Surgalign Holdings, Inc. (NASDAQ:SRGA) Q4 2022 Earnings Call Transcript

Surgalign Holdings, Inc. (NASDAQ:SRGA) Q4 2022 Earnings Call Transcript March 30, 2023

Operator: Greetings, and welcome to the Surgalign Holdings 2022 Fourth Quarter and Year-End Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the call over to David Lyle, Chief Financial Officer. Thank you. You may begin.

David Lyle: Thank you, and good afternoon. I’ll start today with our customary forward-looking statement disclaimer and then turn the call over to Terry Rich, our CEO, who will provide updates on our business operations and key milestones. I will then review our fourth quarter financial results and outlook followed by closing remarks from Terry. We will then open up the call for questions. Additionally, Chris Thunander, our Chief Accounting Officer, is with us today and will be available during the Q&A portion of our call. I’d like to remind everyone that on today’s call and webcast, management will be making forward-looking statements about future events, Surgalign’s business strategy and future financial and operating performance.

Actual results could differ materially from those stated or implied by these forward-looking statements due to risks and uncertainties associated with the company’s business. These forward-looking statements are qualified by the cautionary statements contained in today’s earnings release and Surgalign’s SEC filings. This conference call contains time-sensitive information that is accurate only as of the date of this live broadcast, March 30, 2023. Surgalign undertakes no obligation to revise or update any forward-looking statements to reflect events or circumstances after the date of this conference call. In addition, this conference call may include a discussion of non-GAAP financial measures. Please see today’s earnings release for further details, including a reconciliation of the GAAP to non-GAAP results.

With that said, I’ll now turn the call over to Terry.

Terry Rich: Thank you, Dave and good afternoon. We’ve been quite busy over the past several months, executing on our restructuring plan, closing the sale of our Coflex and CoFix product lines, and further enhancing HOLO portal and our HOLO AI platform. I’ll begin today with an update on our restructuring. Last November, we announced a restructuring program to drive long-term growth, lower cost, strengthen our balance sheet, and put us in a much stronger position operationally. Much of our planning centered on product line rationalization as we had a number of products that had been on the decline for years or had low ROIs and required not only financial resources for both operational resources and human capital to support them.

Our evaluation resulted in the plan, which will reduce our product lines by approximately two-thirds, and in turn enable us to eliminate a large amount of infrastructure costs, which will more than offset reduced revenue resulting from removing lower performing product lines. Some have already been discontinued and others will be over the coming quarters. The end result will be a simplified business, a more focused offering and lower ongoing cash requirements to run the company. Now let’s move to the market and an update on our business. The market overall hasn’t changed much since our remarks in November. We’re still seeing a slow sales process and conditions remain challenging both here in the U.S. and abroad. Hospitals and healthcare systems globally are facing unprecedented times and are coming off perhaps the worst financial year they’ve experienced.

According to the American Hospital Association, hospitals are incurring losses with more than half projected to have negative margins in 2022. Expenses have been estimated to be nearly $135 billion higher than the prior year and beyond financial issues they continue to face workforce shortages, supply disruptions along with lower patient volumes. On the other hand, the need for new technologies that can drive efficiencies in healthcare systems, not just within the OR is building, which brings me to our digital health platform. In 2022, we fell short of our HOLO portal projections. While below plan, we have over 70 opportunities in our pipeline and more than 15 currently in the administrative approval part of the sales funnel. So demand is strong.

As I noted, the buying environment remains challenging and it has been difficult to forecast timing. Thus, given the current environment, we’re going to refrain from forecasting the number of target sites today, but we do intend to provide updates throughout the year as more information becomes available, and especially with system enhancements we’ve made and have planned in the coming quarters. Since HOLO portal was launched, we’ve gathered very important feedback from surgeons, which in turn has been used to enhance the system’s capabilities. New software, hardware and additional features are part of the upgraded system. With over 20 new instruments added, we can now support a broader range of procedures and drive efficiencies in setup and workflow.

Earlier this month, we launched HOLO AI Insights for spine imaging, which we believe will lead to important discoveries through research that will transform patient care with artificial intelligence. According to EMC Digital Universe and IDC, two highly respected industry research firms, more than 90% of patient generated health data is in the form of unstructured medical imaging data. And we address this with our new offering. HOLO AI Insights translate medical imaging data into structured data sets of key biomarkers, which is currently used for research. Insights analyzes lumbar imaging for MRI images, providing quantitative measurements of 16 different anatomic structures in the spine, and can process thousands of MRIs in just a few hours.

In comparison, today the process is manual. Radiologists and surgeons read reports, take measurements, and make assessments with HOLO AI Insights, and for the first time ever, they will be able to analyze medical images based on quantifiable data rather than just someone’s subjective view. This process is automated and will help surgeons make more informed decisions, again, based on data. This is only the beginning. Over time, we plan to leverage HOLO AI Insights for precision medicine. HOLO AI quickly generates very detailed patient specific data for medical images. Because it is designed to automate these measurements, very large data sets can be built and combined with existing patient data and electronic health records, EHR systems to get metrics at the population level.

This will allow us to build a much more comprehensive model of the factors leading to positive outcomes for very specific groups of patients. Ultimately, we believe that prognostic models based on this data will facilitate physician decision-making and patients will benefit by having a much more informed view of how well treatment options succeed with very similar patients. The first adopters of HOLO AI Insights are doctors, Hani Malone, Greg Mundis, and Robert Eastlack spine surgeons with the San Diego Spine Foundation. We couldn’t be happy here to be working with such an experienced team and leading foundation. Which brings me to the question of what’s next for the HOLO portfolio. The first generation of the HOLO portal surgical guidance system was about seating the market and gaining experience.

We’ve had some early successes and adoption is moving forward. At the same time, we’ve gathered valuable feedback from surgeons, which was incorporated in our latest launch. Each next-gen upgrade thereafter will advance the system adding valuable features to improve the surgical experience. Over the long-term, we believe the HOLO portal has a head start on the competition as it is the first FDA system cleared to incorporate both artificial intelligence and augmented reality to expand on the capabilities of stereotactic navigation. Our plan is to follow up just about every quarter in 2023 with additional enhancements. We’ll be upgrading and redesigning the systems form factor, looking to provide physicians and their OR staff more flexibility and OR workflows.

The two bigger initiatives center on the platform itself, as will be migrating towards a more open platform. So that HOLO portal can be used with most, if not all implant systems. We believe this will result in greater hospital and surgeon adoption. Second and of equal importance is system capability. Today, the HOLO portal is only compatible with Medtronic’s OR, which limits the number of accounts we can work in. By expanding system capability with more imaging devices, we increase the number of hospitals and ASCs that we consult to. With respect to our HOLO AI portfolio, we plan to follow up on the spine application of HOLO AI Insights with a research based application for AI assessment of intracranial aneurysms later this year. In addition to the research applications, we plan to release a clinical product for AI assessment of lumbar MRI images in 2024.

Surgalign is playing in a much larger global market than ever before with first mover advantage and AI as it relates to spine, and we believe highly valuable AI technology that can be applied to many different use cases and treatments. Our global addressable market is in excess of $11 billion today and expect to grow to over $180 billion by 2023. There has been a global transformation towards advanced technologies following COVID with AI machine learning being key driving forces behind what is expected to be massive growth in the coming years. I will add software is leading the fastest growing segment, the global AI healthcare market, and North America has been the most aggressive in AI adoption in particular, and this is where we play today.

AI is not about replacing medical professionals, but rather leveraging its power to capture and assess data. AI can use and process information to assist a more efficient medical decision-making. That’s what we’re focused on at Surgalign. Data insights that can be applied first to the spine, then expand to other areas of the anatomy and different fields of use. We are confident in our technology and its potential. Moving on to the sale of our Coflex business in Q1. In February, we sold the Coflex and CoFix product lines in the United States and worldwide intellectual property rights therein to extend medical holdings for $17 million, a transaction that netted approximately $14.8 million in cash to Surgalign, cash, which was needed to extend our cash runway.

We will pursue to have discussions about other assets, but domestically and internationally and per then we’ll pursue every avenue to improve our liquidity and competitive position. With that, I’ll turn the call over to Dave now to cover our financial outlook. Dave?

David Lyle: Thanks Terry. I’ll start with our fourth quarter 2022 financial results and then focus my remarks on our 2023 outlook. We reported Q4 2022 revenue of $20.6 million, which represents a $400,000 increase over Q3 due primarily to growth from the Cortera pedicle screw alpha launch, and our streamlined pedicle screw system. Domestically on a sequential basis, revenue was essentially flat and international increase modestly due to growth out of our HPS product line, and this, despite a weak European environment. Non-GAAP gross margin in Q4 was 71.9% as compared to 74.9% in the third quarter, primarily driven by a product mix shift. GAAP gross margin in Q4 was negative 13.6% compared to 72.8% in Q3, with the difference almost entirely attributable to a non-cash inventory write-down associated with product line rationalization.

As for operating expense, Q4 non-GAAP operating expense was $24.6 million as compared to $26.5 million in Q3, an improvement of $1.9 million sequentially. Cost controls implemented throughout the year and related to the restructuring program as well as a reduction in bonus accrual led to lower expenses in Q4. Excluded from Q4, non-GAAP operating expense was a gain of approximately $683,000 are related to acquisition contain contingency, asset impairment and abandonment expense of $1.1 million, severance and restructuring costs of $1.1 million, and $1.1 million in non-cash stock-based compensation expense, as well as $18 million in transaction and financing expense. To note, the $18 million in transaction and financing expense were predominantly non-cash accounting charges related to the difference between the fair value of warrants and the amount raised in our offering.

Adjusted EBITDA in Q4 was a loss of $9.1 million as compared to an adjusted EBITDA loss of $11.2 million in Q3, an improvement of $2.1 million. The sequential improvement was driven primarily by higher revenue and lower operating expense. Now, I’d like to spend a few minutes to walk through our view of 2023, considering the many changes we have made to our business over the past two quarters. More specifically, our restructuring effort and the sale of our Coflex business, which materially impacts both our P&L and balance sheet. For the full year 2022, we reported revenue of $82 million, which was in line with the range we provided on our Q3 call. Using this as a basis for 2023 and building from the pro forma financials and our SEC filings, I’d like to walk through how we arrive at the 2023 revenue outlook.

In 2023 through our product line rationalization effort, we are removing approximately $18 million in revenue with much of the heavy lifting complete. Some products will be discontinued throughout the year, but are accounted for in the $18 million estimate. Additionally, we sold Coflex on February 28th, 2023, a product family that generated revenue of approximately $14 million in 2022. Given that we sold the business at the end of February, we expect to remove approximately $12 million in revenue for this in 2023, thus using $82 million as a starting point to determine 2023 revenue and then removing approximately $30 million for products that have been rationalized out and for Coflex being sold, that brings us to roughly $52 million in sales.

As we look out into 2023, we expect revenue to be in the range of $50 million to $54 million. We believe this is a conservative forecast as we are projecting modest growth from our HOLO portal and across several hardware and biologic product lines. At the same time, we are taking into account some potential loss revenue resulting from product rationalization. We intend to update revenue guidance throughout the year as we see the impact of rationalization and the new enhancements made to the HOLO portal system. So, let’s now move to where we think we can be in 2023 for gross margin. As a starting point, we reported non-GAAP gross margin of 72.8% for the full year in 2022, with the Coflex business sale where we expect non-GAAP gross margin to decline in 2023 as it was a high gross margin product line generating about 17% of the our global revenue.

With Coflex no longer part of our mix and with ongoing rationalization efforts, we expect 2023 non-GAAP gross margin to be approximately 65% to 70%. As for the balance sheet, we had about $16 million in cash at year-end, netted about $15 million in cash by selling Coflex, and we’ll have burned approximately $10 million by the end of Q1, so we’ll have about $21 million as of the end of this first quarter of 2023. Given our expected cash burn looking forward, we believe we have sufficient cash to get us into the fourth quarter of 2023. We continue to explore all strategic avenues to enhance our balance sheet and extend our runway. We remain focused on long-term sustainable growth, providing value to our stakeholders and maximizing value for our shareholders.

Products that align with our digital health strategy are paramount to our strategy and we intend to continue investing in innovation, but smartly given our capital requirements and the plans we have for our HOLO AI platform in the coming years. Now I turn the call back to Terry for closing remarks.

Terry Rich: Thanks Dave. We’ve done a lot of work over the past few years to remove many of the corporate overhangs on our business and drive our digital health strategy forward. We are executing our restructuring and remain on track to realize the savings we set out to achieve, while strengthening our infrastructure and technology. Throughout everything, we’ve managed our business with our customer’s needs in mind and relationships with suppliers, distributors and partners remain strong. We’ve lowered our working capital needs, simplified our business, and believe we have the resources that are currently needed to execute our plan. With that said, we know we will need additional capital and we remain focused on this, improving our balance sheet to capitalize on the massive opportunity and digital health ahead of us.

It is my belief that we have market-leading AI technology, which will generate value for our shareholders and all key stakeholders. Our AI platform opens up a much larger market on a global scale, and the use of AI and AR in the medical field is only going to intensify. While we have had some speed bumps as it happens when introducing advanced technologies or even more bullish on the opportunity we are creating, we have over 115 employees supporting digital health, and more than half of them are focused on innovation, whether software, hardware, cloud, design testing, or product management, we’re going to continue to invest in digital health, which in our view is the right path for Surgalign to maximize value for all shareholders. Operator, we’re now ready to open up the call for questions.

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Q&A Session

Operator: Thank you. We’ll now be conducting a question-and-answer session. Our first questions come from the line of Matt Hewitt with Craig-Hallum. Please proceed with your question.

Matt Hewitt: Good afternoon. Thank you for taking the questions and for providing the update. Maybe the first question is — and I just want to confirm, I believe you’re at five sites are currently using the platform, and I realize that you’re kind of stepping back from the 10 to 15 that you had previously expected to get to. But one of the things that you had talked about a year ago was your expectation that once you got to seven to 10, your hope was that at that point you could start working on some publications or your sites would be working on some publications at which time you would roll the system out more broadly. Is that still your intention is to kind of get to that seven to 10 and then hopefully start to see some publications or what do you think is going to drive that second layer of adoption?

Terry Rich: Yeah. Hey, Matt. Thanks a lot. Yeah. So, we are working on some publications with some physicians currently. And we open up more sites, there’ll be more to come. But what we found in these early stages is that in terms of us getting the system to market quickly and we thought the system would be used mostly in percutaneous cases. And so, we had very few instruments to support that. And so, seeing that a lot of the business has been in open cases, that’s where we just added the 20-plus instruments to support workflow in open cases and upgrade a couple components. And so, we believe that this will significantly help drive better adoption, or additional sites I should say, and give the surgeons and the staff what they need from a workflow perspective to make the system easier to use.

But we’re also very excited about the release of the HOLO AI Insights. This is really a huge opportunity to get into broader patient analytics and begin down the path of predictive outcomes in spine. And we’re very excited about what that’s offering and our first research projects with San Diego Spine Foundation, with more to come soon.

Matt Hewitt: Got it. And then, I guess, another question, early on — and I realize as markets change, you’ve had to deal with the pandemic and all that, it forces decisions maybe. But one of the early promises of the technology was that as the platform was adopted, you would have this almost a structured sales channel into your proprietary pedicle screws and everything that went with it. And it sounds like you’ve run into some complicating factors with that. And now needing to go to open source. How does that change kind of the long-term model? Or is it your hope and expectation that a decade from now you’re going back to proprietary and needing to use your implants with the HOLO platform?

Terry Rich: Yeah. So, look, I think it’s really driven by market forces and certainly, we’re having degrees of success using it with our current screw system and we’re now integrating our new Cortera screw offering, which believe will help as well. But really the key is these implant systems are surgeon preference and some surgeons are tied for various reasons to different implant systems. It can potentially limit their desire to use HOLO. So, we’re opening it up because we believe we can catch much broader share in the accounts that we’re currently in as well as we go into other accounts. I think the other thing you’ll find is that a lot of hospital administrators are really becoming weary of these new technologies be it, guidance, robotics, whatever it is, being tied to hardware usage.

And they’ve run into a number of issues with this and it’s caused them problems. And so they’re starting to look at things differently. That’s why there’s a variety of companies coming out now in spine, in large bone orthopedics in other areas, that aren’t offering implants. They’re just offering the advanced technology and the ability to work with all systems.