SeaSpine Holdings Corp (SPNE) 2016 Q3 法說會逐字稿

Welcome to SeaSpine's 2016 third quarter financial results conference call.

(Operator Instructions)

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

Thank you, and 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 September 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 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 beliefs based on current information and speak only as of today, November 9, 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 statements, please see our annual report on form 10-K filed with the SEC Commission on March 16, 2016, which is available on our corporate website; www.seaSpine.com and 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. On our call today I'd like to take the first few minutes to review our performance to date, including our recent product launches. I will then turn the call over to our CFO, John Bostjancic, who will provide on our financial results and update on our guidance for the full year 2016. I'll make some closing remarks and open for questions.

Turning to our third quarter performance, total revenue was $31.7 million down 2.9% year over year, including orthobiologics sales of $16.2 million and hardware sales of $15.6 million. Geographically, total revenue in the U.S. decreased 5.5%, while international revenue grew 28% over the prior year. U.S Spine hardware revenue declined as lower demand for our older spinal fusion hardware products and continued mid-single digit pricing pressure in the U.S. market outpaced the revenue growth from new and recently launched products and from recently onboarded distributors.

As we continue to on-board new distributors and cultivate more loyal and exclusive relationship for the long term, we are experiencing revenue declines from some of our longer tenured distributors who may not be as engaged as they were in the past because of the higher expectations we now have for generating growth and investing in their territories. So, while this dynamic is creating some revenue challenges in the near term, we continue to believe that our approach, and the current opportunities we're evaluating to expand our distribution footprint, is the right move for SeaSpine to facilitate sustainable and more accretive growth over the longer term.

Separately, we are beginning to see more pricing pressure in the U.S. orthobiologics market, especially with GPOs and IDNs. We believe that similar to the situation with Spine hardware, it will take more time for the new distributors we signed up to get through hospital approval committees to drive revenue growth and to offset these pricing pressures. We remain confident that we had built a solid foundation for growth through more loyal and exclusive distributor relationships, and by investing in product development and launching more innovative new products that focus on our surgeon, customers' need. However, we underestimated a few things. First, the drag that legacy products would have on our ability to convert new business. Second, the extent of disruption we would experience as we transition legacy distribution to a new growth mindset, and third, the time required and delays in the hospital approval process. Now more than ever we, understand the importance of updating our legacy portfolio of aging products.

As we'll discuss shortly, we have launched and will continue to launch the products that we believe surgeons want, and ultimately, will convert business to SeaSpine. But the transition has taken longer than we originally estimated. As a result, we are reducing our total revenue guidance for 2016 to a range of $128 million to $130 million, which reflects our year-to-date results and the continuation on some of these challenges in the fourth quarter. To adjust to these lower revenue expectations, we have initiated a number of activities that collectively are expected to reduce our -- reduce our cash spend by nearly $9 million in 2017 relative to 2016. In particular, today we implemented a reduction-in-force that will contribute to an overall decrease in our current employee base by approximately 8%. John will review more details of these cost reduction activities in his remarks.

Despite disappointing revenues in the third quarter, I am more encouraged than ever by the traction we continue to make towards expanding and upgrading our product portfolio. We have launched seven new and upgraded products already this year on pace to our goal of eight for 2016 and meaningfully higher than two to three product launches per year that we executed pre-spend. The pace, quality and predictability with which we are now able to launch new and next generation products affirms our commitment to delivering new products that are responsive to surgeon's needs.

This is a turnaround for the organization that we are proud of and we'll continue to build upon. By providing innovative, responsive solutions, we gained the trust of our surgeon customers and build loyalty with both existing as well as new distributors. We believe our relentless focus on understanding surgeon needs and providing solutions will distinguish our products from those of our competitors and build long-term commitment to our platform and product offerings.

At the recent NASS Conference in Boston, booth activity was strong, driven largely by interest in our recently launched products. Of particular interest was our Shoreline ACS, Anterior Cervical Standalone System, which recently received 510(k) clearance and features TruProfile Technology and our nano metaline surface technology. With Shoreline, we set out to build a product platform that reflects the critical needs of surgeon customers that provides advantageous, intraoperative flexibility while addressing key clinical challenges often encountered by surgeons without sacrificing ease of use and technical reliability.

We also launched our Mariner Posterior Fixation System. Our versatile next-generation pedicle screw system, which addresses an estimated $1.8 billion market. The Mariner System is designed to reduce the number of trays needed for surgery and to provide surgeons with multiple intraoperative options to facilitate posterior lumbar fixation. Feedback from surgeries in our initial limited launch has exceeded expectations. Both Shoreline and Mariner represent innovative, new products that we are launching in large market segments that replace existing systems that are more than five years old. We are conducting cases of those systems through a limited launch over the next few months with a full commercial launch expected in the first half of 2017. The buzz generated by these products at NASS and the initial positive feedback from surgeons on cases done so far gives us growing confidence that these two product launches will be critical drivers of future revenue growth, and they are systems that new distributor partners are eager to offer in their territories.

We also recently received five FDA 510(k) clearance for sterile packaging, our nano metaline interbody products. While this isn't traditional new product launch, its evaluation and execution to the market is a large commitment by the organization and it provides a key differentiator for us with surgeons and hospitals by lowering delivery and sterilization cost.

During the third quarter, we made our first acquisition as a standalone company, requiring substantially all the assets of NLT Spine, a medical device company developing innovative spinal products for minimally invasive surgery. The acquired platforms include vertical, lordotic, and lateral footprint expanding interbody technologies which allow surgeons to place smaller implants that expand within interbody space. These patented technologies are designed to enable smaller incisions and less nerve retraction while achieving the same advantages of larger implants, but with easier insertion and potentially less tissue disruption. They also cater to surgeon's needs for better sagittal alignment for their patients. We expect to launch the first NLT device in the first half of 2017. This innovative technology coupled with our nano metaline technology positions us very well for growth of the interbody device market; one of the fastest growing segment of the Spine hardware market.

I'd like to comment a bit more on our traction with new distributors, a key objective for us. We continue to expand our distribution footprint in key regions of the U.S. where we had minimal or no presence or are under-penetrated, such was the southwest. And are in negotiations with potential distributor partners at other regions where we are still really under-penetrated. We have the financial flexibility and a growing reputation for innovation, a customer focus that allows us to attract, pursue and close on the strategic opportunities to establish new relationships with high-performing or high-potential distributors that now have the confidence in our ability to deliver on time the products that our surgeon customers seek. New distributors are leveraging the availability of our growing list of recently launched products, rather than relying on older legacy systems to begin their investment in the training time and resources needed to convert their surgeon customers to our product portfolio. We are also investing more in medical education resources and enhancing our capabilities in that area to provide more value add to our new existing surgeon customers.

Before turning the call over to John, I'd like to reiterate that our fundamental strategy to reverse the multi-year revenue declines and reposition SeaSpine for growth remains the same. We are steadfast with the strategic vision of organization, confident that it will drive top-line growth and ultimately provide long-term shareholder value.

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

Thanks, Keith. Good afternoon everyone. As Keith noted earlier, total revenue for the third quarter of 2016 was $31.7 million; a 2.9% decrease compared to the same period of the prior year. Revenue in the US was $28.5 million, a decrease of 5.5% versus prior year, and international revenue was $3.3 million, an increase of 28%. Revenue from orthobiologics products was $16.2 million, a 1.7% year over year decrease, while revenue from Spine hardware was $15.6 million, a decline of 4%.

Gross margin for the third quarter of 2016 was 56.3% compared to 46.9% in the same period in 2015. The increase in gross margin was mainly driven by a $4.4 million charge reported in the third quarter of 2015 for excess and obsolete spinal fusion hardware inventory, the substantial majority of which was purchased prior to the spinoff and a large portion of which was intended for distribution in international markets.

Operating expenses for the third quarter of 2016 totaled $27.4 million, a decline of 8.7% or $2.6 million compared to $30 million the same period of the prior year, primarily as a result of lower SG&A expenses. R&D expenses increased $200,000 to $2.6 million for the third quarter of 2016, or 8.2% revenue, and in line with our expectations. We are very pleased with the return on our investment in product development as evidence by the many successful product launches that Keith discussed earlier. Selling, general and administrative expenses decreased $2.5 million to $23.8 million for the third quarter of 2016, and includes $1.5 million of stock-based compensation expense in both periods. This decrease was primarily driven by non-recurring spinoff-related expenses that were incurred in the third quarter of 2015.

Net loss for the third quarter of 2016 was $9.5 million compared to a net loss of $14.2 million for the third quarter of 2015. Cash and cash equivalents as of September 30, 2016 totaled $20.8 million, and we had $3.8 million of outstanding debt against our credit facility. In the third quarter, we invested $1 million of cash in the NLT acquisition and an additional $2.2 million on completing the build out of our Carlsbad facility, investing a new sets of instrumentations to support the recent Spine and hardware product launches and stabilizing and enhancing our information systems, particularly to support the outsourcing of our Spine hardware kitting and distribution operations to Millstone Medical, which we completed in October.

We remain in a sound financial position, and with the access to cash available under our credit facility, we plan to continue to invest in organic and inorganic growth activities. As Keith previously mentioned, we have initiated a number of activities that collectively are expected to reduce our cash spend by nearly $9 million in 2017 relative to 2016. In particular, the reduction-in-force that we announced today is expected to decrease operating expenses by $1.6 million in 2017 compared to 216. This is in addition to the almost $1.8 of anticipated annual cost savings from the outsourcing of our kitting and distribution operations and related closure of our Vista, California facility that we discussed earlier this year.

We also expect to reduce our cash spend in 2017 relative to 2016 by more than $3 million following a recent and successful completion of many of the IT stabilization and operational efficiency programs and facility improvement that we kicked off shortly after the spinoff. Additionally, we have already identified and are continuing to identify further cost saving other initiatives that are expected to help us meet or exceed our $9 million cash spend reduction target for 2017, while allowing us to continue to invest aggressively in the product development, sales and marketing resources and activities that will drive growth.

Turning to our financial outlook for 2016; as Keith noted, we are revising our previously communicated revenue expectations for the full year of 2016. We now anticipate revenue in a range of $128 million to $130 million, reflecting a 2%, 4% decline versus full year 2015.

Moving down the P&L, given our lower revenue expectations and the estimated $400,000 of cash expenses related to the reduction-in-force to be reported and paid in the fourth quarter, we now expect GAAP gross margin to be in the range of 56% to 58%, 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 to approximate 8% to 9% of revenue and SG&A, excluding non-cash equity based compensation charges, to approximate 73% to 76% of revenue. Our SG&A guidance includes the non-recurring cost incurred to outsource our Spine hardware kitting and distribution operations and the lead on other expenses directly attributed to business development activities such as the NLT acquisition.

As we build scale to the business and achieve anticipated longer term double digit revenue growth, we 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, between 58% and 62% of revenue. We plan to end 2016 with more than two years of liquidity as measured by cash on hand and availability under our credit facility compared to the expected annual cash spend rate for 2017.

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

Thank you, John. It is taking longer than we originally anticipated to reverse the multi-year revenue decline to the SeaSpine business experience before the spin. While the revenue results from this quarter are disappointing, I remain confident in our team in that we can still achieve the double digit growth that we outlined at the time of the spinoff. Importantly, we are taking the necessary steps immediately to cut non-critical cash spend and to maintain our focus and investment on product and sales expansion, while ensuring that our cash and access to cash provide us with almost three years of runway to realize the return on these investments.

We have repositioned the company for success by investing innovation and reengaging with the surgeon and distributor community. As we continue to innovate and maintain our increased cadence of new and next-generation production launches, we will convert business and achieve the double digit revenue growth targets that remain our number one objective. 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) Matt O'Brien with Piper Jaffray.

This is Matt in Matt for today. Relative to your internal projections, what were the main reasons as to why your distributing partners started to favor newer products relative to the legacy products, and how shall we think about that going into 2017?

Yes, there's a few things going on. I think that when you start looking at the way new procedural demands are, and one of them that I talked about in the call was about kind of the requirement or the desire for sagittal alignment. There are newer products that are coming on that distributors get excited about because that's what they most recently were part of with their previous provider.

And so, the challenge has been making sure that these new products fit that bill which they do. We generated a lot of excitement and had validation of that excitement with new cases that were done with the newer products. But at the same time, another part that I put in there is we are investing more into our training programs as well because a number of the legacy systems that we've done some advancements too have those capabilities. It's a matter of ensuring that we do the hand off to training as well, so that they're experts with those implant systems in the OR. So some of those falls on us as well to make sure that we get them up to a place of proficiency so that they can properly promote those products, the legacy products, if you will, versus only the new products.

And then, I know you recently mentioned that 70% of your distributor relationships don't sell hardware that you guys have. What are your conversation is like with new distributors to do that, and what is the largest gaiting factor going forward to sell hardware?

Yes, so what we had mentioned before just for clarity is that on one part of our business, the biologics business, that we have a larger percentage -- 60% to 70% that are not handling our SeaSpine hardware line because they handle competitive hardware line. So the good news is we're having very good conversations with some of those better distributors, especially with some of the consolidation that's going on in and around the industry. But you're still faced with the same challenges as they convert to our hardware line, you still have to have the proper training process with them and you still may have to get hospital approval in some of the accounts that we may not be selling hardware again.

And then, another question I guess, can you guys talk a little bit about the trade-off between the cost and growth next year and how that may alter the company's growth profile going forward?

Yes, I think the focus that we're putting on the cost reduction initiatives is really a cost in G&A. We're going to continue to invest at similar levels that we've been investing as it relates to sales, marketing and product development. We understand what's going to drive growth. I think we've been successful in really improving our ability to launch new products on time, independently and the activities we're doing with building a more reliable distributor network to drive growth.

We need to continue to do those things and we'll continue to make similar size investments in 2017, but really a lot of our cost reduction efforts are focused on reducing G&A cost, more efficiency or manufacturing operations to reduce cogs, and also looking at inventory and capital expenditures as well. So it's not just operating expenses, it's capital and inventory management as well.

At this time, I'm showing no further questions. I would like to turn the call back to Mr. Keith Valentine for closing remarks.

Thank you for joining us today and I hope everyone have a great evening. Goodbye.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, you may now disconnect.