Christine Zedelmayer - Head of IR Jim Corbett - President and CEO Mike O'Neill - CFO.

Josh Jennings - Cowen & Company William Plovanic - Canaccord Genuity Glenn Novarro - RBC Capital Markets Ebun Garner - General Counsel.

Good day Welcome to the Alphatec Spine's first quarter 2015 conference call. [Operator Instructions] I would like to introduce to you your host, Christine Zedelmayer, head of investor relations at Alphatec Spine..

Jim Corbett, President and Chief Executive Officer; Mike O'Neill, Vice President and Chief Financial Officer; and Ebun Garner, General Counsel. I will now turn the call over to Mr. Jim Corbett..

What’s going on? When I step back from it, what I can see is that during the last several months, while I have been aggressively working on our sales model, we’ve initiated a number of changes. One of the most obvious changes to us was coverage. It’s that coverage challenge that led to the Q1 results. We participate in under 10% of the U.S.

market today in terms of coverage. To be specific, we have a sales rep assigned to less than 10% of the surgeons in the U.S. market, which then of course leaves more than 90% of the surgeons available for us as an opportunity for growth. And that is what really is driving this pillar of commercial expansion.

We’ve focused first on expanding into 40 of the top 100 metro areas where no Alphatec products are sold and no Alphatec sales representatives exist. We’ve made really great progress. As of May 1, tomorrow, we will have 32 of those 40 positions filled. This will make a modest difference in Q2, but Q3 and Q4 is really where it’s at for them.

And that’s where this commercial expansion is going to make the difference, both in coverage, which is rather basic, but also combined with our rich product pipeline. With respect to our international markets, I’ve stated that our intension was to expand into eight basically untouched European country markets.

We have initiated sales in four of these countries, and we expect to sign the rest of them before Q2 is over. This is going to give us a strong momentum in the second half of our international expansion.

Suffice it to say, those four new country initiatives didn’t really contribute to the 25% growth we achieved during Q1, and again, this leads us to the second half story.

With respect to pillar number three, transforming manufacturing and distribution operations, I can report that the second wave of Arsenal instruments, which resulted in the full launch, were received at the targeted 50% reduced cost basis that I mentioned in prior calls.

This causes us to spend less capital than we would have otherwise spent to achieve the same launch with greater efficiency. This is rather core to our return on invested capital objective and accumulating cash for the next two to four years.

With respect to our physical distribution strategy, Arsenal is already operating in our new model, where we centralized inventory and managed the set terms. So although Arsenal will achieve higher turns than the rest of our set inventory, we have formulated our final strategy in terms of how we’re going to manage physical distribution.

We will be rolling that out here in Q2 and Q3 and expect to have it fully implemented by Q4. We’ve made great progress on the manufacturing side, where we continue to experience significant improvement from our Lean manufacturing methodology.

This leads us to lower inventory over time, so we continue to experience improvement in our manufacturing margins and our ability to manage inventory at lower costs. So I look forward to the Q&A, where we can talk about any of your questions or thoughts that you have about our results and our progress on our strategic initiatives.

Now, Mike is going to take a few moments and take you through the details of our financial results and provide an update on our outlook for the remainder of the year. .

an assessment of the overall spine market and our strategic focus for the year. As Jim mentioned, we’re making progress on our strategic pillars. We expect progress to be reflected in our results for the back half of 2015. As a reminder, given the foreign currency headwinds, we issued revenue guidance in constant currency versus 2014.

In 2015, we are reiterating our guidance of full year constant currency growth of 3.9% to 7.2%, which represents constant currency revenue of $215 million to $222 million. As our momentum on commercial expansion gains traction, we believe you should anticipate revenue accumulation to occur in the second half of the year.

We reiterate our guidance for non-GAAP adjusted EBITDA and continue to expect it to be in the range of $34 million to $37 million, or 10.4% to 20.1% over 2014, and representing 15.8% to 16.6% of annual revenue.

Our adjusted EBITDA guidance reflects the continuing improvements associated with our global business as well as our commitment to improving the profitability and cash flow of the company. The leadership team is actively managing for profitability. While we experienced some challenges in Q1, we know what the issues are.

We have the right team in place, and we are executing on our plans to realize our second half expectations. Earlier in the year, we publicly articulated the management team’s strategic direction for the company. Today, Jim has spent time reviewing the three strategic pillars and the commitments we have made with respect to our public scorecard.

The senior leadership team is confident that the actions we are taking and the plans that we are executing should deliver our strategic objectives of accelerating revenue growth, generating free cash flow, and improving the return on our invested capital. With that, I’d like to turn the call back over to Jim..

one, innovating in large, market-driving product segments; two, expanding and deepening our penetration in large global markets; and three, improving profitability through improvements in manufacturing and our physical distribution model. We believe this refocusing of our product development strategy, combined with the expansion of the company’s U.S.

and international commercial footprint, will enable us to compete globally and accelerate revenue growth. At the same time, we are executing on strategies to increase our return on invested capital and accumulate cash through a reduction in the cost of goods sold and the implementation of processes aimed at lowering our capital commitments.

The combined effect of these initiatives should yield an improvement in the fundamental quality of the business, leading to achieving our ultimate goal of 20% EBITDA margins within the next three years.

We believe this will result in our ability to more efficiently provide products and systems for physicians treating patients who need spinal fusion, increased profitability, and enhanced valuation of the company. With that, I look forward to answering any questions you may have. .

[Operator instructions.] And our first question comes from the line of Josh Jennings from Cowen & Company..

Jim and team, congratulations on the progress in each of your three strategic pillars. It’s only been one quarter into the strategic initiatives that you’ve laid out, at least publicly.

And I guess just with the progress that you’ve made, you call out 75% completing the expansion into new metro areas in the U.S., 50% complete sales distribution in the European Union, but how quickly can you complete these initiatives? And then how should we think about those timelines? Could some of these be done by the end of 2015?.

That’s actually a great question. Let me try and characterize them for you. Let me take the pillars in order. The product development and the go-to-market strategy is on schedule. So for example, Arsenal is right now in full launch. CVX, we have our first cases scheduled in the limited market release here in the coming weeks.

The same is true for Battalion. And those are principally the big product initiatives that we’re expecting for this year. The lateral and deformity systems we’re expecting in the first half of 2016. Those are on schedule. When you move to the commercial footprint, our first stage of the U.S.

expansion was to establish representatives in 40 of the top 100 metro areas. And we’re at 32, and we believe that we will accomplish all of those 40 within Q2. So that means through the second half of the year, we’ll be developing those new markets.

With regard to the European Union, the additional four markets we plan to enter, we plan and believe we’ll have that also executed in Q2, which will give us the second half to, again, develop those new markets. The fundamental physical distribution transformation, we expect to compete by Q4.

And that will have a big effect on our ongoing capital needs for replenishment of instrument sets, because we’ll be managing them much more effectively. With respect to Lean manufacturing, that’s quite an ongoing activity. We’re in a market that has consistent, although not dramatic, price competition in the mid-single digits.

For us to constantly maintain margin, we have to, of course continue to improve our manufacturing efficiency, which we expect to continue doing. So we’ll see a lot of things happen. The second half is really when we should see the benefits of these initiatives..

And maybe if I could follow up with just a focus on the U.S. sales force expansion, especially in light of the Q1 performance in the U.S. and thinking about how that can rebound.

Can you just give some more color in terms of how you’re building onto these metro areas and maybe if you want to quantify the number of sales rep adds, essentially where they’re coming from and their background? And then when they can potentially star to contribute meaningfully to domestic revenue growth?.

As I said, 32 of the 40 will be filled by tomorrow. And in terms of background, virtually all of them are coming from a spine background. So from a training point of view, they will be rather up to speed from an anatomy and physiology and technology point of view.

They will be establishing Alphatec in new markets and we do expect that will take some time, although Q2 will be, I would say, probably a modest contribution. Q3 and Q4 is where we should start seeing the impact of those positions. Now, the other eight of the 40, we do expect also to have during Q2, and we are targeting a spine background sales rep.

These actually all are employees in virtually every case. .

And then last question is just with all the progress you plan on making in 2015, and with some of the, I don’t want to call it restructuring, but with these initiatives in play, 4% to 7% constant currency growth, I know you don’t want to give out your guidance here or 2016 guidance, but maybe directionally how we should be thinking about a revenue growth in the out years? Should we be expecting or modeling revenue growth acceleration?.

We aren’t quite prepared to give out 2016 guidance, but it is our strategic goal to achieve double-digit growth over the next three years. So if that can be helpful to you, you might think about that as our goal..

And our next question comes from the line of William Plovanic with Canaccord Genuity. .

My first question is, U.S. sales were down about 5% year over year. I think if you look at your strategy, you’re basically taking territories and you’re just cutting them. So you’re taking away what the reps aren’t using. So I wouldn’t have expected the revenues to be down if everything you’re doing is incrementally additive.

So my question is, is it pricing? Was it volume? What drove that year over year decrease in the U.S.?.

It’s a great question. We studied this issue very deeply. Let me characterize it a couple of different ways for you. First of all, in our previous model, our coverage, our reps, both sales agents, sales distributors, and a few direct reps, did not add new treating physicians on a very consistent basis. That was underlying the sales model.

And by going from geographic sales territories to physician-centric defined sales territories, it enabled us to expand. The adds weren’t happening, so it only takes a rather what I would describe as a phenomena of combination of price and caseload. When you’re not participating in a full market… We know the market is growing.

It didn’t for us during this quarter, and we had very consistent with market experience in terms of price decline. Our volumes were about the same year over year. And so if you just apply a market price decline, you end up where we were without adding significant new customers.

So for us, this transformation strategy, where we are expanding into these 40 metro areas, is going to be a real opportunity for us to increase our top line..

But to clarify that, if you’re down 5%, your volumes are flat, that means your pricing is down 10%. So you would either lose a couple of docs, which is fine, or your pricing was down 10%, per that statement.

Where am I wrong?.

The pricing wasn’t down 10%, but you’re dissecting something. We had case volume down, broadly, in our population of physicians. And we didn’t add a lot of new physicians during that time. So it had the result it did. That’s one of the consequences of a narrow base. You get accelerated effect of both price and case volume. .

So as you’re basically going forward, as the new reps become productive, they add new docs and this all starts to turn around as we head into the back half of the year, is the takeaway?.

That is absolutely the takeaway..

And then the next thing is, you were expecting to launch Arsenal in Japan in the third quarter from the timeline you gave us previously.

Does that move up with the approval that you have in Battalion in Q2? Do you change and accelerate the launch plans for Japan giving the clearances?.

Yes. Well, I may have miscommunicated that. So, Arsenal has been launched in Japan, in April.

Is that the question you’re asking me?.

We have moved up the launch..

But we did move it up, that’s correct. We did move it up. I’ve got the question now. We had anticipated that we would get approval in Q3 and launch in Q4.

And what occurred is we received approval in Q1, both for regulatory and reimbursement, and we shipped our first Arsenal sets in early April to Japan and they’ve been trained and we have commenced doing cases..

And then what about Battalion? Is that going into Japan now as well? Or is that delayed?.

It isn’t delayed. It wasn’t scheduled until later in the year. And so it is not delayed. We haven’t received approval for it yet..

[Operator instructions.] And our next question comes from the line of Glenn Novarro of RBC Capital Markets. .

First, on the revenue guidance for the year, you maintained your constant currency guidance, but the dollar probably has strengthened a bit since you last reported.

So what do you anticipate in terms of reported revenues, growth rates or exact numbers?.

We’re not in the business of forecasting exchange rates, and so we’re sticking with the constant currency approach that we identified with our annual guidance for 2015, and we’re reiterating that. I don’t see value in the company trying to forecast what future exchange rates are going to be..

Okay. Sometimes, companies will say on their calls, you know, if you take current exchange rates today, this is what the reported number would look like.

But you don’t even want to go there?.

No, I really don’t. I think the exchange rate situation is well documented. We went at length to provide constant currency guidance, and we’re sticking with it..

My second question has to do with the Arsenal launch. I wonder if you can give us some more specifics regarding how many surgeons have been trained so far in Arsenal.

What percent of these surgeons are new to Alphatec? And then what is the capture rate? In other words, of the new surgeons coming in to be trained on Arsenal, what percent actually, after the training, go back actually to cases and start to become current or consistent users?.

Those are great questions, I’ve got to tell you. [laughter] Some of those things we don’t disclose publicly, but here’s the one that we do. Up through February, well over 50% of the surgeons who used Arsenal between July and February were new users for Alphatec. So that’s one element.

Now, when we plan forward, we can imagine that the 40 positions that we are filling in 40 of the top 100 metro markets, almost everyone they go to will be new for us. So we do expect and believe that Arsenal is going to be an important contributor to our growth, and that might be a framework that you can use, hopefully..

That’s encouraging, because that’s where incremental growth comes from, picking up new surgeons or surgeons using Arsenal.

And then just last, on Arsenal, is this being priced at parity with the older Zodiac system? Is it a premium? Is this going to give an overall lift to your pricing power in 2015?.

The answer is, we will price and compete in the market. For us, although it’s a premium to Zodiac, it’s quite a jump in competitiveness. At the same time, we are competing in the market, and we will price competitively to gain share. So for us, gaining share is the core objective. Our margins are quite strong, and we expect them to stay that way.

And we will, therefore, be pricing consistent with market. .

[Operator instructions.] And I am showing no further questions at this time. I’d like to turn the call back over to Jim Corbett for any further remarks. .

Thank you to all of you for calling in today. I think that concludes the questions and our time for today. Thank you..