NuVasive Inc (NUVA) 2006 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the NuVasive Inc. third quarter 2006 earnings conference call. 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 The Ruth Group.

Thanks, Operator. Welcome to the NuVasive third-quarter earnings conference call. NuVasive senior management joining us 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 included on this conference call that are not a description of historical facts 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 over those expressed or implied by such forward-looking statements.

The potential risks uncertainties that could cause actual growth and results to differ materially include, but are not limited to, the uncertain process of seeking regulatory approval or clearance for NuVasive Products or devices, including risks that such processes 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, including products under development and those undergoing clinical study; 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 question the benefits of NuVasive's Products or investigational devices, including devices under development, such NeoDisc, 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 www.sec.gov. NuVasive assumes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which was made. With that, I would like to turn the call over to Alex Lukianov.

Thanks, Nick. Thank you, everyone, for joining us this afternoon for our third quarter 2006 call. We're extremely pleased with our operating and financial performance during the quarter. We see increasing momentum with our exclusive sales force and we continue to train spine surgeons on our products and techniques at a robust rate. In addition, in the third quarter we launched innovative new products that strengthened our competitive advantage.

Before outlining how we believe these and other important strategic initiatives will continue to fuel revenue growth, let me take a moment to briefly review our strong financial performance. Revenue for the third quarter was $25.2 million, an increase of 64.6% from the same quarter last year. As a result of this strong performance, we are increasing our full-year 2006 revenue guidance from $90 million to $92 million to a new range of $94 million to $95 million. Our CFO, Kevin O'Boyle, will discuss the financials and key performance indicators in more detail following my remarks.

Our exclusive sales force is generating impressive results. This sales force consists of approximately 175 total sales professionals. The process of educating these sales professionals on our broad suite of products and enabling them to achieve deeper product penetration continues to produce results, particularly with respect to vertical integration of hospitals.

At the end of the third quarter, 39% of hospitals using our products were vertically integrated, versus 33% in June 30. As a result of this strong performance, we are raising our full-year 2006 guidance of between 35 and 38 percent of hospitals vertically integrated to between 42 and 45%.

We are particularly excited about our new distribution facility, which we believe will help fuel our growth for the long-term. Our new facility, which opened in September, is strategically located in Memphis near the Federal Express distribution hub. This strategic location affords additional working hours each day to process and ship products and instrument sets, including an ability to process last-minute East Coast requests for next day surgical procedures.

As our sales force gains momentum, we continue to see stronger penetration in our established markets and we are also pleased to report that our sales force is steadily gaining traction in areas where adoption of NuVasive products had previously been underrepresented.

Training spine surgeons on our MAS platform continues to be a major focus for NuVasive. We trained 177 surgeons during the third quarter, compared to 99 in the third quarter of 2005, and 151 during the second quarter of 2006. Year-to-date, total surgeons trained is 460. This continued momentum into the back half of 2006 is a result of both spine surgeons' strong interest in learning our proprietary XLIF procedure as well as the impact of our exclusive sales force.

Our exhibit at the annual meeting of the North American Spine Society, or NASS, in Seattle in late September was very successful. We were extremely pleased to see robust surge in attendance at each of our XLIF and other product demonstrations and an overall strong interest in our company. Our goals of consistently introducing products that are a step ahead of the competition and obsoleting our own products remain important parts of our strategy.

During NASS last month, we released new products which we believe further position NuVasive as a leader in developing cutting-edge technology in direct response to surgeon needs. Let me briefly outline these products as well as our planned product launches for the remainder of 2006.

Earlier in the year, we launched our Gradient Plus anterior cervical plating system, which allows spine surgeons to choose between fixed, semi-constrained, or dynamic fixation options based on the surgical requirement. This unique system has solidified our entry into the cervical spine business.

We also achieved a number of technological leaps ahead of the competition. MaXcess III is a further enhancement of our MaXcess and MaXcess II systems, with the addition of several features that improve access to the spine. MaXcess III maintains the split-blade design and continues to incorporate the Company's NeuroVision nerve avoidance technology within the posterior retraction blade. MaXcess III also adds a removable fourth blade for increased surgical exposure and also incorporates an improved tilted blade locking mechanism.

We launched a major instrument set redesign for use in all lumbar spine fusion procedures as well this summer. This significant design and engineering effort offers greater efficiency in surgery execution and more logical set configurations, reducing the number of trays required for a specific procedure. Most importantly, the redesigned instrument sets were developed from our comprehensive understanding of the many surgical nuances specific to each surgeon and provide seamless utility with all NuVasive lumbar systems.

Our expanded line of CoRent implants provide an even greater variety of specialized sizes and shapes that are a key component in winning and maintaining a surgeon's business. In the fourth quarter of 2006, we're planning a limited launch of our lateral lumbar XLIF plate, designed for use during our proprietary XLIF procedure. This allows for the placement of an additional fixation device through the same incision used for placing an interbody implant. This provides the option to use the plate for fixation instead of pedicle screws.

We also expect to introduce several NeuroVision upgrades in the fourth quarter, including the incorporation of motor-evoked potentials, or MEP technology, which allows for complete monitoring of nerve activity in the thoracic and cervical regions of the spine, and the introduction of wireless remote monitoring, allowing for greater case coverage.

Let me now briefly address our motion preservation initiatives. In September, we commenced our clinical trial of NeoDisc. Dr. Randy Dryer treated the first patient at the Central Texas Spine Institute in Austin, Texas, marking a major step in our strategy to address the cervical motion preservation market. We continue to believe that highly-revisable procedures, such as that afforded by NeoDisc, represent a significant opportunity to address degenerative disc disease with early intervention while allowing for spinal motion.

These attributes make NeoDisc one of the most innovative spinal motion preservation devices in clinical research. Our cervical TDR Cerpass device incorporates a ceramic-on-ceramic design that we believe increases durability and reduces wear to [breathe]. In the U.S. we are continuing biomechanical testing of Cerpass and expect to be in a position to file an IDE for its U.S. clinical trial in the first half of 2007.

In the lumbar area, we also anticipate filing our IDE application for a U.S. clinical trial of our lateral access PDR at the end of 2007. We plan to launch our cervical motion preservation products suite as well as lateral lumbar TDR outside of the U.S. next year and will provide additional detail on our international expansion during our fourth quarter 2006 conference call.

We recently announced that we bought out all remaining milestone in royalty payments for the NeoDisc for $20 million. This agreement is clearly an attractive one for NuVasive. It provides us the potential to realize maximum long-term financial benefits from what we believe to be one of the most innovative cervical motion preservation devices under development. Kevin will provide detail on the impact to our financial statements following my remarks.

We remain excited about the potential for both NeoDisc and the lateral lumbar TDR in our strategy to pursue the motion preservation markets for both the cervical and the lumbar spine. Let me now turn the call over to Kevin O'Boyle for comments on the financial results.

Thank you, Alex. Our revenue for the third quarter 2006 of $25.2 million was a 64.6% increase over Q3 2005 and 11% increase over Q2 2006. Our gross margin for the third quarter was the 80.5%, as compared to gross margin in third quarter '05 of 78.4% and gross margin in Q2 2006 of 77.6%.

Our Q3 2006 net loss was $18.7 million, for a loss per share of $0.56 on a GAAP basis. On a non-GAAP basis, the loss per share was $5.3 million, or $0.16 per share. Our non-GAAP net loss calculation in the third quarter of 2006 excludes $9.6 million paid under the buyout agreement with Pearsalls Limited relating to the NeoDisc, the $400,000 charge for the obsolete assets and amortization of acquired intangible assets, and stock-based compensation of $3.3 million.

Operating expenses for Q3 2006 totaled $40.8 million. The increase over the second quarter of 2006 primarily reflects costs associated with the transition to an exclusive sales force and the additional amounts paid under a milestone and royalty buyout agreement with Pearsalls Limited for the NeoDisc. The NeoDisc acceleration of milestones resulted in a total deal cost of $33.1 million, eliminating royalty obligations and $12 million in potential milestone payments.

The final payment made in Q3 of $20 million consisted of $12 million in cash and $8 million in stock. The recording of these costs had $10.5 million accrued in Q2 2006 and the remaining $9.6 million in Q3. R&D costs were $5.5 million in the third quarter. The increase in R&D spent from Q2 was due to costs associated with products launched during the quarter. Sales, marketing, and administrative expenses totaled $25.7 million, which broadly reflects costs of transitioning the sales force to exclusivity, the marketing launch of our new product introductions, North American Spine Society activities, surgeon training, and administrative support costs.

As you look at 2007, we anticipate these expenses as a percentage of sales to average in the 67 to 70% range. The stock-based compensation charge for the quarter of $3.3 million was recorded in our operating expenses and allocated as $664,000 in research and development, with the balance of $2.7 million in sales, marketing, and administrative expenses. For the remainder of the year, the quarterly costs should approximate Q3 levels.

Our key performance indicators, or KPIs, for Q3 2006 are as follows, number of surgeons trained, 177 in the quarter, total of 460 year-to-date; and percent of vertically integrated hospitals of 39%. As a reminder, we define a vertically integrated hospital as one purchasing products from each of our three MAS product lines of NeuroVision, MaXcess, and specialized implants.

As of September 30, 2006, we have $121 million in cash, cash equivalents, and short-term investments. Our operating cash burn was $9.1 million for Q3, which partly reflects the development of our next generation MAS products and the build out of our inventory in instruments to support future growth. Our operating cash burn is defined as cash used for operating activities plus additions to fix assets and excludes the $12 million paid in the quarter for the NeoDisc.

Day's sales outstanding, or DSOs, were 55 days in Q3 2006, compared to 57 days in Q2 2006. As it relates to the 2006 guidance, we want to reiterate our previous stated goal of break-even on the non-GAAP basis in the fourth quarter of 2006. As a result of our strong performance in the third quarter, we are increasing our revenue guidance to a range of $94 million to $95 million. Additionally, for the fourth quarter our gross margin of 81% is sustainable.

As it relates to surgeons trained, we had exceptionally strong quarter and are increasing our full-year guidance for surgeons trained for 450 to 475 to a new range of 500 to 525. Now I would like to call back over to Alex for closing commentary.

Thinks, Kevin. NuVasive has established itself as a leader in the development of innovative spine surgery technology. Our culture of absolute responsiveness has developed our reputation as an organization that is focused on rapidly meeting the needs of spine surgeons and providing them with unmatched products and service.

We believe that we now have the tools in place to build on this reputation. Our exclusive sales force is one of the best in spine and is well positioned to achieve deeper product penetration. We remain focused on training spine surgeons on our XLIF procedure. Our broad product suite continues to generate positive feedback and we continue to build the infrastructure for its expanded distribution.

We will also spend significant energy achieving increased operating efficiencies and profitability. Our entire team of employees, or shareowners, as we call them, is focused on making these priorities a part of our culture. We are confident that our shareowners will provide the same level of absolute responsiveness to these priorities as they have with everything else we do at NuVasive. We will now be pleased to answer any of your questions.

(OPERATOR INSTRUCTIONS) Bob Hopkins, Lehman Brothers.

Just a quick question on sales force productivity. Can you remind us or tell us, give a sense as to where you are right now as to what percentage of the 175 people that represent the sales force, what percentage of those are fully-trained and ramped up and selling product?

Everybody has been trained. Basically, where we are is we are still ramping up the sales force, so I anticipate full productivity from the sales force as we move into 2007. As you know, we have continued to increase our penetration as we move to the east. We are approximately -- six months or so is pretty much where we are with regard to, I think, achieving full sales force integration and fully up to speed in each market. So, another six months or so.

Okay, then you mentioned that you are increasing your exposure in previously underrepresented territories. Can you give us a sense as to how many of those underrepresented territories there are in the U.S. for you guys and just a sense as to the opportunity in '07 to reach out into new markets that you're not tackling right now?

Well, really the biggest opportunity for us is in the eastern half of the country, especially in the Northeast. At this point in time, we have every single market covered with the exception of one. The only market that is not covered at this point is Kentucky, but every other market is covered. So where we are right now is we are just scaling all of that up and I think a lot of our growth will come from -- new growth will come from the Northeast.

I was just wondering if you could give us a little bit better sense as to where the growth came from this quarter and the out-performance this quarter. And also wondering if you would be willing to give us any sense as to the growth in the number of XLIF procedures, or any sense as to what percentage of the revenues you think are coming from XLIF procedures?

Well, if you take a look at what the mix is, it is very consistent with what it has been all along in terms of MAS versus classic fusion, as we've talked about the past. So the growth is coming from the XLIF side. Would rather not comment with regard to the specific number of XLIF procedures other than to say that they continue to increase very steadily, as does the entire pull-through of the whole product line.

Okay, then just very quickly, lastly, Kevin, did I hear your right on SG&A guidance of 67 to 70%? What time period was that for that you were talking about?

That is on average for 2007.

On average for 2007, so I'm sorry I think I dialed in just a little bit late. Did you give any other guidance about 2007?

We did not.

So just some basic sense as to SG&A expense.

That's right.

I don't know if you have taken a look at the consensus expectations that exist for 2007. Would you be willing to comment on comfort level with those at this point?

I think we'd rather do that on our fourth quarter conference call, Bob, when we have got the year under our belt and we can talk about international and how that plays and then we can talk more about the NeoDisc and we can really key up a lot of the initiatives for 2000 at that time.

Okay, great. Thanks so much.

Steven Lichtman, Banc of America Securities.

Just a few questions. Any thoughts about opening up remote training centers around the country to even further increase training?

We have actually done several of those, so some of the training did take place in the third quarter. I believe the number was about four or five centers that we have done. As you know, we have also been doing training in Florida, so we anticipate increasing the number of surgeons that are being trained in centers like that as we move into 2007.

Okay. Can you talk about plans for additional sales hires from here, sales rep hires?

Sure. What we're looking at -- so we're at 175 approximately right now. I expect us to be in the range of 200 between the end of the year/start of next year into the first quarter. And then I see that growing at about 10% or so over the course of 2007, so that by the time we leave 2007, move into '08, we will be at approximately 225 in terms of our sales force.

Okay. Then just lastly on the scoliosis indication you mentioned in the press release, are you beginning to see the impact already or is that ahead of you? You talked about those at NASS but can you scale that for us a little bit in terms of the opportunity there?

Sure. What we're talking about his adult degenerative scoliosis and that is usually done over multiple levels. So what we're seeing is in the centers that have been involved with XLIF for some time, they are expanding their indications and this is really being done on patients that otherwise probably would not be able to get much treatment.

So what that is doing for our market opportunity is it is moving our XLIF penetration percent addressable market, I guess is the better way to frame it, from around 20 to 25% to potentially another 5 points. So it puts us in the range of 25 to 30% addressable market as a result of this expanded indication.

Okay, great. Actually lastly, Kevin, for the one piece of guidance you did provide for '07, that 67 to 70, would that be inclusive of FAS 123 or exclusive of that?

That would be exclusive of that.

Okay, thanks a lot.

Matt Miksic, Morgan Stanley.

So the guidance for next year, this 67 to 70, includes your expansion into Europe, or is that just -- or into your international plans, or is that just on the current base?

That is on the current base as we look to 2007, Matt.

Okay, so to the extent you are sort of adding people or building infrastructure there, it could be a little bit higher than that?

I think is important to wait for the whole plan so that we can really discuss what we're doing, where the opportunities are coming from so we don't kind of piece out the international game plan for 2007. So this is just specifically U.S.-based.

Unfortunately, you let, sort of, part of the cat out of the bag, so we are all trying to figure that out.

Well, let me say this with regard to international, it's the same comments I have made before. We see ourselves moving into the international arena late in 2007. So that is more something that really will not have a big effect with regard to revenue next year and should not have a big effect with regard to expenses either her. So our full international launch is really 2008 and we will get into the specifics of that as we talk in the next quarter.

Okay, and then if we think about the SG&A comment that you made, we're looking for this to grow just at a sort of a declining rate throughout '07 to get to a number, to get to a percentage of revenues that you're talking about?

Yes, that is kind of an average for the year.

Got you. Then to Bob's question about sales productivity, you have given some comments in the past about where you would like to see sales rep productivity go on an average revenue per rep. Could you update us on maybe where you think you are now in terms of your exclusive reps and maybe where you think things could be a year from now?

I think where we will be at the end of next year is with a fully-productive sales force, and I think what we are looking to be able to obtain from our sales force is approximately $1 million per revenue per rep. Now, what that means though is that as we move into the end of next year and as we move into 2008, right now, as I've explained before, we have several principles that are both either area business managers or exclusive distributors that are managing as well as carrying the bag. So that number is going to come down as we move into 2008. So there's 40 to 50 market leaders that will ultimately be replaced by reps. You would have to take about 40 to 50 off of the sales force as we backfill them with representatives.

Okay, then those backfilled and what's left, you're expecting sort of on average something in the neighborhood of $1 million out of those by the end of next year?

That really starts to happen as we move into '08.

Got you. Okay, that's hopeful. Thanks.

Ben Andrew, William Blair & Co.

Quick question relative to the distributors and the reps again. You had talked about the incentives for those players basically expiring by the end of the third quarter. Are those incentives at this point completely gone?

You're talking about some of the transitional arrangements, so those are pretty much done and so in the fourth quarter. That is what allows us to move into the breakeven situation as we've commented before.

Okay, and have you seen any kind of disappointment or undue disappointment relative to people's performance under those contracts and the fact that those incentives are coming off but their revenue haven't come up yet?

No.

I think that was an F-14 or an F-18?

It went by too quick. I couldn't tell. Nothing like hanging around the top gun school here, right? No, I don't.

Has there been any particular turnover within specific distributors or reps as a result of those incentives kind of expiring?

No, there has not.

Okay, great. Kevin, just so we can kind of track this a little closer, the R&D spending was a fair bit below what we were kind of expecting this quarter, but SG&A in contrast was kind of making up for that. Do you think that R&D level for the fourth quarter is kind of the same appropriate level versus Q3 or will it come up again as we would have thought?

You know, in Q4 it should come back down to the guidance level we had given in prior calls -- in the low $4 million range.

All right. Then just to clarify again on this SG&A spending comment for next year, you still expect stock-based compensation expense of about $3.3 million a quarter, with the vast majority of that coming out of SG&A?

The vast majority should come out of SG&A and it should be at least at the current levels.

Okay, but it would not be substantially different, maybe $3 million, $3.5 million, something like that.

Probably closer to $3.5 million I would think, but we're looking to recalculate that. A lot of that has to do with stock price and the value of an option given the stock price, so we will give that update on the fourth quarter. So it should be closer to higher number that you mentioned.

Okay, that's hopeful. Then maybe a question for Keith if he is there. Just curious about the early utilization and kind of excitement about the lateral plate amongst people and how frequently that might be used if you think about percentage of XLIF cases.

Keith, do you want to comment on that?

Right now it is being launched, as we classify, in a beta trial basis and it is doing really well. The reason why is the excitement behind being able to put a plate on laterally after completing the procedure instead of slipping and having to do a posterior procedure. So we anticipate a very nice uptake for the implant system. And you're still keeping the total implant costs very much in line with what the hospitals are already seeing, so we think it will be a well-received addition instead of having to flip the patient and do a posterior procedure.

Okay, but it is hard to speculate about percentage of cases longer-term you might look for?

I think will have a better idea on percentages as we go forward the next couple quarters, but we certainly think it is going to be greater than 10, 15 to 20% of the XLIF cases pretty quick that are augmenting with a lateral plate instead doing the complete pedicle screw system.

Okay, that's hopeful. Is there any way we can get you to say anything about the relative contributors to revenue growth this quarter, case volume, pricing, and I guess, if you will, mix? Is it 50-50 mix versus volume? Can you even quantify that directionally for us?

I have made the comments before about MAS is obviously the majority of our business and what we're seeing is very robust growth on the XLIF side. I will leave it at that.

Okay, thank you very much.

Mike Matson, Wachovia.

In terms of the other types of non-XLIF fusions that are done, how do the revenues that you all can get from those compare to the XLIF? Can you get something similar to what you get with XLIF?

You mean in terms of just a straight-forward lumbar effusion?

No, like a PLIF, TLIF, ALIF what have you. I think you guys have instruments for those now. If a surgeon is doing that, what is the potential revenue per case that you're looking at?

It is about the same. The numbers are about the same. They are still in that $10,000 to $12,000 range. That is true of all of those lumbar procedures and exactly as you said, that is where we launched all-new instruments and did a lot of redesign in response to what the customers asked for over the last several years of coming to San Diego and giving us feedback.

Okay, and is there -- for the lateral plate, would the reimbursement be the same with that as it would be if they were putting pedicle screws in?

I'll let Keith jump into that since he has been focused on the lateral plate answers.

Yes, I think depends on exactly what is done from a hospital perspective. There are different reimbursements from a 360 perspective than when you are doing just a lateral procedure, but I think it also depends on what they're going to be doing from a posterior perspective. So if they're getting indirect decompression, that certainly brings them down one avenue.

If they still need to do some type of decompressor procedure but in more minimally-invasive fashion without instrumentation, then there is a posterior procedure that is still going on and there is a different coding. So traditional 360, yes. With pedicle screw and XLIF, there is a different reimbursement than just strictly for XLIF with a lateral plate, but that change in reimbursement structure for both surgeon and hospital should not affect what the uptake is for that lateral plate.

Okay, and then just a question on the definition of the vertical integration. That is basically the percentages of your hospital customers that are buying items from all three of those categories, even if they're not necessarily using those items in every single procedure, in other words? Is that reasonable?

There is no way for us to measure that number exactly because we don't know what happens in every single operating room by any means. We don't know what was a stocking order. All we know is that they are buying across all those lines and so that is the best indicator that we have of vertical integration.

We think it is a meaningful way to look at the business.

So theoretically that could go to 100% then, in the longer run?

Yes.

All right, that's all I've got. Thanks.

Stephan Ogilvie, Thinkequity.

I have question on the MCAC panel in the end of November, going to discuss spinal fusion reimbursement. Just wondering if you had any insight into that and if there is kind of the negative sentiment coming out of that, what your approach is should Medicare reimbursement tighten up.

I don't think we have any more insight than anybody else does on what's going to happen there, but as you know, what they're looking for is they're looking at the relative indications for spine surgery related to degenerative disc disease, as well as taking a look at what the general data looks like for spine fusions. Spine fusion has been done successfully for a very long period of time with very strong outcomes, so I think we generally do not anticipate it being a negative event.

We think that this is sort of part of the due process of some of the things that CMS looks out. Nonetheless, a very small percentage of our business is Medicare business, so I think that if you take a look at most of the kind of patients are treated with our technology, they kind of fall into that sweet spot, that's sweet zone of the 40 to 60-year-old patient.

Okay, then a second question, and this is a little bit sensitive, I see a lot of the innovation and good ideas come from doctors and they are remunerated according to whenever they deserve. I'm just kind of wondering how you manage that as far as expenses and if maybe you could give some color on what percent of your clients are also involved in some sort of consulting or training or involved in the product design process -- may be percent of revenue -- just kind of to better understand how much of that is in play.

As a percentage of revenue, that would be a very small number and I think that what we do, and what we have done all along from really the genesis of the company, is that we have had a certain cadre of surgeons that we know have got great ideas and have been able to help us to develop products. And they are reimbursed for their time on a consulting basis, as well as potentially with royalties on unique ideas and patentable devices.

Okay, great. Thanks.

Rebecca Kujawa, Stanford financial group.

A couple of my questions have actually already been answered, but I wanted to go and talk a little bit about the number of surgeons trained as well as your guidance for what is inside for the fourth quarter. Starting with the latter, with the new guidance that it appears to suggest you may think that only 50 to 60 doctors may be trained in the fourth quarter. Is that more of a reflection of your being conservative as typical or is there a particular reason why the number of surgeons trained would go down fairly significantly in the fourth quarter?

Typically our fourth quarter is our slowest quarter, given the holiday traffic or holiday schedule that we don't get as much traffic as we traditionally would in any other quarter. So we are anticipating a much smaller number in the fourth quarter.

Okay, I would absolutely understand the seasonality. Intuitively that makes a heck of a lot of sense, but you still had, I think if my numbers are correct, about 115 that were trained in the year ago fourth quarter. Again, is there reason to why to think it would be dramatically lower than that? Or, again, is just perhaps that you're being conservative?

When they're looking at the schedule of docs that are signed up for the fourth quarter, we have obviously some visibility to that and we do not anticipate that number to equate to what was in the fourth quarter of last year. We are may be a bit conservative, but not to that degree.

Okay, and the number that you always report, is that the number of surgeons that are completely new to the procedure, or does that also include surgeons that are coming back for training on different products or perhaps retraining?

It includes both and generally that split is about 75% on the new and approximately 25% of returning side.

Has remained roughly stable in the last couple of quarters?

That is about what it has been like for this year, yes.

Okay, one of the things that I think we've thought about over time, about thinking about the adoption curve for the XLIF procedure in particular, is that there is likely to be a set of spine surgeons that are more likely to adopt it, the early adopters, in general. Is there any sense you're getting past those early adopters or can you give us additional insight as to how you think this is being penetrated in the average, if there is such a thing, average spine surgeon across the country.

I think that is exactly what is happening is that we are starting to see some of the more seasoned, if you want to call it that, spine surgeons that have now heard about the procedure by word-of-mouth, have read some of the peer-reviewed articles that have recently been published, and presentations and so forth.

So I think that there is a lot of those surgeons that might be from what you'd call an older school of thought that are absolutely excited about XLIF and learning it. And I think perhaps one of the best ways to sort of described in an example is that one of the people that is really leading the charge for us, with regard to adult degenerative scoliosis, is Dr. Akbarnia. Dr. Akbarnia is President of the Scoliosis Research Society, which is the oldest society, the classic society of spine surgeons, mostly trained in scoliosis, as the name of implied. So we are seeing a lot of traction right now from these sorts of surgeons that are very interested to learn the technique.

Then one last question that should be abundantly obvious, but I want to make sure that we do state the obvious, the 67 to 70 percent to SG&A 2007, that does exclude the stock-based compensation, correct?

That's right.

Okay, thank you very much.

A follow-up from Bob Hopkins, Lehman Brothers.

Question for Keith on the plate. I'm curious if you are seeing or expect any physicians to do both, the plate and screws, or is that overkill?

Yes, I'm sure that that may be necessary in some extreme cases of instability, but I do not think that that is typically going to be necessary. It is a little bit of a challenge because you have a great deal of metallic hardware that's in the vertebral body that needs to be accommodated for.

Should we think of this as just most of the accounts that you're going to go into at first, you would be cannibalizing your sales of pedicle screws or do you think that, just in terms of how this will be rolled out, will it -- will you go right into account where you think you can take competitive shares and convert people that are using pedicle screws from other companies and convert them to the plate?

I think there's really three areas. I think you just named two. And that is that some of it may take our existing pedicle screw business, but the important part to that is it's similar price and is a huge time savings. So it is that time savings by not having to flip the patient and go posterior in that particular example, that would be valuable.

But the other bigger opportunity too is that there are number of times where it is felt that pedicle screw fixation is overkill. But you still -- the clinician may be concerned that they still want some supplemental fixation. And by already being there and already being at the lateral aspect of the spine, you can then apply the plate. So I think you're going to gain some additional opportunities there.

Then the third one is what you mentioned, that you are able to lockout a competitive situation with screws by having a novel lateral plate available right during the procedure when you're there laterally.

Okay, and then just while we are on the subject of training, if I am remembering correctly, at the beginning of this year you gave guidance that you would train similar numbers in '06 to what you did in '05, if not fewer doctors, because you were going to emphasize actually getting out and selling and training doctors in the field that had already been trained in San Diego. And yet obviously, that is not what materialized. Your training a lot more doctors than we anticipated.

As we look forward to 2007, is that a year were we should expect, in terms of the number of doctors being trained, that that will come down meaningfully from where we are in '06 or do you think you can continue at this pace?

I think the 500 number that we are arriving at approximately is a pretty good number. That is what we're going to be looking towards, I think, to be able to maintain that. So it is up approximately 100 from where we thought we would be this year and I think what we are seeing is just a terrific job buy our sales force in bringing in qualified surgeons. We are seeing slightly stronger demand that even we anticipated, so we are very excited about the fact that we have got more surgeons coming in here.

So you think you'll train about the same number next year as this year?

Yes.

Thank you very much.

A follow-up from Mike Matson, Wachovia.

I have two quick questions. Can you tell us what percentage of your revenue roughly comes from your cervical products? Then secondly, can you give us a cumulative number of the surgeons that you've trained so far?

Cumulative number is a little bit over 1000. What is the exact number? 1100. Cumulative is 1100 and cervical has represented approximately 10% of our business. And we have seen that increase pretty nicely over the course of this year.

All right, that's all. Thanks.

A follow-up from Matt Miksic, Morgan Stanley.

A question on ExtenSure. Just wondering if maybe I missed any comments you made on that, how it is progressing. And then I was also curious if you could tell us anything about how the reimbursement for that product, how you would anticipate it to be similar or different from some of the other products out there like the St. Francis products and so on?

As I think we've talked about before, what we're doing with ExtenSure at this point is we're keeping it in the limited release type of mode and kind of waiting to see how things shakeout from an indications standpoint. So we continue to hear different perspectives from surgeons about how they see the utility of products like that. So our focus has largely been on the allograft product and so that is pretty much where we are staying. So I think that clearly from a reimbursement standpoint, it makes -- basically makes it a process for us where we have got to wait and see what happens.

So not really moving forward with the peak version just yet?

That is also in a limited release mode, so we're going to wait and see what happens with regard to St. Francis' progress next year and the continued feedback we get from surgeons.

Okay, then just to clarify a couple things, so some of the costs that you saw in SG&A in third quarter coming out, am I just clear that this is -- you're looking at sequentially down Q4 in terms of SG&A?

Yes.

Then on the number of sales reps, just, again, to make sure I've got this, I was using something in the order of 180 by the end of next year for sort of productive reps. I think you mentioned a number slightly higher than that, but making the adjustments, Alex, that you mentioned, is 180 sort of in the right range?

I think you look at the 175 that we've got right now, I think you would be looking to add approximately 50 over the course of -- so that is exiting 2007. Then what you would have to do is you would have to subtract approximately 50 from that number in order to back out the management positions. But for next year, as far as fully-trained, that number is going to be approximately 200 or something like that and then you deduct the 50. So it puts you closer in the 150 range by the end of the year.

At the end of the year, correct. Right. Great, thanks.

Gentlemen, there are no further questions in the queue. Do you have any closing remarks?

No, thank you very much, everybody. We will talk to you in a quarter.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time.