NuVasive Inc (NUVA) 2009 Q1 法說會逐字稿

Greetings and welcome to the NuVasive incorporated 2009 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. Patrick Williams, Vice President of Finance and Investor Relations for NuVasive. Thank you. Mr. Williams, you may begin.

Thanks, operator. Welcome to NuVasive's first quarter 2009 earnings conference call. NuVasive senior management on the call today will be: Alexis Luklanov, Chairman and Chief Executive Officer, Keith Valentine, President and Chief Operating Officer, and Kevin O'Boyle, Executive Vice President and Chief Financial Officer. During our management comments and our responses to your questions, certain items may be discussed which are not based entirely on historical facts. Any such items should be considered 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 those expressed or implied by such forward-looking statements. These and other risks and uncertainties are more completely described in today's press release and NuVasive's most recent 10Q and 10K forms filed with the Securities and Exchange Commission. With that, I would like to turn the call over to Alex.

Thank you for joining us this afternoon on our first quarter 2009 conference call. Our first quarter profitability and revenue growth demonstrates that our strategy to build market share is performing well. Our XLIF approach to spine fusion has improved patient outcomes as evidenced by the growing number of surgeons performing the procedure. The superiority of XLIF outcomes gives our exclusive sales force a considerable advantage and enables us to grow faster than our competitors. Today, we are laying the ground work for an innovative and best in class spine franchise designed to cover all areas of spine surgery including cervical, biologics and motion preservation, with highly differentiated products to support our goal of $500 million and on to $1 billion in revenue, while increasing profitability as we drive towards becoming the number four spine company in the world over the next several years. Revenue in the first quarter increased well over 50% year-over-year to $80 million, and was up sequentially over 7% from fourth quarter 2008.

Turning to guidance, we are increasing both revenue and earnings guidance for the full year, thanks to strong results across our entire business in the first quarter, as well as higher expectations for the balance of the year. For 2009, we now expect $355 million to $360 million in revenue, up from prior guidance of $345 million to $350 million, representing over 40% growth compared to 2008 results. This assumes $30 million in revenues from Osteocel Plus, up from prior guidance of $28 million. For 2009, we are increasing our earnings guidance despite dilution from the Cervitech acquisition announced today, demonstrating that our business is able to achieve our strategic goals without compromising profitability. Kevin will give a more detailed review of our financial results and guidance later in the call.

We are excited about our major strategic initiative with our acquisition of Cervitech and its PCM device. The cervical disk replacement market holds real promise and it will be one of the fastest-growing segments of the spine market over the next several years, potentially replacing up to 40% of the traditional anterior cervical fusion market. The PCM is an innovative mechanical cervical disk which we believe will greatly speed NuVasive's entry into the US cervical disk market. There are significant advantages in making an early entry into the cervical disk market, and the PCM has the potential to receive US approval before most competitive devices, reaching the market must faster than our current motion preservation product pipeline. Cerpass, our ceramic-on-ceramic mechanical cervical disk, has an approved IDE but has not yet begun enrollment. PCM is at least three to four years ahead of Cerpass on the regulatory pathway.

NeoDisc our embroidery technology with a nucleus-like core has significant potential because of the opportunity for use earlier in the degenerative process. However, the NeoDisc design is unprecedented. We may experience a protracted time line for NeoDisc approval because of the novel nature of the device and the lack of an established regulatory pathway. Currently, NeoDisc is viewed as a total disk replacement at the FDA, but it may well be scrutinized as a nucleus replacement in the future. We expect to have more insight into the NeoDisc approval process once we collect and compile our two-year data which should be complete in late 2010. At that point, we will have greater insight into the approval pathway for PMA submission.

In contrast, the PCM device is a mechanical TDR and has a more conventional regulatory pathway which we believe could save valuable time to market. We plan to submit the PMA in the first quarter of 2010, and depending on whether or not a panel is deemed necessary by FDA, we anticipate possible PCM commercialization in 2011. In consideration, we will pay approximately $47 million up front for the acquisition of Cervitech, followed by $33 million contingent upon FDA approval. In order to maintain our strong cash position, up to half of the payments may be paid in stock. We expect that Cervitech will have a minimal benefit on international revenues in the near term, as we transition the product into our growing global sales network. We anticipate PCM revenue of $100 million annually, within three years of US commercialization. Although this acquisition will be dilutive to EPS until US launch, it does not change our ability to reach our previously-stated profitability goals for 2009, and we remain on track to reach our long-standing goal of 20% non-GAAP operating margins at $500 million in revenue.

Our decision to purchase Cervitech eliminates the need to proceed with the Cerpass TDR project. The knowledge we gained from the development of Cerpass will serve us well as we establish our innovative suite of TDR products. Eliminating the Cerpass trial will save us up to $20 million in clinical trial costs over the next several years, which further helps diminish the dilutive impact of Cervitech. Additional information about the Cervitech transaction can be found on our corporate website and in our 8K filing. We have concluded a series of M&A transactions over the last year that have cash and stock components. We are committed to maintaining a strong cash position as we leverage our top line growth and expect to finish the year with a cash balance of greater than $150 million.

Next, I would like to discuss the (inaudible) lumbar market segment which includes our revolutionary XLIF procedure which continues to transform the fusion market by providing shorter outcomes and shorter recovery. We are currently advancing XLIF products for multilevel spine fusions such as degenerative scoliosis and trauma. In 2009, we plan to launch a new scoliosis system, more core implants and the next generation of our XLP lateral plate. We also have line extensions for our Maxis thoracic product to better equip surgeons to move into the thoracic spine. We continue to roll out our next generation Neurovision platform, the M5 which provides additional monitoring and guidance capabilities. Most importantly, the sophisticated capabilities of M5 further solidify our place as the leading lateral access company by further locking in our proprietary stronghold on safety and reproducibility.

Lastly, I would like to touch on the biologic space. Our acquisitions over the past several years have provided NuVasive with an offering to suit any surgeon preference, and we are extremely pleased with our positioning in this $1.5 billion market. With Osteocel Plus officially in the hands of our exclusive sales force, we are seeing positive early acceptance of this unique stem cell-based technology, and we believe that it is firmly on track to generate $30 million in revenue in 2009. We will provide additional insight on NuVasive's new product launches at the webcasted investor morning we are hosting on May 12 in New York City which will include hands-on demonstrations of our products. There will also be a surgeon panel to answer your questions, provide additional color on the market for spine fusions, and provide data from NuVasive-sponsored surgeon surveys which objectively assess the health of the spine market. It is an opportunity not to be missed. And we hope that you will join us in New York.

I would now like to address the overall spine market and our growth trajectory. In our view, spine fusion surgery has not seen signs of the slowdown as contemplated for other orthopedic markets which are more elective in nature. In fact, in the eyes of most spine fusion patients, spine surgery is not elective at all. Our ongoing dialogue with existing and potential surgeons who come to our headquarters for training has reinforced our belief that the spine fusion market continues to grow at a rate greater than 10%, with well-established reimbursement. Although our sales have more than doubled over the last couple of years, we still only have modest market share in the US, and much less internationally. We feel strongly that we have a long global runway of growth ahead of us.

A major factor in our confidence is our exclusive sales force. During the first quarter of 2009, we grew our US quota carrying sales representative count to 235 from 225. We are on track to reach $1.4 million to $1.5 million in revenues per representative by the end of the year, up from $1.3 million at the end of 2008. We are on track to achieve $13 million to $15 million in international sales in 2009. While still small, we continue to add new share owners and new countries. In 2009, we expect to make our first sales in Australia and recently we began the process of regulatory approvals in Asia. We are very optimistic about NuVasive's potential in international markets, with new offices opening in London, Brennan, Germany, and Melbourne.

Before I turn it over to Kevin, I would like to give a brief update on a few miscellaneous items. The Medtronic litigation is still in the preliminary phases. We will continue to vigorously defend ourselves using all defensive and offensive measures available to us. We have no intention whatsoever to seek settlement and expect to have our day in court in late 2010 or 2011. In the first quarter of 2009, we spent $1.6 million, and continue to expect $5 million in litigation expenses for 2009.

On the compliance front, we expect the government and medical societies to adopt stricter policy, related to the disclosure of surgeon relationships which will provide increasing details on remuneration. We will continue to acquire innovative product ideas and intellectual property from surgeons, and we will continue to work closely with surgeons to proctor and teach our innovative technique, all within the bounds that have been determined by the government and industry groups. We believe surgeons are crucial for driving innovation in the spine market, and helping companies like NuVasive to develop products that deliver outstanding patient outcomes. To place our efforts in context, royalty payments for technology transfer and product development collaboration comprise approximately 3% of total revenue, and approximately .5% of revenue is related to surgeon proctoring and initial product evaluations. Now, I would like to turn it over to Kevin O'Boyle for a detailed review of our financial results and updated guidance.

Thank you, Alex. Our revenue for the first quarter 2009 was $80 million. This represents a 56.3% increase over Q1 2008, and a 7.3% increase over Q4 2008. The strong revenue demonstrates the company's continued ability to take market share. Gross margin for the first quarter was 81.5%, compared to 82.2% in Q1 '08, and 82% in Q4 2008. The gross margin in the first quarter is consistent with our guidance of 81%, 82%, and primarily reflects our product mix and international revenue contribution. Our Q1 2009 GAAP net loss was $4.3 million, or a loss per share of $0.12. Excluding intellectual property litigation expenses of $1.6 million, and costs related to our acquisitions of $1.9 million, our first quarter loss was approximately $800,000, or a loss per share of $0.02, which improved from our previous guidance of a loss per share of $0.19 to $0.21. Please reference the table in the press release for more detail. The strong financial results demonstrate our ability to leverage our revenue growth into improved profitability. A portion of the loss per share improvement is due to the timing of operating expenses and is reflected in our updated full-year guidance.

Operating expenses for Q1 2009 totaled $68.7 million, compared to $50.5 million in Q1 2008, and $57 million in Q4 2008. The increase in operating expenses in Q1 2009, from Q4 2008, is primarily due to costs associated with increased revenue volume, stock-based compensation and acquisition-related costs. As a reminder, with the new accounting rules, acquisition costs are now expensed in the period they are incurred. Our legal expense related to Medtronic lawsuit in the first quarter was $1.6 million, and we remain on track with our previous guidance of $5 million. R&D expenses for the first quarter excluding stock-based comp and intellectual property expenses totaled $7.1 million, versus $5.2 million in Q4 2008. R&D as a percent of revenues for Q1 2009 was 8.9%, versus Q4 2008 at 7%. The increase in R&D spend was principally due to investments related to clinical data, to support our biologics portfolio and the initiation of new development projects.

Sales, marketing, and administrative expenses for the first quarter, excluding stock-based comp, amortization of intangible assets, and acquisition-related costs totaled $50 million, versus $43.9 million in Q4 2008. The increase in sales marketing and administrative expenses was commensurate with commissions on higher revenues, as well as increased training and marketing activities in the quarter. Excluding stock-based comp and the aforementioned adjustments, the percent to revenue was 62.5% versus Q4 2008 at 59%.

The stock-based compensation expense for the quarter of $6.7 million was recorded in our operating expenses, and allocated as $1.4 million in research and development, with a balance of $5.3 million in sales, marketing, and administrative expenses. The interest and other expense for the quarter was $900,000. This reflects the continued trend of low yields on our cash investments, due to market conditions. With $203 million in cash and investments, our primary focus has been and will be going forward, safety of principal. As a result, the majority of our invested cash is in securities backed by the US government.

We anticipate that we will close the year with a solid cash position of between $150 million to $170 million, taking into account expected milestone payments to [Cyrus], the investment in Progentix and the acquisition of Cervitech. In our P&L, included in the other expense total is a new item titled net loss attributable to noncontrolling interest. As a result of our investment in Progentix, we must now consolidate the entire expense in research and development. However, the net loss representing the 60% we do not own is backed out in the line titled net loss attributable to noncontrolling interests.

Our full-year inventory target remains at 20% to 25%, the inventory to sales ratio. At the end of the first quarter, 2009, our inventory position was $82.2 million, or 25.7% of annualized first quarter revenue. We expect that by year-end, we will be back in our target range. Day sales outstanding, or DSOs, were 59 days in the quarter, down from 63 days in Q4 2008. I would now like to turn to a review of our updated 2009 financial guidance. For the full year 2009, we are increasing our revenue guidance range to $355 million to $360 million from $345 million to $350 million, or approximately 43% growth over 2008. This updated revenue guidance includes an increase in our Osteocel Plus sales from $28 million to $30 million. We are improving our full year GAAP guidance to a loss per share of $0.05 to $0.07, from previous guidance of a loss of $0.12 to $0.14. Excluding IP litigation expenses and acquisition-related costs, we are also raising our earnings per share guidance to $0.11 to $0.13 from $0.02 to $0.04. Gross margin guidance for the year has not changed from 81% to 82%.

Research and development expenses, excluding stock-based comp and intellectual property expense adjustments, as a percent of revenues, will increase from our previous guidance of 11%, to 11% to 12% for the full year attributable to the Cervitech acquisition. Sales, marketing and administrative expenses, excluding stock-based comp, amortization of intangible assets, and acquisition-related costs will show progressive leverage from Q1 and therefore we expect to see costs as a percent of sales at the lower end of the 58% to 59% guidance range. As previously mentioned, stock-based comp remains unchanged for the full year at an estimated $27 million, with 20% allocated to R&D and 80% allocated to sales, marketing and administrative expenses. Amortization of intangible assets and interest in other expense both remain unchanged at $5 million each.

I would now like to give some insight into the trend of our operating expenses and impact of the recent Cervitech acquisition. Our updated earnings per share guidance takes into account the dilutive impact of the Cervitech acquisition, which includes expenses to complete the clinical trial and work through the regulatory approval process. Our expected strong financial performance will enable us to absorb the dilutive impact of the Cervitech acquisition.

Consistent with prior years, we expect revenue to increase progressively throughout the year, while fixed expenses should be more consistent from quarter to quarter. As a result, we expect to have higher earnings in the second half of the year. We will continue to maintain the strategic approach to the industry as we drive to achieve $500 million and then on to $1 billion in revenues. For more than two years, we have publicly stated a goal of hitting 20% non-GAAP operating margin, in conjunction with the $500 million in revenues. Today, we are more confident than ever in our ability to achieve this goal. I now would like to turn the call back over to Alex for closing commentary.

Overall, we are very pleased with our financial performance in the first quarter of 2009 and revenue and earnings. We have consistently met or exceeded all 20 quarters as a public company. Our XLIF approach to spine fusion continues to be an extraordinary competitive advantage that offers better reproducible outcomes for both patients and surgeons. With this year's launches we will have over 50 differentiated products for fusion, biologic, and motion, a strategy that we expect will enable us to both take increasing share of today's spine market, and to expand that addressable market. In summary, we have the strategy and the foundation in place to drive toward our goal of being the number four spine company in the world and we plan to get there by adhering to our core values of absolute responsiveness, outstanding customer service and cheetah speed. We will now take your questions.

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. (Operator Instructions). Our first question is from the line of Ben Andrew with William Blair. Please go ahead.

Good evening, gentlemen.

Good evening, Ben.

I wanted to kind of talk a little bit about Cervitech and NeoDisc, I think that is kind of the newest piece of information in this quarter. And maybe you could go through the thought process, other than timing, which is obviously great to move that forward by three years, and discuss if you would a bit more, the regulatory path on NeoDisc, and that just seems like that is a new development there.

Sure. That would be -- well, let me kind of explain it in the same context that we discussed it in the script. So I think if you take a look at Cerpass, and where we are with that, we have obviously decided to not move forward on Cerpass, and instead, to purchase the PCM product, because that allows us to move into the market much more quickly, as we discussed, and we think that that could be as soon as 2011. With NeoDisc, what we're contemplating is that it may be treated more as a nucleus type of device, meaning that it could take us longer to get in front of a panel. The whole process may be protracted, and so as a result, we're not certain of exactly how quickly we can get the device approved.

So if you start to do just the basic math on the approval process, and you take a look at what that looks like, submitting let's say a PMA some time in 2011, being able to get that completed into panel into 2012 is probably reasonable, assuming that's where we are in 2011, and then by the time you complete the labeling process, by the time you go through all of the normal back and forth with FDA, it pushes it out to 2013. So, that is the reality of simply doing the math of how long it takes to go through the FDA process. So our feeling is that it was much better to go with what we believe is a sure thing, relative to coming to the market quickly, with a mechanical device that we think -- that we're not sure if it will require Powell but our guess it will not and it should bring us to the market a heck of a lost faster.

How much insight do you have, at this point, Alex, in terms of the data on NeoDisc, and obviously the European experience, but also the data on Cervitech, is there a shorter term follow-up available that gave you the confidence to do this transaction?

There are a couple of papers now that are being published and so there are 6,000 cases now that are being done with Cervitech, so we feel very comfortable with regard to the data. We have done extensive diligence in speaking to the surgeons who have implanted the device. We feel it is a very solid device. It will be well-accepted by the market. It will give us an opportunity to start to market it to our direct sales force in select countries throughout the world. And then move it into the US with hopefully what will be a much earlier approval time from the FDA, as I said, hopefully some time in 2011.

Okay. Maybe a couple quick questions for Kevin. Can you give us the Osteocel's number in the quarter so we can kind of get a look at the underlying implant numbers? And then talk a little bit about inventory, why they're staying high, and, why it takes toward the staying high, and, why it takes toward the end of the year to bring those back down to normal, if you would?

Yes, the Osteocel's number in Q1 was $5 million. So the underlying business was obviously growing, and if you take out the number from Q4, was growing a little more than 8% sequentially. So, that is all great news, as relates to the underlying business. And as relates to the inventory of $82 million, as part of the transition, we took on additional inventory around the Osteocel product to make sure that we have the inventory for the upcoming ramp of revenues going to $30 million that inflated, if you will, the first quarter inventory number.

But if you look at inventory on the core business, how did the -- can you look at it that way and sort of say the days are a bit more normal or is that possible?

Instead of looking at it in the number of day, we look at it as a percent of sales of 20% to 25%. We're just a little above 25%. And I think as we continue with our sales ramp, and the things that we have, and once the initial inventories are out in the international markets, we can get back into the guidance range of 20% to 25%, and that's where we're comfortable.

Okay. Thank you.

Yes. You're welcome.

Thank you. Our next question is from the line of Raj Denhoy with Thomas Weisel Partners. Please go ahead.

Hi, good afternoon. I'm curious when I look at your guidance for the year, obviously, you're basing a little bit of dilution from the Cervitech deal, but you've also raised your guidance for the year, particularly on the earnings side by quite a bit, and I'm curious what the difference is from just a month and a half ago. Is it that you found less places you need to spend, or is there more leverage in the model than you thought, and what has changed in the last six weeks or so?

Part of it is certainly leverage-based on the revenue beat, Raj, that is certainly there. Part of it is some timing of expenses that we thought would hit in the first quarter that will hit in the subsequent quarters, so there is a combination of both of that. And we're getting some increased leverage out of the SMA line, and we will continue to see some leverage out of that as we go to the end of the year. So you throw all of that together and that gives us the confidence to increase our guidance number.

I guess when we consider though that still pretty heavy spending load you're guiding towards for this year, I mean is that kind of a worse case scenario? Is that maximum spending which we -- and again, what I'm trying to get at is whether that is very conservative guidance still at this point because you beat by pretty handily amount here in the first quarter.

It is called reasonable spending to achieve superior results. And that's what it takes to put up the kind of growth that we're talking about. So I think the numbers are reasonable relative to what we're putting forward. We will see how the rest of the year goes. But we're very bullish on our prospects.

Okay. That's fair enough. Just a couple of ones. Obviously there has been a lot of interesting stories circulating around about your stock over the last couple of weeks and months, and maybe you could just address, some of the ongoing concerns about potential reimbursement changes, and competitive pressure that some are expecting to develop over the course of this year?

Absolutely. Well, first of all, we do not believe that there is a reimbursement issue. We have not been apprised of such. And we have done extensive research because of some of the nonsense and rumors that we've seen develop by the shorts. So to put it in blunt terms, and there is nothing brewing. There is absolutely nothing that has changed. Our reimbursement prospects have not changed. There is nothing being done differently by surgeons. We are following the exact same coding process that we've been following since 2006, as was established by NAS, so absolutely nothing has changed, and, frankly, it is just baloney and there is absolutely no truth to it.

Okay. Fair enough.

That's pretty clear, right?

Yes, that's crystal clear. I will leave the competition for someone else maybe to ask but the international, did you give a number in the quarter.

Not in the quarter but we simply said we're in the track in the range of $13 million to $15 million on the year. So that puts us somewhere in the 3% to 4% range in terms of percentage of revenue.

Let me just, on that number, I mean there is obviously a lot of potential in that number for to you expand internationally, and it sounds like you're doing some things there. But why the decision not to go faster there, in a sense? Overall spine market is maybe 40% international and still a small percentage of your business, you could obviously ramp that a lot faster you chose to and I'm curious why you're not doing that.

Because I think you can do that and we could do that, but we don't think that is a solid way to build a long-term business. The way that you would do that is you would engage distributors, there would be nonexclusive, and you would get a rise in sales, but it would not be ultimately sustainable to the levels that we would expect in terms of our growth expectations. So we feel it is much more prudent to build an appropriate sales force that is exclusive, so we're going exclusive as a result, and started now exclusively, in Germany and Australia have been in the United Kingdom, are making plans to do so in Japan, and our entire process entails hiring very seasoned individuals.

You have to wait for those individuals at times and get the right people in place. But I think that when you take a slightly slower approach, get the right people, hire the right people, then you end up making it up on the back end. And so I see us being able to grow quickly as we move. I think next year, it will be a strong year for international. I think as we continue to move forward, we will expect that to grow commensurate with the kind of pace that we're seeing in the United States, and then some.

That's great. Thanks. Nice quarter.

You're welcome. Thank you very much.

Thank you. Our next question is from the line of Matt Miksic with Piper Jaffray. Please go ahead.

You can hear me okay?

Yes.

Sorry for the background noise. Just one question on the spine market, sort of a follow-up to an earlier question, and some of your comments in the prepared remarks, just to be clear, you obviously have taken share here and have been for a while, but some of the larger players in the space, some of them have not grown as fast as you are, but making comments that they are seeing some deferrals. I guess, what are you seeing in your business, what gives you the confidence that that hasn't changed an awful lot, which is sort of what I read through in your 10%-ish kind of growth number you gave in your prepared remarks. Then I have a follow-up.

Sure. Well, I think there is a number of things. Obviously, it has to do with our product portfolio, our exclusive sales force and our ability to take market share. So clearly, XLIF is doing exceptionally well, we're moving up the spine, we're doing obviously the gender scoliosis application, so it has broad utility. The same thing with moving into the thoracic spine. And I think that that is a critical point relative to our success. We also, as you know, train a large group of surgeons on an ongoing basis here in San Diego, and so we decided that who better to survey the surgeons than us, since we see them on a routine basis . And so when we talk to them about their business, and what it looks like relative to the future, then what we're understanding from 90% of them is that they expect their lumbar spine fusion procedures in 2009 to increase or to be the same as last year.

I think that probably with regard to our space, and we don't know this for a fact, but we believe that there is probably going to be some downward force more on disectomy, laminectomy, type of procedures, but certainly not fusion, and we've not seen a downward trend. We talk to surgeons constantly and the same thing with our sales force, so I think it is all of those things together, being driven by our unique lateral approach, and the confidence that we're hearing from our surgeons that are using XLIF, as well as prospective customers that we also survey when they come through

That's helpful color. Thank you. And another follow-up question.

Where are you calling from, the space shuttle or what? Where are you?

Sorry. I'm in an airport. So follow-up on also on inventories, so how much of this -- you have a lot of questions in the last couple of months on this I'm sure, but as I think about the growth in the sales force, and I'm thinking that some of the new products are rolling out and moving up into the thoracic, how much of the -- if you could give us a sense of how much of the build has been around Osteocel and how much of the build has maybe been around sets? Has there been an effect of stretching some of your inventory across these new geography, can you give me some color on what the fourth and first quarter build has been and in anticipation for the rest of the year?

Before Kevin answers that, I've just got to mention one thing is that we have taken and we have done there now for several years, we have taken an approach of zero back orders when it comes to our products. And we feel that if we're going to be out there taking market share, we've done this before, and we know that the way to fail at taking market share is to not be able to deliver on the products, so we tend to perhaps run a little bit higher on inventory, as a result, and perhaps other companies in that 20% to 25%. We think that is totally acceptable. And over the course of the year, bringing it down to something below 25% is how we have established our target.

And we did beef up on some additional inventory on Osteocel, and I'm not sure we have the numbers to run through with you in particular, but I think Kevin can provide some additional color, but I wanted to explain just how we support our sales force, and we do run to a higher number with regard to that when we move forward on our top line. So that is a normal way that we set things up with our sales force. Our sales force obviously has a quota that is higher than our guidance. That's the way every single company in the world does it. And so we have a tendency to build to a higher number that will support our sales efforts. Those numbers will then tend to intersect and ultimately meet, as we have a successful year, which we certainly would hope to have this year again. Kevin?

Yes. On the Osteocel inventory, in terms of the first quarter, $7 million of that number relates to Osteocel, Mike, so, that certainly gets us over the 25% range. And as we move throughout the year, we have a number of initiatives and things that we're looking to, to make sure that we hit the 20% to 25% range, appropriately so, because that is our internal target and that's the one that we have related to the street. We are confident in that, and it is going to take a couple of quarters to get it back into that range. But, there are a couple of reasons, as Alex just mentioned, as the reason we're at the high end of that range at the moment, but we don't consider that to be a significant problem.

And last question here, just to make sure I heard your comments right on Cerpass and the PCM acquisition. So is it discontinuing your progression of Cerpass, in other words does that program go away, in favor of PCM? Is that what happens?

That's exactly right. And we've not started enrollment. So we have been kind of hedging to see if we could put some things together. So that simply will be [supplanted] by PCM.

Got it. All right. Thanks very much for taking the questions.

Okay. Thank you.

Thank you. Our next question is from the line of Michael Matson with Wachovia Capital Markets. Please go ahead.

Hi, thanks for taking my question. I guess I just wanted to go back to the percentages that you gave of yourself, that you're paying to physicians, either as royalties or as consulting payments. I appreciate the visibility there, and I think that will help alleviate investor concerns. But I was just wondering, do you give stock options at all to any physicians? And if so, would that be included in that number as well?

We give zero stock options. And there are no stock options included.

Okay. And then just with regards to the cervical disk market, it seems like you're pretty bullish on that market segment, and as best we can tell, it seems like the products that are out there are struggling and I guess we're more optimistic about it than the lumbar disk market, but I was wondering if you could give us your perspective on why it hasn't really yet taken off.

We think the products are actually doing better than perhaps the companies are talking about, so as we have our ear to the street, our belief is that they're doing quite well, both of the cervical TDRs are that are out there. So we kind of see that as a very robust opportunity for us, and we've also seen on the reimbursement side, them able to gain additional states and they're kind of going on a local approach with a state by state approach to their reimbursement strategy, but being able to gain more and more traction. So our belief is that this is going to really take off over the next couple of years. And I think the one thing that perhaps is most important is the clinical relevance of the product.

So, it is one of those things where good medicine ultimately prevails. I think it is like the XLIF story in that regard. But motion preservation makes a lot of sense in the neck. In the lumbar spine, it certainly has a place and a space, but it is more limited in application. But in the neck, clearly, as you know, adjacent segment disease is much more easily documented, and has been, in the literature. So I think that you will see this -- and we've seen this with surgeons and with our own diligence, that the surgeons are very bullish on the need for motion preservation in the neck, especially as that disease progresses and patients move down that cascade process, if you start off with a fusion, you're simply accelerating them to another level of fusion. So we believe that that is also going to prevail over the next couple of three years, in particular, as this product becomes more available in the US.

Okay. And then the Asian watch that you're planning, what countries are you entering, and does that involve Japan, and if not, what are your plans with Japan and how long would it take you to get your products on the market there?

Well, Japan is our primary focal point. And so we anticipate essentially being able to have some significant revenue in 2011. The beginnings of that will come in 2010, as we will start scaling up. But we will see it in 2011. So we're going through that regulatory process. We're interested in China as well. We're looking at the Singapore markets. But we're largely focused on making sure we get into Japan. It is the largest market. But the Chinese market is also coming around very quickly as well.

All right. That's all I've got. Thanks.

You're welcome.

Thanks. Our next question comes from the line of Rick Wise with Leerink. Please go ahead.

Good afternoon. And thanks for a really good quarter. Alex, could I ask you for a little more color on the revenue beat? You came in $5 million better than our numbers, anyway. Maybe just color, you might have some other ideas other than what I am going to suggest, was this new reps getting more productive faster than you thought? The more experienced guys penetrating the count faster than you thought? Opening new accounts faster than you thought? More thoracic spine than lumbar spine than you thought? Just trying to understand where the incremental better than you would have expected came from.

We had a very strong performance across the board, and our sales force is measured on mix. So in terms of how it does on XLIF, cervical, biologics, Neurovision, and so forth, and so we came across the board very strongly in every category. That's unusual for any company to have such a strong performance across all categories of mix. But that was the case for us. We also had a stronger number on the Osteocel side than we originally thought we might have. As you know, we transferred that product from the fourth quarter to the first quarter, into the hands of our own sales force. That's gone very well, as a result, we've increased our guidance to $30 million on the year there, but that certainly contributed very nicely also.

Okay. And when we look at that doctor training commitments and planning, any -- do you have a sense that in terms of folks making reservations to come and get trained, has that changed at all, in the last month or so, and how far out are you booked for those trainings at this point?

It has been consistent as last year. So, that time is anywhere from six weeks to eight weeks and our courses are filled, so we have not seen any drop whatsoever in those numbers, and the training rate is the same, it is about 125, 150 a quarter. We just recently had our SOLIS meeting here, which is our Society of Lateral Access Surgeons, we had about 100 surgeons come in for that. So the surgeons I think are very excited about what we're doing. And we're seeing absolutely no change whatsoever in our traffic, nor in our forecast that way.

Raj was kind enough to leave the competitive question to somebody else, I will pick that up. Maybe any updates on your thoughts about new competing lateral approach products, we've got a few coming, that's another recurring concern that we all have to address.

Well, I think that this is just like for us, it has been 20 quarters of success, in terms of being a public company. I think it is just as many quarters of companies trying to copy what we're doing with XLIF, without success. So the reason for that is because Neurovision, being very proprietary, is so far ahead of everybody else, and I think as you talk to surgeons, you can do lateral surgery without Neurovision, it is just not safe and reproducible.

So if somebody wanted to subject themselves to potential nerve damage, then I'm sure they could move towards a competitive product. But from our perspective and from what we hear from surgeons on a routine basis, and we've had quite a few surgeons that obviously have been targeted by companies that use the XLIF procedure to try a competitive offering, and we have gotten the same consistent remarks that there is absolutely no comparison between XLIF, the suite of products, the instrumentation, the approach, the sophistication, our ability to move up into the thoracic spine, so we believe that we are firmly several years ahead of the competition.

We will continue to evolve our products and stay in that lead position. So I think this, and I know you speak with surgeons, but if you talk with any surgeons who have done comparisons they will tell you it is night and day, and they would not move towards subjecting their patients to what I think they have described to us as clearly inferior technology.

Okay. And two last one, maybe for Kevin. Kevin, on the R&D front, I think I understand that Cerpass is going away Cervitech is coming in and no massive shift in R&D spending. But as we look at our models and we look at R&D as a percentage of sales, do we assume -- whatever we assume, it is reasonable to continue assuming, or it is likely to be higher or lower with Cervitech? How do we think about that? Maybe more this year than we might have thought because of the starting of a trial or --

We talked about 11% to 12%, our prior guidance was 11% for the year, so between 11% and 12%, because of the Cervitech, as relates to the R&D line, and for our sales marketing administrative, we had originally guided 58% to 59%, and we are now guiding to the low end of that. So right around 58% for sales and marketing and administrative. So you kind of led your balances if you will, and then when you add in the increased revenue guidance, you start dialing into our guidance on an earnings per share basis.

And last, real quick, I may have missed it or went back too quickly, I understand your $1.4 million to $1.5 million annualized sales per rep, etc., by the end of the year. Did you say what you thought it was in the current quarter?

We gave the rep number of I think 235. You can do the math.

Okay.

But I think it is about $1.3 million and change.

I just wondered if you had said it, that's all. Thank you.

You're welcome.

Thank you. Our next question is from the line of Joanne Wuensch with BMO Capital Markets. Please go ahead.

Thank you. 235 reps, that's I assume is in the United States.

Yes, that is all US.

All US. And what about outside the United States?

Our -- what's our direct count outside the United States? It is approximately 20 at this point and that will increase obviously dramatically as we move into the year.

Okay. And I apologize if I missed this, because I'm bouncing between calls, is Cervitech CE marked approved at this stage?

Yes.

And what is its revenue run rate at this stage?

It really doesn't have a revenue run rate per se. They did -- historically, they did a couple million dollars in revenue on a global basis with a broad range of different distributors. So we're starting effectively from zero with Cervitech, because we're going to move it into our direct sales force and then move it into select countries. So we have worked with Cervitech to cancel the vast majority of those agreements, and so we're just down to a couple of countries that are remaining that we're still working through, and we may use the distributors that were in place. But we're starting all over.

Okay. And you said something which sounded like you were done with the M&A environment. I think you specifically said we have concluded a series of M&A transactions. Is that a pause for now, or how are you thinking about M&A?

I didn't say that. I'm not sure if somebody else said that. But the way that we're looking at it is that we have certainly completed the major transactions that we wanted to get done on the biologics side, as well as on the motion side, so we are not working towards any particular transactions at this point in time. What we do in the future, as we've done now for years, has certainly continued to evaluate technology, technology transfers, but those are smaller ticket items.

Okay. And then just a final question has to do with, it is interesting to me how everyone keeps talking about a slowing spine market, a slowing spine market, and you're clearly not seeing that, so I'm thinking you're taking share, a fair amount. Do you have an updated estimate of what that may be?

We don't. It is a hard one, because it is a moving target relative to the performance of other companies, so we know the same thing that you do about how they're growing. We can simply sort of rehash what we already talked about and how well we're doing with XLIF and how well we're doing across the board, and really, the strength of our exclusive sales force.

Okay. Sounds good. Thank you.

Thank you.

Thank you our next question is from the line of Taylor Harris with JPMorgan. Please go ahead.

Thanks a lot. Like some others, I've been jumping around so hopefully I won't touch anything that you've talked about already. But Alex, just curious, as to what you're seeing in your business, obviously XLIF for you has been the driver for a number of years, but you're more penetrated in terms of what XLIF can do than perhaps your overall spine market share. And so I'm wondering, in some of the applications where XLIF perhaps can't be used, are you starting to take share there as well, and how meaningful can that be for you?

Yes, I mean for example, on -- at 5/1, we have an ALIF offering. So in situations like that, which are not applicable to XLIF, we have had our TLIF approach, but we have put together a nice portfolio for ALIF. It is a small part of our business. But I think what is really working well for us, Taylor, is our ability to really penetrate an account, not just with our lumbar XLIF business but to do the same with cervical, to bring in the biologics products, and obviously to have a strong hold with Neurovision. So I think what we're seeing, as I said earlier, to a question, we're seeing a very strong penetration relative to all of our mix categories.

Okay.

To pull through.

As you incentivize your sales force, how much emphasis is put on new account acquisition, versus existing account penetration?

Not so much on -- well, it depends on the territories. So the way that we focus them is again relative to mix. But we have their territories well defined, and we consentcally grow out our territories, so there are areas where we continue to increase the number of reps because we only have a small number in a particular city, even though they are deeply penetrated. So we will add reps in those particular areas, and they will start from zero, and obviously in that case, they're out there getting new accounts and moving into those territories. But for the most part, what we're trying to do, our strategy, is I would say 75% of our efforts are about building through and pulling through on our existing accounts, and then 25% keeping a reasonable pace, and again, these are just estimates of moving towards new accounts.

Great. And last question, these are tough times, especially for some of the larger companies that you compete against, and my assumption is that there are -- some of these larger organizations are cutting back in terms of expense, whether it is the sales force or R&D or otherwise. Are you seeing that play out in the marketplace, or is that just sort of a thought at this point?

I have not seen that play out in the marketplace, certainly not at this point.

Okay. Great. Well, congratulations on a good quarter. Thanks.

Thank you very much.

Thank you. Our next question is from the line of Bob Hopkins with Bank of America. Please go ahead.

Hi, thanks. A lot of the key questions have been asked but I just wanted to, Alex, get your opinion on the spine market again. Just kind of looking forward, we obviously right now, it is extraordinarily healthy, and just wanted to see what you thought about looking forward over the next 12 to 24 months from a pricing perspective, from a unit perspective. Do you expect this to continue to be a 10% growth market? Do you expect any impact from the economy at all? And then, I have a follow-up as to how that might affect you guys and if it affects you guys.

Yes, obviously, we don't own a crystal ball, and the best that we can do is just kind of talk about the trends that we're seeing. So I think clearly, for 2009, we see 10%, we're not seeing any reason for that to change, as we move into next year. The pressure that we've seen on price has been consistent with what has been taking place over the last several years. And I think our ability to bundle products, our ability to move into accounts aggressively, and again, we're taking share, so that it puts us into a position to move aggressively, again some of the larger competitors has been paying off for us.

So I think that perhaps we're a little bit different from the other companies because of the fact that we continue to take share, but we do see this market as being very robust and largely based upon the comments of surgeons and relative to the queue that they see in their practice, the projected volume that they're seeing for this year. So we expect that that is going to move into next year, although we do anticipate a little bit more pressure on price, just in pace with the things that are being talked about in health care.

I'm not sure how you build up your internal models, but is there a sensitively that you've done, and it strikes me that if the market is growing 10% or if the market is growing 7% or 8%, it probably doesn't make a huge amount of difference to your ability to grow the top line within the range that you've articulated. But I'm just curious, as to your model is there sort of a threshold that you've thought about, if the market is below 5% something below that it is difficult to make your projections, or is that not the way you built up the model?

We have not built up our model that way. And again, I think our ability -- and we still have such a small market share in the United States. And now throw in the biologics piece that we've talked about, throw in OUS, which is very small numbers for us as a company, our ability to take share, I think, is relatively unprecedented compared to other companies. So we continue to invest aggressively and I think a lot of that, and I can just tell you from having been in the industry for years, it is because we're a stand-alone spine company. We don't do anything else. And we don't focus our energies on other areas. And we can make decisions quickly and we can move into new product offerings quickly. And so that is very effective. And I think sometimes that is lost on people, relative to how we're able to do business versus perhaps some of the other companies.

And then last question is just on the cervical disk market. Two things I'm curious about. One is what is your sense as to when this market will really start to happen? Is broad-based commercial insurance the major issue here? And when do you see that happening and loosening up this marketplace? Because there obviously are products out there right now and they're not doing spectacularly well. And then I was just wondering if you could comment a little bit more on the strategic fit of this deal with the cervical program that you already have.

Sure. What I would like to do is I would like to turn it over to Keith to talk about that, and give you a little more color on what we think the market is in the US today, based on our reconnaissance and talk about that and he's got to answer a question or he's going to get mad at me for prepping all this time. So, here, Keith, all yours.

Bob, I think you're going to see a lot of freedom in 2009 right now, and we're seeing it already, we're seeing the payer community more receptive, and I think that the pent-up market share predictions that were put on TDR for both lumbar and cervical made both of them very difficult to live up to. But the good news is if you compare this to the lumbar experience, you're seeing cervical free up on the payer communities, a lot quicker, and you are seeing it free up in a very consistent manner. And we see 2009 as freedom for that space, for the two players that are there, and then we see nice expansion for 2010 and beyond. And it will be well over $100 million market in 2009, and I would expect, if this continues, with the payer and what we're seeing with some of the payer freedoms, that it is going to be on a ramp closer to $200 million for next year. And so I think that it has just been under high expectations, and I think some of the clearances have take an little bit longer than anticipated. But now that you have two very good players with very good options, and great clinical results now, you're getting clinical results out past three years, and they're starting to show some superiority, with certain outcomes, those are the kind of things that really create a nice momentum shift with the payer community.

You think that market might double in 2010, is what you're saying?

Yes, we think it has clear ability if the momentum continues with the payers.

Okay. And just, could you talk about the strategic fit? I am sorry if you have already talked about this, but just how this fits with NeoDisc and just some comments there.

The real opportunity here is that this gets us into that market place as a number three player. And in that, it also gives a great opportunity for our sales force to get on the ground, to be driving a motion preservation platform, which only helps the continued driving as we bring new products such as NeoDisc, after that. And so this really is a great process for us to make sure that we're getting our sales force up to speed in the process, and we're also delivering new technology after this particular technology, this particular motion technology is approved by the FDA.

I'm sorry if you said this, but when do you expect approval of this device in the US?

2011.

2011. Okay. And what is the soonest we would see some good data from it in the US?

There is actually two papers that are out. I'm not sure if they're referenced on our website. Are they referenced on our website? They will be referenced on our website. And so we will make sure they're available shortly to everyone. We will do that very quickly. But there are is already two very strong published papers out.

All right. Great. Thanks, guys.

Thank you, Bob.

Thank you. Our next question is from the line of Bill Plovanic from Cannacord Adams. Please go ahead.

Great. Thank you. Good evening. A couple of questions for you guys. First, just on the Osteocel, was there an impact on your FormaGraft sales or do you feel you're replacing more competitive products that were being used in those procedures?

No impact on FormaGraft. All incremental.

Excellent. And then on the cervical, what was cervical as a percentage of revenues in the quarter in the US?

I think I will have to look it up, but it should be consistent with what it has been. It would be in the 10 to -- 10%, 11% range.

Okay. And then just last question, as you bring in the PCM product, would you expect that post-approval of that, you might come out with a ceramic-on-ceramic version of that product? Is that design, are you able to do that with the PCM design?

I think that what we're going to be looking at are other ways to expand our cervical portfolio, our number one priority is to get PCM out into the OUS market, and to get it into the United States, so we're spending a substantial amount of money in purchasing it and we want to make good on that transaction and get the revenue that we're looking for. But we think there's probably are going to be other opportunities to look at other ways for us to inject further development, components, either directly to PCM, or do things that are related to that.

Okay. Great. That's all I had. Thanks so much.

Okay. Well, that's it for our questions. So we appreciate everybody being on the call today. And we will look forward to speaking with you in another quarter. Thanks, everybody. Take care.

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