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Alphatec Holdings, Inc. (NASDAQ:ATEC)

Q4 2012 Earnings Conference Call

February 28, 2013 5:00 pm ET

Executives

Leslie H. Cross - Chairman and Chief Executive Officer

Michael O'Neill - Vice President, Chief Financial Officer and Treasurer

Thomas McLeer - Senior Vice President of U.S. Commercial Operations

Mark Francois - Senior Director of Investor Relations

Analysts

Raj Denhoy - Jefferies & Company, Inc.

Matt Miksic - Piper Jaffray

William Plovanic - Canaccord Genuity

Josh Jennings - Cowen and Company

Glenn Novarro - RBC Capital Markets

Mark Landy - Summer Street Research

Mark Francois

Ladies and gentlemen, thank you for standing by. I am Mark Francois, Senior Director of Investor Relations for Alphatec Spine. Thank you for joining us today for Alphatec Spine's conference call to discuss our fourth quarter 2012 financial and operating results. Speaking today will be Les Cross, Alphatec's Chairman and Chief Executive Officer; Michael O'Neill, Vice President and Chief Financial Officer; and Tom McLeer, Senior Vice President of the U.S. Commercial Operations.. Also on the call today is Ebun S. Garner, our General Counsel.

During our prepared remarks today, you will be in a listen only mode. After our prepared remarks are concluded, we'll open up the call for your questions, and as a reminder, this call is being recorded today, February 28, 2013, and a replay of that event will be available later on our website and will be there for the next 30 days or so.

Before I turn the call over to Les, I must remind you that today's conference call contains forward-looking statements made under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Such statements include statements related to the Company's revenue and adjusted EBITDA expectations for 2013, the success of the Company's initiatives from 2012 and 2013 to drive global sales growth, increased margins and increased operating efficiencies, the ability to achieve surgeon conversions in connection with the Phygen acquisition, contributions to the Company's revenues and earnings in 2013, and the introduction of new products and sales and marketing strategy, improvements to the Company's cost structure and operating margins from operational initiatives, and the timing of U.S. FDA regulatory decisions that impact the commercialization of products.

These forward-looking statements are based on the Company's current expectations and are subject to a number of risks, uncertainties and assumptions that could cause the actual results to materially differ from the forward-looking statements. The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise.

Most of these risks, uncertainties and assumptions are discussed in our 2011 Annual Report on Form 10-K for the year ended December 31, 2011 filed on March 5, 2012 with the Securities and Exchange Commission, as well as other filings on Form 10-Q and periodic filings on Form 8-K. Our SEC documents are readily available on our website at www.alphatecspine.com.

With that, I'll hand the call over to Les.

Leslie H. Cross

Good job, Mark. Thank you. Good afternoon, everyone, and welcome to Alphatec Spine's conference call to discuss our fourth quarter and year-end financial and operating results. 2012 was an exciting year of change at Alphatec Spine, a year of preparing the Company to deliver sales growth and profitability. We now have a new team, a new vision, a new culture of the Company.

When I talk to people about 2012, I highlight the six major achievements that now implemented we believe will give us a right to win in 2013. These achievements include; a new leadership and a new culture; a focused R&D team that is delivering a continuous flow of new products; significant progress in achieving operational excellence. We have strengthened our U.S. promotional team with the addition of Tom McLeer. In fact, Tom will say a few words today later in our call. I also appointed Pat Ryan as the leader of our international business with a mission to focus on leveraging our impressive footprint, and in a later call, Pat will update our investors on that as well. And finally, we have had tremendous support from our Board of Directors as we have installed this culture of change at Alphatec Spine.

Having spent much of 2012 implementing these initiatives, I am pleased to report a very solid fourth quarter and a strong finish to 2012. The quarter was clearly our best revenue performance of this year, and I am confident the initiatives we have installed are gaining traction. I am extremely proud of the entire Alphatec team to delivering these excellent results.

Since becoming the CEO almost a year ago, in fact almost exactly a year ago, a good portion of the heavy lifting with our initiatives is now behind us. Our focus in 2013 is on executing our plan, the plan that will deliver revenue and profitability results that we hope will meet or exceed the guidance that we're going to talk about later in the call.

With that, I would like quickly to cover a few fourth quarter highlights, and then turn the call over to Tom, who will cover our U.S. commercial strategy. This will be followed by Mike, who will discuss our financial results in much greater detail.

With respect to the top line, we achieved global revenue of nearly $53 million in Q4, about a 7% growth compared to Q4 of last year, or approximately 8% growth on a constant currency basis. We are pleased to see that contributions came from both the U.S. and the international business in driving this excellent result.

Our U.S. business totalled $34 million and grew 4% in the fourth quarter of 2012 compared to the same quarter last year. This was driven by another great quarter from our Biologics business and the traction we're gaining with the Phygen integration which we completed as you'll remember in November of 2012.

Our biologic profile is a broad suite of solutions for surgeons that include demineralized biometrics products in multiple forms, a tissue barrier that prevents scarring, the NEXoss synthetic bone matrix that we licensed later this year, a range of structural allograft interbody spacers, and of course, our stem cell product, PureGen.

The Phygen transaction provides us with access to a network of over 100 leading U.S. spine surgeons who formed Phygen several years ago out of the desire to deliver cost-effective product and improve treatment outcomes to spinal disorders through surgeon inspired technology. Phygen and its products and technologies, combined with those of Alphatec, represents another important growth opportunity for the Company in 2013 as we go through the year and pursue conversion of the Phygen spine surgeons over to the Alphatec family.

Our U.S. implant revenue in Q4 achieved more than a 4% growth sequentially over the third quarter. We expect 2013 to be a better year for our implant and instrument business, driven by the combination of the new products we expect to launch in 2013 and the surgeon conversions we expect from the Phygen acquisition, all of which will be managed by a strong U.S. commercial organization that is led by Tom McLeer.

Our new product pipeline in 2013 includes important line extensions and several new products. Our new anchored, anterior cervical interbody device, called Pegasus, which offers single step deployment of the anchoring blade without the need for impacting the implant. In addition, our new MIS ILLICO, our perfect screw fixation system, enables spine surgeons to immobilize and stabilize spinal segment without the need for pedicle screw and rod constructs. Both of these products have received FDA market clearance in December and we will begin their prospective rollouts as the year moves forward.

Additionally, the new product class of 2013 includes the plan to relaunch our much anticipated Alphatec Solus device, which is a unique anchored interbody device for the lumbar spine. Alphatec Solus was relaunched in Europe in January of this year and we anticipate relaunching the product in the U.S. in late Q2 or early Q3. Overall, including Pegasus, the ILLICO FS, the Alphatec Solus, we expect to launch approximately seven new products in 2013.

With respect to our Biologics portfolio, and specifically PureGen, our stem cell product, I wanted to provide our investors with an update related to the product status in the marketplace. Since our last update on PureGen, we have had ongoing discussions with the FDA and have submitted a formal request of designation to state our case that PureGen should be classified as a tissue-based product and not as a biologic. In prudence, we have also engaged discussions with the FDA to understand the structure of clinical trials that would be required to obtain regulatory approval for PureGen, should it not be classified as a tissue.

Just recently, we became aware that the FDA conducted a site inspection of each of the two vendors who are collectively responsible for the procurement, processing, and storage and shipment of PureGen. In response to these inspections, the FDA issued several Form 483 observations related to the PureGen product. In spite of the fact that the product is being used in over 3,500 patients with no reverse events related to the product, we have voluntarily taken the prudent approach not to ship any additional product until these observations have been addressed to the FDA's satisfaction. We hope this will take less than a month, and we'll certainly keep our shareholders informed.

While we continue to maintain a collaborative relationship with the FDA regarding the classification of PureGen, given the ongoing uncertainty regarding its regulatory status, and the Form 483 observations, we are expecting only modest contribution from PureGen in our 2013 revenue guidance. The potential impact from the lost revenue of PureGen for the remainder of 2013 is approximately $6 million, and the guidance that we will give later in the call does not include this $6 million.

At this time, I'm pleased to invite Tom McLeer, our Senior VP of U.S. Commercial Operations to say a few words about our U.S. strategy.

Thomas McLeer

Thanks, Les. It's a pleasure to be a part of the Alphatec team. 2012 set the stage for an exciting new year with many new product introductions and continued expansion of our flexible distribution model. We firmly believe that our mix of direct reps, independent commission agents, and stocking distributors, as well as our direct to hospital sales efforts provides us with a key competitive advantage in addressing our customers' needs. As the market changes, we will continue to address the combined needs of Alphatec and our customers in a careful and plausible manner.

In addition to our flexible distribution model, we will continue to expand and improve our Biologics and implant product portfolio. Working closely with our surgeon advisors, we have identified several opportunities for product improvement and expansion. We will continue to capitalize on acquisition and licensing opportunities to dovetail with our internal development efforts. We believe that this will allow us to rapidly grow both our per customer and per procedure revenues within our existing customer base. Our Biologics offering continues to see healthy growth each time we launch a new product. We continue to seek to expand this portfolio. These efforts should make Alphatec an even more attractive and comprehensive option to new customers.

A few weeks ago, we held a meeting in [Carlsbad] (ph) for a number of key Phygen surgeons with another meeting scheduled for March 9. The surgeons were exposed to Alphatec products and culture. A good portion of the day was spent discussing the numerous synergies and opportunities created by this transaction. Everyone left the event excited about having Alphatec products available through the Phygen surgeons and the increased exposure of the Phygen technologies received throughout the tech distribution channels. We believe that throughout the year, we will continue to accelerate the synergies and revenues provided by this acquisition.

Les, now I'll turn the call back to you.

Leslie H. Cross

Great, thank you Tom. Outside of the U.S., our international segment also posted strong results in Q4 with revenues of $18.7 million, which represents growth of almost 12% or nearly 16% growth on a constant currency basis. This result represents a new international revenue record for Alphatec. Notable success was achieved in Latin America and Japan. Additionally, international sales grew by almost 18% over the third quarter of 2012. International sales did represent over 35% of our total Q4 revenue. I think this really speaks to the fact that we do have a very successful and broad global organization that we will continue to leverage.

We look forward to continued success from our international business in 2013 which we expect will be driven by deeper penetration in our established European markets, growth opportunities in new markets in Central and Eastern Europe, and the sale of Alphatec products into Latin America and the Asia-Pacific regions. This will happen following receipt of product registration in these important markets. We hope to receive that registration prior to the end of the year. We also continue to target new geographies for the Scient'x and Alphatec product.

Our operations in Japan continue to be a growth engine for our international business and for our Company as a whole. The team there does an outstanding job. The descent receipt of approval in Japan to sell our Novel PEEK Spinal Spacers should also help drive our penetration and our revenue in 2013.

On the operations side of our business, we continue to make incremental progress to the leaning out of our supply chain and manufacturing facility. Lean is a continuous improvement process that has and we expect will continue to pay dividends in reducing our cost structure and our working capital requirement. 2012 was a deep dive into the building and sustaining a lean culture and the beginning of a scaled lean implementation effort. We have much to achieve but I'm very pleased with the progress we have made to date.

So with that, I'm very pleased to turn the call over to Mike O'Neill for discussion of our financial results.

Michael O'Neill

Thanks, Les. Let me echo Les' comments that our fourth quarter was a solid ending to 2012 and that we are pleased to see increasingly more positive financial results for Alphatec after a year of hard work. Les already covered the discussion of global net revenue and growth rates for Q4 2012, so I won't repeat those quarterly figures. For the full year of '12, Alphatec's net revenues were $196.3 million or approximately 1% lower than 2011. On a constant currency basis, fiscal year 2012 is about 1% higher than 2011. Considering the headwinds that the global spine industry continues to face in 2012, along with our internal efforts to strengthen Alphatec's revenue growth and profitability, we feel that this is a respectable result given the traction we achieved in the fourth quarter.

U.S. net revenues totaled $130.5 million, down approximately 3% compared to 2011, reflecting ongoing spine industry challenges in domestic markets, offset by very strong growth within our Biologics business. International net revenues totaled $65.8 million and represented more than 33% of the Company's 2012 total net revenues.

International revenue in 2012 was 3% compared to 2011. On a constant currency basis, our international business grew approximately 7% over 2011. This result reflects continued pressure in spine markets in Europe, offset by our growing operations in Latin America and Japan. Our business in Japan had another record year, with revenue approaching $29 million for the year and growth of 20% over 2011.

Gross profit for Q4 2012 was $32.1 million or 60.9% of revenue compared to $24.9 million or 50.3% of revenue in Q4 2011. The Company's ongoing efforts to improve manufacturing efficiencies continue to yield benefits in the quarter. However, the gross profit and gross margin for the fourth quarter of 2012 included charges totaling approximately $1.3 million associated with the write-off of certain instrument sets and inventory in connection with the ongoing product rationalization strategy for Scient'x and its subsidiary product lines. This negative impact represented 250 basis points of gross margin.

U.S. hospital pricing remained relatively stable in the quarter and both product and regional mix were less of an impact than observed in previous quarters. Additionally, gross profit in the fourth quarter of 2012 was reduced by $1 million for the amortization of a licensed intangible asset as part of the Cross Medical settlement described in prior earnings results calls and noted in today's press release.

U.S. gross margins for Q4 '12 were 66.3% versus 57.2% recorded in Q4 of 2011. International gross margins were 51.1% for Q4 of 2012 versus 36.9% in Q4 of 2011, reflecting the continuing positive performance of Japan. Given the nature of our international distribution business, quarter to quarter fluctuations between regions and product mix do influence the overall gross margin profile of this business, although the impact in Q4 '12 was less than in prior quarters this year.

Total operating expenses for Q4 '12 were $36.1 million, a decrease of $5.3 million compared to prior year of $41.4 million. Q4 2011 expenses were significantly influenced by the litigation settlement charge of $9.8 million. Excluding that charge in Q4 of '11, operating expenses in Q4 of '12 were higher by $4.5 million compared to Q4 of '11.

Operating expenses for the fourth quarter of '12 included $800,000 in transaction costs associated with the Phygen acquisition and $300,000 for certain IPR&D expenses associated with the Scient'x acquisition. Both of these items are specifically excluded from the adjusted EBITDA numbers that we report.

In addition, Q4 operating expenses were impacted by $1 million of Phygen from the business activities, $1 million of ongoing litigation expenses associated with current matters, $700,000 in commercial spending, and $600,000 in administrative expenses. The increase in G&A costs in the quarter are not expected to impact the underlying cost structure of the business in 2013. GAAP net loss for the fourth quarter of '12 was $5.4 million or negative $0.06 per share compared to a net loss of $16 million on negative $0.18 per share for the fourth quarter of 2011.

Adjusted EBITDA in the fourth quarter of 2012 was $5 million or 9.4% of revenues compared to negative $1.2 million reported for the fourth quarter of '11. Adjusted EBITDA represents net income or loss excluding the effects of interest, taxes, depreciation, amortization, stock-based compensation, and other nonrecurring items, such as restructuring expenses, severance expenses, and transaction related expenses.

Cash and cash equivalents were $22.2 million at December 31, 2012, representing a $1.5 million increase from the $20.7 million reported in December 31, 2011. The Company's cash position at December 31, '12 reflects payments totaling $7 million to Cross Medical in 2012 as part of the settlement discussed above, $2 million for the Phygen deal, and an additional $2.2 million associated with licensing investments.

These expenditures have been offset by positive cash from operations and the benefits of our June refinancing with MidCap Financial. The Company has been able to generate cash from its business activities, invest the necessary capital for revenue growth, acquire new technologies to fuel growth in our future, and satisfy our settlement obligations.

As of December 31, 2012, our net inventory position was $49.9 million, an increase of approximately $1.5 million and related to the consolidation of our Phygen inventory. Our net accounts receivable at the end of Q4 2012 is $41 million, a decrease of $700,000 or 1.7% as compared to Q4 2011, and an increase of $3.4 million or 9.3% as compared to Q2 of 2012. The decline in AR year-over-year has been a function of our sales performance coupled with continued diligence with respect to collections. Despite the pressed economic conditions in certain parts of the world, we are not witnessing a deterioration in our ability to collect our accounts receivable.

2012 has clearly been a year of transition for Alphatec. We have endeavoured to lay the foundation to revitalize innovation within the organization, we are integrating new license technologies, we are capitalizing on the enormous opportunities represented by the Phygen acquisition, and we are evolving the culture within the Company. We believe that 2013 will be a significant year for the Company, predicated on the fundamental requirement to execute flawlessly. As we look at the global environment, we are well positioned to take advantage of our geographic presence and to accumulate market share.

For our guidance for 2013, we continue to believe global spine market prices are stabilizing. When we couple this with our new product pipeline, expected Phygen contributions and continued international expansion, we believe 2013 will be a strong year of growth for Alphatec Spine. The encouraging global spine market trends we experienced in Q4 and the Q4 revenue run rate that resulted from this will be muted somewhat by our expectations of PureGen and we therefore believe it is prudent to be cautious with respect to our revenue guidance when we look out over the full year of 2013. We have only included very modest revenue for PureGen as part of our 2013 guidance.

With that said, we expect full-year 2013 revenues to total approximately $204 million to $210 million or approximately 4% to 7% growth over 2012, and full-year 2013 adjusted EBITDA will be in the range of $24 million to $27 million or approximately 21% to 36% growth over 2012.

Now, I'd like to turn the call back over to Les.

Leslie H. Cross

Great. Thank you very much, Mike. Well, I think it's clear, the theme for 2013 is execution, and with that execution, we should have a very exciting year at Alphatec Spine. I would like to thank all of the Alphatec Spine stakeholders, especially our employees for the hard work that is making Alphatec Spine a stronger company. Together we are on a journey to unleash the value of Alphatec Spine for old stakeholders while delivering world-class experience to our customers as well. You have our commitment that Alphatec Spine will remain dedicated to conducting its business with a sense of urgency, accountability, and in search of excellence.

Thank you, very much, and Karen, we would like to open the call up for questions.

Question-and-Answer Session

Operator

Our first question comes from the line of Raj Denhoy from Jefferies.

Raj Denhoy - Jefferies & Company, Inc.

What if I did ask you a little bit about the revenue guidance? It seems like there is some puts and takes here in 2013. Maybe starting with Phygen, I think in times past you've talked about perhaps a $15 million contribution from that in 2013. Are you still comfortable with that?

Michael O'Neill

Yes, we are, and I'm just going to be real transparent here. If you look at 2012 and you look at our guidance for '13, we make assumptions around implied category growth, market growth. We have the same assumption in for Phygen, and we took out $6 million for PureGen. Forgive me if I get my 'P's mixed up, but that's essentially how we get to our guidance range. So the key difference is, given the assessment of overall market growth in the underlying business.

Raj Denhoy - Jefferies & Company, Inc.

Okay. But then if you could think about international – the U.S., there's some puts and takes there as well with Phygen and PureGen as you mentioned, but then internationally, you posted a very strong fourth quarter here. Now if you look at into '13, again is probably going to hurt you guys quite a bit given your exposure there. What do you think you're going to do in international growth in '13?

Michael O'Neill

I think that we still want to see the international business be a significant portion of our growth in 2013. I think our growth profile in Japan is slowing. We've had three years of exceptional performance, and I think the rest of our international markets are still somewhat challenged. I think Les alluded in his scripted remarks about the opportunity for us to get product registrations in say China and Brazil, and we hope there'll be contributions in 2013, but they are not currently part of our guidance range. So, we still look to those regions to provide good quality growth for us. We're also (indiscernible) is, still a significant chunk of our business is distributor, so we are subject to those vagaries, but I think that we have that accommodated in the guidance range.

Raj Denhoy - Jefferies & Company, Inc.

So when you think of the 2.04 to 2.10, how much currency is in there for you? How much of a currency offset?

Michael O'Neill

It's not that significant that I would call it out.

Raj Denhoy - Jefferies & Company, Inc.

Okay. Just lastly then, the fourth quarter international growth, that 16% constant currency number you put up, was there some stocking in there or was there – because it is such a strong number, I'm just curious again?

Michael O'Neill

So, with the exception of direct market, the gain for reference are France, Italy, UK, and Japan. We're stocking distributors in every other country around the world. We had very strong performance in Latin America in Q4. That was a significant contributor. We also saw some of our Central Eastern Europe businesses uptick, but I would also point out that our direct markets delivered pretty good results as well, but certainly Latin America was a standout, as well as Japan continues to fuel the growth.

Operator

Our next question comes from the line of Matt Miksic from Piper Jaffray.

Matt Miksic - Piper Jaffray

Thanks for taking my questions. Just a follow-up on the international versus U.S., and you look at the growth in '13, just to be clear, are you expecting just in reported growth, U.S. business to be growing faster than international or vice versa?

Michael O'Neill

If you exclude Phygen, and just look at our base business, I would say our U.S. business is pretty much growing up market in the plan, and that would be true for our international markets as well, where we have a slightly higher growth profile.

Matt Miksic - Piper Jaffray

Okay, that's helpful. Then, I was wondering if you could give some color qualitative or some sense of the magnitude of how some of these new products you talked about contributed in the fourth quarter as well, Biologics products or any other products that you launched late in '12?

Michael O'Neill

So I think we called out Biologics specifically and I would emphasize non-PureGen. We have an exceptionally strong quarter for our core portfolio of products in Q4. I want to say one of the products was up like 34%, 35% in the quarter. So, it wasn't coming from PureGen, it was coming from the base portfolio. As we think about or as you think about the guidance that we've put out there, we obviously expect products that are either just recently been launched or about to launch to contribute more to the back half. So, I would be thinking, first half is definitely going to be lower than the second half of the year, and I would also provide some color that I think Q1 is going to be the lowest quarter of the year, given the following issues. I mean we've specifically excluded PureGen going forward. So, you have PureGen in Q4, it's essentially out of Q1.

As we get into the adoption curve for the Phygen physicians of both our technologies and their technologies, that's going to build throughout the year, and in addition, some of the new products that Les alluded to in his comments are going to be more biased towards the back half versus the first half in terms of revenue contributions.

Matt Miksic - Piper Jaffray

I'm glad you mentioned the first quarter. Is there also any selling day discrepancies that we should be aware of? Some of your brethren have said that issue facing them in Q1.

Michael O'Neill

Yeah, we looked at that. It's not – I mean obviously we're in a short month right now, so that's the obvious one. So I think we do have, I think we have a couple of days different in Q1 versus Q4, but not a significant component as to why Q1 is below Q4 sequentially.

Matt Miksic - Piper Jaffray

Right, that's helpful. Then finally, I'm not sure if – I'd love to get your sense on these 483s, maybe just speak to your confidence and some color around the type of issues that we're talking about and your confidence that they can be resolved to the agency satisfaction here in the next couple of months?

Leslie H. Cross

Yeah, absolutely. This is Les. They are our vendors, so we don't really feel very comfortable discussing it at any great length what the 483s were about, but I think we said in the script, we would hope that these 483s would be clear within a month or so. So, I think that shows you that there's nothing that major, and they are certainly working together with us and the FDA counsel to make sure we respond appropriately and timely to the FDA.

Operator

Thank you, and our next question comes from the line of from Bill Plovanic from Canaccord.

William Plovanic - Canaccord Genuity

Couple of questions here. You referenced 4% U.S. implant growth sequentially. Is that inclusive or exclusive of Phygen?

Michael O'Neill

In Q4 versus Q3?

William Plovanic - Canaccord Genuity

Correct.

Michael O'Neill

I believe that was exclusive of Phygen. I'm just looking around, I'm pretty sure it was ex-Phygen.

William Plovanic - Canaccord Genuity

Okay, that's helpful. Then, switching to the gross margins, you're paying or you're amortizing [for new product costs] (ph). I think that ends in – does that end in Q3 '13, so in Q4 '13, basically there's $1 million less in cost buried in the (indiscernible) or how do we think about that?

Michael O'Neill

Yeah, it's actually not right on the quarters. I think it actually expires in November. So you do get – there is a bit of a pickup in Q4 from the Phygen from a pure P&L perspective. Let me just clarify, Bill, so I've been connected. It was inclusive of Phygen, not exclusive of Phygen, to your first question.

William Plovanic - Canaccord Genuity

Right, and the Phygen contributed about $1.3 million?

Michael O'Neill

$1.2 million, $1.3 million, yes.

William Plovanic - Canaccord Genuity

$1.2 million, okay. And then it's mid-November, isn't it? It's like the 15th of the month, that's the way it is?

Michael O'Neill

Yeah. You don't get a full quarter relief from costs, you get some pickup.

William Plovanic - Canaccord Genuity

Okay. I've got a bunch of questions so I'm kind of flipping around here. Then, as the PureGen product goes away, was that a big margin contributor or what type of margin impact does that have?

Michael O'Neill

So, I think that like most of our Biologics products, it's been in the 50s, low 50s, sometimes it's the high 40s depending on the SKU mix, plus we also have a commission rate that's not inconsistent with our base commissions from our distributors. So, obviously it contributes something but it's not as painful as some of the metal products when they come down.

William Plovanic - Canaccord Genuity

And what exactly was that hold did you stop sending that product?

Michael O'Neill

I believe two weeks ago. I'm just confirming with the room.

Leslie H. Cross

Yes, two weeks ago.

William Plovanic - Canaccord Genuity

Okay. So basically it was running, it's about $6.5 million a year product. I'm trying to think on a monthly basis, it was about $550 million-ish a month, that's what I'm trying to get at.

Michael O'Neill

It is $550 million to $600 million, yeah. You're not far off.

William Plovanic - Canaccord Genuity

Okay. I'll ask one more and then I'll jump off. Just a simple one, as the medtech tax, as you look at this, where are you putting it in your P&L and how much do you think it's going to cost you on an annual basis, and that's all I have, thanks?

Michael O'Neill

So, we show it as an operating expense. So, it's not in gross margin, it's OpEx. We estimate it's anywhere from $2.3 million to $2.7 million, $2.8 million for us. Like all good companies, we've actually been writing checks since the middle of January for this, and so that's reflected in our operating P&L as part of our guidance.

William Plovanic - Canaccord Genuity

Thank you, and a good quarter.

Operator

Thank you, and our next question comes from the line of Josh Jennings from Cowen and Company.

Josh Jennings - Cowen and Company

Just first on PureGen, is that $6 million that you're not baking into guidance, does that have any incorporation of any pull-through of your Biologics or hardware included in that assumption?

Michael O'Neill

It's a net number. So we have comprehended – the pull through for us is really on the produce side and that's already comprehended in our number.

Josh Jennings - Cowen and Company

Okay, great. And then just understanding Alphatec is more of a share gain story and not as levered to the world market growth, but your commentary on U.S., expectation for U.S. business growing in 2013, so at market levels, can you just describe what your outlook is for the spine market in the U.S. in 2013?

Michael O'Neill

I mean I think not inconsistent with our peers and other competitors here. We're looking at relatively stable situation right now. We're probably in the 2% to 3% in terms of category growth, and that's obviously the demographics of volume are contributing to the upside and the impact of pricing, which again we still see that as a pull-down on the category. We noted modest price declines in our Q4 hospital business and we see that continuing in 2013.

Josh Jennings - Cowen and Company

Any ability to give some – that low single digits that you've been experiencing earlier in the year, you said it was stable. Is that the level, is that the modest…?

Michael O'Neill

I'd say, but I mean we're probably low to mid single-digits declines and we're probably seeing 1%, 1.5%, something like that flow through. So, we're not looking at massive declines, but it's a constant pressure.

Josh Jennings - Cowen and Company

Understood. And then lastly just on physician owned distributors, one, your appetite for any incremental acquisitions similar to the Phygen deal, and then secondarily, any insight into these recent – the OIG increased hospitals inquiring about specific relationships with physician owned distributors and your sense of how the OIG progresses from here? Thanks a lot.

Michael O'Neill

So I think Tom referenced in his commentary, we do have and we continue to maintain a flexible distribution business. We do on our stock and distributor side, we have a distribution policy that basically adheres to the safe harbors identified by the OIG in terms of percentage of ownership of an institution and a percentage of contributions of revenue. So, that's a proxy for if a business model fit within our distribution policy, we are certainly open to doing business with them. We have walked away from business because of structure, and I think we've still got an opportunity for us to participate in this as we go forward.

Leslie H. Cross

Said another way, if a part was for sale and we could make money out of it, we'd certainly take a look at it.

Josh Jennings - Cowen and Company

And then just lastly, any insight in terms of expectations for next steps for OIG or any implications for their recent increase?

Michael O'Neill

I don't think there's anything we can provide just additional color there.

Josh Jennings - Cowen and Company

Okay, I appreciate. Thanks.

Operator

Thank you, and our next question comes from the line of from Glenn Novarro from RBC Capital Markets.

Unidentified Analyst

This is [Brendon] (ph) on for Glenn. Thanks for taking my question. First, to just touch on the strong sequential revenue uptick in the fourth quarter, did you see any increased seasonality in the U.S. in the fourth quarter? And then separately, did you have any big distributor that could have contributed to this performance?

Michael O'Neill

I don't think there was anything. Obviously the Phygen piece was a contributor, the Biologics growth was a big contributor, we didn't add – I don't think we added any significant distributors in Q4.

Leslie H. Cross

That's a new product, I mean we licensed NEXoss, we introduced the BridgePoint product. So, it's basically our plan starting to gain legs, which is what we talked about, right, continuous flow of new products, sales force productivity, and add to that accretive licenses and acquisitions. So, low and behold, I think it's starting to have an impact.

Josh Jennings - Cowen and Company

Okay, that's helpful. And then, Medtronic recently reported and noted some softness in January in Europe. Can you guys talk a little bit about what you're seeing in Europe in the year and if you're seeing the same degree of softness?

Leslie H. Cross

Well, you saw our international results were good. Our direct markets, we saw a good growth, and so that's easily the U.K. and our French market. We saw some strength out of these two in Europe, but certainly Greece and Turkey and some of those places aren't answering the fund right now, but we're offsetting that. But you will remember that Alphatec Spine made an investment in Brazil to create our own business to drive business in Central, South, and Mexico. That's starting to have a great impact for us, and Japan. So I think we've got a very well-balanced international portfolio.

Josh Jennings - Cowen and Company

Okay. Has anything changed in the European market in the first couple months of 2013, I guess was my question?

Michael O'Neill

No, nothing at the macro level there.

Josh Jennings - Cowen and Company

Then, last question, can you provide just an update on the commercial reimbursement in spine, has that got any better, or gotten any worse?

Michael O'Neill

It's just taking a little longer to get the approvals for our fusions, particularly DDD. Some of the carriers are requiring longer conservative care times. So, it's just been pushed back a little bit.

Operator

Our next question comes from the line of Mark Landy from Summer Street Research.

Mark Landy - Summer Street Research

Good evening folks and a good quarter. Just picking up a little bit on Brazil, kind of Latin America, registration (indiscernible) and getting through in visa, how far along that process are you in? How many of the key products have you gotten through that process and ready to be sold with distributors in those markets, in Brazil?

Leslie H. Cross

That is an excellent question. So, to date, our strength there is with the traditional Scient'x products from our French facility. They were registered either before the acquisition or after the acquisition. So, they're being successful to Scient'x products. Some markets, they're already selling Alphatec, Mexico being an example. The approval for Brazil for the Alphatec product is expected in the second half of this year. We've gone through a couple of the stages, including the site inspection, and we would hope to see Brazil approval come through in the second half of the year, and we should be in the market next year in a big way, thanks to the footprint we have not only in Brazil but Central and South America.

Mark Landy - Summer Street Research

Les, in terms of Scient'x approvals, are they under reciprocity or would they go through the (indiscernible) approval?

Leslie H. Cross

I'm not sure I understand that question, I'm sorry, and I'm looking at people around the table and they are all staring at me as well.

Mark Landy - Summer Street Research

There was a period, and I think it's closing or it's become a lot more difficult, to get approval of product in Brazil. You went through those foreign approval reciprocity. So if you had a CE Mark or approval in a foreign country, Brazil would honour that approval and there would be reciprocity and ability to sell.

Leslie H. Cross

I think like I don't know the answer to your question. Scient'x products were approved when I got here. I can tell you we have gone through the long process of getting U.S. manufactured products approved. It is a lengthy process. That's why it's not done. But the important steps are having them visit the facility here, which you have to wait for, and we've achieved that, and they accepted our filing. So, we've done the hard part, it's really just a matter of waiting for a stamped document. You know, we are at that stage but it could be – we expect it in the second half of the year. What happened with Scient'x, I really don't have a lot of clarity.

Mark Landy - Summer Street Research

Okay, I'll ask my next question offline relating to that. But then if we look at that, a little bit of PureGen, you've had some (indiscernible) grief with that relationship. Is there a plan B? It's not out of the woods yet at the FDA and now with the 483s, when do you think about a Plan B for that product?

Leslie H. Cross

I mean it's a good product. The physicians that are using it are getting outstanding success with it. Our partner (indiscernible) continues to work hard with us. I think we are working hard with the FDA and they are listening to us and we have several meetings coming up with the FDA in the not-too-distant future. So, I am very hopeful that a product that actually meets the need in the market and has been successful in implementing, and accelerating fusions, but I always have a Plan B, but I don't think we're ready to discuss it today.

Mark Landy - Summer Street Research

Fair enough. Then last just more of a philosophical high-level question. You implemented the strategy of increasing the cadence of improving some product line extensions over novel product development, obviously given the issue that the FDA not only you were going through but the entire industry is going through, how has that gone and how sustainable is that strategy and when do you have to stop thinking about really pushing the Scient'x novelty through the agency?

Leslie H. Cross

I mean we've had a good track record with the agency in the last few months, and you'll see if you look at our press releases, we've had several products approved. The only major product we're waiting on is Solus, we've talked about that, but in our guidance, I think Solus and Epicage are the only products, they're not in guidance. So, the thin guidance that we gave today are only products that are already approved by the FDA.

Mark Landy - Summer Street Research

Okay, so right now, there is still a little bit of runway room with the line extensions and the improvements and there really isn't that much pressure on really taking let's say the aging spine products through the agency?

Leslie H. Cross

Yeah, that's it. Yes, you're right. But don't forget an important step in the growth of this Company. We've proven now that we fill gaps in our product range through accretive licensing deals and we only do deals these days that have FDA approval, or are about to get FDA approval. So, NEXoss and Pegasus being two examples where we work with fine partners who had already achieved the FDA milestones prior to us getting into the business.

Operator

Thank you, and our next question comes from the line of Matt Dolan from Roth Capital.

Unidentified Analyst

Hey guys, this is (indiscernible) on for Matt. Thanks for taking the questions. I was hoping you could just talk a little bit about the Phygen surgeon conversion cycle. Just at this point, how many of those surgeons have become active ordering customers, and what level of activity have you seen from those converted surgeons at this point?

Leslie H. Cross

That's probably too much information. Frankly, I will tell you we have a strategy, we had a number of surgeons in as Tom talked about here a couple of weeks ago, and we spent a full day educating and demonstrating the product. We had another one of those next weekend I believe, and so we actually have a strategy and a plan, but I think I'd rather not talk about how many surgeons. I mean, it is a competitive business after-all, but obviously in the guidance, we expect to see a steady stream of surgeons converting to our products as the year goes by.

Unidentified Analyst

Okay, fair enough. Thanks.

Operator

I see no further questions at this time. I'd like to turn the conference back to Mr. Cross for any concluding remarks.

Leslie H. Cross

Well, thanks everybody. They were good questions and thanks for listening during our call and we look forward to updating you as we finish the next quarter. So thank you very much and we'll disconnect now.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a good day.

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