Alphatec Holdings, Inc. (ATEC) Q1 2018 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and welcome to the Alphatec Spine Inc. First Quarter and Fiscal Year and 2018 Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Ms. Carol Ruth from Ruth Group.

Okay, thank you, operator. Good afternoon, and welcome to Alphatec Holdings First Quarter 2018 Conference Call. We would like to remind everyone that participants on the call will make forward-looking statements. These statements are based on current expectation and are subject to uncertainties that could cause actual facts 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 US GAAP as well as non-GAAP or pro forma measures. Reconciliations of non-GAAP measures to US 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 Chairman and CEO, Pat Miles; President and COO, Terry Rich; and CFO, Jeff Black. Now I'll turn the call over to Pat Miles. Pat?

Thanks much, Carol. Thanks for joining us today. Welcome to ATEC's First Quarter 2018 Financial Results Conference Call. It has been 6 months since I joined the ATEC leadership team, and I am proud of what we have already been able to accomplish. Execution of our plan to revitalize ATEC has been solid. I believe we are exceptionally well positioned and have the tools we need to succeed. We have the cash to support our growth plans, the volume of know how to advance the value proposition of our broadening product portfolio. ATEC innovators are applying their decades of spine experience to create core technology that will drive our organic growth for years to come. Enthusiasm in the field is exceptional. Not only are we attracting some of the industry's best sales, marketing and engineering talent, we're also attracting some of the industry's most prolific and innovative spine surgeons. We recognize that the process of transforming our sales channel will continue to be challenging and will likely continue to generate lumpy financial results. But we are increasingly optimistic about our collective vision for significant future growth. Total commercial revenue in the first quarter was $19.2 million. Revenue results were driven primarily by the seasonality, experience across our sector and secondarily, by our continued drive to enhance revenue predictability by discontinuing non-dedicated distributor relationships. While revenue results in the quarter were down, both sequentially and year-over-year, several underlying metrics are indicating significant improvement in the health of our core business. Conversion of new surgeon relationships have been strong. Revenue driven by our new surgeon increased about 70% far outpacing revenue performance overall. During the first quarter, we successfully completed the acquisition of SafeOp Surgical, which will substantially elevate our portfolio with unprecedented procedural safety and improve patient outcomes. We are on track to submit SafeOp's EMG technology for FDA clearance, which will soon enable us to pioneer an automated technology platform that uniquely combines SSEP and EMG. The market's need for the platform, nerve location, and especially nerve health information, will accelerate our overall business. We also completed the $50 million capital raise during the quarter. The funds were used, in part, to fund SafeOp transaction with the balance earmarked for supporting our future growth initiatives. First quarter results position us to meet full year revenue guidance of $95 million. We continue to anticipate that US commercial revenue will begin to ramp in the second half of the year. Terry and I am will provide color on expected drivers, which include straightening the value proposition of the ATEC product portfolio and increasing the number of products sold within each procedure, transforming the dedication and sophistication of the new ATEC sales force via the distribution transition that is well underway and continuing to engage ATEC surgeons while integrating new surgeons into the ATEC family. I'll begin by describing how we are revitalizing ATEC's product portfolio. In the second half of the year, we expect to begin enhancing our portfolio with the initial release of a collection of differentiated interbody implants. The implants utilize a porous titanium material that has been shown to promote bone growth, better manage implant biomechanical performance and improve energy. The collection will strengthen our performance across multiple lumbar and cervical procedures. Historically, Alphatec, like most spine companies, manufactured widgets. By that I mean they're focused narrowly on individual often non-differentiated products instead of an overall procedural requirements. The new ATEC team is building sophistication into a procedurally focused portfolio. We are currently developing new solutions and upgrades, which will include the addition of the SafeOp neuromonitoring platform as well as additions to our core spine portfolio in 2019. We anticipate a compounding effect on future revenue growth as the updated ATEC portfolio drives more products per procedure, and a transforming sales channel generates more procedures. We continue to create an organic innovation machine and to add talent capable of defining and validating improved patient outcomes. To that end, I am thrilled to welcome Kelli Howell to our leadership team as Executive VP of Clinical Strategies. Many of us have worked with Kelli in the past and have seen the influence she has had on clinical validation. Her significant experience in spine will contribute immensely to our efforts. We have added almost 40 people to the ATEC product development, operations, clinical and regulatory teams over the last six months. Collectively, the new hires have deep experience in bringing spine products to market expediently, supporting and driving acceptance of new products in the market and growing market share. With that, I will turn the call over to Terry.

Good afternoon and thank you for joining us today. Pat touched upon the portfolio revitalization that is well underway. I'll expand on the other revenue growth drivers. First, we are making product with our distribution transition, and our vision is being validated. We drove the mix of US commercial sales generated by dedicated agents and distributors to about 50%. That is up significantly from about 40% last quarter and from under 15% in the first quarter of last year. The revenue gains from our network of dedicated distributors are beginning to offset the revenue losses created by the termination of the nonstrategic relationships. We expect to continue to see an increasing percentage of our revenue come from our dedicated distribution channel. A year of experience with the transition continues to present new insight into the puts and takes of what we are trying to accomplish. Since the first quarter of last year, we have terminated almost 40 of Alphatec's non-dedicated distributors, while signing on new, dedicated, higher volume distribution relationships. These decisions have driven some lumpiness in our top line results, but they are a solid testament to our efforts. The final major driver of revenue growth in the second half of this year is the surgeon engagement and conversion that the ATEC transformation is beginning to drive. On the engagement front, I am proud to share that the number of surgeon visits to ATEC headquarters has increased for the fifth consecutive quarter. In fact, surgeon visits during the first quarter of 2018 alone exceeded all of the surgeon visits recorded in the entire year of 2017. Additionally, new surgeon conversion in the first quarter was strong. These are two key leading indicators of future performance. As Pat mentioned, revenue was driven by our surgeons increased about 70%, far outpacing revenue performance overall. This strong level of interest and performance is largely being driven by legacy Alphatec solutions. So this is not yet reflecting the innovation that our team is building into the product portfolio. We believe that the dramatic surgeon engagement improvements that we are driving will translate well into improved revenue growth over the course of this year and ultimately, into increasing surgeon conversion. Several key underlying metrics are a testament to the progress of our team. I'm confident that we are solidly on track to achieve our vision of becoming the most respected, fastest growing US spine company. With that, I'll turn the call over to Jeff.

Thank you, Terry, and good afternoon, everybody. In the first quarter of 2018, we drove progress against our key initiatives, and we began to invest in the future growth of our business. We ended the first quarter with $19.2 million in US commercial revenue compared to $20.9 million in the fourth quarter of 2017. The impacts of seasonality and the distribution transition obscured much of the progress we're making. US gross margin was 70% in the first quarter, and we expect it will remain roughly at this level as we move forward in 2018. Our non-GAAP operating expenses, which exclude the restructuring expenses, stock based compensation, transaction related expenses and a $6.2 million gain on a contract settlement, were $17.7 million in the first quarter of 2018 compared to $16.3 million in the fourth quarter of 2017. Following 4 quarters of aggressive operating expense rationalization across all functions, this planned increase reflects cost related to investment in product marketing and development, enhanced regulatory and clinical development initiatives, the integration of SafeOp and legal fees and transaction support. We continue to expect to make growth related investments over the course of 2018, particularly in product development and sales and marketing, and as a result, our operating expenses will increase compared to 2017. In the first quarter, we raised net cash proceeds from our private placement and warrant financing of $46.4 million. Following the payment of $14.8 million for our acquisition of SafeOp and related expenses, we ended the first quarter with $47.6 million in cash compared to $22.5 million at the end of 2017. In addition, we generated cash proceeds of $3 million in April from warrant exercises, which is not reflected in our March 31 cash balance. This is the first time in almost a decade, that ATEC has had the balance sheet to execute a growth strategy. Net of our financing proceeds and cash paid for SafeOp, our cash use, was $7.5 million in the first quarter, which includes about $5 million in debt service. Our debt service was unusually high in the first quarter due to a $2 million net pay down against our revolving credit facility. Excluding debt service, operating cash usage in the quarter was $2.5 million, reflecting continued careful cash management even with the increase in investments in the business. Over the course of the past 12 months, we've continued to aggressively manage cash burn. As perspective, a year ago, during the first quarter of 2017, our operating burn, excluding debt service, was just under $6.5 million. We will continue to responsibly deploy cash resources even as we accelerate investments into product development and instruments that's in the field. We continue to expect total revenue of approximately $95 million for the full year of 2018. We expect US commercial revenue growth to ramp in the second half of the year as revenue gains from increased surgeon engagement, surgeon conversion and new distribution partners increasingly offset the losses driven by the termination of nonstrategic relationships. The slate of initial product releases that we have planned will also contribute to second half growth. We continue to expect some of these gains to be offset by a decline in non-US revenue under our international supply agreement. We're making solid progress behind the scenes here at ATEC. We look forward to achieving the inflection point of revenue growth that we believe will transpire in the coming quarters. I'll now turn the call back over to Pat for closing comments.

Thank you, Jeff. The momentum, both in the field and internally at ATEC, continues to build, and we are increasingly optimistic about the future. Our confidence is driven by the strong impact that our distribution transformation is beginning to have by the expansion in surgeon engagement and conversion we are experiencing and by the portfolio upgrade that we are executing. Our conviction and assured vision to become a top tier spine market player has never been greater. And this is the first time in almost a decade that ATEC has enough cash to execute against the future growth plan. We thank you for your support as we work to establish a rock solid foundation for sustained long-term growth, a foundation built on industry leading talent, innovative prowess and a culture of respect and accountability. The spine market needs Alphatec and ATEC is now exceptionally well positioned to deliver. I'll now turn the callback over to the operator, and we'll take your questions.

[Operator Instructions] Your first question comes from the line of Brooks O'Neil from Lake Street Capital. Your line is open.

Good afternoon and thank you for all the information. I was hoping you might perhaps be able to point anecdotally to one or two situations guys, where you have a leading distributor change and maybe talk about what, sort of, you saw in that territory with the previous distributor. Obviously, no need to identify any parties involved. But talk about what you are beginning to see from your new distributors and your new relationships you are building in those geographies?

Brooks, this is Terry. Appreciate the question. And yes, so we've made a number of changes, and it's very interesting because we're typically not just changing out one distributor as we had a lot of overlap even within hospitals. And so what we're seeing is the new distributors that we're bringing in over much broader geographies, on average, have more reps and work with more surgeons, and those surgeons have a higher average revenue than those that came from our non-dedicated, former partners as well. So the transition continues to go very well. Again, we continue to experience that, in some cases, it takes more time than we would like, based on gaining hospital approvals and different things, but we're very excited about what we're seeing as we make these transactions.

Great, that's very helpful. Could you also - I know you've done this formally and verbally a couple of times, but I just - it helps me to hear it over and over. Describe again in a little bit of detail sort of the significance and strategy behind the SafeOp acquisition.

Brooks, this is Pat. The kind of virtuous value of what SafeOp brings us is that - I would say, that the legacy portfolio that Alphatec had, had little distinction, and so virtually, the type of requirement that we would have for someone to compel a surgeon to engage in utility of our products was very, very challenging. And it completely changes the value proposition when we have the ability to say, hey, if you are going to make a smaller incision, we could tell you where the nerve is, and we can tell you, objectively, about the health of the nerve, and how it either is degrading over time or there's a problem. And so often, what surgeons are looking for is more information in surgery and this conduit provides us the ability to deliver information to the operating room and really openly distinguish our products in the procedure because we will architect them to all work together and so it really becomes kind of a key driver of patient outcomes.

Great and Pat, I really appreciate that. Could you just talk relatively again - I recognize, I'm not a spine expert, so I apologize for that. But are there particular procedures or conditions that you are most focused on that you see the biggest opportunity for Alphatec?

Yeah, the great part is, in spine surgery, there are few procedures whereby there is max nerve retraction. And so if you look at cervical surgery, so if you go to the front of the spine, they often retract the laryngeal nerve. The ability to minimize dysphagia or dystonia, meaning someone's ability to not be hoarse after retracting to access the spine, becomes a deal or have swallowing issues after spine is a big deal. And so, our ability to notify the surgeon that, it's been a long time since you've been on this nerve or you've - you retracted it too much. And so if you look across the different procedures that we are engaging in, everything from anterior cervical discectomy and fusion, which is ACDF, as well as TLIF as well as lateral surgery and there's a ton of application where spine surgery is about decompressing nerve elements, which means you are going to have to move them all of the time. And if there is no objective measure to move them other than the information we provide, that's value creation.

That's really helpful. Thank you very much.

[Operator Instructions] Your next question comes from the line of Sean Lee at H.C. Wainwright. Your line is open.

Good afternoon guys, thank you for taking my question. I just have two quick questions. One, you guys mentioned that revenue from dedicated distributors now make up 50% of the total sales compared to the 40% last quarter and 15% a year ago. While I understand that you - the ultimate goal for the company is to get to - as close to 100% as possible, but do you have a - could you give a little more color on how can we expect that to ramp up over this year?

Yes, Sean, so it's a difficult thing as we get this far through. It's because we are trying to identify as we negotiate with some current distributors, how many of those were going to be able to pull over, to become dedicated, as well as the ramp that we're seeing from the new distributors that we've brought over and identified the ramp of the new distributors that we're currently bringing on. So it really becomes a difficult thing to say, but I think it's fair to say that we're well on track if you consider we have suggested from the very beginning here that this is a two to three year process. I'd suggest that we are well on pace if not ahead of pace to achieve that.

That was helpful. My second question is on the SafeOp EMG. It sounds like a very exciting new technology. I'm just wondering could you give a little more color on the regulatory process to get the device to market. What kind of - what steps still needs to be done and a rough timing for the process?

Yes, this is Pat. The regulatory process on the EMG front is readably straightforward. It is a 510(k), and so we should submit the 510(k) by the middle of the quarter. And really hope to - expect it to be a fourth quarter clearance, and then really start the opportunity to refine and verify every little element of functionality that we deliver in. And so the great part is, there is a predicate for automated EMG. The real, unique value elements are in the automated SSEP, and so that's already cleared, which is great. And so we believe or are confident in the fact that the road should be relatively straight.

Great, thank you for the answers and that's all I have.

Great.

I am showing no further questions at this time. Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.