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RTI Surgical Inc (NASDAQ:SRGA)
Q2 2020 Earnings Call
Aug 7, 2020, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and welcome to the Surgalign Second Quarter Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time.

I would now like to turn the conference call over to Jon Singer Chief Financial and Operating Officer. Please go ahead.

Jonathon Singer -- Chief Financial and Chief Operating Officer

Thank you. Good morning and thank you for joining the Surgalign Holdings, Inc. second quarter conference call. Joining me today on the call is Terry Rich, our newly minted 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 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 US 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 US GAAP and non-GAAP results are presented in tables accompanying our earnings release, which can be found in the Investor Relations section of our website.

Now, I will turn over the call to Terry. Please go ahead.

Terry Rich -- President and Chief Executive Officer

Thanks, Jon, and good morning, everyone. There has been a flurry of activity over the past month, within the company, including but not limited to the completion of the sale of the OEM business, the transition of leadership, a new name, logo and ticker. Our goal today is to provide an overview of Surgalign Spine Technologies, the name of the operating company, my perspective on the business, as well as a high level overview of our strategy moving forward.

Following that, we will provide an update on our recent performance before opening the line for questions. Before digging into the details, I want to take a minute to introduce myself and provide an overview of Surgalign as this is our first call as an independent company. As many of you are aware, I joined the company roughly eight months ago as the Head of Global Spine, a portion of the business that then became Surgalign. Having led this portion of the business and seen the progress made during this period, I'm incredibly excited about the opportunity that exists for Surgalign as a pure play spine company. One of the advantages of joining the company prior to stepping into the role of CEO is that I was able to actively assess the business and be part of building its foundation for the future.

Turning to an overview of Surgalign, we are a global pure-play spine company. Our spine focus, agility and financial resources, allow us to advance spine care to improve patient outcomes. We have a broad portfolio with an experienced collaborative network of reps in step with the surgeons and patients we serve. We will continue to validate our innovation with clinical research and continue to be a trusted resource to our surgeon partners.

Following the sale of the OEM business, we felt that it's essential to rebrand the company in a manner that fit with our long-term strategy and our focus as a global spine company. The name Surgalign is based on the combination of two concepts. Our focus on supporting and aligning with the surgeons we serve to improve patient outcomes. We are positioning to become the spine company surgeons look to for what is more than possible for their patients. The incredibly important notion of alignment, alignment of the spine to maximize health, mobility and freedom for patients.

From a product portfolio perspective, we have a broad portfolio of procedure-specific solutions that enable surgeons to care for patients by treating the multitude of spine conditions requiring surgical intervention including implants for both fixation and motion preservation, access and biologics.

I would now like to share some of my initial observations about what I found to be promising and exciting, as well as the areas that I think we have an opportunity to improve. Starting with the good; following the closing of the OEM transaction, the Spine business had totally overhauled balance sheet, clearing off the debt and preferred and adding approximately $50 million in cash, provides a substantial amount of freedom to pursue strategic initiatives and allocate capital to help grow this business over the long term.

We offer multiple differentiated products, supported by an organizational commitment to clinical data to support and validate patient outcomes. We have cultivated a large and diverse distributor network that supports our approach to innovation and new product development supported by a best-in-class customer service team. We have developed a global footprint supporting both product distribution and procedural innovation. We have a solid national accounts presence providing GPO and IDN access and I am especially proud of the talent and experience of the new leadership team and spine talent we have assembled throughout the organization.

Shifting to areas where we can have the biggest impact going forward, to date, we have limited, organized professional education and sales training. We have the opportunity to build a best-in-class professional education and sales training program led by industry-leading KOLs and developed by a team that has done this before. There is room to integrate our sales organization to broaden product access across our distribution partners and we will develop a procedural approach to innovation that incorporates enabling technologies to improve patient outcomes.

We are building on the tremendous foundation that has been established over several years with the addition of a highly talented and experienced leaders and implementing a targeted growth strategy. As it is early in my tenure as CEO of Surgalign, I want to share my thoughts on our high level growth strategy of build, innovate and acquire. Starting with the first pillar of our strategy, build. We are focused on building and optimizing a global spine organization based on procedural innovation to improve patient outcomes.

Included under the umbrella of build is the consolidation of our supply chain, improving our technology capabilities, optimizing our commercial structure by integrating our novel products into the legacy channel, filling key roles in the organization and bolstering personnel in certain focus areas. From a personnel perspective, we have recently made a number of key spine experienced hires including our Chief Commercial Officer, Scott Durall; and Executive Vice President of Research and Clinical Affairs, Bryan Cornwall. And we are actively recruiting an Executive Vice President of Marketing and R&D, which will effectively complete the build out of our senior leadership team.

Beyond the spine experience we have added to the leadership team, we've already attracted and hired top spine talent in sales, marketing and R&D. This is a testament to how we are being received in the marketplace and for our vision of what we can build. In addition to recent leadership changes, the company's board of directors has undergone a transition following the completion of the sale of the OEM business. Upon the redemption of Water Street's preferred shares on July 24, two members of the board from Water Street, Curtis Selquist and Chris Sweeney have resigned from the board.

We thank them for their leadership and valuable guidance during their time on the board. With Mr. Selquist's resignation from his role as Chairman of the Board, Stuart Simpson was appointed as the new Chairman of the Board, and Mark Stolper has assumed the position of Lead Independent Director. Following these changes, the company's board of directors now consists of eight members.

The second pillar of our strategy is innovate, where we are focused on organically developing new high value clinically validated solutions that will enhance the standard of care. While we continue to invest in specific products, we are also moving toward developing more procedure based approaches in support of improved patient outcomes.

In 2020 and beyond, we are aiming to introduce double-digit new products that incorporate product line extensions, expansion of the biologics portfolio, application of new materials and manufacturing capabilities. The third pillar of our strategy is acquire; while we are excited about the innovation coming from within the company, we will also look for inorganic enabling technologies and capabilities to bolster our portfolio and drive better patient outcomes, thereby accelerating our growth trajectory.

We are investing in technologies that support procedure based approaches, which we believe can drive improvements in the standard of care. While it's too early to provide specifics on exactly what type of assets we are looking to acquire, we will be diligent, disciplined and thoughtful as we pursue deals that drive differentiation and scale.

It is still early days for surge line, we have assembled a high performing, highly experienced team that will be successful in executing on our strategy. We will continue to refine the specifics of this strategy in the coming months and intend to provide more color later in the year. In the meantime, we'll be working diligently to operate through COVID while putting the pieces in place to allow us to achieve our goal of driving profitable double-digit growth.

Turning to an update on the second quarter. As we outlined on our first call in June, COVID had a material impact on our business during the quarter. We put in place several initiatives guided by a focus on prioritizing employee safety, managing inventory levels in our global supply chain, we continue to monitor the situation globally to ensure that we can support procedures during the pandemic in a safe and effective manner.

Shifting to our second quarter performance, for the second quarter 2020, revenue declined 34% to $54.2 million. Spine revenue declined 37% to $20.5 million. After a strong start to the year, we began seeing the impact of COVID in the international business in early March, and domestically, in the second half of the month. The second quarter began quite weak with steep declines in procedures across the globe of somewhere between 60% to 70%. We did see a more rapid return in May and June than we initially anticipated and May revenue declined approximately 36% compared to prior year. And in June, we were only down 13% compared to June of 2019 with overall domestic Spine revenue being approximately flat with prior year.

Despite the recent increase in COVID-19 cases being experienced in four of our top five markets, we saw continued strong demand in July, finishing slightly ahead of prior year. We continue to monitor procedural trends through discussions across industry and believe that it is difficult to predict the ongoing impact of COVID-19 on the company's operations and financial results. However, we continue to execute against our strategy and make sure that we continue to serve our physician customers and their patients.

A lot has changed over the course of the last month. While it may seem like a sudden transformation, the organization has been diligently planning for this transition for months. The team is engaged and energized and we are very excited about the opportunity that lies ahead. The Spine business under RTI was built into a strong franchise over the years and taken to the next level under Camille's leadership. We look to leverage that foundation to build Surgalign Spine Technologies into a leader in the spine industry. This will not be without its challenges, particularly as we continue to navigate COVID and the new normal in surgical care. However, I believe that we have the right people and right long-term strategy to execute and deliver to our customers and patients globally.

With that, I'd like to turn the call over to Jon to provide a review of the second quarter financial performance. Jon?

Jonathon Singer -- Chief Financial and Chief Operating Officer

Thank you, Terry. A lot to cover in the financial section given the impact of COVID-19, the SEC investigation and related costs during the second quarter to file our restated financial statements, transaction-related costs in support of the sale of the OEM business on July 20 and the impact of the bridge financing completed during the quarter to support the cash needs of all of the above factors.

The sale of the RTI Holdings, Inc. OEM business closed on July 20, 2020, accordingly, the reported consolidated financial results for the second quarter include results for both the OEM and Spine segments of the business. However, we will provide additional detail on Spine performance in the related stand-alone cost structure as we go through the results.

Global revenue for the quarter ended June 30, 2020 was $54.2 million compared to $81.6 million for the prior year period. OEM revenue was $33.7 million compared to $49 million in the second quarter of 2020. Global Spine revenue was $20.5 million compared to $32.6 million in the prior year period. The decline versus prior year is driven entirely by the impact of COVID-19 as outlined earlier in Terry's commentary about procedural trends. We are quite pleased by our revenue performance in June and July, although not at the levels we anticipated when we started the year. We have seen a stronger return of procedures than we anticipated at the outset of COVID-19 pandemic. However, there continues to be some uncertainty of ongoing pace of recovery and the impact on procedures through the end of the year.

Our goal is to be exiting the year at a run rate similar to where we were in December of 2019, but we continue to evaluate the COVID-19 impact on our operations and financial results and believe it is too early to resume providing specific financial guidance at this time.

Gross profit for the second quarter of 2020 was $23.1 million compared to $46.1 million in the prior year period. Approximately two-thirds of the decline in gross profit is driven by the decline in revenue, and approximately one-third is due to the impact of unabsorbed overhead due to the reduction of activity in our manufacturing facilities in response to the COVID-19 pandemic. Spine gross profit for the second quarter of 2020 was estimated to be $13.6 million or 66% of revenue compared to $23.8 million or 73% of revenue in the prior year second quarter. We anticipate gross margins should be between 70% to 75% in the second half of the year.

Marketing, general and administrative expenses for the second quarter of 2020 were $37.1 million compared to $41.1 million in the prior year period. The second quarter 2020 expense include $7.8 million of non-recurring restatement related costs, primarily for accounting support, audit and legal fees. Spine marketing, general and administrative expenses were estimated to be approximately $17.1 million compared to $27.8 million in the prior year period. The decline in MG&A is driven by a reduction in distribution, marketing and commissions correlating to the reduction in revenue in the furlough of most of our sales resources during the second quarter of 2020.

We began bringing the sales organization back during June and July and project that Surgalign marketing, general and administrative expenses will be between $25 million and $28 million during each of the last two quarters of the year. R&D expense for the second quarter of 2020 was $3.3 million compared to $3.9 million in the prior year period. Spine R&D was $1.2 million compared to $2.4 million in the prior period. We estimate Surgalign's R&D will increase to $2 million to $3 million during each of the last two quarters of the year.

During the second quarter of 2020, we incurred approximately $4.9 million of non-recurring costs related primarily to legal and accounting fees to support the cost of the sale of the OEM business. In addition, we incurred approximately $13.5 million of costs related to the bridge financing we incurred to support the business during the COVID-19 shut down and the incremental restatement and transaction costs outlined above.

Adjusted EBITDA for the second quarter of 2020 was a $5.3 million loss compared with $9.4 million in the prior year period. The decline in EBITDA was primarily driven by the reduction in revenue and gross profit partially offset by reduction in MD&A spending through the furlough actions and the related reduction in executive compensation. We estimate that the Spine EBITDA for the second quarter of 2020 was a $3.9 million loss.

Finally, there have been several questions regarding our cash position after closing the sale of the OEM business on July 20. The cash purchase price was $444 million, from which we paid approximately $16.7 million in transaction related fees, $77.1 million to settle our ABS [Phonetic] revolver and $155.4 million to settle the term loan and bridge financing with Ares Capital. This left us with $190.9 million in cash at close. We settled the preferred for $66.5 million late last week and anticipate we will have an estimated tax payment of approximately $70 [Phonetic] million due to our friend at the IRS in mid-September. This will leave us with a little over $50 million in cash, which we believe is sufficient to fund the organic growth strategy of Surgalign.

Operator, I'd like to open the call for questions.

Questions and Answers:

Operator

[Operator Instructions] Your first response is from Matt Hewitt of Craig-Hallum Capital Group. Please go ahead.

Matthew Hewitt -- Craig-Hallum Capital Group -- Analyst

Good morning. Thank you for taking the questions, and welcome, Terry.

Terry Rich -- President and Chief Executive Officer

Thanks, Matt.

Matthew Hewitt -- Craig-Hallum Capital Group -- Analyst

A couple of questions, first, obviously, it's nice to see the rebound and that's despite some of the impact that you're seeing and I think you said four of the top five markets your participate in. I'm just wondering, how should we be thinking about the next two quarters from and you provided a little bit of guidance. But as far as -- is that rebound continue because of backlog that was the -- procedures that were deferred or are you starting at least hearing from your customers that they are starting to see that new pipeline of patients starting to build back up?

Terry Rich -- President and Chief Executive Officer

Matt, I think, it's a little bit of both. I think, certainly, there was some backlog that they're working through, but I think the other components is we're learning to live in this new normal and patients need to have their surgeries and the hospitals and surgeons are finding paths to accommodate.

Matthew Hewitt -- Craig-Hallum Capital Group -- Analyst

Okay. Thank you. And then as far as the sales process, you talked a little bit about some of the opportunities and things that you're working on there. But given the current restrictions and some hospitals still have them, others have kind of opened up a little bit more, but given some of those puts and takes, what are you doing as a firm, as a company to kind of help drive adoption of Surgalign's platform?

Terry Rich -- President and Chief Executive Officer

Yeah, you're right. It is kind of regional, how hospitals are reacting, how surgeons are reacting and access to them. So, in some areas it's -- I wouldn't say, quite business as normal, but we do have access and take precautions and are doing labs and different things that we've always done to drive revenue. But we've also started to take steps to do some things virtually in some online events and surgeon talks and that kind of thing as well. So, we will continue to see the response that we get to those and add them as appropriate.

Matthew Hewitt -- Craig-Hallum Capital Group -- Analyst

Okay, great. Maybe one last one and I'll hop back into queue. Regarding the launch plans, double-digits this year and I think this year or next year, how should we be thinking about the cadence, I mean, is that -- are those products ready to go this quarter and it's maybe a couple of week or just to help us understand the cadence of those launches. Thank you.

Terry Rich -- President and Chief Executive Officer

Yeah. So, they will come out, I don't want to say every couple of weeks, but some of them are families of products that we will launch at one time, and we will continue to get them out to the end of the year. We did have some delays due to COVID, but are getting those back on track and we will get them out appropriately over the course of the back half of the year here.

Jonathon Singer -- Chief Financial and Chief Operating Officer

I would say, Matt, that when you look at the double-digit through this year, as Terry indicated, probably two-thirds of the introductions are going to be from a single product family that we received the CE Mark earlier in the summer and have the 510(k) filed and we're building inventory. But that family will launch in the fourth quarter and really start ramping toward the end of the first -- fourth quarter. A couple of the products were launched earlier in the year and then a couple of the introductions are really around tools that support utilization of our products in the surgical suite. And those should launch also more into the fourth quarter. So, I think, in the way that you're thinking about it is most of the impact of this year's introductions will really begin to be felt moving into next year.

Matthew Hewitt -- Craig-Hallum Capital Group -- Analyst

That's great. Thank you.

Operator

Thank you. Your next response is from Jim Sidoti of Sidoti & Company. Please go ahead.

Jim Sidoti -- Sidoti & Company -- Analyst

Hi. Good morning. Can you hear me?

Terry Rich -- President and Chief Executive Officer

Sure, can, Jim. How are you doing?

Jim Sidoti -- Sidoti & Company -- Analyst

Good, good. So, just wanted to get your sense, Terry, about your feels about the size of the direct sales force and the distributors. Are you comfortable where are now or is this an area where you think you will be expanding over the next few quarters and is that more geographic expansion or adding more people in the markets you already in?

Terry Rich -- President and Chief Executive Officer

Yeah, look, I think we're very excited about the distribution networks that we have, but we will always look to add talent as appropriate. There certainly are still some areas where we're under penetrated. And we'll look to continue to add support but excited about the direction that Scott is taking us. And so, yes, we will continue to add but we're thrilled about the organization that we have as well.

Jim Sidoti -- Sidoti & Company -- Analyst

Okay. So, basically you're comfortable with what you have right now and then your tweak it as things go on, but no major changes in the near term.

Terry Rich -- President and Chief Executive Officer

That's correct.

Jim Sidoti -- Sidoti & Company -- Analyst

Right. And then just a longer-term question, this quarter is there anything that typical and you're really starting to see signs of recovering. The Spine business did about $125 million in 2019. And do you see any reason in all while you would get back to those levels into 2021?

Terry Rich -- President and Chief Executive Officer

No, Jim. I don't think there is any reason we can't get back to those levels. Our goal, as we indicated, was to be at the run rate that we had in '19 as we exit the year. So that would lead you to believe without the benefit of the new product introductions that we anticipate, that we should be able to get back there. So, that would be absolutely at the low end of what we were hoping to achieve as we go into next year.

Jim Sidoti -- Sidoti & Company -- Analyst

Okay. And then the last one from me, and you talked a little bit about acquisitions, is that something you're going to start to deal with right away, or you kind of digest what you have over the next couple of quarters, and maybe you look to do those some time next year.

Terry Rich -- President and Chief Executive Officer

Yeah, Jim, we're going to evaluate the opportunities out there and be opportunistic as things present themselves. So, I think, it comes down to, if we find the right technologies, the right opportunities then we would certainly be opportunistic and look to move on them.

Jim Sidoti -- Sidoti & Company -- Analyst

Okay. So if -- possibly if some things, somebody is under a lot of stress this year and working to sell you might actually do something before the end of the year.

Terry Rich -- President and Chief Executive Officer

Possibility.

Jim Sidoti -- Sidoti & Company -- Analyst

Right. Thank you.

Operator

Thank you. [Operator Instructions] Your next response is from Brandon Folkes of Cantor Fitzgerald. Please go ahead.

Brandon Folkes -- Cantor Fitzgerald -- Analyst

Hi. Thanks for taking my questions. And congratulations on getting the OEM sale done. And Terry, congratulations on your appointment. And so maybe just following on from the prior question a little bit, can you just between the three pillars of build, innovate and acquire. Can you just elaborate a little bit more in terms of where your priorities and capital allocation priorities lie among those?

And then, thanks very much for the detailed spending guidance on the stand-alone company. So, just given what you've guided to in the second half of 2020, how should we think of that spending will cadence going into 2021, is this a level that we should expect you to invest and build on going forward in 2021? Or conversely, given that you are now a stand-alone company, are there opportunities to perhaps peer that down or optimize that as we go forward? Thank you.

Terry Rich -- President and Chief Executive Officer

Yeah. So, a lot of questions packed in there. But let me see if I can address them and then at the end, I don't, we'll come back. As you look at build, innovate and acquire, obviously, our short-term priority is around the build, which is really from an external perspective that the visibility to that will be the completion of the leadership team and then the supporting organization underpinning that which the cost is, in general, embedded in the discussion that we had about the cost structure earlier.

From an innovate perspective that's really -- that's R&D spending, right. And so again, from a capital allocation perspective that's essentially being caught into the cost structure of the P&L that we outlined. And then obviously acquire, as Terry indicated, depending upon the nature of what we're looking at. And on acquisition, term is pretty broad, I mean that could be licensing of technology, similar to what we did in the relationship with Aziyo or the Fortilink product where we have a partnership with Oxford Performance management for the material or through acquisition of technology or products.

And so, obviously, it really depends upon the nature of what we do there. I think the cost structure that we outlined for the back half of the year is kind of our current visibility, but obviously with the new leadership team coming on and the continued development of our strategy, we're going to assess that as we go through a more formal operating plan process in the back half of this year. And as we move into next year, we'll give more specific guidance, but that's our best understanding of kind of how we're thinking about it today.

Brandon Folkes -- Cantor Fitzgerald -- Analyst

Great. Thank you very much.

Operator

Thank you. Your next response is from Dave Turkaly of JMP Securities. Please go ahead.

Dave Turkaly -- JMP Securities -- Analyst

Great. Good morning. Terry, I was wondering just at a high level, when we look at what we've got left in Spine here. Can you guys maybe the quantified geographically and/or [Phonetic] by like product category, sort of what the mix was like today? And maybe the areas in those product categories that you might be most excited about.

Terry Rich -- President and Chief Executive Officer

Yeah, Dave, I don't want to dive deep into the product mix and begin to provide that level of information, but there is a lot of products out there that we have that I'm excited about. There are some of the products that are getting ready to launch that I think have tremendous opportunity. But as we continue to pull together the new leadership team add to our marketing and R&D piece, I think there is a ton of opportunity to take advantage of enabling technologies and add them to procedural approaches that will enable us to help drive better outcomes. And I think we've got some products in our portfolio currently that will add to that and excited about where we can take the portfolio from here.

Dave Turkaly -- JMP Securities -- Analyst

Great. Maybe just as a quick follow-up, you mentioned your distribution network, I was wondering, would you be able to comment on sort of the number of agencies you are using or maybe even sort of how many feet on the street you have today or [Phonetic] where you see that going maybe over the next year or two?

Terry Rich -- President and Chief Executive Officer

Yeah, we have again a broad and diverse group of independent agents out there, they have been very excited as we have completed the sale of the OEM and have indicated our focus on Spine. And we will continue to develop partnering more deeply with them, and so we're excited about that. But we're not going to get directly into the number of agents that we currently have.

Dave Turkaly -- JMP Securities -- Analyst

All right. Thank you.

Operator

That concludes the question-and-answer session. I would now like to turn the call back over to Mr. Rich for closing remarks.

Terry Rich -- President and Chief Executive Officer

Thanks again for joining us today and thank you for your interest in and support of Surgalign. As I stated earlier, we believe there is a tremendous potential for Surgalign to become a leading pure play spine company as we pursue our long-term goal of driving double-digit top line growth. We are excited about what the future holds. And we look forward to updating you on our progress on our next quarterly call.

Operator

[Operator Closing Remarks]

Duration: 35 minutes

Call participants:

Jonathon Singer -- Chief Financial and Chief Operating Officer

Terry Rich -- President and Chief Executive Officer

Matthew Hewitt -- Craig-Hallum Capital Group -- Analyst

Jim Sidoti -- Sidoti & Company -- Analyst

Brandon Folkes -- Cantor Fitzgerald -- Analyst

Dave Turkaly -- JMP Securities -- Analyst

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