphatec Holdings Inc Second Quarter Fiscal Year 2017 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 be given at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today’s conference, Carol Ruth, Investor Relations. Please go ahead ma’am.

Thank you. Good afternoon, and welcome to Alphatec Holdings second quarter 2017 Conference Call. We’d like to remind everyone that participants on the call will make forward-looking statements. These statements are based on the 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 management’s view of why this information is useful to investors. Joining us on the call today will be Alphatec’s CEO, Terry Rich; and CFO Jeff Black. With that, I’ll turn the call over to Terry Rich. Terry?

Thank you, Carol, and welcome to Alphatec’s second quarter 2017 earnings call. This afternoon, we reported a solid second quarter with revenue of $24.4 million, a dramatic reduction in operating expenses, and a significant improvement in cash burn. On behalf of the new leadership at Alphatec, I am pleased to share the progress our team has made in just two quarters. Together, we are committed to transforming Alphatec into the most respected fastest growing U.S. spine company with a mission to improve lives by providing innovative spine surgery solutions through a relentless pursuit of superior outcomes. I want to start this afternoon with a few financial highlights from our second quarter 2017, and then I’ll provide a quick overview of where we fit within the U.S. spine market and our vision for Alphatec’s market position. Next, I’ll review the major facets of our strategy to transform Alphatec and report on the progress being made. I will then turn the call over to our Chief Financial Officer, Jeff Black to cover the second quarter financial results in detail before we turn the call back over to the operator to take any questions. Let’s begin with financial highlights. Total U.S. commercial revenue in the second quarter of 2017 was in line with our expectations at $21.9 million. Sequentially, revenue was down slightly due to our intentional decision to transition away from distribution relationships that we do not believe serve our vision for Alphatec. Importantly, in spite of the strategic decisions we are making to discontinue certain distribution relationships, revenue numbers remain stable during the quarter on a daily sales basis. That means we are successfully replacing unstable revenue with sustainable revenue, a strong testament to the health of our core business and to the initiatives we’re driving to improve sales momentum. On the cash management front, our cash burn improved substantially to $6.4 million in the second quarter of 2017 compared to $11.5 million in the first quarter of 2017 in line with our commitment to deploy capital responsibly. With our Q2 ending cash balance at $19.1 million, we continue to believe we are well positioned to execute on our growth strategy. Excluding restructuring charges and a one-time gain on the sale of assets, our operating expenses in the second quarter decreased by more than $2 million sequentially. The improvement was the result of solid execution of ongoing initiatives to more thoughtfully align headcount, facilities, and other expenses with our business needs and some we have made excellent financial progress. We have right sized the expense profile of our organization, use cash judiciously, and position the new Alphatec to significantly lever the sustainable sales momentum that we’re building. Now let me turn to our vision for Alphatec’s market position, where today we are a small player within a $7 billion spine market. Market dynamics are perfectly aligned for nimble innovative players like Alphatec to thrive and we fully intend to exploit that massive opportunity. Let me expand on this market dynamics. First, we believe the spine market is exceptionally ripe for innovation; the adoption of minimally invasive and complex spine surgery continues to expand and there’s a growing appetite for innovation that improves clinical outcomes. As we arm Alphatec’s sales reps with the company’s most promising new solutions in years and thoughtfully invest in our pipeline, we intend to reposition our company at the forefront of innovation in spine. Secondly, we believe that the maturation of the largest players in the spine market is creating excellent new opportunities for innovative players like Alphatec with portfolio depth, resources, and talent to compete and succeed. We are committed and well positioned to evolve into a major market player. Finally, the spine market is increasingly experiencing hospital and contractor consolidation. Our comprehensive spine portfolio, our new innovative products, and our well established access to hospitals creates a competitive advantage that we will continue to exploit. With that, let me turn to a business update. Last quarter, I introduced the new spine experienced leadership team at Alphatec. I outlined our strategy to increase shareholder value by significantly repositioning our brand to customers, investors, employees, and business partners. I detailed the three vital initiatives that we are prioritizing to revolutionize the business. First, strengthening the Alphatec distribution channel; second, driving new product innovation that improves clinical outcomes; and third, executing organizational and cultural changes to return Alphatec to a growth company. Let me walk through each of these initiatives and update you on the progress made by the new leadership team in just two quarters. I’ll start with our efforts today to strengthen the Alphatec distribution channel. We’re thoughtfully and strategically building a consolidated network of established high quality direct sales reps and distribution partners dedicated to selling Alphatec products. The opportunity for improvement is substantial both in current and new geographies. Alphatec is incredibly underrepresented and even completely lacking representation in many of the largest population centers in the United States. As we execute the vision that we have for this transition, we’re looking at new and existing relationships that can introduce surgeons in these important geographies to our company and to our comprehensive product portfolio. Already we have seen early successes in converting new leading surgeons and distributors to the Alphatec portfolio in several of these geographies. As we create partnerships with dedicated distributors, we are finding that the timing for this shift could not be better. Current distributors have expressed their excitement about the positive changes they are seeing and are increasingly interested in partnering more closely with the new Alphatec by becoming dedicated. We will support them and earn their trust as we look to transform those relationships into meaningful mutual partnerships. Industry consolidation is creating an impressive pool of talent seeking new opportunities, particularly in areas where we are underrepresented. Fortunately, the extensive spine backgrounds and relationships that our new leadership team brings are allowing us to attract exceptionally high caliber professionals to the Alphatec network. A great example of that is the sales leadership team that we assembled to successfully drive the new Alphatec mission in the field. In late Q1 and early Q2, we welcome three seasoned Area Vice Presidents, or AVPs, each with over 20 years experience in spine sales leadership roles. We are very excited to be working alongside these professionals and rebranding of our company. And as you will see, they’re already contributing substantially to our mission. We are still actively recruiting to fill a number of direct sales roles to support our AVP team and to build out our national accounts team enhancing the strong foundation and hospital access. As we onboard new sales reps and convert existing relationships into dedicated relationships, we are simultaneously discontinuing affiliations that we feel will no longer serve the Alphatec mission. We have great confidence on what this will do for the reputation and performance of our business. Over the medium to long-term, we expect to substantially elevate Alphatec’s mindshare in the field, accelerate sales growth and as a result create shareholder value. Importantly, our team has experience in converting independent sales channels to dedicated networks. We intend to minimize disruptions and to ensure that our network of current and new distribution partners has access to the appropriate levels of training and resources to truly hit the ground running. We ramped up our efforts at the start of Q2 with the addition of our new sales AVPs and we are already seeing fantastic results. In the first quarter, less than 15% of our revenue was generated by dedicated sales reps and distributors. In the second quarter that percentage grew to more than 18%. The expansion is coming primarily from partnering on a more dedicated basis with many of our existing distributors. We’re also in negotiations with many new distributors in underrepresented markets and expect the revenue from dedicated distributors to grow dramatically over the next two quarters. With the strong momentum we are seeing, we anticipate exiting 2017 with over 40% of our revenue generated by dedicated sales reps and distributors. While the entire conversion process may take another 24 to 36 months to complete, we’re very pleased with the progress and with the momentum we’re experiencing. The second key initiative that we’re prioritizing as we’ve repositioned the Alphatec brand is innovation focused on improving clinical outcomes. And to that point, we’re expanding Alphatec’s comprehensive spine fusion offering this year with three advanced platforms that will address sizable new market opportunities. We are extremely excited for the full commercial launch of Battalion Lateral System late this year. This innovative product fills the gap in our portfolio, opening up a large $500 million market opportunity and allowing us to compete for the first time and one of the fastest growing segments in spine. The Battalion Lateral System is truly the next generation MIS lateral spine surgery. The Squadron Lateral Retractor, a key component of the system, has been uniquely designed with considerable surgeon input to improve outcomes by minimizing psoas retraction time. This next generation technology is now protected by a pattern that we were awarded a few weeks ago. The patent protects key differentiating features of our retractor, which will further distinguish Battalion and in otherwise crowded field for lateral solutions. During the second quarter, we achieved our goal of full commercial release of Arsenal Deformity. Arsenal targets an estimated $650 million market for deformity and we are very pleased so far with the reception in the field. The system is capable of handling the most complex deformity pathologies from T1 to the pelvis. It has been designed to improve clinical outcomes with unique instrumentation and differentiated screws. In fact early in the second quarter, we were awarded a patent for Arsenal Deformity uniplanar and monoaxial screws. The patent protects a distinguished feature that enables optimal screw placement with minimal profile, further highlighting our engineering prowess. Turning to biologics, as a result of the company’s 2015 transition to a synthetic biologic portfolio, Alphatec distributors have been selling competing structural allograft and biologic fillers in the majority of our hardware cases. We’re now relaunching our biologics platform in order to recapture incremental procedural revenue. Our core focus will continue to be on driving innovation in our Fixation portfolio, but this relaunch will generate significant cross-selling opportunities in a $1.5 billion market. In some, the solutions that we have launched and then we expect to launch over the course of this year allow Alphatec to participate in an incremental $2.5 billion market opportunity. These solutions truly open the door to new surgeon and distributor relationships. In addition to the new products that I have mentioned this afternoon, we’re thoughtfully investing in a pipeline of innovation focused on improving spine patient outcomes and addressing unmet clinical needs. We’re even more excited about the innovation we expect to introduce in the near future. The final key initiative that we are prioritizing as we repositioned the Alphatec brand is a brand transformation of the company’s structure and culture intended to return us to a growth organization. We have accomplished dramatic organizational changes over the last two quarters. 12 to 13 members of the Alphatec leadership team in September 2016 are no longer with the company. Of the current 11 Alphatec executives, 5 are U.S. sales spacing as opposed to only one in September 2016. The Alphatec leadership team is now comprised of successful tenure professionals most of whom have significant spine experience and have worked together in the past. The team is structured to better align Alphatec with what matters most in spine, superior outcomes. We also added new board members with spine expertise, who are already contributing immensely to our corporate strategy and transformation. We now have a proven deep team of leaders that are highly incentivized to succeed. In fact in conjunction with the march financing, the entire senior leadership team at the time invested personal assets to demonstrate our belief in the massive opportunity in front of us and our commitment to create shareholder value. Much of the value creation will be derived from company-wide engagement. We’re completely transforming the culture at Alphatec assuming in most cases that what was done at this company before we arrived was wrong. We were overhauling every process, creating a relentless focus on fiscal responsibility, performance, integrity and accountability. To the entire Alphatec team those are much more than just inspirational words that are part of a value system that is at the very core of every decision made, every interaction, every product developed and every sale. There are a set of shared standards that are absolutely paramount as we extend the Alphatec transformation from headquarters here in California, out to the field, into the operating rooms nationwide and to the patients whose lives are solutions are designed to improve. It is with this new organizational and cultural mindset that we are executing initiatives to rebuild the Alphatec reputation with a focus on innovation and improve clinical outcomes in order to return to a growth business with a strong financial outlook. In conclusion, we’re making excellent progress on the initiatives that we have prioritized as we reposition the Alphatec brand. We’re creating a dedicated distribution network, launching new products that will expand our market, and improve outcomes and overhauling the organizational structure and culture of Alphatec. We look forward to showcasing the new Alphatec leadership team and the depth of our comprehensive product offering at NASS, which will be in Orlando in October. Please reach out toward team if you'd like to visit our booth to learn more. With that I'll turn the call over to Jeff to cover financial results in detail.

Thank you Terry and good afternoon everybody. As Terry mentioned, we can point to key highlights in the second quarter as indicators of strong momentum going into the second half of 2017, including top line traction with our dedicated sales agents and distributors, substantial operating expense improvement and a sizable reduction in our cash burn. Let we provide some further insights into some of the financial highlights that Terry mentioned today. We ended the quarter with $21 million in U.S. revenue, a quarter-over-quarter decline of about 7%. The primary driver of this decline can be attributed to our intentional decision to transition away from non-strategic distributors. As Terry mentioned, our revenue from direct and dedicated sales agents grew from less than 15% of U.S. revenue in the first quarter, to more than 18% in the second quarter. We're still in the early days of this transition, but we're beginning to see the impact of our efforts. Our U.S. gross margin improved to 70.9% in the second quarter. Most of this improvement was attributed to a decrease in inventory and instrumental write-offs associated with distributor turnover. We expect our margins to remain at this level for the remainder of 2017. Excluding restructuring expense and a one-time gain on sale of non-core assets, our total operating expenses decreased by more than 11% from $18 million in the first quarter to $16.8 million in the second quarter. A particular note is our G&A line which decreased by about $900,000 in the second quarter. We're beginning to see the impact of our workforce reductions in addition we're driving the expenses lower as we continue to rationalize cost across all functions. We now feel like we've delved in the G&A line to the appropriate level for our organization. Sales and marketing expenses will increase as we continue to invest in our distribution channel to support revenue growth. And we intend to make thoughtful investments in R&D to support continued outcome focused innovation. Restructuring expenses, they've decreased by just over $700,000 over the first quarter, as a result of the wind down of our restructuring initiatives. We entered the second quarter with $19.1 million in cash, compared to $25.5 million in the first quarter. We have been and will continue to be laser-focused on managing our cash resources. Overall, our cash use decreased by $5.1 million from $11.5 million in the first quarter to $6.4 million in the second quarter. And even excluding the onetime working capital adjustment of $3.7 million in the first quarter, our cash burn decreased by $1.4 sequentially. In addition to exiting the second quarter with more than $19 million in cash, we also have $8.9 million outstanding on a $22 million accounts receivable line of credit. Borrowings on this line are dependent upon eligible accounts receivable, so as we grow our revenue base we’ll have access to additional working capital. We're confident today that we have the cash and available resources to execute on our growth strategy. And with that I'll turn the call back over to Terry for closing comments.

Thank you Jeff. I'm exceptionally proud of the progress we have made in just two quarters as a new leadership team. We expect that progress coupled with the momentum we're experiencing to drive second half revenues higher than the first half of 2017. I'm extremely confident the team we’re building, and the expertise that surrounds me, as well as the complete reset that is underway to overhaul legacy Alphatec and transform the culture into the new Alphatec. The relentless focus on our strategy to effect positive change and the innovation that we're driving are incredibly exciting. We are well-positioned to create shareholder value, and I look forward to sharing more progress with you in the near future. We will be presenting at the Rodman Investment Conference in September. So I hope to meet with some of you there. With that I'd like to turn the call back over to the operator and we’ll take any questions.

Thank you. [Operator Instructions] Our first question is from the line of R. K. Ramakanth of H.C. Wainwright. Your line is now open.

Thank you. Good afternoon Terry and Jeff. Congratulations on a very good quarter. Couple of high-level questions. As you mentioned within your strategy of converting the sales and distributors more into the dedicated realm and the quarter that you just exited, you had 18% of revenue coming from these sales personnel. I'm just trying to understand and you said you want to exit 2017 with a 40%. So what is the optimal number you think you need to have so that you can sustain mid to long-term growth whatever that number you have within your own strategic ideas?

Well, over the next two to three years, we expect to get to 100%. But again we're seeing incredible momentum, and one of the really encouraging things is how excited our current distribution channel is in partnering more closely with us, especially given the changes that they've seen in the organization. So I think that the rate that we're on to finish the year with over 40% should provide us with the springboard we need to continue to drive growth into the future.

Okay. So in terms of the pipeline, and sales and the couple of areas where - which you have identified, and I think that's what we see also in the industry, the MIS and the complex surgeries as the growth areas within the spine surgical space. What - you mentioned a couple of products in that you're just launching or just started launching. What sort of plans are out there within your R&D teams in terms of getting them to the commercial stage? And is there a certain number or certain rate at which you want to start introducing products from here onwards, because the more number of products you have in the bag, the better it is for the sales force.

Yes, so we’re very excited about the investments that the company has already made and how the launch of our Arsenal Deformity, as well as our Battalion Lateral System are going. And so, we expect to be able to continue to drive significant revenue out of those on a go-forward basis as well as entering the LMR of our XYcor minimally-invasive TLIF cage. We have a tremendous pipeline, we're very excited about with some very differentiated technology that we look to get out early next year and believe that they will be even more differentiated than the products we're launching currently. So we're very excited about those opportunities. In terms of the number of products. We don't - we're not going to launch an incredible number of products in the near-term. We're going to remain incredibly focused. While it is good for them to have a tremendous bag in the sales force, we already have a broad portfolio and we want to ensure that we're going about things in a responsible manner and ensuring the successes of the products that we launch, rather than investing in a bunch of sets and spending a lot of cash just to get a lot of products out there. We're going to maximize the opportunity with the products that we put out first.

Okay, great. The last question for me is in terms of the personnel, as you said you have brought in quite a few folks on to your team and have done the organizational changes that you needed to do, is it at an optimal place now in terms of personnel to make a successful organization in the spine market or do you anticipate adding more folks going forward, just to round things up, so that you are at a place where you’re ready to and start growing again?

Yes, we're really confident and the senior leadership team that we've assembled and don't anticipate any significant future changes. Now that said, we'll continue to be opportunistic and look to bring in additional spine experience as we see fit to help us execute on our plan. So we would never shy away from bringing on good talent.

Thank you. Thanks Terry for taking my questions.

Thank you.

Thank you. Our next question is from Brooks O'Neil of Lake Street Capital Market. Your line is open.

Good afternoon guys. I got on a couple minutes late. So if you've covered the topics I'm going to ask, I apologize. Perhaps you could just give me a quick overview, but I heard a lot about the progress you're making in many of the areas that are under your direct control and I'm excited about that. Can you just talk a little bit about what you're finding in the marketplace in general in terms of the healthiness of the spine market or weakness or whatever you're seeing? And then also talk a little bit about your competitive position. Obviously, there are some big players in the marketplace. And what are you seeing from them and how do you feel about your ability to compete?

Yes, so Brooks, we feel good about the spine market. In general, it's about a $7 billion U.S. market and we see it growing at about 5%. So I think the market is very healthy. In general, the - sorry, I think that we have a tremendous opportunity. We don't have a ton of market share and so the ability to be nimble and innovative and compete with the larger companies out there, I think, this is a great time for Alphatec. And we're really excited about some of the differentiations that are going to be adding to the portfolio here quickly.

Great. Thank you very much. And congratulations on all you've accomplished in the short time.

Thank you.

Thank you. Our next question is from Beth Lilly of Crocus Hill Partners. Your line is open.

Hi, good afternoon. I wanted to ask about Terry as you look at the business model, you've taken out a lot of cost, but as you look at the model where do you think breakeven is for you guys, breakeven profitability?

Yes hi Beth, this is Jeff. We've not given guidance, so I'm sure you can appreciate that we can't really give specific guidance around where we think breakeven is. What we can say is when you start taking a look at what we're doing on margin, we're seeing margin uptick, we're seeing cash burn significantly decrease. And when you take a look at the cash flow, you'll see that most of the burn is really around working capital and debt service. So from an operating perspective we’re very confident that we’ll continue to build a business that can get to breakeven. We haven't given forward guidance on what that level is.

Okay. How about in terms of, I mean, you took out if you look on a quarter-to-quarter basis, you took out a lot of expenses, particularly on sales and marketing and S&A. So are there more cost that can come out of the infrastructure - cost that can come out of the infrastructure?

Yes it’s something we continue to look at Beth. I think that we will continue to rationalize cost. And I think the answer is on the overhead and G&A line, I think, we're pretty dialed in. We'll continue to kind of take things out on the periphery if we can find areas to really rationalize cost. Sales and marketing, will largely increase in line with revenue growth, right. So when you think about as a percentage sale, we don't expect we’ll see sales and marketing continue to grow relative, but in absolute dollars they will as we grow the revenue line.

Yes, great. Those are all my questions. Thank you.

Thank you.

Thank you. And that does conclude our Q&A Session for today. I like to turn the call back over to Terry Rich for any further remarks.

Thank you operator. And thank you for everybody attending the call. Again, we'd like to reiterate how excited we're about the future and look forward to talking again on our Q3 release Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.