Alphatec Holdings Inc (ATEC) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Alphatec Spine third quarter fiscal year 2011 results conference call. (Operator instructions) As a reminder, today's conference is being recorded. I would now like to turn the conference over to your host today, Michael O'Neill, Chief Financial Officer. Please begin.

Thank you and good afternoon, everyone. Welcome to Alphatec Spine's conference call to discuss our quarter ended September 30, 2011 financial and operating results. With me today are Dirk Kuyper, President and Chief Executive Officer and Ebun Garner, our General Counsel.

By now you should have seen the copy of today's press release announcing Alphatec Spine's third quarter 2011 financial and operating results. If you do not have a copy of today's press release, you can find it in the "Investor Relations" sections of our website at www.AlphatecSpine.com.

Before we start, there are a couple of items we would like to cover. I'd like to remind you that this call is being webcast live and recorded. A replay of the event will be available later today on our website and will remain available for at least 30 days following the call.

We would like to remind you that our discussions today include forward looking statements. These statements are based on certain assumptions made by us based on historical trends, current conditions, expected future developments including business prospects, product development objectives, future financial performance and other factors we believe to be appropriate in the circumstances.

Risks and uncertainties may cause our actual results to differ materially from those projected in these forward looking statements. You can find a discussion of these factors and more information about us in our filings with the SEC, including the "Risk Factor" section on our annual report on Form 10-K, subsequent quarterly reports on Form 10-Q and periodic filings on Form 8-K. These forward looking statements are made by us as of the date of this call and we assume no obligation to update these statements publicly, even if new information becomes available in the future. This broadcast is covered by U.S. copyright laws and any use or rebroadcast of all or any portion of this conference call may only be done with our expressed written permission.

I'll now hand the call over to Dirk Kuyper, Alphatec Spine's President and CEO.

Thank you, Mike. Good afternoon and thank you for joining us today. This afternoon I'll provide highlights of our operating performance from the third quarter of 201l. I'll then turn the call over to Mike, who will provide a more detailed review of our financial performance and updated guidance for 2011. I'll then come back with closing comments and we'll open the call up for questions.

I'm pleased with the overall revenue performance for the third quarter 2011. We achieved revenues of $47.6 million, which represent growth of 6.2% over third quarter of 2010 revenues. In the U.S., we grew our third quarter of 2011 revenues by 8.9%, which outpaced the growth rate of our peers in the broader U.S. spine market. On a year-to-date basis, our pro forma revenues are up 8.2% versus the prior year and pro forma year-to-date U.S. revenues are up 11.4% versus the prior year.

Our broad product portfolio combined with new products continues to drive hospital and surgeon conversions to Alphatec Spine, is a testament to the strength of our team that we can deliver these results in a challenging market environment and outpace the industry throughout the year.

We reported adjusted EBITDA of $3.5 million in the third quarter of 2011 and a net loss of $1.3 million, or $0.01 per share. I'm particularly pleased to announce that we generated a positive $1.8 million in cash from operations in the third quarter. We remain on pace to achieve our goal of being cash flow positive for the full year.

While we are not pleased with our current gross margin in the U.S., it is in large part due to lower manufacturing volumes, in late 2010 and early 2011 as we adjusted to lower global market growth rates and our goal of improving our working capital through a reduction of inventory. This resulted in negative absorption variances that are working through the P&L. The cost reduction initiatives taken in the third quarter, along with the return to normal production levels due to new product releases and lower inventory, should result in incremental improvements in our gross margin in early 2012.

In addition, we have launched a set of three strategic initiatives aimed at improving our performance. The first is reducing our cost of goods sold and increasing efficiencies in our U.S. operations. Second is reducing cost of goods sold in our international operations and third is reducing SG&A expenses internationally.

The initiatives include insourcing currently outsourced manufacturing to maximize capacity utilization and improve cash flow. Currently 80% of Scient'x implants are purchased as finished goods in the European Union and we have initiated transfer of high volume products to our U.S. production facility.

We're also focused on the vital few projects that most affect our success and look to eliminate duplication of effort. We remain committed to our longer-term goal of achieving a non-GAAP adjusted EBITDA margin in the 20% range.

From a business perspective, we continue to focus and deliver on our strategic growth drivers at Alphatec, which are product initiatives addressing the aging spine, MIS and biologics, the continued expansion of our core product portfolio, and expansion of our global distribution network.

In the third quarter, procedures using OsseoFix in Europe were up 27% over the second quarter of 2011, with over 3,300 cases now completed since product launch. The product continues to gain traction as a vertebral body reconstruction implant and is being used in vertebral compression fractures, trauma, and in tumor surgeries. Our focus now is on developing clinical evidence to gain separate reimbursement codes for OsseoFix in key markets and to launch a second generation product in 2012.

In the U.S. we are negotiating with the FDA to accept the patients treated with OsseoFix under the original protocol, as completion of a feasibility study. Provided the FDA accepts the data, we'll proceed with a pivotal protocol and a full IDE study shortly thereafter.

OsseoScrew continues to perform well. At the end of the third quarter approximately 650 cases utilizing OsseoScrew have been performed. We'll continue to expand the use of the product in international markets, as we get additional regulatory approvals.

OsseoScrew continues to gain acceptance in Europe as an alternative to cement augmented screws due to its lower complication rates and improved performance. We continue to be pleased with OsseoScrew's ability to pull through our entire product line into hospitals due to superior performance in complex constructs and poor bone quality.

As previously discussed, we resubmitted our 510(k) for OsseoScrew to the FDA in June. We're currently working with the agency on our submission. The FDA has requested a clinical study and we're currently evaluating how best to respond.

This week at the North American Spine Society meeting in Chicago we'll be featuring several new products, including a next generation anterior cervical plate, Trestle Luxe, our Avalon Occipito-Cervico Plating System, the Epicage MIS TLIF Interbody System, and the relaunch of Alphatec's Solus ALIF device.

The Trestle Luxe is the Company's next generation anterior cervical fixation system. It combines a proprietary zero-step locking mechanism, low profile flush fit design, large graft window and a comprehensive offering of implants and instrumentation to provide surgeons' confidence in the system's performance and comfort to their patients.

Avalon, which is used in connection with our Solanas Posterior Cervico-Thoracic Fixation System, provides surgeons with an innovative and comprehensive solution for posterior cervical fixation. The unique buttress design of the Avalon plate allows a surgeon to place and secure bone graft in the optimal midline location to help promote fusion and improved graft stability without adding profile to the overall surgical construct. The first surgery using Avalon was performed in Texas on October 31st.

The Epicage Interbody Spacer can be used for either TLIF or PLIF procedures. In its resting state the cage has a crescent shape, but due to its unique geometry and design it can be flexed into a straight and narrow shape. The cage can be delivered in a minimally invasive, low profile manner, which upon delivery reshapes to cover a large surface area.

Additionally, it is delivered through a portal that is designed to reduce the potential for nerve injury to the patient and to ensure that the cage is delivered to a precise location upon each implantation. Epicage has been implanted in over 20 patients since its introduction to the U.S. beta sites in the third quarter.

Alphatec Solus provides a biomechanically proven and industry-leading design in treating spinal column stability for internal fixation ALIF devices; four points of fixation, combined with what we believe is the largest competitively available graft volume support rapid and robust arthrodesis potential. Deployment of the internal fixation blade is performed in one step and is designed to decrease incision size, operative time and blood loss.

We remain on track for a full market release in the first quarter of 2012. We're encouraged to see the beta launch process work, which have allowed us to incorporate changes that have substantially improved the performance of the instrumentation.

Also in the fourth quarter of 2011, outside of the U.S. we'll be launching the next generation of Discoserv, the only ceramic artificial cervical disc on the market with a preloaded disposable implant applier. Discoserv has been implanted in over 8,000 patients since launch in 2006 and we believe that this next generation device will accelerate our growth in this segment.

Within our biologics platform, we remain pleased with the uptake of PureGen Osteoprogenitor Cell Allograft. As you'll recall, in June our partner, Parcell Laboratories, received an untitled letter from the FDA regarding PureGen. In the letter, the FDA raised questions in connection with Parcell's position that the PureGen product is within the classification of human cell or tissue-based products that are regulated solely under Section 361 of the PHS Act.

Since our initial joint response to the FDA, we have had a face-to-face meeting with the agency in which we provided more complete information about the function of PureGen. During the meeting we also presented safety data collected to date on over 300 patients, which showed an adverse event rate that compares favorably to other bone grafting options.

We're fully committed to working closely and collaboratively with the FDA to address and clarify questions related to PureGen. While we cannot guarantee any particular outcome, we are encourage that PureGen has been successfully implanted in more than 1,000 patients with no reported adverse events, complications, or complaints.

Our final growth driver is our global distribution network. The macroeconomic environment in Europe continues to be difficult and the third quarter is traditionally slower due to summer holidays. This was particularly true this year when we saw a greater than expected slowdown in procedure volume. We had anticipated several large orders that were delayed and will roll into the fourth quarter and in September procedure volumes have returned to anticipated levels.

During the fourth quarter we'll be launching Alphatec products in Russia, which represents a significant opportunity for the Company. We continue to believe that with the management infrastructure in place, a broad and differentiated product portfolio and a solid sales team that we're well positioned for the future.

In Asia, we continue to grow and enhance our footprint. Japan continues to deliver significant growth for Alphatec in 2011 and as we take share from the competition, we anticipate a robust growth rate continuing into 2012.

In the fourth quarter we anticipate launching Alphatec products in Australia to a new distribution partner. As Australia represents one of the most significant market opportunities in Asia, we are pleased that our core products are registered and have been approved for reimbursement in both public and private hospitals.

In the U.S., we added 10 new distributors and 2 direct sales representatives during the third quarter, as we looked to expand our U.S. footprint in anticipation of new product rollouts. We anticipate these sales team members will contribute modest incremental revenue in the fourth quarter and more meaningfully in the first quarter of 2012. In addition, we have a robust pipeline of potential new distributors and direct sales people and we expect to be able to convert over the next couple of quarters.

In conclusion, we are pleased with our topline growth in the third quarter of 2011, as well as our year-to-date growth, which continues to be driven by new product contributions and our strengthening global distribution network. We are delighted to have generated cash from operations in the third quarter and we are on pace to be cash flow positive for the full year of 2011. We expect to continue to achieve ongoing revenue growth rates greater than the broader spine market.

In closing, I think it's important to point out that over the last 18 months Alphatec has gone through a major transformation into a global Company. During this period, we have made substantive upgrades to the senior management team and to the international management team. We've added a new CFO, Mike O'Neill; a new COO, Pat Ryan; a new Senior Vice President of Human Resources, Heather Rider; a new Vice President of Regulatory Quality and Clinical, Fran Harrison; and have recently added a new Senior Vice President of Marketing, who will be announced soon.

In addition, we have substantially upgraded our team in France with a new general manager VP of operations for EMEA, a new vice president of finance, a new director of human resources and a new director of human resources and a new director of regulatory quality. All of these individuals possess the skill set to take Alphatec to the next level, as we proceed, pursue our goal of being a top five market leader.

I'd now like to turn the call over to Mike to discuss the third quarter 2011 financial results and to provide updated financial guidance for 2011. I'll then offer concluding remarks and open the call up for your questions.

Thank you, Dirk. The following remarks are related to our reported operating performance of the quarter ended September 30, 2011.

To present comparative revenue results between 2010 and 2011, we are using pro forma revenue schedules. The Company's per forma revenues include Scient'x for all periods in 2010 and do not include I&C for all periods in 2010. The press release issued today provides our geographic sales segment performance on both a GAAP and a pro forma basis. On this call I'll be discussing the active performance of our business on a GAAP basis and make applicable reference and performance comparisons.

As previously mentioned, consolidated revenues for Q3 2011 were $47.6 million, an increase of 6.2% from the $44.8 million reported in Q3 2010. U.S. revenues were $32.7 million, representing 8.9% growth over Q3 2010. International revenues were $14.9 million, up 0.7% over Q3 2010 revenues of $14.8 million.

While we continued to see excellent performance in Japan, our remaining international businesses had a more difficult quarter with a number of situations where we anticipate seeing robust business activity in the fourth quarter that was originally anticipated in the third quarter.

Pro forma year-to-date revenues are up 8.2% for the nine-month period and U.S. pro forma year-to-date revenues were up 11.4%, significantly outpacing the growth of the category.

Gross profit for Q3 2011 was $30.2 million, an increase of $1.3 million over Q3 2010 of $28.9 million. Q3 2011 gross margin of 63.4% was slightly lower than Q3 2010 gross margin of 64.5%, but well above the 58.7% gross margin recorded in the second quarter of 2011, which included $2.7 million in write downs.

U.S. gross margin for Q3 2011 was 68.1% versus the 77.8% reported in the Q3 of 2010. U.S. gross margins are still being negatively impacted by reduced manufacturing activity that occurred during the first half of 2011. While this is a short-term impact and not indicative of a long-term trend, we anticipate that this will continue into the fourth quarter and offset the cost improvements we have been working to achieve and reduced expenses associated with the reduction in force that we executed in August.

Pricing in the U.S. has been relatively stable for the last two quarters, so our gross margin has not been materially impacted by price and we anticipate that this will broadly continue.

The international gross margin of 53.3% for Q3 2011 increased substantially on a year-over-year basis from 37.6%. In the prior year period we made a year-to-date classification adjustment between cost of goods sold and operating expenses following the Scient'x acquisition and the quarterly gross margin was negatively impacted in 2010.

On a sequential basis, the Q3 2011 gross margin improved from 50.1% reported in Q2 2011 and is attributable to regional mix in our continuing sales performance in Japan. Overall, we anticipate gross margins in Q4 to be in the range that we have experienced in Q2 and Q3.

Total operating expenses for the Q3 2011 were $32.6 million, an increase of $200,000 compared to prior year of $32.4 million and a sequential decline of $600,000 from the $33.2 million reported in Q2 of 2011.

Modest increases in R&D spending, as well as SG&A functions versus Q3 2010, were largely attributable to the expansion of our international direct sales and marketing organizations, as well as the administrative expenses required to manage the global business. Sequentially, we are realizing the impact of committed expense reductions across our business as a result of the graft gross margin pressure that we have been experiencing.

Net loss for the third quarter 2011 was $1.3 million, or $0.01 per share, compared with a net loss of $3.8 million, or $0.04 per share for the third quarter 2010. In Q3 we had a $1.5 million tax benefit that is a result of a tax settlement in France for years prior to the Scient'x acquisition and continuing tax losses in Europe.

Adjusted EBITDA was $3.5 million in the third quarter of 2011, a decrease of $1.8 million compared to the $5.3 million reported for Q3 2010. The decline in adjusted EBITDA is due to reduced gross margin versus Q3 2010 and a year-over-year increase in operating expenses to support globalization and new products that are not contributing as originally intended.

Adjusted EBITDA represents net income or loss, excluding the effects of interest, taxes, depreciation, amortization, stock-based compensation, and other nonrecurring items such as restructuring expenses, IP R&D, and transaction-related expenses.

Cash and cash equivalents were $22.1 million at September 30, 2011, which is a $300,000 increase from the $21.8 million at June 30, 2011. We generated $1.8 million in cash from operations in Q3 and we are on pace to be cash flow positive for the full year 2011. Sequentially, given the decrease in accounts receivable in September, we reduced our level of borrowing under the credit facility. We anticipate reversing this in the fourth quarter.

As of September 30, 2011 our net inventory position was $48.8 million, a modest increase versus Q2 2011. It represents 26% of annualized third quarter sales, in line with our inventory position reported in Q2 of 2011. Our net accounts receivable at the end of Q3 was $39.8 million, a decrease of $1.9 million or 4.6% versus Q2 2011.

Our day sales outstanding were constant versus Q2, which represents a solid performance given our geographic mix of revenues.

Despite the difficult environment, we remain committed to generating cash flow and improving our level of profitability. The reduction in force announced earlier in the quarter, while difficult, will begin to contribute in Q4 and more meaningfully into 2012 with annualized savings of almost $4.0 million. Clearly, the focus of our attention is managing the global gross margin of the business and the appropriate operating expense levels to ensure profitability going forward.

The action plans underway will lay the foundation for longer-term improvements in gross margin and operating expense leverage. In the immediate near-term, we will realize more moderate improvements in our key profitability metrics.

For full year 2011 we are updating our annual revenue guidance from a range of $195 million to $205 million to a more narrow range of $198 million to $202 million. We are revising our adjusted EBITDA guidance to a range of $15 million to $17 million, which is approximately 7.5% to 8.5% of revenue. We anticipate generating positive cash flow for the full year of 2011.

Guidance for fiscal year 2012 will be provided as part of our fourth quarter of 2011 earnings call.

Now I'd like to turn the call back over to Dirk.

Thank you, Mike. We're continuing to broaden our reach through the launch of products in the U.S. and international markets.

In addition, we are investing in building out our infrastructure and sales organizations globally. We have made significant strides in that regard in the third quarter and we'll continue to aggressively build out our footprint in 2012 as we look to strategically add to our feet on the street. An expanded U.S. sales footprint will allow us to rapidly capitalize on our new product introductions and continue to take share.

We're having notable success in Asia Pacific and in particular in Japan where the recent launch of our ILLICO MIS system into the Japanese market is propelling our growth rates. In Europe, we have a stable business from which to grow and with a fourth quarter launch in Russia we anticipate a potentially strong 2012, notwithstanding the macroeconomic environment.

We continue to harmonize our product portfolio and supply chain operations and with our cost-cutting initiatives we expect to begin to leverage our P&L in the fourth quarter and more significantly in 2012.

We continue to believe that the U.S. spine market has stabilized versus 2010. In the third quarter of 2011 we experienced a sequential decline in prices of less than 1.0% from the second quarter of 2011 and a low single-digit decline year-over-year.

Consistent with our comments from the second quarter of 2011 call, we expect the U.S. spine market to grow by 2.0% to 3.0%, to be driven by increased procedure volumes and offset by continued modest price pressure.

Internationally, we believe the European market will continue to be under pressure from potential structural healthcare budget reductions and we expect this market to be flat. Asia Pacific and Latin America continue to deliver robust market growth in the high single-digits.

While we are pleased with our growth rate versus most of our competitors and the overall market, which is a testament to our team and our products, we are increasingly focused on cash flow and profitability. Our three strategic initiatives are specifically targeted at achieving sustained profitability and free cash flow while continuing to take global market share.

Our ability to generate cash from operations in the third quarter is a positive sign and we look forward to sharing development of our profit initiatives with you in the future. We continue to be uniquely positioned to achieve our goal of being the leading independent spine company in the market.

Thank you and now I'd like to open the call up to your questions.

(Operator instructions) Bill Plovanic, Canaccord Genuity

Great, thanks. Good evening.

Hi, Bill.

Hi guys. So a couple of questions, first R&D is down a significant amount and I'm just curious. Is that part of the restructuring or what's driving that specifically?

Nothing specifically. It's not the restructuring, because we didn't really impact the R&D organization dramatically. It's more to do with the timing of investments and project management.

Okay and then, were there any restructuring savings in the second quarter?

In the second quarter?

Right.

We restructured in the --.

I mean in the third quarter. I'm sorry.

So I think what we said at the end of -- on the Q2 call, that we anticipated seeing very modest improvements. Obviously we took the restructuring charge itself at just under $400,000. We are seeing in September some of the benefits, but not material enough that you would, I would point it out specifically.

Okay. So it wasn't enough to offset the charge.

Correct.

Okay and then what was FX contribution in the quarter?

In the revenue contribution?

Yes.

So, in terms of the actual impact of foreign currency was 2.8% against a 6.1% growth rate.

Okay. I'll do the math on that. And then, you're rolling Solus out you said it's kind of an initial or beta or launch, in Q4, I mean, and then full rollout in Q1. Is that how we need to think about this?

That's correct. So we're rolling back out to the 20 U.S. and 5 international beta sites as we speak and look for full -- and basically we believe that we've got the instrumentation right, absolutely right, so this is really just sort of the initial rollout, if you will, with the full release in the first quarter.

And then my last question is just on Russia and any other geographies. You're looking at Australia. What is the kind of magnitude of the stocking orders for those certain geographies?

They can be quite large, obviously, because they need to establish a base level or product and obviously certainly Russia is a significant opportunity and we think we have a very good partner for the Russian market and Australia as well. Our partner is a very well established company that has a large -- has been in the market a long time. So, I don't think we want to give what the specifics are, but they're substantial, because we need to -- we expect to be able to launch aggressively into those markets.

Is this -- just on that, with -- you mentioned some of the orders at the end of Q3 were pushed off. Is this just because the Euro had weakened so much and then, as we rolled into October, and the Euro strengthened again, that some of those orders might come back? We did some of that in some of the other verticals in med tech that we cover.

Yes, I don't know if it was so much due to the Euro, to be honest. It was really more a timing issue, in terms of just getting them in the quarter. A couple were hinged on getting agreements signed, getting letters of credit in place, and that just took longer than we had originally anticipated.

Great. Thank you very much.

Thanks.

See you next week.

Raj Denhoy, Jefferies & Co.

Good afternoon, guys.

Hey, Raj.

I wonder if I could ask a couple of quick clarification on some of the product announcements. So the OsseoScrew, you mentioned now the FDA is wanting a trial, so perhaps maybe you could update us on what that looks like, the timing on that you think you might have to get back to the FDA for launch here in the U.S.?

Well, it's still very preliminary. What they indicated is that they would want a safety trial and we're trying to ascertain exactly what that means and what the criteria would be. So I don't have a lot of information at this point, but that seems to be where they're holding the line and so we're evaluating options in how we want to move forward.

Well, I guess the question -- but I mean the basic question is, is this still a product which given the continued, I don't know if push back is the right word, but certainly a higher hurdle at the FDA that you're committed to moving forward with getting it approved here in the U.S.?

Well, and obviously what we're seeing is very positive uptake in Europe. Europe, even though the numbers themselves of the procedures in Europe are not huge it's being seen as a go-to product. And what happens is it pulls our entire product line into the facility in a big way, so the overall contribution from the product is quite large.

So we still believe this is absolutely the right product to bring into the U.S. market and we will continue to work with the FDA till we get it approved. It obviously has been more challenging that we would have liked, but I don't think that that's different than most companies are experiencing today. There is a higher hurdle in terms of getting innovative technologies into the market.

We're very encouraged with our new Vice President of Regulatory, Fran, has already weighed in and I think will be extremely helpful in helping us find a path.

Okay. Maybe to segue to PureGen. Interesting you still see strong adoption. I think you said 1,000 cases (inaudible - background noise) last quarter, so people are still using it.

Right.

Despite the FDA having some questions. And I'm curious if you could even offer us anything more about what the FDA is -- what their stance is here. I mean, have you suggested any changes you might make to the label or anything that might get them satisfied or really something on the discussions would be very helpful.

Well, I was not at the meeting, but the meeting was very cordial, very open. They put forward their position. We provided all of the data that we had in terms of the extensive preclinical testing that had been done, the results of the safety data from over 300 patients, and I think the team was encouraged.

So -- but that's all we know at this point, so we've not heard anything back. They did request copies of our presentations after the meeting and we're really in a wait-and-see mode at this point. The only thing I can offer is they certainly didn't ask us to stop marketing the product, in the meeting.

Okay, just a couple more, sorry, but just on the U.S. market growth. I think it was around 9.0%, 8.9%.

Right.

A good number, but it was still, I think, almost exactly half of what you guys did last quarter. How much of it is that dynamic of when you sign a distributor, whether it's a stocking distributor? Because the growth is somewhat lumpy here and I'm just trying to get a sense on how we get comfortable with what that number looks like on a go-forward basis here.

Yes, the second quarter was particularly strong both in terms of number of procedures and just the overall business. It actually surprised us a little bit. The third quarter, of course, is always a little bit tougher because of seasonality. You have a lot of -- you have some key docs that take a month off for vacation. It has an impact and we certainly saw some of that. So we don't take the third quarter as sort of the new normal. It was lower than we had anticipated and certainly we see things progressing in the right direction.

And you would expect the number to be higher than the 9.0%, perhaps, or 8.9%, but lower than 17.8% as kind of something sustainable in the U.S. (inaudible - multiple speakers)?

With the sales people that we added, we don't expect to see a large contribution from them in the fourth quarter, but seasonably Q4 is definitely stronger, usually, than Q3. So, based on that, we would anticipate it being positive.

Okay. I'll let some others jump in.

I'd be careful, though. I'd be careful, though, Raj, that you look at Q2 and just compare that and say we get back to that kind of range in Q4.

Now, I wouldn't have done that either. I guess what I was trying to get at, though, is just when you guys are adding distributors. I mean, so many distributors are stocking distributors.

Yes.

And so there's probably an initial upfront order that skews that number higher. Again, in your commentary, you mentioned you're going to continue to be aggressively adding sales people and I imagine distributors as well. So that number will probably is going to be somewhat lumpy and I just was trying to get some clarity or deeper on what that might look like.

Right. I think the clarification is more on the distributors and representatives, as opposed to stocking distributors.

Right.

Okay, so you don't see expect to get (inaudible - multiple speakers).

(Inaudible - multiple speakers) might. I wouldn't want you to think that we're aggressively adding stocking distributors to the business. That wouldn't be a true statement.

Okay, well, that's very helpful.

Okay.

Okay, thank you.

Charles Chon; Stifel Nicolaus & Co.

Great. Thank you. So I'd like to start out just with the updated EBITDA guidance for the full year. I thought the Company had good visibility on the full year guidance coming out of the second quarter, but I'm scratching my head now trying to understand what exactly is driving the incremental spend, especially after the workforce reduction. And so, again, if you could just kind of take me through what were some of the things that were not contemplated in the EBITDA guidance at the time of the second quarter call, that's be really helpful. Thanks.

Yes. So, I think at the of Q2, what we did we adjusted EBITDA downwards for the inventory write downs that we looked at in Q2 and we were expecting the overall level of gross margin, both in the U.S. and internationally, to rebound faster than it did. So, if you look at -- if you actually look at the quarters two and three, particularly look at the operating expense line, sequentially we were down quarter-over-quarter and that even allows for a provision for the restructuring.

So, if you take out the restructuring as a one-timer, the underlying operating expenses Q3 over Q2, I think it's around $1.0 million pick up. So, clearly, the impact of the budgetary constraints that we're putting in across the business, and to Phil's earlier question, while why we're not seeing the reduction in force materially impact Q3, we will begin to see that in Q4. That explains part of the challenge.

So, as we came into -- as we came in or out of Q3, the gross margin was the piece where we were not as successful as we had anticipated and while we were taking costs out of operating expenses we weren't getting them out of stocks.

As I look forward to Q4, though, in terms of where we are, with the revenue guidance that we had with where I articulated, the gross margin we think is going to be in the immediate near-term and the continued impact of operating expenses, I'm certainly comfortable with the EBITDA range right now.

Would you be willing to -- so you brought the EBITDA margin down by, on the low end, about $7.0 million and the high end about $8.0 million. And so, again, as I think about the blocks that I should be using to bridge me from the previous guidance to this guidance, is most of the reduction coming from the gross margin, updated gross margin guidance? Or -- this is where I'm having a little difficulty trying to understand it.

It's a combination of the revenue projection, the gross margin assumptions and what I would characterize as continuing downward pressure on operating expenses.

Okay. Also, just for my second question, I just wanted to double check on international. Did those geographies in aggregate decline 8.0% on a constant currency basis?

International was down on constant currency basis, yes.

About 8.0%, right?

I'm just trying to -- I'm looking at the Japan versus international. Yes.

Okay and as a follow-up to the previous caller, did you -- were you adding any distributors outside the U.S. during the quarter?

We did not add any material distributors in the quarter of Q3.

Okay and --.

There were some that we would have liked to have had that we didn't get.

Right and Dirk, what does your crystal ball tell you about international going forward? You said the planned sales in the third quarter fell into the fourth quarter, but we've had anemic growth or basically year-over-year declines, on a constant currency basis, for a couple quarters now. So I'm just trying to understand where we think international could go as we exit the year and move into the first part of next year.

Well, obviously on a macro basis, Europe has been extremely difficult this year, as a number of the countries look to cut costs and certainly healthcare is being impacted, so that's something that we just had no control over, but certainly has had an impact. Some of it is timing in terms of getting product regulatory approvals, such as Latin American and Asia, that we're working through.

So we see 2012 continuing to be challenging in Europe until the microenvironment settles out, but we do see substantial opportunities in Asia Pacific and Latin American and so we believe, overall, we should return to growth.

In 2012?

Yes.

Okay and would we have to wait pretty much until the second quarter where we start to lap some of these year-over-year declines to see that growth?

We think, well, that the fourth quarter obviously is going to be better than the third quarter was, partially because that was due to rollover of some of the orders, but we're cautiously optimistic about 2012 internationally.

Okay.

And we don't want to get into describing one quarter versus another at this point in time.

Okay and my final question is just on the updated guidance for 2011, especially the topline, which implies a sequential acceleration in revenue growth for the fourth quarter. So, we had a tough quarter in the third. What exactly is the sequential acceleration, those assumptions based on -- are you anticipating some strong year-end seasonality here in the U.S.? Clearly outside of the U.S. we've got our challenges, so were exactly are we seeing some of this sequential improvement?

Well, I think part of it is that the third quarter was softer than we anticipated and so we saw more seasonality that may be particular in the U.S. to the particular surgeons that we have as high volume guys. And we see that sort of rebounding in the fourth quarter to more normal levels. So, if you look, certainly, at first quarter and second quarter, they were obviously better than the third quarter. And then you have a couple of the orders that rolled over and we see an improvement also, from a seasonality standpoint, internationally.

Okay, great. Thank you very much.

Thanks, Chon.

Thanks, Charlie.

Doug Schenkel, Cowen & Co.

Hey, good afternoon, guys.

Hey Doug.

Does your guidance incorporate any assumption that there will be a pickup in U.S. volumes in the U.S. in the fourth quarter due to the increased seasonality associated with really the dynamic of patients waiting to use up their deductibles and anything you can talk about there?

I mean, I don't know that I would put it down to that level of precision, to respond to your question, but clearly we see a response in Q4.

Okay. Do you guys expect -- I guess this is really a follow-up to Charlie's question. Do you expect organic growth over the next few quarters in Europe?

Well, we've certainly put a lot effort into the distribution network and the direct sales organizations there, particularly in the UK and Italy and so we can anticipate that those sales people will begin to contribute in a substantive way. We're also are in negotiating with our German distributor and so we think certainly incrementally we'll see improvement in 2012, but it also depends on the macroeconomic environment.

Okay, that's fair. Do you -- I guess maybe along those lines of just thinking about the productivity of the infrastructure over in Europe. You talked about some pretty nice growth when it came to OsseoFix, sequentially. Are there signs that that is actually opening up doors for you in terms of actually selling other products? Is that trend continuing?

Yes it is.

Yes. That's been very favorable. I mean, leading with OsseoFix and our OsseoScrew in Europe has been extremely beneficial in terms of establishing Alphatec's image in the European and international markets as an innovation leader. And following that up, then, with products like ILLICO, which is an absolutely phenomenal MIS system, and some of the newer products that are now coming out, like Solus, rolling out we think continues to open doors for us.

I mean, realize too, in Europe in terms of the Alphatec products there's also a timing issue with tenders and a lot of those tenders are coming up sort of around this time of the year in the first quarter. They're multi. They tend to be one, two, or three-year tenders and we feel very good about where we're at in terms of the getting accepted on those tenders. So that should also help us going forward to hopefully accelerate things.

Yes, no, that was kind of -- that's where I was going next, because it does seem like, with some of your higher profile products, that you're actually doing pretty well over there. Obviously the European numbers aren't where you'd like them to be, but I just wonder if some of your success in terms of opening the doors with these products, is being masked by a combination of the macro and the fact that you do have to wait for these tenders to come.

Absolutely. That's correct

Okay and maybe if I could just sneak in one more? Your gross margin in the U.S., as you guys have acknowledged it, it's not where you guys want it to be. It's down pretty significantly year-over-year. Do you have any expectation that this can get back, at least into the 70%s over the next few quarters? Is that a good goal that you think is attainable?

Yes. I don't want to get pegged down on a percentage in the quarter, but clearly in the back half of last year we benefited substantially from the production volumes that we had in the early part of the year. I'll caution we don't want to manufacture to building inventory. That's not the purpose. But we did -- I would expect to have -- U.S. gross margin should be north of 70%.

Okay. Thanks for taking the questions.

Okay.

(Operator instructions) Vivian Cervantes, Kaufman Brothers

Hi. Thank you for taking my questions.

Hey, Vivian.

Wanted to check in a little bit on 2011 revenue guidance. Given some of the things that have already discussed, some snap back in demand from Q3 to Q4, the opportunities in Russia and Australia and more favorable seasonality both OUS and U.S., why did we narrow revenue guidance then? Is that conservatism on your end or is it just conservatism, really?

I think the way that we were looking at it is that with nine months under our belts, we should have line of sight to a revenue projection that didn't have potentially $10 million of variability in it. So, I think we looked at the range of possibilities as we looked at the range of issues that are in front of us and we thought that narrowing the range was more appropriate, given where we are with the experiences that we've had to date.

So I think that if you think about modeling out Q4 on the back of a Q3 that we've just delivered and having a $195 million to $205 million as your P&L projection, it would give you some results that probably don't really make as much sense given where we are.

Okay. That sounds fair. I got you. Some conservatives and then, in part, really narrowing that variability. On Solus, appreciate your comments on some of the initial launch in Q4. Given what's been going on in the spine markets, do you still see the same opportunity for this product, U.S./OUS, as you begin your initial launch in Q2?

Well, obviously there has been some pressure certainly on approvals and for degenerative disc disease, which primarily impacts the lumbar area and so specifically targets ALIF procedures, which are lumbar procedures, but we really think it is a next generation type of product in terms of the single step and the way that it works. So it continues to be a large market opportunity, so we're not really discouraged by the fact that there's been some push back on surgical approval rate. We still think that the product has the ability to take market share.

Okay. I wanted to clarify OsseoScrew and ongoing discussions with the FDA. I know clarity isn't really there and it's still a moving target, but does it sound to you more like a 510(k) with clinicals, as opposed to an outright PMA?

Well, I think that depends on which route we go and where the discussions with the FDA go. With the current indications or the current submittal, it's a 510(k) with clinical. And as I indicated, they're primarily interested in a safety study, which we're trying to quantify what that means exactly, but we're evaluating our options. And we'll know a lot more certainly over the next coming couple of months and as we continue the discussions and weigh the different options and the opportunities and costs of those options.

Understood and my final question and I apologize. I want to just jump back real quickly on Solus. What is your expectation on physician learning curve and using this device? I know it's a one-stop, one-step solution, but I know that there's the ability to do reinforcement if needed. Just walk us through your thinking on the training process and the learning curve.

Yes. The learning curve is really quite short. It's really learning the sequence of the instrumentation. The procedure is basically a standard ALIF procedure. The tools are well adapted for what the surgeon normally does and actually simplifies what he has done traditionally, especially if he's using a product that requires multiple screws to secure it into the vertebral bodies. So it's not like we have do a cadaver lab training. It's really an in-office sawbones training, just so he gets a feel of the sequencing of the instrumentation.

Very helpful. Thank you. I'll get back into queue.

Okay, thanks.

Mark Landy, Summer Street Research

Good evening, folks.

Hey Mark.

Hi Mark.

Hey guys. I'm sorry if I've missed this. I'm dragging a couple of calls, but did you provide an update on PureGen?

We did. We indicated that to date we've done over roughly 1,000 patients, that we had a meeting with the FDA in regards to the untitled letter that our partner received in June. It was a very constructive meeting. We presented our data. We presented safety data on over 300 of the patients that have been treated, which compares very favorably to any other type of bone grafting that a surgeon would use. And it was a cordial meeting and now we're basically waiting to hear back from them on next steps.

Any thoughts on the timeline for resolution? Is it just sitting in kind of never-never land in terms of the responses and the replies?

It could be very quick or it could take some time. It really depends on what they're looking at within the FDA, so we're certainly waiting for their response and we'll act appropriately once we hear it.

Okay, great, guys. If I could move just on to manufacturing productivity and gross margins? At what level of just procedure volumes, generalized procedure volumes would you start seeing some benefit in just terms of volume production versus having to right-size manufacturing to take care of declining volumes?

Well, we think we have our facility right-sized at this point and really, as Mike mentioned a couple of times, we had a significant ramp up in early 2010. Obviously the market was still growing at a much faster rate. We were growing at a much faster rate and we were building in anticipation of that continuing. Then the market dynamics changed quite substantially and so we had a fair amount of inventory on hand that you can see that our inventory's come down.

We feel now that we're through that. We still are dragging some negative absorption into the fourth quarter, but in terms of our production volumes, they've come back up to normal levels. So we don't expect, at the present levels, to continue to build negative absorption, if you will.

And I think that some of the programs that Dirk was alluding to earlier, in terms of being able to bring capacity into the facility is also going to help us get there quicker than we would by the natural evolution of the category.

So that was kind of a follow-up that I had. In terms of those products that are coming in, at what yields -- how quickly will you get to the yields required to see an impact and are they finicky products to manufacture or are they really just straightforward so that your rejection rate would just really be in line with what your current rejection rates are? Or is there a learning curve in ramping up that manufacturing?

It's actually -- the answer to your question is it's complicated. It's both. And the products that we're certainly looking at initially are ones that we already manufacture comparable products currently and those are relatively straightforward. Nothing is fast in terms of moving production, but those are relatively straightforward and there are other ones that will talk a little bit more time.

(Inaudible - multiple speakers).

But our goal, certainly throughout 2012, is to move as much of that volume internally. It obviously has a huge benefit in terms of capacity utilization, which we have plenty of in Carlsbad, but also just in terms of cash flow because we're no longer purchasing finished goods. We're basically just laying out the cash for raw materials and there's a huge difference.

Okay, understand. And then the last question relating to the gross margin. If we do see some lumpiness in procedure volume in 2012, will the gross margin follow that given capacity utilize? Or do you think you can smooth that out through the year to something that's more normalized?

I would like to say I'm ambitious enough that we would want to try and smooth that out.

Okay, in reality?

Yes. I think, for example, before I became part of the Company, if you told me that we would have seen the kind of volume swings year-over-year that we've experienced, it probably wouldn't have been a normal thing to predict, but we had it, right, and we had to deal with it. And we are dealing with it. I think, if you look at the underlying growth rates in the categories around the world, to the extent that they stay somewhat stable over the course of the year, I think we'll be okay.

Okay, thanks guys. Thanks for answering my question.

Okay, Mark.

Thanks.

I'm not showing any further questions in the queue. I'd like to turn it over to Dirk Kuyper for closing comments.

Thank you. The takeaways from the third quarter is that we continue to experience strong topline growth and then particularly in the U.S. We were cash flow positive in the quarter and generated $1.8 million in cash flow from operations.

As we strive for operational excellence, we are taking the necessary steps to improve our cost structure and manufacturing efficiencies. With our broad and differentiated product portfolio and new product pipeline and global distribution platform, we are uniquely positioned to take market share.

Thank you very much for joining us this evening and good evening.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Everyone, have a wonderful day.