Baxano Surgical's (BAXS) CEO Ken Reali on Q1 2014 Results - Earnings Call Transcript

May.10.14 | About: Baxano Surgical, (BAXS)

Baxano Surgical Inc (NASDAQ:BAXS)

Q1 2014 Results Earnings Conference Call

May 08, 2014, 4:30 pm ET

Executives

Mark Klausner - Investor Relations, Westwicke Partners

Ken Reali - President, Chief Executive Officer, Director

Tim Shannon - Chief Financial Officer, Treasurer, Secretary

Analysts

Jason Wittes - Brean Capital

Mark Landy - Summer Street

Matt Miksic - Piper Jaffray

Operator

Good day, ladies and gentlemen, and welcome to Baxano Surgical Incorporated first quarter 2014 earnings 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, today's meeting is being recorded.

I would now like to introduce your host for the conference, Mr. Mark Klausner of Westwicke Partners. Mr. Klausner, please begin.

Mark Klausner

Thanks, Jeanine. Joining us on today's call are Baxano Surgical's President and Chief Executive Officer, Ken Reali and its Chief Financial Officer, Tim Shannon.

Before we begin, I would like to caution listeners that certain information discussed by management during this conference call will include forward-looking statements covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those stated or implied by our forward-looking statements, due to risks and uncertainties associated with the company's business.

The company disclaims any obligation to update any forward-looking statements made during the course of this call. For a discussion of risks and uncertainties associated with Baxano Surgical's business, I encourage you to review the company's filings with the Securities and Exchange Commission, including its Annual Report on Form 10-K for the year ended December 31, 2013, the Form 10-Q for the quarter ended March 31, 2014 expected to be filed on or about May 12 and the Form 8-K filed with our earnings release.

In addition, please note that we will discuss certain non-GAAP and pro forma financial measures on this call, which should be considered a supplement to and not a substitute for financial measures prepared in accordance with GAAP. A reconciliation of these non-GAAP and pro forma measures to the comparable GAAP measures is included in the earnings release posted on our website at www.baxanosurgical.com in the Investor Relations section.

With that, it's my pleasure to turn the call over to Baxano Surgical's CEO, Ken Reali.

Ken Reali

Thank you, Mark. On today's call, I will review operating highlights from the first quarter and then Tim will discuss our financial results in greater detail. Finally I will review our guidance and key operating priorities for the remainder of the year.

For the first quarter, Baxano Surgical reported $4.4 million in revenue which was below our expectations. While our total surgeon users in the first quarter remained consistent with the fourth quarter, our case volume and cases per surgeon were down materially. These case volume declines were primarily due to some seasonal strength in the fourth quarter as patients elected to have procedures prior to their deductibles being reset, coupled with adverse weather conditions in the first quarter in the Northeast and the Midwest which caused procedures to be delayed. We have seen a nice bounce back in case volumes in April, providing an encouraging start to the second quarter.

Looking at worldwide product revenues. iO-Flex revenue was $2.4 million for the quarter, which was down $455,000 from Q4. While iO-Flex had 26 new surgeon users in the first quarter and total users remained in line the fourth quarter, 17 of the top 25 surgeon users experienced a decline in case volume.

AxiaLIF revenue was $1.2 million in the quarter, down sequentially versus $2 million in Q4 due to lower international revenues and domestic case volumes that continued to be adversely affected by available private payor reimbursement in the United States. Two level AxiaLIF declined sequentially at a higher rate than single level as a result of the two level key code still in place for this procedure.

First quarter VEO revenue was $575,000. Total revenue was down sequentially by $302,000 due to a large stocking order to Mexico in the fourth quarter. Globally case volume was up 24% sequentially as U.S. procedures were essentially flat and oUS procedures increased.

First quarter iO-Tome revenue was $131,000, up 48% sequentially in the first full quarter for this new product in our portfolio. We added 15 new surgeon users in the quarter.

Our cash and cash equivalents decreased $7.1 million in the first quarter to finish at $1.5 million at quarter end. Cash used is typically higher in the first quarter due to the timing of some large expenses, including our National Sales Meeting. In late April, we completed a $10 million private placement of convertible debentures to help strengthen our cash reserves.

I would now like to discuss some operational updates. We have spent the last six months analyzing our sales force effectiveness, and as I will discuss in greater detail later, I have come to some important conclusions about the best way to cover the market. Based on this, we have decided to implement a sales strategy that will utilize our direct sales force in certain geographies where we have strong tendered reps and established momentum.

In other regions, we will partner with well-established distributors, which should allow us to shorten the time required to build hospital and surgeon relationships and gain sales momentum in these markets much faster than with a direct model. We believe that this hybrid sales model would drive us towards sequential revenue growth and also lead to a sequential reduction in our operating expenses through each remaining quarter in 2014.

In early April, we received FDA clearance for our Avance MIS Pedicle Screw System, which we view as a significant accomplishment for the company. We expect to commence our limited market release of Avance late in the second quarter. We believe offering an entire solution for degenerative lumbar MIS fusion will improve our competitive position in the market, allowing us to bundle our products to hospitals and own the entire case.

As mentioned, we completed a very successful National Sales Meeting in the quarter, where we were able to further cross-train our sales force and distributor network. In addition, we recently completed a Faculty Summit with 18 of our surgeon trainers, where we focused on continuous improvement of our peer-to-peer and sales training programs.

We also had another peer-reviewed publication on our VEO Lateral System that demonstrate strong clinical results and the ability to identify critical nerves around the psoas muscle due to its improved visualization capabilities.

I would now like to turn the call over to Tim to review the financial results from the first quarter. Tim?

Tim Shannon

Thank you, Ken. I would like to begin today by briefly reviewing our reported financial results which, as a reminder, reflect the closing of the Baxano Incorporated acquisition on May 31 2013. As a result, Baxano's results are included for the entire first quarter of 2014, but not in 2013. After the discussion of the reported results, I will review our pro forma results.

For the first quarter, we reported worldwide revenues of $4.4 million, up 42.4% compared to the first quarter last year. Domestic revenues were $4.3 million compared to revenues of $2.6 million in the prior year period. International revenues $149,000, down $356,000 from the $505,000 reported during the same quarter last year. Recall that our international revenues can vary significantly from quarter to quarter due to the timing of stocking orders from our international distributors. One of the drivers of the sequential decline of our international business was the large stocking order from our Mexican distributor in the fourth quarter of 2013.

First quarter gross margins were 71.4%, an increase of roughly 4.6 percentage points over the 66.7% gross margin in the prior year period. The increase in gross margin was attributable to lower product cost, increased volumes and a shift in product mix.

Operating expenses were $11.8 million in the quarter, an increase of $2.7 million from $9.2 million in the first quarter last year. Net loss was $9.1 million in the quarter or $0.19 per common share, compared to a net loss of $7.1 million or $0.26 per common share in the prior year period. Net loss, excluding special items, was $9.1 million in the quarter or $0.19 per common share, compared to a net loss, excluding special items, of $5.7 million or $0.21 per common share in the prior year period.

Special items of $19,000 in the first quarter of 2014 consisted of merger and integration expenses related to our merger with Baxano Incorporated. Special items of $1.4 million in the first quarter of 2013 consisted of merger and integration expenses as well as costs related to the OIG settlement.

I would now like to review our first quarter results compared to pro forma results from the first quarter of 2013. Revenues of $4.4 million for the first quarter declined compared to pro forma revenue of $6.1 million in the prior year. Domestic revenues were $4.3 million, a decline from last year's pro forma revenue of $5.5 million.

Pro forma domestic iO-Flex revenue was $2.3 million in the first quarter, representing a decrease from $2.9 million in the first quarter of 2013. Domestic AxiaLIF revenues were $1.1 million in the quarter. This compares to revenue of $1.9 million in the first quarter of 2013. Two level cases where we do not currently have a Category I code continued to decline at a greater rate than one level cases. As a result of this shift in mix, average selling prices for AxiaLIF declined sequentially to $12,600 per case. Total domestic VEO revenue was $561,000 in the quarter, a decline from $590,000 in the first quarter of 2013. Domestic iO-Tome revenue in the quarter was $131,000.

Gross margin for the quarter was 71.4%, up over 5.6 percentage points from the 65.7% pro forma gross margin in the first quarter of last year. The increase in margin was a result of lower product cost, higher product balance and a shift in mix.

Operating expenses were $11.8 million in the quarter, down $1.4 million, compared to $15.2 million pro forma adjusted operating expenses in the prior year quarter, which excludes $1.4 million for merger and integration expenses, as well as costs related to the OIG settlement. The decrease in operating expenses is a result of continued focus in recognizing cost synergies from the merger.

Net loss in the quarter was $9.1 million and net loss per share was $0.19 versus a pro forma net loss of $10.6 million or $0.24 per share in the first quarter of 2013.

Moving on to the balance sheet. Our cash and cash equivalents declined $7.1 million this quarter to $1.5 million due primarily to cash used in operating activities. As Ken mentioned, we recently raised $10 million through the private placement of convertible debentures.

Domestic accounts receivable days sales outstanding were 56 at quarter end compared to 59 in the prior quarter. Total accounts receivable days sales outstanding, excluding our Chinese distributor was 71 at quarter end compared to 70 in the prior quarter.

I will now turn the call back over to Ken. Ken?

Ken Reali

Thanks, Tim. I first would like to take a minute to discuss guidance and our expectations through the remainder of 2014. We have been disappointed with our revenue performance since the acquisition of Baxano Incorporated and our integration of the two businesses into Baxano Surgical. While our margins have increased and we have significantly reduced operating expenses, we have been spending at a level based on expectations of higher revenue. We are now in the process of reducing our operating expenses to bring them in line with a more conservative near-term revenue estimate.

Based on these changes, we expect to achieve sequential operating expense reduction through 2014 and look for opportunities to continue to reduce costs in 2015. Despite these cost-saving initiatives, we feel we can return to sequential revenue growth, albeit at initially slower revenue pace, but accelerating as our hybrid direct and distributor sales model gains momentum. For the second quarter, we expect revenues in the range of $4.4 million to $4.8 million.

I would now like to provide you with an update on our key operating priorities for 2014, and the progress we have made to-date. As a reminder, our priorities are, number one, continue to broaden our customer base, utilizing our differentiated iO family of products that allow us to establish ourselves with minimally invasive focused spine surgeons, Number two, take advantage of cross-selling opportunities, especially VEO and AxiaLIF in the near term and advance our minimally invasive pedicle screw system later in the year. Number three, introduce new products and product improvements, such as Avance and development of a TLIF system to be used with our iO-Tome instrument that leverage our existing product lines and surgeon relationships. Number four, continue to expand the clinical and economic data on our minimally invasive family of products that will support adoption with surgeons, hospitals and payors. Number five, expand private payor reimbursement for AxiaLIF, which we believe will unlock the door for future growth in this product line.

We remain focused on driving growth through our VEO, iO-Flex and iO-Tome products. We believe our minimally invasive focused product portfolio represents a strong platform for surgeons and we remain focused on retaining and expanding our surgeon user base.

While our AxiaLIF product continues to face well understood headwinds, one of the initiatives that has been successful, has been targeting our AxiaLIF sales and marketing efforts toward spine surgeons with a larger mix of Medicare patients. We have started to see traction in this area in late Q1 and Q2. We believe that we have the opportunity to utilize iO-Flex, iO-Tome and VEO as door opening products with minimally invasive surgeons and that as our relationships develop that we can effectively cross-sell other products. We have seen success with this strategy and have evidence of surgeons moving from our decompression product, iO-Flex, to our fusion products VEO and AxiaLIF over the past few months.

I would now like to expand on the changes that we are making in our distribution model. As a reminder, TranS1 largely had a direct sales force and Baxano Incorporated had a distributor sales model. Over the last six months, we have analyzed our sales regions that are driving consistent growth. What we have observed is that the longer tenure direct reps at Baxano Surgical, generally those reps have been with either legacy company 18 months or longer, have been able to effectively sell our entire product portfolio and have had success cross-selling. This group represents about half our direct sales force.

We have also seen consistent sales growth in territories with established distributors. They are able to sell our full line of degenerative lumbar spine products. These distributors view Baxano Surgical as their degenerative lumbar spine partner with our differentiated and growing mix of decompression and fusion products.

Our sales strategy, going forward, would utilize a combination of our direct sales force in geographies we have strong tendered reps and sales momentum and we will use established distributors where we are able to shorten the relationship building process and quickly gain sales traction much faster than with our direct model. This hybrid sales approach will also lead to sequential reduction in our operating expenses through 2014 as we discussed above.

We think that there are two factors that make this an ideal time to implement this change. First due to some of the recent M&A activity and consolidation in spine, we have seen and expect to continue to see the opportunity to engage highly qualified distributors with established surgeon relationships that are able to quickly leverage our differentiated and minimally invasive degenerative lumbar spine products. Second, with the clearance of Avance, we believe we now have a broad enough family of products to attract leading distributors.

From and R&D perspective, the top priority for the business continues to be the Avance pedicle screw system. We were pleased with the recently obtained FDA clearance for the product, and the team is preparing for the limited market release in the second quarter. We have recently focused our R&D efforts on delivering products that will have a near-term impact on sales. As a result, we are primarily focused on Avance and the TLIF projects. TLIF development is making progress. We held our first surgeon design team meeting in early March and we look forward to providing more updates regarding this project in the future. As a reminder, we already have FDA clearance for our TLIF Cage.

We continue to be active on the clinical front in 2014. In the first quarter, we had two new papers published. As mentioned, the most important paper published was regarding VEO and demonstrated lower overall initial complications that show the benefits of the direct visualization capabilities of our retractor going through the psoas muscle. At the end of the quarter, our portfolio of publications stood at 94, of which three relate to VEO and four relate to iO-Flex and the remainder are AxiaLIF related.

We were also active in the quarter at tradeshows and had a presence at eight national spine meetings. At many of these, we offered surgeon training events on all of our MIS based degenerative lumbar spine products.

Finally, on the reimbursement front. We are continuing our efforts to secure private payor coverage for AxiaLIF. We still feel that the linchpin positive payor coverage is going to come through specialty society support. We are working with the North American Spine Society or NASS to continue to educate them on the benefits of all of our technologies, but specifically the AxiaLIF technology and have recently met with the CEO and President of NASS as well as with the NASS group that reviews and makes recommendations on payor coverage policies. In addition to our efforts with especially societies, we are continuing our efforts to educate private payors on the expanding body of clinical evidence supporting AxiaLIF.

As a reminder, we currently have approximately $100 million covered lives, including Medicare. This is in line with where the last new CPT code in spine was 15 months after the code was implemented.

We remain confident in our MIS focused product offering and the strong and diverse platform it offers to surgeons. We are excited about the upcoming limited market launch of our Avance pedicle screw system, and believe Avance gives us a complete fusion solution and the opportunity to bundle this product with other Baxano Surgical fusion products. We are confident in our sales strategy now that we are making the appropriate strategic adjustments to drive sustained revenue growth while also achieving operating expense savings. We also continue to remain bullish on our focus in minimally invasive spine surgery, which remains the fastest-growing segment in the spine market today. We look forward to updating you all our progress on the next call.

With that, I would like to open the call to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is from Jason Wittes with Baxano Surgical [sic]. Please go ahead.

Ken Reali

You mean Jason Wittes from Brean Capital. Hi, Jason.

Jason Wittes - Brean Capital

I am not from Baxano. Sorry. Hi, guys. How are you?

Ken Reali

We know you looked (inaudible).

Jason Wittes - Brean Capital

I had a little trouble hearing the call. I had to tell them I was from Baxano. Just I was kidding. I don't know why or how that happened. Anyway, I had a few questions here. Number one, just to talk about the change in the sales force strategy. I am just trying to understand all the comments you made. It sounds to me like you just going to more focus on the more senior, both sales reps and distributors, but also it looks like you meant to add people, but more senior people at this point. Am I thinking about this right? Or could you give a little more clarity here?

Ken Reali

Absolutely, Jason. Really, we have looked at this critically over the past six months, and number one, we seen some real examples of success and growth in our business and that's what we are focused on. We cherry picked those opportunities. We have strong direct sales reps that are tenured that have taken our portfolio of products and really done a terrific job of with them and that certainly is very regionalized and I expect them to continue to grow in those areas.

But also with our expanded portfolio of products and our limited sales reach, we recognize a near-term opportunity with certain distributors and certain geographies that we can leverage. This isn't something we could have gone six, nine, 12 months ago because we didn't have the product portfolio or reach that would attract these quality of distributors.

The other implication that's been positive for us is the market changes. With the consolidation in spine today, there are many distributors that are available, that are of high quality, that have established relationships with both surgeons and the hospital and that's what we expect to achieve here is bring on board some high quality distributors, where we don't have tenured direct salespeople to really provide a compliment because the first quarter was really an indicator of a very regionalized business where we had some issues happen externally, weather and seasonality that was indicative of our regional focused business and we need to get broader.

We need to get broader more quickly, at the same time control our operating expenses. So this hybrid strategy, we feel very confident in and this is not something that is certainly out of the blue. There are many companies in spine with broader portfolios and product line that really have this type of strategy. So is something that we will be implementing fairly quickly here because we have seen it work in isolated cases over the past six months.

Jason Wittes - Brean Capital

I see, and in terms of the change in cost structure, is that something we are going to see immediately in the next quarter or does that take more towards the end of this year that we see that impact?

Ken Reali

You will see a sequential decline over the coming two quarters. So as we implement this, you will see our operating expenses decline, Q2 and then Q3 and Q4, and that's the way we have modeled it.

Jason Wittes - Brean Capital

Is that something you can quantitate at this point?

Ken Reali

We are not ready to do that. We are not going to share our internal models, but it will be significant enough where it will be noticed.

Jason Wittes - Brean Capital

Fair enough. Then just to switch gears. The pedicle screw launch is happening now, I believe. So that should start to show up next quarter? And also could you, on TLIF itself, I know the Cage is approved, but that program itself when does that really sort of -- when do you look to launch a full product there?

Ken Reali

Good question there. On Avance, we do expect to do a limited market release by late second quarter. So what does that mean? It means probably in June timeframe at this point.

Jason Wittes - Brean Capital

Okay.

Ken Reali

We are receiving hospital approvals for the technology now, and we will be in a limited market release from June until September and we will expect to launch fully in the October timeframe. So we will see some revenue pick up in the second quarter, but it will be very small. It will be just the last month of the quarter. You will feel little more in the third quarter and then a much larger impact in the fourth quarter.

Regarding TLIF, we are very excited about this. The TLIF system is going to be a combination of using our iO-Tome device, which we launched in the fourth quarter, and just as a reminder that's a minimally invasive facetectomy removal device. So there is really nothing else like it on the market. It allows a surgeon to quickly remove the facet joint in a TLIF procedure which can be one of the longer portions of that procedure to carefully remove the facet joint. And with our device, which is predicated on a similar technology of iO-Flex, we can quickly remove that.

So we are developing a whole system around this that would be minimally invasive, through a tube and allow them to do a TLIF using iO-Tome and using our Cage system. We have a design team in place that have started working on this. There isn't a regulatory process, but it's really going to be a design process here over the coming couple of quarters. We hope to be in a limited market release with this by the fourth quarter and then going into 2015, at a date to be named because we still have a lot of development work to do, we will launch it in first half of 2015 at this point.

Jason Wittes - Brean Capital

Okay, and then a last question before I jump in the queue. Just going back to the sales force focus, I assume this will be a broad focus on all the products including AxiaLIF, nothing that AxiaLIF generally requires a bit more of our missionary type of sale in terms of getting doctors trained, et cetera. With our a more heavily weighted towards distributors, are they going to also be your actively pursuing AxiaLIF or is that are secondary to their designs?

Ken Reali

Correct. Our strategy is to have two avenues in our sales channel. It's going to be direct in a geography or it's going to be distributor. So they will pick up AxiaLIF, but I do feel that AxiaLIF is at a very different stage right now. We have done over 13,000 cases. We know exactly how to perform the procedure based on the evolution of our instrumentation and our technique and that's something that can easily be trained with a distributor network. It's no longer a technology that has a new mix to it in that regard.

We also offer significant clinical support for first time users across the country and that will continue regardless if it's a direct sales person or distributor. So we feel confident that AxiaLIF is at a stage where they can be handed off to a high quality distributor. And in fact, we have had a significant amount of interest since the Category I code in the technology. Even with the limited reimbursement, we feel like the right targeting campaign on Medicare users, we can see some stability in AxiaLIF over the coming quarters.

Jason Wittes - Brean Capital

Great. Thanks a lot, guys.

Ken Reali

Thanks, Jason.

Operator

Our next questioner is Mark Landy with Summer Street. Please go ahead.

Mark Landy - Summer Street

God evening, guys.

Ken Reali

Hi, Mark. How are you doing?

Tim Shannon

Hi, Mark.

Mark Landy - Summer Street

Good. How are you guys doing?

Ken Reali

Doing well.

Mark Landy - Summer Street

Good. I guess, before I get into some of the nitty-gritty, just one of a philosophical question. First quarter results were a nice tick up from the first quarter of 2013, at least not below your expectation. Are you viewing this as disappointing or is it some sort of aligning in the growth that you are able to put up for that place from last year?

Ken Reali

Well, we obviously, Mark, had an impact as we talked about. I think there is some seasonality and weather that impacted our first quarter. I think what's important to understand is, and this is why we are very bullish about our business, as we have not seen a decline in surgeon users whatsoever. We saw some volume decline in the first quarter over the fourth quarter that we can point to but we continue to see new users on all of our products, except for AxiaLIF at this point, and we know the reasons for that.

We feel that both the key now is implementing the sales strategy, taking what we have learned in the past six months, looking at where we are growing and implementing that countrywide. So that is our focus. I can tell you I am on very excited about it because I think we have reached a point where we have found the right levers in the business to drive and we look forward to drive in those going forward in the next few quarters.

Mark Landy - Summer Street

Okay. So then, obviously relative to our expectations for the second quarter, which I think were in line for the consensus' numbers. Did it dip down driven more by disruptions during the quarter in the programs that you implemented or do you think that the momentum that you are seeing there is just not at the levels to sustain about $5 million to %5.5 million expectation in second quarter?

Ken Reali

Yes. We were guiding very carefully, obviously and that is an important piece to how we look at the business, but as we looked at the first quarter, we had several things happen. We lost significant surgical days, and iO-Flex is a high-volume product as I explained in March. And when we lose a day of surgery, we can lose eight to 10 cases. We have also, for some reason, had some high volume cases not go our way and get canceled particularly towards the end of the quarter and for us, a fusion case, especially if it's a combination fusion case, it can be anywhere from $20,000 to $30,000 per case. So we do expect those cases to come back on as we go forward but we are, at this point, focused on executing our strategy and certainly guiding now to see a sequential increase over the first quarter.

Mark Landy - Summer Street

Okay, and then, if you can, can you just share with us maybe a little bit more of the details with respect to the numbers in terms of the sales force elimination? And how we should think about that is overall number with respect to full-time employees, distributor base and such.

Ken Reali

Well, we are actually not at in the sales force elimination concept. We are going to focus on here is growing where we have tenured reps and that's where we have had consistent growth already. Then in those geographies and there is some pretty significant areas where we don't have salespeople getting the right distributors in place that can pick up our full line now.

And now that we have a full complement of products, particularly with Avance and that was an important FDA clearance that we got, we can really attract the right distributor and leverage those relationships and push that forward. It's just not economically viable for the company to put a direct rep in place and have to wait 18 months for productivity. That's a huge strain on our operating expenses. It's something the company, at this point, cannot afford.

We think with what we have been able to do, the expansion of our portfolio, some of the consolidation that's occurred in spine, it's really given us an opportunity that we absolutely have to leverage. This works with us two ways. The sales reps grow near-term revenue, which is a key need. It also helps us reduce operating expenses sequentially as we go through the year. So the opportunity is there for the company that wasn't there six, nine months ago but it is today and that's something we are going to be driving forward.

Mark Landy - Summer Street

Okay. So the one thing I am just trying to reconcile, Ken, is that is more of a cost elimination but rather than a delay of adding reps that have perhaps, as you said, taking you from 12 to 12 months to come up to speed? Then how should we take the comment in the mitigation of the growth rate? So I am trying to reconcile that, how you are reducing the growth rate guidance versus the fact that you trying to get reps up to speed, is that just a function of transfer because of you not getting the full transfer? Obviously this low transfer cost is not getting the cost of carrying the inventory? How do we reconcile the reduction of the growth versus those comments?

Ken Reali

Because we are making adjustment in our sales strategy and you have to figure, that's going to take a few months as it plays out. So there is some calculus there. Mark. We expect, over the next few months, to bring distributors on board and that's going to be a process here over the next quarter, probably the next two quarters, as we go forward.

And we will certainly talk to that on the upcoming calls as that plays out. But we are careful not to work at something that we don't yet have across the board.

So we know we can do it because we have seen it week in certain places, but certainly we expect our direct sales force to really drive the business in the near term, and like they have been, and certainly as we add distributors strategically, we expect to see upside going in to the second half of the year. But that's not the second quarter, that's more than third and fourth quarter. So I hope that gives you a little more color from that perspective.

Mark Landy - Summer Street

No, it does. Thanks, Ken, and just one last housekeeping. On the iO-Flex lumbar, I know you guys have given, can you just give it to me again?

Ken Reali

The iO-Flex, global or domestic?

Mark Landy - Summer Street

Global.

Ken Reali

We are at $2.3 million.

Tim Shannon

It is actually $2.4 million for the quarter.

Mark Landy - Summer Street

Okay. Thank you very much, guys. I appreciate it.

Tim Shannon

Thanks Mark.

Operator

Our next question is from Matt Miksic with Piper Jaffray. Please go ahead.

Matt Miksic - Piper Jaffray

Hi, guys. Thanks for taking our questions. Can you hear me okay?

Tim Shannon

We can, Matt. How are you doing?

Matt Miksic - Piper Jaffray

I am well, thanks. So the challenges here on sales side, not to harp on this, but I guess if you could help, I am not sure if I understood exactly what some of maybe the root causes of the underperformance have been other than you pointing out that there has been some pockets of real successes, which are you are looking to repeating capitalize on. What do you think the issue has been in terms of either keep focusing or difficulty in executing to the level that you wanted to see?

Ken Reali

I think it just comes down to the strength in the overall channel, Matt. We have some very good reps, very experienced reps that have done very well but, as I mentioned, that's about half of our sales force today. And the other half of our sales force, just doesn't yet have the bandwidth and experience to drive revenue quickly. A typical process in spine is about 18 months. And as we talked ,about that is not something the company can wait that long on to get the revenue growth that we need. Being a small company and being able to act bigger than we are, we really need a broader context with which to launch. And that's where this distributor piece really works for us at this point in time.

There are pretty large geographies that we don't play in. So we are a pretty regionalized business right now. So if you look at the impact of the winter, we are strong in the Northeast and Midwest and that had an impact on our numbers. If we were more diversified and spread more broadly across the country, that would have less of an implication.

So that's exactly why a change in our sales strategy is really warranted at that this point. So we can have a bigger footprint more quickly. We know that tenure and relationships with surgeons and hospitals make a big difference. We now have a broader footprint for executing on that. So that's the way I diagnosed it. It's not an indictment of anything but it's more the size of the sales force, the overall strength and then ability to leverage, especially with the changes in spine, the changes in our platform, our broader platform, being able to leverage those external and internal factors, and really make him some significant strides in our growth profile.

And I will tell you, I am very excited about it. I know this strategy is going to work for us based on what I have seen, because we have some real examples. And now we just have to execute of it. And it's also going to have a positive impact on our operating expenses as we go through the year.

Matt Miksic - Piper Jaffray

And just to, maybe, get some confidence and your ability to attract some of these reps that are falling out of this consolidation that you described. There are a lot of folks angling after those reps. I understand that having the posterior fixation in a broader bag is part of it, can you highlight anything else that helps you draw some of these distributors?

Ken Reali

Absolutely. First of all, our focus with these distributors, just to be clear, is the degenerative lumbar spine area. It's not cervical. It's not deformity. It's really focused in that area. If you look at our complement of products, nobody else has what we have in terms of the wide complement of minimally invasive solutions, the ability to get in the surgeons with iO-Flex, the ability to sell an AxiaLIF and as we add TLIF that's a bit differentiated and then our lateral system which we know is very, very good and competes with any system on market today.

So the way we are positioned with these distributors is the solution for their degenerative lumbar business. That's how we look at it. Those are the conversations that we have had. Those are some of the examples that we have that has really worked. So that's how we see ourselves grabbing a foothold with these guys. The spine is such a competitive business, it is extremely cost sensitive. So most reps, whether you are direct reps or distributors, are attracted to differentiated products because it allows them to maintain price points and getting doors that they can't otherwise.

And we can offer that at Baxano Surgical and offer technologies that they can't get with other companies. So that's really our leverage point, Matt. And I have seen it work. And I see that playing out fairly nicely for us over the coming couple quarters.

Matt Miksic - Piper Jaffray

Okay, just maybe reading back what I am hearing is, in the same way that you are looking at iO and the iO family of products as sort of a way of an entry point into some of these surgeons who might not want to start a conversation by talking about AxiaLIF a year ago or so. Is it fair to look at this as your entry into these distributors is through the same channel and then with the hope that they will start pulling through your posterior fixation and the degen side will start eventually fall in through AxiaLIF. Is that sort of the thinking?

Ken Reali

It is, Matt, and I tell you though, the difference being that with a tenured distributor, just like a tenured sales rep, as we have seen in our sales force, their ability to pull in the fusion products is much easier to do, if they are already established in the territory and have those relationships. iO-Flex is a great tool, a great tip of the spear then. It's more challenging and we have seen this in our model for a new rep to come and really build and penetrate the market, even with iO-Flex.

They can get traction but getting the next step of doing the fusion products, there is still a significant delay in that process. That's what we think with a distributor, just like a tenured rep, they will be able to leverage that same approach that we have seen work and the fact we have seen that work with some distributors already. So we are excited about that and we do see that leveraged.

The key difference with distributor and direct is, you have to have defined territories and you can't have them mixed. What a direct rep or distributor is looking for is exclusivity in a geography and that's certainly part of our strategy of what we are going to provide. That provides motivation. It provides the ability for them to grow and see the opportunity to grow just like what we are looking for sequentially and year-over-year.

Matt Miksic - Piper Jaffray

And just to make sure I understand this, the cost, conservation side of this equation, is enhancing your distribution force with more of the margin, more indirect channel reps rather than taking on additional direct reps. Is that fair?

Ken Reali

It is, and I would look at this way. We, in fact, are going to be expanding our sales force over the coming quarters through this method but with a distributor. It's not salary and T&E that you are going to be paying for. It's a much cleaner model because you are just paying on the commission side and there might be some investment in professional education that you share together. So from our perspective, the cost structure is very different than the direct model.

Matt Miksic - Piper Jaffray

And you mentioned, can you clarify something you said to an earlier question is, you said you were in a reduction mode, but is it fair to say that some part of it is going to determine where the bottom 15% or 20% in terms of performance is more on the direct side?

Ken Reali

Well, we have a strong performance management system in place at Baxano Surgical and we will continue to implement that. That's correct.

Matt Miksic - Piper Jaffray

Okay, and then finally, and I thought I just rolled around the knits and knacks around the sales team. So I am trying to just understand how well you are positioned against all the other folks that are out there as we get off after many of the same reps? But I guess what we hear is that there are a fair number of companies hiring more direct and either moving to higher grade or moving strongly in the direction of the direct distribution model. Is the fact that you are continuing to look at this as an independent distributor opportunity, does that present any kind of edge or selling point for you? You find folks dropping out of those direct conversations because they want to stay independent?

Ken Reali

Absolutely. I think there are, in my experience in spine, and obviously, like hiring somebody, a distributor is a hiring and recruiting process. These guys are very good businessman and the good ones are extremely established have high integrity and they look for opportunities that they can really build something with a company and as a partnership. So that's the type of distributor that we are looking for, Matt.

And they are out there and a lot of them actually like working with small companies because they are able to grow with the small companies and they are able to talk to the CEO and have a stronger relationship with the company in general, not just be another number that may or may not get taken out ifs the company decides to go direct one day, but its a true partnership, just like we have of our direct reps today. And that's certainly the expectation in the model that we are looking to build. We think we have a niche here that is very strong, that plays very well to these guys and we are going to leverage it.

Matt Miksic - Piper Jaffray

Great. Okay. That's helpful color, Ken. Thanks very much.

Ken Reali

You bet, Matt.

Operator

Thank you. Ladies and gentlemen, that was all the questions we have time for today. I would now like to turn the call back over to Mr. Ken Reali.

Ken Reali

Well, thank you, Jeanine. Let me close by thanking all of you for the time to join us on our call today. We are excited about the opportunities that lie ahead at Baxano Surgical. We sincerely appreciate your interest and look forward to updating you on the business next quarter.

Operator

Ladies and gentlemen, thank you for participating in today's meeting. That does conclude the program, and you may all disconnect. Everyone have a good night.

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