NuVasive Inc (NUVA) 2006 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the NuVasive Inc. second-quarter 2006 earnings. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Nick Laudico of Ruth Group. Thank you, Mr. Laudico, you may begin.

Thanks, operator. Welcome to the NuVasive second-quarter earnings conference call. NuVasive's senior management joining us on the call today will be Alex Lukianov, Chairman and Chief Executive Officer; Keith Valentine, President; and Kevin O'Boyle, Executive Vice President and Chief Financial Officer.

NuVasive cautions you that statements made in this conference call are not a description of historical facts and are forward-looking statements that involve risks, uncertainties, assumptions and other factors which, if they do not materialize or prove correct, could cause NuVasive's results to differ materially from historical results or those expressed or implied by such forward-looking statements.

The potential risks and uncertainties that could cause actual growth and resulted to differ materially include, but are not limited to, the risk that NuVasive's sales or development projections may turn out to be incorrect because of unanticipated difficulty in selling products or bringing products to the market; the uncertain process of seeking regulatory approval or clearance for NuVasive's products or devices, including risks that such process could be significantly delayed; the possibility that the FDA may require significant changes to NuVasive's products or clinical studies; the risk that products may not perform as intended and may therefore not achieve commercial success; the risk that competitors may develop superior products or may have a greater market position, enabling more successful commercialization; the risk that additional clinical data may call into questions the benefits of NuVasive's products or investigational devices, including NeoDisc and Cerpass, to patients, hospitals and surgeons; and other risks and uncertainties more fully described in NuVasive's press releases and periodic filings with the Securities and Exchange Commission.

NuVasive's public filings with the Securities and Exchange Commission are available at www.sec.gov. NuVasive assumes no obligation to update any forward-looking statement to reflect events or circumstances arising after the date on which it was made.

With that, I would like to turn the call over to Alex Lukianov.

Thanks, Nick, and thank you, everyone, for joining us this afternoon for our second-quarter 2006 call. The second quarter clearly demonstrates the progress we have made on our key strategic growth initiatives. We continued to train surgeons at a robust rate, made progress on motion preservation clinical initiatives, and most importantly, completed our transition to salesforce exclusivity ahead of our stated guidance.

Before providing more details on the progress we've made during the quarter on these initiatives, let me take a moment to briefly review our strong financial performance.

Revenue for the second quarter was 22.7 million, an increase of 49.5% from the same quarter last year. As a result of our strong performance in the first half of the year, we are increasing our full-year 2006 revenue guidance from 87 to 91 million to a new range of 90 to $92 million. Our CFO, Kevin O'Boyle, will discuss the financials and key performance indicators in more detail following my remarks.

As you know, achieving salesforce exclusivity has been a major objective for NuVasive over the last year. We are pleased with the result of these efforts and meeting the milestones ahead of schedule. Our exclusive salesforce of direct area business managers and distributors now consists of approximately 175 total sales professionals.

The transition to an exclusive salesforce has entailed a significant investment of both time and money. As mentioned on our first-quarter call, we expect the costs associated with our salesforce transition to continue through the third quarter of 2006 and then decrease in the fourth quarter.

We are extremely pleased with the high-quality sales organization that we have assembled and their initial efforts toward achieving stronger vertical integration and deeper product penetration. At the end of the second quarter, 33% of hospitals using our products were vertically integrated versus 31% at March 31. This places us on track to meet our full-year 2006 guidance of between 35% and 38% of hospitals vertically integrated. As a reminder, we define a vertically integrated hospital as one using at least one product from each of our MAS platform product lines of NeuroVision, MaXcess and specialized implants.

As always, training spine surgeons on our MAS platform continues to be a major focus for NuVasive. We trained 151 surgeons during the second quarter compared to 119 in the second quarter of 2005 and 132 during the first quarter of 2006. Our momentum in surgeons trained in the first half of 2006 reflects robust spine surgeons demand to learn our proprietary XLIF procedure. It is clear that both spine surgeons and hospitals have a strong interest in this unique lateral approach, which delivers significant clinical benefits and allows for increased hospital cost efficiencies.

Several of the surgeons who have been performing XLIF procedures for some time now have also expanded their use of our lateral approach to include adult scoliosis indications. We plan to leverage the clinical benefits of XLIF even further with the planned launch of our lateral lumbar plate later this year, which will give surgeons the ability to achieve incremental fixation through the same incision versus placing pedicle screws through additional incisions.

The adoption of XLIF procedures continues to increase significantly. We believe the XLIF procedure remains the highest-quality, safest and most reproducible approach to lateral lumbar spine fusion surgery. The principal differentiator is that XLIF uses an automated nerve avoidance system, NeuroVision, to assist the surgeon in safe and reproducible surgery, together with a unique, minimally disruptive MaXcess retractor system.

In a published study on the first 145 U.S. XLIF procedures, it was reported that in over half of the surgeries, a traversing nerve was obstructing the surgical access pathway. Because of its proprietary automated hunting algorithm, NeuroVision enabled safe navigation around the identified nerves in each of these cases. Additionally, our specialized implant, MaXcess retractors and suite of corresponding instruments completely addressed the surgeons' need for precise lateral access and placement.

From a hospital perspective, we saw documented evidence of XLIF cost savings from Providence Medford Medical Center in Medford, Oregon. The hospital quantified a 20% cost savings for the XLIF procedure compared to a traditional ALIF approach. This included savings on direct surgery costs, primarily reflecting a reduction in the number of implants used, as well as indirect cost savings resulting from a reduction in length of hospital stay and corresponding nursing care and supplies. The average hospitalization time was 1.8 days for XLIF compared to 4.2 days for procedures performed before XLIF was available at the center.

Although the cost savings achieved by Providence Medford are based on a limited sampling, the data fully supports our view that our MAS platform and XLIF procedure provide the highest-quality benefits to patients in an efficient and economic manner. We believe this positions NuVasive to directly benefit from the increased hospital focus on clinical benefits, as well as economics.

With our salesforce established and steadily gaining traction with our products, we believe it is an opportune time to begin marketing the benefits of the XLIF procedure to potential patients, as well as referral physicians. During the third quarter, we will be making an investment in XLIF marketing in key markets, with numerous tools for surgeons to more broadly communicate the technique and its benefits.

Another major milestone achievement was conditional FDA approval of our investigational device exemption to begin clinical trial enrollment of our NeoDisc cervical disc replacement device. The device is simple to implant and we expect it will fill the gap between presurgical treatment and TDR, or cervical spine fusion. We expect patient enrollment for our NeoDisc trial to commence by year end. Patients enrolled in the study will be evaluated by their surgeon at regular interval for a minimum of two years following surgery.

Some key attributes of the study are total patient population is approximately 500; our Gradient Plus cervical plate and effusion procedure will serve as the control; estimated number of clinical investigation cites is 20; and the enrollment timeframe is estimated to be between 12 and 18 months. We intend for NeoDisc, along with our Gradient Plus cervical plating system, to form the core of our U.S. product strategy addressing the large cervical market opportunity.

For our planned expansion into select international countries in 2007, we intend to see commercialization of our entire cervical suite of NeoDisc, Gradient Plus and our Cerpass cervical TDR device. We also plan to launch our lateral lumbar TDR outside of the United States. As a reminder, Cerpass incorporates a ceramic-on-ceramic design that we believe increases durability and reduces wear debris. The IDE approval process regarding Cerpass has been delayed for six to 12 months while additional supporting testing can be conducted in response to evolving FDA requirements.

As I just mentioned, we plan to launch Cerpass internationally, because we believe we have sufficient test and supporting data to meet international standards, and because we believe Cerpass will be well-received by surgeons.

We also plan to launch our lateral lumbar TDR outside of the U.S. next year while simultaneously filing our IDE application for a U.S. clinical trial. We are equally excited about this project because the TDR device is designed to be inserted via our unique lateral approach. NeoDisc, together with our lateral lumbar TDR in particular, have the potential to be a formidable product combination addressing the evolving cervical and lumbar disc replacement markets.

Dr. Luiz Pimenta presented positive preliminary clinical data from Brazil on our lateral TDR at the Spine Arthroplasty Society Meeting in Montreal in May. This device will enable a surgeon to perform a motion-preserving lumbar TDR via our unique lateral approach, affording similar advantages for patient, doctor and hospital as our XLIF procedure versus traditional anterior or posterior approaches to spine surgery.

In June, we completed the purchase of a 100,000 square foot warehouse and distribution facility in Memphis, Tennessee. This infrastructure expansion will support increased demand for our products. The facility is strategically located near Federal Express' worldwide distribution hub, enhancing both our ability to meet last-minute East Coast surgeries by accepting requests for our loaner sets late into the afternoon and evening, as well as supporting OUS sales.

The proximity to the distribution hub also provides additional working hours each day to process and ship products and instrument sets. This acquisition supports our culture of absolute responsiveness and responding rapidly to surgeon requests, which we refer to as cheetah speed.

Before turning it over to Kevin, I would like to very briefly address the recent CMS issuance of inpatient prospective payment system, IPPS, proposals. Simply put, we believe that proposed changes to the reimbursement levels for spinal fusion surgery should not have a material effect on our top-line growth.

Let me now turn the call over to Kevin O'Boyle for comments on the financial results.

Thank you, Alex. Our revenue for the second quarter 2006, 22.7 million, was a 49.5% increase over Q2 2005 and a 15.4% increase over Q1 2006. Our gross margin for the second quarter was 77.6%, which includes a charge of $900,000 relating to obsolete inventory and instruments as a result of the planned 2006 product introductions and related significant instrument redesign. Excluding this charge, the gross margin for Q2 2006 was 81.8%. In Q3, we plan to record the remaining charge of the instrument redesign amounting to 300,000.

Our Q2 2006 net loss was 18.5 million for a loss per share of $0.56 on a GAAP basis. This reflects a $10.5 million milestone charge as a result of the conditional approval for our NeoDisc IDE. On a non-GAAP basis, the loss per share, which excludes stock-based compensation expense, the NeoDisc milestone charge and acquisition-related charges, was 3.7 million or $0.11 per share.

Operating expenses for Q2 2006 totaled 37.9 million. The increase over the first quarter of 2006 primarily reflects costs associated with the NeoDisc conditional IDE approval milestone and the transition to an exclusive salesforce. As Alex mentioned, the investment associated with this exclusivity initiative will continue through the third quarter of 2006. Then, we will begin to see the synergy in the fourth quarter of 2006.

R&D costs were 4.2 million in the second quarter. The increase in R&D spend from Q1 was due to costs associated with products planned for launch in late 2006, all of which remain on track. The costs for the balance of the year should be consistent with our previously stated guidance. Our initial annual guidance for R&D was 4.5 to $5 million per quarter, including stock-based compensation. Additionally, in our Q1 call, we provided an increase to our Q3 guidance, reflecting a 1.3 to $1.5 million shift from Q1 savings. Q4 R&D spending should remain in line with original guidance of approximately 4 million to $4.2 million.

The stock-based compensation amount in the quarter of 3.2 million was recorded in our operating expenses and allocated as 700,000 in research and development, with a balance of 2.5 million in sales, marketing and administrative expenses. For the remainder of the year, the quarterly costs should approximate 3.2 to 3.4 million.

Our key performance indicators, or KPIs, for Q2 2006 are as follows -- number of surgeons trained, 151; salesforce exclusivity, now over 90%; and percent of vertically integrated hospitals being 33. On a go-forward basis, since we have met our goal of salesforce exclusivity, we will discontinue this KPI. In its place, we will disclose the number of exclusive sales professionals, which for Q2 was 175.

As of June 30, 2006, we had 143 million in cash, cash equivalents and short-term investments. Our operating cash burn was 11.7 million for Q2, which broadly reflects the development of our next-generation MAS products, the increase in our instrument sets and accompanying inventory, and the purchase of the Memphis distribution facility. Our operating cash burn is defined as cash used for operating activities, plus additions to fixed assets.

Day sales outstanding, or DSOs, were 55 days in Q2 2006 compared to 57 days in Q1 2006.

As it relates to 2006 guidance, we want to reiterate our previously stated goal of breakeven on a non-GAAP basis in the fourth quarter of 2006. As a result of our strong performance in the first half of the year, we are increasing our revenue guidance to a range of 90 to 92 million. We expect that the third-quarter revenues will be flat quarter over quarter, which is consistent with our prior-year results.

Additionally, for the second half of the year, the gross margin of 81% is sustainable. And as it relates to surgeons trained, we had an exceptionally strong quarter and are increasing our full-year guidance for surgeons trained from 400 to a range of 450 to 475.

I would now like to turn the call back over to Alex for closing commentary.

Thanks, Kevin. We are extremely pleased with our success in the second quarter of 2006. We achieved substantial growth in surgeons trained and revenues, completed our transition to salesforce exclusivity, made progress on our vertical integration strategy and achieved an important clinical milestone with the conditional IDE approval of NeoDisc.

Having already successfully launched Gradient Plus, our third-quarter focus is on the Annual Meeting of the North American Spine Society meeting, where we plan to launch the remaining seven product releases across our MAS and classic fusion product lines.

We would now be pleased to answer any of your questions.

(OPERATOR INSTRUCTIONS). Bob Hopkins, Lehman Brothers.

Just a couple of quick questions. First of all, Alex, could you just give us a little bit more color on the 2007 international expansion, and sort of the timing of that and how that will go?

Bob, that is going to be taking place towards the latter part of next year. We will be talking about that strategy in greater detail over the next quarter or so. But the primary emphasis, as I mentioned in my remarks, will be on a number of the motion preservation products, as well as our full cervical suite.

So it will start in the second half of '07. So that's really something that has more of an impact in '08 for you guys?

Exactly right.

And then of the salesforce move to exclusivity, which obviously has gone very, very well, what percentage of the salesforce now would you say is fully trained and fully functional and fully productive at this point?

I would say as far as fully trained and having established strong relationships with our product lines and their market segments, it is probably, it is somewhere in the range of about 50 to 75%. And that continues to change very quickly as they gain a footing. But they have all been trained. So the training part is complete.

And then the last question that I have is just -- I was wondering if you could just go into a little bit greater level of detail on the revenue mix in the quarter and some of the trends that you saw in terms of your product base, especially relative to what you saw in the first quarter. Are you just sort of selling more of everything? Or are there a couple of products that are really doing better than you expected?

We are certainly selling more of everything. And in particular, MAS is what is really exploding for us. But I will ask Kevin to make any additional comments that he would like.

Yes, just to reinforce Alex's comment, our MAS contribution to the overall business is as high as it has ever been. Our launch of our Gradient Plus cervical plate in the first quarter as it relates from Q1 to Q2 has seen some really dramatic increase in revenue contribution.

And that is supported to some degree, Bob, also by the vertical integration statistic that we talk about, going from 31 -- 33% going to 35 to 38 by the end of the year. So that cross-selling initiative is really showing up, principally in MAS, but and also in classic fusion, which is where the cervical plate gets recorded.

Did you break out MAS?

We do not.

Is that new? Or are you going to be able to give that to us?

We don't break it out, but we do track it in terms of sales quota performance internally with our salesforce.

Haven't you usually broken that number out and given that to us? Or am I remembering incorrectly?

No, we did, and at the end of 2005, that mix pretty much should remain pretty consistent with the level that we talked about at that point in being 80/20. We thought that the usefulness of that statistic was well-served, and now it should principally be in that balance. And then in my comments that I just mentioned, it's gone higher than that in our most recent quarter.

Thanks, and congrats on a great revenue quarter.

Steve Ogilvie, ThinkEquity.

Just a follow-up on the international -- why not XLIF, and do you need to get CE-marked for all your stuff? Is that an additional regulatory clearance?

Well, XLIF is going to get rolled out internationally as well. But our primary emphasis for the end of next year will be on motion preservation. And we will be looking to set up our infrastructure in order to be able to support the training for XLIF.

So I think with motion preservation, a lot of those devices have been pretty well established, as you know, in Europe. So I think it is a faster rollout for us as we move in that direction, whereas XLIF, we've got to make sure that we have the training set up in order to properly support the surgeons.

And then just one last question on the number of exclusive reps. You said 175. Could you maybe give us some color on whether that number should be growing or how it has been steady, the dynamic behind that number?

Yes, that number is going to grow a little bit towards the latter part of this year. And we should be adding somewhere between 10 and 20 representatives over the course of 2006.

Ben Andrew, William Blair.

Just wanted to ask you couple of quick questions. The Cerpass delay that you mentioned, the six to 12 months, what is the change to FDA requirements that kind of compelled that?

Well, it is just additional testing requirements by the FDA. We obviously were able get NeoDisc approved sooner. And that is because NeoDisc was much further along when we acquired it. It also had clinical data to support it. So we were able to get NeoDisc done first. But it's just really a number of things that have evolved with FDA in terms of additional standards of testing.

So we should look for that IDE refiling kind of in the first half of '07?

Yes, I think that's about right -- towards the latter part of the first half.

And I know you tend to not give out these numbers as much anymore in terms of procedure numbers or vertically integrated cases, but is there any detail you can give us relative to, say, something like the percentage of cases that are vertically integrated, so we can get a sense of how that mix is playing out?

Well, I think that's really been -- that's that 33% number. That is what we are trying to give to show how that's changing and how we are getting deeper penetration with the hospitals.

So when you say 33% of hospitals are vertically integrated, does that mean a third of them are routinely doing mixed cases, and that should roughly approximated procedures?

Yes.

And one thing we haven't talked a lot about, but same-store growth versus customer additions -- you used to give more detail on that. But how has that been playing out relative -- certainly, you're training a lot more physicians, but are you seeing that same-store growth tracking with your top line?

Well, again, we don't measure that. And I really don't have any comments with regard to that. We continue to attract new surgeons to San Diego for training, as well as we have some repeat customers coming back to learn about the newest products.

And finally, I guess, just to pin down, maybe, a little bit better, the lateral lumbar IDE filing, is that -- it sounds like it is an '07 event at this point, you said out about a year?

Yes. We are not exactly sure of what the timing will be as we really wrap up all of our testing for that. But it will certainly be sometime in '07.

Michael Matson, Wachovia Securities.

Most of my questions have already been answered. But there is one that you can help me with, maybe. With regards to the study data that you published from the Medford Providence Hospital on the cost savings for hospitals, what sort of reception have you got from that from hospitals and from clinicians? And is there any sort of pushback or kind of doubts about the data, given the fact that it is just limited to one facility?

Well, the short answer to that is no. But I will ask Keith Valentine to elaborate.

I think two things -- one, the market that participated in that study in Medford is a challenged market in the Pacific Northwest to begin with. So I think is probably a more aggressive sampling as far as reimbursement goes. That area is traditionally more challenged, as I mentioned.

But secondly, we are getting good feedback from it for the very same reasons that other hospitals across the country are seeing the same kind of patient returns that Medford saw, meaning that they are getting quicker recovery and patients are leaving the hospital quicker, just as Medford saw. So there's a lot of consistency as far as patients recovering quicker, and that does translate well across the country when it's presented.

That's helpful. Thanks.

Steven Lichtman, Banc of America Securities.

I was wondering if you could talk about the salesforce as this salesforce ramps now -- what are you seeing out in the field in terms of the benefit? Is it helping in terms on -- more on market share or in terms of driving net revenue per procedure or vertical integration or however we call it? What are you seeing in terms of some examples out there in the field?

Well, I think it is working across the board. I think what we are seeing, obviously, is we have seen an increase of surgeons coming to San Diego. They have been brought here by the salesforce through their efforts to expose doctors to our technology. So I think what we are seeing is as our folks start to gain more traction, they are selling more across the product lines.

So I think at first, it is pretty straightforward to get in front of a customer and talk about XLIF, because that is the latest and the greatest technology. But I think as they build that relationship with the surgeon, and that takes anywhere from six to 12 months in those markets, then what we are starting to see is the added penetration of our other products, like Kevin talked about with Gradient Plus being very successfully launched in the last quarter and really picking up steam. So we're starting to see more and more penetration, which we were not seeing with our non-exclusive salesforce early last year, as they were more really cherry-picking our products.

Great. And then as we think about NASS in September, can you remind us of some of the key products that we will see there from you guys?

Well, there's a number of things. MaXcess 3 is obviously a featured product. The NeuroVision will have some additional features rolled out, including [MEP]. Lateral plates, I already talked about, that is going to be shown. We've also got some additional line extensions on CoRoent. ExtendSure is scheduled. Let's see -- SpheRx 2 will be shown there. And then of course, our really big emphasis and effort has been on redoing our instruments. Many of them are several years old. So new XLIF -- some new XLIF instruments, but mostly ALIF, TLIF and PLIF instruments will be featured at NASS. So a lot -- a lot of stuff going on.

Great. And then relative to the second-half trajectory revenues, just similar to last year, again, due to the timing of NASS, right, because we have NASS here at the end of September?

Yes, that is exactly right. We expect to be pretty flat in the third quarter, very strong fourth quarter, just like last year.

And then just to clarify one of the numbers, on the vertical integration from last quarter, I had written down 30%. Was that just for the full quarter last quarter and then exited at 31? Is that right?

No, it is 31, Steve, for the quarter. So just for tracking purposes, when we came up with that statistic, third quarter of last year, we went from 25 to 29 to 31, and now this quarter, 33.

And that lastly, as you start thinking about rolling out that lateral lumbar TDR overseas next year, can you just remind us in terms of some of the benefits of the lumbar TDR coming laterally -- what are some of the benefits going to be versus what we are seeing out there today in TDR?

I think it is going to be very similar to the pickups that we're seeing with XLIF. And as Dr. Pimenta commented on the results of the first -- I guess it's about 20 patients or so that were done, with about six months of follow-up, what we are seeing is the rapid return, quick rehabilitation. So a lot of the same pickups. I will ask Keith to make any additional comments, as I know he is very familiar with the clinical results so far.

Yes, just the approach related are big, but also the size of the device -- you are getting the greatest surface area of coverage on the end plates with this particular device versus anything that has been talked about or implanted from an anterior perspective.

So we are capitalizing on getting good, solid fixation to the [vertebral] bodies in addition to providing motion instead of fusion. So we are building off of the same XLIF concepts as far as surface area, but we are now doing it with motion instead of fusion.

David Lebowitz, Thomas Weisel Partners.

You have guided towards 81% gross margins for the second half of the year, but you were up at 81.8 in the second quarter. Just curious if there was anything about the second quarter that led to the higher gross margin?

Well, it goes along with the product pull-through, and it is kind of what we've been talking about so far on the call. And with that product pull-through, given the mix, it has created a higher gross margin from first quarter to second. And as it relates to guidance for the balance of the year, since that's our first time hitting a margin of 81.8, we'd like to see that margin, and I'm confident in it, but nevertheless would like to see that margin repeat for another quarter before we guide higher.

Would you be able to provide an update on the regulatory process of the non-allograft form of ExtendSure?

Yes, the non-allograft form is cleared, from the FDA's perspective, as a partial vertebral body replacement device. And that is very similar and in line with the rest of the peak alternatives that are available on the marketplace for use right now.

How would you characterize the overall market for the non-allograft?

Well, I think from a feature perspective, it is similar to allograft in that it is an imaging-friendly device. I think it really comes down to surgeon preference and it comes down to what the surgeon's belief and process has been through training as well and their feelings on allograft. I think it is important to be able to offer multiple options. And they can pick whatever they want that feels most comfortable with their training.

And one more question, on the salesforce -- what is the breakdown between area business managers and exclusive distributors?

It is about 45% on the direct side and about 55% on the exclusive distributors.

Bob Hopkins, Lehman Brothers.

Alex, is the potential to partner with a larger player in Europe to help you with distribution there something that you would even contemplate? Or are you 100% going it alone in Europe?

We are still working that out. And we'll have that finalized over the next few months. I would say it is relatively unlikely for us to partner with a larger player, or pretty unlikely.

I mentioned it because there are obviously a couple of large orthopedic companies that don't really necessarily compete with you in spine, yet they're a high presence in Europe. The other question --

Well, as you know, Bob, the real issue, though, is making sure you have a highly trained, well-educated salesforce that is exclusively moving your products. And the question is, would you really get that when you partner with a larger force like that, or do they continue to mostly sell their own products, which has been my experience, in most cases.

And then, Kevin, I just wanted to ask you about that $900,000 charge in the quarter for obsolete inventory related to instruments, only because I haven't seen something like that from the other orthopedic companies that I follow. And granted, 99% of the other orthopedic companies that I follow are much, much larger, but just curious if you could just fill us in with a little more color there?

Sure. As part of our strategy of obsoleting our own products, if you will, from time to time, for our NASS launch, we have redesigned a number of our instruments. And when that happens, which is at the NASS timeframe, which is in September, what effectively happens is you shorten the useful life of those instruments because they are being depreciated. And that depreciation runs through the cost of sales line.

So effectively, we shorten that depreciation to be complete over the next six months, which results in a charge that we took in this quarter and the 300,000 remaining charge we will take in the second quarter. So that is an opportunity to reflect when those assets will be coming out of service, and then the new assets or the new instruments will then be launched at NASS, and that is how you quantify the number.

And how long have these instrument sets been out and available?

Our depreciation policy is three years. We are pretty conservative on that front. Most of these instruments are anywhere from one to three years old.

One additional comment to that is the design of the instruments range from anywhere greater than two years to even four years. So this is an important initiative to update the instrumentation and provide, again, the next generation, if you will, of opportunity for inter-body and partial vertebral body replacement devices to be put in as easy as possible and to make them even better with the MaXcess retraction system. So it's time that they needed to be updated. And it is a great effort to further drive implant revenue.

So, just so I understand this, these are instrument sets used with -- mostly with MaXcess?

These are used to place mostly the inter-body side of our products. So that would be PLIF and TLIF and to some degree XLIF and so forth. So it is substantial. This is tens of thousands of pieces of instruments in total, and also will support our much larger salesforce, set us up with our distribution center in Memphis to have plenty of sets to support our growing needs.

So if we were thinking about new product launches at NASS, it sounds to me like the instrument sets potentially qualify as almost the equivalent of a new product launch as well.

It's actually the equivalent of many new product launches. So when you really go through it, it is all of the instruments are being upgraded. And I think -- and that's not lost on the surgeons. The surgeons absolutely love it when we better reflect their needs and wishes and instruments sets. So versus just approaching it with customized instruments, we are redoing a lot of our sets that, as Keith and Kevin have mentioned, are anywhere from one, two, as much as even four years old now.

David Lewis, Thomas Weisel Partners.

I apologize -- I was fighting with American Airlines here, got in a little late. But a couple --

Did you win?

I was fighting with American and they beat me badly, I am sorry to say. Maybe United next time.

Alex, real quickly here, looking at [our diligence] throughout the quarter, it is clear that MaXcess gained a fairly dramatic market share versus competition. I know it's kind of maybe a difficult question to ask, but I'm trying to get a sense of how much of this is simply the move towards exclusivity, how much of it is physician demand for MAS solutions, or how much of this is really -- you're taking market share from more established competitors? And I don't know if you can put that in percentage buckets or just talk to it qualitatively.

I don't think I can put it into buckets per se, but it is all of those things. If you look at the number of surgeons trained, if you look at the vertical integration, you look at all the things that we have talked about, I mean, it is reflective of an across-the-board increase in penetration.

So what we are not talking about is just some big bolus of activity from one distribution center or from one area business manager. It is really coming across the board. And I think we are very excited, obviously, about our prospects and our ability to gain more sales in a lot of virgin territories. We are still just getting started in the Northeast, so there's a lot of upside there. A lot of these markets, we're just really just entering with a formidable sales presence.

Alex, that's a great segue into my next question, because it seems pretty clear, talking to physicians, that head-to-head, MaXcess wins against the competition. If there is an area where you're not seeing penetration, it's actually when the physician is simply unaware. And is that awareness simply something you can attack with exclusivity alone? Or do we need supplemental sales efforts to create that level of awareness, and would that incur benefit to NuVasive?

I think it is largely the exclusivity initiative that we have put together and now completed. And as we may have talked about before, I think, on some of our calls, the Company's distribution has really grown from West to East. And so it you talk to surgeons, you'll find that in the Western half of the U.S., a lot of them are pretty familiar with our products and our technology, where the Eastern half has been lagging behind.

So I think that as our salesforce is now out there and they are talking to surgeons, and they are following up, and they are getting them out here, that is really what we are starting to see, is stronger penetration in those areas.

So the short answer to the question is I think the salesforce will make a huge difference, and of course, we are launching a lot of additional products. So there's many more opportunities to get in front of surgeons and get them excited about the NuVasive line.

Great, that's really helpful. And Keith, just one last question, I guess, on a strategic product look -- if you look out, obviously, we talked a little bit about NeoDisc on the call, but do you see -- when we're talking to physicians, we are seeing some emergence in differentiation in the market. Do you see a need for a sort of stand-alone nucleus replacement product, as well as an annulus repair product? Do you think there's going to be enough differentiation to drive both products in the market? Do you think there is room for one provider to provide one piece of the equation and someone provide the other piece? And would NuVasive want to provide both of those components?

You are talking strictly probably now mostly from a lumbar strategy, right? Because there's not really a great deal of --

You got it.

Okay. I think a lot of that has to play out. What we see right now is a few pilot trials going on or a couple pilot trials going on that are trying to define what that nucleus opportunity is. We have certainly seen in the past some devices that have come and have had challenges in that space, may even be coming back and trying it again.

So I think some of that has to play out. But I guess right now, as I see it and look at it, I think you are right -- there will be a role for two different providers, one being nucleus and the other being some type of repair of annulus. And I think both of them have to kind of sift through how that reimbursement strategy works for them both to participate in those cases.

That's helpful. Thanks so much. Nice quarter.

Ben [Mack], Rivanna Capital.

Can you please remind me of the cash burn number? It didn't come over clearly. I couldn't hear it.

The cash burn number was 11.7 million, which includes the first [multiple speakers]. Sorry?

11.7?

Yes, sir.

And then for the stock-based compensation in SG&A, was that 2.3 million?

The total stock-based compensation number was 3.2 million in the quarter, 700,000 in R&D and 2.5 million in sales, marketing and administrative.

And one other question with the SG&A. It's going to come down in Q4, from what you guys said? Do you have a long, long-term target, as to what that can be going forward, either as a percentage of sales or where you see it from where it is today?

We will continually develop synergies off that salesforce as they continue to be more productive over time. But we have not targeted any particular percentage as it relates to that line as of yet. We will probably start really looking at that as we give guidance on 2007.

How about for Q4? Is this a fair level to forecast out for Q4 -- roughly $20 million a quarter?

It is probably somewhere in that general range. And as it relates to your earlier question, in sort of looking at the SG -- the sales, marketing and administrative line, we look at it as what is the longer-term -- what is the potential for operating margin for the Company? And we have traditionally have disclosed that we feel that it could be 20, 30% operating margins as it relates to that statistic as we move forward.

Gentlemen, there are no further questions at this time. Do you have any closing remarks?

No, thank you very much. Appreciate it. Bye-bye.

Thank you very much, ladies and gentlemen, for your participation. This concludes today's teleconference. You may disconnect your lines at this time. Have a great afternoon.