Alphatec Holdings, Inc. Q3 FY2021 Earnings Call

Good afternoon, everyone, and welcome to the webcast of ATEC's Third Quarter 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. Reconciliations of non-GAAP measures to U.S. GAAP can be found in the supplemental financial tables included in the press release, which identify and quantify all excluded items and provide management's view of why this information is useful to investors. Leading today's call will be ATEC's Chairman and CEO, Pat Miles; and CFO, Todd Koning. Now, I will turn the call over to Pat Miles.

Thank you very much, Ella, and welcome to the Q3 2021 conference call. We will be sharing some forward-looking statements, so please review them at your convenience. Let's walk through some slides and discuss the Q3 2021 results. The revenue for Q3 2021 was $63 million, reflecting a 53% year-over-year growth, with EOS contributing $11 million. This underscores our unique position for sustained industry-leading long-term growth. There are exciting drivers behind this, especially with PTP. Our ability to expand into the lateral market is evident. We’re improving, and our clinical capability is increasing in the U.S. distribution area. Establishing the foundation and highlighting the value of the EOS information is beneficial for us. Building confidence is creating a halo effect that is boosting the adoption of our entire portfolio. We are also starting to establish a foundation for expansion in the international marketplace. Reviewing the scorecard, the year-over-year revenue growth in a declining market was 29%. We are attracting surgeons, evidenced by a 20% year-over-year growth in surgeon users. However, the year-over-year growth in average revenue per case has been somewhat restrained due to pandemic flare-ups and staffing challenges, which have impacted our ability to conduct more complex procedures. Nonetheless, the adoption of our new products remains strong, which is promising for future growth. The blended average product categories per surgery stands at 2.0 and continues to rise. This marks our 12th consecutive quarter of double-digit year-over-year revenue growth, with 10 of the last 11 quarters surpassing 20%. Importantly, ATEC has achieved the highest organic U.S. growth of any public spine company in every quarter since 2018. Our dedication to innovation and future product development, along with advancing our information-based core competencies, creates clinical differentiation that encourages surgeon adoption. This is why we see significant opportunities for expanding our sales footprint and attracting top clinically skilled salespeople.

Thanks, Pat, and good afternoon, everybody. Thank you for joining us today. I'll begin with revenue. Third quarter total revenue was $63 million, reflecting 53% growth over the prior year and 1% growth compared to the second quarter. Our $63 million in revenue is comprised of $52 million in organic revenue, $11 million in the EOS contribution, and $100,000 of revenue related to our international distribution agreement. Organic revenue of $52 million grew 29% compared to the prior year period and was down 7% sequentially. We estimated the negative impact of COVID-19 resurgence and hospital labor shortages to be approximately $4 million of revenue for the third quarter. Despite those headwinds, our third quarter organic revenue growth outpaced the overall market, with revenue from lateral procedures contributing 50% to that growth, driven by the expansion of our market share. Year-over-year volume growth of 22% was evident due to the continued expansion of surgeon adoption. ASP grew 6% year-over-year, reflecting the impact of fewer complex procedures favoring outpatient settings, which generally require fewer categories per case and generate lower revenue. In the third quarter, we recognized $11 million in EOS-related revenue, up $5 million compared to the second quarter. The timing of EOS replacements drove a better-than-anticipated revenue result. Our gross margin was 72% in the third quarter, down 490 basis points year-over-year due to the consolidation of EOS. Operating expenses reflect our continued investments to fuel long-term industry-leading growth.

Thanks, Todd. Our strategy is about evolving the clinical experience. We believe that good medicine is good business. Through this, we will earn our place in the market. Clearly, the enthusiasm we see around PTP, the addition of EOS, and the continued growth from our entire portfolio assures us that we are setting the stage for sustainable, multifaceted industry-leading growth. We have only just started this process, and we look forward to continuing to evolve the field of spine. With that, we will take questions.

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

Congratulations on sort of powering through the disruption of COVID.

Thanks, Brooks.

I have 1 primary question. I had the good fortune to come visit your headquarters and trading facility in San Diego recently. Can you just talk a little bit about how that integrates with the effort to proceduralize, and sell platform opportunities into the spine market going forward?

Yes, Brooks, thanks for the question. The whole opportunity to demonstrate how to further the field of clinical spine care is about allowing surgeons to physically engage with all our products, simulating the experience as closely to an OR as possible. We provide them with hands-on opportunities to understand the value of each of the individual components that contribute to sophisticated procedures. This offers a robust interest for surgeons in PTP, as they recognize the clinical application of our specific procedures. This enables a strong conversion and trust in our offerings.

I could just say, I was blown away when I saw it. I'm sure everybody else is too. So that's great.

Next question comes from the line of Mathew Blackman from Stifel.

Just to start, I'm curious about the mix headwinds from complex procedure deferrals. Any way to reflect back over the course of the pandemic using 4Q '20 and 1Q '21 as a proxy? How quickly do complex procedures typically come back? Do they generally come back faster or slower than more traditional procedures? Any thoughts there?

Okay. I'll let Todd quantify things because I'll certainly screw that up. But generally, patients that need immediate surgical intervention for claudication will get operated on sooner. Complex procedures can typically be deferred longer since they are not always as urgent. In areas where the pandemic had a resurgence, we saw a decline in volumes and complexity due to staffing shortages and the nature of emergent cases. COVID and staffing will continue to impact our business, but our volume of new surgeons is promising.

Yes, I think I'd add to that, Pat. Certainly, when you looked at the mix of procedures, and kind of how they grew year-over-year, we noticed stronger growth in cervical relative to the other contributors, indicating a lower-risk environment for those procedures. We expect volumes to improve moving into Q4, with the anticipation of a more favorable operating environment.

Importantly, seeing a 20% increase in the volume of new surgeons, coupled with only a 6% ASP increase reminds us that we're experiencing more revenue from less complex procedures. It's essential to understand these business dynamics as they drive our growth.

Great. I appreciate it. And then maybe just some updates on the channel, new reps, exclusive reps, new distributors, new U.S. geographies. Curious if EOS is helping you attract any more higher-performing distributors or sales reps due to the pull-through opportunities?

Yes. We're really focused on strengthening our presence in key metropolitan areas and attracting experienced recruits who are keen on evolving the field. EOS has been a significant driver of interest among high-performing professionals, especially as they recognize the momentum we’re gaining, and the dedication we have to improving surgery, which creates a competitive moat for us.

Next question comes from the line of Jason Wittes from Loop Capital.

Just a quick clarification. In terms of your fourth-quarter outlook, I assume there's still some COVID impact, but do you think volumes will return to more normalized levels by year-end?

Yes, Jason. To provide context, while COVID still presents challenges in specific regions, overall, we're seeing improvement. Our October average daily sales exceeded those of the second quarter, indicating signs of a recovery. We expect a continuation of the upward trend in volumes, supported by seasonal demand as we approach year-end.

Okay. That’s helpful. And lastly, regarding the PTP program, are you seeing a mix of lateral surgeons and traditionally non-lateral surgeons becoming interested in this approach?

Absolutely, Jason. Initially, we questioned whether we would only attract lateral surgeons, but we are successfully drawing in traditionally posterior surgeons as well. PTP offers them the option for direct decompression, which appeals to their perspective. This allows us to expand our access significantly in the market.

Yes, we are beginning to see some shifts in conversion patterns among the newer user demographics, which will bolster our future growth.

Next question comes from the line of David Saxon from Needham and Company.

Can you share your takeaways from NASS and detail what other products were getting attention from doctors?

This year's conference was pivotal for us. Surgeons were incredibly impressed by our EOS technology and other advanced offerings. Our comprehensive product portfolio demonstrates a level of sophistication that captivates them. For instance, innovations like our pedicle screw and modular devices attracted significant interest.

It’s essential to showcase our complete product suite because several of our innovations complement each other to enhance procedural efficiency and outcomes.

Next question comes from the line of Kyle Rose from Canaccord.

Impressive growth, particularly in the lateral segment, which accounts for 50% of the organic growth this quarter. Can you elaborate on how significant the lateral market opportunity is for you moving forward?

While I’m hesitant to assign a specific numeric projection to the lateral growth opportunity, we are seeing very promising early adoption, indicating significant potential. Complex procedures are starting to see remarkable integration with the PTP approach, reflecting both our strength in adoption and market potential for continued expansion.

As we begin looking to 2022, we anticipate that our growth trajectory will remain strong, even amidst tougher COVID comps.

Next, we have no further questions at this time. This concludes today's call. You may now disconnect.