Alphatec Holdings, Inc. (ATEC) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. And welcome to the AlphatecSpine Inc Third Quarter Fiscal Year 2017 Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions for how to participate will be given at that time [Operator Instructions]. As a reminder, this conference call is being recorded. I would like to turn the call over to Carol Ruth at The Ruth Group. Ma’am you may begin.

Thank you. Good afternoon, and welcome to Alphatec Holdings third quarter 2017 conference call. We’d 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. Joining us on the call today will be Alphatec’s Executive Chairman, Pat Miles; CEO, Terry Rich; and CFO Jeff Black. With that, I’ll turn the call over to Terry Rich. Terry?

Thank you, Carol. And thank you all for joining us today. Welcome to Alphatec’s third quarter 2017 earnings call. I would like to start off today by officially introducing Pat Miles, the new Executive Chairman of Alphatec. We’ve greatly advanced our vision of becoming the most respected, fastest growing U.S. spine company with the addition of past 25 years of industry relationships and knowhow. It’s rare to have the opportunity to recruit and hire your own boss, and I could not be more thrilled to be working with Pat once again. There is truly no one better qualified or better suited to this leadership role. Pat here is deeply about our mission to improve life by providing innovative spine surgery solutions through a relentless pursuit of superior outcomes. In fact, he’s build his carrier and reputation in spine by partnering with surgeons to make surgery better. In his first month with Alphatec, Pat has already fully emerged himself in the operational aspect of this organization, greatly accelerating both the quantity and quality of our team building and search and engagement efforts. Pat’s addition allows me to focus on the critical areas I can best influence mainly I will drive the sales and commercial functions, while continuing to serve as the external face of the organization for our corporate partners and the investment community. Alphatec has now assembled one of the most talented spine experienced leadership teams in the industry, and I'm incredibly confident that under Pat's leadership we are well positioned to drive growth by taking market share. With that, I am very excited to turn the call over to our new Executive Chairman, Pat Miles.

Thanks Terry. I'm so pleased to be a member of this team. Aligned behind the outcomes focused strategy that is foundational to the new Alphatec. We have assembled a team with unsurpassed industry experience, a team that has worked together before to build a spine powerhouse. We appreciate the value being nimble and take our responsibility to deliver results, both seriously and personal. We believe that our business is to drive innovation that improves results in the operating room. These are the core principals to the new Alphatec value system and a core principal that’s really driven my entire carrier. I joined this team and united with a company that shares my beliefs and I'm in passion to lead the charge. In my first month on the job, I placed my initial focus really in two key areas. First, externally, engaging with the surgeon community and reintroducing Alphatec to several key influential players in U.S. spine; secondly internally, building on a momentum that this team has already clearly established in focusing our resources to accelerate innovation. Moving forward, I will focus on reemerging the role of Alphatec -- reimaging the role of Alphatec. I know that great companies are those that serve both known and unknown requirements of a marketplace. And whether it realize it or not, the spine market needs the new Alphatec. And tend to manifest that realization by applying my expertise toward continued innovation, experienced decision making and engagement of the most innovative surgeons, is the intention of this entire leadership team to rebuild Alphatec into an innovation machine. I also want to impart that we're determined to earn the trust and respect of the stakeholders by doing what we say we're going to do. Transformations of this magnitude are not without challenges and this one has been and will continue to be no different. But what will be different is our collected impassioned resolve to work through this process in a disciplined, methodical and transparent way, building predictability in everything we do. We will continue to assemble a team a profoundly curious spine experts committed to driving great results. Today, we're reporting financial results that can possibly do just this to what is happening behind the scene at Alphatec. The excitement, both internally and in the field about our new direction is absolutely comparable. We are completely focused on creating long-term shareholder value by delivering solutions to unmet needs in the marketplace. I look forward to sharing our progress in the future conversations. But now, I will turn it back over to Terry.

Thank you, Pat. This afternoon, I will begin with financial highlights then provide a brief progress report on the three initiatives we are prioritizing to revitalize Alphatec. Then I’ll turn the call over to Jeff for additional comments on our financial results. Let’s begin with financial highlights. Total U.S. commercial revenue in the third quarter 2017 was $20.4 million, down slightly from the $21.9 million that we reported last quarter. Third quarter revenue results were down sequentially due to the impacts of weather and the loss of two selling days in the quarter. Nevertheless, very encouraged by the continued momentum we experience in the sales channel. On the crash management front, cash burned in the third quarter of $3.7 million improved substantially, down from $6.4 million last quarter. This improvement is an excellent demonstration of our continued commitment to deploy capital responsibly. Operating expenses improved in the third quarter to $15.8 million compared to $16.5 million last quarter. This is the fourth consecutive quarter that we have driven an improvement in operating expenses. Our team continues to successfully drive ongoing initiatives to more thoughtfully align expenditures with our business needs. In sum, we made solid financial progress in the third quarter. Given third quarter top-line results, it's too early to tell whether second half revenue will exceed first half revenue. We nevertheless expect the strong momentum we're seeing to drive sequential top-line growth in the fourth quarter. Now, a brief update on the three vital initiatives we have prioritized in order to deliver predictable results; first, strengthening the Alphatec distribution channel; second, executing organizational and cultural changes to return Alphatec to a growth organization; third, driving new product innovation that improves clinical outcomes. I am pleased to report that we continue to demonstrate progress with the transition of our distribution channel in the third quarter. U.S. commercial sales, generated by dedicated agents and distributors, expanded to 30% in the third quarter, up from 18% last quarter and up from less than 5% in 2016. We are working continuously to streamline our on boarding process for new distribution partners and ramp up the partners that we have already engaged. We remain on track with our goal to exit 2017 with over 40% of U.S. commercial revenue from dedicated agents, heading into 2018 with strong momentum. As we increase our visibility into the distribution channel, we continue to see two common themes. First, the transition for dedicated distribution relationships takes time. As we reported last quarter, our engagement discussions with existing, established distributors and potential new distributors, are being received even more positively than we anticipated. These transitions, however, take time to fully execute due to the contracting process. Secondly, in line with what we communicated at the outset of this transition, we expect some unpredictability in the top-line as we rebuild sales channel. We believe we're well on our way to executing the strategy we laid out in our first quarter call. Once these transitions have been made, we expect our revenue stream to become more sustainable and predictable. We continue to believe that this will be 24 to 36 month process and three quarters into it, we're very encouraged by our progress. The second key initiative that we are prioritizing as we reposition the Alphatec brand is the broad transformations of the company’s structure and culture intended to return us to a growth organization. A fundamental part of that cultural transformation has involved investing our personal assets. At this point, a significant portion of Alphatec’s common stock is owned by management. We've also created an ownership culture by granting equity to every employee in the organization. We are committed to building trust by creating shareholder value, and the entire organization is highly motivated to succeed. We have accomplished dramatic organizational changes, and we continue to make massive progress. Before getting into more detail on that subject, I want to take a moment to thank and recognize Mike Plunkett, who recently resigned from his role as Alphatec’s President and COO. For five years, Mike has been a key leader in the organization and we greatly appreciate his steady hand during what were often turbulent times. Personally, I would like to publically thank Mike for his support as I transition into the organization. We wish Mike the very best in the future. Now, returning to Company leadership. The executive team at the new Alphatec is comprised of recognized professionals with over 140-years cumulative spine experience. A number that grow substantially as you dive deeper into the organization. Over the course of past several months, we have made strategic clinical hires and in game changing talent throughout the organization. The transformation is under way at Alphatec, is motivating the industry as best and brightest to seek opportunities with us, and we are thoughtfully leveraging the excitement to enhance our team. We have become extremely well positioned to deliver innovation and differentiation in a market that is right for it. And that brings me to our third vital initiative, product innovation. History has demonstrated that in this industry, companies that grow the fastest are those with Spinal knowhow. We’ve assembled a team of spine expects to perform new Alphatec, because we know how much spine experience counts. As we reposition our brand, we intent to exploit the expertise we've masked to drive innovation that truly improves clinical outcomes. Surgeons and hospitals don’t just want more in new products. They want expertise and comprehensive procedurally driven solutions that improve the experience in the operating room. As we look forward, that will be the focal point for our development program. I'm incredibly excited to see the strategic strides that our portfolio will take with the mass of spine knowhow we have assembled and we’ll continue assemble under Pat’s leadership. We just returned from a very successful North American Spine Society Conference in late October. There, we met with prominent spine surgeons from around the world, enthusiastically driving home the message of the revolution and the spirit of innovation that is building with the new Alphatec. The reception we received was exceptional with strong surgeon interest in our new spine experienced team and in our portfolio. Surgeons were especially impressed with the official introduction of the Battalion Lateral System, our next generation procedural solution for lateral spine surgery. And we continue to protect our investment and innovation. Today, we have more than 150 patents and have over 75 patents pending. We were granted 20 new patents in the first half of 2017 and made additional progress during the third quarter with six new patent awards, three that further protect our expanding lateral portfolio. In conclusion and only three quarters, we have made and continue to make excellent progress on the initiatives that we have prioritized as we reimaging Alphatec. With that, I will turn the call over to Jeff to cover financial results in detail.

Thank you, Terry and good afternoon everybody. As Terry mentioned, our execution was solid in the third quarter. We improved cash burn substantially. We strengthened our operating expense profile and we made progress against our key initiatives. We ended the third quarter with $20.7 million in U.S. revenue, which was affected by two fewer sequential selling days, as well as weather related impacts. Adjusted for these factors, our U.S. revenue in the third quarter was flat sequentially. But more importantly, revenue from direct and dedicated sales agents grew to over 30% in the third quarter. This is a key leading indicator for our progress in building sustainable growth and reducing our top line variability. Our U.S. gross margin was 69.1% in the third quarter as compared to 70.9% in the second quarter. We expect our U.S. gross margin to be in this range for the remainder of 2017. Our operating expenses improved by more than $700,000 in the third quarter to $15.8 million from $16.5 million in the second quarter and on a non-GAAP basis, excluding restructuring expenses and a gain on sale of assets in the second quarter, our operating expenses decreased sequentially by $1.2 million. This is the fourth consecutive quarter we've driven an improvement in our operating expenses, reflecting the impact of cost rationalization across all functions. As we noted before, we expect sales and marketing expenses to increase as we continue to invest in our distribution channel to support revenue growth. And these increases will be in conjunction with revenue growth. We also expect to make targeted investments in R&D to drive continued outcome focused innovation. And as a result, we should see R&D expenses increase in both absolute dollars and as a percentage of revenue. Overall, our cash use decreased by $2.7 million to $3.7 million in the third quarter, down from $6.4 million in the second quarter. And this represents a sequential improvement of more than 40% in cash usage. We ended the quarter with $15.4 million in cash compared to $19.1 million at June 30th. In addition in connection with the appointment of Pat to our senior leadership team and Quentin Blackford to our Board of Directors, Pat and Quentin have both committed to invest an aggregate of $3.5 million to $4 million in our common shares on or before January 1st. And we've also received $1.7 million in proceeds from warrant exercises over the past 30 days. As you're probably aware, we recently filed our shelf-registration statement, which when effective, will afford us the flexibility to strategically and responsibly offer and sell securities on an expedited basis, should market opportunities present themselves. I will now turn the call back over to Terry for closing comments.

Thank you, Jeff. I’m extraordinarily proud of the spine experience team and the culture that we have built at the new Alphatec over the course of this past year. We have made impressive progress in our short-time together, working toward the creation of a dedicated distribution network, launching unique products and rightsizing the organization. Looking ahead, I'm incredibly excited to be working with Pat once again to drive shared vision of becoming the most respected, fastest growing U.S. spine company. As we move forward with his leadership, market expertise and dedication to better surgical outcomes are evolution into the new Alphatec will accelerate. He’s uniquely capable of directing teams to architect procedurally complete solutions that dramatically improve the experience in the operating room. And his contributions to our development program and our surgeon engagement efforts will enable us to drive growth by taking market share. The market needs us and the new Alphatec is exceptionally well positioned to deliver. I will now turn the call back over to the operator, and we'll take your questions.

Thank you. Our first question comes from Brooks O'Neil with Lake Street Capital. Your line is now open.

I'm in a building where there might be some background noise, so I apologize for that in advance. Terry, I was hoping you could give us just a little color in terms of some of the new distributions that you brought into the organization. I'm impressed by the move from 18% to 30%. And if you could just tell us a little bit about the kinds of distributors, you’re having success with that would be great.

Brooks, I don’t know that there is common theme amongst the types of distributors that we're bringing in. I think some of this is the result of distributors that we've brought in previously, beginning to ramp up, whether those were current distributors that we’ve been able to contact with the dedicated or report new distributors or direct reps. So I think we’re seeing success across all fronts.

And then could you tell us a little bit about Squadron. I noticed that in the press release and you highlighted the success with Battalion at North America spine. What this Squadron do for you?

So Battalion is really that outlines our current inner body portfolio and Squadron is a Retractor. So what we’re talking about is the combination of the two is our lateral procedural solution. And the initial launch of this was at NASS and it's been received very well. We're very excited about the surgeon feedback that we’ve gotten and look forward to continuing to build out on that platform.

And then maybe just a little detail question. Can you talk at all about what impact that hurricanes might have had on the business? Was that a big deal or small deal for you this quarter?

Brooks, this is Jeff. The combination of weather and the impact of two less selling days had roughly $900,000 to $1 million impact on our Q3 numbers.

And if I’ve been hearing you guys correctly, we would expect for have some modest sequential growth in Q4. And then probably with any luck at all continued ramp into 2018, is that how you’re thinking about the business now?

Brooks, obviously, we haven't provided any guidance. But we do expect sequential growth in Q4 and to achieve the 40% or greater number of our revenue coming through dedicated distributor. And as we indicated, we're looking forward to create a degree of sustainability and predictability. And it is certainly our goal to continue to grow quarter-over-quarter.

[Operator Instructions] And speakers, I am showing no further questions in the queue at this time. I would like to turn the call back over to Terry Rich for any final remarks.

Thank you everybody for joining our third quarter conference call. We look forward to engaging again to deliver our fourth quarter results.

Ladies and gentlemen, this does conclude your program for today. And you may all disconnect. Everyone, have a great day.