Earnings Call Transcript - ATEC Q1 2023

Operator, Operator

Good afternoon, everyone. And welcome to the webcast of ATEC’s First 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 non-GAAP, pro forma or adjusted measures. Reconciliations of non-GAAP measures to U.S. GAAP can be found in the supplemental financial tables included in today’s 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.

Pat Miles, CEO

Thanks very much, Audra. And welcome, everybody, to the Q1 2023 financial results for ATEC. I am going to be providing some forward-looking statements, so please read at your leisure. The momentum for the company is exceedingly strong and I am very pleased to report Q1 2023 revenue at $109 million, which is a 54% growth, 40% surgical volume growth and adjusted EBITDA margin improvement of 1,080 basis points. Some recent highlights: extended momentum of PTPs was the strongest contributor to Q1 growth. We fully launched LTP and we will go into that in more detail, which is very exciting. We introduced Invictus direct Vitera rotation AIS system, which I will elaborate on as well, and it drove $15 million in EOS revenue. Additionally, we acquired the navigational robotics platform to enhance the precision of our procedural strategy, so there are a lot of good things happening and a lot of momentum. When you look back at the momentum, you can trace it back to our established commitments all the way back to 2018, aimed at creating clinical distinction. If we are not doing something better, we cannot compel surgeon adoption. Without compelling adoption, it would be very difficult to garner the type of distribution we desire. So when we talk about clinical distinction, the momentum indicates that we are compelling adoption. Building procedures from the ground up and furthering procedural momentum can be seen in the case of PTP and LTP, alongside elements like the patient positioners and the retractors. We are also thrilled to add the navigation-enabled robotics component. This overall vision of distinction in how we create it is starting to be reflected procedurally. While we still have more to do in terms of reflecting the EOS piece, we are genuinely excited about the influence this innovation is having on idiopathic and adult deformity cases. A deeply familiar area for us is lateral surgery. Considering sophistication being demonstrated through multiple distinctions of the same topic, I would say that lateral is a profound competency for us. We talk about designing procedures from the ground up, and I can’t express how excited we are about our approach with the lateral LTP TransFills. The market has certainly seen a swing back to ALIF, where surgeons desire to perform a conventional midline ALIF, and the beauty of this procedure is that it allows for ALIF at a position of great familiarity. The most commonly treated levels are L3 to S1, and we aim to have a solution for lateral approach surgery. LTP is a reflection of all our internal know-how, and we can't be more enthusiastic about it. It enhances economic efficiency, as turning the room over can lead to significant cost savings, allowing us to avoid the expenses associated with disposables in surgeries. The economics, ergonomics, and optionality that this provides are exceedingly valuable. We also have the opportunity to integrate experiences from patient positioners alongside our successful SafeOp efforts. Our procedural momentum is superb overall. Although our run with EOS is ahead, we're focused on creating the same type of successful procedural momentum for areas like AIS. We launched the Invictus DVR direct Vitera rotation instrumentation, and while this instrumentation has been launched, we are eager to discuss how we will influence a somewhat mature market. With the Alpha Informatix platform, we are employing EOS to automate measurements. When a patient undergoes automated measurements and preoperative planning, and they have a rotational deformity, when a patient is derotated, the surgeon will ultimately use SafeOp for neural monitoring, providing them with confidence regarding the surgical process. Thus, we see how SafeOp offers influence during surgeries. Furthermore, we will offer intraoperative assessments in 2024. This integration allows us to take EOS data preoperatively so we can understand precisely what to expect in the surgery, providing numerous opportunities to expand proceduralization beyond lateral surgeries to increase strength and effectiveness within AIS. A crucial element we often like to underline is how spine surgeries are commoditized, contrasted with how inflation affects spine surgeries as they pertain to implants or screws. The revision rate for total knee surgeries over five years is about 3%, while for total hip replacements it's around 5% in ten years. In contrast, spine surgery revision rates for degenerative surgery can be between 10% and 15% within one to three years, and for adult deformity, it could escalate to 25% to 30% in two to five years. It's fascinating to observe that while spine surgery is perceived as commoditized, there's so much more work to make these procedures better. Our commitment involves mitigating surgical variables, which does not equate to merely using more screws, but rather, incorporating more information to expand the impact of EOS. Developing and integrating our spinal information-based variable mitigation system has been a priority through EOS. Understanding the preoperative phase will significantly evolve with EOS automation. The old days of surgeons manually measuring various parameters will be replaced through automation, hence streamlining surgical planning and diagnostics. We also foresee bringing our advancements into the operating theatre to understand the changes relating to specific patient rods, assessing patient bone quality. We’ll utilize interoperative reconciliations to ensure that we meet our surgical plans and perform consistent follow-ups. Our efforts in this regard aim to create predictive analytics that enhance overall predictability. Our variable mitigation doesn’t end at EOS; we strive to interoperate more sophisticatedly, ensuring we become more precise, which makes our investment in the Fusion Robotics platform incredibly exciting. Our intention is to enhance procedural predictability and efficiency while simultaneously reducing radiation exposure. The integration of robotics, navigation, and neurophysiological monitoring offers unprecedented opportunities in precision. Implementing a navigation-enabled robotics platform will allow real-time monitoring of retractor migration during surgeries while ensuring safer interventions. We believe that all these innovations ultimately drive our variable mitigation efforts, maximizing predictability. I couldn't be more enthusiastic about the distinction that our developments continue to provide, which compels surgeon adoption, allowing us to expand our sales force. Our latest call showed our exhilaration regarding team growth surrounding the Fusion Robotics platform. The team possesses extensive experience and understanding of what it takes to seamlessly integrate this technology into ongoing procedures. We firmly believe that we stand uniquely poised for the impending informatics arms race. Regarding preoperative capabilities, as I described earlier, our focus is on interoperative elements that will enhance procedural sophistication. Understanding postoperative outcomes is key, and feeding that back into practice equips surgeons with insights into patient experiences. We are seeing positive indicators regarding surgeon interest and education, as evidenced by the 100 training sessions conducted this quarter. I anticipate we will organize 400 to 500 sessions again this year, and I'm thrilled to continue welcoming surgeons to our facility in Carlsbad. Lastly, our distribution team is improving, but we are still a relatively small company with less than 5% market share. Our strategic focus is on filling geographical gaps and continuing to engage new surgeon adopters. Our incredible growth rate of 48% among longstanding customers reinforces our belief in the company's trajectory and the clinical attributes that drive our progress. Our goal is to enhance clinical understanding and expand our market share among existing users while penetrating new geographic areas in our current locations. That's the overview of our business, and now I will hand it over to Todd to discuss financials.

Todd Koning, CFO

Thanks, Pat, and good afternoon, everyone. We appreciate you joining the call today. I'll begin with revenue. First quarter total revenue was $109 million, reflecting 54% growth over the prior year and a 3% increase compared to the previous quarter. The $109 million in revenue is comprised of $94 million in surgical revenue and $15 million of EOS revenue. First quarter surgical revenue of $94 million increased 55% compared to the prior year period. Procedural volume grew 40% in the first quarter, with average revenue per case expanding by 11% year-over-year, as our revenue mix continues to shift towards procedures involving more products per case and greater complexity. While revenue from lateral-related procedures contributed the most to growth, revenue from our recently launched posterior expandable cage and biologics also saw solid growth this quarter. EOS revenue for the first quarter was $15 million, a 46% increase compared to last year, bolstered by solid execution on deliveries and installations, including an order fulfilled in a non-strategic international geography. Moving to the remainder of the P&L, the first quarter non-GAAP gross margin was 72.4%, up 20 basis points compared to the prior year. Non-GAAP R&D totaled $12 million or approximately 11% of sales, as opposed to $9 million or 12% of sales in the previous year. The increase in absolute dollars was driven by continued investments aimed at expanding our product portfolio and advancing the Alpha Informatix platform. Non-GAAP SG&A was $81 million or around 74% of sales in the first quarter, compared to $61 million or 85% of sales in the last year. We improved our metrics by over 1,100 basis points, with around 40% of the leverage attributed to variable selling rate improvements alongside the remainder resulting from leveraging our infrastructure investments. Total non-GAAP operating expenses reached $93 million or approximately 85% of sales in Q1, compared to $69 million or 98% of sales in the comparable period last year, demonstrating a year-over-year operating leverage improvement of 1,270 basis points. Adjusted EBITDA reflected a loss of $5.2 million, representing approximately 5% of sales in the first quarter, compared to an adjusted EBITDA loss of $11 million, or 16% of sales in the prior year. The 1,080 basis point improvement as a percentage of sales largely stems from SG&A leverage. We concluded the first quarter with $117 million in cash. This includes $95 million in net proceeds from the gradual term loan, offset by an $28 million paydown of our revolving credit facility. Operating cash use totaled $35 million predominantly due to inventory and instrument investments supporting sales growth and new product launches. The first quarter each year is seasonally burdened with some compensation-related payments. We maintain our expectations that full year 2023 cash use will meaningfully improve compared to 2022 as adjusted EBITDA gains traction, consistent with our long-term plan. Our debt and carrying value stood at $449 million. We still possess undrawn and available borrowings under both the mid-cap revolving credit facility and the Braidwell Term Loan. Now looking ahead to full year 2023, per our prior release on the first quarter financials a few weeks ago, we maintain our outlook for total revenue to grow by 28% to approximately $450 million. That includes expected surgical revenue growth of around 30% to $393 million and EOS revenue of approximately $57 million. As sales growth generates leverage throughout our business, we anticipate reaching adjusted EBITDA breakeven for full year 2023. The strength of our revenue results in 2023 gives us the capacity to absorb about $4 million of investment in the robotic navigation technology we acquired while also staying committed to achieving 100 basis points of adjusted EBITDA margin expansion. The momentum we’re witnessing positions us favorably for attaining profitability and free cash flow goals outlined in our long-range plan. The upcoming slides will provide further context around our 2023 guidance, starting with procedural volume growth expectations and average revenue per surgery, which will influence our surgical revenue guidance. We’ll persist in training surgeons at a robust rate, tracking both adoption and utilization. Surgeons build loyalty, enabling them to increase procedural complexity, which drives utilization. The changing dynamics present a notable trend in utilization growth seen within our surgeon cohorts annually. We now predict high-teens percentage growth in procedure volumes throughout the full year 2023, surpassing our previous estimate that was in mid-teens growth. Average revenue per surgery will also grow, given our mix shift toward more complex procedures requiring additional products, exemplified by our PTP and LTP offerings. Recent additions of expandable implants to our portfolio and increasing biologic attachment rates are allowing us to gain a larger share of procedural revenue opportunities. We expect these elements to push average revenue per surgery growth toward a high single-digit percentage for the entirety of 2023. On the P&L front, we have begun to illustrate how this business scales as we grow, a trend we expect to continue through 2023. Expected breakeven adjusted EBITDA this year implies an 800 basis-point improvement versus full year 2022. Our certainty in achieving this level of operating leverage for 2023 is supported by the 800 basis points of margin expansion that we delivered in the second half of 2022, along with the impressive 1,080 basis points we achieved in the first quarter of 2023. The components contributing to this leverage as we expand align with our long-term plan from last May. We are excited to keep investing in initiatives that support business growth while fulfilling our financial commitments. In summary, 2023 has commenced with strength, as evidenced by ongoing business momentum. We're seeing strong surgeon interest, which Pat previously highlighted via training metrics, indicative of adoption and a catalyst for the growth in procedures we're realizing. It's obvious to us that when surgeons can perform better surgeries, we win their trust, securing a larger share of their overall procedural volumes. Our commitment to investing in innovation is underscored by our research and development efforts. We are entirely focused on revolutionizing the landscape of spine surgery through the acquisition of Fusion Robotics assets, adding an extraordinarily knowledgeable team to our efforts to integrate navigation-enabled robotics into our procedural offerings. We are laser-focused on executing our strategy and feel we are in a great position to thrive at ATEC. We have an active investor relations calendar in the coming months and look forward to connecting with many of you in person. Now, I'll turn the call back over to Pat.

Pat Miles, CEO

Thank you very much, Todd. I really appreciate it. Our view is that the future of spine will be defined by information. The foundation of the SafeOp platform, the EOS asset, and the Fusion Robotics asset that we’ve recently added will be central to our success. Only ATEC possesses the knowledge and technological foundation necessary to establish the standard for information, and that’s the direction we’re heading. With that said, we will now take questions.

Operator, Operator

Thank you. We will go first to Matt Blackman at Stifel.

Matt Blackman, Analyst

Hi. Good afternoon, everybody. Thank you for taking my questions. I have two, and maybe to start a question for Todd, and I am sure you are going to love this one. We are almost a year into the three-year long-range plan you laid out, and as we run our numbers and even factor in some deceleration, it seems like you are tracking well ahead of plan, particularly on the top line. I appreciate this may not be the forum for you to update the long-range plan, but it does feel you could hit your 2025 revenue goalposts as early as 2024. So the question is, am I missing something? Is there a reason beyond comparables or a law of larger numbers that would suggest we might see a deceleration to sub-20% growth over the next 12 months that makes that earlier than expected arrival on the $555 million revenue target more challenging than we are recognizing? I have one follow-up.

Todd Koning, CFO

Well, thanks, Matt. Good to talk to you, too. That’s a good question, and I’m happy to provide context. Our perspective is that the business continues to perform strongly, and we have been clear about our commitment to creating clinical distinction to promote surgeon adoption. The level of adoption we’ve seen, which is driving procedural volume, has been robust. The key indicators of surgeon adoption, such as training, are trending beyond our long-range plan milestones. I am pleased with where we stand relative to revenue, with robust growth this year. Our long-term guidance around 30% year-over-year growth aligns well with our long-range plan assumptions, which are just low 20s percentage growth. Therefore, we feel good about our trajectory as we enter the last two years of our long-range plan with good momentum. I’m not specifically indicating what 2025 revenue will be but it’s logical to see how adjusted EBITDA might deviate from the $80 million figure we’ve discussed. We typically see that more revenue leads to an incremental rise in adjusted EBITDA closer to a $0.10 on the dollar scenario.

Matt Blackman, Analyst

Great. I really appreciate that. And I think there’s a lot of areas to explore here. However, one aspect I haven’t heard mentioned recently is international expansion. Can you remind us where you are with international rollouts such as Australia and Japan? What's remaining in that process, and when should we expect visible revenue contributions? Could we see something in 2024? I believe that 2025 has been considered to be a reasonable target, but I am curious if things are progressing faster?

Pat Miles, CEO

Yeah, Matt, I appreciate the question. I was at SpineWeek earlier this week in Australia, and much of this boils down to having the right people involved. The foundation we are establishing with the Australian team is outstanding, and we are making business introductions literally as of March. The good news is there’s been a favorable reception toward lateral surgery adoption there. Competitive opportunities are clear as well. Although we're just getting started in Australia, we think we will see small contributions towards year-end. In contrast, the Japanese market may require about a year longer for significant progress, but we’re enthusiastic about establishing our presence there effectively. In summary, we have a great foundation in Australia, and we’re excited to develop our international business.

Matt Blackman, Analyst

Great. Thank you so much. Appreciate it.

Pat Miles, CEO

Yeah. Thanks, Matt.

Todd Koning, CFO

Thanks, Matt.

Brooks O'Neil, Analyst

Good afternoon, guys. I'm curious if you could comment on how significant industry consolidation impacts your ability to grow and hit your long-term growth targets?

Pat Miles, CEO

Yeah. I would say that much of this comes down to us working our business as we understand it. I’m not trying to be evasive here—previously, I read that not much happens until the integration takes place, and it has been relatively quiet from that perspective. We love what we’re doing. I appreciate the integration of navigation robotics, and I believe that many recognize how we bring together technology to improve procedures. The successful trajectory of our revenue from $83 million in 2018 to our guidance for $450 million this year signifies our commitment to progress. I believe others notice that as well and understand that SafeOp serves as an effective illustration of our technology integration. I like our chances moving forward; less focus on industry dynamics and more on creating distinctions and compelling adoption is where we excel. We’re committed to attracting and retaining the best sales talent possible, and I’m thrilled to have so much innovation happening here.

Brooks O'Neil, Analyst

Great. Let me ask one more question. You previously had PTP before REMI. Can you discuss if you see REMI enhancing the PTP procedure or if your thinking is more toward LTP and other upcoming procedures?

Pat Miles, CEO

Good question, Brooks. The dynamics indicate that PTP adoption remains strong. However, you may ask why further technology is necessary. The requirement for PTP hinges on achieving orthogonal placement of the first dilator, which currently relies on radiation generated from fluoroscopes or X-ray devices. We aim to reduce exposure to radiation to protecting both surgeons and improve precision with precise placement—and to give surgeons timely alerts, for example, related to SSEP signal degradation. We’d love to establish similar dynamics with REMI to help mitigate variables during surgery. We believe that both PTP and LCP will greatly benefit from this integration, and we’re optimistic about the value brought by combining these technologies, as well as the overall ecosystem of our offerings.

Brooks O'Neil, Analyst

Fantastic. Thanks a lot, and keep up all the great work.

Pat Miles, CEO

Thanks, Brooks. I appreciate it.

Eric Anderson, Analyst

Hi, this is Eric on behalf of Josh. Thank you for taking my questions. I wanted to inquire about REMI feedback from surgeons regarding your acquisition. What are their perspectives on incorporating REMI with the ATEC portfolio?

Pat Miles, CEO

The feedback has been very favorable and quite expected. As mentioned earlier, while at SpineWeek in Australia, I was approached by surgeons from both the U.S. and Australia who expressed their enthusiasm. They recognize and are excited by the potential for integrating these technologies. We have always expressed that integration of independent technologies, such as neurophysiology and navigation systems, can provide dual assurance of surgical safety. I haven't encountered any dissenting comments so far, and we’re confident about demonstrating our long-term value tied to this acquisition through continued integration.

Todd Koning, CFO

And Eric, as Pat mentioned, the real opportunity clocks in when we can combine robotics and navigation into our full procedural approach, as it has primarily focused on pedicle placements thus far. We believe the real value arises from innovating these technologies throughout comprehensive surgical procedures to mitigate surgical uncertainties.

Eric Anderson, Analyst

That makes a lot of sense. I appreciate that it takes time to weave such technologies into the overall portfolio. When would it be reasonable to start witnessing contributions from the REMI acquisition in revenue?

Pat Miles, CEO

Looking at the short-term 6-12 month effort, it's heavily focused on getting our implants through the regulatory clearance process, ensuring everything can be integrated smoothly into established practices. We anticipate some contributions following the integration around Q2 2025, but with solid confidence in the elegance of this process.

Eric Anderson, Analyst

Understood. Thanks for the questions.

Todd Koning, CFO

Thanks, Eric.

Sean Lee, Analyst

Good afternoon, guys, and thanks for taking my question. I have a more high-level inquiry on robotic surgery. Regarding lateral surgeries that Alphatec focuses on, how significant is the current use of robotic assistance in these procedures? Given the right devices and technologies, where do you envision this percentage increasing over the next four to five years?

Pat Miles, CEO

That's a great question, Sean. Currently, I would estimate that fewer than 3% of surgeries utilize robotic assistance, and realistically, it may be closer to 1% right now—in practice, applying robotic assistance, particularly in the anterior column, remains sketchy at best. There’s a considerable opportunity within navigation, and we expect that once we navigate procedures, we can seamlessly employ robotics. To establish predictability and orthogonality in our techniques is highly valuable for us. We intend to demonstrate a stronger position, particularly within automated SSEPs, allowing surgeons to catch warning signs related to signal degradation. As we proliferate our technologies into surgical procedures, the overall value becomes manifest. Therefore, I would contend that while robotics is currently minimal, its potential is immense, and we hope to become the standard-bearer in lateral surgeries.

Sean Lee, Analyst

Okay. That's very helpful.

Operator, Operator

That concludes our question-and-answer session. I would now like to turn the call back over to Pat Miles for closing remarks.

Pat Miles, CEO

Thanks very much, Audra. I appreciate everyone’s interest and excitement about ATEC. We are literally just getting started, and I’m thrilled about our long journey ahead. Thank you all.

Operator, Operator

And that does conclude today’s conference. Again, thank you for your participation. You may now disconnect.