Thank you for standing by, and welcome to the SeaSpine's 2022 Second Quarter Financial Results Conference Call. [Operator Instructions]. I would now like to turn the conference over to your host, Ms. Leigh Salvo, Investor Relations. Please go ahead.

Thank you for participating in today's call. Joining me from SeaSpine is CEO, Keith Valentine; and COO and CFO, John Bostjancic. Earlier today, SeaSpine released full financial results for the second quarter ended June 30, 2022. During this conference call, we will make forward-looking statements within the meaning of the securities laws in regard to our business strategy, expectations and plans, our objectives for future operations and our future financial results and conditions. All statements other than statements of historical facts are forward-looking statements. Such statements may include words such as believe, could, would, will, plan, intend and similar expressions. You are cautioned not to place undue reliance on forward-looking statements, which are only predictions and reflect our beliefs based on current information and speak only as of today, August 2, 2022. For a description of risks and uncertainties that could cause material differences between our actual results and those stated or implied by the forward-looking statements, please see our news releases and periodic filings with the Securities and Exchange Commission, which are available on our corporate website, www.seaspine.com and www.sec.gov. Our discussion today will also include certain financial measures such as adjusted gross margin and adjusted EBITDA loss that are not calculated in accordance with Generally Accepted Accounting Principles or GAAP. Management believes that the presentation of these non-GAAP financial measures provides important supplemental information to management and investors regarding financial and business trends relating to the company's financial results of operations. These non-GAAP financial measures should not be considered replacements for and should be read together with the most directly comparable GAAP financial measures. Reconciliations to the most directly comparable GAAP measures are provided in the tables accompanying the press release we issued today. I will now turn the call over to Keith Valentine. Keith?

Thank you, Leigh. Good afternoon, and thank you all for joining us. Our second quarter results surpassed expectations despite some nominal disruptions from hospital staffing challenge throughout the quarter that were widely experienced throughout the industry. We successfully navigated these sporadic headwinds with our surgeon customers and distributor partners to deliver outstanding revenue growth and gross margin expansion. On the innovation front, we've fully launched seven new products and systems so far this year, including three significant spinal implant systems since our first quarter earnings call. An increasingly more complete spinal implants and orthobiologics product offering, combined with our 7D enabling technology platform is helping attract many distributors from our large competitors to partner with SeaSpine, a few of whom we've already fully onboarded. These groups, along with those were in the process of onboarding, are expected to generate even more momentum as we move further into the second half of the year. Based on all of this, we have confidence in our decision to raise full-year 2022 revenue guidance to a range of USD234 million to USD236 million, representing year-over-year growth of 22% to 23%. In the second quarter, we grew total revenue 19% over the prior year period to $56.3 million. In US, where we generate approximately 90% of our total revenue, we saw revenue increased 16%, reaching $49.5 million. International revenue grew 39% to $6.8 million. As I noted earlier, we continue to expand our product portfolio to address our surgeon customers' needs and attract larger distributors with the recent full commercial launch of three products and systems. This include WaveForm C, a 3D-printed cervical interbody and WaveForm TO, a 3D printed lumbar interbody, both of which utilize our innovative WaveForm 3D technology to deliver a highly porous and yet robust interbody solution, with a design intended…

Thanks, Keith, and good afternoon, everyone. As Keith noted earlier, total revenue for the second quarter of 2022 was $56.3 million, a 19% increase over the prior year. In the US, we posted 16% growth to $49.5 million. International revenue increased by 39% to $6.8 million. US spinal implant and enabling technologies revenue in the second quarter increased 17% to $25 million, with the 7D FLASH Navigation platform contributing $1.1 million of revenue. Products launched or enhanced via line extensions within the past five years continue to fuel revenue growth and drive market share gains and accounted for 74% of US spinal implant revenue. It continues to be an encouraging indicator for sustained growth throughout 2022 and beyond. US orthobiologics revenue in the second quarter increased 16% to $24.5 million and continues to be driven by growth in the OsteoStrand Plus fibers-based DBM product line. Sales of products launched within the past five years accounted for 43% of the US orthobiologics revenue. Our US spinal implant surgery volumes increased 22% compared to the second quarter of 2021, while revenue per case increased mid-single digits compared to prior year. Utilization of our spinal implant systems and orthobiologics products increased to 2.2 per procedure in the second quarter of 2022 compared to 2.1 a year ago. We experienced low single digit average price declines in both the spinal implants and orthobiologics portfolios consistent with prior years. International revenue in the second quarter of 2022 totaled $6.8 million, a 39% increase compared to the prior year and included $1.1 million of enabling technologies capital sales revenue. Our continued focus on margin improvement yielded GAAP gross margin for the second quarter of 2022 of 66% compared to 63.2% for the second quarter of 2021. Adjusted gross margin also improved to 67.9% for the second…

Thank you, John. We are in a period where our largest competitors saw a loss in market share or experienced a slowdown in revenue growth, whether from ongoing supply chain challenges, higher than typical summer vacations or other transitory and COVID-related factors. However, SeaSpine is gaining momentum. We are raising our revenue outlook for the rest of this year and are on track to deliver the meaningful gross margin and P&L leverage we committed to for 2022. We are winning and taking market share with new and existing surgeons and distributors on the strength of our past successes, as well as our continued commitment to acquiring or commercializing innovative and differentiated technologies and complete procedural solutions. We enjoyed for years being called the best kept secret in spine by visiting surgeons and new distributors coming to our offices. That time is gone. The secret is out, as we continue to invest aggressively in growth and to relentlessly execute on our strategy to be the most innovative and customer-focused spine company. With that, thank you all for your time and more importantly, your support. We will now open it up to questions.

[Operator Instructions]. Our first question comes from Matthew O'Brien of Piper Sandler.

This is Phil [ph] on for Matt. Can you hear me all right? Congrats on the quarter. Just from what I see, 7D seemed to come in a bit sluggish. Can you talk about the capital environment right now and the impact it has on your business as a result? And is there any line of sight into how this capital environment will play out in the back half of this year and into '23?

Yes. I think the progress we're seeing on the earn-outs may or may not be indicative of some of the capital constraints that we're seeing with other companies reporting. But we're not seeing any fundamental shift in the outlook for capital sales for the full year or earn-outs. I mean, if anything, we're seeing a greater percentage of earn-outs showing up in the pipeline, but that's kind of what we anticipated as we got our distributor network working with the 7D sales force and really leveraging the spinal implant and orthobiologics portfolio. So obviously, we don't have a huge slice of the market. So it's tough for us to really say we're a barometer. But we're not seeing any fundamental changes, like I said, in the outlook for the year. And if anything, if there is capital constraints in the broader market, it probably plays well for the earn-out opportunities, which produce the longer-term revenue opportunities for us anyway.

And just a quick one here on gross margin. Adjusted gross margin of 67.9% was certainly above our estimates. What's the durability like here? And I appreciate you reiterating the 150 basis points to 200 basis points of leverage. But what's your cadence expectations for the second half?

Yes. So with the large stocking orders for the spinal implants in Europe coming in the third quarter, that's relatively low gross margin. So, we will see a dip in the third quarter gross margin solely because of the impact of that low gross margin final stocking orders, and then we expect it to pick back up in the fourth quarter when we don't have that low gross margin burden from European spinal implants revenue. So yes, we wanted to reiterate the expectations for the full year to deliver that gross margin expansion even in the face of the lower gross margin of roughly $10 million of relatively low gross margin for that European business. So it will be a dip in the third quarter because of that, but we expect it to pick back up to kind of current rates as we get into the fourth quarter and beyond.

All right. I'll hop back in the queue, but congrats again on the quarter.

Thanks.

Our next question comes from Kyle Rose of Canaccord Genuity. Kyle Rose, your line is open.

Great. You're breaking up a little bit there. So hopefully, you can hear me fine.

Yes.

Just wanted to think about the 7D commentary, just about the placements in the quarter and then the trends towards earn-outs. Just how we should think about that layering into the spinal implants business specifically from an earn-out perspective, whether it's internationally or in the US? How should we think about that from a modeling perspective there?

Yes, the earn-outs are really a US transaction. There's not much opportunity for us to do anything outside the US because we're selling to our stocking distributors. They may do earn-outs themselves. But for us, all the upside opportunity for earn-outs is in the US. And I suspect that it will be heavy on spinal implants, although we are seeing some interest in the orthobiologics is sort of the catalyst for the earn-out. But most likely, that will be triggering higher revenue on the spinal implant side. And the $2 million of annualized commitments we have, the units we've got in the pipeline that we expect to go to an earn-out in the third quarter and the fourth quarter is kind of what gives us the confidence to say we expect spinal implants revenue growth in the US to be above 20% for the year because, one, we're taking market share, right? We're seeing growth from bringing on new distribution, existing distributors going deeper with surgeons and bringing on new surgeons, but also just the clarity we're seeing from the earn-out commitments we already have and those we expect to close in the third quarter because those will be the ones that make an impact in the fourth quarter. Anything we close in the fourth quarter probably won't be a significant driver. But it's part of what gives us the confidence to raise our revenue guidance is what we anticipate generating revenue from those earn-outs mostly on the spinal implant side.

Okay. That's helpful. And then on the -- Keith, you talked about -- a lot about the commercial channel and just some of you bringing on onboard new distributors as well as getting ready to bring them on. Maybe just help us understand what's different about these distributors than some of them that you brought on in the past? And kind of just frame out what that pure feet-on-the-street opportunity looks like from upgrading those distributors?

Yes. What's a little bit different is the size and market share opportunity that we have with bringing aboard some of these new distributors. And so there's been a balancing act, if you will, between when we can bring them aboard, making sure that we have enough inventory. We have the investment in sets. A lot of the new products that we talked about that we're launching were key in making sure they were comfortable transitioning, meaning the products fit nicely into the portfolio for their surgeons and their surgeons' needs. And so it's different in the sense that we're investing ahead. We're making the right investments in inventory to bring them over and to make sure that we can satisfy the demand. And a little bit different than previous because a lot of our transitions before, we expected it to be a slower ramp. And these distributors, we are anticipating a faster ramp in how they're able to go after the market.

Okay. Great. And then just one -- squeeze one last [Technical Difficulty].

Our next question comes from Ryan Zimmerman from BTIG.

Can you put Kyle back in the queue? It sounds like he had another -- sorry, operator. Can you put Kyle back in the queue? It sounds like he had another question.

Yes. Ryan's line is open. [Operator Instructions].

Sorry to cut him off there. He will be fine. So let me ask a few questions, guys. I want to ask about, Keith, really the market sentiment and just trends in the July and August. I mean, there's been a lot of commentary from other companies so far in earnings season about momentum in early -- in March and then in April, but we did hear some commentary today on a call about things kind of slowing a little bit into July. Love to get your sense of the market into July and August. And then that was -- that comment was specifically related to the joint recon, a large joint recon just to be clear. So it could be very different in spine. And then I have a follow-up.

Yes. I think we saw, as we mentioned, a little bit in the script that there was some spottiness to the quarter. There was signs of real strength as we kicked off. And then I think we saw some like -- not concerns, but just light shifts in May, June with a strong close. So, I think what we're seeing is a number of factors. At least for us, we know that in our support areas around the United States, there was commentary about challenges with OR staff in certain areas. There was also even challenges with clinicians themselves coming down with COVID and being out of surgery for a week or so. So, I think it's individualized. We didn't see anything that I would say was concerning from a trend perspective, more probably just unique to our business and our coverage and where our market share sits across United States. As you look into the third quarter, we anticipate something similar. There's obviously vacationing schedules. There's going to be still certain areas that have more staffing challenges than others. But we generally and genuinely feel that the coverage across the United States will be able to accommodate those ebbs and flows. But I think the sentiment you're hearing is similar to what we're seeing. We may be just in different pockets for some of it.

No, that's fair. I appreciate that, Keith. And John, when I think about the investments in sets, this is obviously significant amount and you've already purchased a lot. Everything is on time, which is really great to hear given the supply chain environment. When do we see the impact of those spinal implant sets really having a material impact on growth? And as you think about -- and the second part of this question is, as you think about the distributors that you're bringing onboard, are you satisfying all their capacity? And what I mean by that is, do we expect to see more investments next year to meet the demands and the capacity of the new distributors you've brought on this year?

Yes. Sure. So a couple of ways to look at that. The investments we've made in the first half, most of those have been to support new product launches like the two WaveForm footprints that are out, Explorer Expandable Interbody. We just announced Meridian, which is probably one of the most anticipated launches in SeaSpine's history. Those are getting deployed now and should have a meaningful impact on revenue in the second half of the year, because they kind of -- tie that in with the distributors we are onboarding, in a lot of cases, those distributors are not going to utilize the sets we park in their territory very efficiently for the first month or two as they're ramping up. But what we're careful to do is make sure we put more than enough sets in those territories so that they've got comfort they can grow their business as fast as possible without risk of missing a surgery. So, there's typically a 2- or 3-month lag between when we deploy a set, particularly for a new launch or when we're onboarding a distributor. And when you'll see that start to generate revenue as efficient turns, which is a minimum of 3x, 3 surgeries per month because we're bringing onboard transformative distributors who have the confidence in us and our systems. We got to make sure they've got enough sets, more than enough sets to get their business started and to convert as much as they can for those that are flipping everything. Others, it's a more staged and planned conversion surgeon by surgeon, those you might not need to park as many sets, but we err on the side of parking more sets that are needed in those territories to give them the confidence they can turn on their business as fast as possible. And that's why you're going to see a little bit of a lag. So as we said, we've deployed about $30 million of that $40 million investment this year so far in the first half. $10 million more to go to support further product launches like the rest of the WaveForm footprint, but that's going to generate revenue growth in the first half of next year because a lot of those sets will get deployed in the back half of this year and be in a position to be utilized much more efficiently next year and move the needle for revenue.

Kyle Rose, your line is open.

Back in. So we talked about the commercial team on the distributor hiring side. I also wanted to see where you were at as far as building out the direct -- the small direct sales force. And any commentary on the timing around there would be helpful.

Yes. So, we kind of mapped out that, that was going to be a focus for us in the second half of the year. And so we are in and around decisions and driving that process right now. Obviously, we're looking at a couple of different ways. One is areas of white space that need the greatest help that we haven't been able to find the appropriate partners. And then the other is also ensuring that we're doing it as cost effective as possible. So, we'll be giving more updates on future calls on how progress is going on the direct side.

Our next question comes from Richard Newitter of Truist.

Congrats on another great revenue performance.

Thanks.

Wanted to maybe just talk on -- or ask on gross margin, SG&A and R&D. The first question on gross margin. Should we think of the 2Q as kind of a baseline as we think of where 2023 gross margin could be going, particularly considering that the mix is going to be accretive without Europe next year? And then just on S&M on a percent basis, obviously, it's increasing about -- in line with the revenue sequentially from last quarter. When should we start to see leverage there? Is that something that should materialize in the back half? Or is that more of a '23 event? And then R&D, how should we think about you guys getting your R&D margin up towards the target you laid out at your Analyst Day at around 12%? I'd love to just hear any thoughts there.

Yes. So Q2 gross margin, I think, yes, is probably a good indicator of where we can be in 2023 because we won't be having the lower gross margin European spinal implants revenue. We think we're past the biggest risk of E&O, excess and obsolete inventory provisions related to new product launches. E&O is a recurring part of the business, right? So that component will never go away. But I think we're past the greatest point of risk as it relates to new product launches, and we continue to see efficiencies slow but steady at the Irvine manufacturing facility and with volumes going up and being able to grow our orthobiologics revenue more than 10%, 15%, 16% this quarter. We're going to continue to get efficiencies out of that facility because of the fixed costs and the higher volumes, but also that team is implementing more efficient means to manufacture. So as we outlined in that March Analyst Day, there's lots of levers to pull to get that margin. And I think Q2 is a pretty good indicator for where things could go in 2023. On the sales and marketing front and R&D, the lack of leverage in sales and marketing, keep in mind, we had a full quarter of 7D sales and marketing Q2 this year, whereas when we had about a month in last year's Q2. So, a lot of that lack of leverage for sales and marketing is just a full quarter impact of 7D in the year-over-year comparison. On the R&D side, yes, we expect it to be ramping up, particularly with 7D and some of the initiatives they're going to be undertaking in the back half of the year. That will be some heavier project spend that will likely bump that rate up closer to what we expected for the full-year guidance where we said 12% as 7D continues to accelerate their development programs to bring those next-generation enhancements to market as fast as possible.

Thank you. Our next question comes from Jeffrey Cohen of Ladenburg.

[Technical Difficulty]. Just quickly wanted to ask about your purchasing cycles. I know you mentioned it's about a 6- to 9-month process. And I'm wondering if given the additional awareness -- and Keith, I think you said the secret is out, commentary like that, are you seeing that this cycle is actually decreasing, especially when it's coupled with the fact that relatively speaking, you're a much lower cost option.

Are you talking about the lead time with our suppliers?

No, I'm talking about the purchasing cycles for 7D.

Yes. So there are -- there's a couple of things that I think we've tried to make clear over the past, and that is that there's a couple of things that are making it easier for 7D for us. One of them, obviously, is the price point on the capital. But probably the more important one is, as we work through with these hospitals and even ASCs on the kind of the metrics for an earn-out, the earn-out is much more attractive. I mean, obviously, there's a price point component to it, but I think there's also a flexibility of the reality that we don't have a great deal of market share in a number of the accounts that we're talking to about 7D. And so the shift in market share that needs to happen to justify the earn-out is an easier equation, if you will. And so that's why we've had success getting earn-outs in ASCs because ASC settings are sometimes the most challenged to participate in earn-out programs.

Got it. Okay. And then of the systems sold in place this quarter, were they all into new accounts? Or were those any additional placements in existing accounts?

It's a mix, but more so into existing accounts. But the pipeline we're looking at is a lot of new accounts in both capital sales and earn-outs.

Okay. And then just like a quick housekeeping question for me. Actually, technically for you, John. I heard you mention different payment terms for your EU distributors. Should we assume a little higher accounts receivable in the near term?

Yes.

Our next question comes from Ross Osborn of Cantor.

So just looking at 2Q, could you parse out how much of growth was from new distribution agreements versus driving further penetration in existing accounts for the portfolio outside of 7D?

I don't have good metrics on the growth sources from new distributors versus existing distributors going deeper. Sorry. The good news is, we've talked about it in the past, the growth is predominantly coming from new distributors. But we're starting to see a shift of existing distributors going deeper and bringing on competitive reps in the distributorship and recruiting more surgeons to work with SeaSpine. So, I don't have exact metrics, but anecdotally, the most of the growth is still coming from recently onboarded distributors. But I think that will shift in the near term. But with some of the other larger distributors we've got in the pipeline that we anticipate onboarding that can shift right back to the growth coming mostly from new distribution. So, sorry, that's perhaps not the most helpful answer to be able to quantify it. But the good news is both of those sources of growth are alive and well.

No, no. That's perfectly fine. And then I guess just one more on 7D for me. Do you see any increase in demand or at least new interest from ASCs and midsized hospitals?

Yes. It's both in capital sales and earn-outs. But...

Yes. I think that right now, from an ASC perspective, a lot of our discussions and prospective opportunities, we're seeing an increase in interest. And so -- and again, I think it goes back to what we mentioned earlier that the economic equation for it is attractive. The ability to earn out is attractive or if they do want to do a capital purchase, it is more attractive than the competition. I think the other part, too, that bodes well is that they know that we're in the later stages of our MIS early launch, our alpha and beta, and now we're going to be moving towards full launch. And that has a great deal of excitement of the simplicity of our system being used in an MIS fashion.

Great. Congrats on the quarter.

Thank you.

Thanks.

Our next question comes from Jason Wittes of Loop Capital.

First off, just to clarify, you mentioned the tool set and inventory, a lot of it was going to hit at the end of the year and really kind of accelerate in the first half of 2023. Did I hear that correctly? Or is it a more bigger impact in 2022?

No. The question we got asked was the timing of when the sets we're deploying this year are going to impact revenue. A lot of what we spent in the first half of the year, $30 million of that $40 million investment was to support full commercial launches and also some additional sets we're deploying. But the back half of the year, it will be a bit more balanced between just launching more of our high-running sets, but still a meaningful investment in product launches because we still have WaveForm anterior and lateral to be fully launched, the Mariner Adult Deformity to be fully launched in the back half of the year. But we were just talking about the timing of when those set deployments are expected to generate revenue growth. And I was saying it's typically a couple of month lag because we want to park those sets in a distributor's territory as they're converting business. And we err on the side of putting too many sets in those regions because we want to make sure they've got the confidence they can flip as much business as fast as possible. But with that, we have the expectation those sets won't be as heavily utilized in the beginning as we anticipate later on, as those distributors ramp their revenue up. So hopefully, that clarifies it.

Yes. That does. Thank you for the clarification. And maybe another clarification. I think you said that 7D was seeing something like 50% pull-through of implant products or just general products, including biologics. Is that...yes.

Sure. That's on the non-contractual revenue. So on the earn-outs, we talked about the $2 million of committed annual revenue we've got under the earn-outs. The other metric we gave was where we do a capital sale of a 7D unit, and there is no earn-out revenue commitment, in half of those capital sales, we're seeing those accounts increase their purchases of our spinal implants and orthobiologics. So, we just want to give color that even the non earn-outs are producing -- the capital sales are producing upside revenue opportunities in spinal implants and orthobiologics. And it makes sense, right? Because we've talked about how we're integrating our spinal implants to be the easiest to use with the 7D technology. So while it will always be an agnostic system, we, of course, want our spinal implants to be the easiest and most seamless to use with that technology. So logically, it flows that we expect to see some pull-through revenue of our implants and orthobiologics in those non-contractual capital sales.

Okay. You anticipated my full question. And then on biologics, they're growing quite heavily -- quite healthy, I would say, way above market. It's almost double the market or triple the market. Are you surprised with those numbers? I know you do have some pretty significant new products. And in terms of the sustainability of the type of growth rate, how should we be thinking about it?

Yes. It's a great question, Jason. We have been kind of messaging the past 1.5 years or more with a great deal, I think, of interesting data, some that has been even accepted to JBJS and very important publications. And I think what we're seeing now is kind of that momentum shift of hospitals pushing back on expensive biologics, whether that's BMP or cellular technologies. The reality that cellular technologies more and more is being discussed that what you're paying for is not an increase in performance. And further, that DBMs, especially the research that we continue to publish and continue to push forward shows that high-powered newer DBMs with newer technology have the ability to not only be a great graft alternative, but also to be very cost effective. And I think what we're seeing is kind of the culmination of so much of that data finally getting absorbed in the marketplace, accepting that it's a great alternative for their patients in addition to having a nice cost savings for the hospital.

[Operator Instructions]. I'm showing no further questions at this time. I'd like to turn the call back over to Keith Valentine, CEO, for any closing remarks.

Again, thank you, everyone, for joining us this afternoon. And we look forward to updating you on results after the next quarter. Have a good afternoon.

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.