Alphatec Holdings, Inc. Q4 FY2020 Earnings Call

Good afternoon, everyone, and welcome to the webcast of ATEC's fourth quarter and full year 2020 financial results. 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 U.S. GAAP as well as non-GAAP or pro forma measures. Reconciliation 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. Leading today's call will be ATEC's Chairman and CEO, Pat Miles; and CFO, Jeff Black. Now I will turn the call over to Pat Miles.

Welcome, everybody, and good afternoon to the Q4 2020 ATEC Conference Call. Clearly, today, we will be making some forward statements. So if you'd familiarize yourself with that, I will save you from having to listen to me read it. Things are going well, really no complaints. I think when we say well, we oftentimes like to quantify what that means. And so average revenue growth over the past eight quarters has been 30%. And so I think that’s a good start to how we're turning around the company and the momentum that it's created. I guess more importantly and what provides me the most optimism is really what we're doing is fulfilling the mission of revolutionizing the approach to spine surgery. And I think the launch of our Prone Transpsoas, PTP, is really a reflection of that. And I'll give you a little bit more on that to come. We're also increasing the clinical prowess, really the know-how of our sales force in expanding an exclusivity, which is exceedingly important; elevating surgeon and sales training through the state-of-the-art education facility. We just opened it up about a month ago. We have a seven-station cadaveric lab. We have an expanded biochemical lab. We have an expanded, what we call technology advancement group or machine shop. And so the facility really is starting to fit in with a very strategic priority that we've advanced. The other thing is really kind of the greenfield opportunity we have with furthering clinical sophistication through improved information with EOS. So that's very exciting to us. If you were to kind of look back, Q4 seems a long way away, but it was a good quarter. Year-over-year, U.S. revenue growth at 38%, year-over-year growth in revenue per surgeon at 15%. Clearly, there's adoption on the new product side. So 75% of our revenue is coming from new products. Year-over-year, an average revenue per case at 13%, ninth consecutive double-digit year-over-year growth. And we'll get more into this, but the average product category sold per case is increasing. As we think about the future, you’re going to hear the same thing over and over as it relates to our strategic imperatives. And our view is if you're going to make a meaning in this business, you better do something different and you better do something better. And that's what creating clinical distinction is all about, and we feel like we're making progress. Also, compelling surgeon adoption comes from being better and creating clinical distinction, and we feel like we're doing that. And that really helps us revitalize the sales channel that ultimately translates what we're doing with regard to the procedures. So just to jump right into creating clinical distinction, when you think about what the margin has been over the past few years, we've really had a reasonably good approach in terms of making sure that we're making the investments at the proper time in terms of building things. 2020 was reflective of 11 product launches. And importantly, when we think about the effect on the procedures, the return has been pretty good. If you start to look at what we call Alpha Informatix, which includes SafeOp, we have the industry's best, and not for a moment will I ever back off from saying that the new home of lateral sits at ATEC. Also, from a posterior fixation perspective, suggesting there's significant product development aptitude would be an understatement. We're also making progress in the other procedures in ALIF, PLIF, and TLIF. This year should be a significant contribution on the cervical and biologics side, as we are obviating some of the legacy products that were around when we arrived. When you consider how we think about making and where we make investments, we think through procedural means. When we think about making things better, we consider what the procedure needs and the priority regarding specific product development. We believe that, that creates value. The percentage of sales driven by our strategic channel is 95%, and the revenue growth from that strategic distribution group is 47%. The growth in U.S. revenue per distributor is significant and has been. So with that, I will turn it over to Jeff Black.

Thank you, Pat, and thank you all for joining us today. I'll just spend a few quick minutes on some color commentary on the results that we announced today. First, on revenue. Following the initial COVID impact that the industry saw in Q1 and Q2, we did see a robust recovery acceleration in our U.S. product revenue, really on the strength of our new and expanding product portfolio that Pat just walked you through. We actually finished the year ahead of our initial 2020 guidance, even though we did see some pressure on volumes in late Q4 from the uptick in COVID cases. On the international front, our international supply agreement for our legacy products is winding down as expected; that agreement expires in mid-2021. On gross margins, we're running in the high 70% range on a non-GAAP basis, which excludes noncash charges for excess and obsolescence. On a GAAP basis, we're running in the low 70%. We're stripping out excess and obsolescence for now since we've been taking outsized reserves on our legacy product inventory, representing about 800 basis points in 2019, and about 500 basis points in 2020. We will continue to see some of this drag in 2021 but expect that to be primarily behind us at the year's end. Our normalized basis expects E&O to be somewhere between 300 and 400 basis points, and our GAAP margins to be in the mid-70% range. A couple of comments on the P&L: Consistent with prior quarters, we've focused our investments on product development and sales channels. For this view, we strip out stock-based compensation, litigation, restructuring, and transaction-related costs to provide a sense of our true core investments. Looking at R&D as a percentage of revenue, it continues to track above peers as we fill the product pipeline. SG&A is a similar story—growth in SG&A represents increases in variable costs associated with the ramp in revenue as well as key investments in our strategic sales channel. As the business continues to scale, we'll need to make investments in G&A-related infrastructure. Still, we’ve held the line on G&A and are beginning to see cost leverage. In Q4, we significantly shored up the balance sheet, reduced debt, and secured capital required for continued investments in the business as well as the purchase of our pending acquisition with EOS. We secured $250 million in new capital during the fourth quarter, through public and private placements of common stock, and we're better positioned than ever from a balance sheet perspective to execute the business. Regarding our revenue guidance, we are reaffirming the guidance that was provided in Q4, aiming for $176 million in U.S. revenue, representing 25% growth driven by strong surgeon adoption and expanding strategic distribution, along with a ramp-up in new products. We are excited about the EOS transaction, which we expect to close in the second quarter. EOS reported an annual 20% year-over-year revenue increase. Recurring revenue is strong, and we believe there are significant opportunities for us to take advantage of cross-selling opportunities. With that, I'll turn it back over to Pat.

Thanks, Jeff. I got to tell you, we couldn't be more excited. We feel like we have a multi-faceted growth strategy. In the meantime, we're perpetuating clinical distinction by revolutionizing surgery. We're advancing sophistication on both the sales force front and on EOS, which will provide us more opportunities. Cervical and biologics will meaningfully start to contribute with eight to ten product launches a year. We're optimistic about compelling surgeon adoption. Headwinds reputationally and from a sales force perspective have mostly dissipated. We’re enthusiastic about the international supply agreement expiring. Watching Dr. Pimenta, who pioneered lateral surgery, recently present PTP was gratifying. Opportunity will link to the investor section of our website if you're interested in learning more about PTP. But with that, I guess we'll take questions.

Your first question comes from Brooks O'Neil from Lake Street Capital.

Great presentation, great quarter, great everything. So what I wanted to start off with is kind of a big picture question. You spine guys took over ATEC a couple of years ago, and you've done a great job with the company, and the stock has begun to respond. How would you assess where you are in your overall journey? Number one. Number two, can you point to a couple of the big things you hope to accomplish in 2021, these milestones? And then as you think about the next couple of years, what are the two or three big things you feel you need to cross over to get to the other side of the big boy/little boy picture in the spine industry?

Well, we've always felt like we are big players, so we're going to run at that. I'm just kidding, Brooks. I would tell you we're still super early in this. It was important to us that when we acquired SafeOp, it became a conduit into surgery that allows us to deliver meaningful information. Those providing mechanical devices without information will struggle. Much of the opportunity to improve lies in surgical informatics, and we are thrilled about that acquisition. It's the start of our opportunity to identify and deliver critical requirements for each procedure that leads to predictability. We expect this to continue through '21. Closing EOS is a big milestone this year. We've been developing cervical products, which will contribute nicely. Additionally, we hope to enhance sophistication relating to PTP and LTP. Overall, there's a maturation process happening in 2021 that's incredibly valuable, and long-term, there’s great opportunity. People are keen to know what the next 10 years hold, and I believe we're that company.

That's really fantastic. And then just the last thing, I think you were just talking about it, but clearly, your efforts are all about empowering spine surgeons with informatics and great tools, etc. There are people in the industry who think the right approach is to just offer up a robot and get it into the OR. Can you sort of distinguish your thrust from the robotic perspective that you see from some of the other players out there?

Completely. I genuinely have nothing against different types of technologies. However, when you start prioritizing what is going to impact a specific procedure the most, we see the development of PTP as critical. For example, assessing robot impact versus patient positioning in prone transpsoas surgery shows that it's significantly more about the positioner. Being able to identify neural elements is paramount to the outcome, and I believe our understanding should lead product development focus. My bullishness stems from that comprehension of surgical requirements.

Your next question comes from Joshua Jennings from Cowen.

Pat and Jeff, congrats on the strong end to the year and all the progress. I wanted to follow up on Brooks' question about Alpha InformatiX. SafeOp has been a huge enabler for your procedures and techniques. I imagine you aren't standing still on neuromonitoring. Anything you can share regarding how you see SafeOp evolving?

Yes. That's a great question. A lot of the core technology around SafeOp is compelling. Automating SSEPs has been revolutionary, and the speed at which we deliver information is significant. The foundational technology enables us to pick up very small signals, allowing for consistent delivery. There are many applications we can apply this technology to, such as TLIF and cervical applications. Additionally, we are studying if we can provide early alerts for issues like retraction injuries. There are numerous opportunities to utilize this technology to enhance the surgical experience.

Excellent. I noticed in the product portfolio build-out section for Alpha Informatix, you listed TrackX. Can you help us think about intraoperative imaging and its evolution and integration into your Alpha Informatix platform?

Yes. We’re huge fans of imaging technology because it enhances surgical predictability. When we think of procedures that are very predictable, implementing TrackX allows surgeons to navigate safely. Using biplane fluoroscopy creates a pathway to ensure safe corridors during surgery, similar to how modern cars alert drivers if they leave their lane. TrackX is non-exclusive to posterior applications but is exclusive to us for PTP and all anterior technologies.

I just have one more, sorry, just to sneak it in. It’s clear to us the halo effect when you launch a surgical technique like PTP creates pull-through in other procedure categories. Does a PTP customer experience the halo effect even in cervical? More directly, what percentage of your lumbar minimally invasive surgeons also perform cervical procedures?

Yes. This is an interesting business. The concept of a halo effect demonstrates that when you build confidence with surgeons, they are likely to turn to you for simpler procedures. Our goal is to develop a best-in-class cervical portfolio, which will be bolstered by the confidence established through PTP. We believe that when our technology delivers excellent outcomes, confidence in our other products, including cervical, will grow. We are excited about our cervical contributions and our upcoming launch of the InVictus OCT, combining cervical and thoracic systems.

Your next question comes from Kyle Rose from Canaccord.

You guys grew 30% this year, which is multiples above the broader market. When you talk about key products like SafeOp and PTP, these require significant surgeon training. Help us understand how you achieved this growth despite the effort needed for the new product launches, and how does this position you going into 2021?

What we saw in 2020 was really the initial entry into these new technologies. Our alpha evaluation for PTP was robust, and the impact on price per surgery was significant given the number of product categories involved. We see cumulative revenue growth as a result of the volume of cases. The awareness around our technology is growing, attracting experienced sales groups and inspired surgeons, leading to successful experiences with our technology, which fuels our growth potential. Jeff, would you like to add anything?

I think there are multiple growth drivers at play, which may seem hard to pin down. Certainly, PTP expansion is significant, but it's coming from an existing surgeon base using our products. While we are also expanding geographically, we are digging deeper into existing geographies to leverage growth.

I'm looking to understand the growth in the latter half of the year as we progress through 2021. You mentioned a 25% growth year-over-year. With significant comps in the second half of the year, how should we perceive revenue progression, factoring in any ongoing COVID impacts?

We experienced some lumpiness near the end of the year and into the beginning of this year, but we believe that uncertainty is dissipating. Confidence in surgical delivery is returning. The dynamics of what we see and what they see in terms of lumpiness are not very different.

Our next question comes from Matthew O'Brien from Piper Sandler.

To follow up on your growth guidance of 25%, given the strong performance in 2020, you anticipate a deceleration from the previous 30%—is the current approach to be conservative, or are there indications of slowing growth opportunities in lumbar as you branch into cervical?

The thoracolumbar market isn't slowing down. There is lumpiness out there, and given the pandemic’s effects, it's prudent to be cautious. We're enthusiastic about our growth outlook without getting ahead of ourselves.

You have a bigger player spinning off their spinal and dental businesses. While you don't have dental, how can you make a push into their accounts? Additionally, what is your strategy regarding national accounts?

Disruption excites us. Many leaders don’t like spine due to unfamiliarity, creating opportunity for us. We see immense potential in this area. If others wish to spin off their spine divisions, we're ready for it. Regarding national accounts, we've gained entry to numerous IDNs because of our unique product offerings, enabling us to expand our footprint effectively.

Your next question comes from Mathew Blackman from Stifel.

Can you provide more insights on the PTP rollout and surgeon adoption metrics? Has the rollout faced challenges due to the COVID resurgence, affecting your training processes?

The PTP rollout has seen a good reception from surgeons familiar with lateral surgery. The rollout has been smooth as we target both experienced lateral surgeons and those transitioning from posterior approaches. Our aim is to attract a broader range of surgeons while leveraging the confidence from recognized figures in the field.

Considering growth drivers in 2021, can you indicate if there are any shifting trends in relevance of U.S. geographic expansion versus product per procedure or channel productivity?

They are all equally important. Our focus begins with clinical distinction that drives surgeon compelling reasons to adopt, which enhances sales productivity. Success breeds success, and that order consistently guides our strategy. I don’t view the importance of growth drivers any differently than our established approach.

The average product categories per case have room to grow and remain key growth leverage based on our current position. We’re just getting started with expanding both product offerings and geographical reach.

Thinking longer-term, considering your success in 2020 and plans for EOS, can you discuss the sustainable growth rate for Alphatec looking ahead to 2022 and beyond?

We feel we are in the early innings. Though we’re a smaller company numerically, we’re executing at a big level. There is significant runway ahead of us. Our focus will be year-by-year, ensuring we steer clear of becoming overconfident. The pandemic was a reflection of staying grounded, and we intend to maintain that focus while pursuing growth.

Your next question comes from Jason Wittes from Northland.

You mentioned COVID hit, but it seemed indiscernible. Is that a fair understanding? Into 2021, might we see some impacts, but overall stability?

Yes. It’s been lumpy at year-end and beginning of this year we’re seeing similar dynamics to what others report. All levels of decisions varying per region complicate prognostications. Nonetheless, we expect clarity moving forward with improving conditions.

Regarding TrackX, can you clarify its primary role in enhancing navigation strategies and whether its relationship is exclusive?

Yes. Workflow integration is critical, and TrackX aids significantly in that process. It can be updated quickly without needing to redo every setup. TrackX is exclusive concerning PTP, but not for posterior applications, allowing us unique advancements for our anterior technologies.

Regarding EOS, what does integration look like from day one to a full year later? What milestones do you anticipate over five years?

We'll work on integration strategically from the outset, aiming for alignment in sales synergies. The main goal is timely integration of sales processes and surgical support once the acquisition solidifies. The initial focus is equipping surgical planning on our Alpha Informatix platform for seamless enhancement in surgery.

Your next question comes from Sean Lee from H.C. Wainwright.

You mentioned an increasing number of products per procedure and exclusive distributors as key growth drivers. Which product categories do you think need the most new additions? Where do you foresee the greatest potential?

That's a great question. We focus on exclusivity; we earn it. Looking at lateral surgery, we envision up to nine different product categories associated with these procedures, and that’s where we can really distinguish ourselves. The halo effect from PTP also lifts our cervical offerings. These product expansions become vital.

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