Alphatec Holdings, Inc. Q2 FY2020 Earnings Call

Good afternoon everyone, and welcome to Alphatec's Second 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 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 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.

Good afternoon, everybody. Welcome to the second quarter ATEC conference call. I'm coming up on my three-year anniversary in October and really wanted to share with everyone some of our learnings around the transformation of ATEC. When I arrived, I was told that all we needed to do was transform the sales force and all would be well. The reality is that it's never that simple. In our second investor call, we outlined three commitments that we made to transform ATEC. The first one was how do we create clinical distinction? The second one was how do we compel surgeon adoption? And the third one was how do we revitalize the sales channel? So when we start to think about creating clinical distinction, what we meant was really creating more sophisticated surgical solutions, meaning to create the internal know-how to serve the interest of spine surgery. It is about serving the clinical requirements better than anyone. With that, we'd be able to compel surgeon adoption, which means creating confidence and predictability; how we make surgeons buy into or have confidence in the distinction we are generating. The distinction didn't have to come from an individual product but rather from how we were addressing procedures for specific pathologies. The question was, are we creating the type of confidence that can be reflected in surgeons engaging us with more complex surgeries or more products per procedure? The revitalization of the sales channel meant how do we attract the best salespeople? It doesn't matter how well we do things internally if it is not reflected in the field. We are revitalizing our sales force with an interesting clinical aptitude. Our people have to be clinically focused. Last, these people are savvy. They know what companies create products and procedures that determine a prosperous future. We want them to be clinically adept and totally focused on ATEC, which, hopefully, becomes the exclusive approach, which we will earn over time. I'd like to delve into each of our commitments and demonstrate how things have changed. What is important is that we create a methodical approach, which means that our commitments or claims are reflected in metrics. But the first thing you better do is create an organic innovation machine. That is a team of experienced, passionate people, curious as to how to improve spine care. We built the fundamentals of that team over the past few years and have launched 17 products, which make up 61% of our sales. I think spine surgery, as it's been commoditized, holds nothing but opportunity. Spine surgery still needs improvement, and we intend to work with surgeons to do just that. When we talk about compelling surgeons, most of it is reflected in earning procedures where multiple products are used or increasing surgeon confidence where there's an increasing complexity of surgery. Speaking of spine procedural development, we developed products based upon the requirements around the specific approaches. You will see many companies apply legacy technologies to new approaches and claim we've got one of those, but surgeons are compelled by companies willing to design and develop specifically for the approach and pathology. Also, creating a shared interest with surgeons is about designing products beyond only those that are billable; it's about fulfilling the requirements of spine surgery. As a reflection of our progress, the number of products used per case is up 27% since Q2 of 2017. Cases with more than one product sold are up 46%. We look at average revenue per case, which is up 47%. That's significant; it speaks to the confidence surgeons have in the products we're creating. Revenue from our top 20 surgeons is up 51%. The third point is about revitalizing the sales channel. There becomes a cynicism around salespeople who run toward whoever has the highest commission rate. The reality is that they run toward the company with the most promising future. They want to be effective to the surgeons they call on. I believe they enjoy being part of something special, and the great ones are a significant resource for their surgeon's success. They create certainty in an uncertain environment. The number one question a salesperson gets is, "What's new?" Well, at ATEC, there's a lot that's new. What we've seen thus far in our sales transformation is a 77% increase in revenue per distributor with fewer distributors and 91% of sales coming from our strategic channel. So things are getting better. So when we think about creating clinical distinction, I look back over the last few years and as we created the organic innovation machine, we've cultivated unbelievable know-how. There is great know-how at ATEC. It's easy to become consumed with only financial reflection and lose sight of serving the interest of the marketplace. Our job is to serve the interest of spine surgery. We're doing that by serving a process of how we do things. Back in 2018, we acquired foundational technology that enabled us to provide unique information to surgeons. We realized upon acquisition that we were immediately one of two companies that could create distinction in lateral surgery with automated neurophysiology. The beauty of SafeOp was that we knew the value of what we were providing didn't stop at identifying a nerve with automated EMG in lateral procedures. There are multiple applications beyond lateral. However, the value we could provide in lateral was unique. It allowed us to do something no one else could. The competition will say, "We have one of those" or "We can do that," but the surgeons and salespeople know it's just not true. Moving into 2019, we launched over 12 products, including an integrated SafeOp system with peripherals that integrated with our instruments and implants. This marked the start of our effort to proceduralize or build individual approaches. These new products were foundational and enabled us to begin building a portfolio of products to compel surgeons and attract significant sales talent. Our team embedded feature sets with our foundational products that are unique and clinically valuable. Clearly, products like Single Step that integrate with SafeOp are among them. As we entered 2020, we encountered a global pandemic, but we didn't panic. We concentrated on what we knew, which is serving the interest of spine surgery and controlling what we can as we restored the company. We focused on three things: we designed and developed new products that addressed weaknesses in our cervical portfolio; both the Insignia cervical plate and InVictus posterior cervical system will alpha launch in Q3 2020. It seamlessly extends InVictus up to the posterior cervical spine from the lumbar and thoracic region. We also added modularity to InVictus and integrated it with our TLIF retractor, Sigma, which will launch in Q4. These are things we do very well, and we have great expectations around these products. Lastly, we developed a new lateral single-position procedure named PTP, which will also launch in Q4. This is a lateral prone transpsoas surgery that, once again, everyone will claim they have one of those; however, they do not. We are the team that launched lateral surgery back in 2003. The level of lateral know-how at ATEC is unrivaled. Having previously built the lateral market, we are profoundly familiar with this space. PTP will be a significant addition to not just ATEC's armamentarium but the armamentarium of spine surgery. We are several hundred surgeries into our experience, so we are not guessing. There is significant value in the investments that created value over the years. As you can see, where we have invested, we have prospered, and where we haven't, we've struggled. Our priority was to create clinical distinction, with information and lateral programming in our first phase. Since Q2 of 2017, we've grown 61% in categories of information, lateral, and posterior fixation. In phase two, we began investing in ALIF, Plus, and TLIF; that category is up 34%, and we are just getting started. You will see continued launches in 2020 and 2021 in these categories. Our redesign and investment in cervical and biologics is at a very early stage. You'll see the fruits of those investments in 2020 and they will fully launch in 2021. The point is that we've been very deliberate with our investment thesis. We know the market well and our ability to continue to invest and create clinical distinction is significant. Now on to the scorecard for Q2 2020; the momentum we've built is strong and candidly somewhat undeniable. We are up 11% year-over-year and 15% within strategic distribution. We're growing at 25% among our top 20 surgeons; 61% of our revenue comes from new products versus 32% in Q2 of 2019 and less than 10% in 2018. The confidence, reflected in a 14% year-over-year growth in average revenue per case, is significant. It's our seventh consecutive double-digit year-over-year growth quarter. I also want to highlight that we're averaging 1.8 product categories sold per surgery. That indicates we're starting to combine and proceduralize the portfolio in a way that creates clinical distinction. As we look ahead, you're going to see profound changes, which means we're going to do three things: create clinical distinction, compel surgeon adoption, and revitalize the sales channel. This means we will continue to develop products, increasingly tackle more complex cases, attract surgeon interest, advance toward exclusivity in our sales channel, and expand into under-penetrated geographies. Clearly, a lot of good things are happening, and I couldn't be more excited about where we are as a company. With that, I'll turn it over to Jeff.

Great. Thank you, Pat, and good afternoon, everyone. Just a few quick minutes on the financial results. First, regarding revenue. As Pat mentioned, we are expanding our revenue per case. We saw very strong momentum, particularly moving into the last month of the quarter. June was the second-highest month of volume in the company's history. Again, as expected, we continue to see the international headwind under our supply agreement winding down as anticipated. As you start to dig into the growth metrics, we achieved an 11% growth in US revenue that still reflects headwinds from our legacy distribution, which was down 23%. However, strategic distribution grew by 15%. When you look at our performance with a year-over-year growth of 11%, even in a down market, we grew off a significantly strong second quarter 2019 comparison where we experienced 28% year-over-year growth a year ago. So that speaks to continued momentum in the sales channel. Regarding gross margin, the story remains consistent, although we're beginning to gain much clearer insight into the path toward our margins at scale. As expected, we continued to see drag from legacy products, which, last year, had an 800 basis point impact on margin. For the first half of 2020, it's around 600 basis points. Historically, we’ve seen it more in the 300 to 400 basis points range. This points to future margin improvement opportunities as we scale. Looking at the overall P&L, we're making continued investments, expanding the portfolio, and investing in the sales channel. In late Q1, when the pandemic first hit, we took immediate actions to shore up expenditures with an eye toward not compromising key product development initiatives. We are still on track to release 8 to 10 new products in 2020, but simultaneously, we avoided workforce reductions and kept the ATEC team intact. In fact, we made several key hires while deferring expenses where it made sense. While Q2 may not be representative of our near-term expense profile, it reflects our ability to manage cash appropriately when required. Segueing into the balance sheet, we ended Q2 with more than $55 million in cash and available draws on our Squadron line, which provides us runway through mid-2021. Our term debt with Squadron does not begin to amortize until the third quarter of 2022. We also just entered into a one-year repayment holiday on our $1.1 million quarterly obligation to Orthotec. In looking at our cash burn profile, over 50% of our operational cash over the last four quarters supported capital expenditures for new product launches; in Q2, this was nearly 60%. As we consider our financing needs, it's primarily about making the capital investments required to drive continued growth. The shelf filing and the ATM we instituted today are intended to give us ultimate flexibility in accessing capital markets when it makes sense for us. Before I wrap it up and turn it back over to Pat, I want to provide a bit of commentary regarding our historical P&L. When we look at our revenue, our annualized US revenue run rate from strategic distribution in the first half of 2020 has actually doubled since 2017. We've made the investments we committed to in the portfolio and sales channel, which has driven the performance we also pledged to achieve, while maintaining our G&A. What you're seeing in the SG&A line reflects a true investment in the sales channel, expecting operating leverage to come over time. For now, our focus is making the necessary strategic investments to establish predictable and sustainable top-line growth. With that, I'll turn it over to Pat to wrap up.

Thanks, Jeff. Our vision for the new ATEC has begun to materialize, but we have enjoyed our seventh quarter of double-digit year-over-year sales growth. As we discussed a few years back, what creates double-digit growth is focus, execution, and organic innovation, and we have a team here that knows how to do that. So, when you look at our efforts, it's about executing and building a culture committed to serving the interest of spine surgery. I would say we are just getting started. We are very excited. With that, we will turn it over and take questions.

And first question is from Lake Street Capital, Brooks O'Neil. Brooks, your line is now open.

Thank you very much. Good afternoon, guys. It sounds like you spine guys are hitting some strides out there.

We're trying, Brooks.

Way to go. So first question, I guess. I think Jeff mentioned that June was the second highest month in the company's history. Can you give us a little feel for what you're seeing in July and maybe early August? Obviously, some spikes occurring, but what we hear is a lot of procedures are getting done. So what do you guys see?

Yes, Brooks, this is Jeff. Thanks for the question. Yes, momentum continues to be encouraging and strong. We're cautiously optimistic given the current environment, but we're seeing strong demand. The question remains: is spine surgery truly elective when patients are in chronic pain and need surgical intervention? So we're encouraged by what we’re seeing early in the third quarter.

Great. And Pat talked about the efforts to proceduralize various aspects of spine surgery. Obviously, your deep history in lateral with Luis, and all of that is great. What are some of the areas you think you can proceduralize going forward? And maybe talk just a little bit about those efforts.

Yes, Brooks, I hope you are seated. I could speak for an hour. It’s one of those things where I must tell you, I think surgeons are looking for partners that will invest in things that ultimately make spine surgery better. Too often, companies only invest in billable items. Having a shared interest with a surgeon means you care enough about what they are doing to invest in what they need. It may not be a great business regarding the individual components, but assembled, it becomes a great business. Every procedure, from anterior cervical discectomy infusion to TLIF to lateral, requires technology that currently tends to be pieced together, creating an underwhelming experience. Our opportunity is to choreograph or architect these things to create greater predictability. When a patient goes in with a specific pathology, their likelihood of knowing exactly how things will go significantly increases.

Every procedure. Great. Then maybe my last one, I just love to hear how things are going with SafeOp, what the response is out there in the field. If you could share any thoughts about what the next 12 months might bring to the SafeOp platform, that would be really interesting.

Yes, I love SafeOp, and I am thrilled with how it's doing. We intend to create a conduit to deliver information into the operating room. The first piece of information provided will be nerve identification. We're providing better neurophysiology than anyone else, which means both identifying nerves and assessing nerve health, something that no one else is doing today. We have a better solution. How it evolves is based on the procedure being done, so we have many neurophysiological additions we can make to the Alpha Informatics platform within SafeOp. We are also very much interested in additional metrics concerning alignment. What you'll start to see are additional elements on the platform providing extra information. We believe many factors will create predictability in surgery and could be delivered through that platform.

That's great. I told you that was my last question, but I actually have one more. I ask you this quite often, but there’s a lot of buzz in the spine marketplace about robots. We've talked about the fact that you believe in empowering surgeons more than putting robots to work. Tell me what you see with robots in the marketplace today and your interest in pursuing some track along those lines.

Yes, it’s a loaded question. The way I would answer it is we look at a specific procedure applied to a specific pathology. If you examine the applicability of robots, it's relatively narrow. As ubiquitous as everyone wants to claim, they're not. And so those interesting pieces of equipment aren't being utilized as significantly as they could be. I appreciate the excitement surrounding lumbar total disc replacement when it first emerged. Watching these developments, I wonder, what specific pathologic application is it solving or what problem is it addressing? Robots are primarily solving issues related to placing pedicle screws; that's something that has been done for years. So I struggle suggesting a universal value associated with robotics when I see so much good surgery being performed, alongside complicated surgeries with challenging anatomy or major rotational issues where a surgeon struggles. That’s a very narrow market. I remain enthusiastic about the technology, but currently, its applicability is limited.

Okay. That's great. Congratulations on everything you're accomplishing.

Next question from Piper Sandler, Matthew O'Brien. Matthew, your line is now open.

Good afternoon, guys. This is Patrick on for Matt. Congrats on the quarter, especially in light of COVID-19. I wanted to start on the competitive environment you're currently seeing. You're in an excellent position from a capitalization perspective; however, there are smaller players who are less capitalized that are struggling during this time. If you could parse out where some of your competitive wins are coming from, that would be helpful. Are they coming more downstream? Are you getting broad-based wins both up and downstream? That would be helpful for us to understand. Thank you.

Yes, I'll do my best to create some clarity. I would tell you that we're gaining geographic wins based on earning people's interest and enthusiasm for what we're achieving surgically. In some areas, we have very strong clinically adept salespeople. When we have individuals who appreciate the feature sets designed into the technology, we prosper. We struggle where we have more legacy-oriented individuals who don't engage with the clinical sophistication we're providing. When they fail to offer new perspectives to surgeons, we have not experienced prosperity.

No, that's helpful. I appreciate it. It's a convoluted question, and I apologize for that. When we think about the back half of this year, can you discuss some of the dynamics between the backlog and the new patients as we consider your growth rate moving forward? Are surgeons still working through their backlogs? Is much of that work completed? Just how should we think about that for the rest of this year? I have one more follow-up. Thank you.

Okay. Here's my view, Patrick. The pandemic has been a tale of 50 states. There are many variables per practice, making it difficult to discern what's true pent-up demand versus what's normalized demand. We saw many pent-up elements from April resurfacing in May and even parts of June. I expect many variables influence why some people choose surgery and others do not, making discerning between pent-up and normal demands difficult. Surgeons continue to see fewer patients in their clinics, resulting in fewer surgical candidates. Overall, it’s quite challenging to discern.

That's really helpful color. Briefly on your vision moving forward, a component is expanding into under-penetrated geographies. Can you help investors understand where those specific under-penetrated geographies are? As you move into these areas, what's the demand like for distributors to get on board with Alphatec? With all the momentum you’re generating, it seems natural for distributors to join, but I'm curious if you could provide more color there for investors. Thanks again for the questions.

Yes, thanks, Patrick. It’s a great question. What you see is a unique level of sophistication regarding the design and developmental prowess at ATEC. When new distributors come aboard, I think they're blown away by the technology we offer. Frequently, smaller companies attempt to attract distributors, but we often find that when distributors engage with us, they realize our technology exceeds what they previously had. They are also excited about what we have coming forward. The enthusiasm for partnering with us is high. The challenges we face include legacy personalities in some geographies or areas where we have not yet penetrated quickly as we’d like. The great news is there is a lot of opportunity out there. The difficult part is we still face disparities regarding prowess in the field. That’s about as much resolution as I can provide.

Got it, guys. Congrats on the quarter.

Next question is from Northland Capital, Jason Wittes. Jason, your line is now open.

First question; impressive growth, especially relative to your peers. You grew this quarter, which is quite impressive. A follow-up on a previous question. You mentioned that June was your strongest month. Can you provide color on how July compared to June? How did the quarter perform month-to-month? Other companies are providing those metrics.

Yes, Jason, this is Jeff. As I mentioned in Brooks' question, we’re seeing continued strong interest and momentum. Generally, July tends to be slower than June, but the momentum remains strong. Moreover, we have every indication that spine surgeries are being reconsidered as elective based on patient necessity. Thus, I would assert we remain cautiously optimistic about the third quarter.

Given COVID, you’re still not in a position to provide guidance, but it sounds optimistic?

Correct.

I noticed you mentioned your cervical launch. Are you doing much cervical business currently? Or is this potentially a big incremental opportunity with these upcoming launches?

In short, yes, the anterior cervical discectomy infusion is one of the best surgeries. Patients tend to fare very well. However, as a result of prior challenges, Alphatec hadn’t invested enough to evolve its technology. We're left with a dated cervical portfolio. Per one of my slides showing investment demographics, it reflects the prowess we’ve had in different areas. The frustrating part is it’s tough to create significant distinction. We have done an outstanding job regarding InVictus. We've been here for about 2.5 years, and we'll have a complete solution for InVictus, including modularity and all other elements of a posterior fixation system. Most companies require over five years to achieve this. It's actually very exciting. We will have a much more sophisticated quest for solutions.

Great. And another question on the SafeOp platform. I see it as a key technology for you. If you could provide statistics or measurements on who’s using it at this point? What’s the outlook for SafeOp in terms of adoption?

Realize that those of us who built the previous company did so with inferior technology in another context. This technology is far superior. We track usage through linkage to specific procedures and analyze how frequently it's utilized with our screws or lateral surgeries. Those percentages indicate the traction we are observing. Our integration of these tools is impressive, offering scalability compared to the outdated systems we previously used. Our confidence in SafeOp is high, and connection to various spine procedures is strong. I would say it's performing as we had anticipated.

Most of your surgeons are using SafeOp? Or is there still an adoption curve?

There will continuously be an adoption curve. If they're performing lateral surgeries with us, they tend to use SafeOp.

Next question from Canaccord, Kyle Rose. Kyle, your line is now open.

Thanks for squeezing me in. I want to revisit Q2 because the growth you delivered, considering the economic backdrop and what we've seen from your peer group, is exceptional. Can you walk us through the month-over-month performance of Q2? What was the low point, and what productivity improvements did you see? Given your 15% overall growth in the strategic group, your exit velocity in June must have been materially higher than that. What went right?

April was exceedingly tough. There were places still conducting surgeries. Our advantageous position was the sustained surgery activity even during the lockdown. It presented an opportunity for us. That said, our case volume decreased, but we did see an increase in both product variety per surgery and more complex procedures being performed. This resulted in an expanded revenue number.

Kyle, to elaborate on that, we saw about a 4% year-over-year decrease in surgical volumes for the quarter, but we significantly offset that by our increasing revenue per case. Most of that 4% occurred during the peak of the pandemic in April and early May, but we started experiencing a robust recovery. In June, we recorded our second-highest month in company history, hitting daily sales levels that exceeded Q4 2019.

That's very helpful. What uncertainties are you considering for guidance in the back half of the year? What would need to go wrong to materially disrupt your momentum? You grew in April despite one of the largest deferrals we've seen in the industry, so what factors concern you?

Only the uncertainties related to the pandemic present risks. Besides that, there is nothing explicit that I can see could derail momentum other than renewed uncertainties related to the pandemic. I wish I had a more defined answer; however, this pandemic is serving as a tale of 50 states, with numerous variables complicating the clarity.

Understood. Lastly, we’ve heard about hospitals restricting commercial patterns concerning rep access to meet with physicians and engage on contracts. Considering your growth, better talent recruitment, and product launches, how have your conversations fared in converting surgeons and adding new accounts recently? What’s the experience thus far?

I must say, Kyle, that's the pivotal question. As we entered the pandemic, we either could remain passive or be aggressive. We chose to be proactive. From a sales education perspective, surgeon recruitment, and talent acquisition, we were very aggressive. The pandemic has prompted many to reassess their ongoing partnerships and identify scalable companies. Hence, we observed growth in enthusiasm toward our company. While telephonic communications and virtual meetings have taken precedence, we’ve consistently capitalized on this unique opportunity to compel partnerships.

Thank you for the great insights and congratulations on the quarter.

Thank you.

Thank you, Kyle.

Last question from H.C. Wainwright, Sean Lee. Sean, your line is now open.

Good afternoon, Pat and Jeff. Thanks for taking my question. Most of the topics I wanted to discuss have been covered. However, could you provide more detail regarding how the quarter performed in terms of geographies and different types of surgery? Did you experience notable surgery slowdowns in certain regions? Were recoveries faster in certain areas? Were specific procedures affected more than others?

Yes. There were differences in volume and procedures based on varying pandemic severity across different states. For instance, emergent cervical cases, such as those involving myelopathic patients requiring immediate surgery, were prioritized. Consequently, more elective cases and degenerative surgeries were postponed. Regional variances also affected how quickly cases resumed. The pandemic’s affect differed significantly in various geographies, influencing what types of surgeries could be performed.

I understand. You entered preservation mode during the pandemic; have you resumed spending now? Are we back to business as usual? Will the spending slowdown have an impact in the second half of the year?

We are purchasing implants and instruments to keep up with demand. That's our priority as we return to normal operations. We remain cautious about operating expenses, attempting to be prudent in how we move forward.

We've been judicious in our approach, evaluating each hiring decision critically. However, we've maintained pace in product development. Our focus now is on supply chain investments to meet the product demand. We'll continue to explore opportunities to defer or manage spend as needed. The pandemic has led to natural cost savings, as traveling reduces costs, and through virtual training, we also see spending slow. We are ensuring we make the right strategic investments today.

I see. Very helpful. Thank you for the insights.

Thank you for your questions. Companies excel because of people. We've assembled a great team, and we’re excited about the momentum we're starting to build. Thank you for your interest. Take care.

Thank you so much to our presenters and to everyone who participated. This concludes today's conference call. You may now disconnect. Have a great day.