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NuVasive, Inc. (NASDAQ:NUVA)

Q1 2008 Earnings Call

April 22, 2008 5:30 pm ET

Executives

Nick Laudico – The Ruth Group

Alexis V. Lukianov - Chairman of the Board and Chief Executive Officer

Kevin C. O’Boyle - Executive Vice President and Chief Financial Officer

Analysts

Bob Hopkins - Lehman Brothers

Ben Andrew - William Blair

Steven Lichtman - Bank of America Securities

Matt Miksic - Morgan Stanley

Ed Shenkan - Needham

Michael Matson - Wachovia Capital Markets

John Putnam - Dawson James Securities

Joanne Wuensch - BMO

Mike Baron - [Silverback]

Operator

Welcome to the NuVasive, Inc. first quarter 2008 earnings conference call. (Operator Instructions) It’s now my pleasure to introduce your host, Nick Laudico of The Ruth Group.

Nick Laudico

Welcome to the NuVasive first quarter earnings conference call. NuVasive senior management joining us on the call today will be Alex Lukianov, Chairman and Chief Executive Officer; Keith Valentine, President and Chief Operating Officer; and Kevin O’Boyle, Executive Vice President and Chief Financial Officer.

NuVasive cautions you that statements included in this conference call that are not a description of historical facts are forward-looking statements that involve risks, uncertainties, assumptions and other factors which, if they do not materialize or prove correct, could cause NuVasive’s results to differ materially from historical results or those expressed or implied by such forward-looking statements.

Uncertainties that could cause actual growth and results to differ materially include, but are not limited to profitability projections may prove incorrect because of unexpected difficulty earning sales or achieving anticipated profitability; the uncertain process of seeking regulatory approval or clearance of NuVasive’s products or devices; risks that such process could be significantly delayed; the possibility that the FDA may require significant changes to NuVasive’s products or clinical studies; products may not perform as intended and may therefore not achieve commercial success; the risk that competitors may develop superior products or may have a greater market position enabling more successful commercialization; the risk that additional clinical data may call into question the benefits of NuVasive’s products to patients, hospitals and surgeons; and other risks and uncertainties more fully described in NuVasive’s press releases and periodic filings with the Securities and Exchange Commission.

NuVasive’s public filings with the SEC are available at www.sec.gov. NuVasive assumes no obligation to update any forward-looking statement to reflect events or circumstances arising after the date on which it was made.

With that, I’d like to turn the call over to Alex Lukianov.

Alexis V. Lukianov

Thank you, everyone for joining us this afternoon for our first quarter 2008 call. We are pleased with our operating and financial performance during the first quarter, which was driven in part by our continued focus on deepening product penetration, particularly in geographies where we have a long-standing presence.

We continued to invest in our infrastructure to provide the foundation for long-term growth, sustainable GAAP profitability and further leveraging of our expense base.

We also improved our cash position in the quarter with a successful convertible debt offering netting $209 million. These additional funds strengthen our ability to execute on strategic opportunities, which will be a key focus in the near term.

Before outlining our operational progress during the quarter, let me take a moment to briefly review our strong financial performance. Revenue in the quarter increased 54% year over year to $51 million. On a sequential basis, this represents a 9% quarterly increase over our strong fourth quarter 2007 results.

Accordingly, we are increasing our revenue guidance for the full year 2008 by $6 million, and decreasing earnings per share by $0.02 to reflect current market yield on our investments, which Kevin will discuss in detail shortly.

We ended the first quarter with a headcount of 255 in our sales organization and we remain on track for our guidance of growing the group by 10% to 15% this year. In order to maximize the efficiency of our expanding sales force, we recently increased the number of sales regions in our U.S. market from five to 11.

This allows our sales representatives to sharpen their focus on selling our full product mix with existing accounts and further educating customers on the benefits of NuVasive’s complete line of spinal products.

The long-term benefit is deeper penetration and more comprehensive involvement in a surgeon’s practice. It also allows our most seasoned representatives, managers, and directors to focus on the development of new business and ensure these new customers receive the same absolute responsiveness in customer service, which remains one of our major competitive differentiators.

Our XLIF procedure continues to expand across the US, and our representatives continue to gain momentum in educating the market on the unique benefits of our innovative lateral approach to the spine. While we have taken a measured approach to our geographic expansion with a concentric model of focusing on key surgeons and building outward over time, we experienced greater than anticipated success in regions where we have a long-standing presence, such as the Southeast and the West.

The process of ramping operations in our new sales regions will be ongoing as our sales directors focus on building key accounts and market awareness prior to expanding their coverage outward. This process typically takes 12 to 18 months to successfully establish our presence. Our strategy for attracting new business will continue to center on leading with our innovative XLIF procedure and establishing a reputation for unmatched customer service with absolute responsiveness at cheetah speed.

Once our sales team has introduced the benefits of XLIF with our MAS platform and formed a working relationship, it is an essential component of our strategy that we achieve maximum pull-through of our full line of spinal products. Improving the mix of products sold to our customer base will make significant contributions towards our milestone of $500 million in sales.

Accordingly, our sales force incentives are weighted towards the goal of driving sales of the full mix of our products, including biologics and cervical. We believe this will lead to more efficient production from our sales representatives to maximize revenue per representative.

Additionally, as surgeons become more comfortable with the lumbar applications of XLIF, they continue to move up the spine with even more applications, such as Thoracic XLIF and adult degenerative scoliosis, thus creating additional growth opportunities for our sales team. In support of our effort to broaden the reach of our sales force, we are rapidly expanding our sales training programs to develop increasing expertise in all areas of spine to output an entirely elite sales organization.

We have complemented our strategy of improving sales mix with a number of new product introductions, including the first quarter launches in our cervical fixation product line. We have recently introduced the Helix anterior cervical plate and the VuePoint posterior fixation system.

Combined with our Gradient cervical plate, our full line of cervical products deliver flexible and elegant solutions for the various preferences among surgeons for cervical fusion. Initial surgeon feedback on these products has been positive, and we remain confident that our cervical platform revenues will contribute meaningfully to future revenue.

We also saw further penetration of the new products we introduced in 2007, including the XLP lateral plate, SpheRx II pedicle screw system, Formagraft biologic, Thoracic XLIF and NeuroVision. These products are complementing our strategy of expanding the indications of our lateral approach, which is being used more frequently for multi-level procedures, including the thoracic spine.

Moving beyond our product options for spinal fixation, we also continued to execute on our motion preservation strategy for the cervical and lumbar spine. Enrollment in the pivotal trial for our cervical motion preservation device NeoDisc stands at over 85% complete. We anticipate competing enrollment in the next few months.

We also anticipate IDE approval for two of our other motion preservation devices later in 2008. These being surpassed are mechanical ceramic cervical disc replacement device and XLTDR, our lumber total disc replacement device designed for insertion through our unique lateral approach.

In addition to these disc replacement devices, we are currently developing a less rigid rod fusion system that will compete with dynamic stabilization constructs as well as evaluating alternative spinous process-type devices. We believe these motion preservation initiatives will form a larger part of our product offering in the future.

During the first quarter, we began the controlled international rollout of several of our products along with our MAS platform, mostly in Germany, the U.K. and Greece. Our international strategy is focused on infrastructure development and clinical education in select European regions. This targeted approach will allow us to properly educate surgeons on our unique product offerings for laterally approaching the spine as well as motion preservation. Overall, we were pleased with the progress of our initial launch.

Achieving GAAP profitability is an important near term corporate goal. We anticipate achieving this by closely managing our expenses and leveraging our corporate and IP infrastructure. Sustainable profitability will be made possible by the infrastructure investments we are making with respect to our new expanded office space, operating systems, personnel and training. These investments will increase the scalability of our business and allow us to operate more efficiently.

We completed the initial phase of our relocation to our new campus-style corporate headquarters in the first quarter and will complete the balance of the move in the third quarter. We will benefit greatly from accommodating all of our departments in a single location, leveraging our culture of absolute responsiveness across the entire organization.

The new headquarters also provides us with several options to accommodate growth over the next several years as we expand our infrastructure in step with our growing market share in spine.

The implementation of our SAP Enterprise software platform is progressing and will provide incremental efficiency as we expand our operations in the U.S. and in select international markets. This infrastructure is increasingly important to meet the demands of our high growth expectations over the next several years.

However, we believe that when complete, these improvements will significantly enhance our operational efficiency and ability to sustain and grow GAAP profitability as we leverage our established infrastructure and expand the sales organization against our robust revenue growth expectation.

In March, we completed a convertible debt offering, increasing the company’s cash position to $275 million as of March 31. During the quarter we bought out royalty obligations on our SpheRx pedicle screw platform and also acquired exclusive rights to a posted screw intellectual property which ensures the continued expansion of our innovative pedicle screw platform through 2015.

This provides us with a broad product platform for the further development of innovative pedicle-based fusion systems as well as incorporating our ball-rod technology in other systems. We intend to identify and execute on strategic acquisitions in the near term and our significant cash position will give us the flexibility to do so.

We are focused on near term opportunities to acquire products or technologies that represent synergistic additions to our core MAS platform and fit our goal of becoming the most innovative provider of spine surgery products.

I would now like to turn the call over to Kevin for a detailed review of our financial results

Kevin C. O’Boyle

Our revenue for the first quarter 2008 was $51.2 million, a 54.1% increase over Q1 2007 and a 9.1% increase over Q4 2007. International revenue was on target to the 2% to 3% revenue contribution that we guided to for 2008.

Gross margin for the first quarter was 82.2%, compared to gross margin in the first quarter of ‘07 of 82.8% and gross margin in the fourth quarter of ‘07 of 82.9%. We continued to expect full year 2008 gross margins to be in the range of 81% to 82%.

Our Q1 2008 net loss was $7.7 million or a loss per share of $0.22 on a GAAP basis, or $0.10, which excludes one-time charges. On a non-GAAP basis, the company reported net income of $2.1 million or $0.06 per share.

Our non-GAAP net income calculation in the first quarter of 2008 excludes stock-based compensation of $5.2 million, amortization of intangible assets of $392,000 and in-process research and development costs of $4.2 million or approximately $0.12 per share related to acquisition of new pedicle screw intellectual property.

Operating expenses for Q1 2008 totaled $50.5 million. The increase in operating expenses in the first quarter from the fourth primarily reflects the in-process research and development costs, increased selling costs, higher administrative expenses associated with infrastructure advancements and international start-up costs.

Research and development costs were $6.3 million in the first quarter, excluding stock-based compensation. The increase in R&D spend from Q4 was related to the normal enrollment of subjects in the NeoDisc clinical trial and development efforts related to our product pipeline.

Excluding stock-based compensation, R&D as a percentage of revenues for Q1 2008 came in at 12.4% versus Q4 2007 at 13%. Sales, marketing and administrative expenses excluding stock-based comp for the quarter was $34.8 million versus $31.5 million in the fourth quarter.

Excluding stock-based comp, sales, marketing and administration as percent of revenues for Q1 2008 came in at 68% versus Q4 2007 at 67.1%. The increase in spend from Q4 was related to increased costs associated with the territory realignments and facility costs associated with the first phase of relocating our corporate headquarters.

The interest and other income contribution for the quarter was $700,000. Interest on other income includes the effect of the convertible debt offering and is reflective of reduced yields due to current market conditions.

The stock-based compensation charge for the quarter of $5.2 million was reported in our operating expenses and allocated as $646,000 in the research and development with the balance of $4.5 million in sales, marketing and administrative expenses.

As of March 31, 2008, we had $275 million in cash, cash equivalents and short and long-term investments. As previously announced in March, we raised net proceeds of approximately $209 million from an offering of convertible senior notes, due 2013.

Our operating cash burn was $15.6 million for Q1 2008, which broadly reflects the development of our MAS product pipelines, including motion preservation, the national launch of new products and the built out of inventory and instruments to support future growth.

Included in our cash burn were costs related to leasehold improvements for our new corporate facility, the first phase of moving into our new corporate headquarters and the implementation cost for our ERP system, totaling $9 million. Our operating cash burn is defined as cash used for operating activities plus additions to fixed assets.

Our inventory position was $45.7 million at the end of Q1 or 22% of annualized revenue. Inventory has increased each quarter in 2007 and into the first quarter of 2008, principally because of our rapid revenue growth and the new products we have introduced.

We expect our inventory-to-sales ratio to average about 20% to 25%, which may spike in the quarter depending on how many and what type of products get launched. Additionally, a corresponding increase has occurred in our property and equipment costs for the same reasons.

Days sales outstanding or DSO’s were 53 days in Q1 2008, compared to 53 days in Q4 2007.

As it relates to 2008 guidance, we are increasing our full year 2008 revenue by $6 million to $210 to $214 million, up from $204 to $208 million. GAAP earnings per share, excluding one time charges, is being lowered slightly to zero to $0.03 from to $0.02 to $0.05. We are decreasing our non-GAAP earnings per share guidance to $0.54 to $0.57, down from $0.56 to $0.59.

The majority of the revenue increase in our guidance is attributable to the second half of the year, which should offset reductions in our earnings per share guidance in Q3 and Q4 related to anticipated lower interest income contribution. It is important to note that operationally, our outlook has improved and we remain focused in 2008 on cost control and operating expense management in line with achieving profitability.

I would now like to turn the call back over to Alex for closing commentary.

Alexis V. Lukianov

Maximizing the ability of our growing sales organization to efficiently sell our entire line of innovative spinal products while generating new business will be the major driving force behind reaching our goal of $500 million in sales over the next few years. Reaching sustained and growing GAAP profitability is equally imperative and our investments in corporate and IP infrastructure have helped strengthen our ability to achieve this goal.

Our sales directors began the initial transition from five to 11 sales regions in the quarter. As they complete this process over the course of 2008 and strengthen their focus entirely on improving sales mix and expanding to new accounts, we expect to experience even greater leverage and efficiency.

Our further enhancements to sales training will ensure that all of our representatives are experts in selling our complete line of products. Our improved cash position will drive our near-term acquisition strategy to further enhance our product platform with complementary technology.

Our shareowners continue to focus on making NuVasive the easiest spine company to do business with, leveraging our culture of absolute responsiveness to provide all of our customers with unmatched customer service, and doing so at cheetah speed. We are extremely proud of the strong foundation we have built with our exclusive sales force, dedicated shareowners and innovative product offering headlined by our MAS platform.

XLIF is still just scratching the surface, and we see tremendous opportunity for our continued growth and innovation. We believe we are well positioned to leverage this foundation to reach our sales and profitability goals for 2008 and well beyond.

We would now be pleased to answer any of your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Bob Hopkins - Lehman Brothers.

Bob Hopkins - Lehman Brothers

Given your commentary about the potential for near-term M&A, I was wondering if you could go over again to the degree that you are willing to do so, the areas that you are interested in and with the range of possibilities in terms of the size of a particular transaction, just the criteria that you’re looking at?

Alexis V. Lukianov

I think we talked about this little bit on our last call, but our primary focus is to look at things that we’d like to expand our product offering with. Those would be biologics, those would be trauma, those would be focused on other applications of MAS. And the other things that we are looking at are ways to further position ourselves outside the United States. So we are looking at ways to be able to affect distribution potentially with acquisitions in those areas.

We have opportunities, we believe, to further our position in scoliosis as well. And I think as far as the size, we are looking at the type of acquisitions that are likely to be less than $100 million, and then potentially looking at additional smaller technology or licensing IP-type of arrangements as well.

Bob Hopkins - Lehman Brothers

So, it looks like we should expect a number of transactions, is that a fair statement, or are there just one or two major things that you are looking at?

Alexis V. Lukianov

Well, we are hopeful to be able to pull together, I think, a significant transaction and then from there, look at a number of different options of varying size. But we certainly wouldn’t expect it to use up a significant amount of our cash position over the course of this year. But, we would obviously be applying a pretty good portion of it.

Bob Hopkins - Lehman Brothers

And since a lot of these things are fairly early stage, should we expect that there is the potential for a significant push back in the profitability profile of the company as a result of one of these deals, or is that not something you’re willing to sacrifice?

Alexis V. Lukianov

Well, we are certainly working hard on making sure that anything that we do is going to be accretive and that’s our primary focus. So, that’s what we are working towards.

Bob Hopkins - Lehman Brothers

I was wondering if you could go back and explain why you gave the original guidance that you did for this quarter to be flat sequentially, and then what happened during the quarter that allowed you to perform ahead of expectations? It sounds like maybe it was due primarily to key accounts that already exist within NuVasive. I am curious if there is any meaningful contribution from Europe? Just some color there would be helpful.

Alexis V. Lukianov

I think as we have talked before, our strength in terms of our sales progress has really been from West to the East, and that includes the Southeast part of the country. And so that’s how the company has grown over the last several years. That’s where we saw a lot more traction than we really anticipated.

With changing around a number of the regions, we anticipated some softness and we anticipated our directors taking the time to be acclimated to their new geographies, learning the new accounts. And so we still anticipate that happening in the next quarter and it’s going to take a solid, I think a year to maybe even as long as 18 months before the directors are in a solid position to continue expanding.

So it really came from those regions where we have been penetrated for quite some time. And internationally, we got off to a very nice start, consistent with what we talked about in the range of 3% of revenues on the year. So we are pleased with that and that certainly contributed to a strong first quarter.

Bob Hopkins - Lehman Brothers

Could you talk a little bit more about the expansion in your sales force training and exactly what’s going on there? And then also, could you tell us how you’re doing and how your surgery went, and whether that made you more or less of a fan of NuVasive?

Alexis V. Lukianov

As far as sales training is concerned, obviously our product breadth has dramatically increased over the last 18 months in particular. We want to make sure that our sales force is not just expert in XLIF, but expert in cervical and biologic. So we wanted to be certain that our sales force can sell across all market segments and that requires field training as well as in-house training. So we have put a lot of emphasis in those areas, increased the personnel in those areas. And so that’s really what we are doing, and so the scope has expanded.

For me, personally, I don’t know if you saw the fight, but Nate Quarry fought and he has an XLIF in his back. So, he only has one level. He did pretty well. I have two levels, so I think I can probably do even better than Nate Quarry. I have power of 2x. But I am doing very well. I am six weeks post-op.

I had a two level XLIF, because of leg pain and back pain. I also had SpheRx DBR put in, and used our Formagraft product. So I am really pleased with getting rid of my primary symptoms, and back to work full time. So I have to say that I was a fan before having it done, and I am an even bigger fan now of XLIF.

Operator

Our next question comes from Ben Andrew - William Blair.

Ben Andrew - William Blair

What competitive response are you seeing as you increased your efforts in some of these newer regions? Is it any different than what you have seen historically?

Alexis V. Lukianov

No. I think it’s the same. We are up against the same competitors, and I think we mostly do battle with the bigger companies.

Ben Andrew - William Blair

And within the territories where you have gotten to the 10% or 15% market shares that you have commented in the past that you have gotten to, are you seeing a different response in those particular areas?

Alexis V. Lukianov

I’d certainly say we’ve had the greatest success against the larger companies in those areas, because we have been there the longest. So those are probably the best examples of how we have been able to take some pretty good market share from the larger players.

Ben Andrew - William Blair

But they haven’t been able to come up with successful responses?

Alexis V. Lukianov

That’s correct.

Ben Andrew - William Blair

And then talk a little bit more about the process of going from five to 11 regions, and you said it would take upwards of 18 months to really get that implemented?

Alexis V. Lukianov

Obviously with having five regions before and expanding out, we promoted several of our area business managers that we felt were the very best folks and narrowed their focus in some cases, which meant really for those that had five territories, it’d mean that they had smaller geographies.

For those that were area business managers, they had larger geographies. But in all cases, it meant for a lot of these folks going into areas that they were not accustomed to calling on, going into areas where we do not have representatives.

So what we been focused on is ensuring that we maintain the business that we have, the business that we have built, and then asking the new directors to then go ahead and hire new representatives. And we had a pretty robust hiring in the first quarter in the way of new reps to go ahead and place new representatives into these areas and then get them properly trained and move into penetrating those accounts.

But we want to make sure that the directors are leading the way and using their skills. They are the most proficient at selling our technology. They were very successful as area business managers, and we believe will be just as successful as directors in setting the pace and setting the course for our expansion into territories where right now we have either a very small presence or no presence whatsoever.

Ben Andrew - William Blair

As you look at the procedure volumes and I know you won’t comment territory by territory, but have you seen any slippage in particular regions that was made up elsewhere through additional staff additions, such that when you’ve made these moves to bring people out of territories where they are well established that you’ve gone backwards a little bit for a time?

Alexis V. Lukianov

No, we haven’t.

Ben Andrew - William Blair

So that was partially the concern and it wasn’t realized?

Alexis V. Lukianov

Correct.

Ben Andrew - William Blair

The R&D spending was well below what we thought, Kevin. Was that a function of the enrollment of the trial and are we going to see that then pushed back to the balance of the year or because it looks like you are going to continue to be down sequentially from here?

Kevin C. O’Boyle

R&D enrollment should be pretty consistent in Q2 and then as we look to finish the enrollment of the trial where most of the costs are in the next several months, or few months, R&D should start to fall off as a percentage as we get into the second half of the year.

Ben Andrew - William Blair

Stock-based comp that was a function of stock price, but is there reason to believe that, that will actually keep going up from here, or come down next quarter?

Kevin C. O’Boyle

No, I think it will be pretty consistent with the first quarter. I think we guided to $19, $20 million and I think that range is consistent with our expectations for the balance of the year, Ben.

Ben Andrew - William Blair

Alex, you had commented that you were on track with OUS revenues of 3% for the full year, is that a fair number to use for Q1, or you ramping towards that and actually it’s something higher than that on a full year basis?

Alexis V. Lukianov

That’s fair to use for Q1 and that’s what we are looking at right now annually. We will see where we end up, but we are very pleased with the better traction than we expected starting out.

Ben Andrew - William Blair

Is there much inventory build in that number?

Alexis V. Lukianov

There is certainly inventory build in that number, yes.

Operator

Our next question is from Steven Lichtman - Bank of America Securities.

Steven Lichtman - Bank of America Securities

On the dynamic rod, Alex, that you spoke about, can you give us more details on that system and also on potential timing?

Alexis V. Lukianov

Our approach as I think we’ve talked about before is not so much to put forward a dynamic rod, we have a different alternative to that and it’s really are going to be a less rigid system. But it is going to be still a fusion system. So we will be talking about that as we have our product ready to roll out and we plan to be able to do so in the third quarter. So that’s on track and we hope to be able to show that at that time period.

Steven Lichtman - Bank of America Securities

In terms of the international business, as this ramps up over the next year or two and beyond, how can we think about gross margins relative to the U.S, Kevin?

Kevin C. O’Boyle

As we get out where international winds up being maybe 10% of the $500 million number, the gross margins are lower effectively OUS primarily because we will be selling through pure distributorships where they will take title of the product obviously and then resell to the ultimate customer.

Having said that, they step into our shoes in terms of a number of the operating expenses that we have here, they would certainly incur there. So the net should still be very strong. But the margins should be less, and I think until we get even more visibility on our international, that we are comfortable longer term with the margin out at that time in our in the 80% range.

Steven Lichtman - Bank of America Securities

Can you break out for us what percentage of the business today is cervical, approximately?

Alexis V. Lukianov

We talked about that before, its approximately 10% and what we wanted to make sure is that we are maintaining that 10% as obviously our volume is increasing significantly as we grow from 2007 to 2008, and we believe that we can grow it past 10% over the next several years.

Steven Lichtman - Bank of America Securities

Then on artificial disc, obviously the issues with lumbar are well known. It seems as though some of those have crept into the cervical as well. Is it fair to say we are not seeing a lot of shifting towards cervical artificial discs at this point in the marketplace?

Alexis V. Lukianov

I think that’s really just a reimbursement issue and I think that once that’s resolved and I believe that we are seeing a fair amount of light that’s popping around right now in the way of some insurance companies that are starting to step up and move in that direction. I think it’s going to be resolved and I think it’s going to happen over the relative near term. So I don’t believe that’s going to be a problem longer term and I wouldn’t compare it to the lumbar spine.

Steven Lichtman - Bank of America Securities

As we think medium term, where do you think the mix can go on artificial disc, both on cervical and on lumbar over the next few years?

Alexis V. Lukianov

Well, we haven’t changed our position on that. I think we still believe that cervical can ramp up to be 40% of the fusion market, but we also believe that it can expand that market by no less than 10%. So we think that, especially with a product like NeoDisc that has the potential to be used earlier in the disease process, earlier intervention that also has the opportunity to expand the market and PDRs do as well.

On the lumbar side, I think it’s going to take a lateral approach like ours, which gets you moving quickly and I can attest to that, that I was walking around the hospital the next day exactly like Sven or whoever that was in our photograph from our road show that we talked about. But I was walking around the same way.

And I think that once you are able to come in with a lateral approach, it really does change everything. And so, I don’t know that it moves to be a huge number. I think it still keeps it in the probably 20% range. So I don’t think it’s a huge game changer, but I think that it has that potential.

Operator

Our next question is from Matt Miksic - Morgan Stanley.

Matt Miksic - Morgan Stanley

You talked about this on the bottom line guidance for the year, there is about $0.02 of lower interest yield. I just wanted to quantify that to make sure I am looking at this the right way, is that just in the neighborhood of $1 million relative to the last guidance that you gave for interest expense?

Kevin C. O’Boyle

There is two factors as it relates to the earnings per share guidance. One is, that certainly would have been the increase in the earnings per share guidance based on the increase in the revenues and offsetting that is certainly the yield difference in our invested cash. So when you combine both of those, you wind up $0.02 less than our original guidance. So the interest expense yield issue is more like $0.08 and not $0.02.

Matt Miksic - Morgan Stanley

So that is more like $3 million or maybe between $3 to $4 million?

Kevin C. O’Boyle

No, I think it’s a little less than $3 million.

Matt Miksic - Morgan Stanley

I wanted to just check the number that you are working towards on NeoDisc, greater than 85%s where is that, 425 range out of 500 patients?

Alexis V. Lukianov

Yes, approximately.

Matt Miksic - Morgan Stanley

Have you ever quantified or are you willing to give us a round number as to what that’s costing you per quarter?

Kevin C. O’Boyle

No, we haven’t.

Alexis V. Lukianov

We haven’t talked about it per quarter. I think we talked about some annual estimates early on.

Kevin C. O’Boyle

We talked about, I think it was in ‘07, we talked about NeoDisc being about $3 to $4 million a year, so $1, $1.25 million, something like that a quarter, somewhere in there.

Matt Miksic - Morgan Stanley

On the expense side, did you say $9 million of SAP expense in the quarter?

Kevin C. O’Boyle

No, as it related to the cash burn for the quarter, there were other things other than what we would call traditional operating the business type expenditures and that was effectively leasehold improvements and ERP principally and when you add that up, you get to an additional $9 million of burn. That’s right, so it was originally $15.6 million burn for the quarter, of which $9 million can be attributable to our new leasehold improvements and the ERP system.

Matt Miksic - Morgan Stanley

SAP, is that going to be a steady cost throughout the year as well as or is that going to trail off in the latter part?

Kevin C. O’Boyle

No, we expect to go live this summer, so those costs will discontinue at that point, because the investment into the ERP system will have been completed. And therefore, we turn the system live and here we go. So then it’s an amortization effect of the capitalized costs then.

Matt Miksic - Morgan Stanley

I also just wanted to ask a couple of product-related questions in terms of what the uptake is or your mix, some of these products in your procedures. You made an investment in SpheRx, you are talking about a pedicle screw system for next year based on this ball and rod technology, and these other technologies that you have licensed. Can you give us just a sense of at this point, what percentage of the cases that you do in lumbar are you using SpheRx? Or are you using your own pedicle screw systems at this point?

Alexis V. Lukianov

Well, I think as far as using our own pedicle screw system, it’s pretty much in every case. I think that changed with SpheRx II when that was launched last year and also with DBR II. I don’t know what the exact percentage is. We know that MAS is about 85% of our revenue, the balance being made up by cervical and biologics. So, I couldn’t tell you the exact break down. But it’s a pretty fair contribution to that total piece of MAS.

Matt Miksic - Morgan Stanley

Also just a similar question along the lateral plate, you obviously got one, or did you, Alex?

Alexis V. Lukianov

Did not get a lateral plate.

Matt Miksic - Morgan Stanley

You got SpheRx, but no lateral plate.

Alexis V. Lukianov

I had posterior screws as well.

Matt Miksic - Morgan Stanley

What’s the utilization of that defined? I know it was a question early on, how many docs are going to adopt that, what you do you see in there?

Alexis V. Lukianov

It’s pretty much what we talked about before. It’s been about 25%, 30%.

Matt Miksic - Morgan Stanley

And those folks would typically not get posterior stabilization, right?

Alexis V. Lukianov

A combination, some either were standalone or some moved away from posterior, and a lot of it really depends on the patient. For example, for me, being a big guy, I think the surgeons could have done my procedure with the lateral plate. But the surgeons felt like, just because of my general size and size of my bones, better off doing posterior fixation, not because of XLP didn’t work or wouldn’t work.

So you have to look at it only case-by-case basis of what makes the most sense. But I think we’ve got it covered in either situation.

Matt Miksic - Morgan Stanley

I was hoping you can maybe give us a snapshot today versus a year ago in terms of in the lumbar area, what’s your average levels per case? If you can give us some sense, I know you are doing more with SpheRx II, I think you’re doing more, any color there?

Alexis V. Lukianov

We don’t measure that.

Matt Miksic - Morgan Stanley

So you don’t have any visibility there?

Alexis V. Lukianov

We don’t measure that. It’s a next to impossible number for us to get per case because we just don’t have access to that data from the hospital.

Matt Miksic - Morgan Stanley

On the acquisition that you made of SpheRx, you are buying out the licensing and this additional technology. Kevin, is there anything you can tell us about the effect that’s going to have on gross margins going forward, will we see any effect on gross margins?

Kevin C. O’Boyle

No, that should be consistent with our corporate average. It won’t have any negative effect on our gross margins.

Operator

Our next question is from Ed Shenkan - Needham.

Ed Shenkan - Needham

As far as modeling goes for SG&A, should we expect it to increase as a total dollar spend each quarter throughout the rest of this year?

Kevin C. O’Boyle

As the revenues rise, so that you are just even looking at the sales costs of what it takes to sell a million dollars worth of products, so that naturally in dollars will certainly increase every quarter. It better. So, that’s certainly it. And then we will also have additional infrastructure costs for our second phase of our move in the third quarter. And then the ERP system will be turned on and effectively for accounting purposes in the third quarter.

However, having said that, we are getting synergies out of a number of our expense line items that will allow us to deliver GAAP profitability, excluding the one-time charges. So we still feel very comfortable about that, but those are some of the dynamics going on within sales, marketing and administrative.

Ed Shenkan - Needham

And do you still expect to complete enrollment for NeoDisc in the first half of ‘08? And if so, should we expect a sharp drop off in the third and fourth quarter as far as R&D spend?

Alexis V. Lukianov

We certainly expect to be completed this summer as we have talked about before. And as I mentioned over the course of my prepared remarks, we are hopeful to be able to have additional IDEs ready to go. And as those are depending upon when they clear, then we will be looking to start new studies. So we do not have visibility as to exactly when that would be. As soon as we have that, we will report it.

Ed Shenkan - Needham

And the inpatient CMS rates came out recently. Were there any surprises there, and what was of interest to you that you noticed?

Alexis V. Lukianov

No, essentially pretty much what we expected.

Ed Shenkan - Needham

And the spine market as far as growth, any changes that you are seeing macro? And then as far as revenue per case, if you could just tell us, are you in the $13,000 to $15,000 per case and does it continue to rise?

Alexis V. Lukianov

Well, we see a very robust spine market. I think it’s always hard to say how much of that is coming from other players, because we are able to take share. But we still believe that it’s somewhere in the 12% to 15% range and we know that we are getting our fair share of the larger procedure. We don’t measure things out on a per level basis, but we do know that we are getting a lot more one and two level cases overall.

Operator

Our next question comes from Michael Matson - Wachovia Capital Markets.

Michael Matson - Wachovia Capital Markets

Can you tell us what percentage of your sales came from international sales?

Alexis V. Lukianov

Yes. Actually, we talked about that, 3%.

Michael Matson - Wachovia Capital Markets

With regards to your comments on acquisitions, can you give us your thoughts on the vertebral compression fracture market? Is that something maybe you would possibly be interested in?

Alexis V. Lukianov

Yes.

Michael Matson - Wachovia Capital Markets

When you initiate your other clinical trials for the XLTDR and the Cerpass, are you going to have both of those trials running simultaneously, and what’s the impact of that going to be on your R&D? Is that going to drive some meaningful expansion in R&D expense?

Alexis V. Lukianov

Yes, those are things that we are going to have to evaluate once we get to that point. We honestly just can’t give you a straight answer on that right now. It really just depends on the scope of the study, and how we are able to negotiate that with the FDA. So, we will know that as soon the IDEs are cleared.

Michael Matson - Wachovia Capital Markets

With regards to the convertible debt, at what point would that start to hit your share count on a GAAP basis?

Kevin C. O’Boyle

That probably won’t be until well into 2009 because it’s a converted accounting method, and it’s a protracted calculation. But in looking at it from our perspective, that’s probably a mid ’09 and second half of ‘09 when that would be added.

Michael Matson - Wachovia Capital Markets

Is that triggered at a certain stock price based on the conversion price or something like that?

Kevin C. O’Boyle

With the stock price of effectively $49.13 which is the premium to the convert, at that point the holders would have the opportunity to effectively convert to an equity position.

From an accounting standpoint, you can convert those shares based on taking your GAAP net income, adding back the interest that’s effectively attributable to those debt instruments. And if it gets you into a profitable situation, you would then add the outstanding shares to the number.

So there are two events that could trigger that. We don’t really anticipate that really hitting until ‘09.

Operator

Your next question comes from John Putnam - Dawson James Securities.

John Putnam - Dawson James Securities

I wondered, Alex, if you might comment on how you are going about the training of surgeons in the international market and what challenge that presents to you?

Alexis V. Lukianov

We’re doing it with the same standards that we’ve trained surgeons in the U.S., doing it slowly and progressively. So we are using key centers in Europe. We have just a small number that we’ve utilized and of course, we’ve brought over some of the key surgeons to the U.S. So as we talked about, we’re looking for a relatively slow rollout. We want to make sure that we gain some steady adoption with key users and then from there, we’ll ramp it up more in ‘09 and ‘10.

John Putnam - Dawson James Securities

Are you actually doing it though in hospitals over there as opposed to your own training facility here in the U.S?

Alexis V. Lukianov

In terms of training?

John Putnam - Dawson James Securities

Right.

Alexis V. Lukianov

Well, we are actually excellent procedures over there, in Germany and in Greece and starting in the U.K. as well. So we’re using cadaver lab facilities over there, just similar to the ones that you can lease on a daily basis, if you’d like in the U.S.

John Putnam - Dawson James Securities

I know you want to grow your sales force 10% to 15%. At the end of the year, roughly how may people would that comprise?

Alexis V. Lukianov

I think it pushes us somewhere in the neighborhood of around 270, 260. I think that’s right. I think it’s 270. 275 is just a round number, it is about what we are looking for. I am not sure what the exact percentage is, but tentative, 15% approximately.

John Putnam - Dawson James Securities

But roughly 20% more than where you are right now?

Alexis V. Lukianov

Yes, that’s right. It’s about 40% on the year, so I don’t know, I wasn’t doing the math per se but yes.

John Putnam - Dawson James Securities

You talked last quarter about introducing 10 new products this year. Are you pretty much on schedule to being able to do that or -?

Alexis V. Lukianov

We are. And there’s the cervical we talked about and we have got several things coming in terms of CoRoent and next generation NeuroVision, XLIF revisions. So there’s still quite a few products still to launch.

Operator

Your next question is from Joanne Wuensch - BMO.

Joanne Wuensch - BMO

Just to clarify, you did not hire any new sales people this quarter?

Kevin C. O’Boyle

No, we did, we went from 230 at the end of last year to, Joanne, 255 at the end of Q1.

Joanne Wuensch - BMO

And how do we think about them ramping in revenue in terms of average sales per rep? I can take your total revenue and divide it by 255, but I don’t think it’s that easy.

Alexis V. Lukianov

It takes twelve to 18 months as we’ve, I think, discussed in prior conferences for a sales rep to be fully efficient and that means that it gets them up to our target of over $1 million in revenues. So that’s where we want to get our reps, those that are extremely proficient like we talked about in the West and in the Southeast that knocked it out of park in the first quarter, are doing well over $1 million.

Joanne Wuensch - BMO

You talked about targeting to select international markets. How do you think about which markets are you are going to aim for and what are the steps to entering these markets?

Alexis V. Lukianov

It’s based upon the population and based upon the overall predisposition of the surgeon base to new technologies. So we have found that the German-speaking and the English-speaking countries have largely been the most receptive in Europe. Certainly not to say that the others are not, but based on population, obviously Germany is certainly the biggest market in Europe and so we’ve been most focused on that area.

Greece has been a surprisingly terrific contributor for us in terms of OUS and it entails CE marking and so we’ve gone through that process of course and so that has been completed now for some time.

Joanne Wuensch - BMO

And what about Japan?

Alexis V. Lukianov

We have to go through a registration process and so we’ve been working through various registration processes for the Far East countries and working towards distribution in Australia as well as New Zealand.

Joanne Wuensch - BMO

And when might you be in those markets?

Alexis V. Lukianov

It won’t be this year for Japan. Australia and New Zealand, we have an opportunity for later in 2008 to begin or start in those markets.

Joanne Wuensch - BMO

Should we think of Japan as an ‘09 or a 2010?

Alexis V. Lukianov

It’s probably a couple of years off.

Operator

Our next question is from Mike Baron - [Silverback].

Mike Baron – [Silverback]

In your guidance do you still target being cash flow positive in the second half of the year?

Alexis V. Lukianov

Yes.

Operator

Our next question is from Matt Miksic - Morgan Stanley.

Matt Miksic - Morgan Stanley

There was one more on your progress with Formagraft, you talked about it being 5%. We were looking for $2 million in the quarter, in that neighborhood, $2 to $2.5 million, is that the run rate? And going forward, is that the run rate you expect to see for the rest of the year?

Alexis V. Lukianov

We are looking for Formagraft is about $10 million is what we talked about and that’s about the contribution level that we expect for this year. It may be a little bit higher, but that’s about right.

Operator

We have another follow up from Michael Matson - Wachovia Capital Markets.

Michael Matson - Wachovia Capital Markets

On the convertible with regards to the possible accounting changes, can you give us thoughts on that? I guess there is possibly going to be a change that would require companies to graphically financial statements for convertible debt. Do you think that’s going to happen and what would the potential impact of that be?

Kevin C. O’Boyle

I don’t know if I could necessarily speak to that. I could tell you as part of our due diligence in this process in utilizing Ernst and Young as our outside accountants and certainly using the banks that were involved in this to come up collectively with how we are handling that is certainly appropriate and current. So future potential accounting rule changes and so on, I can’t really speak to that.

Operator

There are no further questions at this time.

Alexis V. Lukianov

We will talk to you in another quarter. Thank you so much.

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