Alphatec Holdings' CEO Discusses Q3 2013 Results - Earnings Call Transcript

| About: Alphatec Holdings, (ATEC)

Alphatec Holdings, Inc. (NASDAQ:ATEC)

Q3 2013 Results Earnings Call

November 07, 2013, 05:00 PM ET

Executives

Christine Zedelmayer - Investor Relations

Leslie H. Cross - Chairman and Chief Executive Officer

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

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

Analysts

Young Li - Piper Jaffray

Glenn Navarro - RBC Capital Markets

Imran Zafar - Jefferies & Co.

Mark Landy - Summer Street

Josh Jennings - Cowen and Company

Operator

Welcome to Alphatec Spine Q3, 2013 Earnings Call. At this time all participants are in a listen-only until the question-and-answer session. (Operator Instructions). As a reminder this conference call is being recorded. If you have any objection you may disconnect at this time.

I would now like to introduce you to your host Christine Zedelmayer, Investor Relations.

Christine Zedelmayer

Thank you. Good afternoon and welcome to Alphatec Spine's quarterly update conference call to discuss our third quarter 2013 financial and operating results.

This conference call contains forward-looking statements that involve risks and uncertainties including statements regarding the company's expectations regarding its financial performance, strategies for revenue growth, development of new products, customer acceptance of the company's products and overall trends and economic conditions in the company's markets.

The company undertakes no obligation to update the information presented on the conference call. Actual results could differ material from those projected in the forward-looking statements as a result of certain risk factors. For more information about potential factors that affect our business and financial results we suggest you review our filings with the Securities and Exchange Commission.

Throughout the conference call the company will reference some financial metrics that are derived in accordance with generally accepted accounting principles or GAAP, while other metrics are not in accordance with GAAP. This approach is consistent with how management measures the company's results internally. However non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP Information provided by other companies.

Non-GAAP information should be considered as supplement to and not a substitute for financial statements prepared in accordance with GAAP. A reconciliation of the non-GAAP information to the corresponding GAAP measures is in the press release that was filed today prior to the conference call.

Now let me introduce the other members of the Alphatec management team that are here today. Les Cross, Chairman and Chief Executive Officer; Mike O'Neill, Vice President, Finance and Chief Financial Officer; Tom McLeer, Senior Vice President, U.S. Commercial Operations; and Ebun Garner, General Counsel.

I would now like to turn the call over to Les Cross.

Leslie H. Cross

Great. Thank you Christine. Good day everyone and welcome to Aphatec Spine's conference call to discuss our third quarter financial and operating results.

The afternoon our comments will build on the press release issued earlier today. In a few moments Tom will provide an overview of our U.S. commercial business, Mike will then provide additional detail on the quarter's financial results and comment on our outlook and guidance for the remainder of the year.

When I took over as CEO I focused the organization on the strategic goal of strengthening sales and profitability of the organization. Today I am very pleased to report another strong quarter of execution for Alphatec Spine which demonstrates our laser focus and commitment to continuing to deliver on that strategy.

I would now like to take a moment to reflect upon the numerous accomplishments we achieved during the third quarter. Q3 represents another strong quarter of revenue performance. Q3 ’13 total revenue was $50.2 million and represented a 7.2% growth over the third quarter 2012 or a 10.7% growth on a constant currency basis. We are extremely pleased with this excellent result and this is in-spite of the continued implant pricing and reimbursement headwinds in the global spine market.

Our EBITDA for Q3 also came in strong at $6.7 million or 13.4% of revenues up sequentially from 9.6% in the second quarter of 2013. Again this represents four solid quarters of execution, a testament to our focus and financial discipline and further to the strength of the team here at Alphatec Spine. For the nine months 2013, revenues have totaled approximately $152 million on a reported basis, trending well ahead of 2012 by about 6% or almost 9% on a constant currency basis. We achieved this year-over-year growth despite having to cover contribution losses associated with the removable of our PureGen product from the market. Mike will talk a lot more about this in the financial discussion.

We are exceptionally pleased with our U.S. revenue performance in the third quarter. U.S. revenue was $33.7 million and represented an 8.8% growth over the third quarter of 2012. Excluding the effect of our recently discontinued biologic product, PureGen again we will discuss in more detail later, our U.S. revenue was up approximately 14.6% quarter-over-quarter.

U.S. hospital non-biologic implant business was up 23.3% year-over-year and up 4.8% sequentially. This positive performance was a result of continued solid unit volume gains in our core hospital business and increased surgeon uptake across all our various product lines.

In additional our international business continues to deliver strong results. Overall international revenues totaled $16.5 million, representing a 4% growth as reported and almost 14% growth on a constant currency basis. This quarter we saw strong growth across all our major geographies. We believe this is a testament to our leadership focus on execution and our well established distribution and supply operations that support our overseas customers.

Japan continues to represent our largest international business. This is really driven by our Illico Minimally Invasive product and our Novel interbody devices. In the third quarter Japan grew 21% on a constant currency basis over the third quarter of 2012. We believe that Japan represents a market for continued growth and we will continue to endeavor to take market share by leveraging our well established team and distribution partners.

We are also very pleased with the performance of our product portfolio this year and we are excited about the traction we are making with our new innovative products. Alphatec Solus, our latest Interbody Fusion device, NEXoss, our next generation synthetic bone graft material, in fact internationally we have received over 50 registration approval this year-to-date and we are anticipating further approvals in Brazil and China for key Alphatec products perhaps towards the end of this year or early next year.

Clearly we are making tremendous progress on introduction and geographic distribution expansion for our product portfolio. Tom will provide more in depth regarding the U.S. products and portfolio in a moment.

To drive profitability we have focused our attention on driving operational efficiencies throughout the organization. We have made some difficult but necessary business decisions during the third quarter that are expected to drive overall improvements to gross margin and lowering our existing cost structure. In September, we announced our intention to restructure our operation in France. This includes plans to discontinue commercial activities in France. This represents a significant decision for the company's future but it does support our key strategy of increasing profitability and improving shareholder value.

As a result of this plan we expect to trade-off an amount of unprofitable revenue in the near term in exchange for an increase of EBITDA of $6 million to $7 million on an annualized basis, beginning in the second half of 2014, again Michael will talk a little bit more about this.

We anticipate fully realizing the benefits of this decision at the end of the second year. We are working closely with the French Counsel in France and they’re working diligently as we are to assist all affected employees and their families. We thank them for their efforts.

In addition after ongoing dialog with the FDA regarding our product stem cell PureGen we have made the business decision to discontinue the distribution of this product. This decision was not related to any safety issues with the PureGen product rather it was related to our belief that the product should have been classified as a tissue and the FDA’s final decision to classify as a biologic.

As a reminder together with pull through products PureGen was generating close to $2 million per quarter in revenue prior from our decision to remove it from the market. In order to continue to pursue further commercialization of PureGen the agency would require us to conduct clinical trials in order to market the product as a biologic. We do not believe that significant investment of capital overall link the timeline is a great use of our resources or in the best interest of our shareholders and again Michael will cover this little more fully.

The foundation we’ve been building in the organization over the last year and half is really beginning to deliver results and position us to deliver long-term shareholder value. We have driven positive momentum in the top line again and we’ve focused on operating efficiently and effectively while driving an overall world positive company culture.

I’m extremely proud of the Alphatec’s fine employees and business partners for delivering another excellent quarter and helping transform Alphatec Spine into world class organization.

At this time I would like to invite Tom McLeer, our Senior VP or U.S. Commercial Operations to provide some addition color around a U.S. commercial strategy and results. Tom?

Thomas McLeer

Thanks Les. It was indeed a fantastic quarter for the U.S. business. As I’ve mentioned previously our U.S. commercial strategy is supported by our core focus on increasing the breadth and depth of our technology portfolio. This includes the evolution in key products in our existing portfolio as well the development of new innovative options to support surgeons in the future.

In Q3 the benefit of this focus was reflected in our results, delivering implant growth of 23% over the third quarter of 2012 as well almost 15% growth in our biologics business excluding the impact of PureGen. This growth was supported by our growing distribution channel combined with an improved sales mix that includes our latest innovative products as well as the focus on driving per-procedure revenue by offering a broad fleet of products.

While we continue to experience mid single digit pricing pressure as well as reimbursement challenges we’re successfully advancing our broad portfolio of products to address all aspects of the procedure to help offset these industry headwinds. Our system enhancements to Illico and Zodiac as well as our differentiated Alphatec Solus and Pegasus products have allowed us to attract new surgeons and pull through many of our other core fusion products.

In addition our biologic portfolio provides outstanding options for our surgeon customers. Now I'd like to give you little more color around these products. Alphatec Solus was successfully re-launched earlier in the second quarter of this year. We began to see strong revenue ramp up in the third quarter. Our zero angle approach to locking the implant and the ability to deliver graft material post implantation provides significant advantages over other anchored inner body implants. Feedback from surgeons suggest that they appreciate the quick and easy implantation of the device as well as the benefits it provides to patients for increase fixation and decrease operative conduct.

Pegasus, our new anchored anterior cervical fusion device that provides surgeons with a simplified approach to ACDF procedures was just recently beta launched in the third quarter. We continue to gather feedback from our initial beta sites and move towards full launch. Surgeons like the ease of insertion which requires no impaction, deployment of both ways simultaneously and the ability to reposition the implant if needed.

We have actively been addressing the ongoing shift towards more minimally invasive procedures through enhancement to our ILLICO MIS system called the ILLICO multilevel, which is intended to simplify the surgical procedure and longer contracts. We continue to see increased adoption by surgeons who are moving to less invasive techniques which are designed to result in less operative time, decreased hospital cost and improved patient outcome.

Similarly, our Zodiac DVR Deformity System enhancements are providing consistent growth in both procedures and levels for procedure. We will continue to work with leading deformative surgeons to enhance Zodiac so that we address even the most complex spinal pathologies. Our broad biologic portfolio complements this implant business and offers increased per procedure revenue opportunities.

We continue to enjoy the steady growth of NEXoss, our newest biologic product that provides surgeons with one of the most advanced synthetic options on the market. Similarly we continue to see year-to-date growth in our ProFuse Bioscaffold for those surgeons who prefer [analgenitic] option. In addition we are expanding our Trestle Allograft options to address additional surgeon preferences.

To address the increased pricing pressure, we will soon be launching Bone X a low cost synthetic graft as well as a variety of low cost Allograft shifts which will primarily be used by deformative surgeons, for performing a field evaluation on an autologous point of care system, which creates a product that is designed to allow the release of the patient own growth factors over an extended period of time. As has been the case in the past we will continue to invest in new biologic options to support our industry leading offering.

I would like to take a moment to briefly provide an overview of the surgeon collaboration agreement that we announced in October. This collaboration clearly supports our mission to provide physician and product solutions that enhance the quality of life for patients. As we continue to expand our portfolio of innovative products, it's essential that we gather a wide range of surgeon experiences and preferences. This collaboration agreement will help ensure that our products are relevant and appealing to all client surgeons around the world.

This team of surgeons is excited to work with us and will be partnering with our R&D team on a wide variety of innovative projects. All intellectual property created from this venture will be owned exclusively by Alphatec. We are looking forward to working closely with this physician group as we continue our commitment to enhance the current products we market as well as expand our future product portfolio.

In closing, over the past year we have created a very strong commercial organization in the United States to support our new technologies and biologics. Surgeon education and training labs for Pegasus, Alphatec Solus and ILLICO MIS continue to be a key growth driver. We are excited about our newest product additions to our comprehensive portfolio.

We look forward to continuing develop innovative solutions that benefits both surgeons and patients, by providing an expanding portfolio of innovative products, the complete line of core fusion products and an extensive line of biologics as we continue to diversify our offerings, which should allow us to grow our customer base and increase our per procedure and customer revenue. We continue to build on this foundation as we look towards the end of 2013 and the beginning of the new year.

With that, I would now like to turn the call over to Mike for discussion of our third quarter financial results.

Michael O'Neill

Thank you, Tom. The following remarks are related to our reported operating performance for the third quarter ended September 30, 2013. We’ve already provided an overview of our sales performance. However before reviewing the rest of the financial information I would like to provide some additional commentary with respect to France and our stem cell product, PureGen.

As communicated earlier in September and included in today’s earnings release, Alphatec has made the difficult decisions to restructure our commercial and operational activities in France. The planned restructuring will commence in the New Year once we have concluded the formal discussions and negotiations with our employee representatives in France. The total cost of the restructuring activities covers the expenses associated with the employees severance program, other [social] planning cost for retraining, relocation and other benefits. facility closing costs, restoration, equipment transfers, and contract lease termination and exit costs.

We anticipate the restructuring cost, excluding inventory write-offs to be approximately $11 million. And these expenses will be recognized between Q3, 2013 and Q2, 2014. In addition to the $4 million charge in Q3, 2013, we expect that approximately $4.7 million will be recognized in Q4, 2013, $1.3 million in Q1 of 2014, and $1 million in Q2 of 2014.

As we incur these expenses in future periods we plan to exclude them from our non-GAAP adjusted EBITDA metric, as they are not expenses that are indicative of our underlying business performance. As a result of this planned restructuring, the company anticipates improvements in the overall profitability of our international business by generating between $6 million and $7 million of EBITDA on an annualized basis, beginning in the second half of 2014.

The overall initiative is designed to substantially improve our long-term financial performance of our international business. We will be providing financial guidance for fiscal year 2014 as part of our 2013 year-end earnings discussion. In addition to the provisions we have identified associated with our restructuring activities in Q3 of 2013, we have also taken the decision as Les just mentioned to cease further activities with respect to PureGen our stem cell product.

As a result, we have included in cost of goods sold of Q3 of 2013, a $3.5 million non-tax expense to cover inventory and intangible asset write-off costs. This provision has also been excluded from our adjusted EBITDA numbers. While the expenses for these non-recurring activities are substantial the company is demonstrating a continuing commitment to improve the long-term profitability of the company.

Moving to gross profits and gross margins, the gross profit for 2013 as reported is $24.2 million or 48.3% of revenue compared to $29.6 million or 63.6% of revenue in Q3 of 2012. After adjusting for the one-time items in cost of goods sold discussed earlier, overall gross profit improves to $32.3 million or 64.3% of revenue, which compares favorably to both the prior year and the sequential quarter’s performance.

U.S. gross margin was 58.6% in Q3 of 2013 compared to 68.9% in Q3 of 2012. After adjusting for the PureGen write-off, the gross margin in Q3 of 2013 was 69%. This was an improvement from the 67.6% U.S. gross margin in Q3 of 2013. Compared to the prior year period, favorable channel mix and higher margin new product sales more than offset the negative impact of pricing and some higher obsolescence and product life cycle charges.

International gross margins on a reported basis were 27.1% for Q3 of 2013, compared to 52.2% in Q3 of 2012. After adjusting for the one-time charges of the cost of goods sold, the gross margin in Q3 was 54.7%, reflecting underlying favorable regional mix when compared to the prior period and improved manufacturing cost associated with continued improvements within our core supply chain activities.

As we highlighted in our second quarter commentary we continued to witness ongoing improvements throughout our supply chain as a direct result of the lean initiatives deployed throughout our business. Every week, our score cards indicate improvements in cycle time, reductions in working process, inventory levels and back orders. Our customer service levels and response times are improving. And this is all being accomplished with improved quality metrics.

Our focus on these initiatives support our continuing transformation into a global vertically integrated manufacturing facility in Carlsbad, which will support future growth and expansion of our product portfolio at lower overall cost and increased efficiencies. We firmly believe that we are becoming more efficient and effective in everything we do.

Now turning to operating costs. Our total operating expenses for Q3 of 2013 were $37.4 million, an increase of $5.8 million compared to prior year of $31.6 million. After eliminating our restructuring charge of $4 million in Q3 of 2013 the underlying operating expenses were $33.4 million. The primary increase in expenses were associated with higher legal cost for ongoing litigation matters. The medical device excise tax and the variable selling cost associated with Phygen. It should be noted that no additional cost have been added to absorb the Phygen business beyond the variable selling cost and the acquisition is already accretive to the company.

Adjusted EBITDA, a measure we guide to, was 6.7 million in the third quarter of 2013 or 13.4% of revenues compared to $6 million or 12.8% of revenue reported for the third quarter of 2012. Please note that our adjusted EBITDA was negatively influenced by the currency exchange impact of the Japanese yen on our profitable subsidiary in Japan.

Adjusted EBITDA represents net income or loss excluding the effects of interests, taxes, depreciation, amortization, stock-based compensation and other non-recurring items such as our restructuring expenses, IT, R&D and transaction related expenses.

GAAP net loss for the third quarter of 2013 was $14.5 million or negative $0.15 per share compared to a net loss of $2.5 million or negative $0.03 per share for the third quarter of 2012.

Non-GAAP EPS was positive $0.01 a share for Q3, 2013 and also $0.01 per share for Q3 2012. Cash and cash equivalents were $18.7 million at September 30, 2013 compared to the $22.2 million reported at December 31, 2012. During the quarter we have amended our credit facility with Midcap Financial to provide for a combination of revolving line of credit and term loan that provides the company with a maximum credit facility of $73 million.

The flexible structure of the amended debt facility allowed us to draw down what we need and when we need it. The company’s cash position at September 30, 2013 reflects utilization of $45.8 million of the $73 million facility.

Operating cash flow for the quarter was $3.9 million, offset by capital expenditures of $3.3 million. All other cash flow components were a function of the revised credit facility. As of September 30, 2013 our net inventory position was $43.1 million, a decrease of approximately $6.7 million versus Q4, 2012 and sequentially down $7.5 million versus Q2 of 2013.

While operation improvements with respect to supply chain are yielding visible benefits to inventory levels the write-offs discussed previously are a significant component of the change in net inventory.

Our net account receivable at the Q3, 2013 was $41.7 million which is essentially flat compared to both Q3 of '12 and Q2 of ’13. We continue to manage day sales outstanding in a reliable and efficient manner with minimum write-offs.

Now for our guidance for the remainder of 2013. As we close out the year the company expects full year revenues for 2013 to be approximately $204 million on an as-reported basis which represents an increase of 3.9% in 2012 or approximately 6.5% growth on a constant currency basis.

The implied Q4, 2013 revenue estimate is approximately $52.3 million. The company anticipates non-GAAP adjusted EBITDA to be in the range of $24 million to $25 million or approximately 21% to 26% over 2012 and representing approximately 12% of revenue.

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

Leslie H. Cross

Great, good job. Thank you Mike. I’m very proud of Alphatec’s performance thus far this year. The foundation we have built is clearly generating positive momentum enabling Alphatec to execute on the strategy we laid out for the company two years ago. While we expect the global spine market to remain somewhat choppy with continued price and reimbursement pressures we are committed to continue to identify the way that we can drive top line results while continuing to improve our profitability through diligence focus financial discipline and continue the lean journey.

In closing I’d like to reiterate along with Alphatec Spine Board of Directors and leadership team we remain committed to creating value for our shareholders and our employees, patients and the surgeons that we’re focused on servicing worldwide.

Additionally I’d like to acknowledge and thank the employees of Alphatec and our partners who work hard and they are committed to enable the company to deliver these excellent results.

Thank you. Operator we’d like to open the call up for questions please.

Question-and-Answer Session

Operator

(Operator Instructions). And our first question comes from the line of Matt Miksic of Piper Jaffray. Your line is open please go ahead.

Young Li - Piper Jaffray

Hi this is Young Li in from Matt, and can you hear me all right.

Leslie H. Cross

Yes we can.

Young Li - Piper Jaffray

All right thank you so much for taking our question. So in the quarter your U.S. performance was significantly higher than our expectation, predominantly driven by volumes in key products. Can you talk about what else you are doing in the market that’s contributing to the very good growth rate, are you capturing some share from hospitals work with them less?

Leslie H. Cross

I think we are getting some from products but really it comes through as I mentioned with our new products and driving out now for full launch and being able to then pull through some of our core product line in biologics. In addition we are expanding our distribution and pulling over some competitive distribution.

Young Li - Piper Jaffray

Okay great. And so regarding the collaboration and agreement with the surgeon. Can you talk about the number of surgeons involved? And how you are judging whether the transaction is according to your expectations?

Leslie H. Cross

Yeah, really not a revenue based transaction, a quest about how many surgeons but it's more about the service hours and collaboration we get with them. So as opposed to some surgeons that would work on one specific project we are going to work with them across a whole variety of products to get their experiences and input across the whole gamut of things that we are working on.

Young Li - Piper Jaffray

All right great and one last question. So I guess the guidance implied the deceleration in Q4 itself, understanding there are impacts from biologics as well as international sales and also a bit of a tougher comp in Q4, but is anything else that should be noted as contributing to that decelerating growth?

Michael O'Neill

I think you’ve got obviously currency for on an as average reported pay system care for Q4 last year. PureGen, as you mentioned was in Q4 in last year not in this year. Q4 is historically a stronger quarter and that would be so given this number for Q4 and obviously we are reasonably comfortable with other numbers right now.

Young Li - Piper Jaffray

All right great and thank you for taking the questions.

Operator

Thank you. Our next question comes from the line of Bill Plovanic of Canaccord. Your line is open. Please go ahead.

Unidentified Analyst

Great, thanks this is actually, [Karl] on for Bill can you hear me all right.

Leslie H. Cross

Yes Karl we can hear you.

Unidentified Analyst

Great, the thing I want to do is build on the previous callers question and just if we can drill any further in the U.S. strength. Obviously there is strength in both volumes and also it seems like mix. Wanted to see if you could break down some, how much of that is coming from new customers coming on board through may be more acceleration from the Phygen acquisition and then how much of that is just positive mix from coming from of these new products that you’ve launched?

Thomas McLeer

I would say that obviously with Phygen it's going very well we had a flow start, it's now been accelerating. I think we’ll continue to see that but it's already been accretive. Certainly Phygen’s has helped. The new products some of those aren't fully launched but they are definitely pulling through a lot of the core products. So we are getting a lot of new surgeon interest with the new products and we can expose them to the other core products that we have as well as the biologics.

So a kind of a combination of both certainly Phygen has helped but the new products are really helping to drive surgeon interest.

Leslie H. Cross

So for example if you looked at our biologic franchise if you took our PureGen out of the numbers we are up double digit year-over-year in terms of biologics. So NEXoss is clearly contributing, ProFuse is clearly contributing to the growth.

Unidentified Analyst

Great and then looking towards the development agreement, any more color that you can give us, are there any product gaps you are trying to fill in the portfolio anything that really motivated you for bringing this group of surgeons onboard? And then I understand that it's early but when should we expect to see some of these first products may be come in the market or get an idea of when some progress there?

Leslie H. Cross

So as we’ve discussed before probably our biggest gap in our portfolio now would be on the lateral implant side. So that’s obviously an areas we would like to grow on but really one of the keys to bringing out new products is being able to have the product appeal to the broad base of surgeons, all the way across the gamut of users from neurosurgeons, to osteopaths to international surgeons.

So really we are trying to get a great group of surgeons working with us just to make sure that some of our existing and new products really appeal to the masses.

Unidentified Analyst

Great. And then just one last modeling question for Mike. Just wanted to see if we could get med tax in the quarter and thanks a lot, appreciate taking the questions.

Michael O'Neill

Yeah. So, the med tax taxes, so on our U.S. revenue, we pay substantially less than 2.3%. I don’t want to get into the actual number right now, but you should be modeling well less than the 2.3% on U.S. revenue.

Unidentified Analyst

Great, thanks a lot.

Michael O'Neill

Thanks.

Operator.

Thank you. Our next question comes from the line of Glenn Navarro of RBC Capital Markets. Your line is open. Please go ahead.

Glenn Navarro - RBC Capital Markets

Thanks. Is it a possibly there is a way to quantify what price increase should be used in the third quarter?

Michael O'Neill

So, Glenn one of the things that we have is Phygen -- we are doing business with Phygen physicians prior to the acquisition. And so we have got a little bit of the challenge in terms of an apples-to -apples comparison. I guess I would say if you look at it like this, our hospital implant business is up 23% year-over-year. That’s obviously feeding the category. I think Tom has already addressed the question of is Phygen a big contributor. Clearly Phygen year-over-year has been a big contributor.

When we get into dissecting how much of that growth came from Phygen specifically versus base product, it’s a little bit of a challenge. But I think its worthy of note that the business we closed out at the year with Phygen, very close to what we articulated when we did the deal in late 2012, we got off to a slow start, it is accelerating. Tom has mentioned it's accretive now, we are already in Q3 of ’13. And it's definitely contributing to our underlying growth.

Glenn Navarro - RBC Capital Markets

Okay, that’s fine. That's what I was trying to get at, almost 9% U.S., that’s a very strong growth and obviously Phygen is contributing, just trying to get a sense of what the apples- to-apples or what the organic growth was be in U.S.

Leslie H. Cross

And you remember, when at the beginning of the year I think we guided $15 million of revenue in Phygen and we would expect the year to be -- finish very close to that projection, if that helps?

Glenn Navarro - RBC Capital Markets

Yes, that’s helpful. And then I just wanted to ask a question on pricing. You talked about pricing being down mid-single digits. When we talk to some of your other smaller competitors we are hearing pricing down more like low single-digits. So maybe talk about what’s driving mid single-digits for you and what’s the potential for you to get down to that low single-digit revenue decline. Thanks.

Thomas McLeer

Sure. This is Tom. The majority of our business is still in the core business in the price sensitive sector. So we are seeing a lot of pressure there. As we start with the new product introduction, we are continuing to, none of them are in full launch we are still working that out particularly with Pegasus and we will see what pricing impact as we get those MIS products, the deformity products, the solar Pegasus products, those won't have as much price sensitivity as the core products we have now.

Glenn Navarro - RBC Capital Markets

And the price sensitive segment of the market is clarifying, you are talking about lower back fusion right?

Thomas McLeer

Yeah, I would just say [inaudible] I guess I would say standard inter body implants, surgical plates, synthetic screws.

Glenn Navarro - RBC Capital Markets

Okay, great. Thank you.

Operator.

Thank you. Our next question comes from the line of Imran Zafar of Jefferies. Your line is open. Please go ahead.

Imran Zafar - Jefferies & Co.

Hi, good afternoon. Thanks for taking my question. First, I wanted to ask a broader market question. As you look to 2014, I know you are going to give guidance on the next call, but what are your expectations for broader market growth for next year, the way you see it right now in terms of just overall pricing…

Leslie H. Cross

You mean the overall category situation?

Imran Zafar - Jefferies & Co.

Yeah, just the overall Spine market, what your assumptions are as you formulate your operating plan and your targets for next year?

Leslie H. Cross

So, I think a lot of it is whether we anticipate pricing to be I think for the -- I call the meat and potato products. I think that mid-single digit pricing decline on an annual basis is not unreasonable. I think then you got demographic kicking in and you have got category volumes that are going to offset that to some extent. I don’t think that category my point or one persons point of view I don’t see the category being much more than low single digits and I think that will be an integral part of our planning assumption for ’14.

Imran Zafar - Jefferies & Co.

Okay, and then given the restructuring of PureGen, is there an increased interest and maybe adding to your biologic portfolio, via acquisition or I mean I know the business grew well even net of that in the quarter, how comprehensive do you think your portfolio is, and does it need to be more so?

Leslie H. Cross

I think it’s fairly comprehensive. We have had surgeons that have moved over to NEXoss with bone marrow as a option to PureGen but obviously we are still looking to do licensing and acquisition and things like that to expand that out. And I mentioned a little bit about that as far as from autologous point of care therapy that we are looking at. So I think we have got a very complete portfolio but we are always looking at new products on keeping in mind that price pressure that we face.

Imran Zafar - Jefferies & Co.

Okay, and then lastly just wanted to get your thoughts on artificial technology, there is obviously a lot of buzz about that and as multiple products are approved in the U.S. now obviously reimbursements, gaining adoption there but I wondered how you think that would impact your fusion business and secondly whether you have a R&D program in that category?

Leslie H. Cross

Yeah, that’s a great question. We actually do have a disc in our portfolio. It [inaudible] product outside the U.S. We have not up to this stage invested in bringing to the U.S. because we have some basic knitting to take care of but we have a device that has many thousands of devices implanted outside the U.S. with excellent clinical results. And I think now that we've got a lot of a basic knitting taken care it really is time to look at bringing that very successful and well supported disk to the U.S. in the future. But we are in the phase of evaluating exactly how to do that, the timing of doing that and the cost of doing that, perhaps we might have a little more color for you on the next call.

Imran Zafar - Jefferies & Co.

Okay, and then the potential impact on your fusion business?

Thomas McLeer

Yeah, I think it depends a little bit on reimbursement which remains to be seen how that goes. I think it may have a little impact but I don’t really think in the next few quarters we are going to see a huge impact there but that’s my personal opinion.

Imran Zafar - Jefferies & Co.

Great, okay, thank you very much.

Leslie H. Cross

Thanks.

Operator

Thank you. Our next question comes from the line of Mark Landy of Summer Street. Your line is open. Please go ahead.

Mark Landy - Summer Street

Sure, good afternoon, folks, can you hear me, okay?

Leslie H. Cross

Yes, we can Mark.

Mark Landy - Summer Street

Thanks for taking my questions. Just briefly Michael on France and good luck with the European with the employee representative. Are negotiations done or are you still trying to conclude them?

Thomas McLeer

No, we don’t conclude.

Michael O'Neill

Still one of the reasons we talk about the program as we are in the planning phase is we are not complete yet. That is a Q4 program in terms of final discussion. So it is still between the company and the employee representative in France at this point in time.

Mark Landy - Summer Street

And then let me guess, a whole bunch of those guys are available for discussion in August, right?

Michael O'Neill

Mark, given the timing of our communication it's book1, book 2 there is a set timeline that we have to march through and we are respecting that as best we can obviously.

Mark Landy - Summer Street

Okay, fair enough. And just with that I know it’s a really difficult process to go through specifically with that representative. Have you [inaudible] on most of the issues or are you still expecting some outliers to be brought up in that process?

Michael O'Neill

No, Mark, I think it’s gone very much as we would have anticipated. There is one thing, the one thing I would like to add is we are impacting or potentially impacting a significant number of people’s lives. The French team has actually been -- there are extraordinarily balances they have gone through this. And I think one thing we’re very mindful of it is that it’s a substantial and difficult decision for the company. There is the process we have to go through, which we are absolutely committed to but I think that is really is from an organizational standpoint, the organization has actually responded incredibly well.

Mark Landy - Summer Street

Okay, fair enough. If I just move a little bit on to PureGen and I guess it is year-over-year most of the stuff but with respect to the classification of 361 and being manipulated, what was the difference between your viewpoint and the FDA’s ultimate view point that lets you pull in the product from the market. I understand the process for the clinical costs and the time there and all but what were the differences that you couldn’t reconcile with the FDA with respect I’m sure is manipulated material?

Michael O'Neill

It was really, it came down to just the difference in opinion as to whether our primary function involved metabolic activity or not. So that was really what the discussions centered around we felt it was a tissue should be designated that way and they felt it should be designated as a biologic.

Mark Landy - Summer Street

Just starting through that process do you think that the FDA is becoming more rigorous in its implementation of that or perhaps maybe I think some people have previously went on 360 or around that, looked with the little bit more latitude.

Leslie H. Cross

I can’t speak for the FDA but recently they have sent out several more on title letters regarding stem cell so it tells you that they are at least aware of the category and looking into different product that are out there.

Mark Landy - Summer Street

And then just lastly from me the product that you want to focus on we have with this core group of surgeons Les one of the strategies that you put in place does that have you turn away from products that have lengthy cycles through the regulatory system to focus more on upping the cadence of new products specifically as related to I guess just updating product that you have in the market, what is the focus with this group I’m sure is a mix but you can kind of explain how you plan to address the products with them, is it just get a couple of new things into market then start on development of longer regulatory type products or is this group really as a strong it's going to go after that it's going to move the needle in the longer term?

Leslie H. Cross

This group will be working on some new products and upgrading our existing products but all, it will be 510(k) type projects they will have an impact quickly rather over the long-term. I think long-term we talked about a disk, we talked about some biologics, it’s a mixture but right now you remember we spoke a year how we went from 30 R&D projects down to eight so we could focus our resources, we launched those eight product, we've now identified our eight next programs and this group will help us work with us to make sure they are home runs.

Mark Landy - Summer Street

Just lastly on that there were a couple of these Spinetec products that you’re hoping to bring to the U.S. or your predecessor was hoping to bring to the U.S. which I think kind of shelved. Which one that you’re going to revisit, which one of those projects get in, gets started off again or have you have just kind of shelved all that now and started a clean slate.

Leslie H. Cross

I think I mentioned, the disk, the artificial disk or so, is clearly one where, now that we have the capacity we are spending time exploring the opportunity. That is actually Spinetec number one selling product worldwide and with this now starting to get some reimbursement we think it’s time to look at that particular product and we can talk more about that next quarter.

Thomas McLeer

And we’re looking at some other ,products they have an extendable cage and a few other items like that that might provide the opportunity to get a 510(k) quickly and be sold here in the United States.

Mark Landy - Summer Street

All right, guys, congrats on a good quarter and thanks for answering my questions.

Leslie H. Cross

Thank you.

Operator

Thank you. Our next question comes from the line of Josh Jennings of Cowen and Company. Your line is open. Please go ahead.

Josh Jennings - Cowen and Company

Thanks gentlemen. Just wanted to start off with the ceasing commercial operations in France. Is that, assuming it gets done can you quantify any kind of revenue headwinds that creates I know you are not giving guidance for 2014 but any lost revenues there and does that impact you Q4 guidance at all.

Leslie H. Cross

It does impact our thinking as it relates to 2014 because obviously we do have a business presence in France that we will factor in and we’ll be able to articulate that as we think about 2014 when we end 2013. As it relates to Q4 right now everything in France is on track I mean there is a specific reason or there is many reasons why I wanted to identify the contributions of the organizations in the France and that’s one of them. So the business right now is on track.

Josh Jennings - Cowen and Company

Okay and then if we could just revisit your Q4 guide $204 million for the year it assumes deceleration as was asked during the call. But can you just help us work through you do have the hardest comp, difficult comp year-over-year in 2013 in the fourth quarter and you don’t have PureGen. But looking at that decelerations or anything else that you guys can call out help us get our arms around about the Q4 guide?

Leslie H. Cross

Well the one thing that worth point out or reiterating is the impact of that in our business in ’13. We said when we close out Q2 was about $3 million in Q4. So it's about a $1.5 million per quarter. So that’s the hit that we are overcoming in terms of the operational improvements in terms of the Japanese yen. And PureGen is out but if you look at the run rate that we are coming into Q4 the business is on a solid footing and we are accumulating unit volumes and revenue.

So it's historically our strongest quarter , and I think that you look at the as reported growth the 3.9% and 6.5% in constant currency, it speaks to where we have been all year.

Josh Jennings - Cowen and Company

Great gentlemen it helps. And lastly you’ve had some significant strength in your Japan business over the last number of quarters, I just was hoping if you give us a little bit of a, just detail the sustainability of that strength and what’s driving it there and how much room do you have? Thanks for taking the questions.

Leslie H. Cross

Yeah, it's a great question. Our Japanese business is doing incredibly well. In fact they have a quite a large market sharing in Japan already. They only launched their inter bodies earlier this year so that’s really just ramping up. Japan, the government in Japan is going to take another price cut next year of something around 8% to 10% we expect, but even in the phase of that we expect our Japanese business to deliver solid growth next year.

Operator

Thank you . (Operator Instructions). Our next question comes from the line of [Jan Haselmire of First Province]. Your line is open. Please go ahead.

Unidentified Analyst

Yeah, hello good evening everybody.

Leslie H. Cross

Yeah, good morning to you.

Unidentified Analyst

No, it's close to midnight so. And yeah and not so much left for me. I just wanted to ask if you could just repeat the costs that are associated with the discontinuation of the French activities? And I was also wondering if you and how much of the long term liabilities are interest bearing? And that’s it.

Michael O'Neill

And so on France, it's $11 million for restructuring. We took $4 million in Q3 we estimate $4.7 million in Q4, $1.3 million in Q1 and $1 million in Q2, that should get you to $11 million. If you are asking in relative to the indebtedness, the new debt structure, it's all interest bearing and we have an amortization schedule of three years on the term loan of $3 million a year and that’s all delineated in our disclosure.

Unidentified Analyst

Okay, good thanks.

Operator

Thank you. And with no further questions in queue I’d like to turn the conference back over to Mr. Leslie Cross for any closing remarks.

Leslie H. Cross

Great thank you. So I think that concludes the questions, end our time today. We thank everyone for their interest, for their questions and we look forward to talking to you again when we report our year-end. Thank you everybody.

Operator

Ladies and gentlemen thank you for your participation in today’s conference. This does conclude the program and you may all disconnect. Have a great rest of your day.

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