SeaSpine Holdings Corp (SPNE) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the SeaSpine's 2016 second quarter financial results conference call.

(Operator Instructions)

As a reminder, this conference call is being recorded today, August 9, 2016. I would now like to turn the conference call over to Leigh Salvo, Investor Relations. Please go ahead, ma'am.

Thank you for participating in today's call. Joining me from SeaSpine is CEO, Keith Valentine, and CFO, John Bostjancic. Earlier today, SeaSpine released financial results for the quarter ended June 30, 2016. 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, August 9, 2016. 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 annual report on Form 10-K filed with the Securities and Exchange Commission on March 16, 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 all for joining us. When we spun out from Integra in July 2015, we communicated a growth plan of using the first 12 months to stop the multi-year revenue decline and reposition the Company for growth by investing in innovation and re-engaging with surgeon and the distributor community.

Since that time, we have made demonstrable headway towards meeting that goal through the expansion of our distribution footprint in key regions of the US; the launch of new spine hardware and orthobiologics products and increased investment in instrument sets for new and existing products and by optimizing and expanding manufacturing to ensure adequate supply and scale.

I'm pleased with our results over the past year and confident that the path we are pursuing will secure our long-term future growth. On the call today I'd like to take the first few minutes to review our progress to-date, including highlights of the second quarter. I will then turn the call over to your CFO, John Bostjancic, who will provide a detail on our financial results and an update on our guidance for the full-year 2016. I'll make some closing remarks and open for questions.

Turning to our second quarter performance. Total revenue was $33.2 million, down less than 1% year-over-year and a 5% increase over the first quarter of 2016. As a reminder, our sales include a balanced mix of orthobiologics and spine hardware. In the second quarter of this year, orthobiologics and hardware sales totaled $16.8 million and $16.4 million, respectively. Orthobiologics revenue saw continued growth in our third-generation Accell DBM technology, particularly in the US.

As we continue to see the dividends from the substantial investments we made at our Irvine manufacturing facility to stabilize our supply since the spinoff, global spine hardware revenue was essentially flat versus the prior year as sales of our recently launched proprietary NanoMetalene-coated interbody devices and cervical fixation systems combined with increased sales of our expandable interbody device offset the declines we're seeing in our legacy portfolio of spine hardware products and continued mid-single digit pricing declines.

The progress we've made in re-engaging the surgeon and distributor community and the success of our recently launched products coupled with the additional new product scheduled to launch in the second half of this year, positions us well for accelerating our growth in the spine hardware portfolio. In the US, revenue increased 1.5% in both the hardware and the orthobiologics portfolio in the second quarter.

Internationally, revenue declined 17.8%, or just under $700,000 year-over-year. We anticipated the year-over-year decrease in international revenue since our international distributors had placed large stocking orders in the second quarter of 2015. They placed these large orders to build up inventory in advance of our spinoff from Integra Life Sciences on July 1, 2015 to minimize the risk of supply disruption during the transition. International revenue, which is currently 10% of our total revenue, increased 11.7% sequentially compared to the first quarter of 2016. Moreover, we see meaningful growth opportunities internationally in the second half of this year and beyond as we continue to launch new products that address the needs of our distributor partners and their surgeon customers in international markets and as we target new distributor opportunities in selected markets.

Now turning to the growth plan we have outlined, I'd like to highlight the progress we've made to-date on our multi-pronged approach. First, as it relates to driving sales through new and reengaged distributors in the US, we continued to expand our footprint in the first half of the year by establishing new relationships where we had minimal or no presence or were underpenetrated; in particular, the Northeast and Southwest. And we have reengaged existing high-performing distributors to build a deeper partnership with them.

We believe that the sale cycle takes approximately six to nine months before those activities generate a meaningful impact on revenue. And we began to see that positive impact in the second quarter rev results. We are continuing efforts to expand and build new distributor relationships and enhance our distributor training programs throughout the second half of this year and beyond.

The surgeon community is another key area of focus for us. We are committed to delivering new products that are responsive to surgeon needs and that improve the solutions they can offer their patients. We believe that our approach to engage with surgeons and to understand their needs will distinguish our products from those of our competitors and build long-term commitment to our platform and product offerings.

Throughout the second quarter, we continued our efforts to understand market needs by meeting and engaging the surgeon community through surgeon council meetings and cadaver lab training. These are invaluable activities that help inform us on clinical needs and market trends and will guide our product development priorities. We are encouraged by the positive feedback that we have received from these interactions and we look forward to updating you on future calls as we map out our 2017 product development strategy.

Turning to the near-term product development front, as an independent company we set out to invest in both our orthobiologics in her spine hardware platforms with the goal of launching 8 to 10 new or next-generation products or product line extensions per year. We are on track to achieve this goal in 2016. This year we have already launched four products that have upgraded aging spine hardware systems and extended the reach of our proprietary NanoMetalene technology.

Since the spinoff we have reinvigorated our cervical portfolio, in particular with the launch of the Cabo cervical plating system and a NanoMetalene-coated cervical interbody device. And we look forward to launch early in the fourth quarter of this year of our cervical standalone interbody device that will provide ultralow and no profile cervical spine fixation and realignment with flexible construct modularity to provide a variety of footprint and lordosis options along with better instrumentation.

We anticipate at least three more product launches in the second half of this year, including our versatile next-generation pedicle screw system that incorporates a modular design that can be configured to treat a wide range of pathologies, including degenerative deformity and MIS. And it reduces the number of trays needed in the operating room.

Collectively, our recent and planned upcoming product launches in 2016 address a $3 billion market in the US and represent a critical step to updating and refreshing the aging product portfolio that we inherited with the spinoff. These products also provide a fresh opportunity for our existing distributors to start conversations with surgeons and open the door for us to new distributor relationships. And the pace and predictability with which we are now able to launch new next-generation products confirms our commitment to innovation and builds loyalty with our existing distributor partners. The recent redesign of our expandable interbody device originally launched in late 2014 has also proven beneficial and provides us with an additional opportunity for growth.

From a cultural perspective, we recently completed the move of our spine hardware machine shop, customer service operations and orthobiologics scientific lab as well as an expanded cadaveric training lab in our Carlsbad headquarters. The assimilation of our sales, marketing and product development activities into the same facility has truly made us stronger together. Now with both the orthobiologics and spine hardware commercial teams co-located, we are seeing much better collaboration between these two closely related product portfolios.

The move of our spine hardware kitting and distribution operations out of our Vista facility into a third-party logistics provider near Memphis, Tennessee is on track for completion as planned by yearend 2016. This transition is expected to significantly reduce costs, increase customer service level by optimizing logistics and freight, and provide the 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. Then I will wrap up.

Thanks, Keith, and good afternoon, everyone. As Keith noted earlier, total revenue for the second quarter of 2016 was $33.2 million, a less than 1% decrease compared to the same period of the prior year, and a 5.7% increase over the first quarter of 2016. Revenue in the US was $30 million, an increase of 1.5% versus prior year, and international revenue was $3.2 million, a decline of 17.8% or approximately $700,000 versus the prior year.

As Keith discussed earlier, we anticipated this decline in international revenue because of the large stocking orders placed by our distributors in the second quarter 2015 ahead of spinoff to reduce their exposure to supply disruptions during the transition. Revenue from orthobiologics products was $16.8 million, a 1.3% year-over-year decrease, while revenue from spine hardware was $16.4 million, effectively flat compared to the prior year.

We are particularly encouraged by the 1.5% growth in both the US orthobiologics and spine hardware portfolios. Coupled with the targeted growth opportunities in our international business, we believe that we have taken our first step towards sustained revenue growth. Gross margin for the second quarter of 2016 was 58% a 1.4 percentage point increase compared to the same period in 2015, and a 3.5 percentage point increase compared to the first quarter of 2016.

We continue to expect further gross margin expansion in the second half of 2016, particularly as we begin to sell the lower-cost Mozaik products that we began to manufacture in our Irvine facility in December 2015 compared to the higher cost we've previously paid to Integra under supply agreement with them. The capacity and efficiency improvements that we realized from recent investments in our Irvine manufacturing capability are also expected to benefit our future gross margins.

Operating expenses for the second quarter of 2016 decreased $3.6 million to $31.5 million. In the second quarter of 2015, we incurred $9.8 million of expenses related to her spinoff from Integra and we reported $4.4 million in allocated expenses from Integra. R&D expenses increased $1.2 million to $3.2 million for the second quarter of 2016, or 9.6% of revenue. This increase was primarily driven by higher compensation costs due to increased headcount and higher external costs related to accelerating the many product development programs that Keith discussed earlier. This was in line with a higher R&D expenses as a percentage of revenue that we were anticipating.

Selling, general and administrative expenses decreased $4.7 million to $27 million for the second quarter of 2016, and included $1.3 million of stock-based compensation expense. In the second quarter of 2015 SG&A expense included $9.8 million of nonrecurring spinoff-related charges, $600,000 of medical device excise tax expense and $4.4 million in allocated expenses from Integra. Since the spinoff, we have directly incurred those operating expenses that were previously represented in the allocation from Integra, including the compensation-related costs of our executive management team and expenses associated with being an independent, publicly-traded company, such as audit, insurance and information technology-related fees.

We have also incurred greater expense from the hiring of additional marketing, sales, administrative headcounts since the spinoff. We reported an income tax benefit of $429,000 in the second quarter of 2016 compared income tax expense of $1.5 million for the same period of the prior year. The income tax benefit was primarily related to a refund of tax initially paid for the income tax return for our US subsidiary that was not part of the US consolidated tax group for the period January 1, 2015 through August 31, 2015. We expect to report minimal cash income tax expense for the remainder of 2016.

Net loss for the second quarter of 2016 was $12 million compared to a net loss of $17.7 million for the second quarter of 2015. Cash and cash equivalents at June 30, 2016 total $23 million and we had $395,000 in outstanding debt against our credit facility. We remain in a sound financial position, and with the access to cash available under our credit facility, we are continuing to invest in organic growth objectives.

Turning to our financial outlook for 2016, we are reiterating our previously communicated expectations for the full-year 2016. We anticipate revenue in the range of $136 million to $140 million, reflecting top line growth of 2% to 5% versus 2015. With the growth achieved in the US business in the second quarter and the stabilization of our international business, we remain committed to delivering against these expectations. As we've previously communicated, revenue growth will be weighted towards the second half of the year as we begin to more fully realize the key load of benefits of our expanded and upgraded sales management team and new distributor relationships, recent and planned new and next-generation product launches and surgeon enthusiasm for new product offerings.

Moving down to 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 charge for excess raw material recorded in the first quarter of 2016. R&D approximates 7% to 9% of revenue, and SG&A, excluding non-cash equity-based compensation charges to approximate 68% to 72% of revenue. Our SG&A in guidance includes the nonrecurring cost to transition our spine hardware kitting and distribution operations from our Vista facility to a third-party logistics provider. As we transition out of and close the remaining portions of the Vista facility and complete the outsourcing of our kitting and distribution operations by the end of the year, we estimate that we will realize an excess of $1 million of annualized ongoing SG&A cost savings in 2017 compared to the recurring cost of these activities in the 2016 SG&A expense-base.

We are continuing to identify and plan to implement other similar cost-saving improvement program opportunities in the future as we strive to further improve 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 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 revenue in R&D, and reduce SG&A, excluding stock-based compensation, to between 56% and 60% of revenue.

We plan to end 2016 with roughly two years of liquidity as measured by cash on hand and availability under a credit facility compared to the expected 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 successfully execute to the growth plan we identified during our spinoff a year ago, and we have taken the steps necessary to reverse the multi-year revenue declines and reposition SeaSpine for innovation and scalable growth while staying focused on preserving our liquidity.

We've made meaningful progress in building new distributor relationships and reengaging the surgeon community to understand their needs. All of which is expected to drive growth and deliver improved patient solutions. Moreover, we believe that the cadence of new and next-generation products already launched and scheduled to be launched in 2016 and beyond will provide benefits to our customers that will drive sustainable long-term revenue growth.

With the progress that we've made, I remain confident that we are on track to achieve the milestones that we outlined in our three-year plan post-spinoff. Our confidence in our ability to grow is supported by the investments we've made in more reliable and cost-efficient manufacturing and supply chain processes that will help ensure an adequate supply of our orthobiologics and spine hardware products to give our distributors the confidence they need to market our products globally.

We look forward to updating you on our progress on future calls. John and I are currently in New York and will be meeting with investors here tomorrow with Piper Jaffray, and in Boston at the Canaccord Growth Conference on Thursday. We hope to see many of you then.

With that, we will now open it up the questions. Operator?

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

I thought we could start with the hardware improvement domestically that we saw. I think this is the first quarter where we actually see some growth there. And so I'd love to hear a little bit more about what you're seeing in the marketplace because that performance, as you're adding new distributors, I think you added a couple of new ones back in Q1 that were pretty meaningful.

But at the same time, you're kind of lapping some legacy products seemed like very good performance. So if there's any data points you can give us, maybe in terms of some of the distributors may be added two or three quarters ago, how they grew in the quarter, and then any other trends that are kind of buried within that performance? I think that would be very helpful.

Yes. You may recall from the last call, we had a couple of different scenarios that we're playing out. We've been adding new distributors and some may be just very focused on a smaller region or a few hospitals in a region because they relationship-focused, our distribution channel.

But there were a few larger ones that we talked about that were in different stages. One, as we talked about in the Northeast, had some time to get approvals and to actually sell within some of the accounts that they were to support because we had not previously supported those accounts. And then another one that we talked about in the Southern California area, we were in those accounts and it was a matter of making sure they were getting up to speed. And so we saw both of them make meaningful contributions in this past quarter.

But in addition to that, we have been continuing to add distribution across the country, again, in more smaller focused ways and we were doing that all along through late last year and early this year. We're starting to finally see those actually take hold. As mentioned, it's a kind of six to nine-month process that happens and sometimes it happens sooner if we're already in those accounts and other times, it may take the longer of the six to nine months just because you have to get approvals and go through the kind of a heavy paperwork process, if you will.

We saw the kind of momentum shift that we were talking about from our last call and we feel really comfortable that not only that distribution shift really then adds even more to the new products that we're introducing and the excitement around those new products. And so we feel very comfortable with the distribution channel as it's playing out. We'll be even more excited as we launch more new products in Q3 and Q4.

Just to push a little more there. With some of the existing distributors that you had had on hand that you've reengaged with since the spin. I mean, can you give any sense that you've had from distributors here and there even - reach the low double-digits, high single digit growth within Q2 on the hardware side of the business?

Yes, a lot of the legacy distributors, if you will, the ones that have been with the organization the longest, even going back to [taken] days or earlier SeaSpine days; a number of those have been very excited about the new product launches, such as our new cervical plate and interbody devices. But more importantly as you look into Q3 and Q4, you're going to start seeing some product line additions to some of our older legacy products, especially in the MIS area. And then also with the new pedicle screw launch, that will give renewed energy to some of the product lines that they have had for a long time. I think you'll see more of that kind of stimulus for the legacy distributors as we move into Q3 and Q4.

And then sticking within the pedicle screw launch - July launch, that's been an area that's driven a lot growth for some of your larger competitors in the last couple of years. Can you just talk a little about how that launch would look as far as the number of such you can get out in the field and what kind of contribution you can get from that back half, and then especially in 2017 because that could be a sizeable contributor.

Yes, it really is. When you take a look at how we're approaching the new screw system, there's a couple of things that we're incorporating. One, we want it to be a more versatile system, meeting the ability to accommodate a number of different pathologies. But more importantly, we wanted to be more efficient in its delivery in the OR and the ability not to have to bring in the great need for a large number of trays, especially multiple implant trays and instrument trays and really working to make sure it's more efficient.

What you'll see in the close of 2016 is a much more targeted launch and more of, if you will, alpha-beta kind of style launch. And then as we move into 2017, that's where you really start seeing the larger deployment of sets because we'll be much more comfortable with the delivery of those sets, meaning that the instrument sets will be fully resolved, any changes to instrument design or the way it attaches to the implants will be fully resolved and that's when you really start seeing that full deployment will really be in 2017.

Just a few more, if I may. On the orthobiologics side of the business, again, a little bit better; solid US performance. Can you talk about the market as we stand today to some of the dynamics that are going on there and then your confidence in the ability with your sales force, essentially a little bit more focus on the hardware side of things to continue to deliver solid orthobiologics performance.

A couple few things in that multi-part question I'll try to get at to make sure - if I don't, you remind me of where we missed because there's two parts to that as I see it. The first part is, the general orthobiologics market has shown overall strength and part of that has to do with kind of the resurgence, I think, and what you see in Medtronics numbers on the BMP side, which, I think overall, has been good for the market.

Now, the good thing is how we participate, we do have a significant market share on the DBM side probably closer to 14%, which is helpful because the DBM space is one that that is crowded, but it's also one that doesn't have the reimbursement pressures that you see in some of the other areas of ortho Biologics, including the higher performance products and also the synthetics.

We feel very comfortable on how we're approaching that, how we're also going into future innovations in that area of DBM and plan for how we're going to launch new products in that area as we get into 2017. Now that said, from a distribution perspective, it's kind of interesting; most of our sales for orthobiologics are outside of our spine channels, spine hardware channels. So more of our orthobiologics, probably somewhere close to 2/3, is being sold, if you will, by competitive hardware reps.

And so that's a good thing, actually. I think that gives that platform greater stability because we have not only the existing spinal hardware team driving orthobiologic sales, we also have great opportunity outside of that in the competitive side. And that point itself, we are expanding distribution in both ways. We're not only expanding it with the spinal hardware also getting orthobiologics within their portfolio, we are also expanding our orthobiologics distribution, if you will, with that competitive hardware rep. And we think that still is the way that we keep and grow our market share specifically in that DBM space.

And then on the guidance for the back half of the year, I mean, we've been kind of ticking along with the revenue number for the last few quarters around this rate. We're going to have to see a step-up in Q3 and even a greater one in Q4 to hit the guidance that you laid out there. Can you give us a better sense for where some of that sequential improvement will come Q3, Q4 on the top line?

Yes. A lot of what Keith has touched on, the momentum that we're seeing building in the orthobiologics and the hardware portfolio from the new distributorships, the new product launches. I think the cadence of our product launches, the quality of the product launches, is significantly better than where it was last year. And we spent a lot of time focusing on the product development process itself and making sure that we've got a robust process that produces predictable results.

I think the fact that we launched the four products that were scheduled to launch this year; actually, one of those was a little bit early, the Hollywood VI NanoMetalene we launched in the second quarter. So I think given the predictability and the confidence we have in our refined product development process and the timing of the fairly significant launches in the back half of this year, the new pedicle screw system and the standalone cervical interbody device, and the increasing sales we're seeing our own existing expandable interbody device gives us the confidence to hit what we need to be the still high single-digit growth in the back half of this year to hit our targets.

And we think we've built up good momentum with the results of the second quarter and the expanded distributor relationships and new product launches; I think we're on track to deliver that in both portfolios. And see some upside from the international business as our suppliers have worked through some that stockpile of inventory they had pre-bought ahead of the spinoff.

I think it really goes down to - Matt, you're absolutely right. Q3, Q4, we really have to now start seeing the larger distribution changes we've made or additions that we made really start to continue and expand our momentum, right? It's great that they have gotten aboard, it's great that they're getting the kind momentum we wanted and we saw in Q2, but to really take advantage of the new product introduction with better distribution, they have to start getting more a significant share within those accounts too, and that's what we're counting on for Q3, Q4, and giving us the momentum into 2017.

And then last one for me, just on the SG&A side. The spend here was a little bit steeper than I was expecting. Can you just run through where some of that incremental spend came from? And I think you had mentioned from our marketing and sales folks; just a little more color on what they'll be doing for you would be helpful, and then how all that plays with - what John just backed the cash burn of the Company because we can see the cash balance, but the credit facility isn't as easily accessible.

Just kind of how that should trend in light of all the expenses you've already gone through with the spinoff that you won't see going forward. Just some color on all those topics I think would be helpful as well.

Yes. The SG&A spend, from a quarterly trend perspective, is not far off where we were in the first quarter. We did start incurring costs for the transfer of the Vista kitting and distribution operations to the third party in Memphis, so some of those expenses started to hit in the second quarter, which was part of the slight step-up from the first quarter. But we continued to spend consistent with our plan to end the year at about two years worth of liquidity. Obviously, we haven't tapped into the revolver yet but it's a source of funds that are available.

We've also - stepping this aside for the SG&A for a second, we've managed to keep the burn rate at around $5 million and that included over $1 million spent on CapEx for the build-out of our Carlsbad and Irvine facilities, which there'll be more forthcoming. But I think we've managed to spend in line with our forecast and the Q2 is just a slight step-up, a good chunk of which is attributable to the spend that we've started on the transfer to Vista operations, which again, should be able to turn the result in $1 million of recurring cost savings once we've got that live at the end of this year.

(Operator Instructions)

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

Thank you, ladies and gentlemen, for participating in today's conference. This does conclude the program, and you may all disconnect.