SeaSpine Holdings Corp (SPNE) 2021 Q4 法說會逐字稿

Hello, and thank you, everyone, for participating in today's presentation. Joining me from SeaSpine is CEO, Keith Valentine; CFO, John Bostjancic, and President of Enabling Technologies, Beau Standish.

Earlier today, SeaSpine released full financial results for the fourth quarter and year ended December 31, 2021. The release as well as the presentation we will be using today, is available on the Investor page of the SeaSpine website. (Operator Instructions)

Can we advance to the next slide, please? During this presentation, 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 results and condition. All statements other than statements of historical fact are forward-looking statements. Such statements may include words such as believe, expect, anticipate, should, 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, March 11, 2022.

For a description of risks and uncertainties that could cause material differences between our actual results and those stated or implied by the forward-looking statements, please see our news release and periodic filings with the SEC, which are available on our corporate website, www.seaspine.com and at www.sec.gov, including the press release we issued today and the Risk Factors section in the 10-K we will file with the SEC later today.

I would like to remind everyone that the press release and slide presentation related to this call are available on the Investors section of the company website at www.seaspine.com.

In today's presentation, certain remarks will be based on non-GAAP financial measures. The company believes that non-GAAP financial measures provide important supplemental information to management and investors regarding financial and business trends relating to the company's results and operations. Please refer to the non-GAAP reconciliation included with that slide presentation in the Investors section of the company's website and the press release issued today for a reconciliation between GAAP and non-GAAP financial measures.

And with that, I'd now like to turn the presentation over to Keith Valentine. Keith?

Thank you, Leigh, and thank you all for joining us. Today, it's interesting. This is not our usual closure to the year, but this is exciting for everyone. I'm speaking for John. I'm speaking for Beau, speaking for the entire organization that we're going to -- we're launching our new mission and vision. And that mission and vision has been a series of execution and a series of opportunities for us really to demonstrate how we're operating in the now, and we're going to explain that throughout today. But I think it's an extremely important shift in how we now execute into the OR in a much more meaningful way.

And so as we talk about this transformation and the solutions that we now have at every level, this has been a very guided and very deliberate pathway of innovation. It's been one that we have worked on. We have given indications for how we're going to expand our product portfolio. But what's really exciting is that as we added and are adding the enabling technologies of 7D, we are now in a place to be addressing the needs in the OR with our surgeon partners in a way we've never been able to do before. It's truly about operating in the now. Everything that is available is now. And you're going to see, as we map out the product portfolio and we map out our pathway to profitability, that we are able to do this in 2022 and beyond, and we have the portfolio to execute this vision.

And so as we move through this, you've seen this before, on how we envision navigation in that entire 7D platform, really enabling all the investments that we've had over the past few years, but it really now is a complete solution. And from the products that are in alpha as we speak, moving into full launch this year, our presence in the OR has now changed. It's changed significantly. And as we say, we are operating in the now.

Not only is 7D in the now because it's so active and seamless at how it integrates in the OR, but all of the systems now can come together to really transform and create a better surgical procedure that is more time-efficient and best for the patient.

So as we kind of walk through some of the portfolio and how it integrates, this is a great example. This is how quickly we've been able to integrate one of the key platforms of the organization. Obviously, everyone is very familiar with how important pedicle screw fixation is to the foundation of good fusion surgery. Well, this is one of the early ways we were able to integrate seamlessly. And I think you know, 7D is an agnostic system. And we applaud the fact that it can be used with many different implant systems for the best of the patient. However, we have the most seamless way to integrate, and this is the kind of energy that we now have in the OR.

And as we speak of that energy and we speak of the synergy, this is another great testament to how we invested in science, we invested in surface technology. And now you can see the progression of where we're going in the interbody portfolio. The interbody portfolio, obviously -- the core foundation for years has been NanoMetalene. That was advanced to Reef Topography, which really created a different, more integrating way to get stability fast.

And then, of course, now we're launching -- and our most numerous launches in 2022 going to full launch will be WaveForm, and WaveForm has taken off beautifully in alpha with great demand. And it's complementary to our NanoMetalene technology, using same instruments and the ability to make the choices you need to make depending on the patient or depending on what particular material science a particular surgeon enjoys using.

Speaking also of partnership in synergy, this is a great one, launched a new anterior plating system that obviously works really well with our interbody portfolio. But most importantly, it's the science and our investment in science and us being the only company that's consistently on the podium now talking about surface technology, talking about orthobiologics and the mating of the most cost-effective but highly efficacious DBM in the business.

Another great example of how things really came together this year -- in 2021 and a great opportunity for us in 2022, NorthStar posterior cervical was a very important launch for us. I think we've talked numerous times about how old the 2 legacy products that we have for posterior cervical fusion were. But this particular system gave us even greater capabilities. It gave us the ability to address even deformities in the cervical spine. But on top of that, our orthobiologics group has a fantastic complement to it. The NorthStar Facet Fusion system, which uses fantastic and very effective DBM pellets to give a better fusion result in the posterior spine. And then on top of this, we also have 7D that integrates so well. These procedures are difficult. They're difficult because there's small amounts of bone to put a pedicle screw in or put in a bone screw. And the important part to this is that 7D seamlessly integrates with this instrumentation to give a degree of ease, to use less radiation in the OR and to provide a better overall procedure, very important marriage and partnership.

So I love this slide because I think that we have talked much about our investment innovation. We have talked a great deal about how we have to transform our product line, but you have to be accountable to metrics. And this is a metric that I'm very proud of. That metric is we now, from Q4 '21, over 80% of our revenue is coming from new products. And we see that building and moving on to 90% or greater in the next year to 2 years. Orthobiologics speaks to the strength of that product portfolio. It's been -- the reason it's a #2 player in the marketplace is because it's had a deep user base. But the new products are continuing to expand and grow. And there now, from a Q4 '21 perspective, over 40% are coming from new product revenue. This is a testament to the investments that we've made and the kind of growth we're seeing in new products.

And the important part here, too, the other part of the return on investment here is this gives us the ability to attract bigger, better distribution partners. And John will cover a good deal of how we're approaching that and what our excitement is in that arena.

So before I turn things over to John and Beau, I thought it would be important for us to kind of take a quick 2021 highlights at a glance. Clearly, there has been challenges throughout 2021, thanks to COVID. I mean you look at the disclosure statement when we kicked things off, I don't think anyone would have thought that we had to mention COVID 3 times in a disclosure statement. But it's clearly impacted the direction and challenges in our business. And this was exasperated by the fact that we had also challenges in hospitals beyond COVID that also were around staffing. So staffing was tight. It only became tighter because of the challenges that COVID presented.

But with that, we still had record revenue of $191.5 million. Our year-over-year growth was 24%, considering the different fits and starts that we had throughout the year, thanks to COVID, and different areas of the country shutting down or at least limiting elective surgery, this is a great result. And in that process, we still had 16 product launches. And that's what we're so excited about from 2022 and 2023. We'll be accountable to that return on investment and how we see new products continue to gain momentum on revenue.

And interestingly enough, when you compare this back to 2019, 2 systems and products used per procedure, which we feel is a very important way we continue to get further leverage. And again, if we own the whole procedure in the OR, this number continues to rise.

I think it's important, too, to just look back on 2021 as some very important milestones happen with, of course, the 7D Surgical acquisition, which just to remind everyone, that closed in May of 2021. And since that closure, 17 units placed post acquisition. And I think most importantly, we had messaged that we want to not only take advantage of capital equipment purchases by hospital, but it's important for us to gain market share in the OR and market share at accounts by earn-out arrangements. And we are now feeling that momentum. There is a number of opportunities that are in the funnel, and we'll continue to see that percent as a total grow. Now that's $6.7 million of capital sales revenue, which on top of that, which we love, is $1.2 million of future service revenue just in regards to that.

We're also really proud to be partnered with an industry leader in pediatrics. They are also -- a company, OrthoPediatrics, that really wants to ensure that they are the solution in the pediatric OR, and we have a 5-year exclusive distribution agreement with OrthoPediatrics. And we're really proud of how they're thinking about advancing the 7D technology, which is good for not only patient care, but it's good for also how they're going to gain market share in their pediatric accounts.

But with that comes a big investment. We can't also mate up and have all these procedural solutions in the OR if we don't have the trades, we don't have all of the implants and instruments necessary to be successful. Additionally, probably, the #1 question whenever we're talking to a large distributor, how are you going to invest in me? And what they're really saying there is, how are you going to invest in the inventory demands that I have to be comfortable to promote this product wholeheartedly into the OR? And so with that, ending cash of just over $83 million, we still have access to our $30 million line of credit. And right now, of course, no outstanding debt.

So again, as we continue down the pathway, and I turn this over to John, I really want to stress again that this is a transformational time for the organization. We are reapplying, restating and driving forward a new mission and vision for the company. We're holding everyone in the organization accountable to how we think about we're going to gain greater advantage in the OR. And we're going to do this by obviously doubling down on growth, but you're going to see us creating a different environment that's seamless with our surgeon partner, but even more importantly, our hospital customer is going to be very excited about how we transform their surgical solutions in the OR.

And with that, I'll turn it over to John.

Thanks, Keith. As our 2021 achievements indicate, throughout the uncertainty of COVID, we've steadfastly invested for growth and scale and relentlessly focused on surgeons, patients, payers and investors, all while keeping a close eye on maintaining a strong liquidity position. For the past 2 years, COVID undoubtedly had an adverse impact on our ability to achieve revenue targets and to further the operating leverage gains we had achieved prior to the pandemic. But as we move past the pandemic phase of COVID, we believe we've taken the right steps necessary to accelerate our pattern of market share taking and to regain momentum in generating meaningful operating leverage across many parts of the organization and the P&L.

So how does our past execution and investment translate to the future? The commitment to invest for growth and scale has always been a core strategy for SeaSpine and has become an increasingly focused point for the investment community. So we want to share with you today the key components of our long-term operational and financial outlook.

It starts with deepening and expanding customer relationships and growing spinal implants revenue more than 4x to 5x faster than the market. We plan to achieve that through a focus on continuing to offer best-in-class spinal implants and orthobiologics products, which is the outcome of nearly 7 years of product development focus and execution that has translated into more than 50 new products and line extensions launched; leveraging and enabling technology platform that is not only the safest and most efficient on the market, but one that allows us to deliver long-term revenue commitments through the use of multiyear capital-efficient earn-out arrangements; further increasing revenue per surgery through greater participation in complex deformity procedures and increasing the number of SeaSpine products and systems used per procedure; delivering the best customer service to our distributor partners that is expected from a nimble pure-play spine company; and utilizing our experienced strategic accounts team to reach every major GPO and numerous IDNs in the U.S.

We also expect to realize benefits from the targeted initiatives we've highlighted on this slide, some of which are already underway to generate sustained revenue growth and significant operating leverage on our path to profitability as measured by adjusted EBITDA.

So let's dive into more specifics on these initiatives. Starting with cost of goods sold, we anticipate expanding gross margin by more than 500 basis points by 2024 to nearly 70% through a variety of means, including lower unit costs for our internally manufactured orthobiologics products with increasing production volumes relative to the high fixed costs of our Irvine plant. We also expect to launch our next-generation particulate DBM product line in 2022 with estimated 20% to 25% lower cost to manufacture compared to our third gen DBM product line.

We plan to generate more meaningful gross margin leverage from our U.S. spinal implants product line in the future through a combination of favorable sales mix of higher gross margin products such as WaveForm 3D, from our recent efforts to lower manufacturing costs for our NanoMetalene franchise, which comprises more than 10% of our revenue, greater set utilization and inventory efficiencies from onboarding new exclusive and collaborative distributor partners that will turn our spinal implant sets more efficiently and from the benefits of our recent upgrade to Implantbase, an inventory planning and management software commonly used in the orthopedics space and can also be utilized by our spinal implant distributor partners. And we've invested more than $1 million on this significant upgrade, which went live in February, and we're already seeing the benefits.

We're going to reduce complexity in the new organization and decrease sustaining engineering and quality costs through a more aggressive discontinuation of legacy spinal implant systems with more than 15 systems sunsetted to date and 20 more systems slated to be discontinued by the end of 2024. And we're going to further reduce organizational complexity and increase our focus on the U.S. spinal implants business by exiting the low gross margin European spinal implants market in 2022, which is expected to drive more than 60 basis points of adjusted gross margin improvement in 2023.

So turning to R&D. We're committed long term to investing in product development and clinical data at the historic rate of 9% to 10% of total revenue. For the near term, though, we're accelerating our planned investment in new and next-generation enhancements for the 7D Surgical FLASH technology platform, which we expect to drive R&D expense above 12% of total revenue for 2022 and 2023. We firmly believe the return of this investment in terms of higher sustained revenue growth, and benefits of scale justifies the short-term trade-off. And with the most intensive effort and expense for 7D expected to be completed by the end of 2023, we expect longer-term R&D spend to decrease back to 10% of revenue by 2024, more in line with historic rates.

And now I'll turn the presentation over to Beau, who can provide more color on 7D's R&D priorities.

Thanks very much, John, and thanks to everyone for joining today. Our vision is clear. Our team is laser-focused on providing real-time, clinically relevant information to our surgeons and the patients they serve.

If we look at the FLASH system itself, it all starts with technical innovation. We've leveraged our strong balance sheet and our appetite for innovation and have made aggressive investments into the FLASH system. This is positively impacting our surgical workflows. We're reducing extensively radiation in the operating room, all while allowing our surgeons to focus on the now, to focus on their patients.

You can see on the right-hand side here is a quick refresher on the brains of the 7D system. We have several camera rinks in that imaging head, which all can be controlled from the sterile field of view.

So let's explore several of these innovations that allow our surgeons to operate in the now. Starting with the core technology, the ability to instantaneously 3-dimensionally map patients in nav. FLASH registration is real-time imaging. We've combined our powerful 3D imaging hardware with proprietary intelligence software that allows our surgeons to register patients in less than 30 seconds. Talk about staying in the now, compared to our competitors who can take tens of minutes. This allows our surgeons to maintain focus on their surgical objectives and avoid cumbersome workflows.

Looking at specific features. Those cameras I mentioned that are inside of that surgical light that a surgeon can control squarely, here, we're showing them in a gray scale where we can overlay information on top of the patient's anatomy. And here is an example. If a patient is moved, this is probably the most emotional component of any surgical procedure because the surgeon has lost registration accuracy. They are now challenged with that difficult decision of do I spend the tens of minutes, expose my patients to additional radiation? Or do I abandon navigation altogether and use fluoroscopy feeding? Well, we saw this as an opportunity, leveraging the machine vision system, we can instantaneously retake a 3D image of that patient's anatomy using only visible light and instantaneously correct for that new position of the patient's anatomy. No radiation, all within only a couple of seconds, and you can do this continuously throughout the procedure. Navigation on demand.

Building further. Here is a new feature we've released called our Re-Slicer. This is showing our attention to detail when it comes to software. In a tortuous spine such as here, you can see the anatomy being realigned. Well, how is this occurring? We provide the ability for real-time re-slicing the patient's anatomy, such that the surgeon can see true axial views, true sagittal views, unlike in this image where it's confusing what we're looking at. An axial may look like a sagittal, and the opposite is true, all controlled by the surgeon in real time so they can operate in the now.

The last feature that we're going to touch upon is our FLASH trajectory. Here, we can now see those video feeds on the bottom. And in the procedure, these are real-time videos, giving us low to medium X support type functionality. We can see these videos, and they can, in fact, be expanded out into the operating room. We can overlay digital information, creating that augmented reality experience for a surgeon. In this scenario, they're getting real-time implant sizing, along with a virtual k-wire, such that they can now use a tack or a screw driver without a tractor ray and follow that for the cannulation previously used by a pro.

Finishing up with the Enabling Technologies Group, let's talk about the future. Well, we are focusing on 5 areas of investment in 5 areas of products, seamless integration of our spinal implants, orthobiologics and enabling technologies. And Keith showed a couple of slides of where we've already achieved full integration of our Mariner implant sets, along with the ability to track new products such as our Facet Fusion.

We've also invested aggressively into new camera technology, camera technology that we, in fact, are creating from the ground up and that we will own as proprietary information. This will allow new features, including new visions of the surgical view, higher data throughputs for analyzation with our intelligent software. We're also expanding our real-time patient understanding to account for any correction or where we are correcting the patient in an operating room, inclusive of preoperative planning. And finally, which is really exciting, truly exciting, we've developed these cornerstones of technologies for almost last decade. They've now been accelerated by the overall SeaSpine team. And for the first time, we're going to be deploying this technology outside of the operating room, into different departments within the hospital, creating completely new revenue streams for the organization.

Thanks very much for your attention, and I'll pass it back over to John.

Thanks, Beau. Another critical strategic initiative for SeaSpine is implementing a direct sales strategy in the U.S. We're targeting to add at least 5 direct sales reps in the second half of this year and ultimately increase that to 30 reps by the end of 2024. Now we're not planning on a broad-based strategy to buy out distributors, but rather a targeted approach to hire into the white space where we haven't been successful in recruiting exclusive and growth-oriented distribution. Our expectation is to generate at least 25% of our U.S. spinal implants revenue and as much as 10% of our U.S. orthobiologics revenue in this direct sales organization as we exit 2024.

So while the initial fixed commission arrangements that often come with hiring a direct sales rep will likely be dilutive to commission rates in 2023, we see an opportunity to extract 150 basis points of commission leverage by 2024 compared to 2019, the last year the commission rates were impacted by COVID. And with annual commission expense totaling more than $54 million in 2021, there is clearly a very large opportunity for SeaSpine here.

The last initiative I'd like to cover is our recent decision to exit the spinal implants market in Europe, which has historically comprised about 3% of our total revenue. Given our relatively small market share in Europe, coupled with the significantly higher cost to comply with the recently enacted MDR regulations, we simply don't have enough scale to overcome this higher recurring cost burden. So what was once a relatively low gross margin but modestly profitable business would operate at a loss for the foreseeable future for us.

After making the difficult decision to exit the EU spinal implants market, we gave our distributor partners an opportunity to place final stocking orders, which we can ship to them through September 2022. So we received those final stocking orders. We've placed corresponding POs with our suppliers, and we expect to generate between $12 million to $13 million of revenue in the third quarter of this year for those orders. After that, we'll no longer generate any revenue from the sale of spinal implants in the European market.

So in addition to avoiding recurring operating losses, we expect to benefit from reducing the organizational complexity that came with managing this subscale business and from increasing focus on our U.S. business, which comprises 90% of our revenue. Now keep in mind, this decision was limited to the EU spinal implants market. So we do not expect it to impact sales of our orthobiologics or enabling technologies in Europe nor sales of any of our products in the Latin America and Asia Pacific markets.

So the takeaway from all this is that we are consciously trading off some short-term financial dilution from the acceleration of 7D's development programs and the investment in a direct sales force in return for anticipated higher long-term revenue growth and meaningful P&L operating leverage.

To recap some of these operational efficiencies and other highlights, in 2022, we expect to generate between $226 million and $230 million of revenue, which reflects 18% to 20% growth over 2021 and includes the $12 million to $13 million of revenue from the final EU spinal implant stocking orders. For the first quarter this year, we expect to report between $48.5 million and $49.5 million of total revenue despite a very, very slow start to the quarter, particularly throughout the entire month of January. Because of the adverse impacts of Omicron on hospital capacity and staffing capacity and bed capacity, we still expect to report a solid quarter of growth ranging from 16% to 18%.

And even with the negative impact of the bolus of low gross margin revenue in the third quarter associated with the EU spinal implant stocking orders, we still anticipate delivering 150 to 200 basis points of adjusted gross margin expansion in 2022. We also anticipate reducing our adjusted EBITDA loss by 15% to 20% compared to 2021 through a combination of more efficient revenue growth fueled by the onboarding of additional, more exclusive and high-quality distributors and from a robust cadence of transformative product launches that Keith talked about earlier and from higher adjusted gross margins.

And consistent with amounts spent in 2021, we plan to once again invest more than $40 million of growth capital in 2022 in additional inventory and spinal implant sets needed to support the launch of more than 15 new products and line extensions this year and to enable long-term growth. We're on track to extend and expand our $30 million credit facility for another 3 years by the end of April. And as we've demonstrated in the past, this facility provides real liquidity that extends our cash runway.

Longer term, we expect to generate revenue growth in the mid- to high teens over each of the next 3 years, which should allow us to achieve adjusted EBITDA breakeven at an annualized revenue run rate of $300 million to $320 million as we exit 2024. We expect to substantially reduce our free cash flow burden by more than 50% by 2024 and to opportunistically raise more growth capital in the future to maintain a minimum 2-year liquidity runway. But with the anticipated long-term extension of our credit facility, we do not foresee the need to raise core capital imminently. We intend to use that credit facility in the near term to extend our liquidity runway, which should allow us to wait until much later in the year before we have to approach the capital markets.

I'm really excited about this new path forward that we've mapped out today, and I know that Keith and Beau and the entire SeaSpine organization share the enthusiasm. And we all look forward to charting our progress as we deliver on these short- and long-term objectives.

So now I'll turn the call back over to Keith for closing comments.

So in closing, I hope everyone has been able to get a glimpse of how the mission and vision has changed for the organization. We love kind of our new direction and the play on this, that it's Sea Beyond because we are uniquely transforming the OR. We have the ability now to not only have deeper penetration in partnership in the sales field, but most importantly, to really give our surgeon and hospital partners a different confidence on how they can deliver outcomes for their patients. And the beauty to all of this coming together is we are doing it now.

So with that, I would like to turn it over to questions.

Wonderful. I see that Matt O'Brien has a question. If you'd like to unmute yourself and ask that.

Sure. Can you guys hear me okay?

We can. Hi, Matt.

I guess, Keith, you've done this before on the flip from distributor to direct. I'm not saying you're doing that here. I hear that you're not. But just doing some really quick math. This 25% number by the end of '24 would seem like about half of the growth or maybe a little less than half of the growth you're expecting over the next 3 years, 3.5 years is really going to come from these white spaces and direct reps. So first of all, are those numbers somewhat accurate? And then secondly, just confidence in the ability to plug in direct reps into these geographies successfully, keep them and then grow their businesses?

Yes. You bet. So I think you're thinking about it the right way, Matt, that the -- there will be a time lag for as you bring aboard direct reps until they kind of get their comfort with the feet on the street, they get their comfort with getting hospital contracting and everything else resolved. But yes, we do view it that way that -- especially because we're looking at this in white space environments, that it will be areas that we don't have any store sales, if you will. And so this will all be new store sales and the ability to really get effective leverage in those accounts.

Now that said, we feel comfortable that this shift in strategy also comes because of significant leadership gains that we now have in our sales force that have also done this at other organizations. And I think that's the key. The key is, is that we are going deeper with our distributor partners, without a doubt. So this is not an affront to them. This is really our opportunity to no longer accept white space as a -- as an excuse that there's not good distribution, but instead invest in that space and invest in a direct, which gives us greater leverage points down the road, as Bos kind of identified.

So you're thinking about it the right way. You're thinking about it the same way we are, that the growth strategy, especially as we start getting significant growth in implant revenue upon previous years of growth, that, that has to be done by getting market share in white space with direct sales folks.

Got it. And then just 2 more for me, if it's okay. The first one is just on 7D with those 17 placements. Were all of those into existing SeaSpine accounts? Or were you getting into some newer accounts you hadn't been in before? And can you just talk a little bit about what you're seeing as far as demand for that system as you folded it in, as you're adding these new features?

Yes. I can address the first part of the question. So no, they're not into existing SeaSpine accounts, and that's the great thing is the combination of 7D and SeaSpine -- the introduction to new accounts is working both ways, right? We're getting 7D into accounts where we've got a strong relationship and starting to place units there, but 7D has its own capital sales force, and they're penetrating into accounts, where SeaSpine has had no presence. And then what we're tracking, too, is we're seeing ultimately noncontractual revenue pull-through in those accounts where we had no orthobiologics or spinal implants presence, but once 7D has a foothold in the door, now that we're combined together, the natural introduction takes place, and we're starting to see revenue pull through simply because 7D gets a foot in the door.

So now we can approach accounts historically like we've done, right, with spinal implants, we'd lead with biologics. Now we can lead with enabling technologies, and we're seeing ourselves getting pulled through the door in a greater opportunity beyond just 7D. So it's really working all 3 ways.

Okay. And last one is for you, Bos. Just on the gross margin side. A lot of companies will give these projections and feel comfortable with them. But looking out, 4 years is difficult, 3.5 years is difficult. So especially in this inflationary environment, just the confidence level or maybe some of the wiggle room you've built in to get to that 500 basis point plus improvement in gross margin.

Yes. There's certainly a risk of increasing commodity prices, right? Titanium, obviously, is one of the larger ones we purchased. So we've accounted for some risk in that because of the inflationary environment. But there's a lot of opportunity, Matt, on just simply sales mix, right, with the growth rate of spinal implants and seeing what those gross margins are today.

The lower cost of WaveForm is pretty meaningful compared to the NanoMetalene franchise, but we've also been able to reduce the unit costs of the NanoMetalene processing, and that's 10% of our revenue. So I think there's a lot of opportunity just in the spinal implants portfolio because most of the historic gross margin leverage has come from orthobiologics. But with spinal implants between WaveForm, sales mix, lowering the NanoMetalene processing costs and then this big investment we made in Implantbase, the ability to manage, plan inventory, give our distributors visibility into the inventory, track how they're utilizing those sets, right, it's a whole other level of visibility that not only our asset management team can see, but our distributors can see. And it just -- it really helps us look at how we're going to turn those sets more efficiently, reduce the inventory that's -- that gets unaccounted for in the field because, as you can imagine, there's a large amount of field-based inventory quantities.

And just looking at how we launch products, right, some of the scrap we saw in 2021 was from redesign of implants. And that's going to happen, but I think we've got a better handle on how to manage that better against revenue expectations in the future. So I'd say, yes, there's inflationary risk on the gross margin, but there are so many different new levers we can pull on the spinal implant side that, frankly, weren't even available to us 2 years ago or a year ago.

We have a question from Matthew Blackman. Matthew, if you could unmute yourselves.

Can you hear me okay? Maybe first...

Yes, we can. Thanks for joining us.

A couple of 7D questions and then maybe a question on the cash runway. Let's start on 7D. I guess I'm a little surprised that only 3 systems were placed on earn-outs, but how does that line up with your expectations? And how should that shape how we should be thinking about modeling a full year 7D capital sales in 2020? Maybe start there.

Yes. I think it's a fair question, but it's one that we messaged throughout last year and that there's a couple of things that go on, Matt, to get earn-outs on the map. I mean, first of all, it is an integration with our implant and biologics sales force. They have to be comfortable selling that opportunity. It's also an opportunity for the 7D capital equipment sales force to have a new kind of tool in their toolbox. And so we had messaged that more and more of this will happen, especially as we get our legs under us and understand the different options there are to do an earn-out.

Now keep in mind, there are a great deal of hospitals out there that are excited about earn-out. There's also a great deal of hospitals that aren't excited because they felt they were hostage with some of our larger competitors who had very large earn-outs saddled on to these hospitals. And so some hospitals just insist that it's better for them to either lease something or it's better for them to buy it outright.

And so again, the ultimate mission for us is placements. And don't get us wrong, we love the earn-out equation. We love the ability to know that we're going to have a market share shift. But at the same time, the most important thing is getting this into the OR, integrating it into the OR and really changing the way and the workflow of how a surgeon can help their patients.

That makes sense. Appreciate that. And then maybe, Keith, for you or Beau, just the types of cases you're seeing 7D being used in. And are you seeing, I'll call it, sort of workflow and outcome benefits that you've talked about? Are those playing out in cases, like shorter procedure time, lower blood loss, shorter hospital stays? Just any sort of way to frame where 7D, how 7D is being used in sort of these sort of first initial accounts? And then one follow-up for John at the end.

Yes. So I'll let Beau address that because there is some interesting data that continues to be presented and shared. And he is really the expert on sharing that.

Thanks for the question, Matt. So if we think of the types of cases, we are a broad spectrum spine system. So we support everything from lumbar procedures, S2AI guidance, we really knock it out of the park when it comes to cervical, especially with cervical media with our NorthStar platform. So we are a broad spectrum. We're also now into our beta phase of the Perc Module. So that was the last type of procedure that we are working on towards full commercial launch. And the alpha beta has gone extremely well.

When we think of output, this is where we really start to differentiate the technology versus our competitors. In fact, we had a publication published in the Journal of Spine through an Australian study that compared our technology to an incumbent technology, a Brainlab Z combination, and we reduced interoperative radiation by over 95%. That is a massive amount of radiation savings. Building upon that, we are in the current process of a journal submission where in a complex deformity center, in Driscoll Children's Hospital in Texas, we've reduced the average cases there by 63.6 minutes. So think of that. Think of the last time you've heard of an assistive technology reducing that amount of workflow. Typically, our competitive technologies are adding 30 to 60 minutes, and we're reducing it by that much. And similarly, we're reducing blood flow. That publication, we're expecting to be released to the market and the full findings later this year.

Great. That's really helpful. And then final question for me. Appreciate all the questions. John, again, I appreciate your comments about cash runway. You're extending the credit facility for 3 years. Is there any opportunity to expand it? I guess really what I'm getting at is there may be a need to access capital markets. But are there options or nondilutive options or opportunities that we should be thinking about?

Yes. And part of the extension, I think I mentioned in the presentation is we're looking to expand it as well because we did have a $10 million accordion feature on that credit facility, and we're looking to restore that as part of this long-term renewal. And we're also working with Wells Fargo to increase our borrowing base through higher borrowing capacity on AR, including international AR in some of our inventory accounts. So yes, we're definitely pursuing expanding that credit facility because, as we've grown, we think we can quickly grow into that higher capacity as we added up to $40 million at one point.

And I see we have a question from Kyle Rose at CGF. If you'd unmute yourself.

So I just wanted to follow up just a little bit on 7D. Appreciate the revenue metrics you gave for '21. Wonder if you could just help us understand how we should think about that growth trajectory into '22 and maybe how you think about that progressing as you build out the direct sales team and just over the terms of the long-range plan.

Yes. I think for us, it's going to be a balance of capital sales revenue, but also placing the units under earn-outs, right, particularly in the U.S. And that capital sales revenue can come in the form of just a straight-up capital sale or what we're -- kind of dubbed a reverse earn-out where accounts can purchase the unit upfront in return for rebates down the road, but it requires them to actually increase their purchases of our spinal implants and orthobiologics to earn those rebates.

So we really want to have a balance, depending upon what the hospitals' needs are. So we'd expect to see the capital sales revenue grow as we penetrate deeper into the market. But as Beau and Keith and I've said many times is if we place most of those units under an earn-out, economically, that's the best opportunity for us to get new market share and also retain that new market share because as something Beau's pointed out in the past is if you get a 3-year earn-out agreement with an institution, that's usually going to cross over a GPO contract extension or a local contract you've got with that group. So not only does it get you in the door, but it keeps you in the door.

So we're still looking for a balance of higher capital sales revenue, whether it's a straight up-capital sale or this reverse earn-out where they can get rebates through increasing purchases of our spinal implants and orthobiologics or any original earn-out we contemplated where we placed the unit in a capital-efficient manner in return for a fixed kickback commitment over a longer period of time to either start using our orthobiologics and spinal implants to get new store sales, so to speak, or above a baseline that they've historically purchased so that we know that we're getting growth in return for that free placement.

Okay. So I guess is it fair to say that the contribution from some of those earn-outs, that's included in your 2022 guidance when you talk about spinal implants exceeding 17%?

Yes.

Okay. Great. And then obviously, the company has been prolific from a product development standpoint. You talked about rolling out an additional -- I think you just had 15 new products and line extensions this year. At the same time, you're also talking about rationalizing some products as well. Just help us understand how much of these are really filling white spaces or gaps in the market when you talk about new product launches. I'm just trying to understand, you filled a lot of major gaps in the last several years. Just how much more is there to develop moving forward?

Yes. I think there's a couple of different ways to look at it. So some of it, you're right, has been gaps in our portfolio, and those gaps may have been from products that are older. We've messaged that one of our last larger products is to do partial -- or to do vertebroplasty and -- not vertebroplasty, I'm sorry, vertebral body replacement and the products that are associated to that, which are important to trauma. So I would view those as more gap-oriented.

The other products, though, are really how you round out being a procedural company, right? So none of us want only our interbody and not our pedicle screw. We certainly want interbody with the biologic, with pedicle screw, for example, and then all of that coming together in a seamless way and better workflow with 7D. So I think it really depends on what product we talk about, whether it's truly a gap filler or it's just an important part of completing the procedural solution.

All right. Nice. We have a question from Ryan Zimmerman. Please unmute yourself.

Can you hear me okay?

Sure can. Thanks for joining us, Ryan.

So just on the P&L opportunities, John, that you laid out, I mean, I guess, as I think about the 500 basis points, how does that kind of play out over the next few years? And what do you see as maybe a lower-hanging fruit and easier to achieve? And what's maybe longer term to achieve?

The lower-hanging fruit is the cost reductions we talked about, right? NanoMetalene is 10% of total company revenue. And now having a second source supplier and the ability to reduce the unit cost, I think, goes a long way in the short term as the low-hanging fruit because we've already achieved those savings.

As we go to WaveForm full commercial launch, right, the 3D printed process, it's less costly than the NanoMetalene process. So as we launch those 3D printed implants, right, and they're all expected to go into full commercial launch this year, the revenue pickup we get from full commercial launch given how it's contributed to revenue in just the alpha launch at that lower cost of manufacturing, I think, gives us the low-hanging fruit in the near term.

Longer term, it's leveraging the investment in implant base and more collaborative distributors who understand the value of asset management and are willing to work with us to utilize those sets more efficiently and focus more on managing field inventory that we get the benefit from with greater visibility through Implantbase, but it's something we've got our supply chain and commercial operations teams really focused on.

We brought some new leadership in, in supply chain and commercial operations in the last 2 years who speak the asset management language, right? They come from companies with a long experience in dealing with sets utilization and tracking them. And that's something we're putting a lot more emphasis on, and as Keith said, a lot more accountability on for excess and obsolete inventory reserves -- field inventories, perhaps. So we're really putting a lot more emphasis and accountability on it because we have the tools and the experience and resources within SeaSpine to really tackle that head on where we haven't had that in the past.

Okay. And so just to put a finer point on that. So 150 basis points this year, maybe 150 to 200 basis points in subsequent years in '23 and '24. Like does that assume kind of a cadence for margin expansion over the next 3 years?

Yes. I think it'll be linear like that because we're going to see benefits from each of those different legs on the stool from lower manufacturing costs, better inventory management, sales mix. So yes, I think it looks linear like that.

Okay. And then a follow-up from Kyle's earlier question. Keith, you talked a little bit about kind of the contribution from capital sales. If we think about the new -- absent the new rep contribution, the growth profile of the company for 2022 and beyond, what's that composition of growth look like in the legacy kind of orthobiologics and spinal implant business relative to the faster growth coming out of capital sales?

Yes. So think about -- I think we've kind of mentioned that the orthobiologics still has very good energy. There's no question that we've seen additional market share gains on the orthobiologics side despite orthobiologics growing at a lesser rate than typical spinal implants are in the marketplace. But we've seen energy, thanks to DBM being a strong replacement for the higher and more expensive cell lines, right? So that -- we see that as a continued positive.

I mean we'll be very happy with high single-digit, low double-digit growth on the orthobiologics side. It will depend from quarter-to-quarter. But we still see that product portfolio having strength. I mean a perfect example is they continue to offer new products. We talked about one new product coming down the pike on the DBM side. We're offering a pellet in the cervical spine as part of OCT. So it's -- there's a number of opportunities for them also to expand the product line, but just gaining market share from sales gives us great confidence that even through 2024, we'll see strong growth on the orthobiologics side.

We have Samuel on the line with a question. If you can unmute yourself, please.

Can you guys hear me?

Yes. Thanks.

Okay. Sorry about that. So first one, I just wanted to ask on, Beau, a comment you had made on expanding 7D beyond the OR. I just wanted to understand what that means. Should we think about that as 7D being used in other anatomies or end-uses in the hospital outside of surgery?

Thanks for the question, Samuel. So I think the biggest takeaway is moving the technology outside of the operating -- this is going to open up both new procedure types, new anatomy and different departments in the hospital. So it's actually both.

And how should we think that -- think about that as sort of relating to the broader implant strategy? Can you just kind of elaborate on a sense of where that should go?

Yes. I think probably the way you should kind of capture it is the -- what Beau's referring to is really the investments we're making in the technology that have applications for obviously spine and cranial, which is what we largely sell now, we are going to also make available in other specialties. And we'll make decisions at that time as we move to alpha and beta, whether it's best to seek partnership, whether it's best for us to be at the forefront of driving it. But I think it's -- it goes along with our strategy. And I think the higher level of care that the team in Toronto thinks about, and that is -- it is an agnostic system but it also has broad application. And we feel strongly that, that broad application is more meaningful even outside of spine.

But as we see those products get through the FDA processes, we see them get into alpha, we'll of course share more information. But right now, the focus is on advancing technology, obviously, for spine and cranial. And then if that technology has other applications, to also thoughtfully pursue those.

Got it. That's helpful. And then on the percutaneous modules, can you give us an update on where that is in terms of the commercial rollout? How should we think about units being deployed going forward?

Yes. I think I can take this one, Samuel. So we completed our alpha just at the end of calendar '21. We have now been in beta for just about a month, and we are on track for full commercial release in early summer. So we have to go through the standard elements as required by beta, getting it across a specific number of hospitals and in a specific number of surgeons' hands. But right now, everything is on track for that full commercial launch in early summer.

And are you seeing any accounts maybe delay either placement or a purchase of the system in anticipation of a percutaneous module?

We're not. We're seeing them more as a marketing opportunity because we can now fill that navigation void.

We have a question from Jeff Cohen. If you could unmute yourself?

So I guess I wanted to, firstly, John, if you could comment on CapEx and inventory and shifts that we should anticipate in addition to the slides you presented.

Yes. I think it's going to be very similar, Jeff. More than $40 million investment in spinal implants inventory and CapEx, and that was pretty evenly split in 2021. It was around $20 million each. I think you'll see a bit more of a shift -- even though the total number is going to be about the same, I think you'll see a bit of a shift more towards inventory versus CapEx because we deployed a lot of sets, launched a lot of products in 2021.

Now we've got more going to full commercial launch this year, particularly the WaveForm Mariner Adult Deformity. So you'll still see a healthy amount of CapEx for the sets that we're going to build. But given the growth expectations, I think you'll see a little bit more of a shift of the mix to be higher on the inventory side to support the growth expectations we have for this year, but also for the longer-term growth rates. We want to make sure we have enough sets in inventory, in the sets and on the shelf to be able to replenish that demand and hit those higher revenue growth targets.

Okay. Got it. And then secondly for Beau, 2 items. I guess, firstly, if you could give us a look back on the 7D platform and cross-selling opportunities from previously existing accounts from when the merger took place as far as hardware and/or biologics, and any pull-through there? And then as far as the percutaneous model, could you talk to us a little bit about how that plays out with existing accounts on upgrades or sales as opposed to full systems?

Yes. Sure. So when we think about the cross-selling opportunities with the 7D platform, I mean, in particular, we've had some great results in the Northeast where we have had historically a 7D system. And now they have started to -- or fully moved over specific product lines, whether it's implants or orthobiologics. So we are, in fact, taking advantage of that cross-selling opportunity.

And to build upon that from one of the earlier questions about the proportion of earn-outs versus capital system placements, we really do see either an earn out or as a capital sale, a benefit because it gets that foothold in the door to explore the surgeons use of our additional product lines. And that's proving true in several of our existing sites.

When it comes to the Perc Module, the way that will be marketed is it will be an upgrade for the hospital, generating additional revenue from the system. And one of the -- actually, the biggest sell point of the percutaneous module, which is different than any other percutaneous navigation is we're vendor neutral when it comes to the intraoperative imaging technology. So for example, right out of the box, our system can link up and does not require to be calibrated, it can just link up directly to a hospital's existing GE 3D or their Z or an OR or whatever they have on site. We're seeing that as a huge benefit. And the hospital ecosystem is validating that because they don't have to go out and buy another imaging system. We can use what they currently have.

And we're seeing Ryan has another question. Please unmute yourself, Ryan.

Okay. So we had 2 questions that -- go ahead, Ryan.

Sorry about that. I muted myself, apologies. Just circling back on one thing. John, you've historically talked about operating expenses usually at year-end as we kind of move into the next year. And with the increase in the direct sales force, I'm wondering if you can just give us your thoughts about kind of that incremental operating expense that you'd expect for 2022.

Yes. If you think about sales and marketing, right, it's the biggest line in the P&L. And I don't think -- we don't anticipate the investment in the direct sales force to materially change that in terms of percentage of revenue. It's just we likely won't get a lot of leverage out of the sales and marketing line, particularly the selling component of that because of the commission amount that's in there, because of the fixed commissions that we're going to be paying as we build this direct sales force.

So I don't see it increasing sales and marketing as a percentage of revenue. I just think it limits our ability to get leverage out of that over the 2022 and 2023 time frame. But then by 2024, that's where you should start seeing the commission leverage because we're generating more revenue from that direct sales team, and a lot of them are going to be past that fixed commission time period. So that's kind of how we're seeing that play out.

We talked about R&D, right, short term increasing to 12% of revenue for 2022 and 2023 and back down to 10% for 2024. And as far as G&A goes, that's been one area that we've consistently gotten the leverage on over the last couple of years because as revenue is growing, we've been able to keep G&A to -- adjusted G&A generally to a 3% to 5% increase year-over-year. So I think we'll be in a kind of a similar range and get more leverage out of G&A in the coming years as well.

So there was 2 questions written in by Jason, and thanks for joining us, with Loop Capital. So the first question Jason had was in and around the MIS and some questions through 7D, which were just recently answered by Beau.

The second question was, and I think it's a very reasonable question, do you plan on keeping distributors in place or eventually phase them out in 2022 and beyond? And so yes, I want to make it clear. And I think Bos had mentioned some of this during his slide remarks that this is in addition to -- I think that we're making it very clear that the distributor partners that we're bringing aboard and I think we're making significant commitments to -- when I say commitments, we're committing to them on big opportunities of real estate, so to speak. We're committing to them that we will buy and support them with the right amount of assets. And in return, we have high expectations of how they will get market share gains in that territory.

And so I view that as a very important part of our future partnership and one that doesn't get replaced just by a direct organization. Instead, if we're both investing in each other, that continues to be a very strong strategy moving forward. Most of what we were referring to on the direct side is really taking advantage of areas that there isn't good distributor options or the options that are there don't want to have a more focused or exclusive platform with us. They want to kind of have many different masters, so to speak. And that's really not a direction that we think is valuable for us.

It looks like Samuel raised his hand again. Please unmute yourself.

I just had one follow-up question. Thinking about the mix of complex cases in 2022, should we think about that normalizing versus 2021? I know there have been some mix issues with that not getting back to regular levels with COVID.

Yes. It's a great question. It's one that we're getting our arms around as well. And I think this is a very unique experience in the first quarter. As Bos mentioned, it was a difficult close to the year as we talked about. When we started off the year, it was also a difficult start to the year as January slowdown was very real. But I feel very comfortable that there's a combination of things going on, that the backlog of patients is real. Some hospitals, not all, are able to accommodate this through maybe longer OR time or even weekend OR time, but most are not. And they're not because their staffing issues don't resolve overnight. The good news is their staff is healthy. The bad news is they may not have enough staff to do the kind of flexing that we once saw in the OR for spine procedures.

So that said, we feel obviously bullish that it's going to be a strong year, assuming that intermittent shutdowns don't happen across the country for other reasons and that the hospitals are dealing with their staffing issues or at least trying to accommodate them in different creative ways. But I would go as far as saying that there's going to be huge flex time, and OR time is going to dramatically increase. I think it ends up being more, depending on the hospital system and depending on the area of the country, different sorts of flexibility are presenting themselves.

But I'm certainly very encouraged that if you would have been talking to us in late January or early February, we were concerned about the intermittent slowdowns. And it's been a robust restart, if you will, one that you see in the kind of results that we're predicting for the first quarter.

All right. It looks as though there are no more questions. If not, that will conclude our call. Thank you for joining.

Thanks, everyone, for joining us. Have a good weekend.