Alphatec Holdings, Inc. (ATEC) Q3 2009 Earnings Report, Transcript and Summary

(Operator Instructions) Welcome to the Alphatec Holdings Third Quarter Fiscal 2009 Results Conference Call. At this time, I would like to turn the conference over to the Peter Wulff, Chief Financial Officer, Vice President & Treasurer.

Welcome to Alphatec Spine's conference call to discuss our third quarter ended September 30, 2009 financial and operating results. With me today is Dirk Kuyper our President and Chief Executive Officer. By now you should have seen the copy of today’s press release announcing third quarter 2009 financial and operating results. If you do not have a copy of today's press release, you can find it in the Investor Relations section on our website at www.AlphatecSpine.com. Before we start, there are a couple of items we would like to cover. I would like to remind you that this call is being webcast live and recorded. A replay of the event will be available later today, on our website and will remain available for at least 30 days following the call. We would like to remind you that our discussions today include forward looking statements. These statements are based on certain assumptions made by us based on historical trends, current conditions, expected future developments, including business prospects, product development objectives, future financial performance and other factors we believe to be appropriate in the circumstances. Risks and uncertainties may cause our actual results to differ materially from those projected in these forward looking statements. You can find a discussion of these factors and more information about us in our filings with the SEC, including the risk factor section on our annual report on Form 10-K and subsequent quarterly reports on Form 10-Q and periodic filings on Form 8-K. These forward looking statements are made as of the date of this call and we assume no obligation to update these statements publicly, even if new information becomes available in the future. This broadcast is covered by US copyright laws and any use or rebroadcast of all or any part of this conference call may only be done with our expressed written permission. Now I'd like to hand the call over to Dirk Kuyper, Alphatec Spine's President and Chief Executive Officer.

We're pleased to report that revenues for the third quarter of 2009 were a record $32.7 million representing a 27% increase over revenues from the same period last year. This represents the ninth consecutive quarter of record revenues. Year to date revenue of $95.6 million reflects a 31% growth over the same period 2008. In the US we grew the third quarter 2009 revenues by approximately 21% over the prior year. Year to date revenue growth was 28% as compared to 2008 for the same time period. International revenues reached $6.6 million in the third quarter reflecting a 52% growth over the third quarter of 2009. This performance reflects the ongoing strength of our core business. We're proud to report adjusted EBITDA of $3.6 million for the third quarter which is a 31% sequential increase over the second quarter 2009 adjusted EBITDA of $2.8 million. Year to date EBITDA reached $7.8 million reflecting strengthening operating leverage while we continue to drive strong top line growth, investing in our robust product pipeline and controlling costs. We continue to grow revenues at rates significantly higher then the growth rate of the spine market through the introduction of innovative new products, the strengthening of our US sales force and expansion of our international operations. This morning we will provide additional highlights on our operating performance for the third quarter 2009 as well as an overview of new product introductions and accomplishments in the quarter. Consistent with our comments from previous calls I will focus my remarks on updating you on our four primary growth drivers at Alphatec. 1) Continued expansion of our core product portfolio especially in the area of minimally invasive surgery. 2) Product development initiatives addressing the aging spine. 3) US sales force expansion. 4) International expansion Then I'll turn the…

The following remarks are about our reported financial results for the three months ended September 30, 2009. Consolidated revenues for the third quarter 2009 were $32.7 million an increase of 26.6% from the $25.8 million reported for the third quarter 2008. US revenues for the third quarter 2009 were $26.1 million an increase of 21.4% from the $21.5 million reported for the third quarter 2008. Asia revenues for the third quarter 2009 were $5.6 million an increase of 44.5% from the $3.9 million reported for the third quarter 2008. European revenues for the third quarter 2009 were $1 million an increase of $500,000 from the $500,000 previously reported in the third quarter 2008. Deferred revenues recorded on our balance sheet as of September 30, 2009, were $2.1 million of which $1.2 million relates to our European distributors. Consolidated gross profit for the third quarter 2009 was $20.8 million an increase of $4.1 million over third quarter 2008 of $16.7 million. The third quarter 2009 gross margin of 63.7% was lower then the third quarter 2008 gross margin of 64.7%. The US gross margin in the third quarter 2009 was 68.9% an increase of 1.1 percentage points over the 2008 third quarter US gross margin of 67.8%. The overall decrease in gross margin was primarily due to increased European and Asian sales mix which have a lower gross margin and higher instrument depreciation expense partially offset by decreased royalty expenses and improved manufacturing efficiencies. Total operating expenses for the third quarter 2009 were $21.5 million an increase of $300,000 compared to the third quarter 2008 of $21.2 million. The increase in third quarter 2009 was primarily due to increased sales and marketing expenses to support revenue growth, partially offset by reduced in process research and development expenses. Research and development expenses…

As you may recall, we set out this year to launch a number of new products in 2009 both addressing our core spinal product portfolio and addressing the aging spine market. While we set an extremely aggressive target, the Alphatec team has risen to the challenge and we're pleased that we are basically on track to meet the objective and have, as of now, launched 11 products either into beta or full commercial launch in the market. Our core product launches expand the breadth of the offering. I'm going to take a moment to talk about our exciting new minimally invasive ARC Portal system and GLIF technique which we believe addresses a $200 million market opportunity in the US. The ARC Portal access system and instrumentation is our breakthrough access system that provides a far lateral approach to the spine with the patient in a natural face down position. The G-Width technique, which is an acronym for guided lumbar inner body fusion is designed to allow surgeons to perform a 360 degree minimally invasive procedure without the need for repositioning the patient. When augmented with posterior pedicel fixation the ARC and GLIF are designed to reduce the overall length of the lateral lumbar procedure, thereby reducing operating room costs and trauma to the patient. We recently initiated limited beta launch for the GLIF and our portal system for far lateral lumbar fusion procedures. We met our objectives and confirmed that the system works. The purpose of this beta launch was to validate the system in real operative conditions to make any necessary final changes prior to full commercial launch. We made minor modifications to the portal following our initial experience and have reinitiated the use of the product at the beta sites. We now expect to make our full market…

(Operator Instructions) Your first question comes from Bill Plovanic - Canaccord Adams

On the OsseoScrew you said that you submitted to the FDA and received questions back. Can you give us a little color on the types of questions you're receiving on that?

It wasn't anything that we hadn't really anticipated. The primary one related to bony integration because the screw is slightly different then a traditional screw, they wanted to know that bone would actually grow around the screw which we showed them histology slides from an animal study that we had done. The second one had to do with retrievability post surgery and we showed them both immediately at the time of surgery it could be un-deployed and removed and also after six weeks that it could be un-deployed and removed and that study is continuing and we will give them additional results after they're in.

Do they need those additional results for the approval?

They haven't asked for them at this time.

Do you think that this will get approved before year end or early January?

We're hopeful. We think that we addressed their questions in a very substantive way. We're hopeful, they have 30 days basically to get back to us from the 22nd so we should hear right before Thanksgiving. Always the Holidays make that a little more difficult as things definitely slow down at the FDA but I think worst case certainly early first quarter.

On GLIF could you give us some color on the changes that you made and is this the final tweak and you're ready to go, start manufacturing instrumentation sets?

We've actually already started manufacturing the instrumentation set. What we found in the initial surgery was with, a lot of time lumbar surgery is done on people who are obese and one of the first patients that we got was extremely obese and we saw that the portal was a little bit too short for that type of scenario and wouldn't stay in place so we actually lengthened it a little bit and then also added a couple of pins to it to lock it down into the vertebral body. That's been done, we confirmed it in a lab a couple of weeks ago and so we believe we've got the final solution now. We'll do some more cases in the beta and then the idea is to launch basically right after the beginning of the year.

On the adjusted EBITDA guidance for the quarter you did $3.6 million, if I look at the guidance you'd have to do between $4.7 and $5.7 million in the fourth quarter. It sounds like you're probably going to be more towards the lower end of that given the EPS guidance, is that fair?

We don't comment on the range but we are very comfortable with the guidance we have and with the revenue increase that we expect to continuing growing in the fourth quarter.

We see a reacceleration of the US growth rate. We're very pleased with September and October and that should help that quite a bit.

I know you said you'd be 85% exclusive by year end. Can you give us an update on where the number of distributors are today, the number of agents, reps and your exclusivity to date?

We're over 90 distributor agencies which represents about 267 sales people and exclusivity I think is around 75%.

Its in the mid 70's.

Your next question comes from Matt Dolan - Roth Capital

A follow up on the distributor, can you take that point one step further and give us your targets? I know we've talked about 300 and 85% in the past. When are you comfortable with getting there so we can factor that into growth expectations?

In the third quarter we really were working on consolidating a lot of the distributors that we had added earlier in the year. We didn't see a large growth in the distribution network. We do anticipate that also reaccelerating this quarter and going into the first quarter. I can't give you an exact number because it really depends on when people sign up but we are in negotiation to add to the distribution group and increase that number here in the fourth quarter and the first quarter of 2010 as well. You should start to see that number go up when we report the fourth quarter.

Maybe a longer term type growth question, you had a number of positive variables here; distribution expansion, new products this year, probably some MIS conversion competitively and you continue to grow well above the market growth rate. Can you talk about how things are tracking and your expectations? Do you think a double market growth rate is something that you can sustain given the pipeline you put out there this year?

Absolutely. I think double market growth rate just with our core products is absolutely feasible. We're very excited about the [Solas], stand along inner bodies have picked up very dramatically in the last year with a couple of other product introductions. We fast tracked that from the time we acquired the IP in March we were basically in six month went from concept to a fully tested and submitted product and we think that has some very exciting opportunity for us next year in the US in terms of core products. Our growth rate really still at this state reflects very little in terms of aging spine. I think that'll start to come into play in 2010 once we get approval for OsseoScrew.

On the aging spine, you're getting some good experience in Europe with OsseoFix, do you expect to see any clinical data published out of that experience that you're getting here in the near term? If so, can you describe what forum that might be presented in.

Getting data published obviously always takes some time. We are in the process of initiating several studies in Europe to gather some good scientific data. For instance, at NAS we actually have several European surgeons presenting in the booth and there are a couple posters on OsseoFix. There are some surgeons that will be presenting their cases for us and the results are quite exciting and very encouraging.

The Q4 guidance I think would require about a 67% gross margin in Q4. Its still pretty good ticked up, is that just a mix issue cleaning itself up and what do we think about your ability to continue to expand those gross margins in the next year or two?

I think in the near term for the fourth quarter we're expecting the margins to be in the 64% to 65% range. We are comfortable with the EBITDA guidance for the fourth quarter based on our expected sales growth and improvements in there. The guidance for March and in the future periods we do expect that to up-tick over time really through three areas; one is our continued development and production efficiencies, second is abatement of the royalty expense we have, third is through new product launches that inherently have a higher margin profile.

Your next question comes from Glenn Novarro - RBC Capital Markets

Specifically to your US business you mentioned earlier that the US business was impacted by seasonality. We cover a lot of other spine companies and its looked like the US for some of the other spine companies was quite strong. It appears to me that the US market did well in the third quarter. I'm wondering if you can clarify a few things. One was for Alphatec was you business impacted by the overall market or was it Alphatec specific, if you can clarify and provide a little bit more there. The second question has to do with the enrollment for the OsseoFix in the US. You have eight enrolling centers, how many patients have you so far enrolled in that trial?

Our growth rate in the third quarter for the US was 21% which we think still compares very favorably with the overall market as being quite strong. I would say that the market has not necessarily gone down. We did have within our surgeon group a decrease in just number of procedures that we think was seasonal related to vacations or whatever. We saw that pick up significantly. The other thing is we had obviously planned to launch the ILLICO SE about 30 days earlier then we actually did and that had an impact obviously on the third quarter. We saw an immediate up-tick but it wasn't near as much as we had originally anticipated obviously with the delay. We feel very good about where our growth rate is going in the US and saw both in September and October again a very nice pick up back to the levels that we had anticipated. In terms of OsseoFix getting the sites up and running we had 15 sites trained prior to getting the nod from the FDA to start enrolling patients but then you still have to go through the IRB process and a lot of hurdles to get these sites so that's been quite a task. As I mentioned we have eight out of the 15 fully up and running and looking for patients. As of this date we have about a handful of patients that have been actually enrolled into the trial so we're still very much at the beginning stage.

On OsseoFix for the 100 patients what's your best guess at this time as to when you can get enrollment complete? The reason why I'm asking is obviously with 12 months follow up and then we've got to take into consideration FDA review time it looks like this is probably a 2012 launch. Your thoughts there?

I don't know if its going to be 2012 but its certainly 2011. As I mentioned, everything takes longer then you think its going to and certainly getting the sites up and running has taken us a little longer just getting through all the IRB processes. Now that we have more then half of the sites up and running we hope to accelerate the enrollment process. This is a very prevalent procedure so we don't see a lot of problems getting the enrollment done so we're hopeful that certainly first we'd like to see it completed in the first quarter, it might be first half before we've got all 100. You actually have to do more then 100 because you have some fall out. Certainly by the first half. I think its still late 2011, I don't believe that it pushes into 2012 for US approval.

I'm assuming pricing, price per case was stable to up in the quarter is that fair?

That's correct.

Your next question comes from Bud Leedom - Global Hunter Securities

One question related to OsseoScrew, given the specificity of the questions from the FDA would you believe that a more formal clinical pathway requirement is off the table at this point?

I don't know that you can ever say anything is completely off the table. We feel very good about the answers that we provided and we had a lot of substantive data to support the answers that we gave them. We feel very good about it. We're hopeful that we will get approval without any other significant questions or requirements to do a clinical.

Do you have a CapEx figure for the third quarter?

In the third quarter we spent approximately $1.5 million for surgical instrumentation to support the roll out of the ILLICO SE. Our core PP&E was several hundred thousand dollars, it was relatively low. Most of our core PP&E capital was front end loaded for the year as we had consolidated and moved our manufacturing facility into one site back in March and April.

At this time with no further questions I'd like to turn the conference back over to management for any additional or closing remarks.

Our mission is to be the leading independent full line spine company with a focus on solutions for the aging spine and our goal is to improve the aging patients quality of life. The aging population is a global phenomenon, its estimated that by 2030 over one billion people worldwide will be over the age of 65. This represents a tremendous opportunity for Alphatec going forward. As surgeons continue to see a shift in their practices to increasingly older patients we plan on being their spine company of choice worldwide. As such we have invested heavily in proprietary products that will outperform current standards in aging patients which position the company for market leadership position in what we believe represents the fastest growing segment of the global spine market. Thank you very much for your time this morning and look forward to seeing you in San Francisco.

That does conclude today's conference. We appreciate everyone's participation today.