Alphatec Holdings, Inc. Q1 FY2020 Earnings Call

Good afternoon, everyone, and welcome to Alphatec's First Quarter 2020 Financial Results and Recent Corporate Highlights Announcement. We would like to remind everyone that participants on the call will 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 the 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 views of why this information is useful to investors. Joining us on the call today will be ATEC's Chairman and CEO, Pat Miles, and CFO, Jeff Black. Now, I will turn the call over to Pat Miles, Chairman and CEO of Alphatec Spine.

Thanks, Michelle. Thanks, everyone, for joining the call. Before I get into the presentation, I want to take a minute with some prepared remarks really to the ATEC family because I know many are listening in. First of all, I want to say thanks for your continued engagement and productivity over the past two months. I am so proud of how we support each other during this crisis through the donation of paid sick time or forgoing base salary for stock to preserve cash for payroll, or the extreme focus by everyone on driving the business forward despite being separated. I can tell you, the business has pushed ahead. Regulatory filings have continued. Alpha evaluations have been completed. Surgeries have been fully supported. Recruitment of key talent and customers hasn't missed a beat. I believe we'll exit this challenge stronger than where we entered it, which is what distinguishes great companies. You've been committed to our mission and we are completely committed to you. You can expect to see an increasing presence in the workplace starting soon as our surgery volume and project work continues to pick up, but it will happen in a methodical way, clearly, to ensure that everyone is safe. With respect to our outlook on the business, I could not be more bullish. We saw strong momentum going into the crisis, which is reflected in our Q1 results. While we have certainly been impacted by COVID, the interest from our expanding surgeon community and distribution channel is absolutely palpable. I'm encouraged by signs of recovery in surgical volumes. While it's way too early to predict when we'll see full recovery, I am confident it will come back strong. We have taken critical steps necessary to strengthen our balance sheet and secure our runway. We've made strategic decisions to pull back spend in certain areas, but with a keen focus on preserving our most valuable asset, our employee base, and maintaining momentum on key development initiatives. We recently secured an additional $35 million commitment from Squadron Capital, extending the runway we needed to focus on moving the business forward. We remain unwavering in our commitment to bring innovation to a market that needs it. And we have a team and the resources to make that happen. So, I just want to make sure I didn't miss anything before I jump into the Q1 2020 scorecard. Clearly, the company has strong momentum. When you start to see things like 27% year-over-year revenue growth, you have to be optimistic. Additionally, 56% of that was from new product, which compares to 22% a year ago in Q1 and really less than 10% in fiscal year 2018. We talk a lot about convoyed sales, meaning how many product categories sell into surgery, and we continue to see that tick up. It was 1.7 in Q1. This is our sixth consecutive double-digit year-over-year revenue growth in a quarter. When we go through our business update, the areas that we're going to talk about really is our focus as it relates to revenue momentum, the status of EOS, the balance sheet and really where we see the spine market going. Our business is in the operating room. One thing that we have a penchant for is focus. Our priority will remain the same: we're going to continue creating clinical distinction, compel surgeon adoption and revitalize our sales force. We did that in Q1. We are still planning 8 to 10 releases in 2020 of new products. The design meetings continued in earnest virtually. The surgeons made time for us and were candidly thrilled to engage with us over this period of a slowdown. Regulatory submissions continued. I will tell you that momentum is palpable. As it relates to compelling surgeon adoption, we continue to evaluate our Alpha products and continue to see more and more products used per procedure. It's gratifying to see SafeOp used with our retractors – used with our fixation system or inner body systems. You start to see the procedural strategy come into fruition. I have to tell you, recruiting is going exceedingly well. Savvy distributors know that the future of spine is at ATEC. It's been entertaining to see the volume of distributors that have come our way. Oftentimes, their focus is how they can best serve their customer and when they ask themselves that question, we're clearly the solution that many distributors run to. We're also trying to elevate the aptitude of our sales force during the slowdown with a number of online calls to engage them and keep them versed in terms of what we're doing clinically. Transitioning over to EOS, we've changed directions regarding what we're doing there, proposing alternative collaborations. We still believe in the clinical thesis that drove the transaction, but there has been a material adverse event resulting in our terminating the decision. If you delve in and channel check, you'll realize that the near-term focus from hospitals is in preparedness and cash generation from elective surgery, and our concern was it pushed out the acquisition of capital equipment. But it hasn't undermined our clinical confidence in the collaboration. We are exploring other collaborative arrangements that meet both companies' strategic needs. I would say, that's a big change. From our view in the spine market, we're totally encouraged by the recovery, but it's still way too early to make any concrete judgments. We see spine surgery starting to come back and the enthusiasm for elective procedures. The one thing we know is that hospitals need to generate revenue, and the way to generate revenue is through elective surgery. Spine surgery is probably the closest thing to non-elective surgery in orthopedics. We're seeing an expedient return to procedural volumes. I don't want to get into a long discussion based on the volume of uncertainty that still exists. With that, I will turn it over to Jeff Black to review the financials.

Thank you, Pat. I'll spend a couple of minutes just starting on a key focus area, which is our balance sheet. We think it's important to start with that and specifically speak to cash runway. We ended the first quarter with $27.5 million in cash. We made a draw in early April on our existing credit facility with Squadron. So, we ended the quarter with $47.5 million in cash on a pro forma basis. We executed a commitment letter for a $35 million expansion of the facility with Squadron. A part of those proceeds will pay off our revolver with MidCap and the remaining will be available to draw as needed. We've extended the maturity of the entire credit facility by two years to 2025. We removed all financial covenants, and we expect to close this financing by the end of May. We believe this is the right financing at the right time for us, providing the runway we need to execute on our growth plans. We've made some decisions on cost containment across the organization, again, as Pat mentioned, with an eye toward preserving the employee base and maintaining key product development initiatives. In Q1, our cash burn was elevated over prior quarters really due to transaction-related and litigation expenditures. Recall that litigation was atypically high in Q4 related to our patent litigation. We saw that cash impact in the first quarter. Looking at revenue, we saw 34% year-over-year growth from our strategic distribution channel. This mix is not just increases in surgical volume, but includes case complexity and a continued increase in products per case, which is driving revenue per case higher. Our legacy distribution channel continues to perform above the level we expected at this point. Gross margin has held steady as expected. We continue to see a bit of a margin drag from excess and obsolescence on legacy products; we expect this to continue through 2020 as we transition to new products. Once E&O normalizes, our variations in gross margin will primarily be driven by product mix, but we believe that mid-term we'll maintain margins in the mid-70% range. Our non-GAAP OpEx profile remains consistent year-over-year, again in line with our expectations as we continue to invest in new product development and build out our strategic sales channel. Importantly, we hold the line on G&A, which has been flat for the last 12 quarters and below 2017 run rates when we started the strategic pivot of the company. With that, I'll turn the call back over to Pat for closing comments.

Thanks, Jeff. You've got to know that we remain fixated on stewarding better spine surgeries. We feel like that's a great business and we're going to do it through innovation. Spine is probably the least of the 'elective surgeries,' and we know that the volume of spine surgery will return and is returning, and we're prepared. Thank you very much for your attention, and now happy to take questions.

Our first question comes from Brooks O'Neil with Lake Street. Your line is open. Please go ahead.

Thank you very much. Good afternoon, guys. Appreciate the opening comments and all you're doing to keep the business moving forward. I was just curious, as you look at the spine business and spine surgeries, do you sense there is some growing pent-up demand? Or said differently, have some of the postponed cases gone away permanently, or do you expect those ultimately to get done when the hospitals and ORs open up the business again?

Yeah, Brooks. This is Pat. I think it's abundantly clear that these have been postponed. Hospitals are talking about working on Saturdays and Sundays and increasing the OR hours to make spine surgery available to a broader audience. I would say, absolutely. People are just holding off until insurance is affirmed, and their confidence is affirmed. In speaking to the surgeons and the hospitals, there is a lot of pent-up demand out there.

Great. That's very helpful. And then, second question, obviously, fairly late in the year last year, the release of Alpha Informatix or SafeOp. Can you just talk about what the disruption related to COVID has done, if anything, to your launch there and what you plan to do to try to reestablish the kind of momentum that you all hope to get when the original plans were put in place?

Yeah. Thanks for the question, Brooks. There are many things that come to mind when you ask that question. One of the things I'm so proud of is that the product development team has been excellent during the downtime. We launched the product in late last year, and the momentum has ticked up month after month. Then, we saw the ceasing of the volume of cases in mid-March. The beauty is, we continue to evolve the system. The system is software-based, so there's significant opportunity to create sophistication. I'm confident that this was the right acquisition, whatever it was two years ago. This is a distinguishing element for us to provide information in the operating room, and we will continue to choreograph surgery to provide information. A few companies are providing the limited footprint but the valuable information that the Alpha Informatix platform provides. I'm exceedingly bullish and excited about continuing to evolve and integrate this into every type of procedure and the commercial traction that it gets.

That's great. I'll just ask one more and then I'll turn it over. I heard your comments about the EOS system situation. Totally get it. But how do you read the EOS team? Do you think they still hope to find ways to collaborate with you guys, or is this a jilted partner and they're going to be mad and not going to take it anymore?

Yeah. I don't want to speak to their perspectives. I will say, I'm probably the most disappointed. I like that technology, and I think there’s real value in what it provides. The clinical thesis around our collaboration hasn't changed at all. The concern becomes, as a small company, cash being king, you have to look at how both companies are best served. I think the leadership there is excellent, and there is a great relationship with them. I'm bullish on our opportunity to collaborate. I hope we can put it together. It will serve the interest of both companies, but it has to be a different collaboration than what we originally planned.

Great. I lied. I have one more question for Jeff. Jeff, can you just update us on how you feel about the availability of capital recognizing the new addition with Squadron and what the terms? You said it had no covenants. Can you just refresh us on the rate on that debt with Squadron and how you feel about where you're at right now? Thanks a lot.

Yeah. Thanks, Brooks. Look, we feel, like I said, this is the right financing at the right time. It gives us the runway we need to execute the business while maintaining the employee base and product development initiatives. The terms in terms of interest areLIBOR plus 8%, 10% floor, and 13% ceiling. We've extended our maturity by two years, and removed financial covenants. We feel we're well positioned here with available capital to continue executing the business.

Thank you. And our next question comes from the line of Matthew O'Brien with Piper Sandler. Your line is open. Please go ahead.

Afternoon. Thanks for taking the questions. Three for me. First, just looking back at Q1, the performance was really good, kind of leading among all of spine in terms of growth. Can you just kind of deconstruct where some of that growth came from? And then, Pat, just on the revenue per case side of things, how much further is there to go specifically with that metric?

Yeah. Thanks for the questions. Deconstructing the revenue, I would say the biggest driver is really the confidence in the utility of the new devices and the ability to perform more complex procedures with them. We're attracting more surgeons that ultimately utilize the devices and gain confidence. I don't think we have met our procedural aspirations. When everything gets integrated toward the end of the year, I think the convoyed element will pick up significantly. It's about perception and seeing what our team can do. I'll let Jeff comment if he thinks I'm missing anything.

I'd certainly add that in terms of breaking it out on the increase, it's really across the board. To Pat's point, new surgeons are coming on board and increasing volumes, existing surgeons are doing more business, increasing case complexities and the confidence inspired by surgeons using more products per case. So, the driver for that increase is across the board in all three categories.

Okay. That's great to hear. Looking back toward March, what did you see as far as procedural slowdowns? What did you see in April, and how are you feeling as we think about the rest of this quarter?

We saw a relatively abrupt slowdown in the second half of March. Mostly trauma cases were done or cases that weren't elective. In April, it was very slow, still reflective of the same. But we saw some ASCs doing cervical cases. We're bullish about what's happening going forward. There’s been a general bullishness regarding the recovery. There’s likely to be an increase in the back half of this quarter.

When you think about average daily sales, our fourth quarter being seasonally the highest, going into the pandemic in mid-March, we started seeing the average daily sales approach Q4 volumes. That was encouraging.

Great. Thank you very much for taking the questions. I wanted to kind of touch on the dynamics you saw specifically in the second half of March and into April. He we heard on other calls with companies of varying sizes about procedure volumes declining in the 70% to 80% range for the month of April. Is that fair when you look at your business? And what is happening in the first 10 or 11 days as far as May?

Kyle, this is Jeff. We saw great momentum going into the crisis in the first half of March. We saw a pretty abrupt shutdown or decrease in those volumes. However, in April, starting even the first or second week, volumes were beyond where we expected them to be. So, early signs of recovery, and we're very optimistic.

When we think about the types of cases that are getting done, what types are being done, and where? We're hearing more about ASCs and more simple cases. But, those don't carry the same price tag with larger complex cases. Maybe help us understand the procedural perspective versus a mix perspective and how that might change?

I think you are correct. There’s been a lot of single and two-level cervical cases going on at ASCs. A lot of minimally invasive procedures are being done in a bloodless way. It’s relatively straightforward, with few levels being done.

I think Jeff, you talked about the medium-term margin outlook staying in the mid-70% range. Does that capture any type of near-term headwinds from a gross margin perspective?

With a decrease in volumes, you will see less efficient absorption of overhead. We feel good about our target going into 2021 that we will be in the mid-70s, particularly as this E&O margin drag is behind us. You may see a temporary blip because of less volume to absorb overhead in the near-term. But mid-term, we feel good about that mid-70% target.

Can you talk about the increase in convoyed sales? SafeOp seems to be a real value driver. How much of an opportunity do you have within your existing users now versus in the future?

We are in a profoundly early phase with SafeOp. These are technical devices that take time for us to train everyone. We’re about 25% into it. It takes more time than we want, but the value is extraordinary. Clinically, the experience has been phenomenal. It's a unique technology, and we’re seeing receptivity from hospitals and surgeons, which makes me bullish about acceptance as we integrate this into our procedural way with other adjuncts.

Hi. Good afternoon, everyone. Thanks for taking my question. This is Arthur for Sean Lee. I have two questions. First one is regarding the US, could you guys give us more color on what kind of other alternative collaboration option you would be exploring with them?

I would prefer not to get into it because there's nothing to announce or anything concrete. It's non-acquisition relationships that are more commercial in nature, so that's as deeply as I'd go because it's in such an early stage.

Okay, thanks. And on the regulatory side, I noticed you guys have submitted additional new product applications. Have you seen any slowdown or impact from COVID on regulatory approval?

I have to tell you, let me brag on our regulatory team as they are outstanding. We haven't seen much impact thus far. We're shoring up our portfolio with outstanding products continuing to launch. We have several submissions in, and they’re moving along as expected.

Thank you. And I'm showing no further questions. I'd like to turn the conference back over to Pat Miles for any closing remarks.

I appreciate everybody's interest in ATEC. We are really creating a monster and can't be more excited about what's going on. Hopefully, when we return from this pandemic, everyone will be safe and stronger. Thanks much.

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