Terry Rich - President, COO & Director Patrick Miles - CEO & Executive Chairman Jeffrey Black - EVP & CFO.

Brooks O'Neil - Lake Street Capital Markets Swayampakula Ramakanth - H.C. Wainwright & Co. Scott Gambill - Gardner Financial.

Good afternoon, everyone, and welcome to Alphatec Second Quarter 2018 Conference Call. We would like to remind everyone that participants on the call will make forward-looking statements. These statements are based on current expectations and are subject to uncertainties that cause actual results to differ materially.

These uncertainties are detailed in documents filed regularly with the SEC. During this call you may hear the company refer to reported amounts, which are in accordance with the U.S. GAAP as well as non-GAAP or pro forma measures. Reconciliations of non-GAAP measures to U.S.

GAAP can be found in the supplemental financial tables included in the press release, which identify and quantify all excluded items and provides management's views of why this information is useful to investors. Joining us on the call today will be ATEC's Chairman and CEO, Pat Miles; President and COO, Terry Rich; and CFO, Jeff Black.

Now I'd like to turn the call over to Terry Rich..

Thank you, Valerie, and welcome, everyone. Second quarter results demonstrate the progress being made with our strategic priorities. Total U.S. commercial revenue in the second quarter was $20.4 million, up 6% sequentially, that marks the highest rate of sequential growth generated by ATEC's U.S. business since 2015.

We continue to be encouraged by the victories our teams are experiencing every day. As our transformation progresses, we are increasingly confident that our vision for the new ATEC is taking shape. The metrics we believe are most predictive of the long-term health of our core business are demonstrating significant improvement.

For example, in the second quarter, we hosted a record number of surgeons through our ATEC experience events, the educational programs for visiting surgeons who want to learn more about the new ATEC. Conversions of these new relationships is strong.

Revenue driven by our new surgeons more than doubled sequentially, substantially outpacing revenue growth overall. During June, our average daily sales and shipping volumes reached their highest level so far this year. This growth is especially encouraging, considering we are making progress without the impact of new products.

Growth in the quarter and the strength of these lead business indicators was attributable to the key initiatives that we are driving, enhancing the sophistication of the new ATEC sales force by transitioning to a dedicated distribution network, reengaging legacy surgeons while simultaneously integrating new surgeons into the ATEC family.

The ATEC transformation continues to generate substantial interest in the field. In the second quarter, we expanded the percentage of U.S. commercial revenue, driven by dedicated distribution partners, to 57%, up from 40% at the end of 2017.

As we bring higher volume, more sophisticated distribution partners on board, we are simultaneously continuing to terminate nondedicated distribution relationships that do not serve our long-term vision. With regard to talent, people who know spine are coming to ATEC.

I'm exceptionally pleased to welcome to the ATEC family 2 sales leaders with exceptional influence in the field. Dave Sponsel, our newly appointed Area Vice President for the South Central Region and Emery Rooney, our Vice President in Sales Channel Development. I would also like to welcome Robert Jud, our new Vice President of Finance and Controller.

These new team members had decades of spine industry experience and proven track records of success to ATEC leadership. I look forward to working with them to achieve the ATEC vision. With that, I'll turn the call over to Pat..

Thanks so much, Jerry, and good afternoon, everybody. We're at an exciting point in the cultural and organizational transformation of ATEC. By continuing to attract spines most informed talent, we have driven deep know-how into every department throughout the organization.

From our marketing, product development, biomechanical engineering and clinical teams, to our network of representatives in the field. We are building the skilled infrastructure capable of creating an innovative machine, that improves spine patient outcomes.

The fruits of our efforts are beginning to impact key business metrics, but those results don't reflect the innovation taking place behind the scenes. Today, over 80% of our revenue is generated by products developed and launched in or before 2016. The next phase of ATEC transformation lies ahead.

In the second half of this year, the investments being made to radically advance a distinction in clinical powers of our portfolio will begin to come to fruition. We expect increasing contribution to revenue from our 12 new product, Alpha lunches, that uniquely address a broad range of surgical procedures.

We are harnessing some of the industry's most prolific talent to build exceptional sophistication into a portfolio that was largely undifferentiated for years. Transformation takes time, however, the 12 Alpha lunches reflect the innovation powers and the people that we have brought into the new ATEC.

It is on par with anything I've seen in the 20-plus year in spine and speaks volumes to the organic innovation machine we are creating. The new distributors and surgeons are investing their time and energy with us because they recognize that change is coming and believe wholeheartedly in our mission and trust in our team's ability to build a monster.

They know and we know that the market needs a new ATEC. We cannot wait to deliver. And with that, I'd like to turn the call over to Jeff for financial results..

Thank you, Pat, and good afternoon, everybody. Our second quarter U.S. commercial revenue was $20.4 million, up 6% sequentially, and at the same time we saw revenue growth of more than 20% from our dedicated distribution channel, which grewed 57% of our U.S. commercial revenue.

New surge in revenue was strong, and we're beginning to drive expanded distributor efficiency. Our U.S. gross margin was 69.5% in the second quarter compared to 70% in the first quarter. Our U.S. gross margin is stabilized as we work to optimize our supply chain, and we expect to remain at roughly this level throughout the second half of 2018.

Our non-GAAP operating expenses, which exclude restructuring expense, stock-based compensation, transaction-related expenses and a $6.2 million gain on a contract settlement in the first quarter. We're $19.5 million in the second quarter compared to $17.9 million in the first quarter.

The sequential increase is attributable primarily to sales expenses, litigation support and investment in product development. You'll recall that we implemented an aggressive operating expense rationalization across all business functions in 2017 and those efforts continue today.

We do anticipate continued growth-related investment into the business, over the course of 2018, particularly in product development, sales and marketing. This investment will support our 12 Alpha launches. As a result operating expense have increased relative to 2017, both in absolute dollars and as a percentage of revenue.

We ended the second quarter with nearly $45 million in cash, which included $4.4 million in proceeds from warrant exercises. Excluding debt service and our transaction-related costs, operating cash usage in the quarter was $3 million, reflecting continued careful cash management even with increased investment into the business.

We continue to expect total revenue of approximately $95 million for the full year of 2018. As we continue to execute this transformation, we are intently focused on the long-term vision that inspired the process.

We feel strongly that the decisions being made and the initiatives we are driving will ultimately evolve ATEC in the fastest growing most respected U.S. spine company. I'll now turn the call over to Pat for closing comments..

Thanks, Jeff. In closing I'd like to thank everybody for their support. Our optimism about becoming an organic innovation machine has never been stronger. Second quarter results validate our confidence. We have entered a new phase of the ATEC transformation.

I am fully confident in the investment decisions being made and in the direction of the programs already underway. Spine's greatest expertise now resides under this roof. I can't wait to introduce the meaningful spine innovations to a market that is absolutely right for it.

I'm convinced that our collective relentless focus on improving surgical outcomes will create significant long-term value. I will now turn the call over to Valerie, the operator, for any questions..

[Operator Instructions]. Our first question comes from Brooks O'Neil of Lake Street Capital..

Just like to ask a couple of questions.

Guys, you've mentioned a product innovation, product pipeline, I think you mentioned, Jeff, 12 Alpha lunches for the second half, can you give us any feel, more specifically, around some of the areas of focus for product innovation that might help us be more excited about the outlook?.

Yes. Brooks, this is Pat, for sure. Literally across a number of different procedures we see plenty of opportunity. And I think that if you start to look at the implant in instrument systems that have been undifferentiated for years, you'll see a number of implant evaluations in the back half of the year.

You will also start to see -- our desire is to get 510(k) clearance for the SafeOp investment that we've made, but mostly it's going to be implant system across multiple procedures that will be evaluated and verified through the end of this year..

Okay.

And will we see those later this fall, Pat, or what's sort of the timing, will allow through the back part of the year?.

Yes. So appreciate the question, Brooks. So literally, we ran at getting a evaluation or an Alpha case of our porous titanium from a posterior approach at the end of the quarter. And so our desire is -- these things will start to flush out from now until through the end of the year..

Great. And then I just have one sort of expense question, maybe for Jeff. Look like G&A expense was a little higher than I was modeling. Obviously, you're continuing to build the organization and I understand that completely.

But could you just talk about, sort of, what you might expect over the next couple of quarters in that particular line item?.

Yes, absolutely, Brooks. So the G&A expenses, they did tick up and the primary drivers for that are first litigation-related costs. We talked in the press release about our existing litigation, we had a couple of very favorable outcomes there, so there are costs associated with litigation support that will continue, but it's something we're managing.

And then there is an uptick in stock-based compensation so we're continuing to manage costs, but in terms of core G&A, we believe that we'll continue to operate at the right level, we don't expect to see an uptick in our core G&A costs, like I said, stock-based compensation was the driver as well as litigation costs..

Our next question comes from Swayampakula Ramakanth of H.C. Wainwright..

To start off with your percentage of distributors going really well and the increased momentum that you talked about especially in June.

Do you think the guidance for the year is conservative or is there something that we don't understand in the portion 2 of that number?.

I think, we remain confident, the $95 million that we came out with earlier this year. And the distribution channel, as you pointed out, continues to transition well, but again, there will be some lumpiness at various times, but we feel good about the direction..

Okay. And then, regarding these Alpha launches, the 12 Alpha launches you talked about, normally what's the time lag between initiating a Alpha launch and that product becoming a final revenue contributor, which can become meaningful.

And also, should we think that all of these 12 Alpha launches will become products, say, by the end of the year or early next year?.

RK, this is Pat. As it relates to the timing, it's a great question in terms of what's the timing between an alpha launch and a full launch. So much of our EFOs from the beginning of being in this business has been about predictability.

And so what we want to make sure is that we have absolute predictability with regards to the clinical performance of our products. And so oftentimes what you find is if some of the more simple implant systems, you can have less of a evaluation time and get to a launch time much quicker.

On other things what you want to do is that really make sure the technology has been taken through its paces in a way that you're able to fully appreciate any of the potential unexpected things that you see. And so I wish there was a super clear answer.

What I'll tell you is that on the implant system, usually there's going to be a few months evaluation, and then a time to make sure that you freeze every element of the design such that you're not going to make any changes and you go to a build, which is usually a 60-day timeframe.

And so hopefully, that gives you a little bit of a color around how we think about garnering enough experience to understand the performance and then going to a freeze and a purchase..

Thank you very much, Pat, for that. The last question for me is on gross margin.

What should we think about or how should we think about gross margins going forward and it's trend over the, say, next 2 to 3 years?.

Yes, Raj, this is Jeff. So I think you should expect gross margin to remain right around these levels. There are -- there'll be a fair amount of puts and takes. But frankly, volume is going to be our tailwind, if you will, right? Because fixed cost leverage is extremely scalable for us. We'll continue to drive costs down.

We've got great relationships now some renewed relationships as well as new relationship in the supply chain, we're starting to see cost reductions on components and raw materials. And I think the expectation is, while we're not giving guidance kind of beyond 2019 is that 69% to low-70% range is probably the way to think about it..

Our next question comes from Scott Gambill of Gardner Financial..

It's my first time I've actually been on a live call since I got involved with Alphatec. I have three questions. I think the first one if I remember correctly, you have about $10 million that begins amortizing at the end of this quarter.

Am I correct about that?.

That's correct. Yes, we were talking about our term -- our $30 million term loan. $10 million will begin to amortize at the end of September. That's correct..

Yes, so I'm just curious to how -- what the plan is as far as managing that if it's going to be paid off or are you going to refine or what?.

Yes, Scott, it's a great question. It suffices to say that we're actively looking at a number of opportunities to refinance the debt and extend maturities. Nothing that we're prepared to talk about at this point, but it is something we're actively addressing..

Okay.

Ideally, do you saw meat wrap up this quarter though? I mean there -- if you could? Or are you lucid on the timing as far as dealing with that?.

Yes, and I think sooner the better for sure. We're not prepared to talk about specific timing, but absolutely the sooner the better..

Okay. All right. My next question, on the last call it was expected that SafeOp would do a 5 10 mid-quarter, I have not seen that anywhere. I assume that just because that has not happened yet but again, the scenario, I'm not sure if I'm correct about that so I'm looking for some certification..

You are exactly correct, this is Pat. And what -- everything is moving along fine.

What happens is not being the largest company in this business or -- we get placed as it relates to some of the testing requirements behind other companies, I would tell you that it will go in this quarter and it's just been a nominal, not overly concerned about submission so -- and we'll....

Okay, I'm not worried about it either, but I was just trying to pin it somewhere.

Do you still believe that you guys can get that ready for market by year-end or do you want to give that a little bit more elbow room too now?.

Yes. Our intention was to launch it in the beginning of '19. And so I would tell you that we're on track for that, but clearly I wanted earlier than later..

Okay, all right, great. My last question is -- saving for last because it might require a little bit more dialogue for you guys to explain. I'm going back to last October, so it was right after you jumped on board, Pat, and then the NASS happened, and is -- if I recall various conversation, you guys had some success coming right out of NASS.

I assume that, that's when you talk about some of these metrics now, that's continuation of the effort coming out of NASS? And I see that NASS is now going to occur at the end of September this year. So when we put all of this together, presumably this new portfolio of products will be part of round two.

And I'm just wondering how you guys feel about approaching NASS? And what may be some of your goals coming out of that for 2019, let's say?.

Yes. Thanks for the question. It's one of these things where, NASS as a demarcation is unto itself is not a huge deal. I will tell you, as it relates to having been here a year at NASS, we're making a hell of a lot of progress and we are getting the type of people that we need to ultimately build long-term value.

And so where I would like to think quarter-to-quarter and are we making progress out of products and the vision of just them coming together, it clearly is coming together. I got to tell you, the demographics of this marketplace are such that I think that nimble small companies that created innovative technology are in high demand.

And so it will take some time that you will see the kind of the DNA of the group of people that we have assembled here soon enough, but as it relates to the specifics of NASS, don't really want to get into that on the call..

I'm showing no further questions at this time. I'd like to turn the conference back over to Pat Miles for any closing remarks..

Just to appreciate everybody's support of this endeavor, and look forward to talking to you next quarter. Thanks much..

Thank you. Ladies and gentleman, this does conclude today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect..