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Edited Transcript of ATEC earnings conference call or presentation 9-May-19 8:30pm GMT

Q1 2019 Alphatec Holdings Inc Earnings Call

CARLSBAD May 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Alphatec Holdings Inc earnings conference call or presentation Thursday, May 9, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeffrey G. Black

Alphatec Holdings, Inc. - Executive VP & CFO

* Patrick S. Miles

Alphatec Holdings, Inc. - Executive Chairman, CEO & President

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Conference Call Participants

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* Brooks Gregory O'Neil

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

* Scott Gambill

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Presentation

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Operator [1]

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Good afternoon, everyone, and welcome to Alphatec's First Quarter 2019 Conference Call. We would like to remind everyone that participants on the call will make forward-looking statements. These statements are based on current expectations and are subject to uncertainties that could cause actual results to differ materially. These uncertainties are detailed in documents filed regularly with the SEC.

During this call, you may hear the company refer to reported amounts, which are in accordance with U.S. GAAP as well as non-GAAP or pro forma measures. Reconciliations of non-GAAP measures to U.S. GAAP can be found in the supplemental financial tables included in the press release, which identify and quantify all excluded items and provide management's views of why this information is useful to investors.

Joining us on the call today will be ATEC's Chairman and CEO, Pat Miles; and CFO, Jeff Black. Now I will turn the call over to Pat Miles.

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Patrick S. Miles, Alphatec Holdings, Inc. - Executive Chairman, CEO & President [2]

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Thank you very much. We're going to stick with a presentation format as we did last time. And when we presented last, we talked a lot about a strategic pivot. And so if you look at the slide that's headed strategic -- Our Strategic Pivot, what we said we needed to build a company in double-digit growth is really an organic innovation machine. And so we felt like that was the right approach, and there's really a historical basis for it.

If you look at the graph on the right, and you look at those companies who have grown in double digits, literally, the thing that they have in common is they're focused on spine. They developed products organically, so in-house, and really, they have focused selling entities.

And so those are really the historical basis that reflected double-digit growth, and we thought, gosh, if we're going to pivot the company, there's really a sound reason to do that.

And so if you go to the next slide, really, what we believe to be the key efforts is really to do 3 things. And it's to create clinical distinction, it's to revitalize the sales channel and then really compel surgeon adoption. Really, all of these feed one another in terms of creating results.

And so I would like to delve in a little bit with regard -- on the next slide, of the scorecard of result. And so really reviewing our progress on the goals regarding creating clinical distinction, we grew -- we have 22% of our revenue that's from new products. And so that would reflect progress against our 2019 outlook with regard to the volume of sales from new products, kind of a vitality index. The other really clear thing is not only can we get our SafeOp platform cleared, but also can we initiate alpha evaluations and make sure what we invested in is reflective of what we're getting and building.

And then thirdly, can we release a cadence of products quarter-to-quarter that ultimately is going to account for our 12 annual product launches. And so I'm happy to report that we've really fulfilled the obligation on each of those with really good progress.

If you go to the next slide, and you start to look more deeply into what's creating clinical distinction really mean? And in our mind, as we understand the requirements for surgery, very clearly, surgeons yearn for realtime objective, actionable information. And so when you're creating influence in the operating room, you want to make sure that you have information that drives predictability. And so I think taking a look at lateral surgery and really appreciating the fact that really nobody has effectively competed in lateral surgery outside of the company that created it.

And they built it purely on automated EMGs. Really what we're doing is, we're creating greater sophistication in that approach with not only automated EMGs, but automated SSEPs. And so we've had really excellent progress in integrating the technology, not only in lateral surgery, but in other applications. And so that's going as planned and really excited about the type of contribution that, that, clinically is going to make in our portfolio of products. And so we've been affirming the performance through a collaboration of key surgeons, and look forward to the commercial release in sometime Q3 2019. So I'd say that's exceedingly exciting.

So additionally, on the next slide, in addition to the focus on SafeOp, we also launched 3 new products. And 2 of which are on the IdentiTi family. And so you'll hear us talk a lot about our approaches. And so what we've done is we've launched a product in anterior cervical discectomy and fusion, which is an anterior or front of the cervical spine approach, and then from a posterior approach.

And what makes the launches exciting is, really titanium has become rogue in spine surgery. There's a density in the porous titanium that both enhances imaging and is similarly stiff to host bone. And so we believe that from an imaging perspective and from a performance perspective, it's a very predictable product. Additionally, it’s made via subtractive manufacturing. And everybody's talking about additive or 3D printing these days. And I think surgeons care less about how something is made and does it reflect the requirements of a predictable patient outcome, and so our focus really has been on what is the feature set that ultimately drives predictability, and I think that we got it in both the IdentiTi ACDF products as well as the IdentiTi PLIF product.

Additionally, ATEC has really kind of gone away from a robust biologic portfolio of products, and when we talk about growing our revenue line, one of the things that is a key element to a spine procedure is spine approach is a biologic. And so we've launched our AlphaGRAFT DBM fiber that integrates into all the ATEC approaches, enhances our ability to create convoyed sales. And what it is ultimately is a DBM product with interconnected fibers that really provide a maximum number of growth factors.

And so it also handles very well, and what we've found is the capacity to assemble all of these products in a surgery creates a very good spine approach. And so if you look at the next page, and you look at our progress report on our 12 approach-based product launches, we're making great progress. And so as we look throughout the year, more of those will be green, and that we will launch more of them. But we're 3 for 12 on our way for -- on our way to 12 for 12 for the year. But this is really just a reminder that we think of the world in spine approaches and we architect approaches with products.

And so going on to the next scorecard on revitalizing the sales channel. And so creating clinical distinction really enables attracting the right sales people And so we're in the midst of really professionalizing our sales channel. And the first way you do that is get the right leader in. And so just thrilled to death to have Dave Sponsel with really a lot of Stryker, Stryker Spine and also had a small company experience with Medacta, but thrilled to death to have him leading the charge.

And so when you start to say, are we having an effect on revitalizing the sales channel, and you look at the top 20 distributors, really -- about 50% of our -- 50% revenue growth in our top 20 distributors versus the previous year. So I would suggest that we're having an effect.

Additionally, a 30% increase in the revenue per distributor, and when we talked last, we talked about how do we decrease the volume of distributors, but increase the revenue volume per distributor? And so I think we're seeing that. Now when you look overall, and you say "Gosh, is the strategic group of salespeople having an effect?" And really 84% of our sales are contribution from the strategic network versus 72% last year.

So when we start to say, "Gosh, our goal is approximately 30% growth from our strategic network." You could say, "Gosh, these guys are on track for doing what they said they would do on that front."

And so to delve a little bit more deeply in there, when you professionalize our channel, so much of it is about creating confidence. And really kind of earning our route to exclusivity in a sales force. And so by doing the type of new product development, doing the -- creating the type of clinical distinction, our capacity to attract strategic partners is significantly higher.

And additionally, as we start to wind down or divest the non-strategic relationships, this is where we want to be careful with regard to, we've seen a lot of success in the first quarter, but we want to make sure that we're also being thoughtful with regard to the bumpiness that may ensue from some of the nonstrategic departures.

And so -- if you go to the next slide and you start thinking about compelling surgeon adoption, the focus around compelling surgeon adoption is also moving in a direction that we are excited about. And so literally greater than 100% revenue growth from the top 20 surgeons. And what that means is we're dealing with surgeons that do more surgery, and surgeons that do more complex surgery. And so it's a favorable demographic of the type of complexity and type of sophistication that we're dealing with.

Additionally, there is a ton of enthusiasm to come in and understand what the undercurrent of interest is in the new ATEC. And that's -- there's 38% growth in the surgeons hosted at our home office in the first quarter. Additionally, a 13% increase in the revenue per case. And I think that speaks to the complexity again and the more products per procedure.

And we talked a little bit about convoyed sales last time we talked. And it's key that what you start to see is this number continuing to inch up, so 1.4 products per case in Q1. And so we talked about, "Gosh, if we do the same number of surgical volume, an increase in number of products and surgery, you get to see a growth reflection in that."

And so as we look really at the -- take a step back and look at really the overwriting picture, the great part is we grew top line sales 20%. We grew average daily sales 21%. This is our second consecutive quarter of double-digit growth. And then lastly, the ability to continue the runway with a $30 million expanded credit facility is value because what we're finding is the more time that we have to continue to reflect the experience, the better off we are.

And so I would say that at the bottom line, we are on target. And we're doing what we said that we would do, and it feels like the cadence is pretty consistent.

So with that, I'm going to turn it over to Jeff Black, our CFO.

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Jeffrey G. Black, Alphatec Holdings, Inc. - Executive VP & CFO [3]

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Thank you, Pat, and good afternoon, everybody. I just want to spend a few minutes on 4 points. A little bit of a deeper dive commentary into revenue, address gross margin, some P&L operating expense highlights, and then wrap up with commentary on balance sheet.

So in terms of revenue, we continue to focus on building our strategic distribution channel, as Pat mentioned. We began to see a delivered result from the fourth quarter of last year, and we continued to see that performance in the first quarter. We saw about 40% year-over-year growth from strategic distribution in Q1. And this is happening before we see the full benefits of our new product launches. At the same time, we also saw revenue as expected from legacy distribution continue to wind down as part of our planned transition. This headwind will continue in 2019, as we saw about 16% of our U.S. revenue coming from what we consider more unpredictable or unsustainable sources of revenue.

We also saw revenue from international supply agreement decrease over Q1 of last year, which is consistent with what we expected. The bottom line is our Q1 revenue results are in line with expectations. We're especially encouraged by the performance of our strategic distribution channel. But we're cognizant of the unpredictable nature of our legacy channels.

Revenue guidance for 2019 remains at $94 million to $98 million in U.S. product revenue for the year and total revenue of $98 million to $103 million. On the gross margin, when you see the gross margin, year-over-year has decreased by about 550 basis points, just over 71% as compared to last year, but consistent with our fourth quarter gross margin of 72%. As we mentioned in our fourth quarter call, we saw margin pressure from noncash obsolescence charges. This relates to our legacy products as we prepared for new product introductions. We'll expect to see some continued margin pressure over the midterm, as we introduce new products and obsolete our legacy products. But at scale, we continue to believe and expect that our gross margin will be in line with our peers in the mid-70% range.

In terms of operating expenses, the operating expenses that we're presenting here on a non-GAAP basis may reflect what we consider to be more normalized R&D and SG&A. They exclude noncash stock-based compensation, litigation-related expenses, restructuring, other nonrecurring or one-time charges or gains.

When you look at the R&D line, R&D expense increased in both absolute dollars and as a percentage of revenue compared to last year. And this reflects our continued investment to support new product launches and longer-term product development.

SG&A had also increased in absolute dollars and as a percentage of revenue in the first quarter. We held the line on G&A, but we are making incremental investments in our sales channel in the form of both variable compensation and direct personnel as well as investments in product marketing.

We'll continue to invest in the sales channel in 2019. And we should start to see expense leverage in 2020 on the heels of our planned 2019 product launches.

Just wrapping up with the balance sheet. We ended the year with just under 16 -- I'm sorry, ended the quarter with just under $16.5 million in cash. We've not yet drawn down on the $30 million Squadron expanded facility. So with that, cash available to us, we have just under $46.5 million available to us as of Q1 to continue to fund the business.

Our operating cash burn decreased compared to the fourth quarter of last year. While we're continuing to hold the line on operating cash use, we do expect 2019 to be an investment year. As we continue to support new product launches with CapEx, for new -- with new instrument sets and implant sets and continue to expand our strategic distribution channels.

The refinance of our Globus debt back in November with Squadron Capital, it's enabled us to push out term debt amortization to mid-2021, and enable us to invest those cash resources back into the business. And as we mentioned in our last call, we now have the runway we need to begin building long-term value. We no longer have immediate needs to finance the company. The Squadron facility gives us the runway for the next several quarters to execute the business, which will us plenty of time to demonstrate the performance of the portfolio, and to drive real value.

So I think in summary, ATEC is positioned better than we have been in several years to approach longer term financing solutions, both strategically and opportunistically.

And with that, I'll turn the call back over to Pat for closing comments.

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Patrick S. Miles, Alphatec Holdings, Inc. - Executive Chairman, CEO & President [4]

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Thank you, Jeff. So as I review Q1 of 2019, it's really consistent with what we described that we would do in terms of really creating stability for this company and creating a growth profile that we're all excited about. And so we're creating clinical distinction and increasing the vitality index of new products sold into surgery. We're professionalizing a sales channel that needed to evolve and that's going well and the metrics that we're going to look for in that is really more dollars per distributor, which is what will reflect success, and then compelling surgeon adoption and making sure that what we're doing is the whole approach technology, ATEC, how do we make for more products sold in to each individual surgery. And so if you look at what we're creating and what the strategic pivot is all about. It's really about an organic innovation machine. And really, it's set in motion. And so we're expediently learning, we're accelerating innovation, and really heading toward our initial milestone of creating a couple hundred million dollar company here in 2022.

And so I'd like to close, really, with the last slide, which -- we had a great, what we called a product launch meeting this past weekend. And if you look at the surgeon faculty at this, it would rival any spine meeting out there. And so to be able to have the company together, and it galvanizes to create, really, an organic innovation machine that ultimately is going to reflect the building of a growth company.

And so excited about the first quarter. I want to be thoughtful about exactly where we are and what we're going to do is keep doing the very things that we say we're doing, and create the confidence of our marketplace.

So anyway, with that, that will conclude the presentation. Happy to take any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Our first question comes from the line of Brooks O'Neil from Lake Street Capital Markets.

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Brooks Gregory O'Neil, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [2]

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Congratulations on the progress.

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Patrick S. Miles, Alphatec Holdings, Inc. - Executive Chairman, CEO & President [3]

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Thanks, Brooks.

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Brooks Gregory O'Neil, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [4]

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So I have a couple questions. I was hoping, perhaps, we can get any kind of a feel for the magnitude of the impact of the distributor changes or the impact of product obsolescence charges on the gross margin? Just so we can -- I mean, I don't necessarily want to add those back or anything. I just want to have a sense for how big an impact those had in the quarter, because I though the quarter numbers were darn good.

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Jeffrey G. Black, Alphatec Holdings, Inc. - Executive VP & CFO [5]

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Yes. Thank you, Brooks. I think that your question on gross margin, I mean, when you take a look at year-over-year comparison, it's around 380 basis points, in terms of impact of obsolescence year-over-year on margin. We'll continue to see pressure. I mean, I think, you can expect to continue to see us taking obsolescence charges, and right around at kind of that same level, as we start to sunset products and replace legacy products with new products.

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Brooks Gregory O'Neil, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [6]

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Yes. And thinking about the organic innovation machine. I really like that, personally. But obviously, R&D expense is up. Can you give us any sense for this increased investment? Do you think that's going to yield additional new products beyond the 12 this year or is that setting us up for another cadence similar magnitude in 2020?

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Patrick S. Miles, Alphatec Holdings, Inc. - Executive Chairman, CEO & President [7]

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Yes. Brooks, this is Pat. I think that literally we're building a foundation. And your -- I would hope that people are appreciative of the type of investment that we're making in product development because this is going to create a cadence of 8 to 10 a year into the long future. And so you can't do something once and not continue to obsolete yourself. There's a lot of people out in the marketplace that would love to obsolete you. And part of this -- part of the value of creating this machine is for us to continue to apply our learnings and continue to distinguish ourselves clinically in the marketplace. And so that will be what causes or creates the run.

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Brooks Gregory O'Neil, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [8]

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Cool. And then, I was just curious, Jeff, you obviously gave us a quick rundown on the balance sheet -- cash position. I know there are a lot of investors who think you don't have the money to kind of get this down the road of good measures, so that it's obvious to investors what's happening. But do you think the cash burn this quarter was consistent with your expectations? And where do you think, based on where you're at today and what you're seeing now and over the next few quarters, you think you can get with the cash availability you have now?

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Jeffrey G. Black, Alphatec Holdings, Inc. - Executive VP & CFO [9]

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Yes. Brooks, I think with one exception, absolutely consistent with what we expected. I think the one-time payment of $3.2 million for the SafeOp purchase price, paying down the convertible notes from a year ago. There was some speculation that we may be able to convert those into equity based upon the terms, but the share price was not cooperative. So we did have to settle those in cash. But I think on a normalized basis, I think absolutely consistent with our expectation, I think you need to think about this 2019 year as a continued investment year. We see the Squadron facility and that available cash as a runway to continue to fund the initiatives we need to fund for the next several quarters, and really position us at a point where we can be very -- more opportunistic and strategic about longer-term financing.

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Brooks Gregory O'Neil, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [10]

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Yes. That's good. And then just lastly, I guess, $2.7 million of litigation expense, a big jump year-over-year. Just give us a quick highlight for where you're at with that, and whether you think it's going to continue at that level, accelerate whatever and sort of what the outlook is for the litigation right now?

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Patrick S. Miles, Alphatec Holdings, Inc. - Executive Chairman, CEO & President [11]

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Yes, Brooks. I would jump on that. I would tell you that nobody loves litigation expense. But I would tell you that this is a very aggressive environment. And the expense is going toward defending ourselves. And so my expectation is that we're creating ripples and that's why people love to sue us. And so I expect these to go down and we've had a stay and so expectations are that they'll go down in the next quarter. But I don't think you ever made great progress and become a disruptive company without a little bit of fighting going on. And so, believe you, me, the last thing we'll do during the day is deal with litigation. We do it after 5 because our business is spine surgery. And what we want to do is win in the marketplace. So -- but we'll continue to go down, and we have no interest in perpetuating fights.

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Operator [12]

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

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Scott Gambill, [13]

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I just had a couple of questions. The first was that, over the last couple of years, you've kind of identified the dedicated distributors as a percentage of your whole distributor network. I didn't see that in the earnings release. So is there something changed there you're just not going to break that out anymore? Or is that going to be replaced by the strategic distribution network? What was going on there?

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Patrick S. Miles, Alphatec Holdings, Inc. - Executive Chairman, CEO & President [14]

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Yes. Part of the challenge with all of this becomes the definition of what a dedicated person is and what a strategic person is. And we thought it was more accurate to take a look at those people with whom we want to walk forward with. And so it may not be that they're contracted today as someone who is completely committed to us. It's somebody that we believe that ultimately can be earned into exclusivity. And so I think, kind of the last kind of standard that we've set was dedicated, and I think it's a weak standard. I think our interest is to earn people into exclusivity. And so what we see strategic as is the walk toward exclusivity. I can give you a dissertation, which will bore you to death with regard to what the big companies have done well and what the small companies have not done well. And the small companies have not earned their way to exclusivity.

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Scott Gambill, [15]

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Okay. So in the future, you think the strategic distributor network is going to be the primary metric you'll present, and then somewhere behind that will be ones that are moving towards dedicated, they'll earn their way? Is that -- I understand that correctly?

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Patrick S. Miles, Alphatec Holdings, Inc. - Executive Chairman, CEO & President [16]

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Yes.

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Scott Gambill, [17]

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And then we will not be describing them, instead of created in the future? Or...

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Patrick S. Miles, Alphatec Holdings, Inc. - Executive Chairman, CEO & President [18]

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Yes. So think of it like this. If somebody is strategic, we believe that we're walking together toward exclusivity. And exclusivity is related to -- is the product portfolio large and broad enough to ultimately earn our way to being their only line every day. And so this is a walk that's going to take a couple of years. And so what we want to do is say, gosh, are the people, who are what we call "strategic" are they walking with us until we believe we could get them to exclusive. And so that's the nomenclature. We're going to rid ourselves of dedicated, just because I think it creates fogginess in terms of how we're walking there.

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Scott Gambill, [19]

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Okay. The other question I have regards SafeOp. I believe, if I remember correctly, it was in the fourth quarter, the plan was to receive the FDA approval, do a 3-month soft launch, and then go at the market. Since the approval didn't happen until late February, is it still kind of the plan to run 3 months of soft launch? Or is there -- have you been able to get some of that soft launch even before approval? I'm just all confused about that.

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Patrick S. Miles, Alphatec Holdings, Inc. - Executive Chairman, CEO & President [20]

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Yes. Yes. Not, it's the right question because it's the -- it's one of the great distinguishers in our portfolio of goods. And so it is exactly as you say. We're going to be highly diligent with regard to making sure that it's behaving in the very way we expect. And so that soft launch is going on now and it's going very, very well. And so what we, in essence, are guiding toward is, it will launch in Q3 of this year, and we're doing all the proper work to make sure that it is -- walks out.

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Scott Gambill, [21]

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Okay. I guess the only other thought on the SafeOp, and I think it's just way to soon, but I'd like to understand the long-range applications for that tool. So you guys are going to focus on spine in the near term, but is it right to think about this as something that can be used with other surgeries in the future that are non-spine, where there's a risk of nerve compression? Or is...

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Patrick S. Miles, Alphatec Holdings, Inc. - Executive Chairman, CEO & President [22]

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So the -- we have such a runway in spine. There is so much opportunity that is just staring us in the face. I'm going to drive the focus of our company to spine only. If there presents an opportunity to do something else, but outside of spine with some partner at some point in the future, we would evaluate that. But for the next foreseeable future, we will concentrate on the behemoth, which is spine, because there is just so much opportunity up and down in the cervical spine, in the thoracic spine, and in the lumber spine with regard to this technology. And so we will keep focused on that.

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Scott Gambill, [23]

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On your website, since you're launching so many new products, I've had a little bit of trouble with the -- being able to see them. Are you guys going to have a little bit more information on some of these products as we go forward? Or does it actually work against you to be too revealing about their -- what their features are?

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Patrick S. Miles, Alphatec Holdings, Inc. - Executive Chairman, CEO & President [24]

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No. We will absolutely have more information on the products as we continue to go forward. And it's -- there's a lot to do in this company in terms of evolving it into the machine that we want. And some of the flashes is slower than the substance of the work, and so we will actually have updates and more product reflection on the website.

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Operator [25]

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(Operator Instructions) You have no further questions at this time. I will turn the call over to -- back to Pat Miles for his closing comments.

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Patrick S. Miles, Alphatec Holdings, Inc. - Executive Chairman, CEO & President [26]

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Just a stay the course and a quick note of thanks to those of you who are on the line, and appreciate the continued support. We have a great run in front of us and excited about the new ATEC. Thanks much.

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Operator [27]

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Ladies and gentlemen, thank you for joining us. This concludes today's conference call. You may now disconnect.