SeaSpine Holdings Corp (SPNE) 2016 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Seaspine Holdings Corporation's First Quarter 2016 Earnings Conference Call.

(Operator Instructions). As a reminder, today's conference call is being recorded.

I would now like to introduce your first speaker for today, Leigh Salvo, with Investor Relations. You have the floor, ma'am.

Thank you, and thank you all for participating in today's call. Joining me from Seaspine is President and CEO Keith Valentine and CFO John Bostjancic. Earlier today, Seaspine released the results for the quarter ended March 31st, 2016.

During this conference call, we will make forward looking statements within the meaning of federal securities laws in regards to our business strategy, expectations and plans, our objectives for future operations and our future financial conditions. 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 believe based on current information and speak only as of today, May 12th, 2016.

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 statement, please see our annual report on form 10-K filed with the Securities and Exchange Commission on March 16th, 2016, 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, Leigh.

Good afternoon, and thank you for joining us. When we spun out from Integra in mid-2015, we communicated a goal of using the first four quarters to reposition the Company, reengage with the surgeon and distributor community and stop the revenue decline. During the first quarter of this year, we continue to make meaningful headway towards reaching these milestones and securing a path that we believe will lead to long term future growth.

I'd like to use, as the first part of this call to review the progress we've made to date and highlights of the first quarter. I will then turn the call over to our CFO, John Bostjancic, who will provide detail on the quarterly financial results in an update on our guidance for the full year 2016. I'll make some closing remarks and open for questions.

Turning to our first quarter performance, total revenue was $31.4 million. This represents a 2.8% decrease compared to the prior year period. We continue to execute to plan and took more positive steps towards reversing the multiyear revenue declines inrepositioning Seaspine for innovation and scalable growth.

As a reminder, our sales include a balanced mix of orthobiologics and spinal hardware. In the first quarter this year, we saw continued strength in our orthobiologic sales, which were $16.7 million, 3.9% improvement over the first quarter of 2015. Hardware sales were $14.7 million, a 9.5% decrease compared to the first quarter of 2015 primarily reflects continued pricing pressure in the US and lower case volumes on many of our legacy products, somewhat offset by a higher revenue from new and recently launched products.

We remain encouraged by the progress that we have made and continue to make in re-engaging the surgeon and distributor community to establish and build upon new and existing relationships that will drive future revenue growth in the hardware portfolio. There is roughly a six to nine month lag time between establishing those new relationships and incremental new revenue that moves the needle on growth.

Additionally, we believe that the cadence of new and next generation products already relaunched and scheduled to be launched in 2016 and beyond will provide new and exciting benefits to our customers that will drive sustainable revenue growth. With the progress that we have made, I remain confident that we are on track to achieve the milestones that we outlined in our three year plan post spinoff.

To that end, I'd like to highlight some of the great progress we are making in our multipronged approach to growth. First, as it related to reengaging the distributor community, we expanded our footprint over the past two quarters by establishing new relationships where we had minimal or no presence or were underpenetrated, in particular, the Northeast and Southwest.

We now have the opportunity to significantly grow our revenue base in these geographies and are starting to see tangible results from this in the second quarter and are well positioned to benefit as we approach the seasonal volume pick up from scully season.

Second, an important initiative we took early on as an independent company was to broaden awareness among the surgeon community of who we are and where we are going. Surgeons continue to look for meaningful partnerships with companies that are committed to working together to improve solutions they offer to their patients. Time and again, we get feedback that surgeons do not feel valued by large orthopedic companies.

We know that focusing on and understanding the needs of our surgeons customers is critical to developing new products that are best for the patient and ultimately what will drive our success. Not only will surgeon engagement result in products that address clinical and market needs, but we also expect the collaborative environment we are fostering will make us the spine company of choice, whether for surgeons, distributors or new employees. Partnership opportunities not only include new development projects but also medical education and training programs and events.

To that end, we recently held Seaspine's fifth annual Spring Symposium, where we hosted more than 20 surgeons and physician assistants, including some first time attendees on the safe and effective use of our products. The two day course consisted of two tracks, one focusing on minimally invasive surgery and the other on complex spine surgery. The course included didactic and multiple canaberic surgical sessions. The feedback we received on the event was exceptionally positive, including one well known surgeon who commented that it was one of the best educational events he'd ever attended.

In parallel with the spring symposium event, we conducted a deformity bootcamp course for a select group of distributors and our sales management. This course was the beginning of a six month program that includes canaberic training, didactic sessions, surgery observations and support. We expect those who graduate from the program to be equipped to deliver value to their surgeon partners by understanding the objectives of a variety of treatment strategies and facilitate successful deformity procedures from beginning to end.

Last month, we also conducted the second of our quarterly surgeon counsel events. Surgeon advisors were asked to present challenging cases and discuss the biggest hurdles they face today. These discussions enabled our team to better understand those challenges so we can develop solutions that currently do not exist.

Turning now to product development, we are investing in both our orthobiologics and our hardware platform and continue to target the launch of 8 to 10 new or next generation products or product line extensions this year. We're also devoting resources to support the successful uptake of the products we have recently launched. Of the products currently in our development pipeline or in limited commercial launch, we plan to remain focused on four areas over the next two years, MIS, complex spine and deformity and generative procedures and a next generation excel DBM technology. We are also looking to add a new synthetic orthobiologic product to the bag as well.

Since December 2015, we launched five new products that either refreshed and upgraded aging products in our portfolio or gained us access to procedures where we didn't previously have a product offering to address them. These new products include the pure strip demineralized bone matrix, designed specifically for use in lumbar fusion procedures, a cambria and nano metaline cervical interbody fusion device, a cabo interior cervical plate system and two alternative systems to pedical screw fixation via spinus process plating or the use of a vacep screw.

These five new products provide our fresh opportunity for our distributors to start conversations with surgeons. We are particularly excited about the potential opportunities from our cabos cervical plating system, a low profile plate with very large graph windows for surgeon visibility, a streamlined plate footprint to minimize adjacent segment impingement and a simple camlock to provide confidence in the surgical construct.

The cabo system, the first significant new product introduction since the spinoff progressed from alpha launch to full market launch last month, and replaces our legacy cervical plating systems that were launched in 2005 and 2010.

We are also excited about the future contributions to growth from the new and next generation products and programs that we plan to launch later this year and in early 2017. In particular, because of the size of the markets they address, I'd like to take a few minutes to share some of the details with you.

First, let's start with our next generation cervical standalone interbody device that we expect to introduce in the fourth quarter. This new IBD will provide ultra low and no profile cervical spinal fixation and realignment with flexible construct modularity to provide a variety of footprints and/or doses options along with better instrumentation. You will see that providing more and low doses options to restore saginal balance is a reoccurring theme in many of our new interbody device product launches.

The next gen cervical standalone IBD is an important upgrade to our portfolio, replacing two existing systems that were launched in 2010 and 2011, and is another great addition to our cervical portfolio, following the recent launches of the cambrio nano metal interbody and the cabo cervical plating system.

I'd like to also focus on our next generation pedical screw, a versatile system that will provide a modular design that can be configured to treat a wide range of pathologies including degenerative deformity and MIS to reduce the number of trays needed in the operating room. The cost effective modular design is becoming increasingly more important as companies look to lower the overall costs to effectively and broadly launch new spine implant systems.

We expect to alpha launch this system, which will replace our existing systems launch in 2005 in the fourth quarter of this year. We also expect to launch the next generation of our view apod prime interbody device for A lift procedures in late 2016. The system will include a higher lower doses to options and our proprietary nano metal encoding along with improved instrumentation.

Finally, while not entirely focused on new product introductions, it's important to note that we have refocused the priorities or our lateral program by first emphasizing surgeon and distributor training and education to increase clinical and procedural knowledge and to improving our access system in 2016, followed by the introduction of optimized next generation implants, including more lower doses options and the addition of our proprietary nano metaline technology in 2017.

Collectively, these new and next generation products and technologies that we have already launched and plan to introduce in 2016 address markets that approach $3 billion in the United States and represent a critical step to updating and refreshing the aging product portfolio that we inherited with the spinoff. And while today our international revenue represents only around 10% of our business, we remain focused and committed to developing and launching these and future new products in a cost effective manner and to address the needs of our distributor partners and surgeon customers in international markets as well.

Shifting now toward the continued progress that we are making in 2016 toward the better integration of our hardware and orthobiolgics' commercial activities into our new Carlsbad facility. We're nearing completion of construction of the machine shop for spinal hardware product development and customized instrumentation, our orthobiologics scientific lab and a larger cadaver lab for surgeon and salesforce training. This follows the smooth transition of many commercial and product development functions for the orthobiologics and hardware portfolios at the end of last year.

All these accomplishments give us the capacity to take advantage of a more focused and collaborative approach with sales, marketing, development and integrated supply chain coordination, all under one roof. We also made the decision in late March to move the spinal hardware kitting and distribution operations out of our Vista facility by yearend 2016 and into a third party logistics provider in Memphis Tennessee. This transition is expected to significantly reduce costs, increase customer service levels b optimizing logistics and freight and providing for scalable capacity to facilitate our expected future growth.

I'll now turn the call over to John to provide more detail on our financials and our financial outlook for 2016 and then I will wrap up.

Thanks, Keith.

And good afternoon, everyone. I will review the details of our first quarter 2016 financial performance and will then provide our updated financial outlook for 2016.

Revenue for the first quarter of 2016 totaled $31.4 million, a 2.8% decrease, compared to the same period of the prior year. Revenue in the US totaled $28.5 million, a decrease of 2.8% versus prior year, while international revenue totaled $2.9 million, a 3.3% decline versus the prior year.

Revenue from orthobiologics products totaled $16.7 million, a 3.9% year over year improvement, while revenue from spinal hardware totaled $14.7 million, a 9.5% declined compared to the prior year.

The increase in orthbiologics revenue was led by continued growth of our third generation excel DBM technology and was somewhat offset by declines in our synthetic orthobiologics products. We are very pleased to see the improvements we made in our orthobiologics supply stream have already translated into growth in that business already this year.

Spinal hardware product revenue declined 9.7% in the United States, where our portfolio continues to face mid single digit pricing pressures and lower case volumes for existing products, the effect of which was reduced by increased sales of recently launched products.

Gross margin for the first quarter of 2016 was 54.5%, a 6.5%age point decrease compared to the same period in 2015. Reflected in the current quarter gross margin is a $1.7 million charge to reserve against excess raw material used in the manufacture of certain of our DBM products and approximately $300,000 of amortization of the remaining spinoff related valuation step up on our mosaic inventory. These two have announced combined to reduce our gross margin by 6.4%age points.

The charge for excess raw material, of which $700,000 was purchased by Integra prior to the spinoff, resulted from actions by management to repurpose certain other raw materials in the manufacture of a different type of DBM product. This significantly limits the potential uses of the affected raw material, and therefore left us with quantities that are not expected to be consumed prior to the shelf life expiration. However, it allows us to avoid purchasing at least $3 to $4 million of the repurposed raw material over the next 12 to 15 months. We are also seeing alternative uses of the $1.7 million of excess raw material in other potentially marketable finished goods, that could reduce the ultimate economic impact of the charge.

Looking to the remainder of 2016, we continue to expect gross margin improvement in the second half of the year, as we begin selling the lower cost mosaic products that we began to manufacture in our Irvine facility in December 2015, and as we begin to realize the benefits from increased manufacturing volumes and the greater efficiency achieved in the first quarter of 2016.

Operating expenses for the first quarter of 2016 increased $1.4 million to $29.4 million, with the increase coming primarily from increased investment in product development. R&D expenses increased $1.2 million to $2.8 million for the first quarter of 2016, from $1.6 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 many product development programs that Keith discussed earlier. And it was in line with the higher R&D expenses, as a%age of revenue that we are targeting.

SG&A expenses increased $300,000 to $25.4 million in the first quarter of 2016, compared to $25.1 million for the same period of the prior year, and included $1.6 million of stock based compensation. This increase was mainly driven by an approximately $9.6 million increase in direct operating expenses, including higher salary costs due to increased sales, marketing and administrative headcount and the expansion of our executive management team and increased costs associated with being an independent publicly traded company.

Many of these operating expenses were previously represented in the expense allocation for Integra, recorded in SG&A prior to the spinoff. All of these increases were offset by the absence of $4.2 million of expense allocation from Integra, recorded in the first quarter of 2015, $4.9 million of non recurring global ERP implementation and spinoff related charges and $300,000 of medical device excise tax that were reported in the first quarter of 2015. As most of you know, congress enacted a two year moratorium on the medical excise tax beginning January 2016.

Other income and expense net increased $1 million to $258,000 of income in the first quarter of 2016, primarily due to the positive impact of foreign exchange rates on our outstanding foreign currency denominated inter-company receivables and payables. In May, we settled the vast majority of these inter-company balances and therefore do not expect this level of volatility to foreign currency exchange rates in the future.

We reported an insignificant income tax benefit in the first quarter of 2016, compared to income tax expense of $860,000 for the same period of the prior year. With a revolution in the third quarter of 2015 of the tax and efficient legal entity structure that was inherited with the spinoff, we expect to report minimal cash income tax expense in 2016.

Net loss for the first quarter of 2016 was $12 million, compared to the net loss of $9.9 million for the first quarter of 2015. As of March 31st, 2016, cash and cash equivalents totaled $28.6 million and we got $361,000 of outstanding borrowings against our credit facility.

We remain in a sound financial position and plan to continue to accelerate our organic growth objectives, including the ongoing expansion of our orthobiologics manufacturing capacity and efficiency initiatives, as well as funding and commercially supporting new product launches in our hardware business.

Turning to our financial outlook for 2016, we are reiterating our expectations for 2016 revenue in a range of $136 million to $140 million, reflecting topline growth of 2 to 5% versus 2015. We anticipate that revenue growth in 2016 will be weighted towards the second half of the year, as we begin to more fully realize the cumulative benefits of the increased surgeon engagement, our expanded and upgraded sales management team and a new distributor relationships as well as reasoned and planned new and next generation product launches.

Moving down the P&L, we expect GAAP gross margin to be in the range of 57 to 60%, which includes the impact of approximately $2.7 million of annual non-cash intangible asset amortization and the $1.7 million excess raw material charge recorded in the first quarter of 2016. We expect R&D to approximate 7 to 9% of revenue and SG&A, excluding non-cash equity based compensation charges, but including the non-recurring cost to transition your spinal hardware kitting and distribution operations from our Vista facility to the third party logistics provider to approximate 68 to 72% of revenues.

As we transition out of and close the Vista facilities and complete the outsourcing of our kitting and distribution operations by the end of the year, we estimate that we will realize an - in excess of $1 million of annualized ongoing SG&A cost savings in 2017, compared to the recurring cost base of these activities in the 2016 SG&A expense base.

We are continuing to identify and plan to implement other similar cost saving and improvement programs in the future, as we strive to further improve the efficiency and scale of our growing operations and infrastructure and improve the level of service we provide to our surgeon customers and distributor partners.

In the next two to three years, as we build scale for the business, we continue to expect to generate gross margins in the mid 60% range, invest 7 to 8% of revenues in R&D and reduce SG&A, excluding stock based compensation, to between 56 and 60% of revenues.

We plan to end 2016 with roughly two years of liquidity as measured by cash on hand and availability under our credit facility compared to the annual cash spend rate. This reflects the significant planned investment in 2016 to complete the build out of our Carlsbad and Irvine facilities and additional investments to improve our information systems and related business processes.

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

Thank you, John.

In summary, we continue to execute on plan against our goal to achieve single digit growth this year. I believe a transition like this starts internally and I'm proud of the success we have had in attracting and retaining leaders in this fine industry and from the related medical device field.

Our organization is now more than 350 strong, with everyone contributing to the culture of commitment and accountability that is so critical to our success. We have established a strong financial foundation and have the resources needed for sustainable growth. We have bolstered our product platforms and developed a long term plan for innovation and execution.

Our leadership team has also established a framework and begun to implement reliable and more cost efficient manufacturing and supply chain processes to ensure an adequate supply of orthobiologics and spinal hardware products to give our distributors the confidence they need to market our products globally. At the same time, we have made notable progress on the commercial side by renewing and expanding relationships with key distributors and we have expanded our regional breadth, increased and strengthened our sales management team, created more concentrated sales territories, added new distributors as well as hired key leaders and individuals within product development and marketing.

We look forward to updating you on our progress on future calls.

With that, we will now open it up to questions.

Operator?

(Operator Instructions) Matthew O'Brien from Piper Jaffray.

I've got a number, so let me know if I'm overstepping my quota here -

Okay.

-- but just to start with on the hardware side, Keith or John, you know, this was the lowest quarter that you seen - that the Company's seen in quite a while, and so I'm just - I'm just trying to get a better sense for - you know, what's gone on there. I think - I think the last couple of quarters that have been kind of more stabilizing than this quarter down about 10% off a fairly easy comparison, so just - can you give a little more color on exactly what's going on from a legacy product perspective et cetera?

Yes, I'm sorry, can you repeat that last part of the question?

Yes, just - you know, I think this is the first quarter where - I mean the last couple of quarters you've been more flat on the hardware side, as far as the growth rate goes, and then this quarter you know, it's a step down to about 10% off a fairly easy comparison, and those comps actually get a little easier for you going forward, so you know, what perhaps are a little harder going forward? So, what was it here that really impacted the hardware business from a - you know, legacy - you know, product perspective et cetera?

Couple of things, so if you look at even as recent as Q1 of '15 and compare that to '14, it's about the same challenge. And you know, from our perspective, there's a number of new products that are - be coming online that really either refresh or replace these legacy products and will stop that kind of challenge we have of the promotion that goes along with legacy, right. So, we have not only refreshment that I mentioned, but also new products that will replace those, that we feel really comfortable, especially in our conversations and our strategy with our distribution team that will really move the needle for them as well.

So, you know, I guess we view it from a similar stance that we viewed it probably in Q1 of '15 as well, that the legacy products have to be replaced. And we have the right development projects in place to do that.

Okay. And then you know, how does the distributor base look throughout the quarter? Did you lose some at - to start the quarter and then you replaced them as you exited? Or was there any - anything notable there?

No, actually what's been most notable is the areas that we've had gaps, we have aggressively put in new distribution and then heavily partnered with that distribution to get them a head start as fast as possible. And those areas, as I mentioned, particularly the Northeast, the Southwest and even Southern California are areas that we have a great deal of focus and new distribution that are really going to help move the needle.

We have very little turnover in the distributor network and you know, to the little amount that we have, I believe we're replacing it with - you know, upgrades to the distributor network and as Keith said, it's in geographies where we really didn't have a presence or were underpenetrated. So, we're - you know, we're still adding distributors and I think we adding the right quality and we're adding them into the right places. That's sets us up nicely for the growth that we anticipate in the back half of the year.

Okay. Can you give us any examples of you know, some of those distributors you've onboarded over the last six months that have been - you know, pretty significant successes and you know, what they're seeing, as far as the hardware business goes and what gives you that kind of confidence in - you know, in that business accelerating throughout the course of the year?

Sure. So, a couple of - if you look at two in specific, if you look at the Northeast and compare and contrast that to what goes on Southwest or Southern California, you know, a little bit difference in that the Northeast, there's a little bit greater of a lag as we get access into those hospitals that we've never participated in. So, when distributors first come on, the first is getting the right access. And then from there, we have the opportunity to promote the products appropriately and properly to those surgeons that participate in those health systems.

Southern California on the other hand, a little bit different. We participated in a lot of those accounts already, fortunately a lot of those through our orthobiologics franchise, but more importantly, now we have greater focus and greater feet on the street, so to speak, in the Southern California market that we'll be able to penetrate even quicker.

So, each area has different challenges, one being we first have to get approval and access, which takes a little bit more time. On the other side, in the Southern California example I made, it's a matter of making sure they're educated on the products and the training side of it and now letting them loose in accounts that we already have. So, each of those is different, but gives us great reassurance of how we're going to be able to see the momentum shift as we continue through the year.

Okay. And then Keith, you know, how did - how did the hardware sales progress through Q1, from January, February to March? And I know - you know, I'm sure January was a slower month for you, but if you compared those periods - compared to this time last year, did you see an acceleration maybe in March, as you exited the quarter that gives you confidence in the full year?

Yes. So, I would say we see it pretty similar to how we saw it last year, as well, that the first quarter does have that kind of acceleration toward the end of the year - or sorry, towards the end of the quarter or at least stability I should say. And we're certainly pleased with - you know, how we feel things are going to progress now moving forward quarter 2 into really setting us up nicely in Q3, Q4, which is really where a lot of things hit, right. We have new distribution that will be in a better place. We have new products coming forward as well. So, we really see that shift coming as we start exiting the year.

Got it. Okay, and then just thinking about guidance for the full year, I mean it does - again, you know, that your comps get a little bit more challenging not significantly more difficult, but harder, you know, again, what gives you the confidence of getting to that 2 to 5% number? Would you feel more comfortable if - you know, the consensus/media would be you know, closer to the lower end of that range?

You know, I - again, I think it goes back to what we didn't have last year and the comps that you're providing or referring to are really - we did have the new products and the generation of the excitement and the solutions, right, so I think it's really important to note that we're also very bullish on the fact that the new products combined with better and more expansive distribution will lead to that lift.

So, you know, we look at it still as it's a combination of the two things that I mentioned in the previous question, but we still view it as a - as not only achievable, but one that has to be in effort at the end of the year '16, which really drives the fuel that we promised for (inaudible) well. And we do feel very comfortable that the association of that new product line portfolio with the distribution changes will lead to that lift.

Fair enough. Last one from me, you know, big increase in R&D, investment here in Q1, not surprising you've been communicating that for a while, but - you know, what is it that you're investing in right now that is - that you would view as - you know, more differentiated type of technology we can think about into '17? And just to push you a little bit on the new products, I know - you know, a lot of them are coming out with the nano metaline technology plus lordosis, I'm pretty sure there's a lot of other companies that have lordotic products on the market, you know, what is so differentiated about what you're going to be introducing versus those products? And then back to '17, with this new investment, what is going to be differentiated enough to really capture the attention of surgeons?

Yes, so a few - a few ways to look at it, so there is - there is - some of those products have subtle differentiations, some I think, are more substantial. I think anytime we're talking about interbody devices that are avoiding a coating, and have the nano metaline incorporated into them, it's a much different conversation about the features and benefits of that product. So, that's primary.

The second thing I think we need to focus on is that we have a distribution team that has done what I would capture pretty well of keeping some sort of consistent business with older and - you know, even tired legacy products, and so the key here is that we are doing the right things to refresh those products and get better instrumentation as well as implant design changes, not to mention the brand new products. So, I agree with you, some of the differentiation things may be subtle but it's more important that in the hands of our distributors who have done a really good job of maintaining and keeping the business, we're now offering really nice solutions for patient care as well as simplicity for the surgical procedure itself, that will give them a new conversation with their existing base that has been loyal to them.

(Operator Instructions) And that is all the questions that we had in the queue at this time, so I would like to turn the call back over to management for closing remarks.

Okay. Thank you, everyone for joining us today, and have a great evening.

Good night.

Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program. And you may all disconnect from the telephone lines at this time.