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Alphatec Holdings (NASDAQ:ATEC)

Q2 2014 Results Earnings Conference Call

July 31, 2014, 05:00 PM ET

Executives

Chris Zedelmayer - IR

Leslie Cross - Chairman

Jim Corbett - President and CEO

Mike O'Neill - VP and CFO

Analysts

William Plovanic - Canaccord Genuity

Matt Miksic - Piper Jaffray

Raj Denhoy - Jefferies & Company

Mark Landy - Summer Street Research

Operator

Welcome to Alphatec Spine Second Quarter 2014 Earnings Call. At this time participants are in a listen-only mode until the question-and-answer session. 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, Head of Investor Relations at Alphatec Spine. You may begin.

Chris Zedelmayer

Good afternoon and welcome to Alphatec Spine's quarterly update conference call to discuss our second quarter 2014 financial and operating results as well as to provide an outlook for the remainder of 2014.

This afternoon our comments will build on the press release we issued earlier today. Before we being I would like to remind you that 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 materially 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.

Now let me introduce the other members of the Alphatec team that are here with me today. Les Cross, Chairman of the Board of Directors; Jim Corbett President and Chief Executive Officer; Mike O'Neill, Vice President and Chief Financial Officer; Mike Plunkett, Chief Operating Officer; and Ebun Garner, General Counsel.

The agenda for today's call will include a quick transition overview from Les followed by a business update from Jim, a review of our second quarter financial results from Mike and closing comments from Jim. We will then open up the call for Q&A session.

I will now like to turn the call over to Mr. Les Cross.

Leslie Cross

Great. Thank you, Christine. Good day everyone and welcome to Alphatec Spine's conference call to discuss our second quarter operating results.

Based on the plan that I outlined to you all during our last earnings call, I have been working closely with Jim over the past three months to seamlessly transition the business to him and build upon the momentum that we have generated over the last couple of years.

I am extremely pleased at how quickly Jim has come up to speed. This combined with his vision for the future and his energetic focus. He is actively engaged across the business and he is well integrated into the entire leadership team.

Jim is a solid, committed CEO and I am extremely confident in his ability to take this organization to the next level. I look forward to supporting his vision and his strategic focus at Alphatec as he leads us into the future.

With that said, I would now like to turn the call over to Alphatec's President and CEO and my friend Jim Corbett to provide an overview and key highlights of the second quarter results. Jim?

Jim Corbett

Thanks, Les and thank you everyone for joining us today. During the last quarter, I have been meeting with many of our customers, key stakeholders and our employees to gain insights across all aspects of the business and to be clear about the opportunities and challenges that lie ahead.

Later, I will share key focus areas for our future, but first let me review some of the highlights for the quarter. As detailed in our press release this afternoon, Q2 represented a strong record quarter for both top line and bottom line results for Alphatec.

During the quarter, we also initiated the beta launch for our new spinal fixation system Arsenal. We are excited about this newest addition to our Alphatec product portfolio and the opportunities of this new platform for Alphatec's future.

Q2, 2014, consolidated revenue totaled $53.2 million, representing over 4% growth over 2013. Adjusted EBITDA for Q2 was another record for the company, coming in at $7.7 million or approximately 14% of revenues. This represents growth of 57% compared to the second quarter of 2013 and over 14% growth sequentially.

During the quarter, we also delivered 500 basis points of improvement in gross margin. Over 300 basis points of margin improvement are directly attributable to our continued focus on driving down costs, our commitment to ongoing operational efficiencies, especially in the area of inventory management.

We are extremely pleased that we are able to deliver record global revenue coupled with very strong operational results. Mike will cover the financial results in greater detail in a few moments.

Our U.S. revenue performance was strong for the second quarter of 2014. U.S. revenue in the second quarter was $34.5 million, up 6.2% over the second quarter of 2013. Growth in the U.S. year-over-year is attributable to increased uptake across our broad portfolio of spinal fusion technologies led by our extensive biologics product suite which grew 25% year-over-year.

Our international business continues to deliver solid results and represents 35% of our consolidated sales. International net revenues in the second quarter were $18.6 million, representing approximately 1% growth when compared to the second quarter of 2013.

Moving now to our product portfolio. Continuing to innovate and drive surgeon adoption of our global product portfolio, especially in the area of less-invasive solutions and biologics remains a key strategic driver for delivering profitable growth in the future. In the second quarter we made good progress towards this goal with key product launches in the U.S. and internationally.

In June, we kicked off our U.S. beta launch of Arsenal, our new spinal fixation system. Arsenal is a comprehensive system that combines ergonomic and thoughtfully designed instrumentation with low profile implants which are capable of handling the most complex degenerative conditions, enhance the overall experience for the surgeon.

To date we have successfully completed nearly one-third of our beta patient cases and are on track to complete this phase of the launch in September. We are planning on expanding the beta launch in October with the full launch anticipated in Q1, 2015. We are excited about the future global opportunity for the Arsenal platform and look forward to updating you on our progress in the coming months.

Now turning to our operational results. Alphatec has built a strong operational platform over the past couple of years as expected to provide a solid foundation for delivering profitable growth in the future. As a result, in the second quarter, we were able to deliver our record adjusted EBITDA margin that exceeded 14% of consolidated revenues and improved 480 basis points over prior year.

We will continue to focus on our lean enterprise implementation and global cost savings initiatives with a goal of maintaining this momentum and driving meaningful leverage in the future.

At this time, I would like to invite Michael O’Neill, our CFO to provide additional comments around our second quarter financial performance and our future outlook for the remainder of 2014. Mike?

Mike O’Neill

Thank you, Jim. As Jim mentioned earlier, Q2, 2014 consolidated revenue totaled $53.2 million and international revenues in the second quarter were $18.6 million. We were able to achieve this level of growth despite the absence of revenue contributions from France which accounted for approximately $1.6 million in Q2 of 2013.

It’s important to note while our reported international growth was approximately 1%, we are driving long term improvements in our ongoing operating performance and adjusted EBITDA as a result of our French restructuring activities. When revenues are adjusted for prior year contribution from France, international revenues grew 9% versus the same period in 2013.

Our gross profit for Q2, 2014 was $36.1 million or 67.9% of revenue compared to $32.1 million or 62.9% of revenue in Q2 of 2013. We achieved a 500 basis point improvement in gross margin over the same period. Over 300 basis points of improvement were attributable to ongoing operational improvements and consolidation of the French supply chain activities into Carlsbad.

Approximately 220 basis points of the improvement is the result of the conclusion of amortization expense associated with the Cross Medical settlement in the fourth quarter of 2013. These combined improvements were offset by unfavorable variations in price and regional product mix.

U.S. gross margin was 71.8% in Q2 of 2014 compared to 65% in Q2 of 2013, demonstrating continued underlying performance improvement as well as the reduction in costs associated with the ending of the Cross Medical amortization.

It should be noted that while the amortization expense associated with Cross Medical has ended, the $1 million per quarter payment obligation is not set to expire until the third quarter of 2015.

International gross margins on a reported basis was 60.8% for Q2 of 2014 compared to 59.1% in Q2 of 2013 with ongoing cost improvement partially offset by regional pricing pressures as a result of state funded reimbursement.

Total operating expenses for Q2 of 2014 were $34.3 million, a decrease of 2% or approximately $700,000 compared to the second quarter of 2013. When compare to prior year, G&A expenses in Q2 of 2013 included expenses associated with Orthotec legal matter, favorability in G&A expenses in the second quarter of 2014 were offset by increased R&D expenses primarily attributable to the Arsenal product development program.

Adjusted EBITDA, a measure we guide to, came in strong for second quarter at $7.7 million or 14.4% of revenues compared to $4.9 million or 9.6% of revenues reported for the second quarter of 2013. This represents a 57% improvement over prior year and demonstrates that we have seen the ongoing performance improvements relative to operating results of the company.

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

As of June of 30th, we have substantially completed the activities associated with the French restructuring and estimate that all the expense related to these activities has been booked. We do not anticipate any material cost impacts in the second half of 2014 and only modest cash obligations relating to the social plan moving forward.

This is being one of the most significant operational activities in the history of the company, involving employees across every functional department over a significant length of time. This program has been executed expertly and on schedule, demonstrating a significant increase in the company's organizational capabilities.

GAAP net loss for Q2 of 2014 was $2.9 million or negative $0.03 per share compared to a GAAP net loss of $4.7 million or negative $0.05 per share for the second quarter of 2013.

Cash and cash equivalents were $19 million at June 30th of 2014. This compares to the $23.8 million of cash reported at March 31st of 2014. The reduction was attributable to the shutdown of our French manufacturing operation.

In addition, we have $2 million of restricted cash reserve for the ongoing Orthotec settlement obligations. The restricted cash balance reflects the initial net draw from the Deerfield facility of $19.5 million less the initial settlements payments to Orthotec in the amount of $17.5 million.

With that, I would now like to provide an update on our forward-looking guidance for 2014. With the first half of 2014 behind us, we are narrowing our guidance and anticipate full year revenues for 2014 to be in the range of $208 million to $212 million.

We are reaffirming our guidance for non-GAAP adjusted EBITDA to be in the range of $30 million to $33 million or approximately 19% to 31% over 2013 and representing approximately 14.4% to 15.6% of revenue.

In summary, we had made positive progress this quarter towards our goal of profitable growth. As we move through the remainder of 2014, we look forward to continuing our diligent focus on execution and cash flow.

With that, I would now like to turn the call back over to Jim.

Jim Corbett

Thank you, Mike. It was -- indeed, it was a strong quarter with many perspectives and we took positive steps forward towards profitable growth in the future.

Before I turn the call over for Q&A, I would like to briefly highlight some of my thoughts on Alphatec strengths and our path forward. First, we have a broad portfolio of spinal fusion technologies that include a very extensive portfolio of biologic products that help support successful spinal fusion.

New additions to our portfolio such as our recently beta launch Arsenal system should fuel our future pipeline and establish a platform for innovation in the years to come. We will remain focused on optimizing our portfolio assets globally to drive future value creation.

Second, we have a broad global presence and established distribution channel internationally. Today approximately 35% of our annual revenues are from international businesses and we continue to see opportunity for expansion across all major geographies. Our international sales and distribution model is a unique lever for us and are pursued for future profitable growth.

Third, the organization has spent the last couple of years improving ongoing operations through the implementation of lean excellence, cost savings initiatives and strategic restructuring. Alphatec’s operational capabilities are foundation to driving future improvement and operational expenses and EBITDA margin expansion. And these improvements were demonstrated in our second quarter results.

We continue to build upon a stable platform to help us strengthen our bottom line and increased shareholder value. Last, but not least one of the most enjoyable elements of Alphatec is the positive company culture.

Our organization's level of enthusiasm, engagement and desire to succeed is very energizing. Our team is committed and has an incredible can do attitude, embracing our corporate values in all that they do.

Foundationally, we are in a really great place. We believe that we have a diverse portfolio. We are developing strong operational capabilities. We have a talented team to drive us to our next level. Given a $9 billion global spine market and our broad portfolio of products, we see opportunities to continue to grow global sales profitably.

Having said that, we have a lot to do and we will no doubt face many challenges along the way. Over the coming quarters we will remain diligently focused on execution and continuing our journey towards delivering profitable growth. I am very excited about the bright future ahead of us and look forward to updating you on our progress in the months ahead.

Before we open the call for Q&A, I would like to thank the global employees and stakeholders who work so diligently to deliver our second quarter record results.

With that, I would like to turn the call over the operator to open up the call for any questions you may have.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions)

Our first question comes from William Plovanic from Canaccord. Your line is now open.

William Plovanic - Canaccord Genuity

Great. Thank you. Good evening. Can you hear me, okay?

Jim Corbett

Yes, we can.

Mike O’Neill

We can, Bill.

William Plovanic - Canaccord Genuity

Great. Biologics extremely strong, just a little more color on maybe what's driving that? And then I have a couple of follow-ups.

Jim Corbett

Sure. You know, very fundamentally we compete in almost all segments of biologics. And what you see is the penetration, you know, biologics is the last step in the procedure. So what it represents is an effective sell-through of a broad portfolio along with -- our implant technologies.

William Plovanic - Canaccord Genuity

Okay. But nothing specific, no one product, no change, didn’t help really, I mean, I know you had some headwinds and you faced those with PureGen coming off the market and this was the first clean quarter. But this was a pretty significant growth even when you back the PureGen out from prior quarters, it accelerated. There is nothing -- no product, nothing specific that really ticked it up for you?

Jim Corbett

Well, as I mentioned, one of the things we have been focusing on in our -- our recent communications is that as asset -- Alphatec is our broad portfolio. As we have developed our biologic product line that is, you know, very core element of fusion and to be able to compete in all segments, allows us to sort of tie the implant execution with the biologics. So it’s really about, in this case, execution to the market.

William Plovanic - Canaccord Genuity

Okay. And then on -- typically in the past you have been commenting on core U.S. sales growth. Is there any commentary you would like to provide when you back out some of the stocking and what have you, kind of how the business has done?

Jim Corbett

One of the reasons this quarter that we have gone away from that is that stocking is fundamentally such a minor part of our business. So to speak not really relevant to the big picture. So rather than sort of cloud it, we just – it’s under a $1 million a quarter for example. So that's one of the reasons we have kept a clean - we have got a cleaner picture today.

William Plovanic - Canaccord Genuity

Understood. So it seems to have become just a smaller piece of the picture, it doesn’t matter the comps are getting easier, so you don’t need to break it out anymore. And then just if I could on Japanese price cuts, what's the extent that impacted you this quarter?

Michael O’Neill

On the reimbursement price cut which went in in April obviously we saw the impact of that on our distributors and flows through to manufacturers. Overall, we are continuing to drive our product mix in Japan towards the higher gross margin and higher price products. So they have done a pretty decent job of being able to stave off some of the effects of the reimbursement cuts.

William Plovanic - Canaccord Genuity

So I think that -- as I think of that [JV] [ph] might have 5%, 10% impact on the Japanese businesses, I think about the headwind for the next couple of quarters.

Michael O’Neill

I don’t want to get into the effective percentage from reimbursement. Japan's growth, as you know, they have been on tear for the last couple of years. They are now in the third or fourth position in Japan. So by definition the growth profile for them is changing. So we are seeing a slower growth rate in Japan relative to their historical comp. But that's more from the position of where they are now competing relative to their leading competition.

William Plovanic - Canaccord Genuity

Okay. One last question and then I will jump back and let other people ask. Your accounts receivable was up pretty big sequentially, just wondering if you can comment on why that would have been. Thank you.

Michael O’Neill

June was a strong month.

William Plovanic - Canaccord Genuity

That's all I have. Thank you very much. Congratulation on a good quarter.

Operator

Thank you. Our next question comes from Matt Miksic with Piper Jaffray. Your line is open.

Matt Miksic - Piper Jaffray

Hi. Good evening. Thanks for taking our questions.

Jim Corbett

Hi, Matt.

Matt Miksic - Piper Jaffray

I wanted to maybe get -- as you get started here, Jim, talk about if you could take a minute, given that I think Les had come onboard and sort of spent some time focusing the R&D efforts and had some success in improving the yield and things that were coming through the FDA and getting to market, but also kind of experimented with some alternative approaches to building out distribution or expanding your sales opportunity. And I am thinking of some of the previous activity in PODs or distributorships.

And I guess, looking forward, I'd love to get your thoughts on where you see the biggest growth levers? Is it executing on the products that are coming to market now? Is it building the next tranche of products? I am afraid you're going to say it's all of these things. But I'd love to get a sense of how you think about taking the company forward from here. And then I have a couple of quick follow-ups.

Jim Corbett

Sure. There is a couple of points, I think that are relevant here. I think the areas that Les focused on were actually solving some very big strategic issues for the company like Orthotec, as an example, implementing lean manufacturing, getting the operational effectiveness of the organization going in the right direction, and restructuring a sort of a very unprofitable segment of the company in our French operations. So during his two years, those are very big initiatives.

What we have now is we have sort of a reenergized company without those issues to deal with. And so when we look forward, we see some same things and we see some additional things, the same things in R&D.

Les took great effort to focus the R&D team on fewer projects so that we would get a better yield of high potential products. The Arsenal program, which I am sure someone is going to ask me about, is sort of a consequence of that. And it is almost a quarter of spinal implant market and it happens to be over 50% of our revenue in terms of what the Arsenal program affects. So it coming to market and it’s a one consequence of that.

What's also kind of different directionally is we do have a very broad portfolio that can be leveraged globally. And so our intent over the next 12, 24 months is make sure that we take advantage of that global opportunity. And that is, of course, always countered with the grow profitably attachment. So I think those are the things that are the same, different and sort of big picture look.

Matt Miksic - Piper Jaffray

Okay. And your thoughts on distribution and sort of adds there, or do you have the distribution footprint that you need, for example, in the U.S., or is there any way it would be growing or any thoughts maybe on direct or indirect, that sort of thing?

Jim Corbett

Well, I think there's more of a market we'd like to reach, and we're working on trying to understand how to go about that. I think -- you mentioned pods earlier. I'd like to comment, that’s not -- again, it's kind of like stocking distributors.

They're so small we actually have no intention of adding a new pod distributor if one showed up. But what we are wanting to do is figure out how to reach the broader market footprint than the one we're in today and more to come on that as we learn how to do that.

Matt Miksic - Piper Jaffray

Okay. And then, I guess, a follow-up on -- maybe a segue into this follow-up on executing on that strategy, part of it is having all of the pieces and core essential elements of the bag of business that your reps do need to expand share and move into parts of the market where you're not.

With Arsenal, with the biologic portfolio that you have, with some of the standalone products that you've rolled out for fixation, do you feel like you have everything you need at this point, and maybe is that something that makes this phase of the business different than what we were looking at say a year ago or a year and a half ago?

Jim Corbett

The answer simply is yes. We -- first of all, we're in a market that innovates rapidly, so there's always going to be new segments we need to think about and get into. An area we're not in, for example, like lateral, we don't have a lateral system, but it's a part of the market, not the whole market. And otherwise we participate in nearly every segment.

And so from a portfolio point of view we have clearly a strong product bag, so to speak, to bring to the customer. At the same time, you've got to rejuvenate it all the time. So, -- but we feel good about where we are in that respect.

Matt Miksic - Piper Jaffray

And then just one last one if I could on some of the operational improvements that Les ticked off. And I know it was underway before he came -- before he took the helm as well as in the manufacturing efficiencies and margins that you're able to get out of that in-house manufacturing facility that you have.

Could you give us a sense of maybe where we are -- use a baseball analogy in terms of innings into improving margins or absorbing capacity, or any metric that would help us understand how much headroom do we have here for profitability, given that you do -- you're one of the only companies in the space that has its own manufacturing facility?

Jim Corbett

Yeah, complex question, so let me try and use your analogy as a framework to go about it. There's a big dynamic. There's the continuous improvement. On that fundamental element, we probably are in the fourth inning. And that means a lot of upside.

Having said that, by doing that, it allows us to absorb the dynamic that goes on in the market with provider pricing pressure. There is some of that going on in the market. So, it will allow us to continue to strengthen and make it so that we can not only tolerate that pressure, but in fact, gain relative to it.

So, if you ask me in a year and our numbers are stronger I'll tell you we're still in the fourth inning. So, it's a constant improvement opportunity.

Matt Miksic - Piper Jaffray

That's great. And thanks for taking our questions.

Jim Corbett

You bet.

Operator

Our next question comes from Raj Denhoy with Jefferies. Your line is now open.

Raj Denhoy - Jefferies & Company

Hi, good afternoon.

Jim Corbett

Hi Raj

Mike O'Neill

Hey Raj.

Raj Denhoy - Jefferies & Company

I wonder if I could just spend a little bit on -- a little bit of time on the EBITDA margin. You guys hit 14.6% here in the quarter. I know you've given targets here for 2014. And it's a bit of follow-on to that last question, but if you think about the potential to take that number higher, how do you think about that over the next couple of years? I mean, is this a business that can get into the 20s realistically?

And when you think about that, do you need revenue growth to get there? Or do you feel that there are a lot of things you can still do internally that perhaps can drive that number a lot higher for you?

Jim Corbett

Well, for sure -- this is a -- first of all, our guidance remains, so we're not in a place where we're going to be changing that. But we do need to continue to grow and to compete in the market, and we intend to do so profitably. We will see an improvement in our EBITDA margin on a continuous basis.

So, I like to think about it now as we're approaching 20, and so as we get to 20, we'll redefine where we might be able to get in the business -- get the business to in the context of the market when we get there. But there's a combination of revenue growth and continued operational improvement that really gets the EBITDA margin approving 20.

Mike O'Neill

Raj, I also think that there's an opportunity as we go forward to look at our operating expense leverage. Obviously, some of our OpEx is variable with revenue, and some of it we've maintained and articulated for some time that we should be able to gain leverage in those expenses from that revenue growth.

So, I think it's a combination of managing the global mix of our business in terms of gross margin, as Jim's articulated, and also being very judicious about the operating expenses that we incur in the P&L.

So, as we think of global growth and profitable growth, we're not in a spend now and hope it's going to come later. It's very much to add and pace that spending in as the growth is there.

Raj Denhoy - Jefferies & Company

Okay. So, let me ask you a question about that, then, again, because, as you sort of noted, it's all about tradeoffs, right, in terms of where you want to invest or not. How do you think about the distribution network that you have right now, the number of salespeople, even perhaps benefitting perhaps from some of the disruption that's happening with some of the acquisitions out amongst your competitors?

I mean, do you think that you would be more aggressive at some point, which maybe flattens it out for a period of time, and then you go again? Just really some thoughts about how you're thinking about the business going forward would be very helpful.

Jim Corbett

Well, I think there's likely some coming opportunity in terms of the sort of market disruption of the M&A that's going on. And I think that will present to us some opportunities to expand our network into areas of the U.S. market, particularly, that we do not currently cover.

And given that those costs are variable, they won't prove to be a drag on that EBITDA goal of approaching 20 and help us to drive growth. So, I think as it plays out, we'll see some opportunities to expand in that manner.

Raj Denhoy - Jefferies & Company

Okay. Thanks. We'll just leave it there. Thank you.

Jim Corbett

Okay.

Operator

Our next question comes from Josh Jennings with Cowen & Company. Your line is open.

Unidentified Analyst - Cowen & Company

Hi, good evening folks. This is actually Lynn calling in for Josh. Just kind of have a question on gross margin. You guys obviously saw very good improvements this quarter. Just can you talk a little bit about the sustainability of gross margin kind of improvement? Are you expecting sequentially to get the same level improvements for the rest of the year, or how do you think this will play out for the rest -- second half of the year? Thanks.

Mike O'Neill

Yes, so I think, obviously Jim spent a fair bit of time talking about what inning we are in in terms of gross margin, gross profitability for the company. So, we continue to believe that. I don't really want to get into quarterly forecast in terms of what those numbers can be, but we pace -- we've paced our gross margin improvements over the last years consistent with some of the work that Mike Plunkett's been doing in terms of lean enterprise. And so we continue to be optimistic that those kinds of improvements are going to accrue to the P&L.

But what we're not going to be seeing, I think, is obviously we had a substantial improvement in this quarter compared to prior year. A big chunk of that was amortization. So, I think there's still runway there, but I don't think you're going to see massive step function changes the way that you're seeing just right now.

Unidentified Analyst - Cowen & Company

Great. This is very helpful. Thanks.

Operator

Our next question comes from Mark Landy with Summer Street. Your line is open.

Mark Landy - Summer Street

Good evening folks. Thanks for taking my questions this evening.

Jim Corbett

Hi Mark

Mike O'Neill

Hey Mark.

Mark Landy - Summer Street

Hey guys. Jim, I guess a question for you as you highlighted the four areas; the product portfolio, the broad global presence, operational opportunities, and then company culture, which would you rank those?

And I guess the gist of my question is that unfortunately the cash position or the resources that you have given the settlement, et cetera going forward, perhaps the product portfolio may be the one that has to come last. But I don't want to put words in your mouth. How would you rank those, and how do you unlock the value as you go forward with each one?

Jim Corbett

Well, I think our broad product portfolio is our core asset. And I think what you do is you -- and if I'm ranking, I would, therefore, go after our other core asset which is our people, and that is how you leverage globally. So when you think about where the upside for us, where our growth comes from, the portfolio is in existence. It's not an aspirational point of view and our people are in existence. And what I mentioned about how the enthusiasm in the culture and the can-do kind of attitude. You can't execute that portfolio without sort of driving that with the people.

So I think I'd would focus there and so its product and it is people and then it global opportunity and then its execution, right? That’s sort of order I would put it.

Mark Landy - Summer Street Research

Okay. Just, I guess, last strategy question, I do have a specific question. In terms of -- I'm just looking at the focus, I think Les hit a little bit on this. When Les came in I think he kind of refocused R&D onto cadence and updates to the existing portfolio, away from what was Les bringing some new portfolio, new products, and maybe go for longer regulatory time frames. Coming out of Les' kind of refocusing of that R&D process, how should we think about your strategy? Is it a combination? Is it more bringing in new products with higher opportunities, a continuation of the refreshing of the line?

Jim Corbett

I think you might think about it differently. We are looking to broadly participate in the spinal fusion technology market. That’s what we are looking to do. And that is absolutely -- there is a requirement to participate in a broad array of existing segments, which we do.

There will be opportunities time-to-time to a piece of risk in terms of product development. But I might look at it in a sort of 80/20 mix. As we look forward that broad participation is where the market is going and you can't sort of bet on the sort of the tail of the curve, you have to do place some of your bet there, but not all of it or not even the majority. So I think that’s how I'm thinking about it.

Mark Landy - Summer Street Research

And then my last question I think is the one that you prompted, so I'll ask it. What is Arsenal and the strategy around it?

Leslie Cross

What is Arsenal and what is the strategy around it? You asked for the prompt. I'm giving it to you.

Jim Corbett

No, I just misunderstood you. So Arsenal is a spinal fixation platform. It's in pedicle screws. It's actually a broader platform than we've ever launched. It’s a cervical to pelvis and it has -- someone said, well, how do you-- what makes you different than Zodiac? And Zodiac is over half our sales. So it's kind of -- it is a big issue for us. And Arsenal on its core competes in a broader set of procedures than Zodiac did.

But more important is, if you think about the comprehensiveness of it, someone said well, it's lower profile, it's this, why is it better? And I start off with saying, well, there is 92 different instruments that get delivered in 30 different configurations during our limited market release. So that’s a degree of complexity and completeness that not many of these systems have.

That said, what does describes it, it’s a -- it's actually almost like -- to use an analogy, when they designed the iPhone, they made it intuitive and they made it work well for the user and they made it ergonomically easy to understand, intellectually sort of connecting what you want and how you want to do, and Arsenal does that very well for the surgeon.

And so it is one of those of experiences that when you start going through with the surgeon, the expressions of, oh, my, that’s way easier. Oh, why didn’t anyone ever think of that? And what -- and it's all subtle, each element is subtle, but there are many of them. So we are quite optimistic about how it’s going to go. We are in our limited market release and which we intend to -- we expect to complete around some time during September and that will involve somewhere in the order of 150 to 200 patient cases. And we then will be doubling the scale of that in October, assuming all goes well and with the full launch in the first half.

And one of the great things about our new product is you get to transition and compete in segments you weren’t able to compete in earlier. So for example, a material portion of our allocation of cases, so to speak are to new customers and additionally we have some that are converting from our core base. So it's an opportunity for us to gain share and solidify our base. So it’s a really important program for us.

Mark Landy - Summer Street Research

Awesome. I guess high five to Les and look forward to learning more

Jim Corbett

Perfect.

Mark Landy - Summer Street Research

Thanks guys.

Jim Corbett

Thanks Mark.

Operator

(Operator Instructions) Our next question comes from William Plovanic with Canaccord. Your line is open.

William Plovanic - Canaccord Genuity

Great. Thanks. Couple kind of just simple modeling questions. I know you don't want to give quarterly guidance, but how should we think of gross margins for the year in general? R&D had a big pickup. I assume as long as Arsenal's in beta launch we'll see a big R&D line like through Q3, but how do we think about that on an ongoing basis? I think your G&A's come down a little, your sales and marketing was up a little.

I'm just trying to -- are these kind of the base rates we use for sales, marketing, G&A, or is there more a step function? And I ask this because you've had so much going on and so much flowing through the P&L over the last 12 months it's hard for us just to get a kind of base case of what the numbers look like.

Mike O'Neill

Yes, I think and we all running into a time now where we got a cleaner P&L. From a pure Arsenal development program, yes, we are going to continue to have R&D program expenses. But I don’t really want to get into quarterly phasings of gross margin improvements and EBITDA improvements.

Again, to pick up on some of the conversation we've had, Les has spent a lot of his time clearing the decks. Jim's got some clean runway in front of him as it were. We obviously will have variable expenses with revenue. But our job right now is to manage the expenses, manage the burn rates to continue down the path of improving our margins and improving our EBITDA.

William Plovanic - Canaccord Genuity

To ask this a different way, Mike, the Arsenal -- incremental Arsenal spend in the quarter, I mean, should I think about that as a half a million, a million spend?

Mike O'Neill

So I don’t really want to get into what was incremental in this particular quarter versus any other quarter. Obviously, our Arsenal program is a substantial program. Jim kind of alluded to the size of the product that it’s replacing. The program is still ongoing. I think then our job is to manage those that portfolio of expenses.

Jim Corbett

You know, Bill, this is Jim speaking. One way you might think about this is we are allocating our resources to Arsenal, and as Arsenal moves into full launch, we're going to allocate them towards other programs. So that’s a way for you to think about it.

William Plovanic - Canaccord Genuity

Okay. And then just, as I said, I wasn't looking for quarterly guidance for the rest of the P&L, but from your comments, and not to put words in your mouth, but it sounds like Q2 was a fairly clean quarter and we could use that as a base case, obviously, outside of R&D kind of going forward. Is that a fair statement to make?

Jim Corbett

I think you're going to see us focusing on continuously improving. Is that…

William Plovanic - Canaccord Genuity

Perfect. Excellent. Well, and I was looking back, and from a revenue and EBITDA standpoint Q2 2014 is your best quarter ever, so congratulations on the new record. Thank you

Les Cross

Thanks bill appreciated.

Jim Corbett

Thank you.

Mike O'Neill

Thanks Bill.

Operator

I am not showing any future questions at this time. I would like to hand the call back to Jim Corbett for closing remarks.

Jim Corbett

Well, first of all, thank all of you for joining. I think that concludes the questions and our time for today. I would like to thank you for your interest and your questions. Good night.

Operator

Ladies and gentlemen thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Everyone have a great day.

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