SeaSpine Holdings Corp (SPNE) 2015 Q3 法說會逐字稿

Welcome to SeaSpine's 2015 third-quarter financial results conference call. At this time all participants are in a listen-only mode.

(Operator Instructions)

As a reminder the conference is being recorded today, November 12, 2015. I would like to now turn the call over to [Carrie Mendevel], Investor Relations. Please go ahead.

Thank you for participating in today's call. Joining me from SeaSpine is President and CEO, Keith Valentine; and CFO, John Bostjancic.

Earlier today SeaSpine released financial results for the quarter ended September 30, 2015. During this conference call, we will make forward-looking statements within the meaning of federal securities laws in regard to our business strategy, expectations and plans, our objectives for future operations, and our future financial condition.

All statements other than statements of historical fact 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, November 12, 2015.

For a description of risk and uncertainties that could cause material differences between our actual results and those stated or implied by the forward-looking statements, please see our registration statement on Form 10 filed with Securities and Exchange Commission on June 9, 2015, which is available on our corporate website, www.seaspine.com and at www.sec.gov.

I will now turn the call over to Keith Valentine. Keith?

Thank you, Carrie. Good afternoon and thank you for joining us. I am pleased to provide an update on SeaSpine's first quarter as an independent company.

First, I will provide a brief review of our Q3 performance, then discuss the progress we've made since the spin from Integra and why we're so excited about where we are heading. I will then turn the call over to our CFO, John Bostjancic, who will provide detail on our financial results and provide our financial outlook for 2015. We will then look forward to your questions.

Turning to the quarter, consistent with the revenue decline from periods before the spin, overall revenue in the third-quarter 2015 was down 3%, driven in large part by a 5% decline in the Spinal Fusion Hardware business. What's encouraging in these numbers is the stabilization we are beginning to see, particularly with the US Orthobiologics revenues growing 2% over the prior year, the third consecutive quarter of low single-digit growth in the US.

Keep in mind, that Q3 was our first as a standalone company. I previously have said, it would take four quarters to reestablish ourselves, reengage with the surgeon community, and stop the revenue decline. I don't want to over emphasize one quarter, but I am very encouraged by where we are today and our prospects looking forward.

We have made substantial progress on a number of initiatives since becoming an independent company just a few months ago. And there are several areas where we will continue to focus. One of our primary goals at SeaSpine is to build a culture focused on growth, innovation, and accountability and we're building a world-class team that is excited about what we can accomplish over the next several years.

During the quarter, we continued steadily strengthening our team and deepening the bench. We filled out most of our leadership positions across operations, R&D, and our commercial group with very strong interest from talented individuals in joining our organization. We have made several hires in both the Orthobiologics and spine fusion hardware product development groups to drive sustained innovation and to bolster our product platforms.

On the commercial side, we've added new distributors as well as hired key individuals within marketing and sales management. We also recently announced the addition of Patrick Keran as General Counsel. Pat has over 15 years of legal and operational experience, primarily with respect to capital raising, corporate governance, and FDA regulated entities. I look forward to Pat's contributions driving our teams to embrace process simplification and enabling an ethical compliant path to our future success. These additions, and the high quality candidates interested in the Company, are a testament to the positive culture already being formed here at SeaSpine.

During the quarter, we began transitioning many functions to our new facility in Carlsbad, about 10 miles away from our Vista location. The Carlsbad facility has increased capacity for our machine shop for Spinal Fusion Hardware product development and customized instrumentation, and a larger cadaver lab for surgeon and sales force training. At Carlsbad, we have the capacity to take advantage of a focused approach with sales, marketing and development, and integrated supply chain coordination all under one roof.

By integrating the marketing and product development teams for both Orthobiologics and hardware, it enables a thoughtful approach to the market for each business. While we expect this first phase of the move to be completed by year end, we expect to move the remaining functions, particularly kitting, distribution, and customer service out of the Vista facility by the second quarter of 2016.

During the quarter, I have spent a good deal of time out in the field and visited with a number of distributors, our top surgeon customers, as well as surgeons with whom we could build stronger relationships. I have been gaining valuable feedback on what has been done well and where we need to improve in the field. Looking for opportunities to strengthen and build deeper working relationships in the future; feedback has been consistent.

Spine surgeons are excited by innovation, with NanoMetalene and Accell Evo3 as great entry points for SeaSpine. In addition, we had great booth traffic and interest at the North American Spine Society Annual Meeting in Chicago a few weeks ago. Enthusiasm for the new SeaSpine platform was high with a real buzz at the booth. While we were in Chicago, we also hosted an investor meeting where Dr. Jim Youssef and Dr. James Bruffey provided surgeon perspectives on our products and portfolios; and how they are differentiation adds value to their practices.

Moving to other initiatives underway, we have started many process and operational improvements to better position SeaSpine for long-term success. We are focusing these efforts on enhancing our ERP and other critical information systems to meet the unique needs of a pure-play spine company. Streamlining our kitting and distribution operations, increasing production capacity and reliability, and introducing changes to reduce the cost to manufacture our products. We are starting to see the payoff of these efforts with tangible progress on our supply stream.

During the quarter, we continued to wrap up spin-related activities, which we anticipate to be substantially completed by year end. Taking all of these activities together, we are creating and reinforcing a culture and environment of empowerment focused on process improvement, employee recognition and accountability, and that positions us well for sustained growth.

Turning now to our product portfolio. As many of you know, roughly half of our business is Orthobiologics and the other half is Spinal Fusion Hardware. Across both businesses we are investing heavily and portfolio improvements and innovation, with focus on three areas: One, on the R&D side to support rapid and timely launch of new products. Two, in manufacturing to build redundancies and increase capacity, and to support the efficient scale up of our Orthobiologics platform. Three, in ensuring enough implant and instrument sets are available to support a broad market release of new products, and to establish a recognized commercial presence.

We remain focused on our goal of launching 8 to 10 innovative, new, next-generation products or product-line extensions every year. On the Orthobiologics side of the business, we're in the process of launching the line extension to our Shaped Strip and Pocket Strip human allograft DBM product that provides a natural biologic scaffold with verified osteoinductive potential.

Moving to Spinal Fusion Hardware, we recently rolled out two hardware devices in conjunction with NASS, North American Spine Society. The Cambria NanoMetalene Cervical interbody fusion device is the latest NanoMetalene coated interbody device in the SeaSpine portfolio, which also includes the Ventura and Hollywood NanoMetalene interbody devices for TLIF procedures.

We also launched our new Cabo Anterior Cervical Plate system. This low-profile cervical plate system, with a quarter-turn locking mechanism, is a meaningful improvement to our cervical plating system portfolio, that we expect will generate stronger distributor and surgeon engagement.

Our NanoMetalene technology platform, to which we have exclusive rights in spine, remains a key area of focus. It offers the benefits associated with traditional PEEK devices such as modulus of elasticity, similar to bone, and radial [loosency] for imaging; allowing surgeons to view the operative area and determined the extent of the fusion of the vertebral bodies.

With a molecularly bonded titanium surface, on an uncompromised PEEK-OPTIMA implant, SeaSpine provides customers a durable interbody solution offering the best of both materials. It's worth noting that we put our NanoMetalene products through extensive destructive testing, insertion expulsion testing, as well as several other biomechanical tests. Our testing reveals no surface delamination, even under full plastic deformation of the devices. We have received 510(k) clearance for a number of additional PEEK interbody devices, and are committed to leveraging this compelling new technology and delivery interbodies that provide an optimal environment for fusion. We expect to roll out additional NanoMetalene coated devices in future quarters.

As we communicated on our second quarter conference call, we completed the assessment of our growth strategy for international markets in the third quarter, and adopted an approach to deploy and invest our limited sales and marketing resources dedicated to international markets in a more targeted manner in fewer countries.

As we introduce more new products in the future, we expect to leverage those new product launches to lead our international expansion activities. As a result of this shift in strategy, we recorded a $2.6 million charge for excess and obsolete inventory for international markets in the third quarter, for which John will provide more color in his remarks.

Overall, we expect the recent additions we have made in our marketing and product development teams to accelerate the timelines by which we can more efficiently bring new products to market. Of the products currently on our development pipeline or our limited commercial launch, we're focusing on four areas, MIS, complex spine and deformity, degenerative procedures, and a next generation XL DBM technology.

In summary, we are excited about the progress from our first quarter as an independent public company. We're building a culture focus on growth, innovation, and accountability; and are attracting robust talent across multiple functional areas.

We have started many process and operational improvements which will position SeaSpine for future success, and are building a solid foundation for future growth and a strong and sustained cadence of product launches.

I would now turn the call over to John Bostjancic to provide more detail on our financials and our financial outlook for 2015, then I will wrap up.

Thanks, Keith, and good afternoon, everyone. I will review the details of our third-quarter 2015 financial performance and will then provide updated guidance for full-year 2015 revenue.

Revenue for the third quarter of 2015 totaled $32.7 million, a decrease of $900 or 3%, compared to the same period of the prior year. Revenue in the United States totaled $30.1 million, a decrease of $500,000 or 2%; while international revenue totaled $2.6 million, a decrease of $400,000 or 14%, compared to the prior year. Revenue from Orthobiologics was $16.5 million, reflecting a decline of 1%; and revenue from Spinal Fusion Hardware was $16.2 million, reflecting a decline of 5%, compared to the third quarter of 2014.

The decline in Orthobiologics revenue was attributable to lower sales in international markets, which was partially offset by 2% growth in the United States, led by solid sales growth in our third generation XL DBM technology.

Spinal Fusion Hardware product revenue declined by 5% in the United States and was relatively flat internationally. In the United States the Spinal Fusion Hardware portfolio continues to face pricing pressures and lower demand for existing products, while delays in introducing some of our new products likely negatively impacted revenue in the last quarter. In our international markets, the decline in revenue in the third quarter 2015 was driven primarily by lower sales of Orthobiologics products in Latin America.

Gross profit for the third quarter of 2015 was 46.9%, an 11 point decrease compared to the same period in 2014. This decrease was driven by $4.4 million of charges for excess and obsolete Spinal Fusion Hardware inventory, essentially all purchased by Integra prior to the spin off.

Our gross profit for the third quarter of 2015 was also negatively affected by costs related to sales during the quarter of our Mozaik product inventory, the cost of which was approximately $1 million higher than would be expected had it been purchased subsequent to the spin off under our supply agreement with Integra. These costs were partially offset by lower manufacturing costs, resulting from increased production volumes and more efficient production of our Orthobiologics product portfolio.

In the fourth quarter of 2015, we expect that our gross profit percentage will be negatively impacted by a similar amount as it relates to the cost of Mozaik inventory that we sell. We expect to transition the manufacturing of most of our Mozaik product inventory needs to our Irvine, California facility in December 2015.

The lower cost of that internally manufactured inventory, compared to the historic cost of Mozaik inventory from pre-spin periods, and that which we purchased from Integra, subsequent to the spin off under the supply agreement, is expected to drive improvements to our gross profit percentage beginning in the second half of 2016. Going into a bit more detail on the excess and obsolete spinal hardware inventory charge, as we mentioned during our Q2 call in August, we initiated a reassessment of our international strategy following the spin, which we completed in the third quarter. We determined to focus our limited sales and marketing resources dedicated to international markets on existing distributors with a renewed emphasis on new product introductions. As a result of this shift in international strategy, and included in the $4.4 million charge for excess and obsolete inventory reported in the quarter, was a $2.6 million charge for inventory that was intended for distribution in international markets. Taken together, the $1 million impact of the higher Mozaik cost of goods sold and the $2.6 million excess and obsolete inventory charge for international inventory reduced our gross profit percentage in the third quarter of 2015 by 11 percentage points. We do not consider either of these items to be reflective of our longer term gross profit percentage profile.

As we further refine our global strategy post spin off through the remainder of 2015, we may identify additional risks related to inventory and other assets purchased or otherwise acquired prior to the spin off that could be impaired by those decisions.

Operating expenses for the third quarter of 2015 increased $6.2 million to $30 million, with the increase coming primarily from higher SG&A expenses. SG&A expenses increased $6 million to $26.3 million for the third quarter of 2015, compared to $20.3 million for the same period of the prior year. This increase was primarily attributable to $4.3 million of spin off related transaction fees and transition service fees; $1 million of increased stock-based compensation costs; and $4.9 million of higher operating expenses, primarily related to higher compensation costs due to increased headcount; and higher insurance, audit, legal, and other related fees; and infrastructure costs associated with being an independent publicly traded company. These increases were partially offset by the absence of $4.2 million of allocations of expense from Integra that was recorded in the third quarter 2014.

R&D expenses increased $300,000 to $2.4 million, or 7.2% of revenues, for the third quarter of 2015, compared to $2.1 million for the same period of the prior year. This increase was primarily driven by higher compensation costs due to increased headcount and higher external costs related to product development and clinical studies, and is in line with the higher R&D expenses as a percentage of revenue that we are targeting to drive innovation.

We reported a $275,000 benefit for income taxes in the third quarter of 2015, compared to income tax expense of $840,000 for the same period of the prior year. The primary driver of the tax benefit in the third quarter of 2015 was an increase in realizable deferred tax assets of a foreign subsidiary, partially offset by pretax losses incurred by the consolidated US tax group that received no corresponding tax benefit.

Prior to this quarter, we have historically reported income tax expense despite the reported losses before income taxes because our legal entity structure did not permit the offset of taxable losses generated by certain of our US subsidiaries against the taxable income generated by another of our US subsidiaries. Effective September 1, 2015, we made an election that will allow us to offset any future taxable losses generated by our US subsidiaries against any future taxable income generated by our US subsidiaries.

Net loss for the third quarter of 2015 was $14.2 million, compared to the net loss of $5.3 million for the third quarter of 2014. Cash and cash equivalents totaled $38.5 million as of September 30, 2015. During the third quarter of 2015, we invested our cash in additional Orthobiologics inventory to support the expected accelerating growth in that portfolio in the US, and an additional spine hardware implant inventory and instruments to support the recent and upcoming new product introductions and to increase the number of sets in the field of our higher revenue legacy Spinal Fusion Hardware products. And we made cash expenditures related to the spin off, in commencement of operations as a separate publicly traded company, that contributed to the cash spend since the spinoff.

We expect to incur additional such expenditures related to the spin off in the fourth quarter of 2015, including an additional $1 million to $1.5 million of expenses under the transition service agreements with Integra, that will result in higher operating cash flow spend rate than we expect to incur in future quarters.

We are also making, and plan to continue to make, investments in our new Carlsbad facility and to further increase production capacity in our Irvine manufacturing facility. We are investing for revenue growth and to simplify and streamline our operations now so that we can grow more efficiently in the future. We continue to believe that we are well capitalized with cash on hand to fund our near term growth initiatives and expect to close a credit facility before the end of the year that will provide an additional source of funds to support growth and operational improvements.

Today we are updating and narrowing the top end of our revenue guidance for the full year 2015. We expect revenue will range from approximately $133 million to $135 million, compared to our previous guidance of $133 million to $139 million. Our 2015 guidance represents a 3% to 4% decline versus 2014. Compared to the almost 6% year-over-year decline between 2014 and 2013, our updated guidance keeps us on track with our goal to slow the revenue decline during the first year post spin and; thereafter, to return to revenue growth.

Long-term, and as we build scale to our business, we're targeting gross margins in the low- to mid-60% range; investment in R&D to approximate 7% to 8% of revenues; and SG&A, excluding non-cash equity based compensation charges, to approximate 56% to 60% of revenues. We expect to provide financial guidance for 2016; including revenues, gross margin, and operating expenses when we report our year end results in early 2016.

At this point, I would like to turn the call back over to Keith for closing comments.

Thank you, John. On our last call, we defined our growth objectives which remain in place. In 2016, we're focused on reducing, then reversing, the history of revenue decline. In 2017, we expect to show solid single-digit growth, and in 2018 double-digit growth.

At the same time, we expect to be in a position to drive greater manufacturing efficiencies with scale, bringing down our cost of goods, which will enable us to achieve our gross margin target in the low- to mid-60s. We believe that we have the right products, pipeline, and people to penetrate the market opportunity in front of us. Our focus remains clear, effectively scale our business and advance our market position through targeted investment, strong execution, and a powerful culture.

We look forward to updating you on our progress on future calls. With that, we will now open it up for questions. Operator?

(Operator Instructions)

Matthew O'Brien, Piper Jaffray.

Good afternoon, guys. Thanks for taking the questions. Keith, let's look at the drop with the (inaudible) -- your Orthobiologics performance in the US in Q3 here. Did you say that grew 2%?

Yes, US was up 2%.

Okay, and how has that been trending? Is that the first quarter of growth you've seen in a while?

No, actually we have had three straight quarters of growth in Orthobiologics. As we talked about earlier in the year, we were constrained by the supply issues, and the investments we are making in the Irvine facility are starting to pay off. They've increased production volumes and they're producing things more efficiently with less write-offs. We think we're past the worst of it and expect to see accelerating growth in the Orthobiologics portfolio now that supply is not a constraint.

If you remember, one of the things we're excited on the supply side is we felt constraint because we [could] advance to areas that may not be fully penetrated or expand to new surgeons, and so we're quite excited because of what's happened on the supply side as we move forward to be able to advance properly.

Okay. Was that a headwind here in Q3 that you saw as far as capacity constraint?

No, it's not a capacity. No, actually we have seen us turn the corner in the third quarter. The third quarter -- we went into the third quarter with some challenges on the supply side and we have really seen us turn the corner now, which makes is very excited for fourth quarter and 2016.

Okay. I'm sorry to keep harping on this point, Keith, but was there a level of revenue that you potentially lost out on here in Q3 because you came into the quarter with some challenges?

No, we did not lose revenue to existing customers. Our challenge was how fast we could expand to new customers or even expand to new distributors. That's where we're getting our greatest relief now, is we're able to start thinking and doing that.

Okay. As far as the international change, and I know it is a smaller business for you guys, but should we think about that segment of the business as being somewhat of a headwind for the first half of 2016 as you go through these adjustments? Or can things improve faster there early next year?

No. The way we are viewing it is, this is our opportunity instead of getting distracted by advancing to other areas and starting new distribution, we need to focus on the distributor relationships that we have. And by focusing on those relationships, we feel strongly we will be able to be partners with them to grow their business. We don't view it as a headwind, as much as we view it as a focus issue now with the limited resources we have in international.

Okay. Then a couple more for me, if that's okay.

Yep.

The new distributors that you mentioned bringing on board here in Q3, can you give us a sense for how many of those you did bring on? Were they incremental? Did you replace existing distributors? And then how long did those folks take to get up to speed?

Yes. From a metrics perspective, right now the way I think it is best to look at it is, we did improvements in the third quarter. Meaning, we made the right changes for focus in areas that we were under penetrated. From a numbers perspective, it's not as significant as far as gives and takes on how we did that. I think what's important is we are muscle building, putting the right individuals in place to help really drive the business for 2016 and beyond.

Okay. If we look at Q4 guidance, at the low end of the range it assumes a pickup in your Orthobiologics business and not as much of an issue, I'm sorry, decline in your Spinal Fusion Hardware business. Is that a function of the ability to get to new surgeons where you feel comfortable with laying out guidance that assumes a little bit better performance here into Q4? And then to get to the higher end of the guidance range, what would need to happen? Or should we think about things more at the low end of the range versus the high end?

I think the high end of the range would imply a quicker recovery for hardware to start growing than we forecasted. There's obviously upside opportunity there, but the low end of the guidance implies not a significant improvement in hardware, but growth starting to accelerate with Orthobiologics, which is kind of what we have been signaling all along, right?

We expect the growth to start with Orthobiologics, as we move past those supply issues, and then hardware as we continue to rollout new products we expect to get accelerating growth there. So the high end of the guidance range would imply a quicker recovery in hardware than the original expectations.

Matt, I think as you are aware as this goes, it's such a relationship-based business and we are making the right moves with distribution to really muscle build, as I mentioned before. And so, yes, as John just said, the high end would imply that they are getting traction quicker, right? But I think the reality is, is we expect in some areas this traction to come rapidly, but the realistic expectation is that traction will come progressively. It does take time for them to build a new product line in their bag, so to speak.

Okay. Last one for me, I promise. You guys don't want to talk about 2016 numbers here too much, but you gave us 2017 and 2018 top-line projections. Is it fair to think about 2016 as maybe a low single-digit growth year?

We are reiterating what we've said all along is, it's sort of a three-year progression. So the first quarter is post spin and stop the decline in hardware, and start to see some accelerated growth in Orthobiologics. Year two, is starting to see single-digit growth across both portfolios. And by year three hit double digits.

So again, without giving quantitative numbers for 2016, that kind of fits into that first year profile where we are seeing stopping the decline in hardware and seeing accelerating growth starting to happen in Orthobiologics.

I think I tried to express, Matt, we're very encouraged by how things had progressed in the third quarter, and certainly looking forward to the fourth quarter to define how we can predictably have that growth pattern for 2016, of course. But right now we're very encouraged by the direction it's going. Yes.

Got it. Thank you.

Thanks.

Thank you. I am showing no further questions. I would like to hand the program back over to our management for any additional remarks.

Great. Thank you, everyone, for joining us today and have a great evening. We will be talking to you on the fourth quarter call next year. Take care.

Ladies and gentlemen, thank you very much for your participation. This does conclude the program. You may now disconnect.