Alphatec Holdings Inc (ATEC) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. I'm Mark Francois, Senior Director of Investor Relations for Alphatec Spine. Thank you for joining us today for Alphatec's Conference Call to discuss our Second Quarter 2012 Financial Results. Speaking today will be Alphatec's Chairman and Chief Executive Officer, Les Cross and Mike O'Neill, Vice President and Chief Financial Officer. Also on the call with us is Ebun Garner, our Chief General Counsel.

During our prepared remarks, you'll be in a listen only mode. After our prepared remarks have concluded, we'll open up the call for your questions. As a reminder, this conference call is being recorded today August 7, 2012 and a replay will be available later today on our website and will remain on the website for the next 30 days. Before I turn the call over to Les, I must remind you that today's conference call contains forward-looking statements made under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Such statements relate to the Company's operational initiatives, product development activities, sales and marketing strategies and projections for 2012 and sales and operating results.

Adjusted EBITDA growth, net earnings and economic, commercial market conditions are also part of the forward-looking statements. These forward-looking statements are based on the Company's current expectations and are subject to a number of risks, uncertainties and assumptions that could cause the actual results to materially differ from the forward-looking statements. The Company undertakes no obligation to update any forward-looking statements whether a result of new information, future events or otherwise. Many of these risks, uncertainties and assumptions are discussed in our 2011 Annual Report on Form 10-K for the year ended December 31, 2011 filed on March 5, 2012 at the Securities and Exchange Commission as well as our other filings on Form 10-Q and periodic filings on Form 8-K. Our SEC documents (technical difficulty) available on our website at www.alphatecspine.com.

And with that, I'll turn the call over to Les.

Thank you, Mark. Good day, everyone, and welcome to Alphatec Spine's second quarter 2012 conference call. The second quarter of 2012 marks my first complete quarter as the Company's new CEO. When I became the CEO of Alphatec earlier this year, I set a clear agenda to strengthen the sales and profitability of our organization. And these decisions were based on my years of success at DJO where I led the company's turnaround in 2002 and continued the global expansion of the company until my retirement in 2011.

In a short period of time, we have accomplished a great deal to help us build a new foundation that should strengthen our future revenue growth and continuously improve our profit margins. I did not expect the Company to transform itself in a single quarter. I do, however, continue to expect the Company to achieve measurable progress each quarter with our initiatives to drive global sales growth and strengthen our margin structure. We have executed well against many of our corporate initiatives in Q2 and in this context our second quarter was successful.

So what we have done in Q2 -- so what have we done in Q2 to change the momentum of Alphatec moving forward? First, we need to stimulate sales growth. Throughout my career, I have successfully scaled businesses through acquisition of companies and new products to accelerate top line growth and improve profitability. I am pleased to announce that in Q2 we acquired the exclusive U.S. distribution rights to sell under our own label, a patent protected and FDA-cleared synthetic biologic product for use in posterolateral spine fusions. This synthetic biologic has demonstrated success in clinical studies and in surgical cases. We believe the product's addition positions Alphatec's biological portfolio as one of the most comprehensive in the industry.

Synthetic bone materials are rapidly gaining preference in the operating room as they provide excellent bone fusion results with distinctive advantage of our other fusion solutions. As a result, synthetics are one of the fastest growing components of the spinal orthobiologic space and the subcategory is continued to expect to grow at a compound rate of approximately 10% over the next five years.

As many of you know, the spinal orthobiologic market is estimated to be approximately $2 billion annually in the United States. The synthetic product accounts for approximately $300 million of this market. So we are expecting great things from this new product. In addition to acquiring the distribution rights to this synthetic biologic product, I am very pleased that we have signed a letter of intent to acquire the assets of an excellent small spinal implant business. We hope to close the transaction in a month or so after we complete definitive documents, finalize our due diligence and the customary closing conditions. We expect this transaction to be accretive to the Company in 2013 and will have a meaningful impact on the revenue of the Company once completed. I am extremely excited about this potential deal and how it will help transform Alphatec Spine.

To further accelerate revenue growth, we have made headway with our global distribution strategy. Late in the second quarter we signed several new U.S. distributor agreements that should benefit domestic sales with a ramp that begins in Q3 of this year. On the important international side, we have also strengthened our sale with the addition of new distributors in Austria, Switzerland and certain other countries. The international business represents about a third of our revenue and is an incredible opportunity to accelerate the growth of our business.

As a final point on revenue growth, in Q2, we refinanced our credit facility, providing us with greater borrowing power at a lower cost. It also provided us with additional cash. This combined with the unused $25 million equity line of credit that we put in place last quarter, we now have the financial flexibility to increase our investment in new instrument sets, both for our Trestle Luxe and Illico products that really has worldwide increasing demand, as well as to continue to be -- to make acquisitions of small companies as they present themselves.

On the operational side of our business, we made significant progress in Q2 to drive lean practices throughout our U.S. supply chain and in doing so achieved our goal of $2 million annualized saving that we set for ourselves earlier in the year.

Our operation team has begun the next stage of our cost-saving initiatives and should drive additional margin improvements throughout the year. Over time these important initiatives should help us achieve our long-term goal of greater than 20% non-GAAP adjusted EBITDA margins.

To add considerable depth to our already great operational team I'm extremely excited to announce the appointment of Luke Faulstick to our Board of Directors. Luke is a recognized leader in transforming businesses into global, scalable, customer focused, lean enterprises. It has been my great pleasure to work aside -- alongside Luke for the last 10 years or so while we grew the DJO Global business. Welcome, Luke.

One of the goals that we have identified to better utilize our manufacturing assets is by in-sourcing more of the products that are currently outsourced to third-party manufacturers. During the second quarter, we completed the manufacturing validation of our Trestle Luxe product, our new anterior cervical plate. We're now internally manufacturing a portion of these plates which will have a significant improvement on margin as this is one of our fastest growing products.

As a result of our collective operational improvements, our gross profit margin for Q2 in 2012 improved 390 basis points compared to Q2 2011. Our gross profit margin for the first-half of 2012 improved by 260 basis points compared to the first-half of 2011.

Our operating expenses for the first half of 2012 were $1.6 million lower than compared to the first half of 2011. While we still have much more work to do, with our expense control, we are very pleased with this progress.

Our adjusted EBITDA for the first-half of 2012 improved by $1.8 million compared to the first-half of 2011. And also we generated $2.4 million in operating cash in Q2. Moving forward, we should expect to see even greater operating leverage as our sales growth accelerates in the manner that we expect and now with these acquisitions, we are extremely confident of getting those sales moving.

To reinvigorate the flow of new products developed and commercialized by Alphatec Spine, we have reorganized the product development process to resource those few critical projects that we believe represent the best potential. And you'll remember, we streamlined our R&D project list down from 24 products to eight and we're making great product process getting those out. This does include the partial redesign of the important Alphatec Solus system. I am pleased to say that we have completed our design changes to the system and we expect to file for a new 510(k) for the system by the end of this year. Given the agency's time for reviewing these type of applications, we should expect to have Alphatec Solus back on the market in the U.S. sometime in the first half of next year. We do, however, intend to launch this product in Europe at the beginning of Q4 this year.

Regarding Orthofix, more exciting news, we received conditional FDA approval to begin the Orthofix multicenter pivotal IDE clinical trial of 400 patients in 25 sites. As you remember, OsseoFix is an innovative treatment for compression fractures of the spine, a common injury afflicting approximately 700,000 osteoporotic and aging spine patients annually. Its sister product, the OsseoScrew, a game-changing pedicle screw technology for patients with low bone density. This product continues to do well in Europe. But in the U.S., we have concluded that our best course for regulatory approval is to redesign the current product and we are moving full speed ahead on this redesign.

At the same time, as we're redeveloping the screw, we will also design a novel tool for removing the screw should it fail further request of the FDA. Aside from the products just discussed, we are still expecting to launch several new products and product line extensions in the second half of the year to pick up our revenue growth rate in the second half.

Now I would like to provide an update on the leadership transition we announced several months back. As stated in today's earning release, Dirk Kuyper and I have mutually agreed that Dirk will leave the Company and step down from the Board of Directors and this will be effective today. I personally want to thank Dirk for his commitment to Alphatec Spine and its growth over the last five years. The Company wouldn't be here without Dirk -- all Dirk's hard work, and recently for helping me manage through this leadership transition. In light of this news, I will assume the responsibility for Alphatec's commercial operations in the U.S. and Japan and our global marketing efforts.

I'm very pleased to announce that Pat Ryan, our Chief Operating Officer will assume responsibility for our international sales organization, and as such, will add the title President International to his position as Alphatec Chief Operating Officer. Pat will also have responsibility for the [EMEA] markets, Latin America, Asia Pacific with the exclusion of Japan. These responsibilities are in addition to his current responsibilities for research and development and global operations. To ensure a smooth and effective transition, Dirk will remain as a consultant of the Company for a period of time.

While we acknowledge the market's headwinds and the continued challenges to our business, we are pleased we are making good progress on a number of exciting fronts. This is at the same time we are generating tangible improvements to our margin structure through our ongoing operational excellence initiatives. Our revenue growth does not yet reflect the investments we are making, but it will and we believe we will see this pay back in the second half of 2012.

With that said, I'm pleased to turn the call over to Mike for a discussion of our second quarter operating results.

Thank you, Les. The following remarks are related to our reported operating performance for the quarter ended June 30, 2012. With regard to our Q2 sales results, as is widely recognized, spine markets continue to be challenged by lower pricing and declining procedure volumes. Given these market conditions, our second quarter sales results were similar to those of our first quarter this year. Global net revenues totaled $48.2 million and compared sequentially to the $48.5 million for the first quarter of this year with foreign exchange rates accounting for the difference.

Compared to the second quarter of 2011, a strong quarter for Alphatec and a difficult comparison period, consolidated net revenues for the second quarter of 2012 were down 5.2% or 3.6% on a constant currency basis. U.S. net revenues totaled $32.9 million, slightly higher sequentially than Q1 of this year and were driven by continued growth within our cervical line of products including Trestle Luxe and our biologics portfolio, which again achieved strong year-over-year and sequential quarter growth.

International net revenues totaled $15.3 million and continue to benefit from strong sales growth in Japan, in spite of absorbing an 8% reimbursement decrease that was mandated by the Japanese government beginning April 1 this year. As Les mentioned, O-U.S. sales also benefited from the addition of several new distributors in Europe, although weaknesses in other geographies, including certain countries in Europe continue to offset the progress we are making. Overall, on a constant currency basis, international net revenues for the second quarter of 2012 were lower by approximately 1% as compared to the second quarter of 2011.

Gross profit for Q2 2012 was $30.2 million or 62.6% of revenue compared to $29.9 million or 58.7% of revenue in Q2 2011. The gross margin improvement of 390 basis points from the second quarter of 2011 is primarily attributable to operating efficiencies, regional sales mix and a reduction in inventory write offs. Excluding the $1 million in intangible asset amortization associated with the Cross Medical statement -- settlement that I will discuss in a moment, gross profit and gross margin would have been $31.2 million or 64.8% respectively.

Included in Q2 2012 gross margin is a provision to write off certain Alphatec Solus inventory associated with the recent redesign as well as inventory costs associated with our ongoing international product rationalization program. These costs represent almost $1 million or 200 basis point of margin. Following our comments at the end of Q1, our underlying gross margin performance is in line with expectations and we are seeing the positive impact of our efficiency efforts and less volatility associated with manufacturing throughput.

As we will highlight each quarter, we announced on January 5, 2012 that the Company reached a global settlement agreement with Cross Medical Products regarding a license agreement dispute initiated by Cross Medical and a patent infringement dispute initiated by us. As part of the settlement, we agreed to pay Cross Medical $18 million and we made an initial payment of $5 million in January 2012.

In addition to the initial payment, we will make 13 payments of $1 million per quarter thereafter, starting with our August 1, 2012 payment. From a P&L perspective, the Company has expensed $9.8 million in the fourth quarter of 2011 which was charged to operating expenses as a legal settlement. Of the remaining $8.2 million, $8 million will be recorded as a licensed intangible asset to be amortized over the next seven quarters beginning with Q1 2012 plus an associated interest of $200,000.

A non-cash charge of approximately $1 million per quarter of intangible asset amortization will be reflected in cost of goods sold. However, these amounts will be added back as part of our adjusted EBITDA calculation. U.S. gross margins for Q2 2012 were 68.6% versus 62.9% reported in Q2 of 2011. When adjusted for the amortization impact of the Cross Medical settlement, U.S. gross margins would have been 71.8%, representing ongoing operational performance well ahead of the prior year period. International gross margin of 49.6% for Q2 of 2012 versus 49.9% in Q2 of 2011 reflects the continuing positive performance of Japan offset by lower margins in the other areas of the world. The performance in Japan continue to be impressive in light of the reimbursement rate cut that I discussed earlier.

Looking at our gross margins sequentially in 2012, our Q2 margin of 62.6% compares unfavorably with our Q1 2012 margin of 65.7%. After adjusting for the previously mentioned provisions in Q2, our underlying gross margin was 64.8%, consistent with the comments we provided at the end of the first quarter.

Total operating expenses for Q2 2012 were $33.9 million, an increase of $800,000 compared to prior year of $33.2 million and were primarily attributable to an unexpected increase in legal expenses related to several litigation matters and our financing activities. GAAP net loss for the second quarter of 2012 was $6.4 million, or $0.07 per share, compared to a net loss of $3 million, or $0.03 per share for the second quarter of 2011. Net loss for the second quarter of 2012 included $2.9 million or $0.03 per share related to the refinancing of the Company's credit facility of which $2.3 million is related to an early termination fee and $600,000 was related to the write-off of unamortized debt issuance costs.

Adjusted EBITDA in the second quarter of 2012 was $2.7 million, or 5.7% of revenues, compared to $2.7 million, or 5.4% of revenues reported for the second quarter of 2011. Adjusted EBITDA represents net income or loss excluding the effects of interests, tax, depreciation, amortization, stock-based compensation and other non-recurring items such as restructuring expenses, in-process R&D and transaction-related expenses.

The reduction in adjusted EBITDA versus consensus expectations is primarily a consequence of the sales performance of the Company. Cash and cash equivalents were $22 million at the end of June 30, 2012, which is a $1.3 million increase in the $20.7 million reported at December 31, 2011. The Company's cash position at June 30, 2012 reflects a payment of $5 million to Cross Medical in January 2012 as part of the settlement discussed above, offset by positive cash from operations and our June refinancing with MidCap Financial. The refinancing with MidCap increased our asset borrowing base providing us with a net increase in cash of over $5 million after repaying our obligations to Silicon Valley Bank.

We remain committed to generating positive cash flow and improving our overall level of profitability in 2012. As of June 30, 2012, our net inventory position was $47.4 million, a decrease of $700,000 versus Q1 of 2012. Our net accounts receivable at the end of Q2 2012 were $38.8 million, a decrease of $2.9 million, or 7% as compared to Q2 2011 and a $1.8 million or 4.4% decrease sequentially from Q1 2012. Similar to the first quarter of this year, our sales performance in the second quarter of 2012 reflects a challenging spine category and a robust prior comparable period.

We continue to lay the ground work to strengthen and streamline the operating structure of the Company and hence the overall profitability of our business. We have made substantial progress as Les has outlined, and in this regard, we are benefiting our P&L, balance sheet and operating cash flow.

Now our guidance for 2012. As we stated last quarter and as Les reiterated earlier, our financial guidance has continually been back-end loaded in 2012 based on anticipated revenues from new products, which we still expect to launch this year to drive revenue growth. As we now revisit our guidance based on our revenue results for the first half of 2012 and given the market's lack of fundamental improvement, we are making some adjustments to our earlier revenue guidance of $204 million to $209 million. For full year 2012, annual revenue guidance will be in the range of $196 million to $204 million or minus 1% to plus 3% growth over 2011. Adjusted EBITDA guidance will be in the range of $20 million to $24 million or 10% to 12% of sales.

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

Great. Thank you, Mike. In closing, transformation of Alphatec Spine continues to progress. We believe that we are making solid progress to strengthen our revenue and operating performance. You should expect us to continue to increase our global reach with new distributors in the U.S. and beyond. You should expect us to continue to focus on a continuous flow of new products to assist in our revenue growth. You should expect us to continue to focus on driving down costs in our manufacturing facility and lastly, the financing our credit facility and the establishment of the equity credit line has strengthened my ability to capitalize on the spine market's consolidation that is going through providing us with the flexibility to scale Alphatec as we find interesting accretive acquisitions of companies or product lines.

So with that said, I would like to ask Patrick to open the line for questions. Thank you.

(Operator Instructions). Raj Denhoy, Jefferies.

Hi, this is Amy in for Raj.

Hi, Amy.

Hi, I guess if I could just start off with the U.S. business. It did take us bit of a -- it's flattened and it was sequentially flat. And I know (inaudible) was called out as one of the factors limiting growth in Q1 and getting that back on the market; can you talk a little bit more about what factors may have influenced growth in the U.S.?

Sorry. Just -- yes, so the area that we were pleased about in Q1 was our overall -- our biologics business continues to do well. However, I think it's fair to say that in our core hospital business, we certainly -- we clearly saw some pressures that we haven't seen as much in previous quarters. We do keep a very close eye on pricing and I will say that while we saw a slight deterioration in pricing in our hospital business in Q2, it wasn't something that was dramatically out of line. So it was low single digits if you look at the year-over-year comparison.

I think our -- some areas of our business that are doing well. I think Les alluded to Trestle Luxe which continues to perform well in the marketplace, but albeit, obviously we have our existing Trestle business. Illico continues to perform well and I think some of our interbody business has been under pressure in Q2, most of them we saw in Q1. So a mixed bag from my perspective and I think that -- I think we can attribute it to some internal issues as well as the overall category dynamics.

But I think, I mean clearly looking at our lineup of distributors and the fact that we're identifying and signing up some additional distributors is an indication that we're not happy with the underlying performance.

Great, thanks. And then maybe one on operating expenses. Those I believe you attributed largely to increased legal costs, but those took a step up this quarter. Is this and with new R&D with the OsseoFix trial starting up soon, should we expect OpEx to run at this rate moving forward for the rest of the year or perhaps take a little bit of step down as operational [if with] all your cost-saving efforts falling into place?

Yes, so I think I would say that overall, for example in the area of R&D, we were comfortable with the level of expense. Having said that we're going to see an increase in our clinical trial costs. So that needs to be factored in. I think overall in the G&A area, I'd like to think it was a bit of a high watermark and we're actually taking steps to reduce some of those costs as we stare out to the rest of the year. So I would expect it to come down as we go forward from here.

Okay. Great. And then just last one on Solus inventory. I know last quarter I think it was talked about that there wouldn't be any write-off of any substance regarding Solus inventory, yet this quarter there's a pretty substantial inventory write-down. Does that right-size any outstanding Solus inventory or should we expect to see any further write-offs moving forward?

Yes, so I think that obviously while we communicated on the last call, was we didn't anticipate any write-offs of any substance and that's fair. At that point in time, we had not completed the final field failure analysis of Solus. And it wasn't until we got through that, the decision was taken that not only would we end up having to redesign the instruments, we would have to do some redesign on the implant as well. Given the fact we had curtailed and our instrument investment have been modest, the vast majority of this write-off was associated with the existing inventory that we're no longer able to use. So, I think at this point in time I realize it's a hollow promise, I do not anticipate any additional Solus write-offs, that we're still going through the redesign and getting it ready for launch, but at this point in time, no. I think we're done.

Okay, great. Thanks so much.

Matt Dolan, ROTH Capital.

Hi, guys. Good afternoon.

Hey, Matt. How are you doing?

Good, thanks. First question is on guidance. Just looking into the second half of the year, it's been looking over the past several years, there is typically a seasonal downtick here in Q3, which at the midpoint would suggest a big tip-up in Q4. So can you walk us through what the assumption is there, is that market share gains, just a little more color on the pacing (inaudible) would be helpful.

Yes, so I think -- so combinations of adding new distributors in the U.S. as well as outside the U.S., so we added some late and they're continuing to perform in Q3. Continuing to focus on Luxe and Illico specifically as products that we believe are making a meaningful difference in the marketplace. And as we think about some of the challenges we've had in Q2, we also want to be able to, my phraseology is regain some share. I think that it's not just a category issue. And I think that Les articulated in the call earlier about the acquisition of a new synthetic, we do have some 2012 business that's now included in there as well. So we're quite well aware of the Q3, Q4 splits and certainly the seasonality is specifically where it impacts us in Europe, but we're comfortable with the ranks that we have given the new product activity and the new distributor activity.

Okay. So does Q3 come down from the Q2 level though in aggregate revenue?

No. Not finding that at this point.

Okay. And then on the acquisitions, is there any more color we can get in terms of the magnitude of revenue that's being contributed from either of these deals and how that will be funded?

So I think in 2013, if I think about the bigger of the two deals, I think that in order for us to feel comfortable talking about it today, we believe it's going to add meaningful revenue in 2013. Material for us is defined as 10% of our business. We're not quite at that level, but we believe in the outer years that there is going to be a meaningful contribution for us on top line as well as accretive in 2013 on the bottom line.

In terms of how we pay for it, by virtue of accretive, we're obviously looking at over the bias towards issuing stock to pay for the deals and to the extent that there is a cash contribution, we are handling some of those cash requirements with either the extended credit facility that we've just got or also using some of the equity line that we got into at the end of Q1. So I think that that's how we're looking at some of these proposals.

Okay, so they are within the means of those two items. And just a point of clarity, accretive you're saying is defined as additive to EBITDA not on a per share basis?

It's additive to EBITDA in absolute dollars and it's additive to the earnings on a per share basis.

Thank you.

Matt Miksic, Piper Jaffray.

Hi, can you hear me okay?

Yes, Matt. How are you?

Fine, thanks.

Question for Les please.

(technical difficulty)

[He had a] drink, he is fine.

Yes, I'm fine, on a relative basis, I guess. So changes in the competition and through the competitive landscape in the quarter, you mentioned a number of things sort of impacting your growth product oriented and otherwise, but I'm wondering maybe, Les, as you look at this business, it was sort of another sort of [sideways] quarter, it looked growing below the market. You're talking about adding new distributors, but some of the sort of key products, differentiated products that you're looking to drive the business are still kind of out a few quarters. Just how do you think about your competitive positioning in the market? How do you move the needle when you're sort of you're -- and how do you attract distributors when you have a bag of products that's sort of -- that needs to be kind of restarted or invigorated? And I have a couple of follow-ups.

Well, Matt, I'm not sure I agree with your description of the product range. It's clear that we have self-inflicted wounds from not getting some of the new products out there. But Trestle Luxe is doing incredibly well. Illico is the most successful product we have on a global basis. And in fact we're flat out here really trying to supply the global demand for those two products. So we definitely have competitive advantages there.

Our biologic products continues to grow very, very, very well actually. And now adding the synthetic really gives us a very complete offering that actually will help us attract new distributors. The distributors that are coming to us are being disrupted by the mergers that are happening in the marketplace. So these are good quality distributors being displaced by companies merging and they actually look at our product line and see it as quite a competitive product line and are happy to come over and join us.

So, the product range we offer today is competitive. It would be better if the Soluses of the world had to come out on time, but it didn't. But I think the process we're putting in and the people we're putting in place will accelerate the launch of new products and will give us a continuous flow of new products starting really at the end of Q3 and will go right through 2013.

Competitive pressures, our problems have ever so been self-inflicted by not getting some of these products out on time and I really think that's part of what you're seeing in our numbers and that we have a process in plan to fix.

So it's the anticipation of these things coming later in the year, the synthetic bone grafts, having that in place as you say heading into next year. That prospected enough to sort of -- to bring in on the folks that you feel that you need?

Well, it's enough for them to come on and be excited. But as I say, Illico and Trestle Luxe aren't products to be minimized. They're both very, very successful, high-quality, innovative products. And yes, these distributors are happy to join us and trust me, they can shop. When a distributor wants to move, they have other options. And as I say, a number of them in this last quarter have chosen us. So I actually see that as a very positive sign.

Okay, that's fair. And then I was wondering impact in the quarter in -- let's bring up another sore subject, but the trend of physician-owned distributorships in the market seems to be kind of flat. I'm wondering if you are still in the process of -- is that a flat part of your business? Is it a part of your business that you're sort of tightening around? Did it have any impact in the quarter? And then I have just one follow-up, if I could.

So physician-owned groups, it's kind of regional in some areas. I'd say it's going backwards, in some other areas, it's growing. So until there is a ruling, I think they will continue to be effective lots until the government steps in, our sales because you remember we put in a policy of exactly the kind of physician-owned distributorships that we would do business with. And so we don't do business with a lot regardless of what our competitors say. Our POD business is declining. But in some areas, it is on the increase for sure, but unless they meet our code of conduct standards, we don't do business with them.

But in total you'd say it's declining?

Yes, I mean we've been very public that it's meaningfully less than 10% of our revenue on a quarter-to-quarter basis. And our Q2 contribution from those channels of trades are down versus prior year.

That's helpful. And then just if I could one just an update on pricing. Any significant change that you saw in the quarter? Are we still in that sort of down mid single-digit range, any update there would be helpful?

Yes. So we -- so year-over-year U.S. hospital, we were down low single-digits. And that's where we've been for the last couple of quarters and we had some modest price declines in Q2 over Q1 sequentially. I think that there's been certainly some anecdotal information coming in that there is pricing pressure building up again. But obviously, that's a forward-looking impact as opposed to -- compared to a prior period. So I think that pricing continues to be generally downward trend, mid-single-digits on an annual basis.

Okay. Thanks so much.

Thank you.

Josh Jennings, Cowen & Company.

Hi. Good evening, gentlemen.

Hey, Josh.

Just a follow-up on -- how are you guys? Just a follow-up on the POD question, [I explained] earlier and it's understanding that the OIG advisor opinion and potential Center of Finance Committee hearing on PODs it has been pushed out and no action will be taken prior to the election and most likely until first half of next year. I guess first, is that what you're hearing as well? And then secondarily can you just give us an idea of what your expectations are in terms of the role, possible plans by the industry over the next five years and if there is an increasing role, are you willing to increase your exposure if the government doesn't deem (inaudible), statutes and thus inappropriate?

Well, so how long is a piece of string, right? Yes, we agree that the regulatory -- we're hearing the same news about the -- when the government is actually going to rule on this like everything else. I guess it's going to have to wait till up to the elections. Hospitals are refusing to do business with PODs. I think if anything is probably a growth barrier to PODs, it's the fact that hospitals don't want to do business with them. They see the conflict. So I think PODs will be in the day surgery center, I think the physicians running surgery centers will form PODs. But the large customers, we're seeing a movement for those. Those large customers not to want to do business with PODs.

So I think that will limit the growth of it to some degree and we're happy to do business with a POD that meets our code of conduct which we've discussed on previous calls.

I think if you want to step forward in time, I think none of us really have a line of sight as to what it will look like in five years. I think that there's a fair amount of belief that various kinds of business models are going to be tried and tested. And some of them will morph into accountable care organizations or the such. And I think that, that's where we're likely to see the changes happening in the future.

I think that those organizations that we won't do business with, I think they're not long for this planet. But I think that there are opportunities for the industry to reinvent business models that can accommodate the concerns of every stakeholders.

That's insightful. Appreciate it. And just on the reimbursement landscape, so understanding that Blue Cross and Blue Shield of Minnesota, for the last couple of months issued a relatively restricted reimbursement proposal for lumbar fusion procedures Blue Cross and Blue Shield Michigan, recently instituted restricted policies. So, I mean do you have any insight into the potential of the Minnesota, Blue Cross and Blue Shield proposal being reversed. And any non -- any other negative proposals that are out there and then just lastly, how would you characterize your imbursement landscape deteriorating, improving or stabilizing? Thanks a lot guys.

Well, so obviously, on deformity and cervical trauma and tumor kind of spine surgery reimbursements are fairly constant and that's a lot of areas where we're focusing our growth as a company for that reason. It seems that physicians, patients and insurance companies are starting to find some common ground of what kind of patient will be approved for lumbar fusion and what the indications are and I think that's where we're heading. I think Minnesota, obviously, people are lobbying on that. And we'll have to wait and see what happens. There is no doubt, it's the pendulum swing. I think there were too many procedures done and it's given the insurance companies a bit of a stick to hit the industry with but the patients that need this aren't going anywhere. They will eventually get treated.

Thank you. (Operator Instructions). Bill Plovanic, Cannacord.

Great. Thanks. Good evening. Can you hear me okay?

We can hear you, Bill.

(technical difficulty)

Great. So, couple of questions. One, Mike, just doing some back of the napkin math, about $800,000 impact from FX in the quarter?

Yes.

Okay. And then, on the severance, the $500,000 over 12 months, will that be accrued over the 12 months or does that hit all in Q3?

It will be hit in Q3.

Okay. And then how much debt do you have on to books at the end of Q2?

$34 million, $35 million.

Okay, so about $35 million.

Yeah.

$34 million, $35 million, plus they're (inaudible).

There is other stuff in the long-term liabilities, right, so.

Right. That's what I'm trying to figure out. And then what's the interest rate you're now paying them at? Just remind us?

6.25%.

6.25%, down from 12%, right?

It wasn't that high, no. That's very old information.

Oh sorry. And then just --

I appreciate that.

Yes. As you bring in new distributors, it looks better 6.25% versus 12% looks a lot better. As you bring in new distributors, Les, and you negotiate with these folks, I mean, is this something -- what is the going rate on distributors these days? Are we at the 30% to 40% level or is this 50% plus for the first six months type of stuff? Kind of where are we as we talk about pendulum swinging in terms of paying for the distribution these days?

Yes, so we don't pay any rates high as what you described. We sometimes do, the rates tend to be in the 20%, 24% range I'm just looking, make sure everyone agrees with me. So a 20% to 24% we do sometimes pay bonuses for people to come over or guarantee a period of their royalty, but our long-term commitment is in the 20s not in the 30s or 40s.

Okay, that's helpful. And then just on your updated guidance, I think previously you thought that you would be cash flow positive for the year, excluding the acquisitions you talked about, I take it that's off the table this year?

No, I think the upper end of the revenue range, I think there -- cash flow positive is absolutely the objective, I think as we scale back to that revenue range is clearly going to be a challenge. But I think part of the issue that we need to go comfortable with in terms of some of the expense management that we need going forward is obviously going to free up some cash as well, but I do believe that it's a scale within the revenue range at the high-end we're fine, at the bottom end it's a bit of a challenge.

What do you need to happen to meet that high-end of the revenue range?

I think that the new products needs to continue to be to grow with their acceptance, I think that we need a very positive adoption with some of our distributors as we go into Q3 and Q4. And I think that we need to have some successes internationally in various regions of the world where we've been a little bit hand strong in Q2 and we really got to be able to drive some quality business in Q3 and Q4.

Okay, and then the (inaudible) IDE for OsseoFix conditional approval, what does conditional approval mean?

It means the study is approved, to treat the 400 patients, I think it was and then submit the results to the FDA and at that stage they will decide whether to approve the product or not.

Okay, but there is no other condition, it's just you already--

(multiple speakers) approved.

(inaudible) protocol the results would demonstrate the effectiveness of the product, we would expect to get approval at that time.

Okay. And then I think in your commentary, you talked about some legal expenses being a little higher this quarter for litigation, any clarity on what that is and I think you said you top-tick G&A or this was the high watermark?

Yes, so it's a combination, it wasn't all litigation, it was litigation plus some legal cost on the financing side of the business. We are not going to get specifically into any cases, but I think in to Amy's question earlier, I think it represents a high watermark for operating expenses for the year or the quarter. And I'm not expecting it to continue for the rest of this year.

But is there anything incremental in sales and marketing because that kind of ticked up as well?

Some of the incremental in sales and marketing, so one of the things that we have is, we had a very heavy quarter internationally with conventions and trade shows. So we had a number of big conventions and scientific symposia where we have a lot of people in attendance and as we went through the accruals in Q2 is quite -- it is quite an investment that frankly, from a timing perspective, I don't see that happening internationally for the remainder of the year.

All right. Great. That's all I have. Thank you.

Thanks, Bill.

Thank you.

This ends our Q&A session for today. I will turn it back to Les Cross.

Great. Thank you very much, Patrick. Well, I hope it's clear to everyone on the call that we are in the middle of transforming Alphatec Spine and by that I mean accelerating the top line growth leveraging this new expense base that we're putting in place and continuing to drive costs out of our product. And we expect to make significant progress in all those fronts in Q3 and again in Q4. And we certainly will keep you up-to-date with this exciting acquisition that the team is working on. Thank you, everybody.

Ladies and gentlemen, thanks for participating in today's program. This concludes the program. You may all disconnect.