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spk02: Good day, ladies and gentlemen, and welcome to your Search Align Holdings Incorporated second quarter 2022 results conference call. All lines have been placed in the listen-only mode, and the floor will be open for your questions and comments following the presentation. As a reminder, today's call is being recorded. If you should require assistance throughout the conference, please press star zero. At this time, it is my pleasure to turn the floor over to your host, David Lyle, Chief Financial Officer Sir, the floor is yours.
spk03: Good afternoon, everyone, and thank you for joining us on today's call. I'll begin with our customary forward-looking statement disclaimer and then turn the call over to Terry Rich, our CEO, who will talk about many of the key developments during the quarter and in the period since, along with some general updates on anticipated milestones. I'll finish with a recap of our financial results and will then open up the call for questions. Our Chief Accounting Officer, Chris Thunander, is here as well and will be available during the Q&A portion of our call. As for our forward-looking statement disclaimer, I'd like to remind everyone that on today's call and webcast, management will be making forward-looking statements about future events, Surgiline'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 Surgilign's SEC filings. This conference call contains time-sensitive information that is accurate only as of the date of this live broadcast, August 9, 2022. SurgeLine 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 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, I would like to turn the call over to Terry.
spk00: Terry? Thanks, Dave, and I'd like to welcome all of you who are joining us today. We've made significant progress since our Q1 results with respect to innovation and new products brought to market, the early stage commercialization of our HoloPortal surgical guidance system, and other initiatives around the HoloAI platform. Q2 revenue came in roughly in line with the first quarter, and we expect a strong second half of the year, primarily in Q4, based on new products we've introduced. The revenue range we provided in our last earnings call for the full year remains in place and momentum is building. On our last call, we provided a lot of information with respect to our Holo AI platform and what it means for SurgeLine in the near term and in the future. We spoke about the HoloPortal surgical guidance system and our commercialization plans, the various use cases of the AI platform, and what we intend to pursue in the remainder of the year and beyond. We also spoke about the drive to innovate, and that's where I'll begin. Roughly two years ago, July of 2020, we closed on the sale of our OEM business, RTI, and effectively began our corporate transformation. At the time of that divestiture, we had no engineers remaining in the U.S. Fast forward to today, where we have almost 30 hardware engineers on staff based in the United States and Germany, and all with extensive spine experience from leading spine brands around the world. We have continuously been building out our engineering capabilities as this is what will drive our success. And the team we have assembled has been working around the clock to bring new products to market along with redesigned next generation solutions. In order to succeed, we must have innovation, value-added products, customers need, and we made a lot of progress towards that end of 2021 and more so in recent months. Our vision at SurgeLine is to drive optimal patient outcomes while advancing the standard of spine care. And two products that help us achieve this vision are our CoFlex interlaminar stabilization device and Symmetry SI fusion system. CoFlex, in particular, is one of the most studied devices in all of spines. exhibiting superior results compared to fusion in several instances at two years postoperatively. The unique design of the CoFlex device maintains stability in the spine after direct surgical decompression while preserving more natural movement in the treated area. Our Symmetry SI fusion system is a minimally invasive SI joint fusion system that uses proven orthopedic principles including joint decortication, bone grafting, and fixation to achieve true arthrodesis. We're the only ones that decorticate the joint, which is a standard orthopedic principle in trying to achieve fusion. Last month, we announced a strategic partnership with PREA Healthcare to support the patient access program we launched in May, tailored to improve patient access to our COFLEX interlaminar stabilization device and Symmetry SI fusion system. For the past decade, PREA Healthcare has been partnering with med tech companies, helping patients get access to the latest medical technologies and procedures, and to provide data to payers for coverage determinations. With this new program, we expect more patients will gain increased access to the COFLEX and Symmetry systems, which in turn, should result in better evidence-based patient outcomes, as studies show. This was followed by an announcement on the commercial relaunch of our Cervaline interior cervical plate system. The product was initially introduced in 2019 and quickly became one of our fastest-growing product lines until we issued a voluntary recall last year. While it curtailed results in 2021 and the first half of 2022, and gave us time to properly assess market needs and develop the best product. Designed for anterior cervical discectomy infusion procedures, or ACDF, Servalign works to minimize tissue disruption and complications such as dysphagia. Moving on to inner bodies. Although we haven't publicly announced this yet, we recently launched another innovative product with our FortiLink A with TiPlus technology. Used for anterior lumbar interbody fusion procedures, this is the first in a family of 3D-printed titanium interbody cages and marks our first entry into the 3D-printed titanium interbody market. We've had great success with our Fortaline family of products with Tetrafuse technology, supporting thousands of cases in the U.S., more recently in Europe, and believe with this new titanium solution we'll open up new growth opportunities for the company. We expect to issue an announcement on this launch shortly. We have more products slated to come to market in the second half of the year, and we are continuing to build out our engineering capabilities at our innovation center in San Diego, where there is so much spine talent. The team we have compiled has enabled us to enhance our product portfolio significantly and will help us generate a consistent cadence of next generation products in the coming years. We hope to be launching our first-ever product designed at Surgilign as it is pending 510K. It is not currently available, but we expect it will be soon. One more point to make with respect to new products. We believe they will positively impact our results in the second half of the year. Even with the current hospital staffing shortages and supply chain issues both we and the industry at large have experienced, We are confident that barring any unexpected macro environmental issues, the new slate of products, along with the continued demand for surge line solutions, including the Holo Portal system, will lead to improvements in the second half of the year, with Q4 being the strongest. Let me shift to Holo and provide some updates on second quarter activity in the weeks that follow. For those of you who may be new to our story, we acquired Holo Surgical a company focused on artificial intelligence and augmented reality targeting spine surgery in September of 2020. And in December 2021, we made an equity investment in Interneurial Networks Inc., hiring their entire engineering team and licensed rights to their IP, which is focused on artificial intelligence for intracranial applications. Collectively, These transactions provided us with innovation and highly differentiated AI and AR technology, which we have been deploying further on our road to more widespread commercialization. When I talk about our transformation, these transactions are at the center of it, and a big part of what drives our confidence is we build long-term shareholder value and then work to sustain it. Artificial intelligence is not new in the medical field, but it's used in surgery is. And Surgilign has the only system, FDA cleared for spine surgery, combining both AI and AR. This is our holoportal surgical guidance system. I'll say it again, we're the only company. Every week you see a piece of news regarding an AI application or an AR company announcing FDA clearance or things of this nature. But no one to date has been cleared for for use both for surgery, other than SurgeLine, and investors have been inquiring about the differences. We received FDA clearance in January for our HoloPortal surgical guidance system, making our official commercial entry into the spine fusion market. As I said, this system combines AI and AR and is used intraoperatively to guide surgeons through spinal procedures. The AI autonomously segments the spinal anatomy and suggests a surgical plan to improve efficiencies and outcomes. The autonomous anatomic segmentation of the spine is very unique and is patent protected. AR improves visualization and reduces the surgeon's cognitive load and physical load in the operating room as the surgeon doesn't have to carry a large, heavy device on their head and can still look straight down at the surgical field rather than the current standard requiring the surgeon to look off to the side at a monitor somewhere else in the OR. Most competitive products today are built on stereotactic navigation, which is a technology that's been around since the 70s and little has changed since. For reference, stereotactic navigation is the basis of all spine navigation systems to include spine robots, where it's used to guide a robotic arm which holds a drill guide. A few companies, us included, and more in the pipeline, are combining augmented reality with stereotactic navigation, most of which are headset-based. On the other hand, our HoloPortal system, by virtue of its AI, is a smart system that recognizes anatomy of the spine, and this is the number one differentiator when comparing our technology to other systems. The HoloPortal system provide surgeons real-time information about the patient's anatomy that helps them perform their jobs with a goal to improve patient outcomes. If a surgeon only wants to see the pedicle as an example, the HoloPortal software can show the surgeon just the pedicle, removing all other tissues and bony anatomy simply by looking straight down through our AR display directly in the surgical field. The thing that most people don't understand is that when you open up the shoulder, a knee, a hip, or an ankle, the anatomy prevents itself in a very straightforward way relative to the spine. Now, if you look at the spine, all you see is a white sheet of connective tissues, making it difficult to easily identify the bony anatomy. Our artificial intelligence identifies and segments the bony spinal anatomy, and we then use our augmented reality to color code and display the segmentation over the native anatomy, which in turn helps optimize surgeons' performance. Another point with respect to AR and our current form factor using the portal to deliver the augmented reality display versus us developing a headset to compete against companies like Microsoft, Google, Apple, Lenovo, Qualcomm, and Magic Leap. Instead of competing against these industry giants, We intend to design our technology to port onto their platforms in the future. Our strategy is to be agnostic, align with technology leaders, and provide solutions that surgeons and other medical professionals covet and need. As for some updates with respect to our HoloPortal commercial launch, in May, we announced the first successful surgical procedure utilizing the HoloPortal surgical guidance system. This was performed by Dr. Mario Berkrich, a board-certified orthopedic surgeon at the Indiana Spine Hospital in Carmel, Indiana, and an additional case was performed thereafter with more expected. In July, we announced our second site and clinical expansion in Ohio with a case performed by Dr. Selvon St. Clair. Dr. St. Clair is a board-certified orthopedic and spinal surgeon at the Orthopedic Institute of Ohio. Our plan remains to have between 10 to 15 sites up and running by year end and we are currently in discussions with nearly 20 additional potential sites throughout the United States. Now, similar to what we've experienced on the spine device product side, the market has been somewhat challenging to navigate, but we are working through this. Interest in the HoloPortal system is very strong and there are a number of opportunities on the horizon that will help expand our reach and lead to more procedures. The path forward is clear, and we believe we can hit our target goals. And let's not forget the longer-term premise of the HoloAI platform brings to SurgeLine. This is not just about the spine, nor just about the operating room. The HoloAI platform is about the entire continuum of care, from diagnostics to pre-op to surgery, post-op care, and determination of real patient outcomes. AI algorithms can be applied far beyond spinal anatomy into various medical disciplines, autonomous analysis of both diagnostic imaging and post-op results, segmentation between bone, tissue, vascular and or nervous structures, intracranial indications, pathologies of the brain, musculoskeletal areas, and more. Our first clinical applications for the HoloAI platform in spines will be stenosis and disc degeneration. As we continue to gain medical buy-in and concurrently improve our financial strength, we believe we can expand further in a meaningful way. Over the next two years, we are focused on the commercialization of the HoloPortal system, integrating relevant procedural technologies, and expanding our HoloAI platform capabilities. We will do this through data aggregation upgraded algorithms, continued investments in innovation, and by bringing new solutions to market powered by HoloAI technology. We believe as new applications are layered onto our platform, we will create new and recurring revenue streams and operate on a lower cost basis with a greater bottom line impact. The development team we acquired with the HoloSurgical acquisition and our investment in interneural networks are the biggest assets in the transactions and have dramatically expanded our capabilities in building AI and machine learning algorithms. We have a platform. Now it's about building scale, new networks that can run on top of our platform to improve patient lives. Simultaneously, we are focused on driving innovation in our hardware portfolio, developing and launching new products that have competitive differentiation and customer value. To sum up the quarter, we have made great progress and our business is on track to improve. Our confidence in achieving our full year 2022 plan is driven by the new products we continue to bring to market and strong pent up demand. Longer term, we expect to see more significant improvements, especially as Holo evolves. We have proven that we can successfully bring hardware products to market and the future should be no different. With respect to Holo, we are now playing in a very large global market with technology that we believe will revolutionize the medical industry. We remain committed to turning our vision into reality for the sake of patients around the globe, and in the process, creating higher sustainable shareholder value. With that, I'd like to turn the call over to Dave. Dave?
spk03: Thanks, Terry. I'll start with a review of the second quarter, and we'll compare sequentially against the first quarter, as we believe that's a better barometer for evaluating our results, as we believe that we are on the cusp of returning to growth. Global spine revenue for the second quarter of 2022 was $20.6 million. While revenue was in line with the prior quarter, we were impacted by the same industry-wide issues resulting from the pandemic. Domestic revenue for Q2 was $17.2 million, and international revenue was $3.4 million, similar to Q1. Q2 non-GAAP gross margin of 73.5% increased by 260 basis points compared to 70.9% in the first quarter of 2022, due primarily to a favorable product mix shift. Gap gross margin for both the first and the second quarters was 68.9%. Excluded from Q2 non-gap gross profit was a one-time inventory write-off of $535,000 associated with our product rationalization initiatives and a $414,000 inventory purchase price accounting adjustment, which relates to the purchase price effects of acquired inventory from a prior acquisition that was sold during the second quarter. Moving on to operating expenses, Q2 non-GAAP operating expense was $27.5 million as compared to $28.4 million in Q1. On a non-GAAP basis, excluded from Q2 operating expense was approximately $996,000 in asset charges related to the impairment of instruments during the quarter, $222,000 in transactions and integration expenses non-cash stock-based compensation expense of $925,000, a gain of about $2 million for accounting adjustments to the fair value of milestones. Adjusted EBITDA for the second quarter was a loss of $11.7 million compared with a loss of $13.3 million in the first quarter, an improvement of $1.6 million primarily due to higher non-GAAP gross margin and lower operating expenses. Moving on to the balance sheet, we ended the second quarter with $29.3 million in cash and cash equivalents compared to $44.7 million as of March 31, 2022, or a decline of $15.4 million. Key cash outflows were $9.5 million in cash dues from operations, $1.8 million in capital expenditures, $3.8 million for changes in working capital, and $300,000 in other net cash outflows. As we noted on our last quarterly conference call, we believe additional financing will be required by the end of the year in order to fund the investment in our digital health platform and to return our spine device revenue to historical pre-COVID levels. We've made great progress since Q1 and have held a number of discussions with investment parties looking at a variety of financing options, both equity and debt, as we continue to be mindful of shareholder dilution. We are making progress and will look to secure the resources needed to commercialize the Holo portal, develop the Holo AI platform, and for ongoing working capital needs. Until additional resources are secured, we continue to be diligent in our capital allocation plan. As for guidance for the full year 2022, we are reiterating our prior revenue guidance, expecting to meet the revenue range of $86 to $90 million. As Terry noted, our confidence is driven by the pent-up demand and the expected contributions from new products launched in 2022, such as with our first-ever product organically designed at Surgiline, with FDA 510 pending and expected soon. the relaunch of Cervalign, our partnership with PREA Healthcare for both coflex and symmetry, growth from orthobiologic products, bi-bone multiple and Fibrex, which were launched in Q4 of last year, and revenue from our HoloPortal surgical guidance system. With Q3 typically seasonally soft due to summer travel and European holidays, we expect to see most of the growth in Q4 in meeting our revenue guidance. With regard to non-GAAP gross margin, we believe they will continue to be in the low 70s percent, similar to both Q1 and Q2. From a gross margin mix perspective, as we grow HoloPortal product revenue, which has higher gross margins than our corporate averages, that should create some gross margin uplift. We expect non-GAAP operating expenses to grow slightly from Q2 to Q3 as we invest in talent to build out our digital strategy platform and as we incur higher commission expenses based on incremental revenue growth. Lastly, we issued a release last week announcing the company has reached a settlement with a security exchange commission related to the investigation into former executives of RTI. This stems from business activities dating back to 2015 through 2019, and again, deals with prior management, not our current team. As per the settlement terms, we have agreed to pay a civil penalty of $2 million and have received $560,000 from former executives as part of recouped compensations. The $2 million was recorded in full during our 2021 fourth quarter and was already paid this month. Throughout the investigation, we have been cooperative with the authorities and we're pleased to now have this behind us so we can focus on what matters most, executing our plan and creating value for all of our stakeholders.
spk00: Thanks, Dave. One closing comment before we open the call for questions. Over the past two years, since the divestiture of our OEM business, we have cleaned up and transformed the company. We rebuilt the team from executive level throughout the organization. We enhanced our finance, sales, sales support, and R&D capabilities significantly. We mitigated the material weakness in our internal controls. We enhanced quality controls, product design and engineering, resulting in a stronger product portfolio. Last week, we reached a settlement with the SEC on matters related to the former management teams, and most recently, we settled the ongoing dispute with RTI and Resolve, the OEM business that was sold, resulting in a new contractual relationship, which we believe will be beneficial to both parties. We have done a lot to fix what needed to be fixed. Now our focus is solely on the future, That concludes our remarks. Operator, we are now ready to open the call for questions.
spk02: Thank you. If you'd like to ask a question, please signal by pressing star then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset to make sure your signal reaches our equipment. Again, please press star then 1 on your telephone keypad to ask a question. And we will pause briefly to assemble the queue. And we take our first question from Matt Hewitt with Craig Hallam Capital. Please go ahead.
spk01: Good afternoon and thank you for taking the questions and congratulations on the progress made during the quarter. Maybe first off, regarding the HOLO platform, maybe if you could give us an update on how many procedures have been completed to date as you look out at the back half of the year. Do you anticipate that number growing and ramping as we approach year end, even with the two existing facilities that have the platform in place? And then how should we be thinking about the cadence of the 10 to 14 or 10 to 15 that you expect to add by the end of the year?
spk00: Yeah, hey, thanks, Matt. We're not going to get into case counts, but we will be publishing series from a number of these accounts and giving some insight on system performance and outcomes based on those publications. And, yeah, we are actually training more physicians at those sites. In fact, we've got an upcoming training here in the next couple weeks for one. So we're very excited about how things are progressing. And, look, I think, you know, in terms of the cadence, you know, we have, you know, quite a full funnel. As I said, a number of these negotiations have just taken longer getting through the process, like we're seeing with everything, quite frankly. Getting metal on contract and everything else has just been taking longer than in years past. But I believe that we have a clear line of sight based on all the accounts we're in negotiations with to get to that 10 to 15 by the end of the year.
spk01: Understood. And then regarding the procedures themselves, are the surgeons currently with the platform, are the surgeons making the decision which patients they would like to perform a procedure on next, or are you kind of working in conjunction with them trying to figure out what the best next procedure is?
spk00: No, the surgeons are doing it. We're certainly, you know, working through with them and learning a lot. But, you know, the surgeons are making the calls as to, you know, which patients they're using it on.
spk01: Got it. And then regarding the supply chain disruptions, as you look out over the back half of the year, are you kind of expecting to have worked through that, or is this something that maybe is going to continue to drag on at least for the next quarter or two?
spk00: Yeah, you know, Matt, I wish I knew. Look, we're in a much better place than we have been. And like I said, we've fixed a variety of stuff. We've run into some, you know, a few things on the tissue side and, you know, believe we're coming, you know, out the other side in terms of getting, you know, some of our inventory levels up to speed, especially on stuff like the server line plate where, you know, we're, you know, a very small percentage of the total sets that we originally had out, but we're adding more every month. And so, you know, we believe that between that and some of the other new products, you know, coming out and additional Holo sites, you know, we're going to finish the year very strong.
spk01: Got it. And then maybe one last one. I'll hop back into queue. David, I think during your prepared remarks, you were talking about the new products contributing to Delta versus maybe the run rate here over the past couple of quarters as we look into two half. Is it – geared more towards Q4, I think is what you had said, but is it really that those new products are kind of what's driving the growth, or is it kind of getting some normalization in the procedure volumes that's going to be maybe the bigger driver in the second half of the year? Thank you.
spk03: Yeah, no problem. It's a good question. The answer is it's both. You know, the market has been a little soft just from a procedure standpoint. You know, COVID case happens, and procedures get canceled, that sort of thing. So I think everybody's seeing that. If market conditions improve there, we certainly will see just natural organic growth. But we're pretty excited about all the opportunities for these kind of newer products launching and the potential to really add some revenue growth going into, like you said, mostly in Q4 and then into 2023. And then finally, don't forget about our HoloPortal surgical guidance system. That's going to start contributing here in terms of more material revenue. We think probably more in Q4, again, like the other products.
spk02: Again, ladies and gentlemen, if you do have a question or comment at this time, please signal by pressing star then 1 on your telephone keypad. And we will pause briefly to assemble any further signals. At this time, there are no further signals. We turn back to Terry Rich for closing remarks.
spk00: Great. Thanks, Operator. And again, thanks for everybody for attending our call. We're incredibly excited about the future as we continue to bring innovative hardware and digital solutions to drive the market. We look forward to updating you on our next quarterly call. Thanks.
spk02: Thank you. This does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time. Have a great day.
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