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spk01: Greetings and welcome to the Surgiline Holdings 2022 fourth quarter and year end conference call. At this time, all participants are in a listen-only mode. The question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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.
spk00: You may begin. 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 Dunander, 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, Surgilign'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, March 30, 2023. Surge Align 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.
spk03: 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 HoloPortal and our HoloAI platform. I'll begin today with an update on our restructuring. Last November, we announced a restructuring program to drive long-term growth, lower costs, 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, but both operational resources and human capital to support them. Our evaluation resulted in a 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 HoloPortal 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 HoloPortal 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 HoloAI 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. HoloAI Insights translates 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 HoloAI 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 HoloAI Insights for precision medicine. HoloAI 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 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 HoloAI Insights are doctors, Hany Malone, Greg Mundus, and Robert Eastlack, spine surgeons with the San Diego Spine Foundation. We couldn't be happier 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 HoloPortal surgical guidance system was about seeding the market and gaining experience. We've had some early successes and adoptions 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 HoloPortal 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 enhancement. We'll be upgrading and redesigning the system's form factor, looking to provide physicians and their OR staff more flexibility in OR workflows. The two bigger initiatives center on the platform itself, as we'll be migrating towards a more open platform so that HoloPortal 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 HoloPortal is only compatible with Medtronic's OARM, which limits the number of accounts we can work in. By expanding system capability with more imaging devices, we've increased the number of hospitals and ASCs that we consult to. With respect to our HoloAI portfolio, we plan to follow up on the spine application of HoloAI 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. Surgilign is playing in a much larger global market than ever before, with first mover advantage in AI as it relates to spine, 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 in 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 in more efficient medical decision-making. That's what we're focused on at SurgeLine, 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 Extant Medical Holdings for $17 million, a transaction that netted approximately $14.8 million in cash to surge line, cash which was needed to extend our cash runway. We will pursue to have discussions about other assets, both domestically and internationally, and 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?
spk00: 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 increased modestly due to growth out of our HPS product line, and this despite a weakened 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 related to acquisition 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 28, 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 to $54 million. We believe this is a conservative forecast as we are projecting modest growth from our HoloPortal 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 HoloPortal 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, we expect non-GAAP gross margin to decline in 2023 as it was a high gross margin product line generating about 17% of 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 HoloAI platform in the coming years. Now I'll turn the call back to Terry for closing remarks.
spk03: 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 customers' 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 in 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, we're 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 SurgeLine to maximize value for all shareholders. Operator, we're now ready to open up the call for questions.
spk01: Thank you. We will now be conducting the question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. for participants using speaker equipment and may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for your questions. Our first questions come from the line of Matt Hewitt with Craig Hallam. Please proceed with your questions.
spk02: 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 that 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 7 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 7 to 10 and then hopefully start to see some publications? Or what do you think is going to drive that second layer of adoption?
spk03: Yeah, hey, Matt, thanks a lot. Yeah, so, you know, we are working on some publications with some physicians currently. And, you know, as we open up more sites, there will be more to come. But what, you know, we found in these early stages is that, you know, in terms of, you know, us getting the system to market quickly and we thought the system would be used mostly in percutaneous cases. And so, we had, you know, 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, you know, 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. You know, this is really a huge, you know, 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.
spk02: 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 critical 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, you know, a decade from now, you're going back to proprietary and needing to use your implants with the Holo platform?
spk03: Yeah. So, you know, look, I think it's really driven by, you know, market forces. And certainly, you know, we're having you know, degrees of success using it with our current screw system. And we're now integrating our new Cortera screw offering, which we believe will help as well. But, you know, really the key is these, you know, implant systems are surgeon preference. And, you know, some surgeons are tied for various reasons to different implant systems. You know, 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 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 of, you know, these new technologies, be it, you know, guidance, robotics, whatever it is, you know, being tied to hardware usage. And they've run into a number of issues with this, and it's, you know, 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, you know, large bone orthopedics, and other areas, that aren't offering implants. They're just offering the advanced technology and the ability to work with all systems.
spk02: Got it. And then maybe one last question. I'll hop back into the queue. And Dave, thank you for providing some of the granularity and the puts and takes for the 23 guidance. The one thing I'm curious, how should we be thinking about organic growth? I realize that you've got the COFLEX headwind, if you will, on the revenue side, and you're going to still have some additional product line rationalization. But on an apples-to-apples basis, whether you're looking at Holo or some of the other products that you've introduced, are you anticipating some growth there, or are you kind of looking at this conservatively, saying, okay, let's just, given what's going on in the market, hospitals are struggling and all that, let's just assume that we're flattish this year, and then 24 is where we start to see some growth.
spk00: Yeah, it's a great question. It's going to be complicated when it comes to looking at the actual results quarter to quarter in 2023 because of all the things that are going on right now. So for instance, if you remember, we sold CoFlex at the end of February. So we had two months of CoFlex revenue hitting our Q1 number this year, which is going to make that revenue look higher as we move forward. So by default, not having CoFlex, all things being flat or equal, we're going to have a lower Q2 than we did in Q1. However, there are some other puts and takes here. The rationalized products, meaning the products that we are obsoleting, the two-thirds of the portfolio commentary that we talked about, are still selling, even though we've obsoleted them. And they will continue as we harvest inventory that we have on hand through some period of time over the coming months and quarters. And then lastly, I think that process will start ramping down and should be pretty much complete into Q3. So that being said, it's going to be hard to see when you see the end revenue numbers quarter to quarter. However, when it comes to growth, you know, Terry talked about our new Pedicle Alpha launch, Pedicle's Alpha launch, Cortera, that's done really well for us since it launched over the summer. We saw some growth in the Q4. It was one of our bigger growth drivers in 2022. We expect that to continue and be our biggest growth driver in 2023. So underneath all of those variables I just described previously, you're going to see growth out of products like that and out of some of the products that we had product issues in past years that have now been fixed.
spk02: Got it. Thank you. Appreciate the color. No problem.
spk01: Thank you. As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. Thank you. There are no further questions at this time. With that, it does conclude today's teleconference. We do appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.
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