K2M Group Holdings' (KTWO) CEO Eric Major on Q2 2016 Results - Earnings Call Transcript

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K2M Group Holdings, Inc. (NASDAQ:KTWO) Q2 2016 Earnings Conference Call August 3, 2016 5:00 PM ET


Greg Cole - CFO

Eric Major - CEO and President, Co-Founder


Matthew O'Brien - Piper Jaffray

Matt Taylor - Barclays Capital

Larry Biegelsen - Wells Fargo Securities

Kaila Krum - William Blair & Company

Josh Jennings - Cowen and Company

Matt Miksic - UBS

David Turkaly - JMP Securities

Steven Lichtman - Oppenheimer & Co


Good evening, ladies and gentlemen, and welcome to the Second Quarter of 2016 earnings conference call for K2M Group Holdings Incorporated. [Operator Instructions] Please note that this conference is being recorded and that the recording will be available on the Company's website for replay shortly.

Before we begin I would like to remind everyone that all remarks and our responses to your questions today may contain forward-looking statements that are based on the current expectations of management and involve inherent risks and uncertainties that could cause actual results to differ materially from those indicated, including those identified in the Risk Factors and Management Discussion and Analysis of Financial Condition and Results of Operations sections of our Form 10-K for the fiscal year ended December 31, 2015, filed on March 4, 2016, which is accessible on the SEC website at www.SEC.gov.

Our most recent Form 10-Q, which will be filed shortly, as such factors may be updated from time to time in our periodic reports filed with the SEC, which are available on our website.

Except as required by law, we assume no obligation to update our forward-looking statements. In today's remarks, we will refer to certain non-GAAP financial measures. Reconciliations of those non-GAAP financial measures to the most comparable measures calculated and presented in accordance with GAAP are available in the earnings press release and supplemental disclosure in the Investor Relations portion of our website.

I would now like to turn the call over to Eric Major, the Company's Chief Executive Officer. Please go ahead, sir.

Eric Major

Hello and welcome, everyone, to K2M's second-quarter 2016 earnings conference call. Let me begin with a brief agenda for today's call.

I will start off with a summary of our second-quarter performance and I will update everyone on our progress on the operating front during the period. Then I'm going to turn it over to Greg Cole, our Chief Financial Officer, discuss our financial results for the second quarter and first half of 2016 and will review our 2016 guidance, which we reaffirmed in this afternoon's press release. Then we will open up the call for your questions.

We are pleased with our financial and operating performance in the second quarter of 2016, a quarter in which we posted solid performance in the face of notably strong growth in the prior year, an improvement in our margin and cash flow trends on both a year-over-year and quarter-over-quarter basis.

With respect to operating results, we are particularly proud of the progress we made in Q2 in the areas of new product innovation, increase in awareness of K2M's leading technologies within the global spine surgeon community and, importantly, the growing portfolio of clinical validations in support of our innovative spine technologies.

Overall, we believe that the second quarter represents an improving trend in performance across all areas of our business, including in our international markets. And our results over the first half of 2016, combined with the multiple tailwinds we see in the business in the back half of the year, has us is confident in our ability to achieve our full-year financial guidance.

Now let's discuss Q2 in greater detail. With respect to our revenue growth in the second quarter, we reported total revenue growth of 5.3% year over year on a constant currency basis, led by 9.2% growth in the US, more than offsetting mid-single-digit declines internationally. US growth of 9% year over year was driven by 8% growth in sales of complex spine products, 16% growth in sales of MIS products and 8% growth in sales of degenerative products.

Recall that we posted 24% growth in our US business during the second quarter of 2015. The growth rates posted this quarter are within our expectations and, on a two-year basis, reflect high teens growth rates we expect in the US business for 2016.

Our US sales are up 14.1% over the first six months of 2016, driven by 10% growth in our complex spine business, 22% growth in our MIS business and 16% growth in our degenerative business. This growth is on top of the 22% growth we posted in the same period last year and reflects the powerful combination of the market's response to our innovative technologies and our efforts to focus on distribution investments to maximize our ability to gain US market share.

The 2016 summer deformity season is in line with our expectations so far, and the trend is similar to what we have experienced in the past. It is too early to review our entire deformity season performance. However, we are encouraged by the start of the season.

The market response to the multiple new technologies available for this year's deformity season that were introduced over the last 12 to 15 months include MESA II deformity, EVEREST deformity, NILE and CAPRI has been positive. We look forward to continued anticipated positive trends in our complex spine business during deformity season and the rest of 2016.

Growth in our MIS and degenerative business continue to benefit from the strong market adoption of our new product offerings as well. EVEREST MIXT continues to be a strong contributor to our growth in the minimally invasive procedure category.

EVEREST MIXT is our cannulated top loading articles through system featuring rigid closed top off extension tabs for minimally invasive rod passage. Since the beginning of our alpha launch, we have seen instrument set turns quadruple. Surgeons have provided very positive feedback regarding the rigidity of the tab screw and overall versatility of the system. We have identified and incorporated areas of instrumentation improvement during alpha, and the full commercial launch is slated for late Q3 2016.

Our CASCADIA interbody portfolio continues to be a major growth driver in our degenerative and MIS product categories. This product family features our innovative lamellar 3D titanium technology, developed with the goal of improving interbody technology by allowing for direct bony integration throughout an implant while providing surgeons with increased visualization.

In June we announced new additions to our CASCADIA family of products. The Company received FDA 510K clearances to market the CASCADIA Cervical and the CASCADIA AN Lordotic Oblique Interbody Systems, designed to accommodate the vertebral anatomy and aid in the restoration of proper sagittal balance.

With these new clearances, K2M has solidified our leadership position in the 3D printed spinal device space. K2M was the first leading spine company to introduce a 3D printed titanium interbody device. K2M offers the most comprehensive portfolio of FDA-cleared 3D printed spinal devices in the industry.

K2M's Lamellar 3D Titanium Technology's CASCADIA is currently being used in nine countries worldwide. We have had more than 200 surgeons use our CASCADIA products, and approximately 50% of those surgeons' users are new to K2M.

K2M was the first leading spine company to introduce a 3D printed titanium interbody device. Through continued development efforts and subsequent product launches, K2M offers the most comprehensive portfolio of FDA-cleared 3D printed devices on the market, cementing K2M as the leader in 3D printing of spinal devices.

Turning to an update on our international business. Despite the disruptions in Australia and Japan as discussed last quarter, our international revenue performance exceeded our expectations in the second quarter.

While total international sales declined 5% year over year on a constant currency basis, the results modestly exceeded our expectations. The highlight of our international business remains the performance of our direct subsidiaries, where sales were very strong in Q2 with growth of 24% year over year on a constant currency basis.

Based on discussions and interactions in recent months with our distribution partner in Australia, we remain committed to our partnership with Life Healthcare. Consistent with what they told us in April, we are seeing evidence that Life Healthcare is focused on inventory control and working capital efficiencies across their business lines. Our sales to the Australian market are down 20%, 26% year-to-date, driven by lower set investments and replenishment orders compared to the first six months of 2015.

While we were pleased to see modest improvement in replenishment order trends versus our expectations in Q2, we remain extremely cautious with the potential for growth in this market for the balance of the year. In partnership with Life Healthcare, we continue to support efforts to build awareness in the surgeon community in Australia.

K2M and Life Healthcare will be supporting the Aussie Spinal Tumor and Trauma Medical Meeting again this year, called Deformity Down Under. This two-day event occurs this weekend in Sydney, and we expect a significant number of complex spine surgeons in both Australia and New Zealand to participate in the workshops and presentations featuring K2M products.

Turning to our progress in Japan since our last quarter, our strategy in Japan is a dual-path process. First, we are working closely with our local partner to correct the existing product registrations in order to begin selling again in the market. Second, we have initiated the steps to file our own product registration in Japan. We have made good progress towards reestablishing our presence in Japan and servicing our existing customers. Our partner met with the PMDA in both June and July to understand the issues and to develop a plan for resolution.

Based on these discussions, they have developed and initiated a plan for resolution, which is ongoing. We have strong support among our existing customers in Japan and appropriate messaging surrounding the topic has been communicated at the local level.

We are actively supporting such efforts in hope that this issue will be remedied by the end of the year. In order to ensure our long-term strategic flexibility in the market, we have also initiated the process to file our own product registrations in Japan.

Our expectation is that we will be seeing such approvals in 2017.

Our distribution infrastructure continues to expand and to support our long-term growth objectives. Recall that we employ a hybrid distribution model in both the US and in our international markets. We ended the quarter with a total of 130 direct sales employees and 90 independent sales agencies compared to 124 direct sales employees and 85 independent sales agencies at the end of 2015.

This increase in direct sales employees and agents this year represents early progress toward our strategic initiative to invest incrementally in the US market to maximize our ability to introduce our innovative products to more surgeon customers. We are playing offense with these incremental investments to support our future growth opportunities.

Importantly, K2M has been investing in our distribution infrastructure since 2012, and a major driver of our revenue growth in recent years was the improving productivity of these investments. We expect the improving productivity of our distribution infrastructure to remain a significant growth driver in 2016 and beyond.

In addition to our continued focus on product innovation and the expansion of our distribution infrastructure, K2M is committed to advancing research, education and awareness of new techniques for the treatment of spinal disorders.

During our last call we had just completed our annual Meeting of Minds Symposium, which took place late April in Chicago. As a recap, we are proud to host more than 120 of the world's leading spine surgeons and offered a premier world-class curriculum in the latest approaches and techniques for the operative treatment of spinal disorders.

This included more than 60 hands-on demonstrations, case presentations as well as interactive discussions on key issues in pediatric and adult spinal deformity in minimally invasive and complex spine surgery, including the latest in sagittal plane correction. We continue to receive extremely positive feedback from the meeting.

Last month we participated in the 23rd International Meeting on Advanced Spine Techniques or IMAST. IMAST is the SRS-sponsored meeting that is aimed at advancing complex spine techniques and improving patient care. IMAS K2M workshops were attended by nearly 200 participants from 30 countries. We exhibited a wide range of innovative technologies including the CASCADIA interbody systems, featuring K2M's innovative Lamellar 3D titanium technology.

The NILE alternative fixation system, the RAVINE Lateral Axis System, the EVEREST Deformity Spinal System, the MESA and the MESA Rail deformity spinal system and more.

We also hosted four educational workshops featuring leading experts in the field who addressed cutting-edge techniques for complex spine pathologies including the latest in adolescent and adult reconstruction, minimally invasive techniques, sagittal plane correction, deformity and scoliosis. Importantly, we are extremely proud of our expanding folio of clinical validation of K2M technologies and have been pleased with the market response to these publications today.

In May, K2M participated in the Spine Week [2006] Annual Meeting in Singapore. In addition to highlighting the Company's product portfolio, findings from four scientific studies demonstrating the effectiveness of our RAVINE Lateral Access System for MIS procedures were presented.

According to Mr. Robert Lee, who was the presenting author, the four studies, quote, help establish RAVINE's potential value to surgeons treating degenerative spinal deformities through a true muscle splitting transcell [ph] as approach.

In July, we also announced results from a study published in the July 15 issue of Spine. The study, entitled A Uniquely Shaped Rod Improves Curve Correction in Surgical Treatment of Adolescent Idiopathic Scoliosis or AIS, found that K2M's MESA Rail Deformity Spinal System results in significantly better major curve correction than standard circular rod constructs. Our MESA Rail features a beam-like design that provides enhanced rigidity to aid in the restoration of sagittal balance while maintaining a low profile.

The findings, authored by Doctors Gehrchen, Ohrt-Nissen, Hallager, and Dahl at the University of Copenhagen in Denmark, were gathered from 129 surgical cases from patients treated for AIS between May of 2011 and May 2015.

Subjects were placed into two groups based on the rod they were treated with, either a beam-like rod or a standard circular rod. The study utilized cranial cervical instability or CPI to eliminate bias caused by differences in preoperative flexibility and demonstrated that the results were not significantly influenced by a surgical learning curve. Long-term follow-up is needed to assess if correction is maintained over time.

The findings reinforce that constructs, like MESA Rail with its unique beam-like design, are not only safe but allow surgeons to achieve a better curve correction while also reducing in some patients the frequency of implant-related discomfort or pain. Further, the MESA Rail beam-like rod cohort showed shorter operative time, less blood loss and shorter hospital stays when compared to the standard circular rod cohort. Both groups showed a slight decrease in thoracic kyphosis.

Also at IMAS, K2M's Innovative Spinal Technologies for Adolescent Idiopathic Scoliosis or AIS were featured in two clinical papers in oral presentations. First, data were presented on K2M's MESA Rail Deformity Spinal System, which features a beam-like design that provides enhanced rigidity to aid in the restoration of sagittal balance while maintaining a low profile.

The study, which examined lumbar curve improvement in AIS following selective thoracic fusion or STF, found there was a correlation between thoracic kyphosis restoration in STF with spontaneous lumbar curve correction. This study has been nominated for an IMAS Thomas Whitecloud Award, which is given to both the best basic science and clinical papers presented at the meeting.

Additionally, findings from a multiyear study surrounding a motion preserving scoliosis technology were presented. The study found that the innovative apical fusion technique achieved correction, corrective deformity profiles in AIS patients and maintain mobility of non-used segments with a lower implant density, sparing 52% of the spanned area from fusion.

Obviously, we are very excited about the growing body of clinical evidence of our innovative spine technologies. These studies and findings reinforce from a clinical perspective our commitment to achieving the highest level of excellence in developing innovative technologies, while also empowering our sales force to further engage the surgeon community.

With that, I'll turn it over to Greg for a more in-depth review of our financial performance during the quarter as well as a review of our guidance for fiscal year 2016. Greg?

Greg Cole

Thank you, Eric. Second-quarter total revenue on an as-reported basis increased $2.9 million or 5.1% year over year to $59.2 million. Total revenue increased 5.3% year over year on a constant currency basis. The increase in total revenue was primarily driven by greater sales volume from new US surgeon users and existing US surgeons upgrading to our newer product offerings.

Our US revenue increased $3.8 million or 9.2% year over year to $45.2 million and represented 76.4% of total Company revenue in the period. Second-quarter US revenue growth was driven primarily by the addition of new surgeon users.

By procedure category, complex MI and degenerative represented 41%, 15% and 44% of US revenue, respectively, in the second quarter.

Diving deeper into our US revenue results, our complex spine and degenerative spine categories were the largest drivers of our US growth in Q2. Complex spine sales increased $1.4 million or 8.2% year over year to $18.5 million and degenerative revenue increased $1.4 million or 7.9% year over year to $19.7 million.

Complex spine sales growth was driven primarily by increased usage of our EVEREST Deformity System and degenerative sales growth was fueled by the introduction of our new CASCADIA 3D Printed Titanium Interbody Devices featuring Lamellar 3D Titanium Technology.

Finally, our MIS category sales increased $1.0 million or 15.9% year over year to $7 million, driven by increased surgeon usage of our EVEREST minimally invasive products and increased usage of our biomaterials offerings.

Wrapping up the review of our US results, our same store, same product price decline was in the low to mid-single digits, consistent with the pricing trends we have seen in our US business since early 2014.

Regarding revenue results outside the United States, international revenue decreased $931,000 or 6.2% year over year to $14 million, representing 24% of total Company sales in the period. International sales declined 5.4% year over year on a constant currency basis. The decrease in international sales this quarter was primarily due to the timing of orders in our international distributor markets.

Our international performance in our direct subsidiary markets, where we bill and collect in local currency, was quite strong in Q2, increasing 20% year over year on a reported basis and 24% year over year on a constant currency basis.

Turning to our financial performance throughout the rest of the P&L in the second quarter, GAAP gross margin was 66.9%. Excluding the impacts of amortization expense on investments and surgical instruments and the medical device excise tax, our non-GAAP gross margin was approximately 71.2% compared to non-GAAP gross margin of 73.5% last year.

Note our non-GAAP gross margin in the second quarter of 2015 included the medical device excise tax charges of $664,000 compared to medical device excise tax recoveries of $866,000 this year.

GAAP operating expenses increased $2.6 million or 5.5% year over year to $48.9 million. The increase in operating expense was primarily driven by a 4.4% increase in sales and marketing expenses, a 14.8% increase in R&D expenses and a 4.4% increase in G&A expenses compared to last year.

Our GAAP operating expenses, specifically our G&A expenses, include the impacts of approximately $2.6 million of intangible amortization in the second quarters of both 2015 and 2016.

GAAP net loss was $11.1 million or $0.27 per share compared to a loss of $6.2 million or $0.16 per share last year. Our GAAP net loss includes the impact of non-cash foreign currency transaction gains and losses, which was a loss of $972,000 in Q2 of 2016 compared to a gain of $2.6 million last year.

The difference was driven by fluctuations in foreign currency against the US dollar on our intercompany subsidiary balances.

Our Q2 adjusted EBITDA was a loss of $299,000 compared to a loss of $394,000 last year. For the six months ended June 30, 2016, total revenue increased $8.7 million or 8.2% to $115.5 million compared to $106.8 million for the six months ended June 30, 2015.

Total revenue increased 85 % year over year on a cost currency basis. US revenue increased $10.8 million or 14.1% to $87.4 million from the first six months of 2016 compared to $76.6 million last year. International revenue decreased $2.1 million or 6.9% to $28.1 million for the first six months of 2016 compared to $30.2 million last year. International revenue decreased 5.9% year over year on a constant currency basis.

As of June 30, 2016, cash and cash equivalents were $19.8 million and our borrowings totaled $19.5 million, compared to cash and cash equivalents of $34.6 million and no outstanding indebtedness as of December 31, 2015.

Working capital was $98.9 million compared to working capital of $107.4 million as of December 31, 2015. As of June 30, 2016, we had approximately $23.9 million of unused borrowing capacity under our revolving credit facility.

While we believe that we have the cash we need to execute our plan, we are in the process of completing an amendment to our credit facility that will extend the term of the agreement and provide more flexibility in the determination of the borrowing base of assets. This represents a great example of how we are always looking for opportunities to enhance our balance sheet condition that improve our financial flexibility going forward.

Finally, turning to our full-year 2016 guidance expectations, which we reaffirmed in this afternoon's release, we continue to expect total revenue on an as-reported basis in the range of $231 million to $235 million, representing growth of 7% to 9% year over year. Total net loss of approximately $45 million to $47 million compares to a total net loss of $39.4 million in fiscal 2015.

Adjusted EBITDA in the range of negative $5 million to negative $7 million compared to adjusted EBITDA loss of $142,000 in fiscal year 2015.

With that I will turn the call back to Eric for a few closing comments. Eric?

Eric Major

Thanks, Greg. In closing, we are well-positioned to achieve our full-year 2016 growth objectives. We posted mid-teens growth in the US over the first half of 2016, which we view as solid performance in light of the strong growth we reported in the same period last year. Growth in the US remains the key contributor to our total

Company revenue results, offsetting weaker international growth. As expected, we are seeing strong tailwinds to revenue performance from our continued focus on new product introductions and significant investments in our distribution infrastructure in recent years. And we expect these tailwinds to continue to benefit our results over the balance of 2016.

Our mission remains being the leader in complex spine. Our global surgeon customers look to K2M for innovation and differentiated technology, and we expect to continue to deliver five to eight new products or line extensions and bring new technologies to the market. We are well-positioned with a leading and comprehensive portfolio of complex spine and patient planning technologies.

We had hosted and participated in key industry events over the first six months of 2016, in an effort to continue to raise awareness, educate and solicit feedback from members of the spine surgery community.

Importantly, our interactions with surgeon customers as prospects at these events and in the field have been increasingly productive in recent months as we leveraged the growing portfolio of clinical validation supporting our innovative technologies.

After a solid start to the summer deformity season we look forward to continued progress during Q3 and over the rest of 2016.

Angela, we will now open the call for questions.

Question-and-Answer Session


Thank you. [Operator Instructions] And our first question will come from Matthew O'Brien with Piper Jaffray.

Matthew O'Brien

Good afternoon. Really appreciate you taking the questions. Just one, clarify one real quick, Eric, just on Australia and Japan. I just want to make sure I'm clear as far as what you are saying. With Australia you are sticking with your distributor, you are hoping that you will see some improvement there later this year but you are still not expecting any kind of bump in revenue from that provider. And then is there any sense on next steps as far as Japan goes with your distributor there?

Is there some additional dates that we should look forward to in terms of when they could hear back from the regulatory bodies there?

Eric Major

Sure, absolutely. These were two topics, obviously, that have been a high-profile for everybody. And I can assure you the team has spent a significant amount of time back and forth between Australia and Japan as we look at this.

To answer your question on Australia, we immediately had an opportunity to sit down with our Australian partner, Life Healthcare, to better understand the situation. We found confidence in their focus on the K2 product that they were trying to address and are trying to address the balance sheet, and we think going forward we continue to see interest in the K2 product. Our team is going down this weekend for Deformity Down Under. We believe there will be momentum there.

The issue is that we are down 26% year to date. So while we do believe that we have a good partner going forward and we have confidence based on the meetings with the partner and with our surgeon customers there, we are cautiously optimistic as we move forward here in Australia. And we see a light at the end of the tunnel. We are in the middle of coming through those tumultous waters.

On the Japanese side, we talked about a dual approach - the same thing. Having got on the plane, multiple members of the team, and been back-and-forth in Tokyo to meet with our partners there. Again, confidence that everyone is moving to do the right to address the questions that we had that came in from the PMDA, really taking a dual pathway.

We had noted on the call that there was going to be a meeting in June. We had not had the meeting yet with the PMDA.

Subsequently, there have been meetings both in June and July. The best words around those is that they are very positive. We feel good about Japan, getting through the regulatory issues there. Our partner is working very close with our team. And so that's a dual path approach. Right?

So for the near term we are addressing this by answering those questions with the PMDA as well as our relationship with our partner. Again, we see that moving in a very positive direction.

While we don't see sales there yet, we do see potential to move this in a positive direction.

And then, long term, we have - as we noted before, we now are well along on the way of submitting our own shonen to the PMTA, our own registration process, which is important so that we have that registration under the K2M name. We expect that in 2017.

Matthew O'Brien

Okay. And then moving over to CASCADIA, the commentary there, I thought, was quite compelling, talking about these 200 surgeons using the product now, and 50% are new to K2M. Have you in your history seen that type of dynamic with a new product introduction where you are able to open that many doors?

And then is there a thought as far as timing goes to try to pull through additional sales within the new surgeon users? Or should we expect that dynamic to continue?

Eric Major

You know, first of all, we are really excited about our lead position in 3D printing. We feel like we are a first market mover in the size of the portfolio that we have. We've had many surgeons come through the home office, and we find that gravitating to asking questions about CASCADIA.

The other interesting thing there is that those questions come in when those surgeons - whether those surgeons tend to focus on degenerative, minimally invasive, or complex spine, they are asking us questions about 3D printing. They are asking us questions about Lamellar 3D because the real answer is Lamellar 3D is the unique geometry that we kind of invented on utilizing this new manufacturing technique. And so we are applying it to our technologies.

We are still in the very early phases of CASCADIA. We are in a situation with CASCADIA - how much inventory do we build, we can't keep it on the shelf kind of approach to CASCADIA.

We're confident with our ability to deliver to the needs of the market. We do have to continue to build that inventory. We are obviously very excited as well when we see 50% new users, but you know that it's not just cannibalization from our peak technology but we are getting both new tech conversion of new surgeons is exciting for us.

And also note that that market by size is a larger market because these initial products are in the two spaces of degenerative and MIS. So for our Lateral RAVINE technology, which we just announced a very good study about RAVINE and our approach in our retractor, you combine that now with our CASCADIA 3D Printed Interbody, that gets really exciting. That gets really exciting.

And then, in addition to that, we now have our CASCADIA cervical product that was just cleared as part of our first five products already cleared for 2016.

So yes, we believe that momentum can continue in CASCADIA and we can continue to move market share with new customers in that space.

Matthew O'Brien

Got it. And I know I was supposed to stick with two questions, but just one more quick one - one of your midsized competitors has acquired an asset within the smaller, within the early onset scoliosis market.

Are you seeing any type of impact or anecdotally hearing any type of impact of their presence in the space affecting any type of your customer base or your revenues within complex?

Eric Major

Sure. So we are aware of the technology that was acquired. I noted on previous calls interesting technology, we continue to believe very small segment of the market. We were just at SRS's Innovation Meeting, which is IMAS.

Interestingly, right, with the number of people coming to our hands-on workshops, very little questions or very little discussion around Magic Rod and around Ellipse.

There was really a lot of questions for us around Rail, the studies that were being presented and had come out for us around Rail. And at a complex spine meeting a lot of questions around CASCADIA and Lamellar 3D.

So to answer your question specifically, we just really are not seeing a lot of movement in the market around that. And when that product first came out, there were a number of patients that needed to be converted over to utilizing that type of growing technology or surgeons wanted to.

And then moving forward it's a pretty small market base. And so we just don't see a lot of questions or use of that coming in from our surgeons.

So I've said repeatedly, interesting technology, very good for those patients that need it but very small market size. So we are not seeing an impact there.

Matthew O'Brien

Very helpful, thank you.


We will now go to Matt Taylor with Barclays.

Matt Taylor

Hi, thanks fore the question. So the first thing I wanted to ask was you had CASCADIA and 3D Printing. Can you give us, number one, a sense for where you are in the launch of the CASCADIA portfolio and what inning that's in, relative to the peak of where that product could go?

And then secondly, as you develop this capability in 3D, you are really highlighting being the leader there. What else can you do with 3D Printing just in your spine portfolio probably?

Eric Major

When you think about CASCADIA and you think about where we are taking it, we are early in the process. So, think of it as maybe we're in the second inning of CASCADIA. So, brought the product to market, a lot of interest.

When our global management team comes together, the questions are not focused around how do you sell it, the questions are not around how do you get awareness. The questions are around, when can I get more sets. I'm getting tremendous interest and uptake in this technology.

The best indicator for this is if you look at our website and you look at the CASCADIA presentation there, the imaging just jumps off the screen at you because of, we believe, the fantastic quality of the visualization that you get and then the design of the Lamellar 3D geometry facilitates the bony in growth and the structure of the technology.

Additionally, it has been designed to help surgeons for ease of insertion.

So all those components together is the momentum. So when you think about where we are, we are adding significant quantities of sets in Q3, and those sets are, as we speak, in our operation center, going through quality out and being deployed out to the field. Our management team is coming together, our sales management team, looking at where we can deploy them.

I believe I noted on the last call examples of accounts where a major medical center comes in and is interested in CASCADIA, we find them moving their entire, the vast majority of their business over to our CASCADIA inter bodies.

And then what it has done is it then brings those institutions to a pause, saying, you know, this is for us, as K2, a foot in the door, and then they say, show me the other products you have as part of our tender or part of our broader portfolio of needs here at the hospital. And it has given us access into our other technologies, especially among those degenerative and MIS surgeons.

And the last piece is the number of deformity surgeons, complex spine surgeons that have either used this product as part of doing a complex spine case and/or interested and asking questions about how can Lamellar 3D be applied to other potential products in the area of not only degen and MIS but complex.

So again, when we think about - when you think about that product, the innovation is around the design. So we have taken a manufacturing technique, 3D printing, and we have now taken our own design thought process, our own innovation. And now that we can design in ways we have not been able to before, we applied our patents around those geometries. And so we think this gives us a leading position as a first market mover.

So we're going to continue to add sets and we're going to continue to see growth of this product. Right now we are in nine countries. We have multiple products and you should see growth across the product portfolio, the types of offerings that we have and the places that we go with it.

Matt Taylor

Thanks. And I just had one follow-up on the international stuff. I know you had some projects here in the quarter and I was just trying to think about the future. And as you cycle out some of the inventory reductions, you said you had good replenishment orders through the quarter in Australia.

So when does that really start to bottom out and show some recovery? And just to be clear, you did not update your international guidance for the year; is that correct?

Greg Cole

Yes, that is correct, Matt. So as we said before, our Australian partner did a very large shift in their forecast with us in April. And they are currently in the penalty box with us. And we are seeing good improvements in that replenishment volume over what our expectations were, but it's not yet enough to move the overall guidance range.

Now, we think they are on the right path; we think they are doing the right things. But we need to see a little more stable production from them before we are really comfortable coming back to you guys and adjusting guidance.

All of this has just happened in the last 90 days. We are still in that area where we are a little uncomfortable with the perfect clarity that we would like to have in their balance sheet and company-specific situation before we are ready to declare victory and that things are really back on track.

Matt Taylor

Okay, thanks for that.


We will now got to Larry Biegelsen with Wells Fargo.

Larry Biegelsen

Hey, guys. Good afternoon. Thanks for taking the question. Let me just follow up on Matt's question there. I think on the last call you are expecting $5 million in sales from Australia and Japan in 2016. What's that today?

Greg Cole

So where we are today is they are purchasing ahead of the schedule that we are expecting. And it's a modest improvement over our run rate. But as I was saying, Larry, we've put a specific disclosure now into our 10-Q, and in this last quarter the impact region, which is primarily Australia and Japan for the lion's share of that, that region has contributed 4.5% of our total revenues for the quarter. Okay? And we are going to continue to update that. That's pretty shy against last year's number, which was 6.8%.

So there is still a long ways to go to get to where we would like to see that number be. But again, they are doing the right things. They are headed on the right path.

That company, as you know, is publicly traded. And they have their own annual earnings report coming up here at the end of August. And we are all interested in getting a little more clarity on their particular balance sheet situation. But they are giving us confidence that they are the right partners, that they are not losing business, that they are working to satisfy their cases with K2 product.

They are doing the things that a partner would be doing who is committed to K2. We just need to work through with them their company-specific issues.

Larry Biegelsen

Okay, fair enough. So let me just ask a couple on the guidance. So, Greg, the implied second half guidance by my math is about 6% to 9%. You did 5% in the second quarter, constant currency. What gets better in the second half versus the second quarter? And is that backend loaded or are you expecting an improvement in the year-over-year growth rate in the third quarter?

Greg Cole

Well, first of all, we remain extremely confident in the full-year outlook. That's the bottom line. And we've talked about it before.

First and foremost, you know the comparables in the prior year get significantly easier in the back half of the year. Along with that, we are doing a tremendous number of good things with respect to the new product line introductions, the expansion of our distribution force. And we are seeing the fruits of the additional work that we have been doing, which had always been geared to be backend loaded.

When we make the hires in the front half of the year, the earliest we would see those contributions is typically the back half or 2017. And likewise, the investments we made last year will be good contributors this year. That is all working and coming to fruition the way we had hoped that it would. It's just - unfortunately for you, it has been always in the plan to be a backend loaded success rate for us.

Eric Major

So I'll add to that, Larry. I'll add to the fact that if you look at our US growth year-to-date, we are at 14%. We had talked about the comps in the first half of the year. They look good in the second half of the year. And the other thing is, if you look at the distribution investments that we made at the end of 2015 and 2016, end of 2015, early part of 2016, significantly more feet on the street.

Couple that with very positive momentum and feedback from our sales leadership, believing that those investments are starting to see traction. And what we've seen in July gives us confidence about our ability to perform a strong US number here in the second half of the year.

Larry Biegelsen

But just to be clear, you were asked about your OUS guidance, which is down mid to high teens. But you also had US guidance of high teens on the last call, and you did 14% in the first quarter. So it's safe to assume, I think, that you expect over 20% growth in the US in the second half. Is that the right way to think about it?

Greg Cole

We are expecting extremely strong growth in the back half of the year to get to the same commitment that we've made to you all along on high teens growth in the United States.

Larry Biegelsen

All right, guys. Fair enough. Thanks for taking the questions.


We'll now go to Kaila Krum with William Blair.

Kaila Krum

Hi, guys. Thanks for taking my questions. Just a follow-up on Japan and then one on the US - so, in Japan, I know your partner has had a few meetings with the PMDA and has planned a resolution. And then I also know you are working on your own there. So what is your level of confidence that that $5 million business that was cut out of guidance in 2016 returns in 2017?

Eric Major

That's a very good question. As we are trying to work through that strategy now, the driver on that is clearly first the regulatory pathway. And I will remind you, just for purposes of the call that those were of clerical nature, administrative and not related to clinical issues whatsoever.

And so, based on the feedback from our partner, and I also want to reiterate we've had really good conversations with them. In some ways this has driven a lot of conversations back and forth, and we feel that we've gotten very positive feedback from them about those PMDA meetings and a pathway to clear the PMDA questions on those clinical registration issues and to have a near-term solution.

Then on the long term, as I had mentioned during the prepared remarks, we feel that it is good for us to also have control of our own destiny there on the registration side for the shonen. And so, we have gone through the application process and expect to have that clearance in 2017.

So we do believe we will be back, operating in the market. We believe that we will have a presence in the market, more likely than not in 2016 and the second half of 2016. And then in 2017, what the numbers look like, we are looking at that closely. And it's too premature to start to give guidance on numbers for Japan in 2017.

Kaila Krum

Okay, that's fair. And then just on the US business, I just want to understand - I'm curious, I guess, how much of that 9% growth was driven by new product introductions like CASCADIA or MESA II. And then it sounds like you are obviously still confident in that high teens US revenue growth for the full year. And you had mentioned what you seeing in July, specifically. So what are you seeing or hearing in the field that gives you confidence in that pickup?

Greg Cole

Well, so first and foremost, very directly, the number one driver of growth for us across the Company is always new surgeon customers. There's a bit of a chicken and egg issue there because you don't really know for sure if it's the new product that's bringing the new customer or if it's a culmination of all the sales activities and the distribution channel work that we've done that is bringing the customer.

We really like to believe, in general, that it takes a fulsome approach to attracting a new customer to your company. Great product is fantastic, but if you service them terribly you are not going to keep the customer.

So at the end of the day it really is about attracting new customers. And we do think that we do that through a combination of product distribution and expertise in our field, like the clinical result that we just put out. That's the primary driver of growth for us.

Kaila Krum

Thanks, guys.


We will now go to Josh Jennings with Cowen and Company.

Josh Jennings

Hi, good evening. Thanks, gentlemen. I wanted to ask, Eric, you mentioned about the summer deformity season kicking off and you are encouraged by the start and the market response to the product portfolio. Is there any more color you can give us outside of your prepared remarks just in terms of, I think you said it fell within your expectations. And are you seeing anything to support that, as we have already moved into the third quarter, to support the strength of the deformity season?

Eric Major

Yes. I think the best way to answer that is the larger we get and the more scale we have, there's clearly more customers. And by having a broader base on customer utilization, you will have different surgical schedules and, therefore, some surgeons that are going to go beyond just July and move into treating in August and September as well.

I think, based on that, that gives us confidence based on what we've seen in the first part of the complex spine season, the fact we have a bigger footprint and we are seeing growth in those four product categories. And we are - when we ask surgeons questions in the marketplace, when they say who is K2M, you know the feedback you are going to get is the complex spine company. And the reason for that is our focus in that space and the continued view of the surgeons to us around innovation.

So those four products we brought to market got a lot of buzz. We already spoke about how many surgeons attended the Meeting of Minds as well as the number of surgeons that attended our hands-on workshop at IMAST. So those are two somewhat softer but some metrics that can give you confidence or tell you why we have confidence in our complex spine going through the end here towards the end of Q3.

Josh Jennings

Great. And I was hoping you could just build on - you called out the K spine motion preserving scoliosis technology. Maybe just a little bit more color there and your level of optimism that this could be a technology that is actually meaningful to your portfolio.

Great. And I was hoping you could just build on - you called out the [K] spine motion preserving scoliosis technology. Maybe just a little bit more color there and your level of optimism that this could be a technology that is actually meaningful to your portfolio.

Eric Major

Yes. The best thing about that is that's an area coming out of advanced development that is just very exciting. So the study was presented. Clearly, these are not accepted at a place like IMAST if they are not significant. It has the potential, clearly, to be disruptive technology when you start talking about treating adolescent idiopathic scoliosis and utilizing motion-preserving technology.

This is very different from the growing spine. These are technologies and studies that came in from older patients, in some cases. So it has a lot of potential for the future, but it's early on. And we don't want to get ahead of our skis too much.

So it's in the advanced development group, but you can sell that the study like this being accepted by IMAST is pretty exciting for our internal team and our advanced development group.

Josh Jennings

Thanks. And lastly, for Greg, you called out just same-store, same-product price declines. But can you give us a sense of the combination of price plus mix and whether that was, combined, a headwind or tailwind for the - in the quarter? Thanks a lot, guys.

Greg Cole

Sure. Price is by far the biggest headwind that we have. And we do try to measure that on a same-store basis. And when you throw in mix, typically we haven't had to talk a lot about the mix. But what's fun about having a CASCADIA technologies is that when you have different offerings now that we are now offering to our existing customer base - so we are seeing some mix impact.

And with the new technology like CASCADIA, we are attempting to charge premium pricing for its introduction. And we hope to hold that for as long as we can. So all those pieces work together.

Again, testing is pretty small, big picture, relative to the overall US business, for instance. But it is fun to have those kinds of opportunities. And we will likely have more of an impact from mix to start talking about. But it has not been enough today for us to be concerned about.


We will go to Matt Miksic with UBS.

Matt Miksic

Couple follow-ups on some of the questions on the way the model is tracking for the year - you obviously had, I guess, unusually, unexpectedly strong OUS numbers, certainly better than our numbers for the quarter. But US was right on top of our business lines, at least what we are looking for.

And so, I just wanted to walk through some of the puts and takes because you do have some toughening comps and difficult year-over-year comps, as, Greg and Eric, we talked about before.

So, looking at MIS, for example, you did a very solid 16% against tougher comps in Q2. But those comps get tougher here again in Q3, sort of the opposite for degen, gets a little bit easier in Q3.

But if we are trying to get this, our model right, and give you a little bit of leeway here to, as you say, kind of backend grow into this, let's call it 20%-ish kind of back half growth for US to get your number, should we be looking for slight sequential declines this quarter as we ended the Q3 and then a pickup in Q4 for those two business [lines]?

Greg Cole

It's really hard to look at the individual business lines with all the lumpiness that we've had. Start at the top level bases and then you can work down. The comps for both Q3 and Q4 are simply easier compared to last year. And the first thing we do when we try to do our forecasting is we definitely try to track the two- and three-year stack analysis on the different product lines.

And generally speaking, we stay within a pretty tight band there as we remodel that stuff out. Where we tend to move off those band lines is where we have new product innovations that are very significant.

And the MIS category is a good example of that. We've got a lot of interesting new products there that are very, very good innovations that are drawing great interest in adding additional revenue.

Now, they will cap out at a certain point because we haven't launched those fully national, if you will. They are still in limited production in limited quantity from the field. But as we get more of those products out into the field, that will continue to push that trend on a higher basis. But I really think the way we think about things is the core of what we do is complex spine. That's going to post very good, strong growth. And the two newest categories that we have are MIS and degenerative. They are also going to be good, strong contributors.

So you should expect very strong trends going into the back half of the year. Fourth quarter would be stronger than the third quarter, just on a relative comp basis. And I think you can get there pretty simply and through that modeling exercise.


And we will now move on to David Turkaly with JMP Securities.

David Turkaly

Thanks. You mentioned your international direct sales were up 24% year over year. I don't think there's any one-time items, given that that's direct. But you'd you maybe give us a little color on what was driving that? And is that - maybe categorically how you got to that number for the direct OUS performance.

Eric Major

We've got - frankly, I think in business in general it's about having a good team that's focused. And it's a combination of the products, the team and the overall strategy. We've got a team that has put a good plan together and focused across a number of our direct markets, direct and Asian markets. If you look at Germany, Italy, the UK, some of those markets driving that 24% growth, they are driving that across the portfolio, across MIS and degen and complex.

We made investments in that space. That was part of those earlier year investments we had talked about. We now have very solid teams in those countries.

And so, one of the products that I highlighted here on the prepared remarks were CASCADIA. And seeing nice uptick and interesting CASCADIA. CASCADIA is a product that, frankly, we noted and I think somewhat early to the market that the Europeans and the OUS markets had migrated away from [peak into titanium. We combine market awareness with the idea of utilizing 3D technology, and that really fueled the innovation around CASCADIA. And so, we've seen the uptick of the titanium-based product in Europe as well as the US.

So it's a combination of those things as well as continued focus on med ed training, exposing surgeons and the global community to our product with regional meetings and having a nice presence of places like euro spine and so forth.


We will now move on to Steven Lichtman with Oppenheimer & Co.

Steven Lichtman

Thank you. Hi, guys. Just, first question, bigger picture on Japan, Eric, you mentioned that the issue has provided an opportunity for increased discussions with your distributor there. How big do you see the opportunity in Japan overall? And you talked before about the positive response from surgeons. Could this issue turn into a positive in terms of getting increased focus from your distributor to further accelerate your business there?

Eric Major

For us, that's what was - we talked about it in the last quarter. The Japan market share traditionally, for us, then utilization of our products by some very important key opinion leaders but without scale. And so, there was tremendous opportunity and a very large market in Japan.

So, the one thing that it did allow us to do is have some new and different conversations with our existing partners and to think about the market differently and so forth. So I guess the best way to address that is that think about MESA and the fact that our MESA and Rail Technology specifically very much has interest by the Japanese surgeon community because it's very low profile in nature.

The fact that the implants are smaller and you are dealing with a different patient population that inherently is smaller. Because of that, the key opinion leaders had traditionally been very interested in MESA and had significant uptake and interest.

But however, we did have the footprint for scale. Japan offers a tremendous opportunity for K2. And as a result of this, it has given us the ability to talk to our partner, talk to them about their investments and things that can happen to really scale now and go deeper with this opportunity, long term, for Japanese success.


We will now take a follow up question from Matt Miksic with UBS.

Matt Miksic

Hey, thanks. I did have a couple more questions. Just one - again, not to push you too much on the individual product lines, Greg; I know this isn't easy to provide this sort of insight into quarterly sequential patterns. But if you look at - you've talked before about complex being middle of the year kind business, second-quarter, third quarter, sometimes second-quarter the stronger, sometimes the third quarter is stronger.

And this year, as you are going up against a comp that would, say, last year you had a very strong Q2 and a good Q3 but less strong Q3, we could convince ourselves that is going to go the other way this year.

But I just don't want to get too excited about the idea that we should see acceleration in that season, depending on - you mentioned you've already seen a pretty good season. How should we think about complex spine trends generally, the pattern in the back half?

Greg Cole

Well, to your point, we do look at the comps. That's a big part of what we do. We do believe that the overall US business will be in the high teens as we end the year. I wish I could tell you exactly what the pattern is going to be. I wish I could. I don't know like any more than you know. I had some visibility, obviously, into July.

But I don't know the full season. And we've seen in the past patterns that are buried from our traditional patterns. But 2014 was that great example, we had a really long deformity season and it lasted into October. We didn't see quite the same thing last year.

So I'm optimistic, like you. I'm not banking on it because we have a fantastic business in the MIS and degenerative world. So all of those pieces work very well together. We have multiple levers to pull for that US high teen’s growth for the year.

But we do expect complex spine to be a very, very strong and solid contributor. And it is what we do; it's where we put a lot of attention and focus.

Matt Miksic

And one, if I could, just before I - one last quick follow-up for Eric - you mentioned some very compelling numbers. And I think it was on your OUS stocking. OUS had direct distributors that were showing some very strong growth. And I just would love to get a sense of what you think is driving that. Is there a product cycle that's hitting those distributors? Has something changed in management? Any kind of insight would be helpful.

Eric Major

I think that we - it's not about a go-forward change. It's about the investments we made going into this. Right? When you look at the investments the organization has made, and we have in the past talked about the investments in our SG&A line on the sales team, we have made good investments in the team that, in many ways, is still just getting started in those direct markets.

Now, we have some other distributor partners around the world that are fantastic partners. But that direct team has been really able to execute against the plan. And I will tell you, and I will pause here and say coming off of that last quarter discussion when we were talking about Australia and Japan, the energy and momentum around the organization right now, the fact that we are on plan from what we determined internally, what we thought the first half of the year was going to look like, which was Japan and Australia threw a curveball at us. But going forward, that international team that you asked me about seems to be hitting on all cylinders. The US team is well fueled going into the back into the year after the front end of 14% for the first half. So those coupled, we believe we're positioned well.

Greg, anything you would add on the international component?

Greg Cole

No. We are not doing anything unique. It's not as if they are all focused on one product. We like to talk about CASCADIA, but it's not like they are only buying CASCADIA today.

The international markets primarily sell the complex spine products. That's really what they do. And they are just recently adding things like the Ryan Cervical Disc, which has been new into the portfolio and we are doing a meaningful number of cases there, which is fun, because we are a complex spine company. We're not supposed to have the disc or do well with one.

And so I do think there's a lot of pieces that come together. The market needs internationally are different from the US. They do surgeries different. And we finally have people there who know how to sell specific to that need. We've gone through a lot of rotations of the right team there, and we finally think we have the right pieces to attack those markets.

And it has taken us a while to actually understand those needs to sell them effectively.


Ladies and gentlemen, this is all the time we have for questions and answers. This does conclude today's conference. We thank you for your participation.

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