Alphatec Holdings, Inc. Q2 FY2022 Earnings Call

Good afternoon, everyone, and welcome to the webcast of ATEC's Second 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. Please go ahead.

Thanks, Audra, and welcome to the Q2 2022 financial results call. There will be some forward-looking statements. If you review that at your leisure, we will be providing a forward view. I'd say we finished a very good second quarter with a total revenue of $84 million, reflecting 35% growth year-over-year. The procedural investment thesis is working, and we're aiming for positive adjusted EBITDA in 2023 by training surgeons on PTP. There is significant demand, and we believe PTP represents the future of lateral surgery. We're broadening our indications through new product launches that showcase our competitive advantage based on clinical publications, while also expanding our hospital access. We want to clarify our approach to the procedural investment thesis, aligning with surgeons' perspectives. Surgeons don't just focus on implants or widgets, as those are merely business currencies; instead, they prioritize patient treatment and procedure effectiveness based on specific pathologies and patient needs. Many companies discuss procedures but often limit their focus to implant and retractor design, whereas we concentrate on crafting procedures to meet unique requirements for each surgical approach. For example, a comprehensive automated neurophysiology system like SafeOp, a patient positioner, and a specially designed retractor are essential for effective prone lateral surgery. Additionally, our investment in imaging technology helps surgeons better comprehend unique patient needs, thereby increasing predictability. The main challenge in spine surgery lies in managing numerous variables. Surgeons prefer ATEC because we develop thorough procedures that minimize clinical variability. We believe our growth is sustainable because surgeons recognize our commitment to delivering clinical predictability. Predictability arises from effective planning and execution, which is supported by literature. Surgical planning is critical and encompasses much more than merely determining screw trajectories; it involves selecting the right patients and achieving the surgery's goals of decompression, stabilization, and alignment. Surgeons need to consider factors like bone quality when stabilizing a patient, and EOS can provide that information. Standardized imaging, such as standing weight-bearing full-body images, is essential for the planning process, as it allows surgeons to observe compensatory behaviors in patients. Other companies may not be investing in these diagnostics, which can hinder the establishment of comprehensive plans. Over time, predictive analytics will help us grasp reciprocal changes in spine mechanics due to surgical interventions. Currently, many surgeons lack that understanding. Our objective imaging data will enable surgeons to make informed decisions, which we believe is significant. By merging detailed surgical planning with comprehensive procedures, we enhance predictability. We are confident that our uniquely designed solutions, coupled with computer-assisted tools that integrate multiple parameters and learn from experiences, will transform traditional treatment methods. Changing topics, I want to ensure everyone understands our commitment to surgical planning at a depth that surpasses that of our competitors. Now, let’s review our organic scorecard for Q2 of 2022, which validates our approach. We achieved year-over-year organic revenue growth of 30%, marking our 13th consecutive quarter above 20% growth, excluding the Q2 pandemic quarter in 2020. We also witnessed a 17% increase in procedure volume and a 23% rise in surgeon users. There's a 10% growth in average revenue per case, indicating that we're seeing more products utilized per case, averaging 2.2, which is an upward trend. Our commitments haven't changed. We are focused on creating clinical distinction, revolutionizing spine surgery, and enhancing our information-based advantage. We will continue to encourage surgeon adoption, expand procedure utilization, and foster loyalty by improving clinical predictability. Our sales team is actively enhancing their capabilities, leveraging investments to boost clinical skills across our operations. Let's look at some achievements in clinical distinction. Our market share is approximately 2.5%, meaning we have 97.5% of the market left to capture. We've launched four products and are on track to introduce 8 to 10 annually. The EOS pipeline has grown by 40% since the acquisition, with lateral surgery being the largest growth driver. We had a record number of surgeon visits in Q2 due to interest in PTP. Our surgeons, including Dr. Pimenta and the PTP team, have popularized this surgery; many are keen to learn from their expertise. We hosted over 65 surgeons at a PTP Summit, in addition to more than 150 who trained in PTP this quarter. Our surgeon education efforts are robust. We are excited to apply our learnings from PTP to enhance our Lateral Transpsoas Surgery. We're also witnessing increased utilization in complex surgeries, supported by 19 peer-reviewed publications that affirm our clinical perspective on PTP. One publication studied SSEP monitoring for femoral nerve health during PTP, demonstrating the necessity of developing technology to mitigate documented risks in lateral surgery. Proceduralization is foundational; it’s more than just an implant or retractor; it's about technology that aids surgeons. The study showed SafeOp automated SSEP allows for real-time actionable nerve health monitoring. Historically, capturing SSEPs has been challenging due to their small signals. SafeOp amplifies these signals, delivering real-time information through a moving average, thus enhancing surgical safety. Moving on to the EOS scorecard, I still haven't met a surgeon who doesn’t want EOS. It’s fulfilling its intended role of providing cross-selling opportunities and hospital access. Q2 revenue for EOS totaled $12 million, with pro forma growth around 49%. About 450 EOS units are installed, with a 40% growth in the pipeline since the acquisition, marking the highest unit orders post-acquisition. EOS will continue to strengthen our information-based competitive edge. Just yesterday, I met with our marketing and engineering teams, who shared exciting imaging developments from our portal. It’s thrilling to witness the progress of our informatics system with live imaging—its operational and economic potential is clear, and we’re enthusiastic about our EOS initiatives. Our second commitment is to facilitate surgeon adoption, and that’s evidently in progress. We experienced a 23% increase in surgeon users year-over-year, with more than 150 attending our training events and a 10% rise in average revenue per case, indicating more product diversity per surgery. This reflects our clinical thesis, with an increasing number of products utilized per surgery. PTP continues to lead this growth. Lastly, our sales force strategy has evolved. While some businesses expand by adding distributors, we are simultaneously increasing revenue in established territories, achieving a year-over-year growth rate of 25%. This emphasizes that our efforts resonate with our stakeholders. We’re not just growing through broader business strategies but also adding new distributors. Currently, 34% of our territories exceed $5 million in revenue. Our earlier ambition of reaching $200 million involved approximately 50 agents each doing $4 million, and we have exceeded that projection. We are effectively driving adoption and can demonstrate strong momentum. We also observe increases in average case revenue, which signifies the growing confidence within our approach. Our focus on clinical proficiency is yielding positive results, and our footprint has room for additional growth. We see substantial opportunities ahead. With that, I will turn it over to Todd.

Well, thank you, Pat, and good afternoon, everyone. So I'll begin with revenue. Second quarter revenue was $84 million, reflecting 35% growth over the prior year and a 19% improvement compared to the first quarter of 2022. The $84 million in revenue is comprised of $72 million in organic revenue and $12 million of EOS-related revenue. Second quarter organic revenue of $72 million increased 30% compared to the prior year, which is probably our most difficult quarterly comp given the very strong performance in Q2 of 2021. Year-over-year volume growth of 17% was driven by the continued expansion of surgeon adoption with surgeon users increasing 23% compared to last year. Much of that growth is coming from established sales agencies, with at least one year of tenure. That cohort achieved 25% growth in the quarter, demonstrating durable sales growth from our most tenured agents. Average revenue per case expanded 10% year-over-year as revenue mix continues to shift toward procedures that feature more products per case and procedures with greater complexity. Strength was portfolio-wide, with lateral biologics and ALIF all contributing significantly to the growth this quarter. EOS deliveries in that quarter were solid, driving $12 million in EOS-related revenue and growing 93% compared to the Q2 of 2021 and on a pro forma basis, growing 49%. As a reminder, the transaction closed in May of last year and we've continued to make progress with the integration, showing strong revenue, achieved the highest number of orders in any quarter, and are seeing improvements in the time required to install new orders. Continuing through the remainder of the P&L, second quarter non-GAAP gross margin was 70%. Down 320 basis points compared to the prior year, just under half of the year-over-year decline or about 150 basis points in gross margin was mix related due to the consolidation of EOS Imaging, which had a lower gross margin profile than our spinal implant business. Second is an increase in biologics revenue mix as we are seeing biologics attach rate increase significantly. Biologics come at a meaningfully lower margin profile in overall business, and this contributing about 80 bps of pressure year-over-year. Finally, increased EOS service costs as we address the backlog of service calls created during the COVID-19 pandemic contributing about 40 basis points of pressure. Our expectation is that the margin headwinds outlined above will persist through the back half of the year. Operating expense in the second quarter demonstrated leverage while continuing to thoughtfully invest in long-term, sector-leading growth. Second quarter non-GAAP R&D was $9 million and approximately 11% of sales, 50 basis points lower than prior year. The increase on an absolute dollar basis was driven by continued investment to support organic portfolio expansion and the advancement of the EOS platform. Non-GAAP SG&A was $65 million and approximately 78% of sales in the second quarter compared to $50 million and approximately 80% of sales in the prior year period. This reflects continued investments in the expansion and training of the ATEC sales network, surgeon education and support for the increasing size and sophistication of the company. We delivered 260 basis points of improvement on a percent of sales basis. This speaks to the leverage we have begun to deliver as our business scales. Total non-GAAP operating expense amounted to $75 million and approximately 89% of the sales in the second quarter compared to $57 million and 92% of sales in the prior year period, delivering a total of 320 basis points of operating leverage year-over-year. I'd also like to highlight the fact that we delivered 910 basis points of leverage sequentially. Adjusted EBITDA was a loss of $8 million and approximately 10% of sales in the second quarter compared to a $7 million loss and 11% of sales in the prior year period, an improvement of 80 basis points as a percent of sales. Sequentially, we saw $3 million or 570 basis points of improvement driven by 910 basis points of operating leverage, partially offset by gross margin. As sales growth drives leverage across our business, we continue to expect adjusted EBITDA for the full year 2022 to improve approximately 400 basis points as a percent of sales relative to the 12% we saw in 2021. Now to the balance sheet. We ended the second quarter with $107 million in cash. Operating cash use was $40 million, which was consistent with previous quarters and was predominantly related to investments in inventory and instruments to support our expanding distribution footprint and new product launches. Included in Q2 operating cash was approximately $10 million in one-time legal spend, which if excluded, would bring cash use to approximately $30 million. During the quarter, we settled two lawsuits, including the patent lawsuit originally filed by NuVasive in early 2018. While the specific terms of each settlement are confidential, they are fully resolved multiple future royalty obligations. We are pleased to have put both disputes behind us. With asset leverage and a more favorable full year adjusted EBITDA, we expect cash use this year to meaningfully improve relative to last year, consistent with our long-term plan. Debt at carrying value is $336 million, which includes $316 million of convertible debt. We also recently signed a term sheet for a $15 million revolver with a $25 million accordion feature, which coupled with convertible debt offering placed last year will support our baseline investment plans toward cash flow breakeven in 2025. We expect to have the revolver in place by the end of this quarter. Our outlook for the full year 2022, we now expect full year 2022 will approximate $325 million, representing growth of 34% compared to 2021. We now expect full year 2022 organic revenue to approximate $277 million compared to $269 million previously. Updated expectations for growth of 31% compared to 2021 contemplate the strength of performance in the first half and the momentum with which we have entered the third quarter. We now expect related revenue of approximately $48 million for the full year 2022 compared to $47 million previously. Updated guidance for EOS reflects the strong execution-driven Q2 results. So let me frame up updated ATEC organic revenue guidance with our expectations for procedure volume growth and the expansion of average revenue per surgery. We are raising full year organic revenue guidance due to increased expectations for volume growth, which is driven by expanding surgeon adoption and increasing geographic penetration. We've achieved solid momentum in procedure volumes in the first half of 2022, including 17% in the second quarter. As a result, we now expect procedure volumes to grow at a high teens rate for the full year compared to the mid-teens percent rate we anticipated previously. Average revenue per surgery grows as our procedural mix shift toward procedures like PTP and LTP, which have higher revenue per procedure than our overall average. Our procedural solutions are also being utilized in surgeries with greater complexity, which require more products per surgery and in turn generate higher average selling prices (ASPs). Finally, the level of distinction engineered into ATEC approaches and the cadence of new product launches generally enable us to command a price premium, and we continue to anticipate a high single-digit percent rate of expansion for the full year. As most of you know, our guidance philosophy is to be thoughtful and prudent about how we set expectations by putting numbers out there that we believe we can achieve and have a reasonable opportunity to exceed. In closing, we have built a business capable of driving sustained sector-leading growth, with scale that revenue growth affords is shifting ATEC toward a new phase of business growth, a phase characterized by consistent operating leverage improvement and ultimately, an inflection to free cash flow generation. Our procedural investment thesis is earning surgeon confidence and enabling us to methodically execute to plan. We know that through continued solid financial performance, we are earning your confidence too. We have an active IR calendar over the next few months, including the NASS conference, and I hope to be able to connect with you. With that, I'll turn the call back over to Pat.

Thank you, Todd. What we are focusing on is our share earnings strategy, which involves several key aspects. PTP is gaining market share, including attracting traditional lateral surgeons and those specializing in TLIF and PLIF procedures, who have previously utilized a posterior approach. We're also seeing success with more complex cases, and the use of our solutions in ambulatory surgery centers is growing. This success is having a positive impact across our entire portfolio. Our sales channel is improving, which enhances our confidence in capturing more market share. We are exploring opportunities in international markets in a targeted manner as previously discussed. We aim to leverage the $2 billion EOS opportunity and are working on creating predictability through our planning efforts. We are excited about having access to vital information that will enhance surgical outcomes, which we believe will lead to greater consistency in our performance. Our goal, as highlighted at our Investor Day, is to reach $555 million by 2025, reflecting a 23% compound annual growth rate and achieving $80 million in adjusted EBITDA breakeven this year, while maintaining disciplined investments to ensure cash flow breakeven without additional dilutive capital. This is an exciting opportunity for us to address the significant need for predictability and reproducibility in spine surgery, which is often challenged by numerous variables. We understand that spine surgery requires ATEC's solutions. Now, we are open to questions.

And we'll go first to Josh Jennings at Cowen.

This is Eric on for Josh. I appreciate all the details you guys shared around volume growth expectations for the remainder of the year. I was just wondering if you could help us understand the recent procedure volume trends that you've observed to date that underpin those assumptions. What sort of month-to-month or month-over-month improvement have you seen through June, July and now into August?

When you examine our volume growth, which was 17% this quarter, I won't delve into the specifics of month-to-month changes. However, I can confirm that we entered the third quarter with the same momentum we experienced in the second quarter. There was definitely an improvement from Q1 to Q2 in terms of volume growth. The year-over-year volume growth has remained robust, and it’s on this basis that we raised our guidance, primarily due to the increased unit volume growth.

We'll go next to Mathew Blackman at Stifel.

This is Colin on for Matt. Just one on EOS. Appreciating the pressures hospitals are facing given the challenging CapEx backdrop, could you walk us through how these dynamics really affected EOS placements in the quarter and how that factors into the raised EOS guidance as well?

I'll let Todd take the guidance one, but we're so early in the whole EOS opportunity of worldwide hospital interest and there's so many different ways to acquire this system. I don't candidly see, right now, a huge headwind. And we're such a small player and the volume of units we need to place to be relevant is such that we're not kind of as appreciative of the macro dynamics. That being said, I think people hold onto cash. But again, I think what we're doing is our ability to gain access to an institution with regard to ways to rebate against implant provides hospitals access to the technology while perpetuating a relatively easy entry point to adoption. And so that's kind of how we see it from kind of an operational perspective, but I'll pass it on to Todd for a financial view.

Completely. And Colin, I think what we saw was a significant number of orders in the quarter that were a record. So I guess we didn't really see a headwind from that perspective. And so I think we're very pleased with where we're at in terms of the number of orders in the period. And as it relates to the guidance, really, what we did was we kind of dropped the beat and held the second half on EOS. Overall guidance was raised by $9 million. We beat by about $6 million in the quarter, with $5 million of that being in organic and $1 million of that being in EOS. And so we've really raised in the second half, $3 million organic. And so that's really how you should kind of read through our guidance and the performance in the quarter.

We'll take our next question from Gibran Ahmed at Canaccord.

This is Gibran on for Kyle. Maybe just to dig in a little bit further on EOS. Just curious in terms of what you're seeing between a purchase and an earnout dynamic if you're relatively sort of agnostic to the two. And then secondarily, with the broadened hospital access, just how deep is some of that cross-sell and pull-through opportunity in these early innings? Maybe just trying to get a sense of, obviously, the opportunity is quite wide, but how deep are you getting at some of these initial accounts and initial setups?

It's still early in the process. Most of our sales right now are direct purchases. Interestingly, we're also making sales in private surgeon offices and groups. We've established a use-based rebate agreement with Texas Back, and the volume is meeting our expectations. We're open to various approaches. It's important to note that this is just the beginning. In this quarter, we saw key players like Real Cornell and OrthoIndy, with OrthoIndy being an excellent example of a facility that can benefit from both spine and total joint solutions. Hogue in Southern California is another example. These locations represent a significant opportunity, especially considering our past challenges in gaining access to certain institutions due to previous setbacks. So, I wanted to provide that additional context.

Yes. And I think I'd add to that. Over time, we'll be able to measure after you place these units. We can measure the impact on increased volume from places where we hadn't been. That will kind of happen after we place the unit. But what's nice to know is that the leading indicator here is that these units we're getting orders for where we don't have access with the order, we're getting the access. And that's the leading indicator in why we have confidence that the value thesis is manifesting itself.

And we'll go next to David Saxon at Needham and Company.

This is Joseph on for David. Just wondering if you guys could give us the cadence into next year for cash burn and potential EBITDA breakeven next year.

I think as we laid out in our Investor Day in May 2023 is expected to be cash flow breakeven and 2023's adjusted EBITDA breakeven. 2023's cash burn will be certainly lower than this year. I think we're a bit early to put a number on it, but we're certainly going to improve. The key here is getting our adjusted EBITDA improving and breaking even next year. What gives me confidence is our sequential improvement here in the second quarter, where we saw a pretty significant improvement both in dollars but in terms of the percentage leverage that we saw from Q1 to Q2 and our confidence in the ability to see continued improvements throughout the year to achieve really the commitments that we laid out from a long-term plan standpoint. I view our second quarter performance here as completely consistent with our expectations relative to what we laid out in our long-term plan.

And we'll go next to Amit Hazan at Goldman Sachs.

This is Phil standing in for Amit. I have an overarching question. I know you are still developing in many of your accounts, but staffing challenges and COVID-related issues have significantly impacted many more established companies. I’m curious about your perspective on the current environment. Do you think you would be experiencing faster growth if conditions were more favorable, potentially allowing for greater growth at the top end?

It's kind of interesting. I don't think the environment that we participate in is any different than anybody else. I don't care how big the company is. There still tend to be the ebbs and flows. I think the difference is there's a share-taking dynamic going on that is very apparent. What we're doing is we're growing through it. I think that your point is the right one, which is we'd be growing faster if there was more predictability associated with the environment that we're participating in. But everybody has got the same dynamics.

And we'll go next to Phillip Dantoin of Piper Sandler.

This is Phil on for Matt. Just to ask a quick one. Is there any update on the OUS front following your first PTP in New Zealand in the first quarter?

Thanks, Phil. As you appreciate, this is a one by one by one by one business. We celebrated our PTP in New Zealand. Not much of an update. We have like a great team in place in Australia and we're not in yet, but the Australia, New Zealand team is really kind of outstanding. We have a very high class opportunity in those two places. We can't wait to be able to get into Japan here in the coming years, probably '24 is what we're looking at. Then you have maybe the U.K. and maybe Brazil, but we're going to stay narrow and deep. There's really not a heck of a lot to communicate. We're still just getting going down there and clearly a fair amount of ebbs and flows in that part of the world, but hugely excited about what's going on. We have the right leadership in place here and down there for the opportunity.

And we'll go to Amit Hazan at Goldman Sachs.

It's Phil. Thanks for taking the follow-up. I don't believe I heard during the gross margin commentary, a comment on inflationary pressures and input, kind of product costs. I was just wondering if that's something that you're seeing, especially peak resin prices up so much, if you're having any difficulty with availability or costs are notably elevated.

Yes, we are not experiencing any issues with availability. However, there is some cost pressure that we are facing. When I consider the major factors, those are the significant items we've encountered, but we are not exempt from the cost pressures that others are experiencing due to inflation. We are addressing these challenges. What sets us apart is that we are growing despite these issues, which benefits us overall. Nevertheless, the pressures are present, and we are actively working to manage them.

And that does conclude today's question-and-answer session and today's webcast. Thank you for your participation. You may now disconnect.