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Alphatec Holdings (NASDAQ:ATEC)

Bank of America Merrill Lynch Health Care Call

May 14, 2013 04:00 AM ET

Executives

Les Cross - Chairman and CEO

Analyst

Unidentified Analyst

[Abrupt Start]

…for our next presentation and with the presentation we have the team from Alphatec Spine and Les Cross, Chairman and CEO, I’ll turn the podium to you. Thanks for coming.

Les Cross

Thank you. I think we can make this more of a five side chat by look of things. So, I’m really thrilled to be in Las Vegas, I’m thrilled to be here at this conference but I’m really thrilled because my daughter is a dolphin trainer at The Mirage hotel so I got dinner with my daughter last night. So, it’s been a wonderful trip. If you go over to The Mirage with the dolphins.

So, this is the Safe Harbor statement and we would encourage everyone to look at our public filings which have just all been updated for risks et cetera. This is the first slide; I will spend a little bit of time on this and will fly through the other one.

How we should think about the company? What makes us a little different than the other Spine companies? We are seventh largest in the world, we are based in Carlsbad, we do our own manufacturing and we have an integrated manufacturing facility in Carlsbad, California. This is another interesting fact just over a third about business is outside the U.S., this really came with the franchise position we did a number of years ago. It’s a great footprint for us to leverage as continue to accelerate that growth outside the country and in Q4, Q1 we saw growth over Q4 and in the revenue a lot of that actually came from the international business, reasonably flat EBITDA. I thanks to the medical device tax that we had to pay for the first time in that month.

But as you can see, the business in headcount of an up and down experience, it took over the company year ago, we really focused on accelerating our international growth and new product introduction and our acquisition with customers and I’ll talk about what that all means here in a moment.

I think you all understand that even though the market has the challenges we all faced has still a great market, it’s still going to be driven by the aging population. So, while we’re going through some adjustments in price and what kind of patient deserves the procedure still fundamentally it’s a good industry once we get through the headwinds we were facing right now.

So what are the investment highlights? When I first joined the company, I sent a note out to all the mangers worldwide and said what are you most proud of and they said, innovation, pretty much across the board. The company had a history of innovation, really lost its way a little bit in the last little while. So, when I joined we really focused on reinventing R&D, we are working on a lot of projects, we’re kind of skinning that down, we focused on them and if you look at our public filings you’ll see we had a number of 510-K approvals in the last few months. So, we’re really are getting back to being an innovative company.

Expanding that global sales and distribution model, most companies outside don’t have that international footprint. It’s not in common for a U.S., medical device company outside to have 9%, 10%, 12% of its revenue outside the U.S. that significant we need to leverage.

Operating excellence, when I joined the company has a good manufacturing operation, but I would say it’s not well classed and so our focus is on leaning that and delivering world class customer service, utilizing our assets better, reducing our inventory. Some of you will have noticed that Luke Faulstick who is my Chief Operating Officer at DJO joined our Board and Luke left DJO and has a company that makes power transformers and is doing very well. But Luke agreed to join our Board and he is really my mentor to my operating team on how to introduce our lean concept global supply chain management world class customer service. So, Luke has been a great addition to the Board of Directors. So, together with our Board of Directors I think we have a team that has experienced and knows how to deliver what I am promising.

So the other thing we did when we joined the company was really look at what is our purpose why does the company exist and we are a small company so we like to be a physician inspired company. I mean there is many companies in our space and some of them are easier to work with than others from a physician perspective. We want to be very lean and very focused on our relationships with physicians telling what we are going to do, do what we say not -- there is a lot of, the bigger companies that really don’t respond to what the physicians want in a timely basis so our focus will be on providing physician inspired solutions for patients with pain disorders.

So we are going to leverage our value structure to grow the company and I think you can all see exactly what we talked about product expansion continuous improvement customer experience so how are we going to do this we are going to grow our global market share we are going to do that through our continuous flow of new products geographical expansion all the things you would expect like we did at DJO we are only going to look for accretive acquisitions and these are companies that are going to be $5 million to $20 million in revenue probably orphaned companies but their product will be approved by the FDA they will already have revenue in the United States we will move the manufacturing into our facility we will leverage our overhead to do it and we will require these small companies with a mix of stock and cash to really fill gaps in our product range and accelerate our growth just like we did at DJO. We will regain the reputation we had as being a leader in product innovation.

And something that really is important to me is what we did previously; we will have a performance culture. What do I mean by that? Continuous improvement, urgency, accountability, give people the authority, hold them accountable to lever the numbers. We are transitioning to that kind of culture. Values are important for that compass. when we have to make decisions everyday this is the compass we use to help us make the right decisions for the company and for our shareholders and other stakeholders as well. so the management team as I talked about it is pretty much a new team a lot of experience in running medical device or being involved in medical device companies probably the one that is pretty exciting is Tom McLeer came to join us as you can see Tom has extensive spine experience and frankly that is what it was lacking in my management team was someone that grew up in the spine industry understands the technology understands the relationships so Tom has been a great addition to the team.

So we are going to increase, how we are going to grow the business domestically we want to increase our procedure revenue through biologics. We want to sell them the plates, the antibodies and the biologics that go into it so it is more money from the same procedure. One of the gaps we had in the product range was a synthetic we licensed one called Nexus which is now starting to gain some traction in the marketplace. Many of you will remember we acquired a pod called Phygen. Phygen was owned by 117 spine surgeons. We bought the company for a mix of stock and cash. these physicians are now shareholders in the company whether they use the product or not. We would hope that they would see the benefits of using our product as I say there is over 100 of them. only a handful of them are large customers today. It is an opportunity to have very well qualified sales leads to get in front of the doctors and say doctor you are a shareholder in the company let me show you our new product and I can tell you it got off to slow start but it is really starting to gain traction now.

Strategic accounts GPO this is what we call flexible distribution it is a very fragmented market we all know that and so to have distribution principles, not principles but strict guidelines makes it very tough if a hospital wants to do business with us because that is in their best interest we will do business direct with the hospital if they want to have employed reps we have one hospital now that said I will take an invoice from anyone but the manufacturer and the people at work in this hospital will employees of the manufacturer. We don’t want any commission distributors, we don’t want any agents. We want to do business directly with the company so we oblige. Some hospitals like to use distributors, some like to buy direct. You know we will adjust our distribution strategy to fit what our customer wants rather try to make our customers fit into what we want.

Expand our use of medical education. we use cadaver labs all over the world to help train and accelerate our business. And as you can see we have about 275 reps, a handful of those are direct, you know in territories where direct rep makes sense. We will hire direct reps if we have a good distributor. We are committed to that distributor.

The international business has been an important part of our business. I think the real highlights here; we are awaiting approval for the Alphatec product in Brazil and China. We have a good footprint in Brazil and China with our products we acquired from a French company but we have been working now for a couple of years to get approval. We expect approval in Brazil and China of the Alphatec products by the end of the year.

We’ve jumped through all the hoops. We’ve complied with all the requirements, so we really should see that. We also got Australia on line, which is the Asia (ph) is this. So we think even though the international business, I think are 16% last quarter, 10% the quarter before, we think we can continue that kind of growth thanks to the registrations in China and Brazil. And in Brazil we actually have our own subsidiary. The company made an acquisition there a couple of years ago and they are already doing well, and they are doing well with the French products, not with the new U.S. products.

So I think we are going to focus on accretive acquisitions, just like we did at DJO. So the sweet spot is probably $5 million to $20 million in revenue. The will instantly be accretive because we will do away with whatever overhead they have and move the manufacturing into our manufacturing and leverage our overhead. We will look to fill GAAPs in our product range or find new innovative technology that we can add on top of their product range.

An example of being with the company here we've already done three. The Phygen acquisition as I said over a 100 surgeons own these companies are now shareholders. They are locked up equally for one, two and three years. So they should have an interest in how the company performs. We hope they will and certainly it’s how to get out and show them our new products.

Pegasus which is a cervical device with the blades of lock it in place, it’s very noble technology. There are similar devices. Then what makes this one different, that you turn that key the blades deploy, if you don’t like the way you are, or it’s a revision you turn the key the other way the blades pop back and you pull it out. So the blades are unlocked in forever which they are also competitive products.

I started off by saying one of our goals was to increase revenue for a procedure. So we did a license agreement of this synthetic biologic product so in a year that’s three kind of deal, and this is kind of the field, that the deals will do. You know small acquisitions licensing agreements to fill out our portfolio. So when I got to the company, if you remember, I said we were trying to work on too many products.

We focused down. We focused on a handful of products and I am pleased to say we now have those products in the market. Here we can see Solus which is our anchored antibody for the lumbar. Pegasus anchored antibody for cervical, here you can see an x-ray of multilevel. The beauty of this, the surgeon puts it in, they gets fixation. You know movement is the enemy of fusion, so locking these devices in place, so they are packed with biologics, hopefully helps, stick it in, turn the key, the plates are deployed.

You know Trestle Luxe is a new innovative cervical plate. Avalon is all part of our posterior cervical products, NEXoss we talked about. Bridgepoint, spinal process, fixation system, minimally invasive, these are all the products that were kind of stuck in the pipeline a year ago and Epicage is where the inner body is actually deployed through a straight two. It turns the corner, it's all loaded with the graph and the synthetic and the biologic, turns the corner and straightens out again. And certain physicians think this is going to be a true novel feature.

So, we really do have a complete product offering; as you can see here our product range goes all the way across complete cervical range; (inaudible) lumba range and I should talk about our minimally invasive. This is our fastest growing product worldwide and we just want some line extensions in that allow us to do larger cases. This is probably our number one global; it's almost global product that we have; excluding pedicle screws of course but it really is. It sets us apart it opens a lot of doors and we're expanding that product range.

Our biologic portfolio is very full; we have everything from bone to synthetic biologics, it’s a very full portfolio and the focus is every case we get; we get the plate, the inner body and the biologics, increase the value, put a case and the profit per case. We also have from our French acquisitions from really noble products internationally; we have a ceramic disk which is actually done very-very well in the national and quite a novel range of product.

We have not brought these products to the FDA because of the costs and the uncertainty of getting the products approved. We are a small company; I don’t think we need to be investing millions and millions of dollars in a clinical trial. We will leave that to others, our job is to get products for the market quickly and generate profit some cash.

But the good products they sell well internationally and these are the products today that we are selling in China and Brazil and some of the other markets around the world. So, it’s a very comprehensive product range. So, operating excellence I talked about Luke coming in; I mean I have a good operating team. Luke is really just acting as a mentor, spending time challenging what we are doing, holding the team accountable and is really adding value with; we're driving this, we want to reduce our inventory; we want to reduce ways to reduce inventory and yet deliver world class customer service and we also want to be the most efficient lowest cost manufacturer out there.

So, there is a lot of reasons to drive lean through the organization and some of you that follow DJO know that's what we had to do; when you can make money out of knee braces and arms swing. You have to be good at supply chain management and we are bringing that same culture to this company.

We do have a vertically integrated manufacturing facility since I've joined the company, we've invested in several new pieces of equipment so that we could bring products that we are paying someone else to manufacture in house. And we've also leaned this out; we now have (inaudible) systems in place. We are running smaller patches to reduce lead times to improve service levels for our customers, so really is starting to have an impact. And I invite any of you there in Southern California we would love to give you a tour of the facility and show you what we have done. So, the financial guidance we have given for the year was 204 to 210 in revenue, roughly our 4-7% growth, EBITDA you can see, and we have set for the company, the goal; we set ourselves the goal; short-term goals versus long term but I really like to be here soon or rather and later.

I don’t think it’s a real long path from where we are to get the 20% plus EBITDA and it's time for the company to start generating cash. So, we need to see this kind of the cash flow from the company; it's my history of having companies that have large EBITDA and cash and there is no reason why we can't do the same here.

The only headwind that came to this guidance, we talked about in the earnings call is the yen, the good news is we have a big business in Japan, we are in fact number four in Japan, we are number seven in the U.S. we have a significant business, that’s the good news. The bad news is that the yen has gone to hell in a handbag as you all know. So we do have currency exposure based on the same rate that currency exposure should be covered by the range of guidance. I think we set as roughly $4 million for the exposure for the reminder of the year and the end if the exchange stays where it is. So that's the only thing that might condense that guidance range is what happens with the yen.

And I think I have covered all these as we talked. I’ll leave this up as we go through questions. So we have a few minutes for questions. I would love to take any questions you have.

Question-and-Answer Session

Unidentified Analyst

What's the utilization of your factory currently?

Les Cross

So if I just look at screw machines you know we are probably pretty much at capacity, as we lean it out we will create some more capacity but footprint, I have a lot of footprint to put new machines in and they are not incredibly expensive but as you lean out you increased capacity. but the other the new machines that make plates and the machines that make inner bodies, you know we are probably at 75% capacity, screw machines were probably 90% capacity but you know screw machines are easy to combine, the new machine or a lot faster than the old machines so because we have the space in our facility to add more machines, certainly as we do acquisitions, we will be able to increase our capacity without adding any overhead other than lease on another 200 and some thousand dollar screw machine.

Unidentified Analyst

So just jump in to couple of questions. One you talked about, this is Brazil and China; I mean how much of an opportunity are those markets, how opportunistic you can be in terms of commercializing in those markets?

Les Cross

That’s a great question. Brazil, I probably have my arms around Brazil a little bit more because we are direct there and we have our own subsidiary and it’s already a multimillion dollar territory for us and if you think back at that slide I showed and I think this slide, you know that that’s their product range today, that’s their product range tomorrow. So, I think it’s a huge potential and the same is true in China. China today sale this and sometime between the end of the year they are going to have most of this. So I think it’s a multimillion dollar opportunity in both markets.

Unidentified Analyst

And then just a follow up on that, the global spine market and I not an educated person in this process but, you talked upon your calls about something insurance approval from the challenges in the market you are facing, please walk us through that how much of that, is that same headwind was a couple of years ago or where are you in that curb if you will.

Les Cross

The headwinds changed a little bit. I think insurance companies are still slowing down approvals, I think they are getting more efficient on what patients are going to do better, faster. I think they are definitely expecting patients to go through conservative treatment before they get surgeon, that’s all good medicine, you know that should happen. I support that and eventually that becomes normal and I think that is normalizing, it has been going on as you say for a while now. I think pricing pressures continue to be fairly fierce as hospitals are prepare themselves for the changes that are coming in their healthcare system. We are seeing hospitals being more aggressive in their pricing expectations and we felt the impact to that in Q1 and the reason we probably felt that more than some of our competitors is the lack of new products. new products tend to carry a higher gross margin and tend to protect some of that price erosion of the me too products and so on our new products are now starting, Solus is out in the market, NEXoss is in the market, Pegasus will be in the market shortly. I know one of our competitors call it their vitality index, which I think is a good thing to think about. What percentage of revenue comes from products that were launched in the last couple of years? And ours is very low and I think our competitors that haven't sold the pricing pressure I think their index is high and that's why I've been focused on the R&D effort. Solus has a list price of $11,000 and probably will have an average selling price of 7 or 8 at the end of the day, that offsets few dollars discount in the screw to a hospital. Does that answer the question?

Unidentified analyst

You touched on the $5-20 million acquisition opportunity, how big is that, how many opportunities are if you will, and could you also just touch on that the recent acquisition (inaudible) you said it was a little slow on the uptake in terms of what you anticipated, what do expect from that the rest of the year.

Les Cross

So I think how many acquisitions are out? I think there is a number of small spine companies in the US that were started by a physician with angel investors, they had some interesting technology, they got a patent, they've got FDA approval, they've got the company to that $5-20 million in revenue, they need to raise money to expand, and there's no money for them to expand and so I think they're the kind of companies we're looking for, but we have a couple of rules, has to already approved by the FDA, we're not going to waste money licensing stuff that isn't approved by the FDA, has to have a patent, have some clinical history. And I think there's a number of them out there, there's just no money for them. You know before in spine, everyone was throwing money at these companies and now they're not and I think we become an exit strategy for them, and these aren't the companies Medtronics and things are trawling for, because they're not big enough to move their needle, they're big enough to move our needle. So I think there's a number, we look at deals all the time; turn most of them down obviously.

So Phygen, Phygen why was it slow, the physicians that we've got out and explained the transaction to, get excited and book cases, I haven't got out to talk to enough physicians to explain the transactions. I think we've allowed, we've left it to other people to do it that perhaps don’t have my vision or passion or some of my other leadership team, so it really becomes our responsibility to get out and, just last week I went and visited three Phygen physicians that used to be big Phygen users, kind of drifted away, you know explained the transaction, showed them our new product and walked out of there with two Solus cases booked for this week. You know once we get out there and talk to them, they're smart people and they'll see the benefit of using our new product. I let others deliver the message and it just didn’t come across as clearly as it should have. Gives me something to do anyway, I should have done it earlier. Any other question, there's a familiar face, good to see you.

Unidentified analyst

On the guidance that you gave the 4-7 % growth for the year, I'm just wondering what you're assuming in terms of the global pricing impact in that guidance.

Les Cross

So we assumed about a 5% price erosion in that guidance, for guidance basically said, flat market plus Phygen or slightly the market itself growing in low single digits plus Phygen, you know it's kind of the spread of that guidance. Hopefully it was conservative, time will tell, but that, but yes, we're basing about a 5% price erosion. Look at that, finished on time. Want to see photos of my daughter training dolphins. Thanks for your time and we’re around if anyone has any questions and again if you’d love come to see our facility you're always welcome.

Unidentified Analyst

Thanks Mike. Thank you again.

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