Alphatec Holdings Inc (ATEC) 2007 Q4 法說會逐字稿

Good day and welcome to the Alphatec Holdings, Inc. Fourth Quarter and Year-End Results Conference Call. Today's call is being recorded. At this time I'd like to turn the conference over to Mr. Gordon Bigler, Vice President of Finance and Investor Relations of Alphatec. Please go ahead.

Thank you, operator, and good afternoon, everyone. This is Gordon Bigler, Alphatec's vice president of finance and investor relations, and welcome to Alphatec Holdings' conference call to discuss our fourth quarter and fiscal year 2007 financial and operating results. With me today are Mr. Dirk Kuyper, President and Chief Executive Officer, and Mr. Ebun Garner, Vice President and General Counsel.

By now, all of you should have seen a copy of today's press release announcing our fourth quarter and fiscal year-end 2007 financial and operating results. If you do not have a copy of the press release, you can find it in the Investor Relations section on our website at www.alphatecspine.com. I would remind you that this conference is being webcast live and recorded. A replay of the event will be available later today via webcast on the Investor Relations section of our website.

Before we get into the details of the call, I need to make a few quick disclosure housekeeping comments. During this call we will discuss some factors that are likely to influence our business going forward. These forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995, may include guidance we will provide on future revenue and other operating targets for fiscal year 2008 and other future periods and statements about prospects for our business, product development status, product potential, financial performance and the planned availability of new products.

These statements are being based -- are being made based on management's current expectations and involve risks and uncertainties that may cause results to differ materially from those set forth in the statement. It should be clearly understood that our actual results may differ substantially from the forward-looking statements we may make today and that no forward-looking statements can be guaranteed. Alphatec undertakes no obligation to publicly update any forward-looking statements whether as a result of new information, future events or otherwise. Forward-looking statements on this call should be evaluated together with the many uncertainties that affect Alphatec's business.

Specific factors that may affect our business and future results are discussed in the Risk Factor section of our annual report on Form 10-K for 2006, our prospectus dated August 30th, 2007 and any supplements thereto, our subsequent quarterly reports on Form 10-Q and in other SEC filings. A partial list of these important risk factors is set forth at the end of today's earnings press release. With that out of the way, I will now turn the call over to Mr. Dirk Kuyper, Alphatec's President and CEO.

Thank you, Gordon, and good afternoon, everyone. Before I begin I want to set the agenda for today's call. I will go over selected highlights from the fourth quarter, then turn the call back to Gordon to provide a more detailed review of our operating and financial performance, and then lastly I will come back and discuss our development projects, as well as guidance for 2008.

First, I want to congratulate the Alphatec team on achieving record company-wide fourth quarter and fiscal year 2007 revenue. Although the holiday calendar in the fourth quarter always provides an additional level of uncertainty, we communicated that we would grow our revenues sequentially during the fourth quarter of 2007 and we did. We achieved record company-wide revenues of $21.3 million. This is an increase of 11.2% from the same period last year and an increase of 5% from the third quarter of 2007.

Regarding fiscal year 2007 total year revenue, we had previously guided that we expected fiscal year 2007 to be $79 million and we delivered on that promise. For the entire 2007 fiscal year we achieved record company-wide revenues of $80 million. This is an increase of 8.1% from 2006 fiscal year.

Second, I want to walk you through our gross margin in the fourth quarter. Since I joined Alphatec as CEO in June of 2007, we've taken a hard look at many facets of our business. Our goal has been to focus on improving all aspects of quality, quality products, quality relationships, quality systems and quality financials.

As a result, we've had to make some difficult decisions, such as during the third quarter we announced a reduction in force where we redeployed 24 full-time equivalent positions away from lower impact roles and reallocated those precious resources to research and development and product management.

In addition to these difficult steps and in full consultation with the Board of Directors, we decided to take several onetime charges in the fourth quarter of 2007 to further clean up several outstanding legacy items and it's adversely impacted our gross profit margins.

We took the following actions in the fourth quarter. First, we increased our inventory reserves by $291,000 associated with the write-off of some NOVEL interbody products that had been sent to our Japanese subsidiary in the beginning of 2007 which were found to be not consistent with anticipated product specifications.

Second, we reserved $250,000 in revenue against sales that we made to a Japanese distributor. Third, we reserved for inventory that had been in quarantine of approximately $178,000. Fourth, we closed out legacy work orders in production, some of which have been outstanding for as much as five years. And that action had an adverse impact of approximately $108,000.

Finally, we increased our excess and obsolete inventory reserve by approximately $100,000 related to various one-time inventory adjustments. These one-time charges totaled about $927,000. Therefore, during the fourth quarter, our GAAP gross profit margin was approximately 59.1%. Adjusting for the fourth quarter actions taken, our gross margin would have been 62.7%.

We've recalibrated Alphatec for measured and consistent future growth and are well positioned moving forward. Although the current operating and pricing environment is very competitive, we expect our gross margins to improve as we grow and we're able to amortize certain fixed costs over more units sold.

In addition, we will be changing our depreciable life assumption for our instruments from two years to four years. After a thorough review of industry-wide best practices, analyzing the expected useful life of our product and in conjunction with our outside auditor, we concluded it was appropriate to make this adjustment for 2008 and beyond. This change will have significant ramifications for our gross margin and puts us on par with our industry peers. We also anticipate that our upcoming product launches will also give us additional pricing flexibility as well.

These are difficult decisions but ones that must be addressed to ensure the long term strength of our business. We have taken a thoughtful, disciplined approach to address the challenges we face. As part of our attention to cost management, we plan to accelerate steps to standardize and streamline certain aspects of our enterprise-wide functions, such as human resources, finance and information technology, both to support growth while also leveraging its scale more effectively in areas such as manufacturing to benefit product cycle times and new product launches.

I'd also like to highlight a few strategic executives that have recently agreed to join Alphatec as we continue to upgrade our team and fill in the gaps where we need conviction, leadership and experience to take Alphatec to the next level of growth.

The first is Andrew Mahar, who joined Alphatec as senior director of biomechanics and clinical research. And the second is J.P. Timm, who will be joining Alphatec as vice president of research and development as of March 10th. Alphatec will leverage both Andrew and J.P.'s substantial product development and clinical research and development experience in order to successfully commercialize Alphatec's significant product pipeline.

Lastly, Mr. [Matsuo Assai] will be joining us effective April 1st as the new President of Alphatec Pacific. Mr. Assai comes to us from [Tokai] where he was most recently President overseeing operations in multiple countries. We'll be relying on Mr. Assai's strategic abilities as well as management to help us expand our Asian presence. We'll continue to upgrade our team and fill in the gaps where we need people with world-class orthopedic spine experience.

Alphatec has recently licensed several exciting platform technologies in our strategic focus areas. These technologies will enable us to engage surgeons as well as to expand the market for Alphatec's products.

First, we acquired a revolutionary and unique pedicle screw solution for dealing with patients with poor bone quality that we call the OsseoScrew. It is estimated that in the United States alone, over 42 million people have either osteopenia or osteoporosis and current pedicle screw designs do not offer an adequate solution for surgeons. The OsseoScrew is designed to be implanted into the pedicle and then expanded to achieve increased purchase if the surgeon desires a more secure fixation.

With the over 65 demographic expected to more than double in the next 20 years, the OsseoScrew will lead the way in providing solutions for the aging demographic. Although aimed at providing superior solutions for patients with poor bone quality, this pedicle screw may also become the new standard of care for all pedicle screw technology.

On the Q3 financial results call we announced that we had acquired an exclusive worldwide license for a novel vertebral compression fracture technology system called V-STENT. The V-STENT is an expandable titanium cage that can be implanted minimally invasively into a vertebral body to treat vertebral compression fractures. The V-STENT is squarely focused on the large and fast-growing market for the treatment of these fractures. There are currently over 1.5 million vertebral compression fractures globally. We are in discussions with leading sites for clinical trials this summer in Europe and we will also be conducting a cadaver lab in Beijing, China in March.

Third, we acquired a dynamic cervical plate solution that complements our Trestle by providing a product solution for the rapidly growing dynamic cervical plating segment of the market which is growing at 15% per year. The solution features an advanced self-ratcheting mechanism that allows for axial settling and simultaneously maintains graft compression. This technology combined with the previously licensed patent from Dr. Hansen Yuan for an internally dynamic plate, allows Alphatec to provide the best of both philosophies of dynamic and rigid plating for the cervical spine.

On the [MIS] front, we continue to develop on the [G-LIF] and an MIS screw system and expect to release a comprehensive MIS solution to the market in stages, beginning with a cannulated screw and MIS retractor system in May. These key strategic products supplement more than 20 other active development projects in our R&D group.

All of these products in development are examples of Alphatec's mission to be the leading independent spine company by focusing on the aging spine demographic and being the leader in this market segment. We will focus no providing solutions for spine patients with osteoporosis, improve solutions for treating aging spine deformities, improved products for minimally invasive techniques, and integrated biologics to support every phase of these platforms.

Our goal is to improve the aging's quality of life. We expect to demonstrate all of these products at the 2008 North American Spine Society meeting in Toronto at the beginning of the fourth quarter of 2008. Gordon will now walk through fourth quarter 2007 financials and operating highlights. Gordon?

Thank you, Dirk. As Dirk had mentioned previously, during the fourth quarter of 2007 we achieved record company-wide revenues of $21.3 million. We have two segments in our company and in the U.S. we achieved record revenues of $17.1 million during the fourth quarter of 2007, which is an increase of 4.9% from the same period last year and an increase of 1.6% from the third quarter of 2007.

What is worthy of note is that we achieved these record results really without full releases of our Trestle and Solanas products during the fourth quarter. As Dirk communicated, we are extremely focused on quality and we intentionally withheld the full launch of these products during the fourth quarter because they did not meet our new definition of ready for launch.

As a reminder, Trestle, which is our new low profile anterior cervical plate, is selling well and gaining surgeon interest even in its muted release. Trestle features a large graft window that enables maximum graft site and in-plate visualization. Self-retaining screw locking mechanism is a very thin plate design that competes effectively with the market leading products.

Solanas is our next generation posterior cervico-thoracic system which features a mobile poly-axial head which allows for 80 degrees of motion, top loading hooks provide stabilization in the cervical spine, and the proven buttress-thread closure that has received favorable reviews from the surgeons that have tested the product. Both of these products have received excellent reviews.

In Japan, our other segment of revenue, we achieved again record company revenues of $4.3 million during the fourth quarter of 2007. This is an increase of 45.9% from the same period last year and an increase of 21.3% from the third quarter of 2007. We are especially pleased by the performance of our Asian subsidiary in the fourth quarter.

Earlier in the year we said we had taken steps to short up that business by bringing in -- by bringing onboard an experienced sales team and expected Japanese revenues would recover to previous levels. They have surpassed those previous levels and we feel confident about our ability to have a presence in the very robust Japanese orthopedic marketplace and feel that we are building a beachhead for future success.

Now I want to talk about earnings per share. Net loss computed in accordance with U.S. GAAP for the fourth quarter of 2007 was $11.2 million, or $0.24 per diluted share. Compare that with a GAAP net loss of $5.6 million, or $0.16 per diluted share, for the third quarter of 2007 and a GAAP net loss of $11.3 million, or $0.34 per share fully diluted, for the fourth quarter of 2006.

GAAP net loss for the fourth quarter of 2007 includes $7 million of in-process research and development expense, of which $5 million was associated with a license related to the V-STENT vertebral compression fracture solution technology and $2 million was associated with a license related to the Osseo pedicle screw technology targeted at patients with osteoporosis or poor bone.

I want to now touch on the two non-GAAP or adjusted financial figures that we report. EBITDA, as adjusted, for the fourth quarter of 2007 was $540,000 compared to $1.5 million for the third quarter of 2007 and compared to $440,000 for the fourth quarter of 2006. As Dirk mentioned, EBITDA, as adjusted, in the fourth quarter of 2007 was adversely affected by several onetime charges. These onetime charges totaled approximately $927,000. Adjusted for these onetime charges, EBITDA would have been approximately $1.5 million for the fourth quarter of 2007.

Non-GAAP net loss as adjusted for the fourth quarter of 2007 was $2.3 million, or $0.05 per fully diluted share. Compare that with non-GAAP net loss of $1.5 million, or $0.04 per fully diluted share, for the third quarter of 2007 and non-GAAP net loss of $3.9 million, or $0.12 per fully diluted share, for the fourth quarter of 2006. Again, adjusting for the previously detailed onetime actions, non-GAAP net loss, as adjusted, would have been $1.4 million, or approximately $0.03 per fully diluted share, for the fourth quarter of 2007.

Now I'm going to move on to the balance sheet and cash flow statement. Our balance of cash and cash equivalents at December 31, 2007 was $27.8 million. This is a decrease of approximately $9 million from September 30, 2007, but there's a good reason for it.

During the fourth quarter we completed several exciting technology licenses that are transforming Alphatec. The uses of our cash were as follows; as I mentioned, $5 million was for the V-STENT license, $2 million was used for the OsseoScrew license, $1.2 million was spent on building instruments for existing products to support our growth, and $700,000 was spent on targeted capital expenditures to help drive manufacturing cost savings.

This means the change in cash was completely used by technology licenses, building new product instrument sets and making the manufacturing plant more efficient to increase our cost savings. We will continue to streamline our operations and focus on reducing our quarterly cash run rate while continuing to execute our strategic initiatives. An important aspect of our business model is our ability to grow Alphatec without large incremental capital expenditures to support additional capacity.

Accounts receivable maintained consistent at approximately 55 days during the fourth quarter of 2007. And as I previously mentioned, even though we built inventory to support our 2008 product launches and planned increase in sales, inventory turns were consistent at 1.7 times. I will now hand the call back over to Dirk to give guidance for 2008.

Thank you, Gordon. The back half of 2007 was focused on getting our house in order and setting the stage for the future. We upgraded our management team, we restructured our quality systems, upgraded and streamlined our operations and built out a highly differentiated and innovative strategic product pipeline. We have now set the stage to be totally focused on reaccelerating Alphatec's growth rate moving forward.

Alphatec has strong fundamentals and an excellent opportunity, as it has a consistent revenue platform, ample manufacturing capacity, a solid product offering, high quality salespeople and committed employees. For 2008 we are reiterating our guidance, as we expect consolidated revenue for the entire company to be approximately $95 million. This is a year-over-year increase of approximately 19% from 2007.

For our U.S. business in 2008 we expect revenue of approximately $80 million. This is roughly a 19% to 20% growth rate from 2007. Our growth in U.S. revenue will be driven by several factors, including new product launches. With this we include the full realization of the potential of the Trestle anterior cervical plate, the Dynamo dynamic rod and the Solanas posterior system, all of which have been well received by the market.

Secondly, by completing the redesign of our existing products with significant instrument upgrades. And finally, by expanding and moving to a more exclusive sales distribution network.

For our Japan business, in 2008 we expect revenue of approximately $15 million. This is roughly a 15% growth rate from 2007. During 2007 we shored up that business by bringing onboard an experienced sales team and we feel confident about our ability to have a presence in the Japanese orthopedic marketplace and feel we are building a strong beachhead for the future.

In 2008 our team is tasked with increasing the amount of spine revenue as a percentage of the total and we expect to have many of our spine products in front of the Ministry of Health or MHLW for approval, both by March of this year. This approval process will likely take a year, but we are making substantial headway in our Japanese business. In addition, as it relates to our V-STENT product, Japan is the second largest market globally for vertebral compression fractures with over 500,000 annually. So we see our business expanding there.

Plans for expansion in the European market are on track and we have -- we have substantive discussions ongoing with distributors in several key markets. We expect to begin shipping product to Europe in the second half of 2008. Because some of the product cycles previously mentioned, we expect revenue to build through 2008. However, we expect Q1 2008 to be up sequentially again from Q4 2007 and our growth rate to accelerate in the back half of the year as some of the new products come to market.

Alphatec has never been better positioned. However, we must continue to manage through a transition of priorities and recalibrating Alphatec for consistent future growth. We'll continue to support our surgeons with the products and solutions they need for their patients.

My leadership at Alphatec will be focused on strategically positioning the Company as a leader in the emerging aging spine market, on delivering to the market a dynamic and unique product pipeline, and effective operating processes with improved margins. As part of being a world-class company, we will be focused on reaching GAAP profitability by the end of 2008 as one of our key goals. At this time we'll open the lines up for questions. Thank you.

Thank you. (OPERATOR INSTRUCTIONS). Our first question will come from Tao Levy with Deutsche Bank.

Hi, guys. This is Seth for Tao. Good job on the quarter. Just a couple of questions. First, maybe you could go over your revenue growth a little bit in a little more detail. So revenues were only up 1.6% sequentially and is there any reason for that slowdown? I think we were expecting a little bit more in the domestic market.

I appreciate that, Seth. As previously mentioned, we were able to achieve that sequential growth and, really, we guided for very muted sequential growth and we beat and achieved that. A couple of reasons, really. The muted Trestle re-launch, muted Solanas re-launch. We actually had some revenue that we kind of feel like we pushed out and away from Q4. So we purposely kind of managed to a sequentially up quarter and rightsizing all of our products for full launch as we build into 2008. So I appreciate your comments, but as we promised on the Q3 call, we beat expectations and delivered on our promise and we kind of purposely muted that.

Okay, fair enough. Also, the -- can you just talk about the gross margin for the Japanese business, if you can maybe give us a little color on that? And also, is that business EBITDA positive?

We always characterize the Japanese business, at least historically, Seth, what it's been is right at EBITDA neutral. For those of you that maybe aren't as familiar with the financials, we have cost of goods sold with our Japanese revenue and then all of the other operating expense categories for the Asian subsidiary go into the G&A of the total company. So G&A on a consolidated basis looks a little higher than really it is.

As Dirk attacked the team there to sell more of our spinal products, what we think about that Japanese business is probably in the 20% to 25% gross margin range.

Okay. And one last question and then I'll just hop back into the queue. In '08 are we expecting -- are we expecting any more restructuring charges or new hires that you guys can see or is it going to be pretty clean from here on out?

We've really worked very hard to, as I said, clean our house and I think our spring cleaning is done. So I do not anticipate any further significant charges at this point. We believe that we took all of those and that's one of the reasons we decided to do that all in Q4. So I think you will see our margins rebound in Q1 '08.

Okay, great. Thanks, guys. I'll get back in the queue.

Our next question will come from William Plovanic with Canaccord Adams.

Great. Thank you. Good evening. A couple of questions for you. Can you just help us out in terms of Trestle and Solanas? Are those in full launch or when do you expect that? Maybe lay out a timeline for us just over 2008 exactly what products are going to get initial launch and a data launch and then full launch through the year --

Well --

-- model on the domestic side.

Okay. And I can give you sort of an overview at this point. It'd probably be a more lengthy discussion to sort of take you through the whole -- all of the products, but sort of the highlights.

The Trestle we launched in Q4 but we really launched in sort of more of a limited fashion. We got -- our goal was 125 sets in the market. We got 75 into the market and then decided to hold back because we had a couple of instruments that we just weren't happy with the performance, one of them being a removal tool for taking the screw back out if the surgeon needed to do that. So that has been redesigned.

We expect to release that instrument by the end of this month, by the 28th, and then subsequent to that we'll get the rest of the sets out into the market. So the sets are basically built but we held them back because it has been an issue.

Even with that, sales of Trestle have done extremely well. So we're really pleased with the product overall. But this particular instrument there have been a number of surgeons who've held back, frankly, in using it because of it. So that should be resolved by the end of this month.

Solanas, same sort of scenario. Our goal was to have 60 sets out in Q4 and we managed to get 30 out. The other 30 sets will be out by the end of this month, so we should see full revenue from Solanas starting in March. So we feel very good about that as well. We had a couple of issues with a torque wrench, a couple of other minor things that slowed us up a little bit. But I think by the end of February we expect to have all 60 sets up and running. The next product release will be the MIS cannulated screw system, which should release in May to the market.

Then in terms of some of the products that we've been talking about, we expect to beta launch V-STENT by Q4 of 2008, beta launch meaning release it to 20 or 30 sites. We will start clinical trials, as I mentioned, in Europe this summer. The OsseoScrew, our goal is to be ready for full market launch by the fourth quarter of this year. In addition to that, we're revamping Zodiac. We have 50 sets revamped out of the 150 in the market. The other 100 should be done by the end of March, so that should help substantially as both an upgrade as well as some new products that we're adding in. Next generation deformity system will be released in May.

So that's just sort of a brief overview, but certainly we can get back with you individually and show you some of the other products that we anticipate as well, Bill.

Okay. So I guess what I'm looking for is what's coming in -- do you think that Trestle and Solanas, while they've been giving some sort of contribution, really start kicking in in the first quarter and second quarter?

Yes, we were -- frankly, we were really hoping for more of a kick in Q4. But again, our focus is really on re-branding the Company, if you will, and making sure that we have the quality and the performance we want from the products. So the right decision was to sort of slow those down and mute the release, which is what we did. So I think March we should see sort of full contribution in sort of the first months. So certainly Q1 has started off well but we think March, with the pickup of those products, we should see an acceleration in the growth rate.

To augment that as well, Bill, our interbody, which is our NOVEL product line, really happens to be selling well, specifically year-over-year. There are several products that are coming to market now. Our NOVEL TL for a T-lift procedure where we didn't have any in the market in Q1 '06 is selling very well. Our self-distracting NOVEL, what we call the NOVEL [SD] cage, has got significant year-over-year growth. So those are some other product cycles that, frankly, we're very pleased and the team is really operating all there.

Okay. And then I didn't hear anything on the Dynamo.

Dynamo is released to the market. We released it in December. We have a limited number of -- that is used with Zodiac, so it's not an instrumentation issue. We released a limited number of sets of the implants. We're getting some good pickup in terms of usage. And we anticipate getting -- being able to increase the number of sets in the market dramatically in March as we receive inventory.

Okay. And then I'll ask a P&L question and then I'll jump back in. In the press release you have two items that you call out. One's for $1.01 million and the other's for $325,000, yet the discussion in your remarks mentioned $927,000. What's the disconnect there and --?

That's a good question. So in our press release we have the two called out, the lawsuit settlement, plant shutdown and relocation and the severance costs. In addition to those we felt it appropriate to call out the additional $927,000 in the fourth quarter that I think we went into a lot of detail there.

The reason why we couldn't put those into our published non-GAAP, as adjusted, EBITDA and EPS frankly was because we wanted to be conservative about how we presented that. And our outside auditor felt that although these are very much onetime in nature, they're a classification that aren't in your standard kind of extraordinary classification. So we wanted to call those out separately. So you want to take the $927,000 that we called out on the call and then you would add that onto. Obviously our $540,000 of adjusted EBITDA in Q4 already takes into account that $1 million and $325,000 respectively.

So really you had about $2.3 million in onetime charges --

Correct.

-- then where in the -- where's the $325,000, where in the P&L is it, and the $1.1 million, where is that in the P&L? Like what line item was it in?

The legal would be in G&A, as well as the severance costs would be rolled into G&A as well.

Okay, so the $1.3 million is G&A and then the $927,000 [is cost]?

Correct.

That's correct.

Okay, great. Very helpful. Thank you.

Our next question will come from Steve Ogilvie with ThinkEquity.

Hi, guys. A couple of questions. What's the share count at the end of the quarter?

Share count would be just a tick over 48 million shares.

Okay. And could you talk about looking over the past 12 months what sort of turnover you've had in terms of distributors, like the actual people selling the products, have there been a lot, a little? Can you characterize that?

The turnover in the distribution network has not been what I would call significant. We have had some turnover. More, Steve, I think it's been a function of actually adding where we've taken some real estate away from certain distributors where they just weren't getting any traction and put on additional distributors in those areas. So I think net-net, we actually grew the network in 2007, but not dramatically. So the turnover has been relatively low from my perspective.

Okay. Do you think there's deadweight in your distributor area? I mean it looks the year-over-year growth is probably not what you'd want. I wonder if a year-ago quarter there was some people selling stuff that you'd think, well, they're not going to grow the business [with us] so they'll be taken out?

Well, you're exactly right. There are some areas where we're concerned about that we have not -- we're not getting the traction we want and we are in discussion in several markets with stronger players, if you will. Some of the innovative products that we have in the pipeline are certainly allowing us to have discussions with sort of some what I'll call A tier distributors and we are in active discussions.

I mean that is one of the things we're looking at very hard is sort of underperforming areas and how we can upgrade those. And there are certainly a few that sort of stand out and that we're working on right now to try to upgrade those. You're absolutely correct.

Okay. And then on the new sets it sounds like you have a lot of launches, a lot of new instruments that's coming out into the market. What are you doing to make sure you're not just cannibalizing your old sales but actually expanding the number of cases and doctors?

Well, a good example of that is Trestle and Trestle is sort of a next generation cervical plate and obviously we have Deltaloc and Reveal. But when you look at as a percentage how much cervical business we were getting, we weren't getting a heck of a lot compared to the amount of thoracolumbar. So with Trestle I think we have the opportunity to go back to the active surgeons we have and gain that cervical business which before probably was going to somebody else just because our -- they weren't happy with the solution we had.

So I think that we have seen Reveal drop off some as Trestle has come into the market. We're trying to manage through that obviously. The goal is to get incremental revenue and not cannibalize. With the upgrades, it's really more -- I think those allow us to reaccelerate the growth rate. I mean after a while your product gets a little long in the tooth and by reenergizing those sets and upgrading, then you can sort of get some incremental growth out of those.

So I don't know that we have a lot. It's not like this year we're looking at a next generation pedicle screw coming out. OsseoScrew really will be an add-on in my mind, certainly initially, and should help expand our market share rather than detract from it.

Okay. And then just last question, more of an accounting thing. With the new amortization treatment for your instruments and tools, will that have an immediate impact on 1Q because you're building all these stents?

That's right. That's correct, Steve.

You want to characterize that impact?

Well, it's probably for the full year it's going to have about a $1.5 million in COGS. And I would think our set build tempo is such that you'd probably want to straight-line that, think about that in Q1. So take a quarter of that $1.5 million and that's how the pickup we should look at in Q1.

Okay, great. Thanks, guys.

Our next question will come from Bud Leedom with Global Hunter Securities.

Hi, guys. Just a quick question. I missed it on the special charges related to cost of goods sold. The $178,000 that you mentioned, what was that related to again?

Sure. There was substantial -- when Dirk came on and he reassessed quality, those were -- those were products that were in quarantine. And so what happens in your plant, you've got a section of certain products are in quarantine and with the commitment to quality and increasing cycle times, we took a look at that that frankly nobody had looked at in quite a while and wrote that off. Dirk?

That's correct.

Okay. And then just related to the gross margin, the non-GAAP gross margin of 62.7% in the quarter, is that lower than your previous run rate due to the higher percentage of sales to Japan or is there anything else I should be looking at there?

No, that's the right way to look at it. Certainly the mix a little bit more relative mix of Japanese lower margin business. But that's the right way to think about it. You're right.

Okay. And then just as it relates to Japan, as a percent of total revenue, that's obviously picked up and that's -- it's roughly around 20%, which is greater than the percentage breakdown of guidance for '08. Is Japan tracking better than expected at this point or was there a channel fill in Q4? Exactly what happened there and what do you foresee for Japan moving forward maybe outside the guidance that you'd discussed?

Japan has actually in Q4 did better than we expected and we're seeing that continue. Certainly the challenge that I've given them and the way we've structured their compensation for this year is geared towards increasing the amount of spine -- of Alphatec spine business as a percentage of total revenue. It is at a low double digit today and we want to get that up.

So we've incentivized them to increase that as a percentage of their sales. We added a number of sales reps in the third quarter and that's what started to rebound the sales. And frankly, they're actually doing quite well and we see that trend continuing from where they were. So they're actually on a very good track for this year.

Okay. And then just as it relates to R&D, that was a nice uptick in the quarter. Is that mostly related to payroll or is there anything else embedded in that number?

No, we have increased the number of people in R&D pretty dramatically. Obviously when you hire people, generally there's a fair amount of recruiting that goes on and so there's a fair amount of recruiting fees n there as well.

Okay.

That would be a onetime.

Oh, okay. So but we should expect R&D to continue to ramp through '08, I assume?

Yes.

Okay. And then just finally, you mentioned some of the targeted CapEx that you had spent in the quarter. Could you discuss maybe some of these efficiencies just in brief form? And then as it relates to '08, do you have a ballpark for CapEx?

Sure. We look at CapEx, barring any licensing sort of IP R&D, with about probably right around $2 million a quarter still. And that's a function of kind of plant CapEx, as I called out, in Q4 as well as instrument CapEx.

Okay. And then --

So think about --

And then just related to the efficiencies, briefly what efficiencies you've implemented?

Sure. So Kermit Stott, who's our new vice president of operations that I think Dirk had talked about it, his ability to recruit really world-class leaders and executives. Kermit assessed the plan and felt that he, if had a little bit more capital, could drive some cost efficiencies and savings, as well as get more units through the plant. And it's a -- I think it's two -- it's called a [shikigami] machine that was allocated.

Great. Thanks very much.

Our next question will come from Bruce Jackson with RBC Capital Markets.

Hi, guys. Just a quick question about how the U.S. sales are going to roll out. Of all the new instrumentation in the market at the end of March, should we expect that Q1 would be kind of just up slightly and then we start seeing the acceleration in Q2 or would it maybe the acceleration come in Q3 or Q4? How is that going to look?

I think you will actually start to see some positive acceleration n Q1 and then further acceleration in Q3 and then as some other products roll in further in Q3 and Q4. But I do expect Q1 r be substantially better than Q4.

Okay. And then the same question for Japan. It was -- or for Asia-Pacific it was a good quarter in December. How should we think about Asia-Pacific rolling out over the course of 2008?

Well, we put out guidance at $15 million and they are certainly going to do better than that. Their current run rate has been very consistent sort of the last four months and we don't see any particular reason why that would go down by any significant amount. So I think if they hold at their current run rate, which we saw through all of Q4 and again rolling into Q1, I think things look very good from there on.

Okay, great. Thank you.

Thank you.

We'll hear a follow-up question from William Plovanic.

Great. Thanks. A couple of questions just in terms of distribution. Where were you at the end of '07 in terms of numbers? I don't know if you're sharing that on the annual basis. And then how -- what was the percentage of it exclusive and what are your projections for '08 or your goals for '08?

Okay. The number of feet on the street, if you will, as we count them is around 180 at the end of the year and that's roughly 72 different agencies around the country. We do plan on increasing that some this year. Currently about 40% of those are exclusive to Alphatec and our goal is to increase the percentage that is exclusive towards -- more towards 60% or more.

Okay. And then you used to provide number of surgeries, revenues per procedure, number of surgeons. I know you're moving away from that. Have you come back to that at all?

Bruce, that's a good question. We haven't and the reason why is because we've really become much more exacting in how we look at the business. And growth -- grossing everything by revenue per surgery doesn't give our product managers and our executives the best information to run the business. So what we've done is we've actually -- we look at each product line and how much revenue in that product we're getting per potential case of that product.

And what -- the ramifications of that as it runs through the business, we can be much more exacting of how many sets we need to make to drive that particular product. We can also be much more exacting in if we're doing a Trestle anterior cervical plate, are we getting the complementary NOVEL interbody, which would be our NOVEL XF product line.

And then would we be getting also a biologic, which would be a putty or a gel, as well as the bone chips that go into that and lumping that as a surgery. And if we lump that surgery relative to a Zodiac thoracolumbar surgery in our stainless steel product line, which would be used in a larger scoliotic construct, might be a much different revenue per surgery. And grouping those together didn't allow us to run the business as effectively. So we're segmenting our products and being more efficient about it.

And I think, Bill, I know -- we want you to be patient on this. We'll be talking about those metrics end of '08 and you'll be pleasantly surprised at the level of detail and precision that we can talk about how we run the business. So be patient with us.

Okay. And then in terms of the (inaudible) plant shutdown [relo], I mean you've been clicking at about 1 million a quarter or whatever. In severance costs, is that all going away? I mean those are onetime in nature, but how much more onetime are we going to see?

That's a good question. We've had -- certainly there's been a lot of onetime. I think we're very close to being done, Bill. You can't ever be exact. But the team has been rebuilt. We may have one more issue to deal with, but in general I think all of that you will see a dramatic reduction in 2008 in those onetime charges.

Okay. That's all I have. Thanks a lot.

Thank you.

We'll hear another follow-up question from Tao Levy with Deutsche Bank.

Hey, guys. Just two more follow-ups, one just a clarification. So the $1.5 million you said in COGS (inaudible) we should think about spreading evenly over the year, is that the step up due to the royalty charges or I guess royalty expense to your new partners?

No, no. It's actually a reduction in COGS, not a step up. What we're talking about is we've taken a very hard look at our instrument amortization and we were at two years. And if you look out sort of at the peer group in the industry, it's anywhere between three all the way up to six. And so we've gone through a diligent process of really analyzing where we're at. We believe we can move to four years amortization versus two. And that amortization shows up in cost of goods, so by changing that, we actually will see a benefit or a reduction in cost of goods of about $1.5 million.

Fair enough. Then will these new product launches that you've highlighted, specifically the ones where you've partnered with or licensed technologies, will they negatively impact COGS because of royalty expense associated with sales?

No, I don't think so. We expect significantly higher margins on these products.

Okay. And one last question. You were clarifying the Japanese write-off expenses. I think you said there was about $250,000 for sales to a distributor and another one of $291,000. So just to clarify, are those -- those are sales that you made to a third party distributor that you've since written off that you're not going to collect? That's what it is?

It's two different issues. One issue was actually a product related issue where we shipped product to our subsidiary in Japan and it had been -- it was earlier in the year and that product, frankly, the way -- what happened was the way they got the product approved through the MHLW had a slightly different spec than what we produced. And so we decided in the end that there was nothing we could do with that product so we wrote it off.

The other, the $250,000 is actually a -- we took down sales by that amount and it is to a distributor that had been selling for us very effectively but we were a little concerned about their -- how much they owed us had been growing steadily through the year and they're not paying at the rate. We've come up with a payment plan for them. We hope that they will catch up. But just as a precaution, we decided to take some additional reserves and write those sales down.

Okay. Thank you.

Operator, if there aren't any more Q&A in the queue, we can turn the call back over to Dirk for closing remarks.

We have no further questions.

Okay. Thank you, operator. Alphatec has a strong foundation with which to build the future and we think we've taken the steps to achieve -- to allow us to achieve our goals for 2008. I think we're very well positioned. We've cleaned our house and are ready to reaccelerate the growth and I think you will see that in 2008 as we execute our plan. So we look forward to executing on that plan and delivering benefits both to our shareholders and to Alphatec employees alike moving forward. Thank you very much.

Thank you. That does conclude today's conference call. We thank you for your patience and have a great day.