Alphatec Holdings, Inc. (ATEC) Earnings Call Transcript & Summary

I have the pleasure of having Todd, CFO of Alphatec as well as Robert, the VP of Finance next to me here on the stage. Before we kind of dive into details, I just have to read disclosure. Just please see the research -- Morgan Stanley research disclosure website, morganstanley.com/researchdisclosures. And if you have any questions, please feel free to reach out to your Morgan Stanley sales rep. Todd, so let's kick it off and go into Q&A.

And maybe let's first start on the macro. And as we've kind of heard last week and even at our conference this week or the past few days, there's been commentary about procedure softness in June, July. And as we transition into August and September, things have kind of improved. We'd love to hear kind of your -- what you're seeing on the Alphatec side and just maybe how that's been incorporated into your guidance?

Yes. That's great. First, thanks for having us, we do appreciate it. I think as it relates to kind of the market, I mean, I think the first point from our perspective, so much of our growth is truly coming from share taking that ultimately, kind of what goes on in the market at any given point in time is probably a little bit less impactful on our total revenue results in the third -- second quarter, rather, we grew 30%. And so if the market goes up 2% or 3%, it's kind of not as impactful for us. But ultimately I think what we see is kind of what everybody else is seeing in terms of the dynamics in the market. I think what we're seeing is kind of a reasonably stable market relative to Q2 and kind of -- really kind of all the way back to March, which I think is nice in some ways like no news is good news in many ways. And certainly you see the continued effect of having some staffing challenges. There are still people testing out for COVID and procedure delays along with that. But my sense is that's not happening at any greater rate than it has been historically. And so I think from our perspective it's, I think, kind of neutral is good.

And maybe from your standpoint too, with this ongoing staffing shortage, do you have a sense of maybe what's being limited from a capacity standpoint? I mean, 90%, 95%, like any sense there on what your data shows you?

Yes. It's hard to -- it's just hard to really opine in any -- in a way -- in a resolution that's helpful, I think. But you kind of know it's there. In some places, a little bit more, in some places non-existent.

Got it. Maybe on the other side, kind of the capital environment and like with EOS, I mean, it is a piece of capital at the end of the day. But I mean, it's been surprising that the selling cycle from EOS has actually been getting quicker. So what are you kind of seeing in the capital environment and conversations you're having with hospital executives and with surgeons as they're maybe approaching, purchasing EOSedge?

Yes. I think on our selling cycle improving over time, I think that's really a reflection of the combined entity. I think historically, a sales funnel really would start at kind of a radiologist conference and kind of matriculate its way through the process, and they'd be looking for a surgeon champion and to help them navigate the hospital and the purchasing cycle. And so I think that could actually take a fair amount of time. One of the benefits we have is obviously our surgeon customers are hugely interested in EOS and the clinical value of that. And I think the clinical value of EOS has really been unquestioned. And so there's a tremendous amount of interest in the technology from our customers. Spine surgery is still a winner in the hospital and makes money. And so I think ultimately, our surgeon champion has a reasonably loud voice in the hospital. And so I think that combined with some investments in our sales force as it relates to EOS specifically, have all really kind of shortened our sales cycle time. I think we noted about a 40% increase in our sales funnel in Q2 versus where we were a year prior. And I think that kind of is reflective of the combined entity. In terms of the capital selling environment, we noted on the second quarter call that we had really the strongest quarter of orders we've had so far, which I think is another good indicator of probably increasing sales execution on that front as well as the amount of interest in EOS. And so ultimately, there could have been some headwinds on the capital front. Maybe we could have done better in terms of orders. But ultimately I think we're pretty happy with where it's trending, the level of interest and really our ability to make the most of EOS.

Just maybe to add to that, you think about the capital environment. And I think one of the fortunate thing is working in our favor. A couple of the fortunate things working in our favor with EOS is; one, EOS is reimbursed. So there's some favorable reimbursement associated with it. It's also a highly utilized piece of equipment. So when an EOS is placed, you have -- you might have -- HSS has several EOS units, and you're getting 15, 20 scans a day. And so I can imagine and we're not capital experts, but if you're at a hospital and you got a prioritized capital investments, I would think capital -- prioritizing something that; one, is reimbursable and; 2, has a high utilization by the folks in your facility. That gets pushed towards the top of the list. And so that may be reasons why we're continuing to see strong interest in an environment that maybe is more challenging.

And to kind of go on some of the points you both made. I mean, your guidance, you moved it up to $48 million for EOS. I mean that kind of implies a 20% in the second half over first half ramp. I mean, you sound confident. And -- but I'd like to hear a little bit more about the visibility that you have in achieving that. I mean, are kind of all of those systems spoken for at this point or is it really just all about the pipeline funnel that's driving your confidence?

I think the confidence that we have in our revenue recognition in the second half is really underpinned by the existing order book. So I think really, it's more about the cadence and ensuring that we've got a high level of confidence that we can deliver on the revenue recognition, which is really synonymous with a delivery and an installation of a system. And so we've made some investments there in terms of improving and increasing some of our installation capacity and discipline as well. So ultimately, I think it's been an area of focus for us internally just to get more rigor and more predictability on that front. And so ultimately, from a guide perspective on EOS, we dropped $1 million beat and kind of held in the second half. And that's why we helped in the second half. But to your point, we are seeing a sequentially improving first half to second half. And I think that's just a reflection of the strength of the order book and our continued improvement operationally in installations.

Is it a stretch goal that you get to like 500 units as an installed base for this year?

I mean that would be a pretty big number for us. Our guidance would imply probably something closer to, what, 475.

Got it. Maybe for just broadly in thinking about growth drivers, I mean, we just kind of ran through EOS, and I want to touch on PTP. But maybe before we do, it's like what other growth drivers should we be thinking about for Alphatec into the back half of this year and even into 2023 from a portfolio perspective?

Yes. I think as we kind of lay out our revenue walk, we talk about procedural volume and procedural ASP. And we've talked the procedural volume in our guide kind of being kind of mid to high teens as a percent and ultimately having procedural ASP being at the high single digits, kind of getting an overall roughly 30% guidance for the year. And ultimately I think the question I think you have is like what's driving that strength? I think that reflects about a 20% year-over-year growth in the second half on our spine business. And kind of going forward into next year as well, I think clearly PTP is really what's driving a lot of the volume and interest. And the reality is you not only get PTP, but because you get PTP and you gain confidence, you also get really, we kind of call it the halo effect. And ultimately you get a bigger piece of the surgeons business outside of just their lateral business because of the confidence and the trust you've garnered with them. And so I think we see that more specifically, you might say, -- how is -- how are your procedural ASP growing and some of those other areas that are going to drive growth? I think about the opportunity for us to kind of launch an expandable device in the future here. I think that's a tailwind to procedural ASP going forward. Certainly, our biologics attachment rate, we saw a pretty big step up there in the first half of this year. We expect that to continue into the future, still reasonably low. And so we've got many years of runway is there. I think kind of '23 and beyond, you can kind of think about other areas where we don't have a device like we don't have a corpectomy device for instance. And so I think you'll see some of those types of innovation, product innovation, supporting our procedural approach into the future.

And you're kind of touching on new surgeons adopting PTP. You're seeing the halo effect kind of broadening your portfolio. I mean, you're a little over a year, I guess, in terms of launch for PTP December 28, '21, right or am I wrong? 2020.

2020.

So 2 years, I can't do the math here. But as you've seen kind of the procedure mature over time, are you seeing maybe more rapid surgeon adoption of the overall portfolio now than maybe you did kind of in the earlier stages of PTP launch?

Yes. It's a good question. I think what I can tell you is that, we're definitely seeing an increase in utilization in the complexity of the procedural approach. And I think that's a great indicator for strong adoption. When we look at our adoption numbers on overall, sometimes they get a little bit over-weighted just given the new surgeons. But when you kind of look at the cohorts of people who have trained, the adoption continues to be up and to the right and kind of year-after-year, the productivity and kind of the quarterly surgeon productivity cohorts that we track continue to increase their utilization of not only PTP, but our overall portfolio. And so I think I can answer that in affirmatives.

And just on surgeon training, we shared in our Investor Day that these cohorts that are doing first year training and then what's their case utilization in following years. And there's this nice trend of up and to the right as they continue to adopt and do more complex procedures and the like. And if you look at some of the training indicators that we've shared in the most recent quarters, 150 training events in Q2, and you think about what's the growth drivers into the future? Well, I can tell you that those 150, those are 150 training events that are going to drive really growth over the next 24 months. And so that's not really a current growth driver. That's a growth driver for someone that may try a case in the next 30 days following an event. And then over the next several years, it's going to ramp their case utilization over that time. And so we look at those metrics and we share those metrics because they really are an indication of future growth opportunity.

Got it. Maybe to go back to EOS for a moment, but as you kind of think about enabling technology in spine, I mean, one of the ultimate goals is to see implant pull-through and utilization move higher. And it doesn't necessarily sound like that's been really embedded in your LRP as you're kind of looking out to 2025 and $85 million, I think, is the number that you put out. So I mean, just help us kind of bridge maybe the growth drivers for EOS? I mean right now, it feels more capital, more placements. You do have the potential for upgrades, a huge installed base of the prior generation technology. But just kind of what's going to get the surgeon, what's going to get the spine department to apart EOS and really drive pull-through for Alphatec?

Yes. I think a couple of things there, Drew. One, when we kind of look at how EOS can and is influencing our ability to drive hardware revenue, for instance. You kind of look at first, where is EOS installed base when we acquired the company? And that installed base was in many of the leading academic institutions, a lot of them kind of pediatric deformity, for instance. And so then the question is like when can you start accessing that and kind of improve essentially gaining sales there because you have an EOS machine? And I think that one is probably a longer walk, to be fair because ultimately, they need to see the value that we bring to EOS to allow us to really kind of earn our way into that relationship. And I think the second component to that is, ultimately, when we are selling EOS units that we're selling to new customers, one of the things we require is access. And so our ability to get access into institutions that we probably wouldn't have had historically as kind of ATEC stand-alone or would have come longer down the road is manifesting itself now because ultimately, we trade access for the opportunity to sell them or for them to buy an EOS machine and get access to that technology. And so it's been a big piece of how I think we've been able to gain access to different institutions through the EOS technology. And while that isn't like direct pull-through, it certainly opens up the opportunity for us to engage and sell freely in some of those places where we wouldn't have had access before.

And if you are thinking about kind of the pull-through opportunity, I mean, as you're thinking about 2024 or 2025, maybe even '26, I know it's a long way from that away, but would you expect kind of your spine portfolio or spine implant to really hold more of a 25%, 30% type growth rate versus kind of the CAGR that's kind of implying a 20% growth rate over time?

I'm trying to figure out if you're asking me if I'm going to commit to a number higher than my LRP here. So I think, ultimately, what we laid out, we think the thesis for that is strong. We kind of talked about volume and procedural ASP. I think ultimately, the question is, how much more volume and further penetration can we get in the market? I think there's a lot of opportunity for us. As we laid out, just if you take lateral, for instance, we said lateral is a $1 billion market today. At the LRP, we said in 2021, we were probably mid-single digits penetrated into that existing lateral market. There's another $2 billion of PLIF and TLIF business that ultimately can be addressed through a lateral approach. At the 2025 point of the LRP, we think that lateral market has been growing kind of mid to high single digits from a market growth standpoint and our penetration is in the low double digits. And so there's so much more penetration in that lateral market that we can affect beyond the 2025. And absolutely, our goal is to do a lot more a lot sooner.

And just kind of thinking about the Analyst Day and the slide deck. I mean, there's a slide showing kind of your geographic market share in kind of major cities. And with kind of the turnaround that happened at Alphatec, I mean, you retooled the distribution network. So how much opportunity left is there to really penetrate some of the U.S. geographic opportunities, at least from like a new city kind of perspective and probably have an international question in there, too, but maybe let's just focus on that one for a second?

I mean, do you want to hit that? You spend a lot of time on the log.

Yes. I mean, I think there's clearly opportunity in -- you think about expanding in current territories where we just are under -- our presence is below where we'd like it to be and then greenfield expansion. And the answer is you do -- you still do both, and we have room for both. I think one of the metrics we shared last quarter was that our existing territories, so places we've been there a year or more and in some cases, 3, 4 years, are growing at a rate of 25%. And I think the point is that's where we're seeing -- that's profitable, sustainable growth, right, where we're driving new surgeon adoption within a territory. And we'd like to see more of that. There's plenty of open space within territories to do that. And yes, there are still geographies where there's just no presence. And so we'll continue to do those opportunistically. As we kind of talk about our creating clinical distinction, then that drives surgeon adoption and that compels reps and helps us elevate the sales force. And as you think about that, part of the reason we have open spaces is because it's open spaces where we want to compel surgeon adoption. And so the playbook may be somewhat opportunistic based on where those surgeon pockets where we're creating momentum and then you go in there with the appropriate distribution to support that. So we'll continue to do both. I think there's certainly, as was evidenced in that slide you referenced, there's a couple of greenfield opportunities, but we'll do that in concert with expanding the current territories as well.

And I think the nice thing too is now that our growth going forward is going to be -- more of it will be from the land and expand experience because we have the distribution footprint kind of replaced. And we're going to continue to add, as Robert said, but that expansion of your sales footprint of those existing agent relationships is actually a more cost-efficient way to grow as well. And so I think that ultimately helps us drive leverage through the P&L over time.

And maybe if we kind of shift to profitability and some of the opportunities there. I mean, when you're kind of looking at the LRP, at least from a gross margin perspective, it doesn't look like you're baking much in terms of operating or of gross margin expansion. But maybe just talk about the bridge to getting to 71%. I mean, when we kind of do the quick and dirty math, I mean, it looks like you're holding kind of legacy Alphatec gross margins relatively stable and then maybe a very modest EOS improvement. But just kind of what's the math to get you to 71% and does it have to do with maybe some of the attachment rates from newer products like biologics?

Yes. I think that's -- you kind of hit the nail on the head. I mean, like broadly speaking, we said kind of low single-digit pricing declines kind of offset by some volume leverage, maybe a little bit of a headwind as biologics becomes a bigger part of the overall portfolio. On the EOS side, really, you've kind of got some modest improvement. Now can we drive a little bit more there and can we get a little bit more benefit out of volume and kind of our base business? I think that may be the upside case. But I think you kind of hit the nail on the head in terms of how we thought about it in our LRP.

And the EOS has a potential 45% gross margin type of product for the company longer term?

I mean, I think the opportunity there is to really kind of grow your revenues on and your recurring revenues, in particular, on kind of a fixed service cost base, if you will, on an installation cost base. And I think that's part of the opportunity for us to see some margin expansion there.

Maybe on EBITDA breakeven. I mean, you're targeting 2023 EBITDA breakeven and profitability is becoming a bigger part of the story. So kind of what's your confidence in really achieving that goal for next year 2022, at least we have about a $25 million EBITDA loss. So just kind of help bridge us maybe from the back half of this year and into 2023, what the drivers are?

Yes. So if I just kind of set stage a little bit, we said 2021, we were in a $28 million adjusted EBITDA loss going to essentially $80 million of adjusted EBITDA in 2025 on $555 million in revenue. And really getting cash flow -- excuse me, adjusted EBITDA breakeven in 2023. And so the other piece we said was 2022 would be at least as good as 2021. So kind of putting a floor on the loss of $28 million of adjusted EBITDA loss. And so if you kind of look at where we are today, I think first half of the year, we're at about a $19 million adjusted EBITDA loss, and that really implies probably another 9 million max in the second half. That kind of gets you a 7% and a 2%. If you end at the 2%, you're feeling pretty good about your ability to deliver adjusted EBITDA breakeven next year. I think when you look at how things played out Q1 to Q2, we were up $13 million in revenue. We improved adjusted EBITDA by about $3 million going from $11 million to $8 million. And so, I think you're starting to see or at least in Q2, we started to see some of that leverage play through and play out. And I think that's just a one quarter doesn't make a year, but you got to get one right before you can get 2 right.

And I think because of those reasons, you look at Q3 and Q4, and you feel confident about it. I think the other thing, too, you look at -- we're anniversarying out of the EOS acquisition as we head into the back half of this year. And so it's just -- there's been a little bit of noise there just on that, that drop-through walk that Todd talked about. But I think we're in a cadence now where you kind of see it playing out over the next couple of quarters.

So you have growth drivers outside of PTP outside of EOS. There's more things to come in the portfolio. Just how are you thinking about maybe the top line upside or gross margin upside, maybe filtering down into your operating margin target of 5% in 2025? I mean, we did kind of benchmarking analysis and it's a very realistic goal. But I mean, are you thinking more about reinvesting top line upside or gross margin upside or kind of letting that flow through into profitability?

I think on the main, we -- our first priority is achieved and do our best to exceed the commitments we've made. And I think that's been our experience as a company, and that's what we're trying to do going forward. So I think those are our first commitments. And ultimately, I think we believe there's so much more opportunity to continue to grow this business beyond the 2025 time frame. And that's part of the reason why we've really only baked in 300 basis points of operating margin improvement associated with R&D. Our 2025 is at 8% of R&D. And so I think our belief is that so long as we believe that there's an opportunity to continue to innovate and be a differentiated player in spine and drive top line growth, we're going to be biased to do that. Obviously, we've got to do that with a mind towards say, we got to get to our operating margin commitments and delivering leverage along the way.

So maybe thinking about next year, I know you're very willing to discuss that. But can you just maybe help us think about some of the early puts and takes in framing growth or margin expansion? I mean, you obviously laid out the EBITDA breakeven for 2023, but how should we kind of think about growth translating into next year?

Yes. I think like as we kind of think where the street is at here in the second half, I think we're more or less a 20% grower in the second half associated with the street. And I think our long-term plan is to kind of grow 23%. I think more or less, again, the street is kind of model in our 325.I think they're just shy of 400, which I think kind of -- I feel good about all of those numbers and where they're at. And so I think more or less, I think consensus is a place that we're comfortable with, and I think that reflects the growth rates we've committed to. And I think as we continue to grow, our growth is going to be led by our commitment to the lateral or to the anterior column through lateral. And we're going to continue to innovate around that. And I think you'll also see us bring to bear some new procedural approaches as well over time. All of that to say, we've got a ton of growth in front of us. We're going to try and grow as fast as we can and continue to deliver on the commitments on the both and the top line that we laid out in our Investor Day.

And maybe we're coming up here at the top. But maybe on the balance sheet, and you've really emphasized that your current capital structure, you have capabilities to reach profitability without any dilutive financing. It sounds like that's still very much the case. Just maybe help us kind of get to free cash flow profitability in 2025 and kind of what the inflection is that's going to drive that?

Yes. I think the big inflection really is the shift on adjusted EBITDA and essentially driving operating margin profitability over that time horizon. That's kind of the single biggest change in the cash flow over that time horizon. One of the things that we do as you look at the difference between adjusted EBITDA and cash flow really is our inventory and set investment to drive top line growth. And so we tend to think about 65% to 75% of the absolute dollar growth being invested in that year to support -- invested in inventory and set to support the sales growth. And so I think that relationship holds as we continue to grow, and ultimately, let's the profitability that gets us to the corner. And as we talked about the walk, the operating margin walk, I mean that's really about leveraging the infrastructure build that we've already put in place in terms of building sales training, surgeon training, the management teams in place, sales leadership teams in place. So like all of these big capabilities that are necessary to run a business that's $0.5 billion, $1 billion or $1.5 billion are really in place. And so we're going to leverage those as we grow revenue and then also the variable expense associated with our distribution channel, those will walk down as well just based on the structure, I think we laid that structure out pretty clearly and concisely in our Investor Day presentation. And so the good thing and the confidence I have in our ability to get to where we need to get to is built on the fact that the structural components of both of those attributes, the variable expense and the contracts that are necessary to drive the leverage as we grow as well as the investments we've already made. Those structural elements are in place. And so we just really need to run the play.

Perfect timing. Unfortunately, we just ran out of time. But Todd, Robert, really nice to have you here with us today. Thank you so much.

Thanks.

Thanks for having us.