SeaSpine Holdings Corporation (SPNE) CEO Keith Valentine on Q3 2018 Results - Earnings Call Transcript

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About: SeaSpine Holdings Corporation (SPNE)
by: SA Transcripts

SeaSpine Holdings Corporation (NASDAQ:SPNE) Q3 2018 Earnings Conference Call November 6, 2018 4:30 PM ET

Executives

Carrie Mendivil - Director of Investor Relations

Keith Valentine - Chief Executive Officer

John Bostjancic - Chief Financial Officer

Analysts

Matthew O'Brien - Piper Jaffray

Ryan Zimmerman - BTIG

Craig Bijou - Cantor Fitzgerald

Operator

Good afternoon, ladies and gentlemen, and welcome to the SeaSpine Third Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded.

I would now like to introduce your host for today's conference, Carrie Mendivil, Investor Relations, for a few introductory comments. Please go ahead.

Carrie Mendivil

Thank you, and thank you all for participating in today's call. Joining me from SeaSpine is CEO, Keith Valentine; and CFO, John Bostjancic. Earlier today, SeaSpine released full financial results for the third quarter ended September 30, 2018.

During this conference call, we will make forward-looking statements within the meaning of the federal securities laws in regard to our business strategy, expectations and plans, our objectives for our future operations, our future financial results and condition.

All statements other than statements of historical facts are forward-looking statements. Such statements may include words such as believe, could, would, will, plan, intend and similar expressions.

You are cautioned not to place undue reliance on forward-looking statements, which are only predictions and reflect our belief based on current information and speak only as of today November 6, 2018.

For a description of risks and uncertainties that could cause material differences between our actual results and those stated or implied by the forward-looking statements, please see our news release and periodic filings with the Securities and Exchange Commission, which are available on our corporate website at www.seaspine.com and at www.sec.gov.

I will now turn the call over to Keith Valentine. Keith?

Keith Valentine

Thank you, Carrie. Good afternoon and thank you all for joining us. We had another strong quarter marked by increasing momentum with 13% overall revenue growth and double-digit growth across both our spinal implants and orthobiologics portfolios as well as international sales.

Our top line US growth continues to be driven by increasing market penetration from our recently launched products in both portfolios by a more engaged and increasingly exclusive distributor network and from a deeper commitment in our organization to customer experience and medical education and training.

We also recently strengthened our balance sheet significantly and created financial flexibility through a public offering of our common stock, bringing in net proceeds of over $54 million. With this offering, we now have more than $55 million of cash on hand, no outstanding debt and immediate access to additional capital from our long-term credit facility.

We will continue to invest in the innovation and commercialization of differentiated technologies and the expansion of our global distribution footprint that has been the catalyst of our revenue growth.

We are confident that we are well positioned to maintain our growth trajectory as a market share taker and to deliver cost-effective, procedural solutions to surgeons and hospitals to improve the quality of patient lives.

We expect full year 2018 revenue to be in the range of $141 million to $142 million, reflecting 7% to 8% growth over 2017. As we look ahead, we continue to expand to deliver at least high single-digit top line growth rates in 2019 and longer term. We will provide more detail of 2019 revenue guidance when we report full year 2018 results.

We remain steadfast on executing our strategic vision developing surgeon-centric, cost-effective solutions that combine innovative spinal implant systems with industry-leading orthobiologics that, together, will drive improved procedural solutions and deliver clinical value to the surgeon, hospital and patient.

Turning to our third quarter performance, total revenue was $35.8 million, up 13% versus the year ago period. US revenue increased 12% to $31.7 million with US Spinal Implants increasing 13% to $15 million, and US Orthobiologics increasing 12% to $16.7 million. International revenue increased 18% to $4.1 million compared to third quarter of 2017 and was led by spinal implant stocking orders to a recently added distributor in Australia. In the US, our orthobiologics performance was driven by growth in recently launched products, in particular, by the OsteoStrand Plus fibers-based DBM product and the higher sales of our legacy DBM products.

We are encouraged by the new product opportunities that lay ahead as we work through the additional hospital pricing approvals that should further expand revenue base as we move into 2019. Feedback from surgeons and distributor partners continues to be overwhelmingly positive, and these new products have been a critical factor to our success in converting surgeons to our orthobiologics portfolio.

Turning to spinal implants, revenue growth continues to be led by new products. In the US, products launched since the spinoff comprised 47% of spinal implants revenue, up from 32% in the third quarter of 2017. New and recently launched products are expected to drive revenue growth in the fourth quarter of 2018 and in 2019, and we are most excited about the opportunities ahead of our Regatta Lateral system

At the North American Spine Society or NASS Meeting in September, we announced the alpha launch of the Regatta system, featuring our NanoMetalene technology. Regatta is a comprehensive, minimally invasive lateral interbody fusion system designed to treat the spine through indirect decompression and the restoration of sagittal alignment using 10 and 15-degree lordotic implant options. This system fills an important gap in our spinal implant portfolio.

The launch allows us to more deeply penetrate our existing surgeon base and provides an opportunity to reach an expanded surgeon community, who perform less invasive interbody fusion procedures that minimize the tissue disruption that typically accompanies traditional spinal fusion surgery. We are conducting initial cases through an alpha launch over the coming months and expect the full commercial launch in the first half of 2019.

Since our call in July, we have also launched a line extension of our Daytona Small Stature Pediatric Deformity System, which includes additional implant options for the 4.5 millimeter rod system, adding crossbars and axial connectors to the system that we originally launched in May of 2017. These additions are expected to broaden the reach and application of the Daytona Small Stature System to other surgeons who focus their practice on pediatric deformity cases.

We remain on track to launch a number of line extensions in the fourth quarter of 2018 and early 2019 that leverage our core modular Mariner Pedicle Screw System technology, including full launch of new implants and instruments to address the demands of larger, more complex cases and an alpha launch of a midline cortical screw system that addresses one of the fastest-growing MIS posterior interbody fusion procedures. These extensions will further develop the Mariner brand as it accommodates a wider variety of approaches and techniques.

These new and differentiated products are critical to our success and long-term growth, but equally important has been our commitment to expand and reengage with our network of distributor partners. A large part of our success in attracting a meaningful number of new surgeon users and increasing existing surgeon's usage of our spinal implants systems and orthobiologics products is due to our ability to attract new and more committed distribution and increase our investment in medical education and training to our distributor partners.

To that end, we are encouraged by the level of engagement we are seeing. Through the first three quarters of 2018, more than one third of our total US revenue was generated through distributors that we've onboarded since the spinoff. And we are earning royalty amongst our spinal implants distribution network with 50% of 2018 US spinal implant revenue generated by a core group of increasingly exclusive distributors.

We firmly believe that this building momentum validates our surgeon-centric approach to product development and our belief that our procedural-based spinal implant and orthobiologics offerings meet the needs of surgeons and their patients.

Our focus on innovation and clinical value, coupled with our increasing investment in medical education and training and providing world-class customer experience is further positioning SeaSpine as a spine company of choice among both surgeons and distributors.

We are confident that as we continue to expand our product portfolio with well-supported commercial launches, we will take additional market share in the future and will significantly outpace the growth of the US spinal market.

Or experience at the recent NASS Annual Meeting in Los Angeles reaffirms our confidence. NASS was a great success for us. Activity in our booth and other customer-focused activities was brisk, driven by the excitement surrounding our Regatta launch as well as curious surgeons and distributors who were drawn by the creative talents of our marketing team that designed SeaSpine's movie-themed booth, which created a real buzz on the floor and helped us stand out from the crowd.

I'll now turn the call over to John to provide more detail on our financials and our financial outlook then I will wrap up. John?

John Bostjancic

Thanks, Keith, and good afternoon, everyone. As Keith noted earlier, total revenue for the third quarter of 2018 was $35.8 million, a 13% increase compared to the prior year. US revenue increased 12% to $31.7 million, while international revenue increased 18% to $4.1 million.

US Orthobiologics revenue increased 12% to $16.7 million and was once again driven by recently launched products and higher sales of our legacy DBM products. This growth has been slightly offset by a sales decline in our Mozaik Collagen Ceramic Matrix product line. We are exploring both internal and external development efforts to refresh our synthetic bone graft substitute product offering.

US Spinal Implant revenue increased 13% to $15 million and was led by growth from recently launched products, particularly our Mariner and Shoreline systems. More broadly, we are seeing great uptake in our NanoMetalene product franchise, which increased to 27% of US Spinal Implant revenue in the third quarter of 2018 compared to 15% in the prior year period.

Spinal implant volumes in 2018 had increased in the mid-teens, but have been somewhat offset by mid-single-digit price declines. And while we did get some benefit in the current quarter growth rate from the estimated $500,000 to $600,000 impact of the hurricanes in Texas and the Southeast in third quarter 2017, we believe that most of those surgeries were pushed to the fourth quarter of 2017 and thus create some headwind on our fourth quarter 2018 growth rates.

Gross margin for the third quarter of 2018 decreased 140 basis points to 60.2% compared to 61.6% for the same period in 2017. The decrease in gross margin was consistent with our expectations and was due to higher spinal implant excess and obsolete inventory charges and orthobiologics manufacturing scrap rates and other inefficiencies associated with the production ramp-up of the recently launched products, which were partially offset by lower raw material cost for orthobiologics products manufactured at our Irvine, California facility.

Operating expenses for the third quarter of 2018 were $31 million, a 14% increase compared to $27.3 million the same period of the prior year.

R&D expense increased approximately $400,000 to $3.2 million or 8.9% of revenue for the third quarter of 2018 with most of that increase primarily driven by higher expenses related to clinical studies and outside development spending.

Selling, general and administrative expenses increased approximately $3.4 million to $27 million for the third quarter of 2018. The increase was mainly driven by a $1.1 million decrease for the quarter and a gain from the change in fair value of NLT contingent consideration and by higher sales commission expense.

Compensation expense primarily related to the expansion of our medical education and training organization as well as the hiring of additional product managers to support the launch of new products and trade show expenses due to the timing of NASS this year.

Net loss for the third quarter of 2018 was $9.5 million compared to a net loss of $7.5 million for the third quarter of 2017.

Cash and cash equivalents at September 30, 2018, totaled $11.8 million. We borrowed $3 million of cash using our credit facility during the third quarter of 2018 and had $7.3 million of outstanding borrowings as of September 30, 2018.

As Keith previously mentioned, we significantly strengthened our balance sheet in October through a public offering of 3.7 million shares of our common stock, bringing in net proceeds of more than $54 million. We subsequently used a portion of those proceeds to repay all of our outstanding debts.

Our free cash flow burn, which excludes financing inflows and outflows, was $5 million for the third quarter of 2018. We remain focused on expanding our gross margin and reducing cash-based G&A expenses as a percentage of revenue in the fourth quarter of 2018 and beyond into 2019.

However, we plan to continue to redeploy that operating leverage towards the sales, marketing and R&D initiatives and spinal implant set build capital expenditures that are so critical to driving sustained revenue growth.

Turning to our financial outlook for 2018, as Keith indicated earlier, we expect revenue to be in the range of $141 million to $142 million for 2018, which reflects growth of 7% to 8% over full year 2017 revenue.

Moving down the P&L, we continue to expect gross margin for full year 2018 to be within a range of 61% to 62%. We expect some additional short-term increases in manufacturing costs in the fourth quarter as we work through the inefficiencies and learning curve associated with the manufacturing ramp-up of the new orthobiologics products.

We expect 2018 R&D expense to approximate 8% to 9% of revenue and SG&A, excluding noncash stock-based compensation charges and any noncash gains or losses related to changes in the fair value of NLT contingent consideration liabilities to approximate 69% to 70% of revenue.

With that, I'd like to turn the call back over to Keith for closing comments.

Keith Valentine

Thank you, John. We are extremely pleased with our third quarter performance, and we value and appreciate the confidence and trust that our surgeon customers, distributor partners and most recently the investor community have shown in SeaSpine and our strategy and mission.

And just as important, we want to express my heartfelt gratitude to all the employees who make up today's SeaSpine family who helped deliver not only a strong third quarter performance, but also supported the strengthening of our balance sheet.

The turnaround to accelerated revenue growth was certainly not as linear as we hoped, but we delivered the high single-digit to low double-digit growth that we committed to on schedule, precisely 3 years post-spin.

Looking ahead, progress will continue to be defined by execution of product launches, expansion of our distribution reach and investments in medical education and training for our surgeon and distributor customers. We look forward to updating you on this progress on future calls.

With that, we will now open it up to questions. Operator?

Question-and-Answer Session

Operator

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

Matthew O'Brien

Great, thanks so much. Can you guys hear me okay?

Keith Valentine

Yeah, we can hear you great. Thanks.

Matthew O'Brien

Okay, excellent. So thanks Keith and John. Just I know you don't want to talk too much about next year, but you're kind of - you're absolutely on track with what you've told everybody you would do as far as turning the business around and getting back to the mid to upper single-digit growth rate. We're kind of there now. As we think about next year in an environment where it seems like the market growth rates are getting a little bit better, a bigger competitor is getting acquired by a consolidator, do you think that SeaSpine can be thought of as potentially one of the, if not the fastest-growth spine company in 2019 on the top line?

Keith Valentine

Yeah, Matt, we're absolutely pushing in that direction and I think it's a fair question. But also I think what we're keeping an eye on is we want to make sure that we understand total market growth rate because, as you mentioned nicely, that there are some shifts going on with some of the bigger players. I think we also want to make sure that we have our arms around how pricing changes will be impacted over the next few quarters as well. And so we look to it that we're certainly pushing for the high single-digit, low double-digit growth rates, but we feel very comfortable, for sure, being consistently at that high single-digit rate.

Matthew O'Brien

Okay, super helpful. Keith, you also mentioned, I think, an initial stocking order from Australia. Can you just talk a little bit more about what's going on there? One of the top 3 players in that market specifically is being acquired right now. So is that a bigger growth opportunity for SeaSpine going forward because the international business has been picking up nicely recently.

Keith Valentine

It really is. There's a lot of things that align nicely with the Australian market, the confidence we have in that market largely because of the strong relationships that Australian surgeons share with their US counterparts, in addition, with a number of the new launches that we've launched and the modularity of those systems, it plays well to the distribution network of Australia. I mean, keep in mind, it's a country the size of United States largely and it's, what, 22 million, 23 million folks, so it does have challenges to get equipment in and around the main cities around Australia and we feel like we cater nicely to that with some of the newer modular systems. In addition, we're closely aligning with them from a surgeon education perspective and a distributor and sales-focused education perspective. So we feel like we can use the lessons learned in the United States and also transfer those nicely there with our team. And we feel like as we get into early next year and start really driving some of the new launches together, we're looking forward to some nice growth out of Australia.

Matthew O'Brien

Okay. And if memory serves, that's the third-largest spine market in the world, is that right?

Keith Valentine

Generally, yes, it is when you look at it, and they still have a very good pricing structure similar to the US.

Matthew O'Brien

Got it, okay. And then, finally, for John, and I may have missed a little bit of this, I'm hopping around calls, forgive me. The gross margin that you would have put up excluding the charges would have been what? And then, the SG&A number was higher than I was modeling, not sure if there was extra cost in there that you called out. How do we think about the SG&A spend for the business as we exit this year and into 2019?

John Bostjancic

On the gross margin, there weren't any specific charges that we called out, Matt. It was just a continuation of what we had kind of spoken to in the first quarter and what we thought would last through the end of the year. It's the learning curve on the ramp-up of the new orthobiologics products, the higher scrap rates. It's the first homegrown, internally developed product that we're manufacturing and we're running about 8 years. So we wanted to make sure we built in a conservative gross margin for the year to allow for that learning curve, and that learning curve has come into play, but we anticipate we'll work through the remaining challenges in the fourth quarter and get back to a more normal gross margin in 2019.

On the SG&A side, it's the higher investments in the marketing folks around supporting new product launches, so primarily product managers, but also, as we'd indicated, our commitment to increasing the investment in the surgeon and distributor training and education component. We've completely rebuilt and expanded that team, and those are all investments that were aligned with the guidance we've given for this year. So between the higher sales commissions related to the growing revenue and the investments we committed to make in those areas of marketing, that's where we're coming out on the SG&A line. But we're continuing to focus on reducing the G&A spend as a percentage of revenue, and as I said in the comments before, we want to reinvest those in sales and marketing and activities that are going to drive revenue growth.

Matthew O'Brien

Makes perfect sense, thanks so much.

Operator

Thank you. And our next question comes from Ryan Zimmerman with BTIG.

Ryan Zimmerman

Hey, thanks for taking the question. So just want to ask, first, Matt was addressing '19 guidance. The implied guidance for fourth quarter kind of puts you around that high single-digit range, maybe around 7% or so. Recognizing that you did benefit from the hurricane comps in the third quarter, but even backing those out, I think it's fair to assume that the growth is picking up. So just want to get your sense of how you're thinking about the fourth quarter? Are you being a little conservative? Just how should we think about kind of fourth quarter implied revenue? And then I have another one. Thank you.

Keith Valentine

Yeah, a couple of things to think about, Ryan. You're correct on how we look at the comp from last year with the hurricanes, but I think we all felt as an industry and certainly as SeaSpine that last year fourth quarter much of that surgery was regained, right? There was a lot of effort in those areas to be doing surgeries six days a week and to catch up. So that's some of the headwind, if you will, that phased for fourth quarter, albeit not that large, but still some things that we're thinking about as we get deeper into the fourth quarter and how we see it playing out. So that's why I think that you're reflecting that kind of growth rate.

Ryan Zimmerman

Okay, fair enough. And then Regatta sounds like that it's going to be a big product for you guys. It sounds like you're excited about it. When I think about the composition of your hardware sales, say, a year from now, you're getting traction in NanoMetalene and Mariner is doing well. What does that composition look like, particularly with respect to Regatta? And not looking for set of numbers per se, just how we think about the balance of your US hardware business - or your overall hardware business, excuse me.

Keith Valentine

Yeah, I think it's a fair comment. One thing that might not be fully appreciated is that part of the Regatta strategy, too, is for us to be able to get the best distribution network. And many, many distributors, many, many sales leaders across the United States are very particular that they're not willing to make a change, they're not willing to engage a spinal implant line if it doesn't have certain parts of the implant portfolio launch, meaning we get a better quality distribution opportunity if we have a lateral product offering. And keep in mind, our lateral product offering is going to have to continue to be built over time, but the key part of the lateral product offering that we have caters to the largest part of that degenerative lateral opportunity. And that's kind of how we're continuing to pursue some of the product line additions. That's what you see in Mariner as we start focusing more on MIS and more complex spine opportunities that enables us to be able to have conversations with better distribution, more exclusive distribution in different parts of the country. And so as you see it moving forward, you're going to continue to see more effort being put in that largest part of the market, which is the degenerative space, and certainly, the minimally invasive part of the equation and later in the year, as we get into 2020, having a better deformity offering as well.

Ryan Zimmerman

Okay, I appreciate the questions and the answers. Thank you guys.

John Bostjancic

Thanks.

Operator

Thank you. [Operator Instructions] And our next question comes from Craig Bijou with Cantor Fitzgerald.

Craig Bijou

Good afternoon guys. Thanks for taking the questions. Let me start with you guys have relatively balanced growth between spinal implants and biologics - orthobiologics this quarter. So just looking ahead and maybe as a follow-up to some of the other 2019 questions, just when we look at growth, Keith, I think you mentioned high single digits in 2019. So when we look at the composition of that high single digits, any color on how we should think about spinal implants versus orthobiologics and maybe US and OUS also?

Keith Valentine

Yes, I think we feel comfortable that all of those businesses can see that kind of growth. I think as we've mentioned in the past, international may not be as linear quarter-over-quarter because there's puts and takes with how distributors are coming onboard, what new systems they're investing in, how that stocking order process looks. But I think when you look at a full year 2019, we feel very comfortable that international can achieve the same growth rates that spinal implant and orthobiologics can and where all of our product launches and focus with distribution is on all of the businesses, seeing that kind of growth rate.

Craig Bijou

Okay, that's helpful. And maybe a follow-up on the broader market and I want to maybe clarify comments you made earlier, Keith, just about pricing. I think you said you wanted to see how pricing was going to look. So I just wanted to make sure that - how it's going to look over the next couple of quarters. So I just wanted to make sure that there wasn't anything that you were expecting from a pricing perspective or pricing to get worse in the near term. And then maybe broader market, just we've heard positive trends, a couple of your competitors have talked about uptick in the market. So recognizing that you guys are small, just kind of want to get your sense of the market, your impression of what's going on.

Keith Valentine

Yeah and for sure, we see the same thing. We think, procedurally, the market is doing really well. I think the third quarter saw a more robust third quarter, at least in the checks that we made in the third quarter and in and around NASS that caseloads were quite strong and you're kind of hearing that from some of the other larger competitors as well, how they're doing better on the traditional spinal implant side. That said, I think it's just the reality that we're fortunate that our orthobiologics has enabled us to get into some of the larger buying groups and that enables us to also get our spinal implants systems in there as well. But the reality is we fully anticipate over the next 18 months or so we're going to have to renew those contracts and some of those contracts will, of course, as they do every time there's renewal, see certain kind of pricing demands by the larger groups. And so we anticipate - we absolutely want to participate in those, we absolutely want to have a seat at the table and have a good negotiation, but we also recognize that there will be, generally or contract-over-contract, there will be some pricing pressure.

Craig Bijou

Great, helpful and if I could squeeze one last one in, John, I just wanted to clarify or just make sure I understood the message on kind of 2019 operating leverage. It sounds like gross margin will get back to a more normalized level, G&A will be slightly lower, but you'll reinvest those in sales and marketing. So is that the way to think about it? And I guess, from a percentage of sales basis, is it - should we expect some leverage in '19?

John Bostjancic

I think your initial comment, Craig, nailed it, is we're expecting leverage next year with the gross margin line, with the efficiencies we expect to get from the Irvine manufacturing facility and in continuing the trend of reducing G&A as a percentage of revenue. And our full intent is to redeploy that leverage into additional R&D, marketing, selling expenses and the CapEx that's required to increase the set builds, we can get deeper penetration of the sets that have been so successful in driving our revenue growth. So yes, the short answer is redeploy the operating leverage to continue invest in growth-driving activities.

Craig Bijou

Great, thanks for taking the questions guys.

Keith Valentine

Yeah, thanks Craig.

Operator

Thank you. And this does conclude today's question-and-answer session. I would now like to turn the call back to Keith Valentine, CEO, for any further remarks.

Keith Valentine

Thank you, everyone, for joining us today and have a great evening. Goodbye.

Operator

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect, and everyone have a great day.