Surgalign Holdings: Strong Potential Still Abound
Summary
- Gross margins in 2020 remain elevated despite pandemic headwinds.
- Management maintains Holo platform will revolutionize how doctors perform surgeries.
- Potential in this space is very high. We expect the market to reward any improvements very well.
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We wrote about Surgalign Holdings (NASDAQ:SRGA) back in January of this year and stated that we believed shares had strong upside potential. The reasons for our bullishness were the clear potential in the spine space with respect to digital surgery as well as the huge untapped potential in international markets. The Holo-Surgical acquisition in September of last year definitely got investors excited about this new-look company although it's fair to say that investors (primarily to everything being slowed up due to the ongoing pandemic) need to be patient here.
In saying this, shares are still up approximately 11% since we penned that piece back in January. This is encouraging given the fact that fourth quarter numbers already have been digested by the share price. Sales in the fourth quarter ($26.2 million) came in approximately $5.4 million shy over the same period of 12 months prior due to a significant slowdown in procedures. The net profit number in Q4 was adversely affected by a one-time charge of $95 million concerning the Holo purchase. This meant that full-year sales came in at $101.7 million (13% drop) and net profit came in at -$33.7 million.
On the surface, these numbers may not look that attractive but trends still look encouraging further up the income statement. In a year which was particularly challenging for this industry, Surgalign still managed to report over $61 million in gross profit off of the $101+ million in top-line sales mentioned above. Almost $13 million of the annual gross profit number came in the fourth quarter of which almost $7 million of one-time inventory charges were also booked. Suffice it to say, with respect to profitability, we expect Surgalign's trailing gross profit metric of over 61% to continue to grow which essentially buys the firm time to bring value-added products to the marketplace.
This really is the issue with a company such as Surgalign which is whether it can bring quality products to market quickly without diluting the finances even more. The Chief Financial Officer (Jon Singer) was questioned on this on the recent earnings call. Singer though remained adamant that the share count would remain at the 110 million mark which essentially means that no further offerings would be made for the rest of the year.
The reason for this bullishness over the near term is the fact that management believes 2021 will see increased demand for its mainstay biologics and implants segments. This is important as it buys the company time to execute on the objectives it has set. The firm's long-term objectives revolve principally around innovation where the totally revamped R&D team will be responsible for adding significant value in a new-look portfolio as the industry pivots to digital solutions. Therefore, we would expect the company to double down on acquisitions in the AI and machine learning niches in this space going forward in order to add as much value as possible to future products and services.
Analysts who follow this company expect topline sales to grow by 8% this year followed by almost 13% the following year. Suffice it to say, these trends are resulting in very attractive bottom line earnings comparables this year: The best of which we should see in the first quarter. In fact, if we look at the technical chart, we can see shares look to be caught in a symmetrical triangle for over a year now. We believe this is a bottoming pattern. Shares need to break out above the upper trend-line of the triangle before confirming the pattern. The attractiveness of the pattern is that the short-term target here is well over $6 a share. This assumes, of course, that we can get a convincing breakout above that upper trendline.
We actually got long this stock not long after we penned that piece in January but then lost shares soon thereafter (through covered calls) due to the big run-up in the share price in early February. In fact, if volatility was to return somewhat in SRGA, we would most certainly return to a similar strategy due to the strong downside protection we see in this stock. Hopefully, we will see some FDA approvals for the Holo platform this year which will provide the momentum for more breakthroughs to be made in this area.
Therefore, to sum up, we believe investors need to be patient regarding long-term positions in Surgalign. If another wave of the pandemic was to hit, for example, the number of procedures will undoubtedly remain subdued which would hurt sales. We continue to like however the strong margin profile and also the possibility of the firm moving out of the core spine segment into the more general digital surgery solutions. All investments from here on in will be in line with the company's digital strategy. We look forward to continued coverage.
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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SRGA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (7)
2) Regulatory approval pathways globally may be challenging.
3) The competitiveness of the digital surgery market, as SRGA management wants to expand beyond spine.
4) Existing lack of physician excitement in the platform or in its capabilities.
5) Slow and costly R&D efforts to streamline its product portfolio offering centered on Holo Surgical.
6) An initial uptick in cases and sales following a successful FDA approval only to encounter stagnating growth - physicians are fickle - thus demanding increased marketing spend or a shift in strategy.
7) Lack of synergy between management and employees of Surgalign vs. Holo Surgical leading to operational and execution inefficiencies, and thus to increased costs.
8) Inability to reach sustained break-even due to all of the above until ~2024 to 2025 (by my calculations based on financial assumptions provided by management in latest quarterly call).
10) Running out of cash due to regulatory delays or increased costs from above risks and thus filing for bankruptcy or substantially weakening the balance sheet or diluting existing shareholders.