SPNE (2019 - Q1)

Good day ladies and gentlemen and thank you for standing by. Welcome to the SeaSpine Holdings Corporation First Quarter 2019 Earnings Conference Call. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder this conference call is being recorded. I would now like to turn the conference over to Ms. Leigh Salvo of Investor Relations. Ma'am please begin. Leigh Sa

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 full financial results for the first quarter ended March 31, 2019. 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 results and 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, intent and similar expressions. You are cautioned not to place undue reliance on forward-looking statements, which are only predictions that reflect our beliefs based on current information and speak only as of today May 1, 2019. 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 releases and periodic filings with the Securities and Exchange Commission, which are 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. 2019 is off to a strong start as we continue to see revenue growth momentum in both our spinal implant and orthobiologics portfolios. We were also successful in generating gross margin expansion from the process improvements implemented last year at our Irvine, California orthobiologics manufacturing facility. I'm pleased to see the positive results emerging from our continued focus on execution and investment. Our priorities to drive long-term growth remain the following. First, continued product innovation through timely development and launch of differentiated new products and systems with an investment in a sufficient number of sets and inventory to drive deep penetration into the market. Second, establish thoughtful and collaborative relationships with new committed and more exclusive distributors both in the US and internationally. And third, re-engage existing quality distributors that have the potential to become more exclusive and committed to our products and systems. As a result of our ongoing focus on these priorities, we have been successful in not only gaining market share, but encouragingly growing at a rate that is 4 to 5 times faster than the overall spine market. We remain committed to these priorities and are confident that this path, combined with our sound financial position will enable us to achieve our goals to build the size and scale required in the spine market for improved operating margins and reduce free cash flow burn. We have built an amazing team and culture at SeaSpine that remains laser focused on our vision, developing surgeon-centric cost effective solutions that combine innovative spinal implant systems with industry-leading orthobiologics which together can drive improved procedural solutions and deliver clinical value to the surgeon, hospitals and patients. Turning to our topline performance; revenue for the first quarter of 2019 totaled $36.2 million, an increase of 9% versus the year ago period. Despite there being one less selling day in the current quarter, US revenue increased 8% to $32 million and international revenue grew 15% to $4.2 million. In the US, growth was once again led by increased sales of new and recently launched products and line extensions that are driven primarily by our improved distributor network. New and recently launched products contribute more than 55% of our US spinal implant revenue and nearly 20% of our US orthobiologics revenue in the first quarter of 2019. We are excited about the growth opportunities ahead of us, as we continue to build and develop a more committed and exclusive distributor network that is generating an increasing percentage of our overall revenue. In the first quarter, we were successful in onboarding several more exclusive distributors in the US that carry both product portfolios and we expect to close on additional opportunities in the second quarter. For the first time ever, the percentage of orthobiologics revenue generated by distributors carrying both portfolios topped 50%. Over the past several years we have made tremendous progress towards delivering what we believe is a platform of innovative and highly utilized foundational spinal implant systems and an efficient full-scale production of new orthobiologics products. In addition, we continue to make meaningful investments in further product innovation and new products that are supported by expanding distributor and surgeon training and education programs. As a result, we're able to give our larger and increasingly exclusive distribution network the confidence that we can and will support the growth of their businesses. Turning to the near-term product launches we discussed on our February call, we are excited by the success of the ongoing alpha launches of our Regatta lateral implant and access system and our Mariner cortical system. And we remain on track to fully launch both systems by the end of the second quarter. We also expect to fully launch the Shoreline anterior cervical interbody system incorporating our proprietary Reef technology. And to alpha launch the Mariner Outrigger system for use in revision surgeries by the end of the second quarter. I'll now turn the call over to John to provide more detail on our financials and our financial outlook. Then I will wrap up. John?

Thanks, Keith and good afternoon everyone. As Keith noted earlier, total revenue for the first quarter of 2019 was $36.2 million, an increase of 9% compared to the prior year. US revenue increased 8% to $32 million and international revenue grew 15% to $4.2 million, largely on the strength of spinal implant replenishment orders from our distributors in Australia and Europe. First quarter 2019 results were impacted by one less selling day compared to the prior year and will gain the benefit of an extra selling day in the third quarter of this year. US orthobiologics revenue in the first quarter increased 8% year-over-year to $17 million driven by growth in recently launched DBM products led by the OsteoStrand Plus product . The growth in DBM product revenue continues to be slightly offset by a sales decline in our Mozaik collagen ceramic matrix product line. The anticipated launch by the end of May of the OsteoCurrent product we recently licensed Kuros Biosciences is expected to be an upgrade to our current synthetic bone graft substitute product offering and should help stabilize that declining revenue base. US spinal implant revenue in the first quarter increased 9% year-over-year to $14.9 million and was once again driven by growth in recently launched products, led primarily by the Shoreline and Mariner systems and by our expanded NanoMetalene portfolio. Spinal implant surgery case volumes increased by approximately 15% but was somewhat offset by low single digit price declines in procedural mix. Gross margin for the first quarter was 62.4% compared to 63.3% for the same period in 2018 and reflects a 180-basis point expansion versus the 60.6% gross margin reported in the fourth quarter of 2018. This sequential quarter expansion reflects the anticipated benefits of our focused efforts to reduce manufacturing costs of our orthobiologics products. In 2018 we implemented a series of process improvements at our Irvine, California manufacturing facility that increased manufacturing yields and lowered manufacturing scrap rates for our orthobiologics products. The benefits of which we are realizing the P&L now as that lower cost inventory is sold. Operating expenses for the first quarter 2019 totaled $31.6 million compared to $28 million for the same period in the prior year. The $3.6 million increase in operating expenses was driven primarily by the result of $2.8 million in higher selling, general and administrative expenses, including stock-based compensation, selling commissions, salary and wages and instrument depreciation and replacement expenses. Research and development costs increased approximately $700,000 to $3.5 million or 9.7% of revenue, primarily due to increased stock-based compensation and salary and wages and other headcount related costs, as we upgraded and expanded the breadth and capacity of our product development teams and higher costs related to clinical studies. Net loss for the first quarter of 2019 was $9 million compared to a net loss of $7.1 million for the first quarter of 2018. Cash, cash equivalents and investments at March 31, 2019 totaled $45 million and we had no amounts outstanding under our credit facility. During the first quarter of 2019 we did not sell any shares of common stock under our ATM program nor do we anticipate utilizing the ATM program in the near future. Our free cash flow burn, which excludes financing inflows and outflows was $7.4 million for the first quarter of 2019 compared to $6.3 million in the prior year period. Recall that we payout annual cash incentive bonuses in March of each year. We remain focused on expanding our gross margin and continuing to reduce cash based G&A expenses as a percentage of revenue. However in the short term, we plan to continue to redeploy much of that operating leverage towards the sales, marketing and R&D initiatives and inventory and spinal implant set build capital expenditures that are critical to building the scale and driving the sustained revenue growth that are needed to achieve sustained positive free cash flows in the future. Accordingly, we expect our free cash flow burn from 2019 to exceed the $20.9 million free cash flow burn we incurred in 2018. Turning to our financial outlook for 2019; we are raising the bottom end of our revenue expectations and now expect full year revenue to be in the range of $154 million to $156 million for 2019, reflecting growth of 7.5% to 9% over full year 2018 revenue. This compares to previous revenue guidance of $152 million to $156 million. While we are not providing quarterly guidance, we still anticipate that revenue growth in the second half of 2019 will slightly outpace the first half based on the expected timing of the deployment of additional sets of our recently launched spinal implant systems. Moving down the P&L; we expect gross margin for 2019 to increase to within a range of 62% to 64% as we continue to realize the benefits of the process and yield improvements, we've recently implemented in Irvine. And SG&A excluding non-cash stock based compensation charges and any non-cash gains or losses related to changes in the fair value of NLT contingent consideration liabilities to approximate 66% to 69% of revenue. We now expect R&D to approximate 9% to 10% of revenue to reflect the increased investment in clinical studies and product development headcount. At this point, I would like to turn the call back over to Keith for closing comments.

Thank you, John. In summary, 2019 is emerging as another pivotal year for SeaSpine, as we continue to execute on product launches and expand the reach and exclusivity of our global distributor network. I am proud of the solid foundation for sustainable growth we've established, which is supported by our organization of nearly 400 energized employees, who are committed to providing high-quality, differentiated and complementary technologies that leverage our core competencies in orthobiologics, interbody devices and modular spinal instrumentation systems. With that, we will now open it up to questions. Operator?

[Operator Instructions] Our first question or comment comes from the line of Matthew O'Brien from Piper Jaffray. Your line is open.

Afternoon gents, thanks so much for taking the questions. Just for starters either Keith, either John, can you just give us a sense for the biologic headwind that you're facing because the performance there was pretty good in the quarter. So, just trying to get a sense for if you net out that headwind what that would look like?

So from an orthobiologic perspective, we're still working through I think, as I mentioned in the call, Matt, that 20% of our revenue is coming from new products. We're still working through getting a number of the new products that have been launched over the past year, continuing to work through accounts, getting pricing approval, so we don't -- Yes, I don't believe it's a headwind. I think it's the nature of the market we're in now as new products get launched. It's not just immediately available in some of the accounts. You have to go through a pricing process. So we feel really good about the strides we've made. We're going to continue to see the percentage of new products, continue to go up on the orthobiologics side. I also think that we're continuing to see headwinds in other areas of the market, specifically those on the sell side that spell great opportunity for us especially in the new Strand material products that we have I think, we'll continue to focus and make sure that those products are good alternatives from a cost effective perspective as well as from a clinical perspective.

Fair enough. And then as far as the guidance goes, when we look at what John said about the second half of the year being fast than the first half and Q1 here being pretty good. I'm just wondering is the range that you're providing kind of what would have to happen to get you to the lower end of the range versus the higher end of the range.

Yes, I mean I'd prefer to answer the question with sort of what's the expectations for the back half of the year. It's the set builds that we've got planned that we talked about on the fourth quarter call, right, the strong cadence of new product launches we've got scheduled on the implant side, deploying more of our high utilization sets like Mariner and Shoreline as we continue to penetrate deeper into the market. The expectations we have, based on the first quarter performance and the fact that those set builds and product launches are scheduled to start around the end of the second quarter, early third quarter puts us kind of at an all-time high in terms of our confidence for the revenue guidance range, because of how we executed in the first quarter, and how we're continuing to execute and what the outlook is for the rest of the year.

Okay. But just to be a little bit clearer on that, John, or just get a finer point on that. You did about [indiscernible]. You're saying expect a little bit better for the overall business in the back half of the year. So assuming Q2 is not going to be a massive deceleration, so it just feels like midpoint, even towards a little bit of the higher end of the range is probably fair as far as how we think about the models.

Yes, I agree. And the way you characterized Q2, right, we're not expecting a meaningful deceleration -- a massive deceleration rate. We're just continuing to be cautious with the guidance and being consistent with what we said in the fourth quarter call about how the cadence of product launches are going to impact revenue in the back half.

Got it. And then last one for me just on Keith commentary -- I caught part of it. I don't think I caught all of it, as far as the number of new distributors that you've onboarded sounds like that's ramping nicely. Sounds like there's a lot of opportunity to continue to go even more exclusive. Can you provide a little bit more color, Keith, as far as the exclusivity you're seeing among some of your distributors? And some of these new distributors are onboarding, as far as the quality of those folks, are you moving up tiers as far as some of the distributors you are getting onboard now just given the breadth of the product offering you have? Thanks so much.

Thanks, Matt. Yes, on both of those questions. There's a couple areas that we feel very good about that were white space areas that we have now good partners that have good spinal experience. They also have with that strong contacts and good surgeon education and sales force education in the mix as well. And so part of what we've always talked about is that it does take a bit of time for folks to come aboard, to be trained and also to be proficient on the products and we feel very good about the new quality of distributors that are coming aboard that they're able to start faster and get aboard quicker from an education process. I still think for them to be fully seated and for us to have all the approvals we need at hospitals, it still is that 9 month process to 12 month process, but they're getting traction quicker than we've seen before. And so we feel good about the new folks coming on. We feel good about the ones that are kind of in the pipeline if you will. And the new products, especially the second half of the year that both John and I described on the call, are absolutely encouraging them to come aboard quickly and to get started knowing that the pipeline of innovation is going to produce what they need to be successful as we get into 2020.

Thank you. Our next question or comment comes from the line of Craig Bijou from Cantor Fitzgerald. Your line is open.

Thanks for taking the questions. Hi Keith, want to start with -- maybe just to follow-up on Matt's question earlier on the distributors and bringing them onboard. And not necessarily how quickly once they're on board, how quickly they're going to ramp but I wanted to get a sense for what you're seeing as you're going after better quality, maybe larger distributors, just the negotiation process that you're seeing out there? Is it taking longer to get them over the goal line or identify them? Is there any impact on the cost of bringing them onboard? I know other companies that have had a similar strategy in the past have, once they kind of go up a level and distributors have run into some, maybe it takes a little longer than expected. So I just wanted to get a little color on what you're seeing from that perspective?

Yes, interesting. The number one conversation that we seem to have that's very consistent with all of the new folks whether they're coming aboard or they're working through when they can come aboard thanks to whatever it may be, contractual agreements, non-compete that they all have a very similar theme and the theme is do we have the ability to invest in our innovation. Meaning they're excited about the new products. They're excited about what they're seeing, they're excited to talk to the engineers and the product managers about the direction of those new products. But it always comes back to, are you going to make the appropriate investment in inventory. And that is really where I think both John and I spend a lot of time with our sales management team is ensuring that we can plan out these new adds and that we do have the right investments. And I think we highlighted in the call that we've been very serious about how we are thoughtfully putting together our inventory, how we're thoughtfully making sure it can be deployed for these exclusives and most importantly the timing of it, right. I mean, obviously, some things have different lead time than others and so you have to make your investment earlier to make sure it's available when they actually have approval at the hospital and are ready to go. And so I would say that is the number one concern when they come in the door. And, obviously, with the raise we did last year and our current ability and access to our credit line, we certainly have a very strong pathway to show them how we can afford the inventory and how we're going to deploy it so they can be successful.

Yes, and just to add on the point I drive home and I think really resonates with everybody I meet with that comes here and talk about SeaSpine is just our liquidity position hasn't been better since the spin. It's at its best it's ever been between cash on hand, immediate access to cash through the credit facility. And we kind of recap where we've made investments in sets and inventory, show them the recent investments, how that's translated into the accelerating revenue growth. And I think it really energizes them that we say we're going to continue to invest like this but we've also got the financial means to continue to invest like this. And we've got the confidence to continue invest like this based on the return on those investments, and I think that really resonates with them.

Great, that's helpful. Maybe just turning to growth and, I guess, over the last couple of quarters there's been a bit of a divergence in the growth rates between the orthobiologics side and the implant side. And I know there's a number of moving pieces in each that are affecting that difference. Traditionally you guys have said that implants and orthobiologics should grow roughly in the same area. So just wanted to kind of get a sense for your thoughts on that specifically in 2019 and then maybe just longer term going forward how the growth rates will compare to each other?

Yes, I still think that -- I don't think they're going to exactly mimic each other, but I do think that they are both capable of sustaining the high single-digit, low double-digit growth rates that we promised. There may be some ebbs and flows between them by quarter and there's reasons behind that of certain buying patterns especially on the orthobiologic side. But we also feel really good about some of the new accounts that are coming aboard with our new products on the orthobiologic side. Unfortunately it's just the kind of market we live in right now, it takes longer to get approval for new products than ever before, especially in the larger buying groups. And so it's -- what I enjoy is the fact that we still enjoy a number three position market share almost 15% on the DBM side, which gives us the opportunity to make sure we have a seat at the table, but it doesn't necessarily mean we get expedited approval. And so we're going to continue working through that. The metric we talked about in the call was the 20%, now is new products and we see that continuing to grow. And as that grows, it gives pricing stability along with a better clinical alternative in the OR for surgeons. So I think, you'll continue to see lift in that area and will come as more and more approvals come at the bigger buying groups.

Great, thanks. And if I can just squeeze one last in cash burn, John, you said that was going to be a little bit higher in '19 than it was in '18. Just thoughts -- how should we think about that looking at '20? I know you're not going to provide guidance, but is there a leverage to be gained in '20 and how should we think about the burn there?

Yes, I think a couple of factors. There's the large investment in sets that we're making this year, because of that robust cadence of product launches we talked about on our fourth quarter call, it's this year continuing to drive. Orthobiologics finished goods levels for the legacy particulate DBM as well as the ramp up of the fibers DBM right what we're carrying, I'd say more than is optimal, but we want to make sure we can continue to fill orders and it's beneficial for us to convert existing business over to the fibers based DBM because it's we think better clinically, but also a lower cost profile for us as well. So that helps the gross margin with all the efficiencies, we've been able to implement. So I think as that cannibalization pattern continues to evolve, we'll have better predictability and can start bringing down the legacy finished goods levels on the orthobiologic side and focus more on the ramp up on the fibers-based DBM. Also on the set builds, we've had an opportunity as we launch new products. One of the things we've talked about essentially since the spin is as we launch new products going for international registrations as well and we're able to take advantage of price breaks at higher quantities, if we're buying systems for launch in the US such as Regatta to add on additional systems for international launch when that time comes. While we may not sell those products or those systems designated for International this year, it makes sense financially to buy more systems knowing there is demand outside the US when we get those clearances to be able to sell through the inventory rather than buying fewer sets of higher price points. That's part of our strategy this year and that should give us some benefit next year that we won't need to make those same investments for international because we're making it at the same time we're doing the investment for the US launch. And as I said getting better price points across a greater number of systems.

[Operator Instructions] Our next question or comment comes from the line of Ryan Zimmerman from BTIG. Your line is open.

Hi guys, it's Sam on for Ryan. How's it going? With your distributors carrying -- your biologics distributors carrying biologics and implants now over 50%, just curious to see if you're seeing any faster sales growth there in the implants line and if that might be compared to your exclusively implant distributors and if that can be driving some of the inflection up, just out of curiosity there.

Yes, I think it's a fair question. It is interesting we do see some of our newest exclusives being able to penetrate newer orthobiologics quicker. It's probably too early to tell if that's a consistent trend or not. But keep in mind that to get to the market share position we're at, to be the number three player with a 15% market share in the traditional particulate DBM. I think those are long standing accounts. They're accounts that have been supported very nicely. Some of them even probably have the ability for to be able to shelf product at the account. And so there is a bit of longstanding comfort with the traditional product line but I do think that some of our newer exclusives have done a better job of launching and driving the newer alternatives in Strand and in Ballast.

Great, that's helpful. And then looking at growth in the quarter, when you're thinking about the kind of delta between where you had originally expected growth to be and that came in at the higher end of your guidance. Are you seeing a more rapid uptake on the newly deployed sets, or are you just seeing better utilization on the set that had been in the field would you say?

Well, it's both. We're getting great utilization out of the high-demand systems like Shoreline and Mariner and the expanded NanoMetalene portfolio. And again as we talked about how we think things are going to play out through the rest of the year, with the timing of deploying more of those sets and the full commercial launch of Regatta around mid-year, seeing the high utilization rates we're getting out of these existing sets, timed with the onboarding of the additional, more exclusive distributors and by the time they get ramped up, I think the deployment of the additional sets will timeout well, because we have a lot of confidence they'll be highly utilized, the additional ones we deploy in the field based on the historical usage patterns and that gives us the confidence in the revenue growth being slightly higher in the second half of the year. But to answer your question more directly, it's both.

And then just last one, with the Kuros product coming to the field, how quickly do you feel that that can get across your distributor network? And then as an addition to that, any thoughts on where additional [indiscernible] could add to the portfolio for the year?

Yes, we're excited about the -- having a synthetic alternative, but I think it will follow, as I commented on the DBM side, I think it follows kind of that new product progression. There's still going to be opportunities where we have to get it approved. The good news is I think it absolutely is a premium product that will deserve a premium price, but we're going to have to go through all of the same kind of hurdles that we've had to go to with the Strand material and even Ballast. And so the good news is we're very fresh down this road, but it is a process. So I would look at it as a progressive launch that picks up momentum. I don't think it's just turn a switch and it's a rapid acceleration.

Thank you. Our next question or comment comes from the line of Jeffrey Cohen from Ladenburg Thalmann. Your line is open.

Hi Keith and John, this is actually Destiny [ph] on for Jeff. Thanks for taking the questions. I just wanted to get a little bit of clarity. I know you mentioned, when you were speaking about the R&D spend going forward about some efforts in finance is going towards clinical work. Could you give us an update on what you're currently working on? And then along the same lines I know you're adding -- you're expanding your headcount. Could you give us an idea of what your FTE is now please?

Yes, so I'll answer the first part and let John take the second half of your question, Destiny. So from a clinical perspective, we're keeping very focused on kind of what we have been mapping out from last year and that is we feel like we have a significant economic value and clinical value when you combine our orthobiologically friendly NanoMetalene technology with our newest and greatest, of course, DBM materials and the Strand materials. And so we have made sure that from a clinical effort and even from an animal work effort that everything is focused in and around that, meaning we want to further demonstrate the value of NanoMetalene. And as we talked about on this call, the Reef technology which is an additional feature to the implant that will be a NanoMetalene bonded implant, that will foster potentially quicker opportunities for stability for patients. And in that, we want to make sure that we're designing clinical studies that help demonstrate that. And so we have worked on a number of studies that demonstrate the effectiveness of our NanoMetalene implant systems with our newest and greatest orthobiologics. And it's just a matter of getting study started, recruitment, follow up and everything that goes along with it. But we feel like we are responsibly demonstrating how we are economically valuable as well as better clinical outcomes. And so that's been the focus of those R&D dollars towards clinical.

And then just to answer your question on the headcount, we're just under 50 on the R&D side which is clinical, regulatory and engineering and of that just about 30 of those are in the engineering groups in both ortho and spinal implants portfolios.

Okay, got it. Thank you. And then I guess, I just thought of another one for the clinical side. Should we expect to see any data presented at upcoming conferences in the next two to four quarters? Thanks.

No. From a true patient clinical work, no. It would be further out by the time that we get enrollment and then we start looking at the follow up points. And like it or not, we can show stability early, but most studies like to see something around a year before you start getting them accepted on a podium. There may be opportunities though as we move forward depending on submissions and timing for some of our additional animal work to be presented or at least to be discussed. And we'll keep it posted as those things get submitted and accepted when appropriate.

Thank you. I am showing no additional questions in the queue at this time. I'd like to turn the conference back over to Mr. Keith Valentine for any closing remarks.

So thank you everyone for joining us this afternoon and that you have a great evening. Cheers.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.