Surgalign Holdings, Inc.

Thank you, operator. Good afternoon and thank you for joining the Surgalign Holdings Inc.’

s first quarter conference call. Joining me today on the call is Terry Rich, our President and Chief Executive Officer.

Before we start, let me make the following disclosure. The earnings and other matters we will be discussing on this conference call will involve statements that are forward-looking.

These statements are based on our management's current expectations. They are subject to various risks and uncertainties associated with our lines of business and with the economic environment in general.

Our actual results may vary from our statements concerning our expectations about future events that are made during this call. We make no guarantees as to the accuracy of these statements.

Accordingly, we urge you to consider all information about the company and not to place undue reliance on these forward-looking statements. During the call, we will also present certain financial information on a non-GAAP basis.

Management believes that non-GAAP financial measures taken in conjunction with U.S. GAAP financial measures provide useful information for both management and investors by excluding certain non-cash and other expenses that are not indicative of our core operating results.

Management uses non-GAAP measures to compare our performance relative to forecast and strategic plans to benchmark our performance externally against competitors and for certain compensation decisions. Reconciliations between U.S.

GAAP and non-GAAP results are presented in the tables accompanying our earnings release, which can be found in the Investor Relations section of our Web site. Now, I will turn the call over to Terry.

On today's call, I'll begin by providing an overview of our first quarter performance. Then turn the call over to Jon to provide a financial overview, after which I'll provide an update on the progress we have made thus far in 2021, before opening the line for questions.

Total revenue for the first quarter was $23.3 million, down from $27.1 million during the first quarter of 2020, primarily driven by the negative impact of COVID-19 on elective procedures both in the U.S. and internationally.

While our primary focus is the development of Holo and achieving key milestones during 2021, we continue to successfully deliver innovation within our product portfolio. During the first quarter, we launched a number of new products, including Fortilink in Europe and an expansion of coflex in the United States.

In addition, we recently acquired the assets of a fully capable medical device machine shop in San Diego, which will enable us to support the acceleration of our innovation agenda by providing our research and development team was state of the art prototyping and manufacturing capabilities. The benefit of this investment was on display last week, as we hosted the surgeon design meeting and turned out prototype implants for cadaver testing in record time.

This allowed us to quickly integrate the feedback into our next version of the design. This capability allows us to decrease the time to market and also allows for custom instruments to meet individual surgeon needs.

Turning to Holo. We remain on track with the ongoing development of the platform and are very excited to announce that we have filed our initial 510(k) submission to the FDA for the Holo Surgical intelligent guidance system.

With a clearance expected in the second half of 2021, we remain focused on incremental milestones leading up to the first U.S. cases being performed with the platform by the end of the year.

With that, now I'll turn the call over to Jon for a financial review.

Thanks, Terry. Global spine revenue for the quarter ended March 31, 2021 was 23.3 million compared to 27.1 million for the prior year period.

The declining revenue was primarily due to the impact of the COVID-19 pandemic on global elective procedure volumes. Domestic revenue was 19.8 million, a $2.4 million decline from the first quarter of 2020 and international revenue was 3.5 million or 1.3 million decline from the first quarter of 2020.

Gross profit for the quarter was 17.1 million or 73% of revenue compared to 17.9 million or 66% of revenue in the prior year first quarter. The improvement in gross margin rate is due to the elimination of certain manufacturer related costs as we move from an integrated manufacturer to a fixed price purchase when we sold the OEM business.

Marketing, general and administrative expenses decreased 11.4 million or 31% to 25.9 million for the three months ended March 31, 2021 compared to 37.2 million for the three months ended March 31, 2020. The decrease in marketing, general and administrative costs was driven by a reduction in spending as a result of the decline in revenue and the simplification of the distribution and marketing infrastructure and a reduction in spending due to the sale of the OEM business.

Research and development expenses decreased 1.4 million or 33% to 2.9 million from 4.3 million for the three months ended March 31, 2021. The decline in research and development expense is a result of a reduction in spending as the company has begun to build out its internal R&D organization after the sale of the OEM business.

Adjusted EBITDA for the first quarter of 2021 was a loss of 9.8 million compared with a loss of 20.2 million in the prior year period. The improvement in adjusted EBITDA is predominantly driven by the reduction in operating expenses -- [Technical Difficulty]

I would start turning to guidance.

Sorry about that. I believe we are back.

We were at guidance. The COVID-19 global pandemic continued to impact demand for our products during the beginning of 2021, with a particularly strong impact on our international markets.

We're beginning to see a slow recovery in our domestic markets and as a result expect total revenue for the second quarter of 2021 to grow by 5% to 7% sequentially over the first quarter of 2021. We continue to anticipate full year revenue growth in the range of 5% to 10% compared to full year revenue of 102 million in 2020.

Our guidance assumes the global procedure volume continue to progress and begin normalizing towards the end of this quarter with a slow returns at historical levels for coflex and limited contribution from Cervalign ACP, which was withdrawn from the market due to a recall by our manufacturing partner in January. In addition, we assumed certain biologic products will be impacted by a delay in 510(k) clearance of the products as the FDA has upped classified the regulatory requirements.

Based upon this revenue, we continue to anticipate full year adjusted EBITDA will be in the range of a loss of $35 million to $40 million. I would like to now turn the call back to Terry.

Thanks, Jon. Our primary focus this year is on the ongoing progression of our digital strategy, which includes the build out of the organization and the continued development of the whole surgical platform, and to re-imagine our product portfolio to accelerate the pace of new product introductions that will integrate seamlessly with the whole surgical digital platform to deliver better patient outcomes.

Starting with some of the recent developments with our product portfolio, we continue to work to align our long-term product development roadmap to support Holo Surgical and the promise of digital surgery. In addition to focusing on identifying new development initiatives, we are undergoing a critical assessment of our existing portfolio to identify any individual products, or product segments that we don't believe will be supportive of our digital strategy going forward.

In the near term, we've accelerated our innovation agenda and are building out our portfolio of products that can be integrated into the whole surgical platform. Turning to developments relating to our digital surgery platform, we came into 2021 with a tremendous senior leadership group, which included the fully integrated team from Holo.

Shortly after the end of the first quarter, we added to the talent within the leadership team focused on our digital strategy with the addition of Marc Mackey, our recently appointed Executive Vice President of Digital Surgery. In this position, Marc will head up our digital surgery team, which is tasked with leading our efforts to redefine and lead our digital surgery efforts.

This team includes clinicians, engineers, technologists, medical device veterans working together to re-imagine what is possible with digital surgery. Marc brings tremendous digital surgery and robotics experience having spent more than 20 years at Brainlab prior to its acquisition by Smith & Nephew.

We're excited to have someone of Marc's caliber join the team and look forward to his contribution at this critical point in our development of a revolutionary digital platform. There are a number of key milestones that we expect to achieve in 2021, the first of which is the FDA 510 clearance of the platform.

We're very happy to announce that we have made our initial submission to the FDA. The Holo Surgical intelligent guidance system combines augmented reality and artificial intelligence to automatically segment the spine and define implant trajectories for surgical planning combined with real-time intraoperative 3D surgical guidance.

The system allows the surgeon to see the target of the surgery, which in the initial stages will be the patient's spine with all the relevant anatomical details, as if the patient had no skin, muscles or connective tissue in the way. The system also provides intelligent AI-based validation and guidance for the surgeon regarding such aspects of the procedure, its location, size, angle trajectory of the implant.

All the system's functionality is available via the augmented reality display above the surgical field, so the surgeon does not have to look away from the patient for guidance as they were required to do with traditional navigation systems that only provide 2D images and does require the surgeon to look away from the surgical field. Although surgical represents a one of a kind combination of technologies, as confirmed by the quote in our press release this morning from Dr.

Greg Anderson. Having utilized digital technology in my practice for more than two decades, the Surgalign system is the first transformational innovation I've seen in the digital realm.

Its unique combination of augmented reality and artificial intelligence will not only allow me to make better decisions for my patients, but will allow me to deliver more accurate and efficient care in the surgical environment. It's truly a game changer.

Dr. Anderson is Professor in the Department of Orthopedic and Neurological Surgery at the Thomas Jefferson University and Clinical Director of the Spine Section of the Orthopedic Research Laboratory at the Rothman Institute.

We look forward to working collaboratively with the agency and continue to expect to receive clearance during the second half of 2021. This is the first of many Holo Surgical related FDA submissions we will file as we continue to work to bring incremental capabilities to the platform and expand its applications beyond spine and orthopedics, neuro, general and many other surgical specialties and applications across the continuum of care.

We recently hosted a lab with surgeon thought leaders in which we gained their input on certain of our new product development initiatives and introduced them to the Holo Surgical technology. The surgeons were incredibly enthusiastic regarding the Holo Surgical technology and shared our belief that it will help elevate the standard of care through the evolution of digital surgery.

The quotes from Dr. Anderson and Dr.

Sethi in our press release represent just two of the many accolades the group had to offer regarding this revolutionary technology. Holo Surgical does not only provide best-in-class surgical navigation, but something that is still unique, intelligent guidance.

Our intelligent guidance is a significant leap forward from traditional navigation and robotics that require direction from the surgeon to understand anatomy and trajectories. We need to remember that current robots, despite the significant progress and their [ph] introduction, have not made progress in the two most fundamental aspects, visualization and intelligence.

The current robots are still blind and dumb as they do not know anatomy or difference in tissue, therefore require a human to direct them in real time. The Holo Surgical technology with its comprehensive visualization and intelligent guidance is designed to do the opposite, provide the surgeon with information to deliver improved patient outcomes.

Following FDA clearance, the second milestone for 2021 is the launch of the initial IRB studies. In conjunction with the launch of IRB sites, we will also work to launch alpha sites or early adopters not involved in generating clinical data as part of the studies.

We expect to have approximately 20 sites, a combination of IRB and alpha sites up and running in relatively short order following the clearance. This year's final Holo Surgical milestone will be first cases performed in the United States, and we currently expect that to occur in the fourth quarter of 2021.

I am very excited about what we have accomplished during the quarter, while continuing to build the momentum we generated in 2020 as we drive towards our mission of becoming a digital surgery company. Since the launch of Surgalign and acquisition of Holo Surgical, we have made substantial strides towards both our build and innovate pillars.

In addition to completing the build out of our leadership team, we have added top spine experienced talent in literally every department of the company and tripled the size of what I believe is the most talented R&D team in spine and added to our unmatched digital team in Poland and U.S. We are moving from being a provider of tools surgeons us to being a technology company.

We are highly focused on executing against our strategy during the balance of 2021, as many of the critical components that will enable long-term success of our digital platform will be put into place in the coming quarters. With that, I'd now like to open the line for questions.

Good afternoon. Thanks for taking the questions.

I guess, Jon, just real quick, and I don't want to overstate this too much but reiteration of guidance of 5 to 10 in your press release from mid March was 7 to 10. So are you really kind of steering towards more of that 5% kind of range for the full year?

Well, I think the press release -- our commentary in the last quarter was 5 to 10. So it's consistent with what we had in the script.

I would say based upon the first quarter and what we're guiding in the second quarter, we're trending towards the lower end of that guidance.

Okay, makes total sense. And then just a couple more for me.

And I think, Terry, you were kind of getting to it, but this 20 IRB/clinical site group that you're going to be targeting right away, what should we expect in terms of just kind of them getting the system, paying for a system, volume commitments? And then do you need to get and really kind of compile a lot of usage data, before you roll it out more broadly to clinicians and centers in '22, or is it the expectation that you're going to still be -- you're going to be pushing to sell systems fairly quickly in the first half of next year?

Yes. So, Matt, the goal is to get these systems out here, gain experience and publish on them and show what we believe to be true, which is that we have a highly differentiated and in fact revolutionary system that can help differentiate on patient outcomes.

But to do that, we need data and we need experience with it in surgeon's hands. The other component of that, as I mentioned, this is the first submission, right, and we'll focus on the lumbar spine.

We will continue to expand the application of the systems over time. Still expect to have full release of the system next year.

And again, we'll continue to use the models that exist out there today until we have fully demonstrated that we drive a difference in patient reported outcomes.

Got it. So we should be expecting a pretty measured rollout of the system late this year into next year.

That's fair?

That’s fair.

Okay. And then last one for me is it was interesting to hear you guys acquired that new machining company out West.

You've got this massive R&D group as well now. So I'd say Holo is important, but you're also going to try to augment it with new products.

Can you talk about what we should anticipate in terms of new product flow over the next couple of years? And then, I guess more importantly, on top of that, are you going to have the step capacity to support that new product flow?

Yes. So, look, Matt, the key is, is we stated everything we're doing is going to be compatible with Holo.

And so we need to have best-in-class hardware and differentiated hardware, and we'll look to use Holo to help us differentiate as we continue to move the platform forward. And currently, without having those machine shop capabilities, your development process can get dragged out for forever waiting to get prototypes in, running testing on them, making changes, more prototypes.

This substantially increases our speed to market. So, currently, again, we're focused on some of the key areas that we'll be able to support Holo next year, but sets should not be an issue for us.

Got it. Thank you.

Thanks, Matt.

Hi. Thanks for taking the question.

So, Terry, you mentioned a dynamic and I think you're looking at some of your hardware, some of your product, in terms of what you may or may not keep. Could you just maybe put a little finer point on that kind of have you sized it up, help us understand kind of what you may not be continuing with, and at what point in time?

I’m sorry, you were cutting out a little bit there, but I think I got the gist of it. We've got almost 90 brands over, I forget how many countries and that is a lot to maintain.

And so we need to be smarter about the products that we're going to continue to invest in. And so what we're looking to do is to effectively rationalize the portfolio in smart ways, because the products that we want to continue to come out with are going to be the products that support the Holo platform, and help us to drive outcomes.

So not going to get into specifics on 80-some brands here today, but that's the gist.

Okay. And then just directionally maybe for Jon as a follow up to that, will this have a dilutive, an accretive impact on margins?

I would assume it will help boost margins, but maybe if you could just provide your thoughts on it, Jon?

Look, I think we've given guidance that we're targeting 70%, 75% margins. And this rationalization of products is contemplated in that guidance.

So I don't see it as something that's different than what we've guided at this point in time. And as Terry indicated, we're going to intelligently migrate out of these products in a way that will hopefully be transparent as we bring on -- as we consolidate brands and bring on new product families, we'll be able to transition surgeons in a way that doesn't create a significant change from an operational perspective.

Okay. Thank you for taking the questions.

Good afternoon. Just a couple of questions.

I guess following up on the gross margins there, obviously, another nice little uptick in Q1 here. Should we anticipate that continuing to trend higher over the course of the year as procedure volumes pick up, or are there other factors at play that it's going to bounce around a little bit?

No. We don't get -- because we were buying all our products, Matt, there's no manufacturing leverage.

So the margins should be in the ranges in which you've seen it. It's predominantly a function of mix at this point in time than anything else.

Okay, fair enough. And then during your prepared remarks, you commented on some potential delays with some new product launches regarding the up classing of certain biologics.

Will that only impact existing products in the pipeline or will it have an impact on some of the existing products, and how should we be thinking about that?

Yes, they're in particular, there's a DBM, a legacy DBM that we're getting from Florida that as they went through the process, they got pushback from the FDA. And so it's specific to an existing product that we're potentially going to have a gap in sales.

We've identified an alternative and we're working with a partner, a new partner in order to fill that gap. But I think during the quarter, we could -- this quarter in particular, we could have a temporary disruption.

And how big of an impact is that? A couple percent headwind or any way to help us with sizing that up?

Yes, I think it's contemplated in the guidance I gave you on the projection for the quarter, so it's already embedded in the numbers.

Okay, fair enough. All right, that helps.

Thank you very much.

Good afternoon, guys. I cut out a little bit during the call, so if I ask something that you've already talked about, I apologize.

I'm curious if you would be willing to talk a little bit about how quickly you anticipate being able to integrate and align the Holo capabilities with your existing product line, at least to the extent as you anticipate the product line being configured going forward?

Yes. Thanks, Brooks.

And I think we cut out for a while during the call as well. So day one, we will immediately upon clearance.

In fact, the submission is for clearance with our existing systems. So day one.

Great. Fantastic.

Second question, obviously, you made tremendous progress realigning the organization and whatnot. A, do you feel like you're in a pretty good spot with regard to your organization today?

And b, can you speak to kind of the cultural integration and how that's all going across what is essentially today a global organization?

Yes, absolutely. So, Brooks, as I've mentioned in the past, the organization is the thing I'm proudest of.

We are very clearly a rebuild, and the talent that we're bringing into this organization is literally unparalleled and again, in every department highlighting our most recent executive hire, Marc Mackey, but literally through every level of the organization. And everybody here understands what we have to do and there's full alignment.

And I would suggest the culture continues to grow and get better literally every week. I couldn't be more excited about what we're building.

That's fantastic. Let me just ask you one more.

We're pretty excited about the opportunity internationally. Obviously, the COVID has been in the news internationally.

I'm just curious if you can a, give us a sense for what you're seeing outside the United States? B, what the regulatory pathway looks like for Holo?

And maybe when you think you might be in a place to start doing surgeries with doctors outside the United States as well? Thanks a lot and congratulations on all you've accomplished.

Yes, thanks a lot, Brooks. And yes, what we've encountered is that things have been very difficult in the international markets.

We had a call this morning where they talked about a sales meeting in Germany they were trying to have live, but because of the lockdown had to move it back to virtual. A number of surgeries have been canceled.

And it's been difficult times in a number of the countries over there. And so we're thankful that our team is in good health and great spirits, and look forward to things hopefully continuing to open up as they get the vaccines out.

As it relates to our strategy for Holo, we're still working through what our regulatory strategy is going to be to get Holo cleared in the international markets. As you may know, the change from MDD to MDR has some significantly more clinical components of it.

And so we're in process of understanding that pathway now.

Perfect, makes sense. Thanks a lot for all the color.

Thanks, Brooks.

Hi. Good afternoon.

Two quick ones for me. It sounds like most doctors now, most surgeons are used to using a 2D system.

How long do you think it will take for them to make the transition from a 2D to a 3D? How many cases or how many -- just in general, how long will it take for them to adopt this newer technology?

Yes. Hi, Jim.

Thanks a lot. It will happen in their training, right.

We're going to be required to train before they use the system, and it will happen there. It is literally going to be something that is far more familiar to them than what they've used before as well as a feature set that makes surgery easier that they've never had before either.

Again, we had a design meeting on a number of other products, a bunch of surgeons here in town, and we showed it to them. And I could not have been more excited about the accolades the system received.

We had surgeons requesting units right there, understanding they have to wait for clearance obviously, but wanting to be part of the alphas and IRBs.

Okay. And second one for me, Jon, I don't know if you said this or not.

But after the raise in the first quarter, what should we be using for diluted share count going forward?

Yes. So we've got just right around 110 million, 111 million shares outstanding right now, Jim.

So that's probably -- when you look at the weighted average for the year, that's probably directional.

Okay. Thank you.

Excellent. Thanks everybody again for joining us here today.

Look forward to updating our progress in the next quarter as we couldn't be more excited about what we're building here at Surgalign. Thanks.